UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

MARKET RISK ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Monday, November 2, 2015
 2 

 1 PARTICIPANTS:

 2 Commissioners:

 3 COMMISSIONER SHARON BOWEN (CFTC)

 4 CHAIRMAN TIMOTHY MASSAD (MRAC)

 5 CHIEF COUNSEL ROBERT WASSERMAN (CFTC)

 6 PETAL WALKER (CFTC)

 7 Other Participants:

 8 GERALD BEESON

 Citadel

 9 

 DAVID BURLAGE

 10 CoBank

 11 SUNIL CUTINHO

 CME Group

 12

 DOUGLAS FRIEDMAN

 13 Tradeweb

 14 ANDREW GRAY

 DTCC

 15

 MICHAEL HENNESSY

 16 Federal Home Loan Banks

 17 NATHAN JENNER

 Bloomberg LP

 18

 JERRY JESKE

 19 Mercuria Energy Trading

 20 THOMAS KLOET

 Elmhurst College

 21

 SEBASTIAAN KOELING

 22 Optiver
 3 

 1 PARTICIPANTS (CONT'D):

 2 CLIFFORD LEWIS

 Eurex Clearing

 3 

 GLEN MACKEY

 4 NRG Energy Inc.

 5 KEVIN MCCLEAR

 ICE

 6 

 DENNIS MCLAUGHLIN

 7 LCH Clearnet

 8 SUSAN MCLAUGHLIN

 Federal Reserve

 9 

 RICHARD MILLER

 10 Prudential Financial

 11 MICHAEL MODLOCK

 TriOptima

 12

 SUSAN O'FLYNN

 13 Morgan Stanley

 14 ANGELA PATEL

 Putnam Investments

 15

 EDWARD PLA

 16 UBS/FIA

 17 EMILY PORTNEY

 JP MORGAN

 18

 MARCUS STANLEY

 19 Americans for Financial Reform

 20 WILLIAM THUM

 Vanguard

 21

 22
 4 

 1 PARTICIPANTS (CONT'D):

 2 KRISTEN WALTERS

 BlackRock

 3 

 RANA YARED

 4 Goldman Sachs

 5 LUKE ZUBROD

 Chatham Financial

 6 

 7 

 8 

 9 * * * * *

 10

 11

 12

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22
 5 

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

 2 (10:00 a.m.)

 3 MS. WALKER: Good morning. This meeting

 4 of the Market Risk Advisory Committee is now open.

 5 Commissioner Bowen will welcome.

 6 COMMISSIONER BOWEN: Good morning. And

 7 thank you everyone for being here today. I do

 8 want to encourage you to have donuts and coffee in

 9 the back.

 10 Before we begin our panel presentations,

 11 I invite Chairman Massad to give his remarks.

 12 CHAIRMAN MASSAD: I will be very brief.

 13 First of all, I just want to note that

 14 Commissioner Giancarlo had planned to be here

 15 today but could not be. Unfortunately, his father

 16 passed away late last week, so our thoughts and

 17 sympathies are with him and his family.

 18 Secondly, just on today's topic, all I

 19 want to say is the issue of CCP resiliency is

 20 critical. I've said this since the beginning of

 21 my term. It's very important that we've mandated

 22 central clearing of swaps, but I've also said that
 6 

 1 with that comes the fact that we must focus on CCP

 2 strengths and resiliency. We've made CCPs more

 3 critical in the financial system.

 4 So this meeting is extremely helpful and

 5 important in that regard. We obviously have a lot

 6 of activity going on in this area in many ways,

 7 and so I just applaud Commissioner Bowen for

 8 having the MRAC focus on this, and I look forward

 9 to the discussion today.

 10 COMMISSIONER BOWEN: Thank you, Chairman

 11 Massad. I also extend my deepest sympathy to

 12 Commissioner Giancarlo and his family on the loss

 13 of his father. Are CCPs prepared for what would

 14 happen if a significant clearing member defaulted?

 15 That was one of the questions we asked in our

 16 inaugural April 2nd meeting of the Market Risk

 17 Advisory Committee. At that meeting, three of our

 18 CCPs -- CME LCH, and ICE -- made presentations

 19 about how they are preparing for such a default.

 20 These presentations prompted a fruitful

 21 discussion, and as usual, our MRAC members brought

 22 great ideas to the table. Following that meeting,
 7 

 1 we established a CCP Risk Management Subcommittee

 2 to delve further into the issues that were raised.

 3 The Subcommittee is composed of a diverse group of

 4 market participants, including clearinghouses,

 5 clearing members, buy side, end-users, and

 6 academics. And it is ably led by Tom Kloet of

 7 Elmhurst College and Susan O'Flynn of Morgan

 8 Stanley.

 9 The Subcommittee was tasked with

 10 answering two questions that came out of the April

 11 2nd meeting. If we had a significant clearing

 12 member default, could the efforts outlined in the

 13 CCP presentations be even more reflective of

 14 actual market conditions? Susan O'Flynn has led

 15 the Subcommittee's discussions to respond to that

 16 question, and we will hear their recommendations

 17 today for the consideration for the Full

 18 Committee.

 19 The second question is whether we could

 20 do more to further coordinate the efforts of CCPs

 21 to better prepare for it. Tom Kloet will lead the

 22 Subcommittee's discussions to respond to the
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 1 question, and as a follow-up to that question.

 2 And as a follow-up to our June 2nd meeting, they

 3 are on track to make recommendations early next

 4 year.

 5 As I said at my first MRAC meeting,

 6 though I believe it is unlikely that a significant

 7 cleared member, one whose default could pose a

 8 systemic risk would actually default, it behooves

 9 us to do everything in our power to best prepare

10 for it given the implications for our economy.

11 As vice chair and chair of SIPC, I saw

12 firsthand how devastating the collapse of

13 influential marketplace participants can be. I

14 also personally know individuals whose careers and

15 lives have been permanently altered by the 2008

16 crisis. We regulators owe it to investors and

17 consumers to do everything we can to prevent

18 another crash, even more so, while the global

19 economy is still digging out from the damage of

20 the 2008 crisis.

21 As I noted in my inaugural speech, we

22 cannot be complacent. Just because we've made
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 1 progress in trying to fix the problems that caused

 2 the last crisis, that doesn't mean we are yet

 3 prepared to address future potential threats.

 4 Thus, the importance of effective, robust risk

 5 management of our CCPs cannot be overstated. I am

 6 therefore eager to hear the viewpoints of the

 7 Subcommittee today and the other MRAC members, and

 8 I thank all of the Subcommittee members for being

 9 here today to share your views. I especially want

10 to thank Susan O'Flynn for her leadership of these

11 efforts, and both Susan and Gerald Beeson for

12 their tireless efforts in drafting.

13 Due to a scheduling conflict today, I

14 will need to scoot out before we close today's

15 meeting, so I also thank Tom, who will provide a

16 recap after the third panel before we close the

17 meeting.

18 It is important to me that the MRAC not

19 only be a forum to discuss important issues, but a

20 Committee that gets things done. I am confident

21 that these recommendations will be the first in a

22 line of consequential work product from this
 10

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Committee. I also would hope that interested

 2 members of the public who are watching this

 3 meeting would also submit their views.

 4 I will now turn it over to Ms. Walker,

 5 who will introduce our first moderator and panel.

 6 MS. WALKER: Ms. Susan O'Flynn, who is

 7 managing director and co-head of the Markets and

 8 Securities -- I'm so sorry -- managing director

 9 and global head of CCP Strategy Governance

 10 Optimization at Morgan Stanley will be leading our

 11 first panel. 

 12 MS. O'FLYNN: Okay, thank you very much,

 13 Commissioner Bowen and Petal, for your opening

 14 remarks and comments.

 15 Just a few logistics for everyone. When

 16 you want to speak, please press the button on the

 17 microphone. To the extent you want to make a

 18 comment, please put your name card on its side so

 19 we can go to you following my presentation of the

 20 recommendations.

 21 So to give everyone a bit of background,

 22 obviously, there have been several months of calls
 11

 1 and coordination with all the participants in this

 2 room around what recommendations we wanted to make

 3 today. The first panel is going to address in

 4 particular interdependencies between CCPs and key

 5 intermediaries in markets. The issue description

 6 is set out in the recommendations as set out today

 7 for everyone here, so I won't read through those.

 8 Okay, I'll speak up. But, you know, I'd like to

 9 summarize the recommendations that were made by

 10 this group to the CFTC.

 11 Around interdependencies. The first

 12 one, suggestion of incorporation of -- 

 13 incorporating in default drills the idea that one

 14 of the defaulting members is an institution who

 15 provides one of the larger liquidity obligations.

 16 Recommendation two. When looking at

 17 liquidity stress testing, move from potentially a

 18 cover one to a cover two analysis. Look at what

 19 the liquidity situation would be from a CCP

 20 perspective if two large clearing members

 21 defaulted, not just one.

 22 And three, disclosure of the diverse,
 12

 1 you know, disclosure of liquidity sources that the

 2 CCP has, obviously, in a manner which preserves

 3 confidentiality to a broader universe of a broader

 4 audience, you know, including regulators, clearing

 5 members, to be able to demonstrate the diversity

 6 of those liquidity sources to give greater

 7 clarity.

 8 Now, they were the three agreed

 9 recommendations with the group, but before we go

 10 into a little more detail, I'd like to open the

 11 floor to our CCP colleagues here to kind of give

 12 your thoughts on that. Obviously, before we go

 13 into this, there's been a number of initiatives.

 14 Obviously, the PFMIs around quantitative

 15 disclosures, you know, go live Jan 1 in 2016,

 16 which will address some of these, you know, some

 17 of these requests for increased disclosures, but

 18 there is potentially the gap that there will be

 19 more transparency required by the market

 20 participants I've just mentioned.

 21 So who would like to go first from a CCP

 22 perspective?
 13

 1 MR. CUTINHO: Hi, this is Sunil. I'm

 2 from the CME. In fact, as far as the

 3 recommendations are concerned, they are very good

 4 recommendations, and some of them are actually --

 5 in fact, most of them are addressed in the CFTC

 6 rules as well. When we -- there are a few things

 7 for us to keep in mind, so let's look at this

 8 topic of interdependence. I'm glad that the focus

 9 is on liquidity facilities. It's important that

 10 when we look at our liquidity facilities that we

 11 also take into account the potential failure of a

 12 member providing those facilities. The same goes

 13 for the repos.

 14 But when we talk of settlement banks and

 15 custodians, we've got to take a step back. There

 16 are a few things that are happening there. When

 17 we look at settlement banks, I believe, but I'm

 18 not sure, that the prudential regulators for banks

 19 are actually encouraging banks to avoid dependence

 20 on other SIFIs to settle with FMIs. So there is

 21 definitely a trend where we will see a lot of

 22 clearing members which are affiliated with banks,
 14

 1 especially systematically important banks who will

 2 actually settle with us directly.

 3 When you look at settlement banks, the

 4 way to think of settlement banks is they are an

 5 operational mechanism to actually move funds to an

 6 FMI. You know, it is impractical to expect every

 7 clearing member to have multiple settlement bank

 8 relationships. No settlement bank will support

 9 that. So I think the better solution there is to

 10 actually provide facilities for clearing members

 11 to actually pay the CCP directly at alternate

 12 banking centers if their primary settlement bank

 13 has failed. So that's a much better approach.

 14 Now, when we talk of custodians, the way

 15 to think of custodians is that, you know, they're

 16 not just providing services to a CCP. In fact,

 17 the custodians that CCP use are widely used by

 18 market participants for non-CCP activity. When it

 19 comes to custodians and settlement banks, it's

 20 important for not just CCPs but actually even our

 21 primary regulators -- the CFTC, the SEC, and FINRA

 22 -- to have a good insight into how such
 15

 1 institutions will perform under resolution,

 2 especially when the FDIC steps in. And so that is

 3 the clarity that I think we are missing, because

 4 when we look at these institutions and when we

 5 look at the actions of a resolution authority at a

 6 bank, we need to make -- we need to understand

 7 what actions will be taken, vis-à-vis the services

 8 provided not only to FMIs but to market

 9 participants. I think, we, as CCPS, with Tom's

 10 help, we actually wanted to have a session with

 11 the FDIC and get into not only these details but

 12 others.

 13 So as far as custodian banks, the market

 14 actually has reacted post-global financial crisis,

 15 and if you look at market participants these days,

 16 a large part of -- a large percentage of market

 17 participants would actually not use the same

 18 custodian services of a clearing member affiliate,

 19 but they would use a third party for their

 20 activities or the CCP. So it's important for CCPs

 21 to support a broad array of custodians, and I

 22 would request from the CFTC's perspective to also
 16

 1 look at CSDs because today CSDs -- U.S.-based CCPs

 2 cannot use, you know, security depositories in

 3 Europe, or based in Europe, or based outside the

 4 U.S. So it's important for the CFTC to look at

 5 it. I know the CFTC is looking at it, but those

 6 are all alternatives. So as you give market

 7 participants more alternatives, it's better for

 8 the industry.

 9 I'll yield my time now.

 10 MR. MCLAUGHLIN: Yeah, this is Dennis

 11 McLaughlin from LCH.

 12 So I do support the recommendations that

 13 have been laid out in the paper. I think they go

 14 some way, but probably not all the way, but some

 15 way towards addressing some of the real issues

 16 that we face. A lot of the problems that CCP

 17 actually faces comes down to liquidity in a number

 18 of ways, and we do partly address these in the

 19 recommendations.

 20 The first way is that if there was a

 21 stress event in the market, then by virtue of the

 22 way the VM, the variation margin calls work, the
 17

 1 CCP would find itself drowning in cash. And under

 2 current rules, it is very, very difficult to find

 3 a home for that cash, and these tend to be

 4 overnight rules. We have to, especially client,

 5 that we would have to be able to deposit them 

 6 within the rules. So it argues for some kind of

 7 mechanism to help CCPs to have a deposit account

 8 somewhere that's not with commercial banks. So

 9 this could be like a central bank account or

 10 something like that. It's not a credit risk

 11 because the CCP is depositing cash so there's no

 12 credit involved.

 13 This question of liquidity also arises

 14 in the portability question because especially for

 15 clients, if there is a member default and that

 16 member has a lot of clients, then, of course, we

 17 can operationally work out how to port the clients

 18 but there's no guarantee that there would be an

 19 existing nondefaulted member who would actually

 20 take those clients in the stress event. And this

 21 is linked to many problems such as the declining

 22 capacity for FCMs that are available, particularly
 18

 1 caused by the repo market shrinking balance sheets

 2 that we are seeing in the markets today as a

 3 result of the supplementary liquidity ratio, et

 4 cetera.

 5 So the third point that I'd like to make

 6 is that this liquidity thing keeps coming back in

 7 many, many different ways, and one of the ways is

 8 if you look at the way the CCP has to -- when a

 9 default event happens, the CCP has a lot of

 10 margin. Its noncash margin that it has to

 11 instantly turn into cash, and this is linked to

 12 the problem that is addressed in this paper of the

 13 other financial institutions that are not banks,

 14 that are not members, but things like Sunil was

 15 talking about, custodians, settlement platforms,

 16 et cetera. If there's a problem in one of those,

 17 then, of course, from a financial resource

 18 perspective, the CCP has enough financial

 19 resources but there is a liquidity problem because

 20 those financial resources cannot be transformed

 21 into cash at the drop of a hat. So some other

 22 kind of mechanism is required because obviously
 19

 1 the CCP can't -- it's a third party. It cannot

 2 really do that much to affect this transform, so

 3 particularly if it's a market infrastructure

 4 player, some other mechanism to free up the cash,

 5 free up the bonds to turn into cash is required.

 6 So these recommendations all go towards the

 7 liquidity problem, and obviously there's more that

 8 can be done but these are certainly your first

 9 start.

 10 The final thing I'd like to point out is

 11 liquidity also affects the investment activities

 12 of the CCP because the CCP, by virtue of the fact

 13 that it has so much margins from clients that it

 14 needs to manage, must be able to put those margins

 15 somewhere. And it does so right now primarily in

 16 the repo market because under various regulations

 17 it's restricted as to where it can place the cash.

 18 And so therefore, the availability of capacity in

 19 the repo market plays a key role in the CCP's

 20 day-to-day activities. And this capacity is

 21 shrinking. So again, the ability of the CCP to

 22 access liquidity is what's really the driving
 20

 1 force, I think, behind a lot of these

 2 recommendations.

 3 I'll leave it there. Thank you.

 4 MR. CUTINHO: I just -- wow, now it is

 5 working. Okay. I just wanted to add a few things

 6 to what Dennis was talking about.

 7 In terms of CFTC rules, I think there is

 8 a rule, 39.33, that really talk about noncash

 9 collateral, so it has to -- if a CCP decides to

 10 take noncash collateral, it has to have a

 11 commented or prearranged, reliable facility. And

 12 two things there. One is a CCP like ours, we have

 13 a facility and then it's also transparent. So

 14 it's a diverse set of sources that are 27 members

 15 who participate in this commitment today, and

 16 they're not all clearing members. They're not all

 17 affiliates of clearing members, but it's -- the

 18 important thing there is you cannot expect a

 19 liquidity facility or a large liquidity facility

 20 to be provided independent of banks. Banks are an

 21 important part of the financial infrastructure, so

 22 they are in the business of providing liquidity.
 21

 1 So, of course, CCPs are looking at a diverse set

 2 of nonbank sources, but even if you look at

 3 nonbank sources, they are going to use a bank in

 4 some capacity. So I think it's important to keep

 5 that in mind.

 6 The other issues that Dennis is talking

 7 about are issues that are not specific to the U.S.

 8 but are in Europe where 95 percent of your cash,

 9 which is taken as margin, has to be converted to

 10 collateral through a repo system. We agree with

 11 Dennis that in times of stress, you will see

 12 actually a lot more cash come in. It just

 13 exacerbates the problem that a CCP would have in

 14 such a jurisdiction, especially if the repo market

 15 is also having issues.

 16 MS. O'FLYNN: Can I just ask a question?

 17 You know, thank you very much for your input but I

 18 think, you know, it's back to Dennis's second

 19 point, and Sunil, I think you've just raised it

 20 there. How from a CCP perspective have you kind

 21 of changed your, I suppose, liquidity and

 22 diversification in recognition of the fact that
 22

 1 the repo markets are shrinking given the

 2 (inaudible) constraints that a lot of core banks

 3 have and the accessibility of getting either cash

 4 or securities in good times and in stress times?

 5 MR. CUTINHO: I'll answer. I think

 6 Kevin wants to answer as well. So I'll kick it

 7 off.

 8 The way we look at it, we look for a

 9 diverse set of sources. There are some nonbank,

 10 you know, investors who are interested in this

 11 market as well, but the market hasn't developed

 12 yet. It is still in the process of it. I know

 13 our colleagues at the OCC, they have managed to do

 14 that. But the price is still higher. So to the

 15 extent that the prices are not as competitive as

 16 banks offer, you'll have a lot more banks in the

 17 facility versus investors. But that natural

 18 balancing act will take place as time passes on

 19 because some of the rules -- in fact, for the

 20 liquidity facility, the capital rules that impact

 21 -- directly impact banking institutions is LCR,

 22 and to the extent that gets phased in, you will
 23

 1 see a lot more balance in the market.

 2 MR. MCCLEAR: Good morning. Before I

 3 get into the specific question I'd just like to

 4 make a few introductory remarks on behalf of

 5 myself, Kevin McClear. I'm ICE's corporate risk

 6 officer.

 7 First of all, I wanted to thank the

 8 Commission and the panelists and the marketplace

 9 for including ICE. We own and operate seven

 10 clearinghouses, so we're very familiar with these

 11 issues. I'll echo both what Sunil and Dennis

 12 said. These issues, these recommendations,

 13 they're not new to us. As Sunil pointed out, many

 14 of them fall under our regulatory regime, so we're

 15 already addressing them. Many of them we're

 16 working on, and any outstanding ones we look

 17 forward to working with the Committee and the

 18 marketplace, the users to resolve the issues.

 19 The questions around interdependencies

 20 and interconnectedness are involved. As pointed

 21 out in the recommendations, they touch upon

 22 liquidity facilities, repo lines, macro hedging
 24

 1 strategies, settlement services, custodian

 2 services, but as we've noted early on, they all

 3 eventually come to liquidity, the question of

 4 liquidity. And to answer your specific question,

 5 what are the clearinghouses doing? What is ICE

 6 doing? Like Sunil, we're starting to explore,

 7 because the repo lines, they are tight. We're

 8 finding it hard to find the repo counterparties,

 9 the repo transactions are expensive, and quite

 10 frankly, we don't know if they're reliable.

 11 They're commercial agreements, and the entities

 12 that we enter into these repo transactions with

 13 will be facing stress like us during these unique

 14 market conditions and they'll have their own

 15 liquidity needs. We hope they honor their

 16 commercial relationships or obligations, but we

 17 don't know for sure. So we are exploring nonbank

 18 facilities like OCC did. There's a lot of pension

 19 money out there, but those are in the exploratory

 20 stages.

 21 The best and safest place to place this

 22 cash we're talking about would be with the central
 25

 1 bank. Now, at ICE Clear Credit, we're SIDCO.

 2 We're systemically important, and we have the

 3 ability under Title XIII -- had the ability to

 4 apply for an account. We have an account and

 5 frankly, that's where we put most of our cash.

 6 That's the safest, most liquid source for our

 7 cash. At ICE Clear Credit I should say, we're

 8 fundamentally liquid to begin with. Forty-five

 9 percent of our margin and guarantee fund

 10 requirement has to be in cash. U.S. dollar if

 11 it's a U.S. Dollar contract, or euros if it's a

 12 euro contract. Twenty percent can be in U.S.

 13 dollar cash and U.S. treasuries, and then 35

 14 percent can be in U.S. dollar cash, U.S.

 15 treasuries, or G7 currency. So we're highly

 16 liquid to begin with, but we do hold a lot of

 17 treasuries, and we've been saying these repo

 18 facilities are hard to obtain, maybe not reliable.

 19 We think the best source to get treasury liquidity

 20 would be the Fed. We don't want to borrow money

 21 but we think we should have access to the discount

 22 window to give the Fed our treasuries at a
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 26

 1 haircutted rate, say 105 percent U.S. Treasuries

 2 for cash, only in exigent circumstances. Only

 3 during times of stress, not as business as usual.

 4 I'll just tick through a couple of the

 5 other points that Susan raised, too, because I

 6 think it's important for everybody to understand

 7 that the clearinghouses are dealing with these

 8 issues. For instance, with the interconnectedness

 9 and interdependencies of those institutions I

 10 mentioned, we've started to incorporate into our

 11 default test say a settlement bank failing at the

 12 same time a big clearing member fails. I think

 13 that's very important. Cover two you raised at

 14 ICE pursuant to our liquidity framework. We do

 15 cover two. We're looking at cover two.

 16 I think I've taken through -- oh,

 17 transparency. We are -- clearinghouses are highly

 18 transparent and I think maybe we need to do a

 19 better job of communicating with the marketplace

 20 how transparent we are. But if you look at our

 21 rules, look at our disclosure framework, we're

 22 highly, highly transparent with our regulators.
 27

 1 We're very transparent with our clearing members.

 2 And as Susan pointed out, starting January 1,

 3 2016, the CPMI IOSCO Public Quantitative

 4 Disclosure Requirements will commence. And you

 5 should go to CPMI IOSCO. You should look at those

 6 disclosure requirements. They are very

 7 comprehensive. They'll be, I think, almost too

 8 much information for the marketplace to digest,

 9 but it's all going to be there.

 10 With respect to disclosure about some of

 11 these interdependent relationships to a broader

 12 set beyond the regulators, beyond our clearing

 13 members to the marketplaces generally, we do have

 14 to be careful. We do have, as I say, commercial

 15 relationships. We do have confidentiality

 16 obligations, so we just need to be cautious about

 17 it.

 18 Thank you.

 19 MS. O'FLYNN: Okay, Clifford?

 20 MR. LEWIS: Thank you. I should try to

 21 fake a German accent so I sound more plausible as 

 22 a spokesman for my friends in Frankfurt.
 28

 1 But just three points. First, and most

 2 importantly, we, as my friends here are saying, we

 3 are supportive of the recommendations. Great job.

 4 And it's provided a useful guide to check that

 5 what we're doing on our own is appropriate, that

 6 we're following the best practice advice coming

 7 from a Committee like this.

 8 Two things in particular I want to

 9 mention, however, that are a little bit different

 10 about Eurex Clearinghouse, not necessarily as

 11 better but just to capture some of the regulatory

 12 and historical differences between our

 13 fundamentals and the fundamentals of American

 14 clearinghouses. First, much more emphasis on

 15 electronic trading drove a much different approach

 16 towards the infrastructure associated with the

 17 clearinghouse, and among other things, for

 18 example, that basically meant that the

 19 clearinghouse was designed to support full

 20 segregation at the customer level. From a

 21 technology or administrative perspective, that

 22 sort of technology capability frankly is probably
 29

 1 essential to realistically be able to address

 2 transferring thousands of subaccounts in

 3 real-time. It's hard to see how you could do that

 4 unless you built the system for that purpose at

 5 the beginning, and I know that there are big

 6 investments being made by my colleagues here, and

 7 I'm not suggesting that they don't have that

 8 capability. I'm just suggesting that some of that

 9 plumbing is very important at the clearinghouse.

 10 The second point I'd mention, which is

 11 perhaps even more important, two elements to

 12 which, Eurex Clearing is a bank. That's been a

 13 point of great controversy in the U.S.

 14 clearinghouses back to my day back at the late

 15 lamented Board of Trade Clearing Corporation that

 16 almost applied for a banking license about 25

 17 years ago. Being a bank has a number of factors

 18 that inherently address this. The German

 19 structure is a little bit different because

 20 actually, we are a systemically important bank. A

 21 lot of our pays and collect activity are done at

 22 the gyro accounts at the Bundesbank, which
 30

 1 obviously takes out a layer of risk in all of

 2 this. And I'm not suggesting that the banking

 3 license approach is the right approach; there are

 4 issues with that. But there's an interesting

 5 corollary of that which is worth noting in

 6 passing, which is when I go to the Supervisory

 7 Board in Frankfurt, I'm sitting next to a

 8 representative at the Board meeting of the

 9 Bundesbank in BaFin, the equivalent of CFTC. They

 10 attend the Supervisory Board meetings. Bundesbank

 11 in particular is intimately involved in the

 12 details of these liquidity management processes,

 13 and indeed, that's one of the key differences of

 14 having a banking license and access to the

 15 Bundesbank. And I know the other side of this as 

 16 Kevin was alluding to of having access to the

 17 discount facilities of the Fed is important. I'm

 18 just also pointing out that almost -- the work

 19 that the Committee has done in terms of bringing

 20 different parties together, there's also a

 21 governance issue in this, too, that in fact,

 22 getting close to the central monetary authority,
 31

 1 if ultimately that's going to become an important

 2 part of the process in a highly stressed

 3 environment, is very important to start doing.

 4 What Sunil said about getting together with FDIC,

 5 for example, so that actually there is some

 6 convergence between the resolution, the philosophy

 7 of resolving a large bank is not completely

 8 inconsistent at FDIC versus our world. But as I

 9 say, it is actually -- my observation is it is a

 10 wholesome thing to have the kind of relationship

 11 that has sprung from being a bank, from being a

 12 systemically important bank and having the kind of

 13 relationship that we have with the Bundesbank.

 14 MS. O'FLYNN: Any views from the sell

 15 side or buy side?

 16 MR. KLOET: I guess first I'd like to

 17 congratulate you, Susan, and the people that

 18 worked on this to put together these

 19 recommendations, and I'm very happy to hear the

 20 support from the CCPs with respect to these

 21 recommendations.

 22 I'm especially encouraged and would
 32

 1 support the idea of allowing, under certain

 2 conditions, the systemically important CCPs to

 3 have access to the Fed. I think that's -- I think

 4 that's really important, and being able to do that

 5 could help provide liquidity.

 6 There was one thing in the

 7 recommendations that I just wanted to understand a

 8 little bit better because I'm not suggesting I

 9 don't agree with it but I just want to understand

 10 it a little bit better. When it came to the third

 11 element about -- that CCPs should demonstrate that

 12 they have access to sufficiently diverse liquidity

 13 resources, it talks then further about disclosure

 14 and it suggests that the disclosure of the

 15 information, which presumably is where they would

 16 be getting these resources from, should be limited

 17 to a defined universe. And I guess I'd like to

 18 explore, you know, why that should be the case, if

 19 not at least once a year we shouldn't get some

 20 information from where the CCPs are potentially

 21 relying on those liquidity resources. If it's a

 22 matter of competitive dynamics -- maybe that's
 33

 1 what it's all about -- I certainly don't think we

 2 should have in the public domain the pricing on

 3 any of that. But with respect to what the

 4 liquidity resources are, and in general, what

 5 category of other market participants might be

 6 giving liquidity resources, I just wonder about

 7 whether or not it's in the public interest that

 8 that be disclosed, at least on a once-a-year

 9 basis. And was curious what the thoughts were

 10 behind not disclosing that.

 11 MR. MCCLEAR: I can add a little color

 12 to that. One of the issues is a technical legal

 13 issue, so when we enter into these repo

 14 transactions with the big banks, there's a

 15 confidentiality provision that says that the

 16 agreement is effectively confidential, private. I

 17 think the solution will be -- and you'll find some

 18 of this in the CPMI IOSCO public quantitative

 19 disclosures, is to disclose and, again, regulators

 20 see this or clearing members see this, say the

 21 percentages, how much of our liquidity is

 22 dependent upon repo transactions, how much cash do
 34

 1 we hold, how much treasuries do we hold. I think

 2 if we reported broadly like that it should satisfy

 3 the need, as opposed to identifying each and every

 4 specific individual repo counterparty by name.

 5 MR. KLOET: To be clear, I guess my

 6 suggestion wouldn't be -- and I don't want to get

 7 into the micro part of this -- but wouldn't be to

 8 identify specific counterparties but rather, you

 9 know, we rely on banks to provide this much of our

 10 overall liquidity, nonbank and financial

 11 institutions provide this much of it, and the

 12 various assets. I would group it but I would

 13 think it would be in the public interests of the

 14 market participants to be able to know what the

 15 liquidity -- what the potential liquidity

 16 resources of the CCPS are.

 17 MR. CUTINHO: Yeah, you have a fair

 18 point. In fact, our facility is public. It's

 19 actually on our website. So there's nothing wrong

 20 in putting the sources.

 21 MS. O'FLYNN: I think maybe, you know,

 22 is the ideal state -- and maybe this is where the
 35

 1 CFTC can play a role is understanding the mix of

 2 committed versus uncommitted and a sector

 3 concentration with say large clearing members.

 4 You know, obviously preserving confidentiality is

 5 critical, but I think, you know, it's kind of, I

 6 suppose, framing the liquidity playbook that you

 7 each have and, you know, kind of, I suppose,

 8 ultimately being able to kind of give greater

 9 clarity around exposure you have to any particular

 10 sector of client base, be it a bank, nonbank, or

 11 potentially even a customer. That's just an

 12 observation.

 13 MR. KLOET: Susan?

 14 MS. WALTERS: Kristen.

 15 MR. KLOET: Oh, I'm sorry. Kristen?

 16 MS. WALTERS: Thank you. Thanks, Susan,

 17 for organizing and doing so much work on the

 18 Committee. And thanks to Commissioner Bowen and

 19 Petal as well. We very much appreciated

 20 participating.

 21 You know, these issues around liquidity

 22 are very real. I mean, there indeed has been a
 36

 1 secular shift in liquidity post-financial crisis,

 2 and many of the regulations that were implemented

 3 post-financial crisis that have impacted dealers'

 4 capital, liquidity, and so on and so forth, they

 5 were intended. They were necessary, but they do

 6 have a very meaningful impacts in this space. And

 7 so there is less liquidity. There are fewer

 8 participants. There has been tremendous

 9 compression in the number of FCMs clearing

 10 members. The CCPs are small in number, and in

 11 some respects, you know, small monopolies, which I

 12 think makes transparency very, very important.

 13 Kevin, you were speaking about

 14 transparency, and I know there has been a

 15 concerted effort by everyone kind of in this room

 16 over the last year to make sure there is

 17 sufficient liquidity and transparency. From a buy

 18 side perspective -- and we'll talk about this a

 19 bit more in our third session -- I just want to

 20 highlight that, you know, so again, as an asset

 21 manager, we're a fiduciary on behalf of clients.

 22 We don't have assets. We don't have transactions
 37

 1 that are physically being cleared. We don't have

 2 skin in the game ourselves. However, we do have

 3 the fiduciary responsibility to make sure that we

 4 understand the counterparty risks that our clients

 5 have when they're clearing transactions on

 6 exchanges. In the current environment, we

 7 actually -- our counterparty credit risk team that

 8 independently vets, you know, 800 counterparties

 9 that we transact on behalf of clients against

 10 every year, prefinancial crisis we had the ability

 11 to do proper due diligence for every counterparty

 12 with whom our clients transacted. So if it was in

 13 the traditional bilateral OTC derivatives markets,

 14 that was with banks, and we had the ability and we

 15 did do very extensive and robust and comprehensive

 16 due diligence to understand the financial

 17 condition of the counterparties, as well as, you

 18 know, the ISDA agreements themselves, laid out all

 19 relevant issues around margin, potential to

 20 exposure, what happened in the instance of

 21 insolvency, and so on and so forth.

 22 And so there was risk in those
 38

 1 transactions and that market structure, and we

 2 believe that the risk in the current market

 3 structure, the cleared approach, is actually

 4 theoretically much better. However, we still

 5 struggle because, you know, as a fiduciary, we are

 6 currently not able to do the type of due diligence

 7 that we need to do on CCPs. So we do not have

 8 access currently to the loss-absorbing resources

 9 of the CCP. We do not know how stress tests are

 10 conducted. We don't know the amount of potential

 11 losses that could occur in the instance of a

 12 single or multiple clearing member default, and we

 13 simply don't know in the instance of default

 14 whether or not our clients will be made whole or

 15 the market itself will be made whole. And I think

 16 that we need to think about these issues very,

 17 very seriously and come up with solutions. So

 18 when regulated entities like banks, you know, it's

 19 a bit of an open kimono in today's market. I

 20 mean, every single -- I mean, the banks hold

 21 capital, they do stress tests that are overseen by

 22 regulators. They are held to all kinds of very,
 39

 1 you know, to be honest, constraining capital and

 2 liquidity measures. And I think that's for good

 3 reason. And in this environment where we've

 4 shifted to central clearing, I think that we

 5 really have to ask our CCP counterparts to be held

 6 to the same standards, to have appropriate levels

 7 of their own capital against losses, and to fully

 8 disclose every single detailed component of loss

 9 absorbing calculations, margin methodologies, and

 10 stress tests. And I think it should be done in a

 11 way that's consistent and can be measured across

 12 CCPs. I know that we're trying to move in this

 13 direction, that everyone is on the same page, but

 14 I just want to highlight that today, you know, I

 15 speak for BlackRock, but I think, you know, Angela

 16 will speak later, and others who we worked with on

 17 this SIFMA -- AMG kind of drafted the buy side's

 18 views of this space -- is that it's something that

 19 the buy side sector is very, very concerned about

 20 and we view it as a real issue that needs to be

 21 addressed and solved.

 22 MS. O'FLYNN: Andrew?
 40

 1 MR. GRAY: I just wanted to, along with

 2 my CCP colleagues, again thank the Commission for

 3 including DTCC in these discussions.

 4 On the topic of best practices and

 5 default management, as has been stated in the

 6 recommendations, a number of the recommendations

 7 actually don't necessarily apply to security CCPs

 8 because we operate a bit differently from

 9 derivative CCPs. But nonetheless, there are some

 10 items here, all this data that apply across all

 11 CCPs. We've been speaking about

 12 interdependencies. Interdependencies are, I

 13 think, a very critical topic for the industry and

 14 for the CCPs. At DTCC, we've done quite a bit of

 15 work in looking at interdependencies that we have

 16 with a vast array of institutions, some of whom

 17 are currently members that includes liquidity

 18 providers, settlement banks, investment

 19 counterparties, trade sources, so on and so forth,

 20 and we've done quite a bit of work to look at

 21 where we have exposures to each of those entities

 22 and what we can do to reduce those exposures. So
 41

 1 some of the things my colleagues have discussed

 2 with respect to diversification of liquidity

 3 providers and liquidity sources, diversification

 4 of investment counterparties, are things that we

 5 are also doing at DTCC.

 6 I will also point out as Kevin has said

 7 that with respect to our default drills or

 8 closeout simulations, we are looking at what

 9 potentially happens if one of those interdependent

 10 counterparties fails, so above and beyond the

 11 defaulting entity. And as is the case with all

 12 the CCPs and as required by the CPMI IOSCO PFMIs,

 13 we do look at liquidity stress testing and we look

 14 at the impact of potentially losing liquidity

 15 providers. So many of the things that my

 16 colleagues have spoken about with respect to what

 17 we need to do to manage those interdependencies,

 18 particularly in the liquidity space, we are also

 19 doing at DTCC.

 20 I would encourage us to continue to make

 21 sure that as we move forward we coordinate with

 22 the work that's being done by the CPMI IOSCO
 42

 1 group. We have talked about the fact that there

 2 will be quantitative disclosures that will be

 3 publicly available come the beginning of the year.

 4 We're all working very hard on making sure that

 5 that information is available, and I think that

 6 should address some of the concerns, Kristen, that

 7 you've raised with respect to disclosure. And 

 8 transparency, I think for all of us, has been very

 9 important. We address it through a number of

 10 different means, including disclosure. We also

 11 have involvement from our clearing members on our

 12 various risk committees. We have multiple forums

 13 that involve our clearing members to ensure that

 14 they understand what we're doing and how we are

 15 reducing risk to the system.

 16 MS. O'FLYNN: Richard Miller?

 17 MR. MILLER: Good morning, Susan. Thank

 18 you. I was struck by the fact that a number of

 19 the speakers have endorsed the idea of having

 20 access to the Fed discount window in times of

 21 exigent circumstances. And I would just point out

 22 that what we're talking about when we say that is
 43

 1 that the amendments that were made to Dodd Frank

 2 raise barriers to having access by CCPs so that it

 3 becomes a more political and more difficult

 4 process, which is a change in policy from what has

 5 existed at the Fed for 80-some odd years and the

 6 powers that the Fed had at the time of the last

 7 financial crisis, which proved to be very

 8 successful in the crisis. And speaking as an

 9 end-user that is compelled by law to use clearing

 10 services and the CCPs -- we have no choice but we

 11 have to do it -- it would be an irony of historic

 12 circumstances proportions if in a crisis a CCP

 13 faced a liquidity constraint and could not access

 14 the discount window successfully, and financial

 15 end-users like ourselves suffered damages,

 16 financial damages because of that. I think that

 17 the policies reflected in Dodd-Frank, some of them

 18 are very good, but this one I think is erroneous.

 19 I hope that we can address this in further

 20 deliberations of the MRAC.

 21 MS. O'FLYNN: Commissioner Wasserman?

 22 CHIEF COUNSEL WASSERMAN: Hi, I'm Bob
 44

 1 Wasserman, CFTC staff.

 2 Just a couple of things. I know a

 3 number of folks have mentioned the quantitative

 4 disclosures, and as has been pointed out, those

 5 are going to be coming in no later than the first

 6 of the year, and I think that should be very

 7 helpful. I should note that CPMI and IOSCO are

 8 also doing some current reviews of the

 9 requirements in the areas of stress testing and

 10 margin and recovery and others, and I think

 11 transparency as well, and perhaps added

 12 transparency may well be part of that. Folks have

 13 been talking a lot about liquidity by sector and

 14 that is quite important. However, also in

 15 considering your liquidity arrangements, it's also

 16 very important how much you have to any one

 17 counterparty or any two counterparties because who

 18 is going to fail, assuming the arrangements are

 19 taken, don't have, you know, if you can have

 20 multiple folks who can fail just because one

 21 doesn't participate, that would obviously be quite

 22 problematic. I think you want to look at then
 45

 1 individual failures and what coverage do you have

 2 and do you have coverage that will address

 3 essentially that you have enough despite the fact

 4 that one or two of your counterparties fails

 5 whichever sector they may be in.

 6 Now, there is, of course, one

 7 counterparty that is considered a perfect credit

 8 in terms of depositories and that would be the

 9 central bank of issue. And those -- as Kevin

 10 pointed out, those folks who are SIDCOs are able

 11 to apply for account services, and progress has

 12 been made with respect to account services on the

 13 house side. Our colleagues at the Fed are still

 14 working on account services on the customer side,

 15 and we do hope for progress in that area.

 16 MS. O'FLYNN: Okay. I'm just conscious

 17 of time. We'll go to Sunil, then Emily, and then

 18 Marcus.

 19 MR. CUTINHO: I want to address a few

 20 comments on liquidity. So you know, as CCPs, we

 21 don't take that into account when we size our

 22 liquidity resources to cover the stress losses.
 46

 1 We don't assume that central banks will be there.

 2 The issue that I think Kevin is talking about is

 3 the things that the Bank of England has addressed.

 4 Essentially, if we are assuming -- if we're

 5 assuming that the entire repo market has failed,

 6 if we're assuming that there is no buyer for U.S.

 7 Government Treasuries, you know, sovereign bonds,

 8 then it doesn't make sense for us to assume that

 9 our clearing members will have access. So that

 10 scenario doesn't really make sense. So

 11 essentially, those are exigent circumstances. So

 12 it will be unreasonable for us to sit here and

 13 theoretically assume that a central bank will not

 14 be there because the issues won't be restricted or

 15 won't be localized to just CCPs because at that

 16 point in time you have serious issues in the

 17 financial system as a whole.

 18 So if a central bank is providing those

 19 facilities for certain entities in the system as

 20 let's just say bank entities who have access to

 21 the Fed, then the question is, why wouldn't CCPs

 22 who have this collateral from these entities also
 47

 1 have access, essentially avoiding a circuitous

 2 process as to going through the banking system.

 3 That's essentially what we're talking about here.

 4 The second response -- I want to respond

 5 to a few things that Kristen brought up. I'm just

 6 a little surprised with the comments because there

 7 are a few things when we talk of transparency that

 8 are available. There is public, what is available

 9 on our website on our rule book and is disclosed

 10 openly to all our market participants, and then

 11 there is the second level of transparency is where

 12 a CCP is subject to routine credit reviews. We've

 13 had several, both from clearing members, as well

 14 clients who come and do credit reviews.

 15 The thing about transparency is there is

 16 a line. We have to be very careful. You cannot

 17 compromise the integrity of the system. We cannot

 18 show one set of clients the risks that are brought

 19 by another set of clients. That in a sense is the

 20 problem here. So I don't think you're referring

 21 to that, but if you're talking about the total

 22 amount of resources available, that information is
 48

 1 actually available publicly.

 2 So if the question is on stress testing, 

 3 the stress testing methodologies, all the

 4 information related to stress testing is

 5 available. I think what we're arguing about here

 6 is, you know, certain disclosures that are, you

 7 know, available through CPMI IOSCO starting in

 8 January, and that will actually give you more

 9 information at an aggregate level. Again, not

 10 giving you specific risks from each client but at

 11 an aggregate level. If it is scenarios, I think

 12 the discussion is about standardized scenarios or

 13 standardized principles and I think the argument

 14 in the industry, at least from our CCPs is

 15 principles are much more powerful because that's

 16 something that allows -- market risks are evolving

 17 and a CCP should react to those evolving

 18 circumstance and add scenarios. See, if we just

 19 rely on a standard set of stress tests that don't

 20 change, then you'll get a false sense of comfort

 21 if somebody passes that test. So that's

 22 essentially what we're talking about. So I'm just
 49

 1 surprised that you say you have less transparency

 2 now versus your counterparties in the bilateral

 3 space.

 4 MS. O'FLYNN: Do you want to respond to

 5 that and then move to Emily?

 6 MS. WALTERS: Sure. So yes, the

 7 unfortunate truth is we just don't have the same

 8 level. I mean, ISDA documentation sets forth some

 9 very detailed requirements around transparency and

 10 information that's provided, and the

 11 standardization of that approach makes

 12 transparency and due diligence analysis easier and

 13 consistent across counterparties. We don't have

 14 it yet in the space. I think the disclosures that

 15 are coming in January will, if they're implemented

 16 as written, will help around -- they're not there

 17 now. They'll help around loss absorbing

 18 capabilities as well as margin methodology. In

 19 the stress testing space, the language is a lot

 20 lighter in those quantitative disclosures, so we,

 21 at the moment, don't think -- I mean, we currently

 22 don't have what we need and we don't think we have
 50

 1 enough. You know, as someone who has been, you

 2 know, kind of doing risk management for close to

 3 25 years now, what I would say is that I think the

 4 financial crisis lessons learned, you know, the

 5 banking regulators, you know, did learn some

 6 pretty key lessons about how to resolve, you know,

 7 financial institutions and how to assess capital

 8 adequacy, living wills, and so on and so forth.

 9 And you know, there are some limiting assumptions

 10 in the stress test, but what is very good about

 11 using a standardized approach, and to be honest,

 12 the scenarios do change all the time when they're

 13 conducted, is that the methodology is consistent,

 14 the results are reported in a consistent way, and

 15 it's very -- it's much simpler to evaluate the

 16 results when there is standardization. We also

 17 take much more comfort around a regulator,

 18 overseeing the stress tests themselves, so

 19 overseeing the results, and also the fact that

 20 there is public disclosure.

 21 You know, we do, as an asset manager,

 22 you know, with, I would say 6,000 individual
 51

 1 fiduciary accounts that we manage, assets on

 2 behalf of clients, we do liquidity risk stress

 3 testing on those portfolios, so we look at the

 4 profile of assets over time, of liabilities, i.e.,

 5 potential redemptions, and we do all kinds of

 6 stresses to look at how the market to market of

 7 the assets can change, ability to liquidate

 8 positions, and on potential redemption likelihood.

 9 And it's a different problem set, but I can tell

 10 you that -- and we've invested over 30 years

 11 massive amounts of human capital and financial

 12 resources in developing technology platforms and

 13 analytics to do this, and it's really hard. And

 14 the results are -- I wouldn't say speculative, but

 15 these are ex-ante measures that, you know, are not

 16 easy to be precise about. So we're asking for

 17 more standardization, more comprehensiveness and

 18 oversight by regulators because, you know, we,

 19 ourselves, have experienced great difficult and

 20 complexity with applying similar types of stress

 21 tests to the assets we manage on behalf of

 22 clients. So I think the view is if it's tough for
 52

 1 us and we've, you know, invested in this for 30

 2 years, I think it's really difficult given, you

 3 know, the change in liquidity and the dynamic in

 4 the market for any individual CCP to do it without

 5 benefitting from standardization accorded by, you

 6 know, a regulatory umbrella and oversight function

 7 that's proven to have worked post-financial crisis

 8 for banks.

 9 MS. PORTNEY: Hi. Can you hear me?

 10 CHAIRMAN MASSAD: Yes.

 11 MS. PORTNEY: Thank you, Susan. Thank

 12 you, Commissioner Bowen and Petal for doing such a

 13 great amount of work on all of this.

 14 A few very quick comments in the

 15 interest of time. On disclosure, I think we are

 16 very much in agreement with Kristen. As a

 17 clearing member, we always can -- we come some way

 18 in further disclosure but we certainly can do a

 19 lot more. But I really want to actually, given

 20 the time we have, talk about just access to the

 21 Fed and exigent circumstances.

 22 This is one issue where I think you will
 53

 1 find that all market participants are incredibly

 2 aligned, and I couldn't agree more with some of

 3 the comments that Sunil, that you were just

 4 making. I think -- and the reason we're aligned

 5 is not at all because we want to take taxpayer 

 6 bailout or because it's easier; it's because in

 7 the absence of that, the rules which are now being

 8 put in place are basically rule-based liquidity

 9 facilities, like CCLF or DTCC, which is highly

 10 unpopular and basically you're actively allocating

 11 liquidity out to banks at the worst possible time.

 12 Committed repo lines. Again, doing exactly the

 13 same thing at the worst possible time when the

 14 repo market might be closed down. Payment in kind

 15 arrangements whereby our treasuries and other

 16 things that are on deposit are suddenly

 17 substituted without any say for -- or sorry, our

 18 cash is substituted with other securities without

 19 any way, and again, leaving a liquidity drain on

 20 members and others. And finally, variation margin

 21 haircutting, which absolutely impacts the

 22 end-user.
 54

 1 So the reason -- and I think we were all

 2 saying -- you know, Sunil, you said it very well.

 3 In the absence of any certainty here, we are all

 4 spending a hell of a lot of time implementing

 5 rules and other things which are frankly just not

 6 going to be reliable at the worst possible time.

 7 And so would it be better to at least give us more

 8 clarity as to when perhaps the Fed would step in,

 9 for which institutions, and under what

 10 circumstances, especially given that the

 11 collateral we're talking about is generally

 12 treasuries and agencies, et cetera. And

 13 especially when other institutions, other central

 14 banks around the world have acknowledged that in

 15 the worst possible crisis, this is the only thing

 16 that really can be done to restore confidence in

 17 the markets.

 18 MR. STANLEY: Hi. I want to apologize

 19 first of all for being late there. Dodd-Frank

 20 just does not slow down and there are multiple

 21 things going on that I had to attend to.

 22 I wanted to comment on this issue of
 55

 1 discount window access. This is something that is

 2 very controversial for us. We have some deep

 3 disagreements with the direction with some of the

 4 recommendations from market participants here. I

 5 have to say I'm not too surprised that market

 6 participants would be aligned in getting

 7 assistance from somebody else who is not a market

 8 participant in the event of difficulty.

 9 I do think that one thing -- a couple

 10 points. I think it's important to be clear that

 11 when we talk about the discount window, we're

 12 really not talking about treasuries. We can say

 13 around this table that we're just talking about

 14 treasuries, but what's special about the discount

 15 window is that it i's designed to take illiquid

 16 collateral from banks. It is designed to take a

 17 wide range of collateral. And actually, the

 18 Federal Reserve has plenty of authorities that are

 19 not the discount window that allow it to liquefy

 20 treasuries. The most obvious being section 14 of

 21 the Federal Reserve Act permits open market

 22 operations. Obviously, unlimited buying and
 56

 1 selling of treasuries. I would expect in exigent

 2 circumstances the Fed would be a buyer. Section

 3 13-13 of the Federal Reserve Act permits advances

 4 on treasuries without exigent circumstances.

 5 There's no exiting circumstances qualification in

 6 section 13-13. So these are all existing

 7 authorities that are not the discount window that

 8 allow the liquefying of treasuries.

 9 And what's special about the discount

 10 window, again, is it accepts illiquid collateral,

 11 and the justification for that was precisely to

 12 permit banks to take some risks on potentially

 13 illiquid collateral. You know, this goes back to

 14 the purpose of the Fed as supporting farm

 15 financing and the like. Clearinghouses really do

 16 not have that need. Clearinghouses are not

 17 entities that should be investing in illiquid

 18 assets. And we just have some serious concerns

 19 about undermining incentives for proper liquidity

 20 management by permitting some kind of expedited or

 21 easily forecastable access to the Fed for

 22 liquidity. As everyone here knows, liquidity risk
 57

 1 management is at the center of what clearinghouses

 2 do and we don't want to weaken those incentives,

 3 and we also frankly think Congress spoke pretty

 4 clearly in Dodd-Frank that this should not be a

 5 routine matter.

 6 MS. O'FLYNN: Okay. Well, thank you,

 7 everyone for the feedback. To summarize, I think,

 8 you know, where the group has effectively -- we

 9 need a coalition of the willing to move forward is

 10 the best way to describe it, and you know, I think

 11 there is definitely, you know, as Counsel

 12 Wasserman said, you know, the PFMIs in January

 13 will create, I suppose, more transparency in the

 14 marketplace for institutions to understand a lot

 15 of these questions which are being asked to CCPs.

 16 I think what we need to be prepared for is that

 17 there may be gaps in the disclosure around what

 18 market participants want and it's effectively how,

 19 you know, we evolve together as a marketplace to 

 20 see how we solve for those potential disclosure

 21 gaps. And obviously, with regards to liquidity

 22 management, you know, it's a very important topic.
 58

 1 CCPs are becoming ever bigger. Monetary clearing

 2 goes live in Europe next year, so volumes will

 3 just get -- will increase. And, you know, this

 4 whole topic around liquidity management, be it

 5 for, you know, investing your cash, you know,

 6 emergency liquidity access, I think it's obviously

 7 a critical point of focus for every single

 8 clearing member participant. Obviously, we've

 9 heard some quite diverse views here today, but

 10 that's the purpose of the RMAC.

 11 So, you know, with that, I thank

 12 everyone for being, you know, as open as they have

 13 been, and we look forward to the CFTC as to how we

 14 move forward.

 15 MS. WALKER: Thank you, Susan, for that.

 16 And the first panel is now concluded. We will

 17 start the second panel in about five minutes at

 18 11:15.

 19 (Recess)

 20 MS. WALKER: Okay. So we'll be starting

 21 off our second panel now. Once again, we have

 22 Susan O'Flynn, of Morgan Stanley, who will be
 59

 1 moderating our second panel.

 2 MS. O'FLYNN: Okay. Panel number two is

 3 on Portability and FCM Resource Availability, a

 4 topic that was widely discussed at, you know, I

 5 think either the first or second RMAC,

 6 specifically around two kind of key areas of

 7 focus/concern.

 8 Number one, financial resource

 9 availability, and number two, operational resource

 10 availability. There's been, you know, it's been

 11 discussed, you know, ad nauseam in the marketplace

 12 and in this particular room around, you know, the

 13 constraints FCMs have today in the new regulatory

 14 environment. And the, you know, the purpose of 

 15 this panel is to understand the availability of

 16 FCMs in the event of a large FCM default. And we

 17 want to focus on, you know, I suppose, the CCP

 18 responses to the new regulatory environment and,

 19 you know, to understand portability in this new

 20 world. And from a financial resource perspective,

 21 you know, how is portability envisaged in this new

 22 world? Is there an understanding that there will
 60

 1 be an FCM to be able to absorb the customers of

 2 the defaulting FCM? Or does portability have a

 3 plan B? Is the margin adequate to be able to

 4 support a period during which the transition of

 5 those customers takes some time? And also,

 6 secondly, to understand whether new models are

 7 emerging that may replace the traditional FCM

 8 model, i.e., is it a sponsorship model or is there

 9 potentially direct access for clients? This is

 10 obviously taking -- getting some traction in

 11 Europe, but obviously has some regulatory

 12 constraints in the U.S.

 13 And secondly, around operational

 14 readiness with regards to porting. You know, from

 15 an infrastructure perspective, and I think

 16 Clifford mentioned that in the previous panel, you

 17 know, is there investments needed to be made from

 18 an infrastructure perspective, from a CCP

 19 perspective, to, you know, to be able to

 20 facilitate that portability, to understand

 21 whether, you know, the question of the

 22 availability of FCMs for smaller members. You
 61

 1 know, do they have more than one FCM or is there

 2 an ability for them to have another FCM to do cost

 3 issues? And from a kind of readiness perspective,

 4 do we involve customers in fire drills today or

 5 the recommendation was that customers should be

 6 involved in fire drills to kind of simulate

 7 porting, to understand from, you know, again, an

 8 operational readiness perspective, and then also

 9 an analysis from a financial resource perspective

 10 the available FCMs for those particular customers.

 11 So you know, I'd like to take the same 

 12 format as we took before, turning over to our

 13 clearinghouse members to, you know, respond first

 14 to this, as to what you do today, you know, and

 15 how you've responded to this evolving market,

 16 because I know a number of you have commented in

 17 this particular forum that you already are

 18 responding to the shrinking FCM market and, you

 19 know, how you see this, you know, moving forward

 20 given 2018 is getting ever closer.

 21 MR. CUTINHO: I'll kick it off. Very

 22 quickly, I think, let's start with -- let's start
 62

 1 with -- let's take a step back and I'll share a

 2 little bit about our experiences with porting.

 3 You know, in our experience, the important thing

 4 about porting is to ensure that the customers have

 5 continued access to the markets. That is very

 6 important. And in order to do that, and this has

 7 been our experience in even a very complex event

 8 in 2011, in order to do that, the most effective

 9 way of porting actually is to port a group of

 10 customers at a time. You cannot pick and choose.

 11 We use something called a negative consent, so

 12 essentially, if the customers of the failed FCM

 13 are notified that they're going to a new home, and

 14 then the, you know, the customers maintain access

 15 but then they can discuss with the FCM and move

 16 their positions to their eventual home. So that

 17 in essence has worked out very effectively.

 18 What are the challenges to that? I

 19 think if you look at today's environment, let's 

 20 take a step back, the most important thing, our

 21 success is based on the fact that we had gross

 22 margining regime. So having margins, enough
 63

 1 margins, financial resources associated with those

 2 customers at the clearinghouse is very important

 3 because if there is not enough margin, you will

 4 not have suitors for this customer business

 5 because there are risk discussions involved.

 6 The second thing, and this has not come

 7 to play yet, but there is the new BASEL capital

 8 rules for the agency side of a bank's business,

 9 the clearing firm supporting client clearing. The

 10 current rules, I think, are a mistake. They treat

 11 this client risk as though it is the bank's risk.

 12 They are not the bank's -- they are not the

 13 agent's risk. The clearing firm here is acting

 14 purely in the capacity of an agent. Margin is

 15 collected, and that margin is passed on to the

 16 CCP. So it's important to actually give relief to

 17 the agency side of the business because if we

 18 don't, what has happened, or what would happen is

 19 most of these firms would reach their capacity

 20 today. They wouldn't be in a position, or they

 21 wouldn't love to take on more clients exactly when

 22 we want them to.
 64

 1 The option for a CCP at that point in

 2 time is to liquidate clients, which essentially is

 3 bad for markets. So we have spoken a lot about

 4 this. We have written a lot about this, and we

 5 hope BASEL at its meeting in December would take

 6 note -- would take note of the systemic risk

 7 issues related to SLR treatment of client

 8 clearing.

 9 So we talked about financial resources.

 10 Now, let's address the operational side. Thinking

 11 of porting during a drill is actually good, but it

 12 is purely testing operational capacity. It won't

 13 be able to test the other aspects of porting.

 14 We've heard the term KYC. One of the things that

 15 we ask regulators to take this into account is

 16 that, you know, when you're porting clients in

 17 bulk, it is not possible -- the most important

 18 thing during porting is time. So you need to port

 19 it as quickly as possible. So it's not possible

 20 for the receiving firm to do a KYC on all the

 21 clients that it is receiving. So it's important

 22 for regulators to give relief to the receiving FCM
 65

 1 so that they can do the analysis post-porting.

 2 The second thing we talk about is

 3 information of the clients. So one of our

 4 experiences, and they've actually proposed a rule

 5 to the community and we want our FCMs to actually

 6 share information on their end clients with the

 7 CCP, used purely for the perspective of

 8 maintaining access with the end clients while we

 9 are porting. Information sharing is very

 10 important, so this is transparency going the other

 11 way around. So having contact information of end

 12 clients so that we can communicate with them

 13 during the porting exercise is very important.

 14 This is a rule that is in play. We've given

 15 timelines to our firms to comply with.

 16 So I would like to stop there before I

 17 address new models, just to talk about the current

 18 structure and challenges facing the current

 19 structure because porting has been successful in

 20 the states through several circumstances. We have

 21 done this during the financial crisis, before the

 22 financial crisis, post financial crisis as well.
 66

 1 What I'd like to do here is just point out some

 2 challenges to that before we talk about other

 3 solutions.

 4 MR. MCCLEAR: So I agree with Sunil that

 5 gross margining was, and is, a big, big step to

 6 facilitating porting. You know, we lived through

 7 Lehman, we lived through MF Global, and the first

 8 question I have on this list is, how do we

 9 facilitate continued clearing for the customer

 10 origin before porting? And it's as simple as the

 11 clearinghouse has to have sufficient margin to

 12 manage the risk so that we don't have to liquidate

 13 the portfolio. And we don't want to liquidate the

 14 portfolio. We want to facilitate porting. But to

 15 hold on to that portfolio, we have to manage the

 16 risk, and we are fortunate at Lehman and MF

 17 Global, in particular, where the market wasn't

 18 moving so we had the luxury of time. And to

 19 Sunil's time, we need to move fast to affect

 20 porting so the market doesn't move.

 21 I can tell you just by coincidence this

 22 week, ICE Clear Credit is doing its default test,
 67

 1 and it has a FCM focus. We have 23 customer

 2 positions and we're providing those to the FCM.

 3 The FCMs -- there are 14 FCMs. And we're asking

 4 them to review those customer positions to assess

 5 the risk to see if the FCMs are in a position to

 6 take on those portfolios. So that's practice.

 7 That will help. And then we'll go through the

 8 steps of actually affecting the porting, and we've

 9 been working on automating our systems to affect

 10 those transfers.

 11 The other interesting thing we're doing

 12 and we've done in the past is we have a trustee.

 13 Not a real-life trustee but we have a lawyer

 14 playing the trustee to mimic that process because

 15 that's an important process. We have in the U.S.

 16 loss-sharing provisions in the 4DA and the 4DF

 17 account origins. And before we can port the

 18 margin -- we can always port the positions but

 19 porting the positions without the margin doesn't

 20 do much good to the receiving FCM, so we need to

 21 confirm to what extent we can also port the

 22 margin. So we simulate that trustee process where
 68

 1 the trustee has to go to the bankruptcy court,

 2 assess the available resources, and then they

 3 actually issue an order and we get a letter from

 4 the trustee saying how much margin we can post.

 5 Unfortunately, that's how it works, but we

 6 simulate that. I noticed that was a question.

 7 But the last recommendation I think is

 8 the most important recommendation, and that is the

 9 customers need to find backup FCMs. They should

 10 establish this upfront. They should be ready to

 11 port in the unfortunate circumstance that their

 12 primary FCM becomes insolvent.

 13 MR. MCLAUGHLIN: This is LCH again.

 14 I'll just add to Kevin's comments.

 15 The first thing I'd like to share is

 16 that operationally we can figure out the mechanics

 17 required to do a port, but as Kevin noted, you

 18 know, another party comes in before you can

 19 actually do anything, you need a trustee to opine

 20 on whether or not you can port or not. And for

 21 that reason, we have -- we hold extra margin to

 22 account for this lengthened -- possibly lengthened
 69

 1 time of dealing with the client positions. We

 2 don't see how you can have the same length of time

 3 to margin house positions as client positions.

 4 And so this obviously is more expensive because

 5 you can't really pin it down exactly how long it's

 6 going to take to port these positions. And that's

 7 assuming that you have a home set up and a willing

 8 FCM to take these people. I'd just like to add

 9 that.

 10 MS. O'FLYNN: It's clear that the role

 11 the FCM plays is critical here in all elements.

 12 Number one, from a buy side perspective and from,

 13 you know, an end-user perspective, and to

 14 understand the willing universe who is there to be

 15 their backup. But then it's kind of a symbiotic

 16 process. From a CCP perspective it's, you know,

 17 understanding the availability of FCMs under the

 18 current regulatory regime to be available

 19 depending on another FCM defaulting. I know, you 

 20 know, from a Morgan Stanley perspective, we would

 21 be obviously supportive of, you know, resources

 22 willing to take on our large, you know, client
 70

 1 positions, but it will definitely be challenging

 2 for large FCMs to be, you know, have a, you know,

 3 a broader platform to be able to onboard other end

 4 users. So it comes back to understanding how we

 5 bring these two together. Clearly, there's a

 6 customer concern and there's a CCP concern, and

 7 the FCM, obviously, plays a pivotal role here.

 8 And I think -- I see Sunil, you want to respond?

 9 MR. CUTINHO: Yeah, you know, when we

 10 think of these issues, they don't occur in an

 11 instant, so there's a lot of planning that happens

 12 before. So in the U.S., we've had the benefit of

 13 coordinating with the CFTC, and if it's a

 14 broker-dealer, the SEC had FINRA involved as well.

 15 And so we have a lot of time in advance of real

 16 issues. What is important is that there needs to

 17 be, as you point out, some kind of a planning. We

 18 do "white knight" planning. So you look at, you

 19 know, the way you look at it is you can't --

 20 because you're at a point in time where you can't

 21 disclose this to the broader market, but what you

 22 can definitely do is look at the capital position
 71

 1 of the solvent FCMs and find a good mix, find

 2 potential homes for a failure. Okay. So "white

 3 knight" planning is something that is a part of --

 4 so it is not a default really, per se, but it is

 5 before you get to a default.

 6 The thing to point out is that, you

 7 know, if we are talking about the ability of FCMs

 8 to receive, we have to be very careful. So you

 9 cannot have a situation where you allow the

 10 receiving FCMs to cherry-pick and say "I'll take

 11 this client but I won't take that." That results

 12 in using a lot of time. In our experience, you

 13 take the entire book. You take the entire client

 14 book fully or subsets of it, segments of it. And

 15 then you can work with your clients. So that's a

 16 much more practical approach because clients

 17 maintain access to the markets during the time

 18 period that you're porting. It's very important.

 19 We've seen a recent experience in Australia where

 20 doing the reverse or getting an explicit consent

 21 or expecting clients to react faster and find

 22 their own homes will take much longer. Two, the
 72

 1 extra margin also is not relevant for that kind of

 2 a discussion because in the case in Australia, it

 3 took about a month. So you have to be practical

 4 in these circumstances. So you have to take --

 5 and the idea is to take an entire book or take

 6 parts of the book, and in our experience, we've

 7 seen FCMs actually take that and then work out the

 8 relationships with the end clients for reasons

 9 that could be know your client, credit, and other

 10 reasons, and then -- because they have enough

 11 margin to cover. The most important thing is to

 12 have gross margining, so that margin gets

 13 transferred along with the positions. That is the

 14 key.

 15 MS. O'FLYNN: Rana?

 16 MS. YARED: Thanks, Susan. Sorry, I

 17 wasn't expecting you to do that. I was expecting

 18 you to go to Clifford.

 19 So I want to say a few things on the

 20 matter. You know, first, our unquestioned goal is

 21 to provide clients unbroken access to markets in

 22 times of crisis, but unfortunately, you know, this
 73

 1 is increasingly very challenging for us, and to

 2 the point that Sunil and Kevin have made about

 3 having sufficient margin, indeed sufficient margin

 4 is a necessary but not sufficient condition to

 5 being able to take on the portfolios. And the

 6 main reason for that is the challenges that are

 7 posed by the capital rules which, you know, have

 8 been alluded to in this discussion in which many

 9 members of this Committee mentioned in our first

 10 meeting are indeed counter to the general goal of

 11 clearing more. And until we have specific

 12 resolution or the ability to move on those

 13 matters, which I understand are not, you know, in

 14 the gift of this Committee or Commission, but

 15 nonetheless worth mentioning, it's going to be

 16 very challenging. And it's for that reason,

 17 Sunil, that I think folks are concerned about

 18 having to take on the whole portfolio, because

 19 while, you know, there is a willingness to do that

 20 and an understanding of why that's easier, there

 21 is a practical reality of potentially an inability

 22 to do so which, you know, is very scary; right?
 74

 1 And, you know, we have begun to discuss with two

 2 of the four members up there the possibility of

 3 having named backups; right? Also, with one of

 4 you, you know, our institution has discussed or

 5 been the recipients of your comments. Do we need

 6 to socialize to ourselves and to our clients that

 7 if you don't have a backup and there's no FCM who

 8 can take you for capital, then that means you're

 9 going to get closed out. All right? This is an

 10 ugly reality, but I think the reality is important

 11 to be known so that people aren't surprised.

 12 And so I think that gets us to the

 13 multiplied point which is if, you know, God

 14 forbid, once CCP goes -- has a default, the

 15 reality is that the clearing members that we use

 16 and our counterparties in this room, JPMorgan and

 17 Morgan Stanley use, are very likely the same

 18 entities at more than one clearinghouse. And so

 19 this heightens the importance for coordination

 20 between the clearinghouses. And I swear the B of

 21 E did not put me up to this, but you know, the

 22 Bank of England is suggesting for European
 75

 1 clearinghouses a join drill between Eurex and LCH;

 2 have asked a whole bunch of us to appear before

 3 them to discuss in a few weeks' time, and it's a

 4 worthy discussion to have. However, I think the

 5 reality in the global system is that there is a

 6 third very large pool of risk and it sits entirely

 7 in the U.S., and so we should probably, you know,

 8 have a discussion about the reality of that and a

 9 cross- default that takes into consideration CME

 10 with the European counterparties.

 11 And maybe the last comment I'll make on

 12 this is, you know, a bit of a red herring caution.

 13 So as this discussion has evolved, people have

 14 said to us, "Well, gosh, like, wouldn't it just be

 15 better if, you know, more people participated in

 16 auctions? That would let more people bid for

 17 portable client portfolios." And I think our

 18 response would be, "Most likely the people that

 19 are participating in auctions aren't FCMs." So,

 20 you know, having more people participate in

 21 auctions, an interesting discussion in and of

 22 itself, but shouldn't be conflated with the
 76

 1 ability to increase portability because the

 2 entities that are nonmembers which would

 3 participate in those auctions, are very likely not

 4 to have FCM services. It's important to separate

 5 those two.

 6 MS. O'FLYNN: Thank you, Susan.

 7 Clifford?

 8 MR. LEWIS: Some of what I was going to

 9 cover was just covered much more eloquently in

 10 terms of the inconsistency between the capital

 11 rules and the reality of cover two. Cover two

 12 default and portability, something that Wendy said

 13 the first -- one of these sessions. I fear, and

 14 this is -- now I'm going to perhaps be a little

 15 bit rude -- that when regulators begin to deal

 16 with a world that simply can't be addressed, it

 17 does not have a constructive effect on practical

 18 things that could be improved. And the reality is

 19 porting in the current capital regime, which did

 20 not exist in the previous times when porting took

 21 place, but the idea that you can port all of the

 22 hundreds of thousands of accounts overnight is
 77

 1 crazy. It's not possible. And if the regulators

 2 want to encourage a discussion that is

 3 fundamentally realistic, that's fine. There's a

 4 lot of that that goes on, and the risk here is

 5 that it does detract from discussing more

 6 practical, realistic scenarios as to what you

 7 would actually be able to do.

 8 The general point I also want to make is

 9 a point that from the client's perspective, the

 10 market circumstances where these sorts of problems

 11 happen are obviously stressful, to put it mildly.

 12 Market circumstances; right? And that's, of

 13 course, part of the problem with how you build

 14 your scenarios and so on and so forth. But the

 15 fact of the matter is one of the things that the

 16 clients need to know is certainty of whether their

 17 hedges are still on. And this becomes a very

 18 important point in the kind of circumstances we're

 19 talking about. So, I mean, I think that we would

 20 be well advised to be more concerned about

 21 end-user protections and certainty of hedging in

 22 these very difficult times because absent that, I
 78

 1 think we've kind of undermined the whole economic

 2 purpose of these risk management tools, which is

 3 to say if they're not reliable when they're most

 4 required, what's going to happen? And indeed, an

 5 unintended consequence of these capital rules is

 6 perhaps it will, in fact, reduce the amount of

 7 risk management activity by clients who have for

 8 the last -- since the invention of financial

 9 futures, been able to address these kinds of

 10 risks. This is a point that the chairman, I know,

 11 made an important intervention on with respect to

 12 a particularly -- a particularly interesting

 13 interpretation of how one has to account for cash

 14 margins from a balance sheet perspective. It

 15 applies equally to collateral. It's always been

 16 kind of a foolish part of the way the accounting

 17 has taken place in my view. But thank you for

 18 speaking up about it, but it's those kinds of

 19 issues that if left unaddressed, frankly, makes a

 20 lot of this discussion kind of silly. And I'm not

 21 even sure in the event of a crisis you'd want to

 22 be reminded that we had thought we had solutions
 79

 1 to some of these things.

 2 MS. O'FLYNN: Ed?

 3 MR. PLA: Thank you. Thank you,

 4 Chairman and Petal.

 5 Maybe echoing some of these comments and

 6 sharing an FIA perspective, I'm gratified to hear

 7 Sunil and others recognize the shortcomings and

 8 the implementation of BASEL III and leverage ratio 

 9 rules as it relates to client clearing. We think

 10 that they are a concern for the reasons that we've

 11 argued. I think the concern is not -- I don't

 12 think the FIA denies that there's risk associated

 13 with client clearing activities; we just feel

 14 strongly that it's quite likely that we're poised

 15 to dramatically overcapitalize those risks, and I

 16 think that directly relates to the risk of

 17 porting. I think if we go back and we look at any

 18 previous episodes of clearing member default or

 19 CCP crisis that resulted in porting of positions.

 20 We have to remember they're all pre-SLRM

 21 implementation. So this entire regime that we're

 22 discussing, the whole notion of derivative
 80

 1 clearing, mutualized risk, availability of

 2 portability, is untested under the rules that

 3 we're about to adopt. That should give us pause.

 4 We have to recognize as well that when

 5 we look at the complexities of porting hundreds of

 6 thousands of accounts or checking with trustees or

 7 gauging clearing member willingness to take on

 8 positions, these things are going to be likely

 9 measured in not hours or minutes but in days. And

 10 so I think from our perspective we would

 11 respectfully request the Commission maybe consider

 12 these things and fully engage during the CPMI

 13 evaluation, margin requirements supposed to go

 14 live in 2016. I think there's an opportunity

 15 there to link these issues. So we have to

 16 question whether or not initial margin is going to

 17 be adequate in a stressed period like this

 18 considering the new complexities and obstacles to

 19 ease of porting those BASL3 implementations. I

 20 think that's the real question.

 21 MS. O'FLYNN: Marcus?

 22 MR. STANLEY: Well, I'm going to make
 81

 1 myself a very unpopular person today; I can

 2 already tell.

 3 I just want to address this issue of

 4 capital charges, starting with the argument that

 5 client margin should not be subjected to the

 6 supplemental leverage ratio. You know, as I

 7 understand it, that margin is on the balance sheet

 8 because of gap accounting rules, and gap

 9 accounting rules would not put that margin on the

 10 balance sheet unless banks were in some ways able

 11 to take risks with it, reinvest it, earn returns

 12 from it, and possibly incur risk. And for

 13 reputational and contractual reasons, that margin

 14 is owed to the client. So unless it is rock-solid

 15 segregated in a way that in my understanding would

 16 not put it on the bank's balance sheet, then the

 17 bank is responsible for returning that margin, and

 18 there's a potential risk of loss there. So I just

 19 have a hard time seeing the argument for an

 20 exemption from the supplementary leverage ratio

 21 here. And let's remember that cash -- the

 22 supplemental leverage ratio applies to cash, it
 82

 1 applies to deposits with the Federal Reserve

 2 because it's meant to ensure that there's a

 3 minimal -- minimal 33 to 1 level of leverage for

 4 banks based on their overall size. And holding

 5 margin for the client is part of that overall

 6 size, just like other low-risk kinds of assets

 7 are. So I don't see the argument there.

 8 And in terms of the broader argument

 9 about capital here, I see this kind of

 10 circularity. I think Rana said that we have a

 11 goal of clearing more. I don't think that that's

 12 our goal, clearing more. Our goal is to improve

 13 risk management, and if we end up with a situation

 14 where we're mandating clearing but cleared

 15 transactions are undercapitalized or the risk

 16 management is not good at clearinghouses, then as

 17 we all around this table know, clearinghouses will

 18 become a critical point of failure because that

 19 risk is still there. And I just kind of see this

 20 argument. On the one hand clearing is great

 21 because it mutualizes risk. On the other hand,

 22 let's not capitalize that mutualized risk because
 83

 1 it discourages clearing, which we all know is

 2 great. You know, clearing is good if it's

 3 adequately capitalized and if we provide it for

 4 that risk.

 5 So let's figure out the real total loss

 6 exposure that clearing members are going to have

 7 to face if they actually mutualize that risk,

 8 which means assuming some of that risk that they

 9 may take on derivatives positions from other --

 10 from clients of a failing clearing member. Let's

 11 figure out the degree of mutualization we're

 12 comfortable with and provide capital for that as

 13 opposed to exempting people from capital rules

 14 during a time of financial stress.

 15 And just one final point. Let's

 16 remember that the capital in a failed -- we're not

 17 just talking about the capitalization here of a

 18 clearing member that's solvent that's trying to

 19 port. These rules will determine the amount of

 20 capital that's there in a defaulting clearing

 21 member as well. The more capital, the lower the

 22 likelihood of default, and the more that you're
 84

 1 going to be able to get access to potentially if

 2 somebody is defaulting. So these capital rules

 3 are determining the viability of the clearing

 4 members who might be weak as well.

 5 So everyone can fire at me now.

 6 MS. O'FLYNN: Luke?

 7 MR. ZUBROD: I'd like to address the

 8 comments both by Kevin and Rana on backup FCMs,

 9 and specifically as it applies to smaller

 10 financial entities. You know, I think the

 11 benefits of a backup FCM are reasonably clear.

 12 Certainly, our clients -- and Chatham has about

 13 1,600 clients, about 30 of those are signed up for

 14 clearing, so mostly nonfinancial entities, some

 15 financial entities. I think what I'd like to sort

 16 of bring into light is the cost side of that

 17 equation. So, you know, we can appreciate the

 18 benefits of a backup FCM. Let's talk about the

 19 costs, because this is really a serious constraint

 20 for smaller financial entities as it relates to

 21 the decision of whether to have a backup FCM. In

 22 particular, the key cost is minimum fees that
 85

 1 really serve as an obstacle to really make

 2 clearing cost prohibitive for many smaller

 3 financial entities. These fees generally range

 4 from about $60,000 a year, minimum, to about

 5 $120,000 or more per year, minimum, depending on

 6 the FCM and various circumstances. And so that

 7 can, for a smaller FCM, make clearing cost

 8 prohibitive. Consider someone who is doing a

 9 single hedge over a five- year period and has to

 10 sort of agree to, you know, $300,000 to $600,000

 11 over that period just for the benefit of clearing

 12 that one interest rate swap. Now consider the

 13 possibility of doubling that by some mechanism

 14 that encourages, incentivizes, requires backup

 15 FCMs.

 16 So this is just another constraint to

 17 navigate as, you know, we try to thread the needle

 18 on this, I think there are ways of addressing it.

 19 You know, among them a financial entity de minimis

 20 exception where if the quantity of your

 21 derivatives use is smaller than a certain

 22 threshold deemed to be systemically insignificant,
 86

 1 then you would not be required to centrally clear

 2 those transactions or you as an entity would not

 3 be required to centrally clear. There are other

 4 potential ideas that could sort of address this

 5 concern but I think it's one that needs to be

 6 brought into consideration.

 7 MS. O'FLYNN: Emily?

 8 MS. PORTNEY: Hi. I would just like to,

 9 Marcus, correct or a comment that I actually think

 10 is slightly misleading on the leverage ratio. It

 11 is -- the clearing community wants to and agrees

 12 we should absolutely hold capital as a clearing

 13 member. And there are two places where capital

 14 comes into play in the leverage ratio. One is the

 15 on-balance sheet, which is subject to gap which,

 16 by the way, no one, the clearing members and no

 17 end users are suggesting that we treat that or

 18 change that in any way, shape, or form. If cash

 19 is on my balance sheet as margin, I'm going to

 20 hold capital against it and I fully expect that.

 21 The part that we're all talking about is

 22 the off balance sheet exposure calculation, and it
 87

 1 is in that where we truly feel the exposure is

 2 overstated if you do not recognize the offsetting

 3 nature of segregated margin that is given to us to

 4 protect against the need to liquidate a client's

 5 position. And that margin is sacrosanct. It is

 6 held at the CCP. It is required that it be held

 7 in highly liquid securities and/or cash, and it is

 8 available. The way we've explained it is to the

 9 extent that I've guaranteed a trade for a client

 10 to, say, the CME, that's $100 worth of exposure

 11 and I have to collect $10 in margin. The most I

 12 can lose is 90. I'm happy, happy to hold capital

 13 against the 90. It is overstated to say I have to

 14 hold capital against the 100. And so I just want

 15 to make sure that we're all talking about the same

 16 things because the way you're mixing both the on

 17 balance sheet and the off balance sheet, and one

 18 is just simply an overstatement of exposure. So

 19 that's one thing.

 20 Two, just to talk a bit about the access

 21 of clearing. One question that we've talked about

 22 in terms of -- or that I've often been asked is
 88

 1 aren't there going to be new entrants to the

 2 clearing market? Why wouldn't there be new people

 3 coming in to become clearers? Capital -- there

 4 are three things -- when we talk about a clearing

 5 member or becoming a large clearing member, there

 6 are three things that are incredibly important in

 7 order to even get yourself off the ground and

 8 start running. One is capital. Whether or not

 9 it's under the SLR rules or not, it's -- capital

 10 is important. The other is liquidity. So to the

 11 extent you are a clearing member, you are fronting

 12 your client's margin to the clearinghouse every

 13 morning, in which case you must have access to

 14 liquidity -- either your own liquidity or through

 15 facilities from other parties. Those are getting

 16 repriced and are very, very expensive. So, again,

 17 that is a barrier to entry.

 18 And something we've all started to touch

 19 upon is operational scale. If you want to be a

 20 large clearing member, you need to have the

 21 infrastructure, the risk expertise, the

 22 technology, et cetera, and the operational
 89

 1 capacity to join and keep up with being a member

 2 of dozens of clearing markets. This is a tough

 3 business, so when people say, well, if it's tough,

 4 why don't you just have -- won't there be new

 5 entrants? At the end of the day, the barriers to

 6 entry are really, really high. So I do think we

 7 all have to be very conscious of the fact that

 8 further consolidation among clearing members is

 9 not a good thing, and the likelihood of lots of

 10 new entrants coming in is unfortunately probably

 11 not realistic.

 12 MS. O'FLYNN: Jerry?

 13 MR. JESKE: Emily, very good segue into

 14 actually what I was going to say. I couldn't

 15 agree with you more. As an end-user, I'm here

 16 actually on behalf of the Commodities Market

 17 Council, which is a group of different end-users

 18 -- eggs, financial, as well as energy.

 19 As relates to the leverage ratio you

 20 spoke of, you're 100 percent right. It's simply

 21 an issue that's not being addressed that the seg

 22 margin means segregated. On behalf of end-users,
 90

 1 on behalf of customers, that money is ours. It's

 2 not the banks. This isn't about the banks moaning

 3 about capital restraints. They actually have a

 4 negative impact on the entire market.

 5 That being aside, the point of why

 6 aren't more people getting involved in the market

 7 to become, you know, clearing firms or prop

 8 clearing firms? I think a couple very, very

 9 helpful comments around the table have been cost.

 10 And that was three things I was going to say:

 11 Cost, cost, and cost. That's why.

 12 And you touched on the IT component of

 13 it. You touched on the operational risks. When

 14 you're not in the business of being a FCM and

 15 you're being pushed into becoming a FCM because of

 16 the capital cost that's out there under BASEL III,

 17 then you have to look at how can you do this for

 18 your house? If you're going to do it for house

 19 accounts, it really doesn't help what we're

 20 talking about here in terms of portability because

 21 if you're becoming a self-cleared entity, if

 22 you're going to be part of that pool, you really
 91

 1 don't have any interest in taking agency business.

 2 You have an interest in taking a failed -- I'll go

 3 back to an example years ago. Some group had a

 4 large portfolio and so you had to find suitors who

 5 were going to take that on. Well, then you're

 6 talking about -- I think Clifford mentioned what

 7 sort of hedges do you have associated with those

 8 derivative positions?

 9 So now we're talking about clearing

 10 swaps as well as clearing futures. And what's the

 11 connectivity to the end-user's ability to take on

 12 the entire portfolio? Not just the derivatives

 13 portfolio but a portfolio associated with physical

 14 exposures where the interplay with your banking

 15 relationships is another factor that I don't think

 16 we've really addressed here. So if you're going

 17 to take on a derivatives portfolio, as well as a

 18 physical portfolio, you have to get the approval

 19 of your lenders. And so there the interplay comes

 20 in.

 21 And one other thing that I think the

 22 Commission could address, when I say "cost," is
 92 

 1 the regulatory cost. Ownership and control

 2 reporting, another cost associated with a barrier

 3 to entry. Is it a necessary barrier? I don't

 4 know. It certainly is a cost though. It's an IT

 5 build. It's an infrastructure. It's a head

 6 count. And what's outed there in the Federal

 7 Register as far as what that cost really is, is

 8 completely inaccurate. That cost is 10 times the

 9 amount that's been portrayed to the public. So I

 10 really would implore the Commission to think about

 11 those matters because everything I think we've

 12 said in terms of diversification would be a good

 13 thing for the marketplace, but if these barriers

 14 to entry, as Emily has pointed out, aren't dealt

 15 with, I do think it's unrealistic.

 16 MS. O'FLYNN: Kevin?

 17 MR. MCCLEAR: I just quickly wanted to

 18 follow on to Emily's point and establish for the

 19 record that the clearinghouses are that rock solid

 20 segregation. As Emily pointed out, that customer

 21 margin gets on-posted to us on a gross basis. We

 22 hold it. We don't leverage it. We don't reinvest
 93

 1 it. Bob, hopefully some day we can put it up at

 2 the Fed. It's rock solid segregation.

 3 MS. O'FLYNN: Dennis?

 4 MR. MCLAUGHLIN: Yeah. I'd just like to

 5 mention a possible solution to this. We agree

 6 with all the problems that have been raised. The

 7 key problem for us is time because once the member

 8 defaults and you have this client portfolio to

 9 deal with, it could be quite large. And so there

 10 must be a concept of life support for the client

 11 over the period where you're looking for a home

 12 for the client, however difficult that is. So

 13 we've begun looking at potential solutions, like

 14 forming a, if you like, a fictitious clearing

 15 member, because after all, the client is posting

 16 margin every day that ends up in the clearinghouse

 17 and is segregated. So that client is probably

 18 performing okay. There must be a mechanism to

 19 continue posting margin for those portfolios while

 20 we figure out what to do with it. So that's a

 21 possible way to at least defer the end solution.

 22 MS. O'FLYNN: Marcus?
 94

 1 MR. STANLEY: I'm more than open to the

 2 idea that there are details here that I don't

 3 fully understand, but I can say to you that some

 4 of the banking regulators are not under the same

 5 impression as the people around this table about

 6 the level or security of segregation that's going

 7 on. And they also seem to be under the impression

 8 that it is possible to remove certain kinds of

 9 leverage from the supplemental leverage ratio

 10 depending on the level of segregation that you do.

 11 So I may have been misinformed there, but I will

 12 go back to them and have that conversation again.

 13 MS. O'FLYNN: Sunil?

 14 MR. CUTINHO: So we didn't have to shoot

 15 at you for you to consider that.

 16 I was going to address some of the

 17 things that Emily talked about, but going back to

 18 -- and I don't want to beat that point to death

 19 but I just want to go back to something else. You

 20 know, it's easy to assume that some people can

 21 clear for themselves, self-clearing, but that is

 22 beyond reach for a vast number of clients because
 95

 1 of their charters. They cannot participate in

 2 mutualization. They cannot become a clearing

 3 member. In some cases, you know, the tolerances

 4 for paying the CCP on time cannot be met, and I

 5 think that was the point that Emily was making as

 6 far as liquidity. So it's important to keep that

 7 in mind so there is no -- having clients

 8 self-clear is not a silver bullet solution for

 9 this problem. That's why it's important to get

 10 this kind of relief.

 11 And one thing Marcus, from a risk

 12 management perspective, you know, we're not asking

 13 for a reduction of capital as Emily pointed out.

 14 What we're saying is when a market participant

 15 puts on risk at a CCP, they actually pay margin

 16 for it. That is capital. And that is capital

 17 that is used solely for the purposes of covering

 18 the risk explicitly set out. That's what it is.

 19 That margin actually is passed on to the CCP. So

 20 when you count as capital to cover risk or

 21 collateral to cover risk, you have to take into

 22 account the margin that is collected by the
 96

 1 client. So that is essentially what we're talking

 2 about here. If you don't, then here are some

 3 perverse outcomes. Essentially, every hedger,

 4 directional participant, will end up being the

 5 most risky from an exposure standpoint in this

 6 theoretical reality, which makes no sense. It's

 7 the hedger, not the ones who have balanced books

 8 or hedged books or a market maker who has a flat

 9 book. So they're not the ones. The ones with

 10 directional risk end up being treated as the most

 11 risky, which is perverse, which makes no sense.

 12 So that in a sense is what we're talking about.

 13 We're not talking from the perspective

 14 of cost. We're not talking from the perspective

 15 of a principal side of a bank's business. We are

 16 purely talking about the agency side of a business

 17 which is actually providing access. Without that,

 18 you will have further concentration in market

 19 because some clients will just step out. The

 20 markets will become far more risky.

 21 MS. O'FLYNN: I'm sorry. Jerry?

 22 MR. JESKE: I was just going to follow
 97

 1 up on your point on the hedging, and maybe I

 2 didn't speak to it quite well enough. But when

 3 you're looking at those hedgers in the market,

 4 you're really looking at their total portfolios.

 5 And those portfolios are a lot more complex than

 6 what we're just looking at as a spec account;

 7 right? But in truth, if self-clearing were

 8 easier, if the barrier were less, you would be

 9 looking at an event where a liquidation of a

 10 hedger might be a little bit more straightforward

 11 unless systemically risky to the entire operation

 12 of a CCP. So again, that barrier to entry is

 13 something that, you know, hopefully, collectively,

 14 the industry can address. But, you know, if it is

 15 unrealistic, as Clifford said, we're not here to

 16 talk about things that really can't happen. But

 17 to be able to look at this in terms of the hedging

 18 world, you really do have to take back the

 19 physical component of why the derivatives market

 20 exists. So to uncouple that is, I think, a bit

 21 short sighted.

 22 MS. O'FLYNN: Commissioner Massad?
 98

 1 COMMISSIONER MASSAD: Thank you. This

 2 has been a very, very good discussion.

 3 I wanted to just clarify what I have

 4 said on this issue so people don't -- so people

 5 are clear on what my own position is here,

 6 particularly on the SLR. Because, first of all, I

 7 strongly support having stronger capital

 8 requirements for banks, and I appreciate the goal

 9 of the bank regulators in having the SLR as a

 10 nonrisk-based backstop to those requirements. My

 11 concern is in the way that it does measure the

 12 exposure of a clearing member, and the affects

 13 that it may have on our goal of promoting

 14 clearing. And to that goal, Marcus, I couldn't

 15 agree with you more. Our goal is not just to

 16 increase the amount of clearing; our goal is to

 17 mandate clearing where we think it makes sense,

 18 meaning standardized swaps where we feel promoting

 19 clearing or mandating clearing can reduce the

 20 overall risk in the system, but I've been very

 21 clear about saying we're not going to simply

 22 mandate a lot of products just to increase
 99

 1 clearing. And in fact, we need to be very careful

 2 about what we mandate.

 3 But as to the SLR, I think Emily did a

 4 great job of explaining that there are these two

 5 aspects of it. And on the cash on the balance

 6 sheet, yeah, I'm not calling for any change in

 7 gap, and I recognize how gap does treat it. I

 8 think, though, what I have noted is that the cash

 9 that's taken by a bank and then actually given to

 10 the clearinghouse and held by the clearinghouse

 11 isn't being invested by the bank. And as a number

 12 of people have noted, we'd like that cash to

 13 actually be sitting at the Fed. The Fed is still

 14 looking at that issue. But, you know, there are

 15 issues in terms of the clearinghouse members'

 16 liability to the customer, and that's why I think

 17 people are working on whether there is a

 18 derecognition solution consistent with gap

 19 depending on what that obligation is.

 20 The other piece of it is just the

 21 overall way you measure the exposure. And right

 22 now, the way the SLR works is you take a notional
 100

 1 amount versus a fixed factor. And I think given

 2 the way clearing really works, given the way the

 3 exposure is market to market daily, the

 4 collateral, you know, you must post a variation

 5 margin and so forth, you know, I think we have to

 6 really look at whether that makes sense. Is that

 7 really a proper measure? Now, again, this is

 8 where you come in to kind of this tension where

 9 the SLR obviously isn't meant to be risk-based.

 10 On the other hand, you can't -- need to have a

 11 measure of exposure which is realistic because the

 12 fact of the matter is that large institutions, you

 13 know, this may not matter that much to the overall

 14 SLR and the institution, but they're going to look

 15 at business line by business line, what is the

 16 impact? And I think that's where we're running

 17 into the concern, and it all comes back to the

 18 comments that Luke, and Jerry, and others have

 19 made about the importance of people being able to

 20 hedge and whether we're going to continue to have

 21 a market structure which, you know, facilitates

 22 that.
 101

 1 And this also gets into the question of

 2 what is the overall right amount of margin, and

 3 this is why, you know, it's tied to our

 4 discussions with Europe on equivalents, where I,

 5 you know, I've been very staunch on the issue of

 6 the fact that because we have gross margining,

 7 that's much better I think from a portability

 8 standpoint, from a protection of customer

 9 standpoint as a number of you have made, Ed, and

 10 others have said, in terms of facilitating

 11 portability also. Now we're in a discussion about

 12 whether, you know, there should nevertheless be

 13 more house margin and even using a standard for

 14 house which is higher than customer which is the

 15 reverse of what Dennis and Ed and others have

 16 pointed out.

 17 So all of this comes back to trying to

 18 calibrate these requirements. We are putting in

 19 place an entirely new system in many ways, and as

 20 people have said, it's not been tested, but I

 21 think we're just trying to balance some different

 22 objectives here. And to that extent, that's why I
 102

 1 have said let's at least be open to looking at how

 2 we're measuring this exposure and making sure

 3 we're getting it right.

 4 MS. O'FLYNN: One of the other

 5 recommendations was looking at the emergency of

 6 new membership models, and obviously, it's not a

 7 topic that we have discussed here today but

 8 clearly it leads us to needing to analyze that.

 9 We've seen direct access models evolve in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 10 securities finance transaction clearing which

11 allow restricted access to CCPs for certain kind

12 of real money accounts who obviously, as you said,

13 Sunil, can't be subject to mutualized risk and

14 they have certain charter restrictions. But it

15 comes back to, again, what Emily said, there needs

16 to be a sufficient amount of capital. There needs

17 to be, you know, certain kind of minimum

18 requirements. So does that result in a solution

19 for the bigger end-user but we still have, you

20 know, it's not a natural solution for the smaller

21 end-user because of the operational resources

 

 

 

 

 

 

 

 

 

 

 

 22 required around becoming a direct member.
 103

 1 Obviously, in Europe, it's evolving as well

 2 potentially in the derivative space, but clearly a

 3 lot of the kinds of concerns that people have

 4 highlighted here will ring true and it may result

 5 in, you know, there being, you know, an

 6 alternative solution which means that larger

 7 customers have another way whereas smaller

 8 end-users necessarily are more concentrated to the

 9 existing FCM members in the market. And then it

 10 comes back to the question of portability and

 11 those customers actually, you know, using those

 12 FCMs or having a backup arrangement in the event

 13 of an FCM default. Does anyone have any views on

 14 that? Because I'm conscious we're running out of

 15 time but we haven't really kind of discussed the

 16 direct access model at all.

 17 MR. MILLER: Just briefly, Susan. I

 18 mentioned this in prior meetings that large

 19 financial end-users like ourselves would be

 20 interested in a direct access model provided that

 21 we were not liable for any contributions to

 22 mutualized risk. And speaking from a legal
 104

 1 perspective, maybe Bob has an idea on this, that

 2 it's my understanding that the problem with that

 3 ultimately is the bankruptcy code and the

 4 potential that even a direct access with no

 5 contractual or rule-based mutuality might still be

 6 considered funds and therefore on the hook for

 7 mutualization.

 8 CHIEF COUNSEL WASSERMAN: If you are a

 9 direct member of the clearinghouse, not going

 10 through a FCM, then you're not a customer and you

 11 don't have the bankruptcy code issues with respect

 12 to the FCM. Now, whether it is feasible to have

 13 something where some folks are contributing to

 14 the, you know, if somebody contributes on your

 15 behalf to the mutualized loss, then that could be

 16 feasible. I think the problem is if everyone

 17 says, "Well, actually, I love this clearing

 18 membership thing but this mutualized loss, I'm not

 19 willing to do that," then you might have some

 20 practical difficulties.

 21 MS. O'FLYNN: Rana?

 22 MS. YARED: Thank you, Susan. I would
 105

 1 love that world, too, to be honest. But I think

 2 it poses a lot of very practical challenges. So

 3 one of the CCPs around the table and, you know,

 4 for confidentiality reasons I won't name them, you

 5 know, went to one of the major regulators with a

 6 model that indeed did propose direct access in a

 7 nonmutualized basis for entities that were

 8 contractually unable to mutualize -- that's a 

 9 mouthful -- and that included like an alternate

 10 waterfall and all sorts of specifications. And

 11 the regulator, you know, came back with really the

 12 same point that you just made, Bob, which is if

 13 you have a whole bunch of entities that are

 14 willing to join the CCP directly but only a

 15 handful of entities that are actually willing to

 16 mutualize, how does that actually work and how do

 17 you compensate the willing mutualizers for,

 18 frankly, the risk and the monetary loss that

 19 they're taking. And so, Emily -- sorry, Susan,

 20 this like takes, I think, a whole separate session

 21 because the principle is very much accepted by a

 22 lot of people but the practical implementation is
 106

 1 very challenging, not just on the mutualization

 2 issue but also on issues of default management

 3 participation, whether, you know, in a multiple

 4 default event is the book of a nonmutualizing

 5 party juniorized or closed out versus the book of

 6 someone who is mutualizing and has put up risk and

 7 whose margin and default fund are available as

 8 part of the resources of the clearinghouse, so

 9 there's a lot of detail behind the proposal that

 10 makes it more challenging just saying like support

 11 or nonsupport that are worthy to be worked

 12 through. And as you point out, the securities

 13 servicing world on the equity side has a model in

 14 proposal that is actually live. It will be

 15 interesting to see if any of those specifications

 16 are actually applicable in the derivatives of

 17 futures world.

 18 MS. O'FLYNN: Now, given securities

 19 finance transactions, it's a principal

 20 transaction. There is a quasi-form of margin

 21 there. So I absolutely agree with you that the

 22 challenges of translating a similar model to the
 107

 1 derivatives space seem unlikely. I would assume a

 2 sponsorship model will arise, but obviously that

 3 has its own regulatory constraints currently as

 4 well.

 5 MS. PORTNEY: The only thing I would add

 6 to those comments, generally, the new membership

 7 models that we're seeing are potentially providing

 8 greater access to the buy side, but then to

 9 everyone's point, you have to be careful about how

 10 that is actually happening. Generally, it's off

 11 the back of the clearing member. Someone still

 12 has to guarantee that transaction. So the one

 13 question we would raise, are you just adding more

 14 participants and more risk into the system off the

 15 back of basically the same clearing members? I

 16 think it will be wonderful to come up with another

 17 model that solves this conundrum, but I'm not so

 18 sure that we've seen yet the model that quite does

 19 that. And certainly, none of the models solve

 20 back to our original point the capital

 21 implications we're talking about, because as long 

 22 as the clearing member still has to guarantee some
 108

 1 form of participant, whether it's sponsored or

 2 not, it doesn't help.

 3 MS. O'FLYNN: I think we have time for

 4 one final comment. Sunil?

 5 MR. CUTINHO: Yeah. I think the reason

 6 that you have relief in the repo world, a secured

 7 financial transaction as BASEL III explicitly

 8 calls that out. It basically says if an

 9 institution is acting purely in the capacity of an

 10 agent and if the margin is outside the control or

 11 the access of the agent, then it can offset the

 12 exposure. I think that is what we are seeking for

 13 the derivatives world as well. So, for some

 14 reason we have something, a treatment that is

 15 being accorded to the SFT world but the

 16 derivatives world was left out. So I think it

 17 works the same way. So to the extent that the

 18 margin is, as Emily pointed out, outside the

 19 control and is not used to level up the

 20 institution, it's simply passed on, it should be

 21 given as an offset. So there is a precedent out

 22 there. It's just that it's not been given to the
 109

 1 derivatives space. And there is no risk reason

 2 not to do that.

 3 MS. O'FLYNN: Okay. Thank you,

 4 everyone, for your comments. We will close this

 5 particular panel on that topic now.

 6 There were three other recommendations

 7 which were part of the original five, which I will

 8 just run through very quickly. Petal has

 9 mentioned that there may be, you know, forthcoming

 10 panels or discussions at a future MRAC but not for

 11 today.

 12 The three remaining recommendations were

 13 action process consistency and transparency. So

 14 this concept of a CCP playbook, which will

 15 probably be minimum standards based with some

 16 amount of customization depending on the product.

 17 Obviously, in response to a number of our

 18 colleagues' comments on that particular point. To

 19 create clarity for, you know, clearing members and

 20 end-users to understand -- this leads into the

 21 second point -- around what will actually happen

 22 each time there's an auction or a fire drill?
 110

 1 What are the role sand responsibilities, and what

 2 are the potential ramifications if you don't

 3 participate or, you know, you fail to submit a

 4 bid?

 5 The fourth recommendation was around buy

 6 side participation. The recommendation was that

 7 buy side participation should be possible in an

 8 auction, provided that the buy side were subject

 9 to the same incentives, both financial and

 10 procedural as a full clearing member. So the

 11 concept of having to be subject to generalization

 12 of a sum that would be contributed if you wanted

 13 to participate in the auction. So again, it comes

 14 back to this concept of having some amount of --

 15 to use the phrase but not in its traditional form,

 16 some "skin in the game," with regards to buy side

 17 -- with regards to auction participation.

 18 And then the fifth one was around

 19 default management committee participation.

 20 Ultimately, what I think a lot of the Committee

 21 wanted was almost like a register as to

 22 understanding who sits on what Committee. Clearly
 111

 1 there's a number, you know, as institutions

 2 continually reinvent themselves, the depth of

 3 intellectual capacity to be able to outsource to

 4 CCPs becomes more challenging. So to ensure that

 5 there is sufficient clearing member personnel to

 6 be seconded to CCPs in the times of stress, to

 7 understand, you know, the process of, you know,

 8 eligibility, is it consistent among CCPs? How

 9 often is the turnover of those personnel? And

 10 also as an obligation from the clearing member

 11 perspective. The clearing member should be

 12 obligated to notify the CCP if that personal

 13 person effectively starts trading in another

 14 market or effectively leaves the firm. There's an

 15 obligation of the clearing member to ensure that

 16 there is a firm representative, you know, for the

 17 period of time in which they've signed up for.

 18 And then the last particular point on

 19 that was around, you know, and to ensure -- and I

 20 suppose this comes back to clearing members should

 21 be incentivized to second people in times of

 22 stress. So it comes back to the importance of
 112

 1 this register and it becoming, you know, truly

 2 sacrosanct as the play to form part of the overall

 3 playbook within which if there is a large clearing

 4 member default, everyone is very clear as to roles

 5 and responsibilities. And you know, it would

 6 hopefully enhance, you know, and allow the option

 7 process to be more efficient. And that's it.

 8 MS. WALKER: Thank you, Susan. And as

 9 mentioned, we will be discussing those issues in

 10 future MRAC meetings. Thanks again to Susan for

 11 leading this effort and getting these

 12 recommendations put together. Definitely given

 13 the diversity of viewpoints, we can see that it

 14 definitely took some time and focus in order to

 15 get these recommendations out. Thank you again.

 16 We'll have a 10-minute break before our

 17 third panel, which will start at 12:30.

 18 (Recess)

 19 MS. WALKER: Welcome back. We'll be

 20 starting our third panel now, which will be led by

 21 Gerald Beeson, who is the chief operating officer

 22 and chief financial officer at Citadel.
 113

 1 MR. BEESON: Good afternoon. Our third

 2 panel will be Other Suggestions, so a few

 3 different presenters that we have for buy side

 4 perspective on the issues we've been talking about

 5 today and throughout this Committee. The first

 6 presenter will be Angela Patel, who will be

 7 presenting our buy side perspective on CCP risk

 8 management. Bill Thum from Vanguard will present

 9 SIFMA's Asset Management Group perspectives on CCP

 10 risk management, followed by Kristen Walters from

 11 BlackRock, who will give BlackRock's perspectives

 12 on these issues as well.

 13 With that, I'll turn it over to Angela.

 14 MS. PATEL: Thank you for the 

 15 opportunity to discuss ongoing concerns about the

 16 financial risk management of central

 17 counterparties. My areas of responsibility at

 18 Putnam include oversight of the activities on the 

 19 fixed income trading floor, including fixed income

 20 trading operations and strategic initiatives. I'm

 21 directly involved in risk assessment on both a

 22 counterparty and transactional level, and I am
 114

 1 also directly involved in negotiating

 2 documentation with potential trading and clearing

 3 partners.

 4 Derivatives are not new instruments.

 5 They've been an important tool in portfolio

 6 management for decades. The primary use of

 7 derivatives is to manage and hedge business and/or

 8 financial risk. The structure of a derivative

 9 contract can provide protection against

 10 directional changes in the value of the underlying

 11 assets, be they physical commodities, stocks,

 12 bonds, indices, interest rates, or currencies.

 13 Because of their synthetic nature, the protection

 14 can be obtained without buying or selling the

 15 underlying asset; thus, they have the ability to

 16 both hedge risk and to benefit from advantageous

 17 price movements.

 18 Prior to the implementation of the

 19 regulatory reforms mandated by Dodd-Frank,

 20 derivative contracts were transacted in one of two

 21 ways. As an exchange traded derivative, a

 22 standardized contract on a recognized exchange
 115

 1 offering transparency into the market, the

 2 contract terms were nonnegotiable and the prices

 3 were publicly available with the exchange acting

 4 as the counterparty. They could also be

 5 transacted as an over-the-counter derivative,

 6 which is a bespoke contract negotiated between two

 7 parties offering little transparency into the

 8 market with the terms of each contract privately

 9 negotiated and subject to the ISDA and collateral

 10 documentation executed between each pair of

 11 participants. And I know that we all know this

 12 but it's important.

 13 ISDA and collateral documentation were a

 14 key element in what we had in evaluating

 15 counterparty risk, and although both types of

 16 transactions still occur today along with a third,

 17 which is under regulatory reform we must execute

 18 and clear certain designated derivative contracts

 19 in the manner prescribed by the regulations, and

 20 we have to hold these designated contracts with a

 21 central counterparty. And while the use of

 22 electronic trading has presented an opportunity to
 116

 1 make execution more efficient, the concentration

 2 of clearing activity among just a few clearing

 3 members and CCPs has created additional unintended

 4 risk in the market.

 5 I want to be very clear that the concept

 6 of central clearing is a positive one, but without

 7 a clean look into the resiliency of the CCP in a

 8 stress situation, an understanding of the tools

 9 available for CCP recovery in the event of a

 10 member default, and a clear resolution process

 11 should a CCP itself fail, asset managers are left

 12 in a very real sense worse off than we were before

 13 the regulation.

 14 Prior to central clearing, transactions

 15 were subject to the executed ISDA and collateral

 16 support documentation. This documentation spelled

 17 out the terms under which we were protected,

 18 including credit rating requirements, funding

 19 requirements, and valuation requirements. The

 20 documentation also outlined protections that were

 21 afforded the parties should there be a question of

 22 viability. In addition, it detailed the rights
 117

 1 that came into effect in the event of insolvency.

 2 Counterparty stability and risk were of paramount

 3 importance. With a cleared contract, asset

 4 managers no longer have a look into the stability

 5 and viability of our counterparty. Factors we

 6 cannot see include the resources the CCP itself

 7 has made available in the event of a loss

 8 scenario, the transparency into the margin

 9 methodology employed, and a detailed understanding

 10 of stress testing, including the results.

 11 As detailed in the AMG letter to the

 12 CPMI secretariat and IOSCO, a letter which was

 13 also directed to representatives of the CFTC and

 14 the European Central Bank, the implementation of

 15 the principles assessment for financial market

 16 infrastructures has created a weakness in the

 17 framework, and the resulting regulations due to

 18 the lack of transparency into risk management

 19 deployed at CCPs. For a more detailed discussion

 20 of this, I turn it over to my SIFMA AMG colleague,

 21 Bill Thum.

 22 MR. THUM: Thank you, Angela. Thank
 118

 1 you. As Angela said, I'm Bill Thum. I'm a

 2 principal at Vanguard responsible for derivatives

 3 legal and regulatory matters. Vanguard has been a

 4 strong supporter of the CFTC's reform initiatives,

 5 including the reporting, clearing, margining, and

 6 exchange trading of swaps. We were especially

 7 involved and worked with Bob very closely in the

 8 CFTC's clearing rules with a focus on margin

 9 protection and LSOC, enhanced customer protection,

 10 and the residual interest rule.

 11 We're grateful for the CFTC's continuing

 12 efforts to craft a protective environment for

 13 derivatives clearing, especially as now nearly all

 14 of Vanguards swaps which are used for hedging and

 15 risk management and for cash management are

 16 centrally cleared. Today, I'm here representing

 17 SIFMA's Asset Management Group. AMG members

 18 represent U.S. asset management firms whose

 19 combined assets under management exceed $30

 20 trillion. The clients of AMG member firms

 21 include, among others, registered investment

 22 companies, endowments, state and local government
 119

 1 pension funds, private sector pension plans, and

 2 other fun types.

 3 CCP resilience, recovery, and resolution

 4 are critically important to AMG's members when

 5 clearing derivatives used for managing or hedging

 6 investment risks. Asset managers must assess

 7 counterparty risk, including CCP risk, when making

 8 investment decisions for clients that include

 9 pension funds and mutual funds for which

 10 regulatory directives require managers to protect

 11 invested assets, including from the failure of a

 12 CCP.

 13 SIFMA AMG has closely followed

 14 development of the PFMIs and the public

 15 quantitative disclosure standards for central

 16 counterparties, and on October 23, 2015, submitted

 17 a letter to the CPMI and IOSCO with their

 18 recommendations. I think the letter has been

 19 included in your materials today.

 20 We applaud the expressed intentions in

 21 the quantitative standards to enable stakeholders,

 22 including authorities, participants, and the
 120

 1 public to compare -- to be able to compare CCP

 2 risks it controls, have a clear, accurate, and

 3 full understanding of CCP risks, understand CCP

 4 systemic importance and its impact on systemic

 5 risk, and to understand the risks in participating

 6 in CCPs. That being said, AMG members believe the

 7 implementation of the PFMIs by national regulators

 8 to date has lacked consistency, standardization,

 9 and transparency, and do not allow AMG members to

 10 compare CCPs across products and regimes.

 11 The fundamental purpose of AMG's

 12 recommendations are clear. Incentivize behavior

 13 so that CCPs are resilient. And also provide

 14 sufficient transparency to permit CCP customers

 15 and asset managers who invest their funds to make

 16 informed decisions on the risks presented. SIFMA

 17 AMG therefore calls on CPMI and IOSCO to set

 18 minimum standards and not just principles for risk

 19 management, stress testing, and financial

 20 safeguards. Enhance safeguards to address

 21 scenarios where risk from one CCP could cascade

 22 into other CCPS. Scenarios where risk from one
 121

 1 clearing member could cascade across multiple

 2 CCPs. Scenarios that take into account how many

 3 CCPS clear a given product or an asset class, and

 4 how many clearing members each CCP has.

 5 In terms of transparency, require the

 6 public reporting of stress test results against

 7 the minimum standards, and use the results to

 8 adjust required CCP total financial resources to

 9 withstand financial distress. In terms of skin in

 10 the game, CCP capital commitments must be

 11 standardized, commensurate with the risk managed

 12 by the CCP, fully funded, and transparent. In

 13 terms of recovery and resolution, establish clear

 14 standards for the point of no return at which a

 15 CCP can't be saved. Positions should be

 16 liquidated and margin should be returned. And

 17 finally, in terms of customer margin, a

 18 nondefaulting party's initial and variation margin

 19 should never be at risk or used in a CCP

 20 disruption.

 21 In terms of minimum standards, SIFMA AMG

 22 believes the quantitative disclosure standards are
 122

 1 a good starting point in identifying appropriate

 2 areas of risk. We look for greater granularity

 3 with respect to the approaches to apply such risk

 4 plus minimum standards, not just best practices,

 5 and not principles, to apply such approaches.

 6 More extensive, detailed, and independently

 7 verified stress testing of the approaches against

 8 the standards. More regularized public reporting

 9 of the stress testing results to allow market

 10 participants to make informed investment

 11 decisions.

 12 The letter itself has detailed

 13 recommendations, which we ask the Commission to

 14 review and consider. Some of the key points are

 15 clear standards should be set regarding the

 16 appropriate level of CCP financial resources. The

 17 timeframe for testing of the sufficiency of those

 18 resources. Further specificity should be provided

 19 regarding the use and reporting of stress test

 20 results. Regulators, CCPs, and other market

 21 constituencies should jointly develop minimum

 22 standards for CCP stress tests. In addition to
 123

 1 the standardized stress tests, CCPs would also be

 2 required to perform tests based on their

 3 historical and evolving practices and to test

 4 according to their own unique profile.

 5 Additionally, test standards should include global

 6 CCP stress tests that focus on the areas where

 7 risk from one CCP could cascade into other CCPs or

 8 risks from a clearing firm overlap could cascade

 9 across CCPs. CCPs should be required to obtain

 10 independent validations of stress tests and risk

 11 management models at the outset and on a

 12 semi-annual basis. CCPs should be required to

 13 increase frequency of stress testing during times

 14 of market stress. The CCPs should be required to

 15 disclose stress testing scenarios, including the

 16 relevant inputs into those scenarios, pricing

 17 data, correlation, liquidity conditions. The

 18 relationship between stress testing and the size

 19 of the guarantee fund and a summary of the stress

 20 testing procedures. The responsibilities of the

 21 Risk Committee and the standards used should be

 22 defined and disclosed. Stakeholder committees
 124

 1 should be required to include representatives of

 2 the different interests, sell side, buy side,

 3 asset manager, corporate end-user, and others, and

 4 the CCP should be required to consider their input

 5 on risk management.

 6 In terms of large customer transparency,

 7 it's been talked about that the CCPs currently

 8 provide such transparency to their largest

 9 customers, but this is very different from clear,

 10 uniform standards and stress testing against those

 11 standards and disclosure of the results of the

 12 stress testing to all customers to create a level

 13 playing field and incentivize best performance.

 14 A CCP's financial safeguards should be

 15 risk-based, funded, and transparent. The capital

 16 commitment to the guarantee fund should be

 17 standardized and assessed in a robust manner, and

 18 commensurate with the risk managed by the

 19 clearinghouse. Given the current and growing role

 20 that CCPs play in risk management of derivatives,

 21 current CCP guarantee fund contributions are

 22 generally insufficient and should be increased.
 125

 1 CCP contributions to the guarantee fund should be

 2 mandated where not already in place, and should be

 3 set at minimum risk-based level. The PFMIs and

 4 standards set by the regulators should require

 5 prefunding of certain financial resources

 6 available to the CCP.

 7 Clearing firm assessments, contributions

 8 to the guarantee funds should also be prefunded

 9 and held in escrow accounts or by some other means

 10 for the funds to be readily available. CCPs

 11 should disclose in detail the totality of

 12 resources available for loss absorbency, including

 13 a CCP's capital commitment to the guarantee fund

 14 and the size of the guarantee fund in the event of

 15 a clearing firm default.

 16 As Angela said, the recovery measures

 17 should be robust and clear. CCP recovery measures

 18 should be clarified and enhanced. CCPs should be

 19 required to establish clear rules for portfolio

 20 auctions in advance of a recovery event that

 21 permit the participation of clearing firms, as

 22 well as other market participants, specifically
 126

 1 those with expertise in the asset classes

 2 composing a CCP's portfolio.

 3 When default management fails, the CCP

 4 should quickly transition from recovery to

 5 restitution in order to protect the CCP's

 6 customers. Regulators should establish a clear

 7 standard as to when the point of nonviability has

 8 been reached and the CCP should be closed. The

 9 point should be when the clearing member fails and

 10 the auction process fails to allow the CCP to

 11 rebalance its book. When the recovery measures

 12 have failed, there must be an established, clear,

 13 and rapid process to close out positions,

 14 including immediately establishing a tariff price

 15 to limit end-user losses and systemic impact.

 16 In terms of use of customer margin,

 17 haircuts on initial margin and variation margin

 18 are both in the event of a recovery. The purpose

 19 of margin -- we have to keep in mind, the margin

 20 addresses market risk of a position, the

 21 volatility of a position, or the credit risk of a

 22 customer. It's inappropriate to tap customer
 127

 1 margin in the event of a disruption. Customers

 2 have no ability to assess the likelihood of

 3 disruption and loss of margin. We need to

 4 incentivize customers. Well, by accessing margin

 5 in the event of disruption, you would effectively

 6 serve to incentivize customers to leave a CCP at

 7 the earliest point to avoid the risk.

 8 Use of margin in recovery makes no sense

 9 as effectively the risk management has failed. In

 10 other words, when considering the backstop of

 11 customer margin at the end of a recovery is

 12 illogical given the failure of the CCP at that

 13 point confirms the challenges with respect to risk

 14 management that the CCP faces. Margin cannot be

 15 relied on as an ultimate backstop as it won't be

 16 there. Customers will close out or port their

 17 positions in advance of disruption. Instead what

 18 we need is to mandate clear disclosure margin

 19 methodology, the assumptions related to the

 20 methodology, and the performance against those

 21 assumptions.

 22 In sum, customers are mandated to clear
 128

 1 as Angela said, and given that mandate and limited

 2 options, regulators need to mandate strict rules

 3 to address CCP risk. In terms of standards, we

 4 need to set minimum standards for risk management,

 5 stress testing, financial safeguards, set more

 6 granular stress testing, inputs into testing

 7 scenarios, cross CCP and cross clearing member

 8 risk scenarios, and provide full transparency of

 9 performance against the standards. And finally,

 10 AMG members strongly believe that we should not

 11 allow access to customer margin; instead, set

 12 standards for recovery, define the point of no

 13 return, and move into resolution and position

 14 liquidation and a return to the margin.

 15 Thank you.

 16 MS. WALTERS: Thank you, Bill. So I

 17 represent BlackRock's Risk and Quantitative

 18 Analysis Group, a team of 250 people globally

 19 responsible for investment and market risk,

 20 counterparty credit, and concentration risk,

 21 operational and technology risk.

 22 As an active member of SIFMA AMG,
 129

 1 BlackRock supports all of the recommendations that

 2 are in the SIFMA letter. I would encourage

 3 everyone in this room and also the commissioners

 4 to please review the comments as they were

 5 unanimous from all members that participated, and

 6 I think they reflect an aspect of the CCP

 7 resiliency issue that we've been discussing that

 8 hasn't been addressed in as much detail in this

 9 group until now.

 10 We do feel it is critical for the end

 11 investor's voice to be heard in these discussions,

 12 and we are actually not the end investors but

 13 we're representing them. And in many aspects,

 14 they are actually the public or the taxpayers in

 15 this context, and when we talk about using, you

 16 know, a variation margin or initial margin, in the

 17 event of a default, that's kind of tantamount to

 18 placing a tax on end- users of products which we

 19 feel is very, very inappropriate.

 20 So I just want to add some additional

 21 color to some of the comments that both Angela and

 22 Bill made. First, we believe, as a firm, that CCP
 130

 1 loss-absorbing resources are currently

 2 insufficient in both size, as well as transparency

 3 around the actual amounts of them. We feel the

 4 default waterfalls need to be strengthened; that

 5 market participants need to be ascertained that

 6 loss-absorbing resources will be available in

 7 peacetime and wartime. One thing we saw from the

 8 financial crisis is that what you think could

 9 happen based on history or might happen, can in

 10 many instances be less extreme than what actually

 11 happens in a crisis scenario, which I think

 12 illustrates the conversations and dialogue we've

 13 had around interconnectedness and the fact that

 14 the clearing member community is actually

 15 compressing and it's difficult -- the barriers to

 16 entry are very real. We should all be listening.

 17 You know, when I hear, you know, Ron or Susan and

 18 Emily from, you know, large, sophisticated

 19 institutions that have been in this space for a

 20 long time tell us that it is challenging,

 21 difficult, or potentially not possible for them to

 22 port an FCM. I think that's something we need to
 131

 1 listen to very closely. We're not proposing

 2 rolling back regulations in capital. All of those

 3 regulations were done for a very important reason,

 4 but there are implications of those, and I think 

 5 we can't put our heads in the sand and think that

 6 if there is a default of a major clearing member,

 7 that there is going to be a multiple -- another

 8 clearing member available to step in, and also

 9 need to recognize that these firms are all, you

 10 know, FCMs in every single one of these exchanges

 11 globally. So it's a very real issue.

 12 Therefore, what we would recommend is

 13 significantly increasing the CCP's risk-based

 14 contribution to the guarantee fund, which in all

 15 cases is quite small today, and insubstantial --

 16 not substantial relative to the amount of capital

 17 that other regulated financial institutions need

 18 to hold aside against potential losses.

 19 We think that additional contributions

 20 to the guarantee fund, as well as requiring that

 21 clearing member assessments be prefunded would

 22 enhance the loss-absorbing ability of these
 132

 1 guarantee funds. And we think this will

 2 incentivize the CCPs to at all times have robust

 3 risk management systems and processes in place and

 4 align incentives between the CCP, clearing

 5 members, and market participants. We should not

 6 forget that CCPs today are not neutralized

 7 entities that are operating on a not-for-profit

 8 basis. They are for-profit entities that benefit

 9 from the clearing mandate and have done so --

 10 sorry, you're waving your hands on the other side

 11 of the room. Pardon?

 12 MR. GRAY: Just, sorry. The DTCC is a

 13 member- owned utility.

 14 MS. WALTERS: Yes. So in many

 15 instances, the CCP are actually for-profit

 16 entities that have benefitted quite significantly

 17 from the clearing mandate.

 18 The second thing that we advocate is

 19 increased transparency and consistency, and we

 20 talked about this previously in the session. You

 21 know, market participants need increased

 22 transparency into the risk management practices of
 133

 1 CCPs. As a fiduciary, BlackRock assesses the

 2 credit worthiness of the counterparties our 

 3 clients face, including CCPs. We do not have

 4 access currently to the same degree of information

 5 as we do with bilateral counterparties. Increased

 6 transparency for the swaps market was a central

 7 tenet of Title 7 of Dodd-Frank. While we welcomed

 8 the improved disclosure expected with the CPMI

 9 IOSCO's quantitative disclosure requirements, we

 10 believe additional disclosure requirements are

 11 still needed.

 12 As I mentioned earlier in the first

 13 panel, we still require stress test details,

 14 relevant scenarios considered, and inputs into the

 15 process, specifically risk factors and shock

 16 levels used and relevant pricing data and

 17 correlation and liquidity assumptions applied. We

 18 also need more detail on results. This would

 19 include publishing results beyond the top two

 20 along the lines of the top five to 10

 21 counterparties concentration disclosure

 22 requirements. We would also want to see results
 134

 1 from independent stress test validation. Further,

 2 we believe risk management processes should be

 3 harmonized across CCPs. This includes having

 4 stress testing subject to be independently

 5 determined standards consistently applied across

 6 CCPs and subject to regulatory oversight with

 7 results publicly disclosed. Ultimately,

 8 meaningful harmonization would require that

 9 mandated clear products clear at a minimum of two

 10 CCPs.

 11 The next point we'd like to make, and

 12 I've made it before, is that the margin of

 13 nondefaulting counterparties is not an appropriate

 

 

 

 

 

 

 

 

 

 14 recovery tool. In fact, it's highly inappropriate

 15 and something that should never happen in this

 16 space. Initial and variation margins should never

 17 be used to cover a shortfall in a CCP's default

 18 waterfall. We've had conversations about whether

 19 variation margins should be included in the

 20 default waterfall, moved up from a buy side

 21 perspective. The answer emphatically is no. This

 22 is wrong, and again, tantamount to taxpayers

 

 

 

 

 

 

 

 
 135

 1 essentially absorbing losses of a default.

 2 I think one thing that we'd like to make

 3 a point in this context is when you think about

 4 variation margin gains haircutting, it's important

 5 to remember that broker- dealers, their risk

 6 positioning is generally flat, so the concept of

 7 VM gains haircutting is one that predominantly

 8 applies to end users, so clients of BlackRock,

 9 such as pension funds and institutional investors

 10 who are again representing taxpayers, as well as

 11 commercials, and this positioning by its very

 12 nature is directional, and therefore, application

 13 of variation margin gains haircutting directly

 14 affects end-users, not broker-dealers.

 15 And I just think to clarify once again,

 16 and this point I do think seems to be lost -- has

 17 been lost in this debate, is that variation margin

 18 primarily at risk of being haircut is the property

 19 of end-users. It is not a pot of windfall gains

 20 that happens to be sitting at the CCP on any

 21 particular day. Haircutting amounts to a random

 22 tax on market participants, particularly where
 136

 1 those participants have been required by law to

 2 use CCP services.

 3 Finally, on the topic of recovery versus

 4 resolution, I think I've mentioned this in prior

 5 discussions and BlackRock's been very vocal around

 6 this, we don't like it when any financial

 7 institution fails, but we do know as part of the

 8 financial crisis that we've adopted and

 9 successfully used -- people can argue about how

 10 successfully, but we know how to resolve a bank or

 11 financial institution. And I think in the context

 12 of CCPs, and particularly given some of the issues

 13 we've talked about, you know, FCM portability and

 14 just the practical realities of whether or not

 15 that's feasible in today's markets, CCPs should be

 16 allowed to fail and should have resolution plans 

 17 that include public ex-ante liquidation

 18 procedures. All market participants, including

 19 CCPs, should be allowed to fail while ensuring

 20 protections are in place to avoid systemic risk

 21 and to protect end investors.

 22 Maintaining the continuity of services
 137

 1 of any one CCP is not the key to avoiding the next

 2 financial crisis. The failure of a CCP -- and

 3 again, I've said this before -- reflects a flawed

 4 risk management process, which will impact

 5 customer confidence in the CCP on a

 6 forward-looking basis. This challenges the very

 7 viability of recovery. The majority of our

 8 investors would prefer to be money good rather

 9 than position good in the context of a troubled

 10 CCP. So in the context of recovery versus

 11 resolution, if recovery is straightforward and

 12 practical, then certainly we would support it.

 13 However, at the point where recovery is not

 14 viable, we think that this concept of money good

 15 versus position good is extremely important.

 16 As soon as the CCP has reached the point

 17 of no return, no goods are received for positions

 18 or the cost of replacing the positions is likely

 19 to exceed the CCP's resources. We believe that a

 20 resolution process should be immediately invoked

 21 by the CCP and relevant regulators.

 22 Thank you.
 138

 1 MR. BEESON: Okay. With that, we'll

 2 open up to other comments from participants. 

 3 Sunil?

 4 MR. CUTINHO: I don't know why I'm the

 5 first to raise the tent. Everybody else is quiet.

 6 Thank you for that. Actually, I'd like

 7 to clarify a few things. When you say "loss

 8 absorbing resources" when there is a default,

 9 actually, the default is margin. The default is

 10 guaranteed funds. And then you have the CCP's own

 11 contribution, plus the mutualized pool. It

 12 includes both prefunded and assessments. That is

 13 the loss of job incapacity to manage a default.

 14 So I don't know why there is only a reference to

 15 CCP capital. So when you say it's insufficient,

 16 I'm presuming that you're pointing to CCP's

 17 contribution is insufficient. Yes? You are not

 18 saying the amount. Okay. I see head nods. Okay.

 19 That's fine. Okay. I just wanted to clarify

 20 that. The assessments to be prefunded. So, and

 21 then there is another team that talked about no

 22 sufficient disclosure. The size of the prefunded
 139

 1 assessments is actually cover two. Two largest

 2 failures under stress events, and the assessments

 3 cover number three, four, five, and so on. Right?

 4 So you're suggesting that the prefunded resources

 5 should include failure of all clearing members?

 6 MR. THUM: I think that one point that I

 7 made repeatedly was in addition to looking at the

 8 failure of a single clearing member, the stress

 9 test should consider, and the scenario should

 10 consider the failure not only of a clearing member

 11 to a clearinghouse, but also the fact that that

 12 clearing member may be failing with respect to

 13 multiple clearinghouses. So that was the issue.

 14 In terms of the prefunding, I think the

 15 points were both that it should be prefunded and

 16 held in escrow so that it's available.

 17 MR. CUTINHO: Well, let me point to

 18 those two things. First is historically, if you

 19 look at it, any clearing member that has failed

 20 has failed to multiple CCPs, generally speaking.

 21 If you look at a large clearing member failure

 22 that has happened. And that is taken into account
 140

 1 because there is no netting, so there is

 2 collateralization at each CCP for the exposures at

 3 each CCP, there is no netting going on between the

 4 two. So that's something to keep in mind.

 5 So the second thing is prefunding. So

 6 the way to think about it is what problem are we

 7 solving with prefunding of assessments? So if the

 8 issue is you want greater protection, having

 9 something in escrow is not going to give you

 10 greater protection. So take, for example, a large

 11 -- so the size -- the sizing of a fund is based on

 12 the simultaneous failure of the two largest net

 13 debtors who have losses in excess of their margin.

 14 Yeah? And then the issue is when they fail, they

 15 won't be there to give assessments. That's what

 16 assessments are. They are sized taking into

 17 account that those two don't exist. But if you're

 18 saying prefunding, right, rather than everybody

 19 prefunding, if the issue or the problem you're

 20 trying to solve is assessments won't be available

 21 from the failed entities who are bringing the

 22 largest risk, then it's better to prefund. If the
 141

 1 suggestion is prefunding, it's better to prefund

 2 in the waterfall. Of course, it can be used in

 3 the right order, but it's suggested in the

 4 waterfall. Because if you look at the loss

 5 absorbing chain, it's margin, then guarantee fund.

 6 So even if you touch the mutualized pool, if you

 7 have more capital there, which is a function of

 8 some risk -- maybe concentration, maybe size, size

 9 of the business -- we are not suggesting, by the

 10 way, that this is what we need right now. In our

 11 opinion, assessments are very credible. If you --

 12 if you go back, if you look at the assessments as

 13 a size of the firm's capital, that's one measure.

 14 If you look at assessments as a size of the

 15 typical variation margin that a clearing member

 16 has to pay during times of stress, they are

 17 fractions. Assessments are actually fractions of

 18 that.

 19 Having said that, there is also another

 20 provision, especially in our rules. If the

 21 markets move in a manner so that the defaulter's

 22 margin is insufficient to some threshold level,
 142

 1 assessments can be precalled even before you

 2 exhaust prefunded margin. So assessments I think

 3 are a very, very credible tool because lack of

 4 committing or paying an assessment is a failure,

 5 is a default. So I don't -- I challenge the idea

 6 that assessments are not a credible tool.

 7 MS. WALTERS: You know, I think, Sunil,

 8 what we're simply saying is that --

 9 CHAIRMAN MASSAD: Can I -- excuse me.

 10 I'm sorry to interrupt. I just have to leave. As

 11 important as this discussion is, I've got to go

 12 attend the Financial Stability Oversight Council

 13 Meeting, another systemic risk discussion. But I

 14 just want to thank Susan and Gerald for

 15 moderating. I want to thank Kristen and Angela

 16 and Bill for your presentations. I want to thank

 17 all of you for participating, particularly

 18 representatives of the clearinghouses. This has

 19 been an incredibly useful discussion. I'm sorry I

 20 have to cut out a little bit early, but I look

 21 forward to getting a full briefing on what else is

 22 said. And this work will continue, obviously, not
 143

 1 just through MRAC but through all the other ways

 2 that we are discussing this issue, both within the

 3 Commission and internationally as well. So thank

 4 you all again.

 5 MS. WALTERS: Sorry. I think what we

 6 would say is just in general we feel that the loss

 7 absorbing capacity, including all sources of

 8 funding are currently insufficient to handle, you

 9 know, single or multiple clearing member defaults,

 10 and assessments are a good tool, and we recognize

 11 actually that they would flow through to the cost

 12 of clearing for our clients. But you have to do

 13 them in peacetime, not wartime. So if you hold

 14 off and don't have the assessments done until

 15 wartime, then you're unable to actually -- you're

 16 unable to actually make the assessments or obtain

 17 the cash that you need. That's the point that is

 18 should be prefunded.

 19 MR. CUTINHO: Let me challenge the first

 20 one. Why do you think the loss of job incapacity

 21 is insufficient? I just heard margin plus

 22 guarantee fund plus CCP contribution plus the
 144

 1 mutualized pool. The whole size is insufficient

 2 to cover one default.

 3 MR. THUM: I think, I mean, I could jump

 4 in a little bit. I think there's a couple issues.

 5 You know, one is the issue of overall adequacy and

 6 the other is setting standards.

 7 MR. CUTINHO: Okay.

 8 MR. THUM: I think that with respect to

 9 the clearinghouses that Vanguard uses, I think we

 10 have great confidence in our clearinghouses.

 11 MR. CUTINHO: Okay.

 12 MR. THUM: We also have a fair window in

 13 to the information that comes with respect to

 14 their financial resiliency. That being said, I

 15 think what we're looking for is for the regulator

 16 to establish a minimum standard for these

 17 different areas so that the reporting can be

 18 transparent across all market participants. And

 19 some of the reason why we're raising these issues

 20 about enhancing the standardization, enhancing the

 21 level of transparency is because there are

 22 discussions about haircutting and margin. And
 145

 1 that is of great concern to us, even with the

 2 window in and the great relationship that we have

 3 with our clearinghouses. You know, we're not

 4 presently concerned about our margin. We're not

 5 presently concerned about the clearinghouses. But

 6 we think that particularly as that topic has come

 7 it, it really underlines the need for consistent

 8 standards and transparency. And we think that the

 9 clearinghouses that we use will not only have

 10 performed but will demonstrate superior

 11 performance against those standards and the

 12 transparency.

 13 I would say as well there's a

 14 relationship between the level of transparency

 15 into what the CCP is doing and the level of

 16 capital commitment that needs to be put aside to

 17 support the operations. Certainly, I think

 18 Vanguard is saying the more transparency is

 19 provided, probably the lower the capital

 20 commitment needs to be. In the absence of the

 21 transparency, it is hard to even assess what

 22 amount needs to be set aside in the absence of
 146

 1 transparency. So I think more transparency, less

 2 capital, but clearly standards across the board

 3 and reporting across those standards.

 4 MR. CUTINHO: Let me address your point

 5 on margin haircuts. We are with you. So if you

 6 look at the current rules, they call for actually

 7 closing our positions and giving you back money.

 8 Because if we are talking about a circumstance

 9 where the markets have broken down, you know, and

 10 a lot of members have failed, there is chaos in

 11 the financial markets, right, reasonably? It's,

 12 you know, it's not the cleared markets that, you

 13 know, if you look typically in financial crisis,

 14 of course the future ones may be different. But

 15 at the end of the day, if you consider the

 16 scenario where a lot of members have failed, we

 17 would rather prefer to give you back your money.

 18 Certainty is about giving you back money and

 19 closing out positions so there is no further risk.

 20 So we are with you there. We don't think margin

 21 haircuts is a good approach. It will create a

 22 run. It will force clients to actually close out
 147

 1 their positions.

 2 MR. THUM: The margin will be there.

 3 Right, exactly.

 4 MR. CUTINHO: Yes. But at the end of

 5 the day, I think what we're trying to do right now

 6 is, you know, there are several tools in the

 7 basket. One of them is partial haircut versus

 8 partial termination versus a full termination.

 9 Rather than closing all markets, if there is one

 10 market or a smaller market that has failed, rather

 11 than, you know, closing out the entire market,

 12 just close out -- localize the termination or the

 13 tear up to the markets that are broken rather than

 14 all the markets. Why create a crisis when there

 15 isn't one; right? So that's one.

 16 The second thing is as far as gains

 17 haircutting, there are two things we talked about.

 18 One is gains haircutting and the other is margin

 19 haircuts. The role of gains haircutting is a very

 20 -- is a bad tool. But at the end of the day, the

 21 reason that gains haircutting is a tool there is

 22 to incent people to actually enter into and
 148

 1 participate in auctions. At the end of the day,

 2 the issue there is you don't want somebody there

 3 sitting with gains to just be a holdout, and this

 4 is to solve for the holdout problem when the

 5 object is to actually auction off the book or the

 6 closeout and restore a matched book. So that's

 7 the purpose of gains haircutting and it cannot be

 8 done indefinitely. It's just a limited purpose

 9 tool for a very small set of circumstances to act

 10 as an incentive.

 11 MR. LEWIS: One of the differences in

 12 practice in the U.S. versus Europe is in Europe

 13 for futures, triparty custody is allowed for, you

 14 know, and my only point is that in the Eurex model

 15 where the option is provided not only for triparty

 16 custody of the margin money but also of full

 17 customer segregation which ensures that the client

 18 margin funding is not at risk. Now, the nice

 19 thing about that approach is that it costs more

 20 but the cost is absorbed by the -- that's not a

 21 nice part about it, but it's -- at least for a

 22 different model the cost is borne as was suggested
 149

 1 willingly for the additional protection, and I

 2 just would urge particularly given the continuing

 3 ambiguity about U.S. Bankruptcy protections

 4 against clawbacks in the event of a FCM default,

 5 that you guys should be looking more at tools that

 6 do work effectively elsewhere that would provide a

 7 much greater certainty of protection and that

 8 could be dropped into the current system. As I

 9 say, because we deal with, as you're suggesting,

 10 windows and orphans, you know, national pension

 11 funds in Europe who have these same concerns, and

 12 the structure is really designed to prevent this

 13 from coming up. I don't know. There's

 14 controversy about importing that approach to the

 15 U.S., but at least it would be relatively

 16 actionable I think because I think the CFTC would

 17 have within its gift, in fact, the ability to fix

 18 that problem. There are those that disapprove of

 19 this at the Commission for good reasons, but the

 20 question is if it's a choice and you guys feel

 21 like it would work to protect you, I would just

 22 think that that might be something to consider.
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 1 MR. CUTINHO: Cliff, I'd like to

 2 challenge you there. Actually, I don't think

 3 segregation would protect you in this circumstance

 4 that the team is talking about. In Europe there

 5 is under -- I mean, that is under consideration.

 6 The rules are not out. For margin haircuts, for

 7 nondefaulting clients, it doesn't matter whether

 8 they're segregated or not. So they will be

 9 subject to it when they reach here in the U.S. We

 10 have taken a stand. We have said margins are

 11 sacrosanct. You cannot touch it. It's only gains

 12 haircutting. So segregation, in and of itself,

 13 doesn't help. Of course, you know, if CCP

 14 considers it, it may end up haircutting

 15 everybody's margin. So, it's not about -- the

 16 segregation only prevents losses from one client

 17 affecting another client for failed firms.

 18 L: Good point.

 19 MR. THUM: One other point I wanted to

 20 build on, what Sunil said earlier, just as I said,

 21 I think there's an interrelationship between

 22 transparency and the capital contribution. I
 151

 1 think there's also an interrelationship between

 2 what we're talking about and the standards and

 3 guidelines for mandating a particular product to

 4 be cleared. And I think that not only do those

 5 standards need to be assessed against this risk

 6 discussion and the risk that mandating a product

 7 to be cleared introduces into the system, but I

 8 think it also needs to be refreshed regularly to

 9 make sure that the liquidity levels are what they

 10 need to be, the product is standardized, that

 11 there are multiple clearinghouses that can clear

 12 the product, that those clearinghouses have, you

 13 know, effectively a threshold number of clearing

 14 members that are providing liquidity within them.

 15 I think there's a lot of interrelated issues, so

 16 it's hard to talk about any one of them in

 17 isolation and make a compelling argument given the

 18 interrelationship between all of them. So I know

 19 that certainly the CFTC is focused on these

 20 issues, but I think it's important to lay it out

 21 here. You know, we're mostly talking about

 22 products that are mandated to be cleared, and the
 152

 1 stresses I think that it puts on risk management

 2 back at our house is we were very, very supportive

 3 of the clearing mandate. As I said, Vanguard

 4 clears I think just about all of its swaps at this

 5 point, both on the interest rate side and CDX, but

 6 that being said, as we look at issues,

 7 particularly in the context of folk talking about

 8 haircuts on margin, you know, we want to see not

 9 only recommended best practices, we want to see

 10 not only strong, robust practices of our

 11 clearinghouses that we currently deal with, but a

 12 standardized threshold of behavior that can be

 13 looked at across all clearinghouses, where stress

 14 testing can be applied and the risk management

 15 back at our shops can see how the different

 16 clearinghouses are performing against those same

 17 standards and making a decision to continue

 18 clearing. We fully expect the clearinghouses that

 19 we use will shine in that examination. But we

 20 think it's important that that be one component,

 21 there be minimum standards set stress testing

 22 against that, independently verifiable, and
 153

 1 transparent to all market participants.

 2 MR. BEESON: All right. Being mindful

 3 of the time, we've got a few other comments on the

 4 table here that we'll move forward with.

 5 Andrew, you have a comment?

 6 MR. GRAY: Yeah. I'll be very quick

 7 because we don't really have time for a

 8 point-by-point discussion on each of the items

 9 you've raised, but thank you for sharing your

 10 views.

 11 I did want to point out that there are

 12 some differences with respect to how DTCC

 13 operates. Our ownership structure is different.

 14 As I said before, we are member-owned. We trade

 15 cash instruments. And so we look at these

 16 recommendations a bit differently. And I would

 17 refer everyone to a paper that we produced a

 18 couple months ago on CCP resources and resiliency

 19 where we laid out our views that are specific to

 20 how DTCC operates on many of the topics that have

 21 been discussed here. Thank you.

 22 MR. BEESON: Richard?
 154

 1 MR. MILLER: Thank you, Gerald. Just

 2 briefly, because insurance companies like

 3 Prudential and others are directional players in

 4 the market, I want to endorse your comments. I

 5 think they're right on point, and we, too, would

 6 like to see greater transparency and more

 7 consistency across the stress testing so that we

 8 can underwrite our risks like we would in the

 9 customary over-the-counter market. We'd like to

 10 do the same with respect to CCPs where we're

 11 compelled to conduct our clearing business. We,

 12 too, hope and expect everything will shine when we

 13 look under the hood, but at this point in time our

 14 hands are basically tied. We can't really do it

 15 for ourselves. We need more help.

 16 MR. BEESON: Kevin?

 17 MR. MCCLEAR: Just real quickly, because

 18 like Andrew said, I don't think it's possible in a

 19 short time period to address all the points that

 20 were raised in your good letters. But I would

 21 like to end on a good note. I think we all agree

 22 clearing is fundamentally good. It's the
 155

 1 foundation of the EMIR and Dodd-Frank. It's

 2 disciplined. It's very transparent. It's

 3 becoming more transparent. We'll work with you in

 4 that respect.

 5 The one point I did want to respectfully

 6 challenge though is this notion that a

 7 clearinghouse's contribution to the default

 8 waterfall should be risk-based. I think,

 9 respectfully, that's fundamentally flawed because

 10 clearinghouses are central counterparties. We

 11 don't take on positions. We don't take on

 12 position risk. We manage the risk and that's why

 13 ICE agreed voluntarily to contribute to the

 14 default waterfall. But we did it for commercial

 15 reasons, to align our risk management practices

 16 with our clearing members and their customers. I 

 17 think it's very dangerous to impose a risk-based

 18 requirement on the clearinghouse because it

 19 potentially disincents those behind us in the

 20 waterfall to manage that risk. A good example of

 21 that, too, is when we get to a default auction, we

 22 require our clearing participants to bid on the
 156

 1 defaulting portfolio. But if they see that the

 2 clearinghouse has a big chunk of capital in front

 3 of that, they're going to factor that bid, that

 4 amount of capital into their bid and effectively

 5 lessen the bid. So I think we need to be more

 6 thoughtful and careful when we talk about a

 7 risk-based methodology.

 8 Thank you.

 9 MR. THUM: I think the only point I

 10 would say to that is that, you know, we see the

 11 contribution to really be the discipline that

 12 effectively applies to the CCP's performance of

 13 its role. So while we certainly look to the

 14 CFTC's oversight of the clearinghouses, it's the

 15 clearinghouses that are on a day-to-day basis

 16 assessing the positions that are coming in, that

 17 are making assessments with respect to the FCMs,

 18 are doing the margin calculations, are, you know,

 19 insisting that it all performs in accordance with

 20 its ruleset. And right now we have great

 21 confidence that they will do that. But having

 22 effectively an adequate level of skin in the game
 157

 1 effectively is an incentive to make sure that that

 2 happens on a consistent basis forever.

 3 MR. CUTINHO: Two comments though. One

 4 is I know -- I didn't want to skip the discussion

 5 about for-profit versus not-for-profit. I'd like

 6 to -- I know we have spoken a lot on this, but I'd

 7 like to challenge you to show as an example where

 8 for-profit CCPs are weaker in terms of their risk

 9 management versus not-for-profit. So take any

 10 measure and challenge us. And I think that's

 11 something that we'd like to work with you on.

 12 It'll be a fun exercise for us.

 13 The CCP contribution -- actually, I'll

 14 take a slightly different explanation than what

 15 Kevin did because we do look at it from a risk

 16 perspective. It is actually risk-based. And it's

 17 the risk that we bring. Right? And the important

 18 thing for us -- let me just bring this incentive

 19 effect. Okay? We are talking about CCP capital

 20 contribution to cover the default of a

 21 participant. There are other risks in the system

 22 where a CCP uses its capital to cover. Right?
 158

 1 So-called "skin in the game." So let's go over

 2 these. Right?

 3 So when it is clearing member failure,

 4 you want to make it a "defaulter pays" model.

 5 Anything other than that will result in

 6 subsidization. So that's something to think of.

 7 So let's start from the problem we're addressing

 8 and then let's look for a solution. So in order

 9 to make a default or pays model, you cannot have

 10 the defaulters -- the risk that a default brings

 11 be subsidized. Right? So that is something that

 12 Kevin pointed out. So it is risk based. We have

 13 to make sure the incentive effect is that the

 14 defaulter continues to pay. So you cannot

 15 subsidize a defaulter pays more.

 16 But let's look at the operational risk

 17 and investment risk. Those are risks that a CCP

 18 takes. Of course, a CCP should stand and take 100

 19 percent of that, should not neutralize it. Risk

 20 within their control; right? So the risk within

 21 their control, the risk that they bring, they

 22 should actually bear those risks. So it is risk
 159

 1 based. The CCP contribution should be risk based.

 2 So we are with you. It's essentially the risk

 3 that you think and we think may be different. So

 4 I just want to have that conversation, that open

 5 dialogue.

 6 MR. THUM: That gets at you performing

 7 your obligations and your responsibilities under

 8 the rule set in a full and robust fashion on a

 9 daily basis. So I think, you know, we're in

 10 agreement that that is a major focus.

 11 MR. BEESON: Sorry, go ahead.

 12 MS. PORTNEY: Just two comments. We at

 13 JPMorgan, along with many other clearing members

 14 have been pretty vocal around the fact that CCPs

 15 themselves do -- can and do make risk decisions

 16 day in and day out. They decide membership

 17 requirements. They decide what products to clear.

 18 They alone decide margin. They decide what is

 19 acceptable collateral. They decide what haircuts

 20 to apply to that collateral. Every single one of

 21 those decisions they make, they have the power to

 22 make and they do make, and any one of those can,
 160

 1 and does, introduce risk to the system. And there

 2 are many instances where clearing members have

 3 gone on record for each one of those disagreeing

 4 with what a clearinghouse has ultimately decided

 5 to do in terms of, for example, new products, et

 6 cetera, which, unfortunately, you know,

 7 ultimately, the for-profit incentive to grow the

 8 revenues has really prevailed. So I would say

 9 that's just one thing.

 10 The only other thing I would just say

 11 just as a matter of observation, and I do think

 12 they representatives from the buy side have been

 13 very, very eloquent here and it's frankly better

 14 to hear from you than it is probably to hear from

 15 the sell side. But one thing I would just ask is

 16 at the end of the day, clearinghouses have many,

 17 you know, have many customers, but their clearing

 18 members are a customer and all of the end-users

 19 are a customer. You are hearing in a very -- a 

 20 real loud consensus that at the end of the day,

 21 your end customers and your users feel that you

 22 should have more skin in the game, more
 161

 1 disclosure, and there should be, you know, some

 2 form of more oversight and consistency in stress

 3 testing. Generally speaking, I would think that

 4 an industry actually would want to respond to

 5 their customer base and their end-users.

 6 MR. BEESON: Ed, you had a tent up

 7 earlier.

 8 MR. PLA: Just maybe an echo of your

 9 comment on stress testing. I think we need to

 10 remember that stress tests should be hard and, you

 11 know, again, I think the unison with which you

 12 speak about these issues is refreshing to hear

 13 because I think we should be holding ourselves to

 14 high standards. But we have to remember that

 15 stress tests by their nature are plausible but

 16 incredibly unlikely, which means they should be

 17 hard tests to meet and they should be transparent.

 18 It shouldn't be, you know, they shouldn't be rules

 19 based specific to CCPs, we don't believe. We

 20 believe that they're scoped to standardize these

 21 and make these far more transparent, much easier

 22 to understand, and then we can all assess for
 162

 1 ourselves whether or not stress tests have truly

 2 set a very high bar for the industry at large and

 3 make them easy to compare.

 4 MS. WALTERS: I would just add that I

 5 think, you know, again, post-financial crisis,

 6 stress testing that's been -- that was implemented

 7 and has been conducted on commercial and

 8 investment banks in a standardized way overseen by

 9 regulators has demonstrated that something that's

 10 very difficult can be done. It can be crafted and

 11 nuanced and fine-tuned based on changing market

 12 conditions. And to be honest, it puzzles me why

 13 an approach that, you know, has been battle tested

 14 and can be done, why we would think of trying to

 15 apply something else. I mean, certainly, fine

 16 tuning it so it applies to central clearing makes

 17 sense, but I can't in my 25 years of, you know,

 18 kind of risk management, think of a reason why we

 19 wouldn't want to follow a standard that has

 20 actually worked well.

 21 MR. BEESON: Sorry. Any other comments?

 22 Thank you.
 163

 1 MS. WALKER: Thank you, Gerald, for

 2 leading the panel, and thank you so much for your

 3 leadership with the writing, along with your

 4 staff, including Steven Berger on these

 5 recommendations.

 6 I will now turn to Mr. Tom Kloet who is

 7 here from Elmhurst College but has a long history

 8 in these markets to close us out.

 9 MR. KLOET: Thank you, Petal. And yes,

 10 Commissioner Bowen asked me to close the meeting

 11 out. So first, I want to thank her for her

 12 continued sponsorship, and Chairman Massad for his

 13 active participation today. Having them with us

 14 obviously helped the discussion significantly.

 15 I'd also like to join in thanking Susan

 16 O'Flynn and her team for the great work on the

 17 recommendations. They were well thought through

 18 and very clear. I think we had an excellent

 19 discussion and a number of areas where we had real

 20 consensus. So congratulations, Susan, to you and

 21 your team for putting that together.

 22 But mostly, I think we did exactly what
 164

 1 the MRAC is supposed to do, and that's give the

 2 Commission feedback -- ideas and feedback on these

 3 important risk issues. That's why we're here. We

 4 had an excellent discussion on items one and two.

 5 Items three, four, and five are also within the

 6 view of the CCP Coordination Subgroup and they'll

 7 be part of our discussion during the New Year.

 8 And then finally, like Petal, I'd like to thank

 9 the three representatives -- both Gerald and the

 10 three participants from the buy side. Your input

 11 is very valuable to this process, and we thank you

 12 for your very direct input and clear messaging

 13 with respect to your views.

 14 So with that, I'll turn it back over to

 15 you, Petal.

 16 MS. WALKER: The meeting is now closed.

 17 Thank you.

 18 (Whereupon, at 1:31 p.m., the

 19 PROCEEDINGS were adjourned.)

 20 * * * * *

 21

 22
 165

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 2 DISTRICT OF COLUMBIA

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 4 the District of Columbia, do hereby certify that

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 8 under penalty of perjury; that said transcript is a

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 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

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 22 My Commission Expires: March 14, 2018