UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 ENERGY AND ENVIRONMENTAL MARKETS ADVISORY

 COMMITTEE MEETING

 Washington, D.C.

 Wednesday, July 29, 2015
 2

 1 PARTICIPANTS:

 2 Opening Remarks:

 3 CHAIRMAN TIMOTHY MASSAD

 4 COMMISSIONER MARK WETJEN

 5 COMMISSIONER SHARON BOWEN

 6 COMMISSIONER CHRISTOPHER GIANCARLO

 7 Panel I: How Can Exchanges Help Implement Federal

 Position Limits?

 8

 ERIK HAAS, ICE Futures U.S.

 9

 TOM LaSALA, CME

 10

 RON OPPENHEIMER, Commercial Energy Working

 11 Group

 12 Panel II: A Phased Approach to Position Limits:

 13 STEPHEN BERGER, Managed Funds Association

 Y.J. BOURGEOIS, Natural Gas Supply

 14 Association

 15 WILLIAM McCOY, FIA

 16 Panel II: Trade Options and Forwards with

 Embedded Volumetric Optionality - Where Do We

 17 Stand?

 18 PAUL HUGHES, Southern Company

 19 ARUSHI SHARMA-FRANK, Electric Power Supply

 Association

 20

 AMY FISHER, GE Energy Financial Services,

 21 Inc., on behalf of Cogen Technologies

 Linden Venture, L.P.

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 Other Participants:

 3 JOSEPH ALLEN

 Caterpillar Inc.

 4

 JAMES ALLISON

 5 ConocoPhillips

 6 JIM CATER

 American Public Power Association

 7

 MICHAEL COSGROVE

 8 Vectra Capital

 9 ROB CREAMER

 FIA Principal Traders Group

 10

 TODD CREEK

 11 ICAP Energy LLC

 12 BRYANT DURKIN

 CME Group

 13

 MICHAEL GILL

 14 Independent Petroleum Association

 15 PAUL HUGHES

 Southern Company

 16

 BENJAMIN JACKSON

 17 ICE Futures U.S.

 18 VINCENT JOHNSON

 BP Integrated Supply and Training

 19

 WILLIAM JONES

 20 Jones Petroleum Company Inc.

 21 MICHAEL PADGETT

 Alcoa

 22
 4

 1 PARTICIPANTS (CONT'D):

 2 LOPA PARIKH

 Edison Electric Institute

 3

 CRAIG PIRRONG

 4 University of Houston

 5 MICHAEL PROKOP

 Deloitte and Touche LLP

 6

 VICTORIA SHARP

 7 Citigroup Energy, Inc.

 8 TYSON SLOCUM

 Public Citizen

 9

 ANDREW SOTO

 10 American Gas Association

 11 RUSS WASSON

 National Rural Electric Cooperative

 12 Association

 13 DENA WIGGINS

 National Gas Supply Association

 14

 15

 16 * * * * *

 17

 18

 19

 20

 21

 22
 5

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

 2 (10:02 a.m.)

 3 COMMISSIONER GIANCARLO: Why don't we

 4 all start grabbing our seats and getting set.

 5 Apparently there are some problems on the Metro

 6 today, there's, I gather, a train stuck in the

 7 underground, so some folks may be on that and may

 8 be coming in late, but I think we'll get started

 9 nevertheless.

 10 I thank everybody for coming today; and

 11 certainly thank our panelists for being here.

 12 I'll start with a few remarks and then hand over

 13 to my fellow Commissioners, but before I do, is

 14 there any housekeeping business that we -- just in

 15 terms of calling the meeting to order, or anything

 16 on the agenda that we need to --

 17 SPEAKER: No.

 18 COMMISSIONER GIANCARLO: No?

 19 SPEAKER: You've just done it.

 20 COMMISSIONER GIANCARLO: Okay. Welcome

 21 to the Second Meeting of the CFTC's Reconstituted

 22 Energy and Environmental Markets Advisory
 6

 1 Committee.

 2 And I'd like to welcome four new

 3 Associate Members to the Committee and to today's

 4 meeting. William Jones, CEO of Jones Petroleum

 5 and JP Capital & Insurance from Jackson, Georgia.

 6 Thanks for being with us, Bill.

 7 Martin Bates, President of Strategy,

 8 Energy & Development, Alcoa, from Pittsburgh,

 9 Pennsylvania; and Michael Padgett is in his place.

 10 Thank you, Michael, for being here.

 11 Joseph Allen, Director of Energy Policy

 12 for Caterpillar and Solar Turbines; fulfilling our

 13 environmental portion of our mandate. Thank you

 14 for being here.

 15 And Andrew Soto, the Vice President for

 16 Regulatory Affairs with the American Gas

 17 Association. Thank you for joining the Committee

 18 and for supporting its important work.

 19 In February, the Committee met and

 20 focused on the CFTC's proposed rules to impose,

 21 for the first time, Federal Position Limits on

 22 American energy and environmental markets. That
 7

 1 meeting identified several areas where the current

 2 Position Limits Proposal would be problematic.

 3 One, the proposed limitation on the bona

 4 fide hedging exemption to only a limited number of

 5 enumerated hedges leaves many other strategies,

 6 including bread-and- butter energy risk management

 7 strategies ineligible for the bona fide hedging

 8 exemption.

 9 And also, secondly, the increasing

 10 evidence of a distinct lack of liquidity and

 11 widening bid-ask spreads further out the curve,

 12 perhaps resulting from, some participants noted,

 13 insufficient speculation, that the CFTC's Position

 14 Limits Proposal would exacerbate.

 15 In my mind we must find an approach that

 16 addresses these problematic aspects of the

 17 proposed rule so that U.S. Market participants

 18 may continue to manage the risk associated with

 19 their production and price.

 20 Along these lines, I had the privilege

 21 last week to spend, in the Midwest, meeting with

 22 many agricultural producers, such as dairymen,
 8

 1 pork producers and row crop farmers. And the

 2 number one concern of producers of corn, soybeans,

 3 pork and dairy is what price will they get paid

 4 for their product come harvest time?

 5 The spot price they are paid for these

 6 commodities is what puts food on their tables, and

 7 pays for their kids' school supplies come the

 8 fall. So you can understand their worries this

 9 summer over the current tumbling in worldwide

 10 commodity prices that has been widely reported in

 11 the financial press.

 12 These falling prices led me to ask the

 13 CFTC's Office of the Chief Economist for some

 14 basic data covering the 28 commodities covered by

 15 our position limits proposal. And the information

 16 they provided me was stark. Across the 28

 17 commodities that will be covered by the proposed

 18 Position Limits Rule, there has been a dramatic

 19 double-digit decrease in prices since December

 20 2010. In fact, since the year that the Dodd-Frank

 21 Act was signed into law, there has been a 42.6

 22 percent decline in the 22 commodities covered by
 9

 1 the Bloomberg Investable Commodity Index.

 2 It was apparent from my meetings in

 3 Iowa, in Minnesota, in Illinois, that many

 4 American agricultural producers have reduced their

 5 hedging activity in the past few years, making

 6 them more vulnerable to these types of volatile

 7 price swings in U.S. commodity markets. If and

 8 when the Commission moves forward with a position

 9 limits regime, we must be absolutely certain that

 10 we do not make it more difficult for American

 11 agricultural and energy producers to protect

 12 themselves against huge declines in commodity

 13 prices because of wooden or inflexible rules.

 14 If the current collapse in world

 15 commodity prices continues and the Position Limits

 16 Rules are not made more workable, we may be

 17 imposing burdens on hedging risk at precisely the

 18 wrong time. I trust this Commission has that

 19 concern and foresight to avoid such a result.

 20 Now, let me briefly highlight what the

 21 EEMAC will cover at today's meeting. The first

 22 panel will consider a framework for a CFTC
 10

 1 authorization of the exchanges to grant bona fide

 2 hedging exemptions for legitimate risk reducing

 3 strategies. This approach was recently commended

 4 by Chairman Massad. The major commodities

 5 exchanges, some EEMAC members and the CFTC staff

 6 have all expressed some interest as well.

 7 So the first panel will discuss a

 8 minimum framework for providing discretion to the

 9 exchanges and SEFs to review and approve, where

 10 appropriate, non-enumerated hedging exemptions

 11 from Federal position limits. Of course, this

 12 authority would remain subject to CFTC oversight.

 13 Yet, handled properly, this has the

 14 potential to make the current proposal more

 15 workable, which many commentators have said is

 16 needed. In addition, the first panel will explore

 17 the possibility that exchanges can administer a

 18 position accountability regime as a way to soften

 19 the impact of declining liquidity outside of the

 20 spot month.

 21 Our second panel will examine the

 22 possibility of adopting a phased Federal Position
 11

 1 Limits Rulemaking that would begin by covering the

 2 spot month before turning to rules for the other

 3 months. This approach would avoid exacerbating

 4 the present liquidity problems outside the spot

 5 month that were identified in the February EEMAC

 6 meeting.

 7 It would give all market participants

 8 the opportunity to adjust to the new process of

 9 tracking and reporting commodity swaps along with

 10 their futures and options. It would also provide

 11 the CFTC with additional time to obtain better

 12 data about the over-the-counter market for

 13 physical commodities before setting rules for

 14 later implementation.

 15 I note that the CFTC has had good

 16 success with phased rulemaking, most recently with

 17 its phased approach to implementation of the swaps

 18 clearing mandate. I hope to learn of any reason

 19 why a similarly phased rulemaking would not be

 20 similarly successful in the case of position

 21 limits.

 22 Our third and final panel will consider
 12

 1 trade options and forward contracts with embedded

 2 volumetric optionality. As most of you know, the

 3 CFTC has started taking action to strike the right

 4 balance in its regulation of these very important

 5 transactions.

 6 We recently finalized a revised

 7 implementation of our 7-part test for EVOs to

 8 provide market participants certainty on whether

 9 their physically settled, often long-term

 10 contracts must nonetheless be treated as swaps

 11 because they contain embedded volumetric

 12 optionality. So the third panel will provide us

 13 with an update on the degree to which the recent

 14 actions have resulted -- the recent actions by the

 15 CFTC have resulted in the intended regulatory

 16 certainty.

 17 In addition, we will consider whether

 18 there is more the CFTC can do to ensure that these

 19 vital transactions are not subject to burdensome

 20 regulatory requirements.

 21 With that, I thank you all, and I thank

 22 the witnesses who have prepared thoughtful
 13

 1 presentations. And I thank the CFTC staff for

 2 working so hard to arrange this meeting.

 3 And finally I want to recognize

 4 Committee Member Michael Cosgrove, who has

 5 graciously agreed to Chair today's meeting. Thank

 6 you, Michael. And I now turn to Chairman Massad

 7 and my fellow Commissioners to make their opening

 8 remarks.

 9 CHAIRMAN MASSAD: Thank you, Chris.

 10 First of all, welcome everyone. It's great to see

 11 all of you. We really appreciate the time you've

 12 taken to be here, and to participate in this.

 13 These discussions are always very beneficial. I

 14 want to thank in particular those people making

 15 presentations, because obviously you've taken the

 16 time to prepare those, and put a lot of thought

 17 into it, and we appreciate that very much.

 18 I want to thank Commissioner Giancarlo

 19 for organizing this and his staff in particular

 20 for all the work that they've put into it, and the

 21 rest of our staff for facilitating the event.

 22 I'm going to be very brief. I look
 14

 1 forward very much to today's discussion on the

 2 Position Limits Rule. Generally we've obviously

 3 taken a lot of comments. We've reopened the

 4 comment period a number of times, we are digesting

 5 all those comments and, you know, I think all of

 6 us take these issues very seriously and want to

 7 come out with a rule that addresses the

 8 congressional mandate of reducing the risk of

 9 excessive speculation while at the same enabling

 10 commercial participants to hedge effectively.

 11 On the non-enumerated hedges point, yes,

 12 I have noted that I am willing to look at this

 13 issue, so I'll be interested in what participants

 14 have to say. Let me just say, if we were to

 15 decide to go down this road, then I would expect

 16 us to come up with a proposal and solicit public

 17 comment on that, so as to give everyone, not just

 18 those people in this room, an opportunity to

 19 comment.

 20 On the trade option and EVO issue, as

 21 Commissioner Giancarlo noted, we have taken action

 22 on EVO, we have a proposal out there on trade
 15

 1 options, and the comment period I think is closed

 2 on that. I would hope that we can move forward on

 3 that soon.

 4 Finally, I did note Commissioner

 5 Giancarlo's statement on prices in the Fall, in

 6 commodity prices, and I share his concern, or his

 7 recognition of the concern of many members of the

 8 agricultural community on that. And I agree with

 9 him that that does make it important that that

 10 they can hedge effectively.

 11 I did note also his reference to the

 12 fact that the decline in prices has been since the

 13 passage of Dodd-Frank. Actually, if you look at

 14 the data, in a lot of commodities prices went up

 15 after the passage of Dodd-Frank, and then came

 16 down later. I know Chris is very well capable of

 17 distinguishing causation from correlation, so I

 18 think it is important to recognize that prices are

 19 shaped by a lot of things, and it's important not

 20 to draw too much from a correlation... And again,

 21 as I say, the correlations in some cases actually

 22 would suggest a different point.
 16

 1 So, I think all of this though, the

 2 decline in prices overall, I think just reinforces

 3 the need to come up with a position limits regime

 4 that, again, meets the congressional goal of

 5 limiting excessive speculation, the risk of

 6 excessive speculation, while enabling people to

 7 hedge effectively.

 8 So, I look forward to today's

 9 discussion. I'm sorry, I won't be able to

 10 participate in all of it, but again, appreciate

 11 your presence.

 12 SPEAKER: Chris [Mark], do you want to

 13 go next?

 14 COMMISSIONER WETJEN: Good morning.

 15 Welcome. Nice to see everyone again. Chris,

 16 thank you for convening the meeting today, I'm

 17 looking forward to today's discussion.

 18 I, too, had some meetings last week, and

 19 learned a great deal. The meetings were focused

 20 on the ag sector, and included folks from the

 21 producer community, the cooperative community,

 22 serving as intermediaries, again, in the ag sector
 17

 1 primarily, manufacturers and significantly sized

 2 merchants. And it was a fascinating set of

 3 meetings, and we learned a great deal.

 4 There certainly should be some concern

 5 based on the fact that so many people's

 6 livelihoods depend on the prices of commodities.

 7 And so, the fact that there has been such a

 8 decline is obviously very, very relevant. I

 9 thought another thing that was interesting to

 10 hear, is that the, at least in the ag sector, and

 11 we've heard in previous meetings, both in MRAC and

 12 perhaps even in EEMAC before, I can't remember for

 13 sure, but the ag-derivative market seem to be

 14 functioning very, very well, and I guess, as we

 15 focus on position limits, I think that's an

 16 important thing we need to bear into account.

 17 Accessibility to the market seemed to be

 18 quite good. There were no complaints, and again

 19 this is just a subset of the marketplace that we

 20 visited with, but no complaints about being able

 21 to access the market. The one thing that was

 22 interesting to learn, is that while some used to
 18

 1 do OTC contracts in ag products that no longer

 2 takes place, but they are finding ways to manage

 3 risk in other ways.

 4 I thought in a lot ways it was

 5 heartening to hear a lot of what we heard, at

 6 least in the ag space, that marketplace seems to

 7 be functioning quite well, liquidity was pretty

 8 good. Customer service was pretty decent among

 9 the IB crowd, and customer service and

 10 accessibility, again, seem to be pretty healthy

 11 from the FCM perspective. So, all that was very,

 12 very positive.

 13 As the Chairman said, you know, the

 14 statute obligates us as a Commission to impose a

 15 Federal position limits framework. I've said that

 16 before multiple times now. But what it does not

 17 obligate us to do, is to impose a framework

 18 that's, in Chris' words, wooden and rigid, or

 19 otherwise divorced from the realities in the

 20 marketplace. Those words do not appear in the

 21 statute, and we are not required to do that, so we

 22 have to cognizant of the market dynamics in these
 19

 1 cash markets as we put together a policy for

 2 limits in the derivatives markets.

 3 And so I'm especially interested in the

 4 first panel, and again, this is something that

 5 I've spoken about before when we re-proposed a

 6 Position Limits Rule, there has to be a workable

 7 way that we deal with non-enumerated hedges.

 8 I understand there could be some work to

 9 do, in terms of what also might included as an

 10 enumerated hedge, but beyond that we have to bear

 11 in mind the realities of the marketplace and the

 12 realities facing the Commission, about how, as a

 13 Commission, we are going to deal with those

 14 transactions that do not neatly fit into the

 15 definition -- one of the enumerated hedges defined

 16 in our rules. So, it seems to make a heck a lot

 17 of a sense that we would try and leverage both the

 18 expertise and the resources, frankly, by the

 19 exchanges to help us in that effort.

 20 So, especially looking forward to this

 21 first panel, as well as the subsequent panels; and

 22 again, it's great to be here, it's great to see
 20

 1 all of you here convened, and looking forward to

 2 the meeting. Thanks.

 3 COMMISSIONER BOWEN: Thank you. And

 4 good morning. It's good to be here for another

 5 meeting of the Energy and Environmental Markets

 6 Advisory Committee. And, for those of you who

 7 traveled here from out of town, thank you for

 8 braving D.C.'s less-than-pleasant weather to be

 9 here today. We are covering some important

 10 topics, and I look forward to hearing the views of

 11 this Committee.

 12 I have had the benefit from hearing from

 13 many end-users, such as farmers, ranchers, energy

 14 producers, utilities and manufacturers this past

 15 year. I appreciate the time you all devoted to

 16 share your concerns, and for your continuing

 17 commitment to fulfilling the vital role you play

 18 in our economy.

 19 The Commission recently released new

 20 guidance regarding forward contracts with embedded

 21 optionality. As I have said before, I support the

 22 Commission's efforts to provide legal clarity
 21

 1 regarding these products. And it is important that

 2 we provide relief, so that end-users, particularly

 3 those in the energy and agricultural spheres, can

 4 continue to utilize these contracts for hedging

 5 and also have certainty about their treatment.

 6 Yet, I think we need to do more.

 7 Options and forward contracts are distinct

 8 categories under the Commodity Exchange Act. If a

 9 contract, or some portion of a contract, meets the

 10 definition of an option, that portion which is an

 11 option inherently cannot be a forward contract.

 12 A product that is embedded with

 13 volumetric optionality, or EVO, may be a forward

 14 if the optionality is being utilized as a forward.

 15 If, however, an entity attaches EVO to a forward

 16 and uses that product as an option, the overall

 17 product is not a forward and cannot qualify for

 18 the exclusion.

 19 I believe the Commission does have a

 20 route for providing the clarity that market

 21 participants are seeking, and I have proposed that

 22 the Commission use its exemptive authority to
 22

 1 provide an additional, easier solution for

 2 obtaining the relief that these stakeholders are

 3 requesting. I look forward to reviewing the

 4 comments the Commission receives and working with

 5 my colleagues here to see what more we can do.

 6 I also want to speak briefly about

 7 position limits. Nearly eight months ago, we

 8 re-opened our comment period on the position

 9 limits, something, frankly, we've done quite a bit

 10 recently. At that time I said, I support

 11 reopening the comment period, but we cannot allow

 12 this rule to linger indefinitely on our docket.

 13 It's been over a year since we reopened this rule,

 14 and nearly four years since it was first proposed.

 15 It has now been nearly another year, spring has

 16 turned into late summer, and this rule still has

 17 not been finalized.

 18 Having reviewed summaries of the

 19 comments submitted over the last year, I think

 20 we've seen pretty much all the original comments

 21 we're going to see. In the last comment period,

 22 many comments restated previous ones; in some
 23

 1 cases, almost identically; so, I get the sense

 2 that commentators not only feel strongly about

 3 their positions, but want to make sure we are

 4 hearing from them loud and clear. And we do.

 5 I therefore do not think it makes sense

 6 to reopen the comment period for this rule again,

 7 unless it is necessary to seek public input on

 8 some new, additional approach or proposals that

 9 the Commission has for addressing certain

 10 concerns. I think we really need to buckle down

 11 and finish this rule.

 12 Thank you again to the Committee and the

 13 sponsorship of Commissioner Giancarlo for

 14 providing this opportunity to hear from you today.

 15 COMMISSIONER GIANCARLO: Thanks, Sharon.

 16 Thanks, Tim. And thanks, Mark. We'll now hand it

 17 over to our Committee Chairman, Michael Cosgrove.

 18 Thank you, Michael.

 19 MR. COSGROVE: Okay. Well, so we have

 20 our first Panel, How Can Exchanges Help Implement

 21 Federal Position Limits, and I think without any

 22 further ado -- Well, actually should we introduce
 24

 1 ourselves, or having done that once before, is

 2 that reasonable?

 3 COMMISSIONER GIANCARLO: We have a

 4 pretty tight agenda, Mike, so I think maybe we'll

 5 dispense with that if that's all right. But maybe

 6 we can have the Panelists introduce themselves.

 7 MR. COSGROVE: Okay. Great. Well, I

 8 think without further ado then, if you guys would

 9 like to introduce yourselves and begin, we are all

 10 ears.

 11 MR. OPPENHEIMER: I'm Ron Oppenheimer,

 12 and I'm here representing the Commercial Energy

 13 Working Group.

 14 MR. LaSALA: I'm Tom LaSala; I'm the

 15 Chief Regulatory Officer for the CME Group.

 16 MR. HAAS: I'm Erik Haas, Market

 17 Regulation with ICE Futures, U.S.

 18 MR. LaSALA: I will begin. First on

 19 this Panel, I would like to speak to what I have

 20 called the impact analysis covering the period of

 21 June 1, 2014 through June 30, 2015. What I'm

 22 trying to illustrate for the Committee in this
 25

 1 particular presentation is basically a furtherance

 2 of materials that were touched on and presented by

 3 the CFTC in the rulemaking, generally speaking,

 4 under Table 11A.

 5 So, in that table what effectively

 6 transpired was the Commission detailed out impact

 7 points, how many participants would have been

 8 affected by the imposition of position limits,

 9 whether it be single months, all-months, spot

 10 months. I'm focusing here on single months and

 11 all- months combined, and the rationale that I'm

 12 looking to pass forward here is that I'm

 13 overlaying -- I'm trying to overlay what that

 14 imposition of those limits could have to

 15 legitimate positions held by commercials as well

 16 as non-commercials, and how those positions, if

 17 affected by the limits, will effectively

 18 ill-affect the workings of these markets.

 19 So today, I think everyone is aware, and

 20 I've highlighted in this chart various energy

 21 contracts as well metals and I'm going to focus on

 22 energy, but we are operating in an accountability
 26

 1 paradigm today, not limits. And I want to speak

 2 to the details of the chart in just a moment, but

 3 I think it's helpful if I could first just

 4 reinforce a couple of critical concepts on how

 5 that accountability paradigm is operating today.

 6 So, to further and enhance liquidity,

 7 while being mindful of concentration, we

 8 effectively set certain thresholds for open

 9 interest and monitoring all these markets. And

 10 they are different. Meaning that, if there was no

 11 open interest in a particular month, and Erik and

 12 I traded 500 lots opposite each other, the

 13 position would be concentrated, it's 100 percent

 14 and the open interest is 500 lots.

 15 The point is, is that you can't impose a

 16 liquidity or concentration standard there, you

 17 would just squelch the formation of liquidity.

 18 So, we set on a market-by-market basis, in

 19 operating accountability paradigm, certain

 20 thresholds and they vary. So when certain back

 21 months get to, or all months get to a certain

 22 threshold, we begin looking and managing
 27

 1 concentrations in those contracts.

 2 And the profile of how we look at that

 3 concentration, frankly, across the curve, is

 4 different. As you might imagine in the near-term

 5 months we might be becoming more sensitive with

 6 positions when they are in the 20 or 25 percent of

 7 open interest range. As you get further out the

 8 curve that percentage could, in fact, increase,

 9 and it does.

 10 So, I think these contracts have been

 11 managed under the accountability paradigm, and I'm

 12 going to use the word "successfully."

 13 Successfully because as I go through some of the

 14 examples here, where I'm going to show you the

 15 impacts, not only on the number of participants,

 16 but a greater level of granularity as to how many

 17 days these participants were affected within the

 18 target period, June 1, 2014 through June 30, 2015,

 19 and also the magnitude of how many positions over

 20 the said limit those participants were, as well

 21 what -- and I chose to highlight the peaks -- what

 22 those peak concentrations actually look like.
 28

 1 And what I think you'll find and

 2 conclude is that that accountability paradigm did

 3 operate effectively and, in fact, if we imposed

 4 the single and all-months limit as proposed with

 5 the formula, and I denoted what that proposed

 6 limit would be, you will have significant impacts.

 7 And so, let's take an example, if we

 8 could. I'm going to use the single -- and focus

 9 up at the top, we've broken this chart out by

 10 non-commercials, commercials, and then I did in

 11 fact present an aggregate view. So, I'm going to

 12 look at RBOB in the noncommercial category.

 13 The proposed CFTC limit per the formula,

 14 11,800, the number of participants over a single

 15 month, it's an asterisk because it means there

 16 were fewer than 4. We chose not to identify

 17 specific numbers below that level, we didn't want

 18 folks to try and infer who a participant might be.

 19 So with, you know, fewer than 4, so 3 or

 20 less, the average amount over a single month in

 21 RBOB for that period was 2,696 positions. The

 22 peak was 6,255 positions, so a peak of one of
 29

 1 those 3 or less was at 6,255, and the peak

 2 concentration percentage was 17.20 percent, and

 3 the number of days that the cumulation of the

 4 party, so those three were over, amongst them, a

 5 total 217 days, so it may even 100 -- 117 days if

 6 there were 3.

 7 Looking at the all-months 4 affected

 8 participants, but again, what was the average of

 9 the parties' positions that were in excess of that

 10 11,800; 5,721, the peak 9,934; the percentage of

 11 the peak, 5.59 percent, and the affected days 291.

 12 So, what I'm concluding and putting

 13 forth to Commissioners and to the Committee is

 14 that these positions were allowed to exist in

 15 excess of what the would-be limit would have been.

 16 I would assert to you with no casualty insofar as

 17 ill-affecting the market, in fact, in this

 18 example, and if the Committee would want to go

 19 through all those, I'm happy to. Those

 20 non-commercials were in fact providing valuable

 21 liquidity.

 22 And I'm not saying liquidity in the
 30

 1 context of their -- at the top of the central

 2 limit order book, providing a bid-ask all day.

 3 No. They are taking on positions, positions

 4 opposite commercials in the marketplace who need

 5 that liquidity, that liquidity yields open

 6 interest. That open interest yields more

 7 liquidity to allow these markets to, in fact,

 8 function properly.

 9 So, I'm not dismissive that -- where in

 10 any means, the positions should be unlimited. In

 11 fact, you know, across the period there were a

 12 number of instances, 44 in fact, where we reached

 13 out to participants to question, because they

 14 broke through one of our thresholds. We

 15 questioned them about the details of what that

 16 position represented, and we set for them a

 17 framework of where, I would say, the sensitive

 18 points are in terms of concentration.

 19 So by effectively reaching out, engaging

 20 and illustrating to market users, whether it be in

 21 RBOB or any of these markets, I think the

 22 marketplace understood where the sensitive points
 31

 1 are and we avert the circumstance where we have

 2 to, in many instances, order people to either

 3 reduce or not increase or hold. We did have three

 4 of those instances where we did have to say hold,

 5 hold your position, and they did; so, again, some

 6 context.

 7 I'd like to, if I could, one more

 8 example in the commercial category, and then

 9 certainly per any questions on any of the

 10 particular commodities, I'll answer them, or any

 11 more generic questions, happy to field them. But

 12 if we look at RBOB again now in the commercial

 13 category, that same limit, the affected parties in

 14 a single 3 or less, you see the average overage,

 15 the peak 12,000 and change, a 16.44 percent peak

 16 concentration; 123 days, you know, across those

 17 participants moving to the all-months.

 18 Five participants, the average 4,981;

 19 the peak 13,854; the peak percentage, the

 20 concentration 5.48 for a total of 537 days that

 21 commercials were affected; and while I think we

 22 all know and we are going to be talking later in
 32

 1 this Panel, about commercials and exemptions, as

 2 proposed today, things change, so where some of

 3 these parties, you know, if strict limits were

 4 administered per these levels during this period,

 5 if the paradigm for exemptions was narrowed,

 6 constricted, some of those commercial may not have

 7 been able to maintain those open positions.

 8 And while I think it's the goal of many

 9 sitting in this room today, to further explore, as

 10 the Chairman and the Commissioners have said,

 11 getting to the right place on the exemptions, I'm

 12 simply pointing out that you are getting a clear,

 13 I believe, profile here of what that impact could

 14 be to commercial users as well as non-commercial

 15 users.

 16 So, again, I'm certainly open to speak

 17 with any level -- whatever level of detail you

 18 would need on any of the markets. I focused on

 19 the energy, I did highlight the metals for

 20 everyone to take a look at, and certainly

 21 available to take any questions. Thank you.

 22 MR. COSGROVE: Shall we continue and
 33

 1 have our questions at the end of the panel?

 2 MR. LaSALA: Sure.

 3 MR. COSGROVE: So, is that all right?

 4 MR. LaSALA: Absolutely!

 5 COMMISSIONER WETJEN: Tom, one real

 6 quick question. For purposes of your -- the data

 7 there in the presentation, how do you define

 8 commercials?

 9 MR. LaSALA: The commercials would be, I

 10 think, very similar, Commissioner Wetjen, in

 11 relation to how the Commission defines them in the

 12 COT. So you'd have producers, refiners, there

 13 would be oil traders in that category, we would

 14 have also included swap dealers in that, so it

 15 would be the swap dealers and the others I just

 16 mentioned.

 17 MR. OPPENHEIMER: Good morning. Again,

 18 I'm Ron Oppenheimer representing the Commercial

 19 Energy Working Group. And before I begin I want

 20 to thank all of you and the Commission staff for

 21 spending so much time on this Rule. I know it's

 22 been extensive and it's very much appreciated.
 34

 1 The Commercial Energy Working Group's

 2 view has been all along, if we are going to have a

 3 Position Limits Rule, let's work to get the Rule

 4 right, and we really appreciate the time and

 5 effort that you all have been putting in to do

 6 that, to focus on that same objective.

 7 My presentation today is really a

 8 continuation of the presentation I made at the

 9 last EEMAC meeting. At that time we discussed how

 10 the narrow definition of bona fide hedging in the

 11 proposed rule would limit some of the risk-

 12 reducing behaviors of commercials in the

 13 marketplace currently. And how eliminating their

 14 ability to reduce their risk would add cost into

 15 the system, and how that cost ultimately is borne

 16 by consumers of energy products, so it's an

 17 important consideration.

 18 Now, at the meeting and since, as has

 19 been said in some of the opening statements,

 20 several of you have expressed a willingness to

 21 consider relying on the work that the exchanges

 22 do, to consider where non-enumerated hedges might
 35

 1 fit into the framework of a Position Limits Rule.

 2 And we think that's very constructive. The

 3 exchanges have the knowledge, the expertise and

 4 the regulatory incentive to carefully scrutinize

 5 the exemption process, and they already engage in

 6 a parallel process for their own interest in self-

 7 regulating and ensuring convergence and orderly

 8 liquidation of futures contracts as they come to

 9 expiry.

 10 So, over the past several weeks the

 11 Commercial Energy Working Group has engaged in a

 12 lot of discussions with ICE and CME over what a

 13 possible framework could look like, and we both

 14 describe it today, really not as advocacy, but as

 15 the basis for a discussion as to whether it

 16 provides a viable solution that could break the

 17 logjam that has existed in this space for however

 18 long you want to count it, at least five years,

 19 and allow us to move forward on this important

 20 issue.

 21 So we could go -- The benefits of

 22 relying on the exchanges are pretty obvious. The
 36

 1 first is that it avoids resource duplication.

 2 Secondly, it capitalizes on the depth and breadth

 3 of the designated contract markets, experiencing

 4 and evaluating hedging strategies in the energy

 5 space.

 6 As I said before, they are engaged in

 7 active oversight of market participant positions,

 8 particular in the front market, as I said to cover

 9 convergence and orderly liquidation. Very

 10 importantly it's not disruptive to current

 11 end-user hedging practices. And in this regard,

 12 Tom referred to Table 11-A, I would also like to

 13 refer to Table 11-A, but particularly as it

 14 affects the spot month. Tom was look at the any

 15 and all-months.

 16 In the spot month as you look at it, the

 17 number of people over the potential spec limit in

 18 the physical-delivered commodity is extensive.

 19 Over 80 in natural gas, 40 and 30 in the other

 20 energy commodities, those people have to be

 21 operating today under exchange-granted hedge

 22 exemptions. If we change the definition of what
 37

 1 constitutes a bona fide hedge from what the

 2 exchanges are currently applying to the narrow

 3 definition in proposed rule, all 80 of those

 4 people's hedging activities will be impacted, and

 5 40 in the products, and 30 in the others. So,

 6 it's very, very important that we get this right,

 7 to not disrupt active hedging practices.

 8 And the last point is that it provides

 9 flexibility for market innovation and evolution.

 10 A single list of enumerated hedges without the

 11 possibility of non-enumerated hedges eliminates

 12 the possibility that we'll be able to capture

 13 what's not -- practices not engaged in now, and

 14 not foreseen today. So all very important.

 15 There are really three steps in the way

 16 forward. The first is that we address the types

 17 of hedging that have been in comment letters and

 18 petitions over the last several years, and revise

 19 the list of enumerated hedges to include those.

 20 We've had substantial dialogue on them, it has the

 21 additional benefit of narrowing the areas where we

 22 would have not -- a need for non-enumerated
 38

 1 hedges, and have to rely on a different paradigm

 2 for that. So it's an important first step.

 3 The second is that we would request that

 4 the Commission consider advising that the

 5 positions and strategies that DCMs have currently

 6 employed in their rules be continued going

 7 forward. And we are not saying here that any

 8 specific practice should be -- or any

 9 company-specific positions should be recognized or

 10 grandfathered, what we are really saying here is

 11 that there should be a general endorsement of the

 12 types of practices referred to in exchange rules.

 13 I'll just say for example, CME Rule

 14 559-B talks specifically about anticipatory

 15 hedging and storage, and some of the other things

 16 that we've talked about, so we'd be looking for a

 17 general endorsement from the Commission of that

 18 kind of activity as being appropriate for hedging

 19 exemptions.

 20 And that's important, too, because we

 21 need to look at the statutory framework, both

 22 Sections 4(a)(c), and 4(a)(a)(7) are available for
 39

 1 the Commission to do that, to acknowledge that

 2 those kinds of practices should be the subject of

 3 hedge exemptions.

 4 And finally, and the lynchpin to the

 5 framework to rely on the exchanges is this, the

 6 Commission could, by rule or by statutory

 7 interpretation or order or exemption, or whatever

 8 procedural vehicle it felt was appropriate, the

 9 Commission could state that in the event a DCM

 10 recognized a particular strategy as being a valid

 11 non-enumerated hedge to be used as an exemption in

 12 their markets, that a party relying on that

 13 exemption could also take similar positions and

 14 strategies in the OTC markets, and rely on a non-

 15 enumerated exemption for those positions as well.

 16 There would be a review process, I know

 17 somebody mentioned in the opening, I'm not quite

 18 sure who, I guess it was Commissioner Giancarlo,

 19 that this would not mean that the process would

 20 not be subject to Federal oversight, we'll get to

 21 that in a minute, but there absolutely would be a

 22 process for the Commission to consider whether or
 40

 1 not the exchanges were appropriately exercising

 2 the authority that we would be delegating to them.

 3 The process would rely, very much, on

 4 existing process, and in that sense that's really

 5 a benefit I think to both the market and to the

 6 regulators. An annual application would be made

 7 to the DCM identifying what a particular

 8 commercial entity's hedging needs were, what its

 9 business activities are; an application which, of

 10 course, could be supplemented if things changed.

 11 And just, I'm going to throw out some

 12 numbers, we can get back to an example and talk

 13 about it a little bit more specifically later.

 14 But I'm going to throw out some numbers just to

 15 give you sense of what we are talking about. So,

 16 in that application, for example, a commercial

 17 could show that they had expected exposure of

 18 8,000 lots of futures equivalent, a combination of

 19 a variety of different potential non-enumerated

 20 exemptions.

 21 What the exchange would do, and what it

 22 currently does, is it would analyze that
 41

 1 application both in terms of whether or not the

 2 strategies claimed qualified for an exemption, but

 3 also whether or not the exposures seemed

 4 reasonable to the exchange. So, an applicant

 5 might say I did X last year, I've increased my

 6 staff, I expect to do 20 percent more than X, the

 7 markets are changing, I expect to do another 10

 8 percent in some area. The Exchange scrutinizes

 9 that, and they say, yeah, that's nice, we see what

 10 you've done in the past, we see what you are

 11 expected to do in the future, we think you may be

 12 being a little bit optimistic. Instead of 8,000

 13 we'll recognize that you have, for example, 6,000

 14 lots of exposure in the coming year ahead.

 15 And then they issue -- then they

 16 consider what their market can actually bear, and

 17 in some contracts there might be enough liquidity,

 18 they'd sure you can have an exemption of 6,000

 19 lots. In others they might say, you know, there's

 20 not enough liquidity, we don't see enough

 21 experience on your part in this market, a variety

 22 of other considerations, and they might say, for
 42

 1 our market, you can have a 4,000-lot exemption.

 2 And then they send you a letter and they

 3 describe what they've done and they establish that

 4 limit as the limit on what you can do on their

 5 market. I will point out a couple of things here,

 6 not on the slide, but this comports very closely

 7 with Commission practice, both in existing

 8 practice in the ag markets, in the Vacated Rule

 9 and in the Proposed Rule in that, like a 704

 10 filing, you have an advanced explanation of what

 11 the hedging practice is likely to be, you have an

 12 analysis of how robust both the strategy and the

 13 size of the positions are, and you have an actual

 14 limit established for the non-enumerated positions

 15 that would be taken. It also comports with Rule

 16 1.48 that's currently used in the ag markets for

 17 non-enumerated hedges.

 18 The next step in the process would be

 19 new, and in that part of the process for any

 20 non-enumerated hedge that was granted, the DCM or

 21 SEF would provide a notice to the Commission, and

 22 that notice would identify the non-enumerated
 43

 1 hedge exemption that had been granted, giving the

 2 Commission an opportunity to review it and

 3 understand it.

 4 It would include the DCM's conclusion as

 5 to the size of the party's exposure, that 6,000

 6 lots that I referred to before. And it would tell

 7 the Commission that it had granted the 4,000-lot

 8 exemption. An important note here, that notice,

 9 which would show a party's individual exposure

 10 would have to be given complete confidentiality;

 11 otherwise it would expose the party substantially

 12 in the marketplace.

 13 So, the outcome of all of this is that

 14 we would have a paradigm for non-enumerated hedges

 15 where an exchange would set a limit for what could

 16 be done on its market, and it would also set a

 17 limit, i.e., its analysis of the exposure for what

 18 could be done across all markets. So that 6,000

 19 number that I identified before, which would

 20 represent their view of a party's exposure, a

 21 party would be allowed to take that across DCM,

 22 SEF and OGC [sic - OTC?] markets, assuming of
 44

 1 course that no DCM or SEF that had given a

 2 specific limit, in this case the 4,000 that I

 3 referred to, could a party exceed that specific

 4 limit on that market. And again, we'll go back to

 5 an example at the end to just walk through that

 6 and make sure that its clear to people.

 7 A very important part of this whole

 8 framework is certainty. Reliance on DCM

 9 determinations needs to have certainty to be

 10 effective for the marketplace, we've been debating

 11 these points for a long time, we need to put that

 12 to rest, either by getting them onto the list of

 13 enumerated hedges, or relying on what the

 14 exchanges do and have done historically.

 15 And the review process that I mentioned

 16 earlier is this, if the Commission or its staff

 17 doesn't agree that a particular non-enumerated

 18 hedging strategy qualifies, either when it gets

 19 one of those notices, during a rule enforcement

 20 review, or really at any other time, that

 21 treatment could only be changed prospectively, and

 22 on full Commission review, giving the public an
 45

 1 opportunity to participate in the discussion on

 2 that, and whatever appropriate procedural vehicle

 3 the Commission uses for that, I leave to those who

 4 know the APA better than I do.

 5 So, there are a couple of things that

 6 aren't addressed in this approach. I'm not going

 7 to go into them now, but they are important, the

 8 economically-appropriate test which we discussed

 9 at the last EMAC, Cross Community Hedging, the

 10 so-called Five-Day Rule, and the reporting forms

 11 that are in the proposal, Form 204, which is

 12 currently in place and some of other new reporting

 13 requirements. These are all things that need to

 14 be addressed, but they are outside the framework

 15 that we are putting forward today.

 16 And again, I want to thank you for the

 17 opportunity to put this out there, we really hope

 18 it advanced the ball, we've tried to address the

 19 Commission's regulatory interest and ensure that

 20 claimed exemptions are legitimate, while at the

 21 same time preserving hedging opportunities that

 22 reduce the cost of energy commodities to
 46

 1 consumers.

 2 Now, we look forward to answering any

 3 questions that you have and discussing this

 4 further over the next hour or so. Thank you.

 5 MR. COSGROVE: Erik?

 6 MR. LaSALA: So, I am going to, if I

 7 may, continue, follow Ron, and give some context

 8 in furtherance of the presentation Ron has made

 9 from the exchange perspective. I believe this is

 10 an interesting circumstance we have, because I

 11 think folks will recall a year ago, it was not --

 12 CME Group and ICE were at a roundtable and put

 13 forward the notion that there's a possibility that

 14 we could be of some assistance in the process in a

 15 non-enumerated structure.

 16 We recently, you know, we were engaged

 17 to see if, in fact, what could we come up with.

 18 So we did have engagements, not only with Ron, but

 19 others and, you know, Erik Haas and I representing

 20 ICE work together, very much looking at it from

 21 the standpoint of what were, not only the needs of

 22 the users, but what -- from an exchange
 47

 1 perspective we thought made practical sense and

 2 was workable.

 3 And although many of the concepts where

 4 we've landed reflect exactly a landing point where

 5 we think we have intercepted and we have a

 6 solution. They were certainly seeing as -- there

 7 is an evolution that's occurred during this

 8 engagement.

 9 So, what I'd like to do here, Erik and I

 10 are going to split up this part of the

 11 presentation, I just want to highlight very

 12 broadly some of the points of or cornerstone

 13 points, Ron has mentioned them, turn to Erik, have

 14 him speak a little bit to, more broadly, that

 15 existing exemption process that we engage today,

 16 that I'd like to explore some of the real details

 17 from an exchange perspective on the non-enumerated

 18 process that we've conceptualized.

 19 So, in terms of cornerstone points from

 20 an exchange perspective, these are, again, in

 21 furtherance of what Ron said earlier, we certainly

 22 would like to see the list of enumerated,
 48

 1 recognized enumerated exemptions be expanded.

 2 Whether it be through rule or order, but some

 3 structure that, in fact, the Agency permissions

 4 the exchanges, like DCMs, SEFs, in order to

 5 administer this non-enumerated process.

 6 And then, lastly, some structure, and

 7 we've had discussions, that's practical, I think

 8 we use the word here wholeheartedly, if the

 9 Commission does determine to administer and allow

 10 the -- delegate might be too strong a word -- but

 11 allow the exchanges to administer this process, it

 12 has to be genuine, allow us to make those

 13 decisions, we'll talk to you about our processes,

 14 when we make them, however, there is a process.

 15 You know, we talked about some form of

 16 interpretive action process or other, whereby the

 17 Commission could come in after the fact, look at

 18 the decisions made by the DCMs, the SEFs, and say,

 19 you know what, on this one, we have an issue, and

 20 in that process, I'll say involved parties have a

 21 right to explain what their perspectives are, how

 22 we got here, that ultimately the Commission would
 49

 1 go for some type of a formal, public position

 2 representing that outcome.

 3 So, with that, those cornerstone points,

 4 I'm going to turn it over to Erik Haas at ICE, and

 5 allow him to go through some of the processes in

 6 the exemption world.

 7 MR. HAAS: Thank you. So, as you

 8 consider this as a potential option, we wanted the

 9 Commissioners and the Committee to understand what

 10 has been referred to a few different times, what

 11 the process really is. And so, we are going to go

 12 through our existing exemption process, and with

 13 energy having expirations every calendar month,

 14 this is a monthly and very routine process for us.

 15 It starts out with an application being

 16 filed with the exchange by the applicant. They

 17 have to come to us and tell us the level they are

 18 requesting and what the underlying strategy is.

 19 They'll provide documentation supporting their

 20 exposure as well as they have to give us their

 21 risk-management policies and what their internal

 22 compliance and position-limit monitoring
 50

 1 procedures are.

 2 From that point the market regulation

 3 department at the exchanges reviews this, we'll

 4 first look at the justification that they've

 5 provided to support the level they are requesting.

 6 We'll review the underlying exposure, number one

 7 to make sure it's appropriate, that it exists,

 8 that they have some documentation supporting that

 9 this is real exposure.

 10 We will determine whether the amount

 11 that they are requesting from a limit level lines

 12 up with their underlying exposure, if it doesn't

 13 at that point generally we'll go back to the

 14 applicant and explain that to them, that on our

 15 end what we see is that the level you are

 16 requesting is greater than the exposure you

 17 provided.

 18 We can give them an opportunity to,

 19 maybe, submit more information if they've left

 20 something off, or make a determination that they

 21 don't get the level. Throughout this, there is a

 22 considerable amount of follow-up conversation in
 51

 1 the review phase, we routinely go back to the

 2 applicant, ask for more information, get

 3 clarification on certain policies and procedures,

 4 and I think we've done a pretty good job with it,

 5 since, in Ron's presentation the working group

 6 pretty much explained our exact process on his

 7 own. They are now very familiar with our

 8 interactions at both exchanges.

 9 After our review process, market

 10 regulation is going to make a determination, and

 11 as noted, we can approve the exemption, deny it,

 12 or conditionally approve it. And what

 13 "conditionally approve" usually means is, if an

 14 applicant comes to us and asks for 50,000 lots and

 15 they have the justification of 50,000 lots, we

 16 might determine that that's not appropriate at the

 17 time for the market or for that participant.

 18 So a lot of times what we'll do is,

 19 we'll say, you can have 25,000 lots. If you get

 20 to 25,000 lots, you've already demonstrated that

 21 you have more exposure, come back to us, we'll

 22 look at the market fundamentals, we'll look at
 52

 1 your procedures, and at that time, we'll make a

 2 decision on potentially bumping you up.

 3 But what we are trying to avoid is

 4 giving any one commercial participant, the ability

 5 to just take their position up to the maximum of

 6 their exposure, and to avoid any detriment to the

 7 market that might occur from that. So we are

 8 really trying to manage, not only the exemption

 9 process but how the positions are put on, and

 10 ultimately, if needed, how they are going to be

 11 taken off.

 12 COMMISSIONER GIANCARLO: Erik, I have a

 13 question for you. What level of human and other

 14 resources do you have in place now to manage the

 15 exemption process? And what additional level of

 16 resources would you need if there was the

 17 delegation that you are talking about? And

 18 perhaps you and CME could also answer that

 19 question.

 20 MR. HAAS: Currently we have across ICE

 21 Futures U.S., I'm going to say, there's probably

 22 15, 20 people devoted to market surveillance, and
 53

 1 then that market surveillance, that includes

 2 managing exemptions. And internally we have three

 3 different applications that are utilized to review

 4 exemptions, which is an extensive process even

 5 working with, say, a commercial that we are very

 6 familiar with, and we've had a good relationship

 7 with them, and it's an annual exemption, so each

 8 year they are going to generally come in and renew

 9 it, it's still a brand-new process.

 10 And so the third year, we are familiar,

 11 we know what they are doing, we know what their

 12 exposure is. It's still, I would say, a five-day

 13 process for us to go through all the

 14 documentation, make our own documentation, make a

 15 record of what we are doing and why, to expand it,

 16 it can be done, we would have to see the extent of

 17 what comes in, to make a determination if our

 18 existing staffing can handle it. Since Ben is

 19 here I'm going to say it can't, and we'll have to

 20 definitely increase staffing, probably sooner.

 21 Thanks.

 22 MR. COSGROVE: Go ahead.
 54

 1 MR. LaSALA: Sure. Commissioner

 2 Giancarlo, I would say at the CME Group across the

 3 asset classes, there's approximately 7 to 8 people

 4 that are looking at exemptions across the various

 5 asset classes, they are part of the market

 6 surveillance group, which is a much larger team in

 7 general, but 7 or 8 people. In terms of -- I

 8 think we could certainly -- in handling the load,

 9 I think that one of the interesting points here

 10 we'll get to later is the OTC positions.

 11 I think that in terms of handling

 12 exemptions on our markets, I tend to think that we

 13 can probably kick this process off at current

 14 staffing levels. I can give you some context, and

 15 referring back to that time period I spoke about

 16 earlier with the impact analysis, we processed in

 17 the energy space 167 separate applications, and

 18 just to give the Committee some context around the

 19 integrity around that process, and similar to what

 20 Erik had mentioned, these are not all just simply

 21 approved. A lot of these are considered reduced or

 22 denied.
 55

 1 So, of the 167, 114 of them were

 2 approved but at less-than-requested levels based

 3 on either a host of constrictions that we viewed

 4 insofar as the market's ability to handle the

 5 position, or some frailties with the underlying

 6 exposures; 49 were approved as applied for, and 4

 7 were denied. Thank you.

 8 MR. HAAS: Back to the determination

 9 process. After we make our determination, we are

 10 going to give, in our approval letter, the

 11 applicant the amount they've been granted, we note

 12 the spot month limit, what they can hold on top of

 13 it, and we're specific to what strategies they've

 14 been granted. So, if at any time in the future

 15 they hold a position over the limit, they are

 16 aware of what their underlying strategies can be

 17 for that position.

 18 We don't want any confusion later on

 19 where they feel that had an ability to use a

 20 different strategy, and we're not on the same

 21 page, so again, our process with this is, we are

 22 trying to be as clear as we can with the market
 56

 1 participants, so they know exactly where we stand,

 2 and we know that they know that.

 3 Adding to it, we don't give special

 4 consideration to commercial participants just

 5 because they are hedging, as Tom noted, you are a

 6 commercial participant, you have a hedging need,

 7 but we also have to manage our markets, and so we

 8 will cut them down at times on their requested

 9 level, and touching back on the accountability

 10 process, for our energy contracts, we do have

 11 accountability levels out the curve, and doing

 12 those accountability reviews, we don't exclude

 13 commercial participants, even though they have a

 14 spot month exemption.

 15 We'll still look at them out the curve,

 16 and if we feel that, out the curve, their position

 17 is too large or could be a problem, we are

 18 contacting them, letting them know, and can manage

 19 that process. So, this isn't a -- on the exchange

 20 side, it isn't a process where, you are a

 21 commercial, you come in and tell what you need and

 22 you get it. We are managing our market, we are
 57

 1 not treating them really any differently than any

 2 other market participant.

 3 And then finally, after we provide our

 4 approval, assuming it's an approval, we have an

 5 ongoing surveillance requirement, and even though

 6 the commercial participant has the exemption, we

 7 are following up with them in the future,

 8 reviewing their position and sharing that if they

 9 are over the limit, under the basis of an

 10 exemption, that their positions are tied to that

 11 exemption, and that at any point, that exemptive

 12 position isn't causing a problem in the market.

 13 So, ultimately the market price being not

 14 disruptive due to even a commercial is our biggest

 15 concern.

 16 MR. OPPENHEIMER: Can I just add a very

 17 quick point to that and you can both correct me if

 18 I misstate this, but and you retain the ability to

 19 revoke an exemption if market circumstances are

 20 such that that exemptive size position would be a

 21 problem, in addition to jawboning authority to

 22 just convince the market participant to get out if
 58

 1 it poses that kind of a potential.

 2 MR. LaSALA: Yes, to all. Yes. So, if

 3 I could, and thanks; let me continue with some

 4 further details about the process from the

 5 exchange perspective. As both Ron and Erik

 6 discussed, an application would have to be filed.

 7 And I'll note to the Committee that, and the

 8 Commissioners, certainly, that I would envision

 9 that the applications -- we process, as Erik said,

 10 these applications yearly on an interim basis if

 11 needed. What I would envision is the parties that

 12 come to us on a yearly basis would take the

 13 applications that we have that would be modified

 14 as necessary, and not only include their

 15 enumerated exposures, but their non-enumerated

 16 exposures.

 17 In fact, some of that is on applications

 18 today. Again, I would tend to think in the same

 19 cycle, we would be integrating the totality of

 20 those requests. Again, nothing would stop someone

 21 from subsequently coming up with a new type of

 22 non-enumerated exposure and coming to us, but I'll
 59

 1 note, that in the first bullet, we want to

 2 certainly deal with the non-enumerated ones in

 3 advance of assuming the positions in the

 4 marketplace.

 5 Again, I do see this as somewhat of an

 6 extension of what we are already doing. So, as

 7 Erik said, the DCM or the SEFs would approve or

 8 deny, conditionally, the exemption request, and we

 9 would assign a number on our respective markets.

 10 It could be, as I mentioned earlier, at the level

 11 requested, could be at less than the level

 12 requested, and there could practically be, and

 13 we'll go through an example later, a comingling.

 14 Meaning that a party might come to us,

 15 and say I've got 5,000 contracts of enumerated

 16 exposure, I've demonstrated -- I demonstrate 1,000

 17 contracts of non-enumerated, anticipatory

 18 merchandising, and additionally 1,000 contracts of

 19 non-enumerated storage hedges.

 20 Well, we'd encapsulize all that, you

 21 know, if we felt comfortable that the

 22 documentation was correct, we still might say that
 60

 1 our exemption to you is 5,000 contracts of which

 2 it can be basically populated by the enumerateds

 3 or some combination of enumerateds and 1,000 each

 4 of the two non-enumerateds, if that makes sense.

 5 So, again, I could certainly see that kind of a

 6 circumstance, where we are looking at the totality

 7 of the different types of exposures and denoting

 8 them.

 9 Mentioned by Ron, earlier, in that

 10 letter we would also do another very important

 11 thing that's not what we do today. In the letter

 12 that we would prepare to the participant, we would

 13 have had to have done an analysis of that

 14 underlying exposure with regard to that

 15 non-enumerated hedge. Again, we will go through

 16 an example with numbers, but let's just say,

 17 hypothetically, that it was 5,000 contracts of

 18 anticipatory merchandising, where we only grant an

 19 exemption of two; the letter is going to, in fact,

 20 contain both the numbers.

 21 The number that we granted, and just as

 22 a note, what I'm focusing on here, and I should
 61

 1 state this upfront, I'd like to open in the

 2 context of a spot exemption, to keep simple. We

 3 granted an exemption of 2,000 because we were

 4 comfortable with that, but the exposure might

 5 greater, maybe 5,000. We are going to include

 6 that 5,000 in the letter that goes to the

 7 participant.

 8 Additionally -- I'll go to the next

 9 slide -- we are going to forward, collectively,

 10 between, you know, whether it be Erik, myself, or

 11 any other DCM or SEF, those letters to the CFTC,

 12 effectively, by virtue of the fact that we are

 13 setting, we are granted authority in this new

 14 structure, an exemption for a non-enumerated hedge

 15 in our markets we're, effectively, seeking to

 16 extend that to positions that might held on an

 17 over-the-counter basis.

 18 And in that context, those

 19 over-the-counter positions would be bound by that

 20 larger number that we would be passing forward to

 21 the CFTC. The CFTC staff would then have the

 22 ability to, when looking at the totality of the
 62

 1 positions, because I think cornerstone I probably

 2 should have put on there, and maybe it was

 3 implicit to some, is that we are looking at

 4 positions in our market, we are happy to look at

 5 these exposures.

 6 I don't see, Erik doesn't see the OTC

 7 book on a regular basis, the Commission does. So,

 8 with regard to those OTC positions where the

 9 Commission would be monitoring for, you know,

 10 limit purposes, let us say, in the spot month,

 11 we've got limits in our markets, which we are

 12 monitoring. They certainly could be looking at

 13 that, they are also looking at, per the proposal,

 14 various positions in physical or financial

 15 buckets, and across them, as well as the OTC.

 16 So, there is clearly a role here that

 17 the Commission has to have in terms of the ongoing

 18 surveillance of these markets, but we think we are

 19 passing forward a valuable bit of information as

 20 it relates to each of these prospective

 21 non-enumerated exemptions.

 22 Additionally all -- again, not only
 63

 1 approvals but obviously all denials would be

 2 forwarded promptly to the CFTC. We've discussed

 3 the prospect and reality of conducting regular

 4 meetings, you know, with an eye towards -- we

 5 think it can only be beneficial for the entities

 6 who will be processing these, to look at these in

 7 the same contextual way. Do we think that this

 8 makes sense, so that we are as unified as we can

 9 be in our thinking around this? An outcome that

 10 wouldn't be great is that we are granting

 11 something and recognizing it and someone else

 12 isn't.

 13 So, we would like to think we could get

 14 further on the same page. We would seek to then

 15 publish, on each of our respective website, a

 16 summary of the type of non-enumerated exemptions

 17 that we would have approved, and coordinate to,

 18 I'll say, offer similar characterization. One of

 19 the fears is the infamous tomatoes and tomatoes.

 20 Someone says I'm doing X, X to me is a little bit

 21 different than X to you, and there are likely

 22 those circumstances.
 64

 1 So, we would, again, in the context of

 2 our ongoing interaction to try and support this,

 3 we try to communicate regularly such that, we are

 4 characterizing things that we would have done in a

 5 similar fashion. Consistent with what Ron had

 6 said earlier, the CFTC through the Rule

 7 Enforcement Review process, or at any other time

 8 it deems necessary, can request from us any of the

 9 underlying materials and documentation supporting

 10 the approval or the denial.

 11 And last and certainly not least, it

 12 would be our view in this construct, that if in

 13 fact we had this authority to grant this, did so,

 14 and subsequently, you know, through the process

 15 that I put forth earlier, the Commission sought at

 16 some later date to review the materials and say,

 17 you know what, through some interpretive process,

 18 we don't agree that this particular non-enumerated

 19 hedge should be allowed less some fraud or bad

 20 faith, which wouldn't happen.

 21 We have to have a safe harbor as would

 22 the market participants, so that there wouldn't be
 65

 1 a look-back and say, you know what, the Exchange

 2 made a decision, we don't like it, during this

 3 period you were over the limits and it's a

 4 position limit violation, and you are going to be

 5 sanctioned for it. So if we had that authority

 6 and administer this process, we'd both have a safe

 7 harbor, unless, of course, a similar Act.

 8 I think it would probably make some

 9 sense, too, if we could put up that slide covering

 10 the example. While I spoke to it, it might be

 11 good to look at it on the board. So, an

 12 application for a non-enumerated hedge exemption

 13 is put forward to both CME and ICE. That

 14 application, you know, by the participant for

 15 whatever the strategy is, shows 8,000 futures

 16 equivalent lots of exposure.

 17 We conduct our analysis, and while we,

 18 broadly speaking, agree, we look at that exposure

 19 to be more like 6,000 futures equivalents. Based

 20 on the market liquidity and other considerations,

 21 we each granted 4,000 contracts. In that approval

 22 letter to the participants we denote the
 66

 1 recognition of the six in total.

 2 So, effectively that hedger my enter

 3 6,000 lots of total positions on a combination of

 4 either CME, ICE and the OTC but bound,

 5 additionally, by the 4,000 that both ICE and CME

 6 Group afforded. Anything else I missed?

 7 CHAIRMAN MASSAD: Tom?

 8 MR. LaSALA: Yes.

 9 CHAIRMAN MASSAD: What happens if one of

 10 you says, well actually I think you could have

 11 8,000 but not more on -- no more than 5,000 on

 12 either CME or ICE? Is the one who said the lower

 13 limit bound by the -- or rather, it's one who says

 14 the higher limit bound by the one who says the

 15 lower limit?

 16 MR. LaSALA: The participant would be

 17 bound by the lower limit of the total exposure.

 18 CHAIRMAN MASSAD: So, CME said, I

 19 disagree with ICE, I really think you could have

 20 5,000; but ICE said, no, no, no, 4,000, CME is

 21 bound by the 4,000; the participant is bound by

 22 the 4,000?
 67

 1 MR. LaSALA: No. Let me maybe try and

 2 catch that. We are making independent decisions

 3 with regard to a number on our market, I thought

 4 and I may have misunderstood, that what you were

 5 getting at was in, like this example, the

 6 participant showed to each of us. I have this OTC

 7 -- pardon me -- this non-enumerated exposure of

 8 8,000. I thought what you were getting at is,

 9 when I looked at it, I said, do you know what, I

 10 really think that number is 4,000 and Erik, and

 11 that would be embodied in my letter, and Erik

 12 looked at that application, and said, no, no, no,

 13 I really thought it's 6,000.

 14 SPEAKER: Whatever.

 15 MR. LaSALA: In that example, we would

 16 say that the participant would be bound to the

 17 lower determination before, however, the process

 18 by which we communicate we would hope to strike

 19 the same number on a regular basis. Much progress

 20 has been made.

 21 CHAIRMAN MASSAD: What happens -- Go

 22 ahead, yes.
 68

 1 COMMISSIONER GIANCARLO: I'm not sure,

 2 though, you answered the Chairman's question.

 3 What if the same application goes to each of you

 4 for a product which is on both exchanges which is

 5 -- I have to think about that, but if you grant

 6 different levels, what is the market counterparty

 7 limited by?

 8 MR. LaSALA: Each of us is effectively

 9 recognizing two things, a level on our markets,

 10 mine might be more liquid, I grant a larger number

 11 on my market, his might be less liquid, so our

 12 decision for the number on our market, is

 13 independent. They are independent. His might be

 14 larger and he says, I can handle 5,000 and I say,

 15 do you know what, that's great, I can't. I can

 16 only give you 3,000. The party has to respect the

 17 boundary that I set up on mine, also respect the

 18 boundary set up on his.

 19 It may be that we are in agreement on

 20 our analysis of the macro exposure that we pass on

 21 to the Commission that then, the party can hold in

 22 the aggregate across his exchange, my exchange as
 69

 1 well as the OTC.

 2 COMMISSIONER GIANCARLO: So, without

 3 digressing too much. Maybe the broader thought

 4 is, as we go forward in examining this, whether

 5 there are any opportunities for arbitrage between

 6 the two exchanges that we need to think about.

 7 The coordination when you think about whether --

 8 for products that are fungible, whether there is,

 9 perhaps, some arbitrage opportunity, and if there

 10 is it needs to be addressed in any final approach.

 11 MR. LaSALA: Okay.

 12 CHAIRMAN MASSAD: Let me ask another

 13 question. I think, Tom and Erik, in your

 14 presentation, you talked about the exchanges

 15 publishing some facts about the exemptions you are

 16 granting.

 17 MR. LaSALA: Correct.

 18 CHAIRMAN MASSAD: In Ron's presentation

 19 he noted the need for confidentiality; we also

 20 have the issue of, if the Commission reviews

 21 something, that would presumably be a public

 22 process. Can you talk a little bit about how
 70

 1 quickly would you envision publishing something

 2 relative to the granting of an exemption, and how

 3 do we balance the issue of public entitlement to

 4 know?

 5 The concern Ron noted about the

 6 individual participant's desire for

 7 confidentiality, whether or not the Commission

 8 reviews it, but if the Commission then reviews it,

 9 don't all the facts become public?

 10 MR. LaSALA: Let me clarify and respond

 11 to your question from the exchange standpoint on

 12 the publishing. What we would intend to publish

 13 is by no means who received an exemption, but a

 14 characterization of the type of non-enumerated

 15 strategy that we each recognized. Again, trying

 16 to make that -- those words as similar as possible

 17 to be consistent, and we would do so, I'll use the

 18 word, promptly.

 19 CHAIRMAN MASSAD: What, with amounts?

 20 MR. LaSALA: No. No amounts.

 21 CHAIRMAN MASSAD: And then what happens?

 22 What happens if the Commission then reviews
 71

 1 something?

 2 MR. OPPENHEIMER: I mean, I think that

 3 one is a little more for me, because when I talked

 4 about the confidentiality, I guess, the hope would

 5 be that the Commission would be reviewing

 6 something as it would in the proposed rulemaking,

 7 talking about a strategy as opposed to a

 8 particular party's position or need.

 9 The problem, and I think it's a good

 10 point to focus on, is if the unique strategy can

 11 be divined to be applicable to only one market

 12 participant, and I'm not exactly sure what you do

 13 in that circumstance, and it could present a

 14 conflict.

 15 CHAIRMAN MASSAD: But I guess you are

 16 suggesting we would be publicizing the strategy

 17 but not the amount, and yet, presumably, the

 18 public's concern might be driven by the amount as

 19 well.

 20 MR. OPPENHEIMER: Well, I'm not sure

 21 about that, and I'm not sure --

 22 CHAIRMAN MASSAD: No? Okay.
 72

 1 MR. OPPENHEIMER: -- you know, what the

 2 public's interest is in analyzing that even under

 3 current structure. So, the strategy, for sure, if

 4 it's going to be something that has precedent and

 5 will be applicable to others, either if it's

 6 granted or denied in the future, clearly an

 7 interest in that, but currently if somebody either

 8 -- and let's use the enumerated agricultural

 9 products that the Commission already has oversight

 10 from a position-limit perspective on, if somebody

 11 takes a position in those markets, that's not up

 12 for public debate as to whether or not that's

 13 appropriate.

 14 And if somebody applies for an

 15 enumerated -- a non-enumerated exemption, excuse

 16 me, under existing process for those products,

 17 again it's not open for public debate as to the

 18 size of the position that the Commission might

 19 grant if they granted one of those exemptions.

 20 MR. ALLISON: Let me just add to the

 21 expression of concern about the need for

 22 confidentiality. In the statute, when it talks
 73

 1 about reporting, it attempts to guarantee that the

 2 identity of the entity reporting positions is kept

 3 confidential, but that's details or transactions

 4 that have already happened. In a sense they are

 5 history, yeah, there are some concerns about

 6 getting front runners as you try to hedge your

 7 hedge, but that's history.

 8 When we are talking about reviewing

 9 these applications for exemptions, we are not

 10 talking about history, we are talking about

 11 business we intend to do going forward, and the

 12 competitive value of that information is

 13 dramatically higher. Now, I don't have the legal

 14 answer to what all of the requirements are when

 15 you review material, but you are dealing with

 16 material that is of very high competitive value,

 17 even more valuable than the historical data on

 18 swaps that we have done, where the statute did

 19 explicitly protect the anonymity of the reporting

 20 party.

 21 MR. COSGROVE: Tyson?

 22 MR. SLOCUM: Thank you very much. So,
 74

 1 I'm Tyson Slocum. For those unfamiliar with my

 2 organization, it's Public Citizen, we are a public

 3 interest, nonprofit, consumer-advocacy group. So,

 4 before us we appear to have a fairly significant

 5 proposal that would, in essence, delegate some

 6 Dodd-Frank functions to the private for-profit

 7 exchanges, instead of having these activities done

 8 by the Commission. So that's my understanding of

 9 what this proposal -- No? That isn't what this

 10 proposal is?

 11 MR. HAAS: I think right now what we are

 12 saying, is this version is not a delegation of

 13 really anything to the exchanges. It's allowing

 14 us to continue to do our current process, and the

 15 CFTC passing some rule allowing the person who

 16 receives an exchange exemption to utilize that for

 17 -- an exchange exemption for non-enumerated

 18 hedging, to potentially use that for OTC. The CFTC

 19 would still have the responsibility to monitor for

 20 that and manage that; all they are doing is

 21 allowing us to continue our existing exemption

 22 approval process, but I wouldn't classify it as a
 75

 1 delegation to us.

 2 MR. SLOCUM: I see, but it is serving a

 3 function within the position-limit regime, that

 4 rather than have CFTC conduct a review of an

 5 exemption, that would be, instead, handled by the

 6 market surveillance staff of the exchanges. Is

 7 this accurate?

 8 MR. LaSALA: I'd say, initially that

 9 that would be the case with the -- as we, again,

 10 conceptualize the ability certainly for the

 11 Commission to come in and modify, revocate, but

 12 Tyson, again, remind you, and I think that the

 13 numbers are probably similar for Erik, I guess

 14 when you mention for profit, way more -- more than

 15 double the amount of exemptions that are processed

 16 by the Exchange are tuned down or denied.

 17 So, we are bound, we are getting

 18 rule-reviewed, this isn't about taking on a

 19 process to expand our business model. In fact,

 20 you know, we are exempting here, positions on our

 21 market, but practically speaking we are setting a

 22 boundary of positions that can be held outside of
 76

 1 our market in the OTC space.

 2 So I just want to be clear, I don't see

 3 -- I think the point you may be poking at with the

 4 for-profit exchange. You've got the regulators

 5 here, you've got a clear responsibility that are

 6 getting rule enforcement reviewed on a regular

 7 basis, who are owed to maintaining certain

 8 standards, in that decision-making process, and

 9 additionally you've got the Agency, clear

 10 oversight, and an ability to revocate or evacuate

 11 as they see appropriate.

 12 MR. SLOCUM: So, just to understand. I

 13 mean, the exchanges earn money through fees on

 14 trading volumes of the greater the trader volume,

 15 the greater the fees that you can collect, through

 16 selling proprietary data and then selling

 17 preferential access through collocation services

 18 and things like that.

 19 So the question I have is how exactly is

 20 the independence of the market surveillance

 21 offices maintained within your corporations? I

 22 didn't see a real explanation of that in your
 77

 1 presentations.

 2 MR. LaSALA: Sure.

 3 MR. SLOCUM: I mean are there firewalls?

 4 What are the --

 5 MR. LaSALA: Absolutely! So, I'll speak

 6 about my institution, and certainly let Erik speak

 7 to his. There is absolute independence, number

 8 one there are proprietary systems, there are risk

 9 disclosures, the market surveillance, and just

 10 market regulation team, and my institution doesn't

 11 share public space with other areas of the

 12 company. Strict confidentiality standards, yearly

 13 disclosures, there is an absolute firewall as to

 14 who gets access to data that is regulatory in

 15 nature; absolutely, positively, unequivocally.

 16 MR. SLOCUM: How is that firewall

 17 enforced? What third party oversees that? Is

 18 this an internal enforcement? Is there an outside

 19 third party that enforces that absolute firewall?

 20 MR. LaSALA: It not only is internal but

 21 we have -- I forget, Bryant will tell me that --

 22 internal, not internal affairs, what's it, Global
 78

 1 Assurance?

 2 MR. DURKIN: Yeah. Internal Audits,

 3 yeah.

 4 MR. LaSALA: Internal Audits conducts

 5 reviews of in fact, you know, the independence and

 6 the integrity of that relationship.

 7 MR. SLOCUM: So, just to be clear,

 8 that's an internal enforcement? Is this a third

 9 party entity?

 10 MR. LaSALA: Internal.

 11 MR. SLOCUM: So it's an internal

 12 enforcement of a firewall? I'm not --

 13 MR. LaSALA: And of course the CFTC

 14 conducts Rule Enforcement Reviews that look at,

 15 again, how we are structured, where we sit, and

 16 I'm quite confident if the Agency felt there was

 17 some ill with regard to how our confidentiality

 18 structures were constructed, they'd be more than

 19 happy to make those very public.

 20 MR. COSGROVE: And actually I think we

 21 have number of other questions here, so if there

 22 is time we can come back to this, but I'd like to
 79

 1 recognize Ben.

 2 MR. JACKSON: One other thing I'd add to

 3 that is, as President ICE Futures U.S., that our

 4 regulatory function and compliance function

 5 doesn't even report directly to me, it actually

 6 reports to what's our Regulatory Oversight

 7 Committee, which is an independent set of Board

 8 Directors that oversee that group. So, I have no

 9 reach directly into that group, or visibility into

 10 some of the concerns that you would have and being

 11 able direct and, say, grant an exemption for this

 12 person for X, Y, Z commercial reason.

 13 MR. COSGROVE: Todd?

 14 MR. CREEK: Todd Creek with ICAP Energy.

 15 We serve as an intermediary in the futures market

 16 as well as the OTC swaps market. So, we have a

 17 very holistic view of the marketplace. What I

 18 would like to say is that, just with what's been

 19 implemented so far, we've definitely seen a

 20 decrease in volume, a decrease in the number of

 21 participants, and definitely a decrease of or a

 22 widening of the bid-ask spread out the curve.
 80

 1 So, we are very concerned of what this

 2 might do. Obviously if we implement these

 3 position limits very uniformly without giving

 4 control to -- I should say, having guidance from

 5 the exchanges who know these markets very

 6 intimately. So, one point I would like to make, I

 7 know that a lot of the markets have converted from

 8 swaps to futures, so we have to think about the

 9 headroom necessary to accommodate these

 10 participants as they make the conversion to

 11 futures.

 12 And I know that Commissioner Wetjen made

 13 a comment about the ag market, specifically saying

 14 how well that had functioned. What I might note,

 15 and I'll ask Tom just to confirm this, it's my

 16 understanding that in ags actually the position

 17 limits were doubled in ags I believe in 2012,

 18 specifically corn, for example. So, it doesn't

 19 mean a market can't function just because you

 20 increased the position limits. I think it's been

 21 a success. I don't know if you have comment on

 22 that.
 81

 1 MR. LaSALA: I think that, and I don't

 2 remember the exact numbers, we did up the -- the

 3 position limit hadn't been updated, in many years;

 4 some of that got hung up frankly with the various

 5 rulemaking proposals, but yes, I know we increased

 6 the limit, I believe in the core. Todd?

 7 MR. CREEK: Just one more comment, too,

 8 I'd like to make. We are concerned about heat

 9 rates. I know Ron said that we were not going to

 10 address the cross-commodity hedges as part of

 11 this, but I would like to note that in our

 12 business we see that heat rates are an integral

 13 part of the trading communities today. In fact,

 14 we should take a look at what percentage that

 15 represents, because clearly we are bringing

 16 natural gas into the fold here under this.

 17 And unless we exempt that, I think we

 18 will materially impact the utilities, and I see it

 19 every single day. This is how a large majority of

 20 the electricity contracts or the utilities hedge

 21 today, via heat rates, and it should be addressed.

 22 I know that a number of the comment letters have
 82

 1 spoken to it, but I have yet to see any type of --

 2 it specifically addressed, in any type of

 3 enumerated hedge.

 4 MS. PARIKH: Lopa Parikh with the Edison

 5 Electric Institute. To date in our comment

 6 letters we hadn't really discussed this proposal

 7 of delegating to the exchanges; since that time

 8 we've been talking about it amongst our membership

 9 quite a bit, and we are very supportive of the

 10 proposal and many of the concepts that have been

 11 discussed today by the Commercial Working Group

 12 and the Exchanges.

 13 Especially for energy commodities as our

 14 members are trying through the rule and the

 15 implications, some of the record-keeping and

 16 regulatory burdens that are associated with the

 17 concurrent enumerated hedge proposal they find to

 18 be very troublesome. They normally fall into three

 19 primary categories. The first one would be, you

 20 know, classifying each individual transaction to

 21 try to figure out which bucket of enumerated hedge

 22 they fall into, and possibly developing new
 83

 1 systems to track these.

 2 There's also some conversion issues, and

 3 also issues with the forms itself, because OTC and

 4 power products don't necessarily fit neatly into

 5 any of the fields. And so because of that,

 6 expanding on the successful exchange process that

 7 was just discussed is very attractive to a lot of

 8 our members, and so we would encourage the

 9 Commission to continue the discussion on how that

 10 would work, and possibly delegating more to the

 11 exchanges rather than having enumerated hedges.

 12 In terms of OTCs, we are also

 13 comfortable; many of our members use OTCs and

 14 don't use exchanges at all. And so in discussing

 15 that with our members, they are comfortable with,

 16 you know, having some percentage -- of managing

 17 some percentage of their OTC contracts to the

 18 exchange limits and then notifying the Commission,

 19 you know, when they would go above that threshold.

 20 And so that would, you know, kind of

 21 provide the Commission with transparency in the

 22 process, but still have our membership to continue
 84

 1 in the hedging that they currently do in order to

 2 meet their customers' needs. And so, you know,

 3 we've outlined a full process which I'm happy to

 4 discuss in more detail which is very similar to

 5 what the Commercial Working Group has put forth, I

 6 think it maybe expands on that process a little

 7 bit, but I just wanted to express some of our

 8 concerns with the proposed rule in terms of the

 9 burdens that it places on our members, and why

 10 this delegation proposal is attractive to us for

 11 that reason.

 12 MR. GILL: Thanks Mike. I guess a quick

 13 process question, I think the Chairman answered

 14 this, but just to be sure, this concept obviously

 15 would be some something that would be re-proposed

 16 and put out for public comment?

 17 CHAIRMAN MASSAD: Well, I'll defer

 18 ultimately to our lawyers and other staff, but my

 19 own view would be that if we were to go down this

 20 road, it's important to make sure we have a

 21 process where the public can comment. And so I

 22 would envision -- I would support at least doing
 85

 1 it in a way when on this aspect of the rule, we

 2 take further comment.

 3 MR. GILL: Thank you. And, just a quick

 4 comment on that; Commissioner Giancarlo earlier

 5 referenced farmers and ranchers and concerns over

 6 the drop in commodity prices. Independent

 7 producers of oil are also aware of a drop in

 8 commodity prices, and therefore sensitive to

 9 limitations on hedging strategies and other --

 10 limitations on liquidity, and recognizing, as

 11 Commissioner Bowen said, this rule has been out

 12 there.

 13 I also think that folks, this Committee

 14 seems to be moving more toward the concept of how

 15 to implement position limits, rather than the old

 16 argument of whether position limits are in fact

 17 needed. And therefore, to me, it's still within

 18 the congressional -- the spirit of congressional

 19 intent.

 20 These types of concepts being proposed,

 21 I would not view it as sort of a delay on it, but

 22 rather, this is really in the forward momentum to
 86

 1 getting towards a regime that is workable for the

 2 community, and I think you may get groans if there

 3 is a -- certain segments are re-proposed, but in

 4 the long term, I think that, you know, the

 5 discussion and the viewpoints are such that there

 6 seems to be some still problems to be worked out.

 7 And if we can engage the expertise of

 8 the exchanges to make this work better, then there

 9 ought to be a prudent course, and taking a little

 10 grief on another proposal, it may be worth it.

 11 MR. COSGROVE: Tom, did you want to

 12 respond to any of these comments?

 13 MR. LaSALA: I wanted to just follow up

 14 on a point that Lopa made, because she reminded me

 15 of something critical that I neglected to mention.

 16 We spoke very -- especially me in terms of the

 17 process, we spoke about the applicants coming to

 18 the exchange, applicants that maintained

 19 positions, on our exchange, or transacted, cleared

 20 with us. What I didn't address was, what might be

 21 processing of a request for a non-enumerated hedge

 22 by someone that doesn't touch one of us.
 87

 1 And I put it out to this group, that we

 2 are willing to, and we've had some discussion to

 3 talk about how we could do that. Frankly one of

 4 the issues is, and it goes back to the resource

 5 issue, I don't know how big it is. I think we'd

 6 have to have some type of a dialogue with the

 7 Commission based upon the data that they are in

 8 possession of, to get some kind of context of what

 9 that looks like, because I just don't know.

 10 I don't know if there are two people, or

 11 if there are 63 people that we don't deal with

 12 today that would be wanting to come to us, and it

 13 goes to, how do we potentially support and

 14 resource that. So, I think we are open-minded to

 15 want a dialogue around that further and

 16 prospectively, entertain that, but we need some

 17 more information, and so we'd be anxious to speak

 18 with you.

 19 MR. COSGROVE: Jim?

 20 MR. ALLISON: A question for Tom, going

 21 back to your impact presentation, so back to the

 22 beginning of the morning.
 88

 1 MR. LaSALA: Yes.

 2 MR. ALLISON: So, if I understood you

 3 correctly, you talked about your targeted

 4 concentration limits on the accountability tests,

 5 and you said something like, the further out you

 6 go on the curve, the greater your tolerance for

 7 concentration. Is it reasonable to conclude from

 8 that, that the threat of excessive speculation is

 9 less outside the spot months than within the spot

 10 months, and in fact that threat declines the

 11 farther out the position is?

 12 MR. LaSALA: I think that, Jim, that

 13 would be our position. And I'm not going to, say,

 14 dismiss it completely, but as you go further out

 15 the curve, it's more difficult. And again, I'm

 16 not saying that someone couldn't have substantial

 17 positions across the entire curve and become a

 18 concern for us, but outliers in various months,

 19 you know, basically pose less of a concern for us.

 20 And again, where we see those, assuming they are

 21 through our thresholds, we are addressing them.

 22 MR. COSGROVE: Dena?
 89

 1 MS. WIGGINS: Dena Wiggins with the

 2 Natural Gas Supply Association, and I just wanted

 3 to comment that we have in past comments filed

 4 here at the Commission supported a greater for the

 5 exchanges and very much appreciate the work that

 6 ICE and CME and Ron's working group have put into

 7 this proposal. Looking forward to continuing to

 8 work within this process here at the Commission to

 9 address some of the details that have been brought

 10 up about. I think Jim appropriately pointed out

 11 confidentiality is a huge concern of keeping the

 12 details of these transactions, or these proposed

 13 transactions confidential, but very much look

 14 forward to continuing to work on this, because we

 15 think it's a good idea to have the exchanges

 16 involved in this.

 17 MR. COSGROVE: Vince?

 18 MR. JOHNSON: Vincent Johnson, BP. Tom,

 19 I had a quick question, a process question to

 20 follow up with you around the process, so if --

 21 would you say -- I think you were making

 22 statements around having the enumerated hedging,
 90

 1 the ability to make the decisions and then CFTC to

 2 look at that. But if BP comes and we get approval

 3 for a numerated hedge exemption, three months

 4 later, we are taking on risks, we are hedging sort

 5 of a -- a new business practice.

 6 And then the Commission, six months

 7 later, the Commission comes and the Commission,

 8 not because of bad data, but because of a

 9 difference in interpretations and they disagree,

 10 I'm just wondering how that works, so we set up a

 11 process relying on what you approved, how would

 12 that work; and your thought?

 13 MR. LaSALA: My thought would be that,

 14 if the Commission through that process ultimately

 15 determined that that strategy was not allowable,

 16 we would have to set up some kind of a structure

 17 to talk about how to -- Again, if they are in

 18 excess -- if that in its totality is in excess of

 19 a would-be limit. Talk about some type of an

 20 orderly liquidation. Or, realize that those

 21 positions would have to be warehoused within the

 22 allowable spec limit.
 91

 1 So, if it was, again, if you were over

 2 with regard to that strategy, yes, there is an

 3 impact, where, I think we would have to talk about

 4 an orderly liquidation. Not so dissimilar,

 5 frankly, from the point that Ron touched on.

 6 Market circumstances change, markets change,

 7 someone put on positions. There is a significant

 8 contraction in the open interest profile. We are

 9 concerned about the concentration.

 10 We talk with folks about how to -- in an

 11 orderly fashion. We are not looking to harm

 12 people but we've got to get to a certain point, so

 13 yes, we think we'd have to work through that,

 14 Vincent.

 15 MR. COSGROVE: Russ?

 16 MR. WASSON: Russ Wasson, with the

 17 National Rural Electric Cooperative Association.

 18 You know, we filed a comment letter, and it's our

 19 position that entities that don't speculate, they

 20 should be granted exception under 4a(a)(7). You

 21 know, the Commission should use jurisdiction to

 22 grant that exemption, and the reason, it's because
 92

 1 of exactly what Lopa mentioned when she talked

 2 about cost.

 3 Costs are absolutely critical to our

 4 members. And I don't know how many of you saw the

 5 New York Times article that came late last night,

 6 which said that the President's climate plan, the

 7 Final Rule may come out on Monday. But in

 8 conjunction with looking forward to that, which is

 9 probably going to increase the costs of everyone

 10 in this room, to some degree or another, we

 11 conducted a comprehensive econometric study of

 12 rural America and the 42 million people we serve

 13 in rural America.

 14 And we determined that a 10 percent

 15 increase in the price of electricity, which to us,

 16 doesn't see like that much, to our members would

 17 result in the loss of 500,000 jobs in rural

 18 America, but it would take us 20 years, given

 19 current growth rates in rural America, to recoup

 20 the economic benefits of those 500,000 jobs that

 21 were lost.

 22 So, we have approximately 5.5 million
 93

 1 people out of those 42 million that I mentioned

 2 whose annual income is $25,000 or less. So to

 3 them, a 10 percent increase in the price of

 4 electricity is not a problem, it's a tragedy.

 5 Because they have to make a decision about what

 6 are they going to do? Are they going to spend

 7 that money on food or medicine? Are they going to

 8 pay their power bill?

 9 And so, if we are going to use the

 10 Position Limits Rule to regulate the hedging of

 11 commercial end users who are hedging their ongoing

 12 operational risk, and forcing us to go get the

 13 thousands and thousands of hedges we do along

 14 those lines enumerated and exempted, that's going

 15 to substantially increase our cost of operations,

 16 and on top of everything else going on, it's going

 17 to put a great deal of pressure in the countryside

 18 and rural America where our members provide power.

 19 MR. COSGROVE: Paul?

 20 MR. HUGHES: Paul Hughes with Southern

 21 Company. I don't want to get us off track, but I

 22 do want to make a couple of points and see what
 94

 1 you guys think about this. We have been talking

 2 about position limits, and my assumption has been,

 3 is that everybody is assuming that when we talk

 4 about limits, and we talk about positions, that

 5 would not include anything that would be

 6 physically -- intended to be physically settled or

 7 would be a trade option.

 8 We'll also have a panel later this

 9 afternoon, and I'm not trying to jump ahead, but

 10 when you asked the question, you said, you are not

 11 really sure how big that OTC market is. Depending

 12 on how we answer that question, of what is in the

 13 population, if it includes contracts that are

 14 intended to be physically settled, it's a very

 15 different answer. And so, that's a little bit of

 16 a statement, I guess my question would be, in all

 17 of our discussions so far, are we kind of stating,

 18 hey, we are making an assumption that those

 19 contracts would not be included in the analysis

 20 we've been talking about.

 21 MR. HAAS: I don't think we are

 22 considering what happens with trade options, and a
 95

 1 bunch of those becoming swaps or not, we are

 2 thinking right now, just what would be out there

 3 as defined as your swap business.

 4 MR. LaSALA: Your swap business. And

 5 from the physical bucket, if you will, we were

 6 thinking that those trade options would look more

 7 like forwards.

 8 MR. OPPENHEIMER: And that's what our

 9 comment letter has suggested as well.

 10 MR. COSGROVE: Okay. I know there may

 11 be another question or two, we've run, I think,

 12 very, very thoroughly and well through this topic.

 13 I'd love to thank our panelists, and everyone for

 14 questioning. We are going to take a 15 minute

 15 break now and start again at 12 o'clock.

 16 (Recess)

 17 MR. COSGROVE: Okay. Welcome back

 18 everyone. Our second panel will be discussing a

 19 phased approach to position limits, and I'm going

 20 to let each of you introduce yourselves briefly,

 21 and then begin, and we are very interested to hear

 22 what you have to say.
 96

 1 MR. BOURGEOIS: Y.J. Bourgeois, with NRW

 2 Petroleum on behalf of NGSA today.

 3 MR. McCOY: Bill McCoy, I'm here

 4 representing the Futures Industry Association.

 5 MR. BERGER: Stephen Berger from

 6 Citadel; I'm here on behalf of the Managed Funds

 7 Association.

 8 MR. McCOY: Okay. I think I've been

 9 asked to lead this discussion off. And first of

 10 all, on behalf of Anadarko, and NGSA, I wanted to

 11 thank CFTC and EEMAC Advisory Committee for this

 12 opportunity to present an end-user's perspective

 13 on position limits especially relative to natural

 14 gas.

 15 As the CFTC considers rulemaking in

 16 regards to exchange trader position limits, it may

 17 be useful to consider how a typical end-user

 18 navigates these limits currently, and impacts our

 19 business operation.

 20 Anadarko is one of the world's largest

 21 independent producers, with approximately 2.9

 22 billion barrels of oil reserves and proves as at
 97

 1 December 2014, and 2014 sale of 2.6 bcf a day of

 2 natural gas, and over 400,000 a day -- 400,000

 3 barrels a day of oil and NGLs. We have our asset

 4 portfolio that's diversified with U.S. onshore

 5 plays, deepwater Gulf of Mexico, and an

 6 exploration of additional activities worldwide,

 7 including places like Mozambique, Algeria, Ghana

 8 and Brazil.

 9 The company's most significant market

 10 risk relates to prices for natural gas, oil and

 11 NGLs. As energy prices decline or rise

 12 significantly, revenues and cash flows are

 13 likewise affected. As such the company does

 14 actively use derivative instruments to reduce the

 15 price risk associated with future production, as

 16 well as to manage midstream and marketing

 17 activities derived from various processing,

 18 transportation, storage and purchase and sales

 19 arrangements.

 20 There are a number of broad issues

 21 discussed today with the current Position Limits

 22 Rule that are of concern to Anadarko, including
 98

 1 accurate deliverable supply determination, limits

 2 being set at artificially low levels, and the

 3 relative inflexibility and narrow scope of

 4 enumerated bona fide hedge categories.

 5 But today we'll focus our comments on

 6 the spot month issues. More specifically, the

 7 first step of the path forward is the need to

 8 focus on appropriate spot month limits, to ensure

 9 the continuance of sufficient market liquidity

 10 which is critical to price discovery and the

 11 orderly convergence of spot month futures and cash

 12 prices.

 13 Via the exchanges we currently have a

 14 robust LSI process as you heard about earlier,

 15 designed to ensure an efficiently market. We

 16 further suggest that energy markets are currently

 17 achieving a highly-effective price discovery

 18 process, and believe any position limit changes by

 19 the CFTC should look to maintain if not foster

 20 energy markets.

 21 This efficiency can be seen in how

 22 readily the physical and financial markets
 99

 1 converge each month. Importantly, this

 2 convergence dynamic held true during the

 3 struggling 2008 financial crisis, we were in the

 4 midst of a sharp run-up in natural gas prices and

 5 a quick and sure and dramatic price decline, all

 6 while financial system was in disarray, the

 7 natural gas market continued to converge tightly

 8 with the physical market.

 9 Not only is this a compelling argument

 10 as to how well the price discovery process

 11 functions, but also supports why the current focus

 12 should be on the spot month issues, as outer

 13 months do not undergo the same crucial cash to

 14 futures convergence process. This market

 15 efficiency and integrity should absolutely be

 16 preserved as any new regulations are implemented.

 17 As noted in previous NGSA comments, the

 18 initial focus of the Commission should be centered

 19 on the spot month physically-settled futures

 20 contract, where the greatest potential for market

 21 manipulation, if any, naturally resides due to the

 22 physical delivery mechanism.
 100

 1 Financially settled contracts have

 2 historically posed very little potential for

 3 manipulation and should therefore have the benefit

 4 of much higher limits. To this end, we suggest

 5 the following. An accurate determination of

 6 deliverable supply to determine the appropriate

 7 level of spot month limits for physical futures.

 8 Our view is consistent with NGSA in that position

 9 limits should be closely aligned with physical

 10 deliverability.

 11 The methodology currently put forth by

 12 CME utilizing physical receipt and delivery

 13 capacities, including backhaul capacity at Henry

 14 Hub, suggest upwards of 5.7 bcf a day of

 15 deliverable capacity exists. Taking 25 percent of

 16 the capacity as proposed in the current

 17 regulations would equate to roughly 4,245

 18 contracts at the spot month limit; far above the

 19 existing 1,000-contracts spot limit, which

 20 represents only 6 percent of the current Henry Hub

 21 capacity.

 22 With respect to spot month limits on
 101

 1 financially settled contracts, although we agree

 2 with having limits on physically settled futures

 3 that are correlated to physical deliverability,

 4 spot month limits on financially settled futures,

 5 if any at all, should be based more on a

 6 percentage of open interest.

 7 In other words, establish financially

 8 settled limits as a function of the financial

 9 demand, and reflected by open interest, rather

 10 than an artificial threshold. Also limits, the

 11 financially settled contracts should not be

 12 contingent on having a zero position in physical

 13 futures, which would unnecessarily drain liquidity

 14 from the physical futures market.

 15 In addition, this will support

 16 larger-sized positions to be held in the

 17 financially settled contracts as opposed to

 18 physically settled contracts, posing much less

 19 potential for price manipulation via short

 20 squeezes and/or market cornering.

 21 And thirdly, we support the Commission

 22 utilizing a phased-in approach for implementing
 102

 1 position limits. We believe the initial effort

 2 should concentrate on the spot month issues as we

 3 and others are discussing today. To help foster

 4 market liquidity and healthy function, a measured,

 5 phased-in approach will afford the Commission a

 6 valuable opportunity to evaluate and assess the

 7 effects of new regulation over time to guard

 8 against potential ill effects or unintentional

 9 consequences in the critical spot month.

 10 Further to this point, it is our view

 11 today that the exchanges are doing an excellent

 12 job of monitoring and administering limits to

 13 assure orderly market participation. The

 14 exchanges today already require conformance to

 15 non-spot- month limits utilizing the outer-month

 16 accountability levels that you heard discussed in

 17 the prior panel.

 18 This role could conveniently continue as

 19 any new spot regulations are implemented to

 20 provide the Commission the time needed to allow

 21 for a phased-in approach. After the successful

 22 implementation of the physical -- of the initial
 103

 1 phase; a second phase can be initiated to address

 2 non-spot month limits and associated issues with

 3 the benefit of information gained in the initial

 4 phase.

 5 In closing, it is extremely important

 6 for Anadarko to continue to utilize financial

 7 markets to hedge its commodity price risk. It is

 8 imperative that we maintain the ability to execute

 9 hedging programs as needed, and the essential keys

 10 to this are healthy, liquid, transparent and fully

 11 functional marketplace.

 12 The potential inability or difficulty to

 13 execute our hedging programs due to restrictive

 14 position limits, burdensome regulations or

 15 cumbersome restrictions pose serious financial

 16 concern to Anadarko and our shareholders. We urge

 17 the Commission to consider these issues along with

 18 industry input and participation to achieve a

 19 regulatory framework that has appropriate

 20 oversight while allowing for a liquid and

 21 efficient market. We firmly believe both can be

 22 achieved.
 104

 1 MR. McCoy: Good morning. Thank you for

 2 asking FIA to participate in today's meeting, and

 3 in particular for the opportunity to comment on a

 4 phased approach to position limits. We support

 5 the Commission's efforts to foster competitive and

 6 efficient markets and believe this forum will help

 7 accomplish this goal.

 8 Broadly speaking, we remain concerned

 9 that the position limits -- that the proposed

 10 position limits may disrupt markets and ultimately

 11 do more harm than good. As set forth in our prior

 12 comment letters, we hope the Commission will

 13 reliably assess whether the proposed limits are,

 14 in fact, necessary before imposing new limits. In

 15 our view the assessment should be based on

 16 quantitative data that empirically supports the

 17 adoption of new limits.

 18 Only then can we be sure that we are not

 19 putting the cart before the horse, so to speak,

 20 imposing significant costs and barriers on market

 21 participants without discernible benefits. If,

 22 however, the Commission decides to move forward
 105

 1 with the proposed limits, FIA recommends adopting

 2 the limits in phases, starting with the spot month

 3 limits, and then addressing non-spot month limits

 4 as necessary and appropriate in a separate

 5 rulemaking.

 6 A phased-in approach would have a number

 7 of significant benefits, including: first,

 8 allowing market participants time to comply with

 9 the applicable limits; second, focusing the

 10 regulatory efforts on the spot month, where the

 11 markets are most active.; And third, permitting

 12 the Commission time to consider and modify the

 13 position limits regime as it develops and takes

 14 shape.

 15 The FIA recommends that the first phase

 16 be limited to spot month position limits for the

 17 28 Core Reference Futures Contracts. Most of the

 18 proposed Core Referenced Futures Contracts already

 19 have a CFTC or exchange-set spot month position

 20 limit, and as a result market participants have

 21 some experience monitoring futures contracts

 22 towards the spot month speculative position
 106

 1 limits.

 2 FIA expects significant implementation

 3 issues among our members that necessitate a

 4 transition period to come into compliance with new

 5 Federal spot month position limits. For example,

 6 the current set limits -- the current exchange-set

 7 limits only apply to futures contracts. Market

 8 participants will need significant time to develop

 9 systems to incorporate swaps positions toward a

 10 speculative position limit.

 11 In addition, the CFTC administers

 12 speculative position limits differently than the

 13 exchanges. For existing CFTC-set position limits

 14 on agricultural futures contracts, the CFTC

 15 imposes regular reporting requirements for bona

 16 fide hedging positions, whereby market

 17 participants file monthly reports to the CFTC

 18 identifying cash market positions that serve as a

 19 basis for bona fide hedging positions.

 20 The CFTC's proposed position limits for

 21 futures and swaps in energy, metals and

 22 agricultural commodities includes reporting
 107

 1 requirements similar to the existing CFTC rules.

 2 In contrast, the exchanges typically do not

 3 require the submission of monthly reports. Rather,

 4 as we heard somewhat this morning, a market

 5 participant applies to the Exchange for a hedge

 6 exemption.

 7 In some cases the Exchange, in its

 8 discretion, may grant that for up to a year,

 9 though as we heard the Exchange may revisit it

 10 throughout the course of that year. But market

 11 participants will need time to get accustomed to

 12 the monthly reporting regime under the Federal

 13 Administrative structure.

 14 After the Commission adopts and gains

 15 experience implementing Federal spot position

 16 limits, as part of the first phase, the Commission

 17 should reconsider position limits outside the spot

 18 month, and specifically whether they are

 19 necessary. The Commission should address non-spot

 20 month positions as part of a later and separate

 21 rulemaking proposal, which obviously will have the

 22 benefit of additional comment as various market
 108

 1 participants gain experience with the

 2 implementation of the first phase.

 3 As FIA has commented in the past, and

 4 both CME and ICE described at the last EEMAC

 5 Meeting in February, liquidity for energy products

 6 generally decreases further out in the curve;

 7 because of the limited liquidity available in

 8 deferred months, the Commission should take

 9 particular care, first to find that position

 10 limits outside the spot month are necessary, and

 11 that the levels of any limits are appropriate.

 12 In determining whether levels are

 13 appropriate, it is important that the Commission

 14 use and consider open interest data that is both

 15 comprehensive and accurate with respect to both

 16 futures and swaps. The Commission should evaluate

 17 all the relevant and current open-interest data

 18 for each reference contract and should further

 19 rely on the OTC swap data reported to the SDRs and

 20 swap data reported directly to the Commission

 21 under Part 20.

 22 If the Commission uses open-interest
 109

 1 data that is too narrow or inaccurate in setting

 2 the limits, it runs the real risk of unduly

 3 restricting liquidity for bona fide hedgers, or

 4 negatively impacting the price discovery function.

 5 Now, this phased approach offers a

 6 variety of benefits to both market participants

 7 and to the Commission. For example, after the

 8 Commission adopts spot month position limits as

 9 part of Phase 1, the Commission could focus its

 10 limited resources on the administration of spot

 11 month limits.

 12 As the Chairman has made clear

 13 previously, the CFTC is currently under-funded, so

 14 it should focus its resources on the spot month

 15 position limits, where large positions present

 16 potentially a greater threat of excessive

 17 speculation or even the risk of manipulation than

 18 do positions further out in the curve.

 19 The Commission's staff could continue to

 20 collect the data and analyze the data regarding

 21 futures and swaps positions further out in the

 22 curve in order to determine whether position
 110

 1 limits are necessary and whether any proposed

 2 position limits are appropriate.

 3 The initial phase for spot month

 4 position limits could provide market participants

 5 time to adjust to the new position limits regime

 6 for the most liquid part of the curve, the spot

 7 month. In addition, the Commission's staff could

 8 evaluate its definition of bona fide hedging for

 9 purposes of the spot month limits and make

 10 appropriate adjustments if the Commission

 11 determines to impose non-spot month limits.

 12 In short, a phased approach would allow

 13 the Commission to calibrate the hedge exemptions

 14 as the position limits regime develops. As FIA

 15 has commented in the past, the Commission's

 16 proposed definition of bona fide hedging is overly

 17 narrow and may further decrease liquidity outside

 18 the spot month. If a hedger's positions are

 19 classified as speculative, its activity is now

 20 subject to a cap that reduces liquidity.

 21 Further, if a hedge's position does not

 22 qualify as a bona fide hedging position, a dealer
 111

 1 in the OTC market may be less willing to provide

 2 liquidity to the hedger because the dealer cannot

 3 rely on the pass-through swap exemption to hedge

 4 its swap position with the hedger. Because

 5 liquidity is already limited out the curve, the

 6 Commission should ensure that it establishes an

 7 appropriate definition of bona fide hedging

 8 positions. Otherwise, the Commission risks

 9 unnecessarily limiting liquidity for bona fide

 10 hedgers outside the curve.

 11 If the Commission expands the list of

 12 enumerated hedges and adopts an efficient process

 13 to recognize non-enumerated hedges for purposes of

 14 the spot month's limits in Phase 1, the Commission

 15 could further expand the definition before it

 16 proposes any non-spot month position limits in the

 17 second phase.

 18 Now, as part of this phased approach the

 19 Commission should evaluate the use of position

 20 accountability levels outside the spot month as

 21 opposed to hard limits. In connection with the

 22 last EEMAC meeting FIA submitted a comment letter,
 112

 1 explaining that position accountability levels do

 2 represent a form of position limits, and that the

 3 Commission has the authority to impose position

 4 accountability levels outside of the month.

 5 So, after imposing spot-month limits in

 6 the first phase, the Commission could evaluate the

 7 appropriateness of accountability levels instead

 8 of hard limits outside the spot month. In

 9 addition to conserved Commission resources, the

 10 Commission could evaluate and propose an

 11 appropriate framework to employ the administration

 12 of accountability levels at the exchange levels.

 13 Finally, I'd like to talk about the

 14 authority of the Commission to adopt a phased

 15 approach, as between the spot month and the

 16 non-spot month position limits. As Commissioner

 17 Giancarlo noted in his opening remarks, a phased

 18 approach has been used by the CFTC before in

 19 implementing clearing. We've also -- phased

 20 approaches have been used in the context of

 21 reporting and SEF trading.

 22 Also, in its prior rulemaking with
 113

 1 respect to position limits, in CFTC Regulation

 2 151, the Commission explained that it had the

 3 discretion to phase in position limits for all

 4 physical commodity futures contracts and

 5 economically equivalent swaps but chose

 6 appropriately to start with the 28 Core Reference

 7 Futures Contracts.

 8 Because the Commission has discretion in

 9 its rulemaking to phase in various types of

 10 rulemaking, the Commission has this discretion to

 11 phase in spot month and then non-spot month

 12 position limits. In addition, the Commission can

 13 rely on its exemptive authority in Commodity

 14 Exchange Act Section 4a(a)(7) to exempt non-spot

 15 month positions from speculative position limits

 16 during Phase 1 and thereafter determine whether to

 17 establish position limits outside of the spot

 18 months.

 19 On behalf of FIA, again, I would like to

 20 thank the Commission for allowing us to provide

 21 these opening remarks and entertain any questions.

 22 MR. BERGER: On behalf of MFA, I would
 114

 1 also like to thank the Commission for hosting

 2 today's meeting and thank the Committee for

 3 providing us with the opportunity to address you

 4 all today.

 5 For those of you who aren't familiar,

 6 MFA represents the global alternative investment

 7 industry, including hedge funds, managed futures

 8 firms and their investors, by advocating for sound

 9 industry practices and public policies that foster

 10 efficient, transparent and fair capital markets.

 11 MFA members help pension plans,

 12 university endowments, charitable organizations,

 13 qualified individuals and other institutional

 14 investors to diversify investments, manage risk

 15 and generate attractive returns.

 16 As investors in the commodity markets,

 17 MFA members play an essential and beneficial role.

 18 The research and analysis that we provide and

 19 express in the marketplace leads to greater

 20 transparency, more efficient economic

 21 decision-making by producers and consumers as a

 22 result, and we believe it helps optimize resource
 115

 1 allocation in the real economy.

 2 The market activity of MFA members

 3 enhances liquidity and facilitates the price

 4 discovery process; we believe this helps normalize

 5 prices of commodity futures at different

 6 maturities and dampens price volatility. These

 7 market efficiencies help producers and consumers

 8 with their risk-management needs and help inform

 9 forward capital investment resource allocation

 10 decisions.

 11 The ability of investor capital to take

 12 long and short positions and bring new information

 13 to the marketplace helps foster deep, liquid, and

 14 efficient commodity futures markets. Limiting

 15 legitimate activity undermines all these benefits.

 16 MFA believes that any rulemaking on

 17 position limits should be empirically driven and

 18 not based on partial analyses. Further, we are

 19 concerned by a one-size-fits-all approach and have

 20 specific concerns in the context of the energy

 21 markets that using an approach that's worked for

 22 the legacy agricultural contracts may not at all
 116

 1 be appropriate for energy markets.

 2 We don't believe there's been an

 3 adequate necessity finding yet established with

 4 respect to establishing position limits, but want

 5 to present nonetheless here today our proposal for

 6 how to phase in any position limits if the

 7 Commission does go ahead and go down that path.

 8 MR. SUTARIA: Stephen, can you just get

 9 a little closer to the mic, please?

 10 MR. BERGER: Sure. No problem. In

 11 short, we believe, and I think it mirrors closely

 12 what you've heard from my fellow panelists, that

 13 the CFTC should adopt position limits and position

 14 accountability measures through a two-phased

 15 rule-making approach. Phase 1 of that approach

 16 would focus on adopting spot month position

 17 limits.

 18 Of course, I think the corrections that

 19 Y.J. importantly noted still need to be made to

 20 that proposed regime. That process could also

 21 involve finalizing the Commission's approach and

 22 definition with respect to bona fide hedging
 117

 1 transactions and during that first phase would

 2 provide the opportunity to rely on and review data

 3 from the Exchange position accountability regime

 4 for the non-spot months.

 5 Then in Phase 2 a separate rulemaking

 6 could be undertaken to adopt position

 7 accountability levels for non-spot months based on

 8 further informed data that's gathered during Phase

 9 1. We believe that the key benefits of a

 10 two-phased rulemaking approach is that it would

 11 provide the CFTC with more time to gather accurate

 12 data and reliable data, and it would also minimize

 13 unintended consequences, decrease the risk of

 14 market disruption and afford the Commission,

 15 again, better data on which to base non-spot month

 16 position accountability levels.

 17 We believe that the position

 18 accountability regime for the non-spot months

 19 would strike a better balance between ensuring

 20 effective oversight of the markets while also

 21 preserving liquidity and the efficiency of the

 22 price discovery process. We think that the
 118

 1 position accountability regime as I think earlier

 2 panelists have mentioned does have teeth. There

 3 is the ability to put limits on market

 4 participants from further increasing their

 5 positions or call on market participants to reduce

 6 their positions as necessary. And I think, again,

 7 the exchanges have already outlined this well.

 8 We believe that the two-phased approach

 9 that we proposed would address a number of

 10 concerns that MFA has outlined. The first, again,

 11 being that the CFTC's proposed limits are based on

 12 incomplete data. We believe, I think, as everyone

 13 in this room does, that position limits should be

 14 based on accurate and up-to-date data, both on

 15 deliverable supplies with respect to the spot

 16 month, and open interest across both futures and

 17 swaps with respect to any non-spot month limits.

 18 But, you know, having that full data set

 19 is going to take time to further gather, and in

 20 addition, until the bona fide hedging definition

 21 and approach is finalized, the classification

 22 going forward of what's going to be hedging versus
 119

 1 speculative activity, you know, breaking that

 2 dataset down won't happen.

 3 We believe that the approach would also

 4 address our concern that the proposed position

 5 limits are miscalibrated and have been set too

 6 low. I was particularly intrigued by the

 7 presentation in the first panel from Tom LaSala of

 8 CME, because I think he gave a much more granular

 9 investigation of the data that the Commission put

 10 forward in Table 11-A of the February 2015

 11 release.

 12 You know, when we at MFA looked at that

 13 table, we were very concerned about the number of

 14 participants that it identified as already being

 15 near, at or above the proposed limits, and we

 16 don't believe that -- you know, we think that's

 17 indicative of the fact that the proposed limits

 18 would restrict legitimate market activity. We

 19 don't believe that the CFTC has found or made a

 20 finding that there's excess speculation at the

 21 limits that are proposed, so that leads us to

 22 conclude that either the data is incomplete or
 120

 1 that the methodology is wrong, or perhaps both.

 2 So, position accountability would

 3 certainly provide a much better regime and a much

 4 more flexible regime to investigate, you know, why

 5 there are so many people at or above the limits

 6 that have been proposed and, you know, what's

 7 driving that, and how that can be addressed.

 8 I want to take a minute to just, you

 9 know, look at, again, I think one of the points we

 10 made upfront was that the one-size-fits-all

 11 approach may not be appropriate across different

 12 commodity markets, and so when we look at the

 13 proposed limits that have been put forward for

 14 certain of the energy contracts in the non-spot

 15 month, we see a proposed non-spot month limit for

 16 crude of 109,000 contracts, but for gasoline

 17 11,800 contracts.

 18 And then we look at that in comparison

 19 to what the actual demand in the marketplace is

 20 for those two commodities and you'll see for crude

 21 in the U.S. it's about 16 million barrels per day

 22 while for gasoline it's about 9 million barrels
 121

 1 per day.

 2 So the discrepancy that struck us in

 3 that context is that you have a limit for crude

 4 that is 10 times that of gasoline but in actual

 5 real demand in the marketplace for the product,

 6 there's a 2 to 1 differential. So there appears,

 7 in your view, to be a massive or significant

 8 miscalibration of where the proposed limits are

 9 versus the underlying supply and demand

 10 fundamentals in the marketplace.

 11 Further, the energy markets are

 12 undergoing a period of dramatic change. Over the

 13 last five years, particularly U.S. exports of

 14 distillates and gasoline have grown significantly

 15 to nearly 2 million barrels per day. We believe

 16 that results in increased demand for refiners to

 17 hedge distillate and gasoline production, and

 18 that, you know, disproportionately low limits for

 19 those contracts is going to impair the liquidity

 20 and ability of that market to function.

 21 So I think, you know, that points

 22 further to the fact that a one-size-fits-all
 122

 1 approach is not going to be effective, and that we

 2 need to take a two-phased approach to calibrate

 3 things appropriately for the non-spot month limit

 4 and to understand what approaches are appropriate

 5 for different types of community markets.

 6 In particular, again, just importing a

 7 methodology that has been in place for the legacy

 8 agricultural contracts may not at all be

 9 appropriate for the energy markets. In MFA's view

 10 the energy markets are more global, the products

 11 in them are more fungible, the overall supply is

 12 significantly larger, there's much less

 13 seasonality in terms of production and the energy

 14 markets are much more subject to macro

 15 developments that affect prices and liquidity in

 16 the markets.

 17 In addition, the nature, and I think as

 18 others have pointed out already, in terms of where

 19 open interest is concentrated, whether it's just

 20 in the first few months out, which tends to be

 21 typical in the agricultural markets, versus up to

 22 60 months out in the energy markets. So the
 123

 1 nature of where the open interest is and how it's

 2 distributed along the curve is significantly

 3 different in the two markets.

 4 One last point I wanted to make, in

 5 closing, relates to whether there's the

 6 appropriate authority to pursue a phased approach,

 7 and MFA believes that there clearly is. Both the

 8 CEA and the Dodd-Frank Act, you know, reference

 9 that the Commission may impose limits as

 10 appropriate, and that also there is a requirement

 11 for a necessity finding to be done.

 12 So, if it's inappropriate to impose hard

 13 position limits outside of the spot month, or if

 14 there is not a necessity finding that that's

 15 necessary, it's seems pretty clear-cut that more

 16 tailored approaches could be taken to phasing in

 17 position limits.

 18 Again, thanks for providing MFA the

 19 opportunity to address the Committee today. Thank

 20 you.

 21 MR. COSGROVE: I'm going to -- I have a

 22 couple of questions I'd like to start with, and
 124

 1 then if anyone else has a question please put your

 2 name up, like that.

 3 For Y.J., I'm curious to know if

 4 Anadarko has any activities that you would

 5 classify as speculative?

 6 MR. MCCOY: Not per se. You know, given

 7 the portfolio of assets that we have, we typically

 8 try to hedge forward production. It's the biggest

 9 piece of our positions that we would put on the

 10 marketplace as well as some of the, you know, time

 11 spreads and location spreads, only the

 12 transportation and storage. So everything we do

 13 is, from the corporate perspective, is vetted and

 14 really looked at to hedge anticipated future

 15 production.

 16 MR. COSGROVE: Just as a follow on to

 17 that, has Anadarko noticed a change in the ability

 18 to access markets for hedging, and if so, can you

 19 kind of illustrate that to some degree?

 20 MR. MCCOY: Well, I think besides the

 21 regulations, the other thing that's impacted my

 22 liquidity is just a lack of volatility, and some
 125

 1 of the banking participants in the market has

 2 disappeared, there's no doubt. It is a little

 3 more challenging to execute the hedges that we try

 4 to put on, particularly as we go further out the

 5 curve. I think we would like to have a little bit

 6 more elongated hedges, but we typically now stay

 7 within a 12- to 18-month time period as a result

 8 of some liquidity and the bid spreads that we see

 9 out there.

 10 MR. COSGROVE: I'm just going to ask one

 11 last question and then I'll let everybody else

 12 have a shot here. In terms of the availability of

 13 counterparties for hedging, do you see a trend at

 14 this point or do you see that there's been some

 15 kind of change, you know, that you've just

 16 described and that you've reached sort of a

 17 stasis? I mean, do you perceive that liquidity is

 18 improving, holding the same, or decreasing?

 19 MR. MCCOY: I think it's kind of leveled

 20 out a little bit, so I don't think we see the same

 21 degree of change we saw in the last two or three

 22 years. But any additional burdensome requirements
 126

 1 or additional restrictions on limits we are

 2 concerned that would further limit liquidity in

 3 the marketplace.

 4 MR. COSGROVE: Thank you. I saw Jim's

 5 card go up first.

 6 MR. ALLISON: Thank you. Question for

 7 clarification for, I guess, anybody on the panel.

 8 The term "phased-in approach" could mean a couple

 9 of different things. One possible meaning would

 10 be a proposal that is enacted as a final rule, but

 11 it has different compliance dates for different

 12 timeframes. I gather that is not what you mean.

 13 I gather what you mean is a phased-in approach in

 14 which a rule is passed that deals with one

 15 particular phase, spot month. And then a separate

 16 rule is passed to deal with other phases. Do I

 17 understand you correctly?

 18 MR. BOURGEOIS: Jim, that's an excellent

 19 question. Because, for example, I mentioned a

 20 number of other rulemakings with phased

 21 approaches, as you point out, and in some of those

 22 cases there is a final approach that has different
 127

 1 compliance dates. But FIA believes in this regard

 2 that a phased approach should suggest that for the

 3 non-spot month that there be a separate rulemaking

 4 to enable market participants to provide comment

 5 as the Commission gains experience in

 6 implementation of an existing rule that would deal

 7 with the spot month.

 8 MR. BERGER: I would just add that MFA

 9 concurs with that. In particular, believes that

 10 the data that we'll gather in the improvements on

 11 the data that we already have will occur during

 12 the first phase would probably necessitate a

 13 reproposal of the second phase anyway, so that's

 14 why we would advocate for a separate rule-making

 15 for the second phase.

 16 MR. COSGROVE: Commissioner?

 17 COMMISSIONER GIANCARLO: One of the

 18 challenges that was identified in the first panel

 19 this morning to an authorization of exchanges to

 20 manage non-enumerated hedges is the area of

 21 over-the-counter products. Could you see how,

 22 perhaps, a phased rule-making approach might also
 128

 1 be suitable for dealing with that problem? That

 2 we might be able to learn things from an

 3 authorization for listed products before moving on

 4 to, perhaps, over- the-counter products?

 5 MR. MCCOY: I think anything we can do

 6 to get additional data and to understand, you

 7 know, what's behind the data would help us

 8 establish limits that are reasonable and achieve

 9 the objectives that the Commission is looking to

 10 achieve here. So, yes, I do think that once we

 11 get some better data we can expand it to also look

 12 at the OTC area as well.

 13 MR. BOURGEOIS: Just to elaborate on

 14 that, I think that the data that will require the

 15 greatest deal of attention is this question about

 16 open interest and looking at the data of the OTC

 17 swaps market in conjunction with the futures

 18 market. I know that watching your presentations

 19 you talked about the spot month and looking at

 20 deliverable supply with respect to physically

 21 settled contracts versus the financially settled

 22 contracts where, perhaps, once you look at open
 129

 1 interest in the current proposal, one of the

 2 greatest challenges, I think, FIA has recognized,

 3 and others have recognized is, for the non-spot

 4 month, relying on the open interest data of

 5 futures without necessarily taking into account

 6 the size of the OTC swap market.

 7 MR. BERGER: I'd just add I think -- you

 8 know, in Phase I you still have the existing

 9 exchange, you know, position accountability levels

 10 for the non-spot month, so Phase 2 is really

 11 moving that towards, you know, both a federal as

 12 opposed to exchange-level position accountability

 13 limits in the non-spot month. But also then

 14 bringing in the OTC portion into that in addition

 15 to the exchange-traded portion.

 16 MR. COSGROVE: Brian?

 17 MR. DURKIN: Thank you. And thank you

 18 for your presentation. It seems as though we're

 19 seeing a lot of commonality in terms of possible

 20 approaches to this issue of limits and a lot of

 21 consistency in terms of support for a spot month

 22 limit regime, and the accountability mechanisms
 130

 1 that are in place today seem to be getting a great

 2 deal of support from the community, which we

 3 believe is the appropriate path forward.

 4 There were some comments that were made,

 5 and happy to hear that they were made in the

 6 context of why we're here, and ensuring the

 7 consistent performance of these contracts. In

 8 particular, having confidence in contract

 9 convergence, which is very critical to why we have

 10 a hard spot month limits regime in place today for

 11 many of our contracts. However, you know, I would

 12 have to emphasize the positioning and making sure

 13 that you have that confidence in terms of contract

 14 convergence. We would not be supportive of having

 15 a difference of limits between physically settled

 16 and financially settled products. We do have

 17 concerns in the context of any changes in dynamics

 18 there, not having a 1 for 1 parity in treatment

 19 could actually have a very detrimental effect to

 20 the overall performance of that physically settled

 21 contract.

 22 MR. COSGROVE: I believe Russ is next
 131

 1 and then Ben.

 2 MR. WASSON: I'd like to ask the group,

 3 who can tell me what the deliverable supply of

 4 electricity is in the United States? Does anybody

 5 know? Well, I'll tell you what it is. It's the

 6 demand for electricity because electricity's a

 7 constant delivery product, unlike any other

 8 commodity that we're talking about here. As a

 9 constant delivery product when you start talking

 10 about things like spot month, and you start

 11 talking about things like having to enumerate your

 12 commercial hedges, which commercial end-users are

 13 responding to changes in demand in real time.

 14 I have to tell you, our members are

 15 exceptionally compliance-oriented, but I don't

 16 think they can comply with this. I don't think

 17 any electric utility can actually comply with

 18 this. So when we talk about commodities, every

 19 other commodity that we're discussing, everything

 20 you say is true. But I don't see how that's true

 21 for the electric commodity because it's unlike any

 22 other commodity that we're talking about.
 132

 1 MR. JACKSON: Thanks, Michael. Thanks

 2 for the presentations. We agree with that

 3 phased-in approach as it was clarified out how it

 4 was defined. In simple terms, the reason is that

 5 there's a heck of a lot of work we have to do to

 6 even get it right in the spot month. Examples,

 7 the presentations from this morning that were very

 8 well done in collaboration between ICE and CME

 9 which is novel in and of itself. Just to

 10 implement that in the spot month and to think

 11 about all that dynamic and process that needs to

 12 get sorted out between the exchanges, the

 13 Commission, and our market participants we have to

 14 get that right. We have to get that right for our

 15 market participants so that we don't slow down

 16 their ability to execute hedges and reduce risk.

 17 Second is the definition of enumerated

 18 hedge. There's still a lot of work on what

 19 qualifies as an enumerated hedge. There's been a

 20 ton of comments on this from commercial market

 21 participants that the Commission has received on

 22 this, and we need to get this right. It's not
 133

 1 just an energy issue. It's an equal issue for

 2 participants in my agricultural markets.

 3 Third, it's been brought up a couple of

 4 times in this panel, which I appreciate, is that

 5 the deliverable supply definition, we need to get

 6 that right for our customers. That needs to be

 7 accurate and reflect the true amount of supply

 8 that can reasonably be delivered at delivery

 9 points. Y.J., you brought up the example of

 10 natural gas in your presentation. I'd also

 11 highlight a recent filing we've made around Zone G

 12 in power. Based on comments we've gotten from

 13 market participants that that deliverable supply

 14 estimate for power needs to be updated to reflect

 15 commercial reality for that point.

 16 Fourth, I'd highlight, is just the pace

 17 of overall change. The potential of all this

 18 change getting implemented on our commercial

 19 market participants has the potential to drain

 20 liquidity from the exchanges to the bilateral OTC

 21 markets which, I believe, runs counter to some of

 22 the objectives of Dodd-Frank.
 134

 1 MS. PARIKH: I'd just like to go back

 2 quickly to the Commissioner's question about OTC

 3 contracts. I do agree with everything that's been

 4 said today. I think that, especially for OTC

 5 contracts, I mean, we don't agree that there needs

 6 to be limits outside of the spot month, but if

 7 there are, we think there should be a minimum at

 8 least 12 to 18 months of data before the

 9 Commission even considers that. Part of that goes

 10 back to the regulatory burdens that I mentioned

 11 earlier. Those burdens are increased for OTC

 12 contracts since they're not standardized and they

 13 have individual forms.

 14 There's a lot of work that's going to be

 15 needed under the proposed rule for end users just

 16 to comply with the recordkeeping requirements, to

 17 comply with the transactional requirements. Those

 18 are compounded for OTC contracts going forward.

 19 So there needs a lot of work to be done just to

 20 get the current regime right before we can think

 21 about expanding it to contracts where, as others

 22 have mentioned, there's even less liquidity and
 135

 1 less need for it.

 2 MR. COSGROVE: Professor?

 3 MR. PIRRONG: Morning, I guess. No,

 4 it's afternoon. It's a pleasure to be here. I

 5 just want to make a couple of comments. In part,

 6 responding to what Brian and Russ said. First of

 7 all, I think that a phased in approach is a good

 8 idea because there is an anti-manipulation

 9 rationale for spot month limits that does not

 10 exist for outer-month limits, and so I think that

 11 should be the focus.

 12 In terms of the implementation of spot

 13 month limits, I agree with Brian that there's

 14 really no rationale for distinguishing financially

 15 settled from physically settled contracts. The

 16 reason for that is, is how does one manipulate a

 17 physically settled contract by demanding excessive

 18 deliveries against that contract, creating

 19 excessive demand in the cash market to drive up

 20 prices that allow you to liquidate the rest of

 21 your position at an artificially high price?

 22 Well, if you have a big financially settled
 136

 1 position you can exercise that market power in the

 2 physical cash market itself in order to elevate

 3 prices and profit the rest of your position.

 4 This is particularly true in the case of

 5 electricity, going to Russ's point, which is that

 6 the way you manipulate an electricity market is

 7 withholding some physical asset like generation or

 8 transmission. You can do that to advantage a

 9 financially settled position. So I don't think

 10 that there's any justification for a distinction

 11 between these two. Actually, I wrote some

 12 articles about this 15 years ago, about this

 13 specific issue, so I think that this is something

 14 that deserves some more attention.

 15 In terms of the definition of

 16 deliverable supply, one issue that's always struck

 17 me is the potential inconsistency between the

 18 definitions of deliverable supply for the purposes

 19 of position limits and the way that the Commission

 20 has treated deliverable supply in some

 21 manipulation cases. So I think that that's

 22 something that deserves some further thought in
 137

 1 order to make those things consistent.

 2 MR. CAMPBELL: It is all about

 3 liquidity. I really hope I don't live through

 4 another financial crisis, but if I do it is going

 5 to be the result of illiquidity in the market. I

 6 can't set the regulatory agenda for the Commission

 7 and financial regulators in general. But if I

 8 were to set that agenda I would be focused on how

 9 to prevent -- reduce liquidity in the market, how

 10 to increase liquidity in the market. Because at

 11 the end of the day, it is just paramount.

 12 Paramount for our hedging on exchanges, our access

 13 as a corporation to capital markets. We're

 14 starting to see the trickle-down effects of

 15 financial reform on liquidity in general. I'm

 16 really fearful that that is going to cause the

 17 next squeeze, and the next crash, and the next

 18 crisis if something's not done to reverse that.

 19 The focus on liquidity here is great. I

 20 think that's right. I think if we do go with the

 21 position limits regime we really need to see the

 22 impacts of that regime on liquidity in the spot
 138

 1 month first before we start imposing limits on

 2 outer months. Already in the electricity markets

 3 we're seeing some markets that just aren't trading

 4 really at all outside of the prompt year, even

 5 some within the prompt year, outside of the prompt

 6 three months. So we're already seeing the impact

 7 of liquidity out the curve, certainly in the power

 8 markets. Before we, sort of, put a position

 9 limits regime on all months combined and spot

 10 months I think we really need to study the impact

 11 of position limits on liquidity in the spot month

 12 before we move forward with all months combined.

 13 MR. COSGROVE: Mike?

 14 MR. PROKOP: Lael, your last statement

 15 is exactly where I was going. I think what this

 16 does now, and I'll summarize just a few of the

 17 points that the panel brought forth very well. It

 18 allows the Commission with a phased-in approach to

 19 actually do a phased-in economic study on the

 20 effects in the marketplace of these position

 21 limits. In my history, in seeing how the

 22 Commission performs, I know one of the most
 139

 1 difficult tasks that they're charged with is

 2 actually coming forth with a bona fide, good

 3 economic study of the impacts of these rules and

 4 proposals.

 5 Doing this, we basically have a faith

 6 not only phased in implementation of the rules

 7 themselves, but phases in economic study. So

 8 pointing out, Y.J., you said right now your

 9 numbers show there's a 5.7 BCF deliverable

 10 capacity at the hub, roughly over 4,000 contracts

 11 under current rules per participant. I know,

 12 William, you pointed out the current FTC funding

 13 issues that exist, and the CFTC's ability to look

 14 at data, study data, get data, even. You also

 15 pointed out the existing statutes, and also the

 16 examples of past history where the CFTC has

 17 actually used a phased-in approach.

 18 Finally, Steven, you alluded to

 19 something along these lines, I believe, in your

 20 presentation as well. So to me it makes sense to

 21 have a phased-in approach not only of the rules

 22 themselves, but also to benefit the Commission
 140

 1 given the unfortunate past history we had with the

 2 first position limit round that we had with the

 3 vacating of the rule in the courts, I think it

 4 behooves both the industry and the CFTC to look at

 5 that just from the standpoint of having that

 6 phased-in economic impact study. Thank you.

 7 MR. COSGROVE: Jim?

 8 MR. ALLISON: Two points. First one, I

 9 am going to take the risk of disagreeing with

 10 Professor Pirrong, at least ever so slightly. So

 11 in the discussion of whether it is sensible to

 12 have different sorts of position limits for

 13 physical versus financially settled derivatives,

 14 Professor Pirrong's arguments for having them the

 15 same were largely based on manipulation arguments.

 16 I would like to note that manipulation is illegal,

 17 has been illegal for approximately forever, and

 18 will remain illegal.

 19 The role of position limits isn't to

 20 make manipulation illegal. The role for position

 21 limits is to reduce the threat of excessive

 22 speculation. So if we assume we already have an
 141

 1 effective anti-manipulation regime in place, the

 2 question then is given the effect of anti-

 3 manipulation regime what is the propensity for

 4 something to create the threat of excessive

 5 speculation. I won't belabor it further, but I

 6 think assuming the effective anti-manipulation

 7 regime, I think the financially settled have a far

 8 lower threat of excessive speculation problems

 9 than the physically delivered.

 10 Second, if I can follow up on a point

 11 Lael made about liquidity. In response to a

 12 different question, some of our folks had pulled

 13 together some data that yesterday I had shared

 14 with the Chairman and this morning with

 15 Commissioner Giancarlo. I hadn't anticipated

 16 using it at this meeting, but we had looked at

 17 bid- ask spreads and market depth in the natural

 18 gas financial basis markets out one year. When we

 19 looked at that data we observed that the bid-ask

 20 spreads across most of the delivery points had

 21 widened a little bit, although bid ask spreads

 22 were still quite tight. If there is a liquidity
 142

 1 problem, bid-ask is not where is was manifesting

 2 itself.

 3 They also looked at what they call depth

 4 market, so the question you ask the trader is, on

 5 a normal trading day how much volume could you

 6 transact without moving the market? There have,

 7 in fact, been substantial reductions in market

 8 depth since three years ago. In the case of the

 9 most liquid eastern points the traders were saying

 10 that three years ago they could do five contracts

 11 a day worth of business and not move the market.

 12 That's down to one contract a day now. So that is

 13 a sign of what I might call a fragile market.

 14 You've got nice, tight bid ask spreads. You get

 15 in to do one deal, but if you suddenly need to do

 16 a lot of business there's not the market depth to

 17 support that.

 18 That is problematic for consumers

 19 because in the current environment, low prices,

 20 low volatility, the big consumers of gas have less

 21 incentive to hedge. But if conditions change so

 22 that now they suddenly want to put a lot of hedges
 143

 1 in place it is not obvious that there is the

 2 market depth to support that. Of course, the way

 3 the market will react is, we will see bid-ask

 4 spreads widening dramatically, maybe prices

 5 change, and eventually that will draw more

 6 participants into the market. But as the market

 7 stands right now, there is a sign of fragility in

 8 the form of this dramatic reduction in market

 9 depth.

 10 I had not intended to use that at this

 11 meeting, so I don't know what I need to do to get

 12 the piece of paper I gave you onto the record, but

 13 I'll defer to your judgement on that point.

 14 COMMISSIONER GIANCARLO: I was going to

 15 ask you that. Since you mentioned it, Jim, if you

 16 could have something to go on the record of the

 17 Committee meeting.

 18 MR. ALLISON: I'll put it in, and, Mark,

 19 I can give you a copy also.

 20 MR. COSGROVE: Okay. Well, I would like

 21 to thank our panelists for some very rich and

 22 well-informed views. At this point we'll take a
 144

 1 break for lunch. We'll come back promptly at 2:15

 2 and conclude with our third panel. Thank you.

 3 COMMISSIONER GIANCARLO: Okay. We're

 4 ready to begin. So for our final panel this

 5 afternoon we are going to be discussing trade

 6 options in forwards with embedded volumetric

 7 optionality. Continuing on with our excellent

 8 panels from earlier this morning, I will let this

 9 panel introduce themselves and begin.

 10 MR. HUGHES: All right. Let's have some

 11 fun. Nothing more exciting than talking about a

 12 little trade options this afternoon. There's

 13 three of us here and we've just been talking.

 14 Really, I think all of this hope that this is

 15 going to be as much as a conversation as anything

 16 else as we go, so I don't want to spend a whole

 17 lot of time on our presentations. I really would

 18 like to hear some feedback as we walk through

 19 this. I think it's been nice this morning, it

 20 felt a little bit like a workshop there for a

 21 little while, and I think that's what we're

 22 trying to do. As we go through this, I think
 145

 1 Michael will lead us through it, but bear with us.

 2 We're going to throw up a couple of pictures along

 3 the way. We may reference them back later on, but

 4 we're just going to walk through this and let you

 5 know what we're seeing and then what we're doing

 6 as an industry and anybody can jump in.

 7 MS. SHARMA-FRANK: Just a bit of mundane

 8 before the fun. Our disclaimer above states that

 9 materials and statements expressed in this

 10 presentation do not necessarily reflect the views

 11 of any particular company or association with

 12 respect to any issue discussed herein, and are not

 13 attributable to any party other than the

 14 presenters. Just to reiterate with Paul said,

 15 really the goal of our slides today is to settle

 16 some scenarios that are representative of some of

 17 the discussions that are going on. We do look to

 18 the rest of the committee today to provide their

 19 views and thoughts as we review our slides, so

 20 just keep track of things you hear us say and in

 21 our discussion portion we'll certainly open it up

 22 for that.
 146

 1 MR. HUGHES: All right. Since we were

 2 here last time, obviously, the proposed TO has

 3 come out. I would say that generally supportive

 4 (inaudible) we like it. Most of the folks we've

 5 spoken with generally like what happened in the TO

 6 rule, our proposed TO rule. Look, there's some

 7 things we'd like to say, maybe tweaked or changed

 8 a little bit, some modifications or some

 9 clarifications along the way, maybe particularly

 10 in the preamble guidance, but on a whole, it felt

 11 like a very good move forward in the right

 12 direction.

 13 There are a couple of things, perhaps,

 14 we were slightly disappointed on. It would be

 15 with no mention of the position limits exemption

 16 in the trade option rule. We would have liked to

 17 have seen that, simply, One reason, because the

 18 order seems to matter. If we can get that taken

 19 off the table it might clear things up, and when

 20 we talk about position limits and we comment on

 21 position limits if trade options aren't a part of

 22 the argument I think it makes things a little bit
 147

 1 clearer. There might be fewer commenters and we

 2 even talked about it a little bit this morning.

 3 It makes it easier to define the size of the OTC

 4 markets.

 5 We, Southern Company, are in the process

 6 of reevaluating some of our contracts as we look

 7 at the new EVO rules that came out in December as

 8 well. But the clarity has also been very

 9 positive, I think we have a little bit of a sign

 10 of relief, some of the changes that were made to

 11 the seven part test, in particular. However, I

 12 think since then as we have sat in some of the

 13 various trade association groups, whether it be

 14 EEI or ICA or just conversations amongst

 15 ourselves, we've had a fair amount of conversation

 16 in the last several months since at least the TO

 17 rule came out about the treatment of capacity

 18 contracts in the electric markets, and the way we

 19 look at contracts that allow for zero or nominal

 20 delivery, so we'll talk about that a little bit

 21 more as we go through this afternoon, and maybe

 22 talk about is there some ways that we could, in
 148

 1 the TO rule, where, perhaps, the Commission might

 2 be able to provide a little bit more clarity.

 3 So with that said, we'll move forward a

 4 slide, and if you will forgive me I'm an

 5 accountant, risk manager talking about trade, not

 6 an artist, but if you will look at that any maybe

 7 you can kind of envision a bridge. This was

 8 inspired by the comments from the Joint

 9 Association. They filed some comments and they

 10 talked about the bridge between forwards and

 11 swaps. When you look at that you see on the far

 12 left the brick and mortar. There's simply a good

 13 old- fashion forward contract. It's going to be

 14 physically settled. If you move over to that

 15 first span we talk about forward contract with

 16 embedded optionality still with the intent to be

 17 physically settled.

 18 When we start to get in the middle of

 19 that bridge we label a standalone commodity trade

 20 option. You may have a little bit more option at

 21 the beginning of that, but it's still intended to

 22 be physically settled. We believe that facts and
 149

 1 circumstances would provide a lot of support in

 2 that determination. As we move it further to the

 3 right we see commodity options, your traditional

 4 commodity options, financially settled, obviously.

 5 Then far right, just a straight up financial swap.

 6 All we've done at the bottom, on the

 7 left underneath the forward contracts, from the

 8 Act we've taken what a swap does not include. On

 9 the right-hand side we talk about what the

 10 definition of a swap is. I'm not going to read it

 11 to you. I think everybody's seen this multiple

 12 times, certainly on this Committee, probably

 13 people have spent a lot of times reading those

 14 words over and over and over again. What I would

 15 really like to put out there and make sure that we

 16 as an industry, and you as the commission and the

 17 staff, I've had this fear that we have

 18 nomenclature issues for a long, long time. When

 19 we say one word it means something to the

 20 industry. We say that same word it may mean

 21 something different to the staff.

 22 I'm afraid that's created a lot of
 150

 1 confusion. Sometimes the only way you can clear

 2 up that confusion is just let's talk about it, and

 3 that's what we're hoping we can do today. If you

 4 look at that bridge you'll see that there's the

 5 letters A and B. I mentioned to somebody during

 6 the break, if I'd known somebody was going to

 7 mention the tomato/tomato example maybe I would

 8 have made those tomatoes. Some of the comments,

 9 and I think Commissioner Bowen recognized some of

 10 our concerns in her comments at the end of the TO

 11 rule. In the energy industry we have some

 12 contracts that when you first look at them you may

 13 say that looks like there's an option there, but

 14 when you dig deeper you realize, oh wait a minute.

 15 That is a contract that is used for physical

 16 purposes, and the only way that contract can be

 17 settled is, indeed, physically.

 18 But what I've tried to do on this slide

 19 is point out, perhaps, two different places that

 20 someone can use their judgment in determining what

 21 a contract is. If you see where the letter B is,

 22 I believe this is where we, as an industry, are
 151

 1 drawing a delineation between a contract that has

 2 an intent to be physically settled, and therefore,

 3 we would run that through the seven part test, the

 4 three part test, all of our embedded optionality

 5 test. I think the test, the way they're written,

 6 kind of support that. The way that we get there

 7 is, you know, kind of a play on words is the

 8 bridge of facts and circumstances. I know that

 9 there is some guidance that goes back to the

 10 mid-80s that talks about how we're supposed to

 11 view certain options, but I would contend that

 12 back at that point in time we did not have energy

 13 markets under the same jurisdiction of the CFTC as

 14 we do not. Certainly not physical contracts as we

 15 do today.

 16 In addition, because our energy markets

 17 are so different than agriculture market,

 18 particularly when it comes to things like storage.

 19 We can't just build a silo a store a bunch of

 20 electricity in it. Even in the natural gas market

 21 space, storage is limited. Everything is very

 22 regional, so I think the facts and circumstances
 152

 1 allow us to look at that point B as deciding what

 2 is intended to be physically settled. I

 3 acknowledge, as a market participant, it is up to

 4 me to keep enough records that I need to, so if

 5 anybody asks the question I can show them, yes,

 6 when I did this transaction I intended to be

 7 physically settled.

 8 At the end of the trade option rule in

 9 the comment section, there is some language there

 10 that would lead you to believe that some may be

 11 viewing the delineation point at point A. That's

 12 what I'm hoping we can talk about. I'm going to

 13 move to the next slide real quick, and I'm going

 14 to walk through an example for us, for Southern,

 15 I'll mention gas a little bit and then I'll let

 16 the people with me on this panel talk a little bit

 17 more in more detail. We may come back to that

 18 slide we looked at a second ago.

 19 Just as kind of refresher of where we

 20 are, you know, Southern Company we have a lot of

 21 capacity. We have a generation fleet.

 22 Generation, to us, is capacity. Our generation
 153

 1 fleet is pictured up there with the bad drawings

 2 of some little factory looking thing, but you'll

 3 see those check marks on several of those. You'll

 4 see some of those labeled with PPA, so we may have

 5 a power purchase agreement. You could look at

 6 that and maybe say that's your generation fleet or

 7 your generation portfolio. So we look at all of

 8 those and every day we run what we call a

 9 multi-factored dispatch model. We take lots of

 10 things into account to determine which plants or

 11 which capacity we're going to call on.

 12 Now, we view a PPA in this model the

 13 same way we would view a plant that we built

 14 ourselves. We pay capacity payments. There's

 15 charges we make on that, and so depending on

 16 what's going on, so, for example, if it's 98

 17 degrees outside and I've got a plant that has to

 18 be out of service, well, I'm not going to include

 19 that in my mix for that day. I'm going to include

 20 things like how efficient each plant is, how

 21 available it is to run, fuel cost, some of those

 22 plants may be coal, some of them may be natural
 154

 1 gas, some of them may be renewables, solar, wind.

 2 There's a whole list of factors. So I'll

 3 determine that every single day. We constantly

 4 are running these dispatch models and that's how I

 5 determine what I'm going to call on. It may mean

 6 calling on a contract, but that's what I'm going

 7 to use to determine how I'm going to get the

 8 electricity to my customer base.

 9 Fortunately, I think the revisions that

 10 were made to that seven factor test were

 11 beneficial for us because it made things a little

 12 bit clearer when we go through this process I'm

 13 describing in the pictures. So for power

 14 specifically, we do have regional physical

 15 markets. Electricity is unique. I know you all

 16 are probably tired of hearing this, but we can't

 17 stop saying it, electricity's real time. Our

 18 business we are entering into we have to have

 19 capacity and energy at the same time. We can't

 20 have energy without any capacity, and if I had

 21 with me a contract of a PPA it might be 100 pages,

 22 might be 200 pages, it might be with somebody else
 155

 1 on this panel. Say it's a contract I entered into

 2 four years' ago. When you evaluated that contract

 3 you would see capacity payments. You could look

 4 at the invoices. You'd see capacity charges for

 5 $X million and however many thousands of

 6 megawatts. You would see energy charges on there

 7 as well. That contract has produced power ever

 8 single month that we've had it in effect.

 9 However, those contracts also have to

 10 retain the ability to take zero because we have to

 11 protect the integrity of the grid. There are

 12 times when there's more electricity produced than

 13 there is demand. You can't threaten the grid

 14 because of that. You also have the inverse. So

 15 I'm getting to this idea that there's a time and

 16 place, particularly in the electric markets and

 17 the natural gas markets as well, where it is

 18 perfectly acceptable, and I believe it makes

 19 absolute sense that our contracts allow us to take

 20 zero or a non-nominal amount, I think is the

 21 phrase we've used.

 22 One thing that I think is also
 156

 1 interesting is, we call these capacity contracts

 2 because there's capacity and then there's also

 3 electricity. The accounting rules, the SEC, FASB,

 4 some of you have heard of the old FAS 133 mart to

 5 market rules, right? I know we've got a few

 6 accountants around here. This was put into place

 7 with FAS 133. It's now called ASC 815. The FASB

 8 is actually already kind of ground through a lot

 9 of this sausage we've talked about over the last

 10 couple of years in that they recognize that there

 11 are contracts that when you look at those

 12 initially look like derivatives, but when you get

 13 into the meat of them that they're really not.

 14 They're intended for physically settlement, and

 15 FASB and the SEC they have something they call a

 16 normal purchase, normal sale. They designate some

 17 electricity contracts, it's a fairly high

 18 standard, but they designate some of those as

 19 normal purchase, normal sales, so they're not

 20 included as derivatives.

 21 I have this fear, and it's reflected in

 22 our comments, that if we're not careful we could
 157

 1 end up with a situation where I have a swap, as

 2 defined by the CFTC, that is not a derivative per

 3 my accounting records. That is not where I don't

 4 think anybody want to really end up. The way that

 5 I feel like we can kind of bridge that gap using

 6 the bridge analysis is there is a facts and

 7 circumstances element that our industry is

 8 utilizing and using. I think we're relying on

 9 that because we can demonstrate that even though

 10 we may allow for a zero non-nominal delivery we

 11 can demonstrate that these contracts are being

 12 used every day to keep the lights on or a day like

 13 today or a summer like this summer to keep the air

 14 conditioning on, right? We have to do that.

 15 The gas markets, and they're going to

 16 talk about this a lot more, are very similar.

 17 They're regional in nature. They're storage is

 18 not unlimited. It kind of depends on where you

 19 are. Their real time nature of their business,

 20 partially to support our business, also requires

 21 the ability to take zero, but it does not ever

 22 change the intent to physically settle. In those
 158

 1 instances as well, I think we're talking about a

 2 facts and circumstances analysis that should allow

 3 us to take our contracts, which we're going to

 4 view as physical contracts, and run those through

 5 the tests that we've come up with the last few

 6 years. Because we do not want to end up with a

 7 situation where we cannot utilize those test that

 8 we all worked so hard on. I think I'm going to

 9 turn it over to Arushi and she's going to walk

 10 through some more.

 11 MS. SHARMA-FRANK: Thank you, Paul.

 12 Just to reiterate some of the things we've just

 13 gone over, and we've talked a little bit about the

 14 swap definition and about the interpretations.

 15 We've talked about the basics of facts and

 16 circumstances, and we've talked about also

 17 capacity contracts. So we're kind of laying out

 18 for your now, sort of, a framework for informing

 19 our discussion as a group. How does a facts and

 20 circumstances apply now in light of the

 21 interpretation and the proposed TO guidance, TO

 22 rule?
 159

 1 In addition to that, what's happening in

 2 the market now that could be addressed in the

 3 final TO rule, and, perhaps, what other actions

 4 items might be on the list for the Commission to

 5 consider in conjunction with that. Separately, we

 6 can talk a little bit more about the exclusion of

 7 position limits, applicability trade options.

 8 I've got a slightly more details example

 9 up on this screen discussing how the facts and

 10 circumstances analysis might be applied in the

 11 physical gas contracting space. Taking as a basis

 12 for that model the very standard daily call,

 13 Platts gas daily peaking supply contract, called

 14 sometimes a swing. But the underlying point is

 15 that a secured firm right to call on natural gas.

 16 I want to go into a little detail on how you get

 17 to that type of contract because the devil is on

 18 those details. How we apply the facts and

 19 circumstances test is not simply a look at what a

 20 confirm or what a specific deal says with respect

 21 to whether you're going to take 0, 10,000 or some

 22 percentage thereof. There's a lot more there.
 160

 1 I think one of the places we might be

 2 talked past each other in the energy industry and

 3 with a commission, at least in some of the

 4 deliberations we've had through the common docket

 5 is a more full understanding of what it is that's

 6 happening pursuant to an agreement for a peaking

 7 supply where you make take a zero or a nominal

 8 volume.

 9 Where we started out on the slide here

 10 is that we're discussing a deal between a natural

 11 gas utility, a local distribution company entering

 12 into a master physical gas or a base supply

 13 agreement. There are many terms for that

 14 agreement when using a generic form here with a

 15 gas producer that has the independent ability to

 16 procure or has their own gas storage. I put the

 17 date 1998 there to make a very important point

 18 which is that there is a physical course of

 19 dealing that exists between a utility and its

 20 physical gas counterparties which can date back

 21 years or even decades. That course of dealing is

 22 reflected in a base contract, and a base contract
 161

 1 is not, I repeat it, it's not the transaction's

 2 price and quantity terms. It is, literally,

 3 everything else, but for that. Up to and

 4 including things like liquid damages if one party

 5 doesn't perform. Again, liquidated damages in the

 6 context of physical settlement. So if you were to

 7 not bring the gas to the receipt point then you

 8 would pay a fee so that the utility could go out

 9 and buy that physical commodity somewhere else.

 10 Where the receipt points would be on the

 11 system, which will be further informed by the

 12 transaction confirmation, and most importantly,

 13 the master agreement itself which is the physical

 14 supply, sale and purchase agreement does not

 15 create any obligation on either party to do

 16 anything which means enter into any specific deal

 17 for physical gas which is where you get the

 18 construct then for what happens in a transaction

 19 confirmation. So the master gas agreement sets up

 20 that very general course of dealing and defines

 21 the non-price, non-quantity terms of the overall

 22 agreement.
 162

 1 Then you move forward in time, and I've

 2 used a date here, I think I've got a date up

 3 there, but this could be any time. This could be

 4 ten years' later, five years' later, two years'

 5 later. The gas utility is planning for its winter

 6 procurement. It's doing that the May before the

 7 upcoming winter in a heating season. The utility

 8 will go out, and depending on what the utility

 9 needs, again, referencing what Paul called sort of

 10 a tool box or a stack of the different types of

 11 procurement options that the company may have to

 12 fulfill its physical needs. The utility will go

 13 out through either a formalized RFP process or

 14 independent phone calls or emails or publishing a

 15 notice to the counterparties with which it has a

 16 master agreement in place, and puts out the

 17 request for proposals for satisfying certain

 18 requirements that the gas utility may need.

 19 The purpose of doing that solicitation

 20 is to have it all in place, not necessarily to

 21 confirm delivery at that point or confirm delivery

 22 in the future. The different types of deals,
 163

 1 again, I made some generic terms up there.

 2 Contracts are B1, B2, B3. These are all

 3 requirements and you can basically check box as a

 4 counterparty and then you get to the point where

 5 you itemize your price in quantity terms and

 6 memorialize those in a transaction confirmation.

 7 That's where, in this example, zero to 10,000 or

 8 500 to 10,000 or a minimum take of 6,000, that's

 9 where those additional terms materialize, in the

 10 confirmations.

 11 So you can see there are three scenarios

 12 up there. One is interruptible delivery. That's

 13 fully interruptible by the buyer or seller. It's

 14 not necessarily even viewed as a forward

 15 obligation in the sense that neither the buyer or

 16 seller have to do anything. The second is a firm

 17 variable agreement which will involve some sort of

 18 base or minimum take, and some swing component

 19 which may be a percentage of the base amount or it

 20 may be an additional swing amount that's designed

 21 to serve a exigent need like the weather becoming

 22 colder than expected.
 164

 1 The third contract is a pure firm call

 2 right, just a firm contract. It has no specific

 3 baseload or minimum take component, but it has a

 4 swing component, and that's where you have the

 5 zero to 10,000 type example. Where you have a

 6 peaking or a swing of an up to a fixed quantity.

 7 That's reflected on the agreement. Just a

 8 reminder that each of these confirmations could be

 9 executed with any of the counter parties with

 10 which the utility has a basic supply agreement.

 11 Then the food for thought for us to

 12 think about then is the very last portion of the

 13 slide. Given what we know about this overall

 14 agreement how would you classify these contracts?

 15 We'll just think about that for a minute as we go

 16 into a little more on how the market is responding

 17 to the CFTC rules.

 18 This slide is a very summary take, but

 19 I'll go into just a little bit detail on regarding

 20 where we are now, where we were following the

 21 interpretation's release, the final embedded

 22 volumetric optionality interpretation, and where
 165

 1 we could be moving forward. The first bullet

 2 discusses how clarity has been achieved on firm,

 3 variable, and interruptible. Those were the first

 4 two types of deal confirmations I discussed on the

 5 previous slide. And the important point here that

 6 the interpretation really helped with was this

 7 notion of a minimum take requirement.

 8 Before we had the interpretation, there

 9 was still some uncertainty in the market that if a

 10 contract required you to take a certain amount, a

 11 percentage take of that amount, if that was the

 12 actual amount delivered under that contract that

 13 may be inconsistent with the prior seven factor

 14 test. That clarity has been achieved for a lot of

 15 market participants. I think that that's where I

 16 think Paul and I might both agree that we really

 17 feel like we're in a better place with the

 18 interpretation.

 19 But then we're not really here to talk

 20 about just where the clarity is, but where it's

 21 not. That's in the last contractual example that

 22 I put up there on the previous slide which is the
 166

 1 treatment of firm by market participants. That,

 2 to this day, is inconsistent. There's a few

 3 reasons for that and I just want to go through a

 4 couple examples of what those are.

 5 First of all, this notion of zero

 6 delivery. As Paul was saying on his former slide

 7 regarding the bridge there were two inflection

 8 points where the analysis starts and stops whether

 9 we're talking about a forward, a physically

 10 settled option, or a trade option. Minding the

 11 fact that a trade option or any option is treated

 12 in the CFTC regulatory landscape as a swap. So

 13 right now we still have concerns in the

 14 marketplace about how you would characterize those

 15 contracts. I loved Paul usage of the word

 16 nomenclature. Nomenclature has really been the

 17 issue. The agree to disagree clause has been

 18 rampant in how gas counterparties have modified

 19 their physical contracting relationship.

 20 One counterparty, which is more

 21 sophisticated potentially, and is already doing a

 22 lot of work to report other trade options or other
 167

 1 swaps may decide that that agreement is a trade

 2 option and report it as such. The other

 3 counterparty, even though that counterparty is

 4 filing Form TO since TO, for example, is a form

 5 that needs to be filed by both parties if it's an

 6 end user to end user deal. Then the parties might

 7 agree to disagree on what the transaction is

 8 classified as. We've got a lot of examples in

 9 terms of form agreements that have been pervasive

 10 in the marketplace.

 11 IECA is a good example. The IECA did a

 12 form letter representation quite a few years ago

 13 that would memorialize that people may disagree

 14 ultimately as to how they classify that contract

 15 for their reporting purposes, how they classify it

 16 internally to their company.

 17 Another thing that we're seeing right

 18 now is that smaller suppliers, independent

 19 producers, marketers, storage providers, again,

 20 emphasizing this notion that these are smaller end

 21 users, often enter into these deals with other end

 22 users which may be larger, but nevertheless, may
 168

 1 not have a single other CFTC Part 45 reporting

 2 requirement. These smaller suppliers are still

 3 not responding to solicitations or RFPs that are

 4 very similar to or identical to the types that I

 5 discussed on the earlier example slide.

 6 I've gotten the question that well,

 7 what's the problem now? The TO reporting

 8 requirement may disappear altogether. What is it?

 9 Why would these market participants not come back?

 10 I have a few points about that that I'd like to

 11 share. One is, definitely, that there's still

 12 uncertainty about the zero deliver contract. The

 13 smaller market participants really because they

 14 don't interface with Dodd-Frank in any other way

 15 would not want to invest the time, resources,

 16 legal fees, and some of the other requirements to

 17 figure out why it is that they might be regulated

 18 by Dodd-Frank. So the specter of dealing with

 19 Dodd-Frank for a purely physical, small producer,

 20 independent counterparty that does not have to

 21 deal with any of these requirements in any other

 22 context because they have a 100% physical business
 169

 1 is a sufficient incentive for them to not respond

 2 to that type of RFP.

 3 What happens if you do enter into an

 4 agreement and one of your parties want the other

 5 party, another end user wants to report that

 6 transaction as a trade option because of this

 7 uncertainty? Well, then you, as the other

 8 counterparty, also need to report that transaction

 9 as a TO. You need to obtain an LEI. You need to

 10 engage in, if the trade option proposal were

 11 finalized as written, you'd still need to engage

 12 in some amount of due diligence and record

 13 keeping, tracking and monitoring if you're going

 14 to be entering into any volume that the other side

 15 may end up reporting under the proposed 1 billion

 16 requirement. You need to enter into reps, you

 17 would need to modify your basic transaction

 18 confirmations. Again, these are the actual deals,

 19 B1 through B3 in my example, not the master gas

 20 agreement, but the actual deals, to make sure that

 21 you're consistent with the underlying terms of

 22 what the interpretation or some amalgam of the
 170

 1 interpretation as well as a prior products'

 2 release, and potentially what might be said in the

 3 trade option rule.

 4 I have to impress upon you also that

 5 reps in the industry look completely different.

 6 To the extent that transaction confirmations have

 7 been modified in the gas space is just so that

 8 counterparties can make sure that these are

 9 treated as and viewed as physical deals. Those

 10 reps can take the form of specifying one, two, or

 11 three of the seven factors. They can take the

 12 form of taking a little more of that or a legal

 13 interpretation thereof that references back to

 14 these releases from the Commission. Some

 15 counterparties have a problem signing onto reps

 16 for physical delivery agreements that don't all

 17 look the same, so the amount of negotiation that

 18 can go on to get the same physical firm call deals

 19 done has really been immense for some companies.

 20 That's a burden in and of itself.

 21 So those are some of the basic issues

 22 that we're still facing, and where we'd like to
 171

 1 see a little more clarity. I know that one of my

 2 co-panelists, Amy, will be talking in a little

 3 more detail about a standby peaking contract where

 4 you can get a little more insight into the details

 5 about this uncertainty.

 6 Moving on, our slide, of course, is not

 7 just to tell you today about the problems, but

 8 also about solutions. We are, of course, very

 9 grateful and respectful of the fact that the

 10 Commission is looking at this issue. A lot of

 11 work has already been done on this issue and we're

 12 here to suggest things that the regulator can

 13 adopt to help us get to a better place, and also

 14 to ensure that we're not in the place where we're

 15 talking past each other when, in fact, we may all

 16 intend the same thing which is, essentially,

 17 physically settled contracts and those that are

 18 intended to be physically settled should not be in

 19 the swaps world.

 20 So for us, the TO proposal was an

 21 important starting point. I do believe, based on

 22 what I've heard from the smaller end users both in
 172

 1 the gas and the power space, especially in the

 2 marketing space, is that they could get back in

 3 the game if form TO is no longer required. So we

 4 are very supportive of the elimination of form TO.

 5 I also think that it's been pretty well settled in

 6 the common docket that there are some concerns

 7 about the alternative 1 billion notion of

 8 reporting requirement. That pertains to, of

 9 course, whether or not you'd have to be tracking

 10 if you fall somewhere in the middle of that. I'll

 11 let the Commission consider those comments in the

 12 docket on that issue.

 13 Some of the other comments raised a very

 14 important point because they discuss the

 15 quantification challenges to valuation of TOs for

 16 the purposes of satisfying (inaudible) which is

 17 proposed 1 billion requirement. There are some

 18 methodology proposals in the TO proposal that talk

 19 about calculating future price quantity and what

 20 it really envisions is that there is some sort of

 21 cap on how much gas or electrons, as it may be,

 22 how much of a commodity's actually taken and what
 173

 1 date and what price is listed for that commodity

 2 at the time of physical settlement.

 3 The challenges of quantification really

 4 germinate from the fact that in the marketplace

 5 there's an attempt to fit in TOs that are

 6 physically settled and financially settled. With

 7 that challenge before you, the question is what is

 8 the appropriate way to report or track and value

 9 for reporting purposes an open-ended physically

 10 settled trade option. That issue has also been

 11 discussed in these comments, and in the prior TO

 12 common docket as well. It's, of course, one of

 13 the issues alleged to other no action letters that

 14 the divisions have issued in the past regarding

 15 how evaluation should occur. It's the same story

 16 again. It's the square peg in the round whole

 17 which begs the question that why are physically

 18 settled transactions being reported as trade

 19 option in the first place when they bear no other

 20 characteristics that intend any alternative

 21 financial settlement?

 22 Kind of to that point as well, something
 174

 1 I missed on a previous slide is that to the extent

 2 in that example slide I shared there are financial

 3 obligations built in or financial terms built in

 4 to a master gas agreement or a base contract.

 5 Those puts and calls are pursuant to additional

 6 amendments to the master agreement or they're

 7 actual phrases or language that is embedded in the

 8 confirmation agreements. The market does a good

 9 job of putting out very clearly in documentation

 10 what type of deal you've got. You don't have a

 11 situation where, in the gas world you would, for

 12 example, have a peaking deal and also have some

 13 type of severability of that deal that's not

 14 enumerated very specifically in a confirmation or

 15 in a master agreement. That, again, goes back to

 16 the TO proposals. What are we talking about here?

 17 How would I value a 0 to 10,000 deal under which I

 18 don't have to take anything. I may not need to

 19 take it until next year when gas daily is showing

 20 a winter price that is 17 times the amount that it

 21 is right now in May. How do I value that? So

 22 that's another question that comes out in the TO
 175

 1 reporting context and has also been addressed in

 2 comments.

 3 So with the TO proposal being an

 4 important starting point for us I think that we

 5 are in a place where we need to talk about what

 6 can be done in the final role in addition to what

 7 is already in the proposal that will really help.

 8 We've got a few different points up on the screen.

 9 Bearing in mind that the formulation up there is

 10 something that is reflective in other comments

 11 with slight tweaks. It goes all generally to that

 12 point that the final rule should clarify and

 13 affirm that physical contracts which allow for

 14 zero or nominal delivery may satisfy the CFTC's

 15 interpretation and guidance on forward contracts

 16 and would not be regulated as trade options in

 17 light of a facts and circumstances analysis

 18 demonstrating that such contracts exclusively

 19 intend physical settlement.

 20 That statement, which Paul and I worked

 21 on as a proposal, is replicated quite neatly in a

 22 footnote to the actual EVO interpretation as well.
 176

 1 A language of that states, and this is looking at

 2 Note 32 of the final interpretation. That's Page

 3 10 if any of you have the release. Depending on

 4 the relative facts and circumstances, capacity

 5 contracts, peaking supply contracts, transmission

 6 or transportation service agreements, and tolling

 7 agreements may qualify as forward contracts with

 8 embedded volumetric optionality provided they meet

 9 elements of the CFTC's final interpretation.

 10 In addition to that, and the

 11 interpretation itself got several points noting

 12 that this is a facts and circumstance analysis

 13 consistent with the CFTC's prior precedent from

 14 the 80s. As well as with what is contained and

 15 preserved in the products' release. So we're

 16 looking at a number of different documents. What

 17 we'd like to do is be able to do exactly that, to

 18 undertake the responsibility of engaging in a

 19 compliance regime where we can use a facts and

 20 circumstances analysis and apply it broadly across

 21 the world of physical contracting. Whether it's

 22 peaking supply, capacity or any others when the
 177

 1 exclusive intent of those contracts is physical

 2 settlement.

 3 Right underneath that I've got a point

 4 discussing that our views are consistent with a

 5 seven part test. The test itself effectively

 6 contemplates that actual delivery may or may not

 7 occur. The CFTC has already clarified and the

 8 interpretation has been released that the

 9 determining factor for whether or not you're

 10 within the forward exclusion is the intent to

 11 physically settle. So if the question is of

 12 intent, and we struck language from the prior

 13 seven factor test that gave the impression that

 14 it's how you execute those obligations, and

 15 whether or not there was execution. If intent is

 16 the operative factor than that's consistent with

 17 that fact that actual delivery may or may not

 18 occur.

 19 That, not standing along, but in light

 20 of the other types of facts and circumstances that

 21 may exist, for example, the existence of a master

 22 gas agreement with your counterparty that only an
 178

 1 exclusively conned and placed physical settlement

 2 that should be enough. Getting to that point can

 3 be tough on your own as a company because you have

 4 a culture of compliance that is very, very much

 5 interested in making sure you're following the

 6 rules. To get that clarify from the regulator

 7 would be everyone's preference. We'd like to see

 8 that type of uncertainty diminish as much as

 9 possible. We know that the Commission has been

 10 looking at this issue for years, and we think that

 11 the TO final rule preamble language, for example,

 12 is a good example.

 13 The second bullet there is really

 14 reiteration of what I just said, that capacity

 15 contracts are another area where we really need

 16 clarification. Paul made a great point earlier

 17 when he was discussing what the exact issue was

 18 with capacity contracts. That was that those

 19 contracts produce every month, but you do have to

 20 retain the ability to take zero because we need to

 21 protect the integrity of the grid. There is a

 22 place and time for using peaking supply, capacity,
 179

 1 and other physically settled contracts. They're

 2 made as such whether or not there is a minimum

 3 take obligation. That is something that we

 4 recognize very broadly in the energy industry.

 5 There's certainly a way forward for us to use the

 6 illuminous guidance from the Commission today to

 7 get there, but it looks like we might need

 8 something else.

 9 Finally, the final point is, of course,

 10 that we really do want to see that TOs are

 11 excluded from position limits in this final rule.

 12 I must impress upon the point that one of the

 13 other reasons that you might not have some

 14 physical market participants entering into firm

 15 call agreements with any of the suppliers of the

 16 physical commodity in the marketplace, whether

 17 you're talking about retail or wholesale, is

 18 because it's a specter that future position

 19 limits' rules may be applicable to those trade

 20 options.

 21 Just adding, again, this whole

 22 evaluation issue and the simple idea of tracking
 180

 1 an exclusively physically settled trade option,

 2 with quotes, is replicated and mirrored and

 3 certainly exponentially a larger problem is you

 4 were to try to track trade options for the

 5 purposes of position limits' compliance. Paul,

 6 are there other points you'd like to add?

 7 MR. HUGHES: No.

 8 MS. SHARMA-FRANK: Okay. So we did have

 9 one last slide and that's something that's also

 10 food for thought for you up there. We've gotten a

 11 lot of questions about how the uncertainty around

 12 this issue is impacting liquidity in a physical

 13 marketplace. Aside from what I've told you

 14 anecdotally I think the important point to

 15 remember is that we're looking at a statute that

 16 is about five years' old. By comparison, we're

 17 able to look at what's happening in the physical

 18 marketplace with gas and power in the traditional

 19 energy space under statutes that are bordering on

 20 80 years' old, at this point.

 21 So to answer the liquidity question and

 22 the longer term impact question, there is a need
 181

 1 to make sure that we're thinking about the

 2 timeframe over which we would view those impacts.

 3 I think it would be short-sighted of us to table

 4 the issue of liquidity, but also it's important to

 5 be aware that we're dealing with a new statute,

 6 new rules, and new guidance that's just going to

 7 start to be applied now, this year. I think that

 8 where the Commission can go in a very positive

 9 direction both for the Agency in terms of

 10 addressing the issues that need to be addressed,

 11 and for the marketplace is to really just hit this

 12 issue very directly in the final TO rule.

 13 Hopefully some of the discussion today we hear

 14 from others can be a shared perspective on how

 15 that might happen.

 16 MS. FISHER: Hi. I'm Amy Fisher. I'm

 17 the energy regulatory affairs leader at GE Energy

 18 Financial Services. GEEFS is the asset manager of

 19 a limited partnership which owns the Linden

 20 Cogeneration Facility, and EFS owns 50% of that

 21 facility. I'm here today to talk about one of the

 22 ways in which Linden Cogen is able to arrange to
 182

 1 receive uninterruptable natural gas, its fuel for

 2 generating electricity for sale to New York City,

 3 and to produce steam for sale to the refinery that

 4 it's co-located with.

 5 Linden Cogen is shown in the photo.

 6 It's located off of I-95 in Linden, New Jersey,

 7 and I'm sure many of you have passed it and seen

 8 its banner on the highway that says that it's

 9 energy efficient and environmentally advanced. It

 10 is co-located with the Phillips 66 Bayway Refinery

 11 which is the largest refinery in the Northeast, so

 12 20% of the gas in the entire East Coast comes from

 13 that refinery.

 14 Linden Cogen is a modern cogeneration

 15 facility which uses natural gas efficiently. It

 16 first produced electricity which is transmitted

 17 over an underwater cable between New Jersey and a

 18 con-ed substation on Staten Island, New York City.

 19 The heat from the electricity production is then

 20 used to produce a steady source of steam which is

 21 critical for the Bayway refinery process use.

 22 Linden Cogen was completed in 1992 as a project
 183

 1 financed entity which is a particular type of

 2 financing structure which allows it to obtain data

 3 at a lower cost because it is more highly rated

 4 than its equity ownership. It was originally

 5 owned by its developers which was a small company.

 6 That project financing is a wonderful

 7 financial technique which kind of creates a black

 8 box where are the contractual relations that the

 9 plant is going to have for the next 20 years are

 10 determined up front, and many power plants are

 11 financed in precisely this way, but the downside

 12 of it is there is limited flexibility after that

 13 for, you know, unintended changes in costs or

 14 expenses that the plant might incur.

 15 Linden uses natural gas as its fuel, and

 16 it's the most critical component of its products.

 17 The map shows a simplified path for fuel delivery,

 18 so essentially the plant goes to the Gulf and

 19 sources natural gas. It purchases the gas in the

 20 Gulf and arranges to have it transported to a gas

 21 hub where it is picked up by our local

 22 distribution company which is called an LDC, and
 184

 1 that's essentially what is referred to as its city

 2 gate. The LDC is a very highly regulated entity

 3 by state regulators. It's a public utility. It

 4 takes the gas that it buys from Linden at its city

 5 gate and transports it to the burner tip to the

 6 actual point at the facility where it's used.

 7 The green dot on the slide is the Linden

 8 Cogen plant. The blue dot is the con-ed

 9 electrical substation in Staten Island. The

 10 purple line is the underwater cable connecting the

 11 two which transmits the electricity to New York

 12 City.

 13 So local distribution companies nearby

 14 Linden Cogen are, as I said, utilities regulated

 15 by the New Jersey Board of Public Utilities. The

 16 LDCs have a service obligation for all customers

 17 in the region and they operate under complex

 18 tariffs which describe different types of service

 19 that they provide to different classes of

 20 customers. The rates and terms of service charged

 21 by the LDCs need prior approval from the New

 22 Jersey BPU. So Linden has an agreement with those
 185

 1 entities and that agreement, which is collectively

 2 a full supply agreement of 100% of its fuel needs

 3 was approved by the New Jersey BPU.

 4 However, having said that, the LDCs are

 5 required by the terms of their tariffs, again,

 6 approved by the New Jersey BPU, to provide a

 7 priority for residential heating purposes. So

 8 these LDCs which provide natural gas to a large

 9 industrial complex like Linden also are

 10 responsible for literally providing residents in

 11 Northern New Jersey with their heating needs.

 12 Because of that, the New Jersey BPU requires that

 13 industrial enterprise which, obviously, could

 14 swamp each individual houses' heating needs that

 15 there be a second back up supply for natural gas

 16 for the industrial uses as such times when it is

 17 cold out, below 22 degrees Fahrenheit, and at that

 18 time there be another source of natural gas.

 19 However, it is not clear that at the

 20 time that those weather conditions exist that the

 21 LDCs will not have enough gas to satisfy

 22 everyone's uses. The BPU has another goal which
 186

 1 is to provide as much revenue to the LDCs as

 2 possible, so that they can function appropriately.

 3 They're not anxious to have the industrial loads

 4 find some third- party source of natural gas. The

 5 compromise is that Linden Cogen has to go out and

 6 find some kind of contract which will allow them

 7 to access that natural gas when told to do so by

 8 the LDCs because they, themselves, cannot provide

 9 natural gas on particular dates.

 10 The way this works is that LDCs call up

 11 Linden a day in advance and Linden calls a

 12 supplier with whom it has a contract, and tells

 13 them to go ahead and supply the natural gas. The

 14 natural gas goes on the same path that I had

 15 mentioned before, up from the Gulf, to the hub,

 16 and then title is transferred to the LDCs at the

 17 hub, and it's transported to the facility. None

 18 of that happens unless the LDC calls up Linden the

 19 day before and says, go activate and nominate the

 20 gas under your standby peaking supply contract.

 21 I just wanted to make this point because

 22 I think it's quite important. It's very critical
 187

 1 for Linden to have 100% of its natural gas needed

 2 satisfied one way or the other. We have a firm

 3 contract to supply electricity in New York City.

 4 We're 8% of the load serving capacity in New York

 5 City. We also have a very firm contract with the

 6 refinery to supply steam. We can't produce steam

 7 unless we're running, and we can't run without

 8 natural gas, and so you would think we have two

 9 LDCs, one supplies 80% of our needs, the other

 10 supplies 20% of our needs, but because both of

 11 them can curtail us on cold days we need to

 12 actually have another alternative. The other

 13 alternative does not mean we're getting 100% of

 14 our gas supply taken care of. We're still at

 15 100%, but we need to have a plan B on those cold

 16 days.

 17 Just to talk about the terms of the

 18 natural gas supply agreement. They need to be

 19 approved of by the New Jersey regulators. They

 20 only approve them on an annual basis. We go out

 21 on an RFP basis. We get a third-party to commit

 22 standby supply. The charge for that is a
 188

 1 reservation fee to standby. The gas is priced

 2 upon delivery at the market price. In the event

 3 that we're called on to nominate gas under these

 4 contracts the utilities have, by definition,

 5 agreed to purchase the gas from us when it gets to

 6 their hub, so there's no ability to us to

 7 speculate with this gas supply.

 8 I guess I would say in just having heard

 9 Paul and Arushi comment on this that I'm not even

 10 sure we're even on the bridge, but assuming that

 11 we are and we're looking at a forward contract

 12 here and not just some commercial supply agreement

 13 entirely outside the scope of CFTC rubric, why do

 14 we need relief under the trade option rule?

 15 Everyone beginning in 2012 took a very, very close

 16 look at the nature of their contract relations and

 17 specifically whether they were going to have

 18 additional reporting requirements under contracts

 19 like Linden's peaking gas contract.

 20 I think when we went out and showed our

 21 outside counsel who handles all of our Dodd-Frank

 22 reporting requirements, when we showed them these
 189

 1 types of contracts they said, well, it's a

 2 commodity and it's an option, even though it's not

 3 your option, and so it must be a commodity option

 4 subject to swap rules. We'll give you a break and

 5 we'll call it a trade option, not some other sort

 6 of swap. Therefore, all you need to do is file

 7 this form and follow some of the reporting

 8 requirements and you'll be set. That created

 9 several issues for us.

 10 The first was just a sense that our

 11 people who run the Linden plant would not

 12 necessarily realize that this would be considered

 13 a trade option because they don't have any

 14 optionality with the contract, so there's a

 15 concern that we have that we might miss some

 16 requirement even though those requirements might

 17 be nominal. As Paul suggested, there is a

 18 significant accounting issue. The normal purchase,

 19 normal sale type of accounting that we would apply

 20 to a peaking gas contract was put in question when

 21 we started looking at these agreements as though

 22 they might be trade options, and that cause all
 190

 1 kind of consternation until we worked through it.

 2 In addition, the requirement that we

 3 somehow track these separate from our other

 4 commercial arrangements is very problematic.

 5 Arushi mentioned the valuation issue. I would say

 6 that the release as proposed suggests that there

 7 ought to be some sort of mark to market because we

 8 are pricing this thing as we use it rather than

 9 having a fixed price. That is a big burden for us

 10 for some of the reasons that have been suggested.

 11 We would go back and challenge our counsel to

 12 maybe come to another conclusion, but because of

 13 the record around this issue at the Commission

 14 it's very difficult to find a counsel that is not

 15 going to immediately say, look, this is a nuanced

 16 issue. We're not really sure how we should come

 17 out, so we really think you should adopt a

 18 conservative course and report this as a trade

 19 option. That's precisely what we've been doing,

 20 particularly as the panelists have suggested, our

 21 counterparties have been reporting these as trade

 22 options.
 191

 1 In light of what I've been suggesting we

 2 would suggest that these contracts, in particular,

 3 be taken out of the trade option category. We

 4 realize through the rule the reporting

 5 requirements have been reduced, and we very much

 6 appreciate that, but we really think that it is

 7 just not accurate to think about these types of

 8 arrangements as options at all. It would be

 9 helpful for us to have that acknowledged. We

 10 think this issue has been outstanding for us since

 11 2012, and has really caused a great deal of

 12 thinking and a great deal of confusion in our

 13 organization. We think that the trade option rule

 14 is where people will look for guidance on this

 15 point, and so we think it would be great to make

 16 the clarification in the rule itself.

 17 We very much appreciate Commission

 18 Bowen's proposal, but we think that unless there's

 19 some kind of clarification in this rule people who

 20 are not as sophisticated as the people in this

 21 room will say well, the Commission had an

 22 opportunity to clarify this, Commissioner Bowen
 192

 1 identified the issue. They chose not to, so

 2 therefore, they must consider these items to

 3 continue to be trade options.

 4 I wanted to just spend one more minute

 5 telling you why this is important to not just

 6 Linden Cogen, but to the industry as a whole. In

 7 several of the regions where there are independent

 8 system operators who balance the grid on a

 9 regional basis, so, you know, that's New England,

 10 specifically, and PJM, the Mid-Atlantic states.

 11 There have been new rules just very recently put

 12 into place which very dramatically penalize

 13 entities that don't deliver power, generators that

 14 don't deliver power when they're supposed to and

 15 Although in the past there's been some belief that

 16 not having natural gas would be a reason, an

 17 excuse, to get out of those penalties it is quite

 18 clear now that that is not the case.

 19 Not dissimilarly to what Paul mentioned,

 20 there is a dispatch stack and you're never quite

 21 sure when you're going to be called, when you're

 22 not going to be called as a generator. It is
 193

 1 difficult to commit to firm natural gas resource,

 2 all the time, 24/7. So there's really going to be

 3 a need to get firmable contracts not unlike

 4 standby peaking gas contracts in order for

 5 generators across the region to meet their

 6 reliability requirements that are now imposed upon

 7 them. I would suggest that if the Commission does

 8 not take this up now it really will have to take

 9 it up again at a reasonably soon basis.

 10 Thank you very much for listening to

 11 this story. I hope it's provided some clarity of

 12 how something rather abstract can affect small

 13 businesses and small end users. Thanks.

 14 MR. COSGROVE: I saw Russ had his card

 15 up first and then Jim.

 16 MR. WASSON: Thank you. Our concern

 17 with the question of trade options being deemed to

 18 be swaps, which arose in the product

 19 interpretation from 2012, without regard to the

 20 statutory construction issue, is that if a trade

 21 option is a swap, and as I told you at our last

 22 meeting, with respect to our members, there's only
 194

 1 two possible outcomes with a trade option. Either

 2 physical settlement or no transaction happens at

 3 all. In light of that, if something's a swap we

 4 have all this collateral damage that happens

 5 across multiple CFTC rule makings.

 6 For example, it throws us in to record

 7 keeping and reporting for swaps and the deep end

 8 of the pool with swap dealers and major swap

 9 participants. We're a tiny, little physical end

 10 users, but now we find ourselves subject to

 11 reporting and record keeping requirements, the

 12 same rules that apply to the largest and most

 13 sophisticated financial institutions on the

 14 planet. There are substantial costs we would

 15 incur complying with those rules. It's not just

 16 record keeping and reporting. You have potential

 17 problems with respect to margin, capital, et

 18 cetera. There's no cross reference that would

 19 remove a physically subtle trade option from all

 20 the other swap rules across the sphere of CFTC

 21 reporting and record keeping, and any other rule

 22 that refers to the term swap. So that's our real
 195

 1 concern with it.

 2 I just wanted to thank Arushi and Paul

 3 and Amy because I thought they did a great job on

 4 presenting the current state of affairs, as far as

 5 the industry thinks, with regard to trade options

 6 and enumerating the concerns that we have, so I

 7 appreciate it.

 8 MR. ALLISON: Thank you. I wanted to

 9 follow up on one of the points, and I have a hand

 10 out. Ajay's got in his file and I'm assuming Ajay

 11 can do whatever needs to be done to get it

 12 officially into wherever the record ends up. I'm

 13 very sensitive to the bad outcomes that have been

 14 talked about from the current trade option rule,

 15 not the proposed rule. I'm not sure I agree the

 16 ambiguity. I think they're unambiguously bad

 17 outcomes. Whether that's better or worse than

 18 ambiguous bad outcomes I'm not sure.

 19 The proposed trade option rule, from my

 20 perspective, fixes almost all of those problems.

 21 In the proposed rule, however, the Commission

 22 declined to answer clearly the question of how
 196

 1 trade options would be treated in the position

 2 limits rule. Many of us in our comments on that

 3 proposed rule did comment that the final trade

 4 option rule would be the correct place to address

 5 the question of should trade options be within

 6 scope of position limits. I believe it was

 7 unanimous that we said, no, they should not be end

 8 scope.

 9 The question that I asked our folks to

 10 take a look at is if trade options were in scope

 11 for position limits how much would that add to our

 12 cost to comply with a position limit rule? So

 13 this is only the incremental compliance cost

 14 associated with looking at trade options in

 15 addition to everything else. So the trade

 16 monitoring group within our compliance department

 17 has taken a look at the processes they would have

 18 to go through, and Page 2 of the handout lists the

 19 various elements of the cost that would be

 20 incurred. They looked at a minimum value and

 21 expected value and maximum value. Page 3 then

 22 shows the results of the simulation they ran. The
 197

 1 expected value of the costs we would incur on an

 2 ongoing basis is a mean of about $435,000 per

 3 year, standard deviation about $85,000, so call it

 4 half a million dollars a year. That's per year

 5 for one company in the trade options.

 6 I would argue that the costs we incur

 7 will probably be substantially lower than the

 8 costs some kinds of market participants will occur

 9 for one very good reason. If you look at the

 10 detail on Page 2 of what drives the cost, the big

 11 item is one we've labeled as trade option

 12 identification. A big part of that is under the

 13 position limit rules options have to be treated in

 14 position limits on a delta equivalent basis. So

 15 you have to be able to calculate the delta of the

 16 option as it existed at close of business the

 17 previous day. That delta equivalent of the option

 18 is the contribution that option makes to your

 19 position during the following business day. So

 20 you have to calculate the delta of these options

 21 every day during the spot period.

 22 We can do that because we run these
 198

 1 options through our risk systems. We routinely

 2 calculate deltas for them because that's how we

 3 manage these positions. I am not at all sure that

 4 an LCD or Linden Cogen or any of the other big

 5 consumers that are the natural counterparts on

 6 these options -- I am perfectly willing to believe

 7 they know what delta is. I have no reason to

 8 believe they bother to calculate delta on these

 9 options because they have no need to. Linden has

 10 to have these options. All they care about is do

 11 I have to use the option today. Did my natural

 12 gas supplier call me this morning and say they

 13 were exercising one of those 22 days when they can

 14 curtail me? If so, I have to exercise my option.

 15 All they care about is the option exists when they

 16 need it. They do not care about the delta.

 17 So what is it going to cost them to put

 18 in a system to calculate the deltas for these

 19 things that they have never considered to be

 20 options? So it costs us a non- trivial amount of

 21 money at the margin as best we can estimate it. I

 22 think our costs probably is a gross underestimate
 199

 1 of what it's going to cost a lot of market

 2 participants. The market participants who have to

 3 pay the most are those who are the natural users

 4 of these to satisfy perfectly normal business

 5 requirements such as the panel just described.

 6 MR. COSGROVE: Jim and then Andrew.

 7 MR. CATER: At the risk of belaboring a

 8 point, I wanted to just emphasize the crucial need

 9 for volumetric optionality in electricity supply

 10 arrangements. As all three panel members have

 11 indicated, an electric grid operator has to

 12 balance the demand for electricity and the supply

 13 of electricity instantaneously in real time and

 14 there are no choices. If there are appreciable

 15 deviations of supply relative to demand, either

 16 too little supply or too much supply the lights

 17 are going to go out, and that's just a matter of

 18 physics.

 19 This task of balancing demand and

 20 supply, real time, it's become more, not less,

 21 difficult. It's becoming more difficult. For one

 22 reason is the society is tending to rely more on
 200

 1 renewable resources to provide its electricity,

 2 primarily for environmental concerns. If you take

 3 a typical renewable resource like solar

 4 photovoltaics, for all its favorable attributes it

 5 has one unfortunate characteristic and that is

 6 it's intermittent, and it's intermittent in an

 7 unpredictable way, so a solar panel can be

 8 generating a good deal of electricity when the

 9 sun's out on a hot day, and then a cloud comes

 10 over and the demand for electricity is retained

 11 because it's still hot and humid, but the solar

 12 panel is no longer producing electricity because

 13 of the cloud cover. That's an imbalance that has

 14 to be made up and it has to be made up

 15 instantaneously.

 16 You have to have contracts that allow

 17 you to do that. That's just one example of the

 18 crucial need which, again, is going to grow more

 19 not less troublesome because of this increased

 20 reliance on renewable resources. Now, APPA, as

 21 I'm sure the Commission knows, in conjunction with

 22 other trade associations has commented on the
 201

 1 forward contract final interpretation and on the

 2 TO NOPR, and there's much that we see that's

 3 favorable in both of those, the NOPR and the final

 4 interpretation. Particularly, the construction of

 5 the seven factor test in the final interpretation,

 6 but there are lingering issues. As we've said in

 7 our comments we think the best way to address

 8 these lingering issues would simply be what, in

 9 our view would be consistent with the intent of

 10 Congress, is to exclude these commodity trade

 11 options from the definition of the swap. So

 12 that's it.

 13 MR. SOTO: I'd actually like to talk a

 14 little bit of a step back, and I do so at the risk

 15 of sounding a little bit like Oliver with his bowl

 16 in hand, can I have some more? I know you're

 17 probably feeling why aren't we done with this

 18 issue given its history. It has a history in the

 19 sense that, you know, you first started out with

 20 saying, we'll look to our Brent interpretation and

 21 you came up with the three part test. The second

 22 of which called into question any contract that
 202

 1 had variability as to the delivery time. That, of

 2 course, threw the industry for a loop because one

 3 of the great values and the tremendous benefits of

 4 competition, especially in the natural gas

 5 industry over the last 30 years is not just the

 6 price effects of competition, but it's the

 7 innovation of the services.

 8 There's been a tremendous amount of

 9 variability and tailored products to meet specific

 10 needs all because of the well head decontrol and

 11 competition. The industry, understandably, has

 12 some angst about are all these contracts not going

 13 to be considered swaps? So then you came up with

 14 the seven part test, but then you said, however,

 15 and then had another three part test. The general

 16 council had to come in and give you a five part

 17 test to explain why the however you shouldn't

 18 worry about. Now, well maybe there's a trade

 19 option avenue that we can deal with.

 20 We're all kind of a little confused.

 21 Every time that you make a release or a guidance

 22 or another iteration of the rule it seems to raise
 203

 1 more questions than it answers. We can talk about

 2 are these forwards? We can talk about are these

 3 options? Are they trade options and where do they

 4 fall? We just don't want them to be swaps. These

 5 are intended to be physically settled. We thought

 6 we convinced you of that in one of the iterations

 7 of this. I think we shouldn't lose sight of where

 8 we eventually end up, and that is that we

 9 shouldn't lose the innovation in the marketplace

 10 that's available by creating a doubt as to whether

 11 these are swaps. So whatever clarify you can

 12 provide to the industry on that issue just make

 13 sure that they're not going to be regulated as

 14 swaps. Thank you.

 15 MR. COSGROVE: Paul?

 16 MR. HUGHES: Just for a little bit of

 17 clarity. What we're really talking about are firm

 18 contracts that are still options. We're talking

 19 about options for firm delivery, firm settlement.

 20 So there is no question whatsoever that

 21 settlement's going to occur. It's the only way

 22 that it can incur physically. We say intended to
 204

 1 be physically settled. It's the only way that it

 2 can happen. This has been the case on the power

 3 side. You have to have capacity.

 4 So if I contract and I have an option

 5 for 500 megawatts somebody has to reserve that

 6 capacity for me, they're interlinked. It's not

 7 just a standalone. Secondly, that has to occur

 8 regardless of the financial implication. So it's

 9 just a reminder, we don't exercise these options

 10 or these agreements when they're "in the money or

 11 out of the money." That is not what is driving

 12 our decision making.

 13 The same really holds true for me in the

 14 natural gas agreements we've heard. Even though

 15 I'm speaking as Southern Company, the gas just

 16 doesn't come out of the air. If it's a firm

 17 agreement that has to be reserved somewhere. We

 18 bat along a lot the idea of, kind of, the

 19 Enterprise Rental Car example. So I call

 20 Enterprise Rental Car they come drop off a car.

 21 I've got it in my parking lot. Okay. They've

 22 delivered the capacity for me to drive wherever I
 205

 1 need to drive. I might choose not to go anywhere

 2 because it's too hot outside. I don't want to go

 3 anywhere. Gas -- whatever. But that doesn't mean

 4 that I did not receive that capacity. It doesn't

 5 mean that I haven't already received it.

 6 I think that example holds true both on

 7 the power and the gas side. I think the concerns

 8 you hear are the same ones. I mean, this is one

 9 of those topics where we've been kind of saying

 10 over and over again and you kind of want to have

 11 everybody have a T-shirt, if you're argued about

 12 trade options before you get a free T-shirt or

 13 something like that. But at the end of the day,

 14 we're all still talking about a physically settled

 15 agreement. I think the biggest frustration we may

 16 have is if there's one area where it feels like we

 17 may have talked past each other this may be it.

 18 So what I'm really asked for, I can't

 19 speak for everybody else, is an acknowledgment

 20 that we can use facts and circumstances, which I

 21 think are there in the industry as a whole, to

 22 help us kind of cross the bridge and not end up
 206

 1 with a swap.

 2 MR. COSGROVE: Amy.

 3 MS. FISHER: So I just wanted to comment

 4 on what Paul said. The one thing that we really

 5 don't need, I think, is another circular

 6 discussion that leaves us, at least in my case,

 7 with a prong 2 problem in the seven part test. I

 8 think there needs to be some specific

 9 acknowledgement that zero delivery is contemplated

 10 by the seven part test or some other type of

 11 acknowledgement that these types of contracts are

 12 not swaps.

 13 MR. COSGROVE: Yes?

 14 MS. SHARMA-FRANK: I just think it bears

 15 repeating that every time there is a no issuance

 16 there is a very serious and meaningful look by the

 17 end user marketplace to see how we can get to

 18 where we want to be. The reason you have

 19 uncertainty is not just because the rules

 20 themselves may be unclear, but may be unclear how

 21 you apply them to the various types of contracts

 22 out there, and then disagreement on how you apply
 207

 1 it. So to the extent we want something in terms

 2 of our clarity in the trade option rule we're

 3 looking for very clear statements that can be used

 4 to strengthen that bridge and we can walk across

 5 it ourselves. That's what's been happening, back

 6 and forth, back and forth. Counterparties are

 7 negotiating these deals and coming up with

 8 solutions based on what they have.

 9 But the resources, the time, the amount

 10 of uncertainty, the fact that you may go out into

 11 the marketplace and not get that supply because

 12 there's no one willing to do that firm call deal

 13 with you. That's a lot to take in and realize

 14 that you've got lots of words on paper, but

 15 there's something else we need. To the extent

 16 that on our slides were in the comment record,

 17 there are proposed ways to just immediately center

 18 on this issue and discuss it in full detail in the

 19 TO docket. I think that's going to be very

 20 helpful because it's going to mirror very closely

 21 the work the Commission's already done in the EVO

 22 docket, volumetric optionality docket.
 208

 1 The final interpretation says very

 2 clearly in the very last paragraph, in response to

 3 a request for a no action relief and guidance from

 4 energy associations that was filed in the same

 5 time period as those comments that there is, on

 6 the basis of that final interpretation, good

 7 reason and it is permissible and expected that the

 8 industry will go out and look at what's being

 9 potentially misreported as trade options and

 10 reclassify or develop nomenclature that would take

 11 those contracts or those arrangements out of the

 12 trade option world. So you have that language in

 13 the very last paragraph of the embedded volumetric

 14 optionality interpretation.

 15 With the proposed TO language out there,

 16 to the extent there's any uncertainty created

 17 either by what was not in the interpretation,

 18 what's not in the proposal, or by any of the

 19 issues that were raised in concurrence to that

 20 proposal those can be resolved. Then we'll mirror

 21 what the Commission's already done. So in short

 22 form, seal the deal. Make it easy for us to take
 209

 1 what the Commission's issues and walk that bridge,

 2 and come up with the right answer.

 3 MR. COSGROVE: Well, as there appear to

 4 be no further questions and it's getting to be

 5 late in the afternoon, and we've had wonderful

 6 information from this panel and the previous

 7 panels. I'd like to hand it over to Commissioner

 8 for closing remarks.

 9 COMMISSIONER GIANCARLO: On behalf of my

 10 fellow commissioners and I, I want to thank you

 11 all for being here. I think that you can see by

 12 the attendance of the full Commission here for

 13 most of the day we take the comments made very

 14 seriously. We thank you all for the work that

 15 went in to putting these together. Thank you for

 16 coming today. Thanks very much.

 17 (Whereupon, the PROCEEDINGS were

 18 adjourned.)

 19 * * * * *

 20

 21

 22
 210

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Stephen K. Garland, notary public in

 4 and for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 (Signature and Seal on File)

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

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: May 31, 2018