Page 1

1

2

3 HEARING BEFORE THE

4 COMMODITY FUTURES TRADING COMMISSION

5 FEBRUARY 29, 2012, A.M. SESSION

6

7

8

9

10

11

12 TRANSCRIPT OF ELECTRONICALLY RECORDED HEARING

13 BEFORE THE

14 COMMODITY FUTURES TRADING COMMISSION

15 1155 21st Street Northwest

16 Washington, DC 20581

17 GOV 202-418-5000

18

19

20

21 Atkinson-Baker, Inc.

 Court Reporters

22 (800) 288-3376

 www.depo.com

23

24 TRANSCRIBED BY: CARRIE HEWERDINE, RDR, CSR NO. 4579

25 FILE NO.: A602862
Page 2

1

2 COMMODITY FUTURES TRADING COMMISSION:

3

4 ROBERT WASSERMAN, Chief Counsel

 Division of Clearing and Risk

5

 GARY BARNETT, Director

6 Division of Swap Dealer and Intermediary Oversight

7 TOM SMITH, Deputy Director

 Division of Swap Dealer and Intermediary Oversight

8

 LAURA ASTRADA, Associate Chief Counsel

9 Division of Clearing and Risk

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25
Page 3

1

2 I N D E X

3

4 TOPICS OF DISCUSSION: PAGE

5

6 LSOC for Futures 4

7 Alternative Models for Custody of Customer Collateral 50

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25
Page 4

1

2 COMMODITY FUTURES TRADING COMMISSION HEARING

3 - - -

4

5 TOPIC FOR DISCUSSION: LSOC for Futures

6 BOB WASSERMAN: Thanks everyone for coming.

7 So we have quite a lot to cover today, and so I'm going to

8 get started right now.

9 Just a couple of housekeeping details for

10 panelists. The red button or the button in the middle

11 turns the mic on. When you're done, please turn it off.

12 If everyone in the room could please turn your cell phones

13 to vibrate.

14 Finally, we're going to have a break at 10:30

15 after this panel. We will have another break in the

16 afternoon, in the middle of the third session. Restrooms

17 outside, down that-away (indicating).

18 And so what I would ask is everyone on the

19 panel to please state your name and affiliation. I will

20 start.

21 Robert Wasserman, Clearing and Risk in -- at

22 the Commission.

23 GARY BARNETT: Gary Barnett, Swap Dealer and

24 Intermediary Oversight.

25 TOM SMITH: Tom Smith, Swap Dealer and
Page 5

1 Intermediary Oversight.

2 MICHAEL GREENBERGER: Michael Greenberger,

3 University of Maryland, School of Law.

4 RON FILLER: Ron Filler, New York Law School.

5 SCOTT FERRIS: Scott Ferris, BMO Harris Bank.

6 STEVEN WINTER: Steven Winter, State Street.

7 SANJAY KANNAMBADI: Sanjay Kannambadi, BNY

8 Mellon Clearing.

9 JEFF HAINLINE: Jeff Hainline, Advanced

10 Trading and National Grain and Feed Association.

11 PETER BROWN: Peter Brown, Moore Capital

12 Management.

13 MARK SZYCHER: Mark Szycher, General Motors

14 Pension representing CIEBA.

15 CHRISTINE AYOTTE-BRENNAN: Christine Ayotte16 Brennan from Fidelity.

17 WILLIAM THUM: Bill Thum, principle at

18 Vanguard representing the ICI today.

19 ANDREW KARSH: Andrew Karsh with CalPERS.

20 JOHN TORELL: John Torell, Tudor Investment

21 Corp.

22 JOANNE MEDERO: Joanne Medero, BlackRock.

23 ROSS PARKE: Ross Parke, Barclays Capital.

24 SETH GROSSHANDLER: Seth Grosshandler, Cleary,

25 Gottlieb, representing FIA.
Page 6

1 GARY DeWAAL: Gary DeWaal, New Edge.

2 MICHAEL SCHAEFER: Michael Schaefer, Public

3 Director for FIA.

4 LAURA KLIMPEL: Laura Klimpel, New York

5 Portfolio Clearing.

6 ERIC DELAIN: Eric Delain, Minneapolis Grain

7 Exchange.

8 JOSEPH OTT: Joe Ott, Kansas City Board of

9 Trade.

10 TIMOTHY DOAR: Tim Doar, CME Clearing.

11 LAURA ASTRADA: Laura Astrada, Division of

12 Clearing and Risk.

13 BOB WASSERMAN: Thank you.

14 Finally, I should address somewhat of a

15 perhaps elephant in the room. Staff -- CFTC staff cannot

16 engage in a discussion concerning matters involving MF

17 Global in light of our Division of Enforcement's ongoing

18 investigations, and we would ask the participants to

19 respect our request that specifics of that not be injected

20 into the discussion here today.

21 With that, I think let's get started.

22 And so the first -- the topic of that panel

23 is: LSOC for Futures.

24 As everyone knows, back in January the

25 Commission adopted final rules for projection of cleared
Page 7

1 swaps customer collateral which implemented something that

2 has been referred to as Legal Segregation with Operational

3 Commingling or "LSOC" for short.

4 And in light of recent events, there's been

5 some discussion as to whether that should be extended to

6 the futures space, as well, and the -- essentially the --

7 the exchange traded futures customer account.

8 And so what I'd like to do is get folks' views

9 on the advisability and the practicality of doing just

10 that.

11 TIMOTHY DOAR: Tim Doar, CME.

12 No, you shouldn't.

13 So let's just review the terrain if we could.

14 I'd just like to cite the various documents we've

15 submitted to the CFTC over time concerning matters related

16 to customer protection. We have had, for purposes of full

17 disclosure, some degree of difficulty with LSOC as a

18 methodology for swaps.

19 Most fundamentally we are concerned about the

20 legal basis upon which the CFTC seeks to implement LSOC

21 for swaps. We're not quite sure what the reasoning is for

22 why it will work in bankruptcy.

23 Now, going beyond that, though, there are a

24 variety of risks that LSOC does leave open with respect to

25 followup customer risk.
Page 8

1 Foreign clients going through a foreign

2 broker, which in turns clears as an omnibus account on the

3 books of USFC and will be treated as a single client, so

4 those foreign customers going through a foreign broker

5 face fellow customer risk, one to the other, it seems.

6 There are issues around variation margin which

7 I think the industry has talked about and has come to

8 understand that based on the way that DCO's process

9 variation margin, depending on the timing of a declaration

10 of default, and depending on the timing of when an FCM

11 goes into bankruptcy, there may be fellow customer risks

12 that are borne by clients in the OTC account class,

13 depending on how things are administered through the

14 default event, the timing of when the DCO knows which

15 clients are actually in a state of default relative to

16 when the FCM declares bankruptcy.

17 There's also a fairly robust set of

18 requirements for the DCO. No matter how good the DCO's

19 risk management policies and procedures and capabilities

20 are, the DCO must use, in effect, the defaulting FCM's

21 books and records to administer the default, the portfolio

22 of rights and obligations report, which is very

23 ambiguously defined in the regulations, by the way.

24 Now, given all of that, we are talking about

25 LSOC for swaps. Now, let's just examine the current
Page 9

1 structure of the swaps market relative to the -- to the

2 current structure of the futures market.

3 Notwithstanding that the potential future

4 direction that the OTC swaps markets may take, today I

5 think we can probably say that there's a fairly discrete

6 timeframe in which swaps are transacted and submitted to

7 DCO's for clearing, so that the idea that the portfolio of

8 rights and obligations report, that the FCM submits to the

9 DCO, may be accurate in depicting the relative position

10 exposures of individual clients.

11 Futures though is a far different market.

12 We -- at least on LSOC we have the ability to set accounts

13 up with an eye towards how they can be optimized to meet

14 LSOC requirements from an operation perspective.

15 Futures account structures have grown to --

16 grown from a far different place over time. We should

17 note immediately that omnibus accounts will receive far

18 different treatment under an LSOC methodology than they

19 will under the existing futures methodology, if an omnibus

20 account loses its meaning, essentially, is my take, in an

21 LSOC environment, as opposed to the meaning it has long

22 taken on in a futures context.

23 But new accounts come and go. Frequently the

24 timing with which the FCM will have to disclose

25 information to the DCO relative to those accounts is again
Page 10

1 a question. Trading occurs on 24-by-6 basis.

2 Once trades are executed, post-execution

3 give-ups occur with some degree of frequency. The idea

4 that the portfolio of rights and obligations report is

5 going to be an accurate depiction of an individual firm's

6 clients, as of an end-of-day processing is dubious, I

7 think.

8 The idea that FCM's can turn on a pin and

9 submit the portfolio of rights and obligations report

10 frequently to a DCO or in the course of any given

11 processing day may come to work at some future point, but

12 I don't think it will now.

13 So, in sum, what I would suggest is -- is that

14 the current state of the futures markets is far different

15 than the current state of the market for cleared OTC

16 swaps. I would urge that what the Commission do is

17 reserve its judgment on the applicability of LSOC for

18 futures until we have a chance to actually get our minds

19 around what the implications are, particularly with

20 respect to how defaults will be administered.

21 It is not clear at us to all what the

22 obligations of a DCO are realistically to determine which

23 client defaulted if the settlement bank tells us that the

24 firm is no good in its client origin, howsoever defined.

25 So, with all that having been said, I -- I
Page 11

1 hope I've just indicated there are a number of different

2 concerns that we have. I'm anxious to hear what kinds of

3 concerns the rest of the people have here today. And I

4 would just urge that we do not rush to judgment that

5 having a single customer protection standard in place for

6 these diverse markets is wise.

7 BOB WASSERMAN: Contrasting views?

8 WILLIAM THUM: It's Bill Thum at Vanguard.

9 It's my impression, just to counter that, that

10 historically there's been little appreciation of the risks

11 to margin presented by the futures model.

12 As outside counsel, I often spoke to clients

13 about fellow customer risk, and they were astonished that

14 they had exposure to other clients of the FCM's. While

15 they could try to mitigate FCM fraud and investment risks

16 through due diligence, there is no way to assess and

17 monitor fellow customer risk by each client.

18 Prescient is the only way to describe the work

19 of Bob Wasserman and his team in identifying the need to

20 address fellow customer risks for cleared swaps.

21 Many of the buy side in particular are

22 grateful for his prescience and persistence in addressing

23 a need few appreciated at the time, to make such a

24 proposal when the futures model had functioned flawlessly

25 in the Lehman crisis and to challenge existing well
Page 12

1 established market infrastructure took considerable

2 courage.

3 I remember at the end of my first meeting with

4 Bob and others, in October of 2010, I felt a bit like

5 Oliver Twist at the breakfast table when I asked whether

6 once established for cleared swaps, could the benefits of

7 LSOC be extended to futures. Bob's response at the time

8 was, "We'll see."

9 True to his word and with market events now

10 joining momentum for change I'm pleased that just three

11 weeks from LSOC -- the publication of the LSOC rule --

12 final rule, we're here to discuss the merit of enhancing

13 protection for futures.

14 Why is this so could compelling? One word:

15 Portability. The many enhancements of LSOC are designed

16 to facilitate the consistent, expedited, and efficient

17 porting of trades from a defaulting FCM.

18 Firstly, margin is segregated from both the

19 FCM and from the defaulting client. No longer must one

20 customer's shortfalls be met by another customer's assets.

21 Secondly, FCM record keeping must be shared

22 with DCO's daily both providing the DCO with full

23 transparency as to FCM clients, positions, and margin, and

24 mandating the discipline of the FCM to maintain robust,

25 accurate, and current records.
Page 13

1 Thirdly, customer margin levels are -- more

2 truly reflect actual risk presented by their credit and

3 trades with FCM's and DCO's no longer relying on

4 mutualized risk assessments.

5 What arguments could counter such a change?

6 That loss mutualization related to fellow customer risk

7 has never occurred in the futures market? While MF Global

8 appears not to have involved fellow customer risk, it is a

9 counter -- it is a counter-proof argument for enhancing

10 FCM record keeping and transparency.

11 Consider how grateful MF Global's customers

12 would have been if MF Global was required to provide the

13 clearinghouse with daily records identifying customers'

14 positions and margin holders, as is now required under

15 LSOC's Rule 2211-(c), and if the clearinghouse would take

16 appropriate steps to confirm such information is accurate,

17 and complete, and provide it on a timely basis, in

18 accordance with LSOC Rule 2211(e).

19 For these reasons and others we support the

20 extension of the LSOC model to the futures market.

21 GARY DeWAAL: Recent events clearly have been

22 a bad reflection on this industry and a call for

23 something.

24 However, let's not pretend that there has

25 never been a situation of fellow customer risk causing a
Page 14

1 major issue at FCM.

2 In 1985 Volume Investors Corporation failed

3 because of fellow customer risk because of a situation

4 where three traders, acting in concert, brought down a

5 firm, and there was a hole in the segregated pool, and

6 effectively but for a situation where the principal of the

7 firm ended up contributing to make up the shortfall, in

8 fact, customers would have failed to receive 100 percent

9 of their owed money because of fellow customer risk.

10 In response, this Commission and the NFA

11 studied many alternatives, some of which echo loudly

12 today. They discussed imposing an insurance requirement.

13 They discussed the possibility of requiring individual

14 accounts at the clearinghouse. And all these ideas were

15 ultimately rejected, because, in fact, the thought was

16 that those ideas would, in fact, increase risk, certainly,

17 the risk of moral hazard, the facts that people would not

18 be responsible for choosing their own broker wisely, the

19 fact that they -- individual brokers would not be

20 encouraged to put up the most capital possible.

21 For many reasons, again which echo loudly and

22 clearly today, these ideas, which seemingly sound good in

23 theory, in fact, will not work because at the end they

24 will discourage the intermediators from intermediating.

25 Think of the model of clearing today. Let me
Page 15

1 make it more simple. I go to my insurance company, and I

2 say, "Please, I'd like to insure my car." My insurance

3 company says, "Okay."

4 "How much can I pay you for granting

5 insurance?"

6 Well, that's the clearing model. Okay? Today

7 FCM's effectively provide the insurance to the

8 clearinghouses on a mutualized basis. We've signed up for

9 that, and, in fact, for the privilege of insuring the

10 clearinghouses, we effectively pay for that.

11 It's a strange model. What we're proposing is

12 to make that model, which is questionable to begin with,

13 even more difficult. We're trying to extend the

14 mutualization to not only insure each clearing -- not only

15 to insure the clearinghouses but all our fellow members.

16 That's a very, very difficult risk for us to

17 calculate. That's a very, very difficult contingency risk

18 to guard against. Okay? We're taking a system that

19 probably is somewhat broke to begin with, and we should

20 figure out how to fix it, and making it worse.

21 There is answers to some of the questions. I

22 think later on in this event there'll be discussion of

23 some of the FIA-proposed responses to enhance internal

24 controls at FCM's.

25 At the end of the 1985 debates, which lasted
Page 16

1 through 1987, in fact, that was the bottom line. The

2 bottom line was: You had to encourage the FCM's to

3 enhance their internal controls, and measures which

4 distracted their expenditure of money from that event

5 were, in fact, destructive to the industry.

6 And so as a result the emphasis was to

7 increase internal controls. Unfortunately, over time,

8 maybe firms haven't been as diligent in that area that

9 they could have. We've got to get back to that. We've

10 got to get back to looking at the model, to making

11 clearing work. We've got to make sure that the

12 mutualization process, in fact, works well.

13 There are things that could be done. The

14 suggestion that you can't guard against fellow customer

15 risk -- we have customers often ask us: What's the

16 largest -- tell us about your top customers. Tell us the

17 amount of the percentage they exist in your segregated

18 pool. We want to make sure that this is a diversification

19 in your client base so that no one client can bring you

20 down.

21 There's got to be better questions asked.

22 Everybody's got to participate here.

23 But my concern is that anything that increases

24 the contingency risk on intermediaries risks making those

25 intermediaries disappear. Without intermediaries, this
Page 17

1 business of clearing won't work.

2 BOB WASSERMAN: I would just request if folks

3 can -- in order to maximize the discussion, if folks could

4 keep their remarks a little bit more brief -- that's not

5 directed at any particular --

6 UNIDENTIFIED SPEAKER: Just after the longest

7 speech.

8 KEN ACKERMAN: I'm Ken Ackerman. I share with

9 Gary DeWaal of the experience of having been here at the

10 CFTC and been involved in the investigation of the Volume

11 Investors case in 1985, which, as he mentioned, did raise

12 some of these same issues.

13 I -- I was frankly somewhat surprised when I

14 became involved in this issue, very recently, to have

15 pulled out a copy of that report and seen so many echoes

16 of that case here.

17 The one point on which I will dis -- would

18 disagree somewhat is that in the past several years I've

19 been mostly involved in the insurance world, and I believe

20 that there are some responses to the practical issues that

21 were raised to customer account insurance in the debate in

22 the 1980's, which may have solutions in the insurance

23 world, which I think would be appropriate for discussion

24 in the afternoon panel.

25 For the discussion in this morning's panel --
Page 18

1 I guess reading through the background on LSOC there were

2 two questions that popped up in my mind, and I'll just

3 present them as questions to the panel, because I don't

4 know the answer.

5 When you look at a rule like, this you look

6 at, one, what are the costs, and, two, what are the

7 benefits?

8 I did not see a clear answer to either of

9 those in the -- in the record that I looked at.

10 In terms of what are the benefits, the

11 question to me was: How do we measure this risk of -- of

12 default, of breach of segregated funds, of -- of risk of

13 other party -- of -- of another customer defaulting,

14 placing non-defaulting customers at risk?

15 If we are looking at the Volume Investors case

16 and MF Global and a big void in between, that's a very

17 small risk. It's a risk that can be measured, contained.

18 If the risk is more than that, if there are

19 other cases, if there are other -- if there have been

20 other close calls along the way that did not make it into

21 the headlines, then I think that risk has to be somehow

22 calculated and measured so it can be part of the equation.

23 In terms of what is the cost, again I've seen

24 a lot of general statements in the record about the -- the

25 technical costs, the reporting burdens, the -- the need to
Page 19

1 set up complex systems, but I haven't seen that put down

2 in -- in numbers that can be assessed.

3 So I guess I would -- for my part I would

4 simply throw out as a question to the group: Do we have a

5 better calculation or a more specific calculation of the

6 costs and benefits?

7 RON FILLER: Thank you.

8 So when I look at this issue -- I probably am

9 going to contradict what I thought I -- my original

10 thoughts were several months ago, when the LSOC rule --

11 and in looking at it, when I saw the LSOC rule come out

12 for cleared swaps my first reaction was: Why didn't they

13 do the same for futures? Why is it not comparable -- if

14 the theory of LSOC is to provide enhanced customer

15 protection, why shouldn't that same protection apply to

16 futures?

17 Because the CFTC, in its history, is a futures

18 regulatory agency, why did they not look to the futures

19 world and provide the same protection?

20 But then you go further into the LSOC rule,

21 and I think one of the big issues with LSOC -- and Tim

22 mentioned it a little bit, but he didn't go into more

23 detail -- is: We don't really know, right now, what the

24 additional costs will be for LSOC and the clear-swap

25 world.
Page 20

1 We -- I haven't seen any conclusive statements

2 of how much increase in the initial margin amounts are

3 going to be required by the DCO's for the LSOC rule for

4 cleared swaps. I haven't seen yet -- and maybe it's been

5 published -- how much more guaranteed fund contributions

6 are going to be required for the LSOC model for cleared

7 swaps. And when you try to compare the cleared-swap model

8 to the futures model, you now have to look to the number

9 of accounts.

10 At MF Global there was some 35,000 futures

11 accounts, and if you look at all the major FCM's, we're

12 talking hundreds of thousands of these individual accounts

13 that would have to be accounted for and provided records

14 for. And how much more is the initial margin going to be

15 for futures? How much more will the guarantee fund

16 contributions will be to go to the LSOC model for futures?

17 And I -- I would just ask to see the CFTC to try to do

18 that economic study, do that economic analysis.

19 You're balancing the need to protect customers

20 against fellow customer risk versus the additional cost,

21 additional capital, additional outlay of funds that both

22 customers and FCM's must pay, and -- and we haven't seen

23 those numbers.

24 In the LSOC model you saw DCO's throwing out

25 something like additional 50, 60, 70 percent increased
Page 21

1 margin. You saw guarantee fund contributions going -- I

2 don't know what it is now at the MRG. It's probably

3 around 3 billion dollars the last I looked. I'm hearing

4 25 or 50 billion dollars or more maybe under the LSOC

5 model for cleared swaps.

6 I think we really need to sit back and balance

7 the need for this fellow customer risk versus the actual

8 costs that LSOC for futures or even LSOC for clear swaps

9 might bring.

10 Thank you.

11 JOSEPH OTT: In the event of a customer

12 clearing member default, DCO's need to be able to act

13 immediately in order to address the steps needed to be

14 taken to mitigate the risk associated with the default.

15 Under the current regulations, once a customer

16 account becomes under margin, that customer has five

17 business days to meet that call. The five business days

18 consist of:

19 On Day 1 the account become under margin.

20 Day 2, the account is called for margin.

21 Day 3 it's the first day the call's

22 outstanding.

23 Day 4, the second day the call's outstanding.

24 Day 5, the third day the call's outstanding.

25 As a DCO, we cannot wait five business days to
Page 22

1 see whether or not that call is met or not. DCO's need to

2 be able to act immediately, again, to address the risks

3 associated with -- with the default, and they need this

4 immediately in order to preserve not only the capital of

5 the DCO, but as well as the capital of the other clearing

6 members.

7 Under our current default rules, if there's a

8 client member default, currently we're allowed to apply

9 the defaulting clearing member's margin deposits, as well

10 as guarantee deposits that are on -- on deposit.

11 Under the LSOC rules this will greatly

12 restrict the amount of our default package. The LSOC

13 model only allows for the defaulting customer's collateral

14 to be used in the -- in the default package.

15 As a result of this restriction in our default

16 package, DCO's will have to substantially increase their

17 security deposits in order to have some -- have some

18 available funds to tackle a default, and we think this may

19 have an adverse effect on members remaining as clearing

20 members if we have to raise our security deposits

21 drastically.

22 ANDREW KARSH: So obviously it's interesting

23 to hear everybody's view in terms of the ways that the

24 margin requirements potentially could go up and the cost

25 to DCO's.
Page 23

1 So as a customer of the futures clearing

2 market, and the DCO's, and the brokers, and the banks, you

3 know, one of the things that we look at is -- and to the

4 points raised earlier is: What is a fellow customer risk?

5 What are we paying for that? You know, how are we being

6 compensated for the risk that we, as an institution,

7 that's unlevered, are taking on behalf of other clients in

8 the market?

9 And so, you know, I think that the thing that

10 we are contemplating and concerned about is, to be frank,

11 some of the questions that are being raised about margin

12 increases and how that's going to affect businesses -- you

13 know, I think that the reason we're all sitting here is

14 because some of the events of the past few years have

15 illustrated that increased leverage and increased margin

16 capabilities and relaxed efforts from some of the SRO's

17 and regulatory bodies has sort of allowed things to happen

18 that none of us thought would have happened.

19 And so the thing that, obviously from CalPERS'

20 perspective, that we think about and want to understand,

21 and sort of -- you know, obviously LSOC seems to be an

22 improvement on the model -- is, you know: How do we get

23 more comfortable with putting margin out to DCO's and

24 FCM's and having -- although obviously you can ask

25 questions, there's still a lack of transparency about the
Page 24

1 risks that we're taking, and, you know it's something that

2 when we think about other institutions in the market, and

3 the fact that the futures market, in particular, compared

4 to cash securities market, like bonds or stocks, that we

5 all think about, you know is much more inherently

6 leverable because of low margin requirements.

7 You know, you go buy a billion dollars of

8 Treasury Bonds, you're going to pay a billion dollars.

9 Right? Unless you've got a prime broker who's lending you

10 the money.

11 And so our view is that we're really we think

12 that we need more security in the market, and we, and many

13 of the people in our position, are willing to pay extra

14 margin if we have that security. And certainly in light

15 of the past six months in the market, that it's something

16 that, you know, hopefully the people in this room

17 understand that, you know, our concern is -- you know,

18 again, it's been said all too often, you know, return of

19 capital, not return on capital.

20 And so certainly that's something that, you

21 know, we, as an institution, are willing to take into

22 consideration as this model evolves, and certainly, you

23 know, whether it's the LSOC structure and how that

24 interplays with the Bankruptcy Code -- some of the issues

25 raised before -- you know, if it requires increased
Page 25

1 margin, I think that's something that we're willing to

2 pay, as long as it reduces our risk in the longterm.

3 CHRISTINE AYOTTE-BRENNAN: Listening to the

4 concerns about LSOC for futures, what strikes me is that,

5 barring one or two comments, is that what I'm hearing is

6 not a concern of applying LSOC to futures. I'm hearing a

7 concern about LSOC.

8 And I think that where we are is LSOC has been

9 adopted. I know we're going to talk about some

10 alternatives today, as well, but the fact of the matter

11 is: We have to get ready for LSOC, and the DCO's and the

12 FCM's have to get ready for LSOC.

13 So I think we need to focus on making sure

14 we're all comfortable with that, and then once we have it

15 right, I don't see any reason why it can't be used in the

16 futures model, as well.

17 If it provides the increased stability to the

18 market, and it -- we're willing to pay for it, I don't see

19 an operational reason, you know, stick -- holding that up.

20 We all have to change our operations in connection with

21 LSOC, as well, and I think that as an industry we have to

22 adopt that.

23 JOSEPH OTT: I'd like to followup on some of

24 the comments.

25 I think one of the things that we have to
Page 26

1 remember is that the futures space is occupied by a very

2 different class of inhabitants than exists in the OTC

3 space.

4 The liquidity providers tend to be

5 the e-locals, the market makers in the pits, and so forth

6 and so on, and their ability to transact is very much

7 impacted by the margin requirements on the positions that

8 they undertake.

9 So to the extent that enhanced, increased

10 margins are going to be required -- and I think they will

11 be -- the ability of those participants to continue in

12 that market space and to continue to provide liquidity is

13 going be adversely impacted as well.

14 So the small pool operators, the -- the

15 training advisers, the options market makers in the

16 treasury pits, the S and P market makers, all of the

17 markets that -- that we're interested in as customers,

18 will be impacted in terms of liquidity, and I don't think

19 we should lose sight of that, as well.

20 I don't think we should sacrifice -- I don't

21 think we should rush to sacrifice the good for the

22 perfect. I think we need to analyze all of the cost

23 benefits associated with the proposals that are before us

24 and -- and make a reasoned decision at the end of that

25 kind of analysis.
Page 27

1 JOHN TORELL: Yeah, I would just -- speaking

2 as a -- as a fiduciary to client assets, our reason for

3 being here today is -- is protection of assets. And we

4 believe that LSOC, while it's not perfect for OTC -- and

5 we're going to talk about future or better models later

6 this morning -- we think it actually is better than what

7 you have in the current futures market.

8 And so we support trying to implement that and

9 then hopefully that will migrate to something even better

10 in the future.

11 I think it's a very dangerous thing to say

12 that we sacrifice good for the perfect, because good costs

13 a whole bunch of clients and a whole bunch of employees of

14 MF Global a lot of problems. So I think we are all here

15 today to protect assets.

16 We know it's going to cost more. We know it

17 might increase margining. There are a bunch of buy-side

18 participants who are willing to pay more, and what I've

19 heard from exchanges or some of the FCM's here is reasons

20 why you can't do something, as opposed to: How do we do

21 so something to protect assets?

22 UNIDENTIFIED SPEAKER: If I could just follow

23 up on John's point, MF Global is not a case of fellow

24 customer risk. LSOC would not have prevented MF Global,

25 and it wouldn't do in futures, either.
Page 28

1 JOHN TORELL: We -- we agree with that, and

2 that's why we need to find a custody solution that you

3 used to have in the futures market and that you have in

4 the OTC market, but that's for the next panel.

5 THOMAS HAMMOND: Thank you, Bob.

6 I am thinking about the some of the discussion

7 around the table, and -- and it strikes me that one -- one

8 fact is missing, and that is that while we talk about the

9 cost of increased margin, that horse has left the barn.

10 I mean, when you look at what's required on

11 November 8th, it is a gross margining model for futures,

12 and, as such, essentially the way -- and I'm not going to

13 know it off the top of my head -- but essentially the way

14 that margin has to be calculated is as if each one of the

15 customers were actually a clearing member in the

16 clearinghouse, an aggregate at the FCM.

17 So I mean, I -- as we talk about that and try

18 to apply it to LSOC, I think that's done. I mean, we are

19 now struggling with trying to get that information in a

20 format that we can be compliant as a DCO on November 8th.

21 I think that the -- I think that the

22 Commission and probably the industry is going to be a

23 little bit hard pressed to come up with explanations to --

24 to the marketplace on why a model, that exists in OTC for

25 ECP's and for large -- and large hedge funds can't be
Page 29

1 applied to farmers, ranchers, and cotton growers in the

2 U.S. if it adds extra protection and it's cost effective

3 in the manner for the protection that it provides.

4 I agree that -- that LSOC is certainly a more

5 complex model in futures. There's no denying that. It's

6 a large portfolio of product. It's -- it's an enormous

7 amount of accounts, but I think there are probably some

8 benefits that we can gain from the way that we structure

9 gross margining in regards to some of the -- some of

10 the -- the requirements that we want to see, maybe giving

11 some of the value and portability, giving some -- some

12 value into the -- into the vision, into account structure

13 and risk at an account level at the DCO level.

14 And I think it's important that we also think

15 about, as we talk about our markets and futures, that we

16 don't forget that we still have a great offset product and

17 correlated risk on the OTC side.

18 So to get access to that -- to that offset you

19 have to have some risk structure that -- that can apply in

20 both markets, and generally what we see is that the more

21 conservative model win's that battle.

22 So you -- you've got to correlate a risk in

23 futures. You want to have the ability for -- for cost

24 effectiveness to apply into the OTC -- into the OTC market

25 and vice versa.
Page 30

1 And -- and finally, I mean, I agree with

2 everything that's been said here on -- on essentially the

3 moral hazard and the impact to the FCM model. I mean,

4 that's something that we have to look at hard to make sure

5 that we don't do anything that will adversely affect what

6 I call one of our key risk management waterfalls, and

7 that's our -- that's or FCM's, who are here every day,

8 presenting their capital, putting their risk management,

9 and applying the distribution into our markets with the

10 knowledge of their customers for -- for the betterment of

11 our -- of our risk management model on a whole.

12 CHRISTINE COCHRAN: I represent the Commodity

13 Market Council, and we -- our members including a broad

14 spectrum of commercial participants who are heavily

15 engaged in the future side. And I've really appreciated

16 hearing all of the comments today, and I would just like

17 to add that I think we just need to be careful.

18 What we hear, internally, amongst our members

19 is a -- a deep conversation about the model that exists

20 today in the futures space, but there is also significant

21 reservation about implementing a structural change without

22 a deeper conversation, not only about direct costs, which

23 is what we've been talking about today, but the indirect

24 costs, and the impacts to the market, and the innovation

25 and tools that these folks will have access to, to manage
Page 31

1 their business risk.

2 BOB WASSERMAN: Eric?

3 ERIC DELAIN: Thank you.

4 And I think to echo what Christine was saying,

5 there's a lot of costs that are being talked about, and

6 with LSOC, as has been mentioned before, we're talking

7 about something that's been in the books for three weeks.

8 And to start going to the next stage of

9 talking about expanding into futures before we've seen it

10 in action, definitely seems premature. And Tim and other

11 people have talked quite a bit about costs and things like

12 that.

13 And I understand there's people from the buy

14 side here, but there's a lot of people from the sell side,

15 and when you start looking at the smaller entities that

16 trade in the futures -- and again we're talking thousands

17 of accounts -- I think we need to take our time and -- and

18 make sure that it's going to work on the futures model as

19 opposed to just looking at how it may work for a swaps

20 model that's being relatively built from the ground up, as

21 opposed to a dramatic shift to things that are already in

22 play.

23 BOB WASSERMAN: And if I could make just one

24 additional request, if folks could state your name at the

25 beginning of your remarks so that -- because there's some
Page 32

1 folks on the phone who are listening in.

2 Anyone else?

3 MARK SZYCHER: Mark Szycher representing

4 CIEBA.

5 Just to follow on, on the last panelist's

6 comments, certainly CIEBA members unequivocally support

7 any additional protections for clients, including

8 ourselves, in the futures market, certainly including but

9 not limited to fellow customers.

10 And we, of course, would be supportive of an

11 LSOC implementation that would fully address fellow

12 customer concerns, risk concerns.

13 That said, notwithstanding our support for

14 those additional protections in the futures markets, we

15 would urge the Commission to very carefully consider

16 bandwidth issues for FCM's and DCO's, if we were to go

17 forward in a short-to-medium-term timeframe with

18 implementing a version of LSOC in the futures markets.

19 Let's consider the fact that, by and large,

20 it's the same FCM's, and in some cases it's the same DCO's

21 that are -- that, from the swap market, that are going to

22 be tackling a herculean task in getting themselves ready

23 for the swap clearing mandate.

24 In particular, there are tens if not hundreds

25 of thousands of legal documents to be executed, myriad
Page 33

1 changes in systems and operations, risk management and

2 compliance procedures, reporting, et cetera.

3 In essence, we would ask that from a

4 prioritization standpoint that we ensure that FCM's,

5 DCO's, and other market participants are ready for the

6 clearing mandate before tackling a legitimate but perhaps

7 problem of lesser importance in the futures markets.

8 LAURA KLIMPEL: Laura Klimpel.

9 I agree with a lot of what Tom, and Eric, and

10 others have said in terms of the cost benefit analysis,

11 and the need to -- to do it carefully.

12 One other issue that the Commission should

13 take into consideration are the changes that LSOC would

14 require to the new rules that the Commission has just

15 promulgated for DCO's that we're building out to right now

16 for May.

17 In particular, the stress and back testing

18 requirements that the DCO's have to come into compliance

19 with by May, require stress and back testing at the

20 customer omnibus level as opposed to the under -- the

21 individual underlying customer level.

22 Essentially a lot of that work would be throw23 away if we had to, in the future, implement LSOC.

24 BOB WASSERMAN: Seth?

25 SETH GROSSHANDLER: I'm Seth Grosshandler.
Page 34

1 Other things to think about, that need to be

2 done for existing LSOC: Many FCM's and their affiliates

3 extend credit to customers based on margin that is either

4 posted at the FCM level or at the DCO level, and although

5 I think the intent of the LSOC proposal was to allow that

6 to continue to proceed as it has been done in the futures

7 space, I think there's a real lack of clarity because of

8 some things in the introduction and in the release that

9 need to be clarified.

10 Another -- and that would be just for LSOC for

11 cleared OTC derivatives much less LSOC for futures.

12 Variation margin and the ability of the DCO to

13 net variation margin payments, owing to one customer

14 against a deficit from the other customer, I think is also

15 not very clear in the existing LSOC model. And I think

16 there are circumstances where that can happen, and there

17 are some circumstances where that probably can't happen,

18 but the rule is not particularly clear.

19 And then another point -- and maybe this is

20 more for the DCO's, who -- there's a lot, I think, that

21 maybe we need to understand from the DCO's as to costs

22 and -- and the like of LSOC, but if -- if there were a

23 closeout of multiple customers, how is the DCO going --

24 and is the DCO going to do that on an individual basis,

25 and then allocate it individually, or if it doesn't on a
Page 35

1 portfolio basis, how will it allocate that portfolio

2 closeout to individual customers?

3 BOB WASSERMAN: So a couple things. I think

4 we will, separately from the proceedings today and

5 tomorrow, have contacts, both more formally and perhaps,

6 as well, informally with folks, in terms of questions on

7 LSOC for swaps, but I think for the moment we should

8 probably focus a bit on LSOC for futures.

9 One issue I'd like to get folks focused on --

10 we have about 20 minutes more. So, as has been pointed

11 out, there are a number of things that are now part of the

12 landscape already.

13 So gross margining, effective November 8th,

14 it's part of the landscape.

15 LSOC for swaps, effective November 8th, also

16 part of the landscape.

17 Given those things, what I think would be very

18 helpful for us to get from the panel is discussions of

19 their understandings of costs and benefits that would

20 arise as -- from adding LSOC for futures to those existing

21 things.

22 I would be very surprised if that were to

23 happen on November 8th, but if we were to, in due

24 course -- and I'm being deliberately vague, frankly, on

25 that timing point -- add LSOC for futures, what are the
Page 36

1 benefits? What are the costs? What are the

2 implementation difficulties? What are the solutions?

3 So if I can get folks to talk to that.

4 Michael?

5 MICHAEL GREENBERGER: I'll try and talk to

6 that little bit, but I also want to comment on some of the

7 things that were said.

8 I'm Michael Greenberger. I'm at the

9 University of Maryland, School of Law, and I'm here today

10 representing Americans for Financial Reform.

11 First of all, in terms of cost-benefit

12 analysis and tinkering with LSOC as it applies to futures,

13 this is not going to happen overnight in the CFTC.

14 There's a -- I would assume that there -- if

15 there isn't a concept release, there will be a notice of

16 proposed rule making, a proposed rule. In that effort it

17 will be more than just the people sitting at this table

18 who will have a lot of things to say about this, both as

19 to the substance of LSOC for futures and as to the cost

20 benefits.

21 One thing people should keep in the back of

22 their mind is we may not have the luxury of waiting

23 forever to come up with something to appease the great

24 unhappiness with middle class America here, farmers,

25 ranchers, heating oil dealers, petroleum marketers, which
Page 37

1 have been substantially and seriously hurt, and are angry

2 about the situation as it exists. I think the

3 good-versus-perfect analogy -- I think, as a political

4 matter, getting people to say that the present system is

5 good, whether that's right or wrong as a rational

6 matter -- I think as a political matter, not a lot of

7 people are going to run around on either -- either the

8 Republicans or the Democrats saying the present system is

9 good.

10 They're real people who've lost money that put

11 them interrorum in terms of the way they live their lives,

12 and as Ron said, when you look at LSOC for futures, his

13 initial instinct was, well, why -- LSOC for swaps? Why

14 not LSOC for futures?

15 I think that's going to be a mantra that's

16 going to be heard in the halls of Congress. If this is

17 good enough to protect the buy side in the swaps market,

18 why isn't it good enough to protect people, who frankly,

19 are abandoning, in too large numbers, the futures market?

20 What we -- if anything, whatever the

21 protections are, it is right now more to get protections

22 for customers in the futures market than it is in the swap

23 market. The swap market went on for years without --

24 without segregation concerns by the buy side. And -- and

25 now they've got it, but what -- I haven't looked at the
Page 38

1 most recent statistics, but trading in conventional

2 futures, people who are hedging business exposure is down.

3 It's -- people are aggravated. There are obviously going

4 to be follow-on indictments, subpoenas, investigations.

5 That is going to increase the bad publicity that the

6 futures market has.

7 So my view is that I -- I think that the LSOC

8 for futures idea is certainly one that is worthy of more

9 detailed comment. It is instinctively something that

10 politicians are going to want to know. I think there were

11 even questions raised when LSOC for swaps was passed,

12 about why there isn't the same.

13 Now that comment may have come: Why don't we

14 have the futures model apply to swaps and have one uniform

15 model? But I think the reverse argument is going to be

16 much more handy.

17 And in terms of the economic analysis, you

18 know, that can be done. It could be done very, very

19 quickly. You know, people who are at this table, who

20 might be adversely affected by LSOC for futures, if they

21 had to, could get economic analyses done, I believe, on a

22 relatively quick basis.

23 But the point here is -- and what I worry on

24 cost-benefit analysis is too much looks at the cost per

25 the regulation and too little to the benefit. You see
Page 39

1 from the supply side here, they are prepared to pay more

2 to have better security.

3 I think the question needs to be asked, but my

4 instinctive view is that on the futures side the people

5 who are now worried about losing the capital that is owed

6 them, are willing to pay more to have that kind of

7 protection.

8 Now, I don't know what that would mean on the

9 margin. I'm very sensitive to the fact that the

10 commercial hedging and the margin that's used is in the

11 form of an insurance policy, and if you raise that margin

12 too much, yes, you may drive people from the hedging.

13 But my point right now is people are being

14 driven from hedging from their fear of a system that broke

15 down. And by the way, it's not just MF that we're talking

16 about. There's now a major lawsuit in Southern District

17 of New York with -- with Miami Children's Hospital and

18 others suing with regard to the Revco failure, and their

19 claim that segregated funds were not properly given to

20 them. It's a class -- massive class action in the

21 Southern District of New York.

22 I know that people thought Revco worked out

23 well. You should check the Complaint in that case.

24 WILLIAM THUM: I wanted to jump in with a

25 couple thoughts the cost and benefits, and --
Page 40

1 BOB WASSERMAN: Bill, if you could -- your

2 name.

3 WILLIAM THUM: Sure. It's Bill Thum from

4 Vanguard.

5 So in terms of the costs, obviously, there's

6 infrastructure, build-out, and costs associated with it.

7 Mark went through the list very well, and it was great to

8 hear Bob say that while it may be contemplated, it's

9 unlikely that LSOC would apply the futures model ahead of

10 November 8th. So there would certainly be time allocated

11 to achieve that infrastructure enhancement.

12 The interesting thing is that the infra13 structure enhancement has to happen, in any event, for the

14 cleared swaps market. So some of the same entities that

15 have to make those changes will already have to be doing

16 it for the cleared swaps market.

17 In terms of heightened margin, you know, I

18 think that it's a very hard argument to make that it's

19 going to be challenging for DCO's or FCM's to contemplate

20 having to look at individual clients and understand that

21 they don't have adequate margin to cover the risk.

22 We, on the buy side, certainly of Vanguard,

23 view it as should pay your own freight, and the risk that

24 you present to the system, you should be accountable for

25 in terms of the margin that you're required to pony up.
Page 41

1 Certainly for some clients margin may actually

2 be less, or certainly less than it will be for other

3 clients. Market participants, such as Vanguard, that have

4 a very conservative approach to investing and present

5 other risk mitigating factors in terms of their

6 strategies, may indeed have a more appropriate approach to

7 margin applied to them than certain hedge funds that

8 present heightened risk in terms of their strategies and

9 trading approach.

10 So we really feel that it's pay your own

11 freight. If you present the risk to the system, be

12 prepared to put the margin up or not participate.

13 In terms of the benefits, the one benefit that

14 I didn't mention is certainly portfolio margining and the

15 ability to look across the cleared swaps market and

16 futures market to see what benefits can happen in terms of

17 trading offsets and margin efficiencies. So that's

18 another major benefit if we could have both the margin

19 approach for cleared swaps aligned with the margin

20 approach for futures.

21 BOB WASSERMAN: All right. Sanjay Kannambadi.

22 SANJAY KANNAMBADI: I absolutely agree with

23 Bill on that last part, because cross-margining of assets,

24 as they take off and progress, we need to make sure

25 that -- there's asset protection on both sides of the
Page 42

1 equation, whether it's futures or swaps, are well aligned

2 and harmonized. Otherwise you will have a regime or an

3 account type that has a different asset protection versus

4 the other.

5 BOB WASSERMAN: I should just -- on that last

6 point I should observe the way we set things up in the

7 cleared swaps customer collateral rule making is

8 essentially: If there is, by -- under 4 D, you bring

9 futures into the swaps account, they would then be treated

10 in accordance with the swaps account rules.

11 On the other hand, if you were to take swaps

12 and put them in the futures account, they would be treated

13 in accordance with the futures account rules. So the

14 possibility then of cross-margining is there now, and it

15 would then follow the rules of whichever account the

16 positions are being brought into.

17 GARY DeWAAL: Gary DeWaal.

18 Again, you know, I was struck when I looked at

19 the December seg numbers published by the CFTC with much

20 greater detail, I might add, to note that approximately 10

21 firms held 80 percent of all customer funds seg and

22 secured, combined. That's an incredible concentration.

23 And my guess is that concentration is much

24 greater today than it was 10 or 15 years ago. Yes, I

25 mean, I hear what -- what the good buy-side people and
Page 43

1 Mike are saying about this issue, and, yes, there are

2 things that need to be done. There are -- the system

3 clearly needs to be fixed somehow.

4 My concern, again, is -- you know, certainly

5 what I'm reading and certainly what I'm seeing, and

6 certainly what I'm feeling is that internal controls need

7 to be enhanced. Disclosure needs to be enhanced. I'm

8 concerned about making modifications broad based to a

9 system that has lots of -- lots of unknowns.

10 But, moreover, increases the -- the risk that

11 the individual FCM's are going to be underwriting. You

12 know, it may seem very theoretical. It may seem very, you

13 know, not real, but it is real. And -- and the proof is

14 in the pudding.

15 The number of FCM's out there that are holding

16 the -- the large amount of customer funds is diminishing,

17 and we've got to take note of that.

18 PETER BROWN: Peter Brown, Moore Capital.

19 In terms of costs, I think the FIA issued some

20 recommendations last night. I was a little bleary when I

21 was reading them, but I think those are, you know, easily

22 achievable, I think, low cost.

23 Another key recommendation, which we didn't

24 see there explicitly is: How does the pool of segregated

25 funds, you know, remain protected at all times in terms of
Page 44

1 the FCM's ability to dip into those funds?

2 The CFTC issued a few questions for the

3 panel -- maybe later today -- about whether regulatory

4 authority at some level needs to have some role in

5 ensuring those, you know, pooled assets are always intact,

6 that the residual interest of the FCM is -- is monitored

7 or potentially even approved in terms of release of those

8 assets back to the FCM.

9 So, you know, a key concern for us -- and the

10 comment was made that LSOC, whether it's futures or

11 cleared swaps, doesn't protect customers from an MF Global

12 misappropriation. The key concern for us is: How does

13 the customer pool -- what better protections can be

14 implemented to ensure that it's there at all times,

15 whether it's additional regulatory oversight of that pool,

16 whether the DSRO's [sic] need to have a stronger role in,

17 you know, having -- you know, insight into that pool in

18 real time, and whether there's a role for them in terms of

19 approving return of residual interest.

20 You know, we think that's a critical aspect of

21 all this, that is far in a way the most important factor

22 to get right, whether it's futures, swaps, or anything

23 else.

24 RON FILLER: Another food for thought for the

25 panel and for the Commission staff as they consider this
Page 45

1 issue, and carry on just a little bit more what Gary just

2 said, and one issue has not been raised, and, to me, it's

3 a big issue that could have a tremendous impact on the

4 risk of this industry, and that's the net capital

5 requirements for FCM's.

6 So in the LSOC rule, when you adopted it for

7 clear swaps -- I think I'm correct in this statement --

8 the CFTC estimated that the margin would be somewhere in

9 the $800 billion range -- a range -- and that a lot of the

10 DCO's thought it was going to be another 50 percent or

11 more increase. So we're up to 1.2 trillion, and I've

12 heard $2 trillion in margin for the cleared swap world.

13 And the extra 50 percent was cause for the

14 LSOC rule, and you'd have to apply this 8 percent capital

15 requirement. The guaranteed funds requirement by FCM's

16 are going to increased dramatically with the LSOC rule for

17 cleared swaps, and I assume the same would be true, and

18 any contributions for the guaranteed fund contributions

19 don't count as good capital for purposes of 1.17.

20 And if we start applying this to the futures

21 world, and there's going to be additional capital

22 requirements -- just to talk about what Gary just said,

23 there's not enough capital among the FCM community today

24 for three, or four, or five of these are going to be

25 concentrated in that type of a group.
Page 46

1 And given all the other capital requirements

2 under Basel iii, and all the things that the fed is

3 considering, I am very concerned that as we raise these

4 margin levels, we raise these guaranteed fund

5 contributions, unless the Commission is also willing to

6 revise or relook at the next capital rules, I'm not sure

7 there's enough FCM capital out there to play the game

8 going forward.

9 BOB WASSERMAN: So I should note one thing:

10 Some of the increase in margin and guarantee fund is due

11 to LSOC over naught. I should note a large part of that

12 increase is also due to the fact of essentially bringing

13 cleared swaps -- bringing swaps into clearing. And so

14 it -- one has to compare with and without, rather than

15 with mandatory clearing and without.

16 RON FILLER: But -- you're correct, but even

17 if you have increased amounts, either in contributions or

18 margin -- because this 8 percent of margin is the capital

19 requirement. If you increase that by 500 million --

20 billion dollars, that's another $40 million of capital

21 that's required to play the game.

22 I'm just worried that there's not enough

23 capital among the FCM's to play this game going forward,

24 and are we not concentrating, as Gary just mentioned, the

25 risks of the system among a small number of FCM's going
Page 47

1 forward?

2 BOB WASSERMAN: Michael?

3 MICHAEL GREENBERGER: Yeah. I mean, whenever

4 you add up the costs of the systems, you've got to look at

5 the benefits. I mean, the overall cost of clearing swaps,

6 and segregating swaps must be measured against the

7 trillions of dollars taxpayers pay for a system that

8 didn't have those protections.

9 And it's just -- to make these systems

10 viable -- because if they break down again, all hell will

11 break lose. To make these systems viable, there will be a

12 regulatory cost, and the figures you raise in the

13 trillions -- I mean, the notional value of the regulated

14 futures market has been pronounced by the CFTC to be 40

15 trillion. The notional value of the swaps market

16 world-wide is 800 trillion. The CFTC has been using the

17 figure of 300 trillion.

18 There's a tremendous push to open the clearing

19 up for more members to be part of clearing for swaps.

20 It's going to be, as I see it, a very profitable endeavor.

21 And I think the problems with concentration in the FCM's

22 is not so much the inability to raise capital to be an

23 FCM, but anti -- the anti-competitive structure of

24 clearing facilities which hopefully will be remedied by

25 membership requirements and capital requirements by the
Page 48

1 CFTC.

2 But, you know, this is a profitable good

3 business. The clearing facilities have done well, and if

4 they need to raise more money to protect not only the

5 customers, but the systemic functioning of the worldwide

6 economy, I think that the business is good enough that

7 they can raise that money with the appropriate business

8 plans.

9 And we're certainly seeing at least that the

10 wealthy buy side is prepared to pay their fair share to

11 keep this system afloat.

12 BOB WASSERMAN: Okay. Well, we've run out of

13 time.

14 TIMOTHY DOAR: Okay. Right under the wire.

15 Tim Doar, CME. I'm sorry, Steve.

16 Generally speaking, look, as has been noted,

17 LSOC for swaps is going in. As a DCO, we'll confirm our

18 policies and procedures and risk management to administer

19 to LSOC requirements, of course.

20 We do, though, have a duty to understand what

21 the risk of the LSOC methodology is and a responsibility

22 to understand how we will mitigate those risks.

23 We start with the legal analysis upon which

24 the LSOC is based. We question what we lean on to know

25 that we'll get the kind of outcome that we all expect,
Page 49

1 should a bankruptcy occur. We're not sure what that

2 rationale is.

3 So we start there. I would just urge that

4 before we go further into implementing LSOC for futures,

5 that we think clearly about structural differences in the

6 markets for futures, as opposed to the swaps market as it

7 exists today, so that we get a reasoned outcome in the

8 name of enhancing customer protection.

9 It's very easy to understand why the buy side

10 responds well to LSOC. If you're not the guy that caused

11 the fault, the DCO no longer has the ability to use your

12 margin at the clearinghouse level to clear the default.

13 We respond well to that. We understand, but it's got to

14 hang together. It's got to make sense, and we just want

15 to make sure that, in fact, it does.

16 BOB WASSERMAN: And that will have to be the

17 last comment for this panel. And so we're going to take a

18 break on begin very promptly at 10:45.

19 (Proceedings recessed until 10:45)

20 (Conversations over telephone connections not transcribed)

21 UNIDENTIFIED SPEAKER: This is the two-minute

22 warning.

23 (Proceedings paused briefly)

24 BOB WASSERMAN: If folks could start taking

25 their seats, particularly the panelists, please.
Page 50

1 (Proceedings paused briefly)

2 TOPIC FOR DISCUSSION:

3 Alternative models for custody of customer collateral

4 BOB WASSERMAN: Thank you again, and apologies

5 for being fairly strict in terms of the times, but we do

6 have a lot going on today.

7 So I think since we do have some same

8 panelists, some different panelists, we should probably

9 once again simply go around the table and introduce folks

10 by names and affiliations.

11 Bob Wasserman CFTC.

12 GARY BARRETT: Gary Barrett, Swap Dealer and

13 Intermediary Oversight.

14 TOM SMITH: Tom Smith, CFTC.

15 BAS ZEBREGS: Bas Zebregs, representing the

16 European Federation of Retirement Professionals.

17 RON FILLER: Ron Filler, New York Law School.

18 SCOTT FERRIS: Scott Ferris, BMO Harris Bank.

19 CHRISTINE COCHRAN: Christine Cochran,

20 Commodities Markets Council.

21 STEVEN WINTER: Steven Winter, State Street.

22 SANJAY KANNAMBADI: Sanjay Kannambadi, BNY

23 Mellon Clearing.

24 KEN ACKERMAN: I'm Ken Ackerman. I'm

25 representing the American Feed Industry Association.
Page 51

1 JEFF HAINLINE: Jeff Hainline, Advanced

2 Trading, representing the National Grain and Feed

3 Association.

4 PETER BROWN: Peter Brown, Moore Capital

5 Management.

6 HILARY CORAL: Hilary Coral from Franklin

7 Templeton Investments, representing the Asset Management

8 Group of as SIFMA.

9 MARK SZYCHER: Mark Szycher, General Motors

10 Pension, representing CIEBA.

11 CHRISTINE AYOTTE-BRENNAN: Christine Ayotte12 Brennan, Fidelity.

13 WILLIAM THUM: I'm Bill Thum from Vanguard

14 today representing the ICI.

15 CHRIS PERKINS: Chris Perkins from Citi.

16 ERIC BAGGESEN: Eric Baggesen, California

17 Public Employees Retirement System.

18 JOHN TORELL: John Torell, Tudor Investment

19 Corp.

20 JOANNE MEDERO: Joanne Medero, BlackRock.

21 SETH GROSSHANDLER: Seth Grosshandler, Clearly

22 Gottlieb, representing FIA.

23 ROBERT LEE: Robert Lee, Deutsche Bank,

24 representing ISDA.

25 JOSH COHN: Josh Cohn -- oops.
Page 52

1 Josh Cohn, Mayer Brown for ISDA.

2 OLIVER FRANKEL: Oliver Frankel, Goldman Sachs

3 for ISDA.

4 BYRON BALDWIN: Byron Baldwin, Eurex.

5 CHRIS EDMONDS: Chris Edmonds, ICE Clear

6 Credit.

7 JOSEPH OTT: Joe Ott, Kansas City Board of

8 Trade.

9 TIMOTHY DOAR: Tim Doar, CME.

10 DANIEL MAGUIRE: Danny Maguire, LCH Clearing

11 Group.

12 BOB WASSERMAN: Okay. And I am constrained to

13 repeat -- and you'll be hearing this at the beginning of

14 each panel. CFTC staff cannot engage in a discussion

15 concerning matters involving MF Global in light of our

16 Division of Enforcement's ongoing investigation. We ask

17 the participants to respect our request that such

18 specifics not be injected into the discussion here today.

19 And so this panel is on Alternative Models for

20 Custody of Customer Collateral, and the first question to

21 get is started is: What are the alternative models that

22 participants believe should be adopted?

23 And I should note in this context, at least

24 from, I think, a staff perspective or at least my

25 perspective, there's a couple of things we need to
Page 53

1 accomplish in terms of this.

2 Number one, it has to work within the

3 construct of the Bankruptcy Code, and particularly 766 H,

4 which mandates rateable distribution of customer property.

5 Second, it seems to me is we need to find

6 models that meet the vital interests of all of the

7 stakeholders, and that includes the buy side. It includes

8 the firms. It includes the clearing organizations. It

9 includes the depositories. And so we need to figure out

10 something that really does work for everyone.

11 So with that, is there anyone who would like

12 to get us started?

13 MARK SZYCHER: Mark Szycher representing --

14 rep -- Mark Szycher representing CIEBA.

15 For many years pension schemes, mutual funds,

16 large-asset managers, a number of insurance companies have

17 opted to protect client assets with third-party collateral

18 segregation models. We simply cannot accept the notion

19 that Congress intended, through the Dodd Frank Act, to

20 weaken the client protections once we've moved to a clear

21 swap environment.

22 Hence, we worked very closely with the CME to

23 develop a model where we believe that the requirements,

24 Bob, that you've laid out, have been addressed or will be

25 addressed in certain cases. And furthermore that three of
Page 54

1 the most important protections that we are afforded today

2 would remain in a new re -- in a new regime.

3 And those three are that the client would be

4 ultimately shielded from an FCM bankruptcy or insolvency,

5 that -- that the independent third party would maintain

6 records and the client would have full transparency

7 regarding the assets posted, and, thirdly, that the

8 collateral is maintained exclusively to secure clients'

9 obligations and remains safe from misuse by the FCM.

10 To the extent possible, in terms of setting up

11 the objectives of this model -- and we could call it the

12 CIEBA CME model, but the essence of it is it's an

13 individual segregation account where we, as the client,

14 become, in essence, not a customer of the FCM, but instead

15 we have a special clearing status, we've termed the

16 guaranteed clearing participant.

17 And in essence the objectives that we've

18 attempted to achieve are the following: To the extent

19 possible, we've maintained the current operational

20 structure substituting certain -- in certain operational

21 sense the client for the FCM, regarding the DCO settlement

22 bank operations.

23 Second, we've prevented the margin from being

24 classified as customer property of the FCM.

25 Thirdly, third-party controls and reporting
Page 55

1 over margin have been maintained as we have in the current

2 structure.

3 And, lastly, we believe that -- that this

4 model does not conflict and does not supercede, in any

5 way, other models that could exist side-by-side with the

6 CIEBA CME model.

7 JOHN TORELL: Yes, John Torell from Tudor

8 Investment Corp.

9 I think, as a lot of people in this room,

10 we've become educated in the last few weeks or few months

11 about the CIEBA model, the -- the GCP model, the

12 quad-party documents, and, you know, we are very

13 encouraged as a -- an asset manager that there are

14 potentially a few different solutions that actually truly

15 protect client assets segregated in a custody account or

16 some kind of arrangement that we currently enjoin under

17 OTC trading that is not enjoyed under the futures model.

18 So we're very enthusiastic about that.

19 I think, as a non-attorney here, it does sound

20 like we're trying to create a model that can be viewed as

21 a non-customer account in order to not touch the third

22 rail of the Bankruptcy Code. And so as a non-attorney I

23 fully endorse these models and think they do work under

24 bankruptcy.

25 However, if they don't, I think there are two
Page 56

1 things that are going to be important. One, the CFTC is

2 going to have to step to the plate and interpret these

3 models to fall outside of that, to the extent that that's

4 helpful in the event of some bankruptcy of some SEM, and,

5 two, if that doesn't work, then I do think that it

6 shouldn't be off the table, that a bankruptcy change in

7 that code couldn't be part of the solution, because we

8 have a solution that works now under OTC.

9 You had a solution in the futures market that

10 allowed asset managed -- assets into customer accounts,

11 and that was taken away about seven or eight years ago.

12 So we know that there are models that work, and we should

13 all figure out ways to make those work as opposed to

14 reasons why they can't be put in place.

15 Thank you.

16 BYRON BALDWIN: Byron Baldwin, Eurex.

17 I guess from last August Eurex introduced an

18 individual client asset protection listed by way of double

19 title transfer. So it's -- it meets the needs of the

20 clearing member, seeing the collateral that has been sent

21 from the buy side that's kept at Eurex clearing in a total

22 segregated account. So that gives protection.

23 The aim from Eurex will be to introduce that

24 individual client asset protection in the U.S. to meet

25 U.S. jurisdiction, and -- and that gives the buy side
Page 57

1 complete segregation in the event of an FCM default.

2 HILARY CORAL: Hilary Coral from Franklin

3 Templeton.

4 Yeah, I mean, we -- you know, to the Eurex

5 point, you know, we've been hearing, you know, that, as

6 well. And, you know, our understanding is that, you know,

7 the European Parliament's also considering putting a full

8 segregation, not just as an option but as the default,

9 that participants would have to opt out of.

10 And, you know, our view is that there is

11 certainly a recognition outside of the United States for a

12 need to protect customer collateral, and we feel that in

13 the U.S. the regulations should give the same level of

14 protection to the customers here.

15 So, you know, we do feel that full segregation

16 should be made available to protect, you know, market

17 participants, you know, as -- as several of my buy-side

18 colleagues have said, you know, there is a current

19 framework, you know, in our OTC world, where we have that,

20 and I don't think that the introduction of centralized

21 clearing should decrease the protection for customer

22 margin from what we have now.

23 Thank you.

24 BOB WASSERMAN: Seth?

25 SETH GROSSHANDLER: Seth Grosshandler.
Page 58

1 So obviously margin is posted, in the first

2 instance, to protect the DCO and the FCM from the customer

3 risk, right? DCO is it counter party of the FCM as -- as

4 the guarantor.

5 And so in looking at all these models we need

6 to make sure that that, you know, initial goal of why the

7 margin is there is also -- is also fulfilled. And in the

8 CIEBA proposals I think that it would get rid of a lien,

9 altogether, in favor of the FCM, and I think that that

10 is -- that is problematic from a risk management

11 perspective, and it gets very complicated. You can talk

12 about the lien for the exposure to that DCO, and another

13 DCO, the FCM in its capacity as a broker-dealer, or the

14 FCM's affiliates, you know, all sorts of -- all sorts of

15 issues.

16 There are capital issues with not having that

17 lien under Basel Capital rules that require first prior --

18 you know, a perfected security interest in favor of the

19 FCM for the customer exposure that the FCM is taking on.

20 That needs to be worked through.

21 Now, we've had some discussions about maybe

22 there are ways to have that lien and still -- I think the

23 objection to the lien is that it might get in the way of

24 porting. Right?

25 And there may be ways under certain federal
Page 59

1 statutes that FDICIA, fiduciary clearing organization

2 netting provisions of FDICIA, that may get around that,

3 but that need -- that's a very key issue.

4 Also need to think about the impact of the

5 lien on the customer property analysis as to customer

6 property. If you don't change the code -- really the

7 question is: If everybody does this, in all spaces,

8 there's no customer property left. And how is that really

9 consistent with the Bankruptcy Code mutualization which I

10 think anticipates that there will be some customer

11 property.

12 Finally, the -- I mean there's -- I'm trying

13 to keep my remarks brief, because the -- I could talk a

14 lot of things for a long time on all of this.

15 You know, you look at this structure and you

16 say: Where's the FCM? Where -- this is entirely

17 disintermediating the FCM. It's really just an insurer.

18 And I think I'm sure other people on the panel

19 will talk about the economic effects of this on FCM's that

20 are just insuring -- and as Gary DeWaal said on the last

21 panel, ironically they're paying to insure, but there are

22 legal issues.

23 What is the pow -- if the FCM really isn't an

24 FCM any more, but just an insurance company, does it have

25 to be licensed as an insurance company? Right? What
Page 60

1 are -- what are the authority issues there?

2 So just some things to think about.

3 BOB WASSERMAN: So if I could -- I think now

4 might be a good time to sort of pin down some of the

5 details here, because I think we need to understand what

6 the model on the table is in order to understand some of

7 the implications there.

8 And so first -- I think, Mark, one of the

9 things I heard you say was that this is something that

10 would go on perhaps in parallel to, for instance, the

11 model that we currently have, say, for LSOC. And so it

12 may or -- is this necessarily going to involve each and

13 every customer, or would this be for those customers who

14 are willing to essentially participate in this kind of a

15 model?

16 MARK SZYCHER: Mark Szycher from CIEBA.

17 Bob, I think our view has been and continues

18 to be that, first, with respect to clients, that this is

19 voluntary to the extent that one's level of risk aversion

20 business strategy, as a client, demands or one decides to

21 avail themselves of this option, we'd like this option to

22 be available.

23 And we believe also in order for that to

24 happen, we would urge the Commission to, regardless of the

25 specifics of the segregation or alternative segregation
Page 61

1 model that was selected, to require the DCO to offer that

2 model or at least to support it.

3 We recognize, with respect to FCM's, they may

4 come to different commercial decisions, and we, as

5 voluntary participants in this model, would work out the

6 appropriate commercial arrangements with the FCM.

7 BOB WASSERMAN: And then, as I understand it,

8 the -- these participants would, I'm assuming from other

9 things you've said, not be participating in the mutualized

10 guarantee resource.

11 MARK SZYCHER: Mark Szycher from CIEBA.

12 Yes, Bob, that's correct. The way we have

13 envisioned this process is that the -- the client would

14 take on a slightly different status from that which exists

15 today. That is a cus -- today we are deemed to be a

16 customer of the clearing merchant, whereas in the model

17 that we're proposing, we would be a guaranteed clearing

18 participant.

19 So in certain respects, in certain operational

20 respects, we would appear in some ways like a clearing

21 member with respect to direct access to DCO settlement

22 accounts and the like, whereas from the -- with respect to

23 other obligations of a clearing member we would not take

24 those on, for example, guaranteed pay -- payments into the

25 guarantee fund, the requirement, potentially, to take on
Page 62

1 positions of a failed -- another failed clearing member,

2 should that be necessary.

3 So again we would simply look operationally to

4 disintermediate with respect purely to margin processing,

5 replace the role that the FCM takes on today, but in no

6 other way do we wish to take on the roles,

7 responsibilities, and obligations of clearing members.

8 BOB WASSERMAN: So then I guess there would be

9 an FCM that would be guaranteeing those obligations.

10 And then I guess the issue is -- I -- I would

11 assume there would need to be some interest that the FCM

12 has, to the extent they actually have to, for instance,

13 make a variation payment, they would need to have some way

14 to access the collateral that the guaranteed participant

15 has posted with the clearing org.

16 MARK SZYCHER: That's right, Bob. In essence

17 we -- it would still be required that the guaranteed

18 clearing participant, in fact, have a sponsoring clearing

19 member, and that clearing -- sponsored clearing member

20 would really have the sole responsibility -- or its only

21 responsibility would be to the extent that the -- that

22 there was a shortfall, when the DCO's required margin,

23 that, in fact, that margin be topped up in order to

24 prevent a default to the DCO.

25 And from an op -- from an operational
Page 63

1 perspective, the FCM would in fact, or the sponsoring

2 clearing member would, in fact, have access to the

3 accounts such that that topping-up process, should it

4 become necessary, could be effectuated within the

5 appropriate timeframe for the DCO.

6 BOB WASSERMAN: So let me just throw open a

7 question then.

8 If there is, perhaps by DCO rule, that

9 mechanism is implemented, and then the FCM would have

10 access, by that rule, to excess collateral to the extent

11 it ended up having to make good on that guarantee, is that

12 something that might help the FCM's make this work for the

13 FCM's, Josh?

14 JOSH COHN: Speaking for ISDA, we've been

15 thinking about this. We -- we think it is possible. It's

16 certainly something that the FCM's need, one way or the

17 other, that is, to have a second lien, to have rights at

18 the DCO, perhaps rights as a secured party, second to

19 DCO's rights as a secured party with a holding directly in

20 the DCO's own account.

21 There -- there are other options one could

22 consider, like a mini-seg account at the FCM, where the

23 FCM had a first lien, retained a first lien in the same

24 way it does now, but over a perhaps smaller account. I

25 don't know the figures. Perhaps one of my colleagues
Page 64

1 could speak to that possibility.

2 But there does need to be something, which I

3 think goes back to a point that -- that some of us have

4 made, that is, there -- this needs to be a cooperative

5 effort where DCO interests are protected, FCM interests

6 are protected, and customer interests are protected.

7 And so we have to work in a way that doesn't

8 destabilize the existing system while we do that.

9 BOB WASSERMAN: Seth?

10 SETH GROSSHANDLER: If I understood -- Seth

11 Grosshandler representing FIA.

12 If I understood your question, Bob, you were

13 asking -- I think you were asking: Does the FCM actually

14 need a lien, as opposed to can it just rely on some right

15 against the DCO to payment?

16 And it's a very complicated question. There's

17 no question that a lien is preferable. Without a lien

18 there may be some federal statutes against FDICIA if,

19 under this model, the customer is no longer a customer but

20 is a participant in the clearing organization, that may

21 mitigate some of those risks.

22 But without a lien -- I mean, these

23 participants, they may be non-U.S., they may be offshore.

24 You need to think about non-U.S. laws, right, as to

25 priority. Because the -- the question is going to be:
Page 65

1 The unsecured creditors of that failed guaranteed clearing

2 participant versus the FCM's rights in these assets, and

3 without a security interest you instantly say maybe the

4 FCM has to share.

5 BOB WASSERMAN: So let me -- if I could just

6 press on that for a second, as I'm understanding it, the

7 participant is essentially posting margin to the DCO as a

8 direct participant.

9 The rights in that collateral then are

10 essentially established by the DCO rules, obviously within

11 and under the framework of both the -- the statutory and

12 regulatory environment, but essentially those rights, it

13 seems to me, would be established by DCO rules.

14 And so just as the DCO has an unfettered

15 right, and under federal law, of course, to use the

16 collateral to meet any defaults to the DCO, if, in fact,

17 the DCO, pursuant to its rules, goes to a guarantor and

18 says, no, you need to make this payment pursuant to your

19 guarantee, but, on the other hand you may have an interest

20 in the collateral over and above mine, again, all as part

21 of the rules, all pre-established, I'm not sure where, for

22 instance, the law of the participants -- guaranteed

23 participants' jurisdiction, where that would be relevant.

24 SETH GROSSHANDLER: Well, if they're

25 bankrupt -- and there's a bankruptcy proceeding in -- you
Page 66

1 know, pick your jurisdiction, Cayman Islands. Right?

2 In the Cayman Islands, the rights of the

3 creditors of that bankrupt are going to be to determined,

4 in the first instance, by Cayman Islands law, and the

5 question is: Would you defer to U.S. law?

6 And we're positing that the FCM does not have

7 a security interest. Right? And the normal rule is:

8 Unsecured creditors share. Right? And so what's the

9 rationale for why the unsecured FCM doesn't have to share?

10 There are a couple. Right?

11 One is subrogation. They stand in the shoes

12 of the DCO, but that only gets you to the allegations to

13 that DCO. It doesn't get you to allegations to another

14 DCO, et cetera. Right? Okay? So maybe subrogation is a

15 theory, but does subrogation work in the Cayman Islands?

16 I have no idea.

17 So there's subrogation. There's also -- you

18 know, if the federal statutes, that give primacy to

19 clearing organizations rules, FDICIA, in particular, will

20 the Cayman Islands respect that against the normal

21 principle of pari (phonetic) pass-through distribution for

22 unsecured creditors, I don't know.

23 Whereas, if you have a lien, you can be pretty

24 sure, in most every jurisdiction, a secured creditor is

25 going to come ahead of an unsecured creditor.
Page 67

1 CHRIS PERKINS: Chris Perkins, at Citi

2 representing FIA

3 I think we all want the same thing here. We

4 want to have the most robust and iron-clad segregation

5 regime that is possible in the context of bankruptcy law

6 and regulation.

7 That being said, I think we have to be careful

8 in these designs in that customer protections were

9 originally designed to give customer protections.

10 And now what we're doing is we're taking them

11 out of those protections, and by restricting FCM's

12 liens -- there's a couple of issues that Seth highlighted.

13 I think the first is: We have some regulatory capital

14 concerns that must addressed, and the seconds thing is our

15 risk.

16 And I think, you know, if you look at what

17 we're trying to accomplish here, as we get more complex

18 with these structures, they're going to take a lot of time

19 for us to fully vet an understanding of our recourse to

20 collateral.

21 And if it makes it look too much like customer

22 money, when a bankruptcy does, in fact, occur, we could

23 stuck at the place, where is 776 H, loss sharing. So

24 that's one theme.

25 I think the other theme we have to develop
Page 68

1 is -- there's two issues here. The first is the 766 H,

2 loss sharing. The second is malfeasance. And what can we

3 do, together, as a group to address instances of

4 malfeasance? What controls can we put around, operational

5 controls, transparency can we provide.

6 But, you know, we are open. We'd like to

7 continue to discuss these issues.

8 The last thing I'll say is that the structure

9 contemplated does put additional burden or

10 responsibilities, if you will, on the DCO, itself. In

11 fact, they're going to have to take a -- some

12 responsibilities during the liquidation of a GCP

13 portfolio.

14 I think we have to make sure that they're, you

15 know, willing, capable, and are able to build that

16 capability in -- in the time necessary to implement any

17 kind of changes.

18 BOB WASSERMAN: Chris?

19 CHRIS PERKINS: I want to ask Mark a question

20 first.

21 For the responsibilities that you -- you put

22 out there, that would be outside the GCP's set of what

23 you're signing up for, is it your anticipation that you're

24 guaranteeing FCM at that point in time, or whoever is

25 sponsoring you into the clearing house, would fulfill
Page 69

1 those responsibilities?

2 Are you anticipating that the DCO either

3 wouldn't have access to those types of responsibilities or

4 would need to find some other way to cover that?

5 MARK SZYCHER: I apologize. I'm not sure I

6 understand the question.

7 CHRIS PERKINS: Okay. You don't want to --

8 you don't -- you don't want to be on the hook if their

9 positions are allocated at the end of a waterfall. You

10 don't want to make guaranteed fund distributions I think

11 were the two that you raised, as two examples of

12 responsibilities that GCP would not have in this

13 structure. Right?

14 Are you anticipating that the DCO's not having

15 those resources available to it, or that your sponsoring

16 FCM would covering that as part of the relationship you

17 would have with the FCM?

18 MARK SZYCHER: I think it could be either of

19 the latter two, but, in essence, it would not be a

20 guaranteed clearing participant's responsibilities.

21 CHRIS PERKINS: So at the end of the day, as

22 long as it's not you doing it, you don't care, to kind of

23 shorten it?

24 MARK SZYCHER: Well, we -- we care deeply

25 about -- about systemic risk, and then appropriate and
Page 70

1 proper operation, but from purely our own self-interest we

2 are not concerned as long as, in essence, what is

3 devised -- the system works under that regime.

4 CHRIS PERKINS: Okay. And, Bob, a question to

5 you, and as you understand this, and we begin to work

6 through it, it seems to me there's a slight conflict that

7 we would have to exempt under your idea -- your

8 questioning -- your line of questioning around the rule --

9 if the DCO had rule around some of this that may we have

10 to, as a DCO, provided that we could get comfortable with

11 such a structure, that we would have to file -- I'm

12 guessing -- for an exemption to make sure FCM's in this

13 case are not collecting more than DCO minimums as part of

14 the new promulgated rules?

15 BOB WASSERMAN: So, as I understand the model,

16 and I probably should -- now is a really good time to

17 mention the -- the other disclaimer, which is, of course,

18 that anything that I say does not necessarily represent

19 the views of the staff, the Commission, or even myself if

20 one of my bosses tells me to change my mind.

21 UNIDENTIFIED SPEAKER: On behalf of the

22 (participants talking at the same time) -- we're happy to

23 hold you accountable, and we know how difficult that is.

24 BOB WASSERMAN: And so in this model it seems

25 to me that's part of where there would not be a customer
Page 71

1 relationship.

2 Essentially -- and it strikes me for a number

3 of reasons. And, again, I will reiterate my disclaimer,

4 but it strikes me for a number of reasons that, on the one

5 hand, you do need somebody stepping up to those

6 responsibilities. We need to balance off the risks to the

7 DCO.

8 I think one -- I think also that this is the

9 sort of thing that would benefit from rule making, so that

10 there is essentially a supporting rule structure that

11 addresses some of the -- both addresses some of these

12 issues and gives, perhaps, some at added legal certainty

13 to how the model works.

14 And so part of that, I think, is then the FCM

15 would not be collecting the collateral. It's the DCO.

16 One would expect the DCO to collect at least its normal

17 minimum level of collateral from these participants, as

18 from any other. I don't know if that answers --

19 SETH GROSSHANDLER: Seth.

20 I think it does. The sounds to me like you --

21 because it's not customer, maybe the other rule doesn't

22 impact, but maybe you could volunteer to write another

23 rule that there's going to provide certainty to that. I

24 won't commit you to that at this point.

25 But, you know, from my perspective, I -- I
Page 72

1 think we all share the same concern, as Chris said, you

2 know, protection of customer collateral is a -- paramount.

3 We get that.

4 Protecting customer collateral and de --

5 destabilizing the system, we become concerned at that

6 level. So that's why these two issues that you raise for

7 us, or at least for me, running the DCO, is -- as long as

8 we're all in the same net position, I think we -- we find

9 a way forward.

10 When someone here -- and it's always someone

11 that's going to end up with a different level of risk and

12 how they're going to go compensated for it, how they're

13 going to manage it or whatever that may be, that's where

14 it's becoming a little bit concerning.

15 We all -- all the clearinghouses represented

16 here today, rely, in varying degrees on our membership to

17 provide certain functions. If we're going to start

18 cherrypicking which of those functions that we're taking

19 away, that they should provided or we should provide,

20 we're fundamentally changing the structure of clearing at

21 this point, and maybe -- maybe that's where we need to get

22 to at that point.

23 I'm not exactly sure that's where we've gotten

24 to in the current set of regulations that we're operating

25 under or managing to, but as we do that I become very
Page 73

1 concerned that we are losing that level protection that

2 the membership does provide.

3 And we can take about moral hazard, and

4 that's -- you know, it was belabored in the last panel.

5 We don't need to go back there, but that is an issue

6 facing us at this point in time.

7 I want to find every way I can to protect your

8 collateral all the time, or the -- at least to value your

9 collateral. You know, actual collateral -- we'll have a

10 different conversation on that one -- but the value of

11 that collateral.

12 I'm just very concerned that if we begin to

13 cherrypick those things away, we're going to lose those

14 who provide this membership level for the DCO's, and that

15 seems to be a very bad outcome in the world we're trying

16 to stabilize.

17 BOB WASSERMAN: Tim?

18 TIMOTHY DOAR: Okay. Thanks. Tim Doar, CME.

19 So I feel compelled to just sort of offer some

20 context for how we got here.

21 You'll remember that in the early stages of

22 the comments, that the CFTC put out around customer

23 protection, that the CME was for a futures model with the

24 proviso that added disclosures to be made by the FCM to

25 clients of better assessments could be made to fellow
Page 74

1 customer risk.

2 As events transpired, fellow customer risk

3 became -- what to do about it became what the centerpiece

4 of CFTC rule making initiatives, and ultimately LSOC was

5 the methodology that carried the day with respect to

6 cleared swaps. So be it.

7 Now, the question then becomes, though, from

8 the standpoint of some clients, in considering this issue

9 of how to protect against fellow customer risk -- you've

10 heard it mentioned a couple different times: Why should

11 the move to cleared -- to clearing for -- for swaps

12 occasion a weakening of protections that some clients

13 currently enjoy in the current OTC setup?

14 And so we considered the question: What do

15 you do to assure client protection in that kind of a

16 model? And the answer was: Well, work within the context

17 of the Bankruptcy Code. I'm not a lawyer, by the way, but

18 761(10)(D), you know, of the code, to assure that the

19 client's property is not customer property, per the

20 Bankruptcy Code, and so therefore if the client has no

21 claim on the estate of a bankrupt FCM, it's not subject to

22 766 H, rateable distribution.

23 So what does that mean? It means that, as

24 Mark suggested in his comments, that the entity that

25 avails itself of this approach has an account directly
Page 75

1 with the DCO, and that, though, the FCM has some kind of

2 recourse, we think a secondary lien to the collateral, and

3 that's all that changes, you know, in the way that we've

4 thought about this.

5 So the question of: Well, who provides

6 resources to the waterfall? The answer is: The

7 guaranteeing FCM.

8 Now, look, there's a lot of issues that this

9 proposition has promulgated. The relationship between the

10 FCM and the guaranteed clearing participant is a very good

11 example of that, the quality of the claim of the FCM on

12 the collateral of the guaranteed clearing participant

13 matters for a variety of reasons.

14 The relationship between the guaranteed

15 clearing participant and the bank that provides settlement

16 services is another good example of a relationship that

17 needs to be delved into. The relationship between the DCO

18 and the FCM is equally another relationship that needs to

19 be delved into.

20 Costs, in general, are a good topic. We can't

21 really understand what the cost implications are to the

22 model until we figure out, for instance, what the

23 guaranteed clearing participant's relationship is going to

24 be with the bank. Who's going to provide the funding and

25 liquidity for -- for the account to meet settlements is a
Page 76

1 primary example of that.

2 So -- so, that said, we were interested in

3 exploring how to advance the discussion or on how to offer

4 this kind of methodology, but -- and I respond very well

5 to the notion that we've got to do so in a balanced way.

6 It doesn't do us -- any of us any good to put a

7 methodology in place that fundamentally changes the

8 landscape of the relationship between DCO's, FCM's, and

9 clients in a way that offers the potential for

10 destabilization. So it's a tricky subject, but one that

11 we see no reason not to address head-on, so we can begin

12 to understand what is achievable.

13 BOB WASSERMAN: Joe?

14 JOSEPH OTT: Joe Ott, Kansas City Board of

15 Trade.

16 And we're actually of the opinion that these

17 subaccounts should be required to post a guaranteed

18 deposit. We felt like a guaranteed deposit will provide

19 protection to both the DCO as well as the FCM.

20 The subaccounts are protected when the FCM

21 defaults, but if the subaccount defaults -- what

22 protection does the FCM have? We just felt like the -- if

23 they are required to post a guarantee deposit, that will

24 be additional protection for the FCM.

25 And we also felt like if the subaccount would
Page 77

1 default, then the DCO is without -- has a participate

2 without a guarantee. So that would provide some

3 additional support and comfort, I think, to the DCO's if

4 we knew that there was additional funds to attach to

5 there.

6 BOB WASSERMAN: Joe, if I could just press you

7 on that for a second, when you're speaking of a guarantee

8 deposit, are you talking about a sum over and above margin

9 that would guarantee the participant's obligations or are

10 you talking about a contribution to the mutualized default

11 structure which could be used in the event of the default

12 of a different participate?

13 JOSEPH OTT: No, it would just be for the

14 clearing participant.

15 BOB WASSERMAN: Essentially this would be

16 more -- something that is -- economically --

17 (Participants talking at the same time)

18 JOSEPH OTT: It's a margin --

19 BOB WASSERMAN: -- equivalent to margin or

20 just an additional amount.

21 JOSEPH OTT: Yes.

22 BOB WASSERMAN: Mark?

23 MARK SZYCHER: Mark Szycher with CIEBA.

24 I'm struggling to understand the -- the

25 gentleman from Eurex's comments insofar as even if we were
Page 78

1 not proposing this structure, the FCM would still be on

2 the hook for my obligations as -- as a traditional client

3 of the FCM.

4 The amount of margin that the DCO requires

5 should allow for the market risk of the positions that

6 I've entered into, that is, within some reasonable level

7 of confidence with a fairly severe market move.

8 Furthermore, in -- in any traditional model,

9 and as well is contemplated in the CIEBA CME model, if the

10 sponsoring or guaranteeing FCM feels, from -- as a matter

11 of credit worthiness or perhaps lack of creditworthiness,

12 additional margin beyond that, that was demanded by the

13 DCO, were necessary, that is a commercial matter between

14 the client and the FCM, and again that is contemplated

15 here -- the bankruptcy issues around liens, not

16 unimportant, but at the same time are contemplated here.

17 So again we struggled to understand how

18 this -- how this scenario that you described is, A,

19 different from today, and, B, not dealt with via DCO

20 margin plus any add-on that the clearing member might

21 demand.

22 BOB WASSERMAN: Ken?

23 KEN ACKERMAN: Well -- I'm sorry.

24 BOB WASSERMAN: Folks, please do make sure --

25 sometimes we're a little bit soft spoken. Please make
Page 79

1 sure you're talking into the microphone, so that both we,

2 as well as the court reporter, and the folks on the phone

3 can hear.

4 KEN ACKERMAN: I'm Ken Ackerman with the

5 American Feed Industry Association.

6 Just looking -- looking at this on behalf of

7 the -- of customers in the agricultural world, who tend to

8 be smaller -- relatively smaller customers, the question I

9 had -- and I think you may have just answered it is: If a

10 farmer has -- posts a -- establishes an account, has a

11 position at an FCM and there is a bankruptcy anywheres in

12 this chain, either at the FCM at the GC -- at the -- at

13 the GCP or anywheres in the chain, can the customer

14 ultimately still hold the FCM accountable for their money?

15 Does the -- does that relationship -- does

16 that relationship survive? Is the FCM still accountable?

17 Can the farmer still look to the FCM for their money?

18 MARK SZYCHER: Mark from CIEBA.

19 In other words, Ken, are you saying for the

20 margin that they posted against their positions, to the

21 extent that they are the one -- they, the client, is not

22 in default?

23 KEN ACKERMAN: Correct.

24 MARK SZYCHER: Well, we would look at this

25 model as providing a significantly greater degree of
Page 80

1 protection in exactly that situation.

2 To the extent that the client is the one --

3 the customer is the one who has defaulted, of course, all

4 bets are off at that point, and we are -- we're -- we're

5 not looking in this model in any way to diminish the

6 protections that margin provides to both the DCO as well

7 as the FCM.

8 And, again, we're happy to grant liens. We're

9 happy to do anything that doesn't entangle us into a

10 bankruptcy stay, but we do that believe this model --

11 clients that avail themselves of this model, put the DCO

12 and the FCM in exactly the same economic position with

13 respect to recourse that they had previously, but provides

14 the clients with protection against malfeasance,

15 protections against -- in essence, situations that were

16 not of their own doing.

17 KEN ACKERMAN: So it does not weaken the

18 ability of the ultimate customer to seek recourse, against

19 the FCM because there was another player involved?

20 MARK SZYCHER: Well, we believe the DCO --

21 Mark from CIEBA.

22 We believe that -- that this model provides

23 the DCO with all the recourse -- or we're intending to

24 provide the DCO with all the recourse against the FCM that

25 it would have in -- absent this scenario.
Page 81

1 BOB WASSERMAN: So just to clarify, though, as

2 I understand it, under this model, the -- a guaranteed

3 clearing participant is responsible to the FCM and the DCO

4 for its defaults. The FCM is responsible, just as it is

5 now, to all -- both its -- well, it's responsible,

6 actually, only to the clients, because the -- under this

7 model, the FCM would never be in a position of owing the

8 guaranteed clearing participant anything.

9 It would, if necessary, make good its

10 guarantee to the DCO, in which event it has, in essence,

11 lent money to the GCP, but the collateral would be in the

12 hands of the DCO, and therefore the FCM would never owe

13 the GCP anything.

14 The clients, on the other hand, the -- the

15 customers would remain in the same relationship, which is:

16 The customer owes the FCM for their defaults. The FCM,

17 holding the collateral, owes that collateral back to the

18 customer.

19 The point is: In the event of an

20 insolvency -- in the event of an insolvency of the FCM,

21 the FCM would owe the customer's money, namely, the

22 collateral that it's holding. And to the extent the

23 perfections of otherwise being imperfect, then the --

24 those customers are exposed to loss in a way that the

25 guaranteed clearing participant, who are not -- who do not
Page 82

1 have funds in the hands of the FCM would not be.

2 And the -- and, of course, it would be, on the

3 other hand, from the perspective of the guaranteed

4 clearing participant, a more expensive relationship, in

5 terms of the -- the operation -- if nothing else, the

6 operational infrastructure necessary to do that.

7 Does that -- is that in accord with the folks'

8 understanding?

9 MARK SZYCHER: Agreed. Mark from CIEBA.

10 Just two quick comments, Bob, one of which

11 relates to the possibility that something is owed back to

12 the client in a client-default situation.

13 If a circumstance were to -- were to arise

14 that the amount of margin that was posted by the client is

15 more than enough to satisfy any obligations to the DCO, as

16 well as the clearing member, the residual, of course,

17 would come back to the client.

18 Another point to make, very quickly, is what

19 one -- at least we believe one of the beauties of this

20 model is, in the event of an issue with an FCM that could

21 be a -- frankly, a business issue, insolvency issue, or

22 other issue, the -- we envision that from a quote/unquote

23 porting perspective there would be no porting to from one

24 FCM to another in the traditional sense.

25 That is, if all -- if I were, as a GCP, in
Page 83

1 good standing with my FCM, but something happened to my

2 FCM, I don't have to extradite myself from my FCM in a

3 sense. What I need to do is I need to find a substitute

4 clearing member to become the sponsoring clearing member

5 for my guaranteed clearing participant relationship. So

6 nothing else changes with the exception of the guarantor

7 having gone from firm A to firm B.

8 KEN ACKERMAN: Okay. Just one more question

9 along these things. Do you -- do you picture any

10 situations that could arise where the customer would have

11 to look -- be concerned about a bankruptcy of the GCP?

12 MARK SZYCHER: Mark from CIEBA.

13 I'm not sure I understand the question, Ken,

14 in -- in the sense that the customer is the GCP, at least

15 the way we're asking it.

16 BOB WASSERMAN: I think the question is: How

17 could a default and insolvency of a GCP, how, if at all,

18 could that redound to the harm of the customers of the

19 guaranteeing FCM?

20 And I -- I think the answer is probably not,

21 in the sense that they would -- if the FCM became unable

22 to essentially continue, because it had to make good on

23 its guarantee, and it was unable to do so, those customers

24 would still have their segregated funds segregated.

25 Now, obviously a default of an FCM is always
Page 84

1 going to be -- you know, even if everything's in seg, at

2 the very least, disconcerting, and if -- if there's not a

3 transfer very promptly, harmful in that sense, but that

4 would be the case of any fellow customer.

5 But I think in fairness the question really

6 is: Is this going to be put them at a different risk than

7 they would be in the context of an ordinary customer

8 relationship?

9 Dan, I know you've been waiting to speak for a

10 few moments.

11 DANIEL MAGUIRE: Thanks, Bob. Daniel Maguire

12 from LCH Clearing House.

13 So listening to the conversation and the

14 various industry forums around us, I still struggle to see

15 how any of this isn't solved by LSOC.

16 And we -- well, I think members are sure we

17 embarked on LSOC at a roundtable when Bob introduced it in

18 October 2010. And the reason for getting around a table

19 was the identification of fellow customer risk, that some

20 did know and some didn't know they were exposed to in the

21 futures model.

22 We worked hard as an industry to arrive at a

23 solution, which is LSOC, and that's to -- for all intent

24 and purposes removes fellow customer risk. It protects

25 the customer from the default of the FCM.
Page 85

1 And actually something that's not been

2 discussed, and as a DCO, it's a hard thing to say, but

3 also protects the customer from a DCO default, as well,

4 which you have to consider in all of this.

5 The other aspect that emerged from this was

6 the potential for investment risk. Something new that's

7 been introduced subsequently is the context of malfeasance

8 and fraud risk following MF.

9 But in terms of how this works -- let's just

10 talk through this pretty quickly. If a client has a

11 margin of 100, and the clearing member wants to introduce

12 that to the clearinghouse, to the DCO, the clearing member

13 has to post 100 -- 100 whatever. It could be treasuries.

14 It could be, you know, MBS or whatever. It has to post

15 100, and that 100 is held at the DCO.

16 I'm not going to give that money back to the

17 FCM in their demise, in their default. I'm going to hold

18 that money. I've got the client position. I'm going to

19 let the -- port the client on their associated collateral

20 to a non-defaulting FCM.

21 There is a quirk in the Bankruptcy Code that

22 emerged from this about ratable distribution, but that

23 really isn't about fellow customer risk. It's about this

24 investment risk, and investment risk is basically if we

25 receive cash or we receive securities, and we like to
Page 86

1 liquidate that as a DCO, to enable porting, if we make

2 losses that exceed the value of that -- and that's going

3 to happen when there's a large market move or where the

4 haircuts that we apply to DCO, which should be prudent are

5 breached.

6 If we're doing our job that shouldn't happen,

7 and we protect the value. So we don't protect the piece

8 of paper you give. If Mark gave 120 with securities, but

9 we haircut at 20 percent, so therefore had a market value

10 of 100, we protect 100. That's what we do as a

11 clearinghouse.

12 So I think there's some -- some sort of bad

13 press around LSOC and what it does. And there have been

14 different interpretations of this.

15 So in my view and our view -- and we actually

16 have implemented this in December of 2009 in Europe, and

17 every client in Europe is using an LSOC type model.

18 Appreciate that there are different Bankruptcy Codes

19 insolvency laws there, but it -- it is used and is

20 practiced.

21 It does remove fellow customer risk. The DCO

22 is, if they're doing their job, can either, A, mitigate,

23 or, B, remove the investment risk, or, C, use the default

24 waterfall to cover that.

25 Fraud risk is a totally different thing, and I
Page 87

1 don't think we're solving all the fraud risk by putting

2 any of these proposed models in place.

3 I think just to clar --

4 JOHN TORELL: Whoa, whoa, whoa, whoa, whoa.

5 The concept of a custody account can protect you again

6 operational risk, or fraud, or something like that. So

7 LSOC does not solve MF Global.

8 A bank vault or custody account at a custodian

9 bank solves that problem, at least from our perspective.

10 DANIEL MAGUIRE: Okay. And if a custodian

11 goes into default, what happens?

12 UNIDENTIFIED SPEAKER: How does a custodian go

13 into default and my assets -- or my client's assets aren't

14 protected?

15 Bank of New York goes into default. Those

16 monies are in a custody account. That -- it's not a

17 counter-party risk issue.

18 So if Northern Trust or Bank of -- you know,

19 State Street, or anybody else goes into default, I don't

20 care, because my assets are protected, and I can get them,

21 I think.

22 DANIEL MAGUIRE: I think that's not right,

23 because you're going by cash you're probably just an

24 unsecured --

25 (Participants talking at the same time)
Page 88

1 JOHN TORELL: All right. I'm going to put

2 treasuries in there. Am I protected now?

3 UNIDENTIFIED SPEAKER: More protected,

4 certainly.

5 DANIEL MAGUIRE: But not fully protected.

6 JOHN TORELL: A lot better than LSOC, right?

7 DANIEL MAGUIRE: I'm not disputing that.

8 JOHN TORELL: Yes, you did. You just said

9 it's not going to -- it's going to solve the problem.

10 DANIEL MAGUIRE: I didn't say it would solve

11 the whole problem.

12 BOB WASSERMAN: Okay. Let --

13 DANIEL MAGUIRE: Just moving on, just going

14 back to the points that were raised about LSOC in the

15 previous debate, there was some comment with regard to no

16 DCO actually saying what the size of the cost was.

17 Some CC -- DCO's said that they'd increase

18 their initial margins by 50, 60 percent. I don't know if

19 that's happened yet, but from our perspective we were very

20 public. We don't rely on this. We do not expect to

21 increase margins. There will be no increase in margins.

22 Secondly, there will no increase in default

23 fund, because we do not rely on this fellow customer risk

24 or this or this capability to raid the other customers in

25 the eventuality of default.
Page 89

1 We do not rely on that, and we feel prudent in

2 doing that, and everybody's aware of this risk and feel

3 very vindicated by that. 75 percent of client funds left

4 Lehman five days prior to its default. I think if we saw

5 a similar scenario and a gradual decline we'd see a higher

6 number than 75 percent.

7 BAS ZEBREGS: Then can I comment on that?

8 The -- you just mentioned the -- Bas Zebregs from the

9 European Federation of Retirement Provisions.

10 You just mentioned that the whole of Europe is

11 now using LSOC, and, indeed, big progress has been made by

12 various CCP's, and swap clearing is the dominant CCP,

13 especially for interest rate swaps, but it doesn't mean

14 that buy side in -- in Europe is -- is fully satisfied and

15 fully happy with what is going on.

16 And what is a different, I think, with the

17 U.S. is that if you look at any legislation, the first

18 thing they say is that, both for OTC enlisteds --

19 products, a CCP should at least often -- offer an omnibus

20 and a client segregated option. So that means there is no

21 ratable distribution issue. At least you have a choice.

22 And second of all -- yeah, I think Mr. Baldwin

23 can -- can elaborate on that more, but there are CCP's,

24 and I think swap clear's thinking about it as well, and --

25 about further segregated models.
Page 90

1 And I think in the end Eurex maybe has four

2 segregated -- segregation models in the end.

3 BYRON BALDWIN: Yes, that's correct. I guess

4 from Eurex's point of view we aim to offer the buy side

5 choice. So we will be, forth quarter of this year,

6 offering LSOC, and so from Eurex's point of view, our aim

7 is to offer LSOC full segregation.

8 In -- in all answer to Ken's comments, its --

9 its full segregation is achieved by double title transfer

10 at a separate custodian account, away from the FCM, daily

11 statements in terms of collateral, collateral movements

12 ascent to the registered customer, i.e., the buy side

13 account, as well as the FCM.

14 The FCM has total knowledge of the collateral,

15 because it's trouble title transfer. So it goes through

16 the clearing member, and there is no transformation -- and

17 so the buy side has got complete segregation.

18 But the other important thing is that they've

19 got choice. They can go down the road of LSOC or they can

20 go down the road of -- of individual segregation on a

21 per-fund basis and per-registered customer is the Eurex

22 individual segregation model.

23 BOB WASSERMAN: Okay. Hilary.

24 HILARY CORAL: Thank you. Hilary Coral

25 Franklin Templeton.
Page 91

1 You know, Dan, first of all, I completely

2 agree with you on the -- you know, margin, and that it

3 shouldn't make a difference, you know, from the DCO

4 standpoint on the level of margin that they're charging

5 under either of these models. It's based on the market

6 risk of that particular investment. So I think that makes

7 complete sense.

8 I do think, though, that your comment of --

9 you know, you kind of blew through, I think, some of the

10 risks that are still inherent in LSOC. You've got, you

11 know, accounting risk at the FCM that they've tracked

12 this -- you know, all this money correctly that's in

13 omnibus accounts.

14 You have investment regs, and then, honestly,

15 you know the fraud risk. And -- and I do think those are

16 three real risks that this kind of full segregation model,

17 you know, does alleviate.

18 DANIEL MAGUIRE: I think just on the point

19 about the accounting risk, I think there are the different

20 models from different CCB's. So if you are reliant on the

21 FCM to provide you the positions on the cash balances or

22 the security balances, then I agree with that point.

23 The model we have in place is: We see through

24 to every subaccount, every subfund we calculate the risk,

25 the IM. We calculate the VM, the valuation, the
Page 92

1 market-to-market. We calculate the DBO1, so we know what

2 we need to trade if there's a default of a client or

3 clearing member.

4 And to just put the record straight on that,

5 that's hundreds of -- hundreds of thousands of accounts

6 being calculated intraday and end-of-day for in -- for

7 swaps.

8 So if you're not reliant on the FCM for that,

9 I think it does remove that. That would be the first

10 point.

11 The point about investment risk, I fully -- I

12 admit I -- I accept, but I think DCO's -- that risk will

13 exist if there's investment being done by the DCO.

14 BOB WASSERMAN: So before we move on, I'm

15 going to interrupt the flow for just a few moments in the

16 sense that since the -- the topic of this is alternative

17 models, I just want to make sure that -- we've spoken

18 about, essentially, guaranteed clearing participant model

19 for -- we've spoken, of course, about LSOC and how it

20 works.

21 If there's somebody who has some third model

22 that they want to talk about, I'd like to give them a

23 chance to put that on the table.

24 ERIC BAGGESEN: Let me take a stab at that,

25 Bob. Eric Baggesen from CalPERS.
Page 93

1 One of the things that is really obvious in

2 this entire discussion is that we're basically having a

3 great dilemma over exactly what constitutes a really valid

4 custodian of assets.

5 And the models that we currently have, have

6 moved into a place where we actually have custodial

7 entities also being entities that at times are taking

8 risk, and that risk can ultimately bleed through to the

9 client security.

10 And I think that that's one of our greatest

11 concerns, as a participant in this marketplace. In the

12 current over-the-counter market we find ways to secure

13 that our liability and our counter-party's liability in a

14 way that puts that -- that security off at a third party,

15 that, you know, is -- in essence, is not using that

16 capital in any risk-taking form.

17 One of the things that we've contemplated, as

18 a potential alternative model, is to actually utilize the

19 official custodians of our assets, in essence, as

20 collateral managers and have them facing our liabilities

21 to the clearing organizations, and literally

22 disintermediate that entire function from the FCM

23 category:

24 There are components of this that come through

25 in the CIEBA CME model. We have a certain amount of
Page 94

1 attraction to that, because, in essence, then if we're

2 posting our collateral, the collateral is being posted

3 directly to the clearing organization, not through the

4 FCM.

5 So the clearing organization is getting the

6 gross value of our collateral instead of the net that

7 feeds through from the FCM, which then leaves us exposed

8 to FCM activities.

9 And if they were operating in an environment

10 that was consistent with, let's say, our custodial banks,

11 State Street over here, you know, we might have less

12 concern about that, but it's quite obvious that some of

13 the FCM's and this entire industry have not been able to

14 really understand the true risk imputed by participants in

15 this market.

16 We do not use these instruments in a leverage

17 fashion. So we can fully secure, basically, the

18 liabilities that we incur in this activity. It's the

19 presence of clients like State Street, or Vanguard, or

20 some of these other giant institutions, that not levered

21 players, that allow this entire risk sharing to happen

22 between customers, and now we've attached some of the

23 other market intermediaries in that.

24 And I think that this -- whatever models we

25 come to have to eventually really identify the risk that
Page 95

1 the customers -- where -- where do defaults come from?

2 It's coming from levered players. It's not people that

3 have the capacity to secure their liabilities.

4 And as a fiduciary to CalPERS, I have a really

5 hard time thinking about exposing CalPERS' assets to

6 secure any other participant. That is a breach of my

7 fiduciary responsibility, ultimately.

8 So if I am knowingly, you know, securing some

9 other levered player in the marketplace, I actually really

10 have to consider that very, very strongly and determine

11 where I can even participate in that market structure.

12 BOB WASSERMAN: Let me just press you for just

13 a second. Are you talking about having the -- essentially

14 the -- the custodian guaranteeing your obligations to the

15 clearinghouse or not?

16 ERIC BAGGESEN: In the case of -- in the case

17 of what we're -- we've contemplated, in essence CalPERS is

18 fully capable of securing its liabilities. We have plenty

19 of collateral that we can put behind the positions that we

20 take in the derivatives market.

21 The question then, becomes: How can that

22 collateral be secured to protect CalPERS from any other

23 default in the marketplace and yet still be segregated out

24 for the benefit of the clearing organizations to defease

25 our liabilities?
Page 96

1 That is exactly the kind of the activity that

2 we've set up with tri-party custody agreements, going back

3 decades, basically. And under the current LSOC model, and

4 any of the other existing models that operate in the -- in

5 the currently cleared futures markets, we basically give

6 up the security of that very clear segregation of the

7 assets.

8 So we would see, in essence, for players that

9 are not leveraged in the marketplace -- State Street

10 doesn't have to extend us credit. We can secure our

11 liabilities. That's a different kind of a customer from a

12 customer that actually needs someone to extend them

13 credit.

14 So there needs to be a separation in this

15 industry that attaches the cost of extending credit and

16 the risk of extending credit to the people that are

17 requiring it. And this whole mutualization model operates

18 because of the presence of institutions like CalPERS that

19 are not referred players.

20 If every one of an FCM's customers were a

21 levered hedge fund or something, they would have a really

22 hard time basically securing that kind of a potential

23 liability, and this is all about identifying and

24 allocating costs to the appropriate players.

25 BOB WASSERMAN: So if I could just -- on the
Page 97

1 one hand what you may be describing as a model essentially

2 with having FCM's who are taking less risks or not

3 levering the collateral, and essentially tossing out

4 one -- you know, our Rule 125 and saying basically, no,

5 you just have to take what we have.

6 But beyond that, right now everyone in the

7 structure is either a customer of an FCM who is

8 guaranteeing them, or a direct participant, in which event

9 absent some slightly -- you know, some sort of guaranteed

10 model, they are exposed to the mutualized default.

11 And so if you're looking for a way to not be

12 exposed to mutualized default, I think you're going to

13 need somebody guaranteeing you who is.

14 CHRIS PERKINS: I want to seize upon one thing

15 you said, and I think we'd all agree that bad happens when

16 mutualization occurs.

17 And this was spoken about in the last panel.

18 We need the really focus on cultivating a defaulter-pays

19 model where people are paying for their own risk. That's

20 incredibly important to any structure that's put forth

21 going forward.

22 And one thing that we'd encourage regulators

23 to opine upon are minimum standards for an initial margin,

24 because as clearinghouses are commercial entities, and, in

25 theory, the lower the initial margin, the more attractive
Page 98

1 it could be for client business.

2 So, you know, we encourage a very high level

3 of -- for the minimum standard, to ensure that the vast

4 amount of risk is mitigated through initial margin, so

5 that mutualization through guaranteed fund is minimized to

6 the largest extent possible.

7 RON FILLER: Thank you. Ron Filler, New York

8 Law School.

9 I -- I realize political winds are blowing

10 that changes are needed, and I don't think anyone here has

11 written as much about customer segregation or care about

12 customer protection as much as I am [sic].

13 I'm currently serving now on a special

14 committee at the NFA that we're considering a number of

15 different rule changes at the NFA dealing more with

16 reporting and disclosure. I know that's the topic for the

17 panel later this afternoon, so we can address that, but

18 I'd like the raise a lot of questions and issues regarding

19 this GCP model.

20 First, I don't understand why gross margin

21 doesn't eliminate the concern. Gross margin is requiring

22 FCM's to post at the clearinghouse the full amount of

23 margin for each individual client. There's a one-day

24 risk. I receive the money today. I post it tonight. So

25 there is a 24-hour risk on gross margin approach.
Page 99

1 The client liquidates the position today,

2 returns it back. I have to return it back to the client

3 tomorrow. So there's that 24-hour risk, but other than

4 that, a gross margin model, I think, eliminates a lot of

5 the, quote, fellow customer risks or the concerns that

6 firms like an MF Global might misappropriate client funds.

7 The second thing of it is, under -- in

8 addition to gross margining -- this, I think, when all is

9 said and done with the FM Global, I really believe this is

10 going to be a 30.7 issue. And I know that's the subject

11 for tomorrow's panel with Gary, but I really believe it's

12 mainly a 30.7, and these issues -- this GCP issue does not

13 address 30.7, whatsoever.

14 The other part of this GCP model, if you want

15 to go forward with it, it -- it kills portfolio margining.

16 It kills cross-margining and approach. It's going to kill

17 the single-currency margining regime that we use now in

18 the futures market, and it's going to kill the global

19 clearing arrangement.

20 If I have a global client, and I was at

21 Lehman -- I'm probably the only one in this room who's

22 ever collected money from a client, but if you -- if the

23 client makes $100 over in Tokyo and loses $100 in the CME,

24 there's no margin call issue. Here, you're going to have

25 to have a lot more initial margin.
Page 100

1 The other part I'm not hearing -- I'd like the

2 hear some more information on -- is what about excess

3 margin? An FCM has a right for the custody -- a customer

4 agreement to require more additional margin than that

5 required by the change or the clearinghouse. Is that

6 going to be covered in these CCP's or are they going to be

7 held by the FCM?

8 The CFT's own rules on DCO's requires the

9 DCO's to now require clearing members to collect more than

10 the initial margin. That's excess margin. Is that excess

11 margin going to he held by the FCM or is it going to be

12 held in these GCP accounts? So I think there's a lot of

13 issues that has to be addressed.

14 The other part of it is -- is there's a

15 operational risk. The operational risk is: How soon will

16 FCM's, who are going to act as guarantors, going to be

17 notified about a -- the clients putting money into the GCP

18 program? Is it the same day, the next day, two days

19 later?

20 When I was at Lehman we had a lot of pension

21 plan account. We had a lot of mutual fund accounts. Many

22 of those accounts were managed by large-asset managers who

23 instructed the custodial banks at the pension plans and

24 the mutual funds who sent money in -- and this is just

25 through into one pot, and I can't tell you the number of
Page 101

1 times we had to go back and say, "We didn't collect your

2 money today," but we knew by the close of business that

3 day whether or not the initial margin or variation margin

4 came in.

5 How soon will FCM's be notified, because

6 they're assuming the guarantor in case?

7 The other part of it is -- and I think you

8 have to have a lien and secured of -- the FCM's have to

9 have a lien and security interest, because per the

10 customer agreement, if the client doesn't make these

11 payments to the GCP program, they have the right to

12 liquidate as part of margin.

13 Margin -- if you look at every case law out

14 there, margin is there for the benefit to protect the risk

15 of the FCM, and if you have a lien, and you have a

16 security interest -- I'm not so sure 760 H -- 766 H

17 doesn't apply, because is that not considered kind of

18 possession and control when I have that type of lien and

19 security interest over that account?

20 So I think there's a lot of issues we need to

21 raise. I think there's a lot of issues that need to be

22 addressed, and I haven't heard all the answers yet, before

23 you can go down this GCP model.

24 Thank you.

25 BOB WASSERMAN: Mark?
Page 102

1 MARK SZYCHER: Let me try to unpack some of

2 those several good questions and good issues, I think,

3 many of which we've -- we've spoken about in a -- a

4 smaller set of participants regarding our conversations.

5 The first of which is gross margin eliminates

6 concerns -- or the contention that gross margin eliminates

7 concerns. We certainly agree that gross margin eliminates

8 some concerns, and in particular the concerns about

9 investment risk, that is to the extent that substantially

10 all the gross margin that is collected from clients then

11 gets, in essence, sent up to, if you will, the DCO.

12 The amount of money to be played with, that is

13 the difference between gross and net, obviously shrinks

14 maybe to zero, but it shrinks to perhaps a diminimous

15 amount.

16 That said, I think you did identify the

17 one-day transit risk, which is a bit of concern, and as

18 well we would also argue that from the perspective of

19 porting, we could still end up caught in a -- an FCM

20 bankruptcy situation whereby we are, in a reasonable

21 period of time, unable to ensure that our positions are

22 maintained through an FCM bankruptcy.

23 And that -- that was a very significant

24 concern of a number of public companies who held

25 commercial hedgers, who held positions through MF Global,
Page 103

1 that is, my FCM is no longer in standing with my with --

2 with the DCO, and therefore do I have a -- do I have a

3 significant problem?

4 The 30.7 issue, I'm not a risk manager. I'm

5 not an attorney. So I -- that one I can't speak to.

6 With respect to this killing portfolio

7 margining, it's a little bit difficult to speak to that

8 concern, albeit is a legitimate one. I would suggest

9 first that there may be ways in the CME CIEBA model to

10 address that. I'm not sure we've addressed it as yet.

11 We've left it as a bit of place holder.

12 That said, if that -- or since this is

13 intended to be voluntary on the part of clients, to the

14 extent that, as a business matter, a client views a

15 sufficiently large disadvantage, as to make this an

16 untenable business proposition, then they simply wouldn't

17 adopt it.

18 With respect to excess margin, it is our

19 expectation that any excess margin, that is margin above

20 the DCO minimum, that has been required by the sponsoring

21 clearing member would, in fact, be held at -- at the GCP

22 account, that is in the individual segregated account, and

23 that account would be in the name of the customer for the

24 benefit of the DCO.

25 But in some way, that we've talked about and
Page 104

1 may talk about later today, the interest in some way can

2 be, as a business matter, secured, if you will, with

3 respect to the FCM having a claim on that if needed.

4 Last but not least, in terms of operational

5 risk and timing of the payments, another great issue the

6 gentleman just raised -- and something we've been thinking

7 about a lot, and, in particular, I believe it was on the

8 last panel, the -- the professor from, I believe, the

9 University of Maryland, had brought this up regarding: Is

10 there enough capital, in essence, in the system, once swap

11 clients join a cleared paradigm for FCM's, in essence, to

12 be fronting money overnight or intraday to a hundred --

13 several-hundred-trillion-dollar-swap market?

14 We -- we remain very concerned about that, and

15 in this model we've contemplated the idea of -- and the

16 gentleman from CalPERS mentioned this in a sense -- that

17 transfers could happen, in essence, as a matter of book

18 entry, that is, the DCO settlement bank, who's likely also

19 your custodian bank or could become your custodian bank,

20 would have sufficient assets such that those transfers, in

21 essence, would be book entry transfers on the part of the

22 DCO settlement bank, and the sponsoring FCM could, in

23 fact, be notified within a sufficient amount of time.

24 We're looking on the order of about an -- 45

25 minutes to an hour prior to 7:30 Central Time, such that
Page 105

1 if a topping-up of the DCO settlement account were needed,

2 that the FCM would have to do it within that timeframe.

3 I hope I've addressed some of your questions.

4 BOB WASSERMAN: Oliver?

5 OLIVER FRANKEL: Yes. Oliver Frankel, Golden

6 Sachs, representing ISDA here.

7 With regard to margin calls and -- as you have

8 in your model, FCM's as guarantors cannot pre-fund

9 guarantee TCP's, margin calls, because they would be a --

10 it would be essentially a gross call. We'd have no

11 ability to net gain with losses in that call.

12 And the size of those calls would then be very

13 big, and that would be a problem for us. So you're

14 proposing that you make your -- you make your own calls,

15 you meet your own call -- you meet your own DCO calls,

16 which is great.

17 The book entry transfer needs to be done in

18 cash, and if it's considered that you'll have mainly

19 treasuries or other securities in your settlement bank

20 account, that could be a problem, because you'll need to

21 transfer -- you'll need to turn them into cash to provide

22 to the DCO, as variation margin needs to be in cash.

23 If the -- if the custodian has to lend you

24 against securities cash, we create a lending situation

25 with the custodian. And one of the problems we have in
Page 106

1 getting the security interests or any sort of affected

2 claim on -- on the account if we had to pre-fund a call,

3 is the conflict we have with custodians. Custodial

4 conflicts just creates sort of problems as we've seen.

5 Other things that we would need, in general,

6 to guarantee GCP would be of course, approval of all new

7 trades, continuous real time visibility into at least the

8 value of the collateral in the account, good control of

9 that collateral, which, you know, double title transfer

10 clearly was, but so that the DCO and the FCM have say over

11 whether that amount gets reduced, can be -- withdraw

12 money -- can be withdrawn from it.

13 And we can -- I think that's basically -- the

14 only remaining point that I think is major is that the FCM

15 needs to be the liquidator in the case of default. I

16 don't know how we can truly guarantee something when

17 liquidation of those positions that we've decided to

18 guarantee is done by somebody else.

19 MARK SZYCHER: Mark Szycher from CIEBA.

20 Oliver, in terms of several of your points, I

21 agree with the majority of what you said. I'm not certain

22 that the pre-funding issue -- although I agree with your

23 conclusion, I'm not 100 percent sure I've gotten to that

24 conclusion by the gross net reasoning, but nonetheless I

25 think we've come to the same conclusion, that is, that
Page 107

1 it's our expectation to pre-fund, and, in fact, we

2 actually have to pre-fund or fund, in essence, a -- a call

3 with cash for both various initial, and then subsequently

4 we could substitute -- at least on the initial side we

5 could substitute, you know, pending satis -- satisfaction

6 of that call.

7 That said, with regards to approval of trades,

8 completely agree. That's within your purview today and

9 would continue to be.

10 With respect to what's in the collateral

11 accounts, again you have that today, and this arrangement

12 via the DCO settlement bank, the individual seg account,

13 as well as the DCO settlement account, you'd continue to

14 have that same visibility you have today.

15 We also agree with respect to liquidation,

16 that is, today in the event of a customer default you have

17 full rights to liquidation, and that would be maintained

18 under the scenario that we're envisioning.

19 OLIVER FRANKEL: We actually need greater

20 visibility than we have today, because we need to monitor

21 all these things across many accounts, thousands and --

22 tens of thousands of accounts. And so it requires some

23 sort of more automation than is currently in place. So --

24 but that's something to be built and can be built.

25 BOB WASSERMAN: Bill, and then Scott, and then
Page 108

1 Ron.

2 WILLIAM THUM: Thanks, Bob.

3 I think, just to start out, we at Vanguard and

4 certainly other members of the ICI are very intrigued by

5 the CIEBA model and want to make sure that it gets a full

6 airing, particularly if it's presented as an optional

7 model where the buy side that are interested in avoiding

8 certain risks and are prepared to pay the costs, can opt

9 into it.

10 That being said, there is a wide divergence of

11 views among the buy side on this particular topic. And I

12 think many ICI members, such as Vanguard, have supported

13 LSOC since its inception.

14 Others have questions about certain aspects of

15 it as to its effectiveness, certainly issues that Seth

16 raised earlier in the -- in the meeting are issues that I

17 think need to be cleared up.

18 Some ICI members frankly have suggested that

19 they'll cease swaps trading if LSOC is the best protection

20 available. That's an extreme view, but it is a view of

21 some of the members.

22 The main consensus view seems to be that there

23 needs to be a better understanding of the gaps in risk

24 mitigation under LSOC, and then a balancing of such

25 residual risks in the cost and delays associated with the
Page 109

1 eliminating all such risks.

2 The other point that I want to make in

3 addition to that cost-benefit analysis is indeed the

4 port -- portfolio margining issue that was raised earlier,

5 and our concern particularly with the strategy for many

6 members that enter into a diverse range of products

7 trading with -- through prime brokerage relationships and

8 otherwise. They're very concerned about a model that

9 could potentially foreclose the many benefits to their

10 margin efficiencies and trading strategies if they -- if

11 the margin was locked up the way it has been suggested.

12 Things that I -- I want to talk about

13 certainly -- we've talked about fellow customer risks.

14 We've also talked about operational risk. I think that it

15 is a bit unfair to say that the LSOC rules do not address

16 operational risk at all.

17 And I think that Rule 2211 C and E certainly

18 enhance the requirement for the FCM to maintain

19 transparency in its record keeping and provide the DCO

20 with a full window into its clients, the positions, and

21 their margin. And the DCO is mandated to police that

22 information flow and make sure that it is accurate,

23 current, and timely.

24 In addition to that, we meet with FCM's all

25 the time. They're all hungry for business, for cleared
Page 110

1 swaps. And what they tell us is, quite frankly, there are

2 due diligence exercises that we can embark on to address

3 things likes operational risk and investment risk that do

4 not involve some of the strategies that have been talked

5 about so far.

6 So in terms of monitoring FCM capitalization

7 levels, the FCM's that we talked to don't maintain capital

8 at the minimal levels. They maintain capital at many

9 multiples of those levels.

10 They also suggest that we look to what is the

11 investment pool that they work with in terms of that

12 excess margin, and the FCM's we're talking to don't invest

13 across the full range of Rule 120 -- or 1.25 securities.

14 They only invest in the top tier, the most liquid forms of

15 investments.

16 Also looking at the audit history of the FCM,

17 seeing has it maintained seg, has it been found to be not

18 in compliance with the seg rules in the past? And finally

19 take a look at the FCM custodians and make sure that the

20 custodians -- that there is a rigor in selecting the

21 custodians, and -- and that the legal underpinnings of the

22 custodian relationships are sound.

23 We were also heartened by the suggestion that

24 there will be enhanced SRO oversight and newly

25 standardized best practices for the industry, including
Page 111

1 daily reports by the FCM to the SRO with biweekly audits

2 by the SRO, regular audits for internal control structure

3 deficiencies, enhanced FCM employee qualifications,

4 tightening up the FCM evaluation methodologies for the

5 assets being held and indeed the trades, themselves,

6 tightening the custodial standards and tightening the

7 approach to the access to excess initial margin

8 segregation.

9 So among the buy side there is a diverse view

10 as to whether LSOC is sufficient, whether there are gaps

11 in LSOC that should be identified and possibly corrected

12 by remedial rule making, whether the gaps are so large and

13 the costs manageable to come up with a new approach to opt

14 into may be the answer for some market participants.

15 But I think it's -- it's important that as we

16 consider alternatives we really identify what is the gap.

17 Is the gap something that can be closed within LSOC by

18 subsequent rule making? Is the gap something that can be

19 managed through SRO, oversight, through due diligence by

20 market participants, or whether there needs to be a more

21 extreme answer.

22 BOB WASSERMAN: Scott?

23 SCOTT FERRIS: Scott Ferris from BMO Harris

24 Bank. I'm here to represent sort of the perspective of a

25 settlement bank.
Page 112

1 In addition to sort of the operational

2 services that we provide in that role, one of the other

3 important services we provide is essentially liquidity to

4 the -- today, to the FCM's.

5 I guess, you know, a question that I would

6 raise, as we're talking about these models is: How

7 broadly these models are going to be offered to market

8 participants?

9 And that's important, in that as we understand

10 an -- you know, the individual segregation, you know, it

11 would be akin -- today we -- we process margin payments to

12 and from the FCM and the exchange on a net basis.

13 And so as you start separating and

14 individually segregating, it's -- as we understand it,

15 then we would receive margin calls directly from the DCO's

16 for each of those individually segregated accounts, and we

17 would be asked to at -- at -- early in the morning

18 before -- before the markets are and -- and liquidity's in

19 place, to meet those payments.

20 I think that, you know, if we look at market

21 participants, like those that are seated at the end of the

22 room here, that would be a very easy decision for us to

23 make. There are -- there are market participants where

24 they won't be rich in collateral. You will need to make

25 credit decisions, and the willingness of settlement banks
Page 113

1 to do that, I think to some extent, may be in question

2 with certain market participants.

3 You know, and the other thing that I would --

4 I would point out that -- so under that structure, you

5 know, when the exchange calls for a margin payment, that

6 basically has to be met within 60 minutes. And so once,

7 you know -- so, you know, the -- the -- the scenario

8 that -- that Ron detailed where, you know, the margin

9 didn't get there that day, it didn't get there the next

10 day, that sort of flexibility that may have been afforded

11 to certain participants in the past cannot be -- it won't

12 be allowed by settlement banks that are effectively making

13 those on a -- on a real time basis.

14 BOB WASSERMAN: Robert then Oliver.

15 UNIDENTIFIED SPEAKER: No, I just wanted to --

16 (Participants talking at the same time)

17 BOB WASSERMAN: No, Robert. Do Robert first.

18

19 ROBERT LEE: Sorry, Oliver.

20 OLIVER FRANKEL: Sorry.

21 ROBERT LEE: It's Robert Lee at Deutsche Bank,

22 representing ISDA.

23 A number of commenters have raised the example

24 of tri-party custodial structures that are -- that are --

25 you know, that exist in the OTC market.
Page 114

1 And, you know, one of the things, as we sort

2 of look to that and tried to bring forth -- you know bring

3 into sort of clearing space the same type of protections

4 for customers, I think we also need to sort of look at it

5 from the dealer's perspective in those structures.

6 I mean, the tri-party custodial structures,

7 there -- there is a contractual relationship among the

8 parties, and -- and direct recourse to the extent there

9 are breaches.

10 We need to think about how some of those

11 protections, particularly with respect to making sure that

12 there's transparency in terms of the amount of collateral

13 and the value of collateral that are in those custodial

14 accounts, but also protections against unauthorized

15 withdrawals. Right?

16 One of my concerns, and -- and hopefully this

17 is something that, you know, we -- we think about at --

18 you know, as we talk about these alternatives models, is

19 you know, if the -- the GCP, right, posts the collateral

20 or transfers collateral directly to the -- you know, to

21 the DCP accounts at the DCO's, we need to make sure that

22 the FCM's still have -- you know, because they still wear

23 the credit risk of the client -- they need to have sort of

24 full transparency at a real time level, right into the

25 value and the -- you know, of the collateral and the type
Page 115

1 of collateral.

2 And we also need to ensure that there is

3 protections against unauthorized withdrawals, and it's not

4 only just unauthorized withdrawals with respect to the DCO

5 minimum margin that they're required, but any excess

6 margin that the FCM requires, as well.

7 So one of the questions I have for the group

8 is: Who's going to actually wear that risk, monitor it,

9 and how do we deal with it to the extent that -- and if

10 there's a failing there?

11 BOB WASSERMAN: Yes?

12 OLIVER FRANKEL: Yeah, I guess I was going to

13 say something but very similar, which is that if the

14 settlement bank were to fund -- you know, provide

15 liquidity on the basis of credit, that would create a

16 potential custodial conflict, that we actually would find

17 very difficult.

18 I think Robert said that much more

19 articulately than I.

20 BOB WASSERMAN: Peter?

21 PETER BROWN: Thanks, Robert.

22 So a couple of things. One of the

23 alternatives that we thought of is segregating just the

24 initial margin, which would require sort of a bifurcation

25 between the variation margin and the initial margin.
Page 116

1 Yes, it gets very complex, the details around

2 settlement cycles, but we envision a role where the FCM's

3 obligations to DCO's to settle for customers doesn't

4 change. Customers, though, have the option to segregate

5 their initial margin into individual accounts at a

6 custodial bank. The DCO's have perfect transparency as

7 the FCM's would, into the balances in those accounts. So

8 it looks somewhat like the model we have today in the

9 bilateral OTC space.

10 And then, of course, because the FCM has --

11 has settled with the DCO already, with respect to both

12 variation and initial margin, the DCO is then over

13 collateralized because once the customer has funded, that

14 segregated account, and the FCM already has, then there's

15 a trueing up required between the FCM and the DCO, so that

16 the FCM is effectively being paid by the DCO.

17 But the customer at this point has the

18 transparency, you know, that it wants to be able to look

19 to the settlement bank's website and see for its accounts

20 it's got, you know, X of initial margin required to post

21 at DCO, and there it is.

22 And even though it's gross margining now, and

23 even though the DCO has the first lien control over those

24 assets, if customers want the option to do that, you know,

25 we think that that should -- is an option that should be
Page 117

1 available.

2 And also by structuring it that way -- and,

3 again, it gets complex, no question. The FCM's role in

4 the settlement cycles doesn't change, that daily process

5 at 7:30 a.m. or whenever occurs, or throughout the day.

6 It's just that the customer then funds the

7 initial margin separately, and then the DCO's and the

8 FCM's true up to extent they are now over collateralized.

9 So, you know, we've -- we've talked through this

10 possibility with different FCM's and feel there's general

11 receptivity to it.

12 So it preserves the FCM-DCO relationship. The

13 DCO, has all the collateral it needs. The client has the

14 segregation of initial margin. The client can also -- can

15 always claw back excess, right, can choose not to leave

16 excess margin, but it's FCM, so its exposure remains the

17 initial margin, which is now segregated.

18 In terms of the lien issue -- and I can't

19 speak for others at the table, but I think the concern

20 there is not so much giving the lien, it's ensuring that

21 if the FCM were to become insolvent, that those positions

22 cannot be ported, right?

23 So as long as that ability to move positions

24 to another FCM is preserved and is not tainted by there

25 being an FCM lien over this account, however it's
Page 118

1 structured, I think that's the paramount concern,

2 certainly for us.

3 There was a discussion of the custodian bank

4 risk here. You know, cash we recognize as deposit with

5 the bank and is at risk. However, you know, the

6 segregated account assets of customers today, we imagine

7 are sitting in these exact same custodial banks where

8 these segregated accounts would be held.

9 So, you know, we've done a fair amount of

10 research with our settlement banks or our custodial banks

11 in terms of, you know, the FDIC implication of a bank

12 failure, protection of fully paid customer assets sitting

13 in the custody range of these accounts at these banks, and

14 we're confident that those would be -- those would be

15 preserved for customer or beneficial owners. Cash is a

16 different matter.

17 One -- I'll just shift back a moment. I don't

18 think this room would be nearly as crowded if the MF

19 Global events hadn't occurred. And, you know, the -- the

20 malfeasance risk, you know, we think is real. Those

21 customers who choose to opt out, you know, means that

22 there's a lot of customers who remained in these pools,

23 you know, who may not have the -- the budget to pay for

24 the additional services.

25 And so, you know, as I mentioned in our
Page 119

1 prior -- in the prior panel, you know, we think

2 significant attention needs to be paid to: How does that

3 customer seg pool -- what are the maximum optimal

4 protections around that pool of assets that prohibits the

5 FCM from whether inadvertently or by design,

6 notwithstanding rules to the contrary, from dipping into

7 that pool at the moment when its, you know, customers are

8 most at risk?

9 BOB WASSERMAN: Jeff?

10 JEFF HAINLINE: Jeff Hainline, representing

11 Advanced Trading and the National Grain and Feed.

12 And like Ken, we represent the buy side, but

13 the far end probably from the -- most of the other

14 participants, farmers, ranchers, and agra business.

15 The risks that LSOC covers, and the risks that

16 are still exposed seem -- there still seems to be many

17 risks in the LSOC regimen.

18 And moving forward with that regimen, with

19 those risks still exposed in this environment, doesn't

20 seem appropriate to our customers. While it is better

21 than where we may be today, it still has many holes in it,

22 not the least of which is the malfeasance, the investment

23 risks.

24 And so as you look at these other regimens,

25 whether it's the Eurex or the CME CIEBA, particularly the
Page 120

1 voluntary nature of the CME CIEBA would be very attractive

2 as -- as an investment. It -- it transfers the

3 opportunity to have a higher degree of certainty at an

4 expense at the buyer's choice.

5 And so those are the kind of things that, as

6 we go forward, I hope the Commission waives heavily.

7 JOSH COHN: Taking me back a few minutes here,

8 but just on the -- on the question of custodial risk, it

9 seems there are a couple of levels of custodial risk.

10 And -- and we've talked about perhaps part of

11 it, but there's also the risk -- there's -- there are the

12 risks in custody that were observed when FIN SEG 10 was

13 amended in 2005, and, in fact, the CFTC saw some custodial

14 accounts that had come up short, with questions raised as

15 to exactly how the accounts had been managed.

16 But there's also a problem for custodians who

17 successfully managed their account, and in the CME CIEBA

18 proposal that would be somewhat more complicated than the

19 typical case because CME CIEBA raises the prospect of a

20 quad-party custody account. And so you have a custodian

21 with three parties around it with rights and obligations

22 to be served.

23 And there, there's the risk of the custodian

24 simply -- and -- and perhaps for good cause -- throwing up

25 its hands and throwing the whole thing into interpleader,
Page 121

1 which, of course, doesn't particularly serve anybody's

2 long-term interests.

3 It's -- it's for these reasons that we,

4 thinking about this, at ISDA thus far, really prefer the

5 model, Bob, that you were perhaps broaching, where --

6 that -- that seemed custodian-free, and -- and that

7 essentially kept the money, for the most part -- kept the

8 collateral for the most part at the DCO, subject to rule

9 and perhaps security interests.

10 We would say that both is -- is the way to go,

11 but that seems to take one level of risk out of the

12 picture.

13 BOB WASSERMAN: At the risk of interrupting

14 the flow, I do need to raise one other thing.

15 Ken, earlier, you had asked what might be the

16 impact of one of these models on a guaranteeing FCM's

17 other customers. And I gave you what I should hasten to

18 add is one man's view, but I probably maybe shouldn't have

19 done that, but having -- regardless, I want to reopen that

20 question, because in looking at costs, I think we need to

21 look at costs and benefits, but we also needs to be

22 attentive -- what costs does this kind of an optional

23 model impose on those who do not opt in?

24 And I think that's something to be concerned

25 about, and so folks have views on that. I definitely
Page 122

1 don't want whatever I might have said to squelch that, but

2 rather perhaps inform it, and so, Ken, you looked like you

3 had --

4 KEN ACKERMAN: Thank you. That's a very good

5 segue to the question I was about to ask. Quick -- quick

6 comment and then a question.

7 First, the comment. This has been a very

8 helpful conversation in looking at these different

9 options, the strengths and weaknesses of each, but clearly

10 at the end of the day I think it will be incumbent on the

11 industry and the Commission, as has been said several

12 times today, to come up with a solution so that the

13 outcome of this exercise is a system that still allows

14 another MF Global type event to occur five years from now,

15 as we -- as was the outcome with the Volume Investors

16 exercise a couple of decades ago.

17 The question I had is this, and this is for

18 Mark. And, again, this is just trying to understand

19 the -- the process.

20 You've made the point that the -- that the GCP

21 program would be voluntary, that people could opt in or

22 opt out.

23 As you envision it, are there classes of

24 people who you would expect to opt in and you would expect

25 to opt out? I'm -- specifically is this a system more
Page 123

1 designed to benefit the larger players in the market? Is

2 this designed to benefit CalPERS or -- or the GM Pension

3 Plan?

4 Would this be as suitable for an individual

5 farmer, or an individual member of the grain trade,

6 someone from the agricultural world, the people who are in

7 a fix right now, in the wake of MF Global?

8 MARK SZYCHER: Mark Szycher from CIEBA.

9 With respect to benefits, I -- I'll maybe

10 answer your question more directly in a moment.

11 But I just want to be clear or to at least try

12 to be clear that our view is that -- that this model or

13 this -- this option, if you will, benefits all

14 participants to the extent that first it is available to

15 all, recognizing, of course, that with respect to whether

16 it's a DCO settlement bank, whether it's a sponsoring FCM,

17 no one's forced to do business with anyone they otherwise

18 would not do business with.

19 Now, we did say at the outset that we urged

20 the Commission to make it mandatory that DCO's offer this,

21 because obviously that -- if that part of the chain isn't

22 available, no one else can -- no one else can effectuate

23 these arrangements.

24 But that said, we would view this as a --

25 as -- as an option to all. We would also view this as --
Page 124

1 it's a detriment to none, even if it turned out that

2 certain types of clients, by and large, might opt for this

3 and certain might not.

4 We also think that, to the extent that perhaps

5 a larger number of clients opt into this, there may be

6 some fixed costs that can be spread somewhat more broadly,

7 and thus the cost of this come down to other clients.

8 But perhaps to more directly answer your

9 question, I think we would somewhat have the expectation

10 that some of the larger clients that are fiduciaries to

11 pension plans and other clients, and furthermore have --

12 by the nature of their positions, demands for very, very

13 significant amount of collateral or margin, and therefore

14 have a lot to be risked -- a lot at risk, whether it's

15 operational risk, fraud risk, or other risk, would perhaps

16 be the more likely -- at least initially more likely

17 clients to opt in, but again that -- that does not

18 preclude other clients from opting in.

19 And I think just a last comment is that there

20 are many, many pension funds, institutional investors,

21 insurance companies, and others who have similar

22 arrangements in OTC land, as it is, and they're not -- we

23 think to some extent that the cost issue is a bit of a red

24 herring, not that there aren't some additional costs, but

25 frankly the cost of a couple of thousand dollars for a
Page 125

1 custody account and some of the other processing

2 accounts -- processing costs, we don't believe are

3 necessarily well beyond the reach of a large percentage of

4 the clients.

5 Now, of course, they may feel that even, you

6 know, an extra dollar of cost doesn't buy them enough to

7 make it worthwhile, but we think that that's a -- that's

8 commercial decision, and it's not based on class or size

9 of clients, per se.

10 BOB WASSERMAN: Okay. And so we're building

11 up a bit of a line. Oliver, Ron, Seth, Dan and then Joe.

12 OLIVER FRANKEL: Well, I'll try and be quick.

13 So one of the -- one of the obligations of the TCP model,

14 I think to make it work for guaranteeing FCM's is that the

15 GCP funds its own margin calls and doesn't rely on the --

16 the guaranteeing FCM, which is a -- is not so much a cost

17 but it's an onus, I think, you know, with potential for

18 default if it's not done properly, you know.

19 Another issue is not so much for that, but

20 the -- you know, I'm not sure how we get to solve the

21 security interest requirement. I still haven't seen a

22 solution. And on the basis of those two things, I would

23 also recommend that we think about the LSOC model, the

24 2213 C paragraphs that allow for a DCO to provide greater

25 protection to protect excess collateral in the accounts so
Page 126

1 that malfeasance and so on it -- to protect it against an

2 FCM's malfeasance and so on.

3 So it -- given that we have, in swaps

4 clearing, anyway, multiple CCP's clearing the same

5 product, I -- I would think perhaps the force of

6 competition would get them to create rules and procedures

7 that would also protect the clients that wish it, at the

8 extra cost of so doing, their own excess collateral with

9 the FCM.

10 RON FILLER: Thank you, Bob.

11 First let me try to answer your question.

12 Ron Filler, New York Law School. Sorry.

13 Let me try to first answer your question, and

14 then I have a question for the group if you don't mind.

15 In -- in clearing the world a zero-sum gain,

16 if I lose a dollar somebody else makes a dollar, and if

17 I'm one of the GCP's and I lose a dollar through the

18 trading of -- through that DCO, and the FCM acting as

19 guarantor doesn't have enough capital to meet my dollar

20 loss, then you have to look to the DCO rules, because

21 somebody's entitled to get a dollar.

22 They made a dollar that day, and you have to

23 look to the respective DCO's as far as which priority --

24 who they go after to collect, and under the futures world

25 they would go after the other customers of the futures --
Page 127

1 of that FCM. Some of the DCO's have that type of right.

2 So I think there is a potential fellow

3 customer risk even under the -- the GCP model, only other

4 than if you can somehow -- you really strongly believe it

5 takes it completely out of the Bankruptcy Code, and -- but

6 then who pays that dollar to the customer who made a

7 dollar -- who made the profits that day? And it --

8 because if the FCM doesn't have that capital to pay. So

9 that would be my answer to it.

10 And I have a question. I've been hearing this

11 concept called -- concern about portability, and I've

12 heard it today a couple times in the first panel and again

13 today. And I'm just trying to understand exactly what the

14 concerns are on the right or ability of a client to

15 transfer their positions from FCM-A to FCM-B.

16 I mean, in the aftermath of the Revco and in

17 the aftermath of Lehman, I'm not aware of any large

18 institutional customer who doesn't have multiple clearing

19 arrangements today. I mean, they have clearing

20 arrangements at many different FCM's, and they have the

21 ability to transfer futures. And in the world of the

22 future, clear swaps from a FCM to B.

23 Now, I think the concern is that -- what if

24 that FCM-A is about to file for bankruptcy or has filed

25 for bankruptcy?
Page 128

1 Is the issue on portability that you want to

2 have the right to transfer it to another firm without the

3 other clearing firm accepting these positions, or is it

4 more that if the FCM files, that you have clearing those

5 products, filed for bankruptcy, you want to take whatever

6 measures possible to make sure the trustee doesn't

7 liquidate the open position and give you a certain number

8 of times to either open an account, or transfer it, or

9 whatever.

10 I mean, the bankruptcy rules already provide

11 you some -- it gives the trustee discretion. They have

12 the right to liquidate the same day, but that -- I mean,

13 at Lehman and MF Global, both trustees in place gave

14 basically a -- five days to transfer your position --

15 whether five days is adequate or not.

16 I would like to hear from the group who's

17 concerned about portability what really they're seeking.

18 I'm not sure. I've heard different explanations, and I'm

19 just trying to understand that issue from a -- their

20 concerns.

21 Thank you.

22 BOB WASSERMAN: Seth?

23 SETH GROSSHANDLER: Seth Grosshandler,

24 representing FIA.

25 A number of points. First of all, Bob, on
Page 129

1 prejudice to the other customers who don't opt in, it's an

2 obvious thing, but I'm not sure it's been stated. To the

3 extent that there is an investment loss or a fraud loss

4 it's going to be shared by those folks and not the people

5 who opted into this. So you're just shifting those losses

6 to that pool of people who, for whatever reason, lack of

7 sophistication, or sophisticated and didn't want to do it,

8 or lack of money, whatever, didn't opt into this proposal.

9 You're sifting those kinds of losses to those folks.

10 The -- going back probably an hour now, there

11 was some -- some talk about why would the -- why would a

12 DCO require more margin from a customer in the CIEBA

13 model.

14 And, you know, if we are able to solve all of

15 this and get the FCM in the same position it's in, under

16 current models with respect to its rights, vis-a-vis the

17 customer, I think that's right, that you don't -- you

18 don't change things, but we have all of these issues.

19 Even if there is a lien, is the -- is the FCM in control

20 of the situation? Right? If it's not, then maybe it's

21 more at risk.

22 The more that you put risk onto the FCM, the

23 more the DCO is logically going to think that FCM is not

24 as good a credit. Right? So I need more margin from

25 somebody else.
Page 130

1 The question of whether the lien makes a

2 customer property or not, I actually do think that the

3 CIEBA model does a very good -- even if there were a lien,

4 that it wouldn't be in so close to the porting issue more,

5 but if we make the FCM more in control of liquidation

6 proceeds, right, in a double default situation, right,

7 those proceeds may, in fact, be at the FCM level, and then

8 the defaulting customer now has defaulting FCM risk.

9 Now, maybe that's something you're not so

10 worried about, but it doesn't entirely solve the customer

11 property risk. And, again, as I said at the outset, there

12 are still issues in my mind about -- is this consistent

13 with what Congress was thinking when it mandated clearing

14 of swaps, made commodity contract a broader definition,

15 and it knew that there was a sharing regime?

16 The last thing I wanted to mention was: In

17 all of this we just need to bear in mind underlying state

18 commercial law, the Uniform Commercial Code, 50 different

19 states. For perfection of security interest, it was

20 drafted with the futures model in mind, accounts at the

21 FCM for the customer, and it's not necessarily an issue

22 with all these things, but just need to, you know, not

23 miss that, going forward.

24 BOB WASSERMAN: Dan?

25 DANIEL MAGUIRE: Thanks.
Page 131

1 Just to be very brief, it seems, under the GCP

2 model, which definitely has some merit, we're talking

3 customers and turning them into some form of members.

4 So first question is: What do customers or

5 clients lose by being reclassified? Is there any down6 side to this?

7 Second thing is: We're saying that somebody

8 has to guarantee the participant in this. To my

9 knowledge -- this is relatively new at the moment in this

10 space is -- is that limited to the FCM's or is that -- it

11 just needs to be a direct clearing member, because that

12 doesn't necessarily mean FCM'S.

13 And, thirdly, just on some of the points that

14 were touched in point as of leakage, when we talked about

15 LSOC there was a -- there was a concern about bringing in

16 any form of optionality, whereas you could have leakage

17 between an LSOC group and a gross omni group, and I've not

18 heard so far, is there any danger of any leakage between

19 the GCP and, let's say, LSOC or gross omni there in terms

20 of the rules and the code would work?

21 BOB WASSERMAN: Joe, then Tim.

22 JOSEPH OTT: Joe Ott, Kansas City Board of

23 Trade.

24 Bob, I just want to address the DCO cost issue

25 real quick. Last week I was on a conference call with
Page 132

1 other market participants, as well as other DCO's with

2 CIEBA, and the DCO's had expressed some concern about the

3 cost to implement this structure, and the response from

4 CIEBA was: Well, this will be a financial windfall for

5 DCO's once mandatory clearing comes into place.

6 And I guess I wanted to point out that

7 currently each DCO has a limited number of clearing

8 members they deal with on a daily basis, and with this new

9 structure that could increase substantially.

10 And as an example, let's just say in January a

11 customer puts on a December week calendar swap. The week

12 calendar swaps are marked to the market on a daily basis.

13 Therefore you'd have 250 days of variation margin with the

14 DCO. At $4 a wire that comes up to around $1,000 of

15 expense to the DCO, whereas the fees we're going to charge

16 for that swap are $4.

17 So I don't think there's any guarantee this is

18 going to be a financial windfall for DCO's. In some of

19 the lighter traded swaps it may not make any sense to have

20 this type of structure in place.

21 BOB WASSERMAN: Tim?

22 TIMOTHY DOAR: Tim Doar, CME.

23 You know, I guess to answer one question, you

24 know, we -- it's our expectation that those who guarantee

25 these TCP type of accounts would be clearing from FCM's.
Page 133

1 That's -- just to be clear about that.

2 Ron, you had mentioned earlier questions

3 around portability. It's our expectation -- we consider

4 it to be a best a practice, particularly with respect to

5 cleared swaps, that clients have relationships with more

6 than one FCM, that would go for a GCP.

7 In the eventuality of an FCM default under

8 LSOC, you know, our expectation would be that we'd be in a

9 position to better ascertain the status of any GCP that

10 goes through the guaranteeing FCM than any client that

11 remains in LSOC.

12 Now, that's not to say that we don't have the

13 ability to assess individual client exposures, to value

14 them, to -- to generally risk manage them. We will know

15 who the likely suspects are, who are causing an FCM

16 default, but we are governed by the portfolio of rights

17 and obligations, in terms of how we administer that

18 default.

19 And I expect that we would have to undergo

20 some pains to assure which client or clients were actually

21 at the source of the default, so that we could then go

22 ahead and -- and do our stuff, and administer the default

23 of that. The point being that there might be different

24 timings associated with when porting could occur for

25 non-defaulting clients within the -- the LSOC pool, if you
Page 134

1 will.

2 So I offer that up only as some degree of

3 color over the times of distinctions that we would foresee

4 with the utilization of a GCP type construct. If

5 anything, I think that the immediacy of knowing whether a

6 GCP client is the source of the default or not is actually

7 a benefit to the overall construct.

8 MARK SZYCHER: Mark from CIEBA.

9 Ron, with respect to a couple more quick

10 points on portability.

11 No, we absolutely do not have any intention of

12 foisting ourselves upon a clearing member who chooses, as

13 a commercial matter, not to do business with us.

14 But as far as what do we hope to achieve or at

15 least ensure, regarding portability is I think three

16 things, the first of which is the certainty that our

17 positions are maintained, that is, that they're not

18 liquidated, and we, as a large pension fund, and many of

19 our peers, use swaps to hedge very significant inherent

20 risks in our pension plans, interests rate, foreign

21 exchange, and other risks, and we need to be very, very

22 certain that those positions are maintained through any

23 sort of market or other stress.

24 Second of all, a logical followup to that is

25 that there is a mechanism by which we can expeditiously
Page 135

1 move those positions to an FCM that is, in fact, good --

2 in good standing, so we can make sure our margin payments

3 and other obligations can continue to be maintained as

4 they would otherwise be, again, through no fault of our

5 own something gone awry at the FCM.

6 And last but not least, is to ensure that any

7 margin that we've posted -- initial margin with the FCM,

8 that's having an issue, is, in fact, available to us to

9 move to the new FCM, insofar as then we don't have a

10 double-up situation, that is, we've got a substantial sum

11 that's posted with FCM-A that has a problem. Now FCM-B

12 says, great, you know, we're happy to accept the

13 positions, but now we've got to repost, in essence, that

14 sum again with FCM-B, because FCM-A's -- our margin is

15 tied up with them.

16 DANIEL MAGUIRE: Mark, can I just ask how that

17 differs in the GCP that is LSOC, because our understanding

18 is that under LSOC we'd move the positions and the

19 associated collateral that would be the DCO, as well.

20 So I'm trying to understand what is the

21 difference there.

22 MARK SZYCHER: I think -- I think in -- Danny,

23 I think in principle you're -- you're absolutely right,

24 and I think on paper it should work that way. We just

25 have -- I think we would just derive a great deal more
Page 136

1 comfort if, in essence, we were holding or at least the

2 FCM wasn't holding any collateral, and we were in a better

3 position to, I guess, have fewer entanglements and -- and

4 have fewer steps that we would need to go through, I mean,

5 in order to extricate ourselves from an FCM situation, and

6 as described with the GCP model, we believe, if we've

7 structured it correctly, legally and operationally, in

8 essence we're doing nothing more than replacing the

9 guarantor with another guarantor, a solvent guarantor,

10 which should, in principle, be easier than again the --

11 the extrication from a -- from a more stringent as --

12 (Participants talking at the same time)

13 DANIEL MAGUIRE: I guess the only point I want

14 to say is that the FCM under LSOC doesn't hold the

15 collateral like the DCO does. Again, different models,

16 but ...

17 BOB WASSERMAN: Christine, does that --

18 CHRISTINE AYOTTE-BRENNAN: Yeah. So I just

19 wanted to add a couple of things. I mean, I think the

20 question on portability, Mark tried to, you know,

21 answered, but I just wanted to say from Fidelity's point

22 of view we are worried about the portability, but at the

23 end of the day what we are worried about the most is

24 segregation, and -- and really protecting the customer

25 collateral.
Page 137

1 Excuse me. There was a point made, I think,

2 earlier -- in the earlier panel that we wouldn't be here

3 but for MF Global, and what we're really focused on is

4 futures, because we didn't really worry about that

5 segregation in the swaps market. Not true.

6 You know, we're required, by the '40 Act,

7 obviously, to segregate our collateral. We've been doing

8 it, you know, since 1940. So it's something that we're

9 focused on. It's something that we think our customers

10 deserve.

11 We agree with Tim that there is a difference

12 between the swaps and futures, you know, markets, and

13 we've -- we've argued that from the beginning which is why

14 we think we do need increased protections in the swaps

15 market.

16 And at the end of the day, when we think about

17 it, we see -- you know, we hear: If you want to increase

18 protection, it's going to cost you more, and we can't give

19 up a lien, and -- you know, it -- when we look at it, we

20 see the customer is the one who's bearing most of the

21 burdens here: The increased costs, the reduced

22 segregation protections, and I'm not sure that's the way

23 this was intended to go.

24 When I sit and think about how to solve this,

25 because I've heard all of the concerns and all of the
Page 138

1 proposals, I don't know what the right answer is, but it

2 seems to me that we keep going round and round, because we

3 need a lien, but that makes the customer property, and we

4 have severe bankruptcy issues.

5 I realize that we're going to talk about 190

6 later on today and that tomorrow there's going to be some

7 more bankruptcy discussion, but I really think that in

8 order to solve almost all of the issue that we've all

9 brought up here, we really have to focus on a bankruptcy

10 fix.

11 BOB WASSERMAN: Chris.

12 CHRIS PERKINS: Getting back to portability,

13 we think the key to portability is ensuring that guarantee

14 funds size is not too large, because if you think of the

15 perspective of the FCM, to whom the positions are ported,

16 if they have to post a guarantee fund for a port, not only

17 do they have to fund it during a period of market stress,

18 it's also subject to mutualization.

19 So getting back to my earlier point on the

20 defaulter-pays model, we believe that it's very important

21 to ensure seamless portability, and thus understand

22 segregation is incredibly important, but if portability is

23 successful, you don't even have to get to segregation. So

24 we believe it's equally important.

25 BOB WASSERMAN: Christine.
Page 139

1 CHRISTINE COCHRAN: I'd like to piggyback on

2 what Christine was saying, as well.

3 Again, Christine Cochran with the Commodity

4 Markets Council.

5 I really appreciate CIEBA. They have been

6 very kind to us as an organization, and spending a lot of

7 time walking through their proposal, because, as I said

8 earlier today, you know, we represent a wide variety of

9 market participants.

10 And what I would just like to -- what we are

11 taking from this right now is that this is -- this is a

12 very thoughtful proposal. It addresses a lot of concerns

13 that a number of market participants share.

14 However, we are hesitant to pass judgment on

15 it in a vacuum. We are still waiting for the MF Global

16 bankruptcy -- or MF Global investigation to be complete.

17 You know, there are a matrix of solutions to be

18 considered, and this is what I think Christine did a very

19 nice job articulating, whether they are back-office

20 solutions, like reporting, and disclosure requirements,

21 whether they are bankruptcy changes or these more

22 structural changes, I don't think we can consider any

23 single one in a vacuum. We have to look at them together,

24 how they inter -- interact within each other, and the cost

25 and benefits across all markets participants, because we
Page 140

1 need to be very careful that we're not choosing solutions

2 that benefit one class of market participants any more or

3 less than any other class of market participants.

4 TIMOTHY DOAR: Tim Doar, CME.

5 You know, I think underlying the tone of many

6 of the comments here is the idea that when we talk about

7 swaps perhaps you're talking about interest rate swaps or

8 credit default swaps, but there is the 8515 rule, for

9 instance, which promises to recast many products that are

10 currently cleared as futures, particularly in the energy

11 space.

12 But honestly I don't know what the bounds of

13 this 8515 process will be. So -- okay. Apparently nobody

14 does, but many products --

15 BOB WASSERMAN: Some of my colleagues who

16 focus on that do, but I'm just -- that's not my --

17 TIMOTHY DOAR: All right. Sorry. I didn't

18 mean to make a metaphor here, but I think we do take a

19 different view to the types of record keeping requirements

20 that are associated with LSOC, due to our station in the

21 world.

22 We do offer clearing services for interest

23 rates swaps, obviously, and for credit default swaps, as

24 well, but with the workings of the 8515 rule, many

25 products that are currently classed as being futures, as
Page 141

1 many as 600, our last estimation, will be reclassed as

2 swaps. So that means that if you are an FCM, and you have

3 any kind of activity on ClearPort, for instance, you are

4 going to have to get very used to LSOC standards, your

5 requirements under LSOC's methodology, and the reporting

6 requirements thereunder, which is perfectly fine, but

7 it's -- you know, it strikes us that it's a -- it's a

8 place to exercise some degree of caution for the reasons

9 that I tried to articulate earlier.

10 Many of the accounts that were put in place to

11 service business under ClearPort were developed within a

12 futures context. At least in swaps, when we're talking

13 about rates and credit, we are at the beginning of things,

14 and we can set the accounts up in a way that they can be

15 optimized with respect to whatever the end regulatory

16 requirements become.

17 Within the context of a -- of a futures --

18 traditional futures FCM, and its back-office business

19 infrastructure, accounts have been set up for a variety of

20 purposes, for a variety of reasons. Related accounts do

21 exist in this world. You know, knowing which account or

22 set of accounts to report under, in an LSOC methodology

23 may not be problem, but it might be, you know.

24 So that the disposition of the portfolio of

25 rights and obligations report, going up against the broad
Page 142

1 class of products that will be classed as swaps is not a

2 trivial issue in my mind. I may be alone on this, but I

3 wouldn't trivialize the issue.

4 There are issues that we are going to have to

5 delve into, as this regulation finds its face, and it will

6 have an impact on our FCM's, as well.

7 BOB WASSERMAN: Byron?

8 BRYON BALDWIN: Obviously in terms of

9 portability, in terms of Eurex's individual segregation,

10 portability clauses come into use in the agreement, but

11 also Eurex will have an interim participant facility. So

12 in the event of an FCM default a buy site firm can make

13 margin direct to Eurex Clearing for a five-day period,

14 which gives that buy site time to switch to another

15 clearer. So that -- that's a part of Eurex's cleared

16 swaps offering.

17 BOB WASSERMAN: I'd ask to let that be the

18 last comment. I apologize. I think this is the sort of

19 topic one could spend all day talking about, and I would

20 much enjoy that. But we only have 45 minutes for lunch.

21 We are going to be starting very promptly at 1:30. There

22 are a number of places to get sandwiches or salads, both

23 in this building and within a one-block radius. And so I

24 look forward to seeing you all in 45 minutes.

25 (Proceedings recessed for lunch)
Page 143

1 TRANSCRIBING REPORTER'S CERTIFICATE

2

3

4 I, CARRIE HEWERDINE, RDR, California CSR No.

5 4579, Certified Shorthand Reporter, Nevada CCR No. 820,

6 Certified Court Reporter, do hereby certify;

7 That the foregoing transcription was prepared by

8 me from the DVD provided to me, and that it reflects in

9 typewritten form, to the best of my abilities, the

10 verbalizations presented on said recording;

11 That the foregoing is a true and correct

12 transcription of the recording provided to me.

13 I further certify that I am not a relative or

14 employee of any attorney of the parties, nor financially

15 interested in the action.

16 I declare under penalty of perjury under the laws

17 of California that the foregoing is true and correct.

18 Dated this 11th day of March, 2012.

19

20

21

22 _________________________________

23 CARRIE HEWERDINE, RDR

 California CSR No. 4579

24 Nevada CCR No. 820

25