UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 MARKET RISK ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, November 17, 2016
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 PARTICIPANTS:

Commissioners:

CHAIRMAN TIMOTHY G. MASSAD

COMMISSIONER SHARON Y. BOWEN

COMMISSIONER J. CHRISTOPHER GIANCARLO

Other Participants:

DAVID BAILEY, Director, Financial Market

Infrastructure, Bank of England

GERALD BEESON

Citadel

DAVID BURLAGE

CoBank

THOMAS COYLE

Chicago and Illinois River Marketing, LLC

ANDREW GRAY

DTCC

STEVE GRESKA, Associate Director

Division of Clearing and Risk

MICHAEL HENNESSY

Federal Home Loan Banks

NATHAN JENNER

Bloomberg LP

JERRY JESKE

Mercuria Energy Trading

ANDREW W. LO, Massachusetts Institute of

Technology's Laboratory for Financial

Engineering
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 1 PARTICIPANTS (CONT'D):

GLEN MACKEY

NRG Energy Inc.

KEVIN MCCLEAR

Intercontinental Exchange

DENNIS MCLAUGHLIN

LCH Clearnet

SUSAN MCLAUGHLIN

Federal Reserve

RICHARD MILLER

Prudential Financial

MICHAEL MODLOCK

TriOptima

JOHN NIXON

SUSAN O'FLYNN

Morgan Stanley

ANGELA PATEL

Putnam Investments

EDWARD PLA

UBS/FIA

MARCUS STANLEY

Americans for Financial Reform

ROBERT STEIGERWALD

Federal Reserve Bank of Chicago

KIMBERLY TAYLOR

CME Group

PETAL WALKER (CFTC)

Designated Federal Officer
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PARTICIPANTS (CONT'D):

KIRSTEN WALTERS

 SCOTT ZUCKER

 Tradeweb

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P R O C E E D I N G S

 (10:01 a.m.)

MS. WALKER: Good morning. As the MRAC

 designated federal officer, it is my pleasure to

 call this meeting to order.

Before we begin this morning's panels, I

 would like to turn to Commissioner Sharon Bowen,

 the MRAC sponsor for the welcome.

Chairman Massad, Commissioner Giancarlo,

and Commissioner Bowen will then give their

opening remarks.

COMMISSIONER BOWEN: Good morning,

 everyone, on such a gorgeous, beautiful fall day

 in Washington, D.C. I'll be making my remarks in

 a few minutes so I just wanted to turn it over

 first to the chairman.

CHAIRMAN MASSAD: Well, thank you,

 Sharon. First of all, let me thank Commissioner

 Bowen and

her staff, and also the rest of our

 staff for organizing this meeting. Let me thank

 the members of the MRAC for all the work that has
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 1 gone into this and for being here, and your

participation. We really appreciate it. And I'm,

as always, pleased to be here with Commissioner

Giancarlo.

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 5 You know, I've always underscored the

value of these advisory committee meetings as a

means for us to have a dialogue with stakeholders

and today is, of course, no exception. I'm

looking forward to hearing the recommendations of

the Subcommittee on Clearinghouse default

management. I'm looking forward to hearing David

Bailey's presentation. I know he'll be discussing

one item in particular, the coordinated default

management exercises. We've been pleased to work

with the Bank of England on that and on many other

aspects of CCP resilience.

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beginning of my term that CCP resilience was a

critical issue for us and we've made it a

priority. We've been doing a lot in this area,

including strengthening our own oversight, our own

risk surveillance activities, working with

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 1 international regulators, including the Bank of

England and others on resilience, recovery,

resolution planning, working with our own major

clearinghouses to develop recovery plans and

rules, and we're hoping to complete that very

soon. Working with the FDIC on resolution

planning. Working with the Federal Reserve to

open accounts for the deposit of clearinghouse

cash.

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additional important work we have done. We

released the results of a series of supervisory

stress tests on the largest clearinghouses under

our jurisdiction. And I just want to take a note.

You probably heard about it but let me just

quickly summarize what that report said. We

assessed the impact of stressful market scenarios

across five clearinghouses, the five major

clearinghouses under our jurisdiction, and those

are clearinghouses not just in the U.S. but also

in the U.K. So this is really the first time I

think anyone has looked across borders. I think

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 1 we're probably the only regulator in a position to

do that because we've used actual position and

margin data to do this. And our staff constructed

a number of scenarios, extreme but plausible

scenarios based on historical precedent, and we

applied those to the actual positions.

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on clearinghouses, as well as the impact on

clearing members. And the results showed that the

clearinghouses had ample resources to withstand

these scenarios. Not only did they meet cover

two, but in about two-thirds of the tests they

were able to cover all participant shortfalls or

losses. And our assumption in this was that no

clearing member would make any additional payment,

which is obviously a very extreme assumption in

this kind of a situation.

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things that came out of the test was that risk was

diversified across clearing members. If you had a

loss at one clearing house, that didn't mean you

had losses at all, and I think that's a very

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 1 helpful finding because obviously there has been

some concern about now that we've moved a lot of

transactions into central clearing, what happens

if there's one default? Wouldn't that trigger a

whole series of defaults? We're able to measure

what would happen to multiple clearinghouses and

to the largest clearing members under these

scenarios. There's now extensive margining, daily

reporting that gives us detail. And think back

where we were eight years ago when with Lehman

going under, AIG about to go under, people were

scrambling to understand what the exposures of one

large institution were to another, what would be

the consequences of a default by one. Just think

back to that fateful day when the government was

trying to decide whether to support AIG and how

much it would take, and the number kept going up

by the hour. So we've come a long way.

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 19 The test, and this is the report in case

you haven't seen it. It's available on our

website. The test is only one step. We need to

keep doing this. We need to do a lot more. We

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 1 talk about various enhancements that we may do.

 2 So again, I'm very much looking forward

to the meeting. I appreciate Commissioner Bowen

for really focusing a lot of the work of the MRAC

on the issue of clearinghouse safety. I think

that was a very wise decision on her part, and

again, thank you all for being here.

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COMMISSIONER BOWEN: Thank you.

 9 COMMISSIONER GIANCARLO: Thank you,

Chairman, and thank you, Commissioner Bowen. And

Commissioner, thank you for convening today's

meeting. I note that this is the sixth meeting of

MRAC in a little over two years. That's quite an

accomplishment, and I think I, and all of us, have

found these meetings to be of tremendous value.

The opportunity for committee members to present

their views and findings is very helpful in

assisting my fellow commissioners and me, as well

as the staff and the public, in understanding the

competing dynamics and the risk factors in our

markets.

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 22 I believe the success of MRAC brings
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 1 distinct credit to all of us. We're a better

 regulatory agency because of the commitment and

 efforts of the MRAC members, and none of this

 would be possible without the extraordinary staff

 work that goes into bringing these agendas and

 presentations together, and so I do want to

 commend in particular the facilitator, Petal

 Walker for all of her efforts in organizing the

 six meetings we've had. It's been quite an

 accomplishment.

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first part of today's meeting will address

important details in the management of CCP

default. It's critically important that clearing

and nonclearing members have the ability to

communicate and understand their role in a default

situation, and we must understand how the

mechanics of porting customer portfolios would

work in the event of a default and address any

obstacles to a smooth transition.

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 The discussion is timely. Yesterday, as

 22 Chairman Massad noted, we presented the findings
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 1 from the Commission's Supervisory Stress Test of

Clearinghouses, and this report is really an

important accomplishment, and I commend the staff

for their work, and I commend the chairman for his

leadership in this effort. It really is a

watershed moment. The Commission's report

concluded that the clearinghouses had the

financial resources to withstand a variety of

extreme market conditions. Inherent in this

conclusion, however, is the expectation that all

participants in the CCP ecosystems communicate and

understand their obligations in a crisis

situation, so I look forward to hearing the

Committee's recommendations in this regard.

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 15 And I also look forward to the second

panel today on CCP resilience and hearing

presentations from our distinguished guests,

Robert Steigerwald, senior policy advisor at the

Federal Reserve Bank of Chicago, and David Bailey,

Financial Markets Infrastructure at the Bank of

England. So welcome gentlemen. Welcome all of

you, and thank you for coming today.

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 1 COMMISSIONER BOWEN: Great. Thank you

so much. Welcome to the November 17, 2016 meeting

of the

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 4 Market Risk Advisory Committee. I'm

excited to be the sponsor of this important

committee. But before we begin our meeting today,

I just want to say a few words about the election.

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 8 I'm sure that much can and will be said

about the election's impact on our markets, our

investors, consumer protection, and financial

regulation. But fundamentally, MRAC's focus on 

market risk is even more important today. And in

that vein, I want to thank Chairman Massad and

Commissioner Giancarlo for their support of this

committee's hard work. It's been a privilege to

work with both of you as fellow commissioners

these last two and a half years, and I look

forward to working with you both in the future.

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looking forward to the Committee's vote on the CCP

Risk Management Subcommittee's final

recommendations on how central counterparties can

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 1 further enhance their efforts in preparing for the

default of a significant clearing member. And

hearing from David Bailey, director of Financial

Market Infrastructure at the Bank of England, here

to discuss the Bank of England's coordinated CCP

default portfolio. I really want to thank you,

David, for traveling here from the U.K. to share

your insight with us.

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Giancarlo mentioned, we now have completed the

second year of MRAC and our sixth meeting. We

started our journey on April 2, 2015. The purpose

of MRAC then, as now, was twofold. One, to advise

the Commission in its efforts to detect, analyze,

and mitigate market risk; and two, to provide

information and analysis to the Commission on the

evolving market structure.

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charter, we assembled a diverse, impressive group

of market participants -- end-users,

clearinghouses, exchanges, market makers,

intermediaries, academics, swap execution

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 1 facilities, swap data repositories, service

 2 providers, public interest groups, and regulators.

 3 MRAC's meeting topics in the last two

years reflect a commitment to it meetings its

goals. To meet its market structure mandate, the

MRAC held discussions on the state of the market

dealing with a number of issues, including

liquidity, the use of SEFs, and portfolio

compression. And to meet its market risk mandate,

the MRAC discussed many issues, including CCP risk

management, cybersecurity, and the implication of

resolution above clearing members and CCPs.

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 13 I look forward to today's discussion and

will now turn it over to MRAC's designated federal

officer, Petal Walker, who will get us started.

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 16 MS. WALKER: Thank you for your opening

remarks. Before I begin, I would like to

acknowledge Steve

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 19 Greska, who is the associate director in

the Division of Clearing and Risk. Over two years

ago I had asked Steve about what would be a good

topic for our first meeting and he noted that a

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 1 discussion on enhanced coordination between CCPs

in a case of major default would be a very good

topic, and because of that, over two years ago we

started that discussion and then we had these

recommendations, although the staff did not have a

hand in the recommendations, the germ of the idea

came from Steve Greska. I wanted to acknowledge

him. Thank you, Steve.

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 9 As noted in today's agenda, our first

panel will be a discussion of the CCP Risk

Management Subcommittee's recommendations for CCP

default management.

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 13 I would now like to call upon Ms. Susan

O'Flynn, who led this effort in the CRM

Subcommittee, as well as Mr. Gerald Beeson, Mr.

Dennis McLaughlin, and Mr. Richard Miller, to

present the Subcommittee's final recommendations

to the MRAC on how CCPs can further enhance their

efforts in preparing for the default of a

significant clearing member. As discussed at the

April 2, 2015; November 2, 2015; and June 27, 2016

MRAC meetings.

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 1 MS. O'FLYNN: Thank you, Petal. So just

 2 to introduce my co-panelists, we have

 3 Gerald Beeson from Citadel, COO and CFO;

we have Richard Miller from Miller Consulting; and

we also have Dennis McLaughlin, Chief Risk Officer

from LCH Clearnet.

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 7 With regard to logistics, please press

the button to activate your microphone when you

speak, and please press off when you are finished

speaking.

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 11 Before we move into, you know, each

panelist is going to address some of the

recommendations that are currently in the

document, but I'd like to say a few words first.

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Commissioner Bowen for forming this committee two

years ago to address this very important topic of

CCP default management. It continues to remain a

highly relevant and current topic, especially in

light of the global regulatory attention and

recent papers and guidance issued on resiliency,

recovery, and resolution by the CFTC, the FSB, and

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 1 CPMI-IASCO.

 2 The auction and market participant

involvement following the default of a significant

clearing member is arguably the most important

step of the default management process in ensuring

CCP resiliency and the timely reestablishment of a

matched book. CCPs are becoming the single

largest counterparties from many institutions,

both sell and buy side, given the clearing mandate

and the advent of many other clearing services for

products such as securities finance transactions,

foreign exchange due to resource implications, be

it balance sheet capital or funding. Continued

voluntary flow into clearing for nonmandated

products can be most reasonably observed since the

go live of margin for uncleared derivatives in

September.

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participant obligations, CCP actions, and client

involvement and ex ante transparency of all the

aforementioned are addressed now and clarified as

we move forward into a trading environment where

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 1 many existing products will be cleared and a

defaulting member will likely be clearing many, if

not all of the aforementioned products.

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amalgamation of two separate sub subcommittees'

work over these past two years, as well as

previously published recommendations from those

subcommittees as mentioned by Petal in 2015 and

earlier this year. It must be recognized that

this Committee has a very diverse set of

representatives and this has, at times, made it

challenging to come to recommendations which have

reflected all parties' positions. I'm honored to

be here today to present today's recommendations.

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 15 The document also reflects the areas

which are either for further discussion or

consensus could not be reached in full. I would

also like to personally thank BlackRock, most

notably Eileen Kiely and Kirsten Walters, who were

chief draftswomen for this document. Their help

was invaluable.

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 22 There are six different recommendations
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 1 which fall into two categories: default

management, coordination, harmonization,

enhancement, and porting. Within category one,

default management, several key recommendations

were agreed upon including the following:

communication, establishment of a directory of key

individuals at clearing member and nonclearing

member firms involved in default management will

be engaged with clearinghouses and regulators at

the time of the default of a clearing member.

There were also recommendations around CCPs'

engagement of and communication with nonclearing

member firms in the event of an FCM default, of

the default itself, as well as the porting

process.

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 16 Default management committees.

Recommendations of harmonization of certain

aspects of the default management process, such as

tenure, coordination of rotation of seconded

representatives, as well as maintaining a register

of seconded representatives to avoid one firm

being called multiple times.

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 1 Involvement of material. Nonclearing

member firms should also be considered subject to

certain rules and regulations.

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 4 First, drills. There was wide support

that joint to full fire drills and/or three-way

fire drills should be considered on an ongoing

basis and become a more formalized process.

Clients, as well as clearing members should

participate, and porting simulation should be

included in that fire drill auction process.

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harmonization of auction process and procedure and

a call for auction playbooks. So there would be

ex ante certainly as to what the rules and

responsibilities of clearing member firms and

nonclearing member firms would be in advance of

the process.

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customer participation and auctions, and last but

not least, porting, a topic much discussed at the

previous MRACs and several key issues have been

identified, most notably the resource implications

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 1 for remaining FCMs, as well as the operational

 2 intensity of onboarding new clients.

 3 With that I'm going to turn to my fellow

panelists who each are going to discuss some of

these recommendations in more detail. Gerald will

be going first with customer participation

auctions and portion, followed by Dennis, who will

discuss communication and fire drills. Richard

Miller will then speak on communication and

porting, and I will discuss auction process and

default management committees.

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 12 So I turn to Gerald.

 13 MR. BEESON: Thank you, Susan. Good

morning. My comments will be on the customer

participant

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 16 and auctions from item 1.E. The success

of the auction is perhaps the most critical piece

of the CCPs' default management process, and

bringing to bear that we have an insured that

qualified available and willing sources of private

investment capital are brought to bear at an

auction increases the likelihood of its success,

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 1 the fairness, and the efficiency of auction

 2 pricing.

 3 While direct customer auction

participation is contemplated in select instances,

it is not universal across the CCPs or even across

differing cleared products within the same CCPs --

as an example, futures versus swaps. So rather,

most of the CCP rulebooks look primarily to the

direct clearing members to participate in these

auctions. The Subcommittee's recommendations,

therefore, encourage CCPs to consider means to

allow nonclearing members to participate in the

auctions, in the auction process; acknowledge that

the correct terms, conditions, and procedures need

to be put in place upfront to ensure that there's

a governance of the participation of nonclearing

member process in the CCP auctions. We believe

the customers are an integral process in the

central stakeholder group in clear derivative

markets, and they certainly have a vested interest

in ensuring that these auction processes are

successful.

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 1 Given the correlation of the business

models, it is certainly possible that direct

clearing members as a whole may not be in the

strongest position to bid aggressively at auctions

following a clearing member default, which only

reinforces the importance of bringing other

sources of noncorrelated capital to the table.

There certainly may be concerns that exist either

with respect to the information with respect to:

(a) the defaulted portfolio being leaked to the

market; or (b) the nonclearing firms not being

appropriately incentivized of qualified to bid

responsibly. We believe that those can be easily

addressed by setting a priori-qualified and

appropriate mechanisms for participation ranging

from confidentiality agreements to minimum

deposits to be able to participate in the auction

itself, having a demonstration of the financial

resources required to be able to meet the initial

margin deposits should there be a winning bidder,

demonstrating the capacity to ultimately be able

to clear the portfolio at another clearing member

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 1 should they actually win the process as well, and

then also, potentially having some form of penalty

mechanism should their bid fall below a certain

threshold. These are as a percentage of the

winning bid or below the median of the actual bids

that are submitted in the actual auction process

itself.

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commenting on the issue of porting -- we have a

few comments. First, in terms of the ability of a

solvent customer of a nonclearing member to port

their portfolio, and as importantly, the

associated collateral associated with that

portfolio to a solvent clearing member is one of

the key customer protection features of central 

clearing. Customer porting has certainly worked

in a number of situations in past clearing member

defaults. We believe that further measures should

be undertaken and considered to ensure this is a

viable and efficient process going forward.

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 21 Market participants do believe that

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 1 likelihood of a timely and successful porting

process, including customer onboarding

requirements at the new clearing member if they're

not already in place, if they don't have more than

one clearing relationship; if there are timing

mismatches between the movement of customer

positions and customer collateral; the timing of

bankruptcy court approvals where applicable; and

otherwise industry capacity-wide constraints.

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the subcommittees recommended to develop solutions

that allow for remaining solvent clearing members

to service the portfolios of nondefaulting

customers on an interim basis post the clearing

member default. And this can serve as a very

important bridge while the porting process

proceeds. Further, having investment in and

development of automated and regular use customer

porting capabilities in the nondefault scenario,

and at present, porting positions from one

clearing member to another clearing member on a

regular basis is certainly time-consuming, an

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 1 overtly manual process that can only be done on an

appointment basis. The ability for customers to

manage their portfolios across multiple clearing

members would be enhanced with more automated, ondemand, and straight-through processing based

porting capabilities. And also, the industry

investment in such solutions would pay enormous

dividends in times of market stress as the tools

and capabilities used and developed to efficiently

port portfolios in times of nonstress will be

battle-tested and able to use in the case of a

porting scenario.

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 13 MS. O'FLYNN: Okay, Dennis?

 14 MR. MCLAUGHLIN: Thank you, Susan. I

 15 have to talk about communication, which is a

 16 vital piece of the whole puzzle, because

you have to know who to talk to, how to reach

them, at what times at particular times in the

process, and that should be as smooth as possible.

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we have. The first one is to create and maintain

a global directory of key individuals -- who do

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 1 you contact both at clearing member firms and

nonclearing member firms. Steps have already been

taken to begin this process, so that's a really

key part. And now who are you contacting and what

do you say to them? Well, obviously, for clients,

you can't have a general market communication

about an individual client position, but what you

can do is provide updates to the market in general

about things like when the porting window has

opened, when it's closed, when it's completed, is

there anybody being -- noncustomer liquidations

taking place? But you're not going to talk in the

general updates about specific client positions.

However, you need to talk to each individual

client who is affected about the status of their

portfolio. That's key. So, for example,

especially if they have positions that are being

liquidated as part of the member portfolio, who

they are coming to the CCP through.

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 20 The other part I have to talk about is

fire drills, I think. This is a really key and

much important thing because we have to test

 21 

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 1 exactly whether we're ready or not to handle a

real-life situation. If the CCP can't handle

this, it's going to have a profound effect on the

global markets, and so we have a couple of

recommendations around this.

 2 

 3 

 4 

 5 

 6 The first one is that the joint fire

drills have to be formalized across CCPs,

especially where there is significant product

overlap with agreement reached as to frequency of

drills, the scenarios and the shocks tested in

drills, and the required participants. That

condition about required participants is key

because there are not that many members. There is

a shortage or a potential shortage of members to

spread around in a default situation from the

member perspective. We need to ensure that we

have the most efficient use of resources at the

time of default so nobody is sort of

double-counted in that procedure.

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 20 The other one is that fire drills should

be conducted regularly, and they should include

multiple CCPs so we know what's happening because

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 1 in all likelihood, multiple CCPs will be involved.

They should include both clearing members and

customers. Traditionally, it's been clearing

members, but we need to be also looking at the

impact on customers during the fire drill. So the

drills should periodically include simulations of

the porting and inability to port the nondefaulted

customers' portfolio, and include representative

material customers in this aspect of the fire

drills. So we need to incorporate the customer

view into the fire drill for the default

management process.

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14 

15 

That's all.

 MS. O'FLYNN: Richard?

 MR. MILLER: Thank you, Susan. If I'm

clearing my throat, it's not a virus; it's

 7 allergies. I'm dealing with it. Excuse

me. I think this is the first opportunity I've

had at

 20 the MRAC to give some extended remarks,

so I'd like to begin by thanking Chairman Massad

and Commissioners Bowen and Giancarlo for creating

 16 

 1

 18 

 19 

 

 21 

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 31

 1 this opportunity in this forum. I think it has

 2 been a valuable means of exchanging views.

 3 I'm here representing the American

Council of Life Insurers and the life insurance

industry, and I would like to underscore this

somewhat unique role that I think life insurers

have in the processes that we're dealing with here

today because life insurers are hedgers. They're

prohibited by law to speculate in these markets,

so they use these markets, derivative markets, to

hedge their portfolios and the risks that arise

from the products they sell. And it's almost a

correlated situation where they could not sell the

products that they presently sell to the public

without having the opportunity to hedge as they do

in these markets. And the hedging has been going

on since the emergence of annuity products and

other products that require the hedging, the

proper hedging and risk management by the

insurance companies. And we went through the

crisis. Chairman Massad refers us back to eight

years ago, and I remember it well. And we went

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 1 through the crisis and there were some lessons

learned obviously in the crisis that I'll get to

in a moment, that are relevant to these

conversations here today. And at the time we went

through the crisis, of course, life insurers were

dealing on a bilateral basis. But because life

insurers are financial end-users under Dodd-Frank,

they're compelled now to use the clearing

mechanism of the CCPs when they're using interest

rates and equity products to hedge their risks.

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 11 So in that respect, life insurers, like

other financial end-users, like some hedge funds

and pension plans, are captives of the system. We

have no option, but we must use the CCPs to clear

these products. And captive of the system, we

don't have any direct voice in the management or

the governance or the oversight of the systems

that we are at risk to. So it's very important,

and it's useful in our view to have the means in

this MRAC conversation to interface with

regulators because we rely on the regulatory

scheme and the good faith of the CCPs to manage

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 1 these risks that we're subject to, like captives

 2 in a moving vehicle.

 3 So with that said, I'll turn to a couple

of the recommendations that I've been asked to

speak about. And I don't want to go over the same

territory that makes this redundant, but a couple

of points probably could be underscored.

 4 

 5 

 6 

 7 

 8 I referred back to the crisis.

Obviously, one of the worst things that you

experience in a crisis situation is uncertainty,

not knowing what is going to happen next or when

it's going to happen, so the availability that

we're talking about here of having playbooks with

distinct timelines and means of communication that

provide the market with transparency. So we know,

for example, in the auction process where we are

at what stage, when we can expect the result, and

having a plan beforehand so that there is that

kind of playbook that we can look at would remove

to some degree -- there's always going to be

uncertainty, but at least you'll have something to

rely upon in the crisis situation.

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 1 Similarly with porting. To have a

distinct timeline, to have a playbook, to know

where you stand in the porting process. That's

why the recommendations of the Subcommittee with

respect to transparency in both respects I think

are very well thought of.

 2 

 3 

 4 

 5 

 6 

 7 Two other points. One is referred to

earlier by my colleagues on the Committee having

to do with the availability of FCMs. Large

insurers, like my former employer Prudential and

others that are in the ACLI group, have multiple

clearing relationships, but yet in the life

insurance industry there are smaller life insurers

who are compelled to use central clearing who

don't have the same bulk of transactions so that

they are limited to practically one FCM. They

really can't have multiple relationships. They

don't have the bandwidth to do it. So if that FCM

should be in a crisis situation, they will not

have another one in their portfolio to easily port

their positions to.

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 22 So one of the recommendations of the
 35

 1 Subcommittee is to think about creating "break the

glass" solutions for FCMs that could be, you know,

emerge in a crisis to provide a safety net for

those customers who don't have preexisting

relationships with multiple FCMs. That would give

more confidence to the market and again create the

kind of certainty in a crisis that would eliminate

the uncertainty of where am I going to put my

positions if my FCM is going down and I don't have

a preexisting relationship?

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 11 On that point, one of the issues that we

discussed in the Subcommittee as to which we did

not have a complete resolution of consensus was

whether there should be capital relief, at least

on a temporary basis for FCMs in a crisis so that,

you know, when you increase the customer book of

an FCM, they need a consequently higher amount of

capital. If you could get some relief from that

requirement at least temporarily, an FCM could

take on more customer positions without having to

immediately increase its capital.

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 22 Lastly, being a lawyer I can't avoid the
 36

 1 bugaboos of some of the legal principles involved

here, particularly the bankruptcy issues that

Gerald referred to. There's a disconnect

potentially in the timing of the transfer in

porting of customer positions and the underlying

collateral and margin that creates uncertainty and

disconnection in the marketplace, and it's, I

think, important and the Committee has recommended

that regulators and legislators address that issue

so that we have the bankruptcy fix that's probably

necessary.

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 12 

 

So with that I'll conclude. Thank you.

 13 MS. O'FLYNN: Okay. So that leads me to

the two topics which I'll just make some comments

on.

 14 

 15 

 16 So first, let's look at default

management committees. How can they be enhanced,

harmonized, or further coordinated?

 17 

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 19 Currently, they include seconded

clearing members who bring the requisite skill and

expertise necessary to hedge the defaulted

clearing member's portfolio, as well as structure

 20 

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 37

 1 and liquidate the portfolio via the auction. What

recommendations can be made to enhance the

process?

 2 

 3 

 4 First, a harmonization of certain

elements of the process, such as tenure, timing

and frequency of rotation of seconded

representatives, as well as appropriate sizing of

default management committees, taking into

consideration the complexity and/or the liquidity

of the products. We see varying sizes as to the

default management committees. We just think this

would be an important thing to look at.

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 13 Secondly, CCPs should maintain a default

management committee register of seconded

representatives and this should be shared between

clearinghouses to ensure on clearing member firm

is called upon more than once for a particular

product. This is to ensure that those clearing

members have sufficient trading expertise to be

able to bid well in auctions.

 14 

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 20 

 21 Thirdly, consideration should be given

 22 to expand the existing pool of representatives who
 38

 1 sit on the default management committee to include

nonclearing member firms, those firms are active

in the products liquidated can bring relevant

market expertise into the process. Such

participation should be subject to the same rules

and obligations, such as confidentiality, that

existing clearing members are subject to.

 2 

 3 

 4 

 5 

 6 

 7 

 8 Auction process. It's been touched on

by a number of my peers here but, you know, I

think we just need to reaffirm, and given the

breadth of products now being cleared, consistency

and ex ante transparency into each CCP's auction 

process and procedures are critical to ensure an

auction's success. CCPs should harmonize their

auctions where feasible. Where a single "one size

fits all" may not be appropriate given the breadth

of products, a general alignment of procedures and

timelines is needed, especially where a large

clearing member has defaulted at more than one

CCP.

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 21 CCPs should develop auction playbooks

 22 for participants to give ex ante transparency
 39

 1 which include the following: methods of disposal

available for CCPs including auctions; auction

participation rules, be it mandatory or voluntary

and potential liability; the sequence of events

and timing of the different events in the process;

bid submission auction results; and information

should be delivered and to be received. For

example, the file format. We have to consider

that, you know, and with obviously these drills

which are being run, you know, now joint and

sometimes three-way, that you're going to be

bidding in probably two to three auctions at once

if a large clearing member has defaulted in IRS,

for example. So the standardization of auction

files and formats means from a best execution

perspective and also from kind of an operational

efficiency perspective that is something that

needs to be looked at.

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 19 Today's panel on the joint drill could

not be more timely, and I look forward to hearing

David's comments on these aspects of the auction.

 20 

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 22 MS. WALKER: Thank you all for that
 40

 1 presentation on the CRM Subcommittee's

 2 recommendations.

 3 I would like to open the floor to the

MRAC to discuss any further comment on the

Subcommittee's recommendations.

 4 

 5 

 6 Kim?

 7 MS. TAYLOR: Thank you. Thank you to

the MRAC Committee for hosting this important

discussion.

 8 

 9 

 10 CME was a participant on the default

management working group, and we appreciate the

efforts of the Subcommittee to come up with

recommendations that reflect kind of a

broad-basset set of views; however, kind of by

definition, when you have a paper drafted by a

committee, it's not going to necessarily represent

the kind of full diversity of use, so I wanted to

just make a comment on a couple of items.

 11 

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 19 First of all, communication, we believe,

is critical, and actually, CCPs have a strong

history of having good communication during a

crisis, and so these principles endorse and

 20 

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 22 
 41

 1 encourage that and we support that.

 2 When it comes to coordination, we also

 support conceptually the idea that standardization

of the input and output formats for sure,

standardization of kind of terms and terminology

and types of auctions so that when somebody says

Dutch auction it kind of means the same thing no

matter which CCP is using the term. We fully

support that. And we fully support the idea that

there needs to be some transparency to the

marketplace so that they know what to expect. We

would encourage the industry to stop short of

requiring CCPs to make an ex ante commitment to

follow a defined exact process though because that

might not be the process that given the

circumstances that we're facing at the time is the

best -- going to provide the best outcome for the

marketplace. So I think we're very supportive of

this coordination process as long as there's an

understanding that these are guidelines rather

than an ex ante commitment that the auction is

going to be at two o'clock on the third day. So

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 1 we believe in sensible crisis management

 2 coordination.

 3 The principles advocate sensitivity to

the impact on the clearing members of potentially

being called for multiple default management

committees. We are very supportive of the need to

sensibly manage the impact of that with cross CCP

coordination of who is called to be on default

committees. The principles also advocate

strengthening the default management auction

process not only by standardizing the input and

output formats and definitions but also by

broadening out the participants. I'm very

supportive of the comments that Gerald made on

behalf of bringing in other nonclearing member

participants into the default management process

or the auction process and actually, our

experience has shown in futures, which is somewhat

different, more liquid, more visibly liquid than

swaps, but our experience has shown that we very

effectively were able to use nonclearing member

bidders in the default management process, for

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 1 example, with Lehman. So we are very supportive

 2 of that.

 3 And we support the idea of joint fire

drills. I think it's very important for

clearinghouses to work together in practice the

way we would need to work together in reality if

there is a crisis, and we very much support the

industry recommendations regarding the porting.

The protection of the innocent customers in a

customer default is one of the key things that

underpins the safety and security of the market as

a whole because protecting the innocent customers

and not liquidating more positions than are

absolutely necessary is an important way of

containing the market impact. So we're very

supportive of the suggestions that there be some

sort of safe harbor on the "know your customer"

and the money laundering aspects, the paperwork

aspects of transferring customers from one

clearing member to another, and we would also be

supportive of reasonable and temporary capital

relief that would allow clearing members not to

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 1 have to dramatically increase capital while they

absorbed the new set of customers. But I'm

sensitive to the fact that clearing members need

to be well capitalized, and so we would be

supportive of that relief being relatively

temporary to allow for time to absorb and

capitalize appropriately.

 2 

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 6 

 7 

 8 Thank you.

 9 MS. O'FLYNN: Kevin?

 10 MR. MCCLEAR: Good morning. Thank you

for including ICE in this process. We found it to

be very productive. In fact, many of the

recommendations that we're discussing today have

already become practices.

 11 

 12 

 13 

 14 

 15 And I want to follow up on what Kim said

in many instances and give a real life example.

The CME and ICE recently conducted a join fire

drill. We included ICE Clear Credit, ICE Clear

Europe and the CME with respect to credit default

swaps. And this provided a perfect opportunity

for us to put into place these recommendations

we've been discussing. The first one was the

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 45

 1 coordination of the seconded traders. And to

Kim's point, we shared in advance our respect of

seconded trader lists, so we were in a position to

manage seconded traders across three

clearinghouses, and we didn't have any problem

because of that. We were also able to coordinate

having clearing participants bid simultaneously in

three default auctions and that went smoothly.

 2 

 3 

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 7 

 8 

 9 The other thing we were able to do was

test ICE's newly developed automated default

management system. We had the benefit of

developing our default management system in recent

months, so we were able to incorporate the

standard default terms that Kim referenced so that

the participants were working from, call it the

common play book, and we found that to be very

productive. We had over 200 people set up to

participate in the default auction and entered

bids into the automated default system. They

could cancel bids, resubmit bids, and importantly,

because it's electronic, they could take the

auction portfolios and break them down into the

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 1 risk management systems to price their bids.

 2 We also practiced porting. We

successfully ported customer positions both out of

ICE Clear Credit and ICE Clear Europe. So I've

said before at this forum that practice is so

important, and here's a real life example of us

practicing the very recommendations that come out

of this Committee. So thank you.

 3 

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 7 

 8 

 9 MS. O'FLYNN: Jerry?

 10 MR. JESKE: Hi, I'm Jerry Jeske from

 11 Commodities Market Council.

 12 So to Kim's point about the paperwork, I

think that the Commission should introduce a

regulatory framework when it comes to porting, and

some of the things Kevin mentioned are really

important from a timing perspective. Having lived

the process with Lehman at a large British bank

which will go unnamed, that received a lot of

these positions, timing is critical. There's not

much of it typically.

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 21 So one of the paperwork items that I

 22 think Kim just mentioned in terms of anti-money
 47

 1 laundering and KYC should absolutely be relaxed

because by definition you have an implied

understanding that the KYC and AML has already

taken place for those innocent customers as you

put it, Kim. And that, I think, should not be a

standard or a hurdle for any porting process

because it's already been done. Likewise from a

capital perspective, I think leniency should be

considered. Obviously, you know, not everyone is

made the same and you want to have a robust,

competitive bidding process as Kevin was just

explaining, but not everyone is going to have the

same capital available to them. So again, you

know, some leniency in regards to how that's done

particularly from a timing perspective and more

participants I think would be the best.

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 17 MS. WALKER: At this time, in keeping

with the meeting agenda, the MRAC will take a

break. We will return at 11:05 for the vote.

 18 

 19 

 20 (Recess)

 21 MS. WALKER: We will now resume. I move

 22 that the MRAC adopt the CRM Subcommittee's
 48

 1 recommendations as recommendations of

the MRAC and that the MRAC recommend to the

Commission that it consider the CRM Subcommittee's

recommendations.

 2 

 3 

 4 

 5 Is there a second?

 6 MS. O'FLYNN: I second.

 7 MS. WALKER: Are there any questions or

comments? We do have two MRAC members on the

phone for the

 8 

 9 

 10 vote, John Nixon and Kirsten Walters.

 11 Are there any other MRAC members on the phone?

 12 I now call for the vote on the CRM

Subcommittee's recommendations. Pursuant to the

MRAC charter, our two regulatory members are

nonvoting members and thus will not vote.

 13 

 14 

 15 

 16 All those in favor of adopting the

Subcommittee's recommendations as recommendations

of the MRAC and recommending that the Commission

consider the recommendations, please say aye and

raise your hand.

 17 

 18 

 19 

 20 

 21 Thank you. Do we have any ayes on the

 22 phone?
 49

 1 MR. NIXON: Aye.

 2 MS. WALTERS: Aye.

 3 MS. WALKER: All those opposed please

 4 say nay and raise your hand.

 5 Any abstentions? For the record, the

number of ayes is 19; the

 number of nays is zero; and there is one

abstention. The ayes have it; the motion carries.

So with that, we'll take a five-minute break and

 prepare for --

 6 

 7 

 8 

 9 

 10 

 11 CHAIRMAN MASSAD: I would just would

like to underscore again how valuable this is and

what a great job Commissioner Bowen and Petal and

the rest of her staff and all of you have done.

You know, to have an advisory committee produce

something like this, which is just very, very

useful. There was clearly a need for it. You

brought together all the interests and worked

through the issues. And I recognize as I think

Kim wisely pointed out, a committee product, you

know, maybe it's not exactly what everybody wants

and all that, but you know, it really reflected

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 1 all of these views and you reached a consensus on

these things, and it's terrific work. So thank

you to Commissioner Bowen, Petal, the rest of her

staff, and thank you to all of you.

 2 

 3 

 4 

 5 MS. WALKER: So we'll have a five-minute

break and start at 11:20. Give a chance for the

next panel to come up.

 6 

 7 

 8 (Recess)

 9 MS. WALKER: It is my pleasure to call

 10 this meeting back to order.

 11 As noted in today's agenda, our second

panel discussion will cover a regulatory

perspective on CCP resilience.

 12 

 13 

 14 I would like to introduce Robert

Steigerwald, senior policy advisor of Financial

Markets at the Federal Reserve Bank of Chicago,

who will facilitate this discussion.

 15 

 16 

 17 

 18 MR. STEIGERWALD: Thank you, Petal, and

thank you, Commissioner Bowen, for scheduling this

meeting and for placing on the agenda a very

important topic. I think it's quite fortuitous

that we have the opportunity to discuss in greater

 19 

 20 

 21 

 22 
 51

 1 detail some of the lessons to be learned from fire

drills of CCP resiliency following on the vote by

the CRM today.

 2 

 3 

 4 I'm about to introduce our speaker, our

honored guest from the Bank of England. Let me

just make a personal observation that for the best

of reasons, the international policy community has

been very focused recently on issues of recovery

and resolution for financial market 

infrastructures. Those are very thorny problems

not yet fully worked out, but the attention that

those issues get should not distract us from the

business of thinking about day-to-day CCP

resiliency and the important exceptional, yet

occasional need to deal with clearing member

default and default management processes.

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 17 I think that the discussion today of

fire drills and related policy concerns will help

us focus again on a more ordinary aspect of CCP

risk management.

 18 

 19 

 20 

 21 Our guest is David Bailey. He is

 22 director of the Financial Market Infrastructure
 52

 1 Directorate at the Bank of England, and he will be

making a presentation and taking questions from us

and interacting with us after his presentation.

 2 

 3 

 4 David?

 5 MR. BAILEY: Thank you. Thank you,

Robert, and good morning, everyone. I'd

particularly like to thank Committee Chair Bowen

for inviting me to speak to the Committee today on

this important topic of CCP resilience.

 6 

 7 

 8 

 9 

 10 As supervisors of some of the biggest

and the most systemically important CCPs that

serve global markets, the Bank of England and the

CFTC have a very strong history of collaboration

on market infrastructure and clearing issues and

on which the discussion can build.

 11 

 12 

 13 

 14 

 15 

 16 So I listened with great interest to the

previous panel discussion and on recommendations

regarding CCP default management, and I would like

to congratulate the Committee on agreeing on such

a thorough and pragmatic set of recommendations

which are very important. What I'd like to do

today is follow on from that discussion by

 17 

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 53

 1 focusing on one important element of CCP

resilience, the way in which CCPs test default

management preparations and procedures via default

management fire drills.

 2 

 3 

 4 

 5 So as has already been said, I think

Susan referenced this, we know from past

experience that default of a material clearing

member is likely to be a stressful event for a

CCP. Realistic fire drills therefore help

maintain CCP and clearing member preparedness, and

they test the robustness of default management

arrangements. Fire drills are examples of the

importance of proper preparation in ensuring

readiness from likely and potentially challenging

events. Given that the default of a material

clearing member is likely to be accompanied by a

period of market stress, there is absolutely no

scope for poor performance by CCPs in managing a

default.

 6 

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 20 This is clearly recognized in regulatory

standards and regulations. For example, the

CPMI-IOSCO Principles of Financial Market

 21 

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 54

 1 Infrastructure state that an FMI should involve

its participants and other stakeholders in a

testing and review of the FMI's default procedures

at least annually; know the preparedness extends

beyond just the FMI but also applies to its

participants and stakeholders as well. I think

that's really important. This is also mirrored in

European regulation, which requires CCPs to

regularly test and review their default procedures

to ensure they're both practical and effective,

and I understand that similar requirements also

exist in the Code of Federal Regulations as well.

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 13 Furthermore, and this has also been

referenced earlier this morning, it's very clear

that as a result of regulatory initiative, such as

mandatory clearing obligations, clearinghouses are

becoming increasingly important to global

financial markets and they are increasingly

interconnected with many key market participants.

It is therefore more likely than not that a

material clearing member default will impact

multiple CCPs at the same time.

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 1 So given this at the Bank of England, we

asked ourselves, to what extent does an

idiosyncratic or a single CCP fire drill scenario

on its own still constitute the scale of proper

preparation that we would expect to see? The

answer we came to, and it builds on some of the

recommendations of this Committee, is that

regulators and CCPs must devolve some fire drills

towards multiple CCP scenarios in order to provide

a realistic and proper simulation of a material

clearing member default. The consequences of such

a default would be visited upon a number of CCPs

simultaneously, so it makes sense to test the

response of multiple CCPs at the same time. This

is especially the case, since CCPs rely on their

members to provide bids in personnel and default

managements as the Committee has already talked

about this morning, and thus, there's a clear risk

that the demands of multiple CCPs could overwhelm

available capacity of clearing members. So it's

really important that we test these in a multiple

CCP format.

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 1 We took a first step in this direction

with a conclusion earlier this year of a fire

drill exercise involving RCH Limited, which we

supervise at the Bank of England, and Eurex

Clearing, which is supervised by our colleagues at

Bafin and Bundesbank. The scenario involved the

default of a common, hypothetical clearing member

clearing interest rate swaps and futures and was

integrated into the two CCPs annual fire drills

which were held in parallel. And along with our

colleagues from the Bafin and Bundesbank, we

observed the fire drills. We carried out

post-drill bilateral meetings with both of the

CCPs involved and seven of their largest clearing

members participating in the drill. And we also

reviewed all of their procedural documentations

associated with the drill.

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findings which I'm going to move on to outline.

Our overall objective was to identify, assess, and

ultimately address weaknesses in default

management arrangements, which may not be apparent

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 1 when we tested them in a single CCP default

scenario. In particular, one area of focus which

this Committee is also focused on was the extent

to which clearing members' internal procedures

support their ability to seconded traders to

multiple CCPs in parallel in order to participate

in default management groups. This matters

because seconded traders bring valuable up-to-date

market and trading experience to CCP default

management groups, helping CCPs to return to the

matchbook as effectively as possible.

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 12 Our findings on this point were broadly

positive and I think reflect some of the comments

that we heard around the Committee earlier today.

Our view of a range of CCP members' procedural

documentation and how they behaved in the fire

drill found generally sound arrangements in place

when considering their commitments across the two

CCPs in question.

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exceptions which we're following up to help ensure

that best practices are broadly adopted.

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 We recognize that there are other

factors potentially affecting seconded trader

availability, and our findings are by no means the

last word in this area. Demand for trading

resources are likely to increase as more CCPs

complete and clear similar products, and this,

therefore, remains an area that we'll need to keep

under active review.

 

 

 

 

 

 

 

 9 A second area we assessed was the

operational capacity of clearing members to

process auction files from two CCPs at the same

time. This matters because auctions are an

essential part of the default management process

and a successful auction with effective member

participation helps return the CCP to a matchbook

as soon as possible. It requires members to price

and assess the risk in the CCP's data file which

can be thought of as akin to an auction catalogue,

enough that contains tens of thousands, if not

hundreds of thousands of records describing the

contract specifications for each clear trade. And

we found considerable variation in clearing

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 1 members' ability to process these files in a

 2 timely manner.

 3 In a multiple CCP scenario, this could

throw into question some clearing members'

capability to consistently submit competitive and

timely auction bids to participate effectively in

a CCP's auction, and therefore, default management

process.

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 9 Our analysis attributed this variation

amongst clearing members to a combination of

insufficiently frequent testing of the process by

some clearing members, underdeveloped operational

systems, and the multiple auction file formats

used by the CCPs.

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 15 As a first step in dealing with this,

and again, this builds on some of this Committee's

recommendations that you've just agreed, I'm

pleased to say that the two CCPs in question, LCH

and Eurex, have agreed to work together to explore

opportunities to more closely align their auction

file format and contents and we're expecting them

to report back to us in due course on this issue.

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 1 The outcome we're seeking to achieve

here is to find a simple way of lifting some of

the operational burden from clearing members of

processing files in different formats and

therefore, increase the likelihood of effective

auction participation by members.

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investigation. We identified a number of

prerequisites for running more effective fire

drills across multiple CCPs, and these include

more tightly defining the timing of the CCPs'

hedging activity in auctions to ensure that the

exercise robustly tests clearing members' capacity

to participate. It includes ensuring defaulted

portfolios material in size with correlated risks

above clearing members' business as usual risk

model assumptions. This helps ensure that the

exercise identifies and really tests clearing

members' risk management capacity. And also, it

includes enabling regulators to complete ex-post

reviews of clearing member auction bids,

particularly to assess the impact of capital or

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 1 liquidity costs on the bids that have been put

 2 into the auction.

 3 So jointly, the Bank of England, with

the Bafin and the Bundesbank, we've communicated

with the participating CCPs and clearing members

outlining our observations, and we'll be following

up as necessary over the coming period.

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 8 Looking ahead, we're building on this

exercise which took place in February in 2016,

aiming for the next multiple CCP fire drill with

regulatory involvement to take place in 2017. And

I'm very pleased to announced to the Committee

that building on our close collaboration with the

German authorities and with the CFTC, we've agreed

to extend the 2017 exercise further to run across

three CCPs, and CME, Inc., has agreed to join LCH

Limited and Eurex Clearing in a coordinated fire

drill in the first half of next year.

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working with these three CCPs, as well as our

German and U.S. regulatory counterparts in

continuing to build and involve our approach.

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 1 We're in the process of defining the scenario and

objectives of that drill. It will certainly

include testing, hedging, and auctioning

procedures at CCPs and at members in stress market

conditions.

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 6 Building on some of the comments the

Committee made earlier today, we're also

considering testing the capacity of client porting

arrangements which we recognize is a key area of

focus on both sides of the Atlantic. And I'll be

happy to discuss the outcomes of next year's test

with the Committee at an appropriate juncture.

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 13 So just to conclude before I open up for

some questions. Fire drills, both idiosyncratic

and across multiple CCPs are part of the vital

work that CCPs, clearing members, and regulators

should take forward collaboratively in order to

promote safety, soundness and financial stability.

Building on this Committee's recommendations,

we'll continue to refine and adapt the way in

which they're run to ensure that they recognize

the increasingly complex interconnections within

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 1 global markets and the systemic importance of the

 2 CCPs that serve them.

 3 So I'm going to pause now and I thank

you for your attention. I'm very happy to take

questions, and I'll pass the floor back to Robert

for questions and discussion.

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 7 MR. STEIGERWALD: Thank you very much,

David. For the members of MRAC, in accordance

with the

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 10 usual custom, if you will use your name

tent to indicate your interest in asking a

question, this is now the time to share your

thoughts and inquire further about the comments

David has just made.

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 15 David, let me kick things off while

Richard is thinking of his question. There's

quite a lot of testing going on in this space.

There's back testing of models. There's stress

testing of the adequacy of CCP financial resources

and fire drills as well, all of this directed to

very important policy objectives, of course, but

it takes some time. It costs some resources. How

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 1 do you assess the overall benefits of these

related testing protocols in relation to the costs

associated with them?

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 4 MR. BAILEY: Thanks, Robert. It's a

very good question, and I think I'll tell you two

points in response.

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 7 The first thing is it's really important

that we actively test CCPs and clearing members'

resilience and their preparedness for default

management situations. In the discussions of the

Committee and my comments earlier today, I've

highlighted just how important that is.

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recognize though that testing comes with overhead.

It comes with cost to both clearinghouses and to

their members and to the regulators as well.

These exercises, the more complex they get, the

more complex they are to organize, the more

involvement they need, and as regulators, we can

help with that, especially where we can help to

resolve some of the barriers of doing this on a

cross-border basis. Hence, some of the

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 1 discussions we've been having with CFTC and our

 2 regulatory colleagues in Germany.

 3 I think where possible, we will always

try and build and leverage on existing practices

that are taking place within industry. As I said

earlier, CCPs already have requirements in

regulatory expectations in multiple jurisdictions

that they will run, for example, default fire

drills on a periodic say annual basis. And so in

the case of the multiple CCP drills that I've

discussed, the one that took place in February

this year and the one we're going to do next year,

we'll seek to build on the existing tests that

already happened rather than require something

additional. So what we're seeking is

coordination, i.e., to run the fire drills

simultaneously and in parallel, rather than

request additional tests to be run.

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tests that we will want to run, standardized

stress testing being a good example. Those are

new tests that can be built on existing stress

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 1 tests, and for those of you who haven't had a

chance to look at it yet, I would commend and

recommend you to read the excellent report that

the CFTC published yesterday. We had good liaison

with the CFTC staff as they developed the

exercise, and I think it's got a number of

thought-provoking conclusions and findings that we

can build on as regulators.

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 9 So I think in summary, Robert, what I'll

say is the kind of testing that you mentioned in

your question is really important. We need to

take it forward, and we need to think about how it

needs to evolve in light of increasing importance

of CCPs and increased interconnections in global

markets. But we will seek to do so in a

proportionate way building on existing exercises

where possible, mindful of the overheads and

commitments it brings to all involved, both in

terms of market participants and regulators.

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 20 MR. STEIGERWALD: Thank you, David.

 21 Richard?

 22 MR. MILLER: Thank you. This is an
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 1 interesting subject matter.

 2 You know, from the perspective of

end-users who aren't intimate to the way these

fire drills work, I would be interested in hearing

a little bit more color on how you actually go

about doing this, what form it takes, and you

know, how you arrange the program. And second

question, if you get into the issue of porting in

future fire drills, would you envision including

end-users in the process so that they participate

in the fire drill as well?

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 12 MR. BAILEY: Thank you. So we're going

to take that question in two parts. The first

part is how we go about coordinating them and the

second point is your question around porting and

involvement of end-users.

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the individual CCPs organize their fire drills,

then you've got a number of the experts sitting

already on the Committee who I'm sure will want to

comment on that. I think the additional value

that's added by the multiple CCP fire drill is

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 1 coordinating the timing, making sure that they're

run in parallel and that they're truly, actively

testing arrangements. So they need to be

stressful scenarios that really robustly test both

the CCP's and the clearing member's capacity to 

support the exercises. So what we can bring is

running the exercises in parallel so that in the

case of the CCP of the fire drill I referenced,

that both CCPs were running out to their members

and asking for traders to be seconded at the same

time, that they were running their auctions at the

same time so clearing members were having to deal

with multiple requests. They were having to

price, size, and assess the risk associated with

multiple portfolios at the same time and respond

accordingly and work out could they bid as

aggressively in two auctions at the same time as

they might have done if they were only faced with

one portfolio at the time.

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challenges of coordinating at the same time. And

I think next year when we run this across CCPs,

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 1 we'll see that the complexity will go up by an

order of magnitude again. The more and more we

can test that, I think the more lessons that we

will learn. And as I said, there were already

some very interesting findings. There were

already some points that we are taking and some

actions that we put on both CCPs and the clearing

members involved to ensure that the preparations

can be even better next time. So that's a

response to your first question.

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really -- well, we're still defining the scope and

the scale of the exercise for next year. Were we

to look at porting as part of that, there are a

number of aspects we could look at and we need to

define what's appropriate, what's proportionate,

but we certainly want to make sure that the CCPs

and the clearing members involved actively have

the procedures and purchases in place to

facilitate porting. It sounds, well, in practice

it sounds a relatively straightforward process,

but making sure that the CCPs can facilitate the

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 1 transfer of client positions from one clearing

member to the other, making sure that the

defaulting clearing member has in place the

capacity to provide the necessary information to

the CCP and to the receiving clearing member, of

making sure that the receiving clearing member has

the capacity to assess price and size of the risk

they're taking on and then operationally process

that could all be areas that we seek to look at.

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include clients in that. I can't say at this

point, but we'll certainly think about what the

challenge is for clients as well as clearing

members and CCPs are when we're developing the

test.

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 16 MR. STEIGERWALD: Dr. Lo?

 17 MR. LO: So I want to thank you, Mr.

Bailey, for coming and describing your experiences

at the Bank of England. For whatever reason, the

Bank of England seems to be a real leader in

thinking about these issues, so it's very useful

to get your thoughts on it. I have two questions

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 1 about the fire drill that you conducted, and they

 2 have to do with data and analytics.

 3 So obviously, fire drills are very

expensive to run and there's no substitute for

them because they deal with a lot of the

operational aspects that you really can't tell

unless you go through the exercise. But I wonder

whether there are ways of running ongoing fire

drills virtually by collecting data for the entire

CCP network, mapping that network, and being able

to do simulated shocks over the course of even,

you know, days or weeks and in a way that is a lot

less intrusive. It may not give you the same

information, but it can provide you with some

useful ideas for where the pressure points are and

then you can focus on those during the fire

drills. So that's one question. Is that

something that's feasible or worthwhile to explore

and has the Bank of England looked into that?

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fire drill there's an enormously valuable set of

data that you collect from the results. Is it

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 1 possible to make that data available in some

anonymized form to academics to study to get a

sense of how these markets work under distressed

scenarios? Even if they're simulated, they could

be actually very valuable for quantifying some of

the things that we can only guess at with existing

market data.

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 8 MR. BAILEY: Thank you. Thank you for

the question. So I'll take that again in two

parts.

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 11 The first question was around the

potential to run ongoing, as you described them,

virtual fire drills or tests, and I think taking a

step back, what are the real values of running

fire drills. And I'll split that into two points.

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 16 The first thing is assessing the

financial resilience of the CCP and the clearing

members' capacity to absorb or participate in

auctions and the financial impacts. The second

point, and equally as important, is the

operational capacity of CCPs and clearing members

to run the default management process. And I

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 1 think that second point you can only really test

 2 via the fire drills.

 3 In terms of assessing the financial

impacts of default, you're quite right that there

are exercises that can be run on an ongoing basis.

I think, again, just referring back, and I'm going

to start charging the CFTC for every time I plug

this report of theirs yesterday, so I'll submit a

bill to Chairman Massad later on, but the report

published yesterday was a really good example of

how regulators can do that kind of testing

virtually using the data that's reported to us.

From a Bank of England perspective, that is

something that we are thinking of doing. In fact,

CPMI-IOSCO, learning the lessons and looking to

the lessons learned from authorities that have

done this, such as the CFTC, such as in Europe,

ESMA, are looking to define standards around

standardized stress testing. From the Bank of

England's perspective, we will look to those when

they are defined next year and look to develop

stress tests that would allow us to assess what

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 1 the financial impacts are and the financial

resilience of CCPs and the potential cause they

could make of their clearing members. So I think

we can do that. But on its own, just virtually

testing the financial resilience of the system

doesn't pick up the important operational aspects

that the fire drills actually test. So that's the

first point.

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 9 The second point was around data, and

you're not the first academic to come asking for

data. I think what we're taking away to think

about, we need to be very careful that the data

used here is, first of all, importantly market

sensitive. It is of clearing members' actual

positions at the time that we run the exercises.

And secondly, in many cases, it is constrained and

proprietary in nature, and therefore, there will 

be some quite formidable legal aspects that we

would need to think to. But the point is taken

that should there be any data that we can

released, then it could be used for valuable

academic purposes. So I know that point.

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 1 

 MR. MCLAUGHLIN: Thanks. Very

interesting. Did you give any thought, or have

you given any

 thought to how one would test nondefault

losses in a fire drill?

MR. STEIGERWALD: Dennis?

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 7 MR. BAILEY: So, Dennis, I should have

asked you that question. In fact, I might do

afterwards, and in fact, I might submit a

regulatory action for LCH to come back to me with

a plan of how to do that.

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 12 I think you raise a very important

point. When it comes to a number of aspects of

CCP resilience and recovery, we think about -- we

focus on -- understandably, we focus on the

default of a substantial clearing member. That's

a key risk that CCPs have developed and through

regulatory means we have forced more trades into

clearing. Precisely so, we can remove some of the

bilateral risks that existed in the system

previously, and we can ensure that those risks are

essentially and to very high and transparent

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 1 standards and it can be seen to do so. That very

much promotes financial stability and it promotes

confidence in the system.

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 4 But CCPS are also exposed to other forms

of losses that may not arise purely through the

default of a clearing member, and we need to think

quite carefully about how we assess CCPs and their

members' abilities to deal with that. So as far

as I'm aware, we haven't seen a fire drill run

that takes into consideration nondefault losses

but it's only something that we should think

about. And it's also an important consideration

of the recovery arrangements that have been

developed under CPMI-IOSCO and which CPMI-IOSCO

are currently reviewing is thinking about what

recovery arrangements and what resources are in

place to allocate losses and deal with nondefault

losses where they exceed a CCP's capital. So I

think it's something that we need to think about.

Any input that members of the Committee would like

to give to us as we think about that I think would

be very valuable.

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 1 MR. STEIGERWALD: Susan?

 2 MS. O'FLYNN: Well, firstly, you know, I

think from a clearing member perspective, we

welcome joint rules like the ones that were run in

February, and obviously, as an observer and both a

participant, it was a very useful process to be

able to test our capability to both bid and

operationally intakes files north of 12,000 swaps

I think was one of them. And it's very

encouraging to hear that there's going to be a

three-way process with CME next year because that

effectively reflects the entire IRS market, so we

think that will be really a good, dry run of

potentially what could happen. If there is a

significant clearing member default, we expect

there to be split risk so, you know, you need to

have the whole universe of players involved.

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comforting but it's good to hear that the auction

file format finding is something that is already

kind of in process to create something that's more

consumable from a clearing member perspective to

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 1 be able to bid well and efficiently within the

timeframe. That's obviously one of the

recommendations here today.

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 4 You know, back to I think my initial

introduction, I think it's very important to think

about multiproduct drills. We're talking about

swaps specifically and ETD, but as more products

become clearable, it is likely that a significant

clearing member default will default in repo

exchange trader derivatives and, you know, other

forms of OTC derivatives. How do we think about

drills looking at the cross products and

coordination and capacity? And thirdly, to

Dennis's point around non-default losses, it's

been a topic of great debate in the recovery and

resolution forums. I think we would very much

welcome a drill, looking at that as an

alternative, and also the involvement of clients

just to then, I suppose, for want of a better road

test, the communication policy that Dennis

outlined earlier.

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 22 MR. BAILEY: If I could just respond to
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 1 a couple of those points. That's very helpful,

 2 Susan. Thank you for the comments.

 3 I think in terms of the three points

that you made, firstly, in terms of the file

formats and very much building on recommendations

that this Committee has just approved, we do see

that to be scoped to make enhancements in terms of

consistency. I wouldn't have or want to lay all

of the work at the CCP's feet. I think there is

important work for clearing members to do in

ensuring that they have the systems and the

capacity to absorb those files as they're

developed. We'll seek to make it as easy as

possible, but some of the findings of our test

back in February was clearing members weren't

fully prepared from an operational capacity to

absorb more than one file at a time and run the

price and run the risk on a number of portfolios

at the same time. So there's work to be done both

at the CCPs and at the clearing members.

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 22 about multiple products and I fully agree. I
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 1 think that is a further revolution that we can go

through. We also need to be cognizant as we go to

multiple CCP, multiple product testing, the

complexity of the exercise gets more and more each

additional step that we add and I'm not sure that

complexity increases on a linear basis. I think

it's increasingly more complex the more facets you

add to the test. So I think we will go down that

route in due course. We'll probably go one step

at a time to make sure that we can learn the

lessons suitably at each stage.

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looking at tests to involve clients (inaudible)

yes, the places we'd like to go. We just need to

make sure that we take sensible and proportionate

steps to get there rather than rushing to make the

test as complex as possible because I think there

are enough benefits and enough lessons we can

learn from each incremental stage that we will

make the process more robust, more resilient at

each stage as we increase in complexity step by

step.

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 1 MR. STEIGERWALD: Kim?

 2 MS. TAYLOR: I understand that the

purposes of the joint drills and the simultaneous

auctions probably maximize certain types of

stressors for the clearing members to absorb, but

I'm wondering whether the movement to assume that

the auctions should be held simultaneously would

actually turn out to be the market stability

maximizing outcome. Because I think that it could

be that holding auctions sequentially would

actually allow people to bid on the second and

third pieces or the second and umpteenth pieces of

the portfolio exposure with knowledge of what

they've already won or lost and it might actually

benefit in terms of the bids that we would get for

the different pieces of the exposure. So I'm

interested in thoughts on including that type of

sequential auction rather than just simultaneous

auction in the process.

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 20 MR. BAILEY: That's a really good point,

Kim. Thanks for raising it. I should just be

clear. My earlier remarks, I wasn't implying that

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 1 the auction should be run at exactly the same time

simultaneously, but we do need to think about the

challenges involved in the timing of having a

number of auction processes going on at roughly

the same time.

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one aspect we can test is running them at the same

time. That provides challenges of its own from an

operational perspective. But we do need to think

about in a real-life default scenario, what's the

best outcome for the market as a whole for

efficiency and for stability in terms of timing of

those auctions. And there are a number of aspects

at play. So, for example, I can imagine if you've

got a number of CCPs, there might be a rush to be

the first one to run your auction because you can

give away your positions when members have got the

maximum capacity to absorb those positions. That

might be one outcome.

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 20 A second point we need to think about is

what's realistic in terms of coordination between

CCPs at the time that you're merging a stressful

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 1 material member default.

 2 And thirdly, how much collaboration can

we expect, or how much interaction can we expect

given the legal constraints that you're under and

your own fiduciary duties to your shareholders.

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 6 So there's a number of factors at play,

and I think that's where close collaboration

between the regulators, as well as the CCPs can

come into play because in a default management

scenario across multiple CCPs, we would absolutely

be talking to our colleagues at the CFTC, at other

regulators both on this side of the Atlantic and

in Europe. That doesn't mean to say we would

force a certain ordering, but we just need to

think about some of the challenges and how we

might manage the best outcome for the stability of

the system as a whole. So I think you've raised

some really good points that maybe we can test as

we move into future default fire drills and we

evolve sort of the best practice that comes out of

them.

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 22 MS. TAYLOR: And I think some of the
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 1 comments that you're making also kind of reinforce

some of the comments that we made earlier about

our concerns about kind of an ex ante agreement

that the lockstep process is going to be like this

when we don't, any of us know the exact

circumstances that the CCPs or the market as a

whole will be facing at the time of the crisis.

So I think we encourage the process to allow for

transparency in general about the process without

kind of tying the industry's hands to a specific

process that might not actually be the best one at

the time.

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 13 MR. STEIGERWALD: David, recent events,

in particular the immediate aftermath of the

U.K.'s Brexit vote reminded us of the critical

importance of intraday liquidity, in particular

really time-critical liquidity associated with

variation settlements at CCPs. Now, you've

cautioned us against rushing to include too much

complexity in these fire drills for good reason.

I wonder, can you comment at all on the extent to

which liquidity issues are already incorporated in

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 1 the fire drills and the plan going forward to

incorporate realistic simulations of actual

liquidity constraints in future fire drills?

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 4 MR. BAILEY: Thank you, Robert. So

there are a couple of aspects there, and I'm

 going to take them separately. The

first thing is to talk about liquidity management

and its inclusion in the various tests that we

run. And the second point, I'll come back to the

first comment you made around some of the margin

calls we saw back in June.

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aspects and some of the tests that we run. So

that was not liquidity aspects. Well, I should

take a step back. First of all, liquidity and

liquidity management is just important as a number

of the other risks that CCPs and their members are

managing. Whether that's credit risk or whether

it's operational risk, it's equally as important,

and it's equally a focus of regulators. It wasn't

specifically a test of the default fire drill

exercise that we ran back in February, and again,

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 1 I think it is something that we can usefully pick

up in, for example, some of the stress tests that

we expect CCPs to run on their own, but also some

of the standardized stress testing that I referred

to earlier. And I recognize again it wasn't the

focus -- it's my understanding it wasn't a

specific focus of the CFTC's exercise, but I think

it can be of future standardized stress testing.

And it's really important that we do that because

the calls that CCPs make for the default waterfall

and some of the processes through the auctions can

place or have the potential to place significant

liquidity calls, liquidity needs, liquidity

burdens onto clearing members and we need to

understand the interconnections that we have there

and some of the risks that arise as a result.

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forward. Liquidity risk management is already a

focus, but in terms of the default fire drill

exercises, and specifically, some of the stress

testing exercises that we run going forward, I

think liquidity will be an absolutely important

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 1 aspect of that. So that's the first point.

 2 The second point was you noted some of

the calls from back in June, and specifically, as

you said, referring to intraday variation margin

payments. I think I'll just say two things. The

first one is that variation margin is an important

aspect of the CCP risk management process. It

should be no surprise to anyone that CCPs call

variation margin on at least a daily basis. That

is enshrined within the regulatory expectations

that we have. What I think we can look at, and we

should look at, is some of the processes through

which variation margin is called on an intraday

basis because that can pose some challenges. And

it does vary from CCP to CCP, so that is something

we're thinking about. But the concept of calling

variation margin, whether a large market move or

to cover market moves is an inherent part of the

CCP process. It should not be a surprise; it

should be something that CCPs are expecting to do.

In fact, they're required to do. It should be

something that clearing members and clients are

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 1 expecting. What we need to look at and what we

should think about is the process through which

intraday variation margin is called.

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 4 MR. STEIGERWALD: Kim?

 5 MS. TAYLOR: If I could just add not

really a question but more of a comment to that.

I definitely agree that variation margin is a very

important risk management tool and that the market

should be expecting that the CCPs would use it as

part of their risk management. The other side of

that though, I think the market could fairly have

the expectation that the CCP would not just

collect losses but would also pay out profits,

especially when there are situations as we've seen

recently where there have been big swings in one

direction and then swings back. So that is a way

to help CCPs manage their risk while also not kind

of exacerbating the risk of other elements in the

chain of the market.

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 20 MR. STEIGERWALD: Dennis?

 21 MR. MCLAUGHLIN: Yeah, just a slightly

 22 different question.
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 1 So you've been looking at more of the

operational reasons that the fire drill could

fail. Have you seen, or can you share with us any

reasons why you might think there's a structural

reason why a fire drill might fail? Not an

individual little operational deficiency

somewhere, but are there structural reasons why

something might fail?

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 9 MR. BAILEY: So it's a good question,

Dennis. I'm pausing because I'm thinking hard.

You can probably hear the clock turning. It's

late in U.K. time so I need a little bit of time

to think about that.

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and we need to be cognizant that the default

management process, where the failure of large

clearing members are involved, is likely to take

place in very stressed market conditions, and we

need to think about -- one of the things we can

think about as we increasingly run more complex

fire drills involving more CCPs, more members, and

more products as we talked about, whether there

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 1 are constraints placed on that process by the

level of volatility in markets or simply the

number of participants that are involved. So your

question is a good one and one I would certainly

need to take away and think about, and I think we

need to flush out as we run more and more complex

fire drills. But obviously, if CCPs or their

members already can see some structural

constraints to fire drills being successful, then

that is something we would want to consider now,

as early as possible, so we can aim to remove

those structural constraints where possible and

think about whether we need to evolve the default

management processes accordingly.

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 15 MR. STEIGERWALD: Thank you, David. I

can say personally I've learned quite a lot about

what has been going on with respect to fire drills

and the expectations for such exercises going

forward. Thank you for your time and sharing your

thoughts with us. On behalf of the Committee,

we're grateful for your time.

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 22 MS. WALKER: At this time, and keeping
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 1 with meeting agenda, I would like to thank Robert

Steigerwald for facilitating the discussion, and

Mr. David Bailey for his insights during our

second panel.

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 5 I will now turn to Commissioner Bowen

and the other commissioners and the chairman for

any closing remarks.

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 8 COMMISSIONER BOWEN: First, let me say

that the early finish I don't think is in response

to my growling stomach but I think it is a

testament to how much hard work and discussion

really took place beforehand. So would the

chairman or Commissioner Giancarlo like to --

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 14 CHAIRMAN MASSAD: Just thank you again

for not only a very productive, but a very

efficient meeting.

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 17 COMMISSIONER GIANCARLO: Here, here.

 18 COMMISSIONER BOWEN: So today's vote

obviously is a culmination of two years' worth of

work on CCP default management. As we said before

at the first MRAC meeting in April 2015, the CCP

members presented their default plans and the MRAC

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 1 discussed the strengths and weaknesses of those

plans. As you know, in that discussion two

questions arose. One, how can CCPs' plans better

reflect the likely market conditions during

default? Two, how can CCPs better coordinate

their efforts to prevent and manage a participant

default? And then in November 2015, the

Subcommittee presented draft recommendations in

answer to the first question. On June 27, 2016,

the Subcommittee presented a draft response to the

latter, and now today, the Subcommittee has

presented its combined final recommendations to

the MRAC and these recommendations have been

presented to the Commission.

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 15 First, let me say that I could never

have been more proud than I am today of the work

of this Subcommittee and the Full Committee. It

is no small task to bring together market

participants from such diverse backgrounds to

agree on such knotty policy issues. I'm well

aware that probably no one got the perfect set of

recommendations and everyone probably made some

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 1 compromises.

 2 So I want to give a hearty thank you to

the Subcommittee members, particularly Tom Kloet

who started this process, and Susan O'Flynn who

ably ended it. Susan spent many long days and

nights hammering out consensus and we owe her a

lot for that. And thank you to the MRAC members

overall who thoughtfully and tersely engaged on

these issues to arrive at their vote. I also want

to thank today's guest speakers and presenters.

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 11 I also want to take the opportunity to

thank the staff, the chairman, and Commissioner

Giancarlo again for their continued support of

this Committee. And I want to say a final thank

you to my staff, to Jason, Justin, Vontrece, and

especially Petal, our designated federal officer,

for the many hours, numerous phone calls, and

artful diplomacy in making sure that everyone not

only had a voice but were heard throughout the

process. I'm very proud of the work of this

Committee that it's done so far, and I look

forward to what MRAC can do in the future. We

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 1 know that there's no shortage of market risk and

market structure issues in the derivatives market

today. And with that in mind, I invite the public

to comment on what issues they believe MRAC should

tackle in the upcoming years.

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 6 Thank you so much again, everyone.

 7 (Applause)

 8 MS. WALKER: Just a couple of quick

logistical things before we need. Please,

members, do take your portfolios with you and use

them to bring materials back and forth to your

future meetings. If there is any paperwork that

needs to be handed in, please hand it in before

you go. And those going to lunch, please gather

over here near the door. Our reservation is now

for 12:30.

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 17 And with that the meeting is adjourned.

 18 

 

(Whereupon, at 12:10 p.m., the

 19 PROCEEDINGS were adjourned.)

 20 * * * * *

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

public in and for the District of Columbia, do

hereby certify that the forgoing PROCEEDING was

duly recorded and thereafter reduced to print under

my direction; that the witnesses were sworn to tell

the truth under penalty of perjury; that said

transcript is a true record of the testimony given

by witnesses; that I am neither counsel for,

related to, nor employed by any of the parties to

the action in which this proceeding was called;

and, furthermore, that I am not a relative or

employee of any attorney or counsel employed by the

parties hereto, nor financially or otherwise

interested in the outcome of this action.

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 19 (Signature and Seal on File)

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

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 31, 2017