FINAL

 1 

 

 COMMODITY FUTURES TRADING COMMISSION 

 

 GLOBAL MARKETS ADVISORY COMMITTEE 

 

 MEETING 

 Wednesday, January 12, 2005 

 

 1:12 p.m. 

 

 First Floor Hearing Room 

 Three Lafayette Center 

 1155 21st Street, N.W. 

 Washington, D.C. 20581 
 2 

 

 PARTICIPANTS: 

 

 COMMISSIONER WALTER LUKKEN, Chairman 

 Global Markets Advisory Committee 

 

 SHARON BROWN-HRUSKA, Acting Chairman 

 Commodity Futures Trading Commission 

 

 COMMISSIONER FRED HATFIELD 

 Commodity Futures Trading Commission 

 

 COMMISSIONER MICHAEL DUNN 

 Commodity Futures Trading Commission 

 

 RANDAL QUARLES, Assistant Secretary 

 International Affairs 

 U.S. Treasury Department 

 

 AMBASSADOR PAUL SPELTZ 

 Secretary Snow's Emissary to China 

 U.S. Treasury Department 

 

 DAVID EBERSOLE, Senior Professional Staff 

 U.S. House Committee on Agriculture 

 

 ANDREW MORTON, Chief Economist 

 U.S. Senate Committee on Agriculture, 

 Nutrition and Forestry 

 

 RICHARD BERLIAND, Managing Director 

 Global Head of Futures and Options 

 J.P. Morgan Securities, Ltd. 

 

 ROBERT "BO" COLLINS, (Via telephone) 

 Former President 

 New York Mercantile Exchange 

 

 GEORGE CRAPPLE, Co-Chairman 

 Millburn Ridgefield Corporation 

 

 JOHN P. DAVIDSON III, Managing Director 

 Morgan Stanley 

 

 KEVIN DAVIS, Chairman and Chief Executive 

 Officer 

 Man Financial Inc. 
 3 

 

 PARTICIPANTS (CONTINUED): 

 

 MICHAEL DAWLEY, Chairman 

 Futures Industry Association 

 Vice President, Futures Product Head 

 Goldman, Sachs & Company 

 

 CRAIG DONOHUE, Chief Executive Officer 

 Chicago Mercantile Exchange 

 

 DENNIS DUTTERER, President and Chief 

 Executive Officer 

 The Clearing Corporation 

 

 CHARLES "HARRY" FALK, President and Chief 

 Executive Officer 

 New York Board of Trade 

 

 RON FILLER, Managing Director 

 Lehman Brothers 

 

 ARTHUR HAHN, Partner 

 Katten Muchin Zavis Rosenman 

 

 ROBERT KLEIN, Director and Associate General 

 Counsel 

 Citigroup Global Markets, Inc. 

 

 ROY LEIGHTON, Chairman 

 Futures and Options Association 

 UK Chairman, CALYON 

 

 BONNIE S. LITT, Managing Director, Associate 

 General Counsel 

 Goldman Sachs and Company 

 

 JOANNE MEDERO, Managing Director and General 

 Counsel 

 Barclays Global Investors 

 

 SATISH NANDAPURKAR, Chief Executive Officer 

 Eurex US 

 

 HONORABLE SUSAN M. PHILLIPS 

 Dean and Professor of Finance 

 The George Washington University 

 School of Business and Public Management 
 4 

 

 PARTICIPANTS (CONTINUED): 

 

 BOB PICKEL, Executive Director and Chief 

 Officer 

 International Swaps and Derivatives Association 

 

 ANNE POLASKI, (On behalf of Bernie Dan) 

 Assistant General Counsel 

 Chicago Board of Trade 

 

 DAN ROTH, President 

 National Futures Association 

 

 EMILY ZEIGLER, (Via telephone) 

 Partner 

 Willkie, Farr and Gallagher 
 5 

 

 C O N T E N T S 

 AGENDA ITEM PAGE 

 

 Call to Order and Introductions: 

 

 Walter Lukken 6 

 

 Sharon Brown-Hruska 10 

 

 Mike Dunn 15 

 Briefing by U.S. Treasury Department 

 Officials on Negotiations with China 

 Regarding Its Currency Regime: 

 

 Randal Quarles 17 

 

 Ambassador Paul Speltz 30 

 Briefing by Chicago Mercantile Exchange 

 Official on Negotiations with China 

 Regarding Its Currency Regime: 

 

 Craig Donohue 36 

 Presentation on Segregated/Secured Funds by 

 the GMAC Subcommittee on Bankruptcy: 

 

 Arthur Hahn 55 

 

 Dan Roth 59 

 

 John P. Davidson III 70 

 Update on the CFTC's Reauthorization by 

 House and Senate Staff: 

 

 Andrew Morton 91 

 

 David Ebersole 98 

 Adjournment 113 
 6 

 

 P R O C E E D I N G S 

 

 CALL TO ORDER AND INTRODUCTIONS 

 

 COMMISSIONER LUKKEN: If everybody 

 

 wouldn't mind taking their seats, we'll get 

 started. I wanted to welcome everyone to this 

 

 meeting of the Global Markets Advisory Committee, 

 

 or GMAC, as it's called. I'm Commissioner Walt 

 

 Lukken. I'm Chairman of the GMAC. 

 

 The Commission formed this Committee for 

 the express purpose of seeking industry input on 

 

 matters that impact the global derivatives 

 

 marketplace. Our agenda today certainly delivers on 

 

 that front and I look forward to a lively 

 

 discussion on those matters. 

 Before we get started, I would note that 

 

 since our last advisory meeting, the face of the 

 

 Commission has changed. I wanted to publicly 

 

 welcome Commissioners Fred Hatfield to my left and 

 

 Mike Dunn to my right to the Commission, and also 

 recognize Sharon Brown-Hruska who is our new, or 

 

 relatively new, Acting Chair since our last meeting. 

 

 In a moment, I'll turn it over to them to give some 
 7 

 

 opening comments, but I want to take this 

 

 opportunity to acknowledge the new look of the 

 

 Commission. 

 

 So that no one talks disparagingly about 

 them, I'd also note that a couple of our Committee 

 

 members are participating by phone. I believe we 

 

 have Emily Zeigler, George Crapple, and Bo Collins 

 

 on the line, and we welcome them, as well. 

 

 First on the agenda, I'm delighted to have 

 before us Assistant Secretary for International 

 

 Affairs of the U.S. Treasury Department Randy 

 

 Quarles. Secretary Quarles will outline for us the 

 

 state of U.S. negotiations with China regarding 

 

 progress towards a more flexible currency regime 

 and why such a change is important for the U.S., 

 

 China, and world economies. 

 

 I'm also thrilled to introduce Ambassador 

 

 Paul Speltz, who serves as Secretary Snow's 

 

 front-line emissary in China on these negotiations. 

 Both of these honored guests have been 

 

 strong advocates for our business in China and how 

 

 the derivatives markets, both on exchange and over- 
 8 

 

 the-counter, can facilitate China's transition to a 

 

 more flexible currency regime. I look forward to 

 

 their presentation and hearing from our members on 

 

 these issues. 

 We will also hear from the Chicago 

 

 Mercantile Exchange regarding their technical 

 

 assistance agreement with the Chinese government on 

 

 the development of the Chinese derivatives market. I 

 

 believe that private sector cooperation and 

 technical assistance will be the cornerstone of a 

 

 successful Chinese derivatives market and we look 

 

 forward to this discussion with CME and other 

 

 market participants who are engaged on these 

 

 issues. 

 Our second agenda item is a progress 

 

 report from our Subcommittee on Bankruptcy, which 

 

 was formed at our last meeting in June to analyze 

 

 the handling of customer funds. The current 

 

 segregated funds and secured account regime has 

 been in place for nearly 20 years without 

 

 significant reform or modification. It's 

 

 appropriate to review the adequacy of this system 
 9 

 

 in light of the global and interconnective nature 

 

 of our markets. 

 

 This group has the difficult task of 

 

 determining the most effective means for protecting 

 the financial integrity of our markets, firms, and 

 

 its customers, whether it is the current system or 

 

 a modification of that regime. I am pleased to 

 

 note that the Subcommittee has made sizeable 

 

 progress on these policy questions and I look 

 forward to hearing their update. 

 

 Lastly, our agenda includes an update from 

 

 staff of the Congress regarding CFTC 

 

 reauthorization. The authorization of the CFTC 

 

 expires in September and will require a statutory 

 renewal. Because the procedures of the House and 

 

 Senate are often thought to be as arcane as 

 

 derivatives trading, I have asked two veterans of 

 

 Capitol Hill, Andy Morton from the Senate 

 

 Agriculture Committee and Dave Ebersole from the 

 House Agriculture Committee, to help us make sense 

 

 of the process and to brief us on what we might 

 

 expect in the coming year. Because of the global 
 10 

 

 focus of this Committee, I would ask that any 

 

 comments or questions in this area focus on the 

 

 international side of the business. 

 

 With that outline before us, I would ask 

 our distinguished Acting Chair and other 

 

 Commissioners whether they have an opening comment 

 

 for the good of the order. Chairman? 

 

 CHAIRMAN BROWN-HRUSKA: Thank you very 

 

 much. It's a pleasure to be here today to take 

 part in this meeting of the Global Markets Advisory 

 

 Committee and I just want to thank and commend Walt 

 

 Lukken for his work organizing this exciting agenda 

 

 for today's meeting. The topics, I believe, touch 

 

 on some important areas of the global derivatives 

 industry, the importance of risk management to 

 

 international business and the economy, financial 

 

 and economic integrity, and the role of regulation 

 

 in the global marketplace. 

 

 There is no doubt that the derivatives 

 markets and markets in general are becoming more 

 

 global in nature. I've looked it up and found that 

 

 the value of world commercial services is $1.8 
 11 

 

 trillion and financial services represent a 

 

 significant component of that sector. 

 

 With that backdrop, we know that China's 

 

 progress towards a more flexible currency regime is 

 certainly among today's top issues in world trade 

 

 and in world business. In 2003, China's trade with 

 

 the world was valued at just over $851 billion. 

 

 Now, typically world trade is conducted amongst 

 

 industries and business in a floating currency 

 regime, though not in the case of China, as you 

 

 know, which has pegged its currency to the 

 

 U.S. dollar. 

 

 As a professor of international finance 

 

 before I became a Commissioner, I can tell you that 

 pegged currencies, when they're pegged across 

 disparate economies, can create significant 

 structural problems, including unsustainable 

 balances and painful welfare consequences, primarily 

 in the market of the undervalued currency. Our focus 

 is mainly on the impact in the international 

 

 trade perspective, but I think China is wise to 
 12 

 

 consider moving in the direction of a more flexible 

 

 regime. I would commend them for doing so, because 

 

 economic history suggests that they have a lot to 

 

 gain by moving in this direction, and I would again 

 commend Walt and the folks at Treasury who are here 

 

 today, Randy and Paul--thank you very much for 

 

 joining us--and others who are working towards a 

 

 more sensible currency regime in China. 

 

 As they move in that direction, I 

 know that they have to strive to provide businesses 

 

 and individuals with tools to deal with currency 

 

 risks, and hence futures, options, and 

 

 derivatives. These are the tools that really fit 

 

 the bill and we're happy to provide any expertise 

 that we have at the CFTC and that of our advisory 

 

 committees, as well, to help China in any way we 

 

 can as these markets develop. 

 

 As Chairman of the GMAC, once again, Walt 

 

 has done a tremendous job furthering this effort, 

 working closely with Treasury and Chinese officials 

 

 to help provide logistical support, guidance, and I 

 

 really look forward to the update and the 
 13 

 

 discussion we'll hear today on progress in that 

 

 area. 

 

 With respect to bankruptcy issues, I 

 

 believe that it is also very important for us to 

 understand the consequences of bankruptcy in an 

 

 international setting. It's going to be an 

 

 important issue in every aspect, I think. Whenever 

 

 we're considering new approaches, innovations in 

 

 our markets, we're seeing that bankruptcy is an 

 important issue for us to get our arms around, 

 

 especially if you want to see continued growth in 

 

 this sector, as we have. It's also timely in the 

 

 sense that we're seeing an ongoing development of 

 

 international clearing arrangements and a rising 

 desire of customers and firms to conduct business 

 

 in foreign financial centers. 

 

 And finally, we come to the issue of 

 

 reauthorization and I think the reauthorization of 

 

 2000 was historic in that it really opened up the 

 markets for international derivatives and the core 

 

 principles model of regulation that was enacted in 

 

 the Commodity Futures Modernization Act, 
 14 

 

 really provided a blueprint for regulation that 

 

 enables innovation and change in the global 

 

 marketplace. 

 

 Over the last decade, many changes have 

 come to the derivatives industry in an 

 

 international context and perhaps the greatest 

 

 being the shift to computerized trading, which has 

 

 raised global access and opportunities for the truly 

 global financial services industry. 

 

 So with the reauthorization process set to 

 

 begin, I think it's really timely that we ask this 

 

 question. Is the CEA flexible enough to deal with 

 

 today's global marketplace and changing needs of 

 business and investors? I look out at this 

 

 outstanding group of leaders in the derivatives 

 

 industry and otherwise that comprise the GMAC and I 

 

 certainly know that I can depend on you to focus on 

 

 this issue going forward. 

 Andy Morton, Dave Ebersole, thank you very 

 

 much for joining us and providing your expertise 

 

 and your insight in the legislative sphere and I 
 15 

 

 really look forward to all of your remarks today. 

 

 I again thank you very much for coming and 

 

 participating. 

 

 COMMISSIONER LUKKEN: Mike, do you have 

 any comments for the group? 

 

 COMMISSIONER DUNN: Thank you very much, 

 

 Walt. I'll be very, very brief. I must say that I 

 

 am very pleased to be here today, and I feel 

 

 especially fortunate to be able to attend this type 

 of forum so early in my tenure here on the 

 

 Commission. The increasing globalization of our 

 markets and their participants will continue to 

 raise interesting and significant issues for the 

 Commission, and I very much look forward to the 

 discussion and deliberation that will take place 

 here today. 

 

 Advisory Committee meetings with the 

 

 Commission are an extremely important aspect of 

 

 getting information to the Commissioners. The 

 input that you give is going to certainly have an 

 

 impact on all of us. I've been told that these 

 

 debates can get very lively at times, and I 
 16 

 

 certainly look forward to taking part in that and, 

 

 for the most part, observing. 

 

 I'd like to especially thank Commissioner 

 

 Lukken for putting together an excellent agenda. I 

 would also like to thank our guests from Treasury 

 

 and from the Hill that are here today to help 

 

 inform us, and thank each and every one of you for 

 

 taking the time to work with the Commission. I 

 

 look forward to this discussion. 

 COMMISSIONER LUKKEN: Thank you, Mike. 

 

 Fred? 

 

 COMMISSIONER HATFIELD: I'd also like to 

 

 commend Commissioner Lukken and the Committee for 

 

 the important work that they've done and are doing. 

 I'm very happy to be here, to have joined the 

 

 Commission. A month ago, Mike and I joined. I 

 

 have known some of you for a very long time and 

 

 some of you I've known about 30 minutes. 

 

 [Laughter.] 

 COMMISSIONER HATFIELD: I look forward to 

 

 meeting the rest of you, hopefully a little later 

 

 this afternoon. But I also want to again commend 
 17 

 

 the Committee for the work that it's doing and to 

 

 welcome our guests and turn it back to you, 

 

 Commissioner Lukken. 

 

 COMMISSIONER LUKKEN: Thank you. Just as 

 a matter of technical assistance, please, as you 

 

 speak, turn on the mike, and when you stop 

 

 speaking, turn it off so that others might be able 

 

 to speak. We're updating our mikes soon, 

 

 so we'll be rid of these things shortly. But I 

 just want to remind folks of that. 

 

 With no further adieu, I'll turn it over 

 

 to Assistant Secretary Quarles to update us. Thank 

 

 you so much. 

 

 BRIEFING BY U.S. TREASURY DEPARTMENT OFFICIALS 

 ON NEGOTIATIONS WITH CHINA 

 

 REGARDING ITS CURRENCY REGIME 

 

 MR. QUARLES: Thanks, Walt, and thanks to 

 

 the Commission. I really appreciate the 

 

 opportunity to be here today to discuss the China 

 issue from the Treasury perspective and 

 

 particularly the role that the financial sector 

 

 plays in the matters that we've been discussing 
 18 

 

 with China. 

 

 And just to begin from first principles, 

 

 very briefly, the underlying principle for the 

 

 administration's international economic policy has 

 been to try to increase growth around the world. 

 

 Rapid economic growth at full potential is the most 

 

 effective way of creating jobs, of raising income, 

 

 the best way of pulling countries out of poverty. 

 

 So if there is one principle that everything would 

 fall under, it would be that of increasing economic 

 

 growth, and so in that regard, the very rapid 

 

 growth of the Chinese economy and its increasing 

 

 integration into the international financial system 

 

 and the world trading system is a continuing 

 success and an opportunity for everyone. 

 

 Chinese growth has been a major source of 

 

 support for world economic growth in the last few 

 

 years. I think in 2003, China and the United 

 

 States together accounted for half of the world's 

 growth. 

 

 Now, sustaining China's growth in the 

 

 future is going to depend on a number of things, 
 19 

 

 but among the most important is the creation of a 

 

 modern and efficient Chinese financial system. The 

 

 empirical evidence that links an efficient 

 

 financial sector with economic growth is quite 

 strong. A number of studies indicate this, I 

 

 perhaps most notably a fairly rigorously done World 

 

 Bank study from not too long ago. 

 

 But in China, that link is likely to be 

 

 especially true in the future as the sources of 

 growth in China shift away from dependence on 

 

 increased capital and labor inputs towards reliance 

 

 on productivity increases and increases in total 

 

 factor productivity. An efficient financial system 

 

 is an integral part of ensuring that resources flow 

 to the sectors where they can be used most 

 

 productively and profitably, and in China's 

 

 transition from a command economy, where the risks 

 

 were all socialized, to a more market and private 

 

 sector oriented one, creating instruments for 

 businesses to manage risk is going to be crucial. 

 

 Foreign expertise can and should play a 

 

 crucial role in the development of China's 
 20 

 

 financial sector. Foreign firms can assist China 

 

 in developing its capital markets, its financial 

 

 institutions, its financial instruments and trading 

 

 systems that are needed to modernize its economy 

 and to support its currency reform. Foreign firms 

 

 are important sources of new capital. They're 

 

 important sources of management expertise. They're 

 

 important sources of risk management systems and 

 

 technology. 

 So an integral aspect, in our view, of 

 

 China's financial sector development is going to be 

 

 to open the sector up to foreign competition, both 

 

 by allowing majority-owned affiliates and by 

 

 expanding the scope of products that firms can 

 offer. For example, foreign firms can't establish 

 

 wholly-owned securities operations in China. 

 

 They're still limited to a 33 percent stake in a 

 

 Chinese firm. Asset management firms are capped at 

 

 49 percent. And moreover, current regulations 

 forbid securities dealers from dealing in 

 

 derivatives products. 

 

 So expanding foreign firms' access to 
 21 

 

 China's securities markets and banking sector 

 

 should encourage competition, should introduce 

 

 better products in financial services, including 

 

 foreign exchange. We're encouraging China to open 

 these sectors. 

 

 Some of the recent steps that are 

 

 important in this financial sector and capital 

 

 market reform, China's been allowing foreign non-bank auto 

 

 finance companies to extend auto loans. 

 They've approved over 60 foreign banks and 

 

 financial institutions to provide REMNIMBI products 

 

 and services to Chinese companies. They're 

 

 permitting about 25 foreign institutions to invest 

 

 in Chinese capital markets. I think everyone here 

 is familiar with the fact that Goldman Sachs 

 

 recently was permitted to acquire a controlling 

 

 stake in a domestic Chinese securities firm. That 

 

 may be a one-off transaction, but it does 

 

 demonstrate foreign involvement in China's 

 securities business. UBS has acquired a 49 percent 

 

 stake in a Chinese fund management company. That 

 

 was the first in China. Others are expected to follow. 
 22 

 

 Foreign regulators play an important role 

 

 in this process in sharing their expertise and 

 

 developing regulations and supervisory skills for 

 

 the Chinese, and certainly the Treasury has been 

 very appreciative of the technical assistance and 

 

 training that the CFTC has given to China, in part 

 

 because--in no small part because of the important 

 

 role that the increased availability of derivatives 

 

 products will play in China's currency reform. 

 A well-supervised and well-capitalized, 

 

 well-managed domestic banking system is also 

 

 important to ensure that removing controls on 

 

 capital flows and interest rates is done in a 

 

 manner that safeguards financial stability, and all 

 of this, as well, is integral to the Chinese 

 

 understanding of their currency reform. 

 

 So some steps, some recent steps, at 

 

 least, that the Chinese have made to their banking 

 

 sector reform, they've restructured state-owned 

 commercial banks to attract strategic investors to 

 

 prepare for public listing. There's a focus on 

 

 capital adequacy addressing non-performing loans. 
 23 

 

 Simplifying the procedures for disposal of the 

 

 large number of non-performing assets. Reforming 

 

 the ceiling on bank lending rates, again, moving to 

 

 a more market-oriented system for determining the 

 pricing of credit. And foreign banks continue to 

 

 invest in Chinese banks. 

 

 Now, with that background, let me say a 

 

 few words about the Chinese currency reform. The 

 

 Chinese authorities have clearly stated their goal 

 of moving towards a market-based and flexible 

 

 exchange rate regime. It's for a variety of 

 

 reasons, as Sharon mentioned at the outset. It's 

 

 in the Chinese interest. A more flexible exchange 

 

 rate regime gives China much better control over 

 its own monetary policy, strengthens its tools for 

 

 macroeconomic management to ensure sustained 

 

 economic growth, which again is the overarching 

 

 principle that at the Treasury we're trying to 

 

 promote. 

 The Chinese officials have stressed that 

 

 an important element of their efforts to move to a 

 

 more flexible regime is the development of the 
 24 

 

 infrastructure of foreign exchange trading, 

 

 including the development of FOREX options, futures 

 

 markets that allow firms to manage foreign exchange 

 

 risks. And connected with that is the development 

 of internal controls on foreign exchange exposure 

 

 and the supervision of foreign exchange rates. 

 

 But China's taking measures to expand 

 

 permissible capital transactions in order to 

 

 increase the liquidity of foreign exchange markets, 

 making them more efficient at transmitting price 

 

 signals. 

 

 Some of the steps that China has recently 

 

 taken to liberalize the capital account. One, they 

 

 allowed their national social security fund and 

 domestic insurance companies to invest in overseas 

 

 financial markets. They are permitting residents 

 

 to transfer assets abroad and business travelers 

 

 and students to take more money out of China. 

 

 They're allowing for qualified--there are certain 

 standards that have to be met, tests that have to 

 

 be met, but qualified foreign and domestic 

 

 institutional investors to transfer funds more 
 25 

 

 easily into and out of China. 

 

 Over 25 foreign firms have a qualified 

 

 foreign investor, institutional investor license 

 

 that they can invest in Chinese securities, and we 

 understand that the qualified domestic investor 

 

 program is still under study, but that will allow 

 

 Chinese companies to invest in foreign markets and 

 

 they are committed to moving forward with that. 

 

 Recently, over 20 foreign banks and financial 

 institutions have been granted permission to 

 

 conduct foreign exchange derivative business in 

 

 China and there are efforts to work with U.S. 

 

 exchanges to develop trading systems and financial 

 

 instruments in China. 

 So--and all of this, again, is central to 

 

 what is their stated goal of currency reform, the 

 

 view that ultimately a more--that a regime that 

 

 permits a freer flow of capital is necessary for a 

 

 more flexible currency regime actually to 

 appropriately price the currency and that to allow 

 

 the freer flow of capital, you have to have a 

 

 strengthened banking and financial sector to avoid 
 26 

 

 weakening that sector as capital is allowed to more 

 

 freely leave the country. 

 

 We've been heavily engaged with China on 

 

 this entire range of issues, including the 

 financial sector development. We've developed and 

 

 implement, I guess, a three-leg or three-pillar 

 

 program of financial diplomacy with the Chinese on 

 

 these issues. 

 

 First is our own bilateral engagement, 

 which I think has been very active, as most people 

 

 around this table will know. We've had talks at 

 

 senior levels from the Secretary on down with the 

 

 Chinese and again at very senior levels with the 

 

 Chinese on a range of economic policy issues with 

 exchange rates at the heart of the discussion. 

 

 There were Joint Economic Commission 

 

 meetings in September in association with the World 

 

 Bank and IMF meetings that were led by Secretary 

 

 Snow and Chairman Greenspan. Those meetings 

 included senior financial and securities market 

 

 regulators. The CFTC was there. They were 

 

 extremely central participants in these talks for 
 27 

 

 the reasons that we've outlined today, because of 

 

 the importance of these issues in the Chinese 

 

 consideration of their movement toward currency 

 

 reform. Ambassador Speltz continues his 

 substantive talks on these matters regularly with 

 

 the Chinese on the ground in the area and he'll 

 

 make a few remarks about his activities shortly. 

 

 On the multilateral front, we've broadened 

 

 our engagement with the Chinese in a number of 

 fora, most particularly, I think perhaps most 

 

 importantly, the G-7. For some time now, and most 

 

 of you, I think, are familiar with the G-7 process, 

 

 the so-called G-7 deputies, the vice finance 

 

 ministers of the G-7 countries, they meet very 

 regularly, and for some time now they have invited 

 

 to at least a portion of their meetings the Chinese 

 

 vice finance minister. 

 

 At the most recent meeting at the 

 

 ministerial level, the Chinese finance minister and 

 central bank governor were invited and they will be 

 

 invited again to the ministerial in London. While 

 

 they don't participate in the entire meetings, this 
 28 

 

 is an opportunity for the G-7 and the major 

 

 economic powers of the world to engage with China, 

 

 again, on this full range of economic issues that 

 

 are associated with the integration of China into 

 the world financial system. 

 

 We've also stressed these issues in our 

 

 discussions in APEC, the Asian Pacific Economic 

 

 Cooperation Group, in the G-20, which is the group 

 

 of developed and major emerging market countries. 

 And then, as well, at the technical level, 

 

 where we've had our senior bilateral contacts, we 

 

 have our multilateral contacts and at the technical 

 

 level, we recognize the need to assist China to 

 

 develop its financial infrastructure as part of 

 this entire program and therefore the Treasury, 

 

 with the assistance of our regulatory colleagues, 

 

 has been engaging in technical meetings with the 

 

 Chinese to identify and overcome obstacles to 

 

 moving forward along this path. 

 We've been very busy in that respect. We 

 

 set up a technical cooperation group that has had 

 

 meetings to assist them in discussions about 
 29 

 

 supervising banks for an exchange risk, developing 

 

 FOREX derivatives. Thanks again to the CFTC for 

 

 participating. Later in the course of last year, 

 

 we had meetings on focusing on the banking sector 

 and banking supervision, resolution of 

 

 non-performing assets. In September, the Chinese 

 

 central bank officials came to Washington to learn 

 

 more about official foreign exchange management, 

 

 supervision and regulation of a currency 

 derivatives market, and we really have greatly 

 

 appreciated the exceptional contributions of Walt 

 

 and the talented team at the CFTC for its program 

 

 focused on the factors needed for a successful 

 

 derivatives market. 

 So going forward, we're going to be 

 

 continuing moving in all three of these pillars. 

 

 We'll continue our high-level substantive 

 

 discussions with the Chinese financial leadership. 

 

 We are preparing now our action plan for this 

 technical cooperation group for 2005 that addresses 

 

 the futures markets and other practical aspects of 

 

 exchange rate flexibility. We are encouraging the 
 30 

 

 Chinese to take steps to expand their spot and 

 

 futures trading, developing of FOREX futures 

 

 markets, and encouraging more access to foreign 

 

 firms in these markets, and those are discussions, 

 as well, that are happening in the multilateral 

 

 arena. 

 

 So with those remarks, I'd like to turn 

 

 now to Ambassador Speltz, who is, as Walt noted at 

 

 the outset, Secretary Snow's emissary to Beijing, 

 to talk about some of his work. 

 

 AMBASSADOR SPELTZ: Thank you. Thank you, 

 

 Randy. I'd also like to thank the GMAC Committee 

 

 and also thank you, Walt, and your staff, for 

 

 putting on a very instructive program for the PBOC 

 SAFE in mid-September. They're still talking about 

 

 it. Actually, if you're not careful, I think 

 

 they'll come back here and spend a lot of time here 

 

 with you guys. 

 

 I think Randy has really covered this 

 topic very comprehensively, but I would just like 

 

 to add a few notes. I welcome the opportunity to 

 

 talk briefly about my role as the Secretary's 
 31 

 

 emissary, and most importantly is to stress the 

 

 important role that the private sector financial 

 

 firms play in China. 

 

 Since being appointed President Snow's 

 [sic] emissary to China in April of last year, I've 

 

 been engaged with the Chinese senior economic 

 

 leaders on a range of priority issues of financial 

 

 and economic importance to the Treasury Secretary 

 

 and the administration. In addition to my ongoing 

 consultation with central bank and finance ministry 

 

 officials, I meet with the banking, the CBRC, and 

 

 securities regulators, the CSRC, as well as 

 

 officials from the Chinese exchanges, both Shanghai 

 

 stock and futures exchanges, and other financial 

 organizations. I also work closely with many of 

 

 you who are in this room in terms of your 

 

 colleagues. I looked at the list of attendees and 

 

 I think this is what I call a pretty China-savvy 

 

 group that's sitting around here. 

 This important aspect of my work in China 

 

 is--what I'd really like to spend a lot of time on 

 

 is comparing notes with and meeting with foreign 
 32 

 

 and U.S. financial institutions who are operating 

 

 in China, on the ground in China, and by the way, 

 

 China, I'm talking across the board, Beijing, 

 

 Shanghai, Hong Kong, banks, investment firms, 

 manufacturing companies. It helps, I think, both 

 

 of us, from your side and from our side, in gaining 

 

 valuable insight into your experiences and 

 

 challenges and helps form our financial dialogue 

 

 with the Chinese, and I think it does another 

 thing, too. It shows a very positive collective 

 

 action when we're talking with the Chinese, that 

 

 they do see that we're trying to sing from the same 

 

 song sheet in terms of getting things accomplished. 

 

 As Randy noted, while Chinese recognizes 

 its need and is very interested in our discussions 

 

 to create ways to hedge its foreign exchange risks 

 

 through financial derivatives products, it is also, 

 

 and we have to be very honest here, very wary of 

 

 moving too fast, especially in view of the fraud 

 and manipulational scandals that have plagued 

 

 China's futures markets in the early 1990s. The 

 

 Chinese government understands the need to closely 
 33 

 

 monitor these markets to prevent more of these 

 

 kinds of abuses and, of course, as is well known by 

 

 all of you, transparency, accountability, is an 

 

 integral part of this process and all aspects of 

 it. 

 

 I think one of the major things that's 

 

 going on that we all understand is that as far as 

 

 the Chinese are concerned as they take a look at 

 

 this, they're looking at it also from a Chinese 

 historical perspective and fear of the unknown is a 

 

 major factor for them, and what that leads to is a 

 

 fear of social instability. So it may seem very 

 

 strange, but taking a look at financial matters, 

 

 taking a look at currency matters and all the rest, 

 it goes right back down to the whole point of 

 

 what's going to happen in the future and what will 

 

 happen with their social stability. 

 

 The caution in terms of what they're doing 

 

 was only further validated by the recent futures 

 trading scandal involving Chinese Aviation's oil 

 

 subsidiary in Singapore that, as you all know, led 

 

 to loss of at least $550 million. 
 34 

 

 I wish to also underscore Randy's point 

 

 that the U.S. securities firms and the U.S. 

 

 exchanges can and is, from my point of view, making 

 

 a very positive contribution to developing and 

 improving the performance of China's capital 

 

 markets, including the futures markets. Randy 

 

 mentioned the market access issues of foreign 

 

 security firms, which is the focus of my efforts as 

 

 well as in meetings with the securities regulators. 

 We also raised this issue during recent meetings in 

 

 Washington in September. 

 

 I am optimistic. One has to be, working 

 

 in China. 

 

 [Laughter.] 

 AMBASSADOR SPELTZ: I am optimistic that 

 

 China's leadership understands that what it needs 

 

 to do is to develop a modern market-based financial 

 

 system. They've said it, and they've said it many 

 

 times. They don't want to go backwards. They want 

 to go forward. And they understand the need for 

 

 sustaining what they're doing. 

 

 In my role, I look forward to continuing 
 35 

 

 our productive relationship with China as it moves 

 

 to reform its banks, its capital markets, its 

 

 regulatory systems and currency regime. I also 

 

 look forward to continuing to work closely with 

 many of you who are here in the room and your 

 

 colleagues in Hong Kong and in China and have the 

 

 ability to contribute to this process. 

 

 I'd be very happy to hear about some of 

 

 the business experience you have and just want to 

 check with Randy on one note. This was in the 

 

 newspaper. 

 

 MR. QUARLES: Okay. 

 

 AMBASSADOR SPELTZ: Randy and I do check 

 

 on a few things here. 

 [Laughter.] 

 

 AMBASSADOR SPELTZ: Sensitive subject. 

 

 One thing I just want to note, Randy mentioned the 

 

 point about the G-7. I think that some of you have 

 

 seen it already and I think it is being announced 

 that the Chinese have noted their intention to 

 

 attend the G-7 in London in line with the 

 

 methodology that they used here in their attendance 
 36 

 

 in October in Washington, D.C. To me, that shows a 

 

 continuing signal of their seriousness to stay 

 

 engaged on a global basis and I think that's a very 

 

 good sign. Thank you. 

 COMMISSIONER LUKKEN: Thank you very much, 

 

 both of you, for your presentations. I think 

 

 they’ve raised a lot of questions among the 

 

 group, but before we launch into some questions, 

 

 I'd like to turn it over to CME. You 

 mentioned private sector cooperation and CME has 

 

 been on the forefront on that issue of trying to 

 

 help China develop their derivatives markets from a 

 

 private sector perspective. So I'll let Craig take 

 

 over from here. 

 BRIEFING BY CHICAGO MERCANTILE EXCHANGE OFFICIAL 

 

 ON NEGOTIATIONS WITH CHINA 

 

 REGARDING ITS CURRENCY REGIME 

 

 MR. DONOHUE: Walt, thank you, and thank 

 

 you to your colleagues for inviting us to talk 

 about China and some of the work that we're doing. 

 

 Before I begin, I want to make a special 

 

 thank you to Ambassador Speltz and Secretary 
 37 

 

 Quarles because, as you'll hear from me in just a 

 

 moment, I think the work that they're doing is 

 

 absolutely critical to the long-term success for 

 

 our industry in China as China does emerge and as 

 it does ultimately over time develop, I think, very 

 

 significant and robust derivative markets. 

 

 Having now spent a fair amount of time in 

 

 China and trying to understand the landscape there 

 

 and what's happening, sort of reflecting on your 

 comment about having to be patient, I feel bipolar 

 

 and schizophrenic whenever we talk about China 

 

 because, on the one hand, there's no question that 

 

 it is a huge and emerging marketplace, and there's 

 

 no question that over time they will successfully 

 develop their derivatives markets. 

 

 But one of the things that I've learned in 

 

 the process is that I think it's sort of 

 

 Pollyannaish to think that all they need from us is 

 

 to understand how to successfully develop 

 derivative products, how to establish the critical 

 

 market infrastructure for derivatives trading, risk 

 

 management, and market regulation and supervision, 
 38 

 

 and what I mean by that is that as we've all 

 

 learned in building these markets successfully in 

 

 North America and in Europe, recognize that you can 

 

 only have very strong and successful derivative 

 markets if you have very strong, well structured, 

 

 well regulated underlying cash markets. 

 

 As you begin to understand the true 

 

 situation within China, whether you're examining 

 

 the way in which the cash equities market works or 

 the corporate bond market or the sovereign debt 

 

 market or even foreign exchange trading activity, 

 

 such as it exists within China, you realize that 

 

 many of the issues that they are facing are ones 

 

 that are very threshold kinds of issues and that 

 there's just an enormous amount of progress that 

 

 needs to happen apart from the derivative market 

 

 development and product development itself, simply 

 

 just sort of fundamental building blocks in the 

 

 underlying cash markets that really need to be 

 developed. 

 

 So I have personally a much more enhanced 

 

 appreciation for that. There's no question that 
 39 

 

 when you meet with market participants and market 

 

 practitioners within China, there's a tremendous 

 

 enthusiasm for the reemergence and development of 

 

 the derivative markets there. There's even, I 

 think, a great kind of competitive zeal among the 

 

 different players there. There's a competition 

 

 that exists, I think, between the Shanghai Stock 

 

 Exchange and the Shanghai Futures Exchange, to name 

 

 a couple. Even there's a sense that there's a sort 

 of competitive zeal among the regulators for who 

 

 will ultimately sort of control the oversight and 

 

 regulation function for the different kinds of 

 

 asset classes and products and markets that will 

 

 evolve. 

 While all of that is very exciting, when 

 

 you try to talk to people and understand what the 

 

 true state of play is and the true, you know, sort 

 

 of time line for the introduction of various of 

 

 these products, it's very difficult to gain a real 

 insight, I think, and understanding to what is 

 

 really likely to happen. Very few people in the 

 

 so-called private sector will really respond to 
 40 

 

 those kinds of questions. They'll normally defer 

 

 to the regulators, whether that's the CSRC or the 

 

 CBRC or what have you. Even when you address those 

 

 kinds of questions to them, there's a great 

 uncertainty about exactly when and how these 

 

 markets are going to start to develop and be 

 

 introduced again within China. 

 

 Therefore, having said all of that, the 

 

 primary focus and emphasis that we've had is really 

 on education and sharing of know-how and expertise 

 

 with respect to certainly what CME has done and 

 

 various other people here in this room have done 

 

 over the last 30 years to develop these markets 

 

 successfully and in a fashion that helps avoid some 

 of the historical problems that unfortunately have 

 

 occurred within China in their bond futures market 

 

 and other issues such as the one that the 

 

 Ambassador was talking about. 

 

 And so to do that, we've had a sort of 

 quasi partnership that has developed between CME 

 

 and the CSRC, and also I'll talk in a moment about 

 

 a couple of the other things that we're doing with 
 41 

 

 other players within China. But we've established 

 

 a program where we're bringing government 

 

 regulatory authorities to Chicago, giving them the 

 

 opportunity in conjunction with the University of 

 Illinois to understand derivative markets. They 

 

 have the opportunity to work with people with 

 

 expertise in different areas of CME, whether that's 

 

 the Market Regulation and Supervision Group or the 

 

 Electronic Trading Group and the Globex Control 

 Center or the clearinghouse and come to understand 

 

 how we do risk management in the clearinghouse. 

 

 And we are working with them to also adopt 

 

 some of the standards which most of the exchanges 

 

 and the derivatives markets have adopted over the 

 last 15 years, namely our SPAN system, and that's 

 

 been a very, very good program. We've had two 

 

 exchanges that have lasted for, if you want to call 

 

 them exchange programs, for a week or two each in 

 

 September and November, both of which were well 

 attended. 

 

 And then in May, we're going to be doing 

 

 something again jointly in conjunction with the 
 42 

 

 CSRC which is a symposium that is really oriented 

 

 less toward sort of market structure and market 

 

 regulation and risk management concepts and more 

 

 intended to help impart to people within China 

 basic understanding of the economic principles that 

 

 underlie derivative markets and why derivative 

 

 markets and risk transfer concepts are critical to 

 

 the development of a true sort of open capital 

 

 market. And so to do that, we'll be working with 

 the CSRC. We will have a number of important 

 

 economists who will be part of that process--Myron 

 

 Scholes, Gary Becker from the University of 

 

 Chicago, perhaps others, and I think that will be, 

 

 again, very helpful in this whole process of trying 

 to bring China along toward the kind of market that 

 

 we have here. 

 

 But there's truly much to be done. Just 

 

 in thinking about the development of stock index 

 

 futures markets, for example, a lot of the issues 

 that exist in the underlying cash market there in 

 

 terms of disclosure regime issues, accounting 

 

 standards issues, the fact that so many of the 
 43 

 

 companies there are really state-owned enterprises 

 

 in whole or in part and the dynamic that applies to 

 

 the way that disclosure is managed in that kind of 

 

 an environment and a whole host of other issues, 

 not the least of which is the inability to engage 

 

 in short selling in the cash market, give you a 

 

 sense of the challenges that I think exist before 

 

 you can actually successfully establish these stock 

 

 index futures markets. 

 Similarly, when you look again at the debt 

 

 markets and the foreign exchange markets, there's a 

 

 whole host of things like that that really need to 

 

 be addressed, so education is absolutely critical 

 

 and that's a big part of what we're trying to do. 

 We have--I just thought I would mention 

 

 two agreements that we've entered into with the 

 

 Shanghai Futures Exchange and with an organization 

 

 called CFETS, which is the Chinese Foreign Exchange 

 

 Trading System, both of which have a strong sort of 

 educational and knowledge-sharing component to it, 

 

 but also we're hopeful, and I won't comment 

 

 extensively on that, that we will also be able to 
 44 

 

 develop a commercial relationship as we continue to 

 

 work more closely with them. 

 

 I think Assistant Secretary Quarles said 

 

 it quite well. We, all of us in this room, can be 

 very helpful to emerging players in the Chinese 

 

 market because of the technologies that we've 

 

 developed, because of the critical mass of activity 

 

 that we have in our markets. One might think about 

 

 it as a good way for them to begin to learn the 

 ways in which they can successfully hedge and 

 

 transfer risk and use markets might be by looking 

 

 outside of China, at least in the initial instance, 

 

 to participate in these markets that are well 

 

 regulated, that do have basic sort of safety and 

 soundness features attendant to them, and maybe 

 

 that can be a way on which, over time, they can 

 

 successfully, as they certainly will develop their 

 

 own critical infrastructure markets. 

 

 I'd be happy to answer any questions. 

 That's essentially what we're doing. 

 

 COMMISSIONER LUKKEN: Thank you very much, 

 

 Craig. That's a great overview. 
 45 

 

 As Paul mentioned, I think a lot of people 

 

 around the room are China-savvy and probably have 

 

 some questions for the three of you on what you're 

 

 doing. I would note that the Treasury officials, 

 because this is a sensitive subject on a lot of 

 

 fronts, have the right to not answer certain 

 

 questions that you may ask. 

 

 [Laughter.] 

 

 COMMISSIONER LUKKEN: I'll just open it up 

 to the group. I certainly have some questions, but 

 

 first wanted to allow the market participants to 

 

 ask questions, if they have some, of the officials. 

 

 MR. FALK: I just want to go back one step 

 

 beyond where Craig was. He was talking about 

 undeveloped cash markets to support a futures 

 

 market. I'd like to ask the Ambassador if we feel 

 

 that the Chinese legal system has gotten to the 

 

 point where a foreign entity can get a fair shakes 

 

 in their courts, because one of the problems that 

 have occurred in the past have been where you 

 

 thought you might have Chinese government 

 

 guarantees and all sorts of things like that, and 
 46 

 

 when things go wrong, all of a sudden, it's not my 

 

 dog, so to speak. Before you sort of spend a lot 

 

 of money, I think a lot of us are looking at it and 

 

 saying, if things go wrong, do I have an equal 

 right to sort of claim against a Chinese entity. 

 

 COMMISSIONER LUKKEN: When 

 

 folks ask questions, if you wouldn't 

 

 mind identifying yourselves. I meant to go around 

 

 with introductions early on, but if you wouldn't 

 mind introducing yourself so everybody knows who's 

 

 speaking. 

 

 MR. FALK: Harry Falk, New York Board of 

 

 Trade. 

 

 AMBASSADOR SPELTZ: I think I'd say that's 

 a very fair question, and I think in anything--I'm 

 

 speaking personally--anything I'm doing in China, 

 

 I'm looking at it from a 25-year perspective. I 

 

 think you know very well that if you take a look at 

 

 what China has done in establishing a legal system 

 over the last 15 to 20 years, it's quite 

 

 remarkable. 

 

 Do they have a way to go? Absolutely. 
 47 

 

 But they're realizing that unless they set up very 

 

 transparent and very effective rules which are 

 

 going to protect the foreign direct investor, the 

 

 financial institutions, the banks, unless they do 

 that, they're the ones that are going to suffer. 

 

 So I tie the legal end of it also into the 

 

 assisting, as Randy was talking about assisting in 

 

 the fronts in China, and I think if anything, on 

 

 the legal side, there's been a great deal of work 

 that's been done over the last 20 years on 

 

 commercial law and other areas. 

 

 You raise a good point. It might be 

 

 something you want to take a look at in assisting 

 

 them a bit also on the financial structuring law, 

 especially if you get Craig working in groups and 

 

 things of that nature. That's a special law unto 

 

 itself. 

 

 MR. LEIGHTON: Walt, perhaps if--I'm Roy 

 

 Leighton. I'm the Chairman of the FOA. For those 

 who are not familiar with the FOA, it's the 

 

 European equivalent of the FIA here in the States, 

 

 but I'm also a practitioner. 
 48 

 

 I've been going to China since 1973, so 

 

 I've been doing business there for a long, long 

 

 time and seen lots of changes, and I thought it 

 

 might be helpful if we just told you what we're 

 doing in the U.K. in particular at the present 

 

 moment, because the FOA, following the visit of the 

 

 Chinese Premier, Wen Jiabao, to our Prime Minister 

 

 in the summer of last year, the U.K. offered 

 

 bilateral help in a number of areas, but 

 particularly one of them was the development of 

 

 financial services, and the Chinese asked for help 

 

 in the development of a corporate bond market with 

 

 associated financial derivatives. So we're talking 

 

 about interest rate derivatives rather than foreign 

 exchange, although we keep getting sucked into 

 

 equity derivatives, as well. But it's supposed to 

 

 be interest rate derivatives. 

 

 Now, at the moment, if you are a corporate 

 

 in China and you need more funding, your choices 

 are either to turn to the commercial banks to raise 

 

 equity, either on the domestic stock exchange or 

 

 internationally, or you look for a firm direct 
 49 

 

 investor. Plus, there are some corporate bonds. 

 

 Four percent of all bonds in issue in China are 

 

 called corporate bonds, but they're all bank 

 

 guaranteed by state-owned banks, so they're really 

 quasi sovereign bonds. 

 

 So we have embarked on this project at the 

 

 present time and the Chinese are very keen on this 

 

 also because it provides another investment product 

 

 as they look to develop a long-term savings 

 industry. So it's quite attractive. It also takes 

 

 some of the heat off their banks as they prepare 

 

 them for IPOs because it provides another source of 

 

 funding to corporate participants. It highlights 

 

 all the big issues about proper accounting, proper 

 corporate governance. There are rating agencies in 

 

 China, but they seem to give everything triple-A-- 

 

 [Laughter.] 

 

 MR. LEIGHTON: --so I don't think that one 

 

 has complete confidence that this is the way 

 forward. So one of the things that we have made a 

 

 big issue about is the development of proper rating 

 

 agencies to acceptable international standards. 
 50 

 

 And obviously, the parallel derivatives, 

 

 if this comes to pass, would have to be based on 

 

 government bonds as the sort of benchmark and they 

 

 don't have a complete yield curve profile in the 

 issuing maturities of their government bonds, so we 

 

 have said to them, you have to issue different 

 

 maturities. 

 

 We plan to come up with our report in May 

 

 of this year, the stage one of that report. I have 

 just been, in fact, in China with Paul Boating, our 

 

 Chief Financial Secretary, preparing for the 

 

 meetings in London and talked to Mr. Li Hong, who 

 

 is going to be representing the Chinese there. 

 

 So we feel quite positive about this. We 

 actually--we have strongly encouraged foreign 

 

 participation in their domestic markets, so all the 

 

 points that you were highlighting earlier, we are 

 

 completely signing the same tune. 

 

 It seems to me that they are quite willing 

 to vary permissions and allow additional 

 

 percentages. You put the caps on minority 

 

 shareholdings. But if you've got a good case, you 
 51 

 

 can actually get quite a number of things through 

 

 in their system. 

 

 COMMISSIONER LUKKEN: I wanted to ask Bob 

 

 Pickel, representative from ISDA--I know they've 

 been doing a lot of work in China--to sort of give 

 

 an overview of whether there's any legal 

 

 impediments that you've seen in China. I know we 

 

 talk a lot about legal certainty here in the United 

 

 States and still have the issue with legal 

 certainty on occasion. The Enron case that's 

 

 recently been in the news comes to mind. But if 

 

 you wouldn't mind talking a little bit about China 

 

 and what legal impediments there might be for the 

 

 over-the-counter derivatives market. 

 MR. PICKEL: Yes. The two areas of focus 

 

 that we have looked at in China have been the 

 

 regulations that Secretary Quarles mentioned 

 

 regarding derivatives licenses being granted, and 

 

 there are roughly two dozen banks, foreign banks, 

 that have applied for those licenses. That has 

 

 been a significant step forward. They've taken an 

 

 approach that is focused on putting in place good 
 52 

 

 risk management guidelines at the banks and, 

 

 frankly, allowing the banks a fair amount of leeway 

 

 to put things in place in the right way. So we 

 

 thought that was a very positive development. 

 It is a CBRC regulation, and as was 

 

 mentioned, that means that the securities firms 

 

 cannot engage in the same way that the banks can in 

 

 the derivatives business, and that's kind of the 

 

 next threshold. I think there's a question as to 

 whether the CSRC, the securities regulator, really 

 

 has the ability to grant the similar type of 

 

 exemptions, but that's something that I know that 

 

 the securities firms are quite interested in. We 

 

 are. I know that the SIA has been working with the 

 Treasury Department to raise some of those issues 

 

 or ask them to raise some of those issues in their 

 

 discussions with China. 

 

 The other thing that we always focus on is 

 

 the netting, the close-out netting provisions of 

 our master agreement. We have--our master 

 

 agreement is used in China. There is a Chinese 

 

 language version of it that has been floating 
 53 

 

 around. But still, the fundamental requirement is 

 

 that in the bankruptcy or the insolvency proceeding 

 

 regarding a Chinese entity, that the netting 

 

 provisions be enforced in the same way that they 

 are here in the States and in many other countries 

 

 around the world. 

 

 There is discussion of changes to the 

 

 bankruptcy law, the insolvency law, over in China. 

 

 We have prepared a paper that has been sent to the 

 authorities there laying out the questions that we 

 

 have regarding the current state of the law and 

 

 suggesting ways in which the bankruptcy law should 

 

 be changed to recognize closeout netting and find 

 

 that enforceable. We don't really have any clear 

 indication as to whether or when that would happen. 

 

 That kind of ties back to some of the comments made 

 

 before about you just have to be there and stay on 

 

 top of it and hope that at some place, things fall 

 

 into place, and we'll continue to work on that 

 front. 

 

 So those are the two areas of licensing 

 

 and also the netting provisions. 
 54 

 

 COMMISSIONER LUKKEN: Anybody else? 

 

 [No response.] 

 

 COMMISSIONER LUKKEN: Well, with that, I 

 

 thank our guests from Treasury for coming today. I 

 think what we're going to do, I think they're 

 

 taking off, so we might take a break right now to 

 

 have a cup of coffee and stretch our legs and if 

 

 anybody wants to talk to them before they take off, 

 

 now is the time. 

 Why don't we meet back here in ten minutes 

 

 and we'll start part two of the agenda. Thank you. 

 

 [Recess.] 

 

 COMMISSIONER LUKKEN: I think we're going 

 

 to try to get started. Let's go ahead and take a 

 seat and we'll get started. Let's go ahead and get 

 

 started on the rest of the agenda. 

 

 As I noted in the beginning of our 

 

 meeting, in June, at our first meeting of the modern 

 

 GMAC, we talked about looking at the secured/ 

 segregated funds issue and other relevant 

 

 bankruptcy issues on how customer funds are 

 

 handled. Art Hahn, thankfully, stepped forward to 
 55 

 

 chair that Subcommittee. We had a meeting this 

 

 morning and talked over the progress report of 

 

 what's been conducted so far and it's very good 

 

 information and good work that's been done on this 

 issue. So without any more, I'll turn it over to 

 

 Art. 

 

 PRESENTATION ON SEGREGATED/SECURED FUNDS 

 

 BY THE GMAC SUBCOMMITTEE ON BANKRUPTCY 

 

 MR. HAHN: Commissioner Lukken, thank you 

 for giving us an opportunity to report. Fellow 

 

 Commissioners, it's a pleasure to be here. 

 

 I think the first thing to mention is we 

 

 worked diligently as a Committee, but we've had 

 

 terrific support from the Commission and 

 particularly at staff. They've performed a role of 

 

 being an information and technical resource and 

 

 it's been invaluable. They've saved us a lot of 

 

 time. They've been very thoughtful and have been a 

 

 terrific support for us, particularly Jim Carley 

 and Mr. Wasserman have been just invaluable as we 

 

 did our work at the beginning of the project. 

 

 Andrea Corcoran was very helpful. We wanted to say 
 56 

 

 thank you to the Commission for that support. 

 

 The issue of the possibility of merging 

 

 the seg and secured funds is very complex and I 

 

 think everybody on the Committee is sensitive to 

 doing something in terms of the regime that 

 

 currently exists that might have unintended 

 

 consequences or bad consequences. We want to be 

 

 very careful in this complex area. 

 

 I start out there because our purpose, and 

 one of the purposes in making the report today is 

 

 certainly to be informational for the entire GMAC 

 

 Committee but in a very, very earnest way to 

 

 solicit people's thoughts and comments on what 

 

 we're doing and how we're approaching it as we move 

 forward, because as we found in our work, there 

 

 were moments where we had an idea and we thought it 

 

 was the absolute holy grail, we had solved all the 

 

 problems, only to find when we dug in a little 

 

 further that we had gotten it wrong and that we 

 were going down a path that may not have been so 

 

 wonderful. 

 

 And that same approach, though, of really 
 57 

 

 vetting it carefully, fully exposing all of our 

 

 thoughts on the process, is the way we're going to 

 

 continue to act as a Subcommittee, but it really 

 

 will be important to solicit all of your thoughts 

 so that at the end of it, if we're to be 

 

 productive, we produce something that is really 

 

 right. 

 

 We do have a tentative model for how the 

 

 merger, at least in part of seg and secured, might 

 happen. That model is just now emerging, as Walt 

 

 suggested, at the end of our meeting this morning, 

 

 and I'll lay that out for everyone. But I think 

 

 it's important to understand kind of how we got to 

 

 that point. 

 The way we organized ourselves was to 

 

 split up into two subcommittees. The first was 

 

 chaired by Dan Roth and their charge was to 

 

 understand fully the risks that were attempted to 

 

 be dealt with by the separation of seg and secured, 

 but not to stop there, to say, okay, what risks are 

 

 real? What are no longer relevant? And then what 

 

 are possible solutions? Their charge was to get as 
 58 

 

 creative as they could with the solutions without 

 

 necessarily concerning themselves immediately with 

 

 whether they were or weren't workable. But the 

 

 idea was to throw out any ideas that people had and 

 twist them and turn them and see if there was 

 

 something there. 

 

 The second Committee was headed by John 

 

 Davidson and their charge was to think about, is 

 

 this really an important thing to be doing? Is it 

 worth the candle to put these together? Will there 

 

 be savings? Will there be efficiencies? And 

 

 secondly, to act as a real world, practical 

 

 response to the ideas that the Roth Committee came 

 

 up with and saying, you know, that's a great idea, 

 but it'll take a million man hours to put that in 

 

 place, or it really doesn't work, or you haven't 

 

 thought about this. And John's Committee was very 

 

 diligent on working to put together that piece of 

 

 it. 

 What I'd like to do now is have each of 

 

 these gentlemen report out the work of their 

 

 Committee because I think the different steps they 
 59 

 

 went through may trigger some thoughts among some 

 

 of you and also to give you a sense of how we're 

 

 approaching the problem and then I'll bring it back 

 

 to finish the report to you what this template is 

 that we're going to use going forward to further 

 

 explore and how we're going to be functioning. 

 

 So with that, I'd ask Dan to kind of 

 

 describe the work of his subgroup. 

 

 MR. ROTH: Thanks, Art. Our subgroup 

 included Bernie, Dan, and Joanne Medero and Jim 

 

 Falvey, but I should also mention at the outset 

 

 that we received a lot of additional assistance not 

 

 only from the Commission staff, as Art pointed out, 

 

 but Ann Polaski and Katherine Camp and Ken 

 Rosensweig were all very supportive and very 

 

 helpful in assisting the Subcommittee as we went 

 

 through our discussions. 

 

 We started our discussions by really 

 

 looking at the historical rationale for separating 

 seg and secured back when the Part 30 regulations 

 

 were adopted some time ago, I guess about 20 years 

 

 ago or so, and again, the Commission staff was 
 60 

 

 helpful. We looked at some of those original 

 

 concerns and realized they don't really apply so 

 

 much anymore. 

 

 Back at the time, there was a requirement 

 that all seg funds be held in dollar denominated 

 

 accounts. That would be a problem if you were 

 

 merging seg and secured. However, the Commission 

 

 has subsequently amended its regulations and that's 

 

 no longer an issue. 

 There was also a concern at the time that 

 

 perhaps it would be an inappropriate risk to ask 

 

 customers whose funds were held in dollar-denominated 

 

 amounts to share the risk of currency 

 

 fluctuations. But again, I think the Commission in 

 the 20 intervening years has revisited that 

 

 question and really with subsequent amendments to 

 

 CFTC Regulation 149 it's not so much a continuing 

 

 concern. 

 

 So we really turned our attention to the 

 question of, just as Art indicated, what risks are 

 

 there that customers trading on U.S. markets could 

 

 suffer in any way as a result of the merger of seg 
 61 

 

 and secured. 

 

 We started by noting that under the 

 

 applicable regulations, there are different 

 

 regulatory regimes in place for the handling of 

 customer funds that are in secured amount accounts 

 

 versus segregated accounts. The regulations are 

 

 just different and we recognized a couple of things 

 

 immediately. Number one, that those regulations 

 

 would have to be harmonized. Number two, that the 

 task of harmonizing them was particularly--was at 

 

 least possibly very complex. And that, number 

 

 three, we should therefore immediately get rid of 

 

 that job, and we did. 

 

 [Laughter.] 

 MR. ROTH: We assigned that to John 

 

 Davidson's Committee through a piece of 

 

 parliamentary procedure that we don't need to go 

 

 into here-- 

 

 [Laughter.] 

 MR. ROTH: --but it was successfully 

 

 transferred to another venue and they've dealt with 

 

 that and dealt with it very well. 
 62 

 

 We started talking, then, about the, 

 

 again, the risks that a customer on U.S. markets 

 

 could suffer a loss due to an insolvency that was 

 

 triggered by events overseas and tried to identify 

 ways of dealing with that risk, of limiting that 

 

 risk. And we, in the course of our discussions, 

 

 came up with a number of different approaches, and 

 

 in no particular order, we discussed, for example, 

 

 the possibility of creating a new subclass of 

 customers under the Commission's Part 190 rules. 

 

 We used as a starting point Framework 2 to Appendix 

 

 B to the Part 190 rules, and I think we all know 

 

 Framework 2 to Appendix B to the Commission's Part 

 

 190 rules. 

 [Laughter.] 

 

 MR. ROTH: I know we all thought Framework 

 

 1 was good, but Framework 2 is-- 

 

 [Laughter.] 

 

 MR. ROTH: But we started that as our 

 starting point, really, and pursued the idea of 

 

 could you create a subclass of customers such that 

 

 in the event of an insolvency, those customers that 
 63 

 

 made a decision to trade in the foreign market 

 

 where the events unfurled would have their claims 

 

 subordinated to the rest of the customers. And in 

 

 that way, you could possibly limit the contagion. 

 You could limit that risk, or at least focus that 

 

 risk on those customers that made the decision to 

 

 trade in those markets and try to insulate from 

 

 that risk customers that were trading on U.S. 

 

 markets, and that is an idea that I think has some 

 appeal to it. 

 

 It has some appeal to it because if we can 

 

 figure out a way to make it work, it would achieve 

 

 the desired result of limiting the risks to 

 

 customers trading on U.S. markets, and from an 

 operational point of view, it has certain 

 

 advantages to it. Of all the advantages to that 

 

 approach, simplicity would not be one of them. 

 

 It's, again, a very complex area, and having 

 

 already transferred one complex subject, we felt we 

 couldn't transfer another one. 

 

 [Laughter.] 

 

 MR. ROTH: So there's additional work that 
 64 

 

 needs to be done here and quite a bit of it. But I 

 

 think going forward, that is one option that we 

 

 would like to explore in greater detail, to really 

 

 examine more fully what would be involved, how you 

 would work out those subordinations, how the 

 

 regulations could be drafted, how effective they 

 

 would be in various types of scenarios. 

 

 So the idea of subclasses of customer 

 

 accounts in the event of an insolvency was one idea 

 that we have discussed and continue to pursue. 

 

 We also talked about the possibility of 

 

 limiting the likelihood of a foreign insolvency 

 

 affecting a U.S. FCM by basically in some way 

 

 setting standards and limiting the markets or 

 jurisdictions for which trading could be included 

 

 in the merged seg and secured accounts. That could 

 

 take a number of different forms, but the idea 

 

 would be to identify types of markets where we 

 

 think the risks of an insolvency might be greater 

 and excluding those from the combine from the 

 

 merged accounts, and that could take the form of, 

 

 for example, at one end of the spectrum, limiting 
 65 

 

 the jurisdictions that could participate--for which 

 

 trading would be included in the merged account to 

 

 those jurisdictions where the clearing organization 

 

 was a designated clearing organization, had been 

 approved by the CFTC as a DCO. 

 

 Another version of that approach would be 

 

 more akin with the 30.10 sort of regulatory regime, 

 

 where the Commission would make a determination 

 

 that there was a comparable regulatory regime in 

 that particular jurisdiction, and therefore under a 

 

 30.10 type of approach, those jurisdictions that 

 

 were found to have had a comparable regulatory 

 

 regime could be included in the merged account. 

 

 That would be another means of addressing the 

 risks, not perhaps quite as operationally clean as 

 

 the subclasses under the bankruptcy rule, but 

 

 nevertheless, a basic approach that we have 

 

 explored and will continue to discuss. 

 

 The third approach that we discussed was 

 providing customers with an opt-out opportunity, so 

 

 that customers that chose not to have their funds 

 

 held in a merged seg and secured account would be 
 66 

 

 given the opportunity to opt out of that regime. 

 

 That opt-out provision could also take one of 

 

 several forms. Under one scenario, the customers 

 

 would have the right to opt out and could--it could 

 not be made a condition of doing business by the 

 

 FCM that they opt in, so that the FCM would have to 

 

 offer them the opportunity to have their funds held 

 

 in a merged account or in a traditional seg or 

 

 secured amount account. 

 The other variation on that theme would be 

 

 that the customer would have the right to opt out 

 

 but the FCM would have the opportunity or the right 

 

 to make it a condition of doing business with the 

 

 customer that he opt in, so that if the customer 

 opted out, he would, in effect, be opting out of 

 

 that FCM and could take his business someplace 

 

 else. 

 

 We've been considering both of those 

 

 options. Neither of them have quite the simplicity 

 of operational issues that John's group has sort of 

 

 been looking at, but again, it's one of the avenues 

 

 that we've been exploring. 
 67 

 

 The fourth sort of customer protection 

 

 issue that we've dealt with has to do with the 

 

 possibility that customers could be harmed in an 

 

 insolvency proceeding through the application of 

 foreign bankruptcy law under a regime that perhaps 

 

 doesn't give the same priority to customers, or in 

 

 some way application of the foreign bankruptcy law 

 

 would harm customers trading on U.S. markets. 

 

 When we're working our way through that 

 issue, we tried to create a sort of a matrix 

 

 identifying all the various variables that could 

 

 come up in an insolvency scenario as far as where 

 

 the assets are, who the insolvent person is, 

 

 domestic clearing organization, foreign clearing 

 organization. We listed all the variables that we 

 

 could think of in a matrix and then quickly 

 

 determined by looking at the matrix that the 

 

 possible combinations of scenarios was way too 

 

 many, that there would be over 100 different types 

 of scenarios or combinations of those variables 

 

 that you could put together. 

 

 But the one thing that we identified was 
 68 

 

 that regardless of the scenario, which of the 

 

 various combinations of those variables that you 

 

 came up with, regardless of which one you came up 

 

 with, that it would always be better if the assets 

 were held in the U.S., that if the assets were held 

 

 in the U.S., that there was a greater chance that 

 

 the U.S. bankruptcy laws would apply than 

 

 otherwise. No matter what scenario you came up 

 

 with, that was a truism, that if the assets were 

 held in the U.S., we had a better chance of 

 

 ensuring that U.S. bankruptcy law applied, which 

 

 seemed like just a great idea until we figured out 

 

 that it probably is completely impractical in that 

 

 it would be difficult to require both foreign 

 clearing organizations and perhaps even more 

 

 specifically the foreign clearing brokers to 

 

 maintain accounts in the U.S. 

 

 So that was one of those ideas that seemed 

 

 to have some appeal and upon further examination 

 seems maybe not to be so practical. But we still 

 

 haven't completely jettisoned the idea because 

 

 there's a possible variation of that theme that 
 69 

 

 would involve requiring U.S. FCMs to maintain in 

 

 the U.S. certain excess funds to at least ensure 

 

 that there would be a certain portion of the funds 

 

 that would be held in the U.S. and perhaps limit 

 the application of foreign bankruptcy laws under 

 

 that sort of scenario. 

 

 So that's an idea that's still also very 

 

 much under discussion. The initial idea that we 

 

 had, we think is particularly impractical, but 

 there may be a variation of it that could at least 

 

 give partial effect to what we were trying to 

 

 achieve there. 

 

 So those were really the protection issues 

 

 that we sort of identified. Those were some of the 

 various alternatives that we have discussed. As I 

 

 mentioned, the subclass of customer accounts under 

 

 the bankruptcy code is an idea that continues to 

 

 have some allure for us. I think all of them need 

 

 to be examined a little bit further. But that's 

 the state of our discussions on those issues as of 

 

 this morning, Arthur. 

 

 MR. HAHN: A terrific job, Dan, and we're 
 70 

 

 all very grateful for your kind of pulling that 

 

 effort together and kind of the open-mindedness and 

 

 flexibility with which your Committee approached 

 

 it. 

 I wanted you all to kind of hear that in 

 

 some detail because you can think of some of the 

 

 threads that we're looking at. If you've got a 

 

 variant on that, the way we're doing our business 

 

 is we're open to hearing that or listening to a 

 good idea. 

 

 John, could you give us a sense of how 

 

 your Committee worked your issues? 

 

 MR. DAVIDSON: Sure. Thank you very much. 

 

 The first task of our Committee, of course, was to 

 get out our old moldy dog-eared copies of Roberts 

 

 Rules of Order and figure out exactly which 

 

 parliamentary ploy it was that Dan's Committee used 

 

 to give this to us-- 

 

 [Laughter.] 

 MR. DAVIDSON: --and we searched 

 

 diligently through that document and discovered 

 

 that it was not a documented parliamentary ploy. 
 71 

 

 It's, in fact, something from the Chicago Bears 

 

 playbook which they were very good at this year. 

 

 They fell back and punted. 

 

 [Laughter.] 

 MR. DAVIDSON: So our Committee had two 

 

 tasks. One was to develop a business case for 

 

 arguing for a change of this nature and then 

 

 evaluating some of the operational and practical 

 

 impact of some of the potential solutions that 

 might also serve the risk management interests that 

 

 Dan has elaborated. 

 

 The first question with respect to a 

 

 business case is are we dealing with a material 

 

 issue here, and I think it's fairly clear that that 

 is, in fact, the case. There are on the order of 

 

 $100 billion worth of customer funds in the U.S. 

 

 futures industry and approximately 20 percent of 

 

 them are in secured-amount deposits. So it's 

 

 certainly a material question to look at, do you 

 need to have that distinction. 

 

 And then in looking at sort of benefits 

 

 that we would cite from merging these two pools, 
 72 

 

 there essentially came down to two types. One, if 

 

 you will, are soft benefits and one are somewhat 

 

 harder or more quantitative benefits. The soft 

 

 benefits basically arrive out of the fact that this 

 distinction between segregated funds and secured 

 

 amounts is a distinction that's unique to futures 

 

 commission merchants. 

 

 Customers do not organize their finances 

 

 in that way. A customer doesn't make the 

 distinction between those two types of funds, 

 

 particularly customers that participate in single 

 

 currency margining, that is to say that they give 

 

 their FCM a chunk of collateral and participate on 

 

 a portfolio basis in a variety of markets. That 

 collateral is all denominated in dollars and they 

 

 leave it up to the FCM to engage in the appropriate 

 

 currency conversions for them. 

 

 There's not a lot of evidence to suggest 

 

 that this distinction is producing benefits on the 

 customer level that customers really understand and 

 

 appreciate and it adds a significant amount of 

 

 complexity. It adds complexity to FCMs. It adds 
 73 

 

 work to FCMs. It adds noise in customer statements 

 

 when they transfer funds to the wrong account at 

 

 the FCM and have to move them back. It causes 

 

 noise in their statement when a transaction is 

 inadvertently booked to the wrong type. 

 

 All of those things are things which 

 

 investors in other types of foreign markets don't 

 

 have to experience. They're certainly familiar 

 

 with the notion that if they participate in certain 

 emerging markets or certain markets where there's 

 

 limited currency convertability that they will have 

 

 additional operational tasks. But the notion that 

 

 to participate in markets in major European and 

 

 Asia-Pacific currencies, that they ought to jump 

 through additional operational hoops is not 

 

 something that they face in most other types of 

 

 international investments in which they 

 

 participate. 

 

 So having a simpler and more easy to 

 understand and explain to customers regime is a 

 

 significant benefit, but as noted, a soft benefit. 

 

 We did spent quite a bit of time trying to 
 74 

 

 get our arms around some of those harder benefits 

 

 in terms of costs and we did an analysis of the 

 

 cost of this current regime to market participants. 

 

 Naturally, the composition of our group was such 

 that we were able to do that to the greatest extent 

 

 with respect to the cost to FCMs, and so we looked 

 

 at banking costs and we looked at additional 

 

 staffing costs from having the distinction to be 

 

 maintained and we found significant but certainly 

 by no means material savings associated with 

 

 merging the two pools of customer funds. 

 

 Obviously, all of that needs some more 

 

 fleshing out. We need to have a specific proposal 

 

 that we can look at as opposed to a host of 

 proposals, and in looking at that specific 

 

 proposal, we can add both the hard benefits that 

 

 will arrive from that proposal, but also some 

 

 information about the implementation costs since 

 

 any change in system is not free. It wouldn't 

 necessarily be complicated, but we need to see the 

 

 specific proposal to determine that and we'll get 

 

 there as time goes on. 
 75 

 

 The next thing we did was looked at these 

 

 host of different approaches for managing the risk 

 

 with respect to the merger of the secured amount 

 

 and the segregated funds pool and Dan very nicely 

 elaborated each of those. Fundamentally, the "keep 

 

 it simple" proposition is the one which is most 

 

 attractive here and we're trying to simplify an 

 

 already complex situation. You're not going to get 

 

 a lot of operational benefits out of adding 

 additional complicating bells and whistles. 

 

 Another thing I think that was discovered 

 

 in the process is that this notion of having a 

 

 subclass of customers whose interests are 

 

 subordinate to another class is critically 

 dependent on there being assets to distribute at 

 

 such time as an insolvency occurs. So this concept 

 

 of different pools and subordination is importantly 

 

 determined on how you calculate the amount of 

 

 assets that you have against your obligations to 

 customers. 

 

 Thanks to the help of some of our 

 

 colleagues from the SROs, we did actually go 
 76 

 

 through and come up with a proposal to harmonize 

 

 the calculation. The calculation of segregated 

 

 funds sufficiency and the calculation of secured 

 

 amounts sufficiency are out of sync in certain 

 important areas and we've reached a set of 

 

 recommendations which, of course, will have to be 

 

 vetted against what the specific proposal is before 

 

 they become final, but that was important work that 

 

 the Committee did. 

 With respect to the question of things 

 

 like a dual system, obviously, from an operational 

 

 perspective, the more markets and the more 

 

 currencies that you can include in the merged 

 

 pools, the less complexity you have, so that if you 

 just had a single market outside the United States 

 

 that was part of the commingled pool of segregated 

 

 funds and secured funds, you would not have moved 

 

 very far, and if you had most of the major markets 

 

 in Europe and the Asia-Pacific region included 

 therein, the fact that there were a handful of 

 

 emerging markets that were still in the old system 

 

 would be operationally much more straightforward. 
 77 

 

 Finally, we talked about this concept of 

 

 holding funds exclusively in the U.S., and while 

 

 that's certainly a possibility for a U.S. FCM, it 

 

 is very difficult to understand what would motivate 

 a non-U.S. clearing organization or a non-U.S. 

 

 carrying broker to hold funds in the U.S. Those 

 

 organizations do not currently distinguish among 

 

 U.S. and non-U.S. investors, and in fact, they may 

 

 be prohibited from making that distinction under 

 their own insolvency regulations. 

 

 But there is the possibility that with 

 

 respect to the U.S. FCM, who in this scheme of U.S. 

 

 FCM, foreign carrying broker, foreign clearing 

 

 organization is actually the party that reaps the 

 benefit, that party could, indeed, carry some 

 

 amount of funds, particularly those funds which are 

 

 used to cover deficits in the calculation of 

 

 segregation-slash-secured amount customer fund 

 

 requirements. Those could be carried in the United 

 States, we believe. 

 

 So a lot of work to be done. The next 

 

 stage is probably getting a specific proposal and 
 78 

 

 evaluating the costs and benefits of that. But 

 

 certainly this is an area that is material to the 

 

 business overall. There are significant benefits 

 

 both from a soft side perspection of the 

 marketplace, ease of access as well as cost savings 

 

 to FCMs as well as to investors in making a change 

 

 of this type. 

 

 MR. HAHN: John, thank you very much for 

 

 helping, and to the members of your subgroup for 

 helping on that. 

 

 As we go forward, our plan is this. While 

 

 we will remain open to different, totally different 

 

 ideas, because nothing is set yet by any means, we 

 

 have concluded that we do want to flesh out this 

 idea of a subordination of the foreign 

 

 participation. So simply stated, we would do away 

 

 with the distinction between seg and secured. You 

 

 would have a single fund. But we would identify a 

 

 class of funds that would be subordinated to the 

 main class of funds in order to achieve the 

 

 security goal that Dan identified. 

 

 Precisely how you would make that 
 79 

 

 categorization, that's our work. We have to really 

 

 think about what would go in there, how you would 

 

 scorekeep what went in there, what recordkeeping 

 

 obligation there would or wouldn't be on a daily 

 basis, on an ongoing basis, what currencies could 

 

 or couldn't be in there, what markets would or 

 

 wouldn't be covered by that. 

 

 But when we've explored this to the extent 

 

 that we have so far, it feels currently like it's 

 viable. We don't know the final answer and we 

 

 might hit a stumbling block when we really delve 

 

 into it. But we've concluded as a Committee that 

 

 that's the path we want to currently explore. 

 

 We further concluded that functioning as 

 two separate Subcommittees, although 

 

 extraordinarily useful to this point, was a good 

 

 starting point, we think going forward that we need 

 

 to all work together and bring to the process 

 

 simultaneously the insights of the operational 

 people and the risk people, and so our meetings 

 

 going forward will be as a Committee of the Whole, 

 

 if you will. 
 80 

 

 Through that process, as we've done to 

 

 date, we've invited extra people in to bear some of 

 

 the workload, to give us their thoughts, and I want 

 

 to reiterate that we're saying the same thing 

 again. There may be exchanges or clearinghouses 

 

 that have some insight into this. Roy Leighton was 

 

 good enough to sit in on our meeting this morning 

 

 and he was able to share some European perspective 

 

 on that. We're anxious to have that. 

 We certainly need, when we really delve 

 

 into this, to understand exactly the impact on the 

 

 people on the front line and that will be the FCM 

 

 community. So both the operation and legal people 

 

 from the FCM community need to be fully part of 

 this process. 

 

 It would be--the way we left it, Walt, was 

 

 that we would have a soft reporting date of the 

 

 next GMAC meeting, but we said to ourselves that 

 

 it's more important to get it right than get the 

 thing out quickly. We're going to aim at trying to 

 

 report back next time, but it may take longer as we 

 

 delver into it further. 
 81 

 

 I think that's our Committee's report and 

 

 we're certainly--we would invite questions at this 

 

 point or comments. 

 

 COMMISSIONER: I just wanted to 

 thank Arthur for his exceptional leadership on this 

 

 issue and having to deal with people's schedules 

 

 and getting folks together and without much in 

 

 return, so we appreciate Arthur and also John and 

 

 Dan for all the leadership they've taken on this 

 issue. 

 

 I would want to point out, in case people 

 

 are getting nervous that this is going too fast and 

 

 we haven't been privy to this and what's going on, 

 

 the role of an Advisory Committee is to, on these 

 types of technical issues, to bring transparency. 

 

 That was the point of the Federal Advisory 

 

 Committee Act--to bring transparency to the 

 

 process so that people have input into 

 

 recommendations to the Commission. What this group 

 is working on is to provide, with the input of all 

 

 of you, these new recommendations to us. 

 

 Having said that, once these 
 82 

 

 recommendations are made to the Commission, we 

 

 don't have to necessarily accept them, or if we do 

 

 accept them, they will go out for notice and 

 

 comment and more discussion. So for folks that 

 haven't been privy to this, as Arthur said, we 

 

 welcome your comments, your input. This is moving 

 

 along in a very rational fashion and we certainly 

 

 are willing to sit down with you at length and talk 

 

 about these issues more if you'd like an update. 

 With that, I'll turn it over to questions 

 

 that others may have in the audience. 

 

 MR. FILLER: Thank you, Walt. Arthur or 

 

 Dan, I have two questions. My first question is, 

 

 as you explore the various options emerging seg and 

 secured, any relief or approaches that you come up 

 

 with, any final conclusions or recommendations, can 

 

 they all be implemented by CFTC rulemaking or does 

 

 it require or may require legislative action? 

 

 MR. HAHN: A very good question. The 

 current feeling--but nobody's really dug in deep on 

 

 this, Ron, so we reserve the right to change our 

 

 position--is that it may well be able to be done by 
 83 

 

 changes in the 190 rules and that it could be done 

 

 that way, but we're not going to feel bound by 

 

 that. We're going to try to come up with something 

 

 that makes sense, that would really bring a benefit 

 and bring the protections that we're starting with, 

 

 and if that requires Congressional action, then 

 

 we'll say so. We're not going to shoehorn it. 

 

 We're going to come out with the best solution we 

 

 can and then ask your question. 

 MR. FILLER: And my second question is, 

 

 which obviously would require legislative change 

 

 and a little bit more bolder approach than merging 

 

 seg and secured is merging seg and SIPC. Has the 

 

 Committee been looking at that issue at all or 

 there's just more focus on the secured seg type 

 

 concept? 

 

 MR. HAHN: A whiff of that has gone 

 

 through the room on occasion-- 

 

 [Laughter.] 

 MR. HAHN: --and we thought about things, 

 

 how this might make it easier for portfolio 

 

 margining, but we're not smart enough or brave 
 84 

 

 enough to fully tackle that. What I do think, 

 

 though, is that if we solved this problem, okay, 

 

 what would emerge would be much more suitable for 

 

 looking at the issue you're addressing. So let's 

 take it incrementally. We think it would be a step 

 

 that could be built on if that was what the 

 

 people's desires was. But we don't view that as 

 

 our charge. 

 

 MR. BERLIAND: Richard Berliand from J.P. 

 Morgan. First of all, Art, I think this is a great 

 

 initiative and trying to find, gain standardization 

 

 across the globe is hugely appealing to customers. 

 

 I've got two sort of thoughts that I would add in 

 

 here that I think are important framework, sort of 

 background ideas. 

 

 One is that if you look at the client 

 

 base, I don't think you will find more than five 

 

 percent of the clients that we deal with that have 

 

 a clue about this and the implications of this. 

 The educational aspect of what we're doing here, I 

 

 would argue that clients don't understand what 

 

 exists today. The more complex we make what 
 85 

 

 replaces it, the more the educational challenge is, 

 

 and I think that we have a responsibility to the 

 

 users in the marketplace to make sure that whatever 

 

 we do here is understandable and that we do 

 proactively educate the clients in using that. 

 

 The second thing is something which Sharon 

 

 has heard me say on a number of occasions, is to 

 

 remember that as U.S. FCMs, we have a very 

 

 significant number of clients who are not U.S. 

 domiciled. Now, we know that the U.S. domiciled 

 

 clients can hardly swim off to London and start 

 

 signing up in London to do their U.S. business. 

 

 The Part 30 exemption won't work there. But the 

 

 fact remains is we have a lot of non-domestic 

 customers who very much can choose whether they 

 

 sign up with a U.S. FCM or whether they sign up 

 

 with an FCM in some other jurisdiction. 

 

 Therefore, what we do today has 

 

 significant tax dollar, economic implications on 

 what happens to our U.S. businesses and, therefore, 

 

 it's very important, for example, if we were to go 

 

 down the subordination route, that we do not 
 86 

 

 produce a structure that makes a Cayman 

 

 Island-based customer, for example, that is active 

 

 in the foreign markets end up being subordinated in 

 

 a position that they would not have if they were 

 signing up under English law or some other 

 

 environment. 

 

 So just a caution that everything we do is 

 

 so connected internationally and such a high 

 

 proportion of our clients truly can arbitrage the 

 legal environments in which they work that we must 

 

 keep that in mind. I don't think we want to see a 

 

 wholesale exit of business to other jurisdictions, 

 

 and certainly the Treasury won't, anyway. 

 

 MR. HAHN: Richard, you identify very 

 clearly the thing that we figured out here, and 

 

 that is that it is a very complex project and we're 

 

 scared of unintended consequences, where we come up 

 

 with a solution that satisfies prudential concerns 

 

 or a solution that's operationally simple and then 

 all of a sudden we realize that we distorted the 

 

 market or the business in a way that we didn't 

 

 intend and that isn't helpful. 
 87 

 

 To that end, I would certainly invite you 

 

 and your colleagues to stay close to this process 

 

 and say, hey, that solution you're coming up with, 

 

 you didn't think about this, and I think that's the 

 only way we're going to get it right and our goal, 

 

 we'll just simply be as transparent as we can. We 

 

 have thought about some of that, of who goes into 

 

 that fund. Is it the Cayman company coming into 

 

 the U.S. FCM? Is it the foreign broker who sends 

 his business to the U.S.? How does it exactly 

 

 work? We don't know the answer to that but we've 

 

 identified the issue. 

 

 MR. PICKEL: The world of SCMs and 

 

 segregated and secured funds is a little bit 

 foreign to the ISDA world, but it sounds to me that 

 

 part of the problem and perhaps some of the 

 

 solutions you're thinking about are akin to some of 

 

 the ring fencing type provisions that, like the New 

 

 York State Superintendent of Banks has power to 

 hold on to assets in New York for purposes of 

 

 settling claims against the New York branch of a 

 

 foreign bank. 
 88 

 

 And I just mention it because there is a 

 

 case currently--we've weighed in with a brief--where there's 

 

 a question of the interaction between 

 

 the Federal bankruptcy law and particularly the 

 ancillary proceeding provisions and the powers that 

 

 the New York Superintendent of Banks has to hold on 

 

 to those assets and there's a real question as 

 

 to--the current ruling of the court is that the 

 

 bankruptcy ancillary proceeding provisions override 

 that State Superintendent of Bank power and we 

 

 don't think that's the right solution, but I just 

 

 mention that as background as you go forward with 

 

 your work. 

 

 MR. ROTH: That's real helpful information 

 and maybe we can talk with you later and get a 

 

 little bit educated about that case and read some 

 

 of those briefs. 

 

 MR. HAHN: One of--kind of along those 

 

 lines, as Dan said, we went down a path for a while 

 thinking that the ultimate solution would be to 

 

 have these funds in the United States so that if 

 

 there was a conflict between bankruptcy regimes, 
 89 

 

 you could glom them. That's a technical term. 

 

 [Laughter.] 

 

 MR. HAHN: And that, as John Davidson 

 

 pointed out, is probably a little myopic and it 

 doesn't work. But a part of that may, and we've 

 

 explored, for example, the notion that excess seg 

 

 or excess secured and the information we get is 

 

 that as much as 12, 15 percent of the seg secured 

 

 amount as a practical matter houses need to carry 

 in excess. So if the number's right at $100 

 

 billion, you're talking about maybe $15 billion 

 

 that the industry has to maintain to lubricate it 

 

 all, to have in excess so that it doesn't find 

 

 itself in violation. 

 Well, one notion if we put these together 

 

 is that that $15 million can stand as the cushion 

 

 for both seg and secured. It makes the 

 

 administration of this much easier. And we 

 

 understand that you couldn't, as a practical 

 matter, keep the whole $15 billion in the United 

 

 States because, again, you need to have some of the 

 

 money offshore for certain kinds of immediate 
 90 

 

 purposes. But if as a general rule that excess was 

 

 here, you'd go a long way to speak to some of the 

 

 prudential concerns that we started our inquiry 

 

 with. So that theme is still part of the mix that 

 we're exploring. But it goes right into your case. 

 

 COMMISSIONER LUKKEN: I'll just add that 

 

 the outline that Art has told us about going 

 

 forward on this project—-I think we can agree 

 

 that there's consensus to go forward on this and 

 visit this tentatively at our next GMAC meeting 

 

 this summer, and we will work closely with you and 

 

 your Subcommittee as it's merged back together to 

 

 work on these issues. 

 

 On that front, I would like to thank Jim 

 Carley and Bob Wasserman and also John Lawton, 

 

 who have worked on these issues with the 

 

 Subcommittee. They've added our 

 

 Commission's expertise and I wanted to mention them 

 

 at this time, so thank you again. 

 MR. HAHN: Thank you. 

 

 COMMISSIONER LUKKEN: Now we're 

 

 going to turn to reauthorization, so we'll take off 
 91 

 

 our legal hats and put on policy hats. We're 

 

 fortunate to have some old friends of mine sitting 

 

 at the table. Andy Morton, who is Chief Economist 

 

 on the Senate Agriculture Committee, has been 

 handling CFTC issues for a few years now. And Dave 

 

 Ebersole, who at one time worked at the CFTC and 

 

 has been at the House Ag Committee for many years 

 

 and is good counsel over there on these issues, as 

 

 well. I was going to turn it over to them to give 

 us a briefing on what we might expect this year on 

 

 reauthorization. So Andy? 

 

 UPDATE ON THE CFTC'S REAUTHORIZATION 

 

 BY HOUSE AND SENATE STAFF 

 

 MR. MORTON: Thanks very much. It's a 

 pleasure to be here today. I want to thank 

 

 Commissioner Lukken for inviting me to join--for 

 

 your invitation for me to join you today and make a 

 

 few remarks, not too many, but a few about CFTC 

 

 reauthorization. 

 I also want to take the opportunity before 

 

 I do make those remarks to congratulate Chairman 

 

 Brown-Hruska on her new position and also on her 
 92 

 

 confirmation late last fall for a second term as 

 

 Commissioner. In that same vein, I want to 

 

 congratulate Commissioner Hatfield and Commissioner 

 

 Dunn on their confirmations through the Senate, as 

 well. We had a busy end of Congress last fall. 

 

 I know a number of the folks here on this 

 

 Committee and other people who are in the room 

 

 today. There are others that I haven't had a 

 

 chance to meet yet or just met for the first time 

 today. I'm looking forward to meeting and 

 

 interacting with all of you as we go forward in the 

 

 Senate with CFTC reauthorization this year. 

 

 Senator Saxby Chambliss of Georgia 

 

 officially became Senate Agriculture Committee 

 Chairman on Thursday, January 6, just a few days 

 

 ago. He replaces Senator Thad Cochran of 

 

 Mississippi, who has moved on to become the 

 

 Chairman of the full Senate Appropriations 

 

 Committee. As I think most of you know, I work for 

 Senator Cochran and I worked on CFTC issues during 

 

 his tenure during 2003 and 2004. I think I've 

 

 learned quite a bit. I'm still moving up the 
 93 

 

 learning curve and I know that you folks can all 

 

 help me continue to do that. 

 

 The Agriculture Committee has a total--in 

 

 the new Congress, with our membership now 

 confirmed, we have a total of 20 members, 11 

 

 Republicans and nine Democrats. Senator Harkin of 

 

 Iowa serves as our Ranking Minority Member and he 

 

 has for a number of years and he's also a former 

 

 Chairman of our Committee. Many of our members 

 have served on our Committee for a substantial 

 

 period of time, but we also have the pleasure this 

 

 month to welcome three new members to our 

 

 Commission, and those new Senators are Senator 

 

 Craig Thomas of Wyoming, Senator Rick Santorum of 

 Pennsylvania, and Senator Ken Salazar of Colorado. 

 

 So we have a very excellent group and we have a 

 

 busy agenda ahead of us. 

 

 Chairman Chambliss's first task as 

 

 Agriculture Committee Chairman right out of the 

 gate was to hold a confirmation hearing for the 

 

 President's choice for the new Secretary of 

 

 Agriculture, Governor Johanns of Nebraska, and that 
 94 

 

 hearing occurred late last week, as well, actually, 

 

 the same day that Senator Chambliss officially 

 

 became Chairman of our Committee. The hearing went 

 

 so well, in fact, that the Committee went on to 

 approve and to report out the Governor's nomination 

 

 for Secretary to the full Senate unanimously, and 

 

 that's actually a very rare occurrence, but it 

 

 happened in this case and we're proud of them for 

 

 that. So the Governor's nomination for Secretary 

 of Agriculture as well as other cabinet-level 

 

 nominations will be--I'm not sure it will happen 

 

 immediately when the Senate comes back later this 

 

 month, but it's certainly going to be near the top 

 

 of the agenda for the full Senate. 

 The Chairman is in the process of 

 

 organizing his Commission staff and planning the 

 

 Commission's agenda for the year, and that process 

 

 has really just begun. Very soon, we are going to 

 

 be reviewing in quite a bit of detail the 

 President's fiscal year 2006 budget proposals, 

 

 particularly as those proposals relate to programs 

 

 before our Committee. We'll also be monitoring 
 95 

 

 multilateral agricultural trade negotiations and 

 

 related issues that are under discussion and are 

 

 taking place under the auspices of the World Trade 

 

 Organization. 

 I mention these other issues in addition 

 

 to CFTC authorization, which is also in our 

 

 Committee's jurisdiction, because the Agriculture 

 

 Committee has a very heavy agenda this year. We're 

 

 going to be busy on a lot of fronts and it's going 

 to be quite interesting and a great deal of work. 

 

 As Commissioner Lukken mentioned 

 

 previously, the Commodity Exchange Act, which 

 

 authorizes CFTC to regulate the nation's futures 

 

 exchanges, is in the Senate Agriculture Committee's 

 jurisdiction and CFTC itself, the agency whose 

 

 operating budget is annually appropriated by the 

 

 Appropriations Committee, is due to be reauthorized 

 

 later this year. I believe Walt said that 

 

 September 30 is the date, and that's correct. 

 Periodic reauthorization of CFTC gives 

 

 both our Committee and the House Agriculture 

 

 Committee a chance to review CFTC operations and, 
 96 

 

 if they choose to do so, make changes in the 

 

 underlying Commodity Exchange Act. 

 

 At this point, it's really too early for 

 

 me to tell you how Chairman Chambliss will approach 

 this issue this year, but I can report to you that 

 

 he is not a newcomer to these issues. He was a 

 

 member of the House Agriculture Committee in 2000 

 

 as the Congress considered and ultimately passed 

 

 the Commodity Futures Modernization Act of 2000. 

 He was then and remains to this day a strong 

 

 supporter of CFMA and its general theme to move 

 

 away from prescriptive rule-based regulatory 

 

 approach and towards a more flexible approach based 

 

 on core principles. 

 I should also mention that Senator 

 

 Chambliss, when he was in the House, he supported 

 

 former CFTC Chairman Jim Newsome's proposal to 

 

 provide pay parity for CFTC, and, of course, that 

 

 was enacted as one of many provisions in the 2002 

 Farm Bill, and I think that authority has served 

 

 CFTC well so far. 

 

 On behalf of Chairman Chambliss, I would 
 97 

 

 like to also say simply that we look forward to 

 

 working with all of you, the CFTC, with all the 

 

 Commissioners, Chairman Brown-Hruska, the staff, 

 

 all of you folks on this Committee, and the broader 

 futures market community as we proceed with 

 

 reauthorization. I'm sure we'll be keeping in 

 

 touch. 

 

 If you have any questions that I can 

 

 answer today, I'll do my best to do so. 

 COMMISSIONER LUKKEN: Thank you, Andy. As 

 

 he mentioned, Chairman Chambliss is a friend of our 

 

 agency's. For CFTC staff sitting around the room, 

 

 he's the father of pay parity, which brought our 

 

 salary levels up to comparable levels with other 

 financial regulators, so we have much to be 

 

 thankful for with Chairman Saxby Chambliss. And 

 

 also, his son worked for us for a little period of 

 

 time, Bo Chambliss, who may still be here, I don't 

 

 know. He may be one of the best hires we've ever had 

 in retrospect. 

 

 [Laughter.] 

 

 COMMISSIONER LUKKEN: Anyway, with that, 
 98 

 

 I'll turn it over to Dave Ebersole who will give us 

 

 the House side perspective. 

 

 MR. EBERSOLE: Thank you, Commissioner. 

 

 It's a pleasure for me to be here this afternoon. 

 Madam Chairman, thank you very much for sitting 

 

 here and listening to us. It's always good to 

 

 follow the Senate. We're going to be doing 

 

 everything they're going to be doing. 

 

 [Laughter.] 

 MR. EBERSOLE: But we're going to do it in 

 

 a more relaxed way. Really, nothing is going to be 

 

 happening in the House Agriculture Committee 

 

 probably for at least the first of March. Our 

 

 Committee is not organized. In fact, we have not 

 heard from the Republican leadership exactly who 

 

 makes up our Republican members. The Democrats are 

 

 even further behind that schedule. So it appears 

 

 at this point in time that the Democrats will 

 

 organize late in the month and that we will set a 

 schedule probably for a couple of hearings in the 

 

 Subcommittee of Chairman Moran that probably would 

 

 begin sometime in early March. 
 99 

 

 Now that I've said that, I should advise 

 

 you, Madam Chairman, that knowing that you now have 

 

 four Commissioners to vet your statement, you might 

 

 want to expect an invitation to come up early in 

 February for a hearing. 

 

 We are on a schedule that has not been set 

 

 and we have not really sat down with any of our 

 

 members to decide what that schedule may be. We do 

 

 know that Chairman Bob Goodlatte from Virginia will 

 still Chair the full Committee. Chairman Jerry 

 

 Moran from Kansas will Chair the Subcommittee on 

 

 Risk Management. We have a new Ranking Democrat, 

 

 Colin Peterson from Minnesota. And beyond that, 

 

 it's pretty much up in the air as to who will make 

 up the Risk Management Subcommittee. That's where 

 

 the initial work will be done and probably most of 

 

 the work will be done on the reauthorization. 

 

 It would be good if we could do a simple 

 

 five-year reauthorization of appropriations and be 

 done with it, but that may not occur. 

 

 You're all welcome to come to our 

 

 Committee offices on the third floor of the 
 100 

 

 Longworth building. Just drop in and say hi and 

 

 come on back and talk to us. 

 

 I'm going to leave it at that and 

 

 appreciate your allowing me to come down and fill 

 in for Tyler Wegmeyer, who is Mr. Moran's staff 

 

 person. If you have any questions, I'd be happy to 

 

 try to answer them. Thanks. 

 

 COMMISSIONER LUKKEN: Does anybody have 

 

 any questions for our friends from the Hill? 

 MR. LEIGHTON: May I? 

 

 COMMISSIONER LUKKEN: Mr. Leighton? 

 

 MR. LEIGHTON: As a European, a guest 

 

 here, can I just say, and it's not just because I'm 

 

 sitting here, but it's worked very well and the 

 European perspective in dealing with U.S. 

 

 regulators is that the CFTC is by far the most 

 

 straightforward to deal with, the most 

 

 internationally minded, and the one that we feel 

 

 extremely comfortable with. So I encourage you 

 very much in getting on with this process in 

 

 reauthorizing them. 

 

 [Laughter.] 
 101 

 

 MR. LEIGHTON: I would just like to--I 

 

 come from an environment of a single regulator, 

 

 which I think is a long way away here in the United 

 

 States, but I'd just like to ask you what you think 

 about over-the-counter commodity derivatives, 

 

 because in finally working out the risks in what 

 

 FCMs and practitioners are doing out there, there's 

 

 a greater and greater need to net things off with 

 

 each other where it is appropriate to net them off. 

 In the system that I am accustomed to, that is 

 

 quite easily achieved because the regulation of 

 

 these is exactly under the same hat. Whether you 

 

 are a bank or a commodity house or a securities 

 

 firm, you can deal in commodities if you have the 

 necessary permissions, but net your exposure. I'm 

 

 just interested to know what the prospects are for 

 

 that in the future. 

 

 MR. EBERSOLE: I would seriously doubt 

 

 that we will move any further, at least in the 

 regulatory regime that's now set within the--it was 

 

 basically set in 2000 with the CFMA. In fact, 

 

 there have been problems in some markets that we've 
 102 

 

 been hearing about recently where some of our 

 

 constituents are, I guess they're not all of the 

 

 same mind but are basically saying that we need to 

 

 look at some re-regulation of what was done in the 

 year 2000. So moving any further away or toward 

 

 any more efficient relationship between the off-exchange and 

 

 the exchange environment, I'm not sure 

 

 is going to happen anytime soon as long as the Ag 

 

 Committees have jurisdiction, anyway. 

 MR. MORTON: I would tend to agree. I 

 

 don't see, certainly at the moment, any significant 

 

 change in our regulatory approach as far as how we 

 

 have written the underlying Commodity Exchange Act. 

 

 Under Chairman Cochran's tenure, we had, I believe 

 it was in May last year, we had an oversight 

 

 hearing on the implementation of the CFMA and Jim 

 

 Newsome was the sole witness. And from his 

 

 perspective, and I tend very much to agree with 

 

 him, the CFMA has been a major success. The 

 markets are growing. 

 

 I think from my perspective as our 

 

 Committee's Chief Economist, as I've watched our 
 103 

 

 economy grow and develop and become more integrated 

 

 with the rest of the world, over-the-counter 

 

 derivatives are an extremely important development 

 

 in the well functioning of our capital market, and 

 indeed the world capital market. Maybe to put it 

 

 more simply, I think there's a general view among 

 

 folks perhaps in both Ag Committees to not try to 

 

 fix something that isn't broken. Don't do any harm 

 

 first. 

 CHAIRMAN BROWN-HRUSKA: I would just add, 

 

 as well, that we're seeing a lot of positive 

 movement in that direction by the markets 

 

 themselves. In other words, we're seeing NYMEX 

 

 working toward developing and having offered 

 over-the-counter clearing and then realizing some 

 

 of the benefits of some netting, maybe not 

 

 operationally intermingling or commingling those 

 

 funds, but finding ways to accomplish efficiencies 

 

 in margining and the like. I was going to look 

 over at you, Craig, because I know that from your 

 

 perspective, you do a lot of business with swaps 

 dealers. Swaps market users use your market 

 significantly in the Euro dollars and other 
 104 

 

 products, and I'm just wondering, are there some 

 

 some sort of abilities to attain margin savings 

 within the limits of the current law? So the 

 over-the-counter markets and the exchange-based 

 markets, there are some of those kinds of 

 mechanisms that we're seeing, aren't we? 

 

 MR. DONOHUE: [Speaker off microphone.] 

 

 Yeah. I mean, I think all of us are moving very 

 much in the direction of expanding the range of 

 

 instruments that can be combined into a single 

 

 [inaudible] or other ways in which we could reduce 

 

 performance bond and capital requirements. I do 

 

 think that that's a trajectory that we're all on. 

 I think apart from just the sort of capital and 

 

 margin aspects of [inaudible] from our perspective, 

 

 I very strongly agree with [inaudible] achieved a 

 

 lot in 2000 in terms of enhancing both the OTC 

 

 market and the highly-related exchange traded 

 market. 

 

 [Inaudible] it's not necessary at this 

 

 time [inaudible] think in any fundamental way what 
 105 

 

 I think was a great accomplishment [inaudible] 

 

 beginning to serve us very well and I think 

 

 [inaudible] around at what's been happening 

 

 [inaudible] four to five years since that time, a 

 lot of very positive developments, most of them, I 

 

 think, evidencing a further integration [inaudible] 

 

 markets along the lines [inaudible] suggesting. 

 

 That process is not complete, but it's clearly a 

 

 process that [inaudible] continue, I think. 

 I think the legislation as it currently 

 

 stands [inaudible] sort of instigator, catalyst 

 

 [inaudible] so I'm very strongly supportive 

 

 [inaudible]. 

 

 MR. PICKEL: I was just going to add that 

 I think it's the other financial regulator that may 

 

 create greater hurdles to achieving that greater 

 

 integration of the exposures, because for 

 

 regulatory purposes, and the SEC's got its regime, 

 

 people need to do certain types of business through 

 different legal entities which means you've got 

 

 that hurdle basically from a corporate and 

 

 bankruptcy law perspective of netting out exposures 
 106 

 

 across the different legal entities. And so that's 

 

 going to be the bigger hurdle beyond what we've 

 

 achieved since 2000. 

 

 MR. DONOHUE: By the time it's all over, 

 Bob, you're going to be an expert on seg and 

 

 secured funds. 

 

 [Laughter.] 

 

 MR. DONOHUE: You guys will actually be 

 

 collateralizing and margining things. 

 MR. PICKEL: We're already moving in that 

 

 direction. 

 

 MR. NANDAPURKAR: Thanks, Walt. I think 

 

 there is a good lesson learned here when it comes 

 

 to OTC markets, as you mentioned. When you look at 

 the OTC markets and how we need to move forward 

 

 with where we're at with globalization and the 

 

 things we're trying to get done, I think one of the 

 

 things that happened in the U.S. in the late '80s 

 

 and early '90s was we let an opportunity get away 

 with respect to the OTC markets and having some 

 

 more certainty around the OTC markets. 

 

 Now, the CFMA and the CFTC has done a 
 107 

 

 great job in looking forward and the CFMA gave more 

 

 legal certainty to the OTC markets and you've 

 

 certainly moved the exchange markets along and 

 

 allowed more integration to happen and you should 

 be commended for that. But I think one of the 

 

 lessons learned is that we kind of lost a 

 

 marketplace there in the late '80s and early '90s 

 

 and that marketplace has pretty much moved to 

 

 London and a lot of the innovation in the OTC 

 market is in London today. 

 

 So change happens very, very quickly and 

 

 we've got to stay up with the pace of change, and I 

 

 think it was unfortunately apprehension with the--I 

 

 was in the early stages of my career in the OTC 

 market back then and it was apprehension with the 

 

 marketplace, probably entrenched forces that 

 

 allowed that to happen. But now it's starting to 

 

 come back, which is a very good thing. 

 

 COMMISSIONER LUKKEN: Speaking of our 

 fellow regulator across the town, one question I 

 

 wanted to flesh out with the group, 

 

 during the CFMA, one of the things the CFMA allowed 
 108 

 

 was single-stock futures to be traded, and one of 

 

 the provisions as part of that, not only 

 

 domestically, was to develop joint rules with 

 

 the SEC on broad-based foreign stock futures, but 

 also narrow-based and single-stock foreign stock 

 

 futures. 

 

 So those rules have never been written 

 

 between our two agencies. Those products are, from 

 

 what I read in our clips and the news clips that we 

 see, taking off in Europe. So I 

 

 wanted to sort of ask the group, why are these 

 

 products taking off in Europe? What seems to be 

 

 the impediment of why these markets may not be as 

 

 successful here in the United States? It is 

 margin? Is it the dual regulation? What are the 

 

 issues that might be holding us back and how can we 

 

 move forward on this foreign issue in regards to 

 

 security futures products? 

 

 MR. BERLIAND: I guess like Ron, as a 

 semi-European--Kevin, you're honorary, I guess--I 

 

 think the laundry list of reasons has been debated 

 

 at length in the press and I don't think there's 
 109 

 

 any real need to go through them, but the answer is 

 

 all of the above have a significant impact. At the 

 

 end of the day, there are certain things that are 

 

 within the remit of this advisory group and those 

 people who have the regulatory responsibilities 

 

 that we can fix and there are those that we can't. 

 

 To me, looking externally into the U.S., 

 

 the perceived biggest problem lies around the 

 

 regulatory environment. To me, if I was running a 

 commercial organization and the CFMA had enabled 

 

 the two regulatory bodies to get together and write 

 

 these rules, a commercial body would say, who is 

 

 accountable for failing to deliver on this? And in 

 

 a commercial organization, jobs would be at stake 

 and so on. 

 

 The difficulty we've got here is clearly 

 

 with the political aspects of it. It's all very 

 

 well if there's one party who is extremely willing 

 

 and the other party chooses not to come to the 

 table. But I hope that the reauthorization process 

 

 gives a strong forum for this to be debated as to 

 

 why that element of the empowerment that the two 
 110 

 

 regulatory bodies had to write these rules is 

 

 discussed and that there is some additional 

 

 pressure applied from the House and from the Senate 

 

 to actually achieve that. 

 I think the point that Satish made about 

 

 innovation in Europe around this thing, I don't 

 

 think single-stock futures were innovative in 

 

 Europe necessarily and I think the debate occurred 

 

 simultaneously across both regions. But I think 

 the opportunity that is being missed here in the 

 

 U.S. is going to grow by the year, and I think 

 

 until we sort out the regulatory components, all 

 

 other elements around the economic and commercial 

 

 aspects of using these products will go nowhere. I 

 really do hope that the reauthorization provides 

 

 that platform for debate, and certainly certainly 

 

 as a user, I couldn't encourage it more 

 

 aggressively. 

 

 MR. HAHN: Kind of doubling back, and 

 again, I don't know that it's the highest item on 

 

 your priority list, but in the final days of the 

 

 CFMA when it went through, when it accomplished, as 
 111 

 

 everybody said, a great deal, and we're all better 

 

 for it, the fine points of the single-stock future 

 

 and the foreign allowance wasn't buttoned down. My 

 

 memory is that under the commodity legislation, at 

 least as to foreign single-stock futures access in 

 

 the United States, the feeling was to the extent 

 

 that you could buy the underlying, you should be 

 

 able to buy the option. That was in the commodity 

 

 law. 

 It didn't find its way into the securities 

 

 amendments, and as a consequence, there's no 

 

 ability for U.S. broker dealers, FCMs, to offer 

 

 those things to the public, albeit that in the 

 

 commodity exchange laws, it would suggest that they 

 should be. It was an outtrade, in commodity terms. 

 

 It might be something that could be 

 

 addressed. It would be at least a half a step 

 

 forward in getting the commerce going, and to the 

 

 extent that you've got free flow of commerce, 

 markets innovate and respond to it and you could 

 

 get some things going. Certainly, the laundry list 

 

 of problems that inhibited single-stock futures 
 112 

 

 would have to be addressed before they take hold 

 

 more seriously in the United States. One Chicago 

 

 is certainly doing a yeoman's job, but they're 

 

 doing it with one hand tied behind their back. 

 COMMISSIONER LUKKEN: I guess we'll wrap 

 

 up, then. I appreciate our friends from the Hill 

 

 coming up to brief us. Be certain to grab them as 

 

 they're leaving to introduce yourself, and if they 

 

 need input in the future, I know that will be 

 appreciated. 

 

 Before we leave, I would just like to 

 

 thank a few people that helped put all this 

 

 together, the other Commissioners and all their 

 

 staff, Erin Shaw, Dave Stawick, and my staff, 

 Lindsay Spiller from Commissioner Hatfield's staff, 

 

 Loraine Leonard, and all the other administrative 

 

 and support staff that helped put this together. 

 

 Thank you so much. 

 

 I would invite members who are able to 

 stay, who do not have to catch flights, to 

 

 come up to the Chairman's suite to have a drink and 

 

 converse with us. We would love to have you. 
 113 

 

 So with that, we'll see you next time, and 

 

 thank you very much. 

 

 [Whereupon, at 3:38 p.m., the meeting 

 

 adjourned.]