UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 GLOBAL MARKETS ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, May 14, 2015
 2

 1 PARTICIPANTS:

 2 Commission Members:

 3 CHAIRMAN TIM MASSAD

 4 COMMISSIONER MARK WETJEN

 5 COMMISSIONER SHARON BOWEN

 6 COMMISSIONER CHRISTOPHER GIANCARLO

 7 Panel I: Assessing Clearinghouse Capital

 Contributions and Stress Testing:

 8

 ROBERT WASSERMAN

 9 Chief Counsel, Division of Clearing and Risk

 U.S. Commodity Futures Trading Commission

 10

 JEFFREY C. MARQUARDT

 11 Director, Bank Operations and Payment Systems

 Board of Governors of the Federal Reserve System

 12

 FABRIZIO PLANTA

 13 Team Leader Post-Trading

 European Securities and Markets Authority

 14

 DAVID BAILEY

 15 Director, Financial Market Infrastructure

 Bank of England

 16

 SHUNSUKE SHIRAKAWA

 17 Deputy Commissioner for International Affairs,

 Financial Services Agency

 18 Government of Japan

 19 Panel II: Margin for Uncleared Swaps:

 20

 CARLENE KIM

 21 Deputy General Counsel

 U.S. Commodity Futures Trading Commission

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 PAUL SCHLICHTING

 Assistant General Counsel

 3 U.S. Commodity Futures Trading Commission

 4 SEAN CAMPBELL

 Deputy Associate Director, Division of Research

 5 and Statistics

 Board of Governors of the Federal Reserve System

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 4

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

 2 MS. BARRETT: Good afternoon. As the

 3 GMAC designated federal officer and temporary

 4 chair of this committee, it is my pleasure to call

 5 the 18th meeting of the Global Markets Advisory

 6 Committee to order.

 7 Before we get started, I just want to go

 8 over a couple of things with regards to the

 9 microphones. When you want to talk, please press

 10 the button. And when you're finished, please

 11 press the button again to turn it off. The red

 12 light indicates that it is on. Please refrain

 13 from putting any devices on the table, as it might

 14 interfere with the audio. There are speakers

 15 present on the teleconference line, so make sure

 16 to speak clearly into the mic so that they can

 17 hear you.

 18 For those participants on the audio

 19 conference line, make sure to keep your phone on

 20 mute until you're ready to speak. And when you

 21 are ready to speak, please make sure to identify

 22 yourself beforehand.
 5

 1 For those of you in New York, the

 2 microphones are a little bit different. They are

 3 Polycom. Same goes for you; it's a push-to-talk

 4 mic system. The light will turn green when it's

 5 on, and it will be red when it's off.

 6 Last thing: Please be advised that this

 7 meeting is being recorded and webcast.

 8 Thank you, and I'll turn it over to

 9 Commissioner Wetjen.

 10 COMMISSIONER WETJEN: Thank you, Dani.

 11 Welcome, everyone. I want to thank everyone for

 12 participating. As Dani indicated, we have some

 13 participation here from New York. I see

 14 Commissioner Giancarlo on the screen, and Doug,

 15 and Wally, and Caitlin. So, thank you for being

 16 here in New York. And thanks to those on the

 17 phone. And I want to welcome Chairman Massad and

 18 Commissioner Bowen, as well.

 19 A special thanks to our panelists -- we

 20 have some real experts here with us today from

 21 around the globe. We have David Bailey, from the

 22 Bank of England; Fabrizio Planta, from ESMA;
 6

 1 Shunsuke Shirakawa, from the Japanese FSA; Jeff

 2 Marquardt, from the Federal Reserve; and, on the

 3 later Panel, Sean Campbell, from the Federal

 4 Reserve. So, thank you to all of you for being

 5 with us today.

 6 I want to recognize our staff, too. We

 7 have several staff members from the CFTC who are

 8 helping us; joining us today: Bob Wasserman,

 9 who's with this panel. Later, we'll have Carlene

 10 Kim and Paul Schlichting, from the CFTC. So,

 11 thank you to them, as well. And thanks to the

 12 logistics team and the Office of Data and

 13 Technology for helping us with the

 14 videoconferencing and with the phone lines. We

 15 had to make some last-minute arrangements in light

 16 of the train accident north of Philadelphia. So,

 17 thank you to them.

 18 And, last but not least, thank you to

 19 the GMAC members. I appreciate all of you being

 20 here today. I think we have an interesting and

 21 good discussion before us. We're here to talk

 22 about CCP risk management and the CFTC's cross-
 7

 1 border application of its margin rule for

 2 uncleared swaps -- so two timely topics, two

 3 important topics.

 4 Let me just say a couple of other brief

 5 remarks before I turn it over to Chairman Massad

 6 and my fellow Commissioners.

 7 Since the G-20 communique in 2009, the

 8 CFTC and other regulators around the globe --

 9 including some here -- have significantly raised

 10 the standards for CCPs. This obviously made a lot

 11 of sense, in light of this new market structure we

 12 now have for the swap marketplace. We wanted to

 13 be sure that we had adequate standards and risk

 14 management practices at CCPs. And, of course,

 15 there's considerable international coordination of

 16 this effort, facilitated through CPMI-IOSCO and

 17 other international organizations -- but a special

 18 call to IOSCO in that regard.

 19 Now clearinghouses registered with the

 20 CFTC have enhanced financial resource and

 21 liquidity requirements, as well as other risk

 22 management standards, that reflect their
 8

 1 heightened role in the marketplace.

 2 But as the clearing volumes have

 3 increased, we need to be cognizant of the result

 4 in increased concentration of risk and what that

 5 means for stakeholders. To maintain consensus

 6 behind the cleared market structure, it is

 7 important for policymakers to provide a forum to

 8 discuss the aforementioned concern, and review

 9 whether further enhancements should be considered.

 10 That's why today's meeting has been

 11 convened. It presents us with an opportunity to

 12 sharpen our thinking about whether and how to

 13 further improve the cleared market structure.

 14 Then lastly, global coordination on any

 15 further enhancements will be critical. And that's

 16 one of the reasons why I'm so grateful to David,

 17 Fabrizio, and Shunsuke for being here today with

 18 us.

 19 Finally, we'll look later into the

 20 different approaches laid out in the CFTC's

 21 proposal on the cross- border application of the

 22 margin rule. We had three different options that
 9

 1 we sought comment on, which is a rather novel

 2 approach we took -- at least during my time here

 3 -- and I want to commend again the Chairman for

 4 facilitating that approach. I should note that it

 5 appears as though the consensus view reflected in

 6 the comment file in response to that proposal

 7 seems to favor the prudential regulators'

 8 approach, if for nothing else in order to make

 9 sure there's harmony between the different

 10 domestic regulators on their margin rules or the

 11 cross-border application of their margin rules.

 12 But we'd like to discuss it a little bit

 13 further, as well as touch upon the appropriateness

 14 of initial and variation margin for

 15 inter-affiliate swaps. So, I'm anxious to hear

 16 people's views on that.

 17 Thank you again for being here. And

 18 with that, I'll turn it over to Chairman Massad.

 19 CHAIRMAN MASSAD: Well, thank you, Mark,

 20 and thank you for organizing this very important

 21 meeting of the GMAC. I also want to thank Dani

 22 for her work as designated federal officer for the
 10

 1 GMAC -- and all of our other staff -- both those

 2 who are making presentations and those who just

 3 help put this event together.

 4 Let me also thank all of the Advisory

 5 Committee members for being here. We really

 6 appreciate your attendance and involvement -- and

 7 our guests. In particular, I would just want to

 8 thank all of those who have traveled a long way --

 9 Shunsuke, and David, and Fabrizio, we really

 10 appreciate it -- of course, Jeff, you, also, but

 11 you didn't have to travel quite as far. But no,

 12 your presence here is really helpful to us.

 13 And, you know, people often wonder or

 14 ask me, you know, "What's going on in terms of

 15 cross-border harmonization of swaps rules and this

 16 sort of thing?" And, you know, it's meetings like

 17 this, and it's the constant interaction that, you

 18 know, our staffs have and we have as Commissioners

 19 with our colleagues abroad, which are so

 20 fundamental. So, we really appreciate you all

 21 being here.

 22 The topics we're taking up today are
 11

 1 obviously very critical. Clearinghouse oversight

 2 is extremely important these days. You know, you

 3 all have heard me talk about this in terms of what

 4 we've done to-date already, in terms of

 5 overhauling our rules. The Commission did that a

 6 couple of years ago -- incorporating international

 7 standards.

 8 But the topics we're taking up today,

 9 you know, are especially important. They are

 10 topics that are going to get increased attention,

 11 both by us and internationally, through the work

 12 streams going on, with CPMI-IOSCO and the FSB.

 13 So, I'm just delighted that Commissioner Wetjen

 14 has organized this. I think it's extremely

 15 important that we get some input and have a

 16 discussion on standards for stress testing, as

 17 well as capital needs. On capital needs I think,

 18 you know, many of the issues, as we all know,

 19 pertain to, what, really, does the function of

 20 that capital play? Is it really an alignment of

 21 incentives issue, and how do we ensure there is an

 22 alignment of incentives between the clearinghouse
 12

 1 and clearing members? And how do we think about

 2 that capital in the context of recovery planning

 3 and the recovery process? So, I look forward to

 4 those discussions today.

 5 On the second panel, as Commissioner

 6 Wetjen noted, we have put out an ANPR on the

 7 cross-border application of our margin rule, which

 8 lays out three options. We look forward to

 9 talking about those today, and margin is

 10 critically important. This rule is a critically

 11 important piece of the overall framework, simply

 12 because while we have made clearing more

 13 important, there will always be a large part of

 14 the market that is not cleared. We're not trying

 15 to push everything into the clearinghouses. And

 16 so it's very important that we have a good rule on

 17 margin for uncleared swaps. And, again, the

 18 international dialogue that's going on in terms of

 19 trying to get our rules aligned is extremely

 20 important.

 21 So, I look forward to these

 22 conversations. And, again, just want to thank
 13

 1 everyone for being here, and thank Commissioner

 2 Wetjen again. Thanks.

 3 COMMISSIONER WETJEN: Thank you,

 4 Chairman. Commissioner Bowen?

 5 COMMISSIONER BOWEN: Yes. Hi. Thank

 6 you, and good afternoon. It's a privilege to be

 7 here for my second GMAC meeting.

 8 Clearinghouse, capital contributions,

 9 and stress testing, as well as cross-border

 10 applications of our margin requirements are

 11 important issues for the functioning of our

 12 markets. I want to commend Commissioner Wetjen

 13 for his leadership on these issues and for holding

 14 this meeting.

 15 There has been a great deal of

 16 discussion and debate over the last year about the

 17 current state of clearinghouses, and how much skin

 18 in the game should we be required to hold. In

 19 fact, I recall that this issue was one of the

 20 first ones that was raised during my meetings when

 21 I was first sworn in as a Commissioner last

 22 summer. So, I look forward to hearing from the
 14

 1 participants today on this subject, including your

 2 thoughts on the costs and benefits of acquiring

 3 higher capital contributions from clearinghouses.

 4 I also want to note one point regarding

 5 stress tests. We often hear that stress tests are

 6 devised by taking past historical events, such as

 7 the collapse at Lehman Brothers, and multiplying

 8 the market effects by a factor of two or three.

 9 Given the increased importance of clearinghouses,

 10 the interconnectedness of our global markets, the

 11 evolving technology, and trading strategies since

 12 2008, we need to make sure that these stress tests

 13 not only capture those historical past crisis, but

 14 also that they are truly reflective of the change

 15 realities of today's marketplace.

 16 Finally, I'm looking forward to today's

 17 discussion on large and unfair swaps. The

 18 re-proposal of our margin rule was one of the

 19 first rules I voted on as a Commissioner. I know

 20 all of us want to make sure that we get this

 21 right. I'm hopeful we can finalize it soon, and I

 22 want to thank the Chairman for his diligent
 15

 1 efforts in that regard. Thanks so much.

 2 COMMISSIONER WETJEN: Thank you,

 3 Commissioner Bowen.

 4 And Commissioner Giancarlo, from New

 5 York?

 6 COMMISSIONER GIANCARLO: Thank you,

 7 Mark. I'm here with several members of GMAC who

 8 could not get to Washington today. Can you hear

 9 me?

 10 COMMISSIONER BOWEN: Yes.

 11 COMMISSIONER GIANCARLO: I couldn't get

 12 to Washington today because of the tragedy on the

 13 Amtrak Northeast regional train. And I think it

 14 should be said, I think, on behalf of all of us on

 15 the Commission and the staff, that our thoughts

 16 and prayers go out to the family and friends of

 17 people that were affected by that tragedy.

 18 I'm very much looking forward to today's

 19 hearing. And, Mark, I commend you for your

 20 leadership of GMAC.

 21 When the group of G-20 nations met in

 22 Pittsburgh in 2009 and pledged to wholesale reform
 16

 1 of financial markets in the wake of the financial

 2 crisis, their communique speaks again and again

 3 about the need for coordination of global efforts

 4 in the process of reg reform.

 5 I think GMAC is an important element,

 6 important forum in that process of trying to

 7 coordinate global regulation and the reform of our

 8 financial markets in the wake of that crisis.

 9 And so, again, I commend you for today's

 10 meeting and for your general leadership on GMAC

 11 over the last several years. It does play an

 12 important role, and I think today's meeting is a

 13 step in that direction. So, I wish you, and the

 14 Commission, and all of the GMAC members today a

 15 great meeting, and I look forward to

 16 participating. Thank you.

 17 COMMISSIONER WETJEN: Thanks very much,

 18 Chris; appreciate that. And I echo the comments

 19 of Commissioner Giancarlo about the tragedy on the

 20 railway a couple of days ago. Our hearts and

 21 prayers do go out to the victims and their

 22 families. A lot of us in this room travel that
 17

 1 way pretty frequently, and so it's hit all of us

 2 in one way or another, I know.

 3 Well, let's kick off the first panel. I

 4 think we can do that now; right, Dani? Okay,

 5 good.

 6 I think what we'll do is, we'll start

 7 with Bob Wasserman from the CFTC. Bob, we've

 8 asked you to put together a few remarks to get the

 9 discussion going. And Bob's going to share with

 10 us some of his insights and a description of

 11 what's underway and has been going on for a little

 12 while now in the context of IOSCO, in terms of

 13 further enhancements beyond standards we've

 14 already put in place here at the CFTC. Bob?

 15 MR. WASSERMAN: Thank you very much,

 16 Commissioner. CPMI and IOSCO have been looking at

 17 risk management for a number of years. And so, of

 18 course, in 2012, with the principals for financial

 19 market infrastructures, which are currently being

 20 implemented -- but more recently, I think, we've

 21 realized that it is important that, essentially,

 22 the work is not done, and we have been focusing
 18

 1 for, really since last fall, on stress testing.

 2 And in the past couple of months in discussions

 3 with, as well, other standard-setting bodies, such

 4 as BCBS and, as well, the Financial Stability

 5 Board, we have been working on a fairly

 6 comprehensive analysis of CCP risk, and looking

 7 essentially at our current standards, and trying

 8 to understand how well they can meet, essentially,

 9 the future challenges that we're facing.

 10 In particular, as I mentioned, we've

 11 been looking very much at stress testing, and are

 12 now in the process of first conducting a stock

 13 tank among more than 30 CCPs, trying to understand

 14 what is going on today -- what are the current

 15 practices? And it's a fairly comprehensive

 16 analysis -- basically, a questionnaire of about

 17 100 questions, focused, really, on an analytical

 18 framework which was built with the help of an

 19 expert group that goes in six areas.

 20 The first theme relates to governance

 21 arrangements that underpin the stress testing for

 22 both credit and especially liquidity risks. And
 19

 1 so in governance, you're looking at the

 2 objectives, including the CCP's risk appetite, how

 3 they define extreme but plausible market

 4 conditions, and how these stress tests results are

 5 used to inform risk management.

 6 Then processes and procedures -- how are

 7 the stress tests designed, executed, reviewed

 8 internally -- both as to daily review of results,

 9 but, as well, periodic review of the stress

 10 testing framework to ensure that it continues to

 11 be fit for purpose?

 12 And a very critical point -- a

 13 disclosure -- what are the CCP's procedures to

 14 disclose their methodologies and results to

 15 members, clients, and the public? And at this

 16 point, I should note that the CPMI-IOSCO group has

 17 had a number of interactions with industry folks,

 18 including one focused on stress testing in

 19 Frankfurt back in March. And I think the loudest

 20 takeaway from that is the importance of disclosure

 21 and governance.

 22 And so there's a very strong desire, we
 20

 1 heard from the clearing members, to have some very

 2 thorough disclosure of the methodologies, the

 3 scenario selection, a number of other things I'm

 4 going to discuss in the next few moments, with the

 5 aim of being to active participants in the process

 6 of the CCP's risk management. And a phrase that

 7 someone said that very much resonated with me --

 8 they want to be able to actively challenge the

 9 assumptions and the methodologies that the CCPs

 10 are using. And I take "challenge this" not as a

 11 negative, but as a very positive word -- that,

 12 essentially, bringing to bear their expertise --

 13 and, of course, their interests in a process of

 14 promoting effective and rigorous risk management.

 15 The second theme covers how the CCP

 16 identifies credit liquidity risks which would be

 17 exposed following default of one or more members.

 18 And this includes looking at the sources of such

 19 risks, and those include both the positions

 20 cleared, but also collateral held. They also very

 21 much include liquidity risk. How such risks are

 22 measured -- through a selection of risk sources in
 21

 1 a way that you can keep the problem tractable.

 2 And how the exposures are aggregated -- such as,

 3 for instance, across accounts or clearing

 4 services.

 5 The third theme explores, then, how the

 6 CCP models extreme but plausible market conditions

 7 -- including both the design of stress scenarios,

 8 including the period over which losses or

 9 liquidity needs are measured, historical

 10 scenarios, but, as well, very importantly,

 11 forward-looking scenarios -- because it is,

 12 indeed, very important not to simply apply what

 13 has gone on in the past, but to look very much to

 14 the future to see what new challenges may be

 15 there, both because of new products cleared, as

 16 well as changes in market conditions.

 17 And then, as well, the translation of

 18 those stress scenarios into discrete risk factor

 19 moves -- and that is a very challenging exercise.

 20 One may have very strong agreement as to what are

 21 the sort of macroeconomic challenges that one may

 22 face, but then it is very important -- and, I
 22

 1 think, a fairly complex exercise -- to come to a

 2 how one then takes those macroeconomic factors,

 3 and sees how will those, in fact, affect

 4 individual contracts.

 5 The fourth theme, then, examines how the

 6 CCP applies the risk factor shifts to member and

 7 client portfolios. And that is to produce

 8 estimates of stress loss, as well as stress

 9 outflows -- again, liquidity risk -- but, also, as

 10 well, focusing on additional sources of risk; in

 11 particular, concentration risk and basis risk.

 12 And one of the things I've been hearing,

 13 certainly, over the past couple of months is

 14 increased concern over concentration risk and the

 15 possibility that the impact of concentration is

 16 more than linear because, essentially, as

 17 positions become larger, they become -- not

 18 correspondingly, but at a higher function -- more

 19 difficult to liquidate.

 20 The fifth theme considers how the CCP

 21 uses estimates of stress loss and stressed outflow

 22 to determine, then, its financial and liquidity
 23

 1 resource requirements, and to verify, then, that

 2 it maintains adequate coverage against credit

 3 liquidity risks, even in these modeled extreme but

 4 plausible market conditions.

 5 And the final area refers to the

 6 additional analysis a CCP performs to evaluate the

 7 strengths and weaknesses of its stress testing

 8 framework, including sensitivity analysis and

 9 reverse stress tests.

 10 So, again, the idea is to look at stress

 11 testing at a very, very articulated level, to get

 12 deep into the weeds and to understand what folks

 13 are doing now, and then, based on that, to help us

 14 determine, along with the results of the stock

 15 take, the results of the industry workshops that

 16 we've been conducting, and, essentially, our own

 17 knowledge, to then perhaps come up with additional

 18 guidance. That is likely to happen through the

 19 use, as well, of a public consultation before any

 20 final guidance would be issued. And, obviously,

 21 the guidance would then benefit from the results

 22 of that public consultation.
 24

 1 COMMISSIONER WETJEN: Bob, the group

 2 might appreciate knowing whether there's some

 3 semblance of a timeframe that the working group is

 4 operating under, particularly if there might be

 5 the involvement of a consultation process. Can

 6 you give us a sense of that?

 7 MR. WASSERMAN: So, it is -- I should

 8 note I'm very much under the control of others in

 9 the group, in terms -- and certainly should not be

 10 taken -- yes, I have many bosses in this context.

 11 I think there is a goal to perhaps do a public

 12 consultation as early as possible in 2016. Again,

 13 we are feeling very much the need to proceed with

 14 dispatch, and are working very hard. Indeed, I

 15 just came back from a meeting in New York. I

 16 happily was successful in getting back here.

 17 But on the other hand, need to take the

 18 time to make sure that we get it right. And so

 19 that's, I think, where we are.

 20 As I've noted, from the perspective of

 21 the CCPs, they are actually, as we speak, in the

 22 middle of filling out the survey that we sent on
 25

 1 stress testing. There are other surveys that are

 2 likely to go out as early as possible in the

 3 summer, and that is, as well, going to feed into

 4 the work that the group is doing.

 5 I should note before I turn over that

 6 there is another related group. So, CPMI-IOSCO

 7 has a policy standing group which is doing the

 8 work here. And, indeed, a number of my colleagues

 9 here on the panel are part of that, as well, and

 10 have been contributing very strongly to the work.

 11 In addition -- and we work under the

 12 guidance of a steering group -- other members of

 13 the panel on that -- but, as well, there is an

 14 implementation monitoring standing group. And

 15 that group has been working first at a number of

 16 levels to look at the implementation of the PFMIs.

 17 And so there have been a number of reports already

 18 published at level one, which is essentially a

 19 self-assessment by the various authorities of

 20 their progress.

 21 There have been reports that were

 22 published at the end of February, at level two,
 26

 1 for the U.S., Japan, and the E.U., with respect to

 2 essentially looking at the detailed rules, and a

 3 very close matching of the statutes and

 4 regulations in each of the jurisdictions against

 5 the PFMI.

 6 Relevant here, the group is going to be

 7 working at level three, looking at a sample of

 8 individual CCPS -- and, in particular, focusing on

 9 the issue of risk management, including, very

 10 importantly, stress testing. And that group, in

 11 addition to working through conducting basically

 12 initial-level questions, is then likely to take

 13 the answers to those questions, follow up probably

 14 some degree of direct interaction. And so that is

 15 a very detailed essentially analysis that will be

 16 taking place of a smaller sample of CCPs to see

 17 how they're implementing risk management in

 18 general -- and stress testing in particular.

 19 COMMISSIONER WETJEN: Thank you, Bob.

 20 Next, we'll turn to Jeff, from the Federal

 21 Reserve.

 22 MR. MARQUARDT: Thank you, Commissioner.
 27

 1 Just a quick caveat -- I'm speaking in my own

 2 capacity, not for the Federal Reserve Board or any

 3 specific governor. Having said that, I've been

 4 involved in this work for a long time.

 5 So, let me just start with my top line

 6 message, I think, right now, without front-running

 7 the very important work that Bob is describing.

 8 I think I would encourage very strong,

 9 in-depth work on this topic -- on credit stress

 10 testing and, as Bob emphasized, liquidity stress

 11 testing -- which is really a bit new for some CCPs

 12 and financial market infrastructures.

 13 Second, we really need to encourage the

 14 collaboration that Bob described between the

 15 regulators and the CCPs, but bringing in, also,

 16 the clearing members, the banking organizations,

 17 the buy side. I think that's been very fruitful

 18 so far, and I really strongly encourage the

 19 continuation.

 20 And I guess where I would come out on --

 21 again, not front-running, but I believe that the

 22 Committee should produce a very strong document,
 28

 1 and should substantially move the dial on stress

 2 testing. I think that's expected, and I think we

 3 need to anticipate that that will happen.

 4 Now let me just make five sort of

 5 general points; two background.

 6 One is, the new international standards

 7 actually already have quite a bit of detail on

 8 stress testing -- frequencies, daily, monthly,

 9 annual, governance arrangements. So, there's

 10 quite a bit there, but I think we all would

 11 conclude that there needs to be more granularity,

 12 and, therefore, this work is needed. That was

 13 actually known -- I think came out in the

 14 consultation at the international level with the

 15 principals themselves. There just is a matter of

 16 priorities -- that not everything could be done at

 17 one time. So, now we need to finish the job on

 18 stress testing.

 19 Second background point is just to

 20 emphasize the point that the Commissioner has

 21 made. Not only do we have mandatory clearing

 22 coming in, but we also have increasing voluntary
 29

 1 clearing, central clearing. And as that theme has

 2 taken hold -- and, secondly, as regulators and the

 3 industry have opened up issues of recovery and

 4 resolution -- what are the long tail -- in the

 5 long waterfall, in default or liquidity -- who

 6 does take losses or absorb liquidity risks far out

 7 in the tail? As those issues have been opened up

 8 because CCPs have become important now -- or much

 9 more important -- then the clearing members and

 10 banking organizations on buy side are asking

 11 themselves sort of with new transparency, what are

 12 my risks, and how can I control them? And they

 13 are noting that on their list of counterparties,

 14 CCPs are very high on that list.

 15 So, these issues we're talking about

 16 have become very urgent for the banking industry

 17 -- perhaps unlike 20 years ago.

 18 So, let me just finish out with three

 19 sets of points. My third one here would be just

 20 to throw out the idea, we should have objectives

 21 for what we're trying to accomplish in this with

 22 additional work on stress testing. I'll just give
 30

 1 you a few of mine, but others -- I just really

 2 want to tee that up for discussion. I think we

 3 need to, one, improve CCPs' own stress testing

 4 methodologies and strengthen the organizations. I

 5 think there's a lot of variation across these

 6 organizations in what they do, how much they do,

 7 how robust are the scenarios; we need to work on

 8 that.

 9 Second, we need to enable comparisons of

 10 risk and strength across CCPs.

 11 Third, we need to use this opportunity

 12 for greater transparency -- and not just to the

 13 primary regulator, but there are a large number of

 14 regulators interested in these organizations.

 15 Some are securities and derivatives regulators,

 16 but the banking supervisors and others -- and the

 17 general public. So, there's a transparency

 18 dimension.

 19 Fourth, comparison not just across CCPs

 20 within a single jurisdiction, but also across

 21 jurisdictions -- because, as everyone notes, it's

 22 a global market, and the clearing members are
 31

 1 picking and choosing -- or using multiple CCPs --

 2 and they need to know how strong CCP A is versus

 3 B, and this is one method for sort of baselining

 4 that.

 5 And finally, I think there's an element

 6 of helping the clearing members understand their

 7 risks when they participate in multiple

 8 institutions, and some of the bigger banking

 9 organizations participate in many, many CCPs.

 10 So, my fourth point is, we need more

 11 work. I think Bob described the agenda, so I

 12 won't go into that. But, obviously, there are a

 13 lot of technical issues here that people need to

 14 work on -- both the regulators and, I think, the

 15 papers from the industry are helping, too, so I

 16 encourage more of that.

 17 And finally, responsive to some of the

 18 questions on those, what should be the form of the

 19 new standards or guidance? Again, I'm pushing the

 20 envelope in a personal capacity, but I think we

 21 should be open to some form of minimum

 22 international standards, not just voluntary
 32

 1 guidance. We're in a voluntary world now, and I

 2 think people are looking for something more than

 3 the current state -- or just simply a set of best

 4 practices, as helpful as those could be. So, I

 5 think we should be open to that kind of thing.

 6 And the alternatives are probably

 7 distortions, and risk, and competition, probably

 8 reduced confidence in the CCPs, and even impacts

 9 on financial stability. So, that's my instinct

 10 right now.

 11 And the second part of this -- I think

 12 the press raises this issue of a standardized

 13 jurisdiction-level stress test for all CCPs. And

 14 we may talk some more about that. I think we

 15 should seriously consider the advantages and the

 16 disadvantages of something like that standardized

 17 stress test at the jurisdictional level. And I

 18 think we also have a challenge at the

 19 international level. We should consider some form

 20 of cooperation among regulators -- so how they

 21 could be more coordinated at the international

 22 level, in terms of stress scenarios, and output,
 33

 1 and transparency issues.

 2 So, with that, I hope that's a little

 3 bit provocative, but I wanted to lean forward a

 4 little bit for everyone today.

 5 COMMISSIONER WETJEN: Thank you, Jeff.

 6 Next, let's turn it over to Fabrizio. Fabrizio,

 7 welcome. Thanks for being here. Many Europeans

 8 are celebrating a holiday, I think, today, as I

 9 understand it -- so appreciate the extra effort to

 10 be here with us.

 11 MR. PLANTA: Thank you. It's a great

 12 honor to be here and representing the European

 13 views. It's the second time for me to represent

 14 the Europeans in this important committee.

 15 So, the two issues that you wanted to

 16 focus on in this panel were whether there should

 17 be common standards, and whether there should be

 18 more transparency. And I think that the simple

 19 answer to those two questions are yes and yes, as

 20 also the previous panelist has already confirmed.

 21 In Europe, we decided three years ago

 22 that we needed common standards on the stress
 34

 1 test. David and I worked on these standards.

 2 David actually chaired the taskforce that

 3 developed those. And we are very encouraged by

 4 the fact that, at the international level, we are

 5 now moving into a more granular definition of

 6 common stress test requirements/standards --

 7 certainly not best practices or guidance, as Jeff

 8 mentioned.

 9 What our standard covers -- so we cover

 10 both the stress test and sensitivity analysis. We

 11 cover stress testing procedures, so that includes

 12 both historical and hypothetical scenarios. We

 13 define specific risk factors that needed to be

 14 tested, and we specified that the stress testing

 15 should cover both the financial resources and

 16 liquidity resources. And we also have

 17 requirements for reversed stress tests. On top of

 18 these, we have developed, also, disclosure

 19 framework.

 20 So, in our view, the real question is

 21 not whether there should be common standards, but

 22 what these common standards should cover. And we
 35

 1 think that the European framework is already a

 2 good basis for this, and it's also allowing ESMA

 3 to develop the standardized E.U.-wide stress test

 4 that Jeff mentioned. Indeed, it is a challenging

 5 exercise that we are currently running. We are in

 6 the middle of that process, but, certainly,

 7 without common standards, we couldn't probably not

 8 even started that work.

 9 So, we are, again, very encouraged by

 10 the work at the international level. We are ready

 11 to revise our standard if something more granular

 12 comes out of this work, and we certainly believe

 13 that this is the way forward -- the principle way.

 14 I've always argued that there were (211) for

 15 ensuring consistent standards globally.

 16 COMMISSIONER WETJEN: Thank you,

 17 Fabrizio. I'll turn next to David, from the Bank

 18 of England.

 19 MR. BAILEY: Thank you very much, and

 20 for inviting me to participate in these important

 21 discussions on the topic of CCP resilience.

 22 We've already heard that regulatory
 36

 1 initiatives driven by the G-20 have significantly

 2 increased the role and importance of CCPs in

 3 financial markets. Indeed, I've heard CCPs

 4 described as super systemic on a number of

 5 occasions. And I think it's right, therefore,

 6 that we should constantly challenge the CCP

 7 community and our expectations of them. And by

 8 "our expectations," I mean those of regulators,

 9 users, and other stakeholders -- to ensure the

 10 robustness of a CCP's risk management, and ensure

 11 that their resilience meets standards commensurate

 12 with their systemic importance.

 13 Put simply, these are areas in which our

 14 analysis and thinking should continue to evolve --

 15 which is a point that the FSB has picked up.

 16 I think it's also important to note,

 17 though, that it's clear the international

 18 community has made very significant and tangible

 19 progress in enhancing the resilience of CCPs. The

 20 CPMI-IOSCO principles and their implementation

 21 via, for example, Dodd-Frank in the U.S., EMIR in

 22 the EU, significantly raise the bar for FMIs,
 37

 1 including CCPs. And therefore, it's from that

 2 strong and solid base that we should now build and

 3 enhance our thinking.

 4 So, turning more specifically to stress

 5 testing -- as we've already heard, it sits at the

 6 heart of a clearinghouse's risk management, and

 7 its use is embedded within the PFMI. It's common

 8 practice for CCPs to use stress testing to size

 9 their default funds, to size their liquidity

 10 resources, and, also, to inform wider risk

 11 management decisions. So, therefore, from our

 12 perspective, verifying that a CCP's stress testing

 13 framework is robust is, therefore, crucial to

 14 assessing its resilience.

 15 And whilst the PFMI-embedded reliance on

 16 stress testing -- as Jeff has already said, they

 17 don't include the complete detail on how the

 18 testing should be carried out. This in part

 19 reflects the very nature of the services that CCPs

 20 provide, and stress testing should absolutely be

 21 tailored to the particular markets cleared by any

 22 one CCP. But it does make it more complex for
 38

 1 regulators and users of CCPs to compare the

 2 testing framework of one CCP with that of another

 3 -- and, therefore, the resilience of one CCP

 4 versus another -- and verify that the appropriate

 5 standards are being met, and that there's a level

 6 playing field between CCPs.

 7 So, as a result, we've been vocal

 8 supporters of CPMI-IOSCO taking forward further

 9 analysis on stress testing. And that's an

 10 initiative, as Bob has already highlighted, I'm

 11 personally heavily involved in.

 12 Bob sort of outlined the process that's

 13 going on and the areas that that will be looking

 14 at. And I think it's vitally important that that

 15 work is taken forward and proposals are put

 16 forward in 2016. But given the work is only in

 17 its formative stages, it's too early to say

 18 exactly what measures are needed. But I think

 19 it's right that we consider additional guidance

 20 and additional granularity in all of the separate

 21 areas of the analytical framework that Bob

 22 mentioned. And I won't go through and repeat
 39

 1 those.

 2 But I also think that the work should,

 3 as Jeff has briefly highlighted, the work should

 4 assess the feasibility in use of standardized

 5 stress testing of CCPs, similar to the testing

 6 that already exists in the banking world.

 7 There's real challenges that exist here,

 8 not the least given the diversity of clearing

 9 services and CCP business models, but a concept

 10 should be strongly considered -- but as a

 11 supplement to a CCP's own bespoke stress tests. I

 12 think taken forward, it would be an important way

 13 of providing more transparency and comparability

 14 across the clearinghouse community.

 15 And that brings me to the final point of

 16 my comments -- which is that effective stress

 17 testing is important to all stakeholders in a CCP,

 18 who will all benefit from robust and resilient

 19 CCPs. The clearinghouses themselves obviously own

 20 the process. Regulators have a key role to play

 21 in enforcing our requirements, but a crucial part

 22 must be played by the users, by risk committees,
 40

 1 and directly with the CCPs.

 2 Here, again, CPMI-IOSCO has played a

 3 leading role in enhancing the level of

 4 transparency that will be provided by CCPs through

 5 disclosure frameworks for both qualitative and

 6 quantitative aspects of a CCP's framework. And

 7 it's now incumbent on users to make the most of

 8 these and play an active role in a CCP's risk

 9 governance.

 10 I for one won't look very favorably on

 11 users who don't actively seek to address any

 12 concerns they have with the CCPs directly. And

 13 it's therefore critically important that users

 14 engage fully and frankly with the CPMI-IOSCO work,

 15 as well as the CCPs, to ensure that information

 16 requirements are understood, and that users have

 17 the ability to make their voice heard at the CCP,

 18 in terms of its risk management framework.

 19 So, briefly, a four-point summary of my

 20 comments would be that the stress testing plays a

 21 crucial role in the CCP's risk management, and is

 22 crucial for a CCP's resilience.
 41

 1 The international community has made

 2 much progress in terms of raising the bar, in

 3 terms of risk management standards. But it's

 4 right that we constantly challenge CCP practice in

 5 this area. That's exactly what CPMI-IOSCO are

 6 doing, and we fully support that work.

 7 And finally, users have got a crucial

 8 part to play in helping set the right expectations

 9 in holding CCPs to meet them.

 10 So, thank you, and I look forward to

 11 some questions later from the committee.

 12 COMMISSIONER WETJEN: Thank you very

 13 much, David. Shunsuke?

 14 MR. SHIRAKAWA: Thank you very much for

 15 giving me an opportunity to attend this Committee,

 16 and to present our views on extremely important

 17 topics regarding CCPs' resilience.

 18 I'd like to make comments from the

 19 viewpoints of authorities which regulate markets

 20 other than two largest markets in U.S. and E.U.

 21 It appears that the concentration of

 22 risks at the small number of CCPs is occurring in
 42

 1 the course of implementing central clearing

 2 obligations, and the need to understand the risks

 3 and to deal with systemic implications of such

 4 phenomenon of risk concentration is

 5 well-recognized.

 6 Under the principles for financial

 7 market infrastructures, each CCP is required to

 8 maintain substantial financial resources and

 9 liquidity using the result of stress tests based

 10 on scenarios in extreme but plausible market

 11 conditions. But details are not proscribed in the

 12 PFMIs regarding how to implement stress testing.

 13 Therefore, it is an important step for

 14 international standard setters, such as

 15 CPMI-IOSCO, to start discussions on this topic,

 16 with a view to enhancing transparency to market

 17 participants and comparability among CCPs.

 18 If these goals are achieved from the

 19 standpoints of forced authority of a global CCP

 20 operating across jurisdictions, it can be

 21 justified to defer to its home authorities,

 22 regulatory, and supervisory framework. And we can
 43

 1 avoid unnecessary overlaps and conflicts of

 2 regulations between home and hostile authorities.

 3 However, the CCPs, which truly need such

 4 international discussions, are limited to those

 5 operating globally, and considered systemically

 6 important in multiple jurisdictions.

 7 CCPs operating almost uniquely in

 8 domestic markets, such as in Asia, to respond to

 9 local needs, are quite often still in the startup

 10 stage in their markets, and have fewer resources

 11 to cope with various challenges while they pose

 12 limited systemic risks, at least for the time

 13 being.

 14 If we stick to applying uniform

 15 standards to all CCPs for the sake of a level

 16 playing field, it becomes difficult for an

 17 authority to take into account characteristics of

 18 each market or each product. Accordingly, this

 19 approach might pose serious impediments to new

 20 entrants or development of local CCPs, and thus

 21 might lead to oligarchy of clearing markets by a

 22 handful of global CCPs.
 44

 1 Therefore, it is essentially to conduct

 2 fact- finding exercise first, covering not only

 3 global CCPs, but, also, local CCPs in order to

 4 understand the differences in market conditions

 5 and in risk management practices. Then we should

 6 avoid a one-size-fits-all approach, and discuss

 7 how to strengthen stress testing by focusing on

 8 global CCPs, which are systemically important in

 9 multiple jurisdictions, while trying to establish

 10 a more flexible framework for the other CCPs.

 11 With regard to the PFMIs, I would argue

 12 against trying to make hasty changes, and thereby

 13 making them a moving target -- particularly for

 14 local CCPs. The PFMIs were compiled in 2012, and

 15 many jurisdictions are now in the process of their

 16 implementation. Raising the hurdles for local

 17 CCPs and these jurisdictions could disadvantage

 18 them disproportionately. While I accept that

 19 there are some areas in which the principles lack

 20 granularity, they reflect material differences in

 21 rules and regulations of major jurisdictions.

 22 Therefore, even if we come to the conclusions that
 45

 1 standards for stress testing need to be improved,

 2 we should focus on global CCPs, which are

 3 systemically important in multiple jurisdictions,

 4 while we apply proportionality and sequencing in

 5 the proper manner to the smaller CCPs. Thank you.

 6 COMMISSIONER WETJEN: Thank you very

 7 much. Thanks again to all the panelists. I think

 8 even from the presentations, we could see that

 9 there are differing views on a number of different

 10 topics, so all the more reason that we're here

 11 discussing this.

 12 Let me start with a first question that

 13 we'll throw out to the membership. We have these

 14 experts here; we should take full advantage of it,

 15 and ask them as many questions as we can.

 16 But related to Shunsuke's point, what's

 17 the right way to go here through the process that

 18 our panelists are involved with in one way or

 19 other? Is the goal -- or should the goal -- be

 20 more granular standards that should result in

 21 standards that are actually required -- or does it

 22 make more sense to pursue guidelines or to pursue
 46

 1 guidance?

 2 And I think Jeff suggested that there

 3 might be a pretty significant difference between

 4 the two, and Shunsuke has just suggested that

 5 there might be reasons to do one or the other,

 6 especially in light of the different nature of

 7 perhaps emerging markets -- or at least smaller

 8 ones. So, I throw out that question, and

 9 hopefully someone can speak to it. David?

 10 MR. WEISBROD: So, thank you,

 11 Commissioner Wetjen and members of the panel. We

 12 would say that there should be standardized stress

 13 scenarios for clearinghouses. We would organize

 14 these standards based on three principles --

 15 actually, those that were mentioned by Jeff. They

 16 would be transparency, simplicity, and

 17 comparability -- so that authorities, the public,

 18 and members can make comparisons across

 19 clearinghouses in different jurisdictions.

 20 We would go further to suggest that the

 21 specific stress test scenarios adhere to several

 22 principles. And the principles, we would say,
 47

 1 would be, one, that you need to give some thought

 2 to segregation of assets. So, lumping all assets

 3 into a single default fund has its risks and also

 4 has its impediments, in terms of doing a good

 5 stress test. At a minimum, we would see three

 6 pools here: Credit, rates, and equities. We

 7 would see a mix of different types of stress

 8 tests: Historical, hypothetical, and deep

 9 correlation stress tests. And we would see the

 10 stress test results being combined across all of

 11 these three categories.

 12 What we would suggest is that the

 13 standards be -- the stress test scenarios actually

 14 be published and standardized across the CCPs,

 15 with the results then displayed in a particular

 16 way. The results being displayed, A, by the

 17 cushion, if any, that exists with the initial

 18 margin, and then across into the use of the

 19 mutualized default fund. And so at a glance, it

 20 would be evident to users in the community as to

 21 which stress tests required potentially how much

 22 use of the funded default fund, stress test by
 48

 1 stress test. And we know that there are maybe

 2 hundreds of these.

 3 We'd also add to that the utility of

 4 considering an additional stress test for the

 5 auction procedure, to make sure that if it's the

 6 case that you have to actually go to auction, to a

 7 large extent, you can evaluate what the

 8 auction-ability of the assets are, a priori, and

 9 by utilizing a stress test that would enable you

 10 to see how much alignment there is on the other

 11 side of that trade -- and if so, whether

 12 adjustments can be made through concentration risk

 13 add-ons to the initial margin and so forth.

 14 So, in short, we would be supporters of

 15 standardized stress test scenarios, and that the

 16 methodologies that we've depicted -- and we've

 17 written a paper on this, which we're very proud to

 18 reference, called "Stress This House," and happy

 19 to distribute it to anybody who hasn't seen it.

 20 COMMISSIONER WETJEN: Now David, do you

 21 have a particular view on the process at IOSCO, in

 22 terms of whether they should come up with
 49

 1 guidance, as opposed to perhaps some other body

 2 that should come up with minimum standards?

 3 Perhaps it's a distinction without a difference,

 4 but I'm hearing from the panelists that there are

 5 different viewpoints on that.

 6 MR. WEISBROD: Well, we think that the

 7 outcome should be to disclose and establish

 8 standardized stress tests and an approach to

 9 disclose those stress tests, along the lines of

 10 what we've indicated. Yes, we think that that

 11 would enable comparability. It would at least

 12 further the ability for members, and the

 13 authorities, and others to compare results across

 14 clearinghouses.

 15 COMMISSIONER WETJEN: Sunil?

 16 MR. CUTINHO: Thank you. Thank you,

 17 Mark. So, first, I want to start by speaking to

 18 the concept. First is, let's look at, if our goal

 19 is the strength of the ecosystem, the strength of

 20 the financial market infrastructure, then I think

 21 the framework should encompass both the CCPs and

 22 the clearing members, because it's important to
 50

 1 look through the entire structure, not just the

 2 CCP, but clearing members and how clients'

 3 accounts are set up.

 4 The second thing to take into account

 5 is, when you discuss this debate about stress test

 6 scenarios versus principles, the thing to take

 7 into account is, standards take time to evolve.

 8 Standards cannot evolve as market risks evolve.

 9 So, the more effective way, we feel, is just have

 10 principles -- far more granular than what they are

 11 today. We agree that we are not there today. We

 12 need to get to principles that are far more

 13 granular than they are today. But it is very

 14 important, when you consider CCP, to look at

 15 market risks as they evolve.

 16 So, stress testing is dynamic; it is not

 17 a static thing. To give you an example, today,

 18 you know, we look at the effects markets slightly

 19 differently for even the G-7 currency like Swiss

 20 franc. You know, that's a difference. There are

 21 events such as the debt ceiling debate that took

 22 place only a few years back. So, those are events
 51

 1 that occur in the market, and the market adjusts

 2 its behavior to those events. It's important to

 3 take that into account.

 4 So, having standardized stress test

 5 scenarios -- okay, you have two problems. One is,

 6 you know, standards will lag behind. So, if your

 7 goal is strengthening the system, then that is one

 8 of your biggest weaknesses. The other is a

 9 challenge we all speak to, which is the diversity

 10 of the products that are being cleared and at

 11 different markets. They're essentially different

 12 markets.

 13 So, even in the banking world, the

 14 scenarios of CCAR are different from the scenarios

 15 of ECB. They are not the same. So, if you can

 16 look at it, they are very different. They are

 17 different from the scenarios of the Bank of

 18 England. So, because there are markets, and they

 19 all operate in different environments, and they

 20 are different -- so it's important to take that

 21 into account.

 22 The other thing to take into account is
 52

 1 concentration. We speak a lot about

 2 concentration. Stress testing should take into

 3 account concentration and the profile of the

 4 accounts. So, sometimes, portfolios are

 5 well-hedged, but they are still susceptible to

 6 certain type of stresses. It's important that a

 7 CCP stress these portfolios to find out, where do

 8 they essentially break? What kind of losses will

 9 they face under different conditions?

 10 So, if you establish a standard stress

 11 scenario -- and let's say that is the, you know,

 12 way you measure the strength of a CCP -- are you

 13 sure you got it right? How do you know? So, that

 14 is essentially the question.

 15 So, standardized stress testing is good.

 16 It's good to have standard principles, far more

 17 granular than where we are today, but it's

 18 important for us, as a community not to lock us

 19 into a situation where we end up doing the wrong

 20 thing for the environment.

 21 COMMISSIONER WETJEN: (inaudible) but do

 22 minimum standards really do that, if what the goal
 53

 1 would be is just simply to have minimum standards?

 2 MR. CUTINHO: It is your objective. So,

 3 what is your objective on minimum standards? If

 4 the objective of a regulatory body or in another

 5 jurisdiction for a minimum standard is just to get

 6 comfort that the CCP is strong, then it is not a

 7 good thing.

 8 If the objective of a minimum standard

 9 is simply a comparison, I struggle to figure out

 10 how you would compare this minimum standard,

 11 because for certain CCPs, they would have products

 12 that do not even reflect those stresses. They're

 13 very diverse in different jurisdictions.

 14 Take a CCP that is just offering a

 15 product in Australia versus a CCP that is offering

 16 a product over here. Australian wheat, for

 17 example -- how would you define a stress test

 18 that will give you a sense that they're

 19 comparable? So, that's essentially the question.

 20 Australian wheat market moves differently than our

 21 wheat markets. There are some correlations, but

 22 very different.
 54

 1 So, it's important to keep these issues

 2 and to take these issues into account when having

 3 a discussion about standardized stress test

 4 scenarios. We are not saying that there shouldn't

 5 be standardized stress test principles far

 6 granular than where we are right now.

 7 Now to speak about correlation,

 8 decorrelation -- I think the important thing to

 9 take into account there is -- how those portfolios

 10 are going to be liquidated is a very important

 11 factor into how you stress correlations.

 12 So, there is no hard and fast rule. If

 13 you come up with a hard and fast rule that says,

 14 "Yes, you have three: It's just equities,

 15 credits, and rates" -- we forgot asset class,

 16 which is energy products and others. So, how do

 17 you define those?

 18 Within a given sector, there are

 19 correlations that do not make sense -- or, you

 20 know, should not exist. For example, the coal

 21 market in the U.S. versus an electricity market in

 22 Europe. So, those are the things to take into
 55

 1 account when you do correlation stress testing --

 2 is, how are these products going to be liquidated,

 3 factors into how you stress your correlation.

 4 So, again, when designing standards, it

 5 cannot be, you know, something as prescriptive as

 6 saying, "These are just these three." We would

 7 rather suggest principles that talk about, you

 8 know, how stress testing should justify breaking

 9 of correlations. Stress testing should justify

 10 how they are being liquidated. So, there should

 11 be some relationship.

 12 Finally, I think, as I said, we have to

 13 look at the entire ecosystem. If you look at an

 14 end client, right, they are clearing for a

 15 clearing firm. They are clearing at multiple

 16 markets. The point at which they connect to

 17 multiple markets is at a clearing member, right?

 18 So, when you stress test and you only

 19 look at a CCP, you're only looking at half the

 20 picture. So, you need to look at the complete

 21 picture of when you are stressing the whole --

 22 when you are objective, and your goal is
 56

 1 strengthening the entire market, and strengthening

 2 the infrastructure -- or improving the confidence

 3 in the infrastructure -- you need to look at the

 4 whole market.

 5 So, I'll stop there, and I'll reserve

 6 rest of my comments later.

 7 COMMISSIONER WETJEN: Clinton?

 8 MR. LIVELY: Thanks, Mark. Thanks for

 9 arranging this important discussion today. And,

 10 say, I have a question -- so whether we go to

 11 standards or to guidelines, I'm curious as to the

 12 enforcement mechanisms. And so I was curious --

 13 where are we headed with regards to the

 14 enforcements by their guidelines or standards?

 15 So, David, you mentioned the users as

 16 playing an important role in enforcement. What is

 17 the role of the regulator in the enforcement here?

 18 MR. BAILEY: So, can I make two points?

 19 I'll respond to that question directly, but I

 20 obviously want to just pick up Commissioner Wetjen

 21 and your comment around standards versus

 22 guidelines, as well. Now that I've got the
 57

 1 microphone, I'm not going to let go of it.

 2 So, in terms of enforcement, our role as

 3 regulators is to ensure that -- as a supervisor of

 4 CCPs, my role is to make sure that a CCP is

 5 adhering to the standards that we have set, and

 6 taking action where it does not. And then there's

 7 multiple forms that that action could take place.

 8 My comments were, deliberately

 9 driven-out users have an interest in CCPs. CCPs'

 10 risk governance are set up in ways which allow for

 11 members, users, and even -- in Europe, especially

 12 -- clients of members to have a direct role in the

 13 risk governance of the CCP. And we need to make

 14 sure -- and we expect to see -- that those members

 15 and clients take that role seriously, and actively

 16 challenge the CCP.

 17 This is an area we're doing a lot of

 18 work on at the Bank of England, and we see quite a

 19 varied practice, actually, between the types of

 20 people that different users put on the Risk

 21 Committee and the level of active participation

 22 that they have in the process. And I think it's
 58

 1 really important that everyone is taking that role

 2 seriously, because it's in everyone's interest to

 3 make sure that CCPs are resilient.

 4 So, we have a direct role as

 5 supervisors, but I think users also have an

 6 important role to play, and I would expect to see

 7 users playing that role actively. So, that's my

 8 response on the first point.

 9 My second point -- just, Commissioner

 10 Wetjen, on your comment on standards versus

 11 guidelines/proportionality -- some of the comments

 12 that Shirakawa-san has made -- I just wanted to

 13 note that, in the PFMIs, in certain aspects, there

 14 is the concept of proportionality already embedded

 15 in there. So, for example, you might have a

 16 cover-one standard for CCPs, but a cover-two

 17 standard for globally systemic important CCPs. We

 18 could equally apply that framework here, if there

 19 was concern that standards were going to be set at

 20 a bar that became a barrier to entry -- or a

 21 barrier to CCPs in some markets.

 22 But I think the important thing is that
 59

 1 there is the appropriate level of granularity --

 2 that it's possible for regulators, for users, and

 3 for the general public to see that the

 4 clearinghouses are adhering to them. So, there

 5 does need to be a level of granularity that allows

 6 that assessment to be made.

 7 COMMISSIONER WETJEN: Bob?

 8 MR. WASSERMAN: So, I should note that,

 9 actually, the enforcement mechanism for the PFMIs

 10 is particularly strong -- specifically, our

 11 colleagues at the Basel Committee on Banking

 12 Supervision have determined that in order to be a

 13 QCCP -- a qualifying CCP -- and to therefore have

 14 capital treatment for exposures to that CCP, be

 15 treated in a reasonable fashion, as opposed to the

 16 much more -- frankly punitive -- capital charges

 17 that apply to exposures to CCPs that are not

 18 QCCPs. You need to be held to standards that are

 19 consistent with the PFMIs.

 20 And as I was sort of alluding to

 21 earlier, there is a fairly articulated system of

 22 implementation monitoring to see that those
 60

 1 standards are, in fact, being implemented and, in

 2 fact, being applied. And so I found myself, for

 3 instance, in 2013, in the very odd position of

 4 having CCPs coming and saying, "Could you please

 5 hold us to higher standards?" Because it was,

 6 frankly, quite necessary for them to be held to

 7 the PFMIs.

 8 And thus, I think, to the extent that

 9 what we come up with -- I'm frankly less sure than

 10 my colleagues how much of a distinction there

 11 would be between guidance and standards, in terms

 12 of a fact. It strikes me that to the extent this

 13 becomes guidance for following the PFMI, it might

 14 well be thought to be the case that, therefore,

 15 part of that implementation monitoring structure

 16 would, in future, extend to looking at how people

 17 were applying that guidance.

 18 And so it seems to me that, actually,

 19 from the regulatory perspective, there is a very

 20 strong and sort of interleafed enforcement

 21 mechanism.

 22 COMMISSIONER WETJEN: I think I see
 61

 1 Wally's name placard in New York.

 2 MR. TURBEVILLE: Thank you. This

 3 winter, I had the great pleasure to participate in

 4 OFR's conference on bank stress testing and

 5 resolution. And one of the things that was a

 6 strong sentiment that emerged from that conference

 7 was that a stress test, whatever methodology is

 8 used, whatever scenario is used in a stress test,

 9 you can almost be absolutely assured that that's

 10 actually not something that's going to happen.

 11 There's a level of complexity associated

 12 with banks and also with central clearing

 13 organizations that is very high. The whole point

 14 of stress testing is articulated as extreme but

 15 plausible conditions, which, unless somebody

 16 thinks otherwise, seems to be, in all of the

 17 literature, suggestive of non-historic kinds of

 18 scenarios. And, certainly, it's a completely

 19 nonlinear process.

 20 So, when we talk about a level playing

 21 field, it seems to me that if a level playing

 22 field overly refers to level standards of
 62

 1 analysis, then that's not going to yield

 2 comparability of different central clearing

 3 organizations. Comparability of different

 4 clearing organization means in their particular

 5 circumstance, they're equally safe, and sound, and

 6 reliable for the public, so that the standards may

 7 differ a great deal.

 8 But that does mean -- since there's many

 9 different regimes -- that there will have to be an

 10 extraordinarily strong reliance upon comparability

 11 of different regulatory agencies' demands for

 12 outcomes -- meaning very strong and stable

 13 systems.

 14 But I just wonder if we, in sort of

 15 relying on or thinking that there's some clear

 16 good associated with level playing fields and

 17 perhaps even competition among clearinghouses, we

 18 lose track of the fact that the real comparability

 19 should be about the outcome -- that they are

 20 equally and very securely safe and sound.

 21 COMMISSIONER WETJEN: I'll try my best

 22 to go in order, but I think Stephen's had his
 63

 1 placard up for a bit.

 2 MR. O'CONNOR: Thank you. I was just

 3 picking up on the comparison points. I think it

 4 is important to be able to compare CCPs, both from

 5 a user perspective and a regulatory perspective,

 6 but only where it's worthwhile. So, to Sunil's

 7 point, the Australian wheat CCP perhaps should be

 8 given a more lenient treatment than Shirakawa-san

 9 hinted at, which also goes to the proportionality

 10 point raised by David.

 11 But I think that for globally-important

 12 systemic CCPs that trade in globally-important

 13 markets -- the clearing globally-important markets

 14 -- then a valid comparison by asset class would be

 15 helpful to both users and regulators.

 16 COMMISSIONER WETJEN: Thank you,

 17 Stephen. Larry?

 18 MR. THOMPSON: Thank you, Commissioner

 19 Wetjen, and thank you for having us here at the

 20 GMAC.

 21 DTCC, of course, runs the two largest

 22 CCPs in the world, for the entire equity market
 64

 1 here in the U.S., and most of the fixed-income

 2 market here in the U.S. We support the

 3 establishment of stress testing framework for

 4 CCPs, and we welcome the opportunity to engage

 5 with policymakers in its development. In fact,

 6 very, very soon, we will have a whitepaper out

 7 discussing all of these issues on CCPs and risks

 8 to CCPs.

 9 We think the key purpose of stress

 10 testing for CCPs should be to fully evaluate the

 11 efficient and sufficiency of each of the CCPs'

 12 total loss absorption resources in light of the

 13 products it clears and the market it serves.

 14 Fully standardized CCP tests would provide a basis

 15 for CCP comparisons only between CCPs that clear

 16 substantially the same asset classes in the same

 17 or very similar markets.

 18 CCPs should assess the degree to which

 19 standardized testing scripts may provide valuable

 20 information, but should not maximize

 21 standardization at the expense of genuine

 22 usefulness.
 65

 1 In other words, we would agree that the

 2 market should be looked at as the end results. In

 3 our marketplaces that we look at at DTCC, if the

 4 equity market is being stressed, you would, in

 5 fact, think that the fixed-income market has

 6 actually got to be not stressed. So, you would

 7 have to stress them both in different ways in

 8 order to get a useful result coming out of that.

 9 We also believe that you've got to look

 10 at the holistic view of what the marketplace is,

 11 to see how fully hedged the end user is in a

 12 stressful environment.

 13 COMMISSIONER WETJEN: Thanks, Larry.

 14 Chris?

 15 MR. ALLEN: Thank you. I think the key

 16 point about standardization of approach to stress

 17 testing is about transparency and comparability,

 18 to the extent that that is possible.

 19 I think that when it comes to the

 20 question of the effectiveness of standardized

 21 approach, the key issue, really, is about how

 22 transparent the stress testing methodologies are,
 66

 1 the defaults, the stress scenarios and so on that

 2 have been used by the different CCPs are. But

 3 there's a couple of things that I think are worth

 4 noting there.

 5 One, as a clearing member, I completely

 6 agree with and endorse the view expressed by David

 7 -- that there is a huge interest on the part of

 8 the clearing member in understanding the way in

 9 which different clearinghouses are thinking about

 10 stress scenarios, risk factors that enter the

 11 clearinghouse, and so on.

 12 We see from examples in the banking

 13 sector where it can be a very useful tool, in

 14 terms of identifying risky (inaudible)

 15 concentration where it allows us to respond in

 16 dialogue with our regulators in a manner which

 17 allows us to mitigate some of those risks, and the

 18 principle, by extension, to the clearinghouses --

 19 the thought would be the same.

 20 But the key point here to me is about

 21 transparency. There is currently a lot of opacity

 22 in the way that the different clearinghouses
 67

 1 operate in terms of stress testing. Some are very

 2 open; others are distinctly less so. And as a

 3 significant size clearing member, we're very much

 4 advocates of driving that increased transparency.

 5 I think I would say, in terms of minimum

 6 standards and whether or not the guidelines or

 7 otherwise -- I mean, that's less of an issue to

 8 the fact, instead, that we should be thinking

 9 about them being dynamic. I think it's very

 10 important that this capacity to respond as new

 11 risk factors entering clearinghouses, as you get

 12 new hypothetical stress scenarios that they could

 13 be factored into whichever stress scenarios are

 14 being run by the different clearinghouses.

 15 But I also think that this is not about

 16 being proscriptive. I think that the introduction

 17 of minimum standards -- call them what you will --

 18 should be not a complete replacement for

 19 idiosyncratic stress testing run by individual

 20 CCPs which best reflects the characteristics of

 21 the portfolios and client mix that are part of

 22 that CCP product's offering.
 68

 1 So, I think that standardization or a

 2 degree of uniformity of standard can be helpful,

 3 but only where it's a meaningful facilitator of

 4 transparency and comparability.

 5 CHAIRMAN MASSAD: Let me follow up on

 6 some comments that have been made about both

 7 transparency, as well as the extent to which we're

 8 including the clearing members in the test. I

 9 think, Sunil, you made this point. I want to make

 10 sure I understand what that means.

 11 If you apply a particular stress

 12 scenario, and that suggests some cause for

 13 concern, to the extent that that cause for concern

 14 pertains to one or two clearing members, as

 15 opposed to something across the board, what do we

 16 do with that information? Is that shared with

 17 another regulator? Is it part of the transparency

 18 that's been made public -- or to other clearing

 19 members? What do we do with that?

 20 MR. CUTINHO: So, let me answer that

 21 question this way: So, I think we strongly

 22 support disclosures. As Chris pointed out, it's
 69

 1 important for our clearing members to know the

 2 stress shortfalls that they bring for their client

 3 portfolios, as well as their own proprietary

 4 portfolios for the system -- and, also, the

 5 scenarios that drive them. Right. That's one.

 6 The second thing to take into account,

 7 to address your question directly, is, the way

 8 these scenarios point out the shortfalls -- and

 9 those shortfalls are prefunded. So, in essence,

 10 each clearing member is proportionally, as a

 11 function of their shortfall, going to fund the

 12 waterfall.

 13 The important thing that we were

 14 suggesting is that when you look at a framework

 15 for stressing it, you know, when it comes to a

 16 client, they're facing multiple CCPs. So, at a

 17 single CCP, we stress the portfolio, and we get

 18 the capital to cover it. What is important is

 19 what happens at the clearing member across all

 20 CCPs. So, is there enough capital there to

 21 sustain the failures?

 22 Because think of this as going all the
 70

 1 way from the center down. So, it comes from the

 2 clearinghouse, where there are risks. The

 3 clearing member firm also has clients clearing

 4 through multiple CCPs, and doing some nonclearing

 5 activity, as well. So, you need to stress all

 6 those portfolios together, to see if the clearing

 7 member can sustain the failure, as well.

 8 So, as far as CCPs are concerned, our

 9 visibility is limited to the risks we see -- not

 10 broader than that. Of course, on a periodic

 11 basis, when you do credit analysis, you do see

 12 more, but not as much as in a dynamic way, where

 13 stress testing has to be done, not just as a CCP

 14 but throughout the system.

 15 COMMISSIONER WETJEN: Well, getting into

 16 more specifics, though, how would that be

 17 operationalized? How would we -- or you -- get

 18 that better view into the members? How would we,

 19 as the regulators, be involved in that?

 20 MR. CUTINHO: There are a few things.

 21 Regulators are involved today -- and I can speak

 22 to the U.S. -- where we share stress results and
 71

 1 stress scenarios with you. When it comes to risks

 2 that are not visible to us, we expect that, as a

 3 regulator, you see information from multiple CCPs.

 4 So, you can see as far as a clearing member and

 5 their exposure to multiple CCPs.

 6 One part that we haven't talked through

 7 is, what happens at the clearing member from level

 8 to client stressing? So, you stress different

 9 clients -- and sharing of those results.

 10 There was an activity called Payment

 11 Risk Committee. It's still a body that exists

 12 today. There is an information-sharing mechanism

 13 where clearing members can get information from us

 14 on disclosures that are now being standardized

 15 through CPMI-IOSCO, but the activity -- the next

 16 stage for PRC was for CCPs to get information

 17 outside of the risks they see. But we haven't

 18 gone there yet.

 19 MR. WEISBROD: So, what we're thinking

 20 is really quite specific. First of all, I should

 21 say that we have 10 different default funds

 22 representing the array of different asset classes.
 72

 1 And so, as Larry points out, it's really quite

 2 important not to smush all into a scenery of

 3 equities, and you have a fixed income at the DTCC

 4 -- and to cross- margin between those two would

 5 provide a distorted outcome. So, the axiom has to

 6 be that you need to create as many default funds

 7 as you need to accurately depict and to enable the

 8 comparability between one CCP and another.

 9 What we're suggesting is that for every

 10 single stress scenario, it be defined; each single

 11 member's P&L is run through that stress scenario.

 12 And you can see, for every single member, to what

 13 extent the IM may cover that. So, one

 14 clearinghouse may have very aggressive, if you

 15 will, IM -- in which case their reliance on the

 16 default fund will be lower to begin with. But

 17 there will probably be -- because it is a stress

 18 scenario -- some erosion, you know, that goes

 19 beyond the IM.

 20 And then the disclosure would include,

 21 okay, what percentage of the funded default fund,

 22 including the skin in the game, is utilized once
 73

 1 the IM erosion is taken into account?

 2 And you can see readily, you know,

 3 whether the cover two is met. And, of course, the

 4 way we manage the risk is to run these stress

 5 tests every single day. And when we see an

 6 individual member that approaches a 45- percent

 7 default fund position on any single stress test of

 8 any measure, we will then immediately call for

 9 initial margin. And then when the default funds

 10 are reset, adjust the default fund contribution of

 11 that member to address that deficiency.

 12 So, all of that's done by us -- and, I'm

 13 sure, other CCPs, as well. And I think that's

 14 something that we would suggest can be used in the

 15 market by members, and be helpful, obviously,

 16 without any disclosure on names of individual

 17 members, without a doubt. But that's the concept

 18 that we have in mind.

 19 COMMISSIONER WETJEN: I think Bob's had

 20 his placard up for a bit.

 21 MR. WASSERMAN: Thank you very much.

 22 So, I want to distinguish between two things that
 74

 1 we're discussing here with similar-sounding words.

 2 There is standards for stress testing, and there

 3 are standardized stress tests. And I think it is

 4 fair to say, without front-running where the group

 5 that I'm with might go, that it is well possible

 6 to come to agreement on standards for stress

 7 testing -- in particular, in areas such as

 8 transparency, where there seems to be a lot of

 9 agreement around here today -- and, certainly,

 10 I've heard agreement in other forums on that.

 11 There might be room, I think, as well, for

 12 agreement on the other factors that I was

 13 discussing.

 14 I think coming to an agreement for an

 15 evergreen standardized stress test that would

 16 operate across jurisdictions would be very

 17 difficult indeed. One may agree that there are

 18 certain historical scenarios that, by asset class,

 19 are very appropriate things to include -- and

 20 where one would say, "Wait a minute. If you don't

 21 have this or that historical scenario in your

 22 stress test for thus and such an asset class,
 75

 1 something is rather wrong, or you really do need

 2 to meet a burden of explaining why you think it

 3 isn't appropriate." So, we might have some

 4 agreement around historical stress tests.

 5 When one goes, however -- as

 6 Commissioner Bowen mentioned -- as stress testing,

 7 it's not just historical scenarios, but one must

 8 include forward-looking scenarios. And it strikes

 9 me that arriving at agreed-upon forward- looking

 10 scenarios -- and remember, the agreement process

 11 itself takes time and effort -- and so to agree

 12 upon forward-looking scenarios that would be

 13 evergreen for the life of a particular regulatory

 14 standard would itself be very difficult.

 15 I note that in the banking world, as was

 16 alluded to, there are, within jurisdiction,

 17 standardized stress testing regimes. There are

 18 not -- and I count the E.U. as one jurisdiction

 19 for these purposes -- there is not an

 20 international standard for a standardized stress

 21 test. And, obviously, I'm, to a certain extent,

 22 under the control of Jeff here. But my
 76

 1 understanding is that the CCAR's process, which

 2 the Fed runs, is a process that involves literally

 3 hundreds of highly-skilled people who basically

 4 are going through every year and, indeed, changing

 5 scenarios every year.

 6 And I think that's appropriate. I think

 7 it's important that the scenarios be dynamic. The

 8 challenge of doing that on an international level

 9 and agreeing on an international level on a

 10 standard that would work every year is, to my

 11 mind, quite daunting.

 12 Now one could say, "Well, look, but

 13 isn't that -- even if we get some information,

 14 some comparability, isn't that better than

 15 nothing?" And I guess my answer is maybe, but

 16 maybe not, and maybe it could be worse than

 17 nothing -- because I do get concerned that if we

 18 say, okay, this is the standard, and that standard

 19 is not, in fact, appropriate for this year -- and

 20 even perhaps less appropriate next year or the

 21 year after -- all of a sudden, this standard

 22 becomes -- you know, we have this concern in the
 77

 1 U.S. around education and teaching to the test.

 2 And it does strike me that folks would

 3 then be working to get the best result from the

 4 test, which may not be the best result absolutely.

 5 And thus, I get very concerned about a false sense

 6 of security. Well, look, here's the number; it's

 7 the objective number that everyone's agreed to, so

 8 it must be right. And so that false sense of

 9 security concerns me a lot.

 10 Now one way to make this more tractable

 11 has been suggested. Well, maybe we can isolate

 12 proto-classes -- and so basically make sure that

 13 each default fund is a very distinct product

 14 class. And that has certain advantages from the

 15 purpose of stress testing.

 16 It does, I suggest, have perhaps some

 17 disadvantages, as well. There are some benefits

 18 to diversity. And so if you have non-correlated

 19 exposures, that tends to, to my mind, build

 20 resilience in the system so that, essentially --

 21 and we saw this, for instance, in Lehman, where,

 22 you know, again, the question was not, how far
 78

 1 into the default fund have we gotten -- but

 2 rather, why haven't we gotten more of our margin

 3 back? Why? Because there was essentially

 4 de-correlation between the exposures.

 5 And so I do think there is a lot of work

 6 and a lot of positive results to be gained from

 7 gaining standards for stress testing -- and, in

 8 particular, around the areas of transparency and

 9 governance, but, as well, in these other areas

 10 that I was discussing.

 11 I am a little bit more concerned about

 12 where we might go in terms of standardized stress

 13 tests.

 14 COMMISSIONER WETJEN: This is a little

 15 out of order, but let's turn to Commissioner

 16 Bowen.

 17 COMMISSIONER BOWEN: So, Bob, thanks for

 18 using the word "governance" twice, because my

 19 question really relates to it. And you mentioned

 20 at the onset that the two words you heard the most

 21 was -- the two words were "disclosure" and

 22 "governance."
 79

 1 Why wouldn't you have governance as part

 2 of your standard, in terms of who conducts the

 3 tests? What's the accountability? What's the

 4 membership look like? What's independence? Why

 5 wouldn't that be part of your standards? What

 6 would that look like?

 7 MR. WASSERMAN: And to be clear, I'm a

 8 little bit reluctant to say what that standard

 9 ultimately would look like, and I'm certainly not

 10 saying what it would not look like.

 11 COMMISSIONER BOWEN: Then David can

 12 answer the question.

 13 MR. BAILEY: Did I not duck at the right

 14 moment there? There we are.

 15 So, I think governance is an incredibly

 16 important part of the stress testing process. And

 17 as Bob has already highlighted in his opening

 18 remarks, it's one of the areas that CPMI-IOSCO are

 19 looking at. And I think it's really important, as

 20 I was stressing earlier, that there is the

 21 opportunity for a wide range of users -- and to

 22 input into the stress testing process, both in
 80

 1 terms of the development of the tests and having

 2 sight over the outcome over the tests.

 3 And our role as supervisors will be to

 4 look at that process and make sure it adheres to

 5 the standards. So, I think CPMI-IOSCO, as it

 6 already is, should think about governance as part

 7 of its work. It's too early to say yet what the

 8 outcomes will look like, but it should absolutely

 9 consider, as part of that work, whether there is

 10 additional guidance needed in the area of

 11 governance around the stress testing framework --

 12 and, specifically, the level of transparency and

 13 input that users have into the CCP's own

 14 processes.

 15 COMMISSIONER WETJEN: Let's turn to

 16 Jeff. You've had your card up for a while -- and

 17 then Thomas.

 18 MR. MARQUARDT: Thanks, Commissioner. I

 19 just wanted to stress a couple of points. One is,

 20 despite the debate around the table on, as Bob

 21 very articulately described, standardized stress

 22 tests -- which is a single scenario or a set of
 81

 1 scenarios applied across the stressed institutions

 2 -- that's where the debate tends to focus.

 3 And I just want to go back and say, I

 4 think there's a great deal of consensus that there

 5 needs to be improvements in the methodology that's

 6 provided, either as guidance or as methodological

 7 standards, for individual CCP stress testing.

 8 Sunil probably goes a little more toward

 9 principles in the guidance; I would go more toward

 10 standardized methodological elements, and we could

 11 define what we meant there.

 12 I think there's a large amount of

 13 agreement that there just is an opportunity to

 14 make improvements for the industry. So, that

 15 should not be lost in the debate over standardized

 16 stress tests.

 17 In my remarks, I was talking about

 18 standardized stress tests at the jurisdiction

 19 level, and part of that comes out of the banking

 20 experience, and I think the number of employees

 21 needed to conduct these things is quite a bit

 22 lower for CCPs than for large banks who have very
 82

 1 complex portfolios, and the stress scenarios are

 2 very complicated.

 3 I just want to ask people to seriously

 4 consider these with an open mind. We tend to hear

 5 all the "why it's impossible," but people used to

 6 say it's impossible to do stress tests for banks.

 7 And I think, you know, that's been a remarkable

 8 tool to strengthen the U.S. financial system and

 9 other financial systems since the crisis, and we

 10 ought to think about that. There are definitely

 11 disadvantages, and those have been noted.

 12 But someone ought to put on the table --

 13 and hopefully the international group will study

 14 this -- what would it look like? What could we

 15 do? What could we accomplish with this -- not to

 16 replace this methodological material for

 17 individual clearinghouses, but as a supplement

 18 with its limitation? Let's put something on the

 19 table and discuss it -- because the theoretical

 20 debate will go on, and I think we owe it to

 21 ourselves, and I think the banking industry,

 22 coming out of their experience says, "At least
 83

 1 let's take a look at that."

 2 So, that would be my plea to everyone in

 3 the room.

 4 COMMISSIONER WETJEN: Thomas, and then

 5 Fabrizio.

 6 MR. BOOK: Yeah, thank you very much,

 7 and I would like to speak briefly to the question

 8 of Chairman Massad and Commissioner Bowen.

 9 And I think there were three terms in

 10 this debate that are very relevant. And one was

 11 mentioned in your introduction -- there is the

 12 role of incentives. I think the second topic of

 13 -- and the capital ties very closely into this

 14 one, and the others are certainly governance and

 15 transparency. And I would just briefly remind

 16 everyone, the role of the stress testing is to

 17 define the guaranty fund, and the guaranty fund is

 18 the mutualized component of the waterfall. So, we

 19 are discussing the defaulter's component in our

 20 margining debate that we are having in various

 21 forums. And here, we are now discussing standards

 22 for the mutualized component.
 84

 1 And let's think about the incentives.

 2 So, this mutualized component is, of course, a

 3 liability to clearing members, because it is

 4 potentially at risk, and it is also, of course, a

 5 cost component to clearing members.

 6 Now what we see, I think, clearly, is

 7 that the comparability is limited -- is also,

 8 here, triggering this debate, and there is a good

 9 reason for that, which is -- and it was mentioned

 10 that the stress testing scenarios are very refined

 11 across the CCPs, based on the asset classes, based

 12 on the products. So, it will be a challenge to

 13 define what we'll call sort of the standardized

 14 stress test. And I just would like to mention

 15 that.

 16 The topics of forcing transparency --

 17 currently, we have transparency to the clearing

 18 member itself. He sees all the results. There's

 19 transparency to the Risk Committee, who can

 20 oversee the scenarios and the way it is done. And

 21 there's, of course, full transparency to

 22 regulators.
 85

 1 And then the question is, what

 2 additional transparency will lead to what result?

 3 And, of course, full transparency will drive

 4 competition among clearinghouses, because it is a

 5 factor of costs and a factor of liability. So,

 6 that, I think, clearly says if we then tie also

 7 into the governance -- which I believe strongly

 8 has to be, first of all, with the CCP, who is in

 9 charge of the risk modeling, and then with the

 10 regulators.

 11 There are, of course, certain conflicts

 12 of interest in all of this, which I think have to

 13 be very carefully thought through. So,

 14 immediately, when you define, for instance,

 15 "standardized scenarios," then, of course, this

 16 will be the industry standard, and it will be very

 17 hard to create an incentive to exceed these

 18 standards.

 19 So, I think there are a lot of arguments

 20 that sort of speak towards a principles

 21 outcome-based view on this that really defines

 22 that the methodology leads to comparable results
 86

 1 that allow it to compare the buffers that CCP hold

 2 -- because, in the end, this is about sort of the

 3 shock- absorbing capacity that CCP's hold and I

 4 would be also concerned if this would lead to

 5 regional differences, because this will

 6 immediately, of course, allocate risks to where

 7 these standards are lower, and then the costs are

 8 also in that regard.

 9 So, also, if we talk later about

 10 capital, these topics are very much, in my

 11 perspective thought from an incentive perspective,

 12 what will it trigger if we sort of change the

 13 (inaudible) I very much support the work that is

 14 now ongoing with what Bob Wasserman has included

 15 the questionnaire to really do a fact-finding

 16 mission -- what are the current practices, and

 17 what is, then, the right way to sort of define

 18 standards across all the CCPs that, I think, first

 19 and foremost, will allow regulators to see what is

 20 the stressed level that, in the end, the industry

 21 can absorb from certain market moves?

 22 COMMISSIONER WETJEN: Fabrizio?
 87

 1 MR. PLANTA: Yes, thank you. I want to

 2 come back to the question of the standards for

 3 stress tests and the standardized stress testing.

 4 And I want to second what Bob said.

 5 I think that we needed to proceed to the

 6 first step and the first step is to define, at the

 7 global level, the standard for a stress test.

 8 Then you can think about having standardized

 9 stress tests per jurisdiction, and then start

 10 comparing what the different jurisdictions are

 11 doing. And only after having done that, you can

 12 start thinking about an international-wide

 13 standardized stress test.

 14 So, I think it's far too early to talk

 15 about international standardized stress test.

 16 Let's start from what we already agreed on, and

 17 let's continue the work at CPMI-IOSCO, given that

 18 we all agree on that.

 19 COMMISSIONER WETJEN: Adam?

 20 MR. COOPER: Thank you, and thank you

 21 for convening us today. I thought, I very much

 22 agree with Bob's points. And when he started
 88

 1 talking about teaching to the tests, I thought

 2 maybe we were going to have a debate about

 3 education reform -- which would've made it the

 4 most interesting GMAC meeting ever.

 5 I'm struck by the fact that we're kind

 6 of stuck on the words. Or I think we're getting

 7 beyond the question of standardization versus

 8 guidelines -- because as Bob, I think, you know,

 9 so eloquently put it, it's about standards. I

 10 think we all agree on transparency, and then

 11 comparability is very important. Maybe what we

 12 should be talking about is not identicality, if

 13 that's actually a word, but certainty and

 14 precision, coupled with transparency, will provide

 15 deep insight, and allow us not only across

 16 different jurisdictions to define standards, but

 17 different asset classes to define standards,

 18 right?

 19 And that way, I think we can capture a

 20 range of different experiences, and yet have

 21 certainty and insight for the marketplace as to

 22 the, you know - what the stress test results in.
 89

 1 I guess the other point I'd like to

 2 make, to just echo Commissioner Bowen's point

 3 about governance, is, I think Sunil mentioned the

 4 importance of involving the clearing members in

 5 the process, and the importance of the default

 6 management process in all of this exercise.

 7 I just want to throw a little marker

 8 down for participation by buy-side participants in

 9 the default management committees, and the

 10 governance of the way CCPs think about the default

 11 management process.

 12 COMMISSIONER WETJEN: Thank you, Adam.

 13 Arthur?

 14 MR. LEIZ: Thank you. Well, my nametag

 15 says Goldman-Sachs. I'm representing

 16 Goldman-Sachs Asset Management, so it is a

 17 buy-side view. Just to piggyback on --

 18 COMMISSIONER WETJEN: Duly noted.

 19 MR. LEIZ: Just to piggyback on

 20 transparency -- when I face a counterparty on a

 21 bilateral basis, I'm able to -- I have a breadth

 22 of counterparties that I can choose, and I'm able
 90

 1 to do sufficient due diligence into the risks of

 2 the counterparty that I'm facing, and choose

 3 certain counterparties over other counterparties.

 4 In a clearing regime, I lose that direct

 5 interaction, in some respects, with the CCP,

 6 because I'm facing a clearing member who is acting

 7 as agent on my behalf to the CCP.

 8 So, while the number of ultimate

 9 counterparties has decreased, I think a level of

 10 transparency, of metrics that would be published

 11 to market participants would be useful, because it

 12 would help me determine which CCPs I'm willing to

 13 face and which ones I may not be.

 14 COMMISSIONER WETJEN: Mike, I was about

 15 to call on you anyway. I was thinking that we

 16 haven't heard in a while -- at least this

 17 afternoon -- from one of the clearing members or

 18 --

 19 MR. DAWLEY: Yeah. Look, I think a lot

 20 of great comments today. I think this a really

 21 interesting topic, and I think CPMI-IOSCO has done

 22 a fantastic job to-date. There's a lot more work
 91

 1 to be done.

 2 Also, I'd just like to throw out some

 3 positive thoughts to a fellow GMAC member, Kim

 4 Taylor; wish her well.

 5 But, look, I think there's a couple of

 6 points I'd like to make. First of all, Thomas

 7 made an interesting point around stress scenarios.

 8 It's really to determine the sizing of the

 9 guaranty fund. And I think the process for kind

 10 of building out stress scenarios really should

 11 involve clearing participants, also.

 12 So, I think that's where governance

 13 comes into play. I think, you know, governance

 14 has got to be robust. It's got to be

 15 all-encompassing, and I think there's got to be a

 16 wide group of clearing members who really can

 17 understand the risks associated with various asset

 18 classes.

 19 I also agree that standardized stress

 20 testing doesn't necessarily work. I think that's

 21 going to be challenging. My firm's probably a

 22 member of, you know, 75 plus clearinghouses all
 92

 1 over the world, and I think it would be very

 2 difficult to develop a standardized stress test --

 3 which goes back to the individual clearinghouses,

 4 and the risk committees, and the governance

 5 structures.

 6 These are the folks who really are on

 7 the frontline, who need to develop the right

 8 stress scenarios that match up with that

 9 particular clearinghouse, and their group of

 10 products, and their global footprint, and takes

 11 into account all the different asset classes. So,

 12 I feel that's so integral to this whole process.

 13 The only other comment I would make --

 14 which has been mentioned several times -- is

 15 around transparency. I think we have a lot of

 16 work to do there, even at the clearing member

 17 level. I think clearing members do have access to

 18 a lot of good data, but I think there's a lot more

 19 information that we could use to help us evaluate

 20 the risks of a CCP.

 21 And one other comment that -- to Adam's

 22 point -- I think the end users, or the clients, or
 93

 1 the clearing members are an important part of

 2 this, but, at the end of the day, I think, you

 3 know, their biggest risk is that, once we get to

 4 the end of the waterfall, they certainly want to

 5 evaluate clearinghouses to an extent -- but they

 6 will sustain losses only once we get down to that

 7 level, and that gets us into the whole recovery

 8 and resolution conversation.

 9 COMMISSIONER WETJEN: Adam, do you have

 10 a response to that?

 11 MR. COOPER: I'm not sure that I would

 12 cede that we will sustain losses or should sustain

 13 losses when it gets down to the end of the

 14 waterfall.

 15 COMMISSIONER WETJEN: Why don't we turn

 16 to the second panel, just to try and abide by our

 17 schedule? I'm sorry; Dani's reminding me, not the

 18 second panel, but part B of our first panel. So,

 19 the topic of the CCPs' capital contributions -- I

 20 think we're sticking with the same panelists, too,

 21 but it's already been addressed by a couple of the

 22 others already.
 94

 1 We obviously have standards around the

 2 overall financial resources of the clearinghouses.

 3 And the CFTC rules have less specificity around

 4 exactly how much of that should come from the CCPs

 5 themselves. Maybe it might be useful to kick this

 6 off -- to turn it back over to Bob and just

 7 explain in a little more detail how our rules

 8 work, and why we came to the policy decision that

 9 is currently on the books.

 10 MR. WASSERMAN: So, basically, our

 11 requirements go to the total financial resources

 12 that are required. And so, in other words,

 13 essentially, the default fund is essentially --

 14 what is the exposure, to either, based on either

 15 cover-one or cover-two standard after the

 16 application of the defaulter's collateral that can

 17 be used in this regard?

 18 I think there was less of a desire to

 19 sort of go to the allocation between market actors

 20 -- the CCPs on the one hand; the members on the

 21 other -- who are not retail. And, indeed, even in

 22 the retail case, we don't, for instance, speak of
 95

 1 how much can be charged. And so I think there was

 2 a desire to avoid stepping into that negotiation.

 3 What I've been hearing more generally is

 4 that, you know, there are two possible uses for

 5 skin in the game in this context. One is to

 6 materially increase the resources that are

 7 available. And so, conceivably, one could have

 8 skin in the game requirements that essentially

 9 would either increase the total or replace, to a

 10 large extent, the contributions of the clearing

 11 participants.

 12 I think there's general agreement that

 13 that would be, in most cases -- I understand

 14 there's some exceptions for historical reasons

 15 that some CCPs like in Australia -- but I think it

 16 is fairly difficult to see that one can have

 17 contributions that are going to be that large, to

 18 have that kind of material effect. And that's

 19 what I've been hearing from industry participants,

 20 really, on both sides of this -- although,

 21 obviously, others may disagree who are here.

 22 The other is alignment of incentives,
 96

 1 and that is quite important. And so there is a

 2 thought that, well, look, it is only if you have

 3 skin in the game that you have an incentive there

 4 to manage the risk. I think some folks would say

 5 that. Others would say that there are other

 6 incentives.

 7 For instance, in the case of mutualized

 8 clearinghouses, they are member-owned, and, thus,

 9 their interests are aligned with those of their

 10 members.

 11 In the case of publicly-traded CCPs, one

 12 might wonder what the impact would be on, say, the

 13 enterprise value or the share price if one

 14 suffered the kind of -- you know, not entirely

 15 unprecedented, but actually in the U.S. Entirely

 16 unprecedented -- failure of going into the

 17 mutualized resources. The market might treat that

 18 with some degree of harshness.

 19 But in any event, that's where we are

 20 now. It is something that is being looked at

 21 internationally, and I think, obviously, it is an

 22 area where there's been a lot of contributions in
 97

 1 a number of the papers that we've been seeing.

 2 And I think it's a debate that is well-made here,

 3 because it is something that folks are very much

 4 concerned about.

 5 COMMISSIONER WETJEN: Would one of our

 6 other panelists like to speak to this? As I

 7 understand it, there are differences in approach

 8 in Europe -- and perhaps even in Japan. As I

 9 said, we don't have specifics around the capital

 10 contribution of the CCPs; we have the overall

 11 financial resource requirement. Help us

 12 understand how other jurisdictions might approach

 13 this differently, and why they have done so, if

 14 that's the case.

 15 Fabrizio?

 16 MR. PLANTA: Yes, thank you. I would

 17 like to focus on three key questions on this skin

 18 in the game issue. First is what it is. And

 19 second, is it a good incentive, and what is the

 20 proportionate level of it? What is it?

 21 In our view -- and we have a requirement

 22 for it -- it is a contribution to the default
 98

 1 fund, in terms of CCP capital. And this

 2 contribution comes before the non-defaulting

 3 clearing members' contribution. So, it basically

 4 put the CCP capital ahead of the mutualized

 5 resources. It is an incentive. It is not an

 6 effective line of defense that would replace the

 7 mutualization element that is the typical

 8 characteristic of CCPs. So, I agree with Bob in

 9 saying that it does not replace the mutualized

 10 element, and they should not do it.

 11 In our view, it's also not a recovery

 12 tool, because it needs to be set ahead of the

 13 prefunded resources by the non-defaulting clearing

 14 members. It might be worth considering also

 15 capital at the end of the default waterfall, but

 16 let's call it differently -- otherwise, we will

 17 not understand what we are talking about. So, for

 18 us, it's the first line after the defaulting

 19 clearing members' contributions margins and

 20 contribution to the default fund.

 21 Second question: Is it a good

 22 incentive? We think that it is. We believe that
 99

 1 if the CCP and its shareholders never pay, their

 2 incentive is to set to the margins and the

 3 collateral requirements in the most aggressive way

 4 to attract business.

 5 And although CCPs -- probably many,

 6 also, around the table -- will argue that risk

 7 management is their main characteristic, so they

 8 have an incentive to properly manage risk. The

 9 truth is that the CCP compete everything. And,

 10 also, the absence of an equivalence between E.U.

 11 And U.S. -- that, also, Chairman Massad stressed

 12 last week at the European Parliament -- I think

 13 it's also driven by competitive consideration and

 14 not just by prudential type of consideration.

 15 So, this leads me to my last point. And

 16 what is the proportionate level of the skin in the

 17 game? There is no magic number. I think we set

 18 it at 25 percent of the minimal capital

 19 contribution. But, certainly, the appropriate

 20 level would be a level that would force the CCP to

 21 set its margins only based on prudential

 22 considerations, rather than a competitive one.
 100

 1 And what is a prudential level of

 2 margins? Well, for us, for exchanges trading

 3 derivatives (inaudible) a level that requires a 99

 4 confidence interval in two-day liquidation period.

 5 And we know that one day is not enough; market

 6 events has already determined that. And,

 7 certainly, it's not enough for own business. And

 8 we can debate about this for long, but if we look

 9 from a CCP perspective, the gross or net is not

 10 relevant, because for the CCP, it's always net.

 11 Certainly, clients has other type of protection,

 12 so gross is certainly better for clients.

 13 But if we look only from the protection

 14 of the CCP -- that the skin in the game is for

 15 that, as well -- and for the protection of the

 16 non-defaulting clearing members, then we need to

 17 look at the margin period of risk, and we needed

 18 to consider the two days.

 19 COMISSIONER WETJEN: Thank you,

 20 Fabrizio. David, do you have any thoughts or

 21 views you want to share?

 22 MR. BAILEY: Thank you very much,
 101

 1 Commissioner Wetjen. Three quick points --

 2 firstly, on sizing, it's clear skin in the game

 3 should act as an incentive, but that doesn't

 4 necessarily mean it will represent a substantial

 5 proportion of a CCP's overall loss-absorbing

 6 resources. And it should be calibrated to provide

 7 the appropriate incentive.

 8 Secondly, as Fabrizio has noted,

 9 placement within the waterfall of a CCP's capital

 10 is important. Clearly, the first resource is to

 11 be used in the case of a default. It should

 12 always be the defaulters' own assets -- their

 13 margin and their default fund contribution. But

 14 there's then a strong argument that a CCP's

 15 contribution should follow straight after, before

 16 any loss mutualization takes place, in order to

 17 optimize the incentives.

 18 And as Fabrizio has mentioned, I think

 19 there is merit in considering -- and I'll stress

 20 the word "considering" -- whether a second tranche

 21 of capital should follow later on in the

 22 waterfall, to ensure that CCPs' incentives are
 102

 1 retained throughout.

 2 And finally, I just want to highlight

 3 one area where I think a CCP's capital and

 4 resources have to play the material role -- is in

 5 covering non-default losses, which could be

 6 incurred through investment or operational losses.

 7 Here, a CCP's capital should be the first at risk,

 8 as the parties responsible for the overall

 9 management of the CCPs, but you've then got to

 10 think, what happens if those are exhausted, and

 11 then there is a case for non-default losses to be

 12 allocated to members -- if not doing so would

 13 threaten a CCP's ability to continue its critical

 14 economic functions?

 15 COMMISSIONER WETJEN: Shunsuke?

 16 MR. SHIRAKAWA: Thank you very much.

 17 The financial resources which each CCP relies on

 18 first (inaudible) should be margins and default

 19 funds contributed by the defaulter. Should

 20 financial resources contributed by the defaulter

 21 is not sufficient to cover the losses resulting

 22 from the default, such a CCP would tap guaranty
 103

 1 funds contributed by surviving participants.

 2 Thus, it is critical for a CCP to maintain the

 3 level of margins and guaranty funds -- enough to

 4 withstanding extreme but plausible market

 5 conditions.

 6 For CCPs creating members, or

 7 beneficiaries, or services provided by the CCP,

 8 they are usually in a position to be involved in

 9 the CCP -- the risk management -- taking into

 10 account these facts: A CCP is regarded as an

 11 organization for mutual interest of clearing

 12 members, and the risk of a member's default should

 13 be borne, in principal, by the other members.

 14 Having said that, I would like to draw

 15 your attention to the fact that a CCP operator

 16 itself can be a source of operational risks or

 17 business risks. That's with a view to providing a

 18 CCP operator with adequate incentives to conduct

 19 proper risk management and to maintain prudent

 20 business strategy. It is quite reasonable for an

 21 authority to consider requiring a certain level of

 22 skin in the game.
 104

 1 On the other hand, we should be mindful

 2 of the possibility that it may rather

 3 increasesystemic risks if the skin in the game put

 4 excessive burden on the CCP operators in times of

 5 market stress.

 6 We should also take into account the

 7 differences in risks embedded in each product to

 8 clear and in relationship with clearing members.

 9 As I already mentioned, the management structure

 10 of a CCP may also affect the necessity of skin in

 11 the game.

 12 Against these backdrops, skin in the

 13 game is not required in the current PFMIs, and

 14 Dave has said does not have regulatory requirement

 15 on skin in the game. In fact, there can be

 16 diverse views on adequate levels of skin in the

 17 game, depending on the situations of each

 18 jurisdiction, such as how developed) and how

 19 competitive its (inaudible) derivatives markets

 20 are.

 21 Developing field concerns may not be so

 22 relevant in local and developing markets where a
 105

 1 CCP is playing a rather public role to facilitate

 2 Plain vanilla types of derivative transactions.

 3 Therefore, discussed forced stress Testing -- we

 4 should avoid applying a uniform regulation to all

 5 the CCPs, and had better start discussions

 6 focusing on global CCPs.

 7 Thank you.

 8 COMMISSIONER WETJEN: Thank you. Jeff,

 9 you want to add something?

 10 MR. MARQUARDT: I'll just add two quick

 11 points, Commissioner. Well, three. First of all,

 12 I've learned a new acronym in this discussion of

 13 skin in the game -- it's called SIG. And so now

 14 this is always about SIG, and so the -- just so --

 15 COMMISSIONER WETJEN: That's good to

 16 know.

 17 MR. MARQUARDT: Two serious point -- and

 18 not CIG; SIG -- the two serious points is -- the

 19 first one is, you know, skin in the game

 20 requirement was actually debated in the process of

 21 developing the principles for financial market

 22 infrastructures. And all I can say is, the debate
 106

 1 continues. And Bob and everyone went over the

 2 different effects -- the incentive, the resources,

 3 and so forth.

 4 My conclusion is, there's been enough

 5 further discussion about this issue that, at the

 6 international level, it should be seriously

 7 considered. I'm not saying it should be adopted,

 8 but I think it should be given serious

 9 consideration, and debate, and public comment, and

 10 perhaps even at the jurisdictional level,

 11 considered. Knowing this is one tool, risk

 12 management tool, among many -- and, in my personal

 13 opinion, governance arrangements are probably the

 14 priority in making sure that risk management is

 15 done well.

 16 Second point -- I sort of developed two

 17 common- sense financial stability points to apply

 18 to proposals. And I'm sure others have other

 19 ones. The first one is, there should be no

 20 decrease in CCP resources and preferably an

 21 increase from any of these proposals. So, if the

 22 owned capital of the CCP is contributed early in
 107

 1 the default waterfall, others should not be

 2 allowed to withdraw resources -- or the

 3 configuration should not ultimately lead to a

 4 decrease in resources. That would not help us, in

 5 terms of financial stability.

 6 And secondly -- and particularly -- no

 7 increase in the probability of default of the CCP.

 8 That default probability should not go up, and

 9 preferably should go down. So, if you move a

 10 fixed amount of CCP-owned capital up higher -- too

 11 high in the waterfall, a large block of it -- the

 12 CCP could go broke, covering clearing members

 13 defaults at a higher probability than otherwise.

 14 So, we need to be careful of the unintended

 15 consequences of particular proposals.

 16 And I'll just leave you with that. It's

 17 very important, but, also, you know, we need to be

 18 careful as we consider this.

 19 COMMISSIONER WETJEN: Thank you, Jeff.

 20 Jim?

 21 MR. HILL: Thank you. I think that I

 22 would agree with various aspects of what the panel
 108

 1 has said, insofar as, you know, we believe that

 2 skin in the game is important. It's important to

 3 incentivize the CCP to act in a prudent manner.

 4 We agree that placement in the waterfall is key,

 5 and above the non-defaulting members is where it

 6 belongs.

 7 Where I might differ, though, is whether

 8 or not this needs to be mandated by regulation,

 9 number one. And number two, where I certainly

 10 differ is, should we have a standardized size of

 11 some sort for the skin in the game piece? And I

 12 think that the clearing members who have the most

 13 at stake in a properly functioning clearinghouse

 14 -- and a properly incentivized owner of a

 15 clearinghouse -- should be able to evaluate the

 16 risk management procedures and the management of

 17 the CCP, and make a decision as to the appropriate

 18 size of the skin in the game of the CCP owner.

 19 And a regulation that simply imposes a

 20 standardized size won't necessarily reflect the

 21 appropriate levels at each CCP. And the money

 22 comes at a cost, and that cost will be borne by
 109

 1 the clearing members and the buy side. And so

 2 having an overly large skin in the game piece for

 3 a clearinghouse that's otherwise well-run might

 4 not be appropriate, but having a large piece of

 5 skin in the game in a clearinghouse that perhaps

 6 isn't run as well might be appropriate.

 7 And so I think it's incumbent on

 8 regulators to understand that there is no

 9 one-size-fits-all, and a regulation that imposes

 10 that wouldn't necessarily be appropriate, and

 11 might put costs and burdens on clearing members

 12 and buy side firms that aren't necessarily

 13 appropriate for the level of risk in the CCP.

 14 COMMISSIONER WETJEN: But how do you get

 15 the view into the risk management practices of the

 16 CCPs that you suggested in order to make that

 17 assessment --

 18 MR. HILL: Well --

 19 COMMISSIONER WETJEN: -- as a member.

 20 And would that be accomplished, as suggested, I

 21 think, by Jeff just now, through the governance

 22 structure of the CCP?
 110

 1 MR. HILL: Clearly, in order to make a

 2 decision about the appropriate amount of skin in

 3 the game, as a clearing member, you would need the

 4 right level of transparency. And we talked about

 5 stress tests and the amount of transparency

 6 provided with respect to the results of the stress

 7 test. And as a clearing member, as a member of

 8 the Risk Committee, we have a significant amount

 9 of transparency into the clearinghouse. And I

 10 think on that basis, we could evaluate the

 11 appropriate amount of skin in the game.

 12 COMMISSIONER WETJEN: I'm trying to stay

 13 in order here. Arthur, I think you were up next.

 14 MR. LEIZ: So, I do think that

 15 appropriate level of skin in the game properly

 16 incentives clearinghouses between profitability

 17 and risk management. I also would think that

 18 global regulators would care about skin in the

 19 game, since many of the recent regulations have

 20 moved product to clearinghouses.

 21 So, recently, I was looking at the skin

 22 in the game for certain clearinghouses that I use,
 111

 1 and I literally laughed out loud in some respects,

 2 because the levels that certain clearinghouses

 3 have, you know, posed in the waterfall, I would

 4 classify as de minimis versus the size of the

 5 aggregate guaranty fund and the profitability that

 6 they're making from that sleeve of cleared

 7 product.

 8 So, I would think that an appropriate

 9 framework for determining appropriate skin in the

 10 game would be a balance between ensuring that it's

 11 sized, according to the guaranty fund,

 12 appropriately. What that number is, is up for

 13 debate -- and is also appropriately sized versus

 14 the revenue stream that they're earning from that

 15 product.

 16 That being said, it needs to sting, but

 17 not sting so much that it puts the clearinghouse

 18 at risk if that was eaten through -- and, also,

 19 not sting so much that it transfers costs to the

 20 clearing members and, ultimately, to us on the buy

 21 side.

 22 COMMISSIONER WETJEN: Thanks, Arthur.
 112

 1 And Dani had a good point. We can't see whether

 2 those on the phone might have their name placards

 3 up. So, just a reminder to those who are still on

 4 the phone -- if you have a comment, just speak up

 5 at the appropriate time. I think Remco was next.

 6 MR. LENTERMAN: Thank you. I agree with

 7 a lot of what's been said. I believe that a

 8 degree of skin in the game is very important in

 9 aligning interests between the CCP and its

 10 principal stakeholders. I think that a balance

 11 has to be found there.

 12 Also, I think that the amount has to be

 13 material enough for the CCP so that the CCP has

 14 effective risk management procedures in place, and

 15 is incentivized and aligned with its principal

 16 stakeholders.

 17 On the other hand, I think that it

 18 shouldn't be so material that it dis-incentivizes

 19 the CCP from raising default margins or from

 20 raising the contributions to the default funds in

 21 times of stress. So, I think that that balance

 22 has to be found.
 113

 1 Now I think that the E.U. has chosen in

 2 this regard a more proscriptive methodology, in

 3 terms of the contribution and the skin in the game

 4 to the contribution to the default fund that it's

 5 required. I would caution against -- generally, I

 6 would caution against using proscriptive

 7 regulations. And I think my experience has been

 8 that sometimes it creates unintended consequences

 9 and potential loopholes.

 10 So, I would probably urge regulators to

 11 look more at a principle-based regulatory

 12 framework in this regard, covering these risk

 13 methodologies.

 14 COMMISSIONER WETJEN: Thank you.

 15 MR. BERLIAND: Chairman, it's Richard

 16 Berliand on the phone, may I present a point?

 17 COMMISSIONER WETJEN: Yes. Go ahead,

 18 Richard.

 19 MR. BERLIAND: Just trying to be mindful

 20 here of the economics of the industry at large and

 21 the fact that we continue to be trying to push

 22 business towards a central clearing environment,
 114

 1 but are, at the same time, ever more overhead from

 2 both regulatory and from other processes that are,

 3 in fact, in some cases, incenting business to go

 4 the other way -- and thinking now about the

 5 capital requirement that supports our industry,

 6 and whether we're talking about member

 7 contributions or CCP equity contributions, one of

 8 the topics that is clearly being debated over the

 9 course of the past two years is that contributions

 10 do not necessarily have to be in the form of

 11 straight equity, but, of course, insurance

 12 tranches are one of the ideas that has been

 13 floated quite aggressively over the past few

 14 years.

 15 Recognizing that cost of capital from

 16 certain other industry sectors may be priced

 17 differently, but equally may not be as readily

 18 substitutable or readily immediately available in

 19 the event of a default, I would just be interested

 20 in asking for the panel's views to be shared more

 21 broadly about what they think about use of

 22 insurance tranche availability use indeed by the
 115

 1 CCPs, which is relevant to this topic for skin in

 2 the game, but equally for the members, as well.

 3 COMMISSIONER WETJEN: Any of the

 4 panelists have a response?

 5 MR. PLANTA: Well, in Europe, capital

 6 both for the minimal and the contribution to the

 7 default fund needs to meet the liquid resources.

 8 So, it needs to be in liquid form. So, we are not

 9 talking about immobilized capital.

 10 And there is a difference, and it's

 11 certainly even more immediately available than an

 12 insurance. We generally don't consider insurance

 13 within the waterfall. That could be, really, at

 14 the end of that. We don't consider that, because

 15 we want a waterfall to rely only on liquid

 16 resources.

 17 MR. BERLIAND: And, of course, insurance

 18 does not have to be the traditional, as you say,

 19 in mobile capital; it can be fully prefunded.

 20 COMMISSIONER WETJEN: Bob?

 21 MR. WASSERMAN: Yeah. I think the

 22 concern is -- remember what we're dealing with,
 116

 1 with respect to CCPs. You need payments, in many

 2 cases, on a same-day basis -- certainly within

 3 perhaps a day or two as you go through the default

 4 management process.

 5 And so you would need a scheme where you

 6 could very clearly rely on the liquidity, on the

 7 very prompt availability of those funds. And so

 8 insurance may not work that way, even if prefunded

 9 in the sense that you would need something where,

 10 really, the payment is highly -- you know, the

 11 liquidity is highly reliable, as we say in the

 12 PFMIs. I just have concerns about insurance in

 13 that context.

 14 COMMISSIONER WETJEN: Any of the

 15 clearinghouses have a view on this possibility of

 16 an insurance product becoming part of the resource

 17 plan?

 18 MR. CUTINHO: I have a few comments --

 19 sort of held back for a while now.

 20 So, before I get to insurance, let me

 21 start with the definition of skin in the game. I

 22 think -- sorry -- I have to do this. Skin in the
 117

 1 game does not just mean CCP putting capital

 2 contributions in the waterfall. I liked Bob's

 3 definition as CCP capital contributions in the

 4 waterfall. That's exactly what it is.

 5 And he also referred to the term

 6 "allocation." What that means is that there is a

 7 risk substitution effect taking place. So, if the

 8 CCP's contribution increases, it reduces the

 9 contribution of other participants in the

 10 waterfall. So, that's something to remember. So,

 11 it's an allocation mechanism. Sizing is the

 12 stress testing we talked about. It's used to size

 13 the funds. Allocation is about who contributes;

 14 how do we split that fund across members and the

 15 CCP?

 16 We do agree. We are strong supporters

 17 of the fact that CCPs must have contributions in

 18 the waterfall. We also agree, in terms of

 19 placement, that they should be junior or first

 20 loss after the defaulter's guaranty fund. They

 21 have an important incentive effect.

 22 But it's very important to remember the
 118

 1 risk substitution effect. So, CCP contribution to

 2 the waterfall is not skin in the game, and I think

 3 Jeff rightfully pointed out in his very simple

 4 principles that increasing a contribution should

 5 not decrease somebody else's.

 6 So, having said that, the second point

 7 is, I disagree with Fabrizio from ESMA that net or

 8 gross doesn't matter for a CCP. If you cannot

 9 port a group of clients from one -- sorry I have

 10 to do this, but I have to speak my mind -- if you

 11 cannot port a client from one firm to another, the

 12 next thing you do is, you liquidate the clients.

 13 Liquidating clients has a market impact far bigger

 14 and larger. And I'm sure my clearing member

 15 friends would agree. So, it is very, very

 16 important.

 17 The third thing -- getting back to

 18 insurance. Insurance has been used at CCPs

 19 before. I don't know if a lot of folks were aware

 20 of this, but I echo Bob's two things. One is

 21 certainty of payment. Insurance has a claims

 22 process, right, so certainty of payment is the
 119

 1 issue. The second is availability of funds. So,

 2 once somebody's willing to pay you, the funds

 3 being available. So, I think insurance -- we

 4 don't think it's there yet.

 5 And one of the interesting comments I

 6 have heard in industry circles is, if these

 7 insurance vehicles are not prefunded or they're

 8 contingent funding, then the biggest issue is,

 9 even if they are placed at the end -- let's say as

 10 one of the recovery tools just before resolution

 11 -- then the realization of the insurance industry

 12 is, wait a minute; the entire market is down.

 13 It's collapsed. How am I going to pay you?

 14 So, if four or five members are not

 15 worried about clearing. The rest of the world is

 16 in a bad shape, so they won't be able to pay in.

 17 So, a prefunded is one way to solve for that. But

 18 returns on prefunded capital -- you're not saving

 19 much. Investors demand higher returns.

 20 And the second is certainty of payment.

 21 So, those are the two things to remember. So --

 22 MR. GOONE: This is David Goone from ICE
 120

 1 (inaudible). I'll echo the insurance issue. I

 2 don't know if you can hear me over there. Can you

 3 hear me?

 4 COMMISSIONER WETJEN: Yeah, we can hear

 5 you fine, David; thanks.

 6 MR. GOONE: Okay. So, I'll echo the

 7 insurance issue. We've had insurance before at

 8 ICE Europe the insurers withdrew. But it's

 9 exactly as stated before. You're going to need

 10 money at a moment's notice, and the nature of

 11 insurance is, you basically file a claim, and try

 12 and get your money back. And sometimes, there's

 13 arguing. You don't have that time. We're always

 14 looking at structures. We're constantly looking

 15 for insurance structures, because it would be

 16 great if we could have it at a moment's notice.

 17 But as of this moment, we've not yet

 18 found a solution we think would completely work,

 19 and we echo those comments. Really, it's the

 20 immediacy of payments at a moment's notice --

 21 that, just by nature of how insurance works, is

 22 yet to be resolved for us.
 121

 1 But I think all the clearinghouses I

 2 don't know if I speak for everyone I think all the

 3 clearinghouses are not only being pitched, but

 4 also been looking aggressively for this type of

 5 solutions. They just don't exist completely

 6 enough yet.

 7 COMMISSIONER WETJEN: Steve?

 8 MR. O'CONNOR: Thank you. So, on that

 9 insurance point, I think there is room for an

 10 insurance resource. But to echo the comments

 11 already made, it has to be certain and immediate,

 12 and I haven't seen a product yet that meets that

 13 criteria. But I wouldn't rule it out as a source

 14 of capital in the future.

 15 Just picking up on something Jim said --

 16 I might weave in the second part, as well, if

 17 that's okay, Commissioner. I agree intellectually

 18 with your position. You know, there might be a

 19 tradeoff where a well-run CCP might have lower

 20 skin in the game. But a badly-run CCP might make

 21 bad decisions about what it thinks its skin in the

 22 game should be, and make the wrong decision there,
 122

 1 and have something close to zero.

 2 Coming back onto that second point,

 3 harmonization -- should the rules be the same

 4 globally? I think from a pragmatic perspective --

 5 and looking at this through a different way -- if

 6 One jurisdiction does have mandatory skin in the

 7 game -- SIG -- MSIG -- mandatory skin -- sorry --

 8 and another doesn't, then I think that's a

 9 problem. The more international harmonization

 10 between rules, the better.

 11 To Adam's point -- a close second would

 12 be in the previous discussion in this room between

 13 (inaudible) Patrick Pearson and Gary Gensler on

 14 international harmonization. That is important,

 15 because without -- I think harmonization improves

 16 liquidity, reduces costs, stops perverse outcomes

 17 like entities shifting business to a new

 18 continent.

 19 And so with respect to clearing and CCP

 20 capital contributions, I think it would be very

 21 positive for regulators to harmonize on that

 22 particular point. And failure to do that could
 123

 1 result in business migrating to other

 2 jurisdictions where the bar is lower, potentially

 3 -- resulting in those increased costs, fragmented

 4 markets, fragmented liquidity, and possible

 5 increased global systemic risk, due to what

 6 effectively could be a race to the bottom.

 7 COMMISSIONER WETJEN: Doug, you had your

 8 name placard up there in New York. Was there

 9 something you wanted to speak to?

 10 MR.HEPWORTH: Sure. And thanks for

 11 calling. My clients are generally much more

 12 focused on the credit worthiness of the system and

 13 of these markets right now, and they are

 14 increasingly doing checks of that credit

 15 worthiness. And to the extent that they can do

 16 one credit check, that's better than two. To the

 17 extent that they can do two, that's better than

 18 three. So, to the extent that greater disclosure

 19 of the results of the stress tests incorporates

 20 the credit worthiness of the members, they would

 21 appreciate that.

 22 And furthermore, any insurance solution
 124

 1 would have to be in a bold support of everything

 2 that's been said today -- immediate and prefunded.

 3 So, this, we are engaged in a fairly

 4 virtuous cycle now where there's an arms race

 5 towards credit worthiness, and that should be

 6 supported.

 7 Thanks.

 8 COMMISSIONER WETJEN: Thank you, Doug.

 9 Thomas, and then we'll go to Fabrizio, and then

 10 we'll take a break.

 11 MR. BOOK: And I'll be brief, as the

 12 topics were explained. But just a few comments --

 13 first, on the skin in the game discussion. One

 14 point that I would like to highlight, which I

 15 think the European regulation captures well --

 16 this is an amount that should not be tied to a

 17 guaranty fund size. I think this sets a wrong

 18 incentive. In European regulation, the skin in

 19 the game contribution is tied to the capital of

 20 the CCP, and it is significant. As soon as

 21 regulation would tie it to guaranty fund size,

 22 there might be the interest of reducing the size
 125

 1 of the guaranty fund to reduce the contribution.

 2 So, there is certainly not a good metric.

 3 I think we are seeing, with some

 4 concern, that there are jurisdictions where not

 5 only it is tied to the guaranty fund size, but

 6 also the contribution of the CCP to its own

 7 mutualized lines of defense exceeds 25 or even 50

 8 percent, and one should be very aware that this

 9 distorts -- or can distort -- the incentive to

 10 support the DMP -- or the default management

 11 process and the option process. So, I think the

 12 calibration has to be set very carefully.

 13 And, I mean, as initially pointed out,

 14 it is an important incentive to prudent risk

 15 management, but it is not something that should

 16 replace the loss absorption and capacity, and, at

 17 least from our perspective, the incentive works

 18 (inaudible). Secondly, just a brief comment on

 19 the -- probably the term "insurance" might be a

 20 bit misleading in this context. From our

 21 perspective, I think the important criteria for

 22 contribution of the waterfall, of the prefunded
 126

 1 parts, are certainty of payment and availability

 2 of liquid assets.

 3 In the end, this gets down to the

 4 question, could this also be done by other parties

 5 in such a concept? So, if it is achieved, that

 6 there is certainty of payment, and also sort of

 7 prefunded availability of assets. I think this

 8 should be a workable solution that does not impact

 9 the incentives of the lines of defense.

 10 And one last comment, if I may take the

 11 liberty, just on the net margining -- we should

 12 not be here, mistakenly thinking that there's just

 13 net margin collected in Europe, but there is gross

 14 margin collected by clearing members, allowing

 15 portability. So, we are only looking here at what

 16 part of this segregated pool is passed onto the

 17 CCP, and that is very important, because the

 18 margin is gross collected and protected at the

 19 clearing member level. So, this debate is

 20 probably a bit sort of not considering this.

 21 COMMISSIONER WETJEN: Fabrizio?

 22 MR. PLANTA: I just want to clarify my
 127

 1 point on net and gross, because we agree that,

 2 certainly, clients are better-protected if there

 3 are more margins at CCPs. So, on this, we

 4 absolutely agree.

 5 The point is that in the default

 6 waterfall, the clients' margin cannot be used to

 7 rescue the default of the clearing member that is

 8 defaulting. And I think that we all agree on

 9 this, and we should not change this.

 10 So, if the on-account margins of the

 11 clearing member that is defaulting is lower -- and

 12 it's certainly lower if you are one day -- then

 13 you more immediately affect the non-defaulting

 14 clearing members. So, if you have lower margins

 15 on on-account, you don't have skin in the game,

 16 but this is not your case. Certainly, the effect

 17 on the non-defaulting clearing members are more

 18 immediate. That's what I wanted to say.

 19 COMMISSIONER WETJEN: Sunil, you're

 20 standing between the group and a break.

 21 MR. CUTINHO: Yeah, I make it quick.

 22 I'm not going to talk margin. I think I just
 128

 1 wanted to point out to a few things. I think,

 2 just to react to what Stephen O'Connor just said

 3 about competition, I'd be really surprised if CCPs

 4 compete to reduce their contribution to the

 5 waterfall. I think they'll be trying to do the

 6 reverse.

 7 If you look at the volume of the papers

 8 out there, and if you speak to clients, they

 9 really take it very seriously as to how much

 10 capital a CCP contributes to the waterfall. So,

 11 I'm with Jim. As long as there is complete

 12 transparency into the waterfall structure and how

 13 it works, clearing members and clients take this

 14 very, very seriously. So, it'll work in the

 15 reverse.

 16 So, I don't know if regulations are

 17 really necessary across the board to be exactly

 18 the same. Look at it from an outcome perspective.

 19 And you can make a judgment based on what you see

 20 today. Independently-owned, non-

 21 independently-owned, different jurisdictions --

 22 look at it. I think if you do a discovery, you'll
 129

 1 realize our reality is far different from what we

 2 make out to be.

 3 COMMISSIONER WETJEN: It's 4:25 now. I

 4 suggest we take just a 10-minute break so we can

 5 get started on the second panel. I think Dani has

 6 to technically break us.

 7 MS. BARRETT: Okay, at this time, we

 8 will take a 15-minute break or a 10-minute --

 9 10-minute break. Thank you.

 10 COMMISSIONER WETJEN: So, 4:35.

 11 (Recess)

 12 MS. BARRETT: Okay, everybody, I would

 13 like to call the GMAC meeting back to order, and

 14 turn to Commissioner Wetjen to introduce the

 15 speakers for the second panel -- and, also, open

 16 discussions thereafter about their statements.

 17 COMISSIONER WETJEN: Thank you, Dani. A

 18 reminder to folks on the phone -- again, just

 19 speak up at the appropriate time, when there's a

 20 gap, if you have some comments you want to share.

 21 I'm looking forward to this part of our

 22 meeting. We're going to talk now about the margin
 130

 1 proposal for uncleared swaps. Again, we had

 2 several different options - on the cross-border

 3 application of the rule that we put out for

 4 comment.

 5 I think we'll start with Carlene, to

 6 share in a little more detail what those three

 7 proposals were, and then we'd love to hear from

 8 Sean, from the Fed.

 9 Welcome, Sean. Thanks for being with us

 10 this afternoon. Perhaps Sean can share with us

 11 some of the rationale and policy reasons behind

 12 the approach proposed by the prudential

 13 regulators.

 14 But before we get to Sean, let's start

 15 with Carlene. Carlene?

 16 MS. KIM: Thank you, Commissioner

 17 Wetjen. Let me start with the important

 18 disclaimer that any views that I have shared today

 19 are views of staff working on this matter, and do

 20 not express the views of the Commission.

 21 Last fall, the Commission published

 22 proposed regulations to adopt margin rules for
 131

 1 uncleared swaps with swap dealers and major swap

 2 participants that do not have a prudential

 3 regulator -- which I will refer to as covered swap

 4 entities -- or CSE.

 5 In the proposing release, the Commission

 6 also issued an advanced notice of proposed

 7 rulemaking, requesting public comment on three

 8 alternative approaches to the cross- border

 9 application of its margin rules.

 10 First, a transaction-level approach that

 11 is consistent with the Commission's cross-border

 12 guidance. Second, an approach proposed by the

 13 prudential regulators. And third, an approach

 14 which would apply margin rules at an entity level.

 15 COMMISSIONER WETJEN: Carlene, could you

 16 pull up the mic, please, just a little? Thanks.

 17 MS. KIM: Oh, sorry. Can you hear me

 18 better? Okay. The starting point for analysis is

 19 Section 4s.(e) of the Commodity Exchange Act,

 20 which provides that the margin rules must first

 21 help ensure the safety and soundness of CSEs, and,

 22 second, the appropriate further risk associated
 132

 1 with the uncleared swaps that they hold.

 2 In enacting this provision, Congress

 3 recognized that the safety and soundness of CSEs

 4 is critical to ensuring the safety and stability

 5 of the U.S. financial system. Margin serves as a

 6 first line of defense to protect the CSE firm as a

 7 whole, in the event of a default by a

 8 counterparty. In addition, margin functions as a

 9 critical risk management tool by limiting the

 10 amount of leverage that a CSE can incur.

 11 In granting the Commission new

 12 authorities under the Dodd-Frank Act, Congress

 13 also called for coordination and cooperation among

 14 domestic regulators. The Dodd-Frank Act

 15 specifically requires that the Commission, the

 16 prudential regulators, and the SEC, to the maximum

 17 extent practicable, establish and maintain minimum

 18 initial and variation margin requirements.

 19 At the same time, a CSE's uncleared

 20 swaps with a particular counterparty may implicate

 21 the supervisory interests of foreign regulators.

 22 So, it's important to calibrate the cross-border
 133

 1 application of the margin rules to mitigate the

 2 potential of a conflict or duplication with other

 3 jurisdictions.

 4 Therefore, in developing a cross-border

 5 framework for margin regulations, any approach

 6 that the Commission adopts must take into account

 7 Commission supervisory interest in ensuring the

 8 safety and soundness of CSEs and the need to

 9 harmonize a cross-border application to the extent

 10 practicable with the prudential regulators and

 11 with foreign regulators.

 12 It is essential that the Commission

 13 strikes the right balance among these sometimes

 14 competing considerations. To that end, Commission

 15 staff is closely consulting and coordinating with

 16 the prudential regulators, and has participated in

 17 numerous bilateral and multilateral discussions

 18 with foreign regulatory authorities, including the

 19 E.U. and Japan, which have started to develop

 20 their own margin rules.

 21 Now let me turn to the alternative

 22 approaches referenced in the ANPR. Under the
 134

 1 first alternative, the Commission's margin rules

 2 would be applied on a transaction- level basis

 3 consistent with the cross-border guidance. Under

 4 this approach, the Commission's margin rule would

 5 apply to any uncleared swaps for which a U.S.

 6 Person or a U.S. CSE -- except as to its foreign

 7 branches -- is a party without substituted

 8 compliance available.

 9 With respect to a non-U.S. CSE, margin

 10 rules would apply to any uncleared swap with a

 11 non-U.S. counterparty that is a guaranteed

 12 affiliate with substituted compliance available.

 13 However, uncleared swaps with a non-U.S.

 14 Counterparty that is not a guaranteed affiliate

 15 would be excluded from the margin rules.

 16 The second alternative discussed in the

 17 ANPR is the approach proposed by the prudential

 18 regulators in September 2014. The prudential

 19 regulators would apply their margin rules to all

 20 uncleared swaps of CSEs under their supervision,

 21 with substituted compliance available in certain

 22 circumstances, and with a limited exclusion --
 135

 1 specifically, the prudential regulators would not

 2 apply margin rules to certain uncleared swaps

 3 between a non-U.S. CSE and a non-U.S.

 4 Counterparty where neither counterparty's swap

 5 obligations are guaranteed by a U.S. person, and

 6 neither party is controlled by a U.S. entity.

 7 Under the third alternative discussed in

 8 the ANPR, margin rules would be treated as an

 9 entity-level requirement. The entity-level

 10 approach is similar to the prudential regulators'

 11 approach, with one important difference: No

 12 exclusion is possible.

 13 The staff continues to give a great deal

 14 of thought to what model is optimal, and will

 15 continue to work closely with the prudential

 16 regulators and foreign regulators to harmonize the

 17 rules to the greatest extent possible.

 18 COMMISSIONER WETJEN: Thank you,

 19 Carlene. Sean? Thanks for coming.

 20 MR. CAMPBELL: Thanks for having me here

 21 today. Just to follow on the remarks of my

 22 colleague, Ms. Kim, you know, the part of the
 136

 1 Dodd-Frank statute that we're implementing is

 2 effectively the same statute. We are covering the

 3 swap dealers that are prudentially regulated, so

 4 it's essentially the complement of the set that

 5 will be covered by the CFTC and the SEC. And so

 6 the general sort of nature and tone of the

 7 preamble that Ms. Kim provided essentially goes

 8 for the rulemaking that we're engaged in

 9 promulgating at the Federal Reserve Board, in

 10 conjunction with the other prudential regulators.

 11 I guess just one thing that I would sort

 12 of stress is that the sort of -- the focus on

 13 safety and soundness is a key consideration

 14 throughout the entire rulemaking, as Ms. Kim

 15 alluded to, but it's also very important for

 16 thinking about sort of the cross-border

 17 application of the rules. Safety and soundness of

 18 the swap dealer is a primary consideration that's

 19 important for thinking through the mechanics of

 20 the ultimate rule.

 21 Again, Ms. Kim did a very nice job of

 22 summarizing the prudential regulator proposal, so
 137

 1 I sort of feel as though my thunder was stolen

 2 just a little bit, but just to maybe give a brief

 3 refresher course on what she said three seconds

 4 ago, if you all need that -- so the easiest way to

 5 think about the cross-border application of the

 6 rule and the 2014 proposal is, what are the

 7 transactions to which the rule would not apply?

 8 So, the transactions to which the rule

 9 would not apply are transactions that, you know,

 10 broadly speaking, one can think of as

 11 foreign-foreign transactions. So, the swap dealer

 12 in consideration is a foreign-covered swap dealer;

 13 that's a swap dealer that is not organized under

 14 the laws of the United States of America or any

 15 state thereof -- and their counterparty is also

 16 not an entity that is organized under the laws of

 17 the United States or guaranteed by an entity that

 18 is organized under the laws of the United States.

 19 So, those are essentially those truly

 20 foreign- foreign transactions. Even though they

 21 are transactions that are entered into by a

 22 covered swap entity under our rule, they are not
 138

 1 covered by the U.S. prudential regulator rule.

 2 And then the swaps of other covered swap

 3 entities would be covered by the rule. And as Ms.

 4 Kim alluded to, there would be the possibility of

 5 substituted compliance. And so in cases where a

 6 foreign rule was deemed to be comparable to the

 7 outcomes of the U.S. rule in those circumstances,

 8 those foreign swap dealers would be able to use

 9 the foreign rule and would not have to use the

 10 U.S. Rule in that circumstance.

 11 And so, therein, essentially what we're

 12 doing in that context is, we are recognizing that,

 13 you know, the rules of other jurisdictions -- to

 14 the extent that they provide for comparable

 15 outcomes -- have a similar effect on the safety

 16 and soundness of the swap dealer. And so allowing

 17 those entities to use that set of margin rules in

 18 their dealings with their counterparties in those

 19 jurisdictions will allow for essentially, you

 20 know, a good deal of sort of international comity,

 21 in terms of competition across global markets, but

 22 won't impair the safety and soundness requirements
 139

 1 of the rule.

 2 So, that's a very brief overview of the

 3 cross- border application, but happy to take more

 4 detailed questions if people have them.

 5 COMMISSIONER WETJEN: Thank you very

 6 much, Sean. Well, let's open it up for questions.

 7 Does anyone on the GMAC -- any of the GMAC members

 8 want to share their views on the relative benefits

 9 of any of these three different approaches laid

 10 out in our ANPR?

 11 I see Angie's raising her name placard.

 12 Angie?

 13 MS. KARNA: Thank you, Commissioner.

 14 When we've looked at the three approaches, two

 15 things sort of stand out from some of the comments

 16 that have been made at the outset.

 17 First of all, the scenario where two

 18 truly foreign-foreign are not covered by U.S.

 19 Rules is very important to us, and so that is

 20 something in common between the prudential

 21 regulator approach, as well as the

 22 transactional-level approach of the CFTC.
 140

 1 But the other thing that's very

 2 important -- and Sean alluded to this -- there has

 3 been a tremendous amount of international dialogue

 4 through BCBS/IOSCO on common standards. And so it

 5 seems to us that in a truly global marketplace --

 6 which this is -- there should be the maximum

 7 opportunity for findings of substituted compliance

 8 here than in frankly almost any other set of

 9 rules, because there has been so much dialogue.

 10 So, from that perspective, the

 11 prudential regulators' approach seemed to provide

 12 for more substituted compliance, in that if you

 13 are a -- there is a possibility of substituted

 14 compliance when you're touching the United States

 15 of America -- more so than you saw in the

 16 transaction-level approach.

 17 So, we would encourage you, whatever way

 18 the CFTC ends up approaching these rules,

 19 foreign-foreign should be out, and maximum

 20 opportunities for substituted

 21 compliance/equivalence should be explored in the

 22 context of rules that have been discussed heavily
 141

 1 at an international level.

 2 COMMISSIONER WETJEN: Eric?

 3 MR. LITVACK: Well, I sympathize with

 4 Sean about having his thunder stolen. The prism

 5 through which we look at this is what's going to

 6 maximize the ability to achieve --

 7 COMMISSIONER WETJEN: You kind of have

 8 to pretend like you're eating the microphone --

 9 MR. LITVACK: Okay.

 10 COMMISSIONER WETJEN: -- basically for

 11 it to work, I'm afraid. It's a little awkward, I

 12 know, but --

 13 MR. LITVACK: Right. Gotcha. So, the

 14 prism through which we look at this issue is, what

 15 is going to maximize the likelihood of achieving a

 16 flexible framework for substituted compliance,

 17 and, accordingly, preserving global liquidity

 18 pools? That's really our big concern. If we

 19 don't get an elimination of jurisdictional

 20 conflict -- if we don't eliminate competitive

 21 disparities, then we are likely to find ourselves

 22 splitting the global markets and interregional
 142

 1 silos, and that's a bad outcome -- particularly in

 2 the context of margin rules, which, as Angie was

 3 saying, have been so heavily discussed at the

 4 international level.

 5 I mean, if we can't achieve recognition

 6 deferral/substituted compliance on margins, then

 7 we might as well pack up and go home, because we

 8 won't get it anywhere else.

 9 So, in that light, our concern is that,

 10 unlike full substituted compliance, partial

 11 substituted compliance under the entity level

 12 approach -- or, to a certain degree, under the

 13 prudential regulators' approach -- which also can

 14 be restrictive -- will not eliminate the

 15 jurisdictional conflicts, and will continue to

 16 create competitive disparities.

 17 We consider that, of the approaches

 18 proposed, the transactional-level approach has the

 19 most chance of achieving uniformity in margin

 20 requirements applicable to all swap participants,

 21 whether they're Commission registrants or not

 22 serving a particular geographical market, and that
 143

 1 it offers relative uniformity and broader scope

 2 for substituted compliance.

 3 It's also preferable from the standpoint

 4 of mitigating compliance costs and reducing

 5 opportunities for regulatory arbitrage.

 6 And in terms of achieving substituted

 7 compliance, our view is that it should apply, as

 8 much as possible, to non-U.S. margin rules that

 9 conform to the IS and IOSCO framework.

 10 While we're on the subject, it would be

 11 remiss of me not to mention there's a WGMR

 12 implementation program. We are working very

 13 heavily on putting together a framework for

 14 implementing the margin rules for our members. We

 15 have multiple work streams addressing market

 16 compliance with rules with regard to initial

 17 margin, variation margin, portfolio integrity,

 18 risk classification methodology, dispute

 19 resolution, margin collateral, data sources, and

 20 legal documentation.

 21 One of our concerns with regard to that

 22 is ensuring that we get global validation of
 144

 1 models by regulators as smoothly as possible,

 2 because the timelines are incredibly short. With

 3 regard to timelines, we appreciate the recent

 4 extension to September 2016 of the framework, but

 5 we would very much call for a rapid finalization

 6 of rules, so that we can actually get into

 7 implementation.

 8 COMMISSIONER WETJEN: Thank you, Eric.

 9 Wally in New York, I see your name placard up.

 10 MR. TURBEVILLE: Thanks. It would

 11 really be a fine thing if all jurisdictions

 12 properly measured the risks associated with

 13 derivatives of various kinds, and the risk, once

 14 they were collateralized by margin, where

 15 everybody was agreeable on that, and that the

 16 accounting rules would properly tell us all about

 17 the risks associated not doing that. But that's

 18 probably not the case.

 19 I do think that, leaving that aside,

 20 sort of the more than one-world governance side of

 21 the discussion aside, I think we have to keep in

 22 mind what the point of having these rules at all
 145

 1 is. And the point of it is, that the integrity of

 2 the U.S. Market, in this case, is -- Congress has

 3 determined that it's very important that swap

 4 dealers and major swap participants actually act

 5 to margin their positions and get margin from

 6 their counterparts, and that Congress didn't say

 7 people who rise to the level of swap dealers in

 8 the U.S. who happen to be from somewhere else get

 9 to have a different set of rules.

 10 So, I think in this case, that's what we

 11 have to focus on. This was designed with not only

 12 systemic but also just market process and

 13 integrity purposes -- which, by the way, is also

 14 different from what the Fed does. The Fed has a

 15 different set of mandates, as well -- different

 16 from the CFTC.

 17 So, I think what ones inevitably gets to

 18 is that if we're trying to accomplish this in

 19 order to achieve safety, soundness, and proper

 20 procedures, and proper functioning in the markets

 21 by requiring swap dealers and major swap

 22 participants to engage in margining, that, really,
 146

 1 that's an entity-level activity. And it doesn't

 2 matter if a swap dealer is dealing with a non-U.S.

 3 Person; that can impair the integrity of the U.S.

 4 Market just as well as if they're dealing with a

 5 U.S. person.

 6 So, I think we have to just simply keep

 7 in mind and be sort of very focused and

 8 disciplined about what we're trying to accomplish,

 9 which is that, and not necessarily trying to make

 10 life easy for various firms that are operating in

 11 the market.

 12 COMMISSIONER WETJEN: Thank you, Wally.

 13 Chris?

 14 MR. ALLEN: Thank you. I echo and agree

 15 completely with the observations made by Angie. I

 16 think that the approach, as promulgated by the

 17 Federal Reserve, in terms of its thinking about

 18 cross-border, I think, is entirely sound. I think

 19 the fact that it looks to exclude truly

 20 foreign-foreign transactions from scope, I think,

 21 is sensible - although, as has already been

 22 alluded to, this is a body of regulation that has
 147

 1 attracted a huge amount of international focus

 2 and, in many respects, agreement, in terms of

 3 application of rules in many different

 4 geographies. So, the idea that those activities

 5 would not be subjected to some form of an

 6 uncleared margin rule, I think, is slim.

 7 But I think, also, the approach

 8 advocated by the Federal Reserve also increases

 9 the instances in which effective substituted

 10 compliance is likely to be available -- which, I

 11 think, as we've all observed in other contexts, is

 12 an important characteristic of trying to make

 13 these kind of provisions work in global context.

 14 I think, to be fair, of course if the

 15 CFTC was to adopt a transaction-level approach to

 16 its rule, that would at least be consistent with

 17 various other aspects of CFTC rulemaking, which

 18 would perhaps be advantageous in certain respects.

 19 But I think that that advantage is less persuasive

 20 than the merits of adhering to the view that has

 21 been put forward by the Federal Reserve.

 22 I think just finally, it also is not
 148

 1 entirely helpful in circumstances where you have

 2 rules which were overseen by more than one

 3 regulatory agency for it to be a diverse and

 4 fragmented approach in terms of how those

 5 different agencies think about the application of

 6 those rules on a cross-border basis.

 7 So, an alignment of approach on this

 8 issue between the CFTC and the Federal Reserve, I

 9 think, would be appealing, in terms of reducing

 10 that complexity and fragmentation in terms of the

 11 application of rules to participants in the U.S.

 12 Thanks.

 13 COMMISSIONER WETJEN: Adam?

 14 MR. COOPER: Thank you. I'm going to

 15 agree with Angie and Chris, with a big but and/or

 16 footnote. Truly foreign-truly foreign truly

 17 should be outside the scope of the U.S.

 18 Regulations. But the prudentials' definition of

 19 "foreign," I don't think is accurate. It doesn't

 20 mirror with the CFTC's definition. It's a very

 21 formulistic definition that would say "organized

 22 in the U.S.," as opposed to, I think, the proper
 149

 1 characterization of U.S. Nexus, which is

 2 principal place of business in the U.S.

 3 So, non-U.S. fund managed out of the

 4 U.S. -- principal place of business in the U.S. --

 5 would be considered foreign under the prudentials'

 6 definition. And I don't think that is the right

 7 construct.

 8 As to the entity-level versus

 9 transaction-level, I would say transaction-level,

 10 we think, makes the most sense. I think the

 11 industry -- I think our buy side has invested

 12 tremendous resources in building infrastructure

 13 for transaction-level compliance, reporting, and

 14 all manner of other things; to reorient away from

 15 that and to get to an entity-level sort of a

 16 construct, I think, would be burdensome, and

 17 costly, potentially disruptive.

 18 COMMISSIONER WETJEN: George in New

 19 York?

 20 MR. HARRINGTON: Thank you,

 21 Commissioner, and thank you, Mr. Chairman, as

 22 well, for holding this important panel.
 150

 1 Just a quick note -- I think that many

 2 of you will remember on the cleared swap margin,

 3 we had a relatively outspoken opinion regarding

 4 consideration as far as underlying liquidity. And

 5 I think in this instance, that also should be

 6 considered whenever looking at what the liquidity

 7 characteristics are of the uncleared swaps that

 8 are being considered.

 9 Certainly, when you look into things

 10 like FX NDFs, there are, you know, very, very

 11 active pockets of liquidity, and some of the

 12 interest rate swap products there also are active

 13 pockets of liquidity. And then, of course, as you

 14 go out into more esoteric products, you will find,

 15 you know, great amounts of illiquidity. That must

 16 be considered whenever you're going to be looking

 17 at margin.

 18 And, also, I think from a U.S. point of

 19 view, the fact that you do have options, as far as

 20 where these investments will be offered overseas

 21 has to be considered, as far as making sure that

 22 the margin that's being applied is not too
 151

 1 burdensome on the underlying participants, because

 2 that certainly could drive that business overseas,

 3 offshore, or certainly just put U.S. participants

 4 out of that business and not able to participate,

 5 which creates a very serious competitive

 6 disadvantage.

 7 So, I'll once again echo those same

 8 concerns that we had on cleared.

 9 Thank you.

 10 COMMISSIONER WETJEN: Angie. I'm sorry.

 11 And then I'll turn to Clive.

 12 MS. KARNA: Just for Carlene, who's

 13 taking really good notes -- I just want to clarify

 14 one thing. I'm not saying that we are in line

 15 exclusively with the prudential regulator. What

 16 we really liked about the prudential regulator

 17 approach was a broader view of substituted

 18 compliance, but we actually -- when we looked at

 19 the possibilities for conflicts amongst the

 20 various rules -- other than that issue, the

 21 transaction-level approach to us made the most

 22 sense.
 152

 1 COMMISSIONER WETJEN: Clive?

 2 MR. CHRISTISON: Thanks, Mark. A few

 3 points, I think, around this -- and the role that

 4 energy plays on a commodity basis.

 5 So, I think, firstly, you know, many

 6 energy end users obviously aren't swap dealers so

 7 they avoid the qualification as a financial end

 8 user. Now there are some of us who have swap

 9 dealer entities within organizations, which are

 10 important in terms of where this is heading.

 11 Fundamentally, I think the role of the

 12 uncleared swap market is critical for commodities

 13 such as oil -- or agricultural metals -- because

 14 the importance of quality, time, and location are

 15 key factors around how a participant will look at

 16 hedging and there are not enough cleared contracts

 17 that will be able to cover all those needs,

 18 depending on where you're sitting in the world --

 19 whether you're a Midwest end user who runs a bus

 20 company, looking for a hedge, or the quality of

 21 diesel they acquire in that market, versus, let's

 22 say, a producer in Brazil, who's producing crude
 153

 1 or a virgin quality that's clear today. So, the

 2 role of the uncleared swap market is very, very

 3 important.

 4 I mean, from our perspective, we believe

 5 and expect that there should be a set of rules for

 6 all market participants that use one set of rules,

 7 regardless of where the counterparty is domiciled.

 8 And that's truly because the energy market is a

 9 global market.

 10 When we look at the three approaches, I

 11 think the prudential regulatory proposal is one we

 12 can probably align more for, for some of the

 13 reasons that were already mentioned -- in terms of

 14 application is more favorable, it's more

 15 consistent -- however, I think you need to be

 16 careful about the foreign-to-foreign aspect being

 17 left out of that proposal.

 18 And if the CFTC was going to consider

 19 its rules around the prudential regulatory

 20 proposal, I think it needs to look carefully

 21 between a financial and nonfinancial participant,

 22 and how those needs and applications would apply.
 154

 1 From an entity-level approach, again, I

 2 think the key thing is around, what constitutes a

 3 substituted compliance for both non-U.S. and U.S.

 4 Participants? And, that as we all know, that

 5 definition is one where a considerable amount of

 6 uncertainty remains and needs to be clarified.

 7 And finally, I think the transaction

 8 approach, while it's very clear if you're sitting

 9 here in the U.S., and a participant in the U.S.,

 10 for those who are a non-U.S.

 11 Domiciled and are truly foreign who

 12 don't apply, then I do believe you're risking

 13 moving business from the U.S. to other parts of

 14 the world, who potentially will play a regulatory

 15 arbitrage between what's required here versus

 16 maybe required in other jurisdictions -- again,

 17 playing back to the global market.

 18 COMMISSIONER WETJEN: Tim?

 19 CHAIRMAN MASSAD: Thanks Mark. First of

 20 all, I just want to note, as Angie and others have

 21 said, the importance of trying to get the rules

 22 that we will adopt, as well as those that Europe,
 155

 1 and Japan, and other jurisdictions will adopt --

 2 you know, as much as possible, the same. They

 3 won't be the same. But I don't expect they'll be

 4 the same -- but certainly on as many issues as

 5 possible, we'd like to achieve that.

 6 But having said that, I want to pick up

 7 on something Wally said. You know, there's

 8 probably always going to be jurisdictions that

 9 don't have those rules. And I want to ask

 10 Carlene, and Sean -- and Paul, also, if you want

 11 -- a question that pertains to the phenomenon we

 12 saw last year that we looked into, in terms of

 13 what was referred to as de-guaranteeing -- a

 14 situation where a U.S. parent might have a foreign

 15 entity that previously had guaranteed the swap

 16 obligations, but then it removed the guaranty.

 17 Some participants said that that was in

 18 order to avoid being subject to trading rules.

 19 Trading rules are one thing. This rule is, to me,

 20 fundamental about risk, and fundamental about the

 21 risk that transactions can create.

 22 And so I guess I'd like to understand --
 156

 1 as you think about that issue -- the difference

 2 between the guidance approach, transaction

 3 approach, if you will, and the prudential

 4 regulators' approach. Again, you know, if we have

 5 similar rules in other jurisdictions, and we have

 6 substituted compliance, that's fine, but if we

 7 have a jurisdiction that doesn't have a rule, you

 8 know, does something fall through the cracks here?

 9 So, maybe Carlene, if I could ask you.

 10 MS. KIM: Sure. I mean, the phenomenon

 11 that you mentioned -- the de-guaranteeing practice

 12 by -- as we understand -- certain non-U.S. swap

 13 dealers in order to fall outside Dodd-Frank

 14 transaction-level requirement -- is an issue that

 15 we're very much concerned about, and we're

 16 definitely mindful of it as we are trying to

 17 develop a proposal for Commission's consideration.

 18 As you may well know, under the guidance

 19 approach, transactions between a non-U.S. swap

 20 dealer and a non-U.S. Counterparty that is not

 21 guaranteed by a U.S. person is entirely excluded

 22 from Dodd-Frank transaction-level requirement.
 157

 1 And margin requirements, under the guidance

 2 approach, is categorized as a transaction-level

 3 requirement.

 4 Margin rules is interesting, because it

 5 is calculated on an individual transaction basis.

 6 So, it could be treated as a transaction-level --

 7 and for that reason, it was treated as a

 8 transaction-level requirement as we drafted the

 9 guidance.

 10 But in rethinking this issue and looking

 11 at the safety and soundness concerns that is

 12 intended to be addressed by the margin provision,

 13 we think it may be more appropriate to address it

 14 as an entity-level. And we, at the staff level,

 15 are concerned that, under the transaction- level

 16 treatment of margin requirements, that too many

 17 uncleared swaps of CFTC-registered swap dealers

 18 may be excluded, and, therefore, the risk will

 19 come back to the U.S. person and U.S. financial

 20 system.

 21 For that reason and looking at and

 22 considering the prudential approach, where they
 158

 1 limit exclusion to truly pure foreign-to-foreign

 2 transactions, we think may be worthwhile

 3 considering seriously. Under the prudential

 4 approach, to the extent that a registered swap

 5 dealer has a financial arrangement or financial

 6 relationship with a U.S. Person whereby risk to

 7 that entity through uncleared swaps translates

 8 into risk to the U.S. person, that would not be

 9 eligible for any exclusion under the prudential

 10 approach.

 11 So, taking into consideration the

 12 fundamental purpose behind the margin provision,

 13 which is to protect the safety and soundness of

 14 CSE -- but, of course, keeping in mind, consistent

 15 with the long tradition of this agency to take

 16 into consideration seriously the supervisory

 17 interests of foreign regulators. In appropriate

 18 circumstances, we are balancing, and weighing the

 19 different issues, and trying to develop an

 20 approach that, first of all, addresses the

 21 purposes of the margin provision.

 22 MR. CAMPBELL: So, I don't have too much
 159

 1 to add relative to Ms. Kim's remarks in that area.

 2 I would just say, you know, one further point that

 3 I would make that was already stressed by somebody

 4 else in the panel is that the international work

 5 that's been going on in this area, I think, is

 6 extremely important, because, as was already

 7 mentioned by somebody else on the panel here

 8 today, there's a relatively broad agreement

 9 amongst a very large number of jurisdictions about

 10 how the global framework for margin requirements

 11 ought to be structured across the globe.

 12 And, of course, I would readily admit

 13 that the set of jurisdictions that have signed up

 14 for that framework is not the entire world; that

 15 is surely the case. But if we think about, in

 16 particular, the cross-border approach that's taken

 17 in the prudential regulator rule set, and you sort

 18 of ask yourself, you know, what

 19 provisionally-registered swap dealers potentially

 20 are going to sort of escape any sort of

 21 regulation? I think there, I would challenge

 22 somebody to find me a swap dealer on that list
 160

 1 that wouldn't be subject to regulation in some

 2 jurisdiction that has signed onto the BCBS/IOSCO

 3 framework.

 4 And so I wouldn't reject out of hand the

 5 possibility that the circumstance that's being

 6 described could occur, but I think that, generally

 7 speaking -- at least in light of sort of the

 8 current arrangement of the global financial system

 9 as we have it today, and where they tend to be

 10 located across the globe -- that we've got a very

 11 large swath of the financial system covered.

 12 And it may not be the specifically --

 13 you know, under the prudential regulator proposal,

 14 it may not be the "U.S. Rule" which is going to

 15 apply to some set of transactions, but, for sure,

 16 there will be a rule that will apply, which is

 17 probably consistent with an internationally

 18 agreed-upon framework. And I think, at least

 19 within the context of the prudential regulators,

 20 that specific fact pattern is a sort of primary

 21 rationale in sort of a pillar of the underlying

 22 motivation for the approach that we took in the
 161

 1 proposal.

 2 COMMISSIONER WETJEN: Darcy, in New

 3 York?

 4 MS. BRADBURY: Yeah, I just wanted to

 5 make a brief comment about unintended consequences

 6 -- and even using the example of the un-guaranty

 7 or the de-guaranteeing -- you know, one of our

 8 biggest concerns -- because an investment firm

 9 based in New York, although we have some offshore

 10 funds and some domestic, we're a U.S. person. And

 11 I think we would not want to have diminished

 12 competition for our business if banks and other

 13 dealers truly feel that the U.S. System is not

 14 one that they want to engage in. If we begin to,

 15 you know, have fewer firms that we can do business

 16 with, we won't be able to do as good a job for our

 17 investors.

 18 So, just sort of thinking about that --

 19 so all of this substituted compliance and those

 20 kinds of things would be very important if we're

 21 going to maintain access to a broad set of dealer

 22 counterparties -- and, also, to be able to
 162

 1 distribute our counterparty risks, since, in this

 2 case, these are uncleared trades -- so just ask

 3 you to keep that in mind.

 4 COMMISSIONER WETJEN: Thank you. Let's

 5 tee up another topic here in the context of the

 6 margin rule -- and that's the proper treatment of

 7 these inter-affiliate trades, which tend to be

 8 international in nature, given the way that global

 9 firms manage their risk.

 10 The CFTC proposal proposed imposing both

 11 initial and variation margin on those

 12 inter-affiliate transactions. So, wanted to see

 13 what the members of the Committee here had to say

 14 about that.

 15 We, of course, looked at this a little

 16 bit differently in the case of cleared swaps. We

 17 have an exception from the clearing requirement

 18 for inter-affiliate trades -- some inter-affiliate

 19 trades, based on whether or not certain conditions

 20 could be met. And so this is a slightly different

 21 take on it reflected in the proposal from last

 22 fall.
 163

 1 I see Jim has his placard up. Jim, do

 2 you have any views on this?

 3 MR. HILL: So, we've dealt with some

 4 very challenging issues today. I'd like to think

 5 this maybe is one of the easier ones that I think

 6 does have a right answer.

 7 And that is -- let me just spend a

 8 minute to talk about why a bank would do these

 9 inter-affiliate trades first, because I think it

 10 really sets the table well for what we think the

 11 right answer is.

 12 A bank probably has a

 13 European-registered entity, which transacts with

 14 European clients. And that bank might also have a

 15 U.S.-registered entity, which transacts with U.S.

 16 Clients.

 17 And typically, the European clients are

 18 trading European-based product, and that

 19 transaction would be booked -- the client

 20 transaction would be booked in the European

 21 entity, and the European entity would hedge that

 22 exposure on the European markets, either with
 164

 1 another European client or in the European

 2 interdealer market.

 3 And when U.S. clients are transacting in

 4 U.S.- based product, the transaction is both in

 5 the U.S. entity and then hedged in the U.S.

 6 Markets with either U.S. clients or in the

 7 interdealer market.

 8 From time to time -- and it happens

 9 often -- a European client will want to transact

 10 in a product that is generally traded out of the

 11 United States. So, that client -- its primary

 12 counterparty is a European entity. It transacts

 13 with that European entity. The transaction now

 14 needs to be hedged, and so because the transaction

 15 typically trades in the U.S. markets, the U.S.

 16 Entity will hedge in the U.S. markets.

 17 Now as a firm, we are flat-risk. But

 18 each of those entities -- one is long, and one is

 19 short. And so an inter-affiliate trade is done to

 20 move the risk -- in this case, from Europe to the

 21 U.S., such that the European entity is flat, and

 22 the U.S. entity is flat, as well. And the risk is
 165

 1 managed out of the United States.

 2 The same would happen if a U.S. client

 3 transacted in a European product; the risk would

 4 be moved back to Europe.

 5 So, what those transactions do is

 6 actually flatten out the risk among the regulated

 7 entities. If those transactions were either too

 8 expensive or not permitted, the inter-affiliate

 9 transactions, what would happen is, the hedging

 10 would happen exactly as I described. So, as a

 11 firm, the bank would be flat-risk, but each of the

 12 two entities would actually be off-sides. One

 13 would be long, and one would be short.

 14 It is, I think, for that reason, the

 15 CFTC exempted those trades from the clearing

 16 mandate. The CFTC made a decision that those

 17 transactions have an important risk management are

 18 an important risk management tool, and imposing

 19 clearing on them would raise the costs. People

 20 probably wouldn't do them. You'd end up with more

 21 risky entities, and, therefore, the exemption from

 22 clearing was granted, subject to certain
 166

 1 requirements.

 2 We think the exact same logic applies

 3 with respect to the margin requirement. In fact,

 4 if you impose the margin requirement on those

 5 transactions, you're effectively eviscerating the

 6 exemption that you gave for clearing, and making

 7 it more expensive than clearing.

 8 And so for the CFTC to be consistent in

 9 its rulemaking -- and, also, for us to be able to

 10 manage our risk effectively -- we think it's very

 11 important that the exemption apply for margin, as

 12 well. And remember, we're only talking about

 13 initial margin here. So, those transactions will

 14 be fully margined on a mark-to-market basis, with

 15 a variation margin. It's just the initial margin

 16 that we're talking about.

 17 COMMISSIONER WETJEN: It looks like

 18 Angie had her placard up next.

 19 MS. KARNA: Well, I'll be brief, because

 20 I was going to say most of what Jim said. But I

 21 will just add a couple of additional comments on

 22 top of everything he said, which I agree with.
 167

 1 First of all, when we think about

 2 inter-affiliate margin, we also agree entirely

 3 that you already have a solution. The CFTC was

 4 very thoughtful when they thought about clearing,

 5 and we think this is the other side of that.

 6 When we think about the reasons why we

 7 would want to have inter-affiliate margin not

 8 disincentivized, it's really from a risk

 9 management point of view. We think it creates

 10 risk management problems to have basically

 11 isolated, and ring-fenced, and balkanized regions

 12 of risk where Europe and the United States are

 13 separated.

 14 And the other thing that I would

 15 highlight -- which I don't think -- Commissioner,

 16 you may have mentioned in your introductory

 17 comments -- when we look at rules around the

 18 globe, right now, we don't see inter-affiliate

 19 margin from an IM perspective being applied in

 20 Japan, nor do we see it in Europe. So, we see

 21 that there's a real disconnect between the U.S.

 22 And Europe and Japan, and that causes us more
 168

 1 concern from people sitting in the United States.

 2 And then going back to one of Darcy's

 3 comments earlier -- we're very concerned about

 4 making sure that U.S. Clients have access to the

 5 greatest amount of liquidity, and we think that if

 6 we're adding inter-affiliate margin costs in the

 7 United States and not elsewhere, we're going to

 8 see a decrease of liquidity in this market.

 9 COMMISSIONER WETJEN: Jim?

 10 MR. HILL: Just to follow up with one

 11 other point on this -- my understanding from sort

 12 of wandering the halls of this building is, one of

 13 the reasons why the CFTC is considering not

 14 providing an exemption is that the prudential

 15 regulators took a different approach.

 16 And I think it's worthy of note that the

 17 prudential regulators have taken the approach

 18 they've taken because of other banking

 19 regulations. So, there are regulations which

 20 require banks to treat their affiliates the same

 21 way they treat third parties.

 22 And as a result, the prudential
 169

 1 regulators felt the need to impose upfront margin

 2 on affiliate transactions, because they're

 3 required on third-party transactions.

 4 That obviously is not applicable to the

 5 CFTC, and I think that that's an important

 6 distinction that you should be mindful of when

 7 thinking about this issue.

 8 COMMISSIONER WETJEN: Chairman?

 9 CHAIRMAN MASSAD: So, let me make sure I

 10 understand, then. You'd rather we be inconsistent

 11 with the prudential regulators. On the other

 12 step, you were all saying you've got to be

 13 consistent.

 14 MR. HILL: Yes, but the reason is, there

 15 was a rule --

 16 CHAIRMAN MASSAD: Okay.

 17 MR. HILL: No, but this is important.

 18 The rule that the prudential regulators have

 19 promulgated in this context is a function of a

 20 banking rule that doesn't necessarily apply in the

 21 context of the CFTC requirements, and we think in

 22 this case, it results in a rule that doesn't
 170

 1 actually make a lot of sense, from a risk

 2 management perspective, and it also doesn't make

 3 sense in the context of previous exemptions you've

 4 given --

 5 CHAIRMAN MASSAD: And what will this

 6 difference in our rule -- if we were to end up

 7 different from theirs, what incentives will that

 8 create? How will people then organize their

 9 businesses? Play that through for me.

 10 MR. HILL: I can't answer for the other

 11 firms; it won't change our behavior -- I don't

 12 believe, anyway.

 13 But I think it's important to note that

 14 in the context of the clearing exemption, the

 15 reason why you were able to act the way you did in

 16 providing that exemption is because the prudential

 17 regulators don't have clearing rules, right?

 18 So, you do, and you've made a decision

 19 around clearing, and it's important to be

 20 consistent with respect to margin, because if you

 21 don't, if you aren't consistent, you're

 22 effectively eliminating the clearing exemption
 171

 1 that you've already given. Well, let me explain

 2 why -- because if the trade doesn't have to be

 3 cleared, but, instead, we have to post upfront

 4 margin, the amount of upfront margin that we have

 5 to post is actually substantially higher than the

 6 amount of margin we would've had to post had we

 7 cleared the trade.

 8 So, effectively, the clearing exemption

 9 means nothing.

 10 COMMISSIONER WETJEN: Since we have a

 11 representative of one of the prudential

 12 regulators, Sean -- and not that I don't believe

 13 Jim about the rationale behind imposing IM in the

 14 Fed's proposal -- but is that the reason, or might

 15 there be other reasons, too? What's your view?

 16 MR. CAMPBELL: Sure. So, again, I can't

 17 speak for the Board, and I certainly can't speak

 18 for the other prudential regulators, but certainly

 19 I think, thinking about the proposal, and the

 20 preamble, and the discussion of this issue of

 21 inter-affiliate transactions, I think the point

 22 that Jim made is in part correct; that there are
 172

 1 other banking regulations which do place

 2 limitations and restrictions on the dealings

 3 between banks and their affiliates -- so-called 23

 4 A&B rules, and Reg W, and so forth -- so that is a

 5 relevant consideration.

 6 But I think that there are other

 7 considerations at play, as well, which is -- I

 8 think the fact pattern that has been articulated

 9 certainly occurs -- and, you know, that is one

 10 situation or one fact pattern under which inter-

 11 affiliate swaps may occur, but it need not be the

 12 only fact pattern.

 13 So, you can imagine a large bank holding

 14 company -- the types of which are regulated by the

 15 Federal Reserve that, say, has an insurance

 16 company under the holding company structure.

 17 And in a situation like that, you could

 18 imagine a situation where an insurance company

 19 that engages in swaps -- as many insurance

 20 companies engage in lots of swaps -- they'll now

 21 have a choice. They can either do a trade with a

 22 swap dealer under the holding company, or they can
 173

 1 do a trade with a swap dealer outside the holding

 2 company.

 3 And in a situation where there's no

 4 inter- affiliate margin, to Chairman Massad's

 5 point, you might imagine it's not a very

 6 complicated calculation to figure out which dealer

 7 they're going to be doing their business with.

 8 And so to the extent that those trades

 9 actually do present and create some degree of

 10 counterparty risk when the insurance enters into a

 11 swap -- I think recent history shows that that

 12 does create a certain degree of counterparty risk

 13 for somebody -- that those trades ought to be

 14 margined.

 15 COMMISSIONER WETJEN: Jim?

 16 MR. HILL: If I can respond to that --

 17 if you look at the exemption that you provided for

 18 clearing, there are certain requirements that you

 19 have to satisfy -- one of which, I believe, is

 20 that you are regulated as a swap dealer -- or

 21 similar regulations in a foreign jurisdiction.

 22 So, I think that, in the example you're
 174

 1 giving with the insurance company, the exemption

 2 would not be available.

 3 COMMISSIONER WETJEN: Or, in this

 4 context, perhaps there's a way to address that

 5 problem without requiring IM across the board

 6 (inaudible).

 7 MR. HILL: Yeah, we certainly would

 8 support a requirement that both entities -- the

 9 affiliates that are transacting -- need to be

 10 registered as swap dealers or be subject to

 11 similar regulation in the local jurisdiction. And

 12 I'm pretty sure that's a requirement of the

 13 clearing exemption.

 14 COMMISSIONER WETJEN: Let's go to our

 15 friends in New York. Doug?

 16 MR. HILL: Thanks. One of the reasons

 17 for the Commission's increased scope and expanded

 18 mandate for the last six years is because of the

 19 success of the futures model during the financial

 20 crisis and before. Margining worked for futures.

 21 Margining continues to work for futures.

 22 Margining should work for other transactions.
 175

 1 That said, the unmediated application of

 2 the proposed rules to the inter-affiliate

 3 transactions yields some side effects that are

 4 problematic -- particularly around double-counting

 5 -- concern that the inter-affiliate transactions

 6 -- if they're applied to the $3-billion dollar

 7 material swap threshold -- that's the

 8 double-counting. If they're applied to the

 9 $65-million dollar margin requirement threshold,

 10 that's a double-counting.

 11 And in addition, the reduced level at

 12 which affiliate-dom is measured -- 25 percent

 13 rather than 50 percent -- actually exacerbates

 14 those double-counting issues, and you end up with

 15 a situation where what I think was meant to be

 16 somewhat of a relaxation becomes more restrictive

 17 -- maybe even punitive. But I think the issue is

 18 really in the details, not in the general idea.

 19 Thank you.

 20 COMMISSIONER WETJEN: Thank you, Doug.

 21 Supurna?

 22 MS. VEDBRAT: I'm just going to, you
 176

 1 know, add to some of the comments that Jim, Angie,

 2 Darcy had made.

 3 You know, one, there is a difference

 4 between the cleared swap and the uncleared swap.

 5 We're actually taking the counterparty risk off

 6 the entity that we're facing. So, from a buyside

 7 perspective, if we just use Jim's example, you're

 8 either going to end up with your pricing

 9 increasing -- because the double margining and

 10 what have you -- that's going to essentially get

 11 passed onto the end user -- or it's going to be,

 12 you know, a very onerous and long exercise, where

 13 you are essentially going to have to repaper your

 14 counterparty documents, your ISDA documents with

 15 not only the European entities in that example, as

 16 well as the U.S., if you want to be able to get,

 17 you know, true exposure to the markets that you're

 18 looking for.

 19 So, you know, as we're making all these

 20 decisions, if that could just be, you know, a

 21 valid consideration -- it's not really an easy

 22 exercise to do the repapering. And I think having
 177

 1 increased pricing, you know, for the end user,

 2 where you essentially have flat risk, should be

 3 something that the Commission should keep in mind.

 4 COMMISSIONER WETJEN: Wally, and then

 5 we'll turn to Eric.

 6 MR. TURBEVILLE: Okay, just quickly -- I

 7 think it would be a good thing if the Commission

 8 and maybe the staff would look at the resolution

 9 authority proceedings that have gone on in rule

 10 makings, because just to -- I suspect there might

 11 be some implication for that, since, in resolution

 12 authority, the primary strategy is to pull out

 13 subsidiaries of a systemically important bank, and

 14 separate them out so that each -- it might be a

 15 good thing if subsidiaries, even though they're

 16 inter-affiliates, were independently margined.

 17 The second thing, just as an observation

 18 -- it is true that this makes the uncleared

 19 alternative more expensive than clearing, but the

 20 uncleared alternative wasn't intended as a

 21 business opportunity; it was intended as a policy

 22 which was to be actually discouraged. The thought
 178

 1 was that it would be more expensive, and that's

 2 okay.

 3 COMMISSIONER WETJEN: I think I'll try

 4 and stay in order. Caitlin, you actually had your

 5 name placard up, as well. And then we'll turn to

 6 Eric, and then Jim, and then Angie.

 7 MS. KLINE: Yeah, I just wanted to make

 8 a quick point. I do take issue with this idea

 9 that with inter- affiliate trades, you know, you

 10 have your trade conducted in London with a

 11 European counterparty that needs to hedge in New

 12 York, and that because of the margin -- or for

 13 really any reason -- that they would go un-hedged,

 14 right? I mean, that I don't think actually

 15 happens in practice. Certainly, I never saw it

 16 happen in practice -- and, also, is a pretty

 17 irresponsible way to approach your business line

 18 -- to say, oh, because there is -- you know, what

 19 I think everyone agrees is sort of the baseline

 20 risk management for derivatives -- which is, like,

 21 you know, basic initial margining -- because I

 22 have to do that with my own inter- affiliate swap,
 179

 1 I will otherwise not hedge my derivatives risk --

 2 is, I don't think, a reasonable alternative

 3 scenario. I don't think that is what happens in

 4 practice, and I don't think it's what's being

 5 encouraged by this.

 6 I think, also, the alternative is, if

 7 you're not going to hedge internally with your

 8 affiliate trader in New York, you're going to

 9 hedge with somebody, and you're going to end up

 10 paying that with somebody, right? So, I'm not

 11 sure where this enormous advantage comes to from

 12 staying -- other than that you have netting

 13 benefits from not having to clear. You already

 14 have this sort of exemption existing.

 15 So, I don't -- it's not clear to me

 16 that, for some reason, inter-affiliate trades have

 17 some sort of special status, and they need to not

 18 -- they're going to become so expensive that,

 19 through margin, we need to give them this clear.

 20 And that's not a good practice or a reason not to

 21 hedge, because it's too expensive. Hedging is

 22 hedging.
 180

 1 COMMISSIONER WETJEN: Eric, and then

 2 Angie.

 3 MR. LITVACK: So, there's a few points

 4 that have been raised that I'd like to address

 5 quickly. One was this issue of whether we should

 6 be accounting for resolution rules. And I think

 7 we need to be clear what we're aiming at in

 8 margins for uncleared. We're not trying to solve

 9 for the problem of resolution or individual firms

 10 failing; we're trying to solve for the problem of

 11 contagion.

 12 So, as Jim says, if you have got

 13 (inaudible) that is margins, and that is solving

 14 for the contagion problem.

 15 I also want to take issue with this

 16 notion that we're somehow trying to discourage

 17 uncleared. The notion of cleared (inaudible) --

 18 a transaction that should be cleared is generally

 19 mandated to be cleared and will be cleared anyway.

 20 And in any event, a cleared transaction, at least

 21 for a dealer, will always be cheaper than a

 22 uncleared transaction.
 181

 1 But we shouldn't engage in an attempt to

 2 discourage uncleared transactions, because there

 3 will be lots of products that will not inherently

 4 clear that probably we don't want to push into

 5 clearinghouses, because they may not have the

 6 liquidity or the market size to have a viable

 7 economic model for clearings. So, I don't think

 8 we should be pushing products that are valuable

 9 hedging tools that are currently uncleared, either

 10 outside of the market or through a clearinghouse

 11 when it's not appropriate.

 12 As to the cost of the margins, Supurna

 13 raised the issue of how costs would be passed onto

 14 the end user, and I thought it'd be useful to put

 15 some numbers around that double-margin effect.

 16 We ran some simulations, and the likely

 17 cost of having to double-margin between

 18 transactions would be effective, down to 100

 19 percent more margin -- which is a sizable amount

 20 that inevitably would be passed onto the end user

 21 -- or simply discourage use, discourage hedging.

 22 And finally, a point that probably is
 182

 1 worth mentioning is that if you are imposing this

 2 requirement to hedge between affiliates -- and,

 3 again, it needs to be a targeted exemption --

 4 you're actually creating increased risk facing the

 5 margin custodian. So, I'm not sure that you're

 6 actually ending up any better off net-net.

 7 COMMISSIONER WETJEN: Angie, and then

 8 Jim.

 9 MS. KARNA: So, just to touch on a

 10 couple of points -- Eric already covered some of

 11 them -- one of them is, I don't think that --

 12 speaking on behalf of Jim -- I don't think the

 13 example that Jim was mentioning was a reference to

 14 having unhedged exposure. What that was, really,

 15 is talking about that we would have more isolated

 16 risks that are hedged more to the Street, as

 17 opposed to between affiliates, and that causes

 18 more risk accumulation, less efficiently, in two

 19 different parts of the world.

 20 But the other thing I wanted to just

 21 mention, Commissioner, is, I want to just level

 22 set, so we're not talking about, you know, apples
 183

 1 and oranges. I think when we're talking about --

 2 at least what we're talking about at my firm -- as

 3 a sensible approach and following your clearing

 4 exemption is not a carte blanche.

 5 We're talking about having variation

 6 margin applied. We're talking about having

 7 capital charges for credit risk applied. We're

 8 talking about only covering swaps that are subject

 9 to a group-wide consolidated risk management

 10 program. We're only talking about swaps that are

 11 fully documented with swap-trading relationship

 12 documentation.

 13 Both counterparties would have to be

 14 subject to consolidated financials. A non-U.S.

 15 Affiliate counterparty would have to be in a

 16 region where it is, itself, subject to margin

 17 requirements that are BCBS/IOSCO equivalent.

 18 And then finally, overall, we're not

 19 talking about taking things and moving them to

 20 another part of the world in a large amount to

 21 evade any kind of rules. We're talking about

 22 rules -- going back to the beginning of this
 184

 1 discussion -- that have already been subject to

 2 significant international discussion and attempts

 3 to conform them.

 4 COMMISSIONER WETJEN: Jim, you get the

 5 last word.

 6 MR. HILL: Excellent. So, I think Angie

 7 really hit the nail on the head, but just to

 8 explain this again, so there's no confusion --

 9 we're not suggesting that trades would go

 10 unhedged. What we are saying is that one trade

 11 would be done in Europe, the hedge would be done

 12 in the United States in two different entities --

 13 so the firm has hedged their risk. It's simply a

 14 matter of moving the risk to where the risk

 15 management occurs, which is, in my example, in the

 16 United States, via back-to-back, which is fully

 17 margined on a mark-to-market basis.

 18 And to address the point about the

 19 clearing exemption -- I think it was suggested

 20 that although there is this clearing exemption,

 21 the Commission really didn't want us to use it or

 22 something. I'm going to read from the preamble to
 185

 1 the clearing exemption. So, we'll actually close

 2 this with your words, not mine.

 3 But in talking about the clearing

 4 exemption for inter-affiliate trades, the

 5 Commission said, "In considering the risks and

 6 benefits, the Commission was guided in part by

 7 comments pointing to the risk-mitigating

 8 characteristic of inter-affiliate swaps and the

 9 sound risk management practices of corporate

 10 groups that rely on inter-affiliate swaps."

 11 And it was on that basis that the

 12 Commission granted the exemption to clearing, so

 13 that we would continue to do those inter-affiliate

 14 swaps -- the exact same rationale applies for

 15 uncleared swaps.

 16 COMMISSIONER WETJEN: Thanks. I

 17 actually have one follow-up question, directed to

 18 Sean. Sean, to what degree are folks at the Fed

 19 thinking through this argument that if

 20 inter-affiliate trades -- at least within

 21 companies part of the same holding company --

 22 become too expensive that they're no longer done,
 186

 1 to what degree is that going to increase the

 2 complexity of the firm as a whole? How does that

 3 affect regulators as supervisors? And, God

 4 forbid, how does that impact or make more

 5 difficult resolving a firm?

 6 MR. CAMPBELL: Sure. So, I can't say

 7 too much about sort of the specific internal

 8 machinations of the Federal Reserve, given that

 9 we're in an act of rulemaking. But I would say,

 10 when we look at the comments that we received on

 11 the September proposal --

 12 COMMISSIONER WETJEN: Sean, could you

 13 move to the mic just a bit?

 14 MR. CAMPBELL: Oh, sorry. So, when we

 15 look at the comments that were received on the

 16 September proposal, you know, the rules around

 17 inter-affiliate margining -- if that wasn't the

 18 number-one vote-getter in terms of comments

 19 received, it's on the, you know, Dave Letterman

 20 top 10 list. So, we received a wide array of

 21 comments raising several of the points that have

 22 been raised here this afternoon -- issues relating
 187

 1 to resolution, issues relating to risk management,

 2 issues relating to complexity, and I think that,

 3 you know, we're currently in the process of trying

 4 to sort through all those comments and think

 5 through those issues.

 6 And I think it's fair to say that the

 7 inter- affiliate margining issue -- I think

 8 somebody said at the beginning -- and I'm

 9 paraphrasing -- and maybe not so well -- that, you

 10 know, we discussed a lot of difficult things here

 11 today; this is a relatively easy one.

 12 Speaking for myself, I think there's a

 13 lot of subtle issues that arise in the context of

 14 these inter- affiliate margin trades that the

 15 agencies are working through, as we work towards a

 16 final rule.

 17 COMMISSIONER WETJEN: Mr. Chairman,

 18 Commissioner Bowen, Commissioner Giancarlo, any

 19 last words from you?

 20 COMMISSIONER GIANCARLO: Yeah, thank

 21 you, Mark. There's been some very good commentary

 22 here in New York, but nothing for me to say, other
 188

 1 than thank you very much for a great meeting

 2 today.

 3 CHAIRMAN MASSAD: Same here -- thank

 4 you.

 5 COMMISSIONER BOWEN: Yep, thank you.

 6 COMMISSIONER WETJEN: Okay. With that,

 7 I'll turn it over to Dani.

 8 MS. BARRETT: At this point, as the GMAC

 9 DFO and Temporary Chair of this Committee, I am

 10 adjourning this GMAC meeting. Thank you.

 11 COMMISSIONER WETJEN: Thanks very much.

 12 (Whereupon, the PROCEEDINGS were

 13 adjourned.)

 14 * * * * *

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 22
 189

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

 4 public in and for the District of Columbia, do

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 7 my direction; that the witnesses were sworn to tell

 8 the truth under penalty of perjury; that said

 9 transcript is a true record of the testimony given

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 11 related to, nor employed by any of the parties to

 12 the action in which this proceeding was called;

 13 and, furthermore, that I am not a relative or

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 15 parties hereto, nor financially or otherwise

 16 interested in the outcome of this action.

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 18

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 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 31, 2017