UNITED STATES OF AMERICA 

 COMMODITY FUTURES TRADING COMMISSION 

 PUBLIC HEARING ON EXEMPT COMMERCIAL MARKETS 

 Washington, D.C. 

 Tuesday, September 18, 2007 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 2 

 1 PARTICIPANTS: 

 2 CTFC Commissioners: 

 3 WALTER L. LUKKEN, Acting Chairman 

 4 MICHAEL V. DUNN 

 5 JILL SOMMERS 

 6 BART CHILTON 

 7 Panel Members: 

 8 JOHN FENTON 

 9 JEFFREY HARRIS 

 10 RICHARD SHILTS 

 11 TERRY ARBIT 

 12 JAMES NEWSOME 

 13 JEFFREY SPRECHER 

 14 CRAIG DONOHUE 

 15 PETER KRENKEL 

 16 RICHARD SANDOR 

 17 R. "SKIP" HORVATH 

 18 LAURA CAMPELL 

 19 JOHN DAMGARD 

 20 RUSS STOLIE 

 21 OLIVER IRELAND 

 22 MARK COOPER 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 3 

 1 

 2 PARTICIPANTS (CONT'D): 

 3 GREG ZERZAN 

 4 JOHN GAINE 

 5 SEAN COTA 

 6 

 7 

 8 * * * * * 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 4 

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

 2 (9:05 a.m.) 

 3 CHAIRMAN LUKKEN: Good morning. It's a 

 4 pleasure for me -- me and my fellow commissioners 

 5 -- to welcome you today to a hearing on exempt 

 6 commercial markets. I would like to thank all 

 7 distinguished panelists for being here to share 

 8 their views and expertise with the Commission. 

 9 I would also like to welcome several 

 10 members from Capital Hill who have covered these 

 11 issues and have helped advance this debate. Thank 

 12 you for coming. 

 13 The proper regulation of the nation's 

 14 energy markets is one of the most significant 

 15 issues facing this Commission. Energy prices 

 16 discovered on these markets greatly impact our 

 17 economy and every American ranging from 

 18 residential consumers to main street businesses to 

 19 Wall Street firms. 

 20 It is this Commission's mandate to 

 21 ensure that our energy markets remain free of 

 22 price distortions and fraud. Recent hearings 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 5 

 1 before Congress have highlighted concerns that 

 2 these markets are subject to abuse and not 

 3 adequately reflecting the fundamentals of supply 

 4 and demand. Whether this perception has a basis 

 5 in fact is the subject of today's hearing, but 

 6 regardless, this doubt is troublesome because it 

 7 could keep potential users from managing risk or 

 8 benchmarking prices in these markets. This should 

 9 be of primary concern as we scrutinize the 

 10 regulatory framework of these markets today. 

 11 In 2000 Congress created a tiered 

 12 regulatory structure for the futures markets with 

 13 the passage of the Commodity Futures Modernization 

 14 Act, which attempted to tailor regulated 

 15 requirements to specific risks of the marketplace. 

 16 This calibrated structure has provided regulators 

 17 with the proper flexibility and focus as we strive 

 18 to keep pace with this industry's global growth. 

 19 One cannot argue with the success of the 

 20 U.S. futures industry as demonstrated by its four- 

 21 fold growth since the CFMA's passage as well as 

 22 its growing global market share. Within their 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 6 

 1 tiered design, Congress created a light touch 

 2 regulatory category called Exempt Commercial 

 3 Markets, or ECMs, on which certain commodities 

 4 such as energy could be traded by institutional 

 5 participants. Due to the nonretail nature of 

 6 these markets and their modest beginnings, 

 7 policymakers believed that the risks associated 

 8 with these institutional exchanges to be low. 

 9 However, the energy markets have changed 

 10 dramatically in these seven years, and this 

 11 Commission's regulation of these markets should 

 12 evolve in kind. Although these exempt markets 

 13 have increased competition and lowered costs for 

 14 derivatives trading, certain ECMs now function as 

 15 virtual substitutes to regulated exchanges with 

 16 tight correlation and linking of prices. 

 17 Today, the Commission will reexamine the 

 18 legal and regulatory structure of these markets, 

 19 noting meaningful similarities and distinctions. 

 20 In addition to the testimony of effective groups, 

 21 we will first hear from CFTC staff who will report 

 22 on their extensive interviews with market 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 7 

 1 participants and their economic analysis on the 

 2 price discovery functions of ECMs. 

 3 This broad range of discussions will be 

 4 valuable as the Commission aims to complete the 

 5 evidentiary record and provide timely findings to 

 6 Congress. In doing so, we must remain true to the 

 7 risk-based philosophy of the CFTC and be mindful 

 8 of any potential impact we would have on the 

 9 competitiveness of these global electronic 

 10 markets. 

 11 But the heart of the debate will turn on 

 12 whether the Commission has the proper tools to 

 13 uphold its core mission to ensure that these 

 14 markets are fair, open, and transparent, free from 

 15 manipulation and fraud. This will be our primary 

 16 focus today. 

 17 We look forward to hearing from our 

 18 distinguished witnesses, and I now turn to 

 19 Commissioner Dunn for his opening remarks. 

 20 COMMISSIONER DUNN: Thank you, Mr. 

 21 Chairman, and I wish to commend you for having 

 22 these hearings today. Back in July when we were 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 8 

 1 in front of the PSI on a hearing, you committed to 

 2 a fresh look at what was needed in the market, and 

 3 the swift act and the action that you have taken 

 4 exhibited here today is very commensurate. Thank 

 5 you very much. 

 6 Over the last two years I've had the 

 7 opportunity to meet with a wide range of audiences 

 8 regarding regulation of the derivatives market. 

 9 I've been struck that the basic thing people 

 10 desire is simple: They want to have confidence 

 11 that the game is to rigged. 

 12 Events such as the alleged recent 

 13 manipulation by Amaranth in the natural gas 

 14 markets, the alleged manipulation of propane 

 15 markets by BP, the proven manipulations of Enron 

 16 have led the public to question the integrity of 

 17 the derivatives market and ask, who is in charge? 

 18 Well, when it comes to energy derivatives market, 

 19 the answer seems at times to be no one. 

 20 We have people on tape and in emails 

 21 boasting that they can get away with gaming the 

 22 market because no one is watching them. While the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 9 

 1 Commission aggressively pursues market 

 2 manipulation that comes to its attention, in the 

 3 absence of a regulatory structure of 

 4 accountability and transparency, manipulative 

 5 behavior may go undetected. 

 6 The central problem is that the CFMA 

 7 seems to have placed a large swath of energy 

 8 derivative markets beyond key elements of the CFTC 

 9 jurisdiction. 

 10 We have to consider today whether this 

 11 makes sense and what tools are necessary to 

 12 safeguard energy markets we regulate from fraud 

 13 and manipulation. Things have certainly changed 

 14 since the Passage of the CFMA. 

 15 Recent hearings and past legislative 

 16 battles on Capital Hill have shown there are 

 17 significant concerns among members of Congress and 

 18 the general public regarding exempt commercial 

 19 markets. I know there are a lot of different 

 20 legislative proposals for fixing the problems 

 21 potentially created by 2(h)(3). 

 22 I think the question we need to explore 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 10 

 1 is whether and how 2(h)(3) is flawed. I think we 

 2 need to think carefully about how it fits with the 

 3 larger structure of the CEA and, most importantly, 

 4 I think we need to consider how to best provide 

 5 the openness and transparency the public demands 

 6 and deserves when it comes to its energy futures 

 7 markets. 

 8 Once again, I thank you, Mr. Chairman, 

 9 and I thank those that are participating today. 

 10 CHAIRMAN LUKKEN: Thank you, 

 11 Commissioner Dunn. 

 12 Commissioner Sommers? 

 13 COMMISSIONER SOMMERS: Thank you. Good 

 14 morning. I want to join Commissioner Dunn in 

 15 commending you, Commissioner Lukken -- Chairman 

 16 Lukken -- for holding this important hearing, and 

 17 I also want to thank all the Commission staff for 

 18 all their hard work in organizing today's events. 

 19 As one of the newest members of the 

 20 Commission, I'm grateful for this opportunity to 

 21 learn more about the evolution of trading on 

 22 exempt commercial markets and the integration 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 11 

 1 between ECMs and designated contract markets, 

 2 especially with respect to energy trading. The 

 3 markets that the Commission oversees play a vital 

 4 role in the price discovery process for natural 

 5 gas, crude oil, and other energy products. 

 6 A critical component of our mission is 

 7 to detect and to deter manipulation of those 

 8 prices. Energy trading on DCMs and ECMs has grown 

 9 exponentially since the Commodity Futures 

 10 Modernization Act was passed almost seven years 

 11 ago. 

 12 I think it is appropriate for the 

 13 Commission and for Congress to examine whether the 

 14 regulatory structure that was put into place then 

 15 remains effective in protecting the integrity of 

 16 the markets and fostering innovation today. 

 17 One of the many recent developments in 

 18 this area is the linkage between certain contracts 

 19 traded in ECMs and contracts traded on DCMs. 

 20 Questions have also been raised about the role of 

 21 speculation in both marketplaces. It is important 

 22 to determine whether the Commission has the tools 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 12 

 1 it needs to police these markets effectively and 

 2 to ensure a level regulatory playing field. 

 3 It is also important that we keep the 

 4 global competitiveness of the U.S. markets in mind 

 5 when considering how to address any gaps or 

 6 imbalances that may have arisen. These are 

 7 complex issues that deserve thoughtful and careful 

 8 deliberation. 

 9 I want to thank all the panelists for 

 10 agreeing to participate in the discussion today, 

 11 and I look forward to hearing their views and 

 12 learning more about these important markets. 

 13 CHAIRMAN LUKKEN: Thank you, 

 14 Commissioner Sommers. 

 15 Commissioner Chilton. 

 16 COMMISSIONER CHILTON: Thank you, Mr. 

 17 Chairman, and thank you and Commissioner Dunn for 

 18 holding this place together by yourselves for such 

 19 a long time before Commissioner Sommers and I 

 20 showed up at the jobsite, and thanks for holding 

 21 this hearing. 

 22 I think it is important and I hope we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 13 

 1 will have the others in the future. People have 

 2 said to me that there are myriad issues that 

 3 they'd like to see other hearings held on. 

 4 Everything from carbon trading to event futures. 

 5 Whether or not the CFTC will ultimately regulate 

 6 election result futures or the next Oscars is a 

 7 question that, as they say, inquiring minds want 

 8 to know. So I hope we have future hearings as 

 9 issues warrant. 

 10 CHAIRMAN LUKKEN: Not today. 

 11 COMMISSIONER CHILTON: I was in Senator 

 12 Feinstein's office not too long ago talking with 

 13 her about this issue, and I have got to commend 

 14 her for really having foresight on this issue 

 15 years and years ago. The rest of us are merely 

 16 trying to sort of catch up and get to where she's 

 17 been. 

 18 And likewise, Senator Levin and Senator 

 19 Coleman have, I think, done a great service with 

 20 the PSI hearing, bringing this issue to the 

 21 forefront, and, as Commissioner Sommers said, the 

 22 linkage between the regulated and nonregulated 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 14 

 1 energy markets. So I'm hopeful that Congress is 

 2 at a place where they may be able to do something 

 3 on this issue in the not too distant future. 

 4 The Commodity Exchange Act, as we all 

 5 know we operate under here in this building, 

 6 allows us or gives us the oversight authority, 

 7 rather, and the jurisdiction -- the jurisdiction 

 8 over risk management markets. And in so doing, 

 9 they give us three basic constructs that we are 

 10 supposed to adhere to, goals if you will. 

 11 We're supposed to protect price 

 12 discovery, we're supposed to guard against 

 13 manipulation, fraud and abuse, and we're supposed 

 14 to try to ensure that these markets for futures 

 15 and options operate in a way that's viable, 

 16 effective, and efficient not only for hedgers and 

 17 speculators but for consumers, for consumers as 

 18 well. 

 19 And it makes it really difficult for us 

 20 to achieve those goals when we have these 

 21 look-alike energy markets that are operating in 

 22 the dark which aren't subject to the rules and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 15 

 1 regulations of the Commission. So I'm really 

 2 hopeful that something can be done so that we can 

 3 move forward, and I think that we can. I think 

 4 Congress will take this up. 

 5 And the important thing is that when 

 6 they do that, that they do so as to keep in place 

 7 this principles-based regulatory regime that we 

 8 have that is so unique to this agency. The SEC 

 9 doesn't have it, USDA doesn't have it, nobody else 

 10 has it. This principles-based regulatory regime is 

 11 really different from this top-down prescriptive 

 12 regulatory structure that everybody else has. 

 13 We're not your fathers' regulators, and 

 14 it is good that we aren't because it allows this 

 15 industry to move forward. It allows the agency to 

 16 see around the corner, to be nimble and quick, and 

 17 to in real time make decisions about changes or 

 18 potential changes that may happen be they positive 

 19 or negative. And at the same time this 

 20 principles-based regulation fosters the growth in 

 21 this whole industry, the U.S. futures industry, to 

 22 this rapid growth that Chairman Lukken talked 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 16 

 1 about contributes to the economic engine of our 

 2 democracy, and we're better for it. 

 3 So I think the good government response 

 4 to this issue isn't to sit back and wait for some 

 5 economic calamity to occur; I think we've seen 

 6 with Enron and Amaranth, and with British 

 7 Petroleum the problems that can occur. And, for 

 8 me, it is not a question of if we do it: It is 

 9 how Congress does this. 

 10 And so I'm really appreciative of all 

 11 the witnesses being here today. It is important. 

 12 I know everybody doesn't agree with me -- that's 

 13 okay, that's what this is about -- but I'm really 

 14 appreciative that you've all here with us. I look 

 15 forward to hearing your comments. And today, Mr. 

 16 Chairman, I'll be an inquiring mind. 

 17 CHAIRMAN LUKKEN: Thank you, 

 18 Commissioner Chilton. I just want to welcome all 

 19 the new commissioners as well. It is nice to have 

 20 more faces up here and a diversity of views, and 

 21 it helps us to reach good decisions. I appreciate 

 22 everybody being here and now having our first 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 17 

 1 hearing, public hearing. 

 2 With that, I wanted to lay out a bit of 

 3 the agenda, some logistics for today. We are 

 4 going to have two panels in the morning, two 

 5 panels in the afternoon with a break at lunch. 

 6 There won't be any other breaks between panels. 

 7 If everybody could turn off cell phones and 

 8 blackberries -- they interfere with microphones -- 

 9 we'd appreciate that as well. 

 10 With that we will hear from all of our 

 11 witnesses on a panel and reserve questions till 

 12 the end of the panel's testimony. So we'll hear 

 13 all the panel's testimony before we ask any 

 14 questions. 

 15 And with that, I'd like to introduce our 

 16 general counsel, Terry Arbit, who will begin the 

 17 proceedings. Welcome, Terry. 

 18 MR. ARBIT: Thank you, Mr. Chairman, 

 19 Commissioners. My name is Terry Arbit, and I am 

 20 General Counsel of the Commodity Futures Trading 

 21 Commission. 

 22 I've been asked to help frame the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 18 

 1 discussions at today's hearing by providing an 

 2 overview of the statutory structure for 

 3 derivatives markets under the Commodity Exchange 

 4 Act, which we call the CEA, and describing how 

 5 exempt commercial markets fit into that structure. 

 6 Along the way, I'll identify some common 

 7 misperceptions regarding the legal environment in 

 8 which exempt commercial markets currently operate. 

 9 As the Chairman noted, in the Commodity 

 10 Futures Modernization Act of 2000, the CFMA, 

 11 Congress established a tiered approach to 

 12 regulatory oversight of derivatives markets. Each 

 13 tier is subject to a varying level of oversight 

 14 based primarily on the commodity traded, the type 

 15 of trading, and the nature of the participants in 

 16 the market. 

 17 Among futures markets, the designated 

 18 contract market occupies the top tier representing 

 19 what is often described as a fully-regulated 

 20 futures exchange. A contract market may trade 

 21 contracts based on any commodity, and may offer 

 22 products to retail customers on an unrestricted 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 19 

 1 basis. Under the CFMA's principles-based 

 2 oversight regime, contract markets are afforded 

 3 significant flexibility in how they run their 

 4 operations but, nonetheless, must initially 

 5 satisfy specified designation criteria and 

 6 thereafter must demonstrate compliance with 

 7 comprehensive core principles on an ongoing basis. 

 8 The CFMA also created a new category of 

 9 futures exchange called the Derivatives 

 10 Transaction Execution Facility, or DTEF. There 

 11 are two types of DTEF, a retail DTEF and a 

 12 commercial DTEF. Both DTEF categories have fewer 

 13 regulatory requirements than a contract market, 

 14 but they're subject to differing limitations on 

 15 eligible traders and the commodities that may be 

 16 traded. 

 17 Although subject to a lighter regulatory 

 18 regime, this alternative exchange must have 

 19 compliance and surveillance programs and must 

 20 undertake significant self-regulatory 

 21 responsibilities. To date, no trading facility 

 22 has applied to the Commission to register as a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 20 

 1 DTEF. 

 2 The CFMA also created a broad and 

 3 complex array of exclusions and exemptions from 

 4 regulation for certain derivatives products that 

 5 are traded over the counter either bilaterally or 

 6 on electronic trading facilities. These 

 7 exclusions and exemptions reflect a view 

 8 consistent with various congressional and 

 9 Commission actions during the preceding decade 

 10 that off-exchange transactions between 

 11 sophisticated counterparties, do not necessarily 

 12 require the full weight of the protections that 

 13 the CEA provides for contract markets and DTEFs. 

 14 One such exemption which we are gathered 

 15 to discuss here today is for transactions in 

 16 exempt commodities on electronic trading 

 17 facilities that are known as exempt commercial 

 18 markets. Exempt commodities generally include 

 19 commodities such as energy, metals, chemicals, and 

 20 emission allowances. 

 21 It is sometimes said that exempt 

 22 commercial markets are unregulated, but that is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 21 

 1 not quite right. 

 2 Although largely exempt from Commission 

 3 oversight authority under the CEA, Congress did 

 4 subject exempt commercial markets to a limited set 

 5 of regulatory requirements under Sections 2(h)(3) 

 6 through (5) of the statute. The Commission has 

 7 implemented these requirements in its Rule 36.3. 

 8 In recent years, derivatives trading on 

 9 certain exempt commercial markets has grown 

 10 substantially due in no small measure to the 

 11 regulatory environment created by the CFMA. At 

 12 the same time exempt commercial markets have 

 13 evolved in ways that may not have been anticipated 

 14 when the CFMA was enacted. 

 15 The question arises, therefore, whether 

 16 the regulatory line for exempt commercial markets 

 17 that was drawn by Congress and the CFMA remains 

 18 appropriate today. That is, on the regulatory 

 19 spectrum ranging from no regulation of bilateral, 

 20 over-the-counter transactions on the one hand to 

 21 fully-regulated futures exchanges on the other 

 22 hand, should policymakers adjust that line 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 22 

 1 governing exempt commercial markets further along 

 2 the spectrum toward the degree of regulation that 

 3 is applicable to contract markets and DTEFs? 

 4 With that background, let me now discuss 

 5 how exempt commercial markets are regulated under 

 6 the CEA. 

 7 First, market participants: Exempt 

 8 commercial markets are electronic trading 

 9 facilities that restrict trading to 

 10 principal-to-principal transactions between 

 11 eligible commercial entities. That term "eligible 

 12 commercial entities," like the name "exempt 

 13 commercial markets" itself, connotes a purely 

 14 commercial marketplace among entities that can 

 15 make or take delivery of the underlying commodity. 

 16 But that also is not quite right. 

 17 Under the statutory definitions of the 

 18 CFMA, pooled investment vehicles such as hedge 

 19 funds qualify as an eligible commercial entities 

 20 and their participation on certain exempt 

 21 commercial markets has become both active and 

 22 significant. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 23 

 1 Second, regulatory requirements: Exempt 

 2 commercial markets are subject to certain record- 

 3 keeping and reporting requirements under the CEA. 

 4 The statute requires that an exempt commercial 

 5 market maintain for five years and make available 

 6 for inspection upon request by the Commission 

 7 records of its activities related to its business 

 8 as a trading facility. 

 9 More specifically, under Rule 36.3 an 

 10 exempt commercial market must identify to the 

 11 Commission those transactions which averaged five 

 12 trades per day or more over the most recent 

 13 calendar quarter. For all such transactions the 

 14 exempt commercial market must provide to the 

 15 Commission weekly reports showing certain basic 

 16 trading information or provide the Commission with 

 17 electronic access that would allow the Commission 

 18 to compile that same information. 

 19 The CEA also gives the Commission the 

 20 authority to require an exempt commercial market 

 21 to provide upon special call information relating 

 22 to its business as the Commission may determine 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 24 

 1 appropriate to fulfill certain specified statutory 

 2 mandates. 

 3 The Commission staff has issued several 

 4 special calls to the Intercontinental Exchange, an 

 5 exempt commercial market generally referred to as 

 6 ICE, requesting information on trader positions in 

 7 ICE natural gas contracts that are directly linked 

 8 to NYMEX futures prices. The purpose of these 

 9 special calls was not to surveil ICE, as the 

 10 Commission has no statutory authority to do so. 

 11 Rather these special calls were issued to support 

 12 surveillance of the NYMEX natural gas contracts. 

 13 The Commission has imposed one further 

 14 record-keeping requirement on exempt commercial 

 15 markets in its Rule 36.3. That rule requires an 

 16 exempt commercial market to maintain a record of 

 17 allegations or complaints that it receives 

 18 concerning suspected fraud or manipulation and to 

 19 provide the Commission with a copy of the record 

 20 of each complaint that alleges facts that would 

 21 constitute a violation of the CEA or Commission 

 22 regulations. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 25 

 1 Third, some of the differences between 

 2 exempt commercial markets and contract markets: 

 3 Though exempt commercial markets are subject to 

 4 these limited regulatory requirements, the CEA 

 5 does not subject them to the level of transparency 

 6 and Commission oversight associated with contract 

 7 markets. The contract markets must demonstrate 

 8 compliance with core principles on a continuing 

 9 basis. These core principles require regulated 

 10 futures exchanges to undertake significant 

 11 supervisory responsibility with respect to trading 

 12 on their markets. 

 13 For example, contract markets must have 

 14 rules and procedures for preventing market 

 15 manipulation. They are required to adopt position 

 16 limit or accountability rules in order to address 

 17 the potential for market manipulation or 

 18 congestion, and contract markets must have 

 19 compliance and surveillance programs which the 

 20 Commission evaluates through its rule enforcement 

 21 reviews. 

 22 These statutory requirements do not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 26 

 1 apply to exempt commercial markets which are not 

 2 required under the statute to monitor trading on 

 3 the facility. Nor does the Commission have the 

 4 same authorities to address problems on exempt 

 5 commercial markets as it does for contract 

 6 markets. 

 7 For example, the Commission's statutory 

 8 emergency authority and its authority to force a 

 9 reduction or liquidation of positions, and to 

 10 alter or supplement the trading facility's rules 

 11 do not extent to exempt commercial markets. 

 12 The CEA does provide that the Commission 

 13 may determine that an exempt commercial market 

 14 performs a significant price discovery function 

 15 for transactions in an underlying cash market. 

 16 Such a determination does not trigger additional 

 17 self- regulatory responsibilities or additional 

 18 oversight authority for the Commission. Rather, 

 19 it triggers an obligation by the exempt commercial 

 20 market to publicly disseminate certain specified 

 21 information regarding contract terms, volume, open 

 22 interest, and prices. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 27 

 1 Finally, let me say a word about the 

 2 Commission's antifraud authority over transactions 

 3 on exempt commercial markets. In November of 

 4 2000, the 7th Circuit Court of Appeals suggested 

 5 in the CTS case that Section 4b of the CEA, which 

 6 is the Commission's primary antifraud tool, is 

 7 limited to intermediated transactions, that is, 

 8 those that involve a broker. As part of its 

 9 reauthorization process in Congress, the 

 10 Commission has proposed an amendment to Section 

 11 4b, the terms of which have been agreed to by the 

 12 various sectors of the futures industry. This 

 13 important legislative amendment would clarify the 

 14 Commission's authority to bring fraud actions 

 15 involving the principal-to-principal transactions 

 16 that occur on exempt commercial markets. 

 17 And now with the summary of the 

 18 statutory structure for derivatives markets in 

 19 mind, let me turn it over to my colleagues for 

 20 discussion of the Commission's work with respect 

 21 to exempt commercial markets in practice. 

 22 Thank you. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 28 

 1 CHAIRMAN LUKKEN: Thank you, Terry. Now 

 2 we're going to turn to our Director of the 

 3 Division of Market Oversight, Rick Shilts, who 

 4 will give us an overview of his division and what 

 5 they do in this area. Thank you, Rick. 

 6 MR. SHILTS: Thank you, Mr. Chairman. 

 7 Good morning, participants. As you said, my name 

 8 is Rick Shilts, and I'm the Director of the 

 9 Commission's Division of Markets. 

 10 The Division's primary mission involves 

 11 oversight and surveillance activity on the 

 12 regulated futures exchanges called contract 

 13 markets or DCMs. The Division also carries out 

 14 the requirements of the law related to exempt 

 15 commercial markets or ECMs. 

 16 I'd like to start out by providing some 

 17 background information on the EMCs that are filed 

 18 and noticed to date. As was described by Terry 

 19 Arbit, our general counsel, the EMC category was 

 20 created by the CFMA in December of 2000. Two of 

 21 the first facilities to file notices in 2001 were 

 22 the International Maritime Exchange, or IMAREX, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 29 

 1 and Norwegian market trading freight rates and the 

 2 Intercontinental Exchange in Atlanta, also known 

 3 as ICE, trading energy products. 

 4 From 2001 to now a total of 20 companies 

 5 have filed notifications to operate as an exempt 

 6 commercial market. Just in the past year, we 

 7 received three new ECM filings. In addition, our 

 8 staff is currently in contact with several other 

 9 companies who are actively contemplating filing 

 10 formal notifications. 

 11 Not all ECMs are successful. Currently, 

 12 only eight of the twenty ECMs that have filed a 

 13 notice are active; the others have gone out -- 

 14 have either gone out of business or have been 

 15 acquired by another ECM. Some have not yet 

 16 commenced operations. 

 17 Of the 20 EMCs that have filed a notice, 

 18 many trade or plan to trade energy-related 

 19 products, mostly natural gas, petroleum products 

 20 and electricity. Other commodities that have been 

 21 listed or intended for trading on ECMs include 

 22 emission allowances, metals, freight rates, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 30 

 1 chemicals, uranium, fertilizers, pulp and paper 

 2 products, and liquified petroleum gas. 

 3 The largest ECM in terms of trading 

 4 volume and number of contracts traded is the 

 5 Intercontinental Exchange which, as I noted, was 

 6 one of the first DCMs to file the notification. 

 7 ICE operates an ECM as well as regulated futures 

 8 exchanges in the U.S. and the U.K. 

 9 The principal contracts listed on ICE's 

 10 ECM are in the energy area, especially natural gas 

 11 and electricity, and since acquiring Chem-Connect 

 12 in July of this year, another active ECM, natural 

 13 gas, liquids, and chemicals. The other active 

 14 ECMs currently in operation include the Natural 

 15 Gas Exchange, or NGX, Net Through-Put, Houston 

 16 Street Exchange, IMAREX, as I mentioned, the 

 17 Chicago Climate Exchange,ICAP Electronic Trading 

 18 Community, and ICAP Commodity and Derivatives 

 19 Trading System. 

 20 Five of the eight active ECMs offer 

 21 clearing services, including ICE. Formerly, ECMs 

 22 did not offer a clearing component, initially; 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 31 

 1 they generally did not provide a clearing service 

 2 until they reached some level of success or 

 3 threshold level of activity. This approach seems 

 4 to have changed recently as newer ECMs contemplate 

 5 offering clearing at start-up. In this regard, 

 6 three of the ECMs filing a notice in the past year 

 7 indicated a plan to offer clearing services at 

 8 start-up. 

 9 In discussions with new ECMs, our 

 10 understanding is that the reduced regulatory 

 11 burden compared to contract markets and DTEFs is a 

 12 key reason why companies choose to operate in this 

 13 regulatory tier. They view the reduced regulatory 

 14 burden as being more consistent with their 

 15 business operations and goals. In this regard, 

 16 for many ECMs the majority of their business comes 

 17 from the nonregulated OTC world, including 

 18 institutional traders. Becoming an ECM allowed 

 19 them to expand into electronic trading under a 

 20 relatively less formal and demanding regulatory 

 21 scheme. For many, it does not appear that the ECM 

 22 route is viewed as a first step into eventually 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 32 

 1 becoming a regulated exchange. 

 2 I'd like now to offer a few observations 

 3 regarding the evolution of ECMs since the CFMA was 

 4 adopted in 2000. Initially, ECMs generally were 

 5 bare-bones trading platforms. In many ways they 

 6 were akin to business-to-business facilities for 

 7 large commercial firms. Their key role was to 

 8 facilitate the execution of trades between 

 9 commercial counterparties by offering an anonymous 

 10 and efficient electronic matching system. The 

 11 ECMs believed that their electronic systems were 

 12 superior to the existing voice broker system and 

 13 gave them a competitive advantage in the bilateral 

 14 OTC market, especially in the energy space. 

 15 The first ECMs did not offer a clearing 

 16 component; they addressed issues related to the 

 17 financial integrity of transactions by setting up 

 18 credit filters that allowed traders to limit their 

 19 counterparties to a customized list of traders. 

 20 In addition, ECM participants were primarily 

 21 commercial traders, and most DCMs were start-ups 

 22 or relatively small operations. Initially, ECM 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 33 

 1 trading volumes were small relative to volumes on 

 2 the regulated futures exchanges. 

 3 Finally, early ECM contracts were 

 4 generally, not directly, linked to regulated 

 5 futures markets and did not affect the 

 6 Commission's oversight of activity on the 

 7 regulated exchanges. 

 8 In recent years, we've witnessed a 

 9 number of changes in the ECM landscape. Today, 

 10 while there continue to be small ECMs, many of 

 11 which are start-up ventures, we also see some ECMs 

 12 that have taken on many of the characteristics of 

 13 regulated futures exchanges. 

 14 These ECMS are not just a forum for 

 15 efficient trade execution, they now offer benefits 

 16 and features in response to the needs and demands 

 17 of their participant traders. A significant 

 18 change is that some of the most successful ECMs 

 19 and many of the newer ECMs now offer or plan to 

 20 offer a clearing component that is widely utilized 

 21 by their participants as an efficient and 

 22 effective way to manage credit risk. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 34 

 1 In addition, some ECMs have become major 

 2 trading venues for particular commodities, 

 3 especially for natural gas and electricity. There 

 4 have also been changes in the types of traders 

 5 that participate on ECMs. In this regard, certain 

 6 exchange floor brokers and floor traders now are 

 7 considered eligible commercial entities, or ECEs, 

 8 and thus they can participate on ECMs. 

 9 Also, the trading communities on ECMs 

 10 now includes many noncommercial traders such as 

 11 large hedge funds which constitute a significant 

 12 part of the overall activity and open interest in 

 13 certain ECM contracts. 

 14 Another consideration is that some of 

 15 the ECMs link their contracts to the prices of 

 16 related contracts on the regulated contract 

 17 markets. This feature has created certain 

 18 complications for our staff in carrying out the 

 19 Commission's mandate to oversee the futures 

 20 markets. Of special concern is that the existence 

 21 of cash-settled, look-alike contracts could 

 22 provide an incentive to manipulate the settlement 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 35 

 1 price of the underlying regulated contract market 

 2 price in order to benefit from positions in the 

 3 look-alike ECM contract. 

 4 In view of these developments, certain 

 5 large ECMs now seem to resemble the regulated 

 6 futures exchanges with respect to certain products 

 7 that they trade. For example, with respect to 

 8 these actively- traded cleared products, both the 

 9 regulated exchanges and the large ECMs provide a 

 10 forum for traders to execute transactions on a 

 11 many-to-many multilateral platform. 

 12 For both markets the same types of 

 13 traders are active participants, both markets 

 14 employ the same types of settlement features, both 

 15 types of markets offer a clearing function as an 

 16 effective way to manage counterparty risk, and, 

 17 finally, certain of the derivative products 

 18 offered by both the regulated contract markets and 

 19 the ECMs provide the same economic benefits; that 

 20 is, hedging or risk management or serving as a 

 21 source of price discovery for industry 

 22 participants. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 36 

 1 Recognizing these similarities, there 

 2 have been indications that some ECMs might be 

 3 willing to accept a certain level of heightened 

 4 CFTC oversight with respect to certain types of 

 5 products. In addition, we understand that the 

 6 physical commodities markets have been a topic of 

 7 interest in other jurisdictions. 

 8 For example, the European Commission is 

 9 considering whether to maintain an exemption from 

 10 various reporting and prudential requirements for 

 11 certain commodity traders, including large energy 

 12 companies. The European Commission recently 

 13 conducted a survey on this issue and reported that 

 14 certain regulatory authority may be appropriate. 

 15 As Terry discussed, under the Commodity 

 16 Exchange Act, the Commission staff does not 

 17 directly surveil or monitor trading activity on 

 18 ECMs on an ongoing basis as it does for the 

 19 regulated contract markets. As he also noted, the 

 20 CEA sets forth several basic oversight provisions 

 21 applicable to ECMs, including a price discovery 

 22 provision. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 37 

 1 I'd like now to talk a little more about 

 2 this price discovery requirement. Specifically, 

 3 the law provides that ECMs shall disseminate 

 4 price, trading volume and other trading data if 

 5 the Commission determines that the ECM performs a 

 6 significant price discovery function for 

 7 transactions in the cash market. This provision 

 8 is contract- specific and, if triggered, requires 

 9 dissemination of data with respect to the 

 10 particular contract that has been found to perform 

 11 a price discovery function. 

 12 In 2004, the Commission issued 

 13 regulations stating what constitutes being a price 

 14 discovery market for this purpose. Specifically, 

 15 under the CFTC regulations, an ECM contract is a 

 16 price discovery market if, 1) cash market bids 

 17 offers or transactions are directly based on or 

 18 quoted at a differential to the prices generated 

 19 on the market on more than an occasional basis; or 

 20 2) the ECM's prices are routinely disseminated in 

 21 a widely distributed industry publication and are 

 22 routinely consulted by industry participants in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 38 

 1 pricing cash market transactions. 

 2 It should be noted that the statutory 

 3 price discovery provision is somewhat circular. 

 4 In this regard, the statute mandates dissemination 

 5 of trading data if an ECM performs a significant 

 6 price discovery function for the underlying cash 

 7 market. But the underlying cash market could not 

 8 be relying on the ECM contract for price discovery 

 9 unless such data were already being disseminated 

 10 in some form. 

 11 The Commission acknowledged the apparent 

 12 circularity of the test in the price discovery 

 13 criterion but noted when it adopted it is rules 

 14 that the rule will ensure that the trading data is 

 15 disseminated as Congress intended. 

 16 The Commission has not, under its rules 

 17 to date, issued a formal price discovery 

 18 determination with respect to any ECM contracts; 

 19 however, in connection with this hearing our staff 

 20 conducted a number of interviews with market 

 21 participants to learn more as to how they trade 

 22 natural gas and electricity and whether ICE prices 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 39 

 1 are used as a basis for price discovery for these 

 2 commodities. 

 3 I should note that price discovery is 

 4 not a defined term in the Commodity Exchange Act 

 5 or in the economics profession, and the term may 

 6 mean different things to different people. Our 

 7 chief economist will talk about this in a few 

 8 minutes. 

 9 Most traders and voice brokers express 

 10 the view that ICE is a price discovery market for 

 11 certain natural gas and electric markets. For 

 12 example, with respect to the Henry Hub Natural Gas 

 13 Market, market participants generally view ICE and 

 14 NYNEX as essentially a single market. Traders 

 15 look to both ICE and NYNEX when determining where 

 16 to execute a trade at the best price. They stated 

 17 that both marketplaces offer liquid and 

 18 financially secure contracts. Traders take 

 19 positions in a NYMEX physically-delivered or a 

 20 NYMEX cash-settled contract or in an ICE 

 21 look-alike swap, depending on where they can get 

 22 the best price. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 40 

 1 For natural gas trades at locations 

 2 other than the Henry Hub, market participants told 

 3 us that ICE prices are widely consulted by the 

 4 industry, especially for contracts involving gas 

 5 at certain specific locations in the western U.S. 

 6 For certain electricity markets, traders 

 7 indicated that ICE prices and indexes are widely 

 8 consulted before executing a trade. Ice prices 

 9 are consulted more regularly than NYMEX because 

 10 NYMEX has not gained significant volume in the 

 11 electricity space. 

 12 As noted, Commission regulations provide 

 13 that an ECM contract is a price discovery market 

 14 if cash trades are directly based on the ECM 

 15 prices or if its prices are disseminated in 

 16 industry publications and routinely consulted by 

 17 the industry. 

 18 While market participants generally have 

 19 expressed the view that ICE prices are widely 

 20 consulted and utilized by the industry, for many 

 21 natural gas and electricity markets, we have not 

 22 yet concluded that ICE natural gas or electricity 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 41 

 1 contracts meet all of the specific requirements 

 2 outlined in the Commission's price discovery 

 3 regulations. Our staff continues to gather more 

 4 information about this issue. 

 5 I should further note that staff also is 

 6 reconsidering whether the Commission's price 

 7 discovery criteria remain appropriate. For 

 8 example, since adopting the price discovery 

 9 regulations, some ECM contracts that are linked to 

 10 the prices of a regulated futures market have 

 11 developed significant open interest and commercial 

 12 participation. Since this feature was not 

 13 previously contemplated, the Commission may wish 

 14 to consider other market characteristics that 

 15 would cause an ECM contract to be classified as a 

 16 source of price discovery for t he cash market. 

 17 As mentioned, our discussions with 

 18 industry participants indicate that traders 

 19 regularly consult ICE prices in making trading 

 20 decisions and that they view ICE and NYMEX as 

 21 essentially one market for Henry Hub natural gas 

 22 futures with price formation occurring in both 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 42 

 1 markets. It appears that when two markets are 

 2 linked in this way, both markets may constitute a 

 3 price discovery market for the commodity in 

 4 question, as it is difficult if not impossible to 

 5 split the two and assign the price discovery role 

 6 to a single marketplace. 

 7 Recognizing this, it may be appropriate 

 8 for the Commission to reconsider its price 

 9 discovery criteria to include an additional 

 10 standard for linked markets. 

 11 That concludes my remarks. I will now 

 12 turn it over to our chief economist who will 

 13 discuss the work of his office on the issue of 

 14 price discovery and other matters. 

 15 Thank you. 

 16 CHAIRMAN LUKKEN: Thank you, Rick. We 

 17 now turn to Jeff Harris, who was recently 

 18 announced to be the Chief Economist here at the 

 19 CFTC. We stole him from the University of 

 20 Delaware, but he's no stranger to our world, 

 21 having consulted at the CFTC for a year or two, 

 22 actually, before coming on board. So a very 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 43 

 1 distinguished economist, and we welcome you. 

 2 So thank you, Jeff, and we look forward 

 3 to your testimony. 

 4 MR. HARRIS: Thanks, Walt, and thank you 

 5 members of the Commission. I am pleased to be 

 6 here today to have the opportunity to testify on 

 7 behalf of the Office of the Chief Economist, and I 

 8 appreciate the opportunity to discuss related 

 9 issues in the oversight of designated contract 

 10 markets and exempt commercial markets. 

 11 Our office works closely with the 

 12 Division of Market Oversight in providing analysis 

 13 and advice on matters that relate to the oversight 

 14 and examination of trading in futures markets. In 

 15 preparation for today's hearing, OCE staff have 

 16 collected and analyzed data that may be useful to 

 17 the commissioners in evaluating the Commission's 

 18 oversight of DCMs and ECMs. 

 19 As economists, we view the oversight of 

 20 markets to include many dimensions of the trading 

 21 process. All successful markets bring 

 22 participants together with healthy futures markets 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 44 

 1 allowing for rich interactions between 

 2 participants aiming to manage risk and 

 3 participants willing to assume price risks. 

 4 As my colleague Rick Shilts from DMO has 

 5 touched upon, futures markets are also 

 6 characterized by some level of price discovery. 

 7 For the sake of today's hearing, OCE has examined 

 8 both of these dimensions from an economic point of 

 9 view. We have examined the mix of hedgers and 

 10 speculators in a number of markets with an eye on 

 11 whether the existence of ECM trading appears to 

 12 influence this mix. We've also studied the 

 13 economic process of price discovery in various 

 14 markets with an eye toward whether and how much 

 15 price discovery occurs on ECMs. 

 16 Futures markets of all types have 

 17 witnessed an explosive growth in a trading volume 

 18 during the last few years. Futures volume has 

 19 more than quadrupled, and the number of actively 

 20 traded contracts have more than quintupled since 

 21 2000. Accompanying this growth in exchange 

 22 trading has been a parallel growth in trading 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 45 

 1 activity on ECMs. 

 2 The number of firms filing notifications 

 3 to operate ECMs has now grown to the current 20 

 4 from just three in 2001. The largest ECM based on 

 5 trading volume in the number of contracts traded 

 6 is the Intercontinental Exchange, or ICE, which is 

 7 most active in trading natural gas and electricity 

 8 futures. Since ICE is the most active of all 

 9 ECMs, our economic analysis that relies on data 

 10 focuses largely on ICE and natural gas markets in 

 11 particular. 

 12 One aspect of trading that we have 

 13 examined pertains to the mix of hedgers and 

 14 speculators in these markets. Through data 

 15 provided by DCMs, the large trader reporting 

 16 system, we are able to characterize the mix of 

 17 traders in these markets over time. We can 

 18 monitor the mix of traders in DCMs during the time 

 19 period that ECM trading volume has been growing. 

 20 Figure 1 below displays the mix of 

 21 traders in NYMEX natural gas contracts from July 

 22 2004 through July 2007, a time frame that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 46 

 1 coincides with significant growth in the ICE 

 2 natural gas trading. As shown in Figure 1, 

 3 commodity swap dealers and managed money traders, 

 4 including hedge funds, have shown the greatest 

 5 growth in natural gas trading futures on NYMEX. 

 6 In fact, the growth in noncommercial trading, 

 7 largely speculative trading, has grown from 42 

 8 percent to 52 percent of the market from July 2004 

 9 to July 2007. 

 10 Overall we see that the mix of traders 

 11 on NYMEX remains relatively stable during a period 

 12 of dramatic growth of trading on both NYMEX and 

 13 ICE. 

 14 To look more specifically at changes 

 15 that are occurring in the natural gas market, OCE 

 16 has compiled similar statistics -- see Table A 

 17 below -- for active contracts in other markets: 

 18 Corn, heating oil, and crude oil. 

 19 Table A suggests that the pattern of 

 20 changes in the market share by noncommercial 

 21 speculative traders in natural gas are broadly 

 22 consistent with the patterns of changes in these 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 47 

 1 other markets. Noncommercial trading interest has 

 2 been rising across the board with both managed 

 3 money traders and nonreportable traders driving 

 4 this increase in all markets. 

 5 In this light, the changing composition 

 6 of traders on NYMEX natural gas futures trading 

 7 from 2004 to 2007 likely reflects in large part a 

 8 market- wide trend toward greater noncommercial 

 9 trading. In light of this evidence, the growth in 

 10 trading of natural gas futures on ICE does not 

 11 appear to be a factor in the changing composition 

 12 of traders in the natural gas market. 

 13 In the economist's view, price discovery 

 14 is a process by which new information is impounded 

 15 into prices. Keeping in mind that this view 

 16 differs somewhat from the statutory definition of 

 17 price discovery, I believe our office can also 

 18 provide evidence that can be used to examine 

 19 similarities and difference between DCMs and ECMs 

 20 along this dimension. We have, in fact, conducted 

 21 an economic analysis of price discovery for 

 22 trading in the natural gas futures markets where 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 48 

 1 contracts are concurrently traded both on the 

 2 NYMEX and ICE. 

 3 We collected transaction prices from 

 4 each market from January 3, 2006, through December 

 5 31st of 2006 and evaluated trading for 20 

 6 contracts when trading on each market was 

 7 appropriately active. Since the economist thinks 

 8 of price discovery as the impounding of new 

 9 information into prices, we examine the timing of 

 10 prices changes on ICE and NYMEX to draw inferences 

 11 about where information might arrive first. If 

 12 the price changes on one venue consistently lead 

 13 those on another venue, we may conclude that the 

 14 informed traders prefer trading on the leading 

 15 exchange. A market that consistently leads is 

 16 said to be discovering prices. 

 17 Figure 2 here below presents a 

 18 simplified visual depiction of our economic notion 

 19 of price discovery, tracing prices over time. As 

 20 depicted here at the box on the left, during the 

 21 first part of the time period, ICE prices appear 

 22 to lead NYMEX prices (by at most a minute) as 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 49 

 1 natural prices begin to fall. 

 2 By contrast, the box to the right here 

 3 shows during the later part of the time period, 

 4 NYMEX prices appear to lead the ICE prices as 

 5 natural gas prices fall further. 

 6 By following price changes in both of 

 7 these markets over the entire trading day, we as 

 8 economists can statistically discern which market 

 9 leads the other on each trading day. We 

 10 calculated price discovery statistics for each of 

 11 the 1,265 contract days for our sample to quantify 

 12 the degree of price discovery for ICE and NYMEX in 

 13 natural gas contracts. 

 14 As might be expected from the example in 

 15 Figure 2, on some days both markets might lead the 

 16 other at different times during the day. In 

 17 addition, on some days we are unable to discern 

 18 whether either market might lead the other. 

 19 Overall, however, we find that ICE 

 20 significantly leads NYMEX on 20 percent of our 

 21 contract days. For comparison NYMEX significantly 

 22 leads ICE on 63 percent of contract days. These 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 50 

 1 results appear to suggest that in an economic 

 2 sense, ICE and NYMEX are both significant price 

 3 discovery venues to natural gas futures contracts. 

 4 On that note, I'll turn it over to my 

 5 colleagues from Market Surveillance, John Fenton. 

 6 CHAIRMAN LUKKEN: Thank you, Jeff. We 

 7 now turn to John Fenton, our head of Surveillance 

 8 here at CFTC. I look forward to your testimony, 

 9 John. Thank you. 

 10 MR. FENTON: Thank you, Chairman Lukken 

 11 and commissioners. I'd like to welcome our guests 

 12 as well, and I'm looking forward to the 

 13 discussions as they proceed today. 

 14 My name is John Fenton. I am the 

 15 Director of the Commission's Market Surveillance 

 16 Program. This program's primary mission is to 

 17 deter and prevent price manipulation or any other 

 18 distortion to market integrity on regulated 

 19 futures markets -- that is, designated contract 

 20 markets. 

 21 I am pleased to have this opportunity to 

 22 talk a bit about how we do surveillance on futures 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 51 

 1 markets and, in particular, what we have been 

 2 doing in energy futures markets. 

 3 While the Commodity Exchange prohibits 

 4 manipulation, it does not specifically define it. 

 5 This omission is a recognition by Congress that a 

 6 precise definition would almost certainly fail to 

 7 capture the complexity and variety of potential 

 8 manipulative behavior. 

 9 It has been through the development of 

 10 case law under the Commodity Exchange Act that the 

 11 elements of a definition of manipulation have 

 12 emerged. At the risk of oversimplification, I 

 13 think a general definition of manipulation is that 

 14 it is any market behavior that is intended to 

 15 cause, and that succeeds in causing, an artificial 

 16 price. Of course, this raises the question, what 

 17 is an artificial price? 

 18 An artificial price is a price that does 

 19 not accurately reflect the legitimate market 

 20 forces of supply and demand. In other words, it 

 21 is a price that is an artifice intentionally 

 22 created by the manipulator that otherwise would 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 52 

 1 not exist. 

 2 Although the elements of manipulation 

 3 have emerged through cases brought by our Division 

 4 Enforcement, they are also extremely relevant to 

 5 how we conduct surveillance to deter and prevent 

 6 manipulation. For example, the ability to cause a 

 7 manipulation may stem from a dominant futures 

 8 positions and, as I will discuss more fully in a 

 9 few minutes, to counter this potential threat we 

 10 monitor futures market positions on a daily basis. 

 11 Before proceeding, I should mention that 

 12 my comments are specifically related to the scope 

 13 of the Commission's market surveillance program to 

 14 deter and prevent manipulation on designated 

 15 contract markets, those markets described in Terry 

 16 Arbit's testimony as "fully-regulated" exchanges. 

 17 The Commission's authority to bring 

 18 antimanipulation enforcement actions clearly 

 19 extends more broadly than this, to include, for 

 20 example, manipulative activity in cash markets and 

 21 on exempt commercial markets. 

 22 Futures contracts are of two general 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 53 

 1 types depending on how they are ultimately 

 2 settled, either through physical delivery or 

 3 through cash settlement. 

 4 In both cases, the settlement mechanism 

 5 is meant to ensure that at expiration the futures 

 6 price converges to the cash value of the 

 7 underlying commodity. The pricing integrity of a 

 8 futures contract, its efficiency of a price 

 9 discovery tool and as a risk management tool, 

 10 depends on the expectation that at expiration its 

 11 price will reliably represent the legitimate 

 12 supply and demand factors affecting the underlying 

 13 commodity. 

 14 The overwhelming success of futures 

 15 markets proves that this is usually the case. In 

 16 futures markets settled through physical delivery, 

 17 traders can normally arbitrage between futures and 

 18 cash to ensure convergence. If the futures price 

 19 seems too high relative to cash prices, there will 

 20 be relatively greater interest in making delivery, 

 21 tending to cause futures prices to fall. If 

 22 futures prices seem too low, the opposite will 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 54 

 1 occur. In cash-settled futures markets, the final 

 2 settlement price will necessarily represent the 

 3 value of the settlement index at expiration. 

 4 However, these settlement mechanisms are 

 5 potentially vulnerable to attempts at price 

 6 manipulation. In futures markets settled through 

 7 physical delivery, manipulation or attempted 

 8 manipulation is likely to involve the use of 

 9 market power to dominate the delivery process. 

 10 For example, a market squeeze would 

 11 involve a trader holding a dominant long position 

 12 in excess of the supply available for delivery on 

 13 the contract. 

 14 The long trader could use that dominance 

 15 to extract artificial prices from traders holding 

 16 short positions who could not make delivery and 

 17 would be forced to buy back their positions versus 

 18 the dominant long trader. 

 19 To protect against this type of 

 20 manipulation, our market surveillance program has 

 21 two main tools: large trader reporting and 

 22 spot-month position limits. I will discuss our 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 55 

 1 large trader reporting system in more detail in a 

 2 few minutes, but the point I would like to make 

 3 now is that large trader reporting allows us to 

 4 monitor the size of positions very carefully to 

 5 detect a possible impending squeeze. 

 6 In addition, spot-month position limits 

 7 mitigate against manipulation by restricting the 

 8 size of positions as the contract approaches 

 9 expiration, the period when it is most vulnerable 

 10 to being squeezed. 

 11 Historically, the Commission has used as 

 12 a guideline that exchanges set spot-month position 

 13 limits at a level no greater than 25 percent of 

 14 the normal deliverable supply. The current 

 15 spot-month position limit for the NYMEX Henry Hub 

 16 natural gas futures contract is 1,000 contracts. 

 17 Manipulation of a cash-settled futures 

 18 markets occurs more indirectly. Since a cash 

 19 settled futures market references some other price 

 20 for its final settlement, a manipulative scheme 

 21 would involve manipulation of that reference 

 22 price. In such a scheme, large positions in the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 56 

 1 cash-settled futures contract would provide the 

 2 motive for a manipulation, but the manipulative 

 3 activity would occur in the market for the 

 4 reference price. 

 5 Such a scheme might involve relatively 

 6 heavy buying in the market used for a price 

 7 reference to force that price to an artificially 

 8 high level which would then be used to cash settle 

 9 a much larger long position in the cash-settled 

 10 futures market. The formula for detecting this 

 11 type of manipulative activity is close scrutiny of 

 12 prices and trading activity in the reference 

 13 market, along with large trader information about 

 14 positions that are cash settled using that 

 15 reference price. 

 16 The focus of the Commission's 

 17 surveillance of energy markets has been on the 

 18 regulated futures markets at NYMEX. At leats 

 19 three reasons explain this focus: First, this is 

 20 the mandate provided by Congress in the Commodity 

 21 Futures Modernization Act of 2000. Second, the 

 22 NYMEX Henry Hub final settlement price has played 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 57 

 1 a unique role as a central reference price around 

 2 which other cash futures, and OTC derivative 

 3 prices have revolved. 

 4 And third, this focus reflects the 

 5 reality of limited Commission resources. 

 6 While each of these reasons still holds, 

 7 it is becoming increasing apparent that proper 

 8 surveillance of the regulated markets at NYMEX 

 9 requires increased regulatory transparency into 

 10 trading activity of cleared products linked to 

 11 NYMEX. 

 12 With that in mind, I would like to 

 13 briefly describe some of the key pieces of 

 14 information that we receive for regulated futures 

 15 markets, such as NYMEX, and three special calls 

 16 issued to ICE to obtain similar information. 

 17 Pursuant to part 16 of the Commission's 

 18 regulations, DCMs are required to provide daily 

 19 data showing aggregate positions and trading 

 20 cleared by each clearing member, shown separately 

 21 for house and customer positions. This data 

 22 includes all positions in futures markets at DCMs 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 58 

 1 but it does not provide information on the size 

 2 and identity of customer positions. 

 3 The centerpiece of the Commission's 

 4 market surveillance program is its large trader 

 5 reporting system. Under the large trade reporting 

 6 system, clearing members, futures commission 

 7 merchants, and foreign brokers, collectively 

 8 called reporting firms, file daily reports with 

 9 the CFTC showing futures and options positions 

 10 held in accounts they carried that are at or above 

 11 specific recording levels set by the CFTC. These 

 12 reporting levels vary by market from as low as 25 

 13 contracts for small markets to as high as 3,000 

 14 contracts for the largest market, the Euro dollar 

 15 futures market, traded at the Chicago Mercantile 

 16 Exchange. 

 17 The reporting level for the natural gas 

 18 future market is 200 contracts. The data provided 

 19 in these reports in aggregate has covered about 97 

 20 percent of total open interest in the NYMEX Henry 

 21 Hub natural gas contract during the past year. 

 22 The Commission also receives large 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 59 

 1 trader reporting for contracts that are cleared 

 2 through NYMEX's Clearport facility. Typically, 

 3 these are transactions initially occurr in the OTC 

 4 market, through voice brokers and are then 

 5 submitted to Clearport for clearing. In 

 6 interviews with industry participants, staff has 

 7 heard that contracts cleared through Clearport 

 8 represent a significant portion of the OTC 

 9 activity conducted through voice brokers. 

 10 In addition to large trader reporting 

 11 for NYMEX markets, the Commission receives from 

 12 NYMEX daily transaction data. This data provides 

 13 a complete audit trail of all trades that occur in 

 14 NYMEX markets. Surveillance staff use this data 

 15 to closely scrutinize trading activity during key 

 16 trading periods, especially during the closing 

 17 range of the final trading day. 

 18 The Division of Market Oversight has 

 19 issued three special calls to the Intercontinental 

 20 Exchange for information related to ICE's cleared 

 21 natural gas swap contracts that are cash-settled 

 22 based on the NYMEX physical delivery natural gas 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 60 

 1 contract -- ICE's look-alike contracts. In each 

 2 case, the information requested has been analogous 

 3 to information that the CFTC receives from DCMs, 

 4 including NYMEX. 

 5 The first special call was issued on 

 6 September 28, 2006, requesting daily clearing 

 7 member position data, broken out between house and 

 8 aggregate customer positions. This is similar to 

 9 information that the Commission receives from DCMs 

 10 under part 16 of the Commission's regulations. 

 11 The Commission has been receiving responsive data 

 12 from ICE since October 10, 2006. With this date, 

 13 market surveillance staff can see all cleared 

 14 positions at the clearing member level, but it is 

 15 not possible to determine individual customer 

 16 positions from this data. 

 17 To address this gap, the Commission 

 18 issued a second special call on December 1, 2006, 

 19 to obtain daily individual trader positions. The 

 20 Commission has been receiving responsive data 

 21 since February 15, 2007. 

 22 While the content of this data is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 61 

 1 similar to large trader reporting for DCMs, the 

 2 methodology for reporting is very different. 

 3 Large trader reporting for products traded on DCMs 

 4 is done not by the exchanges but by the carrying 

 5 firms, generally, the Futures Commission merchants 

 6 for U.S. traders and foreign brokers for non-U.S. 

 7 traders. Since the reporting firms know directly 

 8 these positions, this reporting is fairly 

 9 straightforward and highly accurate. The 

 10 Commission's authority to issue special calls with 

 11 respect to trading and positions on ECMs is 

 12 limited to the ECM itself. ICE was not, and is 

 13 not, receiving position reporting from firms. 

 14 Therefore, in order to comply with the 

 15 Commission's special call, ICE has developed an 

 16 algorithm to infer open positions from the sum of 

 17 all trading by each individual trading firm. 

 18 While this approach is innovative and has provide 

 19 very valuable information to the Commission, it is 

 20 not yet as accurate as traditional large trader 

 21 reporting. 

 22 Commission staff continue to work with 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 62 

 1 ICE to improve the accuracy of this data. ICE is 

 2 providing this data in the standard electronic 

 3 format used for Commission large trader reporting, 

 4 which has allowed us to relatively easily 

 5 integrate this data into our computer surveillance 

 6 systems and to examiner traders' consolidated 

 7 positions on NYMEX and ICE. 

 8 I would like to make a few observations 

 9 with respect to insights afforded by larger trader 

 10 reporting for NYMEX and ICE natural gas products. 

 11 The first point is that the composition of 

 12 commercial and noncommercial activity in these two 

 13 markets, as measured by open positions, is 

 14 actually quite similar. 

 15 On a recent day noncommercial traders 

 16 held about 46 percent of the open long positions 

 17 and 52 percent of the open short positions in 

 18 NYMEX's Henry Hub physical delivery futures 

 19 contract. 

 20 On that same date, noncommercials held 

 21 about 46 percent of the long positions and 36 

 22 percent of the open short positions in ICE's 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 63 

 1 linked Henry Hub swap contract. This highlights 

 2 that there is a substantial overlap of traders in 

 3 these two markets. 

 4 The second observation is based on 

 5 Commission staff interviews of industry 

 6 participants in anticipation of today's hearing. 

 7 When asked how much of the total trading activity 

 8 involving Henry Hub futures and swaps that the 

 9 Commission was seeing as a result of large trader 

 10 reporting of cleared positions on NYMEX, Clearport 

 11 and ICE, the unanimous response was that we were 

 12 seeing the vast majority of all such positions. 

 13 The most recent special call to ICE was 

 14 issued on September 5, 2007. This special call 

 15 requires ICE to provide all cleared transaction 

 16 data for the Henry Hub swap contracts, identifying 

 17 counterparties, for the final two trading sessions 

 18 prior to the expiration of prompt-month Henry Hub 

 19 natural gas products. 

 20 This data is similar to transaction data 

 21 that the Commission receives from NYMEX for all 

 22 trading days. When the Commission begins to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 64 

 1 receive this data, we will be able to monitor 

 2 trading activity on ICE during these crucial last 

 3 two days, in conjunction with our analysis of 

 4 NYMEX trading, to provide more complete coverage 

 5 to counter possible manipulative schemes. 

 6 Thank you, Mr. Chairman, for this 

 7 opportunity to briefly describe the Commission's 

 8 surveillance program for energy futures markets. 

 9 CHAIRMAN LUKKEN: Thank you, Mr. 

 10 Fenton. Now, I'm going to open it up for 

 11 questions to the Commission, and I'll start off 

 12 the round. 

 13 This is a question regarding what you 

 14 and our chief economist has presented, growing 

 15 interest in speculative trading. As Jeff's charts 

 16 pointed out since 19 -- I'm sorry, 2004 to 

 17 present, we've seen about a 10 percent increase in 

 18 speculative activity. 

 19 John, as you mentioned, it is been on 

 20 both side of the market, both speculators shorting 

 21 and long in these markets. How do you approach 

 22 this? Is this a concern that's growing trend, not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 65 

 1 just in natural gas but other commodities we 

 2 regulate? How do you approach this from a 

 3 surveillance point of view, and is it meaningful 

 4 from a regulatory point of view in regards to our 

 5 chief economist's questions? John? 

 6 MR. FENTON: Well, the first point, I 

 7 guess, is the numbers that I cited, and I think 

 8 Jeff showed as well, is aggregate speculative or 

 9 noncommercial positions. And so in sum, as long 

 10 as individual traders are trading properly, I 

 11 don't think there is great concern about the role 

 12 of speculation in futures markets. 

 13 Obviously, in the energy markets, and in 

 14 particularly natural gas, a fairly large portion 

 15 of the noncommercial positions are spread 

 16 positions. And we know from the experience of 

 17 Amaranth these are not always risk-neutral 

 18 positions, but it tends to be a view of relative 

 19 prices rather than absolute prices. 

 20 But as I say, I think that as long as 

 21 speculative traders are trading properly and are 

 22 not attempting to manipulate prices, they're part 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 66 

 1 of the mix in the markets and are part of the 

 2 price discovery process. 

 3 CHAIRMAN LUKKEN: Jeff, do you have 

 4 anything to add? 

 5 MR. HARRIS: I think from an economist's 

 6 standpoint, the thing that I didn't point out in 

 7 those charts was that the volume itself has grown 

 8 substantially in these markets. So what we didn't 

 9 see is there still is a large commercial interest, 

 10 the major point of, I guess, the initial chart was 

 11 to show that there is still pretty good healthy 

 12 mix, and as long as we do have the trader limits 

 13 that are in place on designated contract markets, 

 14 then I think it is not a concern from an 

 15 economist's standpoint. 

 16 CHAIRMAN LUKKEN: Thank you. And one 

 17 quick question for Rick. You mentioned that we 

 18 have three broad categories in our markets: 

 19 Designated contract markets, the fully-regulated 

 20 exchange, derivative transaction execution 

 21 facilities, DTEFs and then ECMs. And we've seen 

 22 lots of growth in the DCM category the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 67 

 1 fully-regulated, and lots of growth in the ECM 

 2 category. And then we have this big donut in the 

 3 middle, DTEFs, where no one has taken advantage of 

 4 this., 

 5 This is something we may want to explore 

 6 at the next panel, but do you get a feel, 

 7 intuitive feel of why people haven't registered in 

 8 this category? Are there certain aspects of the 

 9 DTEF that are unattractive to these businesses? 

 10 MR. SHILTS: In discussions with some 

 11 people who have inquired about coming in as a 

 12 DTEF, it seems as though that the major 

 13 consideration is that which way do they want to 

 14 go? If you want to become a DTEF, then you do 

 15 have to set up self- regulatory responsibilities, 

 16 a compliance program, and meet a number of core 

 17 principles. They're no as much as a DCM, but that 

 18 you still have to fundamentally set up a program 

 19 to oversee your markets. And I think the choice 

 20 has been if the decision is that if you want to 

 21 set up a program, then you might, you know, 

 22 compliance program and meet all these regulatory 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 68 

 1 requirements, you might as well just become a DCM, 

 2 and then there are no restrictions on the types of 

 3 products that can be traded or that the types of 

 4 traders that can participate on the market. 

 5 So I think it gets down to the choice 

 6 that they feel that it is not worth it to kind of 

 7 go to this middle ground, that if you're really 

 8 going to -- you're either going to be trade in the 

 9 kind of the DCM space, but if you do want to 

 10 become a regulated market, then you might as well 

 11 go all the way and become a DCM. 

 12 That's kind of the general impression, 

 13 and I think it is a couple of the concerns 

 14 expressed, and that some of these markets do want 

 15 to conclude some sort of intermediation, maybe 

 16 very limited amount of intermediation and that's 

 17 not permitted on the commercial DTEF market so 

 18 that again they would decide, well, we'll just -- 

 19 we'll let go to become a DCM. So it might be that 

 20 there are certain other aspects of the DTEF 

 21 requirements that are inhibiting some of these 

 22 entities from actually using that space. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 69 

 1 CHAIRMAN LUKKEN: Thank you. I'll turn 

 2 to Commissioner Dunn. 

 3 COMMISSIONER DUNN: Thank you, Mr. 

 4 Chairman. And welcome to all of our panelists. I 

 5 appreciate all the hard work the staff does, and a 

 6 special welcome to our new general counsel and our 

 7 new chief economist. Your first times in the hot 

 8 seat in these new positions, and we'll see how you 

 9 like it. 

 10 Let's just start right off with Terry, 

 11 and maybe, Rick, you might jump in on this as 

 12 well. In the development of the Modernization 

 13 Act, was the Commission asked to comment on the 

 14 development of the ECMs? 

 15 MR. ARBIT: Well, I hate to have that, 

 16 for my first question as general counsel -- I was 

 17 actually not involved at that stage. 

 18 COMMISSIONER DUNN: (off mike) 

 19 MR. ARBIT: I certainly know, as a staff 

 20 member here, that drafts were provided to the 

 21 Commission of various provisions, and there was a 

 22 dialogue back and forth. I'm sorry, I actually do 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 70 

 1 not know the extent of the Commission's input on 

 2 these provisions in particular. 

 3 CHAIRMAN LUKKEN: Rick? 

 4 MR. SHILTS: Yeah, I have the same, you 

 5 know, memory as Terry that there was drafts of 

 6 various legislative proposals passed back and 

 7 forth, but I also wasn't intimately involved with 

 8 that process. I don't really -- 

 9 COMMISSIONER DUNN: Was it contemplated 

 10 at the time that they would develop the direction 

 11 and the size they have for those that are 

 12 operating now? 

 13 MR. SHILTS: That I don't know. I don't 

 14 know the answer to that. 

 15 MR. ARBIT: I would add one thing: At 

 16 the time that the CFMA was being debated in 

 17 Congress, the Commission was operating on its own 

 18 regulatory track, something that was called "the 

 19 new regulatory framework." And I believe that 

 20 that had contemplated a three-part regime for 

 21 exchanges or trading facilities. They had a 

 22 different terminology, but the equivalent 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 71 

 1 categories were the fully-regulated contract 

 2 markets and middle category similar to the DTEFs 

 3 that are provided for under the statute, and a 

 4 lesser regulated category for, I think what would 

 5 be sort of equivalent to the exempt boards of 

 6 trade which we really did not talk about in the 

 7 testimony, but is also provided in the CFMA. 

 8 

 9 I don't believe the Commission's new 

 10 regulatory framework had, in addition to those 

 11 three categories of exchanges, I don't believe 

 12 there was another category for this sort of exempt 

 13 commercial market type of facility. 

 14 COMMISSIONER DUNN: Terry, you testified 

 15 that the -- if there are complaints received by 

 16 the ECMs, that they are supposed to be forwarded 

 17 in to the Commission. Are you aware of how many 

 18 of those we've received to date? 

 19 MR. ARBIT: Not -- I don't have the 

 20 exact number. I don't believe it has been a lot. 

 21 I don't believe there have been very many. 

 22 MR. SHILTS: I think it is been around 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 72 

 1 five or so. I'm not exactly sure. 

 2 COMMISSIONER DUNN: Rick, you have the 

 3 overall responsibility of surveillance, and is 

 4 there a difference in, as we're presently going on 

 5 this ad hoc basis -- and it occurs to me we may be 

 6 moving back into command and control type of 

 7 regulations of the ECM to get information -- is 

 8 there a difference in the cost and the amount of 

 9 personnel and effort that you put into regulating 

 10 the two different entities? 

 11 MR. SHILTS: Are you referring to the 

 12 DCMs and these markets? 

 13 COMMISSIONER DUNN: Yes. 

 14 MR. SHILTS: Well, as Terry had 

 15 mentioned, we don't do direct oversight of the 

 16 exempt commercial markets except in the context, 

 17 as John had mentioned and with respect to the 

 18 special calls, in getting additional information 

 19 from ICE in this instance to help oversee NYMEX 

 20 and the natural gas market. 

 21 In general, though, I think there's 

 22 probably a disproportionate amount of time spent 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 73 

 1 looking at the issues related to exempt markets 

 2 simply because we don't have an ongoing presence 

 3 with respect to those markets in the sense that we 

 4 don't receive rules and product filings on a 

 5 consistent basis. We don't do rule enforcement 

 6 reviews or have any other active engagement with 

 7 those entities, so to the extent that our issues 

 8 are questions, it is a lot, to a larger extent 

 9 reinventing the wheel kind of going back trying to 

 10 figure out what's going on just because we don't 

 11 have that routine, you know, relationships with 

 12 the exempt markets. 

 13 COMMISSIONER DUNN: Jeff, you had 

 14 indicated that at any particular time ICE may be 

 15 leading NYMEX, NYMEX may be leading ICE. Do we 

 16 have enough data to establish any trends at this 

 17 point? 

 18 MR. HARRIS: Well, the percentages that 

 19 I reported were actually statistically 

 20 significant, so in that sense it accommodates for 

 21 the number of observations during the day. We did 

 22 exclude the days that there wasn't enough trading 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 74 

 1 on both markets to do the analysis. 

 2 COMMISSIONER DUNN: I'm very interested 

 3 in the economist's interpretation is what is price 

 4 setting versus what we've seen in legislation. 

 5 And if you had your druthers, how would you like 

 6 us to interpret what's price setting? 

 7 MR. HARRIS: Well, I think 20 percent, I 

 8 guess, is the number to focus on perhaps with 

 9 ICE's appearing to have an impact on prices in 

 10 this market, in particular natural gas on 20 

 11 percent of the days. 

 12 It should be noted that some of those 

 13 days, a portion of those days was where we found 

 14 evidence that both NYMEX and ICE were leading on 

 15 those days. So the actual percentage that ICE was 

 16 leading alone was only in the neighborhood of 

 17 seven percent of the contract days that we 

 18 followed. 

 19 COMMISSIONER DUNN: John, when you work 

 20 with the exchanges, you have folks there that are 

 21 in surveillance and oversight that you call, and 

 22 if they're approaching a spec limit, they're 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 75 

 1 responsible for calling a stop to that and also on 

 2 whether or not they're going over their level. 

 3 Who do you do that with, with the exempt 

 4 exchanges? 

 5 MR. FENTON: Well, we have contacts, 

 6 obviously, at -- well, the main exchange that we 

 7 deal with is -- the main exempt commercial market 

 8 is ICE. 

 9 And there are people there that we know, 

 10 and we've gotten to know them especially through 

 11 the special calls. But there is nobody comparable 

 12 to a compliance or a surveillance person at a 

 13 designated contract market who I can call to 

 14 discuss a position in the market or concerns, 

 15 surveillance concerns, about activity in the 

 16 market. 

 17 COMMISSIONER DUNN: At the time there 

 18 was alleged manipulation Amaranth, were you and 

 19 surveillance aware of their position in the exempt 

 20 market? 

 21 MR. FENTON: No, we were not. 

 22 MR. ARBIT: Mr. Chairman, just to follow 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 76 

 1 up on one question from Commissioner Dunn about 

 2 complaints, some complaints from the exempt 

 3 commercial markets go to market oversight, some do 

 4 go directly to our Enforcement Division, so the 

 5 actual number may -- is higher than the five that 

 6 was mentioned. 

 7 CHAIRMAN LUKKEN: Thank you. Let's turn 

 8 to Commissioner Sommers. 

 9 COMMISSIONER SOMMERS: Actually, I don't 

 10 have any questions, but I just want to thank all 

 11 four of you for your hard work, and I appreciate 

 12 all of the information. 

 13 CHAIRMAN LUKKEN: Commissioner Chilton? 

 14 COMMISSIONER CHILTON: Thanks. I've 

 15 just got two quick questions, Mr. Chairman. 

 16 Mr. Shilts, you mentioned the 

 17 possibility of revisiting the criteria for 

 18 determining price discovery triggers, and since 

 19 Commissioner Sommers and I weren't here -- and she 

 20 may know this from her history, but I don't -- why 

 21 was open interest in volume not included as part 

 22 of that? Can you explain it to me? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 77 

 1 MR. SHILTS: I think to some extent it 

 2 depends on what the markets have available and 

 3 make available to post. I think with respect to 

 4 open interest in particular, I think the issue was 

 5 that not all of the exempt markets provide a 

 6 clearing function, and that some of the trades 

 7 that may be executed on an exempt commercial 

 8 market, the entity itself may not know the 

 9 disposition of the trade; they may know the two 

 10 traders were matched and the trade may be -- was 

 11 executed. But after that, it is not clear whether 

 12 they would maintain their positions or they would 

 13 then do a bilateral swap, and then offset the 

 14 position. So, in effect, they would have no 

 15 position, so there would be no open interest in 

 16 that case. 

 17 So I guess, but the real issue there was 

 18 that you wouldn't know exactly -- the open 

 19 interest may not be known because there may not be 

 20 a centralized clearing function. So I think that 

 21 was the reason for open interest, and I don't 

 22 recall what the issue was with respect to volume. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 78 

 1 I'd have to get back to you on that. 

 2 COMMISSIONER CHILTON: Okay, thanks. 

 3 And this is either for Mr. Shilts or Mr. 

 4 Fenton. Say in sort of a dream world 

 5 that today all of a sudden, boom, 2(h)(3)'s gone. 

 6 It is gone. Is there some sound, regulatory 

 7 principle behind allowing the bilaterals to 

 8 continue to operate with exemptions and 

 9 exclusions? 

 10 MR. SHILTS: Let me just start and John 

 11 can add. I think there's a couple of reasons, 

 12 maybe like a principal reason and then maybe a 

 13 practical reason. I think, generally, the 

 14 oversight goes to the marketplace, a centralized 

 15 marketplace where traders go to lay off, hedge 

 16 their positions. It provides that and the risk 

 17 management, and that the price discovery 

 18 positions, is, you know, the key elements of that 

 19 marketplace. 

 20 So I think that to extent, there's a regulatory role: 

 21 It is to supervise and ensure that those functions are 

 22 being met, that there's not, you know, manipulation or 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 79 

 1 untoward activity that would include traders' ability 

 2 to hedge and discovery prices on the markets. And I 

 3 think when you talk about pure bilateral trading, it 

 4 is not necessarily focused on a centralized market; it 

 5 is just two counterparties that execute a trade, so we 

 6 not have these broader impact on the national economy 

 7 or warrant some sort of oversight. 

 8 And I think the more practical aspect just might be 

 9 that the bilateral world can be anybody anywhere, and 

 10 it can be very difficult to actually supervise those 

 11 people and to identify who they are, and to set up a 

 12 regime to get information about them because the 

 13 mature of the contracts could be very diverse and not 

 14 necessarily standardized. And it just -- it may be 

 15 very difficult to actually accomplish it, even if you 

 16 chose to do that. 

 17 MR. FENTON: Now I'll follow up on that 

 18 point. I think it is basically really a cost- 

 19 benefit issue Potentially the cost of getting 

 20 information on the bilateral market could be very 

 21 high compared to our typical reporting regime. 

 22 And the benefits may be quite low. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 80 

 1 We don't need to know every last 

 2 position that maybe affected by trading in futures 

 3 markets to do proper surveillance, especially as 

 4 long as we have authority on a special call basis 

 5 using our Regulation 1805 to go to traders and ask 

 6 them, if we have reason to want to know what their 

 7 positions are in the bilateral market. That 

 8 regulation gives us authority if the trader is 

 9 reportable on NYMEX to get that information. 

 10 But to have a regime of reporting 

 11 broadly across the OTC market would, I think, be 

 12 cumbersome to administer. 

 13 One final point: A fair portion of 

 14 what's happening in the OTC market is being 

 15 reported to us through clearing either at 

 16 Clearport or through ICE. 

 17 The voice broker market is a major part 

 18 of the OTC market, and a large and growing portion 

 19 of that activity is being cleared, and the portion 

 20 of it that is going through Clearport is being 

 21 reported to us. 

 22 COMMISSIONER CHILTON: So just -- I 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 81 

 1 don't want to put words in your mouth -- so if 

 2 2(h), say, were just gone, then we could continue 

 3 as a Commission to allow exemptions and exclusions 

 4 for the bilats? 

 5 MR. HARRIS: Yes. 

 6 MR. FENTON: I would go along with that, 

 7 yes. 

 8 COMMISSIONER CHILTON: Thanks, Mr. 

 9 Chairman. 

 10 CHAIRMAN LUKKEN: All right, I want to 

 11 thank the panel for testifying today, and we 

 12 appreciate it and look forward to assembling the 

 13 next panel. And we have a couple minutes to put 

 14 that together -- but don't leave. We'll be right 

 15 back. 

 16 (Recess) 

 17 CHAIRMAN LUKKEN: Thank you very much. 

 18 We have our second panel here consisting of 

 19 trading facilities in this space. 

 20 First we have the Honorable James 

 21 Newsome, no stranger of the CFTC from the New York 

 22 Mercantile Exchange. Welcome, Jim. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 82 

 1 We second have Jeff Sprecher, Chairman 

 2 and CEO of the Intercontinental Exchange. 

 3 Craig Donahue, Chief Executive Officer 

 4 and Director of CME Group. 

 5 And Peter Krenkel from the NGX. 

 6 And via conference in London we have 

 7 Richard Sandor, who is Chairman and Chief 

 8 Executive Officer of the Chicago Climate Exchange. 

 9 Welcome, Richard. 

 10 So we begin with Jim Newsome. Thank you 

 11 so much. 

 12 DR. NEWSOME: Thank you, Chairman 

 13 Lukken, commissioners. I come to this hearing as 

 14 President and Chief Executive Officer of the New 

 15 York Mercantile Exchange, and on behalf of the 

 16 Exchange, I want to express our appreciation to 

 17 the CFTC for holding this public hearing on exempt 

 18 commercial markets. 

 19 Over the last several months, the role 

 20 of ECMs have received a lot of attention on 

 21 Capitol Hill and elsewhere. During this period 

 22 and prior, NYMEX has observed a broad and growing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 83 

 1 consensus that certain products traded on ECMs and 

 2 DCMs are tightly linked and effectively result in 

 3 one broader market. Consequently, NYMEX along 

 4 with some legislators and regulators have 

 5 concluded that there is a need for appropriate 

 6 statutory change to provide effective regulatory 

 7 oversight of markets that are critical, of 

 8 critical importance to the U.S. consumers and to 

 9 our overall economy. 

 10 The debate over the changes in the 

 11 marketplace I think is now largely settled. The 

 12 real question becomes the appropriate statutory 

 13 response. 

 14 The CFTC has been an outstanding 

 15 success, and the tiered statutory structure for 

 16 trading to sell these has been effective in most 

 17 respects. 

 18 In addition to establishing these tiers, 

 19 the CFTC also shifted away from one-size-fits-all 

 20 prescriptive approach to futures exchange 

 21 regulation to a more flexible approach that 

 22 included the use of core principles for DCMs and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 84 

 1 that confirmed the CFTC's role as an oversight 

 2 agency rather than the prescriptive rules that 

 3 most issue affirmative approval before any new 

 4 innovations could be introduced to the 

 5 marketplace. 

 6 As to exempt commercial markets, while 

 7 transactions executed on an ECM generally are 

 8 subject to any fraud and any manipulation 

 9 authority, the ECM itself is essentially exempt 

 10 from all substandard CFDC regulation and 

 11 oversight. 

 12 In addition, the ECM by statute has no 

 13 affirmative requirements to engage in any self- 

 14 regulatory activities to monitor its markets or 

 15 otherwise to seek to prevent any manner of market 

 16 abuses. 

 17 Since the passage of the CFMA, the 

 18 series of profound changes have occurred in 

 19 various OTC markets, including technical advances 

 20 in trading such that the regulated DCM, or NYMEX. 

 21 and the unregulated ECM, ICE, have become highly 

 22 linked trading venues. This result, which could 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 85 

 1 not have been reasonably predicted only a few 

 2 short years ago, indicates that the current 

 3 statutory structure no longer works for certain 

 4 markets now operating as ECMs. 

 5 Specifically, the regulatory disparity 

 6 between the NYMEX and certain ECMs, particularly 

 7 ICE, which are functionally equivalent to each 

 8 other, has created serious challenges for the CFTC 

 9 and for NYMEX in its capacity as a self-regulatory 

 10 organization. It has become apparent to NYMEX 

 11 that the structural issues raised by changes in 

 12 the marketplace cannot be addressed effectively at 

 13 the level of the individual exchanges. 

 14 For example, earlier this year in an 

 15 effort to cooperate with the Federal Energy 

 16 Regulatory Commission and following consultation 

 17 with the CFTC staff, NYMEX issued a compliance 

 18 advisory in the form of a policy statement related 

 19 to exemptions from positional limits in NYMEX 

 20 natural gas futures contracts. NYMEX adopted this 

 21 new policy on an interim basis and a good faith 

 22 effort to carry out its self-regulatory 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 86 

 1 responsibilities and to address on an individual 

 2 exchange level the market reality demonstrated by 

 3 Amaranth's trading on both regulated and 

 4 unregulated markets. 

 5 However, the new interim policy 

 6 implemented by NYMEX has, 1) reduced volume on 

 7 NYMEX during the critical 30-minute closing range 

 8 period; 2) presumably shifted volume from the 

 9 regulated to the unregulated trading venue; and 3) 

 10 has failed to solve the structural imbalances 

 11 brought to light by Amaranth trading. 

 12 In addition, this policy would create 

 13 new problems by diminishing the vitality of the 

 14 natural gas industry's pricing benchmark. 

 15 Consequently, NYMEX now believes strongly that 

 16 legislative change is both necessary and 

 17 appropriate. NYMEX believes that a targeted 

 18 approach that directly addresses the specific 

 19 issues raised by these industry challenges would 

 20 be the most effective policy response and would 

 21 provide the greatest assurance of limiting the 

 22 unattended consequences of more sweeping and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 87 

 1 draconian changes. 

 2 In particular, for those products traded 

 3 on ECMs that have triggered public policy 

 4 interests and concerns, NYMEX believes that the 

 5 CEA should be amended to require a routine 

 6 mandated large trader reporting and position 

 7 accountability requirements for financially 

 8 settled ECM contracts that are highly linked and 

 9 functionally equivalent with regulated DCM 

 10 contracts. Such ECMs also must be assigned self- 

 11 regulatory organization duties to police their own 

 12 markets and to submit applicable rule changes to 

 13 the CFTC in a manner similar to other regulated 

 14 entities. 

 15 NYMEX believes that such statutory 

 16 changes are necessary and appropriate and would 

 17 not negatively impact the core price discovery and 

 18 hedging functions provided by derivatives markets. 

 19 NYMEX does not believe that the case has been made 

 20 for extending such heightened regulation to other 

 21 products listed on an ECM to other ECMs that have 

 22 not triggered these policy interests and concerns 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 88 

 1 or to the traditional bilateral OTC market. 

 2 On the other hand, the targeted approach 

 3 that NYMEX recommends should not unduly affect the 

 4 ability of ECMs to be sources of innovation, 

 5 including the adoption of new trading 

 6 technologies. 

 7 Mr. Chairman, I thank you for the 

 8 opportunity to appear before the Commission today 

 9 and certainly will be happy to answer any 

 10 questions at the appropriate time. 

 11 CHAIRMAN LUKKEN: Thank you, Mr. 

 12 Newsome. 

 13 Mr. Sprecher? Please pull the mikes, if 

 14 you can, about six inches from you. That helps 

 15 with our audio. 

 16 MR. SPRECHER: Acting Chairman Lukken, 

 17 Commissioners Dunn, Sommers, and Chilton, and 

 18 staff members, my name is Jeff Sprecher, and I'm 

 19 the Chairman and Chief Executive Officer of 

 20 Intercontinental Exchange which you know as ICE. 

 21 I very much appreciate the opportunity to appear 

 22 before you today to discuss the operations of ICE 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 89 

 1 and to share with you our views on the regulation 

 2 of exchanges and of exempt commercial markets. 

 3 Today ICE operates a leading global 

 4 commodities marketplace which comprises both 

 5 futures and over-the-counter contract markets 

 6 across a variety of product classes which include 

 7 energy, agricultural products, foreign exchange, 

 8 and equity indices. ICE provides these important 

 9 risk management contracts to commercial hedgers as 

 10 well as to speculators who provide necessary 

 11 liquidity in our markets, and we do that through 

 12 an integrated electronic trading platform. 

 13 We currently host three separate markets 

 14 on our electronic trading platform. ICE's OTC 

 15 energy market which operates under the Commodity 

 16 Exchange Act as an exempt commercial market and 

 17 two regulated futures exchanges: ICE futures U.S., 

 18 which was formerly known as the Board of Trade of 

 19 the City of New York, and ICE futures Europe, 

 20 which was formerly known as the International 

 21 Petroleum Exchange. 

 22 We will soon be adding a third 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 90 

 1 regulated futures exchange to our platform with 

 2 the recent acquisition of the Winnipeg Commodity 

 3 Exchange. So it is fair to say that we at ICE 

 4 uniquely understand both the value and the 

 5 limitations of regulated trading as we operate 

 6 three global futures exchange franchises. ICE 

 7 began its existence in year 2000 as an 

 8 over-the-counter execution market, and since that 

 9 time we've grown significantly both through 

 10 organic growth fostered by innovation as well as 

 11 by acquisition. 

 12 When focusing solely on the breadth of 

 13 ICE's business, it is tempting for a casual 

 14 observer to apply superficial analysis of the 

 15 appropriate level of regulation for very highly -- 

 16 for highly varied markets. After all, one could 

 17 ask if ICE offered its regulated futures contracts 

 18 through part of its business, why shouldn't it 

 19 offer the same level of regulation for all of its 

 20 businesses, including over-the-counter markets? 

 21 Such a superficial top-down analysis is 

 22 fraud in my opinion, as it does not consider the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 91 

 1 highly varied nature of traded over-the-counter 

 2 markets. and, importantly, how these markets 

 3 fundamentally differ from futures markets. 

 4 As I recently testified before Congress, 

 5 a heightened level of DCM-like regulation, 

 6 including reporting and position accountability 

 7 may be appropriate for certain of ICE's cleared 

 8 OTC swap contracts that settle on futures markets 

 9 and that are the economic equivalent of 

 10 actively-traded futures contracts like our Henry 

 11 Hub natural gas swap. 

 12 However, applying a standard DCM level 

 13 of regulation more broadly to all of the various 

 14 swap contracts that are traded on ICE either 

 15 through the application of DCM-like core 

 16 principles or worse, by eliminating the category 

 17 of exempt commercial markets altogether, would be 

 18 a serious mistake that I believe would not only 

 19 result in less market efficiency but ultimately 

 20 would bring harm to the constituency that the 

 21 Commission is charged with protecting. And that 

 22 is the end users of the markets. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 92 

 1 In considering this question, it will be 

 2 important to distinguish between actively traded 

 3 contracts that serve as pricing benchmarks on 

 4 designated contract markets and those that start 

 5 life as oft-exchanged transactions that are merely 

 6 cleared through a clearing house. 

 7 Finally, without the proper historical 

 8 context, it is easy to lose sight of the reasons 

 9 on how ICE was able to be formed, on how ICE fits 

 10 into the broader context of the over-the-counter 

 11 markets and the benefit that ICE has brought to 

 12 the broader marketplace. 

 13 In the framework of this hearing, I hope 

 14 to illustrate that a one-size-fits-all level of 

 15 regulation is ultimately misguided. The 

 16 marketplace has benefitted significantly from the 

 17 regulatory flexibility that's embodied in the CFMA 

 18 and through the ECM category of markets that's 

 19 recognized by Section 2(h)(3) of that Act. In 

 20 this regard, proper recognition should be given to 

 21 the Commission and to those that supported the 

 22 CFMA, including Dr. Newsome for the real and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 93 

 1 tangible benefits that the CFMA has brought to the 

 2 marketplace as a result of its adoption. 

 3 I thank you. 

 4 CHAIRMAN LUKKEN: Thank you, Mr. 

 5 Sprecher. 

 6 Mr. Donahue? 

 7 MR. DONOHUE: Thank you very much for 

 8 inviting me to be with you today. 

 9 I'd like to begin by complimenting you 

 10 on your able administration of the Commodity 

 11 Exchange Act and on your willingness to ask 

 12 difficult questions as to whether the CEA can be 

 13 improved based on experience and evolving market 

 14 needs. The CEA ha been tremendously successful, 

 15 no doubt, and the CFTC has administered it 

 16 extremely well to the great benefit of customers 

 17 and the national economic health. 

 18 That said, the record indicates that 

 19 there are important issues arising in the context 

 20 of ECMs that need to be addressed. CME Group 

 21 supports CFTC's review of those issues and urges 

 22 responsive action in that regard. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 94 

 1 Historically, there have been 

 2 distinctions between OTC trading platforms and 

 3 regulated exchange markets. I believe those 

 4 distinctions have now blurred to the extent that 

 5 disparity of regulatory treatment is no longer 

 6 justified. OTC trading platforms and regulated 

 7 exchanges are rapidly converging in every material 

 8 respect except regulation. 

 9 Customers for financial futures and 

 10 nonagricultural futures, so-called exempt 

 11 commodities, on regulated exchanges, or so-called 

 12 DCMs, are increasingly also customers of OTC 

 13 electronic trading platforms. Product innovation 

 14 or extension coupled with enhanced trading 

 15 functionalities have dissipated the distinctions 

 16 between exchange and OTC markets. 

 17 OTC platforms today list standardized 

 18 contracts that can be executed by the push of a 

 19 take button, and, similarly, regulated exchanges 

 20 like CME Group are offering standardized swaps and 

 21 other contracts that trade in OTC type market 

 22 structures or execution mechanisms. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 95 

 1 Similarly, credit barriers that once 

 2 prevented certain customer segments from accessing 

 3 OTC markets have broken down with the growth and 

 4 prime brokered services providing credit 

 5 enhancement and access to multilateral trading 

 6 opportunities in much the same way as central 

 7 counterparty clearing systems do. 

 8 Indeed, as this convergence continues, I 

 9 strongly believe that some form of central 

 10 counterparty clearing is inevitable in the OTC 

 11 market. These areas of convergence in our markets 

 12 create a growing conflict between the goals of the 

 13 CFTC and the exemption for ECMs found in Section 

 14 2(h)(3). 

 15 In light of the controversy generated by 

 16 the NYMEX/ICE situation, I believe this is a very 

 17 appropriate time to reexamine the Commodity 

 18 Exchange Act's exemptions and exclusions and to 

 19 consider whether any recalibration is necessary in 

 20 order to protect users of these markets. 

 21 Specifically the elimination of the 

 22 exemption for unregulated commercial markets must 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 96 

 1 be seriously considered. 

 2 I believe that the President's working 

 3 group position on this topic during the 

 4 Commodities Future Modernization Act process was 

 5 correct and had its correct focus on the concern 

 6 about the potential manipulation of these kinds of 

 7 products in an unregulated environment and not 

 8 whether these products would ultimately trade in 

 9 some fashion linked to a regulated exchange 

 10 market. 

 11 As a result of its investments in both 

 12 the regulated and the OTC markets, CME is uniquely 

 13 positioned to comment on this topic. We operate a 

 14 very successful DCM for financial derivatives. We 

 15 are also expanding into the exempt board of trade 

 16 markets with OTC offerings on FX markets base and 

 17 swap stream as well as clearing 360, and I should 

 18 note as well that we've been very successful in 

 19 developing over the counter products like weather 

 20 in the construct of a DCM. 

 21 While the primary subject of today's 

 22 hearing involves an area where the CEA needs 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 97 

 1 amendment to address shortcomings, it is important 

 2 to put that area of controversy in its proper 

 3 perspective. The problems associated with ECMs 

 4 are not representative of what is the overwhelming 

 5 success story that is the current CEA as amended 

 6 by the CFMA. We enthusiastically applaud Congress 

 7 and its oversight committees in having the wisdom 

 8 and courage back in 2000 to enact a modern, 

 9 progressive principles-based regulatory regime for 

 10 the CFTC. We believe the marked success of the 

 11 U.S. futures industry under this regime has 

 12 created a compelling example for the securities 

 13 industry in the United States. 

 14 In our view, reducing barriers to entry 

 15 in global futures and options has strongly 

 16 contributed to business growth and increased 

 17 competition. As an example, the compounded annual 

 18 growth rate in the global futures and options 

 19 industry over the last five years was 28 percent 

 20 compared to only 4 percent for equity securities 

 21 markets. 

 22 This is due, at least in part, to the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 98 

 1 fact that U.S. investors can directly and 

 2 electronically access foreign futures and options 

 3 contracts from the United States. 

 4 Correspondingly, European and Asian investors can 

 5 directly and electronically trade products listed 

 6 by CME and other U.S. futures and options 

 7 exchanges. Moreover, foreign boards of trade can 

 8 effectively offer U.S. Customers access to 

 9 products also traded on U.S. Exchanges, thereby 

 10 increasing global competition in these markets. 

 11 In contrast, under SEC rules, U.S. 

 12 investors cannot directly and electronically trade 

 13 foreign equity securities of foreign issuers that 

 14 do not comply with SEC disclosure standards or 

 15 U.S. GAP accounting standards. 

 16 The CFTC and Congress have wisely 

 17 promoted global growth and competition while 

 18 recognizing that comparability and regulatory 

 19 standards is superior to insisting upon additional 

 20 but not necessarily better regulatory 

 21 requirements. 

 22 I look forward to answering your 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 99 

 1 questions. Thank you. 

 2 CHAIRMAN LUKKEN: Thank you, Craig. Mr. 

 3 Krenkel. 

 4 MR. KRENKEL: My name is Peter Krenkel. 

 5 I am the President of Natural Gas Exchange, also 

 6 known as NGX. I want to thank the Commission for 

 7 providing me with an opportunity to participate in 

 8 this hearing today. 

 9 Although the majority of NGX's 

 10 operations are currently in Canada, from our 

 11 perspective, the natural gas market is now 

 12 continental in nature and the border effectively 

 13 no longer exists. The U.S. currently purchases 

 14 about half of Canada's natural gas production and 

 15 is a significant purchaser of crude oil and other 

 16 energy sources. 

 17 The U.S. regulatory framework has an 

 18 impact not only on NGX as an exempt commercial 

 19 market but more generally in terms of the 

 20 direction in which Canadian regulation evolves. 

 21 NGX is a Canadian company based in 

 22 Calgary and is a wholly-owned subsidiary of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 100 

 1 TSX Group which owns and operates senior and 

 2 public venture equity exchanges in Canada, known 

 3 as the Toronto Stock Exchange and the TSX Venture 

 4 Exchange. TSX Group purchased NGX in 2004 and 

 5 recently acquired an option to purchase 

 6 NetThruPut, Inc., a Canadian-based oil exchange 

 7 exercisable in March of 2009. As publicly 

 8 disclosed, NGX entered into an alliance with the 

 9 Intercontinental Exchange in March of this year 

 10 which primarily involves the provision of certain 

 11 services by ICE and certain clearing services by 

 12 NGX. 

 13 NGX launched this business in 1994 with 

 14 an electronic system and has never operated a 

 15 floor. NGX provides trading, clearing and 

 16 settlement services for natural gas and 

 17 electricity instruments in key markets, primarily 

 18 in Canada. At present, the bulk of our business 

 19 is physical natural gas contracts with the 

 20 greatest liquidity at Alberta and on Ontario 

 21 markets. Our electricity business has evolved 

 22 over the past five years and is starting to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 101 

 1 develop some liquidity levels. 

 2 NGX participants based in Canada and the 

 3 U.S., all of which are sophisticated entities and 

 4 transact as principals, the majority are energy 

 5 companies and, in recent years, we've seen the 

 6 participation by more banks and hedge funds, some 

 7 of the non-traditional players. 

 8 Participants' bids and offers are 

 9 entered into the electronic trading system, 

 10 matched on a price-time priority basis. NGX is 

 11 the central counter party in every transaction 

 12 and, as such, ensures that each transaction is 

 13 firm and anonymous from trading through clearing 

 14 and settlement. 

 15 Since launch, our traded and cleared 

 16 volumes have grown gradually to current levels of 

 17 over 900 BCF a month or approximately twice the 

 18 Canadian underlying physical production. Over 95 

 19 percent of our volumes are spot and forward 

 20 physically settled contracts. 

 21 Our business plan continues to be to 

 22 develop new OTC-style products that are traded and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 102 

 1 cleared in accordance with our standard terms and 

 2 conditions. We have developed certain unique 

 3 products such as balancing instruments that enable 

 4 participants to correct imbalances in their 

 5 pipeline accounts which have provided considerable 

 6 benefit to the marketplace and the pipelines. 

 7 NGX has brought many benefits to 

 8 participants in the energy markets such as 

 9 increased transparency, standardized rules, the 

 10 financial discipline associated with margining and 

 11 clearing, and providing an alternative for dealing 

 12 in bilateral credit issues. NGX provides the 

 13 unique service of clearing physical contracts 

 14 which includes managing daily deliveries of gas. 

 15 In addition, our platform is widely used to 

 16 determine several key price indices that are 

 17 widely used in contract settlements by the OTC 

 18 markets and other exempt and regulated exchanges. 

 19 In Canada, regulation of commodities 

 20 trading is a provincial matter. NGX has exemptive 

 21 relief as a commodity exchange from its primary 

 22 regulator, the Alberta Securities Commission. The 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 103 

 1 exemptive relief order is based on certain terms 

 2 and conditions being satisfied including 

 3 compliance with nine operating principles that 

 4 embody principles-based rules. NGX is essentially 

 5 audited by the ASC on a regular basis which is 

 6 comprised of an annual oversight review that tests 

 7 our compliance with the operating principles. 

 8 We also have exemptive relief orders 

 9 from the applicable provincial regulators in the 

 10 other Canadian jurisdiction. We've been an ECM 

 11 under U.S. law since 2002. 

 12 As the energy markets in Canada are 

 13 inextricably linked with those in the U.S., NGX's 

 14 business perspective has been global. In our 

 15 view, it is essential that there be a comparable 

 16 regulatory regime on both sides of the border. 

 17 The ECM structure is, in general, more consistent 

 18 with the type and degree of oversight currently 

 19 provided by the Canadian regulators, hence, 

 20 reducing our burden of double regulation. We 

 21 believe the regulatory regime must be flexible 

 22 enough to accommodate diverse business models and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 104 

 1 to maintain the appropriate balance between 

 2 regulatory oversight and ongoing evolution of the 

 3 robust and transparent energy markets. 

 4 NGX supports principles-based regulation 

 5 and having different levels of regulation that 

 6 take into account the important distinctions 

 7 between trade execution facilities such as the 

 8 degree of sophistication in the market, the types 

 9 of instruments being traded and the liquidity of 

 10 the products. From our perspective, the ECM 

 11 regulatory framework has been successful in 

 12 striking this balance. 

 13 In closing, NGX is a proponent of 

 14 effective and efficient regulation and has 

 15 embraced regulatory oversight on both sides of the 

 16 border. We continue to be dedicated to the goal 

 17 of ensuring greater transparency and maintaining 

 18 the integrity of the markets which, in part, 

 19 relates to the ongoing sharing of information with 

 20 our regulators including the Commission. We 

 21 embrace opportunities from both an external and 

 22 internal perspective for regular reassessment of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 105 

 1 oversight and look forward to participating in the 

 2 dialogue today on this subject and going forward. 

 3 In closing, thank you, Mr. Chairman, for 

 4 the opportunity to appear before this Commission. 

 5 CHAIRMAN LUKKEN: Thank you, Mr. 

 6 Krenkel. Now, if the audience would turn to our 

 7 video screens, we have Dr. Sandor from London of 

 8 the Chicago Climate Exchange, also an ECM in this 

 9 space. 

 10 Welcome, Richard. We have you on video, 

 11 so please proceed with your testimony. 

 12 DR. SANDOR: Thank you very much, Mr. 

 13 Chairman. It is a pleasure to be here in London 

 14 but be able to talk with you directly about our 

 15 exempt commercial market. 

 16 We are the Chicago Climate Exchange, and 

 17 for those of you who are not familiar with the 

 18 exchange, it trades in the right to emit and that 

 19 is known as cap and trade where pollution rights 

 20 or rights to emit or allowances are given out to a 

 21 variety of industries at lower levels of emissions 

 22 that prevailed previously. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 106 

 1 If an individual firm can reduce its 

 2 emissions, it is free to sell those to others who 

 3 may have a technology breakthrough. It may take 

 4 years to build something. So it provides 

 5 affordably the solution to problems associated 

 6 with climate change and emissions. 

 7 Indeed, the most successful program ever 

 8 launched anywhere in the world is the acid rain 

 9 program of the Clean Air Act of 1990. Being an 

 10 ECM in the Garden State has been a very exciting 

 11 opportunity for us. We were able to not only 

 12 create an exchange but invent an entire new 

 13 commodity in that we are private Kyoto Protocol. 

 14 As opposed to enforcement by the federal 

 15 government, we require contract law. We now 

 16 represent 12 percent of the United States large 

 17 stationary source of emissions and our market 

 18 approximates Germany in its size and breadth. 

 19 The members include for of the Dow 30 

 20 companies, technologies, IBM, Intel DuPont, the 

 21 biggest utility in America, ADP and acid waste 

 22 management, the biggest companies in the country, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 107 

 1 International Paper, thousands of farmers 

 2 including the Lugar Stock Farm, Mr. Chairman, in 

 3 your state, as well as farmers throughout Iowa and 

 4 Kansas, Nebraska, et cetera. 

 5 Our business model and speed to market 

 6 has helped keep the United States competitive, we 

 7 believe, in the growing trend toward recognizing 

 8 the net effects of climate change. Being an ECM 

 9 in a new product, we were very concerned because 

 10 the product was new, that we purchased regulatory 

 11 services and went to the NASD and under a 

 12 commercial contract they provide market 

 13 surveillance and monitoring. 

 14 We are indeed very concerned about the 

 15 space of trades that go on, most recently here in 

 16 Europe, money laundering for emissions trading, 

 17 climate change. We felt that we had to be like 

 18 Caesar's wife, simply beyond reproach. 

 19 We thought the upside of NASD helping us 

 20 not only monitor and surveil but also clarifying 

 21 the fact that the industrial engines made be 

 22 emissions that they claim to. This was a very, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 108 

 1 very critical role. The credibility that the U.S. 

 2 would in fact, in a privately administered system, 

 3 have the same monitoring and clarification 

 4 protocols independently attested to by an SRO was 

 5 very important for our national efforts. 

 6 As an aside, we do also in the United 

 7 States operate a futures market that is regulated 

 8 by the CFTC. We trade SO2 allowances -- that is 

 9 acid rain -- and dominate that market, both 

 10 futures and options. Other criteria for products 

 11 such a futures market on our unregulated 

 12 commodity, carbon, as well a market on certified 

 13 emissions reductions that are approved by the 

 14 United Nations, the first such market in the 

 15 world, and we also operate a stock index of 

 16 renewable energy futures. 

 17 Our experience on the regulated side of 

 18 the surveillance and oversight by the CFTC has 

 19 been fantastic, and our ability to operate in the 

 20 ECM market without undue costs and speed to market 

 21 helped us form a new exchange, beginning an 

 22 innovation that we think will have profound 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 109 

 1 effects for the world. We do believe strongly 

 2 that pollution is very, very critical and that 

 3 market-based incentives are even more important in 

 4 dealing with this important social issue. 

 5 Thank you. 

 6 CHAIRMAN LUKKEN: Thank you very much, 

 7 Richard. We will start our five-minute rounds of 

 8 questions. I will begin. It seems to me from 

 9 hearing from all of the panelists that the 

 10 tradeoff and really the question for policymakers 

 11 is one of regulation versus innovation and where 

 12 you strike the right balance. We have some good 

 13 examples with one of the founding fathers of 

 14 financial futures, Richard Sandor here, talking 

 15 about how this space has allowed for innovation 

 16 for carbon credits and other areas, and certainly 

 17 ICE is a good example of somebody who has grown up 

 18 in this space and has become a competitor and 

 19 brought competition and lowered costs in this 

 20 area. 

 21 So how do we strike the balance? There 

 22 are some suggestions of getting rid of this entire 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 110 

 1 exemption altogether. What are the tradeups that 

 2 we should be considering? 

 3 Certainly, there seems to have been a 

 4 rejection, a moving away of a one size fits all 

 5 structure in the CFMA in 2000. Are we reverting 

 6 back to that by suggesting everybody should go 

 7 into one regulatory category or is there a way to 

 8 create a tiered system that is indeed tailored to 

 9 the risks? 

 10 I'm not suggesting that we don't try to 

 11 meet the risks to public here but try to at least 

 12 calibrate the system so that it fits the risks 

 13 involved in a lot of this trading but still allow 

 14 incubation, innovation, competition to develop in 

 15 these markets. 

 16 So this is sort of a broad statement and 

 17 question to the panelists. If anybody wants to 

 18 jump in, I'd certainly be interested in your 

 19 thoughts. 

 20 DR. NEWSOME: Mr. Chairman, I might 

 21 start if that's okay. I would simply say that 

 22 there's probably no one who has more pride of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 111 

 1 ownership of the CFMA, having implemented that 

 2 regulation when I was chair of this great agency, 

 3 and I believe it has worked. I think it is worked 

 4 very, very well. I think the tiered structure has 

 5 worked well. 

 6 It has provided for innovations and 

 7 advancements in technology that have created 

 8 competitive scenarios for traditional exchanges 

 9 such as NYMEX. It is forced us to change to 

 10 become more competitive, and I think the industry 

 11 as a whole has benefited from that. So, 

 12 certainly, I think those are the positives. 

 13 I think the one negative is that, as 

 14 good as the CFMA was, I think it is impossible to 

 15 predict how all markets will develop, and I think 

 16 that's certainly the case with natural gas. NYMEX 

 17 is not making broad statements with regard to 

 18 other contract areas because of the hundreds and 

 19 hundreds of OTC markets that currently exist, to 

 20 our knowledge, nat gas is the one who kind of fits 

 21 the criteria that we've been talking about, and 

 22 our solution has been just to focus in that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 112 

 1 marketplace to provide the Commission with some 

 2 thoughts in terms of how you can capture a market 

 3 that ends up developing like the natural gas 

 4 market has developed. 

 5 If others, over time, meet those 

 6 criteria, then we believe that the CFTC should 

 7 have the flexibility then to pull them in if they 

 8 become linked to an exchange market, if they serve 

 9 as an effective substitute for an exchange 

 10 contract and if they, in turn, aggregate the risk 

 11 which is not typically the case with a traditional 

 12 bilateral OTC. 

 13 CHAIRMAN LUKKEN: Thank you. Anybody 

 14 else? 

 15 MR. DONOHUE: I'd like to respond to 

 16 that. I think, first of all, I think the CFMA is 

 17 certainly flexible enough even without the ECM 

 18 category which, as I indicated earlier, we think 

 19 should be repealed. 

 20 Secondly, I think as importantly though, 

 21 innovation certainly can occur in the context of a 

 22 DTEF or in the context of a DCM, and I think the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 113 

 1 case has not made that eliminating the ECM 

 2 category will impair innovation in some fashion 

 3 especially relative to what we've noted are the 

 4 substantial risks of manipulation in these 

 5 markets. 

 6 CHAIRMAN LUKKEN: Anybody else? 

 7 MR. SPRECHER: Mr. Chairman, I think one 

 8 of the things that I took away from the first 

 9 panel and then taking away from a broader debate 

 10 on Capitol Hill about this is that the issues that 

 11 have arisen particularly around ICE have to do 

 12 with the Henry Hub natural gas swap. In an effort 

 13 to improve the market, which you staff has been 

 14 doing and which we've been working with them on, 

 15 somehow the debate has gotten incredibly broad to 

 16 the point that we're talking about natural gas in 

 17 Canada and carbon credit derivatives and SO2 

 18 emissions. 

 19 We have a thousand products that trade 

 20 on our platform. Exotic derivatives, niche 

 21 products that I don't believe a futures style of 

 22 regulation would even help and, in fact, as I said 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 114 

 1 in my prepared statement, I actually think we 

 2 could inadvertently hurt consumers by putting a 

 3 seal on approval on those contracts as if they are 

 4 sources of price discovery, as if they've had 

 5 oversight, as if we collectively agree that the 

 6 people should rely on them, because I don't think 

 7 they should. 

 8 So I hope that, in the context of this 

 9 debate, we can separate the problems that I think 

 10 there are a lot of people that see and then a 

 11 broader implication for other markets which, 

 12 unfortunately, I've seen some testimony sort of 

 13 drift to, in my opinion, become overly broad. 

 14 CHAIRMAN LUKKEN: Thank you. 

 15 DR. SANDOR: It is Richard Sandor. I 

 16 wondered if I could just make one or two comments. 

 17 I am shamelessly self-interested in 

 18 innovation. Whatever small success I may have 

 19 had, it is been in inventing new products. We are 

 20 looking at things like endangered species, and I 

 21 just feel that trying to develop that under a 

 22 highly regulated structure doesn't serve the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 115 

 1 public interest. Inventive activity has driven 

 2 this business. 

 3 Virtually, all of my fellow panelists, 

 4 certainly in the organized exchange area, Jim and 

 5 Craig and Jeff, none of our products existed when 

 6 the CFTC was formed. I mean 100 percent, 

 7 virtually, of what is traded, save the currencies, 

 8 didn't exist for most of our financial products. 

 9 I would urge you to really consider do 

 10 you have to get rid of an ECM because one is 

 11 worried about saving polar bears and having a bold 

 12 market structure. The legal costs associated with 

 13 this will, in fact, I think limit creativity, and 

 14 I do believe that much of the emphasis today is on 

 15 expanding capital markets in the United States and 

 16 abroad, allowing American firms to compete 

 17 internationally. One of the vehicles, ECMs, do 

 18 allow us to invent very odd and exotic products. 

 19 They have very little to do with the public. 

 20 Putting a regulatory structure on that, it just 

 21 doesn't seem that that is the best social 

 22 solution. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 116 

 1 MR. KRENKEL: Mr. Chairman, from NGX's 

 2 perspective, we have a couple of points that I 

 3 wanted to make. 

 4 We currently list about 160 different 

 5 instruments. Only about 10 of them are successful 

 6 in terms of generating adequate levels of 

 7 liquidity. It is very competitive. We fight 

 8 daily with the OTC market to bring liquidity from 

 9 that unregulated space onto our exchange and our 

 10 facility. 

 11 Innovation is the key. We tend to roll 

 12 out, on average, one to two new instruments a 

 13 month. We develop these based on consultation 

 14 with the markets. We need to move them fairly 

 15 quickly. When they are successful, there's a lot 

 16 of benefit to the market. When they're not 

 17 successful, we simply delist them. So whatever 

 18 regulatory changes are contemplated, hopefully, it 

 19 will not impair our ability to do that. 

 20 The other issue is on the cost side, of 

 21 course, fees. We compete for liquidities. Fees 

 22 are a big driver of that. We don't want to see 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 117 

 1 our overhead increase to where we have to try to 

 2 pass that fee on to the customer, hence, perhaps 

 3 driving that liquidity back into the unregulated 

 4 OTC market. 

 5 The last point is simply on -- I 

 6 mentioned it in my opening remarks -- coordination 

 7 of similar levels of regulation with the Canadian 

 8 regulators. Our concern is that we end up 

 9 imposing two sets of rules for our customers based 

 10 in Canada and the U.S., creating potentially 

 11 further segregation of that scarce liquidity on 

 12 the markets. 

 13 CHAIRMAN LUKKEN: Thank you very much. 

 14 Commissioner Dunn. 

 15 COMMISSIONER DUNN: Thank you very much. 

 16 I guess I heard former Chairman Newsome say it was 

 17 all working well when he was here. 

 18 (Laughter.) 

 19 COMMISSIONER DUNN: Richard Sandor, let 

 20 me tell you about the interest in what you're 

 21 doing in the climate exchange. I am fortunate 

 22 enough to chair the agricultural advisory 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 118 

 1 committee, and it is been a long time since I've 

 2 heard this much chatter about good things 

 3 happening on an exchange that I've heard from what 

 4 you're doing there. So the farmers and ranchers 

 5 are really enthusiastic and excited about it. 

 6 I'm going to ask kind of a long question 

 7 and ask all of you to respond to it. The question 

 8 really revolves around what is taking place in 

 9 Congress because what we're seeing is Congress 

 10 looking at a problem and coming out with a bullet 

 11 solution rather than a shotgun solution, and 

 12 they're zeroing in on energy right now, but there 

 13 are other exempted commodities out there, metals 

 14 and chemicals, that may develop into the same type 

 15 of problems that people perceive in the energy 

 16 area. 

 17 In your perspective, should Congress 

 18 come out with a narrow fix or do they need to look 

 19 at a broader fix, looking at all the exempted 

 20 commodities and come up with some type of a 

 21 sliding scale that will say here's where you ought 

 22 to begin thinking about core principles and when 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 119 

 1 you shouldn't? 

 2 The other part of that question is why 

 3 aren't DTEFs working? Is it just too simple to 

 4 say I'd rather be an exempted rather than be a 

 5 DTEF? 

 6 If I can just start over here and let 

 7 you all take a shot at that. 

 8 DR. NEWSOME: Thank you, Commissioner. 

 9 I think a couple of things. One, I have 

 10 tremendous faith in this Agency and in the quality 

 11 of both the staff and the commissioners, and the 

 12 faith that I have somewhat paints my view of how 

 13 the Congress should move forward. In my opinion, 

 14 the Congress should move forward with general 

 15 criteria that we've discussed most recently that 

 16 would capture the natural gas market as it 

 17 currently exists because that is the one market 

 18 that we think is at issue. If other markets 

 19 develop similarly, then we believe the CFTC should 

 20 have the flexibility then to capture those markets 

 21 and pull them in. 

 22 NYMEX believes it would be a mistake for 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 120 

 1 Congress at this point to go ahead and capture all 

 2 of those markets and pull them into a regulated 

 3 status. So we think the CFTC should continue to 

 4 have flexibility to identify and pull those 

 5 markets in to a higher level of regulation. 

 6 With regard to the DTEF, I would agree 

 7 with the CFTC staff comments earlier. The DTEF is 

 8 viewed kind of as partly being pregnant and nobody 

 9 wants to be there. They either don't want to be 

 10 regulated or they're willing to be fully 

 11 regulated. The differences between the DTEF and 

 12 the DCM are not that great. So if someone is 

 13 willing to go forward with the SRO 

 14 responsibilities, I think for the most part the 

 15 assumption is let's go for the full deal and 

 16 become a DCM. 

 17 Before I finish, I wanted to go back to 

 18 the question you asked of senior staff earlier 

 19 about the Commission's opinion on exempt markets, 

 20 and I happen to be here at the time, was involved 

 21 in a number of those discussions, and I would 

 22 answer it two-fold. One with regard to financial 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 121 

 1 markets, the Commission was very involved in that 

 2 discussion, provided the due diligence to the 

 3 President's working group that gave the PWG the 

 4 comfort to determine that financial markets 

 5 should, in fact, be exempt. 

 6 Energy and others were very late to the 

 7 equation. I think Mr. Rasler, on behalf of his 

 8 clients, did a great job of raising other 

 9 potentially exemptive markets late in the process. 

 10 The Commission did not take a position on energy 

 11 or others at the time simply because we had not 

 12 done the due diligence that we had done that gave 

 13 us the satisfaction with regard to the 

 14 recommendations on the financial markets. 

 15 COMMISSIONER DUNN: Thank you. 

 16 MR. SPRECHER: First of all, I agree 

 17 with Dr. Newsome that I'd like to see. 

 18 First of all, I believe you have the 

 19 authority to regulate ICE and to get data from ICE 

 20 and to improve the Henry Hub market. In fact, if 

 21 I didn't believe that, we'd be fighting you and 

 22 we're not. We spent hundreds, maybe now 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 122 

 1 thousands, of man hours with some of the best 

 2 technology people in the world that work at my 

 3 company to try to figure out how to take an 

 4 OTC-cleared swap that is cleared in London and 

 5 convert that to a futures equivalent that can go 

 6 into a reporting system that, I'll generously say, 

 7 has a slightly older technology and to make it so 

 8 that staff can have the view that I think we all 

 9 want them to have. 

 10 And so, I believe you have that 

 11 authority. If Congress wants to codify that, send 

 12 a message, that would be fine. In fact, we've 

 13 participated in some dialogue as has Dr. Newsome 

 14 in potentially doing that, but the reality is I 

 15 don't think it needs to be done. I think you have 

 16 the authority. 

 17 More broadly, I would love to see if we 

 18 had a magic wand and could wave it over Congress, 

 19 I would love to see them give you a 

 20 principles-based regulatory regime. There is no 

 21 reason in reality that an energy swap is different 

 22 than an interest rate swap. Energy swaps are 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 123 

 1 becoming so complicated today. There are 

 2 literally interest rate swaps that pay in interest 

 3 based on a settlement price of an energy contract. 

 4 I mean they have morphed into the same thing in 

 5 certain regards. So if you had a more 

 6 principles-based approach, I think when you saw a 

 7 problem, you'd have the flexibility to go after a 

 8 problem. 

 9 One of the issues with this debate has 

 10 been we're focusing 2(h)(3) and DTEFs and DCMs and 

 11 so on and so forth, and we're trying to fit things 

 12 into boxes, and it is very complicated to do that. 

 13 I would love to see a broader approach. I don't 

 14 have high hopes for it. 

 15 I will tell you, as a manager that runs 

 16 a business in London where they have a 

 17 principles-based approach, I think it works pretty 

 18 well. It is also quite intrusive, I will tell 

 19 you. It is not a hands-off regulatory style. 

 20 But, net, the kinds of issues that we've been 

 21 having in our energy markets here that have 

 22 dominated the news tend to be resolved better in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 124 

 1 my mind in the European solution, so I'd love to 

 2 see you have that hand. 

 3 Oh, on the DTEF issue, Dr. Newsome has 

 4 it exactly right. To the extent we were to become 

 5 a DTEF, you basically become a futures exchange. 

 6 DTEF prohibits certain classes of users. Once 

 7 you've made that investment, why not let everybody 

 8 trade in markets is the thinking. 

 9 In saying that, I will tell you I'm also 

 10 arguing to you that I don't think we should allow 

 11 retail customers and non-sophisticated players in 

 12 many of the markets that ICE trades which is why 

 13 we have not made them futures. We've sort of 

 14 self-selected that some of these are inappropriate 

 15 for people. In a way, you all have depended on a 

 16 management team to make that decision, and so far 

 17 I think we stand by our decisions. 

 18 But if we were to become a futures 

 19 exchange, I know our volumes would go up. I 

 20 suspect that we would make more money, but I'm not 

 21 sure in the long term, it is the best thing for 

 22 the markets which ultimately would affect my 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 125 

 1 company, if that makes sense. 

 2 MR. DONOHUE: Well, I'm going to start 

 3 with the caveat that I don't know a lot about the 

 4 polar bear market, but I do think that the 

 5 fundamental question is -- 

 6 MR. SPRECHER: I thought you guys had 

 7 every market. 

 8 MR. DONOHUE: We're working on it. The 

 9 fundamental question really is the potential for 

 10 manipulation in these exempt commodities and, 

 11 Commissioner Dunn, I definitely think that the 

 12 line should not be drawn simply at energy. There 

 13 is certainly the potential for manipulation in 

 14 various of the other exempt commodities, and I 

 15 think that is fundamentally the question. 

 16 I think the points about DTEFs and DCMs 

 17 and some of the differences and being half 

 18 pregnant or not are really the wrong area of 

 19 focus. I think the real question is should there 

 20 be some effective system of self- regulation 

 21 involving an effective system of surveillance and 

 22 compliance programs for exempt commodity markets, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 126 

 1 and I think the evidence is quite clear that I 

 2 think that is quite necessary at this point. 

 3 I would differ somewhat with Mr. 

 4 Sprecher in that I think access to information, 

 5 information gathering alone or information 

 6 reporting is just not a good substitute for an 

 7 effective and comprehensive system of compliance 

 8 and surveillance. I think that if that were in 

 9 place, I don't think we would have seen the 

 10 problems that we did in the Amaranth situation, 

 11 and I think you can easily see that being 

 12 extensible into trading of these various other 

 13 exempt commodities. 

 14 MR. KRENKEL: Mr. Chairman, first of 

 15 all, on the DTEF matter, I agree with what's been 

 16 said before. It didn't seem like a logical place 

 17 to stop. You would either go all the way or stay 

 18 in the ECM space. 

 19 From the perspective that you've singled 

 20 out natural gas, it certainly has captured a lot 

 21 of the headline space. I would agree that it is 

 22 really a reflection that some of the things that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 127 

 1 have happened there have resulted in a very 

 2 successful market. 

 3 Trying to provide some uniform 

 4 regulation across that entire commodity will be 

 5 very challenging because we see buyers and sellers 

 6 in the very simplest form trading day gas, trading 

 7 imbalances, trading yesterday's gas out to the 

 8 very sophisticated instruments that are available 

 9 either on the exchanges or in the LTC markets off 

 10 exchange. So trying to single out natural gas as 

 11 a commodity that requires more regulation will 

 12 have some significant challenges. 

 13 DR. SANDOR: As Richard said, 

 14 Commissioner Dunn, thank you very much. I think 

 15 it is just only the beginner for America's farmers 

 16 and ranchers, and I hope we can continue to 

 17 provide an alternative source of income. 

 18 I would like to simply say and I'm only 

 19 speaking from the point of view of the Chicago 

 20 Climate Exchange, I don't believe that we have any 

 21 less of a standard with regard to manipulation. 

 22 We have hired the LASD that does provide 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 128 

 1 regulatory services. 

 2 If you were to say you away with the 

 3 ECMs of any sort, you would do away with a fully 

 4 regulated exempt market in that it has cobbled 

 5 together through farm bureaus, as aggregators, 

 6 through SROs created in 1938 by the Maloney Act 

 7 like, which is a former NASD. They provide 

 8 monitoring. They provide surveillance. They 

 9 provide anti-fraud. They provide no manipulation. 

 10 It just seems to me as a student of 

 11 inventive activity, why would one simply throw out 

 12 a structure like that, that has five years of 

 13 operation, a history, has never been called the 

 14 desk, is fully surveilled and monitored and to say 

 15 that that is not an organization? To do that is 

 16 to speak against the new and the innovative and to 

 17 try to limit creativity. 

 18 I can only tell you from our point of 

 19 view, we have had no problems whatsoever in either 

 20 measuring forward space, ensuring it complies, 

 21 making sure that there are no big utilities 

 22 manipulating the market, and it works, and that's 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 129 

 1 the only ting I can share with you. 

 2 DR. NEWSOME: Just once further comment, 

 3 Commissioner, and thank you, Mr. Chairman. There 

 4 has been a lot of discussion about manipulation, 

 5 and certainly that's a logical discussion to have. 

 6 But if you go back to Amaranth and you look at 

 7 NYMEX from an SRO standpoint, certainly 

 8 manipulation was a concern but just as big a 

 9 concern was systemic financial risk. When you 

 10 have the aggregation of those OTC positions and 

 11 through that aggregation you get aggregated risk, 

 12 that was our biggest concern at the beginning of 

 13 not allowing that risk to become systemic. I 

 14 think that potentially systemic financial risk has 

 15 to be a component of the conversation just like 

 16 manipulation. 

 17 COMMISSIONER DUNN: You were like our 

 18 staff. You were unaware of the total position. 

 19 DR. NEWSOME: Yes, we obviously knew the 

 20 NYMEX position but had no way of knowing others. 

 21 MR. DONOHUE: I have two comments I'd 

 22 like to add to what Dr. Sandor said. What I heard 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 130 

 1 him say is that effectively he has the kind of 

 2 regulatory programs and surveillance and 

 3 compliance capabilities of a regulated exchange, 

 4 perhaps a DCM or a DTEF. If that's the case, then 

 5 I wonder how onerous those requirements would, in 

 6 fact, be for him given what he's created through 

 7 his outsourcing arrangement with NASD or perhaps 

 8 there are differences and perhaps those 

 9 differences are material. 

 10 I don't know the answer to that, but I 

 11 think that's an important question to ask. 

 12 Secondly, on the topic of innovation -- 

 13 DR. SANDOR: I'll be glad to give you 

 14 the answer to that, and it is a very simple thing, 

 15 but someday I hope we're going to be as big and 

 16 strong as all of the members up in the panel. 

 17 We're a new entity. We have limited 

 18 financial resources, and it is a barrier to entry 

 19 to go through the time and all of those things. I 

 20 spent seven years researching this particular 

 21 product full-time and 15 years part-time. I have 

 22 five full-time accountants, and I spent more on 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 131 

 1 lawyers in the first year of operation than I did 

 2 in the 15 years of inventing the product. 

 3 Speed to market is very, very important 

 4 particularly for a new entity because we are 

 5 resource- constrained. It does take these times. 

 6 Having the exempt market made us good. Putting it 

 7 away and cobbling it so that we got in principle 

 8 what we needed and could be inventive. Including 

 9 farm bureaus and NASD and others, we were able to 

 10 put together a lower cost regulatory system from 

 11 certain points of view. 

 12 And so, it would place the new inventor 

 13 at a competitive disadvantage, and I don't think 

 14 we want to do that. Particularly if you're 

 15 dealing with a new commodity that's small, why 

 16 would we want to make one suit fits all? 

 17 Take a commodity of seven polar bears, 

 18 to use your example. You're going to corner the 

 19 polar bear market, and you're going to worry about 

 20 the public's view of the polar bears. While 

 21 you're worrying about it and studying it, the 

 22 polar bears die. So I think you ought to look at 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 132 

 1 creative structures. 

 2 MR. DONOHUE: The second point I wanted 

 3 to make is again on the point of innovation and 

 4 thinking about how successful we have been in 

 5 heating and cooling degree day, weather futures 

 6 contracts, if you will, in the context of a 

 7 designated contract market regulatory environment 

 8 versus the success that I know Richard has had at 

 9 the Climate Exchange in emissions. So I think it 

 10 is a clear example of how I don't think the DCM 

 11 structure of the DTEF structure is in any way a 

 12 barrier to creative products. 

 13 Essentially, there isn't really a very 

 14 large OTC market at this point in weather because 

 15 it has migrated to the environment that we 

 16 provide. 

 17 MR. SPRECHER: Could I make one comment? 

 18 That's easy to say when you start with the largest 

 19 future exchange, but I started what my checkbook. 

 20 MR. DONOHUE: We started with zero 

 21 volume in weather. 

 22 MR. SPRECHER: I can tell you that to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 133 

 1 build a futures exchange as a single individual 

 2 with a checkbook, which is how I started, would 

 3 have been a daunting task. 

 4 CHAIRMAN LUKKEN: Okay, thank you. 

 5 Let's move to Commissioner Sommers. 

 6 COMMISSIONER SOMMERS: Thank you. I 

 7 have a couple of different questions, the first 

 8 one for Dr. Newsome. 

 9 You talk a lot about the targeted 

 10 approach and the advantages you see to that. Can 

 11 you go a step further and talk about where you see 

 12 the disadvantages to the deletion of 2(h)(3)? 

 13 DR. NEWSOME: I think many of those 

 14 disadvantages have been discussed today. That 

 15 marketplace has been a real innovator both in 

 16 terms of technology. I think it serves very nice 

 17 niche marketplaces that a fully regulated futures 

 18 contract probably would not be able to serve as 

 19 well. So I think there are a number of reasons 

 20 why 2H3s are important. 

 21 As we said, our targeted approach would 

 22 represent some flexible criteria for the CFTC to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 134 

 1 evaluate and make determinations on a case by case 

 2 basis. We think that would be a good approach to 

 3 solely address what is and what may become the 

 4 problem areas. 

 5 COMMISSIONER SOMMERS: Thank you. One 

 6 more question in a different vein for Mr. Donahue. 

 7 You talk about the DTEF category and how 

 8 you think that could have advantages over where we 

 9 are with ECMs. Do you see that that could have 

 10 any kind of global implications? 

 11 MR. DONOHUE: I'm sorry, Jill. 

 12 COMMISSIONER SOMMERS: That's okay. 

 13 MR. DONOHUE: Yes, I think there's a 

 14 global implication to everything that we're 

 15 talking about, and we can become myopically 

 16 focused on if we don't choose to do the right 

 17 thing, what will be the implications of that. If 

 18 we eliminate the ECM category, will all of the 

 19 business flow offshore to less regulated 

 20 environments? 

 21 But I really think that we have a very 

 22 flexible structure, perhaps too flexible. Maybe 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 135 

 1 we have too many tiers, and the allowance of 

 2 trading in these kinds of exempt commodities 

 3 certainly are subject to manipulation. If the 

 4 exempt commodity list had been broadened to 

 5 include real agricultural commodities, I doubt for 

 6 a minute we'd be worried about whether we should 

 7 be imposing some level of regulation and oversight 

 8 and requirements for effective surveillance and 

 9 compliance in those areas. 

 10 I find it troubling that we're willing 

 11 to talk about that in the context of markets that 

 12 have become very large including energy 

 13 derivatives and metals and other categories of 

 14 exempt commodities. So I think it is a question 

 15 to ask in the big scheme of things, but it should 

 16 not be the determining factor. 

 17 I think I'll go back to what I said 

 18 before. I mean CFMA has been a remarkable 

 19 success. The U.S. futures industry has been a 

 20 remarkable success, and I know that there are 

 21 other market segments that are very focused on 

 22 global competitiveness, but therein lies the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 136 

 1 difference between the securities' regulatory 

 2 framework and legislation versus the very 

 3 contemporary and modern legislation framework that 

 4 was adopted in 2000. It works. It has advanced 

 5 this industry. It has made us globally 

 6 competitive with every other market sector in the 

 7 world. 

 8 The difference is the SEC has got to 

 9 catch up with the CFTC. This is a tweak, what we 

 10 are talking about. This is a minor glitch in an 

 11 otherwise great landmark legislation that has 

 12 really promoted vitality and growth and 

 13 competition in these markets. 

 14 COMMISSIONER SOMMERS: Thanks. 

 15 MR. DONOHUE: I'm not fearful of that 

 16 flight to less regulated environments. 

 17 COMMISSIONER SOMMERS: Thank you. 

 18 CHAIRMAN LUKKEN: Commissioner Chilton. 

 19 COMMISSIONER CHILTON: Thanks, Mr. 

 20 Chairman. Thanks, Mr. Krenkel, for your 

 21 testimony. Dr. Newsome, I just wanted to thank 

 22 you for your leadership and your work on CFMA. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 137 

 1 Mr. Sprecher, I want to thank you for being so 

 2 forthright. Congratulations on your success, and 

 3 thank you for being both before the Senate and 

 4 before us. I know you sort of feeling like you're 

 5 the whipping boy on this, but thank you for being 

 6 here and being so candid with us. 

 7 For Mr. Donahue and Dr. Sandor, I think 

 8 maybe I'm missing something -- which happens 

 9 often. It seems to me that you could just get rid 

 10 of 2(h)(3) but then you allow the Agency to make 

 11 exceptions and exclusions. 

 12 I mean, Dr. Sandor, for example, it 

 13 seems that there are ECMs that don't rise to the 

 14 look-alike level. If we could use this 

 15 principles-based regulatory regime, if we can just 

 16 go ahead and exempt people, why isn't that 

 17 something that could be done? I'll go to Dr. 

 18 Sandor first. 

 19 Mr. Donahue, I'm sympathetic to making 

 20 it simple actually because I think it is easier to 

 21 get something approved. One of the great mistakes 

 22 I made was when I got here, I tried to read the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 138 

 1 act and got confused very quickly. So the simpler 

 2 we can make the act, I'm in support of that, but I 

 3 don't want to do something wrong. 

 4 Dr. Sandor and then Mr. Donahue, what do 

 5 you think about that concept? 

 6 DR. SANDOR: Yes, I'm not so sure that 

 7 Craig and I do differ or I may be hearing it 

 8 differently. But from my point of view, certainly 

 9 in the case of the Chicago Climate Exchange, one 

 10 aspect of this is to make it simpler and exempt 

 11 certain kinds of commodities and allow them to 

 12 exempt. The Commission might have a set of 

 13 principles. 

 14 I think it goes back to the prior 

 15 statement about taking a shotgun approach as 

 16 opposed to a rifle approach on this issue. There 

 17 may be certain issues that we can address with the 

 18 shotgun approach, different tiers, different 

 19 principles, and achieve the social objectives. We 

 20 probably all can sit down privately and figure out 

 21 what those are. 

 22 MR. DONOHUE: Well, again, I mean I 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 139 

 1 think simplicity has its virtue. I would be 

 2 loathe, I think, to see Congress move in the 

 3 direction or the CFTC, if it had the ability to do 

 4 so, move in the direction of creating several more 

 5 tiers within a tier. I think that that will break 

 6 down of its own weight very, very quickly, and I 

 7 think that's not the right solution. 

 8 Again, I do understand the burden of 

 9 starting from nothing and creating new markets and 

 10 having the kind of flexibility to be successful in 

 11 a much smaller environment, but where we're 

 12 talking about manipulable commodities, I think 

 13 that there is a minimum cost of entry and a 

 14 minimum capitalization requirement that we need to 

 15 be willing to say is necessary in order to 

 16 facilitate transactions and commodities. 

 17 I don't care who the participants are. 

 18 At some point, somebody gets hurt when there's a 

 19 manipulation of a commodity market. And so, with 

 20 all due respect to that, I think we also have to 

 21 say if we are going to facilitate that, isn't 

 22 there some minimum cost of entry that's 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 140 

 1 appropriate for ensuring protection of customers, 

 2 however sophisticated they might be and whatever 

 3 the trickle-on effects are of their failure to 

 4 other investors in the marketplace. So I think 

 5 that that's important. 

 6 I think the other part of it is that you 

 7 know better than I whether you actually have the 

 8 regulatory authority to make exceptions or 

 9 exemptions and whether that's an effective way to 

 10 utilize the time and resources if you have the 

 11 ability of the CFTC and its very scarce staff. So 

 12 I think simplicity is useful here for that purpose 

 13 as well. 

 14 COMMISSIONER CHILTON: That's actually a 

 15 question I asked our -- 

 16 DR. SANDOR: If I could make, sorry, one 

 17 last point. I do understand the arguments that 

 18 Craig is making, and I think for large commodities 

 19 and manipulations, that may in fact be right. But 

 20 not all commodities are large, and this is the 

 21 only section. 

 22 I would bring to point and score the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 141 

 1 point that Jeff Sprecher made. I, for one, was 

 2 writing personal checks and starting this market, 

 3 and it was all done with my own capital and 

 4 friends and family. I can sincerely say to you 

 5 that I was able to raise the capital based on an 

 6 exempt market, and I probably would have run out 

 7 of money if I would have had to go through the 

 8 legal expenses, okay, and go through the 

 9 regulation at the outset. We can do it now. 

 10 That's not the issue. 

 11 But I'm wondering about those people who 

 12 are beginning new markets and are not like Jack or 

 13 Craig or Jim, who have tens of billions in market 

 14 cap. Then resources aren't the problem. When 

 15 you're Jeff Sprecher, who is an entrepreneur, and 

 16 Richard Sandor, a million dollars is the 

 17 difference between living or dying or a half a 

 18 million or of 12-month loss of time. 

 19 And so, please do score the 

 20 entrepreneurial viewpoint and the capital 

 21 constraints associated with launching a new small 

 22 business, and I don't think the problems arise 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 142 

 1 with new small businesses. 

 2 COMMISSIONER CHILTON: Thanks, Dr. 

 3 Sandor. We do have that authority, Mr. Donahue. 

 4 That's the question I was actually asking earlier 

 5 to senior staff. 

 6 If you're on Capitol Hill and you're Dan 

 7 Berkowitz or you're somebody, you're Dawn Stump, 

 8 and you're trying to figure out how to do this, 

 9 how in the world could you possibly write 

 10 legislation that can anticipate all these things 

 11 in the future? 

 12 Senator Levin has tried to do that, but 

 13 this is really complicated. Even if you get it 

 14 exactly right today, it is different perhaps 

 15 tomorrow. That's the beauty of this 

 16 principles-based regulation that we do have and 

 17 the ability to have this flexibility. 

 18 I'm not making a hard case for just 

 19 getting rid of it and giving us authority, but it 

 20 seems to me that that's something we should. I 

 21 mean I think we have the authority and allowing us 

 22 to continue to do that. It seems to me that there 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 143 

 1 are ECMs that might not raise to the level of 

 2 being fully regulated. 

 3 I don't know all the answers to it, but 

 4 I think we do have the staff. I've never worked 

 5 with a better group of people here. 

 6 For Dr. Sandor, I was just thinking, 

 7 when you were talking about you may be like 

 8 Caesar's wife. We certainly don't want these 

 9 markets to end up like the last scene in Hamlet. 

 10 Thank you, Mr. Chairman. 

 11 CHAIRMAN LUKKEN: I think we have time 

 12 for a few more questions. I just have a really 

 13 quick one. 

 14 This is an interesting debate going on. 

 15 I think everybody, in some ways, is trying to get 

 16 to the same thing, which is rationalizing the risk 

 17 of the marketplace to the regulatory structure. 

 18 There's a variety of ways to do it, either 

 19 stripping down a one size fits all category to fit 

 20 the market or building up the requirements you 

 21 need on a case by case basis as the CFTC might be 

 22 able to do or through a category we could create. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 144 

 1 So this is interesting. 

 2 We don't want to protect the Microsofts, 

 3 circle the wagon around the Microsofts, though, 

 4 and harm the Googles that may be developing in 

 5 this marketplace. So that is at we are trying to 

 6 optimize here. 

 7 Something I wanted to talk about was 

 8 part of the advantages of being in the regulated 

 9 spaces. Something we talk about a lot is 

 10 recognition in foreign countries, of being able to 

 11 compete overseas. One of the things that I think 

 12 is an advantage of being a regulated entity under 

 13 the CFTC is having a regulatory passport, being 

 14 able to go to foreign regulators as a registered 

 15 entity within the United States and allowing those 

 16 foreign entities to recognize that and allowing 

 17 you to operate overseas in regards to that 

 18 recognition. 

 19 How important is that? Is that enough 

 20 of a carrot to pull entities out of the ECM line 

 21 or regulatory space into a designated space? 

 22 Are more carrots needed? There may be 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 145 

 1 tax advantages of being in a regulated space. 

 2 Exclusive jurisdiction might be something that's 

 3 interesting for people in the regulated space. 

 4 Can you talk a little bit, instead of the 

 5 regulatory requirements, about some of the 

 6 advantages of being in the regulated space and how 

 7 that might be useful for us going forward? 

 8 DR. NEWSOME: I'm going to save the 

 9 exclusive jurisdiction comment. Maybe we'll have 

 10 another hearing to talk about that one later. 

 11 I think certainly there are huge 

 12 advantages to being a fully regulated DCM, many of 

 13 which you just mentioned, Mr. Chairman, and that 

 14 has been evaluated specifically by NYMEX. As we 

 15 entered the OTC clearing space, we've set up joint 

 16 ventures and subsidiaries, both domestically and 

 17 in other countries. In every instance, we've 

 18 always come down on the side of being a fully 

 19 regulated DCM. 

 20 I think the access to the full array of 

 21 customers certainly helps build liquidity when 

 22 you're launching new products. There are 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 146 

 1 arguments across the gamut. From the NYMEX 

 2 standpoint, we believe in being a fully regulated 

 3 entity, and we will continue to do so. 

 4 CHAIRMAN LUKKEN: Jeff. 

 5 MR. SPRECHER: It is kind of a mixed 

 6 bag. I'd like to say that the world looks at the 

 7 United States and says great, but unfortunately it 

 8 is not quite the case. 

 9 I do think one thing that this 

 10 Commission did a year or so ago by working with 

 11 the FSA to put that communication agreement and 

 12 cooperation agreement in place has really helped 

 13 because it has brought, at least in the 

 14 commodities area, us into a sort of footprint of 

 15 global regulation where the U.S. will, in a way, 

 16 have a strong hand in dictating the rules. I 

 17 think between you all and the FSA, you've got an 

 18 amazing footprint for exploitation of that. 

 19 We're unique in that we're a company 

 20 that took a bilaterally traded swap contract and 

 21 brought it into a cleared market that was an ECM 

 22 and then eventually took it into a regulated 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 147 

 1 futures market in our case in the U.K., and along 

 2 the way the volumes grew. So it is very much. I 

 3 have definitely have the experience that volumes 

 4 can grow when you add more regulation. 

 5 Regulation itself is not a deterrent. 

 6 In fact, it maybe the thing that really allows new 

 7 entrants to have some confidence in the product. 

 8 So on a product by product basis, we think about 

 9 that. We don't think about it so much as a one 

 10 size fits all on the corporate basis. 

 11 In fact, that particular product which 

 12 was WTI, West Texas Intermediate Crude Oil, which 

 13 happens to settle on NYMEX final settlement price 

 14 is the same structure as the contract that a lot 

 15 of us are talking about here, the Henry Hub swap 

 16 which we have not elected to take into a regulated 

 17 futures environment for a number of reasons, that 

 18 we just don't think that it is really ready for 

 19 that yet. 

 20 CHAIRMAN LUKKEN: Thank you. I'll turn 

 21 to Commissioner Dunn. I know we are running short 

 22 on time here but one last set of questions. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 148 

 1 COMMISSIONER DUNN: I hear quite often 

 2 that there will be unintended consequences if we 

 3 would with one fell swoop get rid of the 2(h)(3), 

 4 and I'm wondering what are those and what would 

 5 happen. Would there be a flight to offshore? 

 6 Is there a competitiveness there that we 

 7 would lose, a competitive advantage, by not having 

 8 that and how do we ensure that those sophisticated 

 9 operators that are really doing bilateral still 

 10 have a place here and aren't going to go somewhere 

 11 else as a result, because there is a cost to being 

 12 an SRO? 

 13 MR. DONOHUE: Yes, I'll start with that. 

 14 Just to begin with, I think that there's an 

 15 unintended consequence effect in almost everything 

 16 we choose to do, and so choosing to include 

 17 2(h)(3) in 2000 certainly has led to unintended 

 18 consequences. I believe certainly in the energy 

 19 markets with what we've witnessed. 

 20 So I think we can't focus on whether we 

 21 can do something exactly correctly, knowing that 

 22 the market will continue to evolve. I think we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 149 

 1 have to focus on doing something that seems mostly 

 2 correct, and I really think that we really 

 3 shouldn't be overly concerned with the unintended 

 4 consequences. 

 5 Again, it seems to me there's been a lot 

 6 of great evidence of successful innovation and 

 7 incubation and development of new markets and new 

 8 products in a regulatory environment. I think we 

 9 should all remind ourselves as well that we are 

 10 operating under a much different non-prescriptive 

 11 oversight regulatory mechanism that allows people 

 12 to bring products to market very quickly, 

 13 relatively inexpensively. 

 14 We have an environment, as some of the 

 15 people here have testified today, where you don't 

 16 have to build and operate your own effective 

 17 compliance and surveillance capabilities. It can 

 18 be outsourced. There are lots of people willing 

 19 to do these things on a reasonable economic basis, 

 20 and I think it is appropriate to say that that's 

 21 important for this country, to have that kind of 

 22 regulatory integrity. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 150 

 1 To answer your larger question, I mean 

 2 certainly we think regulation is a great 

 3 advantage, but to be fair and I always enjoy the 

 4 opportunity to actually find a point of agreement 

 5 with Mr. Sprecher, I think that it is true. 

 6 MR. SPRECHER: We both like the Board of 

 7 Trade. 

 8 MR. DONOHUE: I think it is a great 

 9 advantage beyond that. We like them at a higher 

 10 price. 

 11 Beyond that, we think it is a great 

 12 advantage for us, but I wouldn't be willing to sit 

 13 here and say that it is such an advantage, 

 14 Commissioner Lukken, that in all cases, everything 

 15 ought to be very heavily regulated within the 

 16 scheme of what's available under the CEA. 

 17 Obviously, there are other markets, particularly 

 18 non- manipulable markets, where an exemption from 

 19 regulation is absolutely appropriate, and we 

 20 wholeheartedly support that. 

 21 DR. NEWSOME: Commissioner, my thoughts, 

 22 sir, I hope that I've voiced the viewpoint of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 151 

 1 New York Mercantile Exchange adequately with 

 2 regard to this targeted approach. Craig, I think 

 3 makes good arguments with regard to the viewpoint 

 4 of the CME. 

 5 Our bigger concern for the unintended 

 6 consequences is the even broader approach that 

 7 some members of Congress are verbalizing with 

 8 regard to the traditional bilateral OTC markets, 

 9 and certainly we think that is unwarranted and 

 10 unnecessary at this point. I think it would be 

 11 hard to make the case that one, those should be 

 12 regulated and, two, even if you chose to do so, 

 13 how you would do it. 

 14 MR. SPRECHER: I have a couple of 

 15 unintended consequence concerns that I'll try to 

 16 distill into a soundbite. The biggest one, while 

 17 I have some concern about things going offshore 

 18 and one of the points we put out in our prepared 

 19 testimony was in ICE's top five contracts, one of 

 20 them is located in Asia and one of them is located 

 21 in Canada. What we're really asking broadly is 

 22 will the Canadian energy market and will the Asian 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 152 

 1 energy market respond to oversight by the CFTC? 

 2 We all share the view of we don't want 

 3 manipulated markets. Nobody who is in the 

 4 transaction business benefits by market 

 5 manipulation, but we benefit from market 

 6 confidence. 

 7 The question is would we really have the 

 8 authority to ask a Chinese airline to reduce jet 

 9 fuel position and would they, and would we just 

 10 get to make that call one time and then they're 

 11 gone from our markets? It is fine-tuning that. 

 12 On the other hand, do we want Chinese 

 13 airlines manipulating markets? I certainly don't 

 14 on my platform. So you want some level of 

 15 authority and standard which we've tried to embody 

 16 in our own contract with people that use our 

 17 platform. 

 18 The bigger issue for me is that while 

 19 we've talked about Henry Hub, of the 1,000 

 20 different products that we trade, many of them I 

 21 don't think we would want to say are sources of 

 22 price discovery. I certainly wouldn't want to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 153 

 1 convey to people they should rely on these prices. 

 2 The energy markets have been 

 3 deregulating over much of my lifetime, but there 

 4 are natural monopolies in energy. In the natural 

 5 gas market that we're talking about, there's 100 

 6 delivery points in the U.S. At the center of each 

 7 of those delivery points is likely a natural gas 

 8 utility that has a dominant role. It is not 

 9 uncommon in that utility who's hedging with swaps 

 10 to be half of the market. They're on 50 percent 

 11 of every trade. 

 12 If we were to collectively suggest that 

 13 the prices that they've discovered was the price 

 14 of natural gas in Eugene, Oregon, let's say, and 

 15 if the Eugene, Oregon public utility commission 

 16 were to use those prices in setting rates for that 

 17 utility or FERC were to use those prices in 

 18 pipeline considerations or what have you, we'd 

 19 create an odd situation where a small number of 

 20 trades that are probably dominated by one party 

 21 could take on a role that would actually lead to 

 22 higher prices for consumers. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 154 

 1 A lot of what we're talking about and a 

 2 lot of what Dr. Newsome and I have been working on 

 3 privately and at Congress are these large liquid 

 4 pools that affect like the price of natural gas 

 5 benchmark that we've all come to know, the Henry 

 6 Hub. We had a similar debate on this WTI contract 

 7 a year ago. 

 8 Where these OTC markets can directly 

 9 affect futures markets, I don't see a problem and 

 10 I don't see a flight overseas. I think those are 

 11 natural U.S. markets and they're broad enough that 

 12 the collective body of participants wants there to 

 13 be a regulated or confident market, let's say. 

 14 CHAIRMAN LUKKEN: Commissioner Sommers, 

 15 anything? Mr. Chilton. 

 16 COMMISSIONER CHILTON: I only had one 

 17 question, and I wasn't going to ask this, but I'm 

 18 curious. 

 19 Mr. Sprecher, have you all ever sent to 

 20 us a referral for attempted manipulation or 

 21 manipulation? 

 22 MR. SPRECHER: I can't say only because 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 155 

 1 my compliance staff, we've designed it to keep 

 2 management out of the discussion so we don't mix 

 3 commercial issues, and we do have those 

 4 obligations. I do know that our staffs have been 

 5 working to more tightly coordinate. 

 6 ICE is unique, again, in that we have 

 7 all these physical markets that may generally be 

 8 FERC-related, but we've now been seeing the 

 9 interplay of the CFTC and FERC. So there's been a 

 10 lot of dialogue between the collective staffs over 

 11 where should we refer these things or both places. 

 12 COMMISSIONER CHILTON: You can go here. 

 13 MR. SPRECHER: I think your staff has a 

 14 lot going on right now. 

 15 COMMISSIONER CHILTON: The only other 

 16 thing I wanted to say is again, you know 

 17 Commissioner Dunn gave big compliments to Dr. 

 18 Sandor, and I echo those because I mentioned 

 19 earlier maybe at some point in the future, that 

 20 whole issue of carbon trading is something we can 

 21 take a look at publicly. I think you're doing 

 22 some enormously innovative things. The force be 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 156 

 1 with you. 

 2 Thank you, Mr. Chairman. 

 3 DR. SANDOR: Thank you very much. 

 4 CHAIRMAN LUKKEN: Thanks, Richard. I 

 5 want to thank the panel for their testimony here 

 6 today. We are going to continue in about an hour. 

 7 We will reconvene at 1:00. We appreciate 

 8 everybody appearing today. 

 9 (Whereupon, at 12:04 p.m., a 

 10 luncheon recess was taken.) 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 157 

 1 A F T E R N O O N S E S S I O N 

 2 (1:08 p.m.) 

 3 CHAIRMAN LUKKEN: Welcome back, 

 4 everyone. We have a couple panels this afternoon 

 5 to continue our debate on exempt commercial 

 6 markets. Before us today, we have market users. 

 7 I think they will be helpful in enlightening the 

 8 debate on exempt commercial markets. 

 9 On the first panel, we have Russ Stolie 

 10 who is General Counsel for the Huntsman 

 11 Corporation -- welcome, Russ -- and Skip Horvath, 

 12 President of the Natural Gas Supply Association. 

 13 We have Laura Campbell who is representing the 

 14 American Public Gas Association, but her full-time 

 15 job is with Memphis Light, Gas and Water. 

 16 Welcome. We also have John Damgard, President of 

 17 the Futures Industry Association. 

 18 Thank you all for coming to testify. We 

 19 will turn it over to Russ. 

 20 MR. STOLIE: Good afternoon, Chairman 

 21 Lukken and members of the Commission. My name is 

 22 Russ Stolie, and I am the Senior Vice President of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 158 

 1 Global Public Affairs and Communications for 

 2 Huntsman Corporation. I would like to thank the 

 3 members of the Commission for the opportunity to 

 4 participate in today's hearing on the oversight of 

 5 natural gas trading on the regulated futures 

 6 exchanges and exempt commercial markets. 

 7 With your permission, Chairman Lukken, I 

 8 would also like to submit a written statement for 

 9 the record. 

 10 CHAIRMAN LUKKEN: It is part of the 

 11 record. 

 12 MR. STOLIE: Huntsman is a global 

 13 business manufacturing and marketing what we call 

 14 differentiated chemicals. Our operating companies 

 15 manufacture products that are essential to a 

 16 variety of global industries including automotive, 

 17 aviation, textiles, construction, high tech, 

 18 agriculture and health care. You'll find our 

 19 products in many of the products you buy and that 

 20 touch our lives every day from the shampoos in 

 21 your shower to sophisticated epoxy curing agents 

 22 that are used in the manufacture the wind blades 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 159 

 1 that now populate wind farms. 

 2 Huntsman today has nearly 13,000 

 3 employees and operations in 24 countries and, in 

 4 2006, we had revenues from all operations 

 5 exceeding $13 billion. 

 6 Global companies like Huntsman depend on 

 7 the commodities market for critical raw materials 

 8 and rely on fair pricing in those markets in order 

 9 to be competitive both domestically and abroad. A 

 10 key commodity for Huntsman as well as for 

 11 thousands of other domestic businesses and 

 12 millions of American farmers and consumers is 

 13 natural gas. 

 14 Unfortunately, price volatility in the 

 15 market for natural gas in the United States has 

 16 made the U.S. Significantly less competitive for 

 17 manufacturing operations that rely on natural gas 

 18 as a commodity which has and, if not addressed, 

 19 will continue to have a significant impact on 

 20 employment in the manufacturing sector of this 

 21 country's economy. Our company is one of many 

 22 U.S. companies to have been competitively 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 160 

 1 disadvantaged on the global playing field by this 

 2 price volatility, and we believe our experience is 

 3 representative of the experience of many others. 

 4 Beginning in the year 2000, our 

 5 management began to conclude that ongoing 

 6 volatility in the price of natural gas in the 

 7 United States would likely be such that it would 

 8 be necessary to both divest of those of our 

 9 businesses that are most dependent on the 

 10 consumption of large quantities of natural gas and 

 11 to shift our investments overseas to countries 

 12 less subject to significant volatility in the 

 13 price for natural gas. 

 14 The global composition of our workforce 

 15 followed suit. In the year 2000, approximately 37 

 16 percent of our company's then 10,400 employees 

 17 were working in the United States. By the first 

 18 quarter of this year, that percentage of our 

 19 workforce that are U.S. employees had fallen to 

 20 about 23 percent. By year-end 2007, only 18 

 21 percent of our company's roughly 13,000 employees 

 22 will be located here, a greater than 50 percent 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 161 

 1 reduction of that percentage of our global 

 2 workforce. 

 3 While most of those reductions are the 

 4 result of divestitures of certain of our U.S. 

 5 businesses rather than actual plant closures, 

 6 those divestitures were largely to an energy 

 7 company that can integrate those assets with its 

 8 own, and our reinvestment has largely been 

 9 overseas -- in the end, a net loss of jobs here in 

 10 the U.S. 

 11 Of the multiple new plants and plant 

 12 expansions we have announced, only one of major 

 13 significance is located in the United States. It 

 14 happens to be an exothermic process that also 

 15 produces a byproduct gas stream that rises in 

 16 value with the price of natural gas. 

 17 If you were to look at Huntsman's use of 

 18 its discretionary growth capital, meaning that 

 19 used for new plants and capacity additions on 

 20 existing plants, during the last three year and 

 21 then include that which we have budgeted for 2008, 

 22 you would find that roughly 78 percent of the more 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 162 

 1 than $1.1 billion combined was or, in the case of 

 2 next year's budget, will be used for projects 

 3 located outside the U.S. If we include our 

 4 expectations for 2009, that percentage is 

 5 projected to climb to roughly 85 percent of a 

 6 combined $1.6 billion for the years 2005 through 

 7 2009. 

 8 Our company strongly believes that price 

 9 volatility in the U.S. market for natural gas is 

 10 due to a failure of the current regulatory 

 11 structure for the trading of futures on natural 

 12 gas to serve the purposes of the Commodity 

 13 Exchange Act. 

 14 Now, I'd like to share with you a few 

 15 additional thoughts on why this volatility in the 

 16 price of natural gas so significantly impacts 

 17 Huntsman and the chemical industry overall. 

 18 The price of natural gas intersects our 

 19 profitability at two major points. As you may 

 20 know, while natural gas is largely comprised of 

 21 methane, the market price of its sister molecules, 

 22 ethane and propane, also rise and fall with the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 163 

 1 price of natural gas. Ethane and propane are the 

 2 two principal raw materials for the chemical 

 3 building blocks, ethylene and propylene, which we 

 4 produce and then further use to manufacturer many 

 5 of our other products. 

 6 We must buy huge quantities of ethane 

 7 and propane almost every day to feed our ethylene 

 8 crackers. Ethylene crackers are the mammoth 

 9 manufacturing units that crack ethane and propane 

 10 to produce ethylene and propylene. Because we 

 11 consume such huge quantities of ethane and propane 

 12 and because there is limited storage available for 

 13 these gases, radical volatility in the price of 

 14 natural gas means comparable volatility in the 

 15 prices at which we purchase our two most major 

 16 feed stocks throughout a given month. 

 17 Now, additionally, natural gas also 

 18 serves as the fuel that fires the giant furnaces 

 19 of the typical ethylene cracker which requires 

 20 very high heat to achieve the necessary cracking 

 21 of the ethane and propane molecules. As a result, 

 22 volatility in the price of natural gas impacts 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 164 

 1 both the cost of our feed stocks and the fuel used 

 2 in our manufacturing processes, producing a 

 3 two-pronged impact on our economic viability. 

 4 Now, a few comments on why companies 

 5 such as ours cannot simply manage their way 

 6 through periods of radical price volatility. 

 7 As I already mentioned, we are virtually 

 8 at the mercy of the daily market for ethane and 

 9 propane feed stocks. Additionally, we generally 

 10 buy our natural gas for fuel on a monthly basis, 

 11 fixing our price for the next 30 days based on the 

 12 last three days of trading on the NYMEX in the 

 13 previous month. We occasionally let it float for 

 14 the month if we think that the price has 

 15 substantially spiked during the last three days of 

 16 the month. 

 17 But, on the other hand, our contracts 

 18 for many of our products with our customers, to 

 19 compete, we have to sell pursuant to contracts 

 20 that often permit Huntsman to reprice no more 

 21 frequently than quarterly. Even those of our 

 22 contracts that permit more frequent repricing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 165 

 1 routinely provide that customers don't have to 

 2 accept our announced price increases but can shop 

 3 for alternate sources pursuant to a meet or 

 4 release clause in their contracts. 

 5 When there is significant volatility in 

 6 the price of natural gas, Huntsman must absorb or 

 7 one might say act as a shock absorber for 

 8 unpredictable spikes in our cost of goods sold to 

 9 the extent we cannot pass on those increases in 

 10 cost to our customers. We note that only 

 11 yesterday, Bloomberg reported that natural gas has 

 12 risen again because of speculation that hedge 

 13 funds would be driving prices up higher. In other 

 14 words, we got squeezed. It is this shock absorber 

 15 effect that is driving many in our industry 

 16 including Huntsman to invest in production assets 

 17 in regions of the world with a less volatile 

 18 natural gas market. 

 19 These economics played a major role in 

 20 our decision to divest of our domestic stand-alone 

 21 merchant market ethylene cracker to an energy 

 22 company with a domestic upstream energy producing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 166 

 1 business, retaining only a smaller captive 

 2 ethylene unit to produce ethylene for our own 

 3 consumption. Though still somewhat subject to the 

 4 problems I have described, we are significantly 

 5 reducing our exposure to the domestic natural gas 

 6 market. 

 7 We have found that attempts to fix the 

 8 price we pay for natural gas for longer periods of 

 9 time are ineffective for several reasons. First, 

 10 we must pay a significant premium to lock our 

 11 price for longer periods. 

 12 Second, our customers, with some 

 13 exceptions, generally are unwilling to lock the 

 14 price they pay for our products for longer periods 

 15 for fear of having an uncompetitive cost position 

 16 relative to their competitors should the price of 

 17 natural gas decline, permitting their competitors 

 18 to procure comparable products for less. 

 19 And, third, without such an agreement 

 20 from our customers to fix the price they pay for 

 21 our products for a period of time comparable to a 

 22 long position we might take on natural gas, we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 167 

 1 incur unacceptable risk relative to production 

 2 with access to a less volatile natural gas market. 

 3 While Huntsman applauds the Commission's 

 4 enforcement actions and supports the Commission's 

 5 recent proposals, Huntsman believes that these 

 6 changes alone are not adequate to address the 

 7 problems in the natural gas market. My written 

 8 statement addresses our specific recommendations 

 9 to the Commission to support amendment to the CEA 

 10 and to take further regulatory actions in the 

 11 natural gas futures market. 

 12 Thank you very much for the opportunity 

 13 to be here today. Although I must leave soon, I 

 14 would be happy to address any comments that the 

 15 Commission may have. If there are any questions 

 16 for Huntsman following the remaining panelists, 

 17 with your permission, Chairman Lukken, I'd like 

 18 Oliver Ireland to substitute in my spot and answer 

 19 those questions. 

 20 CHAIRMAN LUKKEN: I understand you have 

 21 a busy schedule, and we'll welcome Ollie to join 

 22 us if he has to. So, thank you. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 168 

 1 Now we'll turn to Skip. Thank you very 

 2 much. 

 3 MR. HORVATH: I'm Skip Horvath, 

 4 President and CEO of the Natural Gas Supply 

 5 Association, the NGSA. Our members are large 

 6 integrated and independent producers and marketers 

 7 of natural gas. We're the guys that put the drill 

 8 in the ground, get the gas out and get it out to 

 9 the buyers around the country. 

 10 We operate in our market on three 

 11 bedrock principles, and those principles are 

 12 integrity of the market, transparency of the 

 13 market and efficiency of the market, so, 

 14 integrity, transparency, efficiency. If those 

 15 were there, we wouldn't be able to do our job. 

 16 This year alone, we are investing over 

 17 $160 billion in new assets, which is more than the 

 18 previous year, the year before that. That has 

 19 been true for about four or five years now and 

 20 constantly increasing up to $160 billion. We 

 21 would not be doing that if we didn't have 

 22 confidence in the market. We know this market 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 169 

 1 works. Now, because we feel these principles are 

 2 followed, we can trust that the market is 

 3 competitive. 

 4 You have to ask the question, why the 

 5 volatility, which the previous speaker referred 

 6 to. The reason for the volatility is our supplies 

 7 are artificially constrained. We have areas of 

 8 gas-prone lands that are off limits. I realize 

 9 that's not the role of the CFTC. It is not your 

 10 job, but you need to understand that while it is 

 11 appropriate that you and Congress look at perhaps 

 12 extending more oversight over energy markets, that 

 13 will have a relatively small benefit compared to 

 14 benefits you'd see from increasing supplies of 

 15 natural gas. We feel those are the real concerns 

 16 as far as volatility and price go. 

 17 But you do have a role. The CFTC and 

 18 FERC both are, in no small part, reasons for why 

 19 the market works so well. You guys are doing your 

 20 job. You are the cop on the beat. We view the 

 21 ongoing cases as proof that you're doing your job, 

 22 and you are doing exactly what you need to be 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 170 

 1 doing. 

 2 So I don't want to give the impression 

 3 that everything is perfect and you can't improve. 

 4 You can always improve the system. You need to 

 5 consider what Congress is talking about, what you 

 6 all are thinking about doing for extending 

 7 regulation, but we ask that you do it prudently. 

 8 Let me give you some examples of what we 

 9 think you all are doing right. FERC's policy 

 10 statement in 2003 helped in price reporting to 

 11 remove uncertainty in the market. The CFTC's memo 

 12 of understanding with FERC and how you're working 

 13 together, I can't tell you how much regulatory 

 14 uncertainty that took out of the market and why it 

 15 is so important for the market to understand that 

 16 agencies are cooperating together. The EPAct of 

 17 2005 increased price transparency in the market. 

 18 We have over 7,000 producers, we have 

 19 millions of buyers, and we have a competitive 

 20 market. We have a role for speculators. 

 21 Speculators help take volatility out of the 

 22 market, contrary to the view of some. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 171 

 1 As a result, the U.S. has the most 

 2 competitive, robust natural gas market in the 

 3 world. You already have the best market. I'm not 

 4 saying you can't improve it, but it is already 

 5 pretty darn good. 

 6 We've got some materials on this side of 

 7 the room, a paper done by a professor locally 

 8 about he feels natural gas is the best market in 

 9 the world for transparency and competitive 

 10 reasons. So I encourage that for your reading. 

 11 I am going to end on that thought 

 12 because I just want you all to realize you are 

 13 doing a good job and we do have a very 

 14 competitive, well functioning market. 

 15 Thank you. 

 16 CHAIRMAN LUKKEN: Thank you, Mr. 

 17 Horvath. Thank you very much. 

 18 We turn to Ms. Campbell. 

 19 MS. CAMPBELL: Thank you, Chairman 

 20 Lukken and members of the Commodity Futures 

 21 Trading Commission. I appreciate this opportunity 

 22 to testify before you today, and I thank the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 172 

 1 Commission for calling the hearing to examine the 

 2 critically important issues of trading on 

 3 regulated exchanges and exempt commercial markets. 

 4 My name is Laura Campbell, and I am the 

 5 Assistant Manager of Energy Resources with Memphis 

 6 Light, Gas and Water. MLGW is the nation's 

 7 largest three-service municipal utility and 

 8 currently provides services to more than 420,00o 

 9 customers. 

 10 I testify today on behalf of the 

 11 American Public Gas Association. APGA is the 

 12 national association for publicly-owned natural 

 13 gas distribution systems. There are approximately 

 14 1,000 public gas systems in 36 states, and almost 

 15 700 of these systems are APGA members. 

 16 Publicly-owned gas systems are not-for-profit 

 17 retail distribution entities owned by and 

 18 accountable to the citizens they serve. 

 19 APGA's members have lost confidence that 

 20 the prices for natural gas and the futures in 

 21 economically linked over the counter markets are 

 22 accurate reflections of the supply and demand 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 173 

 1 conditions for natural gas. Without question, 

 2 natural gas futures contracts traded on NYMEX and 

 3 financial contracts for natural gas traded on the 

 4 over the counter markets are economically linked. 

 5 Markets for financial and natural gas contracts is 

 6 composed of a number of segments which include 

 7 future contracts traded on the NYMEX and financial 

 8 contracts for natural gas traded on the OTC 

 9 markets. 

 10 OTC contracts may be traded on 

 11 multilateral electronic trading facilities known 

 12 as exempt commercial markets or ECMs. They also 

 13 may be traded bilaterally on electronic platforms 

 14 through voice brokers and indirect bilateral 

 15 transactions between counter parties. 

 16 The impact of last year's activities of 

 17 the Amaranth Advisors hedge fund exemplifies this 

 18 linkage. When the positions accumulated by 

 19 Amaranth began to unwind, gas prices decreased. 

 20 Unfortunately, many of APGA's members had already 

 21 locked in prices prior to that period at levels 

 22 that did not reflect the current supply and demand 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 174 

 1 conditions. As a result, elevated prices during 

 2 that period when Amaranth held these exceedingly 

 3 large positions, many of APGA's members were 

 4 forced to pay a premium which was passed through 

 5 to their customers on their gas bills. 

 6 The CFTC has done a good job in catching 

 7 market abuses after the fact. However, the 

 8 Commission did not have a complete picture of the 

 9 full extent of Amaranth's trading position until 

 10 after Amaranth's collapse. Greater transparency 

 11 with respect to traders' large positions, whether 

 12 entered into on a regulated exchange or on the OTC 

 13 markets for natural gas, will provide the 

 14 Commission with the tools to detect and deter 

 15 potential manipulative activity before our members 

 16 and their customers suffer harm. 

 17 APGA believe that there are immediate 

 18 measures that the Commission can and should take 

 19 within its existing authorities to improve the 

 20 current situation. The recent proposed amendments 

 21 to Rule 1805 offer the Commission both the means 

 22 and the opportunity to increase transparency in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 175 

 1 these markets and thereby begin to address the 

 2 current lack of public confidence in price 

 3 integrity. Rule 1805 is a potentially powerful 

 4 tool to shed light on reportable traders' 

 5 positions in all segments of the natural gas 

 6 market. 

 7 APGA believes that the Commission should 

 8 use this authority aggressively to issue special 

 9 calls to all reportable traders in natural gas for 

 10 information with respect to their overall 

 11 positions in all segments of the 

 12 financially-traded natural gas market. This would 

 13 be an important first step in meeting the purpose 

 14 of the Commodity Exchange Act to deter and prevent 

 15 price manipulation of any disruption to market 

 16 integrity. 

 17 However, APGA also recognizes that Rule 

 18 1805 would only apply when a trader has a 

 19 reportable position on a regulated futures market 

 20 and that a large trader could therefore easily 

 21 evade the reporting requirement. For this reason, 

 22 legislation to enhance the Commission's authority 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 176 

 1 by providing a comprehensive large trader 

 2 reporting system that includes all segments of the 

 3 market is necessary. 

 4 APGA strongly supports the Market Trust 

 5 Act of 2007, introduced by Congressmen Baird and 

 6 Graves. This bipartisan legislation would protect 

 7 consumers by requiring the reporting of large 

 8 positions in financial contracts for natural gas 

 9 held in all segments of the market. It is 

 10 important to note that the Market Trust Act is 

 11 narrow in scope and applies only to financial 

 12 contracts, agreements and transactions for natural 

 13 gas. 

 14 Finally, APGA commends the Commission on 

 15 holding this hearing and believes that greater 

 16 public involvement would assist the Commission as 

 17 the market in natural gas changes and as the 

 18 Commission's policies necessarily evolve to meet 

 19 the challenges of the new conditions in the energy 

 20 markets and urges the Commission to establish an 

 21 advisory panel on energy markets. 

 22 Natural gas is the lifeblood of our 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 177 

 1 economy, and millions of consumers depend on 

 2 natural gas every day to meet their daily needs. 

 3 It is critical that the prices those consumers are 

 4 paying for natural gas comes out through the 

 5 operation of a fair, orderly and transparent 

 6 marketplace. 

 7 We believe that the Commission can do 

 8 much within its existing authorities to increase 

 9 transparency and to improve the current situation. 

 10 Moreover, Congress can provide American consumers 

 11 with the protections they deserve by passing the 

 12 Market Trust Act of 2007. 

 13 Thank you. 

 14 CHAIRMAN LUKKEN: Thank you, Ms. 

 15 Campbell. We turn to Mr. Damgard. 

 16 MR. DAMGARD: Thank you, Walt. Let me 

 17 first congratulate the newest members of the 

 18 Commission, Commissioner Sommers and Commissioner 

 19 Chilton. I can hardly wait, Walt, to see that 

 20 Acting come off your name. Congratulations to 

 21 you. 

 22 CHAIRMAN LUKKEN: Thank you. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 178 

 1 MR. DAMGARD: Not to ignore Commissioner 

 2 Dunn whose steady hand has certainly helped 

 3 agriculture through a very difficult period. For 

 4 those of us that are enjoying the benefits of the 

 5 high prices for commodities, I'm pretty happy, and 

 6 Sara Lee and Wonder Bread probably are of the 

 7 other opinion. Prices are meant to go up and 

 8 down, and my view is that the CFTC has done a fine 

 9 job in the past. 

 10 Anyway, Commissioner Lukken and members 

 11 of the Commission, I'm John Damgard, President of 

 12 the Futures Industry Association, pleased to 

 13 appear before you at this important hearing on the 

 14 oversight of trading in energy futures and other 

 15 related derivative contracts. 

 16 FIA's member firms play many different 

 17 roles in the trading and clearing of energy 

 18 transactions both as intermediaries, principals, 

 19 processors and end users. We have a substantial 

 20 interest in energy markets and commend Acting 

 21 Chairman Lukken and the Commission for holding 

 22 this public forum to allow a full spectrum of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 179 

 1 views to be heard. 

 2 Everyone agrees that the price of energy 

 3 is a critical element of our national economy. 

 4 For decades, energy futures have served our 

 5 national interest by providing a means for 

 6 efficiently managing and reliably discovering 

 7 energy prices. The Commission should take pride 

 8 in its effective oversight and stewardship of 

 9 these markets. 

 10 In recent years, energy markets have 

 11 experienced considerable innovation and increasing 

 12 competition. Congress addressed these forces when 

 13 it enacted the Commodity Future Modernization Act 

 14 of 2000. CFMA allows different levels of 

 15 regulation to apply to different forms of 

 16 derivative transactions in different commodities 

 17 that are executed in different ways. This scaled 

 18 regulatory approach was designed to serve equally 

 19 well the public interest and various commercial 

 20 interests. 

 21 In FIA's view, the CFMA has worked very 

 22 well for markets generally and energy markets in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 180 

 1 particular. Look at the competition. In energy, 

 2 the CFMA has made it possible for new markets to 

 3 compete with established exchanges. That 

 4 competition has caused those exchanges to 

 5 modernize through electronic trading or at least 

 6 increase their pace of modernization. The CFMA 

 7 has also encouraged innovative thinking by 

 8 established exchanges in new trading platforms. 

 9 The result is that those trying to 

 10 manage energy price risks and those willing to 

 11 assume those risks now have more choices than ever 

 12 before. The CFMA has sparked these positive 

 13 developments without compromising the public 

 14 interest including the vital interest of 

 15 preventing price manipulation. The Commission 

 16 continues to deploy a wealth of market 

 17 surveillance techniques and an arsenal of 

 18 enforcement weapons in its pursuit of what 

 19 Chairman Lukken has labeled the Agency's zero 

 20 tolerance of price manipulation. 

 21 Clearly, the Commodity Exchange Act and 

 22 the Commission's regulatory apparatus continue to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 181 

 1 target price manipulation as public enemy number 

 2 one. FIA agrees with that emphasis. Price 

 3 manipulation should be prevented whenever possible 

 4 and never tolerated. 

 5 Some have questioned how well the 

 6 existing anti- manipulation defenses work when 

 7 more than one energy derivative market exists. In 

 8 FIA's view, multiple trading facilities like NYMEX 

 9 and the Intercontinental Exchange today in energy 

 10 only enhance the need for vigorous CFTC oversight. 

 11 When trading occurs on multiple markets, it is 

 12 even more important that CFTC market surveillance 

 13 has ready access to all relevant large trader 

 14 information. 

 15 This principle applies whether the two 

 16 or more related markets are DCMs, DTEF, XBOX or 

 17 ECMs. None of those markets would be able to 

 18 survive or be expected to survey all relevant 

 19 positions on its competitive trading platforms. 

 20 The Commission's traditional role as the 

 21 exclusive regulator of futures transactions and 

 22 markets actually compels this kind of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 182 

 1 comprehensive and vigilant multi-market 

 2 surveillance approach. Multiple markets combined 

 3 with multiple regulators would be a recipe for 

 4 disaster. For that reason, in 1974, Congress 

 5 granted the CFTC the extraordinary power of 

 6 exclusive jurisdiction to make sure that only an 

 7 Agency expert in futures pricing would cast its 

 8 surveillance eyes on futures trading activities. 

 9 At the same time, Congress wanted futures market 

 10 participants to be answerable only to that expert 

 11 Agency's judgment. 

 12 The Commission has, in the past, 

 13 correctly made clear to its sister agencies -- the 

 14 states, the courts and Congress -- that monitoring 

 15 futures pricing is its exclusive statutory duty. 

 16 It should continue to do so, not as a matter of 

 17 turf but as a means of continuing to vindicate the 

 18 public policy goals exclusive jurisdiction serves, 

 19 including the avoidance of duplicative or 

 20 conflicting regulation. 

 21 While some may talk of loopholes and 

 22 regulatory gaps, the FIA believes the record shows 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 183 

 1 that the Commodity Exchange Act's 

 2 anti-manipulation foundation in the energy area is 

 3 very strong. FIA does not believe any changes to 

 4 the CEA are vital to the Commission's ability 

 5 on a day-to-day basis to achieve its 

 6 anti-manipulation mission. The statute works 

 7 well, and the CFTC worked well with it. At the 

 8 same time, we recognize that the Commission will 

 9 take whatever steps it determines to be needed to 

 10 update its regulatory approaches consistent with 

 11 its statutory authority. 

 12 Our final point is a familiar one and a 

 13 critical one. Price manipulation is public enemy 

 14 number one because it effects both market 

 15 participants and the public at large. Price 

 16 manipulation can have a serious ripple effect in 

 17 our economy and can hurt many innocent bystanders. 

 18 That is why Commission vigilance is so 

 19 important. It is also why Commission regulation 

 20 benefits not just market participants, but just as 

 21 profoundly, non-market participants. For that 

 22 reason, FIA continues to be opposed, vehemently 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 184 

 1 opposed, to funding the CFTC through a transaction 

 2 tax. 

 3 In our view, all taxpayers benefit from 

 4 CFTC market oversight. Therefore, all taxpayers 

 5 should pay for it. If the CFTC needs additional 

 6 resources, the administration should request, and 

 7 Congress should appropriate the necessary funds. 

 8 But imposing an arbitrary and egregious 

 9 tax, it would be born most by those that provide 

 10 the liquidity that allow futures markets to serve 

 11 so many public interests is a bad idea whose time 

 12 should never come. Thanks for holding this 

 13 hearing and considering our views. And I'm happy 

 14 to answer any questions. 

 15 CHAIRMAN LUKKEN: I thank the panel for 

 16 their testimony. We're going to shake things up a 

 17 little bit, and I'm going to start with 

 18 Commissioner Chilton in our five minute rounds of 

 19 questions. Commissioner Chilton. 

 20 COMMISSIONER CHILTON: Mr. Stolie, when 

 21 people talk about dreaded consequences of having 

 22 an ill-fitted Enron loophole fix, they raise a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 185 

 1 bunch of concerns, and I'm sympathetic to those 

 2 concerns, but you're on the opposite side. You've 

 3 already lost people, and you've gone overseas, 

 4 because we haven't done anything to address this; 

 5 is that correct? 

 6 MR. STOLIE: That's correct. I wouldn't 

 7 say haven't done anything, but what -- the policy 

 8 that's currently in place is, in our experience, 

 9 clearly inadequate to sufficiently protect large 

 10 industrial consumers and sufficiently motivate 

 11 them to invest here. 

 12 COMMISSIONER CHILTON: So we're already 

 13 seeing problems because of a failure to act, is 

 14 that essentially what you're saying? 

 15 MR. STOLIE: Absolutely. 

 16 COMMISSIONER CHILTON: And in your 

 17 written testimony, which is very good, by the way, 

 18 and I commend you for it, you talk about how you 

 19 think that we've gone to the limits of our 

 20 regulatory authority to do things and it really is 

 21 something that takes an act of Congress to change; 

 22 is that also correct? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 186 

 1 MR. STOLIE: Well, I'm not sufficiently 

 2 well versed in the act or in the changes that are 

 3 needed, perhaps the comment. Our perspective is, 

 4 natural gas needs to be regulated like an 

 5 agricultural commodity. It was likened earlier 

 6 this morning to an interest rate, and it is in no 

 7 manner an interest rate. 

 8 There is attached to our written 

 9 statement a map of the world, and it clearly, in 

 10 our view, demonstrates that there are regional 

 11 markets for natural gas. 

 12 COMMISSIONER CHILTON: That's good, 

 13 thank you. You know, this morning I talked about 

 14 the examples that we've seen out there already 

 15 with Enron and Amaranth and British Petroleum, and 

 16 Commissioner Dunn often asked who's watching the 

 17 store. And with particular regard to 

 18 manipulation, this is a tough thing for us to 

 19 catch. And he says -- Commissioner Dunn says, how 

 20 many other times have there been, and you say this 

 21 in your testimony that we haven't caught 

 22 something. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 187 

 1 MR. STOLIE: Sure. 

 2 COMMISSIONER CHILTON: And so it seems 

 3 to me that this is something we need to move 

 4 forward on. As I said earlier, for me, it is not 

 5 a question of if, it is how we get something done. 

 6 My time is up, so I'll stop now, and if we do 

 7 another round, I'm happy to do it, but I'll defer. 

 8 CHAIRMAN LUKKEN: Thank you, 

 9 Commissioner. Commissioner Sommers. 

 10 COMMISSIONER SOMMERS: I'm going to 

 11 continue on a line that I -- a path I went down 

 12 with the last panel, and I have a question for Mr. 

 13 Damgard. When we talk about the different levels 

 14 of regulation and the different levels that the 

 15 CFMA gave us, a DCM versus an ECM, what are the 

 16 global implications, if any, of greater levels? 

 17 MR. DAMGARD: Well, I guess I would 

 18 agree with, you know, almost everyone on the 

 19 previous panel, except Mr. Donahue. I think that 

 20 the existence of more than one training platform 

 21 has contributed tremendously to the incubation of 

 22 all sorts of new and innovative ways to train, and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 188 

 1 it is really spurred competition. And if there's 

 2 one thing that the FIA has always championed, it 

 3 is more and more competition. 

 4 To the extent that those incubations can 

 5 take place here and not some place else, we 

 6 consider that to be very, very good. We think 

 7 that competition, if it exists outside the United 

 8 States and competes with existing exchanges in the 

 9 United States, we think that's just fine. 

 10 And if it is more efficient to do 

 11 business in one market, what that's done is, it 

 12 stimulated existing markets to become more 

 13 efficient. Certainly NYMEX proved beyond a shadow 

 14 of a doubt that they knew how to compete. And 

 15 there's a market, the energy market, where there's 

 16 tremendous competition, and I would argue that it 

 17 is a direct result of the fact that there were 

 18 ways in which, in the specters of the world, were 

 19 able to start markets that had been very 

 20 successful and serving multiple customer needs. 

 21 CHAIRMAN LUKKEN: Commissioner Dunn. 

 22 COMMISSIONER DUNN: Thank you, Mr. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 189 

 1 Chairman. I'm really struck, Mr. Stolie and Ms. 

 2 Campbell, on your testimony here, because it 

 3 really strikes, to me, to what the whole purpose 

 4 of having futures markets all about and what we do 

 5 at the CFTC. I mean we're here to protect price 

 6 discovery function, we're here to prevent 

 7 manipulation, and we're here to assure that we 

 8 have an effective vehicle for risk transfer. 

 9 And what I am hearing you say, Ms. 

 10 Campbell, is that your association, which are 

 11 commercials, have lost confidence in the market 

 12 place. And, Mr. Stolie, you're saying you've lost 

 13 confidence to the point that you're picking up and 

 14 leaving. 

 15 MR. STOLIE: Not entirely; those 

 16 elements -- on a national basis. 

 17 COMMISSIONER DUNN: Mr. Stolie, you 

 18 don't have the luxury of picking up and leaving, 

 19 your customers are still here. What does that do 

 20 for your folks that are responsible for doing a 

 21 legitimate hedge for protection of a resource for 

 22 the consumers that are out there? What are they 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 190 

 1 doing this year after they felt they were burnt so 

 2 badly last year? 

 3 MS. CAMPBELL: Many of our members are 

 4 refraining from hedging at all, frankly, and 

 5 that's unfortunate, because I know with business 

 6 like -- in particular, we believe that the place 

 7 for us to mitigate our price risk is through the 

 8 markets, and really that's -- so that's why we are 

 9 here and wanted to stand up and say we want these 

 10 markets to be fair and transparent. 

 11 And again, from APGA's perspective, what 

 12 we'd like to bring to the current framework, and 

 13 we think the CFMA has worked well for our 

 14 customers and for the members at APGA, that what 

 15 we'd like to see is greater transparency within 

 16 that framework to bring the confidence back. 

 17 You know, I mentioned in my opening 

 18 testimony that we're accountable to our citizens, 

 19 and frankly, we have to go back and justify to our 

 20 customers why we are hedging, especially in a 

 21 market place that is falling. 

 22 So this is something that is critically 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 191 

 1 important for us, to stand up and stand before our 

 2 city counsel and say we believe in these market 

 3 places and they are a true reflection of supply 

 4 and demand forces. 

 5 CHAIRMAN LUKKEN: I'd like to pick up on 

 6 that, because that's what I'm curious about. It 

 7 is not only that our markets serve a price 

 8 discovery function, but also risk management 

 9 function. And, Mr. Stolie, you likened your 

 10 markets to agriculture. Certainly, you know, if 

 11 you look at the wheat markets right now, a fully 

 12 regulated market, volatility is extraordinary in 

 13 those markets. I know you're trying to minimize 

 14 volatility, and we do things to try to prevent 

 15 manipulation, but often times supply and demand 

 16 causes volatility, and the futures markets 

 17 represent a thermometer, what the temperature may 

 18 be of supply and demand. 

 19 And so that's something we have to think 

 20 about. And what I'm interested in, I guess, is 

 21 there something unique to natural gas? Farmers 

 22 have been hedging in our markets for 150 years, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 192 

 1 trying to stop volatility to hedge in, lock in 

 2 prices. 

 3 Are people hesitant for some reason? Is 

 4 it natural gas in particular? Is there something 

 5 at Huntsman, is there a -- you mentioned a premium 

 6 that seemed to be expensive. What is it that 

 7 keeps, not just reacting to price discovery in our 

 8 markets, but what prevents companies like Huntsman 

 9 from actually getting into the market place and 

 10 locking down a price so that they can compete in 

 11 the United States and stay here? 

 12 MR. STOLIE: Let me comment on that. 

 13 There is a cost to doing so. Of course, that is a 

 14 factor in why we don't do it. But additionally, 

 15 and I think this is different from the farmer you 

 16 alluded to, the price for our products moves, it 

 17 moves -- it can move frequently, and we are in a 

 18 very competitive landscape, but we are unable to 

 19 fix the price that we receive. And so if that 

 20 being the case, and I think -- maybe that's the 

 21 distinguishing feature, if we fix the price of 

 22 gas, we're really just -- we're just placing a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 193 

 1 bet, right, we are not, and I know economists, but 

 2 we are not engaging in a classic hedge. 

 3 So let me see if I can flush that out a 

 4 little bit. If it were the case that we could fix 

 5 the price for our products and then lock in gas or 

 6 hedge for that same amount of time, right, then, 

 7 yes, we could be taking steps to mitigate the 

 8 impact of significant volatility, that's not the 

 9 case. 

 10 So, as I mentioned, if we bet wrong, and 

 11 our customers are able to basically come to us and 

 12 say I've got a better price elsewhere, well, then 

 13 our price of gas is fixed, our competitor may have 

 14 placed a better bet, and instead of competing with 

 15 them on the basis of how well we're running our 

 16 respective businesses, we are competing on the 

 17 basis of how well we respectively bet on the price 

 18 of natural gas. Does that help? 

 19 MR. DAMGARD: With all due respect, 

 20 that's business. I mean you're exercising your 

 21 judgement every time you use the market if you're 

 22 in that business, and you're exercising your 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 194 

 1 judgement if you decide not to use the market. 

 2 And I'm sorry that, you know, the airlines aren't 

 3 here. Southwest Airlines is a classic case of 

 4 having locked in their fuel needs for a year in 

 5 advance while all the other airlines said, gee, 

 6 we'll just operate at the vagaries of the market. 

 7 You can be sure that those airlines are now 

 8 employing people who are extraordinarily 

 9 knowledgeable about how these markets work, and 

 10 I'm sorry that they're not here today. And to 

 11 hear that people are leaving our markets in droves 

 12 doesn't comport with the fact that our volume is 

 13 up 30 percent again this year, and we're growing 

 14 at a compound rate of 30 percent. 

 15 So I'm not persuaded that there's 

 16 anything wrong with these markets. I think the 

 17 real market pros recognize that using these 

 18 markets obviously involves exercising a judgement, 

 19 but if you make a judgement and your competitor 

 20 makes a judgement and your competitor has made the 

 21 right judgement, I don't know who he sold out to, 

 22 but the Koch industry boys are certainly doing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 195 

 1 just fine in the natural gas business. 

 2 So I mean I think that you just can't 

 3 come to government and say price volatility is 

 4 evidence of manipulation. Prices move for a whole 

 5 lot of reasons, and it doesn't necessarily, in 

 6 fact, hardly ever involves manipulation. 

 7 MS. CAMPBELL: If I may, I'd like to 

 8 make a point there. When it comes to LDC's, it is 

 9 really not a business decision, nor a bet. Really 

 10 what we're trying to do is to lock in a price, to 

 11 protect our customers, those prices are passed 

 12 directly through to our customers, so we're there 

 13 trying to protect those customers with that price, 

 14 and if the price is artificially high, it effects 

 15 my customer today, because they pay too much. If 

 16 the price is artificially low, it effects my 

 17 customer tomorrow, because we're not sending the 

 18 right signals to the producers. So either way, we 

 19 need to protect these customers from any type of 

 20 price manipulation, ensure, through transparency, 

 21 that we are really reflecting the forces of supply 

 22 and demand. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 196 

 1 MR. HORVATH: I just have two comments; 

 2 one, on the OBC side -- does represent a lot of 

 3 municipalities, a lot of towns, but they're also 

 4 IOU, investor owned utilities, and they also tend 

 5 not to hedge, but they tend not to hedge because 

 6 the state PEC totally understand hedging to 

 7 understand what you do for a living, and they 

 8 either have no policy, which they say is neutral, 

 9 but it is not, because no policy means that if you 

 10 hedge, and you hedge not perfectly, you can get 

 11 back on a prudence review and get hammered. 

 12 So the effect tends to be to reduce the 

 13 number of hedges that LDC's make, so that's one 

 14 point you have to keep in mind, when you see a 

 15 lack of hedging, it is not just always the market, 

 16 there's a difference between state and federal 

 17 regulations that needs to be made aware of. 

 18 On the other side of the coin, my 

 19 members are as much a part of this market as the 

 20 two folks on either side of me and we do hedge, 

 21 and that's -- hedge -- we do in the market, and 

 22 the reason is -- and we have the same issue they 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 197 

 1 have, it is price volatility, which as I said, is 

 2 a result of constraints applied more than anything 

 3 that any regulator is doing. So we do hedge, and 

 4 there are plenty of people in the market who 

 5 hedge. 

 6 On the industrial side, while there have 

 7 been some exiting out of the country, I do think 

 8 it is unfair, I don't think Russ is doing this, it 

 9 is unfair to suggest that people fled this country 

 10 because of natural gas prices, that's just -- 

 11 that's just way too much of an overstatement. 

 12 There are a lot of factors involved in this 

 13 country. And, in fact, industrial demand for 

 14 natural gas is roughly flat, and people are 

 15 hedging in that sector. 

 16 CHAIRMAN LUKKEN: I just want to make 

 17 sure -- and John's point is a good one with 

 18 Southwest Airlines. It is an often cited example. 

 19 They locked in at $26 a barrel for oil, and at the 

 20 time, a lot of people were saying, well, you're 

 21 idiots for locking in at $26. That's when oil was 

 22 at 20 and below at times. It looks brilliant now, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 198 

 1 but you know, farmers do this all the time. 

 2 And what I wanted to make sure is, we're 

 3 educating people enough, if they can use the 

 4 markets, to encourage them, and part of this 

 5 exercise is to build confidence in our markets and 

 6 make sure manipulation isn't happening. But if 

 7 there are utilities out there that could and 

 8 should be hedging their prices, we want to help 

 9 educate, work with FERC to bring those people into 

 10 our market so they can lock in these prices. 

 11 Yeah, Russ. 

 12 MR. STOLIE: If I may make one more 

 13 comment, and then I do have to part. And I'll 

 14 comment on the airline question, which is that if 

 15 you're going to be in the airline business in the 

 16 United States, you're going to be buying fuel 

 17 here. However, as a general matter, capital finds 

 18 its way to its highest risk adjusted return. You 

 19 don't have to be here to be in the global chemical 

 20 business. 

 21 So from the business of -- from the 

 22 perspective of our industry and highest risk 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 199 

 1 adjusted return, what I'm here to communicate, in 

 2 part, is, we're making a decision based in 

 3 significant measure on volatility, excessive 

 4 speculation, and we believe manipulation of the 

 5 U.S. natural gas market, that our highest risk 

 6 adjusted return isn't here. So if I can leave you 

 7 with that message, and I thank you again for the 

 8 time. 

 9 CHAIRMAN LUKKEN: Thank you for your 

 10 testimony. We have another round of questions, 

 11 Commissioner Chilton. 

 12 COMMISSIONER CHILTON: Let me just ask a 

 13 quick one, if that's okay. 

 14 CHAIRMAN LUKKEN: Sure. 

 15 COMMISSIONER CHILTON: I'm pleased to 

 16 see that the airlines are making a little bit more 

 17 money. Maybe if they are able to hedge in the 

 18 future, they'll be able to add some more tellers 

 19 and Mr. Stolie won't have to leave so early. Ms. 

 20 Campbell, I'm curious whether or not you'd be 

 21 satisfied if Congress did what I was sort of 

 22 talking about and just got rid of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 200 

 1 multi-laterals, just address that issue, and then 

 2 regulatorily, the agency would deal with the 

 3 bi-lats; would that be something that you all 

 4 would support? 

 5 MS. CAMPBELL: And when you say that, 

 6 you're saying deal with -- 

 7 COMMISSIONER CHILTON: Get rid of the 

 8 Enron loophole 2(h)(3) -- 

 9 MS. CAMPBELL: The 2(h)(3)? 

 10 COMMISSIONER CHILTON: It is gone. 

 11 MS. CAMPBELL: You know, I haven't 

 12 really given you a full flavor of how we've used 

 13 the ECM, so if you would let me do that. And 

 14 primarily, as I heard Mr. Shilts earlier, their 

 15 growth as a market has really mirrored our use of 

 16 them as a market. Just a few short years ago, 

 17 well, as a practical matter, we have about two and 

 18 a half hours every morning when we have to decide 

 19 how much gas we need that day and to buy it and 

 20 then be ready to nominate and schedule it. 

 21 And that time we used to call dial and 

 22 smile. We would call up as many people as we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 201 

 1 could and find out the price. And now we just sit 

 2 in front of an ICE screen, and we have so many 

 3 different choices, and I, as a manager, am able to 

 4 overlay that with our credit strategy. So it is 

 5 been really a very valuable tool. We've been able 

 6 to not only be able to look at and serve our 

 7 customers, but then beyond that, of course, we 

 8 have excess capacity that we've been able to work 

 9 with and do a lot of savings through that because 

 10 we have the extra time to really look at the full 

 11 picture through ICE. 

 12 So when we talk about ECN's, just the 

 13 price discovery feature of that has really 

 14 fundamentally changed the way that we buy gas. So 

 15 I would really be hesitant to get away from that. 

 16 Now that we're into cleared markets and that type 

 17 of thing, now we've kind of crossed the line, so 

 18 now we're into the part of our business that is 

 19 hedging, and we handle that separately than we do 

 20 the physical side. 

 21 So that's been typically done through 

 22 the NYMEX, however, we have been monitoring, and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 202 

 1 now we will be able to clear trades through ICE. 

 2 So now those two entities look very much the same 

 3 to us. We'd be looking at both of those, they 

 4 provide us an extra data point, so to speak, but 

 5 they are fundamentally working the same, so that 

 6 is my -- we feel very strongly there needs to be 

 7 that transparency, that same level of transparency 

 8 that we had on the DCM that's applied to the ECM. 

 9 That way we can get that confidence back, and that 

 10 way we'll -- all of our members will have -- we 

 11 can bring them into the fold where they are 

 12 hedging and meeting the needs of those customers. 

 13 MR. STOLIE: Do you want to speak to 

 14 that question? 

 15 MR. DAMGARD: I mean I could lose my 

 16 job, because the FIA is totally funded on the 

 17 basis of member firms conducting business on 

 18 designated regulated exchanges. And if you got 

 19 rid of the so called Enron loophole, which I refer 

 20 to as a loophole, it would be forcing everybody to 

 21 do it on an existing exchange, and that would be 

 22 very good for the FIA dues base. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 203 

 1 Sprecher doesn't even use 

 2 intermediaries. I, for the most part, represent 

 3 the big intermediary firms. My own view is, to do 

 4 away with that would run the risk of eliminating 

 5 opportunities for new entries to compete. 

 6 And the ability of Sprecher to come in 

 7 and compete with NYMEX has been extremely good for 

 8 the end user because they are now competitive 

 9 markets where competitive markets didn't use to 

 10 exist. 

 11 And I thought they all made, starting 

 12 with Doc Sandor, I didn't know he knew Caesar's 

 13 wife, but he's been in the business a long time, 

 14 he made a very, very valuable point in that these 

 15 incubation periods for new kinds of trading and 

 16 new kinds of markets and none of us even imagined 

 17 when we went through the Modernization Act in 

 18 2000, for the most part, have been tremendously 

 19 valuable for not only my members, but also for 

 20 their customers, the end users. 

 21 COMMISSIONER CHILTON: Well, I'll just 

 22 make a quick comment and I'm done then, Mr. Chair. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 204 

 1 That's a great point, John, and again, I keep 

 2 thinking, what is it that I'm missing, that if you 

 3 just got rid of a 2(h)(3), but you allowed the 

 4 regulatory flexibility for the agency to say, 

 5 fine, that's an incubator, or the Chairman has 

 6 talked about, you know, some graduation level, 

 7 where it does become significant, this is 

 8 something that we should worry about, but you 

 9 know, I'm curious, in general, we can talk about 

 10 it later, why would that be a problem? 

 11 MR. DAMGARD: I mean you can decide 

 12 where to -- I mean I'm with Laura, I think 

 13 transparency is terribly important. I don't mean 

 14 you run an ad on the Wall Street Journal, but I 

 15 think the Commission and the experts on the 

 16 Commission need to have all the information that 

 17 they possibly can across these competing markets. 

 18 And to Henry Hub, it is too bad Henry is 

 19 not here to testify, because we talked about him a 

 20 lot today. But it seems to me there was one 

 21 market where there was a conclusion that that 

 22 market was so close to an existing regulated 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 205 

 1 market that the CFTC with current authority could 

 2 go in there and demand regular reporting and 

 3 disclosure, et cetera, and if that's what Laura 

 4 wants, then we're for that. But we're not for 

 5 that for eliminating the category, which would 

 6 then effect all these other markets that are 

 7 attempting to get to the point where the Henry Hub 

 8 is today. Thanks, Mr. Chairman. 

 9 CHAIRMAN LUKKEN: Thank you, 

 10 Commissioner Chilton. Commissioner Sommers, 

 11 nothing? Commissioner Dunn. 

 12 COMMISSIONER DUNN: Well, as much as I'd 

 13 like to continue along that line, I think I'll 

 14 move somewhere else. Skip, you and John both 

 15 talked about -- well, John talked about 

 16 jurisdictional oversight, and you talked about the 

 17 MOU with the FERC and CFTC. I'm curious to get 

 18 your impression, and the rest of the panel, as 

 19 well, on this. How can the CFTC and the FERC work 

 20 better together to ensure that we have a better 

 21 market place? 

 22 MR. DAMGARD: Do you want me to take 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 206 

 1 that? It is easy. 

 2 MR. HORVATH: I agree it is easy. 

 3 MR. DAMGARD: I think that the CFTC has 

 4 exclusive jurisdiction because you have the life 

 5 long experience in how markets work, and this is 

 6 new territory for FERC. And it seems to me FERC 

 7 could take the position that the states have under 

 8 the model code. If the states find something 

 9 wrong, and they think it is a violation of the 

 10 Commodity Exchange Act, they should come to the 

 11 CFTC, and together, you could bring that case. 

 12 What doesn't make any sense is two separate 

 13 standards. I mean the people in these markets 

 14 need to know what the rules are, and if there's a 

 15 separate set of rules from two separate 

 16 regulators, that's extremely destructive to the 

 17 business. And I recognize that FERC has a wide 

 18 area of responsibilities about which the CFTC 

 19 knows nothing, and maybe I'll let you speak to 

 20 those. I don't know what they, you know, they 

 21 know about the quality of fuel, it is moving 

 22 through the pipelines, and they probably have to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 207 

 1 worry about breakages, et cetera. 

 2 I mean I don't know exactly what FERC 

 3 does. But markets are your baby, and they don't 

 4 understand markets, and you guys do, and it is 

 5 important that the CFTC stands up and says, we 

 6 want to work with you, we'll cooperate to the end 

 7 of the world, but as far as the markets are 

 8 concerned and as far as the Commodity Exchange 

 9 Act, read the law. Exclusive jurisdiction was 

 10 granted to the CFTC for all the right reasons, it 

 11 is worked extremely well since 1974, and to me, it 

 12 is the backbone of the agency. 

 13 MR. HORVATH: I agree it is easy, but 

 14 maybe for slightly different reasons. This 

 15 happens all the time. Congress -- I would expect 

 16 to have two agencies mesh exactly so that 

 17 jurisdictions just hush, but don't overlap and 

 18 don't leave a gap. 

 19 It is impossible to ask that of 

 20 Congress, and it happens all the time. So what do 

 21 people do? They work it out among themselves, 

 22 just as you all are doing. I know the folks at 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 208 

 1 FERC, they're reasonable people who I've seen here 

 2 today, you folks are reasonable people, they'll 

 3 work it out. So that's the short answer to that 

 4 one. As far as what FERC does in markets, yeah, 

 5 you know, you actually have a couple of good ones 

 6 right, but they are -- what we learned today -- I 

 7 learned something today that just sort of really 

 8 surprised me. 

 9 There are people who will set their 

 10 interest rate based on natural gas contracts. 

 11 That surprised me. Okay. So that tells me 

 12 there's a lot more innovation and creativity in 

 13 the market than anyone thought possible. And 

 14 certainly then Congress thought in 1938 with the 

 15 Natural Gas Act. 

 16 So it is not expected, I don't think, 

 17 that these regulatory jurisdictional disputes be 

 18 forever settled or forever harmonized, because 

 19 they constantly shift as the market creates new 

 20 things. So the important point is, don't worry 

 21 about that, just good people get together and 

 22 figure it out, and I have every confidence, by the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 209 

 1 way, that you'll do that. 

 2 MR. DAMGARD: I have an example. Single 

 3 -- with multiple regulators. These products are 

 4 incredibly successful all over the world, but not 

 5 in the United States, because the FCC has a 

 6 different standard, and in many ways a different 

 7 mission than the CFTC. So single -- continue to 

 8 languish in the United States and we see those 

 9 markets booming in places like Spain and Italy and 

 10 Great Britain. 

 11 MR. STOLIE: Can I make a couple of 

 12 observations? One, where you have two agencies 

 13 with jurisdiction, and it is been described, you 

 14 can have overlaps and you can have gaps, and I 

 15 think gaps are a bigger problem than overlaps. 

 16 Overlaps, you can work out with the other agency, 

 17 gaps, you may not be able to fill and people may 

 18 get through, so you want to make sure there are no 

 19 gaps. 

 20 Second of all, I do think you read the 

 21 Commodity Exchange Act and it envisions that the 

 22 commodities markets will serve as price discovery 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 210 

 1 vehicles for the physical market. And I think the 

 2 role of the Commission is to make sure they're 

 3 serving that function. 

 4 Our concern is, they're not serving that 

 5 function as well as they might in natural gas. 

 6 Other commodities are a different story. We think 

 7 the CFM is a good idea and has sparked a lot of 

 8 innovation, we're all for innovation, we're just 

 9 concerned with the way natural gas has evolved. 

 10 Nobody could have foreseen, and we need to go back 

 11 and look at ways to address the volatility in that 

 12 market and whether or not it is actually providing 

 13 good pricing data. 

 14 CHAIRMAN LUKKEN: I had a question in 

 15 regards to how users of the markets benchmark -- 

 16 we've been talking about the natural gas NYMEX 

 17 benchmark today, and it seems to me that a lot of 

 18 the utilities and others that use that as a 

 19 benchmark look at the last half hour of trading, 

 20 where there can be a lot of volatility. And in 

 21 the past, utilities have used either a moving 

 22 average or a longer period of time in order to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 211 

 1 benchmark their pricing, which might help smooth 

 2 volatility. Has there been discussion among the 

 3 users of the markets of whether the model in which 

 4 they benchmark currently is the right one? 

 5 Do you lose hedging abilities when you 

 6 do that by smoothing volatility? What are the 

 7 trade-offs, and is there some way we can work 

 8 together, the users and FERC and us, to figure out 

 9 if there's a better way of benchmarking in this 

 10 area? 

 11 MR. STOLIE: We've had -- the Huntsman 

 12 problem has been that we have to buy gas products 

 13 on one side and sell products on the other side. 

 14 And so we're looking at prices on both sides of 

 15 ourselves. And if we lock in prices on one side 

 16 of the market, unless all our competitors are 

 17 locking in at the same place, there's going to be 

 18 a difference in how that translates into our cost 

 19 of doing business, while on the other side of the 

 20 market, we have not been able to negotiate fixed 

 21 price contracts without escape clauses, so that 

 22 what happens is, the buyers on that side of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 212 

 1 market go to the competitor who happened to manage 

 2 to lock in at a lower price, if you tried to lock 

 3 in, or priced at a lower price, and that just 

 4 produces a difficult climate to do business in the 

 5 United States, and it is easier to do it 

 6 elsewhere. To the extent that that volatility is 

 7 due to fundamentals of supply and demand, so be 

 8 it, and maybe we have to go elsewhere to get less 

 9 volatility. To the extent that that volatility is 

 10 due to market problems such as manipulation or 

 11 excessive speculation, we think that's a problem 

 12 and we think the Commission needs to look at that. 

 13 But we've tried various pricing 

 14 mechanisms on the buy side and tried to negotiate 

 15 pricing mechanisms on the sell side to deal with 

 16 that, and if we had to be here like an airline 

 17 would be here, we'd live with it, and so be it 

 18 with our competitors. But the plain fact is, it 

 19 is making -- the volatility is making the U.S. a 

 20 less competitive place to produce the kinds of 

 21 chemicals that we're in the business of producing. 

 22 CHAIRMAN LUKKEN: Mr. Horvath. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 213 

 1 MR. HORVATH: Yes; I understood your 

 2 question to address, sir, the structure of our 

 3 industry and -- 

 4 CHAIRMAN LUKKEN: How you reference 

 5 prices in our market. 

 6 MR. HORVATH: Right; those grew out, 

 7 historically, out of the industry, so with the bid 

 8 week of five days, the use of the monthly index, 

 9 the daily index and that sort of thing, I mean you 

 10 have to understand that going back to 1938, we 

 11 used to have a 20 year reserve rule, so producers 

 12 needed to have -- show 20 years of reserve on the 

 13 ground before they were allowed to enter the 

 14 market back -- regulated after the 1954 -- I don't 

 15 want to bring up too much history here, but 

 16 there's a rich history here. And over time, as 

 17 Congress saw that that was an error, we were 

 18 regulating too much of the industry on the 

 19 physical side of the market. All the rules of 

 20 thumb changed. And what we have now is, in a 

 21 sense, the result, an organic, if you will, grew 

 22 out of the market place. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 214 

 1 What happens when you have a whole bunch 

 2 of regulations you shouldn't have had and you 

 3 start peeling it away one by one, in 1989, when we 

 4 have the -- Control Act, was sort of the biggest 

 5 -- that Congress did, and followed by FERC in 1993 

 6 with the 636 that took out the merchant function 

 7 from the pipelines. 

 8 After that, there was a strong 

 9 conversion to the system we have now, which is the 

 10 one you see. So that was a long answer to your 

 11 question. The short answer is, no, we have not 

 12 look at an industry, at redoing it, because it 

 13 seems to have grown organically out of what we 

 14 had. Not saying it is the best system, but it is 

 15 going to take a shock to the system that none of 

 16 us sort of see necessary right now to change all 

 17 that. 

 18 MS. CAMPBELL: You know, from NLGW's 

 19 perspective, what we do is usually enter into a 

 20 swap that gets us directly to that future's 

 21 position, and then once we have that future's 

 22 position, that's going to tie us back to positions 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 215 

 1 on the physical side. But really, I think from 

 2 APGA's perspective, we do feel like there's more 

 3 need -- there's a need there for further review of 

 4 benchmarking, and certainly that would be a good 

 5 avenue for an advisory committee. 

 6 CHAIRMAN LUKKEN: It is something, as 

 7 John mentioned, a lot of us aren't familiar with 

 8 the history of how these -- FERC and all their 

 9 issues, and we're familiar with our own Act, and 

 10 in some ways how our markets have developed and 

 11 how your markets are utilizing our markets, 

 12 there's not necessarily a match there. 

 13 And so I think we need to both look at 

 14 what we need to do from our end, but also maybe 

 15 there's a way that the users can also look at ways 

 16 to smooth volatility through how they benchmark. 

 17 I think it would be an interesting question to, as 

 18 you mentioned, an advisory committee, possibly. 

 19 Thank you. Are there any other questions? 

 20 COMMISSIONER CHILTON: Just make a quick 

 21 comment. 

 22 CHAIRMAN LUKKEN: Sure. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 216 

 1 COMMISSIONER CHILTON: I just wanted to 

 2 respond to the discussion about exclusive 

 3 jurisdiction, and really notwithstanding the FERC 

 4 issue, Mr. Damgard. I agree with you with one 

 5 caveat. I mean I was talking about earlier how I 

 6 was reading the act, and then it got too 

 7 complicated for me, but it didn't get complicated 

 8 by page 29, where you can find the Commission 

 9 shall have exclusive jurisdiction. But it is not 

 10 just important, and again, notwithstanding the 

 11 FERC stuff, it is not just important for that 

 12 reason, it is important for our credit events, for 

 13 Forex, and for the foreign security index futures 

 14 products. And that, along with this principals 

 15 based regulatory regime that we have, really does 

 16 make us different from the SEC, it makes us 

 17 different from everybody else in government, and 

 18 it is something that makes me excited about 

 19 working here, and it is something that I think has 

 20 been helpful to the industry, and as I said 

 21 earlier, consumers also. Thanks. 

 22 CHAIRMAN LUKKEN: Thank you very much. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 217 

 1 Well, I think that's all of our questions. I want 

 2 to thank the panel for testifying. We appreciate 

 3 all your help. And we'll convene the fourth and 

 4 final panel. 

 5 (Recess) 

 6 CHAIRMAN LUKKEN: I think we're getting 

 7 ready to begin. Mr. Zerzan, if you're in the 

 8 building. There he is, okay. Our final panel 

 9 today is market users. I would note that based on 

 10 Commissioner Dunn's previous statement, the Fed 

 11 has cut rates by 50 basis points today and the 

 12 markets are up 200 points. So thank you, 

 13 Commissioner Dunn, for helping out America. 

 14 For the final panel on exempt commercial 

 15 markets, we have a very diverse set of 

 16 participants. And to begin with we have Mark 

 17 Cooper, who is the Director of Research at the 

 18 Consumer Federation of America. Welcome, Mark. 

 19 We have Greg Zerzan, Counsel and head of Global 

 20 Public Policy at the International Swaps and 

 21 Derivatives Association; Jack Gaine, head of the 

 22 Managed Funds Association; and last, but not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 218 

 1 least, Sean Cota, who's President of Cota and 

 2 Cota, but also represents the Petroleum Marketers 

 3 Association of America. So welcome, and we'll 

 4 begin with Mr. Cooper. 

 5 MR. COOPER: Thank you, Mr. Chairman, 

 6 and members of the Commission. I appreciate the 

 7 opportunity to appear before you today on an issue 

 8 of vital interest to consumers. In May of 2006, I 

 9 prepared a report on natural gas for the Attorneys 

 10 General of Iowa, Illinois, Missouri, and 

 11 Wisconsin, which included that structural and 

 12 behavioral problem in commodity markets, 

 13 particularly the lack of regulation of trading 

 14 allowed by the Enron loophole, has influenced the 

 15 price of natural gas in a volatile and upward 

 16 direction. 

 17 I choosed (sic) the word "implements" 

 18 purposefully, because the concept of manipulation 

 19 is far too narrow to describe the problem in 

 20 energy commodity markets or to prevent consumers 

 21 from being abused. 

 22 At the time, federal authorities were in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 219 

 1 full denial mode, similar to the period in late 

 2 2000, when regulators insisted that nothing was 

 3 wrong with the California electricity market, and 

 4 Enrol was the darling of the commodity world. 

 5 Less than two years later, Enron was in 

 6 bankruptcy, and dozens of cases of abuse were 

 7 turning up, but the Enron loophole remained in law 

 8 and regulatory practice. Interestingly, in the 18 

 9 months since my report to the Attorneys General on 

 10 natural gas, several reports from Congressional 

 11 committees, private consultants, and even the 

 12 popular press have echoed my findings. 

 13 The Enron fiasco has underscored either 

 14 how little regulators knew about what was going on 

 15 or how little power they had to prevent it. 

 16 Ironically, the Enron loophole has continued to 

 17 afflict American energy consumers long after Enron 

 18 has disappeared. 

 19 The problem is clear, if you cannot see 

 20 what is happening in all the major interconnected 

 21 markets in which the commodity is traded, you 

 22 cannot know what is going on. If you do not have 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 220 

 1 the power to regulate all of the major commodity 

 2 markets, you cannot stop abuse. Efforts to 

 3 influence the price will be invisible to you or 

 4 beyond your regulatory powers to prevent. 

 5 Thank -- oversight, that is the effort 

 6 to glean activity in unregulated markets by its 

 7 reflection in regulated markets as people lay off 

 8 risk simply result in an imprecise and distorted 

 9 picture. The solution is equally clear. 

 10 Regulators need direct oversight. Large traders 

 11 should be required to register and report all of 

 12 their transactions in all the U.S. Markets that 

 13 can influence the price of a commodity. If large 

 14 traders are unwilling to register and report their 

 15 activities in the U.S., they should not be allowed 

 16 the privilege of doing business in the U.S. These 

 17 are physical commodities that flows and settle in 

 18 physical markets here in the U.S. If they don't 

 19 like it, they don't have to do business here. 

 20 Because the information will be confidential to 

 21 the regulatory agency. It will have no impact on 

 22 the market functioning in any way except to scare 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 221 

 1 the bad guys away. 

 2 This single step will significantly 

 3 discipline unsavory behavior. As we observe with 

 4 private natural gas reporting services, even the 

 5 hint of oversight scares the bad guys away. 

 6 Unfortunately, in the case of the private 

 7 services, they have failed to discipline people 

 8 and require them to report. Federal regulators 

 9 must have mandatory registration in reporting. 

 10 There is more, however; in the case of a 

 11 commodity like natural gas, which has numerous 

 12 characteristics that make it quite vulnerable to 

 13 influence, such as high transportation and storage 

 14 cost, low elasticity of supply and demand, highly 

 15 seasonal to consumption patterns, and end users 

 16 who simply cannot tolerate the physical risk of 

 17 going cold in the dark. 

 18 There are many other steps that 

 19 commodity exchanges should take to reduce 

 20 excessive speculation and the potential for 

 21 influence. A commodity like natural gas does not 

 22 need to be transacted 20 or 30 times between the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 222 

 1 well and the burner tip. It is a physical 

 2 commodity. Efficient allocation does not need 

 3 that many transactions. These transactions raise 

 4 cost, increase risk, and increase volatility. The 

 5 Senate sub-committee on investigations has found 

 6 clearly, residential rate pairs have not 

 7 benefitted from all these wonderful, new products 

 8 that they tell us have come into the market. Our 

 9 prices have been increased, not reduced, as a 

 10 result of them. 

 11 Strict position limits, both during and 

 12 before settlement periods, longer settlement 

 13 periods, higher margin requirements, strict 

 14 accountability rules, and smaller allowed price 

 15 wings will restrain excessive speculation and 

 16 reduce the risk of influence. 

 17 We should regulate these at least as 

 18 closely as we do other commodities because they 

 19 are more vital to the every day life of American 

 20 households and industries. From Enron to 

 21 Amaranth, American consumers have been afflicted 

 22 by the Enron loophole. Dozens of enforcement 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 223 

 1 actions have failed to discipline manipulation, 

 2 excessive speculation, and influence over price. 

 3 After the fact enforcement has not 

 4 cleaned up energy markets now, five years after 

 5 the first evidence of abuse, simply because the 

 6 commodity is so vulnerable to influence that it 

 7 invites abuse. For these special commodities, an 

 8 ounce of prevention is worth more than a pound of 

 9 cure. It is time to close the loophole and 

 10 protect consumers. Thank you. 

 11 CHAIRMAN LUKKEN: Thank you very much, 

 12 Mr. Cooper. We'll turn to Mr. Zerzan. 

 13 MR. ZERZAN: Thank you, Mr. Chairman, 

 14 and members of the Commission. This discussion 

 15 comes at a time of continued dynamic growth, both 

 16 the exchange trade and over-the-counter business, 

 17 and congratulates the Commission for its continued 

 18 leadership in promoting fair, free, and 

 19 competitive derivatives markets. 

 20 -- represents participants in the 

 21 privately negotiated derivatives industry and is 

 22 the largest global financial trade association by 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 224 

 1 number of member firms. We have over 810 member 

 2 institutions, from 56 countries, on six 

 3 continents. 

 4 Recently, activity in the energy markets 

 5 has caused some to question the current 

 6 legislative and regulatory framework. 

 7 Under current law, the Commodity 

 8 Exchange Act affords the opportunity to choose the 

 9 type and level of regulation desired. 

 10 This choice is available both to 

 11 entities in the business of hosting transactions, 

 12 as well as to market users themselves, who may 

 13 select what level of regulatory oversight they 

 14 seek for their transactions. There is no question 

 15 that from a purely quantitative prospective, these 

 16 changes have been an unqualified success. NYMEX's 

 17 average daily volume for crude oil and natural gas 

 18 have increased by 90 percent from 2001 through 

 19 2006. Over-the-counter commodity derivatives, 

 20 meanwhile, grew by over 850 percent from December, 

 21 2001 to December, 2005. Despite the tremendous 

 22 growth these markets have enjoyed, some end users 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 225 

 1 have complained that they are subject to 

 2 manipulation and that the underlying prices which 

 3 end users pay are distorted. 

 4 However, strong and statistically sound 

 5 evidence backing these assertions remains wanting. 

 6 In those cases, where some unscrupulous actor has 

 7 attempted to manipulate the market, punishment has 

 8 usually been swift and severe. 

 9 Ultimately, the price of a physical 

 10 commodity is determined by the inexorable forces 

 11 of supply and demand. Attempts to distort this 

 12 are usually transparent, short lived, and to the 

 13 detriment of the actor who tries. 

 14 When considering whether or not to 

 15 modify the current legislative and regulatory 

 16 system, it is important to have a proper framework 

 17 for determining whether such actions are warranted 

 18 and in the best interest of the market's end 

 19 users. 

 20 In Europe, the European Commission 

 21 operates under the federal regulation strategy. 

 22 As stated by European Union Commission, Charlie 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 226 

 1 McCreevy, his approach demands that regulators 

 2 first ask, has there been a market failure, and if 

 3 so, is government intervention the best way to 

 4 address it. 

 5 The European strategy is important to 

 6 bear in mind for two desperate reasons; first, it 

 7 articulates a clear methodology for approaching 

 8 public policy; second, as the Commission is well 

 9 aware, we live in a time of highly competitive 

 10 global markets. This competition applies equally 

 11 to markets themselves, as well as the countries 

 12 seeking the economic benefits such markets bring. 

 13 It is thus a useful exercise to apply 

 14 Commissioner McCreevy's formula to the question of 

 15 whether current law bears changing. Applying the 

 16 first test, has there been a market failure. 

 17 Notwithstanding the assertions of some industry 

 18 end users, there does not appear to be a strong 

 19 supporting case for the existence of a market 

 20 failure. 

 21 At the very least, in considering 

 22 whether to change the existing framework, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 227 

 1 policy-makers should conduct a thorough and 

 2 comprehensive examination of this question. The 

 3 competitiveness of the United States as the 

 4 leading source and location for the financial 

 5 services industry is threatened now as perhaps 

 6 never before. 

 7 When considering whether statutory or 

 8 regulatory changes are necessary, the Commission 

 9 should consider whether the cost of any proposed 

 10 changes outweigh the perceived benefits. The 

 11 derivatives industry is, without question, one of 

 12 the outstanding success stories of U.S. financial 

 13 innovation, in no small part because of the 

 14 prudential leadership of the Commission. That 

 15 leadership is now needed as much as ever. -- 

 16 demands that the CFTC undertake the following 

 17 actions with respect to exchange traded and OTC 

 18 derivatives; first, the Commission should continue 

 19 to seek to reduce unnecessary burdens on both 

 20 exchange traded and over-the-counter energy 

 21 derivatives. In order to ensure market 

 22 participants are allowed to access different 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 228 

 1 products and markets with maximum efficiency and 

 2 minimum cost. 

 3 Second, the Commission should undertake 

 4 a thorough study of all available evidence, 

 5 including academic research relating to the 

 6 relationships among the over-the-counter, exchange 

 7 traded, and physical commodity markets. 

 8 This inquiry should be directed towards 

 9 determining whether, indeed, exists a market 

 10 failure in the energy markets. If necessary or 

 11 beneficial, the Commission should propose that the 

 12 President's Working Group participate in this 

 13 project. 

 14 Third, to the extent the Commission 

 15 finds evidence of the existence of a market 

 16 failure, the Commission should undertake a 

 17 thorough cost benefit analysis in order to outline 

 18 the most narrowly tailored, least burdensome 

 19 approach to addressing any clearly identified 

 20 market failure. 

 21 Finally, the Commission should continue 

 22 to forcefully reject efforts to increase 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 229 

 1 regulation of the commodity markets in the absence 

 2 of clear and convincing evidence, and any such 

 3 change to the status quo is warranted from both an 

 4 evidentiary and a cost benefit analysis. Thank 

 5 you very much for allowing us to present our 

 6 views, and thank you for your continued 

 7 leadership. 

 8 CHAIRMAN LUKKEN: Thank you very much, 

 9 Mr. Zerzan. Mr. Gaine. 

 10 MR. GAINE: Thank you, Mr. Chairman, and 

 11 members of the Commission. My name is Jack Gaine, 

 12 I'm appearing today as the President of Managed 

 13 Funds Association, commonly known as MFA. It is 

 14 always a pleasure for me to return to the 

 15 Commission. In fact, looking back, I think I 

 16 started work here August 1, 1977, roughly. 

 17 Since then, I think the Great Russian 

 18 Grain robbery had occurred, and we had soy beans, 

 19 and silver, coffee, and a lot of -- the Governor 

 20 of Iowa I think wrote me as General Counsel saying 

 21 that short selling in corn should be forbidden 

 22 because there is far more open interest in short 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 230 

 1 corn than there is in the yearly crop. So some of 

 2 the issues here are not new to any of you who have 

 3 followed the CFTC and the Commodities Exchange 

 4 Act, and I'm delighted to be here and be part of 

 5 it. 

 6 So FMA is the voice of the global 

 7 alternative investment industry. Our members 

 8 include professionals in hedge funds, funds the 

 9 funds, and manages futures funds. It is estimated 

 10 that our members represent the vast majority of 

 11 the largest hedge groups in the world and manages 

 12 a substantial portion of the $1.67 trillion in the 

 13 alternative -- absolute return strategies. We 

 14 have a strong interest in the issues you are 

 15 discussing today. Energy markets and energy 

 16 derivatives are of increasing importance to our 

 17 national economy and to market participants 

 18 world-wide. 

 19 MFA members trade on exchange and off 

 20 exchange. We're neutral in any competitive 

 21 battles that pit traditional exchanges against new 

 22 trading platforms or multi-lateral systems against 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 231 

 1 bilateral dealer operations. Our members simply 

 2 want access to efficient transparent and fair ECM, 

 3 police, SEC -- and financially secure markets. 

 4 MFA's interests have been well served by 

 5 the excellent work of the Commission and its staff 

 6 for many years. Our interests have also been well 

 7 served by the Commodity Futures Modernization Act 

 8 of 2000. 

 9 In that statute, Congress adopted a 

 10 cascading regulatory approach with different 

 11 levels of oversight assigned to trading in 

 12 different categories of commodities, market 

 13 participants, and order execution facilities. 

 14 The Commission has been masterful in 

 15 applying these new statutory provisions to allow 

 16 new market forces to compete with traditional 

 17 exchanges in a host of areas, especially in 

 18 energy. FMA members have benefitted from these 

 19 innovations, and when our members benefit, the 

 20 investors benefit, and I think the liquidity of 

 21 the capital markets benefit. MFA does not see a 

 22 need for major changes in the CFMA. No case has 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 232 

 1 been made to turn back the clock by reregulating 

 2 new trading platforms that have served an 

 3 incubator function for derivatives trading 

 4 innovation. The CFTC's web site has listed 19 

 5 ECM's that have been created since the CFMA was 

 6 passed. Those markets operate as principals only, 

 7 many to many, electronic trading venues for its 

 8 sophisticated, well capitalized market 

 9 participants. 

 10 MFA believes that it is both appropriate 

 11 and important to cultivate those innovative 

 12 enterprises. In that score, the carve-out is very 

 13 similar to what, in the securities law, Sections 

 14 3C1 and 3C7 of the Investment Company Act carve 

 15 out certain funds from the definition -- for being 

 16 registered and regulated as an investment company 

 17 by virtue of the institutional nature of the 

 18 investor population. 

 19 Less regulation does not mean no 

 20 regulation. The Commission retains, as it should, 

 21 the power to place price manipulation on ECM's. 

 22 This power is vital, especially when an ECM offers 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 233 

 1 a contract that is linked to the settlement price 

 2 of a physical delivery contract traded on a DCM. 

 3 MFA supports the CFTC's work with ECM's 

 4 and others to obtain access to all relevant 

 5 surveillance data so that it may police 

 6 effectively the U.S. futures markets. Let me 

 7 close with yet another historical observation. 

 8 When the Commission was created in 1974, Congress 

 9 entrusted it with exclusive jurisdiction over 

 10 futures markets to make sure that no other agency, 

 11 whether it be the SEC, USDA, or the Bureau of 

 12 Mines, would look over its shoulder and second 

 13 guess its regulatory judgements. 

 14 Congress wanted an agency expert in 

 15 futures trading to determine whether a threat of 

 16 manipulation existed or some other major market 

 17 disturbance caused futures markets prices not to 

 18 reflect accurately the forces of supply and 

 19 demand. 

 20 Congress vested extraordinary emergency 

 21 powers in the Commission to address any such 

 22 threat, powers of the Commission once called the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 234 

 1 lynch pin of the act. The Commission has 

 2 correctly used those powers very sparingly, but 

 3 their existence serves a very important purpose. 

 4 Exchanges and market participants alike 

 5 know that the CFTC alone is ready to act when its 

 6 informed expert judgement action is warranted. 

 7 That power cannot work if it is shared with other 

 8 regulatory bodies either at the federal level or 

 9 the state level. 

 10 Nor can more than one agency police 

 11 price manipulation in futures markets themselves. 

 12 Otherwise, exchanges, intermediaries, advisors, 

 13 funds, and other market participants will find 

 14 themselves facing, at worst, conflicting, and at 

 15 best, duplicative government regulation, the very 

 16 ills Congress sought to cure with exclusive 

 17 jurisdiction. Multiple regulators sharing 

 18 concurrent jurisdiction will not strengthen 

 19 regulation, it will just water it down through 

 20 confusion at a considerable cost to market 

 21 participants. MFA encourages the Commission to 

 22 assert vigorously its jurisdiction as Congress 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 235 

 1 intended and the courts have so interpreted. 

 2 Thank you for this opportunity to appear today. 

 3 I'd be happy to answer any questions. 

 4 CHAIRMAN LUKKEN: Thank you, Mr. Gaine. 

 5 Mr. Cota. 

 6 MR. COTA: Honorable Acting Chairman 

 7 Lukken and Commissioners Dunn, Sommers, and 

 8 Chilton, thank you for the invitation to testify 

 9 before you today. I appreciate the opportunity to 

 10 provide insight as both a petroleum marketer and 

 11 on behalf of two trade groups representing motor 

 12 fuels and heating fuels dealers nation-wide. 

 13 It is ironic that you're hearing today 

 14 as a day where crude oil is traded at a record 

 15 high of $81 and change, so hopefully this is a 

 16 pivotal moment. 

 17 First, we'd like to congratulate both 

 18 Ms. Sommers and Mr. Chilton in their recent Senate 

 19 confirmations. Congratulations are also in order 

 20 for Mr. Lukken's recent nomination as Chairman. 

 21 We are encouraged by enforcement 

 22 activities and we look forward to working with you 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 236 

 1 on the Commission and the United States Congress 

 2 to continue to evaluate the need for new oversight 

 3 and new partnerships with key market players from 

 4 energy traders down to the American consumer. I 

 5 currently serve as the Petroleum Marketers 

 6 Association of America, as its Northeast Regional 

 7 Chair. 

 8 PMAA is a national federation of 45 

 9 states and regional associations representing 

 10 8,000 independent fuel marketers who collectively 

 11 account for approximately half of the gasoline and 

 12 almost all of the diesel fuel consumed by motor 

 13 vehicles and heating equipment in the United 

 14 States. 

 15 I'm also President of the New England 

 16 Fuel Institute, a year old regional trade 

 17 association located outside of Boston, and as 

 18 such, I'm representing over 1,000 fuel dealers 

 19 located in the northeast. 

 20 NEFI members deliver approximately 40 

 21 percent of the nation's home heating oil and 

 22 market other products like bio- diesel, bio-heat 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 237 

 1 and et cetera. I'm co-owner and president of one 

 2 of those companies, Cota and Cota of Bellows 

 3 Falls, Vermont. We are a third generation family 

 4 owned and operated home heating fuel provider in 

 5 Southern Virginia and Western New Hampshire. And 

 6 unlike larger energy companies, most fuel dealers 

 7 like me are small second and third generation 

 8 family run businesses. 

 9 Also unlike larger energy companies, 

 10 heating fuel dealers deliver directly to the 

 11 American consumer in small homes and businesses, 

 12 and therefore, we've developed a close 

 13 relationship with those folks. The average fuel 

 14 service company provides -- fuel service provider 

 15 has approximately 30 employees and 4,000 heating 

 16 oil accounts, delivers approximately 3.3 million 

 17 gallons per year, those selling propane average 

 18 2,000 customers and 800,000 gallons per year in 

 19 sales. In a survey of our associations, member 

 20 companies have said that their most -- their 

 21 highest priority is greater transparency in 

 22 accountability and energy commodity markets due to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 238 

 1 volatility, and that that should be an ongoing 

 2 public policy concern because we hedge directly 

 3 for the consumer and the consumer is immediately 

 4 impacted by these trades. 

 5 Because of our hedging activities, we 

 6 strongly support the exchange of commodity futures 

 7 in an open, transparent, and well managed exchange 

 8 subject to the rule of law. It is essential to 

 9 businesses like mine. I utilize energy hedging 

 10 programs and NYMEX based trades on a daily basis 

 11 in order to hedge for my consumers. 

 12 My company began offering fixed programs 

 13 to our consumers 20 years ago. It is common place 

 14 at my company and many others to do these NYMEX 

 15 based contracts with our suppliers who purchase 

 16 these contracts for future delivery and mark them 

 17 up to me for profits. In my company, we aggregate 

 18 all of our consumers together in order to come up 

 19 with a minimum hedge in order to sell these 

 20 programs for our heating season. The influence of 

 21 price setting functions on the unregulated and 

 22 under regulated markets continues to grow as 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 239 

 1 trading on over-the-counter and foreign based 

 2 exchanges continues to become the norm. American 

 3 consumers are forced to ride the same 

 4 rollercoaster ride as energy traders. Because the 

 5 Commodities Futures Modernization Act created a 

 6 new breed of markets, the ECM's and deregulated 

 7 over-the-counter markets, as a whole, this 

 8 rollercoaster has become more and more unstable, 

 9 and the volumes of products controlled by one 

 10 market player alone can determine the price 

 11 direction of this ride. 

 12 The consumer pays for this price 

 13 immediately. These markets are the price 

 14 discovery point for all of these commodities and 

 15 it is immediate. In my own company, as often as 

 16 four times per day. 

 17 In a letter to Congress early this 

 18 month, the Energy Market Oversight Coalition, 

 19 which represents over 70 national, regional, and 

 20 state consumer and trade groups, including NEFI 

 21 and PMAA, said that in recent allegations against 

 22 Amaranth Advisors, LLC and other large hedge 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 240 

 1 funds, have put to rest the notion that the market 

 2 is too big or too complex to be manipulated. 

 3 The letter pointed a broad array of 

 4 actions that Congress can take in order to 

 5 strengthen the Commission and aid to its 

 6 enforcement efforts to create a more stable 

 7 trading environment. In addition to reiterating 

 8 the need for reform, as it calls for in the 

 9 letter, we specifically urge the Commission to, 

 10 one, revisit the use of no action letters to 

 11 reevaluate the need to withdraw from existing no 

 12 action letters held by foreign trade boards to 

 13 perform price discovery functions for U.S. 

 14 Destined products, ensure that the current and 

 15 future regulations of ECM's is sufficient to 

 16 regulate trades of all energy commodities 

 17 essential to the health and welfare of American 

 18 citizens and the American economy, and three, 

 19 include as its advisory committee interest and 

 20 perspectives not currently represented, including 

 21 those of small business consumers, energy 

 22 distributors, storage companies, and noteworthy 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 241 

 1 academics. 

 2 Thank you again, Mr. Chairman, and to 

 3 your colleagues for this opportunity to share my 

 4 insights on this issue, and I'm open to any 

 5 questions you may have. 

 6 CHAIRMAN LUKKEN: Thank you very much, 

 7 we appreciate it. We'll turn to Commissioner 

 8 Chilton for any questions of the panel. 

 9 COMMISSIONER CHILTON: Mr. Zerzan, thank 

 10 you for your excellent testimony. You guys are 

 11 sort of the poster child for potential unintended 

 12 consequences, and we're all interested in making 

 13 sure that we don't do something and overstep. 

 14 Could you sort of highlight these again for us and 

 15 give me, you know, why would it be a poor thing, 

 16 in your judgement, to do what I've sort of been 

 17 asking other panels, simply get rid of the 2(h)(3) 

 18 and then allow regulatory flexibility for 

 19 bilaterals? 

 20 MR. ZERZAN: Thank you, Commissioner. I 

 21 think, in approaching that question, it is 

 22 important to consider what would be the effect if 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 242 

 1 2(h)(3) had not been enacted in the first place. 

 2 I think, for starters, we, you know, ICE is a 

 3 multi billion dollar American company, it employs 

 4 Americans and contributes revenue to the United 

 5 States, and in the absence of 2(h)(3), I really 

 6 don't think ICE would exist, it certainly wouldn't 

 7 exist in the United States. 

 8 So I think there's a very real concern 

 9 about what the effect, both from a competitiveness 

 10 standpoint in terms of the United States as an 

 11 attractive place to do business, and then there's 

 12 also a question of, you know, do these markets 

 13 serve a useful function. Well, clearly they do, 

 14 because they wouldn't exist if there wasn't a 

 15 demand for, you know, the ability to do 

 16 transactions off exchange that you couldn't 

 17 otherwise do on NYMEX or another market. 

 18 And so we understand there's both the 

 19 utility to 2(h)(3) markets, and there's a social 

 20 benefit to 2(h)(3) markets in terms of the 

 21 contribution to the United States economy. 

 22 So given that we know the benefit, then 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 243 

 1 the question is, well, how can we assess what 

 2 would be an appropriate means of looking at the 

 3 regulation of a 2(h)(3) market, and it is clearly 

 4 not an easy position in which you find yourselves, 

 5 because you know, yes, there's a benefit, and on 

 6 the other hand we have a constituency that comes 

 7 forward and says, you know, we don't like what's 

 8 happening to us, we see these prices, we're 

 9 getting manipulated, we're paying too much. And 

 10 that's really why our recommendation is simple. 

 11 We think to the extent that you can identify a 

 12 market failure, then by all means, find the least 

 13 costly way to remedy that. 

 14 The difficulty that we, the industry, 

 15 have is that we have not seen conclusive evidence 

 16 of a market failure. We see a lot of anecdotal 

 17 evidence, and certainly, you know, market users 

 18 represents both, you know, people on the buy side 

 19 and the sell side, right, we have a lot of venues. 

 20 So we don't want people manipulate any 

 21 markets, the hedge funds don't want people 

 22 manipulating markets, no one does. But what we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 244 

 1 really need to consider is, do we have a 

 2 conclusive case, and if we do, then what's the 

 3 appropriate way to remedy that. 

 4 COMMISSIONER CHILTON: Thanks. Mr. 

 5 Cooper, do you have any comments about what Mr. 

 6 Zerzan just said? 

 7 MR. COOPER: Well, for every job created 

 8 by ICE, you've probably lost an industrial job, 

 9 that was the point of the Huntsman Chemical 

 10 statement. So, you know, there are costs and 

 11 benefits, we've got these jobs, we've got these 

 12 instruments, show me the benefit beyond sheer 

 13 quantity of trading, but that's what he cited, 

 14 this incredible increase in the quantity of 

 15 trading. If you look at your own statistics, if 

 16 you look at the physical commodities, 

 17 non-financial commodities, the growth of trading, 

 18 the growth of open positions, between 1998 and 

 19 2005, for agricultural commodities, for medals, it 

 20 increased by 50 to maybe 100 percent. 

 21 These are on exchange credit trade, not 

 22 over-the-counter. The energies increased by 450 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 245 

 1 percent. The immense growth of trading in one 

 2 commodity whose physical consumption and 

 3 production has barely budged. So the answer is 

 4 here, hey, as long as it is traded, it must be 

 5 good. 

 6 We ask people, exactly what good is it 

 7 doing us, and no one could put a finger on it. He 

 8 hasn't told me it drove the price down, he hasn't 

 9 demonstrated that it allocated the resource more 

 10 efficiently. You've heard testimony that it has 

 11 raised the price. 

 12 Those transactions cost money, you know 

 13 that, transactions are not free. Volatility makes 

 14 it harder to get physical people to release their 

 15 commodities. Risk adds to price, transaction adds 

 16 to cost, so there are costs associated with simply 

 17 counting the number of transactions, which is what 

 18 he's told you the benefit is. 

 19 We don't see the benefit, we see people 

 20 who've looked up there and said, hey, there's a 

 21 speculative premium of $20 a barrel and $3 at MCF. 

 22 There's a cost associated with that. American 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 246 

 1 consumers are paying, have paid over the last five 

 2 or six years, $300 billion more for natural gas 

 3 than they did above what is seen as the physical 

 4 cost of the commodity. So if you're going to 

 5 measure cost and benefits, you can't stop at this 

 6 count of transactions. You have to show me how 

 7 those transactions actually improve efficiency. 

 8 You can't just count the jobs he says 

 9 he's created, you have to count the jobs the 

 10 chemical industry says it has lost, because the 

 11 volatility and price of natural gas in the U.S. 

 12 has gotten to be much higher than elsewhere and 

 13 that's where they locate their plant. 

 14 They don't want to go, they prefer to 

 15 use the American laymen, it is much more 

 16 productive. But when the cost of their physical 

 17 inputs become so high, that's when you lose jobs. 

 18 So do the cost benefit analysis. We think there's 

 19 a demonstration of harm. 

 20 And the real answer to your question 

 21 which has been ducked constantly here is, what is 

 22 the cost of registering and reporting, that's all 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 247 

 1 we've asked for, register and report. Honest 

 2 people will be glad to. The bad guys will 

 3 disappear. What is the cost of that simple act 

 4 which has a tremendous disciplining force? They 

 5 keep ducking it, they say, hey, just count the 

 6 benefits. There's very little cost, you're right, 

 7 Commissioner Chilton, there's very little cost to 

 8 what you're asking them to do. 

 9 COMMISSIONER CHILTON: Is the clock not 

 10 working? Because I don't want to -- 

 11 CHAIRMAN LUKKEN: No, go ahead. 

 12 COMMISSIONER CHILTON: I wanted to give 

 13 Mr. Zerzan a chance to reply just briefly. I 

 14 don't want to continue to do a counterpoint here, 

 15 but he said a lot there, so -- 

 16 MR. ZERZAN: Well, thank you, 

 17 Commissioner. Actually, yeah, you know, Mark 

 18 Cooper and I agree, we need to do a cost benefit 

 19 analysis. I think that we often times hear claims 

 20 that the consumer is paying 300 times more for 

 21 natural gas than they should. Frankly, I think 

 22 those claims strain -- to the extent they don't, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 248 

 1 to the extent that those are, in fact, accurate 

 2 figures, then by all means, we would need to do 

 3 something. 

 4 The point is, and this is what the 

 5 Europeans are doing and this is what our 

 6 competitors are doing in terms of financial 

 7 regulation, they are taking a comprehensive, 

 8 thorough look at the market, and they're doing a 

 9 cost benefit analysis. And I know that's what the 

 10 Commission does, and I'm very happy to know that 

 11 you will continue to do that. 

 12 COMMISSIONER CHILTON: Thanks, Mr. 

 13 Chairman. 

 14 CHAIRMAN LUKKEN: Thank you. 

 15 Commissioner Sommers? Commissioner Dunn? 

 16 COMMISSIONER DUNN: I'm not piling on, 

 17 but I really am. Greg, we heard on the last panel 

 18 representative from the Huntsman Company and 

 19 representative from American Public Gas 

 20 Association explicitly said they have lost 

 21 confidence in the futures market. And I think 

 22 I've heard Mr. Cota say the same thing on this 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 249 

 1 panel, and certainly Mr. Cooper is saying that 

 2 there's loss of confidence. Do you consider that 

 3 a market failure? 

 4 MR. ZERZAN: Well, a market failure is, 

 5 by definition, an indication that the normal force 

 6 of supply and demand are not working and prices 

 7 are reflecting some other, what we might classify 

 8 as illegitimate factors. When you look at the 

 9 last several years, in the volatility in the 

 10 natural gas markets, we can all see, in fact, 

 11 there were a lot of rather significant events. 

 12 There were wars going on in energy 

 13 sensitive regions, there were hurricanes, there 

 14 were a lot of isogenous factors at play that could 

 15 have, in fact, effected supply and demand. And 

 16 the conclusion I think of the Amaranth report was 

 17 interesting. What was most interesting was the 

 18 minority review, from my perspective, in which 

 19 they said -- and it is clear that different 

 20 conclusions can be drawn from the same set of 

 21 facts. 

 22 And when you look at the volatility 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 250 

 1 we've experienced in the natural gas market, there 

 2 is no question that that would be something that 

 3 some end users wouldn't want to have to deal with 

 4 anymore, and they would say, all right, we're 

 5 going to pull out of these markets because we 

 6 don't know where prices are going. But that is 

 7 certainly not, in and of itself, proof that there 

 8 is something going on in the market other than the 

 9 natural force of supply and demand, and it 

 10 shouldn't be treated as such. 

 11 COMMISSIONER DUNN: Certainly for those 

 12 individuals that used to be legitimate hedgers, 

 13 they're afraid to get into that market place; do 

 14 they consider that a market failure then from 

 15 their point of view? 

 16 MR. ZERZAN: Well, I think that any time 

 17 you have a loss of peoples ability to go to the 

 18 market, that is unfortunate. 

 19 If you look at the growth of the markets 

 20 themselves, as John Damgard said in the previous 

 21 panel, actually what you see is tremendous 

 22 increase in the number of people coming to the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 251 

 1 market. 

 2 So you are, in fact, going to find 

 3 people who will look at the volatility and say, we 

 4 don't want to participate in those markets. But 

 5 again, that is not proof of a market failure. 

 6 COMMISSIONER DUNN: I think what we 

 7 determined is, we have an increase of open 

 8 contracts in the market place. There may be those 

 9 that say, well, that's because Mr. Gaines' clients 

 10 are the ones that are in there, not necessarily 

 11 those that are hedgers are in there. What about 

 12 Enron, would you consider that a market failure? 

 13 MR. ZERZAN: Well, I think -- actually, 

 14 if you look at the excellent work that the 

 15 Commission did, in their report market growth, 

 16 trader participation, and pricing and energy 

 17 futures markets, a nice way to address the 

 18 question of what happens when you have all these 

 19 new non-traditional market participants, and in 

 20 fact, what happens is, you have increased 

 21 efficiencies and increased price discovery. 

 22 So again, I mean this has been said by 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 252 

 1 others, but we have this old recurring theme in 

 2 these price discovery markets. On the one hand, 

 3 you have end users that say we don't like what's 

 4 happening; on the other hand, you have, you know, 

 5 financial market participants and others who are 

 6 saying, you know, we're sorry, but we didn't cause 

 7 the volatility, we got in because the volatility 

 8 was attractive. 

 9 And that's why a cost benefit analysis 

 10 is really the appropriate way to determine this. 

 11 By all means, if we find people who are doing 

 12 unsworn things, every single person in the 

 13 industry on both sides will say, by all means, 

 14 stop that. But the case has not been made that 

 15 we're conclusively finding some area where the law 

 16 is lacking, and until that happens, we're 

 17 reluctant to say, well, let's make change for 

 18 change sake. 

 19 COMMISSIONER DUNN: You're saying in 

 20 your testimony that while there is no shortage of 

 21 people who will attempt to gain the system for 

 22 their own benefit, the number of people who have 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 253 

 1 successfully done so approaches nil; could that be 

 2 a possibility because we're not seeing the entire 

 3 market place, if we're not seeing the information 

 4 from over-the-counter markets? Do you couple that 

 5 with the loss of personnel at the CFTC, and the 

 6 lack of new IT equipment to give us that 

 7 information? 

 8 MR. ZERZAN: Commissioner, as -- was 

 9 proud to testify before Congress and it will 

 10 testify again, we believe that CFTC needs 

 11 increased funding and we will support that whole 

 12 heartedly to up the staffing in the IT budget. 

 13 Having said that, you know, I don't envy 

 14 the position that you all find yourselves in, 

 15 because you have two different groups of people 

 16 saying two very different things. But I think the 

 17 research that the Commission itself has done 

 18 points to the conclusion that certainly I've drawn 

 19 here today, which is that, yeah, the markets are 

 20 volatile, but we don't have proof that there's 

 21 this concerted effort to manipulate prices and 

 22 otherwise effect people in a way that is not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 254 

 1 subject to the normal rules of supply and demand. 

 2 And until we find that, I actually think 

 3 we set out the possibility to give people false 

 4 hope. If we say, well, we're going to solve your 

 5 problem by passing this new regulatory regime, you 

 6 won't actually solve the problem of volatility, 

 7 you won't solve the problem that some people are 

 8 not going to want to get into volatile markets, 

 9 all you're going to do is make it more attractive 

 10 for people to operate in other markets. And the 

 11 reality of it is, tomorrow people can set up a 

 12 contract or an exchange on the Aisle of Man, the 

 13 traded contract that settled on the NYMEX crude 

 14 price, and there would be a lot of people doing 

 15 business there, and the Commission, you know, 

 16 obviously wouldn't have any means to access that 

 17 information. So I think we're actually better off 

 18 to the extent we can create a regime which I think 

 19 we probably have in the United States, where we 

 20 encourage people to do business here, but we still 

 21 have the enforcement mechanism that the Commission 

 22 has rather successfully exercised. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 255 

 1 COMMISSIONER DUNN: How am I doing on 

 2 time? I'll get the -- 

 3 CHAIRMAN LUKKEN: Well, let me ask a 

 4 question and then we can go back. I was 

 5 interested in the last point, talking about global 

 6 competitiveness. I've been, as many of you know, 

 7 fascinated by Thomas Freedman's "the world is flat 

 8 concept", that in an electronic digital age, 

 9 especially in our world, you can locate just about 

 10 anywhere in the world and conduct business where 

 11 the cost of doing business might be the lowest. 

 12 And so I worry, and this gets to some of 

 13 the -- this phrase is used too much, but 

 14 unintended consequences that people talk about. 

 15 And I want to talk a little bit to Mr. Cooper and 

 16 Mr. Zerzan about this issue, especially as it 

 17 relates to energy. Are these the type of 

 18 commodities that are, by definition, a regional 

 19 commodity. So we don't have to necessarily worry 

 20 that if we do something the market doesn't like, 

 21 that they may move elsewhere? Or are these like 

 22 some of these other commodities that we see, oil, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 256 

 1 obviously related to natural gas, where 35 percent 

 2 of that market share and the WTI now is located in 

 3 London? How should we approach this? Is it more 

 4 the former or the latter? And I'd be interested 

 5 in both of your views on that. 

 6 MR. COOPER: Well, natural gas is not 

 7 nearly as -- as is oil. And so by and large, 

 8 almost all the natural gas consumed in America is 

 9 produced in America or in Mexico and Canada. 

 10 Almost none of it comes from outside of North 

 11 America. So it is a tied physical commodity. 

 12 The hypothesis that people will go to 

 13 the Aisle of Man, trade over there, do what they 

 14 want over there, without the ability to also trade 

 15 here, and remember, that's what I'm telling you, 

 16 that this government has the power to make people 

 17 who want to do business in America behave 

 18 according to our rules with a physical commodity 

 19 such as natural gas, so I'm not concerned about 

 20 that. 

 21 Second point, and it is -- Mr. Zerzan 

 22 makes the point that most efforts to gain the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 257 

 1 market fail. The problem is that, as a physical 

 2 consumer, while the game is afoot, I may pay a 

 3 terrible price, and that's what the Senate 

 4 committee found, that is, yeah, Amaranth in the 

 5 end went belly up. But for a significant period 

 6 of time, they effected the price. And as you 

 7 heard from the previous panel, there are consumers 

 8 who are physical commodity consumers, they can't 

 9 walk away from the table when the financial guys 

 10 say, okay, you're out of luck, because the lights 

 11 go out. You can't sit and be cold in the dark. 

 12 So the consumers pay the price for the game, 

 13 whether or not the people trying to manipulate the 

 14 market succeed. 

 15 Second point, it is not manipulators, it 

 16 is an institutional structure that creates 

 17 volatility, that pumps too much money into this 

 18 market, and transacts and transacts and transacts. 

 19 In the end, it is a BPU of methane coming out of 

 20 the ground over here and a BPU of methane going 

 21 into my burner. And all of those transactions in 

 22 between have a cost. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 258 

 1 And so, frankly, if you cause people to 

 2 register and report, and reduce the number of 

 3 transactions by one-half, you would still have 

 4 plenty liquidity and less volatility, less risk, 

 5 less transaction cost. So the game itself, and it 

 6 is not manipulation, that's why -- you need to 

 7 look at more than manipulation. 

 8 One final point, because people have 

 9 asked this question about double jurisdiction and 

 10 the FERC. When an agency fails to do its job, and 

 11 there is a perception among we end users that the 

 12 commodity markets have been failing us, the 

 13 reaction of the federal government is, in fact, to 

 14 get another agency to try and help it do its job. 

 15 I understand that rubs a little bit raw in this 

 16 agency. But the idea of the FERC being given new 

 17 powers to oversee these markets, they were 

 18 supposed to go beyond what the CFTC does, they 

 19 were supposed to, in my opinion, look past 

 20 manipulation, which is what you specialize in, and 

 21 look to influence. 

 22 Now, they didn't choose to exercise that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 259 

 1 authority. But I'm telling you that if we 

 2 continue down this road, you're going to get more 

 3 and more agencies who are told to do your job. It 

 4 is not multiple jurisdiction, it is that there are 

 5 other problems here beyond manipulation that need 

 6 to be addressed. 

 7 MR. ZERZAN: Well, your question I think 

 8 was, you know, how can we treat the commodity 

 9 itself, and to the extent you have a functioning 

 10 futures market, as we have in the United States, 

 11 and they're very healthy liquid markets, you can 

 12 take that price and settle your over-the-counter 

 13 contract on that settlement price. So as long as 

 14 you don't actually care about, you know, 

 15 delivering at Henry Hub, you are, in fact, free to 

 16 operate anywhere in the world, and that is, in 

 17 fact, what we increasingly see. 

 18 MR. COTA: Mr. Chairman, if I could 

 19 comment on that, as well? 

 20 CHAIRMAN LUKKEN: Sure. 

 21 MR. COTA: With regard to U.S. testing 

 22 energy products, and that's where we've kind of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 260 

 1 drawn the line, the U.S. market is such a large 

 2 energy consuming market that, regardless of 

 3 whether the trading is occurring in the Aisle of 

 4 Man or in Moscow or wherever it wants to be, 

 5 there's enough trading here that's going to occur 

 6 because the physical trades are here and because 

 7 these are physical markets. 

 8 And the speculators will go to wherever 

 9 the play in the market is that they can play it 

 10 all the way out in the safe market. So I think 

 11 that you will continue to see exchanges, whether 

 12 they be underseen by you or wherever, as long as 

 13 it is U.S. Destined products, they're going to 

 14 continue to be here. 

 15 The amount of trading is huge. The 

 16 heating oil market is about eight billion gallons 

 17 annually in the United States. That trade is 

 18 about two or three times a day. So the volumes of 

 19 trades and the amount of liquidity is very 

 20 significant. The measure of liquidity, according 

 21 to NYMEX when we met with them a number of years 

 22 ago, was measuring the options prices, and that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 261 

 1 was the first indicator of volatility and how much 

 2 money was moving in and out of the market. 

 3 I used to be able to hedge for my 

 4 consumer base on options -- I had the money option 

 5 for putting the call for between four and six 

 6 cents about four years ago. Well, that same deal 

 7 this summer, to do a winter hedge, was between 50 

 8 and 60 cents per gallon. So that's a huge 

 9 increase in volatility. And the reaction from 

 10 people in the market, companies like myself, is 

 11 that with that increase volatility and that risk, 

 12 that that's causing a greater reluctance to 

 13 participate in the markets in order to hedge, and 

 14 we need speculators. Speculators are key. But if 

 15 almost all of the transactions are purely 

 16 speculation transactions and none ever seem to get 

 17 into a physical market, people who are in the 

 18 physical market will then migrate out of those 

 19 markets. And we think these markets are very 

 20 important for the consumers. 

 21 That's not going to effect the pricing. 

 22 If government thinks that if you guys are 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 262 

 1 brilliant, the price is going to go down, that's 

 2 unrelated to this. But lowering the volatility 

 3 will create more stability in the markets, and in 

 4 my opinion, make these markets more secure in the 

 5 future. 

 6 CHAIRMAN LUKKEN: All right. Thank you 

 7 very much. Commissioner Chilton. 

 8 COMMISSIONER CHILTON: Just one final 

 9 one. Mr. Zerzan, you mentioned the -- a couple of 

 10 times that this issue is being debated and 

 11 considered in other countries, and one, I'd like 

 12 to know a little bit more about that, but two, is 

 13 that because of Amaranth and the PSI hearing and 

 14 things that have gone on in this country? Are 

 15 they so worried about what's going on here in our 

 16 markets that now they're looking at themselves? 

 17 And if that's the case, what exactly are they 

 18 doing? You talked about it a couple of times. 

 19 MR. ZERZAN: Thank you, Commissioner. 

 20 What we find in most of other jurisdictions in 

 21 which we operate is that there's a unitary regime 

 22 for financial instruments, derivatives being a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 263 

 1 part of that unitary regime. And then the 

 2 application of different parts of the overall 

 3 structure which would apply to derivatives are 

 4 carved out. 

 5 So, for instance, in the European Union, 

 6 we have the markets in financial instruments 

 7 directive, and commodity derivatives are 

 8 separately carved out and excluded from the law, 

 9 subject to a review that's happening right now as 

 10 to what exactly an appropriate regime might be. 

 11 Separately from that, eligible counter 

 12 party contracts are carved out, which is not, you 

 13 know, remarkably different from what we have here 

 14 in the United States. 

 15 With regards to your second question, I 

 16 have found, particularly in Europe, there is 

 17 conversation about Amaranth, there is conversation 

 18 often times about some of the other nation states 

 19 that are not part of the European Union, but take 

 20 your concerns, and so the same debate goes on 

 21 there. 

 22 And that's why actually I think the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 264 

 1 McCreevy formula, the federal regulation formula 

 2 is so useful, because as our counterparts in 

 3 Europe approach this same public policy question, 

 4 how do you balance liquidity and transparency, how 

 5 do you promote free markets, but also make sure 

 6 that people are getting proper prices, they 

 7 encounter it through that two-step process, has 

 8 there been a market failure, and if so, what is 

 9 the least burdensome means of addressing it. And 

 10 so as we go forward in this debate, I think that's 

 11 a very useful strategy to keep in mind. 

 12 COMMISSIONER CHILTON: Thanks; thanks, 

 13 Mr. Chairman. 

 14 CHAIRMAN LUKKEN: Any further questions? 

 15 Commissioner Dunn. 

 16 COMMISSIONER DUNN: Mr. Gaine, you've 

 17 been quiet here, so we have to give you an 

 18 opportunity, and it won't be too tough. 

 19 But I've often heard it said that the 

 20 managed funds do provide a role at providing 

 21 liquidity in the market place on both sides; could 

 22 you amplify on that a little bit? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 265 

 1 MR. GAINE: Well, I think all the data 

 2 that's available would support that notion. In 

 3 fact, even in Amaranth, I believe there are 

 4 published reports that Amaranth obviously was the 

 5 hedge hunt on one side, that there were hedge 

 6 hunts on the other side of that trade. 

 7 And Mr. Cota is talking about a spread 

 8 in his options where, if you didn't have liquidity 

 9 in there, that spread would be wider, my guess 

 10 would be. I think it is grown enormously. I mean 

 11 the alternative investment, which covers a whole 

 12 host of areas, but includes on exchange features 

 13 and over-the-counter swaps and other derivatives, 

 14 the growth has been, from ten years ago, 

 15 approximately $50 or $60 billion to something 1.67 

 16 trillion, I think is the story I'm going with 

 17 today. It is a huge, you know, a huge growth. A 

 18 lot of that would be on your designated contract 

 19 markets, as well as ECM's. And I don't think 

 20 there's any doubt that the liquidity of our 

 21 managed futures programs, as well as the hedge 

 22 funds is an enormous factor in virtually all of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 266 

 1 these markets. 

 2 It is a fact very well recognized I 

 3 think in the President's Working Group reports of 

 4 you and the treasury, the fed, and the SEC, and I 

 5 don't, you know, we're, as Mr. Zerzan suggested, 

 6 hedge hunts have no interest in market 

 7 instability. 

 8 I think volatility possibly to some of 

 9 our members is okay, if the price is moving up and 

 10 down, but there are hurricanes, as he pointed out, 

 11 and there is a war in the Middle East, a 450 

 12 percent increase in petroleum under those 

 13 circumstances, far be it for me, just a lawyer, to 

 14 judge whether that's too high or too little. I 

 15 know your wheat and corn people are pretty happy 

 16 lately. 

 17 You know, picking prices has never been 

 18 my specialty, nor has it been an interest of this 

 19 Commission. And I think sometimes these debates 

 20 evolve into this. I remember we were up before 

 21 the Senate Judiciary Committee on short selling, 

 22 abusive short selling of equities, and that week 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 267 

 1 hedge funds were responsible for lowering equity 

 2 prices and raising energy prices. 

 3 We were kind of like magicians. And I 

 4 don't think -- and recently the FCC has taken a 

 5 number of steps to relax or ease the ability of 

 6 hedge funds to access short selling positions, and 

 7 that's as a result of enormous economic research 

 8 and study over the years by the exchanges, as well 

 9 as the SEC. Liquidity of "the speculator" is 

 10 invaluable to just about any market place. 

 11 COMMISSIONER DUNN: Mr. Cooper, I've got 

 12 one final question. I direct it to you, you've 

 13 talked about registration and reporting. Most of 

 14 the cases, fraud cases that we have brought, the 

 15 energy has been based upon false reporting; do you 

 16 see that as a problem in the energy sector? 

 17 MR. COOPER: Well, that certainly was a 

 18 problem over at the FERC and with natural gas. 

 19 Clearly, the private reporting services had a 

 20 severe problem with people misreporting. Those 

 21 numbers were published and people executed 

 22 transactions on the basis of falsely reported 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 268 

 1 numbers, selectively reported numbers. And it is 

 2 fascinating that the moment the FERC suggested 

 3 that they wanted honesty in reporting, the volume 

 4 of reporting collapsed and never recovered. 

 5 That is, people stopped reporting 

 6 because they were afraid that someone might 

 7 actually check up on whether or not they were 

 8 lying, and that's the mistake of not requiring 

 9 reporting. And now the FERC is in court with 

 10 private agencies to get access to the reports. I 

 11 mean they're claiming -- so the point is that 

 12 reporting is extremely important. One of the 

 13 things that we recommended in the report for the 

 14 Attorneys General, again, looking at the end user, 

 15 and we actually do care about the price, I 

 16 understand that the traders really don't care what 

 17 the price is, but we actually pay the price, we 

 18 write the check. 

 19 One of the recommendations we talked 

 20 about was preventing utilities from indexing their 

 21 prices to any unregulated report. It would be an 

 22 interesting, disciplining force. It'll put those 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 269 

 1 private agencies out of business in a minute. 

 2 But the simple fact of the matter is 

 3 that the person who buys my natural gas is a 

 4 regulated entity who's is extremely risk adverse, 

 5 and my mother and grandmother actually think 

 6 that's a good idea, and so, we start looking at 

 7 ways to drive back from the consumer side to get 

 8 honesty in the process, and that was one of the 

 9 recommendations, was to maybe tell the states to 

 10 stop letting them use any unregulated index as a 

 11 reference price in their contract. Thank you. 

 12 CHAIRMAN LUKKEN: Thank you very much. 

 13 Well, I have no further questions. So on behalf 

 14 of my Commission colleagues, I just want to thank 

 15 this panel and all panelists today for the very 

 16 informative and varied testimony that we received. 

 17 All this information is going to be very useful as 

 18 we go forward in trying to advance this issue. I 

 19 also want to thank all the audience who stuck 

 20 around all day, including some friends from the 

 21 Hill. I know it is been a long day, but we 

 22 appreciate your attendance, and hopefully we'll 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 270 

 1 continue to work with you down the line. 

 2 Before we adjourn, I'd like to remind 

 3 everyone that a transcript of the hearing will be 

 4 made and entered into the Commission's public 

 5 comment record, which will remain open for receipt 

 6 of written comments until next Monday, September 

 7 24th. 

 8 Also, I want to remind folks that our 

 9 next Commission meeting will be on October 2nd, 

 10 the Global Markets Advisory Committee. Charlie 

 11 McCreevy was mentioned here today. We have 

 12 colleagues from the EU coming over to talk about 

 13 these issues that are going on in the European 

 14 Union, in the Commission, and also MFID and 

 15 European Clearing Code of Conduct and other issues 

 16 relating to commodities. So it should be an 

 17 interesting debate, and I wanted to inform you of 

 18 that. But if there's nothing further, the meeting 

 19 is -- oh, Commissioner Dunn. 

 20 COMMISSIONER DUNN: Mr. Chairman, I 

 21 would like to thank the staff for putting the 

 22 meeting together as well if all of us were 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 271 

 1 participants, but most importantly, I'd like to 

 2 thank you. You made a commitment at the PSI 

 3 hearing, you have followed through on it, and 

 4 you're a man of your word. Thank you. 

 5 COMMISSIONER CHILTON: Ditto. 

 6 CHAIRMAN LUKKEN: Well, I wouldn't want 

 7 to let the meeting adjourn before thanking staff, 

 8 as well, because they did most of the heavy 

 9 lifting here today, and we're so lucky to have 

 10 such valued staff here at the CFTC. So with that, 

 11 the meeting is adjourned. 

 12 (Whereupon, at 3:17 p.m., the 

 13 PROCEEDINGS were adjourned.) 

 14 * * * * * 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190