UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 

 

 

 AGRICULTURAL ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Tuesday, September 22, 2015
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 1 PARTICIPANTS:

 2 Moderator:

 3 RANDY FORTENBERY, Chairman, Agricultural

 Advisory Committee

 4 

 5 Introduction and Opening Statements:

 6 TIMOTHY MASSAD, CFTC Chairman

 7 SHARON BOWEN, CFTC Commissioner

 8 J. CHRISTOPHER GIANCARLO, CFTC Commissioner

 9 Ag Market Update:

 10 TIM ANDRIESEN, CME Group

 11 TIM BARRY, ICE Futures U.S.

 12 LAYNE CARLSON, Minneapolis Grain Exchange

 13 FCM - Market Trends:

 14 KEVIN PICCOLI, CFTC, Division of Swap Dealer and

 15 Intermediary Oversight (DSIO) Deputy Director

 16 EILEEN FLAHERTY, CFTC, DSIO Director

 17 SAYEE SRINIVASAN, CFTC, Chief Economist

 18 Position Limits:

 19 MARK FAJFAR, CFTC, Office of the General Counsel

 20 JOE HAWRYSZ, CME Group

 21 ERIK HAAS, ICE Futures U.S.

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 1 PARTICIPANTS (CONT'D):

 2 Other Participants:

 3 CORY CLAUSSEN, CFTC, Director, Office of

 Legislative Affairs; AAC, Designated Federal

 4 Officer

 5 ED ELFMANN, American Bankers Association

 6 BILL MAY, American Cotton Shippers Association

 7 JOHN ANDERSON, American Farm Bureau Federation

 8 RYAN WESTON, American Sugar Alliance

 9 LANCE KOTSCHWAR, Commodity Markets Council

 10 ROBBIE BOONE, Farm Credit Council

 11 TOM KADLEC, Futures Industry Association

 12 MARK SCANLAN, Independent Community Bankers of

 13 America

 14 BRYAN DIERLAM, International Swaps and

 15 Derivatives Association, Inc.

 16 PAUL PENNER, National Association of Wheat

 17 Growers

 18 JOE KOVANDA, National Cattlemen's Beef

 19 Association

 20 LYNN CHRISP, National Corn Growers Association

 21 JOHN OWEN, USA Rice Federation

 22 CHRIS CLARK, North American Millers' Association
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 1 PARTICIPANTS (CONT'D):

 2 STEPHEN STRONG, North American Export Grain

 3 Association

 4 NEIL DIERKS, National Pork Producers Council

 5 EDWARD GALLAGHER, National Milk Producers

 6 Federation

 7 BOB WHITE, National Grange

 8 M. J. ANDERSON, National Grain and Feed

 9 Association

 10 ZACK CLARK, National Farmers Union

 11 SCOTT CORDES, National Council of Farmer

 12 Cooperatives

 13 RON LEE, National Cotton Council of America

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 5 

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

 2 (11:00 a.m.)

 3 MR. FORTENBERY: Good morning. I'm

 4 Randy Fortenbery, the Chairman of the Agricultural

 5 Advisory Committee, and it's my pleasure to call

 6 this 38th meeting of the Committee to order.

 7 Before we go to our first panel I'd like to turn

 8 some time over to Chairman Massad and

 9 Commissioners Bowen and Giancarlo for a few

 10 comments. Mr. Chairman?

 11 MR. MASSAD: Well, thank you, Randy.

 12 And thank you all for taking the time to be here

 13 today. I really want to just welcome everyone to

 14 this meeting of the CFTC Agricultural Advisory

 15 Committee. Particularly for those of you who live

 16 outside of D.C., I really appreciate you traveling

 17 in for this. As you may know our city is already

 18 known as one of the worst cities in the nation for

 19 gridlock and traffic, and now we are going to

 20 welcome Pope Francis so it's very possible that

 21 Washington's traffic problems will soon reach

 22 biblical proportions, and I wish you all good luck
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 1 in getting out of town. We'll do our best to end

 2 the meeting on time.

 3 I'm very pleased that both Commissioner

 4 Bowen and Communication Giancarlo can be here

 5 today. We are only three now, but believe me,

 6 we're all committed to still carrying out the full

 7 Commission workload as best we can.

 8 Before we begin, let me just underscore

 9 the importance of the meetings of this Committee

 10 and all of our advisory committees. They provide

 11 a much-needed opportunity for us to hear directly

 12 from those who are participating in these markets

 13 and affected by our work, and in addition to these

 14 meetings I know all of us have had opportunities

 15 to meet with many of you and meet with others in

 16 the agricultural industry, agricultural companies

 17 and associations. I've given speeches at industry

 18 conferences, visited production facilities such as

 19 most recently a grain mill in Kansas City. I know

 20 Commissioners Bowen and Giancarlo have also, and

 21 all of those meetings and interactions provide

 22 very valuable insights for us into the issues that
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 1 you all face. I look forward to doing more of

 2 that in the future.

 3 I think we are all keenly aware of the

 4 importance that these markets play in the

 5 agricultural industry and to your businesses and

 6 to many aspects of American life, and I often note

 7 that most Americans don't participate in the

 8 derivatives markets. They probably seem very

 9 esoteric to most Americans, and yet they do

 10 profoundly affect our economy and the prices that

 11 people pay in their everyday lives for so many

 12 goods, obviously including agricultural products

 13 but also the cost of heating your home or driving

 14 your car. And so, these markets are so critical

 15 to many sectors of our economy, including

 16 agriculture, [critical] to the ability of

 17 companies in those sectors to hedge routine

 18 commercial risk.

 19 I want to thank Randy for his service as

 20 Committee Chair, for his dedication to that task,

 21 for his work in facilitating this meeting and

 22 helping to put together the agenda. I want to
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 1 thank our CFTC staff for all their work in

 2 preparing for this meeting, and I want to thank

 3 our panelists; those who are making presentations.

 4 We're very grateful to you.

 5 Let me just note quickly the topics

 6 we're going to cover. I'll just give a couple

 7 thoughts of mine on these. Our first session will

 8 include presentations related to developments and

 9 innovations in the agricultural derivatives

10 markets in particular with respect to certain

11 contracts, and I think that will be very

12 interesting. We'll have presentations from ICE,

13 CME, and the Minneapolis Grain Exchange.

14 We'll then have a discussion about

15 trends in the futures commission merchant industry

16 and how those trends may affect your ability to

17 participate in the derivatives markets. I think

18 we all know there's been a decline in the number

19 of FCMs. Now, you'll see some data today that I

20 think is very interesting on how that decline has

21 occurred over a number of years going back at

22 least to 2005, and it's likely the result of many
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 1 factors. At the same time, overall volumes in the

 2 industry have increased, and there has been

 3 concentration of business among the largest firms,

 4 and these are all trends that I am very interested

 5 in hearing your thoughts on today.

 6 Let me just say from my point of view

 7 it's very important that we have a robust FCM

 8 industry. It's very important that all customers

 9 including particularly smaller customers can

 10 access these markets efficiently and effectively,

 11 and so I think we're all interested in hearing

 12 your thoughts and suggestions on what's happening

 13 in the industry and whether there are issues that

 14 this Committee should examine or the staff of the

 15 CFTC can examine further.

 16 Finally we'll talk about position

 17 limits. In particular, today we're going to talk

 18 about two issues in that area. One is the

 19 possibility of exchanges granting non-enumerated

 20 hedge exemptions. This is an idea that I am

 21 certainly open to considering, and we'll hear from

 22 the exchanges on how that would work. And this
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 1 would be -- if we were to go forward with this --

 2 this would be a change to the proposed position

 3 limits rules that were issued in 2013.

 4 We will also discuss another proposal to

 5 modify those rules, and this one pertains to the

 6 aggregation provisions, and I'm pleased to

 7 announce that this proposed change will be

 8 released for public comment today. All of us on

 9 the Commission have supported issuing this for

 10 public comment. This proposal aims to make a

 11 significant, streamlined change to the process of

 12 waiving aggregation requirements.

 13 Under the proposal, instead of requiring

 14 a participant to apply for an exemption and wait

 15 to receive CFTC approval for an exemption, we

 16 would instead rely on a notice filing. So, a

 17 participant who owns 50 percent or more of an

 18 entity can obtain the exemption by attesting to

 19 the Commission that it has no control over the

 20 trading of that entity and no access to its

 21 information. We have notice filings in other

 22 areas as well that work well, and so this notice
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 1 process would mean it would be the same exemption

 2 process whether you own more than 10 percent and

 3 less than 50 or even above 50 percent.

 4 The proposed position limit rules that

 5 were issued by the Commission two years ago are

 6 important and complex, and I know all of you are

 7 very interested in these rules. You've expressed

 8 concerns about them. All of us currently on the

 9 Commission were not here when these rules were

 10 proposed, and therefore I think we're all very

 11 committed to taking the time to make sure we

 12 listen to you, listen to other market participants

 13 and consider carefully the implications of these

 14 rules. We appreciate very much the input you've

 15 given us to date, and we look forward to

 16 discussing today's issues.

 17 We understand that it's vitally

 18 important that as we finalize these rules we make

 19 sure that the rules work, that commercial

 20 end-users are able to continue to use these

 21 markets efficiently and effectively for risk

 22 management and price discovery.
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 1 So, I think all of the presentations and

 2 the discussion we'll have will give us good

 3 information about what's going on in the markets

 4 today and will help us better do our job of making

 5 sure these markets function with integrity and

 6 without fraud or manipulation. And to that end

 7 we've been committed to listening to market

 8 participants on a whole host of issues and

 9 particularly we have taken a number of actions to

 10 address end-user concerns since all of us took

 11 office. All of us took office now -- what --

 12 about 15 months ago? And our goal has been to

 13 make sure we don't create unnecessary burdens on

 14 commercial end-users, and so we've finalized a

 15 change, for example, to the rule on residual

 16 interest. We proposed changes to record keeping.

 17 We've made some important adjustments to the rules

 18 on trade options and contracts with embedded

 19 volume metric optionality. There's a whole host

 20 of sort of end-user things that we've done, and we

 21 will continue to focus on these concerns.

 22 Let me just note for a minute other
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 13

 1 things that are on our agenda for the fall -- and

 2 happy during the breaks to discuss these. We are

 3 looking at ways to strengthen the security and

 4 resilience of our clearinghouses and exchanges

 5 with respect to cyber-attacks and technological

 6 failures. Obviously that is a subject that is on

 7 everyone's minds. We are looking closer at

 8 automated trading, and I expect that we will

 9 propose some additional rules for consideration

 10 there to make sure automated trading does not

 11 result in disruptions or unfairness. And we also

 12 have on our agenda the proposed rule on margin for

 13 uncleared swaps which as you know exempts

 14 commercial end-users and that's obviously very

 15 important.

 16 So, we have other things on our agenda

 17 but let me end it here just in the interests of

 18 time, and let me just say again thanks for being

 19 here and I look forward to today's session. Let

 20 me turn it over to Commissioner Bowen.

 21 MS. BOWEN: Thank you, Mr. Chairman, for

 22 holding this meeting today. I commend the
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 1 Committee for examining the FCM marketplace, and I

 2 look forward to today's discussion about trends in

 3 FCMs, and of course position limits again.

 4 Why is today's discussion particularly

 5 relevant? As we enter the fall harvest season

 6 producers begin to see the fruits of their efforts

 7 this year. Financially they see if they met their

 8 targets, if their hedges paid off. Farmer's and

 9 rancher's access to financing and FCMs is crucial.

 10 Effective hedging is key to affordable financing.

 11 Regarding position limits, I look

 12 forward to this Commission moving forward on its

 13 rule. Earlier this year I was fortunate to visit

 14 Kansas City. I spoke with a wide range of

 15 farmers, processors and others involved in

 16 producing the food that we eat and the plant- 

 17 based products that we use.

 18 At Garrett and Cara Reikhof's farm in

 19 Higginsville, Missouri, Garrett and Cara

 20 highlighted significant capital investments

 21 necessary to farm, the low profit margins

 22 involved, and the unpredictability of income and
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 1 losses. Without access to cost-effective hedging,

 2 financing would be impossible for the Reikhof's to

 3 obtain. I was impressed with their commitment to

 4 food production and biofuels, and I am committed

 5 to making sure that our position limits rule does

 6 not make their already difficult job more

 7 difficult.

 8 At this point we have probably heard all

 9 possible comments on this rule. If we need to do

 10 a supplemental proposal to improve the rule, let's

 11 just do it. I believe there are ways to move

 12 forward on issues such as bona fide hedging to fit

 13 within the rules of the existing framework. So, I

 14 look forward to working with my colleagues and

 15 staff to improve the existing proposal to address

 16 such issues, and I hope we can move forward soon.

 17 Thank you again for convening today's meeting.

 18 MR. GIANCARLO: Thank you Commissioner

 19 Bowen and thank you Chairman Massad for convening

 20 today's meeting. I thank you also for your

 21 sponsorship of the Agricultural Advisory

 22 Committee. It's important that we meet today.
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 1 When I was a young corporate lawyer

 2 building my practice I made it a policy with each

 3 new client to spend time in their offices learning

 4 how they made a living, and I've continued doing

 5 that in my first year as a commissioner as have my

 6 fellow commissioners. I've traveled to Indiana,

 7 Kentucky, Illinois, and Minnesota, and I've met

 8 with cattle, pork, poultry, corn, soybean, dairy

 9 and other ag producers and I've also met with

 10 grain elevator operators, cooperatives, and

 11 manufactures who serve them.

 12 What I heard most about was the steep

 13 drop in commodity prices that is threatening

 14 farmers' bottom lines and personal checkbooks. In

 15 fact, since the last meeting of this Committee the

 16 U.S. Department of Agriculture has issued a report

 17 estimating that net farm income will plummet 36

 18 percent by the end of this year against last year

 19 reaching its lowest level in 9 years.

 20 Many of the everyday working people I

 21 met on Midwest farms and in factories don't know

 22 and don't care what Washington does. They just
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 1 want politicians and bureaucrats to not interfere

 2 with their ability to earn a living. I'm very

 3 concerned that our current position limit

 4 proposals will do just that, so I look forward to

 5 a new approach to aggregation of positions under

 6 our current position limits proposal, and I

 7 support the revised aggregation proposal that the

 8 Chairman announced; one that better recognizes the

 9 very corporate structures of American farmers,

 10 energy producers, manufacturers, and trading

 11 institutions that do business around the globe

 12 today.

 13 Still there are many other changes that

 14 are needed to make the CFTC's approach to position

 15 limits less harmful to the risk management

 16 activities of businesses facing variable commodity

 17 values. We must avoid adopting unworkable rules

 18 that prevent our commodity markets from operating

 19 effectively at a time of falling commodity prices.

 20 That means not displacing the everyday commercial

 21 judgment of farmers and business people with a

 22 small set of allowable hedging options that have
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 18

 1 been preselected by a Washington commission with

 2 limited experience in commercial risk management.

 3 I also look forward to a discussion of

 4 the state of America's futures commission

 5 merchants. As I have said, America's FCMs are

 6 becoming an endangered species due to government

 7 regulations and policies including the fed's

 8 decade-long zero-interest-rate program.

 9 FCMs continue to consolidate at an

 10 alarming rate, and it is no secret that the

 11 remaining FCMs have refused to retain their

 12 smaller, less-active clients including many small

 13 ag producers. I'd like to know whether the

 14 remaining FCMs have stabilized their business

 15 models to better serve the clients they have

 16 retained, and I'd like to know how smaller farmers

 17 and ag producers will be serviced by a reduced FCM

 18 industry; an industry that increasingly imposes

 19 limits on customer size and capacity. We must not

 20 allow Washington regulations to wipe out smaller

 21 FCMs and their customers in the same way that

 22 Dodd-Frank regulations have wiped out small
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 1 community banks across America's agriculture

 2 landscape.

 3 Let us agree on one thing. American

 4 farmers had absolutely nothing to do with the

 5 financial crisis; nothing whatsoever. We must

 6 think carefully about imposing an inflexible

 7 position limits rule set seven years after the

 8 crisis when our farmers today are relying on the

 9 derivative markets to manage the falling price of

 10 the 2015 harvest.

 11 If our position limits rules have the

 12 perverse effect as I fear they will of adding

 13 liquidity risk to the everyday practice of risk

 14 management then the American farmers I met with

 15 will be confirmed in their belief that once again

 16 Washington politicians are part of the problem,

 17 not part of the solution. Thank you very much.

 18 MR. FORTENBERY: Thank you, Chairman

 19 Massad and Commissioners Bowen and Giancarlo. So,

 20 at this point we'll turn to our first topic of

 21 discussion, an update on U.S. ag markets, and this

 22 morning we have three presenters: Mr. Tim
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 1 Andriesen from the CME Group, Mr. Tim Barry from

 2 ICE Futures USA, and Mr. Layne Carlson from the

 3 Minneapolis Grain Exchange.

 4 What I'm going to ask the Committee to

 5 do is keep track of your questions and/or

 6 comments, but let's wait until all three

 7 presenters have spoken, and then we'll have a

 8 general discussion. Mr. Andriesen?

 9 MR. ANDRIESEN: Sorry about that. Thank

 10 you for giving me the opportunity to be here. So

 11 I was asked to talk a little bit about changes in

 12 terms of our contracts, and I thought the best way

 13 to do that is to put that in context of the

 14 process that we use when we look at contracts and

 15 we look at changes.

 16 Over the last couple of years we have

 17 put in place a very specific approach that we've

 18 taken -- that we think has served us well. I'll walk

 19 you through that, and then we'll talk about some

 20 of the specific changes that are in the offing. I

 21 find it really nice in having this conversation

 22 that there are quite a few people at this table
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 21

 1 that have been participants in that process and

 2 have been involved in some of the recent changes

 3 in our contracts.

 4 One of the things we think is important

 5 is to take a proactive approach to looking at our

 6 contracts. When you have a contract where the

 7 underlying delivery process is tied to physical

 8 markets, those physical markets change and evolve

 9 over time. Most recently, for example, on the

 10 livestock side, one of the things we've seen is

 11 heavier and heavier animals, so because we have

 12 contracts where there are parameters around the

 13 weight of the animal and the delivery process,

 14 it's important that we're constantly looking at

 15 updating those contracts to reflect those sort of

 16 things.

 17 In grains... we see different patterns

 18 of movement in the grains. We see different

 19 issues constantly presenting themselves: freight

 20 costs, et cetera. So, one of the things that we

 21 have committed to doing on a regular basis is

 22 evaluating all of our major contracts. I would
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 1 say on about a two-to-three-year cycle we look at

 2 all of our contracts and whether we think they're

 3 operating extremely well or whether we think

 4 there's room for improvement. We put them through

 5 a process where we really reach out to the

 6 industry to get feedback.

 7 The first thing we do in that process is

 8 we'll take our economics team. We'll look at the

 9 contract, look at changes in the underlying

 10 markets and identify what they think might be some

 11 of the potential issues with the contract. That's

 12 pretty much an internal process.

 13 What we'll then do is put together a

 14 focus group of anywhere from 10 to 20 people. The

 15 vast majority of those people are physical users

 16 of the contract, but we will include financial

 17 participants in that marketplace -- or in that

 18 group -- as well. We take the issues that we've

 19 identified. We schedule roughly two- hour

 20 interviews with those firms independently and talk

 21 through the issues and get an assessment as to

 22 whether they think it's an issue. What do they
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 1 think we could potentially do? And are there any

 2 other issues that we should be looking at that

 3 maybe we haven't identified?

 4 Coming out of that, what we'll then do

 5 is pull all those people together. Typically,

 6 we'll invite them to Chicago and lay out for them

 7 what we've heard from the rest of the focus group,

 8 and we'll do it in a way that we'll say, "here's

 9 an issue -- here's issue A, we have some people

 10 who think this should happen, we have some people

 11 who think that should happen. Let's discuss

 12 that." And we've really found those discussions

 13 to be really powerful in that you get people with

 14 different views around these issues that then

 15 articulate those to us, and we can hear the pros

 16 and cons from that group.

 17 Coming out of that, we'll again circle

 18 around and say, "did we hear something that we

 19 feel is significant enough to address the contract

 20 or to change a contract, and if so, what do we

 21 think might be a path forward?"

 22 Once we've done that we go into what we
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 1 would call a broader request for comment stage

 2 where we will put out in the public using

 3 organizations or using other sorts of media

 4 "Here's some things that we're considering doing."

 5 It may or may not take the form of a

 6 questionnaire. It just depends on if the question

 7 we're asking is something that lends itself well

 8 to a questionnaire-type approach or not. That

 9 gives us some feedback as to what we really think

 10 we should potentially change. It also gives a

 11 much wider group the ability to comment.

 12 Essentially our goal is that before anything even

 13 is submitted to the CFTC as a potential change,

 14 it's well, well vetted in the industry so that

 15 everybody has an opportunity to opine on whether

 16 it makes sense or not.

 17 If through that process we finally get

 18 to something that we believe should be changed

 19 with the contract, then we'll finally make a

 20 proposal and submit it to the CFTC for approval.

 21 So, the whole idea of this process is to ensure

 22 that first we get deep, local knowledge, deep
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 1 industry knowledge involved in what potential

 2 changes might be made, and then later to make sure

 3 that everybody in the industry and beyond has an

 4 opportunity to opine on does that make sense or

 5 not.

 6 We think it's served us pretty well, and

 7 I think that people that have been involved in the

 8 process for the most part would say it's one

 9 that's been reasonably effective.

 10 So, I was asked to talk about some of

 11 the contracts and what their status is right now.

 12 We currently have four major contracts that are in

 13 that process. We've recently completed that

 14 process on the lean hog contract. We really

 15 didn't see at this time any particular changes

 16 that we felt we needed to make.

 17 We are going through that process with

 18 the corn futures contract. We have just recently

 19 closed a feedback period and a survey. We're

 20 assessing the data that we've gotten back, then

 21 there are three different areas that we're looking

 22 at for potential changes. One is in terms of
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 1 quality discounts to align them more specifically

 2 with the delivery market. Another is to look at

 3 freight differentials. The freight differentials

 4 on the upper Illinois River have changed, and

 5 we're looking at potentially updating those. And

 6 the final is whether we should look at potentially

 7 extending the delivery territory down the Illinois

 8 River to St. Louis.

 9 The feeder cattle contract is another

 10 that we're looking at. We just recently put out

 11 some comments, and we're looking for feedback on

 12 that. In particular we're looking at the weight

 13 range on feeder cattle. And then the Kansas City

 14 wheat contract is another contract that we've just

 15 gone through the process with. We have asked for

 16 some additional comments from the industry as a

 17 whole around it, though the feedback from the

 18 industry in general was that they didn't really

 19 anticipate any changes or any need for changes.

 20 So, we continue to do this with all of

 21 our products. I would say that the cycle is about

 22 a two-to-three-year cycle that should cover almost
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 1 all of our major contracts, and why I say it's a

 2 little bit iffy is we don't want to load up with

 3 too many at the same time because in many cases

 4 we're tapping into some of the same groups to get

 5 feedback from, so it's really about making sure

 6 that we come to the right conclusions.

 7 What I didn't point out in here is there

 8 are times when we will come up with issues where

 9 we say, "This is a really complex issue. We think

 10 potentially there is something that needs to be

 11 done here." But what we really need to do is get a

 12 smaller group to dig into it. So for example the

 13 delivery of heifers on the cattle contract was one

 14 of those things. We identified it as something we

 15 thought was important. It wasn't something that

 16 we could quickly make a recommendation for, so we

 17 actually worked with the NCBA and with other

 18 organizations to get a small group together, and

 19 over the course of about a year got to where we

 20 had what we thought was a reasonable approach to

 21 including them in the delivery process. So, those

 22 would be my comments.
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 1 MR. FORTENBERY: Thank you, Mr.

 2 Andriesen. Mr. Barry from ICE Futures USA.

 3 MR. BARRY: Thank you, Tim. I'd like to

 4 thank Chairman Massad and Commissioners Bowen and

 5 Giancarlo for the opportunity to address the

 6 Committee on ICE's new world cotton futures

 7 contract. It's probably the most significant

 8 development that we've had at ICE on the

 9 agricultural side in quite some time, and it's

 10 something that we've been working on with our

 11 cotton commercial market customers for nearly two

 12 years.

 13 We're nearing our November 2nd launch

 14 date. We are expecting to file the contract rules

 15 with the CFTC later this week, so the timing of

 16 today's meeting is for us quite advantageous,

 17 quite good.

 18 ICE and its predecessor exchanges -- the

 19 New York Board of Trade and the New York Cotton

 20 Exchange -- have been offering price discovery and

 21 risk management tools to the cotton trade for over

 22 a hundred years, and in fact the first futures
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 1 contract listed on the New York Exchange was the

 2 original cotton contract traded on the New York

 3 Cotton Exchange. It was listed just a few years

 4 after the first grain contract in Chicago, so our

 5 history here goes way back, and our current

 6 contract, the No. 2.

 7 Contract remains the global benchmark

 8 for cotton world-wide, and it's consistently one

 9 of our three most active and heavily-used

 10 agricultural futures contracts, but as the quote

 11 on the screen and the brief presentation somewhat

 12 suggests, over the past decade or so our

 13 commercial cotton customers have given us a

 14 consistent stream of commentary that the U.S.-only

 15 terms of the No. 2 contract -- can, in particular

 16 market conditions, create an unwanted disconnect

 17 between the contract and world market

 18 fundamentals, and that this condition, when it

 19 occurs, can diminish the utility of the No. 2

 20 contract and its key reasons for being: price

 21 discovery and risk management to the trade.

 22 One indicator of these types of trends
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 30

1 is the - that has led to concerns -- is the change

2 in the share of global cotton production and

3 exports, and the chart -- the slide above uses

4 some USDA data -- and it shows that as recently as

5 2003-2004 season U.S. cotton accounted for 19

6 percent of global production. That number in the

7 2013-2014 season had declined all the way down to

8 11 percent, and even more dramatically if you look

9 at USDA export data that shows up in the 2003-2004

10 season where the U.S.-origin cotton accounted for

11 41 percent of global cotton exports, and as

12 recently as '13- '14 that number had shrunk down

13 to 27 percent.

14 So, clearly as other origins around the

15 world have increased production and also improved

16 their quality and reliability in serving those

17 around the world, the dominant role that the U.S.

18 once played in global exports has decreased, which

19 brings us to the World Cotton contract, which is

20 intended to address those commercial market

21 concerns head-on.

22 To be clear, what we're doing with the
 31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 World Cotton contract is introducing a new,

 2 separate, stand-alone price discovery and risk

 3 management tool. We're not amending the terms of

 4 the current contract. The new contract will trade

 5 alongside the No. 2 contract which the exchange

 6 will continue to support and continue to offer,

 7 and the World Cotton contract terms themselves are

 8 built on the successful and tested terms of the

 9 No. 2 contract with differences where needed to

 10 better serve the increasingly international global

 11 cotton trade.

 12 Some of the similarities are that, like

 13 the No. 2, the terms of World Cotton contract will

 14 include at expirations, physical delivery and

 15 exchange certified licensed warehouses, pricing in

 16 U.S. cents per pound to two decimal places, five

 17 contract months a year -- March, May, July,

 18 October and December -- and a trading day running

 19 from roughly 9 p.m. at night to 2:20 in the

 20 afternoon covering a fair share -- a very large

 21 share -- of the commercial global cotton trading

 22 day.
 32

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 And now the differences: The first key

 2 difference between the World [Cotton] contract and

 3 the No. 2 contract is in the par quality that's

 4 deliverable on the contract. For the World

 5 contract, the par quality is color 31, or

 6 middling, as it's referred to in the cotton trade;

 7 leaf 3, staple 36, strength 27 in a particular

 8 micronaire range.

 9 For all but micronaire these par terms

10 are significantly -- are higher in quality -- than

11 they are in the existing No. 2 contract. And not

12 only that, the World Cotton contract terms also

13 provide for a higher minimum delivery quality than

14 does the No. 2 contract. The terms on the No. 2

15 contract -- the quality terms were set quite a

16 long time ago, and they have not been updated, in

17 some cases, for some quality parameters in quite

18 some time.

19 The difference between the contract

20 terms and the difference between the minimum

21 deliverable qualities here is not small. Based on

22 USDA classing data for the most recent season
 33

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 completed, typically roughly 90 percent of U.S.

 2 cotton production last year would have met the 

 3 grade specifications for the No. 2 contract.

 4 Looking at the higher minimum quality

 5 specifications for the world, only about 60

 6 percent of the U.S. cotton produced last year

 7 would have met the world contract specifications,

 8 so significant differences in terms of quality.

 9 A second key difference is deliverable

 10 origins. Unlike the No. 2 contract which allows

 11 for delivery of U.S.-grown cotton only, the World

 12 Cotton contract allows for delivery of cotton from

 13 the U.S. and eight other significant commercially

 14 relevant origins which are Australia, Brazil,

 15 India, and then Benin, Burkina Faso, Cameroon,

 16 Ivory Coast, and Mali. Those last five we

 17 collectively refer to as the West African growths.

 18 For deliveries under the contract, U.S.

 19 is the par origin and each other origin is

 20 deliverable at pre-set premium or discount that's

 21 fixed annually and can change once a year on a

 22 fixed pre-set schedule.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 34

 1 At launch, the schedule provides for a

 2 6 cent per pound or 600-point premium for Australia,

 3 and for discounts for each other origin. A

 4 300-point or 3 cent discount for Brazil, a

 5 700-point or 7 cent discount for India, and a 6

 6 cent or 600-point discount for West African

 7 growths, and those differentials were set based

 8 upon a survey we conducted on key market

 9 participants and their history of the relative

 10 value of those origins against the U.S. origin

 11 for the last several seasons.

 12 As you would expect, these origins were

 13 not -- that are allowed to be deliverable -- were

 14 not chosen on a whim. They were chosen for a

 15 reason. Collectively, again using USDA data,

 16 these origins, in the 2013-14 season, accounted

 17 for almost 3/4 of total global exports of cotton,

 18 so it's clear to see why these origins were

 19 selected.

 20 Finally, the third key differentiator

 21 between the World Cotton contract and the No. 2

 22 contract is delivery points. Like the origin
 35

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 terms of the No. 2 contract, which is U.S. origin

 2 only (the No. 2 contract allows for delivery of

 3 cotton in U.S. delivery points only) - the world

 4 contract will allow for delivery in the U.S., the

 5 same five delivery points that are currently

 6 available in the No. 2 contract. It will also

 7 allow for delivery in Australia in three locations

 8 and then in two locations in Malaysia and two

 9 locations in Taiwan.

 10 For delivery purposes, these two Asian

 11 countries -- which we are referring to as the

 12 destination countries, as opposed to origin

 13 countries of Australia and the U.S., these

 14 destination locations are par and delivery in any

 15 of U.S., and delivery in any Australian delivery

 16 point will be at a pre-set discount that roughly

 17 equates for the cost of moving that cotton in

 18 containers from Australian points or U.S. points

 19 to the destination locations. At launch those

 20 discounts will be 200 points or 2 cents a pound

 21 for Australia and 325 points or 3.25 cents per

 22 pound for the U.S.
 36

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 And again, just as the selection of 

 2 origins was made based on commercial market

 3 considerations, the selection of delivery points

 4 was also made based on commercial market

 5 considerations. Per USDA data for recent seasons 

 6 including 2013-14, Asia collectively has accounted

 7 for between 60 and 70 percent of global cotton

 8 imports over the last several seasons.

 9 So, in conclusion, our launch date is

 10 November 2. Our first delivery month will be the

 11 May 2016 contract, but I need to stress that just

 12 as the concerns about a potential disconnect

 13 between the U.S.-focused No. 2 contract and the

 14 increasingly international commercial marketplace

 15 came to us from our cotton customers, so too did

 16 these terms that I've just described for the World

 17 Cotton contract.

 18 The initial term sheet came to the

 19 exchange from a joint working group of the

 20 American Cotton Shippers, which is represented on

 21 this Committee, and a group based in Liverpool

 22 called the International Cotton Association who
 37

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 collectively came together and recognized the need

 2 to develop a viable, functioning, international

 3 cotton contract to complement the No. 2 and it

 4 brought those terms to ICE as the exchange they

 5 felt could best bring it to successful listing

 6 quickly.

 7 The effort has taken us longer than we

 8 thought, and we've been working for nearly two

 9 years with continued input from our commercial

 10 customers to refine that term sheet into a viable

 11 futures contract and also to make sure that all

 12 the services needed to support a physical-delivery

 13 contract in those locations with those origins

 14 will be there including grading, warehousing, and

 15 provision of electronic warehouse receipts.

 16 One unexpected challenge that we faced

 17 and that we hit in the process was learning that

 18 some of the planned World Cotton contract terms

 19 that we were given -- and that we feel are

 20 appropriate -- conflicted with the nearly 100- 

 21 year-old provisions of the Cotton Futures Act.

 22 That meant that to list this contract in the U.S.
 38

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 with those terms that the trade wanted us to keep,

 2 we literally needed an act of Congress and we got

 3 it. It took nine months, and it only succeeded

 4 because of the help and support we received from

 5 our cotton customers including ACSA as well as the

 6 National Cotton Council who's also on this

 7 Committee.

 8 The exchange is very grateful for the

 9 support we've received in developing the terms of

 10 the World Cotton contract and in getting to the

 11 point where we're just about a little more than a

 12 month away from launch. We're continuing to work

 13 hard to ensure a successful launch and we look

 14 forward to that first trading day, and that's the

 15 end of my presentation. Thank you.

 16 MR. FORTENBERY: Thank you, Mr. Barry.

 17 Mr. Carlson from the Minneapolis Grain Exchange.

 18 MR. CARLSON: Good morning to the

 19 distinguished members of this Committee and all

 20 those in attendance. Thank you very much for the

 21 opportunity to speak before you. My name is Layne

 22 Carlson. I'm proud to say I represent the
 39

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Minneapolis Grain Exchange. Our institution has

 2 been around since 1881, so about 135 years, so we

 3 must be doing something right. I believe we've

 4 earned the respect of generations of

 5 farmer-producers, grain elevators, exporters and

 6 millers, as well as speculators.

 7 We started as a regional cash grain

 8 market and have grown now into a global service

 9 provider by means of the electronic marketplace.

 10 Our principal contract is a North American Hard

 11 Red Spring Wheat contract and each of you around

 12 this table should have material before you

 13 describing a little bit about our contract.

 14 Trading volume has been growing

 15 dramatically. For our last fiscal year, just

 16 ended August 31, we set a new record in terms of

 17 volume exceeding well over 2 million contracts.

 18 This is a 13.4 percent increase over last year's

 19 record, a 69 percent increase over two years ago,

 20 and an 87 percent volume increase from just three

 21 years ago.

 22 What makes these volume numbers
 40

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 impressive is that they have occurred in the face

 2 of a strong headwind. There's been a dramatic

 3 decrease in FCMs, an ever-growing and complex

 4 regulatory burden, and a rise in required capital

 5 to be set aside for margining and security

 6 purposes. Volume growth is going to be harder to

 7 come by as a result, and liquidity is an essential

 8 element for market participants to get in and out

 9 of the marketplace at a price that they desire;

 10 therefore all regulatory authorities, whether MGEX

 11 or CFTC, must seriously weigh the costs of

 12 rulemaking compared to the benefits they're

 13 supposed to provide.

 14 The main purpose of the commodity

 15 futures industry in general is -- , in our high- 

 16 risk Spring Wheat contract, in particular -- to

 17 provide a means for risk mitigation and price

 18 discovery. If we cannot provide this service to

 19 our market participants we fail them; consequently

 20 MGEX has a vested interest ensuring the contract

 21 is able to be used for risk mitigation and price

 22 transparency. Therefore MGEX is constantly
 41

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 reviewing our contract to determine whether it's

 2 meeting the needs of its users. In fact, we have

 3 our market participants on a Hard Red Spring Wheat

 4 contract Committee. They have both been vital in

 5 ensuring our contract's performance. As a result,

 6 MGEX has made changes to the contract to enhance

 7 its value.

 8 For example, effective with the

 9 September 2012 contract month, a delivery elevator

 10 no longer has to provide a certificate of U.S.

 11 origin unless requested. This was in direct

 12 response to the fact that Canadian spring wheat

 13 was entering more and more into the U.S. supply

 14 and delivery chain. In fact, Canadian customers

 15 are using our contract to hedge.

 16 Additionally, effective with the May

 17 2013 contract month, all warehouse receipts issued

 18 for delivery against the Hard Red Spring Wheat

 19 contract had to be marked with a vomitoxin limit.

 20 This was a direct result of customers wanting to

 21 ensure any delivered wheat that entered into the

 22 food supply could be used here and abroad.
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 42

 1 Additionally what we've done is we've

 2 added another contract, a Calendar-Spread Options

 3 contract this year. Calendar-Spread Options are

 4 options on a price differential between two

 5 different futures delivery months. This allows

 6 contract traders to efficiently spread between

 7 delivery months at a single transaction.

 8 Furthermore, to improve transparency we've added

 9 daily grain movement reports and put them on our

 10 website. This provides more transparency into the

 11 marketplace, and that has been well received.

 12 Another essential element that has

 13 contributed to the success of the contract has

 14 been reliable, measurable futures-and cash price

 15 convergence. That reliability has been cited

 16 again and again by market users as a reason they

 17 can trust our contract. Of course, there have

 18 been unusual factors that can interfere in some of

 19 that normal price convergence, and we witnessed

 20 some of that in 2014 and early 2015 with the rail

 21 car shortage, but however MGEX looks to guard the

 22 importance of convergence by monitoring all the
 43

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 various factors involved including transportation

 2 and storage costs.

 3 And of course monitoring our Hard Red

 4 Spring Wheat contract is something we take very

 5 seriously, particularly trades surveillance in

 6 the regulatory aspect, as well as customer

 7 satisfaction in terms of contract performance and

 8 risk mitigation and price discovery.

 9 When we conduct market surveillance, we

 10 monitor for improper activity that might be

 11 manipulative or disruptive such as trading ahead,

 12 and we keep watch on the contract specs as

 13 mentioned earlier; however a real concern of MGEX

 14 and our market participants is proposed regulatory

 15 changes. I don't think that we can over-emphasize

 16 the importance of the topic of speculative

 17 position limits, particularly the negative impact

 18 the 2013 Notice of Proposed Rulemaking will likely

 19 have on our market participants and our MGEX

 20 contract.

 21 The amount of Hard Red Spring Wheat

 22 grown in North America is well over a billion
 44

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 bushels. With such a large commodity, I guess our

 2 preference would be that position limits really

 3 are not necessary. Rather, the contract markets

 4 that list products for trade, such as ours for

 5 Hard Red Spring Wheat, should be allowed the

 6 ability to set position limits; however, we

 7 realize that no limits or setting limits ourselves

 8 may be too much to ask considering that the CFTC

 9 has listed Hard Red Spring Wheat as a core

 10 referenced contract. Therefore we must stress the

 11 importance of parity of speculative position

 12 limits among the three domestic wheat contracts;

 13 specifically Hard Red Winter and Soft Red Winter

 14 in Chicago, and our Hard Red Spring Wheat

 15 contract. All three contracts are listed as core

 16 referenced contracts of the 28 listed by the CFTC

 17 in the Notice of Proposed Rulemaking in 2013.

 18 The CFTC has historically recognized the

 19 importance of position limit parity among the

 20 three wheat contracts, and while history is on our

 21 side, there really are fundamental and practical

 22 reasons for maintaining wheat contract position
 45

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 limit parity. All three contracts have market

 2 participants that trade all three contracts.

 3 Those market participants are both commercial

 4 hedgers and speculators, and both put on active

 5 spread trades between the different wheat

 6 contracts to hedge risk or to take advantage of

 7 perceived price differentials. And speculators

 8 are essential to contract pricing and spread

 9 trading. At times perhaps three- fourths of all

 10 daily trading involved in Hard Red Spring Wheat is

 11 involved in either market spread trading, and

 12 furthermore over half of all Hard Red Spring Wheat

 13 is exported, and most of that is sometimes, or in

 14 some manner, hedged in the futures marketplace.

 15 As already stated, the annual production

 16 of North American hard red spring wheat is over

 17 one billion bushels, making that wheat class the

 18 largest wheat class in North America. This is why

 19 I mention annual production, and the concern we

 20 have with the initial proposed rulemaking in 2013

 21 which starts out with our contract having a

 22 position limit of only 3,300 contracts, Hard Red
 46

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Winter would start at 6,500, and Soft Red Winter

 2 would start at 16,200 contracts. And that formula

 3 is derived from the CFTC's proposed rule for

 4 non-spot month position limits using a formula of

 5 10 percent of the first 25,000 of the contract's

 6 open interest and 2.5 percent of open interests

 7 thereafter. However, this approach allows the

 8 third largest wheat contract to have almost five

 9 times higher limits than the largest wheat class,

 10 and this really makes no sense. Consequently, we

 11 would suggest that we look at production and

 12 volume as opposed to open interest.

 13 Because a large volume of intermarket

 14 spreading, the proposed limits may very well harm

 15 all three contracts as traders may limit activity

 16 to the wheat contract with the lowest limits;

 17 therefore, a one-size-fits-all formulaic approach

 18 is not a good approach to setting position limits,

 19 and that's why MGEX is continuing to make the case

 20 that non-spot position limits among the wheat

 21 products must be treated equally if the CFTC is

 22 going to have position limits. To do otherwise is
 47

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 only going to cause confusion, if not likely cause

 2 price distortion among the three wheat contracts.

 3 Should a definition of bona fide hedging be

 4 narrowed, as proposed, that would only increase

 5 the importance of the need for parity among the

 6 wheat contracts.

 7 And that brings up another important

 8 topic to all market participants who use our

 9 contract. Narrowing or restricting a definition

 10 of a bona fide hedge from its current use is not

 11 the best route to solve perceived or real abuse.

 12 Rather, it's only going to cause consternation and

 13 frustration among a group of hedgers who

 14 legitimately use the futures market for which it's

 15 intended to be used. I will quickly add that

 16 anticipatory hedging is a bona fide hedging form.

 17 In closing I just want to thank this

 18 Committee for the opportunity to speak, and thank

 19 the Commission for the support of this advisory

 20 committee.

 21 MR. FORTENBERY: Thank you, Mr.

 22 Carlson. At this point we'll open it up to the
 48

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Committee for questions and/or discussion. I'll

 2 just remind you to please hit the button and turn

 3 your microphone on when you speak, and then turn

 4 it off when you're done. Any questions or

 5 comments?

 6 I have a question for Mr. Barry. Do you

 7 have a sense for whether or not the volume of

 8 trade, at least initially, in the World Cotton

 9 contract is likely to come from current trade in

 10 the domestic No. 2 contract, or is there sort of a

 11 latent demand for this activity that hasn't been

 12 accomplished anywhere else in the market in the

 13 past?

 14 MR. BARRY: In your question do you mean

 15 first that we would see traders who are active in

 16 the No. 2 also being active in the world contract,

 17 or moving their activity from one to the other?

 18 MR. FORTENBERY: Moving their activity

 19 from the domestic to the world.

 20 MR. BARRY: That's a question we

 21 grappled with from the beginning as to what extent

 22 the new contract might cannibalize the existing
 49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 contract. The net feedback that we've gotten from

 2 current market participants is that there is

 3 latent demand from producers in other areas for

 4 whom the U.S. focused price is not necessarily as

 5 good a barometer or as good as -- the current

 6 contract, the U.S.-only terms, doesn't give them a

 7 sufficiently relevant price to use, so we think

 8 there's latent demand. We think there also will

 9 be significant pickup from current users of the

 10 contract, but we think there would also be some

 11 arbitrage opportunities between the world price

 12 and the U.S. price, so we're here to see. We

 13 think there's a bit of all three.

 14 MR. CLAUSSEN: Could you guys speak more 

 15 directly into the microphones. It's really hard

 16 to hear up here. Thanks.

 17 MR. FORTENBERY: We have a few Committee

 18 members that are connected by telephone as well.

 19 Do we have any questions from the folks that are

 20 remotely connected?

 21 MR. WANDS: Yes, my name is Hayden

 22 Wands. I'm with Bimbo Bakeries USA. Just to let
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 50

 1 everybody know, we're the largest baking company

 2 in the U.S. We currently have about 62 bakeries

 3 in the U.S. and we're owned by Grupo Bimbo, which

 4 is located in Mexico City, and they are the

 5 largest baker in the world having bakeries in

 6 North America, South America, Europe and China,

 7 and so I appreciate everybody's initial comments

 8 on this, and again thank you to the CFTC for

 9 continuing these discussions because as you can be

 10 well aware, the agricultural exchanges, or

 11 futures, to us as an entity are vital, and we want

 12 to see the fluidity of those markets continue --

 13 or the liquidity of those market continue.

 14 I have a question for Mr. Carlson of the

 15 Minneapolis Grain Exchange. Mr. Carlson, you

 16 mentioned a note that you don't want to change the

 17 definition of the current bona fide hedger. Is

 18 that correct?

 19 MR. CARLSON: That's correct. We

 20 believe certainly that the current application and

 21 use of the definition of bona fide hedging

 22 specifically under 1.3 (z) is adequate for the
 51

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 marketplace, and unless there's evidence to the

 2 contrary showing that it needs to be narrowed, I

 3 think we should support the current use of the

 4 definition and its application.

 5 MR. WANDS: And so I'm not quite -- I'm

 6 not aware of that rule. Where do the index funds

 7 fall on that? Are they considered now a bona fide

 8 hedger or not?

 9 MR. CARLSON: I'll have to let some

 10 others speak more specifically to that, but I

 11 think the application of bona fide hedging is

 12 contract-wide, not specific or limited by the type

 13 of contract; whether it's physical or index.

 14 MR. WANDS: Okay. My only concern is we

 15 do quite a bit of hedging in the Minneapolis Grain

 16 Exchange, obviously because we buy a fair amount

 17 of U.S. spring wheat and Canadian spring wheat.

 18 What we want to avoid obviously is 2008 with what

 19 happened in Minneapolis, and so do you think the

 20 definitions that you have now as a bona fide 

 21 hedger, are you comfortable that that won't -- we

 22 put in kind of a guardrails where that won't occur
 52

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 again?

 2 MR. CARLSON: The incidents in 2008 were

 3 across all commodity markets, where there was a

 4 fundamental increase in prices not only limited to

 5 our contract. Again, I think what we find, is

 6 that the commercial industry...in particular, we

 7 should be listening to them in terms of how they

 8 use the specific different contracts for hedging,

 9 and continue to use or allow them to use those

 10 futures contracts for hedging purposes. I would

 11 say that in 2008 hedging was not the instigator

 12 for the increase in pricing at that time.

 13 MR. WANDS: Oh, no, and I don't want to

 14 occupy everyone's time. I absolutely agree that

 15 hedging was not the incidence. It was just the

 16 price action. Minneapolis was, at least, of the

 17 different indexes that we use, was the most

 18 volatile, and so that's -- I just wanted to get

 19 your opinion on if you think that the definition

 20 of bona fide hedgers will circumvent that from

 21 occurring again. That was my only point.

 22 MR. FORTENBERY: Other questions either
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 53

 1 from those remotely connected or sitting in the

 2 room?

 3 MR. KOVANDA: Mr. Carlson, just a quick

 4 question. You mentioned at the beginning the

 5 growth in your volume, and then you mentioned the

 6 challenges that are being faced. Why do you think

 7 the two have coincided?

 8 MR. CARLSON: It's interesting in that I

 9 think what we've been able to do is show them

 10 value of our contract, meaning that we have more

 11 international participants involved in our

 12 contract, and that has contributed significantly

 13 to the growth of that contract. Plus as I

 14 mentioned earlier, we have made contract changes

 15 so that people can use the value of the contract,

 16 specifically removing U.S. origin requirement, if

 17 that was a requirement, and then adding vomitoxin

 18 limits as two specific examples. So, despite the

 19 headwind we still have people seeing the value of

 20 the contract. It's just that it's becoming more

 21 and more difficult I think to see that type of

 22 growth if this type of trend continues.
 54

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 MR. GALLAGHER: Tim Barry, thank you for

 2 presentation on the new cotton contract. I'm a

 3 dairy guy and way out of my league on cotton here,

 4 but I really appreciate how the cotton industry

 5 looked at the changing global marketplace and

 6 created a global contract that trades with the

 7 existing U.S. contract. Right?

 8 So, we had a -- Tim Andriesen --

 9 remember we had attempted to do something like

 10 that at the CME with nonfat dry milk, and Tim, I

 11 think we were a little bit premature, but I am

 12 interested. We have a challenge within the global

 13 dairy industry about world powder derivatives and

 14 not having a go-to place, but I am interested in

 15 your -- one of the challenges gets back to

 16 delivery discounts, and so you've worked with the

 17 industry to identify what they should be. Do you

 18 have a plan to review those over a period of time

 19 to see if they change? And, if they do change,

 20 will you enact changes to those at that point?

 21 MR. BARRY: Yes, for both the origin and

 22 the location discounts that I referenced. The rules
 55

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 dictate specifically when each, for each origins,

 2 for example. Each year by July 1 the exchange has

 3 to announce a new schedule that will take effect

 4 not that same December but December a year

 5 forward, so any changes in the new schedule will

 6 be announced on July 1; in 2016 will take effect

 7 for December 2017 delivery.

 8 So, yes, we have a built-in schedule by

 9 which we need to review them on best available

 10 evidence at that time, announce them to the world,

 11 and at sort of a staggered effective date for

 12 each, so that built into the contract is an annual

 13 review for quality -- sorry, for location and

 14 origin discounts.

 15 MR. GALLAGHER: Tim Andriesen, so when

 16 you're thinking about -- when you look at the need

 17 to change contracts it is generally the industry

 18 coming to you to look for changes, or is it more

 19 the CME reviewing things and suggesting changes to

 20 the industry? How does that dynamic work?

 21 MR. ANDRIESEN: I think it's a bit of

 22 both. We're outside of just simply having a
 56

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 review process. We're generally engaged with the

 2 industry on a pretty frequent basis, so by the

 3 time you get to a review process you've generally

 4 had comments and feedback from people that help

 5 you form what are the things that we potentially

 6 want to look at.

 7 There are cases when it's our thought

 8 process -- in terms of identifying those things

 9 that are driven by the industry -- and there are

10 times when those things are driven internally

11 where we, as the research and product development

12 team, look at the macro drivers, the market and

13 they see as things that potentially are

14 challenging for the contract in the future.

15 MR. GALLAGHER: So you have an

16 interactive approach with the industry in general

17 that you've got contacts, you know the people,

18 they know you, you're constantly working with

19 them. I'm assuming it's the same for ICE and the

20 Minneapolis Grain Exchange? It's no different,

21 and so one of the things that I'm a proponent of

22 is if there are questions as to whether something
 57

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 is a bona fide hedge that the exchanges decide on

 2 whether something's a bona fide hedge, and if so

 3 if there were some sort of a rule that there was

 4 -- with everybody in the room here that we think

 5 that I agree with Wayne that the existing bona

 6 fide hedge rule should continue, but from time to

 7 time there's going to be new things that are going

 8 to pop up, and so new ways of using derivative

 9 markets to hedge a transaction including using

 10 swaps instead of futures. So for instance, in

 11 dairy, there's only one dairy clearing -- CME's

 12 the only one that clears dairy or handles dairy,

 13 and so we may have some innovative way to utilize

 14 a hedge transaction for our farmers or for the

 15 businesses that we own that may be done by swaps,

 16 and so we're going to want to know in advance or

 17 if that swap transaction is going to be a bona

 18 fide hedge, and so we'd like the exchanges to be

 19 involved and I'm curious, if they were -- if in

 20 their infinite wisdom the CFTC agreed and decided

 21 to let the exchanges identify whether something is

 22 a bona fide hedge that is outside whatever the
 58

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 parameters are that may exist at the time it's

 2 implemented, how quickly could the CME make a

 3 determination as to whether something would be a

 4 legitimate bona fide hedge if it was sort of this

 5 new thing that hadn't been tried before?

 6 MR. ANDRIESEN: Very respectfully I'd

 7 suggest Joe Hawrysz is on this afternoon and he's

 8 in market reg. He would be one of the key

 9 decision-makers if we were to look at doing

 10 something like that, so I would suggest that he

 11 would be the person to ask that question to.

 12 MR. DIERKS: If I could follow up with

 13 what Ed just said, I would fundamentally agree

 14 that I think the exchange is in a positon to offer

 15 more real-time observation. I'm not going to --

 16 we'll wait until this afternoon, but I'd also say,

 17 since you mentioned hogs, in the process you went

 18 through in the hog contract I would let the

 19 commissioners know that I think the pork

 20 industry's been satisfied with the outreach the

 21 CME does, the input it solicits. Sometimes it

 22 almost over-solicits, but they make sure that all
 59

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 the parties have an opportunity in that process.

 2 I would also say that I think it's not just a

 3 single spot in time like, oh, gee, the contracts

 4 -- there's no change to the contracts now, okay,

 5 but there's still discussions going on within the

 6 industry with the exchanges on what the future

 7 looks like.

 8 One of those is the exchange just

 9 started publishing a new pork index that may be

 10 the precursor long-term for other kind of risk

 11 management tools that we need in the industry.

 12 And the final comment I'd just - I'd

 13 like to compliment ICE. One of the concerns that

 14 I guess I've had personally is that as we look in

 15 the future and the globalization of agriculture,

 16 one of our strategic resources is our domestic

 17 U.S. exchanges -- the exchanges occurring or

 18 taking care of business for pricing globally

 19 because I'll tell you, in the U.S. pork industry

 20 there are strategic advantages long-term for our

 21 exports if we continue to -- even though there's

 22 no physical pit anymore in Chicago, if we continue
 60

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 to base it here in the United States it should be

 2 global in reach, but it needs to reach the global

 3 market, but in 2008 when we saw $8 corn, $9 corn,

 4 we had people backfilling corn in the United

 5 States from South America we would have been at a

 6 tremendous disadvantage for the pork industry

 7 perspective because suddenly we started pricing

 8 corn off of São Paulo or somewhere else, and I

 9 think it's critically important we keep these

 10 exchanges in a leadership positions.

 11 MR. MASSAD: Thanks, Randy. I wanted to

 12 ask Tim Barry a couple questions. First, is there

 13 any significant competition anywhere on sort of an

 14 alternative cotton contract from anywhere in the

 15 world? Number one.

 16 And number two, you noted -- I'm just

 17 kind of curious on the composition. You note on

 18 page eight the new contract deliverable origins

 19 were up 73 percent of world cotton exports and you

 20 give the breakdown. U.S. is 27 percent, though I

 21 think I heard you say that the amount of U.S.

 22 production that would be eligible -- that would
 61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 meet the criteria is about 60 percent. I'm just

 2 curious when you look at it in terms of production

 3 that meets the criteria, who are the other big

 4 [producing countries] -- is it pretty much

 5 proportional to what you have here on page eight

 6 or is there any variance?

 7 MR. BARRY: Sure, on the first question

 8 there is no direct competitor currently. There is

 9 a very actively-traded cotton contract on the

 10 Zhengzhou exchange in China. It was one of their

 11 -- I think it may have been their first successful

 12 agricultural products. They also now trade sugar

 13 which trades even more volume there than their

 14 cotton contract does. That contract prices

 15 delivery in China; Chinese only, so it's -- as a

 16 benchmark it's potentially a competitor, but it's

 17 not a direct competitor.

 18 In terms of exports, the U.S. -- even

 19 haircutting for quality which we've done and when

 20 obviously that will be in our deliverable supply

 21 estimates when we make our filing later this week

 22 - the U.S. would be the largest contributor to the
 62

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 deliverable supply for the contract. Australia is

 2 typically number two, India number three, and then

 3 the contributors get smaller, so it's not equal,

 4 by any means, but the U.S. is still the biggest

 5 single contributor to that number.

 6 MR. FORTENBERY: Any other of the remote

 7 contacted Committee members have a question? Yes,

 8 Mr. Kadlec.

 9 MR. KADLEC: Tim Andriesen, [I have a

 10 question regarding] CME's very successful dairy

 11 products. Have you explored expanding into Europe

 12 knowing that their consumption is, I think, on an

 13 individual basis, more than us in the United

 14 States? Do you have any initiatives or thoughts

 15 of expanding your contract there?

 16 MR. ANDRIESEN: So, obviously that

 17 market's gone through some deregulation this year.

 18 I'd say just generically we're always looking at

 19 markets that are in transition as possible

 20 opportunities.

 21 MR. FORTENBERY: Mr. Carlson, I have one

 22 quick question. You mentioned that from your
 63

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 perspective the need for parity, I guess that is

 2 the way to phrase it, in terms of position limits

 3 across all the wheat contracts, you talked a

 4 little bit about spreads, and I interpreted that

 5 maybe falsely to mean time spreads, calendar

 6 spreads. But I'm wondering is there much spread

 7 activity between spring wheat and the winter wheat

 8 contracts, and would differential position limits

 9 -- is it significant enough that they might have

10 an impact on that volume of trade?

11 MR. CARLSON: I think that when we look

12 at the activity in our marketplace and among the

13 three wheat contracts, our market participants

14 seem to be active in all three wheat contracts,

15 and our real concern is that under the 2013 Notice

16 of Proposed Rulemaking the initial limits proposed

17 are so disruptive or potentially disruptive to the

18 marketplace, I think I briefly mentioned that with

19 the amount of spread activity, I think it harms

20 all participants because -- those that are

21 actively spreading among wheat contracts in order

22 to avoid potential violations -- they might limit
 64

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 their activity during that date to the contract

 2 with the lowest position limits, and I think that

 3 does a very disservice to providing liquidity to

 4 all three contracts for those that are

 5 speculators.

 6 MR. CORDES: Just a follow-up question.

 7 Layne, when you talked about parity on the

 8 position limits, all three, you talked about a

 9 better way maybe looking at production. In those

 10 numbers are you considering U.S. and Canadian or

 11 just one or both, or how's that factoring in your

 12 thought process?

 13 MR. CARLSON: That's a good question.

 14 When we look at our contract it's really -- we

 15 look at it as a North American hard red spring

 16 wheat contract meaning both domestic, U.S., and

 17 Canadian origin. A lot of Canadian spring wheat

 18 is crossing the border and being delivered into

 19 our supply chain, and we see a lot about Canadian

 20 participation in our marketplace because they see

 21 the value and the correlation of using our

 22 contract with our marketplace.
 65

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 And when I say -- when you asked about

 2 volume, I think that when you look at North

 3 American spring wheat you see a billion bushels or

 4 more being grown, and that's far and away the

 5 largest wheat class in all of North America.

 6 Henceforth that would -- I think we look at the

 7 need of having position limits established more on

 8 a -- perhaps if there's going to be position

 9 limits -- if we looked at it that way we would

 10 look at potential deliverable supply and not just

 11 limit it to potential open interest.

 12 MR. FORTENBERY: Any more questions or

 13 comments? Okay, thank you very much, Mr.

 14 Andriesen, Mr. Barry, Mr. Carlson. We're going

 15 to break for about 15 minutes, so we'll reconvene

 16 at noon to take up our second panel, and I will

 17 see you then. Thank you.

 18 (Break)

 19 MR. FORTENBERY: Okay, I'd like to call

 20 the meeting back to order, please, so if you're

 21 still lingering around if you could maybe take

 22 your seats. For the second panel I'd like to
 66

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 introduce Mr. Piccoli who's with the CFTC's

 2 Division of Swap Dealer and Intermediary

 3 Oversight, and he's going to talk about FCM market

 4 trends. Mr. Piccoli.

 5 MR. PICCOLI: Thank you very much.

 6 MR. FORTENBERY: One quick interruption.

 7 Please lean into your microphone when you speak.

 8 We're having a little bit of a difficulty hearing

 9 from one end of the room to the other, so as you

 10 ask questions or you present, please lean well

 11 into the microphone. Thank you.

 12 MR. PICCOLI: Thank you very much. As

 13 the chairman said in his introductory comments

 14 we're going to be talking here a little bit about

15 some of the statistics on FCMs over the last few

 16 years and taking a look at what's going on and

 17 taking just a little bit of a deep dive behind the

 18 trends in FCMs.

 19 So, I think the initial analysis shows

 20 from 2005 we were at 180 FCMs and then that

 21 dropped down to 76 at the end of 2014, but I think

 22 when you do that deep dive I think here you really
 67

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 have to parse out the main groups that are

 2 involved within the FCM community. So in 2005 you

 3 had three large groups. You had, on the top in

 4 light green, 84 FCMs that had no customer assets,

 5 so in essence introducing brokers that were there

 6 but with an FCM registration so they were FCMs.

 7 Also, we had 11 FCMs with firms that had more than

 8 1 FCM registrant, so for example, you had Morgan

 9 Stanley and Co. and Morgan Stanley Dean Whitter,

 10 so they were -- had not -- did not merge MS Dean

 11 Whitter and MS and Co. into one FCM. You had

 12 Wells Fargo that has 3 FCMs out there and other

 13 examples of that - firms that had a multiple

 14 number of FCMs out there.

 15 And then you had 85 FCMs that held

 16 customer assets, and we'll go into a little bit

 17 more detail behind the trend and what's going on

 18 behind each one of these data points, but at a

 19 high level I think when you look at 2009, for

 20 example, and this was chosen as right after the

 21 financial crisis we dropped down to 133 FCMs.

 22 We still had 62 FCMs that did not hold
 68

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 any customer money, and you had a decrease in the

 2 number of FCMs that had -- a number of firms that

 3 had multiple FCMs from 11 down to 6. We also had

 4 some other things going on there.

 5 There were two bankruptcies that

 6 happened during this period; Sentinel and Lehman

 7 Brothers. We have four firms that were acquired

 8 by others, and a lot of this was pre-crisis, and

 9 it was firms that were doing natural industry

 10 consolidation trying to get more firm assets, more

 11 customer assets, so we saw that naturally

 12 happening in the 2005 to 2008 period.

 13 And then you still had a small number of

 14 FCMs that did go out of business. You had a

 15 number of FCMs that changed their registration

 16 status from a formal FCM -- fully registered FCM

 17 -- to an introducing broker, a CPO or a CTA. And

 18 again, I'll go into a little bit more detail on

 19 that in a minute.

 20 Then if you look at 2014 -- so what

 21 happened here? We had a sizable drop in the

 22 number of FCMs that did not carry customers, and
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 69

 1 part of the reason for this is you had, I think,

 2 the NFA making a little bit of push, talking to

 3 these FCMs, and saying, "okay, why are you

 4 registered an FCM? You really don't need to be."

 5 In some cases it was the FCMs insisted --I'm

 6 sorry, --the NFA's insistence that, no, that FCM

 7 was really a commodity pool operator, and so

 8 therefore you need to register as a CPO. So, I

 9 think you had a little bit of a push from the NFA

10 focusing in on this group of firms, and we see the

11 drop there.

12 Some of the firms simply were

13 rationalizing. You know, then just saying, look,

14 the barrier to entry, the cost of being an FCM is

15 a little bit higher. We had new customer

16 protection regulations coming in that required

17 every FCM to have a chief compliance officer, to

18 have risk management procedures, to have

19 documented business continuity practices, and

20 testing these things, so a number of things that

21 came in with our customer protections regulations

22 during that timeframe. So those I think were some
 70

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 of the rationale behind all of that. So let's go

 2 to the next slide. This just focuses in on that

 3 lower tier going from in 2005 down to 14 -- sorry, 60

 4 -- in 2014, and you see total drop during that

 5 period about 29 percent. [It's] still an important

 6 number that we can't lose sight of, but the drop

 7 from 2009 to 2014 -- a net decrease of five. Keep

 8 in mind net because I think there are a lot of ups

 9 and downs through there.

 10 And just one other point I'd make

 11 because we are into 2015. In 2015, currently,

 12 there is a little bit of a decrease that we see

 13 currently. We saw a couple of firms - Vision,

 14 that I think the NFA had a little bit of a push on

 15 that one to help get them to transfer their

 16 customer assets. Institutional Liquidity has gone

 17 out. We had Newedge that went over to Société

 18 Générale when Société Générale bought 100 percent

 19 of the firm, so we'll still see that, and we know

 20 that there are a couple of other firms that are

 21 rationalizing the number of multiple FCMs that

 22 they have, so I suspect we'll see a little bit of
 71

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 a decrease by the end of 2015. We've seen a

 2 little bit of it now, and we'll see a little bit

 3 more as these firms are rationalized and

 4 particularly the banks that have to deal with the

 5 Basel standards and some of their banking

 6 regulations. They are looking to consolidate the

 7 multiple FCMs that they have.

 8 So, now let's jump into the actual ups

 9 and downs. So here you can see there's a lot of

 10 volatility on both sides of the ledger here.

 11 We've got a number of firms that have been added

 12 during this period from 2006 to 2014, and then

 13 additionally a number of withdrawals, and we'll go

 14 through -- you can see the ledger on the top that

 15 indicates which.

 16 When we look -- let's start with the

 17 added firms, firms that came into being as an FCM

 18 during this period. You'll see early 2006 a

 19 number of firms coming in and then taking an

 20 opportunity after 2009, after the financial crisis

 21 to come in.

 22 Some of these firms are small and still
 72

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 remain small. I think [there are] some [that]

 2 are, in fact, more significant FCMs now, such as

 3 Macquarie, [who] is new to the FCM world. TD

 4 Ameritrade has come in. Phillips Futures,

 5 Straits, ED&F Man, E-Trade, and the most recent

 6 being Wedbush that has just come in with the

 7 acquisition of Crossland and taking over or buying

 8 Knight Capital Group, the old Penson Futures FCM

 9 coming in, so a fair amount of activity on the add

 10 side, so it just wasn't all a net decrease or

 11 total decrease. There were some on the upside

 12 too.

 13 When we drill down a little bit into the

 14 withdrawals and what was going on there, starting

 15 with the red on the bottom you'll see there were

 16 the four bankruptcies that came through: Sentinel,

 17 Lehman, MF Global, and Peregrine that came through

 18 with a fair amount -- about $10 billion of

 19 customer assets associated with those bankruptcies

 20 -- and those customers were obviously absorbed

 21 into other FCMs.

 22 We also had a number of firms that you
 73

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 see in the, I guess, the grayish brown -- the

 2 brown on the screen, gray on my screen here --

 3 that had become IBs, CPOs or CTAs, and as I said

 4 before some of this was the NFA going in and

 5 pushing the firms and saying "let's take a look at

 6 what's your business model, where should you be

 7 registered," so you see that coming through there.

 8 And you'll see a lot more of the

 9 activity in the 2009 to 2011 period where you had

 10 that rationalization. Part of that is the profit

 11 margin. Interest rate spreads remain very low. A

 12 lot of these firms were dependent on the spread,

 13 and it just wasn't there, and they couldn't

 14 possibly sustain it for a long period of time at

 15 low interest rates.

 16 You had new customer protection

 17 regulations coming in, which some of these firms

 18 had had $10 to $15 million in customer assets.

 19 The additional requirement -- for them... it was,

 20 they said, "okay, we have to take out a chief

 21 compliance offer" so that -- I think, was another

 22 factor that possibly came into consideration.
 74

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Overall, though, there is only $440

 2 million of customer assets associated with these

 3 firms, but there are a number of small firms that

 4 are in here: Frontier, Pioneer, MBF Cleary, Far

 5 Financial, Shay Green, Gelber, which I guess

 6 earlier in the period, probably 2008 is when those

 7 guys became IBEs or CPO, CPAs.

 8 The next group, which is the light gray

 9 on this slide, represents the firms that went out

10 of business, and some of these were at the NFA's

11 insistence, but a fair number were there. Three

12 of them make up the majority of the customer

13 assets, and that was Trilon, Temco, and Bank of

14 New York Mellon -- which is interesting as they

15 sort of came in as a new player and then went out

16 a few years later -- but those three firms made up

17 a vast majority of the customer assets that were

18 there; a total of $1.1 billion of customer assets

19 in firms that went out of business, but the story

20 I think is there still were a large number of

21 small firms that at an average of $10 million of

22 customer assets that did go out of business, and
 75

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 obviously those customers have transferred to 

 2 other firms.

 3 And then the final group that you see

 4 there in the green are... there are 10 firms that

 5 were acquired by others. I think early in the

 6 period we saw firms like Fortis, A.G. Edwards,

 7 and Iowa Grain moving. I think a couple of them

 8 went to Mr. Kadlec's firm, ADM. Another went to

 9 Wells Fargo. A.G. Edwards went over to Wells

 10 Fargo. Then you had others -- Penson went over to

 11 Knight Capital Group -- and then a consolidation

 12 of some small and mid-size firms coming into play.

 13 So I think the factors that are there,

 14 [such as] profit margin. There we see the profit

 15 margin for the industry at a low in 2008. It's

 16 increased since then, but it's still at a

 17 relatively known low number averaging in total

 18 around 5 percent, but that's a number that really

 19 needs to be analyzed to make sure we fully

 20 understand what's behind that, but just the raw

 21 number is there.

 22 And the ag firms, the firms that have a
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 76

 1 predominant amount of their customer business as

 2 agriculture-based -- and this is based on the

 3 number of customers, not necessarily the revenue.

 4 We don't have that detailed level of information

 5 to how much revenue is from ag firms. We just

 6 simply -- the number of ag customers that the

 7 firms tell us they have -- whatever, 40 - 50

 8 percent of their business -- is from ag customers.

 9 That's still a fair number of firms, but it is the

 10 smaller firms that are there, I think. The other

 11 factor that we ought to mention is the new

 12 customer protection rules coming in, I think, had

 13 some impact on the firms that are withdrawing.

 14 So here just a different view of the

 15 industry during this timeframe, so the bars

 16 represent the dollars of customer assets and the

 17 left-hand axis is the frame to go by there, so you

 18 see us going from that $130 billion in customer

 19 assets to a total of $250 billion in customer

 20 assets right now.

 21 And now, important to note -- there is

 22 the green in there-- the cleared swaps. Then up at
 77

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 the very top, the very small bar that is tough to

 2 see, is the FOREX assets. Both of those sort of

 3 came in with the new regulations. So, but even

 4 backing out the cleared swaps number, it's still

 5 an increase of 53 percent in customer assets that

 6 were with these firms from 2005 to 2014. Yet you

 7 see the line represents the number of FCMs that

 8 were there. So dropping from, I would say, 133

 9 down to about 60 coming in the end of 2014. So,

 10 just an interesting pictorial. I think they're

 11 raising some questions and thoughts on that.

 12 Taking another look and taking a look at

 13 the largest FCMs, looking at seg and secured

 14 assets only -- so we carved out the cleared swaps

 15 because from a comparative perspective you need to

 16 be apples and apples,so 2005 did not have cleared

 17 swaps so we took that out -- but you can see the

 18 top 10 firms, [the] top 10 firms in 2005, in

 19 particular. So in 2014 you have MF Global. That

 20 obviously fell out. We had two Newedge firms that

 21 consolidated into one; two JP Morgan firms. Now,

 22 JP Morgan Securities is still there and
 78

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 predominant. There's another JP Morgan Clearing

 2 that's still there but it's significantly dropped

 3 off. It's now down to number 25 in the rankings.

 4 So, we [can] look at 2014 and some of

 5 the things that come out. You see Barclays

 6 replaced Lehman Brothers, so I think that's just

 7 sort of a push on that. But you have Deutsche

 8 [Bank] and Credit Suisse coming in. Deutsche

 9 [Bank] and Credit Suisse are always in the top 15.

 10 During this timeframe I think they just have

 11 consistently added market share, but the thing

 12 also to note is [that] in 2005, 67 percent of the

 13 customer assets were with the top 10. In 2014,

 14 the top 10 holds 75 percent of customer assets.

 15 Again, just the seg, secured, and a little bit of

 16 FOREX that's out there, so their market share has

 17 increased from 67 percent to 75 percent. In most

 18 of these firms, you've got to look at where these

 19 firms are at now, in being mainly banks. They do

 20 have pressure from Basel, the new leverage ratios

 21 coming in and some hover rates on return on equity

 22 that are going to be challenging to these firms
 79

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 going forward, so we have to think about the

 2 customer portability of these firms, and their

 3 ability to take on other [customers] and continue

 4 to grow market share... or is that going to

 5 stabilize? Don't know.

 6 Customer portability over the last

 7 couple of years; we had Vision, Global Futures,

 8 and FOREX, Jefferies, and Penson all sort of moved

 9 over nicely to a number of different firms, but I

 10 think going forward looking at the concentration,

 11 it just raises some questions on that standpoint.

 12 Here I will first say that this is

 13 definitely not a graph that a finance guy would

 14 do. It's much too exciting. It is -- the donut

 15 here just presents a different view of the top

 16 firms, and 196 represents -- including cleared

 17 swaps -- so just a slightly different view, but

 18 you see how all of the other firms are sort of

 19 going into a smaller and smaller band in there, so

 20 I thought this was interesting and an interesting

 21 point for discussion.

 22 The final thing I just want to mention
 80

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 is on the CFTC website and here's a picture of the

 2 website and the link to it. We do have all of the

 3 FCM financial data -- obviously non-confidential

 4 data isn't there. You see in the bottom box --

 5 every month you see the data in.pdf as well as

 6 Excel formats so you can play around with that.

 7 Here is what that looks like when you

 8 actually pull it up, and I think it presents some

 9 interesting information to the industry and to

 10 customers, potential customers. Key data points

 11 being -- from my perspective -- excess capital,

 12 target residual. Here are some of the things --

 13 and we know a lot of the firms look at this

 14 frequently to see where they are verses others in

 15 the industry. So, it's an interesting thing.

 16 I wish we could have made this bigger so

 17 you could see the whole thing, but hopefully

 18 you'll go to the website and take a look and see

 19 where we stand. And you can also see the firms

 20 that are FCMs with no customer assets, still

 21 bigger ones with zeros going across the line. So,

 22 I think that's the end of the comments I had and
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 81

 1 the analysis that I had, and Mr. Chairman, go

 2 right ahead please.

 3 MR. FORTENBERY: Thank you very much.

 4 Before I throw it open for comments or questions,

 5 let me just recognize Ms. Eileen Flaherty and also

 6 Dr. Srinivasan who will be helping answer

 7 questions and engaging in discussion.

 8 And just a quick reminder, if you're in

 9 the room, please mute your phone. If you're a

 10 Committee member who's connected remotely, if

 11 you're having a local discussion could you please

 12 mute your phone while that goes on as well.

 13 At this point I'm open for questions or

 14 discussion. Yes, sir, Mr. Chairman.

 15 MR. MASSAD: Let me just add because I

 16 don't know that all of you have met Eileen.

 17 Eileen is the new director of DSIO, so we're just

 18 delighted that she joined us just a couple weeks

 19 ago, and Sayee is our chief economist, so

 20 delighted to have both of them here.

 21 And Kevin, I just had one question

 22 because I may have -- I don't think I heard what
 82

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 you said. On the last -- on the donut chart, the

 2 196 total assets, that's without including swaps,

 3 is that right?

 4 MR. PICCOLI: That is including -- it's

 5 the total assets of the top 10 including swaps.

 6 MR. MASSAD: Just the top ten?

 7 MR. PICCOLI: Just the top ten. The

 8 $250 billion in total; $196 billion is the top 10

 9 alone. Sorry, I should have clarified that.

 10 MR. GIANCARLO: Mr. Piccoli, thank you

 11 for that. Your knowledge of not only the

 12 statistics but just the change in nature of the

 13 market and who's going where is really

 14 authoritative, and it's great to have you on the

 15 beat -- keep an eye on things.

 16 The thing I'm concerned about is not

 17 just the changing trend of the top 10 firms --

 18 which are, there's a certain stability in the

 19 nature of those firms even if their names are

 20 changing -- but what I'm concerned about is recent

 21 reports, as I'm sure you know, when SocGen

 22 acquired the storied Bache firm from Jefferies
 83

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 recently it was widely reported that they let go a

 2 sizable number of the smaller customers and that,

 3 and that report also reflects a number of other

 4 mergers that I've been reading about recently.

 5 So, my question is where do those small

 6 customers go when they get the notice from the new

 7 acquirer that, sorry, but we just can't

 8 accommodate a small account like yours anymore?

 9 Where do they take their business, and do they

 10 have a place to take their business?

 11 MR. PICCOLI: Sure, thank you, Mr.

 12 Commissioner. So, a couple of points. One, when

 13 Jefferies did let us know that they were going to

 14 be exiting the Bache business, we, obviously, from

 15 an examination standpoint, were very actively

 16 involved with them, met with them on a daily basis

 17 upfront, and then weekly thereafter focusing in on

 18 those small customers and making sure that they

 19 just didn't leave people out high and dry. So,

 20 those customers, I think, with the -- and I've got

 21 to give credit to Jefferies because they certainly 

 22 did the right thing as I think almost all FCMs
 84

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 would and that is making sure those customers did

 2 find a home.

 3 A number of them went to some of the

 4 firms that specialize in that type of product.

 5 The ag firms, ag customers, I think lot of those

 6 went to some of the ag firms that we would

 7 traditionally see take on those firms. We had, in

 8 some cases, the metals desk at Jefferies - the

 9 ones trading the metals futures - that whole team

 10 moved to another firm, so those customers

 11 associated with that moved with that team to that

 12 other firm.

 13 So the -- I think -- and I want to be

 14 careful not to give out any confidential data, but

 15 I think that the customers themselves, I think,

 16 pretty much found a home where, [number] one, they

 17 were comfortable, I assume, right? And [number]

 18 two, where the firm said, "yes, these are the

 19 types of customers that we would like." But

 20 you're absolutely correct that when SocGen took

 21 the customers from Jefferies there were quite a

 22 few that SocGen did not take for a variety of
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 85

 1 reasons, the least of which is because they didn't

 2 want the firm, the customer. It just didn't fit

 3 into their business model, so [the portability of

 4 these customers] is certainly one of the things

 5 that is important to look at, so you're absolutely

 6 right there.

 7 MR. GIANCARLO: And I just have one

 8 follow-up question. I understand from speaking to

 9 some of the larger trading houses that it's good

 10 policy to have access to more than one FCM as far

 11 as just a diversity of access and putting their

 12 positions, and I'm told that today that's very

 13 hard to do; that most trading houses, if they have

 14 one FCM they can work with, they're fortunate.

 15 It's very hard to have more. Is that your

 16 experience? Can you comment on that?

 17 MR. PICCOLI: From what we have seen I

 18 think we find that certainly the largely

 19 institutional customers and the professional

 20 traders -- the large professional traders, not the

 21 old floor traders -- do have more than one FCM.

 22 They have their primary FCM and then a hot
 86

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 back-up, if you will, that they do actually trade

 2 with, so we tend to see that, and that's one of

 3 the reasons that we saw not all of the customers

 4 went from Jefferies to SocGen because these

 5 institutional customers already had an account at

 6 SocGen -- Société Générale, excuse me, and so they

 7 didn't want to go there, so they went over to

 8 another firm; JP, JP Morgan Securities, Goldman,

 9 whoever. So, on the large customers or the large

 10 institutions I think we tend to see them more than

 11 one FCM, most likely just two, but there are a

 12 couple that are with three.

 13 MR. LEE: In our discussion with the

 14 Committee I'd be interested to know whether that

 15 experience is mirrored in the experience of the

 16 Committee members.

 17 MR. KADLEC: Thank you, Kevin, not only

 18 for this presentation but a rational thought to

 19 regulation. Commissioner, the lesson learned

 20 post-MF Global was the fact that most of our

 21 constituents in this room have two clearinghouses,

 22 so I can confirm to you that most of our best
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 1 customers on the commercial side have two

 2 relationships.

 3 The large trading houses present what I

 4 believe is to me a different problem. They're the

 5 most educated if you're talking about propriety

 6 shops, and my view is they don't want to pay a

 7 fair rate. That's -- whenever we evaluate

 8 business, and we have been fortunate to receive a

 9 fair amount of business in the last six years

 10 because of disruptions in the marketplace that

 11 Kevin covered.

 12 You go through a process of due

 13 diligence, and the one thing that 2008 and 2009

 14 really reinforced to anybody is real stern and

 15 proper due diligence that covers regulatory

 16 affirmation of the customers that you're

 17 acquiring, proper pricing and capital allocation.

 18 Are they a needy customer? What are their service

 19 requirements? And that's something that we did

 20 get into a great deal, and all FCMs should dig in

 21 a great deal, and the ability to say no at times

 22 to customers is perhaps the best decision I can
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 1 make because it is a strategic relationship, and I

 2 cannot emphasize that enough.

 3 In the chair that I sit in my day job is

 4 that I view customers as a strategic partner in

 5 our business. I would like, in terms of

 6 regulatory outlook, to look at the Commission and

 7 exchanges as a strategic partner, in a different

 8 way, but I really feel that all of our vendors are

 9 -- we have agendas with them and -- it's about

 10 gaining operational efficiencies -- and I think

 11 that the biggest message if you look at the cost

 12 structure of FCMs as they jump around a bit.

 13 The cost structure of regulatory

 14 oversight has doubled in the last five years for

 15 us. It's a direct reflection of Dodd-Frank, Basel

 16 and the MF Global and Peregrine. I'm not judging,

 17 but to answer all the questions, to properly

 18 engage the customer protection rules -- that's

 19 what it takes to run an FCM these days. The

 20 effect is that we have to raise prices on many of

 21 our customers in this room, and we are in the

 22 process of passing those costs on and trying to do
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 1 it in a rational and proper and well-defined way,

 2 and I just -- I appreciate these type of forums to

 3 further explore areas that with the Commission and

 4 with exchanges that we can work together to do

 5 many of the things that you talk about in your

 6 position limits.

 7 I think in terms of efficient processes.

 8 This morning -- I'm sorry, I can't recall your

 9 name -- but your question was and I was concerned

 10 about whether you were going to ask the CME group

 11 to tell us in real time who's a hedger and who's

 12 not? I think we should embrace the exchanges and

 13 the Commission to define our hedges, but I think

 14 it's the responsibility of a customer to be able

 15 to prove that they fit into one of the buckets.

 16 It's critically important that the real-time

 17 decisions are trading decisions and not whether or

 18 not they fit into one of the hedge-exemption

 19 buckets. If that's where we're going, that's

 20 going to be a challenging day, so I got a lot more

 21 to say, Kevin, as you know, but I turn it over to

 22 my fellow Committee members for now. Thank you.
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 1 MR. MAY: Thank you. On behalf of U.S.

 2 cotton merchandisers, just a few comments on this

 3 subject. End users such as our members rely on

 4 FCMs to facilitate their hedging business on

 5 futures exchanges. We're growing increasingly

 6 concerned about the health of this sector and

 7 believe that with many swaps now being pushed

 8 through clearinghouses, further Dodd-Frank

 9 mandates, we arguably need more FCMs, not less;

 10 however that is what we are seeing. FCMs are

 11 pulling out of the business. We encourage the

 12 CFTC to use its expertise and resources to

 13 investigate this growing problem and see what you

 14 can do to help this current trend. Thank you.

 15 MR. CORDES: Thank you, Chairman.

 16 Question for you Kevin -- and I appreciate the

 17 analysis on this -- I've looked at some of this

 18 stuff myself, and in my day job as president of

 19 CHS Hedging we always look at this and I'd echo

 20 the comments around rules and regulations. We've

 21 doubled our costs around headcount, compliance,

 22 and we're probably headed to triples, so we always
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 91

 1 asking ourselves, "how do we continue to have the

 2 size and scale to compete?" We represent one of

 3 these small bars [in the chart], but yet as being

 4 owned by farmers and ranchers and local

 5 cooperatives our mission is to serve agriculture.

 6 So my question...you referenced the

 7 piece around the top 10 and the seg assets here,

 8 the agricultural-type piece, I think you mentioned

 9 around 40 to 50. Do you have more definition

 10 where that's at because I know in my day-to-day

 11 activities and who I compete with, there's a lot

 12 of FCMs that wouldn't be in the top 10 that are in

 13 the ag space, and I think for this panel here it's

 14 probably real important [to see] where that's

 15 represented and who has that size and scale to

 16 work with them.

 17 MR. PICCOLI: I think some of that, the

 18 information that we have there on who, such as

 19 firms like yours, have a percentage of the

 20 customer base that is ag-related verses minerals

 21 verses financial futures, et cetera -- I think

 22 there are a number -- from our estimate about 12
 92

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 firms - that are predominantly, or significantly I

 2 should say, more ag-customer oriented, but again I

 3 caution because that's a bit -- it's just one

 4 number, but you need to truly analyze it because I

 5 don't know how much of that represents revenue

 6 verses just number of customers, so it's a

 7 difficult number to get our hands on. But I think

 8 it is an excellent point, and I think it's one

 9 that I think would be helpful in getting at the

 10 earlier comment of really diving in and trying to

 11 understand what that means and where these firms

 12 are and portability of customers. If one of these

 13 firms went out, where would they go? Very

 14 important questions.

 15 MR. MASSAD: Yes, just to note on that I

 16 think we have, as Kevin said, some data, some

 17 estimates. Unfortunately some of that's also not

 18 public information that we can make available, but

 19 I suspect all of you guys know who the main

 20 players are anyway.

 21 I'd like to ask Eileen whether she has

 22 any sort of general thoughts, and again for those
 93

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 of you who don't know, Eileen now has had about

 2 four weeks as a regulator after about 25 years in

 3 the industry including at Newedge and other

 4 places, so I think your perspective on all this

 5 would be very helpful. And then Sayee, also, if

 6 you have any thoughts.

 7 MS. FLAHERTY: Sure, thank you. I

 8 obviously can't comment on the SG takeover of

 9 Newedge because I came from Newedge, and my

 10 background really is in this industry for the past

 11 25-plus years, and I've worked for multiple FCMs.

 12 I've worked for proprietary trading firms, and

 13 just focusing from the FCM space with my new

 14 regulatory hat, I do bring the practical

 15 perspective.

 16 It's a very expensive business to be in,

 17 and the profit margins are very, very low. I 

 18 wouldn't blame it entirely on regulation, although

 19 there are a lot of rules that have come out that

 20 firms have had to comply with, some of them as a

 21 result of some defaults, failures, [such as]

 22 Peregrine, so obviously customer protection is
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 1 very important. It's very important to the ag

 2 market; it's important to all markets, so some of

 3 those [regulations] are just necessary to keep the

 4 customer funds safe, and other [regulations] --

 5 Congress decided they would put this extra layer

 6 of Dodd-Frank on, and so, yes, it does squeeze the

 7 FCMs because I got to see on a daily basis profit

 8 numbers, et cetera, cost, but just the

 9 infrastructure cost -- putting aside regulation,

10 the infrastructure costs are incredibly expensive

11 to run an FCM business.

12 Between your back-office accounting

13 systems, between your risk management systems, and

14 Tom, has a view to that. He sees it every day,

15 but just the fundamental cost aside from

16 regulation just to be in the business, and you're

17 basically a guarantor to the clearinghouses.

18 You're the insurance entity to the clearinghouses,

19 so if you have a customer that is not -- is

20 experiencing financial bad health -- you are the

21 guarantor to the clearinghouse. And put on top of

22 that the low-interest-rate environment it's a very
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 1 difficult business to be in and to make any money,

 2 and I used the example to Tim a couple weeks ago,

 3 you know, would you want in your 401(k) something

 4 that took a couple billion dollars in capital to

 5 run, had relatively very little profit margin, and

 6 you kind of had unlimited liability, so it's a

 7 really -- it's a tough thing that -- would you

 8 want that in your 401(k)? I might have my view,

 9 but it's -- it is difficult to attract more FCMs

 10 to the space given just the cost that it takes to

 11 run the business.

 12 MS. BOWEN: Can I ask a question also

 13 from a customer protection? Having been at SIPC

 14 at the time of MF Global and Peregrine and having

 15 seen customers not have access to their money, and

 16 frankly not having those funds be segregated came

 17 at an immense cost. Talk a little about that part

 18 of it as well?

 19 MS. FLAHERTY: Sure, lots of us lived

 20 through all the bankruptcies in this industry for

 21 25 years, and they're -- MF Global was one -- but

 22 you're right.
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 1 The difficulty in a bankruptcy -- you

 2 know, and again, having sat at different sides of

 3 the table in these situations, the difficulty is 

 4 finding homes, finding big shoulders for those

 5 customers.

 6 I think the CME worked as diligently as

 7 it could along with the Commission to try and find

 8 homes for those customers, but again some of the

 9 firms have their own risk- management policies

 10 where they don't just take bulk transfers of

 11 customers anymore, whereas 10 years ago maybe they

 12 would have, but now they have requirements and

 13 they have to look at every customer, and so, you

 14 know, the idea of portability is a great concept,

 15 but in the event of a bankruptcy it becomes very

 16 difficult to port and to get, again, big shoulders

 17 to take large groups of customers without that

 18 individual risk analysis of, you know, is this

 19 customer going to default to me the very next day

 20 after having taken them on as a transfer.

 21 But with respect to -- I don't know that

 22 there's a better way to do it, and yes, maybe
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 1 customers don't have access to their funds for a

 2 period of time when they're being transferred, but

 3 the reality is you've got to get them off the

 4 books of the defaulting clearing firm onto

 5 someplace. Then they can, you know -- which many

 6 firms did or clients did at that point -- then

 7 once they were ported then they ported themselves

 8 out, you know, to other firms that they had

 9 selected when there was more time for them to be

 10 able to do it. I don't know that there's a better

 11 way to do that.

 12 MR. FORTENBERY: Let me ask quickly --

 13 I'm sorry, sir, if there's anybody remotely

 14 connected that has a question? Go ahead.

 15 MR. KADLEC: The customer seg rules are

 16 actually quite well done which I'm surprised to

 17 say now that I've lived through it versus when

 18 they were first written, but if I look back and

 19 compare them, we had time. They were clear and

 20 concise, and they were critically important to the

 21 marketplace, so that -- it's just so important to

 22 model additional rules and regulations similar to
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 98

 1 that process, and I -- Chairman Massad - clarity,

 2 the importance of clarity from the Commission is

 3 critically important, and I just -- I cannot

 4 emphasize enough.

 5 Eileen, I agree with everything you said

 6 and just emphasize the one thing that I've already

 7 talked about is portability. We love getting

 8 business for free. Don't make any mistake about

 9 it. Not having a capital investment and having

10 accounts come to us is really a neat thing;

11 however, you have to do the due diligence now. If

12 there's one thing that we've learned in the last

13 10 years with the crisis, that is we have...we

14 have to really dig down and do proper due

15 diligence, and we try to do that along with our

16 competitors.

17 MR. SRINIVASAN: So, as an economist,

18 when I think about this business and I have three

19 or four factors or things that came to my mind.

20 One, is the point that Eileen was making about --

21 a bunch of points -- about this being is an

22 industry which is going through transition for
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 1 various reasons.

 2 The point that Commissioner Giancarlo

 3 made earlier about rates having been really low --

 4 this was an industry wherein the fees that you

 5 were charging the customer were being subsidized

 6 by the float you were getting, and I don't see the

 7 rates -- I'm not a macroeconomist, but I don't see

 8 rates -- really going back up any time soon. So

 9 the float, which has a way of subsidizing

 10 transaction costs, is not a viable option in the

 11 near future. So the question I have -- and then

 12 also the third point that is clearly a shrinkage

 13 in the number of players in this market -- so the

 14 question I have for the ag community is when you

 15 look at the FCM landscape and this is -- you need

 16 to go to these firms to access the futures markets

 17 -- what do you anticipate in terms of some of the

 18 services you expect to get from the FCM going

 19 forward? What is going to be the cost -- what are

 20 your FCMs telling you? Has the transition been

 21 made from that side? Are you expecting more fees

 22 or costs -- to increase going forward? What is it
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 100

 1 that you're seeing -- what are you hearing from

 2 the FCMs?

 3 MR. M. J. ANDERSON: We haven't been

 4 seeing it, but we're being told it's coming.

 5 We've had visits to our office by a couple people

 6 of various charges, and I'm sure we're not unique

 7 in the industry from that perspective.

 8 MR. KOTSCHWAR: I'd echo that. There's

 9 nothing we see that's going to be lowering costs,

 10 and I would be remiss if we didn't remind folks in

 11 here it's really outside our control, but Basel

 12 and leverage ratios and our segregated funds being

 13 classified for purposes, that is -- we're

 14 concerned about that too. That's going to add

 15 costs, and it's going to put continued pressure on

 16 the number of FCMs. We don't know exactly how,

 17 but it's not going to be good for us. Another

 18 unintended consequence of -- although the ag space

 19 was not really being a part of the financial

 20 crisis but yet our costs are increasing because of

 21 that -- so we're concerned about it.

 22 MR. SRINIVASAN: So the other point that
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 101

 1 was made, that maybe some firms are not willing to

 2 actually pay the higher costs. So the costs just

 3 changed; the cost structure in the industry has

 4 changed fundamentally. So, which means -- as an

 5 economist thinking about how the cost structure

 6 has changed-- fees are going to go up, and are

 7 there going to be opportunities that other FCMs

 8 see here?

 9 I like to think in terms of entry

 10 barriers, right, so if a marketplace is a healthy

 11 marketplace, then you're going to see exit and

 12 entry, so the information that was presented

 13 earlier by Kevin says that there's been some exit;

 14 there's been some entry. In going through a

 15 transformation -- at some point you reach a steady

 16 state. Once again talking like an economist here

 17 -- and it's important to see whether there will be

 18 entry barriers -- and from the Commission's

 19 perspective, what is it that we can do in the

 20 margin to sort of be supportive innovation -- new

 21 business models, new pricing models, new ways to

 22 sort of service the ag community?
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 1 So maybe not here, but later... I'd be

 2 interested in having a conversation with the

 3 community so that we can get [information from

 4 you]. You're on the front line. You're having

 5 conversations with the FCMs, albeit a few steps

 6 removed, so anything that you can share with us

 7 about how your business is changing, how FCMs are

 8 [changing]. New firms are going to enter this

 9 space - [we're] sort of eager to hear if you have

 10 any thoughts.

 11 MR. MASSAD: Yes, just to underscore

 12 that, if there are maybe particular aspects to

 13 these issues then it would be helpful for us to

 14 hold a further session of this Committee on, or

 15 helpful for our staff to examine, those

 16 suggestions are welcome.

 17 I also want to follow up on this point

 18 that Sayee touched on, and I don't know if, Tom,

 19 it was your comment or someone else's, and maybe

 20 I'm reading too much between the lines, but I'm

 21 curious about the pricing as between, say, someone

 22 who is participating in these markets and holding
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 1 positions over a longer term versus traders who

 2 maybe are basically flat at the end of the day.

 3 Obviously, we see a lot of volume increasingly in

 4 highly electronic markets from traders who are

 5 flat, or at least aren't holding significant

 6 positions, and I don't know -- I'd be curious as

 7 to what the pricing differentials are and how that

 8 affects the thinking in this business.

 9 MR. KADLEC: Well, without giving away

 10 too many state secrets, it really is capital

 11 allocation, and that -- and an assessment of risk

 12 in terms of counterparty risk, regulatory risk,

 13 and gauging the service that you need to provide

 14 to a customer.

 15 So, the math on the capital allocation

 16 is very straightforward. Eight percent of margin

 17 on an overnight basis is what we use. We probably

 18 add 10 percent because no one can run their book

 19 at 8 percent, and then you bring in a number of

 20 subjective factors, and you try to price your

 21 product accordingly. And I think Kevin's return

 22 is -- sounds reasonable. I assume that's on an
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 104

 1 after-tax basis, but it varies based on the four

 2 or five things that I mentioned.

 3 MR. SRINIVASAN: Just sort of building

 4 on the point the Chairman was making, we have

 5 observed that in a lot of these markets, the

 6 market structure has changed. It's no longer a

 7 flow-based trading. It's all electronic. So the

 8 question is: the volumes have gone up -- so when

 9 you're looking at the cost of accessing the

 10 futures markets for hedging and other business

 11 reasons, we are also sort of interested, to the

 12 extent you can share -- what's happening to the

 13 total cost, I guess, with the change in market

 14 structure? Have spreads changed because, you know,

 15 the fee that you pay the FCMs is just one aspect

 16 of the total transaction cost, right? And on that

 17 basis, I think, we're interested in anything you

 18 can share with us on what's happening to the total

 19 costs with the change in market structure. Have

 20 spreads changed in the marketplace - are you able

 21 to move volumes, and also, sort of, the services

 22 that you're expecting from the FCM?
 105

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 When there was trading on the floor, it

 2 was all manual. You had one set of services that

 3 you were expected from the FCM. Now things have

 4 gone electronic. That's more sort of desk

 5 management tools. There's a lot more automation

 6 and potentially more efficiency gains to be got

 7 from that also, so any insights that you can share

 8 with us would be helpful.

 9 MR. DIERLAM: Let me just pose this

 10 question just out of curiosity more than anything.

 11 Obviously the charts that you've presented here

 12 focus on, say, the top 10 FCMs and the

 13 consolidation and the concentration in the top 10

 14 FCMs. Over the past decade or so -- and is there a

 15 way to -- perhaps for the benefit of the group

 16 here, talk about what you've seen or observed

 17 among the FCMs that would be the top 10 FCMs that

 18 provide retail services to ag-specific customers,

 19 or the top 10 FCMs for the folks around the table,

 20 and would they be inordinately impacted by maybe

 21 the types of things that Lance indicated -- by the

 22 supplemental leverage ratio, the regulatory
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 1 requirements? Would they be impacted more?

 2 What's happening more to them? Would they be

 3 impacted more, say, than the larger institutions

 4 in any way? Would you expect to see any more

 5 concentration or consolidation there than you

 6 would the other top 10? Would there be a

 7 difference?

 8 MR. PICCOLI: Yes, that's an excellent

 9 question because I think you're absolutely right.

 10 If you look at the top 10, [they are]

 11 predominantly banks or directly owned by a bank,

 12 so a lot of them had the risk management. They

 13 had the compliance, processes, procedures. They

 14 had a lot of the elements that we saw -- and a

 15 more diverse revenue model as well -- so a very

 16 different audience.

 17 I think if you look at the mid-size, or

 18 even the large, firms that are more traditional

 19 FCMs, they would not be as impacted by Basel, by

 20 the leverage ratio, by return equity hurdles that

 21 are now being pushed down and even customer-based

 22 return equity as Tom was mentioning before, where
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 1 firms are taking a close look at what's the return

 2 on that customer.

 3 And in some cases the return is going to

 4 be more dependent on a customer that trades much

 5 more often than an agricultural customer... that

 6 would be maybe a straight hedge, so they're going

 7 to put the hedge on and they'll roll it when it 

 8 comes or when they need to, or just take it off

 9 when they need to, but not an actively trading

 10 firm [or] customer.

 11 So, I think you are going to get a very

 12 different perspective on that. I think that's one

 13 -- it's a great point, and I think that we could

 14 drill down on and try and take a look at these

 15 [firms] or the firms in that category and what's

 16 driving the revenue model, the expense model.

 17 As a number of people pointed out, that

 18 does impact everyone. We put out a regulation and

 19 it goes to everyone. It's a question of how does

 20 that regulation get applied to small firms as well

 21 as large firms. A lot of the large firms already

 22 have a lot of this [compliance infrastructure] in
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 1 place, so it wasn't necessarily an added cost, but

 2 a cost nonetheless, so it's an excellent point

 3 that I think would be worth drilling down on.

 4 MR. M. J. ANDERSON: Following up on

 5 that, it's anecdotal, but a few customers we

 6 know...FCMs, I think... Tom and Scott, you guys

 7 are doing good at 2-X. We've heard three, four,

 8 five X in terms of increased headcount as it

 9 relates to regulation, so I think that follows up

 10 on your point.

 11 And also Commissioner Giancarlo, we

 12 operate with 2 FCMs -- we just -- our view is we

 13 can't afford to walk in and not be able to service

 14 our customers.

 15 MR. KOVANDA: Just a question as I think

 16 about this consolidation, we've talked about the

 17 due -- it's been talked about -- the due diligence

 18 on the part of the FCMs, in light of the increased

 19 requirements in regulations, but has anyone

 20 observed increased due diligence by those who have

 21 been referred to as customers in evaluating which

 22 FCM to do business with in light of the -- well,
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 1 I'll just use MF Global as an example where many

 2 that transacted business in the futures market

 3 didn't believe something like that could happen.

 4 Is there -- is part of the consolidation really a

 5 function of customers doing due diligence and

 6 moving towards firms that are more stable as it

 7 relates to seg funds or other financial

 8 measurement?

 9 MR. PICCOLI: If I may just add onto

 10 that because it's a great point. If the

 11 customer-protection rules, particularly disclosure

 12 rules and a lot of the information that is now out

 13 there, if that helped that point because I think

 14 that's great.

 15 MR. GALLAGHER: Yes, funny you should

 16 bring up MF Global. I lived through that and I

 17 never want to live through something like that

 18 again, and I do appreciate everything that the

 19 CFTC and the CME did to make that as bearable as

 20 it possibly could. At the end of the day we got

 21 all our money back, but it wasn't immediate. 

 22 To your point, we look at -- we have a
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 1 different standard of looking at -- who we are

 2 going to deal with as an FCM, and my mission is to

 3 find FCMs who are too big to fail. And if a new

 4 FCM comes along that I don't think is capitalized

 5 very well, they are -- I don't give them the time

 6 of day at this point in time so there probably is

 7 going to be more consolidation over time because

 8 of concerns of FCM failure and looking to see

 9 who's better capitalized. There are going to be

 10 [more consolidations]. At the end of the day it's

 11 just the way it is. They're going to be the

 12 winners at the end of the day. As long as they're

 13 willing to serve agriculture, they're going to

 14 win.

 15 MR. KADLEC: Just to emphasize Kevin's

 16 point, our data, our financial data, our

 17 customer's seg and or capital and our statement of

 18 financial condition is publicly disclosed on our

 19 website and the CFTC's website on a daily basis,

 20 which is the mandate so your customers, our

 21 customers, are able to judge us on a daily basis

 22 and that's a positive thing.
 111

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 I meet regularly -- I probably allocate

 2 10 to 15 percent of my time with customers; that's

 3 similar to the Commissioners -- went out to visit

 4 our customers and our constituents. That's part

 5 of the duty of any FCM leader. I meet with boards

 6 and walk through our financial statements

 7 regularly and customers appreciate it and value

 8 that and should do that.

 9 MR. FORTENBERY: Let me check in quick

10 with the remote members again and see if there's a

11 question.

12 MR. CORDES: Thank you. Just to add on

13 to that, and again I would say some of the same

14 comments, but post-MF I've had a lot of

15 conversations with potential customers and

16 customers who came over just like Tom mentioned.

17 Prior to the MF bankruptcy, typically people,

18 customers, would say, okay, who's the broker I'm

19 dealing with? I like Joe and that kind of

20 information. Never had the discussion about who's

21 holding my money and my positions. MF changed

22 that. We had a lot of discussions that went
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 1 around that; customers that came over wanted to

 2 have more due diligence about who you are, what

 3 you are.

 4 To add on to a few of the other comments

 5 you asked about the pricing model. The one thing

 6 I would add is in the expectations -- and this

 7 comes from the farmers. It comes from local

 8 cooperatives. They expect more volume in their

 9 business will get them a lower rate, so that's a

10 big consideration that comes in as well.

11 The other point around what is the

12 customer looking for in the future, and this gets

13 into the cost of doing business. It's not only

14 regulation. You mentioned, Eileen, around

15 back-office technology. Our customers are really

16 expecting us, coming from the farmer and the new

17 generation that's got that smartphone; they want

18 access 24 hours a day. Can I trade through that?

19 Can I look up my positions? Do I know where I'm

20 at? Well, that puts another increased burden on

21 the FCM, especially as we get into cybersecurity

22 to make sure you don't lose something there and to
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 1 keep those systems up and running at all times,

 2 size and scale again to do that, so those are some

 3 of the expectations that are coming out of the

 4 customer as we move forward.

 5 MR. FORTENBERY: Any more questions or

 6 comments? Yep?

 7 MR. STRONG: So, Kevin, did maybe I

 8 understand or infer from your comments that the ag

 9 industry FCMs may have been hit worse over the

10 last five years, or so, or do you just not know

11 that?

12 MR. PICCOLI: No, I didn't mean to infer

13 that at all. I think that's one of the things

14 that we could look at and take the -- do an

15 analysis of to figure out if that is the case and

16 take into consideration all the other comments

17 that came through here to figure that. I'm sorry.

18 I apologize. I did not mean to infer that they

19 were hit harder.

20 I think they were probably hit as well

21 as everyone else. You know, it's a question of

22 the type of firm, the size of the firm. If they
 114

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 have a lot of capital maybe they can withstand a

 2 low-interest rate environment for a lot longer

 3 than the firm that has a million dollars of excess

 4 capital and maybe can't ride out the

 5 low-interest-rate spreads and couldn't change

 6 their revenue model or the technology that

 7 customers are looking for. Just the cost of that

 8 was too much and they felt they couldn't pass that

 9 on to customers, so I'm not sure. I think it's

 10 one of the things that would be interesting to

 11 look into.

 12 MR. STRONG: Okay, and as a follow up I

 13 think we heard that all customers ended up finding

 14 a home at another FCM, but can you give us any

 15 more color commentary because it seems to me that

 16 we've heard a lot around this room about

 17 increasing costs and evaluating service

 18 requirements that those customers' needs. I can't

 19 believe all of those happily landed with another

 20 firm providing great service at a great price.

 21 MR. PICCOLI: Well, from what we've

 22 seen, and again just thinking of the more recent
 115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 ones such as Vision, Global Futures, and FOREX,

 2 Jefferies that was talked about -- I think

 3 they're, the customers, are all ported to a

 4 variety of different firms out there. You're not

 5 going to find one [firm] -- in the very large

 6 situations like Jefferies or Vision where you're

 7 talking $500 million plus in customer assets.

 8 I know not all are going to end up at

 9 one firm, and I think that's where the portability

 10 question comes in. How do we make sure that we

 11 can port all customers over and that we can make

 12 sure it can get sustained. Whether the customers

 13 stay there -- I think one of the things that you

 14 see when customers are transferred over, we try to

 15 insist that the customer can transfer without any

 16 fees subsequent to that. That's something that we

 17 ask of the firms, but it's up to the firm to do,

 18 but we do try to make sure that the customers have

 19 an opportunity to move to another firm once

 20 they're with an existing FCM and whether it's

 21 something that's done quickly overnight because of

 22 the urgency. Sometimes it takes a little bit of
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 1 time for the customers to understand and get used

 2 to it -- for the firms to do their due diligence

 3 and know their customer and make sure it's a

 4 customer that they want. Sometimes it's the firm

 5 that will actually say to a customer, sorry, you

 6 know, thanks but we'd like you to find another

 7 firm over time.

 8 MR. MASSAD: Yes, I want to just make

 9 sure I understand because maybe Kevin and Eileen

10 or Sayee also can respond. I take it we can look

11 at issues like this at the moment of transfer

12 where you've got a failing firm or some other

13 problem. We don't track what's going on in terms

14 of customers and whether a firm is keeping

15 customers or whether they're doing things to kind

16 of maybe push a customer out the door. We don't

17 have that kind of data. I mean we look at -- I 

18 take it what we look at is a moment where there

19 has to be a transfer, we look at what they're

20 going to port those positions as opposed to

21 liquidating positions. Is that correct, Eileen?

22 MR. PICCOLI: Yes, absolutely, Mr.
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 1 Chairman. It's the -- making sure that we can

 2 transfer all customers immediately if need be, or

 3 in some cases over time, such as Jefferies. We

 4 make sure that that firm is there and will

 5 continue to have the support for those customers

 6 until they're transferred over so that they can

 7 protect the customer assets during that period.

 8 But then once the customers are transferred to

 9 another firm then it's -- you know, the customer

 10 does what they have to do. If they like the firm,

 11 great. If they don't, that's their decision.

 12 MR. SRINIVASAN: We don't necessarily

 13 collect that information. Firms are not required

 14 to send us information on a regular basis, so

 15 default would be making calls on an ad hoc basis.

 16 MR. FORTENBERY: Okay, at this point I'd

 17 like to thank the panel. Oh, I'm sorry. One more

 18 question.

 19 MR. STRONG: Mr. Chairman, maybe, I was

 20 -- I was just wondering if Kevin had some other

 21 color commentary since he was cracking off names

 22 of firms that left the business or merged that
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 1 many of us know intimately, and I can also chime

 2 in with the other question about multiple clearing

 3 firms. While we're a commercial self-clearing, we

 4 also have a significant backup.

 5 MR. FORTENBERY: Okay, at this point

 6 we're going to adjourn for lunch. We will

 7 reconvene at 2:00. I believe the Committee

 8 members that are lunching together, we need to go

 9 upstairs. We'll be escorted, so somebody will

 10 meet you out front, out in the lobby, and escort

 11 you up to lunch. See you at 2:00. Thank you.

 12 (Lunch break)

 13 MR. FORTENBERY: Okay, welcome back.

 14 I'm going to call the meeting back to order. Just

 15 a couple reminders. All the slides and

 16 presentations that we are experiencing today will

 17 be available on the website after the meetings are

 18 over, and we're also being webcast so just to let

 19 you know there's a broader audience paying

 20 attention as well.

 21 What we're going to do is start with our

 22 third panel this afternoon which is basically on
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 1 position limits, and first we're going to hear

 2 from Mark Fajfar, who is with the Office of

 3 General Counsel at the CFTC, and then Joe Hawrysz

 4 from the CME Group and Erik Haas from ICE Futures

 5 will also speak to us. So, with that, Mr. Fajfar.

 6 MR. FAJFAR: Thank you. Good afternoon.

 7 I'm happy to be here to describe the Commission's

 8 recent approval of a supplement to its proposed

 9 amendments to the aggregation standards for the

 10 position limits regime. In short, the Commission

 11 has proposed to modify how aggregation rules will

 12 address situations when aggregation is required on

 13 the basis of ownership of greater than 50 percent

 14 of another entity. Under the new modified

 15 proposal, owners of more than 50 percent would

 16 have access to the same relief that's available to

 17 owners of 50 percent or less of another entity.

 18 Now before I go any further I should say

 19 the Commission has approved for publication in the

 20 Federal Register a supplemental notice of Proposed

 21 Rulemaking that explains the proposed

 22 modifications in full detail.
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 1 Now, I'm going to try and highlight the

 2 key details, but what I say here is just a summary

 3 of that notice, and if there's a conflict or if

 4 I've left anything out, the notice approved by the

 5 Commission takes precedence, so I'm going to

 6 briefly describe the existing proposal from

 7 November 2013 and then describe how the Commission

 8 has just proposed to supplement it.

 9 First, what do we mean by aggregation

 10 for purposes of position limits? The Commodity

 11 Exchange Act requires aggregation of all positions

 12 which a person owns or controls and all positions

 13 of persons acting pursuant to an express or

 14 implied agreement or understanding. To implement

 15 the statutory requirement, the Commission's

 16 current regulations require that a person

 17 aggregate all positions in which the person has a

 18 10 percent or greater ownership interest, that is.

 19 When a person determines what his position is for

 20 purposes of determining whether it's over or under

 21 the limit, it has to include the position of other

 22 entities in which it has a 10 percent or greater
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 1 ownership interest. Either way, this rule applies

 2 in the same way for all federal position limits,

 3 and the Commission intends that it would continue

 4 to apply for all federal position limits that may

 5 be adopted in the future.

 6 There are exemptions from the

 7 aggregation requirement in the current regulations

 8 for, among other things, eligible entities with

 9 independent account controllers. When the

 10 position limit regime in Part 151 was adopted,

 11 exemptions were added for info sharing that would

 12 cause a violation of federal law or regulations

 13 and for an underwriter's ownership of an unsold

 14 allotment of securities, so those are situations

 15 where a person would not be required to aggregate.

 16 In November 2013 the Commission proposed

 17 four additional exemptions from aggregation, one

 18 related to information sharing and the second was

 19 a new exemption for broker/dealers. The third and

 20 fourth exemptions were for persons who hold an

 21 ownership interest in another entity.

 22 So back in November 2013, the third
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 1 exemption that was proposed was for owners of no

 2 more than 50 percent of an entity. To use that

 3 exemption the owner would file a notice

 4 demonstrating compliance with certain conditions

 5 that go to a lack of control of the owned entity

 6 and the implementation of firewalls.

 7 The fourth exemption proposed in

 8 November 2013 was for owners or more than 50

 9 percent of an entity, and to use this exemption

 10 the owner would apply to the Commission for relief

 11 on a case-by-case basis and have to show that

 12 trading is independently controlled and other

 13 conditions are met such as the owned entity not

 14 being financially consolidated.

 15 So, we received public comment on the

 16 November 2013 proposal, and one thing we've heard

 17 is that the last exemption for owners of more than

 18 50 percent is too narrow and difficult to qualify

 19 for, so that is why, among other reasons, the

 20 Commission had determined to revise the proposal

 21 so that owners of a greater than 50 percent

 22 interest would follow the same procedure that
 123

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 would apply for owners of an interest between 10

 2 and 50 percent, that is, those more- 

 3 than-50-percent owners would be able to

 4 disaggregate the owned entities positions upon

 5 filing a notice with the Commission stating that

 6 the specified standards about control and

 7 firewalls had been met.

 8 In other words and to wrap up, under the

 9 proposal as revised, all owners of 10 percent or

 10 more of an entity, that is, owners of up and

 11 including 100 percent of another entity could

 12 obtain an exemption from aggregation following the

 13 same procedure. They would file a notice with the

 14 Commission that meets specified requirements which

 15 mainly relate to a lack of control of trading and

 16 implementation of firewalls to prevent access to

 17 information.

 18 All other aspects of the November 2013

 19 proposal remain the same and the Commission

 20 continues to consider that proposal and the

 21 comments submitted during the earlier comment

 22 periods. The new proposal is available on the
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 1 Commission's website today and comments on the

 2 supplemental Notice of Proposed Rulemaking may be

 3 submitted in the usual manner -- electronically

 4 through the Commission's comments online process.

 5 So, thank you for your attention.

 6 MR. FORTENBERY: Mr. Hawrysz.

 7 MR. HAWRYSZ: Thank you, Commissioners

 8 and thank you, Committee, for allowing me to speak

 9 here on behalf of the CME Group. I kind of feel

 10 like Erik and I are an opening act before the big

 11 event tonight at 4:00 when the Pope makes town, so

 12 I'll try to stay on schedule and not disappoint.

 13 I know there's one thing that we all

 14 agree on in this room and that's that getting this

 15 rulemaking -- this rulemaking being position

 16 limits, and just as importantly if not more

 17 importantly, the exemption portion of that --

 18 getting it right. So I think we all have the same

 19 objective, but what we're here -- myself and Erik,

 20 today -- to speak about is how the exchanges may

 21 be able to assist the Commission in the processing

 22 and analysis and approval of non-enumerated
 125

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 exemptions.

 2 So, Erik will be presenting that in just

 3 a little bit, but I thought before we go there and

 4 get to that point it's probably important for us

 5 to take a step backwards. We talk a lot about the

 6 exchanges having experience and expertise, and I

 7 can tell you, having worked in market surveillance

 8 for 30 years, I absolutely agree with that, but I

 9 thought it would be helpful to give this Committee

 10 and the Commissioners some context as to where

 11 that expertise comes from. What do those words

 12 mean? What does experience mean? So I'm going to

 13 take a step backwards to kind of talk about it

 14 from an exchange perspective. Who are these

 15 people who are processing exemptions?

 16 First, when we talk about the CME Group

 17 and agricultural products, we have, as you may

 18 imagine, quite a variety of agriculturals. We

 19 have the CBOT agricultural products, which have

 20 had and continue to have federal limits. So we've

 21 operated under a federal limit regime in the CBOT

 22 ags, but we also have plenty of other agricultural
 126

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 products, some of which will be included in the 28

 2 core [referenced futures products] in this

 3 rulemaking; others that will not, at least

 4 initially. Those, as you can see, all have

 5 exchange-set limits, right, of a variety of types,

 6 primarily spot- and single-month.

 7 How we process exemptions for both CBOT,

 8 those with federal limits, and CME, those without

 9 federal limits, well, I'll go through that in a

 10 bit, but, in short, the analysis that we go

 11 through is the same. The process is slightly

 12 different given the requirements under the federal

 13 rules surrounding CBOT agricultural products.

 14 So who are these people that we talk

 15 about having experience and expertise? The

 16 exemption process is administered through the

 17 regulatory body of CME Group and that's the market

 18 regulation department. More specifically it's

 19 administered through the market surveillance area

 20 within market regulation, and that is an area that

 21 I oversee both in New York and Chicago. So who

 22 are these people?
 127

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 Let's talk first a little bit about what

 2 their day-in and day-out responsibilities are.

 3 Market surveillance's primary responsibility is to

 4 deter and detect manipulation, right? The

 5 integrity of the markets is of the utmost

 6 importance, and I think that's the second thing we

 7 can all agree on today; that we all want a market

 8 free from manipulation.

 9 But how do we get there? It's a mighty

 10 task, right? What do we do to ensure that we're

 11 able to detect potential manipulations? Well, we

 12 have a group of 56 people in market surveillance

 13 across the asset classes, that being in Chicago

 14 and New York, right? So analysts come on - the

 15 professional folks who have college degrees --

 16 they'll come on and they'll be, after training,

 17 assigned a core product to monitor. Quite

 18 frankly, when someone gets a core product to

 19 monitor, what an analyst does, get this -- he's

 20 responsible or she's responsible for living and

 21 breathing that contract. In order to be able to

 22 detect manipulation, you have to know what
 128

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 manipulation is, right? In order to detect what a

 2 price anomaly is, you have to be able to

 3 understand price relationships.

 4 So, the first thing they do is they

 5 develop a very sound understanding of the physical

 6 markets because, as we all know, whether it's

 7 hedging or futures trading it's all about

 8 relationships. Phases, right? What are those

 9 relationships? What is a signal that something

 10 may be an anomaly in that price? What is a signal

 11 that someone may be using market power in order to

 12 influence that price beyond the economics? So

 13 they develop a very sound understanding of those

 14 physical markets. But that's really only one

 15 piece of it.

 16 Once you understand the soundness and

 17 the understanding of how those markets price, you

 18 have to understand who is in your markets. You

 19 have to understand and know and have knowledge

 20 about the participants themselves. You have to

 21 understand what is the normal -- who are your

 22 major participants? Who are your major
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 129

 1 open-interest holders? What is their normal

 2 trading activity? What are the trends? We

 3 obviously have very sophisticated tools to allow

 4 us to monitor trading activity, position holding.

 5 When do we normally see individuals, participants,

 6 roll their position? All this is part of market

 7 surveillance. So again, you're trying to detect

 8 anomalies. There may not be a price anomaly at

 9 the time, but you're trying to detect and head off

10 [manipulation]. If we see a particular

11 participant who may be conducting themselves out

12 of the norm which, by the way, out of the norm

13 isn't necessarily bad because the markets

14 themselves are sometimes out of the norm, right?

15 The markets move, but it's really us identifying

16 it and then understanding it, right, that gives us

17 the ability to, again, deter and detect.

18 And again, we've talked about it before

19 - [position] accountability. It's really the same

20 principle. In order to administer accountability,

21 you need that same expertise. You need to be able

22 to identify concentrations and trading patterns.
 130

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 So, it's these individuals that I just talked

 2 about. These individuals who have the

 3 responsibility to ensure there's no manipulation,

 4 to be able to detect manipulation.

 5 These very same people are the people

 6 who are processing exemptions. If you think about

 7 it, people are coming in saying I want to be

 8 bigger, right? I need a large position to hedge

 9 my business, so obviously we don't take that very

 10 lightly, so when an exemption comes in -- and I'll

 11 talk through briefly the process in a moment --

 12 but when an exemption comes in, right, there are

 13 two things that help us really expedite the

 14 processing.

 15 One is, I mentioned, really having

 16 knowledge of the physical markets, right? So when

17 an exemption is coming in, we're already ahead of

 18 the game in understanding what those physical

 19 markets are so we can identify the strategy and

 20 how it fits into those physical markets, and for

 21 the most part it's likely we know the participant.

 22 They may not have needed an exemption before, but
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 131

 1 in the course of our day-to-day surveillance,

 2 we've been watching -- our analysts have been

 3 watching -- those markets and understand, you

 4 know, have they been in the markets? Have they

 5 been large? How do they generally liquidate? Are

 6 they orderly, and so forth? So again, I think

 7 that expertise really helps us -- not only

 8 accurately, and in a very sound manner -- process

 9 these. But also, it helps us do it in an

 10 expeditious manner.

 11 And I'll talk about experience in a

 12 moment as well. But before we get into that --

 13 Erik, again, will be presenting the idea that we

 14 collaboratively came together, us and ICE, and

 15 some market users, industry users. It's important

 16 to understand what we believe are the cornerstone

 17 points, right, so before we start talking about

 18 how a non-enumerated process will work, which I

 19 think is highly critical for us to get that down

 20 right, we've got to take a look at the enumerated

 21 hedge rules right now.

 22 I've been doing this for 30 years and to
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 1 my knowledge that list of enumerated hedges hasn't

 2 changed, all right, and as Tim talked about --

 3 Andriesen -- earlier today, we all know the cash

 4 markets have changed. The risks associated, out

 5 there in the physical markets, have changed.

 6 The advent of swaps, right, has changed

 7 over the last decades, right, so I think it's

 8 important at the onset for us to look at things

 9 such as anticipatory merchandising, right, and

10 move that into the enumerated section, right, to

11 not replace what we're going to talk about in

12 non-enumerated land, but to get those things we

13 know are sound -- meeting the definition of

14 hedging -- into the enumerated section, and then

15 we'll move forward.

16 And then, of course, [we'll]

17 periodically review that enumerated list, and I

18 think it's a good idea for us to do it more than

19 every couple of decades or so, just kind of take a

20 look at that and evaluate if we're approving with

21 the right conditions and agreeing on a certain

22 type of non-enumerated [hedge]. It's become very
 133

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 routine as far as the type of hedge exemptions

 2 we're getting in; let's consider whether those

 3 should be or shouldn't be placed in the enumerated

 4 section.

 5 Secondly, when we get to the proposal,

 6 in order for us to do that, there certainly would

 7 have to be some rulemaking, I believe, so we are

 8 looking for the passage of rules that give the

 9 exchange the ability to approve these exemptions

 10 from a federal perspective. And also I think it's

 11 very important that -- if given that authority to

 12 approve our exchange exemptions and it can be

 13 applied to the federal structure -- that there's

 14 some certainty that participants get, right? When

 15 we're approving those exemptions -- while we

 16 absolutely believe the Commission has an oversight

 17 role here, right, and they can't divorce

 18 themselves from the process -- what we don't want

 19 to see happen is a day-in and day-out micro

 20 managing of the decisions we're making, right,

 21 because if that's the case, right, then I think we

 22 haven't really accomplished a lot if I and my team
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 134

 1 are evaluating a particular non-enumerated, and we

 2 feel very comfortable that it fits within that and

 3 upon sending it to the Commission a day later it's

 4 being overturned. That's not going to give anyone

 5 any comfort level.

 6 I think there are processes in place,

 7 right. Currently there are rule enforcement 

 8 reviews that are conducted on exchanges where

 9 those processes can be reviewed -- to the extent

 10 there's something that the Commission feels is

 11 egregious, which I don't believe would be the

 12 case, but to the extent that there is -- certainly

 13 there has to be a process within the Commission.

 14 But we just ask that to be kind of outlined at the

 15 onset as to what that process would be.

 16 So we go to our current exchange

 17 exemption process, I can tell you on the

 18 agricultural side in Chicago. It's basically a

 19 three-pronged approach, so I talked about how,

 20 initially, exemptions will come in, right, and

 21 they'll be processed, reviewed, and analyzed by a

 22 market analyst. It's the analysts, generally
 135

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 speaking, that are on the front end of this and

 2 will have probably two-to-three years' experience,

 3 right. Once they conduct their analysis or review

 4 they will come up with a recommendation.

 5 A recommendation has two prongs to it;

 6 one being, does the exposure meet what that

 7 applicant is asking for, and secondly, what level

 8 would they suggest that that applicant get, and

 9 the two aren't synonymous, right.

10 If you think about it there are some

11 very big participants out there with very big cash

12 books. What we do is we evaluate not only the

13 exposure and the strategy, which obviously is very

14 critical to make sure it fits within bona fide

15 hedging, but we also have to look at our markets.

16 How much can the market handle? When I say

17 handle, we look at the liquidity profile right

18 there in the spot month period. We'll look at the

19 make-up of the market, the profile of the market

20 overall, and we very well may grant a number

21 that's lower than the exposure would justify. And

22 we're doing that, again, to ensure that our
 136

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 markets -- which at the end of the day trumps

 2 everything -- that there's integrity in those

 3 markets, but also affording the ability to hedge.

 4 What we'll then do is we'll review that

 5 number, assuming we granted a number lower than

 6 the exposure. We'll be reviewing that

 7 periodically, and as the contract grows, as open

 8 interest grows around that exemption showing the

 9 contract is being used, since the liquidity grows,

 10 and as we get comfortable that the participant who

 11 was granted [the exemption] is liquidating in a

 12 very orderly fashion within the liquidity profile

 13 of that particular product, we very may well go

 14 back, right, and increase what we had given them

 15 before. Again, provided that the exposure still

 16 supports it.

 17 So the application will come in. The

 18 analyst will do the review, then give that

 19 recommendation to a lead analyst. A lead analyst

 20 is someone who overseas that asset class, so in

 21 agricultural we're talking about either CBOT ags

 22 or CME ags. That lead analyst has usually five to
 137

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 seven years' experience, and they've already been

 2 in that analyst role conducting those reviews. So

 3 they'll review it. She may agree. She may send

 4 it back for more work, or she may disagree.

 5 If she agrees, right, that will then go

 6 to the regional heads in Chicago; that's a senior

 7 director, so someone with over 10 years'

 8 experience who will then make the final

 9 determination and send out either an approval

10 letter, a denial letter, or a modification; a

11 modification, again, would be capping it at

12 something below the exposure itself.

13 The one thing I want to leave this

14 Committee with and the Commission with is

15 something I said earlier on. While this

16 application process is an annual process, once we

17 approve an application it's not a one-and-done,

18 see you in a year, right. We approve these

19 applications, and then we conduct surveillance,

20 right. When someone gets an approval of an

21 exemption, to me it's a contract, right.

22 They have responsibilities; the
 138

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 responsibility might be to be hedging. There are

 2 responsibilities to act in an orderly and a

 3 commercial fashion and to be liquidating and

 4 initiating those positions orderly. To the degree

 5 we see that the obligation is not being fulfilled,

 6 right, we have the ability on the spot to order --

 7 similar to accountability -- order a reduction in

 8 that position. We have the ability to say stop

 9 growing that position.

 10 And we may do that even if they are

 11 being orderly if we see the market around them in

 12 a situation such that we don't think the market

 13 can handle it, so we have very powerful tools once

 14 we grant an exemption as to monitoring the effect

 15 of this or that, monitoring the markets,

 16 identifying potential anomalies in the pricing,

 17 and if need be, either revoke an application or

 18 temporarily halt it while we monitor those market

 19 situations.

 20 So, with that I'll turn it over to Erik

 21 to talk about the idea that we have

 22 collaboratively worked on.
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 1 MR. HAAS: Thanks, Joe. So this process

 2 for non-enumerated exemptions really stems from

 3 the EEMAC, the last meeting of the Energy and

 4 Environmental Markets Advisory Committee in July.

 5 Tom LaSala of CME, Ron Oppenheimer of the working

 6 group, and I presented this idea and I'll note

 7 that this is one proposal. We've heard others.

 8 This is one idea that both ICE and CME can get

 9 behind. We think it's workable in all areas and

10 that's why it's the one we're presenting now.

11 By and large this process would allow

12 the exchanges to continue leveraging their

13 extensive surveillance procedures and practices

14 and apply that to non-enumerated exemptions.

15 We'll start with saying that the application and

16 exchange review process -- what it comes to in

17 this idea -- it wouldn't change from the current

18 process very much.

19 You're going to fill out an application.

20 You're going to come to the exchange, tell us what

21 your strategy is, what your exposure underlying

22 that strategy is, and you're still going to need
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 140

 1 to request an exemption level.

 2 On the exchange side, through our market

 3 surveillance practices, the same ones that Joe

 4 discussed, we will review the strategy to make

 5 sure it meets the criteria for hedging. We'll

 6 look at the underlying exposure and make a

 7 determination on -- I guess what I would say is --

 8 what's the justifiable exposure. That is, someone

 9 might come to us and say, explain their strategy,

 10 tell us they have 10,000 lots of exposure. We'll

 11 look at it and see if we feel that all 10,000 lots

 12 really meet the strategy, so I guess we'll call

 13 that the justifiable exposure. We'll make a

 14 determination on what that exposure is, and then

 15 the third part, which is similar for the

 16 enumerated process -- we'll make a determination

 17 on what exemption level should be granted based on

 18 that exposure and that could be less than your

 19 exposure. And we'll look at market conditions, the

 20 size of the company, for certain products the

 21 stock for deliverable products, and try to ensure

 22 that no one market participant, whether you're
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 1 commercial or not, can exert influence in the

 2 market. Again, that process would not differ

 3 greatly from the existing exemption process.

 4 What this does bring in is the idea that

 5 a hedger that's granted an exemption from the

 6 exchange for a non-enumerated strategy, as opposed

 7 to through a CFTC rule, will be able to rely on

 8 the exchange exemption for that non-enumerated

 9 strategy -- to base their OTC hedging off of. And

 10 that's getting, again, into this non-enumerated

 11 section, which is a little different from the

 12 current process, but we believe that if we're

 13 going to review this non-enumerated strategy and

 14 make a determination on the exposure and whether

 15 it qualifies - to alleviate, I guess, another

 16 burden from this overall process - it would [have

 17 to] be that this hedger could then rely on our

 18 determination that this is a legitimate hedging

 19 strategy under a non-enumerated rule and they

 20 could rely on our approval for OTC or swaps

 21 hedging if so be it.

 22 And then finally, the other idea that we
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 142

 1 think would need to come out of this would be that

 2 the exchanges would submit to the Commission all

 3 of our approvals and determinations for

 4 non-enumerated strategies. It would have to be

 5 done on a timely basis just to ensure the

 6 Commission is working with the freshest data from

 7 exchanges or any other SEF that's granting

 8 non-enumerated exemptions.

 9 With this, the Commission then maintains

 10 the responsibility for ongoing surveillance of

 11 federal limit and the OTC markets, but what we've

 12 accomplished is the exchanges have used our

 13 expertise to make a determination. We've kind of

 14 done the leg work of weeding out the

 15 non-enumerated exemption application, determining

 16 whether it's legitimate, what the underlying

 17 exposure should be, and that, as we provide this

 18 information to the Commission, it aids in the

 19 Commission's responsibility for overseeing a

 20 federal limit and OTC exposure because they know

 21 what we've determined is the justifiable exposure,

 22 and they can compare any entity's position verse
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 143

 1 the level we've determined.

 2 With this, too -- because non-enumerated

 3 exemptions can be one-off and we'd like to -- once

 4 we make a determination on allowing a

 5 non-enumerated strategy, we feel the transparency

 6 of that - the general nature of that strategy is

 7 important, so we would agree to post on our

 8 website the general nature of non-enumerated

 9 strategies that we've granted. There would be no

 10 identifying information based on anyone who

 11 received it, but just letting the market, the

 12 Commission, know types of -- the general natures

 13 of strategies that we've granted under this.

 14 Exchanges -- we would agree to try and classify

 15 those strategies similarly so that it's clear to

 16 everyone what's been approved and so other folks

 17 could rely on that same type of exemption.

 18 And again, it falls into the final point

 19 here is that we believe the Commission obviously

 20 has its obligation to review the market, but also

 21 their oversight of the exchanges through this

 22 process -- they can come to us at any time or
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 144

 1 through the rule enforcement review process to

 2 review any approvals or denials that we've made,

 3 check our work, communicate across exchanges.

 4 They can oversee this whole process and help give

 5 guidance where it's needed.

 6 Moving on, I guess, from the

 7 non-enumerated discussion is a point we want to

 8 emphasize about a one-size-fits-all approach to

 9 limits. I think it's been mentioned a few times.

 10 It's been mentioned at other committee meetings

 11 and, specifically for ICE, we'd like to note the

 12 accountability versus levels an all-months limits

 13 concept, again, and note that single and all-month

 14 accountability levels allow the market

 15 surveillance departments and processes to really

 16 manage and review large positions. Accountability

 17 rules can be more effective at times than limits

 18 given that accountability levels give the exchange

 19 an easy way to force the market participants to

 20 either liquidate or hold their position.

 21 Without accountability, if it's just

 22 under the position limit rule, as it is, exchanges
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 145

 1 would have a much longer process to get a

 2 participant to automatically decrease.

 3 Accountability gives us more flexibility to work

 4 with that person on managing the expectations of

 5 their position, and the data that we've seen shows

 6 accountability is an effective tool and oftentimes

 7 can be more effective than single and all month

 8 limits out the curve.

 9 Just touching on the ICE futures U.S.

 10 products, cotton has federal limits. The rest of

 11 our products all have spot month exchange limits.

 12 OJ and sugar are domestic products and they'll

 13 have single and all month limits, but cocoa,

 14 coffee, and sugar are international commodities

 15 and, per Commission rule, have had single and all

 16 month accountability levels for over a decade, and

 17 what we'd like to point out is that cocoa, which

 18 has a spot month limit, but out the curve, has

 19 single and all month accountability levels. What

 20 we have here is that the price graph for the

 21 prompt month futures contract over the past five

 22 years. Price has gone up four percent and the red 
 146

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 reflects the day-to-day settlement price

 2 percentage change, and so during this period the

 3 average change per day is one percent, so you can

 4 have one percent change from prior day settle to

 5 the next day's settlement, and the vast majority

 6 of these changes falling between plus or minus

 7 four percent on a daily basis, so not extremely

 8 volatile. You don't see wide changes on a daily

 9 basis.

 10 Cotton is an enumerated product. It has

 11 federal spot month, federal single, federal all

 12 month limits. It also has exchange-set spot-, 

 13 single-, and all-months limits and cotton has

 14 daily price limits which lock in the -- the

 15 minimum/maximum that the price can move on any

 16 given day. Cocoa does not have that, but during

 17 that same time period, while the price of cotton

 18 has been down 24 percent, the average settlement

 19 change is one percent with the vast majority

 20 falling between plus or minus four percent.

 21 So, the point we're really trying to

 22 make here is that with a set of products that
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 147

 1 don't have single and all month limits that have

 2 been managed through a market surveillance

 3 standpoint with accountability levels -- we have

 4 other products that have had single and all month

 5 limits for that same period - when you look at the

 6 trend in prices and settlement changes the two

 7 sets of products are indistinguishable.

 8 The international softs which all have

 9 these single- and all-month accountability levels,

 10 which we would hope to maintain, do not exhibit

 11 the symptoms that single- and all-month limit are

 12 intended to protect. Implementing them would be a

 13 solution to a non-existent problem in these

 14 products. Again, we don't think a

 15 one-size-fits-all approach is appropriate for any

 16 markets, whether in-between asset classes or

 17 certain products in asset classes, and by

 18 implementing single and all-month limits, what we

 19 hope doesn't occur, but what we fear might occur,

 20 is that the people that we're going to force out

 21 of the market are the ones providing both price

 22 stability out the curve and liquidity, and doing
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 1 so is only going to harm the market. That's our

 2 presentation. [I'm] happy to answer any

 3 questions.

 4 MR. FORTENBERY: Thank you, panel.

 5 Questions or comments? Yes, sir.

 6 MR. KOTSCHWAR: So, CMC is fully

 7 supportive, Mr. Chairman, of having the SRO, you

 8 know, the exchanges in their SRO capacity, handle

 9 this non-enumerated hedge function, and I think

 10 what Joe talked about is one of the biggest policy

 11 reasons why, which is, they don't just look at my

 12 company's application for a hedge exemption. They

 13 look at it in the context of the operation of

 14 their market. They're not always going to give me

 15 what I ask for, and so they're looking at it

 16 holistically, and I think it makes really good

 17 policy sense for them to keep this activity there.

 18 MR. DIERLAM: I would concur. I would

 19 concur, as well, and I think that Joe, as well,

 20 made another comment, as well, that I think is

 21 important to be mindful of, and that's where the

 22 focus of the presentation, I think, was -- a 
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 1 process for non-enumerated hedges. One component

 2 of Joe's comment was getting the list of

 3 enumerated hedges right as well. And so I

 4 appreciate Joe's comments, both Joe and Erik's

 5 comments, in both regards. Number one is getting

 6 the list of enumerated hedges right in the first

 7 instance and then a good solid process on

 8 non-enumerated hedges, together, for the reasons

 9 that they spoke about and I also concur with

10 Lance's comments.

11 MR. GALLAGHER: Joe, you were here

12 earlier when I asked Tim a question. He punted it

13 to you, so I'll ask again. If it gets back to if

14 it was a series of swap transactions that were to

15 hedge, as opposed to any futures or options that

16 would be traded on your exchange, would you still

17 be the entity that would determine whether that

18 meets a non-enumerated hedge?

19 MR. HAWRYSZ: Right, and thank you for

20 the preview of the question at the first panel.

21 The proposal that we're outlining here would put

22 that decision-making and that process -- continue
 150

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 to keep it within the exchange, right. Well,

 2 you've talked about if it were to occur -- if

 3 you're asking for -- in today's world in corn,

 4 right, you would go to the Commission for approval

 5 and not until you got that approval from the

 6 Commission could the exchanges review it and make

 7 a determination. We're talking that same thing in

 8 dairy, right, or in cattle for the non-enumerated

 9 [hedges].

 10 Today we have the ability to evaluate

 11 everything I've said and approve it and with this

 12 proposal, or at least this idea, we would continue

 13 to do that, right, and even today the Commission

 14 ultimately will always have -- I mean they have a

 15 very unwritten role and that's oversight of the

 16 DCM and the SRO, right -- so they always have the

 17 ability through, you know, rule enforcement

 18 reviews or one-offs, again, if they feel very

 19 strongly about it to come back to us. But by and

 20 large that hasn't happened. I think it hasn't

 21 happened because, again, of the thoughtfulness and

 22 the thoroughness of what we do, and I think some
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 1 in this room know what you -- I don't want to say

 2 it in a bad way -- what you go through, right, to

 3 get an exemption. It's not, as Brian mentioned,

 4 it's not send an application, look at numbers, and

 5 here's your approval. There's dialogue that goes

 6 on.

 7 MR. GALLAGHER: So back to the other

 8 part of the question I had asked was...so if there

 9 are hedges that we do now that for whatever reason

 10 won't be enumerated -- that we're going to go

 11 pretty quickly before this thing gets implemented

 12 -- and ask you to opine on them and see if they

 13 would be non-enumerated.

 14 But things will come up over time that

 15 we haven't thought of yet that we're going to come

 16 to you. How - can you give us some sort of sense

 17 -- how quickly you may be able to get through a

 18 decision-making process?

 19 MR. HAWRYSZ: Sure, and I agree. I mean

 20 non-enumerated [hedges] are always going to exist.

 21 They have to exist, right, because it's impossible

 22 to foresee the future. It's impossible to foresee
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 1 every single situation. You can't list those all

 2 out, so to the degree that would happen -- I guess

 3 I'll answer it this way, all right. There's a

 4 bunch of factors that go into it, right, but let's

 5 look at it in a vacuum. Let's say you're the only

 6 one that comes to me in dairy so we'll talk a

 7 one-off. Obviously if everyone in this room comes

 8 to me on the same day, the number is going to

 9 change from a pure resource perspective. But, to

10 the degree you come to us, we will by and large

11 interact with you because it may be something new

12 and unique which is why it's coming to us. There

13 will be some dialogue back and forth. I would say

14 within probably a couple of days -- assuming

15 there's no miscommunications, right, assuming we

16 get the information that we've asked for -- that

17 we can make that determination, but I will preface

18 it by saying again, it all depends on how many are

19 in at any given point in time where that two days,

20 you know, you might be two days and if you're like

21 the tenth person in, in the same asset class, it

22 obviously can stretch out.
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 1 MR. WESTON: I wanted to basically

 2 concur with Lance and Brian, and want to thank you

 3 for your presentation, both of you. I think that

 4 was very helpful. I know, Chairman, at the

 5 beginning you made some comments on this panel,

 6 and I would like to thank you and the other

 7 commissioners for conducting this. This has been

 8 something that's been important to the sugar

 9 industry. Some of you have met with David Perlman

 10 and some of my member companies. I appreciate

 11 your time doing that. We've been concerned that

 12 if we go forward with the delegation to the

 13 exchanges -- that to then have the extra burden of

 14 regulation on the hedging side -- that was going

 15 to be something where we might actually have extra

 16 regulation added to us.

 17 I would say on the sugar side we are an

 18 interesting product. We have the farmers and then

 19 the farmers own the mills and refineries pretty

 20 much all the way through, so we're the producer

 21 group and we're the agri-business side of the

 22 group, so our work goes all the way through from
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 154

 1 the crop to the white sugar you see either in a

 2 product or being sold to all the companies that

 3 use our product, so we go past the traditional

 4 12-month period. When you plant sugar cane you're

 5 going to have a crop for at least three more

 6 years, maybe four or five, so we're in that for

 7 the long haul.

 8 We don't do hedges that are not bona

 9 fide -- we're not speculators. We're in the

 10 business, so this is something, I think -- as we

 11 look at the presentation such as this -- this is

 12 very helpful, and if we ever have to answer any

 13 more detailed questions we'd be happy -- David, I

 14 could come in and if -- I know you guys have

 15 traveled around. We'd be happy to have any of you

 16 or your staff come to any of our mills down in

 17 Florida, if you have meetings down there. We

 18 start harvest in November and we'll basically go

 19 through March.

 20 MR. MAY: Thank you. Just a few

 21 comments from the cotton-trading community. The

 22 Dodd-Frank Act required the CFTC to adopt positon
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 1 limits on an expanded scope of futures contracts

 2 as well as economically equivalent swap contracts,

 3 if needed to prevent excessive speculation. This

 4 is generally an exercise that our members

 5 supported during the Dodd-Frank debate. However,

 6 proposals to date have included provisions that

 7 would restrict the hedging activities of

 8 commercial end-users, such as my members.

 9 We do not think that result was, in any

 10 way, intended by the Congress. We've written

 11 multiple comments letters to this effect and our

 12 members have testified before the Commission and

 13 the Congress on these points. It is extremely

 14 important that the Commission modify its proposal

 15 to allow hedgers to hedge, and we are hopeful that

 16 these points are recognized prior to the rule

 17 finalization. The consequences of not making the

 18 necessary changes are all bad. Hedging programs

 19 are responsible risk-management initiatives that

 20 can give producers better prices for their crops

 21 and consumers better prices for finished goods.

 22 MR. GALLAGHER: I'd ask a little more
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 156

 1 dialogue on one part of your proposal. It says 

 2 "exchange maintains responsibility for ongoing

 3 surveillance on its market, but CFTC takes

 4 responsibility for OTC monitoring and for federal

 5 limits." Can you talk to us a little bit more

 6 about why you decided to have the CFTC do the

 7 monitoring on the OTC stuff as opposed to the

 8 exchanges doing the monitoring?

 9 MR. HAWRYSZ: I guess the answer is

 10 pretty straightforward in that we don't see the

 11 OTC positions. The Commission is the only one

 12 who'll see all the OTC because of all the stuff's

 13 out there, so we don't -- we wouldn't even have

 14 the ability -- as we do in the futures, right, we

 15 see everything. We can review what's on our

 16 exchange. We just don't have the data on the OTC

 17 side.

 18 MR. GALLAGHER: So I don't know who I

 19 could fairly ask this question to but maybe Mark,

 20 maybe. Are you guys -- are you -- I don't - just

 21 because you're on staff. Are you guys set up to

 22 be able to do the monitoring of something like
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 1 dairy?

 2 MR. FAJFAR: Yes, but it's -- Frank,

 3 that's not my -- I'm not (inaudible).

 4 MR. GALLAGHER: Yes, okay. So not a

 5 fair question for you either?

 6 MR. MASSAD: It's a good question. I

 7 think where we are today is a follow-on. We have

 8 two dozen SEFs. The law has language about them

 9 adopting position limits. The data on what's

10 happening on each SEF is being reported to a

11 swap-data repository. We still have a lot of work

12 to do, I think, to have an overall data-reporting

13 regime that gets us to where we want to be. I

14 often talk about this issue and think of it kind

15 of like a big infrastructure project. You can't

16 just write some rules and expect us to go from

17 zero reporting on the OTC swap market to a perfect

18 system where we can look at exactly what we want

19 and measure it instantly. We're talking about

20 creating a data-reporting system that involves

21 lots of participants, lots of different contracts,

22 but I think what we as a commission have to think
 158

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 1 about is how do you integrate monitoring the SEFs

 2 with monitoring the exchanges, and that's going to

 3 be some combination of what an individual SEF can

 4 do and perhaps what we see in the SDR data.

 5 MR. FORTENBERY: Let me just check in

 6 and see if we have any questions or comments from

 7 remotely connected members. Okay, go ahead.

 8 MR. STRONG: Joe or Erik, a little more

 9 color on the comment that Ed was talking about on

10 page nine about publishing the approvals on our

11 website? How detailed?

12 MR. HAWRYSZ: Well, certainly we would

13 not be publishing names. We would not be

14 publishing company names, and it's an excellent

15 question, right, and we've talked a lot about

16 that. We would publish it in a manner that wasn't

17 detailed enough to, kind of, disclose proprietary

18 strategies. So for example it might be a storage

19 hedge or it may be a cross hedge, but it would be,

20 I'll say, more generically like that. And when

21 that's on the website, you know, as a user, a

22 participant, it wouldn't mean -- it doesn't mean
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 1 it's enumerated. Alright, you would still have to

 2 come to us for an application, but it would at

 3 least give some transparency to -- okay, they are

 4 approving types like this, cross hedges,

 5 anticipatory merchandising, if it unfortunately

 6 doesn't get enumerated, right -- then you would

 7 come to us. So yes, we would not be disclosing

 8 participant names, and we would also be very, very

 9 careful, you know, not to disclose any detail that

 10 would make transparent proprietary information.

 11 MR. CORDES: It's a little bit of a pile

 12 on to Lance and everyone else, but we've been

 13 pretty outspoken about the bona fide hedge. I

 14 think the ability to take a look at what is an

 15 enumerated hedge has opportunity to solve a lot of

 16 our heartburn to -- easier said than done and

 17 it'll probably require some elegance, but I think

 18 that has the potential to -- be a good solution.

 19 MR. FORTENBERY: Any other questions or

 20 comments related to the position limit

 21 presentations?

 22 MR. WESTON: I would just like to note
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 160

 1 that it's nice to see that the farm side and the

 2 agri-business side are actually agreeing on

 3 something. This is a very important issue for

 4 most of us to deal with, you know. Any new

 5 regulation could be burdensome, and this is a very

 6 important thing to make sure we get the best price

 7 we can in a very tough market. As I think a

 8 couple of you noted in your opening statements,

 9 it's going to be a pretty rough couple of years

 10 possibly for farmers.

 11 MR. M. J. ANDERSON: May be expected but

 12 any kind of timeline or timeframe?

 13 MR. MASSAD: We haven't made a decision

 14 on whether we would go forward with this.

 15 Something we're thinking about. Meetings like

 16 this are very helpful to get input so that we can

 17 reflect on that and we'll be thinking about it.

 18 Staff is thinking about it in the days ahead.

 19 MR. FORTENBERY: Anything else on this

 20 topic? Go ahead, yeah.

 21 MR. OWEN: Excuse me. I would just

 22 caution the Commissioners about the unintended
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 161

 1 consequences of over- regulation. And if it

 2 becomes more difficult to obtain hedging

 3 exemptions, I'm afraid you're going to slow things

 4 down, you're going to take us potentially down the

 5 road. As a farmer, the worst thing that can

 6 happen is the market dries up -- there's not a

 7 bid, or if the commercial cannot transfer risk

 8 through the futures market. The only way [the

 9 farmer] is going to be able to transfer [risk] is

10 through basis and that comes down to the farmer,

11 and that really harms me.

12 And also if you have basis that becomes

13 way out of line with the futures market, then

14 people begin to lose confidence in the futures

15 contract. I work with rice. We have a very

16 thinly traded contract. In the past I can

17 remember when basis was 20 percent of the value of

18 the underlying contract, and it's difficult to get

19 any volume in that situation because there's so

20 much risk. You have basis risk that's

21 unacceptable, so you move toward a cash market.

22 So I would ask that you move cautiously towards
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 162

 1 anything that would possibly hurt market

 2 liquidity, and I'm very confident in CME's ability

 3 to grant hedging exemptions. I think they've done

 4 a good job in the past, and I think they will do

 5 so in the future. Thank you.

 6 MR. FORTENBERY: Any other questions or

 7 comments? So, if you look at the agenda the last

 8 item for discussion is new business and/or any

 9 comments you might have about other panels that we

10 had earlier today.

11 I just want to make a couple points

12 though. I was handed a note that suggests that I

13 remind you that today might be a high-traffic

14 volume day; that I guess they're going to shut

15 down 395 in both directions starting, I guess,

16 1:00 p.m. it says. So I guess that's already

17 happened. Is that right? Do I have that right?

18 MR. CLAUSSEN: Yes, it was just going to

19 be from -- I got word that it was going to be --

20 from 14th Street to Anacostia Bridge which

21 actually isn't that big of a stretch, but just as

22 a reminder there are a few folks who had to get
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 1 flights, so there's really no need to rush out,

 2 but we just wanted to give people an opportunity

 3 to leave without feeling bad about it.

 4 MR. FORTENBERY: Right, so we don't want

 5 to encourage you to leave, but we don't want to

 6 have you miss your flight either if it looks like

 7 it's cutting it close. So, I guess I'll ask are

 8 there new business items that you would like to

 9 discuss? Would anybody want to circle back around

 10 some of the panel discussion we had earlier today

 11 before we adjourn?

 12 MR. DIERLAM: I thought I might just add

 13 a couple comments. Layne from the Minneapolis

 14 Grain Exchange mentioned earlier the issue of

 15 equivalency -- I think he used the word parity --

 16 between the various wheat contracts. and I would

 17 just note I tried to look up a list so I could

 18 have the list for you, but I would just note that

 19 a number of industry groups -- I know the CMC; I'm

 20 not certain about NGFA, but okay, I'm getting nod

 21 now, NGFA; I know Cargill did -- many industry

 22 groups in their comments did comment about the
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 164

 1 need for equivalency or parity between the wheat

 2 contracts, so I'll just note that that should be

 3 clearly communicated in the comments that were

 4 received on that issue. There should be plenty of

 5 comments in support for that -- for the

 6 position -- that he spoke about today.

 7 MR. JOHN ANDERSON: Yeah, I don't know

 8 if this is new business or if this is circling

 9 back to the FCM discussion or maybe a little bit

10 of both, but we talked a lot in that discussion of

11 market trends about customer protections, and I

12 guess my question is, or the general issue that I

13 want to raise is, what is CFTC doing? Or maybe

14 [what] can CFTC do to help with monitoring of

15 customer protections? We have these new rules and

16 we've talked about the costs associated with

17 those. What are we getting for that cost and how

18 effective are these new processes and new rules

19 working out to be, and so I'll raise that as maybe

20 an issue that we might come back around to at a

21 future meeting, but any guidance I think the CFTC

22 can give us on how effective these customer
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 165

 1 protections are and what kind of oversight is CFTC

 2 involved in to ensure that these new customer

 3 protections are actually being effective given

 4 both the new rules that we have in place and the

 5 changing structure of that market, I think, would

 6 be a really important issue for us to look at.

 7 MR. MASSAD: I think that's a very good

 8 topic, and I could certainly spend more time on it

 9 at a future meeting. Let me just note one example

 10 though. We had a discussion earlier that touched

 11 on the segregation rules regarding customer funds.

 12 The procedures that have been put in place today

 13 require not only looking at what the clearing

 14 member says but we also get daily confirmation I

 15 believe from the depository of what the amount of

 16 segregated funds is so that we reconcile what the

 17 depository is saying with what the clearing member

 18 is saying. We work with the NFA on that. That's

 19 a quantum leap from where we were before.

 20 MR. KADLEC: Yes, I would concur. If

 21 we're one minute late on sending our seg in to the

 22 exchange and to the CFTC we get calls, and it's
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 1 not a pretty picture. I think the -- at most

 2 FCMs, at least at our FCM -- we had eight

 3 different eyes and six different officers

 4 monitoring seg on a daily basis. That can only

 5 help the process, and I think the third party --

 6 it's important to note that there's independent

 7 verification of the Chairman's comments. They

 8 have data from all of our depositories, and that

 9 is confirmed on a daily basis. That is very, very

 10 high standard and there's no other industry that I

 11 believe that has as high a standard as far as

 12 monitoring. I'd also say that I sit on the CME

 13 Clearinghouse Committee, and we monitor that.

 14 It's part of every audit, and there's no FCM that

 15 would want to be walked in front of that committee

 16 and have any type of seg violations. The fines

 17 are very high, and the perception of industry

 18 standing is a very -- we just -- FCMs do not want

 19 to go there, and I think that's critically

 20 important.

 21 MR. FORTENBERY: Any other comments or

 22 suggestions?
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 1 MR. MASSAD: Let me just say thanks

 2 again to everyone for being here. This has been a

 3 very, very helpful and informative session. We

 4 really appreciate you traveling in, for those of

 5 you that traveled in, and want to get you out so

 6 you get your planes on time. Thanks.

 7 MR. FORTENBERY: Let me just check in

 8 one more time with the remote. Okay, at this

 9 point I'll adjourn the 38th meeting of the Ag

 10 Advisory Council. Thank you for traveling and

 11 travel safely home.

 12 (Whereupon, at 3:56 p.m., the

 13 PROCEEDINGS were adjourned.)

 14

 15 * * * * *

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

 4 public in and for the District of Columbia, do

 5 hereby certify that the forgoing PROCEEDING was

 6 duly recorded and thereafter reduced to print under

 7 my direction; that the witnesses were sworn to tell

 8 the truth under penalty of perjury; that said

 9 transcript is a true record of the testimony given

 10 by witnesses; that I am neither counsel for,

 11 related to, nor employed by any of the parties to

 12 the action in which this proceeding was called;

 13 and, furthermore, that I am not a relative or

 14 employee of any attorney or counsel employed by the

 15 parties hereto, nor financially or otherwise

 16 interested in the outcome of this action.

 17

 18

 19 (Signature and Seal on File)

 20 -----------------------------------

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 31, 2017