UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 MARKET RISK ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Monday, June 27, 2016
 2 

 1 PARTICIPANTS:

 2 Opening Statements:

 3 CHAIRMAN TIMOTHY G. MASSAD

 4 COMMISSIONER SHARON Y. BOWEN

 5 COMMISSIONER J. CHRISTOPHER GIANCARLO

 6 PANEL 1:

 7 SUSAN O'FLYNN

 Morgan Stanley

 8 

 KEVIN McCLEAR

 9 Intercontinental Exchange

 10 DENNIS McLAUGHLIN

LCH.Clearnet

Kimberly Taylor

CME Group

 

 11 

 

 12

 PANEL 2:

 13

 ROBERT STEIGERWALD

 14 Federal Reserve Bank of Chicago

 15 HERBERT HELD

 Federal Deposit Insurance Corporation

 16

 R. PENFIELD STARKE,

 17 Federal Deposit Insurance Corporation

 18 CHARLTON TEMPLETON

 Federal Deposit Insurance Corporation

 19

 PANEL 3:

 20

 ROBERT STEIGERWALD

 21 Federal Reserve Bank of Chicago

 22 JEFFREY BANDMAN

 Commodity Futures Trading Commission
 3 

 1 PARTICIPANTS (CONT'D):

 2 HERBERT HELD

 Federal Deposit Insurance Corporation

 3 

 R. PENFIELD STARKE

 4 Federal Doposit Insurance Corporation

 5 CHARLTON TEMPLETON

 Federal Deposit Insurance Corporation

 6 

 ROBERT WASSERMAN

 7 Commodity Futures Trading Commission

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 9 * * * * *

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 4 

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

 2 (10:02 a.m.)

 3 MS. WALKER: Good morning. As MRAC's

designated federal officer, it is my pleasure to

call this meeting to order.

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 5 

 6 Before we begin this morning's panels, I

would like to turn to Commissioner Sharon Bowen,

the MRAC sponsor, for the welcome. Chairman

Massad, Commissioner Giancarlo, and Commissioner

Bowen will then give their opening remarks.

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 11 COMMISSIONER BOWEN: Good morning and

welcome everyone. I'm going to be really brief

and turn it over to the Chairman.

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 13 

 14 CHAIRMAN MASSAD: Well, thank you.

Well, first, let me just express my appreciation

to Commissioner Bowen and her staff, and all the

members of the Market Risk Advisory Committee for

all the work that's gone into this meeting, and

for your presence here today.

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 20 And let me also thank the rest of our

staff, as well as the staff of the FDIC who is

here today with us. We really appreciate your

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 1 involvement. And, of course, I'm always pleased

to be here with my fellow Commissioner Giancarlo

as well.

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 4 You know, the agenda for this meeting

was set some time ago, needless to say. So we

won't include any discussion of the U.K. vote to

exit the European Union.

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 6 

 7 

 8 But let me just say that the CFTC has

been closely monitoring the markets that we

regulate. And on Friday, as well as thus far

today, they have functioned in an orderly manner

notwithstanding the volatility that has followed

the vote.

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 14 And we will continue to monitor these

markets closely. We'll continue to work with the

clearinghouses, and the exchanges, as well as

other regulators to do all that we can to insure

that they continue to function properly.

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 19 So turning to today's agenda, let me

begin by saying that the Advisory Committee

meetings that we have always provide a great

opportunity for us as commissioners, as well as

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 1 our staff, to hear from stakeholders about

important developments, and to get input on the

many issues that we may be considering.

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 4 And, of course, we'll be benefitting

from that input today. For example, we will hear

more about the CCP Risk Management Subcommittee's

draft recommendations to enhance coordination

among clearinghouses and default management.

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 9 Today's meeting will also serve another

important purpose, which is that our staff,

together with FDIC representatives, will provide

all of you here, as well as the public generally,

with an update on a number of the important

efforts taking place regarding planning for

resolution of central counterparties, or CCPs.

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 16 It's my understanding that the FDIC will

first provide an overview regarding resolution of

Global Systemically Important Banks, or GSIBs.

And that's very relevant to resolution of CCPs for

a few reasons. In particular, because GSIBs often

have affiliated clearing members, or they provide

custodial or settlement bank services to CCPs,

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 1 and, therefore, GSIB resolution has a potential to

 2 impact the resilience of our clearinghouses.

 3 And following that, FDIC and CFTC staff

will discuss planning for the resolution of CCPs.

And as you will hear, a lot of work has already

gone on. And that's true at both the domestic and

international levels.

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 8 I believe we're going to hear about the

international standards that were -- concerning

resolution of CCPs that were developed some time

ago by the FSB, as well as the relevant provisions

of Dodd-Frank that pertain to this.

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 13 We'll hear about the work of the FDIC

together with the CFTC to develop resolution

strategies in light of that legal framework and

those standards. And I just want to note again my

appreciation for the close and collaborative

working relationship we have had with the FDIC on

this.

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 20 And you'll hear about the many ongoing

work streams that are taking place both

domestically and internationally, including the

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 1 work done by the Cross Border Crisis Management

 2 Group on this topic.

 3 I think we're going to touch on the

distinctions between recovery and resolution

planning. But, unfortunately, beyond noting those

distinctions, I don't think time will permit us to

discuss all the work being done on recovery

planning.

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 9 Let me just say that our staff has been

extremely busy in this area as well, both in terms

of developing strategies and standards, as well as

just working with our international colleagues to

develop resolution strategies.

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 14 And you might say that all this reflects

the priority that the CFTC is placing on what I

might term the 3 Rs for CCPs, obviously, not

Reading, 'Riting and 'Rithmetic, but in this case,

Resilience, Recovery, and Resolution Planning.

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 19 Those things have been a priority of

mine since taking office. They are a priority of

regulators around the world as evidenced by the

agreement of international and U.S. regulators

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 1 last year to implement a four-part work plan to

look at resilience standards, recovery and

resolution planning, and interdependencies among

clearinghouses and clearing members, and I'm

pleased that we at the CFTC are leading much of

this work.

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 7 And these issues are top of mind not

just for us, not just for those in Europe, but

also for people in Asia. I just returned from a

trip out there, and I discussed these issues with

regulators and market representatives in some

detail.

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 13 I spoke at a conference in Shanghai of a

new organization called CCP 12, an organization of

clearinghouses that many of the clearinghouses

represented here today are involved in.

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 17 So, again, I think this is a very timely

and productive meeting. I thank Commissioner

Bowen for, and her staff for, organizing it. I

thank, again, the presenters, and I look forward

to the discussion.

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 22 COMMISSIONER GIANCARLO: Thank you,
 10

 1 Chairman. Commissioner Bowen always has

impeccable timing, but I don't think that even she

could have predicted the impeccable timing of

having our Market Risk Advisory Committee take

place today in the wake of what's happened in

Europe over the last few days.

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 7 And I think it shows the commitment of

this Commission, as well as the CFTC staff, to

examining market risk, and understanding it, and

looking for continued ways to mitigate its impact

on market environments.

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 12 It is a great privilege to be here

today. I think you have all seen the commitment

that the three commissioners make to our advisory

committees, and to the important matters that are

discussed at that, and that continues through

today's meeting.

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 18 So with that, I just want to thank all

of the participants for being here. None of these

matters happen without a lot of preparation and

work in advance. I think sometimes just the

meeting itself is one one-tenth of the work that

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 1 goes into the preparation and getting ready for

it. So it's with a lot of gratitude that we

express to all of you as members for your work on

these committees.

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 5 Thank you. Look forward to a good

 6 hearing today.

 7 COMMISSIONER BOWEN: Thank you. Welcome

to the June 27th, 2016 meeting of the Market Risk

Advisory Committee. I am excited to be the

sponsor of this committee, which brings together a

diverse group of market participants to discuss

the important topics of systemic risk, and the

evolving structural changes in our derivatives

markets.

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 15 Before beginning our meeting today, I'd

like to say a few words about the recent British

Referendum. In the next few months, and even

years, we, as regulators, will need to make many

decisions in light of this new reality.

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 20 In the days or weeks to come, the

industry and others who observe these markets will

have a better sense of what are the temporary

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 1 versus the long-lasting effects. I believe that

this committee, which is composed of industry,

academicians, regulators and public policy groups,

will be a key source of advice and analysis to the

Commission.

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 5 

 6 So now, let us just turn to today's

meeting. First, I'd like to thank the Chairman

and also Commissioner Giancarlo today, for your

support for the work of this committee.

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 10 Second, I'd also like to thank the

committee members, our guest speakers, and the

commission staff for their work and participation

in today's panel discussions.

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 14 And last but not least I would like to

thank the logistical staff led ably by Margie and

Altonio, who worked tirelessly behind the scenes

to set the stage for these meetings.

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 18 I have the bittersweet task of saying

goodbye to some of our valued members, while

welcoming some new members to our committee.

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 21 First, the members who have left the

 22 committee: Emily Portney, formerly of JP Morgan;
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 1 Sunil Cutinho of CME Group; Scott Flood of Citi;

Robert Anderson of the Committee of Chief Risk

Officers; Bill Hale of Cargill; and Lee Olesky of

Tradeweb. To Emily, Sunil, Scott, Robert, Bill

and Lee, thank you for your valuable contributions

to the committee's dialogue, and for the unique

perspectives that you brought to the table on

these important issues. You will definitely be

missed.

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 10 We are fortunate, however, to add new

members to our committee, who also bring valuable

expertise and a diversity of perspectives:

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 13 Thomas Coyle, who is Vice President and

General Counsel, General Manager, rather, of

Chicago and Illinois River Marketing, who brings a

vital perspective of agricultural end-users.

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 17 Scott Zucker, Chief Administration

Officer of Tradeweb, who brings the important

perspective of swap execution facilities;

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 20 Jim Taylor, President of Global

Operations, Technology & Risk of the CME Group,

who has had a long and well-regarded career in

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 1 clearing; and

 2 Robert Steigerwald, Senior Policy

Advisor of the Chicago, Federal Reserve Bank of

Chicago, who brings considerable expertise on a

number of topics including CCP recovery and

resolution.

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 7 Tom, Scott, Tim, and Robert, welcome to

 8 the committee.

 9 I'd also like to take the opportunity to

thank Tom Kloet for his leadership of the CCP Risk

Management Subcommittee, which will be presenting

today. The draft recommendations that we will

discuss today are largely due to Tom's efforts.

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 14 Tom, while staying on the subcommittee,

will be giving up his leadership role, and Susan

O'Flynn, whose played a critical role in the

efforts of this subcommittee so far, will be fully

taking over the reins. So thank you, Tom and

Susan.

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 20 Today, we will discuss three topics that

are of critical importance to the market: How

CCPs and better coordinate their efforts to

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 1 prepare for the default of a shared clearing

member; how the FDIC, as a resolution authority,

would address the resolution of a bank, who is, or

is an affiliate of, a clearing member; and, three,

how the FDIC staff, under the Title 2 framework,

would work together in the unlikely event of a CCP

resolution.

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 8 Our first panel on CCP coordination is a

continuation of a conversation that we started

about a year ago. At our first MRAC meeting in

April, 2015, our CCP members presented their

default plans, and the MRAC discussed the

strengths and weaknesses of those plans. From

that discussion arose two questions: How can the

CCPs' plans better reflect the likely market

conditions during a default; two, how can CCPs

better coordinate their efforts to prevent, and

manage, a participant default?

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 19 At our November, 2015 meeting, our CCP

Risk Management Subcommittee led a discussion on

the possible recommendations in response to the

former question. And today, they will do the same

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 1 in response to the latter question. I very much

 2 look forward to this conversation today.

 3 I'm also very pleased to have guests

from the Federal Deposit Insurance Corporation

along with our staff to discuss two very important

issues of market stability, bank resolution, and

CCP resolution.

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 8 In regard to bank resolution, in the

case where the bank being considered for

resolution, is an affiliate of a clear member, it

is important that our two agencies work together

to make sure that we do not duplicate, or

undermine our mutual efforts. Likewise, in

preparation for a CCP resolution, the FDIC, which

is the resolution authority of CCPs, and our

agency, which is the primary regulator of CCPs,

would clearly have to work together. So I'm

really eager to hear the viewpoints of both

agencies today.

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 20 I want to thank you all for joining us.

And now we will turn it over to our Designated

Federal Officer, Petal Walker, who will introduce

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 1 our first facilitator and panel.

 2 MS. WALKER: Thank you for your opening

remarks. As noted in today's agenda, our first

panel discussion will cover enhancing CCP

coordination and default management, discussion of

draft recommendations of the CCP Risk Management

Subcommittee.

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 8 I would like to introduce the

facilitator for this first panel, Ms. Susan

O'Flynn, Managing Director and Global Head of CCP

Strategy, Governance, and Optimization for Morgan

Stanley. Ms. O'Flynn has worked tirelessly in the

subcommittee to produce recommendations on two

occasions, and has definitely thought deeply about

these issues, and she will facilitate our first

panel.

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 17 MS. O'FLYNN: Okay, good morning

everyone. Thank you to Chairman Massad,

Commissioners Bowen and Giancarlo, and, of course,

Petal, for your opening comments. As well, I'd

just like to reiterate a welcome to the new

members of the MRAC.

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 1 Today, obviously, the first panel is on

the recommendations and enhancing CCP coordination

of the CCP Risk Management Subcommittee. And as

Commissioner Bowen said, this is in response to a

number of the recommendations that were made in

last November's meeting. I think you will find in

today's session that there is definitely some real

coordination between the sell, the buy side, and

the clearinghouses around this, what can be done

with regards to CCP coordination. So I think it's

going to be a good demonstration of the

partnership that has emerged through this process.

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 13 So with that, I'm going to turn over to

a series of questions. On the board here, you'll

see the actual recommendations here, 1 to 5, which

our clearinghouse representatives will refer to.

But without any further ado, I will move to the

questions.

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 19 So the first question: How can CCPs

improve their communication with each other prior

to, and in the midst of, a default that involves

the shared clearing member? How can CCPs enhance

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 1 their communication with the Commission prior to

 2 and during a default?

 3 With that I will just to Kim to begin.

 4 MS. TAYLOR: I think the communication

is a very important element of market stability.

So in every crisis that I have been involved in

over the many years that I have been involved in

clearing, there has been, naturally, good

communication within the industry, among the

industry and the regulatory community, and even

among the CCPs globally on certain aspects, but

this recommendation of the working group came

forward and suggested that we firm that up

specifically with respect to the default

management process, the groups of people who would

be running the auction process to liquidate the

portfolios of the clearing members if there were a

default situation.

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 19 So we recommend that, and have made some

progress on creating a global directory of all of

those parties, and putting them in a process of

routine contact because when you're facing a

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 1 crisis, actually, it's good, you form good

relationships in a crisis, but it's better to walk

into the crisis with relationships already formed.

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 4 So the recommendation here is that the

default management branches of clearinghouses have

ongoing communication in both peacetime and then

have coordination in wartime.

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 8 MS. O'FLYNN: Dennis, Kevin, would you

 9 like to comment any further?

 10 MR. McLAUGHLIN: I'll just make one

comment. I think that it's not only CCPs who have

to communicate between themselves, but also

regulators who have to communicate between

themselves and the various CCPs that are involved.

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 15 So we can only go so far, but there is a

role, I think, here that needs to be clarified

exactly what those communication channels would

look like.

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 19 MR. McCLEAR: Hi, Susan. I have a

couple of thoughts. One, I want to follow up on

something Kim said that's so important.

Communications based on good relationships. And I

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 1 can tell you that we, CCPs, have good

relationships, and we're regularly communicating.

We sit on a lot of the same organizations

together. Chairman Massad referenced the CCP 12.

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 5 There's also the, ASIC, Association of

Systemic Important Clearinghouses. We sit on

panels together. FIA regularly is the, we know

each other well. The global directory will help,

that's good, but we know each other. We know who

to reach out to.

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 11 You could imagine on Friday we were

talking to each other about the Brexit situation.

So I just want to confirm -- one of the questions

up there is CCP should establish and maintain

communications. We have good communication

channels in place. We do communicate well.

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 17 MS. O'FLYNN: Okay. Thanks for that.

Just there's a little bit of a volume issues, so

if everyone can really speak into the microphone I

think that will be very helpful.

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 21 And if any of the other subcommittee

 22 members want to ask a question, just turn your
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 1 name tag, you know, vertical, please.

 2 Okay. Second question. How can CCPs

better coordinate the scheduling of traders who

help with the default management process so that

trading desks are not overtasked during a time of

crisis?

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 7 MS. TAYLOR: With the advent of the

over-the- counter clearing, CCPs need to use a

different process to liquidate the portfolios than

they typically would have used historically to

liquidate very liquid futures positions.

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 12 You can go to the market to liquidate

those. You could auction them, but you don't have

to. With the OTC products, you generally need to

auction the products, and because the liquidity is

certainly there, but it's less readily accessible

to CCPs, there needs to be better coordination

with traders in the market for purposes of hedging

the portfolio, and for purposes of running the

auction process.

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 21 What comes with that is the need for the

 22 bank clearing members, the clearing members who
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 1 participate in these markets, to second a trader

to the CCPs for default management purposes, and

because there are multiple CCPs, and generally

speaking when we're in a situation like this, we

would expect that there would be a default by the

clearing member at multiple CCPs at the same time,

there is the possibility for a drain on the

resources of the system, of the desks, to provide

traders.

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 10 So the CCPs have determined that it is

valuable to coordinate the rotation of clearing

members serving on the various default management

committees so that one desk won't be called to

produce a trader for multiple CCPs at the same

time if that is at all avoidable.

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 16 And we think that that will help

alleviate the default management process putting

further strain on the markets at a time when there

is already market, significant market stress, and

significant stress potentially at the bank

clearing members, who are providing these traders.

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 22 As far as progress, CME and ICE have
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 1 already started to work on the coordination of the

rotation of the traders, and we expect that other

clearinghouses will also join in that process.

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 4 MR. McLAUGHLIN: Yeah, I think, I agree

with everything Kim says. I think one thing

that's important to note is that you don't need

one trader for every bank on the default

management committee of every CCP.

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 9 The trader, once they, at least for LCH,

once they're seconded onto the Default Management

Committee, no longer represent the bank. They

represent, they act for LCH. We take the

Blackberry at the door. They sign things. So

they're acting for LCH.

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 15 So the idea of having a critical mass of

traders, one for every bank at every CCP during

the default management crisis, is not realistic

anyway. So I think it can be narrowed down if

we're very good at coordinating who is sitting on

which committee.

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 21 MR. McCLEAR: So I agree that the

 22 coordination of the rotation will be a big help.
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 1 But as Kim said, it really comes down to the

clearing members' resources. It's their traders,

as Dennis says that they're seconding to us. They

come to work for us. They have to sign paperwork

that says that they're working for us, and that

they won't talk to their firms about the

positions.

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 8 One thought I have is when we started

clearing the credit default swaps in 2009, we

worked closely with our clearing members, and our

Risk Committee to establish the Default Management

Committee, where you have the seconded traders.

And the thinking was, as Kim pointed out, there's

some discretion that needs to be exercised with

respect to putting on the hedges. There was also

a concern that the clearing house was new to the

market, and would need the expertise of the

traders.

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 19 Well, one, we've become more familiar

with the market. We've been clearing CDS for

seven years now, and big volumes and open

interest. And, two, we have a process where on a

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 1 daily basis, we're establishing what we call the

first order hedges. So we're looking at the

clearing members' positions, and we see what we

need to do to hedge those positions if there's a

default. So there's less need for the traders to

help us with that.

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 7 So maybe, my point is, I think we

continue to need the traders to help us, but maybe

we don't need three. At ICE Clear Credit, we

second three traders. Maybe we can work with our

clearing members and our risk committees. Maybe

it's two, maybe ultimately it's one. But that

might help the pressure with respect to resources

too.

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 15 MS. O'FLYNN: Just an observation as a

clearing member, who, obviously, has volume at all

those three clearing houses, I think this is one

of the key kind of heavily-debated November

recommendations around clearinghouses coordinating

to insure that no one firm is effectively sending

two people to two different clearing houses in the

event of a clearing member default.

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 1 I think there's also, incumbent on the

clearing members to be, to have a centralized kind

of coordination effort and, certainly, to insure

that there is real kind of scrutiny as to what is

being committed, and also understanding, the bench

that's being left behind to be able to manage and

trade the highest risks.

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 8 So I think it's very much a, you know,

clearing members have really started to focus on,

and, obviously, it is very much a two-way process.

So I think, you know, looking at where things were

this time last year, I think there's been with

coordinating rotation of traders, and

clearinghouses do, and clearing members doing

joint full fire drills like we (inaudible) in

Europe in February, all of those processes help

clearing members to be kind of more coordinated

along and in partnership with the clearinghouse.

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 19 MS. TAYLOR: And I would just add as a

follow up to some of the points that Kevin was

making, I think there are a number of things that

can contribute to less need to rely on a large

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 1 number of traders.

 2 One is, as Dennis mentioned, we don't

need a trader from every firm on any of these

default management committees. I think we might

impanel five clearing members who might need to

participate in any one default exercise.

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 5 

 6 

 7 So that is a factor. Rotating the

firm's differently across the three of us, or the

multiple CCPs, to reduce the duplication is one

way. But also taking advantage of changes in the

market, as Kevin said, or advances in the

electronic trading and visibility, and

readily-accessible liquidity that does not need to

be accessed as much, only through the dealer

mechanisms will also help in that as the market

changes over time.

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 17 And if we get to a point where the

liquidity is as visible and readily accessible in

the size that is needed for the CCPs to liquidate

that is available in the listed futures markets,

then the reliance on a broad set of traders can be

further reduced.

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 1 MS. O'FLYNN: Okay, question 3. Can

CCPs engage in regular joint full fire drills in

order to better understand how their mutual

markets interact during the default of shared

clearing members. Kim?

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 5 

 6 MS. TAYLOR: This is a question that has

been out there for a long time. I remember CCP

default drills being done on a coordinated global

basis back in the nineties. So from time to time,

the CCPs do endeavor to drill together.

 7 

 8 

 9 

 10 

 11 Even if we have drilled together, we

endeavor to coordinate in the time of crisis. I

remember conversations during the Lehman situation

between ICE, who was about to take over clearing,

LCH, who was doing the clearing, and CME, who had

newly taken over the NYMEX clearing about whether

or not there was something we could do on a

coordinated basis with the energy portfolio of

Lehman.

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 So this coordination is a well known

goal of the CCPs to manage collectively the

systemic risk that is facing the industry at a

 21 

 22 
 30

 1 time of crisis is something that we're all very

 2 focused on.

 3 Now, one of the best ways to make sure

that that works well in practice is to practice

doing it, and so there is a recommendation by the

group that there would be simultaneous or joint

default drills.

 4 

 5 

 6 

 7 

 8 There have been some examples of it.

The example in Europe that Susan mentioned, and,

also, CME has done coordinated default drills with

individually a couple of CCPs, ourselves as well.

So there is a movement to start this process.

 9 

 10 

 11 

 12 

 13 The default management process really is

the first part, I consider it part or resilience,

but it, also, if it fails, it can be the first

step toward moving into the place where the CCPs

need to use their recovery tools, and so it needs

to be performed in a way that is set up to

minimize the process of needing to move from

resilience into recovery, and to maximize a good

outcome. Drilling this jointly can only help in

that regard.

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 31

 1 MR. McLAUGHLIN: I would agree with what

Kim says. It's certainly good practice to try and

coordinate logistically in terms of traders you're

seconding in terms of your approaches to the

process.

 2 

 3 

 4 

 5 

 6 I think though there's a limit to what

coordination really means in this context because

the, if there is a default, and we inherit the

defaulter's portfolio, each CCP does, and it has

to auction it off in the market to defuse the

risk.

 7 

 8 

 9 

 10 

 11 

 12 And it could well be that two CCPs are

really trying to auction off a similar position.

And under the way that we're structured, we have

to follow our fiduciary responsibility, and we're

in competition with each other.

 13 

 14 

 15 

 16 

 17 So there's a limit to how much the

coordination could work. We can show each other

our portfolios, for example, because it would be

great if we were on opposite sides of the market,

because then we could cut out the

 18 

 19 

 20 

 21 

 22 (inaudible), spread, we could cross
 32

 1 the trades, but that may or may not

be the case. We have no say of

knowing a priori whether that's the

case.

 2 

 3 

 4 

 5 So in actual fact, there may be a role

here for a regulator to give us taps on the

shoulder and say you should talk to each other in

this particular example, because then we could

actually save a lot of, if you like, money that we

would waste in the auctioning process, or in

trying to defuse the risk.

 6 

 7 

 8 

 9 

 10 

 11 

 12 MR. McCLEAR: So fundamentally, practice

is a really good thing. All of our clearinghouses

that I saw, the clearinghouses here today and

elsewhere, regularly conduct very formal default

drills. They're very structured. We have

playbooks that are an inch thick, and it's good.

 13 

 14 

 15 

 16 

 17 

 18 I think ultimately, we can get to a

similar structure for cross clearinghouse default

drills, but it'll be involved. The good side of

that is that it allows the clearing members and

others to practice handling multiple clearinghouse

 19 

 20 

 21 

 22 
 33

 1 default processes. But it's a project.

 2 I saw recently that FSAC issued its

annual statement, and it's annual statement it has

a section on clearinghouses. And what they've

recommended is that clearinghouses get together.

Both the public and private sector more broadly

should get together in an informal setting, maybe

similar to this, have a roundtable exercise, a

tabletop exercise to get input on the process of

involvement in the process from a broader group.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 MS. O'FLYNN: Okay. Question 4. How can

CCPs better coordinate their auction processes so

that market participants are prepare for auctions

of various CCPs?

 12 

 13 

 14 

 15 MS. TAYLOR: I think one of the take

aways that we all had, and that we heard from the

marketplace after the Lehman situation was that it

would be good if the kind of input/output process

of the auction was coordinated or standardized so

that everyone would, when bidders were receiving

information from CCPs, they would be receiving it

in similar fashion. The auctions would be

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 34

 1 described and run under similar terms and

conditions that everyone in the market would

understand up front, and not have a lot of

questions and potential for confusion at the time

of the auction.

 2 

 3 

 4 

 5 

 6 So the Default Management Working Group

came up with a document. It's actually a fairly

sizeable document. It's on the table over at the

side, and it is the Uniform CCP Terminology for

Default Management Auctions. It lays out the

descriptors associated with the auction process so

that if clearinghouses agree to adhere to this

type of format, and the bidding parties could

actually prepare in advance to be in a position to

understand the output that they're going to get

from the CCPs in order to come up with their bids,

because there is not a lot of time that is allowed

for in this process, and so we need the market

participants who are going to be bidding to be

able to understand and act very quickly once they

have received the information from the CCPs.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 So this is, I believe that this will,
 35

 1 this document will go a long way toward avoiding

the potential for confusion in the case of a

default situation.

 2 

 3 

 4 MR. McLAUGHLIN: Yeah, I read the

document. We agree with the gist of what's going

on there. It's good to have standardized formats

and templates to help the auction.

 5 

 6 

 7 

 8 I think though, one of the things that

we have to look at is why would an auction fail in

the first place. This is only really lubricating

our process. Other structural issues which may

lead to the failure of an option, we have done

some work on that, and we have found that one of

the biggest reasons for failure is that if you

have a member who defaults, and there's very few 

members on the other side of that market, so to

speak, who have kind of the opposite positions,

then you're really exposed to the whim of one or

two members bidding in the auction in the first

place.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 So we think one thing that might be

 22 useful is to try and insure that we monitor that
 36

 1 situation so the markets don't become lopsided,

 2 and that can easily happen in the clearing space.

 3 So I think there's more to do. It's

 4 good first step, but there's more to do.

 5 MR. McCLEAR: So I agree that this

Uniform Terminology Agreement is a really good

document. And there was a lot of work that went

into it. I think there were eight clearinghouses

that participated. And I think it' a good start.

To be effective though, I think it really needs to

be incorporated into the respective

clearinghouses' processes, and I think that will

happen over time.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 At ICE, we were in, fortunately, a

unique position in that we're in the process of

building out our Automated Default Management

System. And so we're using this document to build

out the, and help with the specs of our Automated

Default Management System.

 15 

 16 

 17 

 18 

 19 

 20 MS. O'FLYNN: Okay. Question 5. Are

there any other ways that CCPs can coordinate more

effectively in order to mitigate the effect of a

 21 

 22 
 37

 1 default of one or more significant clearing

 2 member?

 3 MS. TAYLOR: You know, there are a lot

of ways that CCPs can coordinate in times of

crisis. And Dennis actually mentioned one of the

areas that I think we'd love to see some ongoing

and continuing improvement. In terms of the

communication, would be between the regulators of

the GSIBs, and the CCPs, because there is a time

period during which you can observe some

deterioration usually, but in a lot of cases, the

primary supervisor has more information about that

than other parties in the marketplace, and I know

that there are concerns about sharing any of that

information, but the more that the -- the failure

of multiple GSIBs is the, really, realistically,

the only thing that can potentially threaten the

ongoing viability of the CCP mechanism.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 The CCP mechanisms are structured to

withstand the default of X number of large

clearing members. They are funded for two. They

are generally structured to cover the default of

 20 

 21 

 22 
 38

 1 more than two, but there is kind of by definition

a process where the CCPs are not structured to

necessarily withstand the default of, let's say,

five or more large GSIB participants.

 2 

 3 

 4 

 5 So the more that the CCPs have

coordination up front with supervisors of the

GSIBs, the better positioned CCPs will be to act

in a default situation, and to coordinate their

actions in a default situation.

 6 

 7 

 8 

 9 

 10 One of the ways that we have discussed

also working together is on coordination on the

porting of customers, and there are certain things

that can be done there. There is kind of

preplanning about who would be able to take on

customers. There is also some standardization of

tools in inputs and outputs that could be used by

the CCPs that the market participants could

benefit from.

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 I think we've discussed whether we

should include the porting of customers in the

default drill process so that that is also an

element that is practiced by the industry.

 20 

 21 

 22 
 39

 1 But the one situation where the CCPs, I

think, did work quite effectively together to

transfer customers would be the MF Global

situation. It's an unprecedented situation in the

U.S. futures industry in that there was a default

of a large clearing member with a shortfall in

customer funds, and the CCPs were able to work

together quite successfully to get the positions

and a good part of the money, good portion of the

funds to the clients from a clearing member in

bankruptcy very quickly.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 So I think that using that as an

example, we would like to broaden the potential

for coordination to include other types of product

sets where because of, in a lot of cases, because

of the regulatory capital implications, the

porting of customers is somewhat more problematic

and less attractive to the surviving clearing

members than it used to be in the past.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 So I think this is an issue where the

industry should need to work together to insure

that when there is a situation where customers

 21 

 22 
 40

 1 need to be ported, all elements of the industry

work together to kind of alleviate the potential

for there to be a refusal to take quick customers

because of the immediate severe capital impacts.

 2 

 3 

 4 

 5 MR. McLAUGHLIN: Yeah, in the porting of

customers, it's becoming more and more problematic

given the capital requirements some of these buy

side players can bring onto a member so that the

way is not very smooth.

 6 

 7 

 8 

 9 

 10 And we are talking about, for some of

the large buy side, we're talking hundreds of

accounts that need to be ported in a matter of a

day or two. It's very, very onerous the actual

process.

 11 

 12 

 13 

 14 

 15 So it would be useful if there some

alleviation of some of the, and I'm talking about

temporary, of some of the requirements so we can

on board them, and have some kind of holiday for a

few days while we work through the process of

meeting the know your customer, anti money

laundering protocols, because after all, they

would have been board at somewhere else, or they

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 41

 1 would have been working for some other, or part of

some other member's portfolio in another CCP, so

surely inheriting that to another CCP should be

much easier than if they were just off the street

and nobody had a clue who they were.

 2 

 3 

 4 

 5 

 6 So there are things that could be made

easier here. Apart from the process on voiding

and technology wise and, or just physically moving

accounts, just there are some obstacles which

could really prevent timely porting that I don't

think are necessary, and they could be, we could

have some kind of leeway for a few days or

something to get those out of the way so we can

complete the port and keep that client alive, so

to speak, because after all, they were still

paying margin. They are probably fine. The issue

is with the member who defaulted.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 So I think keeping a client in a state

of limbo for a while, while the defaulted member

is being dealt with is a highly desirable outcome.

 19 

 20 

 21 MS. O'FLYNN: (inaudible) we'll get some

 22 questions. So we have -- I'm just going to go to
 42

 1 Michael first.

 2 MR. MODLOCK: Thanks, Susan. So we

heard at the start about the importance of

resilience. And we've heard some really good

things about the way the CCPs are working

together. I think what I'd like to add as an

observation to day is that, as Kim pointed out,

it's likely that the membership of a defaulting

member is going to be across multiple CCPs. And

Dennis made an observation about the limitations

of CCPs to be able to work together because of the

directional risk and in not knowing what each

other have got.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 So what I'd like to think is that the 

head of any default scenario, we as an industry

have one as much as we could proactively, and

Susan, as a clearing member, what could we do with

clearing members and CCPs, and third-party

providers together proactively ahead of a default

so that the default management process in normal

markets as we've discussed good practice, how

could we reduce risk ahead of that scenario, and

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 43

 1 even going into panel two where we're going to

cover some of the improvements and actions of the

regulators in a default, how do we see the

regulatory view of proactive and reactive

opportunities?

 2 

 3 

 4 

 5 

 6 MS. O'FLYNN: Cliff.

 7 MR. LEWIS: Just a general point that

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(inaudible) perspective implies

consent, and what my colleagues

have been talking about, old

friends have been talking about is

your clearinghouse is in complete

agreement.

 8 

 9 

 10 

 11 

 12 

 13 

 14 Two points. First point is one thing

not to forget, and, Susan, you're a good example

of this, that there's a huge amount of bottom up

coordination that has resulted in huge

improvements in the coordination prospects across

different CCPs, and that's because the risk

committees in many cases are made up of the same

people. That's been a huge driver that's, I

think, been, honestly, as important as what the

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 44

 1 regulators have been doing is the people that have

skin, have a lot of skin in the game are looking

at this as you would hope they would, and said,

hey, wait a minute. Here are the things we really

need to focus on, and these are, like I say, the

guys on the firing line.

 2 

 3 

 4 

 5 

 6 

 7 Second point is notwithstanding the

Chairman's admonition not to focus on the last

couple of days, let me just observe that the last

couple of days have been an excellent example of

how the system is working, and is much stronger, I

believe, than before.

 8 

 9 

 10 

 11 

 12 

 13 Moreover, and this is an important

general point with one recommendation. It also

demonstrates the benefit of, pardon me for putting

this in a way that sometimes is described

negatively, but centralizing a lot of the risk,

and, certainly centralizing the processing of the

tickets has been hugely beneficial to the market.

 14 

 15 

 16 

 17 

 18 

 19 

 20 Now, you may have noticed that some

banks have been quite proud of the number of

tickets they've been able to process. That's in

 21 

 22 
 45

 1 part because in the past everyone has prayed for

an event like this on a Friday so people can

beaver away on the weekend. It's one of the

reasons why declaring a member in default on a

Friday is so helpful in terms of porting, porting

members.

 2 

 3 

 4 

 5 

 6 

 7 The fact of the matter is, however, that

the system I'm not sure could have operated

successfully without this kind of centralized

processing, and, critically, recognition of

lawsuits, which in some ways was the catastrophic

element on the AIG CDS mess, which was even worse

because people were aware of it before it

happened. It was a train wreck people were

waiting for years. Remember, Alan Greenspan

giving a speech about it four years before the

crisis.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 The final point I'd make in that regard

is a point which we aren't really talking about

which is how important getting the margining

regimes right is in advance of the crisis,

because, again, if you look at the actual

 19 

 20 

 21 

 22 
 46

 1 experience before, over margining of prospective

at risk members is as dangerous in some ways as

under margining. It's procyclical. All sorts of

problems on that, and my only observation is that

as the clearing houses are all making how

important the clearing house movement to portfolio

margining is, because only with portfolio

margining are you really able to see albeit at a

CCP individual basis what the total net risk

position of a particular clearing member is.

Portfolio margining is a huge part of trying to

prevent a default, and it's a huge part of

simplifying the default process.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 Now, obviously, different products need

to be handled in an auction differently. You

know, it's completely different. The rates

complex from swaps from CDS, but this portfolio

margining get the focus where it ought to be,

which is the at risk clearing member. Thank you.

 15 

 16 

 17 

 18 

 19 

 20 MS. O'FLYNN: Kristen.

 21 MS. WALTERS: Thanks, Susan. So thank

 22 you very much, and you are certainly hugely
 47

 1 proponents of the work that's been done on the

coordination said, very important, obviously makes

a difference. You know, I think from my

perspective thinking about last Friday, I think

the market has functioned well in may different

areas, including in this space, but I don't think

that should give us any false sense of comfort

about the risk that we actually do face.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 So remember that this even while, you

know, not expected to go in the direction that it

did, was we were extremely prepared as a market.

 10 

 11 

 12 So the way that we responded was in a

highly coordinated way across buy and sell sides

firms, clearing firms, and everything went without

a hitch.

 13 

 14 

 15 

 16 However, this type of environment, or

that type of example doesn't happen very often.

So usually, we're faced with, you know, very

unexpected volatility of markets. It happens

quite episodically, tail events, and no one is

prepared.

 17 

 18 

 19 

 20 

 21 

 22 And so I think last Friday just made me
 48

 1 consider the fact that we need, well, what we're

doing is, is effective, and it's in the right

direction. I think we need to do more.

 2 

 3 

 4 And just referencing some of the

comments that Kim made about kind of porting of

customers during a default, and maybe think about

what kind of keeps me up at night based on what

I've heard from this committee over the last year.

 5 

 6 

 7 

 8 

 9 And I think one of the things that I'd

like to see us address in future sessions and have

a broader discussion about, is around the porting.

So I, if memory serves me correct, I believe at

least three clearing members of MRAC have talked,

Morgan Stanley, Susan, correct me if I'm wrong,

Goldman Sachs, as well as JP Morgan, have talked

about their kind of grave concerns about the

ability of some of the clearing members to be able

to actually effectively port positions in the

instance of default for a variety of reasons, but

I believe, if recollection serves me correct,

capital constraints, and other issues that are

affecting clearing members kind of post-regulation

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 49

 1 after financial crisis which were quite warranted.

 2 So my concern, particularly given the

fact that there is, you know, a very, there are a

very small number of clearing members. They're,

basically, clearing members on every single

exchange or CCP around the world. And in the

instance of a default, I'm very concerned that

we're not in practice able to actually port

positions, customers, and so on and so forth.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 So, perhaps, for a future meeting, but 

think it's something that's important to have a

dialogue about.

I

 11 

 12 

 13 MS. O'FLYNN: Gerald.

 14 MR. BEESON: I think building on

Kristen's comment, the other point here is we, and

I think rightly so given the topic, we do focus in

terms of the (inaudible) of piece of how are you

(inaudible) with the porting of positions in

default scenario, but with a number of these

things I think there's also the fact that what you

practice during normal market conditions can be a

precursor to making sure we have an orderly

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 50

 1 functioning of the market during a stress

condition. And I think we all realize that the

actual porting of positions is time intensive,

manual, by appointment. If we can all move toward

having not just (inaudible) I think was, Kevin to

your comment on working on your automated default

management, how we basically move that same type

of automation into the normal daily process of

porting positions, you know, easily among

different FCMs over time such that we can make

that process in a stress scenario, you know, that

much less of an impact into the marketplace.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 MS. O'FLYNN: And this is the comment

from me, and I think it ties back to what Michael

said earlier, and the next panel, obviously, it's

going to be critical to understand how GSIB

regulator and the CCP regulations coordinator

around the process of default, and to understand

as well, especially where it's a large clearing

broker, how the sequencing will work and what is

actually happening to the clients of that

defaulting clearing broker. Are they portioning

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 51

 1 away, and who is left at that clearing broker

which in theory may or may not have another

clearing broker. You know, we need to, I think

that's an open point that we continue kind of to

debate, but we should, you know, hopefully touch

on that in the next panel.

 2 

 3 

 4 

 5 

 6 

 7 And I -- Kim. Beg your pardon.

 8 MS. TAYLOR: A couple of things in

response to what Kristen was talking about about

porting. I think we mentioned it when we talked

originally, but it's probably worth highlighting

it.

 9 

 10 

 11 

 12 

 13 The way that the leverage ration treats

the margin of customers is not good in peacetime,

but it is a killer in wartime. The very best,

most credit worthy set of clients tend to be also

highly directional and, therefore, their positions

generate a decent amount of margin. And those

customers will need to be able to port, and it

will become very difficult, capital will be scarce

at this time, and taking a double hit for taking

the exposure of the client, and taking a hit for

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 52

 1 the margin that you hold when, honestly, that nets

out, that margin nets out and covers the risk is

going to be problematic.

 2 

 3 

 4 And one of the things that has happened

over time when there were crises in the futures

industry, which is when most of the problems

happened before the, at least the U.S. CCPs were

clearing a lot of over-the-counter products.

 5 

 6 

 7 

 8 

 9 The CFTC was always very thoughtful, and

reasonable, and very good crisis managers

themselves in terms of not making things worse by

being kind of draconian about the letter of the

rules, the (inaudible) would be a good example

when some funds were tied up, or the reserve fund

would be another good example. When some of those

funds were tied up, the commission assume that

their value went to zero, and increased the

capital requirement by the full amount.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 They did a haircut and kind of phased in

people's ability to re-up their capital. Now that

the CCPs' members are much more heavily regulated

by or constrained by the regulations that applied

 20 

 21 

 22 
 53

 1 to them in other markets than just the markets

that the CFTC is the primary supervisor for, I

think there's a risk that that same kind of cooler

head might not prevail in the same way that it has

historically. So that's something that I think it

would be good if the regulatory community were

able to work through an advance that would make it

easier for it to happen in a crisis.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 MS. O'FLYNN: Marcus.

 10 MR. STANLEY: Just on this leverage

ratio issue, I mean, I think there is a basic kind

of common sense thing where the more solvent and

the more well capitalized clearing members are

going into a crisis situation, the more room we're

going to have to manage that crisis by potentially

easing up on those rules on a temporary basis

during the crisis situation.

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 And I take the point that there's,

there's a crisis management coordination issue

with the banking regulators and with the federal

reserve, but I just find it hard to believe that

those regulators are going to be saying over a

 19 

 20 

 21 

 22 
 54

 1 couple of weeks' period, over a month's period,

we're not willing to work with these capital rules

in an emergency situation like the failure of a

clearinghouse.

 2 

 3 

 4 

 5 And I think advanced coordination on

what happens during that situation could be a good

idea, but fundamentally I think that the more

solvent clearing members are going into that

situation the stronger a position we're going to

be in.

 6 

 7 

 8 

 9 

 10 

 11 MS. O'FLYNN: Kim. Oh, okay. Question

6, and we've formerly addressed a number of these,

but we'll just go through. Are there any

operational, legal, logistical or other barriers

to CCP coordination, and, if so, can they be

overcome?

 12 

 13 

 14 

 15 

 16 

 17 MS. TAYLOR: I actually do think that

we've talked kind of in general about a lot of

those, although I will say that I think there

probably is difference of opinion among CCPs, and

maybe it's a jurisdictional thing because I think

in CME's view, we have, we have an MOU with the

 18 

 19 

 20 

 21 

 22 
 55

 1 various global CCPs, and we feel comfortable that

we would have the ability to share in a time of

crisis management information, enough information

about the position and exposures that we are

facing to be able to identify whether there is an

opportunity to work with another CCP to kind of

(inaudible) those off, or coordinate the

liquidation of those positions, because as Dennis

mentioned, it would be beneficial to the

marketplace for the CCPs to be able to avoid going

to the open market for positions that actually are

offsetting, but, as they say, it takes two to

tango, and so if only one CCP in the mix is

comfortable sharing the information, then it will

be more difficult to coordinate kind of

consolidated, or a cooperative liquidation of

positions as opposed to running two separate

auctions.

 2 

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 9 

 10 

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 13 

 14 

 15 

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 17 

 18 

 19 So maybe what we need to do is make sure

that in various jurisdictions there is protection

for the CCPs to be able to share the information

in a crisis management if that is necessary beyond

 20 

 21 

 22 
 56

 1 what is provided in the MOUs.

 2 MR. McLAUGHLIN: Yeah, I think this is a

-- I keep coming back to that point, but I think

there's a role here for the CFTC to help us over

this obstacle that we have because the CFTC

obviously would know the relative positions inside

each CCP, and would be able to tell us whether or

not we should talk or not. So it's just an idea.

 3 

 4 

 5 

 6 

 7 

 8 

 9 MR. McCLEAR: I agree with Kim generally

that we're in a position to coordinate. But as

Dennis alluded to earlier, we have to be careful

when we get to the more specific areas of

coordination. For example, coordinating an

auction.

 10 

 11 

 12 

 13 

 14 

 15 It's important to remember we have

different rules, different regulators, different

regulations, different laws, we're in different

jurisdictions, they're different bankruptcy

regimes.

 16 

 17 

 18 

 19 

 20 So to get to the ultimate goal of having

the coordinated auction of the defaulting clearing

members' positions across clearinghouses around

 21 

 22 
 57

 1 the world that are in different time zones, let

alone different jurisdictions, it's along row to

hoe, and it's going to be quite a process, and

we're going to need the cooperation of the

regulators, and the lawmakers, and the clearing

members, and the market participants. It's a big

deal.

 2 

 3 

 4 

 5 

 6 

 7 

 8 MS. TAYLOR: And I agree with that, and

I wasn't necessarily advocating one big coordinate

auction. I was advocating circumstances where I

think there would be pieces of portfolios where

you would be able to identify that you had

opposite sides, and close those out without, and

then auction a smaller, a smaller portfolio on an

individual basis, because I do agree one big

auction would be very highly unachievable.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 I do want to say one other thing though

about places where I think the continued focus on

improving the way the process works is important.

And one of those is the fact that CCPs are proven

over time to be excellent at resilience, and

excellent at what we're now calling recovery,

 18 

 19 

 20 

 21 

 22 
 58

 1 which we called default management before.

 2 So, the, and, you know, there's been

good regulation and good legal basis for CCPs over

time, but there's also been good behavior by the

CCPs in understanding risk management, and

understanding the systemic role that they play in

the marketplace, and in understanding the

importance of promptness, and clarity, and

preserving value in the way that the default

management situations have been run.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 One of the things that I'm concerned

about in the current environment is that there

seems to be a build-up of a desire for resolution

to happen sooner in the process, and I think the,

I think the CCPs have proven over time that

they're really good at recovery, and I think that

policy goal, the market's goal, should be that the

CCPs recover. And so I have a concern that we're

going to end up in a world where resolution is

going to be tempted to preempt recovery, and I

think we should be aware of that, and try to guard

against that across the system so that the CCPs

 12 

 13 

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 16 

 17 

 18 

 19 

 20 

 21 

 22 
 59

 1 have the ability to use their recovery tools and

get back to a state where, remain in a state where

they are functioning in their role in the

marketplace.

 2 

 3 

 4 

 5 The other thing that I have some

concerns about about the way that the recovery and

resolution process, the kind of global discussion

that's taking form is that there seems to be a

goal of having the plans laid out to the Nth

degree. We're gonna do this then, and then we're

gonna this, and we're gonna do this, and we're

gonna do this.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 And the thing that has also been true of

every crisis that we have faced is that they have

all presented slightly differently. It's going to

be very difficult to come up with a plan that is

going to be the best optimization of actions and

time lines for every situation that you might

face.

 14 

 15 

 16 

 17 

 18 

 19 

 20 It's I think, I agree with the police

objective of having the whole process be kind of

better thought out and better documented in

 21 

 22 
 60

 1 advance so the idea of having plans that lay out

what the tools are, I think that's a really good

idea.

 2 

 3 

 4 I'm cautious about the fact that it

could, because if a CCP puts in its rules, I mean,

especially in the U.K., as an example, if they

have rules about default management, and they

follow those rules, they have a safe harbor from

the insolvency process. And if they have rules,

and they don't follow their rules, they don't have

a safe harbor.

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 So the less flexibility they have to act

according to the circumstances, I think we could

face a situation where we potentially impair the

outcome.

 13 

 14 

 15 

 16 So I would encourage the industry to

think about these plans as tool kits rather than

step-by-step enumerations of the exact order of

actions that will occur because you need some

flexibility to respond to the situation that

you're facing.

 17 

 18 

 19 

 20 

 21 

 22 MS. O'FLYNN: Kevin or Dennis, any
 61

 1 comments? Okay. Kristen.

 2 MS. WALTERS: So I think that Kim's

comments are very helpful. I think it's important

to balance what she's saying. I mean, certainly,

you know, we think about the three Rs, Resilience,

Recovery, and Resolution kind of in that order,

and we've been mostly talking about resiliency in

this forum and what to do.

 3 

 4 

 5 

 6 

 7 

 8 

 9 I do think that, you know, as I've

stated before, while the goal is always recovery,

there does come a point where resolution is

necessary, and I think that we've talked about

when the default waterfall has actually been

eliminated that that's a trigger point from our

perspective when resolution should happen, and it

should happen very quickly to protect, our view is

that as soon as, you know, point of non viability

has occurred, the best chance of eliminating

positions through the auction process is when

you're as close to being kind of (inaudible) as

possible.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 So I would just reiterate what I've said
 62

 1 on behalf of Black Rock in the past is that while

it's not a preference and recovery is a

preference, similar to banks which do follow a

very structured step-by-step process administered

by FDIC when recovery is no longer possible, and

banks do get resolved very successfully.

 2 

 3 

 4 

 5 

 6 

 7 My strong view is that a similar process

that should follow a highly structured approach

should exist and be followed for CCPs as

necessary. And, you know, from our perspective,

the ultimate reason is that once the default

waterfall has been eliminated, the remaining, you

know, capital is, essentially,

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 

(inaudible) margin. And we talked

about the fact that at

 least in my view, and I think the view

of Angela and 30 large other asset managers, is

that under no circumstances should client, non

defaulting client margin, VM or IM, we've talked

about the fact that IM is not allowed under CFTC

regulations, but certainly the use of variation

margin should not be an option to continuing along

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 63

 1 the path of recovery.

 2 And, you know, just to clarify, you

know, I agree with what Kim has stated, and I do

think that recovery is first and foremost, but I

just want, you know, to talk the other side of

that argument because I think it's important

particularly when you hit non viability.

 3 

 4 

 5 

 6 

 7 

 8 CHAIRMAN MASSAD: Can I just clarify

that, Angela? You're saying variation margin

 

 

 

 

(inaudible) should not be an option

in the recovery phase, but, rather,

should be reserved for the

resolution phase?

 9 

 10 

 11 

 12 

 13 

 14 MS. WALTERS: Variation margin should

never be used period because it doesn't belong, I

mean, it belongs to non defaulting clients. So I

think what we've said, I mean, it's, you know, I

don't say this currently, but it's, you know,

essentially, non defaulting clients are taxpayers.

They are not, and they're not willingly or

knowingly putting their money at risk. They're

under the impression that it's collateral that

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 64

 1 will be returned to them.

 2 So I don't thing, as I've stated before,

I don't think variation margin belongs anywhere in

any default waterfall, nor should it be used in

any part of default, which is why I think from a

(inaudible) perspective, we argued so consistently

about robust margin methodologies, stress testing

that's similar to what's done on the banking side,

in SECAR, and I think what we've said the one

exception is in the context of an auction if there

is the need to use variation margin gains,

haircutting over a 24- hour period to try to

stabilize and close out all the positions. That

is the only circumstance under which we would not

vehemently oppose.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 CHAIRMAN MASSAD: Yeah, I just think

that severely limits, as I understand it, that

would severely limit the options that we have for

trying to get back to a matched book and the

circumstances where, obviously, we have exhausted

the waterfall otherwise.

 17 

 18 

 19 

 20 

 21 

 22 And I recognize that all account holders
 65

 1 are taxpayers, but we're also trying to come up

with plans that don't use taxpayer money, per se,

which is, obviously, a much broader set of people

than those who participate in the futures market.

 2 

 3 

 4 

 5 MS. WALTERS: Right. So in that context,

what I think is that CCPs are by and large, with

some exceptions, for profit entities that benefit

from the clearing mandate. So clearing members

participate. There's a cost of clearing. It's

increasing.

 6 

 7 

 8 

 9 

 10 

 11 I think the best approach forward is to

have as much transparency as possible. Even if it

means increasing fees to end users, we would much

prefer to give our end user clients, and our

fiduciary accounts, you know, the option to

continue using products at a higher cost.

 12 

 13 

 14 

 15 

 16 

 17 I'm, obviously, not a proponent of

higher costs, but it does look like what's

happening with capital requirements, markets in

general, the cost of clearing is going up, but we

still have to have sufficient loss absorbing

capacity in the instance of default.

 18 

 19 

 20 

 21 

 22 
 66

 1 So I think it should come from, you

know, very robust margin methodologies that

determine exactly how much margin is needed up

front even if it costs more money to end users of

the products, especially our clients, and larger

amounts of capital put aside by the CCPs

themselves.

 2 

 3 

 4 

 5 

 6 

 7 

 8 So we've talked about amounts at least

as large as the largest clearing member, so in

that 8 to 12 percent range, but not using non

defaulting margin of clients.

 9 

 10 

 11 

 12 MS. O'FLYNN: Michael.

 13 MR. MODLOCK: I just want to revisit the

piece before about the ability for CCPs to

coordinate in the auction. And, again, how much

of that can be done in advance where the clearing

members are able to focus in a default scenario on

serving their clients, and how much of the bulk of

the risk, which we know overall might be

relatively neutral, but is likely to be

directional at a given cleared venue, or

bilaterally, and that risk could be substantially

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 67

 1 reduced in advance of any auction process?

 2 MS. O'FLYNN: Kim.

 3 MS. TAYLOR: I was wanting to weigh in a

little bit on the topic of the variation margin

gains you're cutting, which I also am a believer

in the sanctity of client money.

 4 

 5 

 6 

 7 So I think where CME is not in favor of,

certainly, initial margin haircutting, and I agree

it's not really allowed in the U.S. jurisdiction

anyway, but on the topic of variation margin

gains, haircutting I think what I would say is

that when you're talking about the kind of tail

end of recovery of a CCP, or then later than that

if you hop over into the resolution phase of a

CCP, I think we really are talking about the tail

of the tail of the tail.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 And not that we shouldn't plan for the

almost unthinkable to happen because we should,

but what has to happen in order for a CCP to get

even into the place where they would be using the

default fund has got to be something that is far

worse than the crisis of 2008, because no CCP has

 18 

 19 

 20 

 21 

 22 
 68

 1 used anything but the margin of the defaulting

 2 firms in order to satisfy that situation.

 3 So what has happened if we are at this

point is that there has been a total failure of

the bank supervision regime, and a big economic

hit like economic policy has failed in some

significant way. Right? It is a case of kind of

global economic and financial chaos.

 4 

 5 

 6 

 7 

 8 

 9 And so under the circumstances where

you're way out in the tail, you need to make

choices about what is an appropriate way to kind

of cost benefit analyze that. And so I think

that's why we got to a point where for purposes of

the kind of end of recovery, variation margin

gains haircutting seemed like it was an

appropriate thing to do mostly because it provides

everything we're trying to do in default

management, and in the recovery process is

designed to try and incent the proper behavior of

the remaining clearing members to participate in

the default management process.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 And so by having their gains haircutted,
 69

 1 it puts them in a position where, obviously, if

other clearing members are gaining on these

positions, it's likely that the defaulting firm is

losing on these positions, and so it suck up a

dynamic which make the losing positions of the

defaulter more attractive. It increases the

alignment of interests, we think, in the auction

process. So that is why we ended up getting there

at the, you know, in the tail of the tail of the

tail.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 MS. WALTERS: Yeah, I think, I

definitely understand like where you're coming

from, and the logic behind it. And I think

potentially, you know, other, you know,

 

 

 

 

 

 

 

 

(inaudible) participants or others

could get comfortable. I think the

issue that is difficult is that we

don't have good transparency into

the adequacy of loss absorbing

capacity, so I think, you know, the

quantitative disclosures, the

numbers that actually started, you

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 70

 1 know, coming out as a result of

that it's very helpful, but it's

just a number, and we don't have

details into the underlying margin

methodologies, the stress testing

that was done.

 2 

 3 

 4 

 5 

 6 

 7 So I think in order to think about what

you do in the tail of a tail, we would have to

have good understanding with transparency and

disclosure around how the loss absorbing capacity

was actually calculated. And particularly, how it

changes in wartime, which is, and I believe the

FSB or some of the other international regulators

have begun talking about standardized regulatory

oversee and stress tests for CCPs for precisely

that reason.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 So if the capital pool is sufficient, I

understand where you're coming from, and no one's

gonna argue with the tail of a tail type of

scenario. It's just that I think the loss

absorbing capacity at least on the other side of

the table is not clearly known at present.

 18 

 19 

 20 

 21 

 22 
 71

 1 MS. O'FLYNN: Kevin.

 2 MR. McCLEAR: I just want to follow on

quickly to what Kim was talking about, especially

since we're in a public forum here.

 3 

 4 

 5 It's really important to understand the

clearinghouse's risk management practices, and as

Kim says, what we're talking about is the tail of

the tail of the tail.

 6 

 7 

 8 

 9 So, obviously, we have our margin

standards, but with respect to the default

resources, we're at a minimum of cover too,

meaning we have to cover the two largest defaults

of our clearing members. And we're talking about

some of the world's largest financial

institutions.

 10 

 11 

 12 

 13 

 14 

 15 

 16 And that cover two standard is without

assessments. When you throw in assessments

rights, we're really covering four, five, maybe

six of the world's largest financial institutions

defaulting to us.

 17 

 18 

 19 

 20 

 21 Kristen, and to your point,

 22 traditionally the clearinghouses' default process
 72

 1 or (inaudible) was when we got to the end of the

waterfall, we'd wind down. But now -- and

rightfully so. Since we're systemically

important, there's more and more focus on what

happens next. And, in fact, we're required by

regulation to deal with uncovered losses. When we

get to the end of the waterfall, what do we do?

How do we address the uncovered losses.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 And, really, we don't like variation

martin gains haircutting. It's an ugly tool. But

it's really, we've thought about this a long time.

We've worked with the clearing members. We've

worked with the regulators. It's really the only

solution.

 10 

 11 

 12 

 13 

 14 

 15 Now, I was in London, and I won't name

the regulator, international regulator made a

suggestion that I think makes sense and it ties

into what we're about to discuss with respect to

resolution, you know, maybe we can build into our

rule books that Resolution Authority has, because

we're worried about their tools, and I agree with

Kim that we need to allow the clearing house rule

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 73

 1 book to apply before the Resolution Authority

steps in. We need that X ante before the event.

Certainty for the marketplace, for our clearing

members, it's very important.

 2 

 3 

 4 

 5 But one possible solution might be to

give the Resolution Authority, we could bake this

into our rule books, the right to step in at the

end of the waterfall, and to make one more final

assessment. Maybe the assessment's limited to the

amount of the guarantee contribution, but then the

Resolution Authority would be in a position to

make the determination working with the regulators

as to whether there would be an unattractive

systemic impact of various margin gains

haircutting.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 I'm glad you referenced the public

quantitative disclosures. We do believe that

those give you your answers. And I want you to

also, hopefully, and others that don't have the

transparency that our risk committee, our clearing

members, and the regulators that they see to

understand that they are watching us closely.

 17 

 18 

 19 

 20 

 21 

 22 
 74

 1 We have our risk committees. We have

the regulators looking at our margin practices,

our guarantee fund practices, our default

practices. All of this is highly scrutinized not

just by one regulator, the CFTC, who sits here

today, but the FCC, the Fed, the Bank of England.

There's a whole host of regulators overseeing our

clearinghouses.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 MS. O'FLYNN: Okay, Marc, I think you're

going to be our last speaker before we quickly

wrap up.

 10 

 11 

 12 MR. STANLEY: Thanks. I just wanted to

follow up on something Kristen said, and maybe

summarize my understanding of what she said.

 13 

 14 

 15 That, Kristen, you felt that you would,

you would be willing to pay more up front, or you

felt your customers would be willing to pay more

up front for more assured loss absorbency capacity

than, rather than, risk variation haircutting?

 16 

 17 

 18 

 19 

 20 MS. WALTERS: So what I was attempting

to say is that what we would like to do is give

our clients the ability to choose. So right now

 21 

 22 
 75

 1 from a fiduciary capacity, you know, our clients

believe that their margin is, is recoverable

unless there's an actual default that involves

them.

 2 

 3 

 4 

 5 So, however, that's not necessarily true

in the instance that variation margin haircutting

is done. So what I think would be preferable, if

the cost of clearing is, indeed, going up, I do

think that there are signs across many different

institutions that it is going up, and might

continue to go up for a variety of reasons that

we've talked about before.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 If that's true, we would like to

disclose to our clients and give them the option

of do they want to pay the additional cost and

continue using cleared products? Do they want to

remove hedges? Do they want to use other

financial instruments, cash instruments?

 14 

 15 

 16 

 17 

 18 

 19 So as a fiduciary, our role is to give

as much information as possible to our clients and

let them make the decision about their investment

decisions.

 20 

 21 

 22 
 76

 1 MR. STANLEY: But as a fiduciary you

feel like it might be in your client's best

interests to pay a higher cost of clearing in

order to avoid a situation where unpredictably

their margin could be at risk?

 2 

 3 

 4 

 5 

 6 MS. WALTERS: I think it's very

important for all participants in centrally

cleared activities to understand the true cost of

clearing, the cost of default, and the adequacy of

loss absorbing capacity in peace and wartimes.

 7 

 8 

 9 

 10 

 11 And I think the quantitative disclosures

are a step in the right direction, but they're,

certainly, a very step if you think about what

regulated banks report around their risk

management activities.

 12 

 13 

 14 

 15 

 16 So I'm a proponent in more information

so that all participants can make better

decisions. And I do feel as a fiduciary that we

are currently impaired when it comes to doing due

diligence on CCPs so we don't, the CCPs have been,

you know, very helpful, lots of dialogue. It's

just the level and detail of information that we,

 17 

 18 

 19 

 20 

 21 

 22 
 77

 1 that we receive from CCPs versus our OTC bank

counterparts is very different, and we would like

it to be at the same level as bank

counter-parties, and bilateral transactions.

 2 

 3 

 4 

 5 MS. O'FLYNN: Just conscious of time,

and quickly wrap up, and I think it brings a

natural end to this discussion, which, certainly,

got more lively as we went on.

 6 

 7 

 8 

 9 Question 7. What role, if any, should

the Commission play in encouraging greater

coordination amongst CCPs in the default

management process?

 10 

 11 

 12 

 13 MS. TAYLOR: Here again, I think that

we've covered some instances of this. Dennis had

mentioned a couple of cases with the Commission

helping to facilitate CCP information sharing.

And I think we also mentioned instances where we

think it will be important for the CFTC work with

banking supervisors, for example, about

information sharing coming, including CCPs when

there is, you know -- it would be good for CCPs to

know in advance of GSIB being shut down that that

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 78

 1 was coming in order for us to help plan, and I

recognize in saying that the kind of public policy

stance around the safety of the bank information,

so I fully realize what I'm saying, but I think

that CCPs are kind of part of the financial system

fabric in a very important way.

 2 

 3 

 4 

 5 

 6 

 7 And I also think there is an important

role for the CFTC and other kind of front line

supervisors of CCPs to help insure that the, that

resolution doesn't preempt recovery. I do think

that there is a need for the supervisors to kind

of, who understand the best, the ways in which

resiliency and recovery will work to help insure

that there is an opportunity that is preserved for

those things to occur, and, you know, and work

before there is a preemptive action taken by the

resolution authorities because I think the entry

of the resolution authorities as the appropriate

time I think is appropriate.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 The entry of the resolution authorities

ahead of the time when it's time for resolution

probably is actually a market destabilizing event.

 21 

 22 
 79

 1 MS. O'FLYNN: Dennis?

 2 MR. McLAUGHLIN: Yeah, I just in

addition to what Kim said, I think the porting

puzzle is probably the biggest conundrum, one of

the biggest conundrums we face, and any help from

the Commission in dealing with that would be

gratefully received. Particular, things like

facilitating a process from a client, who is in

good shape paying margins. Everything is fine,

but they just happen to be a client of a member

who is in default. It's not the client's fault.

How to find a home for that client, we really, I

mean, we can't really do it by ourselves. We can

do it to some extent, but we really need help on

that.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 MS. O'FLYNN: Kevin.

 17 MR. McCLEAR: I'll just say quickly at a

very high level that this Committee and this

process answers that question, what role can the

CFTC play. This is a really good process. What

you see today is the MRAC, but underneath it I

have to look at my chart because it's gets

 18 

 19 

 20 

 21 

 22 
 80

 1 complicated. We have a CCP Risk Management

Subcommittee that's been discussing all these

issues. Below that we have the CCP Coordination

Sub Subcommittee. And then below that we've had

the CCP Working Group that's made up informally of

all our clearinghouses here and the staff

representative.

 2 

 3 

 4 

 5 

 6 

 7 

 8 So there's been really good discussion.

We really do from a clearinghouse perspective

welcome these discussions. We believe in

transparency. And so I think this has been a

really good process. Thank you.

 9 

 10 

 11 

 12 

 13 MS. O'FLYNN: Clifford.

 14 MR. LEWIS: Other than not worrying so

much about the paisley swan event, I would urge

two very specific items where I think the

Commission can do a lot of work, and we've talked

about one which is portability.

 15 

 16 

 17 

 18 

 19 But in particular, I think the only

realistic solution for a big clearing members to

default is consistent with your acceptance of

gross margining, which, by the way, as you know,

 20 

 21 

 22 
 81

 1 Mr. Chairman, is not what my friends in Frankfurt

 2 do, but they agree that's the right way to do it.

 3 But gross margining makes sense if you

 actually could have an interim step where

 realistically, the clearinghouse is gonna have to

 hold customer margins for some period of time.

 You can't get this done in a day.

 4 

 5 

 6 

 7 

 8 So even on a Friday, I think for a JP

Morgan or a Goldman going toes up, it would take

longer, and I think that's something that you

guys, there are various things, specific things

that you guys can fix.

 9 

 10 

 11 

 12 

 13 Related to that in a point that has been

made by Kris and others is I'm surprised nobody

has focused on trying to fix the U.S. bankruptcy

provision, which we all know about, and don't like

to talk about.

 14 

 15 

 16 

 17 

 18 I know it's really hard, and I

understand that the, the different committees on

the Hill and what not, but I just think as you

have highlighted issues like the unintended

consequences of SLR, and other things, I think

 19 

 20 

 21 

 22 
 82

 1 just getting this out, because I know that in the

30 years I've been involved in the industry, I was

always very casual about saying customer funds are

not at risk, period.

 2 

 3 

 4 

 5 And we only recently discovered that,

actually, bankruptcy judges may have a different

view about that. And I think there are legal ways,

you guys know this better than me being smart

lawyers, at least highlight it. Maybe there are

interim fixes like tri-party custody of margin

money as a choice that costs more to the customer

if they want to pay a little bit more to try to

make it harder for the bankruptcy judge to get at

it, but it may not work. I'm not, I don't want to

practice law without a license.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 I'm cognizant of Mark Twain's comment

 17 about people that represent themselves.

 18 MS. O'FLYNN: Okay. Okay. So -- oh,

 19 pardon.

 20 CHAIRMAN MASSAD: Cliff, to that point,

I'm not quite sure I understood the point, but so

maybe afterward we can, we can follow up on that.

 21 

 22 
 83

 1 But let me just say a couple of quick

things. First, thanks, everyone. I thought it

was a very good discussion. And Kim's point, some

of the others have, I think, referred to it about

resolution not preempting recovery.

 2 

 3 

 4 

 5 

 6 I think that's a very good point, and I

guess I would also phrase it maybe slightly

differently, which is that resolution planning

should not create incentives that undermine

recovery, meaning that as we think about these

things, we have to plan for both. We have to go

through the recovery planning, we have to go

through the resolution planning. Obviously, we

hope that we never get to either of them. But I

think it's very important as we work through these

issues that we don't create potential incentives

in the way we think about resolution that might,

for example, give participants -- that might cause

participants to have less incentive to participate

in an auction, for example, because they think

they might get a better deal in resolution.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 And there are other ways that this can
 84

 1 play out also. So I think that there is a

tension, or there's a relationship between these

two things that we have to very much keep in mind.

I think the FDIC in our discussions has also been

quite aware of this dynamic.

 2 

 3 

 4 

 5 

 6 Finally, let me just apologize to

Kristen. I think I misspoke when I first

referred, I called you by a different name. I

think I called you Angela because you're sitting

next to one another.

 7 

 8 

 9 

 10 

 11 MS. WATERS: I didn't even notice. So

 12 no apology is necessary.

 13 CHAIRMAN MASSAD: Thanks.

 14 MS. O'FLYNN: Okay. Well, I just want

to say thank you to everyone on the Committee

today for your contribution, and at times, lively

debate. And I'll hand it back to Petal if you've

any more comments.

 15 

 16 

 17 

 18 

 19 MS. WALTERS: So thank you, Susan, for

facilitating that panel. We will be starting

again in about ten minutes, about 11:45. This

will be our only break for the morning. I'm sorry

 20 

 21 

 22 
 85

 1 -- yeah, that's right. The only break for the

 morning, so just keep that in mind. Panels

 and 3 will go right into each other.

 2 

 3 

 4 Thank you.

 5 (RECESS AT 11:35 a.m.)

 6 MS. WALKER: It is my pleasure to call

this meeting back to order. As noted in today's

agenda, our second and this panel discussions,

respectively, will cover FDIC staff presentation

on GSIB resolution. And then CFTC and FDIC staff

presentation on CCP resolution.

 7 

 8 

 9 

 10 

 11 

 12 I would like to introduce the

facilitator for our second and third panels, Mr.

Robert Steigerwald, who is the Senior Policy

Adviser and Financial, I'm sorry, Senior Policy

Advisor for Financial Market at the Federal

Reserve Bank of Chicago. Robert needs no

introduction to this community given his extensive

work and deep thought on these matters.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 Thank you, Robert. I'll turn it over to

 21 you.

 22 MR. STEIGERWALD: Thank you, Petal.
 86

 1 That's very kind of you. Thank you for that

introduction. And thank you to Commissioner Bowen

for asking me to be a part of this committee, and

to Chairman Massad for welcoming me here. I'm

quite honored to be a part of this committee.

 2 

 3 

 4 

 5 

 6 And I'm going to try to set a good

example for the panelists on the next two sessions

by speaking loudly and clearly into my microphone.

Hopefully, that will help the folks in the back of

the room, and those who are listening in remotely.

 7 

 8 

 9 

 10 

 11 Well, Petal, you've put me to work right

away in my first meeting, and so that's the best

way I think to learn the workings of this

committee. I'm happy to facilitate this panel.

Let me briefly introduce the speakers in the next

two panels:

 12 

 13 

 14 

 15 

 16 

 17 Mr. Jeff Bandman, Acting Director of the

 18 Division of Clearing and Risk at the CFTC;

 19 Robert Wasserman, Chief Counsel in the

 20 Division of Clearing and Risk;

 21 Herbert Held, Deputy Director, Systemic

 22 Resolution Planning and Implementation Group at
 87

 1 the Federal Deposit Insurance Corporation;

 2 R. Penfield Starke, Assistant General

Counsel in the Receivership Section at the FDIC,

and Charlton Tempelton, the Chief of Resolution

Planning at FDIC.

 3 

 4 

 5 

 6 That's the hardest work that I have been

assigned for purposes of these two panels. The

speakers have arranged a sequence for their

presentations, and I will now hand the discussion

over to them.

 7 

 8 

 9 

 10 

 11 MR. HELD: Thank you. I'd like to start

and say that since the enactment of Dodd-Frank,

the FDIC has been working very closely with the

Federal Reserve Board to make sure that the forums

are in a position where they can fail under the

Bankruptcy Code, a whole process of the living

wills, and that that is the preferred strategy for

the resolution of a global SIFI under the

Dodd-Frank regime.

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 Title 2 of Dodd-Frank, which is the

Orderly Liquidation Authority, provides a backup

to that in case that liquidation under the

 21 

 22 
 88

 1 Bankruptcy Code would not facilitate an orderly

 2 resolution.

 3 And under Title 2, our goals, our main

goals are to minimize the systemic risk of the

failure. Make sure that the costs for the failure

are borne by the owners, creditors, and if

necessary, the financial industry, and not the

U.S. taxpayers, and that culpable management is

removed.

 4 

 5 

 6 

 7 

 8 

 9 

 10 Title 2 gives the FDIC many of the same

powers over SIFIs that we have long exercised in

managing failed bank receiverships, and the FDIC

has a very long history of managing thousands of

failures of banks (inaudible) systemic effect on

the economy.

 11 

 12 

 13 

 14 

 15 

 16 Under Dodd-Frank, we have a pretty

complicated looking process for invoking our

authority. The Fed and the FDIC, two-thirds of

their boards have to vote for making a

recommendation to the Secretary of Treasury. In

cases where the main subsidiary is a broker

dealer, the SEC is a key turner rather than the

 17 

 18 

 19 

 20 

 21 

 22 
 89

 1 FDIC. And for insurance companies, the Federal

Insurance Office is the key turner rather than the

FDIC.

 2 

 3 

 4 For all non insurance company, non

banks, the FDIC would be the key turner, and for

any institution where the bank is the largest

operating sub, the FDIC would be the key turner.

 5 

 6 

 7 

 8 Once the recommendations are made, the

Secretary of Treasury makes the determination

after consulting with the president.

 9 

 10 

 11 Financial companies are offered a

judicial hearing to beheld within 24 hours after

the determination unless the acquiesce to the

appointment, and only after that hearing can the

FDIC be appointed receiver.

 12 

 13 

 14 

 15 

 16 This schematic is a lot scarier thank I

think reality. It shows the process for

appointment and the various parties that are

involved. And this is not very different from the

systemic determinations that we had to make back

in 2008 and 2009 when systemic determinations were

made on the bank level for the FDIC to do

 17 

 18 

 19 

 20 

 21 

 22 
 90

 1 resolutions of some of the largest banks.

 2 

 

 

 

 The process is complicated, and it has

lots of players. They have to make

recommendations, and their boards have to vote

with a super majority.

 3 

 4 

 5 

 6 The reality is that in a crisis, these

recommendations were made quickly, and the

Secretary of the Treasury acted quickly, and the

agencies were very coordinated in their response

to the crisis.

 7 

 8 

 9 

 10 

 11 We have worked closely with all the

agencies involved in planning for this tree keys

process knowing what each role, each agency's role

is, what the recommendations that have to be made,

and who would make them, and what information the

Secretary of Treasury would need.

 12 

 13 

 14 

 15 

 16 

 17 MR. STARKE: Okay. We're going to talk

a little bit about powers that are available to

the FDIC has receiver for a GSIB. As Herb

mentioned before, and it's noted at the top of the

slide, the powers, the statute that makes Title 2

is very similar to the powers in the FDIA for

 18 

 19 

 20 

 21 

 22 
 91

 1 banks. We'll talk later about the CCP resolutions,

but even with, even a GSIB resolution, even the

statute looks the same, the process is gonna be

somewhat different because the facts would be so

different.

 2 

 3 

 4 

 5 

 6 But in any case, the first sub bullet

notes that the receiver stands effectively, as we

say, stands in the shoes of the failed company,

and succeeds to all the rights, titles, powers,

and privileges. Cover financial company is the

term used in Dodd-Frank for the company that had

failed.

 7 

 8 

 9 

 10 

 11 

 12 

 13 As we do for smaller banks now, we have

the ability to have a bridge financial company so

that the company can fail, and yet it's operations

can be maintained in an ongoing entity. The

bridge company is chartered by the FDIC so that's

the change that's, we've around since 1934, but

have never chartered a bank or a company until

now, and would unlikely do so in a GSIB

resolution.

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 We have the power to transfer assets and
 92

 1 liabilities without obtaining consent. Obviously,

it's critical that the transfer be made at the

moment that the receiver of the FDIC is appointed

as receiver, so that will override contractual as

well as statutory limits on transfers.

 2 

 3 

 4 

 5 

 6 For claims that are not transferred to

the third- party, including the bridge, they would

remain behind. The FDIC runs an administrative

claims process in the receivership, and typically

provides receiver certificates to other than

administrative claims. In the event that the

claimant doesn't agree with the FDIC's

determination, it's free to go to court as long as

it does so within 60 days. And it can pursue the

claim in court on a de novo basis. The record

creating by the FDIC in denying the claim won't be

relevant.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 One of the thoughts in working on Title

2 is that there be some, that the FDIC put

together a proposal, a process where claimants who

were turned down might have the ability to settle

rather than having to go to federal court and, you

 19 

 20 

 21 

 22 
 93

 1 know, be engaged in litigation for a significant

 2 period of time.

 3 We talked about transferring assets and

liabilities in general. Specifically, there is

the ability to transfer GFCs.

 4 

 5 

 6 Qualified financial contracts are

generally derivatives as well as repos, and

securities lending transactions. So as long as

those contracts are transferred within one

business day of the failure, any rights to

terminate in the contracts would be overridden for

that day. And to the extent it's transferred to

another financial institution. including the

bridge, that termination rights would be

overridden in their entirety.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 And then, finally, there is a 90-day

stay against termination of non GFC contracts. In

fact, even those that have defaulted prior to the

FDIC being appointed as receiver, the FDIC being

appointed as receiver, the FDIC can maintain those

contracts if it needs them in the short term.

 17 

 18 

 19 

 20 

 21 

 22 So moving on, so we're going to focus on
 94

 1 the accountability aspect of Dodd-Frank.

Obviously, with the significant failures, there

was a concern in the last crisis for their lack of

accountability to managers of failed companies.

 2 

 3 

 4 

 5 As, you know, Herb noted, accountability

is one of the major tenents of Title 2, along with

financial stability and mitigated moral hazard.

This responsibility has been a significant focus.

Obviously, officers and directors can be, or must

be removed. As officers and directors of failed

company, they effectively are removed from that

company by the receiver taking their authority.

They can also be removed from being in the

financial industry in general going forward.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 There is an additional provision that

executives who were substantially responsible for

the failure can have their salaries for the prior

two years before a failure clawed back, and, you

know, put in the receivership estate to help pay

creditors.

 16 

 17 

 18 

 19 

 20 

 21 And, finally, there is a priority of

 22 payments scheme as in any insolvency regime. In
 95

 1 Title 2, it looks very much like the bankruptcy

scheme with one major difference. Rather than all

wage earnings being given a priority, all wage

earners except for senior executives and directors

are subordinated. In fact, they are paid after

subordinated debtholders are paid in full, so

effectively they would be recovered immediately

before equity to try and limit their benefit from

running the company that had failed.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 And then a third topic that we want to

go over generally is the Orderly Liquidation Fund.

This is a fund for the FDIC to use to help in its

resolution activities under Title 2. The FDIC had

suggested that this be pre- funded in the runup to

Dodd-Frank. That did not carry the day. So it is

a ex-post fund. Treasury will have to raise money

to provide to the FDIC. I think in dealing with

GSIB or CCP failures, it's clear that temporary

public funding could be very valuable,

particularly in the short run. It's the FDIC's

preference to try and have the failed company, to

the extent it's in a bridge, raise it's own

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 96

 1 funding, but in the short run, there is money

available. It is not unlimited immediately. The

FDIC is able to borrow 10 percent of the value of

the assets on the most recent financial statements

of the failed company, and shortly after that.

 2 

 3 

 4 

 5 

 6 But in any event, within 30 days the

FDIC can borrow based on the fair value of the

assets available for repayment in the failed

company. That's a fairly broad definition, but it

does not include assets which are not part of the

estate. There's still a lot of calculation.

Generally, it's intended that the FDIC get a

fairly small amount initially, and when it gets to

10 percent, and then when it can make a showing of

the assets that are available for repayment. When

the Treasury get more in our initial determination

for CCP resolutions, it appears that because IM

would be included in the

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 percent calculation, and then probably

not, at least currently, in the 90 percent. The

10 percent and the 90 percent may be very similar

numbers, meaning that they would be a fair

 20 

 21 

 22 
 97

 1 limitation on the amount that could be borrowed

 2 for a CCP resolution.

 3 And one of the tenents of Dodd-Frank, of

course, is that there will be no taxpayers losses

involved with these resolutions, so there are

several ways that the Act insures that.

 4 

 5 

 6 

 7 The first, which I just discussed, is

there is a limited amount that the FDIC as

receiver can borrow from the Treasury.

 8 

 9 

 10 Second of all, in the priority scheme,

the OLF is treated as DIP financing would be in

bankruptcy, and is repaid as priority making its

repayment extremely likely.

 11 

 12 

 13 

 14 However, if all else fails, there's the

requirement that the FDIC assess the GSIB

industry, those companies that are designated

under Title 1 to be assessed by the FDIC and make

payments back to insure that the OLF is repaid in

full.

 15 

 16 

 17 

 18 

 19 

 20 MR. TEMPLETON: I am going to talk a

little bit about international engagement. And

I'll start out by just mentioning, I guess, that

 21 

 22 
 98

 1 my Chairman Grover on a couple of occasions has

noted that we really have an ongoing process among

key jurisdictions to work to develop relationships

that really will serve to foster the basis for

cooperation in the event of failure of a GSIB.

And this really has been a major priority for the

FDIC over the past couple of years.

 2 

 3 

 4 

 5 

 6 

 7 

 8 So, we really think of international

engagement to address obstacles to GSIB resolution

in three primary ways: Bilateral, multilateral,

and institution specific.

 9 

 10 

 11 

 12 So what does this mean? Bilateral work

includes really our great involvement with the

single Resolution Board, or SRB, and that extends

to the ECB or European Central Bank.

 13 

 14 

 15 

 16 It also includes our close involvement

and regular engagement with the U.K., the European

Banking Union member states such as France and

Germany, as well as Switzerland and Japan.

 17 

 18 

 19 

 20 The multilateral work includes our work

with the Financial Stability Board, or FSB, which

really is coordinating important work to develop

 21 

 22 
 99

 1 guidance for banks, insurance company center

Counter Parties or CCPs in the space of resolution

planning. And as you can imagine, we're, of

course, quite involved with those particular

efforts.

 2 

 3 

 4 

 5 

 6 With respect to institution specific

efforts, the Crisis Management Groups, or CMGs,

are really pivotal to the communications among

home authorities as well as key host authorities

in terms of really drilling down into the

resolutions actions and building out the details

of implementing a resolution plan, and trying to

avoid reflexive ring fencing.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 I'll say just one thing now regarding

information sharing agreements because I think

we'll cover that a little bit more in Segment 3.

But I would like to discuss a joint process that

we've developed with our colleagues at the Federal

Reserve Board for outreach with respect to the

Title 1 plans. And this is really to insure that

we're responsive to our colleagues at other

agencies, and are able to provide them with

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 100

 1 feedback and analysis on the plans themselves, as

well as facilitating access to the plans where the

agencies have a bona fide interest in a particular

firm, and are either a home or host authority.

 2 

 3 

 4 

 5 Just to give a few example on the

bilateral side, earlier this year, we participated

in a number of exercises including a table top

hosted by the authorities in Switzerland, as well

one in Germany.

 6 

 7 

 8 

 9 

 10 With our European counterparts, we have

both formal and informal working groups with the

European Commission, and the Single Resolution

Board, or SRB, and this really includes engagement

at all levels of the organization including staff

secondments.

 11 

 12 

 13 

 14 

 15 

 16 Turning to the U.K., which, of course,

is very important to the U.S. in the sense that

all of our, if you look at our GSIBs, you know,

the majority of their asset are outside the U.S.,

or held in the U.K. The FDIC is really built upon

the efforts of our principal level exercise that

we conducted in late 2014 with principals on all

 17 

 18 

 19 

 20 

 21 

 22 
 101

 1 the U.K. Regulatory bodies, as well as the U.S.,

and we really continue to work very closely with

them building on that effort with weekly and

monthly calls to engage on a variety of cross

border resolution planning efforts.

 2 

 3 

 4 

 5 

 6 And then, lastly, the FDIC hosted a

bilateral exercise with authorities in Japan to

discuss cross border resolution issues including

funding and liquidity models, continuity of access

to FMI, (inaudible) protocol and some other key

issue.

 7 

 8 

 9 

 10 

 11 

 12 In terms of multilateral outreach, I'll

touch on just a couple of issues with which the

FSB is involved. With respect to the maintenance

of critical functions and resolution, there are a

couple of work streams I'd like to mention.

 13 

 14 

 15 

 16 

 17 First, the FDIC is co-chair of the FSB's

Cross Boarder Crisis Management Group for

Financial Market Infrastuctures. And I believe

Chairman Massad, I think mentioned that earlier,

this group is really doing very important work

considering guidance with respect to the

 18 

 19 

 20 

 21 

 22 
 102

 1 resolution of the CCP in the event of the material

 2 financial distress or failure of the CCP.

 3 Another work stream is considering the

issue of continuity of access to financial market

infrastructures. Specifically, this is concerned

with issues related to maintaining access to the

critical services of FMIs during the resolution of

a GSIB itself to support the, excuse me, the

payment clearing and settlement activities of the

GSIB.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 The FDIC also co-chairs the bail in and

execution of work stream, which is considering

issues related to valuation, securities issuance,

and so forth, really getting into the details of

how that process would work.

 12 

 13 

 14 

 15 

 16 And then finally, the internal TLAC

Working Group is working to develop guidance based

on the FSB Term Sheet that was issued late last

year.

 17 

 18 

 19 

 20 Going on to institutions specific

engagement, the Crisis Management Groups, we have

established CMGs for our seven GSIBs, and have

 21 

 22 
 103

 1 identified the key host jurisdictions, which means

have CMGs for Bank of America, GPMC, Bank of New,

York, Mellon, Citigroup, Goldman, Morgan Stanley,

and State Street. And in addition to these GSIBs,

we've also established a domestic CMG for Wells

Fargo.

 2 

 3 

 4 

 5 

 6 

 7 Beyond the GSIBs, we've also established

CMGs for the two Global Systemically Important

Insurance Companies, in this case, AIG, and

Prudential.

 8 

 9 

 10 

 11 And then finally, we're evaluating CMGs,

potentially one or more, for systemic cross

borders Central County Parties, and I think we'll

probably talk about that in the next segment a

little bit.

 12 

 13 

 14 

 15 

 16 And then just one last comment, I guess,

with respect to CMGs in general. For the past

couple of years, we've actually had the firms

participate for a half day in the CMGs, and I

think that's been a really positive development to

that, that particular effort, and they generally

send in staff to present on a few issues related

 17 

 18 

 19 

 20 

 21 

 22 
 104

 1 to, that are fairly topical that were extending at

that point talking about GSIB resolution. And,

you know, prior topics included things like their

global funding and liquidity plans, the global

communication plans, and resolution, and so forth.

 2 

 3 

 4 

 5 

 6 I think that's the end of our --

 7 MR. BANDMAN: Before we go into the

second presentation, we thought we would see if

there are any questions from the members of the

Committee about the -- the first presentation from

the FDIC. I'll start with one question.

 8 

 9 

 10 

 11 

 12 You know, the Chairman had alluded,

Commissioner Bowen, about some interconnectedness,

and, obviously, one of the elements of the

relevance of a GSIB resolution to CCP resolution

has to do with the critical services that these

banks provide to CCPs, and I would be interested

in now the FDIC thinks about, you know, the

impacts of a GSIB resolution in terms of the

relationship to continuity and services to a CCP,

custodian, settlement, or otherwise.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 MR. STARKE: So from a legal standpoint,
 105

 1 we're talking about receiver that hasn't been

created, and, you know, I couldn't make any

commitments on their behalf. Obviously, these are

systemic institutions by definition. That's why

we're dealing in Title 2, so that I think there

are some policy concerns that might need to be

raised, and I'd defer to her about those.

 2 

 3 

 4 

 5 

 6 

 7 

 8 MR. BANDMAN: Herb?

 9 MR. HELD: Under our single point of

entry strategy that the FDIC has put forward, the

top tier holding company in one of these

institutions would be placed into receivership.

And the operating companies would be able to stay

open and operate business as usual.

 10 

 11 

 12 

 13 

 14 

 15 The debt equity at the parent level

would be left behind in the receivership, so it

would basically have a balance sheet consisting of

its investments, debt (inaudible) of it's

subsidiaries, and on the liability side, it would

basically have zero.

 16 

 17 

 18 

 19 

 20 

 21 So it would be well capitalized at the

 22 parent. They'd be able to use that source of
 106

 1 strength to convert existing debt from their

subsidiaries into equity to recapitalize the

subsidiaries, and that's the ideal situation.

 2 

 3 

 4 If a subsidiary is hopelessly insolvent,

provides no value to the group, then we wouldn't

be able to support it from the parent because it

wouldn't make any economic sense, and it would

have to go into its own resolution regime.

 5 

 6 

 7 

 8 

 9 So one good things about the U.S. GSIBs

is that they do have a fairly robust level of debt

at the parents. The parents holding companies are

relatively clean. Hopefully, over time they will

become cleaner, with the Federal Reserves proposed

regs.

 10 

 11 

 12 

 13 

 14 

 15 So the single point of entry is feasible

if losses are not beyond the loss

 

 

 

 

(inaudible) capacity of the

corporation.

 16 

 17 

 18 

 19 MR. STEIGERWALD: Otherwise a question

 20 -- oh, I see. Marcus.

 21 MR. STANLEY: So two questions. One is

 22 in terms of the Title 1 Living Will process, it's
 107

 1 my understanding that there's a lot of emphasis

there on making sure that the resolution planning

process provides for adequate liquidity for the

company as it goes into bankruptcy in order to

maintain critical operations.

 2 

 3 

 4 

 5 

 6 Could you talk a little, does that

intersect at all with how a failing clearing

member, would a failing clearing member in

bankruptcy be expected to have any capacity to

provide liquidity still to a clearhouse, or how is

that planned for?

 7 

 8 

 9 

 10 

 11 

 12 MR. HELD: I mean, part of their

liquidity planning is to estimate the amount of

liquidity that they would need to keep their

memberships in the financial market utilities

going. So it can be hard to operate one of these

institutions smoothly unless they have access to

the markets, and the markets are going to require

them to post their collateral, and meet their

market call.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 So within, in the plans, they are

 22 working with all the CCPs to figure out kind of
 108

 1 their needs, and figure that into their living

wills and their liquidity calculations as to who

much liquidity they would have to have at the time

of failure.

 2 

 3 

 4 

 5 So definitely, keeping the access to

financial market utilities is a very important

part of the living wills.

 6 

 7 

 8 MR. STANLEY: And that might actually

prevent them from defaulting in some sense, at

lease to the clearing house.

 9 

 10 

 11 MR. HELD: Yeah, if their projection is

right, they should have sufficient liquidity on

hand to prevent them from defaulting.

 12 

 13 

 14 MR. STANLEY: And just a quick second

question. In terms of the credit line in Title 2,

the Treasury liquidity line, what exactly is

included as an asset of the CCP that could be

loaned against? You mentioned IF.

 15 

 16 

 17 

 18 

 19 MR. STARKE: So it's a fairly aggressive

definition. It's basically assets that are owned

by the institution, so assets that are held in

trust would not be included, and to the extent,

 20 

 21 

 22 
 109

 1 you know, assets were ring fenced by another

jurisdiction, they wouldn't be included, but

everything else that could be deemed an asset

would be valued and would be included.

 2 

 3 

 4 

 5 MR. STANLEY: Including memberships?

 6 MR. HELD: Sure. I mean, we will a

evaluation process, and I'm not exactly sure

they're worth or would be in that situation, but

they would definitely be included.

 7 

 8 

 9 

 10 MR. STEIGERWALD: Any other questions

before we proceed to the next part of the

discussion?

 11 

 12 

 13 Seeing none, why don't I turn it back to

 14 the panelists?

 15 MR. BANDMAN: Great. Thanks. And can we

bring up the other presentation and go to slide 3.

Well, that's happening.

 16 

 17 

 18 So first of all, on behalf of DCR, my

colleagues and my fellow presenters, we would like

to thank Commissioner Bowen and her staff for

inviting us to present, as well as Chairman

Massad, and Commissioner Giancarlo for their

 19 

 20 

 21 

 22 
 110

 1 support of the work, important work of the Market

 2 Rise Advisory Committee.

 3 You know, I'd like to thank the FDIC,

Herb, Chuck, and Pen for the preceding

presentation on GSIB resolution, and their

collaboration with us on the presentation we're

about to go through on DCO resolution.

 4 

 5 

 6 

 7 

 8 And we also are very appreciative of the

very collaborative important work on CCP

resolution that we're working on with the FDIC

both domestically and internationally.

 9 

 10 

 11 

 12 And finally, I'd also like to thank my

colleague, Bob Wasserman, as well as the staff of

the DCR, DCR, Division of Clearing and Risk and

FDIC, who assisted in working on today's

presentation, including Kirsten and Andrea

Goldsmith.

 13 

 14 

 15 

 16 

 17 

 18 Finally, if we could just go briefly to

slide 2. Oops, no, that's 3. Yeah. Just the

disclaimer. The views expressed today are soley

those of the presenters. I'm sure that goes for

my FDIC colleagues as well, and the information is

 19 

 20 

 21 

 22 
 111

 1 not necessarily the view of the agency or any

 2 departmental presentation.

 3 So if we could go to Slide -- perfect.

Thank you. So CCP resolution is an important and

timely topic, and I'm very pleased that we are

having today's meeting. And much of the dialog

today (inaudible) to the discussion from members

of this Committee after the presentation.

 4 

 5 

 6 

 7 

 8 

 9 You know, as was pointed out earlier,

Chairman Massad referred to the 3 Rs. In addition

to resolution, there is CCP resilience and

recovery. You know, we very much hope to never be

in a position where we actually have to implement

all the important coordination and planning that's

being discussed today.

 10 

 11 

 12 

 13 

 14 

 15 

 16 CCP resilience has been and remains a

core critical priority of the CFTC, as well as

other regulators in the international community.

That by in itself has been and could be the

subject of many presentations, but, obviously, is

not the subject for today, but we do note it's

importance, including the ongoing day-to-day work

 17 

 18 

 19 

 20 

 21 

 22 
 112

 1 of risk surveillance and risk management done by

the CCPs, as well as by the clearing members, and

by regulators, including our surveillance branch.

There's important work being done around the world

on martin methodology and stress testing. The CPM

 

 

 

(inaudible), FSB, and other groups,

and the focus on CCP resilience is

critical.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 And again, as has been noted, the work

on resolution, although there is an element of

continuity, it's separate from, but bears an

important relationship to the work on CCP recovery

rules, CCP recover plans, and I will not that CCP

recovery rules and plans has been a major focus of

our division of clearing and risk, and will be a

major focus for the remainder of the year, and we

expect to be providing some public guidance on

recovery rules and recovery plans in the not too

distant future that we hope will inform this

debate.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 Turning now to the focus of today's

 22 presentation at the Market Risk Advisory
 113

 1 Committee, the slide, if we could stay with Slide

3 for a few minutes, few moments more, we'll go

through, first of all, as a background, some of

the international agreements regarding CCP

resolution including the, some important

documents, they key attributes published in 2011,

the FMI Annex published in 2014. We'll also talk

about international development of strategies, the

U.S. Statutory framework, some of the

coordination we're doing together, and then we'll

eventually go to some of the kind of current

issues and challenges.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 But I do think it's important before we

get into kind of today' issues that there be some

focus on kind of the context, and actually how

much has already been agreed, and how much

important work has already been done in the topic

of DCO or CCP resolution, resolution planning and

strategies.

 14 

 15 

 16 

 17 

 18 

 19 

 20 And to really delve deeply into the

challenging issues today requires the appreciation

of that foundation. And, you know, I was

 21 

 22 
 114

 1 searching as we were preparing for this, this

presentation for an analogy to this, and at least

the one I came up with was first year of law

school in property class, and, you know, not to

diminish the extreme importance of that, but, you

know, we jumped in property class immediately into

the most tricky edged situations, the law against

perpetuities, life and being plus 21 years, and

all the intricacies of what that meant, and, you

know, we sort of jumped into that, but without

really establish there's such a body of developed

understanding, important work that's been over the

years.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 And so as we tackle the important

challenges that remain, I think it's very

important to understand te context around it. So

people realize we're not just starting from

nowhere, but there's an enormous amount of work

that's been done to get us to the point where we

are, and I think that's one of the things I hope

everybody will take away from that.

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 So if we could go on to Slide 4 briefly,
 115

 1 key attributes. This was work that was done in

the kind of the, primarily in the central banker

and Prudential regulator focusing on financial

institutions with, I think, a primary focus on

banks.

 2 

 3 

 4 

 5 

 6 But then if we go to Slide 5, there's a

document, the FMI Annex, and we're going to be

talking a lot about that in the beginning of

today's presentation. I'm going to give a brief

overview, and then I'm going to turn it over to my

colleague, Bob Wasserman, to do a bit of a deeper

dive into that.

 7 

 8 

 9 

 10 

 11 

 12 

 13 But that's a very, very important

document for folks to read and understand because

it informs the core of what we all talk about.

And so that is something, a document that was

published in October of 2014 actually by Financial

Market Infrastructures. It includes not just

CCPs, but other type of infrastructures, you know,

such as trade, data repositories, among others,

but, and yeah, there was a big focus on CCPs.

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 The constituents who worked on that
 116

 1 included international prudential regulators such

as, you know, the FDIC, central bankers, and

market regulators, so it represented an enormous

effort. It was chaired by Paul Tocker, who at the

time was Deputy Governor of the Bank of England.

And building on the key attributes, it was issued,

really, it was designed as guidance for national

authorities, yet also with cross border

cooperation and implications for a CCP resolution

in mind.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 And among the many important, high level

principals, goals, and objectives that were agreed

in the FMI Annex included, your know, what are the

objectives of CCP resolution? What is the scope

of the work of CCP resolution? What should be

powers and authorities be in the resolution, and

the resolution authority context? What are some

of the principles around the, the considerations

around the time of entry into resolution? How

should FMI contracts be treated in resolution?

What sort of information sharing should there be

among regulators? And what kind of resolution

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 117

 1 planning should take place at the authority and at

 2 the FMI level?

 3 So as some of the work that's been today

that will be discussed in further detail is

delving into some of the strategy, some of the

technical aspects, how do we fine tune some of

those, how we reach agreement. It's very

important for all of us to bear in mind that a lot

of consensus and mutual understanding has been

reached on these issues.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 And with that, I'll turn it over to my

colleague to take us through the FMI Annex in more

detail.

 12 

 13 

 14 MR. WASSERMAN: Thank you, Jeff. And so

as Jeff was saying, there were quite a number of

entities that worked together to come up with the

FMI Annex. I should note that there was a great

deal of coordination between the folks working on

the FMI Annex and resolution, and CPMI IOSCO work

on recovery that was published at the same time.

 15 

 16 

 17 

 18 

 19 

 20 

 21 And that, of course, is because as

 22 Chairman Massad alluded to earlier, there is a
 118

 1 really tight relationship between recovery and

resolution. And I'll talk a little bit more about

as we talk about some of these highlights for FMI

Annex.

 2 

 3 

 4 

 5 And so the objectives set forth in that

FMI Annex are financial stability, of course,

which is always the key consideration, but as

well, continuity of critical FMI functions, which

is quite important financial stability, and as

well, avoiding exposing taxpayers to loss. And

we'll talk a bit more about that later.

 6 

 7 

 8 

 9 

 10 

 11 

 12 And what the Annex establishes is that

an effective resolution regime, this is what we're

trying to accomplish, is one that achieves

continuity and timely completion of critical

payment clearing, settlement and recording

functions.

 13 

 14 

 15 

 16 

 17 

 18 And timely, of course, in the context of

an FMI, and specifically a central counter party,

is a really demanding standard because,

essentially, CCPs need to continue functions

everyday. And so it requires a very high standard

 19 

 20 

 21 

 22 
 119

 1 of planning and understanding in order to allow

the CCP to do what it needs to do, which is to

have continuous operation, and as well, timely

settlement of obligations, and as well, continuous

access of participants to collateral. And we'll

talk a little bit more about that later.

 2 

 3 

 4 

 5 

 6 

 7 Go to 7 please. Now, in terms of the

timing of entry into resolution, I should note

here that this is when a resolution authority

should be able to put a CCP into resolution. And

so this is not saying and at this point you point

you must put an entity into resolution. Indeed,

one of the basic tenents is that resolution is a

discretionary decision. That is to say, it

doesn't happen automatically.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 And, of course, FDIC colleagues had

explained the whole key turner process, and so

what we have here is then when a authority should

be able to put the entity into resolution. And

speaking as well to some of the issue that Kim had

raised earlier.

 17 

 18 

 19 

 20 

 21 

 22 And so one possibility is recovery
 120

 1 measures are exhausted, and have failed to return

the FMI to both viability and continuing

compliance with legal and regulatory requirements,

or if they are not reasonably likely to be able to

do that within the time frame required.

 2 

 3 

 4 

 5 

 6 Now, on one hand, I should note that in

order to get here, and this is alluding to some of

the discussion we had at the end of the last

panel, in order to get here, first, there would

have had to be a failure of an entity with

extraordinarily large exposures. Almost certainly

going to be one of those GSIBs.

 7 

 8 

 9 

 10 

 11 

 12 

 13 To the extent that as was alluded to in

the last panel, there would be a goal to keep the

operating entities ongoing, and to keep, and to

maintain their access to FMIs.

 14 

 15 

 16 

 17 Well, in order to maintain excess to a

Central County Party, you must timely complete all

of your obligations, which means you will not have

defaulted. And so, in other words, one

requirement of our being here is that despite that

planning, there was, in fact, a default.

 18 

 19 

 20 

 21 

 22 
 121

 1 In other words, not only was there,

essentially, a failure of one or more GSIB, but

the relevant resolution authorities had decided

either not to intervene, or to intervene, but not

to follow the plan of maintaining continuous

access.

 2 

 3 

 4 

 5 

 6 

 7 And so again, a very, this sort of goes

to that whole tail of the tail point. We're here

because it's our duty to analyze this, and to be

sure that we cover all possibilities. But this

goes to how unlikely some of these possibilities

are.

 8 

 9 

 10 

 11 

 12 

 13 Moreover, remember that CCPs are subject

to the PFMI, and certainly for member defaults

must address comprehensively any potential credit

loss. So in other words, the

 

 

 

 

 

(inaudible) that has been alluded

to before, that is what is required

in terms of pre-funded resources

that the CCP is holding in its

hands.

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 But in addition, under the PFMI, the CCP
 122

 1 is required to address comprehensively any

potential credit loss. Now, that is going to be

based on both pre-funded and committed resources,

but, yes, and we'll talk a bit more about this

later, just as in the insolvency counterfactual,

at the very, very end, one probably is looking at

gains based haircutting, otherwise known as

variation margin haircutting.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 Let's go to 8, please. So the powers of

the Resolution Authority, as was alluded to

before, the Resolution Authority is going to step

into the shoes of the entity. And so, in other

words, it would have the power to enforce

unexhausted obligations of clearing members to

make cash calls, as well as to either accept

positions of the defaulting participant, if those

are powers are, in fact, in the rules of the CCP,

certainly, the power to right down equity, gains

based haircutting, and tariff.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 Let's go to 9. Now, I want to very

clearly delineate the difference here between

gains based haircutting on the one hand, and

 21 

 22 
 123

 1 initial margin haircutting on the other.

 2 I know in many ways they, there is,

either way, it's pain. And, you know, pain is

pain, to be sure. But I think both doctrinally,

legally, there are some extraordinarily important

differences.

 3 

 4 

 5 

 6 

 7 And so on the one hand, the Annex says

that engaging VM haircutting must respect to the

rules of the FMI and the hierarchy of claims under

the insolvency regime.

 8 

 9 

 10 

 11 The requirements for initial margin

haircutting are more stringent yet. Only where

initial margin is not insolvency remote, where

it's consistent with the legal framework, and

where it's consistent with the FMI rules.

 12 

 13 

 14 

 15 

 16 And speaking, I can speak with respect

to the U.S. Arrangements. Initial margin is

remote from insolvency. Writing down initial

margin is not consistent with the legal framework,

and it's certainly not consistent with any of the

rules of any of the DCOs.

 17 

 18 

 19 

 20 

 21 

 22 And so initial margin haircutting is
 124

 1 quite simply in the U.S. off the table. I think

that is true in a number of other jurisdictions as

well, but I am speaking specifically with respect

to the U.S.

 2 

 3 

 4 

 5 I would note gains based haircutting is

in many ways the insolvency counterfactual.

Obviously, it's important that there be limits

there, and that's something as well that we are

looking at in terms of things like recovery.

 6 

 7 

 8 

 9 

 10 Let's go to 10. The Annex is aware, or

manifests an awareness, of the systemic concerns

around things like partial tear-up. And so in

considering whether to do that, the Resolution

Authority is directed to consider the impact on

both mismanagement of the participants and

financial stability.

 11 

 12 

 13 

 14 

 15 

 16 

 17 As was alluded to, I think, in the last

panel with respect to banks, one very real

possibility is to transfer the CCP to a bridge, or

its functions to a bridge.

 18 

 19 

 20 

 21 Going to 11. The Annex as well

 22 encourages CMGs for FMIs that are systemically
 125

 1 important in more than one jurisdiction. And I

should note that there is presently a survey going

on being conducted by CPIM IOSCO, and the results

of which will be tabulated and turned over to the

relevant FSB Group, which is the FMI Cross Border

Crisis Management Group, to assess which

jurisdictions consider which CCPs to be

systemically important, and, thus, the tabulation

will reveal things about where FMIs are

systemically important in more than one

jurisdiction, and as well, the importance of

recovery and resolution planning.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 And, finally, and I know I'm running out

of time, on 12, the Annex talks about the

importance of (inaudible) assessments, and as

well, the importance of making information

available.

 14 

 15 

 16 

 17 

 18 And with that, I'm going to turn over to

 19 the FDIC colleagues for 13.

 20 MR. STARKE: Okay. I mean, you could

certainly join in here, Bob. We're talking about

the FMI CBCM. It's an FSB group that consists of

 21 

 22 
 126

 1 members from all the G20 countries I think, has

five or six U.S. members, including Bob and

myself.

 2 

 3 

 4 You know, we've done some basic work.

We've met here in Washington in December. We met

in March in Amsterdam, and a couple of weeks ago

in London, put together a long background paper

kind of setting out what the issues are with CCP

resolution, and now are working on a discussion

note that, hopefully, will be available for

industry comment towards the end of the summer.

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 Ultimately, there's a hope that there

will be a longer guidance paper put out for

comment at the end of the year on the various

topics of interest of CCP resolution. Certainly,

I think it's fair to say we're far from total

agreement within the group. Frankly, Bob and I

agree on more things than a lot of my Foreign

Resolution Authority colleagues do.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 So there's still much to be discussed,

and I think it will be extremely helpful to get

input from the industry at the end of the summer,

 21 

 22 
 127

 1 and then again at the end of the year.

 2 MR. STARKE: Anything you want to add,

 3 Bob? All right.

 4 MR. WASSERMAN: No.

 5 MR. STARKE: All right. Thank you.

Then let's move to the statutory framework for

DCOs. Obviously, the primary insolvency regime for

a DCO is the Bankruptcy Code in which case the

FDIC would have no involvement, which would be

grand, but my understanding is this is limited to

only Chapter 7, actual liquidation and bankruptcy.

 6 

 7 

 8 

 9 

 10 

 11 

 12 And just to be clear, CCPs are not even

if designated under Title 8 of Dodd-Frank, they're

not subject to the living will process of Title 1,

the goal of which is to get large systemic

financial companies to be resolvable under

bankruptcy. That is not a goal for DCOs or CCPs

in general.

 13 

 14 

 15 

 16 

 17 

 18 

 19 There are significant criteria that have

to be met in order to a Title 2 liquidation, one

of which is that Title 2 would have a better

result than bankruptcy, and I think given the

 20 

 21 

 22 
 128

 1 current state of the Bankruptcy Law, that's a

 2 relatively low bar.

 3 We certainly believe that DCOs, FMU's in

general, are subject to Title 2. Only financial

companies can be resolved under Title 2, and

whether your financial company is based on

definitions supplied by the Federal Reserve,

always their preference that we not say that

anything would be (inaudible) too until it

actually is and a decision is made, but I think

it's reasonable to say that the CCPs clearing

activities are financial in nature.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 So assuming that Title 2 applies, you

can see the four sub bullets at the bottom:

Create a bridge; transfer assets, provide OLF

funding, and enforce contracts, including the

rulebook. Sounds very similar to my discussion of

the rules under Title 2 for GSIBs, and then, of

course, the process would be exactly the same.

 14 

 15 

 16 

 17 

 18 

 19 

 20 Want to jump in?

 21 MR. WASSERMAN: Quickly. I just will

 22 note, as Pen alluded to, under Chapter 7, a DCO
 129

 1 would be a commodity broker, and basically under

the Bankruptcy Code a commodity broker cannot

enter Chapter 11 reorganization. It would have to

go through a Chapter 7 liquidation which means, of

course, it's ability to continue to provide its

critical function would end.

 2 

 3 

 4 

 5 

 6 

 7 MR. STARKE: Thank you, Bob. And moving

on to 15, I front ran this a little bit talking

about the resolution of a DCO to say it would have

to be determined at the time whether it was a

financial company. We certainly believe that

clearing activities are.

 8 

 9 

 10 

 11 

 12 

 13 And I think, frankly, this second bullet

came from you, Bob. The notion is that there is a

discussion of complying with some of the

liquidation provisions of Chapter 7 and bankruptcy

that relate to DCOs, and it's hard to imagine that

even Congress would have put that in if they

weren't contemplating DCOs being liquidated under

Title 2 (inaudible) Liquidation Authority. So

that's the purpose of that.

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 And I think it makes good sense.
 130

 1 Thanks, Bob. And defer I would defer to Herb.

 2 MR. HELD: The FDIC and CFTC have worked

together extensively on resolution, on the issues.

Last year, we executed a memorandum of

understanding on information sharing, and we've

got a number of interagency exercises.

 3 

 4 

 5 

 6 

 7 Bob is a frequent visitor to our

conference rooms, and we have learned a lot from

him in our planning exercises. And, also, we've

worked together with Bob on presentations to the

FOC, the Financial Stability Oversight Council.

 8 

 9 

 10 

 11 

 12 MR. BANDMAN: Okay. If I could just add

one thing. I think, also, we, really, as I

mentioned at the outset, you know, greatly

appreciate the collaborative relationship we have.

You know, it's, we have this structure in the U.S.

Where the CFTC is the kind of authority with

respect to recovery, and the FDIC is the

resolution authority. Other jurisdictions don't

necessarily have that structure. And,

fortunately, we had a very collaborative

relationship both domestically, as well as when we

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 
 131

 1 work with our international counterparts, and that

is really a very important thing to have because,

you know, recovery and resolution, you know, the

planning and kind of the rules in the CCP rule

book are a bit of a continuum, but it's one we

greatly value and appreciate.

 2 

 3 

 4 

 5 

 6 

 7 MR. WASSERMAN: And going to 17, and so

as part of this planning that we've been

discussing, SIDCOs, as well, which is the

Systemically Important DCOs, and as well those

entities that have opted into that regime have to

maintain viable plans for recovery or orderly

wind-down.

 8 

 9 

 10 

 11 

 12 

 13 

 14 And as we've been discussing here, there

is a very close relationship between the recovery

plans, and resolution planning both in terms of,

in terms of avoiding, frankly, resolution, but as

well in terms of having a full range of power, of

things that the FDIC could do if they had to step

into the shoes of a CCP.

 15 

 16 

 17 

 18 

 19 

 20 

 21 And so part of that coordination that

 22 Jeff was referring to has been discussions around
 132

 1 recovery planning and discussions around the

 2 recovery plans of the individual entities.

 3 In addition, we have a rule that says

that the SIDCOs have to have procedures providing

both CFTC and FDIC with information that may be

necessary for that planning, and, indeed, the DCOs

have been engaging in a great deal of stakeholder

consultation concerning development of recovery

plans.

 4 

 5 

 6 

 7 

 8 

 9 

 10 And I know that's been a very

fascinating set of discussions because, of course,

considering what might happen in these sort of

tail of a tail of a tail events, is not fun. But

I think it has been a very healthy process, and I

think a lot of progress has been made. Thanks.

 11 

 12 

 13 

 14 

 15 

 16 MR. WASSERMAN: Going to 18? And so as

we've been saying, there is a important

relationship between recovery and resolution.

There is a clear boundary though. So as we've

been discussing, resolution happens when and if,

at least in the case of DCOs in the U.S., when and

if the keys are turned.

 17 

 18 

 19 

 20 

 21 

 22 
 133

 1 And so, there is, in fact, a clear

boundary. During recovery, the CCP remains in

control. Once those keys are turned, the FDIC

would be stepping in. And so that is, I think, a

very important and clear boundary so that you know

where you are.

 2 

 3 

 4 

 5 

 6 

 7 MR. STARKE: So with regard to timing,

this is an issue that we've given a lot of

discussion to with out FSB Group.

 8 

 9 

 10 You know, Kim, I think you set it up

well. You know, the goal is not to go in too

early. In the unlikely event that this ever

happened, I, of course, wouldn't be able to prove

that we didn't go in too early because one we're

in, we're in, and otherwise, that's just the

counterfactual.

 11 

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 17 But there's no question that I think for

all resolution authorities the best resolution is

the one that doesn't happen.

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 20 And even if you look at some of the

proposals around the world, say, reserving the

last cash call for the resolution authority, you

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 1 know, that's only a presumptive notion, and I

think in all circumstances, if the resolution

authority took a look and saw, well, there's one

more cash call left. I could really use that in

resolution. If the view was that that cash call

would restore those CCPs to viability, I think in

all cases that would be allowed to happen in

recovery, and there would be no resolutions.

 2 

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 9 So I think it's particularly important

for resolution regimes that don't provide

temporary public financing there is gonna be more

need to go in and have cash calls available.

 10 

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 13 You know, as we've discussed, under

Title 2, there is the ability to provide OLF on a

temporary basis, and should give us more

flexibility in timing.

 14 

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 16 

 17 So, you know, we're looking at the FDIC

for as much flexibility as possible, obviously, to

avoid resolution if necessary. On the other hand,

if it's clear at any point that either (a)

recovery won't work, or that the recovery is

leading to a lack of financial stability, the

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 1 resolution authority will need the ability to go

in earlier in the waterfall, and that's kind of

the way we're looking at it now.

 2 

 3 

 4 MR. WASSERMAN: So we've talked a lot,

including in the very first session, about

incentives. And one thing is quite critical here,

which is that in developing resolution strategies,

and as we've discussed, that's a lot of the work

that's going on right now both domestically and

internationally, it's important to be sure that

the strategy, you know, you want the strategies to

be effective, but you also want to be careful of

the incentives that you set.

 5 

 6 

 7 

 8 

 9 

 10 

 11 

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 13 

 14 And, certainly what you don't want to do

is set a resolution strategy which incentivizes

clearing members to say, well, maybe I'm not going

to participate actively in that auction, because I

don't, maybe that would bring this thing into

resolution, and I might have some advantages from

that.

 15 

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 17 

 18 

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 20 

 21 And so these are calculations that need

 22 to be made in undertaking and in developing the
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 1 resolution strategies which affects a lot of what

 2 we're discussing here.

 3 MR. STARKE: So I have not been asked to

talk about incentives, but I did want to make the

point that no one wants an incentive for clearing

members to go into resolution, but, you know,

there are several ways to deal with that.

Obviously, getting rid of the incentive is one

way, but providing incentives to stay in recovery

would counterbalance that, and then, of course,

providing incentives to avoid resolution would

also be a factor.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 So just briefly on that. I want to talk

a little bit about the differences between DCOs

and banks. As far as resolution planning is

concerned, you know, I mentioned earlier the

living will process is not applicable to DCOs, but

the recovery process in which the CFTC and the

FDIC have been engaging in I think will be very

helpful to the FDIC in it's resolution planning.

You know, the first issue, of course, is

understanding the company, and we've had the

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 1 benefit of working with the CFTC. We are actually

mentioned in their recovery plan rules, which we

greatly appreciate.

 2 

 3 

 4 If I can go off topic for a second, it's

kind of Ironic that pursuant to the statute in

Title 2, there's really no legal reason for having

the CFTC involved in a DCO resolution. But I

thin, you know, at the FDIC we would realize that

we were fools if we did not partner with them

every step of the way in the resolution, and, you

know, we're very fortunate to have a good working

relationship now to help us build resolution plans

so we would have an idea of where to start if this

ever came about.

 5 

 6 

 7 

 8 

 9 

 10 

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 12 

 13 

 14 

 15 So the resolution planning is a little

different, but I think the result will be the

same. But, you know, obviously, the big

difference between DCOs and banks in resolution

planning is the loss absorbing capacity.

 16 

 17 

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 19 

 20 Banks by their nature, bank holding

companies issue a lot of long-term debt, are

required to have TLAC now, and, you know, where

 21 

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 1 the losses fall is much clearer in the banking

industry. You know, from a resolution

perspective, it would certainly be better that

DCOs had more loss absorbing capacity. Obviously,

the impact on business as usual clearing costs are

a factor there.

 2 

 3 

 4 

 5 

 6 

 7 So I think those are the, the primary

 8 differences.

 9 MR. WASSERMAN: Again, one would note

that, (inaudible) called TLAC, in fact, CCPs do

have some very significant loss absorbing

capacity. Specifically, the cover two pre funded

guarantee fund is a very important part of loss

absorbing capacity as are cash calls, and, indeed,

to the extent one looks at it as a subordination,

the gains based haircutting is as well loss

absorbing capacity.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 And so there is, you know, I've

sometimes been of the view, especially when we

look at things like the pre funded guarantee fund,

that actually TLAC is actually something that

almost started with CCPs because that kind of

 19 

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 1 mutualized default resource is something that

 2 we've had, you know, for many, many decades.

 3 MR. BANDMAN: Just to add to that. I

mean, some ways you can look at a CCP as 100

percent TLAC. You know, it's there completely to

provide loss absorbing capacity and mutualization.

 4 

 5 

 6 

 7 And there is another consideration

present with regard to CCPs where it's a bit

different from a bank in that their fundamental

characteristic is that, you know, the CCP, you

know, it does, there is risk in a CCP. It's job

is, you know, it's job is managing risk as opposed

to taking on risk because it has directional

positions.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 And, you know, to be balanced against

the question of, you know, kind of how much loss

absorbing capacity should there be in a CCP, and

who should provide it, you know, there's a kind of

a moral hazard issue where those who are

introducing the risk, you know, can, you know, it

needs to be looked at that they are the ones who

are bearing the risk of loss. And if an entity

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 1 that's the one introducing the risk is the one

that's going to be the one that absorbs the

losses, then you have to look at what incentives

that creates for the parties that are taking the

risk in the market, which are a bit different from

the CCP.

 2 

 3 

 4 

 5 

 6 

 7 MR. STARKE: But, Bob, just to be fair,

I was talking about loss absorbing capacity in

resolution, and to the extent you use a cash call

and recovery that's not loss absorbing for a

resolution. Honestly, if it's retained for the

resolution authority, that does have resources.

 8 

 9 

 10 

 11 

 12 

 13 MR. WASSERMAN: I just want to

reemphasize something we discussed before, which

is that the importance of continuity of critical

functions, and given the time scale that DCOs and

other CCPs operate under, which is to say needing

to operate literally every business day, that

emphasize the need for the very excellent

cooperation that we've had between ourselves and

our FDIC colleagues, because it is critical that

you're almost basically taking the controls while

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 1 the plane's still in the air. And, happily,

there's been, as I think we've demonstrated here

today, significant cooperation, coordination, to

allow that to happen if ever, heaven prevent, we

needed to.

 2 

 3 

 4 

 5 

 6 MR. HELD: So I guess I'll end on the,

congratulating ourselves on our regulatory

cooperation. I mean, it's very important for the

FDIC both in planning for the failure of a DCO,

and in our planning on, for the failure of a GSIB

itself. Because continuity of services from the

DCOs is vital to make sure that they will continue

in resolution for a GSIB, and then working on the

failure of a CCP which is, you know, is very

difficult, (inaudible) to the bank resolutions.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 And on information sharing, the recovery

plans that the DCOs are preparing now act as

really our window into the operations of the

companies just like the living wills do on the

banks.

 17 

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 20 

 21 MR. STEIGERWALD: It seems that this

 22 would be an opportunity for members of the
 142

 1 committee to ask questions, and I see we have one

 2 down here.

 3 MR. LEWIS: Two questions. One sort of

bureaucratic. Is the team in FDIC that is working

on the DCO resolution process the same that is

looking at how an FCM would be treated in a bank

resolution process?

 4 

 5 

 6 

 7 

 8 And the more general question is just to

get very precise about whether FDIC has a view on

this, would it be expected that a bank going down

would have transferred, would have ported its FCM

customers prior to it reaching the resolution

phase? Or is it envisioned that the, that that

would happen in resolution?

 9 

 10 

 11 

 12 

 13 

 14 

 15 Obviously, the timing of examples of FCM

problems have never reached to the scale of a

systemically important bank. And if the answer is

you haven't, that why I'm just curious. 

 16 

 17 

 18 

 19 MR. HELD: So all resolution planning

would be under my section. So we do both the

banks and the DCOs. Whether its clients would be

ported prior to resolution or after I think would

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 1 depend on the circumstances. You know, if you

have a GSIB that's in trouble, and kind of slowly

deteriorates, then they may be selling off

valuable parts of the company in order to raise

capital and reduce their asset size.

 2 

 3 

 4 

 5 

 6 Things happen very quickly. It's

probably not be able to happen, and we'll have to

deal with the customers in resolution.

 7 

 8 

 9 MR. WASSERMAN: I guess I would note

though to the extent that the FDIC comes in with

the single point of entry at the top and keeps the

FCM operating, then it seems to me there would not

be, again, there would not be an FCM failure, and,

thus, not necessarily a need to transfer anyone,

assuming, again, the decision is to keep the FCM

operating.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 If the FCM were to be subject, on the

other hand, to liquidation, then under Title 2,

the relevant proportion, the relevant provisions,

excuse me, of Sub Chapter of the commodity broker

provisions would be applicable.

 18 

 19 

 20 

 21 

 22 MR. STARKE: Well, and, of course, the
 144

 1 possibility that companies that are subsidiaries

of company and receivership would self liquidate

is fairly great. But I would think there would be

less benefit to assuming that portability had

already taken place for our planning purposes. If

it has, I think that's great, but I think we'd

want to plan --

 2 

 3 

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 7 

 8 MR. LEWIS: What do the living wills

suggest, if that's public? Do they, because they

must address that in terms of the approach that

the banks will take.

 9 

 10 

 11 

 12 MR. STARKE: In general, they talk about

solvent wind down in bankruptcy for their broker

dealers and FCMs. So they basically are thinking

that customers are going to want to move their

accounts, and that they're not going to be engaged

in new business, so it's a matter of how quickly

can they either sell the customer base, or arrange

to have the customers ported to another

institution.

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 21 MR. STEIGERWALD: Kim?

 22 MS. TAYLOR: Thank you, gentlemen, for
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 1 your discussion today. I was glad to hear,

actually, anytime a regulator or a potential

resolution authority acknowledge that it's

important for a resolution not to preempt

recovery, and it's also important for a resolution

not to create incentives that undermine recovery.

I think those are good statements to hear.

 2 

 3 

 4 

 5 

 6 

 7 

 8 I do have a question and a, I guess your

key process. It looks like in Title 2, there was a

provision made for the entities that are subject

to Title 2 to have the primary supervisor of those

entities participate in the decision about putting

those entities into resolution.

 9 

 10 

 11 

 12 

 13 

 14 And so the SEC is there if it's a broker

dealer, the insurance authorities are there if

it's an insurance company, and the Federal Reserve

is there if it's a bank. But if this process were

intended to apply to CCPs, it seems that there's a

very important branch of that chart that includes

the CFTC that is missing, and I have a concern

about that on a couple of levels.

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 21 

 22 One is that it amounts to resolution
 146

 1 without representation, which is, you know, a

little bit un-American, but I also find that it is

resolution that's lacking kind of the balance of

power that would come from the primary

supervisor's view, and the potential resolution

authority's view, and it seems that in the other

cases there needs to be agreement, and it seems

that that protection is, is missing in this case,

which leads me to wonder if the, if Congress

actually intended this process to apply to CCPs

why the protection isn't there.

 2 

 3 

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 8 

 9 

 10 

 11 

 12 MR. STARKE: So there are so many things

that I've been led to wonder about since I started

reading Dodd-Frank. 

 13 

 14 

 15 Our analysis of the statute is a little

different, and I would make one correction. You

said the Fed was there because of bank holding

companies.

 16 

 17 

 18 

 19 The Fed's there because they're the Fed.

They're always there. So, and we think that's

just great.

 20 

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 22 But our analysis is that in the
 147

 1 insurance industry, and at the broker dealer

industry there are different resolution regimes.

You know, the state resolution for insurance

companies and SIPIC, and for those reasons, the

primary federal regulator was brought in.

 2 

 3 

 4 

 5 

 6 There are -- well, first of all, you

know, you don't have to be designated under Title

1 to be subject to Title 2. If the systemic asset

manager were to fail this Friday, they would be

put into Title 2 and the SEC would not be

involved.

 7 

 8 

 9 

 10 

 11 

 12 So I don't think it's a question of, you

know, having the primary federal regulator there.

It has to do with the insolvency regimes. But as

I said, I don't think the FDIC could be more

dedicated to working with the CFTC if it were, you

know, specifically in the statute. Clearly, they

need to be involved.

 13 

 14 

 15 

 16 

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 18 

 19 You know, at the end of the day, it's a

decision about financial stability, so the

condition of the CCP is a factor, but there are

others.

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 1 But I don't think Congress intended to

exclude CCPs because the CFTC was not a key

turner.

 2 

 3 

 4 MR. STEIGERWALD: Richard.

 5 MR. MILLER: Yeah. Yes, Robert. I have

more or less a question that was similar to Kim's

about the authority issue because I've noted

academic literature that has argued that

resolution authority does not apply to DCOs, and

I'm wondering if, Robert, you doing anything to

counter that argument in the atmospherics?

 6 

 7 

 8 

 9 

 10 

 11 

 12 MR. WASSERMAN: So I have noted some

academic literature myself. I've even noted

academic literature that says that Bankruptcy Code

does not apply to DCOs.

 13 

 14 

 15 

 16 First Amendment is very strong, and

folks are free to say whatever they want however

misguided it might be. And so I would note just

again for the record that it is very clear that

the Bankruptcy Code applies to DCO's. That they

fit very clearly within that statutory frame work.

 17 

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 19 

 20 

 21 

 22 Similarly, with respect to Title 2, and
 149

 1 we did not burden this group with a point-by-point

analysis of how you get there, but, basically, the

activities that DCOs and other CCPs undertake are,

in fact, financial in nature, and fit within the

various regulations that the Fed under 4K, and the

FDIC under, basically, Title 2 and somewhat

mimicking 4K did as financial in nature.

 2 

 3 

 4 

 5 

 6 

 7 

 8 And again, for those who say, well, wait

 9 a minute, though. There's nothing in Title

 10 that explicitly mentions DCOs, so how

could they be (inaudible), or even with a

structural argument, as Kim was referring to, but

as Pen noted before, when you look, and this time

we did get straight down to the subsection level,

210M mentions member property under Subchapter 4

of Chapter 7. Member property is solely relevant

to a clearing, a DCO, which is a commodity broker,

and so, in fact, there is, I think, a very clear

congressional intent that DCOs are, in fact,

eligible under Title 2, else they would not have

mentioned member property which doesn't apply to

anyone else in the world.

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 1 MR. STEIGERWALD: Thank you. Let me

 2 turn the discussion back to Petal.

 3 

 

 

 

 MS. WALKER: In keeping with our agenda,

I'd like to thank Robert Steigerwald for leading

the last two panels, and I'll turn to Commissioner

Bowen for closing remarks.

 4 

 5 

 6 

 7 COMMISSIONER BOWEN: This was a great

discussion, and I really do want to thank the

guest panelists today, particularly, the members

from the FDIC for coming today. It's a tough

topic, resolution. Preferably, we won't need it,

but it's best for us to plan for it in any event.

 8 

 9 

 10 

 11 

 12 

 13 But, Susan, thank you. I know Tom just

left. Want to thank Tom and the subcommittee for

all of your work. And Chairman, would you like

to say anything? Okay.

 14 

 15 

 16 

 17 With that, everyone travel safely, and

 18 thank you so much again.

 19 MS. WALKER: The meeting is adjourned.

MRAC members, you do have some paperwork, so if

you can submit those to me if you have it, that

will be great. Thank you.

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 1 (Whereupon, at 1:23 p.m., the

 2 PROCEEDINGS were adjourned.)

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

 public in and for the District of Columbia, do

 hereby certify that the forgoing PROCEEDING was

 duly recorded and thereafter reduced to print under

 my direction; that the witnesses were sworn to tell

 the truth under penalty of perjury; that said

 transcript is a true record of the testimony given

 by witnesses; that I am neither counsel for,

 related to, nor employed by any of the parties to

 the action in which this proceeding was called;

 and, furthermore, that I am not a relative or

 employee of any attorney or counsel employed by the

 parties hereto, nor financially or otherwise

 interested in the outcome of this action.

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 18

 19 (Signature and Seal on File)

 20 -----------------------------------

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 31, 2017