UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 TECHNOLOGY ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Monday, February 10, 2014
 2

 1 PARTICIPANTS:

 2 Opening Remarks:

 3 CHAIRMAN SCOTT D. O'MALIA (TAC)

 4 ACTING CHAIRMAN MARK P. WETJEN

 5 Panel I: Swap Data Reporting, CFTC Data

 Priorities and Path Forward:

 6

 JOHN ROGERS

 7 Chief Information Officer

 Office of Data and Technology

 8

 SAYEE SRINIVASAN

 9 Chief Economist

 Office of the Chief Economist

 10

 ANANDA RADHAKRISHNAN

 11 Director

 Division of Clearing and Risk

 12

 VINCE McGONAGLE

 13 Director

 Division of Market Oversight

 14

 DAN BUCSA

 15 Associate Director, Surveillance

 Division of Market Oversight

 16

 GARY BARNETT

 17 Director

 Division of Swap Dealer and Intermediary

 18 Oversight

 Panel II: Commission's Concept Release on

 19 Automated Trading

 20 SEBASTIAN PUJOL SCHOTT

 Associate Director

 21 Division of Market Oversight

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 ROB CREAMER

 President and Chief Executive Officer

 3 Geneva Trading

 4 CAITLIN KLINE

 Derivatives Specialist

 5 Better Markets

 6 ERIC BUDISH

 Professor

 7 University of Chicago

 8 STUART KASWELL

 Executive Vice President and Managing

 9 Director, General Counsel

 Managed Funds Association

 10

 Panel III: Swap Execution Facilities/Made

 11 Available to Trade Determinations

 12 VINCE McGONAGLE

 Director

 13 Division of Market Oversight

 14 STEPHEN BERGER

 Director, Government & Regulatory Policy

 15 Citadel

 16 MIKE HENNESSY

 Assistant Vice President, Treasury &

 17 Capital Markets

 Federal Home Loan Bank of San Francisco

 18

 SUNIL HIRANI

 19 Chief Executive Officer

 trueEX

 20

 ALEX EVIS

 21 Head of Market Structure Strategy, Global

 Credit

 22 Goldman Sachs
 4

 1 PARTICIPANTS (CONT'D):

 2 Other SEF Issues:

 3 SCOTT FITZPATRICK

 Executive Director

 4 Tradition

 5 Closing Remarks:

 6 CHAIRMAN SCOTT D. O'MALIA (TAC)

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 5

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

 2 (10:05 a.m.)

 3 CHAIRMAN O'MALIA: All right. Can we

 4 find our seats and get started. Well, I'd like to

 5 thank everybody for making their second trip back

 6 to Washington for those who made it down here the

 7 first time, and thank you very much for

 8 rescheduling on a short notice so we could get

 9 this in before the comment period ends and before

 10 the TAC, the mandatory trading requirements take

 11 in, go into effect this Saturday. So it was

 12 important we try to squeeze this one in. And I

 13 apologize for starting on a Monday, but the

 14 schedule is what the schedule is. So thank you

 15 very much for making all the arrangements.

 16 So today we have a very interesting

 17 three sets of topics. We have data, we have a

 18 concept release on automated training, and we have

 19 SEF issues. And we're going to focus primarily on

 20 the made available for trade determination that

 21 the Commission recently put out several

 22 submissions. Now of course I was trying to hold
 6

 1 up a little bit so I could talk about Acting

 2 Chairman Mark Wetjen's efforts to be helpful on

 3 the data front. I'm going to go ahead and say it

 4 anyway even though he's not here, and hopefully

 5 somebody will repeat it to him so I get credit for

 6 that, but he has been a tremendous force in terms

 7 of kind of refocusing the Commission's attention

 8 on data.

 9 And I appreciate his support and his

 10 willing to set up, willingness to set up this

 11 cross-divisional data group and so we can begin to

 12 identify and correct any problems we have in our

 13 data so we can be quite effective in our

 14 surveillance, risk management, and oversight

 15 responsibilities. I also appreciate the strong

 16 support for the comments made by Deputy Secretary

 17 of Treasury, Mary Miller. In her last two public

 18 comments, she's addressed this issue head on, said

 19 she's going to roll up her sleeves and fix this

 20 issue, so I'm grateful for her support. And she's

 21 committed the resources of OFR. So that will be a

 22 great leverage tool for us and provide some
 7

 1 additional assistance to attack this data

 2 challenge.

 3 So we have, we continue to work on our

 4 Office of Data and Technology SDR effort led by

 5 John Rogers working with the four SDRs that we

 6 have permitted to make sure that they're quite

 7 effective in transferring the data to the

 8 Commission, but there's a lot of work that has to

 9 be done. We have the relevant division directors

 10 as well as our economist and representatives from

 11 the Office of Surveillance and we'll hear from

 12 them as to their challenges and what's going

 13 right, what's going wrong with our data, and we'll

 14 see if we can help them out with fixing their

 15 problems. And certainly we'll want to learn more

 16 about their priorities as well.

 17 Panel two, we've got a great discussion,

 18 something this committee has tackled I think from

 19 the very first meeting we had three and a half

 20 years ago, and that's the, what are the

 21 appropriate risk management controls for automated

 22 trading. And so we will attack that again, and we
 8

 1 will talk about it. We, as everyone knows we have

 2 completed the comment period, well, we just

 3 reopened it again until the end of this week, but

 4 for the concept release on the advanced

 5 testing and supervision of automated trading, we

 6 received dozens of very good comments, and we will

 7 have a handful of those people that commented talk

 8 about the proposal here today.

 9 And I am mindful of one of the questions

 10 that Larry Tabb actually posed to me. And one

 11 question that we'll be asking is, what is the

 12 problem that we're trying to fix with this. I

 13 think that's a good question and probably will be

 14 quite helpful in forming our discussion and our

 15 next draft proposal if there is to be one.

 16 Panel three, the SEF issue, made

 17 available for trade has been a hot topic in a lot

 18 of publications, discussion around the Commission

 19 as well. DMO has certified several made available

 20 for trade submissions. The go-live date is next

 21 week or this weekend I guess is the actual date,

 22 but this is an important topic that people are
 9

 1 trying to understand, and we have linked these

 2 benchmark products with -- these package

 3 transactions linked products, and there were a

 4 number of comments in the commenters that

 5 submitted comments that said, we have some

 6 concerns about operational, technical, and

 7 jurisdictional challenges with these made

 8 available for trade submissions and want to

 9 understand that.

 10 Now I was a little frustrated when the

 11 first submission came out that it included package

 12 transactions because it never addressed this issue

 13 in the comment memo to the Commission. And in

 14 fact, in that document, the staff recommendations

 15 to the commission said, regarding package

 16 transactions, such requests are not appropriate

 17 for consideration within the scope of the

 18 Commission's process for reviewing a MAT

 19 determination. Well, if it's not then, when?

 20 So that is one of the reasons why we had

 21 some urgency in scheduling this meeting.

 22 Thankfully the staff has also expressed an
 10

 1 interest in reconsidering the package transaction

 2 and figuring out some of the technical and

 3 operational challenges with implementing package

 4 trades and we're going to have a package trade

 5 roundtable on Wednesday. So that, I'm looking

 6 forward to that. We'll obviously be able to

 7 discuss it extensively here and certainly on

 8 Wednesday. So maybe by the end of the week we'll

 9 have a pretty clear picture of what these products

 10 are and how we should address them going forward

 11 in a temporary relief process.

 12 So those are the three panels we have

 13 today. Again, let me thank everyone for making

 14 adjustments to their schedule to be here following

 15 our snow day. Let me turn it over to the chairman

 16 for any comments he may have.

 17 ACTING CHAIRMAN WETJEN: Thank you,

 18 Scott. Thanks for assembling the TAC group again

 19 today.

 20 As usual a very good and interesting

 21 agenda for the day and number of topics that the

 22 agency could stand to benefit from this committee
 11

 1 in talking through. A couple of points I wanted

 2 to make with regard to data, we've had the SDR

 3 reporting obligation now in place for a little

 4 more than a year, and we've been getting some

 5 useful information through the reporting

 6 obligations; but there has been a sufficient

 7 passage of time now where it's become clear that

 8 we could probably do even better.

 9 And so Scott's been, Commissioner

 10 O'Malia has been very, very vocal about this, and

 11 I appreciate his commitment to making sure that we

 12 solve all of the regulatory challenges and

 13 problems we have that stem from our rules or

 14 otherwise, including this one. But it has become

 15 clear that we need to make sure that the quality

 16 of the data we are getting is as good as it should

 17 be and as good as what was envisioned by our

 18 rulemakings and frankly by what Congress, I think,

 19 envisioned for this agency. So it's entirely

 20 appropriate, given the passage of time now since

 21 the beginning of the reporting obligation, that we

 22 take another look at this and see how we can
 12

 1 improve upon what's already been provided to us

 2 through the reporting, the regulatory reporting

 3 from the marketplace.

 4 So we look forward to the work of this

 5 group we've assembled here internally. We look

 6 forward to the comment that we expect to get from

 7 market participants including the folks in the

 8 room. And we'll continue that process all in

 9 effort again to make sure we maximize the utility

 10 of the information we get. One of the things that

 11 was most important to me is that we, we're not

 12 going to be able to enforce these new reforms as

 13 well as we like unless we have high quality data,

 14 it gives us the very best picture of what's

 15 happening in the marketplace. So we're looking

 16 forward to that process being complete.

 17 Secondly on the made available to trade

 18 submissions, and equally importantly if not more

 19 importantly the trading mandate on February 15th,

 20 this is obviously a critical moment for the

 21 marketplace, but also a critical moment for the

 22 agency; it's one of the last remaining deadlines,
 13

 1 truly hallmark deadlines under Title VII. And as

 2 Commissioner O'Malia alluded to, we've been

 3 spending a lot of time in recent weeks, but even

 4 longer, sorting through some of the issues that

 5 have been brought to us and trying to figure out

 6 how we can do two things.

 7 First is to maximize the level of

 8 trading activity on the SEF platforms or on a DCM,

 9 that's priority number one and that's what the

 10 rulemakings in Congress directed us to do; and

 11 then two, make the transition as orderly as we

 12 can. And there have been a number of key issues

 13 raised including with respect to package

 14 transactions that clearly present some challenges

 15 that we need to think through carefully. And all

 16 in effort, again, to make sure that as much

 17 transactions, as many of transactions as possible

 18 can take place on regulated platforms; but also to

 19 make sure that the February 15th day comes as

 20 relatively smoothly as possible.

 21 So looking forward to the discussion

 22 later on today and at this meeting on that
 14

 1 subject. And also looking forward to the

 2 roundtable as well on Wednesday. And I think

 3 we've learned a lot already, but I expect we'll

 4 learn some more by the end of the day Wednesday.

 5 So with that I'll turn back over to Commissioner

 6 O'Malia. Thank you very much again for everyone

 7 being here.

 8 CHAIRMAN O'MALIA: All right. We're

 9 going to start with our first panel, which is made

 10 up of our division directors, our economist, the

 11 Office of Surveillance, and the Office of Data and

 12 Technology. We're just going to let them present

 13 on what they, what's going right and what's going

 14 wrong with the data. And then we'll have a Q and

 15 A after that and walk through that in our first

 16 panel.

 17 So I -- let me, John Rogers, our head of

 18 -- Chief Information Officer in the Office of Data

 19 and Technology. He'll be followed Sayee

 20 Srinivasan, our Chief Economist. Then Ananda

 21 Radhakrishnan, the Director of Division of

 22 Clearing and Risk. Followed by Vince McGonagle,
 15

 1 Division of Market Oversight. Dan Bucsa will

 2 represent the Office of Surveillance. And Gary

 3 Barnett will clean up with the Office of Swap

 4 Dealer and Intermediary Oversight.

 5 So I will turn it over to you for, what,

 6 six presentations. So thank you very much.

 7 MR. ROGERS: Thank you, Commissioner

 8 O'Malia. Good morning, everyone. Thank you. Can

 9 you hear me? A little closer, okay, all right

 10 good morning, everyone. Oh, that's better.

 11 Before I start, I will say that all statements and

 12 opinions are my own and do not necessarily

 13 represent the view of any Commissioner or the

 14 Commission. I'd like to start by talking about --

 15 first technology challenge, using the remote here.

 16 So I'd like to start -- I’m going to 

 17 talk a little bit about three different subjects,

 18 specifically the harmonization effort that we

 19 have going on with the SDRs here at the

 20 Commission, a little bit about data that we
 16

 1 collect under Part 20, and then lastly an update

 2 on what we are doing with the global trade

 3 repository feasibility study working group. The

 4 data that we deal with in harmonization is data

 5 housed at the SDRs. And the, it's something I've

 6 been here and spoken on a couple of times.

 7 And here the key elements that we're

 8 looking at as it relates to harmonization, just as

 9 a fresher, we are focusing on standardization

 10 because obviously the ability to standardize on

 11 the data will approve the ability to aggregate and

 12 analyze the data, it will improve the data

 13 quality. And an example of that would be the LEI,

 14 which we've been working on for some time.

 15 Another example would be UPI. Another key

 16 priority for harmonization is consistency. And

 17 that's consistency within the SDR, itself, and

 18 then that's consistency across the SDR. So

 19 typically as we talk about the fields that we're

 20 looking at in our harmonization initiative, we're

 21 getting together and talking about what these

 22 fields mean and making sure that we all have a
 17

 1 common understanding of that.

 2 Another aspect of what we're looking at

 3 is in terms of capability. Not only do the SDRs

 4 house data, but they also have portals that allow

 5 us to utilize that data. And so as we look at the

 6 portals, we look at each one of them and see

 7 things that we like in each and make

 8 recommendations as to how those portals can be

 9 improved. So we're trying to achieve the highest

 10 common denominator of standardization.

 11 The other considerations that we have,

 12 I've already mentioned the impact of global

 13 standards LEI and UPI, we're certainly looking at

 14 it from the perspective of how we might use the

 15 data within CFTC, so that's potential data uses.

 16 And we're very much aware of the impact on the

 17 people or the entities that are submitting data to

 18 us and focusing on the relationship of the SDRs

 19 providing data to CFTC and a bit less on the

 20 front-end process, but it actually does bleed into

 21 the front end of how data is submitted to the

 22 SDRs. And I'll touch on that just a little bit.
 18

 1 The other characteristic I would like to

 2 talk about as far as the SDR data is concerned, a

 3 lot of times people think about it as Part 45

 4 data, but really it's much more than that, it's

 5 really Part 43 data, 45, 46, and 49, as well as

 6 optional data that will be flowing into the SDR.

 7 We're looking at all of that data. From the data

 8 that is flowing into the CFTC, we get what is

 9 called, what we call Part 20 data, futures

 10 equivalent swaps positions for commodity data. We

 11 are receiving that on a nightly basis here at the

 12 Commission, performing validations on that data

 13 here, and providing feedback to entities as to the

 14 quality of that data.

 15 Now it's a little bit different than the

 16 activities that are occurring on the SDR data

 17 since the SDR is the entity that is holding the

 18 data, and so that validation is happening on that

 19 end. Excuse me.

 20 What we've done as far as a team is

 21 concerned, is we have an interdivisional team made

 22 up of the representatives of the people to my
 19

 1 right and left and their representatives and we

 2 are meeting with all of the SDRs. We have

 3 meetings that happen with all the SDRs in the room

 4 with us to talk about harmonization, to talk about

 5 how we can develop consistency in the data across

 6 SDRs, but we're also talking to each SDR

 7 individually so that we can focus very

 8 specifically on the things we can see that relate

 9 to an SDR.

 10 So a little bit more detail when we're

 11 meeting with SDRs individually and then raised up

 12 at a higher level to ensure consistency when we

 13 talk to the SDRs as a whole. We're focused on the

 14 content of the data, not necessarily the delivery

 15 method, because each SDR has a different method of

 16 receiving the data into the SDR and we're really

 17 not talking about data coming back to CFTC at this

 18 point but rather the data that's in the SDR, so

 19 it's really not, the subject is not XML versions,

 20 FpML versus FIXML and that sort of thing, but

 21 rather more on what do we see in the data and how

 22 meaningful that is to us and how do we standardize
 20

 1 across that.

 2 Our work has been focused on credit so

 3 far, although there has been a little bit of a

 4 move into other asset classes actually taken up by

 5 the SDRs, themselves; but as we move past credit,

 6 we'll be moving into the interest rate asset class

 7 second, and then on from that point. The SDRs are

 8 responsible for providing action plans for each

 9 phase and by asset class to basically record when

 10 they will deliver the capability that we've agreed

 11 upon through our harmonization activities.

 12 The outcomes that we are looking to get

 13 is to basically get each of the SDRs to provide

 14 data that allows us to compare across SDRs even if

 15 it means creating additional data elements within

 16 the SDRs so that we have that harmonized data

 17 element, because we're, as I said before, focused

 18 on data view at the CFTC and not elsewhere. So

 19 some examples of checks that we would be doing in

 20 harmonization would be an LEI analysis where we're

 21 looking at just how many well-formed LEIs there

 22 are in existence in the swap standard repository.
 21

 1 Another would be a USI analysis, and how is the

 2 USI both traceable among transactions, but then

 3 how well is it persisting within the records that

 4 are submitted to the SDR. So we would present the

 5 results of that to the SDRs as we go through the

 6 harmonization effort.

 7 As it relates to Part 20, the

 8 validations are things that we've internally built,

 9 coded into our systems. We're constantly adding

 10 new validations into that data. We are rejecting

 11 data that is incomplete so that it can be

 12 resubmitted to us by the reporting party. And

 13 this is actually the first instance that we've had

 14 here at the Commission where in an automated

 15 fashion we're examining data and pushing it back

 16 if there are problems with that. And we're

 17 maturing that process as we go along.

 18 An example of some validations we would

 19 do under Part 20 are to make sure that what is

 20 reported is only those commodities that are

 21 covered under Part 20. Another validation would

 22 be that the sum of the counterparty records
 22

 1 notional values is not greater than the principals

 2 record of notional value that either should be,

 3 you know, roughly equivalent. So if it turns out

 4 that someone is reporting a counterparty, a total

 5 counterparty value that's greater, that's a

 6 problem.

 7 In the future one of the things we're

 8 going to be implementing is if it turns out that

 9 the notional value that's reported doesn't match

 10 up with the strike price parameters for the

 11 future's equivalent commodity, then that would be

 12 something that we would object.

 13 MR. MCGONAGLE: May I interject here

 14 just for a minute?

 15 MR. ROGERS: Sure.

 16 MR. MCGONAGLE: I just tapped John on

 17 the elbow to interject just for a minute. With

 18 respect to the Part 20 obligations and John's

 19 going into some detail about validation, but I

 20 think it's important that, because you're going to

 21 hear this from me a little bit later in the

 22 context of the working group, but to sort of step
 23

 1 back and see how we've been thinking about this

 2 from a strategy perspective. And behind me, a few

 3 rows behind me, Greg Kuserk within the Division of

 4 Market Oversight, has taken the lead for our team

 5 to think about what the implementation and

 6 strategy around Part 20, we'll say clean up, is.

 7 So, you know, how are we thinking on

 8 today the current state, and then how do we get to

 9 the future state. So where John is talking about

 10 validation controls and ensuring that, we have

 11 those entities who have reporting obligations,

 12 that they're complying with their reporting

 13 obligations. And to the extent that they are

 14 correcting errors that they've made, that we have

 15 a format in place where that error correction is

 16 either identified to us proactively or we have the

 17 systems in place to sort of clean that data up as

 18 we receive it. And the goal then to, is then to

 19 start to streamline where do we see repetitiveness

 20 with respect to data submission issues, how do we

 21 communicate that out into the community so that

 22 they can be corrected, and then also, frankly, how
 24

 1 do we identify those entities that have a

 2 reporting obligation that are effectively not

 3 reporting as required under the rules, and are

 4 there, you know, do we have gaps because we've

 5 given out maybe certain no action relief.

 6 Do we sort of have an understanding

 7 about our universe of Part 20 reporting

 8 obligations? And so while we're going through

 9 this data verification analysis, we are thinking,

 10 you know, next steps for implementation, how this

 11 data is supposed to be utilized, how can we best

 12 streamline a receipt of data that we feel has

 13 integrity, and then, you know, as part of the

 14 process, what do we do next. Is there guidance?

 15 Previously there were, a guidebook that was made

 16 available for Part 20. And how do we evaluate, on

 17 a going forward basis, for those who aren't living

 18 through the process because we haven't contacted

 19 each and every trader.

 20 OPERATOR: First and last name followed

 21 by the spelling.

 22 SPEAKER: Sure, Jessica.
 25

 1 OPERATOR: And then the last name?

 2 MR. MCGONAGLE: I'm just sort of

 3 interested to see where this goes. And so leaving

 4 off, and then I'll turn it back to John to finish

 5 the communication with whoever is on the phone,

 6 the idea then that, you know, for guidance on a

 7 going forward basis so that we have our resources

 8 available not only internally but externally, so

 9 we're ensuring that those that have the obligation

 10 are complying with their obligation.

 11 MR. ROGERS: Thanks, Vince. So yes, a

 12 lot of what we do is, you know, certainly from the

 13 Office of Data and Technology perspective is in

 14 partnership with the divisions, DMO is a major

 15 partner as it relates to Part 20. And Vince, that

 16 -- so I'll be a little bit shorter because Vince

 17 covered a couple of things that I was going to

 18 say, but thanks.

 19 So in talking about the progress that

 20 we've made, is overall I would say that the

 21 harmonization effort between CFTC and the SDRs has

 22 been very valuable because we've been able to
 26

 1 focus on the roughly 30 fields that are part of

 2 the first phase of the harmonization effort. It

 3 has certainly made the data more usable I would

 4 say. We are focusing on multiple phases of

 5 delivery. We have been focused on phase one, and

 6 the SDRs have provided action plans, and I'm

 7 holding them up just for a visual aid, that

 8 basically lists all of the fields out and the

 9 dates that they will be delivering that

 10 information. And so --

 11 CHAIRMAN O'MALIA: John, is that public

 12 information?

 13 MR. ROGERS: That is not.

 14 CHAIRMAN O'MALIA: Yeah.

 15 MR. ROGERS: So sorry. That's why I can

 16 hold it out at a distance and make sure any, no

 17 cameras were focused on it. But no, it's not.

 18 And but we are also simultaneously working on

 19 phases two, three, and four with each one having

 20 about 30 fields all in the credit asset class, and

 21 then we'll be shifting to the other asset classes.

 22 And the reason that it's 30 is to have chunkable
 27

 1 things that we can focus on and deliver towards.

 2 And there's a long period of internal review be

 3 multiple offices within the Commission before they

 4 get issued. So phase two, the phase two list

 5 should be issued in the relatively near future

 6 followed by three and four.

 7 I wanted to give you some examples of

 8 some of the improvements that have been made under

 9 the harmonization effort and specifically these

 10 are from the SDRs in question. So, for example,

 11 and this actually bleeds into a little bit of what

 12 I was talking about how the SDRs are not only

 13 focusing on the data being given to us, but also

 14 outreach to industry, even though we're focused on

 15 the relationship between us, for example, DDR has

 16 initiated a data quality review with industry to

 17 improve the overall submission quality and

 18 completeness across credit and FX asset classes.

 19 So even though we're focusing on credit, they are

 20 actually going a step further and focusing on

 21 that.

 22 And they've been reviewing the fields as
 28

 1 part of the phase one list in that process and

 2 have been conducting their own individual outreach

 3 to firms to review submissions so that the data

 4 can be harmonized upfront and hopefully flow into

 5 the SDR in a more harmonized fashion. They've

 6 also begun the process of reviewing the rates

 7 asset class. And then from the portal

 8 perspective, they've implemented a series of

 9 enhancements to the portal search capability on

 10 behalf of the CFTC's use of the data.

 11 From an ICE Trade Vault perspective,

 12 they have actually implemented all of the fields

 13 that are in the phase one list. So there have

 14 been changes made to comply with the requests that

 15 we've made to improve the quality of that data.

 16 And they've been working with the ICE Trade Vault

 17 credit submitters to promote the use of LEIs and

 18 have gotten that up to a 90 percent rate of having

 19 valid LEIs. From a CME perspective, they've made

 20 improvements to their portal for reporting and

 21 access to data and increased system controls to

 22 access the data. So those are some examples of
 29

 1 improvements that have been made.

 2 From a part 20 perspective, just to give

 3 you a little bit of a context on it, we've

 4 received since July of 2012, about 500 million

 5 transactions. And we have built 62 validations to

 6 apply to those transactions. And as Vince has

 7 pointed out, you know, we are continuing to

 8 examine that data and will be looking to issue

 9 additional guidance in the future to enhance that

 10 integrity.

 11 From a challenges perspective, I think

 12 that because we have lots of data and it is very

 13 complex, data consistency is still a challenge

 14 because we have focused on 30 fields in one asset

 15 class and we'll be focusing on a set of others,

 16 but there are other asset classes to deal with and

 17 we're talking about hundreds of fields here and

 18 lots of complexity in the data because there are

 19 lots of data relationships that we have to deal

 20 with. So the SDRs from their perspective are

 21 increasing the number of validations that they're

 22 putting on their repositories; but there are other
 30

 1 issues around, you know, potentially identifying

 2 particular trade parties in the transactions that

 3 they have.

 4 These are coming from, this is feedback

 5 coming from the SDRs, themselves. And one of the

 6 things that we've heard as commentary is no-action

 7 relief has created some challenges, because from

 8 the perspective, no-action relief is

 9 fine on one end, but it really leads to additional

 10 validations and things that need to be put in

 11 place in a pretty quick timeframe in order to get

 12 the data into the SDRs properly.

 13 And then lastly, one of the comments

 14 that was made that the fact that there isn't a

 15 global UPI system, a product identification

 16 system, that has created challenges as well. From

 17 a CFTC perspective, some of the challenges that we

 18 see are the just understanding all of the

 19 different permutations of process flow of data as

 20 it flows from the submitters into SEFs,

 21 into DCOs, and into SDRs ultimately. So having,

 22 you know, continuing to develop that map, if you
 31

 1 will, a process map is something that's a

 2 challenge. And then the data consistency, we

 3 would echo that. From a part 20 perspective, I

 4 believe Vince pretty much covered that.

 5 So the last thing I wanted to mention

 6 was the global trade repository working group.

 7 It's an international working group. It's

 8 sponsored by the FSB, CPSS and IOSCO, they're the

 9 co-secretaries on this initiative. CFTC

 10 representing IOSCO and the European Central Bank

 11 representing CPSS. Our co-chairs, myself, along

 12 with Benoit Coeure from the European Central Bank

 13 are co-chairs. My, from CFTC our vice-chair is

 14 Srini Bangarbale who is our chief data officer

 15 here at CFTC.

 16 There are about 25 countries that are

 17 represented on this initiative. And the focus is

 18 on if we think about harmonization from a CFTC

 19 perspective, the more repositories that are

 20 collecting data and trying to get consistency

 21 along those lines, this is, this concept is a

 22 global aggregation capability where repositories
 32

 1 from around the world are potentially providing

 2 access so that from a global perspective, you

 3 know, financial risk can be assessed and stability

 4 can be assured.

 5 So it's on, and it has definitely very

 6 interesting parallels to what we're doing here.

 7 Some of the things that are being focused on as

 8 part of this initiative is to think about the

 9 potential constructs for a global repository. One

 10 would be a central database, a big uber database

 11 that would hold the data, a logically separated

 12 data base; or just having regulators deal with

 13 other regulators when they need data.

 14 So there are other issues from a

 15 business, legal, and technological perspective

 16 that are being focused on as part of this

 17 initiative. The website is up on the slides if

 18 you want to look at the report that's come out, it

 19 actually came out in February and comments are due

 20 at the end of February, and the final report is

 21 due at the end of May. So with that I'm done.

 22 I'd be happy to answer questions at the
 33

 1 appropriate time, but right now I will turn it

 2 over to Sayee.

 3 MR. SRINIVASAN: Thank you. So we're

 4 going to be, the task is to sort of to talk about

 5 what's working and what's not working. And so I

 6 thought sort of John was talking about things at a

 7 certain level of abstraction, and I'm going to

 8 get into something much more granular and which is

 9 the CFTC swaps report, the weekly swaps report.

 10 So I sort of have a question here to the audience

 11 and the panelists, how many of you -- sort of if

 12 you can raise your hand -- how many of you have

 13 actually seen any of our weekly swaps reports?

 14 Okay.

 15 So I think this is a good opportunity to

 16 sort of educate people about what the weekly swaps

 17 report is all about, and we can also talk about

 18 the challenges we face in putting the report

 19 together and how market participants can actually

 20 use the report. So you access it from the

 21 main page here. You go to market reports and

 22 there is --
 34

 1 ACTING CHAIRMAN WETJEN: Yeah, please

 2 move away from the page very quickly. [Laughter.]

 3 MR. SRINIVASAN: So this report comes

 4 out every week, it's a weekly report, and the

 5 report, it come out around, our team releases

 6 around 3:00 p.m. Eastern on Wednesday, so by

 7 3:30, 4:00, it's up for the whole world to sort of

 8 see it. That is, that's an option for you to sort

 9 of make a subscription, subscribe to the reports,

 10 so when the report is released for public

 11 consumption you can actually go see it. There's a

 12 section at the top every week which talks about

 13 special announcement, and it's a space for the

 14 staff to highlight any sort of issues that we see

 15 in the data. And so I'm just going to walk

 16 through the latest report. The, it has, the swaps

 17 report talks about open positions and also gives

 18 the information about transaction data. And so

 19 there is sort of a lag. That is a 12-day lag

 20 in the data that's presented in the report.

 21 And so I'll just sort of go through some

 22 of the tables and, you know, sort of encourage
 35

 1 people to sort of go in and take a look at it at

 2 their own leisure. So if you saw what this table

 3 gives you is a gross notional outstanding, and we

 4 are talking about positions, this is some of the

 5 open interest equivalent from the futures world

 6 and single count. And as you can see, at any

 7 given time we give you data for the -- so this

 8 came out last Wednesday -- it gives you open

 9 positions as of January 24th and also for the

 10 prior four weeks.

 11 And so this is the headline number.

 12 So you can see that the total interest rate, open

 13 positions in interest rate swaps is about 330

 14 trillion dollars. Cleared is 194, and uncleared

 15 is 136. And it's sort of interesting to see on a

 16 week-to-week basis the numbers jump around. We

 17 have questions about why this happens and at times

 18 we have explanations for why it jumps around and

 19 there are times we don't have explanations for why

 20 things in the numbers jump around. We don't

 21 massage the data. Whatever data we get from

 22 the repositories, we just sort of aggregate them
 36

 1 and push them out.

 2 We also break up the interest rate

 3 swaps, a category of interest rate swaps called

 4 the cross-currency swaps, we have a line item for

 5 that. Those are not subject to mandatory

 6 clearing so none of it is cleared. The other number

 7 which we aggregate is the total credit default

 8 swap data. And we also give information for FX,

 9 equity, and other commodities; but a warning,

 10 those are estimates. It's where we are today,

 11 it's sort of a, we're not in a position where we

 12 can actually work with the data.

 13 It has, the staff has spent over a year

 14 working with the various SDRs to clean up the data

 15 for interest rate swaps and for credit default

 16 swaps for us to even calculate the notional

 17 amounts. When you go beyond IRS and CDS, say in

 18 FX and equity and commodity, there's a lot of

 19 commodities -- there's a lot of options

 20 transactions which happen and options positions.

 21 And the data is not cleaned, so if somebody does,

 22 say a longer dated crude oil options contract,
 37

 1 it's a swap, but they just say that I have a

 2 position for 50,000 barrels of crude and here is

 3 the strike price and here's the expiration.

 4 It's difficult for us to figure out

 5 what's the notional amount of the trade. So we

 6 are sort of working with the SDRs to sort of

 7 figure out how to compute the notional amounts for

 8 it, but we are not there yet. But the plan is,

 9 you know, we have a decent handle on the data for

 10 rates and CDS and progressively we have started

 11 working on the commodity, equity, and FX. And as

 12 time goes by, we'll be able to actually report the

 13 actual notional amounts of open positions for the

 14 other asset classes.

 15 CHAIRMAN O'MALIA: Sayee, do you have

 16 timetable on whether you're going to be able to be

 17 more precise on the next three?

 18 MR. SRINIVASAN: I wish I had, but

 19 really it's very, very difficult. As I said,

 20 there are very few standards here. We have weekly

 21 meetings from my, our office and also from staff

 22 from DMO. We are looking at the commodity options
 38

 1 -- the commodity swaps. And the data is all over

 2 the place. And even we'll be looking at certain

 3 slices of the equity swaps. For instance, we

 4 looked at variance swaps, and there is no

 5 consistency in the industry in terms of how they

 6 report the values.

 7 So not making any commitments, but as I

 8 said, we spent over a year working on IRS and CDS.

 9 And in those two markets from what we understand,

 10 there was already a lot of standardization within

 11 the industry, so we could leverage off it, but as

 12 for the other assets classes, from what we

 13 understand, there isn't enough standardization

 14 within the industry. So we can just sort of work

 15 off what work has been done by the market

 16 participants.

 17 So that's essentially, we have a

 18 dependency on the market participants and then

 19 coming up with some standardization. But right

 20 now our main point of contact on these things is

 21 the SDRs. So we talk to the SDRs, and the SDRs in

 22 turn work with the market participants.
 39

 1 CHAIRMAN O'MALIA: Can you briefly

 2 summarize the process in which you receive this

 3 data?

 4 MR. SRINIVASAN: Sure.

 5 CHAIRMAN O'MALIA: Do you go into the

 6 SDR and just pull it, or do they prepare it? 

 7 What is the process that leads up to this?

 8 Briefly.

 9 MR. SRINIVASAN: So initially we spent

 10 some time, initially we downloaded all the raw data

 11 from the SDRs. And then we worked with the SDRs

 12 and they actually collate the data for us at some

 13 level of aggregation and we download it from them.

 14 We go to the websites, and we download the data.

 15 So there are three different SDRs now, and we sort

 16 of download from each one of them. And then we

 17 have standard code which we are using to process

 18 the data. And there are a number of checks and

 19 then we do some data validation, and if we have

 20 issues with it, we sort of, if we need to go back

 21 to the SDR, typically it would be something where

 22 somebody does, say a 10 million Korean -- 10
 40

 1 million U.S. Dollar Korean Won swap, but the

 2 market participant would have reported it as a

 3 large, the Korean Won denomination would have been

 4 in the U.S. Dollar field.

 5 So we find issues like that. There are

 6 times when the SDRs will find issues which they

 7 will sort of flag to us, and so we sort of work

 8 both ways. So it's, the SDRs do some -- they

 9 collate the data, they generate reports for us, we

 10 download it, and then it's a process of collating

 11 the data, cleaning it up, and putting it out.

 12 Where we are, it takes us, there have been some

 13 reports in the press that it takes two staffers a

 14 full week plus to sort of do this report. We have

 15 been working with ODT to automate the process as

 16 much as we can. As I said, we have full -- two

 17 staffers working full time on it. And the plan

 18 clearly is to sort of automate it as much as

 19 possible.

 20 So this is sort of, you get the gross

 21 notional. And then I'll sort of talk about the

 22 transaction volume, which is sort of also very
 41

 1 interesting. For transaction volume, we give both

 2 the number of trades, the trade count as well as

 3 the notional amount that's traded on a weekly

 4 basis. So this is the number of trades that

 5 happened, and this is, the break up is similar to

 6 what you saw earlier for notional. So you see

 7 that there were about 21,000 transactions that

 8 happened for interest rate swaps and about 14,000

 9 plus of them were cleared.

 10 And similarly we do the calculations for

 11 total currency IRS and for total credit. We also

 12 give information by participant type. And

 13 participant type, essentially we break it up

 14 between SDs, MSPs, and others. And as you can

 15 see, say for interest rate swaps on January 24th,

 16 most of the volume was by SDs, MSPs, and others.

 17 Nope, I don't want to give any feedback

 18 now. The swaps of assets class is also available.

 19 So once again, we give only for interest rates and

 20 credit default swaps. I'll sort of take a moment

 21 here, the, there's a challenge we face when we

 22 work with the, through the data in terms of the
 42

 1 taxonomy that's in place for identifying

 2 different swaps. From what I understand, there is

 3 this ISDA taxonomy that market participants are

 4 using when they report the trades and which the

 5 SDRs also follow, but it's not granular, there is

 6 sort of the truncation of the description at some

 7 point in time, at some level, I guess.

 8 So what we have seen and what we're

 9 comfortable with is, you know, aggregating data in

 10 terms of basis swaps, cash flows, debt options,

 11 exotics, fixed-fixed, fixed-float, FRAS, inflation

 12 swaps, OIS, and swaptions. And one of the

 13 things that we had to be sort of careful when we

 14 put this together is that we have to comply with

 15 the Section 8 requirements in the Commodity

 16 Exchange Act which basically says that, I'm sort

 17 of paraphrasing it here, that we can't be sort of

 18 revealing the trading strategies of any market

 19 participant.

 20 So we have tried to sort of get

 21 more granular at points in time, but if we think

 22 that we're running the risk of, if there is just
 43

 1 one trade that has happened on a consistent basis

 2 by a particular asset class, we run the risk of

 3 letting the market know that here's this person

 4 who is sort of identifying an individual

 5 potentially or individual firm who is doing the

 6 trades. So we put it under the other category.

 7 The, we also show by product and

 8 currencies. So once again, you can see most of

 9 the activity tends to be in U.S. Dollar and in

 10 Euros. And this information is sort of useful for

 11 multiple purposes. There was a call a couple of

 12 weeks ago on OIS and how the OIS could be sort of

 13 a good benchmark going forward for the LIBOR for

 14 instance. And so the question came up as, do you

 15 see any transactions in the OIS. So I just had to

 16 sort of go on to our website and say, this is the

 17 transaction that we see, the transaction column

 18 that we see in the data. So now if you see that on

 19 the USD that you just have 73 trades a week, is

 20 that good enough? And is the market liquid enough

 21 as a benchmark? We also show volume by tenor

 22 and by product. And once again, as you can see,
 44

 1 I'm just focusing on OIS here, most of the

 2 activity is in the shorter tenor.

 3 I’ll show the data for credit default swaps.

 4 Once again you have for index Europe, North

 5 America, Asia, and others. There is a lot more

 6 that we can show in terms of the index and sort of

 7 get more granular into the data, but we are at a

 8 point wherein the data is not clean enough for us

 9 to sort of get more granular. But once again,

 10 we're working with the SDRs and as time goes by,

 11 we'll be sort of able to show more details. We

 12 also show data by grade, by market participants.

 13 And we haven't been able to show data by tenor

 14 here because I think most of the activity is in

 15 the five and 10-year.

 16 And I'll wrap this up quickly by showing

 17 the couple of tables we have for the notional

 18 volume that is traded. And this is the

 19 transaction dollar volume aggregated by the

 20 different asset classes. And once again, you can

 21 see most of the rates volume is getting cleared,

 22 and also in terms of credit default swaps, most of
 45

 1 it is being cleared. So if anybody at any point

 2 wants to sort of figure out how much of it is

 3 getting cleared, you just go to our website and do

 4 it. I don't think -- this is data which only we

 5 have access to. And I don't think market

 6 participants have access to it, so the data at

 7 this level of granularity, so I think we sort of

 8 encourage folks to sort of use it and have a more

 9 informed discussion about what's actually

 10 happening in the marketplace.

 11 And swaps by asset class, once again, I showed

 12 you the trade count, and you can also see data by

 13 product and cleared status in terms of notional

 14 volumes.

 15 CHAIRMAN O'MALIA: Sayee.

 16 MR. SRINIVASAN: Yeah.

 17 CHAIRMAN O'MALIA: Can you breakout

 18 package trades out of this data?

 19 MR. SRINIVASAN: Good question. The,

 20 there's a challenge involved in package trades.

 21 And with, even the -- when the package trade -- we

 22 understand that there's a lot of transactions
 46

 1 which happen which are package trades essentially

 2 when you sort of -- let me give you an example, if

 3 somebody does a butterfly, a butterfly in terms of

 4 a crude oil option trade or a butterfly trade, it

 5 has four legs to it; and when you negotiate the

 6 trade, it's negotiated at a particular price, and

 7 then when it gets reported to the SDRs, from what

 8 we understand, the dealers break it up into

 9 the individual legs and report the legs to the

 10 SDRs.

 11 And there is, there's no field in the data

 12 that's sent to the SDR highlighting the fact that

 13 these component legs are a part of a single

 14 strategy. So once again, we are sort of working

 15 with market participants and SDRs to sort of come

 16 up with solutions to identify this issue. We have

 17 the same issue in the DCM world also. There is a

 18 large fraction of trades in, say, the Euro Dollar

 19 futures and also the options in the marketplace,

 20 which are strategies where people are executing,

 21 negotiating these things, trades as a package; but

 22 when it gets sent for clearing, they break it up
 47

 1 into the individual legs.

 2 In the DCM world, there is at least a 

 3 flag in the data we get which says that this

 4 trade was part of a spread trade. And they might

 5 even identify what type of spread it was,

 6 but it is impossible for us to say that these

 7 three line items were part of a single

 8 strategy. So we have that issue in the DCM world,

 9 and we are not even close to that level of

 10 granularity in the SDR world.

 11 CHAIRMAN O'MALIA: Thank you. Do you

 12 have anything else?

 13 MR. SRINIVASAN: No, this is it for me.

 14 CHAIRMAN O'MALIA: Thank you very much.

 15 ACTING CHAIRMAN WETJEN: I just want to

 16 chime in real quickly. Sayee, thanks for that

 17 presentation. I think it illustrates something I

 18 alluded to at the outset which is that there's

 19 already quite a bit of good that's come from the

 20 reporting requirements under our rules.

 21 And I think what Sayee just went through

 22 illustrates that pretty well, I think what we're
 48

 1 here to discuss, and through some of these other

 2 processes we've begun at the agency, we're trying

 3 to figure out how we can improve upon what we're

 4 already able to produce and information we're

 5 already receiving. So I think Sayee's

 6 presentation did a nice job of illustrating that.

 7 Thanks.

 8 MR. RADHAKRISHNAN: Good morning. My

 9 name is Ananda Radhakrishnan. I'm director of the

 10 Division of Clearing and Risk. And I very much

 11 appreciate Scott inviting us to give these

 12 presentations, because we are, this may be the

 13 first time we are publically highlighting some of

 14 the issues the divisions face in getting the data,

 15 aggregating it, and trying to figure out whether

 16 people are actually doing what they're supposed to

 17 be doing. If you step back and think about it,

 18 the reason why you have reporting is because

 19 statute requires it, our rules require it, it

 20 provides information to the Commission so that we

 21 can do, discharge our responsibilities, and in

 22 some instances it provides information to members
 49

 1 of the public.

 2 So let me talk to you about the specific

 3 requirements that DCR or the priorities that DCR

 4 has and will have, what we're trying to find out,

 5 and what problems we are encountering. So first,

 6 we need to ensure compliance with the Commission's

 7 clearing requirement. As you know the Commission

 8 issued a clearing requirement at the end of 2012

 9 with respect to interest rate swaps and credit

 10 default swaps. And so our challenge is to find

 11 out whether people who are required to clear are,

 12 in fact, clearing.

 13 Now there is a fundamental challenge

 14 that the statute poses us and it is as follows,

 15 there are people who are required to clear,

 16 entities are required to clear who do not register

 17 with us. So how do you find out? All right. So

 18 that's a big issue, so I'm not talking about that

 19 issue, but that's an issue that needs to be

 20 highlighted. So in other words, let's say you

 21 take a financial entity who is not required to

 22 register with us, they have to clear. We have no
 50

 1 way of knowing whether they are, in fact, clearing

 2 or not because we don't have a process for self

 3 identification, and that may be something that we

 4 take care of in the future.

 5 The second thing we need to do is ensure

 6 compliance with the exceptions and exemptions to

 7 the clearing requirement. The third thing we need

 8 to do is to review the swap market on aggregate

 9 product-by-product basis to, with respect to other

 10 potential clearing requirements that the staff may

 11 recommend to the Commission for the Commission's

 12 consideration.

 13 With respect to what we want to do in

 14 the future, we want to ensure compliance with

 15 other clearing-related rules, for example,

 16 straight-through processing. We want to review

 17 compliance with the uncleared margin requirements.

 18 There was a proposal out there which we have not

 19 finalized, but there was an international effort

 20 to come up with a broad principles on how we

 21 should deal with uncleared margin requirements.

 22 And I suspect that before too long the Commission
 51

 1 will propose and finalize the requirements for

 2 that. And then we need to do risk-based analysis

 3 of clearing members and customers' positions

 4 across both the uncleared and the cleared swaps

 5 market.

 6 So I mentioned to you the clearing

 7 requirement. Also up to the subject to the

 8 requirement, it must be submitted to a registered

 9 DCO unless there's an exception, exemption, or

 10 other relief from required clearing is properly

 11 elected. The reporting of cleared swaps is in our

 12 words, these are my words, the division's words,

 13 complicated by the fact that you have so-called

 14 alpha swaps, the original swap being reported to

 15 one SDR and the beta and gamma swaps, which are

 16 the positions that result from clearing, reported

 17 to another SDR. And we'll talk about that in the

 18 next slide. And what we see is that the so-called

 19 alpha swap, the original swap remains open in SDR

 20 data. They appear to be bilateral, but they're

 21 subject to clearing requirement. So those two

 22 things can't happen at the same time. And the
 52

 1 data in the SDR must be current and accurate. We

 2 have a regulation that requires that to take

 3 place.

 4 Here's our working assumption, so let's

 5 assume that -- if you look on the left-hand side,

 6 you have two parties who do bilateral transaction.

 7 That's the alpha swap you reported to, in this

 8 case SDR 1, it also happens to be a swap that has

 9 to be cleared and both parties are required to

 10 clear it. So they send it to clearing, to one

 11 DCO. We have a rule that requires the DCO to have

 12 rules when they get a swap for clearing to

 13 extinguish the original swap and replace it with

 14 two equal opposite swaps between the clearing

 15 member and the clearinghouse.

 16 And so this is what we call the beta and

 17 gamma swaps. And those are reported, and I guess

 18 they're reported to a different SDR. So the USI

 19 of the alpha swap may not be associated with the

 20 beta and the gamma swap. The alpha swap may not

 21 be terminated. So swaps that appear to be subject

 22 to the clearing requirement appearing in one SDR's
 53

 1 bilateral and uncleared open swaps when, in fact,

 2 they've been accepted for clearing by a DCO, and,

 3 in fact, have been cleared.

 4 This is not rocket science, ladies and

 5 gentlemen. I don't see why a swap, which was

 6 executed bilaterally cannot be mapped to the DCO

 7 with a USI so that we know that a particular swap

 8 that was executed bilaterally has, in fact, been

 9 cleared. It's mapping exercise, it shouldn't be

 10 that difficult. Now maybe the issues I have --

 11 you know, I'd be interested to know what the

 12 members of the committee think. Maybe the issues

 13 are that our rules are not very clear. Our rules

 14 don't say, you must do this, you must do this, you

 15 must do that. Because it is very unfortunate, my

 16 team and I, let me introduce you to Brian O'Keefe.

 17 Brian O'Keefe, can you stand up. Brian

 18 O'Keefe is the deputy director for products.

 19 He may be calling some of you and asking

 20 you for information. Because we thought we could

 21 get this information from the SDR, we were wrong.

 22 So we had to call market participants, who we knew
 54

 1 had to clear, to find out this information. We

 2 shouldn't have to do that, all right, because

 3 otherwise in my view the reporting requirement is

 4 not doing the job it's supposed to be doing.

 5 After all it's supposed to provide the Commission

 6 with information. And the fact that we cannot

 7 find information in one source is a source of deep

 8 concern to us. So that's why, you know, I applaud

 9 the fact that we have this division-wide working

 10 group looking at this issue.

 11 And I'm sure there are other issues.

 12 You know, as John has highlighted, as Sayee has

 13 highlighted, a lot of other issues we are facing,

 14 but this one seems to be a no-brainer, but, in

 15 fact, it is very difficult for us.

 16 Now entities that respond -- and I'm

 17 going to skip the first, entities responding. Let

 18 me ask, why is it so difficult, why is it so

 19 difficult for us to find whether a particular swap

 20 has, in fact, been cleared? And the response has

 21 been, well, they've actually been cleared, but you

 22 don't know it or they were cancelled or there were
 55

 1 errors. And so again, if some of these things

 2 have taken place, we should know about it. We

 3 should know. Maybe I'm being, you know,

 4 unreasonable. At a press of a button, I should

 5 know exactly all the information that we need or

 6 the Commission should know exactly all the

 7 information that we need, but we don't have it.

 8 So some entities have also highlighted

 9 issues with respect to how Part 45 addresses

 10 cleared swaps and the lack of clarity around

 11 responsibilities with regard to the termination of

 12 the so-called alpha swap. So it could be an issue

 13 with our rules. And if there are issues with our

 14 rules, then hopefully staff can propose solutions

 15 for the Commission so that we can change our rules

 16 so that it doesn't become that difficult to get

 17 the information it is that we want.

 18 So we believe that improving data

 19 quality is important, but, you know, we need a

 20 more practical solution. And again, I talked

 21 about the mapping or matching of information that

 22 we used. We have attempted to use an automated
 56

 1 process using an SAS program developed by

 2 colleagues in ODT to try and get the information

 3 that we want. And we're actively working with our

 4 colleagues in the data office so that we can get

 5 the information that we want.

 6 The other priority is the Commission and

 7 our staff have issued exemptions and exceptions

 8 and people need to elect these exemptions and

 9 exceptions and they need to report them to an SDR.

 10 So one is the end user exemption, the other is the

 11 inter affiliate exemption, the cooperative

 12 exemption, and then the Treasury affiliate

 13 no-action relief that staff granted. And SDRs are

 14 required to monitor, screen, and analyze end user

 15 exception claims by individuals and affiliated

 16 entities. So the division is working with the

 17 SDRs so that we can get the reports to make sure

 18 that people are, first of all, people who are not

 19 clearing and are entitled to elect one of these

 20 exemptions or exceptions are, in fact, doing so.

 21 The third priority is aggregating swap

 22 data so that we can decide whether new categories
 57

 1 of swaps should be cleared. And this will help us

 2 in developing our proposals to the Commission for

 3 their consideration. And in reviewing submissions

 4 by DCOs, we have looked to Part 43 and Part 45 and

 5 other data in order to review the size and scope

 6 of a given product's market. And then by working

 7 with my colleague, Sayee, and his office, we've

 8 been able to, in SDRs and DCOs, we've been able to

 9 get a general sense of a product's notional and a

 10 number of transactions from SDR data; but as Sayee

 11 pointed out, it is not a happy place. So we need

 12 to get to that happy place so that we can, in

 13 fact, make a recommendation to the Commission

 14 that's based on facts.

 15 Because I'm sure you all agree, it would

 16 be not a good scenario for us, A, not to be able

 17 to do our jobs or, B, to try and do something

 18 which is not based on all the facts that are out

 19 there. So and we think that the data that we

 20 should be using going forward is not BIS data,

 21 with all due respect to the BIS, but it should be

 22 data that's sent to the SDR, because otherwise why
 58

 1 have SDRs in the first place.

 2 So going forward, we will participate in

 3 all data-related cross-divisional efforts,

 4 including the Commission-wide prioritization of

 5 data-related matters. And we will continue to

 6 build working relationships with SDRs, SEFs,

 7 contract markets, and DCOs, and reporting

 8 counterparties to resolve issues that we see. And

 9 I'd be happy to take any questions in due course.

 10 Thank you.

 11 CHAIRMAN O'MALIA: Thank you, Ananda.

 12 For anybody that might be on the phone or anybody

 13 interested in these presentations, they are all on

 14 the Technology Advisory Committee website within

 15 the CFTC.gov website. So all the presentations

 16 you will see today, are already up there. Next we

 17 have --

 18 MR. MCGONAGLE: Dan.

 19 CHAIRMAN O'MALIA: We're going to

 20 switch, right Dan. Dan Bucsa, Office

 21 of Surveillance within DMO.

 22 MR. BUCSA: Good morning. As the
 59

 1 commissioner said, my name is Dan Bucsa. I'm an

 2 Associate Director in the Division of Market

 3 Oversight focusing on surveillance. And I'm in

 4 charge of the teams that look after interest rate,

 5 credit, equity, and FX swaps. So I've been

 6 invited to participate and give everyone my

 7 thoughts on the swaps state. And again, they're

 8 just my thoughts, they're not the statements of

 9 the Commission or any particular commissioner.

 10 Before we get started, just to step back

 11 to give everybody some context on what we mean

 12 when we're talking about swaps data. Not everyone

 13 might be ardent followers of the TAC or directly

 14 related to swap data, so I'll give you a frame of

 15 reference to what we're actually discussing. The

 16 data set, to put it mildly, is massive. It's

 17 enormous, and it's incredibly complex. It's

 18 comprised of data from hundreds of different data

 19 submitters, almost 20 SEFs, over a hundred

 20 provisionally registered swap dealers, and it's

 21 constantly changing. As you can imagine, swaps

 22 are entering and leaving the database, terms are
 60

 1 being harmonized and adjusted, and there are

 2 countless upon countless rows and columns of rich

 3 swap data content.

 4 Now if we were asked to do this a year

 5 ago, my presentation would be pretty blank. At

 6 that point we had yet to start looking at swaps,

 7 we had very little understanding of the data, and

 8 we were in a much worse place than we are today.

 9 We've spent a lot of time and committed a lot of

 10 resources within our division working with ODT and

 11 with the SDRs and also look forward to working as

 12 part of this interdivisional working group on data

 13 to get us to the current place.

 14 Now if we were talk to about swap data

 15 status from DMO's viewpoint, the five main tenants

 16 that we would hit on, first, I'd echo what John

 17 and the others said about the importance of

 18 harmonization. It's really important for the

 19 harmonization of the deliverable of the data and

 20 also the standardization of the actual data in the

 21 cells and the inputs, themselves.

 22 Every division that's up here has
 61

 1 different problems. The problems are no better,

 2 no worse, not more important or less important

 3 than others. From the surveillance view, our

 4 problems are different. We don't look at data

 5 from a high level or in summary terms or in

 6 aggregates. We have to find bad actors, bad

 7 actions, potential manipulation, disruption in the

 8 market. So we're looking at things that are very

 9 granular on a discrete basis.

 10 Now without harmonized data or

 11 standardized terms, you can imagine how much

 12 harder it is to do this across this massive data

 13 set and how hard it is to become efficient or

 14 build economies of scale with the limited staff and

 15 resources at our disposal. We're also faced with

 16 validation and reporting errors. Now by

 17 validation, it's limited and there's some

 18 constraints that are placed upon it. And by

 19 reporting errors, I mean, over reporting, under

 20 reporting, duplicate reporting, delayed reporting.

 21 So if you think about it, if you're

 22 being tasked with looking at this massive set of
 62

 1 data and trying to understand these complex

 2 markets, and the data that you're looking at isn't

 3 completely validated or there are various unknown

 4 errors or bugs with it; it makes your job even

 5 harder to really understand what's happening, to

 6 answer any questions, to provide any feedback, or

 7 do any analysis.

 8 We also have various data reporting

 9 interruptions that we've faced the last year. And

 10 by reporting interruptions, I mean, the data just

 11 isn't there. Some subset of it isn't reported or

 12 it's not available for a various slew of reasons.

 13 And from the surveillance view, we don't stop. We

 14 can't wait for the data to get better. The market

 15 doesn't stop trading, prices don't stop moving,

 16 bad actions don't cease just for our benefit. So

 17 it's really hard for us to do the work obviously

 18 if we don't have the data in front of us or we

 19 can't get to it.

 20 Another limitation is the lack of a

 21 transaction and position database, a single

 22 transaction and a single position database. Now I
 63

 1 don't bring this up to allude or to say that we

 2 should be at this point at this juncture after

 3 looking at swaps data for a year, it's just a

 4 frame of reference for what we do with futures.

 5 There's one place where we get all futures

 6 transactions and we can look at it, and there's

 7 one place where we can look at all futures

 8 positions and we can analyze it. Now that being

 9 said, that's after tens of years of receiving

 10 futures data and working on improving the process,

 11 ingesting it, understanding it, and synthesizing

 12 it. So not where we are at the moment, but it's

 13 where we'd like to be.

 14 The final issue that confronts

 15 surveillance when we're looking at swaps are

 16 exotics or bespokes, obviously these

 17 transactions are complex, structured, tailored,

 18 you name it and they have various characteristics

 19 such as different cash-flow waterfalls, different

 20 reference benchmarks, different underlyings. You

 21 name it. When you think about this large data set

 22 I'm speaking of and you think about what everybody
 64

 1 said about data and the quality of it and then you

 2 throw in some sliver of exotics that have even

 3 less terms that are electronically reportable that

 4 are even harder to understand from a conceptual

 5 basis or a risk basis or a market action

 6 perspective, it makes it that much harder to

 7 really understand what you're looking at when you

 8 can't use the same data set and you have to look

 9 at a PDF let's say, or some confirm that was sent

 10 to somebody through some other means.

 11 Now that being said, DMO still has to do

 12 the work today. And mostly from the surveillance

 13 hat that I'm wearing, but also from other parts of

 14 the division in the systems safeguard team, there

 15 are six main things that I'd say we're doing at

 16 the moment. The first is, we're hitting the data

 17 as often as we possibly can at the SDRs.

 18 Accessibility was a really important goal of the

 19 Commission the last year and being able to

 20 directly get to the data, review it, and access

 21 it. And we can do that now. There are several

 22 functional SDR portals. So we can analyze market
 65

 1 events by looking at swaps data in addition to

 2 just futures data.

 3 We can now pursue potential manipulation

 4 theories based on this additional information and

 5 do more than we could a year ago due to this added

 6 transparency. Now our ability to query the data

 7 means that we can build some automated reports.

 8 For the data that we can see and for the data

 9 that's of high quality, we can have staff build

 10 some code, model some tools, and create some

 11 engines that make it more efficient and timely for

 12 us to do our job. And that job, from the

 13 surveillance view again, is to ensure that there's

 14 compliance with Commission rules.

 15 One of our main tasks is to serve as a

 16 referral engine to the Division of Enforcement.

 17 So when you think of swaps data rules, we want to

 18 make sure that people are compliant with what's on

 19 the books. And we do that very simply by looking

 20 for anomalies. Anomalies can be lots of different

 21 things. We think of it in the most rudimentary of

 22 terms.
 66

 1 Does this data point make sense? When

 2 we're looking at the transaction record, is it

 3 looking for a date, when instead we have a

 4 currency? Is it looking for a size, but instead

 5 we have a benchmark? Is it a term that you would

 6 definitely fill out on a paper ticket back in the

 7 day when you're negotiating a swap trade and it's

 8 missing? Is it a term that is in the regulations

 9 that needs to be there and it's not? Is it a data

 10 point that's actually filled out, but it's

 11 completely incomprehensible through some code or

 12 whatever you have it, you just don't understand

 13 what's in the field?

 14 If we reach that point, we invoke our

 15 special call process where we reach out to the

 16 data submitter or the SDR and we just say,

 17 explain. Give us a narrative of what's happening

 18 here. Tell us what we're looking at. We don't

 19 make any assumptions. We don't have that luxury.

 20 We can't give people the benefit of the doubt and

 21 say why the data might be missing. We don't know

 22 why the data looks a certain way our why it's
 67

 1 gotten on to our desks in that format, so we give

 2 it, we leave it up to the reporting counterparty

 3 to explain what's going on.

 4 And based on the response and what we

 5 think of the narrative, it becomes a referral to

 6 the Division of Enforcement for investigation.

 7 All this work on the Commission rules has lead us

 8 to realize that we really need to do a lot of

 9 internal analysis and coordination. We've done

 10 this throughout the year with ODT and with the

 11 other divisions. And like I said earlier, we're

 12 going to be doing a lot more of it with this

 13 interdivisional working group on data. And what

 14 it's really allowed us to do is increase our

 15 understanding of the data throughout this year.

 16 What is this data set contain? And what

 17 are the definitions of the fields? Not just, what

 18 is the field defined as, but what is the purpose

 19 of the data point within the field. You need to

 20 understand what this massive and complex data set

 21 is actually telling you, not just that the field

 22 is filled out correctly and it's in the right
 68

 1 format and it's got the right information, but if

 2 you put it all together with the rest of the

 3 fields in the transaction, what is that

 4 participant doing? If you put it together with

 5 all of their positions, what might they be trying

 6 to influence in the market?

 7 Now what we've also realized is that

 8 through this internal work we really to have to

 9 focus on data quality. And when we spot these

 10 irregularities by hunting around the data or

 11 peeling back different layers of the onion, we let

 12 people know. We notify ODT, the pertinent SDR, or

 13 the data submitter to get these things fixed. And

 14 we have gotten better data over time. That being

 15 said, there is no silver bullet. It's not a

 16 panacea. It's not a one-stop shop. There's no

 17 guarantee that if you fix a field once for one

 18 data submitter on one SDR, that will never happen

 19 again with the same participants or it will never

 20 happen with other participants in the same SDR or

 21 it will never happen with other SDRs.

 22 And again, to continue the theme of a
 69

 1 really large data set, you fix one data point, how

 2 does the next one look? How does the one after

 3 that look? How do they fit together? It's an

 4 incredibly iterative process that will take a

 5 considerable amount of time and resources to get

 6 the data right. We feel like we can get there,

 7 but it's not going to be a short-term solution.

 8 And finally, one of the things we're

 9 doing is looking at Commission regulation 49.24 in

 10 particular. I don't want to prioritize or

 11 emphasize one rule versus another, but we do want

 12 people to promptly report the system disruptions

 13 and planned system changes within their SDR to

 14 DMO. It's much better to be proactive and for you

 15 to tell us what's happening than for us to see

 16 something wrong and to check in with you to see

 17 what's happening. We have noticed that the SDRs

 18 have gotten better about this recently, and we

 19 really hope that this continues in the future.

 20 And then finally, DMO's other data

 21 interest in addition to swaps, we don't just look

 22 at swaps, we look at futures as well obviously and
 70

 1 we have to look at the market as a whole. So we

 2 were hoping to bring up these three topics to get

 3 some feedback and advice from the TAC on how to

 4 challenge them going forward in the future. The

 5 first is ownership and control reports. These are

 6 near and dear to our heart because they'll help us

 7 further understand futures markets. We'll be able

 8 to link a trader's transactions in futures to

 9 their futures positions. We'll understand how a

 10 position was built and by who and what were the

 11 steps that happened in between to get to the final

 12 point.

 13 We also care about messaging data as

 14 well. Right now the only data that flows in are

 15 the consummated or executed trades in futures.

 16 Now this is obviously very useful and high-value

 17 information, but there are certain times where we

 18 would want to know messaging data. And the

 19 additional visibility into the market behavior and

 20 the signals people might be sending via their

 21 messages, and how that influences price, supply

 22 and demand, you name it.
 71

 1 And finally, we're interested in

 2 visibility into our discrete data sets. This

 3 could be underlying prices of selling instruments,

 4 participants in these other markets, or

 5 benefitting positions across other markets.

 6 Again, I'm only speaking from the surveillance

 7 side of the world. So we care about what people

 8 might be doing to impact our markets that violate

 9 our rules. So clearly there are some

 10 jurisdictional swaps and there are some

 11 non-jurisdictional swaps, there are cash markets

 12 that are non-jurisdictional; however, everything

 13 is related to a certain degree, whether it be some

 14 correlation, high or low, to price or directly

 15 related such as impacting the pricing or the

 16 settlement of a swap. For us to be able to say

 17 we're doing oversight on these markets and we

 18 understand somebody's behavior, we'd like to know

 19 at certain times, if not continuously, what is

 20 happening in those other markets and how our

 21 participants are behaving in those other markets.

 22 And in conclusion, it's, to continue
 72

 1 what I said earlier, the data is better. It's not

 2 what we'd like it to be. We're further along than

 3 we thought we would be, and we're going to keep

 4 working together with other divisions and the SDRs

 5 to improve it going forward. Thank you.

 6 MR. MCGONAGLE: Great. Thanks, Dan. I

 7 think that, I'm going to say from the

 8 presentations that you've heard so far this

 9 morning, at least from my perspective I get the

 10 sense and I know that there's an appreciation

 11 within the divisions of the challenges that we

 12 face. And so, you know, I started with the

 13 Division of Market Oversight just a few months

 14 ago. Well, one constant theme of conversation

 15 that I've had within the division and people

 16 coming up to me has been focused on the data and

 17 how can we get the data to a state that we can

 18 effectively evaluate and do our jobs, frankly.

 19 So when the Commission announced most

 20 recently this interdivisional working group, I see

 21 it as an opportunity to leverage the resources and

 22 in some instances the conversations have been
 73

 1 going on, frankly, for quite some time, since

 2 these rules were initially thought about and put

 3 out for review and comment and now on the

 4 implementation stage. So we have an

 5 interdivisional working group that involves each

 6 of the operating divisions from within the

 7 Commission. We have members from the Division of

 8 Market Oversight and I've put as many staff as I

 9 can get my hands on, on this group because we want

 10 to be effective.

 11 And we see also from the other

 12 divisions, you know, sort of a state of

 13 volunteerism, the Office of General Council, the

 14 Division of Enforcement, DSIO, the ODT, and our

 15 Office of Chief Economist have all come together

 16 in the past few weeks to have substantive

 17 conversations, to sort of think about the

 18 priorities that they've seen over the course of

 19 time within their units, but also as they

 20 communicate with each other.

 21 And so in looking at where we are going,

 22 I think in the first instance, we have a lot of
 74

 1 information just internally to think about and to

 2 help us prioritize, and I think that's a good

 3 place to be. The working group was charged with

 4 its, the primary oversight responsibility for the

 5 working group is to evaluate compliance with Part

 6 45 reporting rules, related provisions, and

 7 consistency in the regulatory reporting by market

 8 participants.

 9 And so that's broken down into four

 10 subcategories or prioritizations; review of

 11 industry compliance, data field standardization,

 12 guidance and regulatory improvements, and

 13 technology improvements. So taking each in turn,

 14 industry compliance, my expectation is that market

 15 participants are aware of their reporting

 16 obligations and are diligently executing their

 17 responsibilities to timely and accurately report,

 18 period. My expectation, I'll say it again, is

 19 that market participants are aware of their

 20 reporting obligations and are diligently executing

 21 their responsibilities to timely and accurately

 22 report.
 75

 1 The divisions are charged with

 2 identifying those major compliance failures and

 3 will recommend best, and will recommend next

 4 steps. So where the regulations are clear, the

 5 obligation to report is clear. If there are areas

 6 where there can be more clarity, the divisions are

 7 taking on the responsibility to identify and

 8 provide guidance and recommend rule changes as

 9 appropriate, but a number of the issues that

 10 you've heard this morning, validation errors,

 11 failures to report, inaccurate reporting don't

 12 necessarily or don't at all relate as to whether

 13 the rule should be fixed. They relate to entities

 14 and individuals who have a responsibility to

 15 accurately capture the information that's before

 16 them and provide that information forward.

 17 Data field standardization, we've heard

 18 from John Rogers in particular about harmonization

 19 efforts. The interdivisional working group team,

 20 it will be looking to prioritize those

 21 harmonization comments so that we can look forward

 22 to high level, what are the areas that we feel
 76

 1 will have the most significant impact with respect

 2 to data standardization. This conversation of

 3 course doesn't happen without the registered

 4 entities, the swap data repositories. Their role

 5 and their obligation here is clear. Our

 6 expectation is that the swap data repositories

 7 will continue the hard work that they've been

 8 doing to effectively communicate with the division

 9 and market participants so they can efficiently

 10 and effectively comply with their obligations.

 11 And I look forward to continue to

 12 working with the swap data repositories as part of

 13 this working group's efforts. We are interested

 14 in identifying any data reporting gaps for

 15 execution of our surveillance and oversight

 16 responsibilities. And Dan gave an excellent

 17 presentation concerning how our Division of Market

 18 Oversight appreciates and evaluates its

 19 surveillance challenges and the steps that we have

 20 undertaken and plan to take in the future.

 21 Finally, and I talked about this, this

 22 structure isn't any different than the example we
 77

 1 used this morning with respect to Part 20

 2 guidance. We evaluate where the issues are. We

 3 look to see how reporting obligations by entities

 4 and individuals can be enhanced, where the

 5 information needs to be clarified. And then our

 6 expectation is to get back out to industry with

 7 those clarifications so that we're able, all of us

 8 to get information that's readily usable by the

 9 Commission and by market participants.

 10 The working group is in the process of

 11 compiling questions which we'll put out for

 12 comment. In formulating this working group, I

 13 took on the responsibility to report back to the

 14 Commission by Spring on recommendations for next

 15 steps as it relates to Part 45. The members of

 16 this committee, outside of the working group now,

 17 I'm talking about the TAC, can be instrumental in

 18 forming our opinions and recommendations. So I

 19 request that you please take the comment period

 20 seriously, be diligent about the information that

 21 you provide.

 22 As I've seen in my short time within
 78

 1 DMO, all of the information that comes in is

 2 seriously considered and certainly is helpful to

 3 us in making recommendations. In evaluating some

 4 of the areas that we've received feedback already

 5 within the working group, we have a bullet list of

 6 a couple of dozen topics that the group is

 7 considering. And I'm not going to go into

 8 specifics in terms of identifying, because that

 9 will be part of the question period when we go out

 10 probably, well, we have a due date in mid-March,

 11 so within the next couple of weeks, but by no

 12 later than mid-March; but the idea at least in the

 13 conceptual focus is looking at reporting of

 14 cleared swaps continuation data.

 15 Are there transaction types and

 16 workflows that might require further discussion?

 17 A review of course in Part 45, including all

 18 appendix and tables attached there to. What are

 19 the other SDR and counterparty obligations? Where

 20 is CFTC with respect to implementation? And where

 21 do we see noncompliance? And internally of

 22 course, where should there be referrals?
 79

 1 Going forward within the Division of

 2 Market Oversight, we're also looking

 3 organizationally to restructure our program so

 4 that we have an appropriate emphasis for swaps

 5 data and data and reporting obligations within the

 6 division. And I hope in the next coming weeks

 7 that we'll be able to formally announce steps that

 8 we've taken organizationally to address this very

 9 important topic within the Commission.

 10 Gary.

 11 CHAIRMAN O'MALIA: Hey, Vince, can I ask

 12 you a question?

 13 MR. MCGONAGLE: Sure.

 14 CHAIRMAN O'MALIA: Gary was too slow

 15 getting over to his chair.

 16 MR. BARNETT: Sorry.

 17 CHAIRMAN O'MALIA: So when you chimed in

 18 with John Rogers about Part 20, you had a very

 19 pro-conformance, we want to make sure that

 20 everybody understands the rules, how do we help

 21 you understand, we want to get compliance higher.

 22 This presentation you came off and said, you know,
 80

 1 we're going to make referrals, everybody knows

 2 what the rules are. How does that reconcile? Is

 3 it only the Part 20 where you're going to be

 4 lenient, or are you going to have a very strong,

 5 you know, enforcement bend to this rule

 6 compliance?

 7 MR. MCGONAGLE: Right. So coming from

 8 enforcement people, we're always going to have an

 9 enforcement bend. My expectation always is that

 10 the time and more effort that's gone into the

 11 rules, the expectation is that those rules are

 12 clear. And so if there are, if there is, if you

 13 have an obligation or failure to meet an

 14 obligation within the Division of Enforcement and

 15 anywhere frankly, you first evaluate how clear is

 16 the obligation, where was the understanding of the

 17 reporting party or the entity that you're looking

 18 at; and then you'll make a determination whether

 19 that violation is something that sort of warrants

 20 further review maybe by the Division of

 21 Enforcement or warrants an action.

 22 So taking that sort of vantage and
 81

 1 looking at obligations within the DMO, I don't see

 2 it as a Part 20. I used Part 20 as an example

 3 because frankly the discussions that I've had with

 4 the team are much more concrete to me and just my

 5 evaluation where it was, it is clear that, you

 6 know, there are issues where parties are not

 7 reporting, for example. But there are also

 8 questions about how they report. And so if there

 9 is a reporting error and are they over reporting

 10 because they want to be a good citizen, sort of,

 11 how do we evaluate that sort of over reporting?

 12 That doesn't sound, it might not sound

 13 like an enforcement referral, someone is over

 14 reported. But if someone has not reported, that

 15 could be an area that we could get into. So I

 16 take, I sort of take that experience and then look

 17 to these other areas such as Part 45. Why is it

 18 that if there's a particular reporting field

 19 that's required to be, information is required to

 20 be input, why is that blank? And then why is that

 21 information being sent along to the Commission

 22 which then requires us to go back and sort of do
 82

 1 some validation?

 2 Who has the earliest opportunity to

 3 ensure that the information is being accurately

 4 reported, and then what steps do we have along the

 5 way to capture that information? So I'll start

 6 with referrals or we'll think about referrals

 7 always in the first instance where we see the

 8 violation as being very clear. As you move away

 9 from clarity, you get to questions about, is

 10 guidance appropriate, are rules, additional rules,

 11 should they become contemplated? So that's my,

 12 you know, that's my thinking.

 13 I don't see sort of one-stop process for

 14 any type of evaluation, but if we do see that

 15 there is an obligation to report and people aren't

 16 doing it, I do want to get away from the hand

 17 holding that I think in some instances has

 18 occurred for a period of time during the

 19 transition. We want to step back, recognize who

 20 has the responsibility, and give those individuals

 21 and entities the responsibility, you know, make

 22 sure that they understand that they need to
 83

 1 comply.

 2 CHAIRMAN O'MALIA: You also indicated

 3 the SDRs are going to play a role in this. Are

 4 you going to hold the SDRs responsible for

 5 reporting compliance of the entity, or is it the

 6 fault of the entity if they don't comply?

 7 MR. MCGONAGLE: So in the event we get

 8 to talking about failures, absolute failures by

 9 the SDRs, I think that's part of it, that would be

 10 a conversation later; I think in the first

 11 instance, you know, the discussions that we've had

 12 with the SDRs relates to a lot of the challenges

 13 that you've heard so far this morning, with the

 14 consistency and the accuracy of the reporting.

 15 There's been a number of conversations on, you

 16 know, on a day-to-day level as instances have come

 17 up. If there have been errors in the reporting or

 18 systems have gone down, I want to step back and

 19 have a view sort of on a macro basis what has

 20 happened over the last several months or the year.

 21 What's our trend with the SDR sort of

 22 going forward? Is it -- are there issues that I
 84

 1 need to be concerned about as a director within

 2 the program? Are the questions that we have and

 3 the plans that we've already implemented -- and I

 4 think the SDRs have been very good partners in

 5 terms of some instances very proactive in self

 6 reporting, and I want to continue that dialogue.

 7 So I'm not in a position to answer the question in

 8 a short form now to say whether or what steps need

 9 to be taken to fix the SDRs or say that the SDRs

 10 need to be fixed. I think it's more focused on a

 11 dialogue ensuring that we have a consistency of

 12 communication between us about expectations.

 13 CHAIRMAN O'MALIA: Gary.

 14 MR. BARNETT: Okay. Gary Barnett, DSIO.

 15 DSIO regularly participates in the swap data

 16 harmonization meetings. We're working with our

 17 colleagues in ODT, OCE, DMO, and DCR to ensure

 18 that swap data provided by swap dealers to SDRs

 19 will meet the needs of DSIO. We're also working

 20 to develop methods for integrating swap data, SDR

 21 data into our swap dealer and MSP compliance

 22 program to test for compliance with swap dealer
 85

 1 reporting requirements, into our CPO and CTA

 2 program to test the accuracy of funds reporting of

 3 swaps exposures and into our exam program as part

 4 of our examination of swap dealers and FCMs and

 5 other intermediaries to examine for compliance

 6 with our regulations.

 7 For instance, focusing on SDR data and

 8 swap dealers, seeking to ensure that swap dealers

 9 are demonstrating compliance with CEA and CFTC

 10 regulations, generally, but including more

 11 specifically things like ensuring that a market

 12 participant doesn't act as an SD or an MSP unless

 13 they're registered as such. Ensuring that SDs or

 14 MSPs maintain full, complete, and systematic

 15 records of swap activities. Ensuring that swap

 16 dealers and MSP swap transactions and pricing data

 17 are available to the public in real-time, and

 18 eventually confirming that swap dealer and MSP

 19 compliance with capital margin requirements is

 20 occurring.

 21 With those important aims so dependent

 22 on good information, good data, and good
 86

 1 technology; we're very interested and connected to

 2 the group, the SDR and other swaps data reporting

 3 efforts and beyond to the other issues in our

 4 space. Everything you've heard basically applies

 5 to us in our efforts. But, in addition, we've been

 6 asked to play cleanup batter and to discuss some

 7 of our other data and technology needs. We have a

 8 different orientation. We want to talk to you for

 9 a few minutes about the swap data -- sorry --

 10 the data and technology needs we have in the

 11 pursuit of our mission and the use of those

 12 technologies.

 13 So for instance in addition to our SDR

 14 efforts, we're also involved in the swap dealer

 15 registration process which entails the submission

 16 by swap dealers and our review of mountains of

 17 policies and procedures which are provided under

 18 the Commission's rule 3.10 to demonstrate

 19 compliance with 4s or the swap dealer requirements

 20 under Title VII. Without technology, without our

 21 technology, it would be a nearly impossible task.

 22 And in the process of receiving and
 87

 1 viewing these large volumes of submissions, we use

 2 two basic systems, Concordance, which is actually

 3 an electronic discovery management software that

 4 allows us to gather, manipulate, and search the

 5 data, but also, and also Case Map software

 6 that allows the management of facts and the issues

 7 that arise.

 8 The fund space is another area that DSIO

 9 covers for which we foresee heavy reliance on

 10 technology. In terms of the technology focus in

 11 that space, disclosure documents are filed by CPOs

 12 and CTAs with NFA. We have access to them with

 13 Fax 2000, which is the program through which we

 14 access NFA's database. They're uploaded in Word.

 15 We can download to our PCs. We also have access

 16 to NFA's review documents. But we can't have

 17 policy scope review and issue spotting driven by

 18 NFA. We need to develop our own systems, our own

 19 issues list, and criteria points for which each of

 20 the relevant points, topics, sort of like an audit

 21 module, but for reviewers of legal documents. So

 22 we have that to do as well.
 88

 1 In addition forms PQR and PR, are

 2 uploaded to our servers by NFA as raw data. And

 3 we're working with ODT on developing a database

 4 for it. The SDR reporting data is, gives us, you

 5 know, very granular swap information; but when

 6 conjoined with the reporting, the reporting in a

 7 sense will put together the swap information, but we

 8 can test whether that information, to some extent,

 9 we can test the accuracy of that by looking to the

 10 SDR data. We'll eventually be able to do that.

 11 As the division that has compliance and

 12 examine oversight of intermediaries, in particular

 13 FCMs and swap dealers, our heavy technology needs

 14 relate to reporting and examination of those

 15 entities. And so in that regard, we use two

 16 primary types of software, RSR, which is a

 17 database for maintaining firm information and

 18 TeamMate, which is audit software, basically

 19 electronic working papers for accountants or

 20 auditors.

 21 RSR is a database that intermediaries

 22 send info into via WinJammer. So if they're
 89

 1 sending us financial reports, risk reports,

 2 notices or the like; they can scan it, attach it

 3 as a PDF, and send it. It goes straight into a

 4 file for that submitting dealer or intermediary.

 5 TeamMate as mentioned is auditing software. Once

 6 set up properly to cover our standardized audit

 7 programs, this software facilitates the reviews of

 8 firms by requiring standardized minimum steps in

 9 obtaining required documentation and collects it

 10 in a way that helps make the supervisory review

 11 process more efficient.

 12 In terms of our strategy in using these

 13 two key tools as part of our exam oversight in

 14 examination, RSR is one-stop shopping for all

 15 information on a firm. The examiner can go in,

 16 quickly access all of the financial and regulatory

 17 information about the intermediary and others

 18 across the Commission can access it, too. It's

 19 very important for, given the fact that we lack

 20 staffing, that the staffing we needed, it enhances

 21 our efficiencies and helps us fill the gap of

 22 examiners, but obviously, you know, it's a hurdle,
 90

 1 a burden, but the RSR is a definite help.

 2 We use RSR to perform the initial

 3 analysis of firm filings. For instance filings

 4 that indicate under seg. or under secured

 5 situations, our less-than-early-warning capital

 6 requirements will trigger a red flag that comes to

 7 staff. And we have developed some red flags to

 8 help in that regard, and we use that data to help

 9 develop our wash list.

 10 Also, as part of our strategy is the

 11 hardware. Obviously on-site visits are an

 12 important part of what we do, so laptops and

 13 remote access, remote system access is very

 14 important to us to support the software. Those

 15 are in need of upgrade, but we're in the process

 16 of doing that, so we're grateful for that. In

 17 terms of strategy, we've had some successes.

 18 We've upgraded TeamMate to a current version.

 19 We've developed some financial analytics for the

 20 financial data we received from FCMs including

 21 some trend analysis on an

 22 institution-by-institution basis, but we're
 91

 1 looking to try to develop more of an industry-wide

 2 trend view so that we can find outliers.

 3 In terms of our technology path forward,

 4 you know, we need to gain a handle on the SDR data

 5 for the reasons expressed at the beginning of the

 6 talk, but in addition, in terms of the tools we're

 7 using, in terms of examination and oversight, RSR,

 8 we need to continue to work with ODT to assess

 9 effectiveness of the database. Is there a more

 10 efficient method? It's very useful, but it's very

 11 difficult to upgrade and revise given the changes

 12 that are going on. And a lot of changes are

 13 needed.

 14 Also we need to develop the

 15 industry-wide dashboard that I mentioned before.

 16 We need to continue to evaluate TeamMate and

 17 update hardware and remote access capabilities.

 18 And then we also need to integrate the swap dealer

 19 data into RSR. So that's a little bit of an

 20 overview of what we're doing from the technology

 21 and data perspectives in addition to our

 22 participation in the SDR harmonization efforts.
 92

 1 Thank you.

 2 CHAIRMAN O'MALIA: Gary, are you using

 3 SDR data at all right now?

 4 MR. BARNETT: We're not, we're not.

 5 We're just at the very beginning of that.

 6 CHAIRMAN O'MALIA: Are you responsible

 7 having the swap dealer filings? This looks like

 8 compliance, right?

 9 MR. BARNETT: Yes, it is.

 10 CHAIRMAN O'MALIA: Are they filing the

 11 forms? And I understand we have all, what is it

 12 180,000 pages of SDR filings, and this will all go

 13 into that separate database?

 14 MR. BARNETT: It will, if I understand

 15 your question --

 16 CHAIRMAN O'MALIA: This RSR database?

 17 MR. BARNETT: It will go into RSR.

 18 CHAIRMAN O'MALIA: Okay.

 19 MR. BARNETT: Correct.

 20 CHAIRMAN O'MALIA: So are you going to

 21 use SDR data to develop risk reports and bilateral

 22 systemic relationships, things like AIG, London
 93

 1 Whale, or are you going to use this separate RSR

 2 platform?

 3 MR. BARNETT: Eventually we would use it

 4 to test our database and then probably manipulate

 5 in some other ways. So the SDR reporting gives us

 6 granular information, but looking for trends and

 7 things of that sort and funny patterns, we haven't

 8 gotten our hands around that. We would think of

 9 testing that against the SDR data. But, you know,

 10 if John tells me that we can do something directly

 11 from the SDR data or with an additional tool that

 12 straps on, that would be -- but we're not at that

 13 point yet.

 14 CHAIRMAN O'MALIA: So would you have the

 15 responsibility for evaluating and kind of

 16 identifying risk in the OTC data? Isn't that for

 17 a swap dealer?

 18 MR. BARNETT: On an intermediary basis

 19 we would.

 20 CHAIRMAN O'MALIA: A swap dealer?

 21 MR. BARNETT: Yes.

 22 CHAIRMAN O'MALIA: Right, so but you're
 94

 1 not using the SDR data currently?

 2 MR. BARNETT: Not yet.

 3 CHAIRMAN O'MALIA: All right. Do you

 4 have a timetable when you're going to be mining

 5 that data for risk, bilateral systemic risk in the

 6 OTC market?

 7 MR. BARNETT: No, no. I mean, I know

 8 that it's an imperative. We're a member of the

 9 committee. We're working on it, but I don't have

 10 a fixed timetable to give you for that yet.

 11 CHAIRMAN O'MALIA: In terms of

 12 priorities where does it fall?

 13 MR. BARNETT: We're still in the

 14 registration process with the swap dealers. We're

 15 still reviewing their 4s submissions and their --

 16 you know, so we need to get through that and we

 17 need to continue to coordinate with John and

 18 figure out, you know, what tools are available to

 19 us. We are working on something similar to that

 20 in the funds space, but we have not yet turned to

 21 the swap dealers space. At this point we're just

 22 looking to use the information to help us when we
 95

 1 look to see the compliance with our recordkeeping

 2 rules and things of that sort.

 3 CHAIRMAN O'MALIA: Well, thank you very

 4 much to the panel for your thoughts, your

 5 concerns, the issues you've identified. I think

 6 you've given us a pretty good, but high level

 7 oversight of the challenges we have. And

 8 obviously harmonization was a theme that everybody

 9 touched on. I'd like to open it up to the TAC

 10 members' thoughts, concerns, observations,

 11 questions, further questions. There's dozens of

 12 questions I'd like to ask, but I'd really like to

 13 get your thoughts on how we tackle harmonization.

 14 For example, nobody has touched on a

 15 UPI, what would a UPI, this universal product

 16 identifier, would that enhance things? Is there,

 17 are there things in the industry that would

 18 benefit our efforts in terms of accelerating our

 19 standardization process? I want to talk a little

 20 bit about international. You know, Wednesday we

 21 have SDRs going live in Europe. The obligation is

 22 for anybody over there to report both to the U.S.
 96

 1 SDR and to European SDRs. Where do we stand on

 2 recognizing, assimilating, harmonizing that data?

 3 There's obviously some, a little more

 4 discussion I think we can have on enforcement, risk

 5 management analytics. Obviously, I think we have

 6 clearly a long way to go there. So I'd open up to

 7 the floor, and if there's no questions, I've got

 8 about ten. So and but I don't want to have to ask

 9 them, because it's really your thoughts and

 10 observations that would be useful here.

 11 MS. VEDBRAT: So, you know, I just

 12 wanted to make a comment about, you know, the

 13 tools that are available, you know, perhaps the

 14 end users. You know, currently if I were just to

 15 look at our trades, they are being reported to

 16 three different SDRs, and we don't actually, we're

 17 not giving any tools where we can receive the

 18 information regarding our trades. And one

 19 advantage for that would be that you'd be able to

 20 find any discrepancy in data, you know, and

 21 perhaps lead to some form of harmonization

 22 without, like, the CFTC being, you know, the first
 97

 1 body that identifies an issue.

 2 You know, this is something we've been

 3 asking for from day one, and we have yet to see

 4 this come to fruition. On your question on

 5 international for Wednesday, the requirements for

 6 reporting from a buy-side perspective, you know, it's

 7 quite different just because the reporting party

 8 or the responsibility for one side of the trade

 9 does reside on the buy side. You know,

 10 historically we've been dependent on the sell

 11 side or the swap dealers to do most of our

 12 reporting. So we, you know, expect in the coming

 13 weeks or months that process to be a little bit

 14 bumpy. The market has to get used to a two-side

 15 reporting structure.

 16 CHAIRMAN O'MALIA: Maybe I can ask Vince

 17 could address this issue. We've heard this from

 18 the end users quite a bit on how do end users

 19 validate what's been sent to SDRs, how do they

 20 know. There's a good article on Risk last week

 21 that appeared in our clips. You probably saw it.

 22 End users really addressing the issue of, where's
 98

 1 my data and what if it was misreported, what do I

 2 do about it? This obviously touches on some of

 3 your enforcement thoughts. What do you recommend

 4 for end users?

 5 MR. MCGONAGLE: Let me consult with my

 6 experts here behind me, so just two seconds.

 7 MS. GUSSOW: Good morning, Commissioner

 8 O'Malia and TAC. Some of you already know me.

 9 I'm Laurie Gussow with Division of Market

 10 Oversight. And Vince asked me to take this

 11 question.

 12 Could you rephrase it, please? I mean,

 13 could you repeat it, please.

 14 CHAIRMAN O’MALIA: Just pull it closer and

 15 repeat your question.

 16 MS. GUSSOW: I am so sorry. Can you

 17 hear me now?

 18 MS. VEDBRAT: From an end user

 19 perspective, one of the beneficial tools would be

 20 if the SDRs provide us with the ability to

 21 reconcile the information that's being reported on

 22 our behalf. Currently, like if we were just to
 99

 1 limit ourselves to, you know, cleared swaps or

 2 swaps in general, there are three SDRs where we're

 3 reporting our data, but there's like zero insight

 4 into what's being reported on our behalf.

 5 MS. GUSSOW: Right. So the SDR rules

 6 require that they reach out to the counterparties

 7 to confirm the accuracy of the data. The

 8 methodology that the SDR chooses to do so, it, you

 9 know, that's incumbent on the SDR to develop that

 10 technology. And the services they provide to

 11 their users is also a business decision of the

 12 SDRs, and the rules aren't prescriptive with

 13 respect to the services they have to offer except

 14 that they have to confirm the accuracy of the data

 15 and make their data available to the

 16 counterparties to ensure accurate data and provide

 17 for error and omission corrections, which of

 18 course through the rules indicates that comes

 19 through the reporting counterparty.

 20 So, you know, that might be a

 21 conversation you want to have with your

 22 independent SDR or SDRs.
 100

 1 MS. VEDBRAT: Yeah, we've had

 2 discussions with them. And, you know, I'd just

 3 like to, you know, make a comment because you

 4 mentioned it's their business decision, but this

 5 is a regulatory requirement and, you know, there's

 6 been a lot of emphasis throughout this process by

 7 the CFTC, which, you know, we believe in on

 8 straight-through processing and timely delivery of

 9 information. So, so far what we've seen if you

 10 want to receive information, it would be a very

 11 manual process and almost impossible for us to

 12 reconcile.

 13 MS. GUSSOW: And which regulatory

 14 requirements which are you referring?

 15 MS. VEDBRAT: For the reporting for

 16 mandatory trading and then eventually, you know,

 17 the information of that trade being reported to an

 18 SDR.

 19 MS. GUSSOW: Right. And so that there

 20 is a reporting counterparty chosen interaction,

 21 and then that reporting counterparty submits the

 22 data to the SDR. Then the SDR reaches out to the
 101

 1 counterparties to confirm the accuracy of the

 2 data. And again, that's the SDR's, you know,

 3 decision on how to implement or comply with that

 4 regulation. And so each SDR has a different

 5 methodology in which may have developed to do so.

 6 So again, if you have an issue with

 7 respect to that, you know, you may want to talk to

 8 your specific SDR. And of course, you know,

 9 Division of Market Oversight is always, you know,

 10 happy to discuss this with participants. And, you

 11 know, many of you know we do spend a lot of time

 12 on the phone discussing issues. And again, it may

 13 be something that would be appropriate to comment

 14 with respect to the interdivisional data working

 15 group.

 16 CHAIRMAN O'MALIA: Bob.

 17 MR. GARRISON: Yeah, I'm just curious to

 18 know, a lot has been mentioned about

 19 harmonization, which I think is great and it's

 20 produced as the panel has stated, a lot of good

 21 results; but that's been focused primarily on the

 22 output of the information. And I'm just curious
 102

 1 to know, you know, the output obviously is

 2 dependent upon the input that's coming into the

 3 SDRs, I'm curious to know if there's any form that

 4 exists that allows consistency of approach back to

 5 the other market participants on a way to ensure

 6 that that consistency is coming into the three

 7 SDRs that exist today or whether the harmonization

 8 effort is just focused on the output between the

 9 CFTC and the SDRs.

 10 CHAIRMAN O'MALIA: That's a great

 11 question. I mean, we've, John Rogers has used the

 12 SDR effort, he's been quarterbacking to harmonize

 13 what comes from the SDRs to the Commission. I

 14 know a lot of end users are worried about

 15 standards of harmonization going into the SDRs.

 16 We've relied on the SDRs to be our Rosetta Stone,

 17 if you will, to harmonize this data; but some of

 18 this issue, and maybe this is what we can address

 19 as part of our working group to fix the fields.

 20 Right. We had our appendix in our SDR or Part

 21 45 reporting that said, you know, fill it out this

 22 way. And if there's any uncertainty about how you
 103

 1 fill that out or enough of the fields, maybe we

 2 should address that.

 3 And I think maybe that's going to be a

 4 question that the working group and then the

 5 public comment period will consider. I mean, what

 6 are you considering to help end users conform?

 7 MR. MCGONAGLE: I think that's right.

 8 That is one of the areas that we are considering.

 9 You talked about the Appendix 2, Part 45, so that

 10 is, we see that as part of the process, sort of

 11 the information. And as it gets to the SDR, it

 12 isn't just the SDR being reportable information to

 13 us, it's the utilization of the information that's

 14 coming into the SDRs. So you know, that is a

 15 place that we do want to cover. So I appreciate

 16 that comment.

 17 CHAIRMAN O'MALIA: And I know there's a

 18 rush, everybody talked about harmonization, but I

 19 don't know that harmonization means the same thing

 20 from every division. And is it harmonization from

 21 the three SDRs that have different data

 22 architecture and therefore it's a challenge for us
 104

 1 to download it from them and arrange it

 2 appropriately, or is it the quality of the

 3 material being reported? Can anybody reflect on

 4 where harmonization must occur to make it better

 5 for us?

 6 MR. MCGONAGLE: So I hear it right, it's

 7 all of the above in terms of the types of and the

 8 manner of information or the types of information

 9 that's reported, just sort of some simple

 10 questions about, you know, the identification of a

 11 particular interest rate swap that, you know, is

 12 reporting in different fields, and so people are

 13 sort of capturing sort of effectively the same

 14 swap in different ways, which makes it a challenge

 15 for us to handle that information. And so we say

 16 harmonization. I do think, you know, we are

 17 looking not only at the standardization of the

 18 fields, we're also looking at, you know, what are

 19 the priorities with respect to each of the

 20 divisions and then taking those priorities across

 21 the Commission and saying, well, what is it of

 22 these top three for each division, what is the top
 105

 1 three for the Commission.

 2 And so, you know, we want to cover as

 3 much grounds as we can. And I know I'm being very

 4 high level, but we're not looking to kick things

 5 out currently. We're trying to bring stuff in and

 6 try and get it ranked and be responsive.

 7 CHAIRMAN O'MALIA: Walt. You had your

 8 card up.

 9 MR. TURBEVILLE: Thanks for the

 10 presentation. The whole issue of complete uniform

 11 data, it just strikes me that maybe the original

 12 rules on SDRs should have been much more

 13 aggressive to create a tremendous amount of

 14 leverage from the Commission from the get-go as

 15 some of us had suggested, but that's water under

 16 the bridge and that's not my question. The

 17 question I have is, especially with Ananda and Dan

 18 having talked a bit about uses of the data beyond

 19 just strictly compliance with a rule that exists,

 20 but more of a broader understanding of what's

 21 going on in the marketplace, my aspiration for

 22 this data is so that the Commission and staff will
 106

 1 have a comprehensive understanding of the market

 2 and what's going on beyond just what's an existing

 3 rule.

 4 And the way this is set up is that the

 5 divisions are talking about their particular

 6 needs. I'm wondering is anybody talking about the

 7 overall needs of the Commission to understand the

 8 marketplace in an integrated and comprehensive

 9 way. And what are the data needs so that you can

 10 get, not only the data that you need, but how you

 11 might be able to manipulate that data to have a

 12 more comprehensive understanding of what's going

 13 on in the markets?

 14 MR. RADHAKRISHNAN: I think that's the

 15 whole objective of the interdivisional working

 16 group. If you think about it, it should be a wish

 17 list, right, all the divisions, this is what I

 18 want, this is what I want to look at and then you

 19 vet it with the Commission and then you go out for

 20 comment and say, you know, this is what we need.

 21 Now with all due respect to the industry, you can

 22 suggest things to us, but I submit that the
 107

 1 divisions are sometimes in the best place to know

 2 what it is we want, right?

 3 So it seems to me that it is information

 4 that we need to do our jobs, right? Market

 5 surveillance has a particular function, risk has a

 6 particular function, and then trying to figure out

 7 whether people are clearing or something else.

 8 And then the other issue is, all right, what do we

 9 want? How do we get there? Meaning, you know,

 10 what template do we have, right? And this is

 11 where, you know, ODT colleagues can say, oh, this

 12 is how you. How do you send it? FIXML or

 13 whatever protocol people use should be one.

 14 Choice is nice most times, but when it comes

 15 to something like this, I don't think choice is

 16 good, all right?

 17 You tell people, this is how you do it,

 18 this is the way you do it. And to go to Supurna's

 19 issue, anybody who is, has a stake in the data

 20 should be able to view the data, right? So I

 21 don't understand why, you're saying you should

 22 have what, read-only access to your data; is that
 108

 1 what you want?

 2 MS. VEDBRAT: Read-only or just, you

 3 know, give us the information.

 4 MR. RADHAKRISHNAN: Right.

 5 MS. VEDBRAT: Like, I'm not -- we can

 6 reconcile it among the three SDRs.

 7 MR. RADHAKRISHNAN: Right.

 8 MS. VEDBRAT: Not sure if everyone can

 9 do that.

 10 MR. RADHAKRISHNAN: Right, right.

 11 MS. VEDBRAT: But we're happy to do that

 12 as a --

 13 MR. RADHAKRISHNAN: Right.

 14 MS. VEDBRAT: -- a first step.

 15 MR. RADHAKRISHNAN: Right. So and the

 16 other thing that we don't have is we don't have

 17 the ability to look at the risk posed by unclear

 18 transactions, no clue, right. You've got line

 19 items, it's nice, but it doesn't tell you at the

 20 end of the day what the exposure of, say, the top

 21 ten banks are to each other, right. Now they

 22 should know. I'm assuming they will know, but we
 109

 1 don't know, right, because all we have our line

 2 items. We don't -- unlike the cleared space, we

 3 don't have position information, so that's a big

 4 challenge for us.

 5 MR. BUCSA: And I think what you said is

 6 exactly right. You made a good point and a very

 7 good question and I think it's something we'd like

 8 to do in the future, the piecing together of the

 9 market, of understanding how everything fits as a

 10 whole and how things influence each other and the

 11 framework or the foundation of all of that is the

 12 data and combining the good quality data with

 13 people's knowledge and experience in the markets.

 14 And the tools we can build will get us there, it's

 15 just answering that really complicated question is

 16 something we're not nearly in the place to do at

 17 the moment if you consider all the data issues

 18 that we're having.

 19 CHAIRMAN O'MALIA: Irene.

 20 MS. ALDRIDGE: Hi. Thank you. I

 21 actually am very impressed with the market

 22 reporting tool and somebody who deals with that on
 110

 1 a daily basis. I wonder, are there any plans to

 2 extend the history of the data that's reported to

 3 the public? Because I noticed right now only five

 4 weeks are reported, I believe. And I know I

 5 understand you're trying to increase the

 6 granularity over time. Thank you.

 7 MR. SRINIVASAN: Sorry. It's my

 8 mistake. We do have, I should have pointed it

 9 out, there's an archive section. So if you look

 10 at the weekly swaps report on the columns on the

 11 left, there is a link to the archive section. And

 12 this is a query which came from one of the market

 13 participants, you know, can you send it and can we

 14 download it in an Excel format? So our weekly swaps

 15 report can be downloaded in Excel also.

 16 Somebody asked for CSV. I said, give us

 17 some more money and we'll give you CSV and any

 18 other format you want, but right now you get it on

 19 HTML and on Excel, so and you can get all archived

 20 data also. So --

 21 MS. ALDRIDGE: Thank you.

 22 MR. FISHE: I'm sure I have more of a
 111

 1 comment than a question, and I think it relates to

 2 what Dan was saying. And I wanted to commend the

 3 staff that it sounds like you're taking a very

 4 careful approach to analyzing the granular data

 5 that you need for your role. And I just wanted to

 6 say thank you. As an industry participant, we

 7 have to deal all the time kind with the spurious

 8 conclusions that come out of, you know, I'd say

 9 publication of other people's analysis of that

 10 granular data. And sometimes it's published, you

 11 know, in nanoseconds, you know, quicker than we

 12 make trades, but I just want to say thank you for

 13 what you said. And it sounds like you're very

 14 carefully looking at that granular data.

 15 CHAIRMAN O'MALIA: Brian. And we'll

 16 just go down the row after that.

 17 MR. DURKIN: Thank you. I just wanted

 18 to compliment the panel for their presentations

 19 and would ask us all though to reflect back, it

 20 was really just a few short months ago as these

 21 requirements kicked into effect, and the adoption

 22 of a swap data reporting regime was a monumental
 112

 1 effort on the part of the entire industry, and I

 2 think what you presented today shows that while

 3 there's still some challenges, it's come a long

 4 way in a relatively short period of time.

 5 And, you know, I only ask that we

 6 continue to try to take a pragmatic approach as we

 7 continue to evolve and further develop the

 8 progress that's about made to date. There were

 9 some comments, though, that were made that I just,

 10 I did want to clarify. With all of this that has

 11 been placed on the industry and the Commission,

 12 itself, at the end of the day, you know, I can

 13 assure you from the CME's perspective, we're

 14 deeply committed to its swap data reporting

 15 offering and to providing the Commission with the

 16 capabilities and the facilities that it needs for

 17 the purpose of effectively monitoring systemic

 18 risk.

 19 There are, you know, a number of areas I

 20 think that were raised today that seem to point

 21 itself back to maybe a missing link, which is a

 22 missing product system. And that's been, I think,
 113

 1 an ongoing source of consideration on both the

 2 part of the Commission, Commission staff. And,

 3 you know, there seems to have been an intensive,

 4 you know, focus on that for a period of time; but

 5 now that seems to have kind of lapsed. So, you

 6 know, I think that if we could, you know, possibly

 7 come back to getting to a unified product system,

 8 that might help clear up a number of issues that,

 9 you know, many of us are dealing with.

 10 There was also some comments with

 11 respect to the missing of data or inability to

 12 link up certain data components. And I think it

 13 was Ananda had mentioned the linkage of the alpha

 14 portion of transactions to the beta and the gamma.

 15 First of all, you know, all of the data on cleared

 16 transactions reside in the clearinghouse. So we

 17 have all of the data in the clearinghouse. And

 18 when you start referencing the connectivity

 19 between the alpha portion of these transactions to

 20 the beta and gamma, I know our SDRs shows that

 21 linkage between those various components.

 22 With respect to the gaps associated with
 114

 1 the terminations of the alpha, I thought I had

 2 heard earlier in one of the reports, we've been

 3 sending that information since I believe it was

 4 December of last year. So my point is, there is a

 5 lot of progress that's being made as we continue

 6 to evolve together as an industry. I can't

 7 implore the efforts enough on harmonization and

 8 what we've been trying to do together, working

 9 together, as we learn a bit more about the

 10 progress that is made to continue our focus and

 11 emphasis on harmonization, because again, I think

 12 that helps all of us involved in this very

 13 important program to be even more effective as we

 14 go along in producing and providing the

 15 information that's needed.

 16 When we get to the issue of

 17 standardization of data, you know, I would also

 18 ask that we give some consideration to

 19 standardization at what point, and how do we help,

 20 you know, the Commission teams, themselves, to get

 21 to the point where they need to be in the context

 22 of the data as it's sent back into the systems and
 115

 1 brought to the Commission for its review. And so,

 2 you know, I would just suggest that emphasis be

 3 more so on the back end of the SDRs being able to

 4 submit that information in a very accurate and

 5 standardized format. That might be an area for us

 6 to focus more heavily on.

 7 CHAIRMAN O'MALIA: Evelyn.

 8 MS. FUHRER: I'd just like to focus my

 9 comments on the harmonization that's been

 10 discussed. And, you know, the fact that we're

 11 talking about harmonization this year as opposed

 12 to data gathering that we were talking about last

 13 year, you know, demonstrates the progress that

 14 we've made in actually gathering the data. But,

 15 what I really would like to suggest is possibly

 16 rather than work on harmonization, which if you

 17 think about it from the life cycle of the data,

 18 you're really dealing with the issues at the back

 19 end at the end of the life cycle of the data; I'd

 20 like to suggest that possibly we start thinking

 21 about rectifying and fixing the data, making sure

 22 it's correct as it comes into the system at the
 116

 1 beginning of the life cycle of the data.

 2 And because no matter how much you

 3 harmonize data, you iterate around it, you're

 4 constantly working it, you get closer to the right

 5 answer; but it will never really be perfect unless

 6 it's perfect when it goes into the various

 7 systems. And I know there's been a concern about

 8 not being too prescriptive, but maybe at this

 9 stage of the maturity level of the industry,

 10 there's a recognition that a little bit of

 11 prescription or maybe a lot of prescription goes a

 12 long way to saving the industry a lot of money

 13 overall. And hearing the conversation around the

 14 global groups that are in progress, I mean, you

 15 know, I think we have an opportunity now to learn

 16 from what we've done over the course of the past

 17 year and say, you know, if we have to do it all

 18 over again, can we inject some standards earlier

 19 in the process, it would deal with some of the

 20 issues we talked about, that Supurna has been

 21 talking about and also all the costs around this.

 22 And if we were to think about doing
 117

 1 that, I mean, the way I think we would do it is do

 2 an analysis all the way at the back end and see

 3 how the data is going to be used and say, okay,

 4 for me to be able to use this data in the most

 5 efficient way possible, how would I ideally like

 6 to see the data? Okay. What kind of controls

 7 would I want around the data, how accurate those

 8 need to be, and come up with a list of standards

 9 around that would get injected into the industry.

 10 Thank you.

 11 CHAIRMAN O'MALIA: Pierre.

 12 MR. LAMY: Yes, thank you. And thank

 13 you all for the very good presentations and the

 14 different point of view that you have brought into

 15 the discussion. I have two questions. The first

 16 one relates to misreporting by reporting

 17 participants, which I think is part of the problem

 18 and probably all of you talked in some way, shape,

 19 or form about that dimension; the thing is the

 20 resolution path for that is probably to have

 21 stricter validation logic at the point of

 22 collection. And progress is being made in that
 118

 1 respect. But until we get that, the question I

 2 would have for the CFTC staff is, when you find

 3 issues, for example, this question of the Korean

 4 Won swap with the notional being reported in USD

 5 currency, do you systematically come back to the

 6 reporting participant and say, well, there is a

 7 mistake, can you please adjust? Yeah, go ahead.

 8 MR. SRINIVASAN: So we go back to the

 9 SDR, and the SDR speaks to the market

 10 participants. So there is, and there's a

 11 coordinated process between the Euro process

 12 within the currency sort of around these questions

 13 with the SDR. The SDR in turn speaks for the

 14 market participants. So --

 15 MR. LAMY: Because I believe that with

 16 the process that we have as of now, there is a

 17 number of situations where the reporting

 18 participants, even themselves, they do not realize

 19 that they are just misreporting some data, once

 20 again because of progress that we need to make in

 21 terms of validation logic at the point of

 22 collection.
 119

 1 The second comment and question --

 2 MR. BUCSA: Sorry. If I could just --

 3 MR. LAMY: Yeah.

 4 MR. BUCSA: -- interrupt briefly. It

 5 seems that that approach in a way places the onus

 6 on the Commission first and the submitter second,

 7 third, or fourth in that chain. So but by

 8 systematically, I think it's hard to say that

 9 there's any systematic approach to do that based

 10 on what we all presented about the tools at our

 11 disposal, the staff that we have to work with, and

 12 the data as it is. I think if you were to send

 13 the confirm to a client of yours, you would make

 14 sure it was right before you sent it. You

 15 wouldn't really want the client to tell you that

 16 it was wrong.

 17 I think the same methodology or

 18 attention to detail could be applied in the things

 19 sent to us so we're not the first line of defense

 20 to say, by the way, this doesn't make any sense.

 21 MR. LAMY: I agree with you. And I'm

 22 not suggesting that the CFTC should be the first
 120

 1 line of defense, it should probably be the last

 2 one. But in terms of the fact that you have

 3 hundreds, if not thousands, of reporting

 4 participants reporting according to different

 5 technology, in my view, the first line of defense

 6 should be the SDR. And with the protocols that are

 7 being used, there is a way to validate the data

 8 using the Part 45 rule that you have developed

 9 alongside with the different protocols that you're

 10 using. I'm familiar with FpML. And FpML's rule

 11 of validation would go a long way with a stricter

 12 validation logic to ensure better data quality.

 13 The second comment that I have, I was

 14 interested by the discussion about notional

 15 computation for commodity equity swaps and those

 16 type of things. Is -- what I would suggest, and

 17 I'm sure that, I'm hopeful that you do that

 18 already, is compare notes and confirm the

 19 methodology with existing agency in the U.S. and

 20 outside of the U.S. in terms of the way to compute

 21 the notional. Because I think there is no right

 22 or wrong for those type of products. And what you
 121

 1 do not want to do is have a methodology that would

 2 not be comparable with the one already use because

 3 people already report notionals in currencies with

 4 other agencies. So that would facilitate the work

 5 down the road.

 6 MR. SRINIVASAN: Yeah, that's a useful

 7 comment, I guess. And we also face a similar

 8 situation for which we have a solution in the

 9 futures world. So there are a huge amount of options

 10 activity and we need to compute the notional terms so we

 11 have a structure in place to do that, but that's

 12 something that we're working on as you have

 13 suggested.

 14 MR. LAMY: Thanks.

 15 CHAIRMAN O'MALIA: Michael.

 16 MR. ATKIN: Yeah, so from my perspective

 17 is, this is kind of less a rule problem as it is a

 18 data manufacturing on understanding of the data

 19 manufacturing process problem that the industry

 20 has to go through. So the current model that we

 21 describe of fragmentation, lots of participants,

 22 lots of complex instruments, lots of
 122

 1 transformation processes, lots of relationships;

 2 it's going to always be challenged if what you're

 3 trying to do is harmonize just structured data

 4 against meaning. So I think it was Ananda who

 5 described the problem correctly, this is about

 6 understanding relationships in the context of the

 7 structure of these instruments. And there is a

 8 better way, I think that we have to start thinking

 9 about this problem.

 10 And, Scott, I think you talked about a

 11 true Rosetta Stone. And the Rosetta Stone that

 12 we're looking at, not only aligns data, but it has

 13 to align meaning and it has to be comparable and

 14 it has to include the relationship processes that

 15 exist. And currently the way we're doing

 16 harmonization ignores that side of the problem,

 17 and we have to be able to model those

 18 relationships. And it is possible to do that, and

 19 it's a different way of approaching it, but that I

 20 think is the only way you're going to solve this

 21 problem.

 22 CHAIRMAN O'MALIA: Adam.
 123

 1 MR. LITKE: Yeah, when we go back to

 2 when the committee on data standardization was

 3 meeting, the TAC and the CFTC accepted a number of

 4 principles around data reporting and there were

 5 three of them that were pretty important that it

 6 doesn't -- that I was involved with, but there's

 7 others as well, and I'm asking a general question

 8 as to whether the principles that were accepted

 9 are actually being followed in the work that's

 10 being done afterwards. In other words, are people

 11 going back and reviewing it?

 12 And I'll give the example. One of the

 13 things we said was that the SDR was responsible to

 14 report to the Commission in whatever format the

 15 Commission required, but that the SDR was going to

 16 set its own rules to the street for how it was

 17 going to collect the data. And part of the reason

 18 that was done was because even various firms

 19 couldn't agree on what format they wanted to

 20 report the data in, and so that was supposedly

 21 being left open to the SDRs to allow them to

 22 provide better service to their customers. And
 124

 1 then the last piece was that the data that was

 2 reported to an SDR was supposed to be freely

 3 available for editing and correction to any party

 4 to the swap transaction and freely available for

 5 any correction that was envisioned that there

 6 would actually be APIs that people could get to,

 7 which it sounds like are not there.

 8 So I'm sort of asking the staff members

 9 here, to what extent are you going back, when you

 10 look at these data problems and say, we adopted

 11 these principles for data gathering, are we

 12 actually following them?

 13 MR. ROGERS: So I can't speak to the

 14 second one, but I can certainly speak to the first

 15 one. And the answer to the first one is

 16 absolutely yes. We are looking at the data from

 17 the perspective of how the Commission would gain

 18 access to it. I won't necessarily say receive it,

 19 because there are really two elements to that.

 20 There is the data that is actually at the SDR in a

 21 portal that the Commission can get access to, and

 22 then there's the data that would flow back to the
 125

 1 Commission so that it could comingle with other

 2 data including futures data and that sort of

 3 thing.

 4 Regardless of what the method is, we

 5 want the data to look the same and be, you know,

 6 harmonized across the different SDRs, that means

 7 that people have to have a common understanding

 8 for particular elements and how it's used, have a

 9 common sense of values, and all sorts of other

 10 different things around the data. But in terms of

 11 the first item, regardless of whether it is at the

 12 SDR or being sent to the Commission, we will

 13 determine the form and manner of the data flowing

 14 to us, but we are not talking about the form, the

 15 manner in which the data is flowing into the SDR.

 16 So I think -- and perhaps somebody else could

 17 speak to that.

 18 MR. MCGONAGLE: I want

 19 to follow the point. And I see, if there's an

 20 industry standard or an industry practice about

 21 how entities are executing transactions, then

 22 subject to the vagaries of a particular SDR that
 126

 1 these transactions are reported to, who wants, you

 2 know, to recast it or rename it in some way, I

 3 would view that as problematic. I mean, I think

 4 our staff here would be looking at sort of an

 5 apples to apples review of what's happening on the

 6 street and would be concerned that harmonization

 7 or the application of a naming convention by SDR,

 8 that would give the potential for a lack of

 9 consistency and makes it more confusing.

 10 MR. LITKE: Yeah. I was specifically

 11 alluding to, there was a bit of a knockdown

 12 drag-out fight whether people should have FpML or

 13 FIX reporting. And essentially it was decided to

 14 leave that up, you can have the same data in

 15 either format, but depending on where the swap was

 16 executed, there was a marked preference for one

 17 format or the other.

 18 MR. ROGERS: Sure. I'll just add in, I

 19 mean, I think that what you're asking and the way

 20 that I answered it, I think are in alignment. We,

 21 I mean, we are -- when we get to the point we are

 22 receiving data, just like we do with Part 20 data,
 127

 1 we will decide the particular schema that is used.

 2 Because we've heard, you know, very similar

 3 conversations. And in the case of Part 20, we

 4 actually support, since it's data that we're

 5 ingesting here on a regular basis both FIXML and

 6 FpML because we can.

 7 We'll be focusing on those kinds of

 8 questions down the line as it relates to data

 9 flowing back here, but we're not dictating the

 10 actual message structure as it flows into the SDR.

 11 And each one of them we know does it differently

 12 for particular reasons of their own. At the end

 13 of the day, we need to make use of the data

 14 regardless of the mechanism that the messages, or

 15 the methods in which the messages flow in. And

 16 that's what we're focusing on.

 17 So to get to that point where we can

 18 look at things in like terms across the SDRs is

 19 really more of that content and semantic, you

 20 know, analysis that we would do more so than the

 21 particular message types that would flow into the

 22 SDRs.
 128

 1 MR. RADHAKRISHNAN: If I could just make

 2 a point. There's a technology issue, and then

 3 there's a content issue. So if as long as the

 4 technology does not interfere with the content of

 5 the information that we are getting for our

 6 regulatory purposes, then you can say it shouldn't

 7 matter, right? But I'm not sure, and I'll defer

 8 to my colleague, John, I'm not sure whether that's

 9 the case. If the manner in which the information

 10 is being sent, if there's one better way than

 11 another, why shouldn't we choose the better way?

 12 And if it means, you know, we prescribe

 13 something, maybe that's the way we do it. Because

 14 again, I've got to stress, at the end of the day,

 15 I think a critical function of reporting is so

 16 that we can do our jobs. If we cannot do our

 17 jobs, then something is going wrong.

 18 MR. ROGERS: Yeah, I guess, if I may.

 19 CHAIRMAN O'MALIA: Yep.

 20 MR. ROGERS: I would liken it to what

 21 Dan Bucsa said a moment ago thinking of us. I

 22 mean, when I look at the harmonization activity
 129

 1 that we're talking about, I look at the people

 2 that are sitting next to me as basically

 3 customers. They're the users of the data, they

 4 might have particular purposes, so we are looking

 5 to make sure that the data, the content, itself,

 6 satisfies those purposes. And insomuch as it is

 7 necessary to harmonize that content so that they

 8 can get the business value out of it, that's what

 9 we're going to do and that's where -- in

 10 harmonization we've had lots of conversations with

 11 the SDRs about what this means to us and about the

 12 value that it provides to the Commission.

 13 And if we need to be prescriptive in

 14 that regard, we have been.

 15 CHAIRMAN O'MALIA: We're getting way

 16 over time, but I'm going to hit Karel, Chuck, and

 17 Bob for kind of last observations. So keep it

 18 tight.

 19 MR. ENGELEN: Okay. Thank you. The

 20 taxonomy and product identifiers have been

 21 mentioned a couple of times during the

 22 presentation, so I kind of wanted to pick up on
 130

 1 that. So when the ISA taxonomy was developed and

 2 that is taxonomy that is used for most of

 3 reporting, we kind of deliberately kept it fairly

 4 high level. And I think what's needed in

 5 particular in something like taxonomy is really a

 6 dialogue with the CFTC. Because as mentioned a couple

 7 of times about more detail, but from industry

 8 perspective, I think there is need for better

 9 understanding of where do you want the detail and

 10 what is the detail that you want. So I think this

 11 is certainly an area where more input is required.

 12 My second point on the taxonomy is that

 13 we see the whole taxonomy discussion as a

 14 discussion that should take place on an

 15 international level, meaning ideally you have one

 16 taxonomy, not just for CFTC reporting, but for

 17 global reporting; and so my point is, we are

 18 having discussions with other regulators, but all

 19 regulators have kind of their own requirements.

 20 And so my question to panelists, in taxonomy rules

 21 in other areas, if you could give a little bit

 22 more detail about what the plans are.
 131

 1 And I realize this is kind of almost the

 2 next step after harmonization of the data you

 3 receive here, but what are some of the plans to

 4 work on harmonization on taxonomy on other levels

 5 with other regulators internationally?

 6 MR. ROGERS: So I can tell you that it

 7 is very much in our interest to coordinate both here

 8 in the U.S. and internationally, and we've been

 9 doing some of those things already. We are

 10 significantly constrained by resources to be sure,

 11 but we have heeded the advice from the SDRs that

 12 have actually come out and said to us, you know,

 13 please don't invent your own taxonomy and develop

 14 a system for the CFTC only to then have us have to

 15 do something differently for other jurisdictions.

 16 And so we are trying, we are working, we

 17 are coordinating where we can with agencies like

 18 OFR, also coordinating internationally with groups

 19 like ESMA on the development of a taxonomy, and

 20 we'll plan to continue to do so. And when such

 21 time as there is an international group that

 22 focuses on UPI similar to what is already going on
 132

 1 with LEI, we would hope that the work we are doing

 2 would fit within that and so that there would be a

 3 global UPI initiative.

 4 MR. ENGELEN: Thanks a lot.

 5 CHAIRMAN O'MALIA: Chuck.

 6 MR. VICE: Thanks. A few comments I

 7 suppose. One, I would say the interdivisional

 8 working group, I think as an SDR, we've felt like

 9 in the last few months, that group is, you guys

 10 are, the coordination and the communication going

 11 on that you're doing collectively with the SDRs

 12 and individually is helping us, the industry work

 13 through these problems, it's just going to be a

 14 slog to work through. I think Dan made an

 15 important point in his presentation, the large

 16 trade reporting system for futures took tens of

 17 years to get to the point where it is, and I would

 18 argue that it's not nearly as complicated in terms

 19 of the problem that it solves where much more

 20 fragmented OTC swaps market, much less standard

 21 instruments, and on top of it, rules that require

 22 real-time reporting and movement of data around in
 133

 1 real-time between multiple entities.

 2 I mean, it is a complicated thing. So I

 3 think some of this is to be expected and I think

 4 we just have to work through it as an industry and

 5 we'll get there.

 6 The second point I would make is, I

 7 think it's important to talk about cleared and

 8 uncleared swaps separately. I agree

 9 wholeheartedly with Brian in that for cleared

 10 swaps, that data is the clearinghouse, there's no

 11 under or over reporting, there's margin calls on

 12 that data every day, so it has to be 100 percent

 13 correct. The fact that there is a trade that

 14 exists, there's a position, who is the buyer and

 15 who is the seller, so, you know, there is, it

 16 should not be rocket science, as Ananda alluded

 17 to, for those cleared trades to get into an SDR

 18 with whatever USI audit trail that we need and

 19 whatever alpha trade termination message is being

 20 received and processed. So that is incumbent

 21 upon, I think, the three SDRs and the working

 22 group to make that happen as quickly as possible.
 134

 1 From an uncleared swaps standpoint, we,

 2 for the commodity asset class, ICE operates a, one

 3 of the large or maybe the largest, I don't know,

 4 commodity swap data repository, primarily

 5 uncleared swaps in the asset class that

 6 potentially has the most variation in data. And I

 7 can tell you there, it is going to ultimately be

 8 incumbent upon the SDRs, hopefully on the back of

 9 some standard UPIs or some other type of industry

 10 embrace of taxonomy, to enforce the requirement

 11 that quality data get in the SDR.

 12 We've taken our knocks with our

 13 customers sending us data that we've rejected

 14 because it was improperly formatted or it was

 15 incomplete or it didn't meet the standard field

 16 definitions. They had to go back and fix it and

 17 send it to us again, but we've been fairly strict

 18 about that. We've been very strict about that,

 19 because if -- garbage in is garbage out. So I

 20 think on the uncleared swaps base, I think it's

 21 important that the SDRs have a common approach in

 22 that regard.
 135

 1 The last point I would say is, of course

 2 end users need access to the SDR to be able to see

 3 the trades that they are parties to that are

 4 there, correct, edit any information that may be

 5 wrong. I think we're kind of crawling before we

 6 walk and run in that regard. I mean, I suspect, I

 7 know ICE does, I'm sure, I would think any of the

 8 SDRs have the ability for users to log in to those

 9 systems and see those trades, probably export

 10 data. Are we at the point of APIs? No, I don't

 11 think we are. For somebody as certainly as

 12 sophisticated as BlackRock, I'm sure we'll get

 13 there.

 14 No question they're necessary. There's

 15 no reason not to have them. But I think it's

 16 early days in that regard. And I'm, you know, as

 17 we operate a couple of SDRs, and I can tell you,

 18 even though making it available for end users to

 19 access that data and review it, very few avail

 20 themselves of that at this stage, but again, I

 21 think it's early days. That's it.

 22 CHAIRMAN O'MALIA: Bob.
 136

 1 MR. GARRISON: Yeah, I just have a quick

 2 comment and then an ask. And the comment is

 3 similar to what other people said that, you know,

 4 in the little more than a year to be able to get

 5 up and functioning what this industry has been

 6 able to get up, with a situation where you have

 7 immensely complex data and as a result immensely

 8 complex systems, really is quite a good place to

 9 be when you step back at a high level and look

 10 at what's been accomplished. That's not to

 11 minimize at all the issues that we have going

 12 forward.

 13 The ask is around the cross-divisional

 14 working group, which I think is a tremendous step

 15 forward. The ask that I would have is, you know,

 16 as we have each division head, they all have

 17 different seats, different requirements, things

 18 that they want to see; I think it would help to

 19 have things approached in a very formal way and

 20 prioritize the work that you'd like the industry

 21 to focus on. We can't solve everything all at

 22 once, so to have a sense of what's most important
 137

 1 to the CFTC to move forward, I think would be very

 2 important.

 3 As Dan said, this is an iterative

 4 process, we'll work through those things in the

 5 priority order that gets set, but I think having

 6 that working group be formal and come up with

 7 priorities and collaborate very actively with the

 8 practitioners of the data across the market

 9 participants, I think is also very important.

 10 CHAIRMAN O'MALIA: I completely agree

 11 with that, especially when it comes to our own

 12 budgeting, because if we can't figure out what

 13 their priorities are, it's tough to spend the

 14 money based on their priorities which I think will

 15 dictate our investment. Any final comments from

 16 our division directors? We greatly appreciate

 17 your thoughtfulness, your directness, and

 18 willingness to answer all of these questions. So

 19 thank you very much.

 20 We obviously look forward to having a

 21 very effective cross-divisional working group. We

 22 are over time. I'm going to try to keep that 1:15
 138

 1 timeframe, which only gives us 45 minutes for

 2 lunch. For the TAC members and witnesses

 3 we'll be taking you upstairs for lunch.

 4 And I apologize for running over, but a

 5 lot to get through. So thank you very much. See

 6 you at 1:15.

 7 Can we start panel two, please. Okay.

 8 Panel two, we're going to have a discussion about

 9 something we've been kicking around on

 10 this TAC committee for the past three and a half

 11 years and that's what are appropriate pre-trade

 12 controls in the market and how do we think about

 13 them and what problems are we trying to solve. So

 14 to kick us off, we will have Sebastian Pujol Schott, our

 15 Associate Director of the Division of Market

 16 Oversight, who was largely responsible for

 17 drafting the concept release. I think he's going

 18 to present what it is the proposal does and maybe

 19 some of the comments, an overview that we've

 20 received thus far.

 21 And we've received dozens of very good

 22 comments, some extraordinarily long comment
 139

 1 letters. And so, you know, at least somebody has

 2 an opinion about this stuff, so this should make

 3 for an interesting discussion. And then we have,

 4 what do we have one, two, three, or four panelists

 5 afterwards. A sampling of some of the comment

 6 letters that will give us, you know, to help frame

 7 this debate a little bit, and then we can have a

 8 full discussion. So after Sebastian, I'll

 9 recognize the panelists.

 10 I don't know, have you guys decided how

 11 you want it in order? All right. Well, it will

 12 be ladies first.

 13 Sorry about that, Caitlin. So,

 14 Sebastian, please kick us off.

 15 MR. SCHOTT: Thank you. Good afternoon,

 16 Commissioner O'Malia and members of the Technology

 17 Advisory Committee. Thank you for the opportunity

 18 to update the TAC on the Commission's concept

 19 release on risk controls and system safeguards for

 20 automated trading environments. As you may recall

 21 the concept release was published in the Federal

 22 Register on Thursday, September 12, 2013. The
 140

 1 Commission offered a 90-day comment period that

 2 closed on December 11th of last year.

 3 The Commission subsequently reopened the

 4 comment period from January 21 through February

 5 14th. All comments received are available on

 6 CFTC.gov, and new comments are posted as they

 7 arrive. To date as you mentioned, Commissioner

 8 O'Malia, the Commission has received 33 comments.

 9 And in addition staff has met with several

 10 industry parties. Persons and entities submitting

 11 comments include trade associations, public

 12 interest groups, futures exchanges, an array of

 13 trading firms, members of academia, a U.S. Federal

 14 Reserve Bank, and consulting technology and

 15 information service providers in the financial

 16 industry.

 17 Many of the comments received are

 18 detailed and thorough, including some comment

 19 letters that addressed all 124 questions presented

 20 in the concept release. One commenter conducted

 21 surveys of its member firms to gauge existing risk

 22 management practices. Other commenters provided
 141

 1 academic papers in support of their points of

 2 view. And some focused on elements of the concept

 3 release that are of particular interest to them.

 4 Staff is appreciative of all comments

 5 received and of the work that went into

 6 preparing these comments. Currently an

 7 interdivisional team of Commission staff is

 8 studying the comments and will make initial

 9 recommendations regarding any next steps that may

 10 be appropriate. My statement today will recap the

 11 structure and content of the concept release as

 12 well as provide a high level overview of the

 13 comments received and reviewed thus far.

 14 As members of the TAC are aware, the

 15 concept release asks whether existing risk

 16 controls and automated trading environments are

 17 sufficient to match the technologies and risks in

 18 modern markets. In this regard the concept

 19 release focuses on the totality of the automated

 20 trading environment, including the progression of

 21 orders from the automated trading systems that

 22 generate them to the clearing firms that guarantee
 142

 1 customer orders and onto execution by registered

 2 trading platforms.

 3 The concept release also addresses ATSs,

 4 themselves, including their design, testing, and

 5 supervision, as well as change management

 6 practices. Finally, it raises a number of related

 7 issues ranging from the underlying data streams

 8 that are used by ATSs to inform their trading

 9 decisions to special considerations involved in

 10 trading via direct market access and whether terms such 

 11 as high-frequency trading should be defined by

 12 Commission regulations.

 13 The concept release was informed by a

 14 number of factors, including controls already in

 15 use by one or more industry participants such as

 16 trading firms and exchanges; existing CFTC

 17 regulatory standards, particularly standards that

 18 have been developed over the last several years of

 19 rulemaking; best practices developed by expert

 20 groups, including the Technology Advisory

 21 Committee, FIA Principal Traders Group, IOSCO, and

 22 others.
 143

 1 The concept release begins with an

 2 overview of the automated trading environment,

 3 including the development of automated order

 4 generation and trade matching systems, advances in

 5 high-speed communication networks, the growth of

 6 interconnected automated markets, and the changed

 7 role of humans in markets particularly in the risk

 8 management process. It also highlights the

 9 importance of ATSs as tools for the generation and

 10 routing of orders. These developments were

 11 addressed through a series of 23 potential risk

 12 controls and other measures broadly grouped into

 13 four categories.

 14 The first includes pre-trade risk

 15 controls such as controls designed to prevent

 16 potential errors or disruptions from reaching

 17 trading platforms or to minimize their impact once

 18 they have reached platforms. Specific pre-trade

 19 risk controls include maximum message rates,

 20 execution throttles, and maximum order sizes among

 21 others. Depending on the measure, pre-trade risk

 22 controls could be applicable to all trading firms,
 144

 1 to trading firms that operate ATSs, to clearing

 2 firms, or to trading platforms. The concept

 3 release includes a total of eight pre-trade risk

 4 controls and sub-controls.

 5 And in that regard I do want to

 6 emphasize that even though a lot of discussions is

 7 around ATSs, when you look at the specific

 8 entities that contemplates, do, or might implement

 9 a risk control; there are instances in which does

 10 not discriminate on the nature of the order

 11 generation process. It can be automated, it can

 12 be high frequency, it can be manual. It's not

 13 necessarily calibrated to that particular

 14 parameter.

 15 A second category of safeguards includes

 16 post-trade reports and other post-trade measures.

 17 Examples of this category include reports that

 18 promote the flow of order, trade, and position

 19 information across market participants. It also

 20 includes uniform trade adjustment or cancelation

 21 policies and standardized error-trade reporting

 22 obligations by market participants. These
 145

 1 measures could be applicable to all trading firms,

 2 to trading platforms, or to clearinghouses. There

 3 are a total of five post-trade reports and other

 4 measures or sub-measures in this category

 5 including post-order, post-trade, and

 6 post-clearing drop copies.

 7 The third category of risk control is

 8 discussed in the concept release is termed system

 9 safeguards. These include safeguards for the

 10 design, testing, supervision, and change of

 11 management of automated trading systems as well as

 12 the measure such as kill switches that facilitate

 13 emergency intervention. Such safeguards would

 14 generally be applicable to trading firms operating

 15 ATSs, and depending on the control, might also

 16 apply to trading platforms and others. The

 17 concept release presents a total of seven system

 18 safeguards, some with subparts.

 19 Finally, the concept release also

 20 presents a fourth category of measures that could

 21 be relevant to risk reduction in modern markets.

 22 These include, for example, the registration of
 146

 1 firms operating ATSs and not otherwise registered

 2 with the Commission. And policies and procedure

 3 for identifying related contracts across markets,

 4 for example, securities and derivatives markets.

 5 As a threshold matter, the concept

 6 release recognizes that orders and trades in

 7 automated environments pass through multiple

 8 stages in their life cycle, from order generation,

 9 to execution to clearing and steps in between

 10 accordingly it solicits comment regarding the

 11 appropriate stage or stages at which risk controls

 12 should be placed.

 13 Focal points for implementation of risk

 14 controls described in the concept release include

 15 ATSs, prior to order submission; clearing firms;

 16 trading platforms, prior to exposing orders to the

 17 market; clearinghouses; and certain options, other

 18 options such as third-party hubs to which orders

 19 or order information could flow to uniformly

 20 mitigate risks across various platforms. The

 21 concept release recognizes that the appropriate

 22 focal point or points for a risk control may
 147

 1 depend on the type of control or on its intended

 2 purpose. Accordingly, it specifically seeks

 3 comment on this question, and on the desirability

 4 of a layered approach that places the same or

 5 similar risk controls at more than one stage of

 6 the order and trade life cycle.

 7 Now moving onto the comments that the

 8 Commission has received thus far. I think, given

 9 the variety and complexity of matters raised in

 10 the concept release, it's understandable that

 11 commenters expressed a range of opinions. And my

 12 intent today is to provide an overview of that

 13 range of opinions based on what the staff has

 14 determined thus far. However, I do want to

 15 emphasize that the inclusion or the omission of a

 16 particular topic or comment should not be

 17 interpreted as being of special significance or as

 18 foreshadowing any particular direction. I'm

 19 speaking only for myself.

 20 Many commenters expressed satisfaction

 21 that the Commission has undertaken this review of

 22 risk controls and system safeguards in automated
 148

 1 trading environments. A number of parties support

 2 some degree of Commission action in at least some

 3 areas. For example, eight commenters expressed

 4 general support for coordination between the

 5 Commission and other regulators. Several

 6 specifically noted that coordination in the

 7 securities space to better address circuit

 8 breakers and trading halts across markets would be

 9 helpful.

 10 Most commenters also expressed support

 11 for a multi-layered approach to risk controls. One

 12 commenter stated, for example, the holistic

 13 approach, I'm quoting, with overlapping

 14 supervisory obligations offers the most robust

 15 protection by engaging all levels of the supply

 16 chain and eliminating the possibility that a single

 17 point of failure will cause significant harm to

 18 the market.

 19 At the same time other measures

 20 contemplated in the concept release drew

 21 opposition by a majority of commenters. For

 22 example, of the seven parties who have thus far
 149

 1 commented on the idea of risk control through a

 2 centralized credit hub, five were opposed to the

 3 idea and two were supportive. Those opposed cited

 4 costs, complexity, and the potential concentration

 5 of risk.

 6 Certain questions in the concept release

 7 drew a very divergent opinion across comment

 8 letters. For example, commenters disagreed on the

 9 need for a regulatory definition of high-frequency

 10 trading. Of the nine parties who commented on

 11 this point, five were opposed to a definition

 12 while four were in favor. Those opposed to

 13 defining HFT suggested that no clear metric

 14 distinctions could be drawn between automated

 15 trading and high-frequency trading or that any

 16 definition of HFT would become obsolete over time.

 17 Those who favored the definition generally also

 18 favored controls that were specifically aimed at

 19 HFT firms.

 20 A commenter's opinion as to whether HFT

 21 should be defined typically ran in parallel with

 22 its opinion as to whether risk controls should
 150

 1 apply equally to all automated systems or whether

 2 HFT deserves special regulatory attention. Those

 3 requesting HFT specific measures logically saw a

 4 need to define HFT.

 5 At least one commenter; however, noted

 6 that some pre-trade risk controls contemplated in

 7 the concept release would apply even to orders

 8 placed manually. More fundamentally, academic

 9 commenters, some academic commenters, discussed

 10 concerns around the speed of trading, including

 11 within exchange order books. They suggested steps

 12 to slow trading.

 13 I do want to note as you're aware

 14 and the TAC is aware that, you know, the concept

 15 release has made every effort to be an agnostic

 16 document. It did not include rule proposals. So

 17 the comments, you know, sometimes were bouncing

 18 off of specific items in the concept release and

 19 sometimes they were extrapolating to things that

 20 might not necessarily have been present there.

 21 One recurring theme across comments is

 22 whether pre-trade risk controls and other measures
 151

 1 should be principles based or whether they should

 2 be more granular. Many industry participants

 3 stated that if the Commission were to pursue

 4 rulemaking in this area that any rules should be

 5 principles based. These commenters argued that

 6 prescriptive requirements will become obsolete as

 7 technologies advance, that prescriptive

 8 requirements may not account for the unique

 9 characteristics of different market participants,

 10 and that prescriptive requirements could result in

 11 participants designing around such measures, in

 12 particular if rules required specific benchmarks,

 13 there was concerns that participants might

 14 specifically operate one tick, one measure beneath

 15 that benchmark.

 16 Similarly, some commenters noted that the

 17 best way to achieve any desired standardization of

 18 risk controls is not through prescriptive

 19 Commission regulation, but rather through

 20 implementing best practices developed through

 21 working groups of DCMs, FCMs, and other market

 22 participants. Opinion was divided on this point,
 152

 1 however.

 2 Other commenters did express a need for

 3 more prescriptive rules. One commenter, for

 4 example, argued that prescriptive rules are

 5 necessary unless the Commission receives

 6 documentation that the risk controls implemented

 7 by firms and exchanges are consistent and

 8 effective. Another commenter questioned whether

 9 the incentives facing industry participants would

 10 permit them to "sacrifice speed for prudent risk

 11 controls."

 12 Finally, as with the high level of

 13 questions discussed above, many of the specific

 14 pre-trade risk controls, the 23 enumerated

 15 controls and other safeguards discussed in the

 16 concept release, drew divergent opinions, usually

 17 around the question of whether there was any need

 18 for a regulatory action with respect to that

 19 control or if an action is appropriate, how

 20 granular or principles based a regulation should

 21 be.

 22 Through the comments received, the
 153

 1 Commission is now in possession of more detailed

 2 information regarding individual risk control

 3 practices at both trading firms and at the

 4 exchange level. This was one of the important

 5 objectives of the concept release. And again,

 6 staff is grateful for the comments received that

 7 will help us understand the current practices

 8 better. As I noted previously, an interdivisional

 9 team continues to review all comments received and

 10 to refine its thoughts.

 11 Thank you again to members of the

 12 Technology Advisory Committee, and to Commissioner

 13 O'Malia for having this dialogue and for

 14 continuing and for allowing staff to participate

 15 so that we may refine our thinking further.

 16 CHAIRMAN O'MALIA: Good. Thank you,

 17 Sebastian. As I mentioned it earlier, but the

 18 comment period for this concept release has been

 19 extended until the end of this week, Valentine's

 20 Day. Send your comments in by Valentine's Day,

 21 and you'll be loved. So if there are any

 22 additional comments people have. But it was
 154

 1 largely to accommodate this discussion to make

 2 sure we had this on the record and part of the

 3 discussion is to inform that record. So those who

 4 believe they might have missed it, there's still

 5 time.

 6 Caitlin, can we ask you to go next,

 7 please.

 8 MS. KLINE: Hi, thanks. Can you hear

 9 me? How is that?

 10 I appreciate the opportunity to discuss

 11 the concept release on automated trade

 12 environments. The release is ambitious in its

 13 attempt to catalog and consider the extent to

 14 which modern markets operate outside of existing

 15 regulatory frameworks. And these were designed to

 16 oversee markets that were operationally distinct

 17 in every meaningful way from our current

 18 marketplace. And the release focuses on the value

 19 of prescribing a definition of high-frequency

 20 trading as independent from other automated

 21 systems.

 22 And we see a value in a holistic
 155

 1 definition, particularly in its ability to

 2 identify firms for registration with the

 3 Commission and bring them under regulatory

 4 oversight, but it's equally important to

 5 reconsider the way we think about related trading

 6 practices in the context of automated markets

 7 since they, too, were defined with a manual market

 8 in mind. And specifically, reconsidering the

 9 conventional understandings of market making and

 10 liquidity provision, stability, and front running,

 11 and whether current market definitions of these

 12 practices continue to be applicable in a

 13 high-speed algorithmic environment. With respect

 14 to liquidity provision, true liquidity is a

 15 difficult concept to meaningfully quantify, but

 16 generally there's agreement about certain features

 17 of liquid markets in practice, like market depth

 18 and tradeable bids and offers and prices and

 19 spreads that are reflective of market risks.

 20 Without a doubt high-frequency traders almost by

 21 definition create tremendous volume in their

 22 markets, but volume on its own is of course not
 156

 1 equivalent to liquidity.

 2 For example, to the extent that an HFT

 3 programatically retreats when market activity

 4 falls, it doesn't provide useful liquidity to

 5 the market. So to the extent that an ATF works to

 6 demonstrate tight bid offers, but uses its speed

 7 to avoid execution at the bid of the offer or

 8 moves its tight bid offer away from a detected

 9 flow, it doesn't provide useful liquidity. And to

 10 the extent that a strategy amounts to penny

 11 jumping, rebate harvesting, quote stuffing, churning,

 12 spoofing, layering, hanging, order book feeding;

 13 it doesn't provide useful liquidity and it's

 14 almost certainly abusive.

 15 With respect to stability it's important

 16 to note that while the market's understanding of

 17 what constitutes short term may have decreased

 18 significantly in recent years, but it's

 19 understanding of long term with respect to

 20 investors hasn't changed. And it's unclear how a

 21 market where average holding times are measured in

 22 seconds, provides a stable platform the allocation
 157

 1 of capital.

 2 Importantly, the potential for

 3 dislocations to propagate rapidly between

 4 unrelated markets suggests that our current market

 5 structure might not, in fact, be able to provide

 6 stability for our current market activity. And

 7 the sheer level of complexity in the release

 8 speaks to the possibility that retrofitting an

 9 antiquated marketplace with adequate risk

 10 controls, to the extent that it's possible to

 11 responsibly do so, could far exceed the cost of

 12 redesign.

 13 Finally, with respect to front running,

 14 the conventional understanding of front running

 15 encompasses a broker positioning himself to profit

 16 from information that he has yet to be given to

 17 his clients. In the context of manual markets,

 18 that nonpublic information is thought of as other

 19 client flows or research, but in all cases it's

 20 using advanced knowledge of market information to

 21 profit from your clients.

 22 When HFTs receive and digest market
 158

 1 information many times faster than investors, they

 2 effectively are able to see the future. And in

 3 most meaningful ways, latency arbitrage often

 4 amounts to programmatic front running. And of

 5 course it would be correct to argue that these

 6 aren't technically front running when applying an

 7 outdated understanding of it, but it's unclear how

 8 many of these high-speed strategies are not

 9 functionally front running.

 10 With respect to the release, the crucial

 11 point to note is that these types of modern front

 12 running behavior can't be caught by looking at

 13 trade data alone. Bids, offers, and crucially

 14 order cancellations would all be required to

 15 reconstruct a manipulative trading pattern. And

 16 as the release shows, many of the issues are

 17 pretty complicated when we're looking at automated

 18 markets. But strategies that amount to illegal

 19 manipulation when performed over the course of

 20 minutes or hours, should be permitted -- should be

 21 prohibited when they take place within

 22 milliseconds as well. And practices that are
 159

 1 illegal when performed by humans, should be

 2 equally illegal when done by computers. And if

 3 their regulatory framework isn't able to

 4 effectively account for these, then there is an

 5 urgent need to adapt the rulebook to match the

 6 playing field.

 7 One final note with regards to the

 8 question of what this release aims to achieve.

 9 The release asks a lot of important questions

 10 about how to approach new regulation, but it fails

 11 to ask whether the public does, in fact, continue

 12 to be served by millisecond increment increases in

 13 the speed of trading at potentially great systemic

 14 risk, or does the public continue to benefit from

 15 the slight narrowing of bid offer spreads in more

 16 volatile and less stable markets? It's critical

 17 that the Commission doesn't lose sight of the

 18 bigger picture when implementing important and

 19 urgently needed reforms. Thank you.

 20 CHAIRMAN O'MALIA: Thank you very much.

 21 Stuart, I guess we'll just go right down the line.

 22 Stuart Kaswell representing MFA.
 160

 1 MR. KASWELL: Thank you. I do have a

 2 PowerPoint. I don't know if this is set up, or if

 3 I should just go ahead and --

 4 CHAIRMAN O'MALIA: It should be set up.

 5 You can go back to the -- it should be preloaded

 6 on there, but maybe we can get our technology --

 7 if you reduce this screen, it should be loaded on

 8 the home page.

 9 MR. KASWELL: I can go without, but if

 10 it's here. Okay. So now that we've had the

 11 tryout for technology. Thank you very much,

 12 Chairman O'Malia and members of the TAC. Thank

 13 you very much for inviting me. I'm Stuart

 14 Kaswell, and I'm General Counsel of the Managed

 15 Funds Association. And with me today is my

 16 colleague, Jennifer Han, who is Associate General

 17 Counsel. We appreciate the opportunity to make

 18 comments today and to elaborate on our comment

 19 letter. We filed one of those painfully long

 20 letters, which I'm sure you enjoyed reading, but

 21 do very much appreciate the chance to make our

 22 comments to the Commission and to TAC.
 161

 1 MFA represents hedge funds, managed

 2 future funds, and fund to funds. Our members

 3 serve pensions, university endowments, and other

 4 institutions. Our members are active in the

 5 derivatives markets, so we have a strong interest

 6 in ensuring that the derivatives market's

 7 regulatory framework is robust and evolves to meet

 8 the needs of our investors. Okay.

 9 Yeah, there we go. Oh, okay, now I'm

 10 just going to keep clicking away? Yeah. Oops.

 11 You know what, I'm going to just keep going.

 12 Okay. Now we're on the technology page.

 13 Markets and technology have evolved

 14 together over centuries. Today's electronic

 15 trading platforms are simply the latest step in

 16 the evolution of markets. Technological

 17 developments have created more choices and lower

 18 costs for all market participants. MFA believes

 19 we should embrace these changes as positive. We

 20 should not fear technological developments any

 21 more we should fear the move from dial-up to

 22 high-speed Internet.
 162

 1 So we go to the next slide. If

 2 technological change is good, we must recognize

 3 that new technology has changed the risks we face.

 4 In the age of electronic markets, we believe it is

 5 more important than ever to ensure that there are

 6 appropriate risk controls and system safeguards in

 7 place. We believe, however, that it would be a

 8 mistake to frame the discussion of risk controls

 9 and system safeguards solely around automated

 10 trading, instead we really should focus on

 11 electronic trading. We note the SEC staff has

 12 found that old-fashioned human mistakes and not

 13 some HFT super computer have caused sudden

 14 price spikes or so-called mini flash

 15 crashes.

 16 We've reviewed the current safeguard --

 17 I'm sorry. We have reviewed the current framework

 18 for risk controls and system safeguards, and we

 19 have a few recommendations which I'll get to

 20 shortly. Generally we believe the CFTC already

 21 has adopted the right framework. The CFTC has

 22 rules requiring FCMs, swap dealers, MSPs, and SEFs
 163

 1 to have risk controls in place. We believe the

 2 regulatory --

 3 Okay, all right. I'm just going to keep

 4 going. We believe the regulatory framework best

 5 addressed and mitigates risk by, one, centralizing

 6 risk controls and system safeguards at the trading

 7 platform and intermediary levels and, two,

 8 requiring such entities to require real-time

 9 post-trade reports that market participants can

 10 use to enhance monitoring of their trading

 11 activities. This approach optimizes customer

 12 protection and market integrity, promoting

 13 responsible innovation and fair competition. It

 14 also would be consistent with the Commission's

 15 prior rulemaking.

 16 Trading platforms and other

 17 intermediaries are the gateways to trading

 18 activity. They're in the best position to block

 19 inappropriate or erroneous orders entered by

 20 customers. Market participants are customers that

 21 operate or use automated trading systems already

 22 employ various risk metrics and trading parameters
 164

 1 that are congruent with their trading and

 2 investment strategies. They have a strong self

 3 interest in ensuring that they have robust risk

 4 controls.

 5 Problems arise when a market

 6 participant's risk controls fail or experience a

 7 software malfunction. The most effective way to

 8 mitigate such risks is to require external

 9 real-time risk controls at the FCM, swap dealer, or

 10 MSP levels, and at the trading platform level.

 11 With this framework in mind, I'll now discuss some

 12 of MFA's recommendations.

 13 Generally, we believe trading platforms

 14 and intermediaries are in the best position to

 15 determine which pre-trade risk controls are

 16 necessary and appropriate. Intermediaries or

 17 trading platforms should manage and implement such

 18 controls because the controls need to be

 19 fine-tuned to market characteristics. They are in

 20 the best position to adapt and modify controls to

 21 ensure that the controls evolve with market

 22 practices and can avoid disruptions to orderly
 165

 1 markets.

 2 Nonetheless, we do have two specific

 3 recommendations. We believe that intermediaries

 4 or trading platforms should implement two crucial

 5 pre-risk -- pre-trade risk controls, maximum order

 6 size and credit risk limits. The maximum order

 7 size or fat-finger limit is the first. Manual or

 8 electronic traders are more prone to fat-finger

 9 errors than automated trading systems in which the

 10 size of an order is programmed as a parameter.

 11 Some FCMs already offer their customers fat-finger

 12 limit controls which allow customers to customize

 13 and set their preferred default levels, including

 14 order limits that apply to each individual direct

 15 order and so on. We believe all FCMs should offer

 16 such order size functionality to customers at the

 17 trader level.

 18 The second recommendation is credit risk

 19 limits. These are an effective pre-execution

 20 filter. And like maximum order limit controls,

 21 FCMs in the trading platforms should offer credit

 22 risk limit controls and work with customers and
 166

 1 members in agreeing to a maximum credit limit.

 2 Market participants employing automated trading

 3 systems build credit limits into their platforms

 4 and external control at an FCM trading platform

 5 would help mitigate a customer or member software

 6 malfunction.

 7 Another issue that the concept release

 8 raises is price collars and trading pauses. We

 9 believe price collars and trading pauses can be

 10 effective risk mitigation tools. Price collars

 11 have long been effective in the futures market.

 12 The benefits of price collars became especially

 13 apparent after the flash crash. And we've

 14 submitted comments to the SEC and others to

 15 implement a limit-up, limit-down mechanism.

 16 Interesting the joint CFTC-SEC Advisory Committee

 17 on emerging regulatory issues was not the first

 18 task force to recommend the implementation of a

 19 price collar.

 20 The presidential task force on market

 21 mechanisms created to investigate the October 19,

 22 1987, market crash recommended that across the
 167

 1 stocks, futures, and options markets there should

 2 be coordinated circuit breaker mechanisms such as

 3 price limits and trading halts. We believe

 4 trading platforms should coordinate price collars

 5 for linked equity products. With respect to

 6 trading pauses that since the equity markets have

 7 adopted circuit breakers, we believe it's

 8 important to consider whether a related

 9 exchange-traded derivative product should also be

 10 paused or halted from trading.

 11 Regarding post-trade reports, we

 12 recommend the CFTC should amend and broaden its

 13 regulation to require real-time post-trade reports.

 14 These reports would allow customers independently

 15 to confirm orders and trades sent to their FCMs

 16 and to confirm their overall positions, assist

 17 with the clearing firm's ability to assess

 18 customer risk, and potentially mitigate the impact

 19 of malfunctioning pre-trade risk controls or

 20 algorithms. By comparison, when I shop online, I

 21 immediately get a confirm that says what I bought

 22 and can tell me how to track it on FedEx. We
 168

 1 think that the CFTC regulations could require

 2 something similar.

 3 On the -- oh, you're a little ahead of

 4 me. Okay. Trade cancellations and adjustment

 5 policies. One lesson from the flash crash is that

 6 uncertainty around marketplace trade cancellation

 7 and adjustment policies likely contributed to

 8 market participant’s confusion. We believe it's

 9 imperative that trading platforms have clear and

 10 objective trade cancellation and adjustment

 11 policies that limit administration discretion and

 12 instill accountability. Especially in terms of

 13 market distress, rules need to be predictable.

 14 Next, I move to kill switches. As a

 15 system safeguard, we believe that market

 16 participants operating in ATS trading platforms

 17 and even the market participant's clearing firm

 18 should each have the capability to disconnect the

 19 ATS from trading platforms in the event that a

 20 software glitch or some other unforeseen reason makes it

 21 necessary. Although trading platforms should have

 22 clear objective, policies, and procedures
 169

 1 detailing circumstances that warrant the use of a

 2 kill switch; we also believe they should have some

 3 flexibility in using it based on experience with

 4 the trading style or strategies of each market

 5 participant or instruction by the market

 6 participant at issue.

 7 Moreover, if a trading platform is aware

 8 of a critical ATS systems issue, it should have a

 9 responsibility to disconnect it, to protect market

 10 participants, market integrity, and the public in

 11 general.

 12 Regarding design and testing and

 13 supervision, we support a more robust and more

 14 routine testing of trading software. Trading

 15 platforms should offer market participants and

 16 intermediaries the ability to test their automated

 17 trading systems with trading platform software.

 18 Trading platforms also should offer integrated or

 19 holistic testing where a firm's software interacts

 20 with others. As an aside we note, and I know

 21 we're getting to SEFs at another time, but we

 22 question whether the accelerated implementation of
 170

 1 mandatory SEF trading provides the appropriate

 2 time for testing with respect to ATSs.

 3 We would caution against a

 4 one-size-fits-all approach. Policies and

 5 procedures for market utilities or service

 6 providers may not be appropriate or effective for

 7 market participants or customers with respect to

 8 the testing programs.

 9 I have a couple of final comments to

 10 wrap up. On minimum resting periods, we don't

 11 support these because they would reduce the

 12 ability of market participants to react to

 13 changing market conditions and make them

 14 susceptible to having orders that become stale and

 15 get picked off. We think that would overall hurt

 16 market liquidity and market participation. I

 17 would note that EU, policymakers, have decided

 18 against a 500 millisecond resting period in Mifid

 19 II.

 20 Regarding high-frequency trading on HFT,

 21 we believe that a new definition would not be the

 22 effective way to go. We think that technology,
 171

 1 technological means are the best ways to address

 2 technological challenges. We think that market

 3 manipulation is illegal and we shouldn't tolerate

 4 it whether it's committed electronically or with

 5 carbon paper, but we urge technology to address

 6 these challenges.

 7 Thank you for the opportunity to present

 8 our views. I appreciate the assistance of MFA's

 9 trading and markets committee and my colleague,

 10 Jen Han, who tried mightily to make the PowerPoint

 11 work.

 12 CHAIRMAN O'MALIA: Thank you very much.

 13 So, Eric, you're going to go next.

 14 MR. BUDISH: Yes.

 15 MR. KASWELL: Maybe you'll have better

 16 luck.

 17 MR. BUDISH: Yeah.

 18 MR. KASWELL: We'll see. I'll trade

 19 with you.

 20 MR. BUDISH: Oh, thanks. Great well,

 21 thank you very much. Eric Budish from the

 22 University of Chicago. Commissioner O'Malia,
 172

 1 distinguished committee members, thank you very

 2 much for the opportunity to present my research.

 3 It's a great honor. This is joint work with Peter

 4 Cramton at the University of Maryland and John

 5 Shim also at the University of Chicago. We hope

 6 our work will be a useful input into your policy

 7 debate on automated trading.

 8 The concept release is quite broad. We

 9 focus our research on the arms race for speed

 10 because it is the root cause of many of the issues

 11 and the concerns raised in the release. I want to

 12 start with an example that will be familiar to

 13 many in this room, which illustrates the

 14 high-frequency trading arms race. In 2010, a firm

 15 called Spread Networks invested 300 million

 16 dollars to dig a high-speed fiber optic cable from

 17 New York City to Chicago, and the salient feature

 18 of this cable was that it was dug in a relatively

 19 straight line. The straightness shaved round-trip data

 20 transmission time from 16 milliseconds to 13

 21 milliseconds. And three milliseconds doesn't

 22 sound like much relative to the speed at which the
 173

 1 economy evolves. Just to put in context, blinking

 2 your eye takes 400 milliseconds.

 3 Industry observers called three

 4 milliseconds an eternity. The joke at the time

 5 was that the next innovation would be to dig a

 6 tunnel so it will go through the earth rather than

 7 around the earth to further shave data

 8 transmission time. And that joke isn't funny

 9 to Spread at least, because their cable is already

 10 obsolete. Not due to tunnels, but microwaves.

 11 First 10 milliseconds, then 9 milliseconds. The

 12 state-of-the-art microwave connection between New

 13 York and Chicago is now at 8.5 milliseconds. And

 14 there are analogous races occurring sometimes

 15 measured in millionths or even billionths of

 16 seconds in various corners of the financial

 17 markets estimated at consuming billions of dollars

 18 a year in physical resources not to mention

 19 substantial human capital.

 20 We look at the high-frequency trading

 21 arms race from the perspective of market design.

 22 And what I mean by that is that we assume that
 174

 1 high-frequency trading firms are acting in their

 2 rational self-interest with respect to market

 3 rules as they're presently given, but we take

 4 seriously the possibility that we have the wrong

 5 rules in place. This approach gets us around the

 6 good versus evil debate which seems to dominate

 7 the public discussion of HFT and instead allows us

 8 to ask at a deeper level, what is it about market

 9 design that is incentivizing arms race behavior

 10 and is this market design optimal?

 11 Our central point is that the HFT arms

 12 race is a symptom of a basic flaw in modern

 13 financial market design, and that flaw is

 14 continuous time trading. We propose to make time

 15 discrete. More specifically, we propose to replace

 16 continuous limit order book trading with batch

 17 auctions conducted at frequent but discrete time

 18 intervals such as once per second or once per

 19 hundred milliseconds.

 20 I'm going to go through three years of

 21 work in about 15 minutes. So I ask you to bear

 22 with me if I sacrifice breadth -- if I sacrifice
 175

 1 depth for breadth and cover the material rather

 2 quickly. Let me go right into our argument.

 3 Our first set of results shows that

 4 continuous time markets don't work as expected in

 5 continuous time. This is a plot of the price

 6 paths over the course of a trading day for the two

 7 most liquid securities that track the S&P 500

 8 Index. The E-mini future which trades in Chicago

 9 on the CME and the Spider which trades in New York

 10 on the New York Stock Exchange and the various

 11 other equities exchanges. This is millisecond

 12 level data over the course of a full trading day.

 13 We use the same direct-feed data that

 14 high-frequency trading firms subscribe to.

 15 And over the course of a trading day,

 16 these two securities are very highly correlated as

 17 we'd expect. Here's an hour of data, again, the

 18 securities are very high correlated. A minute of

 19 data, again, very highly correlated. And this is

 20 what the market starts to look like when you zoom

 21 into high-frequency time scales. So this is a 250

 22 millisecond slice of the day. And what you start
 176

 1 to see when you zoom into high-frequency is that

 2 the correlation between assets falls apart. Price

 3 relationships that are implied by basic asset

 4 pricing theory fall apart when you zoom into high

 5 enough frequency.

 6 This is a fancy way of showing that this

 7 phenomenon isn't going away. On the right-hand

 8 side of the graph, we see that in each year of our

 9 data from 2005 to 2011, the market is getting

 10 faster in the sense of incorporating information

 11 from New York and Chicago prices and from Chicago

 12 into New York prices. And that shows up as the

 13 hundred millisecond correlation getting higher

 14 each year. But on the left-hand side of the graph, we

 15 see that in all years at high enough frequency,

 16 the correlation between assets is always

 17 approximately zero.

 18 So why does this correlation breakdown

 19 phenomenon matter? It matters because it creates

 20 purely technical arbitrage opportunities, which in

 21 turn creates an arms race to exploit these

 22 opportunities. For instance, when the price of ES
 177

 1 jumps and SPY hasn't reacted yet, there's a race

 2 to buy the cheap one and sell the expensive one.

 3 In this part of our paper, we use the CME

 4 and NYSE millisecond data to compute the

 5 arbitrage opportunity and look at how it evolves

 6 over time.

 7 The first thing we find is that the

 8 duration of these arbitrage opportunities has been

 9 declining dramatically over time. And in 2005,

 10 the median opportunity was in excess of 100

 11 milliseconds. By 2011, the median was less than 10

 12 milliseconds. And the right-hand side shows the

 13 distribution of arbitrage length duration by year,

 14 which is a more sophisticated way to show that the

 15 market is getting faster and faster.

 16 The profits for arbitrage opportunity;

 17 however, have stayed flat over time, they're not

 18 being competed away over time. And the frequency

 19 of arbitrage opportunities does fluctuate over

 20 time, but we find that this frequency is driven

 21 mostly by market volatility as opposed to market

 22 forces competing away the arbitrage. So to
 178

 1 summarize, competition does raise the bar for how

 2 fast you have to be to capture arbitrage

 3 opportunities, but competition does not eliminate

 4 the arbitrage or even reduce its total size.

 5 These results suggest that we should think of the

 6 arms race as a constant of the continuous limit

 7 order book market design. It's never going away

 8 as long as we have continuous markets.

 9 We calculate that the annual value of

 10 this one trade, ES-SPY is on the order of 75 million

 11 bucks a year. And of course this one trade is

 12 just the tip of the iceberg in the race for speed.

 13 There are many other trades that are very similar to

 14 ES-SPY, highly correlated, highly liquid. In

 15 equities markets fragmentation creates arbitrage

 16 opportunities that are even simpler than ES-SPY.

 17 You can arbitrage a security against itself.

 18 Three, there are statistical patterns that are

 19 subtler than ES-SPY, but still exploitable by HFT

 20 firms. And then, four, there's the race to the

 21 top of the book, which is an artifact of minimum

 22 tick sizes.
 179

 1 We don't want to put a precise dollar

 2 value on the prize in the arms race, but common

 3 sense extrapolation from our estimates suggest

 4 that the annual sums are substantial. So why do

 5 we care about the arms race? We show that the

 6 arms race ultimately harms liquidity. The key

 7 idea in our model is to ask, who are the profits

 8 in the arbitrage coming from. And we show that

 9 the profits ultimately come out of the pockets of

 10 liquidity providers which ultimately are passed on

 11 to real investors.

 12 So to see why, consider the race from a

 13 liquidity provider's perspective. Suppose there's

 14 some publically observable news event that causes

 15 my quotes to become stale. This can be a jump in

 16 the price of ES that causes quotes in SPY to be

 17 stale or something more dramatic like a Fed

 18 announcement. There's one of me trying to adjust

 19 my quotes to reflect the news. So I see the news

 20 event, send a message to the exchange to adjust my

 21 quote to reflect the news, but at the same time

 22 many other market participants see the news event
 180

 1 and try to pick off my stale quotes before I can

 2 adjust, so we have a race.

 3 And in a continuous limit order book,

 4 messages are processed one at a time and serial.

 5 And since we all have access to the same kinds of

 6 information and all use the same kinds of

 7 technology, liquidity providers frequently lose

 8 the race even if liquidity providers are just as

 9 fast as other market participants. So the

 10 takeaway is that in a continuous limit order book,

 11 any time there is public information, there's a

 12 race to respond. And this race ultimately comes

 13 out of the pocket of liquidity providers.

 14 This technical cost of providing

 15 liquidity, we show as incremental to the usual

 16 fundamental costs of providing liquidity such as 

 17 asymmetric information and inventory management.

 18 In a competitive market, picking-off costs get

 19 passed on to real investors via

 20 wider-than-necessary spreads or thinner markets.

 21 Ultimately, all of the dollars spent on the arms

 22 race come out of the pockets of investors.
 181

 1 Let me make a few additional remarks

 2 about our model. First, we show that the arms

 3 race is an equilibrium constant of the limit order

 4 book. It doesn't get competed away as speed

 5 technology improves. It doesn't matter whether

 6 speed technology -- speed advances are measured in

 7 seconds, milliseconds, microseconds, nanoseconds,

 8 et cetera. This tells us that the arms race isn't

 9 going away unless we change market design just

 10 like we saw in the empirics.

 11 Second, our model provides a useful

 12 conceptual insight into the role of high-frequency

 13 traders. In our analysis they perform two

 14 functions, a positive useful function, which is

 15 liquidity provision and price discovery, and a

 16 negative rent-seeking function, which is racing to

 17 pick off stale quotes. Frequent batching, our

 18 proposal is going to preserve the useful function,

 19 but eliminate the rent-seeking function of

 20 high-frequency trading.

 21 So I'm a Chicago guy and I have to ask

 22 the Chicago question, what exactly is the market
 182

 1 failure here? Isn't the arms race just healthy

 2 competition? So there are two answers to that

 3 question, at least two answers to this question.

 4 One is that our model highlights that

 5 high-frequency traders are stuck in a prisoners'

 6 dilemma. And the second answer, and I think this

 7 is especially interesting in light of this year's

 8 Nobel Prize to my colleague, Gene Fama, on the

 9 efficient market's hypothesis, is that our model

 10 shows that a violation of the week-form efficient

 11 market hypothesis is built into the continuous

 12 limit order book market design. It's an

 13 equilibrium feature of the market design that

 14 traders can make money from purely technical

 15 information. Markets are efficient in the short

 16 run, but they're not efficient in the extremely,

 17 extremely short run.

 18 The last part of our paper shows

 19 frequent batching is an attractive market design

 20 response to the HFT arms race. Changing it from a

 21 continuous time design to a discrete time design

 22 is a direct solution to the problems we've
 183

 1 identified with continuous time markets. What I

 2 mean by a frequent batch auction is that there's a

 3 discrete time interval, say one second or even 100

 4 milliseconds, during that batch interval traders

 5 submit bids and asks as price quantity pairs just

 6 like current limit orders; at the conclusion of

 7 the of batch interval, the exchange batches

 8 together all of the bids into a demand curve and

 9 all of the asks into the supply curve; if supply

 10 and demand intersect, then all transactions occur

 11 at the same market clearing price; if they don't

 12 intersect, no trade occurs.

 13 Information policy is that bids and asks

 14 are kept hidden during the batch interval and are

 15 reported to the public only after the auction is

 16 run. So this is analogous to current practice in

 17 the continuous limit order book in which I send a

 18 message to the exchange, it's processed by the

 19 exchange, and then the outcome is reported

 20 publically. An historical aside is uniform price

 21 auctions were invented by Milton Friedman,

 22 suggested in the 1960s that the Treasury adopt
 184

 1 them for bond options. They were subsequently

 2 adopted in the 1990s. This is, these are

 3 supply-and-demand curves. They either cross or

 4 they don't.

 5 There are two reasons why batching

 6 eliminates the arms race. One, is that batching

 7 reduces the value of a tiny speed advantage. If

 8 the batch interval is a second, then a one

 9 millisecond speed advantage is only one

 10 one-thousandth as useful as in the continuous

 11 market. Second, batching transforms competition

 12 on speed into competition on price. So for

 13 example, this past September the Fed made an

 14 important no taper announcement at 2:00, 20000.00

 15 p.m. In the continuous market there was a race to

 16 react and there was a controversy over whether the

 17 race was as fast as legally possible or faster

 18 than legally possible. In the batch market

 19 competition simply manifests in price competition.

 20 At the next batch auction a second later,

 21 competition simply drives price to its new correct

 22 level.
 185

 1 There are also important computational

 2 benefits to discrete time over continuous time.

 3 Conceptually the problem with continuous markets

 4 is that they implicitly assume that computers and

 5 communications technology are infinitely fast.

 6 Computers are very fast, but not infinitely so.

 7 And discrete time batching respects these limits.

 8 More concretely, there are important computational

 9 benefits for algorithmic traders, exchanges, and

 10 regulators. For algorithms, in the continuous

 11 time market, there's always a small amount of

 12 uncertainty about the current state and there's

 13 temptation to trade off code robustness for speed.

 14 In a discrete time market there's

 15 certainty about when I'll receive information,

 16 when others will receive information, and by when

 17 I have to make decisions. Everybody sees

 18 information from the time T-auction in time to

 19 make T-plus-one decisions, use information from the

 20 time T-plus-one auction in time to make T-plus-two

 21 decisions, et cetera. For exchanges, the

 22 continuous market creates a computational task
 186

 1 that is mathematically impossible. Latencies and

 2 backlog are inevitable, and subtle details about

 3 the order in which messages are processed can be

 4 economically meaningful.

 5 In the discrete market the computational

 6 task for exchanges becomes trivial. For the

 7 regulator in the continuous market, the audit

 8 trail is difficult to parse in one market, let

 9 alone across markets. Latencies make it difficult

 10 to figure out the basic order in which events

 11 occurred, as in the several months it took to

 12 piece together the sequence of events on the day

 13 -- on the day of the flash crash. In

 14 the discrete time market, the audit trail is much

 15 cleaner. Stuff happens at time T, at time T-plus-

 16 one, et cetera.

 17 So to summarize, frequent batching has

 18 several important benefits over continuous

 19 trading. It enhances liquidity, it puts an end

 20 to the arms race, and it has substantial

 21 computation benefits. The cost is that investors

 22 and trading firms have to wait until the end of
 187

 1 the batch interval to transact. And we can debate

 2 that whether waiting a second or a tenth of a

 3 second is a big cost or a little cost.

 4 Another cost is the potential for

 5 unintended consequences. One should always be

 6 humble and cautious when proposing a new market

 7 design, though we would also note that the

 8 continuous market has, itself, had numerous

 9 undesirable, unintended consequences. And that's

 10 part of why we're here today.

 11 So with that let me conclude. In a

 12 nutshell, we show that continuous time trading is

 13 a fiction. So you -- and it's a costly fiction.

 14 It induces an arms race that harms liquidity, is

 15 socially wasteful, and will never end as long as

 16 we have continuous trading. Discrete time trading

 17 stops the arms race, transforms the nature of

 18 competition. Competition on speed becomes

 19 competition on price. The incentive to be faster

 20 becomes an incentive to be smarter. And we

 21 preserve the useful function of HFT while reducing

 22 the rent-seeking function of HFT. And third,
 188

 1 discrete time trading is computationally

 2 realistic.

 3 We'd encourage the CFTC to carefully

 4 examine a move from continuous time trading to

 5 discrete time trading. Thank you again for

 6 your time and attention.

 7 CHAIRMAN O'MALIA: Thank you very much.

 8 We'll go to Rob Creamer. Do you have a

 9 PowerPoint?

 10 MR. CREAMER: No, I don't.

 11 CHAIRMAN O'MALIA: All right. Perfect.

 12 MR. CREAMER: So on behalf of the

 13 members of the FIA PTG, I'd like to thank the

 14 Commission and the members of the TAC for the

 15 opportunity to express our views here today. The

 16 FIA Principal Traders Group is composed of firms

 17 that trade their own capital on exchange traded

 18 markets. Our members engage in manual, automated,

 19 and hybrid methods of trading and are active in

 20 various, in a variety of asset classes, such as

 21 foreign exchange, commodities, fixed income, and

 22 equities. We are a critical source of liquidity
 189

 1 in the exchange traded markets allowing those who

 2 use markets to efficiently manage their business

 3 risks.

 4 The FIA, the FIA PTG, and the FIA

 5 European Principal Traders Association have been

 6 in the forefront of efforts to strengthen risk

 7 controls and system safeguards across the futures

 8 marketplace by identifying industry best practices

 9 with respect to risk controls that were to reduce

 10 the risk of market disruptions due to unauthorized

 11 access, software changes, system failures, and

 12 order entry errors. We observed that many of the

 13 safeguards discussed in the CFTC's concept release

 14 have been in place for many years and continue to

 15 be improved by the industry.

 16 Our system safeguards have suggested

 17 that, suggested in FIA and FIA PTG white papers

 18 that, go beyond the risk controls and safeguards

 19 discussed in the concept release. The FIA PTG

 20 supports the CFTC's efforts to improve market

 21 infrastructure through effective risk controls and

 22 system safeguards. As we've noted in the FIA's
 190

 1 response to the concept release, we believe that

 2 risk control requirements are most effective when

 3 they are principle-based. Any risk control that

 4 is overly prescriptive may quickly become obsolete

 5 as markets, technology, and trading strategies

 6 evolve and as a result may introduce rather than

 7 reduce risk.

 8 Although we believe the current

 9 infrastructure underlying the futures marketplace

 10 is very strong, FIA PTG member firms will continue

 11 to work further to strengthen that infrastructure.

 12 The FIA PTG stands ready to support the work of

 13 the CFTC, to better understand where it thinks

 14 improvements can be made. The FIA PTG supports

 15 efforts of the CFTC to use state-of-the-art

 16 technology to more effectively monitor markets and

 17 protect market participants from trading abuses.

 18 The FIA PTG believes that automated

 19 trading technology has provided many benefits to

 20 the overwhelming majority of futures market

 21 participants. Market quality metrics have been

 22 improved across the board as trading has become
 191

 1 more automated and competitive. Trading costs are

 2 lower, markets are deeper and more liquid,

 3 discrepancies in prices across related markets are

 4 reduced, and prices better reflect information

 5 about the value of commodities underlying futures

 6 contracts.

 7 The FIA PTG, therefore, believes that

 8 any regulatory effort to improve market

 9 infrastructure must at a minimum preserve the

 10 quality, market quality improvements that have

 11 occurred as markets have become more automated and

 12 competitive. If the CFTC determines that further

 13 regulation in this area is warranted, this

 14 determination should be supported by solid

 15 empirical evidence and rigorous economic analysis.

 16 The FIA PTG believes that in order to prevent

 17 market disruption due to a malfunctioning

 18 automated trading system, it is pre-trade risk

 19 controls, not credit controls, that should be

 20 used.

 21 Such controls can use various approaches

 22 and act on a very granular level to detect unusual
 192

 1 activity and to prevent unintended trading. We

 2 believe that kill switches if implemented and used

 3 properly can serve as an effective last-resort

 4 means of risk control, but stress that they are

 5 not a panacea and should only be used during

 6 extreme events when other courses of action have

 7 been exhausted.

 8 In a recent survey of FIA PTG firms

 9 showed that all responding firms indicated that

 10 they used some form of pre-trade maximum order

 11 size limits, data reasonability checks, messaging

 12 throttles, and self-trade prevention controls. In

 13 addition, all responding firms indicated that they

 14 were either using or considering using some form

 15 of drop-copy functionality to aid with risk

 16 management.

 17 The FIA PTG does not believe that a

 18 clear distinction can be made between

 19 high-frequency trading and automated trading. In

 20 fact, high-frequency trading, however defined, is

 21 a subset of automated trading and should not be

 22 used interchangeably with the term automated
 193

 1 trading or as a way to arbitrarily identify a type

 2 of market participant.

 3 The FIA PTG believes that instead of

 4 adopting a formal definition of high-frequency

 5 trading, the Commission's efforts would be better

 6 spent focusing on addressing potential risk of

 7 automated trading according to the principle that

 8 all market participants should be subject to

 9 risk controls. The FIA PTG supports a

 10 principles-based approach regarding registration,

 11 certification, and identification of automated

 12 trading systems.

 13 We believe that it should be left to the

 14 individual DCMs to define these policies for their

 15 market participants. U.S. DCMs have used their

 16 own rules regarding identification and

 17 registration of an ATS. Such rules are designed

 18 to allow the DCM to identify orders generated by

 19 automated trading systems and know the supervisor

 20 or supervisors behind these systems.

 21 We welcome the opportunity to discuss

 22 additional information the Commission may seek
 194

 1 regarding from the participants that is not

 2 already included in the DCM's audit trail. The

 3 FIA PTG believes that any type of market-moving

 4 data and statements produced by the Federal

 5 Government should be governed by processes and

 6 released through systems that ensure the accuracy

 7 of such data as well as guarantee a broad and

 8 timely delivery of that data to market

 9 participants.

 10 With respect to privately developed

 11 information, including information that may

 12 potentially move markets, we emphasize that this

 13 type of information is an important component of

 14 the price discovery process. We do not support

 15 government intervention into private enterprise in

 16 this context, but we do encourage transparency

 17 with respect to the policies and mechanics of

 18 information disclosure.

 19 I thank you for the opportunity to be

 20 here today.

 21 CHAIRMAN O'MALIA: Thank you very much,

 22 Rob. I'm going to recognize Richard Gorelick. He
 195

 1 asked to make some brief remarks. Any other TAC

 2 members, subcommittee members who wish to make

 3 opening remarks, just put up your tags, and I'll

 4 recognize you kind of in order.

 5 Richard.

 6 MR. GORELICK: Thank you very much,

 7 Commissioner. I'm Richard Gorelick, CEO of RGM

 8 Advisors, a principal trading firm based in

 9 Austin, Texas. I support the Commission's work on

 10 the concept release and appreciate the opportunity

 11 to participate in this important dialogue on the

 12 Technology Advisory Committee. I'm not here to

 13 defend the status quo. We can always do better,

 14 and we should always strive to improve the quality

 15 and resiliency of our markets.

 16 I've consistently supported a regulatory

 17 environment that promotes fair competition,

 18 encourages innovation, enhances transparency,

 19 manages systemic risk, lowers costs for investors

 20 and hedgers, and gives regulators the tools they

 21 need to detect and deter abuses.

 22 It's important to note that moves
 196

 1 towards open electronic centrally-cleared markets

 2 further these valuable objectives. In recent

 3 years computers have become ubiquitous,

 4 transforming everything we do, from our cars to

 5 phones to shopping, so too with financial markets.

 6 These changes have been broadly positive, but also

 7 unsettling for some. In the markets, computers,

 8 automation, competition, and indeed even

 9 high-frequency trading, whatever that is, have

 10 improved market quality saving investors and

 11 hedgers billions of dollars.

 12 The evidence also shows that as markets

 13 have gotten faster, market quality has improved.

 14 The evidence is clear and overwhelmingly positive,

 15 although some critics have tried to claim

 16 otherwise; but don't just take my word for it. I

 17 urge the Commission to make its own assessment of

 18 the record and not rely on partial readings and

 19 mischaracterizations. The evidence also shows

 20 that increasing automation, competition, and

 21 transparency have made markets on balance less

 22 risky and not more so. This may seem
 197

 1 counterintuitive to some.

 2 The media often reports on technology

 3 glitches disrupting our markets. All market

 4 participants, exchanges, trading firms, and

 5 clearing firms, have the responsibility to

 6 continually focus on ways to reduce different

 7 risks; however, we must not lose sight of the fact

 8 that crashes, panics, and trading errors have

 9 always occurred in the markets whether manual or

 10 electronic and our nation's exchange-traded

 11 centrally-cleared markets have proven to be

 12 remarkably resilient; therefore, any regulatory

 13 effort to improve market infrastructure should

 14 preserve the automation, competition, and

 15 transparency that have benefited investors and

 16 hedgers.

 17 The concept release, itself, creates a

 18 useful record of the many safeguards that have

 19 been put in place by the industry, often for many

 20 years and that continue to be improved on a

 21 continual basis. We appreciate the Commission's

 22 work in cataloging these important efforts.
 198

 1 I also urge the Commission to review

 2 results of the survey conducted by the FIA and

 3 submitted with its comment letter that shows that

 4 best practice risk controls are widely used by

 5 both proprietary trading firms and FCMs. Some

 6 might attempt to construe the concept release as

 7 being preoccupied with high-frequency trading,

 8 defining it, registering it, and singling it out

 9 for special scrutiny; but a better understanding

 10 shows that it's not about a narrow class of market

 11 participants at all. Electronic systems and

 12 automated trading are widespread and used by all

 13 classes of market participants.

 14 The evidence overwhelmingly shows that

 15 neither the flash crash nor recent high profile

 16 technology glitches were caused by HFT.

 17 Furthermore, there's simply no way to make a

 18 reasonable legal distinction between

 19 high-frequency trading and other forms of

 20 electronic trading. Rather regulators should

 21 focus on risk controls for, and surveillance of all,

 22 market participants, rather than just an arbitrary
 199

 1 subset. Risk controls should apply to everybody

 2 with market access regardless of latency,

 3 frequency, or the like. Why create loopholes?

 4 The markets are dynamic and constantly

 5 changing. So rather than codifying specific risk

 6 control practices, it would be far better to focus

 7 on key principles and standards of care. Hold

 8 market participants responsible for their conduct,

 9 but give them the flexibility to manage risks in

 10 ways that make the most sense. It might feel good

 11 to create checklists and rulebooks, but in

 12 reality that won't make markets safer or more

 13 resilient, it could instead create risky new

 14 distractions.

 15 The best way to stay on top of

 16 technology is to use technology. Commissioner

 17 O'Malia recognized this when he restarted this

 18 Technology Advisory Committee several years ago.

 19 Regulators need to know what's going on and should

 20 use computers to understand and surveil markets.

 21 In many ways electronic markets with their

 22 detailed electronic audit trails should make this
 200

 1 responsibility much easier. I applaud the

 2 progress regulators have made so far in this area

 3 such as the CFTC's work through this TAC.

 4 I'd also urge the CFTC to study the

 5 SEC's MIDAS system and website, which has enabled

 6 the SEC to investigate and share with the public

 7 information about activity in the securities

 8 markets. I recognize the funding challenges, but

 9 believe the CFTC should consider rolling out

 10 similar systems in the markets under its

 11 supervision.

 12 Criticizing HFT has become a cottage

 13 industry dedicated to putting forth frightening

 14 narratives that might make for good storytelling,

 15 but are not related to how markets

 16 actually work. I'm confident that the CFTC

 17 Commissioners and staff will see through fear

 18 mongering and hype; however, I am afraid that many

 19 members of the general public might be unduly

 20 alarmed and manipulated. I urge the CFTC, with

 21 the detailed audit trails and other resources

 22 available to it, to act as an expert agency, to
 201

 1 sanity check the claims of commenters and to

 2 report to the public what it actually sees going

 3 on in today's markets.

 4 There are many reasonable critiques of

 5 our markets today, and many ways to indeed improve

 6 them. I urge the Commission to use its expertise

 7 to encourage a rational evidence-based and

 8 constructive discussion of these important issues.

 9 Thank you.

 10 CHAIRMAN O'MALIA: Thank you, Richard.

 11 I think we'll just go down the line with Keith and

 12 Irene and then Chris, et cetera, and then start on

 13 this side.

 14 MR. FISHE: Sure, no problem. You know,

 15 it took me back, listening to some of the

 16 discussion that the panel presented, to when you

 17 first formed the subcommittee on automated and

 18 high-frequency trading, which I want to note was

 19 automated and high-frequency trading, because

 20 there's a lot of concepts that came up and were

 21 presented here and are on the public record and

 22 yet they come up over and over again and need to
 202

 1 be addressed. And one of those is the issue of,

 2 you know, what do automated trading firms do when

 3 they provide liquidity?

 4 And, you know, why does, you know, a

 5 firm potentially, like maybe a firm like mine, why

 6 do we withdraw our quotes sometimes? And

 7 sometimes we do, we do withdraw our quotes in the

 8 face of uncertainty. And we have no benefit to

 9 providing liquidity other than trying to

 10 participate in the market like everyone else. And

 11 when things are happening that we don't

 12 understand, you know, that's a potential loss for

 13 us.

 14 But one of the things that you said,

 15 Caitlin, that was really interesting was that, you

 16 know, an automated trading firm or HFT, as you

 17 called them, you know, detects a large order and

 18 they back away. Well, yes, you know, a large

 19 order has a potential price impact, and not

 20 knowing the potential size of that order is a risk

 21 that another market participant shouldn't take.

 22 And if they're going to be required to take it,
 203

 1 they should be compensated for that risk.

 2 Now in our markets there is no

 3 specialist. There is no firm that we're competing

 4 with that gets a special taxi token for being that

 5 liquidity provider. So the idea that they should

 6 stand there and get run over by a large order is

 7 just unfathomable to me in a competitive

 8 marketplace.

 9 The other thing I wanted to mention is

 10 the idea of, that you mentioned about blurring the

 11 legal definition of front running. That's

 12 something that actually did come up in our panel

 13 discussion over a year ago. You know, what is

 14 functional, as you call it, functional front

 15 running? And that's really, to me, what you've

 16 presented is a really dangerous concept that

 17 there's some line we can draw that somebody who

 18 processes information might be doing something

 19 wrong, but we don't know where that line is. They

 20 did it faster than somebody else, but we don't

 21 know how fast is too fast; and we're going to be,

 22 we're going to arbitrarily and potentially
 204

 1 capriciously determine that they did something

 2 wrong. And that gets into an area of, you know,

 3 thought policing that I think, you know, would be

 4 a complete waste of time for the regulator.

 5 The other thing I wanted to mention, and

 6 just one small point in your presentation, Eric,

 7 is the, you put a slide up about the Spread

 8 Networks going from Chicago to New York and how

 9 much they invested and how microwave has

 10 supplanted them as a faster way of getting

 11 information. But one thing to remember in that is

 12 that that's not an issue for a single matching

 13 engine. That's an issue that information happens

 14 in New York and information happens in Chicago and

 15 people are trying to get that information from one

 16 geographic location to another as fast as they

 17 can. And no matter what methodology you change

 18 the matching engine to, people are still going to

 19 want to try to get that information from one

 20 geographic location to the other as fast as they

 21 can.

 22 So that, you know, that example, I don't
 205

 1 think necessarily justifies your case of changing

 2 the methodology, but I'll leave it at that.

 3 MS. ALDRIDGE: Thank you.

 4 CHAIRMAN O'MALIA: If you want to

 5 respond to that, but if not then we'll just keep

 6 going. Okay. Thank you.

 7 MS. ALDRIDGE: Thank you, Commissioner

 8 O'Malia. Thank you, the panel, distinguished

 9 panel for the opportunity to share my thoughts on

 10 this. I think this is a fascinating subject and I

 11 think this is fantastic that we're discussing this

 12 because this will undoubtedly stimulate further

 13 public discussion and hopefully eventually we'll

 14 reach a consensus on this issue at some point.

 15 My name is Irene Aldridge, and I run an

 16 HFT firm. And what I do as part of the HFT firm,

 17 I develop high-frequency trading models, as well

 18 as risk management systems, as well as market

 19 access systems and market execution systems. And

 20 my clients tend to be billion dollar hedge funds

 21 and broker-dealers and lately family offices.

 22 There are actually quite a few of them all of a
 206

 1 sudden interested in high-frequency trading. So

 2 much of my research, however, not only is devoted

 3 to developing the fastest most profitable

 4 high-frequency trading system, but also to

 5 promoting market stability and determining what

 6 construes the most optimal stable market and et

 7 cetera.

 8 And I actually tend to debate Eric

 9 almost every month, it seems like we cross paths

 10 all the time, so I'm quite familiar with his

 11 research. And I have a few points I'd like to

 12 address with him as well, but first I'd like to

 13 mention that I completely agree with the

 14 representatives of MFA and FIA in their opinion.

 15 But also I'd like to mention that there are two

 16 main points, I think, around which this discussion

 17 is structured. First of all, this is a technology

 18 issue, I think, as we all agree. And second, is

 19 that when we consider opinions of people and we

 20 should really consider the sources and the

 21 backgrounds from which these people come from who

 22 deliver their opinions. So I'll get to the latter
 207

 1 point shortly.

 2 But about the technology, so Eric has,

 3 first of all, brought up this interesting chart to

 4 show that at very high speed that correlations

 5 breakdown between financial instruments. So he

 6 showed two-pair, a pair of instruments that are,

 7 move in tandem over a relatively, I would say,

 8 medium-term horizon; but when you get into a

 9 really high-frequency, then this correlation

 10 breaks down. And basically the prices do not

 11 trend together, they kind of separate.

 12 So I would like to propose an analogy

 13 that Eric has already heard from me a number of

 14 times, but essentially consider an orange grower

 15 in North Carolina -- or not grower, forget it --

 16 an orange seller, okay, we'll just be very simple.

 17 So this orange seller in North Carolina all of a

 18 sudden goes to Florida for a vacation and

 19 discovers that oranges are cheaper in Florida.

 20 All right.

 21 So he puts his money down, he takes a

 22 risk, he hires a truck, he rushes to Florida with
 208

 1 his truck, he fills it up with oranges, he brings

 2 it back to North Carolina and he sells it at a

 3 profit; but he still provides lower prices to

 4 North Carolinian consumers because oranges are

 5 cheaper in Florida and he's making a little bit of

 6 a cut, but he's still delivering better value to

 7 North Carolina orange consumers than would be

 8 otherwise.

 9 So this is an example that's analogous

 10 to what high-frequency traders do in the market

 11 that Eric has shown us. So they detect very small

 12 changes, price discrepancies in the markets, and

 13 they take advantage of them. They buy and they

 14 sell, ultimately providing to consumers a lower

 15 more stable price across the board, but at the

 16 same time making profit on these very isolations. So

 17 the question is, what do we call these consumers,

 18 do we call them high-frequency traders or traders?

 19 Do we call them arms race people?

 20 I mean, you can call the North Carolina

 21 orange seller also an orange arms racer, in a way

 22 simply because he was the first one to find out
 209

 1 about the orange price discrepancy, he was the

 2 first one to think about hiring a truck, and he

 3 was the first one to drive these oranges to North

 4 Carolina and actually takes the price advantage

 5 and make some money off it. So do we call him an

 6 arms race dealer as actually Eric happened to call

 7 me in our previous discussion, or would you

 8 actually call him an entrepreneur, you know,

 9 somebody who is fulfilling his American dream and

 10 making the world a better place? So this is kind

 11 of obviously is subject to interpretation, but

 12 this is just one sour point.

 13 Now another point, I think another very

 14 striking thing that struck me about the data

 15 presented earlier this morning, the data on swaps

 16 from SDRs is that over the last five weeks, and

 17 I'm just talking five weeks of trading in SDRs

 18 that we were shown this morning by the Chief

 19 Economist of the CFTC, the data that's available

 20 on the public website, the CFTC under the, I

 21 believe, market trading information, something

 22 like that; what it shows there, that over the past
 210

 1 five weeks the volume, the aggregate volume of

 2 swaps traded in SDRs has stayed relatively

 3 constant. Okay. It has increased a little bit,

 4 but generally it was pretty flat; however, if you

 5 look at the number of trades, they have quintupled

 6 over the last five weeks. So the trades, I

 7 believe, they definitely have increased. I think

 8 the number was they increased fivefold over the

 9 past five weeks.

 10 So if you take, just do basic math, you

 11 take the same volume of trades, okay, and you

 12 divide them by five times more trades, okay, do

 13 you get higher size or lower size of trades on

 14 average? Lower size. You get at least five times

 15 lower size per trade. Okay. So you have, and

 16 because of this, you also have, well, as I just

 17 said, you have five times more trades coming

 18 through, so obviously they have to occur faster,

 19 right? So we're now, over the past five weeks

 20 since the SDRs have been in business in just five

 21 weeks of the data that we saw this morning, we

 22 have five times increase in the speed of the
 211

 1 markets, just this one particular market that's

 2 completely just been introduced and it's a test

 3 market, all right, it's clean. We can assume that

 4 there's zero manipulation going on simply because

 5 people have not yet figured out how to manipulate

 6 this market.

 7 So what I'm trying to get at is that

 8 this is a perfect test case of how technology

 9 works in markets. And what technology does, it

 10 basically increases the speed with which people

 11 trade. And that's what technology does, okay?

 12 And it's not only that I think that, it turns out

 13 that there is a host of research that's been

 14 generated over the past several decades in

 15 computer science and operations research of which

 16 unfortunately many of our financial colleagues are

 17 not aware.

 18 And I know, Eric, this paper that Eric

 19 presented, I think, was part of his PhD thesis.

 20 He just graduated last year. And the point is

 21 there is an amazing amount of research that has

 22 happened in the past 30 years that highlights, not
 212

 1 only studies the arms race and the implication of

 2 networks, of speed of data networks in various

 3 locales, okay, but also it definitively declares

 4 that there's no arms race in these situations.

 5 And just to give you the context of why

 6 this research originated and what was going on,

 7 similar issues were posed when Amazon was building

 8 networks, for example, to deliver faster

 9 information to its consumers or when other

 10 companies were investing, completely unrelated to

 11 finance, were investing millions, not billions of

 12 dollars, into building faster Internet speed

 13 access ways.

 14 And people were wondering -- the latest

 15 paper that I have in mind is dated 2003, it was

 16 published in 2003, so it probably started

 17 development in 1999, circa time; and the latest

 18 paper is, really the question is, is there any

 19 social value to continuing this process, something

 20 that Eric posed as well, and whether there is

 21 really any purpose for people to pay for advanced

 22 Internet when anybody can get it at the same speed
 213

 1 at the same price. And the definitive answer that

 2 that paper has produced is yes, there's an

 3 absolute, various -- and it's at Harrison Habib

 4 2003. So there is a definite reason why people

 5 should pay, why given their cost structure,

 6 obviously business, et cetera; but there is a

 7 definite reason why people should develop these

 8 networks, and there is social value in doing so.

 9 Okay. This is an example that's not directly

 10 related to the markets, but nevertheless a very

 11 fair example.

 12 Now another point is the solution that

 13 Eric proposed here has actually been implemented by

 14 the Boston Options Exchange, and it has been

 15 implemented since I believe 2003 if not 2005.

 16 Okay. So Eric did his PhD in Boston. And this

 17 company, which is also a Boston company, has

 18 actually encountered significant difficulties in

 19 implementing this model. And they have actually

 20 been running it for money over the past 10 years.

 21 Okay. And one of the interesting outcomes, well,

 22 they have very low levels of interest in their
 214

 1 products, but another one of the interesting

 2 things is that they're forced by their clients

 3 to continuously increase the speed of these mini

 4 auctions.

 5 So I think they started, I'm not sure

 6 what they started with, maybe one-second

 7 intervals, and then they went to one-tenth

 8 intervals, one-hundredth intervals, and another

 9 hundred millisecond intervals; and they're still,

 10 it's -- they're still not there yet. So they're

 11 being pushed by customers, by the marketplace into

 12 a continuous timeframe work. Okay. And it's not

 13 only, this Boston Options Exchange is not the only

 14 example. I mean, universally there were many,

 15 many models of different market systems including

 16 Singaporean Stock Exchange, et cetera, that tried

 17 all sorts of alternatives for their markets; and

 18 they all concluded that continuous time markets,

 19 the one we have today, is really the dominant

 20 model and it's the most practical one and

 21 therefore it's the best one that is there for the

 22 market. Okay. So --
 215

 1 CHAIRMAN O'MALIA: Irene, Irene.

 2 MS. ALDRIDGE: Yes. I'm wrapping it up.

 3 CHAIRMAN O'MALIA: Wrap it up.

 4 MS. ALDRIDGE: Sorry, sorry. Thank you.

 5 I get a little overenthusiastic about this. So

 6 the issue is basically these are my main points.

 7 Now on the last point I'd also like to mention

 8 that I have personally been offered money from an

 9 organization that sounds very academic and but

 10 really to write extremely negative research about

 11 high-frequency trading. And so I would like to

 12 ask Caitlin how she makes her money because it's

 13 not exactly clear to me. Thank you.

 14 MS. KLINE: Sorry. What is your

 15 question?

 16 MS. ALDRIDGE: How do you make money?

 17 MS. KLINE: How do I make money?

 18 MS. ALDRIDGE: Yes.

 19 MS. KLINE: I don't know. I don't

 20 understand what you're getting at.

 21 MS. ALDRIDGE: I'm just, what's your

 22 source of revenue?
 216

 1 MS. KLINE: At Better Markets?

 2 MS. ALDRIDGE: Yes.

 3 MS. KLINE: We have, we're a donation

 4 fund.

 5 MS. ALDRIDGE: Okay. Well, I was

 6 basically offered a similar situation and that's

 7 what I'm trying to say, that to write extremely

 8 negative research about high-frequency trading,

 9 which I obviously refused because I don't believe

 10 this is the way to do that, but to set up is

 11 essentially a similar organization. So that's --

 12 MS. KLINE: Wait. Can I ask what the --

 13 CHAIRMAN O'MALIA: Irene.

 14 MS. KLINE: -- what would the incentive

 15 be for someone to do that?

 16 CHAIRMAN O'MALIA: Let's, this is a --

 17 MS. ALDRIDGE: That's not --

 18 CHAIRMAN O'MALIA: -- little bit off

 19 topic. So let's --

 20 MS. ALDRIDGE: Sorry.

 21 CHAIRMAN O'MALIA: -- keep moving.

 22 MS. KLINE: Thank you.
 217

 1 CHAIRMAN O'MALIA: Chris.

 2 MR. CONCANNON: I'll try to keep my

 3 comments brief. The, you know, I was going to

 4 talk about an apple grower in Upstate New York and

 5 how that relates to -- [laughter.]

 6 First of all, I just want to thank the

 7 panelists. I think all of you did a fantastic

 8 job. These are not easy issues. They are complex

 9 issues. And I think to reiterate what Rich said

 10 was, this concept release is around risk controls.

 11 We're all going to debate the high-frequency

 12 trading debate. It will continue for years to

 13 come, it likely won't be solved; but when it comes

 14 to risk controls and protecting our market,

 15 there's some very basic things that we can do.

 16 And I think most people in the comments

 17 that I read, most of the comments supported

 18 mandated risk controls. So it's very simple,

 19 pre-trade controls mandated by the CFTC or

 20 exchanges, for that matter. We have the exchange

 21 credit controls that work phenomenally well and

 22 they have proven themselves over the years. And
 218

 1 then mandated post-trade controls. In that world

 2 where we have mandated pre-trade controls, credit

 3 controls by the exchanges, and post-trade

 4 controls; we're going to be in a much better place

 5 than we are today.

 6 I do think the comments around the batch

 7 market were interesting. I encourage you to go

 8 forth and build an exchange and try that model. I

 9 think there's a simpler solution to the socially

 10 wasteful behavior that we've all had, and that's,

 11 and I've been pressuring Brian Durkin on this

 12 proposal, and that's simply, if he could move to

 13 New Jersey, we would all be in a better place.

 14 Thank you.

 15 CHAIRMAN O'MALIA: So can I ask you, the

 16 crux of this whole concept release is really that,

 17 what are the appropriate -- if there are already

 18 controls in place at the industry level, right,

 19 CME, ICE have them at the exchange level; what

 20 does mandating them at the Federal level buy us?

 21 MR. CONCANNON: Well --

 22 CHAIRMAN O'MALIA: And especially, you
 219

 1 know, considering our rulemaking process, how

 2 nimble we are. Can you reflect on that?

 3 MR. CONCANNON: Sure. I mean, I think

 4 what it does buy you, I think that mandating

 5 pre-trade controls, so before an order enters the

 6 exchange system, it has been filtered for credit

 7 for a large order or a mispriced order, sort of

 8 some erroneous order, and there's a series of

 9 other checks that it can have; but having that

 10 mandate in place is that extra protection that

 11 even the credit controls of the exchange may not

 12 pick up. And the erroneous order is one where you

 13 can have a filter that does pick up those

 14 erroneous orders which obviously create disruption

 15 in our market.

 16 It could be mandated at the exchange

 17 level. Exchanges could have a rule that requires,

 18 before any participant physically connects to an

 19 exchange system, that they have pre-trade

 20 controls. And those pre-trade controls can be

 21 based on the activities of that participant and

 22 appropriate for those. So if it's a manual
 220

 1 trader, maybe they have oversized order

 2 protections and price protections. But mandating

 3 at the exchange level or at the CFTC level, I

 4 don't think it's that difficult, and I don't think

 5 you'll get that much industry pushback.

 6 CHAIRMAN O'MALIA: Greg.

 7 MR. WOOD: Thanks, Commissioner O'Malia.

 8 What I was actually, I was actually going to say a

 9 lot of the same stuff that's already been said,

 10 but the main thing I want to make a point is that

 11 as a co-author of the FIA response to the

 12 concept release, that document took into account,

 13 not just the thoughts and views of the Principal

 14 Traders Group, but also the FCMs and ultimately

 15 the views of our client base, which, you know, is

 16 increasingly using automated trading themselves

 17 and that's covering asset managers, investment

 18 managers, family offices are becoming more common

 19 now as people start opening up funds, corporates,

 20 et cetera.

 21 And there's a wide range of market

 22 participants with different trading objectives who
 221

 1 are increasingly using the same sort of tools that

 2 we're trying to classify here. And yeah, it's

 3 important to try and avoid defining participants

 4 without -- based on how they trade, but without

 5 looking at why they trade.

 6 So all of these market participants have

 7 a fundamental responsibility for implementing

 8 effective risk controls regarding the development

 9 and implementation and use of automated trading

 10 tools to ensure that the market integrity is

 11 protected. Now where the CFTC can help there,

 12 it's not by layering, sort of one-size-fits-all

 13 requirements around risk controls, but taking the

 14 principles approach that risk controls should be

 15 in place, and if there is a lapse or a failure,

 16 then someone should be penalized because they

 17 didn't have the appropriate controls in place, as

 18 opposed to mandating one type of control over

 19 another, whether it's current controls, fat-finger

 20 controls. All of those controls have parts to

 21 play in part of the process of protecting market

 22 integrity and the integrity of the participants.
 222

 1 Now one of the messages we've tried to

 2 get across throughout the life cycle of the

 3 subcommittee on automated trading and

 4 high-frequency trading is rather than focusing on

 5 types of trading activity, we feel regulatory

 6 emphasis should be on identifying and stopping

 7 disruptive or abusive trading practices. And as

 8 the markets have become increasingly technology

 9 focused, any advertent disruptive behavior due to

 10 technology failures should be understood and

 11 prevented for an increased focus on both risk and

 12 quality management at the user and/or provider of

 13 the technology and the people providing access to

 14 the markets well.

 15 So just in summary, you know, based on

 16 the feedback you get from the concept release, the

 17 FIA, you know, sort of welcomes the opportunity to

 18 work with the Commission to create a framework

 19 around automated trading environments that

 20 addresses the needs and concerns of all

 21 participants. And we would like to take the

 22 opportunity to help the Commission to craft rules
 223

 1 that are straight forward in their intention and

 2 unambiguous in their implementation. Thank you.

 3 CHAIRMAN O'MALIA: Larry.

 4 MR. TABB: I want to thank the panel.

 5 Very interesting ideas. I'm not necessarily sure

 6 I agree with all of them, but I think they are

 7 very interesting and thank you for presenting

 8 them. I generally agree pretty wholeheartedly

 9 with what Greg and Chris had said in terms of your

 10 discussion as to why should controls be

 11 implemented at the Commission level. My view is

 12 really more about consistency. And while the

 13 futures markets traditionally aren't that

 14 fragmented, depending upon how the SEF framework rolls

 15 out, you want to ensure that risk controls are

 16 implemented at least on a policy base horizontally

 17 and so that they can't be gamed or gotten around,

 18 that's my major issue. Thank you.

 19 CHAIRMAN O'MALIA: Wally.

 20 MR. TURBEVILLE: I've got a couple of

 21 things to say. First, having worked at Better

 22 Markets and now at Demos, I will assure the entire
 224

 1 audience that nobody works at either place for the

 2 money. [Laughter.]

 3 Right, Caitlin? Thank you, Professor.

 4 Oh, if he is a professor, you did graduate?

 5 MR. BUDISH: Yes, I did graduate.

 6 MR. TURBEVILLE: Good, that's good.

 7 [Laughter.] Thank you, Professor. Thank you,

 8 Professor, for pulling back the veil, if you will.

 9 So much of this discussion is based on

 10 ill-thought-through notions of what is liquidity,

 11 of what is technology, technology in the hands of

 12 market participants is not designed to make the

 13 marketplace efficient; it's designed to make the

 14 market participant efficient to make money often

 15 from inefficiencies in the marketplace. Thank you

 16 for suggesting that if, in fact, all of this,

 17 there's a class of activity that does, that costs

 18 society money, that doesn't cause society

 19 benefits, and definitionally is riskier, it

 20 creates risks that wouldn't exist if that activity

 21 didn't exist.

 22 What in the heck are we doing talking
 225

 1 about risk controls to try to avert a catastrophe

 2 when it costs us money every day? That's the

 3 point. And thank you for doing something. By the

 4 way, the most recent study that sort of catalogs

 5 all of the information about, all the

 6 positive studies supporting HFT was a professor

 7 named Charles Jones from Columbia University last

 8 year. And you should check out who paid for that

 9 study.

 10 But aside from all of that, let me just

 11 ask the professor a question. You say in your

 12 paper that the batch systems address the issue of

 13 what you call exchange processing anomaly and

 14 address the issue of incentives for sacrificing

 15 algorithm robustness in favor of speed. So both

 16 of those things are issues associated with risks

 17 at the exchange level or the infrastructure level

 18 and at the trader level.

 19 If that is the case, wouldn't under the

 20 kind of system that you're suggesting, which is

 21 definitionally something which views that a

 22 continuous order system, limit order system is one
 226

 1 in which speed actually matters and is valued

 2 inappropriately or not for the benefit of the

 3 public, so since those two things are addressed

 4 and in your suggestion, doesn't that suggest that

 5 slowing down the speeds changes the actual

 6 benefits and costs associated with any kind of

 7 system of sort of prophylactic measures to try to

 8 avoid the risk controls that we're talking about

 9 here.

 10 In other words, it changes the whole

 11 relationships of risk controls since it changes

 12 the risk relationships at both the exchange level

 13 and at the trader level. Is that true?

 14 MR. BUDISH: Thanks for the question.

 15 Let me do my best to address it. So our point is,

 16 I think some of the, there are some proposals in

 17 response -- there are some proposals that are

 18 covered in the concept release such as minimum

 19 resting times. And to my co-panelist, Stuart

 20 Kaswell's point during his discussion, we agree

 21 that minimum resting times are a bad idea, that to

 22 us -- so here's the metaphor I would use, the arms
 227

 1 race is like a fever that tells us that the

 2 underlying market design is sick.

 3 And there are some proposals that are

 4 like throwing the fever patient into a bucket of

 5 ice as a way to cure the fever. And our approach

 6 is to try to go at the underlying cause of racing

 7 behavior, which is continuous time trading. And

 8 we point out in the section of the paper that you

 9 referred to, that continuous time trading in

 10 addition to incentivizing, inducing a speed race

 11 which we show harms liquidity and it's wasteful,

 12 also continuous time trading is computationally

 13 unattractive.

 14 For exchanges, exchanges are put in a

 15 position where they're given a computationally

 16 task to perform. Algorithmic traders are put in a

 17 position where they are, they face an incentive to

 18 trade off code robustness for speed. And in a

 19 discrete time market -- and please keep in mind

 20 that we're proposing discrete time at extremely

 21 high-frequency. So if we run discrete time

 22 auctions once per hundred millisecond, there would
 228

 1 be 234,000 auctions per security per day. This

 2 would still be a market in which algorithmic

 3 traders or automated professional traders would

 4 continue to play a critical and fundamental role

 5 in price discovery and liquidity provision

 6 process.

 7 Our point though is that discrete time

 8 trading enables algorithms to better do their job.

 9 We're trying to preserve the useful function of

 10 automated professional traders, which is liquidity

 11 provision and price discovery and eliminate or

 12 reduce the rent-seeking function of automated

 13 professional traders, which is picking each other

 14 off in a race to pick off stale quotes.

 15 One other comment is that relocating the

 16 CME to New Jersey doesn't address the underlying

 17 problem, which is continuous time markets. It

 18 would make the problem harder for us to detect as

 19 academics. So our data is at the millisecond

 20 level, which is fine enough to detect arbitrage

 21 opportunities between New York and Chicago because

 22 these arbitrage opportunities last on the order of
 229

 1 8 to 10 milliseconds, whereas the analogous kinds

 2 of arbitrage opportunities that exist within

 3 equities markets occur at sub-millisecond levels.

 4 So there's just, there isn't data that we can

 5 obtain as academics that would allow us to do the

 6 same kind of work, but the conceptual point is the

 7 same.

 8 And just to give you, just to, you can

 9 see the correlation breakdown phenomenon in

 10 equities markets just like you can see in this

 11 Chicago-New York arbitrage, so the underlying

 12 failure of continuous markets is there, we just

 13 can't detect latency arbitrage in equities markets

 14 with the kind of data that's research available.

 15 CHAIRMAN O'MALIA: Cliff.

 16 MR. LEWIS: Mr. Commissioner, this has

 17 been a fun topic, and I won't thank anybody, but

 18 I'll make one general observation, one demagogic

 19 observation and then maybe one substantive

 20 observation. The general point is, I think it's

 21 very important to note that CFTC as one of the

 22 implementing agencies of Dodd-Frank is engaged in
 230

 1 a great enterprise. And that enterprise is to

 2 introduce to OTC markets the efficiency,

 3 transparency, liquidity characteristics, risk

 4 management characteristics which have been

 5 synonymous with, shall I say the Chicago, not New

 6 Jersey, markets. No dig against New Jersey.

 7 But the fact of the matter is, those

 8 markets were very resilient during the crisis.

 9 They were not a cause of the problem. They

 10 worked. Now there are alternative models, no

 11 question about it, in terms of how to run a

 12 market. Maybe the extreme example of that are

 13 what are euphemistically referred to as fixings,

 14 discontinuous, in theory, auctions; but like

 15 Libor, gold fixing, there are a variety of

 16 different approaches, alternatives to the Chicago

 17 model. I would just say that unfortunately the

 18 Dodd-Frank legislation has decided that the

 19 Chicago model is the better model.

 20 And one of the key principles that the

 21 CFTC has in that model is the idea of central

 22 limit order books, but, you know, I'm commending you
 231

 1 guys. So it's only appropriate that it's so

 2 farfetched that somebody would say CFTC has got it

 3 right. But the problem is as much as the CFTC has

 4 it right -- as is reflected in the Dodd-Frank

 5 legislation, this mixing of clearing and

 6 liquidity, this incredible democracy effect, which

 7 frankly is to introduce high-frequency traders in

 8 swaps to people that previously had no access to

 9 them. That's really what you're engaged in today.

 10 And it's exactly the right thing. Now we can show

 11 statistics about dysfunctional aspects of various

 12 markets and the continuation of arbitrage, but I

 13 would argue as we've said before, the principle

 14 problem here is not with the fact that CFTC has

 15 some problem, because I think you guys have it

 16 just right and I don't think you need to do

 17 anything more than what you're doing now.

 18 The problem is with the SEC, the reason why

 19 you see that arbitrage example is because Reg. MNS

 20 is nuts and it's obviously nuts. So I'm,

 21 apologies to people from the equity market world,

 22 the fact of the matter is, don't abandon what's
 232

 1 worked well for what hasn't worked. Keep with

 2 what's worked and keep reinforcing it. That was

 3 not yet my demagogic point. The one substantive

 4 point before I go completely demagogic is

 5 remember, too, that one of the basic principles of

 6 the futures is not that they're perfect surrogates

 7 for the underlying cash market, on the contrary,

 8 they're not.

 9 The idea is that they move in parallel

 10 and eventually converge. But the fact of the

 11 matter is that futures entail basis risk and

 12 because of that fact, there are opportunities to

 13 arbitrage. Indeed that's what makes the markets

 14 work. That's what makes the markets work

 15 particularly in agricultural commodities, which is

 16 where the CFTC first developed this framework, and

 17 extended it then to financial products.

 18 And now as I slide into purely

 19 demagogic, let's posit a world where the SEC,

 20 maybe the Fed, too, ruled, where the Chicago

 21 markets had not developed, where high-frequency

 22 traders had not taken up the mantle of what we
 233

 1 used to call scalpers or locals or market makers in the

 2 previous environment of the pit where Brian and I

 3 used to work, and instead we continued to operate

 4 where basically Wall Street got to decide the

 5 price of everything. Do we honestly think the buy-

 6 side would be better off in that environment? No.

 7 Now is my positing of sort of a

 8 manicky choice inappropriate? Of course it's

 9 inappropriate, but it's no more inappropriate than

 10 guys that go after high-frequency trading.

 11 CHAIRMAN O'MALIA: Chuck.

 12 MR. VICE: I'm not as eloquent as Cliff,

 13 but I'll try to make a couple of points anyway. I

 14 do think on the market structure point, there's a

 15 lot of benefits to the markets as they work today,

 16 continuous market as Cliff described some of that.

 17 I'm not -- I don't -- I'm not under the illusion

 18 that there's some panacea. There are merits to

 19 all markets. There're pros and cons. To an

 20 auction market, I mean, one of its cons is you

 21 don't, you have no pre-trade price discovery.

 22 That's what happens in dark pools and other
 234

 1 markets where you don't have resting bids and

 2 offers. So even in absence of transactions,

 3 people don’t have some indication of where

 4 value is in these markets.

 5 So we can debate the pros and cons of

 6 that endlessly. And I think, you know, to the

 7 extent that there are markets and market

 8 participants that prefer a different type of

 9 structure, there's an opportunity for an existing

 10 exchange or a new exchange or whoever it might be

 11 to meet that need. So I think that's something

 12 market evolution naturally addresses.

 13 More at the nuts and bolts level, as far

 14 as the whole HFT concept release, I think we've

 15 had an issue, I think a lot, there's a lot of good

 16 things on the table that are already being done by

 17 the exchanges and the FCMs and the principles,

 18 themselves. So the question really becomes, do we

 19 mandate that by law and do we require HFTs to

 20 register which begs the question of defining an

 21 HFT. And I think that's where we immediately

 22 start to have heartburn, because as operator of
 235

 1 an exchange, we see that continuous spectrum of

 2 automated trading.

 3 Yes, there are guys who invest in

 4 microwave and COLO and all of that, but then

 5 there's a whole gray area of people who have all

 6 types of automated trading algorithms that humans

 7 do not intervene that have various degrees of

 8 latency mitigation around them, some as simple as

 9 Excel spreadsheets, that from an operational risk

 10 standpoint of operating an exchange or from a

 11 market manipulation standpoint operating an

 12 exchange, we're just as concerned about things

 13 like layering, spoofing, runaway order messaging,

 14 all the same things that people talk about with

 15 regard to HFTs.

 16 As an exchange operator, we are just as

 17 much, or perhaps even more so, concerned with all

 18 of the customers from that standpoint. So, you

 19 know, we're not going to win any marks if we have

 20 a non-HFT create problems manipulating a market or

 21 creating operational risk and our defense is to

 22 say, well, they weren't an HFT and we prevent HFTs
 236

 1 from doing that. So from an exchange standpoint,

 2 irrespective of what definitions and rules may

 3 come out of this, we will continue to paint a same

 4 brush for all participants in terms of the risk

 5 controls that they will have to go through in the

 6 surveillance and compliance that they'll have to

 7 comply with.

 8 MR. DEWAAL: Thank you. Because there's

 9 a lot of repetitive statements here, I'm going to

 10 try not to be repetitive. I think the one thing

 11 we will all agree on at this session is that the

 12 folks who came in with certain views will leave

 13 this meeting with the same views, because I think

 14 this is a highly emotionally charged topic and at

 15 least regarding the, you know, the basic questions

 16 of the front end, what I call the front-end-type

 17 issues, I don't think there's going to be

 18 resolution among the members. I tend to put

 19 myself in the camp of folks which, who say that

 20 you shouldn't go after a particular type of

 21 trader. Problems are problems. Market offenses

 22 are market offenses. Front running is front
 237

 1 running. Fraud is fraud.

 2 That being said, and I, and the one

 3 thing that hasn't been mentioned is that since the

 4 last meeting of this Technology Advisory

 5 Committee, there hasn't been another example of an

 6 algorithm gone bad over in Korea. The Hanmag

 7 security situation, which has resulted in, what, I

 8 think about $48 million of loss and a hit to the

 9 guarantee fund there, so a lot of the FCMs are

 10 actually sharing the pain of the circumstances.

 11 I do think that, you know, if the

 12 emotionalism can be eliminated and people step

 13 back, you know, the one area where I think that

 14 really does deserve some attention is the

 15 algorithms gone bad and what kind of better

 16 controls and better thought needs to be isolated

 17 about there. But I also do have one question for

 18 the professor, because I'm a little struck about

 19 what I thought, by the way, was a very interesting

 20 intellectual conversation of another theory of a

 21 better market, you know, I'm regrettably probably

 22 not up to know whether it's good, bad, or
 238

 1 indifferent; but thinking about the Chicago

 2 market, what strikes me though is that most of the

 3 exchanges, in fact, all of the exchanges these

 4 days are for-profit institutions.

 5 And, you know, the debate about good

 6 liquidity, bad liquidity, you know, I'm a little

 7 confused, because if, in fact, the exchanges which

 8 are for-profit institutions are acting in their

 9 best interest, aren't they the ones who are best

 10 able to assess whether the markets, as contributed

 11 to by the algorithmic traders or the so-called

 12 high-frequency traders are good, bad, or

 13 indifferent, aren't -- the fact that they stand by

 14 the systems and they're for-profit, doesn't that

 15 suggest that they're operating in their own self

 16 interest in saying that the status quo is, in

 17 fact, okay, and the liquidity on the markets is

 18 generally okay?

 19 MR. BUDISH: Thanks. That's a very

 20 important question. So let me offer a few

 21 thoughts. So one thought is, before we get into

 22 the, I think the question you're getting at is, to
 239

 1 the extent that we're right that discrete time

 2 trading is a superior alternative to continuous

 3 time trading. And again, discrete time at very

 4 high frequencies, we're talking about discrete

 5 time faster than humans can perceive. If we're

 6 right that discrete time is a superior market

 7 design to continuous time, then your question is,

 8 is that something that market forces will discover

 9 on their own or is that something that requires a

 10 regulatory mandate or some blend, some regulatory

 11 push short of a mandate.

 12 And that's a hard question that I don't

 13 have a clear answer to, but stepping back, one

 14 thing we are trying to do with this paper is shift

 15 the debate of that -- there are a lot of ideas about

 16 high-frequency trading that we think are a bit

 17 muddled. And as I mentioned, a lot of the public

 18 discussion about high-frequency trading has this

 19 good versus evil flavor. And I took some

 20 criticism from the good camp and the evil camp

 21 over the course of these discussions and that's

 22 fine and expected and I'm used to it and have
 240

 1 thick skin. We're trying to refocus the debate on

 2 what we view as the core issue, which is

 3 continuous time trading versus discrete time

 4 trading.

 5 And a lot of the other market design

 6 proposals circulating, we think are

 7 non-constructive. Minimum resting times being one

 8 example. Message to trade ratios being another

 9 example. Tobin taxes being another example.

 10 Message taxes being another example. So there's a

 11 lot of muddled thinking about high-frequency

 12 trading which we're trying to clarify and help to

 13 refocus the discussion. So it's possible that

 14 we're right that exchanges will decide to do this

 15 on their own, but that will still be a useful

 16 input into their decision-making process and also

 17 into the public and the industry's understanding

 18 of the benefits of discrete time trading over

 19 continuous time trading.

 20 That said, the question is, how do we

 21 think about the question of whether market forces

 22 will get there on their own versus whether there's
 241

 1 a justification or a requirement for regulatory

 2 intervention. There are a few frictions, which

 3 even if we're right, might prevent market forces

 4 from reaching discrete time trading on their own.

 5 One friction is that markets involve coordination

 6 problems. Markets are a classic example of a

 7 business with network externalities.

 8 And setting up a new market design based

 9 on discrete time trading versus continuous time

 10 trading would have to bring on board market

 11 participants, investors, et cetera. So while I

 12 appreciate the suggestion that I should set up my

 13 own discrete time exchange, network effects is one

 14 serious obstacle to overcome.

 15 A second potential obstacle is just

 16 regulatory ambiguities. So on both the equities

 17 side and the futures side I've heard -- and I'm

 18 not a lawyer, I'm not a regulatory expert, this is

 19 just what I -- what I hear, there's certain

 20 ambiguities in current regulation that call into

 21 question whether it would be easy for an exchange

 22 to adopt frequent batch auctions on their own.
 242

 1 And so the topic of pre-trade transparency came

 2 up, that's an important topic. We think of the

 3 pre-trade transparency in a discrete time market

 4 as exactly analogous to the pre-trade transparency

 5 that exists in a continuous time market, but

 6 that's a regulatory ambiguity that would have to

 7 be clarified, and that might pose some risk to

 8 an exchange attempting to adopt discrete time

 9 auctions.

 10 And then the third potential friction is

 11 that there are interests in the current continuous

 12 time market structure. What we're proposing is

 13 not what economists call a parade on improvement.

 14 Moving from a continuous time market design to a

 15 discrete time market design does not universally

 16 benefit all participants in markets. Guys digging

 17 high speed fiber optic cables or microwaves would

 18 lose from this or building state-of-the-art

 19 microwaves would lose from this proposal.

 20 The high-frequency trading firms that

 21 I've spoken to have distinguished between

 22 research-based strategies and mechanical
 243

 1 strategies. And mechanical strategies being

 2 trading strategies that only are profitable if

 3 you're slightly faster than the competition to

 4 execute. Research strategies being strategies

 5 that are based on insights that others don't have.

 6 So think of the first category as speed, the

 7 second category as smarts. Speed-based strategies

 8 are no longer going to be profitable under this

 9 market structure, so that's another example of a

 10 potential loser from this proposal. Of course the

 11 smarts-based strategies would continue to

 12 flourish.

 13 So there are, that's a third source of

 14 friction. So again, a coordination problems,

 15 regulatory ambiguities, and then interests in the

 16 current market structure. But it may well be that

 17 exchanges decide to do this on their own one day.

 18 And we'll be patient.

 19 CHAIRMAN O'MALIA: Thank you. Brian,

 20 which will probably be the final word unless

 21 somebody has got something else to say.

 22 MR. DURKIN: So I'll try to be very,
 244

 1 very brief, but I'm going to go back to a comment

 2 that I made when the initial concept release came

 3 out. And I'm going to again compliment Sebastian

 4 for putting together a very comprehensive

 5 questionnaire that I think was very thought

 6 provoking for, you know, many of us that

 7 responded; but you know, the compliment is that it

 8 was labeled concept release and risk controls and

 9 system safeguards for automated trading

 10 environments. And, you know, this is something

 11 that the CFTC, and I think all of us sitting

 12 around this table need to take some pride in, in

 13 the context of the work that's been done over the

 14 course of the last three, three and a half years,

 15 Commissioner O'Malia and the team that has been

 16 put together here to look at these issues.

 17 And you know, when you take a step back

 18 and you see what has transpired between the

 19 efforts of the Technology Advisory Committee, the

 20 CFTC, the CFTC staff, FIA PTG, all of us working

 21 together as industry constituents to help this

 22 global marketplace that has evolved over the years
 245

 1 continue to grow, evolve, and operate with the

 2 highest degree of competence, integrity, and

 3 transparency.

 4 So when you take a look at what has been

 5 achieved in that regard, let's talk about some of

 6 these risk management protocols that have been

 7 adopted as a result of the fine work of your

 8 efforts and the team's efforts around this table.

 9 Many of the aspects of that report have been already well

 10 addressed in the context of risk management

 11 protocols, pre- and post-trade protocols,

 12 requirements and mandates by certain exchanges,

 13 ours being one of them, that you must utilize our

 14 credit controls in order to be able to do business

 15 on our exchange.

 16 Messaging policies, the ability to

 17 identify automated trading participants. Granular

 18 audit trails. You know, I have to address one

 19 more time when I hear about flash crash and the

 20 inability to reconstruct an audit trail, I happen

 21 to be the person that was responsible for doing it

 22 and getting this information to the CFTC before
 246

 1 midnight the night of the flash crash. And I can

 2 tell you that I was able to say down to the

 3 individual participant, down to the individual

 4 message, what transpired in the futures markets.

 5 Can't say the same for the other marketplaces.

 6 And so, you know, what I ask people to

 7 bear in mind as you get into a lot of this other

 8 discussion about high-frequency trading and

 9 whatnot, you know, I think the fundamental premise

 10 of what we've been talking about is having risk

 11 safeguards, adequate controls in place to be able

 12 to maintain the confidence, the integrity, the

 13 transparency, and the vibrancy of these markets.

 14 And I think that we've come an awfully

 15 long way to accomplishing all of those things.

 16 CHAIRMAN O'MALIA: Thank you. Let me

 17 make a comment. Since we started down this road

 18 of defining HFT and we have the subcommittee

 19 members here, it is interesting, Sebastian, I

 20 think you mentioned that five commenters said,

 21 don't need HFT definition at all and then the

 22 other four said you did; but as I recall reading
 247

 1 those, they were all saying, yeah, but you need to

 2 define all of the different threshold levels that

 3 the HFT group couldn't define because they are

 4 very either market or asset specific.

 5 So it is quite interesting that no

 6 matter what we say about HFT, it is tough to

 7 define and then most people kind of say, well,

 8 that's not relevant in this debate anyway. What

 9 you need is good robust controls or you need to,

 10 you know, to the professor's point and Caitlin's

 11 point, you know, get rid of latency, some of these

 12 arbitrage opportunities.

 13 So I appreciate everybody's hard work on

 14 the HFT definition. It seems as though it may not

 15 be as useful as we may have thought before.

 16 And, Professor, when you designate an

 17 HFT, do you have your own criteria or threshold

 18 level for what one is or isn't?

 19 MR. BUDISH: So no, we don't have a

 20 definition that I would propose to you. The

 21 distinction I would draw is between, I guess the

 22 conceptual distinction, I would call to your
 248

 1 attention, is between the information technology

 2 revolution on the one hand versus the speed race

 3 on the other hand. And to some of the commenters'

 4 point, there's substantial evidence that the

 5 information technology revolution has been a

 6 positive force in financial markets, my read of

 7 the academic literature is that there's

 8 substantial evidence that IT has been good for

 9 financial markets just as IT has been good

 10 throughout the economy; but there is evidence that

 11 the speed race, per se, has been beneficial, and

 12 particularly as we think of the last, the current

 13 kinds of speed increments that are currently in

 14 place.

 15 So we don't have a definition of

 16 high-frequency trading that we'd offer to you, but

 17 I would draw a distinction between automated

 18 trading using sophisticated computer technology,

 19 which we applaud and which the empirical record

 20 has kind of -- there's considerable empirical

 21 evidence that the technology in financial markets

 22 has been beneficial, and trading strategies that
 249

 1 are based on tiny speed advantages.

 2 And so it's that latter that we are

 3 trying -- we're trying to do with this discrete time

 4 proposal, reduce the profitability of trading

 5 strategies that are based purely on winning a

 6 race to react to information that many observe are

 7 at once. And so if -- those kinds of trading

 8 strategies are what I would lump together, but

 9 that's short of a definition you can use.

 10 CHAIRMAN O'MALIA: All right. Any other

 11 thoughts? We're a little, again, over time.

 12 Let's switch out the panels. We'll take like a

 13 10-minute break and be back in here. Thanks.

 14 Okay. Panel three, SEF execution

 15 facilities. We're going to focus a little bit on

 16 this made available for trade determination that

 17 we have coming up that obviously makes a big

 18 difference to these markets on the 15th. We have

 19 Vince McGonagle for a repeat performance, the

 20 Director of Market Oversight, and we'll explain

 21 kind of the Commission position right now. And

 22 then we have, what do we have, four other
 250

 1 participants to talk about package trades in the

 2 market, their impact to help us understand them

 3 trade by trade and some of the challenges, whether

 4 it's technical, operational, or jurisdictional.

 5 And then we have Scott Fitzpatrick to

 6 kind of remind us of MAT is not the only issue

 7 facing SEFs and that there are some other, a

 8 handful of issues that he's going to touch on, and

 9 then we're going to open for discussion. And we

 10 should be done about 8:00, 9:00 o’clock tonight.

 11 [Laughter.] So I apologize for running over, but

 12 we'll try to keep this tight. If your

 13 presentations can be tight, we'd greatly

 14 appreciate that. Thank you.

 15 Vince, all yours.

 16 MR. MCGONAGLE: Thank you. Good

 17 afternoon. What I'm going to discuss, I'll just

 18 briefly touch on the registration process, the

 19 made available for trading determinations, and the

 20 package roundtable that we have scheduled

 21 for Wednesday morning. And before I even

 22 get there, I think the first place to start
 251

 1 is to point out and thank the staff within the

 2 Division of Market Oversight and other divisions

 3 that, you know, were confronted with a pretty

 4 big burden in the Fall of 2013 during the time of

 5 government shutdown and then subsequent furloughs

 6 here within this Commission, but particularly, you

 7 know, stayed focused on the fact that we were

 8 looking at a temporary registration process for at

 9 the time was 19 SEFs and then applications for --

 10 or determinations, self-certification for

 11 contracts that have made available to trade

 12 mandate.

 13 And the teams have been working

 14 continuously evaluating, not only those

 15 determinations, but the issues that relate to a

 16 good and steady progression towards the transition

 17 to compliance with the trade execution

 18 requirements, which are currently starting on

 19 February 15th. So I very much appreciate the work

 20 of the staff and their ongoing work as we go

 21 through working on these issues and hopefully

 22 getting to an area of smooth transition in the
 252

 1 coming days and weeks.

 2 With respect to the MAT applications,

 3 the Commission received five made available to

 4 trade determinations via, which is part 40.6 of

 5 our rule, for certain interest rate swaps and

 6 certain credit default swaps. Four of the five

 7 MAT determinations have proceeded. There's one

 8 application for self-certification, which is open

 9 for a 90-day window pursuant to Commission rule,

 10 which will hit that window in the beginning part

 11 of March.

 12 The review process for a made available

 13 determination is fairly discrete. The staff are,

 14 or presentation rather requires that one of six

 15 factors for a SEF to meet under 37.10 or for a DCM

 16 38.12, those six factors are whether they are

 17 ready willing -- ready and willing buyers and

 18 sellers, frequency or size of transactions,

 19 trading volume, number and type of market

 20 participants, bid-ask spread, usual number of resting

 21 firm or indicative bids or offers. So the

 22 Commission's regulations require only one factor
 253

 1 to be considered on each of the MAT applications,

 2 their filings address multiple factors.

 3 The standard review with respect to the

 4 MAT determination process is to evaluate whether

 5 the filing is inconsistent with the Commission's

 6 regulations or the Commodity Exchange Act,

 7 otherwise the swap becomes subject to the trade

 8 execution requirement. The division upon receipt

 9 of the application stayed those applications for a

 10 period of 90 days citing the complexity of the

 11 questions presented. By staying the applications,

 12 that allowed there to be an open comment period,

 13 which was the mandatory time period for 30 days,

 14 approximately 20 comments were submitted with

 15 respect to the MAT applications.

 16 So at this part I want to touch just a

 17 little bit about process and the communications

 18 that we had with the, which staff had with the

 19 applicants, which was focused on, you know, we

 20 conducted our evaluation of consistency with the

 21 Act and regulations. We evaluated the comments

 22 that focused on those factors for determination,
 254

 1 one of those mandatory six factors. We also ask

 2 questions of the SEFs. And we particularly

 3 requested that those, that the SEFs respond to the

 4 comments, so that we were able to have a dialogue

 5 with the SEFs that took in questions or comments

 6 that we saw, but also incorporated those that came

 7 in through the public comment period, which was

 8 very important for us then to ensure that, to the

 9 extent that the public did have comments, that

 10 they filed those or got those to us in a timely

 11 manner as part of the process.

 12 The majority of the comments received by

 13 the Commission emphasized the need to limit the

 14 MAT determination to certain benchmark tenors. So

 15 there was some conversation or communication

 16 surrounding the scope of the products that were

 17 subject to self-certification. During the course

 18 of the Fall some of the certifications were

 19 revised, and the scope of those certifications

 20 were narrowed somewhat. There were several

 21 comments that we received that were sort of

 22 outside of the MAT process.
 255

 1 I know the Commissioner asked this

 2 morning about, sort of what determination we had

 3 in play with respect to how we evaluated the

 4 comments. I'm reading a little more into his

 5 question than what he, how he articulated it; but

 6 getting to the point of the division's obligation

 7 and the self-certification was very narrowly

 8 focused on whether the product as presented was

 9 one that could be self-certified. So questions

 10 that didn't relate to the six factors were not

 11 part of our, sort of internal process, although

 12 they informed the division operationally about how

 13 we should be looking at trading on these complexes

 14 and questions that we had about transition.

 15 And what I'm getting at is sort of

 16 questions surrounding whether there should be a

 17 phased-in implementation schedule, packaged

 18 transactions, which I'll touch on in a minute,

 19 operational concerns, whether the SEFs were in

 20 compliance or not in compliance with the rulebook

 21 obligations. And just stopping there for a

 22 second, as part of the temporary registration
 256

 1 process, the SEFs, of course, are obligated to

 2 ensure that their rules are in compliance with the

 3 Commodity Exchange Act and regulations.

 4 So starting February 15, we will begin

 5 the process of those interest rate and credit

 6 default swap products that are now subject to the

 7 trade execution mandate. Over the past several

 8 weeks we have been in communication, not only with

 9 those applicants who had products self-certified,

 10 but the other SEFs to the extent those SEFs are

 11 interested in also offering products that are

 12 subject to the trade execution requirement. So we

 13 are looking at operationally those SEFs who are

 14 indicating that they have the ability to trade the

 15 product set forth in the made available to trade

 16 determination.

 17 We then also are looking at this

 18 question concerning packages. And to be, and

 19 these words matter, sort of, you know, what is a

 20 package transaction definitionally is something

 21 that we'll talk about a little bit more on

 22 Wednesday, but looking at, you know, as presented
 257

 1 by various commenters in the application, where

 2 you see a grouping of transactions that involve

 3 two or more counterparties, two or more

 4 instruments, one of which will be subject to the

 5 made available to trade requirement, and as

 6 collected; that series of transactions are

 7 contingent, all components are contingent on the

 8 execution of each other.

 9 So loosely looking at that, loosely or

 10 specifically looking at those as sort of some

 11 guidelines for packages, the question presented to

 12 the Commission and to the division in particular

 13 is, how do we transition swaps that are going to

 14 be subject to the made available to trade

 15 determination onto SEF when there are products

 16 being traded or relationships that parties have

 17 entered into that will have multiple components?

 18 And I'm looking forward to having and

 19 hearing more about those issues today and as we

 20 get into the upcoming weeks. The division in,

 21 under the guidance of the Chairman, is looking at

 22 relief for surrounding packages for an interim
 258

 1 period so that we can get to transition over the

 2 course of the next few months and think

 3 thoughtfully about how we introduce those package

 4 transactions onto SEF. So some of the questions

 5 that we'll be talking about --

 6 ACTING CHAIRMAN WETJEN: Vince.

 7 MR. MCGONAGLE: Yeah.

 8 ACTING CHAIRMAN WETJEN: Maybe I'll just

 9 chime in right here.

 10 MR. MCGONAGLE: Sure.

 11 ACTING CHAIRMAN WETJEN: Sorry to

 12 interrupt. But we will release a letter later

 13 today with, along with a press release that

 14 provides some temporary relief in the manner that

 15 Vince generally described. So those transactions

 16 that include multiple component parts, including a

 17 swap subject to the mandate, will have relief from

 18 the mandate until May 15th. We'll continue

 19 sorting through this book today and then Wednesday

 20 at the roundtable to figure out a more thoughtful

 21 solution to these types of transactions, but as I

 22 said, we'll release the letter later today.
 259

 1 There's a few other things, too, we're

 2 going to do, one relates to making it clear that

 3 anonymous trading on the SEF will remain

 4 anonymous. And so we've done an interim final

 5 rule that addresses that, which is to say a party

 6 of a trade cannot learn the identity of a

 7 counterparty by accessing the trade repository.

 8 We're also going to provide guidance

 9 later today related to how consent to jurisdiction

 10 can be provided to the SEF. And then finally, I

 11 think it might already actually be in the website,

 12 but we're going to have a central location on the

 13 website that clearly identifies which instruments

 14 are subject to the mandate. There have been some

 15 questions after these press releases in response

 16 to the MAT submissions that have gone out as to

 17 which precise instruments, getting into some

 18 detail about terms, which ones are actually

 19 subject to the mandate. So in an effort to clear

 20 that up, we'll have a central place that where

 21 that information will be provided on the CFTC

 22 website.
 260

 1 So I thought it might be appropriate at

 2 this time to announce that to the group here, but

 3 look for those three different documents later

 4 today. And as I said, I think the website

 5 probably has information about the mandated swaps

 6 already. So --

 7 MR. LEWIS: Can I ask a question?

 8 ACTING CHAIRMAN WETJEN: Sure.

 9 MR. LEWIS: And is that envisioned a

 10 hard deadline or as one that could be extended

 11 further?

 12 ACTING CHAIRMAN WETJEN: Well, as I

 13 said, I think it allows us more time to figure out

 14 what to do or what the right approach is to these

 15 package transactions, and so it certainly doesn't

 16 foreclose additional action; but I don't want to

 17 predict one way or another exactly what we will do

 18 that week. We have some flexibility with that

 19 date, I think.

 20 MR. MCGONAGLE: Thank you, Mr. Chairman.

 21 And I also want to thank the Commission, too, for

 22 their input as we go through some of these
 261

 1 transitional issues, is particularly, you know,

 2 Commissioner O'Malia's office even in sort of

 3 discussing a game plan around packages and

 4 evaluating how we can build in some time on this

 5 front-end to consider, seriously consider these

 6 issues so that we're effective in our response,

 7 and the Chairman's leadership has been very much

 8 appreciated as well on all of the items that we're

 9 talking about here today and other issues yet to

 10 come out.

 11 On the panel for Wednesday, we've

 12 identified some areas, and then I'll stop in a

 13 couple of seconds. Clearing of package

 14 transactions, the execution, how to, you know, how

 15 do we stay focused on the required methods for

 16 execution as set forth in the SEF rule? There's

 17 been some question concerning whether or how we

 18 might use alternate methods for execution. What

 19 is a package transaction, sort of how it's

 20 defined. And this idea surrounding phasing.

 21 Phasing, you know, cleared versus uncleared

 22 products, products that might not otherwise be a
 262

 1 jurisdictional product, but are nonetheless in the

 2 real world dealt with in these package

 3 transactions.

 4 So we'll be looking for substantive

 5 feedback on these in a number of questions that

 6 the team have prepared and planned to have a very

 7 robust roundtable on Wednesday. Thanks.

 8 CHAIRMAN O'MALIA: That roundtable is

 9 10:00 a.m.? 9:00 a.m.?

 10 MR. MCGONAGLE: 9:00.

 11 CHAIRMAN O'MALIA: 9:00 a.m. Lots of

 12 witnesses?

 13 MR. MCGONAGLE: Lots of witnesses. We

 14 have about 16 witnesses, so we try to incorporate --

 15 what we're going to have is one table for three

 16 hours and so we can bounce, you know, certain

 17 questions off particular witnesses, but then have

 18 the panelists, you know, give input, even on those

 19 areas of course if they're not specifically

 20 directed, directed to answer. And we think that's

 21 a way given the time period that we have, would be

 22 the best way to facilitate a conversation.
 263

 1 ACTING CHAIRMAN WETJEN: I was just

 2 going to add one other quick thing. The purpose

 3 of all of these efforts I just mentioned before

 4 is, you know, we're trying to figure out what

 5 obstacles there are to SEF trading. We're trying

 6 to eliminate those where appropriate, because what

 7 we're trying to do here obviously is maximize the

 8 amount of trading that's happening on these

 9 facilities. And where it's appropriate to address

 10 something, even on a temporary basis that appears

 11 to us at the agency to be standing in the way and

 12 keeping people from wanting to trade on SEF or

 13 being able to trade on SEF, we want to address

 14 that and take away the reasons or excuses or

 15 whatever you want to call them that some folks

 16 might have for keeping their trading activity away

 17 from these regulated platforms.

 18 So I can't promise that we've addressed

 19 every last problem that might meet that criteria,

 20 but that's certainly been the goal and we'll

 21 continue working on other issues as they arise.

 22 CHAIRMAN O'MALIA: Thank you very much
 264

 1 for that. I definitely support the relief and

 2 have been working with the Chairman on this. At

 3 risk of making your roundtable moot, we actually

 4 have four witnesses here that will walk through

 5 and explain the challenges or hurdles. And to the

 6 Chairman's point, we do want onscreen trading, but

 7 I, you know, based on the comments we received and

 8 with all due respect to your characterization of

 9 how we came up with the MAT, you know, what we can

 10 and cannot consider in the MAT determination, you

 11 know, it is important we consider some of the

 12 technical, operational, and as you pointed out,

 13 jurisdictional concerns.

 14 And I believe once we kind of identify

 15 the packages and their different attributes and

 16 the individual challenges facing each one of them,

 17 I think we can tick off, you know, over time and

 18 with the appropriate, you know, certainty in the

 19 market on timetables or investments or technology

 20 requirements that we should be able to take care

 21 of these things and bring them on screen as soon

 22 as possible. How you MAT a non-jurisdictional
 265

 1 product is going to be interesting. I hope the

 2 SEC will be there, shed a little light on what

 3 they feel like, but I think the market is already

 4 solved for that, we can, whether it's MATed or

 5 not, but they can certainly trade these things as

 6 packages and do so quickly and achieve the price

 7 transparency on screen and clearing.

 8 Whether, how we get to the absolute

 9 strictures of MAT will be interesting, but let me

 10 just start, we're going to go, actually I think

 11 we're going to start with Sunil, and then we'll go

 12 with Stephen, Alex, and Mark, and then save Mr.

 13 Fitzpatrick for last there for the new issues.

 14 MR. HIRANI: Scott, if it's okay,

 15 Stephen can go first, he's going to do some

 16 foundational work.

 17 CHAIRMAN O'MALIA: Okay. Never mind

 18 then, ignore the Chairman.

 19 MR. BERGER: Thank you. I did have a

 20 few slides. I don't know if there's a way to get

 21 them up, but okay.

 22 CHAIRMAN O'MALIA: They should be
 266

 1 preloaded. Yeah, there you go.

 2 MR. BERGER: All right, great. So I

 3 thought just for some level setting, I'd start

 4 with the definition of package transactions,

 5 provide a few examples, talk about the economic

 6 benefits we see to package transactions, provide a

 7 quick analysis of the representative transaction

 8 costs of being able to do some certain

 9 transactions as a package versus having to execute

 10 their components on an outright basis, talk about

 11 some of the items we feel we need to address, and

 12 then our recommendations.

 13 But I guess, you know, based on the news

 14 that we just heard, you know, I'd like to say that

 15 we're very grateful for the opportunity to have

 16 more time to flush out these issues, come up with

 17 solutions. We do share the overarching objective

 18 of moving these package transactions onto trading

 19 platforms where they can benefit from the pre- and

 20 post-trade transparency and greater competition

 21 that can be afforded. So, you know, we think it's

 22 a great first step that we have some more time to
 267

 1 think through the issues.

 2 So from a definitional perspective, you

 3 know, I think there's probably a more technical

 4 legal definition that's been laid out on some of

 5 the requests for no-action relief, but generally

 6 when we talk about package transactions, we're

 7 talking about a transaction that involves the

 8 simultaneous pricing and execution of two or more

 9 component instruments. For our purposes, one or

 10 more of those is a MAT swap and the others are

 11 either, another swap that's not MAT or a cash bond

 12 or futures contracts. The transactions are a

 13 combination of buys and sells or pairs and

 14 receivers on a swap. There's a reasonable degree

 15 of correlation between the components. And the

 16 risk of the offsetting components is approximately

 17 equivalent.

 18 And in that context we're talking about,

 19 in the rates market, we're talking about the

 20 interest rate risk, so we talk about these

 21 transactions as being DV01 neutral or duration

 22 neutral.
 268

 1 My comments today here are focused

 2 largely on the rates market, though, I think

 3 analogous, you know, analogies can be made in the

 4 credit markets. And I'll let others talk about

 5 that. So --

 6 CHAIRMAN O'MALIA: Stephen, could you

 7 pull that mic just a little closer.

 8 MR. BERGER: Sure thing. Sorry. Is

 9 that better? Okay.

 10 So some common examples of package

 11 transactions in the rates market, I've listed

 12 here, I won't read them all, but you can kind of

 13 bucket them. There's multi-swap package

 14 transactions, so that's the curves and the

 15 butterflies, so where you're executing a number of

 16 clearable swaps. There's swaps versus securities,

 17 so swap spreads or MBS basis where you're

 18 executing a swap against a government bond or an

 19 agency security. There's swaps versus futures.

 20 So an invoice spread, for example, is a swap

 21 versus a T-note future. And then the last is what

 22 I'd call a cleared swap versus an uncleared swap.
 269

 1 So something like a swap versus a swaption. And

 2 that's the Delta neutral option packages at the

 3 bottom.

 4 Being able to execute package

 5 transactions as a package has a number of benefits

 6 for market participants; you get a tighter bid

 7 offer spread, you only have to cross that bid

 8 offer spread one time versus having to cross it

 9 multiple times if you had to do separate leg by

 10 leg execution, you get more targeted and efficient

 11 risk transfer, and you eliminate the legging risk,

 12 which is the risk that the market moves between

 13 each of the individual executions.

 14 So what I'd like to say is that package

 15 transactions aren't some form of financial

 16 alchemy, they actually do deliver real benefits to

 17 market participants and they're commonly traded

 18 and they're kind of a crucial mechanism for the

 19 global risk transfer system. I don't want to bore

 20 people with the details, but you know, we've done

 21 some analysis here to look at what the

 22 representative transaction costs would be if
 270

 1 you're able to execute a package transaction or if

 2 you're forced to split up the execution of legs on

 3 an outright basis. So the next two slides is an

 4 example of a swap spread, which is a swap versus a

 5 Treasury. And after that a swap curve, which is

 6 two different swaps at different tenors.

 7 And what we found, you know, using real

 8 prices that were quoted in the market is that the

 9 cost of executing the two legs separately on an

 10 outright basis is triple. So you functionally

 11 triple transaction costs if you break up the

 12 simultaneous and contingent execution. So that

 13 kind of brings us to what we believe is the

 14 threshold point, which is that we don't want to

 15 break up the simultaneous and contingent execution

 16 of a package transaction.

 17 So that bring us to the question of,

 18 well, if one leg of the package transaction is MAT

 19 and has to be executed on a SEF and the other

 20 isn't, what do we do about it? Can we get it all

 21 on the SEF or can we not? So as noted in the

 22 beginning we're not philosophically opposed to
 271

 1 moving package transactions onto SEFs. We see

 2 that there would be benefits to that. It's just

 3 not going to be ready by, I think as we all

 4 acknowledge now, by February 15th.

 5 And so what are the hurdles we have to

 6 overcome to get there? One of the first items to

 7 address that we saw was for multi-swap package

 8 transactions is there a communication protocol and

 9 an ability to do credit limit checking at the

 10 package level, and there doesn't appear to be

 11 today. When people execute a curve or a

 12 butterfly, those legs individually go down the

 13 execution to clearing workflow. And you can't do

 14 a pre-trade credit check at the package level, and

 15 the CCP, the clearinghouse, sees the legs come in

 16 individually; and so when they're looking at the

 17 risk that's presented, they don't appreciate that

 18 there's offsetting legs within that package

 19 transaction. So that's one item that we

 20 identified that needs to be addressed.

 21 For swap spreads, since you're executing

 22 a swap and a government bond separately, you want
 272

 1 an assurance that they're both going to

 2 clear/settle. We've also noted there appear to be

 3 some jurisdictional concerns about the trading of

 4 Treasuries on a CFTC regulated platform. So

 5 that's something that, again, taking some time to

 6 think through would be of benefit. Invoice

 7 spreads seem to pose another challenge because

 8 they involve two separately regulated products in

 9 a future and a swap. And something like a swap

 10 versus swaption, it appears that, you know, maybe

 11 we can look to a model that's existed in the

 12 futures space, which is the EFRP model for some

 13 kind of off SEF, ability to execute the MAT swap

 14 leg off SEF, but still subject to the rules of the

 15 SEF and still be able to then pair it with some,

 16 with a swaption.

 17 So our recommendations, we're first to

 18 do no harm. And again, that goes back to the

 19 threshold matter of not breaking up the execution

 20 of package as a whole. We think the industry is

 21 already, and some of the other panelists will

 22 probably talk about this in more detail, the
 273

 1 industry is already working to identify solutions.

 2 For example, the communication language around

 3 multi-swap package transactions. And we think, you

 4 know, with some constructive dialogue with the

 5 Commission, we can find solutions to address

 6 perhaps the jurisdictional issues or whether there

 7 could be an EFRP-style solution for swaps.

 8 And thankfully the last recommendation

 9 seems to have already been realized to some

 10 extent, and so providing a little more time to

 11 think through these issues will, I think, will be

 12 of benefit to the market. So thank you.

 13 MR. HIRANI: Scott, thanks for inviting

 14 us to this.

 15 This is obviously a topic that's near

 16 and dear to our heart, it's something that we've

 17 engaged the Commission about in the past. So, you

 18 know, I think Stephen covered the basic

 19 definitions, you know, of packages. And I think,

 20 you know, so it isn't, obviously the package is

 21 already taking place and those are similar to the

 22 ones that Stephen talked about. So packages are
 274

 1 obviously taking place in the marketplace.

 2 They're taking place, you know, either via RFQ or

 3 via spreadsheets or instant messages. So it isn't

 4 that packages are not taking place. So what's the

 5 issue? What's the issue with packages?

 6 The issue with packages is that you

 7 can't just look at it in the context of, am I able

 8 to trade it on a screen or not. The question that

 9 needs to be asked is, you know, does the

 10 infrastructure exist pre-trade, trade, and

 11 post-trade that can support the regulatory

 12 requirements and the compliance requirements that

 13 are required of all of us, you know, to trade

 14 these instruments. And as we think about it, you

 15 know, the complexity of a risk assessment

 16 processing protocols and standards increases, so

 17 does the legal and regulatory matters as you go

 18 from packages that are entirely composed of MAT

 19 instruments. So you have a package of greater

 20 than one, you know, package that has a greater

 21 than one MAT swaps.

 22 And then it becomes more complex. You
 275

 1 have MAT swaps commingled with non-MAT swaps. And

 2 then you take it to a whole other level when you

 3 comingle cleared swaps that may or may not be MAT

 4 with uncleared swaps. And then you take it

 5 another level of complexity when you say, you have

 6 instruments that are swaps that are governed by

 7 this agency and then non-swaps that are governed

 8 by this agency, then to talk about swaps that are

 9 governed by this agency and other instruments that

 10 are governed by someone else besides the CFTC. So

 11 that's the way we think about the complexity of

 12 packages.

 13 So, you know, we have come here on

 14 numerous occasions to talk about, you know, the

 15 technology and infrastructure that trueEX has

 16 built for packages under our PTC products. So,

 17 you know, as we started interacting with FCMs,

 18 CCPs, buy-side firms, market makers, and credit

 19 hubs, you know, it came to our attention that

 20 there was actually not a single protocol or a

 21 language to describe these packages. So the way

 22 they're currently done is you could have a buy-side
 276

 1 firm that has a package of a hundred line items and each

 2 of those hundred line items, you know, are sent to

 3 this CCP, are sent to the FCM one by one and

 4 there's no intelligence that surrounds the package

 5 that communicates to everybody who needs to touch

 6 it, whether it's the FCM, you know, for pre-trade

 7 credit checks, CCP for clearing it and doing the

 8 risk assessments, or the credit hubs in the future

 9 to subtract the credit limits; they don't have an

 10 infrastructure that can process them as one atomic

 11 unit.

 12 They process them in a linear fashion.

 13 And we already know anecdotally in the marketplace

 14 that numerous large buy-side firms have had

 15 issues, operational issues with the FCMs, those,

 16 you know, an example might be the first, the first

 17 line item you sent, you know, is a trillion

 18 dollars pay fixed in 30 years, and the remaining

 19 99 line items, you know, in essence diffuse that

 20 risk. So you send the first line item, and for

 21 whatever reason, the other 99 don't get processed

 22 immediately, so it has a real impact on risk
 277

 1 margin and the credit profile of the parties that

 2 are involved.

 3 And neither of the credit hubs have the

 4 ability to do pre-trade credit checks in aggregate

 5 for the package. And the processing at the CCPs,

 6 they can process them one at a time, but as I

 7 said, it doesn't exist to do them as one unit.

 8 And the regulatory framework does not exist,

 9 doesn't recognize packages, and doesn't exist to

 10 accommodate the time that's required for pre-trade

 11 credit checks as well for the clearing from the

 12 CCPs. So that is what we feel is missing the in

 13 marketplace.

 14 So, you know, as Stephen alluded to, I

 15 think there's -- so what's a solution? So someone

 16 asked me before the panel, you know, that's great

 17 there's going to be relief, but what's the game

 18 plan? So the solution is that is there needs to

 19 be a common standard protocol, because it's not

 20 sufficient for one or some subset of the parties

 21 to agree to a protocol. And they need to agree to

 22 the protocol on how to describe the container, on
 278

 1 how to describe the packages; but to also agree to

 2 the workflow, to agree to the SEF / DCM workflow as

 3 well as a non-SEF workflow, and also to make sure

 4 that the next versions of FIX and FpML take into

 5 account the protocols that have been largely

 6 agreed to by, you know, a subset.

 7 And so there have been, there's been a

 8 group of folks including SEFs, FCMs, CCPs,

 9 buy-side firms, market makers who have actually

 10 made a lot of progress over the last three months.

 11 There's been agreement on the package IDs.

 12 There's been agreement on the line item IDs.

 13 There's been agreement on the workflows that are

 14 going to be required to process on a SEF basis and

 15 an agreement on how to process it on a non-SEF

 16 basis.

 17 I'm not going to bore you with all of

 18 the details of the protocol, but they're available

 19 and they take into account the variety of

 20 different packages that both Stephen and I have

 21 articulated. Okay. So you need to make sure that

 22 the IDs are there and the workflows are
 279

 1 articulated.

 2 So, what's our recommendation? You know,

 3 obviously our recommendation is to not have

 4 packages be subject to the execution mandate on

 5 the 15th. And, you know, we thank you for already

 6 putting that into action. You know, a couple of

 7 other things to look at is to look at the time

 8 that the FCMs have to evaluate net risk, to look

 9 at the time that the DCOs have to evaluate the

 10 packages. And then we would have a checklist-like

 11 approach to make sure that there's a regulatory

 12 framework that has been accommodated and SEFs

 13 allow market participants to execute packages and

 14 both the FCMs and the credit hubs have the ability

 15 to assess the packages as a whole as well as the

 16 clearing organizations.

 17 And, you know, this is in our letter

 18 that we have previously submitted to the

 19 Commission. You know, we would also urge this

 20 group and the Commission to look the a phasing in

 21 approach. Obviously, you know, look at the most

 22 simple packages first and make sure that there's
 280

 1 no technology or operational nightmares. And then

 2 as we have successes, build on that and increase

 3 the complexity. Thank you very much.

 4 CHAIRMAN O'MALIA: Sunil can you go,

 5 and your chart on page 2, are they in kind of an

 6 order of priority consistent with this phasing? You

 7 said address them individually or kind of on a

 8 swap-by-swap or package-by-package basis. You

 9 have a list of maybe 10?

 10 MR. HIRANI: Yeah, and you know,

 11 there's, you know, I'm not claiming they're

 12 complete, but yeah, I think the first three are

 13 the ones I think that may be in order, but then I

 14 don't think they might not necessarily be in

 15 order. Because the fourth one commingles CFTC

 16 and, you know, a non-CFTC agency. So, I think, you

 17 know, clearly two MAT instruments, a fives versus

 18 a tens, twos-fives that are both MAT, I think that

 19 would be the first one to tackle. And then tackle

 20 butterflies. And then tackles twos versus 17s or

 21 something.

 22 I think, you know, to deal with integer
 281

 1 swaps, you know, MAT integer swaps first, make

 2 sure the infrastructure is there. And I think,

 3 you know, there's, as I said before, there's been

 4 a lot of good work already done on getting, you

 5 know, folks that typically don't work together,

 6 they've been working together very cooperatively

 7 to come to an agreement on things that have

 8 typically taken years in the past to accomplish.

 9 So I would say, start with MAT

 10 instruments first. Let's see how that goes. Get

 11 the infrastructure working and get the credit

 12 -- you know, the most important thing is

 13 looking at the riskiness of the package and

 14 assessing the risk appropriately, getting all of

 15 that to work through the whole transaction life

 16 cycle and all the handshakes to work. I think if

 17 you can do that in the first phase, if you can

 18 sort of kick it down the road, because clearly,

 19 you know, you've got the spigot, you can control

 20 the spigot. That would be the way I would think

 21 about it.

 22 MR. BERGER: Well, just one quick thing
 282

 1 I would add is that the first three transaction

 2 types on the list, those are ones where the

 3 industry for cleared swaps could solve it with the

 4 language fixes, you know, referred to in terms of

 5 if the FpML language can be upgraded to

 6 communicate package transactions as a whole, that

 7 can solve the challenges associated with the first

 8 three on this list. Then we get into more, once

 9 we get past the first three, we get into more

 10 complex actual, like, legal jurisdictional

 11 questions on top of the just infrastructure ones.

 12 ACTING CHAIRMAN WETJEN: If that's the

 13 case, then I guess we can, we don't continue

 14 discussing this, but one of the suggestions there,

 15 one of the other slides, one of Sunil's slides was

 16 that we have to revisit the 1.73 or 1.74

 17 concerning the speed with which the FCM is to

 18 reject a trade or not, if it's -- I guess help me

 19 understand that a little better if you can. Why

 20 would that be necessary?

 21 I thought if we were to do, just allow

 22 for some more time for technological upgrades and
 283

 1 making sure the right connectivity is in place

 2 between all the different infrastructure

 3 participants, it should be easy enough, soon

 4 enough for both the FCM and the DCO to assess the

 5 risk of a package transaction, especially if it's

 6 one just involving swaps.

 7 MR. HIRANI: Yeah, so that's a good

 8 question, Mark. So it takes time to message.

 9 Some of these portfolios can be quite large. And

 10 there's a number that they have been kind of

 11 converging to without the benefit of scale

 12 automation and technology, and that number is

 13 around, you know, 100 to 150. There's, you know,

 14 obviously been some packages that trade, you know,

 15 in several hundred line items, but there's a

 16 reason that the industry has converged to a number

 17 like 100, between 100 and 150, because just the

 18 system cannot process them, in, you know, in an

 19 operationally efficient manner.

 20 So even if you could have a language

 21 that describes the packages, which, you know,

 22 there's a very good version of it floating around,
 284

 1 you still need to communicate it to the CCPs, you

 2 need to communicate it to the FCMs, or to the

 3 credit hub. So that takes time. And then, you

 4 know, and then you have to wait for the turn

 5 around time. So and there is a need in the world

 6 to do packages, you know, vastly greater than the

 7 line items that are being processed here. So

 8 there's going to be time that it takes to send it

 9 to the, whether it's the FCM, CCPs, or credit hubs

 10 and then for them to do their risk assessment and

 11 then to communicate it back.

 12 And, you know, we've done some

 13 preliminary testing of that. We're, you know,

 14 happy to share some of the data. But, I do think

 15 that those numbers will have to be reviewed

 16 because, you know, that may not allow enough time

 17 to process large packages.

 18 ACTING CHAIRMAN WETJEN: Ananda wants to

 19 pipe in here.

 20 MR. RADHAKRISHNAN: If you guys have the

 21 technology to trade the package, how come you

 22 don't have the technology to compress it or send
 285

 1 it to a clearinghouse? I don't get it. So you

 2 say it takes time, it takes time for a credit hub

 3 to figure it out, it takes time for a

 4 clearinghouse to figure out how to clear it;

 5 shouldn't it take the same amount for you guys to

 6 figure out how to trade it?

 7 MR. HIRANI: So yeah, so, Ananda, you're

 8 obviously right, the technology exists to trade

 9 it.

 10 MR. RADHAKRISHNAN: Right. So --

 11 MR. HIRANI: And the technology exists

 12 to communicate it.

 13 MR. RADHAKRISHNAN: Okay.

 14 MR. HIRANI: But what doesn't exist is a

 15 common language to describe it. So we can send it

 16 to CME, LCH and we can send it to the FCMs, but the

 17 infrastructure doesn't exist to evaluate it as one

 18 atomic unit. So they can evaluate it on a line

 19 item basis.

 20 MR. RADHAKRISHNAN: Okay. But if the

 21 trader can evaluate it as one unit, I mean, the

 22 example you gave, right, like so many bits is what
 286

 1 you pay, why can't you give that to -- I don't get

 2 it. I mean, if someone -- are you saying that the

 3 trading community is that much smarter than the

 4 clearing community? Are they --

 5 MR. HIRANI: No. I mean, the analogy is

 6 --

 7 MR. RADHAKRISHNAN: Do they need to come

 8 in and figure it out?

 9 MR. HIRANI: So let's say you go to

 10 Russia for the Olympics. And, you know, they

 11 speak Russian over there. You speak English. You

 12 know, you're both communicating, you think you're

 13 communicating about the same sport; but you need a

 14 translator to get, you know, your language

 15 converted into the local language. That's really

 16 what we're talking about.

 17 MR. RADHAKRISHNAN: Yeah.

 18 MR. HIRANI: See, everybody can evaluate

 19 the risk.

 20 MR. RADHAKRISHNAN: Okay.

 21 MR. HIRANI: But there's not a

 22 consistent way to describe the package and there's
 287

 1 not a consistent way to keep track of the package

 2 and a consistent way to evaluate the riskiness of

 3 it. That's all I'm saying.

 4 MR. BERGER: And I think people can

 5 communicate bids and offers back and forth to each

 6 other about anything you want. I mean, any

 7 product or service anywhere in the world. I think

 8 the issue is that if we're communicating and

 9 market participants are, you know, pretty good at,

 10 you know, identifying what they're communicating a

 11 bid or offer about; but if we decide, you know,

 12 we've agreed on a price for a swap package that's

 13 a butterfly and has three legs and for some reason

 14 the FCM or the CCP sees the first leg and doesn't

 15 know that there's two more coming that, you know,

 16 have different risk characteristics than the first

 17 leg; they can make an errant decision based on

 18 just not having the knowledge that it was part of

 19 something else.

 20 So just the language that I think we're

 21 talking about is a flag that when someone receives

 22 a leg of a transaction, they know it's leg one of
 288

 1 three, two of three, or three of three. So --

 2 MR. RADHAKRISHNAN: What's stopping you

 3 from sending the whole, the entire package to the

 4 CCP?

 5 MR. BERGER: Right now the language

 6 doesn't support the wrapper.

 7 MR. RADHAKRISHNAN: The language what?

 8 ACTING CHAIRMAN WETJEN: But once

 9 the language is in place, right? I mean,

 10 then --

 11 MR. BERGER: Or you know, to get really

 12 nerdy, I mean, there's something called FpML. And

 13 FpML version 5.7 is due to unfortunately not come

 14 out until July and they've agreed on the language

 15 upgrades they want to make to include a wrapper

 16 and to include the itemization so you can say it's

 17 leg one of fifty, two of fifty, et cetera. And,

 18 you know, once that standardization of the

 19 language is agreed upon, people can start building

 20 to it even ahead of the July release date; but it

 21 would have been great to solve that a lot sooner,

 22 but --
 289

 1 MR. HIRANI: Yeah, so, Ananda, I mean,

 2 no work is stopping, you know, so we've already

 3 adopted it, but it's, you know, we need the

 4 industry to adopt it. And that's really what

 5 we're talking about.

 6 MR. RADHAKRISHNAN: So to the extent

 7 that anything you do in this package comprises a

 8 product that has to be cleared, you are sending it

 9 to clearing, right?

 10 MR. HIRANI: Yeah, yeah.

 11 MR. RADHAKRISHNAN: Okay.

 12 MR. HIRANI: Absolutely.

 13 CHAIRMAN O'MALIA: Alex.

 14 MR. ELVIS: Yeah, thank you very much,

 15 commissioner, for the opportunity. And also,

 16 thank you for the relief. It's relieving

 17 certainly. And you'll -- [Laughter.]

 18 CHAIRMAN O'MALIA: I'm glad to hear it.

 19 MR. ELVIS: And you'll also be relieved

 20 to here that Stephen and Sunil got most of my

 21 points, so I won't be talking for very long. But,

 22 I do want to sort of, Sunil mentioned that these
 290

 1 packages are already happening in the market

 2 today, and I wanted to give a little bit of data

 3 as to how frequently they're happening. So swap

 4 spread trades, for example, benchmark swaps with

 5 integer tenors against benchmark Treasury bonds is

 6 the overwhelming majority of the integer dealer

 7 swap volume.

 8 Options with Delta exchanged are also

 9 the overwhelming majority of the interdealer

 10 option volume and approximately 40 percent of our

 11 volume with our investor customers. So not only

 12 are these transactions happening, they're

 13 happening very frequently and they're an

 14 absolutely integral part of how people think about

 15 and manage risk. And I certainly share Stephen's

 16 two goals. You know, I agree that we want to be

 17 able to solve this problem and get these

 18 transactions on to a regulated venue as quickly as

 19 we can, but I think, you know, as important is to

 20 ensure the continued ability of market

 21 participants to be able to execute these

 22 transactions as packages without having to break
 291

 1 them up.

 2 Because in my view, the critical aspect

 3 of what makes a package a package, yes, it's done

 4 simultaneously, yes, there's contingent pricing;

 5 but the risks of the package are almost by

 6 definition much less than the risks of the

 7 individual components, otherwise people wouldn't

 8 want to do them as packages. And so what we're

 9 seeing, and I think what we're thinking about is

 10 not necessarily whether or not these packages

 11 should trade on a SEF, but how they should trade

 12 and whether or not they should be subject to an

 13 EFRP-like regime, a regime that's similar to the

 14 block regime, or the order book, RFQ-3 minimum.

 15 And when you think about these trades,

 16 if one of the legs is a MAT swap and other legs

 17 are not MAT swaps, I think the SEF community and

 18 the staff and the Commission have spoken and said,

 19 well, look, on this six-factor analysis, these

 20 other components of the trade do not have

 21 sufficient buyers and sellers or are not subjected

 22 to clearing mandate or do not demonstrate
 292

 1 sufficient liquidity.

 2 So I think, you know, while we think

 3 about how to get those trades onto a SEF and how

 4 to process them effectively and ensure that the

 5 Treasury leg settles, for example, or that the

 6 swap leg of an option with Delta, if that swap is

 7 deemed to be void because it's rejected for

 8 clearing, we have something consistent to do with

 9 the option leg, I think are part of the

 10 conversation and something that we need to be

 11 thoughtful about.

 12 And then finally I wanted to make one

 13 point about transparency. And I know that, you

 14 know, when we look at the SDR data, we try very

 15 hard to eliminate as much noise as we can from the

 16 SDR data so that we can use it for the purposes in

 17 for which it was intended. It's very difficult to

 18 weed out what is actually Delta risk transfer and

 19 what in some cases is not actually Delta risk

 20 transfer because that particular swap is done

 21 concomitantly with a series of other swaps. So in

 22 Sunil's example, you have the trillion dollar
 293

 1 tenure swap and 99 other smaller swaps that offset

 2 them.

 3 You see the trillion dollar swap on the

 4 trade, on the table, you say, that's a big trade,

 5 a lot of Delta just went through the market, when,

 6 in fact, a lot of Delta didn't just go through the

 7 market. And I think we could enhance and we can

 8 borrow something from the equity markets, you

 9 know, as FpML 5.7 gets rolled out and the wrappers

 10 are identified and designed, we could enhance the

 11 post-trade price transparency quite a bit as well

 12 as the ability for the Commission and staff to

 13 make sure that the package trades are not being

 14 used to evade RFQ to 3 or order book trading by using

 15 something to tie those trades together so that any

 16 participant in the market can see the option and

 17 the Delta that was exchanged, the trillion dollar

 18 swap and the 99 other items and really understand

 19 what was happening in the market and when it

 20 happened.

 21 And that applies on a pre-trade basis as

 22 well. I worry about doing a large
 294

 1 out-of-the-money option trade with a client and

 2 then both of us having to go into an order book or

 3 RFQ folks, RFQ-3 folks each separately in opposite

 4 directions in large amounts of duration, sending,

 5 you know, almost -- no, not almost -- an actually

 6 false message to the market about the amount of

 7 buying and selling and interest that's happening.

 8 So I think, you know, we support the pre- and

 9 post-trade transparency, the benefits of the pre-

 10 and post-trade transparency that SEFs and the SDR

 11 and reporting rules bring.

 12 And I think that just one thing to keep

 13 in mind throughout these conversations that

 14 package transactions actually are quite

 15 complicated when it comes to that and should be

 16 thought about carefully.

 17 CHAIRMAN O'MALIA: Thank you. Mike

 18 Hennessy. I believe I called you Mark earlier, I

 19 apologize.

 20 MR. HENNESSY: No problem.

 21 CHAIRMAN O'MALIA: Who is Assistant Vice

 22 President in Treasury and Capital Markets, Federal
 295

 1 Home Loan Bank of San Francisco. Thanks for

 2 coming all this way.

 3 MR. HENNESSY: Yeah, no, thanks for

 4 having us. We appreciate the invitation to

 5 participate and for the opportunity to talk about

 6 the Federal Home Loan Bank's unique version of

 7 package transactions which has not really been

 8 explicitly addressed by some of the other market

 9 participants either here or in comment letters on

 10 this subject matter. By way of background, as you

 11 may already know, the Federal Home Loan Bank

 12 system is comprised of 12 Federal Home Loan Banks

 13 and the Office of Finance, its fiscal agent, and

 14 was established with the passage of the Federal

 15 Home Loan Bank Act in 1932 to provide liquidity to

 16 the nation's financial institutions.

 17 Currently, and has been the case all

 18 along, the banks are cooperatively owned with

 19 approximately 7,000 member financial institutions,

 20 which include banks, thrifts, credit unions,

 21 insurance companies, and community development

 22 financial institutions. So that said, and moving
 296

 1 right into package transactions, we agree with the

 2 comments expressed here by the other panelists

 3 about how important package transactions are and

 4 that they need to be preserved for the

 5 marketplace. And we generally share the same

 6 concerns around package transactions and agree

 7 with the Commissioner's observation that in many

 8 instances more time for package transactions is

 9 needed, especially for those combinations that

 10 involve swaps and other swaps.

 11 However, the trading practices of the

 12 Federal Home Loan Banks generally do not involve

 13 these types of package transactions. Instead, the

 14 Federal Home Loan Banks use packages in a unique

 15 way, and that is really limited to the negotiated

 16 swap to bond issuance package transactions. And,

 17 you know, issuing debt in the capital markets in

 18 this manner is the primary mechanism by which the

 19 Federal Home Loan Banks fund themselves. We

 20 included some statistics in our comment letter

 21 regarding the MAT submissions, and I'll summarize

 22 those briefly here.
 297

 1 You know, since 2008 and through the

 2 third quarter of 2013, about 73 percent of all

 3 debt issued by the Federal Home Loan Banks on an

 4 account basis was done in a package, and on a

 5 notional basis that's about 67 percent. So I

 6 think, you know, it's obviously very integral to

 7 the Federal Home Loan Banks' business strategy.

 8 And I think I'd like to walk you through an

 9 example of one of these transactions and how they

 10 come about and who the market participants are in

 11 each of these transactions.

 12 So one of the key features of this type

 13 of transaction is that it's multi-party. So the

 14 Federal Home Loan Banks are bond underwriters, and

 15 our swap counterparties have an open dialogue

 16 around, you know, our funding needs. And

 17 essentially each business day the Federal Home

 18 Loan Banks broadcast to the marketplace where

 19 they're willing to issue debt on a package basis.

 20 So we are, we generally take the asset side of our

 21 balance sheet and convert that to three-month

 22 Libor. So we have these synthetic three-month
 298

 1 re-pricing assets. And we make the similar asset

 2 liability hedges on the liability side.

 3 And so, you know, we enter into these

 4 transactions -- we broadcast to the market

 5 participants that we need this specific funding

 6 level on a 3L basis and bond underwriters and swap

 7 counterparties go out and canvas their investor

 8 base to try to deliver that type of package

 9 transaction for the banks. If they are able to

 10 successfully find investors or devote a balance

 11 sheet to our debt issuance needs, they'll present

 12 us with an opportunity to say, Federal Home Loan

 13 Bank of San Francisco, would you like two year debt

 14 at Libor less five. And if that's acceptable, a

 15 few minutes later, all parties to that transaction

 16 will hop on a phone call and read the terms of the

 17 bond issuance and execute that issuance, read the

 18 terms of the swap hedging transaction, execute

 19 that swap. And the Federal Home Loan Banks are

 20 left with their synthetic three-month liability at

 21 Libor less five.

 22 But we, as part of that transaction,
 299

 1 we're not negotiating the individual prices of the

 2 bond or the swap, instead we're solely focused on

 3 that net funding target. And this has a lot of

 4 advantages for the banks, most of which were

 5 already described by the gentleman to my right,

 6 but this is the most cost effective way for us to

 7 issue debt. And, you know, we use it more than

 8 any other strategy as evidence of that. We're

 9 able to obtain better funding levels than if we

 10 were to just go out into the marketplace and issue

 11 a floating rate bond index to three-month Libor.

 12 It also allows our debt to trade with greater

 13 liquidity as we're able to issue across the

 14 maturity spectrum. And it also reduces risks.

 15 It reduces risks for the Federal Home

 16 Loan Banks because we avoid legging risk

 17 associated with the timing, you know, of issuing a

 18 bond and subsequently swapping it; but it also

 19 reduces execution risk for all the parties of that

 20 transaction, and it does this by increasing the

 21 probability that the issuance and the hedging

 22 transaction occurs in the first place. If
 300

 1 issuance and hedging was split apart, which could

 2 be the case as a result of made available to

 3 trade, it will increase the likelihood that these

 4 transactions do not materialize, because the bond

 5 underwriters will be focused on their customers'

 6 needs, delivering a fixed rate bond, for example,

 7 with a specific coupon target.

 8 And that issuance of that transaction,

 9 while it might be suitable for the underwriter and

 10 their clients, the Federal Home Loan Banks are

 11 going to be focused on what that debt issuance

 12 swaps to on a Libor basis. And so the incentives

 13 are not well aligned. And so small market moves

 14 could cause deals to be turned down or not occur.

 15 And so that's an inefficient use of resources.

 16 So, you know, we're concerned basically

 17 about the presence of this third party in the

 18 package transactions, the third-party bond

 19 underwriter, excuse me, it makes it, you know, in our

 20 idea unlikely that these transactions will be able

 21 to be executed on a SEF. At least in the

 22 foreseeable future, there doesn't seem to be much,
 301

 1 you know, development around taking bond issuance

 2 and moving that into this electronic trading

 3 world. You know, it's, you know, yes, we're

 4 talking about swaps and bonds, which certainly

 5 seems to be in play for mandatory trading on SEFs

 6 such as, you know, the swap spread strategy, which

 7 is, you know, swaps versus Treasuries, you know,

 8 but that's a little bit different than what we're

 9 talking about here.

 10 The Treasury note or bond is, you know,

 11 available onscreen. And in many instances already

 12 trades electronically today. Where when you're

 13 talking about a new-issue debt instrument, there's

 14 no CUSIP available. It's not really, you can't

 15 pull it up and analyze it. And that technology is

 16 just not in place today.

 17 So that's really kind of the way that

 18 the Federal Home Loan Banks use package

 19 transactions. And, you know, we're supportive of,

 20 you know, moving towards electronic trading and we

 21 think that it's best for the market, but we are

 22 concerned about this nuance-type transaction. And
 302

 1 we're open for other ideas, because we generally

 2 like the functionality and the efficiency provided

 3 by SEFs, specifically around the speed of clearing

 4 and certainty of clearing and would not be opposed

 5 to, you know, a regime that allows us to privately

 6 negotiate these multiparty package transactions,

 7 but still subject to those, the swap and that

 8 transaction to processing on a SEF.

 9 CHAIRMAN O'MALIA: Thank you. In this

 10 FIXML 5.7 or, there are a couple of things on the

 11 bottom here of this MAT to MAT, MAT to non-MAT;

 12 will this also support, be supported in a data

 13 repository and be informative? I keep thinking

 14 about all the questions, all the data

 15 harmonization issues we had in the first panel

 16 today and I don't --

 17 Vince, I don't know if you've given this

 18 any thought, but maybe as part of your roundtable

 19 that, you know, at least we'll ask the right

 20 questions about how we designate this. And if

 21 they're going to make an if FpML upgrade anyway,

 22 does that increase our surveillance capability and
 303

 1 our ability to see it in the SDR? I know Sayee

 2 mentioned today we don't have a MAT designation.

 3 He's over here if you're looking.

 4 MR. MCGONAGLE: No, I wasn't.

 5 CHAIRMAN O'MALIA: Oh, okay.

 6 MR. MCGONAGLE: I was looking for my

 7 guys.

 8 CHAIRMAN O'MALIA: Oh, all right. Well,

 9 and now you guys are working this cross

 10 divisional. You're all one team, right? So --

 11 MR. MCGONAGLE: Exactly.

 12 CHAIRMAN O'MALIA: But maybe you'd ask

 13 that question and get some thought. And maybe

 14 somebody --

 15 Sunil, I don't know if you have a sense

 16 of if that will help us in the SDR context?

 17 MR. HIRANI: Yeah, I think that was a

 18 really good point that Alex brought up. And in

 19 fact, you know, in the meeting that we had on

 20 Friday, there's three, four of the people from

 21 this group that are liaising with the FpML folks

 22 and FIX and that was a discussion that we
 304

 1 eventually got to, which is, you know, we need to

 2 make sure that the SDRs -- you know, one of the

 3 SDRs was present, the second one wasn't, that they

 4 also adopt the protocol. Because I think, you

 5 know, the point that Alex raised is very valid,

 6 you don't want to communicate, you know, in a

 7 misleading fashion what the intent of that

 8 transaction was. So the codes that, you know,

 9 this group has come up with, you know, we would be

 10 very open to share them with all of the SDRs and

 11 say, this is what, you know, the FCMs, the CCPs,

 12 and the SEFs, and credit hubs have agreed to. And

 13 I think that's a great idea, because it's going to

 14 mislead, the tape will be very misleading if --

 15 you know, the risk will be grossly overstated if

 16 you don't flag it as such.

 17 MR. HENNESSY: Yeah, I agree. There

 18 definitely needs to be some data reporting

 19 enhancements. I mean, quite simply you're, the

 20 swap is not priced as a single-leg transaction.

 21 It's inextricably tied to the other leg. And you

 22 know, if there's not a way to identify that, it's
 305

 1 definitely misleading in the repository.

 2 MR. BERGER: It's interesting and I

 3 definitely agree, it would be great to flush it

 4 out in more detail. I think that clearly with

 5 respect to the real-time post-trade public

 6 transparency, it's, it would be a great addition

 7 to be able to see things at the package level.

 8 Functionally at the CCP and in terms of kind of

 9 how things get risk managed, they still ultimately

 10 then get risk managed as individual line items

 11 because they aggregate across a portfolio, and so

 12 there may actually be a distinction between what

 13 gets done at the CCP and the SDRs in terms of

 14 still keeping it at line item levels, but for the

 15 post-trade transparency, there would be value.

 16 MR. ELVIS: Yeah, I agree with that. I

 17 mean, they could be clearing at separate CCPs or

 18 one could not be clearing at all, for example.

 19 CHAIRMAN O'MALIA: Vince, or anybody on

 20 the panel, this cash futures basis, these trades,

 21 these futures don't trade on SEFs, how do we deal

 22 with that problem? I mean, at least that's
 306

 1 within, both are within our jurisdiction. We have

 2 rules that say, by the way, you can't trade

 3 futures on SEFs, but --

 4 MR. MCGONAGLE: Right. So I don't see,

 5 futures on SEFs are not permitted, so that is, I

 6 don't know that we're going to be, maybe we'll

 7 consider alternatives, but I don't know that we

 8 were planning ongoing down that route. And

 9 certainly looking at these other, sort of

 10 non-jurisdictional products that aren't or

 11 cross-jurisdictional issues, I think are some

 12 areas where there's room for discussion to see

 13 where we're going to go, but we haven't

 14 contemplated or talked about doing anything sort

 15 of on SEF that involves a futures product.

 16 CHAIRMAN O'MALIA: When you say, we're

 17 not going down that route, meaning you're not

 18 going to mandate a package transaction with a

 19 benchmark swap and a future to be MATed?

 20 MR. MCGONAGLE: So I would be looking at

 21 maybe having another conversation about the fact

 22 that either you could do it, you know, work the
 307

 1 deal packages on DCM, where they could do both

 2 futures and the trade executed swap or they're

 3 going to have, whether there then be -- if it it's

 4 on a SEF, it would have to be busted up.

 5 CHAIRMAN O'MALIA: Okay.

 6 ACTING CHAIRMAN WETJEN: But let me ask

 7 a follow-up question. If a trader is looking at a

 8 screen and the screen is provided by an entity

 9 that's jointly registered as both a DCM and a SEF,

 10 first of all, I think that's a possibility, number

 11 one. And then number two, as a practical matter

 12 under that scenario, it probably wouldn't matter.

 13 Isn't that right, Vince?

 14 MR. MCGONAGLE: That sounds right, but

 15 that's one of those things that I'd like to come

 16 back and talk to my group about.

 17 ACTING CHAIRMAN WETJEN: I mean, if the

 18 RFQ is different, but I mean, again, theoretically

 19 anyway, if a package were listed on an order book

 20 and traded on an order book, it would seem that

 21 would be very much possible.

 22 MR. MCGONAGLE: Yeah, we'd want to take
 308

 1 that back.

 2 CHAIRMAN O'MALIA: Anybody else? Oh,

 3 Cliff. I'm sorry. And then Supurna. I know you

 4 were --

 5 MR. LEWIS: I just have, obviously the

 6 timing of the administrative back end processing,

 7 the wrapper, the FpML is all important and you

 8 have a, I'm not suggesting anything be done

 9 precipitously, but I would suggest that ultimately

 10 the package trades have to be brought into this

 11 framework or the framework makes no sense. And

 12 you can't be half pregnant about requiring certain

 13 parts of this to be cleared without understanding

 14 that fundamentally, and we talked about this

 15 before, the sequence of requirements is backwards.

 16 The trading requirement should have

 17 preceded clearing requirement. That's water over

 18 the dam. But if you guys have a fundamental role

 19 of being concerned about systemic risk and not

 20 adding to the risk of these instruments now

 21 residing at clearinghouses, you're stuck. And

 22 every moment that these kind of arbitrage
 309

 1 opportunities continue to exist, they will be

 2 exploited. I know you've heard of the Cubs grab,

 3 right? The new swap product which has a $1 bet

 4 attached to it that the Cubs win the World Series.

 5 That's not me making it up, that's actually a

 6 design to avoid either, any of the requirements,

 7 either clearing, SEF, swap data repository.

 8 Now I'm not saying that that's the

 9 purpose of this. Obviously it has to be feasible

 10 to be able to move these into the environment, but

 11 it is not without considerable risk that the day

 12 in which you force the hard cut over, big bang,

 13 whatever you want to call it, to take place. And

 14 by the way, this is not risk unrelated to market

 15 circumstances. It is not without precedent that

 16 there could be a major interest rate movement.

 17 And, gentlemen, you do not want to be

 18 halfway between these two worlds if that happens.

 19 You know, when margins are going to be readjusted

 20 in a major way. I mean, this is, you know, you're

 21 on a path and I just would urge you to consider

 22 the risks of not seeing this through as
 310

 1 expeditiously as possible. I'm not arguing with

 2 whether this was the right way to do it or the

 3 wrong way to do it. The legislation is very clear

 4 and your purposes have been made very clear in

 5 terms of moving as much as you can into the new

 6 environment. Good luck. I'll be in Argentina

 7 where there's a more stable environment.

 8 MS. VEDBRAT: Yeah. I think, you know,

 9 I'd like to thank the panel for giving us, you

 10 know, a good introduction into the main type of

 11 packages that exist out in the market. I would

 12 just like to add like, you know, one comment about

 13 the package trades. Like, each package, there's a

 14 reason for it, you may be hedging duration risk or

 15 you may be isolating vol[atility] risk, so just to

 16 keep that in mind. Because as clients as, you

 17 know, we're using these packages, there's a reason

 18 behind it. And, you know, if these packages are

 19 forced to trade independently or separately, apart

 20 from the fact that, you know, they exposed us to

 21 all the risks that Stephen outlined as economic

 22 benefits, it also, you know, breaks our ability to
 311

 1 be able to hedge or isolate the risk that we're

 2 trying to hedge.

 3 The other thing, you know, that I'd just

 4 like to, you know, ask, you know, ourselves, as

 5 committee members as well as, you know, our

 6 witnesses, we just got 90 days extension and we

 7 really do need to have a plan of action on how

 8 we're going to get these trades either, you know,

 9 MATed -- not MATed -- to trade on SEFs or to make

 10 a decision that we may be allowed to trade them

 11 off SEF and then just process them on SEF, because

 12 otherwise we're going to be back here on day 89 as

 13 clients still, you know, facing the same

 14 uncertainty of, like, you know premature movement

 15 onto SEFs or like an infrastructure that really is

 16 exposing us to more systemic risk than reducing,

 17 you know, the risk that we're all set out to do.

 18 So I mean, the ones that I'd like to

 19 highlight, we need, you know, the SEFs to be able

 20 to provide us the solution to trade these as

 21 linked packages. You know, that's very important.

 22 I know we have some of the SEFs sitting out there
 312

 1 and then we also have, you know, some of our

 2 dealer counterparties that, you know, provide us

 3 liquidity. And then on the back end, you know,

 4 whether we consider clearing element of it or the

 5 limit checking, all of those need to take into

 6 account linking these transactions and looking at

 7 them as net risk, you know, versus separate risk.

 8 CHAIRMAN O'MALIA: Brian.

 9 MR. DURKIN: I'd like to thank the panel

 10 also and agree with much of what has been said

 11 here in terms of the need for time. And thank you

 12 very much, CFTC, for granting us some time in this

 13 regard. The CME has been working with the

 14 industry in terms of coming up with the mapping

 15 solutions that are required for these

 16 transactions. And I think, you know, the panel

 17 here did a nice job of laying out some of the

 18 complexities associated with doing so.

 19 But, I also, you know, firmly believe

 20 that we can come to that resolution and to that

 21 solution. So this room shouldn't leave itself

 22 like wondering, can this be accomplished. It can
 313

 1 be. And there's very much a focus on making that

 2 come to fruition. Now, you know, there is some

 3 point that has been made here, and I just need to

 4 clarify. We suggest well, you know, use an EFRP

 5 transaction, it's been alluded to, let's just, you

 6 know, be able to do that as a, maybe as a first

 7 approach. And, you know, I need to be very clear

 8 that those around this table and those listening

 9 have an understanding of what we're talking about

 10 in terms of what constitutes an EFRP transaction.

 11 You know, EFRP transactions have been in

 12 place for several years. And today that framework

 13 for these trades, it starts with core principle

 14 nine for DCMs. And that requires that markets

 15 provide a centralized, open and competitive

 16 mechanism for trading listed contracts ensuring

 17 that the price discovery process in the

 18 centralized market is protected. Core principle

 19 nine grants DCMs the right, but not the

 20 obligation, to permit certain noncompetitive

 21 trades from occurring. And that is premised on

 22 the rules that are adopted by the exchange.
 314

 1 So at the CME noncompetitive trades have

 2 historically been and will continue to be a very,

 3 very narrow exception to our centralized open and

 4 competitive trading in these contracts. Our rule

 5 538, which governs EFRPs in our markets, it

 6 limits noncompetitive transactions requiring them

 7 to be, one, privately negotiated, and also only

 8 over-the-counter contracts, that is they aren't

 9 executed or subject to the rules of a DCM or a

 10 SEF, nor are they to be used as that related

 11 position component.

 12 So across all of our DCMs, the EFRPs

 13 account for just over two percent of our exchange

 14 volumes. Now, the low percentage of EFRP activity

 15 does not necessarily suggest that market

 16 participants do not more broadly establish package

 17 exposures as has been explained today. That may

 18 or may not involve our futures contracts. It

 19 means that they most commonly establish those

 20 exposures in a more competitive manner. At the

 21 CME group, we prefer these methods of establishing

 22 package exposures wherever possible because, one,
 315

 1 they contribute to the price discovery process

 2 taking place in a centralized market and they

 3 facilitate a tighter bid-ask spread and they

 4 enhance the overall transparency in our markets.

 5 Before the Commission were to consider

 6 expanding or permitting EFRP-like-type

 7 transactions for SEFs, we recommend the Commission

 8 finalize the proposed EFRP regulations under core

 9 principle nine for DCMs, which have been proposed

 10 -- which have been pending as a proposal for over

 11 three years. In our experience over the past

 12 three years, CFTC staff has in many instances

 13 treated these proposed regulations as final

 14 without an informal staff, even an informal staff

 15 interpretation.

 16 And we believe that this action in the

 17 absence of final regs. has created a lot of

 18 confusion in the marketplace. There's a lot of

 19 uncertainty in terms of compliance risk for

 20 exchanges for FCMs, for brokers, and for market

 21 participants. So that's an area that I think

 22 we're going to have to tackle more deeply.
 316

 1 MR. MCGONAGLE: If you can just

 2 before we go to the next.

 3 MR. MCGONAGLE: Okay. And just to touch

 4 briefly on a different tack to the extent that,

 5 and I thought I touched on this when we started,

 6 that the trade execution requirement talks about

 7 two required methods for execution. So to the

 8 extent that anyone is contemplating sort of some

 9 alternate method, please pay close attention to

 10 the discussion. And if you want to challenge

 11 whether there was a discussion, the sufficiency of

 12 the discussion concerning whether alternate

 13 methods for execution are appropriate with respect

 14 to swaps subject to the trade execution mandate.

 15 So that's a way of saying, you know, the

 16 more legal analysis that folks want to submit to

 17 the Commission or to DMO in particular as we

 18 evaluate this with respect to what the SEF rule

 19 said, what comments were made around the SEF rule,

 20 what are the required methods for execution,

 21 including whether the DCMs are faced the same

 22 limitations as SEFs with respect to required
 317

 1 execution methods; and then to the extent that

 2 folks want to articulate whether or how there

 3 could be an exception, that would be much

 4 appreciated.

 5 CHAIRMAN O'MALIA: Pierre.

 6 MR. LAMY: Yes, thank you. First, I

 7 would like to thank the panel because it was a

 8 very, I would say, fascinating discussion about

 9 the value of those package transactions and the

 10 fact that we need to adjust the (inaudible) that we have

 11 to accommodate those package transactions. The point

 12 that I would like to make is the fact that the XML data

 13 presentation is probably the easy part of all

 14 this. And I think the part of the cross-asset data

 15 presentation is a big part, the fact that we will

 16 have, as you pointed out, the case of OTCs that

 17 we'll have a future as you mentioned, but

 18 also security, the U.S. Treasury example. And I

 19 think that we will need to think about those in

 20 the context of SEF, but also the context of SDRs

 21 and Part 45, Part 43 reporting, which scope is currently

 22 limited only to the derivatives transaction.
 318

 1 So I think we should focus early on with

 2 those assets that are not in the scope of Title

 3 VII as to how we tackle those. Because I just have

 4 the impression that this will be the difficult

 5 part of everything.

 6 And I was also wondering, in the

 7 commodity space, do we have also some package

 8 transactions that would involve physical

 9 commodities or any of those things?

 10 MR. LEWIS: Yes.

 11 MR. LAMY: But that would not include a

 12 physical. That would be the OTC and the

 13 futures, that would be the easy one.

 14 MR. LEWIS: You're right.

 15 CHAIRMAN O'MALIA: Wally, and then we're

 16 going to go to Scott to remind us of the other

 17 outstanding TAC -- SEF issue.

 18 MR. TURBEVILLE: I think a lot of

 19 people, unlike myself, might be predisposed to

 20 saying that if it's happening in the market, it

 21 should continue to happen. Unlike you, maybe I

 22 missed something. I did not hear why the earth
 319

 1 will stop rotating if package transactions are

 2 done in their component parts as opposed to

 3 altogether. I hear that obviously that if a

 4 package deal is done, that means a lot of

 5 different swaps are going to get done, which would

 6 -- if they were done individually, we'd all know

 7 what the price is, and now we'll never know what

 8 the price of them individually is.

 9 I understand that if you own a bond and

 10 you hedge it with a swap, you know, you're going

 11 to have to put a margin on the swap. I understand

 12 that you're doing your deals and you have to do

 13 three-month Libor swaps, but you can do

 14 three-month Libor swaps. The chances of you being

 15 foreclosed from the market are very little there.

 16 So what I hear is that people sort of want to do

 17 these, and I guess sometimes I hear that it's just

 18 convenient and somebody has been told there's an

 19 execution risk, I got that, somebody has been told

 20 that it's a nice thing to do; but I also

 21 understand why it obscures the market, and maybe

 22 the world won't stop spinning if you can't do
 320

 1 these.

 2 There's a roundtable coming up. I'm not

 3 asking you to satisfy my personal needs, whether

 4 it's based on ignorance or maybe lack of bias, one

 5 or the other or both; but I've got to tell you, it

 6 sounds to me like enabling a system that isn't,

 7 that really is a system that's created to create,

 8 you know, deals for folks -- well, for instance,

 9 if you -- well, the whole idea about paying three

 10 spreads, you come to me and say, I want to do two

 11 or three swaps together, and I'll give you one

 12 spread. I'm going to go lay it all off, so I'm

 13 going to experience those spreads and pass the

 14 cost along to you, for instance.

 15 It doesn't sound -- it sounds to me like

 16 a lot of this is a discussion that defies the laws

 17 of preservation of mass and energy, if you know

 18 what I mean. So not today, it doesn't have to be

 19 today, I'm not asking people to stay late or to

 20 satisfy me and you don't have to satisfy me, I

 21 guess; but to me if -- it does sound a little bit

 22 troubling that the world will end if you don't do
 321

 1 these things transparently in components as

 2 opposed to in big wads.

 3 MR. ELVIS: I think I'm willing to stay

 4 late to address that. Well, I think there's, what

 5 you -- the last part of what you said, it's

 6 actually, you know, in many cases in practice

 7 quite the opposite. So, you know, I mentioned in

 8 my initial remarks that the interdealer-broker

 9 market is for interest rate swaps overwhelmingly

 10 composed of spread trades.

 11 And the reason why we can price the

 12 individual singular interest rates swaps that our

 13 clients ask us to perform is because once we have

 14 that risk, we have two hedging tools at our

 15 disposal. We actually have multiple. We have

 16 futures, we have other swaps, and we have

 17 Treasuries. And the ability for us to take the

 18 offsetting Treasury risk, for example, and then

 19 transform that back into the swap that we did for

 20 our client is what enables us to make the prices

 21 that we do. So it's not even so much that we are

 22 passing costs along to customers because we have
 322

 1 to go and do each of the individual legs

 2 separately and hedge each of the individual legs

 3 separately, frequently it actually works the other

 4 way and we will hedge using the most available or

 5 the cheapest or the hedge that fits our overall

 6 portfolio the best.

 7 And then we'll do an invoice spread or

 8 we'll do a Treasury spread to manage that risk.

 9 MR. TURBEVILLE: But somebody has to get

 10 back to the underlying risk eventually.

 11 MR. ELVIS: Well, that underlying risk

 12 has been passed to us, but in my example, that

 13 underlying risk has been passed to us by our

 14 client already.

 15 MR. TURBEVILLE: Does the guy you do the

 16 spread deal with eventually or somebody down the

 17 chain has to get to the actual real risk.

 18 MR. ELVIS: Well, somebody may have, you

 19 know, capacity for Treasury risk whereas we have

 20 capacity for swap risk or that's, you know, that's

 21 -- the reason these things exist is because people

 22 have different portfolios and different goals.
 323

 1 And I don't think anybody is suggesting by any

 2 means that the world will end. I think what we

 3 are suggesting is execution costs will rise, risks

 4 that neither party to a transaction want, they're

 5 going to be forced to have or they will be forced

 6 to bear the execution risk, which you minimize a

 7 little bit; but I think it's real, particularly in

 8 volatile markets. And this is something that

 9 happens, you know very frequently in the market.

 10 And many of the suggestions that we've

 11 been making are designed actually to enhance the

 12 transparency of these transactions. So for

 13 example, linking them on the tape is a

 14 transparency-enhancing suggestion. The managing

 15 the clearing --

 16 MR. TURBEVILLE: Post-trade, post-trade?

 17 MR. ELVIS: Sure, post-trade.

 18 MR. TURBEVILLE: Not pre-trade?

 19 MR. ELVIS: Well, if you have an order

 20 book that's available, you can see where the price

 21 is. And I would also say that you can't quote a

 22 swaption in vol[atility] terms unless you can fix the
 324

 1 Delta leg, otherwise you have to quote the option in

 2 price terms. And as the underlying moves around,

 3 you're going to have to be constantly

 4 recalculating, and it's actually going to be much

 5 less transparent I would say. Because I could

 6 say, oh, well, I see Treasuries at nine plus, no,

 7 I see them at nine, well, my -- you know, if we

 8 say, if we agree the Treasury is at nine plus and

 9 we're going to exchange the Treasury, agree the

 10 ten-year swap is at three percent, we're going to

 11 exchange it at three percent, that makes the

 12 negotiation between the two parties to swaption

 13 much more transparent and much cleaner in my

 14 opinion.

 15 MR. BERGER: I would just add, I mean, I

 16 think we should all be encouraged by the fact that

 17 execution venues are all trying to build better

 18 mousetraps for package transactions right now. I

 19 mean, Sunil could spend an hour talking about his,

 20 you know, portfolio termination and compaction

 21 tool. There are a number of SEFs that already

 22 stream quotes for swaps, curves, and butterflies,
 325

 1 and swap spreads, so and I think, you know, we've

 2 discussed already how in the interdealer markets

 3 there's probably already great central limit order

 4 books for certain types of package transactions.

 5 So there is a mechanism to see this work

 6 in, you know, the post-SEF landscape. I think

 7 there's just, you know, there's some hurdles to

 8 overcome to make sure it works seamlessly.

 9 CHAIRMAN O'MALIA: Thank you. Let's go

 10 to Mr. Fitzpatrick here and close this out.

 11 MR. FITZPATRICK: Thank you, Chairman

 12 O'Malia. For those of you that don't know, my

 13 name is Scott Fitzpatrick. I'm a representative

 14 today here as the current Chairman of the

 15 Wholesale Market Brokers Association. I'm also

 16 representing one of the firms that has a central

 17 order book for some of these package transactions.

 18 I was going to go into a little bit of preamble,

 19 Scott, but -- is that better, okay, all right

 20 we're good -- in the interest of time, I was going

 21 to go into a little bit of a preamble of how we

 22 got here, but I will go straight to the points.
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 1 ACTING CHAIRMAN WETJEN: And for the

 2 record O’Malia is shaking his head.

 3 MR. FITZPATRICK: I see they acknowledge

 4 it from the Chairman, thank you very much. And

 5 what I will say is that it isn't all bad news.

 6 Obviously, you know, we sat here today and there's

 7 been a monumental effort that has gone on across

 8 the industry, not only from SEFs, but from swap

 9 dealers, major swap participants, ECPs, and also

 10 our international colleagues and getting as much

 11 of this market efficiently and functionally

 12 operational on SEFs as it can. However, in saying

 13 all of that, there are still a few issues out

 14 there that merit some discussion or some reference

 15 in today's TAC meeting.

 16 I've deliberately left off the package

 17 transactions knowing the agenda for today

 18 obviously and coming up over the next few days.

 19 So what I want to do is just focus in on four of

 20 these areas. The first one being the confirmation

 21 requirement in rule 37.6(b) and more specifically

 22 footnote 195 in the obligation that SEFs maintain
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 1 privately negotiated master agreements between

 2 counterparties. Second issue I will touch on is

 3 the remaining cross border concerns as they relate

 4 to counterparties and execution platforms. The

 5 so-called embargo rule we'll talk about as point

 6 three and its restrictions on disclosing trade

 7 information under the CFTC's real-time reporting

 8 rules. And finally I'll briefly touch on issues

 9 having to do with post-trade straight-through processing

 10 and the pre-trade credit checks with the CFTC's

 11 guidance that trades rejected by clearinghouses

 12 are immediately void ab initio.

 13 Originally we were going to talk about

 14 each one and open it up for discussions, I'm just

 15 going to barrel through all four, and if anyone

 16 has any comments or wishes to raise discussion

 17 points at the end, we can do that. So first of

 18 all, I'll touch on the confirmation requirements

 19 and specifically footnote 195. Under the final

 20 rule 37.6(b), the Commission requires that at the

 21 time of execution, the SEF provide each

 22 counterparty to a transaction that it is entered
 328

 1 into on or pursuant to the rules of the SEF with a

 2 written record of all the terms of the transaction

 3 which legally supersedes any previous agreement and

 4 serve as confirmation of the transaction.

 5 And the preamble to the final rule, the

 6 Commission stated in a footnote, footnote 195 that

 7 SEFs could incorporate by reference the terms of a

 8 separate master agreement as long as the master

 9 agreement is submitted to the SEF before execution

 10 and nothing in the confirmation terms contradicts

 11 the standard terms from the master agreement. As

 12 a result of the unexpected implications of this

 13 footnote 195, there is widespread confusion

 14 currently and uncertainty within the industry

 15 regarding how to comply with the final rule or

 16 indeed resolve to agree completely on the legal

 17 interpretation of this ruling.

 18 While certain market participants have

 19 engaged Commission staff on this issue, I believe

 20 the industry would generally agree that for the

 21 clarification from the Commission is necessary.

 22 As a practical matter and speaking on behalf of a
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 1 SEF, it would be difficult, to say the least, for

 2 SEFs to house a complete and accurate library of

 3 the privately negotiating terms of free standing

 4 master agreements between customers. Market

 5 participants enter into these bilateral agreements

 6 separately from SEFs. And as a matter of industry

 7 practice until now, these agreements are not

 8 provided to other entities including SEFs.

 9 Even if some master agreements, we have

 10 provided to SEFs entirely, logistical difficulties

 11 would make it impractical for SEFs to ensure

 12 possession of all bilateral agreements and,

 13 secondly, accurate records as these agreements may

 14 be amended and restated periodically, let alone

 15 the fact that the industry would be required to

 16 manage a vast matrix of which SEFs have which

 17 versions of which documents for which products on

 18 an ongoing basis.

 19 As I'll indicate on more than one

 20 occasion during this brief presentation, this is

 21 an example of a situation where the theory is

 22 simple, but the practical implementation depending
 330

 1 on where you fall in terms of the solution, are

 2 potentially complex and time-consuming and

 3 arguably questionable in terms of real value to

 4 the Commission of requiring SEFs to maintain such

 5 a library, thus adding once again to the cost and

 6 technological stress points to the function of the

 7 markets.

 8 On cross-border concerns, we're

 9 understanding that there are a number of ongoing

 10 compliance concerns related to the Commission's

 11 cross-border interpretive guidance and policy

 12 statement, I'd like to focus this particular point

 13 on the staff advisory issued by the Division of

 14 Swap Dealer Intermediary Oversight in November

 15 of last year regarding the application of

 16 transaction level requirements to activity in the

 17 U.S. and the dislocation between the guidance

 18 provided to the trading community versus that of

 19 the SEF community.

 20 Staff advisory number 13-69 stated that a

 21 non-U.S. swap dealer, whether an affiliate or not

 22 of a U.S. person, regularly using personnel or
 331

 1 agents located in the U.S. to arrange, negotiate, or

 2 execute a swap with a non-U.S. person, generally

 3 would be required to comply with the transaction

 4 level requirements. Notably, the division believed

 5 these requirements would also apply to swaps

 6 between a non-U.S. swap dealer and a non-U.S.

 7 person booked in a non-U.S. branch of the

 8 non-U.S. swap dealer if the non-U.S. swap dealer

 9 is using personnel or agents located in the U.S.

 10 to arrange, negotiate, or execute such swaps.

 11 That was quite the --

 12 CHAIRMAN O'MALIA: Do you want to say

 13 that again?

 14 MR. FITZPATRICK: I got it right the

 15 first time, we'll leave it there. Earlier, in

 16 January of this year, the Commission requested

 17 comments on the advisory by providing no-action

 18 relief under CFTC letter number 14-01 to extend

 19 the time for non-U.S. swap dealers to comply with

 20 certain transaction level requirements to

 21 September 15, 2014. Though this no-action

 22 release provides relief to non-U.S. swap
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 1 dealers, it leaves open numerous cross-border

 2 questions related to SEF trading. At the same

 3 time while relief has been given to non-U.S. swap

 4 dealers, there has been no corresponding relief

 5 issued in the context of platforms operating in an

 6 execution capacity for these entities.

 7 To put this into context of TAC and

 8 apply the technological concerns, they're simple

 9 to describe, again, but complicated to implement.

 10 Trading platforms are extremely complex pieces of

 11 technology, any changes, even the slightest of

 12 them, take time to assess, analyze, define, code,

 13 test, and implement for the simple reason that if

 14 they go wrong, they can have a significant

 15 financial impact on liquidity, and worst case a

 16 client position, and as a result run the risk of

 17 damaging the relationship between the user of the

 18 platform and the provider of the platform.

 19 Having situations like the one I have

 20 just described in play currently seriously impacts

 21 day-to-day decision making as to how you run your

 22 platform from a business perspective, a regulatory
 333

 1 perspective, but also where you dedicate resource

 2 to make things right when you don't quite know

 3 what is right and you're overstretched on your

 4 resource as it is.

 5 Leaving that one there, I'll touch

 6 briefly on the embargo rule. The embargo rule

 7 covered under Commission rule 43.3(b)(3), which

 8 generally prohibits a registered SEF or DCM from

 9 disclosing swap transaction and pricing data

 10 related to publically reportable swap transactions

 11 before public dissemination of such by an SDR, as

 12 a result of the rule SEFs and DCMs that would like

 13 to continue to permit workups may face workflow

 14 issues or in a more simplified fact pattern,

 15 cannot share trade information with their

 16 customers until confirmation that the SDR has

 17 published the information or that the SEF or DCM

 18 can confirm transmittal of the required

 19 information to the SDR. This delay could have

 20 material effects on market liquidity.

 21 Anecdotally, I'm aware of potential

 22 remedies that include providing an exception to
 334

 1 this requirement so that SEFs can publish

 2 information simultaneously at the point to which

 3 the swap goes to the SDR; however, even that is

 4 laced with confusion in the context of direct

 5 connection to an SDR versus the use of third-party

 6 technologies and at what point transmittal of

 7 information has been deemed to have happened.

 8 All that said, the reality of this

 9 situation is that the workflow complications are

 10 real, the practicalities of the required

 11 technology solutions are real, and the impact can

 12 be severe.

 13 Finally, on the four points and the end

 14 of my remainder of that there's other things going

 15 on as well as package transactions, pre-trade

 16 clearing certainty. In September of last year

 17 Commission staff released guidance on the

 18 straight-through processing of swaps reminding

 19 market participants of their obligation related to

 20 swaps on a SEF or DCM that are intended to be

 21 cleared. Among other things, the staff stated

 22 that clearing FCMs must screen orders for
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 1 execution on a SEF regardless of the method of

 2 execution, and in turn SEFs must permit clearing

 3 FCMs to screen on an order-by-order basis. The

 4 staff folks have noted that the Commission's

 5 regulations require SEFs to have rules to

 6 facilitate prompt and efficient processing by DCOs

 7 and DCOs to accept or reject trades on a SEF or

 8 DCM as quickly as would be technologically

 9 practical as if fully automated systems were used.

 10 And under the guidance, any trade that

 11 is executed in a SEF or DCM and that is not

 12 accepted for clearing should be void ab initio.

 13 Subsequently, staff issued a no-action letter 13-66,

 14 which stated that subject to certain conditions, a

 15 SEF would not be subject to enforcement action for

 16 implementing the rules that established a new

 17 trade old terms procedure until June 30, 2014.

 18 Before I conclude, I'd just suggest that

 19 the issues here for discussion take on several

 20 forms. Firstly, the readiness of the marketplace

 21 to adopt the various methods and sources of the

 22 credit management process. Are platforms and the
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 1 credit hubs ready with fully tested models for

 2 all market types, central limit order book, RFQ,

 3 voice, on a push, and on a ping basis? Is the

 4 concept of a one and done on a trade that failed

 5 to clear for non-credit reasons realistic and

 6 acceptable?

 7 As I understand it, historically trades

 8 can and do go through several iterations of

 9 resubmission before ultimately clearing. What if

 10 the trade that fails to clear is a component part

 11 of a package transaction? And finally, is the

 12 time limit of 30 minutes for resubmission

 13 acceptable?

 14 At this point I'd like to thank you, Mr.

 15 Chairman O'Malia, for the opportunity to speak

 16 here today. And I'll now hand it back to you to

 17 close.

 18 CHAIRMAN O'MALIA: Well, thank you very

 19 much for doing that. I'm sorry we won't have more

 20 time to discuss it at this meeting. I did want to

 21 think about those. I know the cross border will

 22 be taken up on Wednesday, so that's a great
 337

 1 development. And some of these other things,

 2 we'll continue to look at.

 3 I'm grateful for all the participants,

 4 everybody that rearranged their schedule to

 5 accommodate the snowed-out date. I'm grateful for

 6 the panelists to make their arrangements. I'm

 7 grateful for our staff that have participated in

 8 this meeting, have stayed in here to listen to all

 9 of the recommendations that have been made today.

 10 So with that we are done. Thank you.

 11 (Whereupon, the PROCEEDINGS were

 12 adjourned.)

 13 * * * * *

 14

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 22
 338

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Mark Mahoney, notary public in and for

 4 the District of Columbia, do hereby certify that

 5 the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 (Signature and Seal on File)

 20 -----------------------------------

 21 Notary Public, in and for the District of Columbia

 22 My Commission Expires: March 14, 2014