UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 OPEN MEETING ON THE SIX SERIES OF

 PROPOSED RULEMAKINGS UNDER THE DODD-FRANK ACT

 Washington, D.C.

 Wednesday, December 1, 2010
 2

 1 PARTICIPANTS:

 2 Commission Members:

 3 GARY GENSLER, Chairman

 4 BART CHILTON, Commissioner

 5 MICHAEL V. DUNN, Commissioner

 6 JILL SOMMERS, Commissioner

 7 SCOTT D. O'MALIA, Commissioner

 8 Presenters:

 9 PHYLLIS DIETZ

 Division of Clearing and Intermediary

 10 Oversight

 11 ANANDA RADHAKRISHNAN

 Division of Clearing and Intermediary

 12 Oversight

 13 JONATHAN LAVE

 Division of Clearing and Intermediary

 14 Oversight

 15 JAKE PREISEROWICZ

 Division of Clearing and Intermediary

 16 Oversight

 17 NANCY MARKOWITZ

 Division of Market Oversight

 18

 NADIA ZAKIR

 19 Division of Market Oversight

 20 SARAH JOSEPHSON

 Division of Clearing and Intermediary

 21 Oversight

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 MARK FAJFAR

 Office of General Counsel

 3

 DAN BERKOVITZ

 4 Office of General Counsel

 5 * * * * *

 6

 7

 8

 9

 10

 11

 12

 13

 14

 15

 16

 17

 18

 19

 20

 21

 22
 4

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

 2 (9:30 a.m.)

 3 CHAIRMAN GENSLER: This meeting will

 4 come to order. This is a Public Meeting of the

 5 Commodity Futures Trading Commission to consider

 6 issuance of the following proposed rules under the

 7 Dodd-Frank Act. We have two rules related to

 8 clearinghouses, one related to legal and

 9 compliance matters and a second related to

 10 recordkeeping and reporting. Thirdly, we have

 11 rules and guidance related to designated contract

 12 markets. Fourthly, recordkeeping and reporting

 13 relating to swap dealers. And fifthly, the much

 14 talked about and anticipated joint proposal with

 15 the Securities and Exchange Commission with regard

 16 to entity definitions.

 17 Before we hear from staff, I'd once

 18 again like to thank Commissioner Mike Dunn,

 19 Commissioner Jill Sommers, Commissioner Bart

 20 Chilton and Commissioner Scott O'Malia for all

 21 their thoughtful work to implement the Dodd-Frank

 22 Act. I probably owe them a debt of gratitude but
 5

 1 a bit of an apology for even scheduling the

 2 meeting right after Thanksgiving break because

 3 everybody has thoughtfully done their best to look

 4 through these documents but doing it through the

 5 Thanksgiving holidays and into this week was quite

 6 -- I also wanted to wish both Commissioner O'Malia

 7 and John Riley, our Director of Legislative

 8 Affairs, a happy birthday. I don't know what it

 9 means that John Riley and Scott O'Malia have the

 10 same birthday, but it's probably something cosmic

 11 or otherwise, and I think we're going to have some

 12 cupcakes a little later too. I didn't bake them.

 13 You can thank me for that too.

 14 I'd like to welcome members of the

 15 public, market participants, members of today's

 16 meeting as well as those listening on the phone

 17 and the webcast. This is our sixth meeting to

 18 consider Dodd-Frank rulemakings. Before we turn

 19 to the staff for their recommendations I'd like to

 20 chat a little bit about the agenda going forward.

 21 We have two more meetings scheduled for December.

 22 I think they've been already Federal Register
 6

 1 noticed for December 9 and December 16. In

 2 addition, we now anticipate that we'll have at

 3 least two meetings in January and we'll sort

 4 through those dates. I think your offices know

 5 what we're trying to get to on the dates. And

 6 we'll of course as we have been doing announce the

 7 topics of each of those meetings as we get I think

 8 7 days in advance of each meeting.

 9 In addition to the public meetings,

 10 these four rulemaking meetings that I've just

 11 mentioned, two in December and two in January, we

 12 have two more staff roundtables. One is tomorrow

 13 on disruptive trading practices and the other

 14 roundtable on capital margin is being coordinated

 15 with the Federal Reserve, the Securities and

 16 Exchange Commission, other regulators, bank

 17 regulators, and that one is scheduled for December

 18 10. I think it's important that regulators hear

 19 from the public. Commissioner O'Malia had raised

 20 this and as we reached out to other regulators

 21 everybody signed on very quickly on the issues of

 22 capital margin and I thought I'd raise, and this
 7

 1 is from me and not from the Commissioners, some

 2 questions that I certainly think it would be

 3 helpful to hear.

 4 Under the Act, the prudential regulators

 5 and the Federal Reserve will be responsible for

 6 capital margin for bank swap dealers so that's not

 7 our remit here at the CFTC, but we along with the

 8 SEC will be responsible for nonbank swap dealers.

 9 These may be companies that aren't even parts of

 10 financial institutions.

 11 One question to us is on capital. How

 12 should requirements in the context of nonbanks,

 13 the things that we have to take a look at,

 14 particularly if they're not a financial

 15 institution? Capital requirements have

 16 traditionally been set for banks and other

 17 financial institutions, but as a result of

 18 Dodd-Frank there may be a number of nonbank

 19 entities offering swaps to the public that would

 20 be subject to regulation. I still think there

 21 will be more banks than nonbanks, but we'll have

 22 some of them. And I think that we'll need to hear
 8

 1 from the public on how to account for the

 2 differences between bank swap dealers and nonbank

 3 swap dealers. For example, nonbanks generally

 4 have different assets than traditional financial

 5 institutions. Furthermore, the current regulatory

 6 capital standards for banks and other financial

 7 institutions are most likely not to directly to be

 8 applicable to nonbanks so that that's a pretty

 9 important topic and hopefully this roundtable will

 10 give us some help on that.

 11 As it relates to margin, the Dodd-Frank

 12 Act says, and I'm going to quote, that margins

 13 should be set to "offset the greater risk to the

 14 swap dealer and the financial system from the use

 15 of swaps that are not cleared and that regulators

 16 should help ensure the safety and soundless of the

 17 swap dealer and set margin requirements that are

 18 appropriate for the risk associated with the

 19 noncleared swaps." They certainly are speaking

 20 about noncleared swaps, the bilateral swaps and

 21 about risk not only to the swap dealer but to the

 22 financial system.
 9

 1 There are two areas of questions that

 2 come to mind for me. First, what are the views of

 3 the public about appropriate margin requirements

 4 that might relate to both initial margin and

 5 variation margin, and I'm highlighting initial and

 6 variation, between financial entities, financial

 7 entities like swap dealers, major swap

 8 participants and other financial entity

 9 counterparties? Second, though I certainly can't

 10 speak for the Federal Reserve and I'm not speaking

 11 for the SEC or even my fellow Commissioners, my

 12 view is that uncleared swaps entered into between

 13 financial entities pose more risk to the financial

 14 system than those where one of the parties is a

 15 nonfinancial entity. As you know, this got quite

 16 a bit of debate doing the congressional process on

 17 Dodd-Frank. But interconnectedness between and

 18 among financial entities allows one entity's

 19 failure to cause uncertainty and possible runs on

 20 the funding of other financial entities, and

 21 that's because so many financial entities rely on

 22 short-term funding. It's just the very nature of
 10

 1 the financial system itself. So that risk, the

 2 interconnectedness, can spread and economic harm

 3 can go throughout the country. We know from the

 4 AIG debacle that interconnectedness of financial

 5 entities through their swap books raises the risk

 6 of bailouts. Transactions involving nonfinancial

 7 entities however do not present the same level of

 8 risk to the financial system and financial systems

 9 are the words Congress chose in the statute, that

 10 the nonfinancial entities' interconnectedness does

 11 not present the same risk to the financial system

 12 as those solely between financial entities. The

 13 risk of a crisis spreading throughout the

 14 financial system is greater than more

 15 interconnected financial companies are to each

 16 other. So I think that Congress also recognized

 17 the different levels of risk posed by transactions

 18 between financial entities and nonfinancial

 19 entities when they said in their clearing

 20 requirements that nonfinancial entity transactions

 21 are exempt from clearing if they choose to be

 22 exempt.
 11

 1 Consistent with this I believe that

 2 proposed rules on margin requirements should focus

 3 only on transactions between financial entities

 4 rather than those transactions involving

 5 nonfinancials, but I'd be very interested from the

 6 public on these views and their thoughts on these

 7 topics of margin, so I took a little opportunity

 8 here to talk about next week's roundtable. But

 9 I'd like to thank staff for all of their work in

 10 drafting what they're doing, their thoughtful

 11 recommendations, and before we move forward I was

 12 going to turn to fellow Commissioners.

 13 COMMISSIONER DUNN: Thank you, Mister

 14 Chairman, and let me extend also to my colleague

 15 Commissioner O'Malia a happy birthday and I'm

 16 delighted that my term is up before my next

 17 birthday because is this is the kind of presents

 18 you're going to present, Mister Chairman, I don't

 19 want to be here.

 20 CHAIRMAN GENSLER: But we want you to

 21 stay, Mike.

 22 COMMISSIONER DUNN: I'd like to
 12

 1 associate myself with your remarks on the upcoming

 2 roundtable because I think the bottom line in what

 3 you're talking about here is the need for

 4 transparency in the financial service industry so

 5 that everyone understands where the risk is and

 6 how the interconnectivity sets them up to assume

 7 that risk. I applaud you on that and the upcoming

 8 meeting for the staff and the roundtables and

 9 getting them all together is great.

 10 I want to thank everyone for joining us

 11 today on this important regulatory meeting

 12 regarding the implementation of the Dodd-Frank

 13 Act. Today we're going to talk about the core

 14 principles and other requirements for designated

 15 contract markets, general regulations for

 16 derivatives clearing organizations, information

 17 management requirements for derivatives clearing

 18 organizations, reporting, recordkeeping, daily

 19 trading records requirements for swap dealers and

 20 major swap participants and the definition of swap

 21 dealers, security based swap dealers, major swap

 22 participants and eligible contract participants.
 13

 1 I will support publishing these proposed

 2 rules in their current form, but I am concerned

 3 that the rules addressing DCM core principles as

 4 currently drafted may be too prescriptive. If

 5 this rule was before us today as the final rule, I

 6 would have reservations voting for its release

 7 based on my firm belief that the CFTC should

 8 remain a principle-based regulator and not a

 9 prescriptive regulator. However, after meeting

 10 with staff it is my understanding that many of the

 11 provisions in the proposed DCM core principles are

 12 actually already being followed by industry or

 13 have become best practices over time. In essence,

 14 my understanding is that this proposed rule simply

 15 codified what is already being done. It is my

 16 understanding that many in the industry desire the

 17 establishment of the safe harbor that will ensure

 18 that they are in fact meeting the intent of the

 19 core principles. However, I do not know this to

 20 be true and look to the public comments on this

 21 proposed rule to guide my decision- making process

 22 regarding the final rule.
 14

 1 Comments indicating that we are indeed

 2 merely codifying best practices already in use and

 3 that a safe harbor is needed for legal certainty

 4 will influence my vote on a final rule. The

 5 proposed rules also provide an extension of time

 6 for CFTC staff to review applications. Given the

 7 present staffing level, this may be warranted.

 8 However, it does not allow the agency to be

 9 responsive to industry developments as would be

 10 desirable to an efficient and effective regulator.

 11 I will be guided by the funding levels of the

 12 agency when making final decisions on these

 13 proposals.

 14 I'm also very interested in reviewing

 15 the public's comments on our entities definitions.

 16 These definitions along with product definitions

 17 that will be discussed in a couple of weeks will

 18 finally let everyone know where they stand

 19 vis-à-vis the Dodd-Frank Act. Based on the

 20 interest on these definitions I have to date, I

 21 expect the proposed rules to receive a significant

 22 level of comment. I would like to remind everyone
 15

 1 that these are proposed definitions that with your

 2 help we can write final definitions that work for

 3 everyone. I would like to note, Mister Chairman,

 4 the difficulty in arriving at mutually acceptable

 5 definitions with other regulators and I would

 6 commend you for your personal involvement in

 7 moving this process forward.

 8 Mister Chairman, I put a great deal of

 9 faith in the process we follow under the

 10 Administrative Procedure Act. Recent reports that

 11 the agency is receiving forged comment letters are

 12 a cause for alarm. I have today asked the

 13 Inspector General to investigate these charges and

 14 have further asked the Office of the Secretariat

 15 to develop a procedure for verification of comment

 16 letters sent to this agency. Again, I would like

 17 to thank staff for all the hard work in getting us

 18 here today.

 19 CHAIRMAN GENSLER: Let me thank

 20 Commissioner Dunn, and if I might say that we do

 21 look forward to receiving all comments from the

 22 public. Those are comments that are sent in and
 16

 1 are truly from the public. I will note as

 2 Commissioner Dunn said that the Commission

 3 recently became aware of some comment letters that

 4 were fraudulently submitted in response to a

 5 proposed rulemaking. We have removed the

 6 identified letters from the comment files and

 7 we've also referred the matter to the Department

 8 of Justice. We're working to ensure the integrity

 9 of the comment process which is so critical to

 10 moving forward and for the public's confidence in

 11 these matters. Commissioner Sommers?

 12 COMMISSIONER SOMMERS: Thank you, Mister

 13 Chairman. I want to echo the Chairman and

 14 Commissioner Dunn's thanks to the staffs of all

 15 the teams. I know the hard work that you've put

 16 in on these proposed regulations, the long hours

 17 taking place at night and on weekends and over

 18 your Thanksgiving holiday, so that I want to let

 19 you know how much I appreciate your time and the

 20 efforts of all the teams that are presenting

 21 today.

 22 In the end, I am not supporting all of
 17

 1 the proposed regulations we are regulations we are

 2 considering today. My vote against any of the

 3 proposals has everything to do with basic policy

 4 differences among the five Commissioners and

 5 nothing to do with the quality of work product

 6 before us. Each team has done an exemplary work

 7 and the quality of these documents is nothing

 8 short of excellent.

 9 Today is the sixth Commission meeting to

 10 consider proposed regulations that the Commission

 11 has linked to Dodd-Frank. In each of our meetings

 12 we have all expressed great concern about

 13 Commission resources needed to perform our current

 14 responsibilities while keeping pace proposing

 15 these regulations and the pace that will be

 16 required next spring, summer and fall to attempt

 17 to finalize these regulations. Our concerns about

 18 those resources remain.

 19 I would be remiss if I did not point out

 20 that a number of the regulations that we have

 21 already considered and a number of the regulations

 22 that we are considering today are not required by
 18

 1 Dodd-Frank. Commission staff has spent months and

 2 months drafting proposed regulations that are

 3 purely voluntary and all the while the Commission

 4 is expressing grave concerns about our level of

 5 resources. I suspect we will continue to spend

 6 months and months of our limited staff time

 7 proposing and attempting to finalize regulations

 8 that are not required by Dodd-Frank. This has

 9 been a mistake in my view and an unwise use of our

 10 limited resources.

 11 Over the past few months I've been

 12 speaking publicly about a little-discussed

 13 provision of Dodd-Frank which gives the Commission

 14 the authority to abandon its successful

 15 principles-based regulatory approach in favor of a

 16 prescriptive rules-based approach. I have said

 17 that I think such a move would be a mistake.

 18 Today with these proposals before us, the

 19 Commission is in large part abandoning

 20 principles-based regulation. There does not

 21 appear to be a reason other than we can.

 22 Principles-based regulation has worked very well
 19

 1 in our industry and our industry has flourished

 2 because of it. Principles-based regulation did

 3 not cause or contribute to the financial crisis.

 4 Nonetheless, the Commission will be piling on

 5 regulations and restrictions in the wake of the

 6 crisis. This too in my opinion is a mistake.

 7 Even though we may only be codifying

 8 today's best practices, markets evolve and

 9 innovate and when our markets and market

 10 structures transform because of the requirements

 11 of Dodd-Frank, I think codifying today's best

 12 practices seems a bit premature. I have voted

 13 against proposed regulations at prior meetings

 14 when I thought among other things that the

 15 proposed regulations were too broad or where I

 16 believe they amounted to the Commission

 17 overreaching. Some of my votes today will be for

 18 those same reasons.

 19 I have concerns about a number of the

 20 proposals, but I want to talk a little bit about

 21 the definitions proposal. In addition to my

 22 overall concern that the definition of swap dealer
 20

 1 is too broad and will likely capture entities that

 2 do not functionally operate as dealers, I am

 3 struck by another provision of this proposed

 4 regulation that I think is bad policy and I would

 5 like to publicly address. The preamble to this

 6 regulation states that in connection with the

 7 registration requirement, market participants are

 8 in a position to assess their activities to

 9 determine whether they function in the manner

 10 described in the definitions. That seems

 11 reasonable. Dodd-Frank allows a person to be

 12 registered as a swap dealer or major swap

 13 participant for a single type or a single class or

 14 category of swap or activities and not be

 15 considered a swap dealer or major swap participant

 16 for all classes or categories of swaps or

 17 activities. That seems reasonable as well.

 18 These proposed regulations however state

 19 that a person who is a swap dealer or major swap

 20 participant for any swap or activity shall be

 21 deemed a swap dealer or major swap participant for

 22 all swaps it enters into. This does not seem
 21

 1 reasonable particularly in light of the statement

 2 from the preamble and the provision in Dodd-Frank.

 3 The regulations do allow a swap dealer or major

 4 swap participant to apply for a limited

 5 designation as a swap dealer. However, while the

 6 Commission is considering the application to limit

 7 the designation of the swap dealer or major swap

 8 participant however long that might take, the swap

 9 dealer or MSP will essentially be held hostage and

 10 must comply with all of the regulatory

 11 requirements for all of the swaps including the

 12 capital and margin. I believe this approach is

 13 wrong. If we believe that market participants can

 14 assess their own activity to determine whether

 15 they are a swap dealer or an MSP, surely they can

 16 assess whether or not they are entitled to limited

 17 designation. Our regulations should allow swap

 18 dealers and major swap participants to initially

 19 register in a limited capacity and not require

 20 them to full register and then hope that the

 21 Commission allows them to escape the full

 22 designation. I fear the construct in the proposed
 22

 1 regulation will needlessly impose onerous

 2 requirements on market participants and I cannot

 3 support it. Again I want to say thank you to the

 4 teams today and I look forward to your

 5 presentations.

 6 CHAIRMAN GENSLER: Thank you,

 7 Commissioner Sommers. Commissioner Chilton I

 8 think is with us by phone.

 9 COMMISSIONER CHILTON: Yes, I'm here,

 10 Mister Chairman. Thank you. I'll try to be

 11 brief.

 12 CHAIRMAN GENSLER: Commissioner Chilton,

 13 I don't know if you want to be closer to the

 14 phone. We're not hearing you well.

 15 COMMISSIONER CHILTON: I started to say

 16 I was thinking last night as I was finishing the

 17 Thanksgiving soup and my mother used to make that

 18 and the meat would all fall off the bones and you

 19 had this great aroma and great taste and I thought

 20 we are doing exactly the opposite. We're putting

 21 meat on the bones of this new law and as everybody

 22 has said and continues to put in all these caveats
 23

 1 about what we do, we certainly don't want to end

 2 up with a turkey. I don't think we will because

 3 of the good work of the staff and because of the

 4 public input that we're getting.

 5 I did want to make a comment briefly

 6 about two things, one that's not on the agenda

 7 today, and that's position limits. We were

 8 originally internally talking about doing this at

 9 this meeting and I've yet to see a proposal. I

 10 know staff is working very hard, but yet I still

 11 don't have any papers. This thing didn't fall out

 12 of the sky. We've had it for 4 months and we're

 13 supposed to be implementing it in mid-January so

 14 that I think it's time for us to do something.

 15 Even at our December 9 meeting I think we should

 16 try to get it done. We should certainly hold the

 17 option when we publish in the Federal Register the

 18 issues that may come up, position limits, in case

 19 we have the opportunity to move forward on it. I

 20 know everybody is working hard, but this is one

 21 that Congress clearly wanted done earlier than

 22 other things. I know there are issues that my
 24

 1 colleagues have raised about how we do it, but

 2 there's a way to get it done.

 3 The last little point was I was really

 4 heartened with all the work that people were doing

 5 over the weekend. I had questions including one

 6 on position limits that were answered on Saturday

 7 so that staff was working over the holiday weekend

 8 and this talk that we've seen in the media about a

 9 spending freeze, et cetera, I think for us that

 10 doesn't make any sense. The people who work at

 11 CFTC aren't in it for the money. They could be

 12 making more money some place else. They're in it

 13 to be public servants and the good work they've

 14 done even on a holiday weekend warms my heart more

 15 than any soup could ever. Thank you, Mister

 16 Chairman.

 17 CHAIRMAN GENSLER: Thank you,

 18 Commissioner Chilton. Commissioner O'Malia?

 19 You're going to make a mention about soup and

 20 turkey too?

 21 COMMISSIONER O'MALIA: Why do I have to

 22 follow him? I should on my birthday at least be
 25

 1 able to go first maybe. That would have been

 2 fair. I just can't compete with this. I'll just

 3 read the thing. Thank you for the kind wishes.

 4 Happy birthday to John as well.

 5 Mister Chairman, I'd like to thank the

 6 teams who have worked so hard on the rules we will

 7 consider here today. Staff continues to seek

 8 input from the Commissioners and I appreciate that

 9 and they've worked diligently over the

 10 Thanksgiving holiday to improve these rulemakings.

 11 I should have thought of sending them soup but I

 12 didn't. I would like to commend the various teams

 13 that will be presenting here today, teams headed

 14 by Phyllis Dietz, Nancy Markowitz, Sarah Josephson

 15 and Mark Fajfar. I appreciate your unwavering

 16 commitment to respond to staff's comments,

 17 concerns and criticisms with thoughtful and

 18 professionalism.

 19 This is our sixth in a serious of

 20 proposed rulemakings under the Dodd-Frank Act and

 21 while the format has become routine, the content

 22 is anything but. I am concerned that these rules
 26

 1 will present a deluge of potential outcomes that

 2 we have not fully explored and that may have

 3 negative impacts on the markets we regulate. With

 4 regard to the swap dealer definition, while

 5 reasonable people will continue to debate who

 6 should ultimately fall under the regulatory

 7 category of swap dealer, for years after the final

 8 rules are promulgated, one thing we should all be

 9 able to agree on here today is that the rule

 10 should be clear as to who falls into the category

 11 and who does not. Unfortunately, the 145-page

 12 proposal does not provide the regulatory certainty

 13 that I believe many market participants are

 14 seeking, particularly commercial end users. In

 15 fact, I have concerns that many end users will be

 16 unintentionally swept into the dealer definition

 17 and will be subject to significantly higher costs

 18 to hedge their commercial risk. I commend staff

 19 for their attempts to characterize the activities

 20 of a dealer based on limited statutory direction.

 21 I would have preferred to see a more thorough

 22 discussion of a range of safe-harbor activities
 27

 1 that end users will clearly understand. They need

 2 to know whether or not their bilateral swap

 3 activities will cross the line and earn them the

 4 dreaded Scarlet Letter SD for swap dealer.

 5 I strongly encourage the market to

 6 comment on this proposal establishing what I

 7 perceive to be a very limited de minimis standard

 8 for swap dealing conduct that will result in few

 9 exceptions. I hope that the public comments will

 10 focus on this proposal and will provide guidance

 11 as to the appropriate size of a de minimis

 12 exclusion and whether it should be adjusted by

 13 asset class. It is my hope that after reviewing

 14 the public comments that the final swap dealer

 15 rule can be significantly improved by providing

 16 greater specificity to the dealer definition and

 17 considerably narrowing the definition to focus

 18 only on those entities that perform a traditional

 19 swap dealer role. I know that the end users are

 20 anxiously awaiting the publication of this

 21 rulemaking. And Mister Chairman with regard to

 22 the capital and margin rulemaking, I'd like to
 28

 1 thank you for your willingness to delay this

 2 rulemaking which I recognize takes the Commission

 3 off its schedule in order to conduct an important

 4 hearing on this complex matter. I greatly

 5 appreciate that and your willingness to

 6 accommodate us.

 7 I believe at the end of the day the

 8 proposal will be better informed after receiving

 9 public input prior to publication. I was

 10 particularly pleased with the careful

 11 consideration that Sarah Josephson and her team

 12 gave to the technological advancements in recent

 13 years that have lowered the cost and increased the

 14 feasibility of capturing and retaining

 15 communications regardless of their original format

 16 in her rulemaking. Given that we have yet to

 17 define the facilities upon which many of the

 18 affected transactions will take place, it makes it

 19 especially difficult to define the records and

 20 associated costs of recordkeeping necessary to

 21 conduct comprehensive and accurate trade

 22 reconstructions as required by the Act. I do look
 29

 1 forward to receiving comments on this particular

 2 rulemaking.

 3 With regard to the designated contract

 4 markets, the notice of proposed rulemaking

 5 codifies and interprets the core principles that

 6 applicant contract markets must comply with to

 7 become designated and they must continue to comply

 8 with on an ongoing basis was obviously quite an

 9 undertaking. I appreciate the team's hard work.

 10 I would like to thank the team for considering

 11 under Core Principle 4 different risk controls

 12 that DCM should employ to effectively manage

 13 market disruption. On November 19 after

 14 considerable discussion with Commissioner Chilton

 15 -- I know was supportive -- Commissioner Dunn and

 16 Sommers and the Chairman as well, I established a

 17 subcommittee of the Technology Advisory Committee

 18 chaired by Michael Gorham, the former Director of

 19 CFTC's Division of Market Oversight. I've asked

 20 Dr. Gorham and other subcommittee members to

 21 conduct a review and provide recommendations of

 22 applying pretrade functionality at the direct
 30

 1 access participant trading firms, clearinghouse

 2 and exchange levels. As a baseline, the

 3 subcommittee was advised to consider the FIA's

 4 work with regard to market access risk-management

 5 recommendations and risk control for trading

 6 firms. It is my expectation that the

 7 recommendations or regulatory guidance as the case

 8 may be will provide a roadmap for an application

 9 and implementation of best practices with regard

 10 to direct market access and pretrade functionality

 11 while appropriately steering the Commission in the

 12 right direction regarding identifying and

 13 mitigating disruptive trade practices.

 14 I have serious concerns however with

 15 many of the other provisions in this proposal.

 16 The Commission's core principle regime has worked

 17 well, providing flexibility to adapt to

 18 innovations in our markets as both Commission

 19 Sommers and Dunn have referenced. This notice

 20 moves significantly away from our principles-based

 21 regime by adopting several regulatory requirements

 22 and interpreting core principles in highly
 31

 1 prescriptive ways instead of maintaining guidance

 2 as safe harbors in applicable practices. For

 3 example, the Dodd-Frank bill amended Core

 4 Principle 9 to include language that boards of

 5 trade must provide a mechanism for executing

 6 transactions in a way that protects the price

 7 discovery process of trading in centralized

 8 markets. At the same time, the core principle

 9 explicitly states that the boards of trade may

 10 authorize exchanges -- futures for swap trades.

 11 The statutory language of Dodd-Frank specifically

 12 permits the trading of swaps on DCMs as well as

 13 SEFs. Staff interpretation of Core Principle 9's

 14 language that the price discovery process must be

 15 protected, however, requires that 85 percent of

 16 the trading in a contract must be through a

 17 centralized market for the contract to continue to

 18 be listed on the DCM. The practical effect of

 19 that interpretation may very well be that few if

 20 any swaps will be executed on a DCM and the

 21 contracts known as EFSes will no longer be able to

 22 operate as futures and will be forced to trade
 32

 1 solely on SEFs. There are likely to be negative

 2 implications of this interpretation and because it

 3 is on its face contrary to the statutory language

 4 in the Dodd- Frank Act, I have great concerns

 5 about this proposal. Further, this proposal would

 6 likely create uncertainty for traders regarding

 7 the protections of the segregated funds with --

 8 will receive if they are required to execute

 9 contracts solely on SEFs instead of DCMs and

 10 whether or not they will be able to continue to

 11 avail themselves of certain Commission-approved

 12 market efficiencies like portfolio margining

 13 pursuant to a 4(d) order and they 're able to use

 14 when they're trading on swaps and futures on a

 15 DCM. There are other examples where this proposal

 16 creates regulatory requirements that exceed the

 17 articulated core principles in Dodd-Frank. More

 18 specifically, Core Principle 9 has also been

 19 interpreted by staff to support a regulatory

 20 requirement regarding block trades. I hope the

 21 public will not overlook this proposal and will

 22 provide comment on it.
 33

 1 In closing let me thank my staff and the

 2 rulemaking teams for their hard work over the

 3 Thanksgiving holiday. I know everyone has made

 4 sacrifices by putting rulemakings ahead of their

 5 families on this holiday and I want everyone to

 6 know how important I think their work is and I

 7 appreciate their hard work on these rulemakings.

 8 Thank you.

 9 CHAIRMAN GENSLER: Thank you,

 10 Commissioner O'Malia, and I think all the

 11 Commissioners because we might have some

 12 differences but I think we're working

 13 extraordinarily well together. I think all the

 14 comments and the edits in these proposals are just

 15 proposals, but they're better for all of the

 16 comments from Commissioners' offices and their

 17 legal assistants. With that I was going to turn

 18 to Ananda Radhakrishnan, Jonathan Lave and Phyllis

 19 Dietz who are going to present both of the

 20 clearing rules. I can't recall if you're doing

 21 legal and compliance first. Phyllis Dietz is the

 22 team lead. Thank you, Phyllis.
 34

 1 MS. DIETZ: Thank you, and good morning,

 2 Mister Chairman and Commissioners. I am pleased

 3 to recommend that the Commission approve for

 4 publication in the Federal Register proposed

 5 regulations that would implement certain core

 6 principles for derivatives clearing organizations.

 7 These regulations would establish standards for

 8 compliance with DCO core principles relating to

 9 overall compliance, rule enforcement, antitrust

 10 considerations and legal risk.

 11 The proposed rules would also implement

 12 the DCO chief compliance officer requirements

 13 under the Dodd-Frank Act, revise procedures for

 14 DCO applications, clarify procedures for the

 15 transfer of a DCO registration and add

 16 requirements for approval of DCO rules

 17 establishing a portfolio margining program for

 18 customer accounts carried by an FCM that is also a

 19 securities broker dealer. Additionally, the

 20 notice proposes amendments to the Commission's

 21 regulations to update certain definitions and to

 22 add other definitions for terms relating to DCOs
 35

 1 and clearing activities.

 2 I'd like to take a moment to thank the

 3 DCO core principles rulemaking team for their many

 4 valuable contributions, and I would like to add a

 5 special thank you to members of other teams who

 6 worked closely with us in developing and

 7 harmonizing the proposed requirements for chief

 8 compliance officers. Jonathan Lave has been the

 9 lead attorney on this rulemaking and he will

 10 present an overview of the proposed rules. Thank

 11 you.

 12 MR. LAVE: Thank you and good morning.

 13 I will begin by discussing the proposed

 14 definitions.

 15 The proposed rules would amend the

 16 definitions of clearing member and clearing

 17 organization in Section 1.3 to make the

 18 definitions consistent with terminology currently

 19 used in the Commodity Exchange Act as amended by

 20 the Dodd- Frank Act. The proposed rules are also

 21 proposing to add to Section 1.3 definitions for

 22 the terms customer initial margin, initial margin,
 36

 1 spread margin, variation margin and margin call.

 2 In addition, the proposed rules would amend

 3 Section 39.1 to add definitions of back test,

 4 compliance policies and procedures, key personnel,

 5 stress test and systematically important

 6 derivative clearing organization. These changes

 7 would provide clarity and legal certainty.

 8 The proposed rules would also set forth

 9 three procedural changes. First, the proposed

 10 rules would amend Section 39.3 to streamline the

 11 DCO application process by eliminating the 90-day

 12 expedited application review period. The

 13 Commodity Exchange Act does not set forth a time

 14 period for the Commission to review the DCO

 15 application. Currently the Commission allows for

 16 two tracks, a 180-day review period or a 90-day

 17 expedited review period. Over the past nearly 10

 18 years however the Commission has determined that a

 19 90-day period is not practicable. Accordingly,

 20 the proposed rules would eliminate the 90-day

 21 period and all applications would be reviewed on a

 22 180-day schedule. Of course the Commission could
 37

 1 render a decision in less than 180 days.

 2 Second, the proposed rules would clarify

 3 the procedures to be followed by a DCO when

 4 requesting a transfer of its DCO registration due

 5 to a corporate change. The proposed rules set

 6 forth the information that must be included in

 7 such a request and require representation by the

 8 DCO that the DCO is in compliance with the

 9 Commodity Exchange Act and Commission regulations

 10 and a representation by the transferee that it

 11 will remain in compliance after the transfer.

 12 Currently there are no rules on this topic and the

 13 proposed rule would provide legal certainty.

 14 Finally, Section 713 of the Dodd-Frank

 15 Act allows for portfolio margining of futures and

 16 securities. The Act imposes no deadline on this

 17 rulemaking. Under proposed Section 39.4, a DCO

 18 seeking approval to provide clearing and

 19 settlement services for portfolio margining in a

 20 futures account would have to submit its proposed

 21 portfolio margining rules for Commission approval

 22 under Section 40.5. This is a first step and the
 38

 1 Commission is actively consulting with the

 2 Securities and Exchange Commission regarding the

 3 additional rulemaking.

 4 Turning to proposed regulations

 5 implementing statutory requirements for chief

 6 compliance officers, Section 725(b) of the

 7 Dodd-Frank Act requires each DCO to designate a

 8 chief compliance officer and further specifies the

 9 duties of the chief compliance officer. Among the

 10 chief compliance officer's duties are the

 11 preparation and submission of an annual compliance

 12 report to the Commission. Proposed Section 30.10

 13 codifies the statutory requirements for the chief

 14 compliance officers and adds additional

 15 requirements such as an annual meeting with the

 16 board of directors or the senior officer. The

 17 proposed rules also would require the person

 18 designated as chief compliance officer to meet

 19 minimum ethical requirements and would establish

 20 the procedure for filing the annual report.

 21 Finally, the proposed regulations would

 22 implement certain DCO core principles. Section
 39

 1 25(c) of the Dodd- Frank Act amends Core Principle

 2 A, compliance, to require a DCO to comply with

 3 each core principle set forth in Section

 4 5(b)(C)(2) of the Commodity Exchange Act and any

 5 requirement that the Commission may impose by rule

 6 or regulation pursuant to Section 8(a)(5) of the

 7 Commodity Exchange Act. Proposed Section 39.10

 8 would implement Core Principle A.

 9 Second, Section 725(c) of the Dodd-Frank

 10 Act also amends Core Principle H, rule

 11 enforcement, to require a derivatives-clearing

 12 organization to maintain adequate arrangements and

 13 resources for the effective monitoring and

 14 enforcement of compliance with its rules and for

 15 resolution of disputes. The Dodd-Frank Act also

 16 requires a DCO to have the authority and ability

 17 to discipline, limit, suspend or terminate the

 18 activities of a clearing member due to a violation

 19 of any DCO rule. Proposed Section 39.17 would

 20 codify these requirements.

 21 Third, Section 725(c) of the Dodd-Frank

 22 Act amends Core Principle N, antitrust
 40

 1 considerations, and conforms the standard for DCOs

 2 to the standard applied to designated contract

 3 markets under Core Principle 19. Proposed Section

 4 39.23 would codify Core Principle N.

 5 Finally, Section 25(c) establishes new

 6 Core Principle R, legal risk. This core principle

 7 is consistent with the legal risk standard

 8 recommended by the Committee on Payment and

 9 Settlement Systems of the Central Banks of the

 10 Group of 10 Countries and the Technical Committee

 11 of the International Organization of Securities

 12 Commissions. They concluded that if the legal

 13 framework of a clearing organization is

 14 underdeveloped, opaque or inconsistent, the

 15 resulting legal risk could undermine the clearing

 16 organization's ability to operate effectively and

 17 increase the likelihood that market participants

 18 may suffer a loss because the clearing

 19 organization's rules, procedures and contracts

 20 that support its activities, property rights and

 21 other interests are not supported by relevant laws

 22 and regulations. Proposed Section 39.27 would
 41

 1 implement Core Principle R and require a DCO to

 2 address certain identified legal risks. Thank you

 3 for the opportunity to describe this release.

 4 CHAIRMAN GENSLER: Thank you for the

 5 staff presentation. Do I hear a motion on the

 6 staff recommendation on this rule?

 7 COMMISSIONER DUNN: So moved.

 8 COMMISSIONER SOMMERS: Second.

 9 CHAIRMAN GENSLER: The motion being

 10 moved and seconded, now we'll go to questions. I

 11 want to say I support the proposed rule on legal

 12 and compliance and I'll put a little statement in

 13 the record for that, but I think that it is

 14 consistent with the requirements of Dodd-Frank but

 15 also importantly consistent with international

 16 standards. I do have a question on that I want to

 17 ask Jonathan, Phyllis and Ananda as to whether

 18 you've consulted with the folks in Europe and so

 19 forth with regard to this particular clearinghouse

 20 rule and how it lines up against what's called the

 21 CPSS-IOSCO standards. These are these

 22 international standards for clearinghouses.
 42

 1 MR. RADHAKRISHNAN: The legislation of

 2 the Dodd- Frank Act is a mirror image of what's

 3 called the Recommendations for Central

 4 Counterparties issued in 2004. When staff

 5 provided technical advice to the committees in

 6 Congress, that's what we did. We took a look at

 7 the RCCPs and made sure that the language of the

 8 legislation was if not the same, very, very close.

 9 There is now an effort to modify it but the

 10 problem with that is all we have is drafts, number

 11 one. Number two, nobody has seen a proposal

 12 because there is no proposal yet so we're working

 13 with a moving target. What we have done is every

 14 time we come before the Commission we take a look

 15 at the latest draft and we make sure that what we

 16 are proposing conforms with the latest draft so

 17 that we are actively consulting with our

 18 colleagues both domestically and overseas.

 19 MR. LAVE: I would add that the legal

 20 risks that are identified in the proposed rules

 21 are the legal risks identified by CPSS-IOSCO.

 22 CHAIRMAN GENSLER: That's really my
 43

 1 question. So these are consistent with what the

 2 international standards are as we know them today?

 3 MR. RADHAKRISHNAN: Yes, as we know them

 4 to be. Right. So that if you ask me what are the

 5 international standards, the international

 6 standards in existence today are the 2004

 7 recommendations.

 8 CHAIRMAN GENSLER: Right, but Jonathan

 9 also said these are consistent with what we know

 10 of the draft proposal.

 11 MR. RADHAKRISHNAN: The draft to be,

 12 yes.

 13 CHAIRMAN GENSLER: That even if it's

 14 moving it's consistent?

 15 MR. RADHAKRISHNAN: We've made every

 16 effort to make sure that every proposal that the

 17 division makes is consistent with the latest

 18 iteration or latest version of a draft.

 19 CHAIRMAN GENSLER: My other question is

 20 the chief compliance officer provisions that you

 21 have here, as I understand it Dodd-Frank had

 22 mandated chief compliance officers for
 44

 1 clearinghouses, for swap dealers and I gather also

 2 maybe for swap execution facilities.

 3 MR. RADHAKRISHNAN: For SEFs, yes.

 4 CHAIRMAN GENSLER: So this is compliance

 5 with that?

 6 MR. RADHAKRISHNAN: Yes.

 7 CHAIRMAN GENSLER: Thank you.

 8 Commissioner Dunn?

 9 COMMISSIONER DUNN: Thank you, Mister

 10 Chairman. To follow-up on your first question

 11 because they do say on page 8 of my draft, I'm not

 12 sure which one they're working on in there, that

 13 Section 25(c) of Dodd-Frank establishes new Core

 14 Principle R, legal risk, which is consistent with

 15 the legal-risk standards recommended by the

 16 Committee on Payments and Settlements Systems,

 17 CPSS, and the Technical Committee on International

 18 Organizations of Security Commissions, ISOSCO.

 19 What other international regulators have embraced

 20 these two concepts?

 21 MR. RADHAKRISHNAN: What we have been

 22 told is that all of the participants in the 2004
 45

 1 committee, the people who have participated in

 2 those committees, have embraced the 2004

 3 standards. The issue is some regulators don't

 4 have statutes. For example, the Federal Reserve

 5 doesn't have a statute that codifies this so that

 6 what they have done is they've issued a policy

 7 statement under which the Federal Reserve Board

 8 said they will comply with these standards, but

 9 there are other nations that have told us that

 10 they either have it in statute or this is what

 11 they do by regulation or by policy.

 12 COMMISSIONER DUNN: Jonathan, you stated

 13 and it's also in the preamble that based on the

 14 experience in reviewing DCO applications over the

 15 past nearly 10 years the Commission is proposing

 16 to amend 39.3 to streamline the DCO application

 17 process by eliminating the 90-day rule. You're

 18 going to leave in the 180-day rule but you're

 19 going to streamline by eliminating the 90-day

 20 rule. That doesn't sound consistent to me.

 21 MR. RADHAKRISHNAN: I think,

 22 Commissioner Dunn, what we are proposing to do is
 46

 1 the 90-day rule really doesn't work because as you

 2 know the Commission has a policy or seeking public

 3 comment on DCO applications and the Commission

 4 usually grants a 30-day comment period. What

 5 we've found is despite their best efforts, the

 6 first cut is never enough and as Jonathan pointed

 7 out, this was if I may use the terminology, and

 8 forgive me for using it, shooting ourselves in the

 9 foot because there is no statutory requirement as

 10 to when we need to do this. I understand that we

 11 can't delay, we can't -- 4 years, but we thought

 12 that 90 days was in our experience really

 13 insufficient because what we've been doing in the

 14 90 days is telling people how to do their jobs

 15 which we try not to do, but we want to make sure

 16 that the applications are as sound as possible so

 17 that that's why we thought that giving ourselves

 18 180 days or giving the Commission 180 days is

 19 relevant.

 20 Also we don't get funding. We've got

 21 three DCO applications right now. It used to be

 22 their day job and now it's going to be their night
 47

 1 job looking at DCO applications. So we can't do

 2 anything about the applications we have before us,

 3 but we really think that in order for the staff

 4 and the Commission to make sure that we do a

 5 thorough analysis of the application that 180 days

 6 is warranted. But as Jonathan pointed out, it

 7 doesn't mean that we will take 180 days. If staff

 8 finishes the analysis in a shorter period of time

 9 we will certainly forward our recommendation to

 10 the Commission for the Commission's consideration

 11 but we also don't want to jam the Commission.

 12 MS. DIETZ: I would also like to address

 13 specifically your comment and I certainly

 14 understand about streamlining, how is that you

 15 streamline but you're taking more time? What we

 16 have found with the 90-day expedited process is

 17 because it isn't really enough time to evaluate

 18 some of these very complex and novel proposals

 19 that we get, there is an awful lot of back and

 20 forth between staff and applicant and in the past

 21 on a number of occasions we have ended up having

 22 to stay our review. We either bump it to 180 days
 48

 1 and even at that we may stay the review. So our

 2 view has been if we can just all start out

 3 understanding we've got 180 days, here are the

 4 items we need to have to evaluate, here are the

 5 standards that we're going to be looking for, we

 6 can have a streamlined procedure, we don't feel

 7 tied to rushing around in 90 days and we're not

 8 saddled with the likelihood of the change in

 9 scheduling the stay. This gives us what we hope

 10 would be ample time and we can always make a

 11 recommendation and approve in less than 180 days.

 12 Along with this in the next rulemaking that we're

 13 going to do for DCO core principles, it is staff's

 14 hope that we can recommend adoption of an

 15 application form with instructions that will be

 16 more specific and will enable us to get uniform

 17 submissions, complete submissions, and that too we

 18 hope will contribute to streamlining the process

 19 so that we can do away with a lot of this back and

 20 forth that we've experienced in the past.

 21 COMMISSIONER DUNN: I notice under the

 22 procedures for transfer of DCO registration we
 49

 1 used the term as soon as practical. Is the same

 2 concept applying here?

 3 MS. DIETZ: Yes. We don't want to be in

 4 the position of holding up a corporate event

 5 because we need to give approval for the transfer

 6 of a registration so that the goal there is to get

 7 notice sufficiently in advance, do our due

 8 diligence and be able to approve the transfer. We

 9 have recently done a transfer of registration for

 10 the Minneapolis Grain Exchange and that regulation

 11 in fact formalizes and codifies what we did in

 12 that situation and we think it's very helpful to

 13 put the public on notice if you intend to request

 14 a transfer, here's what has to take place and so

 15 that everybody on notice. Again it seems like

 16 we're adding something, but in fact we're

 17 streamlining what we already do.

 18 COMMISSIONER DUNN: Mister Chairman, if

 19 I can summarize what I'm hearing from staff on

 20 this is that it's not unusual for an applicant to

 21 come in and provide a partially completed

 22 application and the assumption is that staff will
 50

 1 do the work telling here is where you're short,

 2 this is what you've got to do. In fact, they're

 3 asking the staff to do the work of the consultant

 4 or the attorney they may have hired to prepare

 5 this application. I submit, Mister Chairman, we

 6 no longer had the luxury of having staff that can

 7 do that type of job for those applications. If

 8 we're not getting fully funded then these

 9 applications are going to go into a queue in my

 10 opinion is where they should go and we'll get to

 11 them as soon as practical.

 12 I have four sons and when they say

 13 they're going to take out the trash as soon as

 14 practical, one may do it right away, one may do it

 15 when they finish what they're doing, the third may

 16 do it the next day and the fourth may get it out

 17 in time for next week's collection. Industry

 18 should be aware that this process although it has

 19 been established over the years as a convenience

 20 to the industry, we no longer have the luxury of

 21 being able to do that and as a result of that

 22 there may be hold-ups on these applications being
 51

 1 processed. Thank you.

 2 CHAIRMAN GENSLER: Thank you,

 3 Commissioner Dunn. I think also what staff is

 4 recommending meets a lot of what I know you've

 5 been saying in many meetings for the last year and

 6 half, to have the public have a little bit more

 7 transparency into our process. So I applaud staff

 8 on your thoughts that a couple weeks from now we

 9 might have an application form and that everybody

 10 would know what you think is important and then

 11 we'll have to see if we vote for it. I think

 12 that's a good thing that the public will see that

 13 transparency. As you say, you've taken the

 14 Minneapolis situation and you've put it down and

 15 said this is the process. Commissioner Sommers?

 16 COMMISSIONER SOMMERS: Thank you, Mister

 17 Chairman. I have a question regarding the

 18 portfolio margining program. It's been the

 19 subject of interest to me since I've been here.

 20 My question is to explain if we're asking a DCO to

 21 submit their rules to us for approval of the

 22 program before we've reached agreement with the
 52

 1 SEC on the requirements of the program, are we in

 2 a place to approve the rules or how is that going

 3 to work?

 4 MR. LAVE: Right now we're talking about

 5 portfolio margining in a futures account and what

 6 the Dodd- Frank Act says is that the SEC may allow

 7 a futures commission merchant/broker dealer to put

 8 securities in an FCMBD if the portfolio margining

 9 program is approved by the Commission so that we

 10 are setting forth the rules for approval by the

 11 Commission. If the FCMBD wants to put securities

 12 in that account they're going to need to get

 13 approval from the SEC so that we're doing one

 14 piece of the rulemaking.

 15 MS. DIETZ: To follow-up on that, as

 16 Jonathan said, in order for the SEC to grant an

 17 exemption to approve putting securities into the

 18 futures portfolio margining account, there's a

 19 reference here in the statute to pursuant to a

 20 portfolio margining program approved by the

 21 Commodity Futures Trading Commission. Right now

 22 we have two different tracks as you know for
 53

 1 filing rules, you could self-certify or you can

 2 get approval. Under our rules absent what we are

 3 proposing today, a portfolio margining program

 4 implemented through rules, could just be

 5 self-certified. That won't do the trick for the

 6 SEC's approval. So what we are doing is we are

 7 laying the foundation purely procedurally saying

 8 if you intend to do a portfolio margining program,

 9 you're put on notice that you must get prior

 10 approval or the other chain of events won't take

 11 place.

 12 COMMISSIONER SOMMERS: Do we know if the

 13 SEC is in a place to propose their requirements

 14 for a portfolio margining program?

 15 MS. DIETZ: They do have the portfolio

 16 margining program now under NYSE Rule 431 so we

 17 have had discussions with them, but I don't

 18 believe that either staffs are at a point where

 19 we're down to discussing substantive issues.

 20 COMMISSIONER SOMMERS: Requirements for

 21 this?

 22 MS. DIETZ: Requirements for either the
 54

 1 futures account, what would they require in order

 2 to give the green light on the futures account,

 3 similarly what we would require in order to permit

 4 futures into the securities portfolio margining

 5 account. For us this is a first step. On the SEC

 6 side my understanding is that all rule submissions

 7 of this type would have to be approved so that we

 8 are the ones who now want to put this in place

 9 because otherwise they would be certified.

 10 CHAIRMAN GENSLER: Thank you,

 11 Commissioner Sommers. I look forward to any work

 12 staff can move forward with the Securities and

 13 Exchange Commission on portfolio margining. I'm

 14 guessing I'm speaking for all of us. I think we

 15 all do. Commissioner Chilton?

 16 COMMISSIONER CHILTON: I don't have any

 17 questions. I support the rule and thank the staff

 18 for their hard work. Thank you.

 19 CHAIRMAN GENSLER: Thank you,

 20 Commissioner Chilton. COMMISSIONER O'Malia?

 21 COMMISSIONER O'MALIA: I don't have any

 22 questions. This is a very good rule. Thank you
 55

 1 for your hard work on this.

 2 CHAIRMAN GENSLER: I think then I will

 3 call the motion. All those in favor of publishing

 4 in the Federal Register the staff recommendation

 5 on the proposed rule on legal and compliance for

 6 clearinghouses? I think I didn't read something

 7 earlier when I was going to do, a unanimous

 8 consent about putting all recorded votes in the

 9 Federal Register. I can't find the script. I

 10 wanted by unanimous consent to make sure that all

 11 recorded votes are put in the Federal Register.

 12 If I don't hear an objection then that passes.

 13 Then that sets you up to be able to ask for a

 14 recorded vote I think. I'm trying to follow

 15 Robert's Rules of Order.

 16 COMMISSIONER SOMMERS: I understand.

 17 CHAIRMAN GENSLER: All those in favor,

 18 if you can indicate by saying aye.

 19 (Chorus of ayes.)

 20 CHAIRMAN GENSLER: Are there any

 21 opposed? It appears that the yes have it.

 22 COMMISSIONER SOMMERS: Mister Chairman,
 56

 1 I'd like to ask for a recorded vote.

 2 CHAIRMAN GENSLER: Do I do this with

 3 Dave Stawik?

 4 MR. STAWIK: Commissioner O'Malia?

 5 COMMISSIONER O'MALIA: Aye.

 6 MR. STAWIK: Commissioner O'Malia, aye.

 7 Commissioner Chilton?

 8 COMMISSIONER CHILTON: Aye.

 9 MR. STAWIK: Commissioner Chilton, aye.

 10 Commissioner Sommers?

 11 COMMISSIONER SOMMERS: Aye.

 12 MR. STAWIK: Commissioner Sommers, aye.

 13 Commissioner Dunn?

 14 COMMISSIONER DUNN: Aye.

 15 MR. STAWIK: Commissioner Dunn, aye.

 16 Mister Chairman?

 17 CHAIRMAN GENSLER: Aye.

 18 MR. STAWIK: Mister Chairman, on this

 19 vote the ayes are five and nays are zero.

 20 CHAIRMAN GENSLER: Did we follow

 21 Robert's Rules?

 22 MR. STAWIK: Yes, sir.
 57

 1 CHAIRMAN GENSLER: Thank you. With

 2 that, if we can turn to next up on the agenda is

 3 the notice of proposed rulemaking on the

 4 recordkeeping or information management of

 5 designated DCOs, again clearing organizations.

 6 Thank you, Jonathan. We have also Julie Mohr

 7 joining. Ananda and Phyllis are back for repeat.

 8 Jake, I don't want to garble the last name.

 9 MR. PREISEROWICZ: Preiserowicz.

 10 CHAIRMAN GENSLER: What's that?

 11 MR. PREISEROWICZ: Preiserowicz.

 12 CHAIRMAN GENSLER: Thank you. Team,

 13 you're up.

 14 MS. DIETZ: I am pleased to recommend

 15 that the Commission approve for publication in the

 16 Federal Register proposed regulations that would

 17 implement certain core principles for derivatives

 18 clearing organizations. These regulations would

 19 establish standards for compliance with DCO core

 20 principles relating to reporting, recordkeeping,

 21 public information and information sharing. Jake

 22 Preiserowicz has been the lead attorney on this
 58

 1 rulemaking and he will present an overview of the

 2 proposed rules. Julie Mohr, our Associate

 3 Director for DCO Reviews, is also joining us from

 4 Chicago. She and other team members in Chicago

 5 have contributed enormously to this rulemaking

 6 initiative. I'd like to take a moment to thank

 7 all of our team members in D.C. as well as Chicago

 8 for their many important contributions to the

 9 development and drafting of this proposed

 10 rulemaking. Thank you.

 11 MR. PREISEROWICZ: Thank you, Phyllis.

 12 Good morning, Mister Chairman and Commissioner.

 13 As Phyllis mentioned, this rulemaking covers the

 14 reporting, recordkeeping, public information and

 15 information sharing core principles. The proposed

 16 rulemaking implements these core principles and

 17 expands on the regulatory and statutory language

 18 primarily for the reporting core principle and to

 19 a lesser extent recordkeeping. While it proposes

 20 to adopt the statutory language of Core Principles

 21 L and M, public information and information

 22 sharing, they are more or less the same form.
 59

 1 I would first like to address Core

 2 Principle J, reporting. The proposed regulations

 3 have been divided into two types of reporting

 4 requirements, one being periodic reports and two

 5 being event-specific reports, meaning the

 6 reporting requirement would be triggered by a

 7 current specific event. There is still regulatory

 8 language which would continue to allow the

 9 Commission to obtain additional information not

 10 specified in the regulations as necessary.

 11 First, periodic reporting, which has

 12 been divided into three different timeframes,

 13 daily, quarterly and annually. Daily reporting

 14 requirements would require certain information

 15 regarding margin, cash-flows and end- of-day

 16 positions to be reported to the Commission on a

 17 daily basis by the following business day morning.

 18 These margin and other information reporting

 19 requirements provide essential information to the

 20 Commission which a DCO has readily available as

 21 part of its regular business activities. Also

 22 several DCOs already provide such data to the
 60

 1 Commission on a regular basis. By making this a

 2 uniform requirement for all DCOs, Commission staff

 3 will receive a more complete set of data on a

 4 timely basis which lead to more effective

 5 oversight of DCOs and assist with the early

 6 detection of any issues.

 7 Next, the quarterly reporting

 8 requirements which simply restate the quarterly

 9 reporting requirements which have already been

 10 proposed in the financial resources for DCOs'

 11 rulemaking back in October where certain reports

 12 related to financial resources are required on a

 13 quarterly basis. Next, annual reporting

 14 requirements addressing DCOs' annual compliance

 15 report as required by the Dodd- Frank Act is

 16 simply a cross-reference to DCO report that

 17 Jonathan had just discussed. The other annual

 18 reporting requirement is for each DCO to file

 19 annual financial statements at year end with the

 20 Commission.

 21 Next are event-specific reports, the

 22 second category of reporting requirements.
 61

 1 Generally the reporting requirements are minimal.

 2 When more extensive reports are required by the

 3 proposed regulations, it will generally be in

 4 situations where the DCO has this information

 5 readily available in the ordinary course of its

 6 business or in connection with other regulations.

 7 Most of the event-specific reporting requirements

 8 can be categorized into two different categories,

 9 either relating to significant financial changes

 10 at the DCO or problems arising with a clearing

 11 member. In staff's experience, these are

 12 situations which rarely occur and will be expected

 13 to rule in only a handful or reports from all DCOs

 14 over the course of the year. The first example of

 15 a significant financial change would be an

 16 ownership equity decrease of 20 percent or more

 17 which would require the filing of pro forma

 18 financial statements no later than 2 business days

 19 prior to the anticipated decrease. This type of

 20 decrease is generally due to a planned corporate

 21 event such as a dividend payment which the DCO

 22 generally has advanced knowledge of and has all
 62

 1 the information necessarily which it would have to

 2 provide to the Commission as part of that

 3 transaction and other such reporting requirements

 4 where there is a sudden drop in financial

 5 resources or a deficit in the 6-month liquid asset

 6 requirement for DCOs that was also proposed in the

 7 financial resources proposed rulemaking. Both are

 8 situations where the DCO is already required to

 9 have such information readily available to them

 10 and the reporting requirement is a simple notice

 11 to the Commission. The second category of

 12 event-specific reports with clearing members

 13 requires a report to the Commission when there are

 14 issues ranging from a clearing member delaying

 15 initial margin payments to a clearing member

 16 default. These are rare occurrences and would

 17 require the DCO to notify the Commission of the

 18 event.

 19 I also wanted to point out two other

 20 event- specific reporting requirements which don't

 21 fit into these two categories. The first is

 22 certain organizational or corporate changes to the
 63

 1 DCO. Staff proposes advanced notice. These are

 2 planned events that a DCO will know about far in

 3 advance. Here too the reporting requirement

 4 requires information that is readily available to

 5 the DCO as a result of this planned change. Next

 6 is the requirement to report intraday initial

 7 margin calls. This requirement goes hand in hand

 8 with the daily reporting requirements and

 9 supplements daily information. If there are

 10 certain clearing member positions that could

 11 affect the ability of a DCO to meet its

 12 end-day-financial obligation, receiving the data

 13 the next morning sometimes may not be soon enough.

 14 Having this data would almost immediately alert

 15 the Commission to positions that compose greater

 16 risk. This especially important given that

 17 intraday initial margin calls are unusual and are

 18 often due to increasing position size.

 19 The next core principle that staff is

 20 proposing to codify is recordkeeping. The

 21 proposed regulations codify the statutory language

 22 with some additional clarification. The
 64

 1 recordkeeping requirement is intended to require

 2 maintenance of all records generated pursuant to

 3 Part 39, and for additional clarification the

 4 proposed rulemaking also specifies requirements to

 5 maintain records related to swaps. The rulemaking

 6 also includes a cross- reference to the

 7 Commission's technical and procedural

 8 recordkeeping requirements in Regulation 131.

 9 The third core principle staff is

 10 proposing to codify in this rulemaking is public

 11 information. The proposed regulations codify the

 12 core principle language also with some additional

 13 clarification. There are two additions to the

 14 core principle language in the proposed

 15 requirements. A DCO would be required to publicly

 16 disclose its rule book and a list of its clearing

 17 members. Although both are already done by both

 18 many DCOs, this requirement furthers the core

 19 principle mandate that a customer be able to fully

 20 understand the risks associated with a particular

 21 DCO. The clearing members of a DCO and its rules

 22 are a critical component of this in understanding
 65

 1 the financial integrity of a DCO.

 2 The final core principle addressed by

 3 this rulemaking is information management. The

 4 proposed rules would essentially codify the

 5 statutory provisions of Core Principle M,

 6 information sharing, in substantially the same

 7 manner. The language affords each DCO the

 8 appropriate level of discretion regarding the

 9 necessarily information- sharing agreements to

 10 enter into and staff does not perceive the need to

 11 articulate more specific requirements. This

 12 concludes my presentation and I'll be happy to

 13 take any questions.

 14 CHAIRMAN GENSLER: Jake, I thank you.

 15 Before I'll entertain a motion I'm going to ask to

 16 clean up what I just did. I'm going to ask

 17 unanimous consent that all final votes for

 18 publishing proposed or final rules to implement

 19 the Dodd-Frank Act conducted in a public meeting

 20 of this Commission be recorded votes. Not hearing

 21 any objection, it's unanimous consent that they're

 22 all recorded votes if they're on Dodd-Frank in a
 66

 1 public meeting. Now I'll entertain a motion on

 2 staff's recommendation on information management

 3 of clearinghouses.

 4 COMMISSIONER DUNN: So moved.

 5 COMMISSIONER SOMMERS: Second.

 6 CHAIRMAN GENSLER: I support the rule

 7 and I'll have a short statement that will go in

 8 the record. One of the pieces of the rule that I

 9 think I wanted to highlight and confirm is that

 10 Congress mandated that clearinghouses on a daily

 11 basis publish settlement prices and open interest

 12 on all of their contracts. I think this is a

 13 really important feature. Congress did it and

 14 we're putting it in the rules to promote

 15 transparency in the marketplaces that the public

 16 can actually see. Of course there is a lot in

 17 this rule for regulators to see that will help us

 18 help the markets be safer because we'll know

 19 what's happening in the clearinghouses. I think

 20 that largely happens now. I have two questions.

 21 One is am I right about the first part, public

 22 transparency on settlement prices and open
 67

 1 interest on a daily basis?

 2 MR. RADHAKRISHNAN: Yes. Everything

 3 that's critical.

 4 CHAIRMAN GENSLER: Secondly, most of the

 5 rest of it relates to transparency to regulators

 6 and not to the public though more of this may be

 7 brought into specificity, but that's consistent

 8 with what you as staff of a regulator already

 9 receive from the best regulated clearinghouses.

 10 Is that right?

 11 MR. RADHAKRISHNAN: Yes.

 12 CHAIRMAN GENSLER: Commissioner Dunn?

 13 COMMISSIONER DUNN: Thank you, Mister

 14 Chairman. I support this proposed rule. Ananda,

 15 I would like you to tell me what are you going to

 16 do with all this information and who is going to

 17 plow through it?

 18 MR. RADHAKRISHNAN: I'll have Julie talk

 19 about that.

 20 MS. MOHR: The Risk Surveillance Group

 21 and the DCO Review Group in Chicago are the groups

 22 that are going to be primarily looking at the
 68

 1 information on a daily basis. We'll be enhancing

 2 our existing financial surveillance of the

 3 marketplace and we're going to be able to help

 4 identify proactively issues that might be

 5 occurring in an effort to try to mitigate or ask

 6 questions before the issue blows up and becomes

 7 something that's more newsworthy. We think this

 8 helps protect market participants and the general

 9 public as a whole. It will also allow us to look

 10 at the health of the DCO and ensure that it is

 11 following all the procedures that they said they

 12 were doing on a daily basis.

 13 COMMISSIONER DUNN: Can you do that with

 14 existing staff?

 15 MS. MOHR: Right now we think with the

 16 existing rules in place that are proposed we would

 17 need one additional person who would help us out

 18 who would be looking at all the data coming in

 19 daily.

 20 MR. RADHAKRISHNAN: But the unknown

 21 factor is once swaps clearing goes full steam

 22 ahead, then the answer is no. That's why we asked
 69

 1 for more staff.

 2 CHAIRMAN GENSLER: Thank you,

 3 Commissioner Dunn. Commissioner Sommers?

 4 COMMISSIONER SOMMERS: I don't have any

 5 questions. Thank you.

 6 CHAIRMAN GENSLER: Thank you.

 7 Commissioner Chilton?

 8 COMMISSIONER CHILTON: No questions.

 9 Thank you.

 10 CHAIRMAN GENSLER: Thank you.

 11 Commissioner O'Malia?

 12 COMMISSIONER O'MALIA: I have one

 13 question. Rule 39.19(c)(4)(xiii) requires the DCO

 14 to provide the Commission with a notice of its

 15 initiation of a rule enforcement action against a

 16 clearing member or imposition of sanctions against

 17 a clearing member no later than 2 business days

 18 after. This occurs to me maybe as a result of our

 19 becoming more perspective that we're trying to

 20 define dates and times and as a result we may

 21 delay the process in which the Commission receives

 22 information during an investigative stage. It
 70

 1 appears to be that this rule would require 2 days

 2 after sanctions of a clearing member. Will that

 3 impact our ability to work during the

 4 investigative process to share information and

 5 cooperate with clearing members or because we're

 6 being prescriptive they're going to say it said 2

 7 days after so we're not going to talk to you until

 8 then? I'm a little concerned that we're being too

 9 rigid and that might undermine our ability. How

 10 will we get over that to make sure that we have

 11 good communications and we see these things in the

 12 investigative stage as opposed to some back-dated

 13 arbitrary date that we've set in these

 14 rulemakings?

 15 MS. DIETZ: To clarify, as to the

 16 provision, there are two parts to it. It's when

 17 they initiate rule enforcement and then when they

 18 impose the sanction.

 19 COMMISSIONER O'MALIA: So there's an

 20 earlier trigger that they have to notify us?

 21 MS. DIETZ: Yes.

 22 MR. RADHAKRISHNAN: If we get notice of
 71

 1 the imposition of the sanction, we would have

 2 already received notice of the initiation of the

 3 action against the clearing member because they

 4 are obliged to do both.

 5 COMMISSIONER O'MALIA: Thanks.

 6 CHAIRMAN GENSLER: Let me ask does it

 7 say no later than 2 days or?

 8 COMMISSIONER O'MALIA: It says no later.

 9 MR. RADHAKRISHNAN: Yes, no later than 2

 10 days.

 11 CHAIRMAN GENSLER: If there are no

 12 further questions, I'm going straight for the

 13 recorded vote. I think that could work in

 14 Robert's Rules because we had unanimous consent

 15 earlier.

 16 MR. STAWIK: Commissioner O'Malia?

 17 COMMISSIONER O'MALIA: Aye.

 18 MR. STAWIK: Commissioner O'Malia, aye.

 19 Commissioner Chilton?

 20 COMMISSIONER CHILTON: Aye.

 21 MR. STAWIK: Commissioner Chilton, aye.

 22 Commissioner Sommers?
 72

 1 COMMISSIONER SOMMERS: Aye.

 2 MR. STAWIK: Commissioner Sommers, aye.

 3 Commissioner Dunn?

 4 COMMISSIONER DUNN: Aye.

 5 MR. STAWIK: Commissioner Dunn, aye.

 6 Mister Chairman?

 7 CHAIRMAN GENSLER: Aye.

 8 MR. STAWIK: Mister Chairman, aye.

 9 Mister Chairman, on this vote the ayes are five

 10 and nays are zero.

 11 CHAIRMAN GENSLER: We'll send it to the

 12 Federal Register. Thank you all, clearinghouse

 13 team. We see you again I believe on December 16

 14 if we can get through all of this and in

 15 clearinghouse land it will be risk-management

 16 rules and there may be some other things beyond

 17 risk management on the 16th. Is that right,

 18 Phyllis?

 19 MS. DIETZ: Some procedural matters.

 20 CHAIRMAN GENSLER: Some procedural

 21 things, but primarily related to risk management

 22 for the clearinghouses and for the systemically
 73

 1 important clearinghouses. For those listening,

 2 we're giving a moment for one group of staff to

 3 move out and another group to come in, but we're

 4 going to be reviewing staff recommendations on

 5 designated contract markets. These are the

 6 exchanges is what most people would call them in

 7 public, but they've been called designated

 8 contract markets I think since the 1920s and

 9 certainly the 1930s in our regulations.

 10 Next up from the Division of Market

 11 Oversight we have Nancy Markowitz who is the team

 12 lead, Rick Shiltz who is the head of the division

 13 and Nadia Zakir who has been every present, but

 14 there are probably 10 or 15 other people on this

 15 team as well. Thank you and why don't you present

 16 your recommendations?

 17 MS. MARKOWITZ: Thank you. Good

 18 morning, Mister Chairman and Commissioners. Today

 19 staff is recommending for publication the

 20 rulemaking entitled Core Principles and Other

 21 Requirements for Designated Contract Markets. I

 22 first want to thank all the members of this team
 74

 1 particularly my deputy Nadia Zakir and everybody

 2 else who read the 252 pages of this rulemaking.

 3 Current Section 5 of the Commodity

 4 Exchange Act sets forth eight designation criteria

 5 and 18 core principles that designated contract

 6 markets or DCMs are required to comply with as a

 7 condition of obtaining and maintaining designation

 8 as a contract market. Section 735 of the

 9 Dodd-Frank Act amended Section 5 by eliminating

 10 the eight standalone designation criteria,

 11 revising many of the existing 18 core principles

 12 and adding five new core principles thereby

 13 requiring applicants and existing DCMs to comply

 14 with a total of 23 core principles as a condition

 15 of obtaining and maintaining designation as a

 16 contract market. The Dodd-Frank Act also amended

 17 the Commodity Exchange Act to require that the

 18 execution of swaps subject to the clearing

 19 requirement must occur either on a DCM or on a new

 20 type of facility called a Swap Execution Facility

 21 or also referred to as a SEF.

 22 The rules proposed today implement the
 75

 1 new and revised regulatory obligations of DCMs and

 2 also provide for the listing and trading of swaps

 3 on DCMs. To implement the provisions of the

 4 Dodd-Frank Act pertaining to DCMs, staff first

 5 undertook a comprehensive evaluation of existing

 6 regulations, guidance and acceptable practices

 7 associated with general designation provisions and

 8 core principles to determine which core principles

 9 would benefit from new or revised guidance or

 10 acceptable practices and which core principles

 11 would be better served by the certainty of

 12 regulation. Based on that review, staff proposes

 13 revised guidance and acceptable practices for some

 14 core principles and codification of new

 15 regulations in lieu of guidance and acceptable

 16 practices for other core principles. Staff also

 17 proposes new and revised regulations relating to

 18 the designation process for contract markets. The

 19 revised guidance and acceptable practices are

 20 based on staff's regulatory experience and also on

 21 industry practice and developments. The proposed

 22 regulations largely implement new statutory
 76

 1 mandates, are codified commonly accepted industry

 2 practices in order to provide greater transparency

 3 and regulatory certainty for applicants and

 4 existing DCMs. In many instances the proposed

 5 regulations are derived from the existing guidance

 6 and acceptable practices or codify requirements

 7 and practices that are commonly accepted in the

 8 industry today and that based on its experience in

 9 conducting routine surveillance and rule

 10 enforcement reviews staff has found to represent

 11 the exclusive or best means of complying with the

 12 core principle.

 13 It should be noted that while these

 14 proposed regulations prescribe the compliance

 15 obligations of DCMs with respect to certain core

 16 principles, for the most part the proposed

 17 regulations preserve the flexibility for DCMs to

 18 determine the specific manner in which they may

 19 carry out their obligations. In the interest of

 20 time I will provide a general overview of selected

 21 aspects of the proposed rulemaking.

 22 As an initial matter, staff is proposing
 77

 1 new and modified regulations in Part 38 pertaining

 2 to the process of applying for designation as a

 3 contract market and to certain other

 4 designation-related requirement. Staff proposes

 5 to eliminate the accelerated approval procedures

 6 for DCM applications, requiring instead that all

 7 applications be reviewed under the 180-day

 8 statutory review period. Since implementing the

 9 90-day review process in 2004, staff has

 10 determined that the expedited timeline is

 11 inefficient and rarely feasible as applicants

 12 seeking to meet the accelerated approval line

 13 often file incomplete or draft applications.

 14 Under our proposed rule, all DCM applications will

 15 now be reviewed within 180 days.

 16 With respect to the DCM application

 17 process and to provide applicants with greater

 18 certainty of the types of information that is

 19 required to support a DCM application, staff also

 20 proposes to include a new application form with

 21 comprehensive instructions and a specified list of

 22 documents and information that just accompany the
 78

 1 application. The majority of information required

 2 under the form application consists of information

 3 that historically has been required under the

 4 Commission's regulations or by Commission staff in

 5 its review of the DCM applications. Staff is also

 6 proposing new regulations associated with the DCMs

 7 listing and trading of swaps including reporting

 8 obligations and recordkeeping requirements as

 9 required under the Dodd-Frank Act. Staff also is

 10 proposing rules providing that a board of trade

 11 that operates a designated contract market may

 12 also operate a SEF provided that it separately

 13 registers the SEF, meets the SEF registration

 14 requirements and complies on an ongoing basis with

 15 the SEF rules and core principles under Section

 16 5(h) of the Commodity Exchange Act.

 17 For the 23 core principles, I briefly

 18 highlight some of the key proposals as related to

 19 their general regulatory requirements. There are

 20 five core principles that set forth a DCM's

 21 obligations to impose rules and ensure compliance

 22 with those rules in a number of areas. Amended
 79

 1 Core Principle 2, for examples, requires a DCM to

 2 establish, monitor and enforce rules relating to

 3 access requirements, terms and conditions of the

 4 contracts to be traded on its system and rules

 5 prohibiting abuse trading practices. The core

 6 principle also requires the DCM to have the

 7 ability to detect rule violations and sanction

 8 persons who violate the rules. To implement

 9 Amended Core Principle 2 staff proposes

 10 regulations that will require DCMs to prohibit a

 11 list of abusive trade practices all of which are

 12 already prohibited by DCMs to date or to prohibit

 13 those by statue or Commission regulation.

 14 Another proposed regulation requires

 15 DCMs to maintain sufficient compliance resources

 16 and staff to carry out its obligations under this

 17 core principle. This is a flexible regulation

 18 that does not prescribe how large staff should be

 19 but provides a number of factors that DCMs must

 20 take into account in determining the correct size

 21 of their compliance staff. Staff also proposes

 22 regulations that codify existing industry
 80

 1 practices including those requiring automated

 2 trail surveillance systems and their minimum

 3 capabilities, real-time market monitoring and

 4 regulations pertaining to investigations and

 5 investigation reports.

 6 Amended Core Principle 6 imposes

 7 compliance obligations on DCMs with respect to

 8 emergency actions. Under the core principle, a

 9 DCM is required to have rules to provide for the

 10 exercise of emergency intervention in the market.

 11 Recognizing that DCMs may have different

 12 procedures for taking emergency action, staff

 13 believes that it is appropriate to maintain an

 14 expanded version of the existing guidance that

 15 includes provisions emphasizing cross-market

 16 coordination of emergency action and to have

 17 alternative lines of communication and approval

 18 procedures in order to be able to address in real

 19 time emergencies that may arise. Staff believes

 20 that this is an important obligation given today's

 21 fact-paced trading systems and the need for DCMs

 22 to be able to react quickly to market events and
 81

 1 to intervene without delay. Over the years DCMs

 2 have developed certain best practices for

 3 emergency programs and staff is proposing those

 4 are acceptable practices.

 5 Amended Core Principle 14 requires DCMs

 6 to establish and enforce rules regarding

 7 alternative dispute resolution. Staff proposes to

 8 maintain the guidance and acceptable practices

 9 with certain revisions to enable DCMs to structure

 10 their appropriate dispute resolution programs.

 11 Amended Core Principle 9 requires that a

 12 DCM provide a competitive, open and efficient

 13 market and mechanism for executing transactions

 14 that protect the price discovery process of

 15 trading in a centralized market. The amended core

 16 principle recognizes that off-exchange

 17 transactions are permitted for bona fide business

 18 purposes if authorized by the DCM's rules. To

 19 implement this amended core principle, staff

 20 proposes among other things a regulation that

 21 updates the existing regulation with respect to

 22 the types of transactions that may be executed of
 82

 1 a DCM centralized market. Other new regulations

 2 are being proposed to address the specific

 3 statutory requirement under the Dodd-Frank Act of

 4 protecting the price discovery function of trading

 5 on the centralized market. New proposed

 6 regulations impose minimum requirements for

 7 trading on a DCM centralized market for contracts

 8 that are listed on the DCM, mandatory delisting of

 9 contracts if the requirements are not met,

 10 specified procedures for treatment of contracts

 11 existing prior to the effective date of these

 12 rules and limited exemptions for contracts based

 13 on petition to the Commission. In addition,

 14 regulations are being proposed to codify already-

 15 established practices and requirements for block

 16 trades for futures and other off-exchange

 17 transactions. The proposed rule sets forth block

 18 trade requirements for future contracts and

 19 options including who may enter into block trade

 20 transactions, conditions for block trades between

 21 affiliated parties, aggregation, recordkeeping and

 22 reporting procedures. In addition, a new
 83

 1 acceptable practice is being proposed for DCMs in

 2 determining the minimum size of black transactions

 3 for individual contracts and the manner of pricing

 4 block trades and other off- exchange transactions.

 5 By proposing these acceptable practices, staff

 6 recognizes the need for flexibility as the

 7 appropriate minimum size and pricing of block

 8 trades varies among contracts and across DCMs.

 9 Another group of core principle address

 10 requirements that must be met by contracts listed

 11 and traded on a DCM and the DCM's obligation to

 12 monitor trading activities. For Core Principle 3

 13 dealing with contracts not readily subject to

 14 manipulation, staff proposes to maintain the

 15 existing guidance with necessarily revisions to

 16 provide greater detail to DCMs regarding relevant

 17 considerations when designing a contract including

 18 swap contracts. Amended Core Principle 5 dealing

 19 with position limits or accountability requires

 20 DCMs to adopt for each contract as is necessary

 21 and appropriate position limitations or position

 22 accountability and requires that this limit cannot
 84

 1 be higher than the position limitation established

 2 by the Commission for any contract. The proposed

 3 regulation in this rulemaking requires that each

 4 DCM comply with the Commission's regulations

 5 pertaining to position limits.

 6 Amended Core Principle 4, prevention of

 7 market manipulation, was amended to require DCMs

 8 to take an active role not only in monitoring

 9 trading activities within their market but also in

 10 preventing market disruption. As to this core

 11 principle, staff proposes to codify relevant

 12 proposes of the current guidance on acceptable

 13 practices and to include new requirements that

 14 take into consideration the amended language and

 15 developments within industry. To comply with this

 16 core principle, a proposed rule requires DCMs to

 17 have the ability to conduct real-time trade

 18 monitoring and comprehensive trade reconstruction.

 19 In order to prevent market disruptions due to

 20 suddenly volatile price movements, the proposed

 21 rules require DCMs to establish and enforce trade

 22 risk controls including but not limited to market
 85

 1 restrictions that pause or halt trading under

 2 certain conditions. Pauses and halts are just one

 3 type of risk control, and accordingly the

 4 rulemaking requests public comment as to the

 5 appropriateness of a variety of trade risk

 6 controls that may be necessary to reduce the risk

 7 of market disruption.

 8 Two core principles impose financial

 9 integrity obligations on DCMs. Amended Core

 10 Principle 11 requires DCMs to establish and

 11 enforce rules and procedures for ensuring the

 12 financial integrity of transactions entered into

 13 on or through the DCM including the clearing and

 14 settlement of the transactions with a derivatives

 15 clearing organization. This core principle also

 16 requires DCMs to establish and enforce rules to

 17 ensure the financial integrity of any futures

 18 commission merchant and introducing broker. For

 19 the most part, the proposed regulations codify

 20 language in the existing regulations in Section

 21 1.52 and application guidance for Core Principle

 22 11 and the guidance for former Designation
 86

 1 Criteria 5. New Core Principle 21, financial

 2 resources for DCMs, requires a DCM to have

 3 adequate financial resources to discharge its

 4 responsibility and to maintain financial resources

 5 sufficient to cover operating costs for a period

 6 of at least 1 year calculated on a rolling basis.

 7 Staff proposes regulations including those

 8 relating to the types of financial resources

 9 available to DCMs to satisfy their financial

 10 requirements, valuation and need calculation

 11 requirements that the DCM must make but can use

 12 its own methodology and financial resources

 13 reporting requirements.

 14 Finally, new Core Principle 20, system

 15 safeguards, establishes operational and system

 16 safeguard requirements for all DCMs. Among other

 17 things, the proposed rules require that DCMs

 18 establish and maintain a program of risk analysis

 19 and oversight to identify and minimize sources of

 20 operational risk and have emergency backup

 21 procedures. The proposed rules also require DCMs

 22 to notify Commission staff of various system
 87

 1 security-related events and to conduct regular

 2 objective testing and review of its automated

 3 systems. These regulations will provide certainty

 4 and transparency to DCMs as to their system-

 5 related obligations and more security to their

 6 systems. Staff encourages and looks forward to

 7 hearing from the public on all aspects of this

 8 proposed rulemaking and in particular with respect

 9 to the specific questions posed in the proposed

 10 rulemaking. I'd be happy to answer any questions

 11 at this time.

 12 CHAIRMAN GENSLER: Thank you, Nancy.

 13 With that I'll entertain a motion on the staff

 14 recommendation on DCM core principles.

 15 COMMISSIONER DUNN: So moved.

 16 COMMISSIONER SOMMERS: Second.

 17 CHAIRMAN GENSLER: I support the

 18 proposed rulemaking to update rules and guidance.

 19 I note that there is a lot of guidance in this,

 20 that this is not just a proposed rule, but

 21 proposed guidance with designated contract

 22 markets. The Dodd-Frank Act updated language.
 88

 1 There were core principles that were put in place

 2 just 10 years ago and I think that there were if I

 3 recall 15 or 16 core principles -- 18 core

 4 principles, and now there are 23, and even amongst

 5 those 18 some of them were amended by Congress.

 6 So I think it's important to update our rules and

 7 guidance to reflect the changes that there are now

 8 23 core principles and even amongst the original

 9 18 there is changed language.

 10 Further, I think that the Dodd-Frank Act

 11 for the first time allows DCMs, these contract

 12 markets, to also trade swaps or a market

 13 designated contract maybe to be affiliated with a

 14 swap execution facility as staff walked through.

 15 So I think it's important to update the rules and

 16 guidance of these contract markets to these two

 17 really important changes. One, there are now 23

 18 core principles and not 18, and even 18 were

 19 changed. And two, that there are going to be some

 20 contract markets that want to trade swaps and of

 21 course they're going to be swap execution

 22 facilities. We will be considering I think
 89

 1 hopefully next week, I see Reva here -- I think

 2 we're going to try to consider proposed rules and

 3 guidance for swap execution facilities next week

 4 or at the latest 2 weeks from now so that I think

 5 it's also important that we have in place new

 6 rules and guidance on this one.

 7 I do have a couple of questions to

 8 highlight a topic or two. I know that some people

 9 have mentioned that these rules are more

 10 prescriptive than we've been in the past and that

 11 may well be the case. There are now 23 core

 12 principles and there are not 18. But one area

 13 that's been I think important to this Commission

 14 is convergence in wheat contracts and convergence

 15 in other contracts. I think it's at the core of a

 16 well-functioning futures market. This is before

 17 you get to swaps. But I think it's at the core of

 18 a well-functioning futures market that market

 19 participants, farmers, ranchers, grain elevator

 20 operators, investors, even speculators, have

 21 confidence that this contract that we call a

 22 future which is just a derivative actually at some
 90

 1 point in time for even a short moment converges

 2 with the actual price of the physical commodity.

 3 I think that's at the core of this invention that

 4 was about 150 years ago called futures. So I was

 5 glad that staff recommended that in the rules that

 6 it says that a designated contract market must

 7 continually, and this is in Rule 38.252, monitor

 8 the appropriateness of the contract terms and

 9 conditions including the delivery instrument, et

 10 cetera. So we're saying it is prescriptive, they

 11 have to monitor. Then it says the designated

 12 contract market must address conditions that are

 13 interfering with convergence or causing price

 14 distortions, et cetera. We don't say how they

 15 have to address it, but we say they have to

 16 monitor and address.

 17 I'm interested in public comments on

 18 this, but this is one place where I think it was

 19 worthwhile to make a proposal, see what the public

 20 things, convergence is the core of our futures

 21 market. I use it as an example. I think it's

 22 important that the public comments not only on
 91

 1 38.252, but on each of the pieces that staff I

 2 think thoughtfully put forward. I don't have

 3 questions.

 4 MS. MARKOWITZ: I'll also add to that

 5 that we add in our preamble that one of the things

 6 people will get for convergence is delivery terms

 7 and we've asked the public specifically in looking

 8 at convergence factors what are other factors

 9 besides delivery standards should they look at to

 10 make sure that there is convergence.

 11 CHAIRMAN GENSLER: I by the way don't

 12 think it's too much to say they need to monitor

 13 and they should address but it doesn't say how.

 14 They have to address.

 15 MS. MARKOWITZ: It doesn't say ensure

 16 either.

 17 CHAIRMAN GENSLER: It doesn't even say

 18 ensure convergence. That's why this is just a

 19 proposal and we'll see what others think about it.

 20 One other question. I know it's not a percentage

 21 test, but how much of this is guidance versus

 22 proposed rules because I keep stressing that this
 92

 1 is both guidance and rules. Maybe you don't have

 2 a percentage.

 3 MS. MARKOWITZ: I would say about 30

 4 percent continued guidance or 35 percent continued

 5 guidance.

 6 CHAIRMAN GENSLER: We already had some

 7 rules though.

 8 MS. MARKOWITZ: Correct. Part 38 was

 9 all regulations.

 10 CHAIRMAN GENSLER: Part 38 was all

 11 regulations.

 12 MS. MARKOWITZ: Correct. And many of

 13 the regulations, and I could go through a number

 14 of them, are incredibly flexible in terms of how

 15 you comply with those, it's setting out what you

 16 need to do to comply but we leave a lot of

 17 flexibility in how one goes about doing it.

 18 CHAIRMAN GENSLER: Commissioner O'Malia

 19 was very helpful in the language and I know

 20 Commissioner Chilton weighed in a lot on the

 21 language that says that contract markets should

 22 have mechanisms for market pauses and risk
 93

 1 mitigants, but we ask a whole series of questions

 2 as to how to get this right for the final rule.

 3 We're going to have enormous input from our Joint

 4 Advisory Committee on the May 6 events, we're

 5 going to have enormous input from what's called

 6 the Technology Advisory Committee and through this

 7 60-day public comment period. I think that's a

 8 really important feature of this. I know that you

 9 might be voting against it.

 10 COMMISSIONER O'MALIA: That's a good

 11 part of this rule.

 12 CHAIRMAN GENSLER: I think that's a

 13 really important piece and I do think that come

 14 the final rule we'll probably be prescriptive

 15 about some pieces of that. Commissioner Dunn?

 16 COMMISSIONER DUNN: Thank you, Mister

 17 Chairman. I do believe that one of the most

 18 important parts of the futures market is price

 19 discovery and Core Principle 9 which zeroes in on

 20 that is an important aspect of this and I

 21 appreciate staff working on that particular area.

 22 I do have concern as I said in my opening
 94

 1 statements about us moving to a more prescriptive

 2 rather than a principle-based regulatory regime.

 3 I am looking for public comment on this from the

 4 industry that if in fact they're in fact saying we

 5 need a safe harbor and that's what you're

 6 providing us with, I can understand that. But if

 7 I hear what you're doing is giving us more

 8 problems and more hoops to jump through and we

 9 can't be as nimble as we need to be to be

 10 competitive, then I will have concerns. I notice,

 11 Phyllis, that there is also similar to DCIO you're

 12 doing away with the 90-day and asking for 180

 13 days.

 14 MS. MARKOWITZ: Correct.

 15 COMMISSIONER DUNN: Is it a similar type

 16 of problem of incomplete applications coming in?

 17 MS. MARKOWITZ: Absolutely, and it's

 18 like what you've said before that we become their

 19 lawyers and representatives and take them through

 20 the entire process and the back and forth. We've

 21 gotten applications that are not even close to

 22 complete and it's a back and forth and it's an
 95

 1 enormous amount of resources that takes us away

 2 from other things so that it's rarely feasible

 3 that they do this within the 90-day period.

 4 COMMISSIONER DUNN: Thank you, Nancy.

 5 Rick, as I look at this, it's so important for

 6 core principles that we have adequate staffing to

 7 do the RERs. Do we have it at the present time

 8 especially as we're going in to assess other

 9 exchanges?

 10 CHAIRMAN GENSLER: Rick, you might want

 11 to say what an RER is for the public.

 12 MR. SHILTZ: An RER is what we call a

 13 rule enforcement review. It's an examination of

 14 an exchange's ability to comply with various core

 15 principles and their regulatory requirements, and

 16 I think the short answer is no. With the large

 17 number of SEFs that are expected to come in

 18 including SDRs and combine that with all of the

 19 existing DCMs and new DCMs to carry out reviews on

 20 any sort of a routine basis we would need more

 21 staff and that's what we've requested in the

 22 various budget requests going forward for fiscal
 96

 1 year 2011 and 2012. If we don't get that then

 2 somehow we'd have to prioritize which reviews we

 3 do and what adjustments we make in terms of some

 4 of the other missions of the division. But I

 5 would say that at the moment we don't have

 6 sufficient staff to carry out those reviews.

 7 COMMISSIONER DUNN: I have suggested in

 8 the past that we have a couple of choices to make,

 9 one, that we can ask the SROs to do more and step

 10 up to the plate or we can become more prescriptive

 11 as some may say we're doing here already.

 12 MR. LAVE: I'd like to make a comment

 13 when you brought up the rule enforcement reviews

 14 or the RERs, that in terms of what we looked at in

 15 developing these proposed regulations and

 16 guidance. In many cases they were derived from

 17 the conclusions that we made in doing these

 18 examinations, the thought being that if an

 19 exchange didn't have some sort of an automated

 20 surveillance system or some other program in

 21 place, we would come back and recommend to the

 22 Commission that they're not in compliance with the
 97

 1 core principles. To some extent what we were

 2 trying to do when Nancy provide this clarity is to

 3 say that if you don't have these provisions in

 4 place or mechanisms for oversight then staff would

 5 recommend that they're not in compliance reserving

 6 whatever flexibility. That's the motivation

 7 behind what we were thinking when we went through

 8 the review.

 9 COMMISSIONER DUNN: The RERs in fact

 10 become a bellwether to the industry that says this

 11 is what the Commission is interested in and they

 12 are publicly published so that the industry can

 13 say this is what they're looking at. My question

 14 to you is how frequently do we do these RERs? Is

 15 it once every 6 months? Once a year? Every 18

 16 months? Or are we on a 3-year cycle?

 17 MR. LAVE: I guess the short answer is

 18 not often enough. I think if you go back about 10

 19 years or so, the goal was to do each exchange

 20 every 2 years and I think over the last 10 years

 21 the frequency has declined because we haven't been

 22 able to have sufficient staff to do that. I know
 98

 1 the Chairman has said and our goal is to

 2 ultimately be able to have sufficient staff to

 3 look at each exchange, at least all the major

 4 exchanges, on an annual basis and have some sort

 5 of a review ongoing. But again going back to your

 6 first question, it's a question of having adequate

 7 staff to do that.

 8 COMMISSIONER DUNN: Thank you.

 9 CHAIRMAN GENSLER: Thank you,

 10 Commissioner Dunn. I think the statistics are,

 11 and I see Rachel there who runs our RER program,

 12 her whole group of people who do it, is it once

 13 about every 3 years now at best? With the larger

 14 ones maybe a little bit more frequently and the

 15 smaller ones less. Commissioner Sommers?

 16 COMMISSIONER SOMMERS: Thank you, Mister

 17 Chairman. I have some questions regarding Core

 18 Principle 9 and I think that although I realize

 19 that the amendments that were made to Core

 20 Principle 9 in Dodd-Frank are requiring us to

 21 adopt these subpart J proposals, I have questions

 22 about how we have interpreted the language. I
 99

 1 would respectfully suggest that although Congress

 2 put this language in that there may be some

 3 contracts that trade right now that actually may

 4 not perform a price discovery function. In us

 5 interpreting what that language said, I have many

 6 concerns about what we're doing in this particular

 7 area. One, in the requirements under this new

 8 38.502, we are proposing minimum requirements for

 9 trading on the centralized market, and if you

 10 could go through with us because I'm not sure it's

 11 actually explained in here how we came to the 85

 12 percent. If you could talk about the 85 percent

 13 and I would ask that people who are commenting

 14 specifically on this rule to let us know whether

 15 that is an appropriate number or if there are

 16 concerns in this area.

 17 MS. MARKOWITZ: Thank you. I wanted to

 18 first note that your statement that there are

 19 contracts that trade that may not provide the

 20 price discovery function, that contracts that are

 21 really going to be impacted by this core principle

 22 never trade, there is 100-percent off- exchange
 100

 1 trading and that's what the proposed rule is

 2 trying to address.

 3 COMMISSIONER SOMMERS: That's my point.

 4 MS. MARKOWITZ: In essence what we did

 5 is we looked at the new provisions of the

 6 Dodd-Frank Act that said that there should be a

 7 competitive, open and efficient market and

 8 mechanism that protects the price discovery

 9 process of trading on the centralized market,

 10 obviously Congress recognized that there is a

 11 price discovery function from trading and that in

 12 order to implement this we thought that there had

 13 to be some trading on the centralized market to

 14 protect the price discovery process. We thought

 15 it would provide regulatory certainty and clarity

 16 if we gave a certain percentage number. What we

 17 did is we had our trade specialists in Chicago

 18 come up and do a survey of 570 contracts over a

 19 3-month period. These are 10 different asset

 20 classes involving various levels of open interest,

 21 we provided a cross-market sampling of the types

 22 of contract and involved each contract market.
 101

 1 What we found was three categories of contracts;

 2 410 contracts were mostly energy contracts that

 3 never traded on the centralized market. There was

 4 absolutely no trading over this period of time.

 5 There was a middle category of contracts that

 6 there was centralized trading. These are

 7 contracts like euro dollars, treasuries,

 8 agricultural commodities and there was healthy

 9 centralized market trading. Then there is a

 10 third, a middle ground, which I'll get to in a

 11 minute. When we looked at this middle category we

 12 thought it was a good barometer to say let's see

 13 how much off-exchange trading there is in these

 14 contracts and the off-exchange trading over this

 15 period was between zero and 15 percent. We

 16 thought that was a good starting point in saying

 17 that for it to have a healthy centralized market

 18 and still balance that with the other provision in

 19 the regulation, that you can have off-exchange

 20 trading. We thought 15 percent off-exchange

 21 trading was a good starting point.

 22 I'll note that we feel comfortable with
 102

 1 that position initially. We note that the FIA has

 2 a policy that requires no more than 10-percent

 3 off-exchange trading so that we felt we were

 4 fairly with a good ballpark figure. FSA, I'm

 5 sorry. Did I say FIA? We do though as you have

 6 said ask for public comment as to whether there

 7 was another percentage that would be more

 8 appropriate and asking commenter specifically to

 9 say why that would. We also note that we asked

 10 for comments as to whether there should be a

 11 lesser amount if it is a price discovery contract

 12 but a lesser amount on the exchange and whether

 13 there should be an exemption for those types of

 14 contracts.

 15 Let me say that there is a third

 16 category we came up with which was not the extreme

 17 of no trading but it wasn't up to 85 percent

 18 on-exchange trading and there's a middle ground.

 19 We recognize that there are contracts,

 20 particularly new contracts, that take time to get

 21 traction on the centralized markets, some that

 22 have 50 or 60 or even lower, and we do incorporate
 103

 1 a provision in our rules that says in those

 2 situations they could petition the Commission to

 3 allow these contracts more time to grain traction

 4 and get more trading on the centralized market so

 5 that they wouldn't have to go off the market

 6 before that time.

 7 COMMISSIONER SOMMERS: Thank you, Nancy.

 8 I want to clarify that I was referring to those

 9 specific contracts that are contracts that don't

 10 trade often and that have specific terms that I

 11 don't believe have price discovery function that

 12 serves a public good, that everybody is going to

 13 specifically care about what the price of that

 14 little contract is. Those contracts are cleared

 15 now and listed in an exchange and I don't think

 16 we've had a problem with that so I have concerns

 17 about this interpretation.

 18 CHAIRMAN GENSLER: Thank you,

 19 Commissioner Sommers. Commissioner Chilton?

 20 COMMISSIONER CHILTON: Thanks, Mister

 21 Chairman. I think the team has done a great job,

 22 that Nancy has done a super job, on this. But I
 104

 1 was thinking and this was granted the eleventh

 2 hour that these core principles are the Holy Grail

 3 of our regulatory regime and with the advent of

 4 high-frequency trading and robotic trading, there

 5 is really no mention of that in these core

 6 principles at all. There is a story I think

 7 probably people read, that my colleagues read, by

 8 Jeremy Grant in the "FT" this morning. The

 9 headline was something "Super-Fast Traders Post

 10 Risk to Clearing" and they talk about how in the

 11 E.U., 50 percent of the intraday trading is

 12 high-frequency trading. Even here our economists

 13 at the CFTC say that high-frequency trading on the

 14 traditional exchanges, what we regulate currently

 15 as of this beginning of this year, now accounts

 16 for at least a third of all on-exchange trading

 17 and perhaps more, so a third here, 50 percent in

 18 Europe. High- frequency trading is a big deal,

 19 it's arrived and so I'm thinking that we should

 20 add place in here perhaps in the General

 21 Requirements 38.251 and in the Automated Trade

 22 Surveillance System's Section 38.156, some
 105

 1 appropriate reference to high-frequency trading.

 2 I'm wondering, Nancy, if you think that would

 3 create and problem from your point of view.

 4 MS. MARKOWITZ: I don't believe it will.

 5 I also want to note that in our discussion of

 6 having an Automated Trade Surveillance System we

 7 do note that it's important to have an automated

 8 system given the fast pace of trading including

 9 the existence of high-frequency traders so that I

 10 think a reference in this section would be very

 11 helpful.

 12 COMMISSIONER CHILTON: Mister Chairman,

 13 I don't know if anybody wants to discuss it, but I

 14 would make a motion that we let staff at the

 15 appropriate place in the two sections I noted add

 16 an appropriate reference to high- frequency

 17 trading.

 18 CHAIRMAN GENSLER: You're talking about

 19 in the preamble?

 20 COMMISSIONER CHILTON: I'm talking about

 21 in Sections 38.251 where it says General

 22 Requirements, and 38.156 where it talks about
 106

 1 Automated Trade Surveillance Systems.

 2 MS. MARKOWITZ: It's Principle 4 rules.

 3 CHAIRMAN GENSLER: Nancy, could you help

 4 with Commissioner Chilton's question? Maybe I'm

 5 mistaken and it might be in the preamble, I

 6 thought we referred to high- frequency trading

 7 somewhere.

 8 MS. MARKOWITZ: We do in the preamble

 9 but we don't in the rule. What we're proposing

 10 here is --

 11 CHAIRMAN GENSLER: What the Commissioner

 12 is proposing?

 13 MS. MARKOWITZ: Yes, what the

 14 Commissioner is proposing. I think what we had

 15 proposed is in 38.251.

 16 CHAIRMAN GENSLER: Do you have a page

 17 number?

 18 MS. MARKOWITZ: 164. The third-to-last

 19 line right after unusual trading volumes.

 20 CHAIRMAN GENSLER: This is in the rule,

 21 that monitoring of intraday trading must include

 22 the capacity to detect abnormal price movements,
 107

 1 unusual trading volumes, impairments to market

 2 liquidity and position limit violations.

 3 MS. MARKOWITZ: What I believe the

 4 Commissioner is proposing is that the monitoring

 5 of intraday trading must include the capacity to

 6 detect abnormal price movements, unusual trading

 7 volumes, the extent of high- frequency trading,

 8 impairments to market liquidity and then the rest

 9 of the sentence is the same, and position limit

 10 violations.

 11 CHAIRMAN GENSLER: The words are "the

 12 extent"?

 13 MS. MARKOWITZ: The extent of

 14 high-frequency trading.

 15 COMMISSIONER O'MALIA: May I ask?

 16 CHAIRMAN GENSLER: Yes. The Chair

 17 recognizes Commissioner O'Malia.

 18 COMMISSIONER O'MALIA: Thank you. I

 19 know that Commissioner Chilton had circulated some

 20 language before. How would the DCM do that to

 21 detect the extent of high- frequency trading?

 22 COMMISSIONER CHILTON: I'll let staff
 108

 1 answer, Commissioner O'Malia, but when I spoke

 2 with CME when we were in Chicago last month or

 3 several weeks ago, they acted like they're all

 4 over this already. They told me about their 18

 5 years of experience looking at algorithmic trading

 6 and automated trading and they say that they are

 7 looking at this and they are well aware of what's

 8 going on so that I don't really think it's

 9 anything that would be novel to the exchanges and

 10 of course that's why we get comments on it. But I

 11 think it's something they already do and that it

 12 would just be recognized by some insertion in our

 13 core principles. Nancy, did you want to add

 14 further?

 15 MR. SHILTZ: We're not aware now or sure

 16 whether the exchanges have those capabilities in

 17 place to do that but it would be something if it

 18 were required they would have to develop some

 19 mechanism to monitor for that.

 20 COMMISSIONER CHILTON: Rick, let me ask,

 21 you're not aware of whether or not they have

 22 systems that monitor algorithmic and
 109

 1 high-frequency trading?

 2 MR. SHILTZ: Yes, we're not whether all

 3 the exchanges do now or not. They may be in the

 4 process of developing tools to monitor for that

 5 but I don't know off the top of my head and we're

 6 not sure here.

 7 COMMISSIONER CHILTON: That's an issue

 8 too and even more reason for adding some of this.

 9 By the way, I don't think that I circulated any

 10 particular language as Commissioner O'Malia was

 11 saying. However staff feels appropriate to

 12 reference high-frequency traders, that's all I'm

 13 trying to get at. I think it would be obvious

 14 that we are missing something if we don't. I'm

 15 not wedded to any particular language, I just want

 16 to reference the high- frequency traders and it

 17 seemed that those two spots made the most sense.

 18 CHAIRMAN GENSLER: The two spots again

 19 are 251, and what was the other one?

 20 COMMISSIONER CHILTON: 156, the General

 21 Requirement, and then 156 is the Automated Trade

 22 Surveillance System, Mister Chairman.
 110

 1 CHAIRMAN GENSLER: I know we're doing

 2 this ad hoc, but would you be amenable because of

 3 the late moment that we ask a question regarding

 4 38.156 which is Automated Trade Surveillance and

 5 with regard to General Requirements and we'd be

 6 asking whether it would be appropriate to require

 7 them to in 251 to have the capacity to monitor for

 8 high-frequency trading and the similar question in

 9 156?

 10 COMMISSIONER CHILTON: Are you

 11 suggesting that we put it in as a question, Mister

 12 Chairman?

 13 CHAIRMAN GENSLER: Yes, and then

 14 depending on what people say. I'd ask the General

 15 Counsel, but we'd then put people on notice that

 16 we're seriously considering it.

 17 COMMISSIONER CHILTON: To be honest, it

 18 seems incredible that we're not sure if whether or

 19 not all exchanges have systems to monitor

 20 high-frequency trading. It's 30 percent of our

 21 markets, a third of our markets, and 50 percent of

 22 the European markets. It seems to me that this is
 111

 1 something that's prima facie stuff we should be

 2 doing. Mister Chairman, if you object to

 3 inserting this, I'll withdraw my motion.

 4 CHAIRMAN GENSLER: No, I'm supportive,

 5 but right now the words aren't in front of us so

 6 that I'm trying to find a way to do it that best

 7 accommodates getting the support of this

 8 Commission. I'm supportive that exchanges have

 9 some sense of what's going on. You and

 10 Commissioner O'Malia worked hard, you were both

 11 working on the risk monitoring and market pauses

 12 that are really important. They're not isolated

 13 to high-frequency traders, but it's broadly

 14 applicable. I'm supportive, but I'm trying to

 15 find a way through to get the document amended to

 16 help on this point.

 17 COMMISSIONER CHILTON: We've given

 18 staff, Mister Chairman, some discretion on various

 19 things that we've done in our public meetings. If

 20 folks aren't comfortable with giving them the

 21 discretion, perhaps we could ask them to come up

 22 with some suggested language before we conclude
 112

 1 here today. If that's not acceptable, we could do

 2 it as a question, but I assume we'd want to see

 3 that question also. But either way it seems that

 4 if staff could come up with something, it would be

 5 helpful. Mister Chairman, I'll do whatever you'd

 6 like in this regard.

 7 CHAIRMAN GENSLER: I'm looking at Dan

 8 Berkovitz. I want to ask the question the right

 9 way. What I'm suggesting is to capture

 10 Commissioner Chilton's question in a way that we

 11 appropriately put the public on notice that we're

 12 considering this and that we find what the public

 13 thinks on whether exchanges monitor and have the

 14 capacity to monitor the amount of high-frequency

 15 trading on their platforms.

 16 MR. BERKOVITZ: Asking the question in

 17 that manner would certainly be appropriate to get

 18 public comment on that issue. What response the

 19 Commission would take in terms of a new regulation

 20 in response to such comments would have to be

 21 related to the rule as it currently is proposed if

 22 you're not actually amending the rule itself.
 113

 1 CHAIRMAN GENSLER: It's just a question

 2 of whether in this one section should they monitor

 3 the amount of high-frequency trading on their

 4 platforms. I think that's it as I understanding

 5 it.

 6 MR. BERKOVITZ: And depending on how the

 7 final rule is crafted, the Commission may be able

 8 to do it.

 9 CHAIRMAN GENSLER: Commissioner Dunn, do

 10 you have some help here? I'm going to ask one

 11 more question. Nancy, it may be page 150, but

 12 it's 38.251. I'm sorry. I had the wrong one.

 13 251, does not already say that they have to

 14 collect and evaluate data on individual traders'

 15 market activity on an ongoing basis in order to

 16 detect and prevent manipulation?

 17 MS. MARKOWITZ: Yes, it says that.

 18 CHAIRMAN GENSLER: Doesn't that give a

 19 way to collect information on high-frequency

 20 traders? We've been maybe more prescriptive than

 21 Commissioner Chilton is suggesting, but this says

 22 they have to collect and evaluate data on
 114

 1 individual traders' market activity. I guess the

 2 only additional question is whether they have to

 3 aggregate a class of traders. Commissioner

 4 Chilton, if you'd be all right, I'd suggest adding

 5 a question that staff can draft but specific

 6 enough that would say the Commission is

 7 considering and would like public comment on

 8 whether we should add that they aggregate such

 9 data so that they can monitor high-frequency

 10 traders more broadly in the aggregate.

 11 COMMISSIONER CHILTON: That's fine with

 12 me.

 13 CHAIRMAN GENSLER: I'll ask for

 14 unanimous consent for that amendment. Not hearing

 15 any objection, it's so moved. Are there other

 16 questions? Commissioner Chilton was asking his

 17 questions. Commissioner O'Malia?

 18 COMMISSIONER O'MALIA: Thank you. By

 19 coincidence I scheduled a meeting in Delaware on

 20 the day before we had over 500 pages of rulemaking

 21 to approve, but it was a helpful meeting. I was

 22 able to go and join Commissioner Phil Moeller from
 115

 1 the FERC and to speak to the PJM board meeting and

 2 the discussion built on our previous meeting that

 3 Commissioner Moeller and I held here in this

 4 hearing room on clearing in energy markets. I

 5 want to build on what Commissioner Sommers has

 6 said about the importance of Core Principle 9 and

 7 the impacts this change will have on energy

 8 markets. At the discussion, obviously these are

 9 end users and these are people who are exempt from

 10 clearing and the exchange trading mandate in the

 11 bill but do find and have found for the past 8-1/2

 12 years using the ClearPort system to clear trades

 13 bilateral trades, energy trades. You mentioned

 14 410 contracts, and the fact that we've created

 15 this unique class is part of this exchange for

 16 swaps, EFS. We have clearing but they don't

 17 trade, but the nice thing about these products are

 18 that they do manage risk through clearing,

 19 bilateral risk, they're capital efficient as a

 20 result of the netting arrangements they're able to

 21 do with portfolio margining within their accounts

 22 and on the CME platforms so that these end users
 116

 1 really found significant benefit. They're not

 2 under mandate now and they won't be under mandate

 3 in the future. Maybe you have the number. What

 4 is the notional value? I've heard a massive

 5 number of what these over 400 energy contracts are

 6 worth.

 7 MS. MARKOWITZ: I don't know the

 8 notional value.

 9 COMMISSIONER O'MALIA: Somebody

 10 mentioned that it was multiple times, the futures

 11 value of these similar energy contracts so that

 12 we're talking a big collection of products here

 13 it's all clearing which is the goal of this Act.

 14 Now we have a rulemaking that I'm afraid will

 15 jeopardize that and I think this 85 percent litmus

 16 test and I think that if we're kicking them out in

 17 90 days if they don't meet that is kind of

 18 throwing the baby out with the bathwater. I'm

 19 very concerned about the implications of what will

 20 happen. I've asked staff to go through the rule

 21 and see if we even asked this question, What are

 22 the implications on portfolio margining and what
 117

 1 are the implications of the tax treatment of not

 2 treating these as futures but as swap? I

 3 understand that the bill provides a significantly

 4 different tax treatment. Did we include any

 5 questions specifically on portfolio margining and

 6 taxes as a result of this change assuming none of

 7 these are going to be EFSes?

 8 MS. MARKOWITZ: Let me first say that

 9 under our proposed rules the end users will still

 10 be able to enter into these contracts as long as

 11 it doesn't exceed a certain percentage which would

 12 be the 15 percent. These contracts are entered

 13 into solely to take advantage of the clearing

 14 aspect of it in terms of using the segregated

 15 customer account, portfolio margining and tax

 16 benefits. These provisions, like I said, they

 17 will continue to be able to trade on the DCM, not

 18 trade, but actually list and then clear through

 19 the DCM as long as it doesn't exceed 15 percent.

 20 However, if it goes beyond 15 percent, they can

 21 execute on a SEF. It's SEF's understanding that

 22 there are going to be provisions proposed or I
 118

 1 know staff is thinking about having a segregated

 2 swap customer account that will provide bankruptcy

 3 protection as well as staff is thinking of

 4 propounding a rule allowing futures into the swap

 5 accounts so there will be portfolio margining. So

 6 there are alternatives.

 7 COMMISSIONER O'MALIA: But if we don't

 8 change Core Principle 9, they get that benefit

 9 today, they may not get this benefit going

 10 forward. You've laid out a couple of options and

 11 things we may approve and consider, but betting

 12 that this will all fall into place and that they

 13 will not choose to use their end user exemption to

 14 go back into a bilateral space. They're end

 15 users. They're electricity companies and energy

 16 companies.

 17 MS. MARKOWITZ: The difference

 18 post-Dodd-Frank is that they now have a clearing

 19 solution, that they can now have their contracts

 20 cleared which is why initially they opted to list

 21 through EFS process on the DCM, it was purely to

 22 get the clearing aspect of and now their contracts
 119

 1 can be cleared so that I'm not sure they're going

 2 to be harmed in any way in terms of this

 3 percentage requirement because they are going to

 4 be cleared which is why they initially went on --

 5 COMMISSIONER O'MALIA: But what is the

 6 impact on taxes and portfolio margining as a

 7 result of all of this?

 8 MS. MARKOWITZ: As I said and as I

 9 understand, staff is considering allowing futures

 10 to be in the swap account which will allow

 11 portfolio margining. And in terms of the tax

 12 benefits, our rule implemented the Commodity

 13 Exchange Act and we didn't deal with the tax code

 14 and what the tax consequences are.

 15 COMMISSIONER O'MALIA: But it is a

 16 factor. It's got to be a factor.

 17 MS. MARKOWITZ: It's a factor for these

 18 entities I assume.

 19 MR. LAVE: I don't know if it's a

 20 factor. I don't know how we can take account of

 21 the tax code in our regulations in implementing

 22 the Commodity Exchange Act.
 120

 1 COMMISSIONER O'MALIA: Can we ask a

 2 question to find out? Do we ask the question?

 3 MS. MARKOWITZ: No, we don't ask the

 4 question.

 5 COMMISSIONER O'MALIA: We don't ask the

 6 question. I have asked staff to take the liberty

 7 of drafting two questions here and I think it's

 8 appropriate that I'll share with everybody else

 9 rather than read them. I'll pass this down the

 10 line here. I have two questions, one on what is

 11 the impact on portfolio margining in making these

 12 changes, and then one is the impact on taxes.

 13 CHAIRMAN GENSLER: I would say I would

 14 support the first but not the latter. I don't

 15 think we're a tax writing agency and I think we

 16 have to comply with the Commodity Exchange Act.

 17 COMMISSIONER O'MALIA: I don't disagree

 18 with either of those. We are not a tax writing

 19 agency and we will comply with this, but can we

 20 ask the questions of what the industry impacts

 21 might be? This could be a tax increase for a lot

 22 of end users potentially. I don't know.
 121

 1 CHAIRMAN GENSLER: I don't know how that

 2 would influence you, but it wouldn't influence me.

 3 I'm saying that I think that we have to comply

 4 with the Commodity Exchange Act and what you have

 5 here is Congress changed Core Principle 9. And by

 6 the way, on portfolio margining, I think that's

 7 subject to self-help. We can make futures swaps

 8 be in similar accounts, that is, the five of us

 9 can as long as we comply with the Commodity

 10 Exchange Act.

 11 COMMISSIONER O'MALIA: In developing our

 12 enlightened rule, wouldn't it be helpful to have

 13 the input from the market now or as soon as we can

 14 get it within the next 60 days?

 15 CHAIRMAN GENSLER: Absolutely.

 16 COMMISSIONER O'MALIA: Let me circulate

 17 this. If you want me to read it, I'd be happy to

 18 read it. If you want to have staff take a look at

 19 it, by all means. I would like to have both

 20 questions asked and I will ask unanimous consent

 21 to do that. While you're taking a look at that,

 22 let me go on to the next question. Reconciling
 122

 1 Section 735 which allows boards of trade to have

 2 rules that permit EFS and then also 723 which is

 3 statutory language that allows swaps in futures to

 4 be traded on DCMs, those obviously provide for

 5 having EFS on these things and yet we've got a

 6 very strict limiting rule that would kick them

 7 out.

 8 MS. MARKOWITZ: We have two mandates

 9 here in Core Principle 9. One is to protect the

 10 price discovery process of trading on the

 11 centralized market, and the other one is a

 12 recognizing that bona fide off-exchange

 13 transactions are allowed and to marry these two

 14 goals or try to balance them we've proposed the 85

 15 percent with the 15 percent off- exchange, and

 16 again I say propose because we have asked the

 17 public if this is the right amount to do so. I do

 18 not think that requirement is inconsistent with

 19 the statutory requirement that clearable swaps

 20 should be either on a DCM or a SEF because we are

 21 not pushing swaps off the DCM. What we are saying

 22 is though if you are going to trade on the DCM
 123

 1 then you have to trade in an open and competitive

 2 manner and I think this is consistent with

 3 Dodd-Frank's overall purpose of having these swaps

 4 be transparently traded either on a SEF or on a

 5 DCM.

 6 COMMISSIONER O'MALIA: You do recognize

 7 there is a conflict here, that we have a conflict

 8 that allows for this and yet we're being pretty

 9 strict about the priority of having the exchange

 10 trading requirement?

 11 MS. MARKOWITZ: What staff tried to do

 12 is provide a balance with what we saw and based on

 13 --

 14 COMMISSIONER O'MALIA: Trying to balance

 15 the two competing factors.

 16 MS. MARKOWITZ: The two goals or

 17 recognitions I should say in Core Principle 9, one

 18 is to protect the price discovery process and the

 19 other one is the recognition that in certain

 20 situations bona fide off-exchange transactions

 21 should be allowed as long as they're allowed by

 22 the exchange. As I said before, we tried to come
 124

 1 up with a future. We thought an absolute figure

 2 of how much exchange trading should be allowed

 3 would be an appropriate way to provide certainty.

 4 We looked at statistics and based on those

 5 statistics came up with an 85-percentage based on

 6 what the data showed us. Again it was a proposal

 7 and we opened it up to public comment as to

 8 whether that's an inappropriate proposal.

 9 MR. LAVE: To add something, the goal

 10 here isn't necessarily to say that these types of

 11 contracts can't be listed on the DCM, it's the

 12 manner of execution and I think the whole

 13 fundamental principle of Dodd-Frank with respect

 14 to swaps is that they're clearable and made

 15 available for trading and they're executed on a

 16 trading facility, a trading system like a SEF or

 17 they can be done on a DCM. It wouldn't

 18 necessarily mean they're not listed on the DCM,

 19 it's that the DCM could find a way so that these

 20 would be executed on their centralized market or

 21 some trading of a trading facility and not done

 22 bilaterally away from some sort of a trading
 125

 1 platform. And as I was saying, I think one of the

 2 fundamental goals of Dodd-Frank for swaps is that

 3 they if they're clearable and made available for

 4 trading that they be done on a SEF through a

 5 trading platform and that if they're going to be

 6 done on a DCM as a future then similar types of

 7 open and competitive trading should be required.

 8 And to some extent, many of these same contracts

 9 that have no trading are traded on EIS. A lot of

 10 those were the SPIDICs (?) that we determined so

 11 that it's not obvious that these could not be done

 12 on some sort of a centralized marketplace.

 13 COMMISSIONER O'MALIA: I agree. That

 14 brings me to my next point. You have a

 15 requirement of mandatory delisting within 90 days

 16 and 90 days is a pretty quick turnaround after

 17 this determination is made. Should be maybe

 18 consider a longer period of time in order to get

 19 that liquidity once people understand that faced

 20 with this opportunity that they may decide that it

 21 would be better to go with an EFS proposal as

 22 opposed to going with a SEF, whether it's
 126

 1 portfolio margining or taxes?

 2 MS. MARKOWITZ: Commissioner, the 90

 3 days does not apply to the existing contracts that

 4 are on the market. In fact, we have a fairly

 5 generous I should say provision in there that

 6 allows the existing contracts prior to the

 7 implementation on the effective date of the

 8 Dodd-Frank Act to remain listed on the DCM until

 9 either their positions are closed or they

 10 liquidate, and during any of those periods of time

 11 if they start to trade, they can remain on the

 12 DCM. In the past we've tried to encourage these

 13 contracts to be traded by asking -- the contracts

 14 can implement various programs to generate

 15 interest in trading these like market-maker

 16 programs or incentive programs and none of them

 17 have used this. So during this period of time,

 18 some of these contracts go off for 3 years and

 19 we're allowing them to stay on the exchange, they

 20 can try to get trading.

 21 COMMISSIONER O'MALIA: I'm happy to make

 22 the change on the language that takes out the word
 127

 1 tax and I would obviously ask any commenters if

 2 they have an opinion on taxes, they may not, to go

 3 ahead and offer them. We won't state specifically

 4 tax treatment and I know we're running this by

 5 Commissioner Chilton to make sure he's comfortable

 6 with it, but until he's fully informed I'd ask

 7 that we hold off on taking a vote until we get

 8 this resolved somehow. I don't want to put him in

 9 a difficult position somehow. I don't want to put

 10 him in a difficult position.

 11 CHAIRMAN GENSLER: Commissioner Chilton,

 12 do you want us to read the suggested two questions

 13 to you verbally? It was just sent to you

 14 electronically. Why don't you take a look at it?

 15 I was going to say a few words on this Core

 16 Principle 9. Again I do this for the public.

 17 There's a lot to learn when you get into one of

 18 these jobs, but as I understand it some number of

 19 years ago the energy markets and then some other

 20 markets but it started in the energy markets

 21 wanted to bring swaps to clearinghouses and the

 22 way that that was facilitated was through this
 128

 1 exchange of futures for swaps or EFS mechanism. I

 2 don't know why it's not called ESF, exchange swap

 3 for future. And this mechanism actually helped

 4 lower risk in the marketplace where swaps were

 5 being cleared but the only way to actually clear

 6 them was to call them a future. That's in essence

 7 what happened 7, 8 or 9 years ago as I understand

 8 it in some of the markets.

 9 COMMISSIONER O'MALIA: One important

 10 factor in all of this and why this took off was we

 11 had the meltdown or Enron and credit quality was a

 12 significant factor and clearing was a great

 13 solution.

 14 CHAIRMAN GENSLER: I think Commissioner

 15 O'Malia is right. Now with the passage of

 16 Dodd-Frank we have a lot of changes. One is a

 17 full regulatory regime for clearing of swaps, a

 18 full regulatory regime for the trading of swaps on

 19 either swap execution facilities or designated

 20 contract markets and new Core Principle 9 about

 21 open and competitive markets on futures markets,

 22 designated contract markets I'm saying loosely,
 129

 1 brings these cleared-only products because most of

 2 them, 410, don't really trade, into focus. What

 3 the staff has recommended is that in compliance

 4 with Core Principle 9 since there really isn't any

 5 trading, it walks like a duck, it quacks like a

 6 duck, that it's a swap. The difference between

 7 swap and futures is in some economic way not

 8 anything different, but one difference Congress

 9 made was Core Principle 9 that says you've got to

 10 have an open and competitive market for the price

 11 discovery function and I'm supporting this because

 12 staff is saying when there's no trading it doesn't

 13 comply with Core Principle 9. I think you raised

 14 legitimate questions about portfolio margining. I

 15 think that's subject to self-help. I think that

 16 we can ask staff to come forward with very robust

 17 ways that these things can still be portfolio

 18 margined.

 19 I think staff has also recommended a

 20 long phase period. If it's a 3-year contract,

 21 they can continue to list it, trade out of it and

 22 so forth for those 3 years or even if it's a
 130

 1 longer period of time. I'm supporting it because

 2 I think it promotes clearing but there will be

 3 called swaps probably instead of futures. I don't

 4 know if the 85-percent test is going to be in the

 5 final rule, but if there is some percentage in the

 6 final rule it's going to be more than zero percent

 7 and that's what they're trying to address.

 8 COMMISSIONER O'MALIA: I appreciate that

 9 and I appreciate the explanation. I think you're

 10 absolutely right. My concern is something where

 11 we have a good advantage. It's a great

 12 opportunity and we've got billions or dollars that

 13 are being cleared.

 14 CHAIRMAN GENSLER: I share you view that

 15 we want to keep that in the clearinghouses.

 16 COMMISSIONER O'MALIA: I'm concerned

 17 that using the end user exemption which they're

 18 perfectly entitled to that they could walk away

 19 from it and we may not get exchange trading, but

 20 we may also lose clearing and I think that would

 21 be a big loss. One of the reasons why I will

 22 oppose this rule, but I have one more question if
 131

 1 I may so I can keep dancing.

 2 CHAIRMAN GENSLER: Absolutely.

 3 COMMISSIONER O'MALIA: The proposal for

 4 Core Principle 9 contains a regulatory requirement

 5 regarding block trades and the preamble notes that

 6 these requirements were noticed before in 2008 in

 7 a separate NOPR clearly predating my time here. I

 8 under that that NOPR didn't go forward, that we

 9 didn't implement it. What were some of the

 10 criticisms then that we should be mindful of

 11 today?

 12 MS. MARKOWITZ: Many of the comments

 13 were against block trades and many of them were

 14 that the block trade sizes were too large, that

 15 there should be regulations as to block sizes. I

 16 would say that would be 95 percent of the comments

 17 that were against block trades or that there be a

 18 more prescriptive number or size. The feeling was

 19 that guidance in many respects was easy to get

 20 around and would be manipulated and they found a

 21 lack of liquidity on the market because of all the

 22 off-exchange trading.
 132

 1 CHAIRMAN GENSLER: Commissioner Chilton?

 2 Commissioner O'Malia has two questions, one on

 3 portfolio margining and one on any other negative

 4 consequences.

 5 COMMISSIONER CHILTON: I don't have any

 6 objection to adding the questions. I do think the

 7 proposal was intended to promote transparency as

 8 to what the goal of the bill and I think the

 9 proposal does that, but I don't have any

 10 objections to the questions.

 11 CHAIRMAN GENSLER: I think there is a

 12 unanimous consent request to add two questions,

 13 one on portfolio margining and one on whether

 14 there's any negative consequences. It doesn't

 15 mention taxes anymore. Not hearing any objection,

 16 the unanimous consent motion is passed.

 17 COMMISSIONER O'MALIA: I think my

 18 colleagues for their indulgence.

 19 CHAIRMAN GENSLER: With that I will move

 20 the original question that had been properly made

 21 and seconded. Dave Stawik, will you call the

 22 roll?
 133

 1 MR. STAWIK: Commissioner O'Malia?

 2 COMMISSIONER O'MALIA: No.

 3 MR. STAWIK: Commissioner O'Malia, no.

 4 Commissioner Chilton?

 5 COMMISSIONER CHILTON: Aye.

 6 MR. STAWIK: Commissioner Chilton, aye.

 7 Commissioner Sommers?

 8 COMMISSIONER SOMMERS: No.

 9 MR. STAWIK: Commissioner Sommers, no.

 10 Commissioner Dunn?

 11 COMMISSIONER DUNN: Aye.

 12 MR. STAWIK: Commissioner Dunn, aye.

 13 Mister Chairman?

 14 CHAIRMAN GENSLER: Aye.

 15 MR. STAWIK: Mister Chairman, on this

 16 matter the votes are three ayes, two no's.

 17 CHAIRMAN GENSLER: Thank you. Thank you

 18 very much, Nancy, Rick, Nadia and the other 15

 19 people. This is a really important process. I

 20 think all of the Commissioners too because this

 21 one is going to be very important to get public

 22 comment and get it right come next spring or
 134

 1 summer. With that we're going to invite up the

 2 next team unless the Commissioners want to take

 3 any breaks or we just keep moving. For the

 4 public, we're going to take a 5- or at most

 5 10-minute break as the teams are switching out.

 6 (Recess)

 7 CHAIRMAN GENSLER: Thank you for coming

 8 back today. These cupcakes are small and I don't

 9 want you think it's because we don't have much

 10 funding. Is Commissioner Chilton with us as well?

 11 Make sure he knows we're back on.

 12 Sarah Josephson from the Division of

 13 Clearing and Intermediary Oversight will now

 14 present the staff report on the proposed rule

 15 relating to reporting, recordkeeping, daily

 16 trading records, requirement of swap dealers and

 17 major swap participants, and Ananda Radhakrishnan

 18 who runs the division. Sarah, we thank you

 19 because this is your second time in the chair and

 20 in terms of scheduling, on the business conduct

 21 rules we have the External Business Conduct Rule

 22 team with Phyllis Cela. I think you are going to
 135

 1 be up in the chair next week. Again, this could

 2 be 2 weeks away, but we're hopefully scheduling

 3 that for this December 9 meeting. I think we're

 4 looking to do the SEF rules also December 9 and

 5 the end user piece, and there is also another

 6 price of governance. I think those are the four.

 7 Is Bart back on?

 8 COMMISSIONER CHILTON: I'm here, Mister

 9 Chairman.

 10 CHAIRMAN GENSLER: Great. Also on

 11 business conduct, the internal rules, Sarah and

 12 Ananda, you'll be back in front of us I guess on

 13 December 16 with some rules. We're going to do

 14 all the documentation rules then. We've decided

 15 now in the last couple of days maybe to delay some

 16 of the documentation because the capital margin is

 17 delayed until January and we thought as it related

 18 to documentation for what's called credit support

 19 agreements, master netting agreements and

 20 valuation and dispute resolution, that piece of it

 21 we're going to delay into January to get the

 22 benefit of any roundtable thoughts that come from
 136

 1 that. But on December 16 you are also in the

 2 chair again on confirmations so that some piece of

 3 the documentation piece such as confirmations and

 4 portfolio compression. Why don't I now turn it

 5 over since I've filibustered a bit there?

 6 MS. JOSEPHSON: Good afternoon, and

 7 while it's just Ananda and me at the table today,

 8 I have an excellent team and there wouldn't be

 9 enough chairs if we had brought them all up here.

 10 They've all been incredibly helpful and it's been

 11 a collaborative effort so that I wanted to

 12 recognize them and also thank the Commissioners

 13 and their staff people for very, very helpful

 14 comments as we go through this process.

 15 Today staff is presenting for the

 16 Commission's consideration one notice of proposed

 17 rulemaking for publication in the Federal Register

 18 regarding reporting, recordkeeping and daily

 19 trading records for swap dealers and major swap

 20 participants. Section 731 of the Dodd-Frank Act

 21 amended the CEA, Commodity Exchange Act, by

 22 inserting a new Section 4(a). Today the rules
 137

 1 that we'll be proposing relate to Section 4(s)(F),

 2 a recordkeeping and reporting section, and

 3 4(s)(G), the daily trading records section.

 4 Section 4(s)(F) requires that swap

 5 dealers and major swap participants make reports

 6 regarding transactions, positions and financial

 7 condition of the registered swap dealer or major

 8 swap participant. This section also authorizes

 9 the Commission to set forth books and records

 10 requirements for, and I'm quoting here, "All

 11 activities related to the business of the swap

 12 dealer or the major swap participant regardless of

 13 whether or not that entity has a prudential

 14 regulator in addition to the Commission or if the

 15 Commission is the sole regulator of the swap

 16 dealer or major swap participant." All books and

 17 records are to be open to inspection and

 18 examination by representatives of the Commission

 19 and for records that relate to security-based swap

 20 agreements, those records must also be open to

 21 inspection by representatives of the Securities

 22 and Exchange Commission.
 138

 1 Section 4(s)(G) requires that swap

 2 dealers and major swap participants maintain daily

 3 trading records of their swaps and all related

 4 records including records of related cash and

 5 forward transactions. This section also requires

 6 swap dealers and major swap participants to

 7 maintain recorded communications including

 8 electronic mail, instant messages and recordings

 9 of telephone calls. Finally, Section 4(s)(G)

 10 requires that daily trading records for swaps be

 11 identifiable by counterparty and transaction and

 12 specifies that swap dealers and major swap

 13 participants maintain a complete audit trail for

 14 conducting comprehensive and accurate trade

 15 reconstructions.

 16 Staff is recommending one NPRM, but it

 17 contains separate rules. Four of those rules

 18 relate to recordkeeping, only two of them are

 19 reporting requirements. The two reporting

 20 requirements are Rules 23204 and 23205 and those

 21 would require that swap dealers and major swap

 22 participants report in accordance with the
 139

 1 real-time public reporting rules and the swap data

 2 rules, reporting to swap data repositories. The

 3 substance of those rules was voted on and proposed

 4 by the Commission at its November 19 meeting. In

 5 essence it's a cross-reference. Those are the

 6 reporting requirements, so that now I'll proceed

 7 to describe the required records and I'll note at

 8 the outset here that the first rule, 23200, is

 9 just definitions for the rules that will follow

 10 for this part. I'd like to highlight two of the

 11 definitions and thank the Commissioners' staff for

 12 these excellent recommendations. There is the

 13 complaint definition where we elaborated on the

 14 complains that swap dealers and swap participants

 15 will be required to retain and that will be formal

 16 or informal complaints, grievances or criticisms

 17 communicated to the swap dealer or major swap

 18 participant related to any trading conduct or

 19 behavior. The other definition, and this is

 20 important for the daily trading record, is the

 21 definition of related cash or forward

 22 transactions. There we're proposing a rule that
 140

 1 would define that category to be a purchase or

 2 sale for immediate or deferred physical shipment

 3 or delivery of an asset related to a swap where

 4 the swap where the swap and the related cash or

 5 forward transaction are used to hedge, mitigate

 6 the risk of or offset one another.

 7 Proposed Rule 23201 is the required

 8 records rule. This relates to transaction and

 9 position information. Records would include and

 10 complete transaction and position information for

 11 all swaps including all documents in which the

 12 trade information is originally recorded. This

 13 would mean generally speaking documents

 14 customarily generated in accordance with market

 15 practice. The records would be required to be

 16 maintained in a manner that is identifiable and

 17 searchable by transaction and by counterparty. As

 18 to swap dealers and major swap participants, we

 19 are proposing the requirement that they keep

 20 general business records, things like board

 21 meeting minutes, organizational charts, audit

 22 documentation and general financial records,
 141

 1 although I'll note that this is not the financial

 2 condition reporting rule, this is just the

 3 recordkeeping rule, complaints as I mentioned

 4 before, a record of that complaint and how it was

 5 resolved and marketing and sales materials.

 6 Finally, in Rule 23201 there is a

 7 section on keeping records that supports the

 8 reporting to a swap data repository or for

 9 real-time purposes. In particular I'd like to

 10 highlight that for the records that must be

 11 maintained for real-time reporting, that would

 12 include when the swap dealer or major swap

 13 participant has elected to use a less-specific

 14 data field to protect the anonymity of the market

 15 participants and then records relating to

 16 determinations made about block trades and large

 17 notional swaps.

 18 Proposed Rule 23202 relates to daily

 19 trading records. The proposed rule would require

 20 swap dealers and major swap participants to ensure

 21 that they preserve all information necessary to

 22 conduct the comprehensive and accurate trade
 142

 1 reconstructions for each swap and that they

 2 maintain each record as a separate electronic file

 3 identifiable and searchable again by transaction

 4 and counterparty. What we've done is we've

 5 divided the rule up into preexecution data,

 6 execution data and postexecution data which is

 7 important for swaps because unlike some of the

 8 derivatives that we're used to regulating, the

 9 posttrade transaction data is especially relevant

 10 and the preexecution trade data would include

 11 records of all oral and written communications

 12 that lead to the execution of a swap. This

 13 includes records of all telephone calls, voice

 14 mails, faxes, instant messaging, chat rooms,

 15 email, mobile devices and other digital or

 16 electronic media. This would require swap dealers

 17 and major swap participants to maintain records of

 18 telephone calls and other communications created

 19 in the normal course of its business but would not

 20 establish an affirmative new requirement to create

 21 recordings of all telephone conversations if the

 22 complete audit trail requirement can be met
 143

 1 through other means such as electronic messaging

 2 or trading. I would note here, and this is

 3 discussed at some length in the preamble as

 4 Commissioner O'Malia noted at the outset of this

 5 meeting, that many jurisdictions around the world

 6 require recordings of all telephone and electronic

 7 conversations including the United Kingdom, Hong

 8 Kong, Spain, Sweden and France among numerous

 9 other jurisdictions and that's to prevent or to be

 10 able to detect market abuse or fraud manipulation.

 11 The execution trade data would include

 12 all terms of each executed swap and the date and

 13 time of execution to the nearest minute and that

 14 is similar to existing CFTC Rule 135 for

 15 designated contract markets. Postexecution data

 16 would include records of all terminations,

 17 novations, reconciliation, margining, a whole

 18 series of posttrade processing events that it's

 19 important to record. Sometimes these are referred

 20 to as life-cycle events but it's all the

 21 postexecution processing. Then there is a section

 22 of this rule on the records related to cash and
 144

 1 forward transactions and again generally we've

 2 followed the same preexecution, execution and

 3 postexecution requirements there. Staff believes

 4 that requiring one approach to recordkeeping will

 5 be simpler for swap dealers and participants to

 6 implement and will provide the Commission with the

 7 necessary information for its regulatory

 8 oversight.

 9 The last rule is an retention and

 10 inspection rule, how you should keep the data.

 11 For the most part that references an existing

 12 Commission rule, Rule 131, and it says that you

 13 must retain them 5 years overall retention and 2

 14 years readily available. Then there is an

 15 exception for swaps and related cash and forward

 16 positions which must be retained for a longer

 17 period of time and in accordance with Part 45, the

 18 data rules that again the Commission considered at

 19 the November 19 meeting.

 20 CHAIRMAN GENSLER: Thank you, Sarah.

 21 The Chair would entertain a motion on this staff

 22 recommendation on swap dealer recordkeeping and
 145

 1 reporting.

 2 COMMISSIONER DUNN: So moved.

 3 COMMISSIONER SOMMERS: Second.

 4 CHAIRMAN GENSLER: I support the

 5 proposed rule regarding reporting and

 6 recordkeeping and will have a comment for the

 7 record. I think it establishes important mandates

 8 that Congress recommended that swap dealers and

 9 major swap participants are required to maintain

 10 records. Most of this is for regulators and not

 11 for the public, in fact all of it, though with the

 12 information that might be available to the public

 13 would be reporting to swap data repositories or

 14 possibly through the real-time reporting rule that

 15 we had promulgated and are looking forward to

 16 public comment on. I do think it's important to

 17 promote transparency to the regulators and to

 18 promote market integrity so that I don't have any

 19 questions on it. Commissioner Dunn?

 20 COMMISSIONER DUNN: Thank you, Mister

 21 Chairman. I too support those provision. Sarah,

 22 we say that the Commission recognizes that there
 146

 1 will be differences in the size and scope of the

 2 business of particular swap dealers and major swap

 3 participants. Therefore, comments are solicited

 4 on whether certain provisions of a proposed

 5 regulation should be modified or adjusted to

 6 reflect the differences among swap dealers and

 7 major swap participants. Could you amplify for me

 8 on what staff deems as differences?

 9 MS. JOSEPHSON: This same paragraph

 10 appeared in the rule that we proposed the first

 11 time I appeared before the Commission on the

 12 duties and the goal is to address the concerns

 13 that have been expressed or to invite comment on

 14 the differences that may exist between swap

 15 dealers and major swap participants in terms of

 16 the scale of their operations and the extent to

 17 which they have particular operational capacities.

 18 It's a general invitation to comment specifically

 19 and there are some places in the preamble where we

 20 direct the public's attention to key areas.

 21 That's I think what we're thinking, give us the

 22 information we need to craft the final rule
 147

 1 proposal that would be responsive to the needs of

 2 the marketplace.

 3 COMMISSIONER DUNN: Thank you.

 4 CHAIRMAN GENSLER: Sarah, while we're

 5 not there yet, I'm hopeful that commenters will

 6 share with us if you're a swap dealer and you're

 7 doing hundreds of transactions a year, that might

 8 be a different implementation phase than if you're

 9 a swap dealer doing 200 trades a year. You're

 10 still a swap dealer but maybe by scale the largest

 11 among them would implement this rule a little

 12 faster.

 13 MS. JOSEPHSON: Right. I think that's

 14 the other part, that in addition to tailoring the

 15 rules themselves there could be an implementation

 16 phased approach that some of the larger swap

 17 dealers would have more timely implementation and

 18 so that we'd consider and invite comments on the

 19 implementation, the phasing or a tiered approach

 20 is something that we would consider.

 21 CHAIRMAN GENSLER: Commissioner Sommers?

 22 COMMISSIONER SOMMERS: Thank you, Mister
 148

 1 Chairman. I have some questions about the

 2 collection of preexecution data. What do you

 3 believe is the relevance of getting all of that

 4 data and what is typically expected to be captured

 5 when we are asking for all of this? What exactly

 6 are we looking for?

 7 MS. JOSEPHSON: I think this elaborated

 8 a bit in the preamble, but to highlight that, our

 9 understanding is that the Enforcement Division has

 10 been very successful in proving market

 11 manipulation and market disruption cases, false

 12 reporting cases where they've had better audit

 13 trails and it's the preexecution information that

 14 contributes to as is required in the statute the

 15 complete and comprehensive audit trail so that

 16 everything that gives rise to an execution of a

 17 swap or a transaction. That's what we're looking

 18 for, and in the rule itself for the daily trading

 19 records, reliable data or information about the

 20 initiation of the trade, the records of all of the

 21 conversations back and forth related to the

 22 prices, the bids, offers at which you would
 149

 1 ultimately execute a swap, but that back and forth

 2 especially for swap dealers and major swap

 3 participants who are executing bilaterally, that's

 4 what we're looking at and we think it would be

 5 very helpful for understanding market practice and

 6 also as part of the enforcement regime.

 7 COMMISSIONER SOMMERS: I think I

 8 understand for enforcement purposes, but I do have

 9 some questions about if two counterparties are

 10 executing a bilateral swap how we can after the

 11 fact glean from preexecution data say they didn't

 12 accept the best offer or the best bid, how do we

 13 know that there weren't other factors being

 14 contemplated? I'm unclear about how that's

 15 helpful to us.

 16 MS. JOSEPHSON: I think I would defer to

 17 my colleagues in Enforcement on how they would

 18 create a case. I think part of your question goes

 19 to the issue of how you would use the information.

 20 COMMISSIONER SOMMERS: I understand for

 21 enforcement purposes, but besides that if there's

 22 any other reason why if we plan to audit
 150

 1 preexecution data for any other purposes besides

 2 enforcement.

 3 MS. JOSEPHSON: I think the primary

 4 reason would be for enforcement purposes.

 5 CHAIRMAN GENSLER: Thank you,

 6 Commissioner Sommers. Commissioner Chilton? Is

 7 Commissioner Chilton on?

 8 COMMISSIONER CHILTON: Yes, I'm here,

 9 Mister Chairman. We had a couple of questions in

 10 the last rule and I wonder whether or not, Sarah,

 11 this would be an appropriate one to ask the

 12 question on whether or not swap dealers and major

 13 participants should be required to report as a

 14 separate category records relating to

 15 high-frequency trading activity. Would you see

 16 any issue with asking that question?

 17 MS. JOSEPHSON: Commissioner Chilton, I

 18 think the way that I would generally respond to

 19 that is that at least my understanding right now

 20 is that high-frequency trading is not prevalent in

 21 the swaps markets and in the over-the- counter

 22 derivatives markets and I think that I would
 151

 1 ultimately again refer to some of my colleagues

 2 who are actively working on these issues right

 3 now. But at least my understanding is that

 4 high-frequency trading, that sorts of algorithmic

 5 trading practices that are of concern in organized

 6 markets and the trading platforms are not

 7 prevalent in the OTC derivatives markets at this

 8 time. But it is something that we would continue

 9 to look at and as that work continues to be

 10 developed it could be a consideration for

 11 additional rulemaking on a particular reporting

 12 requirement, not reporting, sorry, this would be a

 13 recordkeeping requirement now.

 14 COMMISSIONER CHILTON: Let me ask this

 15 then, and this is I guess a question for counsel.

 16 If we don't ask a question about whether or not,

 17 and I'm not disputing what you've suggested that

 18 high-frequency trading isn't as prevalent in the

 19 swaps market, I tend to agree, but the whole issue

 20 behind this legislation is that we don't know

 21 what's going on in some of these markets and so

 22 we're getting more information. The question is
 152

 1 if we don't ask such a question here specifically

 2 in this proposal, would we be precluded from

 3 inserting something if during the comment process

 4 we determine that maybe we did want to require

 5 reports that are separated by category? If we

 6 don't ask the question now, are we precluded from

 7 requiring it later if we determine a need?

 8 CHAIRMAN GENSLER: Dan Berkovitz has

 9 come to the mike.

 10 MR. BERKOVITZ: Commissioner, the

 11 question would be in the final rulemaking whether

 12 the final rule was a reasonable or logical

 13 outgrowth of the proposed rule so that it would

 14 depend on exactly how the proposed rule is worded

 15 in relation to the final rule.

 16 COMMISSIONER CHILTON: It seems to me

 17 that we should preserve the option of doing

 18 something. Nobody is thinking that everything

 19 that we ask questions on we're going to do, but

 20 once swaps become traded on exchanges, it seems to

 21 me that high-frequency trading reporting might be

 22 something given the sorts of numbers I talked
 153

 1 about on the earlier proposals that we would want.

 2 I'm not sure we would, but it seems like a

 3 reasonable question. Mister Chairman, I'd like to

 4 add that question to preserve the Commission's

 5 options regardless of whether or not we end up

 6 doing anything.

 7 MR. RADHAKRISHNAN: Let me point out

 8 something. Wouldn't that be covered by the

 9 covered by the proposed regulations for DCMs?

 10 There was some question on high- frequency trading

 11 with DCMs so maybe that would be covered. Bart,

 12 do you think they would be covered that way? I

 13 think the point is, and correct me if I'm wrong,

 14 you only get high-frequency trading when you have

 15 a platform. If you don't have a platform there is

 16 no such thing as high- frequency trading so that

 17 maybe it would be covered by the DCM rules.

 18 COMMISSIONER CHILTON: It could be,

 19 Ananda. I'm not suggesting that we should

 20 actually do this, but given the responses we got

 21 earlier, it's clear to me we don't know enough and

 22 so I want to preserve the Commission's flexibility
 154

 1 rather than forestall options given what our

 2 General Counsel told me which was maybe perhaps if

 3 you wrote it a certain way. I don't know why we

 4 would tie one hand behind our backs to begin with.

 5 It's a simple question to preserve the option. If

 6 it's a duplicative question, Ananda, or it doesn't

 7 matter, we can toss it out with the bath water.

 8 Again, Mister Chairman, I'd like to ask the

 9 question.

 10 CHAIRMAN GENSLER: I'm asking if there

 11 is any objection to unanimous consent to include a

 12 question in this rule as Commissioner Chilton has

 13 laid out. Not hearing any objection, we'll add

 14 the question.

 15 COMMISSIONER CHILTON: Thank you, Mister

 16 Chairman. I don't have any other questions.

 17 CHAIRMAN GENSLER: Commissioner O'Malia?

 18 COMMISSIONER O'MALIA: Thank you.

 19 Sarah, I'd like to ask you a question regarding

 20 our existing recordkeeping rules. It's my

 21 understanding that under Rule 1.35, FCMs, IBs and

 22 members of contract markets do not an audit trail
 155

 1 for voice conversation requirement, yet this rule

 2 does. Is that something we're going to fix or is

 3 that under consideration for changing our existing

 4 rule?

 5 MR. RADHAKRISHNAN: I think the preamble

 6 states that there is a DMO advisory that said that

 7 1.35 applies to records that are created or

 8 retained in electronic format including email,

 9 instant messages and other forms of communication.

 10 COMMISSIONER O'MALIA: What about voice?

 11 MR. RADHAKRISHNAN: The statute has a

 12 specific requirement that the Commission

 13 promulgate a regulation for voice communications

 14 for swap dealers and major swap participants. I

 15 don't know whether the CEA has a specific

 16 requirement for FCMs but I do know that the

 17 Enforcement Division was working on a proposed

 18 rule and I can find out where that rule is.

 19 CHAIRMAN GENSLER: Could I help out a

 20 little bit? One of the things that's occurred,

 21 and here I am revealing something, we now have a

 22 thirty-first team. Everybody has heard about
 156

 1 these 30 teams. One thing that occurred to us

 2 some time ago is that the rules for futures

 3 commission merchants, the rules for introducing

 4 brokers, for commodity pool operations, for

 5 commodity trading advisers, other various

 6 intermediaries, may need to be conformed, it might

 7 be a lot of boring technical stuff, but conformed

 8 given the definition Act. In addition, there may

 9 be issues just like Commissioner O'Malia is

 10 raising. William Penner is heading that up. I

 11 don't know that it will be all in front of us in

 12 January, but all of what I'll call the

 13 intermediary conforming amendments, and

 14 particularly as Dodd-Frank included in the

 15 definition of introducing broker, commodity

 16 trading adviser, futures commission merchant and

 17 others, for the first time the word swap was

 18 inserted in each of these. William Penner is

 19 going through and I think this is a question that

 20 I would hope would be put into that team's

 21 efforts.

 22 MR. RADHAKRISHNAN: We actually base
 157

 1 this language on that draft that I mentioned.

 2 William has got that draft so it will probably be

 3 part of the package that will come to the

 4 Commission on these conforming amendments, and get

 5 ready for an avalanche because there are a lot of

 6 them when we do these conforming amendments.

 7 CHAIRMAN GENSLER: Ananda, we've already

 8 had that.

 9 COMMISSIONER O'MALIA: Proposed Rule

 10 23201 requires that records of each transaction be

 11 kept in a form and manner identifiable and

 12 searchable by transaction and counterparty. These

 13 records include everything from cancelled orders,

 14 warehouse receipts, to phone calls and instant

 15 messages. Correct?

 16 MS. JOSEPHSON: Yes, both read together.

 17 COMMISSIONER O'MALIA: From an interest

 18 in technology, how easy is that to do, to search

 19 by transaction and counterparty? Is that

 20 something they easily code? Is that more

 21 difficult than it sounds?

 22 MS. JOSEPHSON: Our understanding is
 158

 1 that currently entities that have swaps on their

 2 books and derivatives generally, they have

 3 internal mechanisms for tracking those, that they

 4 have a unique identifier that's internal that they

 5 use to keep track of things and we're not

 6 prescribing that. What I will mention is that the

 7 rules do cross-reference to the extent the swaps

 8 have to be reported to a swap data repository,

 9 that hey will then use the unique identifier that

 10 the data team is proposing. That might make

 11 things earlier in a way if the counterparty, the

 12 product and the transaction IDs that that team and

 13 the Commission has already voted on if those are

 14 in place. The rules work together in that way and

 15 that's why we coordinated with the data team and

 16 the SDR teams to make sure that they work

 17 together.

 18 COMMISSIONER O'MALIA: Now let me ask

 19 the big question. We're going to feed it into

 20 what machine here that will enable us to search

 21 this and use this efficiently?

 22 MS. JOSEPHSON: This is just
 159

 1 recordkeeping. This is not reporting. This is

 2 telling them what they need to maintain, that

 3 we're not requesting this. It is available to us

 4 for inspection and examination when we need it.

 5 COMMISSIONER O'MALIA: So if we choose

 6 to inspect it and we desire it for only

 7 enforcement purposes, what will we use to search

 8 this stuff? Do we have technology in-house that

 9 is readily available?

 10 MR. RADHAKRISHNAN: I'm not sure whether

 11 Enforcement has that. They may have at their

 12 disposal tools that allow us to do this. I'm not

 13 sure.

 14 COMMISSIONER O'MALIA: I'll follow-up

 15 with them.

 16 CHAIRMAN GENSLER: If there are no

 17 further questions, then Dave Stawik, all the roll.

 18 MR. STAWIK: Commissioner O'Malia?

 19 COMMISSIONER O'MALIA: Aye.

 20 MR. STAWIK: Commissioner O'Malia, aye.

 21 Commissioner Chilton?

 22 COMMISSIONER CHILTON: Aye.
 160

 1 MR. STAWIK: Commissioner Chilton, aye.

 2 Commissioner Sommers?

 3 COMMISSIONER SOMMERS: Aye.

 4 MR. STAWIK: Commissioner Sommers, aye.

 5 Commissioner Dunn?

 6 COMMISSIONER DUNN: Aye.

 7 MR. STAWIK: Commissioner Dunn, aye.

 8 Mister Chairman?

 9 CHAIRMAN GENSLER: Aye.

 10 MR. STAWIK: Mister Chairman, aye.

 11 Mister Chairman, on this vote the ayes are five

 12 and nays are zero.

 13 CHAIRMAN GENSLER: Thank you, Sarah,

 14 Ananda and Dan for your cameo. Dan, please stay

 15 at the desk though for the next one. I thank you

 16 very much for all your efforts. Sarah and Ananda,

 17 we'll see you back here in 2 weeks and back again

 18 in January I guess.

 19 (Recess)

 20 CHAIRMAN GENSLER: Next, Mark Fajfar and

 21 Dan Berkovitz from the Office of General Counsel

 22 will present an overview of staff's
 161

 1 recommendations on rules, further defining swap

 2 dealer, major swap participant, securities- based

 3 swap dealer, major securities-based swap

 4 participant and eligible contract participant.

 5 This is a rulemaking which is joint with the SEC.

 6 I don't know what Robert's Rule say, but if we

 7 vote it out it still has to go through the SEC and

 8 I believe, and I'm not trying to get in front of

 9 them, they've calendared it for Friday. I want to

 10 compliment staff before we get into this and

 11 compliment the Securities and Exchange Commission.

 12 I think that we're working both tirelessly to get

 13 these proposals out and to get the benefit of

 14 public comment on them. They probably even have a

 15 larger docket than we do if that's believable. I

 16 thank the staff because it was even 10 o'clock

 17 last night that they were getting some further

 18 edits from our friends at the Securities and

 19 Exchange Commission and I think the Commissioners

 20 for their patience with that because we

 21 distributed a couple of paragraphs this morning.

 22 There are 10 Commissioners and dozens and dozens
 162

 1 of staff working. I know that we wanted to do

 2 this in the middle of November but here we are

 3 now. It probably highlights that on the other

 4 rules like product definitions that no matter what

 5 date we think we're going to do them it might

 6 slip. Mark and Dan?

 7 MR. FAJFAR: If we had done the rule on

 8 November 19, we could have used Harry Potter's

 9 sorting hat to decide who are swap dealers and

 10 MSPs.

 11 CHAIRMAN GENSLER: Sorting hat to do

 12 what?

 13 MR. FAJFAR: Decide who our swap dealers

 14 and MSPs are.

 15 CHAIRMAN GENSLER: Now we're on December

 16 1.

 17 MR. FAJFAR: I'd like to thank my

 18 colleagues on the Definitions Team including Terry

 19 Arbit, Julian Hammer, David Aaron and Rose Troya

 20 and my SEC colleagues including Josh Konz and his

 21 team for their contributions. I'd like to thank

 22 the Commissioners and their staff for their input
 163

 1 on the rules.

 2 In developing this rule we reviewed more

 3 than 80 written comments in response to our

 4 advanced notice of proposed rulemaking. We met

 5 with market participants and other members of the

 6 public. We consulted extensively both with the

 7 SEC and the prudential regulators. We are very

 8 grateful for the input we've had so far and we

 9 look forward to continuing to meet with the public

 10 and our fellow regulators to develop and put the

 11 details on the final rules.

 12 The Dodd-Frank Act defines swap dealer

 13 in terms of whether a person engages in certain

 14 activities, holding oneself as a dealer in swaps,

 15 making a market in swaps, regularly entering into

 16 swaps as an ordinary course of business or being

 17 commonly known in the trade as a dealer or market

 18 maker in swaps. The proposed rule follows the

 19 statutory definition closely.

 20 Our interpretation of the proposed rule

 21 is guided by special aspects of the swap markets.

 22 Swaps are notional contracts. They're not bought
 164

 1 and sold. Because of this concept, use in the

 2 cash markets for securities and commodities cannot

 3 necessarily determine if a person is a swap

 4 dealer. Instead, we propose to identify swap

 5 dealers by their functional role in the swap

 6 markets. They tend to accommodate demand for

 7 swaps. They're available to enter into swaps in

 8 response to interest from others. They enter into

 9 swaps on their own standard terms or terms they

 10 arrange or customize on request. Also swap

 11 dealers tend to enter into swaps with more

 12 counterparties than do nondealers and nondealers

 13 tend to be a larger part of a swap dealer's

 14 counterparties.

 15 In general, a person who meets the

 16 definition would be a swap dealer for all types,

 17 classes or categories of swaps and be subject to

 18 the swap dealer requirements for all of its swaps.

 19 This requirement would apply to the legal person

 20 who's designated as a swap dealer. However, there

 21 may be some companies especially physical

 22 commodity firms that conduct swap dealing through
 165

 1 a division. The proposed rule permits the

 2 Commission to issue a limited designation as a

 3 swap dealer with respect to only specified

 4 categories of swaps or activities on an

 5 appropriate showing by that person.

 6 The statute includes a de minimis

 7 exception dealing activity that is so minor that

 8 it does not warrant registration. It requires

 9 that a person's dealing over the period 12 months

 10 be limited to swaps with an aggregate gross

 11 notional amount of no more than $100 million of

 12 which no more than $25 million could be with a

 13 special entity which is defined in the Act as

 14 certain governmental and other types of entities.

 15 Finally, the person could enter into no more than

 16 20 swaps as a dealer over the prior 12 months with

 17 no more than 15 counterparties.

 18 There is also an exemption for swaps in

 19 connection with loans made by insured depository

 20 institutions. We propose this would apply to any

 21 swap related to the financial terms of the loan

 22 such as an interest rate or a currency swap, but
 166

 1 it would not apply to swaps related to the

 2 borrower's other business activities even if the

 3 loan agreement required the swap.

 4 To wrap up the discussion of swap dealer

 5 I'll point out that the release also discusses

 6 other issues such as how the definition should be

 7 applied to aggregators of swap positions of other

 8 parties, to the physical commodity markets and to

 9 the generation or transmission or electricity.

 10 We'd like to hear from the public on those topics

 11 and all the others.

 12 Turning now to the definition of major

 13 swap participant or MSP, this is intended to

 14 encompass firms that are not dealers but whose

 15 swap positions are so large they pose systemic

 16 risk. There are three parts to the statutory

 17 definition. First, it covers and person who has a

 18 substantial position in a major category of swaps

 19 excluding commercial hedging and ERISA plan

 20 positions. For this we're proposing four major

 21 categories of swaps, rate swaps, credit swaps,

 22 equity swaps and other commodity swaps. The
 167

 1 second part of the definition includes any person

 2 whose outstanding swaps creates substantial

 3 counterparty exposure that could have serious

 4 adverse effects on financial stability. Third,

 5 the definition covers and nonbank financial entity

 6 that is highly leveraged and has a substantial

 7 position in any of the major swap categories not

 8 including hedging or ERISA positions.

 9 To define substantial position we

 10 propose two thresholds that use objective

 11 numerical criteria. One measures current

 12 uncollateralized exposure only and the other

 13 threshold combines both current exposure and

 14 potential future exposure. A position that

 15 exceeds either threshold would be a substantial

 16 position. The current exposure threshold would

 17 measure a person's total uncollateralized current

 18 exposure determined by marking its swap positions

 19 to market using industry standard practices. This

 20 calculation would deduct the value of posted

 21 collateral and would calculate exposure for each

 22 counterparty on a net basis. The numerical
 168

 1 threshold of current exposure would be $1 billion

 2 in any major swap category expect that the

 3 threshold for the rate swap category would be $3

 4 billion. The second proposed threshold for

 5 substantial position would account for both

 6 current exposure and potential future exposure.

 7 The calculation of potential future exposure is

 8 based significantly on bank capital standards. It

 9 discounts the total notional principal amount of a

 10 person's swaps by risk factors that are based on

 11 the type of swap and the duration of the position.

 12 The calculation also adjusts for netting

 13 agreements, clearing and margin posting. The

 14 second threshold would be $2 billion in current

 15 exposure plus potential future exposure in any

 16 major swap category except again the threshold for

 17 the rate swap category would be $6 billion. As I

 18 noted, the substantial position calculation

 19 excludes swaps that hedge commercial risk. The

 20 proposed definition of hedging would include any

 21 swap recognized as a hedge for accounting purposes

 22 or is bona fide hedging but would not be limited
 169

 1 to those categories. The proposal also covers

 2 swaps that hedge any business risk and it applies

 3 whether the entity is for profit or nonprofit, a

 4 financial firm or nonfinancial. However, swaps

 5 for the purpose of speculation, investing or

 6 trading would not be covered. For the substantial

 7 counterparty exposure part of the MSP definition,

 8 we propose calculations that are the same as the

 9 calculation of substantial position. Unlike the

 10 first test, however, hedging or ERISA plan

 11 positions would not be excluded and this test is

 12 not applied by swap category. The threshold would

 13 be current exposure of $5 billion or a sum of

 14 current exposure and potential future exposure of

 15 $8 billion across all of a person's swap

 16 positions. The third part of the definition for

 17 nonbank financial entities that are highly

 18 leveraged uses the same substantial position

 19 thresholds by major swap category as in the first

 20 part but does not allow for the exclusion of

 21 hedging or ERISA plan positions. To define highly

 22 leveraged, we are proposing two alternatives. One
 170

 1 would allow at a ratio of total liabilities to

 2 total equity in excess of 8 to 1, the other

 3 alternative would set the threshold at a ratio of

 4 15 to 1. We invite comment from the public on

 5 which of these is more appropriate.

 6 To conclude again I'll point out that

 7 the release discusses a variety of other MSP

 8 issues including the application of a definition

 9 to manage investment accounts, registered

 10 investment companies, ERISA plans and sovereign

 11 wealth funds. Now that the public can review and

 12 consider our proposed rules in their entirety, we

 13 look forward to receiving their comments. Thanks

 14 for your attention and we welcome any questions

 15 you may have.

 16 CHAIRMAN GENSLER: I will entertain a

 17 motion on the staff recommendation on the joint

 18 rule with the SEC.

 19 COMMISSIONER DUNN: So moved.

 20 COMMISSIONER SOMMERS: Second.

 21 CHAIRMAN GENSLER: Thank you, Mark and

 22 everybody who's worked on this. I support the
 171

 1 joint proposed rule on entity definitions. I

 2 think it fulfills Congress' direction to further

 3 define these key terms, but it is just a proposal

 4 and it is going to be very helpful to get the

 5 public's comments on this proposal. The swap

 6 dealer definition I believe closely follows the

 7 criteria laid out by Congress. Those criteria as

 8 Mark said had four different aspects including

 9 whether an entity makes a market in swaps, holds

 10 itself out as a swap dealer, is commonly referred

 11 to as a swap dealer or regularly enters into swaps

 12 in the ordinary course of business. I think a key

 13 aspect that is in the proposal is whether a

 14 company makes itself available to people, receives

 15 demand from others in essence. I think that end

 16 users, and there have been hundreds of really

 17 well-thought out meetings I've participated in, I

 18 don't think it's our intent and we will hear from

 19 people, but it's not our intent to capture end

 20 users in the swap dealer definition and I think

 21 that that was a helpful add to this proposal that

 22 holding yourself out and accommodating other
 172

 1 people's demand which is in contrast of going to

 2 seek and hedging yourself. We'll certainly get

 3 comments on that and those comments will be

 4 helpful.

 5 I think that the major swap participant

 6 definition relies on Congress' three-prong test

 7 and the category has been meant to be very clearly

 8 limited only to those entities that have very

 9 large risk, enough pose threat to the U.S.

 10 financial system, and it's for those parties that

 11 aren't swap dealer. This was meant to be a very

 12 small category that you're not a swap dealer and

 13 yet you might have such significant positions.

 14 It's a very complicated thing Congress gave us

 15 because there are three prongs. The first prong

 16 is only if you're not an ERISA plan and not

 17 hedging commercial risk and of course I've lightly

 18 internally called that the speculator's prong, but

 19 the first prong if you're speculating in these

 20 markets and have significant exposure, then Mark

 21 laid out the numbers. The second prong is all of

 22 your counterparty risk and I think staff did an
 173

 1 excellent job. This is not a rule that's directly

 2 tied to notional amounts, it's tied to exposures,

 3 current exposures after collateral and I think

 4 Congress dictated that but a lot of end users and

 5 others have come in and said I hope you're only

 6 going to be looking at the sort of noncleared

 7 swaps and after collateral. We didn't do that

 8 quite but I think this important in that it does

 9 say that it's net of collateral because cleared

 10 swaps postmargin it's very different. The number

 11 is large. It's $5 billion of current exposure or

 12 $8 billion combined of current and potential

 13 future exposure. I'll share a little bit of a

 14 story. Then years or 12 years ago when long-term

 15 capital was failing I had a $1.3 trillion

 16 derivatives book but I'll never forget that Sunday

 17 that I went up there personally and their current

 18 exposures as I remember them but the spreadsheets

 19 weren't kept perfectly, were in that $4 billion

 20 range and I can tell you having lived it, that was

 21 a systemic issue. As for the $5 billion and $8

 22 billion, I don't how people will comment on
 174

 1 publicly. It will be very helpful to hear. But

 2 they're very large numbers and I think in a major

 3 swap participant definition there will be come,

 4 there will probably a handful or something, but

 5 it's meant to be only those people who aren't swap

 6 dealers and are very large. I support the

 7 proposal but very much look forward to public

 8 comments to help us get this appropriately done so

 9 that swap dealers are regulated as swap dealers

 10 but end users don't somehow get caught up in being

 11 a swap dealer and only the largest nonswap dealers

 12 would be ending up being major swap participants.

 13 I don't have any questions. Commissioner Dunn?

 14 COMMISSIONER DUNN: Thank you, Mister

 15 Chairman. Mister Chairman, I'm going to support

 16 this proposed rule simply because I think we need

 17 to get something out on the table. We've gone way

 18 too long for folks to try to figure out where do I

 19 stand in all this, am I in or am I out? This is

 20 our first cut at giving some clarity of where they

 21 stand, and I appreciate all the hard work that

 22 staff of both the CFTC and SEC did working through
 175

 1 that, Mister Chairman, your staff and your

 2 personal intervention in moving this forward so

 3 that we have at least something on the table that

 4 people can begin to comment on. This is unique

 5 since the SEC is going to be taking up a similar

 6 provision. It's like the House and the Senate

 7 working on a bill and we may have to have a

 8 conference later on to ensure that we come

 9 together with these definitions.

 10 CHAIRMAN GENSLER: Are we the House or

 11 the Senate, Commissioner Dunn?

 12 COMMISSIONER DUNN: I've always worked

 13 for the upper house, Mister Chairman. With this

 14 rule and the subsequent rule on product unity,

 15 could you elaborate a bit, Mister Chairman, on

 16 what happens if we cannot come to a conclusion and

 17 the role that FSOC may have in this?

 18 CHAIRMAN GENSLER: You're absolutely

 19 right. There is the role of the Financial

 20 Stability Oversight Council if we can't. I don't

 21 think that's an acceptable outcome. I think the

 22 Securities and Exchange Commission and the CFTC
 176

 1 very much need to do that here, do that on product

 2 definitions and also interestingly there is a rule

 3 that we'll take up in January that's not related

 4 to derivatives but it's related to hedge fund

 5 disclosure and there's a piece of that that's a

 6 joint rule. Maybe General Counsel Berkovitz wants

 7 to give the exact role of the Financial Stability

 8 Oversight Council if we for some reason we

 9 couldn't come to an agreement.

 10 MR. BERKOVITZ: That's right. If the

 11 two agencies cannot agree, it would be determined

 12 by the Financial Stability Oversight Council.

 13 I'll look up the exact timeframe or the exact

 14 wording.

 15 COMMISSIONER DUNN: The clarification of

 16 where this may end up if we can't, but I think

 17 again it is probably is important as anything that

 18 we've done that we get comments on these

 19 definitions.

 20 CHAIRMAN GENSLER: I will say this.

 21 Though this 3 or 4 weeks later than we calendared

 22 it, I think SEC and CFTC staff and the
 177

 1 Commissioners, I know each of you talked to their

 2 Commissioners as I do sometimes too, that it's

 3 been a very collaborative process and it's been

 4 collaborative working through the May 6 issues.

 5 We've had the Joint Advisory Committee, we've had

 6 four or five roundtables together, and I'm sure

 7 we've probably approaching 200-plus staff meetings

 8 between the SEC and CFTC now. We share all the

 9 documents with them even the ones that aren't

 10 joint. I think it's been excellent. There are

 11 times where we disagree and you can probably if

 12 you're very clever look through this document and

 13 figure out through questions and footnotes where

 14 some of those disagreements are. But I think it's

 15 been working very positively so that again my

 16 compliments to SEC and CFTC staff.

 17 MR. BERKOVITZ: As a point of

 18 clarification on the role of the council,

 19 Dodd-Frank provides that in the event that the

 20 CFTC and the SEC fail to jointly prescribe rules

 21 in a timely manner, then at the request of either

 22 Commission the Financial Stability Oversight
 178

 1 Council shall resolve the dispute so that either

 2 Commission would have to request the FSOC to

 3 resolve the dispute. I would also add what the

 4 Chairman has just stated that we have had many,

 5 many discussions but nothing has elevated to what

 6 I would call the level of a dispute between the

 7 two agencies and the fact that we're here today

 8 and they're going to be where they are I think is

 9 a testament to that.

 10 CHAIRMAN GENSLER: Can we kick portfolio

 11 margining upstairs too?

 12 COMMISSIONER O'MALIA: Put it on the

 13 list.

 14 CHAIRMAN GENSLER: Commissioner Sommers?

 15 COMMISSIONER SOMMERS: Thank you, Mister

 16 Chairman. I'll start with questions about the

 17 limited registration that I referred to in my

 18 opening statement. Even though the statute

 19 provides for limited registration for dealers, we

 20 have decided that a person who satisfies the

 21 definition of swap dealer or security-based swap

 22 dealer would be a dealer for all types. And we go
 179

 1 on to say that because we think it would be

 2 difficult to separate their dealing activities

 3 from other activities, could you elaborate on why

 4 that's difficult?

 5 MR. FAJFAR: First of all, we're

 6 starting from the premise that there are very many

 7 different types of swap dealers active in very

 8 many different types of markets. For some swap

 9 dealers it might not be difficult, but we think

 10 that most companies view their swap activity as a

 11 whole, there hasn't been a designation of swap

 12 dealer before the statute and so they view their

 13 activities in swaps as a whole so that they don't

 14 distinguish for example separate books of records

 15 or separate compliance practices for swaps where

 16 they're accommodating demand and responding to

 17 demand from others versus putting on positions at

 18 their own initiative. That's the main reason.

 19 COMMISSIONER SOMMERS: If there are

 20 dealers who can easily separate and they know

 21 exactly what types or classes of swaps that they

 22 are a dealer for, will we be able to provide for
 180

 1 them a limited registration for just those

 2 categories?

 3 MR. BERKOVITZ: Yes, Commissioner, the

 4 proposed rule provides that the dealer in that

 5 category may apply for limited designation and the

 6 rule states that the Commission shall act upon

 7 that application and that would be at the time of

 8 the initial designation or subsequently

 9 afterwards.

 10 COMMISSIONER SOMMERS: I guess I should

 11 clarify. Instead of being categorized as a dealer

 12 first for everything, can they just apply only in

 13 a limited designation?

 14 MR. BERKOVITZ: Yes. At the time

 15 they're coming in with their registration, they

 16 would say we want to be a limited designation so

 17 that that limited designation could become

 18 effective upon registration.

 19 COMMISSIONER SOMMERS: I guess it was my

 20 understanding that the registration rule that we

 21 did didn't provide for that.

 22 MR. BERKOVITZ: That's correct, but in
 181

 1 this rule we have provided for it by the manner in

 2 which we're defining a dealer so they wouldn't

 3 become a dealer with respect to these other

 4 activities.

 5 COMMISSIONER SOMMERS: I misunderstood

 6 because it says here that if you satisfy the

 7 definition of swap dealer for one type, you are

 8 for all types unless you subsequent to that come

 9 in and apply for limited registration which seems

 10 a little backwards to me.

 11 MR. BERKOVITZ: The current version of

 12 the rule provides that you come in --

 13 COMMISSIONER SOMMERS: I'm not working

 14 off the current version.

 15 CHAIRMAN GENSLER: Tell us what page.

 16 MR. BERKOVITZ: It's page 144.

 17 CHAIRMAN GENSLER: Tell us where on page

 18 144.

 19 MR. BERKOVITZ: It's at the bottom at

 20 "scope of designation" at the bottom of paragraph

 21 two.

 22 CHAIRMAN GENSLER: Scope of designation?
 182

 1 MR. BERKOVITZ: Yes. It's 141 for the

 2 swap dealer. Excuse me.

 3 COMMISSIONER SOMMERS: So that they will

 4 not be designated as a swap dealer in all classes

 5 if they apply for a limited designation?

 6 MR. BERKOVITZ: The Commission shall

 7 make a determination upon such application so that

 8 if the Commission were to make the determination

 9 of limited designation, there would not be a time.

 10 COMMISSIONER SOMMERS: Where they're

 11 considered a dealer for everything.

 12 MR. BERKOVITZ: Correct.

 13 CHAIRMAN GENSLER: If I can help because

 14 this is one place where I think Commissioner

 15 Sommers and I agree. If we get through all this

 16 and we have final rules, that somebody could some

 17 in and say I'm only a swap dealer for interest

 18 rate swaps, I do an occasional oil swap but we

 19 don't deal in that, or on the other hand, I'm a

 20 dealer in oil swaps but I occasionally do interest

 21 rate swaps, that we have the clear flexibility in

 22 statute to designate them a swap dealer in one
 183

 1 category and not the other and I'm hoping that we

 2 maintain that flexibility and that the limited

 3 dealer designation is something easy for us to

 4 facilitate, easy because it's what Congress

 5 directed us to do.

 6 MR. BERKOVITZ: That's correct. We have

 7 the statutory authority and the rule here if it

 8 were adopted would provide for us to exercise that

 9 authority upon application for registration and we

 10 would so designate a person as a limited manner so

 11 they would not be a swap dealer at all until they

 12 received either the limited designation or the

 13 full designation.

 14 COMMISSIONER SOMMERS: I guess I would

 15 suggest that's not clear. It says here that

 16 they're subject to all regulatory requirements

 17 applicable to dealers for all swaps into which

 18 they enter.

 19 MR. BERKOVITZ: That's correct, but if

 20 they apply and said they would like a limited

 21 designation, if they come in and say here's why we

 22 think we should be limited, the rule says the
 184

 1 Commission shall determine whether indeed to do

 2 so. So if they don't come in apply, the

 3 presumption is they're for everything, but if they

 4 come in apply and we agree, yes, indeed this

 5 should be limited, then they will become a

 6 limited-designation dealer.

 7 COMMISSIONER SOMMERS: My next question

 8 is with regard to the dealer/trader distinction

 9 that the SEC will use that we have chosen not to

 10 use. I do understand that there may be criteria

 11 in that distinction that may not be applicable to

 12 transactions that are not securities. However, is

 13 it possible for us to add into our definition of a

 14 dealer the concept that they have regular

 15 clientele without adopting everything that we

 16 don't believe is applicable? Again I would

 17 suggest that if you don't have clients, you're

 18 probably not a dealer.

 19 MR. FAJFAR: I think that this is

 20 something that we would be looking to address

 21 during the comment period in the development of

 22 the final rules. I'd like to make clear that
 185

 1 there was not a disagreement with the SEC about

 2 how the distinction applies, and we had a very

 3 useful working discussion with them about the

 4 different rules that we would apply and that they

 5 chose to apply some of their precedents because of

 6 the view of how the security-based swap market

 7 works. Again because of the diversity of the swap

 8 market and all the differences between the

 9 different aspects, we tried to start for this

 10 proposal as I think Chairman Dunn was saying with

 11 something that applies across the board in an even

 12 way to all parties in the swap market and they can

 13 look at it and identify the issues that arise for

 14 them. And if it were to turn out that as a means

 15 of defining who accommodates demand and who

 16 facilities entering into swaps, it may be that the

 17 role of clients or counterparties would be one of

 18 the factors that would be developed in the final

 19 rule. But it's difficult to say now because there

 20 are so many different ways that people enter into

 21 swaps and it could be different for some people.

 22 COMMISSIONER SOMMERS: Let me make sure
 186

 1 I understood that. There could be people who

 2 don't have clients who are still dealer? I guess

 3 that's what I heard.

 4 MR. FAJFAR: You'd have to think about

 5 what the meaning of a regular client base is and

 6 how they enter into swaps.

 7 COMMISSIONER SOMMERS: What if you don't

 8 have any clients ever?

 9 MR. FAJFAR: I think we'd have to see

 10 how the different factors would apply to the

 11 different ways that people enter into swaps.

 12 MR. BERKOVITZ: One of the factors is

 13 whether they hold themselves out for a dealer,

 14 whether they accommodate demand, so it may be a

 15 factor in determining that whether they have a

 16 regular clientele or not, but somebody may hold

 17 themselves out and not have a regular base or make

 18 a market without having a regular base of clients

 19 so that it's a factor but necessarily

 20 determinative either way.

 21 COMMISSIONER SOMMERS: In this same vein

 22 I have questions about how we define or how we
 187

 1 anticipate defining market maker because that is

 2 one of the prongs for definition of being a dealer

 3 and I'm not sure that it's real clear, and if you

 4 have anything you want to elaborate on about who

 5 exactly is a market maker and what do they have to

 6 satisfy in order to be considered in to be a

 7 market maker.

 8 MR. FAJFAR: Through the process of

 9 developing the rule proposal and looking at the

 10 comment letters, obviously the preamble only says

 11 a little bit about what a market maker would be

 12 and that's what we were able to glean from the

 13 meetings we've had and the comments. We're

 14 certainly open to more input on that, but at this

 15 time from the information that we have it looks

 16 like the statutory definition of a market maker,

 17 the use of that word and what a market maker in

 18 swaps is, is what we have to present at this time

 19 and we're opening up to comment on that.

 20 COMMISSIONER SOMMERS: I understand

 21 that, but do you anticipate putting more to that

 22 rule so that it's very clear?
 188

 1 MR. FAJFAR: I think that in general in

 2 these questions, we say right up front, it's on

 3 page 6 of this draft and there's a footnote

 4 addressing it, that we expect that the market for

 5 swaps is going to evolve and change including

 6 through the influence of the Dodd-Frank Act and we

 7 want to have the definitions in a way sufficiently

 8 flexible to address how the market changes and how

 9 people go about making a market in swaps for

 10 example. And we're specifically asking for

 11 comment on how the rules should be both flexible

 12 enough and determinative enough to give guidance

 13 on topics such as what it means to be a market

 14 marker for swaps.

 15 COMMISSIONER SOMMERS: Thank you.

 16 CHAIRMAN GENSLER: May I follow-up on

 17 Commissioner Sommers's question? It occurs to me

 18 that one of the categories that currently is not

 19 participating in any size in the swap market or

 20 high-frequency traders but as this moves into

 21 trading platforms and as Commissioner Chilton has

 22 raised a number of times, high-frequency traders,
 189

 1 if a high-frequency trader as we know them today

 2 made bids and offers on a swap execution facility

 3 and were active, did thousands of trades a year or

 4 tens of thousands because they're high frequency

 5 and they left resting orders and resting bids and

 6 provided liquidity to the marketplace, would they

 7 be under this definition of market makers and swap

 8 dealers?

 9 MR. BERKOVITZ: We haven't squarely

 10 addressed that but I think that certainly could be

 11 possible under the four-prong test. The

 12 functional definition talks about making a market

 13 or accommodating demand. Certainly making the

 14 market or accommodating demand could be in a

 15 number of ways. One would be by posting on the

 16 website saying we're available for swaps, another

 17 could be putting in a number of resting bids or

 18 offers into the market.

 19 CHAIRMAN GENSLER: Certainly the market

 20 will evolve, but I think that it would be good to

 21 hear from the public. It does strike me that

 22 Congress said making markets. How many times have
 190

 1 I met with a high-frequency trader and said we're

 2 making markets to provide liquidity? They may not

 3 be doing it yet, but I think that it may well be

 4 that Congress decided this for us, but we'll get

 5 public comment. It sounds like we haven't

 6 squarely said that here but we'll get public

 7 comment and this may be related to Commissioner

 8 Sommers's question at least. Commissioner

 9 Chilton?

 10 COMMISSIONER CHILTON: No, I'm good.

 11 Thank you, sir.

 12 CHAIRMAN GENSLER: Commissioner O'Malia?

 13 COMMISSIONER O'MALIA: Thank you. In my

 14 little travels, one of the slides that they had at

 15 this PJM conference was they pulled up our

 16 commitment of trader's reports for a bunch of PJM

 17 trading contracts. I noticed this in a lot of

 18 these contracts because as end users they have our

 19 standard definitions of producer/merchant, swap

 20 dealer, manage money and then the

 21 producer/merchant plus swap combination to total

 22 it. In here I was struck by the high totals or
 191

 1 producer/merchant and relatively low totals of

 2 swap dealer. In the PJM peak contract for example

 3 there's 66-percent producer and 7-percent swap

 4 dealer. And since I think people are relatively

 5 comfortable with the way we bin these things and

 6 we use a predominance test, could you explain to

 7 me how this rulemaking might change the way these

 8 people are categorized? Are we likely to see more

 9 producer/merchants in a swap dealer category as a

 10 result of this rulemaking?

 11 MR. FAJFAR: First of all I'd say that

 12 we met extensively with people involved in the

 13 generation and transmission of electricity and one

 14 of the things we learned on those meetings as we

 15 know is that that market is very, very complex and

 16 there is a lot of usage of what they call swaps

 17 and other types of derivative instruments, even

 18 managing next-day delivery or delivery this

 19 afternoon and set this morning, so the approach

 20 that we took in the release is to have a specific

 21 paragraph pointing out that the electricity market

 22 is very different. It's one of the things that I
 192

 1 was referring to in the variety of different

 2 markets where people use swaps. We are

 3 specifically interested in comment on how you

 4 apply a regulatory and statutory definition of

 5 swap dealer to a market where people are for

 6 example managing load on electricity lines. We

 7 couldn't predict right now how this definition

 8 will affect that market or how that market might

 9 evolve, but we are definitely very sensitive to

 10 that and want to hear specifically on that issue

 11 and continue to work with them.

 12 COMMISSIONER O'MALIA: I appreciate your

 13 concern about that, but do you think it's going to

 14 change the way we bin these categories or are

 15 producers going to be in the swap dealer category

 16 in this market based on the extensive

 17 conversations you've had? I'll pulled up all the

 18 meetings we've had with a lot of energy companies

 19 and based on your conversations with them, is it

 20 going to be as cut and dry as our large-trader

 21 reports, our commitment of trader reports are?

 22 MR. FAJFAR: I don't think it will be
 193

 1 cut and dry, no. At this point we haven't

 2 developed a prediction where we could say what

 3 we'll have.

 4 COMMISSIONER O'MALIA: Subparagraph C of

 5 the swap dealer definition excludes from the

 6 definition "A person that enters into swaps for

 7 such person's own accounts either individually or

 8 in a fiduciary capacity but not as a regular

 9 course of business. This language comes from the

 10 1934 Exchange Act. And has not been subject to

 11 extensive judicial interpretation and the SEC uses

 12 a variety of factors to determine whether these

 13 entities are dealers. That being said, at least

 14 one court in New York I believe has determined

 15 that making money through buying and selling

 16 securities is not conduct which in and of itself

 17 makes someone a dealer. My question is what does

 18 it mean for a person to enter into swaps as a

 19 regular course of business?

 20 MR. BERKOVITZ: We've interpreted the

 21 third prong of the swap dealer test also in

 22 conjunction with the exclusion from the definition
 194

 1 of swap dealer which is very similar language.

 2 What the guidance in the preamble says is that in

 3 looking to whether they're entering into swaps as

 4 a regular course of business you have to look at

 5 whether they're doing the functions that we've

 6 talked about in connection with the other prongs,

 7 whether they're accommodating demand or whether

 8 they're entering into swaps in response to

 9 requests from other parties so that it really

 10 relates to the activities that are described in

 11 the other prongs. This is also an issue that we

 12 met with and discussed with a lot of the market

 13 participants and so we're hoping we're providing

 14 that clarity in the we've drafted it in this rule.

 15 COMMISSIONER O'MALIA: But we're not

 16 falling back on some of these litigated terms so

 17 to speak in what is a regular course of business

 18 and the court found that buying and selling of

 19 securities does not make them a dealer

 20 necessarily. Would we use any of those

 21 definitions? You're going back to the activity I

 22 guess is what you're saying.
 195

 1 MR. BERKOVITZ: We're looking at it

 2 holistically in terms of the third prong with the

 3 exclusion in the Dodd- Frank and relating it to

 4 the other types of dealing activities that are

 5 described. That's the business that we're focused

 6 on.

 7 COMMISSIONER O'MALIA: Maybe I missed

 8 it, but how is a market supposed to interpret the

 9 term accommodates demand? Do you want to explain

 10 that, Mark?

 11 MR. FAJFAR: I think we can start from

 12 the premise that there is what you could call a

 13 demand for swaps. There's a need for swaps to

 14 hedge risk, there's a need for swaps to speculate.

 15 People need swaps. And when they want to enter

 16 into a swap they need to find a counterparty and

 17 it might be a one-off situation where they know a

 18 counterparty is available to them, but on the

 19 other hand they might go to a party who maybe goes

 20 so far as to advertise or is otherwise holding

 21 itself out as a dealer and is saying I'm ready to

 22 enter into swaps with people to take the other
 196

 1 side of that swap. When you do that you're

 2 accommodating demand, you're fulfilling the

 3 demand, you're providing what the demand is asking

 4 for and we're starting with the premise that

 5 that's a swap dealer.

 6 COMMISSIONER O'MALIA: I think one of

 7 the other questions that was answered, not

 8 answered but at least asked twice was this

 9 execution on a trading platform and if you

 10 accommodate demand by standing on the other side

 11 of that. I'm very interested to see how that's

 12 going to play out. It's clear in the statute that

 13 Congress intended for an entity with a de minimis

 14 amount of swap-dealing activity to be exempt from

 15 the swap dealer definition, but this exemption

 16 sets thresholds on the overall swap activity and

 17 not the swap dealing. Is that correct or is it

 18 the other way around?

 19 MR. FAJFAR: No, it is for the dealing

 20 activity.

 21 COMMISSIONER O'MALIA: For the dealing

 22 activity. That is definitely the subcategory of
 197

 1 the overall activity?

 2 MR. FAJFAR: Right. The rule and the

 3 preamble both limit to the person's dealing

 4 activity.

 5 COMMISSIONER O'MALIA: I know you

 6 mentioned this or somebody mentioned this, but I'd

 7 like a further explanation. Why doesn't the de

 8 minimis exemption use a net notional calculation

 9 or net uncollateralized risk similar to the MSP

 10 rule?

 11 MR. FAJFAR: First of all, with the

 12 collateral if you said that you can enter into

 13 swaps as long as they're collateralized, that

 14 wouldn't measure your activity, that would be a

 15 measure if anything would be a measure of risk so

 16 that you could enter as the preamble says

 17 virtually unlimited numbers of quantity of swaps

 18 as long as you're collecting collateral. Then the

 19 same principle, if it goes with a net basis

 20 depending on how the netting applies, long versus

 21 short, you could enter into swaps on one side of

 22 the market and then bring down that total by
 198

 1 entering into swaps on the other side of the

 2 market and again you could have extensive swap

 3 activity and remain below a net level. That's why

 4 we look at the gross level for the de minimis test

 5 only.

 6 COMMISSIONER O'MALIA: Thank you. How

 7 do we treat voice brokers in this dealer

 8 definition? Two commercials will bring together

 9 on either a platform or through a telephone call,

 10 are they dealers?

 11 MR. FAJFAR: The first answer is that

 12 the way the two people connect or they enter into

 13 the swap, the manner that they do that, is not a

 14 determinative factor in whether or not they're a

 15 dealer. It's rather we're trying to look at their

 16 overall functional rule in relation to their

 17 counterparties and what role they're playing so

 18 that in a simple case if you had two people who

 19 deal with each other very rarely perhaps on the

 20 basis of some other connection they have, then

 21 that's not a dealing activity.

 22 COMMISSIONER O'MALIA: To give the end
 199

 1 users the confidence that they will not get swept

 2 up in this, what page should they read in this

 3 rulemaking to give them the confidence that there

 4 is a safe harbor for them?

 5 MR. FAJFAR: In terms of safe harbors,

 6 that would have to be determined by the

 7 Commission. We don't propose any safe harbors at

 8 this time. There is a paragraph where we say in

 9 conclusion what a swap dealer is in the discussion

 10 of the application of the test to swap dealers,

 11 and what we were trying to do is lay out a

 12 description of activities that would cause you to

 13 be a swap dealer with the presumption that you

 14 don't engage in those activities you're not a swap

 15 dealer.

 16 CHAIRMAN GENSLER: What page is that?

 17 MR. FAJFAR: It's on pages 12 to 14.

 18 COMMISSIONER O'MALIA: Mark, I

 19 appreciate everything you'd done. This is not an

 20 easy definition. It's not the clearest statutory

 21 direction and I appreciate all the hard work

 22 you've put into this. I do think there is more
 200

 1 work to be done an obviously the comments

 2 hopefully will provide a lot of assistance in

 3 where we draw these lines and certainly hopefully

 4 narrow this so that we actually capture the dealer

 5 activities and protect end users. Thank you.

 6 CHAIRMAN GENSLER: I think staff and I

 7 thank the Commissioners. I think that this

 8 proposal does strike the right balance, but again

 9 it's a proposal that's trying as I think we're all

 10 trying, that end users rather they're hedging or

 11 even speculating, but that they're not swept into

 12 to be swap dealers, but if you read the statutory

 13 definition and add to it what the SEC and the CFTC

 14 are jointly saying about accommodating demand and

 15 Commissioner Sommers asked the question what does

 16 that mean, but accommodating demand where somebody

 17 else is coming to you and you say I'll fill their

 18 order or something, facilitating the markets, that

 19 that was helpful clarification at least for me

 20 that the proposals might come forward. I also

 21 think very importantly in the major swap

 22 participant definition in what was called prong
 201

 1 one, prong is what I call the speculator's prong,

 2 but the noncommercial hedging, the rule does lay

 3 out that if you're hedging an asset, if you're

 4 hedging a liability, if you're hedging an input,

 5 if you're hedging a service, if you're hedging a

 6 future input or a future service, that's hedging

 7 or mitigating commercial risk as long as it's not

 8 "speculation," that the position itself, that the

 9 swap isn't, I think it's speculating or trading or

 10 vesting so that you can be hedging assets,

 11 liabilities, inputs, services or future inputs and

 12 services. Did I get the right list?

 13 MR. FAJFAR: Yes.

 14 CHAIRMAN GENSLER: Thanks. So it's not

 15 just relying on some narrow FASB definition even

 16 though we also said if you're relying on FASB,

 17 that's a commercial hedging. We didn't just rely

 18 on a narrow bona fide hedger definition even

 19 though we said that that would work too. So I

 20 think that we did it, but we'll see when we get

 21 comments. I do think some companies will end up

 22 being major swap participants, but Congress passed
 202

 1 the statute and I don't think we were supposed to

 2 write something that nobody was a major swap

 3 participant. We don't know for sure, but I should

 4 ask how many people do we think might be major

 5 swap participants under this rule and not major

 6 securities-based swap participants, but major swap

 7 participants?

 8 MR. BERKOVITZ: We haven't done a

 9 thorough survey on this, but we're estimating

 10 based on the our interviews maybe a handful, at

 11 most two handfuls, somewhere in the handful range.

 12 CHAIRMAN GENSLER: And that from the

 13 General Counsel of the CFTC.

 14 MR. BERKOVITZ: I'm hedging, Mister

 15 Chairman.

 16 CHAIRMAN GENSLER: What school did you

 17 go to? Mr. Stawik, do you want to call the roll?

 18 MR. STAWIK: Commissioner O'Malia?

 19 COMMISSIONER O'MALIA: No.

 20 MR. STAWIK: Commissioner O'Malia, no.

 21 Commissioner Chilton?

 22 COMMISSIONER CHILTON: Aye.
 203

 1 MR. STAWIK: Commissioner Chilton, aye.

 2 Commissioner Sommers?

 3 COMMISSIONER SOMMERS: No.

 4 MR. STAWIK: Commissioner Sommers, no.

 5 Commissioner Dunn?

 6 COMMISSIONER DUNN: Aye.

 7 MR. STAWIK: Commissioner Dunn, aye.

 8 Mister Chairman?

 9 CHAIRMAN GENSLER: Aye.

 10 MR. STAWIK: Mister Chairman, on this

 11 question the ayes are three, the no's are two.

 12 CHAIRMAN GENSLER: I thank you, Mark and

 13 Dan and I thank the SEC again. We will not send

 14 this to the Federal Register until after Friday

 15 naturally depending on what the SEC does I guess.

 16 We'll have to see there. I'm supposed to though

 17 at this point ask for unanimous consent to allow

 18 staff to make technical corrections to the

 19 document voted on today prior to send it to the

 20 Federal Register.

 21 COMMISSIONER DUNN: Mister Chairman, a

 22 question on that. If the SEC makes some minor
 204

 1 changes that is technical and clarifying in

 2 nature, then it would allow the staff then to make

 3 the decision of sending it forward?

 4 CHAIRMAN GENSLER: I think it would.

 5 The unanimous consent suggestion is that there

 6 would be changes. These are really meant to be

 7 technical corrections. This is supposed to be

 8 very limited.

 9 COMMISSIONER SOMMERS: On that subject,

 10 does that mean that if the SEC does not adopt this

 11 identical rule that we will have to pass it again?

 12 CHAIRMAN GENSLER: Dan, will you help

 13 us? It's a joint rule.

 14 MR. BERKOVITZ: Both agencies have to

 15 approve the identical text for it to be published

 16 in the Federal Register, yes.

 17 CHAIRMAN GENSLER: That makes sense to

 18 me so that we're not sending anything until after

 19 Friday and subject to Friday. We're the upper

 20 house, but we have to wait for the other house I

 21 guess or we're the lower house. I don't know.

 22 Whatever it is. Not hearing objection to the
 205

 1 unanimous consent, that's passed. I'll take a

 2 motion to adjourn. Is there any other Commission

 3 business? I'll take a motion to adjourn the

 4 meeting.

 5 COMMISSIONER DUNN: So moved.

 6 COMMISSIONER SOMMERS: Second.

 7 CHAIRMAN GENSLER: All in favor?

 8 (Chorus of ayes.)

 9 CHAIRMAN GENSLER: We don't need a

 10 recorded vote on that do we? No. Thanks.

 11 (Whereupon, at 1:40 p.m., the

 12 PROCEEDINGS were adjourned.)

 13 * * * * *

 14

 15

 16

 17

 18

 19

 20

 21

 22
 206

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Stephen K. Garland, notary public in

 4 and for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: May 31, 2014

 22