UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 OPEN MEETING OF THE COMMISSION

 

 

 Washington, D.C.

Wednesday, December 16, 2015
 2 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 22

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 

 8 

 

 9 

 

10 

11 

 

12

 

13 

14 

 

15

 

16 

17 

 

18

 

19 

20 

21 

 

 PARTICIPANTS:

 Commissioners:

 CHAIRMAN TIMOTHY G. MASSAD 

 COMMISSIONER SHARON Y. BOWEN

 COMMISSIONER J. CHRISTOPHER GIANCARLO

 CFTC Staff:

 CHRISTOPHER KIRKPATRICK

 Secretary of the Commission

First Presentation:

 JEFFREY M. BANDMAN

 Division of Clearing and Risk

 JULIE MOHR

 Division of Clearing and Risk

 JAMES ORTLIEB

 Division of Clearing and Risk

 VINCE MCGONAGLE

 Division of Market Oversight

 RACHEL BERDANSKY

 Division of Market Oversight

 DAVID TAYLOR

 Division of Market Oversight

 SUSAN STEWART

 Division of Market Oversight

 Second Presentation:

 JOHN C. LAWTON

 Division of Clearing and Risk
 

 1 PARTICIPANTS (CONT'D):

 2 

 

 3 

 4 

 

 5 

 6 

 

 7 

 

 8 

 9 

 10

 11 

 12

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22

 * * * * *

 3 

RAFAEL MARTINEZ

Division of Swap Dealer and Intermediary

Oversight

FRANCIS KUO

Division of Swap Dealer and Intermediary

Oversight

SCOTT MIXON

Office of the Chief Economist

PAUL SCHLICHTING

Office of General Counsel
 4 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 P R O C E E D I N G S

 (10:33 a.m.)

 CHAIRMAN MASSAD: Good morning. This

 meeting will come to order. This is a public

 meeting of the Commodity Futures Trading

 Commission. I'd like to welcome members of the

 public, market participants, members of the media,

 as well as those taking part on the phone or via

 webcast. Today we have gathered to consider three

 important measures. The first two are proposed

 rules on system safeguards, which will address

 concerns in our markets that relate to

 cybersecurity and technological or operational

 risk. In addition, we will consider a final rule

on margin for uncleared swaps.

 Now, before I discuss these rules

 specifically, I want to take this opportunity to

 thank the CFTC staff for all their hard work and

 dedication. I'd also like to thank my fellow

 Commissioners and their staffs for their

 collaboration and constructive input. I'm very

 pleased that we have avoided the obstruction and
 5 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 division that we too often see in Washington in

 favor of working together constructively on behalf

 of the American people.

 I would also like to take just a moment

 to look back at some of the things we have

 accomplished this year. Our enforcement division

 has continued to do an excellent job holding

 entities accountable for their behavior. We

 brought or resolved actions related to integrity

 of benchmarks, improper behavior such as spoofing,

 traditional scams such as Ponzi schemes and

 failure to comply with reporting obligations.

 Over the past fiscal year, the CFTC's total

 monetary sanctions topped more than $3.2 billion.

 This included an $800 million sanction -- the

 largest in Commission history -- and 69 new

 enforcement actions. The Commission has also been

 very focused on the resiliency of clearinghouses.

 With the increased significance they have taken on

 in the financial system, it is important that we

 make sure they are strong and stable. And in

 addition to our domestic efforts in this regard,
 6 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 we are leading substantial work taking place

 internationally.

 We've also focused on automated trading

-- issuing a proposed rule just a few weeks ago.

 We've continued to implement the Dodd-Frank Act

 reforms and, in particular, Commission staff has

 taken a number of actions to fine tune our rules,

 including in the area of SEF trading. SEF trading

 is still new and we still have significant work

 ahead of us and our objective is to not only

 achieve the statutory goals of transparent and

 competitive trading of swaps on SEFs, it's also

 about making SEFs -- SEF trading -- attractive to

 build participation and create a strong foundation

 on which our markets can thrive. We've also taken

 steps to improve and enhance the reporting of swap

 data, as with our proposal on cleared swap

 reporting.

 And finally, we have continued to focus

 on making sure commercial end users can use these

 markets efficiently and effectively. For example,

 we amended our rules so that publicly owned
 7 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 utility companies can continue to effectively

 hedge their risks in the energy swap market, which

 helps them provide reliable, cost-effective

 service to their customers. We approved a

 modification to the residual interest rule, which

 can affect when customers must post collateral

 with clearing members. We clarified the treatment

 of contracts with embedded volumetric optionality.

 We have also issued some proposals that I hope we

 can finalize soon pertaining to the treatment of

 trade options and exempting end users from certain

 recordkeeping requirements. And in that same

vein, the final rule on margin for uncleared swaps

 that we will consider shortly, exempts end users.

 We included this exemption in our initial proposal

 and, in the course of working together to

 harmonize our rules, the bank regulators agreed to

 change their rule to do so as well.

 I won't attempt to preview all that we

 will be doing next year, but I know we will get

 off to a busy start. I hope, in particular, that

 we can finalize a number of SEF registrations
 8 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 early in the new year and take up certain changes

 to SEF trading rules, including the made available

 to trade determination process later in the year.

 We are also continuing to work toward

 harmonization and mutual recognition with Europe

 and other international regulators. And we're

 continuing to work on ways to ensure the data we

 collect for swaps is more standardized and

 complete.

 These are just a few highlights. There

 is obviously work going on in many other areas.

 But regardless of the area, we will continue

 working to ensure these markets are working well

 for the commercial end users who depend on them.

 Thank you and I now recognize

 Commissioner Bowen for her opening remarks.

 COMMISSIONER BOWEN: Thank you, Mr.

 Chairman, and good morning, everyone. I also

 thank the staff for their hard work -- the time

 that they spent with me and my staff on today's

 rulemakings.

 The two subjects before us today may be
 9 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the most important rulemakings our current

 Commission will tackle. They go to the very heart

 of our clear mandate. As regulators, we are

 charged with protecting the safety and soundness

 of our financial markets and we must do so in a

 way that mitigates the risk we faced during the

 2008 financial crisis. The lens through which I

 view my role is to make sure that the voiceless

 and the most vulnerable, our consumers, investors,

 and the public have a seat at the table.

 To cut to the chase, I support the two

 rule proposals on system safeguards which are

 focused on cybersecurity. We know that without

 effective cybersecurity, we cannot be confident

 that important data will not be compromised,

 therefore raising doubts about the integrity of

 our markets. Therefore, I support both of these

 proposals.

 I cannot, however, support the final

 rule proposal on margin for uncleared swaps. It

 fails to fulfill our clear Congressional mandate

 and I believe its shortcomings could make the
 10

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 financial markets we regulate less safe. We know

 that without rigorous margin requirements it is

 possible that firms will make bad bets that would

 then throw the company's overall financial

 stability into question -- one that could provoke

 a spillover contagion panic, which forces us again

 to grapple with the specter of a new Bear, a new

 AIG, a new Lehman.

 Let me first turn to the two rule

 proposals on system safeguards, which I'm happy to

 support. Entities in our markets are facing an

 unrelenting onslaught of attacks from hackers with

 a number of motives ranging from petty fraud to

 international cyber warfare. In recent testimony

 before Congress, the Director of the Center for

 Cyber and Homeland Security stated that one bank

 they queried noted that in one week it averaged an

 attack every 34 seconds.

 Under our current rule structure, many

 of our registrants have system safeguard

 requirements. Yet, I believe the scope of the

 current cybersecurity risk we face today require
 11

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 us to do more. While some firms are clearly

 engaging in best practices, we have no guarantee

 that all of them are. And as I've said before,

 we're collectively only as strong as our weakest

 link and so we need a high baseline level of

 protection for everyone.

 And while I think the staff has put

 together two thoughtful proposals, and there are

 many aspects of these proposals that I

 particularly like, however, I view this as only a

 first step since all of our registrants -- not

 just exchanges, SEFs, SDRs and DCOs -- need to

 have clear cybersecurity measures in place. I'm

 also very eager to hear what the public has to say

 about these proposals. Thus, I will be voting in

 favor of both. Excuse me one second.

 Now to turn to uncleared margin for

 swaps. I think it's important for us to step back

 and ask ourselves a basic question. What is the

 purpose of mandating margin -- uncleared margin --

 and what was Congress asking us to do? I think

 the answer is clear -- to protect against the next
 12

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 financial crisis, to do our best to prevent the

 incredibly high cost our taxpayers and our global

 financial markets have suffered and continue to

 suffer today.

 In 2008, our financial system was

 brought to its knees as a tidal wave of losses

 washed away the savings of many and destroyed

 confidence in our financial markets. It also

 swept away misplaced confidence about the ability

 of large, sophisticated, financial players to

 manage their own risk. We learned -- or should

 have learned -- how vulnerable our financial

 system is to excessive leverage and poor risk

 management. If more margin had been required for

 swaps, some firms would have had the money they

 needed to unwind some of their bad bets. Fewer

 firms may have needed bailouts and the entire

 crisis may have been mitigated. Instead, with no

 margin for these swaps, Washington had to step in

 in a way that still rankles just about everyone.

 The large players were bailed out by taxpayers and

 returned to regular profits.
 13

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 Our taxpayers had no similar help. No

 recourse to the financial institutions that harmed

 them. No help to pick up the pieces and rebuild a

 financial future. Margin requirements for

 uncleared swaps are a critical safeguard against

 repeating those mistakes. They provide the

 covered entities we regulate for protections

 against counterparty default. In essence, initial

 margin and variation margin appropriately align

 incentives to reduce systemic risks and excessive

 leverage to ensure that parties, in fact, have the

 capacity to meet their obligations.

 In 2010, the Dodd-Frank Act created the

 categories of swap dealers and major swap

 participants. And Congress recognized the higher

 risks swap dealers faced from using uncleared

 swaps. While this rule does have some benefits,

 it is inadequate when compared to our own

 September 2014 proposal and the rule passed by the

 prudential regulators. It puts the very swap

 dealers we regulate in even greater risk in times

 of financial stress because of its treatment of
 14

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 inter-affiliate margin.

 This final rule provides an exemption

 for swap dealers -- excusing them from collecting

 initial margin for inter-affiliate transactions

 they enter into with most affiliated parties.

 This exemption only really affects the very

 largest financial institutions, those that are

 central to our financial infrastructure and at the

 heart of the last crisis. I think this exemption

 is a mistake for three reasons.

 First, how will we know whether the

 entities that will receive this exemption are able

 to understand and communicate internally where

 their risks are? The large financial institutions

 that benefit from this exemption have tremendously

 complicated organizational structures with webs of

 hundreds, sometimes thousands, of affiliates

 spread across the globe. The difference in

 political, financial, and legal systems across

 these interconnected, international affiliate webs

 makes if difficult -- likely impossible -- to

 fully predict how risk will unfold across the
 15

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 global entity in a period of severe financial

 stress.

 This is a major deficiency. As Basel

 and IOSCO highlighted, the increased risk posed by

 uncleared derivatives create the same type of

 systemic, contagion, and spillover risk involved

 in the 2008 financial crisis.

 Second, even if these entities do

 understand the risk, not requiring initial margin

 for inter-affiliate transactions removes a key

 safety feature that protects both the financial

 system and the individual firms in a crisis. By

 not requiring initial margin for this large swath

 of trades, it places the swap dealers we regulate

 and their customers at unnecessary risk in times

 of financial stress. Without this initial margin,

 we lose a vital financial shock absorber that is

 intended to protect an institution against the

 risk of default.

 Third, by not requiring initial margin

 for inter-affiliate swaps, we're going against the

 spirit and, arguably, even the text of Dodd-Frank.
 16

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

Our mandate is to promote the safety and soundness

of swap dealers and to harmonize our rules to the

maximum extent practicable with our prudential

regulators. I see no compelling reason not to do

otherwise.

 We are charged to worry about the

financial health of those entities registered with

us -- swap dealers. The risks we are dealing with

may be remote, but with huge consequences.

Financial wizards have shown that they are not

good at gauging and protecting against these

disastrous events. This action today seems to be

a return to blindly trusting in large financial

institutions' ability and will to manage systemic

risk. And we've already seen where that leads.

 Dodd-Frank was intended to mitigate

against that risk. Our failure to provide

comparable protections for our swap dealers, in

any shape whatsoever, makes little sense to me. I

have seen the devastating effects of the last

financial crisis on everyday citizens who lost

their life savings as a result of excessive risk
 17

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 taking by these complex financial institutions.

 Memories of the crisis may fade, but risks spring

 eternal. I cannot vote for a rule that places the

 swap dealers we regulate -- and most importantly

their customers and the general public -- at risk.

 Accordingly, I will be voting no today.

 CHAIRMAN MASSAD: I recognize

 Commissioner Giancarlo.

 COMMISSIONER GIANCARLO: Thank you. You

 may recall, Mr. Chairman, that during one of our

 very first conversations over a year and a half

 ago, we discussed the growing risk that cyber

 threats posed to trading markets. We agreed that

 cyber and overall system security is one of the

 most important issues facing markets today in

 terms of trading integrity and financial

 stability.

 Earlier this year I called for a

 bottom-up approach to combating cyber threats --

 an approach that involves a close and dynamic

 relationship between regulators and the

 marketplace. It requires the continuous
 18

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 development of best practices, defensive

 strategies, and response tactics through the

 leadership of market participants, operators, and

 self-regulatory organizations. As I see it, the

 job of the CFTC is to encourage, support, inform,

 and empower this continuous development so that

 market participants adopt fully optimized and

 up-to-date cyber defenses. It is appropriate that

 we are now taking up the subject of system

 safeguards. I commend Chairman Massad and the

 CFTC staff for putting forth today's proposal. I

 believe it generally reflects the bottom-up

 approach I advocate and I'm pleased to support it.

 It is right that the proposal covers not

 just designated contract markets, but also swap

 execution facilities. From my experience, SEFs

 are as concerned with cybersecurity as our DCMs.

 Nevertheless, it is true that the rules will

 impose additional costs on some SEFs at a time

 when they are struggling to implement the myriad

 new Dodd-Frank requirements and obligations.

 Because system and cybersecurity should be a
 19

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 priority on registrant's precious time and

 resources, the CFTC must find ways to alleviate

 unnecessary regulatory costs. The best way to do

 this is to correct the flawed swaps trading rules

 that remain fundamentally mismatched to the

 distinct liquidity and trading dynamics of global

 swaps markets. Complying with misbegotten swaps

 trading rules absorbs technical and human

 resources that SEFs need to devote to

 cybersecurity.

 Given the constantly morphing nature of

 cyber risk, the best defenses provide no guarantee

 of protection. Therefore, it would be a perverse

 and unfortunate result if any final system

 safeguards rule were to have a chilling effect on

 robust cybersecurity efforts. Market participants

 who abide by the rule should not be afraid of a

 double whammy of a destructive cyberattack

 followed shortly thereafter by a CFTC enforcement

 action. Being hacked, by itself, cannot be

 considered a rule violation subject to

 enforcement. The CFTC should offer clear guidance
 20

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 to market participants regarding their obligations

 under the rule and designate safe harbors for

 compliance with it.

 As market regulators, we can have no

 naïve illusions that cyber belligerents -- foreign

 and domestic -- view the world's financial markets

 as anything other than 21st century battlefields.

 Cyberattacks on trading markets will not diminish

 any time soon. They will be relentless for years,

 if not decades, to come. Cyber risk is a threat

 for which Dodd-Frank provides no guidance

 whatsoever. Together, market regulators and the

 regulated community must make cyber and system

 security our first priority in time and attention.

 Today's proposal is a constructive step

 toward that goal. I look forward to reviewing

 thoughtful comments from market participants and

 the public. I'd now like to turn to margin

 requirements for uncleared swaps.

 Today's final rule regarding margin

 requirements for uncleared swaps is far from

 perfect. The Commission had the unenviable task
 21

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 of harmonizing its rule with the prudential

 regulators' rules and with the BCBS/IOSCO

 standards. Nevertheless, I think the final rule

 is far better balanced than the previous proposal.

 I direct the public to my detailed written

 statement that will be included in the Federal

 Register, but right now I want to focus on just

 two aspects of the rule -- inter-affiliate margin

 and the economic impact of today's rule.

 An honest discussion of margin

 requirements for inter-affiliate swaps must begin

 with the recognition that inter-affiliate swaps do

 not involve transactions between distinct

 financial institutions that were at the heart of

 the 2008 financial crisis. They do not pose the

 systemic risk that the Dodd-Frank Act was

 ostensibly designed to address. Congress

 expressed no particular intention to subject

 inter-affiliate transactions to clearing or

 inter-affiliate margin.

 Accordingly, the CFTC adopted a rule in

 April 2013 to exempt certain inter-affiliate swaps
 22

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 from mandatory clearing. That rulemaking,

 supported by former Chairman Gensler and

 Commissioners Wetjen, Chilton and O'Malia,

 recognized that inter-affiliate swaps provide an

 important risk management role within corporate

 groups. They enable use of a single conduit on

 behalf of multiple affiliates to net down trades

 and reduce the overall risk of the corporate group

 and the number of outward-facing swaps into which

 the affiliates might otherwise enter. This, in

 turn, reduces operational, market, counterparty

 credit and settlement risk. Rather than

 increasing risk, inter-affiliate swaps allow

 entities within a corporate group to transfer risk

 to the group entity best positioned to manage it.

 Moreover, in 2013, the Commission found

 that the exemption promotes responsible financial

 innovation, fair competition and is consistent

 with the public interest. It further found that

 the exemption, which was conditioned on having

 certain risk mitigating measures in place, would

 not have a material effect on the Commission's
 23

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ability to discharge its regulatory

 responsibilities.

 I believe the Commission's 2013 findings

 remain valid. I am aware of no facts that have

 come to light in the interim that would change the

 original assessment made under former Chairman

 Gensler. In fact, since issuing the proposed rule

 for notice and comment, an independent

 cost-benefit analysis recommended, among other

 things, exempting inter-affiliate swaps from

 initial margin requirements as a means to reduce

 the excessively onerous impact of the rule on

 competition, price discovery and overall market

 efficiency without additional systemic risk. I

 concur with that recommendation.

 Earlier this year, in Congressional

 testimony, I explained that the cost of imposing

 initial margin on inter-affiliate transactions

 would have two likely impacts. First, it would

 raise the cost of commercial risk hedging for

 American end-users. And second, it would

 encapsulate risk in the U.S. marketplace and thus
 24

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 increase -- not decrease -- risk of systemic

 hazard in American financial markets.

 Today's final rule is not naïve or

 reckless. It recognizes that inter-affiliate

 swaps transactions are not without risk and sets

 appropriate safeguards. First, it requires

 operation of a centralized risk management

 program. Second, the rule requires variation

 margin. And third, it requires the collection of

 initial margin for non-U.S. affiliates not

 collecting initial margin for their own

 outward-facing swaps with financial entities.

 These measures appropriately address the risks

 associated with uncleared inter-affiliate swaps.

 Now let me turn to the broader topic of

 economic impact. From my perspective, the most

 objectionable aspect of today's rule is its

 foundation in the superficial logic that if the

 cost of margining uncleared swaps is forced high

 enough, then market participants will use more

 cleared instruments. That foundation is not

 supported by either reason or experience. If no
 25

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

clearinghouse is willing to clear a particular

swap, no amount of punitive cost -- no matter how

onerous -- will enable it to be cleared.

 I know something about swaps clearing

because I was involved before the financial crisis

in one of the first independent efforts by

non-Wall Street banks to develop a clearinghouse

for credit default swaps. I am a longstanding

supporter of increased central counterparty

clearing of suitable swaps. Yet I also recognize

-- as do an increasing number of others -- that

central counterparty clearing is no panacea for

credit risk. As regulators, we must be

intellectually honest and adopt a balanced view

acknowledging that there are legitimate and vital 

needs for both cleared and uncleared derivative

products.

 In a modern, complex, $18 trillion

economy, uncleared swaps allow businesses to avoid

basis risk and obtain hedge accounting treatment

under U.S. GAAP for more complex, non-standardized

exposures. Uncleared swaps are an unmatched tool
 26

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

for customized risk management by businesses,

governments, asset managers and other institutions

whose operations are essential to American

economic growth. Their precise risk transfer

utility generally cannot be replicated with

standardized cleared derivatives.

 Today's rule also reflects a

disingenuous reading of the Dodd-Frank Act to

favor cleared derivatives over uncleared swaps.

In fact, there is nothing in the law directing

regulators to set punitive levels of margin in an

attempt to drive market participants toward

cleared products. Imposing punitive margin levels

will lead to a range of adverse consequences

including raising the commercial cost of risk

hedging, reducing trading liquidity in uncleared

swaps markets, and incentivizing the movement of

products otherwise unsuitable for clearing into

clearinghouses into which counterparty risk is

already increasingly concentrated. More

critically, punitive margin on uncleared swaps

will increase the amount of inadequately hedged
 27

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 risk exposure on America's corporate balance

 sheets exacerbating volatility in earnings and

 share prices.

 Yet, I know that my voice alone cannot

 reverse the course of the present prevalence of

macro-prudential regulation -- an approach that

 prioritizes systemic stability over investment

 opportunity, market vibrancy and American economic

 growth. Only time will show that systemic risk

 cannot be managed through centralized economic

 planning. In fact, rather than being managed,

 systemic risk is being transformed today from

 counterparty credit exposure to jarring volatility

 spikes and liquidity risk across the breadth of

 financial markets, with ramifications that will be

 even harder to manage in the future.

 Unfortunately, today's rule will not

 reverse those trends. Yet I will vote for the

 rule, not because it is the right prescription for

 uncertain markets, but because it is much better

 than originally proposed and less harmful to the

 U.S. economy than likely alternatives.
 28

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 I must commend the CFTC staff for their

 hard work, thoughtfulness, and, ultimately, the

 generally improved rulemaking that is before us

 today. Thank you.

 CHAIRMAN MASSAD: Thank you. For each

 of the items on today's agenda, the staff will

 make presentations to the Commission. After each

 presentation, the floor will be open for questions

 and comments from each of the Commissioners.

 Following the close of discussion on each matter,

 the Commission expects to vote on the staff

 recommendation as presented. All final votes

 conducted in this public meeting shall be recorded

 votes. The results of votes approving the

 issuance of rulemaking documents will be included

 with those documents in the Federal Register.

 At this point, I ask unanimous consent

 to allow staff to make technical corrections to

 the documents voted on today prior to sending them

 to the Federal Register. Without objection, it is

 so ordered.

 At this time I would like to welcome
 29

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 Vince McGonagle, Rachel Berdansky, Susan Stewart,

 and David Taylor from the Division of Market

 Oversight and Julie Mohr, James Ortlieb, and Jeff

 Bandman from the Division of Clearing and Risk for

 their presentations on two proposed rules related

 to system safeguards.

 MR. TAYLOR: Good morning, Mr. Chairman

 and Commissioners. Before I begin, I would like

 to thank my fellow Division of Market Oversight

 team members including Rachel --

 CHAIRMAN MASSAD: Make sure you speak

 very close to the mic.

 MR. TAYLOR: Yes, I've learned that.

 Before I begin, I would like to thank my fellow

 Division of Market Oversight team members

 including Rachel Berdansky, David Steinberg,

 Shifra Katz, Susan Stewart, Chris Russell-Wood,

 Mike Bartlett, and Kyle Miller, and my systems

 safeguards colleagues in the Division of Clearing

 and Risk, as well as Dave Reiffen from the Office

 of the Chief Economist and Dhaval Patel and Susan

 Nathan from the Office of the General Counsel for
 30

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 their hard work in preparing the proposals we are

 presenting to the Commission today.

 Today staff is recommending that the

 Commission approve two parallel notices of

 proposed rulemaking or NPRMs, addressing

 cybersecurity and system safeguards requirements

 for designated contract markets or DCMs, swap

 execution facilities or SEFs, swap data 

 repositories or SDRs, and derivatives clearing

 organizations or DCOs. My DCR colleague, Julie

 Mohr, and I will share the task of making the

 presentation.

 The proposed rules would enhance and

 clarify existing Commission rule provisions

 relating to cybersecurity testing and system

 safeguards risk analysis and oversight, and add

 new provisions concerning certain aspects of

 cybersecurity testing. Most importantly, the

 proposed rules clarify the existing rules by

 specifying and defining the types of cybersecurity

 testing that DCMs, SEFs, SDRs, and DCOs must

 conduct in order to fulfill their regulatory
 31

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 system safeguards testing obligations.

 Staff is recommending these rules

 concerning system safeguards testing at a time

 when cyber threats to the financial sector

 continue to expand significantly. While preparing

 the proposed rules, staff considered relevant

 information discussed during the March 2015

 Roundtable on Cybersecurity and System Safeguards

 Testing and the June 2015 meeting of the

 Commission's Market Risk Advisory Committee.

 Participants highlighted a number of noteworthy

 aspects of current cyber threats. Examples

 include an escalating volume of cyberattacks,

 coming from increasing numbers of more dangerous

 cyber adversaries with worsening goals, including

 disruption of operations, theft of data or

 intellectual property and corruption or

 destruction of data or automated systems; advanced

 persistent threats designed to remain undetected

 over a long period of time; and an expanded cyber

 threat field that includes mobile devices, the

 cloud, phishing and other social engineering
 32

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 attacks, and insider threats. Cybersecurity

 testing by DCMs, SEFs, SDRs, and DCOs can harden

 their cyber defenses; mitigate their operations,

 reputation, and financial risks; and maintain and

 increase their cyber resilience and their ability

 to detect, contain, respond to, and recover from

 cyberattack.

 As set out in detail in both NPRMs,

 cybersecurity testing is a well-established best

 practice both generally and for financial sector

 entities. Such testing is becoming a requirement

 for obtaining cyber insurance and it is also

 supported internationally by both financial

 regulators and standards bodies. Its importance

 is increased by the nature of the cybersecurity

 threats faced by the financial sector. It is for

 these reasons, and in light of this background,

 the staff is recommending approval of these NPRMs.

 As we will outline for you, the central

 point of the proposed rules is the proposed

 requirement for all DCOs, all DCMs, all SEFs, and

 all SDRs regulated by the Commission to conduct
 33

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 five important types of cybersecurity testing that

 are essential to an effective program of system

 safeguards risk analysis and oversight. One,

 vulnerability testing. Two, penetration testing.

 Three, controls testing. Four, security incident

 response plan testing. And five, enterprise

technology risk assessment.

 The Commission's existing system

 safeguards rules require these entities to conduct

 testing to ensure the reliability, security, and

 capacity of their systems. Best practices

 establish that it would be impossible to fulfill

 the purposes of that requirement without

 conducting these five types of testing. In this

 respect, therefore, the proposed rules clarify

 what is already required of these entities.

 As we will note in presenting each of

 the five types of testing, the proposed rules

 would also establish minimum testing frequency and

 independent contractor testing requirements for

 all DCOs and all SDRs and for covered DCMs. As

 defined, covered DCMs are those whose total annual
 34

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 trading volume is five percent or more of the

 total annual trading volume of all DCMs regulated

 by the Commission. These requirements are also

 consonant with best practices.

 The proposed rule for DCMs, SEFs, and

 SDRs also includes an advance notice of proposed

 rulemaking, which notes that the Commission plans

 to consider whether, in a future NPRM, it should

 define certain SEFs as covered SEFs and make them

 subject to the minimum testing frequency and

 independent contractor testing requirements. The

 request for comments section of the proposal

 includes a number of questions about whether and

 how this could most appropriately be done.

 MS. MOHR: Before I begin, I want to

 make sure everyone can hear me. Okay. As I begin

 the next section of the presentation, I would like

 to thank my DCR colleagues, Jim Ortlieb, Tammy

 Roust, Eileen Donovan, Laura Astrada, Eileen

 Chotiner, and Joe Opron, along with Carlene Kim

 and Brian Trackman from OGC for their hard work on

 these proposals that we are presenting to the
 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 35

Commission today. We will briefly describe for

you this morning each of the five types of

cybersecurity testing required by the proposed

rules, beginning with vulnerability testing.

 Vulnerability testing is the process of

scanning your systems for weaknesses. As software

is developed and deployed, new weaknesses are

created, which are called vulnerabilities. These

vulnerabilities are created due to various

reasons. For example, adding new features to

existing software generates transaction paths and

logic that create future opportunities for

unwanted users to exploit these features in

unintended ways. Moving software or hardware

around within existing environments can create

interconnections between systems or paths through

existing systems that offer fresh opportunities

for intruders to enter and exploit.

 In addition, existing software is

constantly being tested and probed in new ways by

existing deployments including both research

efforts and real world attacks. As a DCM, SEF,
 36

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 SDR, or DCO deploys, modifies, and runs its

 systems, it must remain cognizant of the fact that

 external entities are constantly probing its

 defenses looking for these vulnerabilities. If

 the organization can discover its vulnerabilities

 before the attackers do, it can attempt to fix

 them before they are exploited.

 Vulnerability testing is covered by

 generally accepted practices and standards such as

 those published by the National Institute of

 Standards and Technology or NIST, the Federal

 Financial Institutions Examination Council or

 FFIEC, and others. Such generally accepted best

 practices call for vulnerability testing at a

 frequency determined by an appropriate risk

 analysis and, in some cases, also provide that the

 frequency of such testing should be no less than

 quarterly.

 The proposed rules address the frequency

 at which vulnerability testing should be

 conducted. As a fundamental principle, they call

 for all DCMs, SEFs, SDRs, and DCOs to conduct
 37

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 vulnerability testing at a frequency determined by

 an appropriate risk analysis. For all DCOs, all

 SDRs and covered DCMs, the rules also include a

 minimum vulnerability testing frequency

 requirement calling for the testing to be

 conducted no less frequently than quarterly.

 In addition, the proposed rules call for

 vulnerability testing by all DCOs, all SDRs, and

 covered DCMs to be performed by independent

 contractors during at least two of the quarterly

 tests each year. Independent contractors provide

 an external insight into an entity's

 vulnerabilities and weaknesses. Having a fresh

 external perspective, one that has been formed

 through experience with other industry players,

 can be vital to informing those critical financial

 organizations about how, where, and why they are

 vulnerable.

 The second type of cybersecurity testing

 that the proposed rules would require is

 penetration testing. Penetration testing is the

 process of simulating an attack on a system in
 38

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 order to discover and exploit its weaknesses.

 There are two main forms of penetration testing.

 They are external and internal. The proposed

 rules define external penetration testing as

 attempts to penetrate the entity's automated

 systems from outside its boundaries to identify

 and exploit vulnerabilities. The proposed rules

 define internal penetration testing as attempts to

 penetrate an entity's automated systems from

 inside their boundaries for the same purpose. 

 Generally accepted best practices, such

 as NIST, FFIEC standards, and the Payment Card

 Data Security Standards, call for organizations to

 conduct both internal and external penetration

 testing and to conduct such tests annually. The

 proposed rules also call for all DCOs, DCMs, SEFs,

 and SDRs to conduct penetration testing at a

 frequency determined by an appropriate risk

 analysis.

 In addition, the proposals call for

 penetration testing at least annually by all DCOs,

 all SDRs and covered DCMs. The proposed rules
 39

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 also provide that the annual external penetration

 tests required of all DCOs, all SDRs, and covered

 DCMs must be performed by an external independent

 contractor. David will now go over the remaining

 three tests.

 MR. TAYLOR: The proposed rules also

 call for all DCMs, SEFs, SDRs, and DCOs to conduct

 controls testing, including testing of each

 control that is included in their programs of

 system safeguards risk analysis and oversight.

 Controls are the safeguards or countermeasures

 used by an entity to protect the reliability,

 security, or capacity of its automated systems or

 the confidentiality, integrity, and availability

 of its data and information. Some controls

 provide safeguards against automated system

 failures or deficiencies, while others guard

 against human error, deficiencies, or malicious

 action.

 Controls testing assesses each control

 to determine whether it is implemented correctly,

 is operating as intended, and is enabling the
 40

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 organization to meet system safeguards

 requirements. Such testing is called for by

 generally accepted best practices and standards.

 The proposed rules address the frequency

 at which controls testing should be conducted. As

 a fundamental principal, they call for all DCMs,

 SEFs, SDRs, and DCOs to conduct controls testing

 at a frequency determined by an appropriate risk

 analysis. For all DCOs, all SDRs, and covered

 DCMs, the rules also include a minimum controls

 testing frequency requirement calling for testing

 of each control no less frequently than every two

 years. Since system safeguards involve large

 numbers of controls, the rules would permit this

 to be done on a rolling basis over the course of

 the minimum two year period or the period dictated

 by appropriate risk analysis, whichever is

 shorter.

 The proposed rules also call for all

 DCOs, all SDRs, and covered DCMs to have

 independent contractors test each of the

 regulatee's key controls, as defined in the rule,
 41

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 no less frequently than every two years. Key

 controls are those controls that risk analysis

 determines to be either critically important for

 effective system safeguards or intended to address

 risks that evolve or change more frequently and,

 therefore, require more frequent review to ensure

 continued control effectiveness. Such independent

 assessments are consonant with best practices.

 The fourth type of testing that the

 proposed rules would require is security incident

 response plan testing. Best practices call for

 financial sector entities to maintain and test a

 security incident response plan or SIRP, which I

 would venture to predict you will hear referred to

 as a SIRP. Such plans are crucial to cyber

 resilience. The proposed rules define security

 incident as a cyber or physical security event

 that actually or potentially jeopardizes automated

 system operation, reliability, security, or

 capacity, or the availability, confidentiality, or

 integrity of data. They would require each DCM,

 SEF, SDR, or DCO to maintain and test an SIRP
 42

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 defined as a written plan documenting the

 entities' policies, controls, procedures, and

 resources for identifying, responding to,

 mitigating, and recovering from security

 incidents.

 The rules note that SIRP testing can

 take a number of possible forms from checklists

 and tabletop exercise to simulations and

 comprehensive exercises. The proposed rules also

 address the frequency at which SIRP testing should

 be conducted. As a fundamental principal, they

 call for all DCMs, SEFs, SDRs, and DCOs to conduct

 SIRP testing at a frequency determined by an

 appropriate risk analysis. At a minimum, the

 proposed rules call for all DCOs, all SDRs, and

 covered DCMs to have SIRP testing performed no

 less frequently than annually. SIRP testing could

 be done either by independent contractors or

 regulatee employees not responsible for

 development or operation of the systems or

 capabilities being assessed.

 Finally, the proposed rules would
 43

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 require each DCM, SEF, SDR, or DCO to conduct

 enterprise technology risk assessments or ETRAs.

 An ETRA is a written assessment including

 identification and analysis of threats and

 vulnerabilities and the harm they could cause in

 the context of mitigating controls. In an ETRA, a

 DCM, SEF, SDR, or DCO may draw together and use

 the results of the other types of cybersecurity

 testing in order to identify and mitigate its

 cybersecurity risks. Conducting ETRAs is

 consistent with best practices regarding system

 safeguards.

 As a fundamental principle, the proposed

 rules call for all DCMs, SEFs, SDRs, and DCOs to

 conduct an ETRA as often as indicated by

 appropriate risk analysis. At a minimum, the

 proposed rules call for DCOs, covered DCMs and

 SDRs to have ETRAs performed no less frequently

 than annually. They would permit regulatees to

 conduct ETRAs by using either independent

 contractors or employees not responsible for

 development or operation of the systems or
 44

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 capabilities being assessed.

 MS. MOHR: The Commission's current

 regulations specify various elements, standards,

 and resources to be included in a registrant's

 program of risk analysis and oversight with

 respect to its operations and automated systems.

 The proposed rules clarify existing rule

 provisions for all DCOs, DCMs, SEFs, and SDRs

 concerning (1) the categories of risk analysis and

 oversight that must be addressed, (2) books and

 records obligations, (3) the scope of system

 safeguards testing, (4) internal reporting and

 reviewing of testing results, and (5) the

 remediation of vulnerabilities and deficiencies

 disclosed by the testing.

 The proposed rule provision addressing

 the required scope of cybersecurity testing is

 especially important because adequate testing

 depends upon the identification of an appropriate

 scope. The proposed rules would require that the

 scope of all testing and assessments required by

 Commission regulations be broad enough to include
 45

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 testing of automated systems and controls

 necessary to identify any vulnerability which, if

 exploited or accidently triggered, could enable an

 intruder or unauthorized user or an insider to (a)

 interfere with the registrant's operations or with

 fulfillment of the statutory and regulatory

 responsibilities, (b) impair or degrade the

 reliability, security, or capacity of the

 registrant's automated systems, (c) add to,

 delete, modify, exfiltrate or compromise the

 integrity of any data related to the registrant's

 regulated activities, or (d) undertake any other

 unauthorized action affecting the registrant's

 regulated activities or the hardware or software

 used in connection with those activities.

 Another important clarifying provision

 relates to the governance of cybersecurity and

 system safeguards, by requiring that reports on

 testing protocols and the results be communicated

 and reviewed by both the registrant's senior

 management and its board of directors.

 Registrants would also be required to establish
 46

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 and follow appropriate procedures for remediation

 of the issues identified, and for the evaluation

 of the effectiveness of the testing and assessment

 protocols. Each entity would be required to

 analyze testing and assessment results, in order

 to identify all vulnerabilities and deficiencies

 in its systems, and to remediate those

 vulnerabilities and deficiencies to the extent

 necessary to enable the entity to fulfill its

 statutory and regulatory obligations.

 Also, the Divisions recommend that the

 proposed rules be open for a 60-day public comment

 period. This concludes our presentation and we

 are happy to address any questions.

 CHAIRMAN MASSAD: Okay. Well I want to

 thank all of our staff for those informative

 presentations and again thank all the staff that

 worked on these proposals. To begin the

 Commission's discussion and consideration of these

 rulemakings, I will now entertain a motion to

 adopt the Division of Clearing and Risks proposed

 rule relating to system safeguards as presented by
 47

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the staff.

 COMMISSIONER GIANCARLO: Second.

 CHAIRMAN MASSAD: Okay. I would now

 like to open the floor to allow the Commissioners

 to make any statements or ask any questions that

 they may have and I will first turn to

 Commissioner Bowen.

 COMMISSIONER BOWEN: Yes, thank you, Mr.

 Chairman. Thank you so much. A great

 presentation. As we discussed, this rule covers

 SDRs, DCMs, SEFs, and DCOs. And I'm wondering 

 whether the staff intends to send proposed rules

 to us with cybersecurity guidelines to cover other

 market participants such as FCMs, introducing

 brokers, major swap participants?

 MS. BERDANSKY: Commissioner, oversight

 of the entities you mentioned falls under the

 Commission's Division of Swap Dealer and

 Intermediary Oversight. However, I would note

 that in October 2015, the National Futures

 Association adopted a cybersecurity interpretative

 notice to three of its compliance rules defining
 48

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the core components of an effective information

 system security program or ISSP for short. The

 notice, which applies to futures commission

 merchants, swap dealers, major swap participants,

 introducing brokers, FOREX dealer members,

 commodity pool operators, and commodity trading

 advisors, requires such firms to adopt and enforce

 an ISSP appropriate to the firm's circumstances.

 The approach is principles based and

 provides that an ISSP should cover several key

 areas, including a security and risk analysis; a

 description of the safeguards against identified

 system threats and vulnerabilities; and the

 process used to evaluate the nature of a detected

 security event, understand its potential impact

 and take appropriate measures to contain and

 mitigate the breach and a description of the

 members ongoing education and training related to

 the information system security for all personnel.

 The notice further requires that ISSP must be

 approved within the member firms by an executive

 level official and requires members to monitor and
 49

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 review the effectiveness of the ISSP at least

 annually, including the effectiveness of the

 safeguards the firm has deployed.

 Finally, I would just note that the

 National Futures Association's notice also directs

 firms to look to industry best practices, in

 particular, the NIST cybersecurity framework when

 developing and adopting an ISSP.

 COMMISSIONER BOWEN: Thank you, Rachel.

 CHAIRMAN MASSAD: Commissioner

 Giancarlo.

 COMMISSIONER GIANCARLO: Thank you. And

 I want to thank Julie and David and Jeff and Vince

 and their teams for their thoughtful approach to

 cybersecurity, which is a tremendous, if not the

 largest, challenge we face today. And it is quite

 a heavy lift to come up with a thoughtful

 proposal, so I commend you for that. David, I

 also note the new acronym of SIRP, S-I-R-P. I

 guess that's our holiday gift for the community to

 roll out a new acronym at the end of the year, so

 we'll all be puzzling over that.
 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 50

 I don't have questions for you, but I do

 want to direct the public to my written statement

 in which I have a number of comments on the

 proposed rule and I look forward to the public's

 commentary and discussion on this. Thank you.

 CHAIRMAN MASSAD: Okay. Well, thank

 you. I have no questions either. I, again, want

 to thank the staff. I know this has been a lot of

 work on both proposals. And I just want to add my

 support for the proposed rule. I think the risk

 of cyberattacks is perhaps the most important

 single issue we face today in terms of threats to

 financial market stability and integrity. The

 examples of cyberattacks are unfortunately all too

 familiar and frequent -- both within the financial

 sector and outside. And today we must be

 concerned about the possibility of attacks not

 only motivated by profit, but that are intended to

 destroy information and disrupt or destabilize our

 markets. So the risk to American businesses in

 our economy is dramatic and the interconnectedness

 of financial institutions and markets means that a
 51

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 failure in one institution can have significant

 repercussions.

 So the proposed rule that we are issuing

 today is an important step toward enhancing the

 protections in our markets. It builds on our core

 principles. Those already require clearinghouses

 to focus on system safeguards. This rule goes

 further by setting standards consistent with best

 practices and it requires robust testing of cyber

 protection, setting forth the type of testing that

 must be conducted, the frequency of testing, and

 whether tests should be conducted by independent

 parties. And it enhances standards for incident

 response planning and enterprise technology risk

 assessments.

 So I believe these requirements should

 come as no surprise. Clearinghouses should

 already be doing extensive testing and, indeed, we

 hope that today's proposal sets a baseline that is

 already being met by many of them. The proposal

 also complements what we as a Commission already

 do. We focus on these issues in our examinations
 52

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 to determine whether an institution is following

 good practices and paying adequate attention to

 the risks at the Board level and on down. And as

 I noted at the beginning, since 2009,

 clearinghouses have become increasingly important

 in the financial system, so I believe we must do

 all we can to ensure their strength and stability

 and this proposed rule is a critical component of

 that effort.

 Now, of course, we welcome public

 comment on this proposal, which will be taken into

 account carefully before we take any final action.

 If there are no other questions, I would like to

 just make sure would any other Commissioner like

 to make any further statements before we proceed

 to a vote on the motions? Okay.

 If the Commissioners are prepared to

 vote, Mr. Kirkpatrick, will you call the roll?

 MR. KIRKPATRICK: The motion now before

 the Commission is on the adoption of the Division

 of Clearing and Risk notice of proposed rulemaking

 on system safeguards testing requirements for
 53

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 derivatives clearing organizations. Commissioner

 Giancarlo?

 COMMISSIONER GIANCARLO: Aye.

 MR. KIRKPATRICK: Commissioner

 Giancarlo, aye. Commissioner Bowen?

 COMMISSIONER BOWEN: Aye.

 MR. KIRKPATRICK: Commissioner Bowen,

 aye. Chairman Massad?

 CHAIRMAN MASSAD: Aye.

 MR. KIRKPATRICK: Chairman Massad, aye.

 Mr. Chairman, on this matter, the ayes have three,

 the no's have zero.

 CHAIRMAN MASSAD: Thank you. The ayes

 have it and the motion to adopt the proposed rule

 is approved. At this point, I will entertain a

 motion to adopt the Division of Market Oversight's

 proposal related to system safeguards as presented

 by the staff.

 COMMISSIONER BOWEN: So moved.

 COMMISSIONER GIANCARLO: Second.

 CHAIRMAN MASSAD: I would now like to

 open the floor to allow the Commissioners to make
 54

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 any further statements and ask any questions that

 they may have. And I again will turn to

 Commissioner Bowen.

 COMMISSIONER BOWEN: No questions.

 CHAIRMAN MASSAD: Commissioner

 Giancarlo?

 COMMISSIONER GIANCARLO: No questions.

 CHAIRMAN MASSAD: Okay. Thank you.

 Well let me just add that I also support this

 rule. It's obviously very consistent with the DCR

 proposal. I will add a couple of comments. I

 previously stated that I did not expect our

 proposal would apply to SEFs. Now, I said that

 not because cybersecurity isn't just as important

 for them, but because many SEFs are still in the

 very early stages of operation. But, my fellow

 Commissioners expressed concerns about potential

 vulnerabilities and both felt that we should

 propose that the requirements apply to SEFs at

 this time. I appreciate their views and I am

 committed to working collaboratively to address

 this issue and, therefore, we have included it in
 55

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the proposal. And as with the DCR proposal, we

 will carefully consider all public comment before

 taking any final action. Let me just make sure

 before we proceed to a vote, would any other

 Commissioner like to make further statement?

 Okay.

 Then I will ask Mr. Kirkpatrick to call

 the roll.

 MR. KIRKPATRICK: The motion now before

 the Commission is on the adoption of the Division

 of Market Oversight proposed rulemaking on system

 safeguards testing requirements. Commissioner

 Giancarlo?

 COMMISSIONER GIANCARLO: Aye.

 MR. KIRKPATRICK: Commissioner

 Giancarlo, aye. Commissioner Bowen?

 COMMISSIONER BOWEN: Aye.

 MR. KIRKPATRICK: Commissioner Bowen,

 aye. Chairman Massad?

 CHAIRMAN MASSAD: Aye.

 MR. KIRKPATRICK: Chairman Assad, aye. 

 Mr. Chairman, on this matter, the ayes have three,
 56

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the no's have zero.

 CHAIRMAN MASSAD: The ayes have it and

 the motion to adopt the proposed rule is approved.

 Once again, thank you to the staffs of DMO and DCR

 for these excellent presentations and excellent

 work.

 At this time, I would like to welcome

 Scott Mixon from the Office of the Chief

 Economist, Paul Schlichting from the Office of

 General Counsel, John Lawton from the Division of

 Clearing and Risk, and Rafael Martinez and Francis

 Kuo from the Division of Swap Dealer and

 Intermediary Oversight for their presentations on

 a final rule on margin for uncleared swaps.

 CHAIRMAN MASSAD: Please proceed.

 MR. LAWTON: Good morning. The rules

 before the Commission would implement Section

 4s(e) of the Commodity Exchange Act. The rules

 address margin requirements for uncleared swaps

 entered into by swap dealers or major swap

 participants. The rules would apply to SD MSPs

 that are not subject to regulation by one of the
 57

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 prudential regulators. That is the Fed, the OCC,

 the FDIC, the FCA, or the FHA.

 In developing the rules, Commission

 staff worked closely with staff of the prudential

 regulators. Commission staff also consulted

 periodically with staff of the SEC and with staff

 of foreign regulators. The rules are very similar

 to the rules that were recently approved by the

 prudential regulators.

 In this presentation, I will briefly

 touch on the following topics: The products that

 are subject to the rules, the market participants

 that are subject to the rules, the nature and

 timing of margin requirements, how initial margin

 would be calculated, what is the acceptable

 collateral, what are the custodial arrangements,

 what is the treatment of inter-affiliate swaps,

 and what's the implementation schedule.

 So turning first to products -- the

 rules would apply to uncleared swaps entered into

 after the effective dates of the regulation. As I

 will describe in a few minutes, these rules would
 58

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 be phased in and the requirements would not apply

 retroactively to swaps entered into before the

 applicable effective date for the parties to that

 swap.

 Turning to market participants -- the

 rules would apply to those SDs and MSPs that are

 not subject to oversight by the prudential

 regulators. We call these firms covered swap

 entities or CSEs. The rules would impose margin

 requirements on (1) trades between a CSE and any

 other swap dealer or MSP, and (2) trades between a

 CSE and a financial end user. The rules would not

 impose margin requirements on commercial end

 users.

 In January, after the proposed rules had

 been published for comment, Congress passed

 legislation addressing the applicability of these

 margin rules to certain entities. The legislation

 required the Commission and the prudential

 regulators to issue interim final rules providing

 that certain entities to qualify for a clearing

 exemption will also be exempt from margin
 59

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 requirements for their uncleared swaps. This rule

 set includes provisions implementing that

 requirement.

 Turning to the nature and timing of

 margin requirements, and turning first to initial

 margin -- the rules would require two-way initial

 margin -- both posting and collecting -- on a

 daily basis for all trades between a CSE and any

 other SD or MSP. The rules would also require

 daily two-way initial margin for all trades

 between a CSE and a financial end user that had

 over $8 billion in gross notional exposure in

 uncleared swaps.

 The Commission and the prudential

 regulators had last year proposed that the

 material swaps exposure standard be set at $3

 billion. In response to public comments, however,

 the rules have raised the threshold at which

 financial end users become subject to the initial

 margin requirements. This provision recognizes

 that financial end users with smaller positions do

 not pose the same risk as those with larger
 60

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 positions. The revised threshold is the same as

 that recently adopted by the prudential regulators

 and it is consistent with international standards.

 Turning to variation margin -- the rules

 would require daily payment of variation margin

 for all trades between a CSE and another SD or

MSP. The rules would also require daily payment

 of variation margin for all trades between a CSE

 and a financial end user. In contrast to initial

 margin, the gross notional threshold would not

 apply for variation margin, so financial end users

 with gross notional exposure below the threshold

 would still be required to exchange variation

 margin. Again, these requirements are the same as

 those of the prudential regulators and consistent

 with international standards.

 Turning to calculation of initial margin

-- the rules would permit the calculation of

 initial margin to be based on models or on a

 standardized table. Models would be required to

 use a 99 percent confidence level over a 10 day

 liquidation time. The rules would permit the 
 61

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 parties to establish a $50 million threshold below

 which margin would not need to be collected. This

 threshold is designed to mitigate the costs of

 these rules while continuing to protect the

 financial integrity of the financial system.

 Smaller exposures would be permitted to go

 uncollateralized, but a significant percentage of

 all large exposures would be supported by

 collateral.

 The final rules include a provision

 allowing a registered futures association to

approve a CSE's margin model. Commission staff

 have communicated with NFA staff, which has

 indicated that it will be prepared to take on this

 responsibility. I point this out as a point of

 distinction between the CFTC rules and the

 prudential regulator rules where the prudential

 regulators do not have a comparable provision

 which would permit approval of margin models by a

 self-regulatory organization. In their case, the

 approval would be required to be done by the

 prudential regulator itself.
 62

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 So turning to acceptable collateral --

 first, for initial margin. The rules would permit

 initial margin to include cash, sovereign debt,

 certain government sponsored debt, investment

 grade debt such as corporate bonds, certain

 equities, shares of certain money market funds,

 and gold. This list is the same as the prudential

 regulators' list and is consistent with

 international standards.

 For variation margin, the rules would

 draw a distinction between trades that involve two

 dealers and trades involving a dealer and a

 financial end user. For dealer-to-dealer trades,

 the rules would require variation margin to be in

 cash. For trades between a dealer and a financial

 end user, however, the rules would permit the same

 collateral permitted for initial margin. This

 requirement was modified in response to comments.

 The proposal had said cash for all variation

 margin. A number of end user commenters stated

 that it could be very burdensome for them to post

 cash as variation margin and so the final rule
 63

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 would adjust the approach for variation margin for

 trades between a dealer and a financial end user.

 Again, the approach taken regarding acceptable

 collateral for both initial margin and variation

 margin is the same as the prudential regulators'

 approach.

 Turning to custodial arrangements -- the

 rules would require initial margin to be held at

 an independent custodian and it would not permit

 rehypothecation of initial margin. Again, the

 approach is the same as the prudential regulators'

 approach.

 With regard to inter-affiliate margin,

 the rules would require the daily payment of

 variation margin between CSEs and affiliates that

 are also swap entities or are financial end users.

 This aspect of the rule is the same as the

 prudential regulators' rule. The rules, however,

 would not require CSEs to collect initial margin

 from affiliates except in certain circumstances

 that I will mention in a moment. The CSEs would,

 however, be required to have a centralized risk
 64

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 management program to design, to monitor and

 manage the risk associated with inter-affiliate

 swaps on a group-wide basis. Collection would be

 required in certain cases where the affiliate

 enters into swaps with third parties and doesn't

 collect margin on the outward-facing swap and then

 does a swap with the CSE.

 With regard to foreign regulators,

 foreign regulators have not yet finalized their

 rules in this area yet. Based on participation in

 international groups and conversations with

 foreign regulators, staff understands that a

 number of jurisdictions are not expected to

 require initial margin or variation margin for

 inter-affiliate swaps if certain conditions are

 met which would enable the parties in normal

 circumstances to meet their obligations.

 Finally, turning to the implementation

 schedule -- the rules establish an implementation

 schedule under which the requirements would be

 phased in according to the amount of uncleared

 swaps trading that the entity engages in. Initial
 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 65

 margin requirements would be phased in in five

 steps beginning September 1, 2016, ending

 September 1, 2020 -- moving from the largest

 market participants to the smaller ones.

 Variation margin requirements would be phased in

 in two steps. The largest market participants

 starting in September of 2016 and the remainder of

 the market in March of 2017. Again, this schedule

 is the same as the prudential regulators' schedule

 and the schedule set forth in international

 standards.

 In closing, I'd like to thank the other

 members of the staff who worked on this project --

 Tom Smith, Rafael Martinez, Francis Kuo, Carlene

 Kim, Paul Schlichting, Scott Mixon, Steve Kane,

 and Lihong McPhail.

 CHAIRMAN MASSAD: Thank you for that

 very informative presentation. To begin the

 Commission's discussion and consideration of this

 rulemaking, I will now entertain a motion to adopt

 the final rule on margin for uncleared swaps.

 COMMISSIONER BOWEN: So moved.
 66

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 COMMISSIONER GIANCARLO: Second.

 CHAIRMAN MASSAD: I would now like to

 open the floor to allow the Commissioners to make

 any statements and ask any questions that they may

 have. Commissioner Bowen?

 COMMISSIONER BOWEN: Yes, thank you.

 We've spent a lot of time together and I want to

 thank you so much for the time that you spent with

 me and my staff. As I understand it, though,

 inter-affiliate swaps make up a large portion of

 the uncleared swaps market. Could you tell us

 what you know about the number or notional amount

 of the trades that would require no collateral to

 be posted?

 MR. LAWTON: Well, first I'd say looking

 at SDR data, we've looked at SDR data for interest

 rate swaps and credit default swaps which we think

 is the bulk of the market. In that case,

 inter-affiliates trades represent about 50 percent

 of the market. I turn it to Rafael for dollar

 amounts if you have any off the top.

 MR. MARTINEZ: I don't have the amount.
 67

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 MR. LAWTON: I mean we did do some

 estimates for individual -- well, no, I'm sorry.

 That's a different. Yes, sorry. I don't actually

 have dollar amounts, but it's approximately 50

 percent of all trades for IRS and CDS.

 COMMISSIONER BOWEN: Okay.

 MR. LAWTON: IRS and CDS.

 COMMISSIONER BOWEN: So if no collateral

 is actually required for these types of trades, is

 it likely that this rule will provide incentives

 for dealers to increase the number of these trades

 that are uncleared?

 MR. LAWTON: I mean I guess I would say

 that to the extent -- and I think they're not

 posting IM for these trades now, we probably --

 and so that would maintain the status quo. The

 percentages would probably remain the same. It

 would probably remain about 50 percent. As the

 market got bigger, presumably if the percentage

 stayed the same, then the amount of

 inter-affiliate trades would grow accordingly with

 the market. I think a related effect might be
 68

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 that because the prudential regulators might be --

 or would be requiring inter-affiliate IM, you

 might see some movement of the inter-affiliate

 business from trades involving

 prudentially-regulated swap dealers to trades

 involving CFTC regulated swap dealers.

 COMMISSIONER BOWEN: As I understand it,

 I had a number of conversations informally with

 dealers and some -- several of them already

 require collateral from their affiliates. So, in

 effect, the rule that we're voting on today would

 actually be a lower threshold -- by requiring

 zero. Is that right?

 MR. LAWTON: Yes. I mean to the extent

 that dealers currently collect initial margin for

 some inter- affiliate trades, they might be

 following a higher standard than the rules would

 require. I guess I should note that there's

 various types of affiliates and the

 inter-affiliate exception that's in this rule

 applies to those affiliates whose financial

 statements are consolidated. So, if an
 69

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 affiliate's financial statement were not

 consolidated with those of the CSE and if the

 affiliate were a financial end user with material

 swap exposure, it might be required -- well, it

 would be required to post margin in that instance

 under these rules. I mean an example of that

 might be if a firm had some sort of money manager

 within their corporate family, that might be the

 sort of firm that might be posting margin. But to

 the extent that those criteria do not apply, and

 someone is collecting initial margin under this

 rule, then -- I'm sorry, currently -- then this

 rule would not require it.

 COMMISSIONER BOWEN: Right. And, in

 fact, in the instance of a severe, let's say,

 financial crisis, the more collateral you would

 have under your control, it would seem to me more

 likely you are going to be able to meet your

 obligations. To the extent that there's no

 collateral here, wouldn't our swap dealer be in a

 better position from a risk standpoint if they had

 collected initial margin in the first instance?
 70

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 MR. LAWTON: I mean I guess I'd start by

 pointing out that we would require variation

 margin to be exchanged on a daily basis. And so

 that would -- should prevent losses from

 accumulating over time. That being said, yes, if

 they had additional collateral beyond that, that

 would certainly help them.

 COMMISSIONER BOWEN: I just also wanted

 just to stress, you know, we are mandated to have

 our rules -- our margin be comparable to the

 maximum extent practicable with those of our

 prudential regulators. Is it practicable in this

 instance to have our CFTC regulated swap dealers

 not to collect initial margin from their

 affiliates?

 MR. LAWTON: I guess I would start by

 saying that, noting that the Act required the

 prudential regulators to issue joint rules,

 whereas it applied this provision that you're

 mentioning, to the maximum extent practicable, to

 the CFTC. So I think there was, within the Act,

 contemplation that they wouldn't necessarily be
 71

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 identical. And that I guess that would reflect

 that there are differences between our general

 statutory scheme and the banking regulators

 general statutory scheme and between the nature of

 some of the entities that are subject to the CFTC

 statutory scheme and the entities that are subject

 to the banking regulators' statutory scheme.

 COMMISSIONER BOWEN: So do you think --

 let's turn a little bit to the harmonization

 question and could you describe to us how this

 rule works with our proposed rule on cross border

 margin, and do they work together?

 MR. LAWTON: I guess I would suggest

 that Paul pick that one up.

 MR. SCHLICHTING: So, just to, I guess,

 explain, is that we have a proposal out for the

 cross border.

 COMMISSIONER BOWEN: Yes.

 MR. SCHLICHTING: Right?

 COMMISSIONER BOWEN: Mm-hmm.

 MR. SCHLICHTING: So, in the proposal,

 the -- you would -- I would -- we look at it as
 72

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 this would overlay on top of the inter-affiliate.

 So for -- you know, and this purely on the

 proposal. So anybody, you know -- so it's a --

 the inter-affiliate moves trade outside, you know,

 from the outside facing trade.

 COMMISSIONER BOWEN: Mm-hmm.

 MR. SCHLICHTING: If it's within one of

 the categories in our proposal -- via day the

 exclusion or an FCS. So if it's an exclusion,

 then we would say those trades are excluded. If

 it's done by an FCS, the outward facing trade,

 then it would have to have substituted compliance

 with that outward facing trade. But then when

 they move the risk over from -- through the

 inter-affiliate trade --

 COMMISSIONER BOWEN: Mm-hmm.

 MR. SCHLICHTING: -- well, that would

 all depend on. So if it was excluded -- the

 outward facing trade -- then we only apply VM --

 variation margin on the inter-affiliate trade.

 But from the other side, from the FCS, it would be

 -- is it substituted compliance on the outward
 73

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 facing trade. And, again, so there would be a

 collection of IM in that situation because we

 would have to do a comparability. And if it's

 comparable, then either they can use the foreign

 jurisdiction's margin rules or ours, which

 requires outward facing trades on IM for FCSs.

 And then when they move it over through the

 inter-affiliate trade, it would be VM. So, that's

 how it would apply. But, again, it's still just a

 proposal in the cross border sense. And, you

 know, we will look at -- you know, because I think

 we made assumptions based on the proposed margin

 rule that we're adopting here on how the

 inter-affiliate worked. Because initially the

 proposal was post collect, so maybe, you know, we

 just have to reexamine how that exclusion works

 and whether John's anti -- well, I guess the

 anti-evasion rule that's in the margin rule, we're

 saying that if you do an outward facing trade in a

 jurisdiction that does not require IM, then IM has

 to be collected by the CSE, well we may have to

 reexamine how that interplays with the cross
 74

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 border.

 CHAIRMAN MASSAD: Can I just ask the

 staff -- be sure you talk very close to the

 microphone. There's some trouble hearing you in

 the back.

 COMMISSIONER BOWEN: So back when we

 were talking about the proposed cross border

 margin rules, I know we talked about our concern

 about de-guaranteeing and all the sophisticated

 players used words to de-guarantee. Given this

 rule, we don't have to worry about that anymore,

 do we? That notion goes away since there will be

 no margin that needs to be collected?

 MR. SCHLICHTING: Well, the

 de-guaranteeing -- that would go -- that's for the

 inter-affiliate transactions, but the actual

 outward facing trade --

 COMMISSIONER BOWEN: Mm-hmm.

 MR. SCHLICHTING: -- I mean, that -- I 

 mean in the proposal, we -- you know, the

 Commission adopt -- well, the proposal says that

 if you are a foreign consolidated sub, you still
 75

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 have to collect margin on the outward facing

 trade. So -- and -- so the guaranteeing is

 separate and distinct from that. And, but as I

 said before, I think the exclusion though is maybe

 something to reexamine, so -- because if you had a

 foreign -- a non-U.S. CSE does a trade with a

 non-U.S. Person --

 COMMISSIONER BOWEN: Mm-hmm.

 MR. SCHLICHTING: -- that would be

 excluded from the rule totally. And then when you

 transfer -- even with that anti-evasion -- so the

 anti-evasion that's built into the

 inter-affiliate, that's still excluded out. So

 then when they do the -- so how the anti-evasion

 should have worked was, in that sense, there

 should have been a collection when the

 inter-affiliate trade occurs. But since it was

 already excluded out, it doesn't even look at

 that. So that's something we just need to

 reexamine.

 COMMISSIONER BOWEN: Okay. Thank you.

 MR. MARTINEZ: Commissioner, if I may,
 76

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 one note, a moment ago when we mentioned about 50

 percent of the swaps market was inter-affiliate.

 I want to note that's sort of an upper bound. And

 one of the --

 COMMISSIONER BOWEN: I'm sorry, Rafael.

 I'm sorry I missed the verb again.

 MR. MARTINEZ: In one of your first

 questions you asked about the size of the

 inter-affiliate market, and we said that of the

 swaps market, our estimate is that 50 percent of

 the swaps were inter-affiliate.

 COMMISSIONER BOWEN: Mm-hmm.

 MR. MARTINEZ: I want to clarify that

 that's an upper bound for the swaps that would be

 exempted from inter-affiliate margin. One of the

 reasons that we didn't -- couldn't provide you a

 number, specific in dollar amounts from our SDR is

 that as we reviewed our SDR, we identified people

 that have an ultimate parent -- that they share

 ultimate parents or they're affiliates, but the

 exemption, I think, in the rule goes to a very

 specific set of entities which we refer to as
 77

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 margin affiliates that have some conditions of

 consolidated risk management and their

 consolidated report, you know, accounting. And

 that's not something that we have identified in

 the SDR. We couldn't be that precise in the SDR

 data to see which of the affiliates that we had

 just because they share a common parent would

 actually satisfy the conditions to get the

 exemption. So the 50 percent would be an upper

 bound, but we couldn't really give you more

 precise numbers from that.

 CHAIRMAN MASSAD: Commissioner

 Giancarlo?

 COMMISSIONER GIANCARLO: Thank you. My

 written statement on this rule contains numerous

 observations and comments. I just want to

 highlight a few. I don't have questions, but I do

 want to say a few things. First, I want to note

 that the threshold for measuring material swaps

 exposure has been raised from three billion to

 eight billion, which brings our requirement

 roughly in line with the IOSCO standard of eight
 78

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 billion Euro.

 I'm also pleased that the swaps of

 commercial end-users, agricultural and energy

 cooperatives that are classified as financial

 institutions and small banks will not be subject

 to the margin requirements if they qualify for an

 exclusion or exemption. And I think that's one

 small assist to America's remaining small banks to

 get their heads back above water in the toppling

 wave of the Dodd-Frank Act.

 I disagree, however, with the definition

 of financial end-user, which is overly broad in

 the rule. It includes entities that are unlikely

 to act as counterparties to swaps, such as floor

 brokers, introducing brokers, and futures

 commission merchants acting on behalf of

 customers, among others. These entities may not

 ultimately be captured by the rule because they're

 unlikely to have material swaps exposure

 triggering application, but I question the logic

 behind their inclusion. Good regulation means

 precisely crafted rules, not ones that are
 79

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 deliberately overly-broad.

 I also continue to object to the 10-day

 liquidation horizon that must be incorporated into

 initial margin models for all types of uncleared

 swaps. The 10-day requirement is a made up

 number. It's not tailored to the true liquidity

 profile of the underlying swaps instruments. We

 must revisit this issue as we gain more experience

 with initial margin models.

 In addition, I remain concerned about

 the cross-border implications for this rule, which

 remain unfinished because they were proposed

 separately from the rule finalized today. An

 appropriate framework for cross-border application

 of margin requirements for uncleared swaps is

 essential if we are to preserve the global nature

 of the swaps market. We must avoid further

 fragmenting markets by imposing another regulatory

 framework that is inconsistent, confusing, or

 burdensome. Doing so will only result in yet

 another competitive disadvantage between American

 institutions and their international counterparts.
 80

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 And I close by again commending the team

 -- John, you and your team -- for your hard work,

 thoroughness, and ultimately the improved

 rulemaking that is before us today. Thank you.

 CHAIRMAN MASSAD: Thank you. I'd like

 to follow up just on a few points to make sure we

 understand and the audience also understood.

 Rafael, you were talking about the data on

 inter-affiliate swaps. So just to be clear, what

 you were saying is right now, our SDR data --

 frankly, I think, we're estimating, first of all,

 how much of it is in inter-affiliate swaps. We

 have to figure out who is related to whom

 manually. We don't really have accurate data on

 that. But, more importantly, when we're talking

 about not requiring initial margin on

 inter-affiliate swaps, we are only talking about

 those swaps between the consolidated affiliates.

 So, for example, if there is an investment fund

 managed by an affiliate, that swap is treated as a

 third party affiliate -- or a third party entity.

 MR. LAWTON: That's right.
 81

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 CHAIRMAN MASSAD: If there is a less

 than 50 percent owned entity, which is not

 consolidated, that is treated as a third party

 swap. So, we have no real sense of the

 distinction between, you know, the amount of those

 kinds of swaps and the amount of the consolidated

 swaps. Is that correct?

 MR. LAWTON: That's correct. Yes, that

 there's some difficulty in identifying who is an

 affiliate and then once you do identify who is an

 affiliate, there is some difficulty in identifying

 whether they're a consolidated affiliate or not.

 CHAIRMAN MASSAD: Okay. And just to go

 back to the de-guaranteeing issue, the

 de-guaranteeing issue goes to guarantees on

 outward facing trades. Is that right, Paul?

 MR. SCHLICHTING: Yes, that's correct.

 CHAIRMAN MASSAD: And our -- I think you

 were saying our proposal on the cross border deals

 with that by saying the application of our margin

 rule to those outward facing trades doesn't turn

 on whether there's a guarantee, it simply turns on
 82

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 whether the entity is consolidated.

 MR. SCHLICHTING: That's correct.

 CHAIRMAN MASSAD: So, the

 inter-affiliate -- whether we require initial

 margin for inter-affiliates is unrelated to the

 application of our cross border rule to the

 de-guaranteeing issue?

 MR. SCHLICHTING: On that end, yes. On

 the outward facing, correct.

 CHAIRMAN MASSAD: Right. Okay. I want

 to turn to the issue of inter-affiliate

 transactions -- talking about large institutions.

 There's a lot of inter-affiliate transactions, I

assume, between these entities, right? I mean

 which we don't even regulate. There's corporate

 overhead allocation, sharing of leases, sharing of

 IT, tax sharing and allocation, working capital

 arrangements, sharing of funding. There's all

 sorts of things, right? Okay.

 MR. LAWTON: That's correct. Yes.

 CHAIRMAN MASSAD: Now, here's where --

as I understand it, the prudential regulator
 83

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 situation is quite different than ours because --

 correct me if I don't have this right, but federal

 law already requires that when you have an insured

 depository institution engaging in an

 inter-affiliate transaction, that transaction must

 be fair to the insured depository institution. Is

 that right?

 MR. LAWTON: That's right.

 CHAIRMAN MASSAD: And, in many cases,

 that insured depository institution must also

 collect collateral for that transaction -- in some

 cases. Is that right?

 MR. LAWTON: I believe that's right,

 yeah.

 CHAIRMAN MASSAD: And Dodd-Frank made it

clear that derivatives are now included in that.

 Is that -- Paul, I see you nodding, but --

 MR. SCHLICHTING: Yes, that is correct.

 CHAIRMAN MASSAD: Okay. That framework

 doesn't apply to us -- to our entities. Is that

 right?

 MR. LAWTON: That's right.
 84

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 CHAIRMAN MASSAD: Okay. And it doesn't

 even mean that those transactions -- those very

 same transactions have to be fair to our entities.

 Is that right?

 MR. LAWTON: No. That's right. 

 CHAIRMAN MASSAD: Okay. All right. So,

 our entities can -- I mean they have a lot of

 things going on and we could have a margin rule

 that says you've got to collect -- let's say it's

 $100 million fixed to floating swap. You've got

 to collect and post margin. Okay. Could they

 then -- instead of doing that, could they just

 loan $100 million?

 MR. LAWTON: I'm sorry. Would the CSE

 be --

 CHAIRMAN MASSAD: Yeah.

 MR. LAWTON: -- making the loan or

 borrowing the money?

 CHAIRMAN MASSAD: Either way.

 MR. LAWTON: Um --

 CHAIRMAN MASSAD: Well, let's assume

 it's -- well, frankly, either way -- vis a vis the
 85

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 fairness to our CSE, right? It doesn't matter.

 MR. LAWTON: Right. I mean there would

 presumably be capital implications, depending on

 whether they were --

 CHAIRMAN MASSAD: Sure.

 MR. LAWTON: -- loaning it or borrowing

 it.

 CHAIRMAN MASSAD: Under our capital

 rule, you're saying?

 MR. LAWTON: That's right.

 CHAIRMAN MASSAD: Yeah. Of course,

 which all of these things could have implications

 under our capital rule. But the point is, in --

 that we could require margin on a $100 million

 fixed to floating interest rate swap where the

 payments -- given interest rates today are, you

 know, not all that large. Whereas, the entity

 could loan $100 million and not take any margin

 for it.

 MR. LAWTON: That's right.

 CHAIRMAN MASSAD: Okay.

 MR. LAWTON: I mean. Right.
 86

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 CHAIRMAN MASSAD: The entity could also

 collect, say, initial margin. If we required

 initial margin, one entity could collect -- our

 CSE could collect $20 million let's say in

 treasury securities from the affiliate. Right?

 As the margin? Okay. Could it then loan those --

 loan some other securities having a value of 20

 million back to that affiliate without any

 fairness or any standards on that transaction?

 MR. LAWTON: Again, yes.

 CHAIRMAN MASSAD: Right.

 MR. LAWTON: The margin would have to be

 segregated, but, yes, some -- they could do a

 separate transaction that's --

 CHAIRMAN MASSAD: My point is there's a

 lot of things going on within a consolidated

 enterprise and I think we've got to think about

 whether imposing initial margin requirements are

 really meaningful. Well, let me put it this way.

 If we have concerns about internal risk

 management, let's address them directly is my

 point. So, let me just then say why I support
 87

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 this rule because, you know, we're spending a lot

 of time on inter-affiliate margin and I think it's

 important to step back and think about the bigger

 picture here.

 I mean this rule is really one of the

 most important elements of swaps market regulation

 set forth in the Dodd-Frank Act. And I've been

 saying that for a while. There will always be a

 large part of the market that is not cleared, and

 that's appropriate. But we must take steps to

 protect against such activity posing excessive

 risk to the system. And that is why we are

 establishing margin requirements for uncleared

 swaps.

 I believe this rule is strong and

 sensible. It requires swap dealers and major swap

 participants to post and collect margin with

 financial entities with whom they have significant

 exposures. It requires initial margin, which is

 designed to protect against potential future loss

 on a default as well as variation margin. It

 allows for the use of a broad range of types of
 88

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 collateral, but only with appropriate haircuts.

 It requires a greater level of margin than for

 cleared swaps and it requires segregation of

 margin with third party custodians and prohibits

 the practice of re-hypothecation so that

 institutions cannot use their customer's margin

 for other purposes.

 Another very important feature, as I

 noted earlier, is that it exempts commercial end

 users from the rule's requirements. Their swap

 activities were not a source of significant risk

 in the financial crisis, so our rule is properly

 focused on the large institutions who engage in

 most of the uncleared swaps activity.

 Now, since I've been in office, you

 know, I hear a lot from people about the fact that

 rules on swaps internationally are not harmonized.

 And so, shortly after I took office, I committed

 to working to make the margin rules as similar as

 we could because, again, they are such an

 important piece of this framework. And our rule

 today is practically identical to those of the
 89

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 United States banking regulators and substantially

 similar to international rules. And I want to

 congratulate the staff, because I know that took a

 lot of work to get to where we are, but that is a

 very important accomplishment.

 Now, the rule is really designed to

 reduce the risk that a covered swap entity default

 leads to further defaults by its counterparties.

 And given the interconnectedness of our financial

 system, that's an extremely important thing. We

 became all too familiar with that risk in 2008.

 Now the issue of how the rule applies to

 inter-affiliate transactions is really a separate

 issue. It's received a lot of attention. And I

 first want to say that, you know, the differences

 in our views on inter-affiliate margin do not

 reflect differences in our respective level of

 concern about the safety of the system or about

 avoiding the problems of the past.

 I spent five years at Treasury helping

 this country dig out from the financial crisis and

 a lot of that time was spent on dealing with AIG.
 90

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 And I think our differences, instead, reflect

 differences in our analysis of what is the purpose

 of initial margin -- particularly in the

 inter-affiliate context -- and what would it

 accomplish or not accomplish. And so I believe

 we've got to look at this issue first in terms of

 the basic goal of the rule, which is to avoid the

 potential for the buildup of excessive risk from

 bilateral transactions between unaffiliated

 parties. Inter-affiliate transactions are not

 outward facing. They do not increase the risk --

 the overall risk exposure of the consolidated

 enterprise to third parties. And instead they are

 typically a means for the consolidated enterprise

 to centrally manage risk related to the activities

 of multiple subsidiaries -- as it does with a

 whole host of activities.

 So we must make sure that

 inter-affiliate transactions are not used as a

 loophole or as a means to escape the basic and

 very strong requirements of this rule to collect

 margin in transactions from third parties. And we
 91

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 have done that. We have imposed a very strong

 anti-evasion standard. As we have said, a covered

 swap entity is required to collect margin from an

 affiliate if that affiliate is directly or

 indirectly engaging in an outward facing swap in a

 situation where it should be, but is not

 collecting margin. And, in addition, as it was

 noted, our proposal on the cross border

 application of our margin rule, which is the

 subject of a separate rulemaking, also addresses

 this because that provides that any affiliate that

 is consolidated with a U.S. parent is subject to

 requirements to collect margin from third parties

 no matter where that affiliate is located and

 whether or not it is guaranteed by the U.S.

 Parent. I'm hoping that we can finalize that part

 of the rule early next year.

 Now, second, we have required the

 exchange of variation margin in all

 inter-affiliate swaps. And this provides mark to

 market protection to both sides and prevents the

 buildup of the liability owed by one affiliate to
 92

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 another. And, third, we've required that

 inter-affiliate swaps be subject to a centralized

 risk management program that is reasonably

 designed to monitor and manage the risks

 associated with such transactions. And I think at

 times, we're suggesting that we should use

 inter-affiliate margin -- initial margin -- to

enhance that risk management -- that internal risk

 management. I think that would be a very costly,

 and not necessarily effective way, to do that,

 because of the examples I've cited and because of

 the complexity of that internal risk management.

 If we are concerned -- if there is a concern about

 the adequacy of internal risk management --

 centralized risk management -- we should address

 it directly, not by imposing the requirements of a

 rule that is designed for trades with unaffiliated

 parties.

 I would also note that the rule is

generally consistent with the rule adopted by the

 Commission in 2013, exempting inter-affiliate

 transactions from the clearing mandate. If you go
 93

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 back and look, you will see the Commission

 explicitly considered whether to require initial

 margin or variation margin in the context of

 inter-affiliate transactions at that time and

 decided that it would not do so. It would not

 require those as a condition of using the

 inter-affiliate exemption from clearing. If we

 were to do so today, that would effectively 

 undercut the inter-affiliate exemption from

 clearing.

 So, I address other aspects of the rule

 in my written statement, but, in short, I believe

 this rule is a strong and sensible approach that

 will contribute to the strength and resiliency of

 our financial system. Thank you.

 If there are no other questions, I would

 again like to thank the staff for all their work

 and their presentations. And I would like to ask

 if any Commissioner would like to make any further

 statements before we proceed to a vote? Okay. I

 would then ask Mr. Kirkpatrick to call the roll.

 MR. KIRKPATRICK: The motion now before
 94

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 the Commission is on the adoption of the final

 rulemaking on margin requirements for uncleared

 swaps for swap dealers and major swap

 participants. Commissioner Giancarlo?

 COMMISSIONER GIANCARLO: Aye.

 MR. KIRKPATRICK: Commissioner

 Giancarlo, aye. Commissioner Bowen?

 COMMISSIONER BOWEN: No.

 MR. KIRKPATRICK: Commissioner Bowen,

 no. Chairman Massad?

 CHAIRMAN MASSAD: Aye.

 MR. KIRKPATRICK: Chairman Massad, aye.

 Mr. Chairman, on this matter the ayes have two,

 the no's have one.

 CHAIRMAN MASSAD: The ayes have it and

 the motion to adopt the final rule is approved.

 Is there any other Commission business? There

 being no further business, I would entertain a

 motion to adjourn the meeting.

 COMMISSIONER BOWEN: So moved.

 COMMISSIONER GIANCARLO: Second.

 CHAIRMAN MASSAD: All those in favor,
 

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22

 95

 say aye.

 COMMISSIONER BOWEN: Aye.

 COMMISSIONER GIANCARLO: Aye.

 CHAIRMAN MASSAD: Okay. The ayes have

 it. Again, I want to thank the CFTC staff for all

 their work and on behalf of all of us at the

 Agency, I want to wish everyone a happy holiday

 with family and friends and a wonderful new year.

 Thank you.

 (Whereupon, at 12:17 p.m., the

 PROCEEDINGS were adjourned.)

 * * * * *
 96

 1 

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16

 17 

 18 

 19 

 20 

 21

 22

 CERTIFICATE OF NOTARY PUBLIC

 DISTRICT OF COLUMBIA

 I, Carleton J. Anderson, III, notary

 public in and for the District of Columbia, do

 hereby certify that the forgoing PROCEEDING was

 duly recorded and thereafter reduced to print

 under my direction; that said transcript is a true

 record of the testimony given by witnesses; that I

 am neither counsel for, related to, nor employed

 by any of the parties to the action in which this

 proceeding was called; and, furthermore, that I am

 not a relative or employee of any attorney or

 counsel employed by the parties hereto, nor

financially or otherwise interested in the outcome

 of this action.

 (Signature and Seal on File)

-----------------------------------

 Notary Public, in and for the District of Columbia

 My Commission Expires: March 31, 2017