UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 SECURITIES AND EXCHANGE COMMISSION

 JOINT CFTC-SEC STAFF ROUNDTABLE DISCUSSION ON

 PROPOSED DEALER AND MAJOR PARTICIPANT DEFINITIONS

 UNDER DODD-FRANK ACT

 Washington, D.C.

 Thursday, June 16, 2011
 2

 1 PARTICIPANTS:

 2 CFTC:

 3 GARY GENSLER, Chairman

 4 ANANDA RADHAKRISHNAN

 5 MARK FAJFAR

 6 DAN BERKOVITZ

 7 ANDREI KIRILENKO

 8 TERRY ARBIT

 9 SEC:

 10 ROBERT COOK

 11 JOSHUA KANS

 12 RICHARD GRANT

 13 GREGG BERMAN

 14 Panel A:

 15 STEVE WALTON

 Bank of Oklahoma

 16

 MICHAEL MASTERS

 17 Better Markets

 18 ERIC CHERN

 Chicago Trading Company

 19

 SEAN COTA

 20 Cota & Cota Oil

 21 ED PROSSER

 Gavilon

 22
 3

 1 PARTICIPANTS (CONT'D):

 2

 RICHARD OSTRANDER

 3 Morgan Stanley

 4 JOHN NICHOLAS

 Newedge

 5

 RUSS WASSON

 6 NRECA

 7 RON FILLER

 New York Law School

 8

 RON OPPENHEIMER

 9 Working Group of Commercial Energy

 Firms

 10

 Panel B:

 11 GREG TODD

 Bank of America

 12

 MICHAEL MASTERS

 13 Better Markets

 14 JON HIXSON

 Cargill

 15

 BRENDA BOULTWOOD

 16 Constellation

 17 JAMES CAWLEY

 Javelin Capital Markets

 18

 JOHN JANNEY

 19 Large Public Power Council

 20 BELLA SANEVICH

 NISA Investment Advisors, LLC

 21

 RON FILLER

 22 New York Law School
 4

 1 PARTICIPANTS (CONT'D):

 2 CAMILLE RUDGE

 The PrivateBank and Trust Company

 3

 MARY-MARGARET COLLIER

 4 Tennessee Comptroller of the Treasury

 5 JOHN McCARTHY

 GETCO

 6

 Panel C:

 7

 MARCUS STANLEY

 8 Americans for Financial Reform

 9 MICHAEL MASTERS

 Better Markets

 10

 MATT NEVINS

 11 Fidelity

 12 PETE KYLE

 University of Maryland

 13

 WILLIAM THUM

 14 Vanguard

 15 RON OPPENHEIMER

 Working Group of Commercial Energy

 16 Firms

 17

 18

 19 * * * * *

 20

 21

 22
 5

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

 2 (9:04 a.m.)

 3 MR. COOK: I think we're going to get

 4 started. Good morning. If people could take

 5 their seats.

 6 Good morning. I'm Robert Cook. I'm

 7 director of the Division of Trading and Markets at

 8 the SEC and I'm going to offer a few introductory

 9 remarks and then a CFTC staff will offer a few

 10 introductory remarks and then we'll begin with the

 11 panel discussion.

 12 I'm joined on this panel by Joshua Kans,

 13 who serves as senior special counsel in our Office

 14 of Chief Counsel, and by Richard Grant, an

 15 attorney in our office of Derivatives Policy.

 16 It's our pleasure to welcome you to this Joint

 17 CFTC/SEC Staff roundtable on the proposed dealer

 18 and major participant definitions of Title VII.

 19 On behalf of the SEC staff I'd like to

 20 thank all of our distinguished panelists who are

 21 here with us to share their insights, views,

 22 recommendations, and thoughts on this very
 6

 1 important topic. We are grateful to each of you

 2 for taking time out of your busy schedules and in

 3 some cases for changing your schedules, to be here

 4 today and we look forward to hearing your views.

 5 I also want to extend a special thanks

 6 to the CFTC for hosting this roundtable and to the

 7 staff at both the CFTC and the SEC who have worked

 8 tirelessly behind the scenes to make this

 9 roundtable a reality.

 10 Before continuing, for the record, I

 11 need to give our standard disclaimer that all of

 12 my remarks and questions and those of my SEC

 13 colleagues participating in the roundtable

 14 throughout the course of today, reflect only our

 15 personal views and do not necessarily reflect the

 16 views of the SEC, any individual SEC commissioner,

 17 or other members of the SEC staff.

 18 Also, before we dive into the

 19 roundtable, I'd like to touch briefly on a few

 20 more general issues that may bear on our

 21 discussions today. First, I'd like to address our

 22 efforts to address the Title VII effective date
 7

 1 issues. At the SEC we announced on Friday that we

 2 intend to take a series of actions in the coming

 3 weeks to clarify the requirements that would apply

 4 to security-based swaps as of July 16th, the

 5 one-year effective date of Title VII, and to

 6 provide appropriate temporary relief.

 7 The Commission took the first of these

 8 steps yesterday issuing an order to provide

 9 guidance regarding which provisions of Title VII

 10 governing security-based swaps become operable as

 11 of the effective date and providing temporary

 12 relief from several of these provisions.

 13 Specifically, the Commission's action makes clear

 14 that substantially all of Title VII's requirements

 15 applicable to securities-based swaps will not go

 16 into effect on July 16th and it grants temporary

 17 relief from compliance with most of the new

 18 Exchange Act requirements that would otherwise

 19 apply on July 16th.

 20 As described in last Friday's

 21 announcement, the Commission will soon undertake

 22 two additional steps, first providing guidance
 8

 1 regarding, and where appropriate, temporary relief

 2 from the various pre-Dodd-Frank provisions that

 3 would otherwise apply to the securities-based

 4 swaps on July 16th. And second, the Commission

 5 will take other actions to address the effective

 6 date including extending certain existing

 7 temporary rules and relief to continue to

 8 facilitate the clearing of certain credit default

 9 swaps by clearing agencies functioning as central

 10 counter parties.

 11 I'd like to stress that our goal in

 12 taking these actions is to provide clear guidance

 13 on what will be required on July 16th and to

 14 provide appropriate temporary relief designed to

 15 preserve, to the extent appropriate, the current

 16 legal framework, until we complete the rulemaking

 17 task before us and until we've developed a

 18 workable implementation plan.

 19 I'd also like to stress that the purpose

 20 of these efforts is not to delay implementation of

 21 these important OTC derivatives market reforms,

 22 but instead to permit an orderly transition to a
 9

 1 comprehensive regulatory framework for

 2 securities-based swaps. Accordingly, we are not

 3 intending to oppose artificial deadlines through

 4 these efforts, but instead to put the agency in a

 5 position where we can implement these important

 6 new securities-based swap requirements in the most

 7 efficient manner while minimizing unnecessary

 8 disruption and cost to the market.

 9 After proposing the key rules under

 10 Title VII, the Commission intends to consider

 11 seeking public comment on a detailed

 12 implementation plan. Commission staff has been

 13 working with our fellow regulators and market

 14 participants in forums such as this to craft rules

 15 and establish implementation timeframes that are

 16 reasonable for the various rulemakings and

 17 reviewing what steps market participants will need

 18 to take in order to comply with our proposed

 19 rules.

 20 These discussions with market

 21 participants are vital to establish an

 22 implementation timetable that is workable. We
 10

 1 also recognize the importance of obtaining input

 2 on the implementation timeline for Title VII.

 3 One final general issue that relates to

 4 the discussions we'll be having today is the

 5 concern expressed by many market participants over

 6 the international reach and effectiveness of our

 7 proposed rules, particularly with regard to dealer

 8 registration. We acknowledge this concern and the

 9 request for greater clarity in this area. The SEC

 10 staff is actively considering how best to approach

 11 this issue including whether we should be

 12 addressing these concerns through a separate

 13 release focusing more holistically on all the

 14 international questions that have been raised.

 15 Turning now to our discussions today, we

 16 will focus on the core intermediary definitions

 17 contained in Title VII. We received extensive

 18 comment on the proposed definitions and appreciate

 19 the efforts that many of you have undertook to

 20 provide these comments and to meet with the staff

 21 of the two agencies. We have an opportunity today

 22 to engage in additional discussions focused on
 11

 1 many of the issues raised in these comments.

 2 I'd like to emphasize that the subject

 3 of the roundtable is the dealer and major

 4 participant definitions. We recognize that these

 5 definitions are linked to a number of related

 6 issues, these include issues about how the

 7 definitions, as well as how other requirements,

 8 will apply to multinational transactions and

 9 entities. These also include issues about the

 10 timing of implementation. We acknowledge these

 11 concerns and request for clarity and have taken or

 12 intend to take actions to address these issues,

 13 but these issues will not constitute the major

 14 focus of the roundtable.

 15 With that, let me again thank our

 16 panelists for their participation. The insight

 17 you bring will be extremely valuable to us as we

 18 move forward with final rules on these

 19 definitions. And now let me hand it over to CFTC

 20 staff for their opening remarks.

 21 MR. BERKOVITZ: Thank you, Robert. I'm

 22 Dan Berkovitz, general counsel of the CFTC and at
 12

 1 the table from CFTC we also have Ananda

 2 Radhakrishnan, who's the director of the Division

 3 of Clearing and Intermediary Oversight, and Mark

 4 Fajfar, who's in the Office of General Counsel and

 5 is our team lead for the swap dealer and entities

 6 definitions rules.

 7 I would also like to welcome and thank

 8 the panelists for taking the time to come here

 9 today and participate in this panel and offer your

 10 thoughts and insights and comments on this issue.

 11 I'd also like to welcome staff of both agencies

 12 and commissioners of both agencies who may be in

 13 attendance today or watching and thank all --

 14 everyone in attendance today.

 15 I'm going to turn it over to Mark who

 16 will give more further remarks on the purpose of

 17 today's meeting.

 18 MR. FAJFAR: Thanks. First of all we

 19 have our technical notes, before we forget. This

 20 meeting is being recorded and there's an official

 21 transcript being kept that will be available on

 22 the websites. For the panelists, the microphones
 13

 1 are push to talk. Please turn them off when

 2 you're done, and as usual, keep the cell phones

 3 and Blackberries off the table. They cause

 4 interference.

 5 Because the -- I'd like to talk a little

 6 bit about the format of the panel, especially for

 7 people in the audience and those on the phones, so

 8 you understand what we're going to be talking

 9 about. We received about 100 -- more than 130

 10 comment letters and we have already had roughly

 11 100 meetings with industry and other participants

 12 to discuss these topics and the primary purpose of

 13 the roundtable is really to address those comments

 14 and to try and coordinate the different comments.

 15 You should understand that we're going

 16 to go directly into the topics. We really won't

 17 have a lot of time to give background or

 18 explanation about the points that we're talking

 19 about. Nearly all of the panelists have provided

 20 extensive comment letters, so if you were

 21 wondering more about what people say you can go on

 22 the websites and look at their comment letters and
 14

 1 you can find more details there. Sometimes the

 2 panelists might refer to what they said in their

 3 comment letters and so forth.

 4 As Robert said, there are some topics

 5 that because of time constraints and to keep a

 6 focused discussion, we've talked with the

 7 panelists and we're just not going to address, and

 8 these include the exception in the swap dealer

 9 definition for insured depository institutions in

 10 connection with originating a loan -- we'll talk

 11 about other things related to ensured depository

 12 institutions, but not that specific exception --

 13 as Robert said, the application outside the U.S.

 14 of the definitions, what are the requirements that

 15 apply to swap dealers after it's determined and

 16 MSPs after it's determined that they should

 17 register, and also we're not talking about what

 18 are the transactions that are covered by the

 19 definition of swap and security-based swap, and

 20 that includes, for example, which transactions in

 21 the electricity space are swaps. That's an

 22 important issue that relates to the entity
 15

 1 definitions, but we're not getting into here.

 2 Also, you should know, that we've talked with the

 3 panelists about the topics that we're going to

 4 address and some of the panelists really only want

 5 to address certain topics. In fact, most of them

 6 are each here to address certain topics, so just

 7 because a panelist is not participating in a part

 8 of the discussion you shouldn't draw any

 9 conclusion from that.

 10 And most of all we'd like to encourage a

 11 dialogue between the panelists and the staff, and

 12 as I said, talk about what the different comments

 13 were and how to coordinate them.

 14 It wasn't said that Josh Kans and

 15 Richard Grant are also here from the SEC and I

 16 thought we would just -- if we want to go with the

 17 panelists on the first panel, just to introduce

 18 yourselves and then we'll go straight to the first

 19 topic. So, we want to start with Newedge?

 20 MR. NICHOLAS: John Nicholas, Newedge.

 21 MR. COTA: Sean Cota, Cota & Cota,

 22 petroleum marketers.
 16

 1 MR. PROSSER: Ed Prosser with Gavilon.

 2 MR. MASTERS: Michael Masters, Better

 3 Markets.

 4 MR. CHERN: Eric Chern, Chicago Trading

 5 Company.

 6 MR. WASSON: Russ Wasson, National Rural

 7 Electric Cooperative Association.

 8 MR. OSTRANDER: Rick Ostrander from

 9 Morgan Stanley.

 10 MR. FILLER: Ron Filler, New York Law

 11 School.

 12 MR. OPPENHEIMER: Ron Oppenheimer, I'm

 13 general counsel of Veto Inc., and I'm here for the

 14 Working Group of Commercial Energy Firms.

 15 MR. WALTON: Steve Walton, Bank of

 16 Oklahoma.

 17 MR. FAJFAR: Okay, so we're going to get

 18 right started with the definition of swap dealer,

 19 security-based swap dealer. In the statute there

 20 are four prongs, we call them, for lack of a

 21 better word. They're basically holding yourself

 22 in the market as swap dealer, being a market
 17

 1 maker, there's a regular business part of the

 2 definition, and the last is engaging in activities

 3 making you commonly known as a swap dealer or

 4 market maker. And we were thinking to start with,

 5 the first prong, to start at the beginning, and we

 6 sort of grouped the first and the fourth together,

 7 the holding yourself out and commonly known are

 8 generally the same, and we wanted to discuss

 9 starting at the beginning how -- the panelists

 10 views of how people make themselves known, and

 11 what it means to be commonly known as a swap

 12 dealer or hold yourself out as a swap dealer, and

 13 in particular, what the relevance of that concept

 14 has in swap markets where there's more of a --

 15 what we could say thinly traded or thinly

 16 executed, the negotiated markets, bilaterally

 17 negotiated, and what factors we should look at.

 18 Is there anybody who would like to start off with

 19 that?

 20 MR. WASSON: Mark, if I may, and I'd

 21 just throw this out for the consideration of the

 22 rest of the panel. When thinking about the word
 18

 1 dealer, which is not itself defined, as I know --

 2 insofar as I know in the statute, it occurred to

 3 me that a dealer has to be suffused with a profit

 4 motive, that it's self-evident that a dealer would

 5 be in business to make a profit. I mean, I can't

 6 imagine an altruistic swap dealer who says that I

 7 will take your trade -- I'll take the other side

 8 of your trade for a fee, but I'm only interested

 9 in recovering my costs. And that's a critical

 10 issue for us, that is public power entities,

 11 because as you know, electric cooperatives and

 12 municipal utilities operate on a not-for-profit

 13 basis. And so, you know, we don't have a profit

 14 motive, we're not driven by a profit motive, we're

 15 end users that hedge our commercial risk in an

 16 attempt to protect our members from price

 17 volatility and the fuels, interest rates, and

 18 electricity markets.

 19 So, when we use the term dealer, to me

 20 it implies someone who inherently has a profit

 21 motive and I just wonder if there's any discussion

 22 around that concept. Is there anyone that would
 19

 1 disagree with that?

 2 MR. FAJFAR: That's a -- another way I

 3 would phrase this question, and a lot we've talked

 4 about is, are you -- the question is, are you

 5 holding yourselves out -- the statute says holding

 6 yourself out as a swap dealer, and when it says

 7 that, does it mean a swap dealer as opposed to

 8 something else as opposed -- somebody who's ready

 9 to enter into swaps. What does it mean to hold

 10 yourself out as a swap dealer, for example, as

 11 opposed to somebody who's ready to enter into

 12 swaps? Is that a significant difference? Is

 13 there a difference between a dealer and other

 14 users?

 15 MR. WASSON: I hesitate to monopolize

 16 everything but it seems to me, Mark, that if

 17 you're holding yourself out as a swap dealer, then

 18 colloquially you are -- I mean, we think of people

 19 coming in off the street wanting to do a

 20 transaction and you as a dealer saying, I'll take

 21 the other side of that transaction for a fee. I

 22 mean, that's the way I think of it. So if I'm
 20

 1 holding myself out as a swap dealer, I would think

 2 that I would be open to doing swaps with the

 3 general public, you know, with folks that anybody

 4 that wants to do a swap. I'll make a market and

 5 I'll do that transaction as opposed to

 6 occasionally entering into swaps to hedge

 7 commercial risk. I see those as two different

 8 things.

 9 MR. OSTRANDER: Mark, I think it is

 10 critical that -- and there's a theme, I think,

 11 that runs through all four prongs, actually, which

 12 is that a dealer is somebody who's willing to

 13 enter into trades on either side of the market at

 14 any particular point in time. That doesn't mean

 15 they're always doing that. It doesn't mean

 16 they're continuously giving two-way quotes, but a

 17 dealer is someone who is known in the market as

 18 being willing to enter into the buy or sell side

 19 of a trade, generally with market participants. I

 20 think that is a critical piece of being a dealer

 21 and I think that piece actually runs through all

 22 the prongs and could help the commissions frame
 21

 1 how they think about all the prongs because I do

 2 think that element in and of itself is pretty

 3 critical.

 4 I think the other element is being

 5 willing to take risk. I think a dealer is someone

 6 who's known in the market as willing to do a

 7 trade. If an entity is not taking any risk, I

 8 would think that's more of a broker activity than

 9 a dealer activity. So, a dealer is someone who is

 10 out there willing to enter into trades, buy side

 11 or sell side trades, and willing to take risk on

 12 those trades. They may flatten their book at the

 13 end of the day, they may flatten it over time, but

 14 at any particular point in time they would be

 15 willing to take risk.

 16 MR. FILLER: So, I'm here from the

 17 academic side, but I have 35 years of experience

 18 in the industry, so I really think it's important

 19 for both commissions to maybe take a step back and

 20 as Russ and Rick just talked about is really to

 21 define what is a dealer.

 22 In the futures world, we don't have
 22

 1 dealers, we have brokers. We're agents. You do

 2 have dealers in the security side so you almost

 3 have to look to the securities world to see what

 4 is their definition of a dealer and whether that

 5 same definition can apply in the swap area. So, I

 6 mean, I think one of the critical aspects for both

 7 commissions is to look at and define what is a

 8 dealer, and as Rick just said, it really applies

 9 to all four prongs. It's just not holding oneself

 10 out, it's in the market making activity and

 11 regularly entered into the business and I think

 12 it's important to come up with a very specific

 13 definition of dealer with respect to swaps. So,

 14 that would be, to me, the most important starting

 15 point and then dealing with the holding oneself

 16 out aspect, I agree with Russ and Rick, it's

 17 really those firms that are willing to take either

 18 side of the market. Either they're going to be

 19 the long on the swap or the short on the swap, and

 20 to be honest, we know those 15 to 25 firms out

 21 there that actively play the role of swap dealer.

 22 I mean, they do 90 plus percent of the business.
 23

 1 The other critical issue for the

 2 commissions to deal with, in not only holding

 3 oneself out, but in the entire panel this morning

 4 -- both panels -- is who else should be falling

 5 within that definition of a swap dealer? We know

 6 the 25 firms or the 30 firms or the 40 firms who

 7 are actively involved in holding oneself out,

 8 taking both sides, but they all deal with hundreds

 9 or tens of thousands of counter parties. Is that

 10 the intent of Congress with Dodd-Frank to go after

 11 the other counter parties? Do they fall under the

 12 definition of major swap participant? Or do they

 13 fall within the exception?

 14 So, I think it's important for the

 15 commissions to not only define what is a dealer,

 16 but also to provide or establish certain specific

 17 exceptions or exemptions from the definition of

 18 swap dealer as well.

 19 MR. WALTON: Could I? I'm here

 20 representing a regional bank and I think that my

 21 position and our concerns are similar to those of

 22 banks of medium and small size throughout the
 24

 1 country that make loans to people who use hedging

 2 as a means to minimize their risk.

 3 I think there are two things that from

 4 our standpoint are important here, and the first

 5 is the issue that was just addressed about clarity

 6 and safe harbors. From the standpoint of a bank,

 7 we can't look at the swap dealer definition just

 8 in terms of its CFTC and SEC implications. Under

 9 the push out rule, as adopted, if a bank becomes a

 10 swap dealer, other than for interest rate or

 11 currency transactions, if it inadvertently becomes

 12 a swap dealer, it becomes ineligible to receive

 13 Federal Deposit Insurance for its deposits, for

 14 its people who use the bank, and can't use the

 15 Federal Reserve window. Those are two fundamental

 16 elements of being a bank. You're basically out of

 17 business if you don't have FDIC insurance for

 18 people who have a checking account at your bank

 19 and you're out of business if you can't use the

 20 Fed window.

 21 So, from our perspective, and I think

 22 that of most banks, clarity is essential here
 25

 1 because to the extent that there is, you know,

 2 general guidance about generally what it means to

 3 be a dealer, most banks will have to stay miles

 4 away from anything that might legitimately be

 5 characterized as swap dealer activity because

 6 being wrong potentially means being out of

 7 business.

 8 So, swap dealer activities for banks,

 9 which are a critical component of this business

 10 for small agricultural producers and energy

 11 producers in particular, is critical. We need

 12 clarity and frankly we think the proposed rules,

 13 though helpful in giving direction and guidance

 14 about what it constitutes to be a dealer, is

 15 simply insufficient for an insured depository

 16 institution that faces the death penalty if it

 17 gets it wrong once in how it deals with the swap

 18 dealer issue.

 19 The second thing I would say in the bank

 20 context is, though I think everyone feels that

 21 there is a general understanding of what a dealer

 22 is in the day-to-day large swap markets, banks
 26

 1 regularly, as part of making loans to small

 2 producers, enter into hedge transactions with

 3 those customers, not as a dealer, but as an

 4 accommodation as part of making that loan.

 5 If we have a farmer in Kansas who wants

 6 a loan secured on his wheat, we want him to hedge,

 7 he wants to hedge. When we make that loan and

 8 take that hedge, we immediately lay the hedge off

 9 on the market so that we as a bank are taking no

 10 risk. This is something the Federal Reserve and

 11 the OCC have permitted banks to do for decades and

 12 it's considered a brokerage activity, an agency

 13 activity, because we are transferring the risk

 14 directly to the market. That small farmer doesn't

 15 want to go to Chicago or New York and establish a

 16 relationship, and we as a bank are in a position

 17 to say to that customer, well, if your wheat goes

 18 up in value, since we have a security interest in

 19 your wheat, and your mark-to-market on the hedge

 20 goes down, you don't have to post collateral

 21 because we're money good, but if you get into a

 22 position where banks have to treat themselves as
 27

 1 dealers and exit this business because of the

 2 risk, that customer, who is -- has his wheat gone

 3 up in value by a million dollars but his hedge is

 4 now negative $500,000, if he's dealing with a swap

 5 dealer, he's going to have to post margin because

 6 the swap dealer's only relationship with him is

 7 that negative mark- to-market.

 8 So, that little farmer, is going to have

 9 to borrow to post margin, which he does not have

 10 to do today if he deals with a bank only. The

 11 commercial end user exception from posting margin,

 12 which I think you've done tremendous work to

 13 develop, is meaningless to a small farmer or

 14 energy produce if he has to transact, on one hand

 15 with the bank for his loan, and on the other hand

 16 with the market as a dealer.

 17 So, in the context of the dealer

 18 definition, my concern for banks is that we are

 19 accommodating customers in a transaction that

 20 transmits the risk to the market. That's a

 21 brokerage transaction and we would like clarity on

 22 that.
 28

 1 MR. FAJFAR: Let me ask, so that I think

 2 those comments really tee up a very good question.

 3 That's a perfect -- let's take that example, the

 4 small farmer who's going to take out the loan, now

 5 they want to hedge that loan. So, it seems that

 6 the consensus, so far, is that if the farmer chose

 7 to go to one of the 25 large banks to get the

 8 hedge, the bank would have to register as a swap

 9 dealer and the farmer would have to post margin.

 10 If, however, the farmer chose to get exactly the

 11 same swap from his commodities supplier, the same

 12 person he's dealing with commodities, he would not

 13 post margin, the commodities firm would not have

 14 to register as a swap dealer because it's in the

 15 business of handling this commodity, and if it

 16 were to go to a regional bank, the same regional

 17 bank that it's getting the loan from, then again,

 18 not a swap dealer because it's getting the loan,

 19 it's merely being accommodated, no need to post

 20 margin.

 21 So, it seems that from the customer's

 22 perspective, those three swaps are identical, but
 29

 1 because of the way the regulation is written and

 2 sort of the history of how the swap market has

 3 developed, they would in fact be very different.

 4 Is that the consensus on the group?

 5 MR. WALTON: I'm not sure. I would say

 6 this. I think it's different from the vantage

 7 point of the different people who transact with

 8 that farmer. If your only transaction with the

 9 farmer is to take his hedge transaction and he's

 10 protecting the price of wheat and wheat goes up,

 11 and you don't have a security interest in all of

 12 his productions, so you're not benefitted on that

 13 relationship. All you have is the fact that when

 14 you do the mark-to-market of his hedges, he's

 15 down, and he's a small guy. You're going to

 16 require that he post margin. For him to do that

 17 in that context, he will then turn to his credit

 18 facility and he will borrow money and if he has

 19 the hedge where he has the loan, the bank -- we do

 20 this every day, with hundreds of borrowers --

 21 MR. FAJFAR: I just want to -- I think

 22 we can address it, but you're saying that we
 30

 1 should write the swap dealer definition to get to

 2 a certain policy result about how people have to

 3 post margin? Is that basically --

 4 MR. WALTON: No, I'm pointing out an

 5 implication of the swap dealer regulation if

 6 banks, in performing this basically -- assisting

 7 that person going to the market category of

 8 transaction effectively have to exit the business

 9 as swap dealers, so that they cannot obtain that

 10 service from the bank that's also making the loan,

 11 because, again, if a bank's a swap dealer, the

 12 bank's out of business, so the bank won't be a

 13 swap dealer.

 14 If the customer has to get the swap from

 15 door number one and the loan from door number two,

 16 you can't look at the relationship on an

 17 integrated basis. There's no one there to look at

 18 it on that basis. You're going to look at his

 19 mark-to-market on the swap, for which he'll post

 20 collateral and he will borrow on the lending

 21 facility. The net result is, people who are not

 22 borrowing to post margin today, because they get
 31

 1 the service from their banks, will be borrowing to

 2 post margin tomorrow because they have two

 3 distinct relationships.

 4 MR. RADHAKRISHNAN: Let me see if I can

 5 clarify this because the Commission has proposed

 6 margin rules for uncleared swaps and in the

 7 proposal the Commission did not seek to require

 8 dealers to collect margin from commercial end

 9 users, so I don't know if you're aware of that --

 10 MR. WALTON: I am.

 11 MR. RADHAKRISHNAN: Okay, so, but what

 12 you're saying is this, I'm a farmer, I come to

 13 you. I borrow money. Why do I borrow money? So

 14 I can go and plant?

 15 MR. WALTON: Yes.

 16 MR. RADHAKRISHNAN: Okay. What's your

 17 security interest?

 18 MR. WALTON: The crops.

 19 MR. RADHAKRISHNAN: The crop. So, then

 20 what else do I do with you? I do a swap -- do you

 21 do a swap or do I do a swap?

 22 MR. WALTON: You hedge your transaction
 32

 1 with me as your counterparty for the swap. I then

 2 put it into the -- you may be a dealer because you

 3 do a swap with me, right? So, I know we're not

 4 supposed to talk about the IDI exception, but I'm

 5 wondering whether the IDI exception may benefit

 6 you, but --

 7 MR. RADHAKRISHNAN: No.

 8 MR. WALTON: It will not. Okay, so

 9 let's assume it does not. So, looking at it from

 10 my perspective, even if you're a dealer, the

 11 Commission is not proposing to require me to put

 12 up margin with you. In fact, all the Commission

 13 is suggesting is that we have a -- some sort of a

 14 credit support arrangement. And whether I have to

 15 post margin with you is a function of, you know,

 16 the credit support arrangement that I have with

 17 you.

 18 So, I'm trying to understand how I'm

 19 worse off.

 20 MR. RADHAKRISHNAN: Okay, it's because

 21 you don't require, from a regulatory standpoint,

 22 that the commercial end user post margin, the
 33

 1 self-interest of the swap dealer whose only

 2 relationship is taking the hedge, we will require

 3 him to take margin. If I'm the farmer and hedge

 4 and tomorrow the price of wheat goes up, and so my

 5 mark-to- market with you, my swap dealer, that's

 6 the only relationship, shows that I'm down

 7 $100,000 on my swap, and you have no other

 8 relationship with me, it really doesn't matter

 9 whether the CFTC requires you, as a swap dealer,

 10 to take margin, you will take margin to protect

 11 yourself against the risk that I have a loss.

 12 MR. WALTON: Fair enough. But if that's

 13 the case, what difference does it make whether we

 14 make you a deal or not? You're going to collect

 15 margin anyway, right? That's what you're saying?

 16 MR. RADHAKRISHNAN: No, what I'm saying

 17 is if we, as a bank, become a swap dealer when we

 18 enter that trade, we won't take that trade because

 19 if we are a swap dealer, we're out of business as

 20 a bank. Banks will stop providing that service

 21 and the bank is in a unique position that it can

 22 say, since I do both the loan and the swap, I
 34

 1 don't have to take margin when you swap goes down

 2 because the collateral for my loan has

 3 correspondingly gone up.

 4 MR. WALTON: Right. You say you're

 5 going to be out of business because --

 6 MR. RADHAKRISHNAN: Under the push-out

 7 rules --

 8 MR. WALTON: Oh, okay.

 9 MR. FAJFAR: I think we're going to have

 10 to move on because people use swaps for a lot of

 11 different things. So far we've talked about swaps

 12 in connection with loans and we'll just -- we

 13 really have to avoid getting into the specific

 14 business purpose that each business uses swaps

 15 because there is about 30,000 end users, so, I

 16 think we'd like to move on to the market making

 17 point, and some of the same points will come up --

 18 MR. FILLER: Mark, may I just make one

 19 other point before we get to the specific on

 20 market making, and Ananda raises a very important

 21 point for the commissions to consider, and it's a

 22 policy argument that is very difficult to address
 35

 1 but you need to consider, and that is, swaps have

 2 always been "a bilateral or unclear world." Dodd-

 3 Frank, and your regulations, are moving swaps to

 4 the traded, clear world, but it's not there yet.

 5 MR. FAJFAR: Right.

 6 MR. FILLER: And it may be six months,

 7 it may be a year or two years before we get to

 8 that environment. Your swap dealer definition is

 9 coming out this year, well before we get to the

 10 "traded or cleared" environment, and how do firms

 11 that deal with this transition period -- because

 12 if you start to clear swaps, as Russ just

 13 mentioned, on the point of view of, well, whether

 14 I do futures, which is margin, or I do clear

 15 swaps, which is margin, and how you finance that,

 16 because it is a hedged security agreement

 17 financing arrangement, what do we do between now

 18 and that point until we get to the cleared

 19 environment, which is a little bit different than

 20 the current bilateral world, and what -- which

 21 firms qualify for a swap dealer now who may not be

 22 in the cleared world is a very difficult issue and
 36

 1 policy argument for the commissions to deal with.

 2 MR. FAJFAR: Right. Okay. Thanks. And

 3 the market making tasks, the thing I wanted to get

 4 to is, you said, and a lot of the commenters have

 5 said, that a dealer is somebody who's willing to

 6 take either side of a trade, basically at any

 7 time, and it was also, I think, putting aside the

 8 cooperatives, I think everybody else on the table

 9 would agree they do not do swaps unless they make

 10 a profit. So, take it for a given that if you're

 11 in a profit making business, you're using the swap

 12 to increase -- to have a business benefit.

 13 So, the question is, if we defined --

 14 there's two questions I have, first of all, if you

 15 said a dealer is somebody who's willing to take

 16 either side in order to make a profit, are we sure

 17 -- is everyone here sure that they could live with

 18 that as the definition? Because I think a lot of

 19 non -- a lot of firms outside of the 25, top 25,

 20 would do a swap with a counterparty if it were a

 21 given that they were going to profit from it and

 22 these counterparties were there ready to do the
 37

 1 swap.

 2 And also, you were saying that the --

 3 this two- sided definition runs through the whole

 4 statute, but should we view the four prongs

 5 separate? Is there a difference between being a

 6 market maker and being -- holding yourself out as

 7 a dealer or being in the regular business of

 8 entering into swaps? Are we saying that the four

 9 prongs are really just sort of facets of the same

 10 point?

 11 MR. CHERN: I think it actually falls

 12 (inaudible), Mark. I agree with the point of it

 13 being one part of the issue being, you know, for

 14 someone to hold themselves out as a dealer. It

 15 means part of it is that they mean -- that they

 16 will take either side at any given time. I think

 17 that's necessary but not sufficient for the

 18 definition.

 19 I find myself asking, hold themselves

 20 out as a dealer to whom? You know, if you have

 21 traditional market maker over the last several

 22 decades trading on the floor in one of our
 38

 1 exchanges somewhere, which is where my firm

 2 started and where a lot of the liquidity providing

 3 firms started, you know, those firms are hardly

 4 swap dealers if you think about it. They're on a

 5 floor, they're holding themselves out as market

 6 makers, I suppose, but to whom? To brokers in the

 7 pit. To maybe the intermediary that's

 8 representing a customer. They're certainly

 9 willing to take either side of a transaction at

 10 any given moment. That is sort of a definitional

 11 aspect of providing liquidity. They certainly are

 12 not touching a customer. They're not facing off

 13 one-on-one with a customer. They're not holding

 14 customer funds, they're not structuring deals,

 15 they're not -- there's no sort of customized

 16 products that are being structured to meet the

 17 needs of a farmer somewhere or a cooperative of

 18 other, so I think that we need to be thoughtful

 19 about how we look at those definitions. I think

 20 that certainly, I agree, you know, swap dealers

 21 are certainly holding themselves out as dealers.

 22 In doing so, they are willing to take either side
 39

 1 of the market.

 2 When I think about the definitions and I

 3 think about really the intent behind Dodd-Frank

 4 and all of the four prongs, really what we are

 5 talking about is the intent to take as much of the

 6 trading that was done in a nontransparent,

 7 non-cleared, non-standard world, and put that

 8 somewhere where the regulators would be able to

 9 see it and understand it and measure it. And I

 10 think that if this definition of swap dealer is

 11 too broad what we're going to find is that the

 12 impact of that will be less diversity in the

 13 marketplace and people who find themselves making

 14 a choice to be a swap dealer or not are certainly

 15 going to be exiting businesses that they already

 16 were in otherwise.

 17 MR. KANS: Eric, if I could ask a follow

 18 up question, though, about that. If your

 19 implication is that to be a dealer is not enough

 20 to have two-sided quotes and be holding yourself

 21 out at any time, you have to do something more,

 22 something with a customer, something structuring,
 40

 1 what exactly -- what is the limiting principle?

 2 How much more would you have to be to be a dealer?

 3 MR. CHERN: Okay, so you're asking -- by

 4 my reason you're saying, what more -- what other

 5 activities is a swap dealer doing than what I'm

 6 saying should be below that level? I think that,

 7 you know, if you look at -- take my firm as an

 8 example. Everything we trade is traded centrally,

 9 it's cleared, it's standardized, it's transparent,

 10 it's fully regulated, there's a broker-dealer by

 11 the SEC and everything we do on all the futures

 12 exchanges, the CFTC has full purview over. So, I

 13 think that when you get into a position where you

 14 are dealing with customers and structuring any

 15 sort of nonstandard, customized, bilateral

 16 agreement, so I think any one of those aspects, if

 17 it's customized, it's not standard. If you're

 18 dealing with a customer, so it's not cleared, it's

 19 a bilateral agreement, if it's not transparently

 20 traded, so if there's not, you know, an open

 21 competitive market place. I think these are all

 22 aspects. I think holding any sort of customer
 41

 1 funds, I think, is another aspect.

 2 A lot of my competitors, and my firm

 3 included, we don't do any of that. When I think

 4 of a dealer, that's exactly what I think of, is

 5 someone who is facing off with a customer to

 6 provide a necessary service to that customer,

 7 that's just not what we do.

 8 MR. BERKOVITZ: Can I ask the question a

 9 slightly different way? It was -- it's been

 10 embedded in several of the questions and several

 11 of the answers. If we have an objective test, I'm

 12 assuming that we could establish an objective test

 13 such as what we're talking about, two-way, always

 14 ready, then to what extent does -- we're talking

 15 about additional factors -- does motivation -- the

 16 underlying motivation for doing that, is that

 17 relevant? Should this be just purely objective

 18 test if somebody on the outside could say, well,

 19 this person is always ready to make quotes on both

 20 sides. Some parties do that as an adjunct to some

 21 other business. Some parties, that's the sole

 22 reason they're doing it. And should those other
 42

 1 -- like the motivation or the business model of

 2 the firm that's engaging in this activity be a

 3 relevant factor in terms of whether that activity

 4 is in fact dealing?

 5 MR. OPPENHEIMER: I think --

 6 MR. MASTERS: I was just going to make

 7 one point, or two points. I mean, the statute is

 8 pretty clear. It's disjunctive in terms of, you

 9 know, there's four parts, so I mean, it's any one

 10 of those, but then the other point is, is with

 11 regard to, you know, the for profit entity, I

 12 mean, you know, I think you've got to be careful

 13 in the sense of, while a swap dealer -- if they

 14 were exclusively a swap dealer and they were just

 15 doing a for profit enterprise I could see that

 16 issue, but what if you're another kind of

 17 financial institution and used the swap dealer

 18 part of your business as sort of a loss leader, if

 19 you will, and you tie that together and sort of

 20 like that makes things a little more complex in

 21 terms of a pure, you know, for profit. You tie

 22 one thing to the next, oh, no, this isn't an area
 43

 1 that we make any money in, but the other part of

 2 the business we do and we, you know, we get

 3 business that way. So, anyway.

 4 MR. WASSON: Of course, I presume that

 5 you wouldn't do the loss leader solely. I mean,

 6 you would have to tie it to a profit making

 7 activity, otherwise you wouldn't do it, I presume.

 8 MR. MASTERS: That's right, and I'm just

 9 suggesting the Commission to be aware of that sort

 10 of avenue.

 11 MR. WASSON: Yeah. And I think the

 12 question about taking both sides of a trade is

 13 interesting for us because, I mean, we don't

 14 trade, you know, we're hedging, and so it seems to

 15 me that the essence of being a swap dealer

 16 involves trading, you know, or dealing, or

 17 speculation.

 18 MR. PROSSER: I do think that motivation

 19 certainly should be a part of how you look at

 20 this. We are a commodity supply chain management

 21 business. We access the swap market infrequently

 22 because of specific risks, but I do have buy side
 44

 1 risk at some point and sell side risk at some

 2 point, so I am on both sides of the market. I am

 3 certainly not making markets, but because I hedge

 4 a producer on one side and a consumer on the other

 5 side, I enter the market looking for both sides of

 6 the marketplace, and certainly the activity that

 7 we create through, we don't feel like should be

 8 defined as dealing in these instruments but we do

 9 need both sides because we are the merchant.

 10 As we move our physical commodities

 11 through the system, sometimes I need to hedge the

 12 long side, sometimes I need to hedge the short

 13 side, either side of the market, but certainly not

 14 making markets in either of those and we don't

 15 feel like that activity should get caught up.

 16 MR. FAJFAR: How do you distinguish that

 17 from -- I mean, because from a customer's -- a

 18 customer is always only interested in whatever

 19 they're interested in, and then there is a source

 20 that's there serving both sides of the -- how do

 21 you distinguish that from a dealer?

 22 MR. PROSSER: Well, again, I think that
 45

 1 this idea of motivation -- my motive is not to go

 2 take bid ask spread from the marketplace by making

 3 a market with outside parties on swaps. My

 4 motivation is to avert risk in my supply chain.

 5 Some of those have to be on buy side, some of

 6 those have to be on the sell side, but my

 7 motivation is not the transaction -- trying to

 8 take profit from the transaction of dealing with

 9 these swaps, it is to try to use the swaps to risk

 10 -- to avert risk inside of my supply chain. So I

 11 do think that motivation gets at the heart of

 12 those that are trying to deal in swaps and those

 13 that are certainly just using them as instruments

 14 of hedging.

 15 MR. OPPENHEIMER: The word we've heard a

 16 lot around the table in every context we've

 17 discussed so far is customer, okay, and that

 18 connotes a motivation. Are you in the market

 19 because you want to serve a customer base or are

 20 you in the market, as was just said, for the

 21 purpose of your own hedging needs or to take your

 22 own position in the market? So, motivation is
 46

 1 clearly a part of this and if your motivation is

 2 customer based, that's when you start looking at a

 3 dealer.

 4 So, we really do have to continue to

 5 focus on that aspect of dealer activity, again,

 6 customers, you're making a profit, it all ties

 7 together in that respect.

 8 The other point I want to say about

 9 motivation is that we use the words, or you used

 10 the words in the proposal, facilitate or

 11 accommodate, okay. Facilitate or accommodate has

 12 to be the purpose for which somebody has gone to

 13 the market, not merely a consequence. So, if

 14 there's an active trader in the market, whether

 15 it's because we're in the supply chain, you've got

 16 both sides there or you're taking positions,

 17 you're just a trader, and I know I'm happy staying

 18 away from the phrase dealer-trader distinction

 19 because that's a little bit loaded, but the fact

 20 is there is a difference between people who are

 21 ready to take a trade as a trader because they

 22 have an interest in that position, and somebody
 47

 1 who's there because they want to serve a customer

 2 base.

 3 So, the point being there is that if the

 4 facilitation or accommodation is merely a

 5 consequence of your being in the market, that's

 6 not swap dealer activity. If it's the purpose for

 7 you being in the swap market, it would be.

 8 MR. NICHOLAS: I think that it's

 9 important to focus on the distinction between

 10 dealer and broker and Ron touched on that topic,

 11 even within the customer space, although obviously

 12 both dealers and brokers deal with customers, and

 13 in particular I think the concern of ours is the

 14 third prong of the test which is entering into

 15 principal transactions in the normal course of

 16 business.

 17 I think that if we look at the security

 18 space, for example, where there is a distinction

 19 between brokers and dealers, brokers often enter

 20 into principal transactions where they're either

 21 the initial trading counterparty on a trade or the

 22 accept a given for clearing purposes and
 48

 1 ultimately are acting in a principal capacity, but

 2 they're solely acting for customers. In other

 3 words, they're responding to customer orders,

 4 they're not taking risk because the transactions

 5 are usually riskless principal, and I think that

 6 there are brokers out there who are unsure as to

 7 whether they fall into the dealer definition

 8 primarily based on that third prong, and I don't

 9 think they should. I think customer-driven,

 10 riskless principal activity does not fall into the

 11 dealer definition even though you're acting in a

 12 principal capacity.

 13 MR. RADHAKRISHNAN: Can I make two

 14 observations? One has to do with this notion of a

 15 customer, and this everybody tells me I'm wrong.

 16 It's entirely possible that a bank could be a

 17 customer because it could engage in the swap to

 18 hedge whatever risk it takes in some other

 19 activity. So, I'm worried that if you take that

 20 notion too far, nobody will be a dealer because,

 21 you know, the bank will say, all I do is I am

 22 basically hedging my own risks, so I'm a customer,
 49

 1 therefore I'm not a dealer.

 2 MR. OPPENHEIMER: I think that's really

 3 not a concern and it goes back to something I was

 4 trying to get in to say before about holding

 5 oneself out. It's really almost ironic or funny

 6 as you look at it, but I think you don't have to

 7 worry so much about the holding oneself out

 8 because the firms that want to do customer

 9 business are going to register as swap dealers

 10 because they want to hold themselves out as doing

 11 that business to gain the customer business. So,

 12 that bank, if they're looking to do swap dealer

 13 business, they're going to hold themselves out and

 14 register because that's sort of the sine qua non

 15 of being able to go out to the marketplace and

 16 say, here I am. And I don't think you need to

 17 worry about that. If there was a bank that only

 18 turned around and hedged its loan portfolio or

 19 whatever, then they could be a customer.

 20 MR. RADHAKRISHNAN: So, what you're

 21 saying is, let people who want to become dealers

 22 register as dealers instead of the Commission
 50

 1 going after people saying, you know, you fall

 2 within the definition, you've got to register.

 3 That's --

 4 MR. OPPENHEIMER: I'm saying that I

 5 think there's an excess of concern about that firm

 6 at the margin, that you're going to get the firms

 7 who are engaged in dealing activity, certainly the

 8 top 10, 15, 25 that Ron was referring to before,

 9 and probably many others who do want to be engaged

 10 in that business coming forward and saying, here's

 11 my ticket, this is me holding myself out, let me

 12 register because now I want to go solicit

 13 customers. You've got a lot of stuff at the

 14 margin where we're having a hard time

 15 differentiating between market making and dealing

 16 or activity that could be market making or dealer,

 17 trading activity that might in some contexts look

 18 like dealing, and I think you don't really need to

 19 worry about that.

 20 You know, another point Ron made about

 21 we're in a transition phase, I think that counsels

 22 to the Commission starting with a very narrow
 51

 1 definition that captures the top 25, 30, 50, the

 2 ones who say I want to do customer business, here

 3 I am, and then let the market evolve, let's go to

 4 cleared trading, SEF trading, that will take out a

 5 lot of activity that currently is dealing activity

 6 where people have been avoiding the futures

 7 markets, doing a swap, and letting somebody else

 8 go to the futures market for them.

 9 A lot of that business will fall away

 10 because of the clearing requirement. After it

 11 does, then you can consider do we need to expand

 12 the market because we've missed a segment of

 13 dealers who really should be regulated.

 14 MR. FAJFAR: I'd like to ask -- a lot of

 15 points have been made. I would wonder where the

 16 authority in the statute is to do that. But we're

 17 going to talk about the de minimis standard in the

 18 next panel, so let's save that, but how would we

 19 respond to somebody who said, no, the dealer

 20 definition doesn't contain any reference to

 21 systemic risk or important dealers or people who

 22 are traditionally known as dealers, and what would
 52

 1 be the authority to say, well, we're going to

 2 capture 90 percent of the dealers and the other 10

 3 percent are not going to be capture, I mean, aside

 4 from the de minimis. Well, we'll talk about de

 5 minimis later. What would be the legal authority

 6 to do that?

 7 MR. OPPENHEIMER: Well, I mean, I think

 8 we've all agreed -- the Commission, I think, said

 9 it explicitly in the release, I'm not 100 percent

 10 sure -- that you tie prong three to exception C,

 11 right, the regular business exception, and the

 12 activities we're talking about that are at the

 13 margin are things that the Commission can easily

 14 interpret what regular business means and work

 15 those things in and manage that process.

 16 MR. FILLER: The specific section is

 17 712(d), when you have -- it gives you broad

 18 authority to exercise judicial prudence in

 19 establishing your regulation as we're dealing with

 20 any of the definitions, so the statutory issue to

 21 me would be 712(d) that you could provide comfort

 22 for. And I think what you're also hearing a lot,
 53

 1 in different ways, I mean, from the dealers, the

 2 banks, whatever, is what is this carve out for a

 3 hedge? Those who gauge in swaps from a hedge or

 4 reducing a mitigating risk perspective, should

 5 there be an exemption for that? And I think that

 6 is going to be a very important, again, policy

 7 argument for the commissions to consider, is

 8 should there be a hedge exemption and what should

 9 the terms of that hedge exemption be, and you've

 10 got to be careful because you can't do 100 percent

 11 test.

 12 As Russ mentioned, there's a profit

 13 test. Well, you can't do 100 percent profit

 14 because there may be circumstances where I am

 15 hedging 95 percent of the time or 98 percent of

 16 the time, but I might do one transaction that's

 17 "for profit" and we cannot allow -- so there's got

 18 to be a predominant or primary type intent to seek

 19 the profit as opposed to 100 percent test.

 20 There's got to be some carve out because

 21 unfortunately the definition of bona fide hedging

 22 was last amended in October of 1978. The market
 54

 1 has changed in the last 33 years and so the term

 2 hedge is, if you go to the hedge exemption, you've

 3 got to be careful about making it a 100 percent

 4 test.

 5 MR. FAJFAR: I think -- I'm sorry.

 6 MR. MASTERS: Well, I was just going to

 7 make one point on the hedge. Whole hedge

 8 exemption, which is a bigger, broader point. So,

 9 I run a hedge fund and there's nothing in my

 10 portfolio that I can't claim is not a hedge on

 11 something, so you have to draw the line somewhere,

 12 and the statute is pretty specific on narrowness

 13 of hedges to business risk. It's sort of

 14 Pandora's box. I mean, you can't just open it a

 15 little bit. So, you know, with regard to the

 16 other point that Ron was making about, you know,

 17 having customer business or -- and sort of -- and

 18 I think Ed was making as well -- on intent,

 19 there's a lot of companies where there's blends of

 20 this, where you've got part of the company doing

 21 one thing and part of the company doing another

 22 thing. And so what you don't want to do is open
 55

 1 something up so the part of the company that's

 2 really a swap dealer, even though there's another

 3 part of the company that's doing legitimate

 4 business risk, gets sort of a blanket exemption,

 5 and so that's -- I think that's a really important

 6 point.

 7 MR. FAJFAR: I'd like to ask, especially

 8 on the -- we've talked about having a motivation

 9 test and also a profit test, so, for you to think

 10 about -- so what kind of books and records

 11 requirements would we have? How would you, if you

 12 came and we brought a case and thought you were a

 13 swap dealer, how would you show that your

 14 motivation is to profit from the underlying, not

 15 from a bid ask spread? What -- how would that

 16 actually -- how would that rule read and then how

 17 would it be implemented? Because really the

 18 reason we have a rule is for two purposes, one is

 19 for people to read it and understand if they have

 20 to register, and the other is for the court to

 21 read it and understand if they have to register.

 22 So, how would that really work that that would be
 56

 1 -- would you be happy if we said a swap dealer is

 2 a person whose motivation is to profit from a bid

 3 ask spread rather than underlying, now you go

 4 figure out what that means in each instance?

 5 MR. OSTRANDER: Well, I guess I'm a

 6 little lost in how profitability has to be from

 7 bid ask spreads or not, but putting that aside, I

 8 think some things that are very important to keep

 9 in mind here, if you're talking about how do you

 10 prove you're not a swap dealer later on, maybe it

 11 would make sense for the commissions not to be too

 12 prescriptive at this point in time as to what sort

 13 of evidence would get you out. I think it is very

 14 important to create safe harbors, perhaps, that

 15 could be -- people could fall within, but I would

 16 have thought the concept here is not to define

 17 precisely what activity brings you over the line

 18 exactly, but rather what are the concepts that

 19 make you a swap dealer, what are some good safe

 20 harbors so people can be sure they're out of this.

 21 And there will be cases on the margin.

 22 And on that side I would also urge the
 57

 1 commissions to -- as has been suggested earlier,

 2 is to go a little bit slowly here, let the markets

 3 adjust to what this definition means, there will

 4 be entities, Morgan Stanley is certainly one of

 5 them, that are going to register as swap dealers

 6 but there are a lot of entities, I think, on the

 7 margins that aren't going to be sure. The burden,

 8 I would think, should be on the commissions to

 9 show that an entity is an unregistered swap dealer

 10 rather than for an entity to have to prove it's

 11 not -- not a swap dealer. Of course, if you got

 12 into a situation, you would want to bring out

 13 evidence, but I don't know if it makes sense today

 14 to specify exactly what that evidence would be or

 15 what form it would take. I think that's going to

 16 have to come out over time as we get used to what

 17 these definitions mean.

 18 MR. FAJFAR: How does that -- a lot of

 19 people really wanted very clear -- a very clear

 20 definition, very bright line. Many commenters

 21 said that, almost universally.

 22 MR. COOK: Maybe if I understood you
 58

 1 correctly, Rick, and I would be curious if other

 2 people agree with this formulation, you tell me if

 3 I get it wrong, is that you could have a general

 4 standard about what is or is not a swap dealer or

 5 securities-based swap dealer, but that wouldn't be

 6 necessarily very precise and prescriptive, but

 7 then you would have safe harbors for people, who

 8 you say, well, you don't even need to worry about

 9 that if you fall into this category. So, one

 10 example would be --

 11 MR. OSTRANDER: Exactly.

 12 MR. COOK: -- the traditional, on the

 13 securities side, trader-dealer distinction. It's

 14 a list of factors, developed no action letters,

 15 people who are on the securities side of the world

 16 sort of know how it works, people who aren't, find

 17 it very confusing and frustratingly vague, I would

 18 suspect, but that might be -- something like that

 19 might be the general standard, but then give

 20 people clarity that you don't have to worry about

 21 it if, and de minimis would be one tool,

 22 obviously, but there would be other tools.
 59

 1 MR. OSTRANDER: And I think you have

 2 definition authority to do all that. You could,

 3 for example, say, entities that are commodity

 4 pools or that are 4(d) act funds or exempt 4(d)

 5 act funds could be presumed not to be dealers. I

 6 think you can find, I'm sure there are a number of

 7 examples out there where you could start to create

 8 either safe harbors or presumptions, perhaps

 9 rebuttable presumptions, about categories that

 10 would give the market some certainty, because I

 11 think we really are talking about the margins here

 12 and, as we say, most of the big dealers know it

 13 and if you created some clean, safe harbors, I

 14 think most of the people who aren't on the line

 15 would get a lot of comfort from that.

 16 MR. CHERN: Yeah, I do think that

 17 there's some specific language you could have out

 18 there. There were a couple of suggestions in

 19 there from Rick. I think that, you know, if we

 20 really -- even just listening to this

 21 conversation, it's very clear the problem is

 22 complicated and it's getting more complicated, not
 60

 1 less, and I think that if we really want to solve

 2 it, we have to simplify it a little bit. If we

 3 look back at what happened in 2008, we had some

 4 very concentrated risk in a few very large parties

 5 that were trading in a way that the regulators

 6 didn't have a view of, simply stated, and I think

 7 if we say, okay, so the intent of this

 8 legislation, this piece of it, is to give the

 9 regulators a view over those activities that they

 10 didn't have a view of before. And so now you can

 11 say, okay, so how do I get back to your question,

 12 if you have entities that are trading 100 percent

 13 cleared, standard contracts, centrally traded,

 14 this -- none of this has anything to do with

 15 creating systemic risk.

 16 On the contrary, in fact, what we really

 17 want to do is to increase the number of liquidity

 18 providers in that space, we want to increase the

 19 diversity, we want to reduce systemic risk by

 20 having more people competing to make markets.

 21 Now, that might not be great for me if I have more

 22 people competing with me, but it's going to be way
 61

 1 better for the markets. It's going to be a

 2 healthier market if we have less concentrated

 3 risk, more people competing to provide liquidity,

 4 more efficient markets for people like Russ.

 5 That's what I think, if you simplify the problem,

 6 I think that that really gets to the heart of it.

 7 MR. NICHOLAS: Yeah, I agree with that

 8 100 percent. I mean, I think we need to get back

 9 to the Congressional intent behind Dodd-Frank,

 10 which I think is transparency and the reduction of

 11 systemic risks. So, I think we really, in

 12 crafting a definition of dealer, we need to think

 13 about and focus on those activities which create

 14 risk. And to the extent that an intermediary or

 15 an end user or whatever is involved in a swap

 16 activity that doesn't create risk, I mean, I think

 17 the presumption should be that that's not dealer

 18 activity.

 19 MR. FAJFAR: Can I just follow up on

 20 that? Now, do dealers create risk? Is that

 21 clear?

 22 MR. NICHOLAS: I think that dealers take
 62

 1 risk, absolutely, they take directional positions

 2 and -- yes.

 3 MR. COOK: I think the last two comments

 4 are sort of saying in a way, taking us in a

 5 direction I wanted to explore a little bit, which

 6 is we've been talking about the definitions, to

 7 some extent, as if they're kind of this abstract

 8 quantity, like, are you a dealer, aren't you a

 9 dealer, how are we going to define it, but really,

 10 to what extent should the way we craft the

 11 definition be informed by what it is we're trying

 12 to achieve in -- and one of the ways you can think

 13 about that is, well, what are the requirements

 14 that apply to a dealer, right, and I know we're

 15 not talking about the substantive requirements in

 16 detail, but there are certain substantive

 17 requirements of being a dealer, including business

 18 conduct requirements, risk management

 19 requirements, internal controls, reporting, and

 20 that's a little bit more granular than the big

 21 Dodd- Frank systemic risk reduction, right? So,

 22 one of the ways to think bout whether someone
 63

 1 should be a dealer is, well, are they -- would it

 2 be -- is there a public policy reason to subject

 3 that entity to those sorts of rules, right? You

 4 only care about being a dealer depending on what

 5 the rules are and the only reason to impose that

 6 status on a firm is to make them subject to those

 7 rules.

 8 So, it's kind of hard to divorce the

 9 conversation from what it means to be a dealer, I

 10 think, I'd offer that for a comment. And if

 11 that's the case, then I think you have to go back

 12 to some of the conversation we've been having,

 13 like, what if I'm only dealing with two sides and

 14 I'm hedged. Well, that might deal, to some

 15 extent, with risk-type issues potentially, but you

 16 still might be dealing with customers where one

 17 could still argue there is a basis for having a

 18 customer business conduct type of standard in

 19 place.

 20 But I'd be interested in hearing people

 21 relate their ideas about where we should draw the

 22 line to what it means to be a dealer and why or --
 64

 1 why is it a good thing if you want to be outside

 2 the box, why you shouldn't be subject to business

 3 conduct or risk management tools and the like.

 4 And for those who are inside the box, why should

 5 they be? Because to me, that's kind of the

 6 regulatory objective in drawing this line.

 7 MR. MASTERS: Bob, I would just -- I

 8 agree with that pretty much wholeheartedly. I

 9 mean, it's not just systemic risk. Business

 10 conduct is a key part of Dodd- Frank and, you

 11 know, one of the reasons, for instance, you've got

 12 the special entity rules because we know some of

 13 the things -- some of the bad actions that happen

 14 with swap dealers, on one side, or dealers on one

 15 side and a customer on the other side, and given

 16 that swaps today are still pretty opaque

 17 instruments, there's an informational advantage

 18 that one person has over the other person in these

 19 markets, and so business conduct is a crucial part

 20 of Dodd-Frank because you've got a customer that

 21 -- you've got basically built in information

 22 asymmetry in these markets, which you have to deal
 65

 1 with, and business conduct is one of the few ways

 2 of dealing. In fact, you could argue that a lot

 3 of things that happened in the financial crisis

 4 wouldn't have happened if you didn't have those

 5 sort of built in information asymmetries in the

 6 sort of this new derivatives market.

 7 MR. CHERN: Yeah, and those

 8 informational asymmetries that Michael is talking

 9 about stem from your direct interaction with a

 10 customer, so in other words, someone who's -- this

 11 is not predicated strictly because you're on both

 12 sides of the market providing liquidity,

 13 especially if you look at, you know, the futures

 14 exchanges as an example. You know, you could be

 15 on both sides of a market trading with an

 16 anonymous counter party, you have no idea which

 17 direction that guy might be going in until the

 18 trade hits your books, and you know, there's no

 19 futures dealer designation right now. The futures

 20 function perfectly through 2008. There's, you

 21 know, daily mark-to- market, intraday

 22 mark-to-market, anonymous counter parties -- it's
 66

 1 fully liquid, so the information asymmetry does

 2 not exist. And so to the extent we can be

 3 successful in pushing as many of these swaps to be

 4 centrally traded and cleared, and margined, you

 5 know, and I understand it's not going to cover

 6 every use of swaps, but the vast majority of them

 7 will absolutely -- can be pushed in this

 8 direction. Now you've reduced information

 9 asymmetries, you have really reduced so much of

 10 the risk that was -- that went hand-in- hand with

 11 trading these things in that more opaque manner.

 12 So, I think that -- you know, one of the

 13 questions I find myself pondering is, to the

 14 extent, it kind of goes back to Ron's point, which

 15 is, as we are in this transformational period

 16 where we are trying to get everything clear to the

 17 extent we can, you know, are we overstepping in

 18 one place because we're trying to create these

 19 definitions to solve a problem that exists today

 20 when by and large maybe 90 percent of that problem

 21 is going to go away and we could be focusing on

 22 solving the other 10 percent in a much more
 67

 1 targeted fashion?

 2 MR. FAJFAR: Can I just add -- and then

 3 we'll get to Sean -- a lot of -- you've talked --

 4 what do the panelists -- when do they think that a

 5 large part of the market, especially for

 6 commodities swaps, will be cleared? What's your

 7 view of how long that is going to take? Because

 8 it seems -- the idea that we should write the

 9 definition for that time would be less of a

 10 consideration if that was going to be further on

 11 in the future.

 12 MR. MASTERS: You know, I think that

 13 depends on a large part of -- I mean, the CFTC has

 14 proposed this idea of listed head equivalents, you

 15 know, not to bring out another acronym, LIGs, or

 16 listed head equivalents adjusted for delta,

 17 LHEADs, which if I know, in terms of -- if the

 18 customer understands what the listed head

 19 equivalent is of every transaction in commodities,

 20 where that can be done, then it's -- in my

 21 opinion, it will be pretty quick because now one

 22 knows what is the disaggregated version of that
 68

 1 swap.

 2 MR. FAJFAR: So, the concern that the

 3 listed cleared swaps would not match -- there's a

 4 lot of concern that cleared swaps wouldn't match

 5 the customers' needs and there would be -- that's

 6 not as much of a concern? That we think that

 7 we're going to go to getting cleared swaps that

 8 match customers' needs well?

 9 MR. OSTRANDER: I think it depends on

 10 the markets that you're talking about. You can

 11 see, you know, how they customize interest rate

 12 swaps or how it's being cleared. In other markets

 13 I don't think it's going to be customized enough

 14 with appropriate risk management frameworks around

 15 the products to be cleared quickly. It's going to

 16 take some time for that to develop.

 17 So, the answer will depend significantly

 18 on the underlying asset class.

 19 MR. FILLER: I think the answer is --

 20 and it's not for discussion here, but what your

 21 final rules are going to be on unclear swaps. I

 22 mean, as proposed, there are some concerns that
 69

 1 they're not punitive, but make it very difficult

 2 to go -- and almost encouraging cleared swaps, and

 3 I'm a big clearing guy so I am not an objection on

 4 it, but there's so many end users out there who

 5 are seeking not to be required to post margin and

 6 clear it and so forth, and I think the actual

 7 answer to your question is, what would be the

 8 final rules in unclear swaps adopted by the

 9 commissions.

 10 MR. COTA: I think relating to that,

 11 there are a lot of clearing mechanisms that really

 12 don't have a lot of volume because there's not --

 13 the requirement isn't there yet, so, you need to

 14 have the requirement and the expectation that

 15 you're going to have to clear in order for those

 16 markets to emerge. The NYMEX ClearPort or CME

 17 ClearPort is a big example of that in energy where

 18 you can get lots of delivery points for that, but

 19 there's very little liquidity in a lot of them

 20 because you can do it better with a swap, so that

 21 will transform when you have that date and what

 22 the alternative penalty is.
 70

 1 Unrelated to that, one of my questions

 2 is, you know, how do you segment the industry?

 3 So, for example, there are very large financial

 4 players that are critical parts of the petroleum

 5 infrastructure and in the ag arena there are very

 6 large ag players that are very big in the

 7 financial segment, so all of these -- these very

 8 large entities have many different subcomponents

 9 and sub corporations with different layers of

 10 ownership, but the way that they operate is a

 11 structure where -- whether it be through loss

 12 leader activities or for different market vantage

 13 points, the entire entity has an integrated way of

 14 dealing with the different swap activity. So, how

 15 do you segment those related activities when they

 16 are intertwined into a greater project?

 17 So, as an example, you know, my industry

 18 I'm taking futures or swaps and converting them

 19 into customer forwards and because I'm an end

 20 user, I don't have to worry about all that stuff,

 21 but similar things happen in other areas of the

 22 chain and different -- the things that make me
 71

 1 scratch my head are, why are hedge funds currently

 2 buying tank bottoms in petroleum, which is a

 3 static inventory that never changes? You know,

 4 why are they doing that? There's got to be some

 5 reason I haven't figured out yet. Why are people

 6 buying stranded gas wells? There's got to be a

 7 reason for that. And if there -- if you have an

 8 entity that is doing some physical portion of the

 9 market, that's an important part of that market,

 10 but it shouldn't exempt them in the segmenting of

 11 the other areas, and I really don't know how you

 12 guys are going to tackle that, but to me it's one

 13 of the key aspects of implementing the rules.

 14 MR. WALTON: Could I address Mr. Cook's

 15 question about the behavior rules? I hate to

 16 again be parochial, but in the context of the

 17 hundreds or thousands of banks that might have to

 18 register, the conduct rule component of the swap

 19 dealer definition and the swap regulatory scheme

 20 is of no issue for banks. We are substantially

 21 regulated by the Federal Reserve and the OCC and

 22 the behavior standards that are implied for swap
 72

 1 dealers and the record keeping requirements and

 2 the rest are not substantially greater or more

 3 onerous than the requirements that already exist

 4 for banks under OCC or Federal Reserve regulation.

 5 The real issue, again, for banks, with

 6 respect to the swap dealer characterization, is

 7 not those standards. It's section 716, which says

 8 that if we are a swap dealer, we can't use the

 9 Federal Reserve window and we don't have FDIC

 10 insurance. So, I think when you think about the

 11 other regulatory -- or the other statutory

 12 justifications for characterization as a swap

 13 dealer with respect to behavior and the rest, and

 14 you focus on the element of the statute that says

 15 there should be coordination with the federal

 16 banking regulators in developing these

 17 regulations, that the two commissions should take

 18 considerable comfort from the fact that if you

 19 exclude banks, and frankly most banks are going to

 20 have to register anyhow in respect of interest

 21 rate and currency transaction components, it's

 22 this other area which -- and there's an exemption
 73

 1 with respect to the qualification for federal

 2 insurance if you're just doing interest rate and

 3 currency -- it's these other activities that

 4 create the death penalty risk.

 5 I think you should take considerable

 6 comfort if you were to reach a conclusion that

 7 banks should be exempted from the types of

 8 behavior that we're talking about from the fact

 9 that all of those conduct rules that you're

 10 concerned about will continue to apply to that

 11 group of exempted institutions anyhow.

 12 MR. GRANT: I think then we get sort of

 13 back to the question that Mark asked earlier about

 14 the desire to focus on motivation but then the

 15 desire for clarity and kind of the conflict, and

 16 one of the proposals that has been mentioned is

 17 the idea of safe harbors, but what would a safe

 18 harbor be that would effect, you know, hundreds of

 19 regional banks or that would provide clarity to

 20 them but wouldn't just swallow the rule?

 21 MR. WALTON: We've proposed a specific

 22 exemption that I've got a copy of -- the rule that
 74

 1 was -- or the proposed safe harbor that was

 2 included with our comment, but it would be a

 3 customer-driven transaction that is permitted by

 4 our primary regulator where the risk aspect

 5 of that transaction is completely replaced with a

 6 mirror transaction into the market so there is no

 7 primary risk that is being taken by the bank in

 8 respect of that transaction. It's

 9 customer-driven, so it's a brokerage type

 10 activity, and I think that fundamentally when you

 11 talk about dealer versus broker activity, that is

 12 the distinction that people have in mind when they

 13 think about swap dealing. It is a customer-driven

 14 transaction permitted by the primary bank

 15 regulator, the risk of which is immediately laid

 16 off in the market, so it's only balanced book

 17 transactions by banks, not the unbalanced thing

 18 that created the problems in 2007 and 2008.

 19 MR. GRANT: And would that differentiate

 20 between some of the larger dealers and the

 21 regional or smaller dealers?

 22 MR. WALTON: Offhand, I can't see that
 75

 1 there is an exception there that would relate to

 2 the size of the institution, but I'm not sure that

 3 there is an issue -- that it is an exemption that

 4 Bank of America or JP Morgan shouldn't be allowed

 5 to use either. If the net effect of the

 6 transaction is beneficial, the size of the

 7 institution using it shouldn't matter.

 8 MR. OPPENHEIMER: The working group has

 9 also put out a proposal on how to identify those

 10 things that would not constitute swap dealing.

 11 We've circulated it, it's sitting at everybody's

 12 place at the table and I think there are some

 13 extra ones over here if people want to take a look

 14 at them, but it goes through sort of what we've

 15 been calling a peel the onion kind of a process

 16 and it says, okay, first take this activity,

 17 that's not swap dealing, take it out of the

 18 definition, and the first one would be hedging or

 19 mitigating commercial risk associated with being a

 20 producer, processor, merchandiser, or end user of

 21 a commodity. Then it takes out trading, unless

 22 the trading is market making, which fits in there,
 76

 1 or is a customer driven transaction.

 2 And so it's not necessarily safe

 3 harbors, but it goes through the same kind of a

 4 process of saying, we're not entirely sure we know

 5 how to define exactly what is dealing, but these

 6 things are not dealing, and when you peel those

 7 away you're left with a core. And to go to Mark's

 8 earlier question of, you know, what kind of record

 9 keeping -- you know, what's the proof -- I don't

 10 think there is a record or a piece of proof and

 11 we've lived with that in many ways. It's not

 12 comfortable, of course, we want clarity. I think

 13 the clarity is in the pieces of the onion that you

 14 peel away and there may be some lack of clarity

 15 left -- with respect to what's left, and then you

 16 look at a totality of circumstances and there are

 17 a few I'd throw out. You know, was the trader

 18 transaction done by a core group of people whose

 19 job it is to market financial instruments to

 20 customers or was the trade done by somebody who

 21 also manages a physical portfolio? Was the trade

 22 done against a counterparty with whom you only
 77

 1 deal in financial instruments or was it done

 2 against a counterparty with whom you trade

 3 physical commodities throughout the course of the

 4 day? Is the organization structured in a way that

 5 the marketers are separate from the balance of the

 6 firm? And then, is the book -- this may not be

 7 articulated all that well -- but is the book

 8 managed generally as a book or do you do swap

 9 transactions on the basis of a price that you pull

 10 from the futures market, add a markup to it, and

 11 give to a customer, which is a standard dealer

 12 kind of a structure? Those are just a few, but

 13 the idea would be that at the end of the day that

 14 would be a totality of the circumstances kind of a

 15 test.

 16 MR. FAJFAR: I'd like to go back to -- a

 17 little bit -- and we have about a half an hour

 18 left -- I asked the question, you know, if the

 19 same end users are doing the same swap with

 20 different people would have different results, and

 21 I haven't really heard a lot of disagreement. And

 22 it seems that -- I just want to get on the table
 78

 1 -- that the view we should take of the swap dealer

 2 definition is really that it should have different

 3 application to different types of people so that

 4 if, say, you're, you know, a registered FCM, this

 5 is sort of what a swap dealer -- you would be out

 6 -- basically you're saying would be out of the

 7 swap dealer definition and the reason you would

 8 give is because you're taking riskless principal

 9 transactions. And then if you're a commodities

 10 firm, you would be out of the -- the rule that

 11 would apply to you would be that because you're

 12 hedging and you're connected with a commodities

 13 business, that's out of the swap dealer

 14 definition. You know, and then we could go around

 15 the table and each person, except for Rick, would

 16 give his reason why he's not covered. And that's

 17 -- I think you have to recognize that to somebody

 18 who's not in the business, that looks a bit odd,

 19 that basically you're having different -- like you

 20 said, you have this general rule then with very

 21 specific carve outs. And I'd just like to

 22 clarify, that's really what we're -- that's how
 79

 1 we're saying this definition should apply, because

 2 the other way is people would look at -- they'd

 3 say, there's four factors in the statute, they're

 4 reasonably clear. I mean, there's some ambiguity.

 5 And I think the starting point was if you do that,

 6 you're a swap dealer, regardless of why -- what

 7 your reasons are, and there's the idea there of a

 8 level playing field. It seems here -- saying, no,

 9 no level playing field because the standard that

 10 protects him won't protect me, so I need a

 11 different standard that will protect me.

 12 How do you -- I'm sure that's not the

 13 way you would characterize it, but --

 14 MR. MASTERS: I mean, I think, you know,

 15 you've got -- like I said, it's disjunctive.

 16 You've got four categories and they're

 17 disjunctive, so it is what it is. I mean, the

 18 statute says what it says. I mean, you know,

 19 policy -- you know, you can argue different ways

 20 about it, but the statute is pretty clear.

 21 MR. OPPENHEIMER: I strongly disagree

 22 with that. You know, the third prong of this
 80

 1 statute basically says anybody who uses a swap is

 2 a swap dealer. Okay? So, you can't sort of start

 3 with that and say that that's a model of clarity

 4 or what anybody's congressional intent was. And

 5 you look to the securities laws, there is this

 6 similar prong with respect to dealer and the

 7 securities laws. Basically anybody who buys their

 8 self a security for its own account, the

 9 securities laws never intended to capture

 10 everybody in that context as dealer.

 11 So, the only way to look at it is to,

 12 again, I said it before, marry that to Exception

 13 C. When you do that, I really don't think there

 14 is precise clarity that anybody could look at and

 15 say, I understand where one ends and the other

 16 begins, and so you have to go through the process

 17 that we're going through of looking at specific

 18 kinds of conduct and saying, should that be dealer

 19 conduct or not.

 20 Now, I don't necessarily think that you

 21 have to have a rule that has each exception carved

 22 out. I think the Commission can give guidance
 81

 1 outside the context of a rule. I don't think that

 2 really matters but I think the notion that you can

 3 look at the rule and everybody should be able to

 4 decide what they are is inaccurate.

 5 MR. OSTRANDER: I also -- sorry, I

 6 wasn't quite thinking of the safe harbors as

 7 saying somebody is a swap dealer, but we're going

 8 to let them behave as a swap dealer, for whatever

 9 reason we're going to let him do it. I was

 10 thinking more that the safe harbors would help

 11 someone understand what isn't swap dealing

 12 activity. And I know that's a subtle distinction,

 13 but I do think it's an important difference that

 14 we're not saying here's 30 types of entities that

 15 are engaged in activity that really everyone says,

 16 yeah, that's swap dealer activity, but we're going

 17 to let them have a pass. I think it's more, you

 18 know, if you were one of these funds or you're

 19 doing things, we're going to either presume or

 20 give you the benefit of the doubt that you're not

 21 acting as a swap dealer. Of course, you can be

 22 proven differently if you really are taking
 82

 1 advantage of the rules, but it wasn't that

 2 everyone's a dealer and we're going to give 30 or

 3 50 or whatever people outs.

 4 MR. FILLER: I mean, I think the hardest

 5 or the most important part is, what is a swap

 6 dealer and what is not. If you fall within the

 7 definition of a swap dealer, whatever that final

 8 definition is, then you have to register, you have

 9 to have that capital, you've got the reporting

 10 obligations, you've got the business conduct

 11 activities, and so from the policy perspective,

 12 what are the intent of bringing in registration,

 13 capital, reporting, business conduct, who --

 14 what's the intent behind Dodd- Frank and which

 15 firms are really designed to meet those other

 16 regulatory obligations. So, the other thing is,

 17 okay, we'll make a broad definition of swap

 18 dealers and then exempt everyone. Well, I don't

 19 think that's the right approach.

 20 I think the better approach is having

 21 very specific exemptions or whether you go the

 22 safe harbor approach, I mean, providing guidance
 83

 1 of which firms do not fall within the swap dealer

 2 definition. And, you know, as I said earlier, we

 3 know the ones that are going to be. It's just

 4 whether or not any other firms out there -- those

 5 around the table here and others who have

 6 submitted comments, is the intent of Dodd-Frank to

 7 go after those other firms as a swap dealer? They

 8 may fall under another definition, they may not

 9 fall within the merits of it. If I'm a swap

 10 dealer, if I'm Morgan Stanley, I'm a swap dealer,

 11 I've got to report all the swaps I'm doing with

 12 all these end users so the commissions are going

 13 to capture that information pursuant to the swap

 14 dealer reporting obligations, but is it really --

 15 if I'm the commercial or the bank or whatever, is

 16 that really the intent of Dodd- Frank for me to do

 17 the reporting, for me to have that capital, for me

 18 to register? And I think not.

 19 MR. PROSSER: It seems inconceivable to

 20 me that we are a physical mover of commodities, we

 21 own bricks and mortar in the commodity space, that

 22 it was ever the intent of the law to take a firm
 84

 1 that moves tons of wheat through the system and

 2 happens to use swaps to avert risk, to be caught

 3 up in the definition of a dealer. This has been

 4 our business practice forever.

 5 MR. FAJFAR: But that's not what I'm

 6 saying. I'm not saying Clause 3, you know,

 7 includes everyone and then we have to back them

 8 out, but it's -- there's the equal argument that

 9 if you were a swap dealer, do you then pull back

 10 because you're in the commodities business, and

 11 how do we write the rule and apply it? Do we let

 12 the commodities firm decide? Do we ask, you know,

 13 ask Ron Filler since he knows who all the dealers

 14 are, we ask him, is he the one that then -- it's

 15 how do you write that rule that says -- I agree

 16 that a commodities firm that is not a dealer is

 17 not a dealer, but the question is, is a

 18 commodities firm that is a dealer -- is it then

 19 pulled back because it's a commodities firm?

 20 That's really the issue.

 21 MR. BERKOVITZ: Right, and I would just

 22 add from a statutory interpretation perspective,
 85

 1 Congress knew how to exclude specifically

 2 commercial and hedging activities. It's part of a

 3 factor in the end user exception, it's part,

 4 partially, in the major swap participant, which

 5 swaps do not get included whether you're an MSP,

 6 but it's not in the swap dealer definition in a

 7 clear, straightforward way. We're left with prong

 8 three to interpret it, so I guess I would ask the

 9 question, is there no -- I'll ask Ron, under the

 10 working group's language, would there be

 11 potentially no commercial firms then that would be

 12 swap dealers? Or are there maybe some very large

 13 commercial firms that do a lot of swap dealing

 14 activity that might fall within and some would

 15 not?

 16 MR. OPPENHEIMER: I think that's a very

 17 valid and fair question and it helps respond to

 18 Mark's point too, and that is, I imagine that

 19 there are some. I think, you know, I hate to

 20 bring up a specific firm's name, but they've put

 21 themselves out there and said so, and I think, you

 22 know, Cargill is an example. They're a large
 86

 1 commercial firm, they have some swap dealing

 2 activity. Just because you're a large commercial

 3 firm, I don't think that anybody is suggesting

 4 that that is a blanket exemption. If you engage

 5 in swap dealing activity somewhere within that

 6 operation, then you're a swap dealer, but I think

 7 the point everybody else is trying to make and

 8 that I'm trying to make is that your commercial

 9 activities that are not swap dealing activities

 10 shouldn't bring you over the line just because

 11 you're active in a particular swap market because

 12 you, you know, occasionally make two-sided

 13 markets. There are a number of things that

 14 commercial firms do that look like facilitating

 15 and accommodating, but they're really not dealing

 16 activity. They're using swaps as a tool in their

 17 business either for hedging or taking a position

 18 in a market.

 19 So, I'm not suggesting that just because

 20 you have commercial operations you get exempt.

 21 There are firms that have distinct swap dealing

 22 activities within their firms.
 87

 1 MR. WALTON: Go ahead.

 2 MR. COTA: I think the same thing is

 3 true for some of the banking entities that are in

 4 the commercial business. Those commercial

 5 entities are very critical and in my particular

 6 industry, the petroleum industry, I often cannot

 7 rely on the traditional commercial players to

 8 supply in a tight market, but I can always rely on

 9 the banks to have the commercial product to supply

 10 in that tight market. So, there's a valid reason

 11 for them to be in that market that is important,

 12 but it's the same point, just conversely.

 13 MR. WALTON: The point I wanted to make

 14 is, I think the thread of what Mr. Prosser is

 15 saying, Mr. Oppenheimer is saying, and what Mr.

 16 Wasson's saying, is that you have this statute

 17 that's written, my sense is, to create a very

 18 broad standard for what might be swap dealers and

 19 the process you're going through now of listening

 20 to people where there are specific commercial

 21 issues that are being characterized in that way

 22 was what was intended, so that the Commission
 88

 1 could go in, not in the short period of time in

 2 which Congress put this act together, but had the

 3 time to look at circumstances where the broad

 4 definition simply doesn't fit, and I think that

 5 the Congressional history here is consistent with

 6 that.

 7 And I think the examples that you're

 8 being given are circumstances in which companies

 9 use swaps incidental to a larger business

 10 transaction, not the swap as the core of the

 11 profit that they're trying to make. A bank

 12 doesn't enter into a hedge transaction with a loan

 13 customer in order to make money off of the hedge.

 14 It does it because it wants its loan to be secure

 15 and it wants to make the loan, and I suspect that

 16 in the case of the various commercial end users,

 17 they are not in the category of what I think are

 18 the 20 to 25 firms people think of as swap dealers

 19 whose primary motivation is to profit from the

 20 swap itself. It's a swap that's entered into

 21 incidental to a broader business operation and

 22 derivatives are so wound into the way in which all
 89

 1 of these commercial institutions do business that

 2 the risk is that if you don't create exceptions

 3 for these incidental conduct, and you force people

 4 out of using derivatives in a useful way, for

 5 instance in lending transactions or otherwise.

 6 So, I think the fundamental notion that

 7 creating exceptions for particular circumstances

 8 would be detrimental to treat people as swap

 9 dealers and it shouldn't be done. It's just

 10 wrong.

 11 MR. WASSON: I would just like to say,

 12 in the electric business -- and let me echo -- I

 13 mean, I agree with you 100 percent because in the

 14 electric business we've been using bilateral

 15 contracts for 100 years and we haven't changed a

 16 thing with regard to the way we were doing

 17 business, but all of the sudden as a result of

 18 Dodd-Frank, you know, the CFTC is perhaps

 19 proposing definitions that call some of what we do

 20 swaps. But we never viewed them as swaps and, you

 21 know, we've been doing these things -- we've been

 22 meeting the demand for electricity because we have
 90

 1 a public service obligation. If someone comes

 2 into our service territory, we have to provide

 3 them electricity. We don't have an option. We

 4 don't have a choice. That's a public service

 5 obligation every electric utility has, and we have

 6 to do that. And we enter into swaps, as you may

 7 define them, for purposes of, you know, protecting

 8 those customers from price volatility in the

 9 (inaudible) market, but it's totally incidental to

 10 our core business, which is keeping the lights on.

 11 MR. RADHAKRISHNAN: So, let me ask a

 12 question, and I want to highlight to the panel

 13 what the two commissions said in the proposed

 14 rulemaking, which was -- and it's on page 80177 of

 15 the Federal Register release. The Commission

 16 said, "We believe that persons who enter into

 17 swaps as a part of a regular business are those

 18 persons whose function is to accommodate demand

 19 for swaps from other parties and enter into swaps

 20 in response to interest expressed by other

 21 parties. Conversely, persons who do not fulfill

 22 this function should not be deemed to enter into
 91

 1 swaps as part of a regular business."

 2 Now, isn't what you're saying -- what

 3 you are doing, you're not accommodating demand, is

 4 that what you're saying?

 5 MR. WASSON: We are not accommodating

 6 demand for swaps, we're accommodating demand for

 7 electricity.

 8 MR. RADHAKRISHNAN: Okay. And that's

 9 the distinction.

 10 MR. WALTON: We're accommodating demand

 11 for loans in circumstances where the loan, to be

 12 safe, and for the customer, to be safe, needs to

 13 have a hedge corresponding to the commodity that

 14 we're secured on.

 15 MR. RADHAKRISHNAN: I'm not saying I

 16 agree with you, I'm just trying to clarify what it

 17 is -- that's your point? Is that your point?

 18 MR. WALTON: Mm-hmm.

 19 MR. FAJFAR: So, are we done then? Then

 20 we put that -- there's no real objection, we could

 21 just clarify that a little bit in the rule,

 22 address some of the other -- there were some
 92

 1 comments, you know, that need to be addressed.

 2 Just -- there seems to be consensus is a dealer is

 3 somebody who accommodates demand for swaps and

 4 facilitates other people entering into swaps as

 5 part of -- that's their business. So, we could

 6 put that as the definition.

 7 MR. WASSON: Mark, it's the third prong.

 8 That's their business. They're regularly carrying

 9 on a business for their own account, and an

 10 electric utility that's trying to protect their

 11 customers through hedging is not doing it for

 12 their own account. I mean, they're not -- that's

 13 not their business and a bank is not doing it for

 14 their own account.

 15 MR. WALTON: Yeah, I think, are you

 16 done? The question would be to a bank, and again

 17 I'll be parochial, that looks at the risk of being

 18 characterized as a swap dealer and is out of

 19 business if it is other than an interest rate or

 20 FOREX and says, okay, if I'm going out and

 21 pitching loans to customers right and left every

 22 day and as part of that, when the customer says,
 93

 1 what do I need -- I want to borrow against my

 2 wheat, what borrowing base will you give me? --

 3 and the answer is, it's here if you're unhedged,

 4 but it's here if you're hedged because I know that

 5 the value is more dependable. They're making that

 6 pitch every day and using derivatives as a

 7 component of that. Have they then entered the

 8 business?

 9 MR. FAJFAR: But then aren't you saying

 10 that -- well, let's just put out -- then for all

 11 the businesses, aside from the IDI exception, we

 12 have the general standard you can accommodate

 13 demand, but there should be types of accommodating

 14 demand and facilitating interest that are not swap

 15 -- that's not really a definition of swap dealing

 16 because there's types of it, for example, if

 17 you're flat, if you're a riskless principal, there

 18 you're accommodating demand, not a swap dealer.

 19 If you're accommodating demand in conjunction --

 20 again, I get back to the same -- we seem to -- we

 21 had consensus on what it is and then we said,

 22 well, but, no, I know I do that in my business,
 94

 1 but I do it -- it's not really or --

 2 MR. OPPENHEIMER: I don't think we quite

 3 had the consensus that you might have thought.

 4 But, you know, if you put the words "for the

 5 purpose of" that would be very helpful. If you

 6 divorced it from a commercial transaction, that

 7 would be very helpful. If you divorced it from an

 8 occasional transaction where a counterparty with

 9 whom you trade physical all day long says, in this

 10 particular case, I'd prefer to do it as a swap,

 11 would you do that for me -- you can take it to

 12 some absurd conclusions if you think about it.

 13 Somebody goes to a swap dealer for a very bespoke

 14 energy swap transaction and that swap dealer

 15 decomposes it and lays off all the risk that he

 16 can on the futures market, let's say, and has a

 17 very small bespoke risk left and goes to the

 18 commercial firm it knows has a profile that can

 19 actually absorb that piece of risk and goes to

 20 him, would you take this risk from me? Now you're

 21 going to convert that end user into a swap dealer

 22 because he accommodated the swap dealer? Those
 95

 1 kinds of things need to be carved out, so I think

 2 you make progress but you don't get there all the

 3 way so there's not quite consensus, but that's the

 4 direction I think you need to be going.

 5 MR. NICHOLAS: Mark, I mean, you know,

 6 you raise some good questions and I think we

 7 probably would disagree on the definition of

 8 dealer if we spent another couple hours on this

 9 topic. But I think that one of the factors that

 10 probably should be considered is, you know,

 11 particularly with respect to firms whose

 12 activities are kind of on the borderline is the

 13 presence of other robust regulation -- excuse me,

 14 the gentleman over here sort of mentioned that with

 15 respect to banking regulators. I mean, I really

 16 think the thrust of Dodd-Frank was to focus on the

 17 unregulated entities and to the extent that you

 18 have another robust set of regulations, you know,

 19 I think there's less of a need to push it into the

 20 swap dealer category.

 21 MR. CHERN: Yeah, I want to -- and I

 22 tend to agree with that and I think that if I
 96

 1 could expand on Ryan's example a little bit, which

 2 I may not completely agree with, but part of your

 3 example there, he was talking about, you know, a

 4 very bespoke energy contract which a dealer then

 5 provides, you know, accommodates the demand for

 6 that swap and then lays off the risk on the

 7 futures market, was part of the explanation.

 8 That's me. That's a lot of entities like CTC,

 9 several entities out there that are competing in a

 10 fully regulated marketplace, standard, cleared,

 11 transparent, you know, all that stuff that we're

 12 trying to encourage. Now, if we can succeed again

 13 in getting as many of these swaps as possible to

 14 be transparent, centrally traded and cleared, and

 15 now keep in mind that, you know, we're talking

 16 about swaps and Ron used the example of some end

 17 user that may need a very particular customized

 18 set there, if they -- if the dealer who trades

 19 with the end user then lays off the risk on the

 20 futures market, I think we would all be in

 21 agreement that whoever was on the other side of

 22 the futures market that helped the dealer lay off
 97

 1 that risk, that trader is not a swap dealer,

 2 they're trading futures.

 3 Well, that's clear enough, but now if we

 4 succeed in getting these swaps, that now the

 5 connotation of a swap is going to be, you know,

 6 some OTC bilateral negotiated contract, but now

 7 we're going to get these swaps to be -- no longer

 8 OTC, they're going to be clear, they're going to

 9 be transparent, they're going to be, you know,

 10 listed. Now, if we can get -- if we can succeed

 11 there, all of a sudden now instead of the dealer

 12 laying off the risk on the futures market, they

 13 actually lay it off on some SEF or they lay it off

 14 on some exchange where there's a swap that's

 15 traded. All of a sudden the entity that they trade

 16 with to lay off the risk is now a swap dealer,

 17 whereas a second ago when it was laid off on a

 18 futures exchange, identical in terms of the

 19 transaction, that was not a swap dealer, and I

 20 think that that's part of the real problem here.

 21 MR. RADHAKRISHNAN: I just would like to

 22 make one observation in response to comments that,
 98

 1 you know, people should not be swap dealers

 2 because they are otherwise regulated, and that's

 3 this. One, you know, we're constrained by the

 4 statute.

 5 Two, there's a school of thought that we

 6 don't force you to do things, you voluntarily

 7 choose to do things and if you do things that

 8 attract regulation, well then, guess what, you've

 9 got to register. Entities that do both futures

 10 activities and securities activities have to

 11 register as broker dealers and FCMs, there's just

 12 no way of getting around that. And to echo a

 13 point that Robert made, if you look at the scheme

 14 that's being proposed, contained in the

 15 statute and the Commission's proposal, one of the

 16 elements of being a swap dealer is, apart from

 17 registration, is you've got to meet business

 18 conduct requirements, you've got to meet capital

 19 requirements, you've got to meet reporting

 20 requirements, and you've got to meet margin

 21 requirements.

 22 So, John said, well, why make me -- I
 99

 1 think you had sent me the letter saying, you know,

 2 why -- I'm an FCM, why make me be a swap dealer?

 3 Well, an FCM is not subject to the business

 4 conduct requirements. You're only subject to the

 5 business conduct requirements as an example if you

 6 are a swap dealer. You're only subject to the

 7 margin requirements for uncleared swaps if you're

 8 a swap dealer. So, I think -- I don't want -- I

 9 want to make sure people don't lose that point

 10 which is, you know, Congress created a scheme for

 11 us and we've got to be faithful to that scheme

 12 that Congress created.

 13 MR. FILLER: Ananda, just to carry out

 14 your -- I agree with you, but when you look at the

 15 traditional FCM-BD definitions, it's a solicitation

 16 type perspective and maybe in looking at these

 17 four tests, adding a primarily, holding yourself

 18 out, you know, some kind of more than, you know,

 19 the majority of your business type stuff, a

 20 primary type test might be a good way to provide

 21 relief for the people who are looking for it and

 22 still bring in your traditional swap dealers.
 100

 1 I also want to add two other things that

 2 had not been discussed that needs to be addressed,

 3 and they were in the comment letters but I still

 4 think it's important, and whether the other

 5 panelists want to comment on it, a lot of firms do

 6 a lot of what we call internal or back-to-back

 7 swaps, and if -- I'm sorry, Rick, if I use Morgan

 8 Stanley does it with another Morgan Stanley

 9 entity, and Morgan Stanley, the primary firm

 10 registers as a swap dealer and doing an internal

 11 or a back-to-back with another Morgan Stanley

 12 affiliate, is the intent also to bring in the

 13 affiliate into the swap dealer definition?

 14 So, I know there's been a lot of

 15 comments --

 16 MR. FAJFAR: Let's get that --

 17 MR. FILLER: I'm sorry?

 18 MR. FAJFAR: Let's get that on the next

 19 panel.

 20 MR. FILLER: Oh, okay.

 21 MR. WALTON: Could I comment on that

 22 one? Because it was about regulation I just want
 101

 1 to respond. I certainly understand that a bank

 2 can stop offering hedges as part of loans. It

 3 will mean that we offer fewer loans and take fewer

 4 loans because the loans would be more risky and we

 5 have lots of pressures on banks from lots of

 6 sources saying that we should make more loans

 7 because they are beneficial to the economy. So, a

 8 structure that says, well, just make fewer loans,

 9 has other implications associated with it, and

 10 second of all, it is inconsistent with a scheme

 11 that is designed to allow commercial end users not

 12 to have to post margin to ignore the fact that for

 13 all the small players in the agricultural and

 14 energy area that don't have an external

 15 relationship, if you bifurcate that relationship

 16 by saying that the bank can't also take the swap

 17 or else the bank's out of business, that person's

 18 going to have to borrow to post margin because its

 19 only relationship with the swap dealer is the

 20 derivative relationship.

 21 So, I think it's inconsistent with the

 22 other positions that the Commission has taken with
 102

 1 respect to posting margin for commercial end users

 2 and the elements of the statute to create an

 3 exception for that should just ignore those

 4 elements and say, well, banks ought to be

 5 characterized as swap dealers when they're

 6 engaging in riskless principal transactions.

 7 MR. MASTERS: I'm just trying to

 8 understand. I mean, why would you just, you know,

 9 given your predicament, why wouldn't you just use

 10 the futures markets? Because if you buy a swap

 11 from somebody else to hedge, you know, your

 12 customer, then they're just going to the futures

 13 markets and doing the hedge if it's similar to

 14 what you describe and why not use it just in the

 15 listed futures markets and not worry about it?

 16 MR. WALTON: Most of our customers are

 17 people who if we say, go to New York and Chicago

 18 and trade derivatives there, will tell us that

 19 they will not do it, and weren't those the folks

 20 that created the financial meltdown in the first

 21 place. They want to deal with their local banker.

 22 MR. MASTERS: I understand. I'm saying,
 103

 1 why don't you do that?

 2 MR. WALTON: We lay off every trade that

 3 we take with the customer immediately. We create

 4 a balanced book and we take the trade from the

 5 customer and immediately mirror that trade in the

 6 market. That's what virtually every bank that

 7 engages in this activity does.

 8 MR. MASTERS: Right. I understand that,

 9 but I mean where you do that, you could do that in

 10 the futures markets as well as the swaps markets.

 11 In other words, it doesn't have to be exclusive to

 12 the swaps markets.

 13 MR. WALTON: No, not to accommodate our

 14 customers' demand, not -- I know we're not

 15 supposed to get into the product definition, but

 16 the way that we have to engage in activity to

 17 accommodate our customer demand, that's not an

 18 answer for us.

 19 MR. MASTERS: But you're going to go to

 20 a swap dealer who's going to do the same thing, I

 21 mean, he's going to go and disaggregate it for

 22 you?
 104

 1 MR. WALTON: Yes.

 2 MR. MASTERS: But I mean, then they're

 3 going -- that's going to get back to the futures

 4 markets. So, I'm just -- see what I'm saying?

 5 MR. OSTRANDER: I know we don't want to

 6 get too distracted on this but I also think 716

 7 would allow you to set up a separate entity

 8 outside of the bank chain to register --

 9 MR. WALTON: Well, it's certainly the

 10 case -- I think that the -- if you said the answer

 11 is that you could create a subsidiary of the bank

 12 holding company, that is certainly an option for

 13 the five or six largest bank holding companies,

 14 but banks have substantially greater access to

 15 liquidity -- I'll give you an example. My bank

 16 has $24 billion of assets. Our market

 17 capitalization of the bank holding company is

 18 about $3 billion. The bank is investment grade,

 19 the bank holding company is not.

 20 When we are posting margin to the market

 21 on the corresponding side of the trade for our

 22 customer, that involves substantial bank
 105

 1 liquidity. That's not available for a subsidiary

 2 of the bank holding company except for the four or

 3 five largest bank holding companies. For them

 4 having the transaction with an affiliate, the

 5 subsidiary of the bank holding company, and then

 6 they can say, we don't have to take margin on the

 7 loan because we've got the mark- to-market benefit

 8 through our sister company works, but it only

 9 works for those bank holding companies that are so

 10 large that they have access to liquidity at a

 11 cost. It's, I think -- frankly, if it goes that

 12 way, it's great for the big banks because it will

 13 push all of that business that's in the small to

 14 medium sized banks right into the hands of the big

 15 banks and I know that because the larger banks are

 16 marketing to our customers just that right now,

 17 that when this comes, their subsidiaries will be

 18 there to take those trades with an integrated loan

 19 and the medium sized guys won't be able to.

 20 MR. OSTRANDER: Just to make sure I

 21 fully understand, I think that you're saying that

 22 you wouldn't have the capital to fully capitalize
 106

 1 the swap dealers, is that what --

 2 MR. WALTON: The cost for capital if we

 3 are to capitalize the swap dealer and take the

 4 capital requirements to do the mirror side of the

 5 trade for the customer that's placed in the bank

 6 is far too expensive for small and medium sized

 7 bank holding companies. Yes.

 8 MR. OSTRANDER: So, I guess it's a

 9 ramification of the capital rules that drive you

 10 -- or what they might be that would drive that

 11 problem.

 12 MR. WALTON: Well, no, it's not the

 13 capital rules, it's the capital requirements of

 14 our counterparty. It doesn't have anything to do

 15 with the new capital rules, it's what the market

 16 would require today.

 17 MR. PROSSER: I would like to comment on

 18 Mr. Walton's -- if the final solution of this

 19 catches those commercial supply chain commodity

 20 firms in the swap dealer definition, we will

 21 change our commercial practices. We will quit

 22 offering services that makes us a swap dealer and
 107

 1 retrench. Those left, medium and small producers

 2 that we leave behind, that we won't provide

 3 hedging services for, will go back to what's left

 4 of the swap dealers which will have less

 5 liquidity, less providers, therefore bigger bid

 6 ask spreads, and I think leaves them in a much

 7 different situation than they are today.

 8 If the intent of this process is to

 9 change our business practice, that would do it. I

 10 hope that's not the case, because I do think that

 11 we provide a service. We will not provide those

 12 same services if in fact it throws us over the

 13 edge. So, to the extent that these rules either

 14 catch or don't catch you in this dealer

 15 definition, it will change the way that business

 16 is conducted and push that activity into a much

 17 more concentrated space, I think, which I don't

 18 think necessarily is to the public good.

 19 MR. FAJFAR: We're going to get into

 20 that in the de minimis test, and I know Josh had

 21 some questions, so since we're at the end of the

 22 first panel.
 108

 1 MR. KANS: Sure. Thank you, Mark. You

 2 know, a lot of the concerns here have been

 3 seemingly specific to commodities and related

 4 products. I wanted to toss out for the panel the

 5 same issues in the context of securities- based

 6 swaps and being a securities-based swap dealer.

 7 Do you have the same concerns or would the

 8 industry generally have the same concerns about

 9 the securities-based swap dealer causing

 10 retrenchment or people offering fewer services?

 11 And also I'm hoping for some comment about the

 12 traditional dealer-trader distinction from the

 13 traditional security space and whether or not the

 14 issues that you discuss here may be different in

 15 the context of the securities-based swap dealer

 16 definition and maybe we can just rely on the

 17 traditional distinction without all these problems

 18 you're seeing.

 19 MR. CHERN: I certainly have the same

 20 concerns on the security side. I know that a lot

 21 of the folks up here only participate on the

 22 commodities side. When you look at the concerns I
 109

 1 raised earlier in terms of, you know, the

 2 transparently traded, centrally traded, cleared,

 3 you know, these sorts of transactions, there's a

 4 large part of the market that -- you know, Chicago

 5 Trading Company, we trade options on all the

 6 listed exchanges and we provide liquidity and we

 7 have a large book of options that we manage. It's

 8 strictly internal capital, we trade our own money,

 9 take our own risk, use our own models, and we're

 10 providing liquidity in the marketplace.

 11 So, you know, to the extent that we are

 12 not participating in any of the over-the-counter

 13 transactions right now, you know, those

 14 transactions probably have a smaller pool of

 15 competitors and we're seeing the runoff as the

 16 dealers who are trading in that marketplace are

 17 then laying off their risk on the floors or on the

 18 electronic marketplaces for the listed exchanges.

 19 To me it seems very clear. I think the

 20 dealer- trader distinction is -- I'm glad you

 21 brought it up. I think that that's an effective

 22 distinction. Again, we trade -- we are a
 110

 1 broker-dealer registered with the SEC. We don't

 2 have any interaction directly with customers, we

 3 don't touch customer funds. So, from my

 4 perspective we are really providing that function

 5 in the markets of competing to provide an

 6 efficient marketplace and providing liquidity and

 7 taking the risk on our books that other people

 8 don't want on their books. I think that's what

 9 we're really -- you know, Dodd-Frank is really

 10 intended to encourage is less centralized -- less

 11 risk that's focused in just a few counterparties

 12 and more transparent trading.

 13 And so to the extent that we are

 14 applying, you know, these definitions more

 15 broadly, I think that that is going to serve to

 16 diminish the number of participants and I think

 17 the real impact of that is going to be, you know,

 18 just as the fellow from -- Ed was saying -- he may

 19 leave the market, there may be parts of the market

 20 that entities could enter if they are now traded

 21 in a more standardized fashion. Those entities

 22 may not do that if the barriers to entry are so
 111

 1 significant that it's not commercially reasonable

 2 to do so.

 3 You know, in our firm, if we want to go

 4 into a new market or new asset class and we think

 5 we have a reason to believe we might be able to

 6 provide liquidity competitively in that space, the

 7 barriers are relatively low for us to enter that

 8 market and I think that's a good thing. We can go

 9 enter a new market on a new exchange fairly

 10 seamlessly, and we can do so and dip our toe in

 11 the water. If the ante to get into some of these

 12 markets that we're trying to create here, really

 13 trying to push some of these swaps onto listed

 14 standardized venues, if we're going to try to do

 15 that and we're going to try to increase the

 16 diversity of liquidity providers by artificially

 17 increasing the barriers to entry, we're going to

 18 directly, on the margins, absolutely reduce the

 19 number of liquidity providers in those places.

 20 MR. WASSON: And that might have the

 21 perverse effect of enhancing or increasing

 22 systemic risk if we just end up with a few large
 112

 1 folks that for people in the commodities space

 2 that's the only people you can deal with.

 3 MR. OPPENHEIMER: Can I make one more

 4 point on the -- it's not on securities-based

 5 swaps, I apologize, but on the notion of barriers

 6 to entry. It's a concern that I'm not sure was

 7 raised as much in the comment letters so I want to

 8 make it here. With respect to market making, to

 9 the extent one actually engaged in market making

 10 in a very narrow scope of swaps, for example, in

 11 the power markets where there are multiple pricing

 12 points called delivery locations, if one were to

 13 provide real market making in that, the

 14 consequences sort of ripple out from that. You'd

 15 be maybe a swap dealer in power, you may be a swap

 16 dealer in the whole other commodities sector, and

 17 so as a result, the cost of that little bit of

 18 market making activity in one location could bring

 19 on this huge consequence with amazing costs. So,

 20 the result would be similar to what people are

 21 describing. You wouldn't engage in that market

 22 making activity, as a result, there wouldn't be a
 113

 1 liquidity provider there.

 2 The same is true with respect to sort of

 3 innovation and new products that might come up,

 4 because if you want to foster the development of a

 5 new product, you might engage in quite a bit of

 6 trading at the outset if that consequence is

 7 you're a market maker for that narrow product, and

 8 then you ripple out from there and bring all the

 9 costs, people are going to refrain from that

 10 behavior.

 11 MR. FAJFAR: Could I ask -- we're going

 12 to cover this in the de minimis, but especially

 13 for the people who aren't on the second panel, it

 14 seems that the consensus is -- to flip it around,

 15 is that we should use the de minimis exception or

 16 the dealer definition in order to decrease

 17 concentration and increase the sources of

 18 different swaps. And it seems that the reason we

 19 should do that is because if we regulated those

 20 sources of swaps, the expense of being regulated

 21 would discourage that activity and then the

 22 argument is, well, since these sources of swaps
 114

 1 didn't cause the last crisis, it's okay to leave

 2 them unregulated because they won't cause the next

 3 crisis.

 4 So, what do we do if we find out -- we

 5 write these, we allow this unregistered swap

 6 activity to occur, whether it's dealing or not,

 7 but then if that activity -- because the swap

 8 dealers are burdened by this burdensome regulation

 9 that other activity percolates along, what are we

 10 going to do if then that's the cause of the next

 11 crisis, because obviously the cause of the next

 12 crisis will be different than the cause of the

 13 last crisis.

 14 MR. WASSON: Mark, I was just going to

 15 say, I think it's an illusion in some respects to

 16 say that we're not regulated, because I mean,

 17 electric cooperatives are regulated by their

 18 boards. Their self interest is they want to

 19 provide electric power to their members at the

 20 lowest possible cost. And --

 21 MR. FAJFAR: AIG was regulated by the

 22 New York Insurance Department and the OTS. That was --
 115

 1 MR. WASSON: But there's a big

 2 difference --

 3 MR. FAJFAR: That was their argument,

 4 that we were regulated -- you can say, well, it's

 5 the fault of the OTS and that's too bad, but --

 6 most firms are regulated.

 7 MR. WASSON: But then you could say that

 8 about everyone.

 9 MR. FAJFAR: But what I'm saying is that

 10 the argument that I'm already regulated is not

 11 really an argument to say I shouldn't be regulated

 12 as a swap dealer.

 13 MR. NICHOLAS: Well, I think, Mark, one

 14 consideration I think that we haven't really

 15 focused on is resources on the side of the CFTC

 16 and the SEC. I mean, in the best of all possible

 17 worlds it would be great to regulate anybody who

 18 even comes close to the definition of swaps

 19 dealer. You know, err on the side of caution, but

 20 those type of resources are not available and I

 21 think it has -- there has to be some type of

 22 triage analysis.
 116

 1 I think the regulators need to focus on

 2 core dealer activities creating the greatest risk

 3 that were clearly the intent of Dodd-Frank to

 4 focus on and the way to do that, I think, is to

 5 narrow the definition somewhat, right, because

 6 then you don't have entities that are on the

 7 borderline that are going to require your

 8 investigative and examination teams to go in and

 9 look at areas that may not be creating risk.

 10 So, I think resources is important.

 11 MR. OPPENHEIMER: It was said before but

 12 it bears repeating -- I'm sorry, Rick -- every one

 13 of these swaps will be reported to a swap data

 14 repository, they'll all be the subject of price

 15 reporting, position limits will apply as positions

 16 roll up to the reference futures contracts, so the

 17 CFTC will have great transparency into this, the

 18 public will have transparency into this and, you

 19 know, to tie it back to what I said at the outset,

 20 you start and you put something in place today

 21 that gets you the biggest bang for the buck and

 22 then when you really understand the true
 117

 1 dimensions of the market, if there was something

 2 that was missed, you'll have the opportunity to

 3 address that.

 4 MR. OSTRANDER: Yeah, and I think

 5 there's a couple points that I wanted to quickly

 6 make. One was that, yeah, you will have access to

 7 all the swaps so I think starting out slowly to

 8 say who you think should be captured or even

 9 enforcing or interpreting the rules slowly, you

 10 will be able to see over time where the activity

 11 is and decide if you think there are players who

 12 are acting in a way that you feel is a dealer

 13 capacity, you will have that ability.

 14 And I do agree, Mark, that we can't take

 15 too much comfort from an entity being rated,

 16 that's a highly regulated entity already. It is

 17 true that the swaps activities were not

 18 necessarily -- even in OCC regulated banks the

 19 swaps activities weren't regulated in the same way

 20 that they would be under Dodd-Frank, but I wanted

 21 to go back to your question, Josh, briefly if I

 22 could, because I think it is worth pointing out
 118

 1 from our perspective a lot of the concepts that

 2 exist in the securities markets and the cash

 3 markets about who was a trader, who was a dealer,

 4 are very applicable, easily transferrable over to

 5 the swaps markets. I do not think you should have

 6 to start over with these concepts while the

 7 underlying products are different and I do take

 8 some of the points in the releases that, you know,

 9 these are not exactly equivalent. We do think the

 10 concepts of being willing to enter into trends at

 11 both sides of the market, being willing to provide

 12 liquidity, taking risk, those are equally

 13 applicable on both a cash or a derivative market.

 14 MR. KANS: Meaning that the

 15 dealer-trader distinction, you think on the

 16 securities side, is a useful dividing line to

 17 preserve in our definition?

 18 MR. OSTRANDER: I think it absolutely is

 19 a great place to start and you can expand those

 20 concepts out to swap dealers as you could cash

 21 dealers, cash traders.

 22 MR. FILLER: I concur. I mean, the
 119

 1 securities industry has much more of the dealer --

 2 historically the dealer role and the trader role

 3 has always been for your proprietary trading or

 4 for your own capital or own account distinction,

 5 versus the dealer who's always dealt with a

 6 principal-based type activity with some other non-

 7 affiliate, meaning a client or something, using

 8 your inventory or whatever, so I agree. I think

 9 the securities aspects of dealer and trader is

 10 right on point.

 11 MR. COTA: I think that the systemic

 12 risk issues are dealt with either through the

 13 uncleared capital requirements or, you know, with

 14 the clearing in something that is cleared, but the

 15 last crisis probably won't be the next crisis and

 16 the thing that concerns me is because the back

 17 ends of a lot of these transactions are

 18 interconnected. You know, Treasury, and you

 19 should complain to Treasury's intent to exempt

 20 FOREX, which is highly leveraged futures to a

 21 large extent, may be something that by exempting

 22 it from the clearing requirements or anything that
 120

 1 relates to Dodd-Frank, may effect the rest of

 2 these markets in how they function. You could

 3 also complain to Treasury.

 4 MR. CHERN: I'd like to get back to

 5 Mark's question for a moment. You raise the

 6 question of, look, you know, if we're just focused

 7 on these products here, because that's what caused

 8 the last crisis, and kind of ignore these ones, I

 9 think if we are focusing on the symptom rather

 10 than the real problem, we would run that risk.

 11 So, if we said, well, really, this problem is

 12 really based on, you know, some mortgage backed

 13 securities, so we're just going to regulate those

 14 things now, or -- I think we'd run that risk.

 15 I agree that it's not about, oh, all

 16 these entities are regulated and, therefore, there

 17 shouldn't be any problem. I think the issue is

 18 that there were plenty of entities, or at least a

 19 handful or a few handfuls, that were fully

 20 regulated but that the regulators didn't have full

 21 view over what was going on in those entities,

 22 what the activities were, and I think it's about
 121

 1 the activities, it's not about the entities. And

 2 so I think that it really gets back to the

 3 definition of what is a swap and if all these

 4 swaps were traded transparently on an exchange

 5 somewhere or on a SEF and if they were all cleared

 6 and centrally traded, the regulators would have

 7 had full view over what was going on and I do

 8 believe that either the crisis would have been

 9 avoided or would have been a fraction of what it

 10 was.

 11 So, I think that that is, you know,

 12 central to avoiding a problem like this in the

 13 future. It's not about looking at, well, where

 14 did this happen, let's go solve that one sort of

 15 symptom, if you will. It's the larger problem and

 16 so that gets back to really, I think, my sort of

 17 core concern is that we are really creating the

 18 healthiest marketplace where we're fostering

 19 competition, transparency, and liquidity.

 20 MR. WALTON: Could I comment? The point

 21 the gentleman from Morgan Stanley made about you

 22 don't want to just create an exception if you're
 122

 1 regulated by the OCC. Certainly that's not what

 2 we are proposing, what other banks are proposing.

 3 We are proposing an exception for those

 4 circumstances where the only risk you're taking on

 5 a derivatives trade is credit risk of your

 6 customer and taking credit risk of a bank customer

 7 is the core risk that banks are organized to take

 8 and are regulated in respect of that by the OCC.

 9 We're not saying that because you're a bank you

 10 ought to go out and trade anything. It's only

 11 those trades that have a balanced book where the

 12 only risk you're taking is the credit risk of your

 13 customer. And we think that's appropriate.

 14 MR. BERKOVITZ: Let me just -- as we're

 15 wrapping up here, I just want to clarify, and many

 16 of the points are excellent points and valid

 17 considerations. Ultimately, though, what we're

 18 engaged in here is not through the definition of

 19 swap dealer to prevent the next crisis, but an

 20 exercise of statutory interpretation. What did

 21 Congress intend? And obviously some of these --

 22 well, Congress couldn't have intended that because
 123

 1 this would be counter to this other Congressional

 2 intent -- those are, you know, all considerations

 3 that are valid comments, but ultimately this is a

 4 very difficult challenging question of statutory

 5 interpretation and rulemaking to implement the

 6 Congressional intent that we're exercising.

 7 MR. FAJFAR: It's 11:00, 11:01, so we'll

 8 take a 15-minute break.

 9 (Recess)

 10 MR. FAJFAR: Okay, we're going to go

 11 ahead and get started with the second panel. I

 12 was asked -- some of you might have noticed we had

 13 some feedback issues during the first panel, that

 14 comes from people having two microphones on at the

 15 same time, they're way too sensitive, so please

 16 try to watch out for that.

 17 We have two new panelists at this end of

 18 the table, Andrei Kirilenko, Chief Economist from

 19 the CFTC, and Gregg Berman from the SEC. And what

 20 we're doing to do, the new panelists can just

 21 introduce themselves like we did in the first

 22 panel, and then we're going to go right into the
 124

 1 issues again.

 2 Obviously, we had a lot of discussion of

 3 the dealer -- definition of a dealer, we want to

 4 get some new perspectives. We're going to talk

 5 about the perspective of some counterparties to

 6 dealers, whether you call them end users or

 7 customers or what term you use, get that

 8 perspective. We'll also talk about the affiliate

 9 point that Ron Filler mentioned, and then we'll go

 10 on to the other points on the agenda. So, Bella,

 11 do you want to start with the introductions?

 12 MS. SANEVICH: I'm Bella Sanevich, I'm

 13 the General Counsel for NISA Investment Advisors.

 14 MR. JANNEY: John Janney with Chelan

 15 County Public Utility District, and also here for

 16 the Large Public Power Council.

 17 MR. MASTERS: Mike Masters, Better

 18 Markets.

 19 MR. CAWLEY: James Cawley from Javelin

 20 Capital Markets, also here on behalf of the Swaps

 21 and Derivatives Market Association.

 22 MR. HIXSON: Jon Hixson with Cargill.
 125

 1 MR. TODD: Greg Todd with Bank of

 2 America.

 3 MR. McCARTHY: I'm John McCarthy,

 4 General Counsel at GETCO.

 5 MR. FILLER: Ron Filler, New York Law

 6 School.

 7 MS. BOULTWOOD: Brenda Boultwood, I'm

 8 the Chief Risk Officer of Constellation Energy.

 9 MS. COLLIER: Mary-Margaret Collier, I'm

 10 the Director of State and Local Finance for the

 11 State of Tennessee.

 12 MS. RUDGE: Camille Rudge, the

 13 PrivateBank and Trust Company.

 14 MR. KANS: Okay, thank you for all being

 15 here, especially the new panelists. I'd like to

 16 tee this off from a -- with a different

 17 perspective from the last panel. On this panel,

 18 we have people who meet the definition of I think

 19 a customer of a swap or a securities based swap,

 20 and also I'd like to talk a little bit and get

 21 some feedback on how the regulations applicable to

 22 dealers will impact customers, both good, in terms
 126

 1 of customer protection, and potentially bad, in

 2 terms of -- so we hear reducing developability of

 3 swaps or security-based swaps to customers.

 4 So I'm hoping that the panelists can

 5 spend a few minutes talking about those issues as

 6 to what this all means to customers and what

 7 happens to customers in the absence of regulation.

 8 MS. SANEVICH: Certainly from the

 9 special entity perspective, particularly as it

 10 relates to pension plans, which is who our clients

 11 are, both public and private, the business

 12 conduct rules, which I know were meant to protect

 13 customers, particularly pension plans, the current

 14 state of the rules could effectively prevent

 15 pension plans from using an invaluable hedging tool

 16 to hedge the liabilities and to invest in the

 17 assets that they feel are in the best interest of

 18 protecting their plan participants.

 19 I can certainly elaborate, but I know

 20 many around here really have heard these issues

 21 before, but in this forum, I thought it would be

 22 important to raise the protections, while they are
 127

 1 very well meaning, could have serious unintended,

 2 negative consequences, at least from the pension

 3 plan’s perspective.

 4 MS. COLLIER: Yes, I'm representing

 5 special entities, as well. I'm representing the

 6 80,000 municipal governments in our country. They

 7 include school districts, states, cities,

 8 counties, and many other authorities. Last year,

 9 over 8,000 of those entities borrowed money in the

 10 capital markets, some of them entered into swaps.

 11 There were 8,000 unique entities, meaning

 12 different bodies that entered into the debt market

 13 in some form or another.

 14 Now, many of them didn't enter into swap

 15 transactions, but that's the population that we're

 16 dealing with. There were over 13,000 separate

 17 transactions that involved municipal utilities, I

 18 mean municipal securities, and cities, counties,

 19 school districts, and so forth in this country last

 20 year alone.

 21 So compared to some of you who are major

 22 market participants, we're very small in terms of
 128

 1 what we do in this particular market, but for us,

 2 it is major; for us, the swap advisory rules are

 3 major. I agree with Ms. Sanevich, for our public

 4 pension funds, these rules are very difficult and

 5 may prevent some public pension funds from

 6 entering into these types of products.

 7 MR. CAWLEY: Let me say something. So

 8 notwithstanding the comments, you know, just

 9 mentioned, I think if you're asking what are the

 10 broader benefits of regulation for the customer, I

 11 think specifically you're looking at -- while

 12 there might be certain issues pursuant to certain,

 13 you know, specific customers, I think broadly

 14 speaking, one has to consider the broader benefits

 15 of the marketplace.

 16 So if you're talking about moving swaps

 17 into regulated environments, I think that is

 18 essentially good in contrast to what we have now

 19 presently and what we've had since the inception

 20 of the OTC swap markets in the '80's and '90's.

 21 Specifically, when it comes to

 22 execution, what you're talking about is moving
 129

 1 products onto exchanges or swap execution

 2 facilities, which brings about greater

 3 transparency, lower transaction costs, and

 4 essentially a fair marketplace where one is

 5 assured a fair shake every time they come in to do

 6 a trade. So these are all benefits that all

 7 customers enjoy pretty quickly in the marketplace.

 8 MR. JANNEY: I wanted to just maybe try

 9 to differentiate a little bit, too, instead of a

 10 broad brush for the special entities, you know,

 11 Mary-Margaret was talking about some of the small

 12 cities and counties and others who may need to

 13 hedge interest rate risk into the market using

 14 swaps and other derivatives.

 15 Speaking for my own utility, we're a

 16 municipal corporation under Washington State law.

 17 We actually have a statute that requires us to use

 18 a swap advisor when we enter an interest rate

 19 swap. That was something that was passed years

 20 ago when we were first authorized to do that.

 21 The interest rate market is different

 22 from our fundamental core business, which is
 130

 1 serving our customers with electricity. We might

 2 do a bond transaction and enter into a swap at

 3 most once a year, probably once every several

 4 years, so very infrequent.

 5 We don't have the expertise on hand

 6 always, and I think maybe the swap advisor in that

 7 context makes some sense. However, in our core

 8 business, which is serving our county residents

 9 with cheap, reliable electricity, we need the

 10 ability to -- we enter into transactions on a much

 11 more frequent basis. The market changes

 12 constantly, and sometimes we might be hedging to

 13 buy, sometimes we might be hedging to sell, and so

 14 it's somewhat impractical to take the same vein as

 15 far as having an independent swap advisor in that

 16 context, where we have the internal expertise to

 17 be able to do that.

 18 And our concern with the special entity

 19 rules is that, if too onerous, it's going to drive

 20 people out of the marketplace Then we will have

 21 fewer counterparties to transact with, the big

 22 spreads are going to widen and it's going to
 131

 1 become much more costly for us to transact.

 2 In addition, instead of being able to

 3 transact with 10 or 12 different counterparties,

 4 if I'm now down to 3 or 4 because that's all

 5 that's left transacting in the market, then my

 6 concentration risk and my credit risk with those

 7 counterparties goes up correspondingly.

 8 So I think that consideration should be,

 9 if we're going to look at the special entity

 10 definition in that context, customer protection,

 11 not having a broad brush, that everyone falls into

 12 the same bucket in that category.

 13 MR. KANS: And just to follow up in the

 14 context, specifically of the dealer definition and

 15 the scope of the dealer definition, is there

 16 reason to be concerned then generally that having

 17 too broad of a dealer definition is going to

 18 unduly limit the ability of customers to obtain

 19 the services they need, or is the issue more in

 20 terms of something that's not on the table for

 21 this panel, which are the actual business conduct

 22 rules applicable to dealers?
 132

 1 MR. JANNEY: Just a comment on that, we

 2 transact currently with a wide variety of

 3 counterparties. Some of them are large banks

 4 which I think would probably clearly fall under

 5 the dealer definition. We also transact with each

 6 other. We may have offsetting exposures that it

 7 makes sense just to transact between two different

 8 utilities. And there are also energy companies

 9 that are in the marketplace.

 10 If the dealer definition gets too broad

 11 and it starts chipping away at some of those

 12 non-bank counterparties that we currently transact

 13 with, again, we get that concentration event,

 14 which is going to drive competition out, increase

 15 our spreads, and increase our overall costs.

 16 MS. SANEVICH: Certainly from our

 17 perspective, the counterparties we deal with are

 18 the entities who will register as dealers, there's

 19 no question, they will be dealers. The big banks,

 20 you know them when you see them, you know, Ron's

 21 definition, and so from our perspective, we're not

 22 concerned that too many people will be caught in
 133

 1 the net and we won't have our usual providers. We

 2 are concerned about the business conduct rules,

 3 which are the other issue.

 4 MS. BOULTWOOD: I'd say it is the broad

 5 definition of swap dealer that is most concerning.

 6 Just in terms of the ability of entities who

 7 traditionally have created liquidity in markets

 8 that are non-financial in nature, and we think

 9 specifically of commodities, other non-financial

 10 products, some market making occurs from the

 11 broker-dealer through the swap dealer, but a lot

 12 of that market making is from commercial firms

 13 that have assets or obligations to supply in that

 14 market.

 15 And if a broad definition is applied,

 16 all the infrastructure record keeping and

 17 oversight requirements that go with that, you will

 18 see, and I think the first panel already echoed

 19 this concern, just many unable to fulfill those

 20 requirements and pull back from those businesses

 21 and create even less liquidity, less transparency

 22 in the market, wider bid offer spreads, less
 134

 1 ability to see price discovery. And ultimately,

 2 the end consumer in the United States would see

 3 higher prices and perhaps an inability to get

 4 transactions completed.

 5 MR. BERMAN: Could I ask a quick

 6 question just to follow up on that? So if we take

 7 the business conduct requirements off the table

 8 since it's not part of this panel, just look at

 9 the breadth of the dealer definition. If we live

 10 in a world -- so two years from now it's all

 11 settled, everything is implemented, there's a

 12 counterparty that is a dealer and there's a

 13 counterparty that's not a dealer, how are you --

 14 putting your fiduciary hat on -- how do you make

 15 the determination that I will go with the non-

 16 dealer versus the dealer even though I may be

 17 afforded less protection by the non-dealer? I mean

 18 would you just strictly look at prices? How does

 19 this play itself out regardless of what the

 20 ultimate breadth of the definition is?

 21 MS. BOULTWOOD: I think when we're

 22 managing our customer exposures, we're looking for
 135

 1 diversification. So you want to have the option

 2 of dealing with the swap dealer if they make the

 3 best markets and offer you the best prices, but

 4 you also want the opportunity to transact with

 5 firms that may have the commercial interests, and

 6 sometimes it's those commercial interests that

 7 allow them to have better pricing because of

 8 better insights into the physical aspects of that

 9 market. So you really need the diversification,

 10 and really, in a world where you have to choose

 11 one or the other, I think that's what we'd like to

 12 avoid, you know, being the result of the

 13 regulatory changes that are happening now.

 14 MR. FAJFAR: Did you have any? Because

 15 from a perspective of somebody with sort of a

 16 duty, not necessarily fiduciary, how would you

 17 make the choice between somebody who's registered

 18 as a dealer and not registered?

 19 MR. JANNEY: I think we'd continue to do

 20 what we do today, which is, we look at each of our

 21 prospective counterparties and do a thorough

 22 credit analysis on them, look at their
 136

 1 capitalization, look at their underlying position,

 2 the type of business they're in, and evaluate how

 3 much exposure we have there from a potential

 4 credit standpoint, and we assign a limit based on

 5 that analysis that we update at least annually,

 6 and we make a determination then based on the

 7 credit worthiness of the counterparty, and then

 8 look at the prices that we're being offered for a

 9 particular transaction and select those within the

 10 approved credit limits that we have for each of

 11 the counterparties we deal with.

 12 MR. FAJFAR: So you're not thinking that

 13 process will change once -- the dealer

 14 registration is basically -- won't be relevant to

 15 you?

 16 MR. JANNEY: The process we undertake

 17 will probably not change. Our concern is that if

 18 the dealer definition is too broad, there will be

 19 fewer counterparties with which to have in our

 20 portfolio. And again, the less competition there

 21 is, the more costly it's going to be for us to

 22 transact.
 137

 1 And the other kicker there is, if I've

 2 got ten counterparties now and they've each got a

 3 $1 million credit limit, I can trade with each of

 4 them up to the million dollar credit limit. If

 5 I've only got one counterparty with a million

 6 dollar credit limit, then I'm really limited

 7 there, and I have to do other things in order to

 8 try to manage that exposure, which, again, could

 9 be more costly.

 10 MR. FAJFAR: I'm not arguing with you,

 11 but I'm seeing a different thing. You don't see

 12 any benefit? There's no benefit going to -- the

 13 fact that the person is registered as a dealer or

 14 not is really not going to bring any customer

 15 protection benefit or other benefit to you?

 16 MR. JANNEY: I think that's true.

 17 MS. SANEVICH: I'm sorry --

 18 MR. CAWLEY: Could I just ask a quick

 19 question? Are you talking about cleared swaps or

 20 uncleared swaps?

 21 MR. FAJFAR: Both.

 22 MR. CAWLEY: Okay. Well, I'm a little
 138

 1 bit confused, because if you're talking about

 2 cleared swaps, and if you're talking about swaps

 3 that perhaps trade on SEF's, how do you even know

 4 who your counterparty is?

 5 MR. FAJFAR: Well, I'm asking, from a

 6 customer's perspective, first of all, we very

 7 strongly heard from the end users, to an extreme

 8 extent they don't want to clear, so they're not

 9 really interested in clearing. So when this

 10 person who then does the end user swap and is --

 11 the question is, do you see any benefit from doing

 12 the swap with a registered swap dealer or not?

 13 Yeah, if you did -- if you just went to clearing,

 14 I see why -- if you went to a clearing, you

 15 executed on an SEF, it wouldn't be a relevant

 16 question. So really we're talking about people

 17 who are doing uncleared swaps, you're right.

 18 MS. SANEVICH: So I mean even though

 19 this probably won't be an issue for us, but as a

 20 fiduciary, which we are, and for very many, you

 21 know, particularly for ERISA and for our clients,

 22 I mean, you would see what the ultimate
 139

 1 requirements are for a dealer that is registered.

 2 So if it gives you an additional cause of action

 3 if they are required to give you a confirm

 4 quickly, but normally you could not negotiate that

 5 on your own.

 6 Or if -- take business conduct. We

 7 won't get into the substance, but let's say you

 8 feel like you need those protections, that would

 9 give you that protection, but if you're an entity

 10 that doesn't need those protections because you

 11 can either negotiate them or you know what you're

 12 doing, then you wouldn't view that as a valuable

 13 factor.

 14 So it really depends on -- in your

 15 fiduciary capacity you evaluate everything. Just

 16 like in Best Ex, you can look at not just price,

 17 but how responsive they are, what to do about

 18 errors, whatever it is that is important to you in

 19 a particular trade, you would evaluate that in

 20 totality. But the mere stamp of registration

 21 doesn't do much, it's really what does the

 22 registration do for you and can you get that on
 140

 1 your own. And in some cases, if the registered

 2 entity has to do something that you think is not

 3 in your best interest, then you would look for an

 4 unregistered entity because you would think that's

 5 better for you or better for your clients.

 6 MS. RUDGE: I would just like to add on

 7 the smaller clients that are looking to hedge tied

 8 to their exposures, I think that the access claim

 9 is particularly important with respect to their

 10 bank, if they don't offer the product in lieu of

 11 being a swap dealer, they may not have access to

 12 that hedging product, if you know the smaller

 13 entities that are out there.

 14 MS. COLLIER: From the local

 15 government's perspective, the swap dealer is the

 16 counterparty. We don't normally work through a

 17 swap dealer to trade with another counterparty.

 18 There have been instances where counterparties

 19 have come through a swap dealer or through a swap

 20 advisor to say we are interested in doing a swap

 21 with this community, but we normally, as I said on

 22 interest rate agreements, we normally have -- our
 141

 1 swap dealer is our counterparty.

 2 It's important for us to know that there

 3 is a broad market. Some swap dealers will deal

 4 with small swaps, others will not. If that small

 5 size swap -- and I'm talking about swaps less than

 6 $5 million -- if we only have large swap dealers,

 7 those folks who are capable of managing a small

 8 swap will not be able to enter the market. So we

 9 have to have a broad range of swap dealers, and as

 10 I said, our swap dealers generally are our

 11 counterparties.

 12 MR. FILLER: I think one of the

 13 analyses, and maybe DMO can look into it, is what

 14 is really the true quantity of what I call the

 15 agency or direct client, direct counterparty

 16 swaps. I would think it's a relatively small

 17 amount versus where one of the counterparties is,

 18 in fact, a swap dealer, and you have to then look

 19 in the clear environment, as Mr. Cawley just said.

 20 I mean I think it's a different element and

 21 different approach from trading on SEFs and then

 22 clearing the swaps through a DCO.
 142

 1 But in the uncleared environment, you

 2 have to, again, look to the proposed regs on

 3 uncleared swaps. Swap dealers have the right to

 4 require margin, have the right to then -- the

 5 client counterparties deposit in a custodial bank,

 6 and how those filed rules I think are going to

 7 come -- when they become adopted is really going

 8 to have a more direct answer to your question.

 9 And will those rules "be written in a way where

 10 maybe the agency or direct counterparty swaps

 11 might increase", so there's something for the

 12 commissions to look into in the uncleared swap

 13 environment, something to think about.

 14 MS. BOULTWOOD: So I think, Mark, part

 15 of your question around customer protection,

 16 consumer protection is answered through the rules.

 17 I think if you look back at the Banker's Trust

 18 incident and the appropriateness of a derivative

 19 for a particular customer, does the stamp of a

 20 registration make a customer feel more comfortable

 21 that they'll be dealt with more appropriately than

 22 the non- registered dealer in that swap, say?
 143

 1 I can't say as a counterparty that I

 2 would feel that the swap dealer stamp provides

 3 that protection. I think part of it has to be

 4 born by the counterparties in terms of

 5 understanding the nature of the derivative

 6 instrument they're entering into. The other part,

 7 just by the reputation and kind of the broader

 8 fiduciary, sense of fiduciary duties that swap

 9 dealer feels they're carrying out. So --

 10 MS. COLLIER: Also on uncleared swaps

 11 for local governments, some local governments

 12 cannot post margin requirements. That money that

 13 they budget for debt service is authorized, it's

 14 appropriated every year, and it's not always

 15 convenient mid-year to go in and get an

 16 appropriation. My General Assembly closed down

 17 until next January at the end of May. If I needed

 18 that appropriation to post a margin requirement,

 19 we would have to call them into special session

 20 potentially to post and get an appropriation to

 21 post a margin requirement.

 22 So we have to consider our process. Our
 144

 1 process is not a nimble process. We can't go in

 2 and immediately transfer money. I have to have

 3 generally 24 hours notice. My accounting

 4 department tells me that if that request is not in

 5 by 5:00 a.m. in the morning it will not process

 6 that day. So that's a part of our business and

 7 accounting process, and that's just one simple

 8 example of timeliness of posting margin

 9 requirements in local governments.

 10 MR. FAJFAR: Go ahead.

 11 MR. MASTERS: I was just going to make

 12 one point. I mean, you know, everyone that is

 13 transacting in uncleared swaps does have the

 14 ability to require from a swap dealer to clear, so

 15 that's -- and I think that's pretty important from

 16 a lot of respects. And not only require the swap

 17 dealer to clear the trade, but to clear it where

 18 you'd like it to clear, in the sense of, you know,

 19 so that's a big option that I don't think should

 20 be overlooked by anyone with regard to this

 21 discussion.

 22 MR. FAJFAR: Okay. We want to leave
 145

 1 plenty of time for the de minimis exception. But

 2 just to pick up the affiliate question that Ron

 3 Filler mentioned, we said in the release that

 4 generally there is some consideration to swaps

 5 between affiliates, so I think the really useful

 6 thing to talk about, to get any input on is, what

 7 do we mean by -- if dealing between -- swaps

 8 between affiliates are not dealt swaps, what do we

 9 really mean by affiliate other than two wholly

 10 owned, you know, twin --

 11 MR. FILLER: Well, I think the analysis,

 12 Mark, from a policy perspective is, if one of the

 13 entities is already registered as a swap dealer

 14 and then engages in what I call internal or

 15 back-to-back swap with an affiliate within that

 16 same organization, and you can define it as common

 17 control or, you know, sister, brother, parent,

 18 sub, whatever -- how you want to define it, does

 19 that bring in the other affiliate to also become

 20 registered, and fall within the definition, and

 21 then become registered and have separate capital

 22 and so forth?
 146

 1 So if one of the entities is already

 2 registered as a swap dealer, does it cause -- and

 3 does a swap with an affiliate, and you can define

 4 affiliate any way you want, common ownership, does

 5 that cause the other entity or affiliate to become

 6 a swap dealer, as well? And that's the test that

 7 the commissioners have to decide.

 8 MR. HIXSON: On that issue, I mean we

 9 would certainly hope that is not the case, and we

 10 might do a back-to-back transaction when we hedge

 11 an international commodity, we'd like to place the

 12 futures in the Chicago pits, for example, and we

 13 may have an affiliate transaction between two

 14 governing entities in international jurisdictions,

 15 you know, it's kind of an in-house, back-to- back

 16 apparent guarantee of two corporate affiliates.

 17 It doesn't make sense to us when we're already

 18 fully margining the underlying hedge, so that

 19 would certainly kind of be our view, is that, in

 20 that instance, it doesn't really make sense.

 21 MR. FAJFAR: Well, just to let the panel

 22 lead the discussion, to me, it sounds like what
 147

 1 you're really talking about is, once an entity,

 2 part of an entity is designated as a dealer, how

 3 far does that designation extend? So since we're

 4 there, that was the last point on the agenda, but

 5 why don't we get into that, because the question

 6 would be, just to tee it up a little bit, we

 7 talked about dealing activities in the first

 8 panel. If you had a company that now has come

 9 around and says, okay, I am offering customer

 10 swaps, I am within the definition of swap dealer,

 11 but that's only some of the swaps, obviously it

 12 would only be some of the swaps I use, there would

 13 be other swaps that aren't in that same use.

 14 How do you draw a line? And one of the

 15 big questions is, does that same question apply to

 16 what everyone seems to understand are the dealers?

 17 Do the dealers -- because obviously even the

 18 people that you acknowledge are dealers use swaps

 19 for a lot of other reasons, so how would you think

 20 that that would be cabined?

 21 MR. TODD: Our institution, we obviously

 22 use inter-affiliate trades, as do all of the major
 148

 1 banks that have multiple institutions that are

 2 trading derivatives. But they're a critical

 3 internal risk management tool that we need in

 4 order to be able to centralize our risk

 5 management. And conceptually, particularly

 6 building on the discussions from the previous

 7 panel, the fact that -- one of the key elements

 8 that a number of the panelists raised the last

 9 time, the focus on dealer activity being customer

 10 driven, being based on making markets, you know,

 11 all of those various criteria that we discussed in

 12 the last panel, none of that is particularly

 13 applicable to internal trades; they're pure risk

 14 transfers.

 15 MR. FAJFAR: What about beyond internal?

 16 Are all of your external -- assuming that Bank of

 17 America could be the type that would be a dealer,

 18 would all of its external swaps be subject to the

 19 dealer requirements?

 20 MR. TODD: Well, we obviously have

 21 components of bank that are sort of end-useresque

 22 in terms of hedging our own balance sheet risk,
 149

 1 for instance. But based on how the regulators

 2 have chosen to draft and conceive of the

 3 definition of dealer itself, it's an entity based

 4 approach. And so to the extent that any of our

 5 non-dealer activities would actually be in an

 6 entity that is also our customer facing entity, we

 7 would expect that those activities would be

 8 subject to any of the dealer requirements under

 9 the current proposal.

 10 MS. BOULTWOOD: I guess I would like to

 11 advocate a different view that I think there

 12 should be a limited designation of swap dealing

 13 activities within a firm. Say the majority of the

 14 firm is engaged in commercial activities and

 15 hedging of those commercial activities but there's

 16 a small piece potentially that there are

 17 activities that could be considered swap dealing

 18 if a broad definition of swap dealer is

 19 promulgated. And in that case, we believe that

 20 there are all kinds of issues that will be raised

 21 around, you know, does it have to be a legal

 22 entity, can it be a specific business division, a
 150

 1 subset of that division, does the company then

 2 self-certify which piece of the business it is and

 3 how it's kind of walling itself -- that piece of

 4 the business off, and can we separate those

 5 activities from the other activities of the firm

 6 but then still utilize central, say, middle back

 7 office infrastructures, central compliance staff,

 8 and other kinds of central utilities of the

 9 company.

 10 So we believe that if a broad definition

 11 is applied, and a small portion of a company's

 12 activity could be construed as swap dealing, they

 13 should be able to say that and designate this

 14 limited area as a swap dealer and have the rest of

 15 its business under kind of a self- certification

 16 process understood as not being swap dealing.

 17 MR. TODD: So if I could just add to my

 18 comments, I wasn't indicating a different point of

 19 view. We obviously would be supportive of a

 20 definition that recognizes the fact that financial

 21 institutions that act as dealers and make markets

 22 for customers in terms of customer facilitation
 151

 1 trades, obviously they are in the business of

 2 making loans and financing and that sort of thing,

 3 where they have a balance sheet risk that they

 4 need to hedge, similar, but obviously slightly

 5 different in terms of the underlying business, but

 6 it does have a similar component to corporate

 7 end-users, as well, and we would certainly be

 8 supportive of a similar construct.

 9 MR. CAWLEY: Clearly under a corporate

 10 umbrella, there is both opportunity for swap

 11 dealing and also opportunity to be an end-user,

 12 and I think that it would be fitting that there

 13 clearly is some relief for those end- user

 14 entities, legal entities, separated from the swap

 15 dealer itself who have legitimate hedging end-user

 16 purposes.

 17 Now, you make mention in the rules on

 18 the CFTC certainly with those which are deposit

 19 institutions, and you can clearly see from making

 20 a loan that there's a legitimate need. There's

 21 also other balance sheet requirements that require

 22 the use of be they credit swaps or interest rate
 152

 1 swaps to hedge, and there should be certainly

 2 relief for that. That said, there should be a

 3 certain distinction and delineation between the

 4 swap dealer subsidiary and the other end-user

 5 subsidiaries under that umbrella.

 6 MR. MASTERS: Yeah, I just sort of echo

 7 that, and maybe go a little further. I mean I

 8 think you've got to be real careful when you sort

 9 of go down that line in terms of Chinese wall kind

 10 of considerations. I mean, certainly from my

 11 perspective and many of the people I know in the

 12 business, none of us trust Chinese walls

 13 whatsoever, and as soon as you start dealing with

 14 customers as opposed to being an end-user, then

 15 it's a tricky place to be.

 16 I mean, there's all sorts of things:

 17 Who gets the information, how does the information

 18 happen, and I think that that customer delineation

 19 with regard to being a swap dealer, if you're

 20 going to be in the business of being a swap dealer

 21 and having customers, then you're a swap dealer.

 22 I mean, you've got to be very careful in terms of
 153

 1 breaking that out, because it's just a different

 2 business model, and if I'm not a customer, and I

 3 can see the information from that customer flow,

 4 all of a sudden I've got an asymmetric advantage

 5 over other participants in the market.

 6 MR. TODD: I think the fundamental

 7 issue, though, with respect to how institutions

 8 like ours organize our business -- I mean our

 9 end-user treasury and sort of balance sheet

 10 hedging business is completely separate from our

 11 market making business.

 12 I understand your concerns about Chinese

 13 walls, but there's absolutely no way that somebody

 14 that's trading in the customer facing business can

 15 have access to the books or the price information

 16 or anything else that the end-user entity, or the

 17 end-user business is receiving. Those businesses

 18 are physically, technologically and

 19 compliance-wise completely separate from each

 20 other.

 21 MR. MASTERS: And with all due respect,

 22 and I'm sure you do, I mean, we've never heard
 154

 1 that from any other swap dealer. I mean, in other words,

 2 every swap dealer says the same thing, that

 3 everything is isolated, nothing ever goes forward,

 4 yet there's example after example after example

 5 where somehow those things do cross over, so

 6 that's the point.

 7 MR. TODD: So are you, in effect,

 8 basically saying that an entity that decides it's

 9 going to be a dealer shouldn't be allowed to hedge

 10 its balance sheet risk to the extent that it's a

 11 financial institution that's offering loans to its

 12 clients, for instance?

 13 MR. MASTERS: No, I'm not saying that.

 14 I'm just saying that from a regulatory

 15 perspective, in terms of encompassing swap

 16 dealers, there's a -- you have to be careful when

 17 you're dealing with customers and then you're also

 18 dealing from the standpoint of hedging your own

 19 book. I mean it's a tricky business.

 20 MR. TODD: We agree and think that a

 21 robust conflict of interest and robust Chinese

 22 wall mechanism would sufficiently protect those
 155

 1 two businesses from -- and keep them completely

 2 separate.

 3 MR. FAJFAR: I think that's really the

 4 issue on the end-user, on the limited purpose

 5 designation, is then would you have sort of a

 6 Chinese wall, a bank type standard apply to the --

 7 so I just want to be -- if anybody else wants to

 8 kick in on that or is that sort of what the

 9 thought is?

 10 MR. HIXSON: Well, for Cargill, I mean,

 11 by and large, we are a commercial company hedging

 12 our own underlying physical movement of

 13 commodities. We do offer customized risk

 14 management products to customers that buy the

 15 underlying commodity from us in terms of

 16 compliance. We also then at times will have

 17 customers come in and say, you know, we like your

 18 cargo, but we don't want to buy all of our soy

 19 bean oil from you guys, but we like your risk

 20 management products, so they'll seek those risk

 21 management products and perhaps not buy the

 22 underlying flow of oil from us.
 156

 1 So from our standpoint, maybe we're

 2 trying to make this too simple, but it seems like

 3 there's a pretty clear delineation of anything we

 4 would register with kind of dealer compliance

 5 activities, based on kind of the fact you're going

 6 to get all the swap data reported to you, and then

 7 on those where we're serving a customer, where we

 8 may not be selling them the underlying oil, we're

 9 providing that swap data and acting as a dealer in

 10 that capacity. So it's a small portion of overall

 11 what we do, but certainly one where we're happy to

 12 provide the transparency, I think, that will be

 13 needed to, in a pretty simple way, distinguish the

 14 two activities.

 15 MS. BOULTWOOD: I'll just say we agree,

 16 and it really does come back to kind of the

 17 business purpose of the entity itself, and if it

 18 can be defined most broadly as commercial, and

 19 hedging the activities with derivatives hedging of

 20 their own proprietary risks because they have

 21 assets with served customers. Then it does make

 22 sense that if their primary activity is this
 157

 1 commercial business then you could see a limited

 2 designation required. But again, it depends on

 3 how broad your definition of swap is and how broad

 4 the definition of swap dealer is.

 5 MS. RUDGE: Yeah, I just wanted to add

 6 to that. In our particular institution, we would

 7 have that bifurcated between treasury and any

 8 business, but to the extent that a smaller

 9 institution that was -- if it was a broad

 10 definition, and to the extent that a smaller bank

 11 was structured as an integrated treasury and very

 12 small sales effort with clients for loan level

 13 transactions or for foreign exchange client

 14 related hedging, they may have a challenge in

 15 doing that, in expressing that bifurcation.

 16 But at the same time, if you look at the

 17 activity, the activity is very specific to hedging

 18 for themselves or for dialoguing around clients.

 19 I think it really has to do with the broader steps

 20 that were discussed earlier in terms of -- and

 21 maybe it leads in a de minimis discussion, but

 22 what is a broad effort in the industry and what is
 158

 1 more of a smaller or a smaller footprint and

 2 smaller activity in the same construct of the

 3 marketplace.

 4 MR. FAJFAR: I just want to follow up

 5 that -- can't help to draw the conclusion, in the

 6 earlier panel, there was a pretty strong consensus

 7 that the dealers are the large major financial

 8 institutions and other sort of easily identifiable

 9 people. The other market participants are not

 10 identified as dealers, which would mean that those

 11 people who are not dealers would not be subject to

 12 any sort of Chinese wall requirement.

 13 In fact, as far as -- tell me

 14 differently, they would be perfectly free to use

 15 the information that they glean from their small

 16 amount of customer facing activity to then get a

 17 better understanding of the market. There

 18 wouldn't be an obligation that they share that

 19 back, you know, that -- is that clear that that's

 20 what we -- that's a good result?

 21 MR. MASTERS: I think that's the exact

 22 wrong result. I mean as soon as you're putting
 159

 1 customers into an asymmetric situation with a

 2 counterparty that's one of the whole reasons we

 3 had the crisis is, there was asymmetric

 4 information out there, and in my view -- and that

 5 of the de minimum exceptions and so forth. I mean

 6 if you're going to be a swap dealer, be a swap

 7 dealer; if you're going to be a hedger, be a

 8 hedger, but as soon as you cross the line, there's

 9 a lot of need for customer protection with regard

 10 to preventing traders from misusing the

 11 information. And again, you can have Chinese

 12 walls and all the other stuff, but it just goes on

 13 all the time.

 14 And I won't name names, but there's

 15 plenty of examples of that happening historically.

 16 So I think that the customer actually needs the

 17 protection that comes with the registration if

 18 you're going to be engaged in that business.

 19 MR. FILLER: Let me share my 35 years in

 20 this industry, and we have these Chinese walls

 21 built into futures, securities, and now it looks

 22 like there's going to be some proposals on swaps.
 160

 1 I'm not aware of one enforcement action ever

 2 brought by the CFTC, and I'm not sure whether,

 3 from the SEC, that there's ever been a violation

 4 of the Chinese walls, and you've got to

 5 distinguish what we're talking about. Swap

 6 dealers deal with customers.

 7 As Greg was talking about, other

 8 affiliates within the firm deal for themselves,

 9 they're traders, not dealers. And, yes, I'm a

 10 trader, I know that I did a deal with XYZ, but the

 11 dealer part of it who deals a customer doesn't

 12 share that information, there's a wall between

 13 that, and you have to distinguish the trader

 14 version versus the dealer version. It's been

 15 there in the business, it's been in the futures

 16 business, it's been in the equity business, it's

 17 been there.

 18 When you have customer information that

 19 is confidential and is to be preserved and the

 20 Chinese walls prevent it, what you do on the

 21 trading side is a different animal, and you've

 22 just got to have the proper Chinese walls to make
 161

 1 sure that the traders don't have access to the

 2 customer side. And I'm not aware of any

 3 enforcement action ever brought in the last 35

 4 years in this area, so the system is working quite

 5 well.

 6 MR. FAJFAR: Stop me if I'm pressing

 7 this too hard, but if -- the Chinese wall is

 8 important. We established this morning that there

 9 would be a lot of people offering customer facing

 10 swaps that would not be dealers and would not have

 11 Chinese walls. I mean not to pick on you, but you

 12 said you wanted a choice between I'm going to do

 13 the swap with a financial dealer, Chinese walls,

 14 can't use my information, or I might go to one of

 15 my peers, which you probably -- maybe you'd be

 16 comfortable that they're not going to use it

 17 against you, but they could if they wanted to, or

 18 an energy firm. Now, if that energy firm were not

 19 registered as a dealer, it could use the

 20 information from the swaps it does with you for

 21 better understanding of the market.

 22 Now, I can see the argument is either,
 162

 1 well, that's just not going to happen that often

 2 or it's not a concern, but I just want to make

 3 clear that we were sort of saying customer

 4 protections of the dealers are not important, but

 5 that was one customer protection it seems you're

 6 saying is very important, and I think it's very

 7 important to the banks to show that they have

 8 that, but the other market participants wouldn't

 9 have that protection.

 10 MR. FILLER: Well, the energy dealer

 11 you're using in your example, which I agree with,

 12 is trading on behalf of its own capital, it's not

 13 dealing with a customer acting in it from a

 14 counterparty perspective, it's a trader, not a

 15 dealer. And, yes, when I'm a trader, I know I did

 16 a deal with X, I did a deal with Y, and I did a

 17 deal with Z, but that's information I did as a

 18 trader, not in the dealer capacity, which is

 19 almost more like an agency type capacity that

 20 we're used to in our business. And, to me,

 21 there's a big difference in acting as a trader

 22 versus acting as a dealer, and if you are acting
 163

 1 as a dealer, and you have confidential client

 2 information, there should be a wall preventing you

 3 from sharing that information with the trading

 4 functions within the same firm.

 5 MR. BERMAN: Can I give that one a try,

 6 Mark? Yes, but that depends -- so I think we're

 7 using the word dealer two different ways. We're

 8 using the word dealer as in someone who you can

 9 call up who you all use today, and who some of you

 10 are today, that's a dealer with a little D, that

 11 has nothing to do with dealer in Dodd-Frank

 12 because that doesn't exist yet.

 13 Post-Dodd-Frank, now there's a dealer

 14 with a capital D, that's a regulated entity. So

 15 let's only talk about that one for a second. So

 16 when you call a firm and you say I would like to

 17 do the following swap, can you make me a market,

 18 can you quote me a price, can you be my

 19 counterparty, there will be entities who are

 20 regulated with a capital D, who will have

 21 requirements to make sure that there are Chinese

 22 walls and that that information is not used.
 164

 1 If you engage with that same swap with

 2 the dealer with the little D who's not regulated,

 3 which many of you have just said you want to

 4 continue dealing with, but at the same time said,

 5 but we need those protections of making sure that

 6 that information is not used, what Mark's point

 7 is, those protections would not be granted. They

 8 might be there, because the firm does their

 9 business that way, but they're not regulatory

 10 protections, and how would you balance the

 11 difference between that?

 12 MR. FILLER: Is the firm with the little

 13 D a trader?

 14 MR. BERMAN: The firm with the little D

 15 is not a regulated entity.

 16 MR. FILLER: Okay. But it's trading on

 17 -- but using its own capital?

 18 MR. BERMAN: It's not a regulated

 19 entity, that's all.

 20 MR. FILLER: Okay.

 21 MR. BERMAN: It doesn't have to abide by

 22 dealer rules.
 165

 1 MR. FILLER: Then from that perspective,

 2 as I mentioned earlier, you've got to go DMO or

 3 whomever from the SEC perspective, what is the

 4 percentage of trades, what I call direct client or

 5 agency trades are out there today, it's a very

 6 small percentage, but it might increase, and

 7 that's a concern you might have, and you have to

 8 deal with how to deal with that. Either one has

 9 to -- you're right, they might be unregulated, and

 10 if I choose to deal with that other firm, I know

 11 that that firm may be using that information, and

 12 as others, John and others said earlier, we have

 13 to evaluate the risk of our counterparties, and

 14 they may determine that, no, I only want to deal

 15 with the firms with the capital D.

 16 MS. BOULTWOOD: They decide.

 17 MR. FILLER: Yeah, let them decide.

 18 Remember, we're dealing only with large eligible

 19 contract participants in this deal.

 20 MR. MASTERS: I would just say, I mean,

 21 even though there hasn't been a regulatory history

 22 with regard to the whole division here, as a hedge
 166

 1 fund manager the number one thing that I worry

 2 about with dealing with a counterparty, number one

 3 is that they're going to reverse engineer what I'm

 4 doing, especially with regard to derivatives, any

 5 kind of derivative transaction.

 6 And so we consistently use markets in

 7 which we can disguise what we're doing from the

 8 standpoint of dealing with counterparties, because

 9 that information is very valuable, and in the

 10 wrong hands, it has potential serious

 11 ramifications. And so from a customer protection

 12 standpoint, I don't think there's any hedge fund

 13 manager that wouldn't argue this, or most

 14 portfolio managers, that's one of the biggest

 15 things that they have to deal with day after day,

 16 is to make sure that people aren't -- I mean

 17 there's business models that are, in fact,

 18 predicated on that, so I mean it's a really big

 19 issue.

 20 MS. BOULTWOOD: But, Mike, that would

 21 speak potentially to being able to transact with a

 22 broad diverse set of counterparties. Some are big
 167

 1 D, others are small D, and you're able to make the

 2 decision based on your optimization of your credit

 3 risk management, your liquidity, and other risks

 4 you're trying to manage. If you take away the

 5 little D, you've just limited your potential

 6 partners, and you're more likely to be reverse

 7 engineered.

 8 MR. MASTERS: I don't think that the

 9 customer protection issue is too big of an issue

 10 for anyone in the market to deal with, I mean from

 11 the standpoint -- I know this isn't part of this

 12 panel in terms of business conduct, but I mean

 13 it's a pretty serious issue to market integrity in

 14 terms of -- that I know that whoever I deal with,

 15 I'm going to get a fair shake whether I deal with

 16 a big dealer or a small dealer. I'd like

 17 everybody to have those protections.

 18 MR. CAWLEY: Can I just -- but your

 19 rules don't call for, with a capital D definition,

 20 your rules don't call for -- the definition there

 21 is really, by what we read, a function of whether

 22 you hold yourself out as a dealer, whether you are
 168

 1 known in the marketplace to be a dealer, or

 2 whether you make markets to counterparties.

 3 And I think what I'm hearing right now

 4 is, it's not making markets to counterparties,

 5 it's making markets to customers. Certainly it's

 6 fair to say that if you're dealing with customers,

 7 and certainly coming from the securities

 8 experience, we can all agree that there should be

 9 certain protections when you're facing customers,

 10 but surely the standard is different when you're

 11 providing liquidity to a marketplace where you're

 12 not facing customers. So a distinction, I think,

 13 should be drawn there, whereas, on one hand you

 14 say, well, look, we need to have dealers who will

 15 be regulated and we need to know what they're

 16 doing because of the systemic risk issue, and what

 17 we're hearing from here is, from end-users is, you

 18 know, we want to be able to still choose which

 19 dealers we deal with, but some of them, we don't

 20 want them to fall under the major swap participant

 21 or major -- or swap dealer definition. So we want

 22 to have our cake and eat it, too. And I can see
 169

 1 the tension there is, on one side, they qualify

 2 and you get the protection; on the other, you

 3 don't get the choice but you also don't get the

 4 protection, so that's a clear tension that needs

 5 to be figured out.

 6 But again, coming back to it, your rules

 7 don't talk about that you shall be considered a

 8 dealer if you face customers. I think it would be

 9 preferable if your rules did say that because

 10 there are legitimate market makers in the space

 11 who provide a greater systemic need, and we could

 12 probably talk about this later, I don't know when

 13 you're going to bring it in with the de minimis --

 14 MR. FAJFAR: How do you distinguish --

 15 when does a person change from a counterparty to a

 16 customer?

 17 MR. CAWLEY: When does a -- I think if

 18 you hold yourself out to seek customer business,

 19 you should be considered a dealer, and you should

 20 be held to a higher standard than somebody who's a

 21 trader in the marketplace.

 22 MR. FAJFAR: But not if you seek
 170

 1 counterparty. A person who seeks counterparty

 2 business would not --

 3 MR. CAWLEY: Agreed.

 4 MR. FAJFAR: -- how do we distinguish a

 5 counterparty from a customer?

 6 MR. CAWLEY: Well, if you go out and

 7 market, if you have a sales force, and you'd

 8 certainly talk about this in your rules, if you

 9 have a sales force, if you hold yourself out as a

 10 dealer, whereas if you're just in providing

 11 liquidity to the market space and you have no

 12 sales force, let's say you're connecting into an

 13 exchange and you're sending prices electronically,

 14 where you're not touching anyone and it's strictly

 15 anonymous --

 16 MR. FAJFAR: But are you saying that

 17 whether the person is a counterparty or a customer

 18 depends on what the "dealer" did to get there, if

 19 they did this, they'd get --

 20 MR. CAWLEY: Yeah, I think -- well, it

 21 begs the definition of what a counterparty is. I

 22 think a customer is a subset of a counterparty,
 171

 1 and the question is, who needs to be protected.

 2 If you're trading with counterparties, you don't

 3 necessarily know who they are if you're trading in

 4 an anonymous all-to-all platform. So how do you

 5 reconcile that then with protecting a customer?

 6 If you're going out and holding yourself out as a

 7 dealer, and facing customers directly, and even

 8 holding customer funds on account at your

 9 institution, to be sure, there should be

 10 regulation around that.

 11 MR. FAJFAR: Okay. Certainly people

 12 here don't agree with that.

 13 MR. MASTERS: I would just say I agree

 14 with that, I mean in the sense of -- with the

 15 whole notion of, you know, when you're facing DCM

 16 or any kind of central counterparty, it's a much

 17 different situation, because you have the

 18 anonymity that you require.

 19 And one of the participants here said

 20 earlier, you know, we do our own credit analysis,

 21 we do our own work on customers if we want to do

 22 that, well, that's all information that I'd rather
 172

 1 not give you if I don't have to give it, and as

 2 soon as I do give that information out, now you've

 3 got an information edge on me potentially.

 4 And so what I think theoretically we'd

 5 like to do is to incentivize more use of DCM's,

 6 because as soon as -- if I can move from that

 7 bilateral information asymmetry world to a DCM

 8 world, then I'm probably in a better situation

 9 from a customer protection standpoint.

 10 MR. FAJFAR: And I just want to make

 11 sure we -- I just want to clarify. The point was,

 12 the dividing line becomes when you know the

 13 identity of the party, you've held yourself out or

 14 somehow you've approached them that now you're

 15 going to use the words accommodate, demand,

 16 facilitate, they're entering into a swap, you know

 17 their identity, that would be where we start to

 18 get into the realm where we need customer

 19 protection. But it seemed -- in the first panel,

 20 there was a lot of argument that that's not

 21 enough. There is more -- you need other elements,

 22 you need to be known as a dealer.
 173

 1 MR. CAWLEY: Well, Mark --

 2 MR. FAJFAR: -- only people who are

 3 known as dealers need to register.

 4 MR. CAWLEY: One other aspect, not to

 5 add fuel to the fire, but I will, one other aspect

 6 is, in your de minimis exceptions, you talk about

 7 agency. Now, historically there's not a lot of

 8 trades that occur on an agency basis today within

 9 the swap market because of the bilateral market

 10 context. But that is certainly going to change as

 11 we move to a multilateral environment on

 12 clearinghouses, where you certainly will have

 13 entities who enter trades on behalf of customers.

 14 So by your own rule, there is a tension there in

 15 itself, because if you're trading against -- if

 16 you're representing a customer on an agency basis,

 17 shouldn't you also be held to some standard with

 18 regard to ensuring that there's no conflict of

 19 interest there or that you're ensuring best

 20 execution on behalf of the customer?

 21 So I think it's tricky. Does then the

 22 swap dealer definition include not only that
 174

 1 you're facing customers, but you're also trading

 2 on behalf of your own account, right, so does that

 3 then become the dividing line?

 4 MR. FAJFAR: No, dealers don't trade on

 5 their own account, that's a trader, right?

 6 MR. FILLER: Yeah, I don't necessarily

 7 agree with that. I mean, I think dealers deal

 8 with third parties, meaning non-affiliates, i.e.,

 9 customers. And to answer your question, what's

 10 the difference between a counterparty and a

 11 customer, unless you're a dealer then every other

 12 counterparty is a customer, okay. But I think

 13 what Mr. Cawley -- you know, we're really in that

 14 world of dealing 99 percent on a bilateral world,

 15 and we're going to move to this traded cleared world

 16 when that occurs. So what do we do between now

 17 and then? And right now we're still in the

 18 uncleared bilateral world, and how do we deal with

 19 moving -- regulating these bilateral swaps, which

 20 is the purpose of Dodd-Frank under Title VII, and

 21 what is the proper regulation of OTC derivatives

 22 during this period? And it's a different aspect
 175

 1 when you get to the cleared world versus the

 2 bilateral world.

 3 MR. FAJFAR: I'm sorry, what is your

 4 response to the highly vocal opposition to the

 5 clearing requirement? People are -- I could

 6 characterize it, you know, with disgust. So are

 7 you saying that they're wrong or that that's not

 8 going to happen? Because it seems like the

 9 uncleared world is something we really are going

 10 to have to have our rules deal with. How can we

 11 say -- I mean, if we said that a cleared swap is

 12 not a dealt swap, how would that help?

 13 MR. FILLER: Well, I think you raise a

 14 very important issue. A lot of the commercial

 15 end-users do not want to clear swaps, and I think

 16 one of the main purposes is they don't want to

 17 have to put up margin. And they prefer the

 18 uncleared world, and they also want to not only

 19 not want to put up margin, but also they want to

 20 be able to customize a particular type of swap,

 21 because once you go to the traded and clear world,

 22 there's going to be more standard or customized --
 176

 1 whatever word you want to use -- and I think

 2 that's going to be a very difficult policy

 3 argument for the Commission, is how to deal with

 4 those firms who qualify for -- or not required,

 5 let's just say to be clear, and how to deal with

 6 them for providing proper customer protections,

 7 and at the same time, trying to provide the

 8 benefits that they're seeking, as well. It's not

 9 an easy answer to that question.

 10 MS. BOULTWOOD: And I think if we're

 11 just speaking about this migration and what will

 12 happen for those end-users that would prefer to

 13 just trade bilaterally and do their credit

 14 analysis, have their own secured lines, they're

 15 managing credit risk; for those end-users that

 16 have decided to clear most of their transactions,

 17 instead of managing the credit risk, which has not

 18 disappeared, they're managing the liquidity risk.

 19 And so you've really just traded one

 20 risk for another. And for the company that's

 21 doing both, they're simply optimizing between

 22 credit risk and the amount of liquidity risk that
 177

 1 can be supported by their balance sheet. So I

 2 think for many firms it's not one or the other,

 3 it's the ability to optimize given the liquidity

 4 profile of your company and your appetite for

 5 credit risk, how are you going to get your

 6 commercial transactions completed.

 7 MS. RUDGE: And you may also find that,

 8 again, tied to more banking product, where these

 9 are hedges, are they commercial end-users that

 10 they're -- it's just easier. They've already

 11 pledged their assets to -- for the lending

 12 perspective, and they may not have the wherewithal

 13 due to their size to go enter the marketplace in a

 14 much broader capacity.

 15 MR. JANNEY: Oh, I'm sorry, speaking for

 16 the public power in my own utility, in a lot of

 17 cases what we do, it's impractical to have cleared

 18 swaps because they do by nature have to be very

 19 customized. To the extent there's a handful of

 20 liquid trading, or transacting locations in the

 21 electricity industry, it's very local. And if I'm

 22 hedging an interest rate, an interest rate is an
 178

 1 interest rate across the whole country, it's all

 2 the same. If I'm hedging grain, there's not a

 3 huge distinction locationally between the price of

 4 grain in Chicago versus Kansas City or Houston or

 5 New York other than maybe a little bit of a

 6 transportation differential. With electricity,

 7 because of the nature of the transmission grid,

 8 there can be huge differences between the price of

 9 electricity in Seattle or San Francisco or Denver,

 10 for example, and so our need to hedge our physical

 11 exposures is highly locational in nature, and it's

 12 impractical to have enough of a volume in each of

 13 those locations that the swaps would be homogenous

 14 enough to have a cleared product. So that's the

 15 first issue with this cleared versus uncleared.

 16 I think in our case in particular, and

 17 many of the energy companies I think have a need

 18 for the customized swaps. The other angle, and

 19 this is sort of what Brenda got to, is that the

 20 challenge with having to be forced to a cleared

 21 product becomes one of liquidity, where as a

 22 municipal corporation, we can't pledge collateral
 179

 1 in the sense of a lien on an asset.

 2 The only thing we can do is revenue

 3 pledges, and that falls into the whole stack of

 4 our bond, our municipal bonds, and the debt that

 5 we issue, and it's just much more of a challenge

 6 for us to actually get a line of credit to be able

 7 to back up some sort of a collateral posting

 8 mechanism. And then in our case, in Washington

 9 State, we don't have express authority to post

 10 collateral. We're looking at implied authority,

 11 but it's not yet crystal clear to us that this

 12 collateral posting is something that's within our

 13 authority to do except maybe in very narrow

 14 situations, and so the ability to have the

 15 over-the- counter bilateral non-cleared serves two

 16 purposes for us: One, the customization to meet a

 17 particular need to hedge our commercial exposure,

 18 and number two, to manage the credit and liquidity

 19 exposure that we have in doing that.

 20 MR. FAJFAR: Let's move onto the de

 21 minimis exception. And I think it would be useful

 22 -- we have a half an hour, if I could just lay out
 180

 1 a couple of the -- just so people know where we're

 2 going. I think the questions are, first, we're

 3 from the general specific, you know, should the de

 4 minimis be a threshold versus a multi factor test?

 5 If it's a threshold, should the threshold be set

 6 objectively, or should the threshold depend on the

 7 person's own activity? And then whether there

 8 should be different thresholds. There's a

 9 question whether different types of activities

 10 should have different thresholds, and also whether

 11 the scale should be different. In other words, is

 12 it simply a matter of applying the same scale

 13 across the board or having actually different

 14 scales for different types of activity? And then

 15 there's the question of whether the de minimis

 16 test should allow for this customer choice that

 17 we've talked about. So, Josh?

 18 MR. KANS: Yes, I would like to add one

 19 more topic to that mix, and it's probably the most

 20 fundamental of the topics, why should we have a de

 21 minimis test? It's in the statute. But we've

 22 seen comments that say it's all about systemic
 181

 1 risk, if you're not systemically risky, you

 2 shouldn't be regulated as a dealer.

 3 Some people talked about costs and

 4 benefits and trying to quantify those into the de

 5 minimis exception. Some have talked about

 6 competition. So in terms of the entree to the

 7 issue and the broadest aspect of the de minimis

 8 exception, how people can address what should be

 9 the guiding principle behind the rules that are

 10 adopted.

 11 MR. FAJFAR: So if anybody wants to

 12 start with the -- so we'll start with the general

 13 -- let's start with that point, what do you think

 14 it's really there for?

 15 MR. CAWLEY: So the tension is, and I

 16 was here for the tail-end of the first panel, as I

 17 understand it, the tension is, on one side you

 18 want swap dealers to have oversight, and on the

 19 other side it's tough to sort of plan into

 20 something that does not exist. So let's talk

 21 about different types of principal and agency

 22 transactions and do they fall in. I mean it's
 182

 1 certainly fair to say that, as I mentioned

 2 earlier, that very few agency dealers or brokers

 3 exist today where they act in an agent capacity to

 4 execute swaps on behalf of end-users or customers.

 5 That's going to change as clearing goes into

 6 effect and as counterparty risk goes away and now

 7 you're facing the clearing entity, the DCO.

 8 There's certainly a whole number of

 9 agency based broker dealers that exist and perform

 10 quite well today in the securities markets, and

 11 they provide a legitimate function as they make

 12 money for themselves by bringing liquidity and

 13 research and so forth, they just don't carry the

 14 positions at the end of each trading day, or

 15 sometimes they do, but to a limited extent.

 16 These institutions, as this market moves

 17 toward cleared, provide a very fundamental

 18 function to the marketplace, vis-à-vis liquidity,

 19 whereas today, you have a bilateral structured

 20 context where you've got really only dealer to

 21 customer trading flow, vis-à-vis, liquidity. Now

 22 what you're looking at is, in a mutualized or a
 183

 1 multilateral context, the ability to also have

 2 customers trade with customers, dare I say it, but

 3 also customers trade and provide liquidity to

 4 dealers. In fact, if you talk to some customers,

 5 large and small, from the liquidity crisis, and

 6 that's really what it was back in October, 2008,

 7 they'll say, hey, you know, we actually had to

 8 provide liquidity to people who we were told were

 9 our liquidity providers.

 10 So what you're dealing with there is --

 11 you're opening up the spigots of liquidity, which

 12 I think we can all agree is a good thing for the

 13 marketplace. Why? Because liquidity brings

 14 transparency, ultimately brings lower transaction

 15 costs, and certainly when you need it most in

 16 times of dislocation it's fair to say that the

 17 markets don't operate, and what you see on CNBC

 18 during the course of the day is these lovely

 19 continuous marketplaces, they do gap, right, and

 20 that's the reality of the marketplace. So more

 21 liquidity is good. So agent/broker dealers

 22 entering the space and helping facilitate that
 184

 1 liquidity is a good thing.

 2 If they're operating on behalf of

 3 someone else, do they qualify under the de minimis

 4 exception? I would say and we would say they do

 5 and they should. That said, those institutions

 6 should be held to some standard recognizing their

 7 fiduciary obligation to their customer. I don't

 8 know where you reflect that, but it certainly

 9 should be there, whether they do it themselves and

 10 the customers can make those decisions themselves

 11 and say, look, we're going to choose broker/agency

 12 dealer A over agency dealer B because they assure

 13 us that they have these Chinese walls and rule

 14 books and so forth and we feel that there's a

 15 greater competency and that they're not going to

 16 be using trading against our positions.

 17 And that really brings it back to the

 18 notion of -- are on dealing desks, notwithstanding

 19 Mr. Filler's assertion to the contrary, which is

 20 -- the truth is that dealer desks do actually hold

 21 proprietary positions and in addition to making

 22 markets operating on a strict matchbook basis, but
 185

 1 coming back to de minimis exceptions.

 2 I think it's fair to say, and it's a

 3 tough sell to say that there's agents that are yet

 4 to exist because the market doesn't exist. I only

 5 like vanilla ice cream because I don't know what

 6 chocolate is. And the benefits -- so that's one

 7 aspect.

 8 When you consider the other aspects,

 9 though, it really comes back to do you face

 10 customers, is that something that feeds into the

 11 customer -- into the definition of a dealer? I

 12 think it should. Should a customer -- should a

 13 dealer be considered and face -- and be excluded

 14 from the exemption because they trade a threshold

 15 amount of swaps? Maybe they should. I don't

 16 think that the number -- we could talk about this

 17 is 100 million, which sounds like a lot of money,

 18 but it's really, on a DVO1 basis, in five years,

 19 it's about $42,000 of risk.

 20 MR. FAJFAR: Anybody else?

 21 MS. RUDGE: Yeah, I was just going to

 22 add, in the previous panel, that discussion about
 186

 1 the participation in the marketplace and potential

 2 participants leaving, if they were deemed a swap

 3 dealer, and I think that part of that comes to

 4 somewhat of an unknown in terms of what the

 5 compliance standards and what needs to be

 6 implemented in a smaller footprint business.

 7 So you may have, and again, I'm kind of

 8 speaking more for smaller banks, you may have a

 9 small commercial oriented derivatives business, so

 10 there are designated staff for that, however,

 11 they're helping clients who are hedging their

 12 underlying risk, and these entities in and of

 13 themselves are rather small in scale by number of

 14 people, they have to have a certain hurdle to

 15 enter the business, but if that hurdle for entry

 16 or to sustain existence is much higher, you may

 17 find that either some don't enter or some leave.

 18 And as that occurs, I think that kind of access

 19 discussion that we had earlier for the clients,

 20 and again, maybe the comment of a small D and

 21 little D, but also maybe a big C and a little C in

 22 terms of clients and their ability to access the
 187

 1 marketplace and how they do that and in what means

 2 they do that and do they want to make the effort

 3 to do that or do they just go unhedged.

 4 MR. FAJFAR: Then just to reiterate,

 5 you're saying basically the de minimis is, you

 6 balance compliance costs, whatever those may be,

 7 we're not sure, versus the level of -- basically

 8 the revenue from the activity, and you should --

 9 if the revenue from the activity wouldn't justify

 10 the compliance cost, yet we still think it's a

 11 wise thing to do, that should be the de minimis

 12 standard.

 13 MS. RUDGE: Well, actually I think

 14 that's -- what I was drawing back to, it really

 15 goes to where to define your swap dealer, and at

 16 that baseline of where you define that, whether

 17 it's wide or more narrow, and if it's very wide

 18 and you encompass the small participants in the

 19 marketplace, then you have kind of a core

 20 challenge. If it's more narrow, then, of course,

 21 the de minimis exemption doesn't become quite as

 22 relevant. So I think really kind of starting
 188

 1 there, and I know you need to talk about this

 2 specific test, but it really kind of gets down to

 3 dealing characteristics. Because I think that not

 4 all dealers, while you may offer a product, you're

 5 not at that same participation in the marketplace,

 6 whether it's by the scale of what you're doing,

 7 the risk that you're taking and offering it, and,

 8 you know, as those are defined, at whichever part

 9 of the definition they become defined in, those

 10 are kind of the core characteristics I think in

 11 terms of -- that are important, because there is

 12 some measure of your size, in terms of if you're

 13 going to be able to handle the registration

 14 regulation.

 15 MR. FAJFAR: So just to clarify, the de

 16 minimis is an exception, it's different, it's an

 17 exception. It says you're a person that engages

 18 in swap dealing, so you're already -- the question

 19 is, we have a person who engages in swap dealing,

 20 but we're going to except them out of the

 21 definition. And so the two questions are why, and

 22 then how do we decide which dealers do we except
 189

 1 out through the de minimis exception. So take it

 2 as a given, you have to give the definition of

 3 dealer first.

 4 MR. FILLER: Well, I think, as Camille

 5 mentioned, I think answering the why from Josh's

 6 and your question is, what's going to be the

 7 definition of swap dealers, and that's going to be

 8 a very important narrow or expansive. But dealing

 9 with the quantity tests, if I read it correctly,

 10 there are three tests, you know, if you had a

 11 notional value of 100 million over, I think, a

 12 rolling 12 months and 20 or 25 swaps in any one

 13 year or whatever, I read it to mean that if I did

 14 one swap for a billion dollars, I'd lose the de

 15 minimis. And so --

 16 MR. FAJFAR: As a dealer, right?

 17 MR. FILLER: As a dealer. And so,

 18 therefore, should it be -- the three tests --

 19 should it be either of the three? In other words,

 20 if I do under 20 swaps in a year, regardless of

 21 the notion of value, is that something, or is it

 22 maybe I'm just throwing this out for a discussion
 190

 1 among the group here and for the commission staff

 2 to consider, or is it a number swaps, is it the

 3 notional value of the swaps in that rolling

 4 period?

 5 I think if you're going to have a narrow

 6 definition, it may not be as important. If you

 7 have a larger, more expansive definition, it's

 8 going to be a more critical analysis. And the

 9 question is, I only do one swap, but it's more

 10 than 100 million, I lose the exemption. Is that

 11 really what the intent is, to want that one firm

 12 doing one swap, being registered as a swap dealer?

 13 MR. MASTERS: I don't think that's the

 14 case, is it? I mean if it's -- in my

 15 understanding, it's a quantity, but it's not -- is

 16 it exclusive, is that --

 17 MR. FAJFAR: No, Ron's right, the way

 18 the rule is written, but I --

 19 MR. MASTERS: So there's --

 20 MR. FAJFAR: -- I think you'd have that

 21 issue no matter -- whenever you have a bright

 22 line. If we -- a lot of people said basically a
 191

 1 $3 billion de minimis level, under that test you

 2 do one swap, $4 billion, one swap, one swap, $3

 3 billion, whatever it is, it's -- so -- and the

 4 comment is basically evenly split on whether we

 5 should look at notional value or quantity. Some

 6 people said one or the other, so there was no

 7 consensus there.

 8 MR. CAWLEY: So just with that, though,

 9 I mean, again, the question of innovation, if you

 10 are an agency dealer looking to become a principal

 11 dealer or a larger dealer and you do one swap, and

 12 the average ticket -- an average two year swap is

 13 400 million, and an average CDS IG trade is 75

 14 million, so you can run through that pretty

 15 quickly. But if you just look at it on a PNL

 16 basis as a dealing desk, I'd say, so I'm going to

 17 go out, and the bid ask spread in IG index is,

 18 let's call it a basis point, so if I quote one

 19 trade, I stand to make $43,000, assuming it's a

 20 five year swap and the DV01 is 420 per million,

 21 which is it. So then the challenge is, is that

 22 worth my while to invest in becoming a swap dealer
 192

 1 to do, you know, because there's going to be a

 2 pretty significant -- it's going to require a lot

 3 more money than $42,000, and I'm going to blow

 4 through that limit pretty quickly, so what's in it

 5 for me to -- I've got to be pretty sure I'm going

 6 to develop and innovate and be successful as a

 7 swap dealer before I make that leap.

 8 MR. BERMAN: But I think, to Mark's

 9 point, you first have to meet the definition of a

 10 dealer. A single transaction for a billion dollar

 11 swap once a year, it may be very difficult to say

 12 how is that person a dealer, why would anybody

 13 have a business where they do one swap a year?

 14 Well, they might be an end-user, they may have a

 15 million reasons to do that swap, but would that in

 16 itself be dealing?

 17 So first you have to say that the way

 18 you're actually engaging the transaction is

 19 dealing, then the question is whether or not you

 20 meet the de minimis. So I think it's a bit of a

 21 red herring, the whole -- if you did one

 22 transaction, because I'm not sure -- unless you
 193

 1 came up with some dealing model where you only did

 2 one transaction a year.

 3 MR. CAWLEY: Well, you know, one thing

 4 is, if you have an agency guide, they're in the

 5 business of transactions, the question is, are

 6 they matching them on an agency basis or are they

 7 becoming -- or are they putting their own capital

 8 at risk, right, are they standing in there. So

 9 you could also do it the other way and say, well,

 10 if I do $100 million transactions, I'm still only

 11 making $42,000, so is this worth my while?

 12 MR. FAJFAR: But your point -- where

 13 you're going, you're clear -- you're okay with a

 14 threshold, it just has to be set at the right

 15 place. But, again, not to peg Camille, but I was

 16 basically saying you compare the cost of

 17 compliance against the revenue from the swap

 18 dealing, and we get to a place where we're

 19 comfortable, and then that gives you -- that's

 20 your threshold, whatever revenue would get you

 21 over compliance cost is -- then that's where the

 22 de minimis bubble is.
 194

 1 MR. CAWLEY: Agreed.

 2 MS. RUDGE: Yeah, I just think it would

 3 be hard to put a value on that. I think

 4 conceptually it would be nice to be able to do

 5 that so that you could have more entrance and it

 6 could be set at a relative level. But, you know,

 7 another concept that I've seen out there is

 8 actually your open risk position or your, you

 9 know, there's uncollateralized positions, there's

 10 a lot of -- not so much notional traded, because

 11 different kinds of swaps have different exposures,

 12 and whether they're offset or not, there's

 13 different exposures.

 14 So you could also look at something that

 15 goes to whether or not the exposure is directly

 16 offset, into the marketplace, and how the end

 17 result is retained and what those numbers are.

 18 MR. KANS: If I can follow up on that,

 19 though, there's ideas of either tying the de

 20 minimis tests to revenues or de minimis tests

 21 exposure measures. What other things could be

 22 lost? I'm thinking in particular about customer
 195

 1 protection issues, that is, if we base things

 2 solely on revenues, exposure, there still is the

 3 opportunity then for dealing with small entities,

 4 special entities, and you may be losing the

 5 benefits of customer protection that aren't going

 6 to be picked up in these other models. Anyone

 7 care to comment about that?

 8 MS. BOULTWOOD: Yeah, I think, Josh, it

 9 goes back to an earlier discussion, where we were

 10 talking about the risks of consumer protection,

 11 and had there really been incidents, have there

 12 been regulatory judgments where that hasn't been

 13 the case, and is that risk really that large

 14 versus the risk in the market of losing a large

 15 number of participants who no longer qualify to

 16 transact with their counterparties, customers,

 17 because they have pulled out of the business for

 18 fear of the costs of holding themselves out as a

 19 swap dealer, given that their business model is

 20 not dealing -- it's perhaps other commercial

 21 purposes.

 22 So I think you're never going to have
 196

 1 one or the other, you're balancing the two types

 2 of risk, and you have to ask yourself, is it worth

 3 limiting market participation, the amount of

 4 transparency, the bid offer spreads, your ability

 5 to get reliable price quotes because you have so

 6 few participants versus broadening the market,

 7 having more participants, and having the potential

 8 vagaries of consumer protection.

 9 And it is a big risk, all of us would

 10 rather deal with entities that have the

 11 segregation, have the Chinese wall, but, you know,

 12 we do our due diligence to try to make sure that

 13 it happens with the counterparties we're

 14 transacting with, but it becomes the

 15 responsibility of the participant, not something

 16 you regulate.

 17 MS. RUDGE: I'm sorry, I was going to

 18 say, I would add for IDI's that the client and

 19 their types of transactions they do based on their

 20 needs are not at the extreme sophisticated

 21 spectrum in terms of market products. This isn't

 22 about products but you are really looking at a
 197

 1 specific segment of the clients that have a very

 2 kind of defined use, over-the-counter derivatives

 3 that are about hedging their exposures typically

 4 in that example.

 5 And with that comes, I think, not that

 6 the consumer protection isn't very important, but

 7 the access to the marketplace and to having the

 8 institution be able to offer the product, and for

 9 the banks themselves to be able to offer the

 10 product because it diversifies their revenue, and

 11 it also provides a greater return on that client's

 12 lending business that they're already doing. So

 13 there's a lot of kind of interplay I think between

 14 that specific part of the market.

 15 MR. BERMAN: A number of commenters have

 16 pointed out to the diversification of the

 17 different counterparties and the choices. I think

 18 we can pull from the equity markets and learn a

 19 little bit about the nature of liquidity. I know

 20 my colleague, Andrei, and I spent a lot of time on

 21 the May 6th Flash Crash on liquidity.

 22 In the swap market, at least in a lot of
 198

 1 the "more liquid markets", a vast, vast majority

 2 of the transactions have a very small number of

 3 dealers on one side of that. So the offsetting

 4 for many of the counterparties that you're talking

 5 about, they're doing another transaction which

 6 eventually is going to get to that dealer.

 7 So we have to think about the system as

 8 a whole, that the diversification is 1,000

 9 different parties that I can deal with, but if 990

 10 of those parties all have to then deal with the

 11 same 10 parties in the end, that diversification

 12 is still there, but it may not be affording the

 13 protection that might appear on the surface. So

 14 when we think about this, we have to think about

 15 the system as a whole, including the fact that it

 16 actually is a very concentrated market in the

 17 aggregate.

 18 MR. KIRILENKO: If I may add to what

 19 Gregg just said, and that concentration is partly

 20 a result of sort of the natural consolidation

 21 forces that over time happened in the industry, so

 22 it just may have started out a lot more -- it was
 199

 1 a lot more participants, and over time, it

 2 aggregated to just a few participants who merely

 3 focus on one particular asset class and are really

 4 good at it.

 5 MS. BOULTWOOD: So is that commentary

 6 leading to the conclusion that you expect there to

 7 become a more concentrated set of participants

 8 then?

 9 MR. BERMAN: No, not --

 10 MS. BOULTWOOD: Because that can happen,

 11 you know, with the right rules, but --

 12 MR. BERMAN: Right, no, the commentary

 13 was not --

 14 MS. BOULTWOOD: -- an assumption here is

 15 that there are competitive markets and you want

 16 many to be able to participate. If it's a

 17 foregone conclusion we're going to get to greater

 18 concentration as the right answer, I think that's

 19 where you'd find a lot of disagreement amongst the

 20 panel about whether that's best for all the

 21 commercial participants in this market.

 22 MR. BERMAN: Right; no, I -- the
 200

 1 commentary was not meant as a judgment on -- even

 2 a prediction on what's going to happen. So to

 3 Andrei's point, I think market forces are going to

 4 drive the market where it goes. My comment was,

 5 when we say we need to have different types of

 6 thresholds for de minimis, because we need to be

 7 very careful about not shutting out somebody who

 8 is able to offer a product that otherwise could

 9 not necessarily have been offered, we have to take

 10 that knowing that that product is only really

 11 offerable because there's a larger system in the

 12 background, and that you can always go back to

 13 that larger system.

 14 So we have to keep that in mind as we

 15 think about -- and we'll just mostly ask you guys

 16 to keep that in mind as you think about what the

 17 effect of the de minimis threshold will actually

 18 wind up being.

 19 MR. JANNEY: You do bring up a good

 20 point, but I think tagging on what Camille and

 21 Brenda were saying earlier from an end-user

 22 perspective, there's this big market backdrop --
 201

 1 back there with people transacting amongst each

 2 other, but from our perspective to the extent that

 3 it limits the amount of potential counterparties

 4 or dealers that we can deal with we've got maybe a

 5 fairly narrow range of prices that were being

 6 offered. If we limit the number, then that range

 7 is going to narrow even more, and it's going to

 8 end up ultimately costing us more money. And then

 9 that credit angle is the other one, if we're

 10 transacting in the customized swap market it's

 11 going to mean that, at some point, that dealer or

 12 counterparty isn't going to want to transact with

 13 me anymore because he's full up to here with

 14 exposure with my particular company or whoever

 15 they're trading with.

 16 And so, again, anything that shrinks

 17 down or limits the competition in the market is

 18 going to have a cost implication and a risk

 19 implication at least for the end-user community.

 20 MR. MASTERS: I would just say that,

 21 just in terms of the cost, I mean obviously I have

 22 conflicting views with regard to customer
 202

 1 protection, but with regard to the cost issue, one

 2 of the things that we proposed in our comment

 3 letter was the desegregation of credit cost to

 4 end-users, so they could actually see what

 5 everybody says what's going to cost me more money

 6 to go to a clearing regime, in fact, it may not

 7 cost you more money to go to a clearing regime

 8 because you're already paying the freight. I

 9 mean, you may not know you're paying the freight,

 10 but you're paying it. I mean, people aren't doing

 11 these services for free. And so if, in reporting

 12 swaps, if part of that swap reporting, and this is

 13 a little bit off the subject, but I mean just in

 14 the sense of -- from a customer standpoint, if in

 15 reporting that, I could see the disaggregated

 16 credit cost, then I think that I may have

 17 different perspectives on it.

 18 MR. CAWLEY: Just one thing I think

 19 that's important to make the distinction on is the

 20 difference between necessarily a dealer and a

 21 liquidity provider to the space, right. Again,

 22 either there are liquidity providers in other
 203

 1 markets that provide lots of liquidity, and in so

 2 doing, provide a more stable market, one might

 3 argue, but don't face customers.

 4 And maybe when you're, again, drawing

 5 back to it, as you're attempting to make the

 6 distinction, do they face customers, and

 7 therefore, do they need the requisite Chinese wall

 8 provisions and so forth versus encouraging the

 9 liquidity into the space.

 10 MR. FAJFAR: So there were a lot of

 11 comments and a lot of you have said that the de

 12 minimis should serve to encourage diversity and

 13 decrease concentration, and I would just ask from

 14 a government regulator's perspective, is that

 15 something a government regulator should do? And

 16 then how would we implement that -- or how would

 17 you envision that that's -- would that standard be

 18 different across different industries? If you

 19 were in our shoes, how would you say, okay, I want

 20 X amount of diversity, but not Y amount? How is

 21 that really implemental in a regulation?

 22 MS. BOULTWOOD: I guess we would put
 204

 1 forward that you would -- assuming we go with the

 2 very broad definition of a swap dealer and now

 3 we're looking to exempt entities from that

 4 definition, you would understand that the top

 5 broker dealers, in regulating them as swap

 6 dealers, you've captured 99 percent of the gross

 7 notional of your outstanding interest rate, FX

 8 commodity swaps, right.

 9 So you've captured the vast majority

 10 already, and then you'd look at that which you

 11 haven't covered, and Camille talked about the cost

 12 benefit, but this would be kind of at an aggregate

 13 level, what's the benefit of going after

 14 additional entities and not allowing them to

 15 qualify for a de minimis exception?

 16 And we would say, because you want that

 17 diversity of counterparty, you would want to

 18 establish a de minimis criteria where one of the

 19 groups that proposed 3 billion used some math to

 20 get there, but small banks are given the 10

 21 billion, but you look at the $600 trillion

 22 notional derivatives market, it seems very small
 205

 1 for the benefit that you derive in terms of the

 2 diversification and broadness of your potential

 3 market. And I would propose you'd start very

 4 simply and ask firms to self-certify, declare,

 5 maybe there'd be a questionnaire that they would

 6 fill out about the nature of their broader

 7 business and why the CFTC would consider -- or the

 8 SEC would consider -- exempting them for some

 9 small portion. How would that portion of their

 10 business be organized, what rules would they apply

 11 internally, and then force the firm to be able to

 12 report on those regularly or at any time to you as

 13 regulators?

 14 And it puts the burden on the firm

 15 asking for the de minimis exception to prove that

 16 they're in compliance with the criteria.

 17 MS. RUDGE: So I'll just add to that, as

 18 the entities that are considered to be dealers as

 19 that is defined, getting to the point Brenda just

 20 made, then you can look at what is remaining, and

 21 at that point it may be very hopeful to look at

 22 the construct of the different types of
 206

 1 participants and how they enter into the

 2 marketplace, who their clients are, what their

 3 activities are, and that might help you rather

 4 than saying it should be three billion or it

 5 should be X billion at this point, because I think

 6 that it gets to the character in terms of the size

 7 and scale by nature of the clients or the

 8 underlying use or purpose of what they're doing, I

 9 think it will fall out.

 10 I don't know, I can't say that this is

 11 the number, but I think that that will begin to

 12 show itself, whether it's in open risk positions

 13 or in notional traded or in asset size of the

 14 firms.

 15 And I think it's, at least speaking from

 16 the banking perspective, I think it's pretty

 17 commensurate with asset size of organizations and

 18 their underlying client bases that they serve,

 19 gets them into certain parts of the marketplace

 20 that are very specific as opposed to broad

 21 ranging, and they're not dealing necessarily with

 22 many other swap dealers, they might be dealing
 207

 1 with small man size corporations, high net worth

 2 individuals, and perhaps very small FI's as

 3 opposed to other larger dealers as clients, and

 4 that begins to kind of form the nuance of the

 5 different tests.

 6 MS. SANEVICH: I think, just listening

 7 to the first panel and listening to the various

 8 participants, the thing that keeps coming back to

 9 me is that there are lots and lots of very unique

 10 users, whether they be natural end- users, special

 11 entities, financial entities, and we all have our

 12 own views as to, you know, we collateralize and

 13 vice versa with counterparties, so this concept of

 14 risk analysis for us, while it exists, it is not

 15 nearly as critical as the folks here who do have

 16 collateral, you know, have maybe posted no

 17 collateral.

 18 You know, for us, a clearing world,

 19 particularly with the margins proposed currently

 20 for uncleared swaps might be better, but for the

 21 fact that the segregation issue is still looming

 22 out there, and so from our perspective, that might
 208

 1 actually make us in a riskier position than we

 2 currently are.

 3 And so this kind of makes me go right

 4 back to, you know, this is a huge, huge market,

 5 and there's really not a lot of information for

 6 the regulators to really base these very important

 7 and critical decisions on who's a broker, and what

 8 should the de minimis rule be. Well, it's hard to

 9 figure out what people are actually doing and who

 10 is a dealer. So this law of unintended

 11 consequences is important for all of us. I think

 12 that's probably why there's so much push back on

 13 clearing, is because we haven't done it before, so

 14 we're all petrified. And it's not that people

 15 don't like clearing, per se, you know, we use

 16 futures and that works really well, but none of us

 17 know how it all fits together, and the systems, I

 18 mean, kind of everything that you all have heard

 19 in the past. And so that might argue for starting

 20 out with -- define a dealer to catch the 50/20

 21 whatever dealers, collect the information, and

 22 then see who's missing. And it doesn't have to be
 209

 1 five years, it could be a year or whatever, but

 2 then you would have a better sense of what makes

 3 sense from a de minimis carve out, or who's not

 4 getting caught that you really do think should be

 5 caught.

 6 And I know the agencies have these

 7 policy-making ramifications to what they do with

 8 every single rule that's out there, and I think

 9 this is just another example of how very specific

 10 end-users have very particular issues with

 11 whatever aspects you do. I mean it's a very

 12 difficult job, and I think it's made that much

 13 more difficult without the right information,

 14 because there isn't that information out there

 15 available to you.

 16 MR. CAWLEY: Yeah, I would agree with

 17 that. It's tough, it's tough to figure it out,

 18 because not only is it tough to find that

 19 information to get a sense of where the market is

 20 today, but also it's where the market is going to

 21 be once clearing goes effective, and how the

 22 landscape is going to change, and the more
 210

 1 prescriptive you get in a rule, the more likely

 2 you probably are to be wrong. So what I would

 3 say, though, when you look at notional amounts,

 4 probably you will create inconsistencies in the

 5 marketplace if you set notional amounts and not

 6 look at it on a risk adjusted basis.

 7 So certain tools you can deploy into a

 8 prescriptive approach. The other thing is, one or

 9 the other rules or requirements is that you limit

 10 it to 15 counterparties. How would that work if

 11 you're facing a clearing or a SEF or an exchange?

 12 I mean that's another limitation. But it's tough

 13 work.

 14 MS. COLLIER: Yes, when you're talking

 15 about the number of dealers that can participate,

 16 from a special entity perspective, I have to say I

 17 want the broadest number of dealers that there are

 18 available. Let me change the situation for a

 19 minute to give you an example.

 20 If I'm bidding bonds at competitive

 21 sale, there are many bonds out there every day in

 22 the market, and whether you're going -- you as an
 211

 1 investment banking firm are going to bid on my

 2 bonds or not, there are many factors. When I get

 3 down to trying to enter into a swap, an interest

 4 rate swap, as most of my entities do, the market

 5 is even smaller. The market gets smaller then

 6 because of the size of the swap, because of my

 7 credit quality, and so I am very limited then in

 8 whom I'm going to deal with.

 9 Now, I'm eventually going to negotiate

 10 with a selected dealer, but generally government

 11 wants a competitive process to select that dealer.

 12 And the more competitors that I have, the better

 13 off as a special entity I'm going to be.

 14 I need to have a dealer to work with who

 15 will offer transparency. I need a dealer who's

 16 going to disclose more than would have to be

 17 disclosed in an agreement with a private entity or

 18 when private entities are involved in the swap.

 19 And I need to demonstrate that there is no

 20 conflict of interest, there's no conflict of

 21 interest between the swap advisor, and the dealer,

 22 and there is no other conflict between the special
 212

 1 entity, any of its participants, and the dealer.

 2 So to get to that specific dealer who's going to

 3 meet all of my requirements takes a broad universe

 4 of dealers who can then be narrowed down and

 5 filtered through to get to that point, who's going

 6 to be a successful and competent dealer to deal

 7 with a special entity and its requirements.

 8 MR. BERMAN: Just to make sure I

 9 understand, I'm trying to think up comments, I'm

 10 not sure which side you're arguing on. So are you

 11 saying that there should be more regulated

 12 dealers, and again, the key here is regulated --

 13 MS. COLLIER: Sure.

 14 MR. BERMAN: -- or less regulated

 15 dealers so that there are more non-regulated

 16 dealers?

 17 MS. COLLIER: Big D.

 18 MR. BERMAN: So you would --

 19 MS. COLLIER: More regulated big D

 20 dealers.

 21 MR. BERMAN: So you would want a larger

 22 universe?
 213

 1 MS. COLLIER: Yes, because depending on

 2 my requirements in my particular case, I need a

 3 large universe to offer my particular interest to.

 4 MR. JANNEY: Mary-Margaret, can I ask a

 5 question on that, because I'm trying to understand

 6 on that one. So you're saying that you would be

 7 restricted from transacting only with regulated

 8 dealers, and that if there were other dealers --

 9 small D dealers out there that met all your

 10 criteria, you wouldn't be able to transact with

 11 them?

 12 MS. COLLIER: I think that for many of

 13 us that would be the case. We have certain

 14 criteria. If we're sending out a request for a

 15 proposal, we're going to have a lot of criteria,

 16 and so we need a large number of people who can

 17 meet that criteria. I don't think that the small

 18 folks, de minimis folks are going to be interested

 19 in us, because our swap may not meet their needs,

 20 so we need to have the biggest universe of people,

 21 because when we put that RFP out to be our swap

 22 counterparty or to be the dealer that we're
 214

 1 negotiating with, we need to have a big universe

 2 of people who could compete because there aren't

 3 going to be that many who will compete because of

 4 our special needs.

 5 MR. JANNEY: Yeah, I see what you're

 6 saying, I just don't know that there might be an

 7 unintended consequence there. If we try to expand

 8 the definition of a regulated dealer, it may

 9 disqualify some dealers because they don't want to

 10 be regulated, they can't cover the cost, and so it

 11 could unintentionally reduce the number of dealers

 12 that you're able to deal with if we expand the

 13 scope of what a regulated dealer is.

 14 MS. COLLIER: I think that's something

 15 that needs to be discussed further then and get

 16 more opinions on how many of these dealers would

 17 participate with special entities, because I know

 18 when I'm looking at my small special entities,

 19 they're going to be very few dealers who will deal

 20 with them, and they have the same criteria as the

 21 largest of the large.

 22 MS. SANEVICH: So I see by Mark's smile,
 215

 1 I bet he knows what I'm going to say, but I feel

 2 compelled to say it anyway. Not all special

 3 entities are created equal, and that is part of

 4 the problem with seeking through what to do for

 5 special entities.

 6 There are pension plans, you know,

 7 private pension plans and public pension plans who

 8 do not have any of these issues and have very

 9 different concerns and problems, including quite

 10 significant absolute barriers, and so that was it.

 11 MR. FAJFAR: But just on the point they

 12 were -- you only deal with the big D dealers --

 13 MS. SANEVICH: Right, so --

 14 MR. FAJFAR: -- so that's just not

 15 relevant to you, what they're talking about?

 16 MS. SANEVICH: It's not -- it was just a

 17 special entity. We're small, nobody, you know,

 18 fewer people to deal with. That is absolutely not

 19 true in our case, we deal with the big banks, who

 20 I expect every single one of them will be a

 21 dealer.

 22 MR. KIRILENKO: It's interesting that
 216

 1 the concept of liquidity being fragmented among

 2 multiple dealers is gaining so much traction. I

 3 keep going back to your comments, that there is a

 4 difference between who the dealers are and where

 5 the liquidity is. Dealers may or may not

 6 necessarily be providers of liquidity. You can

 7 have one exchange that provides a very, very

 8 liquid market and brings together many, many

 9 counterparties and can do lots and lots of things

 10 for you, yet there is only one venue. You can

 11 have few venues where the liquidity meets, not

 12 necessarily those that provide liquidity. To me

 13 it seems a bit like an extension of the current

 14 thinking -- the bilateral thinking that is

 15 liquidity is just synonymous with the number of

 16 providers, yet is that necessary how you're

 17 thinking of that?

 18 MS. COLLIER: When we enter into a

 19 transaction as a general government and we are

 20 entering into an interest rate hedge, we've issued

 21 variable rate debt for 20 to 30 years generally,

 22 and using the GASB 53 standards to have an
 217

 1 effective hedge, we are entering into a hedge that

 2 matches the maturity of that debt. So we have to

 3 have a dealer, a counterparty that is going to be

 4 there for that period of time. When I get down to

 5 I have questions about whether smaller dealers

 6 would be there, I have questions about measuring

 7 risk, I have to keep measuring risk over time, I

 8 have small governments that can't measure risk,

 9 they need a swap advisor or a financial advisor

 10 who's constantly measuring the credit quality of

 11 the counterparty. So to the extent that I have a

 12 strong dealer community, big D, that is regulated,

 13 and gives me some additional assurance, I need

 14 that.

 15 MR. CAWLEY: But that doesn't exist in a

 16 cleared world, right, because you don't have

 17 counterparty risk to manage if you're facing a

 18 clearing house, so I certainly see an environment

 19 where you would have a swap advisor who would

 20 advise the special entity, via-a-vis the ongoing

 21 exposure as the swap rolls out a curve or goes

 22 through time.
 218

 1 But to your point, I think it's fair to

 2 say that it's a tough sell to sell. You know,

 3 end-users are on the benefits of a mutualized all

 4 to all exchange like trading platforms when none

 5 actually exist today. So the frame of reference

 6 is, indeed, the bilateral marketplace. So, you

 7 know, and it's tough for you guys because you're

 8 trying to provide for how the world is going to

 9 look once we have clearing, and -- but to your

 10 point, you know, which I mentioned before, you

 11 shouldn't confuse liquidity on one side with

 12 dealers on the other. You can do that today

 13 because it's one way liquidity, it's dealer to

 14 customer.

 15 MS. COLLIER: Correct.

 16 MR. CAWLEY: But there's certainly -- if

 17 you take an exchange environment, we'll usually

 18 trade in the New York Stock Exchange, for example,

 19 in the equity context, you have liquidity coming

 20 from the exchange itself. You're sort of

 21 indifferent as to who the buyer or who the seller

 22 of, you know, who the liquidity provider is in
 219

 1 that transaction.

 2 MR. FAJFAR: I think we're going to have

 3 to stop because there's a lot of considerations

 4 that go into the dealer definition, so we'll just

 5 have to stop at this point. Thanks. We'll see

 6 you at 2:00 for the MSP, which is much simpler.

 7 MR. KANS: Well, thank you for showing

 8 up. This is the third and final panel of today.

 9 The focus of this panel will be on the definition

 10 of "major participant". And, we have some new

 11 people attendant, so could everyone just go over

 12 and reintroduce themselves, please?

 13 MR. THUM: Sure. I'm Bill Thum from

 14 Vanguard. I'm a principal and I'm in the legal

 15 department focusing on derivatives regulation.

 16 MR. MASTERS: Michael Masters, Better

 17 Markets.

 18 MR. KYLE: Pete Kyle, University of

 19 Maryland, finance professor.

 20 MR. NEVINS: Matt Nevins, Fidelity

 21 Investments, legal.

 22 MR. OPPENHEIMER: Ron Oppenheimer on
 220

 1 behalf of the Working Group of Commercial Energy

 2 Firms.

 3 MR. STANLEY: Marcus Stanley from

 4 Americans for Financial Reform.

 5 MR. KANS: Thank you. The definition of

 6 major participant has a number of different

 7 criterion and is a much different test than the

 8 dealer test. So, a lot of the issues are

 9 substantially different from the dealer issues.

 10 The way I think we're going to have this

 11 panel is, for the first third or so of the panel

 12 we're going to focus on some of the rationales

 13 behind regulating major participants. Because

 14 that's a somewhat novel definition within the Act

 15 that's not found in a lot of other places.

 16 The second third, we can focus on some

 17 of the specific tests that have been proposed in

 18 connection with identifying who is a major

 19 participant. And we'll reserve the final third of

 20 the discussion to talk about one specific issue

 21 that's raised by the definition, which is hedging,

 22 mitigating commercial risk. What does it mean to
 221

 1 be hedging and mitigating commercial risk.

 2 So as Mark said this morning, some of

 3 the panelists are focused on one or more

 4 particular issues, so their silence on other

 5 issues, obviously, does not mean anything.

 6 With that said, I want to toss out as a

 7 fundamental issue, in terms of interpreting the

 8 definition of major participant as it appears in

 9 Title 7, what exactly should the regulators be

 10 seeking to accomplish? What are we trying to

 11 capture? The definitions themselves do speak in

 12 terms -- they use language that alludes to risk

 13 and risk criteria. There are different types of

 14 risks that could be embedded. Counterparty risk

 15 is one definite type of risk that is embedded.

 16 But there also have been views expressed

 17 that in addition to the risk posed by an entity or

 18 the counterparty risk posed, the definition could

 19 also subsume issues about the significance of the

 20 entity in the markets as a whole. For example, if

 21 an entity has to quickly liquidate its positions,

 22 even if there's no default, how would that impact
 222

 1 the markets?

 2 So one core question really is, are we

 3 talking only about counterparty risk? Or are we

 4 also talking about risks that are inherent in a

 5 large position within the market.

 6 And a second fundamental question I'd

 7 like to tee up for people to comment on is, how

 8 significant does the risk have to be? Obviously

 9 there's the definition used as the term systemic.

 10 And whatever systemic means itself is something

 11 that's open to debate. But we're talking about

 12 issues that are -- risks that really have to be

 13 systemic to the economy as a whole, or can we talk

 14 about -- does the definition also encompass the

 15 sorts of risks that go -- drill down less deeply

 16 and affect the counterparties more directly and

 17 maybe the markets, but not the economy as a whole?

 18 So, I'd like to toss out those two

 19 fundamental issues for people's comments.

 20 MR. THUM: Hi, Josh. I think those are

 21 excellent questions. And just to try to level set

 22 with respect to Vanguard.
 223

 1 Vanguard operates 170 registered mutual

 2 funds, has 9 million shareholder accounts and

 3 about $1.6 trillion under management. It uses

 4 derivatives to hedge portfolio risk, lower

 5 transaction costs, and achieve more favorable

 6 execution. Our derivatives trading, which is

 7 fairly conservative and generally small, is fully

 8 collateralized on a bilateral basis. The

 9 collateral is held in triparty accounts with a

 10 fund's custodians. And in looking at the 2008

 11 market disruption, Vanguard funds were able to

 12 apply the pledged collateral that had come in the

 13 door to address the market value of its swaps, and

 14 it was also able to recover the collateral that it

 15 had pledged to the dealer from the fund's

 16 custodian that was holding the collateral.

 17 We agree with what was written in the

 18 release that the major swap participant definition

 19 targets non-dealers, which could pose a high

 20 degree of risk to the U.S. Financial system. And

 21 we also agree with the comments noted from the

 22 Senate colloquy between Senators Hagan and
 224

 1 Lincoln, that the goal of the MSP definition was

 2 to focus on risk factors that contributed to the

 3 recent financial crisis, such as excessive

 4 leverage, under collateralization, and a lack of

 5 transparency about aggregate position size.

 6 We feel the test does address the

 7 appropriate risks. We have concerns around the

 8 edges in terms of the tests being over complex to

 9 actually perform. We also feel some aspects of it

 10 need to be refined to better reflect not only

 11 existing market practice but also some of the more

 12 recent rules that have come out, particularly the

 13 margin rules in terms of initial margin

 14 requirements for un-cleared swaps. But as a

 15 registered funds -- as register funds present it,

 16 none of the risks associated with the financial

 17 crisis. And robust regulations already apply with

 18 respect to their swaps usage.

 19 We feel that the registered funds,

 20 ideally, would be exempt from the category of

 21 major swap participant. But if not exempt, that

 22 we would be able to come up with a safe harbor
 225

 1 test where the funds would not be required to

 2 perform the rather complex tests on a regular

 3 basis until the risk approached -- until the usage

 4 of swaps on an uncollateralized, un-cleared basis

 5 approached certain thresholds.

 6 MR. NEVINS: So, thank you, Bill. I

 7 could probably summarize my comments with two

 8 words and say I agree. That was an excellent

 9 overview and summary. We at Fidelity agree with

 10 much of what -- actually, all of what Bill just

 11 covered.

 12 From our perspective -- to answer your

 13 questions, Josh -- the way we think about the

 14 rulemaking here is it's intended to get to those

 15 non-dealer entities that have the potential to

 16 create risk to the financial marketplace if their

 17 swap positions need to be unwinded. So, if

 18 there's a default, then you'd look at what the

 19 impact would be on the overall financial system.

 20 I think that seems to be the most important policy

 21 behind the definition of major swap participant.

 22 We think that you've done an excellent
 226

 1 job in trying to create a rule that matches up

 2 with that policy goal to capture those entities

 3 that would have the possibility of creating that

 4 kind of financial systemic risk. I think, as has

 5 been mentioned on several occasions and on a

 6 stated -- in the proposed rule release itself, we

 7 understand the intent to be that the MSP

 8 definition is intended to pick up a handful --

 9 maybe two handfuls -- of actual players in the

 10 marketplace, and we support that notion as well.

 11 To get to the question about the

 12 particular risks and counterparty risks in

 13 particular, we think that it's an intelligent way

 14 of designing the thresholds and the tests to have

 15 a test based on current uncollateralized exposure.

 16 We do believe that collateral is the lynchpin of

 17 protection, the most important thing to be looking

 18 at when you're determining what kind of risk could

 19 be created to the system to the extent that you

 20 have collateralized positions. We don't feel that

 21 there really is any risk. So we think that's the

 22 most important test.
 227

 1 We also understand the Commission's

 2 view, though, that collateral may not get 100

 3 percent of the way there because you also need to

 4 look at size and that counterparty risk -- the

 5 potential for there to be an actual systemic

 6 financial failure to the extent that there are

 7 humungous swap positions that aren't

 8 collateralized in the marketplace.

 9 So, we think having that second

 10 potential future exposure prong does make sense.

 11 We think that it's very appropriate to include the

 12 discounting that you propose based on risk factors

 13 both on types of swaps and the tenor of swaps. We

 14 think that it makes complete sense to have

 15 discounting for clearing. In fact, we would

 16 support cleared swaps being removed from both the

 17 current uncollateralized exposure test and the

 18 potential future exposure test completely. So to

 19 have not just an 80 percent discount, but a full

 20 discount for cleared positions.

 21 We also agree with the notion of a

 22 discount for daily mark to market margining, as
 228

 1 well as for netting. So, we think that you've

 2 included the right factors here, they're the right

 3 factors to be looking at. We're very supportive

 4 of the thresholds. We think that it's completely

 5 appropriate to pick up the -- to pick up the small

 6 number of entities that could have that systemic

 7 risk to the system.

 8 MR. STANLEY: So, I just wanted to make

 9 three points on behalf of AFR in response to your

 10 question. One is that we believe you should be

 11 looking more broadly at risks to the market as a

 12 whole, and not only default risk. One of the

 13 things that we saw in 2008 was that companies that

 14 were highly leveraged and had to liquidate a lot

 15 of assets quickly had a big impact on asset prices

 16 in the market. And then that, then, put pressure

 17 on other companies in the market. And that's --

 18 you know, financial panics can work through

 19 bilateral relationships between companies or they

 20 can work through asset prices on the market as a

 21 whole. So we think that's something to pay

 22 attention to.
 229

 1 A second is just to underline something

 2 that was mentioned here, which is the importance

 3 of thinking about future exposures when it comes

 4 to collateral. Particularly with certain kinds of

 5 securities-based swaps, but also with the kinds of

 6 swaps the CFTC is going to be looking at, there

 7 can be highly discontinuous collateral demands. I

 8 understand when Constellation Energy in 2008 --

 9 there was -- they sort of determined by looking at

 10 the credit support annexes to some of their

 11 agreements that they owed $1.6 billion more in

 12 collateral calls than they had originally believed

 13 they owed. And that was --

 14 MS. BOULTWOOD: That was downgraded --

 15 MR. STANLEY: That was a downgrade.

 16 MS. BOULTWOOD: That was a downgrade.

 17 MR. STANLEY: Right. But, as I

 18 understand it, a downgrade can lead to collateral

 19 -- calls can lead to significantly more collateral

 20 demands than might be expected at a company's

 21 current credit rating. And I think that's the

 22 kind of thing that you have to look for and look
 230

 1 ahead to.

 2 So, the kinds of situations that you see

 3 in downgrades with additional collateral demands,

 4 I would think, would be something that the

 5 Commission should look toward as potential danger

 6 for a company.

 7 And the third point was that the major

 8 swap participant definition is not only about

 9 prudential risks -- and you can tell this because

 10 the prudential -- there are banks and companies

 11 that are already subject to prudential regulation.

 12 And in fact, their prudential regulator will

 13 govern their capital and prudential standards.

 14 But they are still required to register. And

 15 presumably, the reason for that is that there are

 16 informational and business conduct kinds of

 17 standards in the designation that are also

 18 important.

 19 So.

 20 MR. MASTERS: I would just highlight

 21 there's a couple of bold positions that we

 22 highlighted in our comment letter with respect to
 231

 1 Better Markets.

 2 The threshold that the Commission

 3 determines to be prudent for the effective

 4 monitoring, management, oversight of entities that

 5 are systemically important or can significantly

 6 impact the financial system. And then secondly,

 7 exposure that could have serious adverse affects

 8 in the financial stability of the United States

 9 banking system or financial markets being the key

 10 second part of that.

 11 Which you know, in our view, doesn't

 12 necessarily only look at systemic consequences.

 13 In other words, it's not just systemically record.

 14 It's -- even if you have a fully collateralized

 15 position, you can still be market-moving, from

 16 that standpoint. And contribute to instability in

 17 the marketplace. So, just in terms of the

 18 language, that's what we see.

 19 And the other thing that I would say is,

 20 with regard to the exposure being reduced, you

 21 know, using a central counterparty or a clearing

 22 -- that makes a lot of sense to us. We think that
 232

 1 absolutely should be the case.

 2 However, if a position is marked daily,

 3 you know, even if it is fully collateralized we

 4 have a bit of a problem with that because you

 5 could still have a problem. And that sort of goes

 6 to the downgrade point that Marcus is making. In

 7 our view, it makes sense in the one -- from a

 8 central clearing regime, but not in the second.

 9 MR. NEVINS: I would just respond to

 10 that briefly, Mike. That the proposal does not

 11 give full credit for daily mark to market

 12 margining, correct? It's an 80 percent haircut.

 13 So I think that they've acknowledged that that

 14 doesn't get you all the way there. But I'm very

 15 supportive of the notion of having the requirement

 16 to post on a daily basis being -- having an

 17 appropriate haircut applied. And we think that is

 18 very logical to include at least an 80 percent

 19 haircut for that.

 20 MR. KANS: And we'll have a chance to

 21 talk about those specific issues a little bit down

 22 the line. But I also want to apologize. I forgot
 233

 1 to introduce Terry Arbit with the CFTC as a fellow

 2 panelist. So, my apologies, Terry.

 3 MR. FAJFAR: Pete, do you want to say

 4 something?

 5 MR. KYLE: I'll say something. I think

 6 that when you're trying to come up with criteria

 7 for these significant participants, you mainly

 8 want to look at whether -- if they started losing

 9 money on their positions, they'd have to delever

 10 those positions and essentially dump them on a

 11 market in a destabilizing manner.

 12 If we look at past history, we can see

 13 two financial crises that directly related to

 14 derivatives. One was the Hunt silver squeeze

 15 around 1980, the commodity markets. And the

 16 second one was the LTCM crisis. You could also

 17 throw the 1987 stock market crash in there with

 18 the portfolio insurance. So there are three kind

 19 of financial crises, all of which involve

 20 derivatives.

 21 But the -- two of them, the Hunts and

 22 LTCM involved entities that were highly levered.
 234

 1 The Hunts had made highly levered investments in

 2 silver, LTCM had made highly levered investments

 3 in fixed income securities. So the question of

 4 whether their positions are fully collateralized,

 5 to me is much less important than the question of

 6 whether, given an adverse market move, they're

 7 going to be forced to liquidate and whether that's

 8 going to create a potential financial crisis.

 9 MR. FAJFAR: I just had a follow-up

 10 question to Marcus and to you, also. You didn't

 11 say whether the current definition -- do you think

 12 it captures -- you talked about, you know, looking

 13 beyond the downgrade or -- well, these different

 14 factors should be taken? Or do you think the

 15 definition should be changed to take something

 16 into account? I wasn't clear on your position on

 17 that.

 18 MR. KYLE: Let me address that by

 19 example. Let's -- an example I use in my classes

 20 at the University of Maryland. Let's compare

 21 Warren Buffet and AIG. They're both involved

 22 heavily in derivatives, they both had significant
 235

 1 exposure to negative shocks to the economy, which

 2 was going to cost their companies billions of

 3 dollars. Buffet had a company that was not very

 4 highly levered, so no matter how negative the

 5 shock he wasn't going to have to post collateral

 6 and he was going to be very stable and he was not

 7 going to be destabilizing the financial system.

 8 In fact, he might have been supporting it by

 9 doubling up on his positions.

 10 On the other hand, you had AIG, which

 11 was highly levered. And it structured their

 12 derivatives so as soon as a bad event happened --

 13 which could have either have been a downgrade,

 14 which did happen, or a margin call from Goldman

 15 Sachs, which also happened, they were going to

 16 have a financial crisis which was going to unravel

 17 their firm, and that's what happened.

 18 So, I think you should carve out a

 19 definition that respects the fact that Warren

 20 Buffet is a lot different from AIG, and Buffet's

 21 firm causes much less systemic risk than AIG-type

 22 firm causes. And it --
 236

 1 MR. THUM: If I could just try and

 2 clarify in my own thinking. The current exposure

 3 test picks up effectively uncollateralized

 4 exposure. And that would, in my mind, at least --

 5 I've been thinking in terms of looking at the

 6 market value of the trades versus the collateral

 7 that was in the door.

 8 Now, if you had a ratings-based

 9 collateral trigger that said you didn't need to

 10 post any collateral at all because of the rating,

 11 then you would have to count 100 percent of the

 12 market exposure for the purposes of this test,

 13 because you hadn't posted any collateral. So, I

 14 think this test actually mitigates the risk that

 15 there could be ratings triggers in the credit

 16 support annexes or in the collateral documentation

 17 because it will pick up those situations where if

 18 you are highly rated and you've agreed with your

 19 dealer not to post collateral -- assuming that

 20 could go on in the future given the new margin

 21 rules -- that this test will pick up that

 22 uncollateralized exposure at that point.
 237

 1 I think also the potential future

 2 exposure test picks up the additional risk. That

 3 from the time an entity becomes insolvent and can

 4 no longer post collateral to the time that its

 5 counterparty can effectively give notice of

 6 termination, can close out the trades, and can

 7 liquidate the collateral that it holds, that its

 8 counterparty is protected based on historic

 9 volatility analysis as to market -- potential

 10 movements from the time the counterparty last got

 11 collateral in the door to the time it can

 12 liquidate and apply that collateral.

 13 So, I think your test -- the beauty of

 14 your test is that it not only looks at current

 15 exposure, current mark to market exposure with

 16 respect to the swaps trading positions, but it

 17 also has a component that addresses volatility so

 18 that you are addressing the additional risk that

 19 is posed by the length of time it takes to close

 20 out trades, apply the collateral, liquidate the

 21 collateral, and apply the proceeds.

 22 So, I don't -- my sense is that the
 238

 1 ratings issue is actually addressed, effectively,

 2 by the rule because if you're not posting

 3 collateral because you have a high rating, you're

 4 going to have to count the full exposure of the

 5 positions in this test because it will be

 6 uncollateralized.

 7 MR. BERMAN: That certainly was the

 8 intent of the dual current exposure and potential

 9 exposure, which is not something that we made up,

 10 that's been used by banks and clearinghouses.

 11 But I'd like to come back to something

 12 you said, Pete, about the leverage aspect. I

 13 think in addition to the ratings concept, which I

 14 think you pick up, what aspect of leverage would

 15 we -- are we missing? Because I would imagine

 16 that if you were levered, then you would not be

 17 able to afford the collateral calls. So, you

 18 would be taking a hit immediately.

 19 So in AIG's case, I think that would be

 20 perhaps different from Buffet's case. So, is

 21 there some way, again, to Mark's point -- is there

 22 something that we should be changing in the rule
 239

 1 because you think there's an element that we're

 2 not capturing?

 3 MR. KYLE: Well, I think if you have,

 4 let's say, two swap market participants that are

 5 of equal size and one of them has a huge amount of

 6 capital and the other one has the bare minimum

 7 amount of capital to sustain its positions, then

 8 the one with the bare minimum amount of capital to

 9 sustain its positions poses much more systemic

 10 risk than the one with the huge capital buffer.

 11 Because, if the one with the minimum amount of

 12 capital has an adverse market move is going to

 13 start liquidating its positions to meet margin

 14 calls. Whereas the one with huge capital buffer

 15 can ride it out and maybe even add to its

 16 positions as markets move adversely.

 17 So, you need to take into account, I

 18 think, the level of capitalization of the

 19 entities. And that's the biggest difference

 20 between Buffet and AIG, that Buffet was not very

 21 levered. That's why he had a AAA rating, that's

 22 why he didn't have to make margin calls. But the
 240

 1 economically important issue behind that is that

 2 Buffet would not have had to delever if the market

 3 had moved against him, which it did and he didn't

 4 delever.

 5 MR. BERMAN: So, I think I understand

 6 what you're saying. But again, I'm trying to

 7 think about how one transcribes that into a change

 8 in the actual rules. So from a -- if you did not

 9 have sufficient capital, the instant the market

 10 started moving from you, your current exposure

 11 would blossom and you'd immediately be captured.

 12 I mean, if I had no money, my current

 13 exposure is zero on day one. I'd be $1 positive

 14 or negative, which would be infinite times my

 15 capital.

 16 MR. KYLE: But you don't want to capture

 17 somebody after it's too late.

 18 MR. BERMAN: Right, so --

 19 MR. KYLE: So, you want to capture the

 20 Hunt brothers while they're building up their

 21 position, not while they're liquidating it.

 22 Because that would be too late.
 241

 1 MR. BERMAN: So that's why -- would that

 2 imply, then, looking at the potential future

 3 explore -- and you couldn't look at the future

 4 exposure because -- assuming it's zero. But you'd

 5 look at the potential future exposure and somehow

 6 measure that with respect to a capital base

 7 instead of just on absolute level --

 8 MR. KYLE: Yeah, potential future

 9 exposure given that the firm maintains its

 10 positions without liquidating any, contemplate

 11 adverse scenarios that that firm might face and

 12 then ask how adverse a scenario can that firm

 13 survive without having to get involved in a forced

 14 liquidation?

 15 And so the answer with the Hunt brothers

 16 was, not much. LTCM, not much. AIG, not much.

 17 But Buffet was pretty solid.

 18 MR. BERMAN: So does that make the test

 19 -- would that make the test more inclusive, then?

 20 Or less -- it sounds like it would make the test

 21 less inclusive. Because you --

 22 MR. KYLE: Yeah, I'm not sure --
 242

 1 MR. BERMAN: You would say, take the

 2 existing test, which is just absolute. So, we're

 3 basically assuming you have no money to cover.

 4 And what you're saying is that, but there may be

 5 firms that have sufficient money to cover. So

 6 therefore, if you also compare that with your

 7 capital base, there might be firms from your

 8 perspective that might meet both those tests but

 9 would fail the third test.

 10 MR. KYLE: Right, so if the firm --

 11 MR. BERMAN: And therefore would be out

 12 --

 13 MR. KYLE: -- if a firm kept its

 14 positions and raised a lot more capital, that

 15 would potentially enable it to say, okay. Take us

 16 off the list of major market participants, which

 17 is exactly the incentive structure you would like

 18 to have in place. Which is, incentives to be

 19 well-capitalized.

 20 MR. FAJFAR: Would it be as simple as

 21 having -- keeping the same tests but just taking

 22 the thresholds and sliding them by a capital?
 243

 1 Instead of a -- you know, whether tranches or

 2 percentages, the different thresholds would apply

 3 depending on the capital level the company has.

 4 Is that --

 5 MR. KYLE: I think that might be how it

 6 would play out in practice.

 7 MR. MASTERS: Or are you talking about

 8 sort of a value at risk sort of standard with that?

 9 MR. FAJFAR: No, no. I'm saying, keep

 10 the test the same, just the threshold changes

 11 depending on the capital level of the company.

 12 So, a company with this much capital has a

 13 threshold, a company with that much capital has

 14 this threshold.

 15 MR. THUM: I think -- I mean, our view

 16 is that the test is -- currently addresses the

 17 right risks. And indeed, is fairly complex. We

 18 have, as I said earlier, been looking for an

 19 exemption for registered funds. And on some

 20 level, what has been said resonates with that

 21 request in that the registered funds are required

 22 to segregate assets related to their trading.
 244

 1 So interestingly enough, for a

 2 registered fund you're not only posting 100

 3 percent of market value but you're segregating

 4 some assets related to your trading position. At

 5 this point, many registered funds do not post

 6 independent amounts to reflect potential exposure.

 7 But of course, if the proposed margin rules are

 8 put in place, both for the cleared world and the

 9 un-cleared world, registered funds will have to

 10 post collateral to address that risk.

 11 So, I suppose that the test could have

 12 an additional exclusion based on high

 13 capitalization or segregation of assets, even if

 14 deals were fully collateralized. But again, I get

 15 back at the test. I feel -- we feel that the test

 16 addressees the appropriate risks and is extremely

 17 complex at present. And I would be reluctant to

 18 see an additional level of complexity.

 19 I think if we look at AIG versus Warren

 20 Buffet, you know, my understanding of the AIG

 21 scenario was that it was not posting margin

 22 because of its rating. Now, certainly the market
 245

 1 moved against it from that point. But certainly

 2 on day one, it had exposure that was

 3 uncollateralized that would be relevant for the

 4 purposes of this test, regardless of its rating.

 5 If this test was in place, it's possible AIG would

 6 have been picked up even before the market moved

 7 against it and a collateral call was made.

 8 So, I think the answer and the thing

 9 that the Commissions want to encourage is full

 10 collateralization is that if you put a test like

 11 this in place, entities like AIG that have a

 12 ratings-based collateral threshold where they're

 13 not posting collateral may be encouraged to

 14 actually post collateral so that they don't fall

 15 into the categorization of major swap participant.

 16 But we feel that across the board, the

 17 matrix of new rules, including central clearing

 18 with collateralization both for market value and

 19 initial margin, new margin rules for over the

 20 counter trading going forward, all address risk

 21 issues. The major swap participant test is

 22 effectively picking up things that fall through
 246

 1 the cracks where you could conceivably have an

 2 entity that is not posting collateral, not

 3 clearing trades, has a significant exposure, and

 4 needs to meet certain capital standards, reporting

 5 standards, and the other issues related to major

 6 swap participant status.

 7 So, we're comfortable with the risks and

 8 the tests, notwithstanding that I think if you

 9 were to add an additional carve-out for capital

 10 levels, you might actually capture fewer entities.

 11 MR. NEVINS: I would just like to add a

 12 couple comments to this discussion. First of all,

 13 just to remind folks, there is a prong of this

 14 test that includes a highly leveraged calculation

 15 as well. So I think that the whole concept of

 16 leverage is already being woven into really the

 17 statutory definition and the rulemaking that's

 18 come out of it.

 19 And I want to pick up on a point that

 20 Bill made, because it's been an important one for

 21 our industry. We have been very supportive of the

 22 notion of an exemption completely for registered
 247

 1 investment companies. I would also put out that

 2 we would be supportive of an exemption for ERISA

 3 plans and accounts. Both are highly regulated

 4 today and have limits on their ability to use

 5 leverage, as Bill was alluding to. The ’40 Act

 6 has requirements to cover positions that

 7 essentially limits the amount of leverage that

 8 registered investment companies can use. So it

 9 would be extremely helpful, from our perspective,

 10 if funds that aren't leveraged and don't have the

 11 ability to use leverage and really don't create

 12 that level of risk could be exempt altogether.

 13 Falling short of that, we would be very

 14 supportive -- as Bill alluded to earlier as well

 15 -- to a notion of a filter or a safe harbor from

 16 having to do daily monitoring and daily testing of

 17 the thresholds for any participants really that

 18 are so far below the thresholds that it wouldn't

 19 seem likely to be triggered. So, that's something

 20 that I would be highly supportive of as well.

 21 I'll take this opportunity to also

 22 throw out my support to the Commission's view
 248

 1 that's contained in the proposed rule to look

 2 solely at a fund-by-fund basis in applying these

 3 tests, and not attributing the swap positions of

 4 the funds that we manage up to the asset manager

 5 and aggregating across different funds. We think

 6 it's absolutely correct to be looking at each fund

 7 and each portfolio, really, within an investment

 8 trust on a separate basis that's the level where

 9 risk is created. It's the level where exposure

 10 exists, and it's the level of recourse that our

 11 counterparties look at.

 12 So, we would -- you know, encourage the

 13 Commissions to continue down that road. The one

 14 clarification that we've asked for in this space

 15 is in the separate account space. So, where we

 16 have separate accounts that are owned by a single

 17 beneficial owner but possibly have multiple

 18 advisors where the documentation for the swaps of

 19 those separate accounts clarifies that recourse is

 20 cut off at the account level. We think that the

 21 Commission should respect where that recourse

 22 resides, as opposed to requiring aggregation up to
 249

 1 the beneficial owner level.

 2 MR. KYLE: So, let's -- the example that

 3 comes to my mind -- to interpret your comments --

 4 is portfolio insurance in the 1987 stock market

 5 crash. So there you had one kind of advisor, LOR.

 6 You had a number of different companies that were

 7 implementing the same strategy, most of which were

 8 highly un-levered pension fund-type entities. It

 9 created the 1987 stock market crash, which we'll

 10 recall was a 20 day -- 20 percent drop in the 

 11 S&P 500 in 1 day, and 100 basis point or something

 12 movement in interest rates in the opposite

 13 direction on the same day. So it was certainly a

 14 huge systemic event, and people knew about it at

 15 the time.

 16 You know, early 1987 even months before

 17 it occurred the SEC and the CFTC both were

 18 concerned about it. And the SEC did a

 19 multi-hundred page study of what would happen if

 20 these strategies blew up.

 21 So it would seem to me that whatever

 22 your definition of major swap market participant
 250

 1 is, it should include entities like LOR that were

 2 associated with the 1987 stock market crash. And

 3 it seems like your definition might have given

 4 them an exemption.

 5 MR. THUM: I think it's important to

 6 keep in mind to bring us up to date, you know, to

 7 2008 or let alone now that in the most recent

 8 market crisis -- significant one involving Lehman

 9 Brothers as I said at the outset -- the registered

 10 funds that we manage and, indeed, registered funds

 11 generally are required to receive collateral, post

 12 collateral, have collateral held by a third party

 13 custodian. And that collateral was adequate to

 14 cover the market risk, and the collateral that had

 15 been posted was returned to the fund. So, that

 16 collateral is posted and is, indeed, negotiated in

 17 contract with the dealers on a fund-by-fund basis.

 18 Collateral levels are set with respect to the

 19 trades that are actually done that each fund is

 20 party to.

 21 And it does seem to make sense, and

 22 certainly based on the most recent market
 251

 1 experience that if you have exposure related to a

 2 single legal entity and that legal entity's

 3 exposure is fully collateralized, that it is not

 4 posing significant risk to the financial system.

 5 And therefore, again, I say that your test is

 6 picking up -- it's addressing the right risks,

 7 it's giving credit where, indeed, you want to

 8 drive the market, which is to clearing and

 9 collateralization. And we feel -- we agree with

 10 Matt that we feel the registered funds and,

 11 indeed, ERISA plans do not present the risk and

 12 are separately, heavily regulated in terms of

 13 their investments. You're really targeting a

 14 different animal here, both in terms of a lack of

 15 regulation and in terms of the level of

 16 un-cleared, uncollateralized swap trading.

 17 MR. FAJFAR: I would like to just ask a

 18 clarifying question. First, what you said about

 19 registered investment companies. Do those same

 20 protections apply to separate accounts -- the

 21 collateralization requirement, the leverage

 22 requirements? And would your idea about not
 252

 1 attributing, would you have that apply even when

 2 the separate account where there's at least some

 3 level of control from the upstairs investor of the

 4 separate account's transactions?

 5 MR. NEVINS: Sure, so -- good questions,

 6 Mark. The -- to answer the first one, it depends.

 7 So, there are lots of different types of owners of

 8 separate accounts. So there are separate accounts

 9 that are ERISA accounts. And in those cases,

 10 where you're governed by a body of regulation that

 11 restricts what you can and can't do, I would say,

 12 yes. It falls into the same category as

 13 registered investment companies.

 14 Otherwise you know, to be intellectually

 15 honest here, you know, it's hard to make that same

 16 argument. So, you know, the two that are sort of

 17 easy examples for us to bring to the table are

 18 registered investment companies and ERISA

 19 accounts.

 20 And then on your second question, the

 21 way that we would draw the distinction is looking

 22 at the documentation itself. So what have the
 253

 1 parties agreed to? If you are a

 2 separately-managed account, managed by investment

 3 advisor A, and you enter into a swap with dealer

 4 B. If dealer B has agreed I'm only going to look

 5 to this pool of assets that are managed by advisor

 6 A and that same account holder, that same

 7 beneficial owner, has a separate swap with

 8 investment advisor D, and that dealer is not

 9 looking to the assets held in D, then why should

 10 you have to aggregate those two swaps together?

 11 That's the point.

 12 MR. FAJFAR: And I think the -- so, the

 13 concern is that -- now from the investor's

 14 perspective, if I was wanting to take large --

 15 just going to throw this out as a hypothetical. I

 16 want to take large swap positions, I don't want to

 17 be categorized as an MSP. So, I'll go to 10

 18 different investment advisors, create 10 separate

 19 accounts, have the accounts provide for at least

 20 some -- so I can give some influence to how they

 21 trade. Then, haven't you -- isn't that basically

 22 a way to get around the MSP designation? I can
 254

 1 have each of those accounts make the same swap

 2 trade, take the same swap positions. Why

 3 shouldn't they be aggregated where I'm then

 4 directing that activity?

 5 MR. NEVINS: I definitely understand the

 6 Commission's concern. As the Commissions have

 7 stated in the proposed rule release, however, you

 8 have anti-evasion authority and there are rules

 9 that can be put in place that could prevent

 10 anybody that's looking to manipulate the system,

 11 either doing it as you suggest or otherwise, from

 12 doing so and being subject to penalty from both

 13 Commissions as they try to take advantage of the

 14 system.

 15 And in any case, if you do have an

 16 account holder that segregates off and ring-fences

 17 their pools of assets and the counterparty only

 18 has access to that pool of assets, that's where

 19 the exposure resides. That's where the risk is

 20 created, and that's the way that our system -- you

 21 know, our financial markets for asset managers that

 22 advise these types of accounts work today. So,
 255

 1 where the parties have structured it that way, I

 2 think that that should be respected.

 3 I should caveat on that that isn't

 4 always the case. So there are certain beneficial

 5 owners that say, you know, we don't want to have

 6 our assets at -- advisor A and advisor B

 7 ring-fenced. We want them aggregated together and

 8 where a client has chosen that, then we think that

 9 it does make sense to aggregate it.

 10 MR. KANS: May I -- to follow up on

 11 that, does the answer change in terms of the

 12 significance of ring-fencing your assets if the

 13 purpose of the major participant definition is not

 14 just to get to the counterparty risk but it's also

 15 to get to the market moving risk?

 16 That is, if I have my -- if a large

 17 entity has assets in a segregated account so

 18 there's no direct recourse, but because of market

 19 movements the entity has to unwind its positions

 20 in that account and other accounts, then even

 21 though the direct credit exposure would not be

 22 large with regard to any individual counterparty,
 256

 1 there still could be the potential for market

 2 movements associated with the unwinding of those

 3 positions. So, does the answer perhaps in part

 4 depend on what we're trying to get at with this

 5 definition?

 6 MR. NEVINS: Again, a good point, Josh.

 7 Good question. And it may. As I mentioned at the

 8 outset, I do believe that the intent here is to

 9 get at systemic risk.

 10 That said, I do think where you have the

 11 potential for a default and that default, again,

 12 is ring-fenced with one particular manager under

 13 one particular instrument and there is no

 14 cross-default, if you will, into the separately

 15 managed pool, that it doesn't make sense to put

 16 those two different swap positions together.

 17 MR. THUM: Could I perhaps probe the

 18 question a little so that I understand it better?

 19 So, day one, an entity is trading -- and let's

 20 ignore the separate accounts at this point. But

 21 is trading and has fully collateralized its

 22 positions. And not only has fully collateralized
 257

 1 the market value of the positions, but also has

 2 fully collateralized the volatility in the

 3 positions that over a time period, appropriate for

 4 the normal closeout of the trades. On day two,

 5 the party desires to liquidate its positions. And

 6 in that liquidation, owes money to the dealer with

 7 which it's trading.

 8 Now, if for some reason the party cannot

 9 pay the dealer the value of the trades for some

 10 reason that it wants to liquidate, the dealer is

 11 holding market value collateral plus additional

 12 collateral relating to volatility.

 13 So, I'm trying to understand how in a

 14 liquidation mode if the trades are fully

 15 collateralized -- not only with respect to market

 16 value, but also potential exposure -- how that

 17 would raise to the level of being significantly

 18 relevant with respect to the financial markets.

 19 The other issue is that with respect to

 20 the separate accounts, certainly with respect to

 21 the accounts where there's a contractual

 22 arrangement, the dealer has agreed up front that
 258

 1 this particular sleeve, that this particular asset

 2 manager is managing is large enough with respect

 3 to the credit lines that the dealer is giving to

 4 do swaps and have recourse only to that limited

 5 scope of assets.

 6 Again, the trades will be put on. They

 7 will be fully collateralized. If they are

 8 registered funds, typically they will not be

 9 posting independent amount, they'll be addressing

 10 current exposure.

 11 If you have five asset managers, each

 12 managing an individual sleeve with recourse

 13 limited to the assets under management by the

 14 individual asset manager, it would seem to me that

 15 the greatest exposure you're going to face relates

 16 to the minimum transfer amount that the parties

 17 have agreed, which is typically a de minimis

 18 amount, such as $250,000, which is an amount which

 19 the parties say, up front it's too much trouble to

 20 actually transfer collateral of $5 if there's a

 21 market movement of $5 a day. We're going to wait

 22 until collateral -- until the market position
 259

 1 moves $10,000, $100,000, $250,000. But generally

 2 in that range. So you could conceivably have five

 3 aggregations of risk related to the minimum

 4 transfer amount. Again, significantly lower than

 5 the thresholds that you've established in your

 6 rule.

 7 So, I think that with respect to both

 8 the separate accounts in those situations that

 9 Matt had mentioned and then with respect to this

 10 idea of liquidating positions, provided those

 11 positions are fully collateralized and, indeed,

 12 potential risk has been addressed by posting

 13 independent amounts, I'm struggling to see how

 14 there could be significant risks presented.

 15 MR. KANS: Well, I -- please.

 16 MR. STANLEY: There does seem to be an

 17 argument here that funds already practice good

 18 prudential and capital management practices, which

 19 I have no reason to doubt. But we can see already

 20 in the statute that even banks that are subject to

 21 prudential standards are still required to

 22 register as MSPs.
 260

 1 And the other question I'm wondering

 2 about with this -- and Bill did start to get at

 3 this with one of his previous answers is, if one

 4 already practices good prudential standards that

 5 are -- that I would assume are similar to the

 6 prudential standards that one would have to follow

 7 under the MSP designation, then how does the MSP

 8 designation create an additional burden on the

 9 funds beyond what they're already doing? I mean,

 10 wouldn't the funds satisfy a lot of the

 11 requirements under the MSP designation already,

 12 based on these prudent practices that they already

 13 follow?

 14 MR. NEVINS: I'll start off, and

 15 responding to that one. A couple things.

 16 First of all, it's not just the

 17 standards that you're going to be required to be

 18 held to if you're an MSP. But you're also subject

 19 to enhanced margin requirements and enhanced

 20 capital requirements, which are costly and

 21 burdensome for our fund shareholders. We're

 22 talking about registered investment companies,
 261

 1 they're retail investors for the most part.

 2 People that are saving for retirement, for college

 3 education, and the like. And the burdens will

 4 fall on them, to the extent that you have a fund

 5 that could be.

 6 You know, again, as I stated at the

 7 outset, we are very supportive of the thresholds

 8 that have been proposed and think that it's very

 9 unlikely that any of our registered investment

 10 companies could give rise to having to register.

 11 The second part of my response to your question

 12 would be that the standards that MSPs will be held

 13 to are different than the standards -- we think --

 14 that the Securities and Exchange Commission

 15 requires of registered investment advisors, and

 16 registered investment companies.

 17 So, you wind up with duplicative

 18 regulation that may, indeed, be inconsistent. So,

 19 it puts more of a compliance burden on our

 20 industry, again, which could result in greater

 21 costs.

 22 MR. THUM: I agree entirely with what
 262

 1 Matt said, and I think, you know, when we think

 2 about risk mitigation techniques, the greatest one

 3 present in our market today is the netting ability

 4 under a master agreement. You do multiple trades

 5 under a master agreement, you come up with one net

 6 amount that is owed, at least within the United

 7 States.

 8 Posting collateral against that is the

 9 next line of defense. And indeed, the present

 10 market requires that. It's standard market

 11 practice. And the third line of defense is the

 12 type of entity that's trading. And investors

 13 choosing to invest in registered funds are

 14 investing in highly-regulated, very specialized

 15 investment vehicles that have an enhanced level of

 16 risk mitigation built into them.

 17 The major swap participant category --

 18 my understanding of it is simply to capture very

 19 large users of swaps that are not -- do not meet

 20 the dealer specification and present risks to the

 21 system. It's not meant to be -- and I don't think

 22 the Commissions probably have the resources to
 263

 1 handle registration of major swap participants

 2 that could include entities like registered funds

 3 that present a level of un-cleared,

 4 uncollateralized swaps trading that is

 5 de minimis.

 6 I think the target and focus for an

 7 efficient use of regulatory oversight is at the

 8 largest users, and you have to look at the other

 9 entities and see, do they have netting? Do they

 10 clear their swaps? Do they have collateral

 11 backing at their swaps? Do they have regulatory

 12 oversight already in place that limits their swaps

 13 trading? And if that's the case, then there

 14 should be if not an exemption, certain safe

 15 harbors that should apply to allow you to focus

 16 where your focus is meant to be on those entities

 17 that present the greatest risks.

 18 MR. FAJFAR: I think -- just would like

 19 to -- before we go too far down on this road, I'm

 20 not -- I just want to put a couple other points

 21 out on there.

 22 The MSP definition, even -- we -- at the
 264

 1 -- at our meeting, there was the two handfuls

 2 example. Even if it's five handfuls -- even if

 3 we're talking about, you know, a number beyond --

 4 we're talking about very few entities in

 5 comparison to the entire market. I just want to

 6 -- but my point really is, I understand, you know,

 7 we have a question of who is on the panel.

 8 I just want to point out we're talking

 9 very heavily about how collateralization solves

 10 the MSP problem, and it's really about

 11 uncollateralized exposure. And I just want to

 12 make sure that the staff is aware that that means

 13 the -- which entities don't want to post

 14 collateral. You can find out -- that's -- that

 15 reasoning is leading to look at those entities

 16 that aren't posting collateral as the MSPs. I

 17 just want to put that out as an issue. And it

 18 makes it very hard to -- it's just a difficulty in

 19 doing the MSP definition.

 20 I'd also like to just point out that

 21 we're aware -- if you look at the categories, the

 22 other commodity category in the PFE test has a
 265

 1 much higher haircut. So I just wanted to make

 2 sure we put that 10 to 15 percent.

 3 So I just want to be able to put that

 4 out on the table, if anybody wants to comment,

 5 that we're aware of that. That, you know, we get

 6 in a discussion of whether registered investment

 7 company is an MSP. That's an important discussion

 8 but there are a lot of other swap users out there

 9 that aren't registered investment companies that

 10 don't post collateral.

 11 And there's that issue, the elephant is

 12 in the room.

 13 MR. MASTERS: I would just say, also,

 14 that I mean, sort of from a broader brush

 15 perspective with regard to the intent of broad,

 16 you know, Dodd-Frank. You know, systemic risk is

 17 an important consideration. But you know, one of

 18 the reasons we have Dodd-Frank is, we're putting

 19 some regulation around a market that really didn't

 20 have any regulation. And there's a lot to

 21 business conduct with regard to this issue, and a

 22 lot of the other issues.
 266

 1 And people like to say, well, it's just

 2 systemic risk. And if I can just deal with that

 3 issue, then I'm okay in everything else. And

 4 that's not it. Or, not just it. I mean, it's

 5 also business conduct. And it's all -- it's the

 6 transparency from the regulatory process that we

 7 get from the standpoint of the general public on

 8 large institutions that we didn't get before that

 9 we'd like to get today. I believe, you know, in

 10 terms of the intent of the law.

 11 MR. BERMAN: Can I just follow a

 12 question on that, Michael? Is there an aspect --

 13 again, if you look at all the rules of

 14 transparency, comes through SDRs through SBSRs, so

 15 there's other rules that apply. Business conduct

 16 issues would be related to folks that deal with

 17 customers, perhaps such as dealers. We have those

 18 conversations.

 19 Is there an aspect for a major swap

 20 participant -- so, someone who is not one of those

 21 other parties that is -- that you think can bring

 22 risk to the table of a type that we have not
 267

 1 considered or is not already captured by other

 2 rules?

 3 MR. MASTERS: I think from -- I mean, I

 4 think there certainly is from the perspective of

 5 liquidity. In the sense of if you've got a large

 6 enough entity that, given the right set of events,

 7 you could have a -- I assume you're talking about

 8 -- you know, from the standpoint of collateralized

 9 or not collateralized or sort of that train of

 10 thought. But there's other issues, in my view, in

 11 this particular situation. I mean, the big one is

 12 sort of liquidity. It's the idea that, you know,

 13 someone that's large enough could be -- could have

 14 pretty significant consequences on the market for,

 15 you know, one day or, you know, whatever.

 16 MR. BERMAN: Right. So to make sure I'm

 17 clear, this would be a case of I'm fully

 18 collateralized, I have more than enough money to

 19 meet all my obligations, I wake up in the morning,

 20 I just choose to liquidate. I'm retiring, so I

 21 sell everything. I am so large that that selling

 22 itself is disruptive to the market.
 268

 1 Not that -- I don't lose any money, my

 2 counterparties don't lose any money. But what

 3 you're saying is that it's just -- I'm so large

 4 that I have the potential to be disruptive.

 5 MR. MASTERS: Right. I mean the -- I

 6 think an easy example to think about is a run on a

 7 money market. You know, suddenly, you know,

 8 someone worries about a particular fund or entity

 9 or whatnot, and now we've got a run on a money

 10 market. And everybody says, you know, I've got to

 11 have my money now. And then that starts off a

 12 cascade.

 13 You know, it's -- you know, you could

 14 say money markets are bad, you know, the Fed would

 15 step in and, you know, but --

 16 MR. BERMAN: Sure. No, that makes

 17 sense. The reason why I wanted to go down that

 18 line again was just to see if there were things

 19 that are -- I think this aspect of major swap

 20 participants is part of Title 7, is part of

 21 derivatives. And perhaps some of the things that

 22 you're talking about are covered in other sets of
 269

 1 rules. Title 1 has what we call SIFIs,

 2 systemically important non-bank financial

 3 institutions, that may address some of those

 4 broader issues.

 5 So, are there things that are specific

 6 to swap users that are -- and the way that the

 7 swap market works where you might have a player

 8 that really isn't captured by any of those other

 9 issues? But yet there's a risk that we are

 10 missing.

 11 MR. MASTERS: Well, I mean, let's say --

 12 let's use commodities, for instance. Where

 13 there's a situation where somebody has, you know,

 14 $10 billion total return swap on -- and suddenly

 15 they have to unwind that. You know, let's say

 16 it's a commodity index and, you know, 2 percent of

 17 that $10 billion notional amount is in the coffee

 18 market, which is a pretty small market.

 19 That has, you know, significant effects

 20 on the coffee market. So, it's a derivative

 21 transaction that's -- you know, there's an

 22 underlying component to it that's now been, you
 270

 1 know -- someone asked on why. And it affects all

 2 these other markets. And given the fact that

 3 there's algorithms throughout the business now

 4 that, you know, their modus operandi is to try to

 5 push correlation, if you will.

 6 If you do something in one market, it's

 7 a derivatives market. Then suddenly, all these

 8 other markets are affected because there's people

 9 that have linked those markets together via

 10 computer algorithms because, you know, typically

 11 these markets were correlated. And suddenly this

 12 market drops and now so this market drops and this

 13 market drops and this market drops, and it sets

 14 off a sort of a chain reaction. And so, that's

 15 the idea of the systemic component.

 16 MR. STANLEY: Yeah, I just wanted to

 17 support what Mike was saying. We're looking to --

 18 I think one difference between the Title 1 SIFI

 19 definition is we're looking to the stability of

 20 the entire U.S. and perhaps the world economy.

 21 Here we could be looking to the stability of

 22 particular derivatives markets.
 271

 1 But the other point I wanted to make is

 2 that we're here discussing a designation rule, not

 3 the requirements under that designation. I mean,

 4 I think there are a lot of potential for

 5 exemptions or safe harbors for particular

 6 requirements for designated entities if they're

 7 already doing good practices -- the kinds of

 8 practices that we want to encourage.

 9 But this is about designation as a major

 10 swaps market participant, and I'm worried if we go

 11 too far down the road of saying entities X, Y, and

 12 Z are admittedly -- everyone admits are major

 13 swaps market participants. But for whatever

 14 reason, they're already safe, they're doing good

 15 practices, they're well-managed, they're regulated

 16 by somebody else. Then, we could really run into

 17 a problem in terms of not designating some pretty

 18 significant entities that perhaps in the future

 19 might not be following those same management

 20 practices.

 21 And of course, we saw one of the

 22 problems that Dodd-Frank is intended to address is
 272

 1 the shopping between different regulatory regimes.

 2 And there's a lot of the belts and suspenders

 3 stuff in Dodd-Frank that I think is aimed at that

 4 kind of shopping between different regimes.

 5 MR. KYLE: I'd like to mention a related

 6 issue to what we're talking about. So, we've been

 7 talking about -- have we missed any entities that

 8 maybe should be labeled as MSPs? The question I

 9 want to address is, how would you detect that if

 10 you were?

 11 And I think the answer goes back to

 12 disclosure. And indeed, the key to everything

 13 that we've been talking about today begins with

 14 disclosure. So my way of thinking about the way

 15 both the morning session and this afternoon's

 16 session should work is that you start with the

 17 idea that a derivatives contract is entered into,

 18 and the simplest rule is to say that one party has

 19 to be a swap dealer. And that swap dealer has an

 20 obligation to report the transaction to -- in some

 21 manner that the regulators, the CFTC and the SEC,

 22 can add it up and understand it.
 273

 1 So under the OFR that's going to be set

 2 up at the Treasury and, I think, here and at the

 3 SEC, you've got various proposals taking place to

 4 identify entities and also to identify the

 5 instruments that the entities trade. So it's kind

 6 of two sets of numerical or alphanumeric

 7 identifiers -- unique identifiers that would allow

 8 you to identify the players and then the positions

 9 that they're holding.

 10 It's going to turn out that that's not

 11 enough. The discussion we've been having today

 12 has indicated that you need some kind of notion of

 13 a subsidiary or an affiliate that would be like an

 14 additional identifier. And, you need some type of

 15 notion of who the asset manager is and whether

 16 he's managing multiple accounts in the same way.

 17 So that's another set.

 18 And I would add something else that's

 19 probably going to happen. So, firms when they're

 20 managing derivatives positions, they have the

 21 value of the derivative contract itself. And then

 22 kind of tacked onto that is the idea of credit
 274

 1 valuation adjustments, CVA. That's the change in

 2 that value of that derivative due to the fact that

 3 the counterparty might default. And then part of

 4 that calculation is how much credit exposure do

 5 you have to that counterparty to begin with. So,

 6 it's kind of two things. How much credit exposure

 7 and what's the probability of default?

 8 There's probably a good case to have

 9 that reported, too. And if that information is

 10 reported along with the derivatives, then one way

 11 to identify major swap market participants is to

 12 look at the exposure that all the other players in

 13 the market have to that entity and to look at how

 14 much of a credit valuation adjustment they are

 15 taking.

 16 And in particular, if you ever reach a

 17 circumstance where the counterparties to an entity

 18 are taking billions of dollars in credit valuation

 19 adjustments, then it's probably systemically

 20 important and it probably should be considered a

 21 major swap market participant. And that will be

 22 one of the early warning devices that you would
 275

 1 get.

 2 Now, I don't anticipate that the

 3 reporting system is going to be efficient enough

 4 to capture all the information that I just

 5 mentioned within the next year or two. But with a

 6 five-year horizon, I think it's feasible that it

 7 could be that efficient.

 8 MR. KANS: We certainly are mindful of

 9 the data issues associated with the major

 10 participant definition, as well as commenters who

 11 have suggested that until we get more data, it's

 12 premature to set the thresholds at a low level.

 13 But before -- I would like a couple

 14 minutes to move on to a couple more discrete

 15 issues. But before we do that, Bill earlier, I

 16 think, raised some very key and critical issues

 17 that go to the heart of the matter. Which is, if

 18 you do have collateralization, minimal exposure to

 19 any time associated to, say, with the thresholds,

 20 minimum transfer amounts -- does that address the

 21 risks that really have to be addressed?

 22 And Pete, since you're the professor, I
 276

 1 want to put you on the spot. In terms of, say,

 2 what you're looking at from history -- the Hunt

 3 brothers, LTCM, obviously the facts are different.

 4 But if you are in a situation where you do have

 5 daily mark to market margining, full

 6 collateralization, no significant counterparty

 7 risk at any time, does that address the sort of

 8 market moving issues that you also alluded to? Or

 9 are they really of a different type?

 10 MR. KYLE: I don't think it addresses

 11 the market moving issues because there's what

 12 people will call potential exposure. But there's

 13 what's going to happen or might happen in the

 14 future that would be an adverse event that would

 15 take an innocent-looking entity and then suddenly

 16 turn it into a systemic nightmare.

 17 AIG is an example. As long as those AAA

 18 honchos are trading at par, you know, AIG is going

 19 to claim that they're immaterial. Essentially,

 20 risk free. But when they fell to 70 cents on $1, you

 21 have a major catastrophe in place. So, you can't

 22 just say they're trading at par, therefore there's
 277

 1 no danger here.

 2 And similarly, LTCM was exactly the same

 3 type of situation. As long as their positions

 4 were profitable and they seemed to be stable,

 5 people would look at LTCM and say that it's

 6 rock-solid. But then as soon as spreads started

 7 widening throughout the market, people realized

 8 that LTCM was headed for a disaster.

 9 Similarly for the Hunt silver situation.

 10 The Hunts were very well collateralized as long as

 11 they could corner the market for silver, because

 12 they had billions and billions of dollars. I

 13 think it was $7 billion worth of silver at $40 or

 14 $50 an ounce. But when it fell to $10 an ounce,

 15 they essentially were bankrupt.

 16 So, you can't just look at the current

 17 situation and ask, are you well collateralized and

 18 fully margined? You have to anticipate the bad

 19 events which can happen in the future, which --

 20 you can call it potential exposure or you can just

 21 use your imagination.

 22 The concept of potential exposure, the
 278

 1 way it's implemented by risk managers, has not

 2 worked very well because the risk managers didn't

 3 have enough imagination or enough pressure on them

 4 to think about how bad the bad things that could

 5 happen would be. And so, they missed a lot of the

 6 credit risks associated with the mortgages and

 7 paid a dear price for that.

 8 MR. MASTERS: I just want to add one

 9 point to that. I think what Pete's saying, you

 10 know, in terms of the way I say it as sort of a

 11 derivatives participant would be the concept of

 12 short gamma. Which is that you know, you think

 13 your risk is here but, suddenly, because of the

 14 gamma embedded in the optionality of the contract,

 15 it suddenly explodes. And you know, there's an

 16 old saying -- it's one thing to be short, it's

 17 another thing to be short gamma. Because the more

 18 the price moves in one direction, the shorter you

 19 get. I mean, your exposure goes up exponentially.

 20 And so, one of the things that I talked

 21 about in an earlier panel that I think is critical

 22 on this subject, which really has to do more with
 279

 1 a reporting issue -- but is, again, when the swaps

 2 are reported to an SDR, when they come from a

 3 dealer, whoever, or the central counterparty of,

 4 you know -- you know, a DCM or a SEF or what --

 5 you know, any kind of reporting transaction, it's

 6 really important to disaggregate those swaps into

 7 component parts. And the reason it's really

 8 important from a systemic standpoint to

 9 disaggregate is to understand the concept of the

 10 short gamma that's embedded in those transactions.

 11 So when I talk about listed hedge

 12 equivalents, then -- and then I say, listed hedge

 13 equivalents adjusted for delta, then I've got a --

 14 you know, what makes sense is understanding that

 15 hedge adjusted for delta and understanding all the

 16 Greeks that go with that derivative contract in

 17 terms of the optionality of the contract. If

 18 there's optionality built into it, only then am I

 19 really going to understand the option and it's

 20 embedded in the transaction or understand the

 21 systemic consequences.

 22 MR. FAJFAR: Could I just ask, would you
 280

 1 -- would that apply across the board? Or would

 2 there be only some -- even if there's -- all swap

 3 users? Or how would that requirement apply?

 4 MR. MASTERS: I think you put it across

 5 everyone. I mean, the other thing is, it's the

 6 only language that we can all understand as

 7 dealers. I mean, it's sort of like, you know,

 8 we're all in a room and we all decide, you know,

 9 we're going to speak Spanish for purposes of

 10 derivatives. You know, we've all agreed to it.

 11 And we already all speak this language. I mean,

 12 dealers and customers already speak the language.

 13 And when you do a swap with a dealer, they

 14 immediately break down that swap into its

 15 component parts.

 16 And the desegregation into component

 17 parts is really a key issue, because -- and it's

 18 especially a key issue as it relates to systemic

 19 risk. Because if you don't know the optionality

 20 that's embedded in that swap contract, you really

 21 don't know the risk of that swap. And by the way,

 22 neither do other participants. And so knowing
 281

 1 that information does several things. It furthers

 2 transparency to regulators, it furthers

 3 transparency to the public. It also allows me as

 4 a customer to evaluate various swap contracts on

 5 an apples to apples basis, rather than you know,

 6 not really knowing what they are.

 7 MR. BERMAN: Mike, I think you make a

 8 very good point about optionality and gamma. That

 9 generally is a concern when folks are reporting

 10 exposures as delta. But a potential future

 11 exposure by design -- by definition, if it's done

 12 correctly, is supposed to incorporate that. So

 13 would there -- what would we change as opposed --

 14 maybe just reemphasizing that?

 15 By the way, when you do potential future

 16 exposure, don't take the delta and multiply it out

 17 by a volatility number. You actually have to do a

 18 full-blown calculation.

 19 MR. MASTERS: Yeah. I mean, if you're

 20 -- you know, and again it goes to the point -- and

 21 in other words, if you're doing a billion dollar

 22 interest rate swap, what does that mean? I mean,
 282

 1 what's the hedge? Because the dealer knows the

 2 hedge before he does the trade. I mean, he's

 3 going to know that hedge. So, he has the

 4 information. So we're asking the dealer to report

 5 the information. And that there's optionality

 6 embedded in that contract, then we're asking to

 7 know the full Greeks. The delta, the theta, the

 8 vega, and the gamma on that position. We need to

 9 know all four of those from a reporting regime.

 10 MR. BERMAN: But, who's the 'we'? And

 11 what does it mean for the major swap participant?

 12 I mean, is it the -- potential MSPs have to

 13 calculate these, but that should be in the PFE

 14 calculation. That is --

 15 MR. MASTERS: Any significant swap

 16 dealer is already calculating -- if they've got

 17 optionality built into the swaps that they're

 18 doing, they're already calculating the Greeks.

 19 MR. BERMAN: Right. But what do we --

 20 what are they supposed to do with that, and how

 21 does that impact the MSP? Is that -- are you

 22 suggesting there should be a test that we add that
 283

 1 includes those factors, or?

 2 MR. MASTERS: I'm really talking about

 3 best practices in terms of reporting. In terms of

 4 -- you know, conduct. Any time a derivative

 5 transaction is reported, it should be reported in

 6 terms of its component parts and then the four

 7 Greeks. Whether it's, you know, by any customer.

 8 MR. KYLE: So, let me -- another

 9 variation on that is --

 10 MR. FAJFAR: Can I just -- I don't want

 11 to put Bill and Matt on the spot, so you can say

 12 no. But, does that sound right to you? Is that

 13 what you would want your dealers to be doing? Is

 14 that realistic?

 15 MR. NEVINS: No. And I'm glad you

 16 asked, so I'll just sort of jump in and say that

 17 you know, from our perspective you've got to

 18 balance two things here. You've got to balance

 19 the need to gather information and test -- again,

 20 those entities that are going to create risk, and

 21 not making the tests overly complicated and

 22 complex for people to apply.
 284

 1 So for all participants in the swap

 2 space, you're going to have to be monitoring

 3 without -- we've talked a bit about a safe harbor

 4 or a filter here. But, without that. You've got

 5 to monitor on a daily basis what your positions

 6 are. And the more complex that we make the tests,

 7 the harder it's going to be to do that. The more

 8 onerous it will be on every participant, the more

 9 compliance systems and build-outs and employees

 10 we're going to need to actually do that analysis.

 11 Now, I mean, to Mike's point. I mean,

 12 dealers may be doing this today and hedge funds

 13 may be doing that today, and some of our more

 14 sophisticated employees are looking at this stuff,

 15 you know, and thinking through their trading.

 16 However, we're not doing compliance testing and

 17 monitoring on that basis.

 18 So one thing that, as I think I've

 19 previously mentioned, you know, we very much

 20 support the notion of keeping these tests simple.

 21 We think that you've picked out the right factors

 22 to apply when you're discounting notional amount,
 285

 1 looking at potential future exposure.

 2 We still believe that the most important

 3 factor is looking at uncollateralized exposure.

 4 And if you believe that there is a necessity to

 5 look at size as well overall counterparty

 6 exposure, that does make sense to discount based

 7 on risk weighting, to discount based on netting,

 8 to discount based on clearing. And, to discount

 9 based on mark to market margining.

 10 And again, as I mentioned earlier, I

 11 think that there's very good policy reasons to

 12 encourage clearing and to get a full discount for

 13 any swaps that are traded through a clearinghouse.

 14 MR. THUM: I think as well -- I agree

 15 with everything Matt said. I think as well, you

 16 know, we really have to look. What are we trying

 17 to hang our hat on here in this major swap

 18 participant definition? And what other tools are

 19 there in the arsenal in terms of transparency into

 20 the market and mitigating risk?

 21 And certainly we discussed in terms of

 22 implementation of the derivatives portion of
 286

 1 Dodd-Frank overall that the -- kind of the crown

 2 jewel, the first piece that needs to be

 3 implemented is the swap data -- the SDR reporting.

 4 And we think it's critical from a number of

 5 reasons. One, of course, to provide the

 6 regulators with transparency into the market --

 7 into potential concentration issues, into all

 8 sorts of things which the regulators have had

 9 virtually no window into up until this point. And

 10 we certainly support that.

 11 Also, it allows the regulators to make

 12 informed views on issues that perhaps are issues

 13 that are occurring to folks at present, but rather

 14 than address the issues in the absence of

 15 information we feel that informed decisions should

 16 be made based on the data as it comes in the door.

 17 So we certainly support SDR reporting in every

 18 way, but we don't feel that the major swap

 19 participant definition needs to be the fix-all for

 20 everything. And we think that it is appropriately

 21 targeted at the right risks, and has the right

 22 tests to achieve its objective.
 287

 1 MR. KYLE: So, I actually with what Mike

 2 was saying earlier. And I think if you have a

 3 bespoke derivative that you're trying to report to

 4 the regulators -- and I agree that the regulators

 5 need to understand what these derivatives are --

 6 how do you report it? You can't send a 500 page

 7 scanned legal document and send that for every

 8 single derivatives contract and expect the

 9 regulators to know what it means. So, it has to

 10 be reported in some form that is understandable.

 11 And the simplest form that would be

 12 understandable would be to say, this bespoke

 13 derivative is more or less equivalent to some

 14 combination of other derivatives that are already

 15 standard derivatives that everybody understands.

 16 And if you report it that way, it captures the

 17 various Greeks that you're trying to capture

 18 automatically. And, it captures even more.

 19 So, it seems to me to do reporting that

 20 way makes a lot of sense. Now, what does this

 21 have to do with MSP definition? If you have two

 22 swap market participants and one of them has an
 288

 1 opaque book full of bespoke derivatives and the

 2 other has an otherwise kind of similar book of

 3 very liquid exchange-traded derivatives, which one

 4 poses more systemic risk to the economy?

 5 And I think the answer is, the book of

 6 bespoke derivatives is going to be much riskier to

 7 unwind because people may not understand exactly

 8 what all these contracts are. There would be

 9 difficulties associated with novating the

 10 contracts over to somebody else if you needed to

 11 swap from one counterparty to another. It would

 12 take a long time to get good bids on these if

 13 they're very complicated, so clearly the

 14 derivatives participant who has a lot of bespoke

 15 derivatives in his portfolio poses more risk than

 16 one where it's all exchange traded.

 17 So, it's kind of -- it would be helpful

 18 to even relaxing the definition of an MSP to allow

 19 the -- to have the reporting be as transparent as

 20 possible so that these difficulties I'm talking

 21 about would be minimized.

 22 MR. MASTERS: Yeah, and just to be clear
 289

 1 -- to Matt's point. You know, it does have to do

 2 with MSPs and what I was really, you know,

 3 proposing was really when the trade is reported.

 4 I wasn't really proposing an ongoing sort of, you

 5 know, compliance thing of, you know -- the reality

 6 is, most firms, you know -- many firms will do

 7 this for their own stuff. I wasn't proposing that

 8 as an ongoing thing.

 9 But when the trade is reported. Because

 10 then, at least you know the Greeks. And to what

 11 Pete's saying is, you've got that. You know, if

 12 you've got a billion dollar portfolio of bespoke

 13 derivatives and you've got a billion dollar

 14 portfolio of listed derivatives, then you can

 15 actually compare the two. And that would be a lot

 16 of use to regulators.

 17 MR. NEVINS: So when we bring it back to

 18 MSP, you know, it might be hard to believe this

 19 but I think we're all kind of saying the same

 20 thing.

 21 So, you know, my view is that you got to

 22 try and keep the test for the people that are
 290

 1 actually going to be doing the compliance

 2 monitoring relatively simple. And I think that

 3 what the Commissions have proposed in the rule

 4 actually picks up what Pete and Mike, you guys,

 5 are suggesting here. There is risk factor waiting

 6 based on different types of swap instruments.

 7 And, there is a discount for clearing swaps, which

 8 are going to be more liquid.

 9 Again, we would support a greater

 10 discount for cleared swaps. But I think that the

 11 distinctions are there. And I think that the

 12 commissions have recognized that and have done it

 13 in a way that tries to not overcomplicate it.

 14 MR. STANLEY: But I think one thing that

 15 both Pete and Mike were getting at is not just how

 16 the test is calculated, but how the reporting

 17 requirements and also -- the reporting

 18 requirements to regulators and the reporting

 19 requirement to customers under the business

 20 conduct rules will change the way the market

 21 works. Because this desegregation is going to

 22 make it much easier, it's going to make prices
 291

 1 much more transparent to customers, and it's going

 2 to make risks much more transparent to regulators.

 3 And the designation of major swaps

 4 participant is kind of the regulatory vehicle

 5 through which these good things are going to

 6 happen. Even apart from the prudential standards,

 7 just the informational elements.

 8 MR. NEVINS: So, can you elaborate a bit

 9 on that? Because I'm not sure I understood that.

 10 The transparent -- so, business conduct rules --

 11 really that's associated with dealers, not the

 12 major swap participants, necessarily, based on the

 13 statute?

 14 If you look at a lot of the reporting

 15 rules, that's not under the MSP aspect. That's --

 16 you have to report whether or not you're an MSP,

 17 whether or not -- doesn't matter who you are, you

 18 have to report. So, all of those things -- so I

 19 think your statement was that the MSP is the

 20 vehicle by which a lot of those good things

 21 happen.

 22 But I think a lot of those good things
 292

 1 happen no matter what. At least, I hope they do.

 2 MR. STANLEY: Well, I'm reporting -- I

 3 hope you're right. And I think that if the

 4 reporting requirements are done well, I hope

 5 you're right about that.

 6 I think on the business conduct

 7 standards, in the statute, at least, business

 8 conduct standards are applied to both dealers and

 9 major swap participants. And I don't think we can

 10 assume -- I mean, the dealer and major swap

 11 participant distinction, it's a very interesting

 12 one. Because the dealer definition doesn't really

 13 have to do with size. It has to do with your

 14 relationship with your customer in a particular

 15 kind of way.

 16 And then we have this other definition

 17 that's based more on size. And I think if you

 18 make a whole bunch of business conduct standards

 19 only apply to dealers, then people may find

 20 creative ways of being big but not dealing with

 21 their customers in a way that brings them under

 22 the dealer definition and start to migrate over
 293

 1 there.

 2 MR. BERMAN: That's a very good point.

 3 Point well taken.

 4 MR. NEVINS: If I just for one moment

 5 just -- can just add on to what you're saying,

 6 Gregg, because I think it's an important point that

 7 the Commissions are both putting out a whole host

 8 of rules that will apply to all swap participants,

 9 not just to MSPs and dealers. There's obviously

 10 enhanced requirements in certain areas for MSPs,

 11 but you know, I think a lot of the concerns in the

 12 swaps markets in general are being picked up

 13 elsewhere. So I think that's an important point

 14 for folks to recognize.

 15 MR. KYLE: So, let me -- can I make sure

 16 I understand? Because if I didn't, I want to make

 17 a point.

 18 So I think if it were to happen the way

 19 I would like for it to happen, every derivatives

 20 transaction would have a dealer as one of the two

 21 parties. But if it doesn't happen that way and

 22 you imagine that some transactions don't have a
 294

 1 dealer but they have a major swap participant

 2 trading on one side and then a -- let's call it a

 3 minor swap participant -- trading on the other

 4 side, then the major swap participants would be

 5 subject to some business conduct standards that

 6 would otherwise be applicable to dealers on that

 7 subset of transactions.

 8 And if that's the case, then I 100

 9 percent agree with what Marcus was saying.

 10 MR. KANS: Okay, I'd like to move on to

 11 a couple more discreet issues. First is, as was

 12 alluded to earlier, there has been a suggestion

 13 for a calculation safe harbor for entities that

 14 are significantly below the thresholds.

 15 Basically, a statement and relief from the threat

 16 of enforcement action that they would not have to

 17 undergo the calculations needed to determine

 18 whether or not they are a major participant.

 19 I'd like people to address the why

 20 behind that because if one is significantly below

 21 the thresholds, then what would be the driving

 22 force behind even having to go through the
 295

 1 calculations if you're already pretty confident

 2 that you would never be a major participant under

 3 the tests?

 4 MR. NEVINS: Okay, sure. I'll go first

 5 on this one.

 6 So, the idea is that as careful

 7 participants in the financial marketplace that are

 8 subject to regulation under your purview, we want

 9 to make sure that we're not running afoul. And we

 10 have duties to our clients to make sure that we

 11 are actually monitoring what we're required to do.

 12 So, you know, the release does say that

 13 the intention of the Commissions is that if you're

 14 far enough below -- and I'm paraphrasing. But if

 15 you're far enough below the thresholds, that you

 16 wouldn't have the burden that's related to

 17 actually doing that daily monitoring. But you're

 18 required in order to do this test, and to test --

 19 to measure the test -- to look at your positions

 20 on a daily basis.

 21 So, the theory behind this is that if

 22 you test, let's say, monthly or you're looking at
 296

 1 monthly numbers or quarterly numbers and you're so

 2 far below the thresholds -- let's say you're 50

 3 percent below every single threshold for current

 4 exposure and potential exposure determined at the

 5 end of the quarter or at the end of the month.

 6 Then it could save a lot of unnecessary work and a

 7 lot of unnecessary compliance obligations to have

 8 that regulatory certainty that we're not going to

 9 get in trouble because we weren't following every

 10 day where our positions are.

 11 So, that's the idea. The notion here is

 12 that it will save us cost, it will save us

 13 manpower where we're so far below the proposed

 14 thresholds. Again, an example would be 50 percent

 15 below every test, then instead of following it on

 16 a daily basis you follow it on a monthly basis.

 17 On one day a month you do your test. If you're

 18 below 50 percent of all the thresholds, then you

 19 move on to the next month.

 20 MR. THUM: Yeah, I think that's exactly

 21 right, Matt. And you know, our aim is not to

 22 avoid responsibilities. Our aim is simply to
 297

 1 clarify what those responsibilities are. And I

 2 think particularly when you have a test that's

 3 based on average daily numbers over a particular

 4 period -- the reason for that is to recognize that

 5 you could have spikes and you could have peaks and

 6 troughs within that particular period.

 7 It does, indeed, suggest that you would

 8 need to run the test on a regular basis if not a

 9 daily basis. So, we of course have run the tests

 10 on individual funds. Our funds use derivatives in

 11 a minimal way. What we have found is the numbers

 12 really reflect risk largely about equivalent to

 13 the minimum transfer amount that we've agreed with

 14 our dealers.

 15 Of course, it's more complex than that

 16 because you have to look at it within major swap

 17 categories -- the six major swap categories, and

 18 you have to do the PFE calculation on the nine

 19 different convergent factors, depending on the

 20 trade type and the maturity of the trade. It's a

 21 very complicated test.

 22 So, we agree that you know, perhaps you
 298

 1 could have a gross notional test. Or if the gross

 2 notional amounts that you're trading are below the

 3 thresholds, then you would simply not need to

 4 calculate the test at all. And only if you met

 5 the gross notional test would you calculate it

 6 monthly, until you reached the 50 percent level

 7 that Matt suggested. Once you reach the 50

 8 percent level of these multi-billion dollar

 9 thresholds, would you then start to calculate

 10 daily.

 11 So I think it would help us, certainly,

 12 to have a clarified -- that given it is an average

 13 daily volume within this particular period, that

 14 we simply would have a way to assess that, indeed,

 15 we don't need to do the test. Although we could

 16 do it periodically, on the basis that I just said.

 17 MR. STANLEY: It seems like a gross

 18 notional test makes some sense in the sense that

 19 the exposure -- your exposure test would be a

 20 subset of gross notional, right? So that if you

 21 met a gross notional test, you'd be guaranteed

 22 that you would make the other test. But in terms
 299

 1 of calculating on one day a month or something

 2 like that, that seems potentially a little bit

 3 tricky or a little bit easier to game than

 4 something like just a gross notional test, which

 5 people should be aware of pretty easily, right?

 6 MR. NEVINS: So, the suggestion that I'd

 7 put out is just that, a suggestion. And Marcus,

 8 you know, we wouldn't be opposed to using gross

 9 notional as opposed to, you know, 50 percent -- a

 10 50 percent threshold of where you fall against all

 11 the tests in the rule proposal. So, there are

 12 lots of different ways of doing this. And you

 13 know, I think that one certainly could look at

 14 gross notional as a standard for when you are

 15 actually required to do the calculations.

 16 MR. THUM: Yes. And if I wasn't clear,

 17 I mean the gross notional would just be a window

 18 in to allow you to start to do it on a monthly

 19 basis. And if you've done it on a monthly basis

 20 and you exceed the 50 percent level of the

 21 threshold itself at any given month end, then you

 22 would do it every day. So, there'd be kind of an
 300

 1 escalating responsibility.

 2 But again, you know, certainly from the

 3 registered funds perspective the numbers are going

 4 to be very small.

 5 MR. KANS: I would like to turn to one

 6 final issue, then for this panel. The definition

 7 of hedging and mitigating commercial risk. This

 8 is a definition that's parallel to the end user

 9 clearing exception, also.

 10 Commenters addressed and critiqued a

 11 number of aspects. The economically appropriate

 12 standard that was proposed, including language on

 13 the SEC side about additional new types and quanta

 14 of risk.

 15 The carve-out -- the exclusion -- from

 16 the exclusion for positions that are speculative

 17 and trading in nature, including language of these

 18 include positions that that themselves hedge

 19 speculative and trading positions, as well as on

 20 the SEC side the procedural aspects.

 21 So, I'd like people to -- ideally

 22 starting with the economically appropriate
 301

 1 standard -- address these issues, please.

 2 MR. KYLE: I don't think it's possible

 3 to make a meaningful distinction between a hedging

 4 transaction and a speculation transaction. That's

 5 implement-able. And I don't think it's very easy

 6 to make a distinction between a commercial

 7 transaction and a non-commercial transaction.

 8 But there is one type of transaction

 9 that's fairly -- where the distinction is fairly

 10 easy to make. And that is, if you enter into a

 11 contract to buy a commodity from the person who

 12 produces it and the person delivers you that

 13 commodity under the contract, then it's not really

 14 a derivative. It's a physical commodity

 15 transaction.

 16 And similarly, if you sell a commodity

 17 to someone -- if you sell soybeans to a facility

 18 that crushes those soybeans and you deliver those

 19 soybeans to that facility and they, you know,

 20 crush them, then it's not a derivative contract.

 21 It's just a physical transaction in the commodity

 22 itself. That should be the basis for the
 302

 1 exemption.

 2 So, the basis for the exemption should

 3 be that it is a transaction and a commodity that

 4 end users are producing and consuming on one side

 5 of the transaction or on the other. Even though

 6 one part of the transaction could be a

 7 merchandiser. I think all the other distinctions

 8 are going to simply result in loopholes and

 9 regulatory burdens and costs.

 10 MR. MASTERS: Yeah, I would just -- I

 11 would sort of echo that.

 12 I mean, the sense of the capital

 13 markets, specifically, you know, with regard to

 14 the SEC. I mean, it's easy with the commodity

 15 markets where you've got hedgers 

 16 and you've got speculators. And there are

 17 some clear delineations.

 18 But, you know, with regard to the

 19 capital markets. I mean, pretty much everybody in

 20 there is a speculator, if you will, or an

 21 investor. And so more representing in the sense

 22 of a fund or whatnot.
 303

 1 So, it's -- so in terms of hedging, you

 2 know, what are you really hedging? I mean, you're

 3 hedging your interest rate risk. Well, your job

 4 is to take risk, and you can take down risk or

 5 take up risk. But I mean, you're there as a risk

 6 taker. I mean, that's your function in the

 7 capital markets as a participant. And so, I think

 8 it's sort of tricky.

 9 But just to go a little further in terms

 10 of, you know, economically effective hedges. I

 11 think there's a couple things that you'd want to

 12 avoid in terms of highlighting. You know, one

 13 would be the idea of a swap that would have a

 14 greater duration than the commercial risk. For

 15 instance, if a swap -- if -- and this would go

 16 back to the commodity -- if you were to be

 17 delivered wheat in December to use in your mill,

 18 and you had a contract for six months later than

 19 that, then that six month period of time now is a

 20 -- is not a hedge in the sense of -- you're making

 21 a bet out in time that you don't need that

 22 represents your commercial interests.
 304

 1 Another thing that I would add on to

 2 that would be -- that's actually mentioned in the

 3 statute that I just pointed out. Would be a hedge

 4 on a hedge. You know, you've got a hedge on a

 5 hedge, and so one of the things that was sort of

 6 thrown out there was, okay. So I'm doing a swap

 7 contract with a counterparty. And then I buy a

 8 CDS contract on that counterparty to hedge the

 9 counterparty. So, that's a hedge on a hedge, in

 10 my view. And that would be something that

 11 shouldn't be considered as part of the hedge.

 12 And I would also say that given the fact

 13 that end users can require that a swap dealer does

 14 the trade on a DCM or centrally-cleared place,

 15 then there's probably no need for that anyway. If

 16 I had the option to make a swap dealer clear a

 17 trade on a DCM, then what's the point of having

 18 CDS protection on them all? It sort of obviates

 19 the need for CDS. So, at any rate.

 20 So those are sort of the points I'd make

 21 on that.

 22 MR. NEVINS: So, a couple things. First
 305

 1 of all, we could probably have a panel that would

 2 maybe last all day on the definition of hedging as

 3 it applies broadly throughout the rule sets here.

 4 Let's not do that.

 5 We have a few minutes left here today,

 6 so instead let's focus on this rule itself. And

 7 the statutory language includes the phrase

 8 "hedging or mitigating commercial risk". So to

 9 me, for this MSP discussion, you've got to look

 10 more broadly than -- even if you took a narrow

 11 view of hedging where you actually have to hold

 12 the underlying in order to be deemed to be hedging,

 13 you've got this piece about mitigating commercial

 14 risk as well.

 15 To the particular question on what's

 16 economically appropriate -- and, you know, we know

 17 that there is some differences in the proposal

 18 between the CFTC and the SEC here on how you

 19 define hedging or mitigating commercial risk for

 20 this rule proposal. You know, one thing that

 21 gives me some pause -- and Josh, you had mentioned

 22 this during your question -- is that the swap
 306

 1 should not introduce any new material quantum of

 2 risks.

 3 And the trouble there -- and that, I

 4 believe, is not part of the CFTC proposal. But

 5 the trouble there and the concern that we have

 6 there is that what if you have a proxy hedge? So

 7 basically, you've got a hedge in place that -- or,

 8 you have a swap in place that hedges out 80

 9 percent of your risk but there may be some

 10 additional, non-hedging piece to that swap. Do

 11 you lose completely the credit of that swap from,

 12 you know, taking it out of the analysis because

 13 it's primarily being used to hedge?

 14 Sometimes, you don't have a perfect

 15 match, whether it's -- you know, in tenor or in

 16 what's covered under the swap. You're using it to

 17 hedge, but it doesn't match up perfectly with the

 18 underlying. And we think a less restrictive

 19 standard for applying the hedge or mitigating

 20 commercial risk standard for this rule would be

 21 appropriate.

 22 MR. OPPENHEIMER: Can we move on a
 307

 1 little bit if you've covered that topic to the

 2 notion of hedging -- swaps that hedge trading or

 3 speculative positions? And I'll really talk

 4 exclusively from the physical commodity side.

 5 And the working group, together with the

 6 Commodity Markets Council, put in a comment letter

 7 on this about a week and a half ago. So, you can

 8 take a look at it if you haven't seen it.

 9 The notion of being able to count a swap

 10 that hedges an underlying trading or speculative

 11 position in the physical commodity markets is a

 12 very, very important question. It's important for

 13 the MSP definition. It's significantly more

 14 important for the end user exception provision.

 15 And I'm going to elaborate a little bit.

 16 I think some of this is really self-evident, but

 17 I'd feel like I didn't use my hour and a half of

 18 sitting quietly without speaking a little bit now.

 19 You know, trading in the commodity sense

 20 is very, very different from trading in the

 21 securities sense -- in the notion that you don't

 22 just plop yourself down and open an account and
 308

 1 start trading paper. In order to trade in

 2 physical commodities, you have to have quite a bit

 3 of infrastructure. You have to have the ability

 4 to charter ships, arrange transportation on

 5 pipelines or on transmission lines. You have to

 6 be able to deal with inspectors of product, you

 7 have to be able to manage logistics associated

 8 with getting ships into harbors. You need to have

 9 customs relationships and ability to deal with

 10 customs for imports and exports. It's a very,

 11 very different business.

 12 And it's long been known in the

 13 commodities trade and recognized in commodities

 14 regulation that there is a whole commercial

 15 marketing chain running from producer, processor,

 16 merchandiser, to end user. And that the

 17 merchandiser, the trader plays a significant role

 18 in the successful delivery of commodities from the

 19 production to the end use.

 20 And the reason for that is, of course,

 21 you know producers don't all contract with end

 22 users. And you don't have all production
 309

 1 committed to long-term contracts where it moves

 2 from the production to the end use. And there

 3 again, there's a very good reason for that. You

 4 wouldn't be able to react to market conditions, to

 5 hurricanes, to pipeline outages, to heat waves and

 6 greater demand in particular locations if

 7 everything was committed to long-term contracts.

 8 So, you have merchants in the middle.

 9 And they move product from place to place. And

 10 whether that's done by a trading company that's

 11 known as a trading company or whether it's done by

 12 an integrated major, it's done by quite a few

 13 kinds of companies in the energy and the

 14 agricultural space, right? And that's the trading

 15 activity.

 16 So, when a trading company owns a

 17 commodity, it has price risk. And when it hedges

 18 that price risk, hedging that price risk with a

 19 swap should be deemed to be hedging or mitigating

 20 commercial risk for the purpose of the MSP

 21 definition, and for the purpose of the end user

 22 exception definition.
 310

 1 And frankly, I can't think of any policy

 2 reason -- trying to put myself in your seats -- as

 3 to why that shouldn't be the case. It has always

 4 been the case. Ironically, it would -- that hedge

 5 would be a bona fide hedge for a physical

 6 commodity market player under the speculative

 7 position limit regime. And it would seem

 8 extremely odd to me if it would be pulled out from

 9 that for the purposes of mitigating -- hedging or

 10 mitigating commercial risk.

 11 MR. FAJFAR: Can I ask a question, Ron?

 12 MR. OPPENHEIMER: Yeah, sure.

 13 MR. FAJFAR: So what -- then for a

 14 commercial firm that's doing everything -- what

 15 you just said. Really, then, in the normal course

 16 or in any course, all other -- almost all other

 17 swaps would be hedges. What would not -- is it --

 18 what would not qualify -- or is that -- is that

 19 the point?

 20 MR. OPPENHEIMER: No. I mean, any one

 21 of those firms might speculate as well.

 22 MR. FAJFAR: What's the difference
 311

 1 between trading and speculation?

 2 MR. OPPENHEIMER: I'm sorry. When we're

 3 talking about trading here, we're talking about

 4 trading the physical commodity. Right? So, the

 5 swaps that hedge that activity would be swaps

 6 hedging trading activity. And from my

 7 perspective, would be swaps that constitute

 8 hedging or mitigating commercial risk.

 9 I thought you had asked me if they also

 10 engaged in other swap activity, which isn't

 11 hedging. And the answer is, they could. They

 12 could engage in speculative swap activity. And

 13 I'm not suggesting that they should be able to

 14 deduct their speculative swap activity when doing

 15 their exposure tests, or claim the end user

 16 exception for speculative swap activity. But I am

 17 saying that any swap that hedges a trading

 18 position, or even a speculative position in a

 19 physical commodity, should count as hedging or

 20 mitigating commercial risk for these purposes.

 21 And when I say a speculative position in

 22 a physical commodity, there are times where a firm
 312

 1 might buy natural gas, put it in storage, perhaps

 2 in the summertime in anticipation of a winter

 3 heating season. And somebody might characterize

 4 that as a speculative position. I don't know if

 5 it is or it isn't, but you might characterize it

 6 that way. The hedge of the price risk that that

 7 party holds while it does that, before it delivers

 8 that gas to an LDC or whatever, should constitute

 9 hedging or mitigating commercial risk. Because

 10 that's in the commercial supply chain, and the

 11 party has price risk while it holds the commodity.

 12 MR. FAJFAR: So just -- so once you make

 13 the determination that the swap is a hedge and

 14 it's hedge-related to a -- the supply chain

 15 point, then you stop? That's your point,

 16 basically?

 17 MR. OPPENHEIMER: That would constitute

 18 hedging or mitigating commercial risk, for both

 19 the MSP and the end user exception.

 20 MR. BERMAN: Can I ask a question, just

 21 of how one might generalize that and what the

 22 implications would be, depending on the
 313

 1 generalization?

 2 So if what you're saying is that there

 3 are firms -- merchant firms -- who, one can view

 4 the physicals out there holding as speculative

 5 positions. And what you're saying is that a hedge

 6 on that is still a hedge, and therefore it should

 7 be considered a hedge as opposed to a speculative

 8 position?

 9 MR. OPPENHEIMER: I am. I mean, my

 10 point, I think, goes more to trading positions.

 11 But I do believe that it -- and I'm certain -- it

 12 -- you could characterize some positions as

 13 speculative positions. And my point would apply

 14 equally to that.

 15 And it's different. Speculation has

 16 this, you know, connotation to it. And so you

 17 know, I just think it's very important to point

 18 out that somebody who owns natural gas in a

 19 storage facility for future delivery on to an LDC

 20 or other user is very different than somebody who

 21 buys a security or some other investment vehicle

 22 for the purpose of earning a profit. You have to
 314

 1 truly be in the business of owning physical

 2 commodities and transporting physical commodities

 3 in order to buy something in the hope that the

 4 price is going to go up.

 5 MR. BERMAN: So if I set up a fund and

 6 basically I speculate on gold, but instead of

 7 buying gold futures I buy gold -- I have a vault

 8 and I purchase that. Would you be able to

 9 distinguish that activity from the activity that

 10 you're talking about? Or would you say that those

 11 are the same?

 12 If you own the physical -- so, I own the

 13 gold strictly because I would like to play the

 14 gold market. But when I get nervous about it,

 15 sometimes I put swaps on the other direction,

 16 instead of selling the gold because I find it

 17 cheaper. Did I -- do I get myself into a

 18 situation where the gold physical hedges the swap

 19 and the swap hedges the gold, therefore I actually

 20 have no positions?

 21 So, how do we not fall into that trap?

 22 MR. OPPENHEIMER: Yeah. I mean, I think
 315

 1 in that example the gold fund is not a producer,

 2 processor, merchandiser, or end user. So I think

 3 you may be able to find a distinction in there.

 4 MR. BERMAN: Okay. So you would be

 5 saying that in the course of their regular

 6 business, they are dealing with the commodities

 7 for -- at some level, non-speculative purposes.

 8 They're part of a supply chain, they're part of

 9 some process. But is that sort of how you make a

 10 decision?

 11 MR. OPPENHEIMER: I think that's a fair

 12 distinction.

 13 MR. KYLE: So, what I see as the problem

 14 -- I kind of would like to agree with what you

 15 said. But what I see as the problem there is that

 16 if I am a pure speculator in various types of

 17 commodity derivatives and I want to pretend that

 18 I'm not, all I have to do is buy a firm that's

 19 engaged in lining up ocean freight and doing a

 20 little storage and doing a little of this and that

 21 that allows me to qualify as a commercial

 22 operation. And then that commercial operation
 316

 1 becomes a cover for engaging in all kinds of

 2 speculative behavior.

 3 And that's what you'll see, right?

 4 You're going to see hedge funds buying, you know,

 5 like commodity operations and kind of pretending

 6 to be engaged in the physical business if they

 7 would otherwise fall under the major swap

 8 participant definition and can use that as a way

 9 of getting out from under it.

 10 MR. OPPENHEIMER: I don't think so. I

 11 mean, if you bought yourself a small little

 12 physical operation and you were engaging in

 13 trading that bore no relationship to that trading,

 14 then I don't see how in any respect you could

 15 claim that that operation turned your speculative

 16 swaps into hedging that commercial operation. But

 17 if you own that commercial operation and that

 18 operation has discrete positions that it hedges,

 19 certainly those would constitute hedging or

 20 mitigating commercial risk.

 21 I don't see how divorced operations --

 22 just the existence of a commercial operation could
 317

 1 provide cover for a speculative trading shop.

 2 MR. KYLE: So you don't think that coal

 3 market transactions can hedge electricity

 4 transactions?

 5 MR. OPPENHEIMER: No, I don't.

 6 MR. KYLE: So if I buy a little coal

 7 mine, does that enable me to engage in electricity

 8 speculation as a cover?

 9 MR. OPPENHEIMER: No, but it would allow

 10 you to hedge your coal prices -- I don't think

 11 you'd hedge your coal prices with electricity.

 12 But if you wanted to do that, I think if you had a

 13 certain amount of expected production in the mine

 14 and you wanted to hedge that with electricity

 15 futures or electricity swaps, you could. But you

 16 couldn't run a portfolio over here that bore no

 17 relationship in size or relationship to what was

 18 happening with the mine.

 19 MR. STANLEY: I think this discussion

 20 points to the importance of tying the hedge very

 21 tightly and directly to the commercial exposure.

 22 And the various requirements that are going to
 318

 1 have to be used to do that.

 2 And we were concerned that the

 3 economically appropriate language in the

 4 regulation was too broad and vague. And there

 5 wasn't the detail to line up the hedge with the

 6 commercial exposure so that you could do what Ron

 7 is saying. You could see whether the exposure in

 8 the derivatives markets bears a real relationship

 9 in terms of timing, in terms of size, in terms of

 10 correlation with the exact commercial exposure

 11 that was being claimed. And that's what the hedge

 12 accounting rules make you do.

 13 And we believe -- I know Better Markets

 14 has said this several times in its comments --

 15 that you should have a hedging strategy at the

 16 company level that's approved at the board of

 17 directors level that lays out what your commercial

 18 exposures are, how that relates to the hedging

 19 practices you're going to do, and then the

 20 specific hedges should slot in under that

 21 strategy.

 22 And I just -- I also wanted to point
 319

 1 out, I was going through your -- the CFTC website,

 2 actually. And I found a communication with SIFMA

 3 where it was stated that SIFMA members believe

 4 that the commercial exclusion should not be so

 5 broad that it permits corporate end users of swaps

 6 to accumulate very large positions without

 7 becoming MSPs. And so, possibly for the first

 8 time ever Americans for Financial Reform gets to

 9 agree with SIFMA. And I think that when that

 10 happens, the regulators should pay attention.

 11 And what's going on here, of course, is

 12 that SIFMA has a lot of members who are

 13 speculators. And they recognize that if this

 14 commercial exemption could easily become so broad,

 15 that they would have to compete with entities that

 16 claim to commercial end use exemption but were

 17 actually speculating and competing with them. And

 18 they don't want to have that competition, and we

 19 don't want to see that happen, either.

 20 And I think the way to avoid that

 21 happening is to really be able to go into a

 22 company and require them to have a clear hedge
 320

 1 strategy that's tied to commercial exposures and

 2 does not, for example, reward traders based on

 3 speculative profits from transactions. But

 4 instead, really ties those transactions to

 5 commercial hedging.

 6 MR. FAJFAR: I just want to go through

 7 it again with Ron, just to repeat since, you know,

 8 it's the end of the day.

 9 So, we take your situation company

 10 involved in the trading stream. I think what

 11 you're saying, this is not our -- what your

 12 position is, that if you look at the swap. If the

 13 swap is hedging, we know -- and it does meet the

 14 definition of hedging -- and it's hedging a

 15 position that's held for purposes of trading or

 16 speculation, that's okay. It's not included in

 17 the MSP test.

 18 If the swap itself is a speculative

 19 position, then it doesn't -- then you stop. It

 20 doesn't -- how you're -- then it would go into the

 21 MSP test. That's basically right.

 22 MR. OPPENHEIMER: That's right. Then
 321

 1 it's a spike in a position, it's not -- excuse me

 2 -- hedging a mitigating commercial risk. The

 3 exposure would be added to the MSP definition.

 4 You wouldn't be entitled to claim the end user

 5 exception for that.

 6 MR. FAJFAR: But you were just

 7 addressing the point that once -- if you make the

 8 determinate it's hedging -- the swap is hedging --

 9 it doesn't matter what it's hedging. That's

 10 really your point.

 11 MR. OPPENHEIMER: And again, I'm not

 12 addressing anything other than physical

 13 commodities. And the answer is correct. If it's

 14 a physical commodity transaction, hedging or

 15 mitigating commercial risk -- and I'll leave aside

 16 the gold example for the moment, too. A swap

 17 hedging that physical commodity transaction would

 18 be deemed hedging or mitigating commercial risk

 19 for the purposes of the two definitions.

 20 MR. KANS: And just to follow up on your

 21 point about limiting your comment to physical

 22 commodities. Understand that that's where you're
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 1 coming from and who you're representing. Do you

 2 have views, though, as to whether or not the same

 3 principles would apply to the financial swaps, the

 4 securities-based swaps? Would the same underlying

 5 principles apply and the same policy issues apply,

 6 or would they be different there?

 7 MR. OPPENHEIMER: I really don't have

 8 the expertise on the security-based side to offer

 9 anything on that.

 10 MR. NEVINS: I'd answer yes. That I

 11 think that the same principle should apply to

 12 securities-based swaps as well.

 13 And again, for the purposes of this

 14 rulemaking, it includes mitigating commercial risk

 15 in addition to hedging. And I think once you've

 16 established that that's what you're using your

 17 swap for -- for risk mitigation, for hedging --

 18 then it's not included as part of the testing.

 19 That would be our position.

 20 MR. KYLE: So, a long-short equity beta

 21 neutral, market neutral hedge fund is a commercial

 22 hedger. And LTCM was a commercial hedger. And
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 1 therefore, get an exemption from major swap

 2 participants?

 3 MR. NEVINS: It's not an exemption from

 4 MSP. It's part of the rule that when you test

 5 substantial position, you back out swaps that are

 6 used for hedging or risk mitigation. That came

 7 from Congress, it's part of the statute.

 8 MR. KYLE: Right. So, Congress has

 9 exempted zero beta hedge funds that structure

 10 their positions as swaps.

 11 MR. NEVINS: They've exempted swaps that

 12 are being used for risk mitigation or hedging,

 13 correct.

 14 MR. KYLE: So, LTCM has been exempted as

 15 well, to the extent they use swaps as opposed to

 16 physical --

 17 MR. FAJFAR: The question --

 18 MR. KYLE: I mean, I agree there's an

 19 issue in whether the statute makes sense. And

 20 that was kind of the point I was making earlier.

 21 I don't see how this can of worms can be resolved

 22 in any reasonable way. It's economics.
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 1 MR. FAJFAR: I just want to restate the

 2 question in a different way. The point of the

 3 question is, when they wrote hedging or mitigating

 4 commercial risk, they meant to include the zero

 5 beta hedge fund. That was the commercial risk

 6 that was in mind when they wrote the hedging

 7 exemption. I think that's the question, right?

 8 MR. NEVINS: I won't speak to the

 9 specific example, but I can tell you that I think

 10 what they had in mind was that if you're using a

 11 swap to manage your risk or to hedge, as opposed

 12 to speculate and take a position on whatever the

 13 underlying is, that those swap positions should

 14 not be included in the calculation of the

 15 thresholds.

 16 MR. FAJFAR: I just want to give you the

 17 chance -- when you said to manage or to hedge your

 18 risk, you didn't say commercial. Your position

 19 is, this is a commercial risk?

 20 MR. NEVINS: Yes, Mark.

 21 MR. MASTERS: I would just say -- I

 22 mean, you know, in terms of -- I think, you know,
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 1 as I said on an earlier panel, you know, being a

 2 hedge fund manager, there's nothing in my

 3 portfolio I can't claim to be hedging a risk.

 4 There's nothing. There's not a trade I do ever

 5 that I can't claim it to be a hedge against

 6 interest rates, or inflation, or against equity.

 7 You know, the fact of the matter is, if you're a

 8 capital market participant, your business is

 9 taking risks.

 10 Contrast that with a -- someone that's

 11 taking commercial risk in an enterprise that's

 12 trying to reduce risk. I should say, their risk

 13 is their business. They're trying to reduce their

 14 price risk. And in my opinion, Congress was

 15 really focused on the commercial risk point, not

 16 -- in the sense of the -- you know, the farmer

 17 trying to hedge his wheat or, you know, the

 18 classic examples that people think about.

 19 But, you know, not some hedge fund

 20 that's trying to, you know, hedge off a certain

 21 kind of inflation risk by, you know -- or credit

 22 risk. I just -- I don't think -- I think if those
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 1 were the only risks out there, we wouldn't have

 2 the distinction, in my view.

 3 MR. THUM: I think it probably would be

 4 helpful for the Commissions to reach out to the

 5 hedge fund industry on this question and talk to

 6 them about that. You have two large asset

 7 managers here that are focused on registered funds

 8 and have very limited swaps trading. It's very

 9 prudent and well-regulated. So, I think that the

 10 question is probably worth getting to the bottom

 11 to and probably is worth engaging directly with

 12 the entities that you're talking about.

 13 MR. STANLEY: I feel like you could

 14 probably predict what a lot of those entities

 15 would say. I just wanted to say, we agree with

 16 the position that the Commissions took that

 17 hedging and mitigating are synonymous in

 18 Dodd-Frank, and that they are used synonymously in

 19 many parts of the legislation. So, we would agree

 20 with that.

 21 MR. BERMAN: I know it's late so I'll

 22 keep my question brief. I do think things turn on
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 1 the word "commercial".

 2 So this is really a question for you,

 3 Ron. If you were looking at one of these firms

 4 that was moving physical commodities, engaging in

 5 swaps, would you be able to distinguish in looking

 6 at that firm saying, why do you own these things?

 7 This does not seem to be part of a commercial

 8 business.

 9 And I say, actually -- we're taking a

 10 bet over there. Yeah, you're right. We have no

 11 clients, we have -- there's nothing going on here

 12 that we're part of a pipeline. That's -- we have

 13 our own bet going on.

 14 Is that distinction meaningful? Because

 15 we're asking about it from the hedge fund

 16 standpoint. But I'd first like to see even within

 17 the physical commodities. Is that a meaningful

 18 distinction?

 19 MR. OPPENHEIMER: If I understand it,

 20 no. So, you're suggesting that somebody owns a

 21 physical commodity like natural gas, like oil, and

 22 they're not looking to market that to an end user
 328

 1 or pass it along in a marketing chain? They just

 2 want to hold it and leave it aside for a while and

 3 see what happens to the price?

 4 MR. BERMAN: So I'm -- maybe I

 5 shouldn't' have used my gold example. I use an

 6 oil example. I buy oil. I stock it up in my

 7 house, and then I hedge it and then I sell it back

 8 and forth. It's purely for profit, I have no

 9 clients, et cetera.

 10 I join one of the energy firms, and I --

 11 and they say, so what's your business? I say,

 12 well I'm going to go off on the side and I'm going

 13 to do this. Now you look at the whole firm.

 14 Would you be able to distinguish and say, you guys

 15 move a lot of oil, a lot of energy is going back

 16 and forth, and I see that. But what is this thing

 17 that you're doing over here? You seem to have a

 18 person who just buys oil for "speculative

 19 purposes". Does that intermingle in such a way

 20 that you can't distinguish "commercial" use of the

 21 oil from speculative use? Or would you be able to

 22 say, actually that does seem to be a distinct
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 1 activity from the commercial use of oil.

 2 MR. OPPENHEIMER: And I'm having a hard

 3 time because I don't know of any company who sort

 4 of buys stuff off on the side, holds it. And I

 5 can't envision that happening.

 6 There are companies that, in the course

 7 of being in the wholesale business, will buy and

 8 sell. But ultimately, those products work through

 9 and are a part of the commercial marketing chain.

 10 I just can't envision what you're saying about

 11 being outside of that scope.

 12 MR. BERMAN: Okay, so most things would

 13 be within -- you think would be in there -- so if

 14 --

 15 MR. OPPENHEIMER: Absolutely, yes.

 16 MR. THUM: I would like to just make one

 17 last point, that you know, there obviously are

 18 three tests here. And the first test, I think,

 19 includes this carve-out. The third test, of

 20 course, excludes the carve-out, has different

 21 thresholds. But one could say that if you're

 22 getting a hedge fund which possibly is leveraged
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 1 -- and indeed, you're looking to consider all

 2 trades for the purposes of establishing whether a

 3 party is a major swap participant -- then the

 4 third test would be the bucket that you'd probably

 5 fit into.

 6 MR. KYLE: And one final point for me.

 7 Many -- if you look at where commodity scandals

 8 come from, many times they come from large firms

 9 that have small groups of traders in them that,

 10 you know, kind of do things and aren't consistent

 11 with maybe the philosophy of the whole firm. And

 12 how are you going to -- and they create problems

 13 in commodity markets from time to time.

 14 So, how do you find those people and

 15 monitor them? I'm thinking about the copper --

 16 there was an example of a copper corner, you know,

 17 many years ago. That was a Japanese firm. But,

 18 you know, it was -- you could argue it was

 19 commercial activity. But there was a huge

 20 speculative element to it and it disrupted the

 21 market quite a bit.

 22 MR. STANLEY: And just to follow up on
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 1 that. I mean, we feel like you guys do face an

 2 issue here in terms of defining more narrowly,

 3 more precisely the definition of commercial.

 4 Because especially you seem to have chosen to

 5 interpret the statute to permit financial entities

 6 to make use of this. There's potentially a real

 7 camel's nose under the tent problem here that we

 8 think you have to really look at. Because there

 9 are speculative trading desks within energy

 10 companies and other physical commodity companies

 11 that also do commercial operations.

 12 And the traders -- those speculative

 13 traders are always going to be very aggressive

 14 about trying to claim whatever exemption you've

 15 created. This raises a lot of the same issues, I

 16 think, that the Volcker Rule does with sort of a

 17 ban on proprietary trading. And you have to look

 18 at the practices within that company, how traders

 19 are compensated, the overall hedge strategy for

 20 that company. And specifically, tie those hedges

 21 to narrowly defined commercial risks, we feel.

 22 MR. FAJFAR: I think if we're ready to
 332

 1 wrap up, I would just like to say at the risk of

 2 being repetitive and -- because I have pressed

 3 some of the panelists on their points. There is

 4 -- we have voluminous comment letters available.

 5 We've had many meetings, they're all on the

 6 record. And especially people reading the

 7 transcript -- just be aware if you want more

 8 information and a full explication of all of these

 9 points, there's a lot more information on the

 10 record. We're aware of that.

 11 And this has just been a snapshot of the

 12 issues. So, just want to make that clear for all

 13 of the panelists on all three of the panels. And

 14 otherwise, just thank you for participating.

 15 And Josh, did you have anything?

 16 MR. KANS: Thank you both to the

 17 panelists and to the people in the audience for

 18 staying with us for so long. Obviously, there's a

 19 lot going on here. We haven't gotten anything

 20 resolved, but I thought it was a very good

 21 discussion and I very much appreciate it.

 22 (Whereupon, at 4:09 p.m., the
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 1 PROCEEDINGS were adjourned.)

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 2 DISTRICT OF COLUMBIA

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 4 for the District of Columbia, do hereby certify

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 8 under penalty of perjury; that said transcript is a

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 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

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