UNITED STATES OF AMERICA


COMMODITY FUTURES TRADING COMMISSION

MARKET RISK ADVISORY COMMITTEE MEETING


Washington, D.C.

Tuesday, April 25, 2017
 
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PARTICIPANTS:

Commissioners:

ACTING CHAIRMAN J. CHRISTOPHER GIANCARLO

COMMISSIONER PETAL WALKER

COMMISSIONER SHARON Y. BOWEN

Other Participants:

SUSAN O'FLYNN (Morgan Stanley)

DENNIS McLAUGHLIN (LCH Clearnet)

JOHN NIXON (NEX)

STEVE CHABINSKY (White & Chase)

JOHN LAWTON (DCR Acting Director, CFTC)

SAYEE SRINIVASAN (Chief Economist, CFTC)

KARL SCHIMMECK (Morgan Stanley)

ROBERT WASSERMAN (DCR Chief Counsel, CFTC)

SCOTT MIXON (OCE Associate Director, CFTC)

GIL VEGA (CME Group)

KATE MEYER (Risk Analyst, DCR)

NHAN NGUYEN (DMO Special Counsel, CFTC)

ANAT ADMATI (Better Markets)

BISWARUP CHATTERJEE (Citigroup)

SUNIL CUTINHO (CME Group)

JERRY JESKE (Commodity Markets Council)
 

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 PARTICIPANTS (CONT'D):

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 LUKE ZUBROD (Chatham Financial)

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 MRAC Members:

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 GERALD BEESON


 Citadel


TOM COYLE


Chicago & Illinois River Marketing

ANDREW GRAY


DTCC


MICHAEL HENNESSY


Federal Home Loan Banks

SEBASTIAAN KOELING

Optiver


CLIFFORD LEWIS


Eurex Clearing


 GLEN MACKEY

 NRG Energy


SUSAN MCLAUGHLIN

Federal Reserve


DALE MICHAELS


Options Clearing Corporation

RICHARD MILLER


American Council of Life Insurers

MICHAEL MODLOCK

TriOptima


ANGELA PATEL


Putnam Investments

EDWARD PLA


Futures Industry Association
 

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 PARTICIPANTS (CONT'D):

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 MARNIE ROSENBERG


JP Morgan


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MARCUS STANLEY


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 Americans for Financial Reform

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 ROBERT STEIGERWALD


Federal Reserve Bank of Chicago

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KRISTIN WALTERS


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 Black Rock


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 SCOTT ZUCKER

Tradeweb


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 * * * * *


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 P R O C E E D I N G S

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 (10:01 a.m.)

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 MS. WALKER: Good morning. As the MRAC


designated federal officer, it is my pleasure to


call this meeting to order. Before we begin this


morning's panels, I would like to turn to


Commissioner Sharon Bowen, the MRAC sponsor, for


the welcome. Acting Chairman Giancarlo and


Commissioner Bowen will then give their opening


remarks.


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 COMMISSIONER BOWEN: Good morning,


everyone. I'm going to try to keep us on


schedule. It's a pretty long agenda this morning,

so I'm going to turn it over to the Acting


Chairman.


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 CHAIRMAN GIANCARLO: Thank you,


Commissioner Bowen. Thank you all for being here

today, coming to


 drizzly Washington for three hours of


your very important, very valuable time.


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 Today's meeting has three of the most


important ingredients I think for a great meeting.

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 It has a really terrific and well-prepared agenda,

compliments to Commissioner Bowen and her team.


It has a great program, important topics to


discuss, and then, most importantly, it has really

great participants -- all of you who have put in


the time to be prepared for this presentation


today. So, thank you all for coming, and I'll


hand it back to Commissioner Bowen.


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 COMMISSIONER BOWEN: Great. It's a


great pleasure to welcome you guys here to our


first meeting of the Market Risk Advisory


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 Committee of 2017.


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 I would first like to thank Acting


Chairman Giancarlo for being here today and for


his longstanding support for the work of this


committee. Acting Chairman Giancarlo and I were


confirmed together, and we've always worked well


together. So, I look forward to continuing in our

shared endeavor to provide for a safer, stronger


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 financial system for the American people.


 Thank you as well to the staffs of the


Office of the Chief Economist, the Division of
 

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 Clearing and Risk Management, and the Division of


Market Oversight for providing technical support


for this meeting.


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 Before turning to today's meeting, I


have the happy task of welcoming three new


members. I never tire of praising this committee,

which has worked with passionate diligence to


provide excellent advice and insight. I'm


confident that these three new members, who are


well known and respected in the industry, will


only augment the effectiveness of our committee.


They are Biz Chatterjee, Global Head of


Electronics Trading and New Business Development


and Credit Market, Citigroup; Dale Michaels,


Executive Vice President of Financial Risk


Management at the Options Clearing Corporation;


and Marnie Rosenberg, Global Head of Clearing


House Risk and Strategy at J.P. Morgan.


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 Welcome, Biz, Dale, and Marnie. Now,
 

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 And last but not least, thank you to the

logistical staff who worked behind the scenes to


put everything together today.


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 turning to today's topics, I'm greatly looking


 forward to our first panel, in which DCR

staff will discuss their reaction to the MRAC's


CCP risk management recommendations that were


voted on last November. I personally believe that

these are incredibly helpful recommendations, and


I want to thank the members of the committee who


worked so hard in developing and preparing these


recommendations.


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 I've heard that market participants have

similarly found these recommendations to be


helpful, and given the importance that CCPs play


in our markets, it is imperative that we stay ever

vigilant on CCP risk management. Thus, I look


forward to the staff's presentation.


 I think our other two topics -­

Cybersecurity and the Evolving Market Structure -­

are also of great importance. In fact


cybersecurity is probably the most important


market risk issue of our decade. I look forward


to hearing from our experienced panel on the


current trends in this ever-changing threat to our


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 markets.

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 Now, I'm eager to get market


intelligence from our MRAC members on our last


panel. It's become an MRAC tradition to start the

year by first looking at the state of the market.


Our diverse markets are changing at such a rapid


pace that it is invaluable to hear about that


evolution, and in fact sometimes revolution, from


a broad cross-section of market participants. It


really informs our oversight as an agency. To


that end, this panel will focus on how well our


derivatives markets are functioning, including


discussions on volatility, liquidity, the impact


of the leverage ratio, the repo market, and the


impact of rising interest rates.


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 I think this will prove to be one of the


most substantive and informative meetings yet,


which is a very high bar to set. So, thank you


all, and with that I'll now turn over the


proceedings to our designated federal officer,


Petal Walker.


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MS. WALKER: Thank you for your opening

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


panel


 discussion will be on the staff response


to the CCP Risk Management Subcommittee's


recommendations for CCP default management. I


would like to introduce Ms. Susan O'Flynn,


Managing Director and Global Head of CCP Strategy,


Governance and Optimization at Morgan Stanley, who


will facilitate and help shape the discussions


during this first panel.


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 Ms. O'Flynn: Good morning. Firstly,


thanks to Commissioner Bowen for sponsoring the


MRAC and getting this group -- the same group


together. And also welcome to our new members.


Also, thanks to Commissioner Giancarlo for being


here today and presiding over the proceedings.


And last but definitely not least, thanks to Petal


Walker for working tirelessly to get us to where


we are today.


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 We, the industry participants, look


 forward to hearing the CFTC's responses to our


 recommendations on CCP default management and the


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 roles and the responsibilities that market


participants, from both a client and clearing


member perspective, may play in the future.


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 The timing of today's meeting is very


interesting. Yesterday we saw the commencement of

the largest coordination drill globally from both


a product scope -- rates, FX, repo and listed


derivatives, among others -- and number of CCPs


involved -- LCH, Eurex, and CME -- that I have


seen in the last several years at a time of


increased market volumes and potential volatility


following Sunday's votes in France. This clearly


addresses and acknowledges some of the final


recommendations and will test both CCPs and market

participants' capacity in a more realistic


environment -- maybe one for the next MRAC for


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 review.


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 With that, I'm going to hand it over to


Kate, Bob, and John for their responses.


 Just from a logistical perspective,


Kate, Bob, and John will speak for roughly 10


minutes. There will be a Q&A session afterwards.


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 If you would like to speak, raise your card, and


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 press the button to speak.


 MS. MEYER: Thank you. Good morning,


all. I'm here with my colleagues Bob Wasserman


and John Lawton, and we have reviewed the


recommendations from the CCP Risk Management


Subcommittee, and we'd like to provide a few


comments. We have a very short deck here, a


PowerPoint that kind of highlights each of the


recommendations, and we'll discuss them in turn.


 So, as most of you are aware, the CCP


Risk Management Subcommittee developed


recommendations related to CCP default management.


DCR staff has reviewed the recommendations. We


find the recommendations to be thoughtful and


useful and consistent in large part with CFTC


regulations. DCR staff supports the


recommendations, and we are ready to work with the


community to the extent that further progress


needs to be made in some of the recommendations.
 

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 With that, I turn it over to Kate Myer,


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 who's going to make the introductions. Thank you.

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 I think we can say some of them have already been


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 achieved, and so we'll go over them.


 At a high level, there were two broad


categories of recommendations, the first related


to coordination, harmonization, and enhancement.


There were five topics under that broad category,


which we will go through in the slide


presentation. And then the second broad category


is porting. Key issues have been identified and,


as I think everyone is aware, that is probably the


stickiest wicket. The most difficult task still


remaining is how best to manage porting,


particularly since -- you know, credit to all the


CCPs -- there have been very few defaults in the


history of our industry, So, there has not been a


lot of practice with this. The last one that we


all know of -- at least the most significant, one


on October 31st of 2011 was MF Global. And so the


CCPs have done a fine job -- as well as the


clearing members themselves -- to ensure that we


do not end up with systemic risk problems.


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 And with that, I'll turn it over to the

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 first -- well, first I'm going to describe how it


 is that these recommendations are consistent with


 the CFTC regulations.


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 The CEA -- Part 39 of the Commodity


 Exchange Act has two regulations related to


 default. There's 39.16 in subpart B and then


 39.35 in subpart C. The 39.16 default regulations

 have been part of DCR's examination program for


 the past five years. So, as some of the CCPs can


 attest to those that are here, we have gone in and

 we have evaluated CCPs' compliance with this


 regulation.


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 Now, keep in mind that the core


 principles do allow for reasonable discretion.


 The CCPs have reasonable discretion in how they


 implement and comply with these regulations. So,


 with that being considered, each CCP may have


 procedures that are somewhat different from


 another CCP. They're not required to have


 identical procedures. But the rules and the


 procedures right now require all of these, that


 the CCPs' written default management plan
 

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 incorporates all of these concepts.


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 The first is that they conduct an annual

test, a fire drill, a simulation. We require also

that they vary the scenarios that they use in


their default management drills each year so that


they're not just testing one aspect of it -- for


example, the auction process. We have found that


the CCPs have the auction process down pretty


well, particularly with respect to swaps, but


there are a lot more things to consider in a


default, including the magnitude of the default


and liquidity issues and things like that.


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 So, our CCPs now do vary their default


management script each year. The scenarios do


include testing all the procedures that affect


clearing members and customers. It's not a


requirement every year, but we do ask that the


CCPs default. If last year they didn't include a


shortfall or a default in customer origin, then


next year they should consider that.


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 The rules must be disclosed. The CCP


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 must disclose to the public its rules in terms of
 

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 how it will manage a default, including its


default waterfall and any obligations imposed on


the clearing members.


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 The first recommendation is related to


communication. As we saw during the MF global


situation, there was a lot of good communication


that took place, but also some people, I think,


felt communication could have been better,


particularly at the customer's side. At times it


wasn't exactly clear which positions had been


transferred or were going to be transferred, or


where they were going to be transferred to, and


Bob will be addressing that concept a little bit


later.


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 But the subcommittee did a great job,


and the very first, I think, significant


accomplishment is they created this -- am I


skipping ahead of myself? -- they created a


contact -- a list of global -- no, that's it, the


directory of contacts has been created. I'm not


sure how widely circulated it has been, because I


don't have a copy of it, but apparently if it's
 

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 confidential information and it's the key


decision- makers at each of the CCPs, so each CCP


knows who -- has the phone number and the name of


who to contact in the event that there is a


default of a significant clearing member that has


clearing relationships at multiple CCPs.


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 Anyway, the minutes of the


recommendations say that this directory has been


created. So, presumably the CCPs do have it,


which was a great idea, and the fact that they've


already achieved it is also an excellent


accomplishment. So, that directory does contain


this detailed information that CCPs would need to


enhance communication as they're managing a


default.


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 The other recommendation is a great


idea, and this has to do with establishing a


mechanism so that CCPs can communicate to clearing

members and customers of clearing members the


exact status of their positions for nondefaulting


customers, whether they're being transferred,


whether they have to be liquidated. I am not
 

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 certain what the status is of that initiative, so


maybe someone on the subcommittee that's worked on

it could provide the group a status, but we


wholeheartedly support that initiative and think


it's a great idea.


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 Okay, next -- the next recommendation is

related to the Default Management Committees. All

CCPs have Default Management Committees. They


have a variety of responsibilities, again given


that CCPs have reasonable discretion in how they


plan to manage a default.


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 The first responsibility, and what many


consider to be the most important, is the seconded

trader's aspect, that CCP regulations in many


cases require that clearing members have traders


available to participate, to go off in a secure


room, and assist the CCP in managing a defaulted


portfolio or a defaulted situation, which,


depending on whether it's customer or house,


whether it's futures or swaps, you know, the


requirements and the things that these seconded


traders have to do may vary. But the concern
 

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 that's been highlighted over time is that if there

was to be a default of a major clearing member who

clears at eight different CCPs and they happen to


have the same trader names on each CCP's seconded


trader list, well, then, there's going to be a


shortfall in terms of traders available. So, the


recommendation is that, first of all, the CCPs


need to communicate amongst each other to try and


avoid having overlap.


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 Most CCPs will change out the names of


the seconded traders quarterly or semiannually -­

and so the recommendation, which we support and


think is a good idea that the CCPs communicate


with each other about which names are on their


list to be seconded at which period of time.


Furthermore, there is an obligation on the part of

the clearing members to notify the CCP if any of


those traders leave the firm or may otherwise not


be available. So, we thought that that was a


great recommendation as well.


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 Okay, next I'm going to turn it over to

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 John Lawton, who's going to talk about -- fire
 

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 drill was the next recommendation.

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 MR. LAWTON: Thanks, Kate. Good


morning. As Susan mentioned, this is very timely,

because in


 fact a fire drill was commenced


yesterday, so I'm going to give you a little bit


-- in the middle of it -- a little bit of an


update.


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 So, the MRAC did recommend that the CCPs

conduct coordinated exercises. The one that's


going on right now includes three very big


clearing organizations -- CME, Eurex, and LCH -­

hitting a number of markets including IRS and


Equity Index and repos. The regulators that have


been participating include the CFTC, the Bank of


England, BaFin, and Bundesbank.


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 I can't give a lessons learned yet,


because the auction portion actually hasn't been


completed, but I can provide some flavor of how


things have progressed so far in the exercise.


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 Our staff was onsite at the CME offices


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 in New York yesterday. Similarly, Bank of England


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 staff was onsite at LCH, my understanding is, and


Bundesbank and Bafin staff were onsite at Eurex in

Germany.


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 At the CME the default that was declared

yesterday was in a large interest rate swap


portfolio. CME had eight traders from seven firms

seconded at the CME office. The exercise started


about 8 a.m. yesterday. The traders were divided


up by currency, so there were two for dollars, two

for pounds, two for euros, and two for pesos.


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 Our staff observed and asked questions


as the traders designed a series of trades that


would hedge the defaulted portfolio. Essentially,

they divided it into two steps: macrohedge and


then later microhedge. And so they would send out

the requests for bids to clearing member firms.


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 The clearing member firms responded.


The traders in consultation with the CME chose


which bids to accept. They basically got the


positions hedged by approximately -- shortly after


noon yesterday. Then in the afternoon, there was


valuation done of what is the value of -- well,
 

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 what is the new position once you incorporate into


it the hedged positions that were executed as part


of the exercise. And there was valuation; there


was mark to market -- what's the current value of


this hedged position now? Later in the day the


CME then sent out the position to firms for


bidding. The firms will have two days to analyze


the position. The actual auction will take place


on Thursday.


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 Our staff has received written reports


of -- again, they're marking the position to


market in the meantime as they would in a real


default situation and then checking what is the


margin erosion of the position against the margin


that they're holding. Again, I can't go into the


details of how the LCH and Eurex auctions are


proceeding, but essentially they're very similar.


The procedures aren't precisely the same, but


they're very similar. Our staff has a conference


call for later this morning, in fact, with the


Bank of England and German regulators to compare


notes on what we've observed so far and what we're


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 expecting for the later part of the exercise on


Thursday. We will do that again after the auction

once we see what's happened with the auctions on


Thursday and possibly going into Friday at the


other clearinghouses. We'll again speak with the


representatives of the other regulators.


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 We also plan to have discussions with


each of the CCPs and with the clearing firms that


participated in the exercise. We're going to try


to get everybody's views on what worked well, what


didn't work so well, what suggestions for


improvement there might be -- for example, along


the lines of setting up portfolios in similar


formats or additional coordination among the CCPs


or among the regulators in the course of such an


event.


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 After we've gone through sort of our due


diligence with the various participants, we will


prepare a briefing for the Commission. I'm


expecting we'll probably have some


recommendations. I can't say what they are at


this moment, but our staff is already thinking
 

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 about stuff that they've observed. And, again, we


want to consult with our other regulatory


colleagues and with the participants to get


everybody's ideas before we put together a


briefing and be probably some recommendations.


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 Thank you.


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 COMMISSIONER BOWEN: So, John, just a


quick question on the fire drill. Was it just


limited to the clearing members, or did we try to


include non-clearing members?


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 MR. LAWTON: I think that it's sort of


broken up into a couple of pieces, and with regard


to the auction of the CME equity index positions,


I think there are some non- clearing members if


they would like to participate in the auction.


That was put off for a day, because there was some


concern, as everyone knows, about the French


elections. So, it ended up not -- that part of


the exercise didn't take place yesterday. But,


yes, so there will be some participation, because


that's, again, something people are interested in:


How well will it work? There are complications if


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 you have end users, but again there is an interest


in ensuring as much liquidity as possible in an


auction process.


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 MR. LAWTON: I think -- is it back to


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 Bob or back to Kate?


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 MS. MEYER: Okay, with that the next


recommendation is related to the auction process.


The two key themes here are communication and


harmonization consistency. We applaud these


recommendations. In large part, they're on the


CCPs to engage in the communication, and to the


extent that they can and choose to harmonize their

procedures and their plans and then publicly


communicate them, you know, that would be a


laudable goal.


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 Also, applause should go out to the


Default Risk Management Working Group, who


developed this document, "The Uniform CCP


Terminology for Default Management Auctions." I


don't know if the author wants to stand up and


take a bow, but it's very well written. It's a


primer on how auctions work, and there's a lot of
 

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 good information in this, so this is in the public


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 domain. This is on the CFTC website.


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 And with that, I'll turn it over to Bob

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 Wasserman.


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 MR. WASSERMAN: Thanks. I'm going to


talk very briefly about customer


 participation in auctions. At bottom as


Kate and Don were saying, we very much want


auctions to succeed. It's much better to have a


voluntary market-based tool, because the


alternatives are very unpalatable things like


mandatory tools such as partial tear-up. And so


to enhance the likelihood that the auction


succeeds, it's, frankly, other things equal,


better to have additional participants in the


auction and having qualified non-clearing members


participate than increases in the likelihood of


success by expanding the scope of bids. So, I


think the recommendation, which I think is a very


good one, is that CCP should be encouraged to


consider permitting non-clearing members to bid.


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 Obviously, you need to have appropriate
 

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 policies and procedures around that. You need to


make sure that all of this participation is


supported by a clearing member in good standing,


because they have to ultimately guarantee those


bids if the bids are winning ones. And, as well,


there are some interesting issues around front


running and confidentiality that need to be taken


into account.


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 Turning to porting, which was discussed


before, this is something that personally is very


near and dear to my heart, because when we have a


failure of an FCM, it is critical to take the


clients -- and particularly if it's a client-led


default -- the non-defaulting clients and port


them to safe harbor. And that has always been a


goal of the Commission and staff and indeed 764(b)

of the Bankruptcy Code protects this. It is


directly encouraged in the Commission's part 190


regulations as well. Doing that, a successful


port protects both the customers, who do not have


to reestablish their positions, but as well the


markets, because if you cannot successfully port,


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 the alternative is all of these customers are


going to get liquidated, and that is just simply


not good for the markets and it's most assuredly


not good for the clients.


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 Historically, we have in fact taken a


very practical approach towards fostering


transfers both for bankruptcy when clearing


members get into trouble and for looking at


certain possibilities under our Part 1


regulations. But, as well, staff have basically


spent quite a few all-nighters trying,


 and along of course with folks at the


clearinghouses and the SROs, trying to find ways


to successfully port customers as quickly as


possible, again, to avoid having to liquidate all


of those customer positions.


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 I can also say -- I know there was some


mention, some concerns around bankruptcy court


approval -- my experience has been that bankruptcy


court approval has been quite prompt, quite


reliable. You have bankruptcy court judges


scheduling hearings on hours' notice. You have
 

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 hearings being held outside of normal court hours.

I think, again, bankruptcy court judges I've


appeared before have been very, very practical in


their approaches. So, we've been very successful


to this point. Indeed, I recall -- but the trend


line is not necessarily good. I recall in the


case of Refco the privilege of being the


transferee was auctioned off, and indeed the bids


went from 80 to 200 million dollars. So,


basically $200 million was paid for the privilege


of taking those customer positions.


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 In the case of Lehman, you had one


entity, and really I don't think they paid


anything for it. And in the case of MF Global I


think there were ultimately 10 transferees that


were -- and homes were found for all the


customers. But now of course, remember, in order


to have transfer, in order to have porting, you


need to have willing and able transferees. As we


see, the trend line's been going in, I think, the


wrong direction. Now you have FCMs who are not


looking for customer business but who are, because


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 of the leverage ratio, pushing it away during


normal times. So, I will say that I am personally


quite concerned that during a crisis time, during


a time of market stress, the ability to find homes


for these customers, to find firms that are


willing and able to take these customer positions


on, is much less sure, frankly much less likely


than I personally would like, and that concerns me


a great deal.


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 And I know you're going to be talking


more about the arbitration later. Thank you very


much.


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 MS. O'FLYNN: Okay, so I'm going open it


to the -- for the group for any questions,


observations, or comments.


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 Marnie.


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 MS. ROSENBERG: Thanks, Susan. The


first thing I would say is congratulations to


 the subcommittee on putting these


together, you know, led by Susan. I think these


are really excellent, and J.P. Morgan has been


really supportive of all of these recommendations


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 and obviously, as both a dealer and a clearing


member, very involved in all of the fire drills


and the work that's been done in the market.


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 More questions for the clearinghouses in


terms of implementation on some of these


recommendations, so one question I have is on the


harmonization of auction procedures and for


specific asset classes, meaning those that


obviously clear interest rate swaps, is there work


being done to harmonize some of those procedures?


I think that would really work to reduce potential


operational risk in a crisis and cause less


confusion in the markets.


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 And then the second point I can't


emphasize enough is the coordination and sort of


standards on frequency and rotation on trader


secondment. You know, we continue to see in the


market, with more and more electronic trading,


less traders. So, I think there's a careful


balance between members being able to have


sufficient resources on the desks to manage our


own internal risks, obviously, as our own
 

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 regulators need us and as from an internal risk


management we need to do. So, I think the more we

can kind of streamline the dependency across the


market on the secondment would be a really good


outcome, and I think having a sort of more


structured process in terms of rotations would be


very helpful.


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 And the final point I would make to what

Bob was just saying is, you know, we are very


supportive of broader participation at auctions,


and I think it really is about how to implement


that, because there are different ways of doing


that, and so I'm very happy to see that there's a


lot of support across the clearing member


community on that.


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 Thank you.

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 MS. O'FLYNN: Sunil, do you want to


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 respond?


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 MR. CUTINHO: Yes, definitely. Thank

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 you very much, Susan.


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 A few things, though. First is: I echo


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 Marnie's comments. We CCPs appreciate that. We
 

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 really want to establish a system where we


coordinate, you know, the resources that we tap


into during a default, because this is a time of


stress and our goal is not to deplete our members


or resources that they need to manage their own


risk.


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 So, we're working towards that. I think


this coordinated drill is actually a test of that,


and we'll see how it worked out. But as a group


we've been working on that.


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 On the second item, in terms of auction


harmonization for like products -- I think that's


what you were pointing to -- I think the CCPs work

together to put that framework together so that we

could get to a good place, to a good starting


point. Of course we have different mechanisms for

communicating right now. We do share with OCC an


infrastructure for auction participants. Dale,


when he was at CME, started that process, so we


have taken that to the next level, so we continue


to use that. We'd like to invite other CCPs to


also participate in that same infrastructure so it

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 makes it simpler. I think the objective is to


reduce as much operational risk as possible. So,


we agree with that.


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 I think the last thing I was going to


point out is there was some question from Kate and


others on progress in communication in relation to


porting. So, here what we've done is -- you know,


especially for the futures world, a CCP doesn't


have end customer information as a matter of a


normal course of business. So, what we have done


is we passed a rule requiring information about


end customers from firms to be used exactly in the


instance that we pointed out. This is one of the


biggest lessons that we learned from 2011, and MF


Global is having access to end customers so we can


communicate with them when their clearing firm has


an issue during the porting process.


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 So, that process is underway. There are


firms already submitting information. We still


have some work to do. We have to complete that.


For the over-the-counter markets customers


register with us directly, so we do have contact
 

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 information. But for futures markets we are going

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 through that process. That is step one.


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 Step two is coming up with a harmonized


process to actually communicate. Here, too,


importing -- it makes sense to coordinate. We


CCPs agree that it makes sense to coordinate


amongst ourselves, because customers typically use


a single firm across CCPs and they net settle.


So, we would - - when you port these customers to


another clearing firm, you know, you don't want to


break that netting set for them, so that will


result in a liquidity demand on them. We are very


cognizant of that, and that's an important part of


our coordination exercise. But for this exercise


we avoided porting. We avoided customer porting


as one of the scenarios in order to further


develop this process.


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 So, I thought it would be useful for


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 everybody to hear where we are so far.


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 MS. O'FLYNN: Richard?


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 MR. MILLER: Thank you, Susan. I think


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 that we're on a good course here, and I had
 

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 a couple of follow-up questions maybe


for you, John, concerning the coordinated fire


drill that you're engaging in. You know, as end

users, we're, you know, very -- everyone here is

concerned, end users are of course concerned and

don't have as much transparency as other market


participants have -- you know, the clearing


members and the CCPs -- so, just a couple of


follow-up questions.


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 In the current fire drill that you're


doing, what's the severity that you're assuming of

the default? Are you assuming two largest


clearing members? I'm curious.


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 And I guess on looking forward, what


kind of transparency can we expect in the way of


feedback to the market participants in the market


in general as to the results of the fire drill and

what we can expect and when?


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 MR. LAWTON: On the first one, it's just

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 a single firm at each CCP in this exercise.


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 Feedback -- I guess we haven't really


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 focused on that, but I think we're very open. I


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A

think that's a very good suggestion that, as I


mentioned earlier, we're going to talk to people


who participated in it. I think it probably would

make sense to, after we've sort of pulled together

those thoughts, talked to people who didn't


participate, and talk to them about what do you


think, sort of explain how it went and some of the

lessons learned that we thought and perhaps get


some feedback from other market participants who


are not participants. I think that's a very good


suggestion.


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 MS. O'FLYNN: Dale.

 13
 MR. MICHAELS: Thanks, Susan. Just to


echo a little bit what Sunil mentioned about


 the standardization of the member


auction process. This has been something that's


been going on for quite a while. It was several


years ago where OCC first started using a


third-party platform, showed it to the colleagues


at CME. They started using the same platform, so


they were using one infrastructure. Members bid


in that same platform, so they don't have to learn

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 the different procedures for the different CCPs.


When we do joint drills with CME, which we've done

for several years now on the exchange trade


products, it's used with the platform and able to


have folks bid fairly aggressively. Since they


already know what that platform looks like, they


don't have to ask questions. It basically fills


some of the operational holes that could come up.


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 As far as the broader participation,


having gone through a number of real-life events,


one thing we have found out is that we very much


endeavor to have more than just clearing members


participate. We want to see the end users


participate in a drill. They tend to be very


aggressive when they are participating in the


auction process. For some career members, when we


have gone to them for certain portfolios, a lot of


times it takes -- they have to get approval to


take in certain products, and getting that


approval in a very short period of time for some


very large broker dealers is just not possible.


When you're having end users, prop shops, and
 

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 other types of end users, they could react very


quickly. They could look at the portfolio and


come up with bids and come up with their


assessment of where their portfolio might be going


very quickly and come up with some very aggressive


bids. So, one thing we found out is that we very


much want to bring other folks into the business


of doing the auction process. In fact, at OCC we


now put in our rules that all members are required


to test with us so that we know that we have a


full bench of possible participants in our auction


process.


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 The last thing I want to address is


Bob's comments and concerns on portability. We


very much share those as well. With the leverage


ratio, what has happened is that even in


peacetime, what we are seeing with members is that


there're asking business to -- there's no longer a


theoretical issue. I just received some


information from a member this week that said they


had to let two members -- two clients, I should


say -- go to another firm.


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 They asked them to leave because of the


leverage ratio, not because of the credit


concerns, not because of their risk at a


portfolio, just because of the size of the option


port fill as compared to the risk. It was


impacting the leverage ratios. So, this is,


again, no longer theoretical, and this is in peace

time. We go into a stressful situation, one thing

that does concern us -- and I think the CFTC, Bob


mentioned has been very practical in their


approach during those stress times, and I could


not agree more. But we would like to see other


regulators also take that type of approach so that

we have some type of temporary restraint and


things such as leverage ratio or other capital


issue so that we could ensure that we have


portability of your clients in these stress times.

If we're seeing clients being pushed away now in a

peacetime because of the leverage ratio, I think


you're going to see even more of that come. When


it's a stress time, we won't be able to have


clients move over very successfully. The last one

A

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 with MF Global -- it was not easy to move them


over to more than 10 clearing members. It was a


struggle to find the 10 clearing members, but


eventually it worked out during that week. But


that was without the regulatory issues that we


have now with the leverage ratio and other


concerns.


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 Thanks.

 9
 MS. O'FLYNN: Dennis.

 10
 MR. McLAUGHLIN: Yes, thanks, Susan. I


just wanted to respond to Richard's question about

the fire drill that's going on at the moment -­

some more color if you like, and to John's


comments about it.


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 The proof of the pudding is in the


eating, in my view, and here we wanted to be a


little bit more extreme. So, yes, we're assuming


that one member goes into default. But in our


CCP, that member was not put in default until


afternoon, so that late-in-the-day problem for


investing cash really comes up. It was a member


with significant PPS relationships. So then we
 

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 were testing the pipes, if you like, for how money

gets to the CCP through intermediary means. It


also provided a settlement function, and it was


also a large counterparty for our treasury


function. So, we were hitting a lot of points


here. It wasn't just the normal test the auction,

so to speak.


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 It also -- the market stress was


Brexit-like, so it was fairly significant stress,


and this member also had a lot of client positions

so that we're in the process now of porting them.


It was of the order of 400 client positions that


we needed to figure out how to port.


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 MS. O'FLYNN: Okay, before we wrap this


up, I just think I want to make a comment. So far

in the drill, yesterday was a very busy day, and I

think what I really appreciate is the clearing


members -- the cross-product nature of this. I


think we have been so much -- too focused on


looking at OTC IRS in kind of -- without looking


at the broader, overall impact in communication to

clearing members when you're talking about
 

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 multi-products. Some clearing houses clear, you


know, three to seven different types of product


ranges, and the communication that comes from, you

know, those clearing houses can be quite


different, depending on the product side. So, I


think it's going to be a great asset test for both

clearing members' participation on a cross-product

basis but also the CCP communication and


coordination around all of those products. But,


you know, we're only into day two, and we have


another eight days to go. So, with that, I'm just

going to wrap it up and turn it to Petal.


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 MS. WALKER: Thank you, Susan. We'll


 14
 have a five-minute break before we start


 15
 Panel 2. Thank you.

 16
 (Recess)

 17
 MS. WALKER: It is a pleasure to call


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

agenda, our second panel discussion will be on


cybersecurity. I would like to introduce Mr.


Dennis McLaughlin, Group Chief, Chief Risk


Officer, at LCH, who will facilitate and help
 

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 shape the discussions during this second panel.

 2
 MR. McLAUGHLIN: Thank you, Petal. And

thanks to the commissioners for facilitating


 what promises to be a very, very


interesting discussion on cyber risk.


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 6
 We are privileged to have three


well-known industry experts in this area. Steve


Chabinsky is a partner at White and Case; Karl


Schimmeck is the global head of vulnerability


management at Morgan Stanley; and Gil Vega is the

chief information security officer at CME Group.


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 So, to begin this, as a CRO it was quite


useful to me when I first read the paper, the


framework written by the National Institute of


Standards and Technology, NIST, on how to think


about cyber risk, because it's an issue which is


very concerning to risk officers all over the


world, and the framework basically has four


components.


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 The first thing you have to do is


identify the key assets in your organization, so


be it data, be it money, be it securities wherever

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 it is, but you have to know where they are. You


then have to, of course, put in strategies to


protect such key assets. You must have a strategy


to detect any threats to those key assets, and you


must be able to respond and recover to any threats


that you perceive.


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 So, there are lots of interesting


questions around this. Having assumed that we've


identified the key assets, the Commission has laid


down three very important questions, which fall


into the other three categories: so, around


protection, protecting the assets, and responding


and recovery.


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 I'll just ask the first key question,


which is: What are the current cybersecurity


considerations in the application of emerging


technologies in the swaps and futures market -­

for example, cloud computing, FinTech, distributed

ledger technology, automated algorithmic trading.


I'll start with -- Gill, if you wouldn't mind


responding to that.


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 MR. VEGA: Sure. I'll respond briefly


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 and allow my fellow panelists to jump in as well.

 2
 Thank you for having me here today.


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 I would categorize these into truly


emerging technologies, such as internet of things,


such as distributed ledger, such as digital


currencies, and technologies that have been around


a while that actually started to make an impact in


the financial sector including things like cloud


security, cloud applications, and the security


implications around that.


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 I would say that some of the things -­

some of the considerations that we take into


account in partnership with our peer firms and our


competitors, because we talk to them all the time,


are making sure that not only do we have the staff


available that have the requisite knowledge of


these new technologies, but we also make sure that


we do a lot of research into potential


vulnerabilities around these emerging technologies


but also try to understand how the vulnerabilities


will be leveraged from a threat actor perspective.


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 The CME group is not unique in our


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 ability to really understand our threat landscape

and understand some of the actors that focus on


our industry but also our company, and having the

ability to do that can help us anticipate some of

the threat actors and their motivations as they


target some of these new technologies.


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 MR. McLAUGHLIN: Thank you.

 8
 MR. SCHIMMECK: Just to add, I think, a

 9
 couple of points to that one.


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 MR. McLAUGHLIN: Sorry.

 11
 MR. SCHIMMECK: For a third party, I


think it's a really large consideration and very


much just trying to go hand in hand when we talk


about cybersecurity, talk about third-party risk


management. When you look at cloud vendors, you


know, you look at distributed ledger, you're


talking about pushing a lot of your key technology

points outside of your, you know, your four walls.

And then how do you gain transparency and have


oversight to that and doing it in a controlled way

that will allow you to make sure you're managing


the risks and you're also -- you've outsourced
 

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 those things for a reason. So, making sure that


those firms in many cases that are concentrated as

we look at our client service providers -- you


know, how are they managing the risks and what is


the oversight that is being put on those, because


in many cases those are not financial services


firms; they are pure technology providers.


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 I think one other piece under


consideration as you look at some of the emerging

tech is just, you know, kind of what the -- we


want to promote innovation. I think that's a


really core component to financial services, and


it helps us, you know, from a business sense. Bu

how do we do that in a controlled way? How do we

do that with, you know, making sure security is


baked in from the beginning, doesn't become a bol

on afterwards.


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 But that is that key consideration,


because, you know, the evolution the last 20-30


years -- we've gotten to a point now where


technology is not something that's -- you know,


it's not an enabler to our business, it's actually


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 a key component. There is no ability to go manual

anymore; there's no ability to do anything without

technology. So, how do we make sure that anything

that we're bringing in is being brought in, in a


safe way; it's being thoughtful, the incentives


are in the right place and security is baked in;


and then, you know, how do we make sure we do


those for those firms that may not ever have


mandatory oversight.


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 MR. CHABINSKY: I wanted to first start


by thanking the Commission for having us here, and


the members as well. This is an extremely


important topic to all of us.


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 And I think I would start by briefly


discussing the NIST framework that you mentioned,


because I think it has added a lot of clarity and


harmony to cybersecurity, at least the way we talk


about it, and also to commend the Commission and,


in fact, other federal regulators for seeking the


harmonization of cybersecurity rules that we spoke


about earlier today, which is extremely important.


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 That said, I think it's extremely


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 important for us to realize that cybersecurity


frameworks are perhaps more easily said than


accomplished. And the NIST framework -- before


you get to the appendix, it's only 17 pages long.


If someone here has not read it, I recommend it.


At least for me -- I confess to being a geek or a


nerd or whatever -- I found it to be a good read.


But in very many ways, because it's so easy to


read, it belies the difficulty underneath the


hood, and when you get to the appendix in the


back, you recognize that these five simple


functions break down into a group of almost two


dozen categories, which further break down into


almost a hundred subcategories, each of which


would give any professional a battle behind it.


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 And that's not even to mention all of


the third parties that we're discussing now that


we've grown reliant upon both directly and


indirectly. Directly -- when I say directly,


there are the products and services that we


ourselves run in our businesses and those that we


contract for, and I consider both of those direct.

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 We have some sort of control, whether it's through

audit or understanding certifications or, more


directly, actually providing the security features

that we need in order to contract.


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 But indirectly we are relying upon an


ecosystem now that impacts all of our businesses


in ways I think best demonstrated by the recent


DDoSattack where we see simple IOT devices already

mentioned at least in the hundreds of thousands


that were taken over in people's houses turn into


a massive attack that included what I would say is

the underlying infrastructure for the Internet


that all businesses rely upon and then become


victims of.


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 To put that in perspective as we talk


today, we all remember the DDoS attacks that


harmed the financial services industry over four


years ago, widely attributed to Iran. The attack


at that time was claimed to be in the nature of


 billion bits per second flooding


computers. That sounds like a lot, and it is a


lot, and it was massively larger at the time than


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 other attacks before it. The IOT attack that we


just witnessed that affected this DNS service was

reported to have been at 1.2 trillion bits per


second. So, that's my way of saying that the


Internet that we have grown reliant upon and that

we regulate and that we try internally to control

has become increasingly out of any individual


organization's control, and it fundamentally


relies upon frameworks that may appear simpler


than they actually are to achieve.


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 That said, the increase in technologies


that we're discussing today are steps in the right

direction. Mr. Vega mentioned cloud security as


one example when we talk about cost systems,


oftentimes we forget to talk about how the cloud


has actually been used to advance security in ways

that otherwise we really would not be able to


achieve security objectives. This includes, for


example, DDoS mitigation which without cloud


resources would not be possible. It includes end


point detection monitoring where each end point is

providing information in a cloud environment
 

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 that's sharing information automatically with one


another and, in fact, able now to update and


operate systems and reporting in a way that almost

starts to look like a self-healing network.


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 So, I think a closing comment for just


this part when we talk about the cloud is to


recognize that cloud resources are being used both


as an innovator and as a security measure.


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 MR. McLAUGHLIN: Thanks, Steve. You're


actually talking a little bit -- beginning to


speak to question two as well, which is the


emerging threat environment. So, if I could move


on, it's a good segue.


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 What do you think -- the current


cybersecurity threat environment risk exposure to


the financial sector, ransomware, and other cyber


crime, recent attacks on financial institutions


and networks? So, what are your thoughts on that


current "evolution," if you like? So, maybe Gil?


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 MR. VEGA: Sure. We've seen this evolve

very rapidly over the last decade or so, and it


continues to evolve to the point that major
 

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 financial services companies like CME and the


large banks have teams dedicated to really getting

an understanding of what that current threat is,


which could change very dynamically. It could


change in days based on a new vulnerability, based

on a change in geopolitical situation globally;


and it could change based on the capabilities of


these actors that seek to do us some harm.


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 Going back to the CSF -- the Cyber


Security Framework -- I just want to say that, you


know, we'll get to this a bit later as we talk


about some of the interactions we've had as a


community, but those last two components of the


CSF, which are respondent and recover, that's been


a key focus for us, because as a community, as a


financial services community, we know we're going


to be attacked.


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 There was a British study of businesses

that was released last week that said 46 percent


of all businesses in the UK had been attacked,


which left me wondering what the other 54 percent

were thinking about, quite frankly.
 

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 So, having the awareness and the


recognition that you're going to be attacked as a


company we're attacked hundreds of thousands of


times per month. That equates to about a couple


of dozen incidents per month. Understanding that


you're going to be attacked, there's heavy


motivation to attack companies like CME and Morgan


Stanley, but having the ability to quickly detect


those attacks at a very granular level, being able


to respond effectively to those attacks, and then


making sure that you have resiliency programs


built in so that you can recover from those, what


I call inevitable attacks.


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 MR. SCHIMMECK: Sure, and I think the


one thing we wanted to add when we talk about the


threat, and this goes to what we're seeing in


these studies and such as that, it's becoming a


more dangerous landscape out there. We're already

a target. There are increasing, I think,


situations where we are becoming more of a target.

You know, we've always been one because of,


naturally, the criminal element. The banks are
 

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 where the money is, that's where theft occurs.


But then you also see the evolution of


geopolitical means in regards to, you know, is the


financial services sector a proxy because of


critical infrastructure? You know, where do we


stand on that? And this goes into a lot of


discussions we've had with the current


administration, with DHS, with FBI in regards to


protection of critical infrastructure and the need


for kind of, you know, U.S. government as well as


other world governance to really look at this and


say, you know, how do you protect those critical


assets that really underlie the entire global


economy, their ability to operate, and safety


soundness, all those sorts of things.


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 So, this is -- you know, we're seeing


the firms are taking this very, very seriously.


This is a board- level issue at almost every firm

out there. Firms are spending money, adding


teams, adding technology in order to make sure


that they're taking risk mitigation very


seriously. Also looking at the underlying
 

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 infrastructure to ensure that we're looking at


what vulnerabilities we have and how do we make


sure we are not providing any kind of easy targets

out there for attackers. So, you have that


combination -­

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 MR. McLAUGHLIN: Karl, could you move


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 closer to the microphone.


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 MR. SCHIMMECK: Sorry, it goes back to


the framework of looking at it across the whole


spectrum of, you know, looking at our


infrastructure; how do we protect, detect; and


then if something were to happen how do we make


sure we mitigate the impacts.


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 MR. CHABINSKY: The typical way we


consider harms in our cybersecurity world for any


industry is breaking it down into harms against


confidentiality, integrity, and availability. And


I think there has been a change in the dynamics of


what we're seeing from the threat landscape.


Initially, we saw much more in terms of harms to


confidentiality -- credentials, for example, being


stolen in order to commit fraud. We still see
 

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 that, of course. In fact, some of the more recent

large-scale intrusions that have occurred in the


financial services sector remain exactly for that


reason, because that's where the money is, and


credential harvesting still occurs and typically


is focused against the consumer, not the better


protected institution.


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 Integrity is an area of concern when


records might be altered, and the institutions


certainly have spent a lot of time and attention


being able to what I would call roll back


transactions, understanding log records,


understanding how the money is moving, which is


increasingly important.


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 I don't have to remind anybody here that

our financial system is based on zeros and ones,


but not zeros as in no money and ones as in dollar

bills. I heard someone express it this way to a


group that was not as sophisticated in finance.


They said: We all know that there's no longer a


gold standard for our financial system, meaning


there's no bar of gold somewhere that represents
 

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 all of our dollars. What most people don't


recognize is there's no dollar that represents


every one of our dollars. And that shows the


issue of integrity that the institutions have


taken quite seriously.


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 And the last is this notion of access


and availability, the ability to bring down


systems for a certain period of time. We see the

bank and finance sector focused on each of these


and each of these as a focus not merely of lowlevel hackers -- that's another area that I think

has changed in the threat landscape.


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 At the beginning, we were always


concerned about the single, individual hacker. I


think to some extent that may have been fostered


by movies like War Games where you think it's one


person in a basement somewhere. But that quickly


emerged that organized crime in this area became


not only big business but logistically incredibly


sophisticated. And I would point to the ATM hacks

that we've seen on a number of occasions moving in

excess of $40 million in a 24-hour period by
 

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 breaking into banks; by altering fraud detection


schemes; allowing transactions to occur in excess


of otherwise controlled limits; making sure money


still remains in accounts so that the limit of the

amount of money that could be taken out in an ATM


is really just the amount of money in the ATM.


But seeing that take place in 12 countries and


over a hundred cities at once with tens of


thousands of transactions where individuals on the

ground are reporting money backup, going through


no fewer than 10 different organizational


capability sets, right? This is big business.


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 And more recently when we're talking


about Bangladesh and the SWIFT incident there and


reports that that was nation state sponsored, that

we have nations that are robbing banks is


something I believe nobody in this room that


represents the private sector ever signed up for,


which does bring us to an important question,


especially from a regulatory perspective, which I


hope we can get more into today, which is whether


the notion of regulating institutions to try to
 

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 defend and protect themselves continuously against

nation-level threats and organized crime groups is

really ultimately a fool's errand that we could


afford to continue with.


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 No doubt enterprises have to provide


modest and reasonable protections, but we really


do have to question our strategy whether a


vulnerability mitigation scheme rather than the


country itself protecting against advanced threat


actors; rather than figuring out if we could


mitigate some of these harms at a much higher


level in the Internet ecosystem before they ever


reach the banks; whether we can talk about the


design of the equipment -- software, hardware,


firmware -- that's more transparent in the


security rules that they apply to make security


easier; whether metrics can be driven across


industry with the help of the government. These


are areas that it would do well for us to look at


so that we don't keep putting the burden of


cybersecurity on the private sector and the end


users.
 

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 MR. McLAUGHLIN: Very interesting


comment, Steve. It brings us to the last


question, because it's


 obviously something that we all share

regardless of who you are in the financial


services. We all share a concern in this area.

How is the industry collaborating in order to


respond to cyber threats?


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 MR. SCHIMMECK: Sure. The industry's


got a -- we have a long history of working with


each other and working with the government to look


at not only cyber security but physical risks to


the sector. So, really, the two main entities


that we've formed -- and they've been around for


about 15 years -- is the FS-ISAC, which is the


Financial Services Information Sharing and


Analysis Center and the FSSCC, which is the


Financial Services Sector Coordinating Council.


So, those two entities working hand in hand with


their government partners -- this would be the


FIBBIC which the CFTC is a member of -- this is


really kind of the underpinning of how we work and


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 collaborate not only with each other but with the

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 government.


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 We work, you know, we are in


collaboration with our partners and with other


firms on a daily basis sharing information,


understanding what's going on, what sort of


intelligence they're seeing, what is going on,


like Steven had said, in an increasingly dangerous

world out there.


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 We also collaborate extensively with


FBI, Department of Homeland Security, Secret


Service -- in our sector, a specific agency, the


Treasury Department. So, kind of with that we


find that the ability to share information rapidly


is an absolute essential piece to understanding


where we need to focus our energies, focus our


resources, and make sure that we're protecting our


friends and our clients as adequately as possible.


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 This is also an area that is a


noncompetitive one. You know, every firm looks at


it as, you know, this was an attack against the


sector. It affects the trust that underlies
 

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 financial services. Hence, we do everything in


our powers to make sure that firms are protected


overall and the sectors are protected overall,


and, you know, that extends, obviously, into all


of our financial utilities and all of our


partners.


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 So, that's kind of been the history.


Where we've gotten to more recently over the last


couple of months is the standing up a new entity


called the FSARC. This is the Financial Systemic


Analysis and Resiliency Center. This is focused


at critical infrastructure, so via Executive Order

13636, any firm -- we have a set of firms that


have been designated by DHS and the U.S.


government as critical infrastructure within


financial services as well as other sectors, and


we've been working together to make sure that kind

of the entities that control the critical


infrastructure of financial services or kind of


going that extra mile to make sure they're


protected, sharing information, and doing some


advanced collaboration. So, that's an entity
 

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 that's just kind of getting out of the gate here


recently. We can expect much more of that in this


coming year, but, you know, sharing is absolutely,


again, the underpinning and essential to what we


do.


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 MR. VEGA: If I could just jump in here


about the FSARC, we're excited as a community to


have the ability to collaborate but to collaborate


in a way that brings those that have more skin in


the game together. The FS-ISAC is an organization


that allows I think it's more than 5,000 financial


organizations globally to come together and share


information sometimes in an automated way. The


FSARC, the Financial Systemic Analysis and


Resiliency Center, allows the eight global


systemically important banks and the systemically


important market financial utilities like CME and


DTCC and ICE to come together in a smaller group


to talk about cyber as it relates to systemic


risk. And I think this is really kind of the leap


forward in our community that allows us to start


identifying those systemic vulnerabilities across
 

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 finance, working with Treasury and other


regulators to -- I'm an Army veteran, so I believe


that you fight like you train, and our training is


these national-level exercises, the Hamilton


series of exercises that are continuing, that


allow us to really examine what's vulnerable in


our ecosystem and how we would collectively


respond to it, not on a firm basis but on a


community basis, and I think the FSARC is going to


be key as that stands up to pushing our


capabilities forward in that regard.


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 MR. CHABINSKY: I wanted to echo the


view of the importance of the FSARC in light of


the incredible work that the FS-ISAC has done to


this point. There is no doubt in my mind -- based


on my prior experience, which includes over


 15 years of service with the FBI where I


had actually built


 and lead the FBI Cyber Intelligence


Program and later served as deputy of the FBI


Cyber Division -- financial services does


information sharing better than any industry group


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 out there. What I think the FSARC is bringing to


this is an additional layer of strategy that


otherwise can be eaten up by the day-to-day


tactics that are involved in cyber security.


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 And to put a finer point on that, I


think that a lot of times we talk about


information sharing as though it were, in and of


itself, a worthy goal: How's information sharing?


What is information sharing? And I've spoken with


other sector groups that I think are not as


sophisticated as the financial services sector in


this regard, some who require their members to


provide information in order to get information,


for example. And really at the end of the day we


should be looking to see if there are any barriers


to information sharing.


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 But ultimately we're trying to solve


problems, and it's a lot better to say: What are


the biggest problems that the industry is facing?


And then: What is least amount of information and


the fewest number of members that would be needed


to be able to analyze and come up with an answer
 

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 that could be used for the benefit of a sector as


a whole? And to the extent there's a free rider


problem in that, which I greatly admit there would

be, then some people would just have to pay for


the solution.


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 But the answer is not otherwise let's


see how much information we could push around from

one group to the other, and I find it discouraging

when I hear groups -- including the government -­

just ask for more information to be shared


without, really, an understanding of what the end


goal is of that. Information sharing is one


means, and there are other means of course, as


well, to understanding how to make the environment

more secure, more resilient and to make sure that


threat actors ultimately are deterred from trying


these actions in the first place.


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 MR. McLAUGHLIN: Thank you, Steve.


Well, there's a lot to digest here, so I'd like to


 throw it open for questions. If you


have a question, please move your card.


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 Well, I have one question. What would
 

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 you expect -- what would you look for from


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 regulators like the CFTC to help in this effort?

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 MR. VEGA: A few things. We are very


appreciative with regard to the new rulemaking and

regulation that came out late last year with


regard to system safeguard testing. We agree


that, and we've commented on this heavily, we


agree that the approach -- the principles-based


approach to regulation is really the approach that

supports true risk-managed and risk- informed


success in this area. What we see globally is


sort of a drifting away of those principles-based


approaches to regulations. Some of the regulation

that's pending is very prescriptive, which may not

drive risk in the direction that we all want it to

go. So, the continued focus on principles- based


regulation in this area I think is going to be


helpful for the quite different, large firms and


financial services to manage the risk.


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 MR. SCHIMMECK: An item I'd add to that


I think is, as we talk about information sharing,


collaboration, you know, we do across the private
 

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 side, I think having at least the U.S. regulators


collaborate with each other I think is really


important. You know, we have this notion and


we're starting to champion out there through,


again, FSIC and FS-ISAC of regulatory


harmonization the idea that in many cases


regulators are asking, not only in the U.S. but


globally, for a lot of same things but just in


slightly different ways. So, just finding ways


that we can do that in a really efficient process


would be incredibly helpful, because at the end of

the day compliances is kind of table stakes here


-- that's just for kind of getting in the game and

our expectations. But risk management is


ultimately where we want to get to, and so how do


we, you know, going to Gil's point, using


principles that underlie, allow really a one-size


approach not to occur and then also working I


think through bodies like IOSCO, from a global


standpoint, that we can say, you know, kind of how

do we pull together all of the -- you know, in


that case, the security regulators to maybe take
 

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 one or maybe a few approaches versus many, many,


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 many approaches to this situation.


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 MR. CHABINSKY: Well, I would add one


thing and echo a second. The point I would like


to add is that it may in fact be time for the


regulators to question whether the strategy is


actually correct that the U.S. is pursuing, which


was pursuant to my earlier comment. Ultimately, I


think it is a fail strategy to believe that the


end users, including critical infrastructure


owners and operators in the financial


institutions, have a sustainable plan, from a risk


management point of view, that will protect our


country and the bank and finance system included


within that. I think we have to move this away


from the end users, and I think that the


regulators can actually step up and actually kind


of look down on what we're all doing. This is not


in any way a critique of what the regulators are


doing. In fact, the CFTC and the federal


regulators have done a better job regulating and


looking towards risk management principles than
 

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 many others.

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 Still, the question remains whether or


not that approach, no matter how well pursued, is


actually the right approach, and I would urge the


Commission to become part of a larger debate of


whether there is room for a greater threat


deterrence and for more involvement by the


Internet ecosystem to get rid of threats and


vulnerabilities at a higher level; to move towards


better metrics involved in what's working as


against the threat; and to be involved in more


transparency and the creation design of software


and hardware that we are all reliant upon. So, I


think there's actually another strategy, that the


Commission can be part of another broader dialog


that ultimately is important.


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 The second is although the federal


regulators have actually done a very good job of


looking towards harmonization, we now see New York


State and the Department of Financial Services


getting into the mix in a way that is not


consistent with what is otherwise being done. And


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 in fact, in recent comments by New York State,


they actually said that in their view a risk


assessment should not include a cost benefit


analysis when it comes to accepting or mitigating


cyber security risk. That does not seem to


comport with basic concepts of enterprise risk


management.


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 And the possibility that other states


will take suit and will also become a federated


view of cybersecurity similar to what we're seeing

in the data breach notification realm would not be

beneficial to consumers in the end run.


Businesses need consistency and an understanding


of where to focus their resources. We need to


move forward in concept and in terms of tactics


and strategies. So, I do believe that this


Commission as well as other regulators need to, as

has been discussed, think of harmonization


unfortunately even broader than the federal


regulators.


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 MR. McLAUGHLIN: Unfortunately, we only


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 have time for one question, I've just been told.
 

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 So, Anat.

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 DR. ADMATI: DR. ADMATI: I find this a


very interesting discussion, because I do think


cybersecurity is an enormous risk, but I


particularly found fascinating the question of


who's problem exactly it is and whether it's


through the private sector or public sector. So,


a couple of comments.


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 First of all, there have been a lot of


mergers in banking, and I hear from sources within


that IT systems have not been really streamlined


and that, you know, IT is kind of, in some of the


ones that have had lots and lots of mergers over


the years, vulcanized and hard to find


information. So, those are things at that level.


So, that's question one.


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 And question two, and comment, has to do


with your comment, Steve, about how it's a broader


problem, it's a public -- it's a sort of


collective action problem and all these


jurisdictions and all these public sector and


private sector actors. And so I think it is
 

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 ironic right here in CFTC -- which is probably the

poorest of regulators -- to throw it at other


people without all of us here lobbying for some


federal government or somebody to take this on as


opposed to passing it on from one party to the


other. I would say that the private sector often


has more resources than the public sector or


somebodies in the public sector to do stuff. So,


obviously collaboration is critical, but just


that.


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 MR. CHABINSKY: I'd comment on your


second point, although not the first, because I


wouldn't be aware of the vulcanization issue that


companies are seeing. I might agree with you


entirely that if we're going to get this right,


it's going to require the private sector and


indeed an international effort to understand how


best to resolve this, and I do think that with the


resources that the private sector has, certainly


in terms of strategy and will, that a lot could be


advanced on where we should recommend our next


steps in coordination with the government.
 

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1
 MR. McLAUGHLIN: I'm afraid we'll have


to leave that very interesting discussion. Thank

you, everybody.


A

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 MR. CHABINSKY: Thank you.


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 MS. WALKER: Thank you, Dennis. We'll


take a 10- minute break and start again about


11:35.


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 (Recess)

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 MS. WALKER: It is my pleasure to call


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


agenda, our third panel discussion will be on the


state of the market. I would like to introduce


Mr. John Nixon, Senior Advisor for NEX who will


facilitate and help shape the discussions during


this third panel.


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 MR NIXON: Thank you. Welcome all back.


I'd also like to offer my thanks to Acting


Chairman Giancarlo and Commissioner Bowen as well


as to Petal, for all the work that they've done in


putting this together and many thanks to all of


the MRAC committee members who have taken the time


to be here today. We don't have any speakers for
 

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 the session today. We've asked a few people who


are members to help initiate some of the


discussion on each of the topics but obviously all

of you are welcome to join and any of the topics


just please raise your name card and we will call


you out. We'll speak for probably about 15


minutes on each of the topics leaving some time


for any closing remarks and any other topics that


the MRAC members might want to bring up.


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 The questions today all of you have


them. Just to let you know these are the


questions that were submitted to the MRAC


committee by the CFTC. They are their areas of


interest. They are topics that they would like to

hear from the MRAC committee so if you don't like


any of the questions don't blame the facilitator


because I didn't come up with them.


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 Let's start with the first question on


volatility events. How did the markets cope with

the recent volatility events particularly around


Brexit and the U.S. election. What are some of


the concerns that your organizations have about
 

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 the potential short term and long term


consequences of these volatility events. How are


you preparing, how are we coping. If you don't


mind I'd like to call on Kristen Walters to start


us off and then we'll open it up to everybody else

to join in on the discussion.


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 MS. WALTERS: Sure. Can everyone hear


me okay? So, I would say from a short term


perspective particularly with regard to liquidity,


both recent events, the U.S. election as well as


Brexit were addressed effectively by markets. We


were surprised by the outcome but certainly


markets were able to adapt and address. I would


say more broadly, there has been a very


significant change in market volatility and how it


presents itself in financial markets. At least


from my perspective for many, many years before


the financial crisis, developed market behavior,


economic policy in developed markets was highly


homogenous. Unlike emerging markets where there


was lots of heterogeneity and market shocks caused


by economic policy, we just didn't see that in
 

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 developed markets. In general, from a risk


management perspective statistical models and


stress testing could be used to reasonably


estimate the impact on P&L and portfolios and


alpha in adverse market conditions.


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 I think starting with the financial


crisis, post financial crisis with very


significant monetary policy intervention for many


years, structurally the nature of markets has


changed and they appear to be structurally much


more susceptible to economic policy shocks. So,


in today's markets particularly with the rise of


populism in the UK, the U.S. and continental


Europe, what you tend to see are economies and


markets that are quite heterogeneous from an


economic policy perspective which I think has


resulted in the markets appearing to be benign for

very long periods of time. So, you'll see


situations where volatility has been very, very


low. In fact, encouraged by monetary policy and


real negative rates for a prolonged period of


time, but the markets are very susceptible to
 

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1
 economic policy shocks and large movements to the

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 downsize on economic policy surprises.


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 So, as a risk manager, what I do and


what my team does globally, is we spend a lot of


time working with economists and investors across


the firm talking about what events could


potentially occur. Instead of defining a single


event in a set of outcomes such as Brexit, what


we'll do is we'll look at varying permutations of


an event that could unfold. Currently, I think,


recently it is looking more and more like a hard


Brexit might occur but we run models against our


portfolios to look at the impact of varying


outcomes as the UK starts to separate from the


European Union. What it means is it is more


difficult to measure risk and there are a lot more


surprises that are significant, multiple standard


deviation moves that we've never seen in the past.


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 I guess the last comment on Brexit, in


particular, is that appear that the market reacted

quite significantly on the downside. UK equities,

property and the currency itself, I think,
 

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 potentially there could be more volatility on a


hard Brexit but the real concern that we have is


the long term impact on the UK economy. There


have been some, I think, her Majesty's Treasury


did a study before Brexit and there was a view


that GDP could fall between 6 and 7.5 percent in


the event of Brexit which would make the UK a


poorer country in that event. So, I think, that


is our concern specifically with regard to Brexit.

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 CHAIRMAN GIANCARLO: Kristen,


traditionally, in the markets that we oversee at


the CFTC, futures and swaps, there is a fair


amount of correlation: heightened activity levels


say in interest rate futures would also see


heightened activity levels in swaps. We watched


the Brexit event from our perspective here in


Washington, very carefully. One of the things


that was actually somewhat remarkable was the


activity levels in futures, including interest


rate futures which were heightened in the wake of


Brexit, activities in the correlated swaps were


actually fairly quiet. Does that activity cause
 

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1
 us to question whether market participants, in the

wake of the new information provided by the Brexit

vote in reassessing their portfolios, perhaps may


have been reluctant to engage in products that had

been subject to reg reform, in particular, Dodd


Frank, and chose to participate in markets that


were subject to more longstanding traditional


regulation like the futures market, or are


unregulated, such as the currency markets. Is


there something about the quietness we saw in the


swaps markets following Brexit that may actually,


say something about the markets' comfort level


with some of the changes that have been made.


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 MS. WALTERS: I mean from my personal


perspective, I don't think so, but you definitely


raise an interesting point. We definitely see, in

times of market stress, much more activity in the


most liquid instruments. Certainly, you'll see


lots of flows in ETF's, for instance, in adverse


market environments on the equity and fixed income

side and it's not surprising that you would see


increased futures activity with many market
 

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1
 participants taking views on the rate side via


futures. Why the lack of activity in swaps, I


don't know. From Black Rock's perspective, I


think, we nearly at 97ish percent of any


derivatives that we transacted on behalf of our


clients' accounts are either in futures markets or


centrally cleared. We have viewed clearing of


swaps to be a very significant plus for financial


markets and as a risk reduction tool overall. The


only point I would make about liquidity is I


certainly share Bob Wasserman's and other's


concerns about liquidity issues and portability


given regulatory capital requirements and


leverage. So, I do view that particular issue as


an added risk from a liquidity market perspective


to markets. I guess I would leave it and see if


others have comments on swaps versus futures post


Brexit.


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 MR. NIXON: Jerry, do you have something

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 you might want to add?


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 MR. BEESON: Well, I think in a similar


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 comment in terms of thinking about the swaps
 

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1
 versus futures point, from our vantage point, I


think, one of the primary concerns have been,


would you see iteration terms of the liquidity


available across the different SEFs in a way


either leading into Brexit or post Brexit. From


our standpoint, I think we saw a very resilient


liquidity available on the SEFs that for those


that wanted to trade the swap market that they


were able to do so very resiliently.


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 MR. NIXON: Sunil?

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 MR. CUTINHO: I think I wouldn't be


answering the Chairman's question but I will just


be acknowledging a few things. One is for both


those events, what we noticed was very high


liquidity during the Asian and the European time


zones. These were well anticipated events. I


think at least for Brexit, we were quite aware of


the fact that a lot of traders, in even the


European time zone, had positioned themselves to


participate during the Asian time zone.


Immediately post the results were published. So,


that is one factor. The second is we saw
 

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 significant volatility in the Asian time zone,


especially in the Nikkei contract. We saw a lot


of activity in safe assets, gold and treasury


futures, FX especially the sterling and the Euro


moving and then finally, treasuries rallying


significantly.


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 So, as Kristen pointed out, I think,


liquidity is basically an evolving thing


throughout the 24 hour time zone and we noticed


that a lot of traders were actively participating


in the futures markets at that time.


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 From a risk perspective, that is a


CCP's, that's how we look at things from a risk


perspective, these were anticipated events that we


could prepare for just like Kristen pointed out.


I think, CCPs across the board were preparing for


them well in advance. It holds true for this year


as well. We have a lot of elections that can to


Kristen's point, create or inject more volatility


into the market. I think from a risk manager's


perspective, you cannot bias your views on one or


another outcome, you have to prepare yourself for
 

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 any outcome. That has been the focus for us CCPs.

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 The second focus for us as CCPs is to


make sure that we don't create unanticipated


demands on our clearing members as well as our


clients in terms of liquidity. That's a very


important thing to keep in mind because a CCP


cannot think of itself but it has to think of the


entire ecosystem. I think the markets performed


very well throughout both those events. I think


the CCP actions were very measured throughout both


those events. And as CCPs, we stand prepared for


the events to come as well and that is what we


have to look forward to for the rest of this year


until September.


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 MR. NIXON: Dennis.

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 MR. MCLAUGHLIN: Thank you. I'd just


like to add where do we go now from where we are.


So, Brexit has happened. The CCPs all managed to


get through it, the market got through it but


there is increasing noise especially in Europe


about clearing Euro products on the continent.


From a risk management perspective, that raises a


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1
 lot of concerns. The biggest concern I have is


that once you artificially fracture a global


liquidity pool, for example, as we have in swaps.


You then have less members to bid on a defaulted


members portfolio. You have less members to which


you could actually port a client's portfolio. You


have less members who are involved in the


assessments that could happen. You have less


members around which to share the losses from


variation margin and gains haircutting and you


have less members to basically at every step of


the waterfall as you move down, you have a worse


position than you had before. So, that increases


the systemic risk and this is one of the big


concerns that I have.


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 MR. NIXON: Before we go onto the next


question can I open it up to a couple of the other


members. Maybe one of the banks could give their


view.


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 MR. CHATTERJEE: So, John, thank you.


To kind of directly address the Acting Chair's


question, I'd like to pick up on something that
 

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1
 Sunil was eluding to. Which is the fact that there

are fragmentations in anticipated in futures while

there is a whole lot between futures participants


and interest rate swap participants. I think the


timing of when the event occurs is very relevant


as to who can react to it. For example, Brexit,


the final news came out pretty much very late


night during U.S. hours. Most of the market


participants while they may have staff that is


overnight which is usually a normal event, the


markets in Asia were open. Because we do see a


concentration of let's say swaps, trading based on

regional and kind of SEF rules, the swap market


wasn't really up and alive at like 2 a.m. New York

time whereas the futures market was open for


business in Asia. That being in the middle of the

day, you kind of started seeing the activity.


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 The same thing happened with the U.S.


election results. The results were coming around


3 a.m., 4 a.m., and while again desks were usually


staffed to prepare for such an event. Markets in


Asia and markets in Europe were already opening.
 

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 So, by the time the regional focus on the U.S.


dollar swap markets starts to happen whether it is


U.S. dollar swaps or CDX, the markets in Asia have


already led the processing on the event and the


volatilities kind of dampened as the market


opened. So, these may be some of the reasons why


sitting at a market maker or bank, we see these


events already playing out and people's


expectations or their concerns around these events


dampened a little bit already.


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 MR. NIXON: Maybe we could use that as a


segway into the second topic around which has


already really been talked a little bit about,


around liquidity. Liquidity on the SEF's or


liquidity on any of the venues. I would just like


to hear some comments from the MRAC members about


the liquidity issues that they may have faced


either during times of stress or are there any


liquidity issues now that you are concerned about


that you'd like to share with the CFTC. There is


one thing that I think I would note that during


the Brexit situation, the markets obviously,
 

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 particularly the currency markets around sterling


were extremely volatile for a day and then that


volatility subsided pretty quickly. It seems to


me that a lot of these liquidity stress events


seemed to happen in a very short window and the


markets have a tendency to calm down very quickly.

But I'd just like to open that up and get some


more views from the MRAC members on the state of


liquidity in the marketplace both on a regular


basis but also in times of stress. Bis, do you


want to take one more crack at that?


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 MR. CHATTERJEE: Sure. So, John thank


you again for the opportunity and thank you Acting


Chair Commissioner and Petal for setting up the


discussion. I think I wouldn't want to blame


anyone. I think these are very excellent topics


that have been chosen. As we at Citi look at the


SEF market and the liquidity available, we


approach the market as principle market makers


looking to satisfy the risk needs and our end


users, some of who are here around the table might


have. In our experience over the last two to
 

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 three years as we look at the SEF regime mostly


across the interest rate swap and the credit


default swap markets, we think it is working


satisfactorily. When I mention satisfactorily, I


think from a normal day to day functioning, people

seem to be able to meet their needs around their


liquidity, their risk whether that is standardized

or non standardized.


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 We do see the SEF regime as a


marketplace where many SEF options do exist but


liquidity or the actual trading volume seems to


call us around a few venues. It is a little more


concentrated in the credit default swap market


with one or two venues whereas in the interest


rate swap market, that is probably spread out more


over three to four venues. And that seems to be a


consistent trend and not changing.


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 Why is it the fact that you see this


kind of construct and this concentration of SEF's


versus something like equities which is a much


more widely traded product across multiple venues.


I think that goes back to the comment I mentioned
 

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earlier on the Brexit is, the more concentration


of participants in a product class the tendency


for it to trade on fewer venues. So, for example,

if you compare the asset classes of credit default

swaps and interest rate swaps, you clearly see it


is a smaller marketplace in terms of number of


participants and the volume that has transacted.


Hence, the fragmentation across venues is much


lesser. And that number grows as you move from


the least concentrated asset classes to the more


concentrated asset classes.


CFTC Edits Page: 92
 

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 We do acknowledge and accept and, I


think, Kristen eluded to it, that stress market


conditions will occur. Stress market conditions


will occur and I think the market, looking at the


SEF construct has been living with the comfort


that these have been rare and when they're rare,


as John mentioned, the volatility and the stress


conditions seem to be dying out on their own


fairly quickly. They're not lasting over multiple


days or weeks. However, we do think that the SEF


rules by themselves or the event that happens
 

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 --how soon the volatility dies out I don't think


is aided by the SEF rules. That probably points


more to the construct of who are the nature of the


market participants and to the extent that there


are people that can warehouse the risk and have


the incentive to be the end user or the end


provider risk. That seems to me more, in their


capacity, seems to be the larger reason why some


of these events die out much faster. So, that is


our observations that the SEF construct and the


rules said as itself, doesn't help or hurt to


dampen the liquidity of the volatility.


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 As I said, we see flexibility in the


availability of SEF regimes, we welcome that.


However, we should understand that having multiple

venues connected to multiple SDR's connected to


multiple CCP's, does create kind of a complex web.

If everybody's ability to access these markets,


everybody's ability to have equal resources to be


available to connect to these markets, if that


were truly a level playing field, then you


probably see more trading and flexibility across
 

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 these venues. However, we know that every market


participant is different and to the extent that


market participants have varying amount of


resources to be able to support all these


platforms, all of these connectivity venues, you


definitely see them focusing around fewer venues.


Because there is a cost to be able to trade on


every venue, to be able to connect it to every


venue.


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 So, that kind of takes me down the path


as we look at the SEF construct, is there room for


improvement, can something be done. I think the


first area we'd like to point to which is


something, I think, the commission in the past has


looked at, is to make sure we have certain basic


guidelines for robustness and operational


capabilities that the SEF support. One of the


other areas of concern is that the SEF just has


one method of connecting to a part of the chain


which is a clearing house or maybe an SDR. We


welcome SEF's and some of them are around the


table to reflect on the fact that they do have
 

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 backup systems of connectivity and processing and


operational standards that would allow them in the


case of a failure in one of these connectivity


components to be able to process the trades and


not bring the markets to a standstill.


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 The other area which is again, been a


big area of focus is cross border harmonization


and we welcome the commission's efforts to reach


out to other jurisdictions. Case in point it was


very evident when the SEF rules went into place a


few years ago. We immediately saw bifurcation of


the market between U.S. SEF's and non SEF's. It


certainly is a concern for us and it is certainly


a concern for our customers. To the extent that


people don't have either the ability or the


resources to immediately connect to different


regimes and support regimes or there are political


irregulatory boundaries that prevent and we


certainly saw that. We had the experience that


there were certain non SEF markets that prevented


U.S. participants from joining them. I think the


commission should definitely work to ensure that
 

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 that doesn't happen.

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 And finally, we do welcome a continuous


evaluation of the SEF regime because it is not


like these rules are set in stone. So, we welcome


the opportunity for the market to be involved with


the commission and looking at SEF rules expanding


product requirements, bringing more products to


it. But we think any changes or modifications


certainly places a large burden on the market to


adapt to new products and new rules should be done


in the light of harming or helping liquidity and


should definitely have a cost benefit analysis


associated with it.


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 MR. NIXON: Jerry can I turn to you

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 there?


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 MR. JESKE: For the sake of


compartmentalizing, I'll defer to Richard because


my comments relate to the commodities market as


opposed to rates and CDS. So, it's up to you,


John.


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 MR. NIXON: Go ahead.

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 MR. JESKE: All right. I prepared some
 

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1
 remarks which are my own remarks reflecting on it


from a non-banking perspective and related


specifically to the commodities market. That


being eggs, energy and non-interest rate, non- CDS


to give a little bit different vantage point.


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 From a liquidity standpoint, the market


remains in a state of non SEF, still an OTC


marketplace in the commodity space. And to that


end, the number one item on the list that is


impacting liquidity is the $8 billion de minimus


ratchet down to the $3 billion. Continues to


reduce liquidity in the commodity space. Lack of


action on the part of the commission to affirm the


$8 billion as an appropriate threshold level for


non-bank dealers, is keeping market activity to a


minimum and is hurting commercial end users. We


continue to see the result through bankruptcies.


Sighting the Westinghouse bankruptcy here, $8


billion bankruptcy as well as many of the


bankruptcies occurring in the upstream oil area.


Both due to lack of hedging in connection with


lower prices in those commodity sectors.
 

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 The policy objectives of the commission


is to participation and competition in the


markets. It regulates without fear of


participants occurring cost of registration and


regulation, sighting the CFTC staff report from


2015 relating to the preliminary report on swap


dealing threshold. There is a need for legal


certainty and maintaining that $8 billon threshold

according to that preliminary report would create


some legal certainty. Moreover, the report refers

to the registration goal has already been met. 80

percent of the commodity swaps markets already


deal with a dealer on one side or another. The


report goes on to state, over 3400 non financial,


non registered entities traded swaps between Q2


'14 and Q1 '15. The vast majority of the dealers


are financial entities. Only 12 unregistered


entities traded over 5000 swaps in that same year.

The commission in action and having a negative


impact on the material percentage of that 3400 non

financial swap users from transacting swaps of any

size or frequency.
 

A

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 I ask the commission; does it make sense


for the commission to continue to impose a ratchet


down to capture nearly 12 non financial firms that


traded in excess of 5000 swaps annually. Why not


approach the 12 entities and simply ask them why


they are not registered and save the other 3400


perspective swap end users, non-financial


businesses, from the cost associated with being a


dealer. Those costs are registration, business


conduct compliance, recording, recordkeeping, risk


management requirements, legal compliance


requirements, legal disclosures, for CCO


employment and material capital set asides, or


face the prospect of leaving the commodities swap


markets or artificially capping its activity.


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 Before this special entity threshold was


fixed a few years ago, there was a special entity


that testified at the APPA testimony in front of


the House Ag Committee in March 2013 that


two-thirds of it counterparties had diminished or


had otherwise gone away mitigating any ability to


hedge its risk. Commissioner Bowen recently gave
 

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 a speech at the Euro High Level seminar in


Amsterdam. Quoting from her speech quite


eloquently here, "we can better achieve our


purposes as regulators to incentivize the


formation of efficient, transparent, well


collateralized markets that are safe for


counterparties. To do less is to fail to do our


jobs". I assert that a failure to maintain the


legal or regulatory certainty of an $8 billion


threshold is a failure of the commission to do its


jobs for the commodities swaps markets. I'm sure


that the current commissioners and its staff have


no interest in failing the commodity swaps


markets.


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 However, just to maintain the $8 billion


threshold is not enough. The commission has also


proposed a capital rule for non swap bank dealers.


So, those non-banks who might want to be a dealer


that is due for comment in mid-May so, I think,


this is a very timely panel to talk about


liquidity which the number one issue is obviously


capital set aside.
 

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 The former capital rule along with the


regulatory threat of the $8 billion ratchet down,


now have been the largest farce to entry in the


commodity swap dealing space. New capital rules


now that have been proposed are very welcomed


additions. For those who haven't read them, it's


a draft that has been out there for probably three


or four months, but the former rule was from 2012.


The new rule was introduced what has never been


introduced before which is a tangible net worth


test for non-bank dealers. Very insightful and


welcomed addition but there are questions that


remain. There is a three part test to the


tangible net worth. $20 million plus market risk


charges and/or credit risk charges. Or, 8 percent


of uncleared swap margin plus initial margin for


cleared futures. Or the deferment to the


registered Futures Association which is the NFA.


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 The questions are as follows: Is it up


to the industry to define the best practice or


will the commission provide some type of guidance


with regard to credit and market risk charges. The


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 draft rule refers to a standard deduction under


reg 1.17, however, that standard rule is not clear


from an end user or commodity market participant


standpoint. So, the process for approval of an


internal capital model is another question. Will


there be really a process or is that something


that the firms can use their own business


judgement to render. Alternatively, one can turn


to 8 percent of swap margin calculation but is


that determined off the gross notional of swaps or


is it related to any letters of credit or parent


guarantees. Many of the folks in the commodity


space deal with LC's or PG's and is 8 percent


calculation off of those posted letters of credit


sufficient. Does the 8 percent have a


subordinated debt sufficiency in it one way or


another. Some of these questions aren't answered


in the draft rule but hopefully over time we're


able to get at them to get some legal clarity for


those that might want to get involved in the swaps


commodities market.


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 As also noted by Commissioner Bowen


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 earlier in her speech, financial stability by


applying a capital penalty is counterproductive


and risk driving transactions back into the


darkness of the markets. Surely the new capital


rule cannot be met to be a penalty or perspective


non-bank commodity dealers. Presently, there's


very few based on the study that staff has put


forth. Without more clarity, the capital rule and

the commodity firms that might choose to become


dealers are unable to grow in a productive or


create any sort of liquidity in what is otherwise


a shrinking market.


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 One other point being is the 3400


non-bank commodity participants were in no way


part of the making of the 2008 financial housing


crisis and should not now be penalized by a forced


regulatory cost or forced registration due to a


failure of the commission to maintain the $8


billion threshold or establish clear capital rules


for non-bank dealers. Thank you.


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 MR. NIXON: Thanks Jerry. Sebastian,


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 can I call on you for a second.
 

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 MR. KOELING: Sure. I was focused more


on answering the Chairman's question with regards


to the liquidity in the markets especially during


the distress events. So, I will confirm what I


heard a couple of people say already. Indeed,


we've prepared to provide liquidity throughout the


night from our U.S. operations as well as from our


Asian and European operations. And because of the


fact that futures markets are open pretty much 24


hours, I feel the markets are able to absorb


whatever the volatility is coming from these


events pretty fast. We do, indeed, notice that


the liquidity typically sits in the most liquid


products so looking at the ten


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 year treasury and the S&P options if we


look at the index options. Looking at the smaller

says the liquidity there is a lot smaller. We try

to provide liquidity but the necessity for that


seems to be a lot lower during the first couple of

hours after events with unexpected outcomes have


happened.


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 So, looking at the liquidity, I actually
 

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 think the markets work really well being able to


get these volatile events priced in relatively


fast. I know I will have some more things to say


because it has already been mentioned a couple of


times, one of the biggest problems that we see


with regards to liquidity is the leverage ratio


problem that keeps coming up more and more. It is


actively impacting competitors. We have a lot of


talk about that because it becomes harder and


harder to actually provide liquidity. Not just


from the bank side but also from propriety of


trading firms and market makers like ourselves


that use clearing at different banks because it is


virtually impossible to get more room on their


balance sheet which just means we either have to


widen prices or we're less able to provide


liquidity in all the months that are out there.


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 MR. NIXON: Thanks, Sebastian. We are


going to come back to the leverage ratio and I'm


sure that there will be a lot of comments in


regards to that. Just moving for a second to the


interest rate environment. The CFTC has asked
 

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 what changes you guys might expect to see as the


interest rates begin to rise. Do you have any


particular concerns around stress in the


marketplace as interest rates begin to take a


direction that they haven't taken in a long period


of time. I open that up. Ed, do you want to take


a crack at that?


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 MR. PLA: No.

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 MR. NIXON: Bis:

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 MR. CHATTERJEE: Thank you, John. As we


look at the interest rate environment that exists


across the world, we like to break it up into


three regions. The first being the U.S., then


obviously the European zone and then Japan. We do


see, in the marketplace, interactions of


participants across these three regions. In the


U.S., obviously our view is there is the monetary


policy in effect. We do see, however, especially


election and post-election, a counter effect


coming from the proposed or the expected fiscal


policy. An assessment currently where it exists


in the U.S. right now, the interest rate and the
 

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 yield curve is trying to balance out the counter


effect. If I can elaborate, we see the effect of


the monetary policy as laid out by the fed to kind


of raising short term interest rates but overall


keeping the yield curve on a flatter basis.


However, the expectation from the fiscal policy


and as the details begin to emerge from the new


administration, we kind of see that as kind of


steepening the yield curve as the focus seems to


be on longer term growth. We've been seeing this


effect starting November onwards where


post-election and the kind of sudden expectation


for fiscal policy jumps, seem to indicate that the


yield curve would steepen. However, as details


are emerging or have taken time to merge, we kind


of see the market policy starting to dominate


again. So, we expect this to continue. Overall


our expectation from our economists is that the


current monetary policy in the U.S. leads to a 4


to 6 kind of rate hikes, kind of topping out near


the 2.5 percent regime. We think the current


growth rate in the U.S. probably supports interest


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 rates up to that level.

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 Moving on to Europe, our view is the ECB


has probably reached the maximum of the QE that it


was kind of expected. We do see signs of growth


emerging from the European regime. However, the


bigger issue in Europe seems to be the recent


political kind of landscape that is emerging.


We've slated for three large elections in Europe


and we're in the middle of one right now. I think


the policy in Europe will continue and the rate


environment in Europe will continue to get


effected by the political environment.


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 Moving on to Japan, we observed,


obviously historically, very low interest rates


there. Our expectation is that the focus on the


policy continues to be more on maintaining the


exchange rate and focusing on the exchange rate,


rather than on the interest rate. As a result, if


you are looking at interest rate flows, we do see


borrowing in the end being getting converted to


dollars and being invested in the U.S. rate


market. That was a large trade in the prior
 

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 couple of years and while there was a little


slowing down in that rate, we think that it is


picking up again. So, we expect the cycle of


borrowing from Japan and investing in the U.S.


dollar market to kind of dominate the flows going


forward.


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 MR. MILLER: Thank you, John. In the


context of interest rates and the yield curve, it


is probably appropriate to jump in on the comments


I have with respect to the life insurers


industries ability to execute hedges in what are


in its case, long duration products and the


challenges that they're facing finding liquidity


in those marketplaces. The aggravating extra


factor of the 15 minute delay in reporting that is


allowed, which we think is not sufficient because


of the liquidity concerns we're facing. Just to


be a little bit more specific, life insurers are


using the interest rate markets to hedge their


long dated risks, so they're often in the


swaptions market and forward starting swaps. In


the durations that they're trading, these are not
 

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 very deep in liquid markets and they cannot


complete their hedges within the 15 minute


reporting period. So, after their trades are


posted after 15 minutes, they still have more to


do, these are complex hedge activities and the


market dries up even further and prices widen.


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 And there is an extra aggravating factor

that has become more evident is the ability of the

dealers and other market participants to data mine

the activity thathat is actually occurring in the


market within the 15 minute period, to see and


discern that there is a block being worked in the


marketplace so that they know even within the 15


minutes that there is a big trade. The second


aggravating factor is that life insurers, unlike


many other market participants, have fairly


transparent portfolios because they're required by

state regulators, to disclose their derivatives


positions. The banks can upload that data and


with the ability to data mine again, they can see


what is going on, perhaps after the fifteen


 minutes, after the trades are reported.


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 They can actually see who is in the marketplace

and that there's trades being done that are


reflective of the activities of a particular


insurance company.


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 So, you have these two aggravating


elements to the situation. I'm mindful of the


fact that under the CEA, we're supposed to have a


block trading regime that accomplishes two things.


The rules of the CFTC should accomplish two things


which are to maintain anonymity of the block


trader and be capable of maintaining a liquid


market, not have a material adverse effect on the


liquidity of the market. We question whether the


15 minute rule in the light of experience is


accomplishing the objectives of the act and it is


becoming a more apparent question and we're


raising it as a matter of market risk because the


life insurers obviously are using these markets to


hedge their risks. So, I think it is an


appropriate subject for discussion.


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 MR. NIXON: Thanks, Richard. Sunil do


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 you want to?
 

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1
 MR. CUTINHO: Yes, I'll be very quick.


I think the focus of my comments would be from a


risk perspective. So, as we heard from Bis, there

are expectations in terms of monetary policy in


different environments especially in the U.S.,


Europe and Japan. But from a risk perspective, we

look at surprises to those expectations. So, we


get to see the common trade but we also are


cognizant of the fact that there are several other

things that are happening in the market that may


turn out to be surprises for these normal trends.


So, I think to Kristen's point earlier, one thing


is for sure volatility is here to stay but it's


not constant. It ebbs and flows so in some cases


we see markets being far too complacent and then


reacting as Kristen point out. So, I think for a


CCP, and for a risk manager, that would be our


primary focus when it comes interest rate


environment and the future.


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 MR. NIXON: Thank you. I think we'll


probably want to move on to the next question


which seems to be everybody's favorite topic, the


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 leverage ratio. I'd love to hear from the members

of the committee, their views on the leverage


ratio, and the application and the impact that it


has had on market efficiency. Anat, why don't we


start with you.


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 DR. ADMATI: Thank you. I've been


sitting here waiting patiently. It is all the


fault of the leverage ratio we here, that poor


ratio that is jumping on it. So, let me try to


put it into perspective about the hated leverage


ratio. What is wrong with a lot of things that I


see from where I am and I'll make a comment about


that later is poorly designed regulations. So, a


lot of what I see is that result and it includes


the leverage ratio. I have some writing here and


I can speak to it for hours because I've been


thinking about it for almost a decade about what


is wrong with the way we designed capital


regulation including leverage ratios. Now I just


want to remind us all that the ratios we're


talking about are small and that there are many


ways to satisfy them. You need room on your
 

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 balance sheet, I hear, and all these things but


there can be an expansion of the balance sheet


with retained earnings too. However, every


unintended consequence to everything, can often be

traced to the way the regulation is implemented.


In particular, in my writing, I haven't advocated


a ratio at all but more an amount of equity that


one plays with. Also, such a wide range to absorb


losses that we're not responding to a ratio in


being on that margin of that ratio. Because


obviously stuff happens, stress happens and you


saw about the dynamics and promptly intervening as

stress builds up. The problem is that the system


is so fragile that we immediately get nervous when

there is a little bit of stress and I can


elaborate on that.


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 Now a lot of words are thrown around,


especially in this committee, there are obviously


members of CCPs and others and then there are the


CCPs. It is interesting for me to watch when they


disagree but we all love liquidity. I was


yesterday at Treasury and we all love credit
 

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 there, love it. All these wonderful words and


level playing fields also, can't have enough of


all those great things. What my concern is as an


academic as a non-interested party except for the


public is when markets get distorted, when things


are mispriced. So, we could have too much and too

little of all these things, credit and liquidity


and all those things. They will go boom, they


will go bust. So, the question is why are they


unstable or why do they get mispriced. Again, it


is the distorted incentive and the failure of


regulation to control them.


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 I've been on this committee from the


start and also in the spirit of the discussion of


cyber security in which we kind of came to the


insight that is a collective action problem, I


should mention maybe why I'm representing Better


Markets and just clarify that Better Markets is a


non-profit organization, it's not paying me to be


here. As Petal knows, I couldn't be here


representing the institution that is paying my


salary to do this community service and be here
 

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 because my colleagues are not here and are doing


other things to advance their careers. So, I


appreciate being here very much but not for myself


really.


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 So, let me just say, some rules are


costly or inconvenient but these days when we have


from the very top, the mantra that regulations are


costly, just that word, we have to always remember


who's costs. We're talking about where there are


all kinds of rules, laws and regulation. I don't


want to go as basic to say that it is inconvenient


for us, it has happened to me to be caught


speeding but we're not going to belaying the speed


limit for that ticket and we would not lobby


against certain speed limits. Most of them we


accept as reasonable so, I think that is a good


analogy.


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 To summarize, I think the leverage ratio


as implemented is poorly designed. The


regulations related to them are inadequate and I


know how to improve them. If they have unintended


consequences that are bad, then we should discuss
 

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 it because the intention of people like me is not


to constrain all the good stuff that we should


have but to get everything working efficiently


without transferring risk to the public. That's


all.


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 MR. ZUBROD: Thank you. In responding


to this question, I offer the perspective as a


firm that has historically represented the buy


side. The buy side including end users which, in


most cases, is not directly subject to capital


requirements and doesn't customarily undertake


capital calculations. It is not always best


position to identify the exact sorts of


difficulties they observe in the marketplace.


However, the buy side is well positioned to speak


to the difficulties themselves and to invite


scrutiny about whether those difficulties are


proportional to the benefits of a given policy.


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 On this score, we can very comfortably


assert that central clearing is expensive. I have


spoken to this committee before about those


expenses in emphasis on the minimum fees charged
 

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 by FCMs. Fees that are at least six figures per


year. Fees that have risen since the early days of


buy side clearing and fees that particularly


burden those that transact in small volumes.


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 We are confident that the expenses are,


in part, a function of the leverage ratio and


appreciate that it is economically reasonable for


FCM's to be compensated by the buy side for the


costs FCM's bear in providing their services. We


understand capital and funding requirements


including those that result from the leverage


ratio to be among the most material costs FCM's


face.


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 However, we did not believe addressing


the leverage ratio, whether through recognition of


the risk reducing nature of initial margin or via


mechanisms like direct clearing to be a silver


bullet. Indeed, while direct clearing is at a


nescient stage meriting further experience and


study, it is our present expectation that direct


clearing will not be a game changer for addressing


the cost difficulties with clearing for smaller
 

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 market participants. Of course, we would welcome

being proven wrong as the concept and market


matures.


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 We believe in FCMs costs to set up and


serve clients are high, that a portion of these


costs is fixed and that it is not possible to


cover these costs absent sizeable minimum fees.


Fee difficulties for end users have been further


exacerbated as a number of FCMs have determined to


leave the business. The leverage ratio no doubt


contributed to these market exits. In some cases,


these FCMs were among those offering more


aggressive fee schedules. As a result of


diminished competition from those pricing more


aggressively, remaining FCM's have had greater


latitude to raise prices and numerous of our


clients are now subject to higher fees then


existed at the beginning of their FCM


relationships.


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 These difficulties are among the reasons

we believe the end user exception from clearing


and margin requirement should be expanded. We're


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 certain financial end users do not meaningfully


contribute to systemic risk because of the


relatively minimal quantity of derivatives


activity they undertake and because they use


derivatives to reduce risk, we believe it


appropriate and beneficial to scope them out of


such requirements. In essence, such an approach


would limit the universe of market participants to


whom the high cost of clearing whether resulting


from the leverage ratio or from other costs would


directly apply. If appropriately tailored, such


an approach could be undertaken without


undermining the objectives of Dodd Frank.


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 While we appreciate the limits of the


CFTC's authority to narrow the scope of


legislative mandates or to address regulatory


burdens imposed by prudential regulators, we


believe an open dialogue on whether to revisit the

scope of Dodd Frank mandates is timely and


consistent with the CFTC's aim of fostering safe


and healthy markets.


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 MR. NIXON: Thanks, Luke. Kristen.
 

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 MS. WALTERS: So, I would just say that


as a risk manager, it certainly makes sense to


limit leverage in some way. Certainly, leverage


was not anyone's friend during the financial


crisis. Given that I currently do risk management

at a buy side firm, I can't speak to this


specifically to the impact of leverage on the


markets regulated by the CFTC. But what I can say


is that there have been structural changes in


liquidity risk in both the bond markets and the


futures and centrally cleared markets. In the


bond markets, there has been an ability to adapt


and shift. So, principally the bond markets have


been OTC in nature for many years. Post financial


crisis they've shifted, in part, as a result of


regulation and potentially due to reduced dealer


inventory and the impact of regulatory capital on


the ability of dealers to kind of intermediate


markets. As a result, the markets have shifted


more from purely principle to more of a hybrid,


principle agent market and large asset managers


like Black Rock have changed the way that they
 

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 interact and engage in markets. So, we don't act


as principals in markets but we're certainly


acting as price makers on both sides in a way that

we never have and markets are less liquid in that


large blocks now get broken up quite regularly and

so on.


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 The reason for pointing this out is that


the bond markets have been able to adapt and


change in addition to the way asset managers now


engage directly in markets. There has also been


proliferation of more electronic trading venues,


anonymous, non-anonymous partly lit or dark and


this has changed or shifted liquidity. So, in the


bond markets we don't think that liquidity has


been adversely impacted, we just think the nature


of liquidity and its sources has changed. I think


my question with regard to markets that are


regulated by the CFTC is that the same entity, the


same broker dealers that have changed the nature


of how they engage in bond markets, are still the


clearing members that sit behind all of the


futures and centrally cleared swap activities that


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 go through your markets. Certainly, the number of


participants has decreased. We've heard CM,


Clearing Members, talk about some of the


difficulties and from our perspective, there has


been increased interconnected risk, more


concentration risk and concerns about portability


in the instance of default. I don't think have an


answer but I think clearly the challenge is a


little bit greater for the CFTC given the fact


that you just have a small number of market


participants that are acting as clearing members.


I'm curious to get others thoughts on that.


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 MR. NIXON: Thank you. Before I come

back I just want to take a couple comments over

here.


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 MR. WASSERMAN: So, this is Bob


Wasserman. I spoke a little bit earlier about


some of the concerns I had about our ability to


port in the event of a crisis and I'm not going to


come back to that. Rather I want to talk about


two other points. One is we speak about things


like perhaps direct clearing memberships and other


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 solutions. They might work for some of the very


large entities but I think we all know for the


small hedgers, farmers and ranchers who actually,


this commission was originally formed to help,


those solutions are completely irrelevant. I get


very concerned about the impact on those guys of


the basically losing available clearing members,


increases in prices and nothing that we're talking


about is going to help them and that, I think, is


a very real concern and should be for all of us.


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 The second is that I hear my learned


friends at the prudential regulators talk about


the importance of bank capital. Bank capital is


important and covering risks is important. Having


a business that doesn't cover its risk, is indeed,


a bad thing. But the thing to remember is that


the leverage ratio is deliberately designed, not


to be risk sensitive. So, if indeed, the biggest


part of this battle is over the refusal to


recognize the risk reducing elements of margin.


And so, if we had a risk sensitive leverage ratio,


then it would cause less market distortion. So,
 

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1
 it strikes me that that's a large part of the

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 problem here.


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 The other thing is in talking to my


friends and some of the bank regulators, many of


them are economists and very concerned around


incentives. Well, oddly enough, the leverage


ratio creates incentive effects. And it is those


incentive effects that, I think, are causing the


problem here and thus it seems to me would be very

helpful. At this point, all I have I fear is hope

that eventually there is some recognition of the


importance of recognizing a more risk sensitive


leverage ratio. Thank you.


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 MR. STANLEY: Yes, I guess responding to


that, a leverage ratio that was oriented toward


being risk sensitive would no longer be a leverage


ratio. Because the point of a leverage ratio is


precisely that it is a back stop to the risk


calculations that are being made by regulators. A


back stop that ensures that there is a minimal


level of capital and loss absorption in the


system. The leverage ratio as it applies to
 

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 derivatives, of course, is not simply the 5


percent leverage ratio, the 20/1 leverage ratio


generally. But that 5 percent is applied to


credit exposure metrics that are in turn, a very


small fraction of the very all notional value of


derivatives in the system. I think at commercial


banks when you look at leverage capital as a


fraction of notional value, it is something like


three basis points. And we know that there were


very large increases and non-predicted increases


in netted credit exposure of derivatives soon


before the crisis. And I think what the leverage


ratio in the derivatives context is really about


is making sure that we have some kind of secure


back stop for those unexpected swings that are not

predicted by regulators risk models. I don't want

to go down the rabbit hole of the whole margin


debate, but margin is money that is owed by people

in the system whether that is banks or clearing


houses to their members or to their end users. If

that is in a completely segregated lock box


somewhere, that's one thing that we can discuss
 

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 but this is money that is owed.

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 I think just to go back on the liquidity


discussion that was being discussed before, Anat


brought this up. But liquidity is not an


unalloyed good. There can be an inverse


relationship between liquidity in more ordinary


market circumstances and the liquidity that is


available in more extreme circumstances. That is


particularly true if the mechanism for supporting


liquidity in more normal times is permitting


excessive leverage of liquidity providers. In


that circumstance, liquidity providers are going


to come under stress in those extreme


circumstances and they are going to pull back.


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 Anat made reference to changes that


could be made in the leverage ratio rules and how


leverage ratios are designed. I think where


people are open to that but I think people have a


very great concern about what the total capital is


in the system under pinning people's potential


exposures in stress periods. That capital is what


is protecting the broader public, people who are
 

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1
 not intermediaries in the financial system from


potentially disastrous outcomes in very extreme


circumstances. I do think that if one views this


only from the perspective of people who are


intermediaries in the financial system, one will


get a somewhat skewed perspective. Because it is


inconvenient for market participants to have to


spend additional time finding a buyer when there


is unexpected new that maybe a stressful


experience for them. That is part of the natural


process of markets. Market volatility is part of


the natural process of markets in the face of


unexpected news. Some of that additional


inconvenience or stress for market participants


might be the cost of protecting the broader


public.


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 MR. NIXON: Thank you. I know we're


going slightly over the time that we allotted for


this topic but it is an important topic, I know,


for everybody here on the committee. I Can I go


to Sebastian and then Ed?


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 MR. KOELING: Thank you. I will
 

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1
 definitely agree that I can see that there is a


need to look at what the leverage is in the


financial system. However, I'm definitely going


to agree with the fact that the way the


calculations are done right now make not a lot of


sense at all. Essentially, there is no


calculation method whatsoever to look at any


offsets and derivatives that are 99.5, 99.9


percent correlated. And it's leading to first and


foremost also parties like ourselves that are


trying to provide liquidity through centrally


cleared markets so that the banks that we clear


through are held to these leverage ratios. We are


going to get excessive fees from them as well,


which at the end of the day, the only thing we can


do is incorporate them in the prices for the end


users. It also, interestingly enough, actually


leads to a lot of markets trying to steer clear


from having products cleared through financial


institutions which is actually counter to what


we're trying to accomplish in the last five, six,


seven years.
 

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 Thirdly, I think, this what we've talked


about, I think, a year and a half ago, this was on


the agenda the fact that there are less and less


clearing members out there. Again, this is going


to lead to more parties actually pulling out of


this business. I know from the options


perspective, obviously, the effect of these 99.5,


99.9 correlations are a lot bigger than some of


the other parts of the industry. But we've seen


it quite a bit where the actual competitors in


this space has dwindled down to pretty much three


that have a cross margin possibility between the


equities and the futures space which in index


options is a very large part of the markets.


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 And then finally, one of our clearing


firms actually talked to me about this and they


mentioned exactly what Bob said this morning. The

portability of clients, is one of these three


parties goes down, they will not be able to take


any new people on board. So, the portability


test that we're doing, I would hope that this is


part of the test because quite frankly, I don't
 

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1
 see how some of the clearing members will take

anyone. That doesn't sound like what we try to

accomplish.


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 MR. PLA: Thank you. So, I heard the


phrase, capital is a loss absorbing mechanism.


That's exactly what initial margin is. Clearing


members are willing to guarantee a client's


exposure to a clearing house because that


potential future exposure has been prepaid heavily


through initial margin and then supplemented


through daily mark to market variation margin


payments. So, the residual risk associated with


guaranteeing a client's trades is the conditional


portability of a move that is bigger than all that


margin collected, times a simultaneous and


solvency of the client. It is relatively low and


imperially we know it is relatively low.


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 A couple of other thoughts. I think


three things have changed in the market since the


last time we've had to deal with a large scale


porting of risk. We've seen continued


consolidation, it is well documented, it has been


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1
 flight for years. It is particularly acute in OTC

swaps where I think there is a significant amount


of notional. The second thing that has changed is

exactly that, that we're clearing as an industry,


dozens and dozens of trillions of notional more


than we did back when we were dealing with the


last porting under, let's say Lehman or MF Global.

And the third thing that has changed is the


beginning of the implementation of the Basil 3


leverage ratio.


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 So, the confluence of fewer


participants, a greater concentration of


participants especially among within that segment


of the market with acute notional sizes. Capital


rules that are maybe over taxing or over


collateralizing or over capitalizing some of these


exposures doesn't feel like a great outcome. So,


I do think that it might sound alarmist to talk


about porting being a risk but I think it is


untested. I think it is very untested in this


current regime where you've got those three


confluences of indicators.
 

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 MR. CUTINHO: So, Bob left me speechless


and then Marcus brought speech back to me, so,


thank you, Marcus. I'd like to address some of


the things that you raised as comments, very


directly. I think there is a confusion when it


comes to leverage ratio. You have to understand


that we are not, when we are talking here, we're


not talking about the clearing firm as a


principle, we're talking about a clearing firm as


an agent. I think that was clearly articulated by


Ed. There is a difference. Nobody here is going


to argue against good capital, well capitalized


firms, we all share that goal. That's just not


trying to flatter somebody but it is being a safer


market trade for us.


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 As a clearing house for us, the way we


look at resources is how Ed pointed out. Our


margin and gross margin, client by client gross


margin, is the first level of resource. So, a


defaulter's margin is the first tier of resource.


So, you called it an obligation, actually it is an


asset, it's actually paid in. And it is remote
 

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1
 from the agent and it is sitting at the clearing


house. So, at the end of the day, the problem we


have is a flawed understanding of clearing when it


comes to thinking about leverage ratio. So, we


are not arguing against the concept of leverage


being in back stop, it is just that when you


compute resources, you have to take into account


the fact that resources have been collected. So,


for an agent, the agent is collecting resources


from their clients and actually posting it to a


CCP.


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 Now let's talk about the implications.


The implications are here as such. If our goal is


a diversified set of clearing members, a


diversified set of market participants and less


concentration and less too big to fail or too


important to fail. Then you should be on the same


page as us in terms of recognizing the fact that


we need as many participants as possible to have


access to markets. Now, as Bob pointed out very,


very clearly, futures markets or derivative


markets are used as hedging tools. You have a lot
 

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 of end users here around the table. They need


access to these markets and they do not want to


face the clearing house directly because they


cannot. There are clearing firms that perform an


important role from a risk perspective in


monitoring the risk and making sure that on top of


our margin, they collect more margin. That margin


is credit sensitive margin and all of that asset


according to CFTC rules, is segregated, is


completely segregated from the propriety funds.


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 So, at the end of the day, when you look

at the concept of leverage, it has no bearing,


there is no relationship between that and a


cleared market. So, there is a complete


misunderstanding of client clearing when designing

supplemental leverage ratio as it applies to bank


affiliated clearing members. So, thanks for


bringing my speech back.


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 MR. NIXON: All right. We're going to


move on to the repo topic. I know the leverage


ratio is near and dear to everybody's heart and we


can perhaps circle back here at the end if we have


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1
 time. The repo markets are obviously a critical


source of short term liquidity that fuels the


derivatives market and the CFTC has asked what is


the state of the repo market both from a liquidity


and a functioning perspective. I'd like to get


some of the views from the MRAC members about the


repo market. If I could, I might start off with


Susan.


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 MS. O'FLYNN: I promise not to mention


leverage ratio in this particular topic but I


think it is influencing some of the changes we've


seen in the repo markets. I think with regards to


the functioning of the markets today, I think,


interdealer things continue to function well. I


think collateral has responded well. Since money


market reform, we continue to see collateral being


well bid and obviously a richening of collateral


driven by the move of money market investors to


govie funds as well as broader market requirements


for collateral itself. If you think about


institutionally banks requirements for margin both


from a UMR and clearing perspective.
 

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1
 What I'd like to focus on is the client


impact. I think to quote Dickens, it's a tale of


two clients. We have those who want leverage and


we have those who are liquidity providers. There


are three core issues that continue to me to be


the core ones. It is very simple. It is


capacity, access and pricing. How have these


changed. If we just look at capacity first and


let's look at our leverage takes, their the


leverage ratio has either seen dealers cut balance


sheets entirely or reduced balance sheets for


smaller market participants. Or you have seen


kind of an intra-month provision of balance sheet


which effectively disappears at month and quarter


ends. So, I think it is either gone for good or


it is available -- it is not available probably at


times when it is most important.


A

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 When I think about the capacity for


liquidity providers, there is increased liquidity

in the system but less places to deploy that


liquidity because it comes back to the dealer


capacity to be able to provide that short term
 

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1
 treasure repo and because of the ratio that we've

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 just continually debated about.


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 So, what has the market done and what is


the response. Well, we see the evolution of peer


to peer platforms and they continue to grow. It


is where effectively liquidity providers will face


leverage takers directly. Now, I think there is


still somewhat in establishment versus growth


phase but I don't think they will solve the


mismatch and maturity issue between those two


types of market participants. But it definitely


solves potential capacity issue. It also


potentially creates some type of access to better


pricing. Then the other option is obviously


clearing. That's very topical here given the


number of clearing houses here. Obviously,


everyone is working on a solution to try to bring


those clients into clearing.


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 Now, we've been very supportive of


expansion of memberships for clients in repo for


probably now three to four years. From a


sequencing perspective, I think we've always felt


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1
 liquidity providers should come into the clearing


house first to be able to get the liquidity in


there so it can be deployed to the institutions


who seek liquidity. Now obviously not to call out


on anyone, but obviously, FICC have filed with the


SEC a membership solution for treasury tri party


repo called, CCIT. This will allow non-RIC


institutions to be able to trade reverse repo on


treasuries with dealers. Which effectively will


give a new trading environment where they can


deploy this liquidity and be able to capture some


of the pricing benefits that you see trading on


GCF repo versus where the funds are actually


paying on a return basis.


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 Now with regards to, so, that's kind of


solving the capacity issue. Now, I think, there


are other clearing houses working on similar type


solutions but it is just the next step to be able


to addressing those issues. Now, it also


obviously will feed into the broader discussions


that we've been talking about around CCP default


management but I'm not going to focus on those
 

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 there.

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 Now if you think about the other side of


the coin, the leverage takers, how do you


establish a clearing membership for institutions


who seek leverage. Does the traditional FCM model


work in repo. It actually doesn't. So, a number


of clearing houses have been working to establish


an FCM light model to be able to facilitate access


of these institutions who are seeking liquidity


into these clearing houses. Now many of those


esteemed clearing houses are sitting around this


table and I think we should see a solution, I


would say, in the next 12 to 18 months' subject to


regulatory approval. However, there are, I would


say, different regulatory impacts for U.S. banks


versus European institutions as to what the


potential regulatory capital costs of actually


offering that service to institutions who are


seeking leverage and financing assets such as


treasuries or bonds or gilts. So, I think that is


one asymmetric regulatory impact we've observed


and I think the clearing houses are trying to
 

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 solve to that issue.

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 Now where does this get us all. I think


with regards to we think about the three core


issues, capacity, access and pricing, we've seen


access disappear for clients because of dealers


being constrained from a resource perspective and


therefore, capacity has also been constrained. If


we think about clearing being the solution, it


definitely solves a capacity issue for our clients


because we do believe and dealers do believe that


they can provide that intermediation capacity in


clearing in a way that is more resource efficient


and to be able to redeploy that capacity to


clients. Access will be solved by clearing houses


establishing appropriate memberships for both


types of clients which we all look forward to


seeing.


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 And then pricing. So, we have observed


the basis in pricing between cleared versus


uncleared in many markets. I think that will


probably emerge in repo too because ultimately it


will come back to dealers pricing in their
 

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1
 resources and clients being able to benefit from


potentially those resource savings be it SLR or


RWA capital by looking to execute those


transactions in a cleared environment. So, it


almost solves all three. There will be increased


capacity in a clearing house that you don't see


today in the uncleared markets and also in theory,


pricing may be more attractive. So, I think it


solves a lot of the current issues that clients


are facing in the markets today. I'll stop there.


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 MR. NIXON: Sunil, do you want to?

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 MR. CUTINHO: That was a very nice set


up by Susan, thank you for that. I think I would


add two other things that clearing achieves. The


federal reserve and thinking about reforms for the


repo market was concerned about two risks. One


was the run risk and the other is a fire sale


risk. I think clearing is meant to solve those


two as well. So, any clearing solution that is


out there will have to address those two. We know


from clearing and the way it manages defaults, is


to actually solve for the run risk and the fire
 

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 sale risk is to actually provision for liquidity


during the period where the asset is being


liquidated in the open market. So, I think in


addition to what Susan pointed out was two


additional benefits that clearing would bring to


the repo market.


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 MR. NIXON: Tom.

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 MR. COYLE: Well, I represent the grain


handlers, processers, feed mill so, my comments


are really more granular. I'm going to make a


comment about repos and actually on interest rate


environment. A little bit of Susan's comment


about the fact that there is a lot of liquidity in


trying to find a place to go. I would say that as


it comes to a grain handler, our use of capital is


either from futures, derivatives, hedging margin


calls or inventories. In this country, we've got


growing inventories of all commodities, corn,


beans, wheat, that requires more capital.


Answering the question the interest rate


environment, interest rates are creeping higher,


doesn't really have an impact on our industry
 

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 right now because prices are so low. Also get to


the repo where unlike derivatives in repos, really


we use repos to fund inventories. With such large


inventories in this country it ends up being quite


a big deal. At this point, I would say that there


is ample capacity. It seems like we get a call a


day from someone that wants to fund inventories


and not using as much capital as they would


normally use. Changes when we get prices a lot


higher so, it is just kind of a heads up, at some


point, it changes.


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 The other thing we've noticed in the


industry with prices lower, we're starting to see


an interest rate issue maybe on the farm


community. Where you actually have farmers, who


are struggling because prices are lower.


Therefore, they have a harder time getting a


return. The result of that is that margins in the


grain industry have actually declined over the


last couple of years. I would say after ten years


of quite attractive margins and a lot of liquidity


what we're seeing right now in the environment is
 

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 that margins are shrinking. That does have an


impact. It doesn't have an impact to today, but


go through a period of time where you have lower


margins and get a spike in prices, all of the


sudden the liquidity changes quite a bit. So,


again it's maybe even off topic because everything


we're talking about here are futures, derivatives


and hedging and what is regulated by the


commission. But there is another side of funding


and liquidity that relates to grain handlers.


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 MR. NIXON: Anymore comments on the repo


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 markets?


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 MR. STANLEY: I just wanted to respond


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 to Sunil before, so this is not about repo.


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 MR. NIXON: It's not about leverage

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 ratio either is it?


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 MR. STANLEY: It is about the leverage


ratio. Just a quick response to Sunil. I think


the question that continually comes up with this


is that if the margin is truly simply an asset


that is held by the clearing house, then why does


it appear on the banks' balance sheet. And why do


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 we have prudential regulators consistently saying


to us that in many cases, the banks do have


control over investment of that margin and do


receive revenue from the investment of that


margin. That's number one and number two, I think

all of this sort of indirectly relates to these


debates over clearing house resolution. When you


look at the clearing house default fund, it


becomes very clear that the level of capital and


the financial stability of the clearing members is

something that very much could come into play in


terms of where are the other sources of private


sector loss absorbency once you get past margin if

they are not going to be in the solvency of the


clearing members. Now, I realize that clearing is

a different risk management method and it relies


on the exchange of margin based on market prices.


It is capital only comes into play when clearing


has failed in some sense or when that risk


management mechanism has failed. But I think it


just continues to be a really important question.


How much private sector back stop do we have
 

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 including through the clearing members.

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 MR. NIXON: Okay I know you want to


answer that but we're going to go on to the last


topic that the CFTC asked that you guys would talk

about and that was uncleared margin. They are


asking, why was there a surge in clearing of NDF's

and inflation swaps after the margin rules were


implemented and what was the impact on liquidity


if any. Have the margin rules caused market


participants to shift to other lower cost products

to do their hedging. Luke, do you want to start?


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 MR. ZUBROD: So, Chatham serves a broad


range of end users including non-financial end


users such as multinational corporations and even


professional football teams. Financial end users


such as regional and community banks. We also


serve those that uncomfortably straddle the line


including real estate funds which fundamentally


invest in non-financial assets through entities


that are, themselves, non-financial but do so with


an ownership structure that includes collective


investment vehicles that are deemed financial as a


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 matter of U.S. law.

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 The margin rules implemented for these


entities on March 1, have been among the most


consequential of the Dodd Frank reforms for the


markets broadly and for many of our clients,


especially those with financial affiliates. Of


course, margin rules are the most germane to the


issues that arose with AIG's derivatives positions


which because of their illiquid nature are not of


a type that would have been appropriate for


clearing houses.


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 It is worth noting that margin and


clearing rules represent a public policy wager.


They were purposed to attack credit risk in the


system, but they did so at the expense of


increased liquidity risk. By liquidity risk, I


mean that sharp market movements give rise to


margin calls which, in turn, necessitate that a


firm have access to liquid resources to meet those


calls. In the event of insufficient liquid


resources, a firm will fail and while the


consequences of the failure may not be felt within


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 the derivatives market eco system, because the


firm's positions are collateralized, the


derivatives market eco system will be complicit in

the pain the firm's failure causes in the economy.

This is not to say that I think the wager was


wrong, time will tell, but I do believe we should


not look at margin requirements as an unmitigated


good. For example, and as previously stated, I


believe margin requirements for financial end


users whose positions are not systemically


significant and that use derivatives for risk


management purposes were established without


sufficient evidence as to the potential for harm


to the financial system.


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 The imposition of costly requirements on


those undertaking societally valuable business


practices, that is risk reduction activity. Which


bring no harm to others, has created adverse


consequences. In particular, it has increased


incentives for market participants to use products


or strategies that imperfectly address their risk


management objectives or that address their
 

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 objectives at significant costs.

 2
 In some cases, these costs can be


prohibitive. For example, market participants may


undertake a series of responses to these high


costs associated with these requirements. They


may substitute fixed rate loans for swapped


floating rate loans, even though the pricing and


prepayment characteristics of the floating rate


loan are superior. They may substitute options


for swaps or swaps for options due to the economic

or administrative impacts of each of the products.

They may use standardized exchange traded futures


instead of customized OTC derivatives to satisfy


their risk management needs generally taking on


some basis risk in the process. Or they may use


exempt effects forward as a substitute hedge for


effects options or collars, or worse, they may


choose not to hedge.


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 While each of these distortions and


market activities suggest that market participants


are, in most cases, finding ways to hedge their


risks, the manner in which they hedge them, has in


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 some cases, changed. These kinds of changes


afford little or no benefit to society, even while

they cause harm to the risk management disciplines

of individual companies.


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 MR. NIXON: Do we have any other members

who would like to comment on the uncleared margin


situation? Susan.


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 MS. O'FLYNN: So, I'm just going to


comment predominantly on the clearing of NDF's.


So, it is a product that Morgan Stanley started


clearing in 2015 so, I think, we were one of the


first three. I think we've seen a migration of


dealers to clear NDF's. I think some institutions

probably wanted to do beforehand but, I think,


it's a general sense of let's understand what the


pricing of resources around both options. I


think, from our perspective, I think the


centralization of liquidity in a clearing house is

an appropriate venue for this but also as well, it

then establishes effectively a sense as to trading

the product under clearing house rules and margin


versus under UMR from a resource perspective. I
 

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 think that ultimately gets us back to the original


aim here was to essentially clear as many products


as possible which are appropriate from a liquidity


and risk management perspective.


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 I think it accelerated what a lot of


institutions were planning to do but then when you


think about the broader kind of currency


portfolio, if you look forward you will see cross


currency swaps and FX forwards are all in many


clearing houses kind of plans for this year to


establish essential clearing venue and environment


for those types of products.


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 I do think it is probably more expensive


to clear NDF at the moment then it is to trade


under SIMM because a lot of dealers are executing


their hedging activity there. So, when your


direction on the clearing house, it tends to be


more expensive. I don't think it necessarily a


cheaper option for dealers yet. We see and expect


clients to actually start clearing NDF's towards


the end of this year. So, I think that will


balance the members within that particular
 

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 clearing house and also potentially make those


margin costs more balanced. But I don't think it


was a cheaper option for many dealers despite when


you run the numbers on a comparable basis because


it is something that we obviously look and monitor


as part of our broader resource management view.


I think it was a collective, I think UMR was an


influence, but I don't necessarily think it


resulted in cheaper margins for dealers because of


who's actually clearing at the clearing house and


also the risk that those dealers are bringing into


the clearing house.


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 MR. NIXON: We have one more minute.

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 Jerry, do you have a comment?


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 MR. JESKE: Sure, it relates to the


commodities market. Luke mentioned the March 1


requirement for margin which actually the


commission provided relief out to September. It


has created some strife in connection with those


that are end users that do transaction swaps that


transact with a bank is. ISDA put out a protocol


yet again that essentially forced folks to either


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 opt out characterizing themselves as a


non-financial entity which on a its face, one


would think is a rather easy analysis to make. But

when you actually look at the definition of what a

financial entity is under CFTC regs and other


prudential regulators, dictate a litany of various

types of entities that fall under a financial


entity. So, I would suggest that definition be


readdressed because it is certainly not fit for


purpose for many. And has caused those that are


offering swaps as dealers that are non-margined,


non-cleared, to make that determination between


themselves. So, in other words, the relationship


has been stressed. It is something that, although

it has been mitigated by the relief, it is going


to come about again in September.


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 MR. NIXON: Thank you. I think we've


come to end of this session so, let me just make


one or two quick closing remarks before handing


the microphone over to Petal and to the Acting


Chairman and Commissioner Bowen.


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 First of all, I want to thank all of the
 

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1
 MRAC members for coming here today. It has been


an insightful discussion, I'm sure, for the CFTC.


All of you have taken the time to leave your day


jobs and come here and participate, and I'm sure


that they appreciate it. One thing that I find


absolutely refreshing, is the fact that all of you

come here with your views and not all of them are


the same. People bring different perspectives to


the marketplace and a marketplace is about


different perspectives. It is great to have all


of you come here and share those with the CFTC.


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 So, before I hand that over, I just


wanted to let you guys know one thing that just


happened to come across, I just happened to find


out recently and he's going to get very


embarrassed. Our Acting Chairman here happens to


be a very, very accomplished musician. He is a


very good guitarist who plays in a band and he is,


I'm pretty sure is at the FIA in Boca next year


when he does the Chairman's remarks, he is going


to show up there with the guitar and he's going to


be singing to all of you, a very famous song by
 

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 the Rolling Stones called, You Can't Always Get


What You Want. On that note, I'll hand it back


over to Petal.


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 MS. WALKER: Thank you, John. It is now

 5
 time for closing remarks.


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 CHAIRMAN GIANCARLO: I don't know how to


respond to "you can't always get what you want,"


but we've certainly heard a lot of both short and


long term concerns that the commission has been


asked to take into account as we look at some


things that are coming up in the next few months,


but also some longer term concerns about the


health and the stability and the durability of the


markets that we oversee. The perspective that, as


I listened to the remarks, all of which I found


very helpful across the board, all well based,


well argued. At the end of the day, the concern


that I have is that our markets continue to serve


healthy risk transfer, which is essential to


economic growth. Which has been something that


I've been talking about since I came to this


commission and will continue to talk about for so
 

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 long as I serve on this commission. So, when I


view the issues, I think about them in terms of


are they supportive of the strength, vitality and


durability of the markets that are necessary for


risk transfer. Because without risk transfer, you


can't have healthy investment. Healthy investment


is necessary for economic growth, which is


certainly something that we've had a public


discussion on in the past few months here in this


country, and I think that the emphasis certainly,


of the new administration, is toward generating


healthy, strong, sustainable and broad-based


economic growth. So, those are the things I'll


bear in mind as I reflect on some of the things


we've heard today. Over to our sponsor.


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 COMMISSIONER BOWEN: Great, thank you so

much. I really wanted to thank our facilitators


today who did a fantastic job. Susan O'Flynn,


Dennis McLaughlin and John Nixon, really tough


questions. All three panels were extremely


substantive. I think I said at the beginning that

I thought that this would be one of the most
 

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 interesting and informative discussions we've had


which was a pretty high bar. Well, you guys


actually met that today so I have no idea what


we're going to do in our June meeting but it is a


pretty high bar. I also want to thank our key


speakers who provided important insight for our


commission to consider and I finally want to thank


our logistical staff, my staff, Acting Chairman


Giancarlo and his staff for participating today.


Thanks so much everyone.


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 11 MS. WALKER: The meeting is adjourned.


For those MRAC members who are joining us for


lunch, we're going to meet at the door and try to


leave at 1:25. Thank you.


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 (Whereupon, at 1:18 p.m., the

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 PROCEEDINGS were adjourned.)


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 * * * * *


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1
 CERTIFICATE OF NOTARY PUBLIC

 2
 DISTRICT OF COLUMBIA


 3
 I, Carleton J. Anderson, III, notary


public in and for the District of Columbia, do


hereby certify that the forgoing PROCEEDING was


duly recorded and thereafter reduced to print under


my direction; that the witnesses were sworn to tell


the truth under penalty of perjury; that said


transcript is a true record of the testimony given


by witnesses; that I am neither counsel for,


related to, nor employed by any of the parties to


the action in which this proceeding was called;


and, furthermore, that I am not a relative or


employee of any attorney or counsel employed by the


parties hereto, nor financially or otherwise


interested in the outcome of this action.


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 (Signature and Seal on File)

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

21
 Notary Public, in and for the District of Columbia

 22
 My Commission Expires: March 31, 2021
 

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