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1

2 UNITED STATES OF AMERICA

3

4 COMMODITY FUTURES TRADING COMMISSION

5

6 PUBLIC ROUNDTABLE TO DISCUSS PROPOSED REGULATIONS

7 IMPLEMENTING CORE PRINCIPLE 9 FOR DESIGNATED

8 CONTRACT MARKETS

9

10 WASHINGTON, D.C.

11 TUESDAY, JUNE 5, 2012

12 9:31 a.m.

13

14 CORRECTED TRANSCRIPT

15 FRIDAY, JUNE 15, 2012

16

17 Atkinson-Baker, Inc.

 Court Reporters

18 (800) 288-3376

 www.depo.com

19

20 Job No. A605372

21

22
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1 PARTICIPANTS:

2 Rick Shilts

 CFTC, Director, Division of Market

3 Oversight

4 Michael Penick

 CFTC, Economist, Office of Chief

5 Economist

6 Aaron Brodsky

 CFTC, Attorney-Advisor, Division of

7 Market Oversight

8 Ananda Radhakrishnan

 CFTC, Director, Division of Clearing and

9 Risk

10 David Van Wagner

 CFTC, Chief Counsel, Division of Market

11 Oversight

12 Nadia Zakir

 CFTC, Associate Director, Division of

13 Clearing and Risk

14 Nancy Markowitz

 CFTC, Deputy Director, Division of Market

15 Oversight

16 Thomas Farley

 President, ICE Futures U.S.

17

 Tom LaSala

18 Managing Director and Global Chief

 Regulatory Officer, CME Group

19

 Stephen Humenik

20 General Counsel and Chief Regulatory

 Officer, Eris Exchange

21

 David Downey

22 CEO, OneChicago
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1 PARTICIPANTS (Continued):

2 Thomas Callahan

 CEO NYSE Liffe US

3

 Supurna VedBrat

4 Managing Director, Co-Head of e-Trading

 and Market Structure, BlackRock

5

 Michael Cosgrove

6 Advisor, GFI Group

7 Patrick Hamilton

 COO, ICAP Energy LLC and ICAP

8 Corporates LLC

9 Scott Mackle

 Managing Director, Head of Power Trading,

10 Constellation Energy

11

12

13

14

15

16

17

18

19

20

21

22
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1 P R O C E E D I N G S

2 MR. SHILTS: All right. I think

3 we'll get started right on time. Good morning

4 everyone. My name is Rick Shilts and I'm the

5 director of the division of market oversight here

6 the CFTC. I'm pleased to open this public round

7 table to discussion the implementation of the one

8 of the key provisions for designated contract

9 markets or DCM's. This involves the requirements

10 under DCM core principle 9 which was amended by

11 the Dodd-Frank Act.

12 The specific purpose of today's

13 round table is to hear the opinions of persons

14 with different interests, experience, and points

15 of view on the commissions proposed regulations

16 implementing core principle 9 for DCM's. The

17 round table discussion will focus on the proposed

18 centralized market trading requirement, certain

19 aspects of the requirements for exchange of

20 derivatives for related positions, and the

21 appropriate reporting time frame for block

22 transactions in futures contracts.
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1 As you know, one of the key goals of

2 the Dodd-Frank Act is to bring over-the-counter

3 derivatives under comprehensive regulation.

4 Certain derivatives are to be traded on

5 transparent trading platforms and cleared by

6 regulated counterparties similar to how futures

7 are now traded and DCM's.

8 A fundamental goal is to increase

9 pretrade transparency, which will produce more

10 price competition and greater liquidity. Open

11 and transparent markets can benefit the entire

12 economy, and generate more competitive prices

13 which lead to more efficient markets, and

14 ultimately lower costs for companies and their

15 customers.

16 With respect to price transparency

17 on DCM's, the Dodd-Frank Act amended the language

18 of DCM core principle 9 to provide that Board of

19 Trade shall provide a competitive, open, and

20 efficient market and mechanism for executing

21 transactions that protects the price discovery

22 process of trading in the centralized market of
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1 the Board of Trade.

2 On December 22 of 2010, the

3 commission proposed rules, guidance, and

4 acceptable practices to implement the 23 core

5 principles for designated contract markets,

6 including core principle 9.

7 Among the rules proposed under core

8 principle 9 were three areas that are the subject

9 of today's round table. First, to implement the

10 core principle's requirement, the DCM's provide a

11 market and mechanism for executing transactions

12 that protects the price discovery process of

13 trading in a centralized market. The notice of

14 proposed rule making set forth a minimum

15 centralized market trading requirement.

16 The proposed rule required in part

17 that 85 percent of the total trading volume of

18 any one contract listed on a DCM must be on the

19 centralized market.

20 Second, rules were proposed that

21 specified requirements related to exchange of

22 derivatives for related positions or EDRP
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1 transactions, which would include exchange for

2 futures for swaps and exchange of futures for

3 physicals.

4 Among other requirements, the

5 proposed rule would require that an EDRP

6 transaction must be bona fide and is not

7 contingent upon an offsetting transaction.

8 Finally, with respect to block

9 trades, the proposed rule would require, among

10 other things, that each such trade be reported to

11 the DCM within five minutes after execution.

12 On May 10th of this year the

13 commission approved the final rule-making on core

14 principles and other requirements for designated

15 contract markets. The rules implementing core

16 principle 9 were not finalized at that time, in

17 order to provide the commission with additional

18 time to consider the available alternative

19 contracts that may not comply with the proposed

20 centralized market trading requirement, as well

21 as the related implications of the rules for

22 blocks and EDRP transactions.
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1 It is expected that the commission

2 will consider the final rules implementing core

3 principle 9 when it considers the final swap

4 execution facility or SEF rule making.

5 The commission received many

6 comments on the proposed core principle 9 rules

7 and guidance. Staff is continuing to consider

8 these comments, some of which we look forward to

9 hearing again today.

10 I'd like to thank the many

11 distinguished panelists who have taken time out

12 of their busy schedules and agreed to participate

13 on today's panels to discuss these subjects.

14 I'd also like to thank the staff of

15 the CFTC for their work in planning today's round

16 table. Staff has been analyzing the numerous

17 comments received in order to develop final rules

18 that are consistent with the legislation and that

19 take into account the issues and costs to be

20 borne by market participants to come into

21 compliance. The discussion will greatly assist

22 us in drafting final rules and guidance
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1 implementing the core principle 9 requirements.

2 For the record, I'd like to know

3 that all statements and opinions that may be

4 expressed and all questions asked by CFTC staff

5 are those of the staff and do not necessarily

6 represent the views of any commissioner or the

7 commission collectively.

8 In order to ensure that we're able

9 to hear the opinions of all the participants, and

10 all the panel scheduled for discussion today, I

11 encourage you to limit your remarks to the issues

12 at hand.

13 Please note that the meeting is

14 being reported and a transcript will be made

15 public. The microphones are in front of you.

16 Press the button and you'll see the red light.

17 That means you can talk. Please speak directly

18 into the mic, when and you finish, please the

19 button again to turn off the microphone.

20 We also ask that you refrain from

21 putting any Blackberry or cellphones on the

22 table, as they can cause interference with our
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1 audio system.

2 Before we start, I'd like to go

3 through today's agenda. As I noted, we have

4 three panels scheduled. The first is entitled

5 Proposed Minimum Centralized Market Trading

6 requirement. It will run for one hour and 15

7 minutes, after which we will take a five-minute

8 break.

9 The second panel is entitled

10 Proposed Requirements for Exchange of Derivatives

11 for Related Position Transactions. And that will

12 run for about one hour, after which we'll take

13 another break. And the final panel is entitled

14 Proposed Requirements for Reporting Block

15 Transactions in Futures Contracts which will run

16 for about 30 minutes.

17 We plan to conclude around 12:30

18 today. So I'd like to get started with the first

19 panel, but first I'd like to go around the table

20 and let everyone introduce themselves.

21 Again, I'm Rick Shilts, director of

22 the division of market oversight at the CFTC.
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1 MS. MARKOWITZ: Nancy Markowitz,

2 deputy director.

3 MR. BRODSKY: Aaron Brodsky,

4 division of market oversight.

5 MR. RADHAKRISHNAN: Ananda

6 Radhakrishnan, director of the division of

7 clearing and risk, CFTC.

8 MR. VAN WAGNER: David van Wagner,

9 division of market oversight.

10 MS. ZAKIR: Nadia Zakir, division of

11 clearing and risk.

12 MR. PENICK: Michael Penick, office

13 of the chief economist.

14 MR. SHILTS: If the panelists could

15 introduce themselves. Tom.

16 MR. CALLAHAN: My name is Tom

17 Callahan. I am the CEO of NYSE Liffe U.S., which

18 is the U.S. futures exchange of NYSE Urinext.

19 MR. DOWNEY: My name is David

20 Downey. I am with OneChicago.

21 MR. FARLEY: Tom Farley. I'm senior

22 vice president of financial markets at ICE.
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1 MR. HAMILTON: I'm Pat Hamilton.

2 I'm the CEO of ICAP Energy.

3 MR. HUMENIK: Stephen Humenik. I'm

4 the general counsel and chief regulatory officer

5 of Eris Exchange.

6 MR. LA SALA: I am Tom LaSala. I am

7 the chief regulatory officer for the CME Group.

8 MS. VED BRAT: Supurna VedBrat. The

9 co-head electronic trading and market structure

10 for BlackRock.

11 MR. SHILTS: Thank you all for

12 participating. Now I'd like to turn it over to

13 Aaron Brodsky who will lead off with the first

14 question for the panel today.

15 MR. BRODSKY: Thank you, Rick. Just

16 a few more quick procedural notes. The first

17 panel consists of five questions, so the group

18 will have about 15 minutes to discuss each one.

19 Please be mindful of this time constraint as you

20 answer each question, and if you don't have a

21 response to a particular question, feel free to

22 pass.
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1 For this panel, for each question

2 why don't we start on my left and we'll just work

3 our way down the table for each question.

4 So let's get started with the first

5 question. As Rick alluded to in his opening

6 remarks, the CFTC proposal contemplates that to

7 comply with core principle 9 there must be some

8 centralized market trading for price discovery to

9 occur. How does a contract that does not trade

10 on the centralized market comply with core

11 principle 9.

12 MR. CALLAHAN: Thank you very much,

13 and thank you to staff for inviting me here today

14 to speak at this round table. I would start

15 answering the question with just a perspective

16 for NYC Liffe U.S. We are a new futures

17 exchange, probably -- well, I guess after Eris,

18 the second newest exchange represented.

19 And our mission is really to provide

20 competition in the U.S. futures market, largely

21 based upon innovation, not only in products, but

22 also in services. We built a new futures
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1 clearinghouse called NYC Liffe U.S. -- excuse me,

2 called New York Portfolio Clearing, which is the

3 first clearinghouse to offer portfolio margining

4 between cash bonds at futures.

5 We are also listing many new and

6 innovative futures contracts, many of which have

7 never existed before, and our greatest anxiety

8 around this proposed rule is that it would have a

9 very chilling effect upon the ability of new

10 exchanges to compete and upon new contracts to

11 succeed.

12 There was a statistic that was cited

13 at the FIA conference in Boca is that 90 percent

14 of new futures contracts fail. So there is

15 already a great challenge in this industry to

16 innovating and launching new products. Our

17 concern is that the rules as proposed would make

18 that mountain even higher to climb to launch new

19 products.

20 So to specifically answer your

21 question, I would say that, first of all, the

22 Commodity Exchange Act does provide that a DCM
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1 have reasonable discretion in how it adheres to

2 core principles. And to move away from that

3 reasonable discretion standard towards a more

4 prescriptive numerical threshold in terms of

5 percentages of central order book trading we

6 think would be counter-productive to the best

7 interests of the market.

8 Secondly, I would cite that core

9 principle 9 does say that the Board of Trade

10 shall provide a competitive and efficient market.

11 The key word there being "provide," as opposed to

12 ensure or mandate that any specific percentage of

13 trades happen through a central order book.

14 And, thirdly, I would say that there

15 are futures contracts, including those listed on

16 our exchange, that do not provide the central

17 price discovery for a given commodity. I would

18 cite specifically our many gold futures contract.

19 The primary price discovery market

20 for gold futures is in London, it's the bullion

21 market. And then secondarily it would be the

22 COMEX market where large volumes trade. Our --
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1 our mini-gold and mini-silver products are really

2 retail access products not meant to provide the

3 primary price discovery for that commodity, but

4 it's meant to provide retail and access to the

5 market that they would not otherwise have.

6 So I think if you consider that

7 certain contracts do not meet the standard of

8 primary price discovery, then to place an

9 additional burden upon them for percentages of

10 trades happening at central order book just

11 wouldn't -- wouldn't be consistent.

12 MR. DOWNEY: Thank you. OneChicago

13 runs two match engines. We have a central order

14 book where traditional marketmakers place

15 two-sided bids and offers, and for firms that

16 choose to allow their customers to participate,

17 they're allowed to hit lift electronically, like

18 every other electronic exchange.

19 There's a feature of the single

20 stock future which it's imperative that you try

21 to understand. Not try, actually understand

22 because it separates us from all other types of
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1 futures. We're really not a future, we're a

2 security.

3 Any swap where two parties swap

4 collateral for a security, they have a ISDA

5 agreement that they sign. This is the agreement

6 is a legally binding document that makes the two

7 parties conform to the terms of the original

8 agreement and calls for the return of the capital

9 and the security at the end of the term.

10 Single stock futures is that

11 agreement. It is an exchange traded, transparent

12 centrally cleared, legally binding contract that

13 is one leg of a swap. Some parties can

14 participate on it. Other parties cannot. In an

15 EFP, and exchange of future for physical using

16 security futures, is an equity financing

17 transaction akin to a securities lending

18 transaction or an equity repo. These are

19 fundamental features of the capital markets.

20 Now, when you call for open and

21 competitive, I don't understand what you mean,

22 because many people cannot participate on an EFP
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1 because if they do they will generate a tax

2 event, and they will shy away because if they

3 sell their stock to buy the future, they will

4 trigger a taxable event.

5 There are some people who are mark

6 to mark professional broker-dealers, pension

7 funds who don't have taxable implications, they

8 can participate. But if you own IBM stock and

9 you're long $80 a share and somebody wants to

10 borrow it from you, you should be able to use the

11 EFP but you can't because it would trigger a tax

12 event.

13 So this doesn't mean that the

14 product is bad. It doesn't mean that EFP's are

15 bad. That some people can't participate, even if

16 they can, but they don't. They won't, because

17 it's a problem with taxes.

18 Secondly, as I note, November of

19 2009, the commissions, the SEC and the CFTC, put

20 out a notice that allowed single stock futures to

21 be listed, security futures to be listed on

22 anything that underlies our option. The reason
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1 for that is because the CFMA specifically said

2 that the listing standards of single stock

3 futures can be no less restrictive than those of

4 security options. Each time they mention it,

5 they say to us, and permit the listing and

6 trading of futures based on any security that is

7 eligible to underline an option, may facilitate

8 price discovery in, and be useful for hedging for

9 underlying securities. Exactly.

10 It's not price discovery in the

11 futures market. The commissions have already

12 understood that this allows for price discovery

13 in the underlying markets. So when you say, we

14 have to protect price discovery, allow for the

15 trading of blocks in EFP's, and we will

16 facilitate the discovery of prices in the

17 underlying markets, as you've already stated.

18 MR. FARLEY: I agree with Tom and

19 David. So I'll keep my answer brief and won't

20 repeat the same arguments that they mentioned,

21 but I'll elaborate around the margins. This

22 issue -- actually, the series of issues that
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1 we'll consider today internally at ICE we've

2 evaluated as thoroughly as any issue that's

3 arisen as a result of Dodd-Frank.

4 And our thinking has evolved on this

5 issue to the point where we're concerned that

6 really any type of 85 percent rule, if you will,

7 to use a colloquial term, could be disruptive to

8 the markets; could drive contracts that are

9 currently cleared, participants that are

10 currently clearing, particularly end users, into

11 the bilateral market and generally be

12 counter-productive as a policy matter.

13 Let me just highlight one additional

14 point. Core principle 9 that Rick read exists

15 largely unchanged post Dodd-Frank. And there's

16 been contracts that are 100 percent traded away

17 from a centralized marketplace prior to

18 Dodd-Frank, and there are contracts that are 100

19 percent traded on centralized marketplace prior

20 to Dodd-Frank, and I'm not aware of really any

21 problem with that that's been articulated in any

22 significant fashion.
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1 The component that's new, if I'm

2 getting right, and please correct me, Rick, if

3 I'm wrong, the component that's new is there is

4 this new phrase or sentence that says core

5 principle 9 requires the Board of Trade to

6 protect price transparency. That is distinct

7 from saying that a board of trade must mandate

8 that all trading be centralized or on the

9 centralized market of that board of trade. In

10 fact, it's an entirely different notion.

11 So our view is that protecting price

12 discovery on a board of trade is very different,

13 in fact, from that mandate and could take many

14 different forms, such as simply offering an

15 electronic and efficient central limit order book

16 without undue burdens in terms of access and how

17 market participants access that market. Thank

18 you.

19 MR. VAN WAGNER: I'm sorry, can ask

20 just a follow-up, because you're right, it is the

21 same language as before, except for this phrase

22 at the end that's been added about the
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1 centralized marketplace having some prominence.

2 And I think this picking up on what Tom said as

3 well.

4 I don't -- I mean, there's two

5 phrases there. There's market and mechanism. I

6 mean, to me, when I read mechanism, I see you've

7 got to provide a trading system or what have you

8 that would be compliant. But market is another

9 word, and obviously they're both there. I mean,

10 I wonder if there's any meaning that you give the

11 word "market." Again, sorry to be a lawyer, but

12 parsing the words of core principle 9, I don't

13 know if it's simply you get to turn on a switch

14 which says, you can trade on a trading facility,

15 an electronic trading facility and that satisfies

16 it.

17 So, I mean, just to throw that in,

18 if anybody has any thoughts about what "market"

19 means in core principle 9 as well, so thanks.

20 MR. HAMILTON: Thank you for letting

21 ICAP express our views. We -- first of all, the

22 process of having liquidity off the central limit
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1 order book we believe has served the energy

2 markets well. This has been a process that's

3 been applied to the energy markets. It seems to

4 us that the boards of trade have the requirement

5 to manage the liquidity that happens on their

6 system or on their central limit order book, but

7 that they've been given the discretion to take

8 trades away from the market. That has led to a

9 high percentage of clearing for those items that

10 are available to be cleared.

11 The -- pardon me. The core

12 principle 9 doesn't require that -- we believe

13 that core principle 9 doesn't require that all

14 trades take place in a single physical facility.

15 The variety of execution venues have served the

16 market well and has led to many of the goals of

17 the Dodd-Frank legislation. More than 90 percent

18 of all clearable contracts that we broker are

19 currently cleared. We don't see any need at this

20 point to disrupt that flow. That's all.

21 MR. HUMENIK: Good morning.

22 MR. RADHAKRISHNAN: Sorry, let me
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1 ask a question. If you're saying that there's an

2 execution on a venue that exchange A provides,

3 and then there's an execution on a venue that

4 somebody else provides, then why isn't that other

5 venue also a contract market? I think that's the

6 issue, because it seems to me that, you know,

7 you've got execution on one venue, I'll pick CME,

8 for example, right, not to pick on you, but

9 you're here. So you've got execution on one

10 venue, but then you're saying that core principle

11 9 also contemplates execution of that exchange

12 outside that exchange, which is another venue.

13 So to my simple way of thinking,

14 isn't that other venue also a contract market or

15 behaving as a contract market. What you're

16 saying is that it should be the same. But what

17 I'm asking is why shouldn't it -- other than you

18 also be a contract market?

19 MR. HAMILTON: In the case of the

20 transitory swap, those contracts would be

21 executed on a SEF and the SEF's going to have the

22 reporting requirements that it has. There will
Page 25

1 be the transparency rules that come from the

2 other rule sets that the designated contract

3 markets don't manage that, that you're going to

4 have another whole set -- a whole 'nother set of

5 requirements that meet your other goals, but that

6 these executions that take place where there's

7 different levels of liquidity, other than simply

8 a screen or a pit or something like that; that

9 all these markets have been well served by the --

10 by the variety of execution venues that have been

11 out there that have been development over time to

12 push all of those into one place for one size

13 fits all.

14 And again I can speak in the energy

15 commodities, that many of these markets have

16 varying degrees of liquidity. Even the most

17 liquid product only has liquidity for two or

18 three months, and there needs to be a variety of

19 other screens or voice intervention that can take

20 place to give people the hedges or risk manage

21 the way they want to.

22 That only one type of execution for
Page 26

1 a future doesn't seem to further public policy at

2 this time. I don't know what damage is being

3 done in that. Yes, it is unusual that they're

4 being executed in different ways, but at the end

5 of the day, what problems have arisen from a

6 variety of execution venues.

7 MR. HUMENIK: Good morning, and

8 thank you again for the opportunity to

9 participate in today's panel. As Tom mentioned

10 before, we're the first execution venue to

11 receive DCM approval from the commission under

12 the Dodd-Frank Act.

13 Just a few preliminary remarks just

14 about Eris and then I'll speak to the question.

15 Eris was founded to introduce an innovative

16 product to the marketplace, the Eris Exchange

17 interest rate swap futures contract. And the

18 Eris contract attempts to triplicate a

19 hypothetical collateralized OTC interest rate

20 swap but process and clear as a future utilizing

21 existing futures industry infrastructure.

22 We offer the trading of our futures
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1 contract both on a central limit order book, and

2 also under our block trading rules, as well as

3 part of EF -- exchange for physical -- exchange

4 of derivatives for related position.

5 As we've expressed in our comment

6 letters, we strongly oppose the 85 percent rule,

7 and we take the view of a new exchange in which

8 we have a new product and in which we're trying

9 to gain traction in the product, therefore

10 historically block trading has provided a way for

11 a new contract to gain traction in the market.

12 Therefore, we believe that the

13 85 percent rule and a hard percentage would

14 threaten the ability of new and innovative

15 products that come to the market.

16 Specific to the question that's

17 being posed, I think, you know, people on the

18 panel have mentioned it, and when you look at

19 core principle 9, it does have a new language

20 from the amendment with the Dodd-Frank Act, but

21 it does permit for off-exchange transactions.

22 And those transactions comply with core principle
Page 28

1 9 because -- simply because they're permitted

2 under the act.

3 If an exchange wishes to offer block

4 trading in a contract, it self-certifies a rule

5 with the commission, so that rule is subject to

6 commission oversight as part of the

7 self-certification process, and then it's a

8 regulated contract, if it goes through block

9 trading.

10 The exchange has certain

11 responsibilities to make sure that the contract

12 is being regulated subject to oversight.

13 Therefore, it complies with core principle 9,

14 again, because it is a regulated contract and

15 complies with the core principle.

16 You know, I think it's important to

17 point out as well that there's never been a

18 specific percentage in the Commodity Exchange Act

19 of trading that has to occur in the central limit

20 order book.

21 So to the extent that the commission

22 finalizes a rule with a percentage, this would be
Page 29

1 a great departure from where the market has

2 traditionally been in terms of allowing products

3 to innovate without meeting some sort of

4 percentage threshold. And just to go back on my

5 prior comment, the contracts and the DCM itself

6 are subject to the core principles. So there's

7 an overarching regulatory structure that can --

8 that will serve as a check and balance, if you

9 will, on the trading of a contract.

10 So to the extent that there's an

11 issue with the trading of a contract, it can be

12 by the DCM, and it can also be addressed by the

13 commission through the regular process.

14 MR. SHILTS: Tom, before you start,

15 just kind of as a focus, as Steve said, it's

16 clearly true that the act does provide for

17 various types of trades to be done away from the

18 centralized market, whether it be blocks or

19 EFS's, EFP's and whether or not there's some

20 specific requirement for a percentage of trading

21 that would be through the centralized market, but

22 just as part of the, you know, with your answer
Page 30

1 and others, can a contract that has no trading on

2 the centralized market in your view be in

3 compliance with core principle 9, if there is no

4 price discovery occurring, no pretrade

5 transparency at all for a particular contract?

6 MR. LA SALA: Rick, in response to

7 that question, I think the answer is it can,

8 because of the fact that the statute in section B

9 clearly provides for the ability to engage in

10 transactions outside of a centralized market. I

11 think the point is that centralized markets, and

12 we offer lots of centralized markets and

13 contracts that don't have I think that liquidity

14 that you're speaking to.

15 Not every market that's offered

16 provides a price discovery function. I think

17 that that's an observation that Commissioners

18 Sommers, O'Malia made, you know, early on when

19 they dissented to the original rules. We agree

20 with that. I think that others on the panel have

21 already spoken to that.

22 DCM's, you know, are afforded under
Page 31

1 core principle 9, specifically section B, you

2 know, flexibility insofar as how it in fact, you

3 know -- mechanisms by which to bring contracts

4 into -- under the auspices of the Exchange and

5 into clearing. I think that obviously a matter,

6 you know, that's very poignant in folks minds is

7 ClearPort and the effect on ClearPort, and

8 certainly we'll be talking about this quite a bit

9 today.

10 The centralized market percentage

11 standard I think just unduly creates an

12 obligation that from a practical standpoint

13 serves no practical benefit. We've got, you

14 know, a decade of experience now in the manner in

15 which we've brought these transactions in under

16 the safety and soundness of futures, of

17 instruments cleared as futures. And an effort to

18 artificially install some type of a centralized

19 standard, you know, to the points echoed by some

20 of the panel members, inability to innovate, why

21 would you do it. It almost favors going to a

22 swap paradigm. Why would we disenfranchise
Page 32

1 futures in that regard.

2 So I hope that's responsive. Thank

3 you.

4 MS. MARKOWITZ: Tom, I just have a

5 quick question. How would you interpret the

6 requirements of core principle 9 in your view?

7 MR. LA SALA: Nancy, I think that we

8 have got -- the purpose here is to afford, you

9 know, abilities for DCM's to offer contracts.

10 Where there is a centralized market, I mean, I

11 think we have to keep in balance the notion --

12 where there is a centralized market that is

13 serving a price discovery function, I think we

14 have to keep in balance the use of these other

15 mechanisms that we don't in fact deteriorate

16 that.

17 So if we had -- I'll give you an

18 example. If you had core natural gas or core

19 crude oil that are liquid central limit order

20 books, if somehow the off exchange, the B

21 component were somehow deteriorating that

22 function, you know, we'd have to examine that.
Page 33

1 However, where in fact we offer and we do offer,

2 contracts on -- in a centralized fashion, whether

3 that be in a pit or on Globex, and in fact the

4 market for whatever host of reasons has chosen

5 not to in fact engage that, you know, B certainly

6 provides, you know, flexibility to allow the DCM

7 to offer contracts and bring them in as futures.

8 MR. SHILTS: I'm going to let us

9 finish here. But then I want to come back to

10 that, because I'm curious, too, like in your

11 view, say, as a regulator, what would constitute

12 a violation in your view of core principle 9 by

13 an exchange? In other words, what would the CFTC

14 look for in terms of a violation, and from what

15 you were saying, it's your view that we would --

16 the commission would have to conduct like a SBDC

17 determination for every contract to assess

18 whether it's serving a price discovery function

19 before we could apply core principle 9? But

20 let's finish first. But that's something to

21 think about.

22 MR. VED BRAT: You know, my comments
Page 34

1 are more just from an end user perspective. In

2 our use of a DCM and the trading protocols that

3 would go along with it, whether it's off exchange

4 or in the centralized limit to the book, is going

5 to be dependent on the liquidity available and

6 the transparency of price as well as depth of

7 book. And taking into account, you know, the

8 ability to allow for new innovation and for

9 competitive future contracts to come into

10 existence and functionality that the DCM software

11 such as, you know, the ability to have an overall

12 market, anonymous trading and equal and open

13 access, you know, will be important in that

14 determination.

15 MR. SHILTS: Any more follow-up on

16 that or response to my question?

17 MR. DOWNEY: You know, I think it

18 would be useful to understand, and I take my

19 product specifically, we created a platform, an

20 electronic open-access platform for the trading

21 of blocks, the dissemination of block bids and

22 offers for the point-and-click participation in
Page 35

1 those markets.

2 Point and click for EFP's, you can

3 see them see them on my website, I post them

4 every day, they update every second. Anybody can

5 go and see these marketplaces. Again, if you

6 happen you align yourself with a brokerage firm

7 that allows you to trade these products, you can

8 have access to them. They are there. And we do

9 have individual customers who do participate in

10 the marketplace. We disseminate every

11 transaction that we do contemporaneously on our

12 website.

13 We provide transparency to the

14 marketplace, A, because we are going after a

15 particularly dark segment of the securities

16 business called securities lending, which has

17 nerve shown -- never been transparent, and the

18 forces on that market distort the prices in the

19 equity options, and they distort the prices in

20 our stock futures in ways that no academic has

21 ever been able to explain. You have to simply be

22 able to have access to it to understand it. We
Page 36

1 are trying to push this out.

2 So I think that the commission could

3 in fact try to expand their views of what a

4 centralized market is and embrace the fact that

5 even if there is just pricing on -- without any

6 transactions, that is an information flow that's

7 extraordinarily valuable to the market, and that

8 is in fact the transparent competitive

9 marketplace, even if there's no transaction.

10 That's an information flow that's valuable.

11 MR. FARLEY: Rick, to answer your

12 question about what might be a violation of CP9.

13 If the Board of Trade did not offer a

14 competitive, efficient, centralized marketplace,

15 that would be a violation for a given contract.

16 Another example is they didn't give

17 fair access. Pick an absurd but illustrative

18 example, you know, they only let companies with

19 names that began with A through D become members,

20 well, you get the idea. Those would be

21 violations in my mind of the post Dodd-Frank

22 language of CP9.
Page 37

1 MR. RADHAKRISHNAN: If the

2 commission were to allow futures contracts listed

3 on a DCM to be executed completely off exchange,

4 how would you assure pre-execution transparency?

5 Because that's one of the hallmarks of an

6 exchange, right, you get to see the bids and

7 offers on the exchange. And if we go the extreme

8 and say, you know, certain contracts you can

9 trade 100 percent off the exchange, how would

10 market participants get to see bids and offers?

11 MR. SHILTS: And just to add to

12 that, just from what you, Tom, you know, your

13 earlier comment. I think historically the

14 commission has always viewed off centralized

15 market trading as an exception. And I guess what

16 we're trying to get our head around is what

17 happens when it's the rule, when all of the

18 trading is off the centralized market? There is

19 no pretrade transparency on the DCM. Just, I

20 mean, following up on Ananda.

21 MR. LA SALA: Well, again, I think

22 that you can have certainly scenarios where the
Page 38

1 trading can be outside of a centralized market.

2 And I don't believe, except for language that was

3 in Dodd-Frank specific to swaps, that there was

4 any requirement for pretrade price transparency.

5 You know, you might say it's nice, if in fact you

6 can get it under the auspices of a DCM, but it's

7 not required.

8 I think that's, you know, again, in

9 my opinion, I think that that's -- that's a

10 cornerstone concept that we -- you know, you're

11 not necessarily required to. In the market we

12 allow, you know, market user, where appropriate,

13 where markets have -- you know, are deep enough

14 and, you know, parties are able to post bids and

15 offers, that's a very nice situation where it

16 avails itself.

17 One or the other speakers mentioned

18 earlier, markets are different. Some of them,

19 you know, you could talk about a contract. A

20 contract has got -- you know, is not only the

21 front month but it's the back month. We start

22 talking about, you know, protecting a centralized
Page 39

1 market and a trading standard, a percentile,

2 these contracts all start looking different, the

3 front of the curves look different from the back

4 of the curves and you get a rather dicey

5 situation to deal with.

6 MR. DOWNEY: I know, again, in my

7 marketplace most of the people who are interested

8 in creating better financing for their equity

9 positions normally trade in the equity markets.

10 And they have what's called dark pools.

11 Now, I don't completely buy into

12 what a dark pool does, but I can tell you that it

13 works because there are a proliferation of them

14 and there's a reason for it. It's allows for

15 transactions to occur without disrupting the

16 marketplace and there's a valuable rationale

17 behind that.

18 In these dark pools, there's an

19 enormous liquidity. People ask, David, there's

20 no liquidity in single stock futures, and that's

21 BS, because it's basically arbitrage. If the

22 futures get out of line in any way, someone's
Page 40

1 going to come in and sell the overvalued future

2 and buy the cash and lock in financing till term.

3 That's very simple.

4 The fact that they don't get out of

5 line is because the market forces are in fact

6 keeping those markets in line, even without any

7 transactions.

8 Now, when you have parties that want

9 to do large transaction in any market, whether

10 it's IBM securities or whether it's large

11 options, on the floors prior to electronic

12 trading when people came down to an S & P pit,

13 there was volume going up in that pit all the

14 that wasn't announced in the crowd or was

15 announced by whispering in the bottom of the

16 crowd, right. Or in the options pit, Goldman

17 Sachs would come down, Eddie Kelly would come in

18 the options pit, how are you going to get options

19 in the mid-40s and everyone would freeze. And he

20 goes, well, I'll buy 200, I'll buy 50, I'll buy

21 70. Okay, I'll sell, sell, sell. And I'm going

22 to cross 40,000, is that okay. You see. So is
Page 41

1 that transparent?

2 You know, so all they did was they

3 came down and they had to abide by the rules of

4 the exchange but the fact of the matter is

5 everybody got out of the way.

6 And I think that if you have the

7 rules and you have the people that enforce the

8 rules and you provide transparency to the

9 marketplace, you are getting to where you want to

10 go. And I'm all in favor of bringing these

11 exchanges to markets and that is distorting the

12 other prices, bring them on, let's post those

13 prices. Let the market view exactly the forces

14 that are happening on the order counter all over

15 the world.

16 MR. CALLAHAN: I would just say from

17 an NYSE Euronext's perspective, we take a

18 slightly different view, running both equity

19 exchanges and fixed income exchanges. You know,

20 the dark pool phenomenon I think would be a great

21 tragedy, if that were to ever come to the futures

22 market, because with, you know, a third of equity
Page 42

1 volume now happening away from central exchanges

2 in the equity markets, I think there's no

3 question that at some point the tail starts

4 wagging the dog, and the integrity of the central

5 order book is compromised. And I don't know at

6 what point that happens, but there would be some

7 that may argue we're already there in the cash

8 equity markets.

9 You know, Rick, to specifically

10 answer your question, there is nothing in our

11 business plan or anything we're trying to do as

12 an exchange that would be intended to offer

13 products that traded 100 percent outside of the

14 central limit order book.

15 We are a futures exchange. We're

16 trying to create liquid central order book

17 products. But the reality is, when you launch

18 new contracts, sometimes that's very, very

19 difficult to do, and we're doing it every day.

20 We have market maker incentive programs. We have

21 fee incentive programs. We sit around all day

22 long and try to think of creative ways to drive
Page 43

1 people into the central order book.

2 But what we have found when we

3 launch new contracts is that very frequently

4 customers will choose to establish initial

5 positions via blocks. And I am concerned that if

6 there were a sword of Damocles hanging over those

7 customers head that said, okay, if for some

8 reason we trade too many blocks and we trigger

9 some arbitrary threshold, then these contracts

10 are going to be thrown into sort of an oblivion

11 of liquidity. Are they a futures contract. Are

12 they a swap. Who knows. That's really going to

13 drive people away from new contracts.

14 So what we would argue is that, you

15 know, there should be a principles based approach

16 here as you look at any contracts. And if it

17 gets to a level of liquidity outside of a central

18 order book, that raises questions. Well, there's

19 an awful lot of things that could be potentially

20 causing that. Are the right incentives in place

21 at the DCM to incentivize that central limit

22 order book trading. Are there things happening
Page 44

1 in a related market.

2 A lot of our MSCI equity index

3 futures, people trade them against ETF's. Well,

4 is there something happening in the ETF market

5 that is incentivizing large block trading. What

6 are the motivations of people that are doing

7 these block trades. Have they tried the central

8 order book but they couldn't get liquidity. So

9 this is sort of plan B. Are they establishing or

10 are they liquidating positions.

11 You know, there's no simple test.

12 There's no bright lines. You'd have to take all

13 of these things into consideration to determine

14 whether a core principle 9 violation has

15 occurred, and I think that staff should have that

16 broad latitude to consider all those factors when

17 making this determination, as opposed to one

18 simple numerical test.

19 MR. HUMENIK: If I could just echo

20 some of those comments as well. I think core

21 principle 9 does not exist in a vacuum. There's

22 other core principles that a DCM has to follow.
Page 45

1 So in terms of determining whether a contract is

2 complying, you have to look at the whole view.

3 So core principle 9 is one piece of the puzzle,

4 so to speak.

5 Echoing on what Tom just said about

6 core principles for a new exchange and a new

7 contract, again, you need that time to get

8 traction in the contract and block trading

9 provides a mechanism to do that. And I think

10 it's important, you know, in the theme or in the

11 essence of principles-based regulation when you

12 look at the DCM proposed rules that the

13 commission put out, there's specific guidance as

14 to how a DCM should look at its block sizes and

15 what it should do. And it's actually a quite

16 extensive list. There's nine factors.

17 So I think, you know, in terms of

18 block sizes, I think if DCM applies those

19 principles it gets to a good place, a good

20 starting point that complies with core

21 principle 9 and complies with the core

22 principles.
Page 46

1 MS. VED BRAT: I just want to

2 respond in answer to your question on pretrade

3 price transparency. I think it depends on the

4 stage of evolution of a contract. You know, in

5 the initial stages when there's something new,

6 you know, that is -- the price discovery is going

7 to be based on, you know, the understanding of

8 the product and between, you know, bilateral

9 counterparties. You know, then it's going to

10 move into the stage where, you know, you may

11 have, you know, broker screens that will provide

12 some level of pricing.

13 And, you know, if that, you know,

14 along with end-of-day pricing is available, you

15 know, it does give, you know, a certain legal of

16 confidence that you were within the ballpark of

17 where this contract should trade, and that's

18 going to lead to confidence moving into the

19 central limit order book where, you know, there

20 will be liquidity providers as well as clients

21 willing to act on the prices that they see on the

22 screens. So It's important to look at the
Page 47

1 different stages of evolution.

2 And just to comment a little bit on

3 what Eris and NYPC, what we heard over there.

4 You know, if we were to see functionality that

5 would encourage more market participants to

6 trade, you know, in a central limit book, that

7 will also help liquidity migrating onto that

8 platform.

9 Just a simple example, you know, for

10 something that would help this, you know, if the

11 DCM, you know, or the clearinghouse were to

12 offer, consistent average price for futures, you

13 know, average pricing modules to end clients,

14 then, you know, which is necessary if you're

15 trading, you know, in smaller sizes and block,

16 then that would help price migrate to the

17 liquidity available on the central limit order

18 book.

19 MR. FARLEY: I'm largely in

20 agreement with the comments that have gone before

21 me, including Supurna's and Tom's and Steven's.

22 I just want to go back to, Ananda, your question,
Page 48

1 which I thought was a good question. Interesting

2 thought exercise. Essentially being, you know if

3 futures were allowed to trade off a DCM, how do

4 we know they wouldn't all trade off a DCM.

5 It reminds me of two analogous

6 situations, not identical. I'll go through just

7 quickly one, and you know, Ananda, the history of

8 ICE. But if you go back a decade or so ago, ICE

9 introduced lots of energy contracts for trading.

10 And we did so with a flexible execution

11 architecture, if you will. We had central limit

12 order book trading, voice trading. You know,

13 whether it be blocks or what have you.

14 And what you see over time is we

15 were essentially a board of trade but not in the

16 regulatory sense, but we were offering an

17 efficient marketplace much like CP9 asked for,

18 and over time you've seen the highly liquid

19 contracts migrate to nearly exclusively

20 centralized trading, for instance, our Henry Hub

21 contract which is again essentially all central

22 limit order book with some de minimis exception.
Page 49

1 And on the other hand, some off the run Asian

2 refined product is nearly all negotiated away

3 from the central marketplace and cleared. And

4 then in between is everything else.

5 So, for instance, gas, the SoCal gas

6 basis contract might be 50 percent in the central

7 limit order book. So I think you can take

8 comfort that over time the highly liquid

9 contracts will migrate to the centralized

10 marketplace, and you can take comfort that were

11 it not for the innovations of ICE and our

12 colleagues at CME, all those contracts would

13 potentially at this point still be bilateral and

14 so there's been a greater good.

15 And the second example, which I'll

16 go through even quicker, I promise, is the

17 example of currency pairs where you have the

18 transitory EFP's which look and feel a lot like

19 the contingent EFS's that you have the in

20 commodity world, if not mechanical,ly certainly

21 by commercial intent. And what you see in the

22 listed currencies business is that the euro, that
Page 50

1 trades in the centralized board of trade. But

2 the off the run, you know, knocky socky currency

3 pair is all traded away from the board of trade

4 and passed in as a transitory EFP.

5 So those are analogous situations I

6 think will give you an idea of what will

7 transpire and I think those are also healthy

8 situations.

9 MR. HAMILTON: I'd just like to add

10 that -- or two things about the execution away

11 from centralized board of trade. First of all, a

12 lot of those would be swaps. You would have a

13 different set of rule making that would cover

14 those, depending on blocks and execution methods

15 that would be prescribed by the commission.

16 And secondly, just because it

17 happens away, I'd like to emphasize that it's --

18 there may not be price transparency on the

19 screen, but to customers there's price

20 transparency. The competition for some of these

21 off-the-run markets that he's talking about and

22 he's talking about customers have three lines
Page 51

1 open to three different brokers. They have

2 transparency, they know what's happened.

3 In addition, at least in the energy

4 space, they're all referenced to the key core

5 markets that are published continually all the

6 time. It's not as though there's some dark

7 corner where these transactions are happening.

8 Brokers compete all day all the time for these

9 trades. Customers, we have collectively in the

10 WNBAA, we have more than 5,000 lines open to

11 customers all the time. So there is

12 transparency, at least between the brokers.

13 MR. LA SALA: One point. I think

14 some of the folks on the staff know that we've

15 spoken to you in the past about technology called

16 CME Direct. I just note that whether -- and that

17 technology might be used, you say, by third-party

18 lessees, call them brokers, whether those be for

19 swaps or for futures.

20 So the point, I think, Tom made

21 earlier, you know, although not necessarily a

22 central limit order book, whether it be a
Page 52

1 whiteboard, could at one point be a central limit

2 order book. You know, customers seeing pricing,

3 over time you can get to potentially parties

4 becoming comfortable. That a central limit order

5 book is appropriate and they've comfortable with

6 placing that. So I know that we've spoken to

7 some of the staff on that in the past. That is

8 obviously something that we're focused on going

9 forward.

10 MR. BRODSKY: Okay. Well, why don't

11 we move on to the second question. The

12 commission proposed that any contract that does

13 not meet the minimum centralized market trading

14 requirement must be delisted and transferred to a

15 SEF or liquidated.

16 What are the implications and

17 consequences of the commission's proposed

18 delisting requirements for these contracts and

19 we're particularly interested in hearing the

20 consequences for the affected DCM, for SEF's, and

21 also for traders with positions in those

22 contracts.
Page 53

1 And as a follow-up question, how

2 long should noncompliant contracts be permitted

3 to be listed before being required to be

4 delisted, and what sorts of measures should a DCM

5 be able to take to increase trading that would

6 demonstrate trading with core principle 9.

7 So why don't we start again on my

8 left and pause afterwards for the new participant

9 to introduce himself.

10 MR. CALLAHAN: Thank you. I think

11 the issue is that both options presented -- being

12 presented, delisting or being transferred to a

13 SEF, are going to be enormously unappealing to

14 market participants, which is going to keep them

15 away from the contracts.

16 And I'll just give you a practical

17 problem that we would face. You know, we're a

18 small start-up exchange. We have a mission which

19 is to establish, you know, liquid central order

20 book futures. We're not in the SEF business, we

21 don't have plans to become a SEF. We also are

22 unique in that we're one futures exchange that
Page 54

1 has two clearinghouse. Our straight products

2 clear at New York portfolio clearing. Our equity

3 products and our metals product clear at OCC in

4 Chicago.

5 So, for example, if one of our MSCI

6 products were to fail a test that would require

7 transfer to a SEF, well, I don't have one, so I

8 don't -- I'd have to find a SEF that would take

9 it. But even more importantly it's not clear to

10 me at all that OCC would want to continue to

11 clear those products. They clear futures

12 contracts. And if this is no longer a futures

13 contract with any presumption of liquidity, they

14 might not clear it anymore.

15 So I look at this, you know, for

16 just a vertical exchange like some of the others

17 on the panel and say, easier proposal, you know,

18 they own the clearinghouse and they're going to

19 own the SEF, so they move it from, you know, one

20 division to another. It's not so clear for us

21 that that's even a possible. So really the only

22 viable option becomes, delisting.
Page 55

1 And we've all seen that when markets

2 go into liquidation mode fair value and accurate

3 pricing doesn't matter anymore. Trades to

4 liquidity, you know, where the buyers and sellers

5 meet, so things diverge and move away from fair

6 value and that means that market participants and

7 the integrity of the market could really be hurt.

8 So, you know, I think that's the main concern

9 that market participants would feel when they

10 looked at these two potential options.

11 MS. MARKOWITZ: I just have a quick

12 question, Tom. In the prior panel you said we

13 should take a principle based approach. If a

14 contract is trading on the market, liquid, you

15 know, the parties doing, are they doing incentive

16 programs. Are they marketing incorrectly.

17 Is this -- is there any end to that

18 kind of analysis? I mean, are you saying that a

19 contract that doesn't trade should just still

20 maintain being listed? Is there any end that we

21 should say at some point that this contract is

22 not -- should be delisted or are you saying that
Page 56

1 it just -- it's just that analysis should go on?

2 MR. CALLAHAN: I think the reality

3 is, as much as we -- as exchanges would like to

4 say that we can control how markets trade, you

5 know, water finds its own level. You know, one

6 of our primary missions is trying to move

7 liquidity from one exchange in certain products

8 to our exchange and it's very, very difficult.

9 And you can create all the incentives you want

10 and sometimes the market still choses to trade in

11 one venue versus another.

12 So what I would hope the commission

13 would look at is again all those principles based

14 factors. And ultimately, if all of the right

15 incentives were in place, to incentivize central

16 limit order book trading but if the market were

17 still choosing to trade in some percentage away

18 from an order book, there's probably a very good

19 reason for that. And then I think you'd have to

20 look back to this issue is price discovery being

21 harmed. If the answer to that question is no,

22 then I would say, yeah, there may be a point at
Page 57

1 which the commission would be satisfied with a

2 very low percentage of trading happening in a

3 central order book if that -- if that price

4 discovery function were not being harmed. And if

5 it were, then you would at that point choose to

6 mandate delisting.

7 MR. COSGROVE: Good morning. I'm

8 Michael Cosgrove. I've sorry I'm late. It was

9 Amtrak's fault. They're normally extremely good.

10 I'm her representing GFI. We're a large global

11 energy dealer-broker. We arrange transactions in

12 a broad range of assets classes, and thanks very

13 much for having me.

14 I'd like to start by associating

15 myself with Tom's remarks. I think they're --

16 they very much speak to the position that we have

17 on this. I also, though -- and because I'm a

18 little late, stop me if I cover something that's

19 already been touched upon. But since we're

20 talking about the -- about whether -- what

21 criteria to apply to determine whether a product

22 trades on a DCM or a SEF, I'm still unclear on
Page 58

1 what the rules of execution are for a SEF.

2 So it's difficult when asked, what

3 will the impact be if we move futures contracts

4 to a SEF, I don't know what rules a SEF is going

5 to be required to follow in order to satisfy its

6 requirements for executing those.

7 So depending upon the rules that are

8 ultimately promulgated, it could be just a

9 terrible nuisance or it could be, I would say,

10 market destroying to move instruments from a

11 futures market to a swap market.

12 If SEF's and DCM's are regulated

13 essentially to the same standard, then I think it

14 begs the question of why bother with the

15 consideration at all, because if you hold a SEF

16 and a DCM to the same standard, why would anyone

17 then care if it's a swap or a futures.

18 So I realize that's not this

19 particular question. This may have already been

20 touched upon, but again, without knowing

21 essentially how a SEF is going to be permitted to

22 operate, it is very difficult, I think, to give a
Page 59

1 response to this question.

2 I am aware that a number of the

3 distinguishing factors between swaps and futures

4 have been resolved in the last couple of years.

5 I understand that Dodd-Frank section 724 has now

6 given swaps the same status under bankruptcy law,

7 which I think was very important.

8 I think that -- let's see, there's

9 still obviously the difference in tax treatment

10 between futures and swaps. I don't know the

11 extent to which that influences traders'

12 activities on a day-to-day basis. But as near as

13 I can tell, that seems to be the last remaining

14 critical distinction between swaps and futures.

15 And I think -- I wish I was qualified to provide

16 you with some guidance in regard to how

17 disruptive that difference would be if a contract

18 were delisted as a future and turned into a swap.

19 But I would say that some additional

20 clarity in terms of the permitted range of

21 execution for a SEF would be extremely helpful in

22 order for us to formulate a response to the
Page 60

1 likely disruptive impact that moving a contract

2 from a DCM to a SEF would likely have.

3 I know that's not a great answer but

4 it's the best one I have.

5 MR. DOWNEY: I don't have time to go

6 into how disruptive it would be on my market.

7 I've spelled it out in our comment letters

8 repeatedly. Respectfully, I don't think you have

9 the unilateral right to include my listing

10 standards, and that includes forcing me to

11 delist. That is something that was put on the

12 joint commissions of the SEC and the CFTC.

13 Again, the document I referenced earlier put out

14 by both commissions referenced it as well. It's

15 a joint authority, not unilateral.

16 If do you ask me to delist my

17 contract and move it to a SEF, there are no

18 SEF's, I don't know what they are, but none of

19 them have the authority to trade security

20 futures, number one. Even if they did, they

21 would trigger automatic best execution

22 requirements that the SEC has already said that
Page 61

1 they will impose on competing exchanges or

2 execution arenas, which would cause all of the

3 market participants to immediately have to

4 connect to the SEF, which they're not going to

5 want to do.

6 Furthermore, 75 percent of the

7 positions are held by FCM's which are not going

8 to be in a position to go to a SEF. As you move

9 a product onto a SEF, the security side will

10 immediate hedge their position by buying or

11 selling the security and locking themselves in

12 with no intention of delivering that product at

13 expiration. The FCM's have no interest in taking

14 delivery. They would like to roll and now

15 there's no functional allowing them to roll,

16 they're stuck.

17 Lastly, if I am forced to delist my

18 product because of the rules that Congress has

19 set saying that the delisting standards can be no

20 less restrictive for futures than they are for

21 equity options, you would be forced to ask the

22 equity option exchanges to delist their products
Page 62

1 as well. Good look when Bill Brodsky comes

2 visits your door.

3 MR. FARLEY: It's a bit of a mind

4 bender when you think about the delisting

5 process. So I want to articulate it and just

6 make sure that we understand some of the

7 difficulties that are embedded here.

8 If you think about a given contract

9 that's being delisted because the contracts that

10 are being traded are being traded off exchange,

11 really definitionally what you're saying is that

12 those contracts are being executed in some other

13 way that isn't offered by a DCM. Therefore,

14 despite the fact that a DCM can list swaps for

15 trading, definitionally the DCM is not going to

16 just change that futures contract into a swap on

17 that DCM, because a DCM is not allowed to offer

18 the additional flexibility of execution that a

19 SEF is.

20 Now, I want to put a placeholder

21 there because I want to come back to that. But

22 we think that that, in and of itself, is an odd
Page 63

1 and not helpful inconsistency that the same

2 contract that's fungible at the clearinghouse,

3 similar compliance standards, position limit

4 standards has different execution protocols on a

5 DCM from a SEF. But be that as it may.

6 So the futures contract is delisted.

7 Now it's going into a new entity, i.e., a SEF.

8 Compound that to what Tom Callahan mentioned, it

9 may, too, go to a different clearinghouse at the

10 same time. And at the same time it is most

11 likely moving to a different clearing account

12 class. Each one of those things is difficult to

13 explain even to a market practitioner. Each one

14 of these requires contracting, customer hold

15 handing -- hand holding, pardon me, clearing firm

16 hand holding.

17 And so I think when you walk through

18 that process, assuming we understand it

19 appropriately, the question answers itself with

20 respect to will that be disruptive.

21 MR. HAMILTON: ICAP Energy opposes

22 the application of core principle 9 whereby there
Page 64

1 might be a mass demotion of open interest that's

2 out there that is currently being traded on the

3 swap-to-futures market. We believe that our end

4 users value the EFS process, and we think that

5 the open interest that's out there would be

6 particularly disruptive in the electricity,

7 natural gas, and refined oil contracts. It would

8 create a great deal of uncertainty at a time when

9 the market's trying to digest all of the

10 applications that Dodd-Frank is coming up to it.

11 In addition to that, having some

12 large transition, as he spoke of, of open

13 interest in those particular markets, especially

14 in these less liquid markets where these

15 contracts have been used for hedging by end users

16 would create particular difficulties in the

17 markets.

18 MR. HUMENIK: You know, delisting is

19 in our view a disruptive regulatory practice. I

20 think I mentioned before that in terms of a new

21 product incentivized trading on the central limit

22 order book you can do so through the block
Page 65

1 trading levels, and there's appropriate guidance

2 in the DCM proposals regarding what a DCM should

3 look to in terms of setting up block sizes.

4 And I think it's important to point

5 out that if a futures contract is forced to

6 transform into a swap, it's -- first, it's

7 contrary to the language of the Dodd-Frank Act

8 which specifically excludes futures from the

9 definition of swap. And, in addition, forcing a

10 futurized swap to delist from a DCM and then

11 relist on a SEF do only what essentially is a

12 liquidity requirement relates to disparate

13 treatment for a DCM and its products.

14 As we pointed out before on the

15 panel here, principles-based regulation has

16 worked well and I think there's the ability to do

17 that in the DCM core principles. And what

18 happens when you add this uncertainty of is my

19 product going to be delisted and it's a long

20 dated futures contract, it just adds a level of

21 uncertainty to the marketplace that is not

22 required and is not needed.
Page 66

1 And, you know, I've said that the

2 futures framework is a known regulatory

3 framework. It's worked well in the past, and it

4 can work well in the future, if we don't place

5 prescriptive rules on the core principles and how

6 they functioned in the past.

7 And I just point out, to echo Tom

8 Farley's comments, that delisting is a severe

9 penalty and an end user won't use a contract, if

10 they think it's going to be listed. They have no

11 idea if they actually do compliance with the DCM

12 core principle 9 and any given percentage. I

13 don't know if an exchange would have to have like

14 a meter on its exchange to let people know, are

15 we getting closer to the 85 percent almost like a

16 fundraising campaign.

17 And if a product is forced to

18 transform from a future to a swap, there's tax

19 consequences to that as well. It goes from a

20 60/40 tax treatment to a swap tax treatment. And

21 as Tom pointed out as well, you'll have an issue

22 of moving collateral from 4DA to 4DF.
Page 67

1 And what if the end user who's using

2 the futures contract doesn't even have a clearing

3 firm that supports the clearing of swaps. So now

4 they have to go out and repaper and get an FCM

5 that will actually clear swaps for them. So I

6 think there's so many consequences to having the

7 penalty of delisting that it's an inappropriate

8 penalty and there's other ways. Again, as I

9 mentioned, through block trade management,

10 incentivized trading in the central order book

11 that are available to the commission that can be

12 used that will get to a good policy result.

13 MR. LA SALA: Let me begin by saying

14 I think that Steve, Tom, and Mike have stolen a

15 bit of my thunder on this one. But let me note

16 to the staff that I can think of right off the

17 bat about 34 million good reasons why

18 transforming what's currently futures into what

19 would be swaps as proposed is just simply the

20 wrong path to go.

21 Again, some of the panel has spoken

22 to them. There are tax implications. It's even
Page 68

1 beyond 60/40 treatment. I think there is

2 potentially a taxable event in the context of the

3 transformation, Unsurety to market users, if in

4 fact -- again, we talked about liquidation as one

5 option. The other is, again, the transformation

6 has got tax implications.

7 Mike talked about, you know --

8 astutely noted, we don't yet know on the swap

9 execution front the details because the rules are

10 not finalized. But at least as proposed, I just

11 certainly want to raise one point that I struggle

12 with constantly.

13 That being is, of that approximately

14 34 million contracts, I seriously question what

15 regulatory good we've achieved in that

16 transformation. Meaning that at the very least,

17 at least as proposed, and again, we don't have

18 infal rules, some of these contracts are going to

19 continue to be, I'll simply say, intermediated

20 and brokered. So they're cleared today, they've

21 got surety as futures, and they're intermediated

22 by, you know, by IDB's.
Page 69

1 Tomorrow they'll be cleared, they'll

2 be intermediated by IDB's, yet they'll be swaps.

3 Again, if I take a step back and simply say, you

4 know, what good to the marketplace did we in fact

5 achieve by, you know, conducting this -- this

6 wholesale transfer, I just -- you know, frankly,

7 and respectfully, I'm struggling with a good

8 answer to that. So thank you.

9 MR. VED BRAT: You know, what we

10 would like to see is at a time of listing, you

11 know, whether it's DCM or a SEF, did

12 determination of how liquid the contract would be

13 if made at that time. There is enough

14 intelligence gathered from the dealer community

15 or the liquidity providers to make that -- to

16 make that determination.

17 Also, you know, at the same

18 evaluation should take place, is it better to

19 have this type of risk staff in a swap form or a

20 futures form. And once that's made, the contract

21 should be allowed to live through maturity.

22 There will be natural -- if the
Page 70

1 liquidity were to fall, you know, whether it's

2 because of market events or some other event,

3 there will be natural market forces that will

4 allow for the unwinds to take place, you know,

5 versus a forced liquidity event. And I think

6 that that's going to be very important for

7 clients, because it's very hard to price in the

8 optionality of a termination or a conversion.

9 I think, you know, earlier on it was

10 mentioned on the conversion between a futures and

11 a swap, you know, does require redocumentation or

12 documentation finding a clearing member,

13 understanding the account classes and everything.

14 You know, we at BlackRock actually

15 have a very good understanding of all the

16 different elements, and it is very complex. And

17 that conversion, you know, also would imply that

18 the account that you're trading on behalf of has

19 the ability to trade or, you know, to take in

20 futures risk as well as swaps, which is not

21 always the case.

22 So our recommendation would be to,
Page 71

1 you know, allow contracts, once they're listed,

2 to live, you know, through maturity and allow

3 natural market forces, allow the unwind of risk.

4 MR. BRODSKY: Okay. Thank you for

5 that. Why don't we move on to the next question.

6 If the commission were to move

7 forward with some sort of centralized market

8 requirement, should the commission consider a way

9 to address new products and those with low

10 liquidity, and one example of that might be an

11 exemption to delisting for contracts that meet a

12 specified de minimis level of open interest or

13 overall trading volume. And if that is something

14 that you think might be workable, what would the

15 appropriate measure of liquidity be for purposes

16 of such an exemption.

17 Why don't we start with you.

18 MR. CALLAHAN: Yeah. I think this

19 is a critical pont, again, with the idea of not,

20 you know, throttling innovation in our industry

21 that new contracts, which I think by definition

22 are going to be more likely to trade in wholesale
Page 72

1 markets, need to be given a little runway in

2 order to take off.

3 So I would say if I had to pick a

4 number in terms of an ADV threshold, something

5 along the lines of 50,000 contracts, ADV would

6 make sense. It would be very difficult to argue

7 below that standard that a contract was

8 performing a primary price discovery function if

9 it's trading at small volume, so something around

10 50,000 to me would make sense.

11 I think it's also important that we

12 exempt options for the same reason. Options

13 don't provide a primary price discovery function

14 for anything. They price volatility of the

15 underlying. They don't price the underlying.

16 And options are, by definition, less liquid than

17 futures in a central order book. So I would say

18 50,000 ADV for futures with then an exemption for

19 options.

20 MR. COSGROVE: Is there a definition

21 for centralized market somewhere that we're using

22 for this discussion, by any chance? Because
Page 73

1 I'm -- I don't mean to throw a spanner in the

2 works, it's just that I can sort of apply my

3 common sense interpretation of that, but it may

4 not be the same as everyone else's. I think of a

5 centralized market as central to limit order

6 book, an open outcry pit, right.

7 MR. SHILTS: For DCM's, that's

8 right.

9 MR. COSGROVE: Right. Okay. But I

10 also think of a centralized market as a trading

11 pit that can be extended technologically. So I

12 think of many to many voice market as a

13 centralized market, too. So with that as a --

14 you know, sort of my definition of a centralized

15 market, I think that -- I think that a far

16 less -- a far higher standard could be applied to

17 new products, provided that the markets are given

18 an opportunity to choose the form of centralized

19 market that best suits that -- that contract and

20 that market.

21 So, in other words, Tom Farley said

22 earlier, you know, customers have made the choice
Page 74

1 over the years about which forms of execution

2 they've chosen to adopt. And a central limit

3 order book is immensely effective. It's cost

4 effective. It's cheap. I mean, it's cheaper to

5 use, generally. It's the way to go. And the

6 only reason you wouldn't use that, really, in the

7 broadest sense, is because it isn't the best way

8 to get the business done.

9 Perhaps human intermediation is

10 required. Perhaps some RFQ functionality is more

11 suited to the market due to an episodic nature or

12 due to the market participants. And so I would

13 say that, depending upon whether we define a

14 centralized market as an electronic central limit

15 order book, on the one hand, or we apply a

16 broader definition of, you know, the DCM sort of

17 definition of an open outcry pit, and my

18 definition of an open outcry pit extended by, you

19 know voice technology to create a many to many

20 voice market.

21 So depending upon which of those two

22 broad extremes we would take, I would suggest
Page 75

1 different standards for determining whether or

2 not a swap is required to be traded on a,

3 quote-unquote, central limit order book.

4 So I'm very much an advocate for

5 allowing markets to choose a form of execution

6 that suits the market within reason, and I think

7 that provided that centralized market is defined

8 in a sufficiently broad sense, it becomes less

9 important as to whether or not the swaps -- the

10 futures are given some runway, essentially, to

11 meet certain limitations in order to continue to

12 be listed.

13 MR. DOWNEY: I think that there

14 should be some thought given to getting away from

15 the concept of volume and open interest, and in

16 certain circumstances activity can be measured by

17 transaction rates.

18 The average contract per trade in

19 our central limit order book is five. That's 500

20 shares of stock. That is something that would be

21 electronically executed on any electronic stock

22 exchange, trying to get it out of the way of all
Page 76

1 the other trading that really makes sense, not to

2 minimize its strength.

3 But to the extent that you're going

4 to look at are people interested, are there

5 incentives? I would say, if you could, please

6 incent the member firms to connect, and just tell

7 them, if you don't connect and do enough volume,

8 you're going to turn into an FCM. And if don't

9 connect and you're an FCM, if you don't connect

10 you're going to turn into a broker-dealer.

11 If somebody comes in and wants to do

12 a contract, but they do it in such a size you're

13 not going to like it, so you're going to make me

14 delist the contract. Doesn't make any sense to

15 put a gun to my head like that.

16 I think you should look at it, is

17 there actual interest in trading the product at

18 any level, and I think you can start that with a

19 transaction rate. And I think that reasonable

20 transaction rates would be an average daily

21 transaction rate of 1,000 units per day over the

22 last six months would be something that says,
Page 77

1 okay, there's interest in this product, volume

2 should be migrating to those types of facilities.

3 Absent that transaction rate, I

4 think any transaction, any interest in the

5 product that brings transparency to the

6 marketplace should be encouraged and not

7 discouraged.

8 MR. FARLEY: I suppose, if you

9 forced ICE to kind of answer this question

10 directly, yes, we think that a new contract

11 should not be subject to delisting. But I do

12 think it's important, I won't reiterate the

13 arguments from the prior question, but I think

14 it's important to highlight that that's distinct

15 from saying that we think that at the end of that

16 period, two or three years of its low volume, it

17 should be delisted.

18 And I just want to highlight an

19 example or two for you. We would have some

20 concern -- a lot of the conversation we're having

21 today I think emanates what our colleagues at CME

22 have built very effectively, ClearPort and the
Page 78

1 mechanism there, and it's largely commodities

2 contracts.

3 And I would have some concern that

4 using this methodology of, hey, for new contracts

5 we'll give them some room to run, but if they

6 don't have the sufficient percentage of central

7 limit order book trading, we'll then delist them.

8 It runs a risk of breaking up or balkanizing

9 contracts which should otherwise be traded

10 together, and I'll give you a stark example.

11 Take a given power contract.

12 Typically, with power contracts, you have

13 something called on-peak which refers to the

14 hours during the day which are the heaviest load

15 and then you have off-peak, which are the

16 remaining hours in the day. Those off-peak

17 contracts, again, definitionally, are more

18 illiquid. They're traded less. But they are

19 very much thought of as a piece for the people

20 trading in that market with the on-peak

21 contracts.

22 So could you end up in a situation
Page 79

1 where, let's say, ICE started trading some

2 on-peak and off-peak power contracts at a given

3 location. At the end of three years you look,

4 and you say, oh, these are 86 percent traded on a

5 central market and these are two, let's delist

6 this second contract, and that could foul up the

7 risk-management approach of the customers who are

8 using those products to hedge.

9 MR. HAMILTON: I think for us it's

10 still that we oppose the demotion, so to speak.

11 So it's very difficult, without knowing more

12 about what the SEF rules are going to be, other

13 than with the innovation of clearinghouses and

14 exchanges and brokers at the table, if there's a

15 contract that's not going to be successful as a

16 future, it my become successful as a swap, and

17 then it will take care of itself. As long as the

18 market allows that innovation, it may not be

19 necessary to set a time frame for it demotion.

20 There may be some -- on the other

21 hand, there may be some other contracts that are

22 mature and have been around for a very long time
Page 80

1 and have been used for clearing, and are used by

2 end users for risk management but don't have a

3 lot of volume. But having the option of a

4 central clearinghouse, and it just so happens hat

5 they might be futures, I don't see any objection

6 why those need to be demoted today, because end

7 users have benefited from the central limit order

8 book or central limit order book counterparty

9 clearing.

10 MR. HUMENIK: I think the point was

11 made earlier that I tink 90 percent of contracts

12 that are listed actually fail and meet their

13 demise. So I think, you know, at the end of the

14 day the market will ultimately delist the

15 contract if it's not serving I'm purpose to, you

16 know, serve commercial needs or price discovery.

17 You know, again, we're opposed to

18 delisting as the ultimate outcome. I think

19 there's other ways to incentivize trading in the

20 central order limit book for a new product, and

21 it's critical to give those products the

22 opportunity to gain traction so they can achieve
Page 81

1 transparency in the central limit order book.

2 I think I heard at one point there

3 was discussions about having a study where, you

4 know, a new contract could be listed and over

5 time the DCM would have to take a look and decide

6 why, why is this contract trading, you know,

7 85 percent block and 15 percent in the central

8 limit order book. So, again, there's other

9 methods out there that will allow the commission

10 and the DCM to achieve the purposes of the core

11 principles without having delisting as a penalty.

12 MR. LA SALA: I don't have a formula

13 or some type of an ADV or an open interest

14 threshold to impart to the staff. What I will

15 say is that, with regards to CME Group, we're

16 certainly not adverse to looking at incentives of

17 putting contracts on, you know, Globex. In

18 addition to where some of the contracts we offer

19 are in the pit. Many of them are. Others are

20 additionally on Globex. We're not adverse to

21 that.

22 But the point is is that some type
Page 82

1 of -- again, a centralized standard as a

2 mandatory item that jettisons something from a

3 future into, you know, another -- it

4 recharacterizes it effectively, just doesn't

5 seem, you know, market serving.

6 I'll further note, as we talk about

7 it today, we struggle with this question, I think

8 some of the -- many of the contracts we're

9 talking about here, these transactions are

10 happening off the exchange. I think we all know,

11 we're not targeting aggregates or mom and pop.

12 These are sophisticated users that, you know,

13 choose to use multiple venues to execute their

14 transactions. I think it's an important point

15 that we don't want to lose in this.

16 And in some regards I say, to the

17 extent that DCM's or, let's say, boards of trades

18 fail, are slow to maybe realize that a

19 centralized market is effective, is ripe for

20 pretrade price transparency, some of that,

21 frankly, you know, shame -- shame on us.

22 Meaning, you know, if there is a board of trade,
Page 83

1 a DCM, or a would-be SEF that gets there and is

2 able to find that liquidity base, okay.

3 But, you know, markets tend to do a

4 very good job of -- or users of markets, of

5 deciding, you know, what's effective and what's

6 beneficial and to artificially structure

7 percentages and requirements that make those

8 decisions for the market, generally speaking, I

9 don't think serves the -- serves the market users

10 well.

11 MS. VED BRAT: The open interest in

12 volume, I mean, those are quantitative measures.

13 I think we also have to consider some of the

14 subjective -- subjective elements that would --

15 that would support liquidity or trading in

16 central limit order books. In order for us to be

17 us to be able to participate in a club or in a

18 DCM, you know, we need liquidity providers who

19 provide liquidity. We need clearing members to

20 provide clearing, you know, for the contracts

21 that are listed. You know, it's optional on both

22 ends.
Page 84

1 So you could have a contract there

2 that clients, you know, have interests, would

3 like to be able to participate in, but by the

4 choices made by, you know, the clearing members

5 or liquidity providers, you know, choosing not to

6 provide liquidity, it just makes it an illiquid

7 product for us.

8 You know, the other thing is, you

9 know, we can have -- you know, there can be

10 unintended to consequences to delisting. You

11 know, you can have a market event, a temporary

12 market event that may cause, you know, you know,

13 clients to get out of positions and stop trading

14 a product, you know, because of the fear of

15 conversion or termination, which should be

16 considered as we go through this process.

17 Another point that, you know, I'd

18 like to make is that, you know, if there is a

19 concern on the liquidity, low level of liquidity

20 of a contract on a DCM, then why would we

21 consider the swap SEF which is also an

22 electronic, you know, trading medium that is
Page 85

1 supposed to be standardized to be the right, you

2 know, area for something to convert into.

3 So, you know, a little bit of

4 hesitancy over there would be that this may

5 actually lead to the bilateral world where you,

6 know, clients would be required to take on

7 bilateral risk and -- and start to lose some of

8 the benefits of clearing and counterparty risk

9 reduction which, you know, we've been very

10 supportive of on a going-forward basis.

11 MS. ZAKIR: I just wanted to come

12 back to one of the questions that we posed a

13 little earlier to give everybody a chance to

14 comment on.

15 One of the comment letters --

16 actually, a couple of the comment letters had

17 suggested that in place -- in lieu of mandatory

18 delisting of certain contracts that we would

19 allow DCM's to take specific measures to increase

20 centralized market trading.

21 Can we just make sure that we go

22 down the panel one more time just to make sure
Page 86

1 that we get anyone who has any thoughts on what

2 those measures can be, specifically any success

3 stories you have in implementing those measures

4 in the past, and what time period is sufficient

5 to allow a DCM's measures to take effect.

6 MR. CALLAHAN: I can comment on some

7 of the types of incentives that we have in place

8 right now and that we would consider going

9 forward to incentivize central limit order

10 trading activity.

11 Certainly having designated market

12 maker programs in place, and I would say not just

13 during U.S. trading hours, but one of the things

14 we'll been able to do to improve central limit

15 order book activity is to have those during Asia

16 or European hours. So you have robust DMM

17 programs.

18 Certainly adjustments to block trade

19 thresholds would be another way that you could,

20 you know, impact central order book trading.

21 Economic incentives, or surcharges

22 for block trades or discounts for central limit
Page 87

1 order book trades. You know, some combination of

2 all of those things I think are important.

3 I think at the same time we also

4 need to be aware that there are certain trades

5 that have the potential to be disruptive to a

6 central limit order book. And we've probably at

7 various times on our exchange all seen minor

8 examples of this where sometimes, in a relatively

9 thin market, you put a really big trade through a

10 central limit order book, and that can cause

11 disruptions in and of itself, which could cause

12 undue volatility.

13 And -- and there are certain trades

14 that at certain times of the day, when market

15 conditions are thin, that actually it's less

16 disruptive to the market to actually have a trade

17 in a wholesale format. So these are all the

18 things that need to be balanced, but a

19 combination of the factors I described are the

20 things we use to drive activity to a central

21 limit order book.

22 MR. COSGROVE: Well, I don't have
Page 88

1 anything to add to that. I'd be interested to

2 know if anybody else does.

3 MR. FARLEY: Yeah, really, I think

4 the primary thing you can do is, at the risk of

5 sounding cavalier, is leave the DCM's alone. And

6 the reason why I say that is, we are, by nature,

7 incentivized to have products traded on a central

8 limit order book.

9 As I was just kind of thinking about

10 the ICE portfolio, I'd guess, and it's just a

11 guess, our top 15 products are 90 plus percent

12 traded in a central limit order book. In other

13 words, that's where we generate volume. That's

14 where we make money.

15 Not withstanding the great success

16 of ClearPort, when I think of CME, they're big

17 contracts, they're central limit order book

18 traded. So there is a natural inclination on

19 behalf of the DCM's to see those contracts move

20 in that direction. But it's important to know

21 note that, you know, you can incent a cat to be a

22 dog but it will never be a dog.
Page 89

1 Some contracts will never be central

2 limit order book trading, and that doesn't make

3 them a bad thing. And so I'd be careful to say,

4 hey, given Alberta off-peak power contract, we're

5 going to go and do a bunch of market making

6 deals, and we're going to do this, and we're

7 going to do that, because you could end up

8 inadvertently querying the market through those

9 efforts, whereas it serves a perfectly legitimate

10 purpose, it's just not central order book traded.

11 MS. ZAKIR: And just to follow up on

12 that, Tom, could you just give us some examples

13 of what types of programs you've put in place to

14 increase centralized market trading. I mean, I

15 understand that maybe products are specific in

16 some cases, but what are some of those examples?

17 MR. FARLEY: The primary one, in our

18 case, is good technology, frankly. It's -- it's

19 having a central limit order book that's very

20 fast and responsive to customers and has the

21 order types that customers are looking to add.

22 We've tried many other things, but I
Page 90

1 can tell you they've all met with varying

2 success, and the one commonality among our

3 successful products is that they run on a

4 technologically sophisticated platform.

5 MR. BRODSKY: Why don't we move on

6 to the last question for the first panel. And

7 that is, to what extent do market participants

8 prefer to clear OTC derivatives through a DCM as

9 futures contracts as opposed to through a SEF or

10 a DCM as swaps, and why do markets participants

11 have these preferences?

12 MR. CALLAHAN: I think my fellow

13 panelists have covered this pretty well. There's

14 tax issues, documentation issues, clearing

15 issues, regulatory uncertainty around SEF rules.

16 I think all those together probably determine

17 that preference.

18 MR. DOWNEY: It's our experience

19 that it comes down to transaction fees. And with

20 equity swaps, securities lending and equity repo,

21 they can do that transaction for free without any

22 regulatory oversight coming down onto exchange
Page 91

1 that are subject to fees and clearing expenses

2 that they don't have today.

3 MR. FARLEY: Pardon me. Aaron, was

4 the question about trading or clearing?

5 MR. BRODSKY: Clearing.

6 MR. FARLEY: Clearing, okay. Yeah,

7 no. The commission has set up a regime that

8 greatly favors clearing of futures over swaps.

9 And without enumerating all the reasons, just to

10 give you a few that may seem overly technical but

11 are very important, one is you can use letters of

12 credit to satisfy margin obligations for futures.

13 While you're unable to do so for

14 swaps, you can receive 60/40 tax treatment, which

15 has already been mentioned. It's worth noting

16 that prior to Dodd-Frank there was some ambiguity

17 about that. Now there is no such ambiguity.

18 And I think the -- perhaps the

19 biggest one is the margin requirement which says

20 that the margin requirements for swaps is kind of

21 two times plus the margin requirement for

22 futures. And there are other examples around the
Page 92

1 margins, but those are -- those are some of the

2 big ones.

3 MR. HAMILTON: From our customers'

4 pont of view, where they choose which venue --

5 which venue thing choose to clear, whether it be

6 the swaps venue and energy advice or the CME

7 venue for futures, that's not the only terms of

8 competition. These entities compete on their

9 price, on the straight-through processing of

10 technology, what post-trade matching services

11 they provide. They compete on the quality of the

12 interday marks. Swaps versus futures is

13 important. It's not the only thing that they do.

14 In today's environment where there

15 is some time frame between the -- when customers

16 are told they're done on the phone or the chat or

17 however a voice market's done, it may be deemed

18 that -- understood it was going to clear at one

19 exchange or the other. If for some reason

20 someone couldn't clear it at exchange A, the

21 other counterparty might be okay to switch to B.

22 So it's not an always, everywhere,
Page 93

1 all the time. It's not -- it's not the only

2 thing in town. It is -- it is an important

3 factor, but I think one thing to note is there's

4 both active markets in both the futures and the

5 swaps. There's switch markets in between.

6 There's not a normal basis that says

7 one of those two is more valuable than the other.

8 It's a day-to-day market -- it's a day-to-day

9 market. So it's not as if a future is always

10 more valuable. The price of a similar contract

11 on a futures exchange isn't different from a

12 similar contract on the swap exchange.

13 MR. HUMENIK: I think others have

14 mentioned this, but obviously the regulatory

15 environment for swaps is still developing so

16 there's a lot of uncertainty as to what that's

17 going to look at. Obviously, cost is a

18 determinative factor.

19 I've pointed out before that, you

20 know, Eris Exchange believes that the futures

21 framework provides that, a known regulatory

22 framework with a lot of advantages. And there
Page 94

1 are known advantages as well in terms of standard

2 and straightforward documentation, use of

3 existing futures post-trade clearing, systems and

4 infrastructure, the potential to have one day

5 bar. Real time credit checks on a trading

6 platform. And also the opportunity to have

7 traditional bank swaps desk providing liquidity,

8 as well as additional new liquidity providers.

9 So there's a lot that the futures

10 market can offer participants, and obviously Eris

11 Exchange offers those benefits.

12 MR. LA SALA: I think the question's

13 a bit tough because, as we talk about swaps and

14 SEF's, some of that just simply doesn't exist

15 yet. So if I just simply just for a moment

16 reflect on the future, I think that Tom touched

17 on a number of the items, including margin and

18 the like, but I just focus on also margin as it

19 relates to credits.

20 You know, choices of whether you

21 want to do -- you know, clear something at a

22 particular clearinghouse, regardless of whether
Page 95

1 it's a swap or a future, sometimes becomes a

2 function of where the mass of someone's book in

3 fact is. It may be that -- you know, it may be

4 beneficial to execute a swap to clear it at ICE

5 versus doing something comparable as a future and

6 clearing it on NYMEX because the mass of

7 someone's book is at that other clearing

8 organization.

9 So I think there are a number of

10 factors that go into that mix.

11 MS. VED BRAT: You know, BlackRock's

12 been very supportive of central clearing. The

13 OTC swap market, it's, you know, it's primarily a

14 wholesale institutional market.

15 And as we've been going through this

16 journey on cleared swaps, if you take away, you

17 know, some of the main characteristics of being

18 able to customize swaps, being able to transfer

19 risk immediately as a block to liquidity

20 providers where they play the role of providing

21 liquidity to us, and clients are no longer in

22 control of the market brokerage of day trades and
Page 96

1 the size of the trades are, you know, reduced,

2 the swap begins to feel a lot more like a

3 futures.

4 And, you know, our expectation is

5 that in the coming months there is going to be an

6 emergence of many more swap-like contracts or

7 futures contracts, you know, that will begin to

8 trade. Especially, you know, if you look at what

9 would you trade on a SEF club as a swap or, you

10 know, a DCM futures. They look and feel very

11 similar.

12 And then, you know, some of the, you

13 know, characteristics that my fellow panelists

14 have mentioned, you know, as far as margin

15 requirements, fee, there is, you know, also a

16 certain amount of infrastructure and familiarity

17 already built into the futures framework that I

18 think will play heavily into a decision of should

19 we trade futures or should we trade swaps.

20 MR. LA SALA: Can I just add one

21 last point following what Supurna just mentioned.

22 Just noting that in those choices that customers
Page 97

1 have today, I want to be clear that there --

2 there is a component, I think we might touch on

3 it in another panel, but there is clearly a

4 component of an open access or an open

5 architecture that exists today.

6 I think that some of the -- like,

7 you know, Mike Cosgrove can speak to the fact,

8 you know, parties will today go to, you know, is

9 firm and talk about clearing something, whether

10 it be NYMEX cleared or ICE cleared, it so happens

11 that in one instance it's a swap and in one

12 instance it's a future, but the customers are

13 making those choices, you know, today.

14 MR. BRODSKY: All right. Well, I

15 guess that will conclude the first panel so why

16 don't we take a five-minute break and then we can

17 resume the second one.

18 MR. SHILTS: Thanks to everyone.

19 (Recess taken.)

20 MR. SHILTS: If everyone wants to

21 take their seats, we can try to get started with

22 the second panel.
Page 98

1 MR. BRODSKY: Okay. Well, why don't

2 we get started with the second panel. Why

3 doesn't everyone just start by introducing

4 themselves briefly. We have one new panelist but

5 why don't we start with you and just introduce

6 yourself.

7 MR. MACKLE: Scott Mackle with

8 Constellation Energy and head of power trade.

9 MR. LA SALA: Again, Tom LaSala, CME

10 Group.

11 MR. HAMILTON: Pat Hamilton, CEO of

12 ICAP Energy.

13 MR. DOWNEY: David Downey,

14 OneChicago.

15 MR. COSGROVE: Michael Cosgrove, GFI

16 Group.

17 MR. FARLEY: Apologies. Tom Farley,

18 ICE.

19 MR. BRODSKY: Okay. Well, the first

20 question is a two-part question. How do

21 companies utilize EDRP's, and what are the

22 benefits of these transactions. And what are the
Page 99

1 primary products for which EDRP's are utilized

2 today.

3 So why don't we start at the end of

4 the table to my right and we'll just continue the

5 way we did last panel.

6 MR. MACKLE: Okay. So, I mean,

7 Constellation is an end-user hedger. We use

8 EDRP's pretty much in all of the various products

9 and marks that we trade. You know, across gas,

10 electricity, you know, oil, you know, coal. You

11 know, the benefits obviously, you know, the

12 centralized clearing, you know, centralized

13 margin, reduced collateral. You know, pretty

14 much -- I guess that's -- you know, not to go on

15 too long, but those are the fundamental reasons.

16 Price transparency, liquidity, and

17 all the reasons that, you know, we've been

18 talking about here so far today.

19 MR. LA SALA: Thank you. Well, at

20 CME Group EDRP's are instruments or transaction

21 types that are used across a host of different

22 markets. Those would certainly include
Page 100

1 agricultural markets, equities, treasury markets,

2 currencies. And, again, their usage, frankly,

3 varies, depending on, you know, the market.

4 In some cases these are certainly

5 done in I'll say the traditional EFP, where

6 you're talking exchange of futures for physicals.

7 In some cases there's a derivative exposure

8 that's exchanged.

9 In some of these markets the

10 transactions are -- I know we'll talk about these

11 later, some of them, especially the energies, we

12 do have the transitory or contingent

13 transactions. In other categories those types of

14 transactions are expressly prohibited.

15 Again, my other panelists spoke of

16 some of the reasons why his firm uses them. I'd

17 agree with all of those. And just further note

18 that in the end I think this panel is pretty

19 keenly focused in the energy space.

20 There is, in fact, the mitigation of

21 counterparty risk through bringing that

22 transaction in and having a cleared instrument at
Page 101

1 the end. Thank you.

2 MR. HAMILTON: ICAP's customers use

3 the EDRP methodologies to access voice markets

4 where screen liquidity hasn't been available to

5 them, but because of either no liquidity on

6 particular contracts or liquidity or the lack of

7 liquidity in longer dated tenors of more actively

8 traded contracts.

9 The most -- the primary use for

10 these products have been in the electricity,

11 natural gas spaces and refined oil products, with

12 some further use in agricultural commodities and

13 coal.

14 This process has benefited these

15 customers for more than -- for the last 10 years

16 and ICAP -- ICAP proposes that this venue be

17 allowed to persist because of the lack of

18 liquidity in most of the energy markets. We

19 believe this structure has -- has -- was put in

20 place primarily for the energy markets.

21 It has -- we don't advocate it being

22 just generally applied to many -- to all other
Page 102

1 markets on all other occasions because, number

2 one, the commission took into -- a deliberative

3 process to allow this process to take place in

4 the energy markets because of the particular

5 liquidity and competition factors in the energy

6 markets.

7 In order to spread this widely and

8 beyond the energy markets, we think the

9 commissions should undertake a similar process

10 that took into consideration the competitive

11 factors out of liquidity, various venues.

12 MR. FARLEY: As far as we

13 understand, EDR -- let me first say, I agree with

14 what they said and I don't have much to add. I

15 won't repeat any of the statements of the prior

16 panelists.

17 Just to add a couple of points.

18 One, our belief is that our best guess is that

19 EDRP's have been around for 80 years, if not

20 longer. In fact, we know they've been around for

21 80 years, if not longer, and they've -- they've

22 served -- they've served a good benefit.
Page 103

1 The second thing I want to add is, I

2 agree with Pat that they've been particularly

3 helpful in the commodities world. We at ICE like

4 to think that we were the prime kind of movers

5 and innovators in moving energy into a cleared

6 environment, but -- but we have to acknowledge

7 that our colleagues at CME, too, were drivers in

8 moving that business into a cleared world, which

9 I think we all would agree, coming out of the

10 Enron bankruptcy and some of the credit crisis

11 that occurred in that merchant community, wasn't

12 a very good thing.

13 I also want to highlight that

14 specifically the short duration or contingent or

15 transitory EFS that are the norm, specifically at

16 ClearPort, but elsewhere, serve a very valuable

17 purpose and the very valuable goal of moving

18 product into a cleared environment.

19 MR. DOWNEY: Equity participants

20 have a embedded cost of carry that varies from

21 the people who trade at Charlie Schwab on a

22 margin account to a hedge fund that relies on
Page 104

1 their prime brokers and multiple prime brokers

2 for financing and leverage.

3 The single stock future pricing

4 model is simply the stock plus an interest rate

5 competitively derived that is substantially lower

6 than even the hedge funds obtain from their prime

7 brokers.

8 As a preamble to why one would do an

9 EFP, if they're currently along a stock paying a

10 relatively high margin rate, they can reduce that

11 rate by EFP'ing out which is a simultaneous

12 transaction where they sell their stock and buy

13 the delta exposure in the future at a

14 substantially reduced component. It's a

15 financing game.

16 In a similar way, someone who is

17 short the stock is subject to varying rebate

18 rates that vary on a day-to-day basis. They're

19 also subject to recall where a hedge position

20 would certainly become unhedged, not because

21 something that they have done, simply because one

22 of their brokers have recalled the stock.
Page 105

1 This situation could again be

2 refinanced by buying stock back in, eliminating

3 that short, and simultaneously reestablishing

4 that short position with the future, and they

5 would be locking in that interest rate and they

6 would be locking in that effective loan out till

7 time. It's a financing transaction.

8 In addition, there are many desks,

9 they're called delta one desks on the securities

10 side. They provide leverage and financing. They

11 do not like to take market exposure. They love

12 to trade EFP's. They are long stock and they are

13 short futures.

14 They are, in fact, extending money

15 on a short-term loan, covered by a legally

16 binding agreement which is the single stock

17 future. There is no doubt exposure to the

18 underlying movements. They can go up and down

19 100 points and they don't care because they're

20 locked in. But a expiration their future premium

21 will decay as profit to them that creates a yield

22 for them, so it's all a pure financing
Page 106

1 transaction. Nothing to do with direction.

2 None of the three that I've just

3 described have anything to do with taking risk,

4 has nothing to do with taking a point of view on

5 the direction of the underlying stock. It has to

6 do with financing their activity, and that is the

7 efficiency that I point to in a lot of your

8 reports is, we should be acting in an efficient

9 manner. I agree. And that's what the EFP using

10 security futures does.

11 MR. COSGROVE: In the North American

12 commodity markets, and energy in particular,

13 these transactions are used essentially to marry

14 the best available execution with the best

15 capital management that is achievable through

16 clearing.

17 So a customer -- as it has been said

18 earlier, that the participants in these markets,

19 at least the market that GFI are involved in, and

20 I would say that ICAP are involved in, are

21 professional markets. The users are seeking the

22 best execution that they can, and they're
Page 107

1 professionals at achieving this.

2 Once they've got that execution,

3 then they want the same thing what everybody else

4 in the room wants. They want to reduce their

5 exposure to individual credit, individual

6 counterparties, and they want to achieve -- they

7 want to maximize their -- the capital that they

8 have available through margin offsets, and so

9 they tend to concentrate with a single

10 clearinghouse where there's portfolio benefits.

11 So I'd say that really this process

12 allows professional market participants to select

13 the best execution, and then to -- having

14 obtained their best execution, to then place

15 their trade with their preferred clearer to

16 obtain all of the benefits that Dodd-Frank and

17 everyone in the room wants the market to attain

18 in terms of capital efficiency and the reduction

19 of systemic risk.

20 MS. MARKOWITZ: I have a quick

21 question for Tom. You had said -- you talked

22 about contingent or transitory EFS's, and you
Page 108

1 said they're good because they move a product

2 into the clearing environment, so they have a

3 good purpose. Are those necessary post

4 Dodd-Frank, given the fact there is a clearing

5 solution on a SEF or just either there is a

6 clearing solution now for swaps; so is the

7 contingent EFS's, you known, needed to do this.

8 MR. FARLEY: Yeah. No. That's a

9 good question, Nancy. Our answer would be yes,

10 and let me just give you a little bit of context.

11 Revert back to something I said in the prior

12 panel. We think there is a need for a set of

13 final rules and proposed rules that greatly favor

14 the clearing of futures, and provide greater

15 certainty to market participants when you clear

16 as a future.

17 And the contingent or short duration

18 swaps that are the de facto standard, again in

19 the ClearPort model and, Tom, I'm talking about

20 your business, feel free to contradict me if I

21 get it wrong, they facilitate that. So market

22 participants are confident entering into that
Page 109

1 swaps transaction that at the end of the day

2 they're going to get up with a future which is

3 something they feel comfortable about, and it has

4 resulted in this greater good of additional

5 clearing and in fact clearing as futures.

6 I will highlight, though, Nancy,

7 because I think it is closely related, that the

8 act, however, does say that swaps must be

9 reported to a swaps data repository. Swaps that

10 are traded count against your swap dealer

11 designation. And I'm not suggesting that those

12 would just magically go away with these

13 contingent EFS.

14 I'm expecting that if somebody

15 submits a contingent EFS to a DCM, for instance,

16 to ClearPort, they are in fact saying they have

17 executed a swap. That's what the S stands for in

18 EFS. And therefore you should be able to trace

19 that swap back and see that it was reported to an

20 SDR, and probably subsequently torn up at the SDR

21 once the EFS is submitted, and it's going against

22 the eight billion test for swap dealer
Page 110

1 designation, et cetera.

2 So a bit of a long answer to your

3 question. The short answer is yes, we think

4 they're necessary, but we're not expecting that

5 it will be completely status quo as it is today.

6 MR. SHILTS: Can I just have a quick

7 follow-up. And, Tom, you're probably going to

8 respond too. So you're saying that this EFS

9 mechanism has benefits and all. But does -- what

10 is the benefit for having this mechanism with

11 respect to the DCM as opposed to, say, the DCO?

12 Because I'm trying to understand --

13 it sounds like the benefit you're saying is

14 because it brings these products into clearing.

15 But what -- what advantage is there for going

16 through the DCM? I mean, particularly for those

17 where there is no liquidity or there is no

18 trading?

19 MR. FARLEY: Sure, sure. No, it's

20 fairly clearcut in my mind. It's that -- it's

21 what we spoke about in the last panel, without

22 rehashing it, that you need to nurture new
Page 111

1 products. Some products will go up to be central

2 order book, highly liquid futures. Others will

3 not. But having this mechanism in place allows a

4 DCM a greater probability, a greater likelihood

5 of developing, of nurturing, and ultimately

6 raising, you know, central order book children.

7 That's a bad metaphor. Carried it too far.

8 MR. LA SALA: I agree with the

9 points Tom just made, that some of these

10 instruments can in fact grow in.

11 That stated, I want to speak just a

12 moment on his commentary about the mechanism and

13 the usefulness. It's my opinion, our opinion,

14 when you look at core principle 9, as you're

15 focused here on questions around contingent EF

16 EDRP's, I do believe that under B3 there is an

17 alternative means to in fact potentially bring

18 the transactions in under the auspices of a DCM

19 and in fact not use an EDRP, wherein the DCM

20 clearly seems to have the flexibility to scribe

21 rules, you know, on its books that would define

22 the ability and potentially, you know, again
Page 112

1 limit the type of participants to ECP's as

2 generally EDRP's are to in fact bring these

3 positions in as futures from inception. Versus

4 going --

5 MR. SHILTS: Could I -- I'd just

6 like to clarify. What position are you talking

7 about? Because if they're contingent, there's no

8 position. So what are you -- just so I

9 understand what you're saying.

10 MR. LA SALA: I'm saying, Rick, as

11 an alternative to -- to right now you're talking

12 about the contingent EFRP. You've got a swap and

13 an offsetting swap that ends up in a future.

14 There's the contingency that I think you speak

15 to. But, in fact, the remaining component after

16 that transaction is in fact a futures transaction

17 that occurs under the auspices of the DCM.

18 I think the core principle 9 in

19 section B3 additionally affords another

20 prospective means to in fact bring the positions

21 in as futures from inception.

22 MR. VAN WAGNER: Just to ask the
Page 113

1 overlay, though, which is that -- and this is all

2 premised that initially there is a swap that is

3 done. And I understand there's legal uncertainty

4 now. But, I mean, let's assume two, three years

5 down the road from now we have a swap that

6 standardized, subject to clearing, perhaps even

7 subject to a trade execution mandate.

8 I guess this is both the Toms,

9 right, are you positing that that swap that will

10 eventually be the basis of an EFS and result in a

11 futures contract, are you saying that that swap,

12 though, is going to be relieved of any kind of

13 independent trade execution or clearing mandate

14 because, after all, it eventually, through the

15 EFS mechanism, it's ending up attributed to a DCM

16 as a future, attributed to a DCO for clearing

17 that future?

18 I'm just wondering what -- because,

19 I mean, obviously, right now there's -- there's

20 not any kind of requirements around that swap as

21 a component of ERFS. But looking forward, what

22 are you envisioning that -- will that swap ever
Page 114

1 have any independent existence?

2 MR. FARLEY: Yeah. There was a

3 couple of questions embedded in there. What I

4 was suggesting and what we are in fact

5 envisioning is that the swap would not have an

6 existence -- it would not be cleared, let's put

7 it that way. And it would either not exist or it

8 would exist for some infinitesimally small period

9 of time.

10 However, I'm curious to hear Tom

11 elaborate. He's gone a slightly different route

12 saying that what is executed is not executed as a

13 swap and it therefore independent of SEF rules,

14 SDR reporting, swap data -- swap data -- getting

15 caught up in the $8 billion bucket. I'm not

16 suggesting that. I'm saying, in fact, because

17 the market participant is submitting an EFS,

18 they're saying, look, we executed a swap.

19 The tricky thing here -- it's kind

20 of mind bending. You say, well, wait. If it

21 never existed, then what is that thing. The act

22 contemplates, and historically we've contemplated
Page 115

1 in the CEA, and CFMA, and Dodd-Frank, a bilateral

2 swap and a cleared swap. This is a third thing.

3 It's neither cleared nor bilateral, and it's been

4 in practice for 10 years, and that's the -- you

5 know, that's the elephant in the room. And we

6 see nothing wrong with it but it is a swap, in

7 point of fact. And therefore we expect it will

8 be treated as an OTC contract until it is

9 accepted for clearing as a future.

10 MR. LA SALA: I think that what Tom

11 first mentioned I would agree with, meaning that

12 at its inception there's a swap. It will be, as

13 rules get promulgated, would be subject to

14 compliance with whatever those finalized rules

15 were.

16 However, what I proffered, and the

17 point -- I'm not making this for the first time.

18 If you folk look back to our comment letter, we

19 made reference to the use of CP9B3. I'm just

20 simply positing the notion if, in fact, you know,

21 contingent EDRP's, you know, were prohibited, I

22 think there is flexibility still within the
Page 116

1 statute to allow the DCM to effectuate, you know,

2 a rule set that would otherwise allow

3 transactions to be, you know, negotiated, and

4 this would have to be certainly by registrants,

5 but they would at inception be futures

6 transactions that come in through the DCM,

7 through this rule set.

8 And we haven't -- no one's used

9 this. You know, I'm not aware of any futures

10 exchange that's used this. We -- we haven't.

11 But as we've simply looked at the statute, we see

12 that flexibility there.

13 MR. SHILTS: And what is the

14 flexibility for? Because I'm a little -- I don't

15 remember what B3 says, I'm sorry.

16 MR. LA SALA: What B3 says is a

17 futures commission merchant acting as a principal

18 or agent to enter into or confirm the execution

19 of a contract for the purchase or sale of a

20 commodity for future delivery, if the contract is

21 reported, recorded, or cleared in accordance with

22 the rules of the contract market or derivatives
Page 117

1 clearing organization.

2 It seems to me, seems to us, that in

3 the context of this statute, there was some

4 flexibility there that would allow the DCM to, in

5 fact, assuming, again, natural progression here,

6 is that the client certainly has a relationship

7 with an FCM, to in fact allow a DCM to construct

8 a rule set that would govern how such

9 transactions would come in.

10 You'd certainly have, as the statute

11 says, reporting, recording, so let's call it

12 prompt or contemporaneous reporting of the price,

13 which is something you don't get today via the

14 EDRP. So there -- you know, there's -- I'm

15 simply noting that as we read the statute, there

16 is an alternative to the EDRP route that seems to

17 be available in the -- the statute as it exists

18 today.

19 MR. SHILTS: So just -- just so I

20 understand, so you're saying that could develop

21 another mechanism for bringing whatever

22 transactions into clearing and not going through,
Page 118

1 say, an EFS type mechanism? I think as Tom

2 Farley was saying, if you're using an EFS

3 mechanism there's a presumption that there's an

4 S, the bona fide swap. Otherwise it, you

5 know . . .

6 MR. LA SALA: I'm not disagreeing

7 with Tom Farley's, you know, point on -- if it

8 was, you know, an EFS, for example. I'm just

9 simply positing that there seems to be,

10 contemplating the statute, the latitude for an

11 alternative.

12 However, that alternative would have

13 incumbent upon it additional criteria. That

14 being -- one of those key criteria being, you

15 know, I'll say, contemporaneous or a prompt price

16 report to the marketplace, which is something

17 that, with regard to EDRP transactions, does not

18 occur today.

19 MR. FARLEY: And for the importance

20 of that, I'm not disagree with what Tom's

21 describe. I'm just simply saying, as Rick

22 articulated, if you're accepting an EFS, that
Page 119

1 thing, the swap, should be subject to the swaps

2 rules. But I'm not agreeing with CME. I would

3 never do that. You guys are too powerful.

4 MR. LA SALA: And I would agree with

5 that also.

6 MR. BRODSKY: One of the regulatory

7 differences between futures and swaps is that a

8 DCO is required to provide nondiscriminatory open

9 access for clearing swaps but is not required to

10 do so for futures.

11 What are the implications of core

12 principle 9 and the related EFS transaction

13 issues that we've been discussing on

14 nondiscriminatory open access.

15 Maybe start with Mr. Mackle.

16 MR. MACKLE: You know, maybe just --

17 maybe some be better answered by the folks from

18 the exchanges, I would think. From our

19 perspective, and again looking into those

20 differences between, you know, the open access

21 rules between the swaps and the futures

22 exchanges, that's not something that, you know,
Page 120

1 us at Constellation or other end users or market

2 participants I think, you know, spend a lot of

3 time thinking about.

4 You know, obviously it's in -- it's

5 in every respect of exchanges to conduct their,

6 you know, businesses and practices in such a

7 manner to, you know, draw business to their

8 exchange, respective exchanges.

9 So, you know, to the extent that,

10 you know, the rules aren't technically the same,

11 you know, I don't know -- you know, again, that's

12 not something, you know, I guess that's an

13 embedded risk in the business, you know, as we're

14 doing it if we're clearing, you know, futures

15 versus swaps. But that's not -- you know,

16 practically speaking, I don't -- I can't think of

17 an example where that's been an issue.

18 Obviously, as a result of core

19 principle 9, if you've got sort of stranded

20 futures that you've got to liquidate, you know,

21 there's -- depending on the rules that are

22 surrounding that, if it were to come to that,
Page 121

1 that would be a consideration to -- to take into

2 mind. But in terms of currently how -- you know,

3 how we view -- you know, do we direct business or

4 consider, you know, that difference in stature,

5 you know, as we're conducting business, you know,

6 the answer is no.

7 Again, how that would -- how that

8 would -- the implications for, you know, changing

9 the rules around, you know, EFS -- clearing EFS's

10 as futures, you know, obviously, the commission

11 would have to give serious thought to -- you

12 know, to what would happen to again the -- the

13 stranded futures and what would happen to market

14 liquidity, you know, I think was brought up in

15 the previous panel.

16 MR. LA SALA: I actually mentioned

17 in the previous panel, so I'm repeating myself a

18 bit. I do think that, while I note that the

19 paradigm you talked about, DCM, core principle 9

20 versus what's at least proposed for swap

21 execution facilities, the paradigms are

22 different.
Page 122

1 There clearly is a articulated open

2 access component with regard to the swaps. That

3 stated, and I go back to what I stated in the

4 prior panel, I think that open access or open

5 architecture with regard to customer choice,

6 frankly, has -- exists today, and has existed for

7 the last decade, by virtue of the fact that the

8 principal parties to transactions in this -- in

9 whatever space we're talking about, I'm making

10 this very energy centric, because I think that's

11 where much of the focus is being applied here, I

12 think that, you know, there are some folks on

13 this panel that will speak to the fact that, you

14 know, open access has occurred, because parties

15 are openly and readily choosing every single day

16 whether they want the instrument to clear NYMEX

17 or clear ICE. In one instance it goes in as a

18 cleared swap. Another instance it goes in as a

19 clear future.

20 So while I see the difference in --

21 in the paradigms, I think that you have today,

22 and you would have, in many regards tomorrow,
Page 123

1 that open access. I further note that on the DCO

2 side, if in fact CME Group were offering futures

3 through its DCM, I'm quite confident that if

4 there are, you know, similar swap-type

5 instruments that parties want to clear at CME

6 Group, we're certainly going to be interested in

7 clearing those instruments on the DCO.

8 MR. HAMILTON: We believe that the

9 open -- if a DCM wants to avail itself of a

10 more -- a broader EF -- broader EFS to futures

11 model, that they need to comply with the open

12 access rules as if it was a swap. That the idea

13 that they could have the ability to, say, close

14 the window to the swap model doesn't make any

15 sense.

16 And in the long run it wouldn't make

17 any sense economically for them either. If they

18 want this product and they've allowed it in the

19 past, they're going to continue to allow it. And

20 just as a mechanism, obviously, in the language

21 of the day, to speak of the ClearPort model,

22 those probably wouldn't be something that you
Page 124

1 would have approved today, but it exists, it's

2 been in existence for 10 years, it's used quite a

3 bit. We've -- we have cleared 50,000 trades this

4 year with 400 different counterparties.

5 The idea that a certain exchange

6 would want to close that off at some point

7 doesn't make a lot of sense. I think it should

8 be memorialized in a way that said, if they want

9 to avail themselves of that process, then they

10 should treat that swap to the futures process as

11 a swap when it comes in because it's a swap to

12 begin with.

13 MR. FARLEY: I agree with Tom's

14 comments. Again, I don't have anything further

15 to add.

16 MR. DOWNEY: Not to wade too deep

17 into fungibility, but I don't think swaps,

18 bilateral swaps need to be fungible. I think

19 that the two parties are either going to want to

20 carry the position together or exit the positions

21 together. And I'm not quite sure -- this is my

22 ignorance, I'm not quite sure how far THE
Page 125

1 innovation process begins, but if they're trying

2 to capture some of these bilateral swaps, I don't

3 think fungibility is necessary.

4 MR. COSGROVE: Well, I think --

5 well, I think this is kind of a nuclear issue,

6 actually, because we have -- the two incumbent

7 clearinghouses in North American energy must be

8 earning -- I mean, it's all public information,

9 it's going to eight, $900 million a year, and

10 clearly fungibility between clearinghouses would

11 allow, you know, for some competition to enter

12 the space.

13 Right now it's kind of siloed. And,

14 you know, the chairman has used the -- has sort

15 of referred humorously to fungibility as the F

16 word in Chicago. And I think that really -- you

17 know, this is a big issue.

18 Notwithstanding that, I think, you

19 know, our -- GFI's position is that, you know,

20 when taken as a package overall, we think the

21 85/15 rule is -- is not helpful. But on this

22 particular issue of competition, the requirement
Page 126

1 for a clearinghouse to provide unaffiliated

2 execution facilities with impartial access is

3 something that would introduce a tremendous

4 amount of competition.

5 It would be -- it would be harmful,

6 possibly very harmful or possibly just a bit

7 harmful, to ICE's clearing business and CME's

8 clearing business, and it would create

9 competition in the market where I think the

10 perspective for competition in that regard is --

11 is weak at the moment. It doesn't mean that it's

12 the right thing to do or the wrong thing to do,

13 but I think that's simply a fact.

14 I would echo some of the statements

15 that Pat made a few minutes ago. But I would

16 point out that the lack of impartial access does

17 exist today, and I'll provide one specific

18 example. And I don't mean to pick on ICE, ICE is

19 a great business. I've often said it's the best

20 managed business in the energy space, but ICE

21 refuses to provide unaffiliated execution

22 facilities with the same connection to the
Page 127

1 clearinghouse.

2 So in our case, for example, we're

3 required to type in manually a transaction that's

4 going to go to ICE for clearing. Whereas, with

5 CME, we've had an electronic connection for

6 post-trade API for years and years.

7 So in the case of -- in the case of

8 CME, it's very easy for our brokers to broker a

9 transaction, enter the transaction once into

10 GFI's trade capture facility, and then have that

11 transaction populate all of the various databases

12 and models and so forth both internally at the

13 clearinghouse and at the customer's location.

14 Whereas with ICE, we literally have

15 to employee people to sit there and type the

16 trade into a web interface, and there's no

17 technological reason why that needs to be done.

18 That's purely done to make our execution facility

19 less competitive relative to ICE's affiliated

20 facility.

21 Now, again, I would do the same

22 thing, if I were running ICE. And I don't mean
Page 128

1 to say that these are evil guys doing bad things.

2 They're smart guys doing smart things, but this

3 is a fact. And this impartial access issue is

4 something that, you know, we find troubling.

5 But, frankly, in the scheme of things, if we had

6 to opine one or another on the 85/15 rule,

7 knowing that we were going to be precluded from

8 having the open access that we'd hoped to obtain

9 we would forego that in an effort to do away with

10 this particular issue in favor of the overall

11 health of the markets that we think this -- this

12 would create.

13 MR. FARLEY: I just wanted to

14 respond specifically to the -- to the comments

15 Mike had about ICE. I don't -- and he referred

16 to it as this is a fact. I disagree with his

17 categorization of the facts. I don't think it's

18 necessarily apropos of this hearing. But just to

19 be specific, the OTC markets that Mike's

20 referring to are markets that are eligible to

21 ECP's, ECE's.

22 These are very -- these are very
Page 129

1 sophisticated market and they tend to be illiquid

2 markets, as I think Mike would acknowledge,

3 particular those that his -- that GFI or even

4 ICAP for that matter, the markets where their

5 brokers are entering trades, and they also tend

6 to be fairly few in number. And, in fact, in

7 many of those markets ICAP and GFI, they are our

8 distribution source and, in fact, 100 percent of

9 the trades can come from -- from these parties

10 and zero from our own platform.

11 So the idea that we're intentionally

12 disadvantaging them in those markets where we

13 have a zero percent market share and potentially

14 no hope of having central limit order book

15 trading doesn't pass the sniff test. And further

16 I just want to point out, as Mike acknowledges,

17 we provide access to every broker and we do it in

18 an impartial way. In other words, we don't say,

19 hey, Pat, you know, you can have a straight

20 through processing via an API and, Mike, you can

21 tab it in by hand.

22 MR. COSGROVE: Just one final
Page 130

1 comment.

2 MR. DOWNEY: I'll back up here.

3 MR. COSGROVE: Sorry. I do have --

4 I do have a lot of respect for these guys but I

5 don't understand why there's not an electronic

6 connection. CME's given it to us for ten years

7 and ICE hasn't. And this isn't a court of law

8 where I'm coming to make a case for you guys just

9 to tell Tom to give us this access. But it is a

10 fact that we don't have it.

11 And it is, I don't think defensible

12 that it's technologically impossible to provide

13 that. It does create an impediment and an

14 additional cost of business, and an additional

15 steps where errors can be introduced as a result

16 of having to key a transaction in twice. And so

17 I do see no other explanation for this, if it's

18 not technical, that it can't be provided.

19 Again, I'm not coming to plead for

20 you to require this to be done, but merely to

21 point out that it is a commercial issue that we

22 have -- that does exist.
Page 131

1 MR. DOWNEY: Not to get in the way

2 here, but it is a commercial issue. And if he

3 doesn't want to expend the money or he has other

4 things that he can build that he thinks is going

5 to be better for his business, he has that right.

6 MR. COSGROVE: Indeed, he does. But

7 since we're asked specifically about the question

8 of, you know, how the impact of impartial access

9 is for unaffiliated facilities, I felt that

10 providing a specific example that does have

11 impact in our world would be beneficial. But,

12 yes, it is.

13 And again, I -- you know, I don't

14 mean to throw a lot of mud and then at the end

15 say, but I love you. I do have a lot of respect

16 for this organization. They are -- they do a

17 tremendous job, and if I was in their position,

18 I'd be doing the same thing. But you've asked

19 the question and I have answered.

20 MR. RADHAKRISHNAN: So how about

21 this, the statute says that the rules of a DCO

22 shall provide for nondiscriminatory clearing of a
Page 132

1 swap executed bilaterally or on or through the

2 rules of an unaffiliated DCM or a SEF. You're

3 neither a DCM or a SEF, but what means whatever

4 is executed on GFI is executed bilaterally.

5 How about the two of you guys come

6 and see me, and you can both make your case as to

7 why you think they are discriminating. Fair

8 enough? Unless you don't want to.

9 MR. COSGROVE: No. I'd be happy to

10 do that. I didn't -- you know, I came to respond

11 to the questions that were asked, not to seek

12 redress of --

13 MR. RADHAKRISHNAN: I'd like to come

14 to -- unless you guys can sort it out in the next

15 five minutes.

16 MR. COSGROVE: Well, no. I think,

17 as David said, we don't have to sort it out.

18 They have, in the same way that, you know, none

19 of the DCO's clearing futures are under any

20 obligation to provide unaffiliated execution

21 facilities with impartial access, at the moment

22 none of the swap clearing facilities are either.
Page 133

1 If we come and say, give us impartial access,

2 again, let me reverse the roles. Let me say I'm

3 sitting here and someone says, give me impartial

4 access. I would say, on what basis do I have to

5 give this to you. Well, because the statute says

6 that you have to give it to SEF's. Are you a

7 SEF? Well, no because I haven't -- there aren't

8 any yet.

9 MR. RADHAKRISHNAN: It says,

10 executed bilaterally or on or through an

11 unaffiliated DCM or SEF. So there's that

12 additional language. It says nondiscriminatory

13 clearing of a swapped execute bilaterally or on

14 or through the rules of an unaffiliated DCM or

15 SEF. So the way I see it, you're neither a DCM

16 or a SEF, so whatever's executed right now on

17 your platform is a bilateral execution. That's

18 how I look at it.

19 MR. COSGROVE: True.

20 MR. RADHAKRISHNAN: So the statute

21 says that the DCO cannot discriminate,

22 irrespective of the execution.
Page 134

1 MR. COSGROVE: Okay.

2 MR. RADHAKRISHNAN: I'm trying to

3 help you out.

4 MR. COSGROVE: I'm happy to come by.

5 MR. RADHAKRISHNAN: Okay.

6 MR. BRODSKY: We talked a bit

7 briefly earlier in the panel on contingent

8 transactions. Are there any additional thoughts

9 of the benefits and costs of a prohibition on

10 these contingent EDRP transactions?

11 MS. MARKOWITZ: And specifically, I

12 can't -- I'm trying to wrap my head around this,

13 and it may be repetitious, but if we are in

14 agreement that the S has to be legitimate, which

15 is executed, how likely is it and beneficial that

16 you're still going to then take an execute swap

17 and EFS it to become a future and clear it as a

18 future?

19 MR. FARLEY: We're expecting that's

20 exactly what's going to happen. In other words,

21 SEF's will offer contingent swaps for trading,

22 and market participants will execute contingent
Page 135

1 swaps on a SEF which will immediately be cleared.

2 And I also want to highlight or I

3 want to also answer Aaron's question and say, our

4 expectation is if contingent swaps for some

5 reason were no longer allowed, that would be very

6 disruptive. Because the way this market works,

7 and Pat and Mike can tell you more about it, but

8 Pat and Mike are out putting together

9 counterparty.

10 In many cases, those counterparties

11 may be anonymous to one another. The trade is

12 put together and the reason why they're

13 comfortable stepping into that swap trade is

14 because they are know the contingent nature and

15 it's going to immediately be cleared as a future.

16 And so to say, hey, these contingent

17 swaps, which have served a good purpose for ten

18 years, we're going to decide these are no longer

19 permitted would be, in our view, disruptive.

20 Again, I just want to reiterate

21 something I said previously. The expectation

22 would be the swap is executed and we would argue
Page 136

1 that, if we can, I know this isn't about the SEF

2 rules, but if we can preserve the current

3 execution infrastructure to help out the business

4 models of the ICAP's and GFI's, that would be a

5 good thing. In other words, make the execution

6 very flexible on a SEF. But then there would be

7 swap data repository reporting. It would count

8 against the swap dealer. A billion, not to --

9 not to repeat myself. That's how we see this

10 fitting together.

11 MS. MARKOWITZ: Well, what's the

12 contingent, then? So if you don't clear it as a

13 future, you unwind the swap?

14 MR. FARLEY: That's right. That's

15 right. Because otherwise if it were rejected for

16 clearing, you could argue you have an illegal

17 swap at that point. So, yeah, it's a contingent

18 swap and if it's not immediately accepted for

19 clearing as a future, it's torn up.

20 MR. VAN WAGNER: Just to clarify, I

21 mean, you're speaking about SDR reporting. Are

22 you also envisioning that this underlying swap is
Page 137

1 subject to a trade execution mandate? Are you

2 envisioning that that -- there would be some sort

3 of pre-execution -- well, that you'd be executing

4 it actually on the SEF?

5 MR. FARLEY: Well, yes. And I --

6 and I acknowledge that I've said that. But I'm

7 being fairly prescriptive. I guess I could ask

8 the question to you. I mean, what are you

9 envisioning and how do you -- how do you see it

10 working?

11 MR. VAN WAGNER: Yeah, I don't know.

12 Because obviously we're fleshing out what the SEF

13 rules look like. But as it's been described, as

14 the elephant in the room, of course, is

15 ClearPort. And conceded that there's been a

16 ten-year history of it. But there's an overlay

17 now which is slightly different, and that is pre

18 Dodd-Frank, I mean, swaps were not cleared.

19 Swaps were not traded on a trading venue.

20 Now there's -- you know, Congress

21 has given us a charge about swaps; that to the

22 extent standardized and cleared, they should be
Page 138

1 done on a SEF, on a trade execution facility of

2 some sort or another, and there's things that

3 flow from that, realtime reporting. You know,

4 pretrade transparency, et cetera.

5 And, you know, query -- I'm trying

6 to envision what you're talking about here. What

7 the overlay is going forward. Are those

8 things -- are we going to be able to see those

9 things on a SEF.

10 MR. FARLEY: Right. And I could

11 give -- again, I could give a prescriptive answer

12 or I could just -- I could just tell you, here

13 are the questions we asked, and we came up with

14 potential answers.

15 But the questions are, are

16 contingent swaps going to be allowed. We think

17 that they should be. Will contingent swaps be

18 required to be traded on a SEF. Will contingent

19 swaps be offered by a SEF. Will a contingent

20 swap that's executed have to be reported to an

21 SDR. Will contingent EFS be allowed.

22 Once contingent EFS is accepted,
Page 139

1 will the swap have to be closed at the SDR; in

2 other words, an offsetting trade submitted. Will

3 the contingent swap executed on the SEF count

4 towards the swap dealer definition. Will the

5 future that ultimately clears be subject to this

6 swaps part 20 large trader reporting or

7 presumably futures large trader reporting. And

8 at long as we get all those answered before we

9 leave today, we should be set.

10 MR. SHILTS: But those are the

11 elements of what would -- that we're looking at

12 that would constitute determination as to whether

13 the S, the swap, is legitimate and whether it's a

14 bona fide EFS. So that's all of the things that

15 we talked about, the real time reporting,

16 reporting to the SDR, being subject to a trading

17 mandate, whatever, would go into, presumably, a

18 determination of whether that is a bona fide swap

19 and hence a bona fide EFS.

20 MR. FARLEY: And my last comment,

21 because I'm at risk of monopolizing the time on

22 the panel, that's why our prescriptive, the
Page 140

1 scenario we came up involves the executed

2 contingent, swap on a SEF. Again, hopeful it's

3 easy to execute. And, you know, voice is a

4 mechanism to be able to do that. And then you

5 have to report to an SDR.

6 You -- it does count against swap

7 dealer, and you're actually reporting twice to

8 the SDR, once when you open it, once when you

9 submit the EFS, and ultimately it's cleared as a

10 future on the DCO.

11 MR. LA SALA: If I could just maybe

12 another question or note on an item that I'm not

13 sure. That being, I'm not sure if in fact the

14 swap that might be, I'll say, offered, if it's a

15 swap that's mandated for clearing and trading,

16 I'm not quite sure if in fact it's going to be

17 appropriate to somehow switch its identity from a

18 swap to a future.

19 I think those might just simply have

20 to go in pipeline straight as swaps; whereas, the

21 contingency may be more applicable to

22 instrument -- swap instruments that are not
Page 141

1 clearing and trading mandated. I don't know.

2 I'm noting it as a -- as a question.

3 MR. VAN WAGNER: I guess I'm -- why

4 are you troubled? I mean, don't you have that

5 situation now with ClearPort and EFS's? I mean,

6 the --

7 MR. LA SALA: I'm not sure if I

8 understand your question.

9 MR. VAN WAGNER: I thought you were

10 positing a situation where it's actually somehow

11 difficult to convert a swap into a future.

12 MR. LA SALA: No. I'm not saying

13 it's difficult. I think what Tom was stating is,

14 he was making the case, and I think in a fine

15 fashion for, you know, contingent, you know,

16 could be still allowed.

17 And my -- my comment would say,

18 yeah, with the caveat that I'm not quite sure --

19 I'm just not quite sure if in fact that -- if the

20 instrument was at its inception a swap that was a

21 trading and clearing mandated if in that scenario

22 it just didn't pipe straight in, if you still had
Page 142

1 the ability to almost say redirect it. I'm not

2 sure.

3 MR. SHILTS: Redirect it for

4 clearing as a future?

5 MR. LA SALA: Correct.

6 MR. RADHAKRISHNAN: Because there's

7 account implications. The commission determines

8 that a particular swap, say, an energy swap, has

9 to be cleared. At the customer level, it has to

10 be cleared in the cleared swaps account because

11 it is a swap, not a futures contract.

12 And let's say the next step is it's

13 made available for trading on the SEF or a DCM.

14 It is a swap, right. It is not a futures

15 contract. So if you want to convert it to a

16 futures contract, the question is, do you have to

17 get out of the swap and restable a futures

18 contract or is there some other kind of mechanism

19 that, you know, could -- that you could exchange

20 a position in a cleared swap for a position in a

21 cleared futures contract.

22 MR. SHILTS: And Tom, I'm just --
Page 143

1 MR. HAMILTON: I just wanted to

2 follow up about the contingent -- well, two

3 things. One, that does it need to continue to

4 exist. And we would say yes, because there is

5 most certainly a cost of the change from where

6 they exist today to where it doesn't exist.

7 That market participants have found

8 the ways that are most efficient for them to

9 execute, be it voice, on a screen, sometimes on a

10 screen, sometimes on a voice, depending on how

11 they need to do it. So we think there would be a

12 very large cost.

13 The second thing is, I want to talk

14 about the contingent nature. While it's a

15 troubling word in this context, how -- it's

16 contingent, oh, my goodness, how awful is that

17 going to be. The actual nature of the

18 contingent -- contingency isn't that great.

19 Again, we've emphasized that these

20 are professional market participants. They come

21 to professional venues where -- where

22 transactions take effect. The actual amount of
Page 144

1 trade breaks that happen are very, very low.

2 On a centralized -- you know, in the

3 pit, trades break. On a block trade sometimes

4 trades break. And in these venues sometimes

5 trade break. But the amount -- the number of

6 trades breaking is very low.

7 The difficulty is going to be in --

8 even in decreasing that number with respect to

9 the SEF rules and making sure that pretrade

10 execution certainty. You know, execution

11 certainty of 100 percent is much different than

12 we're well over 99 percent. I would assume

13 Michael will back this up. There's not a lot of

14 these trades that break.

15 So I just want to make it clear that

16 this isn't something all day long trades are

17 breaking, for ICAP single digits for the whole

18 year, and we're talking about 100 -- you know,

19 more than 100,000 clearing events.

20 MR. COSGROVE: Yeah, that's our

21 experience also.

22 MR. SHILTS: Could I just follow up
Page 145

1 on a question, Tom, on your comments before. And

2 I know you said you hadn't -- this was just an

3 idea you had. But if there was to be a DCM to

4 generate another provision for bringing trades to

5 the -- for clearing through the DCM, not through

6 the EFS mechanism, where that would be done

7 directly, presumably the trade would then be --

8 the product would be a future that would be done

9 off market and then brought on.

10 MR. LA SALA: Correct.

11 MR. SHILTS: But if that product,

12 say, essentially is identical to, you know, a

13 swap, which many of them are, maybe previously

14 they'd been done as an EFS, then doesn't that

15 create a way just to completely circumvent all of

16 the pretrade transparency provisions for

17 Dodd-Frank?

18 I mean, because there wouldn't be --

19 from what you're saying, there wouldn't be any

20 obligation for a centralized trading on the DCM

21 as the future, and then there would be no way to

22 have a trading mandate on the swap because it
Page 146

1 would never be a swap? So I'm just -- maybe I'm

2 missing what you were saying.

3 MR. LA SALA: No, Rick. I think,

4 like I stated in the earlier panel, I think that

5 the pretrade -- I see your point. I get it. But

6 I think that the pretrade provision, you know, as

7 contemplate in Dodd-Frank, was clearly

8 articulated or contemplated. Not a requirement

9 but I think a goal was focused on swaps. That

10 wasn't, you know, for futures.

11 I'm simply looking at what I read,

12 and we may have differing opinion on the reading

13 of the statute. I'm just simply looking at the

14 statute and saying, it does appear that this

15 flexibility exists.

16 I completely understand how you

17 would say, well, I see that there could be a

18 conflict, you know, between the two. And maybe a

19 fair observation.

20 MR. SHILTS: Is the implication from

21 what you're saying is that there's a higher

22 standard for pretrade transparency on SEF's and
Page 147

1 swaps than there is for DCM's and futures? Which

2 seems odd but, I mean . . .

3 MR. LA SALA: In the context of

4 Dodd-Frank, pretrade price transparency was, you

5 know, focused on swaps. I didn't see anything

6 that made a mandate for pretrade price

7 transparency for futures.

8 MR. SHILTS: Unless it were viewed

9 as part of the core principle 9 amendment.

10 MR. VAN WAGNER: Well, unless you

11 also take the position that DCM at bottom is

12 supposed be a trading facility, which is a fairly

13 robust definition of many people being able to,

14 you know, see and trade with many other people.

15 And perhaps that obviated the need for talking

16 explicitly about pretrade transparency, but

17 that's at heart what a DCM is supposed to be.

18 We're just throwing out possible explanations.

19 MR. LA SALA: Sure, David. But, I

20 mean, stated again earlier, you've got DCM's that

21 are offering these arenas. And if the

22 marketplace doesn't, for whatever reason, choose
Page 148

1 to use that arena, it does seem that -- again,

2 the statute certainly seems to provide other

3 means.

4 MR. FARLEY: Can I just make one

5 quick comment. You know, I get the sense from

6 the reaction that the view is, you know, Tom's

7 making somewhat of a radical comment. I think

8 his comment was really only radical going back to

9 the early part of the last century before there

10 were any form of noncompetitive trades. And then

11 there were EFP's, and then there were EFS, and

12 then there were EOO's, and then there were

13 blocks, and then there were transitory EFP's, and

14 then there were contingent EFS.

15 And I think what Tom is smartly

16 suggesting is maybe there's another in that

17 evolution. And it goes back to what we talked

18 about in the last panel, just because you allowed

19 this -- and it actually goes to Mike's expansion

20 of the trading pit idea to the voice community.

21 Just because you allowed some futures execution

22 in the voice and instant messenger ether doesn't
Page 149

1 mean that all of a sudden a given market would go

2 wholly in that direction.

3 So I'm reacting on the fly to Tom's

4 comment, but just pointing to kind of the logical

5 continuation of existing evolution in the market.

6 MS. MARKOWITZ: I have a quick

7 question for Tom. Currently in the energy space,

8 what percentage of the trading is financial to

9 financial versus end user?

10 MR. LA SALA: I'm sorry, would you

11 repeat the question, Nancy.

12 MS. MARKOWITZ: In -- for ClearPort

13 trading, what percentage of the trading is end

14 user versus financial to financial?

15 MR. LA SALA: I'm not sure. You're

16 talking about principles to the transactions?

17 MS. MARKOWITZ: I'm sorry?

18 MR. LA SALA: Principals to the

19 transactions?

20 MS. MARKOWITZ: Yes.

21 MR. LA SALA: We've certainly have

22 got fair participation by end users and
Page 150

1 financials. I would be guessing. I don't want

2 to. I could follow up with you afterwards on

3 percentages.

4 MS. MARKOWITZ: Okay.

5 MR. BRODSKY: Thanks everyone for

6 participating in the panel. Why don't we take a

7 five-minute break again and we'll resume with the

8 third panel.

9 (Recess taken.)

10 MR. SHILTS: If everyone can take

11 their seats so we can get started and end this.

12 MR. BRODSKY: Okay. Well, thanks to

13 everyone for coming back for the third panel.

14 This one should be a bit shorter than the first

15 two.

16 What are the challenges of reporting

17 block trades to a DCM within five minutes of

18 execution, and what are the benefits of such a

19 requirement?

20 Start with Mr. Downey.

21 MR. DOWNEY: The -- one, the DCM

22 could provide cumbersome reporting mechanisms
Page 151

1 that they have to keypunch in, subject to error

2 rates that would have to be corrected.

3 Two, some of these trades that are

4 designed to be reported as block sizes, and I'll

5 give an example because I'm in discussion with

6 the commission now on it, as an example, we have

7 large CTA's who would like to take delta exposure

8 in futures. Those large positions are -- no one

9 wants to give them a market on them, so they go

10 to the delta one trade desk on the securities

11 side, crossing the divide between the futures and

12 the securities.

13 The discussions take place as to

14 what in fact is -- what the basis of the

15 transaction they would like. They're going to

16 allow those delta one desks to prehedge and

17 attach a basis to the view op price of the hedge.

18 And so, as I brought to the

19 commission's attention, in the middle of this

20 view op'ing, enough goes on where they say, okay,

21 now we've done a one-lot single stock future, but

22 it's not large enough to be reported as a block
Page 152

1 size transaction, so they're waiting to report

2 until they get all those executions done. That

3 accumulates up so it would be a block size.

4 Now, there are times when those

5 discussions are, I can only do it up to a certain

6 level. If the marketplace rises above that

7 level, then the view op stops. And now we're in

8 this odd limbo where the view op has produced a

9 certain number of these single stock futures

10 transactions, unreportable, but they can no

11 longer do any more view ops because the price

12 level has risen. So they don't report these

13 blocks to us, and they should.

14 So we have two rules. One that

15 says, you must report without delay. And the

16 other one is, you have to report to only 100 lots

17 or more. Now, the problem is -- and this limbo

18 state only occurs when the hedge has produced a

19 profit, right.

20 So the delta desk have gone in,

21 they've bought the stock because they're going to

22 sell the future. Now, they've bought the stock
Page 153

1 up to a limit, the stock has rallied, they can't

2 buy any more, but they have a built-in profit on

3 the stock side, right. Now, they can't report

4 because my rules say they can't, because it

5 doesn't meet block trading requirements. But

6 they have this profit built in.

7 The customer on the futures side

8 knows he has a profit built in. So now they have

9 an incentive to say, we can't violate the rules

10 of OneChicago. So why don't you just sell your

11 stock and we split the profits. I don't want

12 that to happen. They agreed that there was going

13 to be a transaction. So this butts up against

14 block trading sizes and there are certain -- we

15 trade 1900 different names. They range from 20

16 cents to over $900, all right. So a 100-lot in a

17 20-cent wide, I think liquidity is pretty good.

18 But a 100 lot which is 10,000 shares of Apple,

19 they're not always easy to get off.

20 And so we believe that we have a

21 very unique product, and I think that it would be

22 useful to at least examine that one size does not
Page 154

1 fit all. And we have put forth that but we came

2 to the decision that block size transactions need

3 to be reported without delay, and if there is

4 these problems that force them to hesitate, how

5 do we address them reasonably.

6 And I think we can address them by

7 bringing down those block size levels on not an

8 individual name level, but in bands, maybe three

9 to five bands, that are reviewable from time to

10 time that encourages the marketplace to abide by

11 the rules and report without delay. They can do

12 that but sometimes our rules get in the way.

13 MR. FARLEY: We -- I'm going to come

14 at it from a slightly different perspective than

15 David did, which is really just the logistical

16 challenges in reporting block trades, which is

17 the issue or the set of issues that we've had to

18 deal with.

19 So we, speaking from past experience

20 at ICE Futures US, we had a block trading

21 reporting requirement of five minutes. And what

22 we found was that we were fairly consistently
Page 155

1 getting late reporting, and then we'd go and we'd

2 find market participants and, you know, it was

3 kind of building ill will with those guys because

4 what they were saying back is, hey, we can't --

5 we just can't do it in that time period.

6 And when we dug deeper, it was

7 really with complex trades. So if you're doing

8 butterfly or you're doing something that has

9 three legs or four legs and you want to make sure

10 that you have all the strike prices right and you

11 don't want to ten-key in a mistake, so we now

12 have a requirement that's five minutes for all

13 trades, other than those which are multilegged,

14 in which case we bump it up to 10 minutes. And

15 it's actually three legs or more, pardon me,

16 not -- it's not multilegs, three legs or more, so

17 in other words, a call spread laid up in the

18 future, and that's 10 minutes, and that -- that

19 works quite nicely for us and for the market and,

20 you know, that's -- that's our view.

21 MR. HUMENIK: I think it was just

22 mentioned a moment ago by David in terms of ICE
Page 156

1 fits, all and I think there is another area where

2 the DCM's self-certify their rules and have an

3 opportunity to discuss those with the commission.

4 And, you know, there could be a standard that's

5 without delay, 15 minutes, five minutes, it

6 depends on the market.

7 So, again, you know, rather than

8 laying down a hard and fast five minutes as was

9 proposed, I think there should be flexibility in

10 terms of the right time.

11 And as Tom just mentioned in terms

12 of multileg trades, there are -- there is a

13 concern about having the time to input that. So

14 I think that's something that needs to be

15 acknowledged in the rules as well.

16 And I think, you know, again, just

17 to point out that, you know, like a DCM will

18 analyze it block sizes, it's probably going to

19 look at the time requirement, too, and will do

20 that on a continuing basis. So again there's

21 checks and balances within the core principles to

22 allow that to happen.
Page 157

1 And, you know, at the end of the day

2 the DCM's are a self-regulatory organization so

3 if they see an issue where the market

4 participants are reporting too slowly or their

5 reporting methodology is not working for them,

6 then it needs to be addressed by the DCM.

7 MR. LA SALA: I'll be brief because

8 I think the other panelists have done a good job

9 with this. I'll just simply make the comment

10 that markets -- we've heard it earlier today,

11 markets are all different.

12 So in some markets the ability to

13 price report due to liquidity considerations are

14 different than others. If in fact you've got

15 complex trades or instruments, you know, where a

16 DCM chooses to have a block facility, there

17 should be under -- again, under a concept of core

18 principles, some level of flexibility and "for

19 that matter, the DCM should be able to, when

20 certifying why it chose the timing requirements,

21 express those to the commission such that you

22 clearly understand and they're defendable.
Page 158

1 Thank you.

2 MR. SHILTS: Do you also, just

3 before we go on, have similar provisions that Tom

4 was mentioned for multilegged type instruments?

5 They're longer?

6 MR. LA SALA: We don't articulate it

7 the same way but, broadly speaking, for options

8 we allow for longer time period, and implicit in

9 that is the exact reasoning that Tom put forth.

10 MR. MACKLE: I think a couple of

11 things I would add. You know, in a couple of

12 instances where it might be a challenge to get --

13 have the reporting done within five minutes, if

14 you're working -- you know, even if it's a

15 complex trade, this might be two legs and you're

16 working one spread that's clear and maybe one leg

17 in another market and you've got -- you know,

18 you're buying one leg and you agree with the

19 seller, okay, you know, I'll buy whatever the

20 contract size is, say 50 megawatts of power.

21 You know, the seller might say,

22 well, I'd sell 100 there. And you might say,
Page 159

1 well, I'm working on a leg, you know, let me come

2 back to you. You run the risk of, you know, the

3 seller might say, if the market moves, might say,

4 okay, I'm off, I only sold you 50 or, you know,

5 you might be able to work the other leg of your

6 trade and get another -- you know, that leg done,

7 and that takes you a few minutes or five minutes

8 or, you know, within a reasonable -- you know,

9 whatever.

10 Again, it's hard to say what the

11 time is, but it could be more than five minutes,

12 so you've already done a trade, you could add to

13 it if you get that other leg done. That's not

14 going to last for half and hour or an hour,

15 obviously. But, again, to sit there and say five

16 minutes is the right answer, it's tough to say.

17 You know, there could be a situation

18 where, again, you agree to a trade with, you

19 know, counterparty, we're going to clear. The

20 counterparty says, oh, I don't know if I want to

21 do it NYMEX or ICE. Let me check. You know,

22 they might need a few minutes to, you know, check
Page 160

1 with their credit departments, you know, if

2 they're looking to do that to maximize their

3 margining.

4 So they might come back to you and

5 say, you know, give me a few minutes. I'll let

6 you know if it's going to be NYMEX or ICE. Maybe

7 that takes six minutes or seven minutes or

8 whatever the answer it. You know, I guess those

9 are probably a couple of additional examples

10 where to sit there and say a hard and fast rule

11 of five minutes you can come up with, in addition

12 to the, again, the complex trades, you know, sort

13 of contingent-type trades, again, where it's

14 credit or whether those are the legs of a

15 transaction that you're working in the market

16 through other venues might cause that window to

17 be exceeded.

18 MR. DOWNEY: Just in addition, our

19 broke in EFP trading systems allows for the

20 posting of anonymous bids and offers which can be

21 hit lifted. Now, when someone does hit lift

22 that, that is not an instantaneous reporting
Page 161

1 because I pass that through a series of risk

2 management devices. These risk management

3 parameters are set by the firms, and we defend

4 the firms against fed finger access.

5 From time to time, participants try

6 to enter block transactions, especially block

7 rolls which we consider both legs in determining

8 the risk. Sometimes they do bump up against

9 their risk limit and we stop the transaction, not

10 because it's not valid, simply because the firm

11 has asked us to. And they have to go to their

12 risk departments to dial in and to reset those

13 variables which, does from time to time, occur.

14 They raise those variables up to allow the trade

15 to go through, and then they come back in and, as

16 they should, they raise those -- bring those

17 levels back down so there's no more risk can be

18 brought on the terms.

19 And in those instances we don't know

20 whether that is reporting or not. But we think

21 that reporting is when we tell the tape that a

22 trade has occurred, and there are times where
Page 162

1 that trade is stopped from reporting based on our

2 definition simply because we're doing risk

3 management reviews, and I think that's

4 appropriate.

5 MR. BRODSKY: Are there variables,

6 other than the complexity of a trade, that might

7 impact the appropriate time for reporting a block

8 transaction?

9 MR. HUMENIK: I think I've made the

10 point in the previous panel just about a new

11 contract. And I think, again, there has to be

12 flexibility with a new contract because, you

13 know, typically you won't have as much trading

14 going in the central limit order book with a new

15 contract.

16 So the reporting of block trades

17 obviously impacts what's going on in the central

18 limit order book, and there also has to be time

19 for the market participant to hedge their

20 position and do what needs to be done within that

21 time. So with a newer market it's just --

22 there's a complexity there.
Page 163

1 So, again, just to point out that

2 that exists and, again, it's appropriate for a

3 new contract to have flexibility. We have 15

4 minutes now for our futures contract and, as I

5 said before, part of a DCM's obligation is to,

6 you know, surveil their markets and make sure

7 that they're complying with the core principles,

8 and over time there can be changes that are made

9 to the rules.

10 MR. FARLEY: I agree.

11 MR. MACKLE: I'd say another

12 example, like on the electricity space, for

13 example, you know Constellation, if we're

14 participating in a load auction and, you know,

15 you've got a window, you know, you're notified as

16 the winning bidder of a certain load auction,

17 typically, as a winner, you're going to be

18 notified in advance to give you a window to

19 hedge.

20 Obviously, you build certain hedging

21 transactions into your margin, you know, that

22 obviously ultimately get passed through to the
Page 164

1 end user through the load auction process.

2 So, you know, if you've got at

3 three o'clock or whenever, you know, depending

4 when the load auction notification is, if -- you

5 know, you've got to go out and hedge a certain

6 size, depending on location or the tenor of the

7 market and, all of a sudden, if the very first

8 transaction you do, you know, within five minutes

9 that's got to get reported, you know, the other

10 participants in this auction process are going to

11 say, okay, something's just cleared, we didn't

12 win, and all of a sudden, you know the market's

13 going to move against you before you get a chance

14 to sufficiently hedge your exposure, you know, as

15 the winning bidder in the load auction.

16 So, you know, you've got to

17 obviously factor that in going forward to your

18 margin when you're pricing this up, if you don't

19 have sufficient time to, you know, to hedge the

20 resulting exposure.

21 So I would say, you know, again,

22 call its complexity, call it, you know, the
Page 165

1 nature of the transaction, examples like that, I

2 would think you'd want a larger window to be able

3 to, you know, hedge your -- again, you know, the

4 downstream -- you know, the beneficiary of

5 successful hedging is going to be obviously the

6 load that's being served to this load auction so

7 the ultimate user.

8 MR. DOWNEY: I think that the

9 exchanges, the DCM's, their goal is to do what's

10 right. Their rules are written to try to

11 encourage the people to do what's right, and they

12 monitor their markets. And if a customer does

13 something that looks like it's outside of those

14 prescriptions, I think that I'd speak for myself,

15 but I know the other exchanges do it as well,

16 we're all over our customers to make sure they do

17 it right because the questions from you are going

18 to come to us, not to them and we're going to

19 have to respond.

20 So I think there are a very --

21 varied amounts or varied states that every

22 exchange is comfortable with, whether it's five
Page 166

1 minutes, whether it's five minutes or 10 minutes

2 with contingencies, we chose without delay for a

3 specific reason.

4 There is a complexity as you jump

5 from the futures into the securities side and

6 vice versa in getting these executed, and we

7 thought that that was prudent on our part just

8 simply to give the flexibility the customers

9 needed while holding their feet to the fire at

10 the same time.

11 MR. BRODSKY: Okay. Well, thank you

12 all for participating on such short notice, and

13 we appreciate it. It's been extremely

14 informative.

15 MR. SHILTS: Thank you everyone.

16 (At which time the meeting concluded

17 at 12:41 p.m.)

18

19

20

21

22
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1 C E R T I F I C A T E

2 I, AMY E. SIKORA, RPR, CRR, CSR-NY, CLR,

3 and Notary Public for the District of Columbia ,

4 hereby certify that the foregoing transcript is a

5 transcription of my stenographic notes of the

6 attached proceedings.

7 I further certify that I am not related by

8 blood or marriage to any of the parties to these

9 proceedings nor am I interested directly or

10 indirectly in the outcome of these proceedings;

11 nor am I in the employ of any of the parties to

12 these proceedings.

13 IN WITNESS WHEREOF, I have hereunto set my

14 hand this 11th day of June, 2012.

15

16

17 ____________________________________

 AMY E. SIKORA, RPR, CRR, CSR-NY, CLR

18 Notary Public

 for the District of Columbia

19

20 My Commission expires: 7/31/14

21

22