UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 GLOBAL MARKETS ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Wednesday, December 9, 2009
 2

 1 PARTICIPANTS:

 2 CHAIRMAN GARY GENSLER

 3 COMMISSIONER MICHAEL DUNN

 4 COMMISSIONER BART CHILTON

 5 TERRY ARBIT

 6 THOMAS CALLAHAN

 7 GEORGE CRAPPLE

 8 BERNARD DAN

 9 MICHAEL DAWLEY (Participate by phone)

 10 DAVID A. DOHNALEK

 11 PROFESSOR RON FILLER

 12 SEBASTIJAN HROVATIN (EU)

 13 PETER KARSTENS (EU)

 14 ROGER LIDDELL (Video Conference)

 15 BONNIE LITT

 16 JOANNE MEDERO

 17 JACKIE MESA

 18 JAMES NEWSOME (Participate by phone)

 19 JIRO OKOCHI

 20 PATRICK PEARSON (EU)

 21 ANADAN RADHAKRISHNAN

 22 DAN ROTH
 3

 1 PARTICIPANTS (CONT'D)

 2 ERIC VINCENT

 3 BOB WASSERMAN

 4 DONALD WILSON

 5 DAVID WRIGHT (EU)

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

 2 (1:14 p.m.)

 3 COMMISSIONER SOMMERS: Good afternoon.

 4 I think we'll go ahead and get started. I want to

 5 start off by thanking everyone for being here this

 6 afternoon. I know travel in from either New York

 7 or Chicago was not easy this morning, so I really

 8 appreciate you all being here.

 9 Today is our 13th meeting of the Global

 10 Markets Advisory Committee. This advisory

 11 committee was created in 1998 to report and make

 12 recommendations to the Commission to be utilized

 13 by the Commission to obtain input on international

 14 market issues that affect the integrity and

 15 competitiveness of U.S. markets and U.S. firms

 16 engaged in global business.

 17 It is interesting to look back at the

 18 agendas of the past 11 years to note that in June

 19 of 2004 the discussion revolved around global

 20 clearing and regulatory coordination between

 21 nations. While the issues we are struggling with

 22 today have been brought into focus by the
 5

 1 financial crisis that unfolded over the past year,

 2 it's somewhat daunting to remember these issues

 3 have been at the forefront of importance with

 4 respect to the futures markets for many years.

 5 We are meeting today to obtain the views

 6 of the committee members on bankruptcy issues with

 7 an emphasis on how the insolvency regime in the

 8 U.S. compared to the insolvency regime in the

 9 U.K., particularly in the case of the bankruptcy

 10 of Lehman Brothers Holdings and Lehman Brothers

 11 International Europe. We will also discuss global

 12 financial regulatory reform.

 13 This dialogue could not come at a more

 14 crucial time for market regulators as we consider

 15 the proposals for harmonizing regulation and

 16 closing regulatory gaps.

 17 Policymakers face the challenge of

 18 reshaping financial market oversight, to better

 19 serve the public by strengthening regulation where

 20 needed and eliminating inefficiencies where

 21 possible. The questions surrounding most issues

 22 are enormously complex and require thoughtful
 6

 1 resolutions. Comprehensive financial reform will

 2 not be easy but it is moving forward, and I

 3 believe reform is important to restore confidence

 4 in the system.

 5 International coordination is also

 6 essential to ensure comprehensive regulation of

 7 the over-the-counter derivatives markets. We must

 8 not leave gaps in our regulatory structure that

 9 allow traders to evade one country's regulations

 10 by taking their business elsewhere. The

 11 Commission has been working not only with our

 12 fellow regulators here in the U.S. but with our

 13 international counterparts to prevent

 14 opportunities for regulatory arbitrage.

 15 Through discussions with regulators in

 16 Europe we have found that proposals in the U.S.

 17 and in Europe are complimentary, and we're pleased

 18 to tell you that today with us is David Wright,

 19 the Deputy Director-General for Internal Market

 20 and Services of the European Commission, to

 21 discuss issues of mutual importance to U.S. and

 22 European policymakers.
 7

 1 And joining Mr. Wright is Patrick

 2 Pearson, Head of Financial Markets Infrastructure

 3 at the European Commission, and Sebastijan

 4 Hrovatin, Administrator of Financial Markets

 5 Infrastructure of the European Commission, and

 6 Peter Kerstens, the First Counselor of Economics

 7 and Finance with the Delegation of the European

 8 Union to the United States. The Commission is

 9 honored to be hosting our colleagues from the

 10 European Commission and we hope for a productive

 11 discussion comparing and contrasting the European

 12 derivatives proposals with U.S. proposals.

 13 I'm now going to turn to my fellow

 14 commissioners but first want to welcome three new

 15 members of GMAC that are joining us today: David

 16 Dohnalek from the Boeing Company is here with us.

 17 Don Wilson from DRW Trading Group is with us, and

 18 Jiro Okochi is here from Reval. So thank you to

 19 all three of you for your participation in the

 20 GMAC, and we welcome you here today.

 21 I'm now going to turn to our Chairman

 22 for his opening statement.
 8

 1 CHAIRMAN GENSLER: Thank you, good

 2 morning. Thank you, Commissioner Sommers, for

 3 chairing today's meeting of the Global Markets

 4 Advisory Committee. This is my first GMAC

 5 meeting.

 6 As Chairman of the Commission I look

 7 forward to today's discussion. I think I've met

 8 many of the committee members before, but look

 9 forward to getting to know each of you, and I,

 10 too, welcome Don, and David, and Jiro to the

 11 committee.

 12 I also want to give a particular warm

 13 welcome and thanks to David Wright who not only,

 14 for all the reasons Jill said about the need for

 15 coordination with the European Commission and

 16 being here today, but I also want to thank you

 17 because the last time I saw David was in Brussels

 18 where I was honored. As he invited me over to

 19 speak to a group, or as the European Commission's

 20 Conference of Over-the-Counter Derivatives Reform,

 21 he did put me in a room with about 400 people and

 22 put me on the dais, and then they didn't let me
 9

 1 leave for three or four hours. And I took a lot

 2 of very interesting and probing questions from

 3 end-users.

 4 But I really -- it's a great honor,

 5 David, you're here with your colleagues Sebastijan

 6 and Patrick, and -- is it Pierre or Pieter?

 7 Pieter -- and I look forward to ongoing

 8 cooperating with the European Commission on

 9 bringing comprehensive reform to the

 10 over-the-counter derivatives marketplace.

 11 I mean, last year's financial crisis

 12 really just reminded us what we knew, that our

 13 financial markets are global in nature. Capital

 14 and risk knows no geographic boundaries, and that

 15 what we have to do to respond to the worst crisis

 16 in 80 years, it is a response which needs to be

 17 global. In the United States, our legislative

 18 process is in full swing, as you know. This week

 19 the House of Representatives is debating the

 20 regulatory reform package that introduces

 21 comprehensive reform for over-the-counter

 22 derivatives for the first time. It is truly
 10

 1 historic what the House is taking up this week.

 2 The Senate, of course, will have their

 3 process and their own procedures. And, hopefully,

 4 with the support of the House later this week, the

 5 CFTC will continue to work with both chambers

 6 providing both advice and technical assistance to

 7 bring the most comprehensive and effective reform

 8 forward.

 9 Fortunately, I think it's that the U.S.

 10 is not alone in this, and in October the European

 11 Commission, with a lot of help from the four

 12 gentlemen that are in the room here, announced a

 13 broad agenda of regulatory reform in derivatives.

 14 The Commission's plan included similar

 15 provisions to what we have been recommending here,

 16 so though we have different cultures and different

 17 political systems, we're dealing and grappling

 18 with the same problem, and it appears -- I'm very

 19 optimistic -- it appears we're coming up to the

 20 same suggested solutions.

 21 The Commission proposals include central

 22 clearing -- I should say mandated central clearing
 11

 1 -- of derivative transactions that are

 2 standardized. It requires higher capital for

 3 customized over-the-counter derivatives

 4 transactions and mandates trading of all

 5 standardized transactions in regulated trading

 6 venues. So I'm very encouraged that we're moving

 7 in the same direction.

 8 Now again, though we have different

 9 cultures and political systems, we've been coming

 10 together with a consensus, and we're going to

 11 continue to have dialogues, and today is an

 12 important part of that as well. I think reform

 13 starts with bringing transparency to these opaque

 14 markets. Economists for decades have recognized

 15 that market transparency benefits the public, and

 16 if derivative users knew what others were paying

 17 to enter into similar contracts, would they not

 18 receive better pricing on their transactions?

 19 Isn't that really at the heart of what we're

 20 trying to do?

 21 I mean whether it's a small

 22 municipality, or a retailer, or an oil company,
 12

 1 they would all be able to make better decisions on

 2 their hedging; they would get better pricing on

 3 their contracts if it was based upon reported

 4 pricing and a broader market. I mean could you

 5 imagine an investor buying 100 shares of a

 6 security and not knowing where that security just

 7 traded? Would you even go into a store and buy an

 8 apple if you didn't know where the pricing of the

 9 apple was?

 10 But that's exactly what we ask end-users

 11 to do in the derivatives marketplace right now. I

 12 don't know. I mean the bill before the House does

 13 a great deal: It subjects Wall Street banks to

 14 broad regulatory requirements and also subjects

 15 Wall Street banks to a transparency requirement

 16 trading with each other where Wall Street banks

 17 trading between Wall Street banks would have to be

 18 brought into regulated trading platforms and

 19 clearing.

 20 But as Congress continues to debate

 21 regulatory reform in the over-the-counter

 22 derivatives marketplace, I believe it's critical
 13

 1 that we also bring this to the transactions with

 2 the end-users; that we not have exemptions from

 3 mandatory trading requirements for standardized

 4 transactions. I think that the only group that

 5 really benefits from these exemptions is Wall

 6 Street, and that end-users, whether they be small

 7 municipalities or the largest corporation,

 8 benefits from transparency in these marketplace.

 9 So during today's meeting, I look

 10 forward to hearing participants' views on the

 11 global financial system. I specifically would

 12 like to hear thoughts on how we're progressing and

 13 how that works in an international context. And I

 14 know that I've heard from some of the

 15 organizations represented around the table that

 16 the U.S. should not reform our regimes until

 17 foreign regulators reform theirs. I actually

 18 think it's in reverse. I think that if we don't

 19 reform our regulatory system, others around the

 20 globe will fail to reform theirs.

 21 And we've got a great consensus right

 22 now. I thank our friends from Europe for being
 14

 1 here and all the committee members, and I turn it

 2 back to Jill and my other commissioners.

 3 COMMISSIONER SOMMERS: Thank you, Mr.

 4 Chairman. Commissioner Dunn?

 5 COMMISSIONER DUNN: Thank you, Madam

 6 Chairman, for convening this Global Market

 7 Advisory Committee. I look forward to hearing

 8 from the experts gathered here today and hope that

 9 their thoughts and insight can help to inform the

 10 Commission of recently confronted bankruptcy

 11 issues and on the various over-the-counter

 12 derivatives proposals.

 13 It is important that we take the time to

 14 look at the global impact that the financial

 15 meltdown has had on the sector of the financial

 16 market that the CFTC regulates. We need to review

 17 the lessons learned and understand the

 18 shortcomings of our current domestic and global

 19 regulatory regimes. And, most importantly, we

 20 need to work with regulators around the world to

 21 address those issues that are identified.

 22 While Thomas Freedman's notion that the
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 1 world is flat has gained mainstream acceptance in

 2 recent years, it is also clear to me that not only

 3 does equal opportunity exist in our global

 4 marketplace but also a degree of interdependency.

 5 What we do here in the U.S. affects markets around

 6 the world and actions taken around the world

 7 affects markets here. Accepting the existence of

 8 global interdependency, we as regulators must work

 9 harder to understand developments around the world

 10 and be more cognizant of the global effects that

 11 our own actions may have. The world's regulatory

 12 bodies must work in harmony to address needed

 13 changes to prevent future financial crisis, and if

 14 one does arrive, be prepared to face it on a

 15 global playing field.

 16 Today we'll examine some of the concerns

 17 that became evidence over the last couple of years

 18 and discuss what actions are necessary to address

 19 these actions. We're really taking our cue from

 20 the heads of states. At recent G-8 and G-20

 21 meetings have resulted in heads of states calling

 22 for the need for regulators to address excessive
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 1 price volativity [sic] and energy and agricultural

 2 markets. The September G-20 called for work by

 3 regulators in four areas: collect data on large

 4 concentrations of trader positions on oil

 5 commodity markets; implement a data collection

 6 system covering OTC oil markets; publish more

 7 detail and disaggregated data and analyze the

 8 issue of excessive volativity; and review of

 9 possible measure to prevent market manipulation.

 10 International organization of security

 11 commissions has reconvened its commodity futures

 12 market task force to address the G-20 directives.

 13 If we are to make headway in providing true global

 14 reform, it is important that we embrace this

 15 notion of global interdependency and work together

 16 to diligently and quickly provide the world

 17 meaningful financial regulatory oversight.

 18 Today's meeting is a milestone in the journey to

 19 achieve that end.

 20 I thank all of you for your

 21 participation and work.

 22 COMMISSIONER SOMMERS: Thank you,
 17

 1 Commissioner Dunn. Commissioner Chilton?

 2 COMMISSIONER CHILTON: Thanks, Madam

 3 Chair, and welcome to everybody, particularly our

 4 new members. And thinking about sort of half of

 5 the continental United States as encumbered with

 6 some sort of severe weather today, I'm pleased

 7 that everybody was able to get here or will be

 8 here. It made me think of a talk I gave last year

 9 which was entitled Driving On Ice.

 10 And what I said about regulatory reform,

 11 the analogy I tried to make was that when you're

 12 driving in bad weather, when you're driving in ice

 13 that maybe, if you veer too far one way -- and I

 14 made the analogy that we may be veered too far to

 15 the right since 1999 with banking and mortgage and

 16 deregulating credit and false swaps -- that we

 17 need to be careful not to oversteer and to go back

 18 too far; that the middle of the road sometimes is

 19 a good place to be. And I think there's a

 20 recognition that there are appropriate guard rails

 21 on this road to regulatory reforms, metaphorical

 22 road to regulatory reform, that we can all agree
 18

 1 on whether or not we're first or the E.U. is

 2 first. It doesn't bother me. I associate my

 3 remarks with the Chairman, I don't have a lot of

 4 trepidation about going first just as long as we

 5 do it in a fashion that isn't overzealous.

 6 The first speed limit in the world was

 7 in Britain. It was two miles an hour in 1865.

 8 That's in the city for horseless carriages; four

 9 miles an hour in the country, and you had to have

 10 three people: two drivers and another fellow

 11 walking out in front of the horseless carriage

 12 with a red flag waving it. Now that's

 13 overzealous.

 14 So as long as we are thoughtful -- and

 15 keep in mind what our end game is and that's

 16 protecting consumers -- and to my mind protecting

 17 consumers means ensuring that the commercial

 18 interest, the reason these markets sort of began

 19 are able to legitimately use the markets to hedge

 20 the risk and price discovery, I mean it doesn't

 21 ultimately become what people are concerned about

 22 it, justifiably or not, a private jungle gym for
 19

 1 speculators, to play on, that I think we'll get it

 2 right.

 3 And in particular, if we look, if that

 4 wasn't enough reason to move forward with

 5 thoughtful regulation, if you look at what's been

 6 going on just this week in the U.S. with EPA and

 7 their designation of carbon and what they're

 8 talking about in Copenhagen -- and Commissioner

 9 O'Malia may have a better clue than I since he's

 10 been up on the Hill more recently -- but I

 11 wouldn't be surprised if we don't have some sort

 12 of cap and trade bill at some point that could

 13 equal a $2 trillion transactional market, the

 14 largest physical commodity market in the world,

 15 more than better -- larger not better -- larger

 16 than crude oil.

 17 So without additional authority like the

 18 Chairman was talking about from Congress,

 19 additional rulemaking changes from the CFTC

 20 without the additional staff that Commissioner

 21 Dunn's talked about so many times, the additional

 22 resources, there's a whole host of problems that
 20

 1 we can open the door for.

 2 But in summation, I'm not worried about

 3 going forward as long as we get it right. As long

 4 as we keep our eye on the ball and think about,

 5 you know, we're going to protect consumers, and I

 6 think we'll be fine.

 7 Thanks, Madam Chair.

 8 COMMISSIONER SOMMERS: Thank you,

 9 Commissioner Chilton. Commissioner O'Malia?

 10 COMMISSIONER O'MALIA: It's no fun

 11 following Bart. Really, 1865? I don't think it

 12 was four, I think it was in kilometers at the

 13 time.

 14 SPEAKER: We have the question. Read

 15 the footnote.

 16 COMMISSIONER O'MALIA: Okay. Thank you,

 17 Commissioner Sommers, for organizing this meeting,

 18 and I appreciate the willingness of all the

 19 participants, including our friends from Europe,

 20 to join us today to share their views and

 21 knowledge with the Commission regarding the state

 22 of our global over-the-counter markets and the
 21

 1 opportunities for regulatory reform.

 2 In response to the financial crisis,

 3 both the United States and European Union

 4 regulators have recommended significant reforms to

 5 these markets. Both proposals seek to better

 6 manage risk, increase transparency through

 7 improved trade reporting, and expand the use of

 8 clearing to minimize counterparty trading exposure

 9 and reduce systemic risk.

 10 This meeting is timely and will provide

 11 the Commission with the opportunity to compare

 12 U.S. and E.U. proposals to regulate these

 13 increasingly global markets. According to the

 14 Bank of International Settlements, the global OTC

 15 market size is estimated at $600 trillion. Over

 16 90 percent of the Fortune 500 companies use these

 17 products in the course of business to hedge risk,

 18 manage global activities ranging from interest

 19 rates, foreign exchange commodities, and the CDS

 20 market. As regulators, we must be cognizant that

 21 the U.S. is not the center of all trading and

 22 markets. In fact, 80 percent of all OTC trades by
 22

 1 value are executed in markets outside the U.S.

 2 Interest rates make up $420 trillion of the $600

 3 trillion OTC markets with over 74 percent of

 4 trades done overseas.

 5 Foreign exchange trades are worth $50

 6 trillion and with roughly 85 percent of trades

 7 executed outside the U.S. We must ensure our

 8 cross-border rules and regulations do not offer

 9 opportunities for regulatory arbitrage or

 10 undermine U.S. Competitiveness.

 11 I hope to see a regulatory framework put

 12 in place that will establish clear market rules

 13 for years to come and to enable these markets to

 14 serve as a cost-effective mechanism in managing

 15 commercial risk. The rules we put in place today

 16 also must expand our capability to identify and

 17 management systemic risk for the future.

 18 I'm pleased to have several experts here

 19 to provide the views on U.S. and regulatory

 20 reforms, and I look forward to their

 21 presentations. Thank you.

 22 COMMISSIONER SOMMERS: Thank you,
 23

 1 Commissioner O'Malia.

 2 I want to take care of a couple of

 3 housekeeping items. The microphones, I think,

 4 will not work if there are more than two on at one

 5 time, so when you're finished speaking if you'll

 6 just turn your mike off. If you have a question,

 7 if you'll raise your name placard, we can call on

 8 you for questions.

 9 And for the court reporter, if you could

 10 introduce yourself before asking a question. I'm

 11 going to have everybody introduce themselves

 12 around the table, but I first wanted to check, we

 13 have a couple of members that I believe are

 14 participating via telephone: Jim Newsome, former

 15 CFTC Chairman and CME board member. Jim, are you

 16 on the phone?

 17 MR. NEWSOME: I am on the phone,

 18 Commissioner.

 19 COMMISSIONER SOMMERS: Great. Thank

 20 you, Jim. And Mike Dawley who's Chairman of the

 21 FIA, I believe was also going to participate via

 22 telephone. Mike, are you there? Maybe not, okay.
 24

 1 And we are supposed to have Roger Liddell via

 2 video conference for this part of the meeting as

 3 well, so hopefully that will be hooked up shortly.

 4 So I'll start with Eric, if you'd like

 5 to go around the table and introduce yourself.

 6 MR. LIDDELL: I can hear you and see

 7 you, but I don't know if you can hear or see me.

 8 Roger.

 9 COMMISSIONER SOMMERS: Great, Roger,

 10 thank you. Thanks for being with us.

 11 MR. VINCENT: Thanks, Commissioner.

 12 Eric Vincent. I'm president of Osprai Management

 13 and Board Member of the Managed Funds Association.

 14 MR. CALLAHAN: My name is Thomas

 15 Callahan. I'm Executive Vice President of NYSE

 16 Euronext and CEO of NYSE Liffe U.S., the U.S.

 17 derivative exchange of NYSE Euronext.

 18 MR. OKOCHI: Good afternoon. My name is

 19 Jiro Okochi. I'm the CEO and Cofounder of Reval.

 20 MR. KLEIN: Good afternoon. My name is

 21 Bob Klein. I'm a Managing Director and Counsel at

 22 Citi Group.
 25

 1 MS. MODERO: I'm Joanne Meedero, a

 2 Managing Director of Black Hawk.

 3 MR. CRAPPLE: George Crapple, CoChairman

 4 and Co-CEO of Millburn Ridgefield. We're a CTA

 5 and CPO. I'm also on the Board of the FIA and the

 6 NFA.

 7 PROFESSOR FILLER: My name is Ronald

 8 Filler. I'm a professor of law now and Director

 9 of the Center on Financial Services Law at New

 10 York Law School.

 11 MS. MESA: I'm Jackie Mesa, the Director

 12 of International Affairs at the CFTC.

 13 MR. WASSERMAN: Bob Wasserman, Associate

 14 Director in DCIO here at CFTC.

 15 MR. WRIGHT: My name's David Wright.

 16 I'm the Deputy Director-General in the European

 17 Commission dealing with financial markets.

 18 MR. DOHNALEK: I'm Dave Dohnalek,

 19 Treasurer of the Boeing Company.

 20 MS. LITT: I'm Bonnie Litt. I'm a

 21 Managing Director and Associate General Counsel at

 22 Goldman Sachs, and I'm also president of the
 26

 1 Executive Committee of the Law and Compliance

 2 Division of FIA.

 3 MR. ROTH: I'm Dan Roth from the

 4 National Futures Association.

 5 MR. WILSON: I'm Donald Wilson. I'm the

 6 Founder and CEO of DRW Trading, which is a

 7 proprietary trading group. We focus on providing

 8 liquidity in exchange traded markets.

 9 COMMISSIONER SOMMERS: Thank you,

 10 everyone. I'm going to go ahead and get started

 11 with the first part of our meeting, which is

 12 having Jackie give us an update on IOSCO issues.

 13 Thank you, Jackie.

 14 MS. MESA: Thank you, Chairman Sommers.

 15 I was hoping that maybe you just ate right through

 16 my time, and I would just sit here and pleasantly

 17 smile at everyone. But seeing that you're still

 18 going to want me to go forward, I wanted to

 19 provide an update on IOSCO issues, and IOSCO has

 20 been very busy in the last year as you can

 21 imagine. So I won't go through everything they're

 22 working on but sort of what they've been doing
 27

 1 post-crisis.

 2 In response to a G-20 call for action,

 3 IOSCO formed three task forces: one on unregulated

 4 markets and products, one on unregulated entities,

 5 and one on short selling. The CFTC participated

 6 in two of those, unregulated markets and products

 7 and the task forces on unregulated entities. Both

 8 task force have released final reports adopted by

 9 IOSCO.

 10 In the unregulated markets and products

 11 report, it focused on two instruments that were

 12 viewed to be at the core of the crisis:

 13 collateralized debt obligations and credit default

 14 swaps. On CDOs, IOSCO felt that because CDOs

 15 contained such complex leverage that even an

 16 accredited investor sometimes had difficulty

 17 understanding the risk. IOSCO recommended several

 18 actions: 1) to improve disclosure; 2) encourage

 19 members to reconsider the standard of a

 20 sophisticated or a credited investor; and finally,

 21 ask regulators to examine incentives, and that's

 22 typically known as the skin in the game
 28

 1 requirement.

 2 Regarding CDS, IOSCO encouraged

 3 standardization of products. For those that were

 4 standardized, IOSCO encouraged clearing and

 5 exchange trading of those CDSs and recommended

 6 that counterparties have appropriate capital and

 7 margining for nonstandardized products. As you

 8 can see, I think the U.S. and E.U. and other

 9 countries have moved generally in that direction

 10 which was the agreement of regulators very early

 11 on right after the crisis.

 12 Currently, both of these task forces are

 13 considering monitoring the implementation of the

 14 recommendations and are considering particularly

 15 with the unregulated markets and products if this

 16 can be extended to all OTC products.

 17 On unregulated entities in June 2009,

 18 the TC endorsed and published a report and

 19 recommended six principals for hedge fund

 20 regulation: 1) Hedge fund managers should be

 21 subject to mandatory registration; 2) that hedge

 22 fund managers which are required to be registered
 29

 1 should be subject to appropriate ongoing

 2 regulatory requirements -- and there are a number

 3 of details which I won't go through here; but

 4 they, prime brokers and banks providing funding to

 5 hedge funds, should be subject to mandatory

 6 registration and regulation and a public oversight

 7 system and have them place appropriate risk

 8 management systems and controls; that hedge fund

 9 advisors and fund brokers should provide to the

 10 relevant regulator information for systemic risk

 11 purposes. This is the area that IOSCO is working

 12 on now and trying to go forward on a united front

 13 on what information they're going to collect from

 14 hedge funds; 5) that regulators should encourage

 15 and take account of the development,

 16 implementation, and convergence of the industry

 17 good practices where appropriate; and 6) that

 18 regulators should have the authority to cooperate

 19 and share information.

 20 IOSCO is also up getting its 30

 21 principles for regulation for securities and

 22 futures regulators and is going to adopt at least
 30

 1 three new principles: 1st) on systemic risk; 2nd)

 2 on the perimeter of regulation; and 3rd) for

 3 credit rating agencies, auditors, and other

 4 "information providers."

 5 There are also separate standards for

 6 clearing and settlement systems, i.e., the IOSCO

 7 CPSS standards. These are also going to be under

 8 significant review. Right now IOSCO is reviewing

 9 these standards to update for OTC clearing but

 10 during this update, discovered that there are a

 11 number of areas that needed significant review and

 12 update and have agreed to go forward and revise

 13 those principles.

 14 I'm going to address a couple more areas

 15 that IOSCO is looking at. One is direct

 16 electronic access, and the reason I'm pointing

 17 this out is because this was the subject of the

 18 last GMAC meeting where we had significant

 19 discussion.

 20 IOSCO did put out a report in this area

 21 for consultation, and one of the primary

 22 recommendations was that markets should not offer
 31

 1 direct electronic access unless they can ensure

 2 automatic pretrade controls that allow the

 3 responsible firms the ability to limit the market

 4 members' exposure.

 5 Although a majority of commentators

 6 supported the proposed principles, some objected

 7 to mandating the use of automated risk limits

 8 controls as an infringement on their activities.

 9 Their standing committees are still looking at

 10 comments and deciding what is appropriate given

 11 the high speed algorithmic trading that occurs

 12 today and making sure that regulators are up to

 13 date and in their rules and regulations.

 14 And, finally, the last point I'm going

 15 to talk about is the commodity futures markets

 16 task force, and it's the subject that Commissioner

 17 Dunn highlighted in his opening remarks. This is

 18 a call by the G-20 to specifically look at oil

 19 markets and how regulators can handle the

 20 volatility over the last couple of years in the

 21 oil markets. Specifically, they asked for us to

 22 look at large concentrations and to look at on
 32

 1 exchange and over-the-counter.

 2 We met just Monday in London, so sorry

 3 if I look a little tired. I just flew back, and

 4 some of you flew here today as well. And it was a

 5 very good meeting, and there was substantial

 6 progress made during the meeting on Monday.

 7 Regulators are going to take steps to look at oil

 8 trading and over-the-counter markets to actually

 9 aggregate that data and put it forward for the

 10 public and to make sure that they are properly

 11 looking for manipulation and other abuses in the

 12 oil markets.

 13 So that's it for me. Thank you.

 14 COMMISSIONER SOMMERS: Thank you,

 15 Jackie. Does anyone have any particular questions

 16 on the IOSCO projects that are ongoing? If not,

 17 we're going to move on to the first part of our

 18 meeting, and we are honored to have Ron Filler,

 19 who is a long-time member of GMAC, back with us

 20 today. Thank you for being here, Ron, and

 21 participating as he's going to give us an overview

 22 of the bankruptcy issues associated with Lehman
 33

 1 Brothers bankruptcy that happened last year.

 2 PROFESSOR FILLER: Thank you,

 3 Commissioner Sommers. As I mentioned, I am now a

 4 professor of law, but I think the reason I was

 5 asked to come here is, before joining the faculty

 6 at the law school, I was a managing director in

 7 the Capital Markets Prime Service Division at

 8 Lehman Brothers for over 15 years where my

 9 responsibilities included a variety of business

 10 and legal issues affecting Lehman's global futures

 11 business.

 12 So I hope to use those perspectives and

 13 during my 30-plus years in this industry, I've had

 14 the opportunity and privilege of serving on a

 15 number of governmental exchange industry and

 16 clearing house boards and advisory committees.

 17 And I want to thank Commissioner Sommers

 18 for using this forum to bring this issue to this

 19 discussion. This issue goes to the very heart and

 20 purpose of our industry, and that's the providing

 21 soundness and safety to customers who trade not

 22 only futures but this issue has also got to be
 34

 1 addressed by this agency; and, as Commissioner

 2 Sommers mentioned, by global regulators as you

 3 tackle concepts like portfolio margin.

 4 I deal with the OTC clearing issues.

 5 When you deal with the concept of segregation and

 6 the role that segregation should or may play in

 7 connection with these and other concepts, so it's

 8 a very important issue and it's a global issue.

 9 And the task before this Committee is a very

 10 challenging one because of the global issues and

 11 the differences in the bankruptcy laws that exist

 12 around the world.

 13 So let's go back to September the 15th,

 14 2008, a little over 15 months ago -- it seems like

 15 a lifetime -- but on Monday morning, September the

 16 15th, 2008, as you may remember and I have a paper

 17 for you that has a lot of the facts in it --

 18 Lehman Brother Holding, the parent holding company

 19 of Lehman and of all of its affiliates, filed for

 20 bankruptcy. And many of the Lehman subsidiaries

 21 around the world also filed for bankruptcy that

 22 same morning.
 35

 1 Lehman Brothers, Inc., that regulated

 2 broker dealer in FCM, does not file for

 3 bankruptcy; it still has the necessary capital to

 4 play the game, although by the end of that week on

 5 September the 19th that entity, the LBI, also

 6 files for bankruptcy. And while Lehman has, I

 7 think when we filed our org. chart listing all the

 8 different maps, material-affiliated persons,

 9 probably a chart of some 200 different companies,

 10 I want to focus just on those Lehman entities that

 11 held or dealt with futures clients.

 12 So you have LBI here, Lehman Brothers,

 13 Inc., in the U.S. You have Lehman Brothers

 14 International, Europe, or LBIE, or Lehman London.

 15 You have Lehman Brothers, Japan, which was the

 16 clearing member of the three exchanges in Tokyo.

 17 You have Lehman Brothers Futures, Asia Limited, or

 18 which was a clearing arm in Hong Kong, and you had

 19 Lehman Brothers PTE, which was the clearing firm

 20 on the SGX Exchange in Singapore. And the way the

 21 Lehman system was structured from a futures

 22 perspective, LBI -- only LBI and LBIE held client
 36

 1 accounts. LBI probably had about 65 percent of

 2 the business, and LBIE had about 35 percent of the

 3 business.

 4 And also what's important in this,

 5 thinking about the structure and the issues that

 6 we're about to talk about, LBI would then have a

 7 customer omnibus account with each of the other

 8 Lehman affiliates around the world that acted as

 9 the respective clearing member on those clearing

 10 houses. And to the extent Lehman did not have a

 11 clearing membership on some of the exchanges,

 12 where we use a third-party clearing firm, LBI

 13 would have the customer omnibus account with those

 14 third-party firms.

 15 So LBIE was the clearing arm for Europe,

 16 LBI was the clearing arm for the U.S. and had the

 17 relationships with all of the other Lehman

 18 affiliates primarily in Asia. So when Lehman

 19 Brother Holdings filed for bankruptcy, and if you

 20 also remember Monday, September the 15th, the

 21 markets were extremely volatile that day. So I

 22 think it's best in looking at the picture and to
 37

 1 try to figure out what issues, what reforms, what

 2 concepts need to be addressed, I like to separate

 3 what happened here in the U.S. and then look what

 4 happened outside the U.S. for discussion purposes.

 5 In the U.S., I think with the exception

 6 of one small glitch which we're going to talk

 7 about, the system worked pretty well. Monday

 8 morning -- and Lehman's client business was

 9 strictly institutional, probably some of the

 10 premier mutual funds, pension plans, state

 11 retirement plans, money managers, hedge funds,

 12 corporations, and governments -- we really had, I

 13 considered, a premier list of institutional

 14 clients.

 15 Many of them had multiple clearing

 16 relationships. They would be not only using

 17 Lehman as their cleaning firm but they would have

 18 clearing relationships with other clearing firms

 19 on the street. And those firms that had clearing

 20 relationships with those clients, had accounts

 21 with us, that also had an account at another firm,

 22 obviously, with the news breaking that morning,
 38

 1 they started sending us what we call a, in the

 2 industry, an ex-bid transfer letter requesting

 3 that their open positions be transferred off the

 4 books of Lehman, LBI, to the other clearing firms.

 5 And in the course of that week that's what

 6 happened.

 7 Monday night the positions that we got

 8 letters for removed to other firms. Tuesday --

 9 that happens after the close of business on Monday

 10 -- Tuesday morning we all come in and the

 11 positions were closed out and therefore no open

 12 positions remained on the books of Lehman for that

 13 account. We then transferred the assets that we

 14 use for margin patch and collateral to the

 15 clearing member that received those positions on

 16 close of business that night.

 17 Tuesday night -- Tuesday during the day

 18 the same thing happened. We got another lot of

 19 requests, and Wednesday morning we transferred the

 20 funds. Wednesday night we had -- Wednesday during

 21 the day, we got more requests. Everything was

 22 working smoothly until Thursday. And that's the
 39

 1 one glitch that, to be honest, I don't have an

 2 answer for you. I know it's an answer or an issue

 3 that maybe the Commission is looking at, but our

 4 custodial bank, J.P. Morgan Chase, for whatever

 5 reason -- and I have never seen the reason behind

 6 it -- froze the assets that were held in the

 7 segregated account. And so while all the

 8 positions got moved that week and the moneys had

 9 been flowing out in a very smooth way Monday,

 10 Tuesday, Wednesday and so forth, on Thursday those

 11 assets were frozen. But through the great efforts

 12 of the Commission staff and others in the

 13 industry, about -- was it eight or ten days later?

 14 -- J.P. Morgan eventually did move the cash and

 15 collateral that we held with that bank over to the

 16 respective clearing firms that receive it.

 17 So addressing the U.S. approach, I would

 18 say the systems worked. The laws dealing with

 19 segregation, the regulations dealing with

 20 segregation under 1.20, it worked for the most and

 21 very successful. And by the close of business on

 22 Friday, September the 19th, if you recalled after
 40

 1 the close of business that day, those clients who

 2 did not have a clearing account at another firm,

 3 all of their positions were moved to Barclay's

 4 Capital which bought all of the client assets and

 5 accounts at Lehman after the close of business on

 6 that Friday.

 7 So by the close of business of that week

 8 the great news is all the positions and eventually

 9 all of the moneys flowed over to the customers and

 10 clearing firms, I should say, where the customers

 11 now had accounts.

 12 So the system works here, and it worked

 13 pretty well. Now let's turn our attention --

 14 CHAIRMAN GENSLER: Could I just ask one

 15 quick question?

 16 PROFESSOR FILLER: Sure.

 17 CHAIRMAN GENSLER: What portion moved

 18 during the week versus the Barclay's portability

 19 at the end of the week?

 20 PROFESSOR FILLER: You mean the last

 21 part of the piece?

 22 CHAIRMAN GENSLER: Yeah. I mean did,
 41

 1 you know --

 2 PROFESSOR FILLER: The answer, Chairman

 3 Gensler, is there was just those client accounts

 4 that did not have a multiple clearing

 5 relationship. I don't know the exact number, but

 6 I'd probably say it's about 25, 30 percent. I

 7 may be wrong in that number, it's a guess on my

 8 part.

 9 CHAIRMAN GENSLER: And so the vast, or

 10 the majority, maybe 70-75 percent has moved

 11 already.

 12 PROFESSOR FILLER: Correct.

 13 CHAIRMAN GENSLER: And 20 --

 14 PROFESSOR FILLER: This was just -- and

 15 it was impossible for those firms or clients to

 16 open up an account that quickly that week with all

 17 the things going on. And with Barclay's acquiring

 18 all of the accounts that still remained on the

 19 books of Lehman that day, the good news is all the

 20 client positions got moved healthily.

 21 CHAIRMAN GENSLER: Right. And just to

 22 clarify, this is all just futures, it's not what
 42

 1 happened with prime or (inaudible) --

 2 PROFESSOR FILLER: Prime or futures got

 3 --

 4 CHAIRMAN GENSLER: -- got force swaps.

 5 PROFESSOR FILLER: IMF futures got --

 6 CHAIRMAN GENSLER: Right. Right, so --

 7 all right, thanks.

 8 PROFESSOR FILLER: No, the swap world

 9 we're still dealing with. And it's interesting

 10 what you raise because the equity world is

 11 slightly different than the futures, and, you

 12 know, a lot of people will say, boy, it took five

 13 days to move those futures positions. To me

 14 that's a good thing. Some people say it should

 15 have been done in one day or two days or three

 16 days. But when you compare the futures regime to

 17 even the equity regime, it's a much better regime

 18 to facilitate transfers of both positions and

 19 collateral to another firm.

 20 Outside the U.S. we got a bigger issue,

 21 and that issue I think if you talk to any lawyer

 22 in this room, prior to September the 15th you
 43

 1 would have got a different answer to the question

 2 about the raise or the issue than what we now

 3 know. And what we learned post-Lehman is that the

 4 bankruptcy laws trump all the regulations that we

 5 have in place to protect customers. And the

 6 bankruptcy laws in London and Japan and Hong Kong

 7 preempted all of the rules and regulations and

 8 customer protections that we thought were in place

 9 within the connection with both not only LBI but

 10 LBIE clients as well.

 11 London, as you know, the U.K. has a

 12 client money rule regime which is very similar to

 13 the segregation rule here. There are some subtle

 14 issues dealing with what happened in London, but

 15 the concepts of customer protections are quite

 16 similar between London and the U.S., but the

 17 bankruptcy laws differ significantly outside the

 18 U.S. versus what we have here. And if you think

 19 about one of the more forward-thinking concepts

 20 that we have here in the U.S. regarding bankruptcy

 21 laws, we have specific provisions under the U.S.

 22 bankruptcy code that deals with the bankruptcy of
 44

 1 a securities firm called SICP.

 2 We have a different set of provisions

 3 dealing with the bankruptcy of a commodity firm

 4 and it's called "segregation," and the rules in

 5 specific behind provisions, I should say, under

 6 the bankruptcy code, all of which are designed to

 7 protect the client assets against the claims of

 8 creditors of the bankrupt firm.

 9 So our regime is pretty good. But now

 10 that you're considering portfolio margining,

 11 you're considering OTC clearing, there is no

 12 concepts of swap dealers in those codes.

 13 There is no -- and the issue that we

 14 deal with in the U.S., and it varies even between

 15 securities and futures, is a concept called,

 16 specifically, an identifiable property. How do

 17 you treat assets of a bankrupt estate that

 18 belonged to a particular individual versus cash.

 19 And with futures margin and with OTC clearing with

 20 cash being a principal player, you got to be very

 21 careful and you got to address these issues just

 22 to make sure customer assets are protected down
 45

 1 the road.

 2 Now let's go across the ocean. Monday

 3 morning, as I said, all four of these Lehman

 4 affiliates as well as many others file for

 5 bankruptcy in their respective countries. So I'm

 6 going to focus mainly on LBIE, meaning Lehman

 7 London, but the issues that happened in London

 8 also exist as we speak in Japan and Hong Kong,

 9 Singapore, and everywhere else. Morning the U.K.

 10 government appoints, as you know, Price Waterhouse

 11 Cooper as the administrator. And the

 12 administrator is very similar to the concept of

 13 bankruptcy, a trustee in bankruptcy that we have

 14 here.

 15 And PWC comes in Monday and really

 16 doesn't allow any transactions, transfers, or even

 17 positions liquidations to occur. Tuesday they do

 18 not allow any transfers or position liquidations

 19 to occur. By Wednesday afternoon, through a lot

 20 of pressure, through put on by the PWC through a

 21 lot of other entities, they finally allowed

 22 positions to either be liquidated or transfers to
 46

 1 other firms.

 2 Now I want to give some special credit

 3 right now to LCH Clear Net. I know Roger is going

 4 to be talking in a second.

 5 I want to give special credit to Andreas

 6 Preuss at Eurex Clearing. Those two clearing

 7 houses stepped up to the plate and really helped

 8 what's happened on Thursday and Friday of that

 9 week. On Thursday and Friday, every customer

 10 position held at LBIE got transferred to other

 11 firms, and, to me, in a two-day period it was a

 12 miraculous transfer. But by the close of business

 13 on Friday, September the 19th, no Lehman entities

 14 held any customer position. That's the great

 15 news.

 16 The bad news is not one dollar has been

 17 transferred out of the bankruptcy estate in the

 18 past 15 months. Margin, as we all know, are used

 19 to provide risk protections to the clearing firms,

 20 and when the positions are liquidated or

 21 transferred and there's no longer a need for

 22 margin, there's no longer a need for the clearing
 47

 1 ember to hold that cash or collateral for margin.

 2 By September the 19th with all the

 3 positions around the world transferred out,

 4 there's no longer a need for the margins to be

 5 held by any of the bankrupt estates, but because

 6 outside the U.S. as same pot that the futures

 7 margin was held, you have securities margin, you

 8 have OTC swap margin or cash, or collateral, and

 9 when you have the one-pot approach issue, they're

 10 not going to allow the moneys that are held that

 11 were strictly for futures to be released until

 12 they resolve the entire pot.

 13 And that's one of the issues that I hope

 14 that this committee and the Commission through

 15 IOSCO or whatever, how do we address the

 16 bankruptcy provisions globally? Bring them up to

 17 some level where clients of a bankrupt estate do

 18 receive the necessary protections, and not only to

 19 protection of the assets but the rights to get the

 20 assets distributed if the risks are no longer

 21 associated. The products are no longer on the

 22 books of the bankrupt estate and no longer in the
 48

 1 need for margin, how do we get margins or cash,

 2 client cash or collateral transferred out of the

 3 estate and back into the hands of the customers or

 4 their new clearing firms?

 5 So it was a lesson that I think was

 6 learned post-Lehman. I think if you asked me that

 7 question before September the 15th, I would have

 8 said of course the margins would have been

 9 transferred out. But I was wrong.

 10 Yes, sir?

 11 CHAIRMAN GENSLER: I clearly know a lot

 12 less about this subject than you do, but I didn't

 13 follow. Your U.S. company by Friday, everything

 14 had been moved out, and I thought you were saying

 15 is the London Company, this LBIE, though it was a

 16 different process by that Friday, also everything

 17 -- because you gave a compliment to Roger and

 18 Andre.

 19 PROFESSOR FILLER: Positions were moved

 20 but not the underlying cash or collateral that was

 21 used to margin those positions.

 22 CHAIRMAN GENSLER: Oh, I see, so that --
 49

 1 PROFESSOR FILLER: It's the margin --

 2 CHAIRMAN GENSLER: -- the current assets

 3 --

 4 PROFESSOR FILLER: -- the margin that

 5 was there in September of 2008 --

 6 CHAIRMAN GENSLER: Still sits there

 7 today.

 8 PROFESSOR FILLER: -- still sits there.

 9 The counterparty might have had the trade moved,

 10 but the --

 11 CHAIRMAN GENSLER: Right, and so --

 12 PROFESSOR FILLER: Then they had to have

 13 a lot of lawyers chase after the margin.

 14 CHAIRMAN GENSLER: Well, if you think

 15 about it, the client base were a lot of large U.S.

 16 mutual funds and pension plans who had a global

 17 trading strategy. Maybe they were trading

 18 equities globally, and they used the stock index

 19 futures outside the U.S. as a hedge. Those

 20 positions --

 21 SPEAKER: (inaudible)

 22 CHAIRMAN GENSLER: I understand that.
 50

 1 So in the U.S. The position and the marge moved

 2 --

 3 PROFESSOR FILLER: Correct.

 4 CHAIRMAN GENSLER: -- by Friday. There

 5 was --

 6 PROFESSOR FILLER: Well, the margin with

 7 a little bit of a glitch.

 8 CHAIRMAN GENSLER: Yeah. There was a

 9 glitch by Friday it moved, right, that J.P.

 10 Morgan glitch?

 11 PROFESSOR FILLER: Well, it was about a

 12 week later the margin got -- but it got moved.

 13 CHAIRMAN GENSLER: But in Europe the

 14 positions were moved but not the margin.

 15 PROFESSOR FILLER: Correct.

 16 CHAIRMAN GENSLER: I got that.

 17 PROFESSOR FILLER: A couple of changes

 18 around the world chose not to allow the transfers.

 19 They were smaller amount.

 20 They were not significant to our client

 21 base, but a couple of smaller changes chose to

 22 liquidate and not allow the transfers to occur.
 51

 1 So those are probably the exceptions on the

 2 positions, or the open positions. But as you're

 3 going to hear probably today from other speakers,

 4 the issues outside the U.S. are not just

 5 futurecentric; it's because of the one-pot

 6 approach for all products you have that issue that

 7 needs to be addressed and try to figure out what

 8 reforms, either legislative or regulatory, are

 9 needed to provide greater protections to

 10 customers, because it is a global market.

 11 MS. LITT: Ron, in the jurisdictions

 12 where positions were liquidated, what happened to

 13 the release of margin in connection with those

 14 positions?

 15 PROFESSOR FILLER: No difference.

 16 MS. LITT: No difference. It was all

 17 held up, yes.

 18 PROFESSOR FILLER: It was. Those are

 19 both European exchanges, Bonnie.

 20 MS. LITT: Mm-hmm.

 21 PROFESSOR FILLER: And LBIE had a

 22 customer omnibus account --
 52

 1 MS. LITT: Right.

 2 PROFESSOR FILLER: -- and they've still,

 3 to my knowledge they're still holding them. And

 4 they may have been returned to PWC. I don't know

 5 the answer to your question.

 6 The same thing happened with LCH and

 7 UREK. We had a lot of client margins, obviously,

 8 to place with the clearing houses to clear those

 9 positions. I really haven't stayed with the issue

 10 of what happened. Did PWC collect those assets

 11 and still holding those assets?

 12 The one thing I have heard, and again,

 13 by the way, I was not a Lehman at the time. They

 14 invited me back that week to come help, so I want

 15 to make that straight. I was in academia land --

 16 and, by the way, academic land is great. I

 17 haven't followed what happened to the moneys, what

 18 happened with the PWC. So at LCH they had a bunch

 19 of client assets because Lehman was clearing.

 20 When the positions got moved, did they give it to

 21 PWC?

 22 And the one thing I have heard, and I
 53

 1 can't verify this, is that the assets around the

 2 world are still protected, still being held? It

 3 just haven't been released, so that's the key part

 4 of the issue.

 5 COMMISSIONER SOMMERS: Actually, Roger

 6 may --

 7 MR. NEWSOME: Hey, Ron, this is Jim

 8 Newsom.

 9 COMMISSIONER SOMMERS: Okay.

 10 MR. NEWSOME: One question. On the

 11 exchanges that forced liquidation, how quick was

 12 the liquidation period and how damaging was that

 13 to the customers?

 14 PROFESSOR FILLER: Thank you, Jim. I

 15 think they happened on that Wednesday of that

 16 week. I mean I was on -- I was brought back, as I

 17 mentioned. I was on the phone call with those

 18 officials at those exchanges pleading with them

 19 from a public interest, public policy perspective

 20 that it's not in your interest to liquidate. And

 21 we had a home for those, so why not transfer them,

 22 let's say, to a Goldman Sachs that night?
 54

 1 They're no longer on the books of LBIE,

 2 they'll be on the books of Goldman Sachs at that

 3 particular exchange, but they just chose to

 4 liquidate.

 5 Now, the good news is it was a very

 6 small portion of the total pot.

 7 COMMISSIONER SOMMERS: Eric, do you have

 8 a question?

 9 MR. CRAPPLE: Ron? Sorry -- when the

 10 LBIE positions moved without the money, did the

 11 new clearing firms require that margin to be

 12 deposited before they would accept?

 13 PROFESSOR FILLER: No, I think -- well,

 14 as in any exit transfer, you take the positions

 15 and expect the margins to come the next day, given

 16 the fact that a lot of the clients were, you know,

 17 very premier U.S. clients. What happened to

 18 those, those clients had to put up extra margins

 19 at the new clearing firms just to margin these

 20 positions that came on that Thursday and Friday of

 21 that week.

 22 MR. VINCENT: Ron, I assume that had
 55

 1 been bankruptcies before Lehman of other broker

 2 dealers in the U.K. whether it's Barings or -- I

 3 don't know of any others. But why do you think

 4 there was a lack of clarity in this case? Was it

 5 something unique to this situation, or was it -- I

 6 mean do you think there was a lack of diligence on

 7 the part of various market participants about how

 8 this regime worked?

 9 PROFESSOR FILLER: Sorry -- thank you,

 10 George. It's -- I don't have the exact answer to

 11 your question, and I think you have to look at

 12 Lehman, and you also have to look at the U.K.

 13 bankruptcy laws. They have a unique approach to

 14 -- much different than what we have here in the

 15 U.S. Their approach is if you're the

 16 administrator, PWC, and you release the funds, and

 17 as it turns out that transfer or distribution of

 18 those funds turns out to be an incorrect one,

 19 you're personally liable. And they are fighting,

 20 as you may know, or trying to wrestle with the

 21 courts over there to allow a lot of the assets to

 22 be distributed. And to date the courts have not
 56

 1 authorized those transfers, and there's a court

 2 over there in their U.K. Bankruptcy laws that, to

 3 me, needs to be addressed and fixed.

 4 We don't have that issue here, but it

 5 does exist there. I think that issue as much as

 6 anything else has held up the transfer and

 7 distribution of the asset. That's my personal

 8 opinion, but I haven't been dealing with that on a

 9 personal level in over a year.

 10 MS. LITT: I also -- and this is

 11 somewhat anecdotal -- but I think that to some

 12 extent as the complexity of cross-margining and

 13 cross-lien relationships and looking at single

 14 pools of money to support multiple products and

 15 multiple transactions, the possibility of moving

 16 pots of money that are sort of clean and neat gets

 17 harder.

 18 And so if you're a trustee in bankruptcy

 19 and you're very worried about the fact that you

 20 could be liable for supporting one group of

 21 creditors versus another, you're at much more risk

 22 if those cross-collateralization arrangements
 57

 1 exist which, of course, is, you know, something

 2 that we all need to think about as we talk about

 3 portfolio margining and multiple SX classes

 4 sitting in a single pool of customer funds.

 5 PROFESSOR FILLER: But, Bonnie, let me

 6 just raise a little slightly different issue --

 7 MS. LITT: Sure.

 8 PROFESSOR FILLER: -- with futures.

 9 Where you're talking about a -- let's take an LBI,

 10 LBI had a customer omnibus account with LBIE, and

 11 the only positions in that one account, which is

 12 the name of LBI on the books of LBIE, were futures

 13 positions.

 14 Let's say, hypothetically, the margin

 15 requirements were $100 million. I don't know the

 16 number. When the positions were moved out by

 17 Friday, September the 19th, you can identify that

 18 that $100 million belongs to LBI and the customer

 19 of LBI, and I am still uncertain and surprised

 20 why, because they've been able to identify that;

 21 they haven't released it.

 22 Now, I think the answer is, is because
 58

 1 this is the one-pot approach and if the swaps or

 2 other products had a shortfall, everyone has to be

 3 treated in a prorata basis. So I can't distribute

 4 a hundred because there may be a 10 percent

 5 shortfall, or a 20 percent shortfall, or some

 6 other amount. So why haven't they even

 7 distributed 50 or 60 percent, or some other number

 8 back to the Lehman clients issue? That's the one

 9 part I have not heard a proper answer for.

 10 COMMISSIONER SOMMERS: I think at this

 11 point we'll turn to Bob Wasserman to give -- oh,

 12 sure. Commissioner Dunn has a question.

 13 COMMISSIONER DUNN: Just a quick

 14 question, Ron, because I thought your paper was

 15 excellent and your recommendation, 13

 16 recommendations that you had in there, of what we

 17 ought to be doing is very important.

 18 But No. 12 on your recommendations that

 19 we -- that comes to the tip of your tongue, I'm

 20 sure is to put together a task force to come up

 21 with some best practices. And, frankly, I was

 22 dismayed that we here at the CFTC did not have a
 59

 1 contingency plan available. Fortunately, we have

 2 some very dedicated employees like Bob Wasserman,

 3 who was on vacation at the time, was working from

 4 truck stops calling us, telling us: Here's what

 5 you've got to do and here's how we establish it.

 6 But that appears to me as something that

 7 could be done immediately in concert with our

 8 regulator brotherhood to think about these base

 9 practices, at least in the futures side establish

 10 some of those now, and have these contingency

 11 plans so that you're not called back from academia

 12 the next time there's such a --

 13 PROFESSOR FILLER: Well, a couple

 14 comments, Mike. First of all, then acting Walt

 15 Lukken, his staff, Ananda and his staff were

 16 fantastic that week in September. I was on the

 17 phone with them two, three, four times a day

 18 bringing information to them, alerting them about

 19 current status as well as seeking their assistance

 20 on a number of issues. So I want to commend not

 21 only Chairman Luken's staff but the staff of DCIO.

 22 They were fantastic that week.
 60

 1 But the reason I think the task force

 2 and why I recommended it, I was on the Barings

 3 task force -- what was it, in '95 or '96? -- and,

 4 you know, Barings alerted us to a very important

 5 and large problem that existed, and I thought that

 6 task force really brought together not many people

 7 of different types within the global industry, and

 8 it came out with a lot of reforms that followed

 9 that task force. I thought, if you ever read the

 10 task force report, I think it was one of the

 11 better reports this industry ever did. And I

 12 think the same type of study review, analysis

 13 should also be considered in connection with this

 14 issue.

 15 COMMISSIONER SOMMERS: Bob, if you

 16 would, please walk us through from DCIO and from

 17 the CFTC's perspective.

 18 MR. WASSERMAN: So I'm going to do,

 19 ultimately, three things: One of them is to

 20 discuss our perspective on what happened to

 21 Lehman.

 22 The second is to talk about actually an
 61

 1 IOSCO project that we're currently leading in

 2 terms of understanding and bringing, frankly, out

 3 to the world an understanding of what both

 4 customer protections regimes and insolvency

 5 regimes for investment firms look like.

 6 And, finally, talking about some of the

 7 things that we're doing now. I want to do the

 8 first two of those now, and then the third after

 9 Roger Liddell has had a chance to speak.

 10 If we could the put Power Point up, or

 11 -- thanks. So very briefly, in terms of our

 12 perspective as to what happened during the Lehman

 13 insolvency, basically, protection of LBI's futures

 14 customers worked. They were transferred to

 15 Barclay's, not quite on Friday -- actually we had

 16 to wait until the bankruptcy court approval which

 17 happened at about 1:15 a.m. Saturday morning --

 18 and then the process happened, happily, over the

 19 weekend so that by the time the markets were open

 20 on Sunday, customers who had been at Lehman were

 21 transferred to Barclay's.

 22 And with minor exceptions, and Ron
 62

 1 alluded to that with some of the issues with,

 2 well, customer funds, customers did not lose

 3 control of their positions or their property. And

 4 so, in other words, again, subject to those minor

 5 exceptions, at all times futures customers for LBI

 6 had control.

 7 Protection in other jurisdictions worked

 8 somewhat less promptly and effectively, and in

 9 most jurisdictions that process is ongoing and in

 10 many of them it is unclear that all futures and

 11 securities customers will recover the value of all

 12 customer property.

 13 I'd like to talk a little bit about,

 14 from my perspective, what the requirements that we

 15 have that contributed to the success of our model.

 16 First is that the Act, Section 4d in our

 17 regulations require that all customer property be

 18 segregated at all times; that no liens on customer

 19 property are permitted; and that while we do,

 20 under 1.25, have certain arrangements like

 21 hypothecation of investments, the full balance --

 22 and that's the proceeds from that hypothecation
 63

 1 are required to be in segregation.

 2 Our bankruptcy code and the Commission's

 3 regulations in Part 190 encourage transfers, and

 4 those transfers are protected against avoidance

 5 under the bankruptcy code 764(b).

 6 There are also some circumstances, some

 7 factual issues that contributed to our success.

 8 Lehman chose to compute their Part 30 secured

 9 amount in a manner consistent with 4d; that is to

 10 say they chose to require that all foreign futures

 11 customers, all of their customers who they were

 12 clearing positions for on non-U.S. exchanges, they

 13 had their funds and property segregated as part of

 14 that secured amount, and they did all customer

 15 property rather than the minimum requirements

 16 which would be required margin plus accruals.

 17 We're also lucky that there was no

 18 shortfall on customer property. A number of you

 19 will remember Griffin Trading where there was, and

 20 things did not work quite as efficiently.

 21 And the fact of the matter is that if

 22 you have a book of business with no shortfall on
 64

 1 customer property, that's valuable. Somebody's

 2 going to want to buy that. Indeed -- I mean in

 3 this case there was a transfer that included real

 4 estate in for some billion dollars, although I

 5 think -- I think the value of the book was not

 6 that quite so much.

 7 And Refco a couple of years ago, the

 8 transfer of the book brought into that estate $200

 9 million, just simply the privilege of having that

 10 book.

 11 I'd like to talk a little bit about an

 12 insolvency project that CFTC has been leading at

 13 IOSCO. And this is within Standing Committee 3 on

 14 Intermediaries, and the purpose is to summarize

 15 the regimes for protection of customer property

 16 for futures and securities customers in major

 17 jurisdictions. And that we have first designed a

 18 survey to look at protection of customer property

 19 both preinsolvency and as part of the insolvency

 20 regime.

 21 And I guess one of the important points

 22 here is that I think prior to Lehman, a lot of
 65

 1 folks were thinking, okay, here are the rules for

 2 protection of customer property, and we're going

 3 to segregate it, and we're going to follow those

 4 rules and make sure people are following that.

 5 And every rule will live happily every after,

 6 without thinking, well, that's nice, but how does

 7 that work in practice when the insolvency comes?

 8 And so it's not enough to look how

 9 things work in the ordinary course, but then

 10 practically, will it work? And this survey covers

 11 both periods.

 12 We've received preliminary answers to

 13 the survey, and we're going to be working with

 14 other jurisdictions to clarify those answers,

 15 summarize and compare the results, and with the

 16 approval of the technical committee to publish the

 17 responses in a summary of that, of those

 18 responses. And, if practicable, arrive at common

 19 principles.

 20 And because, of course, this is an

 21 organization that works frankly, primarily by

 22 consensus, it may or may not be practical to come
 66

 1 to consensus as to, at least within this

 2 organization, as to what principles there should

 3 be. However, I think we're fairly comfortable

 4 that simply providing these answers is going to

 5 advance the ball significantly.

 6 MR. OKOCHI: Bob, what is the time frame

 7 for the survey to be complete and potential

 8 recommendations are practical solutions?

 9 MR. WASSERMAN: Hopefully, within the

 10 next six months. And as I say, we've gotten back

 11 preliminary answers. I think staff here are going

 12 to be working sort of bilaterally with the other

 13 jurisdictions to clarify those answers, and we

 14 basically are intending by our meeting in April to

 15 essentially be able, hopefully, to finalize that.

 16 That may or may not be practicable.

 17 I'd like to talk over about the

 18 preliminary results. Because they are

 19 preliminary, I'm not going, in general, not going

 20 to be too specific with regards to who said what

 21 in the survey.

 22 First let's talk about segregation.
 67

 1 Some jurisdictions require segregation on a

 2 customer-by-customer basis; that is, each

 3 individual customer has their own separate pot and

 4 therefore is not exposed to their fellow

 5 customers. That protects against fellow customer

 6 risk, but there is, to be sure, some costs in

 7 efficiency.

 8 Some jurisdictions permit customer

 9 property to be topped up promptly after a periodic

 10 reconciliation. So, in other words, you can have

 11 -- do over a reconciliation, say, weekly, and if

 12 you find out that you don't have enough, you have

 13 until the next day to put the money in.

 14 Well, that's great. It certainly is

 15 better than not doing that, but if an insolvency

 16 occurs before the reconciliation or before you've

 17 topped up, you've exposed yourself to a shortfall.

 18 Debit balances. Some jurisdictions

 19 permit a debit balance in one customer's account

 20 to offset a credit in another customer accounts,

 21 and, for instance, the Reg. 3-3 calculation for

 22 security. However, that, of course, leaves
 68

 1 recovery dependent on collection from the

 2 customers with the debit balances, and it may make

 3 transfer less practical.

 4 Firm property as a buffer. Our regime

 5 permits and, de facto, I think strongly encourages

 6 a buffer firm property in the customer account.

 7 We require daily reconciliation. If at any time

 8 when you do the daily reconciliation you realize

 9 that you didn't -- don't have enough money, you do

 10 the reconciliation by noon as of the close of

 11 business the previous day. If you find that you

 12 were undersegregated, you have to report what is a

 13 violation.

 14 There's a practical matter. More often

 15 than not it will be some sort of innocent error,

 16 and what'll happen is your self-regulatory

 17 organization will be paying special attention to

 18 you and make you, you know, write it on the

 19 blackboard you won't do it again. But,

 20 essentially, it is a violation and, therefore,

 21 people want to avoid that. They put extra money

 22 in which in the event of insolvency is therefore
 69

 1 available. Or, in the event of a large customer

 2 loss, again the money's already there, and so

 3 therefore there's that additional measure of

 4 protection.

 5 Some other jurisdictions permit such

 6 buffers; some jurisdictions actually prohibit

 7 leaving firm funds in the customer account. And,

 8 specifically, there's a concern -- the U.K. is one

 9 of these -- that there would be possible damage to

 10 the trust status; that, essentially, if it's

 11 supposed to be a trust for customer funds, then

 12 you could only have customer funds in there.

 13 Again, the downside of that is there's less money

 14 available if and when something bad does happen.

 15 Liens and rehypothecation. Some

 16 jurisdictions allow liens on customer property

 17 with permission of the customer, and some allow

 18 the films to rehypothecate customer property.

 19 Well, when you think about it, property

 20 that's been subject to a lien or has been

 21 rehypothecated may not be available in case of the

 22 firm insolvency, in fact, it likely won't be. And
 70

 1 I think, frankly, in the case of the U.K. a lot of

 2 the difficulties that they have are tied up in

 3 that permission, that you have customers who

 4 granted permission to have their assets

 5 rehypothecated, which essentially undercuts the

 6 protection of those assets. And so if you grated

 7 a right to use your property, it may not be there

 8 for you when you need it.

 9 That is the issue -- those are the

 10 issues preinsolvency. Let's talk about what

 11 happens in the context of the insolvency. Some

 12 jurisdictions permit the futures of securities

 13 regular control or influence over the selection of

 14 a trustee, administrator, or similar officer. In

 15 our context, what happens is we've been in contact

 16 with the U.S. trustee who tends to select trustees

 17 in the case of bankruptcies in Chapter 7, or we

 18 were in contact with our colleagues at CIPIC in

 19 the case of BCFCM bankruptcy in a CIPRO

 20 proceeding, and so essentially there is a greater

 21 likelihood of having a trustee and/or an attorney

 22 for the trustee who's familiar with the industry,
 71

 1 who understands what's going on. Because if you

 2 come in there without that understanding, there's

 3 a steep learning curve and almost no time to get

 4 up that learning curve.

 5 Some jurisdictions provide specific

 6 guidance for the trustee and, for instance, our

 7 Part 190 is pretty much a cookbook as to what it

 8 is they're supposed to be doing. Others do not,

 9 and, as I say, a customer who's unfamiliar with

 10 the industry taking charge in volatile markets,

 11 acting without instructions from a regulator, can

 12 cause some difficulties.

 13 Transferring customers. Our, as I said,

 14 our rules and statute encourage the trustee to

 15 transfer customer property and positions to a

 16 solvent firm, if practicable. Now, as I mentioned

 17 before, the practicability in large part depends

 18 upon, is the customer property there? If the

 19 customer property isn't there, transfer is going

 20 to be a lot less practicable.

 21 But we've had in the past couple of

 22 years a number of very large insolvencies, Refco
 72

 1 and Lehman, where the property was there, and that

 2 instruction to transfer, that guidance to transfer

 3 I think has helped. And, of course, transfer is

 4 ideal for transferred customers and, arguably, for

 5 the markets. But that efficiency may come at the

 6 expense of fairness to other creditors.

 7 And so I think folks in other

 8 jurisdictions view that -- because, essentially,

 9 for instance, we protect those transfers and the

 10 transferred property against any call back.

 11 That may happen at the expense of other

 12 creditors. We've taken the decision, our

 13 Congress, that essentially that's to the good

 14 because it's important to protect the markets.

 15 But other jurisdictions can weight that somewhat

 16 differently. As I said, protection against "law

 17 backs."

 18 Compensation schemes. Many

 19 jurisdictions have compensation schemes to protect

 20 securities and futures customers against loss.

 21 But that protection from a retail perspective is

 22 very significant; from an institutional
 73

 1 perspective perhaps not so much.

 2 For instance, CIPIC's $500,000 limit is

 3 among the largest among the jurisdictions that

 4 report it. Most of them are closer to around

 5 $100,000.

 6 Allocation of losses, and this actually

 7 is important and, I think, goes to some of the

 8 things Ron was talking about earlier in the U.S.

 9 Some jurisdictions allocate the losses pro rata.

 10 We do both on the futures end and on the

 11 securities end, except the securities end has the

 12 CIPIC protection. And so, essentially, we can

 13 look at the customer property pot and say, okay,

 14 everyone's going to get 50 cents on the dollar, or

 15 maybe more, but we've got enough to pay people a

 16 dividend, and so you can have dividends and get at

 17 least some of the money out.

 18 Some jurisdictions will allow allocate

 19 losses based on customer permissions, so those

 20 customers who said, well, you can use my

 21 collateral are going to be treated differently

 22 from those customers who said no, you can't.
 74

 1 Of course, once you have that permission

 2 out there, there's an immediate practical effect

 3 of you're going to need to pay some accountants a

 4 whole lot of money to untangle all of that,

 5 untangle the records and say, well, this customer

 6 gets treated this way because the records say

 7 this. And that one gets treated that way. There

 8 is an efficiency to treating everyone the same and

 9 mandating a treating everyone the same where,

 10 because you can then say, okay, everyone's treated

 11 the same, you don't have to worry each individual

 12 customer.

 13 Some jurisdictions allocate losses based

 14 on which property is missing. The U.K. is among

 15 these. And so heres for customer funds they would

 16 operate pro rata. With respect to customer

 17 property, they're going to allocate losses based

 18 on which property is missing. If one customer, or

 19 if one group of customers -- in other words, the

 20 property they posted was IBM stock, another group

 21 of customers posted Amazon stock -- and it turns

 22 out that the IBM stock is almost all missing, the
 75

 1 Amazon stock is there, the first group of

 2 customers is going to be allocated more of the

 3 losses.

 4 So until you can untangle who owns what,

 5 then you can't do the distribution, and again,

 6 hanging over the trustee, of course, is the fact

 7 that, hey, if I distribute the wrong thing, I'm

 8 personally liable. Not only that, but the courts

 9 in the U.K., the trustee has been trying to urge

 10 them to allow even some means of having a scheme

 11 of distribution that would have some deadlines and

 12 saying, okay, you've got to make your claim by

 13 thus and such a time or we're just going to

 14 distribute the money.

 15 And my understanding is that first the

 16 Queen's Bench, and then -- or the commercial

 17 court, rather -- and most recently the Court of

 18 Appeal have essentially held, no, sorry, you can't

 19 do that. You've got to follow normal trust law,

 20 however complicated it might be.

 21 And the rest of it I will cover later.

 22 COMMISSIONER SOMMERS: Thank you, Bob.
 76

 1 We have Roger Liddell from LCH, who is also going

 2 to speak on this subject from what happens from

 3 the Libby side and from LCH.

 4 Roger?

 5 MR. LIDDELL: Thank you very much, Madam

 6 Chairman. I will be brief for two reasons: First

 7 of all, I think Ron did a great job of describing

 8 the general sort of activities and not just U.S.

 9 activities, so I won't repeat all of that.

 10 And, second, I think it's pretty more

 11 productive to leave time for some questions or

 12 discussion which is, I think, is the way this

 13 discussion seems to be going.

 14 But let me just a little bit more

 15 current and give you a little bit more specifics.

 16 I think you know, what we experienced in the first

 17 hours in the first couple of days were some events

 18 that we hadn't anticipated and certainly hadn't

 19 experienced. I think some of those were, you

 20 know, some of the specific differences in the

 21 bankruptcy regimes in different countries and the

 22 relative protections that they offered to
 77

 1 customers and the relative difficulties they have.

 2 So the fact, you know, they are different is an

 3 issue.

 4 The other related issue, though, is that

 5 it is a large, you know, fully-integrated

 6 financial institution like Lehman Brothers, it's

 7 an integrated network. And to separate out

 8 regional pieces of activity and handle in

 9 isolation, you know, really doesn't work that well

 10 these days. We think it raises so much broader

 11 issues.

 12 You know, there are issues around the

 13 single pot which, you know, Bob referred to a bit

 14 earlier. They complicate things with from a

 15 liquidation perspective which can be a problem.

 16 It's also, frankly, a huge benefit, alternatively,

 17 so gross having a single pot of collateral

 18 covering a whole range of different asset classes

 19 meanted [sic], as we were, to liquidate some more

 20 quickly than others. The hedge room that that

 21 liberated was effectively usable to us to create

 22 more protection against some of these other asset
 78

 1 classes. So there are pros and cons with that.

 2 But in terms of the, you know, specific

 3 events, the first issue, of course, was that, you

 4 know, we didn't have good access to data. But the

 5 reason that was important, actually, the primary

 6 reason that was important, was because a high

 7 proportion of the futures clients of Lehman

 8 Brothers International Europe, a high proportion

 9 of them -- and I think the number was probably

 10 around 60 percent by value -- had opted out of

 11 segregation protection in the U.K. Many of these

 12 were U.S. customers. I think about 50 percent of

 13 them were U.S. customers.

 14 Now, we were not explicitly aware of

 15 that because, basically, the activity that we had

 16 with the Lehman Brothers International Europe was

 17 traditional futures clearing member activity house

 18 account with a lot of positions in it and

 19 declining omnibus account with a lot of positions

 20 in it.

 21 So as the events started to unfold

 22 actually over the weekend but then on the Monday
 79

 1 morning, we started the process of identifying the

 2 risk in the house account to hedge it, and in

 3 identifying the client positions in order to

 4 transfer them.

 5 What became apparent within the first

 6 hour or so was that a lot of the positions in the

 7 house account were in fact clients and really

 8 realized this because we recognized some of the

 9 names.

 10 So then it became obvious that we

 11 obvious that we couldn't hedge any of the house

 12 positions because we would be potentially hedging

 13 some of the client positions that needed to be

 14 transferred. So that created an immediate

 15 requirement first to understand from the books

 16 records of Lehman Brothers precisely which of

 17 those positions were in fact house accounts and

 18 which were client accounts.

 19 And, you know, just scanning down this

 20 list and looking at the names, it just isn't

 21 obvious because a lot of internal trading desks in

 22 big financial institutions look like small funds,
 80

 1 look like hedge funds, you know, West Coast

 2 commodities, you know, desk, and things like that.

 3 So we realized that we needed this

 4 information from Lehman Brothers and tried to get

 5 it. And that where we ran into the problem that

 6 Ron referred to earlier which was under the U.K.

 7 regime with administrative, and with the potential

 8 liabilities that they had individually. They were

 9 very nervous about even giving information away.

 10 So after an hour or two of trying to get

 11 information electronically, we actually sent

 12 people down physically to just go and get it. And

 13 that wasn't easy either. They were turned away,

 14 there were security guards preventing them going

 15 in. You know, we were threatened with police

 16 action because we were trying to sort of get

 17 through the (inaudible) and lots of stuff.

 18 So, eventually, after a long time, a few

 19 months ago (inaudible) June afternoon and started

 20 to sit at the terminals inside the Lehman offices,

 21 started to print from screens client positions and

 22 so on and so forth. In the meanwhile -- and again
 81

 1 this is probably sort of the more extreme, you

 2 know, examples of the mismatch between the

 3 insolvency regime and the need to have an orderly

 4 liquidation of important client positions --

 5 meanwhile the administrators were sort of giving

 6 interviews on the TV and whatever.

 7 They're saying, "Look, this is what's

 8 happening," and explained the process. And, by

 9 the way, you know, none of the staff for the

 10 Lehman Brothers is going to get paid. So all of

 11 the people that we were working with to try and

 12 get all this information just sort of disappeared.

 13 So the next morning we went down to get

 14 into this again, managed to persuade all this

 15 stuff that had on to come back and gave them

 16 contracts of employment just so to hire them, and

 17 went to try and get these positions to do the

 18 transfer on the Tuesday.

 19 By this stage the lawyers had been in

 20 there, and I realized a high proportion of the

 21 people in that room are lawyers and I won't be

 22 disrespectful, but that wasn't a healthy step in
 82

 1 the process. And the administrators were there

 2 for very nervous about giving us access to data.

 3 All of the terminals that had this information had

 4 all of their ports blocked to prevent our people

 5 from getting anything to be able to download

 6 information to bring back to our offices to use,

 7 which is really quite an incredible sort of state

 8 of affairs.

 9 Meanwhile, we had some screen prints

 10 from the night before, so we knew exactly which

 11 reports we needed and where all the data was.

 12 And, thankfully, we were able to speak to the

 13 folks in the New York office, Ron and some of his

 14 ex-colleagues, and say, "Look, you know, we really

 15 need some help here. Can you get these files for

 16 us and send them electronically?"

 17 So while we were having big arguments

 18 with the lawyers and the administrators in London,

 19 we were actually working in a much more

 20 collaborative way with the staff in New York who

 21 were able to transfer all these files to us, or

 22 all the data that we needed in order to transfer
 83

 1 customer positions. So that was great.

 2 Ron, I think you referred to the

 3 restrictions that the administrators faced on in

 4 terms of being willing to allow us permission to

 5 move assets. Ultimately, actually, they were not.

 6 Actually, we could not get them to agree to allow

 7 us to move clients' futures positions, not the

 8 client's futures positions, and they wanted us to

 9 sign all sorts of disclaimers that if, you know,

 10 that we'd move it more it back under certain

 11 circumstances, none of which was compatible with

 12 the futures (inaudible), generally. So what

 13 actually happened was because we had this

 14 information, the electronic information from the

 15 States, that we not only needed the data from the

 16 U.K., we chose not to require the permission from

 17 the administrators to move it. So, basically, we

 18 moved all of the positions, our positions, without

 19 the permission.

 20 Over a fairly concentrated period of

 21 time -- and actually that introduced an awful low

 22 more risk than would have been the case had we got
 84

 1 access to the right information within the right

 2 sort of time frame. Now, this was obviously a

 3 huge problem and a huge source of frustration.

 4 Thankfully, it went okay in the end. This will

 5 require changes to the U.K. insolvency regime and

 6 the bankruptcy legislation, no doubt.

 7 In the short term, however, I'm

 8 confident that there has been a good level of

 9 understanding reached between the local

 10 regulators, the courts, and the primary insolvency

 11 (inaudible) so that in the event that the similar

 12 circumstances happen again, we would -- I'm

 13 confident we would be allowed access to the data

 14 that we need, and things would move much more

 15 quickly.

 16 But again, it was a combination of the

 17 lack of availability of data to us and the fact

 18 that a lot of clients had chosen -- how obvious it

 19 was to them that they'd chosen or not, you know,

 20 we don't really know -- but they'd chosen to opt

 21 there a segregated protection, which meant that we

 22 had to treat the firm and the house collectively.
 85

 1 I could go on a lot more, but I think I

 2 won't. I think it's pretty best if I just close

 3 thee and invite any questions.

 4 COMMISSIONER SOMMERS: I think we do

 5 have some questions for you, Roger.

 6 CHAIRMAN GENSLER: Hi, Roger, it's good

 7 to see you again. I had a question. You were

 8 talking this through, but this was more broadly

 9 than just futures. We this also futures and the

 10 swaps? Or were you narrowly talking about just

 11 one book of business?

 12 MR. LIDDELL: I was narrowly talking

 13 about just the futures. The same problem didn't

 14 occur in swaps at all, or elsewhere.

 15 CHAIRMAN GENSLER: Do you want to take,

 16 you know, maybe it's two minutes, but tell us

 17 about how you transferred the swap book.

 18 MR. LIDDELL: Yes, I will, and I'll try

 19 not to -- I'll try to avoid a commercial. The

 20 first thing is the swap book only involved

 21 interbank activity, so we basically were sitting

 22 between the Lehman Brothers trades and each of
 86

 1 their interbank counterparties. And I'll describe

 2 briefly how it happened. But after Thursday,

 3 there were no customer positions that needed to be

 4 transferred.

 5 What this has meant, however, is that,

 6 as we know of preparing to get involved with real

 7 customers' business, we obviously aren't happy

 8 that this regime does not work well, you know, for

 9 real customers in OTC derivatives. So what

 10 actually have put in place now for swaps in

 11 particular is a regime which allows us to actually

 12 bypass the administrator and to actually liquidate

 13 collateral in the omnibus account that the bank

 14 will have with us on behalf of its clients, and to

 15 sell that collateral, and to move it to the

 16 incoming clearing member that's inheriting those

 17 positions, and to bypass this entire process

 18 which, as Ron quite accurately described, has not

 19 yet unfrozen.

 20 CHAIRMAN GENSLER: So you have an

 21 approach in the future to be able to deal with

 22 customer, or what some people here call end-user
 87

 1 clearing, by having the omnibus account or the

 2 Collateral Act, LCH, rather than over at the bank

 3 where the administrator might freeze it.

 4 MR. LIDDELL: No, the accounts are still

 5 in the bank, but the omnibus account of all of the

 6 bank's clients is with those as usual futures.

 7 But what we've developed is a regime that would

 8 allow us to sell the collateral in it and to

 9 allocate it, proportionately, to all the clients.

 10 But it hasn't changed the situation with

 11 regard to the futures activity; that remains the

 12 way it is today. So we haven't solved the futures

 13 problem, but we have actually made provisions for

 14 those derivative markets.

 15 But the way the swap defaults actually

 16 was handled was that, basically, because there's

 17 no means of us liquidating it over exchanges, we

 18 introduced the default management process that had

 19 been developed over the years which really

 20 entailed us calling in nominated individuals that

 21 had been preassigned by, you know, five of the

 22 main 12 swaps dealers to come in and trade under
 88

 1 our instruction and on our behalf in order to

 2 liquidate the portfolio, which is what happened.

 3 COMMISSIONER SOMMERS: Does anybody else

 4 have any questions for Roger at this point? Ron?

 5 PROFESSOR FILLER: Jill, can I just -- I

 6 want to clarify one little point that Roger just

 7 mentioned, and at least this was the situation

 8 when I was there. Things might have changed, but

 9 we did not have any U.S. futures have a direct

 10 account with LBIE. Every U.S. base futures

 11 account had an account with LBI, and then LBI had

 12 an omnibus with LBIE. I think what Roger is

 13 referring to when he said several U.S. Clients

 14 quoted, opted out were really were offshore hedge

 15 funds whose money managers were based here in the

 16 States, but the entities themselves were offshore.

 17 They were doing their OTC equity derivatives with

 18 London, and if they're doing the OTC equities

 19 derivatives, they were doing their futures as

 20 well.

 21 So I don't in my mind, even though the

 22 money managers are based here, the funds being
 89

 1 offshore, I never looked at them as, quote, "a

 2 U.S. account." In fact, if any client ever asked

 3 me, "Do you allow us to opt out," it was no way.

 4 I'm just not an opting out person.

 5 So to the best of my knowledge, unless

 6 things change, no U.S. person opted out, but some

 7 of our offshore hedge funds, because of the

 8 capital and the way you play the game over in

 9 London was a lot cheaper than you could play it

 10 here, a lot of the actual hedge funds did have

 11 direct account, so if they could do the OTC in

 12 London, they might as well do the futures and all

 13 the other products there.

 14 COMMISSIONER SOMMERS: Don?

 15 MR. WILSON: Yeah. Roger, this is Don

 16 Wilson from DRW. It's my understanding that LCH's

 17 new swap clearer structure is -- really only

 18 offers clearing for the dealer members. In other

 19 words, large users of the market, and even major

 20 liquidity providers who currently operate

 21 exclusively in centrally-cleared markets will not

 22 have the option of clearing their trades but will
 90

 1 instead faith their children prime broker in

 2 traditional bilateral arrangements. And although

 3 LCH has attempted to mitigate some of the risks

 4 traditionally associated with bilateral trades,

 5 the trades nonetheless remain bilateral. So it's

 6 not really a central counterparty; it's merely a

 7 clearing between dealers.

 8 And the other flaw that I see in LCH's

 9 new proposed swap clearing model is that by virtue

 10 of this structure, users of the market will only

 11 be permitted to trade with LCH dealer members. In

 12 other words, the market in interest rate swaps

 13 will not receive the benefit of the liquidity

 14 provided by nonbank liquidity providers. And

 15 rather than taking the opportunity to reduce the

 16 reliance on, you know, too big to fail banks and

 17 the LCH's model instead perpetuates this

 18 structure.

 19 And so, you know, I just -- you can

 20 correct me if anything that I've said is wrong,

 21 but I wanted to highlight those concerns because I

 22 don't think that that structure is in the best
 91

 1 interest of the marketplace.

 2 MR. LIDDELL: Okay. Well, I mean

 3 essentially the situation is similar, almost the

 4 same of the futures markets, which is that we're

 5 directly the members. We don't care whether we

 6 trade -- they can trade with any way they want as

 7 long as they clear it through a clearing member.

 8 So as long as both parties turns out to a

 9 transaction, each have a clearing member to clear

 10 on their behalf, then that's fine. We can clear

 11 any trade that comes from anywhere. It doesn't

 12 matter.

 13 MR. WILSON: So you're saying that one

 14 customer of the market could trade directly with

 15 another customer for the market as long as both of

 16 those trades -- as long as both of those customers

 17 cleared their trade through an LCH swap clearing

 18 member.

 19 MR. LIDDELL: Yeah. Absolutely.

 20 CHAIRMAN GENSLER: But I think Roger's

 21 point is, will you allow nondealers to become

 22 clearing members? Will you have open access to
 92

 1 clearing members as we've proposed in our

 2 regulatory regime in front of Congress that the

 3 clearing houses allow nonswap dealers to be

 4 clearing members?

 5 MR. LIDDELL: Yeah. I mean there are

 6 criteria that needs to be met in order to become a

 7 clearing member. The criteria does not include

 8 the type of institution that any particular firm

 9 is. They do, however, include their regulatory

 10 stages, their level of capital, and also the size

 11 of the stock portfolio that they have.

 12 And the reason for that is that,

 13 ultimately, in default situation, you know, we,

 14 the clearing house, don't have the ability to just

 15 go out and close out across an exchange and need

 16 to have a complicated hedging mechanism where the

 17 banks within the service effectively mutualize

 18 that risk amongst themselves.

 19 So all the firms that need to

 20 participate in that process needs to have access

 21 to a lot of liquidity and needs to have the

 22 capability internally of having a big portfolio.
 93

 1 So the rules are fairly onerous and

 2 stringent, but they don't determine the type of

 3 organization that can become a member.

 4 CHAIRMAN GENSLER: Could a nondealer

 5 realistically meet those? Or are they so written

 6 that if they just, you know, the dealers are going

 7 to be --

 8 MR. LIDDELL: It would be very

 9 difficult, frankly. It needs to be a regulated

 10 entity, and the size of the portfolio needs to be

 11 at least a trillion dollars. These are the rules

 12 that have been in place for 10 years.

 13 CHAIRMAN GENSLER: Yeah, and just to

 14 repeat what I've probably said just one per -- I

 15 think that swap clearing is very important. It

 16 helps lower risk, but I think it best benefits

 17 markets if it's opened up more than what you've

 18 just probably described.

 19 MR. WILSON: Just to touch on the first

 20 point that I made, I mean is my understanding

 21 incorrect that the trade that the customer make

 22 are technically not cleared trades? They're still
 94

 1 bilateral trades even though there is kind of a

 2 centrally-cleared element to the component that's

 3 between the dealers related to those trades?

 4 MR. LIDDELL: I'm not sure I understand

 5 the question fully, but again, we have two kinds

 6 of policies. Whoever they are can transact. As

 7 long as the transactions are submitted via two

 8 clearing members, or even a (inaudible) member,

 9 then they'll come to the system and will be

 10 subject to the same protection, the same margin

 11 regime as all the transaction.

 12 COMMISSIONER SOMMERS: Tom, did you have

 13 a question?

 14 MR. LIDDELL: Now, getting on the books

 15 of the clearing member that has those

 16 transactions, effectively they have a back to

 17 back, one with us and one with their member. So

 18 the protection that that client will get will be

 19 exactly what I described before, which will be the

 20 portability of initial margin and the ability to

 21 transfer s position outside of the regime of the

 22 defaulting member.
 95

 1 MR. WILSON: Yeah, I guess that's my

 2 point. If that it is a back-to-back trade, it's a

 3 bilateral trade between the customer and the

 4 clearing dealer, and then, you know, yes, then the

 5 other side of the trade is with the clearing

 6 house. But I mean, for instance, if a customer of

 7 a dealer who clears, let's say, J.P. Morgan, calls

 8 up Goldman Sachs to transact a swap, then they can

 9 transact the swap with Goldman Sachs. The result

 10 of that trade will actually be a cleared trade

 11 between Goldman Sachs and LCH, another cleared

 12 trade between LCH and J.P. Morgan, and a bilateral

 13 trade between the customer and J.P. Morgan.

 14 MR. LIDDELL: Yeah, but the key element

 15 is that this is a sort of one-way protection

 16 right. So, effectively, the process protects the

 17 clearing house and the clearing system and the

 18 rest of its members from the risk of a defaulting

 19 member.

 20 So that from the -- the clearing member

 21 bears the risk of the original customer, whereas

 22 the customer of that clearing member doesn't bear
 96

 1 the risk if it's a clearing member. Though if the

 2 clearing members goes under, then we bypass the

 3 clearing member and access and move the initial

 4 margin, the variation margin of the end customer

 5 to an incoming clearing member.

 6 MR. WILSON: Right, as long as

 7 (inaudible) --

 8 MR. LIDDELL: It's kind of one way.

 9 MR. WILSON: -- agrees to take those

 10 trades. So I just -- I think it's important to

 11 point out, it is a bilateral trade, however, you

 12 put some clever mechanisms in place to hopefully

 13 lower the risk in the event that the, you know,

 14 the clearing member files for bankruptcy. So it

 15 has --

 16 MR. LIDDELL: Yeah, but the only issue

 17 is the one that I think you alluded to, which is

 18 that if there is no clearing member willing to

 19 take on those positions, then there's nowhere for

 20 those positions to go, in which case that position

 21 has to be liquidated.

 22 MR. KLEIN: If I can ask Roger what I
 97

 1 hope was a clarifying question, I've been involved

 2 in a lot of discussions, as have many people,

 3 about the difference between clearing on an agency

 4 basis and clearing on a principle basis, but I

 5 guess the fundamental question is, is the legal

 6 model that LCH has established for clearing

 7 nonclearing member swaps significantly different

 8 than the legal model that LCH believes exists for

 9 clearing futures contracts?

 10 MR. LIDDELL: Well, I mean I guess it

 11 depends where, because futures contracts are

 12 different in different locations around the world.

 13 But, broadly speaking, I think from a client

 14 perspective the regime goes well beyond what

 15 exists in most futures markets round the world,

 16 particularly in Europe.

 17 COMMISSIONER SOMMERS: Tom?

 18 MR. CALLAHAN: Roger, it's Tom Callahan.

 19 We've discussed in some detail in this meeting of

 20 the potential complications that arise out of

 21 cross-margining and crossing arrangements in the

 22 event of a client or member firm default.
 98

 1 But you also said in your introductory

 2 comments that there's another side of the story

 3 that in a default scenario there's a benefit to

 4 seeing, essentially, the whole of a defaulting

 5 member's position. So I was wondering if you

 6 could just elaborate that, on that a little bit

 7 further in the context of what I believe was a $9

 8 trillion liquidation that LCH managed without

 9 touching any default or guarantee funds, which is

 10 a remarkable achievement. But was portfolio

 11 margining a factor in that successful liquidation?

 12 MR. LIDDELL: Well, ironically, I didn't

 13 -- the $9 trillion was the size of the swap

 14 portfolio and in Lehman Brothers' case, they

 15 actually used a different entity for that to all

 16 of the rest of the activities. So everything else

 17 they did with us was in one (inaudible), and the

 18 short portfolio was in a different one. So there

 19 was no benefit in that particular case to us of

 20 the portfolio effect. With the rest, though,

 21 there was. And that made a significant

 22 difference.
 99

 1 But I think, you know, as we talk more

 2 about cross-product margining, that effectively

 3 the benefit that we were able to enjoy outside of

 4 the short portfolio, arguably, moves away from the

 5 clearing house and toward the client once you

 6 offer a more comprehensive cross-product

 7 margining, which is why I think that we need to be

 8 particularly thoughtful as to how we eventually do

 9 that.

 10 An the issue, I think, really, frankly,

 11 is less to do with cross-product margining and

 12 more to do with cross-product default management,

 13 because it's easy when you can take individual

 14 portfolios and liquidate them separately.

 15 But if you go, if you're allowing

 16 cross-product margining and giving relief because

 17 there's natural offsets, then you have to have a

 18 much more integrated, organized liquidation

 19 process, and that's the sort of stuff we're

 20 looking at now.

 21 COMMISSIONER SOMMERS: Thank you. We

 22 are running just a little bit behind schedule, so
 100

 1 I think what I might suggest at this point is Bob

 2 had a few more slides left on what the CFTC staff

 3 has proposed that the CFTC's effort with regard to

 4 these kind of issues going forward and of eight

 5 lessons learned on these issues. You all have

 6 these in your packet. So if you have any further

 7 questions on these particular issues, you can let

 8 us know at a later time.

 9 We are going to take about a ten-minute

 10 break and come right back to start discussion of

 11 the U.S. and E.U. OTC derivatives proposals.

 12 Thank you, Ron. Thank you so much,

 13 Roger and Bob, for participating in this

 14 discussion. Thank you.

 15 (Recess)

 16 COMMISSIONER SOMMERS: We're going to go

 17 ahead and get started if everybody can take their

 18 seats. As I mentioned in my opening comments, the

 19 CFTC is very honored to have with us our

 20 colleagues from the European Commission here

 21 today. This is a very challenging time for market

 22 regulators and more important than ever, really,
 101

 1 for us to be coordinating with our counterparts in

 2 Europe. And we are so pleased to have David

 3 Wright here with us today to talk about these

 4 issues.

 5 Patrick Pearson is also to his right at

 6 the table, will be participating in the

 7 discussion, and I'm going to go ahead and start

 8 with David and to let him give an overview of the

 9 communication that the E.C. put out in October,r

 10 and maybe, David, if you could go over the

 11 timetable with us to give us an idea of where

 12 Europe is headed.

 13 Thank you.

 14 MR. WRIGHT: Commissioner Sommers,

 15 Chairman Gensler, Commissioners of the CFTC, thank

 16 you very much indeed for inviting us from the

 17 European Commission to this Global Markets

 18 Advisory Committee. We have worked very closely

 19 with the CFTC over many years, and we very greatly

 20 value our close relations and very much welcome

 21 all our contacts with Jackie Mesa and your staffs.

 22 We were very honored, as Gary said
 102

 1 earlier, to have him over and explain in

 2 considerable detail your policy, the U.S.

 3 administration's policy on OTC derivatives in a

 4 public hearing we had in Brussels, Belgium earlier

 5 this year in September. And I'm here today not

 6 just as a gentile act of reciprocity, but also

 7 because we in the European Commission, the

 8 organization in Europe that proposes European law

 9 in the European Union. We believe very strongly

 10 that on this subject of OTC derivatives, and

 11 indeed on many others, it is absolutely essential

 12 that we have a common view and convergent policy

 13 outcomes between the United States and the

 14 European Union.

 15 That, indeed, is the spirit of the G20

 16 with which we concur. As we all know, the U.S.

 17 and the EU have by far the biggest capital markets

 18 in the world. By some measures we believe in the

 19 European Union; we could be bigger than the United

 20 States, but, of course, that's not the point. For

 21 derivatives almost all the trading, major trading,

 22 is carried out in our jurisdictions.
 103

 1 We have, of course, very different

 2 policy processes. We have different timing and

 3 sequencing, and I will say something about that.

 4 We have different political forces. You have your

 5 Congress, and we have our member states in the

 6 European parliament who decide. But jointly we

 7 must, I believe, work very closely together to

 8 assure our common goals and objectives, so this

 9 would be easy; but as I said, I think it's

 10 essential.

 11 If we do not do this, if our policy

 12 outcomes on derivatives show very wide variance,

 13 the results will be very simple: It's going to be

 14 regulatory arbitrage, unacceptable potential risk,

 15 even the seeds for future financial trouble.

 16 We can't afford this and we shouldn't

 17 accept. This financial crisis will resolve this

 18 year in the European Union of a loss of four

 19 percent of GDP, growing unemployment, and a

 20 burgeoning public sector deficit which in the

 21 European Union as a whole means that our public

 22 sector deficit will have grown by 20 percent of
 104

 1 GDP in three years.

 2 And the same, I believe, say magnitude

 3 of destruction has happened here in the United

 4 States as well.

 5 So the system has got to be repaired,

 6 and we need on this issue more than ever two

 7 mechanics, the United States and the European

 8 Union, acting together, acting as one.

 9 Already, ladies and gentlemen, there are

 10 strong signs that some would like to divide on

 11 these issues. I'm quoting from The Financial

 12 Times of the 2nd of December headline: "Europe

 13 and U.S. Split Over the Reform of Derivatives."

 14 Some of our companies apparently as accusing you

 15 of being unwilling to relax the proposed reforms

 16 referring to the issue, of course, whether to

 17 exempt end-users from the reforms. And somebody

 18 is quoted as saying, "Well, if that results in

 19 divergence between the E.U. and the U.S., so be

 20 it."

 21 So the warning signs for both of us are

 22 there, and we better take care that we can avoid
 105

 1 them.

 2 Let me briefly set out the goals we have

 3 with our forthcoming OTC derivatives reform

 4 package. The timing, as far as I know it -- and

 5 let's focus on some of the difficult issues where

 6 convergence, our convergence, will be most tested.

 7 Now, we made a major policy statement on

 8 derivatives on October the 20th. Now this

 9 document is being distributed to you in your

 10 package here. It forms part of a policy process

 11 which will result in us proposing legislation in

 12 next year, and I can tell you that our President,

 13 President Barroso, confirmed now for a further

 14 five years as president of the Commission, has

 15 made it very clear in his testimony to Parliament

 16 that this Commission, his new commission, will

 17 propose an ambitious initiative next year. Our

 18 starting point is exactly the same as yours, and

 19 I'd like to quote Chairman Gensler's testimony

 20 before the House Committee on Energy and Commerce,

 21 Subcommittee on Energy and the Environment, on

 22 December the 2nd. So you can see here we look
 106

 1 very carefully, and we follow all your comments.

 2 CHAIRMAN GENSLER: I'm very honored.

 3 MR. WRIGHT: You said, Chairman, "Though

 4 there are certainly many causes of this crisis, I

 5 think most would agree that the unregulated OTC

 6 derivatives marketplace played a crucial role."

 7 We fully agree. We believe these markets

 8 exacerbated the crisis, the leverage levels into

 9 connectedness, lack of transparency catalyzed this

 10 deep financial crisis, and, frankly speaking, I

 11 believe very nearly decapitated the whole of the

 12 financial system. Credit derivatives did not

 13 dispose risk -- disperse risk; they concentrated

 14 at risk and concealed it.

 15 Now let's look at what we are planning

 16 to do. And let me say here that we have a change

 17 of administration coming, as I told you. We have

 18 a new Commissioner for the Internal Market and

 19 Financial Services who will take office, if all

 20 goes well, on the 1st of February next year. That

 21 is Michelle Barnie from France. But we have a

 22 strong presumption that the policy I'm about to
 107

 1 outline to you will perform the core of our

 2 thinking in the months ahead.

 3 First of all, in terms of general

 4 considerations, we are talking about a paradigm

 5 shift. We not so going to tinker around the

 6 margins while Rome burns. We want a comprehensive

 7 policy; we want strong international cooperation;

 8 and we will include the nonfinancial part of the

 9 industry.

 10 The first part of our policy is to

 11 reduce counterparty risk. We will propose

 12 legislation to ensure that CCPs are safe and sound

 13 with common safety, regulational and operational

 14 staff.

 15 We will propose to improve the

 16 collateralization of bilaterally-cleared contracts

 17 both in terms of initial margin and variation

 18 margin. We will propose to raise significantly

 19 capital charges to bilaterally-cleared as compared

 20 with CCP-cleared transactions; and we will propose

 21 mandating CCP clearing for so-called standardized

 22 contracts.
 108

 1 The second strand of our policy is to

 2 reduce what we call "operational risk." And by

 3 that I mean we want to encourage further

 4 collective action by the industry to promote

 5 standardization of the legal terms of contracts

 6 and of contract processing. We want also to

 7 assess the need to reshape operational risk in the

 8 capital requirements directive for translation of

 9 the parcel process in order to prompt

 10 standardization of contracts and electronic

 11 processing.

 12 Now I can tell you we're going to use

 13 the Pigon, if necessary, and we're going to set

 14 very tough deadlines for industry action.

 15 The third strand of our policy concerns

 16 improving transparency. What does that mean? It

 17 means mandating the reporting of positions and all

 18 transactions to trade, we hope.

 19 It means reposing -- proposing

 20 legislation on trade repositories and the

 21 supervision of them. It means mandating trading

 22 of standardized derivatives on organized trading
 109

 1 venues, and it requires improving and increasing

 2 pre and posttrade transparency as part of the

 3 upcoming review of our investment services

 4 directives, so called "method" today. And this is

 5 for all derivatives markets, including commodity

 6 derivatives.

 7 The fourth part of our policy is to

 8 strengthen market integrity and oversight. What

 9 do I mean? I mean curbing insider dealing and

 10 market manipulation by extending our market abuse

 11 laws. We will, I believe, also in the future,

 12 look at ratcheting up, collectively, in the

 13 European Union, the overall level of sanctions.

 14 We must also give regulators the possibility to

 15 set position limits to counter disproportionate

 16 price movements and concentrations of speculative

 17 positions.

 18 So that is the basic approach, basic

 19 building blocks of our policy.

 20 Now in terms of timing, first of all we

 21 have to do something which we believe is very

 22 important as we our final proposals. We have to
 110

 1 carry out obligatory and impact analysis.

 2 And that means before we make our formal

 3 proposals we have to look in great detail at

 4 whether those strands of those policies that I've

 5 been outlining are the right ones. We have to

 6 look at the economics of the benefits and the

 7 cost, and we have to make judgments about some of

 8 this fine detail that will form the final part of

 9 our proposal.

 10 We try to do our work in a very open

 11 way, and I am a big believer that the more open

 12 than transparent the policy process the better it

 13 gets. And so our intention -- and we have to see

 14 now according to the new Commission which takes

 15 office, again, on the 1st of February -- but our

 16 intention would be to start testing some legal

 17 texts early next year with our member states and,

 18 of course, with the industry. And we will

 19 certainly be seeking views from the United States

 20 and indeed particularly from the CFTC.

 21 Thereafter, around the middle of next

 22 year we hope to finalize the first part of our
 111

 1 legal text which would basically cover the CCP

 2 issues and the trade repository issues.

 3 That's Part 1; final proposals, we hope

 4 by around the middle of next year. Thereafter we

 5 will bring forward the amendments on the capital

 6 requirement side and on the investment services

 7 side towards the end of next year. So we're going

 8 to do this in two parts. That is the best timing

 9 I can give you today.

 10 I hope that will be confirmed. The

 11 president, as I said, has made it perfectly clear

 12 that this is top priority for his new commission.

 13 Let me now raise, if I may, ladies and

 14 gentlemen, some of the difficult issues that it

 15 seems to us still need to be discussed and indeed

 16 resolved. And some of them we know, having been

 17 here for 24 hours, and 24 hours is always a long

 18 time in Washington. But we know, a long -- a lot

 19 of these issues have already, are already being

 20 actively discussed.

 21 The first issue I want to raise with you

 22 is the following, and that is the issue of scope.
 112

 1 We favor, as I said, a comprehensive approach

 2 interalia to avoid regulatory arbitrage. We do

 3 not favor exclusions for specific segments of the

 4 market, some of the forex markets for examine. We

 5 think CCP, per se, is desirable, and we believe

 6 the burden of proof is on those who believe that a

 7 segment X or Y should be excluded.

 8 Why should they be excluded? And,

 9 frankly speaking, we have not heard any convincing

 10 arguments of why one part of this market should be

 11 included and other parts should not. So we like

 12 the idea of a comprehensive approach.

 13 Let me now say a few words on the big

 14 issue, and this is a big issue here and,

 15 certainly, will be and is already in Europe, which

 16 is the so-called end-user issue. Now, this issue

 17 has come quite late in a sense to the debate. We

 18 are on the record in our 20th of October

 19 communication. We have said the following and I'm

 20 quoting: "The costs of strengthening OTC

 21 derivatives markets should not be carried by the

 22 taxpayer but by those who directly enjoy the
 113

 1 economic benefit of using derivatives." Some of

 2 it can be expected to fall on nonfinancial

 3 institutions.

 4 In other words, what we're saying is

 5 that there's been a general underpricing of risk

 6 in these markets, and so the burden has to be

 7 shared to a degree by everybody. We've said that

 8 we're going to carry out a full impact analysis on

 9 how on how we allocate these charges. We

 10 recognize that most -- and again I'm quoting here

 11 -- "Most financial institutions are not of

 12 systemic importance." And we will strive to

 13 ensure that in our response we make sure that

 14 nonfinancial institutions who use these markets to

 15 hedge their risks will be able to continue to do

 16 so.

 17 There is no intention to close off

 18 markets or close off participants in those

 19 markets, but what is clear here is that we are not

 20 going to try -- we certainly, we will not accept a

 21 policy which is full of the holes of an Emmental

 22 cheese. We do that to make sure that we have a
 114

 1 consistent approach across all segments.

 2 So we don't have any firm positions yet.

 3 Some of the questions were going to be very

 4 important that we have to answer is how to

 5 separate the end-users that are purely managing

 6 risk from those who are managing speculative

 7 positions. How do we avoid another Emmental

 8 gesellshaft in Europe? How do we avoid regulatory

 9 arbitrate allowing financial firms to shift their

 10 risks into the unregulated area of oversight? In

 11 other words, we want to avoid the build-up here of

 12 another new shadow financial system.

 13 And how do we achieve the same objective

 14 in the United States and Europe because we're

 15 going to have, probably -- we have different legal

 16 instruments, and at the moment we have different

 17 legal definitions than your definition of the

 18 major swap participants, the MSPs. It's going to

 19 be very important in shaping that argument.

 20 The third issue which preoccupies us in

 21 a technical sense is the future role of the CCPs.

 22 We fully share the view that it should be
 115

 1 mandatory to clear so-called standardized,

 2 clearable derivatives through CCPs. Indeed, the

 3 G20 has fully agreed that. But who is going to

 4 decide on what is so-called standardized or

 5 clearable? The regulators? The CCPs? Both?

 6 How? Should the CCP not be able to

 7 decide whether it thinks product X or Y could be

 8 cleared safely?

 9 In other words, CCPs might not be

 10 directed to clear products if they feel they are

 11 unsuitable to be cleared. I think we feel at this

 12 stage the decision on whether a contract accepted

 13 for clearing by a CCP could be subject to the

 14 general clearing requirement should be left to the

 15 authorities. So we clearly see a role here in the

 16 general decision on whether a product should be

 17 cleared.

 18 Another issue in Europe concerns the

 19 ownership, governance, and robustness of CCPs.

 20 Now, this ownership issue, which we know has come

 21 out strongly in the United States, is less of an

 22 issue for us for several reasons: First of all,
 116

 1 we don't necessarily think that excluding some

 2 dealers from ownership of CCPs is necessarily the

 3 right policy. There could be very strong

 4 incentives for those dealers who do own CCPs to

 5 make sure the CCPs are efficient and indeed safe

 6 and sound. But that's one argument.

 7 A second argument for us is basically my

 8 institution doesn't determine the shape or

 9 composition of companies. We do not determine

 10 ownership in any activity that we carry out in the

 11 European Commission, and indeed, it's against our

 12 treaty.

 13 Member states can decide the types of

 14 structures they want for the CCPs.

 15 Now we are concerned in Europe that any

 16 movement towards clearing -- and we all support

 17 that -- should be robust enough to withstand any

 18 financial Armageddon. There are and will be more

 19 systemic institutions -- and we have in Europe not

 20 just one but several CCPs, as many as eight --

 21 that could be clearing this business, clearing

 22 trillions of dollars in euros of various
 117

 1 derivatives. So who should be the regulation

 2 supervisor here? What role for the CCP Risk

 3 Committee should we see? And, indeed, should

 4 there b a backstop if there is difficulties and

 5 trouble in a CCP? -- something, of course, that I

 6 know is very unpopular to contemplate, something

 7 that is very present in your discussions in

 8 Congress? But it's an issue we have to look at.

 9 I noted that Jerry Korrigan, who's

 10 immensely knowledgeable about these matters, has

 11 suggested that CCPs should be placed -- there

 12 should be enough safety in CCPs that if two major

 13 participants fail, the system can still continue

 14 and not collapse. So what is failsafe? How do we

 15 define that?

 16 And how will the default mechanisms work

 17 both in the CCP, and let's think about even more

 18 complex issues between CCPs, not necessary just in

 19 Europe but a default mechanism between a European

 20 CCP connected with a U.S. CCP? Who's going to

 21 call out? Who's going to make those decisions?

 22 And we have other issues in Europe that
 118

 1 perhaps you do not have here in the United States,

 2 one of them being how do we get interoperability

 3 of clearing houses in Europe? We do not have a

 4 mandatory obligation for that today. Should this

 5 be a right? An obligation? Well, I think, so

 6 we're going to have to mandate this in law.

 7 And then comes another question: Is

 8 this in only equities or do we include

 9 derivatives? I certainly hope, and I believe we

 10 should be bold here and require interoperability

 11 across all financial products cleared on NCCPs in

 12 the European Union.

 13 Ladies and gentlemen, we have other

 14 issues before us, issues of definition, issues of

 15 data reporting and data protection, issues of

 16 margin requirements and margin imposition in

 17 segregation. We've been hearing about that

 18 already, very interestingly, today.

 19 I come back to my basic point here.

 20 This issue is of tremendous importance for both

 21 the European Union and the United States. We are

 22 going to go the extra mile to try and converge our
 119

 1 positions with you without positions emerging in

 2 Congress as far as we can. I believe that's

 3 right. We believe that we will end up with safer

 4 financial markets, markets that will grow with a

 5 degree of safety that it did not have before.

 6 And I believe there's almost an ethical

 7 duty, and I say that very strongly, between us to

 8 try and get this legislation to converge to the

 9 maximum extent possible.

 10 And once again, Commissioner Sommers and

 11 Chairman Gensler, thank you very much for giving

 12 us the opportunity to put forward our views on

 13 these crucial matters in Washington today.

 14 COMMISSIONER SOMMERS: Thank you, David.

 15 I'm sure there's probably lots of questions, but

 16 at this point I'm going to turn to Terry Arbit

 17 from our Office of General Counsel, and Ananda

 18 Radhakrishnan is also here from the Division of

 19 Clearing and Intermediary Oversight. And Terry is

 20 going to give an overview of the proposals in the

 21 U.S.

 22 MR. ARBIT: Thank you, Commissioner
 120

 1 Sommers, Chairman Gensler, and commissioners. I

 2 will try to be relatively brief so that we can

 3 leave more time for discussion among the committee

 4 members.

 5 Staff at the CFTC has been working hard

 6 on the legislative matters, not just general

 7 counsel and clearing divisions but all of our

 8 other divisions as well -- market oversight,

 9 legislative affairs, international affairs. We

 10 appreciate the support of the commissioners that

 11 we've had for many, many months dating back to

 12 Commissioner Dunn's tenure as Acting Chairman

 13 earlier this year.

 14 In the materials, I think there's a

 15 short -- some call it a chart, some call it a

 16 table, but we've tried to summarize some of the

 17 issues that would be most relevant to trying to

 18 compare what's going on in Congress with the

 19 issues that we just heard about in the

 20 international perspective. This by no means is

 21 all of the provisions in the 200-page material.

 22 CHAIRMAN GENSLER: Terry, I am just
 121

 1 going to help. It looks like this. It's a side

 2 by side some people might call it.

 3 MR. ARBIT: Side by side by side by

 4 side.

 5 CHAIRMAN GENSLER: Yeah.

 6 MR. ARBIT: And I think it's seven pages

 7 long. And I'm going to try to just walk through

 8 those issues without getting into a great layer of

 9 depth on any of them. I think most people have

 10 some familiarity with them. Much of this side by

 11 side I think now is actually just of historical

 12 interest for those who've been following the

 13 events on Capitol Hill.

 14 We have several columns to talk about,

 15 various bills from the House Financial Services

 16 Committee, House Agriculture Committee, but the

 17 key at this point in time this week is the

 18 right-hand column, which would be the

 19 Peterson/Frank Substitute Bill which, as I

 20 understand, or this legislative process, will be

 21 the vehicle to go to the floor of the House of

 22 Representatives later this week. And that will be
 122

 1 the OTC bill that people will be voting on and

 2 offering amendments on.

 3 So that's the column that I'll be

 4 focusing on primarily in talking about this.

 5 Just one other introductory comment on

 6 the chart. What we've tried to do here at the

 7 staff level is highlight those where there have

 8 been disagreements during the debate.

 9 And so you will see that there are some

 10 provisions that are vitally important but that

 11 actually are not listed in the chart, swap

 12 repositories being a good example. There are

 13 provisions on repositories in the legislation, but

 14 they've remained the same from the

 15 administration's original proposal all the way

 16 through to the Peterson/Frank Substitute.

 17 They are not very detailed, actually, in

 18 the legislation about repositories but leave it up

 19 to the CFTC and the FCC and our rulemaking

 20 authority to implement those.

 21 But the chart, we tried to focus on

 22 those issues that had generated debate and
 123

 1 controversy over time, and actually, a good and

 2 other example on the flip side of the repository,

 3 so another issue that is not in the chart because

 4 there has not been a difference among our

 5 committees on it. But following up on the first

 6 half of today's meeting is bankruptcy. That's,

 7 from what we heard this morning or later today,

 8 obviously, a critical issue, and yet none of the

 9 bills that have been offered have included

 10 bankruptcy provisions in them. So that remains a

 11 gap, really, across the board, and that's why you

 12 won't see them in the chart. We have nothing to

 13 compare.

 14 But in terms of what is here and the

 15 issues that have come up, these really do, I

 16 think, track what's going on in Europe. Certainly

 17 all the discussions we've had at the staff level,

 18 with counterparts overseas, the same issues are

 19 coming up, and there seems to be harmony of

 20 approach at the staff level.

 21 What I'll try to do is summarize where

 22 Congress seems to be at, at least at the House of
 124

 1 Representatives side.

 2 The first question, which always is sort

 3 of who's in and who's out, and there we have

 4 definitions of swap dealers and major swap

 5 participants. They are in. I'm not going to

 6 really focus much on swap dealers because I do

 7 think the critical one is probably the major swap

 8 participant issue. And the relevance here is

 9 primarily who will be subject to the capital

 10 rules, the margin rules, the business conduct

 11 rules, the reporting and record-keeping rules.

 12 That's the significance, primarily, of whether you

 13 are or are not a major swap participant.

 14 And the same issues that are being

 15 confronted out in Europe are certainly being

 16 confronted here, the smaller the category of major

 17 swap participants and, some would argue, the

 18 larger the loophole from the regulatory regime, on

 19 the other hand, sweeping in entities and firms

 20 that, arguably, should not be swept in is also not

 21 good public policy.

 22 I've heard there seems to be, at least
 125

 1 in meetings I've been in, a fair amount of

 2 agreement on kind of what the concept is, but is

 3 reflected by the side by side. There have been an

 4 awful lot of efforts to capture that agreement,

 5 and the totalers to determine whether they've hit

 6 it yet.

 7 The general sense is that true risk

 8 management,l true commercial hedgers should

 9 perhaps not be swept in unless that failure of a

 10 hedger, a firm like that could have implications

 11 for other counterparties that are sufficient but

 12 they need to be brought into the regulatory

 13 regime. That seems to be the goal that most of

 14 these bills have been trying to hit, but they each

 15 have done it a little bit differently.

 16 The Peterson/rank Substitute of the

 17 formulation that hasn't appeared before in some

 18 respects ha got some similarities, some

 19 differences. The key phrase that is generating

 20 debate this past week seems to be the references

 21 to operating and balance sheet risk, which would

 22 be a means to exclude firm from the definition of
 126

 1 major swap participant which again would then

 2 exclude them from the requirements of business

 3 conduct, record-keeping, capital, and margin.

 4 So that's the general issue of who's in

 5 and who's out. We then get to a couple of issues,

 6 the clearing requirements and the transaction

 7 execution requirements, which are critical to the

 8 entire regime. Again, first on clearing

 9 requirement, there does seem to be the general

 10 consensus that as many transactions as possible,

 11 as many swaps as possible, should be cleared

 12 consistent with the G20 declarations. But we have

 13 the same questions here: Who is going to decide

 14 what is clearable?

 15 And what are going to be the standards

 16 for making those decisions? And again, if you

 17 just look across the columns of this chart, there

 18 have been a lot of proposals fashioned to do that.

 19 The current version, the Peterson/Frank

 20 Substitute, does not specifically rely on notions

 21 of standardization, but it does have the concept

 22 of an active role of the regulatory agencies, the
 127

 1 CFTC and the FCC. The regulators will determine

 2 whether a swap must be cleared based on various

 3 factors that would be in the legislation, and that

 4 can be done either at the request if a clearing

 5 house or at the Agency's own initiative.

 6 But there does have to be a regulatory

 7 determination that the swap must be cleared in

 8 order for it to go forward.

 9 You then get to the issue of it's a

 10 clearing requirement, but what exceptions are

 11 there to the clearing requirement? And this is

 12 what we were just talking about, the so-called

 13 end-user exception. It's similar to the major

 14 swap participant definition issue but a little bit

 15 different. This goes to the question of who must

 16 clear their swaps. It's not so much the question

 17 of who's subject to capital and margin

 18 requirements. The question is, should there be

 19 any exceptions to the clearing requirements, and,

 20 if so, how extensive should they be?

 21 Certainly, some have argued that there

 22 should be no exceptions at all; others have argued
 128

 1 that there may be room for some exceptions as long

 2 as they are narrowly tailored to try to capture

 3 purely commercial firms.

 4 Again, I think where the Peterson/Frank

 5 Substitute comes out is again the critical

 6 language probably about balance sheet risk and

 7 operating risk. There's also a sort of odd

 8 requirement to staff here that, in order to take

 9 advantage of the exception, there has to be a

 10 notification to the CFTC of how a non-dealer or

 11 non-major participant addresses its obligations

 12 with noncleared swaps. There's actually no

 13 requirement that we do anything with that. We

 14 don't have to decide anything; we simply have to

 15 be notified of it in order for the participants to

 16 take advantage of the end-user exception.

 17 That, then, leads into the question of

 18 an exception from the trading requirement.

 19 Generally, swaps are mostly traded on trading

 20 venues, either contract markets here or the swap

 21 execution facilities. But the question came up,

 22 if the swap doesn't have to be cleared, does it
 129

 1 still have to be traded on one of these trading

 2 platforms? Some have argued that the two are

 3 distinguishable, and even if it's not cleared, the

 4 swap should still be traded on a trading platform.

 5 Most of the bills -- in fact I think all of the

 6 bills -- have not taken that route.

 7 They have all provided, one way or

 8 another, that if the swap is out of clearing, it's

 9 also out of the trading requirement.

 10 CHAIRMAN GENSLER: Terry, where I don't

 11 expect you to take a point of view as the Deputy

 12 General Counsel, but are they distinguishable?

 13 Just that point, is a clearing requirement and a

 14 trading requirement from a technical-legal point

 15 of view, could you distinguish the two?

 16 MR. ARBIT: I think they could be

 17 distinguished.

 18 CHAIRMAN GENSLER: Okay.

 19 MR. ARBIT: The Peterson/Frank

 20 Substitute, while like its predecessors does link

 21 the two, but it does make clear that reporting is

 22 required. If the swap is not cleared, it doesn't
 130

 1 have to be traded on one of the organized venues

 2 but does still need to be reported.

 3 I'm really going to quickly just touch

 4 on the others. I think those are the key issues,

 5 the critical ones that probably are the most

 6 interesting for discussion. But just a couple of

 7 the others, or of the ones that are in the chart

 8 and have international implications, the

 9 Peterson/Frank Substitute would give us here in

 10 the CFTC and the industry a new set of DCO core

 11 principles.

 12 These principles are consistent with

 13 international standards today. They were designed

 14 to respond to criticism by some that the existing

 15 core principles from the CFMA nine years ago were

 16 not sufficiently robust. But in addition, under

 17 the Substitute, the CFTC would also have

 18 rulemaking authority to supplement or change or

 19 adapt the rules for clearing houses as time goes

 20 on.

 21 The next of these is trading platforms,

 22 the swap execution facilities. This is an
 131

 1 interesting area because I think that the question

 2 that's come up is sort of what model these

 3 platforms are going to have. Clearly the

 4 administration's bill was focused on a model of a

 5 certain platform similar to the Intercontinental

 6 Exchange. You'll see if you follow the flow of

 7 the chart that over time the definition of these

 8 facilities has expanded to encompass different

 9 models similar to the alternative trading systems,

 10 on the security side. The voice brokerage type of

 11 business, and I think how that business relates to

 12 the swap execution facility, how that fits in is

 13 probably an issue that really isn't fully resolved

 14 in the House bill and will probably be debated

 15 further when it gets over to the Senate.

 16 Position limits. All of the bills have

 17 provisions where the CFTC may set aggregate

 18 position limits that will include swaps, that will

 19 include Foreign Board of Trade contracts that are

 20 linked to U.S. contracts. The one thing I

 21 highlight in the chart is that the Peterson/Frank

 22 Substitute also does include a requirement for the
 132

 1 CFTC to set futures and options limits within a

 2 short number of days after the bill is enacted for

 3 physical commodities, the energy and the

 4 agriculture. That's one place where the

 5 legislation is extending beyond swaps to cover

 6 futures and options as well.

 7 Foreign boards of trade. There are

 8 provisions on foreign boards of trade. Again all

 9 of the bills have consistency that for a foreign

 10 board of trade that seeks direct access to U.S.

 11 customers, the legislation essentially codifies

 12 the Commission's current policy on what conditions

 13 will be posed on that situation. Where they've

 14 differed, as you can see, is whether actual

 15 registration will be required of foreign boards of

 16 trade. The administration had proposed that there

 17 should be a registration requirement, which I

 18 think staff here thought of it as kind of a

 19 "registration lite" type of regime.

 20 But that is not included in the

 21 Peterson/Frank Substitute. There's not a

 22 registration requirement.
 133

 1 The old concept of the multilateral

 2 clearing organizations under FDICIA and the CFMA

 3 has disappeared in the Peterson/Frank Substitute,

 4 although all of the bills have had provisions

 5 where the CFTC can exempt foreign clearing houses

 6 that they find are subject to comparable,

 7 comprehensive supervision and regulation by

 8 appropriate regulators overseas.

 9 And last, extraterroriality, the last

 10 one on the chart concerns a swap provision that

 11 was in neither the administration bill nor any of

 12 the others leading up to it. It actually,

 13 explicitly addressed the application of the

 14 statute to activities overseas concerned with

 15 swaps, and the Peterson/Frank Substitute does

 16 include a provision that specifically spells out

 17 that the law will not apply to activities outside

 18 the U.S. unless those activities have a direct and

 19 significant connection with activities in or

 20 effect on U.S. Commerce, or if they contravene

 21 rules that the CFTC sets up to try to avoid

 22 evasion of the new law.
 134

 1 I think that's generally consistent with

 2 the extraterritoriality provision that already

 3 exists in the Federal securities laws.

 4 That's the chart. I want to mention

 5 just two other things very quickly that didn't

 6 make the chart. The one I know is very important

 7 to everybody here and overseas, which is

 8 governmental access to data in the repositories.

 9 And the legislation is very clear that data that

 10 is in a U.S. repository is available to foreign

 11 financial supervisors, foreign central banks, and

 12 foreign ministries subject to the confidentiality

 13 provisions that are in the Commodity Exchange Act

 14 already to protect futures and options type of

 15 information.

 16 And last, just to support the comment

 17 about how fast things move, it's not really day to

 18 day; sometimes it's hour to hour. I finished this

 19 chart shortly before the meeting started, and as I

 20 came down here I got a message on the BlackBerry

 21 that it's already obsolete. There have already

 22 been further changes, so I stand by my analysis at
 135

 1 least until it changes, but they did the current

 2 version of the Peterson/Frank Substitute, does

 3 include a provision relating position limits.

 4 But the CFTC shall strive to ensure that

 5 trading on a foreign board of trade will be

 6 subject to comparable position limits, and any

 7 limits here will not cause price discovery in the

 8 commodity to shift the trading on the foreign

 9 board of trade.

 10 So that's currently in the

 11 Peterson/Frank Substitute. And I think that was a

 12 quick run through the general international

 13 highlights, and I'll stop so we can get to the

 14 discussion.

 15 CHAIRMAN GENSLER: Terry, could you just

 16 expand on one area that I would think would be

 17 interesting to everybody -- but particularly David

 18 Wright and his colleagues -- is you talked about

 19 extraterritoriality, but when in the bill could

 20 the SEC or CRTC, or for that matter the prudential

 21 regulators.

 22 Under the bill, David, the prudential
 136

 1 regulators set the capital standards for these

 2 swap dealers.

 3 When could the SEC, CFTC, or prudential

 4 regulators rely on foreign regulators, because the

 5 largest, the 12 or so largest financial firms or

 6 swap dealers are all global in nature?

 7 When could we rely on them with regard

 8 to intermediaries? When could we rely on them

 9 with regard to clearing houses and swap execution

 10 facilities? There may be three different answers,

 11 I don't know.

 12 You might want to hit the button.

 13 MR. ARBIT: Thank you. One of the

 14 answers I'm not entirely sure about. There is --

 15 there are provisions for the CFTC to exempt

 16 clearing houses and the swap execution facilities.

 17 We could exempt these entities if they're

 18 regulated by the SEC or by a foreign regulator.

 19 That's that language I was talking about, a

 20 compre- -- if we find there's comprehensive

 21 supervision and regulation by appropriate

 22 regulators in the home country of the clearing
 137

 1 house or the execution facility, and the CFTC may

 2 grant an exemption. It's not automatic.

 3 CHAIRMAN GENSLER: So it's comprehensive

 4 appropriate regulation, and then we can grant it.

 5 MR. ARBIT: Right.

 6 CHAIRMAN GENSLER: How about the

 7 intermediaries?

 8 MR. ARBIT: That, you know, there were

 9 versions of the bill that did not include that for

 10 intermediaries. It was for the trading platforms.

 11 I think that's the case in the final, but I will

 12 need to look at the final and make sure of that.

 13 But there were versions of the bill that drew that

 14 distinction that not the intermediaries but the

 15 exchange platforms and clearing houses.

 16 COMMISSIONER SOMMERS: There are a lot

 17 of issues to cover, and I know many of you have

 18 questions and comments about several different

 19 portions. So I'll go ahead and open it up.

 20 CHAIRMAN GENSLER: I just want to thank

 21 Terry Arbit and everybody in the legal staff.

 22 It's just an amazing job that -- well, under --
 138

 1 and Dan Berkovitz, who is here, too -- I mean

 2 providing this type of document for this meeting,

 3 but well beyond that providing technical

 4 assistance to the House, the Senate, Republicans

 5 and Democrats alike. It's just remarkable what

 6 you guys have been doing.

 7 COMMISSIONER SOMMERS: So I'll go ahead

 8 and open up the floor. Jiro?

 9 MR. OKOCHI: Hi, my name is Jiro Okochi.

 10 Mr. Wright, just for clarity I should say, I

 11 represent about 400 end users, so we may have to

 12 agree to disagree. But you made a point in your

 13 document about how credit may have been

 14 undercharged, and some of it was clearly evident

 15 in the financial crisis. And then in your opening

 16 statement you mentioned that end users should pay

 17 for the cost, I guess for the privilege of using a

 18 distributive market.

 19 I guess I'm trying to understand how you

 20 can clarify why the cost should go up, so if I

 21 look at, you know, there's 200 swap dealers in the

 22 marketplace in ISDA. They're clearly making some
 139

 1 profits from entering into derivatives, and from

 2 an end-user perspective, when they enter into a

 3 swap transaction, they're looking at the overall

 4 cost of the banking relationship, and I believe

 5 it's vice versa. So you're looking at how much

 6 you're paying for your loans, how much you're

 7 paying in fees, and related to that how much are

 8 you paying for the costs of entering into the

 9 derivatives.

 10 So I'm just trying to understand if you

 11 think derivatives are underpriced for end-users,

 12 and the cost for margining and clearing should

 13 make up for, you know, the new price under the

 14 reform, or if I'm missing something.

 15 MR. WRIGHT: Well, in our paper, and

 16 it's only an official position, what we clearly

 17 state here is that we want, on these markets, we

 18 want risks to be priced properly.

 19 I think it's a fairly heroic assumption

 20 to make that in these markets risk has been priced

 21 properly. You may say that. I think that we

 22 fundamentally disagree. And if, as we'll, I
 140

 1 think, agree on the policy side that we want to

 2 drive more of this business to be cleared, drive

 3 it on to exchange, make it more transparent, et

 4 cetera, et cetera, if that is going to require

 5 more cost and a higher price for nonfinancial

 6 firms, then we think that is correct.

 7 We think that is entirely correct, and

 8 we believe that the benefits of that public policy

 9 will result in something that's pretty precious,

 10 and let's not forget the value of that which is

 11 called financial stability. And let us not forget

 12 that this financial crisis -- let me talk about

 13 the European Union again where so far we have

 14 authorized expenditures to bail out the banking

 15 system to the tune of 31 percent of GDP.

 16 Not all of that has been used.

 17 Actually, we've been -- we've used 12 percent.

 18 So there's something very seriously

 19 wrong here. I think we all know that, and some of

 20 that -- not all of it, but some of it -- we think

 21 has been because the pricing of risk in these

 22 markets has not been entirely correct. So this
 141

 1 policy is going to possibly result in more costs

 2 for hedging positions.

 3 We've made it very clear that we do not

 4 want to cut off bilateral trading, bilateral

 5 custom-made derivatives, but again, we think that

 6 the risks require more capital to be posted.

 7 We're going to change our capital

 8 requirements directive to make sure that is the

 9 case. The firms, whether their market -- whether

 10 their dealers or market participants decide that's

 11 what they want, nonfinancial firms, so be it. But

 12 the cost will go up, and the cost, we think, has

 13 to go up in order to make the system safer.

 14 So, you know, there's a fundamental

 15 question here. We're not dictating prices, but we

 16 are saying we want a safer system, yes. Very much

 17 so.

 18 COMMISSIONER SOMMERS: I think this is

 19 an interesting and challenging issue. And as

 20 Terry captured it so well, although there may be

 21 agreement on which direction to head with the

 22 decision-makers on Capitol Hill, capturing that
 142

 1 decision in actual language has been the real --

 2 On this particular issue, does anybody

 3 else have comments? George?

 4 MR. CRAPPLE: If the cost of the end

 5 user is going up because of the posting of margin,

 6 that could be offset by through the transparency

 7 and the execution rules that much better

 8 executions are become available. Or were you

 9 talking about specifically assessing some sort of

 10 charge to the users?

 11 MR. WRIGHT: I think it's clear that we

 12 think that as more and more trading goes on

 13 exchange, and you would expect over time those

 14 additional costs I was referring to should

 15 decline, hmm? That's clear.

 16 But I've outlined a policy here which we

 17 believe is the right one, and we believe may --

 18 may and is likely to require and result in

 19 additional costs.

 20 Now, the issue then becomes -- and this

 21 is the big issue you're debasing, and we've just

 22 heard from your general counsel about who's in and
 143

 1 who's out, hmm, of this system, hmm?

 2 And we've noted very clearly what

 3 paragraph 4 in talking about this triple

 4 cumulative conditionality about who has to -- who

 5 is going to be inside this system and who's not.

 6 We will be looking at that as well.

 7 We have, I think, an a priori view that

 8 we want the exemptions to be extremely narrow.

 9 Because we have a view -- it may be wrong, but we

 10 have a view -- that if we do not -- if we have an

 11 open-ended system here, basically we'll end up

 12 with arbitrage and another shadow system with all

 13 the dangers that results.

 14 And so again I think it's too early to

 15 say how these economic effects will play out.

 16 We're going to analyze this very carefully, and as

 17 we design our exemption regime, if we have one --

 18 but let's assume we have one, we haven't said

 19 we're not going to have one -- we want to make

 20 sure that these new disciplines, and there are new

 21 disciplines, apply as widely as possible.

 22 COMMISSIONER SOMMERS: David?
 144

 1 MR. DOHNALEK: I would like to at least

 2 provide the perspective of the business end user

 3 since I'm perhaps in the minority in the room

 4 here. But I'll just make a few points.

 5 As a business end user, we clearly see

 6 the benefits of the financial regulatory reform,

 7 especially in the areas of increasing transparency

 8 and reducing systemic risk, and restoring

 9 financial stability. Those are certainly all good

 10 things from our perspective.

 11 However, we're keenly interested in

 12 making sure that any new regulation does not

 13 eliminate the important flexibility we think we

 14 need to effectively manage risk in our business.

 15 And so, specifically, what do we mean?

 16 First off, we believe that, you know, business end

 17 users do not pose systemic risk to the financial

 18 system and, in fact, end users, you know, trades

 19 represent only a small minority of the total sort

 20 of OTC derivatives market. You know, we're not in

 21 the business of speculating and gambling for

 22 profit; it's not in our policy or our charter.
 145

 1 We believe it's imperative that end

 2 users continue to have the flexibility to enter

 3 into bilateral customized transactions that best

 4 address the risk profile that we have in various

 5 aspects of our business and to mitigate that risk.

 6 And so we're clearly in favor of

 7 exemptions for business end users from central

 8 clearing and bilateral margining.

 9 Now, without these exemptions, we think

 10 we'd suffer the burdens of losing hedge accounting

 11 treatments in many cases for many of the

 12 transactions that we would engage in, which

 13 introduces significant earnings volatility to our

 14 P&L. It would also impose perhaps onerous

 15 requirements for taking capital away from what we

 16 would deem more productive investments in our

 17 business and in growing our business and

 18 employment, and divert that precious capital to

 19 cover things like margin requirements.

 20 So, bottom line, we as a business end

 21 user support many of the benefits of the proposed

 22 regulatory reform, but we'd like to ensure that
 146

 1 that regulation not overreach and end up stifling

 2 or inhibiting the important flexibility we need to

 3 mitigate the risk in our business and to invest

 4 the capital that we need to grow our business.

 5 CHAIRMAN GENSLER: Could I just ask,

 6 then we might have a rebut response, and thank you

 7 for joining the committee, by the way.

 8 You mention ability to customize. I

 9 asked you if you were familiar that the

 10 administration proposal and every bill in Congress

 11 that's been submitted so far since May allows for

 12 customized transactions. So that's a valid point

 13 you're raising. The administration supports it.

 14 Chairman Peterson's bill, Chairman Frank, Chairman

 15 Dodd's bills -- I think Senator Reid also had a

 16 bill -- all supports that exact point.

 17 Is it some other point that you're

 18 debating? I think it is. I think it's saying

 19 that as an end user you don't want standardized

 20 transactions to be on clearing houses. I just

 21 wanted to separate what I think it is that you're

 22 raising. But customized transactions have been
 147

 1 fully supported by the administration and by each

 2 of the committees. And if I'm correct, then the

 3 question of standardized transactions -- by the

 4 way, you would still be able to get hedge

 5 accounting -- I find that being raised, with all

 6 respect, is adequately addressed because you could

 7 customize a transaction and be able to get your

 8 hedge accounting.

 9 I probably come out a different place.

 10 I'm where David Wright is. I think that the

 11 taxpayers in this country have $180 billion in

 12 AIG. That's $600 each one of us has in there, and

 13 I know that at Boeing you probably had sales go

 14 off.

 15 You had to look at a year that was

 16 probably very much below your current budgets. So

 17 it hit Boeing, it hit every shareholder of Boeing,

 18 every employee of Boeing. And I don't know how

 19 many people you probably would have hired if the

 20 employment was better in this country.

 21 So this calamitous situation hit

 22 everybody at Boeing as well, so I sort of warm
 148

 1 with where David Wright is. I think we should

 2 have all standardized swaps in clearing. But

 3 recognizing maybe the votes aren't there in

 4 Congress, maybe the Boeings and the others in this

 5 great democracy of ours will convince Congress not

 6 to do it.

 7 My question for you is, could you, as

 8 Treasure of Boeing, support requiring that

 9 standard swaps be brought to a trans-prior in

 10 trading venue while you're exempt from a clearing

 11 requirement?

 12 MR. DOHNALEK: Well, Mr. Chairman, I

 13 guess I would have to make sure I understand the

 14 technical distinction you're making. I think that

 15 --

 16 CHAIRMAN GENSLER: Well, I'm here, I'll

 17 explain it.

 18 MR. DOHNALEK: Yes.

 19 CHAIRMAN GENSLER: Trading is where

 20 buyers and sellers meet in the marketplace where

 21 price discovery occurs, where information deficits

 22 that occur in the market right now are exposed,
 149

 1 and where a transaction occurs, and then prices

 2 are reported: posttrade transparency.

 3 Clearing is something that happens for

 4 months or years after the trade that has to do

 5 with risk mitigation. Risk mitigation because

 6 these derivatives values change in value.

 7 Right now we have Wall Street, really

 8 five banks, that internalize both the trading and

 9 the risk management. And what I am strongly

 10 recommending for the benefit of economic growth

 11 and efficiency in markets is that both are moved,

 12 but the trading side benefits. If every treasurer

 13 in America, every assistant treasurer in America

 14 had a screen and could see the pricing of interest

 15 rate, currency, commodity, equity, credit default

 16 swaps, the spreads would narrow. And economists

 17 say when spreads narrow, liquidity goes up.

 18 Wall Street will probably contend, no,

 19 not really liquidity won't go up. But I think you

 20 benefit as a treasurer of Boeing every time you're

 21 thinking about issuing debt that there's something

 22 called, you know, that corporate bonds are now
 150

 1 reported in a realtime basis. I think you benefit

 2 when you do a share repurchase. If you were going

 3 to do a share repurchase and you didn't know where

 4 your stock was trading, you'd say the SEC wasn't

 5 fully doing their job.

 6 And if you were hedging something in the

 7 futures market, and you were trying to hedge it

 8 and didn't know where the last futures price

 9 traded, you'd say that we here weren't really

 10 fully doing our job.

 11 So what we're talking about is not

 12 small, it's a big thing. But it would shift an

 13 information advantage to you as an end user, and

 14 then let you decide with your counterparty whether

 15 you would keep -- you might keep the trade on the

 16 books with the bank, have your credit arrangement

 17 with the banks as you do now, not be required to

 18 move it to central clearing but at least have the

 19 benefit of the transparency.

 20 MR. DOHNALEK: All right, so we --

 21 what's important to us is that we be able to have

 22 that bilateral discussion with the bank because
 151

 1 some of our requirements are unique and long-dated

 2 and end up --

 3 CHAIRMAN GENSLER: You would have that

 4 on all the customized swaps you will want,

 5 absolutely.

 6 MR. DOHNALEK: Right. So what we're not

 7 wanting is to be forced into standardized

 8 transactions through an exchange because that

 9 won't fit the risk --

 10 CHAIRMAN GENSLER: My question is, is

 11 you would completely have flexibility to do all

 12 the customization you want. But if you happened

 13 to do a standard swap, a one-year interest rate

 14 swap that is listed on a trading platform, then

 15 the counterparty, the big bank, would have to, you

 16 know,on that transaction expose it to the price

 17 discovery function.

 18 MR. DOHNALEK: Well, certainly something

 19 that we'll consider. But you understand that

 20 what's important to us is to be able to have --

 21 and I think, fundamentally, I mean you mentioned

 22 AIG, you --
 152

 1 CHAIRMAN GENSLER: Mike, [sic] can I ask

 2 you, what wouldn't be good for Boeing and your

 3 employees and your stockholders of that?

 4 MR. DOHNALEK: I'd have to think about

 5 it, Mr. Chairman. I think that, fundamentally

 6 again, it's the ability to customize, the ability

 7 --

 8 CHAIRMAN GENSLER: We have that.

 9 MR. DOHNALEK: -- to get hedge

 10 accounting because that is important to us, the

 11 earnings volatility issue. And the ability to not

 12 be required to post margin because it does take

 13 cash away --

 14 CHAIRMAN GENSLER: I've said yes to

 15 every one of those.

 16 MR. DOHNALEK: Okay.

 17 CHAIRMAN GENSLER: I can't understand

 18 how this wouldn't be an unabashed good thing for

 19 you.

 20 MR. DOHNALEK: All right, and I'm not

 21 sure that it is, but let me -- let me get back to

 22 you on that.
 153

 1 CHAIRMAN GENSLER: I'd thank you.

 2 MR. DOHNALEK: All right.

 3 MR. WILSON: Here it seems to me that

 4 the possibility that you raise of trading

 5 standardized swaps which are not cleared in a

 6 central marketplace really highlights what would

 7 then be happening, which is you would then be

 8 giving the liquidity providers of those swaps the

 9 ability to tie together, simultaneously, the

 10 pricing of the derivative and the credit component

 11 implicit in not requiring collateral.

 12 Some people might say that that's

 13 anticompetitive because your tying together

 14 multiple services at the same time, and it doesn't

 15 seem like the right approach. The better approach

 16 seems to me to be to recognize that issue and to

 17 split those things apart.

 18 CHAIRMAN GENSLER: Thank you. Don, what

 19 could come to a judgment.

 20 COMMISSIONER SOMMERS: David, did you

 21 have a comment?

 22 MR. WRIGHT: Well, I very much agree
 154

 1 with what the Chairman has been saying here.

 2 Again, our position is I want to just read out one

 3 or two passages because, maybe to reassure my

 4 colleague on the left here, we're not saying that

 5 there shouldn't be any customized derivatives

 6 trading in the future, but we want that trading to

 7 be properly prices. And we intend to, because we

 8 believe it is much safer to trade as much as

 9 possible and to clear as much as possible, we are

 10 going to provide incentives by requiring more

 11 capital to be posted for this type of trading in

 12 the future.

 13 So that is a deliberate policy choice,

 14 and it's a policy choice for financial stability.

 15 And I repeat that point.

 16 So, secondly, let me say that we clearly

 17 state in our papers that we do not, will not put

 18 forward policy -- which prevents Boeing, in your

 19 case, sir, or anybody else -- from managing the

 20 risks in your business. We're not saying that.

 21 And what we say about variation margins

 22 is the following: Variation margin requirements,
 155

 1 if needed for financial firms, should be tailored

 2 in such a way that they do not undermine the

 3 corporate sector's ability to use derivatives for

 4 transferring risk, especially in the case of

 5 companies whose use of derivatives is below a

 6 threshold.

 7 So there are signals there that would

 8 perfectly understand the issues you are raising.

 9 But there is a much broader point, and I come back

 10 to the broad point, and I come back to the

 11 economic damage and the financial stability issues

 12 here. That is what's really important. And we

 13 believe, as the Chairman has said, the more

 14 transparent the markets are, you and your firms in

 15 the end will benefit from that by tighter spreads,

 16 by more transparency, by understanding exactly

 17 where the market is. So we want to encourage

 18 those trends, we want to clear transactions

 19 because we believe it's much safer, and we want

 20 the CRTC and our parallel regulators and

 21 supervisors to have fully information about what's

 22 going on in these markets. And that was not the
 156

 1 case in this financial crisis.

 2 So I don't think we're closing off what

 3 you want to do; we're just saying there's going to

 4 be an economic price if you don't do it in the

 5 more so-called inverted commerce standardized way

 6 or through clearable transactions.

 7 COMMISSIONER SOMMERS: George?

 8 MR. CRAPPLE: Taking this Boeing hedging

 9 example that has been discussed, I think I heard

 10 two different things. Chairman Gensler was

 11 saying, no, they won't have to put up margin for

 12 their customized bilateral long-term derivatives;

 13 and Mr. Wright is saying, yes, they would.

 14 MR. WRIGHT: No. No.

 15 MR. CRAPPLE: No?

 16 MR. RIGHT: No. You didn't listen to me.

 17 I said variation margins, if needed. I said "if

 18 needed." So first of all, that's' not a position

 19 that's --

 20 MR. CRAPPLE: Oh, that's variation

 21 margin but you --

 22 MR. WRIGHT: Yes.
 157

 1 MR. CRAPPLE: -- also talked about a

 2 positional --

 3 MR. WRIGHT: Asci.

 4 MR. CRAPPLE: -- capital --

 5 MR. WRIGHT: So it depends. In terms of

 6 the U.S., it depends on the definition of this

 7 famous category here under No. 4, is it not, about

 8 who is covered by the exemption?

 9 MR. CRAPPLE: I guess I'm still confused

 10 because I thought I heard you say that a, you

 11 know, bilateral, negotiated, customized swap

 12 transaction that a capital deposit would be

 13 required.

 14 MR. WRIGHT: Well, clearly, what we're

 15 saying is that where there's OTC trading we intend

 16 to change the capital requirements rules -- hmm?

 17 CHAIRMAN GENSLER: For banks.

 18 MR. WRIGHT: For banks. So clearly for

 19 banks who will be required to post -- to have more

 20 capital for that type of trading, for the stuff

 21 that cannot be centrally cleared. And the Basel

 22 Committee right now is looking at that. So that,
 158

 1 of course, will in a sense add to the cost, and/or

 2 potentially add to the cost, and that price you

 3 would imagine would increase for the OTC

 4 transactions.

 5 CHAIRMAN GENSLER: And just to clarify,

 6 if you like, the administration and this

 7 Commission, because I testified on behalf of the

 8 full Commission before Commissioner O'Malia was

 9 here, has been supportive of customized

 10 transactions that individual hedgers, whether it's

 11 Boeing, whether it's small, whether it's large, or

 12 even individual speculators would have an ability

 13 to tailor their over-the-counter derivatives and

 14 enter into bilateral transactions after any

 15 legislation moves forward.

 16 The banks providing that service would

 17 have capital charges and possibly margin, but

 18 certainly be able to provide those customized

 19 tailored transactions to both hedgers and

 20 speculators.

 21 What I think really the debate is over

 22 is that part of the market that can be cleared or
 159

 1 that part of the market that's listed on a swap

 2 execution facility. It's so standard that it can

 3 be cleared, is there a requirement? And what I

 4 was raising is I think the two were separable.

 5 And as our General Counsel's Office, Terry Arbit

 6 said it can be separable with Congress' help.

 7 I think that is what I was trying to

 8 elicit from David is that I think the legitimate

 9 issue that end users have raised about their

 10 costs, I side with David Wright, I think it's

 11 important not to ship that cost to taxpayers. But

 12 if Congress decides to have an exemption for end

 13 users from clearing, which I understand may well

 14 be what develops -- that's what's part of our

 15 great democracy -- I think that the transparency

 16 part of it is something that corporate America has

 17 an opportunity right now to influence this debate

 18 in a positive way, in a positive way to your

 19 bottom line.

 20 I'm appealing to your fiduciary duty. I

 21 think you should ship that information advantage

 22 from the Goldman Sachses to your left to the
 160

 1 Boeings. And there's five firms right now that

 2 are dominant in this country in this business. I

 3 would think you would want to ship that

 4 information advantage to the thousands of end

 5 users.

 6 MR. CRAPPLE: I'd just like to clarify

 7 that I really agree with everything you both have

 8 been saying about the benefits to the end users

 9 and, of course, to our financial system.

 10 I'm not quarreling with it at all. I

 11 agree with it entirely.

 12 COMMISSIONER SOMMERS: Is there anything

 13 further on this issue? Mike, did you have a

 14 question?

 15 MR. NEWSOME: Commissioner, this is Jim

 16 Newsome.

 17 COMMISSIONER SOMMERS: Jim, we can hear

 18 you.

 19 MR. NEWSOME: Okay, thank you.

 20 Certainly, I, even though I'm on the board of the

 21 CME I don't speak on their behalf.

 22 I think the management of CME has done
 161

 1 that quite well throughout this whole debate with

 2 both the Commission and the Congress, and I, as

 3 well as I know the CME management has supported

 4 the overarching goals of the Congress and the

 5 administration to reduce systemic risk. And,

 6 certainly, I completely understand the

 7 conversation here between standardized and

 8 customized, but I think on behalf of the clearing

 9 house standpoint I wanted to raise an issue with

 10 regard to standardized contracts and get both

 11 David and the Chairman's view. And I think even

 12 behind that the CME has supported the benefits of

 13 central party clearing. There's been discussion

 14 about whether it should be mandated or whether it

 15 should be incentivized, and I won't get into that

 16 right now.

 17 But contracts that are standardized,

 18 even though they are standardized, if they're very

 19 infrequently traded, makes it extremely difficult

 20 for the clearing house to clear because it's

 21 difficult for the clearing house to calculate

 22 collateral climates consistent with prudent risk
 162

 1 management. How would you deal with even

 2 standardized contracts that are very infrequently

 3 traded when it creates a lot of difficulties in

 4 the clearing house?

 5 CHAIRMAN GENSLER: Oh, my god, David

 6 Wright wanted me to go first.

 7 Hi, Jim, it's good to chat with you even

 8 over the phone here like this, and it's an honor

 9 to be in the job you once held. I think that what

 10 the House bill contemplates, and we support though

 11 there's been various alternatives to this, is sort

 12 of a two pieces to this: that the regulators, the

 13 SEC and CFTC and the clearing houses, have a role

 14 to play in these determinations of what's

 15 clearable. But both have a role to play where the

 16 clearing decision is an important one. But it all

 17 has to be under robust risk management standards.

 18 And one of the key things, I believe, to

 19 robust risk management is that a clearing house

 20 can adequately price the transactions because

 21 clearing houses market to market transactions on a

 22 daily basis and need to have some ability to do
 163

 1 that. That's for more accessible in the rate

 2 markets, interest rate and currency markets, less

 3 so in some of the credit markets and commodity

 4 markets. But I think it's central to the question

 5 of what is clearable is how well you can risk

 6 management of contracts. So I suspect there's not

 7 going to be -- I think there will be a mutual

 8 interest between regulators and the markets to

 9 make sure that the clearing houses are robustly

 10 managed and that anything that is deemed to be

 11 clearable is done with that in mind.

 12 Also the bill contemplates a public

 13 comment to it. I think, if I'm right, Terry Arbit

 14 can tell us that if a clearing house asks

 15 something to be cleared or if the SEC and CFTC

 16 wants it to be cleared, we have to put it out for

 17 comment for, I think -- 30 days maybe in there,

 18 Terry?

 19 MR. ARBIT: Right. That's right.

 20 CHAIRMAN GENSLER: And though that was

 21 recommended by people in Congress, I fully support

 22 that. I think that's a good idea so that the
 164

 1 marketplace will be able to comment, and then a

 2 determination would be made as well.

 3 MR. NEWSOME: Mr. Chairman, I think that

 4 flexibility, you know, in very unusual

 5 circumstances like the one I mentioned would be

 6 very useful to both the Commission and the

 7 clearing house. And let me finish by saying I'm

 8 glad that I'm not sitting in your chair right now.

 9 MR. WRIGHT: Very briefly, I think we

 10 have a similar philosophy to you here. I think

 11 it's clear that there's a role both for CCPs and,

 12 of course, ultimately the regulators. We would

 13 avoid a situation where we have a so-called

 14 standardized product, but the CCPs say, "Look,

 15 really we're not -- we think this is -- we don't

 16 think it's right that this should be centrally

 17 cleared." But, clearly, the regulators at the end

 18 of the day have got to make, in our view, general

 19 judgments about whether our products should be

 20 cleared.

 21 So we're struggling with this issue.

 22 We're struggling about how it works. We can see
 165

 1 some dual responsibility here at the end of the

 2 day. Of course I think it is the regulators,

 3 supervisors, who have to decide.

 4 And let's be clear here. We would pay a

 5 lot of attention to the CCP's views because we've

 6 got to be extremely careful about this

 7 concentration of risk and default, back up and so

 8 forth, those points that I mentioned earlier.

 9 And so robust standards and robust

 10 standards for CCPs are going to be absolutely

 11 essential. But I, again, we're thinking our way

 12 through this, but I quite like the process of the

 13 Chairman and counsel were outlining here.

 14 COMMISSIONER SOMMERS: Is there anything

 15 else on those particular issues? I know Mike has

 16 a question.

 17 COMMISSIONER DUNN: Just a statement on

 18 that, and then I'll go to another question. And

 19 that is I think it's the intent of Congress and

 20 certainly this regulator to tell the whole world

 21 that the days of cheap risk aversion with the

 22 taxpayer as the backstop is over.
 166

 1 Now the good news for the end users is

 2 the over-pricing of risk management should be over

 3 as well, and you should understand more closely

 4 what you're paying for and have some options

 5 there.

 6 Now I'd like to change the subject

 7 matter here. David, when you were talking about

 8 the E.U.'s process, and you laid out that the

 9 first year you will have a proposal ready, that it

 10 will probably be adopted sometime mid-year. Let

 11 me follow up on that because by the time it gets

 12 down to the eventual regulator, the FSA and the

 13 Boffin, the CFTC counterparties, what date do you

 14 see promulgation of regulations?

 15 MR. WRIGHT: Well, Commissioner, it's

 16 rather like asking you the exact date when the

 17 Congress will agree on your package. But our best

 18 -- our best estimate at this stage is that we

 19 would hope with good preparation, good

 20 coordination impact analysis that if we put

 21 forward the main legal text in the middle of next

 22 year, we would hope, given the urgency of these
 167

 1 issues, that we could get these texts to be

 2 entering into force around in 2012 and probably

 3 towards the end of 2012.

 4 Now that sounds a long time. It's

 5 possible -- possible we could go faster. We have

 6 different legislative techniques here, and we will

 7 certainly want to go as fast as possible, but we

 8 have an important deliberative process. We have

 9 two chambers member states and our European

 10 parliament who have to debate and decide on these

 11 matters. So this takes a lot of time.

 12 So I'm hoping that within a year of our

 13 tabling this work, these tabling these proposals,

 14 we could get agreement.

 15 And if we put them in the form that

 16 they're directly applicable to the member states,

 17 that sometimes can speed up matters.

 18 So I don't want to promise that the CCPs

 19 should be in Europe. So we have an open mind.

 20 I'd like to move forward on a broader context.

 21 We've done that in the past with the CFTC. We

 22 haven't been able to move forward as fast as we
 168

 1 wanted with the SEC, but we think the way forward

 2 in the future is to build up strong regulatory and

 3 supervisory systems both in the U.S. and in

 4 Europe, and to mutually recognize each other and

 5 trust each other, hmm? That's the right way

 6 forward.

 7 But for legal reasons in the U.S. and

 8 for these are complex areas of policy, we know

 9 that, it's going to take time.

 10 But on the CCP side, we do have some

 11 concerns, systemic concerns, and, you know, we

 12 come back to that question I asked:

 13 Do we need a backstop for CCPs? Well,

 14 if we do, who's that backstop going to be? It's

 15 going to be the European Central Bank or the

 16 European central banks -- other European central

 17 banks one form or another.

 18 So that's where we are at the moment,

 19 and we're listening to all the arguments.

 20 COMMISSIONER SOMMERS: Just to recognize

 21 --

 22 MR. NEWSOME: Madam Chair --
 169

 1 COMMISSIONER SOMMERS: -- that this CFTC

 2 has had our mutual recognition program in place

 3 for over 20 years, and we have talked about this

 4 issue for a lot of years and recognize that we

 5 think what we have in place works well, codifying

 6 it may be the direction that we're heading.

 7 And, Tom, I didn't hear in your comments

 8 that you would have a problem with codifying what

 9 our current regime is.

 10 MR. CALLAHAN: No, I tried to be very

 11 specific and say that the current regime we view

 12 as effective and appropriate.

 13 COMMISSIONER SOMMERS: Thank you, Tom.

 14 CHAIRMAN GENSLER: Tom, one form of

 15 codification would be just call it a registration.

 16 It would be a different registration similar to

 17 what I believe the FSA has; it has two forms of

 18 registration, one that you're probably familiar

 19 with which is their fully-regulated regime for

 20 entities there, and another is for these foreign

 21 -- from their perspective -- foreign boards of

 22 trade.
 170

 1 We've had a no action process where one

 2 way to codify that no action process is to have

 3 Congress make a registration requirement for

 4 foreign boards of trade, but it would be

 5 consistent with what we've been trying to achieve

 6 with some enhancements, of course.

 7 COMMISSIONER SOMMERS: I think I heard

 8 Jim making a comment. Jim?

 9 MR. NEWSOME: Yes, ma'am, thank you.

 10 Going back to the administration goal to reduce

 11 systemic risk through central clearing, I've got a

 12 couple of questions maybe Terry Arbit may be the

 13 best to address. And I'm thinking again from the

 14 clearing house standpoint.

 15 Terry, is there anything in either of

 16 the legislative bills that would impair a clearing

 17 house's ability to respond immediately to a swap

 18 dealer default? And, secondly, would all customer

 19 collateral be protected in the event of a swap

 20 dealer bankruptcy?

 21 MR. RADHAKRISHNAN: Jim, this is Ananda.

 22 Could you repeat your first question because we
 171

 1 have problems hearing you.

 2 MR. NEWSOME: Yeah, I'll be glad to. Is

 3 there anything in either of the House or the

 4 Senate bills that would impair the clearing

 5 houses' ability to respond immediately to a swap

 6 dealer default?

 7 MR. RADHAKRISHNAN: To a swap dealer --

 8 SPEAKER: Default.

 9 MR. RADHAKRISHNAN: Default.

 10 MR. NEWSOME: Default.

 11 MR. RADHAKRISHNAN: No. I don't see,

 12 no. No. And your second question is?

 13 MR. NEWSOME: Yeah, would all customer

 14 collateral be protected in the event of a swap

 15 dealer bankruptcy?

 16 MR. RADHAKRISHNAN: We haven't seen the

 17 -- I think the Chairman alluded to that -- we

 18 haven't seen -- or Terry did. We haven't seen the

 19 bankruptcy piece of it in the legislation nor have

 20 we seen any -- and correct me if I'm wrong, Terry

 21 -- nor have we seen any provisions relating to

 22 segregation of funds.
 172

 1 MR. ARBIT: Well, there is some on

 2 segregation.

 3 MR. RADHAKRISHNAN: Beg your pardon?

 4 MR. ARBIT: There is some on

 5 segregation.

 6 MR. NEWSOME: Thank you.

 7 MR. RADHAKRISHNAN: There is some

 8 segregation but we haven't seen the bankruptcy

 9 piece, I think.

 10 MR. ARBIT: Right, yes.

 11 MR. RADHAKRISHNAN: Because --

 12 MR. NEWSOME: Do you think there will be

 13 a bankruptcy piece, or would that be punted until

 14 another time?

 15 MR. ARBIT: Jim, this is Terry. We --

 16 yeah, I don't think it's going to happen on the

 17 House side if they're going to the floor this

 18 week. We've had discussions with Judiciary

 19 Committee staff on the House side. Chairman

 20 Gensler, in his letter to the Hill last August,

 21 supported bankruptcy provisions and provided some

 22 sample text that we on the staff level very much
 173

 1 supported. So, and we would do everything we

 2 could, but as to whether it happens, it's out of

 3 my hands, but --

 4 CHAIRMAN GENSLER: And, Jim -- Gary here

 5 -- I think on the first question some earlier

 6 versions of the resolution authority, not the

 7 derivatives bill but the resolution authority,

 8 stayed any obligations under contracts up to 5

 9 o'clock on the day after a default, which I was

 10 asked to testify on broader matters but raised in

 11 Congressional testimony in front of the House

 12 Agriculture Committee a very real concern that

 13 that should be -- that should no go to margin and

 14 obligations under clearing houses; that that

 15 would, in fact, undermine the clearing house's

 16 ability to move quickly.

 17 What I don't know is whether that's been

 18 modified. We recommended the modifications to the

 19 Hill. We still believe those modifications should

 20 be -- that clearing obligations of defaulting swap

 21 dealers should be able to be quickly closed out,

 22 and that it is actually destabilizing if there's a
 174

 1 36-hour stay.

 2 MR. ARBIT: If I could just add just one

 3 more note on the bankruptcy, the Peterson/Frank

 4 Substitute does include a provision that the

 5 Financial Services Committee had adopted, I think

 6 it's 180 days the SEC and the CFTC need to report

 7 to Congress on changes that we think should be

 8 made to the insolvency regime with respect to

 9 swaps. So, but that's as far as it goes at this

 10 point.

 11 MR. RADHAKRISHNAN: Well, I think, as

 12 the discussion earlier demonstrated, if we had a

 13 segregation and insolvency regime for cleared

 14 swaps which is very similar to if not the same as

 15 that for futures, then we could possibly take care

 16 of the default situation in a similar fashion to

 17 that which happened in Lehman. But absent one of

 18 those, then I don't -- it might just be making the

 19 situation worse if not -- as opposed to making it

 20 better.

 21 MR. NEWSOME: I agree. Thank you,

 22 Ananda.
 175

 1 COMMISSIONER SOMMERS: Commissioner

 2 Chilton?

 3 COMMISSIONER CHILTON: I was going to

 4 ask a question about timing, too, but Commissioner

 5 Dunn sort of asked it, and it was helpful.

 6 But I did want to not only join my

 7 colleagues in thanking David and your colleagues

 8 for being here, but say how impressed I am with

 9 the document that you have, and I'm stuck by the

 10 similarities in a lot of them. And so I'm

 11 particularly pleased to hear you talk about the

 12 comprehensive fashion, you talked about forex.

 13 We've talked about metals a lot of times -- I

 14 think we need to include metals -- but just a very

 15 impressive document. And I think part of, you

 16 know, my message, my takeaway from this is we're

 17 actually moving in tandem on a lot of these

 18 things.

 19 Like I said in my opening statement, I'm

 20 not as concerned about who goes first, sort of

 21 like everybody's jumping in the pool, everybody's

 22 sort of scared at first. I wanted to make a
 176

 1 clarification, too, because the Chairman talked

 2 about the timing on the legislation, which I think

 3 he's probably right.

 4 It's probably the end of the first

 5 quarter when we might see legislation from the

 6 Hill dealing with the OTC market. But that

 7 doesn't mean that we may not move forward -- and

 8 none of us can prejudge what the Commission will

 9 do -- but with regard to position limits on

 10 current markets. And so I didn't want anybody to

 11 think that we were talking about, you know, a year

 12 from now there.

 13 And, as I said, I think, you know, if

 14 you go forward in a reasonable way, if you, for

 15 example, err on the high side that this potential

 16 of regulatory arbitrage, which I think is a real

 17 concern -- Commissioner Dunn's raised it a number

 18 of times -- that maybe that's not as large a

 19 concern if you're not clamping down so

 20 devastatingly tight that people say, "I gotta go

 21 someplace. I gotta go to the OTC market before

 22 it's regulated," or, "I'm gonna go overseas."
 177

 1 And so I think, like I said at the

 2 beginning, if you have a middle of the sort of

 3 road figuring out how to go along, putting on

 4 appropriate guard rails, this sort of

 5 stammer-stepping between the E.U. and the U.S. can

 6 actually work out very well. So kudos to you all

 7 for what you're doing, and thank you again for

 8 being here.

 9 COMMISSIONER SOMMERS: Don?

 10 MR. WILSON: I'd like to raise a

 11 different concern which has to do with the

 12 definition of swap dealer in the current

 13 legislation. It currently defines as a swap

 14 dealer anybody who makes markets and swaps. And

 15 swaps are defined as, very cleverly, anything

 16 commonly known as swaps.

 17 Therefore, even a market --

 18 CHAIRMAN GENSLER: You like that, Don,

 19 huh?

 20 MR. WILSON: It's not very technical,

 21 but anyway, therefore, even a market participant

 22 that provides liquidity in a swap, which
 178

 1 essentially cleared will be defined and regulated

 2 as a swap dealer. And yet the Treasury says in

 3 their discussion of regulatory reform, which was

 4 kind of the precursor to all of this legislation,

 5 that derivative dealers who create large exposures

 6 to counterparties should be subject to a robust

 7 regime of prudential supervision regulation. And,

 8 you know, an enhance this whole concept of a swap

 9 dealer, but clearly a market participant that

 10 exclusively makes markets and cleared swaps, and

 11 does not make markets in bilateral swaps -- which,

 12 coincidentally, is the category in which DRW falls

 13 -- should not come under this new set of

 14 regulations which is being created to prevent

 15 another so-called AIG.

 16 CHAIRMAN GENSLER: Maybe, Don -- we've

 17 agreed on a lot of things today, but this one I

 18 might take a little bit different side -- and it's

 19 just one person's view. I'm not speaking for the

 20 Commission. But I think just as we regulate all

 21 broker dealers, whether they're the largest of

 22 multinationals or the smallest -- and there's
 179

 1 about 6,000 broker dealers that hold themselves

 2 out -- we regulate futures commission merchants.

 3 I don't remember our count, but it's the largest

 4 to the intermediate size. Somebody holds

 5 themselves making market in swaps, we want them to

 6 be under the full recordkeeping and reporting with

 7 an audit trail, the business conduct standards,

 8 and may well be that the capital standards would

 9 be quite low if they're all cleared. As you said,

 10 it might all go to clearing.

 11 But I think to bring the registration

 12 and regulation only to the five big houses and not

 13 to other swap dealers, if they're really swap

 14 dealers -- they're dealing in swaps and holding

 15 themselves out to the public making markets in

 16 swap -- the business conduct recordkeeping,

 17 reporting are valid and as a way to get consistent

 18 uniform rules to a marketplace.

 19 MR. WILSON: I mean I'm particularly

 20 focused on the instance where, you know, a market

 21 participant may just be making electronic markets

 22 in swaps. So there's no issue of holding out,
 180

 1 necessarily, although they may enter into a

 2 market-maker agreement with an exchange. And but

 3 they're just posting prices electronically just

 4 like they do in futures markets. And, by the way,

 5 you know, in that instance from an economic

 6 perspective there's probably not a lot of

 7 difference between something called a swap, which

 8 is cleared, and something which is called a future

 9 and is also cleared.

 10 CHAIRMAN GENSLER: Well, I'd imagine

 11 that we'd allow ourselves a chance to debate this

 12 as we would go forward in rulewriting. But as I

 13 think the statutory language allows us define swap

 14 dealer as well, but, conceptually -- and I can't

 15 speak for future rulewriting. I think that it's

 16 more than just the five big swap houses if you're

 17 really holding yourself out to the public making

 18 markets.

 19 But, you know, I haven't thought through

 20 the specific of, you know, as you say, electronic

 21 marketmaking of some sort.

 22 COMMISSIONER SOMMERS: We only have
 181

 1 about 10 more minutes left of the meeting today,

 2 if anybody else has any issues they'd like to

 3 bring up.

 4 MR. WRIGHT: If I may I have one

 5 comment, thank you very much for your kind

 6 comments, Commissioner, about our position, which,

 7 you know, I've been doing this work for 10 years

 8 and I believe that this is a classic area where if

 9 we can do a good job together, and I mean that

 10 converge out outcomes to the maximum extent

 11 possible given the differences in our political

 12 systems, we actually de facto set the world

 13 standards here, hmm?

 14 This is not just the E.U.-U.S. anymore,

 15 it's G-20, we have emerging countries. We have

 16 the lion's share between us of these huge markets.

 17 So this isn't just a bilateral discussion,

 18 actually, it's a global discussion, it's a G-20

 19 discussion. And what is true here, by the way, is

 20 true in many other areas -- I could list many of

 21 them -- accounting standards, investment services,

 22 banking -- you name it.
 182

 1 And I do think here that this is perhaps

 2 one of the best examples where we have a unique

 3 opportunity to do a job of work to make the

 4 financial system more stable. I'm repeating what

 5 I've said earlier, but from my position, from our

 6 position, that's how we see this. And we are

 7 going to do everything we can and, hopefully,

 8 convince you about on or two points, and you will

 9 certainly convince us on some other points that we

 10 end up in a closely synergistics sort of outcome.

 11 And, you know, neither of us can promise

 12 what our political systems can deliver, but I

 13 think if we say, well, look, you know, we've --

 14 our position both justified economically and

 15 justified politically, and justified strategically

 16 is very similar to the United States, and vice

 17 versa, I think it sustains -- I think it sustains

 18 our positions with our political authorities.

 19 COMMISSIONER SOMMERS: Thank you, David.

 20 Do any of my fellow commissioners have a closing

 21 comment?

 22 COMMISSIONER CHILTON: Well, just a -- I
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 1 mean one other point I was thinking about as you

 2 were saying that, David, is that reduces the

 3 ability for regulatory arbitrage at other places

 4 around the globe, that it won't be a race to the

 5 bottom.

 6 And even if it is, it would be temporary

 7 and short-sighted. So if we do these things in

 8 general together, as you say in tandem, I think

 9 that's going to be great for the world. Thanks.

 10 And Thank you, Jill, thank your staff, Marcia and

 11 Andy, for doing a great job on this.

 12 CHAIRMAN GENSLER: Yeah. I want to

 13 thank all the participants. It's my first GMAC

 14 meeting, I want to thank Jill for hosting this

 15 meeting.

 16 I particularly want to thank David and

 17 Patrick and Sebastijan and Peter for making the

 18 trip this far. I think it's really added to both

 19 our knowledge and our debate here at this critical

 20 time as our House takes up critical legislation in

 21 the Senate. It no doubt will follow with the

 22 House, as I surely would recommend that they do,
 184

 1 as in passing this historic reform. And I am -- I

 2 continue to be very optimistic that we have a

 3 consensus here to bring the transparency and lower

 4 the risk to the system.

 5 In moving forward, I want to thank the

 6 members of the Press Corps, and maybe David didn't

 7 understand that they were all here, but I think

 8 they probably, too, heard --

 9 SPEAKER: (Inaudible)

 10 CHAIRMAN GENSLER: -- what's that? --

 11 that we really do have quite a consensus here

 12 grappling with similar issues, and though

 13 different political systems that it's important

 14 that we end up -- it won't be exactly the same,

 15 but largely the same will be a very important

 16 accomplishment for both of our publics.

 17 COMMISSIONER DUNN: Let me join my

 18 colleagues in thanking Commissioner Sommers for an

 19 excellent meeting. I have found this most

 20 informative and very, very, very helpful.

 21 David, I will let it be known that we're

 22 letting you off a lot easier than you let our
 185

 1 Chairman off when he -- but I do -- the question I

 2 ask you, what assistance you would provide us if

 3 we did see regulatory arbitrage, and I'd like you

 4 to seriously think about that and see what kind of

 5 feedback you can give us in that arena.

 6 Again, for all of your staff, Madam

 7 Chairman, and the staff of the International

 8 Division, and our General Counsel's Office. and

 9 our DCIO group, thank you all for putting together

 10 this fantastic meeting.

 11 COMMISSIONER O'MALIA: David, thank you

 12 very much for coming. Your testimony and your

 13 observations were very informative about how our

 14 two countries and, well, at least the E.U. and

 15 this country can go down a path together. So I

 16 appreciate that.

 17 And thank you, obviously, to all the

 18 participants, International and DCIO, that gave us

 19 some good presentations on Lehman.

 20 And then, obviously, Jill, and your team

 21 that put this together, this is very, very

 22 informative.
 186

 1 COMMISSIONER SOMMERS: I also just want

 2 to echo all of the thanks to you, our colleagues

 3 from the EC for being here.

 4 I mean I think, from certainly the

 5 entire GMAC perspective, this kind of discussion

 6 is at the heart of why this Advisory Committee

 7 exists. So we much appreciate you being here

 8 today and engaging in the dialogue with these

 9 particular market participants because it's very

 10 helpful to this Commission.

 11 And also thank you to all of the staff

 12 from the CFTC who participated -- to Roger Liddell

 13 and Ron Filler for being here today to help us in

 14 our discussions of these very important issues.

 15 So the meeting of the GMAC Committee is

 16 adjourned. We hope to schedule another meeting

 17 maybe in late spring to early summer, and we'll

 18 try to get on your calendar at an early date this

 19 time.

 20 Thank you all for being here.

 21 (Whereupon, at 5:00 p.m., the

 22 PROCEEDINGS were adjourned.)
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 1 CERTIFICATE OF NOTARY PUBLIC

 2 I, Carleton J. Anderson, III do hereby

 3 certify that the forgoing electronic file when

 4 originally transmitted was reduced to text at my

 5 direction; that said transcript is a true record

 6 of the proceedings therein referenced; that I am

 7 neither counsel for, related to, nor employed by

 8 any of the parties to the action in which these

 9 proceedings were taken; and, furthermore, that I

 10 am neither a relative or employee of any attorney

 11 or counsel employed by the parties hereto, nor

 12 financially or otherwise interested in the outcome

 13 of this action.

 14 /s/Carleton J. Anderson, III

 15

 16

 17 Notary Public in and for the

 18 Commonwealth of Virginia

 19 Commission No. 351998

 20 Expires: November 30, 2012

 21

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