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1 MEETING OF THE CFTC

2 TECHNOLOGY ADVISORY COMMITTEE

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8 TRANSCRIPT OF PROCEEDINGS

9 Washington, D.C.

10 March 29, 2012

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13 ATKINSON-BAKER, INC.

14 COURT REPORTERS

15 (800) 288-3376

16 www.depo.com

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23 REPORTED BY: JENNIFER M. O'CONNOR

24 FILE NO.: A6030F8

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1 APPEARANCES:

2 BRENDA BOULTWOOD, Constellation Energy

3 SEAN CASTETTE, GETCO, LLC

4 BART CHILTON, CFTC (via phone)

5 MICHAEL COSGROVE, GFI Group

6 RANDALL COSTA, Citadel, LLC

7 R.J. CUMMINGS, ICE

8 NANCY DOYLE, CFTC

9 BRYAN DURKIN, CME Group, Inc.

10 GARY GENSLER, CFTC

11 RICHARD GORELICK, RGM Advisors, LLC

12 MICHAEL GORHAM, Illinois Institute of Technology

13 PAUL HAMILL, UBS

14 JILL L. HARLAN, Caterpillar, Inc.

15 DOUGLASS E. HARRIS, Promontory Financial Group, LLC

16 JOEL HASBROUK, NYU

17 STEVEN JOACHIM, FINRA

18 ANDREI KIRILENKO, CFTC

19 JEFFREY MARON, MarkitSERV

20 GARRY O'CONNOR, Int'l Derivatives Clearing Group

21 SCOTT O'MALIA, CFTC

22 DEAN PAYTON, CME Group

23 EVELYN PURE, Promontory Financial Group, LLC

24 JIM RUCKER, MarketAxess

25 JILL SOMMERS, CFTC
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1 APPEARANCES: (cont'd)

2 CHARLES VICE, Intercontinental Exchange

3 MARK WASSERSUG, ICE

4 MARK WETJEN, CFTC

5 DR. MATTHEW WHITE, ISO New England, Inc.

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7 AUDIENCE MEMBERS:

8 JOSEPH SALUZZI, Themil Trading, LLC

9 LARRY TABB, TABB Group

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

2 (10:10 a.m.)

3 COMMISSIONER O'MALIA: Thank you very

4 much. Thank everybody for attending and

5 participating. We have kind of a three-ring circus

6 here today. We have the full TAC committee members

7 sitting around the table. We have the Data

8 Standards Working Group on our left and we have the

9 new High Frequency Trading ATS Subcommittee on my

10 right, and we're going to have a series of three

11 panels here today. So I greatly appreciate

12 everybody coming today and participating and we'll

13 get the fifth Technology Advisory Committee off to a

14 start here.

15 We've covered a variety of issues thus

16 far, including pre-trade functionality. One of our

17 first groups, Dr. Gorham helped us establish that

18 working group, the first working group we ever had.

19 We've had the SEF Showcase, and now we're going to

20 tackle high frequency trading in addition to the

21 work that the Data Standard Subcommittee has

22 presented us today.

23 Despite its ubiquitous utilization in our

24 markets, high frequency trading is not only -- is

25 not well understood by the public and the relevant
5

1 regulatory bodies, as I believe it should be. So

2 that's one of the reasons we're going to tackle

3 that.

4 Today's discussion will cover three

5 different topics. Our first panel will discuss the

6 role high frequency trading plays in our markets.

7 Working with our chief economist, Andrei Kirilenko,

8 we have selected 24 individuals to participate in

9 the new subcommittee on automated and high frequency

10 trading, and hopefully over the next several months,

11 depending on their work product and time tables, we

12 can have much better clarity into the practices and

13 the definition into this -- into this area.

14 The second panel will focus on the final

15 recommendations of the subcommittee on data

16 standardization. As I have said before, data is the

17 foundation of our markets and essential to

18 supporting our transparency requirements. Our

19 ability to capture market data is -- in a universal

20 electronic form is essential to automating our

21 surveillance and oversight programs.

22 The third panel will explore the

23 deployment of technology solutions in the swaps

24 market with a specific focus on evaluating the costs

25 and technological and scheduling challenge posed by
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1 fully integrating pre-trade credit checks by October

2 1, 2012, as a technological substitute for

3 documentation. In particular, I'm interested to

4 understand how the industry will develop a seamless

5 interconnection of FCMs, SEFs, DCMs and CCPs to

6 ensure that trade -- trades come off without

7 breakage.

8 Technology has been the true driver of

9 change in our markets and continues to dictate its

10 evolution. Automated and high frequency trading

11 strategies have narrowed market pricing and provided

12 liquidity. The Commission's challenge, however, is

13 to ensure that as markets evolve, the Commission is

14 able to keep pace and develop oversight and

15 surveillance capacity to ensure markets function in

16 their appropriate manner.

17 There is little empirical data regarding

18 the impact of HFT strategies on market pricing and

19 overall market behavior and better data and standard

20 definition of these market behaviors must be

21 developed. It seems on a weekly basis there's a new

22 story about automated trading and high frequency

23 trading. In fact, today in The New York Times I

24 read Nathaniel Popper's story quoting Richard

25 Bentley of Progress Software, and many of you know
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1 Progress because John Bates serves on the

2 subcommittee. He could not make it today. And Mr.

3 Bentley said, we've managed over the past several

4 years to equip traders with Ferraris and the

5 regulators are trying to keep up with them on

6 bicycles.

7 Recent headlines have announced the FIA

8 Principal Traders Group and the FIA European

9 Principal Traders Association developing

10 recommendations on procedures for the development

11 and testing of deployment of trading software. Last

12 week the UN Conference on Trade Development

13 published a report which purports to demonstrate an

14 economic correlation between high frequency trading

15 and distorted commodity prices.

16 We also witnessed the impact of -- poor

17 computing coding can have on a market with the

18 unfortunate computer glitch associated with the IPO

19 of BATS on its own exchange. And on Tuesday I read

20 that the EU is considering a definition of

21 additional controls on HFT strategies as part of its

22 Method 2 proposal, and they have four to five

23 different proposals, very specific in that paper.

24 And Markus Popper, the lawmaker who -- or Markus

25 Ferber, who is the lawmaker steering that proposal
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1 through, has advocated also a 500-milisecond resting

2 period for ATS orders.

3 There are definitely strong opinions on

4 both sides of the HFT debate, and on both sides of

5 the Atlantic, for that matter. In an effort to

6 undertake and define this practice, last November I

7 sent out a letter to the subcommittee members, or

8 the full committee members, asking them for their

9 opinion and definition of HFT. And as I noted

10 earlier, I have asked Andrei Kirilenko, the chief

11 economist of the CFTC, to lead a subcommittee to

12 develop an appropriate definition in the -- of HFT

13 within the university ATS, the Automated Trading

14 Systems.

15 My goal is to have a working description

16 of the attributes of HFT in order to better

17 understand the impact they have on our market.

18 Developing a nomenclature is important, if only as a

19 means to study the trading activity on a consistent

20 basis. Working with Andrei, it is up to the

21 workings groups to establish their own working

22 schedule and meetings and to develop recommendations

23 for the full Technology Advisory Committee to

24 consider within the broad parameters of that

25 subcommittee.
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1 I have also requested that the Securities

2 and Exchange Commission, working with Chairman

3 Schapiro, to send staff to participate in these

4 working groups, as well to ensure full coordination

5 by our two agencies. And we are pleased to have the

6 participation of Dan Grey and Mike Watson from the

7 SEC.

8 Today we will hear from four witnesses to

9 kick off our debate on the ATS/HFT debate. And I

10 have three goals in mind for today's discussion.

11 One is to establish -- to establish the existing

12 exchange oversight and controls monitoring of HFT

13 activity in the markets today. We have Dean Payton

14 and Mark Wassersug. Dean Payton from CME, I'm

15 sorry, and Mark Wassersug from ICE will identify --

16 will testify regarding what each exchange is doing

17 to manage trading on their respective exchanges.

18 Second, we will evaluate and discuss the

19 current state of economic research regarding

20 identifying and analyzing ATS behavior and their

21 economic impact, and we're pleased to have Joel

22 Hasbrouck, who will provide an update on the current

23 economic research as well, from New York University.

24 And third, identify the attributes of ATS

25 strategies and the firms and to the extent in which
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1 they participate and impact futures markets. Sean

2 Castette from GETCO will provide his perspective on

3 ATS/HFT strategies.

4 Before I turn to my colleagues for their

5 remarks, I want to let the members of the TAC and

6 the two subcommittees know how much I greatly

7 appreciate your service. I remind my colleagues

8 that everybody here is serving -- has a full-time

9 job and is serving in -- using extra time and taking

10 time away from their families and their jobs to come

11 support our efforts to understand these markets

12 better.

13 I personally have benefited enormously by

14 your participation and your influence and your ideas

15 and I greatly appreciate that and I know the

16 Commission policy will be better served through your

17 support. I do want to recognize, and I think I said

18 earlier, we're a little early for the data standards

19 guys. I think they're coming in after lunch, but

20 they have put in an enormous amount of work and

21 effort doing calls that have been open to the

22 public, but have worked extremely hard to put

23 together four working group papers that will be

24 presented here today, and we greatly appreciate

25 their service.
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1 Recognize everybody on the HFT, the 24

2 members who are going to participate in that. We

3 greatly appreciate your time as well. And I want to

4 also thank our staff facilitators, and probably the

5 best time to recognize them, we have -- if you'll

6 just stand up, so we need to make the link between

7 the HFT Working Group and our staff. On Working

8 Group 1, Joan Manley and George Pullen. On Working

9 Group 2, we have Harry Hild and George Herrada.

10 Working Group 3 we have Andrei Kirilenko, Richard

11 Haynes and Jeremy Cusimano. Working Group 4 we have

12 Andrei Kirilenko, Richard Haynes and JonMarc Buffa.

13 Right after lunch, Andrei, I think, is

14 going to lead a brief meeting to make sure we --

15 that we're able to get the staff with the working

16 groups so you're familiar, you can exchange contact

17 information, and begin to lay out a strategy for

18 your meetings and time table. So I appreciate

19 everybody's cooperation, willingness to come and

20 participate today.

21 I'm going to turn it over to the chairman

22 for his comments.

23 CHAIRMAN GENSLER: Thank you Commissioner

24 O'Malia, or should I say Chairman of the Technology

25 Advisory Committee, for convening this meeting of
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1 the Technology Advisory Committee, and also

2 convening the first meeting of the Subcommittee on

3 Automated and High Frequency Trading of the

4 Technology Advisory Committee, if I got all the

5 words right.

6 I also want to thank all the members of

7 the full committee and all of the members who are

8 willing to advise us and serve on the High Frequency

9 Trading and Automated --

10 COMMISSIONER O'MALIA: It's a mouthful.

11 ATS/HFT, whatever you want.

12 CHAIRMAN GENSLER: Well, being willing to

13 associate yourself with the word "high frequency

14 trading" in itself is a really interesting thing.

15 So we applaud that. But financial reform means the

16 Commission must continue to adapt our oversight to a

17 changing market structure, including emerging trends

18 in electronic trading, and you've been talking about

19 that for some time.

20 But of course in the markets, one thing we

21 can be quite sure of is that means of communication

22 and technology will continue to advance and affect

23 our markets. This was true in the 19th Century when

24 telegraphs came along. It was -- it led to the

25 introduction of the ticker tapers we all know. It
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1 also is true in the 20th Century when telephones

2 first allowed a central quote system where market

3 participants could get instantaneous bids and offers

4 at that point in time. And I'm sure there was a lot

5 of debate and controversy at that time.

6 It was further true during the last decade

7 when futures markets went from largely open outcry

8 to now nearly 90 percent traded electronically. So

9 where market makers used to meet on the floor of

10 exchanges, they now often sit at computers miles

11 away or even in another continent. And while market

12 participants used to be involved in each of their

13 trades, they now often rely on algorithms to execute

14 those trades.

15 So humans are much more frequently relying

16 on the judgment programmed into their machines,

17 which will then initiate and execute their trading

18 strategy. The markets have evolved to where we

19 increasingly find machines competing with each

20 other. So regulators, I believe, cannot assume that

21 the algorithms in the markets are necessarily well

22 designed, tested or supervised. Our regulations

23 have to adapt as the markets increasingly move from

24 man to machine.

25 Only through adaptive regulation can
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1 hedgers and investors have confidence in the markets

2 and the integrity of those markets. This year the

3 Commission will continue to adapt and work on our

4 oversight of these changing markets, including

5 emerging trends relating to electronic trading. The

6 Commission's already taken a number of steps, and

7 you've already been very helpful in these in that

8 regard.

9 As it relates to both trading and

10 clearing, the Commission has proposed that there be

11 pre-trade filters to protect the markets and the

12 clearing system and our proposed designated contract

13 market rules and our proposed swap execution

14 facility rules. These trading platforms were

15 required to put in place effective risk controls,

16 including pauses and/or halts to trade in event of

17 extraordinary market events.

18 We also sought and received many helpful

19 comments on possibly requiring additional risk

20 controls, things like price collars, limits on

21 maximum order sizes, stop loss and kill buttons.

22 And I know later today, I think one of the groups is

23 going to be talking about that, which will be very

24 helpful.

25 This month we did actually finalize some
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1 rules to strengthen risk management procedures and

2 clearing members. The final rule requires that

3 futures commission merchants and dealers and the

4 like establish risk-based limits on their customers

5 and house accounts. Basically risk filters and

6 procedures would help secure the financial integrity

7 of the clearing system.

8 In addition, the Commission finalized

9 internal business conduct rules with regard to swap

10 dealers. Doesn't necessarily affect many of you

11 now, but there might be a time that some of you will

12 be electronically trading swaps and this will be

13 helpful because within those rules, maybe not well

14 noticed, but within those rules a risk management

15 procedure requiring swap dealers to have policies

16 and procedures that detect, identify and promptly

17 correct deficiencies and operating and information

18 systems.

19 Furthermore, the risk management

20 procedures are required to be tested and reviewed.

21 So taken together, these requirements are important

22 enhancements to protect a rapidly changing market,

23 because one day swaps may be in a similar place that

24 our futures markets are now.

25 Further, I expect the Commission will
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1 consider putting out for comment a concept release

2 concerning testing and supervision of automated

3 market participants, especially those with direct

4 market access. Concepts will be designed to address

5 potential market disruptions at high frequency

6 traders and others who have automated systems and

7 access and costs.

8 The Commission's also looking to propose a

9 rule when reporting of ownership and control

10 information for trading accounts. That will give us

11 more information as well. These rules would enhance

12 our surveillance capabilities, increase transparency

13 of trading.

14 So again, I'd like to thank Commissioner

15 O'Malia for his work on this, as well as Chief

16 Economist Andrei Kirilenko. I note that both of

17 them ride to work on a bicycle every day, so I know

18 that this article was probably referring to you.

19 But some of us just run or walk as regulators. I

20 think, Commissioner Wetjen, you ride a bike as well,

21 right?

22 Yeah, so I think they're referring to the

23 three of you. But the work of this committee and

24 this subcommittee helps inform and infuse good

25 advise and your thoughts in all that we're doing.
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1 That which we've already done I think was better for

2 it. That which we've put into the designated

3 contract market and SEF proposals came right after

4 the FIA and this committee, and I think under your

5 leadership was working about a year ago or 18 months

6 ago into that, and I think it will really help us as

7 we continue to move forward to adapt to changing

8 market structures.

9 So I thank Scott. I thank all of you,

10 those particularly willing to associate yourself

11 with high frequency trading.

12 COMMISSIONER O'MALIA: Thank you, Mr.

13 Chairman. Commissioner Sommers?

14 COMMISSIONER SOMMERS: Thank you. And I

15 just want to echo the gratitude of my colleagues to

16 all of you and to the Commission staff that are

17 willing to put in extra hours on these very

18 important issues. I can't say enough about how

19 important it is for this Commission to be more

20 informed and to have a greater understanding about

21 the types of new market activities and the type --

22 the ways that these markets are evolving.

23 The Commission has a long history of

24 regulating actors within the markets for their

25 specific behaviors, floor brokers, CPOs, CTAs, IBs,
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1 with regard to their different activities in the

2 market. But we've never based our regulatory scheme

3 on the type of access that someone has or the

4 different hardware or software that they utilize.

5 I believe that it's absolutely appropriate

6 for us to understand and recognize different trading

7 activities and to impose different regulatory

8 obligations on those activities. But I believe it

9 would be unprecedented for this Commission to decide

10 that we draw distinctions between market behaviors

11 or methodologies. In my mind, this would be like

12 regulating the guy on the outside of the ring

13 differently than you do in the guy in the inside of

14 a trading pit based on their location difference,

15 based on their different trading style, or maybe

16 even the sound of their voice.

17 Hopefully with the help of this advisory

18 committee and the ATS/HFT Subcommittee, we can

19 define and develop the appropriate regulatory

20 framework for the specific market activities. I'm

21 confident that this further analysis can prevent us

22 from requiring certain market participants to be

23 registered in categories that do not fit their

24 activity and help us to avoid policy decisions with

25 the potential to cause adverse market implications.
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1 Again, just to echo what the chairman said

2 about Commission O'Malia's work on all of these

3 issues, this particular advisory committee and the

4 subcommittees that he's developed I hope will help

5 us gain a better understanding and help us to

6 improve our oversight regime.

7 COMMISSIONER O'MALIA: I think we have

8 Commissioner Chilton on the phone?

9 COMMISSIONER CHILTON: Yeah, I'm here.

10 Good morning.

11 COMMISSIONER O'MALIA: All yours, Bart.

12 COMMISSIONER CHILTON: Well, I'll echo

13 what my colleagues have said, but thanking you,

14 Scott. I do so privately a lot of times guys.

15 Commissioner O'Malia has done a great job on this,

16 as has his staff, and I very much appreciate it.

17 You've done more with the advisory committees than

18 I've seen in the time that I've been here, and

19 really to be commended.

20 I appreciate you doing this over the

21 phone. I won't be long here, and I'm just going to

22 be around for the morning, Scott, and I'll just

23 listen after this. But I came across an interesting

24 statistic a couple of weeks ago and it was in

25 working with DPCC, and then talking with somebody
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1 who's pretty smart on this stuff.

2 There are over 160 million financial

3 transactions taking place around the world every

4 day, and that's not people, a check clearing their

5 bank. But it's 160 million market-related financial

6 transactions taking place all around the world. And

7 it's just sort of amazing when you think about a

8 normal size and breadth of the markets and how

9 traders are not just up on one market or one

10 exchange, but they're arbitraging all across the

11 world. And these things are -- the HFTs, the

12 cheetahs as I call them, are sort of churning away

13 and burning up the fiber 24/7/365.

14 It's pretty amazing actually and I commend

15 the exchanges for the work they've done, that we

16 don't see more problems than we do. They do a

17 really good job of trying to keep track of it. But

18 that said, there has been some noticeable trips and

19 falls and I won't get into those. You know what

20 they are.

21 The argument that I hear a lot, and both

22 Commissioner Sommers and Chairman Gensler referred

23 to it, but I hear this a lot, that while the

24 cheetah -- the FHTs are really just an extrapolation

25 of the day trader. It's just like the pits. You
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1 know, these guys are basing their trades upon intel

2 that they just get. It's as sophisticated as it can

3 be, that they try to execute fast in order to get an

4 advantage. And they try to be essentially flat or

5 have as little exposure as possible at the end of

6 the trading day.

7 So while I accept that those are

8 similarities with the day traders, you know, there

9 are still -- that's still an argument that some

10 people use to say to regulators, so since they're

11 like the day traders, there's nothing to see here.

12 Move along folks.

13 Remember that old day tripper song, the

14 Beatles song, it says got a good reason for taking

15 the easy way out. Got a good reason for taking the

16 easy way out. Well, I understand why some people

17 would make that argument. They don't want to be

18 regulated. That's the easy way out. And for us

19 it's naive to think that these things aren't

20 different, that the cheetah traders aren't different

21 than day traders, and dangerous from a regulatory

22 perspective.

23 And so I really appreciate the fact that

24 we're looking at this. I know you all believe that

25 we need to understand it better. I talked about not
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1 only registration, but of the pre-trade

2 functionality testing essentially before HFT

3 programs go into the production environment, about

4 kill switches in case the programs go sterile.

5 Those are three things that I think make some sort

6 of obvious sense.

7 But I appreciate the work that everybody's

8 done there. I appreciate all that the TAC and the

9 subcommittee for --subcommittee for your future

10 work. And let's just hope that if we go forward

11 with this in the right way and have a balanced

12 approach, as Commissioner Sommers is talking about,

13 that technology in market isn't simply a one-way

14 ticket. Thank you.

15 COMMISSIONER O'MALIA: Thank you,

16 Commissioner Chilton. Commissioner Wetjen.

17 COMMISSIONER WETJEN: Thanks Commissioner

18 O'Malia. I was just going to add my voice to the

19 chorus of praise for Commissioner O'Malia and all

20 his hard work on this issue, and his effective use

21 of the advisory committee has been -- you've been

22 very clever and effective in figuring out how to use

23 us as a useful tool, and not just for the

24 Commission, but I think also for the benefit of

25 market participants.
23

1 I also appreciate the fact that today with

2 this meeting there's some targeted issues that

3 hopefully everyone here in the room are going to be

4 able to help us grapple with, and I think focusing

5 the discussion that way is especially good for the

6 Commission.

7 And then lastly, again just want to pile

8 on, I guess, with what the others have said. I know

9 -- I know how difficult it can be for folks that are

10 here today to make time to do this kind of thing,

11 but again, it's very -- it's very, very useful to

12 us, very, very important to get your input. So

13 appreciate the fact that you trekked to D.C. if

14 you're from out of town and taking yourselves away

15 from your regular day jobs. We really benefit from

16 it and really appreciate it.

17 So look forward to the discussion today.

18 COMMISSIONER O'MALIA: Thank you very

19 much. Next we're going to hear from Andrei

20 Kirilenko, our chief economist.

21 MR. KIRILENKO: Thank you, Commissioner

22 O'Malia. I'd just like to make a few brief remarks

23 to introduce the new Subcommittee on Automated and

24 High Frequency Trading of the Technology Advisory

25 Committee. I think this is going to be a terrific
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1 effort and highly anticipated effort, as you can see

2 by all the commissioners and the chairman.

3 This subcommittee includes 24 very, very

4 able individuals who have kindly agreed to devote

5 their time to public service. They're extremely

6 well qualified. They represent a diverse set of

7 views. We have exchanges, designated contract

8 markets. We have futures commission merchants. We

9 have a variety of different HFTs. We have traders

10 who are still human traders. We have a variety of

11 experts, experts both on the technology of automated

12 and high frequency trading and experts on the impact

13 of it.

14 We also have data vendors. Data is an

15 integral part of this ecosystem. So we really look

16 forward to their participation on this. We've split

17 up this 24 very able individuals into four working

18 groups. We've done this before. This is done for

19 -- to make -- to basically make this operational, to

20 make this work in a sort of focus, to have each

21 working group focused on specific tasks.

22 The first working group is going to work

23 on the definition of HFTs. The second will work on

24 different types and maybe tag HFTs. The third will

25 look at surveillance, regulation, other things. And
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1 the fourth one will look at sort of broader market

2 microstructure issues, as Chairman Gensler said,

3 which has been evolving, and we need to think of

4 adapting our regulation and oversight.

5 The objective of each working group would

6 be to see -- to produce written recommendations that

7 could be consumed by the public and used by the

8 Commission for consideration and adoption. These

9 recommendations will be then given to the Technology

10 Advisory Committee and you will see how it's done

11 sort of later this afternoon where the other

12 subcommittee that we have on data standardization

13 will be giving their recommendations to the

14 Technology Advisory Committee.

15 So that's sort of what the endpoint sort

16 of looks like. It doesn't mean that sort of work

17 ends here. We think of this as a catalytic effort.

18 There's an effort where we catalyze with you and

19 with us a sort of broader trends within the industry

20 to move towards an environment where these automated

21 and high frequency trading is better understood,

22 where it's better understood what oversight and

23 regulatory measures need to be in place in light of

24 their presence in the markets.

25 So I'm very excited that we are starting
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1 this process. As Commissioner O'Malia has said, you

2 and the working groups are going to have a chance to

3 meet very dedicated staff of the Commission and

4 observers from other agencies who will be working

5 with you. They'll be facilitating. I've heard

6 there will be -- they will be there to serve your

7 needs. But you're the advisory subcommittee. You

8 will be the ones advising all of us.

9 We have -- to get things started for the

10 subcommittee, we've select -- we asked four

11 representatives of the subcommittee to speak on a

12 number of issues related to exchange oversight,

13 academic review and sort of a practitioner's view to

14 get things started. We anticipate to have some

15 additional public meetings of this subcommittee

16 going forward where you'll have a chance to speak in

17 public, where each working group will have a chance

18 to present its views in full public view.

19 We have curtains drawn so we can be seen

20 by anyone. This is time for these issues to come

21 clearly out in the open by people who know what

22 they're talking about, and they're excited to have

23 this opportunity to start this process today.

24 Thank you all again.

25 COMMISSIONER O'MALIA: Great. Thank you,
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1 Andrei. As I noted, I started this creation by

2 sending out a definition of what is ATS/HFT. And I

3 sent that to the Technology Advisory Committee. I

4 think to start it off, I'd like to recognize Richard

5 Gorelick. He has some comments to make about this

6 issue.

7 If any of the other TAC members haven't --

8 want to say something, that's fine. We can arrange

9 for that and then we'll go to the panels. So

10 Richard, thank you.

11 MR. GORELICK: Thank you very much,

12 Chairman. Thank you, members and staff of the

13 Commission, for inviting me to participate in this

14 important discussion. I'm the CEO of RGM Advisors,

15 a principal trading firm based in Austin, Texas.

16 I have consistently supported regulation

17 that promotes fair competition, enhances

18 transparency, manages systemic risk, lowers costs

19 for investors and hedgers, and gives regulators the

20 tools they need to detect and deter abuse. Most

21 importantly, I believe that any inquiry should be

22 driven by empirical evidence of what's actually

23 going on in these markets.

24 Right now the Commission, through its own

25 records and through the exchanges, has unique access
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1 to fully attributed audit trail data on every single

2 order and trade in the futures markets.

3 An essential first step is for the

4 Commission to analyze this information that's

5 available to it. If the Commission does not believe

6 that it has the technology or the expertise to

7 archive or evaluate such data, this group, the

8 Technology Advisory Committee, is well suited to

9 advise the Commission.

10 Two areas warrant special examination

11 within the data. First, what is the overall quality

12 of the market? Existing research consistently shows

13 lower trading costs, tighter bid-ask spreads,

14 greater liquidity, reduced short-term volatility and

15 approved price discovery over recent years. But

16 don't just take my word for it. It's appropriate

17 for the Commission to look at the data independently

18 to get to the bottom of what it says about market

19 quality.

20 The second issue is to surveil the audit

21 trail for improper market behavior. Unfortunately,

22 discussions of abusive or disruptive trading

23 practices are largely driven by suspicion, emotion,

24 rumor and anecdote. That's the wrong way to make

25 good policy. Rather, why not look at the data, get
29

1 evidence, investigate and take appropriate action?

2 One of the great virtues of public

3 electronic markets is transparency. I urge the

4 Commission to shine light on what's really going on

5 in the markets before engaging in finger pointing at

6 a particular group.

7 Where to start? At the December TAC

8 meeting, as Chairman O'Malia indicated, I suggested

9 that the Commission define a group of direct ATS

10 participants, firms that use an automated trading

11 strategy directly connected to an exchange. Instead

12 of starting with a narrow group defined by arbitrary

13 thresholds, by starting with this broad universe and

14 then sorting and filtering based on relevant

15 criteria, regulators would get a complete picture of

16 market activity.

17 Recall that an automated trade by a mutual

18 fund was an important factor in the Flash Crash. It

19 does not make sense to turn a blind eye to some

20 market activity by defining your way at the outset.

21 Moreover, it would be a shame to have spent such

22 considerable time and effort attempting to study

23 high frequency trading only to realize that we still

24 don't have a full understanding of what's going on

25 in the markets.
30

1 That's why we maintain that anyone trading

2 should have proper risk controls and should be

3 subject to appropriate market surveillance, no

4 matter at what frequency they operate.

5 Mr. Chairman, I'm hopeful that the actions

6 today will help us to move beyond the preoccupation

7 with high frequency trading and to take thoughtful

8 and concrete steps based on real evidence to

9 strengthen our markets. Thank you.

10 COMMISSIONER O'MALIA: Thank you very

11 much. Anyone else from the TAC want to make a

12 comment? We're going to go to the -- our four

13 panelists, and I'd remind everybody, everybody's got

14 microphones in front of them. You can ask any

15 question. We're going to ask questions. And we're

16 getting microphones for the HFT members as well so

17 you can ask questions. And we'll go down the line

18 and take questions after each panelist -- at the end

19 of the panel. I'm sorry.

20 Panel 1, we have Mark Wassersug, vice

21 president of Operations of ICE. Mark has been with

22 ICE since 2001, has been vice president of

23 Operations since 2004. He is responsible for

24 overseeing all trading and clearing platform

25 technology operations, including the global network
31

1 and infrastructure design and operation. It's my

2 understanding that Mark's job is to cover these

3 markets like stucco.

4 So we have Mark in the first panel,

5 followed by Dean Payton, managing director and

6 deputy chief regulatory officer of the CME Group,

7 and has been in that position since November of

8 2009, and responsible for overseeing CME Group's

9 regulatory efforts for CME, CBOT, NYMEX and COMEX.

10 Following Dean we have -- Joel Hasbrouck

11 has been at the Ken Langone Professor of Business

12 Administration and Professor of Finance at the Stern

13 School of Business at New York University, and his

14 research focuses on the analysis, design and

15 regulation of securities trading and mechanisms, and

16 he's the author of empirical -- of empirical market

17 microstructures study, Oxford 2006, and numerous

18 other articles. We're pleased to have your

19 participation as well.

20 And Sean Castette is chief information

21 officer at GETCO, a little small firm some of you

22 have heard of, and he is -- joined them in 2001 and

23 currently leads the firm's fixed income commodities

24 and currencies trading groups. In his role, Sean is

25 responsible for overseeing GETCO's global trading
32

1 activities in these asset classes, including the

2 identification and development of new and enhanced

3 trading strategies and technologies initiatives. He

4 also serves on the GETCO senior management team,

5 helping guide the firm's overall strategy.

6 We're very pleased to have all of you here

7 today. We're going to start with Mark and work our

8 way across. So Mark, it's all yours. Thank you.

9 MR. WASSERSUG: Thank you, Commissioner

10 O'Malia, and the rest of the Commission, for

11 inviting me to speak today. I am vice president of

12 operations for ICE, and as Commissioner O'Malia

13 said, yes, I cover the ICE markets like stucco. But

14 really I would say it's more like the purple skin on

15 an eggplant.

16 What I would like to talk about today is

17 our oversight of automated trading systems and

18 controls and functions that we have within the

19 exchange to cover those systems. So it's a -- I

20 have a very brief presentation. Happy to take

21 questions throughout the presentation, or at the end

22 of the presentation.

23 So the first slide I'd like to just

24 discuss how ICE, we at ICE, from an operations

25 perspective and compliance perspective, think about
33

1 automated trading systems. To me, the category is

2 very broad. It's with two main focuses, one,

3 automated order submissions, and two, direct market

4 access.

5 So we have a broad view of clients who

6 automatically submit orders to the ICE exchange. We

7 can be talking about a simple ISV that has a

8 spreadsheet hook to it through to an auto-spreader,

9 or finally to a significant and sophisticated black

10 box algorithm. But all of these customers maintain

11 a direct market access. From the exchange

12 perspective, that's how we would evaluate an ATS,

13 and we really don't look at subcategories beyond

14 that from a monitoring and a compliance perspective.

15 As many of you have talked about, the

16 benefits of ATS are providing liquidity, market

17 making abilities and tighter bid offer spreads, but

18 unlike with any benefits, there are risks also

19 associated with these same types of activities.

20 Next slide, please.

21 From a risk perspective, we really look at

22 two broad sides of risk, one, the operational risk,

23 and two, compliance risk. As you can imagine over

24 the last five years, we've seen significant growth

25 in transaction rates and order and message
34

1 processing and just with the amount of data that

2 we've had to consume and analyze.

3 This is -- one of the risks to our

4 exchange obviously is to be able to keep pace with

5 technology, bandwidth, monitoring, et cetera, to

6 match the demands that our clients have for the

7 consumption of that -- of that technology.

8 These -- the types of processing that

9 we're doing could potentially impact performance,

10 not only from the exchange by slowing down the flow

11 of messages and flow of transactions, but also our

12 users can be impacted as a result of having consumed

13 more and more information and process that

14 information.

15 The second set of risks that we look about

16 -- look at from an exchange perspective is a

17 compliance risk. So we have to be able to monitor

18 and closely analyze purposeful or accidental market

19 impacts for -- from orders coming into the market at

20 a very high rate on a large scale and have the

21 capacity and the ability and the tools to actually

22 monitor, report on and analyze this data in real

23 time as well as in the past. Next slide.

24 Over the 11 years that I've been at ICE,

25 we have put in a significant number of controls,
35

1 automated and manual, to help alleviate some of the

2 risks that we have within the exchange. And these

3 controls are not -- were not put in place to deal

4 with automated trading to do with HFTs in

5 particular.

6 Our view is that these controls are

7 systemic and need to be in place for any type of

8 user on the exchange, whether they are a user using

9 a mouse or a computer trading against the exchange.

10 Some of the controls that I want to speak about

11 really fall into two categories, automated order

12 entry validations and then manual validations and

13 controls.

14 From an automated perspective, what our

15 mandate is from the exchange side is to protect the

16 exchange from errant events, anomalies. So here I

17 have listed five sort of the high-level controls

18 that we put in place. Message throttle limits for

19 one. So we throttle an individual user, an

20 individual market session with a certain number of

21 messages over a certain period of time. So we can

22 control a runaway API. We can control a user

23 potentially floating hundreds or thousands of

24 messages in a given period of time.

25 This allows -- this allows us to not only
36

1 monitor and regulate the amount of messages coming

2 in from a particular user, but it also gives us a

3 good understanding of how a user's trading strategy

4 can be used, and we will work with the user to

5 figure out appropriate message thresholds based upon

6 their activity.

7 Another automated control we have in place

8 are maximum quantity limits. So you might look at

9 -- you've heard fat finger error, where a user might

10 be looking to bid or offer 10 and they accidentally

11 type in 10,000. Well, we have set quantity limits

12 across the exchange by market, which will eliminate

13 the ability for a user to make a fat finger error

14 such as this. An order that comes in beyond a

15 maximum quantity limit would be rejected and an

16 alert would go into our operation center, as well as

17 to the user that the message was rejected and the

18 reason it was rejected.

19 I think one of the unique features that we

20 have as commodity exchanges, both CME and ICE, are

21 the price reasonability validations. What we --

22 what price reasonability means basically is we

23 collar an upper and a lower range of price

24 acceptance based upon the current market price at

25 any given time. And that range is preset by market
37

1 and will reject any order that comes in above or

2 below that particular range.

3 So for example, much like the fat finger

4 error on max quantity, if a user is attempting to

5 float a bid at 10 and it's 10,000, we would -- we

6 would be rejecting that price limit through our

7 reasonability validations and the order, again,

8 would be rejected and the user would be notified.

9 The fourth point is our position

10 validation, so whereas the first three were more

11 along the lines of floating an order, position

12 validation is actually looking at real time

13 position, long or short position, and rejecting

14 orders for trades once a position limit was --

15 position limit was met.

16 That is controlled not by the trader, but

17 more at the risk manager level or at the clearing

18 firm member level, whereas these are credit checks

19 that can be done again in real time based upon

20 active live position from a particular user, or a

21 particular account.

22 And finally, one of the things from the

23 FIA principles is the order to move upon log-out.

24 All ICE users who are disconnected from the system

25 can -- will have all of their orders removed from
38

1 the market upon disconnect. Now we do have the

2 ability for a user to float an order that stays live

3 after disconnect, but by default orders are removed

4 upon log-out. So we don't have orders sitting in a

5 market where a user may have lost connectivity or

6 there might be a problem on their end or on our end.

7 From a manual validation perspective, one

8 of the key features that we have is a log off user

9 and kill all button, so whereas similar to once

10 users log out, all their orders are pulled, again,

11 risk managers, clearing members have the ability to

12 log in and remove a user from a market, which would

13 kill all of their orders that were live at the

14 market at that time.

15 We also give clearing members another tool

16 that allows them to suspend, close, deactivate

17 clearing accounts, which again eliminates a user's

18 ability to trade at any given time, thus pulling all

19 of the orders out of the market. Again, these are

20 risks controls that we feel go beyond just the

21 trader's ability or the trading firm's ability, but

22 sit at the heart of mitigating risks at the clearing

23 perspective.

24 We have a very well documented cleared

25 trade policy, error trade policy, as well as no
39

1 cancellation range across all of our markets and

2 across all of our exchanges. So those are -- those

3 are really the controls that we have in place. One

4 of the unique features that we just added to ICE two

5 weeks ago is something called the Interval Price

6 Limit. It's something we've been working on for

7 about a year and a half. And we began this work as

8 a result of the Flash Crash. Next slide, please.

9 The Interval Price Limit is basically

10 ICE's circuit breaker to prevent or protect against

11 price spikes. What the IPL does is it provides a

12 rolling floor or ceiling price over a given time

13 frame that is configurable to a particular market.

14 This rolling price recalculates on a particular X

15 interval, or Y interval, X interval over time and at

16 a particular interval height up or down, and it

17 eliminates the ability for a user to either offer

18 through the market or bid above the market.

19 What the -- how the IPL works is if we --

20 if a market hits a low point along the IPL, let's

21 say the interval price limit is set to $10 and --

22 the price of the -- sorry, the price of the -- the

23 price of the future is trading at $20 and we have an

24 IPL of -- range of $10, we would have a low limit of

25 10 and a high limit of 30. If that low limit were
40

1 enacted, it traded below or offered below that

2 limit, the market would be put in a hold state. Now

3 hold doesn't mean closing the market. It doesn't

4 mean suspending all transactions. What it means is

5 it holds the ability for any offers to come in below

6 that $10 low limit, but allows bids to come in to be

7 able to stop any gap down that might be taking

8 place. And it also allows the ability for people to

9 trade above that low hold limit.

10 The hold is configurable. Generally on

11 our system right now it's configured anywhere from

12 five to 30 seconds across different market types,

13 and although it hasn't been triggered, we are going

14 to be looking at what those intervals are and

15 resetting them based upon market activity.

16 What's important is the notification of

17 that hold goes out to the market in real time, so

18 all users are aware in real time that the market is

19 held, why the market was held, the price information

20 that put the market in a hold state and what the

21 interval will be and when the hold will be lifted.

22 And finally, once the hold ends, a new IPL upper and

23 lower limit are calculated and trading can resume.

24 If we go to the next slide.

25 I put a diagram together to sort of
41

1 represent what that -- what this might look like.

2 So on the first section on the left there, you've

3 got this -- our IPL interval. You can see APs

4 are -- we're calling it the average price, anchor

5 price of the market at any given time. The

6 reasonability limits are what we won't let the price

7 trade above or below at any given time in the

8 market, and our IPL range is the thick upper and

9 lower lines.

10 As you can see after the first interval,

11 the average price is going down. We recalculate the

12 IPL, but the price now has some precipitous drop and

13 we see a trade below or attempted below the lower

14 IPL limit. This immediately puts the market in a

15 halt state, or hold state, so no trading below that

16 IPL limit can take place. However, trading can take

17 place within that trading allowed range and above

18 the lower IPL limit.

19 And then our assumption and our hope is

20 that we see market orders come into the market that

21 will add some strength to the lower end and the

22 market will rebound off the low, eliminating or --

23 eliminating the ability for the market to spike

24 downward where we would see potential stop orders

25 start coming into the market and you would see a
42

1 precipitous drop in price. As the -- as a hold is

2 lifted, a new IPL calculated and we continue to move

3 on in a direction of normalcy afterwards. Next

4 slide, please.

5 The second side of the controls scheme

6 that we look at are really the system monitoring and

7 the system controls. So whereas the first were our

8 functional controls within the system, this is more

9 of our oversight and monitoring of particular

10 markets at any given time.

11 We have -- I guess one of the key points

12 about having any ATS in your marketplace is being

13 able to validate that ATS performs in a way that you

14 would expect it to perform. We have a rigorous

15 testing and conformance program that is run out of

16 ICE which requires all ATSs to actually conform with

17 particular test cases and a particular program, and

18 until that ATS is certified by the conformance test

19 and meets all the criteria of the performance test,

20 it will not be permitted to trade on the ICE

21 exchange.

22 One of the -- I think the key features is

23 the recertification as either ICE goes through

24 changes on the trading system that could impact ATSs

25 or ATSs go through significant changes within their
43

1 technology or functionality. We do require

2 recertifications as well.

3 We also, much like our -- the message

4 thresholds we talked about, we have message rate

5 thresholds, whereas the regulator on an individual

6 ID looked at particular IDs. We actually look at

7 message rates across a particular market over any

8 given time period. So we're able to monitor if

9 there's a spike of activity, a flurry activity, not

10 just by an individual user, but again, at the entire

11 market level, and we've got our operations team that

12 is responsible and surveillance team that is

13 responsible for handling any of these types of

14 issues, any of these types of alerts.

15 We generate system performance reports

16 internally, it seems like within every five minutes

17 of the day, that are responsible for basically

18 looking at the exchange at any given perspective,

19 looking at performance levels, traffic levels,

20 capacity levels, and being able to identify any

21 potential -- any potential issues that might have

22 taken place within the last time interval that we

23 look at.

24 We also generate, I think, which is unique

25 to the industry, an ATS efficiency report where we
44

1 look at particular ATSs on the exchange and we

2 designate what their message efficiency looks like,

3 really looking at the quality of the messages in

4 orders that they are generating compared to the

5 number of transactions and the number of -- and the

6 amount of volume that is being traded.

7 Two other key pieces that I am going to

8 touch upon briefly are our SMART system, which is

9 our real time compliance surveillance system, and

10 our message policy and WVR reports. So SMARTS, we

11 did the demo this last week to the CFTC. We're not

12 prepared to do a demo today, but it's our real time

13 market surveillance. It's essentially a real time

14 historical graphical representation of an entire

15 market at any given time over any given period of

16 time.

17 The -- our SMARTS system is used by our

18 surveillance teams in Atlanta, Chicago, New York and

19 London. It's able to reconstruct a full order book

20 and synchronize a playback for a particular market

21 looking at very granular individual orders and time

22 stamps of orders coming into the market based upon

23 user information.

24 We've been able to -- we've had SMARTS in

25 place for about two years. We've been able to
45

1 customize a tremendous number of alerts that allow

2 us to detect anomalies, significant price movements,

3 potential market abuses, and those alerts are then

4 generated into our compliance and our operations

5 teams to allow them to further diagnose and analyze

6 any particular issues that SMARTS may alert us to.

7 There's also a significant amount of

8 historical information that's presented in SMARTS

9 where we can go back and do multiple analyses based

10 upon anything that happened in the past. The --

11 next slide, please.

12 The key -- one of the other key points

13 that we want to talk about, and this is specific to

14 ATS, is our messaging policy. ICE has had a

15 messaging policy really for the last four years, but

16 three of the four years was -- we really looked

17 simplistically at overall messages or orders coming

18 into the market based upon the number or within

19 ratio to the number of lots traded. And what we

20 realized was that really wasn't giving us a good

21 picture of how the markets operated and how our

22 customers particularly operated with regards to the

23 quality of the orders that were being placed in the

24 market.

25 What we established last January and
46

1 implemented last March of 2011 was a new policy

2 where we look to discourage inefficient messaging

3 basically by penalizing messages that were further

4 away from the market at the time of their entry and

5 rewarding the messages that were on the market or

6 close to the market at the time of entry. This --

7 we coined this the WVR or Weighted Volume Ratio.

8 WVR is really, the weighting is a

9 multiplier that's based upon the proximity of that

10 order at any given time. Our policy's enforced at

11 the firm level and it's enforced on firms only

12 meeting a particular number of submissions on a

13 given day, so a threshold. And we broke the policy

14 down into multiple tiers, really a minor tier and a

15 major tier, and I'll get into that in a little bit.

16 Next slide, please.

17 So the weighting that I mentioned earlier

18 looks at the time of submission where that order is

19 in relation to the best bid or offer at the time.

20 So what we realized, that we like market makers, we

21 like ATSs who are submitting prices at the market,

22 best in market, a tick off the market, two ticks off

23 the market, and we wanted to reward that behavior.

24 But we wanted to penalize those users who were three

25 to five or five ticks outside of the market at any
47

1 given time. Although we realized there are

2 strategies that implement those procedures, we

3 didn't want -- we wanted to at least force the ATSs

4 to take a look at why and how they were entering

5 orders, the proximity of those orders, so they could

6 better assess whether that strategy could be refined

7 to be improved.

8 The calculation that we use is simply the

9 multiplier, so where that message is, by its

10 proximity times the number of messages that come in

11 divided by the total sum of the lots, to come up

12 with our weighted volume ratio. And what we found

13 was that with minimal prodding, the ATSs were able

14 to back and refine their strategies where they

15 didn't necessarily reduce the number of messages

16 that they were sending. But they were able to

17 refine those messages and make them tighter into the

18 market, and it ultimately allowed us to have more

19 efficient markets, essentially tighter markets with

20 fewer outliers outside of particular price bands

21 that we felt were not reasonably tradeable. Next

22 slide.

23 One of the ways we were able to share this

24 information with ATS is from the feedback we were

25 able to give them. What we provide every one of our
48

1 ATSs who submits orders onto the exchange, is a

2 report daily that basically gives them a breakdown

3 of where every single order was, the percentage of

4 those orders, the average quantity across a

5 particular market, and where they fell within those

6 buckets that I mentioned, the better, at one tick

7 away, et cetera.

8 So we were able to provide a report such

9 as this, and this is just a sample from one user

10 from one particular day, back to the ATSs, so they

11 could go back and evaluate their strategies against

12 actual performance data that they had from the

13 previous day. And this was, I think, a significant

14 breakthrough from a lot of the understandings of the

15 ATSs, because really this data was not available to

16 them from a market perspective outside of through

17 the ICE exchange.

18 So -- and again, we made this available

19 for free on our website. If a user does violate a

20 particular low threshold or upper threshold, they'll

21 receive a similar report to this e-mailed to them

22 directly next business day, but it will actually

23 show them where they violated, what user violated

24 the particular policy. And again, we'll be able to

25 allow them to go and dig into the strategies that
49

1 they are using to help refine their approach going

2 forward.

3 We feel that working with our customers in

4 this way we've had significant advantages improving

5 message efficiency and order -- on order ratios

6 within the exchange, and I think we can show that by

7 the next slide. Overall on ICE we implemented this

8 a year ago. It's been one year of data. We've seen

9 a 33 percent reduction in the WVR ratios over the

10 past calendar -- over the past year, and we've seen

11 some significant reductions in our U.S. futures, in

12 our OTC markets and good reductions in our U.K.

13 markets.

14 I think what's the largest standout stat

15 here to me is that we've seen a 93 percent reduction

16 in the amount of major violations, so reaching a VR

17 -- WVR threshold of 500 since we implemented this

18 procedure. And again, we haven't necessarily seen a

19 reduction in the number of orders, but what we have

20 seen is much efficient orders that are much tighter

21 to the market.

22 This concludes my presentation and I'm

23 happy to answer any questions. Thank you.

24 COMMISSIONER O'MALIA: Thank you very

25 much. I know the chairman's got a couple of
50

1 questions already, so we will just go ahead with

2 questions.

3 CHAIRMAN GENSLER: I'm going to lay out

4 all three of my questions. One of the earlier

5 pages, you had, I'm going to call it message

6 throttle limits. So I was kind of curious whether

7 we're on a country road and your speed limit's 20

8 miles an hour, you're on a highway, it's 70, or it's

9 the Indy Speedway and it's 210, but it would be

10 really interesting to know what the speed limit is.

11 Some example you could use, I don't know, you're

12 Henry Hubb contractor, you know, just something that

13 we're familiar with.

14 Second question I had is just overall, if

15 you could give us a sense of what is the ratio of

16 messaging to transactions? I mean, I occasionally

17 use something in a speech that Andrei's given me,

18 but I'm not sure the number's right. I mean,

19 Andrei's always right, but I'm not sure that -- I'd

20 like to know what your -- what's the average that

21 ICE, or if you can give some contract.

22 And then the third thing is, if I

23 understand this Weighted Volume Ratio approach, is

24 it possible that you could have an inadvertent

25 reaction that you'd have less depth to book, and so
51

1 in quickly moving or volatile markets if you're

2 dis-incentivizing people to be five and six ticks

3 away that you might find that you actually have sort

4 of something you didn't want, but then the thing

5 could just blow right through?

6 So those are my three questions.

7 MR. WASSERSUG: Sure. Let's take them

8 from the top, Mr. Chairman. Thank you.

9 The messaging threshold limits, so that is

10 actually set on a -- by a particular individual

11 basis. So the range can be very broad. For

12 example, a particular WebICE user --

13 CHAIRMAN GENSLER: So different speed

14 limit. Rick's got a different speed limit than

15 maybe each of the 24 members of the new advisory

16 committee.

17 MR. WASSERSUG: Correct. And that speed

18 limit can vary based upon how that -- based upon how

19 many cars are driving on the highway. So if a

20 particular user is trading just Henry Hubb, that

21 speed limit is going to change if that particular

22 user -- it's going to be different than if that user

23 is trading Henry Hubb and sugar, for example.

24 So we have to allow for that speed limit

25 to be able to handle both markets at the same time.
52

1 The user has the ability to trade multiple markets

2 across the same -- across the same trading session.

3 After a certain period of time though, our

4 recommendation to that user is that they split up

5 the individual sessions, so they put sugar in one

6 car and they put Henry Hubb in another car, and then

7 we can reduce the speed limit overall on the

8 highway.

9 CHAIRMAN GENSLER: So just because there's

10 probably a lot of questions, a lot to go through, if

11 you could provide the five of us just something that

12 is in plain English, just to understand.

13 MR. WASSERSUG: Sure.

14 CHAIRMAN GENSLER: You know, is it like a

15 -- you know, you can put 1,000 messages in six

16 nanoseconds, or is it like 100 messages in three

17 seconds? You know, I'm just trying to understand.

18 MR. WASSERSUG: From an ATS perspective,

19 messages per second perspective, on a initial put

20 orders into the market, the setting that we go with

21 generally by rule of thumb is 300 orders in one

22 second for an ATS. For single clicker WebICE

23 session it's an order of magnitude less than that.

24 CHAIRMAN GENSLER: That's helpful. It

25 just gives it perspective. And then on the other,
53

1 how many orders per transaction do you -- whether

2 it's Henry Hubb or sugar, on average?

3 MR. WASSERSUG: Can you back up one slide?

4 So looking at this -- this is our analysis for our

5 Weighted Volume Ratio. This is across the entire

6 exchange here, so our Weighted Volume Ratio, the red

7 line is a 30-day moving average. It's roughly 12.5

8 orders, messages, per lot traded. That's on the

9 weighting side, 12.5 messages per lot traded across

10 the entire -- all of our exchanges.

11 CHAIRMAN GENSLER: So Andrei, if I

12 inadvertently included in a speech or two a 80 to

13 90, what's that number compared to this?

14 MR. KIRILENKO: I'd like to understand

15 better what I think that the lot came in one --

16 what's the definition of the lot? One contract?

17 MR. WASSERSUG: One contract, yeah. And

18 again, we're blending this across our U.S. future,

19 our U.K. futures, our Canadian futures and our OTC

20 contracts.

21 CHAIRMAN GENSLER: So maybe just, you

22 know, over the next couple weeks you guys, it will

23 be just helpful to understand that.

24 MR. WASSERSUG: I can provide that.

25 COMMISSIONER O'MALIA: Can you go back to
54

1 maybe on page 12 in your sugar example?

2 MR. HASBROUCK: Excuse me, Scott. If you

3 don't mind?

4 COMMISSIONER O'MALIA: Yeah, sure.

5 MR. HASBROUCK: I think the chairman had

6 one last question I was going to try to respond to.

7 You were asking, I think, does the -- this WVR

8 policy, does it have an adverse effect of

9 potentially reducing liquidity, three, five, seven

10 ticks away from the market? And I think we

11 experimented with a lot of settings, by the way, in

12 looking historically at what would it look like if

13 we had had various weightings in.

14 And I think the important thing to

15 remember on this is these -- this policy doesn't

16 even kick in until you -- unless you're a user that

17 submits a minimum number of orders per day, which is

18 a very high number. So all of those users that have

19 resting orders in could be hedgers, could be anyone

20 have resting orders in at three, five, 10, 100 ticks

21 away from the market. None of those are affected by

22 this. Those are all -- rest in there. There's no

23 penalty to anybody for that.

24 So this is -- this is targeted

25 specifically at users who spend a -- send a very
55

1 large number of orders.

2 CHAIRMAN GENSLER: Chuck, your thought is

3 is if you're pretty active in the market, an ATS, if

4 you're a low-latency trader, you can adapt, and a

5 very quickly moving market could then put the next

6 set in.

7 MR. HASBROUCK: We just saw that there was

8 a -- I think there was a lot of order changing

9 activity far away from the market. There are all

10 kinds of levels of HFTs out there and they've all

11 gotten smarter and better and more proficient, I

12 think, at their algorithms. But some are, you know,

13 in early days may not be terribly elegant.

14 And so if there are being different

15 markets, they could be frequently changing the

16 prices 30 ticks away from the market and they're

17 changing it every second, and that really doesn't

18 add any value to anybody. So what we were trying to

19 -- we're trying to drive that out.

20 CHAIRMAN GENSLER: That's helpful. Thanks

21 for that answer.

22 COMMISSIONER O'MALIA: And I assume your

23 Weighted Volume Ratio is also integrated with your

24 Interval Price Limit, which is your circuit breaker

25 approach?
56

1 MR. WASSERSUG: The Weighted Volume Ratio

2 is really a next day analysis, whereas the Interval

3 Price Limit is a real time throttle.

4 COMMISSIONER O'MALIA: And to address, I

5 think the question the chairman had about the

6 volume, the messages versus lots traded on page 12,

7 I assume that on that top line that messages means

8 the number of messages submitted. Just want to walk

9 us through what we're seeing on that top line?

10 MR. WASSERSUG: Sure. So we're looking at

11 a particular strip. This is the Sugar 11 contract

12 for U.S. futures for May 2013. So in this

13 particular contract, this particular firm -- this is

14 based on the firm level, submitted 5,477 orders.

15 That's -- that was 13.8 percent of the total orders

16 that they submitted within the Sugar 11 futures

17 contract.

18 The average quantity that they submitted

19 across all 5,400 of those orders is 4.82, and 91.91

20 percent of those orders were the best bid or offer

21 at the time that they were submitted. And then as

22 they -- as you go out, 5.2 percent were at the

23 market. So they matched the best bid or offer at

24 the time, and et cetera, et cetera as you go out.

25 Based upon all 5,477 orders that were
57

1 submitted, there were two transactions generated and

2 each transaction was one lot, or a total quantity of

3 two lots were generated. And then as you go down

4 the row, we're looking at again same -- different

5 strips, but the same metrics used throughout.

6 And again, this is just a -- this was a

7 sample of one user. It's not the entire percentage

8 don't add up to 100 there, as you'll see. So this

9 is just an excerpt from one report.

10 CHAIRMAN GENSLER: So just whispering

11 to -- Andrei tells me that some numbers that he had

12 looked at were 99 messages to every one transaction

13 in the E-mini that must be what I've been using in

14 some -- so it would be very interesting just to --

15 because I'm sure each of these markets are a little

16 different and sugar is probably different than Henry

17 Hubb, just to understand message to transaction

18 volumes, which you think is maybe closer to 12 or 15

19 at least on that other page?

20 MR. WASSERSUG: Correct.

21 COMMISSIONER O'MALIA: Any other questions

22 for Mark? Oh, Michael.

23 MR. COSGROVE: First of all, just a

24 clarification. Is the messaging, that 12 to 1,

25 that's overall market? That's not 12 to 1 for high
58

1 frequency traders, right?

2 MR. WASSERSUG: That's correct. It's

3 overall market.

4 MR. COSGROVE: So that could be a basis

5 for some discrepancy, if the 80 to 1 is being is

6 being applied to high frequency traders, whereas --

7 the whole market, okay?

8 MR. KIRILENKO: There's a whole market,

9 E-mini.

10 MR. COSGROVE: It's the whole market? Got

11 it.

12 MR. KIRILENKO: Okay, we have -- we have

13 CME representatives here. They may wish to say

14 something if they feel like.

15 MR. PAYTON: I think in terms of our

16 messaging policy, with respect to E-Mini, we

17 actually have a ratio of 4 to 1 in the E-Mini. So

18 four messages to every one lot traded is the

19 threshold for our messaging efficiency policy. So

20 it's actually the tightest of any of the products

21 that we have on the exchange.

22 MR. COSGROVE: Great. I do have two

23 questions. I was curious, how do you adjust price

24 reasonability validation? Is that adjusted

25 automatically in real time, daily?
59

1 MR. WASSERSUG: Yes. That's adjusted in

2 real time automatically through our trading system.

3 So for every -- for every price update, the new

4 reasonability is calculated.

5 MR. COSGROVE: And then my last question,

6 since the speed limit is applied to individual users

7 or individuals companies, is there a sort of

8 standard that -- sort of a standard that applies to

9 anyone, you know, if you do this volume of business

10 you get this, or not volume, but is that

11 standardized or is that somewhat --

12 MR. WASSERSUG: That's a good question.

13 We have called default settings initially, so that

14 300 setting, the 30 setting, and then over time we

15 will work with the individuals from the firms to

16 understand their trading patterns. So we don't have

17 any, okay once you've done X amount of transactions,

18 you've fallen into a particular bucket. Everybody

19 can be a little bit different. And as strategies

20 change, so might the speed limits change as well.

21 So it's more on -- it's a unique setting

22 per user per session.

23 MR. COSGROVE: Thank you.

24 MR. HASBROUCK: I think it's just

25 important to -- this is an operational protection.
60

1 It's not -- it's not a mechanism for rationing

2 bandwidth or capacity or anything else. It's a

3 really a -- it's really a mutual discovery with the

4 customer and us and trying -- what is it you're

5 doing in this session, this log in? What's the

6 typical type of activity so that we know what to

7 expect, you know what to expect, so if we're -- so

8 we can set a limit so that it doesn't let something

9 beyond what you're expecting to be normal go on.

10 So it's -- that's what that's for. It's

11 really what Mark's talking about when we say -- when

12 you're doing -- when you're trading four very liquid

13 markets with one session ID, part of the reason

14 we're suggesting you break that out into two or

15 three IDs is so that if you have a problem with one

16 of them, it's only affecting one of the markets

17 you're trading in as opposed to some of the others.

18 It's all -- that part of it is much more

19 operationally, you know, redundancy oriented as

20 opposed to compliance or level playing field

21 oriented.

22 MR. KIRILENKO: I have a question about

23 this. I'm sorry, about the calculation. Let's say

24 -- let's say hypothetically you have 100 messages

25 per one transaction and that transaction was for 100
61

1 lots. So would your calculation be one message lot

2 traded? So either one of you.

3 MR. WASSERSUG: Our ratio is based upon

4 messages per quantity of lots traded, not based upon

5 transactions. So in that case, the ratio would be

6 one.

7 MR. KIRILENKO: One to one?

8 MR. WASSERSUG: Yes.

9 MR. KIRILENKO: Right, so if the average

10 transaction size is not one lot, then you will

11 divide by that average transaction size and get to

12 the number of your lots, right?

13 MR. WASSERSUG: Yes.

14 MS. DOYLE: It's purely void.

15 MS. BOULTWOOD: Mark, I was wondering if

16 you could comment, to what extent are these controls

17 that you've implemented that's practiced, and is

18 there a form for comparing across exchanges? You

19 talked about the ordered renewed based on an FIA

20 principle. How much of this is common? How much do

21 you think ICE is just ahead of the pack?

22 MR. WASSERSUG: Well I think ICE is ahead

23 of the pack. There's actually multiple principles

24 that the FIA comes down with from an exchange

25 perspective on how we should mitigate risks in the
62

1 markets, and I think every one of those bullet

2 points was one of FIA's best practices. So I feel

3 like we're well positioned from a risk mitigation

4 standpoint and an FIA best practices recommendation

5 standpoint.

6 I know that our exchanges in particular,

7 you know, we look at reasonability limits. We look

8 at things like flash crashes. So I think we are --

9 we, CME and ICE, are both ahead of the game when you

10 look at us compared to the equity exchanges, stock

11 exchanges.

12 But again, you know, I think from an

13 innovation standpoint, IPL that we just recently

14 released is quite innovative. I don't think anybody

15 in the industry is doing anything like that. We're

16 constantly trying to tweak our technology and tweak

17 the exchange to offer more and more -- you know,

18 more and more risk mitigation and best practices

19 within our systems.

20 COMMISSIONER O'MALIA: Steve?

21 MR. JOACHIM: Yeah. I have two questions.

22 One is, do market participants know what the

23 threshold, the dynamic thresholds are for the IPL,

24 and if so, how do you communicate to them on an

25 ongoing basis what those thresholds look like?
63

1 And my second question is, and a whole

2 different direction is, is test cases. I'm curious

3 to know how you construct your test cases before

4 participants come onboard. How do you ensure that

5 they have fully and adequately tested those

6 facilities to ensure that there's no damage as a

7 result of the connections?

8 MR. WASSERSUG: Good question, Steve.

9 Regarding the IPL, we provide a framework for how

10 the IPL is going to operate, so we will provide

11 information on our website to customers that tell

12 them how long the IPL period is, how long the hold

13 period is, and what the range to the upper and lower

14 threshold is.

15 So if a customer wanted to, they could in

16 real time calculate that based upon average price at

17 a particular time. But it's more important for them

18 to understand the range that an IPL is going to be

19 in as opposed to what the actual number is at any

20 given time. So that's well communicated to our

21 customers.

22 Again, we rolled this out two weeks ago,

23 so it's a learning process for all of us. And as we

24 make changes to IPL limits, I think we're going to

25 have to continue to work with our customers so they
64

1 understand what those limits are going to be.

2 That answered your first question.

3 Regarding test cases, so I mentioned that we have a

4 pretty significant conformance testing team and

5 program that all ATSs must go through. We have a

6 relatively stringent and very long test program that

7 ATSs must follow, so we give them actual specific

8 test cases throughout all of the scenarios that we

9 envision they will deal with from a trading

10 perspective, and we're actually looking for what the

11 output of that test case is from the ATS.

12 So they have to fill out a questionnaire,

13 run through a scenario, fill out what the output is,

14 generate that back to our team, and then our team

15 will score the ATS's response to us.

16 We have separate and dedicated

17 environments, testing environments where an ATS can

18 go and they will schedule time to run through a test

19 program so there's no outside influence, potential

20 anomalies taking place within the -- with that test

21 system. So we know that they can -- that their test

22 cases are going to be accurate and valid.

23 COMMISSIONER O'MALIA: Anyone else? Okay,

24 Michael.

25 MR. GORHAM: Quick question. The SMARTS
65

1 charts on slide nine, I'm just trying to figure out

2 how to read that. Can you kind of -- I'm not sure

3 what those little balls are on the top between the

4 green and the red.

5 MR. WASSERSUG: I put this thing small so

6 you couldn't read it. I just wanted to make sure.

7 So what we have is the balls between the green and

8 the red are actual traded -- are actual trades that

9 take place. We have offers and bids, so red is

10 offers, green is bids. And then you can actually

11 drill down into those individual data points and you

12 can look at a particular transaction.

13 So you can see counter-party information.

14 You can see time stamp information. You can see all

15 that information in there. And then you can zoom in

16 and actually look at what the bid offer spread was

17 at any given point along that curve as well.

18 MR. GORHAM: And the bars along the

19 bottom?

20 MR. WASSERSUG: I'm assuming those are

21 just volume bars, total volume that was traded over

22 that particular time band.

23 MR. GORHAM: Great thanks.

24 COMMISSIONER O'MALIA: For this HFT

25 Subcommittee, guys, we do have microphones if you
66

1 want to grab -- if you have a question. I think

2 there are one on either end. Any other questions?

3 All right, Dean, you're up.

4 While they're switching over, I think it's

5 useful to point out, we asked both Mark and Dean to

6 come in last week and give a similar presentation of

7 the slides they're showing today to our staff just

8 so we could develop a baseline for what is being

9 undertaken by the exchanges in our markets today,

10 and it was a well-attended event and I think very

11 useful for our staff.

12 We were in this room and many of the seats

13 were full, so we appreciate their in-house

14 presentation as well.

15 MR. PAYTON: Hi. Good morning. Thank

16 you, Commissioner O'Malia, for hosting this dialogue

17 today. What I want to do in the time that we have

18 today is talk a little bit about electronic trading

19 at CME Group and hopefully to Richard's point that

20 he made earlier, give people a little bit of

21 competence with respect to how much information that

22 we actually have and the capabilities that we have

23 in the context of oversight for automated trading,

24 electronic trading generally.

25 So our industry, and obviously the global
67

1 financial markets in general, right, have

2 experienced tremendous change and innovation over

3 the course of the last decade. And technology has

4 certainly been a critical -- critical driver in that

5 evolution.

6 I actually began my regulatory career when

7 we still had IBM Selectrics and white-out in the

8 office, and certainly things have evolved

9 tremendously. We have broader markets, much larger

10 markets, faster markets and more automated markets

11 than we've ever had before, and that's certainly

12 required us to change the way that we think about

13 market oversight and risk management.

14 That being said, certainly again, just to

15 echo what Richard was saying earlier, automation

16 itself is fundamentally a good thing, and certainly

17 most of these studies that have been done in terms

18 of looking at what we've seen with the

19 electronification of trading is that the market

20 quality metrics have substantially improved over

21 time.

22 And that said, right, I think everybody in

23 this room certainly agrees that -- that changes have

24 also dictated that we needed to change the types of

25 systems and the types of capabilities that we have
68

1 from a risk perspective and a market oversight

2 perspective.

3 So to give just a quick picture of kind of

4 where we are today, electronic trading volume at CME

5 Group accounts for 88 percent of our total

6 competitively executed volume with open outcry

7 accounting for the other 12 percent. Within that 88

8 percent that was traded electronically, that really

9 accounts for predominately the overwhelming majority

10 of our futures transactions and probably just under

11 a third of our options transactions.

12 Within that overall space though, there is

13 certain degrees of automation that really are

14 differentiated by asset class. So the more

15 financial asset classes like FX, interest rates,

16 equity indices, those tend to be more automated than

17 the commodity asset classes, you know, energy,

18 metals and agricultural.

19 So if you take a quick look at this chart,

20 this tells us a little bit about the evolution of

21 what we've seen over time and the improvements that

22 we've made to our trading infrastructure at CME

23 Group, along with the broader technology changes

24 that you've seen in the marketplace have resulted in

25 much more efficient markets in terms of the
69

1 turnaround time that you see from the time that the

2 match engine receives a particular order entry or

3 order request, and the time that we acknowledge that

4 back to the customer.

5 So that's actually down to just about 3.5

6 milliseconds in terms of round trip time, and what

7 we see there is not surprising, that as the markets

8 have become more efficient and become faster and

9 become more automated, you also see corresponding

10 growth in the market and growth in the messaging.

11 With that admittedly cursory backdrop of

12 where we are from an electronic trading perspective,

13 now the question I think is where does that leave us

14 in terms of how market oversight is evolved? I've

15 highlighted four particular topics here and we

16 certainly could spend days, and probably a lot of

17 folks in this room have spent days thinking about

18 and talking about these issues.

19 But I just want to touch on four of them

20 relatively briefly today. The first has to do with

21 fair access. The second, which we've talked a lot

22 about and Mark spent a fair amount of time talking

23 about ICE's controls, is the risk of market

24 disruption. The third, which I think Richard was

25 pointing to earlier, is the scope of what the
70

1 oversight capabilities are. And then fourth,

2 concerns about trading practices and are there

3 things that we need to focus on there?

4 So starting with fair access -- so

5 starting with full fair access, I mean, there's no

6 question that market participants have different

7 needs and different business models and make

8 different choices in terms of how they want to

9 employ technology in the marketplace. I think

10 what's important for people to take away is that as

11 these markets have evolved, what -- we've created a

12 very level playing field in terms of access and

13 opportunity to access the markets. So today, all

14 participants have non-discriminatory access to the

15 same connectivity options at the same prices. So

16 that's -- creating that, that level playing field

17 that everybody has the same opportunity.

18 Additionally, a lot of this talk about

19 concerns about high frequency trading actually

20 originated with the press about flash orders that

21 came out of the equity markets a couple years back.

22 And what's important again to understand in our

23 markets is that all the market data is disseminated

24 to every participant at the same time, and it's the

25 identical market data. So again, there's a
71

1 fundamental fairness in the way the market operates.

2 And third, the match engine obviously is

3 unfailingly objective in terms of the way that it

4 matches orders. Those matching algorithms that

5 Globex uses are obviously very transparent to the

6 marketplace. Everybody understands how they work

7 and they work the same way for everybody every time.

8 You know, we at CME Group, I think many

9 folks know recently launched our co-location

10 facility at the -- at the end of January. Again,

11 there's been a lot of talk about co-location in the

12 context of fair access and that actually continues

13 the drive toward fair access for all participants.

14 So you have a situation where everybody

15 has access to the co-location facility, again, at

16 the same prices and on the same terms. Today I

17 think we have about 120 firms that are live at the

18 co-location facility, and that includes a diversity

19 of firms. There is proprietary trading firms.

20 There's hedge funds. There's intermediaries and

21 banks. And importantly, there are service providers

22 who take space at the co-location facility and make

23 that available to a broader set of market

24 participants.

25 And again, within that facility, it is
72

1 ensuring that everybody has equidistant -- precisely

2 equidistant connections to the match engine to

3 support that fairness in the process.

4 So the second issue is how regulators can

5 actually oversee what's happening in these very

6 dynamic markets. Today, we have a very, very

7 granular audit trail that allows us to track every

8 order, every modification, every cancelation, every

9 transaction, every book state change, and we can do

10 all of that at the millisecond level.

11 So in terms of some of the points that

12 Richard was making, there really isn't any mystery

13 as to what actually is being transacted in the

14 marketplace and how each order and each change to an

15 order is interfacing with the broader market.

16 So if we take just a quick picture of the

17 scope of some of the audit trail tools and the

18 amount of information that we're taking in from a

19 regulatory perspective, on the order entry side,

20 through our RAPID system, we're taking in somewhere

21 north of 250 million messages a day, and each of

22 those messages has up to 35 data fields. We also

23 have the cleared trade data, which is the process

24 data that's coming through the clearing house. That

25 data is very enriched, includes a lot of additional
73

1 attributes, 120 data fields, 7.5 million

2 transactions a day.

3 And then our market data system, which is

4 giving us all the order book information, price

5 volume, book state changes, and that's another 80 to

6 100 million messages that we're taking into our

7 regulatory systems every day. So that's a

8 tremendous amount of detailed, very detailed

9 transactional data that is on the desktops of the

10 regulatory team, and we'll talk a little bit more

11 about these tools that we used to actually review

12 that activity.

13 One other thing to keep in mind is in

14 addition to all the transactional data that we have,

15 we obviously have large trader reporting in our

16 industry and so we not only have the transaction

17 data, but we have the end-of-day position data of

18 participants in our market.

19 So we know what's happening in the market.

20 The question then is do we know who is acting in our

21 market place? And again, just going to the point of

22 how much detailed information that we have, when an

23 order comes in to us at CME Group, we obviously get

24 the clearing firm that's guaranteeing the trade, the

25 trading firm that's submitting the trade, the
74

1 session ID, which basically is the connection that

2 Mark was talking about earlier, that are all

3 identified as part of the order.

4 We also have an account number --

5 COMMISSIONER O'MALIA: Hey, Dean, can you

6 pull up your microphone a little closer?

7 MR. PAYTON: Sure. We also have

8 attributes, including the account number, which for

9 all member and member accounts at the exchange are

10 actually registered. We have the country of origin

11 from which the order originated. We have this ATS

12 order identifier, which was something that we

13 introduced last year which designates whether a

14 particular order is being entered into the system

15 through automated means or manual means.

16 So those are some attributes on the

17 periphery of what comes in. Importantly, in the

18 center here you have two additional -- two

19 additional pieces of information. First is the

20 operator ID or the Tag 50. This is a unique

21 identifier for the particular individual who's

22 interacting with the system. So essentially it's

23 the person who is entering the order into Globex.

24 We register all member, member firm employee

25 operator IDs. We have their names. We know who
75

1 those individuals are.

2 And in the case of an automated trading

3 system, the way those are registered is that you

4 have a head trader and you also have the team of

5 individuals who support that ATS. So you may have a

6 risk manager. You may have a secondary trader. You

7 may have a monitor. All those folks would be

8 registered with the exchange for those Tag 50s that

9 are required to be registered.

10 Additionally, something that we do

11 internally at CME Group is identify the market

12 participant ID. And so when we are looking at

13 information on our regulatory systems and there's a

14 transaction for a particular account, we not only

15 know this unique account number at this firm, but we

16 also know who the controller is of that account. So

17 we have a name associated with each of these

18 transactions.

19 So again, there's very deep visibility in

20 terms of who's participating in the market and

21 exactly what it is that they're doing. And when you

22 think about this in the context of what regulators

23 are able to see in an electronic environment, I mean

24 this is an incredibly precise, rigorous audit trail

25 that has been developed, right? And this has been
76

1 evolving over time, things like the country of

2 origin ID and the ATS order identifier or newer

3 tags.

4 You know, the market participant ID is

5 something that we developed over time because it

6 substantiated the types of surveillance that we were

7 doing in our market. So we've got all this data,

8 very good data, and the question is, well, how does

9 the oversight work within the exchange? And it's

10 really a multifaceted operation that we use in order

11 to effectively oversee trading at CME Group.

12 So I'll start up in the left with the

13 global command center. So that -- the global

14 command center is really the epicenter of market

15 operations for our electronic trading facility and

16 the staff there has terrific technology that they're

17 using to monitor the markets 24/7. So they run

18 shifts of people who are constantly monitoring

19 what's going on in the market.

20 This is the group that also works to

21 establish the risk parameters for the risk controls

22 that we'll talk about in a little bit. They are the

23 folks who manage our messaging efficiency program.

24 They have tools that allow them to carefully monitor

25 kind of the guts of what's happening on Globex and
77

1 manage messaging efficiency. They're also the group

2 that handles our trade cancelation and price

3 adjustment policy, and they would manage any issues

4 associated with trading halts.

5 The clearing house risk group is another

6 group that has important functions, the context of

7 how we oversee automated trading. This group is

8 responsible for doing risk management reviews of all

9 of our clearing firms in terms of how they manage

10 risks, credit risks and electronic execution risks

11 for each of the clearing firms.

12 We'll also talk a little bit about Globex

13 credit controls, but they administer those important

14 controls for us. And we've also developed certain

15 types of alerting capabilities that is on a live

16 basis monitoring what's going on on the Globex

17 platform, keeping track by account of positions in

18 each particular contract.

19 So the alerts that we have will identify

20 both position alerts and volume alerts, both on an

21 absolute level and based on something that's

22 anomalous for that particular account. And we have

23 staff in clearing risk that are monitoring those,

24 again, on a real time basis throughout the day.

25 And then Market Regulation is responsible
78

1 obviously for conducting trade practice

2 surveillance. We have a wide variety of programs

3 and research efforts that we use to monitor the

4 activity in our markets for potential market abuses

5 and concerns that we might have there, and there's

6 very robust data query and analytical tools that

7 support those efforts, including the tools that --

8 we have both the position and volume live alerting

9 tools, as well as market alerting tools that

10 identify on a live basis for us when there are

11 anomalies in terms of the amount of volume trading

12 in a particular product or a price move in a

13 particular product.

14 So we've got a number of different

15 transactional systems. And again, this is kind of

16 what's key to how we evolved in terms of oversight

17 of these markets. What we've done, we anticipated a

18 lot of the changes in the growth in the markets and

19 developed capabilities that really allow us to see

20 deeply in terms of what's happening, who's doing

21 what and when.

22 So our RAPID system is actually a system

23 that's connected into the Globex infrastructure and

24 we use this on both a live and historical basis.

25 But it's a very powerful tool that allows us to read
79

1 and aggregate up to a billion messages per second.

2 So we can immediately pull up any detail that we

3 want about orders or trades that occur on the Globex

4 system. We're able to aggregate that data extremely

5 rapidly, so to the extent that I wanted to identify

6 who the highest messaging Tag 50s or firms were in

7 the E-mini over the last quarter, I mean, literally

8 that's an exercise that takes seconds for us to do

9 with the tools that we have available to us.

10 It also allows us to reconstruct the order

11 books, both on an individual basis, so we can see an

12 order book and who's behind each of the orders at

13 the price levels in the order book.

14 Our SMARTS system is the system that we

15 use that is a very highly enriched data set. So we

16 have a tremendous amount of data in the system. We

17 use it on a T+1 basis and it captures information

18 from all the venues that we trade on at the

19 exchange. But the capabilities of the system are

20 very sophisticated. We maintain participant and

21 market profiles for all of our markets and everybody

22 who trades within our markets, and what that allows

23 us to do is to identify anomalies and to also use

24 those anomalies in the context of the pattern

25 detection capabilities that we have.
80

1 So we have identified a host of different

2 types of potential market abuses that we use the

3 pattern detection capability to identify and it

4 really allows the analysts in the market regulation

5 group to do a whole host of things that really allow

6 us to protect the integrity of the marketplace.

7 The volumetric analysis again is something

8 that gives us pictures into what's happening in the

9 market. So for example, if we wanted a picture of

10 what happened during a day or a 10-minute period

11 during the day, it will break out for us on a

12 minute-by-minute basis, a second-by-second basis,

13 you know, how much volume was trading, what the

14 price move was, and show that to us graphically in

15 order to pinpoint places that we may need to focus

16 on.

17 The Armada system is a third system that

18 is our order data system. It allows us to look at

19 all of the data that is being distributed probably

20 to the marketplace. So we can see the book as any

21 market participant would see the book. And what

22 that allows us to do as well is replay the market.

23 So any time we want to, we can take a particular

24 slice of the market and we can go in and basically

25 do a market replay and we can do that at speeds that
81

1 humans can actually understand what's going on. So

2 we can slow it down and actually see message by

3 message what's happening in the market and how

4 that's impacting the marketplace.

5 Within the market regulation department,

6 there's a host of different types of surveillance

7 and investigations that we conduct and I've

8 highlighted a few of them here. So one type of case

9 that we will work on are cases related to disruptive

10 risk management problems. So as folks have talked

11 about around the table this morning, one of the

12 risks of highly automated marketplaces is that

13 things can go wrong with technology, and that does

14 happen from time to time.

15 And so when we go in we're looking at the

16 risk controls, the testing, the supervision

17 processes that people have in place to prevent those

18 types of events from occurring. There's also the

19 potential for disruptive trading or messaging

20 practices. There's been significant talk about

21 issues related to spoofing, manipulative conduct in

22 the marketplace. And again, as I think Richard was

23 pointing out earlier, the data, very granular and

24 precise data is there for us to be able to look at

25 how particular participants are interfacing in the
82

1 marketplace and to identify whether or not there is

2 something that's problematic around that activity.

3 There's also a variety of trade practice

4 abuses that we have patterned detection modules to

5 identify and certainly we're focused on various

6 types of anomalies in the marketplace and following

7 through on complaints that we receive from market

8 participants.

9 So the fourth piece is really the issue

10 around risks. And at CME, again, as the markets

11 have evolved and technology has evolved, we've

12 really worked on building very robust risk

13 management and volatility mitigation tools that

14 allow us to protect the market, and a lot of these

15 tools are similar to those that Mark talked about.

16 And so in the interest of time, I'll focus on a

17 couple of them that are different than those that

18 Mark talked about.

19 So the protection points for market and

20 stop orders, if somebody enters a market order into

21 a CME Group market, it will automatically assign a

22 limit price to that order. So that market order can

23 only move the market so far and if it's not filled

24 in its full quantity at that level, it becomes a

25 limit order at that point.
83

1 So a lot of the issues that we saw in the

2 context of the Flash Crash on the equity side where

3 you have market orders going into the marketplace

4 and trading down to zero or up to exorbitant levels,

5 those types of events can't occur in this market

6 because a market order is going to be stopped before

7 it moves through that far in the book, and the same

8 with stop orders.

9 We have similar to ICE, dynamic price

10 banding, maximum order size protection and we also

11 have stop logic functionality, which again

12 identifies within the marketplace the potential for

13 stops to be elected and cascade down. And so what

14 we'll do when that condition is identified within

15 the engine, we'll actually pause the market for

16 somewhere between five and 20 seconds, depending on

17 the particular market.

18 And again, what that does is allow

19 liquidity to come into the marketplace, and assuming

20 that it does, that market will then reopen after

21 that short pause.

22 COMMISSIONER O'MALIA: Hey Dean?

23 MR. PAYTON: Yes?

24 COMMISSIONER O'MALIA: Wrap it up.

25 MR. PAYTON: Okay. The last two are the
84

1 messaging volume controls. And again, similar to

2 those that ICE has, we do that on a rolling time

3 period and then on the Globex credit controls, these

4 are controls that were built, again, something that

5 was quite innovative, because people were reluctant

6 to use controls from the standpoint that it impacted

7 the latency.

8 So the Globex credit controls were built

9 in a way that it doesn't impact latency in terms of

10 coming to the engine, and it provides firms with the

11 ability to get e-mail notifications when somebody

12 reaches a particular threshold. If they breach a

13 threshold, it allows them to take any number of

14 automated actions in the marketplace.

15 So I'll leave it there for the moment and

16 open it up to any questions.

17 COMMISSIONER O'MALIA: Thank you, Dean. I

18 have -- your Tag 50 discussion in 128, Mark, I

19 assume ICE has similar tags?

20 MR. WASSERSUG: Yes, that's correct. We

21 do. It's not exactly the similar tag numbers and

22 names. We don't tag as many tags as they have on

23 those fixed orders. We rely actually on a few

24 secondary systems that are outside of the order

25 itself for the registration of ATSs and the names
85

1 and the countries and all those types of things.

2 COMMISSIONER O'MALIA: But in the data

3 that we would receive that you provided the

4 Commission, we would know whether it's an ATS or

5 not?

6 MR. WASSERSUG: Correct. Yes.

7 COMMISSIONER O'MALIA: Dean, on the market

8 abuse area you identified in this disruptive trading

9 and messaging, have you -- I assume you have, and

10 you've referred it to us, but can you identify a

11 nefarious practice that you've identified that

12 you've kind of worked through and said, you know,

13 this really isn't good for our markets and kicked it

14 off? And if so, what was that?

15 MR. PAYTON: Sure. You know, there's any

16 number of them, but if we start at the top, we've

17 obviously had situations where somebody had an

18 algorithm that was operating in the market that

19 malfunctioned and didn't operate the way that it was

20 intended to operate.

21 COMMISSIONER O'MALIA: Can you speak up a

22 little bit? Get a little closer.

23 MR. PAYTON: Yeah. In those cases, we've

24 actually gone in, investigated what led to the

25 disruption in the marketplace and took appropriate
86

1 action with respect to the firms and also ensured

2 that the remedial actions were taken in terms of the

3 risk controls and having appropriate testing and

4 supervision in place.

5 From a disrupted trading practices

6 standpoint, we've had a lot of discussion with the

7 Commission around those topics and in the context,

8 for example, of spoofing, one type of practice that

9 from an exchange standpoint that we find disruptive

10 and would be a problem, would be a situation where

11 somebody is entering an order without the intent to

12 execute that order for the purpose of misleading

13 other market participants and then exploiting that

14 deception for their own benefit.

15 And we recently had a case that I think

16 the Commission is aware of where we identified that

17 type of conduct and again, took appropriate

18 disciplinary action.

19 There's other types of conduct that we've

20 identified in terms of activity during the

21 pre-opening period, so activity that occurs prior to

22 the time that the market is open, but orders are

23 coming into the market. And there was activity that

24 was designed to be manipulative in terms of the kind

25 of conduct that was being transacted. And again,
87

1 we're able to identify that conduct, deal with it

2 from a regulatory perspective.

3 COMMISSIONER O'MALIA: Any questions? Any

4 other questions?

5 MR. KIRILENKO: I have a question, Dean,

6 about -- I think you mentioned in passing about

7 something about particular methods, a throttling

8 policy that you have for the E-Mini. Could you

9 maybe elaborate more broadly about what your message

10 for the throttle policy is?

11 MR. PAYTON: There's actually two

12 different issues. One is the messaging efficiency

13 program, which very much like Mark talked about is

14 really an operational program that is designed to

15 work with market participants to ensure that the

16 messaging that they're bringing into our marketplace

17 is responsible and efficient.

18 So for each of our select product groups,

19 we identify a product benchmark. So again, that is

20 the total number of messages relative to the total

21 volume that's executed. And those benchmarks are

22 different depending on the profile of the particular

23 product, and our global command center team is the

24 team that works with market participants in the

25 event that they breach one of those messaging
88

1 thresholds. They'll work with that participant in

2 order to help them fine tune their messaging

3 practices in a way that serves the marketplace in a

4 more effective manner.

5 The messaging throttles are something

6 different. That's really a risk control that's

7 designed to protect against a market disruption, a

8 runaway algorithm. In those cases, we've got

9 particular standards that we set in terms of the

10 number of messages over a rolling time period and in

11 the event that that's breached, we have the ability

12 to either reject those messages coming in, and at

13 some point they can actually be automatically

14 disconnected.

15 So it really goes through three stages of

16 warning, reject, disconnect.

17 COMMISSIONER O'MALIA: When we -- when Dr.

18 Gorham put together a pre-trade functionality, we

19 spent a lot of talk -- we spent a lot of time

20 talking about the wash sale issue and what checks

21 exchanges can do to prevent excessive amounts of

22 wash sales. It never made it in to the trade

23 practice -- abuse pre-trade functionality to ban it.

24 Has there been any evolution as a technology with a

25 lot of trading across market? People are invariably
89

1 hitting themselves in terms of trades. How are you

2 minimizing that?

3 MR. PAYTON: Yeah. Well, there's two

4 ways. So first, the technology is out there for

5 front-end systems to implement wash blocker

6 functionality. So basically what wash blocker

7 functionality does is if I have an offer at 10

8 sitting in the market and I decide that I want to

9 buy 10s, when I enter my order to pay 10 for 100,

10 what that will do is automatically cancel my offer

11 before my buy order goes in.

12 So that functionality is widely available

13 and widely used. So that's probably the primary way

14 that market participants avoid trading with

15 themselves. From our standpoint, in terms of the

16 way that we police issues related to wash trading,

17 to the extent that there are inadvertent washes,

18 again, that's a situation where we will identify the

19 conduct through our surveillance programs and then

20 we will work with those market participants to

21 identify what are the circumstances that are leading

22 them to trade with themselves.

23 In some cases, market participants don't

24 have -- again, their algorithms aligned or tuned in

25 the most optimal way and we'll work with them to
90

1 address that.

2 CHAIRMAN GENSLER: I'm glad Commissioner

3 O'Malia has raised this, because this is one that's

4 -- we've all talked about on a number of occasions.

5 I'll leave it at that.

6 You say wash blocking software is

7 available for market participants, widely available

8 you said.

9 MR. PAYTON: Correct.

10 CHAIRMAN GENSLER: Do you think it's

11 widely used?

12 MR. PAYTON: I do think it's fairly widely

13 used. It's not -- it's not all market participants.

14 And again, there may be situations when that wash

15 blocker functionality doesn't quite work, because

16 you have the cancel and the order entry, which are

17 two messages that are going in, and sometimes

18 they'll miss each other and the transactions will

19 occur anyway. But --

20 CHAIRMAN GENSLER: So if I can ask you in

21 a hypothetical.

22 MR. PAYTON: Sure.

23 CHAIRMAN GENSLER: If it's widely

24 available and widely used, do you think that we

25 should see in our surveillance data that firms are
91

1 meeting themselves on a regular basis or on a very

2 rare basis?

3 MR. PAYTON: I think that you will see

4 that it's rare in the context of the overall

5 activity. So --

6 CHAIRMAN GENSLER: And if we're seeing one

7 firm hypothetically that is not rare, what would

8 that mean?

9 MR. PAYTON: Well, I think that you'd have

10 to look at it and understand what's happening in

11 that particular situation.

12 CHAIRMAN GENSLER: Do you consider -- I'll

13 pick on Rich, because he's sitting there. But if

14 Rich's firm meets Rich's firm on some regular and

15 repetitive basis, that's a bunch of wash sales? I'm

16 just -- but there wasn't a -- it could have been --

17 MR. PAYTON: Yeah, it really depends on

18 the circumstance. So Rich may have 20 different

19 traders working for him. Each of those traders is a

20 separate operator and separate individual in the

21 market running separate algorithms. In that case,

22 if there's no intent for those two algorithms or two

23 traders to meet each other, that doesn't

24 fundamentally constitute a wash sale. Those are two

25 traders in a broker place.
92

1 CHAIRMAN GENSLER: I don't know. That was

2 your view. I don't know if it's the Commission's

3 view. I don't know --

4 MR. PAYTON: Okay, well, from our

5 standpoint, a wash sale requires intent. So if you

6 have two independent traders that are inadvertently

7 meeting in the marketplace --

8 CHAIRMAN GENSLER: So my last question, do

9 you think people are using wash blockers to ensure

10 that two of their traders don't meet, or that one

11 trader doesn't meet themselves?

12 MR. PAYTON: Yeah. It's predominately for

13 one trader not meeting themself.

14 CHAIRMAN GENSLER: Okay. Thank you. You

15 want to respond?

16 MR. GORELICK: Since the chairman picked

17 on me, I just wanted to chime in a little bit. One

18 point is generally speaking, firms don't want to

19 have wash sales because they're expensive. If we

20 could match a trade internally, we don't pay for

21 that. If we purchase that service from an exchange,

22 it's quite expensive. So we do have a lot of

23 motivation to use the tools to prevent those washes

24 where they are available.

25 CHAIRMAN GENSLER: So you're saying that
93

1 if you had 20 independent traders, you would prefer

2 that if one is buying and one is selling that you

3 did that internally and you didn't go through and

4 pay the whatever fees?

5 MR. GORELICK: Exactly.

6 CHAIRMAN GENSLER: And do you use this

7 wash blocker software?

8 MR. GORELICK: You know, I'm not -- I'm

9 not sure if we use the specific feature that he's

10 mentioning at the CME, but I know we use that type

11 of technology on a variety of exchanges wherever

12 it's offered.

13 CHAIRMAN GENSLER: Oh, I'm sorry, so it's

14 an exchange software, or is it something they have

15 had?

16 MR. PAYTON: No. This is front-end

17 software as opposed to an exchange software.

18 MR. GORELICK: But many --

19 MR. PAYTON: There are exchanges that have

20 that.

21 CHAIRMAN GENSLER: I'd be interested, as

22 these subcommittees work, to learn more about this

23 whole area that Commissioner O'Malia raised, and

24 certainly been one that a number of us have been

25 talking about is how to in this rapid environment,
94

1 stay with the spirit and the letter of the law

2 against wash sales.

3 MR. VICE: If I may just comment there. I

4 think from an exchange standpoint, we would -- if

5 Rich's firm accounted for let's say 5 percent of the

6 volume in a given market, then -- and we knew that

7 he had traders running independent strategies in

8 that market and our strategy and some other type of

9 strategy, then we wouldn't expect him to run into

10 his own traders more than 5 percent of the time.

11 So I think there are some kind of rough

12 metrics there that we look at, probability analysis

13 type of thing, that would -- if it's much higher

14 currency that, then you have to ask yourself is

15 there some intent here and something else going on

16 as opposed to independent strategies being executed

17 independently.

18 And I think it's important that they --

19 that those independent strategies be able to rely on

20 the bid offer in that market, even if it's an

21 affiliated strategy. Otherwise, you're essentially

22 saying a fund can only run one strategy in a market

23 at one time, and I don't think that's going to be

24 good for the markets or liquidity.

25 So I think -- and I don't like using the
95

1 term "wash trading" so loosely either. It does --

2 intent is a key element of that. We refer to it as

3 paired trading for lack of a better term. Paired

4 trading. And then we look at paired trade

5 occurrences to see if this is a possible evidence of

6 wash trading, of actual wash trading where there is

7 some intent that we can see.

8 CHAIRMAN GENSLER: But I take it from what

9 Rich was saying, they would like to take the paired

10 trades and match them in their own world because

11 then they logically wouldn't be transferring some of

12 their economic returns to you as an exchange

13 operator. You might want them to take their paired

14 trades to the exchange. There might be --

15 MR. VICE: I mean, clearly they're

16 motivated to not do that, as Rich said. We don't --

17 I mean, we've got the priorities of the day, a lot

18 of priorities above a consideration like that.

19 COMMISSIONER O'MALIA: I do think this

20 issue is probably right in the wheelhouse of

21 probably the working group four, kind of a

22 microstructure issue. So hopefully they'll address

23 it. Steven?

24 MR. JOACHIM: This will be a question for

25 both Mark and Dean. Do you do any cross-market
96

1 surveillance? Do you cooperate in terms of

2 regulatory activity, so if you have a few pieces in

3 one market, do you share information across the

4 other market?

5 And then a corollary to that is do you

6 also look at the underlying cash markets that --

7 where there are cash markets, and for arbitrage

8 abuses across those markets?

9 MR. PAYTON: Yeah. I think that broadly

10 speaking the cross-market surveillance primarily

11 occurs outside of the particular exchange venue.

12 That being said, to the extent that we have

13 information in our markets that creates concerns for

14 us, we're members of, for example, the Intermarket

15 Surveillance Group.

16 So we have had occasion where we may be

17 looking at something in our E-Mini contract and in

18 order to conduct the kind of analysis that we want

19 to conduct, we require information from one of these

20 securities exchanges, and the cooperate and provide

21 that information, as we would to them.

22 So I think that some of the cross-market

23 surveillance issues, I think, are an area where the

24 federal regulators need to have a significant impact

25 on that.
97

1 MR. WASSERSUG: Just to add to what Dean

2 was saying. From a cross-market perspective, we

3 actually look at, since we have some complimentary

4 markets, to SEMI markets as well. We are actually

5 looking at SEMI data feeds as we do our analysis.

6 So as I showed you that SMARTS analytical tool,

7 we'll actually pull in SEMI data feed prices so we

8 can look at alerts not only on our market, but also

9 at the SEMI market for complimentary markets, to

10 determine if there might be an anomaly in one market

11 and how that might impact our market as well.

12 MS. BOULTWOOD: A related question on

13 cross-market kind of opportunities, because the

14 reality is you compete as exchanges on specific

15 locations, contracts. And how do you look at

16 business practices that one thing might be

17 encouraging volume, like co-location facilities,

18 which you both have, or volume rebates to

19 participants, or the initial margin rates that you

20 charge on contracts that might be very similar in

21 cases where you do compete? Is there an exchange of

22 information on those types of items, or do you just

23 let the market work so to speak?

24 MR. PAYTON: I think broadly speaking we

25 do what we think is right for our market and market
98

1 participants. So when you talk about something like

2 margin, that's not a competitive issue for us.

3 That's a risk issue for us. So we're setting our

4 margin levels at those levels that we think are

5 appropriate for our marketplace in order to manage

6 the risk that we have to manage at the clearing

7 house.

8 So something like that isn't a competitive

9 issue for us. From the standpoint of something like

10 co-location, certainly the efficiency of your market

11 infrastructure is a competitive issue, and from CME

12 Group's perspective, we're always going to be

13 looking to innovate and be able to provide our

14 customers with the kinds of services and products

15 that will attract them to our exchange.

16 MR. WASSERSUG: We do compete with the

17 CME. We make publicly available information that is

18 deemed to be publicly available and necessary for

19 our participants to be able to determine where they

20 want to do their business.

21 I think for some of the inside baseball

22 pieces, that we keep that very close at heart. And

23 we don't really look to share information outside of

24 our company that is -- that we deem to be valuable

25 to us.
99

1 CHAIRMAN GENSLER: Do you keep it like

2 stucco?

3 MR. WASSERSUG: A little bit, yeah.

4 COMMISSIONER O'MALIA: Any other

5 questions? Then we'll get on to our next panelist,

6 Joel Hasbrouck.

7 MR. HASBROUCK: First, thank you,

8 Commissioners, for the opportunity to discuss these

9 issues. I'm going to talk a little bit about some

10 of the broad-brushed stuff that is going on in the

11 academic research.

12 First, in the studies I'm going to be

13 discussing, most of them are based on what's going

14 on in the equities markets. This is important for

15 two reasons. First, equities are in futures, and

16 second, the market structure is different. The

17 equity markets are very fragmented. When we see

18 something, we ask ourselves, is this an attempt to

19 somehow, or an artifact of somebody trying to tie

20 these disparate markets together?

21 When people discuss high frequency

22 traders, there's no precise definition, but as it

23 gets implemented in practice, they tend to be large.

24 They cover multiple markets, not just one. I should

25 say, not just one exchange. They co-locate. They
100

1 account for a lot of the message traffic, and they

2 react very quickly.

3 The trading styles, the studies will be

4 able to generalize. There are high rates of order

5 cancelation. There's high turnover, as very tight

6 position management, meaning not only do you go home

7 flat, you go to lunch flat. You end every five

8 minutes flat. It's very, by and large, very

9 disciplined and very controlled.

10 And for that reason, we often compare them

11 to market makers. And in fact, many of them do

12 trade passively like market makers, putting out a

13 bid or an ask and waiting for somebody to come in

14 and hit it, but not all the time. They also trade

15 very actively as necessary when they need to lay off

16 the position or when they need to simply take

17 advantage of market timing.

18 Now most of the studies are equity market

19 studies. The first one I'm going to discuss is not.

20 This is a study that Andrei did with people in the

21 CFTC and outside.

22 One aspect of it certainly was looking at

23 the May 6th crash, and the main conclusion there was

24 that the high frequency traders didn't trigger it

25 certainly, but they weren't complete bystanders
101

1 either. But for today's purposes, the more

2 important thing is how do the high frequency traders

3 behave in normal times, and the answer, according to

4 the study, is that they behave like market makers,

5 low inventories, high turnover. But by comparison

6 with our traditional market makers, they do tend to

7 trade more actively.

8 Another recent study, this one is from

9 European equities, and it's interesting, because it

10 shows the effect of the entry of high frequency

11 trading. It's a study by Albert Menkveld on the

12 Chi-X system, which is an alternative market to the

13 Euronext Equities Markets. The Chi-X is dominated

14 by one high frequency trader.

15 What Albert found is that when this trader

16 entered spreads at all the markets, that is, the

17 Euronext markets, the so-called primary markets,

18 dropped as well. The high frequency trader, to

19 nobody's surprise, is profitable. Most of these

20 profits occur in positions that are held five

21 seconds or less. So very quick, rapid profit

22 realization and 80 percent of its trades are

23 passive.

24 Gideon Saar, Cornell and I have looked at

25 about 500 stocks on NASDAQ's Inet system and when we
102

1 look at our strategies of cancel and replaces and

2 seen their effect on what's going on in the book --

3 and generally when this kind of thing takes off, you

4 see lower posted spreads, lower effective spreads,

5 short-term volatility drops, and there's increased

6 depth.

7 Now the reason causes here is in quotes is

8 that in econometric analysis, we use that as a

9 statistical causality, not a mechanical or deep

10 relationship causality. NASDAQ made a contribution

11 last year putting together a collection of trades

12 from members that it identified as high frequency

13 traders by the usual criteria, co-location, high

14 turnover and so forth, and their data, which they've

15 made publicly and generally available to all

16 academics, records all the trades and all the

17 prevailing quotes.

18 And here there have been a couple of

19 studies using this data. One, high frequency

20 traders are very active. They're involved in about

21 68 percent of the volume, sometimes demanding

22 liquidity, often supplying it. Their strategies

23 tend to be correlated. That is, they're not

24 independent. They tend to move in the same

25 direction. They tend to herd.
103

1 There's also some evidence that they can

2 predict future order flow, and that's an important

3 point I'll come back to, because it alludes to their

4 -- the source of high frequency trading profits.

5 What do they do to volatility? Well, it depends.

6 Does volatility draw in high frequency trading? It

7 depends whether you're talking about the broad

8 market or stock specific. If it's broad market

9 volatility, high frequency trading in the individual

10 issues tends to increase.

11 But if stock specific volatility goes up,

12 HF activity tends to drop. Going in the other

13 direction, if high frequency trading increases, that

14 tends to be followed by reduced volatility. Again,

15 that's an association, not necessarily a causal

16 mechanism.

17 Terry is also participating, and Ryan

18 Riordan have also looked at these data and find that

19 the high frequency traders, when they're trading

20 actively, they tend to anticipate subsequent price

21 movements. In other words, they seem to have better

22 information.

23 The conclusion this study draws is that

24 high frequency activity enhances what's called price

25 discovery, price formation, and also market
104

1 efficiency, that is, information gets into the price

2 more quickly.

3 So if we can summarize these studies, and

4 this is just some of the key ones, the effect of

5 high frequency trading seems to be beneficial or

6 benign. Now having drawn that reassuring

7 conclusion, I'd like to point out some of the

8 limitations. First of all, we're not quite sure

9 what information is driving high frequency trading

10 activity and how it makes markets more efficient.

11 The other qualification is that these

12 studies characterize average or routine or ordinary

13 market behavior, not sort of the extremes. These

14 are important points, so let me elaborate.

15 Efficiency, we say a market is more efficient when

16 it reflects information more quickly. This idea is

17 a holdover from the idea of fundamental information.

18 If there are fundamental economic developments, we

19 want them to be in the price as soon as possible.

20 For example, we have regulation, FD in the

21 equities markets. Company makes an announcement.

22 Everybody has to get the same info at the same time.

23 The value of informational efficiency is less clear

24 when one player is trading on advance knowledge of

25 another trader's order, or an advanced guess.
105

1 And a paper by Jarrow and Protter have

2 looked at that and concluded -- and I might point

3 out this is an empirical paper, a theoretical paper,

4 not an empirical one -- they point out this is

5 obviously dysfunctional.

6 Now I'd like to talk about some of the

7 extreme behaviors. Although volatility and high

8 frequency trading seems to not exacerbate each other

9 in normal times, when you look at the data, you see

10 some rather strange cases that are difficult to

11 explain. Now these are from the equity markets, so

12 nobody in this room has to feel threatened. You

13 didn't regulate it. You didn't run the market which

14 it arose.

15 But the question is, can it -- can it

16 occur in the futures markets? So here -- and I also

17 don't mean to imply that these are -- that there was

18 manipulative intent here. But I'm going to show you

19 two cases. This is the National Best Bid and Offer

20 for ticker symbol AEPI. And there are -- this is

21 not a singular case. There are many cases like

22 this. The National Best Bid is in blue. The

23 National Best Offer is in red, from a typical day

24 about a year ago.

25 Now there's not a lot of fundamental
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1 information hitting the market here. And yet, in

2 the hours shortly before noon, we have incredible

3 volatility in the bid. If you stepped into the

4 market to trade during this time, if you'd been

5 using a market order, the price you would have

6 received would have depended on whether your order

7 came in on an even millisecond or an odd

8 millisecond. This is difficult for us to reconcile

9 with a well-functioning market, particularly when

10 there's no fundamental information arriving.

11 Here's another example. This one is from

12 the Inet system going back about three years on a

13 nice day in June. Here this is a 10-minute window.

14 The message traffic is clicking along at about five

15 to 10 messages per second, and then all of a sudden

16 shortly after 12:18 somebody throws the switch and

17 the message traffic jumps up to over 200. Stays

18 that way for a little over a minute, then they hit

19 the off switch and it drops back down to five to 10.

20 Again, this is very difficult. Did it

21 cause a meltdown? No. Did it cause a crash? No.

22 And yet it imposed certainly a burden on the

23 systems. Prices were changing during this time and

24 I would say it introduced noise into the market

25 process that other participants had to react to. So
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1 again, not one of your markets, anybody in the room,

2 but the question is, could it happen?

3 Thank you.

4 COMMISSIONER O'MALIA: Any questions?

5 Joe, in the back. There's a microphone down here.

6 Probably have to turn it on. You can just -- it's

7 remote, so just grab it.

8 MR. SALUZZI: Hi. I just had a quick

9 question for the professor. Would you agree, in the

10 equity markets, of course, that there are two

11 different sets of quotes, one that you can create

12 yourself if you had all the technology, being that

13 we're in a fragmented market, 13 stock exchanges and

14 so on, and one that the SIP, or the Security

15 Information Process, provides to the general public?

16 And if these two quotes are different, is one faster

17 or slower than the other?

18 MR. HASBROUCK: Okay, it's common

19 knowledge that the consolidated feed is slower than

20 the subscriber feeds that the exchanges make

21 available to their subscribers. If you want to call

22 that two different sets of quotes, I'd agree with

23 you. As far as that being sort of a deliberate

24 technique of sort of a two-tier information and

25 two-tier pricing, that I can't address.
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1 I believe that they -- the exchanges

2 claim, and I see no reason to doubt this, that they

3 make the information available to their subscribers

4 and to the SIP at the same time.

5 MS. BOULTWOOD: Joel, have there been any

6 academic studies looking at product rates of high

7 frequency trading? You talked about equities, but

8 then you looked at sugar or you looked at oil.

9 And then kind of a related question. If

10 you put global contracts aside, like a WTI contract,

11 are we studying at geographic differences in high

12 frequency trading?

13 MR. HASBROUCK: All right, I can give you

14 a partial answer to that, which is that we observed

15 what we think of now as high frequency trading first

16 in U.S. equities markets, not initially at least in

17 European equities markets. And the reason was at

18 the time they had cancellation fees and throttling.

19 They have since decided to compete on

20 latency and as a result, what you have over there is

21 starting to resemble a lot more closely what we have

22 here. But that I would say -- oh, and I should also

23 -- another anecdote from the Foreign Exchange

24 Market. The people at Intercap tell me that when

25 they introduced an automated feed, an application
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1 program interface to their foreign exchange trading

2 systems, the traffic just exploded.

3 So you certainly need the means. You

4 certainly need a low-cost structure, and then it

5 seems to be why not?

6 MR. GORHAM: The second to the last chart

7 on AEPI, so this is -- looks like an incredible

8 illiquid stock. You go for an hour, it looks like

9 without even a single trade. So what's your

10 interpretation of this activity? Is it a few orders

11 come in and then there's a lot of --

12 MR. HASBROUCK: The trades are not

13 indicated on this graph. As it happens, there was

14 trading activity near the market open and near the

15 market close, but not during the period of time when

16 I -- when I referred to the high frequency activity.

17 Now you can conclude that because there

18 were no trades, no harm, no foul. But we see

19 similar instances where there do seem to be trades,

20 and even if there aren't trades, I view the bids and

21 asks as important price signals that other

22 participants are relying on, and any noise in them

23 at all is cause for concern.

24 That said, when I look in greater detail

25 at these episodes, I can tell a story about what's
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1 going on. On the bid side, I see a series of

2 attempts to sequentially ramp up the price and then

3 cancel it, almost as if somebody were trying to run

4 an auction. But that's speculation.

5 And if they were trying to run an auction,

6 it did not ultimately end up with a success.

7 MR. GORELICK: First of all, I wanted to

8 applaud the professor's work today. I think this is

9 the kind of empirical work that I was talking about

10 both in terms of the overall market quality side and

11 in terms of the anomalous trading side.

12 A couple things I did want to point out,

13 these last couple of slides, which clearly are

14 unusual graphs and does lead people asking questions

15 about what's going on here. I think as Commissioner

16 Chilton said early on in his presentation today that

17 there are 160 million daily transactions every day

18 around the world in the financial markets, and with

19 that volume of transactions, it's not surprising to

20 me that you'll be able to find anomalous behavior in

21 particular markets.

22 And as Professor Gorham pointed out, this

23 may be a relatively illiquid security where you're

24 probably more likely to see that kind of thing. But

25 that said, it's exactly the type of unusual behavior
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1 that we should surveil for, that the exchanges, if

2 they see something unusual, they should get to the

3 bottom of it. They should call up whoever sent

4 these orders and ask them why they did it,

5 especially if it's the kind of thing that happens on

6 a regular basis.

7 And it's exactly the type of unusual

8 behavior that should be pretty easy to surveil for.

9 MR. HASBROUCK: I want to be clear. I

10 don't -- I have no evidence, or actually any

11 suspicions that there was any kind of nefarious

12 intent here.

13 COMMISSIONER O'MALIA: The old adage about

14 shooting the messenger. Is there anything we can do

15 as a Commission to improve the data, to improve your

16 research, to help things along?

17 MR. HASBROUCK: We are always helped by

18 better, more timely data, whether it comes from the

19 Commission or whether from the exchanges themselves.

20 Andrei in particular has been very helpful at

21 engaging academics and making opportunities

22 available, and we urge the Commission to continue in

23 that vein.

24 CHAIRMAN GENSLER: One thing that I think

25 I've said this publicly somewhere, but though we've
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1 been strained on funding as an agency, we have

2 gotten a little bit more funding on technology. And

3 so earlier this year, we initiated a project where

4 we'd start downloading order data as well on a

5 regular basis.

6 We've been blessed for years -- whomever

7 did it it was before we were at the Commission --

8 that we daily get open positions and transaction

9 data from the exchanges, and that's worked pretty

10 well. The SEC does not get that data as a contrast.

11 So like 9:00 in the morning May 7, we already had

12 the download of everything, as we do every day.

13 But we don't normally get the order data

14 unless we go out and ask the exchanges for it, but

15 we're initiating now because data storage costs have

16 come down a lot to actually download the order data

17 into the CFTC. It's going to take a while. It's

18 not going to happen in a couple months. But it's

19 just sort of a 18-month to two-year project that

20 we'll be working with, and I think the exchanges

21 already know this. If you didn't, I'm telling you

22 this, so that we can in our surveillance and

23 enforcement have that in the futures world as well.

24 MR. TABB: Is this on? Now it's on. When

25 you look at HFT basically being a more efficient way
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1 to make markets, I guess, or creating efficiencies

2 in the market, are you looking, and are the symbols

3 that you looked at, are they more large cap names or

4 are they across the capital spectrum?

5 So are we, you know, having a selection

6 bias because we're only looking at the more liquid

7 stocks because that tends to be where they play?

8 Are we looking across the broad spectrum of

9 capitalization?

10 MR. HASBROUCK: Initially they were

11 playing in the high cap stocks, but now I believe it

12 is much more broad. And my impression also is that

13 the strategies are shifting from being single market

14 to multiple market strategies, and I'm basing that

15 observation on the increased premium that technology

16 providers seem to be stressing on long distance

17 latency delays, building high-speed networks for

18 example, to span the Atlantic.

19 That suggests to me that multiple market

20 strategies are becoming more important.

21 COMMISSIONER O'MALIA: Sure, Chuck.

22 MR. VICE: I guess I'm struggling to

23 understand the significance a little bit. I mean,

24 we put the charts up with squiggly lines and

25 everybody kind of, what's going on here? As an
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1 exchange operator, I'm trying to read, what should I

2 be doing about this type of activity on one hand? I

3 think both CME and ICE have talked today about a lot

4 of steps we take to discourage extraneous messaging.

5 So to the extent that these orders are far

6 away from the market, and if no interest to anyone,

7 I think we got effective policies in place to try to

8 deter that. To the extent someone's running an

9 auction, and I take that to mean, and you correct me

10 if I'm wrong, an HFT potentially, or any other

11 traders improving their bid gradually to see if

12 there's interest, I call that trading and helpful to

13 anyone who's looking to sell stock on the other side

14 of that.

15 So I'd like to hear a little more color

16 from this very -- you know, this expert group in the

17 room of what we're to make of this, because I'm

18 struggling a little.

19 MR. HASBROUCK: First, if I could just

20 make one point. This is not deep in the book. This

21 is the national best bid. And also though, I can

22 assure you, I am puzzled myself about how to look at

23 it. It imposes a cost on participants, yet it also

24 makes opportunities available.

25 CHAIRMAN GENSLER: I find myself somewhat
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1 thinking the same question Chuck just raised. This

2 is $29.30 to 29.70, and somebody's probing, as you

3 say, maybe creating opportunities. If there was no

4 transaction in that time frame, then of course there

5 may have been, as you said, some costs. But if

6 somebody actually had executed at one of those

7 prices, they would have done so willingly, I assume.

8 MR. HASBROUCK: On the equities markets,

9 there would be special concerns because the MBBOs

10 are being used as reference prices for other trades.

11 So in a futures market, this would not be a concern.

12 On an equities market, it would be -- it might be.

13 COMMISSIONER O'MALIA: I think Chuck has

14 given us a good opportunity. We'll let the panel

15 think a little bit about it. We're going to go to

16 Sean to keep things moving, and then we can come

17 back and maybe you all can reflect on that point.

18 MR. CASTETTE: I think we have the

19 technology here figured out. It's often times

20 harder than it seems like it should be, which I

21 think is a theme for us.

22 Thank you, Commissioner O'Malia, for the

23 invitation to speak today and the invitation to be

24 on the subcommittee to define high frequency

25 trading. As you mentioned at the opening, I've been
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1 with GETCO now a little over -- right around 11

2 years, and in that time I've had a variety of roles,

3 including chief technology officer, and I'm

4 currently head of fixed income commodities and

5 currencies globally for the firm.

6 In my roles at GETCO, one of the things

7 that I've been able to do is to see a lot of the

8 tremendous change in electronification of the

9 markets that we've seen over the last 10 years in a

10 very first-hand manner.

11 I'm going to share some of that

12 perspective with you today because I feel it's going

13 to be beneficial to some of the work that we're

14 going to do in our subcommittees. I'm going to do

15 it by giving you some aspects of the history of

16 GETCO, and along the way providing some perspective

17 on some of the changes.

18 We were founded in 1999 with the express

19 goal of facilitating the transfer of markets from

20 the analog model of pit and phone trading to the

21 electronic digital age. As we've quoted a couple of

22 times today, that transition has been highly

23 successful, and we believe that we were a part of

24 making that happen.

25 Our early years were dedication to moving
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1 the liquidity of the pits in Chicago to the

2 electronic platforms being developed by the CME and

3 CBOT. Our first trades involved traders in the

4 pits, communicating with traders using click-based

5 trading screens to keep the markets synchronized.

6 It was a highly competitive endeavor, and in the

7 largest products, we and others were able to achieve

8 our goals of moving price discovery from the pits to

9 the screens where the true market could be seen by

10 everyone at the same time, not just the select few

11 at the pits in Chicago.

12 Following our successes in moving

13 liquidity to the screens, we began market making

14 these products. Essentially, we moved our traders

15 in the pits who were making two-sided quotes

16 upstairs and into an electronic venue. The traders

17 used technology to calculate the prices of their

18 markets and manually manage their orders.

19 At this point, we had helped to achieve

20 our fundamental goal of improving transparency and

21 competition in the markets. However, we still

22 believed that spreads could be tightened and

23 liquidity improved. This feeling pushed us toward

24 the world of automated trading.

25 Before talking about our experiences and
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1 automated market maker, I want you to know a few key

2 beliefs that drive GETCO. The core of our beliefs

3 come from our founder's view that strong financial

4 markets are the lifeblood of the economy. They

5 believe that the best markets are the ones that

6 combine a relentless push for efficiency with the

7 lowest friction as necessary to ensure the safety of

8 the market itself. You can see these beliefs in our

9 constant push for increased competition,

10 transparency and smart regulation.

11 What our founders did not set out to

12 create in GETCO is another trading firm that's

13 inwardly focused on profits. They set out from the

14 beginning to build a 100-year business that they

15 knew that in order to do that, we had to offer a

16 service to the market that was well received. That

17 service had to be competitive and priced well so

18 that customers would want to continue to use it.

19 This has focused GETCO on what we believe

20 is best for the market, and we believe that as long

21 as we align our business with what's best for the

22 markets, we will continue to be successful. These

23 beliefs drive the firm as we look toward the -- to

24 adapt to the constant change that occurs in our

25 markets.
119

1 For most of our last 10 years, we've spent

2 our energy focused on development and improvement of

3 our automated trading -- our automated market making

4 capabilities. The core of the service that we offer

5 to the markets is a continuous two-sided market at

6 good prices. Providing a service to more than 50

7 markets around the world has taken a constant focus

8 on both the technology that we use to make the

9 markets and the operational excellence required to

10 successfully manage the many forms of risk

11 associated with large-scale participation in the

12 markets.

13 Our technology has changed, along with the

14 level of efficiency in the market. The changes have

15 come across the whole spectrum of our trading

16 process from risk management evaluation to order

17 management. And the biggest and most visible aspect

18 of our innovations and those in many of the other

19 participants, have come in the area of speed.

20 Speed, as we generally view it, is an important part

21 of being able to provide the tightest, best quotes

22 in the market. The faster we're able to react, the

23 tighter and larger we can quote. The slower we can

24 react, the wider or smaller we can quote.

25 Our goal has always been to tighten
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1 spreads and so it's imperative that we are among the

2 fastest participants. The reason that speed matters

3 so much to market makers like us is that we're

4 providing firm quotations to the market for a large

5 number of products. The transition from the floor

6 model to the electronic world has been accompanied

7 with a transition to firm quotes that come with the

8 obligation to trade. That means that a market maker

9 who is showing a competitive two-sided marketing,

10 every Euro/dollar expiration is taking substantially

11 more risk today than they did in a pit model. That

12 risk is mitigated if the market maker can adjust or

13 change its quotes very fast in response to changes

14 in the market.

15 Failure to react fast enough means the

16 market maker's quotes will be acted on by other

17 participants, most likely to the detriment of the

18 market maker. Ten years ago, acceptable reaction

19 times for market making systems were measured in

20 seconds or hundreds of milliseconds. Today they are

21 measured in single digit microseconds, single digit

22 milliseconds, and sometimes even microseconds.

23 Another area where we have invested a lot

24 of time and energy is in operational excellence.

25 For us this means that we take very seriously our
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1 responsibility to participate in the markets on a

2 continuous basis. We focus on building the

3 protections and safeguards into our systems that

4 allow them to trade -- allow them to provide markets

5 in some of the most extreme conditions, like those

6 experienced on May 6th.

7 The protections and safeguards in our

8 systems are an ever evolving set of checks and

9 monitors both pre- and post-order entry. These

10 checks protect the markets by limiting what our

11 traders can do in areas like the frequency that

12 orders can be entered or modified, the size of the

13 orders, the prices that can be traded, and we work

14 diligently to improve our protections in the system

15 every day.

16 We believe that most automated market

17 makers hold -- build similar checks into their

18 systems with similar goals and similar results.

19 In recent years there has also been a

20 significant increase in the risk management and

21 monitoring capabilities produced by the exchanges,

22 as we've heard from both ICE and CME today. These

23 protections augment our internal protections and the

24 protections that other participants build into their

25 systems.
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1 This combination of protections very much

2 decreases the likelihood of one of these events

3 occurring. The better the combination of our checks

4 and monitors with the exchanges, the more confidence

5 I have in our ability to provide competitive

6 markets.

7 On May 6th, we were one of the few market

8 makers who actively provided liquidity during a

9 period of highest uncertainty. We believe that we

10 were able to do this in part because of our trust

11 that our systems and everything around them worked

12 properly in the face of highly uncertain conditions.

13 And we believe that that trust comes from our

14 experience and our focus on these risk management

15 and operational concerns.

16 While the markets have changed

17 significantly over the past few years, a few things

18 haven't. We believe that the fundamental traders,

19 like investors and hedgers, continue to provide the

20 core price direction in the markets. Intermediaries

21 continue to provide the service as necessary for the

22 market to find equilibrium. What's changed for

23 these participants is the technologies and practices

24 that are necessary for them to be successful.

25 We believe that the percentage of the
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1 market that's done using automated or algorithmic

2 trading is increasing and in our estimation this

3 will continue as end users gain more trust in the

4 new breed of technology enabled intermediaries. As

5 users adopt those -- these technologies in their

6 trading, end users will look more and more like

7 their currently automated counterparts. They will

8 also present similar operational risks to the

9 market.

10 Another key aspect of the market that is

11 unchanged is the uncertainty around future prices of

12 products. This seems like a trial point, but I

13 state it because intermediaries can be criticized

14 for not accumulating large positions in the face of

15 real and balances of demand, like those seen on May

16 6th. An event like this -- in events like this,

17 intermediaries absorb the risk that they are

18 prepared to manage. When that limit is exceeded,

19 the intermediaries -- or experience something

20 outside of norm -- their normal expectations, and

21 when this occurs, they need to assume that the

22 market knows more than they do.

23 We do not believe that the risks that

24 intermediaries are willing to take is fundamentally

25 any different now than it was in the days of pit
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1 trading. Intermediaries have long had the

2 responsibility to understand the ebbs and flows of

3 their markets and to be in tune with their natural

4 rhythms. We believe that technology has allowed

5 intermediaries to automate this feeling and to be

6 more precise in managing it, but that there are

7 capital and risk management responsibilities that

8 limit the maximum positions of any intermediaries at

9 any given moment.

10 So much has changed in the last 10 years,

11 it's hard to list it all, but there are two items I

12 feel are worth highlighting. Both of these topics

13 represent aspects of the overall improved efficiency

14 of today's market relative to 10 years ago. Costs

15 for individual transactions have come down. This

16 means that it costs a lot less for investors and

17 hedgers to execute the fundamental business of the

18 markets. That's a good thing.

19 And these costs include explicit costs

20 like clearing cost and exchange fees, as well as

21 implicit costs like slippage or spread widths. In

22 some markets that we participate in, the cost of an

23 estimate, to be down approximately 60 percent over

24 the last 10 years. We received feedback from

25 participants like Vanguard that these savings are
125

1 being passed directly on to investors in the form of

2 higher returns and lower fees.

3 While transaction costs are down on

4 average, operating costs for liquidity providers has

5 increased dramatically over the last 10 years. The

6 investments and technology that are necessary to be

7 successful -- a successful liquidity provider in

8 today's markets require a much higher level of

9 expense on both the technology itself and the talent

10 necessary to bring it to life.

11 These investments by automated

12 participants continue to rise as the bar for

13 competing at the highest levels continues to raise.

14 While these costs are high, they are not exclusive.

15 As the CME pointed out earlier, the fair access

16 rules of the exchanges level the playing field for

17 all participants and allow new entrants to enter the

18 market freely. The markets remain highly

19 competitive because new entrants are taking

20 advantage of this and are able to raise the capital

21 and investment in these capabilities. There are

22 few, if any, barriers to entry in the modern markets

23 in our opinion.

24 Another major improvement in the markets

25 over the last 10 years has been the tremendous
126

1 change in transparency. The area where we are most

2 excited about is the ability of regulators and

3 academics to do the in-depth analysis on the

4 behavior of the markets like the ones we've seen

5 today and the ones we've read about on May 6th.

6 This ability did not -- sorry. This

7 ability did not exist 10 years ago, and while there

8 is certainly more data to sift through today, the

9 availability of the data for analysis opens up a

10 tremendous capability for our regulators to ensure

11 the fair and orderly behavior of the market.

12 My view as a participant in the markets is

13 that there have always been people who abuse the

14 system. They were there when the markets were

15 primarily in the pits, and they're there in our

16 electronic markets of today. But I believe that

17 many of the behaviors that have been attributed to

18 high frequency trading have always been

19 characteristic of intermediaries in the markets.

20 What's changed is our ability of regulators to

21 leverage the unprecedented access to market

22 information and that that provides me with the

23 confidence that they can monitor and catch

24 undesirable behaviors in a way that was not possible

25 years ago.
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1 Overall, there's been a tremendous change

2 in the market over the last 10 years, and we believe

3 that the changes have made the markets significantly

4 more efficient. These efficiencies have come with

5 changes in technologies necessary to be an

6 intermediary exchange or regulator, but changes will

7 continue in the future as more parts of the market

8 become automated.

9 That automation will continue to affect

10 the behaviors of all participants. In the equities

11 markets, we have seen customer orders become

12 increasingly executed by smart algorithms, and doing

13 this has allowed customers to execute their orders

14 in even lower overall net costs.

15 We also believe that the fundamental

16 stability of the markets is a concern that everyone

17 must take seriously. Events like May 6th undermine

18 the confidence of people in the markets themselves,

19 and we believe that regulators, exchanges and market

20 participants have all worked steadily to improve the

21 reliability of the markets and the protections built

22 within it, but there is much additional work ahead

23 of us.

24 An open dialogue and discussion like the

25 one we planned for the subcommittee, is the best
128

1 tool for bringing awareness to potential problems

2 and stopping them before they occur. I believe the

3 subcommittee is going to produce very positive

4 change in the safety and stability of the markets.

5 I want to thank you for the opportunity to

6 present these views and to participate in this

7 subcommittee.

8 COMMISSIONER O'MALIA: Sean, I don't know

9 if you're aware, FI Principal Traders Group, which I

10 understand GETCO's a member of, put out in November

11 2010, recommendations for risk controls for trading

12 firms, kind of a baseline for best practices. I

13 guess in March of 2010, about a week ago, FI

14 European Principal Traders Association put out

15 software development change management.

16 Now this is only a month old. This is a

17 year and a half old, or something. What is the

18 status of deployment of PTG members abiding by the

19 standards listed in here; are you aware?

20 MR. CASTETTE: I am not aware of the

21 status of the deployment of those risk protections

22 across all the members of the PTG.

23 COMMISSIONER O'MALIA: I would assume that

24 if you signed up for it, you're doing all of these

25 things.
129

1 MR. CASTETTE: We have put considerable

2 effort over the last 11 years in implementing those

3 and other measures into our systems.

4 COMMISSIONER O'MALIA: Yeah. A lot of the

5 things that were raised by the exchange, change

6 management and testing, conformance testing, error

7 controls, pre-trade risk management price collars,

8 volatility, fat finger, et cetera. The interesting

9 thing about this -- the European version, or

10 European software development, it talks about

11 maintaining source codes, source code review and

12 audit-ability, and all of this will be maintained,

13 who is -- I assume it means maintained at the firm.

14 Would that be available to the Commission, for

15 example?

16 MR. CASTETTE: I'm not -- I don't think

17 I'm qualified to comment on whether or not it would

18 be available immediately. I do know that we have

19 had our codes subpoenaed by the SEC and we have

20 provided and worked with them to make sure that they

21 understand the particular parts of anything that

22 they've asked for.

23 I assume there are some firms that are

24 both members of the U.S. If anybody wants to

25 comment on this. This is an interesting piece and
130

1 I'm just kind of wondering what -- what's intended

2 by it. Anybody?

3 MR. GORELICK: My firm participated in the

4 drafting of both of those with a lot of other firms.

5 I know GETCO had representatives on both as well. I

6 think they're just good demonstrations of the fact

7 that the industry participants have been thinking

8 about these issues for a long time. It's not like

9 we woke up in 2008 and started trading with

10 computers and you never thought about risk or

11 software controls or any of the types of risks that

12 we deal with daily.

13 As Sean mentioned, this has been sort of

14 an important skill for our business since they were

15 founded. The purpose of these efforts is to really

16 benefit not only from the learning that's come from

17 individual firms within the walls of those firms,

18 but to broaden out and talk as an industry and make

19 sure that we're thinking about the types of risks

20 that not only have we experienced personally or

21 thought of personally, but that our peers and

22 competitors have as well.

23 COMMISSIONER O'MALIA: Maybe we could get

24 an update as to where firms are in applying these

25 things and maybe that's the FIA needs to provide
131

1 some sort of update on that. I know this is a new

2 document, but it raises a number of questions about

3 --

4 MR. CASTETTE: Even though they're new

5 documents, by the time most of these practices --

6 these are best practices that are documented by the

7 FIA. Most of those practices have been in place at

8 firms like ours or Richard's for a number of years.

9 What we're doing is codifying them so that other

10 participants can learn from the practices that we've

11 developed.

12 And many of them are taken from other

13 industries as well. The software development

14 practices of code control and things like that, and

15 testing, are commonplace.

16 COMMISSIONER O'MALIA: I think everyone

17 heard the chairman. He kind of laid out that we're

18 also looking at new initiatives, and if you're

19 already doing these things, maybe you can help us

20 understand what -- if there's any gaps or we're

21 missing anything, et cetera, that you aren't already

22 doing or the exchanges aren't already doing. I

23 mean, that's what kind of this meeting was about, is

24 to establish that baseline for where we are today.

25 Anyone else have a question?
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1 MR. VICE: Scott?

2 COMMISSIONER O'MALIA: Yes.

3 MR. VICE: In that regard, ICE, about a

4 month or two ago, sent a survey out to our -- a

5 group of high frequency traders, defined with direct

6 market access, automated trading, asking them if

7 they've adopted those by best practices, and point

8 by point. At this point, it's just a survey. I

9 think it's certainly sent out with an expectation

10 that they do, and we've asked them where they don't,

11 to just explain why they don't.

12 We'll be happy to share the high-level

13 survey results, not individual results obviously,

14 but high-level results of that when we finish that

15 activity.

16 COMMISSIONER O'MALIA: Great. That's very

17 helpful. Thank you.

18 Any other thoughts, questions? Yeah, Dr.

19 Gorham.

20 MR. GORHAM: You probably know also that

21 the Chicago Federal Reserve Bank has been doing over

22 the last year or so a survey of firms and exchanges,

23 firms and vendors, and they've come out with two

24 reports so far that I know of, one on exchanges, one

25 on vendors. I don't know if the one on firms has
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1 come out, but you might be able to -- you can get

2 their raw data. That might be useful to the

3 Commission.

4 COMMISSIONER O'MALIA: I wasn't aware of

5 that. Thank you. In my packet of kind of research

6 material, I also had this interesting, provocative

7 study that came out last week, I think, David

8 Bicchetti and Nicolas Maystre, synchronized and

9 long-lasting structural change on commodity markets

10 and evidence from high frequency trading.

11 This is a provocative study, to say the

12 least, about the role HFT has had in commodity

13 markets. And if you think you had a problem with

14 any of the slides that Mr. Hasbrouck put up there,

15 you should read this study.

16 But we will leave that for another day.

17 We are over our time. And I do want to thank the

18 panelists here, thank the HFT. We're going to

19 excuse everybody but the HFT Subcommittee because we

20 want to have a brief organizational meeting. So I

21 appreciate everybody's participation. If the

22 subcommittee would stay around, I'd appreciate it.

23 Thank you very much to our panelists.

24 We'll be back at 2:00.

25 (Whereupon, at 1:02 p.m., a luncheon
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1 A F T E R N O O N S E S S I O N

2 (2:18 p.m.)

3 COMMISSIONER O'MALIA: Before we begin, we

4 have our legal disclaimer that we have to deal with.

5 In order to -- Nancy will explain the process for

6 receiving the documents and the recommendations.

7 Nancy Doyle is our assistant general counsel.

8 MS. DOYLE: Good afternoon. This is

9 pretty much for the record and I apologize for those

10 that worked on the Data Standardization

11 Subcommittee, because it may be repetitive of what

12 you already know.

13 As we explained at the outset of the Data

14 Standardization Subcommittee process, the charter --

15 this is a federal advisory group, charter for it --

16 provides that it renders advice, proposals and

17 recommendations to the full Technology Advisory

18 Committee. We have met with representatives of the

19 TAC to vet and process these proposals. Done a

20 great job. And they're here today to present the

21 Data Standardization's Subcommittee's four working

22 group proposals to the full TAC. It's presented to

23 you today.

24 And let me explain what the TAC's role on

25 this is just in terms of FACA, advisory committees
136

1 and charters. The FACA -- this is being passed

2 through the main committee up to the Commission.

3 The FACA receives these and recommends that they be

4 submitted to the Commission for its deliberations.

5 When you receive these, and generally recommend, you

6 are not having to formally vote. You won't have to

7 formally vote, although we have a quorum here today.

8 What you will be doing by a voice approval

9 when Commissioner O'Malia calls you to the end --

10 you may want to know this -- is agreeing that these

11 are worthy of being relayed to the Commission for

12 its consideration. So please do not feel -- and I'm

13 stating this publicly with a court reporter here --

14 that you are signing on to every footnote in every

15 one of these working group reports you've been

16 viewing for the last three months. You'll be happy

17 to know that.

18 So just like a good lawyer, just to repeat

19 again, here's the written words. The purposes of

20 today, for these materials, which have already been

21 previewed to this committee in its previous

22 meetings, is to be formally received by the full TAC

23 for recommending for delivery to the Commission with

24 your general endorsement.

25 TAC subcommittee members are free to
137

1 discuss, comment on or disseminate the

2 recommendations as they see fit, but of course,

3 neither the Subcommittee on Data Standardization or

4 the TAC should say that the Commission now at this

5 stage endorses the recommendations.

6 The Commission itself isn't taking action

7 today, of course. What actions, proposals,

8 endorsements or deliberations the Commission

9 undertakes with respect to any or all of these four

10 working group reports will be at the Commission's

11 future election and discretion.

12 So if anyone has any questions on this,

13 I'll be available to help you, but it's important to

14 just clarify what it is and what it isn't, and I

15 thought it would be of some comfort to the TAC

16 members in particular to know about.

17 COMMISSIONER O'MALIA: Thank you, Nancy.

18 We're going to proceed right away to Doug Harris,

19 full TAC Committee member, to present the

20 recommendations on working groups two and four.

21 Doug.

22 MR. HARRIS: Thank you, Commissioner

23 O'Malia, and good afternoon. I'm pleased that you

24 asked me to vet the recommendations of the

25 subcommittee two and four. I realize that this is
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1 an important step in --

2 COMMISSIONER O'MALIA: Doug, can you pull

3 that microphone closer?

4 MR. HARRIS: -- an important step in

5 bringing additional clarity to the obligations of

6 swap entities, DCOs, DCMs, SDRs under Title VII of

7 Dodd-Frank Act and the Commission's expectations

8 with respect to the reporting, maintenance and

9 retrieval of swap data.

10 I'd like to take just a moment to thank my

11 boss, Gene Ludwig, for making the firm -- CEO of

12 Promontory Financial Group, for making the firm's

13 resources available to me and to engage in this

14 vetting. And I want to particularly thank Evelyn

15 Fuhrer, who's sitting here with me. She's the head

16 of Promontory's Financial Services Technology Group,

17 and I relied upon her quite a bit in doing this

18 vetting.

19 I also want to say that Promontory doesn't

20 have any particular proprietary interest in any of

21 these working group recommendations, nor did we

22 approach the review of these recommendations from

23 any one client's perspective. Our clients have

24 included the CFTC, existing DCOs, DCMs and other

25 entities or registered swap dealers. So our concern
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1 here was on the integrity of the reporting process

2 and the accuracy of the reporting process.

3 In conducting the vetting, we determined

4 that there were five considerations that we should

5 assess each of these recommendations against,

6 consistency with Dodd-Frank Act, the statutory

7 provisions and rule-makings, cost and ease of

8 implementation, time to market, consistency with

9 current industry initiatives, and action-ability.

10 First the recommendations of working group

11 two. The first recommendation is adopt the generic

12 product representation for reporting of complex and

13 BISPO (ph) products to equip regulators with an

14 appropriate level of information while preserving

15 the ability of the marketplace to innovate.

16 We support this recommendation, but we're

17 aware that the generic product representation would

18 not fully comply with the existing CFTC reporting

19 rules under Part 43 and Part 45. So currently there

20 is a process for 180 -- 180-day exemption from the

21 reporting requirement for complex and BISPO

22 products. We think that this exemption is going to

23 need to be extended over time. In fact, what we

24 think is that there will need to be a long-term

25 exemption for complex and BISPO products. As new
140

1 products are developed and evolve, it will always be

2 the case that the generic product representation

3 will not fully capture all of the primary economic

4 turns.

5 So we would suggest that the TAC suggest

6 to the CFTC that they consider a long-term exemption

7 for BISPO and complex products and possibly consider

8 a process whereby over time, as new products are

9 developed, that the CFT -- the CFTC assess whether

10 certain complex and BISPO products are now

11 adequately captured by the generic product

12 representation and no longer need an exemption.

13 Recommendation two, leverage the ISDA

14 standard credit support annex initiative to create a

15 highly standardized data representation of the ISDA

16 SCSA and explore possibility and options for

17 electronic execution. Again, we support this

18 recommendation and we think that the TAC should

19 recommend to the -- that the CFTC continue outside

20 of the formal rule-making process to encourage the

21 develop of the SCSA, and thereafter a

22 machine-readable representation of the SCSA.

23 And we note that this effort would be

24 consistent with current industry initiatives of ISDA

25 to create the SCSA and at -- FpML has also put
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1 together a working group to develop an electronic

2 representation of the SCSA. So that was one of the

3 factors strongly in favor of our support of this

4 recommendation.

5 Recommendation three, regarding legacy

6 portfolio legal agreements finalized and industry

7 wide survey to identify legal agreement information

8 relevant to systemic risk. The survey will confirm

9 scope, feasibility and collate information relevant

10 to a cost benefit analysis.

11 On this recommendation, we actually

12 suggest that the CFT -- that the TAC suggest to the

13 CFTC that it delay taking action on this

14 recommendation, though we think that gathering this

15 information from legacy portfolio document agreement

16 is going to be very important for the CFTC in order

17 to better assess systemic risk in the swap market.

18 We also think that -- that the obligations

19 imposed by Title VII have already put a strain on

20 the resources of many firms and especially the

21 technology resources. And we would recommend that

22 the CFTC consider delaying the survey until after

23 industry participants have completed some of their

24 initial compliance efforts under Title VII.

25 We're going to switch now. You're going
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1 to have to switch documents to the recommendations

2 of working number four. The first recommendation,

3 1a, concerns data format. The recommendation is the

4 first step to standardized trade reporting across

5 market sectors should be develop -- to develop a set

6 of common XML elements and then work towards

7 establishing a unified set of XML tags over time.

8 Further, setting up a process to manage

9 and evolve standards over time using the expertise

10 of industry groups is the best way to achieve

11 success in standardization projects. We agree with

12 the direction of this recommendation, but if in fact

13 the recommendation is intended to mean that the CFTC

14 should undertake that effort, we don't think that

15 that is the best use of CFTC resources. We think

16 that the TAC should recommend to the CFTC that the

17 CFTC provide guidance on the initiative and support

18 to the industry in further developing the common XML

19 elements and a unified set of XML tags.

20 Recommendation 1b, data format. The CFTC

21 should not dictate the input format to the SDR as

22 long as the SDR can produce output to the CFTC in a

23 format that the CFTC finds acceptable. We agree

24 with this recommendation and in fact, we don't think

25 any further action really needs to be taken here
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1 because the CFTC has already effectively implemented

2 this recommendation in 17 C.F.R. Part 45 by not

3 dictating the input format to the SDR. However, we

4 also believe that implicit in this recommendation is

5 an obligation on the part of the CFTC to define

6 acceptable data transmission output formats for

7 recording to the CFTC and disseminating these

8 requirements in a timely manner to SDRs so that they

9 have sufficient time to comply.

10 Recommendation 2a deals with storage. The

11 recommendation is it is likely that there will need

12 to be a way to reformat or transfer old records into

13 newer media from time to time. SDRs will need

14 procedures to do this in a way that still maintains

15 the integrity of the original data by maintaining

16 the readability over time. In this area it would be

17 helpful to have further guidance to clarify first,

18 to clarify best practices for developing and

19 implementing such procedures.

20 We note that this is absolutely consistent

21 with the existing regulatory requirements. Part 49

22 requires SDRs to establish sufficient procedures and

23 policies and procedures to prevent a valid swap from

24 being invalidated. We agree with this

25 recommendation and we think it would be extremely
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1 helpful for the CFTC to provide guidance on

2 sufficient policies and procedures. And further, we

3 have some ideas as to what those policies and

4 procedures should be, and they would include robust

5 change management policy -- policies and procedures

6 that address periodically updating storage media,

7 databases and associated application systems.

8 We think the TAC should also suggest to

9 the CFTC that the CFTC consider providing SDRs with

10 further guidance on establishing a control framework

11 that is reasonably designed to ensure that the data

12 continues to be credible and useful over time.

13 Recommendation 2b also deals with storage.

14 The long duration of some swaps may require that

15 original data be maintained in its native format for

16 extended periods. The term "data file format"

17 appears to need further definition, as it is unclear

18 whether this means the format created by a sender of

19 data, the format that might exist in transmission,

20 or the format that a receiver of data uses to state

21 the data.

22 The working group believes that for a

23 cleared swap trade, the native format of the

24 transaction record is that used and maintained by

25 the DCO for a privately-negotiated trade reported to
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1 the SDR. The native format would be that used and

2 maintained by the SDR.

3 This one we actually have some issues

4 with. We think that possibly the focus on the

5 native format may be too restrictive, and what's

6 actually more important is the integrity and

7 credibility and accuracy of the data over time. So

8 we think the TAC should recommend that the CFTC

9 consider providing guidance on developing

10 appropriate controls and audit trails to ensure that

11 stored data remains credible.

12 Now the one issue we -- that possibly goes

13 against our conclusion, is the fact that native

14 data, native file format may be necessary in certain

15 enforcement proceedings. We haven't made that

16 determination and so I think what would be

17 appropriate, is to first have some kind of legal

18 opinion or analysis as to whether the data native

19 file format will be required for the CFTC to pursue

20 enforcement actions. But aside from that issue, we

21 think the real issue is the ongoing credibility and

22 integrity of the data.

23 Recommendation 3 deals with versions.

24 Rather than allow every minor change to a product

25 definition to result in a new and distinct product
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1 ID, keep product IDs stable by associating a version

2 with product IDs. It would be important to match

3 the product ID and the version, particularly when

4 contract lifetimes are long compared to the duration

5 of a given version.

6 We agree with this recommendation

7 primarily because it is consistent with current

8 industry initiatives. Currently identifiers are

9 used. Versions are used for CDS and we know that to

10 use to a UPI initiative will involve versioning of

11 the UPI and product taxonomy for all asset classes.

12 Recommendation 4a. In order to make it

13 efficient for interested parties to retrieve data,

14 every SDR should provide the same standardized API.

15 Access to different parts of the data would be

16 configurable so that all parties could use the same

17 API. We also agree with this recommendation and we

18 think that it would assist the industry and the SDRs

19 to comply with the reporting requirements and

20 facilitate retrieval and analysis of data.

21 Recommendation 4b also deals with storage.

22 Swap participants should be given the ability to

23 view all data reported to SDRs on swaps that they

24 are party to over the life of such transactions.

25 The reporting entity will need to be able to
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1 directly amend data, although this ability should be

2 limited to reported data only.

3 The counter-parties should have the

4 ability to report errors in data so that they may be

5 corrected by the original reporting party, or

6 subject to some form of dispute resolution. We

7 agree with this recommendation, but we don't believe

8 that the CFTC should necessarily prescribe the

9 process by which SDRs accomplish these tasks.

10 Different SDRs may have different methods for

11 correcting data and providing access to data, and we

12 questioned -- we questioned whether a reporting

13 entity needs to be able to actually directly amend

14 the data.

15 That would imply that the reporting entity

16 actually has -- can go into the system and report

17 the data. That presents, in our minds, certain

18 security issues. And so therefore, we think that

19 it's probably best that the TAC recommend to the

20 CFTC that the CFTC allow SDRs to follow through on

21 this recommendation and to allow access -- to allow

22 data to be corrected in the form that it sees fit.

23 Recommendation 4c, access, the CFTC should

24 establish more detailed requirements for the

25 analysis of data by SDRs on a regular basis, as well
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1 as for ad hoc requests by the CFTC, until the CFTC

2 establishes more detailed requirements, including

3 the expected types and urgency of requests. It is

4 unknown what future functionality SDRs will need to

5 support, which has important implications from a

6 software perspective.

7 This information will also help SDRs

8 determine the need -- the needed computing

9 horsepower for their middle offices. We note that

10 SDRs are expected to routinely monitor data for the

11 purposes of any ongoing swap surveillance and

12 objectives of the CFTC, as well as for ad hoc

13 requests.

14 We support this recommendation because we

15 once again believe that the more lead time and

16 direction that the SDRs have as to what the future

17 surveillance objectives of the CFTC will be, the

18 better equipped they will be to respond to requests.

19 And we note that there is going to always be a cost

20 associated with complying with these requests. So

21 the earlier that the CFTC provides us guidance to

22 the SDRs, the more efficiently they can carry out

23 their responsibilities to respond.

24 Finally, recommendation 5 goes to timing.

25 The initial data loaded into SDRs should be OTC swap
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1 data, as the primary goal of the relevant portion of

2 the Dodd-Frank Act is to bring transparency to this

3 sector of the market. With this in mind, the

4 subcommittee recommends the following sequence for

5 required reporting into SDRs.

6 Phase 1, ensure SDR requirements are

7 international and applied consistently. Phase 2,

8 begin reporting of non-cleared trades. Phase 3,

9 begin dissemination of public data on a real time

10 basis. Phase 4, require the reporting of cleared

11 trades into SDRs. Phase 5, provide query

12 functionality to regulators. And Phase 6, provide

13 more complex portfolio analytics to the regulators.

14 It's pretty clear that the working group

15 in this case phased in these various requirements

16 based on information that they thought was going to

17 be most important to the CFTC's surveillance and

18 monitoring activities. We would approach it

19 slightly differently. We would suggest that the TAC

20 recommend to the CFTC the CFTC go after the

21 low-hanging fruit first, and that would be reporting

22 cleared trades and non-cleared trades, then

23 disseminating public data, then providing query

24 functionality, and then providing more complex

25 portfolio analytics.
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1 What we disagree with is that Phase 1,

2 which would seem to have to occur before these other

3 phases occur, is the proper first thing to try to

4 tackle. We think international consistency is going

5 to be hard to achieve, and in our view, it should be

6 an ongoing process doing these other phases rather

7 than the first phase that has to be accomplished

8 before these other requirement -- reporting

9 requirements are put into place.

10 As we see at the end, we think the

11 reporting of cleared trades can be achieved fairly

12 easily and it would be considered to be a big win

13 for the Commission.

14 And that's it.

15 COMMISSIONER O'MALIA: Thank you very

16 much. It goes without saying, but I will say, I

17 can't thank both Doug and R.J. and their respective

18 teams for all the hard work they did to take all the

19 work of the data group, and I greatly appreciate the

20 data group's work to assemble all this and to make

21 your recommendations on a very short time.

22 I know our staff appreciates your

23 assistance. I do. And I know I speak for the

24 Commission on that. So thank you very much --

25 MR. HARRIS: You're welcome.
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1 COMMISSIONER O'MALIA: -- for all the work

2 you did to distill this and give thoughtful

3 reflection on the rules -- or on the reports. R.J.,

4 you ready?

5 MR. CUMMINGS: Yeah.

6 COMMISSIONER O'MALIA: Fire away.

7 MR. CUMMINGS: Okay, I'm going to move

8 through mine pretty quickly. We had to do

9 recommendations on the group one and group three,

10 product and entity identification, specifically UPI

11 and LEI, and then group three was the use of

12 semantic descriptions for financial instruments.

13 We went through the TAC's recommendations

14 that were provided in December. And what we have is

15 that we recommend the use of an asset class accepted

16 product taxonomy for Part 43 reporting, real time

17 reporting, and move the fields listed in the Part

18 43's table A1. We feel that those -- that table's a

19 little bit restrictive.

20 As the use of UPI for Part 43 is optional,

21 ISDA has taken on the sort of optional

22 responsibility to complete taxonomy definitions for

23 all asset classes that would ensure that required

24 fields are covered for reporting purposes. We also

25 recommend that UPIs will only be provided for Part
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1 45 reporting where appropriate, and to continue to

2 work with the CFTC in order to get detailed guidance

3 for granularity of UPIs. This specifically relates

4 to standardized products versus exotic or bespoke

5 products on each of the asset classes.

6 This will further categorize products for

7 systemic risk management until such time that the

8 taxonomy provides sufficient minimum classification.

9 The existing rules of operations documents are

10 available. The government changed process for OTC

11 taxonomies at ISDA. It's a working framework right

12 now. And at this point, for a July 16th

13 implementation date for credit and interest rates,

14 the industry should adopt the ISDA proposed taxonomy

15 to allow for timely implementation.

16 We also recognize that the taxonomy

17 approach that ISDA has put forward can change over

18 time. UPIs have a unique appeal for product

19 classification, but the difference in definition and

20 use of a common UPI in Parts 43 and 45 to some

21 degree limits the value that UPI would represent for

22 SDR reporting.

23 An absence of clear guidance on UPI

24 granularity should allow the industry infrastructure

25 providers to leverage proxy UPIs until such time as
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1 the CFTC can prescribe a more universal approach to

2 product classification.

3 So the taxonomy approach serves to

4 categorize OTC asset classes in a meaningful way in

5 the immediate term. We believe the CFTC should

6 continue a dialogue with other regulators to ensure

7 consistent application of the OTC taxonomy

8 recommendations.

9 The governments of the steering groups or

10 authors of taxonomy and UPI categorization materials

11 need additional analysis. Primarily, industry

12 groups have not formally recognized, and I stress

13 formally, DCO, DCM, SDR and SEF participation in

14 current classification activities.

15 As these entities will have to adopt and

16 support data transmission activities to one another,

17 a mechanism for dispute resolution will be required.

18 Current steering committee guidelines have not

19 previously had to formally acknowledge -- I stress

20 formally again -- confidentially -- confidentiality

21 or non-disclosure practices with a wide range of

22 commercially competitive entities now tasked with

23 participating in a product classification process.

24 New product innovations and timing considerations

25 will have a larger role to play.
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1 LEI, we recommend the support for Part 45

2 LEI initiative being coordinated by FSB that

3 leverages the ISO 17442 LE standard for CFTC

4 reporting. SWIFT, DTCC and ANNA are developing an

5 industry solution to address the roles of the

6 registration authority, facilities manager and

7 third-party provisioning capabilities for LEIs.

8 That process is well underway today.

9 We recommend the immediate notification

10 and distribution of existing LEI records industry

11 wide where available. We understand that there are

12 roughly 50,000 cleansed LEIs and there are probably

13 about 9,000 that are ready to go today.

14 We recommend the use of proxy LEIs until

15 such time as the industry can fully adopt and

16 support ISO 17442 for designated swap dealers where

17 LEIs don't yet exist. We recommend an appropriate

18 industry integration and testing period in advance

19 of required reporting compliance data.

20 Integration and testing should allow for a

21 beta phase of no less than nine months, in our

22 opinion, and a live implementation period with a

23 definitive compliance date. LEIs are consistent

24 with and highly correlated to several other

25 Dodd-Frank initiatives, including LSOC and position
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1 limits. In some cases, the stated compliance dates

2 of related Dodd-Frank reporting requirements could

3 preempt adoption of standardized LEIs in favor of

4 proxy LEIs in order to meet parallel reporting

5 objectives. So we have a little bit of a race

6 condition here.

7 The actual implementation cost associated

8 with the initial development and distribution of the

9 industry solution for LEIs does remain unclear, and

10 it's not entirely clear if there is uniform

11 international support or agreement for the CFTC's

12 LEI approach, as foreign sovereign regulator --

13 regulatory mandates similar in nature to Dodd-Frank

14 are either in draft form, still under discussion or

15 have yet to begin in earnest. The CFTC should

16 continue to actively push for an international

17 solution while endorsing a proxy LEI approach for

18 markets under its jurisdiction to allow for

19 sufficient integration and testing time.

20 Group three, semantic representation of

21 financial instruments. We recommend the continued

22 use of XML-based reporting schemas, FpML and FIXML

23 in order to capitalize on the existing technology

24 and framework investment of the industry for

25 regulatory reporting. The standards available to
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1 the industry infrastructure providers, clearing

2 members and trading entities today are capable of

3 addressing the needs of the industry and regulators

4 with little, if any technical modification.

5 We recommend that any additional parallel

6 analysis on the implementation impacts of

7 ontological or semantic technology should be

8 deferred until existing Dodd-Frank initiatives can

9 mature and be reviewed for additional efficiencies

10 and capabilities.

11 The proposed benefits and opportunities of

12 semantic representation of data appear encouraging

13 with regard to the enhanced classification and

14 analysis of data. However, a proper cost benefit

15 analysis should be done before further investing in

16 this area. A good starting point could be a gap

17 analysis of the reporting infrastructure once it's

18 fully developed by the industry, in line with

19 regulatory requirements. We believe that any

20 attempt to force the use of semantic representation

21 would only serve to complicate existing reporting

22 requirements.

23 COMMISSIONER O'MALIA: Thank you very

24 much. You want to say anything about it, Chuck, as

25 a full TAC member?
157

1 MR. VICE: Other than I guess as a full

2 TAC member I'll recommend R.J.'s -- the working

3 group's recommendations on those two topics. And

4 would also just like to add one point of concern for

5 the CFTC to consider going forward on the proposed

6 solution for -- recommended solution for LEI

7 determination and the entities mentioned there to

8 provide that.

9 We do support it. However, we do

10 recognize that that's essentially going to be --

11 this was not put out for an RFP, and so this is

12 essentially a monopoly service and we just -- we

13 want to make sure that the concerns are addressed in

14 terms of how this is paid for and the costs are

15 determined and fees are determined and so forth.

16 MS. BOULTWOOD: Can I just clarify that?

17 COMMISSIONER O'MALIA: Yeah.

18 MS. BOULTWOOD: I mean, it wasn't clear to

19 me in reading the recommendations who's responsible,

20 what are the roles and responsibilities in terms of

21 the UPIs, the LEIs, you know, creation and

22 assignments, I guess. And then also, didn't we also

23 discuss transaction identifiers?

24 MR. VICE: I'll tell you my high-level

25 understanding and R.J. can correct me where I get it
158

1 wrong. The LEIs, I believe it's SWIFT, DTCC and

2 ANNA, there's three organizations there that have

3 been more or less recognized globally. There is

4 some global momentum behind that solution and I

5 think it makes the most sense.

6 And so they will -- determining an LEI

7 will be a fairly straight forward thing, a corporate

8 entity or hedge fund or swaps dealer, whoever it may

9 be that doesn't have one. I equate it to some

10 extent to the old Dunn and Bradstreet codes that

11 every company had. So I think it's a pretty

12 straight forward thing. You just need to have a

13 code so everybody knows that when they see that code

14 that that's you.

15 The UPI, I think what they're recommending

16 there is more of a process of determining a UPI code

17 as opposed to the codes themselves, so that it has

18 the flexibility as new products come along,

19 variations of products are developed, anyone can use

20 the taxonomy to derive the same product code as

21 anyone else.

22 And then I believe the USI, I'm not sure

23 that was a topic of one of the working groups.

24 MR. GORELICK: No, that wasn't. That

25 wasn't a topic. Well said.
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1 MS. BOULTWOOD: Transaction identifiers

2 are something to be addressed in the future or --

3 MR. VICE: There -- in some of the

4 rule-making, I mean, I think in terms of SEF

5 establishes those. I think if the SEF traded -- I

6 mean, there are some guidelines emerging. Maybe

7 they're even in the rule-making; I can't recall.

8 COMMISSIONER O'MALIA: Well, a lot of this

9 data is -- you know, hopefully we can adopt,

10 consider it as part of our decision making going

11 forward and how we're going to implement it and what

12 the challenges are from a technology cost, et

13 cetera.

14 Global coordination on the LEI is critical

15 and I believe it's this week that meetings in Basal

16 are occurring to kind of harmonize, make sure

17 everybody's on the same page. There is some issues

18 to Chuck's point regarding the governance that I

19 think are still being considered, but by and large,

20 the standardization of how they're going to be --

21 you know, what's going to be implemented and how

22 soon they can be implemented using this proxy

23 proposal, is moving forward. But there are a couple

24 of items still left open and we will have to use the

25 proxy to move forward.
160

1 The four working group papers are on our

2 website and both R.J. and Doug here have kind of

3 provided their review through Chuck as well, to make

4 recommendations or recommendations on those working

5 groups to be kind of forwarded to the Commission for

6 consideration.

7 So what I'll ask you to do here is to

8 basically approve both of them, to make sure that

9 the Commission's aware of both of them. Since this

10 is an open meeting and a public record, we will

11 allow for other comments to come in on both the

12 papers and the recommendations themselves. So if

13 you have any further thoughts, we're -- we'll

14 include all of that and provide that as a

15 recommendation to the Commission.

16 A lot of their -- the LEI's a good example

17 of something that is very near term and immediate.

18 And there are some other concepts that both -- some

19 of the other working groups considered that are

20 farther range and will be valuable to us in

21 considering how we tackle these issues. Even there

22 was in one working group no specific single

23 consensus, so on the taxonomy, that's a challenge

24 for all of us to figure out what the next steps are

25 on that.
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1 But it really will provide us a good range

2 of ideas and concepts that we need to think about,

3 not only for immediate rules, but longer range

4 rules, and how we're going to integrate further

5 automating and creating a universal record for all

6 of this trading, and to automate all of it.

7 Because as we heard this morning, the

8 volumes and the speed in which all of this occurs

9 really dictates kind of a computer-aided strategy

10 here. So I can't thank enough the working groups --

11 I see them sprinkled about here -- who have

12 participated, and I greatly appreciate your input

13 and efforts on that. It was extremely valuable.

14 These are very thorough recommendations

15 and reports. They're on our website. I encourage

16 you to take a look at them and download them, review

17 them, et cetera. Provide comment. We're going to

18 allow for that.

19 But if you would, I will just ask if

20 there's kind of a unanimous consent, or if there's

21 any objection to forwarding all of this on to the

22 Commission. Does anybody have any objection on the

23 TAC from forwarding all of these documents and

24 recommendations to the Commission? Well thank you

25 very much and I thank the Data Standards Working
162

1 Group for their service to provide this information

2 as well.

3 We are going -- anything else from a legal

4 standpoint?

5 MS. DOYLE: No. Just to clarify what's

6 happening, for the record. I think it's clear, but

7 in case I misheard it, it's not just the four

8 working group reports. Also the work product. Mr.

9 R.J. Cummings and Mr. Douglass Harris and their

10 organizations, which again, this is an educational

11 process for staff too, this whole working group has

12 been really grateful. It's great working with you.

13 That will also be forwarded on to the

14 Commission for reading too. And I already said it,

15 but I'll repeat it again. In agreeing to do this,

16 you're not agreeing to any footnote in anything, of

17 binding any of your organizations. The entire point

18 of FACA is that people come from their own industry

19 perspective and they share it with the government,

20 and we consider it for further action, if any, we

21 might take with respect to one or not.

22 COMMISSIONER O'MALIA: All right. We'll

23 move to panel three. Thank you very much, R.J. and

24 Doug, Chuck, thank you.

25 (Pause)
163

1 COMMISSIONER O'MALIA: We're get --

2 somebody's getting your name tents. If you'll just

3 have a seat. We won't let that hold us up. This is

4 the third panel for the day. This is an idea. We

5 had a rule-making a couple weeks ago that talked

6 about documentation and how we're going to solve for

7 a trade breakage and issues going forward. We want

8 to make sure that through documentation that there

9 wouldn't be any anti-competitive behaviors.

10 We imposed some rules on that, but what

11 fascinated me the most about this is what are we

12 for? What will the Commission be for? What is the

13 industry for in integrating the swaps market from a

14 transaction to clearing perspective, keeping in mind

15 that this is different than the futures markets? We

16 are going to have more SEFs. We had ICE and CME,

17 two prominent players in the futures markets.

18 And in the swaps market, we're lucky to

19 see many more transactions or transaction venues,

20 swap execution facilities. We have to integrate the

21 FCMs. We have to make through multiple clearing

22 houses. It all has to happen in less than a blink

23 of an eye.

24 And so our challenge is obviously to make

25 sure that from a technology standpoint that this
164

1 functions effectively, efficiently and a time frame

2 that we have -- we have created our rule-making and

3 that you can all transact without any problem.

4 So this is the panel, what are we for?

5 What is possible? And it's clear to me that it's an

6 industry solution and we're going to rely heavily on

7 the industry. The good news is when we first put

8 our proposal of rule-making on the documentation,

9 document -- that's when the documentation lifespan

10 ended and the next concepts began.

11 The four gentlemen we have here today have

12 taken a very active role, buy side, sell side.

13 We've got execution. We've got confirmation to try

14 to give you a representation of all elements in a

15 very short panel of how we're thinking, how the

16 industry is thinking about it and how we can expect

17 the transac going forward to make sure that we have

18 credit checks on all of our trades.

19 We have the ringleader, Randall Costa,

20 managing director of Citadel. He is responsible for

21 a range of strategic initiatives for Citadel,

22 including OTC derivatives. Prior to joining Citadel

23 in 2007, he was a CAO of fixed income in Citi-group.

24 We also have Paul Hamill with UBS, and who

25 did not send in a bio. He's managing director of
165

1 UBS and has spent a lot more time in Washington,

2 because we've seen him a lot more.

3 Then we have Jeffrey Maron, managing

4 director of MarkitSERV. Jeff served -- joined

5 MarkitSERV in 2000 -- in January of this year as

6 managing director and a member of the management

7 committee. Prior to this he was head of client

8 technology and the head of administration of

9 E-Commerce at GFI with over 20 years of experience

10 in the financial markets.

11 And then finally we have Jim Rucker, head

12 of Credit and Risk, MarketAxess. Jim served as

13 chief operations and credit and risk officer at

14 MarketAxess Holdings from 2010 to February of 2011,

15 and previously served as the CFO, June 2004 to 2010.

16 Also served as head of finance as well, vice

17 president of international fixed income operations

18 at Chase Manhattan before that.

19 So gentlemen, I don't know if you have a

20 specific order. I don't. But you're free to start.

21 With Paul Hamill. And if you want to give us any of

22 your background, I apologize. I just didn't have a

23 document for you.

24 MR. HAMILL: (Off microphone).

25 COMMISSIONER O'MALIA: Okay. Hit the
166

1 button. Light it up and --

2 MR. HAMILL: Okay. Thanks. I guess what

3 we thought we would do by way of introduction is

4 just give some history to sort of the working group

5 and the business problem, just so people have the

6 context of kind of what we're going to talk about

7 today.

8 From a business standpoint, the problem

9 here is one of certainty of execution and I think as

10 a group of market participants, industry

11 participants, we started to talk about that in

12 various forms throughout the course of mostly last

13 year, and really that is as we move to an

14 environment where the products we trade are subject

15 to some sort of mandatory clearing requirement, then

16 the kind of trade is not done until the trade is

17 cleared, and that's obviously different to the world

18 we live in today and was a problem that we would

19 have to solve for.

20 So that kind of certainty of execution

21 problem started to manifest itself more quickly as

22 we started to talk about some of the sort of

23 standardized documentation structures that we were

24 looking to put in place as an industry, especially

25 last year.
167

1 A small working group formed around about

2 June last year and started to look at how other

3 markets solved this problem and what are the

4 technologies and other solutions might be out there

5 to achieve some of the things that were being

6 discussed in the documentation so we have the

7 trilateral documentation structure. But it was also

8 a view that we should think about how technology

9 might solve some of those problems, and start to

10 examine how other markets worked.

11 So we did that, and that small group

12 worked closely with CCPs, SEFs, buy side, sell side,

13 you know, pretty much anyone who was interested from

14 a market standpoint, and sort of tried to establish

15 some principles, and then ultimately that folded

16 into what became the FIA as the working group, which

17 was then used to kind of more broadly socialize some

18 of the issues and the concepts to try to get more of

19 a consensus view across the market and what the

20 outcomes kind of might be.

21 So I would say -- and currently the FIA as

22 the working group is probably best described as

23 being in the process of sort of finalizing the

24 consensus around what those principles are, and I

25 think we'll talk about a few of those today.
168

1 With that, I'll probably hand over to

2 Randall.

3 MR. COSTA: And further just to set the

4 stage, there was a slide, I don't know -- there's

5 one. Oh, it might be on here. Well, I'll start and

6 then if we can get the slide. The purpose is to

7 really set the stage for -- this is a really

8 interesting problem set, because it's at the

9 intersection of risk, legal, plumbing and market

10 structure, so where the money flows, and how markets

11 evolve or -- and at what pace?

12 As Paul set up, once a swap is accepted

13 for clearing, bilateral counter-party credit risks

14 or performance risk, is eliminated through the

15 interposition of the clearing house. Then the

16 clearing house becomes the buyer. We know. So the

17 question is, how do we get from the point of

18 execution to the point of clearing acceptance or

19 make them the same?

20 Looking at the illustration, if alpha fund

21 executes a swap with swap dealer Y with the

22 intention to clear it, and were any time to elapse

23 between the point when the parties say done and the

24 point the clearing house accepts it, there is risk,

25 however small, that the trade is not accepted,
169

1 mostly likely because one party exceeded its credit

2 limit for clearing.

3 If the trade is not accepted and time has

4 passed, the replacement price for the non-breaking

5 party may be different than the price for the trade

6 originally executed, the difference in price we

7 refer to as breakage.

8 The discussion topic here is how to deal

9 with this risk. This is not a new challenge. It's

10 been solved in a range of existing cleared

11 derivatives markets, as Paul alluded to, such as

12 futures, listed equity derivatives, and energy

13 swaps. And in part based on those existing

14 frameworks, solutions are built or under

15 construction for cleared OTC derivatives.

16 We hope -- I don't know what the protocol

17 is typically for this panel, but while we represent

18 buy side, sell side, trading venue and middleware --

19 and confirmation, there are clearing houses

20 represented on the panel that are very much a part

21 of our solution process here, our industry. So we

22 hope they can speak freely as we go along.

23 When we look big picture at those existing

24 markets -- and what we're looking at today already

25 with cleared OTC derivatives, there are two
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1 operational models -- there's host execution

2 clearing acceptance and pre-execution clearing

3 guarantees. If we were to walk quickly through -- I

4 can try to refer to the diagram -- I know these are

5 very familiar to most people in the room -- in

6 post-execution acceptance, the trade is executed, so

7 it would be alpha fund and swap dealer Y. They

8 would execute it through whatever modality, voice,

9 SEF. They would execute it and the trade would be

10 submitted to the CCP for clearing.

11 Before the CCP can accept it, it has to

12 run through some fundamental checks. If we look at

13 this diagram, it's first of all, of course, is the

14 product one that they accept for clearing. And the

15 SEF or the trade capturing utility may already have

16 filtered for that.

17 Two, is the swap dealer. Let's imagine

18 the swap dealer was self-clearing. Are they within

19 their limits at the clearing house? Three, is alpha

20 fund within its limit set by its clearing member

21 such that the clearing member will say, I accept

22 this? I stand for this trade? And four, is

23 clearing member X also within its limits at the

24 clearing house?

25 If the CCP runs through all those checks
171

1 and those are affirmative, it sends a message back

2 to the participants, trade accepted. What I just

3 described is all known to you as ClearPort. Happens

4 in seconds, breaks very rarely, if -- very, very,

5 very rarely. That's the post-execution acceptance

6 model.

7 In the pre-execution guarantee model, the

8 counter-parties to the trade are not able to trade.

9 They're not permitted to trade unless they first

10 pass a filter that assures that they have already

11 sufficient clearing limit, and the focus in all of

12 these industry discussions for the bulk of this time

13 has been around the client, presumably the greater

14 risk.

15 So the filter, as we're going to discuss a

16 lot here, can be held at the SEF, or the limit could

17 be in principle reserved on a trade-by-trade basis,

18 and we'll talk through some of those different

19 options that would overcomplicate the diagram if we

20 had put it here.

21 But the point is that if alpha fund goes

22 to trade with swap dealer Y, if there's already a

23 facility in it in place where swap dealer Y can rely

24 on clearing member X on behalf of alpha fund, having

25 vouched for that trade, in other words, through
172

1 automation, alpha fund goes to input the trade, and

2 it passes a filter, the effect of which is to say

3 that clearing member X is going to stand for its

4 client in that trade, then swap dealer Y doesn't

5 have to worry about even the hypothetical

6 possibility that the trade would break in a

7 post-execution context.

8 And what I just described is all very well

9 known to you from, for example, and there are many

10 examples, like Globex. In effect, I think even this

11 morning it seemed there was some discussion about

12 those kinds of filters, those pre-execution filters

13 that ensure that the parties through the trade know

14 that the trade is going to get cleared.

15 The CME rules say basically, if we see a

16 match trade done in Globex, it's accepted. In

17 principle, that's because the CME -- the clearing

18 house can rely on those checks having been done.

19 And of course, CME is watching its clearing members

20 as you go along, so it knows that that trade is

21 stood for, especially when we're talking about an

22 indirect clearing participant or alpha fund, the

23 client. We know that the clearing member is going

24 to stand for that trade.

25 The -- if post-execution acceptance
173

1 operates in real time, that is, if the parties to

2 the trade know immediately whether the trade is

3 accepted, even in the post-model, then if the trade

4 is not accepted, there is no trade and there is no

5 breakage. Again, we're talking something familiar

6 to all of you in the ClearPort model.

7 However, if time were to pass in the

8 post-execution approach between execution and

9 clearing acceptance or rejection, there would be the

10 risk of breakage. The pre-execution guarantee model

11 prevents parties from even entering into the trade

12 unless there is sufficient clearing limits set aside

13 to ensure that it will be accepted.

14 However, a pre-execution model, as we're

15 bound to talk about here, creates more processing

16 steps and credit limit management complexity. The

17 -- just one big picture, market structure point, if

18 through post-trade real time acceptance or through

19 especially pre-execution guarantees, the risk of

20 breakage is eliminated, then each party is free to

21 trade with any other party and secure best available

22 pricing. Real time or guaranteed acceptance is

23 fundamental therefore, to anonymous central and

24 mid-order book trading since each participant in the

25 club doesn't know who it's trading with and needs to
174

1 rely on the framework to ensure that its trade gets

2 done. Also for the club, because execution prices

3 are displayed to the market in real time, they need

4 to be definitive.

5 Finally, real time acceptance or

6 pre-execution guarantee by eliminating the risk of

7 breakage eliminates the need for any documentation

8 between executing counter-parties that would seek to

9 allocate the risk of breakage. If there's no

10 breakage, there's no need to have documentation that

11 allocates that risk. And that in turn eliminates,

12 from our perspective, on the buy side, a huge

13 barrier to getting up and running with clearing.

14 So we have to, before we trade, exchange

15 perspectives. In terms of the big picture

16 principles that we're moving forward with in the

17 FIA, is the working group, which is a working group

18 that works by consensus. It's a bunch of folks

19 coming together with the spur, the incentive, the

20 framework of regulation, the incentive, economic

21 incentives of collectively maintaining a healthy

22 market, and also avoiding building infrastructure

23 that people won't use.

24 So there's a sort of a collective need,

25 even if we have different perspectives, to try to
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1 arrange where we can around standardized solutions

2 where we don't see competitive advantage. So in

3 that context, there's a broad consensus that while

4 the post works and is working and, you know, if

5 there was an economic crisis and I as a buy side

6 firm had a choice between not clearing or clearing,

7 we could live with that just fine. There's a broad

8 -- I'd say a broad consensus to move to pre, because

9 it will enable all forms of trade execution, all the

10 different modalities that we just touched on.

11 And how we build that requires

12 clarification on where we put the limits, where we

13 particularly house -- and we have to break it into

14 two discussions. One is where we put the customer

15 credit limits established by the clearing member,

16 and then separately, how we treat -- how we treat

17 the clearing members or self-clearing or direct

18 clearing participants.

19 Again, we're solving for something that's

20 been solved for in many other markets, so we have

21 the benefit of transposing technology and workflow

22 that exists in those with the difference, as

23 Commissioner O'Malia, you pointed out, that we're --

24 here we have a market where -- well, in some markets

25 we have multiple clearing houses, so we solve for
176

1 that. We now may have a larger group of execution

2 platforms and modalities going at the same time.

3 I don't know if you want to speak to -- I

4 mean, there has been some movement toward consensus.

5 I don't know, Paul, if you want to speak to it, in

6 the group, but then we can each offer perspectives

7 from our stakeholder positions.

8 MR. HAMILL: That summarizes it well. I

9 mean, I think you could debate this question of need

10 for pre or post all day long, and you could sort of

11 debate the idea that technology is going to get you

12 to that place where posts can happen quick enough.

13 I think however long you debate it,

14 there's a feeling from a risk standpoint by the

15 majority, as Randall pointed out, of the market

16 participants that when executing these kind of

17 trades, such as like a credit default swap, that the

18 risk of the product requires that you know you have

19 a trade at the point of execution.

20 It's just simply too much concern out

21 there that people have around doing trades and

22 finding out later that they don't exist. It's just

23 not a deep liquid market where you're perhaps just

24 going online to trade or break it or whatever. You

25 know, the market could have moved materially. A
177

1 series of events likely to occur along the lines of

2 someone having a trade rejected and a very volatile

3 market could result in big losses.

4 And I think most people involved in the

5 group are just concerned generally that the market

6 is illiquid enough. A lot of the changes that are

7 going to occur already create some risks that people

8 will leave the product or not understand how the

9 product now works. And so what we certainly don't

10 want to do is introduce sort of another layer of

11 risk which is a lack of certainty around execution

12 as an unintended consequence of the way in which we

13 choose to clear the trades.

14 So that's really been -- it may seem a

15 small point, but it's been very, very relevant to a

16 lot of the participants. And I think even if over

17 time it's fantastic if we do get to a place where

18 things happen post, I think in the initial stages

19 it's essential that we have pre -- pre-trade credit

20 checks to get people comfortable.

21 So I think we talked through a range of

22 different options. We obviously have this -- a

23 world where you could do something like a trilateral

24 where everyone would communicate a limit to each

25 other via document. That's quite complicated.
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1 Along that spectrum you have a world where

2 everyone -- you could communicate limits to all the

3 different execution venues, such as SEFs and other

4 people, which is even more fragmented and

5 complicated, or you could have -- where you

6 communicate limits through CCPs or lastly, some kind

7 of uber (ph) single central hub type model.

8 I think where the industry sort of came

9 out was on the set of CCP solution, largely because

10 people are focused on using -- you know, focused on

11 costs. They're focused on using infrastructure and

12 pipes and plumbing that exists today, focused on

13 time to market and obviously concerned with well the

14 idea of this kind of hub thing is a nice idea. It

15 only works if you only have one hub. What if you

16 have five? Suddenly you're then back to the same

17 problem where you kind of wish you were just using

18 the three CCPs, or however many it is that we have.

19 So I think there's recognition that each

20 of the solutions has pros and cons and some flaws.

21 Generally I think we've sort of gotten to a place

22 where it's a pre-trade -- pre-trade credit check by

23 and large residing with limits at the CCP, which the

24 SEFs and other sort of execution venues will be able

25 to tap into for credit checking at the point of
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1 execution.

2 MR. COSTA: And if I can just set up a few

3 vocabulary words that I know we're going to keep

4 talking about. It's the -- we talked about -- it's

5 the three Ps. We talked about post. We're going to

6 talk about ping and we're going to talk about push.

7 So the ping is the higher latency. The

8 notion would be that wherever the credit limits are

9 housed -- let's take Paul's example. Let's say

10 those limits, as with ClearPort with -- let's say

11 they're up at the CCP. An alpha fund is going to

12 trade with swap dealer Y, let's say on an RFQ.

13 Before alpha fund -- it says I'm going to introduce

14 my RFQ and I want it to go through the SEF and be

15 displayed to five dealers.

16 The way to secure this pre-trade workflow

17 in a ping model would be that the SEF would --

18 before allowing my RFQ to go through to those five

19 dealers, would ping the credit limit housing

20 facility at the CCP where it would say, hey, alpha

21 fund wants to do a trade of 10 in X, is there a

22 limit for that, yes or no?

23 And the limit housing facility having

24 stored and the limits set by clearing member X

25 dynamically changed through the course of the day
180

1 and dynamically changed automatically as automation

2 gets -- you know, is built around it -- would say

3 yes, limit lock, limit reserved. And that would --

4 and the message would go back and then the SEF would

5 allow the RFQ to go out to the five dealers and the

6 dealers would know that because it was allowed

7 through by the SEF it has that clearing member

8 sponsorship behind it.

9 The push by -- so that's fine in a higher

10 latency environment. And that means that you have

11 one little -- one pot, let's say in my example of

12 CME, CDS, credit for alpha fund established by

13 clearing member X. So you draw from that pot. It

14 goes and it reserves 10. If the trade gets done, it

15 consumes that 10. If the trade doesn't get done,

16 it's unlocked, and you could proceed all day like

17 that.

18 And that limit again, that pot could

19 change dynamically, depending on clearing member X's

20 view at any given point of alpha funds credit. If

21 instead we weren't particularly motivated by a need

22 for a lower latency, let's say we want a limit order

23 book and we don't want to be held up even for those

24 -- that round trip of the ping, then we have a push,

25 which is alpha fund says to clearing member X, look,
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1 you can keep my single pot up there at the clearing

2 house. That's good. You gave me a hundred in

3 limit. But I want you to put 40 at SEF X, Y, Z.

4 That's a cloud. So that the filter is held right at

5 the SEF.

6 And every trade as I go to enter into that

7 order, or aggress an order is -- either passes the

8 filter, or as I said before, it doesn't happen if it

9 doesn't reach it. So the counter-party on the other

10 side isn't exposed to the risks of breakage. So

11 that's the push.

12 COMMISSIONER O'MALIA: Jim, I think we'll

13 go to you and then Jeffrey.

14 MR. RUCKER: Thanks, Commissioner O'Malia.

15 Let me just preface what I'm about to say by saying

16 that MarketAxess is an electronic trading platform

17 in the credit space. So the class of swaps are

18 traded on the platform as CDS. So the solutions

19 that we build are specifically for CDS. I would

20 imagine that they're not dissimilar for other types

21 of swaps, but that's not what -- the only swaps that

22 trade on the platform of CDS.

23 We took a bold step a little while ago

24 building in pre-execution credit limit checks on our

25 platform based on what we were hearing from the
182

1 industry. We currently have two ways for those

2 pre-execution credit limit checks to take place.

3 The first of those is we allow FCMs to upload to us

4 at the beginning of the day their credit limits for

5 their clients.

6 As trades are done over the platform then,

7 when the inquiry or the order is created, we check

8 against those limits of the FCMs as they're provided

9 to us. If it passes the credit check, then the

10 inquiry can progress and the trade can be completed.

11 If it doesn't pass the credit limit checks, the

12 trade is held up at that point and it can't progress

13 any further.

14 We collect trades during the day so we're

15 monitoring the gross notional trades executed

16 against the limit and we would expect that every

17 morning we would receive new limits updated from the

18 FCM against which we would check the trades of the

19 coming day.

20 So that's method number one. The second

21 way we have of doing this is when an inquiry or

22 order is created on a platform, we have the ability

23 to message out to an FCM, or the ping method that

24 Randall spoke about that allows the FCM then to

25 confirm back to us whether the inquiry or order is
183

1 within the limits that the FCM has for their

2 clients.

3 Now obviously that second method also

4 opens itself up. Instead of limits being managed by

5 each individual FCM at the central credit limit hub,

6 it's pretty easy for us to have messaging out to a

7 central limit hub rather than messaging out to each

8 individual FCM. The reason that we built it that

9 way is to give us the flexibility, depending on

10 which solution the industry chooses to do it both

11 ways.

12 But that's essentially what we've built so

13 far. In terms of the cost of doing that, we spent

14 something in the range of $200,000 to date in

15 programming those solutions into the platform. At

16 this point, we halted development of this stage,

17 waiting to hear more about the industry feedback and

18 the work of the FIA as a group.

19 To really round out the credit limit

20 checking, we need to do some additional work. If it

21 remains along the current lines of the SEF

22 monitoring limits and reaching out to either the

23 FCMs or central hub, we estimate there's probably

24 another hundred thousand dollars of development

25 spending we need to make to really complete the
184

1 credit limit checking on the platform. So we

2 estimate the solution, when completed, will cost us

3 in the region of $300,000.

4 So that basically is what we have. The

5 one thing I would add is I think we would be

6 supportive of some industry solution that created

7 some central method after checking credit limits.

8 Now obviously there would be substantial work to do

9 if we had to create the connectivity and the

10 messaging with all of the FCMs that would have

11 clients participating on a platform. That itself

12 would create some additional work.

13 So as I say, we would be in favor of

14 finding some sort of central solution.

15 MR. COSTA: Directly responsive to that, I

16 should mention that a key work product for the FIA,

17 as to working group, is -- so the first is what Paul

18 said, which is a defined set of consensus principles

19 to the extent possible so that there is guidance

20 there. Separately though, there is a technology

21 group that is being formed literally this week whose

22 charge is to establish a messaging protocol to be

23 standardized across the industry. That's to that

24 point that -- you know, nobody, I think, sees

25 competitive tritiation in messaging protocols.
185

1 And what messaging protocol means is at

2 one level highly technical, so that all of the

3 stakeholders in that diagram can communicate

4 according to the same -- using the same language.

5 But more specifically, in alignment with the

6 principles as you work through the use cases, some

7 of which we've just described in general here, there

8 would be agreed messaging, little sequences so the

9 protocol for a ping sequence coming from a SEF to

10 the credit limit housing facility and back again,

11 would be fully standardized, so that we're

12 eliminating barriers to entry across all the

13 different SEFs, and minimizing the extent of access

14 investment around standardization that's good for

15 everyone.

16 MR. RUCKER: A standard messaging protocol

17 would clearly be a significant benefit to us in

18 ensuring that the work in connecting to all of the

19 individual FCMs was minimal.

20 CHAIRMAN GENSLER: Just one question.

21 Your hub, the document that I'm looking at, which I

22 assume is MarketSERV's. So it's Jeffrey's hub, but

23 I apologize, because Jim talked about hubs.

24 MR. MARON: We're all in this together.

25 CHAIRMAN GENSLER: What's that?
186

1 MR. MARON: We're all in this together.

2 CHAIRMAN GENSLER: That's right. To bring

3 -- to bring transparency to America. I'll wait for

4 Jeffrey, but the question that I'll have for both of

5 you is just how your respective hub or hubs relate

6 to the rules that we just finalized a week or so

7 ago.

8 MR. MARON: We can talk through that.

9 That would be great. Thank you.

10 So Randall did a very nice job of walking

11 us through and describing a lot of the issues. My

12 grandmother always said, a picture's worth a

13 thousand words. So I'll talk you through some of

14 the diagrams as well.

15 Just by explanation, MarkitSERV currently

16 is involved in the infrastructure in the industry.

17 We're the messaging system that people use today

18 from execution to clearing houses to the DTCC, which

19 is one of our parents, in terms of warehouse, all

20 the way through.

21 So we already have a good understanding of

22 what the structures are. We currently house a lot

23 of the static data that would be required to make

24 this operate properly. And we already communicate

25 with the clearing houses.
187

1 So let's just quickly through some of the

2 potential models as Randall described them. So the

3 first one is the CCP holds the limit, and in which

4 case, each FCM provides a CCP, but they provide each

5 CCP with a limit, which means if we have several

6 CCPs -- we do around the room today. We've got ICE.

7 We've got CME. We've got IDCG.

8 Each FCM would have to everyday decide how

9 much to give to each CCP. They can dynamically move

10 intraday, but they're always deciding ahead of time

11 how much line to leave each one of their clients at

12 each one of the CCPs. And as we have Eurex and

13 others that are looking to enter the market, that's

14 going to continue to fracture out the liquidity

15 that's available for clients to execute and move

16 liquidity around intraday.

17 The second is for the SEF to hold the

18 limit as allocated by the FCM, and we all know --

19 God knows how many SEFS we're going to have. There

20 seems to be more every day. We're going to settle

21 down to fewer than we have today, but even still,

22 that results in fracturing the lines that are

23 available out there, each FCM to have to manage now

24 across all the different SEFs, how much limit to

25 make available.
188

1 Going clockwise, the FCM can hold the

2 limit and do it per trade query, in which case, they

3 hold it centrally. They know in real time what's

4 available. They can view it against the futures and

5 options positions. They can do it against cash and

6 do basis, but that means that every SEF needs to

7 contact out to every FCM. And although that's been

8 done to some degree thus far for asset class, we

9 would need to have a proliferation of those.

10 The fourth choice in the lower left-hand

11 corner is the hub holds the limit, in which case

12 there's one central location for all the FCMs to get

13 together and put the limits in place for all the

14 SEFs to go to to look for those limits, and for all

15 the CCPs to come in as well.

16 So how would this actually work? What are

17 the risk measures and what are the different

18 choices? Well, the FCM could continue to calculate

19 the risk every time a trade came in. They'd have

20 the benefit of knowing the portfolio and could look

21 at this across a wide variety of options.

22 However, that adds latency in its time and

23 again has to go back to the FCM. The hub could

24 calculate it as well, and we've come up with some

25 methodologies for optimizing how this could be done
189

1 and in reducing latency. One of the things that

2 Markit -- our other parent does very well is pricing

3 of derivatives. So we have the benefit of using

4 their models, which are ready industry standard.

5 Also, the SEF could calculate it, but again, each

6 one's highly autonomous and there are quite a number

7 of SEFs that are out there.

8 So when would we reserve the line? As was

9 mentioned early, the best thing is to do it

10 pre-trade. So every time the bid or an offer would

11 be entered into a SEF, they could reach out to the

12 hub and check at that point in time. And as that

13 order moved around the market, it would already have

14 pre-trade certainty. You would know that that order

15 was good, that bid or that offer was available to be

16 executed against. And therefore, when people looked

17 at the market and looked at the SEFs for price

18 transparency to get an estimate of liquidity, they

19 would know what they could do and they would know

20 what couldn't be done. And this would work both

21 from a central order book as well as on an RFQ

22 basis.

23 Well, how would limit be calculated?

24 There are a couple different models that are out

25 there. We could do notional, but as people started
190

1 to get into spreads, got very difficult. We could

2 do it the simple basis, or what we decided to do was

3 just do a simple DV01 with a matrix. That took

4 everything down to a pretty common methodology for

5 most of the FCMs to work with.

6 What's acceptable latency? The answer is

7 almost none. So folks that were looking for it to

8 build this platform currently build and operate

9 exchange trading platforms. We're looking for a few

10 milliseconds, which means that when a bid or an

11 offer goes into the market and joins the bottom of

12 the stack, by the time it iterates up through, you

13 already know whether that trade can be done or not.

14 How do we take care of the individual

15 fund, which is a significant issue? And you guys

16 have solved that fairly recently by saying that

17 we're going to operate almost like an IB basis where

18 it will be done at the block pre-allocation level

19 and then allocation will take place later on.

20 Confidentiality? People were concerned,

21 if the FCM needs to give the line out to each one of

22 their individual clients every SEF or every CCP

23 that's out there, more knowledge is available about

24 what those lines are than some folks felt

25 comfortable with.
191

1 By keeping it in the SEF -- sorry, by

2 keeping it in the hub, that enabled only one

3 location to know what their true line was. And

4 because today we already know all the trades that

5 have been executed and no one seems to have an issue

6 with how well we're keeping confidentiality, we

7 believe that was a reasonable solution to that

8 problem.

9 In terms of failure models, as was

10 discussed earlier today by ICE and CME, people

11 already have issues with how to do this and people

12 already have come up with solutions as to how to

13 handle disconnects and other issues. We don't

14 expect this to happen very often, if at all, but we

15 need to assume that there's going to be fell over,

16 there's going to be two live systems, there's going

17 to be disaster recovery, that everything be

18 mirrored, and they all operate in real time, and

19 that's all built into the solution.

20 So in summary, what are the pros and cons

21 of a central credit hub? First, standard messaging

22 protocol. Randall's 100 percent correct, and the

23 FIA as the working group is 100 percent correct. We

24 all need to have a standard methodology for

25 communicating with each other. But if everybody had
192

1 a right to everybody else, in subtly different ways,

2 or over and over again, that sort of takes away from

3 having the standard for messaging protocol. It's

4 easier to write once -- write to one central place.

5 The cost of building the hub is less than

6 the total cost of every FCM writing to every CCP and

7 every SEF that's out there. It also enables a new

8 entrant to come into the market. So IDCG entered

9 the market. If someone else was a creative as they

10 were and entered later on, would every FCM and every

11 SEF want to be willing to write to them?

12 In the case of a hub, they would only

13 write once and everybody would have equal access to

14 them. Standard security, standard monitoring. So

15 all of the risk measures that were spoken about, and

16 in the documentation and last week's rule-making,

17 are available in there as well. There's a global

18 kill switch, so an FCM would have access to turn off

19 a particular client across all SEFs, the same way a

20 CCP would have access to turn off an FCM across

21 those trading failures.

22 Real time updates, the availability for

23 every FCM to update all their credit lines in real

24 time if they chose, or discreet points in time if

25 they chose to do that. And it's totally
193

1 independent. It's not owned by any CCP, any

2 execution venue or anybody else.

3 Cons, there's a little bit of latency.

4 It's a couple milliseconds. I'm sure some other

5 folks will come up with some other issues as well,

6 but that's the one that we hear the most and we

7 believe the trade off of having a couple

8 milliseconds of latency by getting that pre-trade

9 certainty out of the way benefits the market

10 overall.

11 CHAIRMAN GENSLER: So it's free. It's low

12 cost. It's a profit center for -- can I just ask?

13 How does it fit into the rules we just passed?

14 You're -- I'm familiar with the rules, but I'm not

15 familiar with your architecture here.

16 MR. MARON: In terms of the rules of

17 making sure that every FCM has a series of limits

18 for all of their clients, they can put the limit at

19 the hub and do it once rather than fracturing that

20 limit out. Therefore, they have greater certainty

21 that the limits that they establish and the risk

22 measures they established are all contained in one

23 place.

24 We can have the hub, and we plan to have

25 the hub send notification out to the FCM as a level
194

1 of orders builds up to a certain point. So if

2 someone were to hit orders of 50 percent of their

3 credit line, we would send a message, then 60, then

4 65 percent. And by the same token, the FCM could

5 take a look around and see how many orders are

6 outstanding by going to one place and seeing what

7 those risk managers are on a per trade basis.

8 CHAIRMAN GENSLER: I think what I'm

9 hearing is your perspective is you're trying to

10 market to the FCMs -- you didn't use that word --

11 but market to the FCMs that you could fulfill their

12 requirements that we just passed, that risk

13 management filter. They would be hiring you.

14 They'd still have the legal obligation, but you'd be

15 their survey?

16 MR. MARON: Right.

17 CHAIRMAN GENSLER: You'd be their

18 third-party vendor, but what you would be trying to

19 appeal to them is that you could do it for the whole

20 market, or at least a portion of the market, and

21 then folks who actually trade in the market would

22 have to decide, because some FCMs probably wouldn't

23 use the hubs, some would and --

24 MR. MARON: It would achieve critical

25 mass?
195

1 CHAIRMAN GENSLER: What's that?

2 MR. MARON: Hopefully it would achieve

3 critical mass.

4 CHAIRMAN GENSLER: From a business

5 perspective that's what you're -- I see.

6 MR. MARON: And then for their own, from

7 an eligibility perspective, people -- the SEFs would

8 be able to go directly to the hub and know that this

9 client can trade this instrument through that FCM

10 out to this clearing house. Because we know of

11 multiple clearing houses clearing similar products,

12 as well as a kind of equivalent products, whether

13 it's ears and swaps.

14 MR. COSTA: What the rule requires is that

15 there be either immediate post or pre-execution

16 certainty, and the pre-condition for that, going

17 back to the earlier models, is that either

18 immediately after or in advance, the trade has to

19 pass a credit filter. In respect of a customer

20 trade, the clearing member has to vouch for it.

21 So what's at discussion here is that a hub

22 is one way to try to solve for that. We do face a

23 challenge with the different role players about

24 where to put those credit limits. And it's a

25 balance between getting to market sooner,
196

1 competitive advantage, latency certainly, and who

2 has to do what.

3 So maybe to sharpen the debate and start

4 to form a little bit of a debate here with regard to

5 the hub, ultimately you've got risk, so the FCM is

6 the risk taker. The FCM's going to take risk on my

7 behalf. They're going to determine at any given

8 point in the course of a day how much limit they're

9 willing to extend to me.

10 An important distinction, and I take up

11 with you, is that there's a difference between limit

12 and liquidity. So they may decide the liquidity

13 that I have is the amount they're willing to take.

14 So JP Morgan's my clearing member. They say I have

15 100 in limit. The challenge for me across different

16 clearing houses, let's say -- let's go to the ICE --

17 the energy example today. I clear in two clearing

18 houses. My clearing member has to manage that

19 unitary 100 limit across those two clearing houses.

20 Now the liquidity I have with my clearing

21 member is 100. The limits they may prescribe for

22 me, which are held today at the clearing houses, may

23 be more, because they know how I trade. They know

24 me. They know that when I go into a given market I

25 score on one out of 50.
197

1 And they get to know you over time and

2 they determine a limit that will always keep me from

3 blowing my actual 100 limit, but will allow me to

4 trade within that. And they certainly are prepared,

5 as they do today, to dynamically manage between

6 those two clearing houses.

7 We should add that any such system -- and

8 this ties to other aspects of the rules and was

9 alluded to here -- has to have certain safeguards,

10 that if there are larger limits than the actual

11 liquidity that my clearing member wants to give me,

12 there need to be safeguards at the SEF level. So

13 this is part of the build for the SEFs, and I think

14 they're all attentive to this, but it does need to

15 be finalized as we go forward.

16 Fat finger, a lot of this stuff you saw

17 for the very high velocity markets this morning need

18 to be built in for our lower velocity today. Fat

19 finger checks, maybe size limits. The kill switch

20 is critical. If we've got a kill switch that's a

21 critical safeguard for FCMs, and also for clearing

22 houses in the event one of their FCMs starts to

23 wobble, then there need to be heartbeat monitors

24 that ensure that from SEF to clearing house, there's

25 never a lost connection, because if they hit the
198

1 kill switch, they know it has to work.

2 So those are all aspects actually of the

3 messaging protocol. But what the industry would

4 decide as the most efficient place to put the credit

5 limits is very much an open question now in going

6 forward how we do that.

7 COMMISSIONER O'MALIA: Jeffrey?

8 MR. MARON: If I could. I think you raise

9 a very good point, and I think the world as it

10 exists today has certain mechanisms for trading,

11 because you go to the voice broker, you might go to

12 three or four voice brokers and put an offer into

13 each of them. And as soon as the first one takes

14 that offer you'll call yourself off the others, and

15 you're only exposed really -- you're exposed in

16 three different voice brokers, but only

17 realistically you're going to get it done in one.

18 However, the new ecosystem for swaps,

19 we're executing through SEFs and electronic

20 platforms. People are building arrogation platforms

21 to then take the liquidity from all of those SEFs

22 and arrogate it together. So the likelihood of

23 someone getting swept and having all of their orders

24 getting executed immediately is now much higher than

25 it was in the voice broker world.
199

1 A number of FCMs have mentioned to us the

2 concern about assuming that some of the trades will

3 get done and some won't. They are very much

4 concerned until we actually see how the ecosystem

5 works and how things shape themselves out, that in

6 the beginning they may end up having to allocate

7 more credit line than they expected to because

8 people do get swept, and all of their orders were

9 executed rather than just the first one at the first

10 voice broker. Now all three can get done instantly,

11 and they won't have the opportunity to cancel the

12 other two.

13 MR. COSTA: But let's be clear. We're not

14 in a high frequency central limit order book world

15 today. It's a fair point. We need to plan for it.

16 That was this morning. I mean, we'll get there, I

17 hope. I was actually thinking it would be great if

18 in a year we have this morning's presentation for

19 these markets, but we're not there yet.

20 And the -- there's an important thing to

21 realize. We don't even have any functioning central

22 limit order books for the buy side today. When we

23 get there, there may be one or two, but the whole

24 rest of the market is likely to move step by step

25 through block trading, voice trading and RFQ.
200

1 MR. HAMILL: If I can make a point. I

2 think that a lot of these points are really good

3 points. I do think though the market will change.

4 I mean, today if you think about maybe the

5 investment index market, we make like 250 up

6 markets, right? I don't see a world where we're

7 making 10, 250 up markets across 10 SEFs and 10 live

8 order books. It just won't happen.

9 So I think a lot of people have speculated

10 that available trade sizes on platforms will go

11 down. I would say that's one consequence we would

12 expect to see. So I think it's a valid concern, but

13 I think there's ways people can react to -- I mean,

14 no one is going to hang themselves out there to get

15 lifted on 2.5 billion -- you know, if someone finds

16 some way of doing that. It's just people will

17 protect themselves.

18 So I think that's a concern, but I think

19 there's a way in which people adapt to the

20 electronification of the market and won't try to

21 trade exactly the same way as they do today to

22 protect themselves.

23 COMMISSIONER O'MALIA: Can I ask you a

24 question? To Jeffrey's point, whether it's 2.5

25 billion or 5 million, I mean, nobody's going to want
201

1 get lifted on multiple.

2 MR. HAMILL: I think it will depend -- I

3 mean, I don't know the answer to that question,

4 because we've never lived in a world where there are

5 10 SEFs, or whatever it might be. But we're

6 probably going to want to have our markets out on

7 multiple venues, that's for sure.

8 And if some of those venues operate any

9 live environment, which some of them will, because

10 some of the products kind of already do, like the

11 indices, then I don't think we'll have a choice. So

12 I think it is definitely a concern. We haven't yet

13 really begun to sort of think about, or I don't know

14 if something that the industry themselves can

15 answer. I don't know if it's more of a regulatory

16 question.

17 But we foresee a world where we will have

18 live markets on multiple venues and in theory could

19 get lifted at the same time and the same product in

20 multiple venues. And I don't know how we -- one way

21 in which we sort of protect ourselves from that.

22 It's just the size that we show up.

23 But that's a natural -- I'm not saying

24 that's a bad thing that you show a smaller size. I

25 think some of the SEFs will likely create -- well,
202

1 two things will happen. Some of the SEFs will

2 likely create sort of iceberg workup type trading

3 functions, is my guess, so that people can show

4 smaller size.

5 COMMISSIONER O'MALIA: Is this another ICE

6 product?

7 MR. HAMILL: No. Sorry, just a

8 coincidence, although I think they have one. But

9 no. What I mean by iceberg is you show a smaller

10 size than what you're -- than what you really want

11 to trade. So there's the opportunity to do more,

12 and somehow that is only discovered at the point of

13 execution.

14 Equally we're all spending time and money

15 building technology so that when we do get hit or

16 lifted on a particular platform we can pull our

17 liquidity off of other platforms. And again, I

18 think that's -- that's not a new feature that we

19 deal with.

20 COMMISSIONER O'MALIA: Chuck, an ICE

21 product that is being offered that was announced

22 down at Boca, I think, is your Plus One solution.

23 Do you want to mention that? I would like to get

24 industry input on this one. I've got a couple other

25 questions, but I'd really be interested to hear kind
203

1 of the industry comment on this debate.

2 MR. VICE: Sure. Sure. We -- and we had

3 to give it a name, because otherwise it was this

4 thing we're trying to refer to. But this Plus One,

5 ICE is a active participant and the FIA is the group

6 that Randall was referring to, and so we're -- as is

7 CME and other CCPs, and we've all been struggling

8 with this ping versus push versus hub versus very

9 complicated solutions, kind of gold-plated solutions

10 with a lot of moving parts, and I think from our

11 point of view, operational risk.

12 We've gone into it with the same

13 priorities as everyone else, trade -- everyone wants

14 to have as much execution certainty as possible.

15 The FCMs want to be as fully protected as possible.

16 We all want as low latency as possible. But I think

17 for us, we also want -- we have two other

18 requirements. There's little operational risk

19 introduced as possible. And we also have some tight

20 deadlines to meet. We can't be -- we don't have

21 three years to build this.

22 We're big fans of phase one, phase two,

23 phase three type of approaches to things. So for

24 us, what we -- what Plus One was all about, and I

25 can get into the details of that, if you want. But
204

1 we've put out a lot of information about it. But I

2 think in a nutshell, we've said as a CCP, regardless

3 of whatever else SEFs and hubs and the industry

4 does, they're certainly free to do and expect them

5 to do.

6 But as a CCP, we're going to have customer

7 level limits that FCMs will set for their customers

8 that we will maintain, and as executed trades come

9 to us from SEFs or other sources, we will check both

10 sides of that trade against that limit, accept it,

11 do all the messaging you would expect, let them know

12 that we accepted it.

13 And each FCM would set a threshold on each

14 account and the first trade that puts them over that

15 threshold will take that trade, so there's certainty

16 of that trade. But we send a message out to all the

17 SEFs that that account is essentially disabled until

18 further notice or further trading.

19 So what we've tried to do is minimize as

20 many moving parts. And this is not rocket science.

21 I think as someone said earlier, there's variations

22 of these things out there. And then going forward

23 we as a CCP may enhance that solution to have more

24 pre-trade capabilities than that initial version, or

25 it may be that the FCMs, working with third parties,
205

1 or FCMs working directly with SEFs, adopt one or

2 more of those models you saw up there to achieve

3 whatever last narrow remaining piece of pre-trade

4 certainty that they want to have.

5 I think part of our view is formed by the

6 fact that we have operated OTC execution platforms,

7 central limit order books in fact, very -- with high

8 frequency traders in them, with pre-trade limit

9 checks in --

10 CHAIRMAN GENSLER: It does work, doesn't

11 it?

12 MR. VICE: -- for 10 years. It does work,

13 which is good. I know that's where these guys want

14 to get to, and we do as well. But we also know that

15 the experience behind that is it's rarely -- very,

16 very rare. I mean, far less than .1 percent less

17 than that, that an order is actually rejected

18 because it hit a limit.

19 So I think in terms of the 80/20 rule and

20 tight deadlines, we take that experience and say,

21 let's not build this complicated system to deal with

22 the .001 percent of the time. Let's get something

23 out that allows the 99 percent to happen

24 efficiently, and it gives us more time as an

25 industry to work on more complicated solutions to
206

1 better handle higher frequency trading and interest

2 rates, credit and some of these other markets.

3 That's what Plus One was all about.

4 MR. O'CONNOR: I think it's important to

5 remember that the markets that we were talking about

6 this morning exist in a vertically, integrated,

7 exclusive arrangement, and I think that's not what

8 we're talking about with a swap market and that

9 creates a lot of complication.

10 I think with regard to this debate, and I

11 know that the groups working on it have concentrated

12 on this issue, and that is, the cost of going from

13 instantaneous or near instantaneous post-trade

14 acceptance to pre-trade certainty, the cost of

15 making that very small leap is significant, and I

16 think it's important that we think about what

17 benefit are we getting from taking that extra step,

18 because the costs are -- the costs are substantial.

19 And I think we heard a little bit about

20 where those costs come in, and they come in in two

21 different ways. Number one, we're having to build a

22 whole new set of infrastructure that's going to have

23 to be funded, and it's not trivial infrastructure.

24 It's a complex machine. And number two, any time

25 that you ask either a clearing house or an FCM to
207

1 extend its resources, its limits beyond its own four

2 walls, that they get hair cut. There's just no way

3 around it.

4 We heard about various limit monitoring

5 systems. We heard gross notional and we heard of

6 DV01 matrix. Now I can see how they work from a

7 latency perspective, but there is no operational OTC

8 clearing house who monitors their risk in that way.

9 They use far more complex ways of monitoring their

10 risk, which are higher latency.

11 So in order to expose ourselves, expose

12 our resources to that type of environment, we have

13 to hair cut them. There's no way around it. So you

14 reduce the limit resources available in the system

15 and you increase the cost of transactions by making

16 a very small leap in terms of instantaneous

17 post-trade certainty to pre-trade certainty.

18 MR. HAMILL: Maybe -- I mean, looking at

19 it from perhaps an execution side of looking at the

20 product, I mean, I don't -- I don't think anyone --

21 we talked about this in the industry group at

22 length. I'm not sure anyone really thinks there is

23 a question around that.

24 I think the tradeoff of some kind of

25 operational cost versus introducing meaningful risk
208

1 to the product that could damage the product isn't

2 really a tradeoff. I mean, today you have a product

3 that when you trade it, it is done. If you move

4 into a world where you don't have pre-trade checks,

5 you have a product that you trade it and then you

6 wait and see.

7 I'm not saying it couldn't be very fast,

8 but you've changed the way the product works and you

9 need to change what people think about managing risk

10 around it. So from a risk standpoint, I don't know

11 anyone who thinks that that's a simple question of

12 just operational latency and cost. I think everyone

13 sees it as a risk question.

14 MR. O'CONNOR: I disagree entirely. I

15 think -- I don't --

16 MR. HAMILL: Then you disagree with

17 everyone who's in that group basically.

18 MR. O'CONNOR: No.

19 MR. COSTA: I'll try to speak the middle.

20 I think the bulk of the buy side actually aligned

21 with more what Garry said. But looking forward and

22 wanting to support efficient electronic trading, we

23 are very supportive of, well, first of all, the ICE

24 model, because that gives that increment of

25 reassurance. Or ultimately pre-trade, because
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1 that's what will enable central limit order books,

2 very simplistic.

3 Now, it seems to me as we walk before we

4 run, the bulk of trading that's going to be done in

5 the next six months or nine months, will be much

6 higher latency. We could manage with a slower

7 process, including a slower pre-trade, if we start

8 to move to central limit order books. Whatever was

9 said before as a customer, I'm happy to be

10 fragmented.

11 So if there's a SEF that's a true central

12 limit order book and latency matters, then take a

13 piece of my single pot, even my post-pot, and go

14 ahead and push it up, haircut me so that I can take

15 the latency. And then I don't want any intermediate

16 steps. I don't want to wait even a little bit to go

17 check somebody else, but only when we get there.

18 MR. O'CONNOR: But it's only required if

19 you get there.

20 MR. COSTA: Yeah.

21 MR. O'CONNOR: Let me finish my point

22 before I upset everybody in the industry. And that

23 is that the way that it works today, I think is what

24 happens is at the time of transaction, there's a

25 contemporaneous process of credit check. Now from
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1 the outside looking in, that may feel like pre-trade

2 certainty, but it's not necessarily pre-trade

3 certainty. A trade may -- a trade may not be

4 executed because a limit is not available.

5 Now is that -- you know, in the brave new

6 world, is that instantaneous post-trade approval or

7 is that pre-trade certainty? It's not clear to me

8 that it's one or the other.

9 MR. DURKIN: I just wanted to echo some of

10 the comments that Chuck said earlier. I mean, we

11 should not dismiss the models that have been in

12 place for sometime that deal with both, I think

13 effectively post- and pre-trade credit checks. And

14 so when we talk about going down maybe a slightly

15 different path, you also have to look at what has

16 been put on this industry in general in terms of

17 operational readiness and the timelines to be able

18 to get all of this accomplished.

19 And so while we're all very sensitive to

20 trying to get to that ultimate end, I do think we

21 shouldn't dismiss what's out there today and what is

22 working very well as we move towards that direction.

23 MR. HAMILL: I feel like I'm the only one

24 arguing though for the pre-trade check, but maybe

25 I'll just reiterate. I don't think because it's
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1 easier to have a post-trade check that you do that

2 and give away safety. Like that just doesn't seem

3 to me like a sensible trade that anyone would make.

4 And I think whatever anyone would say

5 about what that group concluded, there was a large

6 majority of that working group, including buy and

7 sell side, who would rather have a pre-trade check.

8 That's not to say people don't recognize there's

9 hair in getting it done and it's complicated and

10 it's hard. But if you ask someone, pretty much

11 anyone who trades credit default swaps, for example,

12 at the point of execution, would you rather know

13 then your trade is done or would you rather wait a

14 little bit of time? The answer is, I'd rather know

15 my trade is done.

16 But the question is, how do we achieve

17 that? And no one's saying that's easy, but it's not

18 a simple question of -- there's no value in it, so

19 let's just look at what we have today.

20 CHAIRMAN GENSLER: Can I ask this? How do

21 you read the rule that we just finalized if we said

22 futures commission, everybody's sort of entering

23 into a cleared trade has to have a futures

24 commission merchant guaranteeing them? Isn't that

25 in essence saying it's -- I mean, at least the FCMs
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1 on the hook? Whether the FCM is checking pre or

2 post, the FCM is on the hook so that you can have

3 anonymous trading and let's hope that the FCM is

4 managing it in a way -- not more than hope, but that

5 they really are managing in a way that works.

6 MR. HAMILL: Go ahead.

7 MR. COSTA: I would say -- I was actually

8 -- and this is part of the -- let's call it the

9 dialectical synthesis in the sense that on -- the

10 greater risk in theory is on the customer side. So

11 I think we would agree that if -- and it's a less of

12 a lift for the FCMs to stand for their customer

13 trades, including through even a ping. We're

14 hearing that from the SEFs. We're hearing that from

15 the FCMs.

16 Where it gets -- where we really would be

17 trying to revise the world would be to ask CCPs to

18 put pre-execution limits out against their FCMs.

19 MR. MARON: And I think this is an

20 evolutionary process. We're not looking to go whole

21 hog and get to the end stage immediately. We would

22 like to get to pre-trade certainty and have that

23 pre-trade credit check, and it's going to take for

24 us all to get there. But the FCM has to know about

25 that order that was put in in order for them to
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1 stand behind it. And they can either do that by

2 having each of the SEFs tell them about it, or a hub

3 or somebody else tell them about it.

4 But otherwise, how do you get them to

5 stand behind a trade that they're not aware of until

6 after it's gone through the clearing house?

7 CHAIRMAN GENSLER: But I'm gathering that

8 you do interpret the rule that we just finalized,

9 that everybody's got to have an FCM standing. So

10 thus, if you enter a market anonymously, and you

11 don't know who's on the other side, but you know by

12 force of some law that the party on the other side

13 has to be guaranteed by an FCM.

14 MR. MARON: Yes.

15 CHAIRMAN GENSLER: I mean, that helps the

16 clearing houses.

17 MR. HAMILL: I think we're just talking

18 here about the practical implementation of that,

19 right? For an FCM to get comfortable with that,

20 they have to put that limit somewhere and be sure

21 that trade is being read against that limit. I

22 think that's what we're effectively -- I think

23 everyone agrees that's the best -- that's how the

24 central limit order book needs to work.

25 MR. COSTA: I think the one section of the
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1 rule would certainly accommodate ClearPort, in the

2 sense that it's real time automated acceptance that

3 would potentially be post.

4 CHAIRMAN GENSLER: But the FCM still has

5 to stand behind it?

6 MR. COSTA: Yes.

7 CHAIRMAN GENSLER: I was talking about the

8 FCMs. I recognize you're talking about the clearing

9 houses, but I was talking about the FCMs.

10 MR. RUCKER: I just wanted to add a point

11 on the practical implication of this, in my view is

12 that way or another, the industry does need to reach

13 a consensus on the way this is happening, because

14 from a trading venue standpoint, and as hopefully a

15 SEF, what would be hardest is if we end up with all

16 these different models we've talked about operating

17 in different circumstances. That, I think, would be

18 very costly and very inefficient to the industry.

19 My personal view is that all of the

20 solutions we've talked about could work to ensure

21 that we get a clearing certainty, a point of

22 execution. But what we do need to decide as an

23 industry, what is the method we're going to follow?

24 Otherwise, we really will create a lot of additional

25 cost.
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1 MR. HAMILL: To that point, I would say, I

2 think, from a UBS standpoint, being both an FCM and

3 execute, there may be -- there may be people who try

4 to set up different models. I think the market will

5 find its own equilibrium. I would not envisage we

6 will trade on a SEF without a pre-trade credit

7 check. Just couldn't see that working. I wouldn't

8 envisage that as an FCM we would just waive trades

9 in not based on some sort of limit that we have for

10 these kind of products.

11 So it will sort of self-police itself,

12 because if someone goes out there and says yeah,

13 hey, I'm setting up this SEF, it's a essential on

14 the order book, there is no pre-trade limit check,

15 we're going to check after the fact, and then

16 someone else says, I'm going to set up a central

17 order book, I'm going to require that somehow you

18 post your limit to me and ICE is going to give me a

19 venue to do that and I'm going to push it out there,

20 and I know -- and they know what the point of

21 execution that trade is done, and I can immediately

22 read as an FCM how much of my limit is being used,

23 that's how the market's supposed to work.

24 So I think we will go to the venues that

25 operate the way -- that make the most sense from a
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1 risk standpoint for our firms. That's how I think

2 that stuff polices -- I don't think we'll get to a

3 single standard. I think that's obvious from some

4 of the discussions we're having today actually.

5 CHAIRMAN GENSLER: Randall, can I ask you

6 a question about your earlier chart? You happen to

7 have in the box trade execution central and

8 mid-order RFQ, voice, and I was just curious, does

9 anything on this chart differ between those three or

10 are you sort of neutral? Because you put all three

11 in the box.

12 MR. COSTA: Does it differ in the sense of

13 how we address the limit?

14 CHAIRMAN GENSLER: Or all of this sort of

15 the financial integrity of trades.

16 MR. COSTA: In terms of pulling, a little

17 bit potentially in the sense that -- I'm sorry, I'm

18 still struggling a little bit about your earlier

19 question that the rule-making. I think would still

20 allow a ClearPort like structure even in the sense

21 that it doesn't -- the trade does not have to pass

22 to be within the rules. An FCM pre-existing limit

23 filter, it could be done first and then within real

24 time accepted. It's a fine point, but it becomes

25 relevant to the voice trade context.
217

1 Am I being clear?

2 CHAIRMAN GENSLER: That's all right. It's

3 the plumbing and the plumbing, so I'll try to catch

4 up later.

5 MR. COSTA: The issue with voice is this.

6 In the world -- there will always be -- like block

7 trades, right? There will be voice trades, like on

8 Globex today, we have a huge liquid trade.

9 CHAIRMAN GENSLER: Actually, I'll say --

10 as I've said over and over again, block trades,

11 absolutely.

12 MR. COSTA: Yeah, they will happen. So

13 the thing is, we say done -- Paul and I say done off

14 an RFQ. So there's no way as we're doing -- we're

15 talking this through on the phone normally, that we

16 -- we'll get there, but normally we would do this on

17 the phone, and then we would input it into a trade

18 capture facility.

19 And the way it would be processed, as I

20 understand it even today, I'm looking over at Bryan

21 at CME, it's like ClearPort. It's immediate post

22 acceptance. It would hit the filters, both my FCM

23 filter and my CCP checking, that it's within the

24 FCM's limit. And from my perspective, that will

25 work fine forever. It worked for futures for a long
218

1 time.

2 If you are -- if you want perfection and

3 you want pre-execution certainty even on the voice

4 trade, we can give that to you too, by leveraging

5 the same infrastructure that we're talking about

6 here. In principle market access, could -- let's

7 say there's a trade that -- you know, I could do a

8 trade and I could do an RFQ. It's going to pass

9 through our ping filter or the push, and it's going

10 to go to file. But I've got a blocked trade. And I

11 agree with Paul; we could in theory leverage the

12 same infrastructure and run it through.

13 We could put in the trade to one, because

14 it was blocked. It didn't have to go to five. It

15 goes to one. But before it goes to Paul via

16 MarketAxess, it passes the credit filter. So he

17 really wants that thousand percent certainty that

18 there's no risk, that he breaks between the time we

19 say done and the two seconds that the clearing house

20 delivers the message back; you could have it that

21 way.

22 And it isn't -- I don't think anyone built

23 it, but it's not hard since everyone is busy

24 building what MarketAxess set up. And we have

25 certainly talked about that in the FIA as to form.
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1 That's the only difference I see.

2 CHAIRMAN GENSLER: So you're saying in

3 voice, or at least the voice you're identifying,

4 which is a block, it's for a few seconds bilateral.

5 Because it's not anonymous. You know it's Paul.

6 Paul knows it's you.

7 MR. COSTA: Yes. It's not anonymous.

8 It's between the counter-parties. We would say

9 done, but we're intending to do a clear trade. If

10 we're in a mandatory cleared world, there's no

11 bilateral trade that gets converted to a cleared

12 trade. We're doing a cleared trade, but it hasn't

13 -- it's subject to acceptance and it hasn't been

14 accepted for the time it takes for the two of us --

15 if we were using a trade capture utility like

16 MarkitSERV or ICE Link or VCON, he'd type in the

17 trade and I'd type in the trade at the same time.

18 The trades would match immediately, just

19 like with ClearPort, and as long as they align,

20 there weren't an exception kickback, we'd fly to the

21 clearing house, run through the ClearPort checks and

22 pop back. And by the time basically we got done

23 typing and took a breath, we'd have an accepted or

24 rejected message back.

25 The buy side view generally is that if
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1 somehow it was in that .0001 percent of being sort

2 of rejected because I was stupid enough to blow my

3 limit and not watching my fuel gauge, Paul knows who

4 I am. He can say, oh, it was you. I know you're

5 okay, or I'm walking, you know, I'm just walking

6 from this trade. And I think that's the way the

7 energy markets have worked and the way futures block

8 trades work.

9 We don't sue each other. We don't need

10 execution documentation to get this done. But there

11 are other -- there are folks who are very concerned

12 even about that instance. And we have a

13 technological solution to it. It's MarketAxess

14 leveraging or MarkitSERV, as a middleware or trade

15 capturing utility could in theory plug into credit

16 limit pots as well and deliver the same

17 functionality, or the CCPs could offer it.

18 ICE, I think we've talked to ICE about it,

19 or CME. They could similarly offer just like they

20 have ClearPort today, or ICE Link today. I could

21 just go to ICE Link and there could be a screen that

22 would function as if it were ICE Link supporting

23 credit techs or supporting a SEF.

24 MR. HAMILL: I think it's actually quite

25 simple. You have one risk limit and you kind of
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1 have three ways of trading. You're either trading

2 on a limit order book or you're trading on a screen

3 using a request for call or you're trading by voice.

4 It doesn't really matter which one of those you're

5 doing.

6 You're sort of doing the same thing and it

7 just -- it's just more like a slow motion version of

8 it as you -- on the central limit order book. It's

9 already there and it's done. On the RFQ, it can be

10 done. The limit could be checked as the RFQ is

11 launched. And the voice is very similar to an RFQ

12 trade. Sort of by voice trade, someone's calling

13 you. There's a period of time. You give a price.

14 I think what's more complicated about the

15 voice trade is where is it that you're going to look

16 for the limit? Where is that limit exposed to?

17 Does the clearing house do it through a front end,

18 or do we check in on a SEF, or whatever it is?

19 But again, that's not hard. It's just a

20 decision and it's also a competitive one that I

21 think people will be continuing to try to build the

22 best mousetraps for. I mean, it's my view that the

23 -- you know, the risk managers will set up the

24 clearing house and/or the MarkitSERV hub and if they

25 want to be successful, they will offer a feature
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1 that does something like this, so that people can

2 get pre-trade certainty on voice trades as well.

3 I don't know that it's all that different.

4 COMMISSIONER O'MALIA: How long is it

5 going to take to get to the ideal world of having it

6 all plumbed and wired? I think our rule says

7 October 1 of this year.

8 MR. COSTA: I just want to -- I don't

9 think -- I think you've heard a number of us say we

10 don't need to get to the ideal world. You've heard

11 some real full ideals expressed here. What we need

12 to get to by October 1 is a standardized messaging

13 protocol. We need to, ideally, if we can, align

14 around risk measures for asset class. That would

15 certainly make the FCM's task easier and the CCP's

16 task easier. But if we didn't, it wouldn't be the

17 end of the world.

18 We need the SEFs, if they're active, to

19 build the ping, or if elected, the push. And to be

20 prepared to activate or handle the safeguards that

21 we talked about that are intrinsic to the system,

22 and also required in the rule-making.

23 We need the FCMs to finish the limit

24 automation that they've already undertaken with

25 respect to their individual customers. And then we
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1 need the CCPs to build their Plus Ones effectively,

2 or their equivalents. I've heard all of those

3 stakeholders in my discussions with them say --

4 you've got a bunch of them around the table, that

5 they're prepared to do that for us to get up and

6 running.

7 When we go more high velocity, then we

8 want to intensify the robust -- the strength of the

9 infrastructure to handle that lower latency.

10 MR. MARON: And there are interim steps

11 that as was just mentioned, already in place. We

12 won't be able to achieve that by October for the

13 hub. We'll have it shortly thereafter, the next

14 generation credit.

15 CHAIRMAN GENSLER: Bryan, did that sound

16 like the -- right roughly?

17 MR. DURKIN: Yes.

18 CHAIRMAN GENSLER: Paul, just because

19 earlier you peaked my interest on something. How

20 many SEFs do you think there might be, you know,

21 assuming we do our thing and actually finalize the

22 rule this summer?

23 MR. COSTA: Per asset class.

24 CHAIRMAN GENSLER: No, no, no. Our bet's

25 a little broader.
224

1 MR. HAMILL: Twenty-five. That's a real

2 number. I'd say about that.

3 MR. COSTA: You mean worldwide or U.S.?

4 MR. HAMILL: SEFs are global then?

5 MR. COSTA: Because I count 14 now that I

6 -- on my list.

7 COMMISSIONER O'MALIA: I just want --

8 Cosgrove said there's -- he was a buyer at 100.

9 MR. COSGROVE: That was until I saw the

10 SEF registration form.

11 COMMISSIONER O'MALIA: We're just trying

12 to help.

13 MR. COSGROVE: You are helping.

14 MR. HARRIS: Thirteen SEFs have already

15 signed up with NFA for -- 13 institutions have

16 already signed up with NFA for regulatory services

17 and I think it's going to be upwards of that.

18 MR. COSTA: But I think -- if I can

19 contextualize, if not all of those are all asset

20 classes, and very few of them are central limit

21 order book. I think that's important to appreciate

22 as we look at this discussion and decide what

23 milestones we need to hit when.

24 MR. MARON: I thought most of the newer

25 SEFs that were out there are all central limit order
225

1 book and all the IBs that are offering their

2 platforms are all central limit order book. I think

3 there are a few people today who do dealer client

4 very well, like MarketAxess, that will offer RFQ

5 potentially, a central order book as well, if we're

6 not -- as they choose as the rules go through.

7 But I would be a betting person on the

8 side of more central order book rather than less.

9 CHAIRMAN GENSLER: It somewhat depends on

10 how we finalize. How we propose is everybody has to

11 at least facilitate live, actionable ammo. So

12 executable quotes, bids and offers with full market

13 access, or impartial access, as Congress said.

14 I understand that Commissioner O'Malia is

15 about to wrap up, so I just wanted to thank

16 everybody. I think this is just really a terrific

17 set of advice, advisors. I haven't seen what the

18 smaller groups are doing with Andrei, but I think

19 our Commission all benefits and the public benefits.

20 We have a lot of work in front of us and

21 as these markets move and change, the technology

22 component is critical. So I thank you.

23 COMMISSIONER O'MALIA: Any other final

24 thoughts of TAC members, panelists? Let me thank

25 you all very much. I want to thank our teams that
226

1 help set this up. Margie Yates and her team. We

2 have the AV team that makes all of this work.

3 Cornelius Sessions, Michael Jones, Gene Robinson,

4 Joshua Griffin.

5 I want to thank my staff, Laura Gardy,

6 Carl Kennedy, and Nancy Schnabel for their help.

7 Obviously all of the people with the General

8 Counsel's Office that -- and all of our staff

9 assistants that will be helping out on the working

10 groups.

11 I also want to -- just kind of a

12 housekeeping matter. All good things must come to

13 an end. The TAC Committee is no different. But

14 it's only version 1.0. TAC 2.0 will be -- we have

15 to renew the charter. The charter expires in June

16 and I will renew it. I will renew -- obviously

17 there will be seemless transition for the ATS and

18 HFT.

19 I'm interested in what more work the Data

20 Committee is interested in doing, and I'm certainly

21 interested in the full committee's -- and we will

22 renew it and if you're interested in participating

23 again on the next one, 2.0, let me know. Those who

24 you think would be good candidates, let them know.

25 I'd also like to know about different topics, as
227

1 well, what do you think would be useful for us to

2 attack and address going forward?

3 So this is a useful process. I've

4 benefitted a lot in the brief two years that we've

5 done it. We've got a lot of work out of you all and

6 I greatly appreciate it. And so we'll renew this

7 again, chairman willing, of course.

8 CHAIRMAN GENSLER: Commission willing.

9 It's a Commission, General Services Administration,

10 things like that. But it's been highly beneficial.

11 COMMISSIONER O'MALIA: Good. So to that

12 end, we will keep going. Let me know if you're

13 interested in serving again and we'll move from

14 there.

15 Again, let me thank everybody for their

16 time, their effort to participate and to support

17 these groups and to support the Commission. It's

18 very beneficial. So thank you very much for coming

19 today and thanks for your participation. Thanks.

20 (Whereupon, at 4:14 p.m., the meeting was

21 adjourned.)

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