UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 MARKET RISK ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, April 2, 2015
 2

 1 PARTICIPANTS:

 2 Panel 1: Default Management at CCPs:

 3 Moderator:

 4 THOMAS KLOET

 Elmhurst College

 5

 Key Speakers:

 6

 SUNIL CUTINHO

 7 CME Group

 8 DENNIS McLAUGHLIN

 LCH.Clearnet

 9

 IAN SPRINGLE

 10 ICE Clear Credit

 11 SCOTT L. FLOOD

 Citi's Institutional Client Group

 12

 SUSAN McLAUGHLIN

 13 Federal Reserve Bank of New York

 14 EMILY PORTNEY

 JP Morgan

 15

 MICHAEL MODLOCK

 16 TriOptima

 17

 18 Panel 2: Market's Response to the Introduction of

 SEFs:

 19

 Moderator:

 20

 ANDREW LO MIT

 21 Lab for Financial Engineering

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 Key Speakers:

 3 DARCY BRADBURY

 D.E. Shaw Group

 4

 RANA CHAMMAA

 5 UBS Investment Bank

 6 MICHAEL O'BRIEN

 Eaton Vance Management

 7

 Other Participants:

 8

 ANAT ADMATI

 9 Better Markets

 10 ROBERT ANDERSON

 Committee of Chief Risk Officers

 11

 STEPHEN BERGER

 12 Citadel

 13 DAVID BURLAGE

 CoBank

 14

 KARA DUTTA

 15 ICE Clear Credit

 16 DOUGLAS FRIEDMAN

 Tradeweb

 17

 ANDREW GRAY

 18 DTCC

 19 BILL HALE

 Cargill

 20

 MICHAEL HENNESSY

 21 Federal Home Loan Banks

 22
 4

 1 PARTICIPANTS (CONT'D):

 2 NATHAN JENNER

 Bloomberg SEF LLC

 3

 JERRY JESKE

 4 Commodity Markets Council

 5 SEBASTIAAN KOELING

 Futures Industry Association, Principal

 6 Traders Group

 7 ADA LEE

 LCH.Clearnet

 8

 CLIFFORD M. LEWIS

 9 Eurex Clearing

 10 GLEN MACKEY

 NRG Energy

 11

 RICHARD MILLER

 12 Prudential Global Funding

 13 SUSAN MILLIGAN

 LCH.Clearnet

 14

 JOHN NIXON

 15 Americas for ICAP

 16 SUSAN O'FLYNN

 Morgan Stanley

 17

 ANGELA PATEL

 18 Putnam Investments

 19 EDWARD PLA

 Futures Industry Association

 20

 MICHAEL PROKOP

 21 Deloitte

 22
 5

 1 PARTICIPANTS (CONT'D):

 2 MARCUS STANLEY

 Americans for Financial Reform

 3

 KRISTEN WALTERS

 4 BlackRock

 5 RANA YARED

 Goldman

 6

 LUKE ZUBROD

 7 Chatham Financial

 8

 9 * * * * *

 10

 11

 12

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22
 6

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

 2 (10:10 a.m.)

 3 MS. BOWEN: Good morning, everyone, and

 4 welcome to the inaugural meeting of the Market

 5 Risk Advisory Committee of which I serve as

 6 sponsor. I'm pleased to be joined here today by

 7 Chairman Massad and our fellow commissioners, Mark

 8 Wetjen and Chris Giancarlo.

 9 Before discussing today's meeting, I

 10 will turn the podium over to the chairman and the

 11 other commissioners to see if they have comments

 12 for us.

 13 Thank you, Sharon. Let me first just welcome all

 14 of you, both the members of the committee as well

 15 as the members of the public who are here. I want

 16 to thank all the members of the committee for

 17 agreeing to serve. It's very, very helpful to us.

 18 And I want to thank Commissioner Bowen for her

 19 work in putting this together, not just obviously

 20 this meeting, but this committee. This is a new

 21 committee for us, a very important committee, and

 22 she's done a terrific job over a very short period
 7

 1 of time in putting together I think a great

 2 collection of people and a great agenda for today.

 3 I want to thank her staff who I know has worked

 4 very, very hard on this effort, as well as the

 5 rest of our staff in putting this together.

 6 These advisory committees are very

 7 important. Our style here is that each of us as a

 8 commissioner is the sponsor of one of the

 9 committees, and they are a very important way for

 10 us to get input. And by input I mean not simply

 11 comments that people make. We get comment letters

 12 obviously on all of our pending rules and so

 13 forth. But the advantage of meetings like this is

 14 that there can be a discussion, there can be an

 15 exchange of ideas, and that's very, very valuable

 16 to us. We all and our staffs go back and look at

 17 the transcripts from these meetings also as we

 18 think about issues.

 19 And the issues today that we're talking

 20 about are obviously extremely important. CCP

 21 resilience, stability, what happens in a default,

 22 are issues that have received a lot of attention
 8

 1 lately. We had a roundtable as many of you know.

 2 Some of you participated in CCP recovery issues,

 3 kind of a different set of that broader range of

 4 issues concerning CCPs than the specific issues

 5 we're going to talk about today. But this is

 6 obviously going to be a set of issues that will

 7 and should receive a lot of attention going

 8 forward. And the second panel on SEFs and how the

 9 market is reacting to SEFs is equally important.

 10 So, again, I just want to thank all of

 11 you, thank Sharon, and I look forward to today's

 12 discussion. And with that, I'll turn things over

 13 to Commissioner Wetjen.

 14 MR. WETJEN: Thank you, Mr. Chairman,

 15 and thank you, Commissioner Bowen, for convening

 16 the meeting. When I started at the CFTC about

 17 three and a half years ago and some of my initial

 18 meetings were over those first several months,

 19 people kept raising this idea of perhaps there

 20 being a need for an advisory committee that

 21 focused on risk and at the time we did not have

 22 one. A number of people came through and observed
 9

 1 that that was something that was missing if we're

 2 going to get a full picture from the industry

 3 through these advisory committees, making sure

 4 that we're informed on any number of different

 5 things going on in the marketplace.

 6 So we authorized this particular

 7 committee -- I guess it was about a year or so ago

 8 -- and finally we actually have the very first

 9 meeting. So it's great that we are here today and

 10 that Sharon is sponsoring this committee and

 11 leading it now in an able way. I'm really looking

 12 forward to the topics under discussion today and

 13 hearing the viewpoints of the members on these

 14 important issues. As the chairman said, CCP risk

 15 has been getting a lot of attention, and we're

 16 taking a look at a subset of issues here today

 17 related to that. And then, of course, trade

 18 execution, which is still very, very novel and new

 19 to the marketplace. And our rules are relatively

 20 new, so it will be good to have the input we're

 21 going to get today and see if there might be some

 22 other initiatives we might undertake as a
 10

 1 Commission to make sure that's the kind of

 2 marketplace that we and the Congress envision.

 3 So thanks again, Sharon. I'm really

 4 looking forward to the discussion. Thank you.

 5 MR. GIANCARLO: I'll be brief. Thanks,

 6 Mark, and my compliments to you for

 7 conceptualizing the MRAC a few years ago and to

 8 Sharon for taking it on with such gusto and such

 9 verve. Today is going to be a terrific day.

 10 The MRAC is certainly a committee and an

 11 area of inquiry whose time has surely come,

 12 whether it be looking at issues of systemic risk

 13 or cyber risk or CCP risk or clearing risk or,

 14 most importantly, liquidity risk, any number of

 15 those areas of risk. So I'm looking forward to

 16 not only today's program, but the program of this

 17 committee in the months and the years to come.

 18 I'm sure it's going to be a very important venue

 19 for a lot of good discussion between the regulator

 20 and the regulated as we examine these issues and

 21 make sure our markets are as risk-resistant as

 22 they possibly can be. So thank you very much.
 11

 1 MS. BOWEN: Thank you for your remarks.

 2 It really has been a privilege for me to be a

 3 commissioner, and it's been great working with

 4 each of you these last 10 months. So thank you so

 5 much again. I want to thank the members of the

 6 MRAC for bringing their passion, their expertise,

 7 and their intellect to these important issues.

 8 I want to especially thank today our two

 9 moderators: Tom Kloet is Trustee at Elmhurst

 10 College and Andrew Lo is the MIT Sloane Professor

 11 of Finance. Both are well regarded and bring a

 12 wealth of knowledge to us and to our committee.

 13 I want to thank my staff, particularly

 14 Petal Walker, who's our designated federal officer

 15 for the committee.

 16 I, too, would also like to thank the

 17 staffs of the Division of Market Oversight, the

 18 Division of Clearing and Risk, and the Division of

 19 Swap Dealer and Intermediary Oversight.

 20 And to those of you who helped set this

 21 up today, Margie, my executive assistant,

 22 Vontrice, and Tony and others, thank you. You
 12

 1 make this look seamless.

 2 The purpose of MRAC is to provide the

 3 Commission with market intelligence and

 4 recommendations from industry and other

 5 stakeholders about the market risk and market

 6 structure issues that we face. Because MRAC is a

 7 newly formed committee and given the breadth of

 8 our mission, I felt it was especially important to

 9 seek input from the public, so we asked for

 10 nominees for our membership and we asked that

 11 people give us issues or topics that we should

 12 think about.

 13 It was equally important for me that

 14 MRAC represent a diversity of viewpoints and that

 15 the potential members would have an equal

 16 opportunity to have a seat at the table. The

 17 importance and recommendations of this committee

 18 will be invaluable. We will help the Commission

 19 in our efforts to identify, analyze, and mitigate

 20 market risk. As we all know, the markets that we

 21 regulate are constantly changing and this

 22 committee's members can play a critical role in
 13

 1 helping the Commission understand these changes

 2 and their implications for market risk. Through

 3 the work of this committee, we hope to gain not

 4 only a better understanding of the range of

 5 systemic risks and the implications of our

 6 ever-changing market, but also to get the best

 7 thinking about how the Commission should respond

 8 to them.

 9 This is a very impressive group before

 10 us today with decades of experience and diverse

 11 viewpoints. Pursuant to our charter, our members

 12 include end users, exchanges, clearinghouses,

 13 market makers, intermediaries, academics, and a

 14 regulator. Represented here are entities are from

 15 different corners of the market ranging from

 16 Prudential, Cargill, Federal Home Loan Banks, JP

 17 Morgan, Bloomberg, as well as the Federal Reserve

 18 Bank of New York, advocates of financial reform,

 19 and noted academics. I'm very excited about this

 20 committee.

 21 During the comment period, market

 22 participants raised a variety of market risk and
 14

 1 structure issues for us to address, including CPC

 2 risk management practices such as default

 3 management, recovery and resolution, and margin

 4 valuation, cybersecurity, unregulated service

 5 providers and FCM concentration. So there's a lot

 6 for this committee to consider.

 7 Today, though, we turn to two important

 8 topics, one pertaining to market risk and the

 9 other pertaining to market structure. Though it's

 10 unlikely that a significant clearing member would

 11 default, it behooves us to do everything in our

 12 power to best prepare for it given the

 13 implications it would have to our economy. The

 14 importance of effective, robust risk management of

 15 CCPs cannot be overstated. The big question that

 16 we are trying to answer today is whether the

 17 default drills and other default preparations of

 18 CCPs are sufficient as they are currently

 19 constructed and whether they actually reflect our

 20 best thinking in terms of what the world will look

 21 like if there were to be a default. So along

 22 those lines I'm looking forward to a good
 15

 1 discussion, hopefully, whether or not we should

 2 think about CCPs coordinating or standardizing

 3 their practices to better prepare for a default.

 4 The second panel, dealing with market

 5 structure, asks the question as to whether SEFs

 6 have changed the fundamental swaps market,

 7 including the effect of the practice of name

 8 give-up. A central goal of Title VII was to bring

 9 the once opaque swaps markets into the light. The

 10 creation of SEFs was an important part of that

 11 effort and mission. Now that the SEF rules have

 12 been in effect for well over a year, we want to

 13 hear from the market participants about what

 14 effect, if any, it has had on the markets and how

 15 the Commission should be thinking about and

 16 possibly addressing the issue of name give-up.

 17 In order to engage in a hopefully

 18 fruitful discussion today, for each panel we have

 19 divided our 31 member committee into an inner

 20 circle and an outer circle. Basically the inner

 21 circle will be leading most of today's discussion,

 22 and then after the break we will be switching to
 16

 1 our second panel within a circle. We also have

 2 today members of the Commission staff on hand to

 3 answer any questions that may arise in terms of

 4 regulatory issues. And with that, I turn it over

 5 to Tom.

 6 MS. WALKER: The meeting is now

 7 officially open.

 8 MR. KLOET: Thank you for that important

 9 announcement, though. First off, my name is Tom

 10 Kloet and as Commissioner Bowen mentioned I am a

 11 trustee at Elmhurst College. In the interest of

 12 full disclosure, I'm also a nonexecutive director

 13 at NASDAQ Oil Mex, so any of my comments today

 14 aren't NASDAQ related, but they will be --

 15 MR. CUTINHO: Tom, I don't think we can

 16 hear you.

 17 MR. KLOET: Is that better? So my

 18 comments really are -- I'm a representative here

 19 of Elmhurst College.

 20 First I'd like to thank Commissioner

 21 Bowen and the chairman and your colleagues for

 22 putting the MRAC together. The CFTC has a history
 17

 1 of being an outstanding regulator, setting a

 2 standard for excellence in my view and having a

 3 committee like this continues to set a great

 4 standard. You're to be applauded for having the

 5 vision to put this together and frankly attracting

 6 an outstanding group of colleagues of mine here in

 7 the MRAC. So I really look forward to a great

 8 discussion. And to the chairman's point, it

 9 strikes me that it's great to be able to have

 10 discussions like this and have an interactive

 11 discussion as we go through these issues.

 12 To that point let me briefly just talk

 13 about the agenda. We'll start with some

 14 presentations from three different clearing

 15 organizations. Then we'll get into some macro

 16 questions on default scenario, working our way

 17 toward some more micro questions, and complete

 18 this section of the panel by around 12:10 or 12:15

 19 or so I think is the plan.

 20 So with that, just a couple of

 21 logistical announcements for how this is going to

 22 work. When you want to speak, please press the
 18

 1 button in front of you on the microphone. Unlike

 2 me, get your microphone close to you so that you

 3 can be heard. The roundtable is being Webcast and

 4 it's also being Audiocast. So the folks calling

 5 in will be able to hear if you have your

 6 microphone on and you speak into it. Although we

 7 can hear each other in the room, it's important

 8 that we allow the people on the Audiocast and the

 9 Webcast to hear. On the other hand, please turn

 10 your microphone off when you stop speaking as we

 11 can only hear a limited number of microphones at

 12 one time, so we don't want you to use bandwidth if

 13 you're not speaking. If you'd like to be

 14 recognized, what I recommend is -- and I'll try to

 15 demonstrate that -- just move your name banner up

 16 like that. If I don't see that, then show your

 17 hand or something like that and I'll try to call

 18 on you.

 19 So with that what I would like to do is

 20 turn it over to Sunil from CME to make a

 21 presentation on behalf of CME.

 22 MR. CUTINHO: I thought ICE --
 19

 1 MR. KLOET: Oh, I'm sorry. We'll start

 2 with Ian Springle of ICE.

 3 MR. SPRINGLE: Thank you, Mr. Chairman,

 4 commissioners, for the opportunity to speak here

 5 today. My name is Ian Springle and I work for ICE

 6 Clear Credit, so I'm here to represent ICE Clear

 7 Credit. I was part of the --

 8 MR. KLOET: Ian, I think you're like I

 9 did --

 10 MR. SPRINGLE: Okay, sorry. So I was

 11 just saying. May name's Ian Springle. I work for

 12 ICE Clear Credit. I've been with ICE Clear Credit

 13 since 2008 when we were launching the

 14 clearinghouse, and I've had various roles,

 15 including head of product development and chief

 16 product officer. I've been responsible for the

 17 design and the execution of the testing of the

 18 default management drills, so I've done about five

 19 ICE Clear Credit default drills and participated

 20 also in a couple of ICE Clear Europe default

 21 drills to date and counting.

 22 I'm turning to slide #2 of the
 20

 1 presentation. We've chosen in answering the

 2 question today of what are CCPs doing in

 3 preparation for a default of a major clearing

 4 participant in the broadest sense to start. I'm

 5 sure we'll get down into some details, but it's

 6 worth looking at the bigger picture initially I

 7 think. There are four areas really that we are

 8 preparing for a default in, going across the page

 9 from left to right.

 10 So the first one where we concentrate

 11 typically a lot of the conversations is what are

 12 our financial resources? So obviously we have to

 13 maintain sufficient resources so that in case of a

 14 default we can absorb the losses of the default

 15 portfolio and also liquidate the default

 16 portfolio. So that's where a lot of the focus of

 17 our risk management framework lies.

 18 Also more and more we're focused on

 19 liquidity, so part of our preparations are making

 20 sure that we have sufficient liquid resources to

 21 meet our daily cash payouts required during a

 22 default, and particularly we're focused on that
 21

 1 first day of default. So just to put that in

 2 context, if a CP is to default to the

 3 clearinghouse because of a failure to pay, they

 4 would miss their payments at 9:00 in the morning

 5 New York time. We as a clearinghouse then would

 6 have 1 hour, until 10:00, to pay our euro

 7 obligations on behalf of that defaulted portfolio;

 8 and then a further couple of hours, until 12:00,

 9 to pay our USD obligations. So we really have to

 10 have enough liquid assets available so that we can

 11 meet that first day of default obligation and

 12 that's part of what we look to test in our drills.

 13 So the second area in which we're

 14 preparing is really around our processes and

 15 tools. So the first one of these is what we're

 16 focused on probably a lot of the time today, our

 17 default management plan. This describes how we as

 18 an organization will work together to address the

 19 defaults and also how we'll work with our clearing

 20 participants, with our regulators, with our

 21 vendors. So there are a lot of moving parts

 22 involved and there's a balance to this plan in my
 22

 1 mind. On one hand you want the plan to be as

 2 prescriptive as possible so that it's fully

 3 transparent. Everyone knows exactly what to

 4 expect, how we'll use the funds, how decisions

 5 will be made. On the other hand, you also want to

 6 have flexibility so that the clearinghouse is able

 7 to respond to the facts and circumstances of any

 8 particular default that may be unique in nature.

 9 So you don't want to be hampered by very specific

 10 rules. You need some flexibility to make some

 11 judgment calls. I think that's the art and

 12 science of developing the plan.

 13 The second part of the processes and

 14 tools obviously is the tools. So there are two

 15 major components of managing a default, as I'm

 16 sure most of us are aware. The first one we

 17 basically when there's a default we hedge a

 18 portfolio or have the option of hedging. We need

 19 to do this very quickly and then execute the

 20 hedging trades. There likely won't be so many

 21 hedging trades, but the piece here is to respond

 22 very, very quickly.
 23

 1 The second element we need tools for is

 2 for the auctions. So this is just really an

 3 operational, logistical, issue to face. If you

 4 think about what the scale of this task is, we can

 5 have multiple auctions. Each auction can have

 6 multiple subportfolios. For each subportfolio, we

 7 have to collect separate bids from, in our case,

 8 30 or so CPs. So you're talking about many

 9 hundreds of pieces of communication, collecting

 10 bids in, making sure that you receive and process

 11 them correctly, and then communicating the results

 12 out to all the CPs. So really, in terms of the

 13 toolset, we try and develop -- you need automation

 14 to do this and that's what we've been focused on

 15 really, providing automated tools to reduce the

 16 operational risk of this practical issue of

 17 running the auctions.

 18 Another element that we have to consider

 19 internally is we have default waterfalls and

 20 liquidity waterfalls, so we have a certain set of

 21 rules around how we can use our different

 22 resources and in what order. And we need internal
 24

 1 tools to track how we're consuming our default

 2 resources and making sure that we're following

 3 those rules. And when you consider things like

 4 juniorization of guaranty funds, which are

 5 dependent upon how people bid in the auction, it's

 6 kind of a dynamic process that you have to follow

 7 to make sure that you're using your resources

 8 appropriately.

 9 MR. KLOET: Ian, can you move your mic

 10 closer to you. I'm not sure everybody can hear.

 11 There's people in the back and the audio people

 12 won't be able to hear.

 13 MR. SPRINGLE: So as part of developing

 14 these tools it's also important that we develop

 15 standards for information exchange. So that's

 16 another area that we've been focused on, and we're

 17 focused on in our testing. We develop standard

 18 file formats so that we can provide our CPs in a

 19 standard way with the portfolios that they've got

 20 to price. We agree on standard bid formats for

 21 collecting bids on those portfolios, and we

 22 establish standard formats for providing the
 25

 1 awards back to our CPs. So from a CP's

 2 perspective, you can imagine they may be dealing

 3 with several clearinghouses at once trying to

 4 price portfolios not just from ICE Clear Credit,

 5 but other clearinghouses of a multiple-asset type.

 6 So it's an onerous task for them, and we try to

 7 make that as easy as we can and as standard as we

 8 can.

 9 Finally, I just wanted to mention

 10 another way that we're preparing for default

 11 really is in exploring additional elements of the

 12 actual default management plan itself. We try to

 13 innovate and include the latest thinking. There

 14 are a number of enhancements that we're currently

 15 contemplating that will improve, especially around

 16 resolution and recovery, and also providing the

 17 buy-side opportunity to bid directly in our

 18 auctions.

 19 So the third component in our

 20 preparations really is our management information

 21 systems. Here it's important obviously that we

 22 provide the information that everybody needs to
 26

 1 make the decisions around risk and the auction

 2 splitting in a timely fashion. So we have systems

 3 internally to provide the risk pricing, all the

 4 basic information from the clearinghouse, in a

 5 timely manner in real-time views through our

 6 systems and also through our end-of-day reports.

 7 But there are also some practical

 8 matters to consider just in terms of the contact

 9 information. There are literally hundreds of

 10 people within various organizations that we have

 11 to make sure receive the information around the

 12 auction execution, and we have to maintain that

 13 ongoing throughout the year, not just in the

 14 default management tests.

 15 And, finally, around the hedging, in

 16 order that we can respond in the timeliest fashion

 17 to put on these hedges or consider the hedging of

 18 the portfolios, we actually compute our first

 19 order hedges every day automatically, which

 20 provides some transparency to how we're

 21 calculating the hedges as well as a timely

 22 execution.
 27

 1 The fourth component really then is

 2 around the testing itself. The first point here

 3 is we have an industry test that we hold every

 4 year, which includes all of the stakeholders that

 5 we've mentioned already. We really run through

 6 the end-to-end process as much as possible. I'll

 7 speak about that a bit more in a second. But we

 8 also have internal ad hoc tests throughout the

 9 year. For example, the Treasury Department has to

 10 test its liquidity facilities that it might have

 11 or test its credit facilities that it might have.

 12 And also I would include in our preparations as

 13 stress testing and back testing for our funding

 14 and also for our liquidity. So we focus on that

 15 throughout the year as well.

 16 So that gives a broad view of how we're

 17 preparing. I just wanted to touch on a couple of

 18 points that I made here in a bit more detail.

 19 The next slide -- I'm on slide #3 for

 20 those who aren't in the room. So if you look on

 21 the right-hand side of this slide, it's worth just

 22 setting in context our default waterfall, which is
 28

 1 similar to a lot of the CCPs that we have around

 2 the table. So we have a funded and unfunded

 3 component.

 4 In the funded component we have initial

 5 margin that we collect from our CPs -- this is the

 6 first element that we can use in a default -- and

 7 then we have the guaranty fund of our defaulted

 8 CP. So we use the defaulted funds first. We then

 9 have two elements of ICE skin in the game. The

 10 first one is the $25 million ICE priority

 11 contribution, which we use before the

 12 nondefaulters' funding, guaranty fund. We also

 13 have a pro rata $25 million contribution, which we

 14 use prorated during the consumption of the

 15 nondefaulters' guaranty fund.

 16 We also have an unfunded component where

 17 we can call if we run out of funded funds for one

 18 times the guaranty fund contribution prior to the

 19 default for additional funds. Importantly also in

 20 terms of liquidity, the idea for our liquidity

 21 tier -- I won't go through the detail here -- is

 22 really that we have enough funds on hand in a
 29

 1 liquid format or cash format to cover our expected

 2 or maximum day 1 obligations of the default, and

 3 then enough in assets that we can liquidate within

 4 one day to cover the subsequent days' obligations.

 5 We also have a concept of a liquidity

 6 waterfall where we can use the cash component of

 7 tiers of the default waterfall that are later on.

 8 So, for example, we can use the cash of the

 9 nondefaulters' guaranty fund so long as we pledge

 10 the noncash collateral from the defaulter's

 11 portfolio. So it's an opportunity for us to make

 12 sure we have the most liquid resources that we

 13 can. So that's how the two waterfalls work.

 14 If you look now on page 4, ICE has

 15 developed a unique model for CDS clearing, which

 16 is really beyond the scope of this discussion, but

 17 I just wanted to point out a couple of items to

 18 put the resources in context. First of all, in

 19 our initial margin model one of the main

 20 components is the spread response requirement, and

 21 this is based on a five-day, 99 percent, quantile

 22 level. And secondarily, in terms of our guaranty
 30

 1 fund, it's designed to provide funds for a cover 2

 2 protection looking at the largest uncollateralized

 3 losses under extreme, but plausible conditions,

 4 and also at three simultaneous defaulting

 5 reference entities. So the net effect on the

 6 right of the page is really that we have

 7 substantial levels of funded resources based on

 8 the cover 2 requirements.

 9 So at the end of the year it was $17

 10 billion in initial margin, a guaranty fund of $2

 11 billion, and then the ICE contribution of $50

 12 million. In addition to this, we also have

 13 significant unfunded resources, which cover beyond

 14 the cover 2 scenario. So any depletion of our

 15 funds is likely to involve several more than two

 16 defaulting CPs at the same time, which is really

 17 in history kind of an unprecedented event. So it

 18 just sets the event that we're dealing with in

 19 some context.

 20 MR. WETJEN: Ian, on the bullet point

 21 there, what exactly do you mean when you say "the

 22 default of three or several of the world's largest
 31

 1 institutions in addition to the cover 2?" What

 2 does that mean? Are you talking -- are you

 3 suggesting that you're meeting a standard that's

 4 like cover 5 or something? What exactly does that

 5 mean?

 6 MR. SPRINGLE: Yes, the funded

 7 contribution is based on the cover 2 requirement,

 8 so that's how we scale our funded funds. But then

 9 in addition to that, you have the assessment

 10 rights. So really we have more resources that you

 11 could argue than the cover 2 requires and also

 12 just looking at some of our stress testing

 13 results. Typically we see that it would require

 14 more than the two CPs defaulting to deplete our

 15 funds even under some very extreme scenarios that

 16 we use in our stress testing. So we're confident

 17 in the level of the resources.

 18 On the other hand, it's an efficient

 19 model that we have, which provides for portfolio

 20 benefits as well. So we try and draw the balance.

 21 But, yes, we may have more than the cover 2.

 22 MR. KLOET: Ian, why don't you go ahead
 32

 1 and continue and finish and then we'll take

 2 questions after that.

 3 MR. SPRINGLE: So given the time, I'll

 4 just cover the plan that we have on page 5 for

 5 default management, which is really if you think

 6 about it, these are the elements we would test in

 7 any default test. So we cover both at the same

 8 time.

 9 So really there are two phases. The

 10 first one is a very quick phase. We have to

 11 complete all these tasks in about 3 hours. The

 12 declaration of default process really -- we

 13 monitor and prepare for the default, so it's

 14 unlikely that a default event will happen without

 15 anybody being aware of the event. There's some

 16 credit monitoring that we perform overtime leading

 17 up to the event. Importantly, this will likely

 18 give the clients of our CPs an opportunity to pull

 19 any of their positions ahead of a default, and we

 20 would work with them to facilitate that.

 21 Secondarily, we then have to demonstrate

 22 that the default conditions are met. There are
 33

 1 several types of defaults, such as failure to pay,

 2 bankruptcy and suspension, so we have specific

 3 rules that we test in ICE Clear Credit to make

 4 sure that we're accounting for all of those

 5 different types of events. We then have to obtain

 6 the appropriate approvals. There's kind of a

 7 hierarchy of levels of authority that we have to

 8 be able to achieve in a small timeframe, ranging

 9 from an eligible officer of ICE Clear Credit, to

 10 the Chairman of the Board, all the way through to

 11 a majority vote from our Board. So we also test

 12 those components in as near real time as we can

 13 during our tests. We then have the ringfencing of

 14 the defaulter's portfolio, so we make sure that

 15 the defaulter cannot clear any further positions,

 16 cannot contribute to our pricing process, and then

 17 we have a communication out to the public and to

 18 our CPs and to regulators.

 19 The next two components, funding and

 20 activating our Default Committee, happen at the

 21 same time. The funding really as I spoke about is

 22 making sure that we liquefy any assets that we
 34

 1 have so that we can meet our payment obligation

 2 deadlines and then look forward to subsequent days

 3 of the default to make sure we have liquid assets

 4 at that time.

 5 And then we have the Default Committee,

 6 which consists of three traders from three firms

 7 who come into the ICE offices to consult with the

 8 risk department around the hedging and liquidation

 9 of the portfolio. So during our tests, we

 10 actually invite them in and check that they can

 11 reach our offices within an hour to participate in

 12 the testing.

 13 So by 11:00 of the day of the default

 14 basically we've seconded our traders. They're at

 15 our offices. We've liquefied our collateral and

 16 paid our obligations. And then the focus really

 17 on the remaining days is on the hedging and

 18 liquidation.

 19 So on the bottom of this slide the first

 20 part is the hedging, which we've already really

 21 spoken about. But I just wanted to mention the

 22 porting. So under our rules we have the
 35

 1 discretion to transfer the positions of a

 2 defaulted FCMs' client portfolio of the

 3 nondefaulting clients to a nondefaulting FCM or

 4 one or more nondefaulting FCMs. This is another

 5 component that we try and incorporate in our tests

 6 and we have done in two prior tests. Part of this

 7 porting is also to negotiate with the trustee. So

 8 in practice we're going to have to talk to the

 9 trustee to understand how much of the initial

 10 margin and how much mark- to-market margin the

 11 trustee is willing to pay on behalf of the

 12 defaulting FCM and that will obviously take some

 13 time. And we also in choosing the FCM that we can

 14 port to have to consider the impact from a risk

 15 perspective of moving those positions to the FCM

 16 and also the impact on the remaining portfolio

 17 that we'll have to auction. But that's something

 18 that we would do on behalf of our clients. And

 19 then the final component is obviously the auction.

 20 I won't go into any more detail because I know I'm

 21 running out of time here.

 22 So really I think that covers most of
 36

 1 our broader introduction. I think my colleagues

 2 probably will be dealing more with the mechanics

 3 of the actual default test, so I'll leave it to

 4 them to go through that.

 5 MR. KLOET: Thank you, Ian. I know

 6 there are questions on Ian's presentation. What

 7 I'd like to do is have all three clearing CCPs

 8 present first and then I'll open the floor up for

 9 questions. So with that I'm going to go to Sunil

 10 Cutinho from CME.

 11 MR. CUTINHO: Thank you, Tom. This is

 12 the first time I've heard somebody call a white

 13 person with an Indian name -- Sunil -- that was

 14 good. That's the joke for the day.

 15 Before we go into the details of default

 16 management, I just wanted to set context. I think

 17 if we all start repeating what Ian has just

 18 presented, it will make for a very boring day. So

 19 let's start by just taking a step back. What are

 20 we trying to do in a default management process or

 21 when there is a default? There are two things.

 22 One is restoring a matched book as far as the CCP
 37

 1 is concerned, and the second is we cannot forget

 2 -- I think Ian covered that as well -- is porting

 3 the nondefaulting clients to a solvent FCM,

 4 another FCM. So those are the two big things to

 5 take into account in addition to other

 6 considerations.

 7 Another important aspect of default

 8 management, as Ian pointed out, is the preparation

 9 before there is a default. These events are not

 10 instantaneous. There is credit deterioration.

 11 There are issues that happen before the onset of a

 12 default. There are, of course, surprises, but

 13 it's very unlikely from our experience that that

 14 is the case. So active monitoring, monitoring of

 15 risk, and actually a little bit of contingency

 16 planning when it comes to the customers, are very

 17 important aspects of default management before the

 18 onset of a default. You can start working on

 19 customers and porting of customers immediately and

 20 as soon as practicable rather than waiting a few

 21 days. So I don't want everybody to take away from

 22 this conversation the fact that these are events
 38

 1 occurring in a sequence. We can actually port

 2 customers while we're also performing the auction

 3 on the house book.

 4 With that I just wanted to give

 5 everybody a sense of the experience that the

 6 industry has had, and we particularly have had,

 7 with multiple defaults that have occurred in the

 8 past and there are four key things that we take

 9 away from that.

 10 I think the first one is one size

 11 doesn't fit all. Market structures are different

 12 when it comes to liquid central limit order books,

 13 transparent markets versus an over-the-counter

 14 market where pools of liquid -- there are multiple

 15 pools of liquidity, but there's no centralized

 16 pool. So there are differences in how you

 17 construct or how you manage auctions in both those

 18 situations. In both cases it's important that

 19 there are no structural limitations to

 20 participation because when it comes to a default

 21 auction, our goal is, especially for the house

 22 book, our goal is essentially we want bidders --
 39

 1 the more bidders, the better price. At the same

 2 time you have to balance that with the number of

 3 participants and how much information gets out in

 4 the market. So those are the two things to take

 5 into account, and we take that very seriously.

 6 The second thing is customers, porting

 7 of customers. There is a lot of experience on

 8 this. There are different types of porting.

 9 Sometimes if there is a shortfall in the seg

 10 funds, which was the case in MF Global, it gets

 11 complicated. It is not about -- LSOC doesn't

 12 solve that problem. This is a shortfall. This

 13 shortfall was not driven by a customer default,

 14 but there was a shortfall. In such circumstances,

 15 there are things to consider. There are

 16 bankruptcy rules. You're dealing with a trustee,

 17 and you're dealing with what can be done and what

 18 cannot be done. We had to take the step --

 19 because we take customer protections very, very

 20 seriously, we put our own capital down to give the

 21 trustee confidence that we want to move our

 22 customers to alternate firms as quickly as
 40

 1 possible because markets are moving and we want

 2 these customers to participate in those markets

 3 and have as much of their collateral as possible

 4 in these circumstances. So that is something to

 5 keep in mind as well.

 6 The third thing is the importance of

 7 default drills. I think we're all going to speak

 8 to it. The default drills is not one size fits

 9 all, but there are a few common things that we'll

 10 cover in the next few slides that are important to

 11 reduce operational risk, to reduce

 12 misunderstandings, and to actually broaden

 13 participation. There are a set of things that we

 14 test there, as Ian pointed out, incentive effects

 15 on how to make sure that auction participants are

 16 incented to actually make good markets and what

 17 are the consequences if they participate, but they

 18 make bad markets.

 19 Coordination is an important point.

 20 Coordination is not just between derivatives

 21 clearinghouses, but we have to think of the

 22 security side of the world as well because market
 41

 1 participants -- when we talk of a default, these

 2 participants typically are also broker-dealers and

 3 they participate in the equity markets,

 4 securities, and also options. So it's important

 5 to take that into account. Coordination is very

 6 important, coordination from many perspectives.

 7 We'll cover a few things as far as coordination is

 8 concerned, but I think there is work to be done as

 9 far as coordination is concerned.

 10 So with that, let's go to some best

 11 practices that we think will help us along the

 12 way, will guide us when we think of default

 13 management.

 14 MR. KLOET: Sunil, if you could also

 15 speak up into the microphone so that everybody can

 16 hear.

 17 MR. CUTINHO: Ah, this is the first time

 18 somebody has shown me I'm not heard. Thank you.

 19 So I think as far as best practices are

 20 concerned, it's important to take into account

 21 market structure. In our experience for

 22 liquid-listed markets, buy-side participants have
 42

 1 participated successfully and they've been

 2 aggressive and they've won the auction. There are

 3 no restrictions. It's important for the clearing

 4 firms of these buy-side entities to be aware of

 5 the fact that they're participating and they

 6 should know the risks that they are taking on, but

 7 that in and of itself is not the only tool because

 8 there are markets. So there is a broad array of

 9 tools for these markets to actually resolve the

 10 auction.

 11 When it comes to over-the-counter

 12 markets, the markets are still evolving. We talk

 13 about market structure; that's your next panel.

 14 They are still evolving, but CCPs when they

 15 started clearing these have instituted a process

 16 where generally participation in auctions is an

 17 obligation for clearing member firms or clearing

 18 participants, whatever you want to call them. The

 19 reason is that these clearing member firms have to

 20 have the wherewithal to actually liquidate these

 21 portfolios when their clients default as well, so

 22 they have to have this capability to get into this
 43

 1 business. So having them actually participate in

 2 auctions and having that as an obligation is a

 3 good thing, but there are also incentives

 4 associated with it.

 5 Despite that, I think structurally we

 6 should not limit buy-side from participating

 7 because when you talk about a default, you don't

 8 want to place limitations on how many people can

 9 bid. But these relationships cannot be struck at

 10 the eleventh hour. We should invite them to

 11 participate during the drill process so you

 12 establish a relationship, and they also should

 13 understand that there are certain obligations that

 14 come along with participation and the auction.

 15 I think a few weeks back or a week back,

 16 I'm losing track of time, there was a discussion

 17 about what are the appropriate incentives to make

 18 sure that buy-side participants do not abuse this

 19 process. The thing to keep in mind is that even

 20 the incentives that we talk about as far as

 21 clearing members are concerned, there are

 22 incentives for participation, but essentially even
 44

 1 if you have an auction where there is one winner,

 2 there are a few people, other people, who have

 3 seen the activity, who have seen the portfolio.

 4 So abuse is possible and it's not just limited to

 5 buy-side. It's something that you have to address

 6 across the spectrum.

 7 So the way to address that is auction

 8 participants should know that participating in the

 9 auction comes with the possibility that their

 10 activity, prior to the auction and after the

 11 auction, is auditable, can be reviewed. So that

 12 in and of itself is a good way to ensure that

 13 there is no abuse post the auction.

 14 So the other things we talk about, Ian

 15 covered some of it. There is macro-hedging. You

 16 think about hedging and a default -- when there is

 17 a default and a firm fails to pay typically early

 18 in the morning, let's say at 8:30 New York time --

 19 they're supposed to confirm settlements and the

 20 settlement bank says the firm is no good -- at

 21 that point in time there two things. One is the

 22 CCP has to have liquidity to make the payment, so
 45

 1 the liquidity facility should be sized to cover

 2 that instance and that should be tested very

 3 often, drawdowns and things like S- draws, that's

 4 one.

 5 The second thing is in that very, very

 6 short period of time immediately following that

 7 event, the most important thing is macro-hedging.

 8 So it can be done by a CCP itself using very

 9 liquid markets, liquid tenors, even for OTC

 10 markets, to make sure that we reduce the risk as

 11 much as possible from a mark-to-market

 12 perspective. The Active Default Management

 13 Committee and others who come in later on is to

 14 further reduce the risk, the threshold. To give

 15 you a sense of that is the margin, so margin pre-

 16 hedging and margin post-hedging. So the goal is

 17 to reduce margin as much as you can and its

 18 mark-to-market as much as you can -- let's say 90

 19 percent is a good threshold example -- but then

 20 you have to balance that with a cost. How much

 21 money are you going to spend hedging? So those

 22 are some considerations CCPs make and it's being
 46

 1 tested. That's the whole point of testing, and

 2 we'll come to testing a little bit in simulations.

 3 I think Ian covered this. The

 4 collateral that a firm has -- the purpose of a

 5 liquidity facility is to actually get liquidity

 6 without having to actually go to the market with a

 7 lot of collateral and get a poorer price for it or

 8 move the market by liquidating the collateral in a

 9 very short amount of time. The liquidity facility

 10 buys you time. The collateral should then be

 11 liquidated. There are liquidation agents who

 12 actually do this, and we should test this very

 13 often. That's very important for CCPs to do that.

 14 And the idea is once you've gradually

 15 liquidated the collateral as needed in order to

 16 make sure you pay the variation margin -- and even

 17 in an auction sometimes, something to keep in

 18 mind, is that, as Ian talked about, a liquidity

 19 waterfall. Sometimes auction participants are

 20 fine taking Treasuries rather than cash as value

 21 because what people are actually bidding is how

 22 much money would they want from a CCP to take on
 47

 1 the portfolio. Slightly different from valuation;

 2 valuation is a component in it, but what they're

 3 bidding for is how much money or margin would they

 4 want to take on the portfolio.

 5 And we spoke about porting. The

 6 importance of porting is it has to start

 7 simultaneously. Contingency planning is very

 8 important. Here, too, and there is a little bit

 9 of coordination with other CCPs that is important

 10 because customers that are coming through that

 11 failed firm and clearing at a CCP have activities

 12 at other CCPs going through that very same firm.

 13 So they could be trading the products in such a

 14 way that they are settling with that firm on a net

 15 basis. So when you port them, you port these

 16 clients, and if the two CCPs were to port this

 17 very same client of very different firms, then

 18 automatically the client is settling on a gross

 19 basis. So it will impact the client. So

 20 coordination becomes important when thinking of

 21 clients and porting.

 22 We talked a little bit about
 48

 1 coordination. We have actually conducted a drill

 2 with a major CCP in the U.S., and we intend on

 3 continuing that with other CCPs. Our goal is

 4 several-fold: Joint exercises, coordinating,

 5 especially when getting traders who are seconded

 6 from those firms, from the clearing firms,

 7 empaneled firms. We have to make sure that when a

 8 CCP empanels a clearing member that the same firm

 9 is not empaneled to participate at another CCP for

 10 the same product set. That will be a draw for the

 11 same trader from two places. That is what we have

 12 to avoid and that's a second important point.

 13 The third one is the risk that a

 14 clearing member has is diverse. It will not be

 15 the same direction at all CCPs, so you have

 16 opportunities, so, essentially, how you deal with

 17 such situations because you can get a very

 18 beneficial outcome if you coordinate your auction

 19 actions with the other CCPs in such a scenario.

 20 I'm not going to go through all of these

 21 bullet points as far as preparation for the drill,

 22 but I'll just talk about a few things. First is
 49

 1 it's important for the portfolio -- the

 2 construction of portfolios is very important.

 3 It's important to construct portfolios in a drill

 4 that simulate risk, difficult risks to auction.

 5 So you want to actually test the limits of your

 6 auction process, so the construction of the

 7 portfolio becomes important.

 8 The second is the environment in which

 9 this portfolio will be auctioned. So you cannot

 10 choose the current environment. If you choose the

 11 current environment, the market environment, then

 12 you're only testing the operational aspect of a

 13 default. You want to simulate a stressed

 14 environment. So it will be good to take a period

 15 in 2008, maybe post-Lehman default, a small period

 16 of time and that is just basically for certain

 17 markets. It's not the same at cross markets. So

 18 you can look at crises in energy markets around

 19 Enron and things like that. So those are

 20 simulations. So that simulation is important.

 21 It's not just at the day of the auction; it is a

 22 week or two weeks post the default date. So you
 50

 1 get a sense from your traders and from market

 2 participants who are participating in the auction

 3 that this is the world you're in. What are the

 4 prices you will contribute in this auction? How

 5 would you participate in this auction? That's

 6 very important. And for the CCP it will give a

 7 sense of the size of the variation losses, the

 8 hedging, the challenges. It will give a sense of

 9 the challenges.

 10 Because you choose a simulated

 11 environment and you choose a simulated portfolio,

 12 you have to actually prepare every participant to

 13 be ready to participate, prepare the tools that

 14 take into account the situation.

 15 I'll just skip to the last two slides,

 16 so I'm conscious of time. In the last two slides

 17 I'd like to cover a few things. We think it's

 18 important to cover a drill twice a year. Please

 19 don't take this as a race between once a year,

 20 twice a year, and all of that. The reason being

 21 there are many diverse asset classes, so things

 22 that we have to test is a participant that
 51

 1 defaults, a large participant that defaults, will

 2 default across markets. So you want to

 3 coordinate. If you have multiple risk pools,

 4 multiple safeguards packages, then you want to

 5 simulate a default across them so they will

 6 default to all of them. You also want to -- and

 7 we talked about the coordination standpoint -- you

 8 want to also coordinate with other CCPs. The

 9 important thing is testing of the systems, the

 10 communication. I think Ian covered that. It's

 11 important to know your participants. It's

 12 important to know your clearing members in good

 13 times, so that in bad times you're not searching

 14 for these people. And it's not just one person,

 15 it's the team. Who are the traders who are

 16 participating, not just the head of the firm --

 17 and the risk team, not the least to mention.

 18 The other thing is bidding incentives.

 19 Structuring bidding incentives is something that

 20 you have to test. How will this bidding incentive

 21 work? And you have to also share the results with

 22 these firms.
 52

 1 The resources -- I don't want to go

 2 through it. I think all of us have clean rooms.

 3 They're audited, making sure that these things are

 4 tested often so there are not surprises. We know

 5 where the traders are going, and we know the

 6 environment they're going to work within. We know

 7 all the tools they're going to have and how

 8 they're going to operate within that.

 9 We were just talking about a timeline,

 10 similar to what Ian covered. Day 1 of the default

 11 is all about macro- hedging and hedging as much of

 12 the risk as you can. The balance is how much

 13 margin are you going to consume. The ADMC is the

 14 Active Default Management Committee. There is a

 15 committee that will give you guidance, but the

 16 Active Default Management Committee are the

 17 traders who are seconded and they are the ones who

 18 are going to participate. The reason -- and I

 19 know there's been a lot of criticism on this, but

 20 it is a very important thing for over-the-counter

 21 markets because the resources that you need, you

 22 need to have expertise in these markets and these
 53

 1 resources cannot be just hired and kept in reserve

 2 just to participate in a default if it happens.

 3 None of these resources will stay. In order to

 4 have them keep pace with the nature of the

 5 markets, the state of the market at the time of

 6 the default, you need to draw these resources from

 7 the participants in the market rather than hiring

 8 them, keeping them in reserve. So that's

 9 important to keep in mind. Coordination is a way

 10 to solve for avoiding a double draw on these

 11 resources or having them not show up.

 12 Day 2 to day 5, this is mostly for

 13 over-the- counter markets. To give you a sense --

 14 I keep pointing to the difference. In our

 15 experience for listed liquid markets, we've

 16 successfully completed auctions within a few hours

 17 on the day of the default, so that's why, because

 18 of the nature of this market structure. You know

 19 over-the- counter markets are diverse pools of

 20 liquidity and then they're also bespoke products.

 21 They're nonstandardized. So pricing time and

 22 auction time are slightly different than for
 54

 1 listed markets.

 2 So for day 2 through to day 5 it's all

 3 about auctioning a hedged portfolio. There are

 4 different types of auctions. It could be

 5 simultaneous auctions with multiple portfolios or

 6 sequential auctions where portions of a portfolio

 7 are taken down. There are different styles of

 8 auctions -- Dutch, modified Dutch, things like

 9 that -- and they all depend on the structure of

 10 the portfolio and the nature of the market, so

 11 that's to keep in mind.

 12 So in the drill there are two things.

 13 One is you want to have a process that notifies

 14 the winners that they've won the portfolio and at

 15 the same time you also want to show every

 16 participant how the bidding incentive played out,

 17 so the hypothetical impact of their bid on the

 18 seniorization of their guaranty fund contribution.

 19 This is in situations where clearing members are

 20 obligated to participate.

 21 We talked in general about cost of

 22 default management. Things to review post-drill
 55

 1 are monitor throughout the drill and review

 2 post-drill. What is the cost of hedging? What

 3 does a variation margin cost? What's the auction

 4 cost? And what are the assumptions? The thing to

 5 take into account is all these three costs are an

 6 important input into the margin model, so there

 7 are aspects of the margin model. Most people

 8 think in very simple terms about how much margin

 9 is it for a single trade or for a small portfolio,

 10 but margin models have concepts such as

 11 concentration margin and liquidation triggers

 12 where margins start to scale up significantly. So

 13 these triggers are tested to make sure they're

 14 adequate. Think about what the test is. The test

 15 is testing the performance of the auction in a

 16 stressed market.

 17 That brings to an end most of my

 18 presentation. The one last word I would have is

 19 that I think automation to an extent is very good.

 20 Standardization is good, but it is product

 21 specific. And there are two aspects to this --

 22 I've talked about it -- valuation and bidding
 56

 1 price. Valuation is essentially making sure

 2 everybody knows or has a similar value, so

 3 valuation is tested periodically. Mark-to-market

 4 is all about valuation. But it's important to

 5 also test valuation in a stressed market, so

 6 testing valuation is an important part of a

 7 default drill to see how people value portfolios

 8 and to see how far different firms are.

 9 The second thing is the bid price. The

 10 bid price essentially is how much margin people

 11 want, and the bid price will tell you what is

 12 important for the incentive effects, how they're

 13 testing the incentive effects that are structured

 14 for the default.

 15 And then as far as technology is

 16 concerned and infrastructure is concerned, it's

 17 very, very valuable. And having similar tools

 18 across CCPs may be valuable as well because when

 19 these auction participants are interacting with a

 20 CCP, it's good for them to interact with similar

 21 tools. So we worked with another major U.S. CCP

 22 to double up our tools.
 57

 1 So, thank you, and I'm sorry for going

 2 too long on this.

 3 MR. KLOET: Thank you, Sunil. And

 4 Dennis McLaughlin from LCH.Clearnet -- we'll have

 5 your presentation next.

 6 MR. McLAUGHLIN: Thank you for the

 7 opportunity to be here. There is a presentation,

 8 which I understand is going online at some point

 9 soon. But rather than delve into it because of

 10 the two excellent presentations we've just had,

 11 I'll just start off with a few --

 12 MR. KLOET: Dennis, if you'd just move

 13 your mic closer and speak a little louder.

 14 MR. McLAUGHLIN: So I'd just like to

 15 make a few comments because we do a very similar

 16 process to the other two CCPs that have just

 17 spoken. But I think that we also focus very

 18 importantly on the coordination aspect of what's

 19 going on because when a default is imminent or

 20 happening, a lot of people who normally don't talk

 21 to each other suddenly have to be contacted and

 22 communicated with and the structure of how that's
 58

 1 done is quite important.

 2 So you have regulators. You have the

 3 press. You have members who have to be notified.

 4 You have the defaulting member who has to be

 5 notified of what's going on. Lots of things have

 6 to happen in a very coordinated way according to a

 7 very strict timeline. So the people have to get

 8 reports that they don't normally get. There need

 9 to be processes that are not normally part of the

 10 business as usual away from a default. So to the

 11 extent to which we can automate most of that and

 12 get rid of the potential for manual errors is very

 13 important.

 14 So our focus is really twofold. On the

 15 risk management aspect, of course, we're doing

 16 everything that we can to ensure that we have

 17 enough margins collected, et cetera, and doing

 18 everything that we can to make sure that we

 19 understand the credit quality of the member as

 20 it's approaching default and the alarms are set

 21 off, et cetera, but we're also doing everything we

 22 can to understand who needs to talk to who when
 59

 1 there is a default.

 2 So let me just highlight a couple of

 3 things that are different or potentially slightly

 4 different from the other CCPs that have spoken.

 5 The first one is on client porting. So we

 6 recognize the fact that if the defaulted member

 7 has a lot of clients, that's a big operational

 8 issue to make sure that they're all ported

 9 correctly because a lot of people have to be

 10 communicated with. So for that very reason, we

 11 actually hold an additional two days' margin to

 12 cover that period because if there are no clients,

 13 that's fine, you can deal with the closeout. But

 14 if there are clients, you certainly can't deal

 15 with it -- there has to be a nonzero time added to

 16 the margining period to cover that, so we allow

 17 two days for that. And we hold additional margin

 18 just to cover for the headache and the time wasted

 19 to try and figure out how on earth we can deal

 20 with a large number of clients to be ported.

 21 That's quite a large undertaking and it can be

 22 very, very onerous.
 60

 1 The second thing is that we also started

 2 to look at for the first time losses that could

 3 arise not from the clearing side of the house, but

 4 from shall we call the investment activities. You

 5 may have a counterparty to our Treasury portfolio

 6 activities who defaults. Now, if they're a

 7 clearing member also, that creates a big problem.

 8 But if they're a nonclearing member, we don't have

 9 as much information on them as if they were a

 10 clearing member. We can't see their trading

 11 patterns, et cetera.

 12 The other thing that we have to realize

 13 is that any problem with the trading activity on

 14 the margin investment goes straight to capital.

 15 There are no default funds in the way so to speak

 16 to protect or there's no margin in the way. It's

 17 just a straight loss, a straight hit, to capital.

 18 So we're very focused on running nondefault loss

 19 fire drills, which means outside the clearing

 20 service on the actual investment of the margin

 21 themselves. If we have a problem, how are we

 22 going to deal with that? What's the strategy for
 61

 1 dealing with those kinds of issues?

 2 The third one I want to bring up that's

 3 probably different is the fact that we also look

 4 at our interactions with the settlement platform

 5 because if we're having a cover event, the

 6 settlement platform also is having some kind of

 7 major trauma happening to it. So we want to know

 8 how the interaction back and forth, the flow goes

 9 back and forth, with the settlement platform. Are

 10 trades still settling? We don't know. We want to

 11 make sure that that's happening. That's what I

 12 mean by the coordination emphasis that we put on

 13 the activity.

 14 As far as other CCPs are concerned, we

 15 haven't gone down that road as yet. We do think

 16 there's potential to do that, but I think there

 17 needs to be some kind of framework to interact

 18 with the other CCPs because you can very quickly

 19 get into competitive concerns here. Because in a

 20 default situation, if we have a member in default,

 21 the chances are that the same member in the other

 22 CCP is also in default. The issue is that we
 62

 1 might both have portfolios that are long, so i.e.,

 2 similar portfolios. We can't offset them. We

 3 can't net them. We're actually competitors then

 4 because we both own at that stage. We own the

 5 defaulted member's position, so we're in

 6 competition in the market. The reason I'm

 7 bringing this up is if that were to happen, unless

 8 there's a very tight structure in place, the

 9 chances of dealing with legal action later on in

 10 the process from the trustee of the defaulted

 11 estate, can be quite high.

 12 So I think there's a role for the

 13 regulatory community here to try and come up with

 14 some sort of way for CCPs to interact. Now, I do

 15 think that they can interact in a straightforward

 16 way in terms of things like do we have overlap in

 17 the default management group. So if there was a

 18 default, are we sure that we can get the right

 19 people in the right room at the right time and

 20 that we're not competing for very scarce resources

 21 in terms of just the operational aspect of the

 22 default.
 63

 1 So that's just the few words to start

 2 with. I'm not going to go through all this

 3 presentation because, as I said, it's very similar

 4 activities to what has been discussed earlier. I

 5 would say that we do look at the design very

 6 carefully of the default management fire drill.

 7 We're looking at all end-to-end processes. The

 8 timeline goes pre-default all the way through

 9 default to the final calculation if you like of

 10 the losses and the communication of that back out

 11 to the members. We look at the types of exposures

 12 that should be involved in the design of this.

 13 We're looking at obviously LSOC concerns. We look

 14 at different kinds of people who are involved in

 15 the exposure process in terms of calculating the

 16 exposure process. So, for example, we can have

 17 interdependent relationships between clients and

 18 members that need to be analyzed very carefully as

 19 we design the process of what happens in the fire

 20 drill.

 21 Just to give you some sense of what

 22 we're talking about, we have approaching something
 64

 1 like $100 billion in terms of financial resources

 2 spread over ten default funds. So that is a lot

 3 of assets and a lot of people that we're talking

 4 about. So obviously the extent to which we can

 5 control and structure that process is quite

 6 important. That's what I mean by the operational

 7 processes that we need to focus on. A lot of the

 8 issues can arise from not so much the financial

 9 resources, but from the fact that you don't have

 10 somebody's phone number. You don't quite know

 11 where they are. You don't know who to contact to

 12 get them in the room. That has to be all

 13 preplanned and sorted out beforehand.

 14 The other thing we look at is the stages

 15 of the default waterfall that we need to test. So

 16 in some fire drills we've tested different stages,

 17 particularly as of late we've started to test when

 18 you have the unfunded calls that you make and when

 19 you're digging deep into the default fund, you

 20 start to test that procedure, which is shall we

 21 say not as established as the normal funded

 22 default funds procedure.
 65

 1 So we're looking at a lot of moving

 2 parts here, so coordination is actually key. Just

 3 to give you a sense of the coordination problem

 4 again, we have to look at all these lines across

 5 the page in terms of people who are involved aside

 6 from the individual services that LCH.Clearnet

 7 has. So, obviously, there's a default management

 8 group that has to be convened. Risk is involved.

 9 Legal is very key in this whole thing because you

 10 have to know the exact grounds on how you're

 11 moving in terms of taking action. Do you have the

 12 right to take this action, et cetera, et cetera?

 13 What are the rulebooks saying? Compliance is key

 14 as well. You have to know that you're within the

 15 regulatory rules when you do something.

 16 I would just mention collateral and

 17 liquidity management is very important here

 18 because we need get instant reports from all the

 19 products as to how the jigsaw is coming together

 20 in terms of what are liquidity needs shaping up to

 21 be. This is what I meant about people who don't

 22 normally worry about these kinds of reports.
 66

 1 Suddenly you have to have an automated process to

 2 get these reports to you rather than working with

 3 manual spreadsheets on the day of the default and

 4 dealing with the misinterpretation that may happen

 5 if that's the case.

 6 Collateral operations is very key

 7 because we need to know what collateral we

 8 actually have, what's actually come in. Have we

 9 turned off the collateral or what has settled so

 10 that we know exactly where we stand? We can't be

 11 working off yesterday's file. We have to have the

 12 most up- to-date information as of the time of the

 13 default.

 14 Communications is very, very key because

 15 we have lots of stakeholders here. A lot of

 16 people, and a lot of preplanned, shall we say

 17 communications, have already been drafted that are

 18 ready to be sent out should the default happen.

 19 We all have now lists of people to call, the

 20 numbers, what to say when we call them, and the

 21 communication that we then give to them to inform

 22 them what's going on.
 67

 1 Regulators are invited as well to attend

 2 our default fire drills to see what's happening.

 3 Certainly our primary regulators are involved in

 4 many of them, but we have many examples of

 5 regulators who are secondary regulators who come

 6 in as well to see what's going on.

 7 By our policy we must have one

 8 group-wide default fire drill every year, but as I

 9 said we have ten default funds. So each default

 10 fund will have ad hoc fire drills throughout the

 11 course of the year, but we need to be able to

 12 ensure that we can stitch everything together.

 13 And when you stitch it together, the fact that

 14 normally people who aren't talking to each other

 15 are now suddenly talking to each other, what

 16 happens is we need up-to-date, real-time reports

 17 on where we are relative to the defaulted member's

 18 resources. So have we used it up yet, or how are

 19 we using it up, and how much have we used up. And

 20 to the extent that we're starting to invade skin

 21 in the game gives us a sense of how successful we

 22 are in dealing with the default. So that's the
 68

 1 planning.

 2 The execution I think is pretty similar

 3 to what has been said, so I'm not going to go in

 4 there.

 5 I would say, finally though, the

 6 evaluation phase. So you do this default fire

 7 drill and so what? Well, of course, when group

 8 risk plans out the things to test so to speak to

 9 make sure that we hit the sore points, that will

 10 give us a scorecard if you like of the things that

 11 didn't quite work. This scorecard is taken by

 12 audit to the Board and that ensures that there's

 13 absolute focus on remedying these issues because

 14 there's no point in running a fire drill if you

 15 don't learn anything from it. So I would say that

 16 it's a very disciplined exercise.

 17 After all, we've been around as a

 18 company for I think 170 years or so, but it's

 19 really only in the last 10 years, in the last 5

 20 years particularly, that the science of how you

 21 run a default fire drill has changed pretty

 22 dramatically. And I would say that we're finding
 69

 1 that the operational part of this is absolutely

 2 key because the traditional CCP was always focused

 3 on financial resources. This is something else.

 4 So we're just dealing with a very complex world

 5 that we probably haven't been used to dealing with

 6 and this is the evolution, the next step, so I

 7 think things are moving on.

 8 I think that's probably enough because

 9 the other people have probably said everything I

 10 need to say. Thank you very much.

 11 MR. KLOET: Thank you very much, Dennis.

 12 We have run well past what I thought we would run

 13 in terms of the time on this, although to be very

 14 frank, this sets the stage for some of the

 15 important discussions we have to have. So I did

 16 intentionally let it go a little longer because I

 17 think as we think of this committee as an

 18 iterative process, this really very well sets the

 19 stage for a number of discussions I think we have

 20 to have.

 21 What I'd like to do is I know --

 22 Kristen, you had your card up and I want to give
 70

 1 you a chance to ask a question. I think it was

 2 you who had your card up first. I'm going to take

 3 two questions and if I can limit it to questions

 4 directly related to the CCP's plan. I'm going to

 5 ask you to hold comments on it because while I do

 6 want to engender comments, I'm going to come back

 7 and ask for comments later. I have a series of

 8 questions I'd like to go to about what a real-life

 9 default scenario would look like because I think

 10 the plans themselves are very well laid out. The

 11 three CCPs have done an excellent job showing us

 12 those. But what I'd like to do is provide to the

 13 Commission some of the industry's thoughts on what

 14 a real-life scenario would be.

 15 So I want to get into that discussion a

 16 little bit in a second, and I have a few speakers

 17 lined up on a few questions along that line. But

 18 with that said, I'll have two questions; if we can

 19 have the responses and the questions relatively

 20 quick so that we can get on to that further

 21 discussion.

 22 Dennis, I'm going also plant a seed here
 71

 1 that within the next 45 minutes I'm going to try

 2 to come back to as well. Dennis referenced in the

 3 middle of his presentation a suggestion to the

 4 Commission with respect to coordination. The last

 5 question I'm going to ask today for this panel is

 6 -- and it's a really important one -- is what

 7 should the Commission be doing? What can we ask

 8 -- the regulator is asking us as an industry to

 9 give them feedback. So I want everybody to be

 10 thinking about what thoughts we have that the

 11 Commission should be thinking about? I have a

 12 couple. I'm sure a whole bunch of us do. But

 13 where we add value is giving them thoughts as to

 14 what they should do, and I want to clearly do that

 15 before we get to the end.

 16 So with that, Kristen, I'm going to hand

 17 the mic to you. Then we'll come over to you and

 18 then we'll go to some of the other questions that

 19 I articulated before.

 20 MS. WALTERS: Thank you very much. My

 21 question actually refers to page 4, Ian, of your

 22 initial deck. So as an asset manager, clearly
 72

 1 we're charged with managing on behalf of clients

 2 in a fiduciary capacity. We're not counterparties

 3 to these transactions, but it's our responsibility

 4 to understand at a highly granular level two

 5 things: One, the actual estimate of potential

 6 loss to our clients in the instance of default.

 7 In this case Ian has presented a case with

 8 simultaneous default of two clearing participants.

 9 And second, to make sure that we

 10 understand the totality of the loss-absorbing

 11 resources of the CCP so that we can ascertain

 12 whether there is sufficient resources to cover

 13 potential client losses and to provide

 14 transparency to our clients to understand if they

 15 actually want to embed that risk in their

 16 portfolios or choose other options potentially

 17 off-exchange in bond form.

 18 So, Ian, my questions are -- I'm looking

 19 at page 4 of your deck -- based on your

 20 risk-modeling results, what is the actual total

 21 expected dollars that you view would be required

 22 to absorb simultaneous default of two clearing
 73

 1 participants? And how does that relate to the

 2 financial resources that you've listed on your

 3 page?

 4 So you've listed initial margin of $17

 5 billion, a guaranty fund of $2 billion, and ICE's

 6 capital contribution of $50 million, and I'm

 7 assuming unfunded assessment rights. In

 8 particular, what is the role of the $17 billion in

 9 initial margin with regard to absorbing losses in

 10 the instance of default? Clearly we view this as

 11 sacrosanct and something that would not be

 12 considered at all in the context of financial

 13 resources in the event of default beyond the IM of

 14 the defaulting clearing member.

 15 MR. KLOET: So if I can just make sure I

 16 understand the question. I think you're asking a

 17 really great question. What's the risk of me as

 18 customer A within a clearing firm if it is

 19 customer B that creates the default -- or, I'm

 20 sorry -- clearing member A and clearing member B

 21 creates the default as clearing member A's margin

 22 at risk.
 74

 1 MS. WALTERS: It's actually a little

 2 simpler. So what is the total expected loss

 3 that's being modeled by ICE if two clearing

 4 members default simultaneously? What's that

 5 dollar amount and how is it derived? And two,

 6 what financial resources are available to absorb

 7 that loss and how would they be allocated? And

 8 specifically, I am concerned about seeing $17

 9 billion in initial margin as a financial resource

 10 that ICE would use in the event of a default.

 11 MR. SPRINGLE: So maybe I'll speak to

 12 that a little bit. So the initial margin

 13 component is the collateralization of the losses

 14 of each CP's portfolio under distressed

 15 conditions. The guaranty fund is then the

 16 uncollateralized. We look at the loss of two of

 17 the biggest CPs, biggest loss-generating CPs, and

 18 we look at what we haven't collateralized through

 19 our initial margin and then we hold additional

 20 funds for that. So the combination of the two of

 21 them is designed to address the cover 2 scenario

 22 that we have. So the $17 billion is a large
 75

 1 number, but don't forget that that $17 billion is

 2 the sum of everybody's initial margin. So if

 3 there's a CP default, if it's one CP's default, it

 4 won't be $17 billion that we have. It will be one

 5 CP's initial margin. It's much less than the $17

 6 billion that we have on the page.

 7 So the funds that we compute that we

 8 require to address that cover 2 is the sum of the

 9 defaulting CP's initial margin plus the guaranty

 10 fund. And then we have an additional $50 million

 11 from ICE's contribution designed really to align

 12 the incentives of the clearinghouse in making

 13 decisions with those of the CP's. And then the

 14 assessment rights can be thought of kind of

 15 additional funds on top of the amount that we

 16 computed that we needed that we have in reserve.

 17 So at the moment, for every defaulting

 18 CP, the expectation is that we can call an

 19 additional amount of the guaranty fund. We have

 20 plans in place in other clearinghouses. We limit

 21 that to three times the guaranty fund for three

 22 defaults. So we're allowed to call another amount
 76

 1 of the guaranty fund from everybody up to three

 2 times if there are three defaults.

 3 MS. WALTERS: So, thank you.

 4 Unfortunately, you didn't actually answer my

 5 question. I think we can take this offline, but I

 6 think it is very important, in fact essential, for

 7 the CFTC working with all of us at the table to

 8 actually understand this math. If two clearing

 9 members default simultaneously, what is the loss?

 10 If a loss happens, how is it absorbed? Who

 11 absorbs it, in what order, and what is the role of

 12 initial margin in that context, bearing in mind

 13 that any use of initial margin is going to have a

 14 direct impact on investor behavior?

 15 I think as an asset manager we have kind

 16 of unique insight into this. So the extent to

 17 which there are issues with a CCP before a

 18 liquidity crisis occurs, as it is actually

 19 percolating our clients will close out their

 20 positions. Again, I don't want to take more time,

 21 but talking about this math is something that we

 22 have to do, all of us, whether we're a central
 77

 1 clearinghouse, clearing members, and investors,

 2 buy-side firms.

 3 MR. KLOET: I think I'd like to ask Bob

 4 to -- first off, thank you for the question

 5 because it's a great question. I agree with your

 6 call for some transparency and an understanding

 7 about this. Bob, I think you can add some

 8 important elements about how the rules work around

 9 this, how the regulation works around this. So I

 10 want to ask you to step in and comment on this.

 11 MR. WASSERMAN: I should note that that

 12 $17 billion figure, that is simply not available.

 13 What is available is the initial margin of the

 14 defaulter. And I should note CPMI and IOSCO

 15 recently issued back at the end of February a

 16 quantitative disclosure framework that is going to

 17 require for those entities that are going to be

 18 compliant, or consistent rather, with the

 19 principles for financial market infrastructures --

 20 and basically that is required in our rules for

 21 systemically important DCOs and those who have

 22 opted in -- to provide that kind of information
 78

 1 and so you'll be getting those numbers. And so

 2 the cover 2 number really would need to be covered

 3 at least by the default fund plus the initial

 4 margin of the defaulter's assessments would be on

 5 top of that because you have to have prefunded

 6 amounts already there, again, limited to the

 7 initial margin only of the defaulter.

 8 I will say a lot of times I've seen CCPs

 9 provide the total amount of initial margin they

 10 hold. It's a very impressive number, but,

 11 frankly, it's not really relevant.

 12 MR. KLOET: Thank you for the clarity

 13 there, Bob. I think that's an important point.

 14 It gets at one of the hearts of the question

 15 because let's remember among the key things here

 16 is that the integrity of the markets is something

 17 that we have to make sure the system protects at

 18 all times. That's the most important thing.

 19 That's why we're here. Understanding that is

 20 important because I think Kristen is raising a

 21 good end user view on the exposure and what it

 22 would really mean if it weren't the case. Anat?
 79

 1 MS. ADMATI: Thank you. I do want to

 2 note that $50 million -- that's an "m" in front of

 3 it -- that's a very small amount in these markets.

 4 So my question is quite related to the

 5 issues that already came up because we say a

 6 member and there are members and there are

 7 members. So there is MF Global, but there's JP

 8 Morgan Chase, and those are very different

 9 members.

 10 So the scenario that we're talking about

 11 is one where -- you know, another duty I have,

 12 which is Advisory Committee to the FDIC on

 13 systemic resolution comes in. What exactly is the

 14 scenario for the systemic ones, which are kind of

 15 the ones we should worry about the most? Because

 16 in a scenario of their default, should we ever get

 17 there, which I'm not sure we'd allow, then it's

 18 far from unique in that particular scenario and so

 19 assessment abilities and other things should be

 20 questioned.

 21 But I am concerned and I want comment on

 22 closeouts specifically and also on stay because I
 80

 1 know the safe harbor provisions, and we were

 2 taking hours here to do this, but I think under

 3 FDIC Title II resolution, there is 24 hours of

 4 stay potentially and there was some action with

 5 ISDA about buying into that, which some did and

 6 some didn't, so they dispensed with the two

 7 counterparty czar. So there are a lot of details

 8 here that I feel must be ironed out when the

 9 particular defaulting member might be or is

 10 considered potentially to be before a default a

 11 systemic institution.

 12 MR. KLOET: Thank you. I think that was

 13 more of a comment than a question, but if you have

 14 a response --

 15 MR. WASSERMAN: Just a very quick

 16 observation -- well, two quick observations. I

 17 think when you look at who's going to be driving a

 18 cover 2 scenario and who's systemically important,

 19 in most CCPs certainly the larger ones. I think

 20 there's going to be heavy overlap there.

 21 The second thing I would note very

 22 importantly is that the stay does not apply to
 81

 1 payments to clearinghouses except insofar -- to

 2 the extent that if there's a failure of payment

 3 when due to a clearinghouse, the clearinghouse is

 4 permitted to liquidate without regard to that stay

 5 or rather as part of the provisions under Title II

 6 because, of course, it would be inconsistent with

 7 the nature of a clearinghouse.

 8 MR. KLOET: Thank you, Bob. With that I

 9 want to move on to take a step in front of the

 10 presentations we just had and have a conversation

 11 about a couple of questions.

 12 First, what's the most likely real-life

 13 default scenario of a significant clearing member?

 14 I mean in other words what would be the cause of

 15 that, and what would it look like? How likely is

 16 it that that default scenario of a significant

 17 clearing member would be escalated to that -- or

 18 isolated I should say -- to that clearing member;

 19 or alternatively, how likely is it that multiple

 20 clearing members and clearing members with

 21 multiple CCP memberships would be affected as

 22 well?
 82

 1 And, finally, another question I'd ask

 2 is what would be happening on the road to default?

 3 What would it look like on a path before a

 4 default?

 5 So I think we have three people that I'm

 6 going to ask for some short comments from. First

 7 I'll ask Susan McLaughlin from the Federal Reserve

 8 Bank of New York to comment first.

 9 MS. McLAUGHLIN: Thank you. Can you

 10 hear me okay? I'd like to thank the Commission

 11 for the opportunity to participate in this

 12 important discussion.

 13 I probably will leave aside the question

 14 of what the real-life scenario will look like and

 15 let those closer to the day-to-day in these

 16 markets answer that. But I think it's likely a

 17 default of a clearing member would occur in a

 18 stressed market environment featuring elevated

 19 price volatility and reduced market liquidity.

 20 And the default could either be a product of

 21 stressed market conditions or could itself

 22 precipitate stress.
 83

 1 For this reason, CCPs and the regulatory

 2 community should do everything possible to ensure

 3 that CCPs are a source of strength and not

 4 instability in stress. If the CCP were able and

 5 willing to perform on the defaulting member's

 6 payment obligations to other CCP members, we'd

 7 expect the default to remain isolated to that

 8 clearing member. However, if a CCP were for some

 9 reason unable to perform on the defaulting

 10 member's payment obligations in a timely manner

 11 and in the expected currency, its surviving

 12 members would face liquidity shortfalls that would

 13 quickly trigger a cascade of failures on their

 14 obligations to their counterparties beyond the

 15 CCP, transmitting liquidity risk more broadly to a

 16 wider set of market participants.

 17 A key public policy benefit of central

 18 clearing is the role that CCPs can play in

 19 mitigating systemic risk and contributing to

 20 financial system stability during a stress event

 21 by stepping in for a defaulted member to avoid the

 22 sort of contagion that I've just referred to. A
 84

 1 well- managed CCP can serve as a source of

 2 strength and stability by mitigating the risk of

 3 contagion.

 4 As part of this, it's really critically

 5 important that there's ex-ante clarity regarding

 6 the rigor and credibility of the CCP's stress

 7 testing and the quality and reliability of its

 8 liquidity resources. This is essential to build

 9 market confidence in the CCP's ability to manage

 10 through a stress event. If members lack

 11 confidence that they will receive amounts owed in

 12 a timely manner, they may not continue to make

 13 payments into the CCP. In extremis, this dynamic

 14 could depress new trading activity, undermining

 15 broader financial market functioning.

 16 Similarly, if members and end users lack

 17 confidence in the robustness of the CCP's

 18 back-testing and stress-testing processes, they

 19 may doubt that the clearing fund is adequate to

 20 cover all credit obligations of the defaulting

 21 member during the transaction back to a matchbook.

 22 And they may pull back further activity from the
 85

 1 CCP in an effort to limit their potential losses,

 2 thus undermining market liquidity.

 3 At the Fed, we scrutinize FMUs' default

 4 management procedures in our supervisory and

 5 oversight processes carefully, particularly with

 6 respect to liquidity risk management, to determine

 7 whether FMUs are adequately preparing to meet

 8 their obligations in a stressed context in which a

 9 large default or multiple defaults could occur.

 10 We want to see things like the underlying

 11 assumptions being appropriately conservative, not

 12 simply assuming the default is occurring in benign

 13 market conditions. We would like to see expected

 14 liquidity needs sized based on the robust stress

 15 testing. It's important that resources to meet

 16 intraday payment obligations to members are

 17 available whenever needed. The CCP should have a

 18 credible strategy for returning to a balanced book

 19 of positions through liquidation or auction of the

 20 failed clearing member's portfolio, and that

 21 there's a clear and transparent process ex-ante

 22 for allocating credit losses resulting from the
 86

 1 liquidation of the member's portfolio among CCP

 2 members and end users. And these criteria become

 3 even more important when we contemplate the

 4 defaults simultaneously of multiple members.

 5 Maybe I can hand it off at that point to

 6 my fellow speakers.

 7 MR. KLOET: Thank you, Susan, for those

 8 important insights. Scott Flood represents Citi,

 9 and Scott, I'd like you to make a few comments as

 10 well, please.

 11 MR. FLOOD: Sure, thank you. In looking

 12 at this, you had asked what would happen on the

 13 road to default. One of the things that we

 14 thought about is that we think it's going to be a

 15 very bumpy and uneven road. In going down that

 16 road, we think that a significant clearing member,

 17 if they default, that lots of other things are

 18 likely to happen in other markets and it will be a

 19 default across multiple asset classes, that all of

 20 the significant clearing members are also members

 21 of multiple CCPs.

 22 We also should recognize at least at
 87

 1 this time that this clearing member is going to

 2 have activities outside of this market, so we're

 3 going to see a lot of activity in the repo market,

 4 for example, where there are also defaults

 5 happening. There is some market in uncleared

 6 swaps that continues to exist so there'll be

 7 bilateral defaults that are happening also at this

 8 time and defaults in other markets that are

 9 happening to this member that will cause stress

 10 and liquidity needs and liquidity dislocations in

 11 the marketplace at the same time.

 12 We don't think that it's likely that

 13 this will be isolated, but it will depend a great

 14 deal on what kind of default and what the event is

 15 that has driven the default. We've seen all kinds

 16 of defaults over the last 20 years and that they

 17 have been in pockets and fairly unique. In some

 18 cases they're event driven, so they might be

 19 driven by a market dislocation like in 1998 with

 20 long-term capital where the Russian ruble affected

 21 multiple entities all at the same time that were

 22 directional in that view. And so it wouldn't be
 88

 1 isolated in that type of situation. It could also

 2 be operational that could affect multiple CMs at

 3 that time. And also, as pointed out, there could

 4 be a lack of confidence that starts to bring to

 5 the marketplace where a significant clearing

 6 member that is defaulting could cause a lack of

 7 confidence in the marketplace, generally with

 8 clearing members of that type, that starts to

 9 promote a liquidity scare and a liquidity need

 10 that happens in the marketplace at that time.

 11 We think that there will be challenges

 12 in valuations that are occurring at this time that

 13 will make potentially the investment management of

 14 the collateral a challenge. So there could be

 15 additional collateral calls on other CMs and that

 16 might accelerate other defaults that occur because

 17 of the liquidity and the drying up of liquidity at

 18 that time. So changes in variable margin caused

 19 by a stressed market, changes in initial margin

 20 caused by a stressed market, changes in the

 21 default fund as the default fund is being

 22 liquidated that calls for additional assessments
 89

 1 in short periods of time could drive and actually

 2 cause additional defaults by other clearing

 3 members through their own liquidity needs and

 4 their liquidity drains that are happening in the

 5 markets that are emanating from the CCPs.

 6 A couple of just quick things to

 7 consider: I think we heard very interesting

 8 presentations, and I think that there are

 9 additional considerations that we should think

 10 about. One of the things is there's a requirement

 11 that there are adequate traders that are available

 12 to do and to absorb all the valuations that are

 13 happening in the market needs at a very stressed

 14 time. And what happens if those traders aren't

 15 available or they're actually trying to resolve

 16 their own portfolios at that time and aren't

 17 available for secondment? So there could be a

 18 human resource drain that is also happening at

 19 this time.

 20 The other thing is that there may be and

 21 there probably will be -- if a significant

 22 clearing member defaults, there probably also will
 90

 1 be customer defaults that are happening also at

 2 this time that adds stress to the marketplace.

 3 Just a few observations that I think:

 4 What could be helpful is uniform default

 5 management and coordinated default management here

 6 in the United States and with the European

 7 clearing organizations, and transparency on the

 8 stress as well as the default frameworks that

 9 we're using.

 10 And I will pass it to Emily.

 11 MR. KLOET: I'd like to ask Emily

 12 Portney from JP Morgan to come up.

 13 MS. PORTNEY: Can you hear me? First of

 14 all, thank you very much for the opportunity to be

 15 present at this committee. I'm going to try to

 16 keep it very brief, too, and cover things that we

 17 think about as a clearing member. And we actually

 18 think that this committee, as well as all market

 19 participants, should be thinking about on the road

 20 to default as well as during a default or

 21 post-default.

 22 So certainly in terms of the road to
 91

 1 default, I think my colleagues covered it well,

 2 that it can be an idiosyncratic stress event that

 3 ultimately erodes market confidence and puts a lot

 4 pressure economically on lots of market

 5 participants. It can be a stress on a single

 6 player, but ultimately that has some market

 7 contagion. So there can be lots of different

 8 reasons for it.

 9 The one thing that we would like to call

 10 attention to is that on the road to default

 11 generally speaking something that CCPs would do,

 12 understandably so, is to impose trading

 13 restrictions on a member that they'd be worried

 14 about defaulting, increase margin requirements

 15 across all members, increase the frequency of

 16 margin calls, and probably also increase haircuts,

 17 all of which when you think about it are

 18 procyclical. So just something to consider, or we

 19 all as a market should possibly be considering, is

 20 just the procyclicality of these measures and,

 21 whether it's popular or not, definitely there

 22 should be more transparency in and around how
 92

 1 these measures are set should there be some floors

 2 or minimum requirements on margin; likewise,

 3 minimum haircuts, similar to what's being applied

 4 to banks for the LCR; and some restrictions on

 5 actual collateral and what types of securities can

 6 be used as collateral. So that's on the road to

 7 -- I'm trying to cover things that haven't been

 8 covered -- but on the road to default, I would

 9 think about some of those things.

 10 In terms of an event of default, so a

 11 clearing member is defaulting. The one thing we'd

 12 like to call attention to is the fact that CCPs do

 13 have very broad-based powers in terms of when it's

 14 within their interpretation or how they can

 15 declare a default. So, for example, it can

 16 certainly be insolvency and bankruptcy of a

 17 clearing member, which I think all of us would

 18 agree would make sense. It can be an appointment

 19 of an administrator or receiver, which I think all

 20 of us would agree would make sense, a breach of

 21 rules. Also, though, it can just be within their

 22 sole determination that a clearing member just
 93

 1 does not have adequate operational or financial

 2 resources, or they feel that they are approaching

 3 a point where they won't have adequate financial

 4 or operational resources. It can also be because

 5 an affiliate of a clearing member actually

 6 defaulted when actually the member itself is

 7 fulfilling all of its obligations and performance.

 8 So the other thing we would just draw attention to

 9 is that at the point of default, CCPs have a lot

 10 of discretion. And each CCP is very different

 11 when you look at the rulebooks around what exactly

 12 is an event of default. You can easily get a lot

 13 of certainly confusion, especially if those

 14 clearing members are members across lots of other

 15 clearinghouses.

 16 In terms of post-default -- and I'll

 17 just add a few comments because I think a lot of

 18 things have been covered -- certainly what happens

 19 we've all talked about. The secondment of traders

 20 to actually participate in default management and

 21 the auctions. I think everyone has called

 22 attention to this fact, but there is a potential
 94

 1 human resource drain and, frankly, one of the

 2 things I would really highlight here is especially

 3 as less liquid products are being pushed into

 4 clearinghouses, whether it is swaptions or

 5 inflation swaps, the likelihood of not having

 6 enough traders to actually participate in the

 7 default management process could be a real issue

 8 that we have to think about.

 9 When we get to liquidation or auction,

 10 something I would highlight is that every

 11 clearinghouse has a different bidding process; a

 12 different auction process; the consequences of

 13 participating, not participating are very, very

 14 different. So the consequences of a failed

 15 auction, very different. Is it invoicing back,

 16 allocating the positions? All of the things that

 17 we're talking. So, again, it's a lack of clarity

 18 and the fact that across every clearinghouse it

 19 can be very, very different. So if you're a large

 20 clearing member of many clearinghouses, you're

 21 trying to prepare for every possible alternative

 22 and option and that's hard.
 95

 1 Something we haven't talked about yet,

 2 but -- well, we've mentioned -- and, again, I

 3 think the clearinghouses have a good job of

 4 outlining their plans, but the things you have to

 5 think about are porting of positions. There's an

 6 obligation for all market participants to

 7 certainly help out and try to port positions. I

 8 will tell you that, especially in this environment

 9 when we think about just pure capacity nowadays --

 10 and I'm not talking about operational capacity,

 11 but we're also talking about capacity in terms of

 12 balance sheet and capital -- we really do have to

 13 think about whether if a large clearing member or

 14 more than one went down, would there be another

 15 clearing member that actually could take on that

 16 book of business in light of the capital

 17 considerations that we all now have?

 18 Liquidity we talked about. Certainly if

 19 the initial margin of a defaulting member should

 20 not be sufficient, you hit the default fund. And,

 21 of course, you have to think about what if the

 22 default fund itself, which is the funded portion
 96

 1 as everyone talked about, is not sufficient?

 2 Well, then you move into things like assessments,

 3 which I think we've been very public about our

 4 view, especially given the size of assessments can

 5 be anywhere from 2 times, 3 times, or 5.5 times

 6 and this is tens of billions of dollars, whether

 7 they will really be there. You also move into

 8 things like payment in kind, variation margin

 9 haircutting, all of these things that just put

 10 additional liquidity pressures and funding

 11 pressures on all market participants, and we have

 12 to be thinking about that sort of thing.

 13 And so for us, we would say think about

 14 the unfunded portion of this stuff. Do we have to

 15 move whether it's popular or not to some form of

 16 funded resolution plan at some point for a CCP if

 17 funded resources are not sufficient? So I would

 18 just highlight some of those concerns.

 19 And the only other thing I would just

 20 say is I think we all talk about and we get a lot

 21 of comfort perhaps in like oh, we handled Lehman,

 22 but a lot has changed since 2008. Volume at
 97

 1 clearinghouses obviously has increased

 2 tremendously. The number of market participants

 3 now participating in clearing has increased

 4 tremendously. Concentration of CCPs and clearing

 5 members has increased, so you have less

 6 participants and certainly reliance on a few. The

 7 interconnectedness of the markets is more.

 8 Obviously the same clearing members are members of

 9 all the same clearinghouses. We're talking about

 10 cross-margining. We're talking about open access.

 11 When we talk about -- we did mention that

 12 certainly some clearing members' affiliates are

 13 settlement banks and custodians. So if one of

 14 those clearing members is having an issue, they're

 15 likely having an issue all over the board.

 16 Likewise, most clearing members have affiliates

 17 who are responsible for providing all of the

 18 liquidity because of the new liquidity

 19 requirements for CCPs. So it's all circular and

 20 we should all be thinking about the

 21 interconnectedness, which is much more than it

 22 used to be.
 98

 1 I already talked about the capacity in

 2 terms of capital and everything else that we

 3 certainly have to talk about and that could impact

 4 actual, realistic -- whether or not portability is

 5 realistic. Likewise, there's a bigger move to

 6 less liquid clearing, less liquid products

 7 potentially expanding collateral. Fully

 8 understand why end users want that, but we have to

 9 think about what that actually means.

 10 So from our perspective, and people have

 11 kind of already highlighted it, it's very much

 12 around further transparency, a bit more

 13 consistency perhaps, certainly more

 14 predictability. We do need coordination. We have

 15 to think about multiple defaults of clearing

 16 members and potentially more than one CCP and

 17 certainly minimum standards on haircuts,

 18 collateral, margin, and finally, CCP resolution.

 19 As terrible as that sounds, what happens if that

 20 should happen?

 21 MR. KLOET: Thank you, Emily. Those are

 22 important comments. I'm going to take the
 99

 1 prerogative of the moderator and make one comment.

 2 Referenced in the middle there somewhere were some

 3 important comments you made about customer

 4 portability. As I was listening to the CCP

 5 presentations, I have a personal view that I'll

 6 express that is that in the kind of scenario we're

 7 potentially envisioning, for the kind that we'd be

 8 concerned about impacting market integrity, it'd

 9 be my suggestion that customer portability will be

 10 anything but routine especially given the kind of

 11 capacity constraints you referenced, Emily.

 12 Then add to that things like the various

 13 products that people may be carrying where they

 14 are hedging one asset by using the risk management

 15 products within the futures markets for them. And

 16 then continue to expand that scenario to be

 17 international in scope. So I would suggest that

 18 as the MRAC continues to evolve, Commissioner, I'd

 19 suggest that we spend a little more time on

 20 customer portability because one could frankly

 21 take comfort in the fact that yeah, it's all going

 22 to be okay and we'll take care of moving
 100

 1 customers. But even healthy customers with good

 2 positions may be hard to place in the kind of

 3 volatility that we may expect to see in a

 4 significant default scenario. So I think customer

 5 portability would be something easy to

 6 underestimate the importance of.

 7 Commissioner Wetjen, you had your card

 8 up. Are -- okay, Chairman?

 9 MR. MASSAD: Well, let me just ask a

 10 question. But, Tom, I'll defer to your plans in

 11 terms of how you want to run this because frankly

 12 my question is something that I would like this

 13 group maybe to spend about an hour discussing at

 14 some later date, and that's to follow up on the

 15 issue of coordination between CCPs and in

 16 particular Dennis's comment about how that may be

 17 difficult given legal concerns, about possible

 18 legal actions by the trustee of the defaulted

 19 member.

 20 I guess what I'd like to ask of the CCPs

 21 as well as others on the committee is to think

 22 about what are the objectives of that
 101

 1 coordination, and what should we as the CFTC think

 2 about in terms of facilitating that coordination

 3 or cooperation?

 4 MR. KLOET: I think that's a subject

 5 that we could spend a whole lot of time on.

 6 MR. MASSAD: If you want to reserve that

 7 -- Sharon, if you want to reserve that for a

 8 separate discussion, I'm fine with that because we

 9 could --

 10 MR. KLOET: Let the commissioners and me

 11 confer on that, but my initial reaction subject to

 12 -- she is the sponsor and I fully respect that --

 13 but my initial thought is that we should have a

 14 panel on that or a section of the next panel on

 15 that because I think, Chairman, what we've done is

 16 create the framework for that discussion today. I

 17 don't want to take away from Professor's Lo's

 18 discussion on SEFs.

 19 MR. MASSAD: That's fine.

 20 MR. KLOET: But I actually think that's

 21 a really important question and would suggest that

 22 we spend a lot of time on it. And I think we're
 102

 1 proving the value that getting this group together

 2 to have that discussion would provide. I'm happy

 3 to go to either one of you.

 4 MR. GIANCARLO: Thank you and it's a

 5 question, not a suggestion for an hour-long

 6 discussion, so I'll make it quick. I found it

 7 very interesting Ms. McLaughlin's and Mr. Flood's

 8 concern about liquidity crunch as perhaps a

 9 trigger for widespread default, and Ms. Portney's

 10 concern about the human elements certainly to run

 11 any type of auction process. So my question to

 12 the CCPs is when you do your fire drills and your

 13 emergency risk scenarios, to what extent do you

 14 use scenarios that really stress the liquidity,

 15 market liquidity, scenario to come up with your

 16 fire drill analysis? How dire do you look at

 17 market liquidity issues when you do your fire

 18 drills?

 19 MR. KLOET: If you could keep the

 20 responses -- sorry, I don't want to short circuit

 21 it -- but if you could keep the responses

 22 relatively short because I have one other
 103

 1 important question to go through first that we

 2 have a brief presentation on.

 3 MR. CUTINHO: As I spoke before, these

 4 drills are hypothetical situations. So we use

 5 information that exists to structure the

 6 environment that I spoke about. These are

 7 stressed environments and it's important for all

 8 participants to know that it is a stressed

 9 environment. I think Scott referred to something

 10 good, which is the stressed environment impacts

 11 markets that are outside of CCP's view. I think

 12 the important thing that the Default Management

 13 Committees or Active Default Management Committees

 14 do, this is the importance of why we draw from

 15 these resources is they give us a sense of what

 16 does environment really mean outside the CCP's

 17 view. So it gives us a sense of what is

 18 available.

 19 The resource constraint that was raised

 20 is true, but it is the best of all the

 21 alternatives available and coordination between

 22 the CCPs is one way to resolve that. I'll also
 104

 1 give you another circumstance. When we plan our

 2 drills, it's important to also pick in our case

 3 the election, Greek election, was a period of

 4 stress now. So conducting a drill at that time

 5 was very informative, so we knew who would

 6 participate and who couldn't and why some

 7 institutions could not participate. So it gives

 8 us under good circumstances a venue for

 9 conversation to find out what are the real

 10 stresses, especially when it comes to resources.

 11 So that is my short answer to your question.

 12 MR. KLOET: So we have about 15 minutes

 13 left till our break -- oh, I'm sorry.

 14 Commissioner, you have one more question?

 15 MR. WETJEN: Thank you, just real

 16 quickly. Emily, you mentioned a number of actions

 17 that the CCPs can take on the road to default, so

 18 before an actual default. You mentioned that

 19 maybe one of the CCPs represented could answer.

 20 It wasn't clear to me based on your comments, but

 21 one of the things you said is that what can happen

 22 is more frequent margin calls, and then you had a
 105

 1 variety of suggestions about other things that

 2 CCPs might do that could be appropriate.

 3 So my question is are those spelled out

 4 in the rulebooks? Does it get into detail about

 5 how frequent margin calls might be? It seems like

 6 that might be kind of hard to do, but it wasn't

 7 clear from your remarks, Emily, whether there's a

 8 lack of transparency around that as well. So this

 9 again would be actions taken by the clearinghouse

 10 before a default.

 11 MR. CUTINHO: I think I'll answer it

 12 this way. It's important to make sure that CCPs

 13 have flexibility in terms of tools. At the same

 14 time, there is a lot of responsibility on CCPs,

 15 especially to make sure that from a systemic risk

 16 perspective, you don't make the matters worse. I

 17 know Dennis pointed out this issue, but at the end

 18 of the day what are the objectives of a CCP.

 19 Think about it. If a CCP were to do or act in a

 20 reckless manner in terms of frequent margin calls

 21 are imposing a liquidity strain, then it will only

 22 make matters worse for itself in terms of
 106

 1 resolving the default as well as creating an

 2 unstable environment. To give you an historical

 3 experience, and this is one of the things that we

 4 should keep in mind, we have a regulatory

 5 organization as a part of CME, our SRO. So we

 6 interact on the event -- before we get to a

 7 default, we interact very, very closely with other

 8 organizations such as FINRA and the SEC as well as

 9 the CFTC. So there is a lot of coordination

 10 taking place at the onset.

 11 There are new players such as FDIC and

 12 the Fed. It is important to get that transparency

 13 going ahead of time. Other CCPs who have the same

 14 clearing member join these coordinated calls. The

 15 objective of these calls is to make sure that we

 16 act in a very coordinated manner and we don't make

 17 the environment worse because sometimes default

 18 management is not a cookie cutter approach. You

 19 could get clients of a client book. You could

 20 protect the clients; get the client book of a

 21 clearing member in distress to a safe place well

 22 before the default of the firm. So that's
 107

 1 something that has happened in our experience. We

 2 have engineered these things without an impact to

 3 the clients. And the clearing member in distress

 4 also appreciates that because in some sense they

 5 are selling some assets and getting the most value

 6 they can get for these assets. But if CCPs

 7 increase the distress or impact the market, they

 8 will get less value and make matters worse for

 9 themselves. So I think CCPs are cognizant of

 10 that. We have a rich experience doing this. So

 11 it's important to keep that into account.

 12 Risk management cannot be restricted.

 13 So trading restrictions is not -- I wouldn't say

 14 it's trading restrictions. Risk management is a

 15 responsible action, but it's important to do it in

 16 a balanced manner. You want to make sure that an

 17 institution that is progressing in distress at the

 18 onset is not increasing its risks; it's reducing

 19 risk. It is a continuum and there are different

 20 stages of this continuum. So you want to get to a

 21 place where they're controlling their risk and

 22 overtime reducing the risk to a place where it is
 108

 1 manageable. Doing that in an orderly manner is

 2 much better for the broader market. I don't

 3 believe in restricting a CCP's capability to do

 4 that, and these processes are not arbitrary.

 5 They're done in a very organized manner and tying

 6 a CCP's hands or asking for an enumeration of all

 7 these actions, I don't think is the right

 8 approach.

 9 MR. WETJEN: I can agree to that. But

 10 maybe back to you, Emily, were you suggesting that

 11 there is a bit of lack of transparency around some

 12 of the tools that could be deployed before the

 13 default as well as is there not enough clarity in

 14 the rulebook?

 15 MS. PORTNEY: Well, certainly, I think

 16 there could be more clarity and more transparency,

 17 but I was probably also more trying to emphasize

 18 the fact that a lot of the measures that a CCP

 19 would take on the way to default are procyclical

 20 -- so raising IM ultimately, increasing haircuts,

 21 increasing the frequency in the number of times

 22 that you're calling for margin. We should be
 109

 1 thinking about now in what isn't a stressed

 2 environment whether, frankly, there are floors.

 3 For example, we're all talking about in separate

 4 markets like SEC lending, et cetera, whether there

 5 are minimum haircuts. There's other measures you

 6 can take now in a normal market that, again, might

 7 not be the most popular, but can at least ensure

 8 that it's not necessarily the actions that you

 9 take on the road to default are procyclical. But

 10 they'll be more conservative in peacetime.

 11 MR. KLOET: Commissioner Giancarlo, did

 12 you have a follow-up question to your earlier

 13 question? Okay. Sunil, did you want to respond

 14 to that?

 15 MR. CUTINHO: Yes, I want to quickly

 16 respond to a few things.

 17 MR. KLOET: Okay, because I think Susan

 18 had --

 19 MR. CUTINHO: I can't speak for every

 20 CCP, but CCPs should not change haircuts when

 21 there is -- haircuts are associated with

 22 collateral, liquidation of collateral, and they're
 110

 1 not associated with a specific institution. They

 2 are broad based, so they don't end up changing

 3 just because one specific institution or two

 4 specific institutions have a problem. Let's take

 5 the other view, like if institutions are having a

 6 problem and the collateral that's being used and

 7 its prices are volatile. Two things to keep in

 8 mind are CCP's mark-to-market collateral on a

 9 daily basis. As far as haircuts are concerned,

 10 they are designed with stresses in mind, so you

 11 take a stressed situation for this collateral.

 12 Haircuts are designed to cover those stressed

 13 circumstances. In fact, they are far more dynamic

 14 than static haircuts that are set. So in our case

 15 -- I mean Emily is right, there is liquidity

 16 facility. When you work with banks on a liquidity

 17 facility, you get a view into haircuts as well.

 18 So if you use a liquidation agent in the market,

 19 you get market color, and that gives you another

 20 source of information to set your haircuts. So

 21 haircuts are not institution specific.

 22 In terms of margins, I know there's a
 111

 1 lot of discussion about procyclicality of margins.

 2 The thing to keep in mind is -- and I have talked

 3 about this coordination -- the objective of a CCP

 4 when entering into is not to ratchet up the

 5 margins. That is counterproductive. Margins

 6 should be a function of the risk, not the credit

 7 profile of the institution. That's the role of

 8 margin. The margin should cover at the 99 percent

 9 level in the liquidation period for the risks that

 10 an institution has. If they change, they're a

 11 function of the market, again, not institution

 12 specific.

 13 So the thing to remember about

 14 procyclicality, the red herring argument here, is

 15 margin versus -- actually I think it was pointed

 16 out -- mark-to-market. I can see it's a function

 17 of the moving market, so that can be procyclical,

 18 but that is the nature of the market. Prices are

 19 moving. There is volatility and as a result you

 20 have mark-to-market. This is why we've got to be

 21 very careful about this word "procyclical." There

 22 are things that are procyclical and things that
 112

 1 are not.

 2 MR. KLOET: Thank you. Susan, you've

 3 had your card up for quite some time and I'd like

 4 to let you ask your question or make your comment,

 5 and then I'm going to move on to the next subject.

 6 MS. O'FLYNN: It's more a quick comment

 7 and it's just kind of I echo a lot of what Scott

 8 and Emily have said here in relation to kind of

 9 the dealer perspective, but I --

 10 MR. KLOET: Susan, can you get the mic a

 11 little closer? I want to make sure that people

 12 who are listening elsewhere can hear.

 13 MS. O'FLYNN: Better? Good. So I echo

 14 a lot of what Emily and Scott said in relation to

 15 earlier. I think it's the concept of identifying

 16 what's fundamentally important here. We want to

 17 reduce contagion, understand the

 18 interconnectivity, and then understand the CCP's

 19 response to that and how we create protections

 20 within the market.

 21 It's also -- and one thing that I didn't

 22 think was identified -- is a lot of the large
 113

 1 clearing members are other types of institutions

 2 than existed in 2007. They're better capitalized.

 3 They have more liquidity. So there has to be

 4 recognition of the fact that from a counterparty

 5 risk perspective, some of the large systemic

 6 institutions are in far better shape than they

 7 were in '07.

 8 It then comes back to ultimately

 9 resources, and it's margin versus default fund

 10 versus assessments. What's available? It's back

 11 to Chris' point at the beginning, knowing the

 12 numbers. And to me it just comes back to one

 13 fundamental kind of theme that runs through all of

 14 this, and it's transparency and kind of

 15 comprehensive understanding around how each CCP

 16 actually works. I think the industry is seeing

 17 that there has been -- and what's happening that

 18 the FIA is doing this year is the CCP rulebook

 19 review. For me, being a user of that, it's been

 20 very interesting for me to understand. It comes

 21 back to -- on the path to default, what are the

 22 powers that each different CCP has and how
 114

 1 proscriptive some of those are, or how implicit

 2 they potentially could be. So it comes back to

 3 kind of to me transparency, understanding kind of

 4 the stress testing that each different CCP uses,

 5 and potentially the role of this committee to be

 6 able to design those stress tests with clearing

 7 member input and regulatory input. So there is

 8 kind of real understanding that we have created a

 9 robust model.

 10 And that's where I'm going to draw the

 11 line because, as you say, we could on for hours.

 12 MR. KLOET: Thank you, Susan. I'd like

 13 to call on Mike Modlock from TriOptima because one

 14 of the comments earlier on was about what we can

 15 do -- what DCOs can do to either coordinate or

 16 standardize their practices in order to better

 17 address what would happen in a real-life default

 18 scenario. I think you had some thoughts on that

 19 and I'd like to ask you to share those.

 20 MR. MODLOCK: Yes, good morning, and

 21 thank you to the Commission for the chance to

 22 serve on the committee. I've been asked to say a
 115

 1 few words specifically on the concept of risk

 2 rebalancing for OTC derivatives between CCPs. And

 3 as we've heard today, there are more CCPs and

 4 multiple clearing venues.

 5 The way that we see this is as an

 6 opportunity to reduce systemic risk through the

 7 rebalancing of counterparty risk exposures. So

 8 what does that mean? Well, if we look at the

 9 clearing venues today, given trade is often

 10 determined to clear other CCP by the client,

 11 potentially you could have a clearing member with

 12 a relatively market risk neutral portfolio, but

 13 it's spread across multiple CCPs so that's not

 14 necessarily risk neutral at a netting set level.

 15 This leaves the clearing members with

 16 the task of managing that risk across multiple

 17 venues. Additionally to that, we could consider

 18 the fact that there are a number of products that

 19 are not clearable and all the bilateral netting

 20 sets that exist with nonclearing members, which

 21 are numerous again.

 22 The ability for a clearing member to
 116

 1 manage that risk, they can't offset the risk from

 2 one CCP to another and there's no mechanism in

 3 place at present for the CCPs to be able to

 4 provide that to the members. So what we think is

 5 the opportunity -- and highly benefits the default

 6 management process specifically -- is we believe

 7 that there's an opportunity to proactively

 8 rebalance these exposures. In terms of how that

 9 would help the default management process, we

 10 think it could make it simpler, potentially make

 11 it shorter. It's complementary to clearing. And

 12 ultimately we believe that if you can help the

 13 clearing members to be stronger by rebalancing

 14 those risk exposures, then that leads to a

 15 stronger set of clearing members at each CCP --

 16 whereas it's been pointed out are not members at

 17 all CCPs -- which, in turn, leads to a better

 18 default management process, reduced contagion

 19 risk, and improved financial stability.

 20 MR. KLOET: Thank you. I know there are

 21 some name cards in the air, but, unfortunately, we

 22 are very close to out of time. So what I'm going
 117

 1 to do is go back to the question I referenced

 2 before. In this case I also want to invite the

 3 outer circle members to participate as well. I

 4 may not be able to see all your cards, so you may

 5 have to like raise your hand or something. I

 6 don't think you have to stand up, but if you raise

 7 your hand or something, I'll probably see you.

 8 But the question -- and the Chairman

 9 kind of teed this up in a sense as well. What I'm

 10 thinking about here is we're laying a foundation

 11 for future discussions, but what role, if any, do

 12 you think the Commission should play in addressing

 13 these issues? I think with this question what

 14 we're particularly aiming at is, you know, is

 15 there something that the Commission may be missing

 16 in what they're doing today around these subjects

 17 that they should be looking at? And I think this

 18 is a question we will come back to later on as

 19 well, but maybe it'd be good to take a little bit,

 20 a couple of minutes, here before we break to get

 21 people's views. I already see panelists going up.

 22 So, Cliff, why don't I go to you first?
 118

 1 MR. LEWIS: Thank you. This is specific

 2 to your query as to advice, maybe welcome or

 3 uncongenial advice, to you people with a very

 4 difficult job. I think, in fact, one of the

 5 things that is a real challenge is not only are we

 6 sort of fighting the last war, recognizing that

 7 market structure is going to be very different,

 8 not only are we setting up utterly unrealistic

 9 scenarios that essentially could be characterized

 10 as sort of canned goods and ammo kind of risk

 11 management techniques where essentially the whole

 12 system is collapsed -- and that's a scenario that

 13 really you can't plan for inherently; it's why we

 14 have a lender of last resort, in fact, in

 15 situations like that. But the bigger issue I

 16 think is the coordination and consistency of

 17 government policy on the overall utility of these

 18 markets, which the decision has been made to say

 19 are going to be more important, in particular the

 20 mandating of clearing. And I think there is a

 21 pretty fundamental inconsistency between many of

 22 the capital rules -- and the Chairman I think is
 119

 1 doing standup work on this -- but can the system

 2 work with the regime that's being proposed in

 3 terms of leverage ratios SIFI premiums?

 4 And I think an honest answer would be

 5 no, but at least that's a question that has to be

 6 openly addressed by this committee, by others.

 7 And if the answer is no, then I think the

 8 Commission's responsibility is to help the

 9 industry figure out what an alternative clearing

 10 structure would look like. And to that extent all

 11 of the comments that the clearing firms are making

 12 are quite reasonable. You're saying hey, we bear

 13 the cost, we bear the risk, we get a small

 14 fraction of the upside for this. That will be

 15 reflected in their willingness, as they said, to

 16 accept portability. I mean is it feasible with

 17 the liquidity rule to really expect a major

 18 institutional user like BlackRock if JP Morgan

 19 goes under, the answer is no. That won't be able

 20 to happen. There's nothing that clearinghouses

 21 can do to fix that problem.

 22 So the question really is if you can't
 120

 1 get relief on some of these capital rules -- which

 2 in my view would not sustain, could not sustain,

 3 careful analysis as to their net consequences --

 4 but if you can't change them, then I think we need

 5 to have a long look at other regulatory changes

 6 because essentially that will mean that market

 7 participants will increasingly have to clear their

 8 own business, which is not unprecedented in the

 9 history of the markets. It's just not what's been

 10 going on really since the crisis, really since

 11 financial futures came in honestly is where the

 12 distinction was.

 13 So, again, a lot of things that the

 14 Commission could do, if only to hedge -- pardon me

 15 for invoking an industry term -- against alternate

 16 futures. One of the things I would really

 17 encourage -- and it's great to have Kristen and

 18 others from the owner asset management community

 19 here -- is to sort of query hey, what would make

 20 you more able to use these instruments as you do

 21 today, but with a model that would reduce the

 22 dependency on bank intermediaries, particularly
 121

 1 given that systemically important bank

 2 intermediaries may not be able to do this at an

 3 economic price.

 4 MR. KLOET: Thank you. Ed, I think you

 5 had your card up. Does it relate to this

 6 question?

 7 MR. PLA: Yes.

 8 MR. KLOET: Okay, please.

 9 MR. PLA: Thank you. I think maybe in

 10 response -- maybe the pithy answer to the

 11 Chairman's question about what could the objective

 12 be, I think maybe there are three principles that

 13 we should consider in terms of greater

 14 international coordination and fire drill

 15 management: Standardization, I think this has

 16 been raised multiple times; simplicity, I think

 17 any of us who are in the industry as practitioners

 18 who would reflect back on the last 6 to 8 years of

 19 developments would probably agree that we're

 20 living through a bull marketing complexity. And

 21 complexity to me engenders fragility and fragility

 22 is sort of the enemy of systemic stability by
 122

 1 definition. So I think anything we can do to

 2 increase simplicity and predictability of what

 3 we're doing internationally would be tremendously

 4 beneficial.

 5 So some examples might include things

 6 like standardizing certain elements of CCP

 7 rulebooks. We shouldn't be flipping through these

 8 things in a crisis to remind ourselves what they

 9 say. There should be a degree of consistency

 10 around auction management, whether that's

 11 communication or bid submission. The CME online

 12 tool for doing this could be a template and there

 13 could be others like that. So we should use

 14 existing tools and see if we can build on those.

 15 Standardization of elements of risk

 16 management: So to the degree that defining risk

 17 management principles is ultimately what protects

 18 the system, some consistency around transparency

 19 and the content of risk management principles I

 20 think is beneficial.

 21 And I think I'll probably leave it at

 22 that -- maybe Treasury management practices at
 123

 1 CCPs, but I think, again, stability,

 2 predictability, simplicity, I think all these

 3 things would be great.

 4 The second thing I'd say is that this

 5 notion of dress rehearsals is absolutely

 6 imperative and it's great that CCPs do them. But

 7 what's changed also since 2008 is the fact that

 8 CCPs are now tending to clear like products.

 9 Previously you had systems of vertical integration

 10 where you had certain contracts that were

 11 copyrighted and executed and cleared in exchanges.

 12 Now we have things like dollar interest rate swaps

 13 that can be cleared in multiple jurisdictions and

 14 multiple CCPs. That virtually guarantees

 15 contagion given the small number of clearing

 16 members.

 17 So I think, again, we need to -- I know

 18 it's a challenge because we have international

 19 regulators and many different stakeholders -- but

 20 I think we have to recognize that thankfully,

 21 these things happen very infrequently. Crisis

 22 management understanding and knowledge has a half-
 124

 1 life. It decays. Many of the people who lived

 2 through Lehman or MF Global or Revco have moved on

 3 in their positions or are not in the industry

 4 anymore. So dress rehearsals in this kind of

 5 international coordination provides a very

 6 countercyclical booster shot of understanding and

 7 predictability. So I think to Emily's point when

 8 we talked about procyclical things, these sorts of

 9 things or the principle might be, what are the

 10 things we can do that are countercyclical that

 11 protect us in advance?

 12 And then the third I would say is

 13 minimum thresholds for skin in the game not just

 14 relating to CCPs, but it strikes me that given the

 15 amount of conversation we're having about default

 16 management and so forth, maybe there needs to be a

 17 refreshed conversation about the adequacy of

 18 initial margin. The beneficial owners who are

 19 putting risk into the system incrementally

 20 ultimately should be putting sufficient capital

 21 behind that initiation of risk so that, hopefully,

 22 we never get to the point where we're implementing
 125

 1 assessment rights and haircutting variation

 2 margins and so forth. So, again, sufficient skin

 3 in the game not just for CCPs, but beneficial

 4 owners of the risk through a reexamination of

 5 initial margin principles.

 6 MR. KLOET: Thank you. Marcus Stanley,

 7 I think you had your panel up.

 8 MR. STANLEY: Thank you. This actually

 9 relates to a lot of things Edward was saying, so

 10 maybe it's a good point. I think that when we

 11 think about this from the public interest

 12 perspective, we have two real kinds of priorities.

 13 One is that the price of derivatives in normal

 14 times really reflects some of these tail risks

 15 that can materialize. And the CFTC has only

 16 limited control over that because some of the

 17 margin and capital rules are also dependent on

 18 other regulators. But the dependence on internal

 19 models at CCPs I think can create a situation or

 20 nonstandardized internal models can create a

 21 situation where those tail risks are not genuinely

 22 priced in. I was looking at an IMF simulation
 126

 1 that claimed to find that just changing the

 2 portfolio netting assumptions from extremely high

 3 portfolio netting just down to moderate portfolio

 4 netting increased default potential, default fund

 5 contributions, by tens to hundreds of billions in

 6 a stressed market scenario. So these are things

 7 in terms of detailed oversight of those internal

 8 models that the CFTC can do.

 9 And I think the second thing, which

 10 follows on what Edward was saying, is that we

 11 obviously can't price the entire tail in because

 12 there are potentially unlimited liabilities here

 13 practically. And we really have to standardize

 14 the process of default. And I think clearinghouse

 15 wind down in a way that is ex-ante very, very

 16 clear to people, whether it's by trying to

 17 standardize this process of default management

 18 across clearinghouses, but also introducing some

 19 kind of wind down and tear up process if an

 20 auction has failed. If the portfolio cannot be

 21 rebalanced, introducing that process in a clear,

 22 quick, swift manner so people reach a point of
 127

 1 clarity, of what their actual situation is instead

 2 of keeping these potentially unlimited liabilities

 3 out there changing day to day. That certainty

 4 could really be beneficial. Even if it means that

 5 there are losses taken by market participants, at

 6 least they know what those losses are. And I

 7 think there's a real role for regulators in that

 8 clearinghouse wind down, and I think that's much

 9 preferable to a public backstop for

 10 clearinghouses.

 11 MR. KLOET: Thank you. Anat Admati.

 12 MS. ADMATI: I want to echo some of the

 13 comments about sort of reducing the procyclicality

 14 by being better prepared. One thought, something

 15 that didn't come up, but I urge the Commission to

 16 look at, is the margin rules with respect to are

 17 they uniform for participants because it seems

 18 important that there are no presumptions made for

 19 any participant, including the CCP and the others,

 20 of bailouts. So to the extent that an end user

 21 has a margin requirement, a systemic participant

 22 should have the same margin. In the hypothetical
 128

 1 -- in service, a conceptualization of it, they are

 2 not too big to fail in which case they would be

 3 needing to really be in that game.

 4 MR. KLOET: Bob, do you have a comment

 5 on that particular point?

 6 MR. WASSERMAN: Yes, just very quickly.

 7 I should note there's concern about bailouts and

 8 the like. Under our rules, under the PFMIs, all

 9 credit exposures must be fully addressed within

 10 the rules of the CCP. And so at the end of the

 11 day the last stage is going to be something along

 12 the lines of complete tear up and gains

 13 haircutting to meet the resources.

 14 MS. ADMATI: The problem of bailout is

 15 only about the bailout alternatives. That's what

 16 we're talking about. We have lenders who have

 17 left because the alternative is worse and so

 18 that's what I'm concerned with. It's not that we

 19 have a rule that says no bailout, but that we

 20 might not want to follow that kind of rule.

 21 MR. KLOET: Okay. Sunil --

 22 MR. MASSAD: Actually, can I just follow
 129

 1 up, though Bob, because I thought Anat's question

 2 was going to the collection of margin from

 3 participants and I don't think -- I mean our rules

 4 require that a clearing member collect 100 percent

 5 of the margin from participants, but I don't

 6 believe the PFMIs say that, do they? And I don't

 7 believe other jurisdictions' rules necessarily say

 8 that.

 9 MR. WASSERMAN: That's a fair point.

 10 Essentially --

 11 MS. ADMATI: These are mutualization of

 12 losses? How is this conceived?

 13 MR. WASSERMAN: So from a margin

 14 perspective and was quite rightly pointed out, the

 15 clearinghouse sets the margin requirements for the

 16 members. Our rules require that more than 100

 17 percent of that amount be collected from each

 18 customer. Every customer, no matter how

 19 creditworthy that customer may be, the member must

 20 collect from that customer at least that amount

 21 and in some cases it will be more. And likewise

 22 the clearinghouse will be collecting from all of
 130

 1 their members, again, the same required amount.

 2 Mutualization only comes after you run

 3 through that margin of the particular participant.

 4 And, indeed, certainly in the U.S. then as well

 5 the skin of the game of the clearinghouse and as

 6 well the default contribution of the defaulting

 7 member such that at least in the U.S. -- and folks

 8 have pointed out well, look, things have gotten a

 9 bit more complicated since Lehman and that's quite

 10 right. That said, historically the question has

 11 not been gosh, how much of those mutualized

 12 resources have we eaten into. Indeed, in the U.S.

 13 historically we've never even gotten there. In

 14 the Valukas Report on Lehman the question was

 15 well, gosh, why haven't you given us more back?

 16 So I think there's certainly room for

 17 coordination around that, but I think so far

 18 things have proven reasonably resilient. There is

 19 certainly room as well to consider and

 20 continuously improve this. I should note at an

 21 international level there is going to be in the

 22 coming months consideration about issues with
 131

 1 respect to margin and margin models, issues with

 2 respect to stress testing. So there is going to

 3 be a lot of work on there at an international

 4 level by CPMI and IOSCO in the coming months.

 5 MR. KLOET: Okay, well, unfortunately, I

 6 know there's some more panels in the air.

 7 Unfortunately, I have to cut off the discussion at

 8 some point. We're well past time and, in fact,

 9 we're encroaching into Andrew's time on SEFs. So

 10 with that, let me thank everybody for a great

 11 panel. I think, Commissioner, what we've tried to

 12 do here today is really lay a foundation for

 13 further discussions. I think we all knew we

 14 wouldn't resolve all the possible default issues,

 15 but I think what you've heard from the industry is

 16 concerns, comments, and really a willingness to

 17 help work with the Commission on how we can set a

 18 framework to protect market integrity in a really

 19 important way. I think the MRAC has continued

 20 work to do as we work through this.

 21 MS. BOWEN: We do.

 22 MR. KLOET: I'll work with Petal on
 132

 1 thinking about some further discussions as we go

 2 through this. Thank you for this afternoon.

 3 MS. BOWEN: Thank you, Tom. You did a

 4 great job moderating and the robust discussion,

 5 that's the whole point of these advisory

 6 committees. So thank you for speaking up.

 7 MR. KLOET: I have a couple of just

 8 logistical things. First, we're going to take a 5

 9 minute break, so let's all be timely. Now, I will

 10 say while everybody's rushing to the bathroom that

 11 your nameplates, will be moved. So when you come

 12 in don't be surprised if you're sitting somewhere

 13 else because I will assure you, everybody,

 14 including myself, is going to move. So we'll all

 15 move and you might want to make sure you kind of

 16 have your stuff gathered so you can grab it quick

 17 because we are -- a lot of us have flights to

 18 catch, but we want to get to the next panel as

 19 soon as we can. So thank you everybody, 5

 20 minutes, be back in the room and ready to

 21 participate in the next panel.

 22 (Recess)
 133

 1 MR. LO: Let's get started. So I want

 2 to begin by thanking Commissioner Bowen for

 3 sponsoring the Market Risk Advisory Committee and

 4 inviting me to be a member of this distinguished

 5 group. I also want to thank Chairman Massad and

 6 Commissioners Wetjen and Giancarlo for their

 7 leadership in dealing with some of the most

 8 complex issues facing financial regulation today.

 9 This is going to be a shorter session.

 10 I realize that we're standing in the way of lunch,

 11 so we're going to keep our comments relatively

 12 brief and to the point. We're very fortunate to

 13 have three experts on SEFs to get the discussion

 14 going: Michael O'Brien from Eaton Vance, Rana

 15 Chammaa from UBS, and Darcy Bradbury from D.E.

 16 Shaw. I'm going to ask each of the speakers to

 17 start off by giving us a short 3-to-5 minute

 18 overview of their perspective on how the swaps

 19 landscape has changed in light of SEFs and then

 20 we'll open it up to a broader discussion with the

 21 rest of the group.

 22 Just as a matter of housekeeping, please
 134

 1 press your button to activate your microphone when

 2 you speak. This roundtable is being Webcast and

 3 Audiocast and we can't hear you unless you speak

 4 into the microphone. And then also when you're

 5 done, please turn it off. And afterwards when we

 6 open it up for general Q&A, please turn your tent

 7 cards to the side if you would like to be called

 8 on. With that let me start with Michael O'Brien.

 9 MR. O'BRIEN: Thank you, and thank you

 10 to the Commission for inviting me to participate

 11 in this event today.

 12 The question that I really wanted to

 13 address was whether market structure has changed

 14 from a trading perspective with SEFs. My response

 15 to that question would be from my seat on a

 16 trading desk on the buy side, nothing has really

 17 changed. The way we execute trades and the market

 18 structure and how we interact with the market has

 19 not changed except it's become more expensive.

 20 Both the explicit and implicit costs of trading

 21 have certainly increased since SEFs were brought

 22 into existence.
 135

 1 And the reason I say that is prior to,

 2 or if I look back to September of 2013 before SEFs

 3 formally came into existence, most of the trading

 4 we were doing in the products that now have a MAT

 5 designation was electronic. It was electronic on

 6 a handful of platforms and the liquidity providers

 7 were the banks. We would do it using an RFQ; it

 8 would be RFQ to 2 or 3. We would execute the

 9 trade and it would remain bilateral or clear, but

 10 that's the way we were interacting with the

 11 market.

 12 If I fast forward to today, the primary

 13 way that we interact with the market is the same

 14 thing. It's for the most part the same platforms.

 15 It's the same liquidity providers. And it's the

 16 same trading mechanism, which is RFQ. So from

 17 that standpoint, I would say nothing that we're

 18 doing has really changed that much.

 19 We still remain very optimistic that

 20 some of what we viewed as the goals that SEFs were

 21 intended to achieve, including additional

 22 transparency, alternative trading mechanisms such
 136

 1 as order books or other things that may come up.

 2 We certainly believe that the potential is still

 3 there for those to happen in the right environment

 4 and with some patience. It is true that the buy

 5 side doesn't adopt anything new very quickly for a

 6 variety of reasons. It's a very diverse group

 7 with diverse investment and trading strategies, so

 8 nothing comes quickly. But I certainly believe

 9 that there are things that can be done to

 10 encourage the buy side to adopt or to move in a

 11 direction of what we hope SEFs will be able to

 12 achieve. Some of those things we'll discuss

 13 today. But to end just to come back to answering

 14 the question, I don't believe that anything has

 15 really changed with market structure with regard

 16 to trade execution.

 17 MR. LO: Thank you. Rana?

 18 MS. CHAMMAA: I also would like to thank

 19 the Commission and you, Professor Lo, and Petal

 20 Walker for the opportunity to speak today. I just

 21 want to make sure you can hear me correctly?

 22 Okay, perfect.
 137

 1 Certainly I think we can completely

 2 understand the position from the trading side. I

 3 think it's important to note, however, that there

 4 have been a number of positive impacts that have

 5 resulted from the implementation of the CFTC's SEF

 6 rules.

 7 MR. LO: Rana -- sorry -- can you bring

 8 the microphone a little bit closer to you?

 9 MS. CHAMMAA: Yes, absolutely. Is that

 10 better? Okay, thank you.

 11 So as I was saying, there are a number

 12 of positive impacts I think we should note that

 13 have arisen from the implementation of the CFTC's

 14 SEF rules. For one, the rules have created a

 15 cleaner and more robust execution workflow. So we

 16 now certainly have pre-trade credit checks and

 17 straight-through processing, both of which are

 18 critical in ensuring trades executed on SEF are

 19 done so quickly and successfully and cleared

 20 successfully.

 21 The CFTC created a mandate for impartial

 22 access on SEFs where all market participants
 138

 1 should be able to access every SEF and in

 2 constructs. This mandate has allowed clients to

 3 access markets that were previously only available

 4 to the dealer community. Additionally, the SEF

 5 rules provided clients with a variety of

 6 alternatives on how they can access these new

 7 liquidity pools, be it through direct

 8 participation or through an intermediary agency

 9 execution offering like the one we provided UBS,

 10 UBS Neo, or even just looking at other asset

 11 classes like futures in alternative ways and

 12 connecting.

 13 However, to echo what Mike O'Brien was

 14 saying, more needs to be done to further solidify

 15 the full implementation of the SEF rules. Our

 16 clients find two particular items most critical,

 17 post-trade name give-up and impartial access. I

 18 can go on about those, but maybe I'll give Darcy a

 19 chance.

 20 MR. LO: Darcy?

 21 MS. BRADBURY: Thanks. So trying not to

 22 repeat what my colleagues have already said here
 139

 1 on the panel, I want to start by kind of going

 2 back to first principles. We were very supportive

 3 of the swaps reforms, in particular the focus on

 4 central clearing. That was very important to my

 5 firm and I think to most firms in reducing central

 6 credit risk that we had from counterparties.

 7 We're also pretty optimistic about the better

 8 availability of data, some of which is going

 9 directly to the regulators. And I realize there

 10 are a lot of issues around the swap data

 11 repositories, but nonetheless, I think as a work

 12 in progress that's an important goal.

 13 I think getting better information for

 14 us to trade with is very important and that is

 15 something that we see improving because of the

 16 SEFs. You have the price screens. You can see

 17 data now, which you didn't used to be able to see,

 18 but I think the trading is probably the most

 19 disappointing part of the reforms. I think that

 20 the goal as envisioned by the Commission several

 21 years ago when they embarked on this was a little

 22 more revolutionary. And I think as Mike has
 140

 1 pointed out, we haven't really changed very much.

 2 And in particular, we've ended with a bifurcated

 3 market where you have a couple of

 4 customer-to-dealer SEFs where basically that's the

 5 only place the customers can trade. And then you

 6 have the deeper pools of liquidity, the central

 7 limit order books, at the interdealer broker SEF

 8 platforms. And so we think overtime we would like

 9 to have access to those interdealer SEFs. We'd

 10 like to actually not have them be just

 11 dealer-to-dealer, but in fact, have them all be

 12 open to any customers and dealers. By doing so

 13 we'll both get better information about what

 14 pricing is, and we'll also get more competition

 15 and be able to access deeper pools of liquidity.

 16 And, hopefully, at times even be able to use

 17 central limit order books instead of just the RFQ

 18 process that's available on the customer-to-dealer

 19 SEFs.

 20 MR. LO: Great, thank you. So given

 21 that you raised the issue of this two-tiered

 22 system and the issues about liquidity, are there
 141

 1 any particular factors affecting liquidity that

 2 you think can be changed in order to enhance

 3 liquidity? Michael, you want to start with that?

 4 MR. O'BRIEN: Well, for me the most

 5 important thing is the development of order books.

 6 Order books provide -- if it's an order book that

 7 everyone has access to, so it's an all-to-all and

 8 we move away from the dual structure model where

 9 we have a dealer-to-dealer and a dealer-to-client

 10 market where everyone can see the same information

 11 similar to the way it works in the futures market.

 12 That transparency could certainly help alleviate

 13 some of these issues. Right now as I mentioned,

 14 we're still in an RFQ world, which is the way it's

 15 been for a long time.

 16 The most important thing for us, though,

 17 is we have executed trades in an order book, but

 18 there's not sufficient liquidity for all of our

 19 trades in the order book. We need more buy-side

 20 participants in the order book. We need new

 21 providers to alternative liquidity providers

 22 besides the banks in the order book. And we need
 142

 1 more participation from the banks in the order

 2 book to increase the liquidity there.

 3 The biggest issue when I talk to my

 4 colleagues on the buy-side is the issue of name

 5 give-up. As an execution desk on the buy-side, if

 6 we want to interact anonymously in the market,

 7 which is one of the great benefits of an order

 8 book, that's the way we want to interact. If we

 9 wanted name give-up and we believe we'd get better

 10 execution that way, we'd use the RFQ model, which

 11 is something that is well established even in SEFs

 12 at this point.

 13 The challenge with name give-up for us

 14 is in today's market you can execute a large trade

 15 in swaps or CDX. I anticipate that as order books

 16 become more liquid, you'll see a similar size be

 17 able to be executed, but it will be in smaller

 18 ticket sizes and more numbers of trades as we've

 19 seen in other markets as it becomes more

 20 transparent. That's the type of environment where

 21 name give-up becomes a very significant issue to

 22 me because as soon as I do my first small trade,
 143

 1 now I have information leakage into the market

 2 about potentially what my intentions are. I can

 3 speak for myself, but I suspect many other buy-

 4 side firms feel this way, that's really a deal

 5 breaker for executing on order books. And

 6 speaking to other colleagues at other firms, I

 7 think is a big reason why they're not interacting

 8 with order books today.

 9 MR. LO: So let's turn directly to the

 10 name give- up issue then since that seems to be at

 11 the heart of some of these concerns. Rana, you

 12 have some thoughts on that?

 13 MS. CHAMMAA: Yes, I would absolutely

 14 agree with that. Post-trade name give-up is often

 15 the number one hindrance to order book trading

 16 amongst our clients. We certainly think that it's

 17 an archaic and unnecessary practice. And with

 18 regard to Mike saying how to attract a greater

 19 number of market participants, that would probably

 20 be the biggest proponent to that.

 21 So I would also say there remains a

 22 trading mechanism that is the traditional way to
 144

 1 trade in the swaps market, which is RFQ, whether

 2 it's name disclosure. So in terms of thinking

 3 about impartial access, attracting more

 4 participants to SEFs, they should have a choice on

 5 whether or not they want to remain anonymous and

 6 in some cases potentially prevent information

 7 leakage. So I would absolutely agree. That's the

 8 number one cited reason for no greater adoption to

 9 SEF order book trading.

 10 MR. LO: Darcy -- Commissioner Wetjen?

 11 MR. WETJEN: I didn't mean to interrupt

 12 the flow there, my apologies. The panelists, all

 13 of you, are suggesting that -- well, you're

 14 suggesting one impact from eliminating this name

 15 give-up practice is that you'd presumably get more

 16 buy-side participation, but what would happen if

 17 the Commission were to clarify that name give-up

 18 were not permitted? What would happen with

 19 respect liquidity forming in a CLOB or forming

 20 perhaps even more in an RFQ? And maybe -- I guess

 21 a follow-up question on that would be would that

 22 be a temporary phenomenon or would you expect that
 145

 1 if temporary would reverse or would it be

 2 permanent? In other words, people might want to

 3 take their liquidity elsewhere, depending on the

 4 immediate impacts of doing away with name give-up.

 5 Help us understand those effects a little bit

 6 better.

 7 MS. BRADBURY: Well, I guess I would

 8 make one comment about that in addition to the

 9 effects you've described. There's a reason that

 10 the Commission has to act here because this is a

 11 very -- the interdealer broker market, it's very

 12 competitive. There are four or five firms and

 13 it's in some kind of death duel I think. I mean

 14 it's obviously a very competitive industry. And I

 15 think that it's very difficult for any one

 16 platform to step up and say gee, if I got rid of

 17 this rule, I'd get the buy-side on my platform.

 18 That would create more liquidity. That would be

 19 great because if some of their current clients

 20 don't like it, then they'll all pretty easily --

 21 they'll have the buttons on their desks. They'll

 22 just pretty easily move their -- so it's a classic
 146

 1 thing. The first mover really can't act, and so

 2 it's a case where the government, the regulator,

 3 really needs to step in and say to all of them

 4 look, you don't need to do this practice. It's a

 5 legacy of when these markets were uncleared, when

 6 you needed to know who your counterparty was.

 7 That's not true anymore. So for the cleared

 8 swaps, it's just not necessary. Let's get rid of

 9 it and then see what competition does.

 10 MS. CHAMMAA: I'd also actually address

 11 that question specifically on kind of liquidity

 12 and what may or may not happen. I think that

 13 often there's a potential concern on whether the

 14 traditional liquidity providers in this space

 15 would pull back or whatnot. But I think that what

 16 we need to note is that regardless, if nothing was

 17 to take place and no changes were to be made, the

 18 expectation is that liquidity would dry up anyway

 19 considering the regulatory capital constraints

 20 that will be impacting, and continue today

 21 impacting, the liquidity provision amongst the

 22 traditional dealer community. So it just
 147

 1 reinforces why, to Mike's point earlier, we need

 2 alternative market participants who will also be

 3 providing liquidity as and when that happens.

 4 MR. LO: Rana Yared and then Marcus

 5 Stanley.

 6 MS. YEARED: Thank you, Professor. I

 7 just want to comment on the concept of order books

 8 and name give-up. So I'll start by saying that

 9 for as long as I can remember, since maybe 2009,

 10 Goldman has been an adamant supporter of order

 11 books, what we call benchmark interest rate swaps,

 12 to 5, 10, and in the cases of the U.S., 7, as

 13 well. We've been agnostic as to whether or not

 14 that developed in what I'll call a traditional OTC

 15 form or whether indeed a future-like form, be it

 16 deliverable or nondeliverable, came to pass. So I

 17 start with this by saying that like the firm is,

 18 in fact, very supportive of order book trading

 19 around those points because we think it will have

 20 the same positive effect that has been created in

 21 the FY and TY on the future side.

 22 That said, we have significant concerns
 148

 1 about the removal of name give-up. And the reason

 2 for our concern is that we feel that the U.S.

 3 market still continues to trade in a spreadover

 4 manner and that there's substantial risk on those

 5 package trades if we don't know with whom to

 6 execute the Treasury like. So far the mitigants

 7 for that risk that have been presented to us have

 8 not been any less scary, so one of them is asking

 9 the interdealer brokers to use their own broker

 10 dealers to intermediate that risk to FICC, the

 11 subsidiary of the DTCC. Another version of that

 12 has been to simply hope that what we call the FICC

 13 prime broker of nondirect members has done an

 14 appropriate credit check in the same way that

 15 their swaps clearing member has. There are not

 16 equivalent standards on the FICC side for that and

 17 so we're kind of living on hope in both cases.

 18 So as long as we're in that world,

 19 particularly for package trades, we get very

 20 nervous about name give-up. It might be a bit of

 21 a nuance in the market, which is there might be

 22 market participants that are very supportive of
 149

 1 name give-up as a concept, but that the mechanics

 2 of the market have not yet evolved to that. And I

 3 would just note, I remember in February 2013, ICAP

 4 Tradition and Dealerweb all turned on their order

 5 books and like nothing was there. A year later,

 6 there was quite a lot there and today on Infomat

 7 there's even more there. And so I would hope that

 8 we don't lose sight of the fact that the market is

 9 learning how to deal with some of these challenges

 10 and order book trading is growing as we hope that

 11 it will.

 12 MR. LO: Marcus Stanley.

 13 MR. STANLEY: Thank you. I guess I'd be

 14 -- it would feel like letting the tail wag the dog

 15 to let the package trade issue drive the overall

 16 name give-up issue. I mean we've had these

 17 technical issues around package trades just with

 18 making them available to trade. The truth is that

 19 the swap itself is cleared. I don't understand

 20 any reason why you're not directly exposed to the

 21 credit of your counterparty on a cleared swap. I

 22 would say we are somewhat mystified as to why the
 150

 1 Commission has not yet acted on this name give-up

 2 issue.

 3 As some of you know, we felt that the

 4 Commission's original rules should have advantaged

 5 order books more compared to what are almost

 6 bilateral RFQs that don't really change the state

 7 of play or the business as usual from before

 8 Dodd-Frank that much. And to permit name give-up,

 9 which frankly we see as something that would

 10 enable discrimination by dealers against buy-side

 11 participants who do use the order book, is really

 12 problematic given the very clear mandate in

 13 Dodd-Frank for impartial access.

 14 Just to close on a general statement

 15 about Dodd- Frank, I mean we have all this

 16 verbiage in Title VII because the Commission is

 17 mandated to change the market structure in what

 18 were formerly bilateral over-the-counter swaps.

 19 That's the whole reason that we have this mandate

 20 to create SEFs in the first place. So let's make

 21 sure that the rules there really do enable that

 22 kind of liquidity and the kind of impartial
 151

 1 participation by both buy-side and sell-side and

 2 the future-like exchanges that were envisioned in

 3 Dodd- Frank.

 4 MR. LO: Jerry Jeske.

 5 MR. JESKE: I'm Jerry Jeske on behalf of

 6 the Commodity Markets Council, a group of end

 7 users from an energy and agricultural standpoint.

 8 Just to follow up on what Marcus was saying, I

 9 really don't believe rules can dictate how

 10 liquidity works. So rule implementation has to be

 11 done in a way that makes sense to the markets.

 12 We're going down a bit of a rabbit hole in

 13 connection with one asset class so far today --

 14 interest rates -- that's it.

 15 The rule set is applicable across the

 16 commodity sector. So I think several commenters

 17 have said one size doesn't fit all. I think Rana

 18 pointed out the mechanics associated with the

 19 marketplace are very critical, and I would echo

 20 that. The mechanics associated with oil swaps

 21 versus grain swaps versus natural gas swaps or

 22 electricity swaps and interest rate swaps are not
 152

 1 the same thing. So when we look at how does a SEF

 2 interact in this place, it's not an easy concept

 3 to get across. Central order book isn't

 4 appropriate across the board. If you don't have

 5 liquidity that already exists in a certain locale,

 6 voice brokers don't just flip a switch overnight

 7 and become electric marketplaces. That's the

 8 difference I think between the various types of

 9 markets that have to be appreciated. So certainly

 10 some thought is appropriate from the Commission as

 11 to how does this apply across the gamut of the

 12 commodity sector?

 13 MR. LO: Nathan Jenner and then Steve

 14 Berger.

 15 MR. JENNER: Hi, can you hear me? I'd

 16 just like to respond to a couple of points. I

 17 think Jerry raised a good point in terms of some

 18 of the asset classes do have different

 19 characteristics that require different

 20 consideration. So at Bloomberg for our SEF, our

 21 order book is fully anonymous pre- and post-trade.

 22 We don't use middleware in our order book for the
 153

 1 explicit reason to preserve post-trade anonymity.

 2 That is how our order book works, and it was a

 3 pretty simple decision for us because that is what

 4 nearly all of our buy-side expressed as a desire.

 5 But having said that, it's just been an

 6 interesting observation to note that while

 7 activity has grown dramatically, nearly all of the

 8 activity has been concentrated in the index CDS

 9 portion. Of course, our order book exists across

 10 asset classes and it has the same characteristics,

 11 but nearly all of the flow that we see -- and we

 12 are predominantly sort of buy-side flow -- nearly

 13 all of the activity is concentrated in the index

 14 credit market.

 15 MR. LO: Stephen?

 16 MR. BERGER: From our perspective we

 17 believe that the net impact on pricing and

 18 liquidity from eliminating post-trade name give-up

 19 would be overwhelmingly positive. By contrast I

 20 agree with some of the points made, that the

 21 consequence of inaction will be progressive

 22 liquidity impairment in the marketplace. I think
 154

 1 it's well documented that there are constraints on

 2 traditional liquidity providers in the market and

 3 they're only going to grow sharper going forward.

 4 And so the solution to that to us seems to be to

 5 open up the modes of interaction that can occur in

 6 the marketplace.

 7 I think there's always going to be names

 8 disclosed RFQ, but that can exist alongside truly

 9 anonymous central limit order books. I think the

 10 structure we have today confines any buy-side

 11 market participant to a permanent price taker

 12 role. And I think the overall liquidity profile

 13 of the swaps market will be enhanced if any

 14 participant can make as well as take a price.

 15 That's a structure that's worked well in a number

 16 of other -- it's how the equities markets work,

 17 it's how the futures markets work. And so when

 18 you have anybody being able to make as well as

 19 take a price, you increase the diversity of

 20 liquidity provision in the marketplace and we

 21 think that will overall have a positive impact on

 22 the breadth and depth of liquidity that's
 155

 1 available. That's going to be the solution to a

 2 challenge that we're otherwise fearful of, which

 3 is a constraint among the appetite of the

 4 traditional liquidity providers to continue to

 5 service the market.

 6 I think it's true. It's not one size

 7 fits all. I mean I think a lot of this discussion

 8 is focused on the MAT product set within the

 9 interest rate swap and credit default swap space

 10 right now. I think there are certain challenges

 11 with respect to package transactions, certainly

 12 package transactions that are all cleared swaps,

 13 so outrights as well as curves and butterflies. I

 14 don't think there's any particular challenge to

 15 eliminating post-trade name give-up. I think

 16 there are solutions that are being developed,

 17 which could solve the anonymity problem for

 18 spreadovers. Two of them were alluded to. I

 19 don't think they're fundamentally flawed, so you

 20 can have the broker-dealer affiliate of a SEF

 21 intermediate the Treasury leg and preserve

 22 anonymity for that trade flow. You can also have
 156

 1 clearing relationships just as you do for swaps to

 2 access FICC.

 3 So those are both solutions that can

 4 work. I'm not saying they'll work tomorrow, but

 5 there's no long-term barrier to those being

 6 solutions for the spreadover market. And I think

 7 if you solve spreadover Treasuries as well as

 8 curves and butterflies, you've solved most of the

 9 package transaction issues or at least the biggest

 10 chunk of that volume.

 11 And then finally, just to Commissioner

 12 Wetjen's point, I guess I'm not fearful that

 13 people will just pick up and take their liquidity

 14 elsewhere because I don't think the interdealer

 15 market will suddenly go to RFQ and start RFQing

 16 each other. So I think interdealer liquidity

 17 would stay on the order books and it would just be

 18 enhanced by additional participation.

 19 MR. LO: Luke Zubrod?

 20 MR. ZUBROD: So Chatham Financial is an

 21 adviser to end users. We work with both financial

 22 and nonfinancial end users. Of course, the
 157

 1 nonfinancial end users are not presently using

 2 SEFs. With respect to our financial end user

 3 clients, they range in size from those who use

 4 smaller volumes to those who use larger volumes.

 5 And certainly amongst all of them, they're using

 6 derivatives to hedge idiosyncratic risks. And so

 7 our use of SEFs has focused on interest rates.

 8 What we've found because we've evaluated

 9 all of the interest rate SEFs and are working with

 10 a couple of them. We're primarily executing swaps

 11 on a single one of them. And because we're

 12 intermediating swaps on behalf of end user

 13 clients, what the dealer counterparties that we

 14 show our trades to through the RFQ platform see is

 15 our name, Chatham Financial. They don't see the

 16 name of the client on whose behalf we're trading.

 17 And so in effect they're sort of transacting on an

 18 anonymous basis. The only piece of information

 19 that dealers have to make their decisions about

 20 how to price our trades is based on our name, not

 21 based on our client's name.

 22 And what we've found is that that's been
 158

 1 a very positive thing for particularly our smaller

 2 volume users because dealers have to price those

 3 trades just the same as they would for larger

 4 clients on whose behalf we trade. And so I think

 5 you can kind of line up the analysis based on is

 6 it a smaller volume or a larger volume hedger. I

 7 think because it's a hedger, RFQ is kind of the

 8 natural platform to transact those kinds of

 9 trades. And I don't think even if the order books

 10 became very liquid that those would be a natural

 11 venue for managing the risks of hedgers.

 12 But then I think for the larger volume

 13 clients, we haven't seen any negative impact on

 14 their pricing as a result of SEFs. If anything,

 15 it's been positive. It's been more efficient.

 16 For smaller volume hedgers, it's been oftentimes

 17 much more efficient in particular because dealers

 18 don't have the ability to differentiate their

 19 pricing based on their size.

 20 MR. LO: John Nixon, Rana, and then

 21 Sebastiaan.

 22 MR. NIXON: As an operator of one of the
 159

 1 SEFs, I actually find some of the comments quite

 2 interesting. Rana did say and I agree that the

 3 evolution of the central limit order book and the

 4 interest rate swap market has taken a period of

 5 time, but it is definitely growing and going in

 6 the right way. On any given day at least 20

 7 percent and sometimes 30 or 40 percent of our

 8 trades are being done on the central limit order

 9 book. Clearly, we do feel and have seen in our

 10 Treasury platforms or our FX platforms the more

 11 entities that you get onto a platform trading

 12 electronically, the more liquidity that you build

 13 and I think the better execution people will get.

 14 I'm encouraged to hear that there are a

 15 lot of buy-side who feel that coming onto the

 16 central limit order book and trading in interest

 17 rate swap markets is what they believe is the

 18 right direction for them to go. I would say that

 19 to this day that has not necessarily been the case

 20 in practice. There has not been as much demand I

 21 would say from the buy-side for them to come onto

 22 our platforms. Michael, as you said, the buy-side
 160

 1 often moves relatively slowly in making its

 2 changes. If its time has come, if the time is

 3 now, it will be interesting. I think that if you

 4 need the CFTC to opine on the anonymity and make

 5 that decision and that's going to help grow our

 6 markets from a participant perspective, I think

 7 that that's probably the right direction for us to

 8 go. But I will say that so far, we have not

 9 necessarily seen as much of a push as we would

 10 have thought we would have had two years ago from

 11 the buy- side to participate in our platforms.

 12 MR. LO: Rana?

 13 MS. CHAMMAA: I'd actually like to say a

 14 few words with regards to the last two comments.

 15 So I think that we're in a fairly unique vantage

 16 position considering that we offer intermediary

 17 agency execution services to our clients to the

 18 SEFs. And I would comment and say that

 19 potentially the demand that you have seen as of

 20 late or historically hasn't been as large as we'd

 21 all want because of this post-trade name give-up

 22 impediment. So really we know from several of our
 161

 1 clients are currently sitting on the sidelines

 2 wanting to execute on SEF central limit order

 3 books, but are holding off because there's not

 4 pre- and post-trade anonymity.

 5 And further on, just with regards to the

 6 actual size of the clients and how much they're

 7 hedging or whatnot, I would suggest that that is

 8 all the more reason to actually allow even smaller

 9 buy-side participants to participate on central

 10 limit order books because of the fact that they

 11 may not be getting better pricing by RFQ and

 12 certainly in the future wouldn't be because of

 13 their size.

 14 MR. LO: Sebastiaan Koeling and then

 15 Marcus Stanley.

 16 MR. KOELING: Thank you. So I'm

 17 representing the Proprietary Traders Group here

 18 and that's a group of 20 or so market makers in

 19 the futures and equity spaces. And we are a group

 20 that is actually part of this buy-side interest to

 21 join this. Back in 2013 when this swap execution

 22 facilities model came out, we were very
 162

 1 enthusiastic about it because we believe strongly

 2 in transparent markets, possibilities to compete

 3 with traditional players in these markets, and we

 4 would think that that would lead to better pricing

 5 for end users. Unfortunately, there were a couple

 6 of things that made it harder for us to

 7 participate in these markets. First of all, we

 8 had some larger problems with having to register

 9 as a swap dealer and those things led to

 10 relatively large capital inefficiencies.

 11 And then I'd like to echo some of the

 12 statements that were made with regards to the

 13 central limit order book possibilities for market

 14 makers like us. Unfortunately, this bifurcated

 15 market that still seems to exist does not help for

 16 us to actually participate in these markets

 17 because we'll also end up more on the

 18 dealer-to-customer side where the only possibility

 19 for us is to be a price taker rather than a price

 20 maker, what would be our traditional role if we

 21 were to do what we normally do.

 22 So with regard to that, we are still
 163

 1 hopeful that it would move towards a central limit

 2 order book. And I would like to make the

 3 statement that there are definitely more market

 4 makers out there that are interested to provide

 5 liquidity, especially as that was also pointed out

 6 as a problem potentially with the new capital

 7 rules that are coming out that banks might

 8 actually drop out as being liquidity providers.

 9 So we think that the need for us to come onboard

 10 would be there as well, both for competitional

 11 pricing as well as the general need for liquidity

 12 in the SEFs.

 13 MR. LO: And can I ask what your sense

 14 of name give-up would be in terms of enhancing

 15 liquidity?

 16 MR. KOELING: Sure. I think name

 17 give-up is also one of the things that I think is

 18 a problem, but I wanted to mention a couple of the

 19 other ones as well because I think a large part of

 20 the things that name give-up have been mentioned

 21 actually.

 22 One thing I'll add is with regards to a
 164

 1 lot of strategies that trading firms use as

 2 regards to market making. People have their own

 3 specific way of how they want to trade and

 4 post-trade name give-up obviously gives away some

 5 of the strategies used to price your products and

 6 to actually -- it also gives away some of the

 7 positions that you may hold in regards to the

 8 swaps that you've traded, which does not help you.

 9 It actually came up in the previous discussion as

 10 well with regards to the auctions of specific

 11 positions. If other parties know what your

 12 position is, there is a risk there. I think that

 13 also exists in post-trade name give-up, which

 14 doesn't seem to be necessary because the trade is

 15 always done with the central counterparty in terms

 16 of cleared swaps.

 17 MR. LO: Marcus and then Jerry.

 18 MR. STANLEY: Well, I've said our piece

 19 on name give-up and we favor the Commission

 20 banning it, but I wanted to just add a few more

 21 things. First of all, we're concerned that the

 22 Commission's cross-border position has permitted
 165

 1 the routing of significant business by U.S.

 2 Entities to Europe where there does not exist an

 3 exchange trading requirement as yet. The exchange

 4 trading requirement has not been implemented and

 5 will not be implemented until 2017. We don't

 6 believe that compliance should permit basically

 7 the substitution of a nonregime for a regime.

 8 It's intended to permit comparable regimes to be

 9 substituted for each other. We believe that if

 10 the Commission took a stronger position on some of

 11 these cross- border issues, then it would channel

 12 more liquidity into U.S. exchanges when traded by

 13 entities that are affiliated with U.S. banks or

 14 have a U.S. nexus.

 15 And just second of all, I think this is

 16 probably known to you guys, but just to remind

 17 people. We really feel there are very substantial

 18 systemic risk externalities to encouraging clear,

 19 transparent exchange trading where there's

 20 significant liquidity and where a wide variety of

 21 participants can act as both price takers and

 22 makers. We heard one from Sunil Cutinho in the
 166

 1 previous panel where he said that when you have

 2 deep exchange traded instruments, these are much,

 3 much easier to manage those risks in the event of

 4 a clearinghouse failure. So you would be taking

 5 OTC derivatives and making them easier to manage

 6 in a systemic risk event. And you're also

 7 increasing the possibility of potential

 8 counterparties in the event of a major dealer

 9 failure, which was one of the problems that we saw

 10 during the financial crisis. So I kind of feel

 11 like exchange trading has become a bit of the

 12 orphan of Dodd- Frank, but it's actually a very,

 13 very important piece of the puzzle for wider

 14 systemic risk reasons as well.

 15 MR. LO: So we're running out of time,

 16 so Jerry and Mike will be next. But in getting

 17 ready to wrap up, let me ask the panelists to

 18 consider one final point, which is what the role

 19 of the CFTC is in mandating some of the issues

 20 that we've been discussing. Clearly, if the CFTC

 21 were to ask all of the trading to occur on one

 22 exchange, we would obviously have lots of
 167

 1 liquidity or more liquidity, but that would create

 2 huge problems in terms of the bespoke nature of

 3 this market. In Commissioner Giancarlo's White

 4 Paper, he pointed out a number of important

 5 features about swaps markets that make them

 6 heterogeneous and difficult to fit into one

 7 particular format and I've heard that from a

 8 number of you.

 9 So if you can comment a bit on what you

 10 think the SEC should be doing in terms of dealing

 11 with these markets, that would be helpful.

 12 Already some of you have, but for those of you who

 13 haven't. Jerry?

 14 MR. JESKE: Andrew, I'll try to address

 15 my comments to that point. I think you meant the

 16 CFTC.

 17 MR. LO: Sorry.

 18 MR. JESKE: But in terms of what can be

 19 done, I was going to pick up on Sebastiaan's

 20 comment. Some of the collateral damage that has

 21 already been done by some of the rulemakings is

 22 something that the Commission can consider, such
 168

 1 as how or what incentives does one have to become

 2 a market maker, to create liquidity on a SEF? Are

 3 there incentives or are there disincentives such

 4 as rule 1.35, such as the prospect of becoming a

 5 swap dealer. These cost lots and lots and lots of

 6 money. So if I'm a market maker, do I really want

 7 to have all these high entry costs to become a

 8 participant in a SEF marketplace?

 9 Another thing that's out there still and

 10 to my knowledge hasn't been settled is the rule

 11 sets for the SEFs. As a legal compliance person

 12 reviewing voluminous documents from various SEFs

 13 knowing that those documents are going to change

 14 as far as the rule sets for the SEFs based on what

 15 the Commission opines upon one way or another,

 16 that is time consuming and is something that

 17 should probably be considered as well in terms of

 18 the horizon of time and when implementation should

 19 or shouldn't occur across asset classes.

 20 MR. LO: Michael?

 21 MR. O'BRIEN: I just wanted to spend a

 22 moment commenting on the idea of the buy-side
 169

 1 demand for central limit order books. I believe

 2 that the buy-side does have interests in central

 3 limit order books even if they're not calling SEFs

 4 and they may not be talking to their dealers. As

 5 an asset manager, the primary business is managing

 6 money. So you look towards how can I execute this

 7 in the most efficient way currently available?

 8 Well, yes, that today is an RFQ because there are

 9 many constraints on the order book that are just

 10 not acceptable for a buy-side trader looking to

 11 execute a trade.

 12 And so I'm happy for there to be a

 13 market-led decision on whether the buy-side's

 14 going to continue with RFQs or order books if the

 15 order books are free of constraints and are

 16 competing without an arm tied behind their back.

 17 If the buy-side still doesn't come, then okay, the

 18 market has spoken. But right now the competition

 19 isn't fair. The RFQs are well established. The

 20 order books don't function even like order books

 21 in other markets. So what I would ask the CFTC to

 22 do is to make that a fair competition and see
 170

 1 where the market leads.

 2 MR. LO: Stephen?

 3 MR. BERGER: One additional point I

 4 wanted to note, and I think Rana alluded to it at

 5 the start. The foundation's already been set for

 6 this next stage of the evolution of the swaps

 7 market structure. The CFTC's rules on

 8 straight-through processing really established the

 9 right execution to clearing workflow for order

 10 book trading to evolve. So trades are routinely

 11 now when executed on SEFs accepted for clearing

 12 within seconds, and every order that goes onto a

 13 SEF has received a pre-execution credit check. So

 14 the standing of any order in the marketplace on a

 15 SEF, irrespective of who's placing that order, is

 16 the same. There's already a clearing guarantee

 17 behind it to ensure that it's going to be accepted

 18 by a DCO for clearing.

 19 So we've accomplished a lot and this is

 20 now just the next step to take what we've

 21 accomplished in building the right execution

 22 clearing workflow and allow that to start to
 171

 1 improve the market structure that exists for

 2 trading swaps.

 3 MR. LO: Darcy?

 4 MS. BRADBURY: I'll just mention that

 5 when the CFTC allowed the SEFs to really get

 6 going, there was no comprehensive review of the

 7 SEF rulebooks. And I think what we kept hearing

 8 repeatedly from staff when we would go meet with

 9 them and discuss issues is tell us what the

 10 problems are. If there are specific rules, we

 11 don't necessarily have the resources to do a

 12 comprehensive review of all the SEFs, all their

 13 rulebooks, but if there are specific problems,

 14 bring them to us and we'll try to address them.

 15 So I hope that's really what we're doing

 16 with this forum. And I very much appreciate,

 17 Commissioner, for creating the opportunity. This

 18 is a very specific rule that we think is really

 19 impeding competition and impairing open access,

 20 and I think it'd be great to see what happens.

 21 MR. LO: Great. Well, we're out of

 22 time, so I want to thank all of the panelists for
 172

 1 participating and thank Commissioner Bowen for

 2 giving us the opportunity to talk about these

 3 issues and the CFTC for giving the opportunity to

 4 deal with these issues as they arise. Thank you.

 5 MS. BOWEN: Thanks, everyone, and

 6 particularly to the MRAC members for your time and

 7 your travel and your focus on today's issues. We

 8 have a lot of work to do, and I look forward to

 9 it, to work with all of you. Obviously, for the

 10 public that's out there, we want your ideas and

 11 suggestions as well, but great job. Thank you so

 12 much, Andrew. Thank you so much, Tom. Have a

 13 good day.

 14 MS. WALKER: The meeting is now closed.

 15 (Whereupon, at 1:30 p.m., the

 16 PROCEEDINGS were adjourned.)

 17 * * * * *

 18

 19

 20

 21

 22
 173

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Mark Mahoney, notary public in and for

 4 the District of Columbia, do hereby certify that

 5 the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 (Signature and Seal on File)

 20 -----------------------------------

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 14, 2018