UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 CFTC STAFF ROUNDTABLE TO DISCUSS PROTECTION OF

 CLEARED SWAPS CUSTOMER COLLATERAL

 Washington, D.C.

 Friday, June 3, 2011
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 1 PARTICIPANTS:

 2 CFTC Staff:

 3 ANANDA RADHAKRISHNAN

 Division of Clearing and Intermediary

 4 Oversight

 5 BOB WASSERMAN

 Division of Clearing and Intermediary

 6 Oversight

 7 MARTIN WHITE

 Office of General Counsel

 8

 DAVID REIFFEN

 9 Office of the Chief Economist

 10 LAURA ASTRADA

 Division of Clearing and Intermediary

 11 Oversight

 12 Speakers:

 13 DAN MAGUIRE, LCH Group

 14 CHRIS EDMONDS, ICE Trust

 15 KIM TAYLOR, CME Clearing

 16 OLIVER FRANKEL

 Goldman, Sachs & Co.

 17

 ATHANASSIOS DIPLAS

 18 Deutsche Bank

 19 RAYMOND KAHN

 Barclays Capital

 20

 JOHN NICHOLAS

 21 Newedge USA, LLC

 22 KEVIN FOLEY

 Katten Muchin Rosenman, LLP
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 1 PARTICIPANTS (CONT'D):

 2 ALESSANDRO COCCO

 J.P. Morgan Futures, Inc.

 3

 EDITH O'BRIEN

 4 MF Global, Inc.

 5 RICHARD PRAGER

 BlackRock

 6

 JOANNE MEDERO

 7 BlackRock

 8 SUPURNA VEDBRAT

 BlackRock

 9

 JOHN MACFARLANE

 10 Tudor Investment Corporation

 11 RUPERT COX

 Brevan Howard

 12

 CHRISTINE AYOTTE-BRENNAN

 13 Fidelity Investments

 14 NEVIS BREGASI

 MFS Investment Management

 15

 WILLIAM C. THUM

 16 The Vanguard Group, Inc.

 17 MARK SZYCHER

 General Motors Pension Plan

 18

 JAMES HARSHAW

 19 General Motors Pension Plan

 20 STEVEN WINTER

 State Street

 21

 22 * * * * *
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 1 C O N T E N T S

 2 AGENDA: PAGE

 3 Session One 5

 4 Session Two 72

 5 Session Three 148

 6 Session Four 251

 7

 8

 9

 10

 11

 12 * * * * *

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22
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 1 P R O C E E D I N G S

 2 (9:35 a.m.)

 3 MR. RADHAKRISHNAN: Good morning. I

 4 think we'll start.

 5 MS. O'BRIEN: All right.

 6 MR. RADHAKRISHNAN: Morning. My name is

 7 Ananda Radhakrishnan. I'm with the Division of

 8 Clearing and Intermediary Oversight, CFTC, and

 9 welcome to the Staff Roundtable on the Protection

 10 of Cleared Swaps Customer Collateral. I

 11 appreciate everybody's participation.

 12 There will be three panels. The first

 13 one is "Implementation"; the second is "The Option

 14 Approach"; the third is "The Advantages and

 15 Disadvantages of The Complete Legal Segregation

 16 Model in comparison to Legal Segregation with

 17 Recourse, the Futures Model, and the Optional

 18 Approach".

 19 CFTC staff participating: Martin White

 20 from the Office of General Council and Bob

 21 Wasserman from DCIO; Laura Astrada from DCIO; and

 22 David Reiffen from the Office of Chief Economist.
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 1 So, I'm going to hand it over to Bob, who will be

 2 conducting most of today's proceedings. Thanks.

 3 MR. WASSERMAN: Thank you. I'm going to

 4 start with some housekeeping details. This

 5 meeting is being recorded, and there's a court

 6 reporter. Microphones are push-to-talk, so please

 7 press the button on the microphone and speak into

 8 it. When the light appears red, your microphone

 9 is on. And then when you're finished talking,

 10 please press the button again to turn it off.

 11 Please keep your Blackberries and cell phones away

 12 from the table as they can cause interference.

 13 Bathrooms are outside, down the hall,

 14 far back. And we're going to be taking a break

 15 after this panel, a break at noon for lunch, and

 16 then in the middle of the third panel at around

 17 3:15.

 18 So, I think the best way to start is to

 19 just have everyone introduce themselves, and then

 20 off we go.

 21 MR. WINTER: Steven Winter, State

 22 Street, head of the futures and swap clearing
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 1 business.

 2 MR. SZYCHER: Mark Szycher, General

 3 Motors Pension Plan, head of risk management.

 4 MR. THUM: Bill Thum, Vanguard, Legal

 5 Department.

 6 MS. BREGASI: Nevis Bregasi, MFS

 7 Investment Management, Legal Department.

 8 MS. AYOTTE-BRENNAN: Christine

 9 Ayotte-Brennan, Fidelity Investments, Fixed-Income

 10 Legal.

 11 MR. COX: Rupert Cox, Brevan Howard,

 12 risk management.

 13 MR. MACFARLANE: John MacFarlane, Tudor

 14 Investment Corporation, vice chairman, general

 15 management.

 16 MS. MEDERO: Joanne Medero, BlackRock.

 17 MR. MAGUIRE: Daniel Maguire, LCH Group,

 18 risk management.

 19 MR. EDMONDS: Chris Edmonds, president

 20 of ICE Trust.

 21 MS. TAYLOR: Kim Taylor, CME Clearing.

 22 MR. FRANKEL: Oliver Frankel, Goldman
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 1 Sachs.

 2 MR. DIPLAS: Athanassios Diplas,

 3 Deutsche Bank, global markets.

 4 MR. NICHOLAS: John Nicholas, Newedge

 5 USA, Legal Department.

 6 MR. WASSERMAN: And then on the phone?

 7 MR. COCCO: Alessandro Cocco, JPMorgan,

 8 Legal Department.

 9 MS. O'BRIEN: Edith O'Brien, MF Global,

 10 Treasury Department.

 11 MR. WASSERMAN: Let's get started. So,

 12 this panel is on implementation issues, and I

 13 think the biggest question is what are the steps

 14 that would need to be taken -- and we're going to

 15 first start with the proposed complete legal

 16 segregation model, and then we will move on to how

 17 those steps would be changed if we were to adopt

 18 either the legal segregation with recourse model

 19 or the futures model or one of the optional

 20 models.

 21 So, starting with the complete legal

 22 segregation model, if I could have some folks from
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 1 the buy-side talking about the steps they would

 2 need to take, and then I'll move onto the firms

 3 and the clearing organizations.

 4 MR. THUM: Sure, it's Bill Thum at

 5 Vanguard. We are very active in the bilateral OTC

 6 derivatives market and have trading relationships

 7 across the street. We have collateral

 8 arrangements on a fully collateralized basis, and

 9 we are talking to several FCMs at present to

 10 valuate them serving as our FCMs for cleared

 11 derivatives. We have been engaged with them in

 12 terms of understanding their infrastructure, their

 13 strengths in terms of assessing the credit risks

 14 presented by clients, and as well having them

 15 evaluate our portfolios to understand what is

 16 clearable by which clearinghouse and assessing the

 17 margin levels that each clearinghouse would

 18 present.

 19 We have very active relationships

 20 already where the dealers and the FCMs are very

 21 familiar with our funds. We have already

 22 exchanged all the money laundering information.
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 1 That's all accomplished. So, at this point we are

 2 moving through developing the relationship.

 3 From there we have to engage in the

 4 dialogue on the documentation, which involves

 5 upgrading our futures agreement to address cleared

 6 derivatives, signing up the addendum to the

 7 futures agreement, and then entering into the

 8 execution agreements with the different executing

 9 brokers.

 10 So, we see that playing out over

 11 possibly a year to two years, engaging with our

 12 investors and clients to explain to them the

 13 implications of the new cleared swaps world;

 14 having upgrades to disclosure in the fund

 15 documentation; and having the investment

 16 management agreements upgraded to address clear

 17 derivatives. And obviously the issue presented by

 18 the protection for margin for cleared derivatives

 19 raises a number of issues, and depending on how

 20 the Commission comes out on this and we support

 21 the full legal segregation model or the LSOC model

 22 as it's otherwise known, we will have to explain
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 1 to the clients how their margin will be treated if

 2 it's going to be treated differently in the

 3 cleared world than it is in the uncleared world.

 4 In the uncleared world, as I said, we

 5 have the CSAs; we have bilateral collateral

 6 arrangements; and we have custodians set up where

 7 the margin that we post and the margin that we

 8 receive are held by custodians. It was very

 9 useful for us in the Lehman bankruptcy to have the

 10 margin there, so we have invested heavily in that

 11 infrastructure to protect the margin, and we would

 12 have to engage in significant dialogue with

 13 clients if we had to explain any changes or

 14 weakening of the protection for margin.

 15 MS. AYOTTE-BRENNAN: It's Christine

 16 Ayotte- Brennan from Fidelity. We are doing the

 17 same process as Vanguard is going through now

 18 talking to FCMs, talking to clearinghouses, and

 19 getting on board.

 20 I think a few of the other things that

 21 we have to do to be ready to implement any

 22 collateral system that is chosen is that our back
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 1 office has to work with both the FCMs and the DCOs

 2 to make sure that they can reconcile the margins

 3 calls that will be made. So, all of that back

 4 office work still needs to be done regardless of

 5 which model is chosen. And as Bill mentioned, we

 6 also have to go out to the clients and talk to

 7 them about how collateral is going to be managed

 8 in the new derivatives world. And, again,

 9 regardless of which scheme is chosen, we will have

 10 to do that.

 11 So, in terms of being ready to implement

 12 one of these things, when we think about what is

 13 best for the clients, we fully support the

 14 complete legal segregation as well. And when we

 15 look at that, we think it's, one, the best

 16 protections for the client and, two, it will not

 17 take any longer to implement than the other

 18 choices, because we will have to do the back

 19 office work and go to the clients regardless of

 20 which is chosen.

 21 MR. SZYCHER: Mark Szycher from GM

 22 Pension. I'd echo the sentiments and some of the
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 1 work that both William and Christine's

 2 organizations are doing regarding complete legal

 3 segregation.

 4 I would also add two other elements that

 5 I think would be very important. I mean our

 6 implementation process, the first of which is to

 7 make a thorough assessment of investment risk.

 8 You know, as the proposed rule has detailed, we

 9 recognized that though the fellow customer risk

 10 perhaps has either been eliminated or at least

 11 greatly mitigated by complete legal segregation,

 12 we still maintain a degree of investment risk as

 13 our collateral has been transformed or otherwise

 14 invested by the FCM.

 15 Furthermore, and perhaps even more

 16 importantly, the ultimate effectiveness of

 17 complete legal seg in a bankruptcy or

 18 double-default situation would really rely on the

 19 completeness and accuracy of the records that are

 20 being held by the FCM to figure out what we're

 21 actually holding and, therefore, what we are

 22 supposed to receive back. I think our significant
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 1 practical concern with the proposal, or at least

 2 the way things are done today, is that in essence

 3 we would be reliant upon what is going to be a

 4 defunct or bankrupt entity or certainly

 5 in-serious-trouble entity to, in fact, maintain

 6 those records.

 7 I'm sure we all have vivid memories of

 8 watching on television as the rather unfortunate

 9 Lehman Brothers employees were filing out of the

 10 building tearfully carrying their boxes out. And

 11 for us to depend upon those records, you know, in

 12 a situation like that, ultimately to retrieve the

 13 value of our capital, our initial margin posted,

 14 would be of grave concern.

 15 Our strong recommendation, if complete

 16 legal segregation were mandated, would be that the

 17 records of our collateral would, in fact, be

 18 independent, would be verifiable and available to

 19 us, and as well would stand up to an audit; that

 20 is, it would have to be created and shadowed by

 21 someone who is independent of the process that is

 22 not simply the FCM or the DCO.
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 1 MR. WASSERMAN: And I would note that in

 2 the futures model we currently have

 3 self-regulatory organization audits, and we of

 4 course supervise the self- regulatory

 5 organizations. And of course in Lehman, there

 6 were quite a few problems outside of the futures

 7 portion of the operation, but actually the futures

 8 portion of the operation went across to Barclays

 9 fairly seamlessly, so.

 10 But Nevis, you had --

 11 MS. BREGASI: I think I was just going

 12 to echo what Christine and Bill said before, that

 13 the complete segregation model will not add any

 14 extra time or cost to us when we put swaps into

 15 the cleared world.

 16 MR. WASSERMAN: On the firm end.

 17 MR. DIPLAS: I think from the dealer

 18 side obviously what has already been expressed in

 19 terms of what is required to be done is similar,

 20 because we have to do the reverse of what the

 21 clients basically expect. So, the implementation

 22 work is definitely there.
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 1 There is work that needs to be done on

 2 the personal side in terms of identifying

 3 basically the client IDs associated with the

 4 trades. Of course, for that information to be

 5 properly maintained and also taken apart in the

 6 event of default, that information has to be part

 7 of the trade, and that is not currently the case.

 8 So, I think that is something that we need to

 9 actually do, not alone but in conjunction with the

 10 DCOs if such a change rescue were to be

 11 implemented in a way that's going to be probably

 12 consistent among different DCOs.

 13 So, there's going to be an issue of kind

 14 of standardization of how we're going to maintain

 15 that information, because, as I said, that is not

 16 currently maintained. And that perhaps goes back

 17 to the point that Mark mentioned also creating

 18 that the record that's going to be auditable and

 19 verifiable in the event of the demise of the SCM

 20 or the DCO in particular.

 21 So, from that perspective, I think that

 22 there is a fair amount of work that needs to be
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 1 done on the IT side, and it's not clear that right

 2 now all DCOs are equally ready to do so. Some

 3 people have already chosen that model; some have

 4 not. So, those who have not probably will have to

 5 do some of that work.

 6 MR. WASSERMAN: I don't know if --

 7 Oliver, do you have anything else to add?

 8 MR. FRANKEL: No, not really. It

 9 doesn't seem like a huge amount of work in order

 10 to provide also portability on the back of that.

 11 I think that some templates need to be developed

 12 again by the DCOs, and so we would take the lead

 13 in getting that done.

 14 MR. WASSERMAN: Folks on the phone?

 15 MR. COCCO: Yes, it's Alessandro Cocco

 16 from J.P. Morgan, and we think that in the OTC

 17 framework we're getting the data. The roundtable

 18 is a very helpful opportunity to discuss these

 19 matters, but we are, you know, still working

 20 through the information that is necessary to

 21 provide a full feedback.

 22 The situation in the OTC framework is
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 1 that for some clients we do provide the collateral

 2 held at a third- party custodian, but that is not,

 3 as far I'm aware, the majority -- what happens for

 4 the majority of clients. So, we absolutely hear

 5 the need for providing clients with certainty with

 6 respect to their collateral, so we're absolutely

 7 willing to work together with them and with the

 8 Commission.

 9 But we think that there are some costs

 10 that we will have to face in terms of opening up a

 11 large number of accounts for implementing the

 12 complete segregation model. But, of course, if

 13 that is the way that the developments go, we will

 14 do our best to comply in the time frame allotted.

 15 MR. NICHOLAS: I think that -- as a

 16 broker I think there, you know, should be an

 17 acknowledgment that moving to a complete legal

 18 segregation model would add another level of

 19 complexity to brokers, particularly joint

 20 broker-dealer FMCs that are already dealing with

 21 multiple segregation requirements, that this

 22 additional level of complexity will result in some
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 1 increase in operational risk. I think that's just

 2 the nature of the game. I mean, more

 3 specifically, I can see potential changes to daily

 4 -- additional computations, perhaps additional

 5 monitoring, additional daily reconciliations, and,

 6 you know, perhaps changes in customer account

 7 documentation.

 8 MR. WASSERMAN: So, what would you see

 9 in terms of additional calculations? I mean, for

 10 instance, with respect to the relationship between

 11 you and your customers, I assume you know, every

 12 day, the positions and contracts of each customer

 13 and do risk calculations and the like?

 14 MR. NICHOLAS: Yes, absolutely, but I

 15 think the point is here you're adding another

 16 factor to consider. By moving away from the

 17 futures model, you're adding another

 18 consideration, another requirement that has to be

 19 followed.

 20 MR. COCCO: Bob, it's Alessandro. May I

 21 add one point?

 22 MR. WASSERMAN: Please.
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 1 MR. COCCO: One of the considerations

 2 that we've been focusing on when evaluating the

 3 four models has been the fact that based on the

 4 analysis we've conducted so far, there is a very

 5 significant difference for us between establishing

 6 the full segregation and the model that we

 7 commonly refer to as LSOC, the Legal Segregation

 8 Operation Commingled. And the difference is that

 9 the operational commingling aspect, really from a

 10 practical point of view, makes a very significant

 11 difference, and that's the difference between

 12 creating a single individual bank account per

 13 currency per legal entity fund versus having one

 14 omnibus account, which -- for instance, in the

 15 case of a transfer of positions for porting --

 16 would not require the creation of several new

 17 accounts, possibly running in the thousands or

 18 hundreds of thousands of accounts.

 19 Of course, one way to deal with that

 20 would be for clients to set up two clearing

 21 members and hoping that they don't both experience

 22 difficulties at the same time so that they can
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 1 transfer from one set of very many accounts to the

 2 other set of very many accounts in the case of

 3 full legal segregation. But I think that it is a

 4 fact that the full legal segregation would result

 5 in very significant additional work when compared

 6 with LSOC, the futures model, and the fourth

 7 model.

 8 MR. WASSERMAN: And so just to clarify,

 9 we are focusing on what had been called LSOC,

 10 which we renamed for good or for ill -- maybe for

 11 ill -- as complete legal segregation, the proposal

 12 does permit the operational commingling just as

 13 today. And as I say, it's -- yeah, we changed the

 14 name from legal segregation with operational

 15 commingling, because it seemed too much of a

 16 mouthful.

 17 That being the proposed model, I guess

 18 the question is -- so you're permitted, in other

 19 words, to commingle as you do today. There's

 20 additional information that you would have to be

 21 passing up to the clearing orgs -- and we're going

 22 to be talking to them in a few moments -- but from
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 1 the firm perspective, from my understanding -- and

 2 you folks will correct me, please, if I'm

 3 misunderstanding -- the biggest change from the

 4 firm's perspective is you're going to need to pass

 5 this information up to the clearing orgs every

 6 day. And so the question is from an

 7 implementation perspective -- that's obviously

 8 that nothing in this life is free -- the question

 9 is how complicated is that, and what are the steps

 10 you would -- more importantly, what are the steps

 11 you would need to take to implement that from the

 12 firm perspective?

 13 MR. DIPLAS: Yeah, just to be clear, the

 14 comments we made were for what was formerly known

 15 as LSOC that you right now refer to as full

 16 segregation operational commingling, okay? So,

 17 otherwise the operational requirements would have

 18 been much more onerous.

 19 So, we focused a lot -- you were correct

 20 to focus a lot on the transmission of information

 21 about the client account to the DCO. I think in

 22 terms of how onerous that task is, I think it is
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 1 probably less onerous than what I think the

 2 buy-side mentioned, which is the documentation

 3 task is probably going to be the most important

 4 hurdle, bar none, and this is going to be

 5 secondary in that respect.

 6 MR. COCCO: So, Bob, can I ask one

 7 question and then I'll be quiet for some time?

 8 Are we saying that when the buy-side

 9 firms that spoke before express their support for

 10 complete legal segregation, that would be the

 11 model formerly known as LSOC, and so is the legal

 12 and operational segregation model not up for

 13 discussion today?

 14 MR. WASSERMAN: I think there are

 15 probably at least some folks on the buy-side who

 16 would prefer the complete physical segregation.

 17 But I think the proposal that we're discussing and

 18 focusing on today starts, I mean, from the far

 19 end, if you will, with the complete legal

 20 segregation; and then after we hear from our

 21 colleagues, the DCOs, with respect to that, we'll

 22 talk about some of the other models. But they
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 1 move, I think it's fair to say, in the opposite

 2 direction, that is to say, less protective and

 3 moving down toward the futures model.

 4 MR. COCCO: Thank you.

 5 MR. FRANKEL: Probably the easiest way

 6 to do it would be for the DCOs to keep a client ID

 7 on all trade records, and then the FCMs would only

 8 have to report daily the mapping from client to

 9 client ID and any associated credit multipliers or

 10 other information that would be necessary. That

 11 would be it.

 12 MR. WASSERMAN: Which is a great segue

 13 to talking to our colleagues from the DCOs.

 14 MS. TAYLOR: Okay, Bob. I think Edith

 15 wanted to talk.

 16 MR. WASSERMAN: Yeah, Edith?

 17 MS. O'BRIEN: Thank you, Kim. I think

 18 that member firms are actively trying to prepare

 19 for the final regulations that are released, Bob.

 20 I do think the challenges that were cumbersome as

 21 some as undefined or specified sections. So, for

 22 example, omnibus. I think that we continue to
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 1 struggle with how we're going to handle omnibus

 2 accounts under this new proposed structure,

 3 specifically how do we have the data? How do we

 4 get to the data of the underlying client? This is

 5 something we currently rely upon our omnibus

 6 affiliate, that's a foreign broker, to maintain

 7 and handle. This isn't something that is readily

 8 transparent to US FCMs. I do think that is a

 9 major undefined, unclarified items.

 10 I also think that there is the issue of

 11 portfolio and cross-margining. Is this something

 12 we can do? What would we have to do to prepare to

 13 implement this under the new structure?

 14 Additionally, based on the outcome of

 15 those two, what is the amount of IT work that may

 16 need to be done in order to satisfy these

 17 requirements? Information is going to be,

 18 obviously, the critical component, how we

 19 communicate to the DCOs.

 20 MR. WASSERMAN: Let me take a moment to

 21 speak to that. One observation I should make. So

 22 this is -- I know a lot of you have seen the
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 1 proposal on the website. It's 190 typescript

 2 pages. I regret to say that our colleagues at the

 3 Federal Register have not yet gotten this

 4 published. I understand that they were about to

 5 and then their building lost power. In any event,

 6 to the extent -- and I'm certain there are at

 7 least some areas that are ambiguous and

 8 unintentionally so. You know, certainly we very

 9 much welcome comments that would help us

 10 essentially clarify ambiguous points and do so in

 11 a way that makes implementation of whichever of

 12 these models is ultimately implemented done in a

 13 manner that is as efficient and painless as

 14 possible.

 15 With respect to the foreign broker

 16 point, I would note that these regulations speak

 17 to FCMs and DCOs. And so to the extent you have

 18 swaps coming through what we would, I guess in the

 19 futures context, consider from foreign customers

 20 -- and I'm not going to start talking

 21 extraterritoriality today, because that is an

 22 entirely different topic -- but however that ends
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 1 up getting resolved, if you're having things come

 2 from foreign customers through foreign brokers,

 3 the foreign brokers are not subject to this.

 4 They're not FCMs, and thus they would not be

 5 obligated to pass information up on individual

 6 customers and thus the foreign broker omnibus we

 7 would not be imposing a requirement that there be

 8 individual protection.

 9 Now, if the foreign brokers of course

 10 would be regulated in their own jurisdictions, and

 11 so there is I know -- and my understanding is in

 12 terms of EMIR and in terms of a number of the

 13 things coming in other jurisdictions, there may

 14 well be similar requirements, perhaps even more

 15 stringent requirements. I can't really speak to

 16 those here, because, again, that's imposed by

 17 colleagues in foreign jurisdictions. But from our

 18 perspective, we are not requiring anything of the

 19 foreign brokers, of course beyond the usual large

 20 trader things, which again are not topics here.

 21 And in terms of portfolio margining, it

 22 seems to me that if you have essentially other
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 1 things brought into swaps account, they would be

 2 treated similarly and so you would have, of

 3 course, the portfolio margining, and then the

 4 collateral would be treated the same way. And

 5 indeed, of course, arguably that provides some

 6 advantages in terms of seeking, say, 4D orders and

 7 the like.

 8 But in any event, let me turn over to my

 9 colleagues, the DCOs. Kim?

 10 MS. TAYLOR: Okay, Thanks, Bob, for

 11 having us today. I guess I would start out by

 12 confirming a lot of what some of the other

 13 panelists have said about the ease of

 14 implementation of the LSOC model -- if it's okay

 15 if I call it that -- the LSOC model. So, I think

 16 there will need to be changes to reporting

 17 requirements that we'll need to work out so that

 18 the FCMs can report to the DCOs the status of the

 19 accounts.

 20 I think there might need to be changes

 21 to the 1-FR reporting process, as well as related

 22 to what needs to reported differently in this
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 1 environment. It's a little bit unclear, but I

 2 think it certainly is workable. I think we might

 3 have changes to make to the way that we do

 4 settlements between ourselves and the clearing

 5 members, because I'm not certain that there is the

 6 protection for us to be able to net settlements

 7 and have those transactions stand. So, the legal

 8 certainty there is of concern to me, so we might

 9 need to change our settlement procedures. And I

 10 think we need to review our audit processes,

 11 possibly that affects the staffing, and possibly

 12 we even need to evaluate a cost pass-through model

 13 to the industry if the costs of auditing for this

 14 type of activity skyrocket. Right now those are

 15 costs we just bear as a benefit to the industry.

 16 And as Edith mentioned, I think there

 17 are things that need to be clarified around,

 18 things like the omnibus accounts and some other

 19 items around the edges. But I think the overall

 20 summary there is that I congratulate the CFTC on

 21 coming up with a model with LSOC that is

 22 relatively easy to implement, and it seems that it
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 1 would work pretty effectively on the average day.

 2 I think that it does not work effectively on a day

 3 when we really need it. So, the main thing that I

 4 think we'll be looking at and worried about

 5 implementing when we're looking at the LSOC model

 6 is I'll be at home going through all of my

 7 cookbooks looking for the recipe that shows me how

 8 to unscramble eggs, because that is going to be

 9 the position that we're going to be in, in a

 10 situation where we need to actually port the

 11 customers' positions. And I'm very, very

 12 supportive of the customers' desire to have their

 13 positions be portable.

 14 And the gentleman from the GM Pension

 15 Fund mentioned some of the concerns about the

 16 maintenance of the records and the bankrupt entity

 17 and their ability to operate effectively in an

 18 environment like that. I think there are also big

 19 questions about what it means for a client to

 20 default, because the clearinghouse generally

 21 settles on a net basis across all of the

 22 obligations. Some of the clients are making
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 1 money; some of the clients are losing money on any

 2 given day. And the clearinghouse settles with the

 3 FCM on a net basis for a net amount. If we settle

 4 for that net amount, then there is no protection

 5 for -- there's protection for the clearinghouse

 6 and having certainty around that payment perhaps,

 7 but there's no protection for the customers that

 8 were making money, because they were netted off

 9 against the losses of the customers who were

 10 losing money.

 11 So, that leads me to think, okay, the

 12 better thing to do would be to separate out our

 13 settlement process so that we first make an

 14 aggregate call to the clearing member for all of

 15 the money of all of the customers that owe. And

 16 once we have certainty that we have received that

 17 money, then we make a settlement transaction for

 18 paying all the customers who are making money, and

 19 I think that that can work on a day-in and day-out

 20 basis where it becomes, I think, a little bit

 21 complicated even there.

 22 On the day when the clearing member
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 1 defaults because of the activity of a customer

 2 that is shielded from the settlement bank's

 3 ability to know and it's shielded from our ability

 4 to know yet -- we don't know that anybody's

 5 defaulted yet, right? -- we send the transaction

 6 to the settlement bank. They're going to say yes

 7 or no to the entire transaction. Does that mean

 8 that all of the customers who happen to be on the

 9 same side of the market as the customer who caused

 10 the default have actually defaulted to the

 11 clearinghouse? I certainly think you can read it

 12 that way. Therefore, it will end up being a

 13 coincidence whether or not any particular customer

 14 actually gets the benefit of the LSOC model,

 15 because once a customer has defaulted to the

 16 clearinghouse, they no longer have the protection

 17 of not having their assets be used.

 18 And then there is the complex. If I

 19 follow the chain right in the release, there's a

 20 complex web of going back to the first FCM and

 21 seeing if there's more money in the defaulting

 22 customer's account to be passed through the
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 1 clearinghouse. Then, if he's not the original --

 2 if it's an omnibus account or there's a

 3 non-clearing FCM involved, he goes back down the

 4 chain to see if that guy has money that he can

 5 send through, goes back down the chain to the

 6 foreign customer, and it says that you have to

 7 wait for an entire day before you know anything.

 8 So, the problems that I have with the

 9 model are nothing to do with the ability to

 10 operationally implement it. I think that the

 11 concerns that I have are that it is unclear that

 12 it will effectively work and provide you with the

 13 protection that you want at the time when you need

 14 it. So, the unscrambling eggs problem is my

 15 biggest problem.

 16 MS. MEDERO: Kim, I understand what

 17 you're saying, but the risk management rules for

 18 DCOs going forward are going to require that you

 19 receive gross margin from each customer. So, I'm

 20 having trouble reconciling your scenario of the

 21 net and who's on what side of the market, which

 22 should go to default with the fact that you will
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 1 have gross margin.

 2 MS. TAYLOR: Okay, I will have margin.

 3 I will have margin that is the aggregate of the

 4 margin requirements of all the clients. I was

 5 going to have that in the baseline model; I'll

 6 have it in the LSOC model; I would have it in the

 7 full physical seg model. I would have the

 8 individual client's margin right now, what the

 9 margin requirement was at the last time it was

 10 calculated, and I'll have the money for that.

 11 But there's P&L. And it was really

 12 unclear to me in the release whether the P&L -- I

 13 mean, there was actually place in the release it

 14 said that the clients are entitled to their

 15 designated share of the funds that are being held

 16 at the clearinghouse as noted the end of business

 17 the prior day. And it specifically said with no

 18 effect being given to what happened to portfolio

 19 movements today.

 20 Well, portfolio movements today are most

 21 likely to be the thing that causes large

 22 customer-driven default. Other things are more
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 1 likely to cause a house-driven default, but

 2 portfolio movements today, an inability to pay

 3 your losses--

 4 MR. MAGUIRE: Isn't it more likely

 5 portfolio movements yesterday?

 6 MS. TAYLOR: Well, they've already been

 7 settled. Presumably they've already been settled,

 8 right? They've already been settled at the

 9 clearinghouse, so --

 10 MS. MEDERO: I mean, I've never seen an

 11 intraday failure.

 12 MR. WASSERMAN: I think your point on

 13 this score is that essentially -- let's assume

 14 everything goes well on Monday.

 15 MS. TAYLOR: Mm-hmm.

 16 MR. WASSERMAN: And so there are certain

 17 positions on Monday, and there is a certain amount

 18 of collateral associated with those positions as

 19 of Monday night. Then Tuesday happens and there's

 20 a final -- then the demand is made, which is

 21 supposed to be paid Wednesday morning, and it is

 22 not. And so then the issue is the last time you
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 1 had a good settlement was essentially Tuesday

 2 morning --

 3 MS. TAYLOR: From Monday night.

 4 MR. WASSERMAN: -- as of Monday. So,

 5 that I think is the --

 6 MS. TAYLOR: Okay, so the unpaid mark to

 7 market, the part that has been vectored in to the

 8 calculation, because the calculation of what

 9 you're protected on at the clearinghouse is static

 10 as of a point in time, and it does not include

 11 movements that have happened since that point in

 12 time until the point in time when the default is

 13 likely to be realized. That's one of the concerns

 14 that I have.

 15 I mean, actually, I think, I question a

 16 fair amount that we really have a big problem to

 17 solve, because I think portability actually is

 18 very, very good in the current baseline futures

 19 model. I have the ability to port the positions

 20 of non-defaulting firms at the current settlement

 21 prices as soon as they can find a place to go or

 22 as soon as I can find a place to send them.
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 1 The money can't go right away. That is

 2 true. So, the portability of your positions is

 3 immediate and better in the baseline futures model

 4 than it would be with LSOC or certainly with LSOC

 5 with recourse. The only thing that would be equal

 6 or potentially better, because maybe your money

 7 can come with it sooner, would be the full

 8 physical segregation -- and I can't remember what

 9 we're calling that now.

 10 The unscrambled eggs models I think

 11 create heightened uncertainty at the time when I

 12 am desperately trying to provide you with the

 13 portability and the protection that you want. But

 14 it seems as if, in reading these regs, I can't

 15 even act to take action until the close of the

 16 business on that day and if we presume the most

 17 likely time to get defaulted on is 7:30 in the

 18 morning.

 19 That's a long time. But there's nothing

 20 I can do, because I have to wait for people to

 21 reach out to the FCMs and the chain and see if

 22 there's any money to be passed up, and I have to
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 1 trust that that money is not actually sitting at

 2 the FCMs, who actually could be compelled by the

 3 CFTC regs to pass it up the chain.

 4 That money is actually sitting in banks

 5 or custodians somewhere who know that the clearing

 6 member -- or that there's been a default, and as

 7 soon as there's a situation where the customer's

 8 name, the defaulting customer's name, is attached

 9 to some of that, I don't know that I feel

 10 comfortable that that will get passed on through

 11 --

 12 MS. MEDERO: -- But that's the that's

 13 the issue in the futures models today, right?

 14 Does the custodian bank understand what its

 15 obligations are and do they perform? That's no

 16 change.

 17 MS. TAYLOR: Well, I think it's -- I

 18 actually think it's worse, because I don't think I

 19 can do anything. Until I know which customers

 20 have defaulted, I don't think I can do anything to

 21 move the positions. So I think I have to wait

 22 longer. That's my concern. My concern is that I
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 1 don't know that there's legal certainty. I think

 2 it will be hard to unscramble eggs. I'm very

 3 sympathetic to the issues that the gentleman from

 4 GM raised about that.

 5 MS. MEDERO: But portability in the

 6 futures model without the cash coming with it

 7 isn't terribly satisfactory either.

 8 MS. TAYLOR: And if that's the issue,

 9 then I really think that what we need to do is

 10 ultimately we have to have a model that works. It

 11 has to work for you; it has to work for the

 12 clearinghouses; it has to work for the FCMs. I

 13 think we ended up at LSOC, because there were lots

 14 of costs associated with providing for everyone a

 15 physically segregated account, but I think that

 16 we're actually in an environment where not every

 17 customer is as concerned as some of you are about

 18 being in a pooled spot. So, I think the model

 19 that might best serve the industry in terms of the

 20 safety you want, viability to deliver the safety

 21 that you want, and the clearing members' ability

 22 to manage the impact of it would be to have there
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 1 be physical segregation but with an option so that

 2 only customers who really value the additional

 3 protection elect it. And that should mute the

 4 number of accounts that everybody in the chain has

 5 to bear the cost of, because the FCMs would have

 6 to bear the cost of all these accounts and the

 7 DCOs would have to bear the costs of all these

 8 accounts. Ultimately that means that you guys

 9 bear the cost of all of these accounts. But if

 10 only the people who really value the protection

 11 elect the accounts, it will be, I suspect, a much

 12 more contained process.

 13 MR. WASSERMAN: And so I promise we will

 14 be talking about optional models in the next

 15 session, and we will get into that. But before we

 16 do, Kim, one very clear point. If anything in

 17 that proposal suggests that your hands are tied in

 18 terms of acting based on the information you have

 19 and the cash you have, and having to wait for

 20 something, then I think that was not what was

 21 intended, I will say by me, obviously, the

 22 Commission. But it certainly wasn't intended by
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 1 me, and that's something that I would be delighted

 2 to work to clarify, you know, whichever model we

 3 end up going with in any final rulemaking.

 4 MS. TAYLOR: It's good. I'm glad that

 5 you don't want to tie our hands. It's not just my

 6 hands. So, the -- but then I think we get back to

 7 the other thing that I am afraid, is that the

 8 customers will walk away thinking that they have a

 9 protection that they don't in fact have, because

 10 if the clearinghouse does not get paid on losses

 11 that are due and owing to it from the clearing

 12 member on behalf of the clients that owe money,

 13 the clearing member has defaulted. And I think by

 14 definition all those clients have defaulted unless

 15 they have in their account enough excess margin

 16 perhaps already with the clearinghouse that enough

 17 excess margin is allocated to them to pay for the

 18 losses for their share of the losses that day.

 19 Otherwise, I think that they have defaulted,

 20 because the LSOC model pools them all together for

 21 payments and so the clearing members are going to

 22 either pay or not pay, whereas the physical
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 1 segregated model would require everybody to pay

 2 individually, but at least then it would be very

 3 clear who paid and who didn't. That's my dilemma.

 4 MR. WASSERMAN: Fair enough, and I'm

 5 going to need to wrap this up. But let me just

 6 try and answer that point, which is so if the

 7 collateral is -- I'm a customer, and I am a

 8 non-defaulting customer in the sense that I have

 9 essentially deposited in my account at the FCM

 10 sufficient amounts. My position has associated

 11 with it a collateral requirement of a thousand

 12 dollars.

 13 MS. TAYLOR: And what's in your account,

 14 a thousand dollars?

 15 MR. WASSERMAN: Well, at the

 16 clearinghouse -- remember, you don't know what's

 17 in my account at the FCM and I can't make you

 18 responsible for doing that, because that would

 19 create all sorts of problems. So, from your

 20 perspective at the clearinghouse, I've got a

 21 thousand dollars. My position loses a hundred

 22 dollars.
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 1 MS. TAYLOR: Right.

 2 MR. WASSERMAN: Now, ultimately, I'm

 3 going to have to pay that hundred dollars. I lost

 4 it. It's going to ultimately come to you. At

 5 that point, you owe me $900, because again a

 6 thousand minus a hundred. That hundred might be

 7 there at the FCM.

 8 MS. TAYLOR: Actually, you owe me a

 9 hundred dollars.

 10 MR. WASSERMAN: Right.

 11 MS. TAYLOR: Because you have an

 12 obligation to have your position margined and have

 13 your losses paid.

 14 MR. WASSERMAN: And so --

 15 MS. TAYLOR: And either one of those

 16 things -- failure to do either one of those things

 17 is an event of default. If a clearing member does

 18 not meet a call for additional margin or a call

 19 for losses, those are both events of default.

 20 MR. WASSERMAN: Absolutely, so --

 21 MS. TAYLOR: So, you owe me a hundred

 22 dollars.
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 1 MR. WASSERMAN: I do, but essentially I

 2 owe you a hundred, you have a thousand of mine.

 3 MS. TAYLOR: I do, but you owe me 1,100.

 4 MR. WASSERMAN: Well, yes.

 5 MS. TAYLOR: Right?

 6 MR. WASSERMAN: Yes. Well --

 7 MS. TAYLOR: Because you owe me the

 8 margin and you owe the losses.

 9 MR. WASSERMAN: And so the one thing --

 10 MS. TAYLOR: So, you're not even with

 11 me.

 12 MR. WASSERMAN: I understand from that

 13 perspective. What I'm saying is you have the

 14 privilege -- and, again, I in my regulatory

 15 capacity as opposed to my customer capacity would

 16 not limit that privilege. If you'd look at the

 17 market and you say you know what, I just have to

 18 liquidate all of this, I think -- you know, and

 19 for reasons we've had comments on, that would be a

 20 very bad thing from a market perspective, but from

 21 a clearing perspective and from a regulator of

 22 clearing perspective, if you believe it necessary
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 1 to liquidate that position, even -- heck, even if

 2 I had a gain that day, because it's not supported

 3 by a clearing member in good standing you have the

 4 privilege to do so. You retain the privilege to

 5 do so.

 6 MS. TAYLOR: So, where's their

 7 protection?

 8 MR. WASSERMAN: The protection -- and

 9 again that would be true in physical segregation,

 10 right? If we had everything physically separated,

 11 you have to have the privilege -- you know, until

 12 it transfers, until the transfer is accomplished,

 13 you're on the hook, the normal route in theory of

 14 clearing is every position is backed by a clearing

 15 member in good standing. My clearing member is

 16 not in good standing. So, you could liquidate

 17 those positions if necessary. If you liquidate

 18 this position, again we would -- you know, the

 19 ideal would be to allow for some re-margining at

 20 some point, which if, you know, again your hands

 21 are not tied, if you believe it is appropriate to

 22 do so and given what the market conditions are and
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 1 the information you can get and the money you can

 2 get, you may choose to take that. Or you might

 3 liquidate the position, in which event, again

 4 assuming no further market change -- you have a

 5 thousand, there was a loss of a hundred. That 900

 6 would then come back to the trustee, and that

 7 essentially -- in other words, I am not suffering

 8 the fellow customer loss. I may well suffer a

 9 loss from liquidation, but that, again, is

 10 inherent, and that's true across any model.

 11 But let's continue this. I do want to

 12 -- unless -- well, okay.

 13 MR. MAGUIRE: Thanks, Bob. I think, to

 14 just try and summarize this, what we're referring

 15 to there is losses incurred due to variation

 16 margin P&L, as Kim rightly points out. But that

 17 in play in all of the models that we have today.

 18 That's the same as gross omni or LSOC -- that's

 19 not an LSOC- specific thing.

 20 When we started talking about collateral

 21 protection, this was about protecting the

 22 customer's deposit of initial margin in the first
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 1 instance, that risk position so that we could lift

 2 it and move it to somewhere else, port it. All

 3 that variation margin stuff exists today in the

 4 existing market practice.

 5 So, going back to the original question

 6 about, you know, what we'd have to do to implement

 7 this, first of all, from our standpoint I think

 8 you made it pretty clear in all the proposed rules

 9 that all clients have to be margined on a gross

 10 basis. Number two, DCOs and FCMs must keep

 11 records of client positions at the lowest level,

 12 at the client ID level. That's in the rules.

 13 That's not an LSOC-specific thing. That's a DCO

 14 risk requirement- specific item. So, from our

 15 standpoint as risk managers, we have to be able to

 16 see all the way through to the end client. So, we

 17 have to be able to see the client ID, to

 18 Athanassios' point. We have to be able to see

 19 through that, because at some point as a CCP we

 20 could face the risk that the FCM's gone, the

 21 client's gone, we have that risk; therefore, we

 22 have to go close it out.
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 1 So, every single day as the rules are

 2 proposed, we need to be able to calculate the

 3 variation margin, the initial margin, the risk for

 4 closeouts in default at the lowest level, at the

 5 client's ID level. That's what we're doing. So,

 6 that's just the cost of clearing. That setup has

 7 to be done. That's not an LSOC thing. That's not

 8 a gross omnibus thing. That's prescribed rules

 9 for the DCOs. That's what we have to do. And,

 10 quite frankly, as a DCO that's what we have to do.

 11 We have to be able to see our risk. We have to

 12 close it out in a Lehman-type event.

 13 I think on top of this, to answer -- to

 14 maybe go to some of the concerns of the buy-side

 15 around this -- we will see your position in terms

 16 of risk, and we'll also -- what LSOC says -- or I

 17 forget the new name -- what LSOC says is we will

 18 take your position if you port, and we'll be able

 19 to give you the value of your position. So, the

 20 initial margin at the point of default, we'll be

 21 able to split each of the collateral amounts --

 22 sorry, the omnibus amount -- split into equal
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 1 chunks relative to the margin you had at the point

 2 of default. That's the collateral value. And

 3 we'll be able to lift and identify that and port

 4 you.

 5 So, this -- I'm sorry to disagree with

 6 Kim on this, but I actually see this as we've

 7 unscrambled the eggs at the beginning so we can

 8 see this at the very start so we don't have

 9 scrambled eggs. We have segregation so we can see

 10 what the risk is and what the value of the

 11 collateral is. It's very different. It's a full

 12 set where we can see the piece of paper. But we

 13 can see the value of the collaterals. That's why

 14 I think this is essentially different. From an

 15 implementation standpoint, I think if the DCOs are

 16 obliged to calculate the risk at that level and

 17 have records at that level and, therefore, need

 18 the client ID at that level, they have to do this

 19 kind of infrastructure anyway. That's just the

 20 cost of clearing; it's not the cost of LSOC.

 21 MS. TAYLOR: But that doesn't solve the

 22 problem of knowing -- absolutely we will know what
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 1 the margin was in the account, what the risk was

 2 in the account, what the positions were in the

 3 account. What I'm concerned about is that when

 4 there are losses, we will be settling those losses

 5 at an aggregate basis by the clearing member.

 6 Therefore, if the clearing member fails to pay its

 7 losses, I think the read is that every client who

 8 lost money that day failed to pay their losses

 9 and, therefore, is in default under the definition

 10 of default. And so perhaps we can take the money

 11 that they owed in their default and take it out of

 12 the margin that we have, and if they very quickly

 13 move their money somewhere else they can move it

 14 short.

 15 But I think there's also another

 16 complication that we didn't talk about, about the

 17 fact that the other thing about unscrambling eggs

 18 is that for operational purposes the current

 19 members are allowed to put up whatever collateral

 20 they want as kind of a pool, but we have to

 21 allocate value from the collateral to the

 22 individual clients in order to realize that value
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 1 and because the clients share in what this

 2 characterizes the investment risk and in the risk

 3 of the haircuts not being sufficient. The

 4 liquidation of the collateral has to happen across

 5 everything, I think, in order to be able to move

 6 the funds with people, because you won't know what

 7 the pro rata share of the liquidation losses on

 8 the collateral are unless you liquidate the

 9 collateral.

 10 MR. WASSERMAN: And key point on that --

 11 in a bankruptcy what you're entitled to is value.

 12 I mean, essentially in an insolvency there is

 13 going to be liquidation. We have, of course, and

 14 you folks impose as do we, I think fairly good

 15 haircuts, but there is in the rule something that

 16 basically says in the event the haircut is

 17 insufficient, yes, those investment losses would

 18 be essentially allocated among the customers. So,

 19 I did want to clarify those points.

 20 MR. MAGUIRE: Is that non-porting

 21 customers?

 22 MR. WASSERMAN: Essentially what you're
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 1 allocating -- so, what you owe the customers is

 2 the collateral that's required as of the day

 3 before for the positions as of the day before to

 4 the customers whose information you will have

 5 gotten as of the day before. In the event that --

 6 so, let's assume that totals a hundred million

 7 dollars. Let us further assume that the

 8 defaulting customer's allocated collateral is $10

 9 million, leaving 90. Let us further assume that

 10 you have all the collateral as of the day before

 11 and that the haircut value was $101 million. But

 12 because it was 105 and then after haircuts $101,

 13 so it's more than 100. You liquidate it, you only

 14 get 98. So, we're not going to force you to

 15 allocate $100 million out of 98 million of

 16 collateral. That 2 percent you would be

 17 allocating among the collateral so that

 18 essentially we're not imposing on the clearing

 19 house.

 20 Now, again, we're talking day over day,

 21 and so one would hope that this would be a

 22 non-event. But we did account for that
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 1 possibility.

 2 MR. MAGUIRE: Is that specific to LSOC

 3 or is that generally collateral for cleared

 4 derivative transactions?

 5 MR. WASSERMAN: We made it clear for

 6 LSOC, I think, to the extent and -- it would work

 7 that way for LSOC. It would ultimately work the

 8 same way with recourse. And for the futures model

 9 it just would -- it would net out in the wash

 10 because that's all you'd be --

 11 SPEAKER: It's the timing difference.

 12 So it applies to everything. It's a moment in

 13 time when that happens and when they port.

 14 MR. WASSERMAN: And, Chris, I haven't --

 15 okay, in which event what we have -- we may run a

 16 little bit over. I did want to talk about

 17 implementation timing, and so -- but we had

 18 mentioned in the release at least a straw man with

 19 six months from finalization -- from final rules

 20 being promulgated. What are people's views on

 21 doing that, and would that differ depending upon

 22 the model?
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 1 MR. NICHOLAS: Bob, when you say

 2 "finalization of the rules," are you talking about

 3 all of the relevant rules relating to -- or just

 4 this particular rule? I guess the reason I ask is

 5 I'm not sure that anybody can really assess the

 6 timetable necessary until some of these other

 7 rules are finalized and put into place.

 8 MR. EDMONDS: I think there's got to be

 9 some coordination with the mandate going into

 10 effect, you know. So, I mean, it's probably not

 11 six months from the mandate, but whenever your

 12 mandate, which would, I think, at least encompass

 13 a majority of the rules, what we'll call phase I,

 14 what have you. But when you're going to make that

 15 mandate, that means those impacted have been

 16 defined, those exemptions have been defined, and

 17 those rule sets are in place. He's got to

 18 coordinate with that. Otherwise, we're not going

 19 to know whether or not we got it to where it needs

 20 to be.

 21 MR. WASSERMAN: Let me press on that

 22 just for a second, because there may well be
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 1 things -- and maybe you can tell me where there at

 2 least is a logical connection, but let's say for

 3 instance clearing mandates. And so that would

 4 certainly affect when you need -- you know, you

 5 are required certain things, but right now all of

 6 you folks are already clearing some things --

 7 clearing some swaps, that is to say -- and so how

 8 would not having the mandate to clear other swaps

 9 affect the implementation of how you protect the

 10 collateral of such swaps as they are cleared?

 11 MR. COCCO: Bob, may I make a comment?

 12 It's Alessandro Cocco from J.P. Morgan. We have

 13 devoted very significant resources to following

 14 developments on the regulatory front, of course,

 15 and this is a key priority for us. And we are, as

 16 you mentioned, liable in clearing for some of our

 17 clients, although we're open for business on that

 18 front.

 19 It is a fact that we have been following

 20 developments, and the regulatory mosaic that has

 21 been introduced is very complex. So, we think it

 22 would be extremely helpful to have all of the
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 1 rules published in their near final form, to have

 2 another comment period in addition to the one

 3 that's expiring today open again, because the

 4 impact of a rule of great relevance like the one

 5 we're discussing now can only be assessed in

 6 conjunction with the other very complex rules that

 7 are being introduced.

 8 So, we really do think that whilst we're

 9 in favor with the overall perspective that has

 10 been introduced by Dodd-Frank and the regulatory

 11 activity that is implementing it, if what we want

 12 to achieve is great stability, we do really need

 13 to have enough time to understand the

 14 interconnectedness between the various rules that

 15 are being introduced and in practice how we are

 16 going to comply with them. So, I think that that

 17 will require time for us, speaking from a dealer

 18 perspective, to implement those rules.

 19 We would like to have the opportunity to

 20 comment once all of the rules are finalized,

 21 because we are every day working on practically

 22 how we would implement them. And I don't want to
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 1 speak from the buy-side, but I heard that there

 2 were some concerns, so of course it would be very

 3 interesting to hear their thoughts on this point.

 4 Thank you.

 5 MR. WASSERMAN: Let me press just for a

 6 second on that. I'm going to put aside whether

 7 it's a good idea or not, you know, in terms to

 8 having further opportunity to comment on the rules

 9 as a whole, because that's really beyond my scope.

 10 But I guess the question I would have is let us

 11 assume, just for the sake of this discussion, that

 12 the decision is made that, okay, at the point --

 13 you know, let's assume Thanksgiving -- this rule

 14 is promulgated. Let's further assume that some of

 15 these other rules might not be promulgated. I

 16 guess the first question I would have is which of

 17 those rules would you need to know the results of

 18 in order to be able to promulgate this rule? And

 19 I guess, second, how long would it take to

 20 implement, let's say, LSOC regardless of what the

 21 other rules are?

 22 MR. MAGUIRE: I think I speak on behalf
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 1 of everyone. It would be nice to see the whole

 2 mosaic, but practically. LCH Group perspective,

 3 this -- we have a model analogous to this life in

 4 Europe today with clients clearing on every swap

 5 transaction. So from an infrastructure

 6 standpoint, we have it. If we say for clearing,

 7 we have to calculate gross. We can see collateral

 8 value. We can see the client IDs. So from our

 9 perspective, and we'll probably get onto the

 10 initial margin guarantee fund debate later,

 11 there's relatively no change. This is purely LCH

 12 Group, so we think it's something we could do

 13 relatively quickly.

 14 MS. AYOTTE-BRENNAN: From our

 15 perspective, I think that we have been working, as

 16 we said, with the FCMs and the DCOs to try and

 17 figure out, you know, the reconciliation process

 18 and make sure our backup is comfortable. But I

 19 think from our point of view, we can't finalize

 20 that process until we have the final rule and

 21 until models at the clearinghouse have stopped

 22 moving after the final rules are promulgated. So,
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 1 there is some lead time after the final rule when

 2 everything gets finalized by the DCOs and the FCMs

 3 and then flows down to the customer base so that

 4 we can finalize our tie-ins with those groups.

 5 MR. WASSERMAN: That kind of lead -- I

 6 mean, is six months --

 7 MS. AYOTTE-BRENNAN: No. We're

 8 thinking, as Bill I think said, you know, 18

 9 months to 2 years to get all the tie-ins and the

 10 customer work done, because as asset managers, we

 11 now have to go back to all the customers as well

 12 and get all of those documents done. So, it's

 13 kind of a dual track there where we have to do the

 14 lead-in work -- we have to do the tie-in work from

 15 the operational standpoint, but we also have to do

 16 the legal work once we know what the final rule

 17 is, how the margin will be calculated, so we can

 18 understand that and explain it to the customers so

 19 that they will know what of their portfolio is

 20 being held as collateral by the DCOs and what

 21 might be put at risk.

 22 MR. WASSERMAN: And so that's the
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 1 documentation, then, between you and your

 2 customers, which is somewhat separate from -- I

 3 think but tell me if you think I'm wrong -- this

 4 would essentially be the relationship between you

 5 or your customers and --

 6 MS. MEDERO: They're going to sign those

 7 agreements, the futures agreements with the

 8 addendum. So, it's -- don't think of it as just

 9 the IMA or the pure arrangements. Today they open

 10 the futures account. The client opens the futures

 11 account.

 12 MS. AYOTTE-BRENNAN: We as asset

 13 managers simply act as their agent. They are the

 14 principle on all of those contracts, so they need

 15 to understand what those contracts are and

 16 actually realize the liabilities or the

 17 obligations they have under those contracts.

 18 MR. THUM: And I think it's fair to say

 19 that while overall we see this as a fairly

 20 involved long process. I don't think that we make

 21 a distinction that it will be longer if it's LSOC

 22 or full physical segregation. Perhaps if the
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 1 futures model is used, we will have to have more

 2 engaged discussions with our clients about how

 3 their margin will be at risk in a way that it's

 4 not at risk in the bilateral world.

 5 MS. MEDERO: Right, so in fact those

 6 clients who signed ISDAs are now going to have to

 7 sign futures agreements.

 8 MR. THUM: Yeah.

 9 MS. MEDERO: And we'll have to explain

 10 what that means.

 11 MR. WASSERMAN: So, what I'm

 12 understanding is that is true regardless of

 13 whichever approach we take.

 14 MR. THUM: That's right.

 15 MR. DIPLAS: But I think you --

 16 MS. MEDERO: It's a cost of moving to

 17 the cleared world regardless of how it's done.

 18 MR. DIPLAS: You might have two

 19 different issues you're discussing here, I think,

 20 in the sense of the finality. There are also

 21 things fundamental for you to start your

 22 documentation process with the client, so I think
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 1 that's a given, and that is what I was saying

 2 initially. How quickly we can move the

 3 implementation of the legal segregation regime or

 4 not could be a separate issue. And I think that

 5 is the six-month part that you were referring to,

 6 which I think -- six months for the Commission is

 7 very low.

 8 MR. WASSERMAN: Yes.

 9 MR. DIPLAS: But for that kind of

 10 implementation, I don't have a final number, but

 11 it seems to live within the low side from the

 12 standpoint in terms of the work, the IT work that

 13 needs to take place between, like, FCMs and DCOs,

 14 the testing, et cetera, and also even the

 15 agreements that we might have to do in terms of

 16 consistency, of how these reports should look, and

 17 how the client IDs should be done, et cetera, so

 18 that we don't have -- each DCO have a different

 19 methodology in that respect. So, instinctively

 20 six months seems low from that perspective.

 21 MR. WASSERMAN: But what I'm hearing you

 22 say is six months may seem low, but not as low as
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 1 compared --

 2 MR. DIPLAS: I think the real

 3 constraining factor as I said in the beginning, is

 4 getting that final documentation with the clients.

 5 Even though some of the other work would be done

 6 earlier, at the end of the day they will not show

 7 up to clear unless they have it signed on the

 8 dotted line, and that's what is going to take the

 9 most of the time.

 10 MS. AYOTTE-BRENNAN: Right, but we also

 11 have IT work, right? So, the six months for your

 12 IT work may be okay, but then on our side once

 13 that IT work is done, we need to do our IT work to

 14 make sure it ties in with the FCMs and the DCOs

 15 and make sure that the calculations that come

 16 through we can reconcile the margin calls on

 17 behalf of our clients, because today when we get a

 18 margin call from a broker, from our swap dealer,

 19 we don't simply pass on the money; we reconcile

 20 that margin call to make sure we agree. And so we

 21 will need to build those new algorithms into our

 22 systems to make sure that we can reconcile those
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 1 amounts as well.

 2 MR. WASSERMAN: I'm not sure I

 3 understand that, simply because the amounts of

 4 margin may change and we're going to be discussing

 5 those kinds of concepts this afternoon. But the

 6 nature of the margin that your clients would be

 7 paying may change when you move from the uncleared

 8 world to the cleared world. But the nature would

 9 not vary based on how in the cleared world it's

 10 going to be protected unless one of you folks

 11 thinks I've got -- I'm seeing heads nodding. So

 12 the nature of that margin won't change, the amount

 13 we'll discuss, and so your IT work would be to

 14 make clearing work but not to make LSOC versus

 15 futures model versus -- yeah, those distinctions

 16 would not be affected.

 17 MS. AYOTTE-BRENNAN: Right, but what

 18 I've heard being said is that if we use LSOC, then

 19 we may have additional costs that may be put into

 20 the margin. And what I'm saying is that depending

 21 on what the final rule is and which model is

 22 chosen and how margin will be calculated, then we
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 1 will need to make sure our systems line up with

 2 how it is calculated so we can verify the amounts.

 3 MR. WASSERMAN: And let me make sure I'm

 4 not getting this wrong here. The amount of

 5 collateral required might change. The amount of

 6 fees that are imposed might change. But the

 7 nature of the two -- in other words, the margin is

 8 collateral, fees are fees. You may end up having

 9 more of either or both. But the nature of the two

 10 won't change. So, I think that's why, at least

 11 from where I'm sitting, I'm not understanding how

 12 that would require changes on your end. You know,

 13 again, to make clear -- to do clearing absolutely,

 14 but to do clearing where the collateral is

 15 protected one way versus another, I don't see that

 16 that would affect you from an IT perspective.

 17 MS. AYOTTE-BRENNAN: No, I agree. It's

 18 to implement clearing. It's just that if we don't

 19 have the final rules and see everything together,

 20 then we can't do all that work.

 21 MR. WASSERMAN: Absolutely.

 22 MR. MACFARLANE: Bob, if I could just
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 1 add a slightly different perspective. Tudor would

 2 not be subject to or restricted by the long lead

 3 time that some of the other buy-side firms have

 4 mentioned. We would, in most cases, be able to

 5 participate as soon as the DCOs have made products

 6 available for clearing. And, therefore, we would

 7 ask that in implementation that whatever

 8 guidelines are established would be implement by

 9 as opposed to implement when, meaning that firms

 10 should be allowed to clear when they are ready,

 11 when their FCMs, their DCOs and they are ready.

 12 Additionally, we would strongly recommend that

 13 implementation not be phased by institution type,

 14 but be phased by product type so that buy-side

 15 participants and dealers could implement at the

 16 same time.

 17 MR. DIPLAS: If I can comment on the

 18 other thing, in terms of the timing I think it's

 19 very important to remember that they also open

 20 client positions at the moment, so you need to be

 21 very careful that there's the one you will impose

 22 the mandate for the segregation to be in place.
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 1 Otherwise, you could be in the situation that

 2 current open positions might have to be closed

 3 down if the DCOs are not ready. If we said, just

 4 to give an example - if we said tomorrow we have

 5 to implement LSOC. Well, no, no, I'm exaggerating

 6 obviously. We don't have that. Therefore, these

 7 open positions would have to close down. And

 8 that's something that we need to basically make

 9 sure we work with you very appropriately. We

 10 haven't done all the operational work. That's why

 11 I was avoiding giving you a time whether it's six

 12 months or nine months or a year, and we need to do

 13 a lot of that with the DCOs and with all the

 14 market participants and give you that information

 15 before we can impose that mandate. As I said,

 16 with respect to the open position, with respect to

 17 John's point in terms of we -- do agree in terms

 18 of in general we want to make services available

 19 to whatever clients can use them. We do think,

 20 practical speaking, that the mandate for the

 21 dealers probably will have to go earlier than what

 22 happened to the rest of the clients just from the
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 1 standpoint that dealers are already clearing and

 2 from a systemic risk perspective it probably makes

 3 sense to capture that large source of systemic

 4 risk earlier rather than wait till the last client

 5 is ready to do so. That's the only difference.

 6 MR. MACFARLANE: Could you expand on

 7 that a little bit more? What's the rationale for

 8 sequencing dealers ahead of buy-side?

 9 MR. DIPLAS: Well, from the standpoint

 10 of time to capture the largest systemic risk

 11 contributors, there is an urgency of getting the

 12 dealers, which actually probably from an 80:20

 13 perspective are the largest systemic risk

 14 contributors. They are the ones, when they go

 15 under, I'm going to put them on the system that's

 16 stressed the most.

 17 From our perspective, commercially

 18 speaking, we have the incentive to get our clients

 19 up and running as soon as possible. That's what

 20 we -- these are the services we are trying to

 21 sell. But we are also mindful that not every

 22 single client can actually get there at the same
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 1 time, so that's why we won't have a system by

 2 which -- yes, we have a mandate on the dealers

 3 that will go in first. But from the clients who

 4 want to make the service available as quickly as

 5 we can for the clients that can actually afford to

 6 use the service and then have a mandate that

 7 actually takes into account the needs of probably

 8 the most economic resource constrained clients or

 9 the largest accounts set up.

 10 MR. MACFARLANE: I guess all Tudor would

 11 ask is that whenever the dealers begin to clear,

 12 that clients be offered that same service by the

 13 FCMs, and those that are ready to clear can clear;

 14 those that are not ready to clear presumably would

 15 be offered a wider window to comply by. But to

 16 sequence to allow the dealers to go in first could

 17 cause a distribution of the critical mass favoring

 18 one DCO over another and remove from the buy-side

 19 the choice of where their transactions would be

 20 cleared. So, we feel pretty strongly that --

 21 MR. WASSERMAN: And so with respect to

 22 when clients clear, that is a separate question
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 1 outside the scope of here today. I think, for

 2 various bankruptcy reasons, among others, we are

 3 constrained with regard to whatever is cleared the

 4 protection for clients would be the same, could

 5 not vary based -- you know, if the client is clear

 6 -- every client that is clearing would be treated,

 7 you know, through a particular FCM, would be

 8 treated the same. We'd have to do that. The sort

 9 of sequencing I think you're talking about deals

 10 with when folks have to bring things from the

 11 uncleared world to the cleared world.

 12 So, we've actually run a bit -- more

 13 than a bit overtime. A couple of things first.

 14 To the extent we've not had a chance to finish

 15 these things, and even to the extent that we have,

 16 it is very important and I very much encourage

 17 each of you and everyone out there to please put

 18 these matters in the written comments.

 19 We're going to break I guess for about

 20 12 minutes. I don't want to cut too much into our

 21 next panel. And so if we could reconvene for our

 22 second panel at 11:00. Again, restrooms down, end
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 1 of the hall.

 2 (Recess)

 3 * * * * *

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 1 MR. WASSERMAN: Ladies and gentlemen, if

 2 everyone can take their seats?

 3 Okay. We have two new panelists who've

 4 joined us, and I'll let them introduce themselves.

 5 Kevin?

 6 MR. FOLEY: Yes. I'm Kevin Foley from

 7 Katten Muchin Rosenman. I'm here on behalf of the

 8 FIA.

 9 MR. KAHN: Hi, Ray Kahn, Barclay's

 10 Capital, head of OTC clearing.

 11 MS. VEDBRAT: Supurna VedBrat, BlackRock

 12 global trading and market structure.

 13 MR. WASSERMAN: So this panel is on the

 14 various optional approaches that we identified in

 15 the -- well again, the proposed rulemaking. And

 16 so, the first question I'd like to get folks

 17 talking about is how they would see an optional

 18 model implemented. And ultimately, I think we

 19 need to sort of get a little bit into the weeds to

 20 understand what are the challenges that would have

 21 to be met to get from not the optional online

 22 only, in theory, but in implementation.
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 1 Is there anyone who would like to start?

 2 MR. FOLEY: Well, I will start. Let me

 3 emphasize that at the FIA, this is very much a

 4 project that we're just really at the start of.

 5 The firms have been -- although we've gone through

 6 the rules and are trying to understand them,

 7 there's no strong sense, I think, on the part of

 8 the firms that they understand all the

 9 implications of the words as they're written down.

 10 As you were saying, Bob, there are

 11 things that maybe -- that you intended -- that the

 12 staff intended one thing and it may not actually

 13 read that way to others. And so there are things

 14 that we are going to have to take time to truly

 15 understand.

 16 I do think from a bankruptcy point of

 17 view, we have an issue if we have an optional

 18 model that we need to kind of all sit down and

 19 really think through and make sure if -- is there

 20 one? And if there is one, how do we fix it if we

 21 can? And I -- when you say the optional model, I

 22 guess the first question is, is it optional on a
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 1 clearinghouse by clearinghouse basis? Or is --

 2 Kim mentioned earlier, can we allow certain

 3 customers who are prepared to pay a fee of some

 4 sort somehow to basically opt out of the customer

 5 seg requirements that we have and do something

 6 different.

 7 I think you had alluded when you were

 8 talking with Kim that it would be very difficult

 9 on a client by client basis to allow that to

 10 happen within the bankruptcy rules and the

 11 bankruptcy code in particular. And I think that's

 12 right, too. But as I said, we all need to kind of

 13 think -- spend more time on that.

 14 I think in terms of if it's a

 15 clearinghouse by clearinghouse issue, as was noted

 16 in the release, that might require each clearing

 17 firm -- if one firm wanted to clear three

 18 different clearinghouses, they would -- they might

 19 have to have three different FCMs each -- for each

 20 model -- a separate one for each model. And if

 21 you had the same customer who was clearing a CDS

 22 at the CME, interest rates at LCH, and energy at
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 1 ICE Clear, you would have the same customer at

 2 three different clearing firms. And that could be

 3 difficult.

 4 So, I think there are operational

 5 issues, legal issues that would make that

 6 difficult. But then again, we all need to spend

 7 more time on it.

 8 MR. WASSERMAN: And thank you for

 9 raising all of those issues. Given that you have,

 10 I think maybe we will take things a little bit out

 11 of order from the agenda perspective, and maybe it

 12 makes sense to first start talking about what the

 13 practicalities are for individual customer choice,

 14 if you will. And then depending upon where that

 15 goes, talk about some of the models that were more

 16 clearly discussed in the release, namely where

 17 there would be different models by DCO.

 18 And so, there was some issue raised as

 19 to individual customer choice. And here's the

 20 concern I have, and I think we expressed it in the

 21 release. Which is the bankruptcy code 766(h)

 22 requires that distribution of collateral be
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 1 ratable. And so, if we tried to say, well, okay.

 2 Some customers will have omnibus and they're

 3 subject to fellow customer risk. And other

 4 customers can pay a premium and they would not be

 5 subject to fellow customer risk.

 6 So the first question, I guess in my

 7 mind, is, but then how does that comport or how

 8 can you make it comport with the requirement of

 9 ratable distribution? And relatedly, don't you

 10 have the danger that the folks who earlier said,

 11 oh, I'm not concerned about fellow customer risk

 12 are going to be going to the bankruptcy court and

 13 saying, wait a minute. Sorry, 766(h) says I have

 14 to get the exact same treatment as these other

 15 folks. And so essentially, there ends up being

 16 legal uncertainty there.

 17 MR. MACFARLANE: Bob, in reply. If you

 18 have the flexibility in the rulemaking to

 19 accommodate both and institutions come to the same

 20 conclusion that you've pointed out and discerned

 21 out a risk, and they would lean towards LSOC,

 22 which would require presumably a lower level of
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 1 margin. However, if with time the industry is

 2 successful in modifying the bankruptcy code, would

 3 it not be to the advantage of the marketplace to

 4 then have a mechanism that would accommodate the

 5 full physical segregation if customers chose to

 6 pursue that?

 7 And I would just point out that you

 8 know, questions about the distribution of assets

 9 in bankruptcy have been dealt with fairly

 10 successfully historically by the industry. In the

 11 case of Repo in '84 post-Lombard law there was an

 12 amendment to the bankruptcy code. And similarly

 13 in the case of Swap Collateral amendment to the

 14 bankruptcy code. So, perhaps -- you know,

 15 providing the flexibility might give the clients

 16 both, you know, the opportunity to make their own

 17 -- come to their own legal conclusion and provide

 18 the flexibility if there was a subsequent change

 19 in the bankruptcy code to move to full physical

 20 segregation.

 21 MR. WINTER: I would say as it relates

 22 to the optionality, I don't think it's a question
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 1 of are you doing it by DCO? I think it's a

 2 question of between a client and its clearing

 3 broker. And that's where the optionality should

 4 be.

 5 Recognizing that at the end of the day,

 6 if you look at the clearing model today it's open

 7 spoke model. In the center of that, you have the

 8 DCOs. On the outside of that you've got the FCMs,

 9 and then the FCMs have the relationship with the

 10 clients. So I think that's the only way you can

 11 actually make that work.

 12 MR. WASSERMAN: And so, with respect to

 13 John's point, at least for the current rulemaking

 14 we've got to deal with the bankruptcy code that we

 15 currently have. If there is a change in the

 16 bankruptcy code, then one can reconsider things.

 17 The issue with respect -- given that

 18 what we're talking about is an insolvency,

 19 ultimately the FCM is going to be in a position

 20 where it doesn't have the ability to meet its

 21 obligations. And so then the question is, in

 22 terms of any distribution or in terms of any
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 1 transfer which, essentially, accomplishes a

 2 distribution otherwise -- given that there is a

 3 requirement of ratable distribution, my concern

 4 is, again, in the current bankruptcy code and

 5 until it changes, the concern is how can you --

 6 you know, even if the -- whether it's the FCM or

 7 the DCO or even our regulations say well, okay.

 8 These customers will be treated differently.

 9 Ultimately the question before the

 10 bankruptcy judge is, okay were those agreements --

 11 I mean, agreements are overturned in bankruptcy

 12 court every day. That's the nature of the

 13 exercise. And indeed, my fear would be that the

 14 judge would say, how nice, CFTC, that you have

 15 this rule. Unfortunately it does not comport with

 16 the code, and I'm enforcing the code.

 17 I mean, we have, indeed, a number of

 18 powers under the Commodity Exchange Act and under

 19 the bankruptcy code which protect things in ways

 20 that other creditors are not.

 21 MR. EDMONDS: So, Bob. Is it your

 22 interpretation that there's no way either through
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 1 rule set, documentation, or regulation that this

 2 agency controls? That ratable distribution by

 3 class could be put into place without that

 4 material change?

 5 I mean, we're going to be dealing with a

 6 lot of things that don't provide absolute

 7 certainty as we go through this. Hats off for,

 8 you know, the work that's been done to try to get

 9 to that point. But there's still some that we're

 10 betting them to come with us a little bit.

 11 But if it were clear -- and obviously,

 12 there are ratable distributions based on classes

 13 in bankruptcy a lot. Why would this be any

 14 different in that case if we wanted to provide a

 15 way for folks to either have it or not have it?

 16 And it included the documentation between FCMs and

 17 their customers, documentation between clearing --

 18 membership documentation between the DCOs and the

 19 clearing participants, and then codified in the

 20 rule set that this commission can control.

 21 MR. WASSERMAN: And so, we do -- you're

 22 correct. We do have, for instance, account
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 1 classes. And so right now we have separate

 2 classes for futures, for foreign futures. We've

 3 added, of course, just over a year ago a specific

 4 account class for cleared OTC.

 5 But all of these have followed, you

 6 know, ever since the late '80s -- and we sort of

 7 discussed this a little bit in the release. It's

 8 in the footnotes, but. Since the late '80s, all

 9 of these have been based on the type of the

 10 product. And indeed, they draw sustenance from

 11 some legislative history of the bankruptcy code

 12 saying that, well, you would have different

 13 estates based on the type of product.

 14 And so futures are a different product

 15 than swaps, and futures -- there's important

 16 differences product-wise from foreign futures. To

 17 then take the leap and say, well, okay. Each

 18 person his own account class. Or, customers who

 19 elect this are in a different account class from

 20 customers who don't. That, it seems to me, is a

 21 much further step than ever we've taken.

 22 And yes, some of -- well, I'm not sure I
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 1 agree that we're looking at that things are --

 2 we're sort of taking gambles in terms of the

 3 interpretation. My colleagues from OGC would be

 4 very upset with me if I agreed with that. And

 5 indeed, I think they're right that, essentially,

 6 we are trying to interpret the law as best we can.

 7 And I guess from where I'm sitting, I don't see

 8 how you can interpret ratable distribution and

 9 account classes to get there.

 10 I guess there would be a separate issue,

 11 which is -- so we start out saying, well, gosh.

 12 Customers can pay more and then they would get

 13 something better. And if there were an insurance

 14 company out there who is offering policies on

 15 fellow customer risk, then maybe we could get

 16 there. But I'm not aware that there is one, so

 17 then the implementation question I would be asking

 18 is, so the customer pays more, okay. Who are they

 19 paying it to? And how at the point at which you

 20 need the money does that translate into protection

 21 from fellow customer risk? In other words, if the

 22 customer is paying money to make someone else bear
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 1 the risk of loss, great. Who is that person and

 2 how are they going to do that?

 3 MR. DIPLAS: We tend to agree with your

 4 interpretation. I think our -- you know, we need

 5 to do a little bit more work. But our read of the

 6 current -- the code as it stands is that we

 7 probably need to offer these services out of

 8 different FCMs. We have to create different FCMs

 9 -- capitalize them separately to offer one

 10 segregation versus another, for the clients to

 11 feel comfortable that they will get the treatment

 12 they expect in bankruptcy.

 13 To continue some of your questions, you

 14 could say I could go -- if I'm a client, I could

 15 go with the -- you know, like a commingled model

 16 until three days before default, and the last two

 17 days convert to the fully segregated. And of

 18 course, everybody will do the same and there will

 19 be nobody on the other side.

 20 So, I just don't know how it operates.

 21 I think you probably need to create these kind of

 22 silos if you were to offer basically -- if you
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 1 were to offer --

 2 MS. TAYLOR: If you were to offer choice

 3 by clearinghouse --

 4 MR. DIPLAS: Choice by clearinghouse,

 5 yeah --

 6 MR. MACFARLANE: But Bob, what's the

 7 downside of offering both and allowing the

 8 individual market participants to make their own

 9 judgments about the bankruptcy code or the risks

 10 associated with one model versus another?

 11 Because if you don't offer both, then

 12 you really rob the opportunity to perhaps take

 13 some initiative with respect to the bankruptcy

 14 code or address that problem that full segregation

 15 may present in different ways. So, it would seem

 16 -- you know, you're not weakening the system. In

 17 fact, we would argue that you're strengthening the

 18 system. And we're concerned about the systemic

 19 consequences of omnibus model and the

 20 mutualization of risk that that creates. It

 21 really under-prices the distribution of credit in

 22 the system.
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 1 And so, there are other systemic reasons

 2 to think about the full segregation model and to

 3 try and work in a way to make it practical.

 4 MR. WASSERMAN: Again, unless we can be

 5 convinced that there's, you know -- if not legal

 6 certainty, at least some very, very strong legal

 7 arguments that would support the non-ratable

 8 distribution than to simply say, well here's a

 9 model out there. We don't think it's going to

 10 work, but hey. It might. I'm not sure that's

 11 something that would be responsible for us as a

 12 regulatory agency.

 13 Because I fear -- my experience has been

 14 when bankruptcies happen -- you know, before

 15 bankruptcy everyone says, well gosh, don't worry

 16 about those risks. We've got it covered. And we

 17 don't want to have to pay to avoid them. We'd

 18 much rather have this or that.

 19 Post the -- when the bankruptcy happens,

 20 then people forget all of that. And then the

 21 question is, well, gosh. Why didn't you set this

 22 up in an airtight fashion? And so, I think we
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 1 need to set it up in a fashion that we believe is

 2 reasonably airtight according to the law. And

 3 yes, if there is a change to the law that would

 4 make -- you know, then we could look at things

 5 differently.

 6 Although again, the question I still

 7 would have on the table is, okay, great. You're

 8 paying more. Who are you paying it to and how --

 9 who is bearing the risk? How is the client paying

 10 more convincing someone to bear the risk of that

 11 fellow customer loss? You know, how are you going

 12 to calculate it, how are you going to pay for it?

 13 You know, where are the arrows go from customer

 14 pays money to customer gets money back?

 15 MS. TAYLOR: Hey, Bob?

 16 MS. VEDBRAT: Bob, you know, when you

 17 mentioned paying more, are we making that

 18 reference from the baseline model? Because like,

 19 you know, the OTC market today for customers that

 20 have opted to, you know, engage in a tri-party

 21 agreement, they already have a cost associated

 22 with it. So it's more a transfer of that payment
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 1 into the cleared world.

 2 You know, the other piece is that, you

 3 know, our discussions with LCH has indicated that

 4 the LSOC model itself should not actually have any

 5 additional costs to clients.

 6 So, if we can just -- I mean, the costs

 7 -- my questions was more, is it, you know,

 8 additive to what an OTC client has selected today

 9 in a triparty? Or are we talking about like a

 10 wider audience here?

 11 MR. WASSERMAN: And I think you make an

 12 excellent point there, that there are costs

 13 already that are incurred today in the un-cleared

 14 markets that, in terms of the difference.

 15 But what I'm talking about here, I

 16 think, is if you're saying, look. Some clients

 17 will pay less and have less protection. Some

 18 clients will pay more -- in a cleared model. Some

 19 clients will pay less and have less protection.

 20 I think the theory of -- and Kim, you'll

 21 -- I'm going to give it back to you in a second.

 22 If what you're saying is, well, look. Some
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 1 clients would pay less and have less protection.

 2 Some clients would pay more and have more

 3 protection. My question would be, okay. Put

 4 aside for the moment how much more. How do you

 5 get from the client paying more to the client

 6 getting the protection? And what happens -- who

 7 is bearing the risk of loss?

 8 MS. TAYLOR: Who's bearing the risk of

 9 loss in a shift? Because both of these models are

 10 a shift. They're -- the LSOC model is a shift.

 11 The full physical protection is a shift.

 12 To the higher chance that there'll be a

 13 mutualization. And you can manage that, to some

 14 extent, with higher margins and with concentration

 15 margin. And you can do all of that. But

 16 ultimately, all of those things are an estimate of

 17 what you think the worst case loss would be. And

 18 the estimate could be wrong, and a clearinghouse

 19 would be irresponsible not to have enough

 20 resources available to be able to weather the

 21 default of its largest participants and its

 22 biggest loss at a time when the estimates were
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 1 wrong.

 2 So, all of these are a risk shift. So

 3 if it's -- I think you're trying to make it like a

 4 matter of fairness, like it's unfair that some

 5 people would pay more and get better protection.

 6 I think I would look at it a little bit

 7 differently -- and I'm kind of going back to

 8 Chris' question about account class. There is an

 9 account class for -- pretty sure there's an

 10 account class for deliveries. And deliveries --

 11 they are not different products than futures.

 12 They are customers who took the option of going

 13 into delivery, whereas other customers did not

 14 take the option of going into delivery. And

 15 there's a provision in the code now for those two

 16 sets of customers to be in different account

 17 classes.

 18 So, I don't really follow why there

 19 couldn't be a case where customers took the option

 20 of pooled segregation and customers took the

 21 option of individual segregation, and those could

 22 be also different account classes. I don't quite
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 1 follow the logic.

 2 MR. WASSERMAN: So, two things. Well,

 3 actually three. I'm really not talking about it

 4 in terms of fairness that -- well, this one paid

 5 more and this one paid less.

 6 The issue there is, you know, the

 7 ratable distribution requirement to the bankruptcy

 8 code and how you get around that.

 9 MS. TAYLOR: But it only goes to an

 10 account class.

 11 MR. WASSERMAN: And in terms of --

 12 MS. TAYLOR: Right?

 13 MR. WASSERMAN: Right. But and so in

 14 terms of making that a separate account class and

 15 the delivery account class, yes, indeed, delivery

 16 is a different account class. Of course,

 17 customers who are in delivery -- I guess I'm not

 18 sure that I would look at it as a different

 19 option. Rather, they're in a different stage of

 20 the contract.

 21 MS. TAYLOR: But they opted to go there,

 22 right? They took an option that other clients
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 1 didn't take in the same product set, and they

 2 ended up in a different account class.

 3 MR. EDMONDS: Still a conscious

 4 decision.

 5 MR. WASSERMAN: But customers make

 6 conscious decisions every day to maintain their --

 7 you know, by that same token customers make

 8 conscious decisions every day to maintain their

 9 positions. And so by that token, again we could

 10 have everyone their own account class. I'm not

 11 sure that that logic is legally strong in terms of

 12 saying, okay. This is a different product.

 13 Rather, again, the delivery is, I think, looked at

 14 more as a different stage in the process. And

 15 essentially, as long as you don't liquidate out

 16 earlier, that's where you are.

 17 MR. NICHOLAS: Bob, what I would say is

 18 -- I mean, it seems like as the gentleman from the

 19 buy side said, this is something of interest to

 20 customers. And if that's the case, then I think

 21 it should be looked at and pursued.

 22 That said, I'm not sure the timing is
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 1 right for the optional approach at the moment.

 2 Until, as you say, the legal certainty on the

 3 bankruptcy side is a little more well-established.

 4 And I would also maybe just add in that the --

 5 just the complexity right now. The whole mosaic

 6 of the changes. It adds yet another layer of

 7 complexity.

 8 I think one case which is a little bit

 9 illustrative is the case of single stock futures.

 10 I think in that situation, clients do have a

 11 choice, I believe, in terms of whether they want a

 12 securities protection or futures protection, which

 13 are clearly different bankruptcy regimes. But I

 14 think maybe the difference there is that there is

 15 some certain -- there is certainty. I mean,

 16 they're different but you know what you're going

 17 to get. Whereas I think in this context, as you

 18 said, you don't really know what you're going to

 19 get.

 20 Ultimately, you know, it may be that

 21 people have to go back to Capitol Hill and hash

 22 this out and have something developed in the
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 1 bankruptcy code to provide that certainty. And at

 2 that point, then I think, you know, it is

 3 something that should be looked at.

 4 MR. KAHN: I'd like to add in the

 5 concept of optionality, there's a set of clients

 6 that we've been speaking to that have said, we

 7 really -- we don't have optionality.

 8 Our clients expect us to have the

 9 highest level of protection. So even if we would

 10 like to stay at the -- you know, the lower level

 11 for return basis or cost basis, they don't have

 12 the optionality. They have to choose under their

 13 charter or bylaw. And they have stated as a

 14 concern that, you know, what we've been talking

 15 about is some sort of free riding, you know, that

 16 as a stronger credit or as a pension fund or

 17 something like that that they are allowing others

 18 to not select into the highest level of

 19 protection. And that has been expressed to us.

 20 MR. THUM: Well I think as well,

 21 assuming there could be separate account classes

 22 set up or separate customer account classes set
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 1 up, and assuming people could make a choice, at

 2 the end of the day the DCO has to establish margin

 3 levels that will meet the risk presented in each

 4 bucket. So, for the bucket that is the LSOC

 5 model, presumably the margin levels would be

 6 higher. Perhaps the guarantee fund might be

 7 higher, things like that. In the futures model,

 8 the margin levels presumably would be less.

 9 But I think that one thing that we have

 10 to consider -- and I think it's brought out in the

 11 release -- it's been mentioned by LCH, it was

 12 mentioned by Athanassios -- is, in that bucket --

 13 in the futures bucket, will clients stay in that

 14 bucket as the FCM starts to weaken?

 15 Clearly, the clients can assess their

 16 fellow customer risk. They don't -- other than

 17 understanding how the FCM makes its client

 18 decisions. They cannot assess the fellow customer

 19 risk. But they can assess the FCM itself. And

 20 while -- if the assumption is that we're setting

 21 lower margin levels because we have access to the

 22 overall pot of collateral. But then the overall
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 1 pot of collateral is diminished, how is that a

 2 sustainable model?

 3 Vanguard, of course, will opt into the

 4 LSOC model if it is a choice. If it is not a

 5 choice, for many on the buy side it will involve a

 6 much more engaged discussion. If there is a

 7 choice, it will be a much more engaged discussion

 8 with clients to explain the risks. And we'll have

 9 much greater disclosure, I would think,

 10 obligations. But Vanguard and for Vanguard funds,

 11 would definitely pick the LSOC model.

 12 But I think, you know, once you get past

 13 can we set it up so that it works or a bankruptcy

 14 co-perspective, and will clients make that choice,

 15 is it an actual sustainable choice that will

 16 protect both buckets?

 17 MR. MAGUIRE: Bob --

 18 MR. COCCO: Bob, it's Alessandro Cocco.

 19 I just wanted to say that I think that the

 20 bankruptcy law issues, of course, need to be

 21 resolved. And the question of optionality is

 22 linked to the question of the timing that we had
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 1 in the previous session.

 2 So, I think from a timing point of view

 3 there is a difference between the various models

 4 being proposed and the futures model. Because in

 5 the futures model, I think from what I hear from

 6 my colleagues in operations, it would be easier to

 7 just implement what we already do for futures.

 8 LSOC would present some differences, so

 9 even though we're still assessing them they're

 10 probably of an order of magnitude that can be

 11 dealt with. But they're more than zero. LSOC

 12 with optionality would require wealth -- from a

 13 personal point of view, I think it is a very

 14 attractive idea. Whenever I check with operations

 15 and we are doing the work to double check this, it

 16 would be requiring a significant amount of work

 17 because now you need to track who opted in and who

 18 opted out. And then to, finally, the full

 19 operational segregation model from a timing point

 20 of view would require a lot of work.

 21 And so, I think that we -- again, we are

 22 doing the work to come up with more precise
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 1 estimations. And we will either directly or

 2 through the trade associations file our comments.

 3 But you know, finalizing the comments on the

 4 timing period. I think that anything under one

 5 year would be extremely problematic for us.

 6 MR. MAGUIRE: Bob, I think just to frame

 7 this. Are we trying to make this operationally

 8 easier? Are we trying to make this better risk

 9 protection? Because a lot of it's about

 10 implementation.

 11 I think introducing the cost and the

 12 margin is relatively motive, because we're going

 13 to talk about that later. And there are different

 14 views from different DCOs on this. I think what

 15 we're talking about is protecting those who chose

 16 LSOC versus those who chose the -- if you're the

 17 futures model. And how can we bifurcate those two

 18 from each other under the bankruptcy code?

 19 The cost and margin will come onto, and

 20 hopefully explain in greater detail later. But

 21 the only way we can really see this can actually

 22 work is if you have one customer type, if you will
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 1 -- the LSOC going through -- an FCM. And then,

 2 the other -- the omni going through another FCM at

 3 the overall same firm.

 4 Now, I'll let the FCMs comment on what

 5 that means for them, because I'm sure that's quite

 6 an overhead encompassing undertaking. But the

 7 only real way to do that is through account class,

 8 go up a level and do it at the entity level. So

 9 you have two separate FCMs so they all, if you

 10 will, divorce from each other. So you could have

 11 a LSOC FCM with the OTC class and you could have

 12 an omni OTC class FCM as well. And therefore,

 13 those two things should be potentially divorced

 14 from each other or bifurcated.

 15 MS. VEDBRAT: I think also, Bob, you

 16 know the selection of FCM is also dependent on the

 17 optional model that might be presented. Because

 18 if it's an omnibus structure, you may -- we may

 19 request for an FCM to provide a parent guarantee

 20 of some sort. Or like, we may want to deal with

 21 an FCM where there's -- you have a known pool of

 22 clients.
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 1 So, that needs to be considered.

 2 MR. WASSERMAN: And so to be clear, the

 3 proposal mentioned as one optional model.

 4 Essentially, yeah. Splitting the FCMs. That is

 5 to say, so I don't think it would be practical

 6 under this to say, have an FCM deal with one DCO

 7 that, let's say, does the futures model, and

 8 another that does the LSOC model. Because if the

 9 default happened with the FCM that did the futures

 10 model, then the customers who thought they had

 11 maybe only dealing with the other DCO -- which has

 12 the LSOC model but under a ratable distribution

 13 they would be very surprised and disappointed to

 14 see that it is, in fact, ratable.

 15 So, the proposal -- and I want to, in a

 16 few moments, get to --

 17 MS. TAYLOR: You're going to mix account

 18 classes now across FCMs?

 19 MR. WASSERMAN: To be clear -- okay,

 20 forgive me. If you have two separate FCMs --

 21 well, if you have one FCM and they're dealing with

 22 two different models, my point is that does not
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 1 work because if the FCM becomes insolvent and if

 2 the insolvency is caused by a loss at the DCO that

 3 undertakes the futures model, then ratable

 4 distribution would mean that customers -- even

 5 customers who are only dealing with products that

 6 are cleared at another DCO that does the LSOC

 7 model, they would still be suffering losses. And

 8 that would -- so that is impracticable. That does

 9 not work.

 10 MS. TAYLOR: Without a separate account

 11 class.

 12 MR. FRANKEL: Well, the futures model

 13 being the baseline model for cleared swaps.

 14 MR. WASSERMAN: Yeah, the pure omni.

 15 MR. FRANKEL: Yeah.

 16 MR. WASSERMAN: And yes, unless the

 17 account class were to work -- and as I say, at

 18 least my legal analysis and, you know, very much

 19 invite comments with a detailed legal analysis as

 20 to why the account class would work. But for the

 21 moment, I guess I'm thinking that the account

 22 class does not.
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 1 What the proposal was -- and I was

 2 instructed, okay. But try and come -- you know,

 3 can we do -- what room for optionality is there?

 4 And so, if you said, well, look. Each FCM has to

 5 be uniform, homogeneous. They only deal with DCOs

 6 that all do the same model. So you can have one

 7 FCM that deals with DCOs that do the LSOC model,

 8 and a separate FCM that deals with DCOs that use

 9 the futures model. And again, you know, they

 10 would be -- they could be affiliates. But they're

 11 separate legal entities.

 12 Then, the distribution from the one

 13 doing the futures model would proceed in

 14 accordance with that, and all the customers there

 15 would get that kind of distribution. And the

 16 distribution from the FCM doing the LSOC model

 17 would proceed in accordance with that model. That

 18 is mentioned and questions are asked in the

 19 release. That is a place where the Commission

 20 could go.

 21 And so the question here is, if we went

 22 down that path what are the implementation issues?
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 1 What are the practicalities?

 2 MR. NICHOLAS: One question on that

 3 through, Bob, is -- maybe I'm misunderstanding.

 4 But isn't part of Dodd- Frank gives the customer

 5 the ability to elect which DCO to go to? And how

 6 would that -- if they elect to go to one that

 7 doesn't have the protection that that FCM wants to

 8 -- it provides?

 9 MR. WASSERMAN: And so, I'm not sure

 10 that the -- I mean, if an FCM. So, you know, put

 11 this issue aside. Answering your question.

 12 If an FCM clears, let's say, at CME and

 13 ICE but does not -- is not a member of LCH. And I

 14 as a customer come to that FCM and say, well you

 15 know, I want my swaps cleared at LCH. I don't

 16 think they would have to say, well gosh, okay. We

 17 better get that clearing.

 18 My colleagues may disagree -- and don't

 19 hold me to this -- but I think there would be some

 20 practical issues with forcing an FCM to go to a

 21 DCO and become a member. Let alone the DCO may

 22 look at the FCM and say, sorry. And again,
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 1 separate issues there. I really don't want to get

 2 into the open access issues.

 3 But in any event. So, if you then said,

 4 okay, instead of saying well, sorry. I don't

 5 clear with that DCO, the answer might be, well,

 6 yes. But my affiliate does. So I don't think

 7 that's a practical barrier to implementing things

 8 this way.

 9 MR. NICHOLAS: But that's assuming

 10 there's an affiliate. I mean, not all FCMs are

 11 going to be able to have multiple affiliates.

 12 MR. WASSERMAN: Yeah. And well to be

 13 clear, that's one of the questions I'm asking.

 14 MR. NICHOLAS: Right.

 15 MR. WASSERMAN: What are the

 16 practicalities if we tell the FCM, look. Right

 17 now you're one entity, one capital pool. You

 18 know, one form 1-FR. If you want to proceed on

 19 because different DCOs are adopting different

 20 models, you're going to have to sort of hive off

 21 and have separate FCM. Is that practical? I

 22 mean, there are some folks who have told me yes,
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 1 and there's some folks who have different views.

 2 And I'd like to hear what folks around the table

 3 here think.

 4 MR. NICHOLAS: I mean, just real

 5 quickly. I mean, I would say it could present

 6 capital resource issues. You know, FCMs don't

 7 have necessarily unlimited amount of capital. And

 8 now you're splitting it in half. Resource and

 9 staffing issues also come into play.

 10 MR. MACFARLANE: But why wouldn't we let

 11 the market decide? I mean, if some FCMs decided

 12 to bifurcate and offered to FCMs one which

 13 integrates with DCOs providing baseline, and the

 14 other one that provides LSOC and let them, the

 15 clients, decide which they choose. And you as

 16 FCMs can compete with one another. Some of you

 17 may chose a monoline structure, some of you may

 18 choose based on your survey of your clients a

 19 bifurcated structure.

 20 MR. COX: I mean, I think if you want to

 21 go down this road, presumably what you're saying

 22 is that each DCO would actually have to offer both
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 1 approaches to fellow customer risk and then FCMs

 2 would decide which they were going to offer. And

 3 there would be some banks would have two FCMs, one

 4 for one kind of margining and one for the other.

 5 Which, I mean, it's not unusual, right?

 6 A lot of banks used to have these triple-A

 7 entities for doing -- you know, over the counter

 8 bilateral swaps. If you wanted to do a swap at

 9 Bear Stearns, you could trade with Bear Stearns

 10 single-A or you could trade with Bear Stearns

 11 whatever it was, triple-A thing. And there was a

 12 different price for dealing with Bear Stearns

 13 triple-A. I don't know if any of those still

 14 exist, but it's not really a new concept.

 15 MR. WINTER: Bob, I'd like to go back to

 16 a comment that you made, though. And you can't

 17 separate out the issue of the open access.

 18 Because if you start separating FCMs into more

 19 than one, they're going to have different capital

 20 structures. And then what's going to happen when,

 21 you know -- particularly if one of those entities

 22 doesn't have a trillion dollar open book to be a
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 1 clearing member of LCH? Then they can't compete

 2 in that market. So that creates problems.

 3 So, you can't separate the two issues.

 4 MR. WASSERMAN: So what I understand you

 5 to be saying is essentially because you're

 6 separating them out, essentially now you have two

 7 capital pools, it makes it that much more

 8 difficult for clearinghouses, then, to accept

 9 these now smaller FCMs.

 10 MR. WINTER: That's one of the side

 11 effects that can come out of that. That's

 12 correct.

 13 MR. DIPLAS: But I think this is --

 14 we're making the assumption that this is past the

 15 finalization of the rules to respect the

 16 membership requirements and all that stuff. So

 17 we're going to know what the barrier is.

 18 I think your point before was valid, in

 19 the sense that if a client comes to me and says, I

 20 want to clear at LCH but I'm not a member at LCH.

 21 Well, I'm not available for that. I can become a

 22 member, and this is not going to be any different.
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 1 I think the part we agreed is that we think we

 2 would need multiple FCMs.

 3 So, there is a capital constraint there,

 4 I would agree with John's point. That it's not

 5 necessarily the most efficient. But I think that

 6 would be the facts that we're going to face at

 7 that point.

 8 There might be 10 FCMs here and 6 FCMS

 9 there, or -- and so, clients might have fewer FCMs

 10 available than the total net that is available

 11 now. But that would be the choice, I guess.

 12 MR. KAHN: I think you have the issue of

 13 capital efficiency is important. But you also

 14 have the issue of resource efficiency, basically

 15 at a time when the industry is trying to get

 16 clearing to go live. So the question is, how many

 17 resources can each FCM, DCO put aside to basically

 18 establish this two or more FCM structure?

 19 And then the other question is, how many

 20 buy side clients are going to use it? Are we

 21 going to establish something that then is only

 22 used by a very -- one or the two is going to be
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 1 established by a very small percentage of the

 2 industry. And was it worthy of basically taking

 3 those resources and dividing them? And also,

 4 whatever costs there are -- which I obviously am

 5 not prepared to speak to. But it's an issue of

 6 timeliness to market, and along with capital

 7 efficiency.

 8 MR. MACFARLANE: We have to be careful,

 9 and I think Chris -- rather, Dan said it well.

 10 That we're not overly expeditious and trying to

 11 optimize or minimize cost as it relates to

 12 collateral and operational cost. Because that may

 13 drive us to a conclusion that systemically puts --

 14 makes the system more vulnerable.

 15 And an example would be, if we

 16 systemically under collateralize, we choose an

 17 omnibus model because it results in the lowest

 18 amount of collateral. Then, you inevitably are

 19 going to -- there would be a misdistribution of

 20 risk because you're asking counterparties to put

 21 up less collateral than they would otherwise have

 22 to put up if they were margined individually,
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 1 because they're being co- insured by the others in

 2 the omnibus pool.

 3 And if we do that, inevitably there will

 4 be an institution that will take all of that --

 5 all of that runway that's given them to take risk,

 6 and over lever. And putting the system more at

 7 risk. So, we shouldn't be afraid to properly

 8 collateralize on a stand-alone basis transactions.

 9 Because that's how you're going to properly

 10 allocate risk within the system.

 11 MS. VEDBRAT: And I think we also have

 12 to consider, I mean, the small set of -- there are

 13 a small set of clients that do require

 14 segregation. So, you know, as we move to the

 15 cleared role we cannot, like, take a solution

 16 where we basically eliminate them out of the

 17 market.

 18 MR. DIPLAS: No, I think we all agree on

 19 that. I think perhaps Ray's comment was -- if I

 20 give you an example. Let's say there are 20 FCMs

 21 now. And if, for argument's sake, 18 of them

 22 decide to go with model 1 and only 2 with model 2
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 1 and 1. There is a situation that clients might

 2 end up only having a choice of two FCMs in that

 3 case, if they want to chose model two. So there

 4 is a bit of an issue in terms of whether -- yes,

 5 they try to make this investment decision and

 6 trying to be there, you know, on time as to how

 7 many of them would be able to offer both services

 8 at the same time. It's going to be a question of

 9 -- there's going to be some guessing in terms of

 10 how many clients will actually chose model one

 11 versus model two.

 12 MR. SZYCHER: Well, on that particular

 13 instance, seemingly model two is not something

 14 that's being supported by the marketplace and will

 15 probably simply fade to black.

 16 Just, I guess, kind of a quick comment,

 17 you know, with respect to what Ray had mentioned.

 18 You know, of setting up, you know, multiple legal

 19 entities. I realize there are, you know, capital

 20 considerations. But as far as operational

 21 personnel, I don't think anyone's suggesting here

 22 that we've got, you know, a distinct set of people
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 1 who are working for, you know, FCM A and, you

 2 know, the two versions of, you know, let's say

 3 Barclay's FCM. You know, as you know, all your

 4 banks have, you know, literally hundreds of legal

 5 entities that are set up. And generally speaking,

 6 we're all working for, you know, a multitude of

 7 those at any given time. So I'm not sure the

 8 challenges of those are necessarily as -- that

 9 hurdle is insurmountable.

 10 MR. COX: Of course, in that example

 11 your choice of two FCMs is still better than a

 12 choice of none, which is what you'd have if no one

 13 offered choice number two.

 14 MR. EDMONDS: Bob, I want to go back to

 15 what I think I heard you say a little bit earlier.

 16 You said the Commission could go one direction

 17 where you could choose to have the option or some

 18 option around the LSOC piece. If you could get to

 19 that point, why couldn't you also have optionality

 20 around a more complete segregation model? And

 21 have that same separation. Did I misunderstand

 22 what you said?
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 1 MR. WASSERMAN: Yeah, I think what I was

 2 talking about is that -- and we may disagree.

 3 And, you know, I really look forward to the

 4 analysis and the comments on the legal issue of

 5 having it by the customer. But if you do it,

 6 then, now by DCO, I think the question then is not

 7 simply a practicality of, well -- so even if one

 8 DCO says, well, fine. We'll offer complete legal

 9 segregation.

 10 I was less -- the concern here is if you

 11 do this by DCO where each DCO is dealing -- or

 12 rather, each FCM is dealing with DCOs that are

 13 uniform based on model. And yes, that model could

 14 be full physical segregation. Although again, I'm

 15 not sure that helps given that you've got this

 16 ratable requirement.

 17 But what a number of folks seem to be

 18 raising is, in order to have, then, right now one

 19 FCM can deal with all clearing organizations. You

 20 know? So long as the clearing organization will

 21 accept them, they've got the operational

 22 infrastructure. A particular legal entity can
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 1 deal with all clearing organizations.

 2 Under this approach, you would only --

 3 you couldn't have -- if different clearing

 4 organizations adopted different models, then the

 5 FCM would have to split off so that it would have

 6 one affiliate that deals with those clearing

 7 organizations that, if any there be, that adopt

 8 the LSOC. One affiliate that deals with those

 9 clearing organizations, if any there be, that do

 10 full physical segregation. One affiliate that

 11 deals with those clearing organizations that do

 12 the futures model.

 13 And so, that kind of splitting off, I

 14 suspect and what a number of folks seem to be

 15 suggesting is, there are some disadvantages there.

 16 There's some concerns in terms of the practicality

 17 because you're taking what was one entity and one

 18 capital pool and splitting up the capital pool

 19 into smaller pieces.

 20 MS. VEDBRAT: Bob, on the DCO side. You

 21 know, I think, you know, we'd have some concern if

 22 you were to have DCOs that opted, you know, one
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 1 model or another. Because that's going to impact

 2 liquidity on the front end. And that -- you know,

 3 that we would like that to be a consideration.

 4 MR. WASSERMAN: Fair point. Let me ask

 5 -- just focusing on the DCOs. Because I don't

 6 want to presume what folks are going to do. What

 7 criteria would you rely on to choose a segregation

 8 model? And how would that decision be based --

 9 you know, if at all -- on choices made by other

 10 DCOs?

 11 MR. EDMONDS: I mean, I -- from our

 12 perspective it's going to be risk-based, right?

 13 It's going to be our evaluation of the risk

 14 associated with that model that may or may not be

 15 prescribed in the rules. I mean, you're giving us

 16 a hypothetical that there may be some menu of

 17 choices that we could take, and we'd do that on a

 18 risk- adjusted basis, full-stop. And then, you

 19 know, after that risk evaluation is done, what can

 20 we do to commercialize that for our shareholders?

 21 MS. TAYLOR: I mean, I think in our case

 22 it would also be a risk-based evaluation. Based
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 1 on setting the right balance between customer

 2 protection on the one hand and systemic risk

 3 containment on the other hand. And I define that

 4 as the ability to stop the default of one clearing

 5 member to bleed through and adversely affect the

 6 other clearing members. That's a very important

 7 element of what clearinghouses do and the way the

 8 customer protection mechanism is set up. And the

 9 risk management protections you put around that

 10 affect that.

 11 As -- and you know, I think I made

 12 myself pretty clear in the beginning here that the

 13 legal certainty around how things are going to

 14 work at the very worst point in time is going to

 15 be a very important part of that. Clearinghouses

 16 do not have the luxury of waiting to find out if

 17 they're going to get paid. And so, our timelines

 18 are very tight. We issue instructions and get

 19 paid within an hour. And if someone doesn't pay

 20 us, there is a default. And that needs to be

 21 acted upon, because if it is not acted upon we are

 22 creating undue and potentially unnecessary risk
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 1 that is going to be imposed on the other clearing

 2 members who are meeting their obligations.

 3 So, that's -- it's finding the right

 4 balance between serving the customer protection

 5 requirements -- and we are very sensitive to the

 6 customers getting protection that they feel is

 7 valuable to them. But also, balancing the

 8 systemic risk containment.

 9 MS. AYOTTE-BRENNAN: Bob, I think from

 10 an asset manager's point of view -- sorry.

 11 MR. WASSERMAN: We'll be coming to you

 12 guys in a second. But if we could let Dan --

 13 MR. MAGUIRE: Okay, I'll be brief.

 14 Risk-based and default management practicality

 15 would be priority. But you know, moving down it

 16 would be also customer demand. And their clearing

 17 member's ability to be able to offer these

 18 services. And then, let the market decide, you

 19 know? We are not averse to offering growth only

 20 LSOC and other account classes, if they're

 21 allowed, or other account styles. But it won't be

 22 necessarily what the other DCOs are doing. It's
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 1 more for what the clients are choosing and the

 2 clear members can offer.

 3 MR. WASSERMAN: Let me talk, then -- as

 4 a question, then, for the clients and the firms.

 5 And basically, if the DCOs are allowed to chose,

 6 do you anticipate that there would be different

 7 models chosen? And if different DCOs make those

 8 different choices, what do you see as the factor

 9 in your ability to chose a clearing model?

 10 MS. AYOTTE-BRENNAN: I think from, you

 11 know, the asset manager's point of view, it gets

 12 back to something that you said. That you know,

 13 just implementing two options -- two or more

 14 options without knowing for certain or as certain

 15 as you can be that it would work under the

 16 bankruptcy code would not benefit us.

 17 And the reason why I say that is, going

 18 back to what Ray was talking about, that you have

 19 certain clients who are going to say you need to

 20 take the safest option. And if we take that

 21 safest option, what we think the safest option is

 22 and we're paying more for that and then it turns
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 1 out it's not the safest option, they end up where

 2 the same people who chose the least-safest option

 3 and paid less are. Then, we're not in a good

 4 spot.

 5 MS. BREGASI: And I think - sorry. I

 6 guess our concern would be that even if we get to

 7 a spot where we actually from a bankruptcy

 8 perspective, we are sure that it actually will

 9 work. So if you pay more and you choose one

 10 model, it actually -- in bankruptcy, it will turn

 11 out to be that way.

 12 Our other concern is whether the

 13 optionality will really be offered. So, one

 14 question would be, would the DCOs really pick

 15 something other than the futures model, which they

 16 are comfortable with today? And they understand

 17 how it works and the timelines that it works

 18 under. So it's one issue.

 19 The second issue is, what about the

 20 FCMs? And what will be the real cost of the

 21 optionality? Because if you require LSOC from day

 22 one or full physical segregation for everyone, it
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 1 seems to me that the FCMs and the DCOs have an

 2 incentive to make those work in the best and most

 3 efficient manner.

 4 If you allow optionality, is there

 5 really an incentive to make it efficient? Or will

 6 they just make the costs of the model that's

 7 harder for them and more expensive for them so

 8 expensive for the clients that, in fact, there is

 9 no optionality? And if you divide between two

 10 different FCMs and now you have less FCMs and less

 11 clearinghouses where you have the choice of LSOC

 12 or full physical segregation if that's what you

 13 want, then do you really have an option?

 14 Because certain -- for example, interest

 15 rate swaps or another swap in the future might

 16 only be cleared at one clearinghouse. And maybe

 17 they don't offer LSOC or full physical

 18 segregation, they only offer futures model. So

 19 where is really -- do we really have an option?

 20 And how much are we really paying for it?

 21 MR. THUM: I wanted to go back to

 22 something that Kim mentioned. Which was the
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 1 obligation of the DCO to protect the solvent FCMs

 2 from the risk bleeding over from the insolvent

 3 FCM. And if you had an FCM that opted into the

 4 futures model and other FCMs that were in the LSOC

 5 model, would there have to be some sort of limit

 6 on portability in the futures model so that

 7 clients didn't leave? Because if the bulk of the

 8 clients left, then there would not be that omnibus

 9 account.

 10 MS. TAYLOR: But actually, there was

 11 quite a lot of talk in the documents and quite a

 12 lot of talk today about the downside of the

 13 clients leaving the FCM that is deteriorating.

 14 And I was very surprised by that, because that is

 15 exactly one of the risk management benefits that

 16 the industry has, is that clients have an

 17 incentive to want to move if their FCM is

 18 deteriorating.

 19 So you absolutely want people to be

 20 moving their accounts if the FCM is deteriorating.

 21 And that is something that when they go -- if they

 22 take their collateral, they're taking their
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 1 positions, too. And monitoring the exposure that

 2 we're facing from each FCM is something that we're

 3 doing on an ongoing basis. So, it adapts very

 4 quickly to changes in the exposure profile that

 5 the FCM faces.

 6 But that's one of the concerns that I

 7 have about a model. And we will provide a model

 8 that provides the kind of safety and soundness

 9 that is desired by the customers and allowed by

 10 the regs. And we can make it safe, from a

 11 bankruptcy point of view. So we're open to

 12 providing the type of protection that you folks

 13 feel that you need.

 14 But I think that there's a very

 15 important thing that's being missed here as I sat

 16 here and listened to all of you talk about the

 17 fact that if we had all these, you know, multiple

 18 FCMs spawning off to support different options.

 19 And the capital is going to get fragmented, and

 20 those are going to be less-worthy counterparties

 21 just by definition because the firms are going to

 22 devote X amount of capital to this cleared
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 1 business. And if they have to divide it between

 2 three FCMs, they'll divide it. Right?

 3 So, there's going to be a weakening,

 4 then, of the counterparties that you face. And

 5 nobody seemed concerned about that. And that's

 6 one of the concerns that I have about moving from

 7 a model that provides an incentive for the clients

 8 to care about the credit worthiness of the

 9 clearing members. I really think that is a part

 10 of the bedrock that has made the futures industry

 11 very safe over a very long period of time.

 12 Yes, there is an omnibus customer

 13 protection model. Yes, theoretically you are all

 14 exposed every day to fellow customer risk. But

 15 there are so many protections in the system to

 16 prevent that from ever becoming a reality that it

 17 has a very good track record of being very

 18 successful over a long period of time through

 19 extreme crisis situations. In fact, it has been

 20 so successful that the government decided it

 21 needed to be the model that was applied to other

 22 markets where the safety mechanisms were not as
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 1 successful. And now, we're in a place where we're

 2 going to be adding in a bunch of new business and

 3 a bunch of new exposure to the cleared model and

 4 taking out the bedrock safety and soundness

 5 mechanisms that have underpinned it.

 6 So, the whole aspect of moving all the

 7 new products into clearing while at the same time

 8 gutting the protection mechanisms that are in

 9 place and replacing them with others that we

 10 presume will work is something that I think we

 11 need to really consider very carefully. And

 12 listening to you all talk about not caring about

 13 the -- kind of the deterioration and quality of

 14 your counterparties, this is a little bit of a

 15 concern for me.

 16 MS. VEDBRAT: Can this now -- there's no

 17 known trigger that tells us that we have a

 18 deteriorating FCM or that we're exposed to an

 19 increase in fellow customer risk. In the

 20 government model, you know, other than being aware

 21 of your counterparty from, you know, your normal

 22 risk practices, there's no -- within the model
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 1 itself, there's no trigger that would allow us to

 2 know that there is a fellow customer risk that

 3 might have increased.

 4 MR. COX: I'd also like to challenge --

 5 MS. TAYLOR: But your fellow customer

 6 risk really only applies when your clearing

 7 members is also weak, right?

 8 MR. VEDBRAT: I know, I know.

 9 MS. TAYLOR: So, you definitely can see

 10 if your clearing member is weakening. And you can

 11 definitely trigger -- you can trigger yourself to

 12 have a counterparty discussion and decide if that

 13 is still the right counterparty for you and ask

 14 your clearing member some questions about, you

 15 know, their practices and their risk management.

 16 I realize it's not perfect.

 17 MS. VEDBRAT: Yeah, no. I think if --

 18 MS. TAYLOR: And obviously, you have

 19 said as a group that it is not the kind of

 20 protection that you want. And so, the industry

 21 will find another way to provide you with the

 22 protection that you want.
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 1 I guess I'm just putting it out there

 2 that I would encourage you to be thoughtful and

 3 careful about what you ask for. Because what you

 4 have had has theoretical risks. But it has

 5 absolutely performed. It's the only thing that

 6 did perform in the credit crisis. To such an

 7 extent that it has become the mechanism that

 8 everybody wanted to use to protect the world from

 9 future crises. And now we're in the process of

 10 changing it in ways that might have unintended

 11 consequences, because we're doing it very quickly.

 12 MS. VEDBRAT: I think, Kim, but there's

 13 also this piece that, you know, the OTC market is

 14 very different from the futures market. And we do

 15 need to take that into account as we are looking

 16 at the futures model for OTC.

 17 MS. TAYLOR: And it will be -- and it is

 18 very different. And it will remain different for

 19 a while. But I think over time, it will become

 20 less different.

 21 MS. VEDBRAT: But if you were just to

 22 take size and tenor of the OTC market versus
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 1 futures. That in itself would say that we do need

 2 to look at the model and see if we're comfortable

 3 with the risk as it stands today in futures.

 4 I think most of us here have been

 5 talking on behalf of the swap market moving into

 6 this model, and have not really said, you know,

 7 much on the futures model itself for futures.

 8 MR. WASSERMAN: Okay, and let's let --

 9 MR. COX: Yeah, I just wanted to make a

 10 couple of comments. First is, this issue of

 11 fragmenting capital. If you have one FCM with a

 12 billion dollars of capital, and you now split it

 13 into two with half a billion in each and half the

 14 customers go in one, half the customers go with

 15 the other, I don't see why those two new entities

 16 are any less creditworthy than the original FCM

 17 was.

 18 They may be, but just because they're

 19 smaller that doesn't actually mean they're more

 20 likely to default.

 21 MS. TAYLOR: I think the excess capital

 22 will also get fragmented. I think is really --
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 1 MR. COX: But it's still the total

 2 amount of capital in the system --

 3 MR. FRANKEL: It's the same total, but

 4 you will have pools from each side that before

 5 would have offset to some degree. And so the

 6 reserve capital you need to support those pools in

 7 each, in sum total, would need to be bigger.

 8 Because there's no offset in-between the two.

 9 MR. COX: But I guess I'm still not

 10 following. If you've got a more diversified group

 11 of counterparties, then actually it would sort of

 12 be a less risky thing in aggregate. I mean, the

 13 pools they're offsetting would still offset,

 14 right?

 15 MR. KAHN: In the example of 50-50, it

 16 probably does work. If you're an example of one

 17 side is 90 percent and the other is 10 percent, I

 18 think you have a different dynamic, then.

 19 MS. TAYLOR: Or, one side gets all the

 20 longs, one side gets all the shorts.

 21 MR. FRANKEL: Yeah, but in general it's

 22 not quite so black and white. But there is always
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 1 some savings from putting it in the same pool,

 2 which will be lost. And so there will be capital

 3 --

 4 MR. COX: Doesn't that -- that's the

 5 whole part of the clearinghouse, right? The

 6 clearinghouse is what pools the risk.

 7 MR. WASSERMAN: Yeah, but there's

 8 another issue there --

 9 MR. FRANKEL: No, but you need capital

 10 reserves to guarantee the --

 11 MR. COX: Right, but you still have the

 12 same capital reserves that you -- I mean, I don't

 13 know. Maybe --

 14 MR. WASSERMAN: It's a separate legal

 15 entity issue. Because when you split it up --

 16 MR. MAGUIRE: It's legal entity.

 17 Separate legal entities only have access to one or

 18 the other. The net total is the same, unless it's

 19 guaranteed by the same parent group.

 20 MR. COX: Right. But if each legal

 21 entity has got an unbalanced portfolio compared to

 22 what the original one had, soon you're going to
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 1 charge them more margin.

 2 MR. MAGUIRE: That's correct.

 3 MR. DIPLAS: Well actually, there is a

 4 difference also depending on what you do in the

 5 guarantee fund calculation. We're talking only in

 6 the margin here, there's not really split in the

 7 guarantee fund calculation because it's going to

 8 be done at the clearing member level.

 9 MR. COX: Right.

 10 MR. DIPLAS: You're going to get the

 11 offsets that you don't get when you do the initial

 12 margin at the cost level.

 13 MR. MAGUIRE: There would be a minimum

 14 contribution to a guarantee. I think one of the

 15 main things is minimum contributions are guarantee

 16 funds. So if today you put --

 17 MR. COX: Absolutely --

 18 MR. MAGUIRE: -- 2 per -- if you put 10

 19 for 1 clearing member, you'd have 20. That's

 20 where it really has impact.

 21 MR. COX: Because then you have true

 22 fixed contributions. Then as you split off, more
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 1 -- you know, it's going to become less efficient

 2 for the ability of the parent entity --

 3 MR. DIPLAS: I think the minimum is kind

 4 of peanuts, practically speaking. I mean, whether

 5 it's 10 or 20 or 40 -- each one, for most

 6 entities. The -- most of the active, at least,

 7 FCMs will be way above the minimum guarantee fund

 8 contributions.

 9 The officers, I think, within about 40

 10 are probably much more substantive at the

 11 guarantee fund level than anywhere else. But

 12 anyway, we're digressing a little bit here.

 13 MR. WASSERMAN: Yeah, and let me let

 14 some folks at this end of the table --

 15 MR. WINTER: There's one other issue,

 16 though, related to if you split the two FCMs. And

 17 it's also, what's the other activity the FCM is

 18 performing? Because it's not just clearing

 19 customer business, it's also clearing proprietary

 20 or affiliate business. And quite frankly, most

 21 FCMs that have gone bust have gone bust not

 22 because of the customer business, because of the
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 1 proprietary activities. So you can't ignore that.

 2 And so where does that business then fit

 3 in? Which entity does it go into? And does it

 4 therefore increase the risk to the clients in one

 5 entity over the other? So you can't separate the

 6 two in that regard as well.

 7 MR. WASSERMAN: I would note that under

 8 any of these models, the clients are fully

 9 protected against proprietary losses.

 10 MR. WINTER: That -- I'm not suggesting

 11 that, the commingling losses. But there's a

 12 higher probability that there will be a failure in

 13 one entity over the other, potentially. Just

 14 because of the proprietary activity.

 15 MR. WASSERMAN: And then there is the

 16 exposure to the loss from liquidation.

 17 MR. WINTER: And the other clients that

 18 could be in deficiency at that time.

 19 But the other thing I'd like to throw

 20 out there, though, is that when we talk about

 21 optionality, again the issue is when you look at

 22 the buy side today, they have the ability to
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 1 control how they manage their risk. They do that

 2 today in the OTC market. They can use triparty,

 3 for example, for getting bilateral and all the

 4 rest of that stuff. But they can do triparty.

 5 Why couldn't you allow triparty in the clearing

 6 mechanism? That would give them the same

 7 protection, recognizing that they'd have a

 8 triparty somewhere else.

 9 The FCM has to substitute its own cash

 10 or collateral to meet the margin. And that's no

 11 different than what they do every single day today

 12 first thing in the morning, because they first

 13 have to pay up the clearinghouse in the morning

 14 and then during the day they're collecting that

 15 money from their clients.

 16 MS. TAYLOR: I think you have stumbled

 17 into optional physical segregation. Which

 18 apparently doesn't work without an account class.

 19 Which I think we could create an account class for

 20 it, but --

 21 MR. WINTER: That's exactly the point.

 22 I think you create an account class, you allow for
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 1 triparty, you resolve the problem, and it's not

 2 overly burdensome.

 3 MS. BREGASI: But if triparty works, why

 4 are we making it optional? Why aren't we just

 5 making that the model?

 6 MR. WASSERMAN: And the difficulty is --

 7 I mean, right now -- first off, we're talking

 8 about triparty I think in the current world is

 9 that the collateral is not -- so the collateral

 10 wouldn't be going up to the clearinghouse. The

 11 collateral would be sitting at a depository. And

 12 I'm not sure, Kim, if that's something you're

 13 going to be comfortable with, or?

 14 MS. TAYLOR: Well, I mean, the way that

 15 the gentleman described it, the clearing members

 16 fund this now when they have triparty arrangements

 17 where they are allowed for other things.

 18 So, I think what it really boils down to

 19 is, we have to figure out what problem we're

 20 trying to solve, and then come up with the best

 21 conclusion for how to solve it. Because if being

 22 able to use your triparty accounts -- which I
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 1 think is what your issue is. Because you have

 2 them in the OTC market, right? And you feel that

 3 you're protected, and you probably are protected

 4 from the default of your prime broker counterparty

 5 because you have your collateral in a triparty

 6 account.

 7 And the problem with the moving to a

 8 cleared environment is that the basic existing

 9 CFTC customer protection mechanisms pulls that.

 10 You could still have a triparty account, the firms

 11 could still finance it, they could still put the

 12 margin up with the clearinghouses. But when it

 13 all shakes out, that would be subject to a pro

 14 rata distribution, along with everything else.

 15 So if we made those triparty accounts,

 16 that's exactly what I mean when I say full

 17 physical segregation with an option. Because not

 18 everybody wants -- not everybody now has triparty

 19 accounts in the OTC arena, right? Only some of

 20 you feel that it's important enough to be worth

 21 the costs or burdens or whatever it is -- the work

 22 to set it up. And then, those of you who do that
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 1 work to set it up reap the benefits. And people

 2 who don't, don't reap the benefits.

 3 That is -- other than sticking with the

 4 existing model, which has theoretical risks that

 5 really are very low probability of happening, I

 6 think that's the best option.

 7 MR. THUM: I just wanted to respond to

 8 one --

 9 MR. WASSERMAN: Just to clarify a

 10 question, though? Under the third party model

 11 that you're thinking of, would the initial margin

 12 be held at the third party? At the clearinghouse?

 13 Or, both?

 14 MS. TAYLOR: I think it depends on what

 15 problem we're trying to solve. Sometimes I think

 16 the problem we're trying to solve is that you

 17 don't want your -- you'd rather have your money

 18 with the clearinghouse than with the FCM. But I

 19 think that that probably goes away if you've got

 20 triparty, because they don't really have access to

 21 the money, either. Right?

 22 So I think it could be done either way.
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 1 It depends on what problem we're trying to solve.

 2 MR. WASSERMAN: So you're saying you

 3 would accept a model where the collateral of the

 4 customer is not held at the clearinghouse, but

 5 only at a third party depository?

 6 MS. TAYLOR: If the margin at the

 7 clearinghouse was funded by the clearing member.

 8 MR. WASSERMAN: So, both. So in other

 9 words, the model you're talking about is one where

 10 --

 11 MS. TAYLOR: It's a collateral upgrade

 12 model, basically --

 13 MR. WASSERMAN: -- the client has money

 14 at the third party and then you'd have double seg

 15 with the firm, posting money at the clearinghouse.

 16 MS. TAYLOR: But I would also accept a

 17 model where the third party account attached where

 18 -- attached to -- I'd accept a full segregation

 19 model that could be made to work where the

 20 attachment of the third party account was actually

 21 between the third party and the clearinghouse, if

 22 that solved the problem. But it comes down to, we
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 1 have to figure out what problem we're trying to

 2 solve and then find the very best way to solve it

 3 that works for the clients and the FCMs and the

 4 DCOs. Because it has to, ultimately, work for all

 5 three legs in order for it to work, right?

 6 MR. THUM: I think the problem we're

 7 trying to solve is very basic. And we have it now

 8 in the bilateral world. And that's if we're not

 9 defaulting, we want to get our margin back. So,

 10 we accept in the LSOC model we may be susceptible

 11 to investment risk, but we're not susceptible to

 12 fellow customer risk.

 13 Also, I think it is important to point

 14 out that if there is the optional approach and

 15 there are two FCMs and there's got to be two pots

 16 of capital, that would be an issue for us as we

 17 choose our FCMs. And indeed, in interviewing FCMs

 18 one of the main components has been what is the

 19 capital level? Is it set at a minimum level

 20 required by the DCO? Is there some cushion there

 21 that we could then monitor? If the cushion goes

 22 away, then we decide to move it to another FCM
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 1 well before there's a problem with the FCM.

 2 So indeed, I don't know that anyone here

 3 suggested that that's not a critical issue.

 4 Certainly for Vanguard it's a very critical issue.

 5 But the problem to be solved is getting the margin

 6 back. We don't think we will ever default. And

 7 in the Lehman situation, the bilateral world, we

 8 were well protected. Certainly we were protected

 9 with our futures, given the way the futures model

 10 is set up and the risk parameters of the future

 11 product.

 12 In the derivatives model, though, not

 13 only do we hold all the collateral of the

 14 custodian we also, in evaluating our derivatives

 15 dealers, in the event the volatility of the

 16 position is great, we go out and buy CDS

 17 protection on the dealer. So, there's many levels

 18 of protection that we can build in in the

 19 bilateral OTC world. And we're looking to get not

 20 significantly worse protection in the new cleared

 21 derivative world.

 22 MR. WASSERMAN: Okay, let me have
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 1 another chance --

 2 MR. FOLEY: I just -- I mean, I don't

 3 pretend to understand the finances of all this.

 4 But I do know, I mean, that we have third party

 5 accounts authorized for several years -- many

 6 years. And my understanding is, the firms who

 7 offer that even for futures found it to be highly

 8 expensive because they had to use their own funds

 9 to finance the margin at the FCM. There are

 10 capital implications for doing that.

 11 If we're -- if that were to be offered

 12 in with swaps, where my understanding is that the

 13 margin will be higher, the charges on the firms

 14 will be that much higher. And I think it's going

 15 to become exceptionally difficult for FCMs to

 16 offer this.

 17 One of the goals of the Dodd-Frank Act

 18 was to increase the firms, the clearinghouses,

 19 dealers who were going to be involved in the swaps

 20 market. And it seems that everything that the

 21 rules try to fix only serve to narrow who the FCMs

 22 are who are going to be able to afford to do this
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 1 -- who the clearinghouses are who are going to be

 2 able to afford to do this. And so I'm just

 3 concerned.

 4 I mean, I think it's wonderful to offer

 5 this. And as Kim said, everyone wants to give

 6 their customers what the customers want. But we

 7 need to find a way to get it done in an economical

 8 way that -- and a way, obviously, that fits within

 9 what the law is at the present time. If we need

 10 to change the law, then let's all get together and

 11 change the law.

 12 MR. MACFARLANE: Tudor would happily pay

 13 the incremental costs, both in terms of collateral

 14 and operational costs. And we've invited our FCMs

 15 to come up with a model and show us the cost.

 16 We already pay a higher cost in our

 17 execution of OTC transactions, through the use of

 18 the triparty mechanisms. We've spent money to put

 19 triparty mechanisms into place. We've paid

 20 custodial fees to the custody bank that holds the

 21 triparty collateral.

 22 The cost of not doing it is actually
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 1 greater, in our opinion, because if we did not

 2 have those mechanisms in place and we had another

 3 event as we did in 2008, the uncertainty that's

 4 created by not knowing who we're sharing risk in

 5 the omnibus pool would cause us to pull our

 6 capital back from the market. And so, as many

 7 leveraged players did, they delivered their

 8 positions in September of 2008 because they

 9 weren't sure about their prime brokerage risk.

 10 Similarly, that could happen in the OTC

 11 market if we were unsure about who might be in the

 12 pool with us and whether or not they might

 13 default. There's -- that's not hedge-able. And

 14 the only way to reduce our risk is to de- lever.

 15 So we'd be pulling capital back from the market at

 16 a time when the market would most need that

 17 capital.

 18 So, again, it comes back to the point

 19 that I think Dan made at the beginning. We've got

 20 to be careful that we find a balance between

 21 operational, efficiency, collateral efficiency,

 22 and what's right systemically to make sure we
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 1 don't build something that will be weaker if we --

 2 not if, when we have another crisis.

 3 MR. FOLEY: I'm not challenging that.

 4 My point is that my understanding is, these

 5 accounts are highly expensive. And I don't -- so

 6 I think it's something that would have to be

 7 looked at very carefully, taking into account.

 8 MR. MACFARLANE: Well, getting back to

 9 Kim's question, what does the client want?

 10 Speaking as a client, we want better protection

 11 and we're willing to pay for it. So -- and I

 12 think if -- getting back to Bob's question. You

 13 know, if you give -- if you unnecessarily restrict

 14 the market's options, you may push them into a

 15 model that does not suit their risk profile. If

 16 you give them options, they can pick something

 17 that suits their risk profile and they can make

 18 the decision as to whether or not they want to go

 19 with an omnibus model and post less collateral but

 20 take the risk on the back end. It's a pay me now

 21 or pay me later, I think, equation.

 22 And others will choose the other model,
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 1 which would give them more certainty about whether

 2 or not they get their collateral back.

 3 MR. WASSERMAN: Nevis.

 4 MS. BREGASI: I just wanted to make two

 5 points. I don't think -- I still didn't really

 6 understand whether the DCOs are happy with leaving

 7 the collateral at the triparty. So instead of

 8 having the FCM separately pay the DCOs while the

 9 collateral of the customer that's supposed to do

 10 the FCMs stays at the triparty. Because I think

 11 that's where Kevin's point came in about it being

 12 very expensive for the FCMs.

 13 MS. TAYLOR: And from our point of view,

 14 we would want to work through the nuts and bolts.

 15 But I'm confident that there is a way that we

 16 would be able to be comfortable with that.

 17 MS. BREGASI: So I think --

 18 MS. TAYLOR: So --

 19 MS. BREGASI: Just keeping it there, if

 20 that's the case then I think Kevin's points about

 21 the FCM -- this being very expensive for FCMs

 22 would not stand. So that's one point I wanted to
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 1 make.

 2 And then the second thing on

 3 optionality. While I totally agree that it's

 4 better to have optionality than just to stick with

 5 the futures world, going back to your point about

 6 in today's world not every customer wants triparty

 7 and a lot of them chose not to have triparty, I

 8 also want to say that we want triparty and cannot

 9 get it from brokers. So in fact, there is no

 10 optionality today. They will only do it if it's

 11 legally required. So for our mutual funds,

 12 they're happy to do a triparty. For our other

 13 accounts, they are not legally required to keep

 14 their collateral at a triparty, at the custodian.

 15 The brokers are not coming back and

 16 saying, we'll just charge you more. They're

 17 saying, we're just not doing it. I know that they

 18 are doing it for other asset managers that are

 19 bigger than us -- and we're not small. We have

 20 $240 billion under management. But right now the

 21 answer for us is, no.

 22 So, my other concern with optionality --
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 1 like I said before is, whether it's a real option.

 2 MR. NICHOLAS: Is that futures? Or is

 3 that --

 4 MR. COCCO: Sorry. Bob, this is

 5 Alessandro speaking for the dealer -- for at least

 6 my institution. We have trilateral agreements on

 7 the OTC side for some clients. And it is

 8 something that we work on.

 9 I think that if you take a lot of the

 10 collateral for the whole market and place it into

 11 third party custodians, I think you would be

 12 appropriate to conduct an analysis of, is it

 13 really safe once it's there? And who bears the

 14 risk of a failure by the custodian?

 15 I think those are questions that would

 16 be -- it would be very prudent to find very clear

 17 answers to those questions. I'm not saying it

 18 doesn't work or it shouldn't be offered. I'm just

 19 saying we should make sure it works, if that's the

 20 route that we go towards. Because from a systemic

 21 point of view, you would want to make sure that

 22 you have adequate protections for FCMs for
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 1 clients, of course. For the clearinghouse, and

 2 also for a third party custodian.

 3 MR. NICHOLAS: Just to -- sorry. To

 4 throw in my thoughts here. I certainly understand

 5 the concern of the customers to limit risk.

 6 Obviously that's critical.

 7 But I wonder -- and I guess this is more

 8 of a question. Isn't another path towards

 9 limiting risk getting perhaps more information

 10 about the FCM? What are the -- you know,

 11 information that's not currently being disclosed,

 12 leverage issues, concentration issues, proprietary

 13 trading issues. Doesn't that really get to your

 14 concern more?

 15 Because even in a complete legal

 16 segregation model, given bankruptcy limitations

 17 I'm not sure that in all cases you'd be getting

 18 everything back. I'm not a bankruptcy expert, but

 19 I'm not sure that that's the case. Whereas if

 20 you're looking deep into the FCM, you're going to

 21 see your real risk.

 22 MR. WASSERMAN: And I think we're going
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 1 to address those questions this afternoon in

 2 detail. Because I think there are some

 3 interesting issues in terms of, you know, the

 4 motivations of the buy side. And we've sort of

 5 alluded to that. And there's also been some

 6 allusions to, well, how much information can

 7 practically they get and can practically you give

 8 them.

 9 But, I am -- it's pointed out that the

 10 time -- we've gone fairly over. And I really do

 11 want to make sure that everyone does get a chance

 12 to have a good, healthy lunch. And so -- it's

 13 only an hour and five minutes you have. There's a

 14 number of places around here. And I very much

 15 look forward to having folks back here promptly at

 16 1:30 to begin.

 17 (Recess)

 18 * * * * *

 19

 20

 21

 22
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 1 MR. RADHAKRISHNAN: Please take your

 2 seats for the third panel.

 3 MR. WASSERMAN: So, housekeeping detail.

 4 Please everyone remember to turn your mike on when

 5 you speak and then turn it off with the red

 6 button. Then we have two folks who are new to

 7 this panel and I will let them introduce

 8 themselves.

 9 MR. PRAGER: Thank you Bob. Ritchie

 10 Prager, BlackRock.

 11 MR. HARSHAW: Jim Harshaw, GM Pension.

 12 MR. WASSERMAN: We're now going to talk

 13 about the advantages and disadvantages of the

 14 different models, and most importantly, the

 15 advantages and disadvantages of the models

 16 compared to each other. One of the things that

 17 was alluded to earlier and I'd like to raise it

 18 here now is what are the differences if any

 19 between swaps and that industry and both cleared

 20 and uncleared and the futures markets that are

 21 relevant to this discussion?

 22 MR. PRAGER: I think we heard some of it
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 1 in the prior panel and I think it's a great

 2 question to start with to frame some broad

 3 differences. When we look at the OTC market and

 4 the swap market and look at some of the statistics

 5 published by ISDA, my understanding is there is

 6 some $600 trillion notional outstanding. We have

 7 today I think in the cleared space some $200

 8 trillion of which is cleared primarily on LCH in a

 9 dealer- to-dealer environment. So that's one

 10 metric. I think if you look at another metric and

 11 you look at tenor, I think most dealer books'

 12 outstanding average life would probably be

 13 somewhere between 3 to 4 years. If you look at

 14 LCH, my understanding there is that the average

 15 life of their cleared population is some 8 years

 16 of tenor. So if you start thinking about the

 17 variation margin in the context of 8-year average

 18 life, that's something to consider. Then if you

 19 look at CME and some of your figures, and I'm sure

 20 they'll help me if I get their figures very, very

 21 wrong, but I think in CME's interest rate complex,

 22 just thinking of Eurodollars, T notes, SET funds,
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 1 there is some current open interest of some $15

 2 trillion or so. And if you take Fed funds out of

 3 that it's about a $11 trillion size market. So a

 4 very different size that we're talking about.

 5 Then if you look at the tenor, most

 6 futures are fairly short dated in maturity. Think

 7 of rolling in Eurodollar futures with huge

 8 volumes, most of the volume is in the front

 9 contracts and they mature every 3 months, so the

 10 variation margin over the life of 3 months is

 11 going to be very different over the variation

 12 margin of something that's 8 years. So I think

 13 when we, again it's a great benchmarking question

 14 to start with because when we start talking about

 15 these different models and we defer to something,

 16 we say we defer to the futures model, in a lot of

 17 these conversations these are apples to oranges

 18 when we start talking about risk. That would be

 19 my cut at the broad differences.

 20 MS. TAYLOR: Can I ask a question

 21 though, Ritchie? You're making it sound as if

 22 there's a difference in the way the risk posed by
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 1 the variation margin if something exists for a

 2 long period of time or if it exists for a shorter

 3 period of time and with the variation margin being

 4 settled every day, I'm not sure I understand the

 5 distinction.

 6 MR. PRAGER: Well I'm just looking over

 7 the life. I think that's a fair point, Kim. I

 8 think first of all these sheer volumes, we're

 9 talking very, very different sized markets. A lot

 10 of these futures that we're talking about in the

 11 futures market are very short dated contracts

 12 anyway so if you look at the daily variation

 13 margin of something that has 3 months of duration

 14 and a very small BVP versus an average life

 15 contract of 8 years, just the daily variation

 16 margin alone and the sheer size and the longer

 17 duration with the higher BVP are much larger

 18 numbers.

 19 MR. DIPLAS: Ritchie, I agree with your

 20 comments already but I would add to that also the

 21 difference in terms of how the products trade in

 22 the sense that a lot of swaps reside in a book for
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 1 a long time after the initial trade so that the

 2 unwind aspect of the book is going to be different

 3 versus a shorter dated 3 month future basically,

 4 which is eminently observable so that it requires

 5 a longer unwind horizon and it has to be handled

 6 with more care I guess.

 7 MR. KAHN: Also the operational needs of

 8 margining and doing the computational calculation

 9 every day is different on the OTC products. They

 10 have longer dated cash flows and they have coupon

 11 resets and things like that. So in doing the

 12 portfolio every night, which both the FCM and the

 13 CCP need to do, it is a more computationally

 14 complex instrument.

 15 MR. FRANKEL: Also more model based,

 16 valuation is more model based. While we build an

 17 interest rate curve, all the off the runs or

 18 anything that's not traded that day is discounted

 19 and so there's a model valuation that's separate

 20 from a widget price that trades in the central

 21 order book. There is no central order book for

 22 the swaps.
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 1 MR. RADHAKRISHNAN: It seems that the

 2 comments you're making go toward differences in

 3 how they could be cleared.

 4 MR. FRANKEL: Yep, and also the

 5 variation margin is collateral, which is a rather

 6 substantial difference from the futures clearing

 7 model where variation margin is daily settlement.

 8 MR. RADHAKRISHNAN: So you're saying the

 9 VM is collateral. What is IM in an OTC trade?

 10 MR. FRANKEL: Also collateral, but the

 11 VM collateralizes current exposure and IM

 12 collateralizes potential future exposure is the

 13 way we think about it.

 14 MR. HARSHAW: I think one of the things

 15 that's important to understand is that in the OTC

 16 area for most of the people on this side of the

 17 panel, the buy side, they don't post what you call

 18 in the futures area initial margin, but in the

 19 swap area it's called independent amount so that

 20 out of the box when you go to the cleared side,

 21 it's an economic negative. Second, the models

 22 that exist today, the futures model and the swaps
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 1 model, over 90 percent of global derivatives are

 2 done in the OTC swaps market as compared to the

 3 exchanges, and people have chosen that for a

 4 reason. There is a lot more flexibility in the

 5 OTC area to establish the types of protections

 6 that you want to have with your counterparty, how

 7 much you want to be exposed to the risk, how

 8 little you want to be exposed to the risk. When

 9 it comes to the margin that you post in the

 10 futures area, you really don't have much choice.

 11 In the OTC area you can negotiate that, and in

 12 addition you can actually control it, and that has

 13 important portfolio management consequences. If

 14 I'm holding a bond and I've got a triparty, that

 15 bond is still mine. It's pledged for the benefit

 16 of the secured party, but it's still in my

 17 portfolio and I'm getting the income on that bond

 18 and when you look at my assets list it's going to

 19 have that bond.

 20 In a futures area, I give up a bond to

 21 the FCM. Your treasury could get converted to a

 22 grease fund the next day. I don't the treasury in
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 1 my portfolio anymore. So there are significant

 2 differences between the futures and the swaps

 3 market and today the buy side ops for the swaps

 4 market model.

 5 MR. WASSERMAN: Let me try and focus

 6 folks a little bit though on the distinctions to

 7 the extent there are any between swaps as they

 8 might be cleared and futures. One of the points

 9 that folks have raised is wait a minute, we've got

 10 a futures model. It works. It's worked for a

 11 very, very long time. So we should then bring

 12 swaps into this model that has proven itself. I

 13 guess the question is are there in fact any

 14 differences that would challenge that or in fact

 15 is a cleared swap really the same as a cleared

 16 future and maybe that argument has weight?

 17 MR. HARSHAW: I think one of the things

 18 that we need to pop pretty quickly is the 100

 19 years example. In 1987 when the market crashed

 20 the CME as I understand from people who served on

 21 the Risk Committee during that time went to get

 22 margin from the FCMs and many of them couldn't
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 1 post it because they couldn't get it from their

 2 banks, and when margin is called it's called on a

 3 T plus 1 basis from the customer and on the CMEs

 4 we understand that they could get called that day.

 5 We understand that there was pressure by the

 6 government to force the banks to lend to the FCMs.

 7 Had they not gotten the capital, we may not be

 8 bragging about CCPs today. In fact, one of the

 9 CCPs in Hong Kong went under. So we're talking

 10 about a structure that hasn't been tested. It's a

 11 bicycle compared to the OTC car and it's carried

 12 the weight of that person, but now you're taking

 13 tons of bodies and trying to put them on the

 14 bicycle and it can't bear it. What we're saying

 15 is that the risk assessments of the CCP need to be

 16 rethought in light of the volume.

 17 MR. MAGUIRE: May I come back on that

 18 because it has been tested -- cleared interest

 19 rate swaps. Ours traded in the OTC market and no

 20 change to the way they're executed which negates

 21 statistics just to correct them a little bit. We

 22 have over 50 percent of the open notional going
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 1 through swap clear today and when Lehman Brothers

 2 defaulted that was a $9 trillion portfolio of

 3 interest rate swaps, idiosyncratic, no trade the

 4 same so therefore no profile of risk on each

 5 trade, the same, so nonstandard. The 66,000

 6 trades were at maximum maturity of 30 years. They

 7 were in five different currencies and we closed

 8 all that risk out using in the region of 100 to

 9 150 hedge trades in the market, big trades, macro

 10 hedges and then auctioned the portfolio and gave

 11 that back to the market. So that was all done

 12 well within the margin that we had at Lehman so

 13 that nobody was impacted in a mutualized way.

 14 Obviously this is very much dealer to dealer,

 15 centric back then and we're expanding that model

 16 out now to dealer to client. But to say these

 17 infrastructures haven't been tested is not 100

 18 percent true. I know Kim mentioned in one of the

 19 earlier sessions that one of the reasons we're

 20 moving into this model is because of the success

 21 of the futures model. I'd like to think as well

 22 that's maybe something to do with the successive
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 1 closing out of the large OTC derivative portfolio

 2 at Lehman as well.

 3 So if you take a slice of our portfolio

 4 which is cleared swaps, we'd have 910,000 trades.

 5 When we did a slice through of about 850,000

 6 trades that we had, more than 95 percent of those

 7 trades using eight fields to match were difference

 8 so that every single trade is pretty much

 9 different than you clear today. I think that's a

 10 fundamental difference, to answer your question,

 11 between swaps and futures. They're not standard,

 12 they are different and they are idiosyncratic. So

 13 I think we have to be very cognizant that you can

 14 take a swap product or an OTC product and clear

 15 it, but to Kim's point, the risk profile on these,

 16 the maturity profile, the way you hedge these, is

 17 very different from futures. But I think I'm sure

 18 everybody will agree on the DCO that the risk

 19 principles we apply should be the same, it's just

 20 maybe the metrics and the models should be

 21 slightly different.

 22 MS. TAYLOR: I would agree with the
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 1 statements about the way that the model has worked

 2 and the way that it's been tested. The fact that

 3 the Fed flooded the market with liquidity in the

 4 crash of 1987 is going to have been a fact whether

 5 or not there were futures or not and all of the

 6 settlements were met at the CME. There was not a

 7 failure by any participant at that time. So that

 8 was a test. I think the credit crisis period was

 9 a test certainly on the Lehman side in London

 10 where there actually was a default. But I would

 11 suggest even on the Lehman side in the U.S.

 12 Because of the difference in the bankruptcy

 13 structure, the registered entity didn't actually

 14 default but it did operate in a state where it had

 15 an impaired parent and I think that the mechanisms

 16 that were in place operated very well to be able

 17 to allow customers to manage to a very good

 18 outcome in a very stressful time period.

 19 MR. WHITE: I'd like to repeat the

 20 question but maybe in a little bit more focused

 21 way of taking some of the observations that people

 22 have made about differences with swaps and again
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 1 taking as a given that we're talking about the

 2 subset of swaps that are going to be cleared in

 3 the future, then focus especially on how if at all

 4 these differences would affect fellow customer

 5 risk. Even if there's a greater volume on a

 6 transaction-by-transaction basis is the fellow

 7 customer risk and managing it either from the DCO

 8 or customer kind of way going to be the same or do

 9 some of the differences that Dan for example has

 10 talked about affect this.

 11 MR. HARSHAW: I think one of the things

 12 on the fellow customer risk is it's just not

 13 something we have to deal with today so that again

 14 you have the untested aspect to it. On the sell

 15 side, has a lot more experience than the clearing

 16 side, there's been very little cleared by buy side

 17 and so the experience that maybe other people have

 18 had and have tested on hasn't really been so on

 19 the buy side. We're really not set up to measure

 20 the credit aspects of any other customer let alone

 21 all the customers of an FCM. Frankly, we don't

 22 feel we have enough tools to measure the risk of
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 1 our FCM. We don't feel the DCOs have enough tools

 2 to measure the risk of the FCM. We think capital

 3 is a specious test because you could be levered

 4 out the wazoo and have a lot of capital and we've

 5 certainly seen that to be the case. We think

 6 leverage is hugely important. AIG was highly

 7 rated but highly levered and none of us knew that.

 8 So I think for us the fellow customer risk just

 9 underscores the fact that the buy side just

 10 doesn't have the tools or the information to

 11 evaluate it.

 12 MR. PRAGER: If I can add on to that, I

 13 think this is a key point and so if you look at

 14 both fellow customers and FCM. We talk about

 15 Lehman and the very successful experiences both

 16 the CME had with futures and LCH had in cleared

 17 swaps, not every situation we're going to have

 18 CNBC talking to us for weeks in advance basically

 19 saying move your exposure. That was a unique

 20 situation where there was a neon sign flashing 24

 21 hours a day saying you may want to think of moving

 22 your exposure so I don't think we can count on
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 1 that unless the DCOs themselves are going to

 2 establish that neon sign and somehow rate the FCMs

 3 and somehow put out a yellow warning or red

 4 warning or whatever because we don't know. We can

 5 make our own initial assessment on the health of

 6 the FCM and we do. We look at capital and we look

 7 at other metrics, but it's largely judgmental with

 8 not a lot of objective measures in terms of their

 9 ability to select clients, their ability to comply

 10 with DCO rules. We don't know if you publish the

 11 ratings. It would be great if there were some

 12 sort of rating system. I go into a deli in New

 13 York and I see a little score there whether I

 14 should buy a sandwich our not.

 15 Then on fellow customer risk, no idea.

 16 Clueless. We are then back to looking at the FCM

 17 and the DCO to provide guidance so that we have no

 18 idea if there is an Amaranth in there, if there

 19 are other types of clients, and we have no idea.

 20 They may be in every FCM. This is an area of

 21 great concern where I think that's a risk that we

 22 do not take today in the bilateral swap world. We
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 1 do not have to worry about it. We can insulate

 2 ourselves some from it full stop. So I do think

 3 this is a very key component and we wrote that in

 4 our comment letter that we'd like to see something

 5 coming from the DCOs on how they monitor the FCMs

 6 and what guidance they can provide clients with.

 7 MR. EDMONDS: I was going to say,

 8 Ritchie, I think it's a little bit bigger than any

 9 one DCO. There is common membership across all

 10 three of us and some entities and other entities

 11 have different levels of that. At some point in

 12 time that may need to be a regulator function

 13 providing that. With your deli analogy, it's not

 14 the individual block association that's putting

 15 out that sign that says this deli is good, it's

 16 the Health Department of the City of New York. We

 17 would like to see that too especially as we've

 18 evaluating membership and offering new products

 19 and soliciting the right group of people to

 20 provide that service in the right level of

 21 distribution out to customers like yourselves. We

 22 also need that type of help and that's going to
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 1 require some effort from this agency and other

 2 agencies and if we think about the holistic view

 3 of that when some of the clearing members are

 4 registered banks of there's the likelihood that

 5 some of them will be or have some affiliate

 6 structure with that and the rules around that, we

 7 also need to know what that means on the other

 8 side and what those regulators are thinking and

 9 there is no good place to go to. So even though I

 10 could give you an A rating on FCM A, they may not

 11 have A ratings at the other two places and vice

 12 versa. There is no single place to put that and

 13 it's a risk I think we all face in the industry,

 14 not just your side of the fence.

 15 MR. MAGUIRE: I agree with that. You

 16 have fellow customers, we have fellow CCP risk I

 17 guess. We need to know what the leverage is, the

 18 capital is, the risk, about their leveraging and

 19 how it's being used, what the liquidity aspect

 20 would be on the capital that they've got. We

 21 can't see that. We can see what we can see, but

 22 we can't see across the piece. So it's a similar
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 1 issue that the buy side is raising. But in terms

 2 of differences between futures and swaps with

 3 reference to the account structure, there's a

 4 blend of things. Obviously the swap products and

 5 the OTC products are longer dated. We could argue

 6 all day, but one would argue that longer dated

 7 probably has slightly more volatility in price.

 8 We could argue about that, but equally one thing

 9 we wouldn't argue about is liquidity and the

 10 further out the time structure you go, the further

 11 out the maturity profile you do, the less deep the

 12 market is and the less liquid the market is.

 13 So what does all that mean? It means

 14 that in the worst case scenario where we have a

 15 default, it's going to be hard to close out that

 16 risk. If it's going to be hard to close out that

 17 risk, the last thing we want to do is have to

 18 close out more than the defaulting entity. In

 19 terms of collateral segregation, an LSOC or a full

 20 seg model for that matter, a segregated model. We

 21 have pretty good confidence because we can see the

 22 client's I.D., we can see through to the end
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 1 client and we can apportion the collateral in that

 2 model. We can safely lift those people and move

 3 them to a safe clearing member at that point so as

 4 a DCO we don't feel necessarily that we're going

 5 to have to close out additional risk for somebody

 6 who has not defaulted, they just can't port and

 7 the reason they can't port necessarily is because

 8 in today's structure in the omni account we're not

 9 going to let people port unless we are confident

 10 that we're not going to have to use that client

 11 mutualization there. Whereas under an LSOC model

 12 we can say you can go as fast as you can go rather

 13 than as fast as the slowest person.

 14 MR. WASSERMAN: To clarify, what I'm

 15 trying to understand, Dan, is what you're saying

 16 there's a difference in liquidity generally

 17 between cleared swaps and cleared futures?

 18 MR. MAGUIRE: I'm saying there's a

 19 liquidity difference and it's harder to close out

 20 longer dated risk on swaps than it would be on a

 21 standard futures contract where you trade in and

 22 out.
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 1 MR. FRANKEL: It's that the risk is so

 2 much bigger and there's no central order book to

 3 put it, but the risk is so much bigger.

 4 MR. DIPLAS: I think the biggest

 5 difference between the futures and the swaps,

 6 first of all, traditionally futures trade in a

 7 silo environment. You will see one risk being in

 8 one location. Here we're most likely going to

 9 have the same instrument traded at at least two

 10 CCPs. It's going to make it more difficult for

 11 them to actually see for the same shock what is

 12 going to be the behavior of the client and how

 13 much is a certain client affected. They know that

 14 they have exposure to a billion of an index in CME

 15 but there might be another billion in ICE. They

 16 don't know what the impact is going to be. I

 17 think when it comes to assessing the health of the

 18 clearing members, the FCMs, I agree with Chris

 19 that they don't have the tools to actually do that

 20 themselves. At some point I think we're going to

 21 need the regulators to be able to try to conduct

 22 some kind of stress test for the existing FCMs to
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 1 access the health of those FCMs for general shocks

 2 in the market.

 3 MS. TAYLOR: I think there's a

 4 difference, I would draw a distinction I think

 5 between the ability to manage risk at the CCP

 6 level or at the regulator level and the ability or

 7 efficacy of putting out a rating. I think we all

 8 found that the rating services sure put out

 9 ratings, but they weren't necessarily as helpful

 10 as they might have been relied upon to be. But as

 11 far as risk management, we do our risk management

 12 in the listed business and we're set up to do it

 13 in the over-the-counter business at the individual

 14 customer level. In the futures world you can't

 15 see every customer. You can only see the ones

 16 that have 25 contracts or more so you can only see

 17 the ones that are even by anybody's definition

 18 marginally material. If you have any kind of a

 19 presence in the market, we can see you. We can

 20 evaluate the concentration risk that the clearing

 21 members have among their customer base and the

 22 CFTC as the central mechanism sees that across all
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 1 of the markets and I presume will see that across

 2 all the cleared and probably the uncleared swaps

 3 because of the SDR and the reporting functions

 4 that will be in place. So I think there will be

 5 an ability for there to be risk management that is

 6 performed that includes each CCP doing it from

 7 their own viewpoint and then the regulator being

 8 in a position to do risk management at the

 9 overall.

 10 MR. DIPLAS: Who is the we you're

 11 talking about? You're not going to be able to see

 12 the uncleared transactions that someone else will

 13 have. Only the regulator will have access to that

 14 information.

 15 MS. TAYLOR: Right. We each can see our

 16 own piece, the DCOs and the regulator can see the

 17 whole picture.

 18 MR. WASSERMAN: Before we move on to

 19 risk management and we will, I wanted to wrap up

 20 one point I'm trying to understand here. What I'm

 21 hearing is that there is greater risk because of

 22 perhaps either longer structure, lesser liquidity
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 1 on the swaps end than the futures end. The

 2 question is, what would the impact of those

 3 distinctions be for fellow customers?

 4 MS. TAYLOR: I think one of the things

 5 is you're hearing that there is more risk but you

 6 didn't also mention that there is different risk

 7 management that attaches to some of those risks.

 8 Those products are margined differently from the

 9 way that the simpler structures are margined and

 10 the default management practices that each of us

 11 has in place to facilitate the liquidation of the

 12 less liquid, less visibly liquid product sets are

 13 very different.

 14 MR. WASSERMAN: That default management

 15 would be --

 16 MS. TAYLOR: It is different risk and

 17 it's managed differently as well.

 18 MR. HARSHAW: Bob, I think one of the

 19 key points here to understand is that when you're

 20 talking about collateral, we have transparency

 21 right now so in a triparty arrangement there's a

 22 third party record keeper independent of the FCM
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 1 who gives transparency on the collateral that's

 2 been posted by the FCM or the collateral posted by

 3 us, I mean our swap dealer, or the collateral

 4 posted by us for the benefit of the swap dealer.

 5 In the DCO world, what we understand, and I'm glad

 6 to stand corrected, is that although the DCOs and

 7 they vary among them in terms of what they can see

 8 at the customer level, although they can see

 9 margin exposure, they don't see collateral. So

 10 they don't get to see what I posted to the FCM.

 11 They get to see my margin exposure for my

 12 contracts, but the DCOs don't have transparency

 13 into the collateral. So there is a key protection

 14 that we've got in the OTC area that doesn't really

 15 exist in the CCP area and that is the transparency

 16 on the collateral.

 17 MR. WASSERMAN: Let's focus on that.

 18 MS. TAYLOR: And on a day-to-day basis

 19 we don't see the collateral that's in the account

 20 of a customer at an FCM, but we do have

 21 transparency into the efficacy of the practices of

 22 holding margin and holding it in segregated
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 1 accounts through the financial supervision and

 2 audit functions so that there is ongoing

 3 monitoring of that but it isn't a day-by-day view

 4 into the balance of the accounts at any point.

 5 MR. HARSHAW: It's a periodic versus a

 6 daily reporting that we can get from a third-party

 7 bank.

 8 MR. WASSERMAN: Just to be clear, as I'm

 9 understanding what you're saying, Kim, you of

 10 course know what they've posted with you.

 11 MS. TAYLOR: I know what the FCM has

 12 posted to me and if we live in the LSOC world I

 13 won't know anything different in an LSOC world

 14 than what I know now because right now I'm

 15 margining each account individually, the FCM has

 16 enough margin up so if you allocate it across all

 17 the requirements, everybody's got enough margin up

 18 and that's exactly the same thing that I will know

 19 in the LSOC model. I won't know that it's

 20 actually James's collateral though.

 21 MR. WASSERMAN: No, you don't know whose

 22 it is. In other words, you know what you have.
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 1 Secondly, as I'm understanding it and I understood

 2 this way before and this is what I'm hearing you

 3 say now as well, you supervise your members. You

 4 don't know every day what they've collected from

 5 customers, but on a periodic basis you look and

 6 you see what they've collected and you evaluate

 7 then if they are undertaking what is from your

 8 perspective appropriate risk management.

 9 MS. TAYLOR: That is correct.

 10 MR. MAGUIRE: Bob, this distinction

 11 between full seg and LSOC, on the full seg, if

 12 James does a trade or a bunch of trades via an FCM

 13 and the margin on those trades is 100, the DCO

 14 will not register or clear those trades unless

 15 they've got 100 from the FCM so we will always see

 16 that we have 100 against those trades and if

 17 William next to him has done 100, we'll see 100 as

 18 well and we'll have 200 in the account so that

 19 we'll always see the collateral value. The

 20 distinction here is that we won't see that James

 21 gave the FCM some T bills and William gave the FCM

 22 corporate bonds and did some transformation and
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 1 passed them through, but we will always see the

 2 collateral value relative to their risk. We will

 3 always have that reconciled in the clearinghouse,

 4 certainly in the LCH model.

 5 MS. TAYLOR: That would be true in any

 6 model that we would have collateral.

 7 MR. EDMONDS: Even in the case that we

 8 have today at ICE Trust, we take gross margin on

 9 behalf of clients' trades and if a clearing member

 10 today charges additional margin or we'll call it

 11 excess, so if the clearinghouse is calling Dan's

 12 example $100 for that given position and the

 13 clearing member says we need $120 to support that

 14 position for whatever the reason and whatever risk

 15 management they've decided to put on the customer

 16 account, we're collecting all $120 in that or at

 17 least $120 is being paid. But to Dan's point, the

 18 composition of that $120 and what you may be

 19 giving to your clearing member, there is no

 20 visibility in that. All we know is that we needed

 21 $100, $120 was collected, we're taking that $120

 22 and we're segregating that off and putting that
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 1 out of harm's way.

 2 MR. WASSERMAN: So as I understand it,

 3 on a day-to-day basis you don't have that

 4 visibility. Do you have the ability to look at

 5 your members on a periodic basis to determine the

 6 quality of the risk management that they have?

 7 MR. EDMONDS: We certainly monitor their

 8 behavior on a daily basis and I would say that

 9 there are periodic reviews and certainly there are

 10 times where operational issues around their

 11 risk-management capabilities are discussed at

 12 appropriate levels within the governance structure

 13 in our entity.

 14 MR. HARSHAW: My question would be did

 15 that help in the Lehman situation? Because the

 16 reality is that you can have that periodic

 17 oversight but it didn't stop anybody from allowing

 18 Lehman to continue to clear.

 19 MR. WASSERMAN: On that score how much

 20 did you folks lose in Lehman?

 21 MR. MAGUIRE: Zero.

 22 MS. TAYLOR: Zero.
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 1 MR. HARSHAW: One of the things that

 2 we're talking about is what happens with my

 3 collateral and what's the risk associated with

 4 that. I think we'd all agree that this room can

 5 accommodate a certain number of people and we're

 6 all comfortable with that, but as the numbers get

 7 bigger our level of comfort goes down. As we

 8 talked about at the beginning, the volume that

 9 these platforms have had before, while significant

 10 in certain cases, has certainly not been the $600

 11 trillion.

 12 When I post collateral today, I get to

 13 see it and I get a walk through its transit. That

 14 transit risk doesn't get protected, it doesn't get

 15 covered in the LSOC, it doesn't get covered in the

 16 futures model, so when variation margin comes back

 17 and forth it gets passed around and there is risk

 18 in transit. One of the advantages to the triparty

 19 arrangement and as was suggested this morning

 20 perhaps adding to the DCO to that is that you

 21 don't have that transit risk. So in a bankruptcy

 22 where there are tons of players, much more than
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 1 we've ever had before, on the clearing experience

 2 that people were talking about and praising that

 3 there was zero, there were a very few players on

 4 those markets because it was just the dealers.

 5 Now we're talking about adding the whole market.

 6 So albeit it's comfort. Is it complete comfort?

 7 Absolutely not. And we would say when we went

 8 through Lehman we had tens of millions of dollars

 9 of exposure to Lehman. Guess what? We got it

 10 because it was in our account with the bank and it

 11 protected us. What we're saying is if you're

 12 asking me to get out of a car with air bags, seat

 13 belts, side bags and get into a car without that,

 14 I say I should have a right to wait until it has

 15 it. So we're suggesting that the optionality

 16 model here would address collateral, these transit

 17 risks and these other risks and we should just

 18 wait until we get that taken care of.

 19 MR. NICHOLAS: I mentioned this toward

 20 the end of this last session, I think one of the

 21 things that would make the buy side feel more

 22 comfortable is greater insight and greater
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 1 disclosure into the FCMs as this gentleman at the

 2 end of the table said and it's something that we

 3 suggested in a comment letter that we wrote some

 4 time ago on this topic, greater disclosure. I

 5 speak for our firm, but I don't believe that many

 6 FCMs would have an issue with that.

 7 MR. WASSERMAN: Let me ask about that

 8 because I assume what you're talking about is

 9 things about information on your balance sheet.

 10 MR. NICHOLAS: Yes. What I was thinking

 11 is I'd be very interested to hear from this group

 12 what information they would find useful or what

 13 would think would be material information that

 14 they're not getting right now.

 15 MR. WASSERMAN: Let me ask this. Would

 16 the information that you're willing to disclose

 17 also include the policies that you have for doing

 18 risk management?

 19 MR. NICHOLAS: I would think so.

 20 MR. WASSERMAN: Would that also include

 21 the exceptions to those policies?

 22 MR. NICHOLAS: I don't know. I haven't
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 1 really considered that, but again I'd rather hear

 2 from this crowd.

 3 MR. MACFARLANE: Bob, I'll take a shot

 4 at that. I think if given the choice between more

 5 transparency around our FCM and their policies,

 6 and it would have to go beyond that because we'd

 7 have to have transparency into who else is in the

 8 client pool if we're using the omnibus method. If

 9 I had the choice of that versus a full segregation

 10 model that would give the certainty around the

 11 collateral, I'd choose the latter because the

 12 former while it would give you some comfort, the

 13 world is a very dynamic place and those exposures,

 14 those financials, those counterparties can change

 15 from one day to the next. I think many of us,

 16 you've heard that there is a common theme, we'd

 17 really like to have control over our own destiny.

 18 That's what we've had in the OTC market. We've

 19 been able to choose our OTC counterparties, we've

 20 been to isolate our risk. If we choose one

 21 counterparty and not another, we know we have no

 22 exposure to that counterparty. However, in an
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 1 omnibus model, we could be exposed to that

 2 counterparty in the omnibus pool so we'd lose

 3 control over our own destiny. Again, I'm sorry to

 4 come back to this, but if we're not given a

 5 choice, what we will choose to do in a market that

 6 is disrupted, we will back away. We'll pull our

 7 capital away and that will add to the diminishing

 8 liquidity in the marketplace that will already be

 9 there as a result of the crisis itself.

 10 MR. PRAGER: If I could add, and I

 11 completely agree with John, if given the choices,

 12 I'd rather not have to make those judgmental calls

 13 based on ratings and judgments of fellow

 14 customers, and as a fiduciary we would like not to

 15 have to make those types of risks. We are hired

 16 to make investment risks and if we could

 17 standardize this by having the segregation and

 18 take that decision making away and then we can

 19 focus on our expertise, that's what we're hired to

 20 do. Maybe where we end up is forcing more

 21 disclosure with FCMs and then we are going to just

 22 have to hire ourselves more credit people that can
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 1 make those assessments and we will be forcing you,

 2 John, to tell us every time you have an infraction

 3 and we want to know whatever the regulators do to

 4 sanction you, we will expect that to be disclosed

 5 and we'll want to know all those customers. That

 6 sounds to me like going down a path which is

 7 unnecessary given the options on the table and the

 8 proposed rule negates the need to do all that.

 9 MR. WASSERMAN: To be clear, if you were

 10 to do that, would that impose any costs on you?

 11 MR. PRAGER: Absolutely. That's why I

 12 said we'd have to hire all sorts of

 13 risk-management people, we'd have to be going out

 14 doing the same sort of diligence. Ken was talking

 15 before about soaring audit costs. We'd have to

 16 hire whole departments, go out to interview FCMs,

 17 monitor change every time there's any change in

 18 their balance sheet, look at different customer

 19 profiles. It's just a whole different nature of

 20 risk that today we don't have as you heard down

 21 here in the bilateral world. We have a limited a

 22 number of counterparties, but we don't have this
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 1 notion of fellow customer. That's this unknown to

 2 us.

 3 MR. NICHOLAS: I'm not sure I completely

 4 agree with that because even when you're dealing

 5 with a dealer, that dealer has multiple products,

 6 multiple activities, multiple customers, you don't

 7 know on the other side of your activity what it's

 8 doing necessarily.

 9 MR. PRAGER: But if we're in a triparty

 10 it's not an issue.

 11 MS. TAYLOR: You won't lose your

 12 collateral, but I think you'll lose your position.

 13 MR. COX: That's a good point. We keep

 14 talking about triparty as though it's a silver

 15 bullet. In all of our derivative counterparties

 16 that we use triparty arrangements with, there is

 17 still the risk that the position that you have

 18 with that dealer losing your favor while you're

 19 trying to replace it and you incur costs that way

 20 so that this idea that somehow having a triparty

 21 arrangement with one counterparty totally

 22 eliminates your counterparty risk I think is a
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 1 little bit disingenuous. It really doesn't.

 2 The other thing I'd say is I don't think

 3 anyone is suggesting a model for cleared

 4 derivatives where we do bear customer risk. I

 5 thought that was off the table. So we spend a lot

 6 of time talking about fellow customer risk. I

 7 thought what was being proposed here was this LSOC

 8 model where that's been eliminated as long as you

 9 think it works.

 10 MR. KAHN: I think no matter where we

 11 end up in terms of segregation, I think as an FCM

 12 as Bob suggested, Barclays does agree and would be

 13 willing to show our risk- management procedures

 14 and policies, and we do talk to our buy side

 15 clients about that. One thing where we are

 16 extremely cautious and will continue to be is

 17 client confidentiality in the NDAs. This is a big

 18 concept that when buy side firms are looking at

 19 FCMs to provide clearing services, we are often

 20 and I'm sure my colleagues from the FCMs are asked

 21 who also do you clear for. We have not said any

 22 time a specific client that we are providing
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 1 clearing services for so that if Barclays is

 2 providing clearing services for any of the

 3 individual firms on the other side of the table,

 4 we do not say that, nor would we ever give out any

 5 position level information. It is very important

 6 to us that in whatever paradigm it's set up and

 7 how you evaluate from a risk-management standpoint

 8 that the buy side and their trades that they've

 9 put on that we are serving remains confidential

 10 and does not leak to the market in any side.

 11 MR. WASSERMAN: Just to be clear, if on

 12 the other hand somebody from the clearinghouse

 13 came and said you're a member. We're auditing

 14 you. We're reviewing your work. We need to know

 15 this kind of information. Is that information

 16 that they would be able to get?

 17 MR. KAHN: To be honest, I would have to

 18 go to my compliance team and legal team. Just

 19 someone showing up and saying I'm from the CME,

 20 I'm from ICE, that would not be enough. Once it

 21 was cleared from compliance, we are going to take

 22 so much caution on that, I can't tell you. So,
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 1 yes, from a regulatory standpoint whatever is

 2 acceptable to the community is fine, but we will

 3 guard our clients' positions with tremendous

 4 emphasis.

 5 MS. TAYLOR: And we don't tell either.

 6 So when we know when people clear, that's very

 7 confidential information and I'm very sympathetic

 8 to the fear about fellow customer risk, but I'm

 9 also very sympathetic to the fact that none of you

 10 would want your information disclosed so that

 11 there is a balance on the other side and I think

 12 there are probably ways to get some disclosure

 13 that would be anonymous and reflective of risk

 14 profile without being reflective of exact client

 15 mix. But again I heard both of you loud and

 16 clear.

 17 MR. PRAGER: We are not a proponent of

 18 that. We're a proponent of the proposed rule and

 19 we don't have to worry about that.

 20 MS. TAYLOR: You would have optional

 21 physical segregation.

 22 MR. WASSERMAN: To be clear, Kim, I know
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 1 you folks don't disclose things, but when the Dow

 2 Michael's people or Ann Begin's people go in, they

 3 do get access to information that cannot for

 4 confidentiality reasons go to fellow customers.

 5 MS. TAYLOR: Yes.

 6 MR. MAGUIRE: An important distinction

 7 to make as well, we do keep talking about the

 8 bilateral arrangements and I think it's been

 9 raised, but to make sure everyone is very clear,

 10 you have protection for the collateral and you

 11 hold out for the P&L on your positions, maybe for

 12 your independent amounts as well, but then if that

 13 broker goes into default, you have replacement

 14 costs and that's the difference here that we're

 15 talking about with clearing, you do not have to

 16 replace your position. We just talked about $600

 17 trillion long dated illiquid markets, highly

 18 volatile, you do not have to go into the market

 19 and place -- that's the insurance you're buying

 20 here rather than anything else.

 21 MR. RADHAKRISHNAN: Let me ask a

 22 question about the bilateral arrangements. Jim,
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 1 you mentioned the triparty agreement and Ritchie

 2 you had mentioned that as well. Essentially if

 3 you have a trade with a dealer and the dealer asks

 4 you for collateral, if I understand you correctly,

 5 you put out the collateral but it goes to a third

 6 party who holds it. The question I have is

 7 legally how does that party hold it? Does that

 8 third party hold it in trust for your

 9 counterparty? Number two, if there is a default

 10 or if your counterparty goes bankrupt, you

 11 mentioned that in Lehman you got your money back.

 12 How secure is that? In other words, is that

 13 purely a contractual right which a court cannot

 14 touch? Or is it so secure that in the event of an

 15 insolvency you're very comfortable that the money

 16 will come back?

 17 MR. HARSHAW: The way the account is set

 18 up is when we have collateral to post, the

 19 custodian which is a third party unaffiliated with

 20 either one of us will open up an account in the

 21 name of the GM Pension Plan for the benefit of the

 22 dealer. The collateral that's posted is ours and
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 1 remains in our title. We're the legal owners.

 2 They're a beneficial owner to the extent we

 3 default, but if we don't default it's still ours.

 4 Similarly, if the dealer has to post collateral,

 5 the custodian will open up an account that says X

 6 dealer for the benefit of the GM Pension Plan.

 7 In an insolvency of either one of us

 8 which for pension plans is not something that can

 9 happen, in the insolvency of the dealer what

 10 happens is that we then have the ability to close

 11 out our trades and under the agreement subject to

 12 bankruptcy law we're able to pull back that

 13 collateral in payment of the amounts owed. So,

 14 yes, we are very confident that that works and it

 15 has been tested not just in the Lehman situation

 16 but for other counterparties that have defaulted

 17 over the years.

 18 MR. THUM: To add to that, these are

 19 control accounts under the UCC so there is a

 20 perfected security interest in the assets held in

 21 the account.

 22 MR. RADHAKRISHNAN: By you?
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 1 MR. THUM: By the secured party.

 2 MR. RADHAKRISHNAN: The secured party,

 3 so the secured party has a security interest.

 4 MR. THUM: A perfected security

 5 interest. They would deliver a notice of

 6 exclusive control to the custodian if the pledger

 7 experienced a default and they closed out the ISDA

 8 and the security's intermediary would transfer the

 9 collateral to the secured party. Likewise, the

 10 industry is working through documentation so that

 11 the pledger is also protected in the event the

 12 security party suffers a default so that the

 13 pledger can get the collateral back by sending

 14 instructions to the securities intermediary. So

 15 it's within the regime of the Uniform Commercial

 16 Code, well established to create the perfected

 17 security interest.

 18 MR. RADHAKRISHNAN: The reason I ask you

 19 these questions is what you're trying to do, and

 20 let's be frank, you're trying to replicate what

 21 you have in the bilateral world in the cleared

 22 world. Right? That's what you're trying to do.
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 1 What I want to know from the FCMs and the DCOs is

 2 can that be done, one? Number two, if it can be

 3 done, how much does it cost? And number three,

 4 how long does it take? Because the one thing --

 5 MR. WASSERMAN: May I add a fourth?

 6 MR. RADHAKRISHNAN: Yes.

 7 MR. WASSERMAN: Is that equally

 8 effective to protecting your ability to access

 9 that money in the event of a default? For

 10 instance, one question in mind as I'm thinking

 11 about this is there are security interests, so as

 12 I understand it, your counterparty has a security

 13 interest in the amount you've posted with the

 14 third party. My question is, is that a margin

 15 payment within the meaning of the financial

 16 contract provisions of the bankruptcy code such

 17 that essentially they don't need to do anything to

 18 enforce that security interest, they can just grab

 19 it. In the event of your bankruptcy, essentially

 20 do they have the money or do they have to go and

 21 get the money? Then the questions goes to you

 22 folks. Are you happy with money that is not in
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 1 your possession but, rather is held at a third

 2 party in which you have a security interest?

 3 Mr. MACFARLANE: Can we be clear that

 4 we're talking about initial margin and not

 5 variation?

 6 MS. TAYLOR: Right.

 7 MR. RADHAKRISHNAN: One more point I

 8 wanted to add is in the bilateral world there is

 9 just one party asking for collateral and that's

 10 your counterparty. It's both ways, but let's

 11 saying you're being asked for collateral. In the

 12 cleared world, there are two parties and they're

 13 not related to each other. In other words,

 14 there's the firm that's asking you for collateral

 15 to protect itself, and then there's the DCO that's

 16 asking the firm for collateral. How does that

 17 change the whole dynamic? That's what I'd like to

 18 ask.

 19 MS. TAYLOR: Ananda, I think to answer

 20 some of these questions, I doubt that right now

 21 the way these things are structured they would

 22 fall under the Commodity Exchange Act as margin
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 1 payments because they're bilateral transactions,

 2 but I would assume that the documents could be

 3 written in such a way that there was an

 4 acknowledgement in the document that the payment

 5 was margin under the Commodity Exchange Act and if

 6 there was a default it could be seized as such, so

 7 I think you could get around the legal

 8 distinctions about it. From a clearinghouse point

 9 of view, there are definitely two ways to

 10 structure it and I don't want to get in front of

 11 what the dealers might prefer. There's a way to

 12 structure it where the dealer has the account for

 13 the most part and then it only becomes the

 14 clearing's lien when it is passed through because

 15 they might have more collateral. You might need

 16 two accounts. There's definitely a way that you

 17 could make it work. I think that from a

 18 clearinghouse point of view I feel like it gives

 19 the customers better protection by far than the

 20 LSOC model because it is absolutely clear at the

 21 time and it is clear to the clearinghouse whether

 22 or not that customer defaulted and you don't have
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 1 to unscramble eggs. So from that point of view I

 2 think it gives the customers who are using it much

 3 better protection. I think it costs more and so I

 4 would hesitate to have us set up an environment

 5 where every customer had to bear the cost of that

 6 if they did not feel it was worth the tradeoff and

 7 where the dealers would have to bear the cost of

 8 that for every single customer that they had

 9 instead of customers of whatever the appropriate

 10 scale would be and the same thing for the

 11 clearinghouses.

 12 MR. FRANKEL: To make a point, I think

 13 the collateral what we're talking about would be

 14 DCO eligible collateral which is a restricted set

 15 of collateral. If you have in mind a whole range

 16 of collateral that you now post to dealers, it's

 17 not that.

 18 MR. PRAGER: Kim, a point of clarity, if

 19 I may. You're saying it's superior to LSOC and it

 20 is legally segregated. How does it then fit in

 21 the waterfall? How does the current FCM model

 22 treat that subject to the waterfall?
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 1 MS. TAYLOR: Right now it's not allowed

 2 under the waterfall so in the world where there

 3 was physical legal segregation, the way I would

 4 see it is the customers who had the physical legal

 5 segregation, think of them as pools of their own

 6 and they would make settlement on an

 7 individualized basis so it would be clear whether

 8 or not they defaulted. And if the customers who

 9 didn't chose that option, if one of those

 10 customers defaulted, that would be a pool and it

 11 would be managed as such and the customers over

 12 here in the separate pools would be free to port

 13 without having to do wait to find out if there was

 14 more money coming or figure out which one of them

 15 actually was the one that drove the default. If

 16 you have enough money in your account to meeting

 17 your obligations, you didn't default to the

 18 clearinghouse. You can pick up and move somewhere

 19 else, and believe me, we would be helping you to

 20 do that if you needed help. Because it's in

 21 everyone's best interest that as many customers as

 22 possible to not have their trading disrupted, not
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 1 lose their hedge and not lose their collateral.

 2 So we're all very aligned in that regard. The

 3 uncertainty of the LSOC model is where it becomes

 4 harder for me to be comfortable that you would get

 5 what you want.

 6 MR. PRAGER: You had a bankruptcy debate

 7 prior? First of all, this doesn't exist today so

 8 it's not an option.

 9 MS. TAYLOR: Our attorneys feel like it

 10 is. I don't think that they've been able to

 11 convince the CFTC, but I think there's definitely

 12 room for discussion. There is definitely viable

 13 interpretation that says that it's okay.

 14 MR. WASSERMAN: To be clear, you

 15 mentioned your attorneys think that it is and of

 16 course we got something from Mr. Salzman who said

 17 he was speaking on his own behalf and not on

 18 yours. But in any event, beyond that which is on

 19 our website, is there any other analysis that

 20 you're aware of that explains why this would work?

 21 MS. TAYLOR: I don't know that we have

 22 shared anything else with you, but we certainly
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 1 would be happy to. One of the other distinctions,

 2 and I'm not a lawyer so I'm at a disadvantage in

 3 having this conversation with you, is that the

 4 ratable distribution only applies to things that

 5 are defined as customer property and I don't think

 6 that collateral like this in these third-party

 7 accounts held at a clearinghouse would necessarily

 8 be customer property. Therefore it's not subject

 9 to the ratable distribution.

 10 MR. WASSERMAN: To make that clear, what

 11 you're saying is customers would be posting this

 12 collateral but it would not be eligible for

 13 treatment as customer property under the

 14 bankruptcy code? There's a bit of a bitter with

 15 the sweet issue. That is to say, the bitter is

 16 that the ratable distribution, there are some

 17 sweet things about being treated as customer

 18 property and protected as customer property under

 19 the bankruptcy code and so I guess the question is

 20 --

 21 MS. TAYLOR: In this circumstance what

 22 would those be?
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 1 MR. WASSERMAN: Essentially, for

 2 instance what we saw with Lehman, that instant

 3 transfer where essentially there was this separate

 4 estate that got to be transferred out without

 5 waiting for essentially the bankruptcy process to

 6 work its way through and people eventually

 7 collecting. Customer property essentially can be

 8 moved. For instance, with 764(b) we get to

 9 approve and we have by rule and could by order

 10 approve transfers which are then not subject to

 11 claw-back, things like that. Those are good

 12 things that customer property benefits from.

 13 MS. TAYLOR: And these are things that I

 14 presume that you --

 15 MR. HARSHAW: Bob, I think you've hit

 16 the nail on the head, that you by regulation in

 17 terms of the analysis, we did have a law firm look

 18 at this and the viewpoint was that the bankruptcy

 19 code requires that the distribution of customer

 20 property be done ratably. Ratably is focused by

 21 Part 190 which provides that ratable distribution

 22 is done by customer class and then the customer
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 1 class is actually done by you and in your adopting

 2 release that created the concept of customer

 3 class, I'm quoting, "The reason for identifying

 4 classes of customer accounts is to permit the

 5 implementation of the principal pro rata

 6 distribution so that the differing segregation

 7 requirements with respect to different classes of

 8 accounts benefit customer claimants based on the

 9 class of account for which they were imposed."

 10 The customer account categories are such that

 11 there is broad flexibility. For example, you've

 12 got an account for a leveraged account. That's

 13 not based on who the customer is, it's based on

 14 the type of account strategy that's being

 15 employed. We think you have the regulatory

 16 authority to make a customer account for those who

 17 pick full segregation. We also believe you have

 18 the regulatory authority to deal with the customer

 19 property issue that you were just talking about.

 20 So we do think that there is flexibility to take

 21 this triparty.

 22 When we talk about costs, let me take a
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 1 second on that. There exists today these

 2 custodian accounts. It's a contract. Under the

 3 CFTC regulations we're going to have to realize

 4 all of our derivative contracts so we're already

 5 there. There is no more additional cost. One

 6 additional thing that we could do here in our

 7 contracts is to revise is to give the DCO direct

 8 access to that collateral. We could provide it in

 9 a way that accomplishes concerns from systemic

 10 risk not adding any more accounts because they

 11 already exist and we would give the FCM the rights

 12 that it needs and would give us the third-party

 13 recordkeeping, reporting, et cetera. One of the

 14 great things about internal controls is it says

 15 separation of duties. One of the bad things about

 16 the futures model is there is no separation of

 17 duties. The DCO relies on the FCM and many of the

 18 clearinghouses to tell them what their customers'

 19 exposures or collateral is. The FCM tells us what

 20 our reports are. The great thing about this model

 21 is it permits everybody, the DCO, the FCM and the

 22 customer, to get transparent reporting and still
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 1 keep costs down because those accounts exist and

 2 all we have to do is change the contract which we

 3 already have.

 4 MR. WASSERMAN: Speaking to the

 5 bankruptcy point and this of course came up

 6 earlier this morning in terms of whether the

 7 account classes work and folks expressed a great

 8 deal of confidence in our ability to pass

 9 regulations that would make that work. Back 14

 10 years ago, Griffin Trading went bankrupt and there

 11 was a challenge to our rules under Part 190 which

 12 said that we've got to count everything as

 13 customer property. And Judge Katz in the

 14 Bankruptcy Court in the Northern District of

 15 Illinois said, sorry, CFTC. That rule was beyond

 16 your powers. So having been through that and been

 17 part of that, you can understand why I've got a

 18 little bit of a concern to make sure that we don't

 19 to beyond our powers and start putting things in

 20 the regulations that are beyond our powers and

 21 then people rely on them and the industry builds

 22 up a structure around that and then a bankruptcy
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 1 judge chops it down and then all of a sudden all

 2 of the things that folks are counting on aren't

 3 reliable.

 4 MS. TAYLOR: The Griffin example, wasn't

 5 that the case where we were trying to have the

 6 customer as a class be a preferential creditor to

 7 everybody else for everything else the firm had?

 8 It was not a question of there being a question

 9 about the things that were actually customer

 10 property.

 11 MR. WASSERMAN: That was the facts of

 12 that case. But the point I'm making is that if we

 13 go beyond -- again the bankruptcy code has a

 14 structure and part of that is 766(g) and the

 15 ratable distribution and so the challenge then

 16 won't be from other creditors against the customer

 17 creditors, but it will be between customers and

 18 subject to the same thing where you have somebody

 19 who's not getting what he thinks he should and he

 20 thinks that the law entitles him to going and

 21 challenging our regs and bankruptcy judges who in

 22 my experience are not always entirely enamored of
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 1 our regs looking at them and being able to say --

 2 maybe they'll say, yes, you got it just right, but

 3 on the other hand it's also possible they'd say,

 4 sorry, you've gone beyond your powers, and if that

 5 were to happen then in the middle of a bankruptcy

 6 we have essentially a change. One of the things

 7 I've learned in terms of the implementation issues

 8 is the industry needs to build structures around

 9 our rules and you need to implement them and it's

 10 going to cost people a lot of money and time and

 11 if we put out a rule and it gets undercut, first

 12 of all, it would be undercut at the worst possible

 13 time and secondly it would undercut what might

 14 some very expensively built structures so that

 15 that is the reason for caution.

 16 MR. MACFARLANE: Bob, having heard that

 17 there are different legal interpretations from

 18 different lawyers who are advising the firms

 19 around this table, that's a risk that we all take

 20 just like market risk. Again wouldn't it be

 21 better to give the market participants the choice

 22 and let them decide which risk they'd rather take?
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 1 Would they rather take this legal bankruptcy risk

 2 or would they rather take the omnibus risk? And

 3 then let the market decide where it wants to

 4 allocate its resources and then in a way disclose

 5 that this risk exists but not warranted.

 6 MR. RADHAKRISHNAN: The concern for us

 7 is if we take the legal risk and you have a

 8 catastrophic insolvency then it would have an

 9 outcome on market operations that nobody wants.

 10 I'd like to know what the DCOs think about this

 11 because as Kim pointed out, in most of the issues

 12 that we've dealt with in the past 10 years, we've

 13 been lucky in that there has not been any instance

 14 where there was difficulty in moving positions.

 15 For example, in Lehman, we went to court and the

 16 judge agreed with us and everything went fairly

 17 smoothly. But what I think I'm concerned about is

 18 let's say we say, fine, you take the risk. You

 19 have customer choice and let's take the risk that

 20 the judge will agree with what we think. What

 21 happens if the judge does not? What happens with

 22 fairly significant firm which goes under and there
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 1 is a great deal of uncertainty as to whether

 2 positions can be transferred or even worse, where

 3 the judge says no liquidated -- so that's the

 4 concern?

 5 MS. TAYLOR: That is a real issue that

 6 everybody would need to think through and maybe

 7 it's a good point that everybody should have the

 8 ability to think that through themselves and make

 9 their decision. I got to believe that the

 10 contracts that are around these third-party

 11 custody accounts have the ability to stand up to

 12 bankruptcy issues anyway or they wouldn't have

 13 worked in the Lehman situation. I almost feel

 14 like we're going to have belts and suspenders in

 15 terms of the protection because there's the

 16 contractual provisions that stood up in a non-CFTC

 17 regulated bankruptcy and then there's the CFTC

 18 regs layering on top of it. I got to believe it

 19 makes it better and not worse.

 20 MR. WASSERMAN: The question is whether

 21 they work together. One point I would make to try

 22 and get toward tying this up together is there are
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 1 a number of views that have been expressed and

 2 some second hand in terms of lawyers, we're

 3 eventually going to have a comment period once the

 4 Federal Registry gets around to publishing. One

 5 of the things we would very much appreciate if

 6 people have divergent views in terms of the legal

 7 issues here is certainly if any one law firm were

 8 to file essentially a comment in the nature of an

 9 analytical memo that would help explain why there

 10 might be a divergent view, that would be very

 11 helpful. In other words, as a practical matter

 12 sitting around here we can't go too deeply into a

 13 complete legal analysis. On the other hand, a

 14 comment that says I think X is nowhere near as

 15 helpful as an analytical comment, I think X and

 16 here in detail are the reasons why.

 17 MR. EDMONDS: Bob, do you have the same

 18 issue with LSOC as it's being proposed? Are you

 19 just dead certain and it's legally tied up that

 20 LSOC absolutely under no conditions could be

 21 misinterpreted or turned over in a bankruptcy

 22 proceeding?
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 1 MR. WASSERMAN: Here's why, because

 2 under LSOC at the end of it if you liquidate, what

 3 you would be giving back, the idea is you would

 4 have to give back to the trustee whatever is left

 5 of the collateral that is attributed to each of

 6 the customers. Thus the fellow customer risk

 7 would not be realized. Liquidity issues is a

 8 separate story. I realize that. But the fellow

 9 customer risk would not be realized because

 10 essentially you would be looking at those

 11 positions customer by customer by customer. That

 12 money would then go back to the trustee and the

 13 trustee would be distributing that ratably and

 14 there wouldn't be the fellow customer losses

 15 because that would be a ratable distribution. In

 16 other words, the intention, the design and again,

 17 are you asking am I quite confident? Yes. Is

 18 there basis for others to question it? Of course.

 19 But what I'm saying is that the intention was to

 20 design something that would work with the grain of

 21 the Bankruptcy Code, with the concept of ratable

 22 distribution rather than trying to get out of the
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 1 Bankruptcy Code and saying we're going to have

 2 something that we'll distribute it individually

 3 rather than ratably but to keep the ratable to

 4 protecting all of the customer collateral.

 5 MR. HARSHAW: Bob, one of the things you

 6 talked about is the ratable distribution and as we

 7 noted before, that's by customer class.

 8 MS. TAYLOR: Yes.

 9 MR. HARSHAW: Those classes are already

 10 done. You've already established customer classes

 11 and so if there is a risk that that whole concept

 12 of a customer class won't be honored in a

 13 bankruptcy, it's not a new risk. It's a risk that

 14 exists today for every customer class that's out

 15 there. So if a bankruptcy court were to say that

 16 the CFTC does not have the authority to set

 17 customer classes, they could do that today. So

 18 we're not creating a new risk. It's a risk that

 19 already exists. In addition, those customer

 20 classes, you have the flexibility to provide as

 21 the release said for the concept of customer class

 22 to accommodate different segregation requirements
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 1 and we really do think that the law is pretty

 2 clear, not unclear, that you have that authority

 3 and if there is a risk associated from different

 4 interpretations, it's a risk that we're living

 5 with today.

 6 MR. FOLEY: I'd have to challenge that,

 7 sir. All this may have a certain amount of legal

 8 uncertainty to that, but the Commodity Exchange

 9 Act requires segregation of customers depending on

 10 are you trading futures, are you trading swaps.

 11 There is nothing in the Commodity Exchange Act

 12 that says you can establish separate segregation

 13 requirements for customers trading the same

 14 product. The Bankruptcy Code I think it may be

 15 accurate to say does not mention account classes,

 16 but it does define a claimant's right based upon

 17 whether or not it is a customer and it is a

 18 customer with respect to certain products. It is

 19 a customer that has a claim against an FCM if it's

 20 trading futures on a U.S. Futures market. It has

 21 a claim against a U.S. FCM if it's trading foreign

 22 futures. It has a claim against an FCM now if it
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 1 is trading cleared swaps. Those are the account

 2 classes that I think the Bankruptcy Code

 3 contemplates. All this requires a lot more

 4 thought and a lot more detail and I think Bob's

 5 point about legal briefs or memos makes a great

 6 deal of sense and I think it would be helpful

 7 quite frankly if all of us had access to

 8 everybody's legal memos so we could sit around and

 9 really kind of hash these issues out. These are

 10 not simple issues and there are no simple answers

 11 to them and I think it is troubling. What I'm

 12 hearing over here quite frankly is you don't like

 13 the Dodd-Frank Act requirements and that's fine.

 14 If that's what you don't like, that's fine that

 15 you don't like them.

 16 MR. HARSHAW: I don't think that's the

 17 case.

 18 MR. WASSERMAN: To follow-up on that,

 19 Kevin you're quite right, I would note we did in

 20 the release at Footnote 91, I'm not sure where

 21 it's going to be in the Federal Register

 22 ultimately, discuss going back to the 1978
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 1 Bankruptcy Act House report how they were looking

 2 at different types of customers, separate estates

 3 for leveraged transaction merchants versus for

 4 options customers and again I think the point is

 5 we put Mr. Salzman's comment on the website very

 6 quickly and as we get these things in we would be

 7 delighted to have them, to read them and to put

 8 them very quickly up on the website so that to the

 9 extent there are differing views on this point

 10 they can be informed by the legal reasoning and we

 11 can do this on an analytical basis because of

 12 course there's a limit to how much we can do this.

 13 MR. HARSHAW: Absolutely. One last

 14 point here. The Footnote 91 that you referred to

 15 refers to the CFTC thought there was a problem

 16 with separating classes other than by kind of

 17 customer in each customer class and the reality is

 18 that's already been done. For example, the CFTC

 19 created the deliverable account which is based on

 20 the method of settlement and not rather the kind

 21 of customer. There is also, Mr. Foley, across

 22 accounts. One of the customer classes is
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 1 leveraged accounts which is to my knowledge not

 2 product specific.

 3 MR. FOLEY: No, that is product specific

 4 and it's just a product that's not being offered.

 5 MR. HARSHAW: Then I stand corrected.

 6 But the point is that we believe that there is a

 7 basis to do it on for example deliverable accounts

 8 on other than just the kind of customer.

 9 MR. MAGUIRE: Bob, we started off on

 10 this path with what's the impact of this model

 11 versus LSOC for the DCOs and FCMs, so may I bring

 12 us back to that?

 13 MR. WASSERMAN: Yes.

 14 MR. MAGUIRE: Looking at it very simply

 15 at risk rather than a lot of the legalese around

 16 this, under LSOC the DCO has the money from the

 17 FCM from the customer in its account. Under this

 18 model it doesn't. So I know that one feels more

 19 certain in the first instance. Then let's talk

 20 about what are the impacts in terms of

 21 implementation and the impacts on the DCOs -- but

 22 in that construct it's not in our powers to hold
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 1 that collateral so in our account is better than

 2 not in our account just being very simple about

 3 it.

 4 Then you've got some operational

 5 complexity. If you've got 1,000 clients, they're

 6 likely to have more than one FCM, there's going to

 7 be therefore say three FCMs, therefore that's

 8 about 3,000 collateral accounts and you're going

 9 to have more than 1,000 clients one would expect

 10 and each DCO would have to have similar in each of

 11 the custodians and then you're going to have to

 12 talk about is it one custodian or more custodians.

 13 All of these things are achievable but there are

 14 layers of complexity and reconciliation work that

 15 needs to be built to be able to do this, so that

 16 there are those angles.

 17 Then we also have to look at when you

 18 put your collateral into a custodian, you're

 19 transferring the credit risk from either the FCM

 20 or the DCO into the custodian as well. Custodians

 21 may go pop as well so there are assessments that

 22 would have to be considered around custodians as
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 1 well. On top of that my concern with going down

 2 this route in the first instance, I think LSOC is

 3 one step toward it, but in the first instance of

 4 moving down this route is some people on the other

 5 side of the table I'm sure have very high-grade

 6 quality collateral that we would accept as DCOs.

 7 I would wager that not everybody on the buy side

 8 does so it could become a two-tier structure where

 9 those with collateral that is acceptable to the

 10 clearinghouse because you have to have acceptable

 11 to post it to the clearinghouse direct, they could

 12 use this kind of model, whereas those clients that

 13 didn't necessarily, they wouldn't be able to use

 14 this model unless we as DCOs went down the

 15 collateral curve, the credit curve and took less

 16 liquid creditworthy collateral so that by moving

 17 down this route it puts further pressure on the

 18 DCOs to take a broader range of collateral in --

 19 so we just needs to be cognizant of where this

 20 would lead and also -- between some clients that

 21 have good collateral and some that don't.

 22 MR. EDMONDS: I think, Dan, the last
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 1 point of it is the type of collateral under 125 is

 2 -- universe and not everyone represented by the

 3 buy side holds all of that type of collateral all

 4 of the time when they need it. There is going go

 5 be an unintended cost for that acquisition of that

 6 collateral if we're going to post direct through

 7 that and not use the intermediation factor through

 8 the FCM to get through there which is problematic.

 9 One question I asked to ask is we talked

 10 about the LSOC model and you went through why you

 11 think it is better than the other alternatives

 12 from a legal structure perspective. Isn't it also

 13 theoretically possible that if we go through the

 14 liquidation and we do all the things that we have

 15 available to us in the toolbox in the time of

 16 stress, the loss to the buy side is going to be

 17 greater than what their fellow customer could be

 18 in that scenario by the time to go replace the

 19 positions, the P&L, the move and all that in order

 20 to get back to the net position that they were in

 21 before? Was there any thought around that in

 22 development?
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 1 MR. WASSERMAN: Let me answer that

 2 question and then what I'm going to want to do is

 3 have us move on a bit and then we might come back

 4 to this because later on on the agenda we're going

 5 to talk about specifically operational costs and

 6 risk costs and maybe after we talk about those

 7 turn those back and talk about optional models in

 8 those terms. But in answering your question,

 9 Chris, as I see it if you're doing things on an

 10 omnibus basis, then essentially there's enough

 11 money in the account or there isn't. If there's

 12 enough money in the account, then under model,

 13 this is Refco, this is Lehman, under any of those

 14 models it's just a matter of finding someone who

 15 can handle the book and transferring it to them

 16 but that's if there is enough money, in other

 17 words, if the loss wasn't from a fellow customer.

 18 But if there was a fellow customer, then I'm

 19 trying to see how there would be a greater loss to

 20 the customers if their money is at risk, how there

 21 could be a grater loss if their money isn't at

 22 risk than if you're entitled to look to their
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 1 money, their collateral, their value, to make up

 2 the loss to the fellow customer.

 3 MR. EDMONDS: I could be completely

 4 wrong about this, but if the fellow customer loss

 5 is a dollar on a pro rata share and we have to

 6 liquidate because that dollar is not there, so we

 7 the DCOs come in and we liquidate those positions,

 8 close them out, hand the collateral back, it's all

 9 there. Everybody is happy with the collateral.

 10 But because we liquidated those positions, they

 11 need to reestablish those positions for what it

 12 means to their book over time and it takes a few

 13 days to do that, and when they reestablish those

 14 positions they're in a worse off place than they

 15 were for their overall book for the buy side.

 16 Does it theoretically exist that it cost them more

 17 money now?

 18 MR. WASSERMAN: I guess what I'm saying

 19 that's an apples and oranges to my mind and here's

 20 why. Essentially there are two separate

 21 questions. One is based on the circumstances are

 22 you going to liquidate? So if the loss was a
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 1 dollar, I'm going to think under of these models

 2 unless the market was really, really bad you

 3 wouldn't liquidate. I guess what I'm saying is if

 4 you're comparing if we go under LSOC and we do

 5 liquidate versus if we go under the futures model

 6 and we don't liquidate, yes, of course it's going

 7 to be more expensive with the first than the

 8 second except I don't see how you get there

 9 because how is it --

 10 MR. EDMONDS: You and Kim had the

 11 conversation this morning about are the customers

 12 in default or they're not in default and as a

 13 clearinghouse we have to make a decision within a

 14 finite period of time, and I'm proposing that they

 15 could be, and I freely admit that I could be wrong

 16 here, but the time value that is there, at that

 17 money in time that the clearinghouse makes that

 18 decision, you and I have had a conversation about

 19 duty of care from clearinghouses to members and to

 20 their customers over time, we make the decision to

 21 liquidate because we had no visibility to that

 22 other side. The net result is from a collateral
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 1 perspective we're in a whole position, but from a

 2 market perspective the buy side ended up worse

 3 than the other.

 4 MR. COX: What is the circumstance where

 5 you'd do that under the LSOC model and you

 6 wouldn't have done it in under a futures model?

 7 MS. TAYLOR: I don't know that there's a

 8 circumstance where we would do it under the LSOC

 9 model where we wouldn't have done it under the

 10 futures model under the pooled model because the

 11 event is the same. The triggering event is that

 12 the FCM did not say so the way I have thought

 13 through the unintended consequences of how LSOC

 14 works, I think we're going to end up in a place

 15 where we're going to collect from the FCM the sum

 16 total of all the monies that are due and owing

 17 from all the customers who owe first and then

 18 we'll pay them the money that are due and owing to

 19 the customers who made money. It exaggerates the

 20 settlements and we can manage around that by

 21 letting the banks at least know the other side is

 22 coming so that they can net it off on a credit
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 1 basis, but the FCM is either going to pay or

 2 they're not and then there is a decision and I

 3 think this is one of the decisions that would be

 4 also very challengeable by customers who don't

 5 think they were treated fairly, all the customers

 6 who owed us money, none of them paid and so if we

 7 decide that we're going to let some of them take

 8 their money and their positions and go somewhere

 9 else then I think we'll be in a position where

 10 we'll get challenged by other ones who would have

 11 though maybe they couldn't port, maybe they didn't

 12 find an FCM quickly enough. I don't think it's

 13 foolproof.

 14 MR. WASSERMAN: On that last point I

 15 will note that we did, I think it was in 190.06,

 16 explicitly give you folks the power to do partial

 17 transfers and we mentioned in the preamble -- we

 18 reinforced the importance of your ability to do

 19 partial transfers.

 20 MR. COX: My only point was that I

 21 agree, in an extreme case you might expect every

 22 customer who'd up on the day to be able to port to
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 1 a new FCM very easily and you'd just be left with

 2 those that are down on the day and wondering

 3 whether they're going to meet the margin cost.

 4 That's kind of extreme. My only point was I don't

 5 see how this is any worse than the existing

 6 futures model, that absolutely you could have

 7 replacement cost for customers to replace

 8 positions, but I think you've got that in the

 9 existing futures model or the LSOC model. It's

 10 the same deal.

 11 MS. TAYLOR: Actually I think it's the

 12 opposite because in the existing futures model

 13 you're absolutely going to get your positions.

 14 Your money might be a little behind and it might

 15 be short so it might be a pro rata distribution,

 16 you're absolutely going to get your positions

 17 because it is very clear that the positions can be

 18 transferred to another FCM at the current mark to

 19 market value. You don't take your equity with you

 20 necessarily, but you definitely preserve your

 21 position much more certainly I think in the

 22 omnibus model.
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 1 MR. WASSERMAN: Why so?

 2 MR. COX: I don't see that.

 3 MR. WASSERMAN: Because in addition to

 4 the issue that of course you'd need to be able to

 5 remargin because the transferee is not going to

 6 take those positions without the collateral and

 7 happily we've on to the next point on the agenda,

 8 portability, how is it easier to port the

 9 positions under the futures model versus the LSOC

 10 for an individual customer? Take your pick.

 11 MS. TAYLOR: If you know who defaulted,

 12 you absolutely can transfer the positions of the

 13 nondefaulting customers in the futures model. You

 14 can't necessarily send the money right away, but I

 15 don't think you're going to be able to send the

 16 money right away in the LSOC model either because

 17 you need to liquidate it. The clearinghouse is

 18 allowed to liquidate the collateral and if the

 19 collateral comes up short, everybody takes a short

 20 payment on the investment list. The collateral

 21 can move. It will be circumstantial. It's not a

 22 guarantee. It will be circumstantial.
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 1 MR. WASSERMAN: I can understand an

 2 argument that it would be the same, but my

 3 question is I thought I heard you say it would be

 4 easier to move it under the futures model than

 5 under the LSOC and that I do not understand.

 6 Positions.

 7 MS. TAYLOR: The positions? It's

 8 absolutely clear to me that we would move the

 9 positions of the nondefaulting customers at

 10 current market prices without money if the clients

 11 wanted them. So if the clients can find another

 12 home and can remargin their position, they can

 13 transfer it right away.

 14 MR. MAGUIRE: I think that's the key,

 15 that they have to remargin so they'd have to

 16 double margin. That's the key point for a period

 17 of time which is the same under both.

 18 MS. TAYLOR: For a period of time.

 19 MR. COX: Why wouldn't you let them do

 20 that under the LSOC model?

 21 MR. MAGUIRE: You could. It's

 22 identical.
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 1 MR. WASSERMAN: Why wouldn't you do that

 2 under the LSOC model? Put for the moment the

 3 margin aside.

 4 MS. TAYLOR: I could do that in the LSOC

 5 model for the customers who made money the day of

 6 the default, but I can't do it for the customers

 7 who lost money the day of the default because

 8 every one of those customers technically has

 9 defaulted and until I find out if I can get more

 10 money from any of them, they have all not met

 11 their obligations to the clearinghouse, therefore

 12 I have an obligation to preserve the right to take

 13 the actions that protect the rest of the clearing

 14 members from exaggerated losses from not taking

 15 advantage of the ability to do liquidate the

 16 positions of all of the defaults.

 17 MR. DIPLAS: Kim, I don't get this. Why

 18 can't they default in the omnibus model? What's

 19 the difference.

 20 MR. MAGUIRE: It seems to be a

 21 double-standard.

 22 MR. DIPLAS: I think you know that these
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 1 four people that paid the money or you don't.

 2 MR. KAHN: And to go one step further, I

 3 think all three of the FCMs, there are more than

 4 us that are shaking our heads, if we're a

 5 good-standing FCM we cannot take the positions

 6 without money coming with it because we're going

 7 to end up with the positions that we are then

 8 going to own and the margin may not travel with

 9 us.

 10 MS. TAYLOR: Clearly the client needs to

 11 remargin.

 12 MR. MAGUIRE: I think the key to all of

 13 this is that DCOs who take good collateral can

 14 take the right hair cut and this whole thing

 15 disappears.

 16 MR. THUM: I think we're trying to

 17 understand better how one client's default gets

 18 attributed to multiple clients who have performed

 19 and if there is some technical glitch in the

 20 drafting of the proposal because I can't imagine

 21 that was ever the intention of the drafters and it

 22 certainly wouldn't be our expectation in
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 1 supporting LSOC which we do. So I think we should

 2 try and identify what that glitch is because I

 3 cannot imagine that any of us wants the default of

 4 one client to tar the rest of the client base that

 5 has performed.

 6 MS. TAYLOR: The way the thing reads

 7 right now, by definition people have not performed

 8 if they haven't paid so the clearing member either

 9 pays or doesn't pay on behalf of the losses that

 10 it suffers to the clearinghouse which is likely to

 11 be the sum total of all the losses that its

 12 accumulation of customers suffered. So every

 13 customer who lost money the day that some

 14 customer's failure causes the FCM not to pay is by

 15 definition not in compliance with the requirements

 16 to have paid their P&L. So there will be a period

 17 of time where we try to get that money so we can

 18 make sure that that customer is whole before we

 19 would be willing to transfer I think. It will be

 20 circumstantial, but I think you'd need to make

 21 sure whether or not you had a customer who was or

 22 was not a defaulter. It's harder to determine
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 1 which customers were or were not defaulters than I

 2 think it is in the omnibus model.

 3 MR. WASSERMAN: So Kim, under the

 4 omnibus model, if I'm a customer, I've got certain

 5 positions -- first of all, if you don't know me

 6 until I -- in other words after the default you

 7 don't know me until I introduce myself, but those

 8 positions may have lost money on the day of the

 9 default. You haven't gotten money for them. So

 10 in fact under the omnibus model I'm not sure you

 11 know anything about me other than what I tell you

 12 and indeed my positions may have lost money, but I

 13 still want to transfer them because I had already

 14 paid the FCM and I promise you that's the case,

 15 but you don't know that. Under that case I think

 16 if you're willing to transfer me then you're

 17 willing to transfer me despite the fact that there

 18 was a default that touched my positions.

 19 Switching to the LSOC model, we did put in things

 20 there to make it clear that if I had, again using

 21 my example from this morning, $1,000 worth of

 22 collateral attributable to my positions and those
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 1 positions lost $100, CFTC is not going to force

 2 you to give me back $1,000. You are perfectly

 3 free to apply that $100 against the $1,000. That

 4 doesn't mean there is any reason for you not to

 5 transfer those positions and $900 to another FCM,

 6 and I'm not sure why you would have any greater

 7 right or incentive to do that on the LSOC model

 8 than under the futures model or refuse to do that.

 9 MS. TAYLOR: I think it's because the

 10 way that I read it we're making a decision that

 11 potentially makes the loss that is mutualized

 12 across all the other clearing members worse versus

 13 one that doesn't change the position of the loss

 14 that is applied for all the other clearing

 15 members. Remember we're trying to balance the

 16 systemic risk containment of not bleeding losses

 17 over to parties who are not the defaulter. So in

 18 the case of a pooled regime where I am entitled to

 19 use all of the collateral that I have, if I let

 20 positions go with no collateral because customers

 21 want to put their positions, have gotten rid of

 22 exposure without collateral, I have not worsened
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 1 the loss that's going to go across all of the

 2 other clearing members and I have more flexibility

 3 to do that. I might not always be able to do that

 4 because it might be that all of the positions that

 5 want to move actually do worsen the ability to

 6 liquidate the portfolio, but I have better

 7 flexibility to do it because I'm not worsening the

 8 loss. Whereas if I let a customer who didn't meet

 9 this obligations and I would have had the right to

 10 liquidate his collateral and his positions in

 11 order to reduce the losses that the other clearing

 12 members would suffer, I might be making a decision

 13 that worsens the loss.

 14 MR. WASSERMAN: We're not talking with

 15 recourse. So essentially at least the way it was

 16 meant to be written and if it was imperfect, mea

 17 culpa, but essentially I've got a set of

 18 positions, collateral of $1,000. I've got credit

 19 for that. There was a loss then of $100. So what

 20 you have is you can take that $100 out of the

 21 $1,000 and if you transfer the positions then I'm

 22 not sure how any of your other members is made
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 1 worse off by transferring the positions to another

 2 FCM. And again you're taking that $100. That's

 3 what I owe you. You're taking it out of the

 4 $1,000, only transferring the $900. I'm not sure

 5 how you're making any other member worse off.

 6 MR. MAGUIRE: Bob, can I give you an

 7 example? We have this model live in Europe and we

 8 test this and I can tell you how it works. I'm

 9 going to pick on the three gentlemen there,

 10 Ritchie, John and Rupert. I'm going to pick on

 11 Ritchie and say he's the defaulting client because

 12 I know that will wind him up. In that instance

 13 you have a client that's taken down a clearing

 14 member. Each of these individuals had a risk of

 15 $100 and it's collateralized at $100. I can't

 16 care whether it's T-bills, corporates or whatever.

 17 I have a collateral value - you're giving me $100

 18 each. In each you have a mark to market on your

 19 portfolio of $50. So at the point of default John

 20 says he wants to go to another clearing member

 21 because he's a legally segregated operation,

 22 they're commingled, I say to John, you've got $100
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 1 and your mark to market was $50, but by the time

 2 you port to your new FCM, the market has moved to

 3 $55 so you've got to make good on that $5. Let's

 4 go the other way around, $45. You've lost $5. So

 5 I migrate you across. I say you go to another

 6 clearing member, Ray maybe, I'm only going to take

 7 you if you give me the $100, but also he really

 8 insists you must make good on the other $5 lost

 9 that's accrued in the period of time from the

 10 default until such point you've paid the VM. I'm

 11 going to do the same Rupert. Rupert wants to go

 12 to a different clearing member. He's lost $7 so

 13 he's now down to $43. We go okay, you're going to

 14 go to one of the other FCMs. We take you with a

 15 collateral value of $100, not the same piece of

 16 paper you gave him I'm afraid over a year ago.

 17 And then Ritchie, we're going to close his

 18 portfolio out. Now if the situation arose whereby

 19 when we liquidated that collateral we didn't get a

 20 value of $100 for John and a value of $100 for

 21 Rupert because we'd haircut incorrectly, under the

 22 European model we incur that. That's actually a
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 1 loss borne by the clearinghouse and the defaulters

 2 -- so we say we're confident in our risk

 3 management. We will take hair cuts. We'll price

 4 the collateral on a daily basis and we expect to

 5 be able to close the collateral out within the

 6 assumptions we've got in our risk, and if we don't

 7 that comes out of the waterfall. We don't

 8 actually redistribute that across the clients so

 9 there's no investment risk there as such is what

 10 we call it. That's pretty much how it works in

 11 Europe and how we test it.

 12 In the U.S. model that's being proposed

 13 here, if we did have a reduction in the value of

 14 the collateral and there was a loss, we'd expect

 15 those guys to still port, we'd take their

 16 positions, but let's saying rather than having

 17 $100 it was $98 because we've miscalculated the

 18 hair cut, we'd ask John and Rupert to pay an

 19 additional $2 to Ray and the other FCM to make

 20 good on that. We're not going to not send them

 21 because they've only got $98 and not $100, we'd

 22 send them across and they'd have to make good to
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 1 make that successful as a transfer and if they

 2 didn't, we'd say, sorry, you can't go and then

 3 it's either pay or we'll liquidate. So that's how

 4 it would work in either the U.S. or the European.

 5 One way to take this issue off the table is follow

 6 that similar model whereby it's the clearinghouse

 7 that bears the risk and has to have confidence in

 8 its hair cut collateral, et cetera.

 9 MR. THUM: Dan, what you were saying

 10 seemed to be that Ritchie had defaulted, there was

 11 a market loss on the other two positions. Kim was

 12 saying she wouldn't port any of them because of

 13 the combination of the default and the market loss

 14 so you couldn't therefore determine at that time

 15 who had defaulted.

 16 MS. TAYLOR: The problem is that they

 17 would be defaulting clients where you would

 18 entitled to the liquidation of their collateral

 19 end positions if you needed it and you wouldn't

 20 know yet what you're going to realize on the sale

 21 of the collateral. You don't know what the loss

 22 is going to be.
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 1 MR. FRANKEL: That's sort of odd because

 2 they really wouldn't have to pay their part of the

 3 margin until late in the afternoon and you would

 4 consider them in default in the morning because

 5 the clearing member was in default in the morning.

 6 That seems a little odd. Certainly you'd like

 7 some assurance that it would be paid.

 8 MS. TAYLOR: The clearinghouse has to

 9 make a decision as Chris was saying at a very

 10 specific point in time. That's why the mechanism

 11 because it's very clear when there is or is not a

 12 default and what can be done.

 13 MR. WASSERMAN: I still don't

 14 understand, So again, you've got $1,000 of

 15 collateral attributable to me. There was $100

 16 loss on that and there is the position remaining.

 17 I can perfectly understand your saying, Bob, there

 18 is no clearing member, there's less than $1,000,

 19 we're going to liquidate you because we don't want

 20 to risk further losses. I've got that so far. On

 21 the other hand, if I said, wait, Kim, Laura over

 22 here, she's a member in good standing. She'll
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 1 take that position and she'll take it with the

 2 $900. I've made arrangements with her to get the

 3 $100. I don't see where the clearinghouse is at

 4 risk. You've got your $100 because you're taking

 5 it out of $1,000. So I'm still not understanding

 6 why it is you're not willing to let me transfer

 7 over to her those positions either with or without

 8 the $900. But why aren't you willing her to let

 9 her take the position? She's a member in good

 10 standing.

 11 MR. KAHN: From this conversation it's

 12 important to come up with the most simple and easy

 13 to transact portability process. We have an

 14 extremely savvy, sophisticated group of people at

 15 this table and now we're trying to explain exactly

 16 how it happens. To Dan's example, if one guy went

 17 under and the other guys had $100 but their mark

 18 to markets were $5 million or $2 million and we're

 19 obviously in a market that's really not

 20 tremendously stressed, the fact is under the

 21 example if that were to happen, you're probably

 22 potentially going to have positions that are
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 1 moving 60 points. So if you move a position at

 2 $100 million of IM and it moves two, then the

 3 other FCM is probably likely to take it because

 4 they're going to be able to look at and feel okay.

 5 The fact is if you have $100 million and it

 6 potentially moves 60 or you're really not assured

 7 where it is, then you run the risk of having a

 8 portability situation that could be extremely

 9 chaotic and it does concern people at Barclays.

 10 So I think no matter how we figure out how to do

 11 this, it's important that the market understands

 12 it and all the market participants understand it

 13 because when a port situation comes up again,

 14 hopefully it never does again in a basis, it's

 15 going to be in a chaotic market. If we are having

 16 this conversation, think about the people who have

 17 not spent the time and the focus to understand

 18 this.

 19 MR. MAGUIRE: And I think that is

 20 absolutely why the DCOs have to be able to

 21 calculate risk, P&L, initial margin at the lost

 22 level on a client I.D. level because the FCM is
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 1 gone. You cannot rely on it at this point. I

 2 need to know what every single client has got,

 3 what the P&L is so I can see and raise examples.

 4 The losing 60 of the 100, this is a big risk. I'm

 5 going to close that out unless they pay me that 60

 6 now. That is absolutely fundamentally why the DCO

 7 has to be able to do this at the lowest granular

 8 level.

 9 MS. TAYLOR: And it will be hard for you

 10 to give the customer the opportunity to make the

 11 choice to give you the 60 because you've got to

 12 have an arrangement in place with the customer the

 13 way you do in a physically segregated.

 14 MR. WASSERMAN: I got to keep the

 15 discussion moving, I apologize.

 16 The next point on the agenda is

 17 operational costs and I'm going to take Dan's

 18 comments as an opportunity to segue there because

 19 one thing that is very clear to me is that the

 20 clearinghouses under the LSOC model are going to

 21 have responsibilities at a client level, maybe not

 22 every client, maybe just those clients who are
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 1 actually going to threaten the FCM, but that does

 2 raise at least some cost issues. What I

 3 understand you to be saying, Dan, is that you

 4 already look at the client level because you

 5 believe that's necessary even today even under an

 6 omnibus model. Kim, I understand you to have said

 7 earlier that under an omnibus model but for swaps

 8 because of your concerns about the products, you

 9 are also looking at an individual customer level.

 10 So my question is going to be first, Chris, I'm

 11 going to turn it over to you for a second and then

 12 ask from a clearing perspective are there material

 13 operational costs in going to let's start first

 14 with the LSOC model?

 15 MR. EDMONDS: In our current model on

 16 the customer business that's been cleared, we say

 17 we collect -- already. We may not know the exact

 18 identity of who that is, but we know it's a client

 19 customer and we know it's a unique client I.D. of

 20 the clearing member that we have, and we know

 21 we're holding that collateral and potentially

 22 excess collateral being collected by the clearing
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 1 member for their defined reasons separately and

 2 it's there and we close it out. I don't know that

 3 there are material changes in that although I

 4 would say it would seem to be based on the earlier

 5 comments made by some of the members on the buy

 6 side that that reconciliation process is different

 7 than what they're accustomed to so I think there

 8 will be operational requirements both from the DCO

 9 to the FCM to the end user, the buy side here,

 10 where that there will be changes in process today,

 11 there will be some associated investment in. I

 12 can't tell you exactly to the penny what those

 13 would be, but we don't route all that information

 14 back. We take that information in and as

 15 positions close out the money flows accordingly

 16 whether it be excess margin coming back, that the

 17 clearing member does something based on the

 18 contractual relationship and themselves.

 19 MR. WASSERMAN: Let me turn to the firms

 20 for a moment. Again under one of the proposed

 21 rules, I think this is 12, you would be required

 22 every day to be passing information on individual
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 1 customer exposures to the clearinghouse. My

 2 understanding is you already know that, but there

 3 would be a new thing and that you'd have to pass

 4 it upstream -- material operational costs from

 5 that, material operational costs from other things

 6 that I haven't mentioned?

 7 MR. FRANKEL: From the swaps clearing I

 8 think passing the client identity and there is a

 9 multiplier or some other multiplier that explains

 10 how much excess there is in the seg account for

 11 the client, I think that's a small build. I'm

 12 concerned though if we're looking at

 13 cross-margining putting futures into the cleared

 14 swap account class. Since we don't today put a

 15 client I.D. on futures how that infrastructure

 16 would work. So I think there's a cross-margining

 17 issue, but for cleared swaps themselves, I think

 18 the build is fairly minimal.

 19 MR. WASSERMAN: If you were

 20 cross-margining today and you were cross-margining

 21 between futures and swaps, wouldn't you need to

 22 have that at that individual client level to do
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 1 the calculation for the client's required margin?

 2 MR. FRANKEL: Yeah I think we can, it's

 3 just the cross-margining is not really done in

 4 that fashion, but if we're reporting it out, we'd

 5 have to set up the infrastructure to do that.

 6 MR. WASSERMAN: Because you don't

 7 currently do that for client level?

 8 MR. FRANKEL: We don't do it in that

 9 same fashion. We keep records separately in a

 10 different system so we'd have to submerge systems

 11 but it's not that hard.

 12 MS. TAYLOR: May I ask a question? It's

 13 a little bit off topic. I think that the

 14 operational aspects of once a client went into the

 15 OTC pool to get cross-margining, I think we have

 16 foreseen treating them just like other people in

 17 the pool or other positions in the pool. So I

 18 think that we would be expecting that the client

 19 I.D. would be reported. But the real thing that

 20 Oliver triggered when he said that is for the

 21 cross- margining if certain customers are opting

 22 to go out of the pooled segregation for futures
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 1 and still trading the same products but going into

 2 a different account class, it's a direct parallel

 3 to having people opt to go out of the OTC account

 4 class pool into a different account class that we

 5 were talking about with the physical segregation.

 6 That's just a thought I wanted to add.

 7 MR. WASSERMAN: I don't think so because

 8 I guess in harking back to the 2008 interp that we

 9 did I guess for two reasons. All of the

 10 collateral then is margining in this case -- let's

 11 say you put futures into the swaps account class

 12 and indeed I think this is alluded to in 22.1,

 13 we're treating the futures positions and

 14 collateral as swaps positions and collateral and

 15 that's the nature of the 4(d) just as when we

 16 would do a 4(d) order today and we're taking

 17 foreign futures and putting in the futures account

 18 class or cleared swaps and putting in the futures

 19 account class, A, we're treating those positions

 20 as positions of the new host. Second, all of the

 21 collateral margins the positions in the host

 22 class. So if you're cross-collateralizing between
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 1 swaps and futures in the futures account class,

 2 all of your collateral is margining futures and

 3 therefore could be treated as that. That's a

 4 different thing than saying we're going to be

 5 treating one group of swaps customers different

 6 than another group of swaps customers based on the

 7 choices they've made for protection.

 8 MS. TAYLOR: But they just chose to get

 9 their positions and collateral treated as subject

 10 to this other different new account class as

 11 opposed to --

 12 MR. WASSERMAN: No. What has happened

 13 is we have by order permitted these particular

 14 transactions to come into that account class and

 15 again the collateral regardless of whether it's

 16 margining futures, there are futures in that pool

 17 but there are swaps, otherwise there wouldn't be

 18 cross-collateralizing and therefore all of the

 19 collateral is margining swaps which is the nature

 20 of the account class that they're in.

 21 MR. MAGUIRE: I think there are many

 22 points about cross-margining, that if you start
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 1 putting swaps in a futures account you're going to

 2 have impacts on the futures default fund and all

 3 that. The cross-margining thing is important but

 4 it's not really what LSOC is about.

 5 MR. FRANKEL: It would also affect the

 6 default management of the futures class which

 7 would have to go from a 1 day to a much larger

 8 time span so it would be problematic.

 9 MR. WASSERMAN: Let me ask if any of the

 10 other firm folks have anything to say with regard

 11 to operational costs and then hopefully we can

 12 wrap this up in a few minutes and then I can

 13 permit folks to take a bit of a break.

 14 MR. KAHN: Very quickly, Barclays is

 15 building what we hope to be a very flexible and

 16 dynamic system. On LSOC, we have been fully

 17 serving and clearing a client out of LCH since

 18 last year so we're set up to do that, not only

 19 whatever regulatory standpoint we up end up in

 20 whether it be in the U.S. or in the E.U. or across

 21 a country, our tools are extremely flexible and we

 22 will continue to build more flexibility. In terms
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 1 of the cost, the fact is OTC is a little different

 2 than futures because there is a tremendous build

 3 that everyone is doing in the case of OTC so if we

 4 need to build LSOC which in essence we've done in

 5 the LCH European model, there is a cost of that

 6 but I can't really define what it is. It's

 7 relatively small and not material. It's part of

 8 the cost that we have to build. To make something

 9 similar in the U.S. in the FCM structure we can

 10 do. In terms of the various identifiers that we

 11 may need from a regulatory standpoint, we have

 12 worked incredibly hard to build a stand-alone

 13 system that does that and build out new things.

 14 In terms of risk managing, what we have to do, we

 15 understand we have the counterparty risk to our

 16 buy side clients and to get our buy side clients

 17 comfortable that we can handle this type of risk.

 18 We have to have all that stuff available at the

 19 legal entity level and we have to be able to

 20 manage it and we are well on our way to doing so.

 21 MR. WASSERMAN: Let me turn briefly to

 22 the buy side. Let me tell you my understanding
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 1 and please tell me where I might be going wrong.

 2 Clearly if these guys incur operational costs,

 3 those are going to find their way out of your

 4 pockets because they're going to impose them on

 5 you. Putting that aside, operational costs that

 6 you would incur separate from whatever you're

 7 paying this side, there are risk issues, but I

 8 don't see that there are operational costs.

 9 Please tell me where I'm going wrong on that.

 10 MR. THUM: We think that operational

 11 costs could decline by entering into this model.

 12 Right now we have significant operational costs

 13 across our dealers to maintain the custody

 14 accounts, to maintain the collateral valuation of

 15 margining across the multiple dealers that we have

 16 and we see that narrowing and having a much more

 17 consolidated, efficient approach when we do this.

 18 So we see this as a cost sayings. But in any

 19 event, we're prepared to bear the cost to provide

 20 for the margin protection that our clients need.

 21 MR. HARSHAW: Apologies that I use car

 22 analogies to a manufacturer here, but it's cheaper
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 1 to make a car without safety features. It doesn't

 2 mean you want to. So, yes, I agree with what Bill

 3 said. There is less complexity to the LSOC model

 4 to the OTC triparty. Absolutely. Do we want it?

 5 No. I think one of the things that gets lost here

 6 as we focus on cost is we haven't talked about the

 7 benefit. CCPs which are going to be bearing these

 8 costs just got a monopoly by law. If it's a

 9 standardized contract, it's required to be traded

 10 on the platform and they're going to get all the

 11 business. They didn't have to spend any marketing

 12 money for it, they didn't have to do anything to

 13 get it and they're going to get it. Yes, they're

 14 going to have some costs, but they just got a

 15 windfall. Right now in our triparty arrangement,

 16 for years we've had dealers pay for the cost of

 17 the triparty arrangements. We didn't have to pay

 18 for anything. Why should that change now that

 19 we're going to go to a cleared model? We should

 20 be able to get what we've been able to negotiate

 21 in the past. So I think the cost needs to be also

 22 focused on losses. We will lose. We will be
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 1 exposed to depending on which model gets adopted

 2 fellow customer risk, investment risk, transit

 3 risk, recordkeeping risk. We lose netting across

 4 products because of clearing. We have initial

 5 margin. We got lots of costs that we have to bear

 6 and nobody is crying in their tea about us. The

 7 point is that the costs really shouldn't be the

 8 focus. They're getting a windfall to get all of

 9 this business. They should incur the costs

 10 associated with that. We shouldn't lose anything

 11 as a result of it.

 12 MR. WASSERMAN: I understand your

 13 perspective. Let me tell you where I'm coming

 14 from. Section 15 of the Commodity Exchange Act

 15 requires that the Commission before it passes a

 16 rule consider among other things cost and benefit

 17 issues. This is ultimately part of a rule-making

 18 process. We must consider cost and we're not

 19 allowed to just simply say they're getting some

 20 goodies from Dodd-Frank. What I'm trying to get

 21 on the record here and what I'm trying to

 22 understand is in fulfilling my obligation to the
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 1 Commission to help the Commission consider costs,

 2 we've separated out operational and risk costs and

 3 we're going to do risk costs after the break. I

 4 want to get the issue done with operational costs.

 5 Are there any operational costs that if we did

 6 LSOC versus say the futures model that would

 7 increase for the buy side?

 8 MR. HARSHAW: Yes. The fact that I have

 9 to do things that take me a lot of time today

 10 doesn't mean that to get ready for everything else

 11 won't cost me stuff. In fact, I will have lost

 12 all the money that I spent setting up those things

 13 to provide protections. And you also mentioned

 14 that you have to consider benefits. The things

 15 that I just mentioned are the benefits that the

 16 CCPs are getting as a result of this.

 17 MR. WASSERMAN: I want us to consider

 18 the benefits, but I'm trying to get an

 19 understanding with respect to the costs. So

 20 you're saying you would pay more. There would be

 21 additional costs that you would incur under the

 22 LSOC model that you wouldn't incur under the
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 1 futures model?

 2 MR. HARSHAW: What I'm saying is that

 3 the full seg model which is what we're advocating

 4 for as I think many of the people on this side of

 5 the table, that we have sunk money into it. That

 6 money will get lost as a result if we go to a

 7 model other than that. In addition, we will have

 8 to incur other money to get set up technologically

 9 for a new paradigm so that that is cost to us as

 10 well. So there's a loss of investment into

 11 operational investments we've made already for our

 12 triparty setup and then there's a cost for us in

 13 terms of getting set up for each of the CCPs, each

 14 of the FCM models in terms of how they're going to

 15 do it. So, yes, they are significant.

 16 MR. WASSERMAN: There is a cost if we

 17 adopt the LSOC model versus a complete legal seg

 18 model?

 19 MR. HARSHAW: Exactly.

 20 MR. WASSERMAN: I understand that point

 21 and that is noted. My question is, complete legal

 22 seg versus futures. Is there an addition cost to
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 1 complete legal seg versus futures?

 2 MS. BREGASI: There is no additional

 3 cost between LSOC and the futures model.

 4 MR. PRAGER: We don't see them incurring

 5 other than the start-up costs, the one time that

 6 everyone will have to incur to set up, the running

 7 cost. We don't see any incremental cost.

 8 MR. MACFARLANE: I would agree there are

 9 no additional operational costs. However, there

 10 may be additional credit hedging costs which we

 11 may get to.

 12 MR. WASSERMAN: We're going to get those

 13 right after the break. It is now 3:25. I think

 14 maybe since we've run over, can we get back very

 15 promptly at 3:40?

 16 (Recess)

 17 * * * * *

 18

 19

 20

 21

 22
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 1 MR. WASSERMAN: So ladies and gentlemen,

 2 I know a number of folks have flights and such and

 3 are counting on being able to leave at 5:00 p.m.

 4 precisely, so we've had our last overtime.

 5 Okay. I think we're now going to start

 6 talking about risk costs, and that is, I think,

 7 going to be yet more interesting. And so the

 8 question I'd like to raise now is for each of the

 9 models: What are the risk costs? That is to say

 10 not just simply operationally but because of

 11 greater risk that may be imposed on various folks

 12 whether it -- you know, moving essentially risk

 13 from customers to FCMs to DCOs, what are the

 14 additional risk costs, how do you measure them,

 15 how is it that you're likely to allocate them?

 16 MR. NICHOLAS: Bob, if I could just sort

 17 of start with the big picture, and we certainly

 18 can get more specific after that, but I do believe

 19 that there's a systemic risk cost to moving away

 20 from the future's model. I do think that it will

 21 result in FCMs electing not to maintain excess net

 22 capital because that excess is at risk. That
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 1 excess can be pulled from them by the

 2 clearinghouse. It's a risk that they don't have

 3 control over, and so I think you would be left

 4 with less well-capitalized FCMs, creating more

 5 systemic risk.

 6 MR. WASSERMAN: Let me ask about that.

 7 Right now we have, as you know, our net capital

 8 rule, and so I guess my question would be is the

 9 capital that we're calling for under our net

 10 capital rule sufficient or should we be changing

 11 that net capital rule to require increased

 12 capital?

 13 MR. NICHOLAS: I saw that in the

 14 release. I don't think it's really right on

 15 point, though. And I know where you're going with

 16 that and that -- but I think FCMs are encouraged.

 17 I mean it's different to mandate it as opposed to

 18 needing it for good business prudence practices.

 19 I think the motivation won't be there anymore, and

 20 that's not to say that capital levels should be

 21 increased or reduced, but I just think the

 22 motivation won't be there.
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 1 MS. TAYLOR: I think what I would add to

 2 that is I don't think of -- I mean required

 3 capital is capital, but required capital and

 4 excess capital actually perform somewhat of a

 5 different function in the way that they help the

 6 clearing members protect the customers against the

 7 erratic behavior of other customers, right? You

 8 need to be in regulatory capital compliance, so

 9 raising capital requirements increases capital in

 10 the firm but it doesn't increase the firm's

 11 ability to be resilient to losses that would eat

 12 away at capital. You need excess capital to be in

 13 the firms no matter what the capital level is

 14 because they need to be able to maneuver and cover

 15 losses and still be in compliance with regulatory

 16 requirements. So there still is a need for it,

 17 and I think in a model where customers are less

 18 incented to care about the credit risk worthiness

 19 of their clearing members, and some of you have

 20 said that you still would be very concerned, so

 21 that is good. But if there were an environment

 22 where customers were not as concerned about the
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 1 creditworthiness of their clearing members, I

 2 think that does probably result in a reduction in

 3 the balance sheet that parent entities would

 4 allocate to the future's business because there's

 5 not any competitive value for having it because

 6 you're not going to necessarily attract a

 7 different class of customers because the customers

 8 are less attuned to the balance sheet of the

 9 clearing member.

 10 MR. WASSERMAN: But I guess the question

 11 I'm asking, the assertion is made that there's a

 12 systemic risk that because FCMs are going to be --

 13 essentially have more capital at risk, they're

 14 going to reduce the amount of capital they hold

 15 thereby creating systemic risk, and I guess my

 16 question is if -- are our capital requirements

 17 then for that matter -- the DCO, of course they

 18 have capital requirements for their members -- are

 19 those sufficient? And if the answer is yes then

 20 how can we say there's systemic risk if people

 21 meet those requirements? And if the answer is no

 22 then why shouldn't both we and the clearing
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 1 organizations be increasing the capital

 2 requirements?

 3 MR. FRANKEL: I think the first line of

 4 defense that we should talk about at first is what

 5 initial margin requirements there would be because

 6 once we've understood that then I think the

 7 residual risk will become clearer, become sorted

 8 out. So if we start with initial margin under the

 9 different models, we put in our common letter --

 10 is the common letter a heuristic which for the

 11 future's model margins levered at something like

 12 99 percent, five-day coverage and so on. Moving

 13 to a 99.9 percent confidence of coverage we think

 14 will increase margins by about 60 percent, 60, 70

 15 percent --

 16 MR. DIPLAS: For rates.

 17 MR. FRANKEL: For rates, yes. This is

 18 just for rates. I think for a CDS it could be

 19 more than double. I'll let Chris talk to that.

 20 But going back to rates for a moment, the 60

 21 percent increase is somewhat demonstrated by the

 22 CME's current margin system, the one they're about
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 1 to use, which is very similar to LCH's but which

 2 charges -- where the 60 percent number is

 3 demonstrated for -- that's three points -- is the

 4 margin for a ten-year swap, and for LCH it's five

 5 points which is I think very much in mind with the

 6 claim.

 7 MR. WASSERMAN: And is that essentially

 8 going from a 99 percentile to a 99.9 percentile?

 9 MR. FRANKEL: Very much that. It's

 10 slightly different, but very much that.

 11 MR. MACFARLANE: But does that

 12 accommodate which model? The going from baseline

 13 to LSOC or going from LSOC to seg?

 14 MR. DIPLAS: Yes. To LSOC.

 15 MR. FRANKEL: Okay. LSOC to seg I don't

 16 think is any real change in IM requirement from --

 17 from LSOC to complete seg or full seg.

 18 MR. MACFARLANE: Yeah.

 19 MR. FRANKEL: But going from futures to

 20 either of the two is a 60 percent increase as far

 21 as we can understand it.

 22 MR. MACFARLANE: Well, that in itself is
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 1 an interesting statement about the degree of

 2 mutualization or risk that is occurring, so you

 3 just in essence -- and you're asking us on this

 4 side -- I guess those of us on this side of the

 5 table would benefit in the short-run by having to

 6 put up less collateral, but what's being said, if

 7 our transactions had to be margined on an

 8 individual basis it would require that we put up

 9 60 to 70 percent more, which says that then the

 10 real risk of that transaction is 75 percent more

 11 than what we're collateralizing. So in the event

 12 of a default, not by us but by another

 13 counterparty potentially, they will be

 14 under-collateralized relative to what their

 15 individual transaction would require, and then

 16 that potentially could work its way back to us.

 17 MR. FRANKEL: It's true, but here's the

 18 rub on that. The diversification in the client

 19 account is so great across customers, in the

 20 future as well -- in our future client account,

 21 one individual client does not comprise very much

 22 at all of that account, and so the fellow customer
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 1 risk gets shared across so many other clients that

 2 it's de minimis loss.

 3 MR. PRAGER: That's the theory, but

 4 again --

 5 MR. FRANKEL: Yes.

 6 MR. PRAGER: That's the theory, and I

 7 believe it's the CFTC's own work that demonstrated

 8 the reduction of that client collateral in the

 9 case of Lehman, so that's a theoretical

 10 diversification --

 11 MR. FRANKEL: Oh, totally theoretical.

 12 Absolutely.

 13 MR. PRAGER: So we have to be really

 14 careful.

 15 MS. TAYLOR: But the exposure went down

 16 in Lehman, too. That's the thing that everybody's

 17 leaving out of the picture. You want that to

 18 happen. That's part of why the risk management

 19 regime works is that people have an incentive to

 20 leave a firm that is appearing not to do well.

 21 MR. PRAGER: Yeah, but --

 22 MS. TAYLOR: And they take their
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 1 exposure with them along with their collateral.

 2 MR. WASSERMAN: But Kim, are you

 3 guaranteed that the people, that the exposure that

 4 will be leaving is not the exposure that causes

 5 the default?

 6 MR. FRANKEL: Let me just continue my --

 7 what we found was that the closeout cost in the

 8 future's model was the most expensive. I mean

 9 closing out a client account and rates could be

 10 extremely devastating to the market, and of course

 11 we're thinking losses, replacement costs of the

 12 order of six to ten or more times the amount of

 13 fellow customers, so they'd be really significant

 14 losses, and any way they can be avoided would be

 15 beneficial to every participant in the market. To

 16 think of a large financial end user losing all its

 17 hedges could be catastrophic to the taxpayer, too.

 18 So we're really concerned that there is a weight

 19 to port, and any weight the people -- the clients

 20 can port out. Any model that provides that is

 21 superior to one that doesn't.

 22 MR. MACFARLANE: I think that's probably
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 1 more a matter of perspective because not only --

 2 again, systematically if -- first of all, was that

 3 analysis conducted on existing cleared products or

 4 perspective cleared products, because my guess is

 5 perspective cleared products are going to be more

 6 volatile and the multiplier is probably going to

 7 be in excess of that 60 to 70 percent. Again

 8 meaning that -- let's say that it goes to 100

 9 percent, that the market --

 10 MR. FRANKEL: Yes. That's for what is

 11 about 60 for CDS. I think you're measuring at a

 12 hundred and something?

 13 MR. DIPLAS: CDS. We talked about --

 14 MR. FRANKEL: Yes. So, and swaps are

 15 even more so. So you're right. Absolutely.

 16 MR. MAGUIRE: The more of them in you

 17 get the bigger the number.

 18 MR. MACFARLANE: Right. So again, we're

 19 inviting then counterparties to participate in a

 20 mechanism that requires that they not put up

 21 enough collateral or capital to support the risk

 22 of their stand-alone instrument. And so again,
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 1 are we building a house with toothpicks or shall

 2 we be looking for something that's going to give

 3 it a little bit more strength when the storm comes

 4 up. And maybe these transactions should be

 5 required to stand on their own in terms of the

 6 collateral that's put up, and that way then you

 7 spread risk appropriately. You don't encourage an

 8 institution to take more risk than they should

 9 because they can.

 10 MR. DIPLAS: We agree with you. The

 11 important building elements here are both to have

 12 the appropriate level of collateral but also to

 13 have the mechanism to ensure the portability. The

 14 portability is what is basic. And I think all of

 15 this point was not I would prefer it if it was the

 16 baseline model, but it is if we do not have

 17 portability the cost associated with the unwind

 18 would be higher than the fellow customer risk port

 19 probably. I'm not saying that we prefer that. It

 20 is fundamental that we build the portability and

 21 have structure that actually allows the

 22 portability to take place. That is the only
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 1 point.

 2 I think for summarizing what all we were

 3 saying is that not having the additional pool of

 4 funds that are associated with the fellow

 5 customers means that we definitely need to

 6 actually margin from a CCP perspective, the higher

 7 confidence interval. That will differ depending

 8 on the asset class we're looking at. Some of

 9 them, at least based on the existing pool of

 10 trades, it could be manageable like at 60, 70

 11 percent in rates. We'll talk about three to four

 12 times the amount that -- in credit -- and the more

 13 we get to instruments with fatter tails the higher

 14 the number is going to be. I think that is

 15 something that clients need to be cognizant of. I

 16 think like you said a lot of people might see that

 17 as an actually very reasonable trade-off basically

 18 and accept that. But those are I think very

 19 basically kind of the choices that we have to make

 20 here.

 21 MR. COX: But --

 22 MR. WASSERMAN: So let me press on that
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 1 point just for a moment because I've seen from the

 2 comments some folks talking about increases in

 3 margin, I've seen folks talking about increases in

 4 guarantee fund, and so what I'd like to get to is

 5 how would you determine how much additional

 6 margin, how much would you -- how would you

 7 determine how much additional guarantee fund, and

 8 also very importantly, how would you determine the

 9 mix. In other words, are the numbers we're

 10 talking about A or B, you know, is it both

 11 additional margin and additional guarantee fund,

 12 or is it A or B, or how are you going to combine

 13 them? So --

 14 MR. EDMONDS: It's a balance. It's a

 15 balance. I mean I don't know that we can -- I

 16 mean certainly in our comment letter we went

 17 through and we took every one of our existing

 18 portfolios. Okay. And we took them at the 99

 19 percent competence interval there today and we

 20 scaled it up to 99.9 to show you what the

 21 difference would be based on a factor. And if a

 22 factor of one is 99 percent, the average for CDS
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 1 at 99.9 percent was 3.7. So a 2.7, 270 percent

 2 increase if you want to think about it that way on

 3 average. Some are higher than that.

 4 But as we walk through those pieces of

 5 that puzzle there are other considerations that

 6 this agency doesn't impact. As we relate to our

 7 membership at the end of the day and the

 8 constraints that they have placed on them by other

 9 regulators that may have some insight, some

 10 control over. So to give you an answer on that

 11 question of what it would be, you know, to

 12 determine that balance I've got to figure out what

 13 bank capital charges may be for some of the

 14 entities that will be faced with that in order to

 15 give you an adequate picture at the end of the

 16 day.

 17 Or we can just say, you know what, we're

 18 going to reduce the guarantee fund because we're

 19 going to go to 99.9 percent as other models

 20 represented here have, and at that 99.9 percent

 21 we're going to have a very limited guarantee fund

 22 so that mutualization rests like -- if initial
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 1 margin doesn't cover it, and you know, we can show

 2 you all the models there and these products that

 3 historically haven't been cleared or have just

 4 recently began clearing and say this is it, and we

 5 believe we're right, and chances are we are. But

 6 the cushion that you have in the intermediated

 7 model that we have today won't be there anymore.

 8 So that's the tradeoff that you're going to make

 9 in that type of assessment.

 10 MR. WASSERMAN: So here's --

 11 MS. TAYLOR: And that is an important --

 12 is a mixed decision, and I agree that you can make

 13 different mixes and make them work and you can't

 14 really call it right now until you see the

 15 portfolio and the conditions and the regs and the

 16 capital rules and everything that's going to be --

 17 that you're going to be facing. So nobody can

 18 make a call on exactly how they're going to do it.

 19 The problem --

 20 MR. WASSERMAN: And I'm going to say --

 21 just --

 22 MS. TAYLOR: The problem is if you go --
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 1 MR. WASSERMAN: -- second --

 2 MS. TAYLOR: -- if you go too far in one

 3 direction --

 4 MR. WASSERMAN: And I'm understanding

 5 part of that is because of the bank regulators as

 6 well.

 7 MS. TAYLOR: And if you go too far in

 8 one direction and go higher, higher on the margin

 9 you can do that, and you could go lower on the

 10 guarantee fund, and up to a point that is fine.

 11 There is a point where I actually think going

 12 below a certain level on a guarantee fund is

 13 improper systemic risk containment behavior by a

 14 clearinghouse because a margin is based on an

 15 estimate that's based on your statistical

 16 assessment of what the worst-case loss is going to

 17 be tomorrow, and it might not be that. It might

 18 be worse. And so that is why margin needs to

 19 cover the tail risk -- or the guarantee fund needs

 20 to cover the tail risk event that could happen

 21 beyond the margin, I think no matter what kind of

 22 statistical estimate you use to cover the margin.
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 1 MR. DIPLAS: But you use different --

 2 hold on. Just to explain how we got here, the mix

 3 we chose on the credit side was determined when we

 4 had only direct clearing members and not clients.

 5 Because of the fact that also the credit asset

 6 class we initially went with more mutualization,

 7 that as a result increase the guarantee fund

 8 contributions and decrease the initial margins.

 9 It is very difficult to pass these costs on -- the

 10 moment we do to these clients that actually don't

 11 -- are not exposed to that mutualization, so

 12 perhaps they -- the model going forward would be

 13 one that's going to err on the side of initial

 14 margin versus guarantee fund. That is actually

 15 consistent also with the way I think also

 16 international regulators in treating the guarantee

 17 fund contributions of clearing members, and if the

 18 current proposals under Basel go through they're

 19 going to make it extremely punitive to actually

 20 have guarantee fund contributions. So the

 21 incentive would be to reduce those and therefore

 22 you will see a very large increase on the initial
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 1 margin levels.

 2 MR. KAHN: I think the concept here, to

 3 make it simpler which is what we've done is this

 4 pitcher represents the amount of margin, the water

 5 that needs to exist. Okay. If you take out the

 6 mutualized part you end up with what I'll define

 7 as an hourglass. Right. And in the hourglass the

 8 top part is what the buy side pays and on the

 9 bottom side is guaranteed fund and the CCP

 10 contributions. Okay. So a lot of the

 11 conversation we usually have talking to clients

 12 and such is that how much IM do you have to post?

 13 When we get to we have to come up with a system

 14 that's efficient, we have to have strong FCMs, we

 15 have to have strong CCPs, we obviously need strong

 16 investors, we have to come up and obviously Basel

 17 is important. The overall cost you have to -- and

 18 I think John alluded to it -- is you have to pay

 19 for your risk. We're all kind of like storage

 20 units. If you have a lot of furniture you've got

 21 to get a bigger storage unit. So if you're

 22 bringing in a lot of directional risk you're
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 1 paying much higher IM. If you're bringing in --

 2 if you're a real value trader doing curve trades

 3 and things you're margin is not nearly going to be

 4 as high.

 5 But the function -- the real decision,

 6 which is the hardest decision, and unfortunately I

 7 can't give a step definitive view is if the cost

 8 to the market participants, the risk takers or the

 9 risk makers, have to be viewed as both the IM plus

 10 the capital cost that the FCM or the CCPs have to

 11 charge because in the long run if we have -- let's

 12 make a bad example -- but if you have two FCMs

 13 that are willing to basically pay the guarantee,

 14 put a lot of money into the FCM, but they're

 15 materially cheaper because they're not charging

 16 for it and thus all the buy side is paying is for

 17 the IM then you're going to have potentially all

 18 of the exposure run to two very cheap FCMs and

 19 then you're going to have not mutualized risk;

 20 you're going to have two very large ones. So the

 21 fact is, while Barclays wants to be very large in

 22 the clearing space, and important, we need other
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 1 dealers - my friends on this side -- to also be

 2 very strong FCM and clearing dealers to have a

 3 strong contained and protected capital market.

 4 MR. MAGUIRE: Bob --

 5 MR. WASSERMAN: Let me follow up on that

 6 point because essentially the point you're making

 7 is look, if you're taking part of the capital

 8 pullout, namely the potential collateral of fellow

 9 customers, you're saying hey, that's going to have

 10 to be replaced somehow. And so here's my

 11 question. When we're saying that you're going to

 12 go from 99 to 99.9, is that tied to an estimate of

 13 the amount of collateral or the amount of capital

 14 that you would have to meet a default that you'd

 15 otherwise use or is it just simply well, we're

 16 just going to go up to the next level of

 17 magnitude, 99 to 99.9. In other words, are you

 18 saying okay, here's how much we have, here's how

 19 much we expect from fellow customer collateral;

 20 that's going to cost, you know, when we do the

 21 Lamfalussy calculation that's going to -- we're

 22 going to have so many billion dollars less in
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 1 collateral available so we have to make that up

 2 somehow and basically rejigger the model, or is it

 3 just simply okay, 99 to 99.9 because that's the

 4 next level of magnitude?

 5 MR. FRANKEL: I think the original model

 6 was always to have a 99.9. The defaulter would be

 7 paying for their own risk. We split it up so that

 8 the mutualization covered some of that, so in my

 9 IM I'm paying a certain amount of then my

 10 guarantee fund contribution and basically paying

 11 the rest so that in total I reach a 99.9 kind of

 12 confidence level with mutualization sort of

 13 ratcheted so as to cover the model risk that Kim

 14 was talking about.

 15 For clients I think the fellow customer

 16 risk covered that tail so they, too, had -- not on

 17 a pay basis on some potential loss basis --

 18 covered that same sort of tail, so the residual

 19 was very, very little, too. So in a sense there

 20 was mutualization in the customer book that also

 21 effectively it took them to the same level. I

 22 think it's not so much 99.9 but it's sort of
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 1 covering extreme but portable market conditions.

 2 That was the notion.

 3 MR. WASSERMAN: If the customer happens

 4 to get wind of the FCMs weakness because they're

 5 --

 6 MR. FRANKEL: Sure.

 7 MR. WASSERMAN: -- looking at the CNBC

 8 and they pull the money out --

 9 MR. FRANKEL: They pull the money out

 10 and then the --

 11 MS. TAYLOR: They will pull their money

 12 out by taking their exposure.

 13 MR. FRANKEL: Right. So the exposure

 14 comes down as clients perceive that an FCM is

 15 getting weaker and they pull out their risk.

 16 MR. WASSERMAN: But I guess what I'm

 17 saying, and that's --

 18 MR. MAGUIRE: It's the other client

 19 defaulting's exposure that you're worried about,

 20 not the one that's porting away.

 21 MR. FRANKEL: Right.

 22 MR. MAGUIRE: So that's the fundamental
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 1 point here, and that is why we in our public

 2 letter said you cannot rely on it. Yes, we said

 3 it's zero, and I know everybody will disagree and

 4 say it's probably not zero but it's probably not

 5 100 percent, either, but the only thing I can make

 6 a conservative and realistic assumption is that

 7 it's likely not to be that. And yes, 75 percent

 8 of clients went I'm going to take everybody's

 9 point. They took their collateral and they took

 10 their exposure. But what we're talking about here

 11 is the client that didn't take their exposure and

 12 they went under. I'm relying on that 75 percent,

 13 80 percent, 90, whatever, to actually close that

 14 out. What is that number is the question.

 15 MR. FRANKEL: I think that's right, but

 16 I think that a CCP seeing that an FCM is losing

 17 all its clients and potentially leaving one rather

 18 large one will super-margin that account to make

 19 sure that it's now at a 99.9 percentage. The

 20 super-margining now taking the place of fellow

 21 customer risk. I'm speaking for you, actually.

 22 MR. KAHN: But we're making the
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 1 assumption that 75 percent is going to move at

 2 that -- at that omnibus that's moved at that

 3 level. It's really uncertain how big that client

 4 level is going to be. It's a variable. We don't

 5 really know how large it's going to be. It's a

 6 function of the amount of risk that's been put in

 7 the storage unit. So whether it's been moved or

 8 we're just not certain how large it's going to be.

 9 I mean I know there's been estimates from ISDA,

 10 each dealer has estimates and stuff, but it's

 11 uncertain how much is going to come from there.

 12 MR. MAGUIRE: Is the safest assumption

 13 not for a DCO to say "I can't rely on it" rather

 14 than making all these theoretical nebulous sort of

 15 predictions of what you may have, the safest thing

 16 to John's point about risk, systemic risk

 17 reduction, we assume zero, and if there's anything

 18 then great, we'll use it, and an omnibus will

 19 come. But if it's not that and you don't fight to

 20 that end --

 21 MR. FRANKEL: As a clearing member

 22 guaranteeing my clients I would definitely prefer
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 1 that.

 2 MR. WASSERMAN: And so Dan you assume

 3 zero.

 4 MR. MAGUIRE: Yes.

 5 MR. WASSERMAN: As the percentage of

 6 what might be available.

 7 MR. MAGUIRE: And just to act it out, so

 8 therefore margins and guarantee funds would not

 9 change from omnibus to LSOC.

 10 MR. WASSERMAN: So Kim, I think you're

 11 saying, and Chris you're saying margins would

 12 change. So I guess my question would be when

 13 you're doing your models, and I don't want to -- I

 14 don't want to ask you to give sensitive

 15 information out and so I understand that you may

 16 need to give a somewhat vague answer, but I guess

 17 my question is are you assuming 100 percent or

 18 something less of that fellow -- in other words,

 19 essentially the diversification effect, are you

 20 assuming that that's there to extent of 100

 21 percent or something less?

 22 MS. TAYLOR: I'm not entirely sure I
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 1 understand the question. Are you asking me --

 2 when we do our calculations now on what our

 3 guarantee should be? Is that what you're asking

 4 me?

 5 MR. WASSERMAN: Yeah.

 6 MS. TAYLOR: We do stress testing that

 7 is kind of independent scenarios for different

 8 sets of products, kind of combine the worst-case

 9 losses across the different asset classes, we take

 10 into consideration the resources that would

 11 legally be available to us to cure that default,

 12 and then we look at the gap and we set the

 13 mutualization package to more than cover -- well

 14 more than cover that gap. But I mean at least at

 15 the minimum the best practice standard is to be

 16 able to cover the worst-case loss of your worst

 17 counterparty in a systemically bad condition.

 18 MR. WASSERMAN: And what I'm asking,

 19 though, is you mentioned the resources that are

 20 legally available to you.

 21 MS. TAYLOR: And that would --

 22 MR. WASSERMAN: So here's the thing with
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 1 the fellow customers.

 2 MS. TAYLOR: That would change. That

 3 would change in an LSOC model, and our estimates

 4 of what the margin increase would be likely to be

 5 are -- if we did it with all margin, you know,

 6 you'd have to make a mix decision, are not unlike

 7 the estimates that Oliver already talked about.

 8 MR. WASSERMAN: But the question --

 9 forgive me -- the question I'm asking is under the

 10 future's model, under the current model --

 11 MS. TAYLOR: Okay.

 12 MR. WASSERMAN: -- you mention that

 13 you're going to look at the resources that are

 14 legally available to you.

 15 MS. TAYLOR: Mm-hmm.

 16 MR. WASSERMAN: So one that's clear is

 17 under the future's model all of the fellow

 18 customer collateral that is there on the day of

 19 the default is legally available to you.

 20 MS. TAYLOR: Mm-hmm.

 21 MR. WASSERMAN: But in comparing what is

 22 there as of the day you do the calculation to what
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 1 you would expect would be there on the day of

 2 default, are you assuming that all of the

 3 collateral that's there on the day of calculation,

 4 the non-defaulting customers, is going to be

 5 available to you on the day of default?

 6 MS. TAYLOR: And I guess here's what I

 7 would say about that. We could take a haircut on

 8 it; we don't because we would be making an

 9 assumption about -- the collateral goes along with

 10 the exposure, and so we are making the assumption

 11 that we have the right amount of collateral for

 12 the exposure that we have at the time under the

 13 set of circumstances that we're margining for, and

 14 if we do this every day and if there is a change

 15 in the amount of collateral we have there is also

 16 a change in the amount of exposure that we have,

 17 and when we assess whether we've got sufficient

 18 resources in our package we take both of those

 19 things into consideration. And so we would have

 20 to be making assumptions that would be -- you

 21 know, they would be guesses, right, on what you

 22 were assuming you would lose in terms of the
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 1 exposure versus in terms of the collateral. They

 2 go together.

 3 MR. WASSERMAN: So you're assuming 100

 4 percent of the fellow customer collateral that's

 5 there on the day of calculation would be there on

 6 the day of default because, as I understand it,

 7 you're calculating every day, and so if customers

 8 start essentially melting away you'd be changing

 9 those calculations.

 10 MS. TAYLOR: Right.

 11 MR. WASSERMAN: Here's my question on

 12 that score. So you would be then asking for

 13 additional guarantee fund contributions at the

 14 same time that you have a member that is

 15 essentially on the down-stroke which might

 16 correspond to a time when markets are a little

 17 bit, well, more volatile than usual. Isn't that

 18 procyclical?

 19 MS. TAYLOR: If you -- it could be, but

 20 we also look at if the exposure profile changes

 21 there are many things that we can do. We can

 22 change margins in general, we can change
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 1 concentration margins in particular, in particular

 2 markets, with particular customers, with

 3 particular clearing members. We can change the --

 4 MR. WASSERMAN: But wouldn't you then be

 5 trying to get money out of the same clearing

 6 member?

 7 MS. TAYLOR: We can change the

 8 guarantee funds.

 9 MR. WASSERMAN: Wouldn't you be then

 10 trying to get money out of the same clearing

 11 member which is currently on the down-stroke? I

 12 mean in other words, using Lehman as the example,

 13 and happily they didn't have a default by a

 14 customer, but essentially, so during that week 75

 15 percent of the customers who were there were of

 16 course going to other -- other FCMs. Assume

 17 contrary to what -- the experience that they had

 18 some customers and some big customers who didn't

 19 who happened to be the ones who were defaulting --

 20 MS. TAYLOR: Right.

 21 MR. WASSERMAN: Your ability to get

 22 additional collateral out of Lehman, do you think
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 1 that --

 2 MS. TAYLOR: Well, that is a good

 3 question and that is why we did not just sit on

 4 our hands the week of Lehman and we made sure that

 5 we were helping to find solutions for people to

 6 move their positions. The very best outcome in

 7 any of these situations is for customers to be

 8 able to exit the failing clearing member before

 9 there is a problem. We very actively do that. We

 10 actively solicit on an ongoing basis a set of what

 11 we call white knight firms who stand ready to look

 12 at situations where we might need them to take

 13 kind of a bulk transfer of clients. We have a

 14 stable of people that have offered to look at a

 15 portfolio if we ever need bidders. We have a

 16 stable of White Knight potential bidders who will

 17 look at a portfolio if we needed to sell one on

 18 short notice. We actually liquidated the Lehman

 19 house portfolio in basically five hours because we

 20 found out very late one night that they were -- it

 21 was not going to be part of the bankruptcy

 22 transaction, the purchase, and by 8:00 the next
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 1 morning we sold the entire book, and people got

 2 the portfolio information at like, I don't know,

 3 2:00 in the morning. So it was -- we're able to

 4 marshal the resources and the capacity to risk

 5 manage situations as they're occurring very

 6 readily and very actively. If we just sat on our

 7 hands you would be asking me some really good

 8 questions.

 9 MR. MAGUIRE: Could I just maybe ask a

 10 question of the FCMs? If there's been a default

 11 of an FCM on the clients, and there are a bunch of

 12 clients who wish to pull from the defaulting FCM,

 13 or just prior to it going to default to

 14 yourselves, are you more likely to accept that

 15 port on a 99.9 percent confidence interval or on a

 16 99 percent confidence interval where they're

 17 paying for the margin themselves? Because if you

 18 take the 99 you're going to be paying a higher

 19 guarantee fund which will also have capital

 20 charges under Basle III. So what would the FCM do

 21 in terms of giving a higher probability of

 22 portability? Which approach would be preferable?
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 1 MR. FRANKEL: The 99.9.

 2 MR. MAGUIRE: I rest my case.

 3 MR. FRANKEL: I mean you're asking us to

 4 guarantee risk in an extreme conditions and we

 5 would like margin to cover that. Whether it was

 6 the minimum or not we would want it.

 7 MR. DIPLAS: But then in general, I mean

 8 you take the portfolio at the level that you do an

 9 evaluation if there's adequate margin coming along

 10 with it.

 11 MR. KAHN: But we made the assumption at

 12 the beginning of this panel after lunch that these

 13 products, the OTC derivative products, had more

 14 price volatility. That's an assumption in

 15 futures, and it's great that it kind of flowed

 16 smoothly in futures. At the same time that Lehman

 17 was melting and this stuff was happening behind

 18 the scenes the bid for various OTC derivative

 19 products, particularly in credit, was not very

 20 good. Okay. In fact it was almost nonexistent.

 21 Or it was one by one for a single-name CDS. So

 22 the fact is I'm not convinced that the ease of
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 1 finding the white knight on OTC derivative

 2 portfolios will be as easy as it has been.

 3 MR. MAGUIRE: Agreed. I understand they

 4 said probability, so I'm just saying the

 5 probability would be higher that you take

 6 something with a higher confidence interval, but

 7 you know, you can't guarantee that.

 8 MR. PRAGER: But I think that's an

 9 excellent point that you're making, Ray, because I

 10 think when you started off today, Bob, by drawing

 11 these parallels so we can just make sure we're

 12 having apples-to-apples conversations, and Kim, I

 13 have no doubt that you will handle the Lehman

 14 situation fabulously, but I do think that with

 15 just not comparing it to what the cleared swap

 16 portfolio will look like it's going to be a much

 17 different risk profile. Not just priced volatily,

 18 Ray, but this liquidity situation that I think we

 19 talked about. Someone drew out that distinction

 20 before. So I think we have to go back to what did

 21 LCH experience, how did that happen, over what

 22 time period because that was real. And that's the
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 1 type of portfolios we're talking about.

 2 So I do think if you string together

 3 some of the comments that John made about the

 4 subsidization that we see in the future's model,

 5 and then maybe that's acceptable with these, you

 6 know, the type of products we're talking about

 7 which have smaller volumes and less liquidity

 8 issues than swaps, that's -- maybe that's

 9 acceptable, but I do think we have to look to

 10 where we've seen the precedent with LCH in an LSOC

 11 environment with the higher IM, with assuming that

 12 there'll be no client buffer there and if you have

 13 to pay for the risk you should.

 14 The only other point I'd add to that is

 15 that higher IM has another effect, which is its

 16 incentive for clients like ourselves and others to

 17 keep tidier books. So if you want to get that IM

 18 back you just go and do more tear-ups and you

 19 actively manage line items so you're not consuming

 20 all of that initial margin out there so it has

 21 actually a very positive ancillary effect to

 22 managing risk, and it's good for the system.
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 1 MR. WASSERMAN: So Richard, I just want

 2 to make sure I'm understanding. What I think I

 3 hear you saying is that while in Lehman there was

 4 a, you know, that five-hour, you know, the

 5 liquidation and the ability to sell the portfolio,

 6 your concern is that there is a higher probability

 7 in the swaps world that there may be portions of a

 8 portfolio that will not transfer anywhere near as

 9 readily. You got to speak into the mic.

 10 MR. PRAGER: I agree. Yes.

 11 MR. MAGUIRE: Maybe to give some color

 12 of how the Lehman close-out happened for the

 13 interest rates. I was there, I was involved, and

 14 we had a holding period. In the first instance

 15 you take the 66,650 trays or whatever it was, nine

 16 trillion, etcetera -- I won't bore you with the

 17 detail -- but we break that down into risk,

 18 trading risk into delta pillars. We traded -- we

 19 executed in the region of 100, 150 large hedge

 20 trays across multi-currencies, and that micro-

 21 hedged the portfolio probably within the first two

 22 or three days, and then we didn't -- using Kim's
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 1 phrase, we didn't just sit on a hunch. You have

 2 to keep micro-hedging, dynamically hedging the

 3 portfolio, the portfolio of interest rates or

 4 credit derivative swaps is a living organism. It

 5 changes shapes and moves by the second, so you

 6 have to keep micro or dynamically hedging that.

 7 But once we got to a point of low

 8 volatility in the portfolio so minimal variation

 9 margin volatility in the portfolio, we then enter

 10 into the next phase which is an auction. I think

 11 it's really important. We actually executed real

 12 trades. We didn't auction live risk. We hedged

 13 the portfolio within a degree of tolerance then we

 14 broke that up into chunks and we gave that back

 15 out to the non-defaulting clearing members for

 16 them to take the portfolio in, or for the tens of

 17 thousands of trades, revalue the portfolio against

 18 their own curves, calculate the risk, any novel

 19 positions in the curve risk, reset risk, etcetera,

 20 and then they made a bid on it, and then we took

 21 -- we accepted bids. But this was over the course

 22 of a two, three week period.
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 1 So yes, in the first two or three days

 2 we'd hedged the risk, but we still have this

 3 living organism, for want of a better phrase, over

 4 a two, three-week period whilst we auctioned the

 5 positions off and transferred them to the non-

 6 defaulting members. To give you some context,

 7 that was all within -- we give back about I think

 8 it's within 40 percent of the initial margin, so

 9 we gave back about half of the initial margin back

 10 to Lehman Brothers Estates, so the end result was

 11 there was nobody impacted. None of the clearing

 12 members were impacted by that, or any of the

 13 clients.

 14 MS. AYOTTE-BRENNAN: Well, I think it's

 15 also important to Richie's point is that -- and to

 16 Ray's point -- that the porting of these books

 17 could be much different because today our swaps

 18 are done out of a different entity than the FCM

 19 with our dealers. Now you're going to have those

 20 transactions all done with the FCM. A client may

 21 reach its exposure with an FCM much quicker now on

 22 those trades because now you have futures and
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 1 swaps that may need to be ported, and it may not

 2 be able to go to just one FCM if that FCM doesn't

 3 want to take on the exposure to fidelity at that

 4 level because it already has swapped some futures

 5 with us. So we may reach our credit levels much

 6 quicker with an FCM and have to port to more FCMs

 7 than we did in the Lehman situation.

 8 MR. KAHN: So that point we will have

 9 limits, portfolio limits, for all of our clients.

 10 You're likely to have your margins potentially

 11 going up at that period and more payments, so you

 12 know, the question is can you take it all in. And

 13 you have the operational issues of -- as I stated

 14 earlier, operationally if there's large hundreds

 15 or thousands of line portfolios that need to move,

 16 do the FCMs, do the CCPs have the manpower to

 17 basically move thousands of line items in a one,

 18 two, three-day period. I can't tell you all the

 19 people -- I'd love to be able to tell you that

 20 Barclays can handle every line item of the clients

 21 represented over there, but if it's a stress

 22 situation I don't know that we can do that on a
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 1 one or two day period.

 2 MR. WASSERMAN: Well, you guys have the

 3 most experience with that now.

 4 MR. KAHN: We're doing the best we can.

 5 I mean we're all trying to build straight through

 6 processing, but let's be honest with reality. I

 7 mean taking in -- to the point of my fellow FCM

 8 colleagues, we'd love to look at the portfolio and

 9 say this is a portfolio we like, it's short, it's

 10 long, all this type of stuff, but if you have a

 11 thousand line item portfolio you've got to bring

 12 that in and also process it operationally.

 13 There's a lot of stuff going on.

 14 MR. DIPLAS: No, but that's why I think

 15 clients probably want a lot of options as to where

 16 they're going to go. Probably pre-default

 17 portability is the answer. Post- default I think

 18 is going to get a lot more complicated.

 19 MR. WASSERMAN: Speaking of options,

 20 actually what I'd like to do, and at the risk of

 21 complicating this yet further I want to bring back

 22 our discussion of optional models here because I
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 1 guess my -- you know, we were talking about going

 2 from 99 to 99.9 and/or some increase in guarantee

 3 fund.

 4 So let's say instead we do an optional

 5 model, and let's say folks representing 50

 6 percent, 60 percent of a book decide to take that

 7 optional model. So it seems to me there are two

 8 questions. What would be the impact -- we already

 9 spoke about operational costs and what would be

 10 involved there and what folks were already

 11 incurring, so let's for the moment put those

 12 operational costs off to the side, simplify this a

 13 little bit. Risk costs, how would you impose the

 14 additional risk costs on the people who are taking

 15 the option to have greater protection and what

 16 would be the impact of risk costs on those folks

 17 who don't to the extent that having the people who

 18 are looking for the greater protection, their

 19 diversification is now walking off the scene and

 20 so you may have whatever is left in my

 21 hypothetical 40 or 50 percent of the book, which

 22 is less diversified because these guys who
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 1 probably will tell us that they tend to be the

 2 less risky of the customer base, they're walking

 3 off, so what are the impact I guess risk costs on

 4 them and what's the impact risk costs on the rest

 5 of the book if we were going to say an outside

 6 model?

 7 MR. MAGUIRE: Fundamentally we don't

 8 believe that that client mutualization there will

 9 be that. Now we know it's probably not zero, but

 10 we made that assumption, so just to be crisp on

 11 this, the margins would be the same and the

 12 guarantee fund would be the same. We made no

 13 distinction.

 14 MR. KAHN: But Dan, you guys offer an

 15 option, right?

 16 MR. MAGUIRE: We offer options, but the

 17 margin is the same under each option because we

 18 don't rely on any client mutualization under any

 19 of those.

 20 MR. KAHN: But would you expect when the

 21 many clients, thousands of clients, come into the

 22 space, which one do you think they'll choose?
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 1 MR. MAGUIRE: The one with better

 2 protection for the same price.

 3 MR. PRAGER: From -- yeah, from our

 4 perspective that's the answer.

 5 MR. DIPLAS: But if it's the same price

 6 why would anybody take anything less --

 7 MR. FRANKEL: Let me try and also -- it

 8 seems if the quality of a fellow customer risk,

 9 that mutualization shrinks, then the DCO, the CCP

 10 will have to increase the margin levels from 99 to

 11 99.3, 4, whatever it is to make up to the same

 12 level of security for the DCO, which just means

 13 that at more risk with more money and it's looking

 14 less and less attractive. I don't know why

 15 everybody wouldn't move now to the legal seg

 16 model, and I don't see the value of offering the

 17 optionality in that case. I think that there

 18 would have to be a migration. I think it would

 19 just be a natural economic affair. Everyone would

 20 migrate to the legal seg model.

 21 MS. TAYLOR: Well, but there's the --

 22 MR. FRANKEL: I mean it's hypothetical.
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 1 MS. TAYLOR: At a risk cost basis if it

 2 got to the same place then I would agree, people

 3 would tend to choose the greater protection for

 4 the same price, but there's also the operational

 5 costs, and I don't know if those outweigh it for

 6 people.

 7 MR. DIPLAS: Kim, could you do it -- you

 8 couldn't do it even at a different price. If you

 9 have five clients, four of them get 99.9, the

 10 fifth one gets 99, well, who is going to pay for

 11 that difference?

 12 MR. KAHN: Yeah, but the biggest cost

 13 is, as we said here, is the movement in IM going

 14 from 99 to 99.7. There's no way the operational

 15 costs are going to come anywhere near that --

 16 MR. PRAGER: As we said, there is none.

 17 MR. FRANKEL: I think, talking for Kim

 18 --

 19 MS. TAYLOR: Not everybody --

 20 MR. FRANKEL: I think Kim's --

 21 MR. WASSERMAN: And just to be clear,

 22 what I'm saying is analytically I'm not sure that
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 1 the operational cost is changing it. I guess what

 2 I'm trying to get at and trying to -- but again,

 3 tell me if I'm going down a bad path here -- is

 4 that if -- the thought earlier was, and I think

 5 there's this general thought, let's offer options;

 6 those who want better protection pay more, those

 7 who don't want to pay more get lesser protection.

 8 And I guess what I'm asking is as a practical

 9 matter and as a logical and economical matter,

 10 because of the risk cost issues, because I think

 11 -- and tell me if I'm wrong -- risk cost depends

 12 upon diversification if you're taking -- if some

 13 customers, if some large portion of -- not the

 14 number of customers but the weight of the

 15 customers, the weight of the margin, if you will,

 16 goes off and is protected individually, then are

 17 the folks who choose, who want to opt not to pay

 18 more really going to be paying less because I

 19 think the risk costs then would be permeating

 20 throughout the account. But please somebody tell

 21 me where I'm going wrong.

 22 MR. FRANKEL: I cannot. But I think Kim
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 1 was referring to the option between the future's

 2 model and the full seg model as opposed to the

 3 complete seg model, and I was referring to the

 4 option between the future's model and the complete

 5 seg model, the LSOC.

 6 MS. TAYLOR: Which one is -- okay.

 7 LSOC.

 8 MR. FRANKEL: LSOC. So I think we just

 9 more or less agreed. But that's why the

 10 operational cost, because he was referring to the

 11 full seg.

 12 MR. WINTER: If I can, I may be missing

 13 something here, but if the margin is commensurate

 14 with the risk of a client's portfolio and a client

 15 opts to move into one seg pool versus another,

 16 what remains doesn't change in terms of the

 17 existing pool that's losing it because if it's got

 18 a lot of risk it's taking a lot of collateral. If

 19 it's got low risk it's taking low collateral. So

 20 I don't think it's going to overly impact that.

 21 And as far as the cost, I mean that's a dollar and

 22 cents cost for moving it into an option where you
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 1 can get that better protection. So I'm afraid we

 2 might be combining two separate issues here, and

 3 one is the cost of having that optionality in

 4 terms of pure dollars and cents versus margin to

 5 protect each client or every FCM and therefore

 6 every participant to make sure that the client is

 7 properly margined.

 8 MR. WASSERMAN: But your assumption

 9 here, and this is -- the assumption you're making

 10 is that each client is providing sufficient

 11 collateral for his or her individual position, and

 12 as I understand it in the future's model each

 13 customer's position is guaranteed partly by that

 14 customer, partly by the capital of the FCM, and --

 15 say it quietly -- partly by the fellow customer

 16 collateral of that FCM in the event that there is

 17 a default by the FCM. And so if that --

 18 MR. MAGUIRE: Caused by another

 19 customer.

 20 MR. WASSERMAN: I'm --

 21 MR. MAGUIRE: Caused -- if the FCM's

 22 default was caused by another customer.
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 1 MR. WASSERMAN: Yes. An FCM.

 2 Absolutely. But the point is to the extent you're

 3 relying on fellow customer collateral, then

 4 essentially part of what's meeting it, that's

 5 where the change is, part of it is the fellow

 6 customer collateral. If you're not relying on it

 7 then there's absolutely no cost and that's Dan's

 8 position.

 9 MR. FRANKEL: I think Steven's point is

 10 right if you're charging 99.9 in one account and

 11 99.9 in the other. If you charge at different

 12 confidence intervals that's when you get the

 13 situation you talk about.

 14 MR. THUM: Bob, I think you hit the nail

 15 on the head, and I think running from the LCH

 16 approach which has zero effect to the fellow

 17 customer risk, I think what Oliver was saying made

 18 a lot of sense, that as that diversification

 19 component exits the future's model the margin

 20 level will have to go up from 90 -- from 99

 21 percent up to 93, 94, 95, and as that increases

 22 those people will jump out of that bucket into the
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 1 LSOC bucket because they really will not be saving

 2 anything and be taking on considerable risk.

 3 MR. COX: But why is there equilibrium

 4 when they've all moved? I mean couldn't there be

 5 some point where it goes from 99 to 99.2 and at

 6 that point then I, okay, well I'm paying a bit

 7 more than I was but it's still better than 99.9 so

 8 I'm going to stay put.

 9 MS. TAYLOR: It absolutely could do

 10 that. It all depends on what happens to the

 11 exposure profile of the -- of the pool.

 12 MR. DIPLAS: But the thing is it's going

 13 to be very difficult to have these two -- to have

 14 clients that are margined at different confidence

 15 intervals coexist in the same pool. I think it's

 16 going to be very difficult. If you can take it to

 17 the extreme cases that there's only one client

 18 left that's margined at a different level, you're

 19 going to have a deficit. You're going to need to

 20 have the same confidence interval for the whole

 21 account. Either these funds are there or these

 22 funds are not there. I think it's going to be
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 1 very difficult to have this hybrid that some

 2 people choose to pay a little bit more and some

 3 will not because you don't know what ratio, what

 4 mix you're going to have with clients.

 5 MR. COX: Don't you FCMs do that anyway?

 6 I mean it sounds like already you should all be

 7 margining your customers to 99.9 because you don't

 8 get the benefit of cross- customer risk, right?

 9 One of your customers defaults you don't go --

 10 MR. DIPLAS: No. It's the CCP level.

 11 It's the CCP level that I'm saying they wouldn't

 12 want to have the certainty that when we go under

 13 as a result of a client default.

 14 MR. COX: Right.

 15 MR. DIPLAS: There is going to be a

 16 guarantee effectively that there is going to be

 17 enough money there. But that's a bonus. But if

 18 at the end the only people that are left there are

 19 actually -- is one client that was margined in 99,

 20 you just have a one dollar deficit.

 21 MR. COX: Right.

 22 MR. DIPLAS: What do you do at that
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 1 point?

 2 MS. TAYLOR: But Athanassios, if you

 3 got there the CCP would be taking some action

 4 because there is no diversification in that pool.

 5 So --

 6 MR. COX: Practically thinking, do you

 7 guys really do that, the CCPs? I mean how many of

 8 your FCMs are you super-margining at the moment?

 9 MS. TAYLOR: How many FCMs are on

 10 super- margining at the moment? Maybe like 15.

 11 MR. DIPLAS: When you say you're taking

 12 action you're basically moving from kind of this

 13 formulaic opposed to ahead to something, but

 14 you're moving from 99 to 99.9 effectively. You're

 15 moving that plan up. That's what you're

 16 effectively doing by taking action. You're taking

 17 -- you're charging higher margin at that point.

 18 MR. EDMONDS: And I certainly think the

 19 use of concentration margins, Rupert, you would --

 20 those exist and those are active today, and we

 21 collect those, given the position that we hold for

 22 that individual. So they're active and I would,
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 1 you know, roughly say the percentage of members

 2 that are paying that at the moment inside of ICE

 3 Trust is probably close to the percentage that Kim

 4 just gave you inside of CME.

 5 MR. WASSERMAN: And just now may be a

 6 good time to mention we had put in the rule, I

 7 think it was 22.13, some specific provisions

 8 noting that DCOs -- we wanted to make sure that it

 9 was clear that you had certain tools that -- and

 10 that may have been belt and suspenders -- that you

 11 could require individual FCMs to collect

 12 additional collateral from individual customers or

 13 individual FCMs to put up additional collateral

 14 from their own funds that would be free for you to

 15 use. I don't know -- I hope that's --

 16 MS. TAYLOR: We already have rules that

 17 allow us to do that.

 18 MR. WASSERMAN: And so that is a helpful

 19 tool. Yeah, then I'm not surprised that you

 20 already can. That is a helpful tool for

 21 addressing this so that there is a closer tie

 22 between who is in fact imposing the risk and who
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 1 in fact is paying for the risk. Is that -- I mean

 2 does that help at all?

 3 MR. EDMONDS: I think you're codifying

 4 in the regulations what's already in our

 5 individual rule books today, so you know, from the

 6 standpoint that there's no path to escape I would

 7 say that that is helpful from that perspective.

 8 MR. WASSERMAN: And just to be clear

 9 that essentially to the extent you do that on an

 10 individual customer basis there would be greater

 11 than -- there would be greater margin that's

 12 accessible to you even under LSOC, and likewise to

 13 the extent that you collect the money from the

 14 firm, again that is additional collateral that's

 15 available to you under LSOC. Not -- in other

 16 words, not just simply under your current rules

 17 but even with LSOC you'd be able to get additional

 18 pinpointed protection, if you will. Pinpointed

 19 collateral.

 20 MR. EDMONDS: As it relates to a

 21 granular position, yes. Bob, are you at all

 22 concerned about, you know, we talked a lot today
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 1 about portability and making the ease of

 2 portability and I don't think anyone disagrees

 3 with that because it is an effective tool

 4 especially as mentioned earlier on a pre-default

 5 basis, you know, to make sure we're -- we

 6 understand Ray's analogy, what we're putting in

 7 that cup and what we're going to manage in those

 8 points in time -- if we look at that from a more

 9 holistic perspective as -- and I don't want to

 10 spend time getting into membership requirements

 11 and the rules that you've contemplated there, but

 12 as it relates to that, one thing that the fellow

 13 customer risk does introduce is it does make it

 14 incumbent, and I appreciate Richie's point and

 15 others that have made the point where they don't

 16 have the tools set to see exactly what their FCMs

 17 have in their book, and certainly there are a

 18 number of us that spend a lot of time talking

 19 about what unencumbered capital may look like and

 20 if we could ever get to a world where that type of

 21 information become more public and things of that

 22 nature, but nonetheless, the fellow customer risk,
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 1 there is an obligation that there has got to at

 2 least be some recognition and concern that could

 3 dissipate. Not necessarily from the sophisticated

 4 folks in this room, but they don't represent

 5 exactly all of the buy side that we have to deal

 6 with or all that would take some interesting

 7 position, to make certain they understand who

 8 they're doing business with. If you protect them,

 9 if the protection is all the way around and we

 10 don't care are we inviting more of that? Have you

 11 thought about that as we went through the creation

 12 of that?

 13 MR. WASSERMAN: And the answer is yes,

 14 and I guess I would have a couple of responses

 15 there. First, as Jim will point out, has pointed

 16 out to me and I imagine will continue pointing out

 17 to me, the protection we're dealing with, that

 18 we're creating with LSOC, is not perfect. There

 19 are -- he's pointed out a number of ways in which

 20 it falls short of perfect.

 21 MR. EDMONDS: That's the only agreement

 22 we've had in the room today.
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 1 MR. WASSERMAN: I'm sorry?

 2 MR. EDMONDS: That's the only agreement

 3 we've had in the room today.

 4 MR. WASSERMAN: And so we've -- you

 5 know, again at least from where I was coming from

 6 I intended to design it on -- with a lot of

 7 consideration of cost and benefits and aiming to

 8 achieve the greatest level of benefit at the least

 9 level of cost, but in doing that you end up at

 10 least sacrificing some benefits and achieve less

 11 than perfection, one.

 12 Two, even if we had achieved perfect,

 13 you know, something perfect, I don't think anybody

 14 on this side of the room or anybody in that kind

 15 of position would enjoy the kind of roller coaster

 16 ride that is simply guaranteed if your FCM happens

 17 to become insolvent. Indeed, as I've said

 18 repeatedly, I am not prohibiting you from

 19 liquidating all the customer positions that a FCM

 20 the moment they become out of good standing

 21 because again that, you know, from where I'm

 22 sitting, has to be your right.
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 1 So again, these -- in short what I'm

 2 saying is, am I changing the level of exposure the

 3 folks on the buy side have? Yes. Am I removing

 4 their incentive for doing at least some degree of

 5 due diligence to make sure that the firms they

 6 deal with are not going to go insolvent? Heck no.

 7 I rather think they are going to continue to have

 8 those incentives to avoid -- you know, there was a

 9 definite residual both in terms of risk and in

 10 terms of just simply -- I don't think their

 11 clients are going to be happy with them if they --

 12 if they're dealing with a defaulting FCM

 13 regardless of how well they end up getting

 14 protected. I imagine there's going to be some

 15 reputational risk there. Again, when you add that

 16 to the fact that as we've discussed for them to do

 17 anything, you know, anything more than a cursory

 18 due diligence, a real deep due diligence where you

 19 can say well gosh, there's a connection between

 20 their incentives and therefore they're going to

 21 exert market discipline because they're going to

 22 do effective risk management of their clearing
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 1 member, I don't think that's possible.

 2 I think for reasons we've discussed that

 3 the clearinghouses are structurally in a far

 4 better position to do it because they get better

 5 information, because they have concentration of

 6 expertise, because they're already doing it and

 7 already have to be doing it in their role as

 8 clearinghouses, so to have these guys each create

 9 a department of people who would have the

 10 capabilities -- you know, even if they could get

 11 the information, which they can't, to have them

 12 create a department of people who have the

 13 capability and the expertise that your people

 14 have, the people you're already employing, would

 15 be imposing a lot greater cost for I think very,

 16 very little benefit.

 17 MR. HARSHAW: I know our time is coming

 18 close. I want to just make a couple points.

 19 First off, I want to thank you for the great

 20 movement from a nothing in any proposal to a very

 21 significant movement and your team, Laura, as

 22 well, and we're grateful for that. We view this
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 1 as a significant first step, and there is -- the

 2 market is going to have to undergo a significant

 3 cost. There will be winners. The DCOs are

 4 clearly big winners. But one of the things that

 5 we would say is that if you can't get us the

 6 protections that we have today for political, for

 7 cost, for whatever reasons there are, that the

 8 Commission has made some policy decisions. For

 9 example, we get to choose where we clear. We get

 10 some choices. And we would argue, at least for

 11 our pension plans, you know, we paid billions of

 12 dollars out of benefits every year and we want to

 13 keep being able to do that. We had protections

 14 during the Lehman crisis and the credit crisis

 15 that served us well. We would ask that if it will

 16 take time, if it will take cost, if it will take

 17 political movement in order to get us to full seg

 18 what we have today, that we adopt the policy that

 19 the European regulators seem to be going to, which

 20 is to exempt pension plans from having to clear

 21 until those costs, operational issues and

 22 political ones, are resolved so that we don't put
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 1 the common man and common woman at risk because

 2 that's exactly what Dodd Frank was drafted for, to

 3 protect the common man and the common woman. And

 4 what we're saying here is that we -- we

 5 acknowledge that all of these issues are

 6 legitimate ones and thorny ones -- exempt us from

 7 clearing until they're worked out.

 8 MR. NICHOLAS: Yeah. If I could just

 9 get back maybe to Bob's point, I'm not -- I don't

 10 think that it would be a case where the buy side

 11 would stop doing due diligence on FCMs, but I mean

 12 I do think that it would become less of a factor

 13 in -- I mean there's a number of factors why they

 14 choose FCMs. There's cost, there's a whole bunch

 15 of things. But I can't believe it would become

 16 less of a concern if they knew that at the end of

 17 the day their positions are guaranteed.

 18 MR. PRAGER: I'm sorry, you're saying it

 19 would be less of a concern?

 20 MR. NICHOLAS: No. I'm saying it would

 21 be -- I would think it would be less of a concern

 22 for customers.
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 1 MS. AYOTTE-BRENNAN: That won't happen.

 2 I mean we're fiduciaries and we have a fiduciary

 3 responsibility to do this analysis, and we will

 4 not stop doing it regardless of what model is

 5 chosen. We care about the creditworthiness of our

 6 FCM and we care about that due diligence. And as

 7 a fiduciary if we didn't we wouldn't be doing our

 8 job.

 9 MR. NICHOLAS: I hope that's true.

 10 MR. PRAGER: I agree.

 11 MR. NICHOLAS: And for the folks in this

 12 room I'm sure it is, but I'm not so sure that that

 13 would be true of all customers. The other thing,

 14 just real quickly before we go, one of the points

 15 that you -- that is raised in the release as to

 16 why the staff selected this particular -- or

 17 prefers this particular model -- is portfolio

 18 margining. And it seems to me that introducing

 19 another potential -- you know, having the future's

 20 model, the legal seg, complete legal seg model,

 21 and then a securities model, you're just

 22 complicating -- maybe I'm not understanding it,
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 1 but it seems to me you're complicating portfolio

 2 margining rather than --

 3 MR. WASSERMAN: Actually no because

 4 here's the deal. Under an omnibus model, whenever

 5 you're bringing something from outside the pool

 6 into the pool you're putting a risk not only for

 7 the folks who are trading and are getting the

 8 benefit of the portfolio margining for their mixed

 9 positions, but you're also exposing to the same --

 10 to that risk -- all the other customers because

 11 again, remember there's essentially a

 12 socialization of the risk.

 13 Under an individual customer protection

 14 model each customer bears their own risk and the

 15 other customers are being, if not perfectly,

 16 substantially insulated from that risk. And so if

 17 I'm bringing in an additional risk that I bear but

 18 Laura does not then the regulator has less of a

 19 concern than if I'm bringing in a risk that I'm

 20 also sharing with Laura because again

 21 individualized risk means less concern over

 22 portfolio margining.
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 1 MR. RADHAKRISHNAN: Okay. I'd like to

 2 thank everybody for their contributions. I know

 3 extremely weighty topics, particularly for

 4 discussion on a Friday, but I am very grateful for

 5 everybody's contributions. I would encourage not

 6 just everybody here but all of those who are

 7 interested in this topic to please write to us.

 8 As Bob has pointed out, the document has not made

 9 it yet to the federal register. Is that correct?

 10 Hopefully it --

 11 MR. WASSERMAN: Federal register has not

 12 yet seen fit to publish the document. It made it

 13 to them many, many weeks ago.

 14 MR. RADHAKRISHNAN: Okay. So they've

 15 not seen fit to publish the document. And how

 16 many days did we give people to comment?

 17 MR. WASSERMAN: Sixty days from when it

 18 does.

 19 MR. RADHAKRISHNAN: Sixty days. But

 20 you've had the advantage of looking at it these

 21 past six weeks because it's on our website, so --

 22 and I don't think we're going to change, there's
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 1 not going to be any changes in the document.

 2 MR. WASSERMAN: No. There are changes

 3 in formatting that are completely non-substantive.

 4 MR. RADHAKRISHNAN: So please, you know,

 5 you guys have all made very important points and a

 6 lot of things for us to think about in your

 7 points. I was just waiting for the point that Jim

 8 made to be made, which is -- and I know that EMIR

 9 has said -- has basically exempted pension funds,

 10 is it three years or something to that effect, so

 11 I was waiting for that point to be made. I'm glad

 12 you made it. Otherwise I'd be very disappointed

 13 if nobody had made that point. So thank you again

 14 for your valuable contribution, and enjoy your

 15 weekend. Thank you.

 16 (Whereupon, at 4:46 p.m., the

 17 PROCEEDINGS were adjourned.)

 18 * * * * *

 19

 20

 21

 22
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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Irene Gray, notary public in and for

 4 the District of Columbia, do hereby certify that

 5 the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: April 30, 2016

 22