UNITED STATES OF AMERICA 

 COMMODITY FUTURES TRADING COMMISSION 

 ENERGY POSITION LIMITS AND HEDGE EXEMPTIONS 

 Washington, D.C. 

 Wednesday, July 29, 2009 

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 1 C O N T E N T S 

 2 Call to Order and Introduction: 

 3 CHAIRMAN GARY GENSLER 

 4 Opening Statements: 

 5 COMMISSIONER MICHAEL DUNN 

 6 COMMISSIONER JILL SOMMERS 

 7 COMMISSIONER BART CHILTON 

 8 Panel 1: 

 9 JEFFREY SPRECHER 

 Intercontinental Exchange, Inc. 

 10 

 CRAIG DONAHUE 

 11 CME Group 

 12 Panel 2: 

 13 RICHARD "BEN" HIRST 

 Delta Air Lines, Air Transportation 

 14 Association 

 15 LAURA CAMPBELL 

 Memphis Light, Gas & Water, American Public 

 16 Gas Association 

 17 SEAN COTA 

 Cota & Cota, Petroleum Marketers Association 

 18 of America 

 19 TODD PETZEL 

 Offit Capital Advisors, LLC 

 20 

 21 

 22 * * * * * 

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

 2 (9:04 a.m.) 

 3 CHAIRMAN GENSLER: Good morning. I call 

 4 to order this meeting of the Commodity Futures 

 5 Trading Commission. This is the second of three 

 6 hearings of whether federal position limits should 

 7 be set by the CFTC for commodities of finite 

 8 supply. 

 9 I would like to start by thanking my 

 10 fellow Commissioners, Commissioner Sommers, 

 11 Commissioner Dunn, Commissioner Chilton, and our 

 12 distinguished witnesses who will be here today. 

 13 We're going to have two panels. And just to give 

 14 a little heads up for our second panel, we're 

 15 going to have -- we'll go through a couple rounds 

 16 of questions using a five minute clock. 

 17 Yesterday, it seemed that two rounds of questions 

 18 were enough for the Commissioners, but if we go 

 19 for three, I hope you oblige us, so it may be 

 20 about an hour before we get to our second panel, 

 21 judging from yesterday. 

 22 Yesterday, the CFTC held its first 

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 1 hearing on setting position limits to protect 

 2 against the undue burdens that may result from 

 3 excessive speculation in the energy markets. We 

 4 had a very productive discussion on the 

 5 legislative history of position limits, the 

 6 current state of federal position limits and 

 7 exchange-set accountability levels, and who would 

 8 be best at setting position limits in the future. 

 9 Our first panel included the Chief Executive 

 10 Officers of the two biggest futures exchanges, 

 11 Intercontinental Exchange and the Chicago 

 12 Mercantile Exchange, or NYMEX, their subsidiary. 

 13 Both exchanges made announcements that showed 

 14 tangible progress towards regulation to protect 

 15 the American public from the burdens that may come 

 16 from excessive speculation. 

 17 The CME made a very significant 

 18 announcement, that it supports adoption of a hard 

 19 limit regime, including single month and all 

 20 month's limits. This is a welcome change. No 

 21 longer must we debate the issue of whether or not 

 22 to set position limits. But there still remains 

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 1 three very important questions; who should set 

 2 position limits, who should be exempted from 

 3 positions limits, if anyone, and at what level 

 4 should position limits be set and what formula 

 5 might be used for them. I'm certainly going to be 

 6 thinking about all three questions as I work with 

 7 -- through my questions with each of the 

 8 panelists. 

 9 As I stated at yesterday's hearing, I 

 10 believe the CFTC does have a duty to protect the 

 11 American public from fraud, manipulation, and the 

 12 burdens that may come from excessive speculation. 

 13 Thus, I believe it should be the CFTC that sets 

 14 position limits on energy market participants. We 

 15 have the statutory authority, we are the most able 

 16 to strike a balance between competing interest and 

 17 the public interest. I was interested to hear 

 18 from a number of the panelists and their 

 19 testimonies, from both today's hearing and in 

 20 reading your testimonies, and also yesterday's 

 21 hearing, that they believe the CFTC is also in the 

 22 best position to set such aggregate positions. 

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 1 This is also every encouraging. 

 2 This brings us to the very important 

 3 question of exemptions. Some panelists have 

 4 suggested that a class of financial parties be 

 5 exempted. Of course, the swap dealers testifying 

 6 here today suggested that the swap dealers should 

 7 be exempted from position limits. Index investors 

 8 -- or an index fund testifying today suggested 

 9 that index funds should be exempted. An exchange 

 10 traded fund operator testifying today suggested 

 11 that exchange traded funds might be exempted. 

 12 At the core of promoting market 

 13 integrity is encouraging markets I believe not to 

 14 become too concentrated or allowing concentrated 

 15 economic power within a market. We do this in 

 16 other laws at the core of the CFTC statute, this 

 17 was set out in 1936 to set up position limits. I 

 18 think this is even more relevant because of the 

 19 developments that we've seen in financial markets 

 20 since the first exemptions were issued in 1991. 

 21 The financial markets are much more concentrated 

 22 today than just 18 years ago. 

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 1 The financial crisis also highlighted 

 2 the risk that can come to the markets and the 

 3 American public brought about by large 

 4 concentrated actors upon the financial stage. So 

 5 I would like to hear from each of our panelists as 

 6 to why, if we were to apply position limits, they 

 7 think that they should not apply consistently to 

 8 all non-commercial players. 

 9 While I believe that we should maintain 

 10 exemptions for bona fide commercial hedgers, I'm 

 11 just concerned about granting exemptions for 

 12 financial risk management that in some way could 

 13 defeat the effectiveness of position limits. 

 14 On the last question of what level 

 15 position limits should be set at, I'm certainly 

 16 interested to hear from our panelists ideas on 

 17 this, and if we move forward in rule-writing, we 

 18 look forward to see how to set formulas through a 

 19 rule-writing process. 

 20 The CFTC's rules and decisions have 

 21 meaningful implications on the day-to-day lives of 

 22 the American public. It is essential that we 

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 1 utilize all of our existing authorities to ensure 

 2 fair and orderly markets and protect the American 

 3 public. To do this, I believe we must also work 

 4 urgently with Congress to secure additional 

 5 resources to effectively police our markets. And 

 6 to the extent that we might be in the business of 

 7 setting aggregate position limits, or as some, the 

 8 panelists have suggested to look through swap 

 9 dealers to the end users, we will need to work 

 10 with Congress on additional resources. 

 11 I also believe that we need to work 

 12 urgently with Congress to establish new 

 13 authorities to police the over- the-counter 

 14 markets, and particularly as it relates to the 

 15 possibility of setting aggregate position limits. 

 16 I look forward to hearing from today's 

 17 witnesses. On top of yesterday's very productive 

 18 discussion, I believe today's hearings will add to 

 19 the diversity of points of views on the very 

 20 important subject. For the record, I also want to 

 21 say that written comments on this topic, a record 

 22 will be held open until August 12 for comments 

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 1 from the public or for additional follow-up with 

 2 panelists. And with that, I'd like to turn to 

 3 Commissioner Dunn for any opening remarks he might 

 4 have. 

 5 COMMISSIONER DUNN: I have no opening 

 6 remarks. I'm here to listen to the panel. 

 7 CHAIRMAN GENSLER: Commissioner Sommers. 

 8 COMMISSIONER SOMMERS: Thank you, Mr. 

 9 Chairman. I just want to echo a couple of points 

 10 that you made and to thank the panelists for being 

 11 here. I think that these hearings are extremely 

 12 important as we consider these issues. 

 13 This is a very challenging time, as I 

 14 pointed out yesterday, and I think some of the 

 15 questions that the Chairman pointed out in his 

 16 opening remarks today still remain, but it's 

 17 important for us to listen to the variety of 

 18 market participants that we have testifying 

 19 throughout the three days of these hearings, and 

 20 to help us answer these challenging questions, 

 21 because our mission here is to protect the U.S. 

 22 futures markets, and we have an obligation to do 

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 1 that, it's in our mission, and we need to make 

 2 sure that if we're moving down this path, that we 

 3 carefully make these changes to make these markets 

 4 useful for all of the participants, and I'm very 

 5 glad to have you here today and participating in 

 6 the dialogue, because it's important for us to 

 7 consider. Thank you. 

 8 CHAIRMAN GENSLER: Commissioner Chilton. 

 9 COMMISSIONER CHILTON: Thanks, Mr. 

 10 Chairman. The only thing I wanted to say is, I 

 11 wanted to associate my remarks -- your remarks 

 12 rather from yesterday on this press report about 

 13 our swaps report. As I said, the last thing I 

 14 said at the end of our hearing yesterday was that 

 15 I commended the Chairman for the greater detail he 

 16 is trying to put, the greater transparency both on 

 17 our Commitment of Trader's Report and in our swaps 

 18 report. 

 19 A lot of people know I disagreed with 

 20 the data because I thought it wasn't good enough 

 21 last year, and it wasn't good enough, in part, 

 22 because we were asked to meet a timeline and 

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 1 didn't have the staff to do it, and I just thought 

 2 it was faulty data, and I thought people, 

 3 therefore, still made conclusions based upon that 

 4 data. 

 5 I'm competent that this year, that we 

 6 won't make conclusions based upon inaccurate data. 

 7 And so I associate myself with your remarks, and 

 8 don't want to pre-judge what the report is going 

 9 to say until the report comes out, and it'll speak 

 10 for itself, and I have a lot of confidence that 

 11 it's going to be a much better report, our staff 

 12 has done a great job, and I look forward to 

 13 sharing it with you all at the appropriate time. 

 14 CHAIRMAN GENSLER: Thank you, 

 15 Commissioners. Thank you, Bart, for those 

 16 comments, too. And if we can turn to our 

 17 panelists, I'm going to start with Ms. Masters, 

 18 and we'll then go to Doctor Jarecki, and then 

 19 around to Mr. Slocum, and Mr. -- is it Casturo? 

 20 MR. CASTURO: Casturo. 

 21 CHAIRMAN GENSLER: Thank you. 

 22 MS. MASTERS: Thank you, Mr. Chairman, 

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 1 Commissioners, the staff at the CFTC. My name is 

 2 Blythe Masters, I am a Managing Director at J.P. 

 3 Morgan, and I'm responsible for our global 

 4 commodities business. I'm also the Chair of 

 5 SIFMA. And I thank you for the opportunity to 

 6 provide testimony today. 

 7 J.P. Morgan's commodity business 

 8 provides thousands of customers with risk 

 9 management and transactional services around the 

 10 globe, in both physical and financial commodities. 

 11 We wholeheartedly support your efforts to prevent 

 12 excessive speculation, as well as to improve the 

 13 overall framework for regulation of OTC or 

 14 over-the-counter derivatives. We also believe 

 15 that those efforts must be undertaken in the 

 16 context of a broader understanding that 

 17 speculation, per se, plays an essential role in 

 18 all markets and commodity markets. If investors 

 19 were discouraged or prevented from assuming price 

 20 risks, hedges would have much more difficulty 

 21 entering into transactions, markets would be more 

 22 volatile, and the CFTC's mission of protecting 

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 1 risk management and price discovery would be 

 2 compromised. 

 3 Thus, in discussing position limits and 

 4 exemptions, it's critical to consider the role 

 5 they play in facilitating risk management in the 

 6 OTC derivatives market. The vast majority of 

 7 American corporations enter into OTC derivative 

 8 transactions to hedge risks that arise out of 

 9 their core day-to-day activities. Financial 

 10 intermediaries such as J.P. Morgan stand between 

 11 those entities that want to offload risk, 

 12 typically in the over-the-counter markets, and 

 13 those entities who wish to assume risk. 

 14 Intermediaries like us aggregate risks 

 15 and manage the net resulting positions on a 

 16 portfolio basis. And typically we flatten out our 

 17 net resulting positions on exchanges. Thus, for 

 18 risk management purposes, exchange and OTC markets 

 19 are used interchangeably, and the ability of a 

 20 financial intermediary to use exemptions to 

 21 position limits to effectuate the OTC transactions 

 22 is key to being able to provide risk management 

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 1 tools to end customers. The most active commodity 

 2 hedges are companies like producers, 

 3 manufacturers, utilities, airlines and the like 

 4 that face material risks to their financial 

 5 performance arising from commodity price 

 6 fluctuations and the effect of that on day-to-day 

 7 operations. 

 8 Hedging for these companies often 

 9 represents the only meaningful way for them to 

 10 protect against adverse price movements and to 

 11 lock in their margins. For example, airlines 

 12 frequently hedge their jet fuel costs using OTC 

 13 jet fuel swaps. Many of these activities can't be 

 14 done on exchange because the exchanges don't offer 

 15 the customized contracts that are needed. For 

 16 example, there is no jet fuel contract on a 

 17 futures exchange. 

 18 Firms with good hedge risk management 

 19 practices can reduce the cost of and increase the 

 20 availability of funding to run their day-to-day 

 21 operations, and/or they can lower their ultimate 

 22 prices to their own customers. And time and 

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 1 again, we see that the difference between hedging 

 2 or not hedging has been the determining factor in 

 3 the viability of plans to develop major new 

 4 investment projects. On the other side of such 

 5 transactions is often an investor who enters into 

 6 OTC transactions to obtain exposure to price 

 7 movements of commodities. Commodities offer 

 8 diversification to investors, and with respect to 

 9 inflation, a more correlated hedge than most other 

 10 investments available in financial markets. 

 11 In a recent survey of inflationary 

 12 expectations among J.P. Morgan's institutional 

 13 client base, some 20 percent of 1800 respondents 

 14 confirmed that they had used commodities to hedge 

 15 against future inflation. 

 16 Investors are an important part of 

 17 commodity markets and their participation has been 

 18 beneficial because often more producers of 

 19 commodities are interested in hedging than 

 20 purchasers. Investors fill these gaps, and so 

 21 they facilitate the efficient and smooth price 

 22 discovery process. 

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 1 Importantly, these investors do not take 

 2 physical delivery of the underlying commodities 

 3 and they have no mechanism for withholding or 

 4 hoarding supplies from the end consumer. For 

 5 every buyer of a futures contract, there is, by 

 6 definition, a seller. 

 7 Furthermore, once an investor's initial 

 8 investment allocation has been made, positions are 

 9 typically rolled forward each month with each 

 10 contract being sold prior to expiration and rolled 

 11 to the next month. For sustained upward price 

 12 pressure on prices to occur, investors would have 

 13 to continuously add to their allocations through 

 14 time. In fact, our experience shows that more 

 15 typical behavior is for investors to sell 

 16 following price appreciation and vice versa in 

 17 order to maintain a constant dollar amount of 

 18 funds invested. This tends to stabilize price 

 19 action rather than driving it. 

 20 We are aware of no credible academic 

 21 study or analysis that demonstrates the presence 

 22 of non-commercial interests in commodity markets 

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 1 to have been detrimental and many that, in fact, 

 2 reach the reverse conclusion. 

 3 Over-the-counter markets and exchanges 

 4 work in tandem and facilitate the efficient risk 

 5 transfer within our economy. Swap dealers use 

 6 exchanges to hedge their net economic positions 

 7 arising from both physical and financial 

 8 activities. 

 9 Importantly, managing risk on a 

 10 portfolio basis in this way requires the 

 11 intermediary to assume basis risk. Basis risk 

 12 occurs when a position is hedged with offsetting 

 13 position that is expected to approximately, but 

 14 not exactly, offset the risk of the underlying. 

 15 For example, it's common to hedge power prices 

 16 with natural gas. 

 17 CHAIRMAN GENSLER: Okay. If you want to 

 18 try to summarize up, because -- and I just want to 

 19 say for all the panelists, your full written 

 20 reports will be in the record. 

 21 MS. MASTERS: Understood, sir. So it's 

 22 common for dealers to hedge power prices with gas 

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 1 or fuel prices with WTI and the like. As entities 

 2 transacting on the exchange, dealers are subject 

 3 to position limits. And hedge exemptions are 

 4 critical because they facilitate over- the-counter 

 5 activity for customers. These hedge exemptions 

 6 are granted for specific purposes, limited size, 

 7 limited application, and a dealer is held to those 

 8 standards. A dealer acting in its own speculative 

 9 capacity has no ability to avoid any such limits. 

 10 We have three specific recommendations 

 11 that derive from work already commenced last year 

 12 by the CFTC in conjunction with its special call 

 13 for data relating to futures and over-the-counter 

 14 markets. That data requires us and other dealers 

 15 to disclose for both index and non- index 

 16 activity, gross long and short positions by 

 17 activity type, by counterparty type, by 

 18 counterparty name, for large positions, by futures 

 19 equivalent contract. In short, everything about 

 20 our over-the-counter business is disclosed. 

 21 Though setting up that information was expensive 

 22 and time consuming, we have found it useful above 

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 1 and beyond the regular application. And we 

 2 believe it sets the CFTC up to use that 

 3 information to impose more useful and informative 

 4 and effective limits going forward. 

 5 CHAIRMAN GENSLER: I'm fearful; to be 

 6 consistent, I need to apply consistent limits, so 

 7 why don't we make it one more minute, if we can? 

 8 MS. MASTERS: Okay. So three specific 

 9 recommendations; first, imposing a large trader 

 10 reporting system for over-the-counter positions, 

 11 just as you do for exchange base positions. The 

 12 information in the special call would allow you to 

 13 do that and make that information at an aggregated 

 14 level public. That would be valuable extra 

 15 transparency across all OTC activities. 

 16 Secondly, we believe it would make sense 

 17 to impose position limits across all markets, both 

 18 OTC and exchange base markets, and looking through 

 19 to the end market participant as you evaluate 

 20 whether that participant's position is over or 

 21 under a particular threshold or position limit 

 22 level. I'm not a lawyer, but my layman's read, if 

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 1 your existing authorities would suggest, you have 

 2 the power to do this, and if not, we would be 

 3 supportive of legislation needed to achieve that. 

 4 Finally, we do believe that it's vital that 

 5 exemptions from position limits are maintained for 

 6 those who act as aggregators, and that you look 

 7 through those aggregators activities to the end 

 8 position held by the underlying customer in order 

 9 not to prevent those customers from conducting 

 10 their necessary investment and risk management 

 11 activities in over-the-counter markets. Thank 

 12 you. 

 13 CHAIRMAN GENSLER: Doctor Jarecki; thank 

 14 you. 

 15 DOCTOR JARECKI: Thank you, Chairman and 

 16 Commissioners. 

 17 CHAIRMAN GENSLER: Just to help a little 

 18 bit, I'm told that when that light starts 

 19 flashing, I mean you don't have to think like it's 

 20 politics or anything like a debate, but when that 

 21 light starts flashing, you're getting close to the 

 22 two minute warning. 

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 1 DOCTOR JARECKI: Thank you, Chairman and 

 2 Commissioners. My name is Henry Jarecki, I'm the 

 3 Chairman of Gresham Investment Management, a 

 4 company I formed to implement TAP, a conservative 

 5 long-only tangible asset portfolio which we 

 6 developed more than 20 years ago. We presented 

 7 you with a number of charts, and this shows the 

 8 portfolio composition. We've been managing this 

 9 strategy for ourselves and others since 1987, and 

 10 we've, over that time, provided better returns 

 11 than the S&P 500, with less volatility, and we've 

 12 improved the performance of the stock and bond 

 13 portfolios into which it's been introduced. We do 

 14 these diversified commodity investments by buying 

 15 futures for our customers, not by engaging in 

 16 commodity swaps, and not by netting other 

 17 positions. We've applied for the appropriate 

 18 regulatory permissions when appropriate. 

 19 I, myself, have been in the futures 

 20 industry for over 40 years, and during that time 

 21 I've seen one market drama after the next. As a 

 22 matter of fact, I was on the Board of the 

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 1 Commodity Exchange when it had to address one of 

 2 our market's greatest manipulations, that of the 

 3 Hunt Brothers, who bought large quantities of 

 4 physical silver which they hoped, after moving the 

 5 market upwards, to sell. 

 6 What folks like us do is not only good 

 7 for diminishing an investor's global portfolio 

 8 volatility, but also, as said, for protecting him 

 9 or her against the ravages of inflation, which is 

 10 of increasing importance to people who want their 

 11 pensions to keep pace with the cost of living. 

 12 Our clients include numerous state and Fortune 100 

 13 and union pension plans, insurance companies, and 

 14 a host of foreign enterprises. The customers are 

 15 stable, well financed entities that decide to take 

 16 part only after they study the idea for a year or 

 17 two, not because they think there's some special 

 18 goody in the markets. They do not, any of them, 

 19 use leverage, any of them speculate or take 

 20 delivery of physical commodities. They maintain 

 21 their core positions even when the markets fall, 

 22 and they provide stability and trading liquidity 

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 1 to the market in general. What better market 

 2 participants can there possibly be? 

 3 Our activities are tiny compared to the 

 4 size of our two big competitors, the Goldman Sachs 

 5 and the UBS indexes. We undertake trading in 

 6 accord with simple rules we established over 20 

 7 years ago, in which we articulate afresh to our 

 8 clients annually. And I'm here because I'm 

 9 naturally fearful that our business will be 

 10 throttled in the false understanding that 

 11 commodity futures index purchases can cause prices 

 12 to rise. 

 13 Because of my 40 years of experience in 

 14 these markets, I'm surprised to think that high 

 15 prices can be attributed to commodity futures 

 16 acquisitions. Prices are made on the factory 

 17 floors, and at the gas pumps, and the level of the 

 18 farmers who grow wheat, and the consumers who eat 

 19 bread, and the oil companies that take oil out of 

 20 the ground, and the car owners who buy it at their 

 21 gas stations. Futures markets are proud of 

 22 themselves and have a lot to be proud of, but the 

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 1 idea that they make the prices rather than reflect 

 2 them I think is absurd. The amount of buying and 

 3 selling that's done in the real physical markets 

 4 is typically ten or 20 times as much annually as 

 5 the open interest is. 

 6 Now, this hearing has been called on the 

 7 topic of position limits in the energy markets. 

 8 That seems, to me, to be a euphemism for what can 

 9 we do to make sure that Crude doesn't trade over 

 10 $140 again. And oil prices were very high last 

 11 year, but the high prices were also found, and I 

 12 show this in this chart, which I think is quite 

 13 significant, in steel, in coal, in cobalt, and 

 14 they don't trade on futures markets at all. 

 15 Also, if it was clear that the prices 

 16 were so high, why didn't the folks who know the 

 17 most about oil, who have the best oil economists 

 18 in the world, the Middle Eastern oil companies, 

 19 show many years worth of production when the price 

 20 hit 147, or the U.S. government did believe the 

 21 oil prices are too high, why doesn't it just sell 

 22 some to lower the prices for the benefit of 

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 1 consumers? Or if it's so easy to manipulate the 

 2 prices by acting on the futures markets, why 

 3 doesn't OPEC simply go in there whenever they 

 4 think the prices have gone too low? One important 

 5 question which I recommend to you is to be found 

 6 in chart 12, which is the showing that the flows 

 7 into index funds do not correlate with oil price 

 8 rises. In some periods, as these charts show, the 

 9 correlations are, indeed, negative. That is to 

 10 say this is relevant because the Commodity 

 11 Exchange Act talks about actions that the 

 12 Commission ought take to prevent things that cause 

 13 fluctuations in the price of a commodity. And the 

 14 flow data that we are showing here shows that this 

 15 causative element does not exist. 

 16 So for all of these reasons, I think 

 17 it's inaccurate to believe that index providers 

 18 are the cause of high oil prices. Money-printing 

 19 and money-spending is one cause; fears of 

 20 shortages and of inflation are others. Special 

 21 circumstances, like public subsidies of the 

 22 petroleum in China and India, the high cost of new 

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 1 production are further elements. 

 2 I appreciate, however, that the idea 

 3 that commodity futures purchasers cause high 

 4 physical market prices is superficially appealing. 

 5 And I accept that the Commission may, in response 

 6 to public concern, decide that something should be 

 7 done. Ut aliquid fiat, we used to say when I 

 8 practiced medicine, in order that something be 

 9 done. When the relatives were -- 

 10 CHAIRMAN GENSLER: Doctor, you might 

 11 want to try to summarize or finish up. 

 12 DOCTOR JARECKI: When the relatives were 

 13 pushy and asked us to do more, we gave very large 

 14 and very colorful pills. Ut aliquid fiat 

 15 videatur, we said, in order that it be seen that 

 16 something is being done. The position limits 

 17 something that the Commission may well do should, 

 18 however, be directed at those who actually engage 

 19 in excessive speculation or undertake large 

 20 purchases. It's illogical to apply position 

 21 limits at the level of firms like ours that 

 22 passively implement the investor's decisions, and 

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 1 it's actually counterproductive -- 

 2 CHAIRMAN GENSLER: I'm going to give you 

 3 one minute, and I'm actually going to do this for 

 4 all of you. I'm going to cut you off, and I 

 5 apologize, but I really mean we're going to move 

 6 on. Thank you. 

 7 DOCTOR JARECKI: I'd like to say finally 

 8 that it is counterproductive and would be 

 9 manifestly unfair to have long-only diversified 

 10 commodity funds such as ours who openly identify 

 11 our intended proportions a year in advance, and 

 12 openly trade and register our positions on each 

 13 exchange and its clearinghouse and fully how the 

 14 price of every trade that we do on the long side, 

 15 the short side, and the hedging side to anyone who 

 16 looks. If people like us aren't permitted on 

 17 exchanges, and only swap exemption folks were to 

 18 be called hedgers, it would encourage secrecy, and 

 19 that is not what the exchangers, the regulators, 

 20 or the public want. 

 21 Indeed, before thinking about position 

 22 limits themselves, the regulatory body should 

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 1 revisit the question of swap exemptions, and, if 

 2 necessary, require all those currently enjoying 

 3 such benefits to request the exemptions we have 

 4 asked for and been granted. 

 5 Finally, I would say it would be grossly 

 6 anti- competitive and would put out of business 

 7 small enterprises like ours if what we do were 

 8 banned or limited in any way before the same 

 9 effective constraints are placed on those who 

 10 assert swap exemptions. Thank you, Mr. Chairman; 

 11 thank you, Commissioners. 

 12 CHAIRMAN GENSLER: Thank you, Doctor 

 13 Jarecki. Mr. Slocum. 

 14 MR. SLOCUM: Mr. Chairman, members of 

 15 the Commission, thank you very much for inviting 

 16 Public Citizen here today and for holding these 

 17 hearings. My name is Tyson Slocum, I direct the 

 18 Energy Program at Public Citizen. We were founded 

 19 in 1971, we're America's largest consumer advocacy 

 20 group, and I focus on FERC jurisdictional and CFTC 

 21 jurisdictional energy market regulations. 

 22 My constituents are the American people. 

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 1 We are directly funded from the contributions by 

 2 over 90,000 dues paying families across the United 

 3 States and from private charitable foundations, 

 4 and so we are advocating policies on behalf of our 

 5 constituents, working families across the United 

 6 States. 

 7 And there is no question that the era of 

 8 deregulation has eroded consumer protections and 

 9 removed effective transparency from energy 

 10 markets. And our economy and our families in this 

 11 country have been paying the price for these bad 

 12 decisions to limit transparency in these markets. 

 13 Public Citizen's reform proposals are 

 14 going to sound a lot more in common with Adam 

 15 Smith than with Hugh Chavez, because we are 

 16 calling on increasing transparency in these 

 17 markets because we understand that a market that 

 18 is adequately transparent is a better functioning 

 19 market and a more competitive market, that when 

 20 you allow huge over-the-counter derivative markets 

 21 that are free from effective oversight by the 

 22 federal government, you are encouraging 

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 1 anti-competitive collusive practices that result 

 2 in higher prices to end consumers, my 

 3 constituents. 

 4 I have been very encouraged by recent 

 5 pronouncements and actions by the CFTC to address 

 6 the role that speculation has played in 

 7 contributing to higher prices and making some 

 8 early concrete steps to begin the long process of 

 9 re-establishing effective transparency and 

 10 regulations over these markets. 

 11 I am going to address four basic areas 

 12 where Public Citizen would like to see the CFTC 

 13 take further action. One of these is absolutely 

 14 establishing strong effective position limits 

 15 across all markets and for all products, reaching 

 16 into swaps dealers and index funds. 

 17 We believe that the lack of effective 

 18 position limits over these entities has allowed 

 19 the accumulation of too much market power and has 

 20 limited effective competition in these markets and 

 21 allowed a hand full of very powerful entities, two 

 22 of which are seated here at the table today, 

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 1 Goldman Sachs and J.P. Morgan, to take very large 

 2 positions in under regulated format. We would 

 3 like to see those trading position limits across 

 4 all months, and only provide exemptions for bona 

 5 fide commercial interest, only allow those types 

 6 of hedge exemptions for folks that can demonstrate 

 7 that they have a direct financial interest in 

 8 hedging their risk. 

 9 Secondly, I think it's been clear that 

 10 deregulatory actions by Congress and by the CFTC 

 11 over the years has greatly expanded the reach and 

 12 the size of the OTC market, and as a result, swaps 

 13 dealers have been replacing traditional pit 

 14 exchanges as an avenue for entities to get access 

 15 to hedging their risk. 

 16 And so I think that the CFTC needs to 

 17 make adjustments, recognizing the large expansion 

 18 of these OTC markets, and increase regulations 

 19 accordingly. The CFTC has the authority to 

 20 declare an emergency in these markets if market 

 21 prices do not reflect the underlying supply demand 

 22 fundamentals. 

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 1 And I believe that the CFTC should 

 2 explore whether or not it can use that existing 

 3 authority, that emergency authority to reach into 

 4 the OTC market and try to effectively regulate 

 5 that market by going the route that Obama 

 6 Administration has proposed in terms of requiring 

 7 standardized OTC contracts to be cleared on 

 8 exchanges regulated by the CFTC. And for those 

 9 contracts that are non-standardized, the CFTC 

 10 should impose strong margin requirements to 

 11 dissuade trying to classify standardized OTC 

 12 contracts as non-standardized, and that the CFTC 

 13 should be making the determination. Also, it 

 14 should be the CFTC making the determination, not 

 15 the exchanges, about the position limits. 

 16 The third main point is, to the maximum 

 17 extent possible, the CFTC ought to ensure that 

 18 exempt commercial markets like electronic 

 19 exchanges such as ICE and swaps dealers are 

 20 providing data to the CFTC in formats that are 

 21 compatible with your software that your market 

 22 monitoring staff is using. 

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 1 I know that there might be some gaps in 

 2 the ability to easily process data and make data 

 3 more useful for the Commission, and ensuring that 

 4 entities in these markets are supplying data that 

 5 is as useful as possible to the Commission ought 

 6 to be a priority. 

 7 And fourth, I know I'm out of time, but 

 8 the CFTC ought to commission several reports, one 

 9 of which examining any potential market problems 

 10 associated with the combined role that some 

 11 entities have in operating simultaneously as swaps 

 12 dealers, operating as managers of index funds, 

 13 while also engaging in significant proprietary 

 14 trading. And also the Commission ought to take a 

 15 look at the role that some financial firms have in 

 16 acquiring or controlling access over energy 

 17 infrastructure assets, and how communications with 

 18 energy infrastructure affiliates facilitate 

 19 proprietary trading operations. Thank you very 

 20 much for your time and I look forward to any 

 21 questions you may have. 

 22 CHAIRMAN GENSLER: Thank you; our last 

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 1 panelist. 

 2 MR. CASTURO: Chairman Gensler and 

 3 fellow Commissioners, my name is Don Casturo and 

 4 I'm a Managing Director of Goldman Sachs, where I 

 5 am responsible for the firm's commodities investor 

 6 trading desk. Thank you for the opportunity to 

 7 share our views regarding important issues in the 

 8 energy markets. 

 9 Increasing in volatility and the 

 10 outright prices of energy commodities have raised 

 11 concerns at the CFTC and among policymakers about 

 12 changes in the marketplace. Some have questioned 

 13 the role of index investors, other financial 

 14 participants, and intermediaries such as my firm 

 15 that are commonly referred to as swap dealers, 

 16 hence our participation in these hearings. 

 17 During my 14 year career, I observed an 

 18 evolution in the commodities markets which has 

 19 yielded two noteworthy trends. The first is 

 20 increased participation by financial investors, 

 21 which has brought new capital to the commodity 

 22 markets. This, in turn, has facilitated efficient 

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 1 hedging by commercial participants. The second is 

 2 that swap dealers have become the predominate 

 3 source of liquidity for both commercial and 

 4 non-commercial entities, and in so doing, have 

 5 provided more customized forms of risk management 

 6 products to end users. 

 7 We believe that both of these trends 

 8 have been positive for the marketplace. An 

 9 assertion that was confirmed in the testimony 

 10 yesterday of two of the commercial participants on 

 11 yesterday's panel. 

 12 Futures markets allow commercial 

 13 entities to mitigate their exposure to commodity 

 14 price fluctuations. For a producer, hedging frees 

 15 up expensive equity capital and allows it to focus 

 16 on its core competency of operating its business. 

 17 Index investors are well suited to bear the 

 18 commodity price risk associated with this producer 

 19 hedge. They regard this exposure as a source of 

 20 portfolio diversification and a safeguard against 

 21 future inflation. 

 22 There has been much debate recently over 

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 1 whether this financial participation has distorted 

 2 prices away from fair fundamental price. In order 

 3 to address this concern, I would note that 

 4 financial participation takes place in the futures 

 5 market and not on physical markets. Futures, as 

 6 the name applies, are contracts whose values 

 7 express the equilibrium price for commodities at 

 8 distinct points in the future. The assessment of 

 9 fair value for these points is far more 

 10 complicated than spot fundamentals which are 

 11 derived from more observable data. Too often 

 12 recently, however, many market commentators have 

 13 tried to explain futures prices by only applying 

 14 spot fundamentals. 

 15 The second trend I would note is the 

 16 increasingly central role of the swap dealer in 

 17 commodity markets. Swap dealers have successfully 

 18 developed risk management products tailored to 

 19 absorb specific risk with a level of precision 

 20 beyond that which is practical in the futures 

 21 markets. 

 22 Additionally, they have established 

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 1 credit lines with end users that recognize the 

 2 relationship between credit exposures and the 

 3 ability of the end user to meet obligations under 

 4 hedging arrangements. Again, the Commission heard 

 5 commercial participants identify both of these 

 6 benefits in their testimony yesterday. 

 7 While it might often appear that a swap 

 8 dealer has taken a large position in the futures 

 9 market, in reality, the swap dealer is using the 

 10 exchange to manage the risk incurred in their 

 11 capacity as an important intermediary in the OTC 

 12 markets. First and foremost, the swap dealer is a 

 13 market maker that maintains relationships with 

 14 producers, consumers, and financial participants 

 15 in order to provide more competitive pricing and 

 16 tailored products to each. 

 17 In order to perform this role 

 18 efficiently, the swap dealer may require access to 

 19 futures markets beyond existing position or 

 20 accountability limits. This is the rationale for 

 21 the swap hedge exemption. One concern with this 

 22 policy, however, is the so called swap loophole or 

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 1 the notion that end users in the OTC markets have 

 2 the ability to accumulate exposure beyond what we 

 3 permitted under future position limits. 

 4 We acknowledge this as a concern. At 

 5 the same time, we do not believe that eliminating 

 6 hedge exemptions or limiting them to situations 

 7 where the dealer is only transacting with the 

 8 commercial hedger will address the core issue. 

 9 We do, however, believe that such an 

 10 approach will have unintended and undesirable 

 11 consequences. These would include, one, 

 12 commercial entities paying a higher price for 

 13 their customized hedge; two, encouraging more 

 14 transactions to be executed all futures exchanges 

 15 and away from existing regulatory oversight; 

 16 three, splintering the market; and four, driving a 

 17 large number of index and other investors to 

 18 non-U.S. commodity futures exchanges. From our 

 19 point of view, the swap loophole is better 

 20 addressed by looking to swap dealers for 

 21 information regarding counterparty positions, as 

 22 it has done since establishing the special call 

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 1 procedures, and looking through the swap dealers 

 2 to apply limits at the end user level across 

 3 derivatives and futures. 

 4 In this manner, the CFTC would 

 5 effectively establish aggregate position limits at 

 6 the end user level across the full spectrum of 

 7 traded markets. 

 8 Lastly, I would like to comment on the 

 9 appropriate size of these position limits. The 

 10 Commission is focused on establishing limits to 

 11 prevent and eliminate excessive speculation. 

 12 Given that Chairman Gensler's previous testimony 

 13 acknowledges the role of some speculation in the 

 14 markets, the challenge is to determine what size 

 15 limits should be set to prevent excessive 

 16 speculation; in other words, at what level, are 

 17 the position limits low enough to prevent 

 18 excessive speculation while still being high 

 19 enough so as to not restrict the level of 

 20 speculation that is necessary to balance between 

 21 producer and consumer hedging interests. While 

 22 this may be a complicated process, we believe that 

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 1 the CFTC is the appropriate authority to engage in 

 2 the exercise and support the idea that the 

 3 Commission establish a consistent methodology to 

 4 set limits across all commodities. 

 5 In sum, we appreciate the focus that the 

 6 Commission is bringing to important energy issues 

 7 in the energy markets and look forward to 

 8 continuing to work with the Commission on these 

 9 issues. 

 10 CHAIRMAN GENSLER: I want to thank our 

 11 witnesses. I want to thank you for being within 

 12 the five minutes, impressive. We're going to try 

 13 to do the same five minute clock here, and I ask 

 14 for your purveyance, because it may be three 

 15 rounds, it may be just -- there's a lot of 

 16 substance here and this is a very important set of 

 17 witnesses, and the next set of witnesses, we might 

 18 go three rounds, as well. 

 19 I just wanted to first comment on 

 20 something Doctor Jarecki mentioned. And there was 

 21 a lot of Latin, and I never took Latin, but I 

 22 think it translated, in lay terms, you were 

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 1 suggesting this is just sort of a political thing 

 2 here, and it's not for this Commissioner, this 

 3 Chairman. I really think, and Congress laid out 

 4 in our statute very clearly that we have an 

 5 authority and that we shall use that authority to 

 6 best promote the fair and orderly functioning of 

 7 markets. We are not a price setter as an agency, 

 8 and under this chairmanship, I don't see us as a 

 9 price setting agency, but we are about making sure 

 10 that markets are fair and orderly and work for the 

 11 American public. 

 12 As I was rightly quoted, speculators are 

 13 a very important part of the functioning markets 

 14 and have been for well over 100 years. Hedgers, 

 15 whether they be a farmer, a grain elevator 

 16 operator, an oil producer, somebody down the line, 

 17 a purchaser, a miller, or ultimately the American 

 18 public benefit that risk can be hedged and then 

 19 commercial enterprises and farmers can focus on 

 20 the risk they want to retain, whether that's 

 21 employment or within their business, but we are 

 22 trying to protect the markets. 

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 1 And so that leaves me a little bit to my 

 2 question to, if I can direct it to Ms. Masters and 

 3 Mr. Casturo. I take it from your testimonies, 

 4 they're somewhat similar in approach, that you 

 5 both support the CFTC setting position limits, 

 6 aggregate position limits, but if I may use the 

 7 term, on end users, looking through the swap 

 8 dealer community; is that correct; do I read the 

 9 testimony correctly? 

 10 MS. MASTERS: Yes, sir. 

 11 MR. CASTURO: Yes. 

 12 CHAIRMAN GENSLER: And in setting those 

 13 position limits on the end users, how would that 

 14 benefit the functioning of the markets? 

 15 MS. MASTERS: I think that the 

 16 suggestion made by Don Casturo, which is that the 

 17 objective, if to impose position limits is to 

 18 avoid excessive speculation, then you need to size 

 19 those limits in a fashion that enables the market 

 20 notwithstanding those limits to balance the 

 21 imbalances between producer and consumer flows. 

 22 If that is the objective, then the role 

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 1 of the aggregator or intermediary plays no net 

 2 economic effect on that, all it does is facilitate 

 3 buyer aggregation activity, the meeting of the 

 4 buyer and the seller. 

 5 The benefit of having additional 

 6 investors or speculators is, you're more likely to 

 7 be able to have those buyers and sellers met 

 8 through time with less results in volatility. So 

 9 the logic for exempting an aggregator, only on its 

 10 net, flat positions, and imposing those limits on 

 11 the end user is that ultimately it is the end 

 12 market participant who has a net economic 

 13 position. 

 14 CHAIRMAN GENSLER: I'm sorry, I do want 

 15 to hear from Mr. Casturo, but just so I clarify, 

 16 my question is, that was helpful, but my question 

 17 is, what benefit comes to the market from setting 

 18 the position limits on the end users, not what 

 19 benefit in exempting the aggregator. 

 20 MS. MASTERS: Well, I think -- we have 

 21 -- we see in our data, which is only a portion of 

 22 the market, obviously, no situations where the end 

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 1 activity of either a producer, a consumer, or an 

 2 investor is so significant that it is affording 

 3 that entity the opportunity to manipulate or abuse 

 4 prices. However, at least in theory, we certainly 

 5 appreciate the potential for that to exist. And 

 6 so if you were to impose those limits, you would 

 7 have insurance against that eventuality, and, of 

 8 course, the ability to monitor against those 

 9 limits. 

 10 CHAIRMAN GENSLER: Okay. 

 11 MS. MASTERS: I think, personally, the 

 12 monitoring is more important than the limits. 

 13 MR. CASTURO: Yes; I think the primary 

 14 point to be made is that if you're looking for 

 15 possibilities of excessive speculation, as you've 

 16 heard in testimony all over the panel, the markets 

 17 are broader than just the future markets, and to 

 18 look at the entire spectrum of trade in markets 

 19 for any single entity that may accumulate an 

 20 exposure that may be deemed as excessive, and the 

 21 only way to do that is to go to the end user 

 22 level. 

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 1 One other point that I'd like to make, 

 2 that, in our discussion of how we think these 

 3 positions limits should be set up at the end user 

 4 level, we are not advocating that Goldman Sachs 

 5 have any special treatment, we should be held to 

 6 the same at risk level of position limits as any 

 7 other end user. We're only taking futures to 

 8 facilitate end user activity, and that our net 

 9 exposure, our net at risk exposure would be 

 10 subject to the same limits. 

 11 CHAIRMAN GENSLER: I fear I see my 

 12 yellow light, but I'll make a statement. You can 

 13 be thinking about it while you answer other 

 14 questions. I noticed in earlier Mr. Casturo's 

 15 oral statement, you mentioned about splintering of 

 16 markets, and someone else, and it may have been 

 17 Doctor Jarecki, used fragmenting, I think was the 

 18 word maybe, but one person splintering and another 

 19 person fragmenting might be a -- somebody else's 

 20 diversity in markets. And so I'd like to come 

 21 back when we get to the next round and understand 

 22 your view on this, because I do think there is a 

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 1 logic to avoid concentrated economic power in any 

 2 market. But, of course, if you avoid concentrated 

 3 economic power, you might call that splintering. 

 4 So Commissioner Dunn. 

 5 COMMISSIONER DUNN: Thank you, Mr. 

 6 Chairman. I don't with to pick on Mr. Casturo and 

 7 Ms. Masters, but I will. Your testimony, if I can 

 8 paraphrase it, you, in essence, said that things 

 9 have changed in the marketplace, and, in fact, 

 10 over-the-counter has really replaced pit trading 

 11 to some extent, and that instead of going through 

 12 a clearinghouse, there should be the residual net 

 13 worth of those folks that are the counterparties 

 14 and the swaps that protect the sanctity of those 

 15 trades. 

 16 It occurs to me that that's exactly what 

 17 got us into the financial meltdown that we have. 

 18 And, Ms. Masters, you even make the point, in 

 19 your last paragraph, where you say that 85 percent 

 20 of those are based upon ratings, and again, the 

 21 problems you say, of the remaining 133 billion of 

 22 exposure, 85 percent of the entities that were 

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 1 rated investment grade, and some of this exposure 

 2 was secured by the kinds of collateral that I 

 3 mentioned above, property, equipment, reserves, et 

 4 cetera, all across the line. 

 5 MS. MASTERS: That refers to J.P. 

 6 Morgan's internal ratings, not rating agency 

 7 ratings. 

 8 COMMISSIONER DUNN: That's an internal 

 9 one then and not one of the external ones that we 

 10 have had concerns about, got you on that. The 

 11 problem I have, going back to what I know, the old 

 12 agricultural pits and looking at those, is, we had 

 13 very specific supervisory and compliance 

 14 requirements of those exchange. There were 

 15 cameras looking over the shoulders of the pit 

 16 traders as they traded. There was immediate and 

 17 -- calculating who made what trade and reconciling 

 18 that at the end of that trading period. 

 19 That type of openness with compliance 

 20 and somebody following up when there was a problem 

 21 is not there in the over-the-counter. Who will do 

 22 the surveillance and compliance? 

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 1 MS. MASTERS: In the latter part of my 

 2 written testimony, I made reference to J.P. 

 3 Morgan's belief that there is an important role 

 4 for a systemic risk regulator whose authorities 

 5 would include the oversight of transacting in the 

 6 over-the-counter derivative markets, as well as 

 7 setting capital requirements, as well as setting 

 8 collateral requirements and the like. I do agree 

 9 that over-the-counter derivative activities should 

 10 be regulated and supervised in some form. I don't 

 11 agree that the only way to achieve that is by 

 12 forcing transactions to be conducted on a 

 13 centralized exchange. 

 14 MR. CASTURO: I would echo those 

 15 comments and mention that it also agrees with the 

 16 comments of Mr. Slocum, that we're also 

 17 supportive of additional regulatory oversight into 

 18 that over-the-counter space because it is as 

 19 important as we've identified, and not just we've 

 20 identified, even the commercial participants that 

 21 have given testimony have identified the benefits 

 22 of transacting in the over-the-counter space. 

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 1 COMMISSIONER DUNN: All of you have 

 2 indicated that at the end of the day, we ought to 

 3 know the aggregate position of those participating 

 4 in the market. Mr. Slocum says, well, we could 

 5 use our existing software, I wish it were true. 

 6 The amount of effort went into our special call, 

 7 it took up about a third of the time of our 

 8 surveillance staff. 

 9 We did get some of that stuff down to 

 10 the point and we are in the process of trying to 

 11 establish IT programs that will do the type of 

 12 evaluation and raise the red flag, but, you know, 

 13 every day there are millions of transactions that 

 14 are taken, and that is going to require, on behalf 

 15 of all of you in the industry, to respond to the 

 16 needs of giving us information in the format that 

 17 we are going to require. Is the industry ready to 

 18 do that? And I really appreciate J.P. Morgan and 

 19 Goldman Sachs offering solutions here. 

 20 MR. CASTURO: Yes; we recognize that 

 21 there's a large burden and expense involved in 

 22 what we're proposing, but we believe this is the 

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 1 right approach and are prepared to meet those 

 2 burdens and expenses and work with the exchange in 

 3 getting you the data that you require in the right 

 4 format. 

 5 My belief, as I've stated to the 

 6 Commission before, is that your special call last 

 7 year was remarkably accurate given the short time 

 8 frame that you had to enact it in terms of what it 

 9 was seeking, and we look forward to working with 

 10 you more and refine that process even further if 

 11 so needed. 

 12 MS. MASTERS: I hate to say it, but I 

 13 agree. 

 14 COMMISSIONER DUNN: You indicated that 

 15 you got some good out of that special call; could 

 16 you elaborate on that? 

 17 MR. CASTURO: Yeah; I just think that, 

 18 in terms of examining our business and what the 

 19 makeup of our over- the-counter participants is, I 

 20 mean, broadly I understood, obviously, what they 

 21 were because that's my role on the desk every day, 

 22 but to actually look at the data in the format 

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 1 that you requested gave me additional insights as 

 2 to where these flows came from, none of which did 

 3 I feel there was any damaging -- was damaging to 

 4 the markets in any way, but was just useful 

 5 analysis of how our business operates. 

 6 CHAIRMAN GENSLER: Commissioner Sommers. 

 7 COMMISSIONER SOMMERS: Thank you, Mr. 

 8 Chairman. I'm going to follow a line of 

 9 questioning that I had yesterday with some of our 

 10 market participants and it's regarding the formula 

 11 that we use to set the position limits and what we 

 12 look at as the entire marketplace. And as you 

 13 know, we don't have the current authority over the 

 14 OTC markets right now, but through our special 

 15 call, have been getting information. To all of 

 16 the panelists, do you feel that it's important for 

 17 us to look at the total open interest, including 

 18 OTC positions, in order to set the position limits 

 19 on these markets, and how difficult is that going 

 20 to be to achieve accurate numbers? 

 21 DOCTOR JARECKI: I'd be happy to comment 

 22 briefly on the question. I think you do need the 

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 1 entire quantum, but you also do need the look 

 2 through to be individual holder. And I want to 

 3 just respond briefly to your question, to also 

 4 touch on the Chairman's question of what the 

 5 importance is in identifying the position, the 

 6 final position holder is, because it's the final 

 7 position holder that is the -- that is the swing 

 8 element. 

 9 Index operators and folks like ourselves 

 10 are simply passive mechanics of implementation. 

 11 It's the customer, not we, who decides to 

 12 purchase. And I'm speaking here of investors. So 

 13 one speaks here of disaggregation, that is, not 

 14 pulling it together in the sense that you mean, 

 15 but identifying what the position is of each 

 16 individual long holder. 

 17 He's got to save his position anywhere 

 18 near position limits, otherwise, an investor could 

 19 buy five wheat directed funds, he could own a 

 20 billion dollars worth of wheat futures and yet not 

 21 be subject to position limits at all. Making the 

 22 investor, not the aggregator, responsible closes a 

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 1 giant unintended loophole, and that loophole 

 2 exists under what is currently foreseen, one 

 3 doesn't get to the end user, the end long user. 

 4 So I think it is -- I think the overall position, 

 5 including the derivatives and the over-the-counter 

 6 trades is important, but the end user's position 

 7 is where the most important activity is, that's 

 8 where the abuses can occur, our colleagues claim 

 9 they have not occurred, and I have no data on 

 10 that. 

 11 COMMISSIONER SOMMERS: Just to clarify 

 12 before the rest of you answer that question, do 

 13 you disclose to anyone the positions of your 

 14 individual investors? 

 15 DOCTOR JARECKI: We have -- we are asked 

 16 about it and we do provide large holders, we 

 17 provide information on large holders, yes. 

 18 COMMISSIONER SOMMERS: Thank you. 

 19 MS. MASTERS: So in answer to the 

 20 question, do I believe that limits should apply to 

 21 over-the-counter positions, as well as exchange 

 22 positions, yes is the answer. Had you asked the 

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 1 question, how feasible is that a year ago, I might 

 2 have paused before answering. But I do think that 

 3 in the form of the special call, rushed and 

 4 exhausting as it certainly was for all parties, 

 5 the CFTC has set an important precedent and could 

 6 institutionalize that process, higher frequency, 

 7 more standardization, hopefully rendering it more 

 8 a lot electronic, which would require work from 

 9 both sides, obviously, I think it's very feasible, 

 10 because you have the makings of all of the 

 11 necessary information there. 

 12 COMMISSIONER SOMMERS: I just want to 

 13 clarify that we're getting all of your positions, 

 14 your entire book in OTC positions so that we could 

 15 take all of that into consideration for what we 

 16 would clarify as the whole -- the entire market? 

 17 MS. MASTERS: Correct. 

 18 COMMISSIONER SOMMERS: Okay. 

 19 MR. CASTURO: Yes; I would again echo 

 20 that, looking at the entire traded spectrum is the 

 21 proper approach, and only then do you get to the 

 22 true answers on who's holding positions that may 

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 1 be deemed excessive. I think it's very feasible. 

 2 Again, the special call data is certainly -- I can 

 3 accurately comment on Goldman Sachs, you're 

 4 getting all and accurate information. 

 5 MR. SLOCUM: Yeah; the Public Citizen 

 6 supports, you know, considering the position 

 7 limits across all the markets, the OTC markets 

 8 have a lot of action in them now and it's crucial 

 9 that the action in that market be taken into 

 10 account when setting the position limits. 

 11 COMMISSIONER SOMMERS: My other question 

 12 is a little bit off of the topic of position 

 13 limits, but it goes back to something that one of 

 14 our participants yesterday talked about. 

 15 Commercial participants that use swap dealers or 

 16 use the OTC markets to hedge their risk indicated 

 17 that they post no margin and that it is cheaper 

 18 for them to use swap dealers to hedge their risk, 

 19 and I'm assuming that some of these large 

 20 commercial participants are your clients, and 

 21 maybe some of these people are both of your 

 22 clients. How do you know that you are not both 

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 1 using the same collateral to back up the positions 

 2 that these commercial counterparties have with 

 3 each of you at the same time? 

 4 MS. MASTERS: So, first of all, there 

 5 are certain customers, commercial customers of 

 6 J.P. Morgan and any other major bank in this space 

 7 who have unsecured lines under which to do the 

 8 hedging activity. There are many others that have 

 9 secured lines where the collateral, the margin can 

 10 range from cash and government securities all the 

 11 way up to property, plant, equipment, commodity, 

 12 molecules in the ground, et cetera. 

 13 When it comes to evaluating whether or 

 14 not and how much of an unsecured exposure to take 

 15 to a commercial counterparty, any bank, J.P. 

 16 Morgan certainly, would first conduct a thorough 

 17 credit analysis of the credit worthiness of that 

 18 company. So we would look at the totality of its 

 19 assets and liabilities, its cash flows situation, 

 20 et cetera. And very often we find that when 

 21 hedging activity is being undertaken, there's a 

 22 component of what we refer to as right way risk. 

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 1 Right way risk reflects a situation where someone 

 2 is buying protection, for example, a gas producer 

 3 hedging his gas production, buys a gas swap from 

 4 J.P. Morgan. Under the mechanics of that swap, 

 5 our exposure to him increases as gas prices rise. 

 6 Of course, a gas producer is a more 

 7 credit worthy entity, it has higher enterprise 

 8 value if gas prices are higher. So just as our 

 9 exposure rises, so does the credit worthiness of 

 10 that company. So we are able to make value 

 11 judgments along those lines to decide how much 

 12 exposure we have. 

 13 As it relates to how can we be 

 14 comfortable that a company is not doubling up and 

 15 tripling up on all of its activity, that's all 

 16 about knowing your client and having a deep and 

 17 confidential credit relationship with your 

 18 customer so that you understand the nature of 

 19 their business, the nature of their hedging 

 20 activity. And just as you would evaluate when 

 21 you're making a loan to the company, that they're 

 22 not quietly taking loans from many others that you 

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 1 don't know about, you would have the same dialogue 

 2 about what their hedging activity is, too. 

 3 DOCTOR JARECKI: I'd like to just add, 

 4 if I may, that in the businesses that we do, we do 

 5 not have any customers with unsecured lines. Our 

 6 customers don't even put up margin with us, they 

 7 put up 100 percent of the amount of money that is 

 8 required to purchase their commodity. So it's not 

 9 -- they get far less leverage with us. They don't 

 10 even get the five or six percent they would get 

 11 with the exchange, which purports them to sell out 

 12 when the market falls. They put up with us 100 

 13 percent. 

 14 And this is -- therefore, it's not 

 15 surprising that our kind of customers, and I'm not 

 16 familiar with the folks who take and give 

 17 unsecured lines because our company is too small 

 18 to tolerate this, but they don't go anywhere when 

 19 the markets fall, they just stay there and say, 

 20 okay, we'll wait until it goes back up. 

 21 CHAIRMAN GENSLER: Thank you. 

 22 MR. CASTURO: I would just like to add 

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 1 that the special call data also gives access to 

 2 over-the-counter trades that are enacted by our 

 3 commercial client. So to the extent that a large 

 4 commercial client may be having exposure that is 

 5 even beyond what their commercial or physical 

 6 exposure is, you would have access to that data, 

 7 as well, so it would re-enforce knowing your 

 8 client even at the regulatory level. And 

 9 secondly, the notion of unsecured lines in right 

 10 way risk really is our credit department's 

 11 practice in evaluating commercial clients. It's 

 12 not the practice to evaluate non-commercial 

 13 clients in the same manner, those are largely 100 

 14 percent collateralized. 

 15 MR. SLOCUM: If I may add something, I 

 16 think that I have a public policy problem with 

 17 allowing entities like Goldman and J.P. Morgan to 

 18 subsidize their very lucrative swaps business by 

 19 using the regulated exchanges essentially to hedge 

 20 their own risk. And I think that that's why it's 

 21 so crucial that Congress and the CFTC get control 

 22 over the OTC market. 

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 1 I don't think I need to talk to the CFTC 

 2 about the role that counterparty risk played in 

 3 the current economic crisis. My esteemed 

 4 colleagues wouldn't be here today but for the 

 5 generosity of Congress using the outstanding debt 

 6 of the American people to bale out AIG and other 

 7 entities when they got in over their heads in 

 8 deregulated markets. And so I think that's the 

 9 crux of the issue here, that a very lucrative 

 10 business line for these banks, they're hedging 

 11 that for themselves in the regulated markets while 

 12 wanting to preserve all of the benefits that an 

 13 unregulated OTC market provides for their bottom 

 14 line. 

 15 CHAIRMAN GENSLER: Commissioner Sommers. 

 16 COMMISSIONER SOMMERS: I'll go back to 

 17 that. 

 18 CHAIRMAN GENSLER: Thank you. I suspect 

 19 we'll have a few rounds here. Commissioner 

 20 Chilton. 

 21 COMMISSIONER CHILTON: Thanks, Mr. 

 22 Chairman. Doctor Jarecki, you mentioned as part 

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 1 of your reason that you didn't think there was an 

 2 impact on oil prices, that coal and steel were 

 3 increasing, not traded, et cetera, but don't you 

 4 think that coal and steel are impacted by oil 

 5 prices? 

 6 DOCTOR JARECKI: Well, there's an awful 

 7 lot of things -- you would have to take -- to 

 8 believe that, you would have to look at things 

 9 like real estate prices that were moving upwards 

 10 at the same time, and at many other objects. If 

 11 you looked at the general level of prices during 

 12 those dramas, you could say happened at the same 

 13 time, I guess it was caused by, but I'm so fearful 

 14 of talking anymore Latin here that I won't say 

 15 post hoc ergo propter hoc. But the -- 

 16 CHAIRMAN GENSLER: I assure you, I 

 17 understood your Latin, but it wasn't in Latin, I 

 18 understood it. 

 19 DOCTOR JARECKI: But it's true that 

 20 things move together, but you don't know which is 

 21 the chicken and which is the egg. What is 

 22 important to see is, in the chart on page 12 which 

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 1 I've shown, which is, as money poured into these 

 2 funds, that was not coupled with the increase in 

 3 prices. It's, in many cases, negatively 

 4 correlated, and there would be -- I think a burden 

 5 would be on somebody to demonstrate the causative 

 6 issues. I'm not arguing that they hung out 

 7 together at some times, but there were many times 

 8 that they didn't hang out together. 

 9 COMMISSIONER CHILTON: So you think that 

 10 the passive longs, and you'll agree that there has 

 11 been an increase in passive longs, but you don't 

 12 think they have any impact on the market, and you 

 13 think the only ones that we should be concerned 

 14 about are those who take physical delivery of 

 15 products? 

 16 DOCTOR JARECKI: I'm not familiar, and I 

 17 know the history of markets for 100 or 200 years. 

 18 I'm not familiar with speculations or 

 19 manipulations that act solely in the futures 

 20 markets without activity. In the physical 

 21 markets, the world I knew best in this 

 22 manipulative thing were the Hunt Brothers, who 

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 1 took billions of dollars worth of silver, hid it 

 2 from the public, moved it out of the exchanges so 

 3 that they could pretend that there were -- that 

 4 there was a diminished physical supply, then took 

 5 a broker in a loud, red, check jacket, had him go 

 6 on to the exchange floor and say, limit up bed for 

 7 1,000 lots, that was a manipulation, that was an 

 8 effort to cause the price to go up so they could 

 9 take their physicals and back a whole bunch of 

 10 silver back bonds with it. 

 11 But there aren't histories. Whether you 

 12 go to secreten curio (?) I could name you, I'm 

 13 sorry, these are all the people that have done the 

 14 great dramas, Sumi Toma, they've all done their 

 15 things in the physical markets. 

 16 And you can have a short manipulation, a 

 17 week, a day, an hour, somebody can go into the 

 18 exchange with a loud check jacket, and sure 

 19 enough, the markets went up, limit up, because he 

 20 was bidding limit up for 1,000 lots, but it's not 

 21 something that can last, and it's not something 

 22 that can last over the extensive period of time 

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 1 that that bubble lasted. 

 2 COMMISSIONER CHILTON: Okay, thank you. 

 3 Mr. Slocum, you mentioned that you thought we 

 4 should have position limits in all markets, and 

 5 since Doctor Jarecki just raised silver, I'll ask 

 6 about the metals complex. And I know that's not 

 7 your specific area of expertise, but you're an 

 8 expert in these markets in general, and it's my 

 9 view that, you know, what's good for the goose and 

 10 that it would make sense to do it for all of 

 11 these; do you have an opinion on that? 

 12 MR. SLOCUM: Yeah, I think I agree with 

 13 you. Like I said, my area of focus is on energy 

 14 markets, but it would make a lot of sense for the 

 15 Commission to be consistent with all commodities 

 16 under its jurisdiction. You know, I have 

 17 particular concern in the emerging pollution 

 18 derivatives markets, and I hope that the 

 19 Commission embraces its hopefully new authority 

 20 over those markets. 

 21 But, yeah, I think that all of these 

 22 anti- speculation and pro-competitive regulatory 

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 1 actions by the Commission should apply to all of 

 2 the commodities under your jurisdiction. 

 3 COMMISSIONER CHILTON: Let me just -- 

 4 I'm going to run out of time, so I'll just go back 

 5 to you still, Mr. Slocum. I think there's some 

 6 merit in the argument that some of the exchanges 

 7 gave us yesterday that if we just do position 

 8 limits here, and I'm not prejudging what we will 

 9 or won't do, but if we just do that, there is some 

 10 possibility that, theoretical at least, that 

 11 positions could move OTC and that it would be less 

 12 transparent. That's not what we're trying to do, 

 13 we're trying to create more transparency. So I've 

 14 said that I think, you know, Congress needs to act 

 15 to give us this OTC authority, too, but I wanted 

 16 to know your view, and maybe you can elaborate on 

 17 that point. 

 18 MR. SLOCUM: I think that any time that 

 19 industries or businesses or individuals throughout 

 20 history have been threatened with enhanced 

 21 transparency measures, the first line of defense 

 22 is always the I'm going to flee defense, and I 

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 1 don't know that I fully buy that for commodity 

 2 markets. 

 3 I think that given the precarious state 

 4 of financial markets in general, I think that 

 5 those entities that try to become the Cayman 

 6 Islands of commodities regulation are not going to 

 7 be looked upon favorably. 

 8 I think that given the fact that the 

 9 global community is acting fairly aggressively 

 10 finally over tax havens, I think that you see that 

 11 there is a recognition among countries, even 

 12 developing countries, that a race to the bottom 

 13 from a regulatory perspective is not conducive to 

 14 long term economic development. So I do not buy 

 15 the argument that if we employ sensible 

 16 regulations that folks are going to flee to some 

 17 other country, I'm not convinced of that. 

 18 COMMISSIONER CHILTON: I know my time is 

 19 up, but I did want to make sure that people 

 20 understood. But you do think that Congress should 

 21 approve greater oversight of OTC markets for the 

 22 CFTC? 

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 1 MR. SLOCUM: No question. 

 2 COMMISSIONER CHILTON: Okay. 

 3 MR. SLOCUM: And we have been 

 4 communicating that very loud and clear to 

 5 Congress. 

 6 COMMISSIONER CHILTON: Thanks. 

 7 CHAIRMAN GENSLER: Thank you. Doctor 

 8 Jarecki mentioned that he thought -- and what he 

 9 does, and he's a passive mechanic, so my question 

 10 for Ms. Masters and Mr. Casturo is, in running 

 11 your commodity swap businesses, are you just 

 12 passive mechanics at J.P. Morgan and Goldman 

 13 Sachs? 

 14 MR. CASTURO: Well, to the extent that 

 15 we offer swaps to index investors, we largely have 

 16 a similar profile as an investor in an index fund. 

 17 They make the decisions, we don't, and we -- while 

 18 we make them a risk price to engage in that 

 19 transaction, we, in most cases, immediately hedge 

 20 that risk either by offsetting it with some of our 

 21 commercial participants, and that's actually quite 

 22 common, or by using the futures exchanges in the 

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 1 interim to offset that risk. But it's largely 

 2 passive from our perspective. We're just a pass 

 3 through. 

 4 MS. MASTERS: I think if you take our 

 5 business as a whole, there are a number of 

 6 different components, and facilitating index 

 7 investors is one area where I think you could 

 8 accurately characterize the business as being 

 9 closest to a passive facilitation role. Can't 

 10 quite get to the passive mechanic phraseology, but 

 11 you know what I mean. 

 12 I think, however, there are other areas 

 13 where we're acting more in our own capacity, and 

 14 in those -- just to be clear, I think our position 

 15 is that while we are acting in our own proprietary 

 16 capacity, we should be subject to the exact same 

 17 restrictions that any other entity for any reason 

 18 is subjected to by the CFTC or an exchange or any 

 19 other authorized body. So we're not asking for 

 20 special treatment other than in the situation 

 21 where we are facilitating business for others. 

 22 CHAIRMAN GENSLER: See, I think this 

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 1 might be at the core of, frankly, our difference. 

 2 I don't see a Goldman Sachs swap desk or a J.P. 

 3 Morgan swap desk as a passive mechanic, and the 

 4 billions of dollars of transactions that you do 

 5 just as a passive mechanic, or the billions of 

 6 dollars of profits, or the billions of dollars of 

 7 compensation wouldn't be a passive mechanics. I 

 8 mean it is a highly sophisticated risk business, 

 9 and it's an important component of our financial 

 10 markets, a very important component of our 

 11 financial markets, but not a passive mechanics 

 12 component. 

 13 And so that's why, when I think about 

 14 your earlier question or comment that I'm going to 

 15 now question, is, you thought that we should apply 

 16 position limits on end users, which is very 

 17 encouraging, and there's some common ground here, 

 18 but then you thought it shouldn't be applied on 

 19 the aggregators, the aggregators of risk, the swap 

 20 dealers, and so I want to come back to that and 

 21 ask why that is, because I don't think it's just a 

 22 passive business, you know, I don't think the 

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 1 American public thinks it's just a passive 

 2 business either. 

 3 MS. MASTERS: So to clarify, I'm not 

 4 suggesting that an entity because it is in the 

 5 swap dealing business should be entirely exempted. 

 6 I am, however, suggesting that, with the benefit 

 7 of full transparency, which rules are recommending 

 8 here, you will be able to clearly identify and 

 9 delineate those situations where we are seeking to 

 10 lay off risks that we are assuming from one 

 11 customer and intermediating. And to the extent 

 12 that we're unable to convince you of that, then 

 13 you can classify it as non- passive or 

 14 non-intermediating business and apply limits or 

 15 other rules as necessary. 

 16 We are offering and have provided the 

 17 necessary transparency for you to be able to 

 18 evaluate that in the special call and on a 

 19 hopefully continuing basis. So I think you will 

 20 be in a position to, in your own rights, evaluate, 

 21 rather than just taking our word for it. 

 22 So I think it is absolutely the case 

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 1 that we do play a major facilitating role for 

 2 hundreds, if not thousands of clients around the 

 3 globe, it is a complex business, we hedge options 

 4 with futures, we hedge power with natural gas, we 

 5 hedge jet fuel with WTI, et cetera, and so we're 

 6 going to have to have some language whereby we 

 7 explain to each other what do we mean by 

 8 intermediation because it's not just plus one and 

 9 minus one, it is more complicated than that, as 

 10 you correctly point out. But it is not so 

 11 complicated that it cannot be conveyed. And with 

 12 the transparency that you will have, i.e., total 

 13 transparency, I have no doubt that we would be 

 14 able to achieve the needed goal. But again, where 

 15 we're not intermediating, we shouldn't be exempt 

 16 from anything. 

 17 MR. CASTURO: Yes; I'd just like to 

 18 clarify my earlier comments here that we might be 

 19 seen as being on a different side of the issue 

 20 here. I was only referring to our capacity as 

 21 providing a swap to an index investor in terms of 

 22 that particular activity being relatively passive, 

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 1 right. Our broader business, I would agree, does 

 2 involve us taking some risk. And the suggestion 

 3 by Ms. Masters, I would agree with, as well, that 

 4 our capacity to engage in that speculative risk 

 5 element of our business should be limited, like 

 6 every other counterparty, and that's every other 

 7 entity in that space by the position limits that 

 8 we're proposing. 

 9 CHAIRMAN GENSLER: I appreciate both of 

 10 your comments because I'm really grappling with 

 11 the common ground of applying position limits on 

 12 the end users and aggregating, and I think it 

 13 would be very tangible and fruitful suggestions 

 14 about using the special call. But I'm still 

 15 personally grappling with why the swap dealers 

 16 would be outside of that, and I'm hearing, well, 

 17 maybe they wouldn't be outside of it, but maybe 

 18 you're suggesting part of your business would be 

 19 outside of it. I'm sorry. 

 20 MR. SLOCUM: Mr. Chairman, if I can just 

 21 add something very quickly. I had the pleasure of 

 22 reading through Goldman Sach's 10K report for its 

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 1 GSCI index, and not to pick on you, but -- and it 

 2 was a page turner, but in the disclosure for this 

 3 10K annual report, because it's to the SEC, which 

 4 is a shareholder rights agency, it has a 

 5 disclaimer in there for potential investors in the 

 6 index fund saying, you know, we invest as a 

 7 passive investor in this basket of 24 commodities, 

 8 but, by the way, Goldman Sachs has other 

 9 affiliates that will be taking active proprietary 

 10 trading in these same commodities, and we need to 

 11 let you know that, that we are -- we have a large 

 12 business involved with that. 

 13 And so looking at these activities in 

 14 isolation I don't think provides an accurate 

 15 reflection of a company's footprint in the 

 16 marketplace. And I think that's why, in my 

 17 opening statements, I talked about the CFTC 

 18 examining the totality of banks and other 

 19 financial firm's involvement in these markets, in 

 20 all of these different affiliate components. 

 21 DOCTOR JARECKI: I'm so relieved to hear 

 22 that there is unanimity here about the 

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 1 appropriateness of considering our business only 

 2 an end user business. Our firm has no trading 

 3 profit. We do 100 percent of our trades for our 

 4 customers, and that is the only group for whom we 

 5 trade. So apparently there is now a unanimity, if 

 6 there's not a trading profit, then surely one 

 7 would not be involved in position limits, and I'm 

 8 very grateful for that unanimity. 

 9 CHAIRMAN GENSLER: I can only imagine 

 10 you're speaking on behalf of the panelists because 

 11 you cannot be speaking on behalf of the 

 12 Commissioners. I am probably -- I know I have 

 13 some more questions, so with the patience of the 

 14 panelists and the next panel, I'm turning to 

 15 Commissioner Dunn, but alerting that we'll have at 

 16 least a third round. 

 17 COMMISSIONER DUNN: I thought you were 

 18 implying it would take a great deal of patience 

 19 for me to answer a question. I'm kind of -- I 

 20 think this is a great panel, we're learning a 

 21 great deal here. Doctor Jarecki, I hope we don't 

 22 end up prescribing a placebo, but even if we do, 

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 1 we know placebos have an impact on the patient, 

 2 and it takes constant re-examining of what goes 

 3 on, and that is, again, something that's going to 

 4 take a lot of time, and some of your suggestions 

 5 on what we ought to be doing is that there's a 

 6 follow-up, that anything that we do will have an 

 7 impact on the marketplace, and we must be assured 

 8 that we go back and revisit that, that's the 

 9 reason why Congress reauthorizes every -- 

 10 periodically, five years or so, and so -- and 

 11 that's why we get new people on the Commission, as 

 12 well. 

 13 But I'd like to hear from all of you 

 14 about what drives the passive or speculator 

 15 investor. Mr. Casturo, you talk about they push 

 16 the market back into balance, and you delineate 

 17 between a macro and a micro. 

 18 Doctor Jarecki, you talk about a hedging 

 19 really for inflation, and the fact that there are 

 20 -- we think there are going to be better times 

 21 there, and so we think that commodities like oil 

 22 and metals, et cetera, are going to go up in 

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 1 price, and there are optimists that we might call 

 2 on that that are investing for the long term or 

 3 they're hedging their concerns about inflation. 

 4 But often times when we see some of 

 5 these hedge investments that were out there, they 

 6 may be only relegated to the sophisticated 

 7 investor that's out there, and I'd like to 

 8 understand, Mr. Slocum, what do you see the role 

 9 for the mom and pop type investors, the kind that 

 10 the doctor represents? So if I could hear from 

 11 all the panelists on --- 

 12 DOCTOR JARECKI: May I start with that? 

 13 At the risk of appearing excessively academic, I 

 14 have to go back to Lord Keynes, who spoke about -- 

 15 who spoke exactly about the topic that you're 

 16 talking about. And he led us to believe that 

 17 there was a natural profit in the commodity market 

 18 for the speculator, for the group -- the aggregate 

 19 of all speculators, because, he said, the farmer 

 20 looks out at his land and he's planted it, and 

 21 he's kind of happy with how it is, and the weather 

 22 is good, and the prices are high, and he becomes 

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 1 panicky that he's going to -- that the prices will 

 2 go down and he'll lose, and so he's willing to 

 3 sell at a -- sell for a one year delivery, that 

 4 is, sell for when he gets harvested. 

 5 The baker has no interest in buying 

 6 wheat at that moment, he wants to buy it a week or 

 7 two before he uses it because if grain prices are 

 8 excessively high, he'll bring bread prices up. 

 9 Keynes said that this was the normal 

 10 condition and said that there was a normal 

 11 backwardation, that is, that forward prices would 

 12 be lower than expectation because of the farmer 

 13 and the producer's desire to sell. That means 

 14 that there is naturally the commercial --- the 

 15 producer is short, and the commercial who wants to 

 16 buy something is -- he is long only in the nearby. 

 17 That time period, somebody is paying for. And 

 18 that payment, which is the payment of 

 19 backwardation, and I don't mean price 

 20 backwardation, but expectation backwardation, I 

 21 don't want to get too technical, that is what 

 22 comes out of the market. 

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 1 And it is -- the speculators are being 

 2 paid to diminish the anxiety of the producers. 

 3 This is true in the oil markets, it's true in 

 4 every market. And I don't know if I've been 

 5 useful in making that comment about that 

 6 distinction between the natural speculative long 

 7 and the natural producer short. Thank you. 

 8 MS. MASTERS: Today's investors are 

 9 accessing the commodity markets through a number 

 10 of different channels. The one in which you most 

 11 regularly see, the smaller retail investor 

 12 represented is by our ETF's. And as you know, 

 13 ETF's have grown wildly in popularity in recent 

 14 years, and specifically, ETF's reference in 

 15 commodities, natural gas, crude oil have been 

 16 amongst those and so the strong representation of 

 17 the individual investor in those areas. 

 18 As it relates to index or swap investors 

 19 that are facilitated by the swap dealers, 

 20 generally speaking, those investors are large 

 21 institutional investors who very often represent 

 22 the interests of the retail individual in the form 

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 1 of, for example, they might be a pension plan, or 

 2 an endowment, or some other institutional money 

 3 manager managing money on behalf of a pool of 

 4 individuals. There are also other sophisticated 

 5 investors in the form of Sovereign Wealth Funds, 

 6 for example, who have used the same investment 

 7 vehicles, so there's a whole spectrum. 

 8 And then at the most sophisticated end 

 9 of the spectrum, where you very rarely find 

 10 activity in the passive index type of strategy, 

 11 and rather you see much more directed and 

 12 individualized strategies, both long and short, in 

 13 the hedge fund community. So there's a whole 

 14 spectrum of different types of investor at play 

 15 here, and each of them provides liquidity in their 

 16 own way. 

 17 MR. CASTURO: Commissioner Dunn, I'm 

 18 glad you asked that question because I think this 

 19 is the basis for a lot of the misunderstanding 

 20 about how these markets work. I've done a lot of 

 21 thinking about this. To go back to Doctor 

 22 Jarecki's mention of Lord Keynes and his theory, 

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 1 really what's going on there, there is an 

 2 imbalance between the producer's desire to hedge 

 3 and the consumer's desire to hedge on a forward 

 4 basis, and that's because the consumers are very 

 5 diversified, they're individuals like you and I 

 6 that are not organized enough to think about how 

 7 much their commodity prices are going to be in a 

 8 year, or big enough to act individually to do 

 9 that. The case of the index investor is almost 

 10 like representing a collective group of those 

 11 consumers, particularly if you look at who makes 

 12 up these index investors, they're largely 

 13 endowments and pension funds that represent a 

 14 larger group of people, who actually have all the 

 15 shorts in the commodity markets, they have the 

 16 exposure that if prices go up, they're the ones 

 17 that are going to have to bear the cost. 

 18 In the wheat example, the baker just 

 19 passing onto the consumer. So those entities, in 

 20 a sense, represent the hedging interest of a 

 21 broader group of consumers that are required in 

 22 the marketplace to offset the producer's desire to 

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 1 hedge price risk to the down side. So I think 

 2 that's the key point that you want to consider in 

 3 terms of what they make. 

 4 Now, with regard to my testimony, we're 

 5 distinguishing that group from what we would call 

 6 true speculators, which are those that are more 

 7 price sensitive and try to take advantage of 

 8 perceived distortions from fundamentals and bring 

 9 the market back into line. That's a group that 

 10 will enact -- again, in the futures space, they're 

 11 only talking about future perception of 

 12 fundamentals, which is, again, hard to quantify. 

 13 But that speculative interest is more -- is where 

 14 you get into the balancing that I'm talking about 

 15 in my written testimony, where if there is any 

 16 perceived distortion that there might be in a 

 17 futures market in terms of prices and 

 18 fundamentals, the speculators come in and bring 

 19 that market back into line. 

 20 Now, ultimately, all these groups are 

 21 governed by true physical spot fundamentals when a 

 22 contract goes into expiration and converges to the 

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 1 cash market price. Where there is true consumer 

 2 -- end user consumer and produce -- and producers 

 3 meeting in the cash markets. 

 4 MR. SLOCUM: Again, I want to reiterate 

 5 concerns that Public Citizen has when entities 

 6 like large, sophisticated financial institutions 

 7 wear a lot of different hats at the same time and 

 8 pretend like different affiliates have no 

 9 communication with other affiliates. 

 10 I started my career at Public Citizen in 

 11 the year 2000, and something called the California 

 12 Energy Crisis was going on, and I learned what 

 13 derivatives were from sifting through Enron's 

 14 financials. And one of the things that Enron did 

 15 was, it created this electronic trading platform 

 16 called Enron Online, and it said to all of its 

 17 competitors, here, look at this fun, new exchange, 

 18 let's use this instead of those old, rickety, out 

 19 dated pit exchanges, and what Enron was doing was, 

 20 collecting information on what its competitors 

 21 were doing in the markets, and its competitors 

 22 didn't know that at the time, and Enron was making 

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 1 corresponding bets. 

 2 I find it hard to believe that banks as 

 3 successful and as sophisticated as these are not 

 4 sifting through the mountains of data that they 

 5 have access to as part of their brokering 

 6 activities, as part of their handling passive 

 7 investments in these markets, and that they are 

 8 not communicating that with proprietary trading 

 9 operations. 

 10 When you have affiliates doing a lot of 

 11 different things, you've got lots of opportunities 

 12 to benefit from all of that different information 

 13 in the marketplace. And I think that we ought to 

 14 have regulators take a look at that and determine 

 15 how much of a concern that is to market integrity. 

 16 CHAIRMAN GENSLER: I thank you, 

 17 Commissioner Dunn. I noted there was one question 

 18 across the panel. I have to ask if we can try to 

 19 just help us out, get our questions in. But, 

 20 Commissioner Sommers. 

 21 COMMISSIONER SOMMERS: Thank you, Mr. 

 22 Chairman. I just want to clarify back to my last 

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 1 line of questioning something that Mr. Slocum said 

 2 in an answer, that you have a problem with swap 

 3 dealers using the futures markets to hedge their 

 4 risk, and I want to dig a little deeper there. 

 5 You have a problem with them internally netting or 

 6 you have a problem with them acting as an 

 7 intermediary between these commercial 

 8 participants? 

 9 MR. SLOCUM: From my understanding of 

 10 the market, there are risks associated with them 

 11 accepting bets from entities, particularly those 

 12 entities that are not posting any collateral, and 

 13 that the corresponding bets that are being placed 

 14 in a regulated exchange are to shield the swap 

 15 dealer from the risks associated with that trade. 

 16 Is that an accurate description of what's going 

 17 on? I've got folks at the table that probably 

 18 could give me an accurate description of that. 

 19 MS. MASTERS: I don't understand the 

 20 point, but that isn't an accurate description of 

 21 what's going on. To reiterate, when we take 

 22 unsecured exposure to a counterparty, after 

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 1 careful analysis, J.P. Morgan is at risk to the 

 2 consequences of getting that analysis wrong, first 

 3 of all, and not the exchange, and not a regulated 

 4 market. What we are doing when we hedge our 

 5 market risk position on the exchange is, we are 

 6 laying off our exposure to, for example, the oil 

 7 price. So our market risk is transferred to the 

 8 exchange, the counterparty risk is retained 

 9 between us and our over-the-counter derivative 

 10 counterpart. 

 11 COMMISSIONER SOMMERS: Thank you. I 

 12 also wanted to talk a little bit about both of 

 13 your suggestions that we look through to the end 

 14 user or your counterparties, and thought maybe it 

 15 would be helpful if you compared it to on exchange 

 16 business, and to ask you if what you're asking for 

 17 is the same treatment that floor brokers get on 

 18 exchange? 

 19 MS. MASTERS: Can you run that one by us 

 20 again? Sorry. 

 21 COMMISSIONER SOMMERS: So that a floor 

 22 broker on exchange is just acting as an 

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 1 intermediary, so they're not carrying positions 

 2 and they're not subject to the position limit the 

 3 end user, that they're acting as an intermediary 

 4 for. 

 5 MS. MASTERS: Okay, now I understand, 

 6 sorry. Just to clarify, we are not acting as 

 7 agents, we are acting as principals when we 

 8 operate in these markets. And the distinction 

 9 here is that very often we assume basis risk 

 10 between the risk we take on and the risk we lay 

 11 off in the futures market or on the exchange, for 

 12 example, the basis between long dated or short 

 13 dated exposure, between jet fuel and WTI and so 

 14 on. So we would have to use a language to 

 15 translate our exposures that we assume in the 

 16 over-the- counter land into futures equivalence. 

 17 Indeed, today, in your special call, you 

 18 ask us to do that. So, for example, all of our 

 19 business with airlines, for example, which is 

 20 usually denominated in jet fuel over-the-counter, 

 21 will be asked to be translated into futures 

 22 equivalent contracts in either WTI or gas/oil, for 

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 1 example, and that is one translation mechanism 

 2 that can be used. 

 3 So it's not quite the same treatment 

 4 that somebody who's a pure agent would receive, it 

 5 requires some translation, but there's an economic 

 6 analogy, I guess. 

 7 MR. CASTURO: Yes, I would agree with 

 8 that entirely. I really have nothing significant 

 9 to add. 

 10 DOCTOR JARECKI: I'd point out for -- 

 11 sake that those who like us buy only futures for 

 12 our clients, while the fund that we do it in may 

 13 have its own separate existence. We are fully, 

 14 from an economic standpoint, fully agents for our 

 15 clients. 

 16 CHAIRMAN GENSLER: Commissioner Chilton. 

 17 COMMISSIONER CHILTON: Thanks, Mr. 

 18 Chairman. Do any of you believe that large OTC 

 19 contracts don't impact or can't have a possibility 

 20 of impacting the exchanges that we currently 

 21 oversee, the regulated exchanges? Everybody 

 22 believes that they can't have an impact, okay. So 

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 1 some of you, most of you I think, have called for 

 2 OTC clearing of standardized products; how do we 

 3 come up with that definition? What is a 

 4 standardized product? And what sort of thing 

 5 should we be careful about in developing such a 

 6 definition? All of you. 

 7 MS. MASTERS: I'll take a stab at that. 

 8 I think the risk of getting the definition wrong 

 9 is that you encourage or force, in the worse case 

 10 scenario, contracts that a clearing system or an 

 11 exchange doesn't really have the tools to risk 

 12 manage, to be accepted into that forum, and 

 13 thereby, you undermine the stability of the 

 14 clearinghouse itself, which obviously defeats the 

 15 purpose and will create more systemic risk than 

 16 you're avoiding in the first place. 

 17 So we need to start at a point of 

 18 contract definition from the perspective of, are 

 19 the sources of risk in that position adequately 

 20 understood by a potential clearer, such that they 

 21 are able to offer clearing services with 

 22 credibility. And I think that it -- off the top 

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 1 of my head, I don't have the perfect definition, 

 2 but I can conceive of coming up with definitions 

 3 that would define standardized products as those 

 4 where clearing services are offered by one or more 

 5 central clearinghouse, where prices on those 

 6 contracts are quoted by, you know, more than one 

 7 entity, perhaps visible electronically or quoted 

 8 by multiple parties. 

 9 Those types of definition would I think 

 10 lead you in roughly the right direction. There's 

 11 a lot more detail and work that would need to be 

 12 done, but that's I think the sort of thing that 

 13 would be feasible. 

 14 MR. CASTURO: I would add that the 

 15 exchanges that were represented here yesterday, 

 16 it's in their interest to try to define what 

 17 standardized is and create futures contracts for 

 18 anything and everything that would make sense to 

 19 be cleared already. They've probably undergone 

 20 that exercise and tried to do it, we know that 

 21 they have. The risk is to try to force more 

 22 things into that system that the exchanges already 

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 1 haven't tried would be at the detriment of taking 

 2 away the flexibility, beneficial flexibility that 

 3 we heard the commercial participants identify in 

 4 using somewhat non-standardized approaches that 

 5 are possible through the OTC markets. 

 6 MS. MASTERS: I would add just one quick 

 7 thing, which is, by comparison to other asset 

 8 classes in which derivatives are traded, as a 

 9 general observation, commodity markets already use 

 10 a higher degree of central clearing between 

 11 counterparties than most other derivative markets 

 12 have done historically, so we're well ahead, for 

 13 example, relative to the credit derivative 

 14 markets. 

 15 Perhaps that's a function of the 

 16 volatility inherent in commodity prices, the less 

 17 than stellar credit worthiness of certain 

 18 commodity market participants because of their 

 19 small sizes and so on. I can't give you a 

 20 definitive answer, but it's certainly the case 

 21 that a significant amount of clearing already goes 

 22 on today. 

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 1 COMMISSIONER CHILTON: I want to just, 

 2 and I'll get to Mr. Slocum, but Mr. Casturo, so 

 3 are you suggesting that it would be a poor idea to 

 4 let the exchanges determine what standardization 

 5 is and clearinghouses determine what 

 6 standardization is? 

 7 MR. CASTURO: No, on the contrary. I 

 8 actually think it's a good idea. I think that's 

 9 been there traditionally --- 

 10 COMMISSIONER CHILTON: Will that capture 

 11 everybody that --- 

 12 MR. CASTURO: -- and they -- they're in 

 13 the industry of trying to evaluate what makes 

 14 sense to bringing an exchange. 

 15 COMMISSIONER CHILTON: But will that 

 16 capture everybody that you think we need to 

 17 capture? I mean they're going to do it only if 

 18 it's economic for them. You know, we would be 

 19 looking at it from a transparency perspective, a 

 20 counterparty risk perspective, you know, we've got 

 21 a little bit different motive that doesn't involve 

 22 the world profit. 

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 1 MR. CASTURO: Yes, I recognize that, and 

 2 I think from a regulatory perspective, your role 

 3 is going to be very much enhanced by what we're 

 4 proposing in terms of having access to the trades 

 5 that are non-standardized that occur in the OTC 

 6 space. You'll still have the reporting and the 

 7 ability to monitor those activities even if they 

 8 are not on an exchange. 

 9 COMMISSIONER CHILTON: Okay. Mr. 

 10 Slocum, I'm sorry. 

 11 MR. SLOCUM: Yeah -- no; I think that 

 12 it's very important that the CFTC be the entity 

 13 making that determination of what a standardized 

 14 versus a non- standardized OTC contract. I think 

 15 that the potential for classifying contracts to 

 16 avoid transparency and regulation is too important 

 17 to leave that decision to exchanges. I would like 

 18 to see the CFTC make that determination. I think 

 19 that the basics of the administration's policy on 

 20 this issue is an excellent beginning. 

 21 You know, I maintain that one way to 

 22 create an economic disincentive towards finding 

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 1 complex ways to structure OTC contracts to make 

 2 them non-standardized is to play some sort of 

 3 margin requirement on non-standardized OTC 

 4 contracts so that you don't have this issue where, 

 5 as we've heard today, folks can go into the OTC 

 6 market, put up no collateral, and become a market 

 7 participant. 

 8 I also think that in terms of enhancing 

 9 disclosure, I think that one thing I neglected to 

 10 mention in some of my opening comments is adding 

 11 more detail, or adding swaps and indexes on a 

 12 company specific basis in the commitment of trader 

 13 reports that the CFTC releases each week. I know 

 14 that there are considerations now about enhancing 

 15 the type of disclosure, and I think that that 

 16 would be an important addition to those weekly 

 17 reports. 

 18 COMMISSIONER CHILTON: Thank you. 

 19 CHAIRMAN GENSLER: Thank you. We are 

 20 going to go a third round. I'm going to try -- I 

 21 have five questions, I'm going to try to do two of 

 22 them that you're going to maybe just follow up on. 

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 1 But these are really going to be, with all respect 

 2 to Doctor Jarecki and Mr. Slocum, I want to just 

 3 turn and take the opportunity to talk about over- 

 4 the-counter derivatives regulation, because we 

 5 have these two swap dealers in front of us. 

 6 I was encouraged, there's a lot that we 

 7 believe working with Congress we have to do. We 

 8 have to regulate the dealers and have a full 

 9 regulatory regime. And I think I heard earlier, 

 10 if you want to disagree, tell me, but that you're 

 11 supportive of Congress moving forward and 

 12 regulating the over-the-counter derivatives 

 13 marketplace for capital and margin requirements 

 14 for the dealers. 

 15 We are also calling for business conduct 

 16 standards and transparency and record keeping and 

 17 reporting, where the SEC and the CFTC would have a 

 18 lot of authorities there. 

 19 We are also, though, calling for 

 20 standardized products to come into centralized 

 21 clearing and onto exchanges. And I'd like to -- 

 22 my first two questions are focusing on some 

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 1 differences I think I heard. I think I heard 

 2 generally support for a lot of that, but where 

 3 there are two differences I'd like to get some 

 4 thoughts on is, I think I'm hearing and reading in 

 5 your testimony that you think on posting of 

 6 collateral, that the dealer should do that, and 

 7 maybe the dealer should do that possibly with some 

 8 end users, but a lot of end users corporate 

 9 customers shouldn't have to post collateral. 

 10 I think that -- and I'm particularly 

 11 concerned because that seems like it might be a 

 12 very significant motivation that everybody would 

 13 try to say it's a customized swap with an end user 

 14 and that we would not lower risk in the system. 

 15 And on that point, Ms. Masters, you 

 16 actually said J.P. Morgan was at risk of getting 

 17 it wrong when I think Commissioner Sommers might 

 18 have been talking about this, but ultimately the 

 19 America public are at risk of J.P. Morgan getting 

 20 it wrong. Both of these institutions are large 

 21 financial institutions that -- we can debate 

 22 whether they're going to be systemically relevant, 

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 1 but I think most Americans would say if J.P. 

 2 Morgan gets it wrong, the American public might be 

 3 on the hook in some way. The second difference 

 4 that I heard was something about exchange trading. 

 5 I don't know if I really understood the point, but 

 6 I heard Ms. Masters say at one point you're not 

 7 sure the benefits of exchange trading for swaps, 

 8 so I'd like to just hear that a little bit more if 

 9 I misunderstood it. But I, for one, think there's 

 10 a huge benefit for tens of thousands of end users 

 11 to get the transparency from exchanges and seeing 

 12 the standardized product and the pricing on a real 

 13 time basis to see that. 

 14 It may shift the information advantage 

 15 away from Goldman Sachs and J.P. Morgan to tens of 

 16 thousands end users, but I see an advantage. 

 17 My third question, just for now, and 

 18 then I do have two follow-ups then, is when credit 

 19 default swaps. And, Ms. Masters, I understand you 

 20 were actually at J.P. Morgan when these products 

 21 were first formed and founded, so you have a 

 22 personal and distinct history; I don't know if you 

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 1 would say you're a co-originator or innovative, 

 2 but you were at least at J.P. Morgan when it was 

 3 originated. 

 4 In these days, I don't know how much, 

 5 you know, you want to take into the birthing of 

 6 that product. But my question really is, beyond 

 7 everything else we're doing, do you think credit 

 8 default swaps have such unique characteristics 

 9 that when we're working with Congress, there 

 10 should be additional safeguards beyond everything 

 11 else that we've talked about? So those -- I know 

 12 it's a lot, but however you want to try to help us 

 13 on these three questions. 

 14 MS. MASTERS: Okay. So if I understood 

 15 it, the first question related to whether or not 

 16 we agreed or fully supported the notion that all 

 17 standardized contracts should be traded on 

 18 exchange and/or centrally --- 

 19 CHAIRMAN GENSLER: That's correct. 

 20 MS. MASTERS: -- and/or centrally 

 21 cleared. Speaking for J.P. Morgan, I can 

 22 certainly reflect that we do support the mandatory 

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 1 clearing of standardized contracts between dealers 

 2 and any other systemically relevant entity, 

 3 whether they be a corporation, a hedge fund, or 

 4 anyone else, to be determined as to whether they 

 5 are systemically consequential by the appropriate 

 6 regulator. 

 7 That makes sense to us, and that would 

 8 attack and tackle and reduce the vast, vast, vast 

 9 majority of the systemic risk in the system, 

 10 certainly would have tackled the risks that have 

 11 subsequently become infamous over the course of 

 12 the last 12 months. We do have a point of 

 13 difference, and that is that we do not believe 

 14 that end users should be forced or mandated to 

 15 centrally clear their business. And the reason 

 16 for that -- they should certainly have the right 

 17 and the ability to do that. But the reason for 

 18 not mandating that is that many of our end 

 19 customers, corporations, small and large alike, 

 20 simply do not have the business model that 

 21 accommodates exchange trading as a way of life. 

 22 And the most obvious area in which 

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 1 there's a difference is that typically, as I 

 2 describe earlier, those companies need to pledge 

 3 as collateral things like plant, property, 

 4 equipment, commodity, molecules in the ground and 

 5 so on, and those are just not acceptable forms of 

 6 collateral for central clearinghouses or 

 7 exchanges, and likely never will be. 

 8 If you remove the ability for those 

 9 companies to tap into that sort of liquidity, you 

 10 force them to curtail their business activities, 

 11 they will have less access to credit, and 

 12 generally this is a sector of the economy that is 

 13 not overly leveraged presently. 

 14 CHAIRMAN GENSLER: If I might, isn't it 

 15 true that they're currently being charged --- in 

 16 their current swap business, they're being charged 

 17 for the risk and also the credit, so they are 

 18 being charged for that currently? 

 19 MS. MASTERS: Yes, absolutely. 

 20 CHAIRMAN GENSLER: Absolutely, that's 

 21 what you -- but -- so what we're really just 

 22 saying, as regulators and working with Congress, 

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 1 is, we want to lower risk on the standard product 

 2 to be posting margin, like the futures exchanges, 

 3 but on the customized products, then they would be 

 4 posting margin, of course, with their 

 5 counterparty, the swap dealer, or maybe it is 

 6 non-liquid collateral, but having some lowering of 

 7 risk through collateral arrangements? 

 8 MS. MASTERS: For the corporate end 

 9 user, the distinction between a customized product 

 10 and a standardized product in this context really 

 11 doesn't make that much difference from the point 

 12 of view of how easy it is for them to pledge 

 13 liquid cash and government securities as 

 14 collateral. 

 15 CHAIRMAN GENSLER: Did you have a view 

 16 on credit default swap before Mr. Casturo? I'm 

 17 giving myself luxury because I'm trying to avoid a 

 18 fourth round. And I'll give all of you luxury, 

 19 too. 

 20 MS. MASTERS: I think I understood the 

 21 question to be whether credit default swaps have 

 22 unique characteristics that --- 

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 1 CHAIRMAN GENSLER: Is there anything in 

 2 addition that we should consider? Some people 

 3 same ban them all together, some people say ban 

 4 naked credit default swaps, some say you have to 

 5 have insurable interest, but maybe there's some -- 

 6 and again, it's just the coincidence that you were 

 7 at J.P. Morgan when these were founded and I 

 8 thought I'd ask you. 

 9 MS. MASTERS: I think that -- my view on 

 10 the subject is that credit derivatives are a 

 11 product that have enormous benefits and should not 

 12 be ruled out of existence. And we need to be 

 13 careful in distinguishing between the value of a 

 14 tool itself and the propensity for individual 

 15 companies to misuse that tool. 

 16 We definitely saw some instances of 

 17 those tools being used very inappropriately from a 

 18 risk and a systemic risk point of view during the 

 19 course of this crisis. In my view, the way to 

 20 tackle that is to ensure that major market 

 21 participants, whether they're dealing in credit 

 22 default swaps or any other form of derivative are 

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 1 appropriately supervised and regulated, and hence, 

 2 our support for a systemic risk regulator, whoever 

 3 that may be, to be determined, but someone to 

 4 oversee the activities of systemically relevant 

 5 companies in the over-the-counter derivative 

 6 markets. I think that statement applies just as 

 7 equally to interest rate swaps as it does to 

 8 credit derivatives I don't think there's anything 

 9 inherently or uniquely different about a 

 10 derivative applied to credit as opposed to a 

 11 derivative applied to equities or commodities or 

 12 anything else. 

 13 MR. CASTURO: Yeah; two points I'd like 

 14 to make. First of all, regarding non-standard 

 15 products and whether they should be on exchanges 

 16 or forced on exchanges, I want to make the point 

 17 that we're not solely or even primarily arguing 

 18 for our own self-benefit that these things should 

 19 remain an over-the-counter transaction. 

 20 We heard the testimony of commercial 

 21 participants yesterday that identified that the 

 22 benefit the commercial participant gets by having 

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 1 this arrangement, and again, reiterate the notion 

 2 of right way risk, that it's not introducing a 

 3 greater systemic risk to the system because the 

 4 capacity for these commercial participants to be 

 5 able to make payment is in line with the way the 

 6 market moves. 

 7 And, in fact, even though there are some 

 8 charges involved with the way we treat these, they 

 9 are lower than what they would be in a 

 10 standardized exchange model, which actually 

 11 benefits these commercial participants and 

 12 ultimately benefits the users of the commodities 

 13 that they produce, because lower cost to them 

 14 equates the lower cost to the consumer. The 

 15 second point I want to make is regarding the 

 16 exchange trading for swaps and a potential 

 17 information advantage the dealer may have by 

 18 maintaining that environment. 

 19 I think we've heard the testimony here 

 20 from just about everybody that we're all in favor 

 21 of increased transparency. So to the extent that 

 22 that swap activity has been shielded from public 

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 1 domain, we're offering that up in terms of special 

 2 call data to be more frequently gathered and 

 3 disseminated. 

 4 Although one point I would make is, we 

 5 would -- we maintain that the confidentiality of 

 6 any individual client always be maintained. 

 7 CHAIRMAN GENSLER: I fear my time is up, 

 8 I'm going to hand off to Commissioner Dunn. 

 9 COMMISSIONER DUNN: Chairman has a great 

 10 deal of prerogative when it comes to his own time. 

 11 CHAIRMAN GENSLER: You have as many 

 12 minutes as I had, or more if you want. 

 13 COMMISSIONER DUNN: How many was that 

 14 Jas, did you keep track? Let me zero again on Mr. 

 15 Casturo and Ms. Masters. And Mr. Slocum had 

 16 brought up the overlapping of activities of being 

 17 a CPA, of being an advisor, predicting what's 

 18 going to happen in the future, of having a trading 

 19 arm within institutions, and then trading on 

 20 behalf of counterparty --- 

 21 MS. MASTERS: There are several areas 

 22 where firewall type concepts are applicable. The 

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 1 first of these is relating to research. So 

 2 there's been some commentary around whether or not 

 3 investment banks put out research and might have 

 4 privileged access to that ahead of time, position 

 5 themselves accordingly and so on. 

 6 As you know, there was a research 

 7 settlement impacting the equity market some years 

 8 ago. While those rules do not explicitly apply to 

 9 commodity markets, certainly the practice at J.P. 

 10 Morgan, and it is my understanding that it is the 

 11 practice at other major investment banks, that 

 12 similar rules are, in fact, imposed on the 

 13 separation of research in commodities just as they 

 14 are in equities. So, for example, our research 

 15 --- 

 16 COMMISSIONER DUNN: Who oversees those? 

 17 MS. MASTERS: Internal compliance; so if 

 18 our research department publishes something, it 

 19 goes to the customer and does not go to the 

 20 trading desk until after it's gone out to the 

 21 broad customer base. One main area, as it relates 

 22 to proprietary trading activities, those are 

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 1 walled off and separated from the client facing or 

 2 market making desks. So, again, that is monitored 

 3 or imposed by internal compliance to ensure that 

 4 those separations are kept there. And there are 

 5 separations and systems and other things, not just 

 6 a physical separation of individuals. 

 7 MR. CASTURO: Goldman Sachs operates 

 8 under the same principals. And with regards to 

 9 research, that distinction and firewall separation 

 10 between the research arm and the trading arm, 

 11 though it's not currently mandated, it's been 

 12 withheld at Goldman to the same standards as it is 

 13 within the equity markets. 

 14 MR. SLOCUM: May I just add something? 

 15 I think that, with all due respect, I think that 

 16 internal controls like that are completely 

 17 meaningless. With no penalties for 

 18 non-compliance, with no third party assessment of 

 19 these internal controls, I think that there are 

 20 serious risks to the public and to market 

 21 integrity unless we've got government regulators 

 22 drawing up these rules, enforcing these firewalls, 

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 1 again, with all due respect. But I just do not 

 2 think that internal firewalls have a history of 

 3 being effective in industries. 

 4 MS. MASTERS: You've obviously never 

 5 experienced them, but to the extent that they were 

 6 regulatorily imposed, I don't think that would be 

 7 a problem. 

 8 MR. CASTURO: Agreed. 

 9 COMMISSIONER DUNN: When we did our 

 10 special call, we found that some of those folks 

 11 that we had categorized in one area were, in fact, 

 12 should have been categorized in another area. Who 

 13 do you feel should be responsible for the 

 14 delineation of what category you fall in; should 

 15 it be the CFTC, should it be the -- if you're 

 16 representing a group of folks, the persons that 

 17 represents them, or individually? And I'd ask for 

 18 all of you on that. 

 19 MR. CASTURO: I think the regulator is 

 20 in the right position to make that distinction. 

 21 Obviously, it would be done on a basis where they 

 22 would need to quality by certain criteria to be 

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 1 classified in a certain category or not. 

 2 MS. MASTERS: I agree. 

 3 DOCTOR JARECKI: There is a bit of a 

 4 problem, I think, because there is an effort, I 

 5 know, on the part of the administration to 

 6 harmonize the activities of the securities 

 7 regulators and the commodities regulators. And 

 8 even in these concepts, we have here the concept 

 9 that the non-commercials are speculators, whereas 

 10 in the SEC definition, there is a distinction made 

 11 between speculators and investors. 

 12 The general -- of course, we recognize 

 13 we're in a funny world, I appreciate the 

 14 Chairman's concern that this not be seen as a 

 15 price control discussion, but we really can't 

 16 ignore the fact that the stomach of probably 

 17 everybody is, wouldn't it be nice if commodity 

 18 prices were low and security prices were high, and 

 19 how can the human race, when it has that feeling 

 20 in its stomach, really ignore that when it's 

 21 trying to regulate? 

 22 I apologize, I'm not trying to argue 

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 1 with the Chairman, but recognize your own stomachs 

 2 and you will see the merits of that worry. 

 3 COMMISSIONER DUNN: I argue with him all 

 4 the time, that's fine. I just got a statement 

 5 here that Mr. Slocum, in your prepared testimony, 

 6 say Public Citizen was similarly encouraged by the 

 7 Obama Administration's plan, developed the support 

 8 of the CFTC to establish regulatory proposals for 

 9 over-the-counter derivatives markets that would 

 10 require other things, all standardized OTC energy 

 11 contracts to clear through the exchange related by 

 12 the CFTC. Well, you're saying it's the CFTC 

 13 support. What we have was a letter from the 

 14 Secretary, the Treasury, to some members of 

 15 Congress that outlined how we might operate. 

 16 We are an independent body here. Each 

 17 of these Commissioners may have different thoughts 

 18 on that. I happen to set on the dias as the 

 19 Acting Chairman with Chairman Shapiro and 

 20 Secretary Geitner, release that, now that, after 

 21 the fact, I can tell the rest of the story. 

 22 I got a good deal of encouragement and 

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 1 information on derivatives from our now Chairman, 

 2 and I appreciate that. In exchange, I let him in 

 3 on the intricacies of the wheat convergence, so it 

 4 worked out. But please keep in mind that the 

 5 Commissioners all have their own thought on these 

 6 things, and when things come out and says the 

 7 Commission says this, the Commission -- find out 

 8 who the Commission is. 

 9 MR. SLOCUM: My apologies. I should not 

 10 have indicated that the independent Commission was 

 11 in lockstep with the administration, but rather in 

 12 consultation with the administration on providing 

 13 maybe input and feedback on the development of 

 14 policies. 

 15 CHAIRMAN GENSLER: I again find myself 

 16 in association with Commissioner Dunn, as I did 

 17 yesterday, on the subject of co-location, which 

 18 was my fifth question, but he got my fourth one, 

 19 so hopefully somebody will get it. We'll get back 

 20 to co-location. Commissioner Sommers. 

 21 COMMISSIONER SOMMERS: Thank you, Mr. 

 22 Chairman. I wanted to ask both Ms. Masters and 

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 1 Mr. Casturo about global standards, and when we 

 2 are looking at all of these different issues, not 

 3 just position limits, but looking at 

 4 standardization of OTC derivatives and just the 

 5 overall regulation of OTC derivatives, I'm 

 6 assuming you both operate globally, and if you 

 7 could just comment on the importance of global 

 8 standards. 

 9 MS. MASTERS: They're critical. If you 

 10 have inconsistent rules, business will, like 

 11 water, flow to the easiest way out. And if you 

 12 have certain regimes overseas that are not as 

 13 transparent, but easier to execute in, because of 

 14 the absence of limits and regulation, whether we 

 15 like it or not, and this is not a threat, it's not 

 16 if you do this, then we will go there, it's a 

 17 prediction, the business will flow there. And 

 18 there are a number of commercial entities around 

 19 the world that are eyeing with interest these 

 20 developments, with a view to seizing the 

 21 commercial opportunity to essentially steal away 

 22 the lead that the American futures and derivatives 

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 1 markets have if there is inconsistent application. 

 2 So I think it's -- and the negative of that would 

 3 be that business would end up being done in 

 4 jurisdictions where there's much less customer 

 5 protection and less transparency, and it may end 

 6 up being done by non-U.S. persons, depending, 

 7 which would obviously be a massive competitive 

 8 loss for this economy. 

 9 MR. CASTURO: I would agree that it's 

 10 critical that there's a consistent approach. It's 

 11 very much akin to the situation between the 

 12 futures market and the OTC markets. If you have 

 13 two different venues to which trading can occur, 

 14 whether that's in format, like futures or OTC, or 

 15 in location between different jurisdictions, it's 

 16 not a good situation if there's different policies 

 17 applied to them. 

 18 DOCTOR JARECKI: -- one last comment on 

 19 that, which is that you can't ignore the fact 

 20 where the customers come from. We've given a list 

 21 of the categories of our customers. Forty-five 

 22 percent of our customers are foreign. For foreign 

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 1 customers to use foreign exchanges, with that 

 2 reference to the United States, it would be 

 3 trivial. It's sort of a fluke almost that so much 

 4 of this business today moves through American 

 5 enterprises, and that risk exists. And, as Ms. 

 6 Masters says, it's not a threat, it's just 

 7 reality, if they can't do it here, they'll go do 

 8 it somewhere which doesn't touch the United 

 9 States, because the foreigners themselves are 

 10 involved. 

 11 CHAIRMAN GENSLER: Commissioner Chilton. 

 12 COMMISSIONER CHILTON: Thanks, Mr. 

 13 Chairman, thanks for doing the last round, and I 

 14 don't have anything after this. And I also ask my 

 15 colleagues' indulgence to some extent. I want to 

 16 go a little bit off subject here; first Mr. 

 17 Slocum. 

 18 You've talked about the need to do -- 

 19 have congressional statutory changes also in the 

 20 OTC market. One of the things that was included 

 21 in the House bill out of the AG Committee, it was 

 22 approved by a bipartisan basis, was the ability 

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 1 for the CFTC to have criminal authority. And, you 

 2 know, it's very difficult, these are complicated 

 3 markets, and when we have to take a case, bring a 

 4 case to court, we often go to the Department of 

 5 Justice or other criminal authorities and they 

 6 reject roughly two-thirds, roughly two-thirds of 

 7 the cases are rejected, not because they're not 

 8 meritorious cases, in fact, 100 percent of those 

 9 cases, 100 percent we win, but they're just very 

 10 complicated, and you have these U.S. attorneys and 

 11 others who maybe don't understand all these laws, 

 12 et cetera, so that's a change that they put in the 

 13 House AG Committee bill, and I'm wondering whether 

 14 or not you've taken a look at this and if Public 

 15 Citizen thinks this is a good thing for Congress 

 16 to do also. 

 17 MR. SLOCUM: Yeah, Commissioner Chilton, 

 18 we have taken a look at that provision, and we 

 19 strongly support granting the CFTC criminal 

 20 authority in that. I think that, in addition to 

 21 the fact that too many referrals to the Department 

 22 of Justice are rejected, not because the case is 

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 1 meritless, but because the DOJ does not fully 

 2 understand the issue, but also, it would vastly 

 3 strengthen the hand of the CFTC and your market 

 4 monitoring staff. 

 5 If you confront entities that you 

 6 suspect of violating the law, and you come to the 

 7 table with criminal authority, that is a very 

 8 strong negotiating tool, understanding that not 

 9 all prosecutions end in a trial or -- but are 

 10 often settled, I think anything we can do to 

 11 strengthen the hand of regulators in dealing with, 

 12 you know, often what are very sophisticated, deep 

 13 pocketed entities, I think is required. 

 14 COMMISSIONER CHILTON: Thanks; do any of 

 15 the other panelists disagree with the general 

 16 thrust of what Mr. Slocum said? Everybody agrees? 

 17 Okay. The last thing I wanted to say is, you 

 18 know, it's tough, Doctor Jarecki, at times to be 

 19 commodity blind and to be price neutral, but maybe 

 20 not as tough as people would think. 

 21 I mean, you know, we all fill up our 

 22 cars with gas and everything, but people make a 

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 1 living, farmers like high prices. I've worked for 

 2 farmers before, dirt farmers, people who barely 

 3 make a living, so they wanted high prices. You 

 4 know, in the job that you're in, you have to make 

 5 those distinctions, and I found it a lot easier 

 6 than I thought actually. 

 7 And so what concerns me is not whether 

 8 or not as much as they're high or they're low or 

 9 if it's this commodity or that one, but ensuring 

 10 that the markets are operating efficiently and 

 11 effectively, that we're doing everything we can, 

 12 not just to react to problems that we see, not to 

 13 get a report and then react to it, but to look 

 14 around the corner, to be nimble and quick, and I 

 15 don't think we've done that as regulators, not 

 16 necessarily anybody on this panel, but in general, 

 17 in the last, you know, dozen years. I think we've 

 18 been a little bit more lax, and maybe there were 

 19 some good things that came about of that, but 

 20 there's also collateral damage that lays all 

 21 across the economic landscape from that sort of 

 22 approach. So I think what we're doing now is 

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 1 being a little bit more proactive, I think that is 

 2 a shift in general, not necessarily just here, but 

 3 in government. 

 4 I do support many of the things the 

 5 administration proposed with regard to the Reg 

 6 Reform Proposal, and I think it's a good thing. I 

 7 think it's a good thing for markets and I think 

 8 it's a good thing for consumers, too. Thanks. 

 9 CHAIRMAN GENSLER: Thank you, 

 10 Commissioner Chilton. We're not going to have a 

 11 fourth round, but I've gotten permission from a 

 12 number of my Commissioners, I didn't ask Bart. I 

 13 just want to mention the fourth question I had 

 14 Commissioner Dunn raised, and I think it's a very 

 15 important one about firewalls, and I was 

 16 encouraged by what at least two large banking 

 17 institutions said on that subject. 

 18 But I think that the Commission will 

 19 probably move forward and sort of think more about 

 20 this and whether, in a regulatory context rather 

 21 than a voluntary context, we try to put something 

 22 appropriate under our statute in place. And the 

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 1 fifth one is just -- is a follow-up, if you can 

 2 come back to us, and it's really to the two 

 3 panelists in the middle. But yesterday, again, 

 4 Commissioner Dunn had raised it, but it was 

 5 something very much in the newspapers, as well, 

 6 about the location, it's a very technical thing, 

 7 the location of terminals, or the co- location of 

 8 servers for big investment banks and banks near 

 9 the servers of the exchanges themselves, what's 

 10 called co- locations, so that you could get 

 11 advantages and rapid advantages that might be down 

 12 into the milliseconds, and so that markets are 

 13 fair to all participants and not just the one that 

 14 has the computer three inches away from the server 

 15 instead of 100 feet away from the server. 

 16 I certainly associated myself with 

 17 Commissioner Dunn yesterday, and I think this 

 18 Commission is going to want to talk to the 

 19 exchanges and talk to the market and really 

 20 understand whether it's appropriate and whether 

 21 there needs to be some standards set so that 

 22 there's, you know, in the concept of what's called 

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 1 co-location or rapid transaction. 

 2 MS. MASTERS: That was actually news to 

 3 me for the record. 

 4 CHAIRMAN GENSLER: News? 

 5 MS. MASTERS: The existence of, or the 

 6 embracing of co-location opportunities. 

 7 CHAIRMAN GENSLER: Well, maybe one of 

 8 your competitors had something on you there, Ms. 

 9 Masters, I don't know. 

 10 MS. MASTERS: They -- apparently it 

 11 explains a lot. 

 12 CHAIRMAN GENSLER: I see; I don't know 

 13 if Mr. Casturo wants to respond to Ms. Masters on 

 14 that. 

 15 MR. CASTURO: No, I have no comment. 

 16 CHAIRMAN GENSLER: I see; that maybe 

 17 explains a lot. 

 18 MR. CASTURO: As you suggested. 

 19 CHAIRMAN GENSLER: Well, we'll be 

 20 looking into that then. But I think this has been 

 21 enormously beneficial to the public, to the 

 22 Commission, it was to inform the public, inform 

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 1 the Commission. There are a number of areas where 

 2 there's support for moving ahead from position 

 3 limits, and as we know, there's a number of 

 4 differences, but it's all in all very helpful. 

 5 We're going to take a short break, five to ten 

 6 minutes, but no more than ten minutes. We just 

 7 need to give everybody a chance, but then if our 

 8 other witnesses can come up and -- we thank 

 9 everybody for their patience. 

 10 (Recess) 

 11 CHAIRMAN GENSLER: I thank you for that 

 12 recess. I'm going to call the Commission back in 

 13 order or whatever our lawyers tell me I'm supposed 

 14 to say somewhere here, David usually tells me. If 

 15 we might turn to our next panel of witnesses, as I 

 16 did earlier, and I thank you for having the 

 17 patience to sit through a full, but a very helpful 

 18 panel. Your written statements will be in the 

 19 record and we'll keep the record open, as well, 

 20 through August 12 for any additional follow-up, 

 21 but if you could try to help us and summarize your 

 22 statement. We've all had an opportunity to read 

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 1 it even if it was a little late last night. But 

 2 summarize in five minutes and then we'll see how 

 3 many rounds we need for the Commissioners. But 

 4 Mr. Lothian. 

 5 MR. LOTHIAN: Lothian. 

 6 CHAIRMAN GENSLER: Lothian, thank you, 

 7 all right. 

 8 MR. LOTHIAN: My name is John Lothian 

 9 and I am here as a participant and observer and 

 10 commentator about the global futures and 

 11 derivatives markets. I want to thank the 

 12 Commission for inviting me to testify on the 

 13 important issues considered in today's hearings. 

 14 My futures industry career has spanned over 30 

 15 years since I started working for a soybean trader 

 16 and broker as a 17 year old high school student. 

 17 I began watching the markets when the treasury 

 18 futures at the Chicago Board of Trade were just 

 19 one year old, stock index futures were not yet 

 20 introduced, and the Chicago Board of Trade had 

 21 over 50 percent of the volume of all yearly 

 22 futures traded globally. 

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 1 The purposes of the futures markets are 

 2 two-fold, price discovery and risk transfer. The 

 3 price discovery process is made up of people with 

 4 an economic interest in the underlying 

 5 commodities, bona fide hedgers, and those without 

 6 speculators. 

 7 Traditionally, speculators have been 

 8 defined as individuals or firms seeking to profit 

 9 from anticipated increases or decreases in futures 

 10 prices. 

 11 Over the years, speculators have 

 12 dynamically used futures to take micro views on 

 13 price movement of an underlying commodity or 

 14 financial contract or take a macro view of an 

 15 aspect of the national or global economy. High 

 16 frequency electronic proprietary traders are 

 17 examples of those taking a micro view on trying to 

 18 profit from price movement. Index traders would 

 19 be the most relevant and dominant contemporary 

 20 example of those taking a macro view of prices and 

 21 the global economy. 

 22 Futures markets, price discovery, and 

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 1 risk transfer functions allow for the supply and 

 2 demand of a commodity or underlying instrument to 

 3 be allocated or rationed over time. However, U.S. 

 4 futures markets represent greater dynamics than 

 5 just those of the specific contract specifications 

 6 of the underlying commodity. 

 7 Wheat producers around the world look to 

 8 the benchmark prices and liquidity of the Chicago 

 9 soft red winter wheat futures for hedging and risk 

 10 management purposes. The same is true for the CME 

 11 Group's West Texas Intermediate crude oil traded 

 12 on the New York Mercantile Exchange for energy 

 13 producers and consumers. These are global 

 14 benchmarks of global commodities with interlocking 

 15 pricing relationships and interchangeable uses. 

 16 The very concept of a finite supply of a 

 17 commodity flies in the face of the market function 

 18 of price and the dynamic substitutability of the 

 19 products. When the price of beef gets too high, 

 20 people eat more chicken and fish and less beef. 

 21 Consumers replace the high priced product with a 

 22 lower priced substitute that accomplishes the same 

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 1 goal, thus reducing demand for the high priced 

 2 product. Producers of the high priced product, 

 3 seeing the reduced demand, will seek to increase 

 4 the supply to the market while prices are still 

 5 high. This change in demand through substitution 

 6 and increase in supply has the effect of bringing 

 7 prices back into normal relationships with 

 8 competing substitutes. The best cure for high 

 9 prices is high prices; the best cure for low 

 10 prices is low prices. 

 11 Excessive speculation is another topic 

 12 altogether. It is difficult to define and even 

 13 more difficult to prevent. Traditionally, there 

 14 are position limits put on speculators to limit 

 15 the number of contracts they may control, thus 

 16 avoiding excessive speculation. However, these 

 17 limits are mere speed bumps, not the true limits 

 18 that they are intended to be. 

 19 Speculators and hedgers have always 

 20 found a way to manage their risk despite rules, 

 21 laws, and negative public opinion. During the 

 22 1979 Russian grain embargo, when President 

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 1 Carter's administration shut down trading for 

 2 several days and U.S. grain futures exchanges, 

 3 traders substituted by trading contracts on the 

 4 Winnipeg Commodity Exchange. Rather than waiting 

 5 to offset their long positions at substantially 

 6 lower prices when the U.S. Exchanges reopened and 

 7 began trading after a limit down move in prices, 

 8 some traders shorted Winnipeg grain futures 

 9 contracts to trade their positions. In an example 

 10 of the law of unintended consequences, price 

 11 discovery moved from Chicago to Winnipeg for 

 12 soybeans, corn, and wheat through the surrogates 

 13 of rape seed, feed wheat and other contracts. 

 14 During the Civil War in the United 

 15 States, when Abraham Lincoln and his Treasury 

 16 Secretary, Salmon Chase, became incensed at 

 17 excessive speculation of gold, they pressed 

 18 passage of the Gold Bill of 1864, outlawing 

 19 delayed deliveries of gold. This law just had the 

 20 effect of moving trading from the Gilpin's News 

 21 Room in New York to traders' offices and street 

 22 corners. The primitively organized gold futures 

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 1 market of the 1860's simply moved to an over-the- 

 2 counter market. 

 3 And in another example of the law of 

 4 unintended consequences, this move probably 

 5 substantially aided the development of bucket 

 6 shops, which were a severe problem in the late 

 7 1800's. 

 8 Finally, position limits for globally 

 9 traded substitutable commodities are just speed 

 10 bumps, which can slow down the speculative process 

 11 and make it more expensive for speculators, but 

 12 they are not the true limits of speculation on 

 13 commodities with a finite supply. 

 14 CHAIRMAN GENSLER: Thank you, Mr. 

 15 Lothian. 

 16 MR. LOTHIAN: Like Midlothian. 

 17 CHAIRMAN GENSLER: Lothian; that works, 

 18 too. 

 19 MR. LOTHIAN: Yes. 

 20 CHAIRMAN GENSLER: Mr. Krenkel. 

 21 MR. KRENKEL: Mr. Chairman and members 

 22 of the Commission, my name is Peter Krenkel, I am 

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 1 the President of Natural Gas Exchange, Inc., also 

 2 known as --- 

 3 CHAIRMAN GENSLER: You might want to 

 4 move the mic a little bit closer. 

 5 MR. KRENKEL: Is that better? I am the 

 6 President of Natural Gas Exchange, Inc., also 

 7 known as NGX. We are a Canadian company based in 

 8 Calgary with an office in Houston and have been 

 9 operating in electronic trading and clearing 

 10 facility for energy products since 1994. 

 11 We are a wholly owned subsidiary, the 

 12 TMX Group, which is a leading integrated multi 

 13 class asset exchange group with a history that 

 14 dates back over 150 years. The group subsidiary 

 15 operate cash and derivative markets for multiple 

 16 assets classes, including equities, fixed income, 

 17 and energy, and provide trading markets, clearing 

 18 facilities, data products and other services to 

 19 the global financial community. On behalf of NGX, 

 20 I want to express our appreciation to the 

 21 Commission for providing us with an opportunity to 

 22 participate in the hearing here today. 

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 1 As I mentioned, we provide trading and 

 2 clearing services for natural gas, electricity, 

 3 and oil products at various markets in North 

 4 America. The focus of our business is in the 

 5 physical energy space, specializing in physical 

 6 clearing of natural gas contracts. Our products 

 7 are designed to be fungible with the OTC markets. 

 8 We have a combination of reasonably well 

 9 established, but also operate a number of emerging 

 10 marketplaces. In terms of size, we're a 

 11 relatively small player in the overall North 

 12 American energy markets, but are very significant 

 13 in the Canadian physical markets. 

 14 Our traded and cleared volumes are 

 15 currently 1140 BCF a month of natural gas, which 

 16 we're very proud of, and it's a big number by 

 17 Canadian standards, but represents about one day 

 18 of activity on the CME or ICE. In addition, five 

 19 terawatt hours of electricity and five million 

 20 barrels of crude oil. Just as a matter of 

 21 interest, about 50 percent of Canadian gas and oil 

 22 production is actually exported through the U.S., 

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 1 so our energy markets are extricably linked, even 

 2 though we're located in Canada. 

 3 With respect to the issues here today, 

 4 rather than read, I thought I should summarize 

 5 exactly what I think our positions are. First of 

 6 all, with respect to significant price discovery 

 7 contracts, we encourage the CFTC to get the scope 

 8 right. 

 9 We do operate a lot of emerging 

 10 contracts, and I don't believe that they would 

 11 necessarily be considered significant. So we may 

 12 have a few contracts that are deemed significant 

 13 and meet all the other criteria, but a lot of the 

 14 emerging contracts were really trying to just 

 15 gather business from the OTC markets. Putting 

 16 limits into place for those may not be 

 17 appropriate. 

 18 With respect to position limits, we 

 19 agree that -- we agree with position limits for 

 20 spot contracts and crude oil and natural gas, that 

 21 means up to the prompt month. We also believe 

 22 that the CFTC is the right authority to set those 

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 1 limits, to ensure that they are fair and 

 2 transparent. The only comment we would make is 

 3 that the limits may need to be flexible and 

 4 responsive as market conditions change. With 

 5 respect to anything forward, beyond the spot 

 6 month, from an NGX perspective, we have very low 

 7 market share there. Putting position limits in 

 8 applicable to our exchange only would perhaps 

 9 serve to just drive that business away from the 

 10 exchange. So unless the position limits can be 

 11 applied to the OTC markets, they don't really make 

 12 sense for the amount of business we have in our 

 13 exchange. 

 14 As far as the so called hedger 

 15 exemption, again, with respect to our business, we 

 16 have seen some non- commercial start to 

 17 participate in our market. They bring the welcome 

 18 liquidity that's badly needed in some of our 

 19 energy contracts. Without liquidity, the business 

 20 tends to move into the bilateral or the OTC 

 21 market, so in order for the exchanges and the 

 22 clearinghouses to be successful, we need 

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 1 liquidity. 

 2 At present, the hedgers, we've not seen 

 3 nearly the volume impact that some of the other 

 4 exchanges have, and our view is that, at this 

 5 time, there's no real need to change the hedger 

 6 exemption requirements applicable to our markets. 

 7 Again, I think this is in addition to 

 8 the testimony I filed, okay. I'll close here. 

 9 And I want to thank you for the opportunity to 

 10 share our views today, and I'm happy to answer any 

 11 questions that the exchange may have. 

 12 CHAIRMAN GENSLER: Thank you so much. 

 13 And our last witness, Mr. -- is it --- 

 14 MR. FELESKY: Felesky. 

 15 CHAIRMAN GENSLER: Felesky. 

 16 MR. FELESKY: Thank you, Mr. Chairman 

 17 and fellow Commissioners. My name is Adam 

 18 Felesky, Chief Executive Officer of BetaPro 

 19 Management, Inc., the Trustee and Manager of the 

 20 Horizon BetaPro ETF's, which are listed on the 

 21 Toronto Stock Exchange and are the fastest growing 

 22 family of exchange traded funds in Canada. 

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 1 I'd first like to thank the Commission 

 2 for this opportunity as an international ETF 

 3 provider to share our views as relates to the 

 4 Commission's review of the application of position 

 5 limits and exemptions in the energy marketplace. 

 6 Specifically, we support any regulatory 

 7 action that would improve transparency of all 

 8 market participants, including ETF's in order to 

 9 eliminate the potential for excessive speculation 

 10 and market manipulation. The Horizons BetaPro 

 11 ETF's currently have assets in excess of $2.5 

 12 billion amongst 38 ETF's, 14 of which are 

 13 commodity based and six of which are specifically 

 14 linked to natural gas and crude oil. We 

 15 specialize in offering currency hedged exposure, 

 16 both long and short, and we're the first managers 

 17 to offer such products for commodities in North 

 18 America. All of our ETF's are rebalanced daily, 

 19 which limits an investor's risk to the capital 

 20 invested. 

 21 Several of our commodity based ETF's 

 22 have been or are the most actively traded 

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 1 securities on the Toronto Stock Exchange, and 

 2 currently they count for over 37 million shares 

 3 traded each day. This translates in tremendous 

 4 and substantial daily liquidity into the 

 5 underlying futures market. 

 6 Our commodity based ETF's are in the 

 7 aggregate investments of thousands of investors 

 8 acting independently. And to our knowledge, no 

 9 one investor has indirectly obtained a significant 

 10 position in any one of our commodity based EFT's. 

 11 As an example, as of July 24, 2009, our energy 

 12 long EFT's, which had on average 35,000 unit 

 13 holders per ETF, held less than.51 contracts per 

 14 investor. 

 15 In addition, a majority of our commodity 

 16 investors use our short ETF's to hedge the risk in 

 17 their long equity portfolios. As a further 

 18 illustration, I'd like to speak to the role our 

 19 commodity ETF's had during the 2008 price 

 20 appreciation of crude oil to the high of $147. We 

 21 ironically launched the first leverage long and 

 22 short crude oil ETF's in North America on January 

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 1 16, 2008. On that date, the price of oil was 

 2 roughly $90. 

 3 On July 11, 2008, when crude oil peaked 

 4 at 147, only six months after we had launched 

 5 these products, our Horizons BetaPro NYMEX crude 

 6 oil Bull Plus ETF held less than 100 million in 

 7 notional long exposure or 450 contracts, while our 

 8 Horizons BetaPro NYMEX crude oil Bear Plus fund 

 9 had soared to approximately 600 million in 

 10 notional short exposure, or short 3,850 contracts. 

 11 Clearly, our investor saw a significant 

 12 opportunity to hedge their long equity positions 

 13 after such a dramatic increase in the price of 

 14 crude oil. Our data continues to show that our 

 15 commodity based ETF's attract sellers when 

 16 commodity prices are rising and buyers when 

 17 commodity prices are falling. 

 18 Instead of being a source of volatility, 

 19 our commodity based ETF's have proven to be a 

 20 source of price stability. For example, our 

 21 designated market maker has seen trading activity 

 22 levels were on counter to the price of crude oil 

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 1 69 percent of the time since the inception of our 

 2 ETF's. To address the Commission's primary 

 3 concern regarding transparency and disclosure 

 4 about the positions held by individual investors, 

 5 we believe the focus should not be on the holdings 

 6 of the ETF, but on the holdings of its individual 

 7 investors. 

 8 To void any concerns about excessive 

 9 speculation or market manipulation, we suggest the 

 10 CFTC might want to consider the following; one, 

 11 requiring disclosure to the CFTC by ETF's of any 

 12 investors who indirectly hold investments with a 

 13 dollar value that is more than a specified level 

 14 of the speculative limit on a regular basis; two, 

 15 mandating any investor in such ETF's to notify the 

 16 manager if their investment at any time exceeds 

 17 100 percent of the current dollar value of the 

 18 speculative limit; and finally, three, requiring 

 19 the managers of such ETF's to have the ability to 

 20 force an investor to redeem all or a portion of 

 21 their investment so that investors do not exceed 

 22 any speculative limit adopted by the CFTC. 

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 1 We believe that implementing these 

 2 requirements, which will require the involvement 

 3 of the applicable regulatory authority such as the 

 4 SEC, and in our case, the Ontario Securities 

 5 Commission, can provide a viable solution whereby 

 6 the CFTC can effectively monitor the users of 

 7 ETF's without having an adverse impact on the 

 8 marketplace. In summary, we strongly believe that 

 9 our commodity based ETF's provide a cost 

 10 effective, transparent, liquid, limited risk 

 11 alternative for investors who want to access the 

 12 commodity markets while playing an integral role 

 13 in enhancing the underlying liquidity of those 

 14 markets. 

 15 We also believe our commodity based 

 16 ETF's are one of the most accessible investment 

 17 tools for the public who want to hedge against 

 18 potential commodity appreciation. To ensure there 

 19 are no concerns about excessive speculation, 

 20 market manipulation regarding ETF's, we fully 

 21 support any regulatory effort to increase 

 22 transparency of individual investor positions 

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 1 within ETF's. Thank you, and I look forward to 

 2 your questions. 

 3 CHAIRMAN GENSLER: I thank our 

 4 panelists. I'll try to also live with the five 

 5 minute rule and we'll see how many rounds we have. 

 6 Even though the day is going on, we might have a 

 7 couple of rounds here. I was interested a little 

 8 bit, Mr. Krenkel, in what you said about operating 

 9 your exchange. You said that you're supportive of 

 10 setting position limits in the spot month or near 

 11 month, but I'm not sure I really followed where 

 12 you were on sort of a combined month approach, and 

 13 if you -- because so often where you sit is where 

 14 you stand. If you had our job, would you be 

 15 looking at setting position limits on a combined 

 16 month basis to protect against concentrated 

 17 economic effects in these markets? 

 18 MR. KRENKEL: Right, yeah. We have, 

 19 just to give you a little perspective on my 

 20 answer, we have the bulk of our liquidity --- 

 21 CHAIRMAN GENSLER: Again, you might pull 

 22 that a little closer. 

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 1 MR. KRENKEL: -- the bulk of our 

 2 liquidity is really in the spot contracts on 

 3 natural gas. And we have a very large market 

 4 share with the OTC market there. It makes sense 

 5 from our perspective to put position limits into 

 6 place from a market perspective, also from a 

 7 clearing perspective. Once we get beyond month 

 8 two, we have a very small level of liquidity. 

 9 CHAIRMAN GENSLER: No, I understood that 

 10 you all had a small liquidity, so it might not be 

 11 as relevant on your exchange, so I was looking for 

 12 if you -- as a market participant and in 

 13 knowledgeable markets, what do you think is 

 14 appropriate? 

 15 MR. KRENKEL: Right, yeah. I think if 

 16 you can manage those limits across the OTC market, 

 17 then they can be effective. If they apply to the 

 18 exchange business only, you've recreated sort of 

 19 an unlevel playing field. 

 20 CHAIRMAN GENSLER: I think I understand. 

 21 So, yes, if we could do position limits that 

 22 include over-the- counter derivatives, as well, 

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 1 and find a way to do that --- 

 2 MR. KRENKEL: Right. 

 3 CHAIRMAN GENSLER: -- but your concern 

 4 is greater if it was only on the traded markets? 

 5 MR. KRENKEL: Yeah, that's correct. 

 6 CHAIRMAN GENSLER: Mr. Felesky, in 

 7 reading your testimony, you talked about a concern 

 8 of what you said fractionalization, and our 

 9 earlier panel of witnesses, one member talked 

 10 about splintering of the market, and I'd like to 

 11 explore that a little bit more, because I think if 

 12 you had a diversity of investors, diversity of 

 13 speculators in a market, that the market might -- 

 14 that might promote liquidity rather than having 

 15 one or two or even three large participants who, 

 16 in a sense, are so concentrated, they might be 

 17 detracting from markets rather than enhancing 

 18 markets. So I'd just like to understand your 

 19 thinking. 

 20 MR. FELESKY: Sure, thanks for the 

 21 question. I think what we're referring to is, if 

 22 position limits were imposed and they were done at 

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 1 the ETF level, for example, the majority of our 

 2 clients are Canadians, if the limit was imposed on 

 3 the ETF level, there would be the potential, 

 4 depending what that limit was, that we would have 

 5 to take our existing exchange rate fund and create 

 6 five or ten versions of that same fund to 

 7 facilitate the demand for those same investors. 

 8 So it's a fractionalization of the ETF's 

 9 themselves. I don't see the end user being a 

 10 greater amount of individuals just because you've 

 11 increased the amount of ETF's. I think the end 

 12 user is still the same people. So the result is a 

 13 way higher burden of cost to the investors because 

 14 you don't have the economy scales of that ETF. 

 15 CHAIRMAN GENSLER: But our agricultural 

 16 federal limits originally were set at ten percent 

 17 of the open interest up to a certain level, 25,000 

 18 contracts, and two and a half percent afterwards, 

 19 so one could think there has to be at least a 

 20 minimum number of ten or 11 speculators on any 

 21 side of the market because the inverse of ten 

 22 percent. Are you suggesting that a market that's 

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 1 concentrated that only has three speculators is 

 2 more liquid than if you have 12, 15, 20? 

 3 MR. FELESKY: Absolutely not, I 

 4 completely agree with your comments. My point is, 

 5 we have -- let's just take an example. For our 

 6 natural gas products, we have 40,000 unit holders. 

 7 If we have -- if we create ten more of those same 

 8 ETF's, those 40,000 unit holders will just be 

 9 divided amongst those products, because they'll 

 10 have all the same investment objectives. So if 

 11 the 40,000 went to 50,000, which is more unit 

 12 holders, more speculators, that's a good thing, 

 13 that's no different if it -- the effect into the 

 14 market is no different if it's one ETF or across 

 15 ten. 

 16 CHAIRMAN GENSLER: I'm going to switch 

 17 over to Commissioner Dunn, but I may follow up 

 18 after at my next chance. 

 19 COMMISSIONER DUNN: Thank you very much, 

 20 Mr. Chairman. Peter, you are -- your home 

 21 regulator is from Alberta, Canada, is that --- 

 22 MR. KRENKEL: Yeah, the Alberta 

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 1 Securities Commission, yes. 

 2 COMMISSIONER DUNN: Alberta Securities 

 3 Commission; but you are also an ECM and recognized 

 4 as a DCO? 

 5 MR. KRENKEL: That's correct, yes. 

 6 COMMISSIONER DUNN: Okay. I'm 

 7 interested to know how that works. 

 8 MR. KRENKEL: Yeah; it's pretty 

 9 manageable for us as an organization. We, you 

 10 know, we're domiciled in Canada, we're in the 

 11 province of Alberta, hence, our lead regulator is 

 12 the Alberta Securities Commission. Their rules 

 13 and principals are actually quite closely aligned 

 14 with those of the CFTC. We have clients, you 

 15 know, both sides of the border, do business across 

 16 the border, and so we chose the path of seeking 

 17 recognition with the CFTC, as well. 

 18 COMMISSIONER DUNN: When we promulgate 

 19 new regulations or change things, how does that 

 20 work with you and your lead regulator? 

 21 MR. KRENKEL: Well, I think, you know, 

 22 we'd have to understand exactly what direction you 

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 1 were going, but it would apply to all our market 

 2 participants. We'd have to make, you know, the 

 3 necessary rule book changes and get our regulator 

 4 to cooperate with you. 

 5 COMMISSIONER DUNN: So you are saying in 

 6 this age of globalization, it is really important 

 7 for us to have a good relationship with our sister 

 8 regulators in other countries; is that --- 

 9 MR. KRENKEL: Yeah, and vice versa. 

 10 COMMISSIONER DUNN: And vice versa. We 

 11 often hear that, when we do something here in the 

 12 United States on our regulation, that that is 

 13 going to result in flight, that someone is going 

 14 to go to another country, and you've got a home 

 15 base, or you've got an operation in Houston; is 

 16 that --- 

 17 MR. KRENKEL: Yes, we have an office 

 18 there, yes. 

 19 COMMISSIONER DUNN: -- as well; do you 

 20 see that as a viable threat, that if we make 

 21 things too onerous in the area of position limits 

 22 or other things, that folks may run to Canada to 

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 1 other countries? 

 2 MR. KRENKEL: No, I don't think that's 

 3 likely to happen. Certainly, I don't think they 

 4 can run to Canada. There may be other places in 

 5 the world that they can go to. My concern is more 

 6 that they'll run away from the structured markets 

 7 into the OTC market either in Canada or the U.S. 

 8 COMMISSIONER DUNN: Adam, do you have 

 9 some thoughts on that? 

 10 MR. FELESKY: That's really outside of 

 11 our expertise as an ETF provider. 

 12 COMMISSIONER DUNN: John, I appreciated 

 13 your paper, and we've been referring to spec 

 14 limits as kind of a stop sign. You're calling it 

 15 just a speed bump. Could you kind of amplify on 

 16 that a little bit? 

 17 MR. LOTHIAN: Well, if I can't --- if 

 18 there's a limit here, you know, say there's a 

 19 limit in wheat, I'm going to go find another wheat 

 20 market where I can lay off some of the positions 

 21 to get that same exposure. Wheat, on a global 

 22 trade, for example, is a very fungible product. 

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 1 Every country grows it and uses it. 

 2 Back when --- referring to the grain 

 3 embargo of '79, there was a USDA study that found 

 4 that basically it's a fungible product world-wide, 

 5 and so us not selling to the Russians actually 

 6 didn't deprive them of any wheat, it just meant 

 7 that a bunch of other trading partners traded here 

 8 or there. So if that's what's happening on a 

 9 commercial basis, that's what's going to happen on 

 10 an investment hedger basis, as well. 

 11 The, you know, if I'm a fund manager and 

 12 I'm up against position limits, I'm either going 

 13 to go to the OTC market to lay it off or I'm going 

 14 to go find another venue in a regulated market in 

 15 another location in order to do it. I'm not going 

 16 to send the money home, okay, I'm going to find 

 17 some place to invest it. 

 18 MR. FELESKY: Commissioner Dunn, I would 

 19 just add to that as -- John referred to the fund 

 20 manager. At the end of the day, the fund manager 

 21 of the ETF, the speculator is going to go where 

 22 there's liquidity. So the question is, if any 

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 1 regulation was imposed that was so dire that the 

 2 liquidity moved somewhere else, and then I think 

 3 it becomes more of a risk that the flows move 

 4 elsewhere, but until the liquidity moves 

 5 elsewhere, no one is going to move their business 

 6 elsewhere. So it's a chicken in the egg, and I 

 7 think it's going to be more of a function of the 

 8 policy and how aggressive it is. 

 9 CHAIRMAN GENSLER: Commissioner Sommers. 

 10 COMMISSIONER SOMMERS: Thank you, Mr. 

 11 Chairman. I think I want to follow up on the same 

 12 line, but a concept that Mr. Lothian had in his 

 13 testimony with regard to exposure through cash 

 14 settled contracts rather than the physically 

 15 settled contracts, and to talk a little bit about 

 16 whether or not that is appropriate for people that 

 17 are just looking for passive exposure. If they're 

 18 out of the physically delivered contract, does 

 19 that help? 

 20 MR. LOTHIAN: Well, I think it does. I 

 21 mean the issue is that we've seen some of these 

 22 physically deliverable contracts have tremendous 

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 1 exposure to this investment money. I think that 

 2 that has changed the behavioral aspects of some of 

 3 those commodities, because such a large dominant 

 4 player is not acting by the rules of the market 

 5 that I grew up with, okay. When the market goes 

 6 up, you take profits, okay. 

 7 So basically, to use the wheat example 

 8 again, you have an index investor coming in 

 9 investing across a broad index, price of wheat 

 10 goes up, some other things might go down, some 

 11 other things might go up, we're not responding 

 12 like a traditional speculator and selling out the 

 13 wheat and taking profits, they're looking at the 

 14 entire index as a whole and saying, oh, things are 

 15 going up, we're going to invest more money. 

 16 And so you've got this aggregate demand 

 17 type of approach to commodities as an asset class, 

 18 which I believe has changed some of the dynamics 

 19 of some of the markets. The markets are adapting 

 20 to that, but it becomes critical when you get into 

 21 the delivery period. And so I think cash settled 

 22 contracts as proxies for that investment money is 

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 1 a good thing so as not to interfere with the 

 2 delivery process. 

 3 COMMISSIONER SOMMERS: Thank you. Can 

 4 the other panelists address that and what you 

 5 think about -- especially Mr. Felesky, the passive 

 6 investment in cash settled contracts rather than 

 7 physically settled? 

 8 MR. FELESKY: I think a lot of the 

 9 panels yesterday and this morning spoke to the 

 10 fact that, in particular our business, in 

 11 commodity exchanged traded ETF's, our funds, for 

 12 the most part, are positioned in the nearby 

 13 futures contract on the long side. And the 

 14 effect, if any, is to, when we roll, is to sell 

 15 the nearby and buy the next one. So the net 

 16 effect to the end consumer in the physical market, 

 17 if anything, is a downward pressure on the nearby 

 18 contract. 

 19 MR. KRENKEL: I've got nothing further 

 20 to add. 

 21 MR. LOTHIAN: I'd just like to add to 

 22 that, though, that in some instances, the index 

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 1 players have become such large, dominant players 

 2 that they are the fundamental in the marketplace, 

 3 and so the traders are playing the role, as it 

 4 were, for the index players because that's the 

 5 dominant theme in the marketplace, that's the 

 6 dominant flow in the marketplace, as opposed to 

 7 perhaps the cash futures convergence, and so that 

 8 element of it can get overwhelmed. In fact, you 

 9 know, several years ago, when we saw wheat prices 

 10 spike, part of the problem was that the pit 

 11 traders were all situated one way in the market to 

 12 take advantage of the role, and when Australia 

 13 said, hey, we have some problems with our crop and 

 14 some other problems cropped up around the world, 

 15 and all of a sudden the nearby prices shot up and 

 16 these wheat traders lost not only what they made 

 17 this year, but what they made last year, as well, 

 18 thus decreasing the available capital to, you 

 19 know, absorb, you know, fluctuations in the 

 20 market. 

 21 MR. FELESKY: If I could just add, 

 22 because I think this is a discussion that's had a 

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 1 lot of commentary from the perspective of index 

 2 players and commodity ETF's and their impact and 

 3 roles; the one thing that I think everyone has to 

 4 remember is that specifically contango, which is 

 5 the term referred to, futures prices being higher 

 6 than the nearby, it's something that's existed in 

 7 the marketplace forever. In fact, crude oil is in 

 8 contango 60 percent of the time, and natural gas 

 9 is in contango over 80 percent of the time. And 

 10 then in particular, when you see huge price 

 11 appreciations, you'll tend to see larger 

 12 backwardation than the historic norms. 

 13 Conversely, when you have huge price 

 14 depreciations, you're going to see larger 

 15 contangos than the norm, and that's just 

 16 factually -- 

 17 CHAIRMAN GENSLER: Commissioner Chilton. 

 18 COMMISSIONER CHILTON: Thanks, Mr. 

 19 Chairman. Mr. Felesky, you've talked about 

 20 individual investors being monitored by the 

 21 agency, but is there some level at all that you 

 22 think ETF's should be monitored? I mean at what 

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 1 point --- do you think there should be some 

 2 additional regulation or do you think there 

 3 shouldn't be any at all? 

 4 MR. FELESKY: I mean I really don't see 

 5 us any different in some ways as the swap dealer 

 6 or the exchange that's effectively processing 

 7 trades. We, as an entity, are not making any 

 8 investment decisions, we're just an aggregate of 

 9 these thousands of investors. And if you impose 

 10 the limit specifically on the ETF itself instead 

 11 of the individual, I think you discriminate 

 12 against that tool versus the futures market, for 

 13 example. 

 14 COMMISSIONER CHILTON: Eighty percent of 

 15 open interest is okay? 

 16 MR. FELESKY: Our view is that it's all 

 17 about the end user, and that if the end user is 

 18 using the instruments to achieve a position that 

 19 exceeds the speculate limit that you set, 

 20 absolutely, they should be forced down to reduce 

 21 their position. 

 22 COMMISSIONER CHILTON: Do you believe 

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 1 that accountability levels have any deterrent 

 2 effect on ETF's trading currently? 

 3 MR. FELESKY: I think they do. I think 

 4 everyone looks at different marketplaces to ensure 

 5 that their exposure isn't concentrated in one 

 6 exchange. 

 7 COMMISSIONER CHILTON: How about the 

 8 other panelists on that sort of line of 

 9 questioning? Mr. Lothian Mr. Krenkel. 

 10 MR. LOTHIAN: Well, the question that I 

 11 ask is, can I, as an investor, accomplish what I 

 12 want to accomplish in a different way? Can I 

 13 substitute an individual account with a broker 

 14 buying gold as opposed to buying gold ETF, and the 

 15 answer to that is yes, okay. So what we have done 

 16 is, we have created products which have made it 

 17 easier for people to be able to accomplish 

 18 specific investment goals. 

 19 If we prevent them from making it 

 20 easier, are they going to stop doing that? No, 

 21 they're just going to have to pay a little bit 

 22 higher price or do it in a different way. Now, 

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 1 futures trading is not for everyone, okay, that's 

 2 one of the reasons why we have products like ETF's 

 3 that take some of the risk out of that and manage 

 4 it in a better way. Index funds do the same type 

 5 of a thing, particularly where they're having 

 6 investors put up 100 percent of each and every 

 7 contract trading. So they're doing it in a 

 8 slightly different way that perhaps is a better 

 9 risk profile for those particular customers. 

 10 But are those customers, are those 

 11 investors going to say, well, you know what, China 

 12 is accumulating large amounts of commodities, and 

 13 I think that this is going to go up for a while, 

 14 and I think the price of the dollar is going to go 

 15 down, and I want to own commodities. Now, am I 

 16 going to be stopped from doing that because I 

 17 can't buy an ETF? No, I'm just going to go into 

 18 something else. 

 19 COMMISSIONER CHILTON: Mr. Krenkel. 

 20 MR. KRENKEL: Yeah; I mean we haven't 

 21 seen the impact of the ETF's on our market that 

 22 perhaps some of the other market participants have 

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 1 seen, so we don't really --- 

 2 COMMISSIONER CHILTON: And you're mainly 

 3 spot month anyway. 

 4 MR. KRENKEL: Exactly; and spot month 

 5 and in sight, so it's not a big concern for our 

 6 market. But, yeah, my concern would be if they 

 7 are faced with position limits, does that just 

 8 result with them moving their business somewhere 

 9 else? 

 10 COMMISSIONER CHILTON: I mean just 

 11 something for you to think about. I mean, to me, 

 12 80 percent of anything is too much, so --- 

 13 MR. KRENKEL: Yeah. 

 14 COMMISSIONER CHILTON: But if you have a 

 15 large percentage, and whatever number it is, and 

 16 people understand that you have this large 

 17 percentage, in part because with an ETF, you're 

 18 reporting, it's more transparent, which I think is 

 19 good, and everybody knows when you're going to do 

 20 your role, you have to be crazy not to be thinking 

 21 about that if you're in the market. So I think 

 22 it's having -- it can have at least a theoretical 

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 1 possibility of having an impact. Anyway, my time 

 2 is about to expire, I won't let it beep on me. 

 3 MR. FELESKY: I don't think any of us 

 4 would deny that there's a theoretical impact; in 

 5 fact, there is an impact. But I think the beauty 

 6 of the marketplace, particularly our marketplace 

 7 in the commodity exchange rate fund is, it's 

 8 completely arbitragible between the physical 

 9 market, and this whole role phenomenon I think is 

 10 being dramatically overplayed as the physical 

 11 market can quickly take advantage of that, and we 

 12 saw that this spring with people putting an 

 13 immense amount of commodity, particularly crude 

 14 oil, into storage. 

 15 CHAIRMAN GENSLER: If I could ask Mr. 

 16 Lothian; did I get it? 

 17 MR. LOTHIAN: You can't say it, can you? 

 18 CHAIRMAN GENSLER: John. 

 19 MR. LOTHIAN: John. 

 20 CHAIRMAN GENSLER: How do you pronounce 

 21 your name? 

 22 MR. LOTHIAN: Lothian. 

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 1 CHAIRMAN GENSLER: Lothian; Mr. Lothian, 

 2 do you think that, as I'm hearing this back and 

 3 forth and reading your testimony, did I hear that 

 4 you feel that index investment has had an 

 5 influence on the marketplace? 

 6 MR. LOTHIAN: Yes. 

 7 CHAIRMAN GENSLER: And as it relates to 

 8 the wheat market, if I can just get your expert 

 9 advice there, do you think that it's been a 

 10 contributing factor to the lack of wheat 

 11 convergence at times, you know, in this past 

 12 couple of years as wheat convergence problems have 

 13 existed? 

 14 MR. LOTHIAN: I think that there's a 

 15 number of factors that are involved with the wheat 

 16 convergence problems. I think that the large 

 17 passive long in the market is a factor. You know, 

 18 one of the things that I believe has happened 

 19 because of the billions of dollars that have 

 20 flowed into index funds is that, you have an 

 21 algebra problem, okay, you have a lot of X and not 

 22 enough Y, okay, and in particular, because you've 

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 1 had all of this money flow in, you kind of have a 

 2 natural balance of long hedgers and short hedgers, 

 3 okay. 

 4 So here you have a natural long, 

 5 passive, non- manipulative that's in the 

 6 marketplace, and there's a natural short hedge 

 7 that's going to participate in the market that's 

 8 going to match up with that long hedge, okay. So 

 9 as you get more and more money flowing into this 

 10 market, the quality of the short hedger 

 11 capitalization, you know, whatever, decreases, 

 12 okay. And that, I believe, leads to increased 

 13 volatility, okay. 

 14 There's other things that, you know, is 

 15 there a concentration in, you know, in the grain 

 16 elevator business and all of that, are there 

 17 enough locations that are actively participating 

 18 in this, are those locations making more money 

 19 pumping out corn, you know, through them, or 

 20 soybeans, or other products as opposed to wheat? 

 21 It's great that, you know, you can make a nickel, 

 22 you know, storing wheat, but can I make a dime 

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 1 three times over doing something else? And if you 

 2 don't have enough capacity to be able to switch 

 3 and manage that, then you're going to have some 

 4 problems. 

 5 You know, there's a lot of participants 

 6 in the market. I mean we talk about high 

 7 frequency traders and all this kind of stuff that 

 8 are participating in the market that are just 

 9 looking for certain algorithms and patterns and 

 10 all of this kind of thing as opposed to people 

 11 that had more of an opinion about the market. 

 12 CHAIRMAN GENSLER: Let me, because I 

 13 might only get one more question, so I thank you, 

 14 but I heard a yes, you think that --- 

 15 MR. LOTHIAN: It's a factor. 

 16 CHAIRMAN GENSLER: -- it's a factor. 

 17 Could I turn back to Mr. Felesky and follow up on 

 18 Commissioner Chilton's question about whether 

 19 there's any size that could be too large, and ask 

 20 you again to think about clearinghouses and 

 21 markets, exchanges, both clearinghouses and 

 22 exchanges, not when the skies are clear and the 

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 1 sun is out, but when we get to stormy times, or 

 2 when we get to hurricane season like we've seen in 

 3 financial markets in the last nine months. Isn't 

 4 it the case that a large concentrated position, 

 5 whether it's 80 percent, 50 percent, or even 20 

 6 percent is harder to liquidate and distorts the 

 7 market more in stormy times than if it's a two 

 8 percent position, or an eight percent position? 

 9 MR. FELESKY: I think a couple things; 

 10 one, I think you're assuming that if the end unit 

 11 holder who is our end client, if he's not in our 

 12 fund, he's not participating in any other manner. 

 13 CHAIRMAN GENSLER: I wasn't assuming 

 14 anything except for I was wondering whether a 50 

 15 or 80 percent market participant, whether it's an 

 16 ETF, whether it's a swap dealer, whether it's a 

 17 hedge fund, anybody, needs to liquidate in a 

 18 difficult market environment, whether you think 

 19 the CFTC should take that into consideration when 

 20 we're thinking about position limits. 

 21 MR. FELESKY: I have no problem with 

 22 that as a consideration in your discussions. 

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 1 CHAIRMAN GENSLER: Thank you. 

 2 Commissioner Dunn. 

 3 COMMISSIONER DUNN: Thank you. Mr. 

 4 Felesky, in your written testimony, you indicated 

 5 that if there is any direct impact emanating from 

 6 your long commodity based ETF activities, that it 

 7 would exert a downward effect on price and a 

 8 moderate upward price pressure. If true, does 

 9 this downward pressure tend to distort -- to be a 

 10 distortion of price discovery process? 

 11 MR. FELESKY: A couple things; one is 

 12 how the mechanic of our product actually works, I 

 13 think is what I was referring to in our long ETF's 

 14 ruling from the current nearby to the next, which 

 15 would impact the nearby contract by pushing that 

 16 price down. How that converged to spot I guess is 

 17 the question, and I'll leave it to experts in the 

 18 industry to talk specifically about that. 

 19 However, I think the other question or 

 20 the other data points you can look at is just our 

 21 history of our asset flows, which, you know, 

 22 through the whole dramatic increase in commodity 

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 1 prices, saw huge net inflows in our short ETF's 

 2 resulting in downward pressure of selling as the 

 3 commodity appreciated, and conversely you're 

 4 seeing a support in commodity prices today as our 

 5 flows come in from the buy side. That said, 

 6 natural gas as an example, both in Canada and our 

 7 competitor here in the United States, we've seen 

 8 substantial inflows of assets, but natural gas has 

 9 still managed to fall approximately 40 percent in 

 10 that time. 

 11 COMMISSIONER DUNN: Mr. Lothian, you say 

 12 in your testimony here that position limits should 

 13 be set dramatically by the Commission. 

 14 MR. LOTHIAN: Dynamically. 

 15 COMMISSIONER DUNN: Dynamically, excuse 

 16 me, by the Commission, not dramatically. It may 

 17 be some dramatically. On a regular, pre-defined 

 18 interval, the Commission should take into 

 19 consideration the size of the participation of 

 20 commercial and financial hedgers and the 

 21 volatility of the market. 

 22 The Commission should have the ability 

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 1 to set divergent position limits for long and 

 2 short speculators. When prices rise, the 

 3 Commission should set the short speculative 

 4 position limits at higher levels than long 

 5 position limits; the position limits for 

 6 speculators should be a fixed number of contracts 

 7 for that particular interval; and limits should be 

 8 applied to all months with different intervals set 

 9 separately for delivery months, spreads should be 

 10 counted on gross basis against the limit, meaning 

 11 a long and short is two contracts, and that's 

 12 something I'd like to explore, but how onerous 

 13 would it be for the Commission to do that? How 

 14 many people are we going to need? You and I have 

 15 talked in the past about the resources we have 

 16 here. 

 17 MR. LOTHIAN: Right; I think that that 

 18 is something that an advisory committee made up of 

 19 industry participants across the spectrum could 

 20 make a recommendation to the Commission on. I 

 21 think that's where the expertise would be and 

 22 could be utilized for setting the dynamic limits, 

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 1 that is. 

 2 COMMISSIONER DUNN: Could you amplify a 

 3 little bit on counting the spread? 

 4 MR. LOTHIAN: Well, you can put on a 

 5 very large position when you have a spread on as 

 6 opposed to an outright position. And a spread is 

 7 not necessarily a -- is not necessarily less 

 8 risky. In fact, if you look at the disclosure 

 9 document you have to sign when you open an 

 10 account, it'll tell you just that as much, okay. 

 11 There's a lot of people that have the 

 12 idea that just because they're spread, that 

 13 they're somehow protected. I have some nasty 

 14 stories to tell about spreads that -- for a 

 15 non-public hearing. But the -- I think that 

 16 people tend to put on larger positions on spreads 

 17 because they feel like they have less risk, and 

 18 that's not always the case, so I think that it 

 19 needs to be -- it needs to be measured in a way 

 20 that represents that risk that they're taking. 

 21 COMMISSIONER DUNN: (off mike) 

 22 CHAIRMAN GENSLER: Commissioner Sommers. 

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 1 COMMISSIONER SOMMERS: I'm going to 

 2 continue actually down that same path, because I 

 3 had questions from yesterday with regard to how we 

 4 set limits, making it fair for the marketplaces. 

 5 Do you set the limits based on open interest on 

 6 each market so that each market has different 

 7 position limits, or you know, so your dynamic rate 

 8 is interesting to me, if you could talk a little 

 9 bit --- 

 10 MR. LOTHIAN: Well, I think that you 

 11 need to take a look at the entire marketplace, 

 12 both the regulated futures markets and the OTC. 

 13 You know, we talk about the CME having 95 percent 

 14 of the U.S. futures market, but when you look at 

 15 the greater market in which they are trading, both 

 16 from a, you know, OTC market, cash market, and 

 17 global market, it's a much broader playing field. 

 18 And likewise, you have to look at the 

 19 cash market, you have to look at the OTC market, 

 20 as well. It's very easy to do an exchange for a 

 21 physical type of transaction, offsetting your 

 22 futures position by interacting with somebody in 

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 1 the cash market. So the pool that you're looking 

 2 at, if you say you have 80 percent of the futures 

 3 market, you know, it might be just that your 

 4 denominator is wrong. 

 5 COMMISSIONER SOMMERS: Thank you. My 

 6 next question is for Mr. Krenkel, and it's with 

 7 regard to your comment and your testimony on the 

 8 significant price discovery contracts and how that 

 9 -- how that impacts you as an ECM and the 

 10 unintended consequences of an ECM that have 

 11 participation from emerging markets; if you could 

 12 talk a little bit about that. 

 13 MR. KRENKEL: Yeah; as I said earlier, 

 14 our contracts are really all designed to be fully 

 15 fungible with the OTC activity. In fact, they're 

 16 interchangeable in a lot of client's books. So 

 17 what we're simply looking for is a situation where 

 18 there are some limits over here that do not apply 

 19 to the dark part of the market, hence, the 

 20 unintended consequences that it drives business 

 21 away unintentionally, so that was my concern. 

 22 We do --- with respect to the emerging 

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 1 markets, we list a number of contracts where 

 2 they're new, we're trying to standardize some 

 3 things at different market centers, we're trying 

 4 to shepherd the business onto the exchange and 

 5 into the structured clearinghouse. I don't think 

 6 it's appropriate to reach down to those and start 

 7 applying limits. It'll potentially harm the 

 8 development of the markets in terms of bringing 

 9 that business to the exchanges and the 

 10 clearinghouse, so that was really at the root of 

 11 my comments. 

 12 COMMISSIONER SOMMERS: So just to 

 13 clarify, until they become fungible, the limits 

 14 aren't appropriate? 

 15 MR. KRENKEL: Yeah; I feel until they 

 16 become more liquid, the limits may not be 

 17 appropriate, may actually be detrimental to 

 18 development of the market. Liquidity is really 

 19 the key for us, and for any exchange, for that 

 20 matter, but it really makes the exchange function 

 21 and allows the clearinghouse to operate, so we 

 22 don't want to see anything that drives liquidity 

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 1 away from -- particularly in an emerging market, a 

 2 new product for us. 

 3 CHAIRMAN GENSLER: Commissioner Chilton. 

 4 COMMISSIONER CHILTON: Thank you, Mr. 

 5 Chairman. Mr. Lothian, let me go back to this 80 

 6 percent, and forget that it's 80, say it's just a 

 7 large percentage of an ETF, and I don't want to 

 8 pick on our panelists, let's just say you know 

 9 that it's coming up, you know that there's a role 

 10 coming up, what do other traders in the market do 

 11 with that information, if anything, or what could 

 12 they potentially do? 

 13 MR. LOTHIAN: Well, it's kind of like an 

 14 annuity to them because they know that it's there, 

 15 it's contractually within the agreement of the ETF 

 16 or the fund or whatever. In fact -- I mean, you 

 17 know, if I were more involved in that, I would say 

 18 -- what I would do is, go and invest in those 

 19 ETF's and go and invest in those index funds and 

 20 make sure that I knew exactly what the rules were 

 21 for how they were going to do it and then make 

 22 sure that I took that in consideration for my 

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 1 trading. 

 2 It's kind of like selling premium, 

 3 though, with options, it works until it doesn't 

 4 work, and as the experience -- the wheat traders 

 5 back in, I don't know, 2006 found out, that, you 

 6 know, you can collect a lot of premium, but then 

 7 something can happen that changes the rules and 

 8 you can lose it all and more. So, you know, it's 

 9 not a riskless trade by any means. 

 10 COMMISSIONER CHILTON: And to pick up on 

 11 what Commissioner Dunn and Commissioner Sommers 

 12 were asking you about with regard to, you know, 

 13 predefined intervals of setting the position 

 14 limit, I'm curious whether or not you think 

 15 there's any sense in a hard cap position limit 

 16 that might be in tandem with a percentage, as 

 17 Commissioner Sommers is talking about, of open 

 18 interest. Maybe this level, except, you know, in 

 19 this circumstance, because in some of these small, 

 20 you know, fairly liquid markets, you might have a 

 21 high percentage of open interest. I'm just 

 22 curious as to your thoughts. 

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 1 MR. LOTHIAN: You know, again, I think 

 2 that it's difficult to even talk about real 

 3 effective hard limits when you don't have a view 

 4 of the entire market. So if the CFTC doesn't have 

 5 a real good view of what the OTC market size is, 

 6 and a good feel on the cash, then it's very easy 

 7 to set the wrong parameters or the wrong limit for 

 8 that. So I think that you guys need, you know, 

 9 additional authority over those parts of the 

 10 market. 

 11 Greater transparency is a great thing, 

 12 it brings more people into the price discovery 

 13 process, but it's -- there's a broader market out 

 14 there than just the future, so it's very -- it's 

 15 difficult. That's why I think it just needs to be 

 16 a little bit more dynamic. And as I said in my 

 17 comments here, when the markets go up, they're 

 18 advertising for selling, and so we need to perhaps 

 19 be a little bit more responsive in terms of limits 

 20 like that to allow a greater speculative of 

 21 interest even to participate in the market, to 

 22 help, you know, stabilize things. 

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 1 COMMISSIONER CHILTON: So sort of like 

 2 some of the other panelists have suggested, 

 3 whatever we do or potentially do needs to be done 

 4 sort of in tandem with additional legislative 

 5 authority from Congress, otherwise, it could have 

 6 some unintended consequences, at least holds the 

 7 possibility of that. 

 8 MR. LOTHIAN: Right, absolutely. I 

 9 mean, for example, the Commitment of Traders 

 10 Report, you know, it's tremendous information, but 

 11 I think it only tells part of the story, and it 

 12 could tell an exact opposite story if I could see 

 13 the rest of the market and what was going on, so 

 14 it can be very misleading. 

 15 COMMISSIONER CHILTON: Okay, thank you. 

 16 MR. FELESKY: If I could just add to 

 17 John's comment about the role of speculators and 

 18 how we define that, that our investors, I should 

 19 say, played again in 2008, if you look at our 

 20 flows, you look at our major competitor here in 

 21 the United States, who I think is testifying next 

 22 week, it's the same experience. They were a 

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 1 source of price stability. We were all selling 

 2 into the dramatic commodity price appreciation in 

 3 2008. It's just that's what the data is. 

 4 CHAIRMAN GENSLER: Can I just check 

 5 whether my Commissioners want another -- do you 

 6 have a question? Well, I'm going to thank all of 

 7 our witnesses. It's just been fabulous to hear 

 8 from you, to get your perspective. I think we 

 9 might want to follow up, John, you said you wanted 

 10 to say something to us in private about spreads, 

 11 because I don't want to leave that out there, if 

 12 there is something that this Commission needs to 

 13 hear, we'd like to hear that. 

 14 But thank all of you and thank our 

 15 earlier panelists, as well. We're going to, as a 

 16 Commission, come back together in public hearing 

 17 on August 5th at 9:00 a.m. That's probably going 

 18 to be a full day, because, as it turns out, on the 

 19 last day, some people, you know, want to get in, 

 20 and we might have to have three panels on that 

 21 day. 

 22 I think, again, it's just been very 

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 1 helpful. There seems to be a diverse -- within 

 2 this diversity of opinion, still support from the 

 3 exchanges yesterday and even support from some of 

 4 the major market participants today, and another 

 5 exchange for us to consider -- seriously consider 

 6 position limits. There's a lot of debate around 

 7 who said it, what are the numbers, and whether 

 8 there are appropriate exemptions. But this has 

 9 been very helpful for all of us here today, so I 

 10 think this Commission stands adjourned. 

 11 (Whereupon, at 12:34 p.m., the 

 12 PROCEEDINGS were adjourned.) 

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 1 CERTIFICATE OF NOTARY PUBLIC 

 2 I, Carleton J. Anderson, III do hereby 

 3 certify that the forgoing electronic file when 

 4 originally transmitted was reduced to text at my 

 5 direction; that said transcript is a true record 

 6 of the proceedings therein referenced; that I am 

 7 neither counsel for, related to, nor employed by 

 8 any of the parties to the action in which these 

 9 proceedings were taken; and, furthermore, that I 

 10 am neither a relative or employee of any attorney 

 11 or counsel employed by the parties hereto, nor 

 12 financially or otherwise interested in the outcome 

 13 of this action. 

 14 /s/Carleton J. Anderson, III 

 15 

 16 

 17 Notary Public in and for the 

 18 Commonwealth of Virginia 

 19 Commission No. 351998 

 20 Expires: November 30, 2012 

 21 

 22 

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