UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 THIRD MEETING OF TECHNOLOGY ADVISORY COMMITTEE

 Washington, D.C.

 Tuesday, March 1, 2011
 2

 1 PARTICIPANTS:

 2 Commission Members:

 3 GARY GENSLER, Chairman

 4 BART CHILTON, Commissioner

 5 JILL SOMMERS, Commissioner

 6 SCOTT D. O'MALIA, Commissioner

 7

 8 Panel 1: Discussion of the Pre-Trade

 Functionality Subcommittee Report on Direct Market

 9 Access Controls

 10 HAROLD HILD

 Division of Market Oversight

 11

 MICHAEL GORHAM

 12 Industry Professor of Finance; Director, ITT

 Center for Financial Markets Illinois Institute of

 13 Technology

 14 NICK GARROW

 Global Head of Electronic Trading Newedge Group

 15

 Panel 2: Presentation and Discussion of Costs and

 16 Technology Challenges in Implementing the Trade

 Execution, Processing and Records Management

 17 Requirements under Dodd- Frank

 18 SUPURNA VEDBRAT

 Business Adviser, Fixed Income Trading and Market

 19 Structure Blackrock

 20 LARRY TABB

 Founder and CEO, Tabb Group

 21

 ROBERT GARRISON

 22 Chief Development Officer
 3

 1 PARTICIPANTS (CONT'D):

 2 MARISOL COLLAZO

 Vice President Trade Information Warehouse

 3 Depository Trust and Clearing Corporation

 4 Attending:

 5 BRENDA BOULTWOOD

 6 JOHN BREYAULT

 7 PETER CARR

 8 MICHAEL COSGROVE

 9 GARY A. DEWAAL

 10 JILL HARLAN

 11 DOUGLAS E. HARRIS

 12 RICHARD B. GORELICK

 13 SIMON GRENSTED

 14 PETER G. JOHNSON

 15 GARRY N. O'CONNOR

 16 DEAN PAYTON

 17 MATT SCHATZMANN

 18 THOMAS SECUNDA

 19 CHARLES A. VICE

 20 CHARLES F. WHITMAN

 21 * * * * *

 22
 4

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

 2 (1:00 p.m.)

 3 CHAIRMAN O'MALIA: Thank you everybody

 4 for coming today. Welcome to our new hearing

 5 room. I think this is our third event here. I

 6 thought I'd try to go a little "Today" show style

 7 with open windows so that if we get any protestors

 8 or obscene gestures, we'll close them, but we'll

 9 let the light in for right now. This is a new

 10 transparency. I expect none of the panelists to

 11 make obscene gestures.

 12 I'd like to welcome everybody to the

 13 Third CFTC Technology Advisory Committee. As you

 14 know, this meeting was originally scheduled for

 15 January 27. However, the morning of the 26th

 16 Washington was in the crosshairs of another winter

 17 storm, not like New York, but it's tough for us.

 18 I realize that while many of you could get here,

 19 the odds of getting out even just a few hours

 20 later would have been slim to none if received any

 21 accumulation whatsoever. So in the interest of

 22 everybody's schedules and your safety we postponed
 5

 1 the meeting. This was a good thing because the

 2 storm arrived just government officials directed

 3 everyone to leave early. This paralyzed the city

 4 and commutes that normally take an hour took 10,

 5 12 to 14 hours. The region appeared to be

 6 unprepared for the storm, but that was not the

 7 case. The problem was that the snow fell at an

 8 alarmingly fast rate, but by not coordinating the

 9 efforts, area employers created a rush hour during

 10 the height of the snowfall so that we were a

 11 victim of speed and failure to coordinate. Speed

 12 and coordination dominated our first two committee

 13 meetings and as we explore computerized trading

 14 and high-frequency trading and the results of the

 15 May 6, 2010 events. Today we're going to take our

 16 first shot at tying all of this together in the

 17 interests of preparing for the new regulatory

 18 world which is dominated by high speed and demands

 19 a coordinated approach.

 20 To begin we'll have Harry Hild, our

 21 senior economist of the Commission's Market

 22 Surveillance Group who will provide some
 6

 1 background on the current role of electronic

 2 trading and the use of Stop Logic functionalities

 3 on designated contract markets. On May 6 the

 4 deployment of one such functionality was critical

 5 to stopping the cascading of prices in the futures

 6 markets. As we explore our options we should

 7 never lose sight of what has already proven to

 8 work, but we should always be mindful of the

 9 potential for improvement. With our first panel

 10 there will be a discussion of the pretrade

 11 functionality subcommittee report on the

 12 recommendations of the pretrade practices and

 13 trading firms clearing and exchanges involved in

 14 direct market access. Dr. Gorham put this

 15 proposal together with the support of the

 16 subcommittee members. We thought we circulated it

 17 and I understand that many of you did not receive

 18 many of the handouts for today's hearing. I'm

 19 very sorry for that. They are all in your

 20 booklets here and obviously I would have preferred

 21 that you would have had the opportunity to review

 22 the subcommittee report beforehand, but we do have
 7

 1 Dr. Gorham here and he will present on that so

 2 we'll all be better informed for that.

 3 The subcommittee drew on the existing

 4 work of the FIA and the CFTC-SEC Joint Advisory

 5 Committee regarding the events of May. The PFS

 6 can serve as the foundation for our future

 7 proposed rules concerning testing and supervision

 8 requirements related to algorithmic trading. The

 9 PFS members who contributed their experience and

 10 expertise in drafting the report including Chuck

 11 Whitman, Chuck Vice, Gary DeWaal and Bryan Durkin.

 12 By raising the standards and establishing best

 13 practices, we can ensure that all participants are

 14 treated equally and ensure that the markets are

 15 protected by untested algorithms that could

 16 undermine well-functioning market.

 17 In addition to discussing the PFS report

 18 during the first panel, Nick Garrow, head of

 19 electronic trading at Newedge Group will lead a

 20 discussion on the technological applications

 21 needed to implement the PFS recommendations and I

 22 think you will be fascinated to learn about the
 8

 1 opportunities and challenges facing the market.

 2 Our second panel will focus on a

 3 different kind and coordination, the speed with

 4 which we can build and connect the technological

 5 infrastructures underlying the trade-execution,

 6 processing and record-management requirements

 7 under the Dodd-Frank Act. I know I say this

 8 often, but I continue to believe we must be

 9 realistic about the technological, budgetary and

 10 infrastructure challenges ahead and work to

 11 facilitate coordination of this infrastructure

 12 that sets reasonable timeframes to accomplish it.

 13 I'm interested to hear from the speakers and

 14 listen to the debate. This is our first attempt

 15 to tackle the technological-integration challenges

 16 and to get your input on this.

 17 Presentations will include a discussion

 18 of interconnection and execution of swaps by

 19 Supurna VedBrat of Blackrock, a discussion of the

 20 estimated costs and required investments led by

 21 Tabb Group CEO and founder Larry Tabb, and a

 22 discussion of the feasibility and proposed
 9

 1 universal identifiers and supporting data

 2 reporting requirements led by Marisol Collazo of

 3 DTTC.

 4 Our third and final panel has been

 5 intentionally left open for discussion. This is

 6 your time to raise issues and provide comment. I

 7 think the second panel should provide us some

 8 interesting options and challenges and I'd really

 9 like to facilitate that with discussion of what

 10 you see in the market and your thoughts on that.

 11 I would obviously like to thank my

 12 fellow Commissioners for their participation and

 13 would like to welcome our committee members and

 14 guest presenters. All of you have taken time out

 15 of your busy schedules to participate and

 16 contribute to the discussion today and we greatly

 17 appreciate that.

 18 I'm going to turn to the Commissioners

 19 for some comments and then we'll go to the opening

 20 panel. Mister Chairman?

 21 CHAIRMAN GENSLER: Thank you. Good

 22 afternoon and thank you, Commissioner O'Malia, for
 10

 1 chairing not only today's meeting but the whole

 2 Advisory Committee in bringing forward this group

 3 with these recommendations. I also want to thank

 4 my fellow Commissioners and the dedicated staff of

 5 the CFTC for all their hard work on Dodd-Frank

 6 implementation. Lastly I want to thank the

 7 members of this committee for participating and

 8 specifically the recommendations, the report of

 9 the Pretrade Functionality Subcommittee, that's a

 10 mouthful, and the presentations we're going to

 11 have on the second panel as well on implementation

 12 issues that are so critical.

 13 As Commissioner O'Malia mentioned, the

 14 Joint CFTC-SEC Advisory Committee which met I

 15 guess it was about 2 weeks ago on February 18

 16 addressed some similar issues with regard to

 17 advanced technology and the advances and some of

 18 the lessons out of May 6 and as we have witnessed

 19 in the past, technology changes, whether it was in

 20 the 19th century when we first had the tickertape

 21 or in the early 20th century, I believe it was in

 22 1929, when this newer invention called telephones
 11

 1 was allowed on the floor of the New York Stock

 2 Exchange and there was a consolidated,

 3 instantaneous bid-and-offer price brought together

 4 by telephones in 1929. We now regulate a futures

 5 marketplace that is approximately 90 percent

 6 electronically traded and the Advisory Committee

 7 made recommendations in this context and those

 8 recommendations include cross-market circuit

 9 breakers, pretrade risk safeguards which I know

 10 that the subcommittee is also looking at and other

 11 ways of testing for risk-management controls and

 12 supervisory requirements and I join Commissioner

 13 O'Malia in that we have directed staff to come up

 14 with some recommendations hopefully based on your

 15 input today, based on the public's feedback and

 16 based on the Joint Advisory Committee on

 17 supervision and testing.

 18 In terms of the report itself, I look

 19 forward to hearing your thoughts about how

 20 clearinghouses, trading firms and exchanges can

 21 address themselves to pretrade risk safeguards and

 22 I know that you've addressed quantity limits and
 12

 1 price collars and throttles, intraday position

 2 limits and the like and all of that is going to be

 3 very helpful for us to learn from you.

 4 Before I close I do want to say

 5 something briefly about our resource needs here at

 6 the CFTC. To fulfill our statutory

 7 responsibilities to continue to oversee the

 8 markets, the futures markets that we oversee as

 9 well as take on the new responsibility in the

 10 swaps marketplace, the CFTC does require adequate

 11 funding. I believe now is the time to invest in

 12 the oversight of the derivatives markets, both

 13 futures and swaps, for our key commodities whether

 14 that be agricultural, energy or metals, being the

 15 physicals, or the financial products that are so

 16 significant to our economy. Of course you know

 17 the statistics. We've been regulating a market

 18 that's about $40 trillion of notional size, in the

 19 swap markets about seven times that size or about

 20 $300 trillion, and our current funding at

 21 approximately $168 to $169 million, the agency is

 22 small compared to the industry we regulate by any
 13

 1 measure.

 2 Our resources are primarily staff and

 3 technology. We currently have about 676 staff.

 4 They're experienced, they're thoughtful, they're

 5 hard working, but they also need technology. We

 6 spend about 18 percent of our budget as of last

 7 year's numbers on technology and we need to make

 8 further investments in technology to efficiently

 9 oversee both the futures and swaps markets and I

 10 think it's only through that investment that we

 11 can adequately oversee a market that has this

 12 breadth and the size that we have. In fiscal 2011

 13 you know we're faced with the challenge where

 14 we're currently under a continuing resolution.

 15 That means we're funded where we were last year

 16 and unfortunately we've had to make some hard

 17 choices ones that I don't believe are of great

 18 benefit to our mission going forward to make cuts.

 19 I might not be traveling to Boca as I was asked

 20 earlier, but the more serious cuts are how do we

 21 do technology and we have cut back on that and I

 22 don't think that's good for the long term, and we
 14

 1 don't have any grant money and we don't have any

 2 money that goes outside.

 3 We need both technology and we need

 4 people. We need the staff obviously to process

 5 registration applications and conduct

 6 surveillance, rule enforcement, investigate fraud

 7 and the like that computers alone can't do, but we

 8 do need the technology. The President's 2011

 9 budget had an increase for both staff and

 10 technology, but on a percentage basis it was far

 11 more for technology. The 2012 budget includes a

 12 45-percent increase in staff but over 100-percent

 13 increase in technology and both are critical. For

 14 the CFTC to be a cop on the beat to ensure that

 15 markets for commodities, futures and swaps are

 16 protected and are transparent, I think we need

 17 both.

 18 Again I want to thank you. I want to

 19 thank Commissioner O'Malia for letting me say a

 20 little bit on resources as well.

 21 CHAIRMAN O'MALIA: Commissioner Dunn?

 22 COMMISSIONER DUNN: Thank you, Mister
 15

 1 Chairman. I want to thank you for holding this

 2 Technology Advisory Committee.

 3 During my tenure on the Commission I've

 4 observed firsthand the migration of trading from

 5 the pit to electronic platforms, the introduction

 6 of high-frequency trading and the growing

 7 significance of collation. I have marveled at the

 8 industry's technological advances while despairing

 9 over the Commission's inability to keep pace. I

 10 am more convinced than ever that unless the CFTC

 11 has a firm grasp on the technology advances being

 12 made in the world of derivatives trading, we will

 13 be woefully unprepared to meet the agency's

 14 mission after implementing the Dodd-Frank Act.

 15 In order to adequately meet our

 16 regulatory mandates, the Commission must have the

 17 technology and knowledge to understand what

 18 traders are doing and the resources to purchase

 19 and manage systems that will allow us to perform

 20 the necessary surveillance and oversight of the

 21 markets we regulate. I look forward to hearing

 22 the recommendations from the TAC and the sub-Task
 16

 1 Force on how the Commission fulfill its regulatory

 2 mandates in this rapidly changing technological

 3 environment. With the help of Chairman O'Malia

 4 and the TAC, I have no doubt that the Commission

 5 will know what we need to do to complete the

 6 mission before it. Unfortunately, due to the

 7 budget crisis facing the CFTC, I do not believe

 8 that we will have the necessary fiscal resources

 9 to meet the technological demands that face this

 10 agency.

 11 Many of the Dodd-Frank mandates are

 12 technologically intense including data

 13 recordkeeping and reporting, real-time reporting,

 14 oversight of swap data repositories and swap

 15 execution facilities. Each of these areas will

 16 undoubtedly require greater understanding of and

 17 reliance on technology. However, without adequate

 18 funding for technology, the Commission will be

 19 forced to rely on the SROs and the industry in

 20 general to perform some of these functions.

 21 To some this may sound like putting the

 22 proverbial fix in the henhouse. I believe that
 17

 1 the recommendations of the TAC indicate that

 2 industry-wide consistency of uniform adherence to

 3 standards is necessary. Unfortunately, there will

 4 be those who will try to game the system. It is

 5 my opinion that the recruitment, retention and

 6 training of our workforce to monitor the

 7 industry's compliance is of paramount importance.

 8 I look forward to today's discussion and I'd like

 9 to thank our panelists for their presentations and

 10 extend a special thanks to all the members of the

 11 Technology Advisory Committee who will help the

 12 CFTC as we try to understand the impact that

 13 technology is having on our markets. Once again,

 14 Chairman O'Malia, I'd like to thank you and your

 15 staff for this meeting today.

 16 CHAIRMAN O'MALIA: Commissioner Sommers?

 17 COMMISSIONER SOMMERS: Thank you, Mister

 18 Chairman, and thank you all for being here today

 19 and for the time that you dedicate to these types

 20 of advisory committees for the Commission which

 21 are very helpful to all of us as we struggle with

 22 some of these important issues.
 18

 1 As many of you in the room know, I've

 2 worked on these issues for approximately 16 years

 3 and some of the issues that we deal with never

 4 change. They're the same issues that we have

 5 every year such as our resource issue seems to

 6 really never go away. We always struggle with

 7 having the adequate resources that we need here at

 8 this Commission. Some things do change as the

 9 futures industry has evolved more than I would

 10 have ever imagined when I started working in this

 11 industry.

 12 The particular issues that we're dealing

 13 with today on direct market access and pretrade

 14 functionality have changed dramatically just in

 15 the almost 4 years that I've been here at the

 16 Commission so I think today it is very appropriate

 17 for us to be talking about the changes and the way

 18 the industry is dealing with many of these issues,

 19 and I want to thank you for bringing these issues

 20 to us today and for your leadership on the TAC

 21 Committee. And thank you to all of the presenters

 22 who are here today who are not part of the TAC
 19

 1 Committee, but thank you all for your time and

 2 dedication to these issues.

 3 CHAIRMAN O'MALIA: Commissioner Chilton?

 4 COMMISSIONER CHILTON: I'm here. Can

 5 you hear me, Commissioner O'Malia?

 6 CHAIRMAN O'MALIA: We can. Fire away.

 7 COMMISSIONER CHILTON: Thanks, and

 8 thanks for everybody's participation and thank you

 9 particularly to Commissioner O'Malia for his

 10 commitment and support for technology and

 11 everything we need to be doing at the CFTC.

 12 I've been calling and I did last week so

 13 I hope my colleagues will bear with me, I know you

 14 weren't there, the members of the TAC, but I've

 15 been calling HFT traders, cheetah traders, and

 16 that's not cheetah with a Boston accent, it's

 17 cheetah as the fastest land mammal. My concern is

 18 that at such an incredible speed that we need to

 19 keep up. As my colleagues have said, I don't

 20 think there is any way we can keep up with the

 21 budget circumstance that we're enduring right now

 22 and that we will potentially faced with in the
 20

 1 future. I think we can't keep up with the

 2 cheetahs full stop.

 3 There are a couple of things that I've

 4 said I think we need to be looking at and

 5 potentially doing. One is some sort of basic

 6 testing regime before cheetah trading programs go

 7 live. I'm not saying that the CFTC should do

 8 this. We clearly don't have the expertise. But

 9 perhaps the exchanges in their testing

 10 environment, perhaps NFA. I'm not talking about

 11 some exhaustive testing regime that would learn

 12 the fundamentals of all the algo and HFT trades,

 13 but maybe some sort of basic maybe like a Jiffy

 14 Lube 10-point checklist to make sure that when

 15 these things start operating in the markets, they

 16 operate efficiently and effectively and they don't

 17 roil markets.

 18 The second thing is I think we need some

 19 sort of fine-tune of exchange controls and the TAC

 20 subcommittee talked about this a little bit, a lot

 21 actually, the limit- up/limit-down, the circuit

 22 breakers and I very much appreciate that work.
 21

 1 The third thing which the subcommittee also talked

 2 about are those pretrade credentialed firm

 3 controls. I look forward to talk about these

 4 things specifically.

 5 I've also read in the last couple of

 6 days and perhaps everybody else read this when it

 7 came out. There was a very interesting study that

 8 was out at the end of November by Cartilla and

 9 Penalva and it's something that shed light on

 10 different aspects of how the cheetah traders are

 11 doing things. It's not just that they're fast,

 12 it's what they do in the markets and they gave

 13 four different examples, three of which apply to

 14 our markets and one is a securities model, of what

 15 they're doing in the markets. It is more than

 16 just being quick to the trade, so to the extent

 17 that we have time, Commissioner O'Malia, I'll be

 18 asking some questions about that too. Thank you

 19 again and thank you for your staff, Commissioner

 20 O'Malia, for setting this up.

 21 CHAIRMAN O'MALIA: Thank you. Let's go

 22 to Harry Hild. He is a senior economist at the
 22

 1 Division of Market Oversight here and advises on

 2 policy on both agriculture and financial futures.

 3 He is leading the DMO team in developing automated

 4 surveillance programs and has over 12 years of

 5 experience at both the CBOT and the CFTC. Harry,

 6 we welcome your participation to give us a good

 7 overview.

 8 MR. HILD: Thank you very much. I'm

 9 glad to be here. The following slides that I've

 10 prepared present some electronic trading statistic

 11 in the United States. Following that I'd like to

 12 very briefly discuss some Stop Logic

 13 functionalities.

 14 Very quickly or very briefly I should

 15 say, the first slide is titled "U.S. Futures and

 16 Options Trading." The data source for this is

 17 CME, CBOT, NYMEX and ICE Futures volume data which

 18 together represented 99 percent of total U.S.

 19 volume in 2010. The Y axis shows this volume in

 20 millions of contracts and as you can see the total

 21 U.S. Futures and options volume was over 3

 22 billion contracts in 2010. Eight-three percent of
 23

 1 that volume was attributed to electronic trading.

 2 The graph also shows that pit volume, the blue

 3 bars, has been between about 500 million to a

 4 billion contracts since 1998 and pit volume has

 5 been decreasing since 2006.

 6 The next slide is electronic trading

 7 percentages for designated contract markets. The

 8 CME, CBOT and NYMEX are grouped in the CME group

 9 totals. This slides shows that seven exchanges

 10 have 100-percent electronic trading volume. These

 11 exchanges do not currently have physical space

 12 dedicated to trading pits. There are four major

 13 exchange groups that will have trading pits and at

 14 those exchanges electronic trading represented

 15 from 82 to 87 percent of total volume.

 16 Next I'd like to briefly touch on the

 17 topic of stop loss cascading and show Stop Logic

 18 numbers from the CME for 2010. DMO, the Division

 19 of Market Oversight, is in the process of

 20 reviewing the different methodologies of Stop

 21 Logic cascading mitigation. That's a lot of words

 22 all put together, but cascading mitigation
 24

 1 functionality is in place at the exchange level so

 2 that it's not really pretrade, it's at the

 3 exchange level. I'm not aware of any trading

 4 firms that have this in place but that's really

 5 the place for it to be because the exchange has

 6 the full vision of all the markets. CME, NICE,

 7 the New York Stock Exchange Liffe and ICE have

 8 slightly forms of Stop Logic cascading mitigation

 9 functionality. While the exact mechanics of each

 10 of these programs is different across the

 11 exchanges, they do share some basic similarities

 12 such as price bands, limits and reasonability

 13 ranges. In short, they are very similar yet they

 14 are very different. I will defer specific

 15 questions about Stop Logic to the exchanges. I

 16 understand that Dean Payton is here and I'm glad

 17 to see him because Dean provided me with some of

 18 the information regarding CME Stop Logic

 19 functionality.

 20 The point I'm trying to make is that

 21 these functionalities are at the exchange level,

 22 that they're different and that we're looking in
 25

 1 the market impact that these different

 2 functionalities have if any or is there is a place

 3 for us to either normalize or not, but we're like

 4 I said in the process of evaluating these options.

 5 They all effectively serve to safeguard

 6 the market from cascading and we definitely saw

 7 this on May 6. The numbers on the chart, as you

 8 can see in the energy complex at CME there were 22

 9 Stop Logic events in 2010, in the agricultural

 10 space there were 25, metals had six, equities

 11 eight, the FX market had 14 and interest rates had

 12 two. Cascading stop loss orders are triggered if

 13 the market moves up or down to the level

 14 preselected by the trader entering the stop

 15 orders. Generally the rules provide that when the

 16 market moves up or down to the trader's

 17 preselected stop level for such an order, the

 18 order becomes a limit order with a specified limit

 19 price. These orders are then executable only to a

 20 price within the range of reasonability permitted

 21 by the system instead of becoming a market order.

 22 The CME uses a methodology called Globex Stop
 26

 1 Logic functionality which pauses trading. This is

 2 called the Stop Logic reserve period. This occurs

 3 when the trading engine recognizes that it has a

 4 series of resting stop orders that would lead to a

 5 cascade. Trading is halted for 5 seconds. If it

 6 occurs between 9:30 a.m. And 4:15 p.m. in the

 7 E-Mini S&P for example, and for 10 seconds during

 8 the balance of trading. During the reserve

 9 period, Globex accepts market and limit orders

 10 that are priced within the reasonability range and

 11 will then execute the orders after the 5-second

 12 pause. The system will pause for another 5-second

 13 reserve period if the market and limit orders

 14 submitted during the previous pause are outside of

 15 the reasonability range. This would then cause

 16 the market to gap open after the two 5-second

 17 reserve periods. On May 6, 2010, this

 18 functionality was only triggered for one 5- second

 19 reserve period.

 20 The next exchange that we looked at, ICE

 21 futures, call their program cascading stop

 22 mitigation which is very similar and it applies to
 27

 1 "system-based ICE-managed orders." It does not

 2 apply to stop orders which rest in front of ISV or

 3 DIA systems which are not within the control of

 4 the ICE trading platform. This functionality is

 5 currently in place for the USDX and Russell Index

 6 markets but not for the sots (?) markets.

 7 Those are the two programs that we've

 8 looked at so far. The New York Stock Exchange has

 9 one but we haven't dug into that one very much,

 10 but that's all I have. The point I'm trying to

 11 make here is that this is at the exchange level,

 12 it's not at the clearing firm of the trading firm

 13 and we're looking at in DMO some of the

 14 consistency that this provides to the market and

 15 whether or not these programs should involve

 16 stopping the market or just pausing it to let

 17 other market orders in. That's all I have. Are

 18 there any questions?

 19 CHAIRMAN O'MALIA: Thank you. Dr.

 20 Gorham?

 21 DR. GORHAM: I don't know, Harold, if

 22 this is for you or for Dean Payton, but when you
 28

 1 look at these numbers up there you see quite a bit

 2 of difference. Is the driver there essentially

 3 liquidity and the greater the liquidity that

 4 exists in the market the less frequently this has

 5 to be triggered?

 6 MR. HILD: I'll defer that to Dean.

 7 MR. PAYTON: Dr. Gorham, I think that's

 8 largely correct and it also has to do with the

 9 parameters of the Stop Logic functionality. But

 10 if you look in our most liquid products, say the

 11 E-Mini product, the Stop Logic event that we had

 12 on May 6 was the only situation during 2010 where

 13 that Stop Logic was implemented and that was

 14 similarly true in 2009 as well. When you have

 15 contracts that are potentially more deferred

 16 contracts that have more liquidity gaps, that's

 17 what the Stop Logic functionality is there for.

 18 It's to mitigate those transitory liquidity gaps

 19 and allow other market participants to come in and

 20 replenish that liquidity. If you look at the

 21 statistics that Harry has up there, arguably those

 22 are 77 instances where potentially disruptive
 29

 1 trading activity was mitigated by having this

 2 control at the exchange level.

 3 CHAIRMAN O'MALIA: Go ahead.

 4 DR. GORHAM: I want to comment that I

 5 think that this is a great innovation and I don't

 6 know if people remember this, but back in

 7 2003-2004, we used to get what we then called

 8 liquidity vacuums in the E-Mini S&P and in the

 9 similar contract at the Board of Trade and you

 10 would have these situations often times right

 11 before a 3-day holiday or 3-day weekend in which

 12 there weren't many traders there and in these

 13 electronic markets you'd get the same kind of

 14 thing we had in the flash crash and this is a

 15 great example of the exchanges themselves coming

 16 in in both cases and creating a functionality that

 17 essentially erased that for quite a while.

 18 CHAIRMAN GENSLER: I think that's

 19 correct that on May 6 it was very helpful. As it

 20 turned out it was the absolute bottom of the

 21 E-Mini. I have one question. The Joint Advisory

 22 Committee, the other advisory committee that the
 30

 1 CFTC-SEC raised is whether there are some

 2 circumstances where the stop loss functionality as

 3 it worked if it were to be triggered a second time

 4 whether there is need for a longer than 5-second

 5 gap so that I was curious whether you have a point

 6 of view or whether your subcommittee looked at

 7 that because the other committee raised it.

 8 DR. GORHAM: I don't have a point of

 9 view on that but there are many smarter people on

 10 my subcommittee than me so I don't know if anybody

 11 does.

 12 MR. PAYTON: Chairman Gensler, I think

 13 in terms of the manner in which the Stop Logic

 14 works, first of all, we do have situations where

 15 the Stop Logic isn't 5 seconds, it can be

 16 calibrated at 10 seconds, we have some that go out

 17 to 20 seconds so that there is a calibration

 18 period.

 19 CHAIRMAN GENSLER: That's by product.

 20 Right?

 21 DR. GORHAM: Yes, that's by product.

 22 Then additionally when a Stop Logic event occurs,
 31

 1 if that liquidity doesn't come in the way the Stop

 2 Logic functionality works in that situation is we

 3 would expand the price range and the timeframe and

 4 that would go through iterations of extending the

 5 pause to allow liquidity to come in at different

 6 price levels. So I think that the Joint Advisory

 7 Committee in their dialogue around that

 8 functionality didn't appreciate the full scope of

 9 what it's capabilities are.

 10 CHAIRMAN GENSLER: Dean just they've

 11 already taken care of it, but my question is given

 12 that the advisory committee raised this, maybe it

 13 would be good to know if you had a point of view.

 14 They were concerned with potential cascading of

 15 stop loss functionalities. I think Dean is saying

 16 you've taken that into consideration. And you may

 17 have. I'm just saying that the committee did give

 18 us something on that so it would be helpful if you

 19 had any view on it.

 20 CHAIRMAN O'MALIA: We have included in

 21 your packets the May 6 report from the joint

 22 committee. I think it's in the back there so that
 32

 1 you might take a look at that. Chuck, do you have

 2 an observation on ICE's similar Stop Logic tool?

 3 MR. VICE: Yes. I would say we're still

 4 evolving that. We just exchange-traded stop

 5 limits probably about a year ago or maybe a

 6 year-and-a-half ago to the platform and prior to

 7 that I think probably still a majority of the

 8 stops that we get today are triggered on our

 9 front-end ISV and so what we see is a market

 10 order. We have market order protection limits

 11 that make sure that market order doesn't go

 12 through a price band. The Stop Logic that we have

 13 that Harold alluded to earlier is turned on in

 14 some of our markets. With an exchange-traded stop

 15 there are essentially only a few things that you

 16 can do when you have a cascade. You can implement

 17 some kind of pause or trading floor or ceiling

 18 depending on the direction of the move which is

 19 probably where we're going to evolve to. You can

 20 cancel any unfilled order which is what our

 21 current logic does. Some people like that and

 22 some people hate it. Or you can reprice the
 33

 1 triggered stop at the floor. A lot of people view

 2 that as the worst option because if it is a

 3 momentary move or a spike and it's going to

 4 reverse quickly, you're likely going to get

 5 executed at the worst of the day. None of those

 6 are panaceas, and as Dean described a minute ago,

 7 I think that logic can get very complicated

 8 quickly, almost more complicated than the original

 9 problem.

 10 I think we're also looking at continuing

 11 to evolve our Stop Logic functionality with a

 12 broader velocity-oriented speed bump or whatever

 13 you want to call in any of the markets where we

 14 can deploy if it does down X percent or X number

 15 of ticks in Y amount of time, then again don't

 16 stop trading but set a temporary price floor or

 17 price ceiling depending on the direction of the

 18 move with the same general idea, if there is

 19 anything erroneous going on, give the market time

 20 to put more logical prices back in and hopefully

 21 bounce off that floor. It's a move driven by

 22 market events then eventually you're going to
 34

 1 remove the floor and the market is going trading

 2 in the same direction.

 3 CHAIRMAN O'MALIA: Thank you. Are there

 4 any other questions for Harry or Alice? Dr.

 5 Gorham, if you'll present your report. Thank you,

 6 Harry. Dr. Michael Gorham is the head of our

 7 subcommittee which we created at Thanksgiving in

 8 order to begin to address these pretrade

 9 functionalities associated with direct market

 10 access. Many of our rulemakings are considering

 11 what options we have in implementing these

 12 pretrade controls as we develop new rules for the

 13 designated contract market and SEFs. We asked Dr.

 14 Gorham to reflect on the proposals in the industry

 15 today and any other observations we might add. He

 16 has put together the report before which is in

 17 your binders and he will present that. He is from

 18 the Illinois Institute of Technology and served

 19 for more than three decades as a research

 20 economist at the Federal Reserve Bank of San

 21 Francisco and served as the Vice President of

 22 Product Development and Commodity Marketing,
 35

 1 Education and International Marketing spanning 18

 2 years at the CME. He also has academic and

 3 research experience at IIT's Center for Law and

 4 Financial Markets, has been the editor of "The

 5 Journal of Global Financial Markets" and also

 6 served as the first Director of the Division

 7 Market Oversight for the CFTC. We appreciate his

 8 experience and he is the best candidate to conduct

 9 this subcommittee review, and we look forward to

 10 his presentation.

 11 DR. GORHAM: Thank you. That actually

 12 makes me about 112 years old. I was counting up

 13 those numbers.

 14 The first thing I want to say is that

 15 I'm doing this presentation, but the committee put

 16 this report together so that this is the

 17 intellectual product of these guys. One of the

 18 points that we make in the paper is that there are

 19 really three tiers in the electronic trading

 20 world. There is the trading firm, there is the

 21 clearing firm and there is the exchange.

 22 Commissioner O'Malia did a great job I think
 36

 1 putting this subcommittee together because you've

 2 got all three. In fact, the exchanges are the

 3 most important in this sphere and you've got the

 4 two major exchanges in the U.S. on the committee

 5 and that's really good. Bryan Durkin can't be

 6 here today, but Dean Payton will be here to talk

 7 about anything that might be relevant there.

 8 You've got Gary DeWaal in person from the clearing

 9 firm and you've got Chuck Whitman from one of the

 10 premiere trading firms in Chicago. I just found

 11 out a few minutes before we started today that

 12 Richard Gorelick had put together a set of

 13 proposals I think even 3 years before the FIA came

 14 out with their initials ones so that there is a

 15 lot of other very thoughtful consideration in the

 16 room that I think we'll be able to tap into. What

 17 I'll do is walk you quickly through what the paper

 18 says and then I hope that my committee members

 19 will be able to respond to all the questions and

 20 even add things if there aren't questions.

 21 In terms of focus, first of all, we

 22 focused on direct market access. The idea here is
 37

 1 that we are recommending pretrade measures that

 2 would preserve market integrity in the case of

 3 direct market access. I want to put this one

 4 thought in your heads before we proceed. Being at

 5 the CFTC is sort of like being a New York cop to

 6 some extent. What you see are all the problems

 7 that you have to solve and all the stuff that you

 8 fix, and you do. That's why you guys are all

 9 here. But I want to remind you and all of us here

 10 at the table that there are a lot wonderful things

 11 that have come out of electronic trading. Many of

 12 us in this room have seen trading evolve all the

 13 way through. There is much greater transparency,

 14 there is much longer cost, there is greater

 15 liquidity, there is much broader participation in

 16 the markets than ever before and there is much

 17 faster access to these markets. One of the things

 18 that we were trying to do in the things that we

 19 came up with is not to mess those things up, but

 20 to preserve those.

 21 The principles that were guiding us as

 22 we made our choices were first of all this is an
 38

 1 incredibly dynamic industry. You can jump back 2

 2 years or 2 years before that and you probably

 3 wouldn't have imagined seeing all the things that

 4 you've seen that have come out. We want to keep

 5 that dynamism. One of the things that may be a

 6 little controversial here is this concept of

 7 bringing all hands on deck. In other words, we

 8 talked about all three tiers in the industry and

 9 what we're doing is we are putting this

 10 responsibility into the laps of all three of those

 11 tiers. Some have argued which is partially

 12 correct that the exchanges are key. They are the

 13 most important. There are fewer exchanges. They

 14 are the ones that ensures that everybody who comes

 15 to the exchange would have to do what was required

 16 once you got to the matching engine so that that's

 17 really the most important. This may seem

 18 redundant, but we put obligations on the trading

 19 firms and on the clearing firms as well and you'll

 20 see why in just a second. The third thing here is

 21 to make sure that we recognize that each of these

 22 tiers has incentives. The trading firms obviously
 39

 1 are trying to be faster than all the other trading

 2 firms and do whatever they can to minimize latency

 3 and that's where direct market access came from,

 4 the fact that you can save a certain number of

 5 milliseconds from doing that. The brokers

 6 obviously want to have that business and an

 7 increasingly significant amount of business

 8 putting and the burden solely on the brokers as

 9 was done with the SEC is something that really

 10 doesn't make sense, but the clearing firms have to

 11 be involved and the exchanges are obviously are

 12 competing with one another so that they have their

 13 own incentives in terms of minimizing latency for

 14 that purpose, but certainly anybody coming in to a

 15 single exchange would have to abide by any

 16 standards that the exchange sets.

 17 There are two fairness issues. The

 18 first one relates to what I just said which is we

 19 don't want to have a situation where there is any

 20 kind of a race to the bottom where a clearing firm

 21 or a trading firm that acts less responsibly is

 22 put at some kind of an advantage so the standards
 40

 1 that we put in try to do that. The other part of

 2 the fairness issue is to make sure that the new

 3 swaps execution facilities are treated the same as

 4 the designated contract markets and of course any

 5 foreign board of trade that's relevant in the U.S.

 6 market should have the same obligations. Finally,

 7 in terms of these guiding principles there is this

 8 issue of coordinating with the SEC. You have a

 9 joint commission on that. The idea here is that

 10 those firms that are both FCMs and broker dealers

 11 would certainly benefit from having similarity

 12 across the two regulatory worlds.

 13 We looked at the other reports, not just

 14 the FIA reports but certainly the April and

 15 November FIA reports and some of you in this room

 16 have participated in that. What we've attempted

 17 to do is to distill from those reports the things

 18 that we felt were essential to get done. One of

 19 the issues I think that can be discussed is did we

 20 leave anything out or does this do an adequate job

 21 of doing that.

 22 I'll quickly go through the three
 41

 1 levels. Starting with the trading firms, the

 2 trading firms must establish pretrade quantity

 3 limits for each order. In fact, these first two

 4 things, the quantity limits and the price collars,

 5 are restrictions that the firms would put on

 6 themselves that would even prevent the order from

 7 leaving the firm and going to the exchange. The

 8 pretrade price collars obviously are meant to

 9 prevent orders from being submitted that have

 10 prices that are far off the current market. The

 11 next two things, the execution throttles and the

 12 message throttles, are cases where you would stop

 13 shipping trades if in fact two many executions or

 14 too many messages were resulting from these

 15 algorithms and there would have to be human

 16 intervention before that could start up again.

 17 Finally, every trading firm would have to have a

 18 kill button in order to stop orders from being

 19 executed that had been already sent and to stop

 20 any further orders from going in. This would be

 21 hopefully something that would almost never

 22 happen, but it would be a fair-safe backup.
 42

 1 In moving to the clearing firms, the

 2 major job of the clearing firms is to ensure that

 3 their client trading firms behave. The idea would

 4 be that they would have to ensure that the trading

 5 firms do establish the functionalities that we

 6 just listed, that they would utilize these

 7 functionalities for all trading done by the

 8 trading firm, that the parameters in these, that

 9 is to say the price limits, the quality limits,

 10 would have to be parameters that had been agreed

 11 to by the clearing firm and that the clearing firm

 12 would obtain written certification of all of those

 13 things that I just mentioned as well as written

 14 certification from the independent software vendor

 15 if in fact the trading firm's trading was done

 16 from the ISV's server as opposed to the trading

 17 firm's server itself. The clearing firm would

 18 have to have access to the trading firm's kill

 19 button.

 20 Finally, the exchange. As I said

 21 before, the exchange is really the key anchor in

 22 controlling risk. Whatever it would set up, it
 43

 1 would have to require that all firms use these

 2 controls. The firms wouldn't have a choice or

 3 not. They would all have to do that. The

 4 exchanges would have pretrade quantity limits on

 5 individual orders, they would have intraday

 6 position limits that would be set by the clearing

 7 firms, they would have pretrade price collars that

 8 we spoke of before and also have message

 9 throttles. In addition to that, the exchanges

 10 would allow clearing and trading firms to set

 11 automatic cancellation of orders if there were a

 12 case where the trading firm was disconnected from

 13 the exchange and would also allow the trading

 14 firms and clearing firms to view both working and

 15 filled orders and to cancel working orders if

 16 necessary. The final thing for the exchange is

 17 ensure that they have clear error trade policies.

 18 I should say that the exchanges have a lot of

 19 these things that we're talking here already but

 20 have clear error trade policies that favor trade

 21 price adjustment as opposed to simply busting

 22 trades.
 44

 1 The idea here is that if all three of

 2 these tiers work together on this problem, we

 3 think this would go a long way to prevent any sort

 4 of errant algorithm sneaking in and taking the

 5 system down. Maybe I would first ask if any of my

 6 fellow committee members want to add anything to

 7 what I've just said.

 8 MR. VICE: I had a couple of points. I

 9 thought Mike did a good summarizing our report.

 10 I can think of three additional points.

 11 One, all of the things that we were suggesting the

 12 exchanges should do we feel strongly should apply

 13 to swaps execution facilities equally as well

 14 particularly any that are going to offer direct

 15 market access. My second point is I think we

 16 tried to keep in mind, I don't know that we

 17 explicitly said it in the report, the original

 18 request of the Commission and that is to give some

 19 guidance on how prescriptive can you be or not be

 20 in potential rulemaking to require these three

 21 different tiers to do these things. I think

 22 you'll see in the report that we had general
 45

 1 agreement on the bulleted items. On the exchange

 2 there you see the pretrade quantity limits,

 3 intraday position limits, pretrade price collars

 4 and message throttles and so forth that I think we

 5 feel that's the level of prescription that maybe

 6 the Commission should target, not specify how

 7 message throttles should be done, leave that up to

 8 the exchanges to innovate there and to come up

 9 with policies that fit individual markets

 10 depending on how liquid they are, how widely

 11 traded they are, what time of day they trade and

 12 those types of things, but at least to give you

 13 some specificity that you could put into some

 14 rulemaking.

 15 I think the third point in response to

 16 what I believe Commissioner Chilton raised in his

 17 remarks concerning putting close ties between HFT

 18 traders and someone else in terms of a second set

 19 of eyes looking at what they're doing -- the

 20 Commission or the exchange for that matter could

 21 go in and sit on their side of the table and know

 22 what's going on with their algorithm, but I think
 46

 1 both Bryan both felt from the exchange side that

 2 we already have fairly rigorous conformance tests

 3 that the direct market access traders have to go

 4 through. It's largely technology oriented making

 5 sure that the orders that they're sending us and

 6 that we're receiving are indeed the ones they

 7 intended to send and that they are interpreting

 8 our market data feeds in the proper way and so

 9 forth. I think we can add some additional checks

 10 there that would largely be documentation provided

 11 by the HFTs and representations by the HFTs

 12 because most of the tests you'll notice are

 13 negative tests, don't send us something, don't

 14 send me too messages to that there is no way for

 15 us on an exchange side to see a sign of whether

 16 that happened or not but it's a natural extension

 17 of our relationships with these high-frequency

 18 traders to bolt on some additional verification of

 19 the conformance process and they're signing that

 20 they indeed have incorporated this pretrade

 21 functionality.

 22 CHAIRMAN O'MALIA: Gary?
 47

 1 MR. DEWAAL: Thank you. I agree that I

 2 think our chairman of our subcommittee did an

 3 excellent job in summarizing where we came out.

 4 I would say that when I read the

 5 SEC-CFTC Advisory Committee on Emerging Regulatory

 6 Issues and their special report, what did strike

 7 me was the fact that the discussion only related

 8 to the exchanges and the brokers. I was surprised

 9 at other than trying to induce liquidity through

 10 maybe some kind of congestion pricing, there

 11 wasn't a lot of discussion about the trading firms

 12 except to bemoan the fact that market makers are

 13 sort of disappearing and high-frequency traders

 14 are somehow there. I do think that when we look

 15 at this issue that you've got to consider the

 16 responsibility of all players. I think that's

 17 what the FIA best practices study did last year

 18 and I think that it's something important to

 19 consider.

 20 The other thing that I was struck with

 21 is when I was asked personally, What kind of

 22 regulatory proposals do you think we need to do
 48

 1 something and make things better? I was also a

 2 little surprised by that because as a clearing

 3 firm I thought I had responsibilities already in

 4 this area. I thought I had responsibilities to

 5 have prudent risk- management practices and I

 6 thought I had the duty of supervision over my

 7 accounts so I was wondering whether or not I was

 8 now being given a by somehow and I had just been

 9 more conservative all these years than I should

 10 have been.

 11 CHAIRMAN GENSLER: Just know.

 12 MR. DEWAAL: Rats. I thought I'd try.

 13 COMMISSIONER DUNN: Know all pass few,

 14 Gary.

 15 MR. DEWAAL: I think there's an element

 16 of practicality here that we've got to look at. I

 17 know Nick Garrow, I don't want to keep him. He's

 18 my colleague from London and he's going to speak

 19 in a few minutes about some of the logical issues

 20 and some of the practical issues that we've had

 21 trying to implement solutions and it's late there

 22 so I'm definitely going to shut up quickly.
 49

 1 This all begins as a matter of

 2 practicality. One thing that strikes me again is

 3 that, yes, trading firms are customers and to the

 4 extent that trading firms do stupid things like

 5 sometimes they do now and they commit market

 6 offenses, the CFTC has never lacked authority to

 7 go after people who commit manipulation or commit

 8 other types of market offense under 4(c). So as a

 9 result because trading firms have an interest in

 10 not violating the rules as they exist and they

 11 also have an interest in their own financial

 12 solvency, the responsible ones act responsibly and

 13 they do a lot of the stuff that we're already

 14 talking about they should do.

 15 From the brokerage firm and this is

 16 where I've always been a little confused, and I'll

 17 speak a little story because I think it's useful,

 18 we have an obligation right off the bat. We don't

 19 have as in the securities industry the technical

 20 know-your-customer types of obligations and

 21 suitability although we obviously have them in the

 22 AML area. But obviously we select our customers.
 50

 1 We also are concerned about our capital and our

 2 preservation and we want to do business with

 3 customers who aren't going to put us out of

 4 business ourselves so that there is a certain

 5 amount of due diligence that we want to conduct

 6 right off the beginning and that's important.

 7 It's important that we select customers

 8 particularly in the high-frequency area who we

 9 think are responsible and when the trading firms

 10 themselves came out again last year with some

 11 recommendations that they themselves should be

 12 held to, we said that's good because that's the

 13 kind of stuff we can now hold them to in our due

 14 diligence process.

 15 But there's another real practical

 16 issue. When this whole debate rose up last year

 17 and we changed CEOs in our organization globally,

 18 he asked a very question. He asked, How much do

 19 these firms make for us? He asked you've got to

 20 look at a reward-risk analysis and not only is

 21 there a suitable assessment in the first place,

 22 but since you are taking the risk that one of
 51

 1 these firms could do something wrong, blow up or

 2 whatever, you better make sure that you're making

 3 a fair amount of money so that there is the right

 4 ratio of return risk. I think at the beginning

 5 brokers not only have an initial obligation to

 6 assess their clients to make sure that they're

 7 doing the right things, that they're reputable

 8 people, and in the high-frequency world again we

 9 now have these new standards to test, but ongoing

 10 to keep on making sure that they're abiding by the

 11 rules they agreed to and probably even though it's

 12 not a regulatory issue making sure that they make

 13 money.

 14 Then obviously we think that it's very,

 15 very important that there be risk filters at not

 16 just the exchange level because as Charles said I

 17 think that would prejudice the exchange. Any

 18 regulated type market whether it's the regulated

 19 exchanges or the ATSes in the securities world,

 20 whether it's the SEFs, the DCMs in our world, if

 21 you're putting out a public exchange and you're

 22 allowing people to come in in a direct access way,
 52

 1 then there should be some kind of filters there.

 2 We believe they should be at the exchange level

 3 and I think even our clients believe they should

 4 be at the exchange levels because if not you have

 5 a situation like you have now in the securities

 6 world where you are going to have a race to

 7 minimum compliance to whatever the rules are going

 8 to be at the broker level. Because at the end of

 9 the day we're all competing with each other, the

 10 trading firms are all competing with each other,

 11 the name of the game as we discussed early on is

 12 low latency and we want to have a high bar and not

 13 a low bar and the markets themselves are best able

 14 because they know what the parameters of their

 15 markets are, they know the liquidity issues, they

 16 know that there might be a difference between how

 17 you should allow access to agricultural markets

 18 versus equities markets versus fixed- income

 19 markets. They know and have a better feel of what

 20 kind of risk controls should be there and they can

 21 make the bar equal for all entrants. We think

 22 that's very, very important not just in the
 53

 1 futures markets where traditionally it's been

 2 easier to have controls at that level, but in all

 3 markets, securities as well as futures, and going

 4 forward when the SEFs are out there also.

 5 Finally, again from the broker

 6 perspective, one of the issues, and I know it's a

 7 debate that goes on, is what kind of electronic

 8 prefiltering should occur. Obviously it's not in

 9 our interest as a broker to allow our clients to

 10 do dumb things, but technologically it's not as

 11 easy as it seems to be to prevent dumb things.

 12 One of the great struggles we've had as an

 13 organization globally, and not so much in the

 14 United States but certainly outside the United

 15 States, is even getting timely feeds after the

 16 fact of exchange data that we can run through our

 17 computers to do analytics that we want to do to

 18 make sure our clients are behaving. The problem

 19 with running those analytics in advance of trading

 20 and acting on it is that on behalf of clients we

 21 may not be seeing the entire trade, we may be only

 22 seeing a part of a trade and for us to stop a
 54

 1 trade because we think something in a nanosecond

 2 may be wrong could be devastating to that client

 3 because it's part of another trade that we're not

 4 seeing and we could be wrong and the liability

 5 issues would be dramatic on us after the fact. At

 6 least under the current legal framework this is

 7 not something that we hope we have to get into

 8 because it's a mess. But posttrade, absolutely.

 9 We should be given as a brokerage company data as

 10 quickly, in a uniform layout as possible again

 11 because we're responsible and we want to do

 12 analytics on our clients as quickly as possible.

 13 Again to reinforce what's been said,

 14 it's a shared process. People who are responsible

 15 in this business who are already acting

 16 practically and as the technology gets better we

 17 can even act better, and as far as I was aware,

 18 I've already got this kind of obligation. So

 19 whether there needs to be a little tweaking here

 20 or there, I'll let others decide other than me,

 21 but to me the obligation to be responsible is

 22 already out there.
 55

 1 CHAIRMAN O'MALIA: Brenda?

 2 MS. BLOUTWOOD: I would like to thank

 3 the subcommittee for the balanced view across the

 4 trade process of risk-management responsibilities.

 5 I think it's important. But I have a question of

 6 the subcommittee and that is your thoughts about

 7 the role of the regulator. After the rulemaking

 8 occurs, what type of governance process perhaps or

 9 postexecution penalties? What did you discuss as

 10 the ongoing role of a regulator?

 11 DR. GORHAM: I'll start. We really

 12 didn't get into the area of penalties at all and

 13 depending on the funding of the Commission, it's

 14 going to be difficult to say what could be done

 15 from the point of view of enforcement. We were

 16 kind of coming from an ideal world, but you're

 17 raising a great question and let me punt it to

 18 anybody else on the committee who has some

 19 thoughts on this.

 20 MR. DEWAAL: As I just said a few

 21 seconds ago, I've liked under the assumption that

 22 I have a duty, an obligation to supervise my
 56

 1 accounts, my personnel, and having just been fined

 2 by the Commission a couple ago or my firm, I know

 3 it's serious that if you don't act responsibly

 4 you're probably going to get penalized. I think

 5 there's a debate that goes on forever. In fact, I

 6 was having this debate with a foreign regulator

 7 last night. I remember 15 years ago when London

 8 regulators went to principles-based regulation and

 9 everybody said that's going to be a great scenario

 10 because there are going to be broad principles and

 11 strict enforcement and the industry wanted that.

 12 Then in about 3 years when there was a lot of

 13 enforcement action, of course the industry said,

 14 no, we don't want such broad principles. We want

 15 things that are much more narrow so that we have a

 16 careful map to know what we're going to do. So I

 17 know there's always tension.

 18 But it seems to me again that the

 19 reality of life is whether I want it or I don't

 20 want it, if I act irresponsibly and if there is

 21 going to be a problem out there, market

 22 participants are going to get dinged. That's just
 57

 1 the way it works in a regulated environment.

 2 Obviously the regulators need the tools to be able

 3 to monitor markets. I am very sympathetic when I

 4 hear the pleas of the Commissioners for funding.

 5 I know what it costs my organization and again

 6 Nick Garrow will speak in a few seconds. I know

 7 what it costs my organization just for the bid of

 8 the trades that we look at. I just have to assume

 9 it's multiples of that for what the Commission is

 10 looking at and they desperately need the

 11 technology and they desperately need the

 12 cooperation of the exchanges probably not just in

 13 the United States because through the memorandums

 14 of understanding just like we need to understand

 15 that the client is placing his trade on the CME

 16 versus trades against the Hong Kong exchange and

 17 the TAIFEX, the regulators at the CFTC need that

 18 too to truly understand what's going on out there.

 19 The technology demands are tremendous so that I

 20 think they have the obligation or responsibility

 21 to do the proper kind of surveillance to

 22 understand the full scope of what's going on and
 58

 1 they need to work with their international

 2 colleagues. Then as far as industry participants,

 3 I'm probably going out on a limb here and I'm sure

 4 I'm going to get yelled at all my colleagues at my

 5 competitors, but the name of the game is if you

 6 act irresponsibly you're going to get dinged.

 7 COMMISSIONER DUNN: If I can drill down

 8 on what Brenda has started here, as I look at this

 9 and it appears, Michael, that the sub committee is

 10 basing it upon the FIA's PTG white paper and

 11 that's what everybody has come together on a

 12 consensus that that's where we are and I'm

 13 wondering where that is vis-à-vis the regulations

 14 that we're currently working on. The second thing

 15 that strikes me is that because you're asking both

 16 the exchanges and the clearing firms to supervise

 17 the trading firms and you're saying that they

 18 should take reasonable measures. I'd like to know

 19 what does reasonable measures mean because that's

 20 something that we're wrestling with right now.

 21 Then, Gary, if I understand your answer, you think

 22 the regulator come in at the end when someone
 59

 1 steps over the boundary and slaps their hands or

 2 gives them a fine. When I made my opening

 3 statement about people thinking that we're putting

 4 the fox in the henhouse, we're asking the industry

 5 to do this overall regulation and we don't have a

 6 role until the end of the day when we see that

 7 something has happened. Is there a role for the

 8 regulator before we get to that point?

 9 DR. GORHAM: Chuck I think started to

 10 say something. Can you weave that in?

 11 MR. WHITMAN: I think there are a couple

 12 of points that are worth noting on this. I

 13 thought, Gary, you explained the role of the

 14 clearing firm very well and I think one of the

 15 things that's important is for us as a trading

 16 firm, there are a series of things that as Gary

 17 talked about, if you look in the -- trading

 18 community or if you look in the principle trading

 19 community, most of us trade our own money. As

 20 such it's our own capital that's at risk on a

 21 day-in and day-out basis. We don't have clients.

 22 We don't have customers. A big thing for us is
 60

 1 reward to risk. We want to make sure that

 2 tomorrow we can come back and trade. I can tell

 3 you from my own experience that we've had

 4 strategies that we've gone through and looked at

 5 where we made choices at the expense of latency to

 6 make the strategy more safe and stable. One of

 7 the things that I wanted to clarify that Michael

 8 talked about is we control the pretrade quantity

 9 limits and the pretrade rice collars, but we also

 10 control the message throttles and the message

 11 throttles are a key component that use in managing

 12 orders going in and out the door. Quantity limits

 13 keep orders that are too big from going out, price

 14 collars keep mispriced orders from going out and

 15 throttles keep too many orders from going out.

 16 The one thing that I think we all have

 17 learned is that you do everything you can to

 18 eliminate errors. We have a code base that's

 19 several-million lines of code for our company and

 20 when you have several-million lines of code, no

 21 matter how hard you try you are going to have some

 22 errors. Then what do you do to minimize the
 61

 1 impact of errors? You do everything you can to

 2 eliminate them and then if you do have them, how

 3 do you minimize them? These are things that we've

 4 put in place to be able to minimize the impact of

 5 an error.

 6 In addition, one of the things that I

 7 will back up that Gary said is all of our clearing

 8 relationships both when we came in from an

 9 introductory standpoint and then in an ongoing

 10 standpoint, we are going trough a thorough

 11 interview and they come through and there are a

 12 lot of things they want to see. Do you have a

 13 quality assurance department? Are you stress

 14 testing your releases? Are you stress testing

 15 your software? What are your oversight policies?

 16 -- these sorts of things that we are being held

 17 accountable for to be able to have the

 18 relationship in the first place.

 19 One of the things that we did last year

 20 is we started a risk working group within our firm

 21 where people from compliance, people from

 22 technology, engineers, they meet twice a month and
 62

 1 they talk about what can we do to make the way

 2 that we trade in our firm more stable and more

 3 safe, and we have given access to that to some of

 4 the clearing firms at various points in time so

 5 they can come in and have even more comfort with

 6 how we do things.

 7 One of the things I also want to add is

 8 that Michael alluded to this race to the bottom.

 9 I believe that standardization for firms like ours

 10 is a benefit to somebody like me because

 11 standardization makes a level playing field and I

 12 don't have to worry about somebody else cutting a

 13 corner that then not only hurts the industry but

 14 also potentially hurts us and one of our

 15 strategies. I want to make sure that I represent

 16 that from the firms side that firms like ours

 17 spend a lot of money and put in a lot of time in

 18 to make sure that we stay safe. It's our business

 19 that's at stake.

 20 The next thing is going to your

 21 question, Commissioner or your statement, when we

 22 put this plan together one of the things we talked
 63

 1 about as a committee was how could we put this

 2 together in a way that was enforceable and that

 3 could be looked after. One of the things that we

 4 believed is that you needed to have multiple

 5 layers of redundancy at the firm level, at the

 6 clearing firm level and at the exchange level.

 7 And from a regulator's standpoint, the easiest

 8 places for the regulator to check in is at the

 9 exchange. At the firm level there are so many

 10 firms and there are so many strategies that it's

 11 very hard to get into the specifics of any one

 12 thing, but if you have principles and you have

 13 checklists of things that you have to have in

 14 place, like you have a quality assurance team and

 15 you have to stress test releases before you put

 16 releases out, things of that nature are things

 17 that are good for firms like ours and they're good

 18 for the industry. And I think as we put that

 19 together, that was why we put together the

 20 proposal the way that we did in that we put it in

 21 a way that we thought was practical to be

 22 enforced.
 64

 1 MR. VICE: I was going to add that the

 2 nature of the remit that the subcommittee was what

 3 kind of technology can you and should you

 4 implement at these three levels to prevent bad

 5 things from happening. In most of the world you

 6 can only prevent so many things. Policing is

 7 typically an after-the-fact function. The crime

 8 has already occurred. This was an opportunity and

 9 a scope of discussion based on the FIA report to

 10 at those three tiers what can we do to prevent

 11 excessive messaging or to prevent fat-finger

 12 errors that result in error trades. We're not

 13 going to consider it an enforcement issue if

 14 someone sends us an excessive amount of messages

 15 that it goes past our throttle, we're not going to

 16 accept it as an exchange, we're going to look at

 17 the firm that sent that to us. They may have a

 18 different parameter set than we did. We didn't

 19 vouch for their parameter. It's up to them to set

 20 their parameter at a proper level and it's up to

 21 us to protect the exchange and the rest of the

 22 participants from excessive messaging. The
 65

 1 parameters may be different, we're probably going

 2 to have a discussion there, but we're not going to

 3 view that as a type of issue that some enforcement

 4 action needs to take place.

 5 I think there are other things we do

 6 that are beyond the scope of the subcommittee

 7 which was in the pretrade area but the exchanges

 8 certainly do and I'm sure the clearing firms do as

 9 well. We tend to be the enforcement entity, the

 10 SRO. We have things like volume messaging

 11 policies to discourage excessive messaging, to do

 12 more than discourage it, actually find them and

 13 charge a fee on it. I think maybe as an

 14 interesting point I would mention that I would say

 15 over the last year in our exchanges, we've moved

 16 toward viewing those types of things as a primary

 17 purpose in protecting the exchange, in other

 18 words, the integrity of our markets, the capacity

 19 of our systems. The point is we may have

 20 thresholds and penalties at levels that are far

 21 below a level that would cause any problems, but

 22 based on the market in question and the type of
 66

 1 messaging we're getting, are they bids and offers

 2 that are far away from the market that tend to be

 3 noise, are they result in very few fills, to look

 4 at it more as a structural issue for our

 5 participants and not quote stuffing which has been

 6 thrown about which is a way of saying a lot of not

 7 productive messaging and orders that everyone has

 8 to consume and process, to minimize and reduce

 9 that. So there's a little change in focus there

 10 from internally looking at what we can handle

 11 versus what's reasonable to expect a typical

 12 customer to be able to handle.

 13 COMMISSIONER SOMMERS: I have a couple

 14 of different questions I think with regard to the

 15 scope. As I alluded to in my opening statement,

 16 we've been discussing these issues for a number of

 17 years and I think the discussion continually

 18 evolves, and I appreciate what you've given us

 19 here with the different levels in the supply chain

 20 having different best practices or guidance for

 21 every level along the way. But the concern I

 22 think that we've always had is how consistent are
 67

 1 these principles or guidance applied across the

 2 market? Do you have sort of sense to tell us? I

 3 know that people around the table say we do this.

 4 Trading firms, clearing firms, exchanges, we do

 5 this. But is it broadly consistent that everyone

 6 in the market has or abides by these principles?

 7 As a follow-up to that following on to Brenda's

 8 question, if the Commission looks at this, then do

 9 we adopt these as hard-and-fast rules, that these

 10 are rules that every step along the supply chain

 11 has to abide by and if everyone doesn't

 12 consistently apply them then you're violating the

 13 Act?

 14 DR. GORHAM: Even though he's not on the

 15 committee, could I ask Rich Gorelick to respond to

 16 that because he said something directly along

 17 those lines earlier today?

 18 MR. GORELICK: Thank you, Michael. I

 19 have a couple of things on that. I think that

 20 there is probably a regulatory role for some

 21 broad-level enforcement or some broad-level rule

 22 setting about what types of checks should be in
 68

 1 place at the various levels. That said, I would

 2 caution having a very static prescriptive list

 3 because I think that would both give us a false

 4 sense of security as markets change, as strategies

 5 change and as best practices change. And it would

 6 also limit us in ways that where we wouldn't

 7 necessarily be pushing toward the best risk

 8 management that we could possibly have. In that

 9 regard I think this subcommittee is very helpful

 10 and very useful. I feel that putting the

 11 responsibility at all three levels is particularly

 12 helpful, and as you point out there is probably a

 13 fourth level which is where the regulator should

 14 touch in with the process. My guidance would be

 15 to have it at a broad level rather than at a

 16 highly detailed level.

 17 That said, going through this list I

 18 came up with another list which are additional

 19 checks that we think are helpful and that we do,

 20 and I wouldn't want to have anything that would

 21 discourage that type of continual evolution of

 22 thinking. Whenever we read about some kind of
 69

 1 problem in the industry, some kind of unexpected

 2 trading, we try and get together and do an

 3 in-house post mortem and ask do we have checks

 4 that would have prevented us from doing that

 5 particular thing and to continually be learning

 6 from the process. A couple of things that I would

 7 want to throw out to the group for discussion, one

 8 thing that's not on the trading firm list here for

 9 example is position size limits. They've got a

 10 trade-by-trade quantity limit but not a limit on

 11 an overall position size and I think we all intend

 12 to limit how big our positions are in different.

 13 You can view that on a product-by-product basis,

 14 you can view that on a strategy-by-strategy or on

 15 a portfolio-wide basis taking into account both

 16 the capital at the firm that's intended to be

 17 exposed as well as different risk metrics. I

 18 think it's important to be thinking about those.

 19 CHAIRMAN O'MALIA: Rich, may I ask you a

 20 question? There's an intraday limit on here. Is

 21 that different than the overall position and if so

 22 how?
 70

 1 MR. GORELICK: The intraday limit that

 2 you are looking at, that is at the exchange level

 3 and what I'm urging is that those position limits,

 4 they may intraday, they may be cross-day depending

 5 on the strategy, should be considered not just at

 6 the exchange level by at the clearing firm level

 7 and at the trading firm level.

 8 MR. WHITMAN: He is exactly right. For

 9 example, at our firm we're an options

 10 market-making firm so that we have position limits

 11 not in contract space but in vega space, gamma

 12 space, unit space, calendar spread space and

 13 literally the system will shut down if somebody

 14 violations a position parameter that we have in

 15 place. They won't be able to trade anymore.

 16 That's an example of what Richard is talking

 17 about. We might have a group and we might set and

 18 it's tied to capital. For example, a group may

 19 not be able to be long or short more than $50,000

 20 of weighted vega which is a measurement of

 21 volatility and if they get longer more than

 22 $50,000 they can't trade anymore and they get shut
 71

 1 down and we have to turn it back on for them so

 2 that it comes to us and that is an example of what

 3 he's talking about.

 4 MR. GORELICK: Exactly. And that's also

 5 a good example where you need to take into account

 6 not only pretrade risk but posttrade risk because

 7 a lot of those options Greeks evolve based on

 8 what's going on in the market rather than just

 9 what's going on so you can't necessarily feel that

 10 if you prevent an order from going out at a

 11 particular time that you've solved that particular

 12 problem.

 13 Another limit that we measure for are

 14 lost limits again on a strategy-by-strategy basis

 15 or on a firm-wide basis. A good sign that

 16 something is not going as intended is if you're

 17 losing more money than you would expect to have in

 18 a normal risk setting. That's an important limit

 19 that needs to be set at the trading firm level and

 20 possibly at the clearing firm level although as

 21 Gary pointed out, it may be very difficult to do

 22 that at the exchange level because so many
 72

 1 strategies are cross-market.

 2 We've seen different problems at various

 3 exchanges in multiple markets that we -- one of

 4 them is a number of open orders problem. In a

 5 different market outside of the CFTC's purview

 6 there was a situation where someone sent a million

 7 orders at different levels in a price book. We

 8 sat down and asked do we have a check that would

 9 prevent us from doing that? We had checks that

 10 would prevent other things that would be related

 11 to that but not that specific thing that we built

 12 into the system. I'm always cautious to brag

 13 about risk management. It's not something you

 14 want to do. We all make mistakes. It's all

 15 possible. I want this to be taken in the spirit

 16 of we need to continue to learn and need to

 17 continue to calibrate as we go forward.

 18 I have a number of other things that I

 19 don't take everyone's time with today, but a

 20 couple of other things I think are worth

 21 considering as a responsibility of both the

 22 trading firm, the clearing firm and the exchange,
 73

 1 the near- time posttrade risk management that

 2 needs to be considered, particularly the ability

 3 to get efficient drop copies from exchanges and

 4 clearing firms and to circulate those so that we

 5 can do a real-time or near-time reconciliation to

 6 make sure that our views and positions across

 7 exchanges, across clearing firms and across

 8 trading firms are accurate and consistent. I

 9 think that's something that is evolving in the

 10 industry that we try and do wherever we're able to

 11 get the appropriate feeds from the exchanges and

 12 the clearing firms, but it is an important thing

 13 to keep in mind that particular types of problems

 14 would not be caught merely pretrade and I'll leave

 15 it at that. Thank you.

 16 COMMISSIONER SOMMERS: On my first

 17 question, if you or if anybody around the table

 18 has a sense on how consistently these

 19 recommendations are being abided by.

 20 MR. PAYTON: Commissioner Sommers, I

 21 think there are two things and I'll answer your

 22 question more directly in a second. But I do
 74

 1 think that it's important for this group, the

 2 Commission and all of the industry to recognize

 3 the tremendous work that's been done. I don't

 4 think in our industry that it has been a race to

 5 the bottom and notwithstanding the fact that we

 6 haven't had prescriptive regulations, all of these

 7 good things have developed over the last 5 or so

 8 years. If you look at our industry, on May 6 we

 9 didn't bust any trades. On the securities side

 10 there were more than 20,000 trades that were

 11 busted. We did have Pause Logic in effect. We do

 12 have circuit breakers in effect. We have

 13 protection points. So that there are a lot of

 14 good things that have been developed. And the

 15 things that Rich and Chuck talked about in terms

 16 of the things that firms have put into place to

 17 protect themselves and their clearing firms, those

 18 are all very good things that continue to evolve.

 19 People are interested in protecting against

 20 problems in the marketplace and as both Gary and

 21 Chuck said, protecting their own capital that's at

 22 risk. I think it's important first of all to
 75

 1 celebrate all the good things that have been done

 2 in the industry over the course of the last 5

 3 years and I think it's a testament to the fact

 4 that people are focused on these things.

 5 To your point, I do think that broadly

 6 speaking virtually all of the proprietary trading

 7 firms that are out there do employ these types of

 8 checks on their systems some better than others.

 9 In most of the situations where we have seen

 10 things gone array it's not because they didn't

 11 have any checks in place, it's because certain of

 12 the checks that they had in place didn't work as

 13 well as they had anticipated they would under

 14 those particular market circumstances. It is a

 15 constant learning issue and I do think that some

 16 of the things that Commissioner Dunn and

 17 Commissioner Chilton talked about earlier in terms

 18 of doing more work up front to certify that there

 19 are processes and procedures and testing in place

 20 are all very constructive things to do. But in a

 21 world at our exchange where we're trading 3

 22 billion contracts a year and you have tens of
 76

 1 thousands of market participants and all this

 2 technology coming together, there are going to be

 3 errors, there are going to be mistakes and I think

 4 what we try and do on an exchange level and what

 5 industry participants try to do is put in place

 6 certain types of checks whether they're risk-

 7 mitigation checks or volatility-mitigation checks

 8 to really try and keep those types of issues from

 9 occurring. Just think of all the times at the

 10 exchange level the fact that you have protection

 11 points in place prevents something bad from

 12 happening or all the times that you have Stop

 13 Logic kicking in that prevents something bad from

 14 happening.

 15 CHAIRMAN O'MALIA: We're going to move

 16 to the Chairman's questions now. If everybody can

 17 keep their questions or responses tight, it's

 18 going to be one of those meetings if we don't.

 19 CHAIRMAN GENSLER: Yes. I don't want

 20 more than one person to answer any one of my

 21 questions. I think this is an excellent report

 22 and very helpful. What I get confused about is
 77

 1 when people say don't be prescriptive. That

 2 reminds me of where they say you think that

 3 everybody should have a speed limit but each

 4 person on the highway cab pick their own speed

 5 limit.

 6 I'm going to focus on the exchanges with

 7 just a yes or no. Should we as a regulator

 8 include in our rules something proscriptive with

 9 regard to any one of these four things, pretrade

 10 quantity limits? I do recognize if we say have

 11 pretrade quantity limits that the exchanges could

 12 compete and have a race to the bottom. Yes or no,

 13 should we be proscriptive or not? I'm not asking

 14 what the limit should be.

 15 MR. PAYTON: I think the exchange is in

 16 a better position to determine what those

 17 parameters are.

 18 CHAIRMAN GENSLER: That's a no and

 19 that's from the exchanges. Dr. Gorham? You

 20 helped write this report.

 21 DR. GORHAM: It wouldn't matter. I'm

 22 reluctant. I've got a gut reaction that there
 78

 1 should not be a proscriptive limit.

 2 CHAIRMAN GENSLER: I'm only one

 3 Commissioner, but my reaction is it's like saying

 4 there should be speed limits but don't set them

 5 because there is competition between exchanges and

 6 as Chuck point out, there will be SEFs and I don't

 7 know how many there will be. So what if there is

 8 what you might consider to be a less-responsible

 9 platform than you have proposed? I know where you

 10 are, Dean. I got it.

 11 My second question is even if we don't

 12 set them, would the exchanges have something

 13 specific that all trading firms have to have these

 14 policies and procedures there in the first phase?

 15 Is that what the recommendation is?

 16 DR. GORHAM: I'm sorry. Would you ask

 17 that again?

 18 CHAIRMAN GENSLER: Is it your

 19 recommendation that the exchanges have policies

 20 and procedures where everyone one of the trading

 21 firms must have the five categories, but that all

 22 trading firms have to have the five?
 79

 1 DR. GORHAM: The recommendation is that

 2 as with the last side on the exchange is that the

 3 exchange would have those things itself and the

 4 clearing firms would ensure that the trading firms

 5 had those five.

 6 CHAIRMAN GENSLER: So that the clearing

 7 firms would have to have to have a rule to make

 8 sure that the trading firms have these five thing?

 9 DR. GORHAM: Correct.

 10 CHAIRMAN GENSLER: But again there could

 11 different quantity limits, different price

 12 collars, different throttles or different kill

 13 buttons?

 14 DR. GORHAM: Correct, and even could be

 15 different by trader, by firm and by product.

 16 Exactly.

 17 CHAIRMAN GENSLER: How do you avoid the

 18 race to the bottom then?

 19 DR. GORHAM: I'm going to let Chuck

 20 Whitman respond to that.

 21 CHAIRMAN GENSLER: Is that because you

 22 don't you could avoid it?
 80

 1 DR. GORHAM: It's a potential problem.

 2 CHAIRMAN GENSLER: I've finished my

 3 questions on that. My only other question is how

 4 many of the firms by a show of hands spend less

 5 than $31 million a year on technology? The CFTC

 6 is the only one. We're not a firm. That's the

 7 challenge we have right now, a great challenge we

 8 have. None of the firms around the table spend

 9 less than $31 million. We're a regulator that's

 10 to ensure that the American public has a

 11 marketplace that's transparent, open, competitive

 12 and free of fraud and manipulation and spends 1

 13 year on technology less than any of the firms on

 14 the Technology Advisory Committee. That's the

 15 challenge we have so that we can only write rules

 16 because we really can't do much and rely on the

 17 exchanges where I'm worried there will be a race

 18 to the bottom, and rely on the clearing firms. We

 19 didn't let you off the hook.

 20 COMMISSIONER DUNN: Let me be the

 21 devil's advocate to the Chairman. I do see a role

 22 and frankly I'm buoyed when I hear Chuck and
 81

 1 Richard talking about every time something happens

 2 out there that the risk committees get together

 3 and they assess it and they say it didn't happen

 4 to us but could it happen to us? But how

 5 widespread is that and is it uniform throughout

 6 the industry? The only way we're going to be able

 7 to have that holistic look that you're talking

 8 about of who's on the other side of the trade or

 9 what else is in that trade is by having the

 10 technological capabilities to see that. Also then

 11 we're responsible or the SROs are responsible.

 12 We're going to go out and do a regulatory review

 13 to see how well you are complying with whatever we

 14 come up with which is getting out of that

 15 prescriptive mode that we've got and into what

 16 we've had in the past which is a principle-based

 17 regulatory regime here. But I don't think we have

 18 the resources to be able to do that.

 19 CHAIRMAN GENSLER: I'm agreeing with

 20 you, Commissioner Dunn, that we don't have the

 21 resources. I think that the exchanges might go

 22 from two to many -- swaps execution facilities and
 82

 1 so I think it would be very helpful to know maybe

 2 not today, not this side but earlier slide that

 3 had the four or five things that we might have for

 4 trading firm. I'm sorry, the exchanges. On the

 5 exchanges' pretrade quantity limits, how do we

 6 ensure that there is some consistency to use

 7 Commissioner Sommers's point that the exchanges

 8 aren't competing with each other even if we rely

 9 on the exchanges maybe in collaboration to set a

 10 number that there's not some competition on the

 11 four very thoughtful points at the exchanges?

 12 That's what I'm concerned about that there could

 13 be -- competition is good but not necessarily in

 14 all places like you wouldn't want one exchange to

 15 have lower risk and one exchange to have higher

 16 risk because of these four points.

 17 MR. VICE: I think like the trading

 18 firms and the clearing firms that have their money

 19 at risk, the exchanges do as well, that even

 20 though there is intense competition going on, with

 21 all of these things there hasn't been a race to

 22 the bottom, there has been a multiplication of
 83

 1 additional checks and more pretrade functionality.

 2 So I think it's in our business' best interest to

 3 have people not have a bad experience, that

 4 regulators not see bad experiences for things

 5 going on in our exchange. I would give a

 6 counterview I think on your question earlier. I

 7 think from ICE's point of view I'm not necessarily

 8 putting these items in rulemaking, but I will say

 9 that ICE is not necessarily opposed to it either

 10 if that's what you feel like you need to do. The

 11 exchanges already do these things, the trading

 12 firms do these things, most of them anyway

 13 certainly so that we're already there. However, I

 14 think we would very much draw the line from going

 15 any further than those words right there on those

 16 bullets.

 17 And to the other point you were making

 18 of how do we know that CME sets the limit at X and

 19 ICE sets it at Y? First of all from a latency

 20 standpoint, some type of check is a check is a

 21 check. Whether you're checking if it's higher

 22 than X or higher than Y, the effect on latency is
 84

 1 effectively the same so I think there is not a

 2 material difference in terms of parameters that we

 3 would set. We may innovate and come up with, they

 4 may or we may, faster ways to handle a price

 5 collar just as effectively that may not be

 6 consistent with a prescriptive rule that was

 7 written 2 years before that. So I think in our

 8 view we don't have a problem with that level of

 9 specificity if you feel you need to do it. We

 10 don't think it's necessary, but if you feel like

 11 it's needed we would be comfortable with that but

 12 we would certainly advocate that you not go any

 13 more detailed than that.

 14 CHAIRMAN O'MALIA: Peter, you had your

 15 hand up.

 16 MR. JOHNSON: Thank you. I was going to

 17 make the comment I think to Commissioner Sommers's

 18 earlier question around how strictly do the three

 19 constituencies currently apply or deploy these

 20 risk tools. I think the greatest variance is

 21 possibly going to be seen in the FCM space. I was

 22 going to ask the question earlier if the
 85

 1 suggestions or these recommendations were that

 2 FCMs apply the pretrade risk tools separate from

 3 what the exchange gives us access to because I

 4 think that in the U.S. the exchanges are very

 5 good. They make available, actually it's

 6 mandatory that you have to go through them both

 7 ICE and CME. There are some other exchanges, BMNF

 8 is another example outside of the U.S., but you

 9 have to go through their risk packages to access

 10 the exchange so that it makes latency irrelevant

 11 at least at that level.

 12 To Gary's point earlier most of which I

 13 agree with, we as FCM employees both view our

 14 responsibility first and foremost as protecting

 15 the house, protecting the firm so that we are

 16 going to do our due diligence to make sure that

 17 clients are deploying the right risk tools and

 18 have the right risk approach culture, et cetera,

 19 before we're going to sign them up. But there is

 20 at the FCM space a lot of our competitors have a

 21 big commercial incentive to keep latency as low as

 22 possible and when you're adding risk layers to the
 86

 1 process that increases latency which hurts our

 2 chances of winning business from some of the

 3 bigger high-frequency trading firms. I think

 4 that's where you see the biggest variance. And to

 5 Chairman Gensler's point about the race to the

 6 bottom, I think that's where to some extent you've

 7 already seen a race to the bottom in the brokerage

 8 space with brokers who are competing on latency

 9 only and in Asia a lot of exchanges have no

 10 exchange-hosted risk controls. They don't even

 11 acknowledge the practice of DMA or sponsored

 12 access. So it's really the wild, wild west. We

 13 tried to touch on that in the FIA market access

 14 risk recommendations paper a year ago and that was

 15 the point, to put pressure on those exchanges to

 16 act more responsibly like CME and ICE to provide

 17 exchange-hosted risk controls because it's the

 18 right thing to do.

 19 For the most part I definitely feel that

 20 risk- control or risk-management be shared across

 21 those three constituencies and I think the

 22 industry does a pretty good job generally, but the
 87

 1 one space to probably look at is in the brokerage

 2 space because the risk cultures vary so I think

 3 wildly depending on who you're talking about.

 4 CHAIRMAN O'MALIA: I think in order to

 5 keep on schedule we do have a Q and A at the very

 6 end of this in which I expect that are going to

 7 deal with this issue and other issues associated

 8 with that. So write your questions down and let's

 9 think about them. We'll leave them to a final

 10 panel when we have about an hour to go over this.

 11 I'm going to try to get back a little more on

 12 schedule.

 13 COMMISSIONER DUNN: I don't want to wait

 14 on this because what I'm hearing you say is trust

 15 us. We're the industry and we're not going to do

 16 anything to ruin the industry, and that's exactly

 17 the same thing we heard on credit default swaps,

 18 that we're all responsible adults here and we're

 19 going to care of it. That is the reason why

 20 Dodd-Frank was passed because they've asked us as

 21 a regulator to come up with ways to ensure that we

 22 can trust you on it and I'd like to see it be as
 88

 1 much of a regulatory regime that uses

 2 principle-based regulations rather than being

 3 prescriptive, but I'm not hearing you come back

 4 and say here is how we're going to be able to do

 5 that without being prescriptive. I trust you and

 6 we didn't have it in the futures industry, but

 7 you're giving us the same argument that we heard

 8 for the credit defaults.

 9 MR. DEWAAL: Maybe I'm hearing things

 10 slightly differently and maybe there could be some

 11 refinement. Certainly at the broker level I

 12 thought, and don't ask me for the rule number

 13 right now, I was obligated to maintain

 14 risk-management procedures.

 15 MR. PAYTON: (inaudible)

 16 MR. DEWAAL: There you go. Thank you.

 17 I also wanted to address something that Jill had

 18 said a few seconds ago. If as part of the

 19 guidance, obviously that rule was released a long

 20 time ago, but if there were an amendment to that

 21 guidance and it said, by the way, as part of those

 22 risk-management procedures you should be
 89

 1 addressing different types of customers with their

 2 specific types of risk among which are the

 3 high-frequency traders, that I wouldn't have an

 4 issue with that because I think we already do

 5 that. In fact, one of the concerns, I was smiling

 6 when Commissioner Sommers asked do all your

 7 traders apply the same standards? I also just

 8 came back as Peter did from a trip to Asia and

 9 when the Chinese exchanges very recently put

 10 restrictions on the amount of cancellations and

 11 they put some other restrictions out there to

 12 limit high-frequency traders, it had a big impact

 13 on retail volumes and that's the problem. The

 14 problem is when you start targeting one particular

 15 group, you concentrate on that and you forget that

 16 other groups may share characteristics of that

 17 group, and that's one of the things that we as

 18 brokers do all the time. We look at the risks of

 19 all of our different types of clients. We don't

 20 care what they're called. We try to understand

 21 what they're doing and we try to deal with the

 22 specific issues addressed by those types of
 90

 1 trading strategies, et cetera.

 2 If there needed to be refinement

 3 certainly at the broker level in the guidance as

 4 to what are the areas that we should cover in the

 5 risk-management procedures, I think that would be

 6 fine. I don't want to speak for the exchanges,

 7 but obviously the Commission designates them as

 8 contract markets, we'll see what happens with the

 9 SEF rules if there will be an equivalent process,

 10 but it seems to me that that would be the

 11 appropriate place to talk about a condition of

 12 designation. I don't think it's just an issue of

 13 saying trust us. You have some authority to

 14 mandate that we deal with this. What we're saying

 15 is leave it to us to figure out what might be the

 16 most appropriate way.

 17 And to follow-up on the Chairman's

 18 point, it's no different than saying, yes, it's

 19 not trust us on speed limits. It's just that an

 20 80-mile-per-hour speed limit might work perfectly

 21 in Nevada on the big open highways but probably

 22 not too well in New York City.
 91

 1 CHAIRMAN O'MALIA: Commissioner Chilton,

 2 do you have a question? I'm going to save mine

 3 for the last, but if you have time constraints, go

 4 ahead.

 5 COMMISSIONER CHILTON: Just maybe one,

 6 Commissioner, and a follow-up on what Commissioner

 7 Dunn was saying. A lot of the discussion that we

 8 have on this and other things is trying to figure

 9 out what the right balance is. So even when I

 10 talk about I think these are things we should be

 11 looking at, definitely we want to be careful with

 12 dreaded untended consequences. We don't want to

 13 have that. But there is a little bit I think I

 14 have some sympathy for what Commissioner Dunn was

 15 saying. I agree we don't want to have static

 16 regulations particularly with regard to HFTs and

 17 algos, it's going to change too fast so that we

 18 want flexibility. I don't know that we'd go all

 19 the way to a principles-based approach, but we

 20 need some flexibility. But what I think we're

 21 trying to get at and I hope this is the case for

 22 everybody is that if something bad does occur that
 92

 1 we will be in a very reactive mode and then we

 2 will probably overreach so that now is the time to

 3 try to really get at the nub of what we need to

 4 do. When I look at some of the recommendations I

 5 start thinking those are generic recommendations

 6 for everything and there is not really anything

 7 specific here for HFTs. There are a few actually,

 8 but overall it's like we have to do this anyway

 9 and nothing needs to be done specifically.

 10 I have just one question because I think

 11 there are some specific things that we need to

 12 look at. You were talking earlier when folks were

 13 talking about limits. Say we have our position

 14 limits. For the sake of theoretical conversation

 15 say we have a 10-percent limit of open interest in

 16 a market. If you were talking to a commercial

 17 trader, I guess there is the theoretical

 18 possibility that they would sell or buy 10 percent

 19 of the open interest in a day. But an HFT could

 20 theoretically buy and then sell within 15 to 20

 21 seconds. Does that help the markets if they're

 22 buying and selling and should that be something
 93

 1 that's just okay to buy and sell many times

 2 whatever the position limit is? I'll just leave

 3 it to that one question, Commissioner O'Malia.

 4 CHAIRMAN O'MALIA: Does anybody want to

 5 respond to that?

 6 MR. WHITMAN: Just to be very honest

 7 about it, I think that's virtually impossible. To

 8 by 10 percent of the open interest in a 15- to

 9 20-second window, if you look at the size that we

 10 trade you're talking about a fraction of the open

 11 interest, nothing near that size. Liquidity

 12 constraints would not allow you to buy 10 percent

 13 of the open interest in a market. It just doesn't

 14 exist. In firms like ours if you go through and

 15 you look at the open interest that we carry,

 16 typically the open interest we carry is hedged and

 17 depending on the open interest measurement, if

 18 there open interest has any size to it, our

 19 percentage of open interest is usually very, very

 20 small. If there are 200 contracts open, yes, we

 21 could be 200 contracts.

 22 COMMISSIONER CHILTON: So you wouldn't
 94

 1 have any problem saying that you couldn't do it

 2 since there is no way you would do it. Right?

 3 MR. WHITMAN: Yeah, you can't do it.

 4 COMMISSIONER CHILTON: I have an

 5 amendment, Mister Chairman. I'm good. Thank you

 6 very much.

 7 CHAIRMAN O'MALIA: We're going to go to

 8 the phone. Nick Garrow is Global Head of

 9 Electronic Trading for Newedge. Nick has 17-plus

 10 years of electronic-trading trading experience in

 11 the derivatives and equity markets. As Global

 12 Head of Electronic Trading, he oversees a team of

 13 100 and supports more than 4,000 end users on more

 14 than 80 markets across all assets globally. To

 15 understand the challenges that these pretrade

 16 controls are going to do and with the challenges

 17 of latency, I think Mr. Garrow can help us

 18 understand what it's going to take from a

 19 technology standpoint to implement these goals and

 20 objectives that we've laid out here and what seem

 21 to be articulated by some of the Commissioners to

 22 go further. So we're going to hear from Nick and
 95

 1 see what the art of the possible might be. Nick,

 2 are you there?

 3 MR. GARROW: Yes, I am indeed. Can

 4 everybody hear me?

 5 CHAIRMAN O'MALIA: Yes.

 6 MR. GARROW: Scott, do you have a copy

 7 of the slides?

 8 CHAIRMAN O'MALIA: We have you on an

 9 enormous screen and everybody can see it.

 10 MR. DEWAAL: And your photo you should

 11 be aware.

 12 MR. GARROW: Thank you. First of all

 13 Mr. Chairman and Commissioners, ladies and

 14 gentlemen, thank you for the opportunity. What

 15 I'm going to try and do is I'm going to try and

 16 keep this relatively brief in the interests of

 17 time. What I'm going to try and do is outline the

 18 current practices that we have at Newedge and also

 19 some of the challenges that we have with regard to

 20 CMA pretrade risk controls. I know the focus of

 21 this particular meeting is on DMA, but I also

 22 wanted to talk briefly on SDMA.
 96

 1 CHAIRMAN O'MALIA: Nick, can you hold on

 2 a second? We can't hear you very well. If you

 3 could maybe slow down and speak up. If you could

 4 pick up your handset might be the recommendation.

 5 MR. GARROW: Can you hear me now?

 6 CHAIRMAN O'MALIA: Perfect. My

 7 apologies for that. We're on slide 2, Scott, in

 8 terms of the presentation overview. I wanted to

 9 start off by giving a picture of the current

 10 electronic trading landscape as we see it at

 11 Newedge. We have a very large client base. I

 12 know the focus of this meeting is on DMA, but I

 13 also want to touch briefly upon SDMA -- direct

 14 market access and some of the challenges there on

 15 the pretrade risk-control side of things. I also

 16 then want to go on to talk about what our approach

 17 is at Newedge currently and moving forward in

 18 terms of how we're going to better manage pretrade

 19 risk controls both on the DMA and the SDMA

 20 segment. Then finally also share with some of the

 21 investment requirements we have in terms of

 22 dollars spent and also some of the implementation
 97

 1 challenges we have as well.

 2 I think or I hope that the presentation

 3 will draw together many of the things we've been

 4 talking about here. I'm certainly not going to

 5 talk from a technology perspective, I'm going to

 6 talk from a practical and practitioner's

 7 perspective.

 8 If we could change or move on to slide

 9 3. Can you see that?

 10 MR. GARROW: Broadly, we see our

 11 customer base split into two bodies. We have what

 12 we describe as SDMA clients. These are customers

 13 that we are sponsoring on two exchanges. Then we

 14 have DMA customers and these are customers who are

 15 trading through our -- trading infrastructure.

 16 What I wanted to do was briefly touch upon the

 17 differences between these two client bases, also

 18 some of the challenges we have with both of them

 19 and what our current policies, procedures and

 20 practices are with regard to pretrade risk-control

 21 management and also where we're going in the

 22 future.
 98

 1 I'd like to start off if I could with

 2 the DMA customers, in fact a comparison between

 3 the two. What's the difference in our world

 4 between an SDMA client and a DMA client? A DMA

 5 client is defined as one which is trading through

 6 a Newedge trading infrastructure over which we

 7 have direct, exclusive and full control. For DMA

 8 customers we currently run a number of different

 9 systems and platforms some of which you're

 10 probably familiar with, TT Trading Technologies

 11 and CQG. We have clients trading through FIX (?).

 12 We have clients trading over PAT (?) systems so

 13 that we support a wide range of different

 14 technology platforms. The key thing is that for

 15 each one of those systems and platforms we have

 16 full and exclusive control over the pretrade risk

 17 limits and the limits that we can include many of

 18 the limits we were discussing or you were

 19 discussing earlier on which you recommended need

 20 to be set both at the clearing firm level and

 21 indeed also to a certain extent that trading firm

 22 level as well.
 99

 1 This focus here is on pretrade quantity

 2 limits and fat-finger limits. It's also looking

 3 at daily position limits as well on contracts by

 4 contract and by maturity as well. On the DMA side

 5 therefore we have full access, we have exclusive

 6 access, we have full control. The types of

 7 pretrade limits vary according to the existing

 8 system or platform we're using, but broadly

 9 speaking the requirement is to be able to set

 10 quantity limits and position limits as well.

 11 On the SDMA side of things, obviously we

 12 are sponsoring clients onto an exchange. They're

 13 trading using the Newedge NPID or session ID. And

 14 the pretrade risk- management control with these

 15 guys is much more of a challenge. What we do and

 16 I think we've adopted to a certain extent some of

 17 the recommendations that have been laid out

 18 already is we conduct due diligence on the trading

 19 firm itself with quite an exhaustive

 20 questionnaire. I'm not familiar with the names of

 21 the people who were speaking earlier on, but some

 22 of the questions that they were asked by their
 100

 1 clearing broker or the FCM are typical of the

 2 questions we would want answered as well. So we

 3 conduct some due diligence on the trading firm.

 4 We are looking or seeking to achieve clarity and

 5 clarification around how or whether they have

 6 pretrade risk controls in place and how they work.

 7 We're also seeking clarity around from an

 8 architectural perspective where the customer's

 9 technology is going to be located, how obviously

 10 it's going to access the exchange, et cetera, so

 11 that for the SDMA customers and clients we're

 12 conducting a piece of due diligence.

 13 We also have a minimum requirement

 14 within Newedge that regardless of the answers to

 15 all of the above questions, we have to have the

 16 capability to do four things. Number one, we need

 17 to be able to see the client's orders. That can

 18 either be through some kind of drop copy directly

 19 from the client or from the exchange. We need to

 20 be able to stop the client from trading so that

 21 that is the sort of kill button that's been

 22 mentioned I think in the previous presentations.
 101

 1 We need to be able to view access and have access

 2 to the client's limits and also to change them as

 3 well. So our requirements are relatively

 4 stringent. The technological challenges in doing

 5 all of that are immense. We have currently a

 6 large number of SDMA clients trading obviously not

 7 just U.S. markets but global markets and across

 8 multiple asset classes as well. My challenge or

 9 our challenge at Newedge goes beyond just the

 10 world of futures or exchange-traded derivatives.

 11 It extends obviously into the equities world, the

 12 fixed-income world as well and FX. Often clients

 13 will be running multiple connections into multiple

 14 exchanges and multiple markets so that the

 15 challenge there is getting an holistic view in as

 16 close to real time as possible in terms of what

 17 the customer is doing across multiple destinations

 18 and I'm going to on to talk about this a little

 19 later on. So those are some of the challenges in

 20 terms of managing, view and getting control of

 21 risk management on the SDMA clients. On a

 22 posttrade basis we're taking executions and
 102

 1 execution reports into our posttrade

 2 risk-management systems. For the DMA customers

 3 it's a big more straightforward in the sense that

 4 because we've already got the pretrade risk limits

 5 in place, the DMA platforms we use, typically RSV

 6 sorts of systems and platforms all fixed, provide

 7 us to a large extent with the visibility over the

 8 customer's orders, they give us the capability to

 9 change limits and, frankly, they give us the

 10 capability as well to switch a client off and to

 11 stop them or block them from trading.

 12 For SDMA clients as I said before, all

 13 of the customers and clients are scored by the

 14 operational risk department and we conduct a piece

 15 of due diligence on the customer's trading

 16 applications and their pretrade risk- management

 17 controls. For DMA clients because we have the

 18 pretrade risk in place and greater visibility and

 19 control, then obviously we have to go through --

 20 agreements and pretrade limit approval and setup.

 21 The challenges frankly on both sides of

 22 these customer bases are quite enormous. On the
 103

 1 DMA side as many FCMS are, we're running multiple

 2 systems and platforms. Each one of them can be

 3 slightly different. In terms of manpower and

 4 support running these systems and platforms, it's

 5 quite a large burden. To a great extent as well,

 6 much of the limit inputting and processing is

 7 manual and it's not automated. It's a very

 8 difficult process to automate so that there is

 9 obviously the possibility for human error. But

 10 broadly speaking, that's a quick overview in terms

 11 of the environment currently as we see it.

 12 What comes out for me from this

 13 environment currently are three things. Given the

 14 range of customers we have and given the range of

 15 destinations they're trading and the range of

 16 asset classes, it's a huge challenge to get proper

 17 pretrade real-time visibility over every single

 18 customer so one big thing for us that would help

 19 our lives and those of our clients we believe as

 20 well is a better and more uniform consistency of

 21 pretrade risk controls at the exchange level. I

 22 use the words uniform and consistency quite
 104

 1 importantly because many exchanges have pretrade

 2 risk-management controls in place, but the way

 3 that they are implemented is different so that

 4 when we're dealing with a customer trading across

 5 three different regions or geographies, the

 6 challenge of maintaining real-time risk visibility

 7 over the customer is quite large. The second one

 8 which I believe has been touched upon already on

 9 numerous discussion groups is the posttrade drop

 10 copy data. It's really important both for us and

 11 indeed for our customers as well to go to the

 12 bible source of executions and working orders and

 13 we believe that is at the exchange level. What

 14 we're looking to do is to take in in real time

 15 both working orders and execution reports from all

 16 of our customers particularly those who are going

 17 onto exchanges through the SDMA route, but there

 18 is again a lack of consistency particularly

 19 outside of the U.S. I have to say in Europe and

 20 certainly in Asia with regard to the quality of

 21 the drop copy data that's provided.

 22 Finally my third point on this is the
 105

 1 behavior that we would like to see more consistent

 2 across exchanges on customer and client

 3 disconnect. There is a large amount of focus

 4 quite rightly on the pretrade risk-management side

 5 of things. There is also a large area of

 6 operational risk and systemic risk when a

 7 high-frequency trading firm disconnects for

 8 whatever reason from the market. As I think we've

 9 noted, these customers and clients can be working

 10 a large number of orders. If they disconnect from

 11 the market, the behavior we like to see is we have

 12 for cancels on disconnect which are supported by

 13 the exchange at the exchange level so that to the

 14 greatest extent possible we understand or believe

 15 that the client's orders will be cancelled. What

 16 is dangerous and risky is having multiples of

 17 hundreds or sometimes thousands of orders working

 18 on an exchange when for whatever reason the client

 19 has become disconnected.

 20 Those are the three things broadly

 21 speaking if I looked at some of the current

 22 challenges and issues that I would pick up on is
 106

 1 better and more consistent pretrade risk

 2 management at the exchange level, better and more

 3 consistent quality of drop copy data and better or

 4 more consistent behavior on client disconnects.

 5 If we move on to slide 4, slide 4 is an

 6 overview framework in terms of where we're going

 7 with our risk- management and our risk-management

 8 approach at Newedge. Broadly speaking what we've

 9 done is we've split risk management down into

 10 three buckets if you will. All of these buckets

 11 are within Newedge and I'm talking about controls

 12 within Newedge and I'm not expanding this out into

 13 either the exchange-based controls or the

 14 trading-firm controls. Broadly speaking we're

 15 splitting risk into three pieces. We have the

 16 pretrade risk management. This is obviously

 17 geared toward preventing erroneous trades getting

 18 to an exchange and stopping a trade executing or

 19 getting to the venue if it shouldn't. On the DMA

 20 side of things, the pretrade risk management is

 21 provided predominantly by the different ISV

 22 vendors. We're looking at simplistic things here
 107

 1 really but nevertheless measures that prevent

 2 erroneous trades or a high frequency number of

 3 orders getting to the market so it's quite simply

 4 quantities per order, it's position limits on a

 5 daily basis and it is where possible also the

 6 number of message or message throttles as well.

 7 For the SDMA, for the sponsor

 8 direct-market access clients, pretrade risk

 9 management is a big challenge. Obviously I'm

 10 working quite hard at the moment on the SEC ruling

 11 in the U.S. which effectively bans naked access

 12 trading as far as I can see on equities, equity

 13 options and a range of other instruments as well.

 14 There is a huge challenge in the U.S. at the

 15 moment which is to find a pretrade risk-management

 16 solution that will suit both the requirements of

 17 our clients in terms of speed but also the

 18 requirements of the regulators in terms of

 19 control, exclusivity of control and access as

 20 well. If you take that challenge outside of the

 21 U.S. onto some of the other markets as well in

 22 Europe and APAC, it's very difficult to find
 108

 1 solutions or vendors that can come up with a very

 2 low latency pretrade risk-management solution that

 3 covers all markets and all products.

 4 Finally on the pretrade risk-management

 5 side of things, I think the other place as I've

 6 touched upon earlier on where we will be looking

 7 for some more conformity is the exchange-level

 8 controls. We look quite closely at the degree and

 9 types of pretrade risk controls which are

 10 available on different exchanges and we rank the

 11 exchanges as well internally according to the

 12 levels of protection they provide to us the FCM.

 13 There is a great degree of inconsistency between

 14 the controls, where we as the FCM as the clearing

 15 member have to fill often the vacuum or the void

 16 between the customer and the exchange. Getting

 17 this consistency of control, and as I say this not

 18 just a U.S. problem, this is a much bigger issue

 19 and problem in Asia, is a big issue for us.

 20 The piece we're really focusing on as

 21 well now is what I describe as the at-trade risk

 22 management. The pretrade risk checks should stop
 109

 1 an erroneous order getting to the market. The

 2 piece we're looking at now with the at- trade risk

 3 management is about trying to get as close as

 4 possible real-time visibility over all of our

 5 clients' working orders and executions. It's an

 6 additional set of controls that we've put in place

 7 which says for whatever reason if the client

 8 manages to get a trade through on a pretrade basis

 9 which they shouldn't have done, the at-trade pick

 10 it up provided we can get visibility over the

 11 client's working orders and executions and it will

 12 set additional alarms and alerts. We're building

 13 out an at-trade risk solution at Newedge globally

 14 currently which is focusing on equities and

 15 exchange-traded derivatives. The initial focus is

 16 going to be certainly for the SEC ruling in the

 17 U.S. but also more importantly across all of our

 18 SDMA clients. What we're doing there is we're

 19 feeding in or we're getting access to all of the

 20 drop copies where possible from every single

 21 exchange and we're putting them into a centralized

 22 risk tool at Newedge and the risk tool will
 110

 1 provide us with real-time visibility of orders

 2 working at an exchange and real-time visibility

 3 over executions so that it gives us an additional

 4 alerting mechanism should there be an issue or

 5 problem with the client. The important piece with

 6 the at-risk risk-management tool that we're

 7 implementing can deploy what I call pretrade

 8 agents into the field and the pretrade agents

 9 consist of either full-blown pretrade

 10 risk-management controls on a low- latency basis

 11 or cutoff switches and devices which would stop a

 12 client from trading on an exchange and if we

 13 detect it on the at-trade basis they are in

 14 breach. So it's trying to build a consistent

 15 global at-trade risk view. To do that we require

 16 very good quality and very fast real- time fixed

 17 drop copies. It's a large project. It's a

 18 complex project. The volumes of data are

 19 enormous. But we feel what we need to do is to

 20 bring this at-trade visibility into the sort of 1-

 21 to 10-second timeframe so that we're looking for a

 22 gap between the client entering an order and us
 111

 1 being able to detect it and pick it up in the

 2 at-trade system at somewhere between 1 and 10

 3 seconds globally.

 4 The posttrade risk-management piece is

 5 as the name suggests a different thing altogether.

 6 The posttrade risk at Newedge is looking at taking

 7 the clearing feeds in from the exchanges or from

 8 the clearinghouses and running more complex risk

 9 calculations over customer and client positions so

 10 that we may be looking at stress testing a

 11 position or a portfolio and the time delays in

 12 doing so are obviously longer. This strategy here

 13 of pretrade, at-trade and posttrade is the sort of

 14 framework around which we are building our

 15 risk-management controls processes. It gets

 16 changed by the regulatory environment. It can

 17 change by the micromarket environments as well.

 18 But broadly speaking that's what we're looking to

 19 build out.

 20 CHAIRMAN O'MALIA: Nick?

 21 MR. GARROW: Yes?

 22 CHAIRMAN O'MALIA: My apologies. Can we
 112

 1 have to move to the challenges or a conclusion

 2 because we're running out of time? Thank you.

 3 MR. GARROW: We'll skip slide 5 and go

 4 on to slide 6. I think I've touched on most of

 5 these points already to be honest with you. The

 6 main challenges or some of the challenges involved

 7 in implementing this are around data consistency

 8 and what I call data transportation. There are a

 9 lot of moving parts and a lot of data to move

 10 around between the different risk systems and

 11 between the exchanges and Newedge. There is also

 12 the challenge around implementing these

 13 low-latency pretrade risk controls. We're seeing

 14 in the U.S. with regard to the equities markets a

 15 rush toward single -- single-digit microsecond

 16 pretrade management. This is becoming a key

 17 commercial consideration. And also obviously we

 18 have to keep track of and keep fully mindful of

 19 the regulatory environment and how that's changing

 20 as well.

 21 I was also asked to give some indication

 22 in terms of the sort of costs involved to
 113

 1 implement these technology solutions and that's

 2 the final piece of the presentation. We're

 3 looking at around $4 or $5 million to set these

 4 controls up, then between $4 and $6 million to run

 5 which includes the hardware, the software, the

 6 market data reporting and everything else. Then

 7 also more importantly it's not just a question of

 8 building out the technology and the tools, but

 9 also having the right people in place to interpret

 10 what the tool is saying and also take the

 11 appropriate action around it. We are investing

 12 quite heavily in people to support these tools and

 13 these applications as well.

 14 I won't go into the appendix. The

 15 appendix is a framework around how we're

 16 classifying clients and what controls we need to

 17 put in place on a pretrade, at-trade and posttrade

 18 basis but I think in the interests of time,

 19 Commissioner, I'll probably stop there and take

 20 any questions.

 21 CHAIRMAN O'MALIA: Thank you very much

 22 and thank you for complying with our time
 114

 1 constraints. Does anybody have any questions

 2 about this? This is obviously a complicated

 3 challenge and I think as Gary DeWaal pointed out,

 4 this is something they've taken on on their own

 5 initiative to serve their clients and probably

 6 meet the regulatory challenges that they have.

 7 Gary, do you want to comment on why Newedge has

 8 taken this step?

 9 MR. DEWAAL: I think the challenge, and

 10 I'm still struck by Commissioner Sommers's

 11 question, is our clients often trade multi assets

 12 internationally simultaneously. And when I do

 13 hear the discussion about possibly restricting

 14 trading in advance I shudder because of that. The

 15 problem that we have as a global broker again is

 16 not just obviously complying with the U.S.

 17 requirements, but complying with the requirements

 18 all around the world and obviously of sister

 19 agencies here. I think the challenge to our

 20 customers is also very, very similar because

 21 obviously from their perspective to the extent

 22 that they're granted direct-market access or as
 115

 1 Nick calls it sponsored direct-market access, the

 2 lack of consistency internationally is very, very

 3 challenging. It's very, very challenging.

 4 Obviously your mandate is the U.S. futures

 5 markets. Our issue and our clients' issues are

 6 the global markets. The problem of being

 7 prescriptive in place is that it could do a lot of

 8 damage internationally. Yes, I'm very sensitive

 9 to the debate about rushing to the bottom. I was

 10 sharing with Commissioner Sommers already about

 11 how as a global broker we already see the majority

 12 of our business being booked in the U.K., not just

 13 the majority, a substantial majority almost to the

 14 exclusion of our other zones just because of the

 15 environment and some of the things you can do in

 16 London that you can't do here in the United

 17 States. We would be very, very concerned about

 18 the CFTC coming up with very prescriptive

 19 requirements for the markets here because we think

 20 it would be very anticompetitive. Obviously we

 21 don't want the U.S. to go to the standards of Asia

 22 which in many cases are still being developed from
 116

 1 scratch. But the problem with these markets is

 2 they're not in isolation anymore, that's the

 3 biggest issue and that's the challenge we have.

 4 Nick is trying to create an infrastructure that

 5 deals with the four asset classes that he

 6 discussed and the 30-plus markets that we provide

 7 access to so that it is an amazing challenge.

 8 CHAIRMAN O'MALIA: Thank you. We're

 9 going to go to the break. Come back in 20 minutes

 10 at 25 after and then I'll obviously impose on our

 11 next panelists to keep their presentations very

 12 tight so that we can continue to have this

 13 discussion. I'll see you in about 10 minutes.

 14 (Recess)

 15 CHAIRMAN O'MALIA: If we can get started

 16 again, we'll go to our second panel. We have

 17 Supurna VedBrat who is a strategic market

 18 structure business adviser to the head of

 19 fixed-income trading within Blackrock's Portfolio

 20 Group. Supurna has spent over 18 works working in

 21 the sell wide in the fix-income market spanning

 22 most asset classes in both cash and derivatives
 117

 1 working in the U.S. and Europe and for the last 18

 2 months has been focusing on market structure

 3 strategy and has been leading initiatives for

 4 fix-income trading and buy-side investments

 5 focusing on anticipated changes and emerging

 6 alternatives based on the Dodd-Frank Act.

 7 Supurna, thank you for coming and look forward to

 8 your presentation.

 9 MS. VEDBRAT: I'd like to thank the

 10 Commission for giving us this opportunity to

 11 present on interconnectivity.

 12 Interconnectivity is a consistent

 13 business process with integrated technology

 14 support. Trade interconnectivity within the

 15 context of a buy-side investment process involves

 16 many independent entities. Within the cleared OTC

 17 derivative space it will involve CCPs, multiple

 18 SEFs, affirmation platforms, client investment

 19 platforms, executing broker platforms and FCMs,

 20 among others. Some of these entities are known to

 21 us today and some will emerge as a result of the

 22 new market structure. Efficient interoperability
 118

 1 among these entities is the thread that will hold

 2 the process flow together. This interoperability

 3 is dependent on providing an open architecture

 4 solution and having a standardized open- messaging

 5 protocol that will flow the transaction data

 6 information in a consistent manner as it

 7 progresses through the trade process flow.

 8 Today we will evaluate the challenges

 9 and concerns related with interoperability using

 10 three dimensions. The first is implementation and

 11 sequencing. The second is one-time implementation

 12 costs and the potential future running costs and

 13 tools. And the third is structural impediments

 14 from the standpoint that they impair the deepened

 15 liquid markets that the current OTC markets offer

 16 us.

 17 This diagram represents a high-level

 18 flow and the interconnectivity of the various

 19 entities that will be involved in a typical

 20 real-money asset-management investment flow for

 21 cleared products. In the chart below there are

 22 many interconnectivity points mentioned and I
 119

 1 could spend many hours discussing them. However,

 2 in the interests of time we will focus on a few

 3 key areas of concern. First, all entities within

 4 this flow must support open architecture solutions

 5 so that market participants can connect to them

 6 using their existing technologies or preferred

 7 technologies. The efficient interoperability of

 8 these entities is highly dependent on

 9 standardization of messaging protocols so that no

 10 one vendor or entity has too much control on how

 11 data is exchanged or interchanged. Otherwise it

 12 will become a barrier to entry and put new market

 13 players at a competitive disadvantage. It will

 14 also be too expensive for market participants to

 15 make changes as the market continues to evolve.

 16 In some ways it may slow down the overall

 17 implementation for clearing. Standardization also

 18 helps make technologies spent more manageable.

 19 Other benefits of standardization are it helps to

 20 reduce time and cost barriers for new entities to

 21 emerge as viable competition and for new market

 22 participants to enter.
 120

 1 The second area of concern is the

 2 development of gateways to the CCPs such as the

 3 affirmation platforms. In the diagram it's toward

 4 the center right. Care must be taken the

 5 interconnectivity of these gateways do not impede

 6 new affirmation platforms to connect. From a

 7 client perspective it is important that an

 8 affirmation platform connects to multiple CCPs and

 9 supports affirmation for multiple asset classes.

 10 For example, an affirmation platform should

 11 support both IRS and CDS so that a client does not

 12 have to link and pay tolls to different

 13 affirmation platforms for different products.

 14 This will allow operational efficiencies and

 15 consistent workflow reducing operational risk and

 16 trade breaks in the overall system.

 17 The third area of concern is the

 18 posttrade allocation that occurs within the

 19 investment management process. This is in the

 20 center of the diagram above. I cannot emphasize

 21 how important this is not only as an integral part

 22 of the buy-side investment process but one that
 121

 1 requires more education and much more awareness as

 2 market structure workflows are defined. This

 3 continues to be an underinvested and

 4 underappreciated area as we write the rules and

 5 design the workflows for the new market structure.

 6 It is important to note that an asset manager may

 7 manage many different money vehicles such as

 8 pension funds, insurance companies, separate

 9 accounts, collective trusts and many more for many

 10 different client types such as institutions and

 11 corporations among others. It is just as

 12 important to understand that the complexity in

 13 this step comes from the fact that each client

 14 account or fund has within their investment

 15 management agreement constraints and targets that

 16 may include their choice of custodian, the

 17 counterparties with whom to execute, the potential

 18 clearing members that they choose and other

 19 investment services. Let us look at the next

 20 slide to see some more detail on this.

 21 An asset manager may have multiple

 22 investment strategies that are linked to many
 122

 1 different client accounts and services. Take for

 2 example in fix-income at Blackrock we may have 150

 3 strategies that span across 3,000 client accounts.

 4 When a strategy generates an investment idea, this

 5 idea is applied and distributed among many

 6 accounts. More often than not it is applied

 7 across multiple accounts. It is also worth noting

 8 that a key metric for asset manager performance is

 9 the consistency of fund out performance relative

 10 to the benchmarks and the stated investment

 11 objectives. It is very important as we design the

 12 implementation and sequencing of interconnectivity

 13 that the allocation of a block trade to client

 14 funds and accounts that legally own the risk is

 15 taken into account and that ownership connection

 16 is followed through to the appropriate CCPs and

 17 the multiple FCMs chosen by the various clients

 18 themselves.

 19 Up until now we have talked about

 20 technology interconnectivity. Client funds are

 21 brought into the structure via various legal

 22 agreements that authorize money managers and
 123

 1 various service providers and vendors such as SEFs

 2 clearing members to act on their behalf. This

 3 diagram is meant to represent the anticipated

 4 documentation that is needed to on board client.

 5 As you can see, there are many touch points that

 6 need client documentation so that if we want

 7 smooth client adoption, these documents need to be

 8 standardized, simply and keeping the overall

 9 process in mind kept to a minimum where possible.

 10 The sooner we start the process of creating these

 11 documents the sooner we will be able to on board

 12 clients. These documents can be created alongside

 13 rule writing and implementation rather than wait

 14 until the very end. We strongly discourage client

 15 documentation to be used as an excuse to delay or

 16 sequence onboarding of clients behind other market

 17 participants.

 18 Before concluding I would like to spend

 19 a moment on sequencing and timeline. We look at

 20 this through three lenses. The first lens is

 21 infrastructure. We believe we start with

 22 clearing. This is where we believe the market has
 124

 1 experience, confidence and endorsement for

 2 adoption by most market participants. Over time

 3 we introduce executing facilities and allow for

 4 markets to gain confidence with the phased

 5 implementation into each of the respective areas.

 6 Once confidence is established, liquidity should

 7 follow.

 8 The second lens is market participants.

 9 Dodd- Frank promotes an all-to-all market

 10 structure. The only way to achieve an all to all

 11 with all market participants is to have them move

 12 in lockstep together. Anything other than that is

 13 a perpetuation of the status quo and where we saw

 14 no client adoption. To design market structure

 15 for clients without clients is a flawed approach.

 16 A standard onboarding of market participants will

 17 overall be more expensive and more likely the

 18 higher costs will be borne by the market

 19 participants that are brought on later.

 20 The third lens is product. We need

 21 market structure to develop simultaneously for

 22 multiple products. Otherwise we will end up with
 125

 1 vertical silos that are not designed to

 2 efficiently be used across more than one product.

 3 We collectively here are working toward a market

 4 structure that is durable and sustainable over a

 5 long period of time. Therefore it is more

 6 important to have the right market structure that

 7 has confidence in it from all market participants

 8 than one that is put in place too quickly or too

 9 fast.

 10 In conclusion to design and implement

 11 interconnectivity properly there needs to be an

 12 understanding of the operating processes and

 13 respective workflows for all constituents involved

 14 and there needs to be a consensus and coordination

 15 among the constituents on standards. This will

 16 reduce operational risk, barriers to entry and

 17 will make the overall trade process more conducive

 18 to adaptability and adoption as the market

 19 changes. On this last slide we leave some

 20 overarching questions as takeaways for everyone.

 21 Again I'd like to thank the Commission for giving

 22 us this opportunity to present our views on
 126

 1 interconnectivity.

 2 CHAIRMAN O'MALIA: Thank you very much,

 3 Supurna. Next is Larry Tabb who is the founder

 4 and CEO of the Tabb Group, a financial markets

 5 research and consulting firm focused on helping

 6 financial service firms, vendors and technology

 7 integrators better understand and create their

 8 technology vision. Prior to founding the Tabb

 9 Group Larry was a vice president of Tower Group

 10 Securities in investment practices where he

 11 managed research across capital markets. Larry's

 12 career included various operations in North

 13 American investment at Citibank. Larry, thank you

 14 very much for participating.

 15 MR. TABB: You're welcome. Thank you

 16 very much. I want to thank the Commission for

 17 allowing me this time to talk. Commissioner

 18 O'Malia asked me to talk about the technology

 19 implications of Dodd-Frank on financial markets

 20 and what I focused more on is the derivatives

 21 aspects of that business.

 22 We'll start pretty quickly with
 127

 1 high-level workflows and then look across various

 2 entities, how they exist now and then what's

 3 proposed along the SEF level, clearing dealers and

 4 prime brokers. Then we'll look at some estimates

 5 on what we think the major dealers are going to be

 6 spending, a little bit about dealer progress and

 7 then some conclusions and we'll try and go through

 8 a lot of the workflows pretty quickly.

 9 We did a lot of this work in late summer

 10 or early fall. We interviewed and talked with a

 11 lot of the interdealer brokers, we talked with

 12 probably 10 of the largest 15 swaps dealers to try

 13 and get a good understanding of what technology is

 14 involved, what they're going to be spending and

 15 what are the challenges and some of this comes out

 16 of that.

 17 If we look at the existing market, the

 18 existing market is built as almost a phone market

 19 way of taking end user risk, hard inventory,

 20 minerals, agricultural, currency, interest rate

 21 risk and energy risk and then transferring it into

 22 the financial markets to absorb it. To a certain
 128

 1 extent this part of the business we don't think is

 2 going to change significantly as a lot of the

 3 users are carved out of Dodd-Frank. The issue

 4 developing a whole new market for the standardized

 5 agreements that are done mostly between financial

 6 institutions to a certain extent and we think that

 7 is going to become more of a traditional

 8 exchange-type market or a SEF or DCM market and

 9 that's on the right side of this that's going to

 10 change. To a certain extent we're going to wind

 11 up with an SEF and a clearing mechanism interposed

 12 in between the two halves of this market, the

 13 existing market between the end users who are

 14 still trying to manage inventory risk or financial

 15 risk and the right side of this which are the

 16 financial institutions trying to manage risk on

 17 their own but take risk in the marketplace and the

 18 SEFs meeting the two. We believe that the large

 19 dealers are still going to wind up being

 20 interposed with the end users trying to help them

 21 carve out specific end user swap agreements and

 22 then taking gap risk and then leveraging that
 129

 1 through the SEF into the financial institutions.

 2 The financial institutions we believe

 3 will be broken out into a couple of different

 4 groups or working with a couple of different

 5 intermediaries, the large dealers or the dealers,

 6 clearing firms representing smaller dealers and

 7 prime brokers managing hedge funds and prop shops

 8 interflow into that market and all will be revolve

 9 into the trade repository and the clearinghouse

 10 process.

 11 The SEFs generally are going to wind up

 12 having a number of different types of

 13 infrastructures. Certainly on the upper left

 14 there may be colo depending on how high frequency

 15 this business gets. Certainly there is going to

 16 be a connectivity part with managing information

 17 flow between all the different members and

 18 participants. There will be a credit-management

 19 process of pretrade risk. Certainly there is

 20 going to be a market-data distribution process, a

 21 surveillance process and at the core a matching

 22 engine with drop copies that I think was talked
 130

 1 about earlier going back to all the different

 2 participants and then linkages in with the

 3 clearinghouse. The clearinghouse is going to be a

 4 repository for offsetting a lot of this risk.

 5 They are going to need a very significant risk-

 6 management infrastructure which is in the upper

 7 right-hand side of this, certainly a

 8 cash-management process to figure out where all

 9 the cash is coming from, a way of being able to

 10 compare all of the transactions, to take all the

 11 information in, aggregate it and compare it to

 12 make sure there are no breaks, make sure that all

 13 the netting and novation works right, aggregating

 14 positions which then go on to risk management,

 15 there is going to be a whole margin process and a

 16 way of collecting all that margin that needs to be

 17 managed and that information is going to wind up

 18 going into multiple trade repositories that may be

 19 located around the world, and then there is going

 20 to be a whole issue of identifier management issue

 21 that is going to be fairly problematic since a lot

 22 of these products don't really exist now and I
 131

 1 think the next topic is going to talk about that.

 2 The dealer infrastructure which is going

 3 to be we think to a certain extent the largest

 4 portion of the spend in this market is going to

 5 come from building out a lot of the internal

 6 infrastructure because they're not only going to

 7 need to manage the existing process today, but

 8 build out a lot of the primes live in the dealer

 9 infrastructure. They're going to need to build

 10 out an electronic trading process. They're going

 11 to need out connectivity to all of their clients

 12 and their clients are going to be multiple types

 13 of client from asset managers, hedge funds,

 14 insurance companies, prop shops, smaller dealers

 15 and I'm sure some end users as well are going to

 16 want to partake in a lot of these transactions as

 17 well. They're going to need a risk- management

 18 infrastructure both on the pretrade side and the

 19 posttrade side. They're going to need a way of

 20 being able to interact with all the different

 21 regulators, the clearinghouses, the clearing

 22 banks, the repositories, multiple SEFs plus
 132

 1 they're got a P&L process and a margin process

 2 that winds up having to go across again multiple

 3 entities around the world and this is across

 4 different geographies as well as a market data

 5 infrastructure that's going to need to be managed.

 6 The primes will probably be more focused at the

 7 prop shops and the hedge funds that will be a kind

 8 of subsegment. It will be more around margin and

 9 interactivity and being able to aggregate smaller

 10 clients or hedge funds and get them into the right

 11 place and manage credit.

 12 We think that we're looking at probably

 13 around a billion-eight from the larger dealers

 14 that is going to be invested in building a lot of

 15 this infrastructure. This is going to take place

 16 generally from last year into 2010 and we think

 17 that it's going to be broken out into five or six

 18 different categories: the e-commerce side which

 19 we're looking at as the trading infrastructure,

 20 the ability to take positions within the

 21 organization and be able to trade within the

 22 organization and market make; the low-touch
 133

 1 distribution channel which is the distribution

 2 side of the business which is building out all the

 3 infrastructure that goes out to their clients, all

 4 the messaging, all of the pretrade risk, all of

 5 the messaging standards, all of the drop copies,

 6 all of the analytics, all of the platforms that

 7 are going to go out to all of their clients; the

 8 CCP infrastructure working with all the different

 9 CCPs around the world trying to get them to link

 10 and be able to get all their transactions to the

 11 CCPs, get the output from the CCPs and being able

 12 to manage all the margins associated with that.

 13 We think the next part is the risk side of the

 14 business which also includes a lot of the

 15 reporting, the data management, the analytics,

 16 looking at positions and managing the internal

 17 risk of these firms and their clients. Then the

 18 collateral management side. Again a lot of that

 19 is also margin and risk as well and being able to

 20 manage all of the collateral that's on deposit and

 21 with the CCPs.

 22 We think the bulk of this is going to be
 134

 1 picked up by the top four or five firms or three

 2 or four firms. It's going to be a fairly

 3 extensive load mostly because these firms are

 4 global, they're going to be trying to do this both

 5 in the U.S. as well as in Europe and they're doing

 6 it across multiple asset classes.

 7 CHAIRMAN GENSLER: Larry, may I ask a

 8 question on this chart?

 9 MR. TABB: Yes.

 10 CHAIRMAN GENSLER: These top three or

 11 four firms, if you have an estimate what do they

 12 spend annually on technology?

 13 MR. TABB: The top firms on the

 14 investment banking side are spending in the U.S.

 15 $4 or $5 billion a pop on technology.

 16 CHAIRMAN GENSLER: $4 or $5 billion per

 17 firm?

 18 MR. TABB: Per firm.

 19 CHAIRMAN GENSLER: That's in the U.S.

 20 Internationally?

 21 MR. TABB: Two-and-a-half times that.

 22 CHAIRMAN GENSLER: Two-and-a-half times
 135

 1 4 is 10 and two-and-a-half times 5 is 12-1/2, so

 2 $10 to $12/2 billion?

 3 MR. TABB: Yes.

 4 CHAIRMAN GENSLER: So that annually they

 5 spend $10 to $12/2 billion.

 6 MR. TABB: This is over 3 years.

 7 CHAIRMAN GENSLER: This is over 3 years?

 8 MR. TABB: So we're looking at about $50

 9 million a year or something like that for the top

 10 firms, $50 to $60 million a year spread out over 3

 11 years.

 12 CHAIRMAN GENSLER: $60 million a year,

 13 and I know it's an estimate compared to their $10

 14 to $12 billion technology budget.

 15 MR. TABB: Right.

 16 CHAIRMAN GENSLER: It's significant

 17 money, but as a percentage it's somewhere less

 18 than 5 percent or around 5 percent.

 19 MR. TABB: Yeah, um-hum.

 20 COMMISSIONER DUNN: To follow-up on

 21 that, then is this amount something they would be

 22 doing under their ordinary course of business or
 136

 1 is this strictly as a result of Dodd-Frank?

 2 MR. TABB: We think that this is a

 3 result of Dodd-Frank because a lot of these

 4 products and services wouldn't necessarily be

 5 needed because the market would exist the way it

 6 is today. When we look at what U.S. Broker

 7 dealers are spending in the U.S. market, it's

 8 somewhere around $20 to $22 billion overall.

 9 Globally it's probably about 2 to 1/2 times this.

 10 CHAIRMAN GENSLER: I should note now I

 11 see that our $31 million a year --

 12 MR. TABB: You have to add the billion

 13 that the SEC gets too.

 14 CHAIRMAN GENSLER: They don't have a

 15 billion on technology?

 16 MR. TABB: No, not on technology.

 17 Overall. It's a drop in the bucket.

 18 CHAIRMAN GENSLER: I might end up

 19 quoting you.

 20 MR. TABB: In terms of growth rates, the

 21 growth rate of technology has been challenged over

 22 the last couple of years because of the recession.
 137

 1 We see it's coming back, but still it's not coming

 2 back at the growth rates that we saw especially in

 3 the early part of the 2000 timeframe, but it is

 4 coming back.

 5 How firms are prioritizing their OTC

 6 derivatives initiatives is client demand and

 7 regulatory compliance are the two big issues that

 8 they're really trying to focus on as well as

 9 competitive differentiation and value-added

 10 services. The bigger guys are out there trying to

 11 figure out what their clients want and trying to

 12 build it.

 13 Where are they with readiness? Out of

 14 five, most folks that we talked to again late in

 15 the summer, or early fall, felt that they were

 16 pretty good on the way to clearing and execution,

 17 a little less on reporting and compliance and

 18 least on reference data and reference data becomes

 19 a big issue in risk management. When I mean

 20 reference data, the OFR stuff, all the issues

 21 about unique identifiers for securities, unique

 22 identifiers for customers and trying to get all of
 138

 1 their data aligned within their organizations

 2 especially for products that don't necessarily

 3 exist right now.

 4 Where are they in terms of their product

 5 priorities? What are they focused on? They

 6 focused mostly on the credit and the rate side and

 7 much less on the commodities, equity and FX side

 8 so that the big issue is credit rates which tend

 9 to be their bigger businesses.

 10 Conclusions. Dealers are absolutely

 11 scrambling to build out their capabilities. We

 12 think the top 15 guys are going to be spending

 13 about a billion-eight over a 3- year period to

 14 comply with Dodd-Frank. While dealers have

 15 invested heavily over the decades, products,

 16 clearing, trading, businesses, distribution models

 17 all are changing because there's a whole new way

 18 of looking at the swaps business. While

 19 regulation is significant, client demand is

 20 driving development as well so that clearing and

 21 execution are the key investment areas and as I

 22 said they're focused mostly on credit rates more
 139

 1 so than commodities, equities and FX.

 2 CHAIRMAN O'MALIA: Larry, thank you very

 3 much. Those were some great slides. Bob Garrison

 4 is Chief Development Officer at DTTC's Information

 5 Technology Division and is responsible for all IT

 6 applications and development efforts at DTTC and

 7 he is also experienced in investment banking as

 8 well.

 9 MR. GARRISON: Good afternoon to the

 10 Commissioners and members of the Technology

 11 Advisory Committee. I am here with Marisol

 12 Collazo who is Vice President in charge of DTTC's

 13 Trade Information Warehouse. We are here today to

 14 discuss some of the challenges and opportunities

 15 in helping the Commission achieve its objective

 16 around market transparency. Marisol will run

 17 through the presentation and we're happy to take

 18 questions on our experience and observations in

 19 working with the industry on derivatives

 20 transparency and data reporting.

 21 MS. COLLAZO: As well good afternoon and

 22 thank you for the opportunity to speak today.
 140

 1 First a bit of background. The Trade

 2 Information Warehouse is a subsidiary of DTTC and

 3 it operates as an industry utility governed by its

 4 users. The warehouse provides a centralized

 5 global repository for OTC credit derivatives today

 6 which includes both legal recordkeeping and

 7 centralized lifecycle processing. The warehouse

 8 has been in operation since 2006. Today over 95

 9 percent of the trades held in the warehouse are

 10 electronically confirmed. The remaining

 11 population, the paper confirmations, are reported

 12 unilaterally by the submitting party with the

 13 current open inventory and certain key economic

 14 details.

 15 The warehouse database currently

 16 represents 2.3 million contracts with a gross

 17 notional of 29 trillion. It is based on these

 18 types of existing automated processes that I will

 19 discuss today how we think the Commission can

 20 achieve one of its key goals on market

 21 transparency by leveraging those processes that

 22 are presently capable of producing high-quality,
 141

 1 robust and accurate data in a timely manner.

 2 Based on such a model, the Commission would

 3 benefit as it is assured to receive the best

 4 quality of data currently available.

 5 To achieve this there are four key

 6 points that underpin this premise. First,

 7 coordinated technology implementation must take

 8 place across the entire industry. Second,

 9 mitigation of delivery risks where possible by

 10 utilizing existing robust, accurate and auditable

 11 reporting processes. Third, the Commission should

 12 be indifferent as to the data-collection process

 13 for the data elements required so long as the data

 14 is complete and provided on a timely and accurate

 15 basis. Fourth, standardization is necessary and

 16 useful but by itself is insufficient to allow for

 17 appropriate and timely aggregation of data.

 18 I'm going to stay on this slide and hone

 19 in on each of these four points and provide some

 20 background. With respect to point one, to ensure

 21 successful implementation of an SDR there must be

 22 a coordinated effort with the industry in defining
 142

 1 the framework for submitting these records. This

 2 includes defining the business requirements,

 3 reviewing the message choreography, connectivity

 4 points, identifying reconciliation tools where

 5 necessary, drafting functional specs, training,

 6 user testing. Also some similar things that I

 7 heard earlier today about ensuring that the firms

 8 can connect and that the testing is there. It's

 9 important to note that the industry, the buy side

 10 and the sell side, are taking these reporting

 11 requirements very seriously and have been actively

 12 engaged at the warehouse as an industry utility

 13 provider in discussions as to how they can meet

 14 their reporting obligations. We do not believe it

 15 can be successful without industry coordination

 16 which builds confidence and momentum to solutions

 17 and overcomes uncertainty and ambiguity which may

 18 lead to extensive delays. In this regard, the

 19 Trade Information Warehouse has kicked off several

 20 work streams to review data attributes and

 21 validations needed and message choreography and

 22 lifecycle events. The response thus far is that
 143

 1 most of what has been prescribed with respect to

 2 the data elements can be provided particularly

 3 where automated processes are already in place.

 4 The key challenges that the industry faces is in

 5 reviewing who needs to report what by when, and

 6 I'll talk more about that in point three.

 7 This is particularly impactful where

 8 data needs to be reported in advance of existing

 9 automated processes, in effect decoupling the

 10 reporting requirements from the automated process

 11 and resulting in potentially lesser- quality data

 12 being reported. Another key challenge is

 13 reporting of paper confirmed trades as there are

 14 no automated processes in place due to the

 15 customized nature of these transactions.

 16 Apparently the sense of working group

 17 that has been formed is to ask this Commission to

 18 consider reporting of these trades to be satisfied

 19 through real-time record submission with an image

 20 copy of the confirmation representing the fuller

 21 legal and economic terms -- the Commission --

 22 support an increase in electronic confirmation
 144

 1 processes over time, an approach similar to the

 2 effort that the OTC Derivatives Supervisor's Group

 3 has enforced with major dealers in the past.

 4 These challenges lead into the next key

 5 point which is mitigating delivery risk where

 6 possible by utilizing existing processes. The

 7 Commission would be best served by leveraging the

 8 existing automated process. For example, the key

 9 difference between the primary economic terms data

 10 and the confirmation data is the timing. The

 11 challenge to sending primary economic terms and

 12 confirmation data are not significantly different

 13 so that it is not necessarily safe to assume that

 14 an accurate reporting process can occur that much

 15 faster than the current confirmation process.

 16 However, the degree of accuracy and the quality

 17 achieved through a matched confirmation are much

 18 higher than a unilateral reporting of primary

 19 economic terms. A confirmation record that is

 20 matched and agreed to by both parties through an

 21 automated process ensure that the Commission

 22 receives data that is complete and accurate and
 145

 1 systemically verified by both parties. With

 2 respect to timeliness for credit rates and

 3 equities, most trades are confirmed intraday. For

 4 interest rates, 80 percent are electronically

 5 confirmed within approximately 30 minutes, for

 6 credit these trades are mostly confirmed within a

 7 range of 30 minutes to several hours following

 8 execution and equities tend to be more within

 9 intraday for standard contracts.

 10 I would say here too this has been an

 11 evolutionary process where the industry has worked

 12 with its respective supervisors to improve the

 13 confirm timeliness by refining the existing

 14 operational process and standardizing where

 15 possible.

 16 CHAIRMAN GENSLER: May ask for rates how

 17 long did you say?

 18 MS. COLLAZO: For rates it's

 19 approximately 30 minutes. The Commission should

 20 consider monitoring these industry commitments as

 21 a measure toward improving the existing automated

 22 processes to improve confirm timeliness further
 146

 1 bridging the gap between the primary economic

 2 terms and the confirmation data. It is also

 3 important to note that the regulatory reporting

 4 has also evolved in this space. Based on the Data

 5 Access Guidelines provided by the OTC Derivatives

 6 Regulator's Forum which is comprised of 40

 7 regulators including the SEC and the CFTC, DTTC

 8 has launched the Regulatory Portal. The portal

 9 enables regulators coincident with their authority

 10 to view trade- level data as well as counterparty

 11 and reference-entity exposure reports for the

 12 entities or jurisdictions over which they have

 13 authority. For central banks, they are able to

 14 view data for the largest financial institutions

 15 trading in that respective currency as a proxy for

 16 those institutions that are systemically

 17 important. For market regulators and prudential

 18 supervisors, discrete trade-level data is

 19 available and that is updated on a daily basis.

 20 The feedback we've received from the ODRF has been

 21 largely positive from a credit perspective and

 22 it's viewed to be fairly compliant. More work
 147

 1 needs to take place with respect to rates and

 2 equities to achieve that same high level quality

 3 of data and that continues to progress in that

 4 space.

 5 Turning to point three, as long as

 6 reported data contains all the data elements and

 7 is reported on a completely, timely and accurate

 8 basis, the Commission should be indifferent to the

 9 data-collection process. In Part 45 of the CFTC's

 10 proposed rules there are two different for how an

 11 SDR can review data, either snapshot or lifecycle

 12 depending on the asset class. DTTC proposes that

 13 the Commission consider flexibility in allowing

 14 the industry to define how data is collected in

 15 the SDR. For example, for electronic

 16 confirmations where automated processes are in

 17 place, it is much more likely that the industry

 18 would favor a lifecycle approach where trades are

 19 updated in the SDR based on centralized lifecycle

 20 updates to those records. Whereas for paper

 21 confirmations, the industry is likely to favor a

 22 snapshot approach as there is little to no
 148

 1 automation for these customized records. As to

 2 who reports, the Commission should allow for

 3 industry participants to identify the

 4 authoritative reporting source based on who has

 5 the best available information. For example, SEFs

 6 may not have all the information necessary to

 7 report the data elements prescribed in the

 8 proposed regulations. Also foreign dealers may

 9 want to provide U.S. End user reporting parties

 10 with the ability to report these trades to the SDR

 11 on behalf of the end user. It is simpler to make

 12 the reporting parties responsible and this clearly

 13 establishes a single point for control of data

 14 into the SDR. Swaps primarily different from

 15 other products because of their lifecycle events

 16 and these do not necessarily occur in the same

 17 service as creation data so that coordination

 18 across multiple submitters is complex. DTTC

 19 thinks the majority of reporting should be done by

 20 dealers and DCOs but it is not necessary to

 21 prescribe that a DCO reports lifecycle events and

 22 a dealer intrinsic events where the same process
 149

 1 can likely report both.

 2 Turning to the last point, DTTC is

 3 supportive of universal identifiers for

 4 counterparty swap and product. Such standard

 5 identifiers will enable consistent standards for

 6 aggregation of data. However, in and of itself it

 7 does not fully address the aggregation question.

 8 Timeliness of aggregation of data is key

 9 particularly during times of crisis. In the wake

 10 of the Lehman financial crisis, it was not well

 11 understood what the counterparty exposure was to

 12 Lehman as an underlying entity. The warehouse was

 13 able to provide such transparency by reporting the

 14 net notional and the potential amount of funds

 15 transferred between all the counterparties based

 16 on the sum of their bilateral exposures. There is

 17 a great risk that with too many SDRs this

 18 information would be fragmented and it would be

 19 too difficult for regulators to collect the data

 20 in a timely and accurate manner. Additionally,

 21 the process would be further frustrated as the sum

 22 of the net notionals on open positions provided by
 150

 1 each SDR would not equal the whole. Today the

 2 warehouse holds both cleared and uncleared

 3 contracts with up-to-date information ensuring

 4 that in times of crisis the regulators can view

 5 the aggregate counterparty exposures for their

 6 entire portfolio and inventory. There are also

 7 additional benefits that the public, industry and

 8 central clearinghouses derive from aggregation as

 9 it easily provides transparency as to the

 10 liquidity and the depth of each asset class.

 11 There has been support from regulator forums

 12 toward a centralized aggregation model as well.

 13 Both the ODRF and the Financial Stability Board in

 14 its recommendations on trade repositories urge

 15 that central aggregation of data is key and

 16 adopting uniform standards to allow regulators to

 17 access such data. Today the warehouse already

 18 meets this through our current regulatory

 19 reporting and we believe the Commission should

 20 look to preserve these existing processes where

 21 possible. Standardization is necessary but not

 22 sufficient for risk reporting. Data needs to be
 151

 1 aggregated on a timely basis and this requires an

 2 understanding of the data, of the aggregation

 3 process and the consolidation of service for it to

 4 be efficient and evolving over time.

 5 In closing I'd like to leave you with

 6 these final thoughts when considering these four

 7 key points. First, regulators can rely on

 8 existing processes to implement reporting

 9 procedures. There is no reason to reinvent the

 10 wheel. There are existing processes in certain

 11 asset classes. Second, the market can evolve over

 12 time. The timeliness of reporting and

 13 confirmation will increase as market participants

 14 adjust to a new regime. Finally, regulatory

 15 transparency is also available with DTTC's

 16 Electronic Portal following ODRF guidelines.

 17 These capabilities can exist and provide

 18 regulators with valuable data now. Thank you for

 19 your time.

 20 CHAIRMAN O'MALIA: Thank you very much.

 21 As I indicated earlier, we're going to open this

 22 up for any questions from the first panel or this
 152

 1 panel, but I do have a question. Marisol, you

 2 mentioned on the swap dealer and MSP reporting

 3 versus the SEF and you said there is greater

 4 fidelity of data with the swap dealer. Can you

 5 explain what the shortcomings of SEF data may be?

 6 MS. COLLAZO: There are certain data

 7 attributes within the SEF that the SEF may not

 8 hold itself, for example, trader I.D.'s or desk

 9 I.D.'s. It's certainly a question of is that

 10 something that the SEF builds or is it better to

 11 have the reporting party directly submit it

 12 because it has all that relevant if you will

 13 static data information that it can provide

 14 directly to the SDR. The other point that I was

 15 making there is that we also have foreign swap

 16 dealers or dealers that also are facing off to

 17 U.S. parties and in that instance the U.S. party

 18 would be responsible for reporting and where that

 19 U.S. party is an end user, that end user or rather

 20 that foreign dealer may want to be able to submit

 21 that record on behalf of the end user.

 22 CHAIRMAN O'MALIA: Can you speak to the
 153

 1 universal identifiers and the challenges that it

 2 will take to integrate this and to have everybody

 3 here have an I.D., have a counterparty I.D., have

 4 a product I.D. report that and understand that?

 5 We've heard from staff level and other meetings

 6 that this is an extraordinarily big challenge for

 7 the industry to implement. Can you go over some

 8 of the challenges you see?

 9 MS. COLLAZO: Certainly we think that

 10 standard identifiers is good. It is a challenge

 11 and it depends on which one we're talking about.

 12 One, as far as the unique swap identifiers are

 13 concerned, we already have a process within the

 14 warehouse where we identify unique I.D. so that we

 15 think that to the extent there can be a common

 16 language about how unique swap identifiers are

 17 provided that we can include that in the existing

 18 workflow. Certainly the choreography around that

 19 unique swap identifier and where it gets created,

 20 how the reporting party gets that identifier back

 21 into their system, how do they ensure that these

 22 trades continue as there is a lifecycle process to
 154

 1 them, how do they ensure that they keep that

 2 identifier, there are certain challenges in what

 3 we call the many to one process where you have a

 4 trade that initially executed then subsequently

 5 compressed or fully allocated and how do you keep

 6 that unique identifier unique and following the

 7 record through compression.

 8 CHAIRMAN O'MALIA: Can you talk to the

 9 timeframes that DTTC thinks that it might take to

 10 implement this universal I.D., and then maybe

 11 Larry or Supurna if you have some things about

 12 what you've seen in the market related to this

 13 issue or the challenges you may have in the case

 14 of Blackrock?

 15 MS. COLLAZO: It's hard to talk to the

 16 timeframes particularly because essentially in

 17 looking at our model to build the SDR we're

 18 putting it in as a placeholder. We know that

 19 there needs to be industry discussion on this

 20 point to identify a common method in which to

 21 submit the USI. We're putting a placeholder for

 22 it and in a worst- case scenario we think that we
 155

 1 have a way in which we can prefix those records so

 2 that we can use our existing identifier and

 3 provide a prefix for it and that's been our

 4 working assumption.

 5 MS. VEDBRAT: When we look at this

 6 universal swap identifier I think one of the areas

 7 when a block trade is broken into the allocated

 8 components, in that area we would expect that

 9 unique identifier to be replicated so that the

 10 block identifier follows the different

 11 allocations. The challenge comes when we look at

 12 what do we do when we compress our portfolios.

 13 How do we deal with the identifier in that case

 14 because we have to come up with a mechanism where

 15 the compressed trade and that swap identifier of

 16 the old package trades somehow reaches the SDR and

 17 let's the SDR know that those trades have been

 18 replaced by the new compressed trades so that it

 19 is the second piece of it that is more challenging

 20 than the first.

 21 MS. COLLAZO: That's a many-to-many

 22 problem. That's where you compress many trades.
 156

 1 You take 100 trades, you compress it to 10 trades,

 2 what identifier goes with what. The next day you

 3 compress those 10 trades into another eight trades

 4 so that it's a difficult audit trail problem as to

 5 how you follow that USI across compression.

 6 MS. VEDBRAT: The compression is a very

 7 important piece of how we keep our books clean and

 8 how we manage risk.

 9 MR. TABB: That's with the transaction

 10 I.D., but even in terms of the security I.D., we

 11 have a hard enough time getting globally unique

 12 identifiers for equities and then when you look

 13 for something that's even issued and you can be

 14 traded around the globe in different organizations

 15 and the industry coming with what is the swap and

 16 number it is a really challenging issue mostly

 17 because if we create our own unique I.D., then

 18 Germany decides they need to have their I.D. and

 19 they create another one that's different from

 20 ours, it will have a different numbers of places

 21 and fields and then you wind up with having to

 22 create a table to say, no, this I.D. is equal to
 157

 1 that I.D. and it becomes a big pain in the butt.

 2 Excuse my language.

 3 MS. COLLAZO: To answer, there is

 4 another identifier that's been quite challenging,

 5 the counterparty identifier, and here there were

 6 two things in the rules. One was about

 7 identifying the legal entity, the UCI, for the

 8 counterparty to the contract. There was also a

 9 reference regarding hierarchies and affiliate

 10 relationships. One of the things that the

 11 warehouse has been based on is identifying who

 12 that legal entity is to the contract. We think

 13 from that perspective of looking at a way in which

 14 to uniquely identify the UCI for the contract is

 15 the right process and it's part of what should be

 16 included in the submission to the SDR. A bigger

 17 challenge is we think when you start to look at

 18 the affiliations and the hierarchies and gathering

 19 that information because again we're looking at

 20 this from a global repository perspective as these

 21 markets are traded globally and how do you get

 22 that information, how do you validate that
 158

 1 information? Is there self-certification along

 2 with independent validation? How do you ensure

 3 that the information is kept up to date? All of

 4 this is much more difficult to do when you look at

 5 it from an affiliation perspective. But we do

 6 think that from a legal entity of the contract

 7 itself that that's something that certainly should

 8 be part of what the SDR provides.

 9 CHAIRMAN GENSLER: Before I ask a

 10 question I wanted to mention that as excellent as

 11 this meeting is and as many people in the public

 12 are tying in, these documents will be on our

 13 website. I don't know if they are yet, but they

 14 will be on our website all that you've done which

 15 is terrific. We ask for the public to comment on

 16 the advice of Dr. Gorham's subcommittee as we did

 17 also with the Joint Advisory Committee so that

 18 you're not alone that we've asked the public to

 19 comment on reports that are given to us. All of

 20 this is also in a public record. I can't think of

 21 how many proposed rules have been discussed here,

 22 but to make sure that we're complying with the
 159

 1 Administrative Procedure Act I'm going to ask that

 2 this entire transcript be put in the public

 3 comment record and be put in the right comment

 4 file. Certainly speaking only as only one

 5 Commissioner, I am considering those things you've

 6 said today in moving forward and it's very helpful

 7 to hear from the public so that I'm saying that

 8 for the record and I know my fellow Commissioners

 9 are listening closely.

 10 I did have a question. The swap data

 11 reporting that we proposed in a rule said that if

 12 it was bilateral that it was reported by the

 13 dealers and I think that's consistent with what

 14 you're saying. But if it were on a swap execution

 15 facility or designated contract market and I know

 16 it's not just you too. It might be others. Tom,

 17 you might form a SEF. We proposed I think in some

 18 sense a thought that it would be less burdensome.

 19 It's interesting to me that you would be

 20 suggesting maybe -- I don't know how many dealers

 21 there would be, but there are probably more

 22 dealers than there are SEFs so that we did propose
 160

 1 that it would be the DCMs or the SEFs that would

 2 report the traded, cleared swaps.

 3 MS. COLLAZO: It's that SEFs really have

 4 all the information. I believe if the language

 5 were such that the SEFs would report and have the

 6 reporting obligation, to the extent there was any

 7 information that was missing, the reporting party

 8 would provide that subsequent information and I

 9 think that was in reference to the UCIs perhaps.

 10 There's concern that as the reporting they want to

 11 ensure that what's in the SDR is accurate so that

 12 there is a reconciliation question there as to,

 13 one, has the SEF reported everything and if there

 14 is a gap then how do I report that and it's

 15 looking at the existing process of where do I

 16 build that in and certainly the thinking is if the

 17 SEF is going to report then the SEF has some work

 18 to do if there is a gap in fields. Second, I am

 19 going to have to ensure reconciliation.

 20 CHAIRMAN GENSLER: My other question is

 21 to the extent that there may be multiple data

 22 repositories that the law allows -- I know you're
 161

 1 smiling because that means competition, the law

 2 allows that clearinghouses themselves could

 3 register as data repositories and certainly there

 4 are a number that have told us privately that

 5 they're considering it. We don't know what

 6 they'll do, but they're considering it. Have you

 7 had any dialogue or do you have any advice for

 8 this Commission that might have to aggregate data

 9 across multiple data repositories for our

 10 surveillance, compliance and other functions that

 11 we do?

 12 MS. COLLAZO: That goes to the last

 13 point that standardization is good. The challenge

 14 that you have there is that in order to do that

 15 aggregation you need the granularity of the

 16 transactions. A specific example that I think is

 17 in our PowerPoint speaks to if you took the open

 18 positions, an aggregate number by a clearinghouse

 19 and you took the aggregate number of bilateral and

 20 you looked at what the net notional is for each

 21 and you summed that up, that's too high. I have

 22 to have the underlying detail in order to do
 162

 1 appropriate aggregation. I think the biggest

 2 challenge for the Commission is in having multiple

 3 SDRs you then need to have that transaction-level

 4 detail in order to be able to perform that type of

 5 aggregation. Our history of having developed the

 6 warehouse has been that most of our spend on

 7 technology, about half of our technology over the

 8 evolution of where we started from confirmation

 9 services through posttrade lifecycle services has

 10 been on that posttrade up-to-date record and

 11 aggregation and that's been half of our technology

 12 budget.

 13 CHAIRMAN GENSLER: Maybe I'll leave my

 14 question there on any thoughts you have because

 15 the statute does not provide for unique swap data

 16 repositories. It allows for what might end up

 17 being either multiple within an asset class or it

 18 might be geographically, there may be one in

 19 Europe and one here. Larry, if you could

 20 follow-up because it would be helpful in our

 21 consideration as to cost-benefit analyses and all

 22 that we do here before we go to final rules. This
 163

 1 was enormously helpful. I don't have any specific

 2 questions, but if you have anything further

 3 regarding details on the cost. I was particularly

 4 intrigued when you said that these large dealers

 5 spend $20 to $25 billion in aggregate here in the

 6 U.S. or individually $4 to $5 billion, and then

 7 you said maybe they spend $10 to $12 worldwide. I

 8 think as we continue to move forward we do

 9 recognize there are costs in relation to the

 10 benefits. That's how we have to do our work. But

 11 you could help us identify cost in relation to

 12 their aggregate spending and so forth.

 13 MR. TABB: We would love to help you,

 14 Commissioner.

 15 COMMISSIONER DUNN: Let me thank all of

 16 the panelists. This was absolutely fantastic and

 17 I especially liked the diagram because it tells me

 18 what's going on there. It is extremely helpful

 19 for me.

 20 My question is on the universal

 21 identifiers, is this something that if the

 22 Commission with the SEC tasks the industry to do
 164

 1 that you can come to some agreement on this or are

 2 we going to have to dictate something?

 3 MS. COLLAZO: I'll start. As I

 4 mentioned earlier, the industry is taking this

 5 very seriously and there have already been

 6 discussions about how to broach both the unique

 7 swap identifier and the unique counterparty I.D.

 8 Certainly from a DTTC perspective we are engaged

 9 with other providers to look at where we can

 10 provide such offering through our Avox subsidiary

 11 so that it something that we're looking at and the

 12 industry is looking at and they're mobilizing

 13 around it. I wouldn't anticipate that it would be

 14 something that the CFTC would have to prescribe

 15 but you have to let the process go through and see

 16 where they get to.

 17 MR. TABB: This is typically a pretty

 18 difficult challenge but I think that because of

 19 Dodd-Frank and the OFR, I know Mike Atkins behind

 20 me has been working with the Treasury Department

 21 to try and tackle these issues so that I think if

 22 it's going to happen, it's going to happen now.
 165

 1 It's been very challenging to now to get the

 2 industry to come together on any type of universal

 3 identifier. Hopefully it will happen now, but

 4 historically the odds have not been great.

 5 MS. VEDBRAT: I think that as far as

 6 what we plan to achieve by having the universal

 7 identifier, maybe some guidance on that would be

 8 helpful, but how it's defined and how it's

 9 implemented, the industry should be able to work

 10 that out among themselves.

 11 COMMISSIONER DUNN: Larry, you had made

 12 the point earlier that this is not just the U.S.

 13 but it's worldwide. Is this something that we

 14 should look for the G-20 or the FSB to take the

 15 lead on, to push for so that we don't have

 16 something that is worldwide?

 17 MR. TABB: I can't answer whether we

 18 should push at the G-20. I'm not familiar with

 19 how that process works, but it's certainly

 20 something that needs to be addressed globally and

 21 if there is a way of doing that through the G-

 22 It might be worth bringing up. It is
 166

 1 definitely a global challenge because the products

 2 are global and the counterparties are global.

 3 CHAIRMAN O'MALIA: Is this something

 4 that we can move forward with, reporting trades

 5 without having a universal I.D., or if we don't go

 6 down this path of having a universal I.D. first

 7 we'll screw everything up?

 8 MR. TABB: I think if we wind up with

 9 multiple universal I.D.s what will wind up

 10 happening is that there will need to be a way of

 11 reconciling them so that it will either have to be

 12 done at the regulator level, certainly at the

 13 dealer or the bank level, and then God forbid

 14 there is some sort of fiasco where we're going to

 15 need to do it on a supernational level.

 16 CHAIRMAN GENSLER: It strikes me that

 17 what Commissioner O'Malia question is is could we

 18 phase implementation? Could we in essence have

 19 requirements for swap data repositories, SEFs and

 20 clearinghouses and they might come into being in

 21 whatever period of time, I don't want to yet

 22 predict, where it's phased in and they are there
 167

 1 and that that unique identifier may take another

 2 6, 12 or 18 months or whatever? Particularly I

 3 say this because Congress didn't say in the

 4 statute that there must be unique identifiers but

 5 they did say that there has to be a swap data

 6 repository. What I'm asking is there a way

 7 possibly to phase it where we comply with

 8 Congress' mandate that there are swap data

 9 repositories, there is reporting and then if it

 10 takes the industry a while to do that which

 11 Commissioner Dunn was talking about that it's

 12 phased in?

 13 MR. TABB: I think you would have to

 14 phase it in. I'm sure it's going to be hard to

 15 get a global agreement. But on the other hand,

 16 there are commercial benefits to owning the swap

 17 I.D. number. We've seen this with Red Coats and

 18 we've seen this with any type of CUSIP numbers or

 19 ISIN (?) numbers where there are benefits to

 20 owning the number so that if I own the number then

 21 somebody else is going to create another number

 22 because there are benefits to owning that number.
 168

 1 MS. COLLAZO: Also I think that that is

 2 true and there is also the sensitivity to the

 3 per-asset class, that it's an asset class question

 4 as well so that to the extent that in the

 5 warehouse we have for OTC credit derivatives a

 6 unique identifier that's not as fully prescribed

 7 as the USI, there are some challenges as we

 8 mentioned earlier with the audit trail and

 9 compression for example, but there are some

 10 existing processes that you can look to with an

 11 asset class perhaps as a phase in implementation

 12 as the identifiers start to form.

 13 MS. VEDBRAT: I think in a phased

 14 approach one thing that we need to be careful of

 15 is that we don't end up with a situation where we

 16 need to do back entry of the identifier because

 17 that's going to be very, very hard and close to

 18 impossible.

 19 CHAIRMAN O'MALIA: I'd be interested to

 20 get any impressions from end users or

 21 clearinghouses at the table here about some of

 22 these presentations about integrating all of this
 169

 1 technology and what you're looking for, what

 2 you're thinking about and have you ever thought

 3 about some of these things that obviously the

 4 dealers and the exchanges and new SEFs we're going

 5 to have to move into. Before I do that I want to

 6 check and see if there's anybody on the phone. I

 7 understand there are more people than just

 8 Commissioner Chilton on the phone and see if they

 9 want to speak or have a question on any of this or

 10 Commissioner Chilton of course.

 11 COMMISSIONER CHILTON: Commissioner

 12 O'Malia, I want to pick up on what Chairman

 13 Gensler was saying about phasing in. The law is

 14 pretty clear on certain things about when we are

 15 to implement things, but on a lot of it we also

 16 have some flexibility where it says not less than

 17 60 days after we promulgate a final rule. I'm a

 18 little concerned about how we go about

 19 implementing some of these regs, in particular

 20 some of the stuff we're talking about now. I

 21 don't want it to be a competitiveness problem for

 22 the U.S. if the timing is too short. As the
 170

 1 Chairman said, we'll look for comments, and this

 2 is very helpful today, but we certainly need to be

 3 cautious as we go forward. I don't have a

 4 question, Commissioner O'Malia.

 5 CHAIRMAN O'MALIA: Thank you. Is there

 6 anybody else on the phone? Are there any thoughts

 7 from end users or clearinghouses about integrating

 8 technology?

 9 MS. BLOUTWOOD: For a generic company

 10 and I'll use an energy company unnamed as an

 11 example, we presented a case study and an earlier

 12 white paper where we discussed our internal

 13 project before Dodd-Frank came along trying to get

 14 to standard exchange product definitions excluding

 15 OTC transactions, but mapping our own internal

 16 systems to the different exchange product

 17 definitions because all of the exchanges have

 18 different product definitions as well. This was a

 19 fairly large team. It took us 9 months to map the

 20 first 60 percent of our transactions, a year and a

 21 half to get to the next 30 percent and 6 months

 22 additional to get to the last 10 percent and it
 171

 1 only applied to standard cleared products so that

 2 this was into a 3-year project simply to map our

 3 own internal systems and we had multiple over the

 4 years to exchange product definitions. Then you

 5 have the issue that across exchanges you can have

 6 the same product but all the data field's name

 7 definitions are different so that you're spending

 8 a great deal of time for the same product ensuring

 9 that you have consistency across the different

 10 exchanges. We're now in the process of mapping

 11 OTC products but we're looking again at a

 12 multiyear project. I'd say here we've been

 13 talking about global issues and to bring it back

 14 home to one particular company, I don't think we

 15 can underestimate what it takes in terms of it's

 16 systems work but it's process and standardization

 17 of the definitions internal to a company.

 18 CHAIRMAN O'MALIA: I think that's a

 19 great point. One of the reasons we had this

 20 discussion, some of the first slides we've seen in

 21 detail about how all of these boxes will be

 22 interconnected, and I think it's fascinating and I
 172

 1 think I can speak for all of the Commissioners

 2 here that putting this all together I think the

 3 staff has been challenged to understand how all

 4 the parts will link together. I'm grateful for

 5 your presentations today that help us map that

 6 out. This is the first high-level we've had on

 7 this but I think to your point to take it to the

 8 next step and further on will be a great challenge

 9 and it would be informative to us to understand

 10 all of these pieces will come together and I think

 11 that's where the industry is trying to put all of

 12 our rulemakings together to figure out how all of

 13 these parts come together. I think this will not

 14 be the last discussion we have of this and I think

 15 it's a fascinating kind of look at where we have

 16 to go and the time that we have to get there.

 17 CHAIRMAN GENSLER: I sense when we put

 18 this on the website and ask for comment we will be

 19 benefited and grateful for all the charts that are

 20 going to come in now that Blackrock, DTTC and

 21 Larry's group put together these charts. I think

 22 we'll benefit and we welcome the other public who
 173

 1 put their various charts and comments in on the

 2 mosaic.

 3 CHAIRMAN O'MALIA: I did want to go back

 4 at the risk of opening up a can of worms to the

 5 first discussion and the issue that we had at the

 6 May 6 event 2 weeks ago, the issue of order

 7 cancellation or excessive cancellation and some of

 8 this quote stuffing. It was equated to disruptive

 9 trade practices and there were several of the

 10 Joint Advisory Committee members who spoke to that

 11 end in saying that excessive quoting or excessive

 12 cancellation to disruptive trade practices. I

 13 thought it would be helpful if we had a better

 14 understanding of what's in place today to prevent

 15 that. I think Chuck you briefly spoke about it

 16 earlier and if you could make a brief comment and

 17 maybe Dean briefly talk about some of the controls

 18 that you have on order traffic and what standards

 19 you have to defeat that disruptive trade practice.

 20 MR. VICE: We have message throttles

 21 which is a pretrade functionality we've talked

 22 about a lot today, but on the issue of excessive
 174

 1 quoting, that's more of a compliance issue and

 2 there is a policy around that that is I think

 3 called volume-weighted ratio or something and it

 4 was a simpler policy that we've recently made a

 5 little more sophisticated because we wanted to do

 6 two things. One, we want to discourage excessive

 7 messaging, but we also wanted to encourage tighter

 8 bid offer spreads. An order is not an order is

 9 not an order. An order that comes in that is

 10 let's say -- a bid comes in at or better than the

 11 best bid and it gets a particular weighting. A

 12 bid that comes in that may be 5 ticks away from

 13 the best resting bid is going to get a much

 14 heavier weighting, a much heavier penalty than

 15 otherwise against that volume ratio and we have

 16 different thresholds for each market depending on

 17 the nature of the market and then there are

 18 penalties if you go over those thresholds. If you

 19 hit a certain threshold, it's $1,000 a day. You

 20 get 7 days in a month -- on the eighth day and

 21 after you would get hit with $1,000. If you

 22 exceed an even more egregious threshold, it's
 175

 1 $2,000 a day with no waiver of any days. We find

 2 the HFT traders not only want to avoid paying the

 3 penalties but also being perceived as violating

 4 exchange thresholds and we find it be an effective

 5 policy. I think as I said earlier, we in the last

 6 year have been evolving that policy from one that

 7 was focused on our own system capacities to a more

 8 holistic view of even though there may be an

 9 amount of messaging that we can handle, is some of

 10 it going to be deemed excessive in terms of ratio

 11 of fills to orders with this weighting in mind and

 12 therefore we may want to set thresholds so that

 13 some of that gets dialed back which is what we've

 14 been doing.

 15 CHAIRMAN O'MALIA: Dean, do you have any

 16 thoughts?

 17 MR. PAYTON: At CME Group we follow

 18 similar types of procedures, but I think one of

 19 the things to keep in mind is one of the things

 20 that we've talked about in the context of May 6

 21 was people's concerns about there not being

 22 liquidity and as that market was moving very
 176

 1 rapidly that deeper in the book we didn't have

 2 liquidity so that you want to be real careful

 3 about now discouraging messaging that's coming in

 4 to the marketplace even though it may be later

 5 cancelled. We do two things. We have message

 6 throttles that test for message per second and if

 7 we exceed some threshold we don't accept

 8 additional orders from that connection into

 9 Globex, and then we have a messaging policy that

 10 is the messages versus volume so that it's really

 11 about the quality of the messaging and similar to

 12 how ICE works. We work with our market

 13 participants. If they don't correct their

 14 messaging behavior within the benchmarks that we

 15 set on a per-product basis, then we issue

 16 surcharges to those firms.

 17 CHAIRMAN O'MALIA: Are there any other

 18 thoughts or questions? I greatly everybody's

 19 attendance today and I greatly appreciate the work

 20 of the subcommittee to respond in very short order

 21 to survey the market and prepare a report for us

 22 to consider here today. You're not relieved of
 177

 1 your duties. The subcommittee is not going away

 2 because I think it's going to have an important

 3 role in our rulemaking process in identifying the

 4 best practices which I would note came from the

 5 industry in the first place and it was the

 6 industry standards that we worked off of. We're

 7 obviously interested to see all other standards

 8 and we want comment on this report and input from

 9 the public and some additional thoughts to see

 10 what other standards we might follow-up with. I

 11 do have some further questions about integrating

 12 all of the FIA proposals and what result from this

 13 study so I'll follow-up with that myself. But I

 14 greatly appreciate that and will follow-up with

 15 you going forward and I'm sure staff and our

 16 rulemaking teams will have some questions for you

 17 as well so I greatly appreciate your help. Let me

 18 open it up to the other Commissioners here to make

 19 any final comments, but let me thank everyone

 20 again for their outstanding presentations and

 21 participation here today. Thank you.

 22 CHAIRMAN GENSLER: Let me start by
 178

 1 thanking Commissioner O'Malia for having put this

 2 all together and Chris, Laura and Adrian who

 3 probably don't get a lot of attention. I do not

 4 know who has undertaken all of the efforts.

 5 CHAIRMAN O'MALIA: And Shanise upstairs

 6 for organizing all of this.

 7 CHAIRMAN GENSLER: Shanise upstairs,

 8 yes, with three able counsel, all of you. The

 9 pretrade risk functionality I think will be very

 10 helpful for us. I know that I'm going to direct

 11 that it go into the various comment files on

 12 designated contract markets and swap execution

 13 facilities because we have asked questions about

 14 pretrade risk safeguards and your thoughts have

 15 been very helpful and the other three reports have

 16 been enormously helpful. They'll probably go into

 17 a lot of comment files, but even beyond that in

 18 terms of implementation phasing and the overall

 19 mosaic of our rule writing and the mosaic related

 20 to cost are enormously helpful and to the extent

 21 the public wishes to comment on your comments, we

 22 look forward to that as well. Thank you all and
 179

 1 thank you, Commissioner O'Malia, again.

 2 CHAIRMAN O'MALIA: Commissioner Dunn?

 3 COMMISSIONER DUNN: Let me echo the

 4 Chairman's remarks. I want to thank you Scott and

 5 your staff for putting this together, but for the

 6 subcommittee and the committee as a whole, this

 7 has been very, very valuable for me and I would

 8 ask the public to comment on the report that was

 9 given but also on this meeting in general because

 10 here again this is influencing us as we go through

 11 our decision-making process, I was most taken,

 12 Larry, with the $1.8 billion amount that is going

 13 to be spent on the technology and the Chairman's

 14 $31 million that we have on technology. This is

 15 something that this committee and the public has

 16 got to help this Commission on how do we make sure

 17 that that $31 million's tail isn't wagging the

 18 $1.8 billion dog.

 19 CHAIRMAN GENSLER: It's actually greater

 20 because the U.S. industry spends $20 to $25

 21 billion per year according to Larry, not that we

 22 need to do that. This year unfortunately we're
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 1 down to less than one-tenth of 1 percent of that

 2 because we've had to cut back on the $31 million.

 3 CHAIRMAN O'MALIA: It's even greater

 4 than that because a lot of this is for telephones,

 5 tax machines and toner cartridges.

 6 CHAIRMAN GENSLER: That is true as for

 7 our number, but I didn't know what their number

 8 was. You are absolutely right, Commissioner

 9 O'Malia, that we spend all too little to fulfill

 10 our mission where in the futures industry there

 11 are about 11 or 12 million contracts a day, the

 12 swaps market that we're about to take on doesn't

 13 have that many transactions a day, but obviously

 14 it's volume in terms of risk and complexity is

 15 greater.

 16 COMMISSIONER DUNN: I didn't mean to

 17 start a debate.

 18 CHAIRMAN O'MALIA: I thought we were

 19 agreeing. Commissioner Sommers?

 20 COMMISSIONER SOMMERS: I want to echo my

 21 colleagues in thanking all of you and want to say

 22 that as we continue following these very important
 181

 1 issues on direct market access and pretrade risk

 2 functionality that I find it is really impressive

 3 how the industry has within itself kept raising

 4 the bar on complying with best practices and where

 5 we are compared to where we were 3 or 4 years ago

 6 with these issues I think is very impressive.

 7 Thank you all for being here.

 8 CHAIRMAN O'MALIA: Commissioner Chilton?

 9 COMMISSIONER CHILTON: Real quick and I

 10 don't want to open anything back up, but my

 11 takeaway and perhaps Dean and Chuck will want to

 12 email me a nastygram on this, but it seems to me

 13 more is needed. If we have all this messaging

 14 going out and if you all are already penalizing

 15 folks, it seems to me that maybe the fines aren't

 16 working or need to be greater. I do want to

 17 commend to everybody, I don't get a chance to talk

 18 about it too much, about this study from November

 19 that I highlighted in my opening remarks. It's

 20 entitled "Where is the Value in HFTs" and it's by

 21 a couple of fellows in Spain, Cartilla and

 22 Penalva. I'd recommend it to people. It's
 182

 1 interesting reading and I'm hopeful we can look

 2 into this a little bit more in the future,

 3 Commissioner O'Malia. I do notice that as that we

 4 were in our meeting now that Congress looks like

 5 they're going to pass their CR and we'll have

 6 funding for another couple of weeks, but I echo

 7 what all of my colleagues have said earlier about

 8 we can't regulate the swaps market and the OTC

 9 market without an increase and if we end up being

 10 cut, we can't regulate the markets that we have

 11 jurisdiction over now. Thank you very much for

 12 all of you being here and thank you again,

 13 Commissioner O'Malia and your staff, for your

 14 excellent work on this. Thank you.

 15 CHAIRMAN O'MALIA: Commissioner, if you

 16 would send us an email of that report we'll put it

 17 on the Technology Advisory Committee's webpage.

 18 COMMISSIONER CHILTON: Will do. Thank

 19 you.

 20 CHAIRMAN O'MALIA: Thank you very much

 21 for everybody's participation here today.

 22 (Whereupon, at 4:50 p.m. the
 183

 1 PROCEEDINGS were adjourned.)

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 184

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Stephen K. Garland, notary public in

 4 and for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: May 31, 2014

 22