1 

TESTIMONY OF CRAIG DONOHUE 

CHIEF EXECUTIVE OFFICER 

CME GROUP INC. 

BEFORE THE COMMODITY FUTURES TRADING COMMISSION 

ROUNDTABLE DISCUSSION 

TRADING ON REGULATED EXCHANGES AND 

EXEMPT COMMERCIAL MARKETS 

SEPTEMBER 18, 2007 

INTRODUCTION AND OVERVIEW

 I am Craig Donohue, Chief Executive Office of CME Group Inc. (“CME Group” or 

“CME”), which was formed by the 2007 merger of Chicago Mercantile Exchange 

Holdings Inc. and CBOT Holdings Inc. CME Group is the parent of CME Inc. and The 

Board of Trade of the City of Chicago Inc. (the “CME Group Exchanges”). CME Group 

also owns Swapstream Operating Services Limited, an over-the-counter (“OTC”) trading 

facility, and owns an interest in FXMarketspace Limited, an FX trading platform that is 

authorized and regulated by the Financial Services Authority. CME Group Exchanges 

serve the global risk management needs of our customers and those who rely on the 

price discovery performed in the competitive markets maintained by the Exchanges. 

CME Group Exchanges offer a comprehensive selection of benchmark products in most 

major asset classes, including futures and options based on interest rates, equity 

indexes, foreign exchange, agricultural commodities, and alternative investment 

products such as weather and real estate. Additionally, we offer access to energy 

products through our Globex® electronic trading platform. CME Group is traded on the 

New York Stock Exchange and NASDAQ under the symbol “CME.” 

 We have been asked to participate in this hearing whose stated purpose is to 

examine the oversight of trading on regulated futures exchanges and exempt 

commercial markets (“ECMs”). I am pleased to be here and I know that a great deal of 

attention has been focused on the consequences of the coexistence of the natural gas 

futures contract of the New York Mercantile Exchange (“NYMEX”), which is subject to 

NYMEX’s self regulation and oversight of the Commodity Futures Trading Commission 

(“Commission” or “CFTC”), and the economically identical contract of the 

Intercontinental Exchange (or “ICE”), which is traded in a largely unregulated 

environment by means of its ECM status. This situation challenges the Commission’s 
2 

ability to fulfill its statutory responsibilities to prevent market-disrupting conduct. The 

NYMEX/ICE issue has attracted significant, justified attention, in some measure 

because of the underlying philosophical issues—but more because the underlying 

commodity, natural gas, is important to the economy and to the interests of residential, 

commercial and industrial users and their representatives in Congress. The 

representatives of NYMEX and ICE, who are on this panel, are best situated to discuss 

the consequences of that specific overlap. 

 Therefore, I would like to focus my comments today on the more general 

problems respecting differential regulation of certain derivatives trading platforms and 

the attendant regulatory systems implications of the convergence of regulated and 

unregulated trading systems. Before doing so, I want to emphasize that these 

problems, although important, exist in the context of a generally well-functioning 

regulatory scheme. Congress should be credited for the creation of the principlesbased Commodity Futures Modernization Act of 2000 (“CFMA”) and the CFTC deserves 

praise for its effective implementation of the CFMA. 

Under the CFMA, Congress has invested jurisdiction and authority in the CFTC to 

protect the public interest through self-regulatory programs by registered entities that: 

• deter and prevent price manipulation or any other disruptions to market 

integrity; 

• ensure the financial integrity of all transactions and avoid systemic risk; 

• protect all market participants from fraudulent or other abusive sales practices 

and misuses of customer assets; and 

• promote responsible innovation and fair competition among exchanges, other 

markets and market participants. 

Historically, there have been distinctions between OTC trading platforms and 

regulated exchange markets. I believe that these distinctions have now blurred to the 

extent that disparity of regulatory treatment is no longer justified. 

 OTC trading platforms and regulated exchanges are rapidly converging in every 

material respect, except regulation. Customers for financial futures and “nonagricultural” futures (the “exempt” commodities”) on regulated exchanges or so-called 

Designated Contract Markets (“DCMs”) are increasingly also customers of OTC 

electronic trading platforms. Product innovation or extension coupled with enhanced 

trading functionalities, have dissipated the distinctions between exchange and OTC 

markets. OTC platforms today list standardized contracts that can be executed by the 

push of a “take” button. Similarly, regulated exchanges like CME Group are offering 

standardized swaps and other contracts that trade in OTC type market structures or 

execution mechanisms. 

 Similarly, credit barriers that once prevented certain customer segments from 

accessing OTC markets have broken down with the growth in prime brokerages 

services – providing credit enhancement and access to multilateral trading opportunities 
3 

in much the same way as central counterparty clearing systems provided by regulated 

exchanges. Indeed, as this convergence continues, I strongly believe that some form of 

central counterparty clearing seems to be inevitable in the OTC market. 

 

 These areas of convergence in our markets create a growing conflict between 

the goals of the CFMA and the exemption for ECMs found in Section 2(h)(3). In 

retrospect, it may be that Section 2(h)(3) did not receive adequate public scrutiny during 

CFMA deliberations, which would have been helpful since it conflicted even then with 

the findings and recommendations of the President’s Working Group on Financial 

Markets (“President’s Working Group” or “PWG”).1

 However, it is now clear that many 

of the key purposes mandated by Congress in Section 5(b) are jeopardized if trading 

facilities for contracts in exempt commodities are permitted to coexist with regulated 

futures exchanges that list those same commodities. While this fact may not have been 

evident back in 2000 when Congress was in the throes of crafting the CFMA, 

experience since then clearly demonstrates ECMs do not have any system of “effective 

self-regulation” of their facilities or of their market participants. ECM contracts are 

traded based on the prices of commodities that have limited supplies and that may be 

subject to manipulative activity and disruptive market behavior. There is no mechanism 

in place “to deter and prevent price manipulation or any other disruptions to market 

integrity.” The Commission cannot track the build-up of dominant positions. The ECM 

has no real power over its users. At best, the Commission has power to punish such 

conduct after the fact. We find this to be a serious problem that is at odds with 

Congress’s intent behind the CFMA and which, if left unaddressed, can jeopardize the 

public’s confidence in the CFTC’s ability to do its job. 

 In light of the controversy generated by the NYMEX/ICE situation, I believe this is 

a very appropriate time to reexamine the Commodity Exchange Act’s (“CEA’s”) 

exemptions and exclusions and consider whether any recalibration is necessary. 

Specifically, the elimination of the exemption for unregulated commercial markets must 

be seriously considered. As a result of its investments in both the regulated and the 

OTC markets, CME is uniquely positioned to comment on this topic. CME operates a 

very successful DCM for financial derivatives and also is expanding into the EBOT and 

OTC space with offerings on our FXMarketspace and SwapStream platforms and our 

Clearing 360 initiative. 

 This forum also gives us an opportunity to examine some of the challenges to the 

U.S. regulatory regime for financial markets and the unjustified efforts of some long-time 

proponents of transferring the CFTC’s functions to the Securities and Exchange 

Commission (“SEC”) to use criticisms of market structure and regulatory philosophy that 

pertain exclusively to the SEC as an excuse to increase the SEC’s jurisdiction. On the 

contrary, as will be discussed further below, the CFMA and its administration by the 

CFTC provide a useful regulatory model for the SEC. 

 

1

 See discussion beginning at page 4 below. 
4 

DISCUSSION

I. THE CONVERGENCE OF UNREGULATED OTC MARKETS AND 

REGULATED EXCHANGES CHALLENGES THE COMMISSION’S ABILITY TO 

FULFILL ITS STATUTORY MANDATE. 

A. Trading standardized, cash settled, fungible commodity contracts on 

a multilateral execution facility is indistinguishable from futures 

trading. 

 Bi-lateral swaps, including swaps respecting energy, metals and other nonagricultural products, as defined at section 2(g) of the CEA, were excluded from the 

exchange trading requirement of the CEA because they had developed into an 

important product and a formal confirmation of their excluded status was desirable. The 

Commission’s Policy Statement Concerning Swap Transactions, 54 Fed. Reg. 30,694 

(July 21, 1989) was the first step in the direction of excluding financial product swaps. 

The Futures Trading Practices Act of 1992, Pub. L. No. 102-546, 106 Stat. 3590, 

amended the CEA and clarified the Commission’s authority to exempt certain 

transactions from the exchange trading requirement. The Commission adopted such 

regulations in 1992, e.g., 17 C.F.R. 35. An excluded bi-lateral swap must be “subject to 

individual negotiation by the parties and not executed on a trading facility.2

 

 CEA Section 2(d)(2) excluded electronically traded contracts based on certain 

financial measures that were deemed unlikely to be subject to manipulative activity (an 

“excluded commodity”) if the contract is entered into on a principal-to-principal basis 

between eligible contract participants. This exclusion is based on the recommendations 

of the President’s Working Group. The PWG carefully limited its recommendation for an 

excluded electronic trading platform to a class of commodities that did not include the 

types of commodities traded on an ECM: 

“Accordingly, the Working Group unanimously recommends that Congress 

amend the CEA to clarify that entering into or trading excluded swap 

agreements (i.e., agreements between eligible swap participants that do 

not involve non-financial commodities with finite supplies) through 

electronic trading systems with certain characteristics does not affect the 

status of the agreements traded through the system and does not provide 

 

2

 (g) Excluded swap transactions 

 No provision of this chapter (other than section 7a (to the extent provided in section 7a(g) of this title), 

7a-1, 7a-3, or 16(e)(2) of this title) shall apply to or govern any agreement, contract, or transaction in 

a commodity other than an agricultural commodity if the agreement, contract, or transaction is-- 

 (1) entered into only between persons that are eligible contract participants at the time they enter 

into the agreement, contract, or transaction; 

 (2) subject to individual negotiation by the parties; and 

 (3) not executed or traded on a trading facility. 
5 

a basis for regulation of the system. Over-the-Counter Derivatives 

Markets and the Commodity Exchange Act, Report of The President’s 

Working Group on Financial Markets, at 18-19 (November 1999) 

(emphasis supplied) 

 CME supported and continues to support those portions of the CFMA that 

exclude bi-lateral swaps in financial commodities. We also support the electronic 

trading of financial derivatives on Exempt Boards of Trade as provided in CFMA. But, 

the contracts traded on ECMs are not such bi-lateral swaps. They are standardized 

derivatives whose terms are set by the operator of the trading platform. Identical 

contracts become fungible if the platform provides central counterparty clearing. 

Consequently a buyer can offset his position by selling an equal and opposite contract. 

The price of the transaction is set at the time of the transaction but delivery is deferred. 

We do not consider these to be forward cash contracts because they are not regularly 

settled by the delivery of a specific cash instrument; rather they are cash settled like 

many financial futures contracts. 

 The only significant differences between traditional DCMs and ECMs is the 

“eligible contract participant” (ECP) qualification of the ECM’s customers and the 

requirement that ECM customers execute transactions without a broker or other 

intermediary. However, it is only those traders that are large enough to satisfy the ECP 

requirements who are likely to be involved in manipulative activity. Of course, CME 

Group Exchange customers can also directly enter their orders into the GLOBEX 

trading system and most customers do qualify as eligible contract participants. That 

difference may justify a different set of customer protection rules for ECMs, but it does 

not justify the lack of a self-regulatory system, large trader reporting or information 

sharing with other exchanges. 

B. Coexisting regulated and unregulated markets for economically 

equivalent commodity contracts impair information flows necessary 

to prevent misconduct. 

 Large trader reports are the key element of Commission and self- regulatory 

organization surveillance programs to prevent disruptive market activities. ECMs do not 

require large trader reports and do not participate in the Intermarket Surveillance Group, 

which shares information across exchanges. There is no logical basis for this 

distinction. If the prevention of disruptive market behavior is to remain a goal of 

derivatives regulation, information collection and sharing is essential. 

 The intensity of concern respecting this lack of information depends on the 

likelihood of manipulation or other market disruptions that may be caused by trading 

particular underlying products, i.e. excluded versus exempted commodities. Again, the 

1999 PWG report is instructive. The PWG’s recommendations for eliminating the 

exchange trading requirement and easing regulatory burdens on electronic trading 

facilities, hosting transactions involving derivatives based on excluded commodities, 
6 

were premised on its considered judgment respecting the risks of manipulative and 

market distorting activity in the excluded commodities: 

“Where regulation exists, it should serve valid public policy goals. The 

justifications generally cited for regulation of the futures markets include 

the goals of protecting retail customers from unfair practices, protecting 

the price discovery function, and guarding against manipulation. With 

similar policy goals in mind, the Working Group has recommended limiting 

the proposed exclusion for swap agreements to eligible swap participants 

trading for their own account . . . . It has also recommended limiting 

proposed exclusions to markets that are not readily susceptible to 

manipulation and that do not currently serve a significant price discovery 

function.” Over-the-Counter Derivatives Markets 

and the Commodity Exchange Act, Report of The President’s Working 

Group on Financial Markets, at 22 (November 1999) (emphasis supplied) 

The PWG made it abundantly clear that trading facilities for energy and metals products 

should not be exempted: 

“Due to the characteristics of markets for non-financial commodities with 

finite supplies, however, the Working Group is unanimously 

recommending that the exclusion not be extended to agreements involving 

such commodities. For example, in the case of agricultural commodities, 

production is seasonal and volatile, and the underlying commodity is 

perishable, factors that make the markets for these products susceptible 

to supply and pricing distortions and to manipulation. There have also 

been several well-known efforts to manipulate the prices of certain metals 

by attempting to corner the cash or futures markets. Moreover, the cash 

market for many non-financial commodities is dependent on the futures 

market for price discovery.” Id. at 16 (emphasis supplied) 

 The testimony adduced at the recent congressional hearings on the Amaranth 

episode and energy trading issues confirms the validity of the PWG’s concerns about an 

exclusion for energy trading facilities. 

C. The Remedy: The Section 2(h)(3) exemption for unregulated 

commercial markets should be eliminated. 

 Potential disruption of regulated markets and the cash market for certain 

exempted commodities justifies an increase in the flow of current information from 

organized OTC markets to the Commission. One seemingly simple solution is to 

change reporting requirements. Our experience suggests that this will be a failure. In 

order to provide accurate reports, a market needs an effective surveillance and 

compliance system. This implies that an effective system of self regulation must be put 

in place. The logical conclusion is you must implement at least the core principles 

required of a Designated Transaction Execution Facility (“DTEF”) to get a useful result. 
7 

 The 2(h)(3) special exemption for commercial markets trading commodity futures 

contracts based on energy, metals and other non-enumerated commodities is directly 

contrary to the recommendations of the President’s Working Group on which CFMA 

was based. The PWG expressly found that an exemption for exchange-like trading of 

derivatives based on underlying commodities that were not immune from manipulation 

was not appropriate. The legislative history of the CFMA provides no explanation for 

why Congress deviated from the PWG recommendations. 

 If the CFTC needs any further justification for taking action to reverse this hole in 

the CEA’s regulatory safety net, Intercontinental Exchange’s Jeffrey Sprecher’s recent 

testimony before Congress adequately confirms that there is ample need for it now. He 

conceded that it is essential to the performance of the CFTC’s oversight function that 

there be enhancements “to the quality and quantity of information currently available to 

the CFTC and, in particular, its ability to integrate data from ICE and NYMEX.”3

 

Additionally, our sense is that the CFTC devotes an outsized proportion of its human 

and financial resources to trying to stay abreast of problems in the ECM market and 

dealing with other off-exchange trading. Eliminating the 2(h)(3) category would produce 

significant efficiencies of administration and more effective regulatory oversight without 

any adverse implications for innovation, competition or market flexibility. Any trading 

facility that is now successfully operating as an ECM can easily and inexpensively 

convert to a DTEF or DCM. Beyond the market protections reflected in a DTEF’s core 

principles, a DTEF has an affirmative obligation to deter market abuses and to 

implement systems and procedures to comply with that obligation4. The Commission 

has oversight powers to insure that the obligation is met. The existing DTEF regulatory 

scheme would appear to provide an effective remedy to the problems identified with 

ECMs without the need to invent something new. 

 The Commission’s publicly available list of ECMs confirms our belief that there 

appears to be no barrier for ECMs to convert to DTEFs or DCMs. There are numerous 

providers to whom any servicing needs, such as clearing and/or compliance, can be 

outsourced efficiently. The significant entrants, such as ICE, ChemConnect, Inc., 

 

3

 Testimony of Jeffrey C. Sprecher, Chairman and Chief Executive Officer, Intercontinental Exchange, 

Inc., Before the House Agriculture Subcommittee on General Farm Commodities and Risk 

Management Committee on Agriculture, page 8 (July 12, 2007). 

4

 CEA Section 5a (c)(2) provides as follows: 

Deterrence of abuses.--- 

The board of trade shall establish and enforce trading and participation rules that will deter 

abuses and has the capacity to detect, investigate, and enforce those rules, including means to-- 

(A) obtain information necessary to perform the functions required under this section; or 

(B) use technological means to-- 

 (i) provide market participants with impartial access to the market; and 

 (ii) capture information that may be used in establishing whether rule violations have 

occurred. 
8 

Chicago Climate Exchange, Inc., and TradeSpark have affiliates that are already 

regulated by the Commission. HoustonStreet seems to be a marketplace for physical 

crude oil and other refined products that makes certain NYMEX ClearPort products 

available in a linkage arrangement. NetThruPut Inc. appears to be a cash crude oil 

trading system. It is unclear, from its websites, what ICAP is actually doing as an ECM. 

Some, such as Optionable, Inc. and Commodities Derivative Exchange, Inc., are out of 

business. Others appear to be trading agricultural commodities like pulp and salmon, 

which, not being exempt commodities, are not within the purview of ECMs. 

II. THE CFTC’S PRINCIPLES BASED REGULATORY MODEL AND ITS POLICY 

OF CROSS-BORDER ACCESS TO WELL-REGULATED FOREIGN 

EXCHANGES ARE USEFUL EXAMPLES FOR U.S. SECURITIES MARKETS. 

While the primary subject of today’s hearing involves an area where the CEA 

may need amendment to redress a shortcoming, it is important to put that area of 

controversy in its proper perspective. The problems associated with ECMs are not 

representative of what is the overwhelming success story that is the current CEA as 

amended by the CFMA. As earlier noted, CME Group enthusiastically applauds 

Congress, and particularly the congressional agriculture committees, in having the 

wisdom and courage back in 2000 to enact a modern, progressive, principle-based 

regulatory regime for the CFTC. 

 The success of foreign capital markets in attracting new listings to the apparent 

detriment of U.S. markets has focused attention on the U.S. regulatory system for 

securities exchanges and markets. The discussion has tested the premise that US 

financial markets have been hamstrung in meeting international competition by a 

panoply of federal and state regulators and the overly-prescriptive and expensive nature 

of regulation. A strong case has been made that innovation is slowed and U.S. markets 

cannot attain a first mover advantage because of the lag between idea and 

implementation. It is notable that these complaints do not arise from participants in the 

US futures markets which have enjoyed unparalleled growth, competition, and 

innovation since the CFMA’s enactment. 

 We believe that the marked success of the U.S. derivatives industry under the 

regulatory regime created by the CFMA provides a compelling example for the 

securities industry. In our view, reducing or limiting barriers to entry in the global futures 

and options industry has strongly contributed to business growth and increased 

competition. For example, the compounded annual growth rate of the global futures 

and options industry from 2001 through 2006 was 28% compared to only 4% for equity 

securities markets (based on notional values). This is due, at least in part, to the fact 

that U.S. investors can directly and electronically trade foreign futures and options 

contracts from the U.S. Correspondingly, European and Asian investors can directly 

and electronically trade products listed by CME and other U.S. futures and options 

exchanges. Moreover, foreign boards of trade can efficiently offer U.S. customers 

access to products also traded on U.S. exchanges, thereby increasing global 
9 

competition in these markets. In contrast, under current SEC rules, U.S. investors 

cannot directly and electronically trade foreign equity securities of foreign issuers that 

do not comply with SEC disclosure standards or U.S. GAAP accounting standards. The 

CFTC has wisely promoted global growth and competition while recognizing that 

comparability in regulatory standards is superior to insisting upon additional, but not 

necessarily better, regulatory requirements. 

 We are concerned, however, that most discussions of regulatory shortcomings in 

the U.S. lump derivatives and securities markets together under the aegis of financial 

markets and treat the regulatory problem as if it were caused by separate regulation of 

those two sectors. We have not discovered a single, considered explanation of why 

separate regulation of futures and securities has adversely impacted securities markets. 

 The fact is that the US futures industry was able to keep its place as a world 

leader and innovator because CFMA adopted a principles-based regulatory regime and 

the Commission embraced and fostered the concept. The CFMA was revolutionary in 

concept and scope and unleashed unprecedented incentives for competition, innovation 

and international expansion of our domestic futures markets. Since enactment of the 

CFMA, we have witnessed explosive growth in futures volume, a revolution in the use of 

cost-effective electronic trading, the creation of new exchanges and forms of offexchange futures trading, and the CFTC’s approval of numerous new domestic and 

international competitors, both regulated and unregulated, in our markets. No other US 

financial market, especially those that see themselves mired in overly-burdensome 

regulatory regimes, can boast a shadow of the robustness, vibrancy, health, and 

success the futures markets have achieved under the CFMA. 

 Some observers argue that the occasional jurisdictional “overlap” between the 

CFTC and SEC with respect to some innovative new products demonstrates a 

dysfunctional system that must be changed. Those “border disputes” certainly exist and 

are unfortunate, but they have no bearing on the effective and efficient regulation of the 

great mass of futures products that lies solely within CFTC’s jurisdictional purview. The 

proper resolution is the course that the Commission has pioneered, that is, finding a 

solution that permits the new products to trade under both regimes and permitting the 

“market” to choose. 

 The continuing calls for merging the CFTC and the SEC may sometimes appear 

justified as a means to resolve these minor conflicts. However, such a merger has no 

value for futures markets which already enjoy principal-based regulation. There is no 

benefit to the customers, since the most likely outcome will be the elimination of the 

better regulatory system. The inadequacies of securities market regulation cited by 

critics need to be resolved by reform of that regulatory regime, not by subjecting 

derivative markets to a system that is not effective in a global economy. 
10 

CONCLUSION 

The CFTC should be complimented for both its able administration of the CEA 

and its willingness to ask difficult questions as to whether the CEA can be improved 

based on experience and evolving market needs. The CEA has been tremendously 

successful and the CFTC has administered it extremely well to the great benefit of 

customers and the nation’s economic health. That said, the record indicates that there 

are important issues arising in the context of ECMs that need to be addressed. CME 

Group supports CFTC’s review of those issues and urges responsive action in that 

regard. 

 On behalf of CME Group, I thank the Commission for this opportunity to 

participate and offer our insights. We are prepared to assist the Commission in any way 

that you might find helpful.