UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 INDIVIDUAL CUSTOMER COLLATERAL PROTECTION

 Washington, D.C.

 Friday, October 22, 2010
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 1 PARTICIPANTS:

 2 CFTC Staff:

 3 ANANDA RADHAKRISHNAN

 Division of Clearing and Intermediary

 4 Oversight

 5 BOB WASSERMAN

 Division of Clearing and Intermediary

 6 Oversight

 7 MARTIN WHITE

 CFTC Office of General Counsel

 8

 NANCY SCHABEL

 9 Division of Clearing and Intermediary

 Oversight

 10

 Speakers:

 11

 RICHARD PRAGER

 12 BlackRock

 13 WILLIAM THUM

 Vanguard

 14

 STUART KASWELL

 15 Managed Funds Association

 16 ROB HUSTON

 AgriVisor, LLC

 17

 MARK SZYCHER

 18 General Motors Asset Management

 19 EDITH O'BRIEN

 MF Global

 20

 MAUREEN BURKE

 21 Bank of America, Merrill Lynch

 22
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 1 PARTICIPANTS (CONT'D):

 2 ED ROSEN

 Cleary Gottlieb Steen & Hamilton

 3

 DAVID MALOY

 4 Credit Suisse Securities (USA)

 5 ARTHUR MAGNUS

 JP Morgan

 6

 DANIEL MAGUIRE

 7 LCH.Clearnet

 8 KIM TAYLOR

 CME Clearinghouse

 9

 CHRIS EDMONDS

 10 ICE Trust

 11 PAUL SWANN

 ICE Clear Europe

 12

 13

 14 * * * * *

 15

 16

 17

 18

 19

 20

 21

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

 2 (12:57 p.m.)

 3 MR. RADHAKRISHNAN: All right. Good

 4 afternoon, and welcome to CFTC's Staff Roundtable

 5 on the discussion Individual Customer Collateral

 6 Protection. My name is Ananda Radhankrishan. I'm

 7 with the Division of Clearing and Intermediary

 8 Oversight, and I welcome all of you to the CFTC,

 9 and I appreciate your participation in this

 10 roundtable, and, for some of you, you're doing

 11 double duty because you were here this morning. I

 12 really appreciate you spending the day with us.

 13 A couple of rules. This event is being

 14 recorded. A transcript of the proceedings will be

 15 on our Web Site. It's a staff roundtable, so, if

 16 we offer any opinions, it'll just be our own, and

 17 will not reflect the opinion of the Commission or

 18 any individual commissioner.

 19 I'm going to first go around and have

 20 the CFTC staff introduce themselves, and then go

 21 around the table and have everybody introduce

 22 themselves.
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 1 So, Martin?

 2 MR. WHITE: I'm Martin White with the

 3 CFTC Office of General Counsel.

 4 MR. WASSERMAN: I'm Bob Wasserman in the

 5 Division of Clearing and Intermediary Oversight.

 6 MS. SCHNABEL: Nancy Schnabel, Division

 7 of Clearing and Intermediary Oversight.

 8 MR. PRAGER: Ritchie Prager, BlackRock.

 9 MR. THUM: Bill Thum, Vanguard Legal

 10 Department.

 11 MR. KASWELL: Stuart Kaswell with the

 12 Managed Funds Association.

 13 MR. HUSTON: Rob Huston representing the

 14 National Council for Farmer Cooperatives.

 15 MR. SZYCHER: Mark Szycher representing

 16 the General Motors Pension Funds.

 17 MS. O'BRIEN: Edith O'Brien representing

 18 the FIA from MF Global.

 19 MS. BURKE: Maureen Burke, Bank of

 20 America, Merrill Lynch, representing FIA.

 21 MR. ROSEN: Ed Rosen, Cleary Gottlieb,

 22 representing FIA.
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 1 MR. MALOY: David Maloy, Credit Suisse,

 2 representing ISDA.

 3 MR. MAGNUS: Arthur Magnus, JPMorgan,

 4 representing ISDA.

 5 MR. MAGUIRE: Hi, I'm Danny Maguire,

 6 head of OTC Derivatives Risk at LCH.Clearnet.

 7 MS. TAYLOR: Kim Taylor, CME Clearing.

 8 MR. EDMONDS: Chris Edmonds, ICE Trust.

 9 MR. WASSERMAN: Actually, one or two

 10 more technology points. If anyone here at the

 11 table has a BlackBerry or the like, please make

 12 sure to keep it off the table or it'll interfere

 13 with the sound. Also, if folks could, as a

 14 courtesy, turn your cell phones to buzz rather

 15 than ring.

 16 And we are hoping to have Paul Swann of

 17 ICE Clear Europe appear on the phone. There may

 18 have been a technological difficulty.

 19 Paul, are you there?

 20 MR. SWANN: No, Bob, I'm on the phone.

 21 Thank you for introducing me. I apologize I

 22 didn't introduce myself because you didn't give an
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 1 opportunity for phone-joiners to introduce

 2 themselves.

 3 I'm Paul Swann, ICE Clear Europe.

 4 MR. WASSERMAN: Excellent. That

 5 technology did work.

 6 Well, thank you, all, for coming. The

 7 issue we're confronting here is sometimes referred

 8 to as a fellow customer problem. If a customer

 9 defaults, who is exposed to the losses? Now, in

 10 the industry, the first two answers are very

 11 clear; the customer himself and the firm that is

 12 carrying that customer. But what happens when the

 13 loss exceeds that capital? Well, we come to the

 14 question of then who should next bear that loss?

 15 Is it the fellow customers at that firm or the

 16 clearinghouse which, the way things are organized,

 17 tends to ultimately mean other clearing members.

 18 And, so, on the agenda today, what I'd like to

 19 first do is start out talking about what the buy

 20 side, the customer side feels about these issues

 21 and what their concerns are. Then move on to a

 22 model or models for addressing that, and then talk
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 1 about how effective those models might be and,

 2 very importantly, what the costs of those models

 3 are.

 4 So, without further ado, Richard, if

 5 you'd like to begin.

 6 MR. PRAGER: Thanks, Bob. I mean, I

 7 think the reference point that we choose to start

 8 from is where we're coming from, which is the OTC

 9 market, and while this sometimes turns out to be a

 10 future's discussion, that certainly was not our

 11 intent. Our intent was to seek on behalf of our

 12 clients to maintain the same level of protection

 13 they now enjoy in the bilateral market if they

 14 choose to enter into a tri-party agreement to

 15 secure their exposure. So, as we migrate into

 16 this new, brave world and look at Dodd-Frank and

 17 the rationale for adopting the new regulation,

 18 which BlackRock is strongly in favor of, there is

 19 this one issue here that we're confronting, which,

 20 on behalf of our clients, we think we need to

 21 maintain that aspect of the market structure for

 22 this account class.
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 1 So, today, we have an environment where

 2 not all our clients choose a tri-party, but those

 3 that do have that ability, they understand that

 4 there's incremental costs associated with that

 5 security, and we contract those costs, we pay that

 6 cost today, and while we do hear a lot of support

 7 for our concern, we also hear a lot of concern

 8 about the cost associated with achieving the

 9 segregation. So, in that vain, I think it's

 10 important that when we look at what we're seeing

 11 is this associated cost, we really need to look

 12 again at our starting point, which is we know the

 13 cost today of the tri-party arrangement, and we

 14 think that should be the right benchmark. We also

 15 want to highlight that there is cost to the new

 16 regulation, and that the retooling of the entire

 17 OTC market, as we go from the unclear to the clear

 18 world, has costs, and it has costs for all

 19 participants, and we don't think that these

 20 retooling costs should all be associated with this

 21 one issue that we're highlighting, which is the

 22 need for a segregated account.
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 1 So, really, I think those would be our

 2 opening comments, Bob.

 3 MR. WASSERMAN: Bill?

 4 MR. THUM: Yes, it's Bill Thum here from

 5 Vanguard, and I think I could echo just about

 6 everything that was said on behalf of BlackRock.

 7 Our concern really relates to the existing

 8 platform and the customer protections that apply

 9 in the OTC bilateral world and how that will

 10 translate into the cleared world. And while

 11 Vanguard is very supportive of the aims and

 12 objectives of Dodd-Frank and, indeed, clearing

 13 standardized derivatives, our concerns relate to

 14 the protection of the margin that we will be

 15 posting on behalf of our clients and how that

 16 margin will be held, and, ultimately, how that

 17 margin that we will be handled in the event of a

 18 default involving another client of our

 19 derivatives clearing member. So, we want to talk

 20 through the differences between the existing state

 21 and the future state, our aim in terms of

 22 achieving a different approach for the cleared
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 1 derivatives compared to cleared futures trades,

 2 and then, obviously, talk about the implications

 3 that that would have.

 4 MR. KASWELL: I actually have a formal

 5 statement. Is it okay if work through that?

 6 Okay, great.

 7 Well, again, I'm Stuart Kaswell with the

 8 Managed Funds Association, and we appreciate the

 9 opportunity to be here today, and we hope to

 10 assist the CFTC in implementing the Dodd-Frank

 11 Act.

 12 For those of you who don't know, MFA is

 13 the voice of the global alternative investment

 14 industry. Our members include the vast majority

 15 of the largest hedge funds in the world, who

 16 manage a substantial portion of the $1.5 trillion

 17 invested in absolute return strategies. MFA

 18 strongly supports Dodd-Frank's goals of enhancing

 19 transparency and reducing systemic risk for the

 20 OTC Derivatives Market. It is of utmost

 21 importance that the CFTC develop rules for OTC

 22 derivatives in general, and the segregation of
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 1 collateral in particular that would enhance the

 2 financial market and maximize customer protection.

 3 On the issue of segregation, MFA favors

 4 the segregation of customer initial margin and

 5 separate individual customer accounts as opposed

 6 to combining customer assets in an omnibus

 7 segregated account.

 8 The failure of Lehman Brothers is a key

 9 example of why segregation is necessarily. It is

 10 well-known that Lehman's customers lost billions

 11 of dollars, and those customers include MFA

 12 members. Losses from Lehman include customers who

 13 had posted margin that was not segregated.

 14 However, omnibus segregation, while an

 15 improvement, still exposes customers to

 16 substantial risk of losing their margin.

 17 Customers cannot quantify their risks since they

 18 do not know the risk profiles of the FCM's other

 19 customers. There is no way for customer A to know

 20 whether customers B, C, and D are solvent or

 21 exposure the FCM to risk. Customers who can't

 22 protect themselves against risk are less likely to
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 1 invest generally and less likely to want central

 2 clearing.

 3 We appreciate that the CFTC must take

 4 into consideration a range of concerns when

 5 adopting rules on segregation for cleared swaps.

 6 We respect the CFTC's need to explore fully the

 7 potential benefits and drawbacks of all available

 8 segregation options. However, we want to ensure

 9 that all alternatives remain on the table and that

 10 the CFTC does not prematurely eliminate individual

 11 segregation as an option.

 12 We understand that those who favor

 13 omnibus accounts suggest that the cost of

 14 individual accounts, the central clearing party

 15 will be too high, the infrastructure changes will

 16 be too complex, and the implementation will take

 17 too long. We respectfully urge the Commission to

 18 examine that view carefully. We also urge the

 19 Commission to consider both direct costs and

 20 external costs, such as the cost of buying CDS

 21 protection to protect against the failure of an

 22 FCM.
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 1 As a general matter, our members do not

 2 want to delay the move to clearing or incur

 3 unreasonable costs to obtain the benefits of

 4 individual segregation, but we think those who

 5 oppose the greater protection collateral should

 6 have the burden of proof of showing why individual

 7 accounts are not practical. If after careful

 8 review the CFTC determines that the cost in

 9 infrastructure complexities of individual

 10 segregation are prohibitive, we are open to

 11 discussing an alternative model that would

 12 optimize customer protection, but we think it is

 13 premature to consider lesser alternatives.

 14 For uncleared swaps, we believe that the

 15 right to individual segregation of customer

 16 initial margin is essential for effective OTC

 17 derivatives regulation. We respectfully request

 18 that adopting rules related to uncleared swaps,

 19 the CFTC should clarify two points on the meaning

 20 of segregation with an independent, third-party

 21 custodian.

 22 First, we suggest that an affiliate of
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 1 the dealer counterparty be precluded from serving

 2 as custodian. Second, we recommend that the FCM

 3 segregate collateral in separate, individual

 4 customer accounts pursuant to contractual,

 5 tri-party agreements.

 6 Some may interpret the segregation

 7 provisions of Dodd-Frank more loosely, permitting

 8 the dealer counterparties affiliates to serve as

 9 custodian. They also imply that a bilateral

 10 contractual arrangement solely between the dealer

 11 and counterparty and the custodian is efficient.

 12 Without segregation and an unaffiliated custodian

 13 or tri-party agreement, there is no true

 14 segregation from the interests of the dealer.

 15 Absent these protections, the dealer maintains

 16 exclusive control over its customers' collateral.

 17 Lastly, we recognize that the Dodd-Frank

 18 Act does not require the CFTC to adopt rules

 19 jointly with the SEC related to segregation of

 20 collateral. We strongly recommend that the CFTC

 21 coordinate with the SEC to ensure that, to the

 22 extent possible, the agencies' rules result in
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 1 consistent, if not identical, outcomes.

 2 Thank you for the opportunity. I'd be

 3 happy to answer questions.

 4 MR. WASSERMAN: I just would note that

 5 actually, and even though this roundtable is a

 6 CFTC roundtable, on your last point, we are

 7 working fairly closely with our colleagues at the

 8 SEC in discussing these issues.

 9 Rob?

 10 MR. HUSTON: Thank you very much. My

 11 name is Rob Huston. I represent the National

 12 Council for Farmer Cooperatives. We represent

 13 over 3,000 farmer cooperatives in the United

 14 States, with over $116 billion in sales. Roughly

 15 70 percent of the farmers are associated with a

 16 cooperative. We have over $6 billion in exports,

 17 provide over about 250,000 jobs in the United

 18 States, with a payroll of about $8 billion a year.

 19 And our concern, and we appreciate the

 20 opportunity to be here today, but it's

 21 specifically related to agricultural swaps, and

 22 our concern is that we're putting the cart before
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 1 the house a little bit. We've had a system in

 2 place for decades that have allowed for the

 3 collection or margin and don't see an immediate

 4 need for change. The cleared agricultural swaps

 5 that are traded today in the form of calendar

 6 swaps have their place. The majority of the them

 7 are traded in between market hours, on weekends,

 8 and in between the times that the Chicago Board of

 9 Trade is open or the CME Group is open for

 10 business, but, as an aggregator of end-users, in

 11 exchange traded futures and uncleared swaps

 12 provide an effective tool for the American farmer

 13 to hedge price risk in today's volatile markets,

 14 and I concur with the statement from BlackRock,

 15 that we're concerned about the costs associated

 16 with the new regulations and then how that might

 17 effect the American farmer.

 18 MR. SZYCHER: Good afternoon and thank

 19 you. My name is Mark Szycher, and I'm vice

 20 president in charge of enterprise risk management,

 21 GM Asset Management, representing the GM Pension

 22 Funds. My duties include overseeing risk
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 1 management of all derivatives activities conducted

 2 on behalf of the GM pension plans.

 3 By way of background regarding GM

 4 Pension Plans, the GM plans cover over 650,000

 5 active and retired workers and their family

 6 members, both union as well as salaried employees

 7 and former employees. The GM plans distribute in

 8 excess of $7 billion to retirees and to their

 9 surviving spouses. And for many of those retirees

 10 and their surviving spouses, the GM pension

 11 benefits represent the lion's share of their

 12 monthly income. In addition, it's also during

 13 this conversation important to bear in mind that

 14 the GM Pension Funds fall fully subject to ERISA,

 15 and our principal regulator is the Department of

 16 Labor, although, of course, our activities in the

 17 markets also put us in contact with a variety of

 18 other regulators.

 19 As an ERISA fiduciary, we're held to

 20 what is widely accepted to be the highest standard

 21 of care and the duties of loyalty of any market

 22 participant. I appreciate the opportunity to
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 1 speak to you today regarding our concerns and the

 2 concerns that we share with many plan sponsors

 3 regarding the potential loss of protections that

 4 we enjoy today unless swap clearing models are for

 5 certain collateral protection features. And those

 6 features that we enjoy today in our arrangements

 7 in the uncleared or over-the-counter swap markets

 8 include the following: Full segregation of

 9 collateral both from the counterparty, as well as

 10 from other clients of our counterparty. In

 11 addition, an independent, third-party collateral

 12 custodian who holds any posted collateral support.

 13 Our counterparty has no access to the collateral;

 14 that is no access to either reinvest that

 15 collateral or to re-hypothecate it. Furthermore,

 16 the counterparty is required if they are out of

 17 the money to post collateral support to that

 18 third-party custodian, as well as our doing so as

 19 needed. In addition, the collateral that is held

 20 is subject to U.S. bankruptcy law. And, lastly,

 21 and very importantly, that we do have certainty as

 22 to the precise quality and the nature of the
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 1 collateral that is posted by either our plans or

 2 to the third-party custodian via the counterparty,

 3 as this is agreed to by ourselves and the

 4 counterparty.

 5 I think the essence of our concerns are

 6 really that, potentially, under some of the models

 7 being discussed, we could be exposed to two risks

 8 that we're not currently subject to today. The

 9 first risk is the risk of default by another

 10 client of the FCM. And, furthermore, default by

 11 the FCM due to poor investment choices, or,

 12 perhaps, a situation involving an affiliate or a

 13 subsidiary of that FCM. And, in doing so, we

 14 recognize, and the one of the other panelists

 15 brought up the example of Lehman Brothers, and we

 16 can certainly say from our experience that the

 17 approach that I had described a moment ago served

 18 us extremely well and protected our plan assets

 19 against what could have been a very significant

 20 loss of plan assets upon the Lehman bankruptcy.

 21 In closing, if we're looking at the

 22 intent of the act to be reducing risk, in essence,
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 1 we are being asked to take on a certain number of

 2 risks that, first off, we don't have today, that

 3 we believe for our pension beneficiaries have

 4 absolutely no benefit whatsoever to take that

 5 risk, and, lastly, that we lack the transparency

 6 to make a business assessment whether we would

 7 want to take such risks.

 8 Thank you.

 9 MR. WASSERMAN: Before we go on to

 10 talking about models, I'd like to throw it open to

 11 the rest of the table to react or discuss what

 12 we've been hearing to this point.

 13 MR. MAGNUS: I'd just like to comment on

 14 one point regarding the uncleared swaps, to just

 15 get that off the table quickly, and that is to

 16 provide a letter to the CFTC outlining its view,

 17 which supported that dealers should provide the

 18 option to the buy side for a variety of

 19 segregation, including independent tri-party, but

 20 that it should not be required to provided

 21 independent tri-party, and allow the buy side to

 22 choose the model that worked best for them, given
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 1 the cost of that various model. And some of you

 2 and some of the buy side clients would chose the

 3 "independent," as you described it, non-affiliate

 4 tri-party relationship, and others would

 5 potentially choose affiliate and/or choose other

 6 models in between, and we just feel that all those

 7 should be available, and it is fair for the

 8 dealers to have to offer a tri-party and an

 9 independent dealer, but not be required to offer

 10 that.

 11 MR. KASWELL: I guess this means me,

 12 right? Yes, well, and we appreciate that. I

 13 think we'd say that there should be some minimum

 14 rules of the road here, and that the opportunity

 15 is for a race to the bottom or for people to make

 16 decisions that might, in the short-term, be

 17 advantageous, but in the long run, it might

 18 jeopardize the investors' position. We think that

 19 the tri-party should provide the two features that

 20 we discussed.

 21 MR. RADHAKRISHNAN: What kind of rules

 22 of the road would you have us provide, because I'm
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 1 not taking a side, but it seems to me that if, in

 2 a bilateral role, somebody offers a choice and

 3 lays out the cost of the choice, or maybe one

 4 independent, here's how much it's going to cost.

 5 I'm trying to understand what the worry is,

 6 because I think what you're asking is for the

 7 government basically to say you must mandate X or

 8 Y. So, I'd like to know why.

 9 MR. KASWELL: I think it's because we

 10 think that there can be situations where, in the

 11 short-term, you might say well, I don't think I

 12 want to pay the higher cost, and that could create

 13 competitive advantages in the marketplace. One

 14 firm's costs are lower, and, therefore, it has

 15 competitive advantage. But when things get ugly,

 16 that deal may not look like such a happy bargain

 17 after all, and that we think that the system is

 18 better served by saying there are some things --

 19 we say cars have to have seatbelts. We don't say

 20 some cars can have them and some can't. We've

 21 tried that, sometimes it works, sometimes it

 22 doesn't. I think in this setting, we think that
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 1 the overall financial system is better served.

 2 MR. RADHAKRISHNAN: So, let's get

 3 specific. Would you want the CFTC to promulgate a

 4 rule that would say if the end-user choose

 5 segregation, are we going to give the choice of

 6 segregation or is it going to be mandatory or

 7 bilateral?

 8 MR. KASWELL: Well, but the bilateral,

 9 we have to give the choice of --

 10 MR. RADHAKRISHNAN: Okay. All right.

 11 So, we give the choice, but the collateral must be

 12 held in a bank that is now affiliated with a

 13 dealer, right? So, the rule, of course, we cannot

 14 specify which bank it is. Well, we already have,

 15 and that it cannot be the bank affiliated with the

 16 dealer. It could be some other bank.

 17 What kind of rules would we impose? I'm

 18 just trying to get a sense of would it have to be

 19 a bank where the -- well, we can't use credit

 20 ratings anymore because the law says you can't do

 21 that, right? Would it have to be a minimum

 22 capital? Would it have to be location-specific?
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 1 I'm just trying to get a sense.

 2 MR. KASWELL: I don't think we got into

 3 that level of detail. I think we were just trying

 4 to set out two basic parameters to saying these

 5 are sort of the minimums we think are necessary in

 6 order to make it safe, that if the whole idea is

 7 that it's separate, then the counterparty

 8 shouldn't be able to touch it and that it's in a

 9 separate place, and separate really should mean

 10 separate.

 11 Now, the other factor, and this is sort

 12 of maybe a side benefit, this will have the

 13 tendency to spread stuff around, and there's some

 14 advantage in not keeping all the eggs in one

 15 basket. That can create benefits and competition

 16 and so on. I understand it can also create

 17 complexities that you may say well, is there

 18 someone who's available in order for me to find

 19 somebody else who really is independent? And that

 20 may get complicated in some setting. We'd rather

 21 take that chance than risk that when a situation

 22 gets ugly that, all of a sudden, that collateral
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 1 that you thought was there really isn't.

 2 MR. THUM: It's Bill Thum of Vanguard.

 3 I think, as well, there's an important distinction

 4 that can be made between the present bilateral

 5 derivatives model and the existing futures model,

 6 and that relates to the issue of loss

 7 mutualization. So, while there can be a mandate

 8 that a dealer needs to offer segregated tri-party

 9 accounts to hold collateral that's being posted to

 10 cover derivatives positions, bilateral derivatives

 11 positions, the missing problem, the problem that

 12 does not exist in the bilateral derivative world

 13 at present is the concept that if another client

 14 of the dealer fails to satisfy its margin

 15 obligations, the margin that's being posted by

 16 another client is not being used to satisfy that

 17 obligation.

 18 So, I think from Vanguard's perspective,

 19 the issue really gets the problem of loss

 20 mutualization connected with the futures model and

 21 applying that concept to margin being held to

 22 cover exposures related to cleared derivatives.
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 1 MR. RADHAKRISHNAN: Just to be clear

 2 though in case people are not clear, the prospect

 3 of a non-defaulting client losing its margin only

 4 will apply if the clearing member defaults to the

 5 clearinghouse in the customer origin. And if the

 6 clearinghouse chooses the margin, I just want to

 7 make it clear that that's what we're talking

 8 about, because, otherwise, in a case where the FCM

 9 is fine and one customer has defaulted to it, our

 10 seg rules prevent the FCM from using another

 11 customer's seg deposits to cure the other

 12 customer's default. So, what we're talking about

 13 right now is a situation where, and I don't think

 14 it has ever happened. Well, has it happened maybe

 15 once?

 16 MR. WASSERMAN: Yes.

 17 MR. RADHAKRISHNAN: Maybe once, but

 18 where client defaults to a clearing FCM. That

 19 causes a clearing FCM to default to a DCO, and

 20 CFTC to an Interpretative Letter in 85 said that

 21 the DCO, if it wants to, can attach all of the

 22 collateral of the defaulting FCM to satisfy the
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 1 loss.

 2 MR. PRAGER: I mean, from our

 3 perspective, Ananda, we do acknowledge we're

 4 talking about an extraordinary event of both a

 5 customer default and a FCM default, and while we

 6 have the ability to monitor the FCM to some

 7 extent; I mean, we do see financials posted and we

 8 do see there are capital levels that clearinghouse

 9 has -- we have no visibility to the other

 10 customers, so, we do acknowledge it's extreme, but

 11 there's no tools available to allow us to risk

 12 manage this, even though it is extreme event. I

 13 mean, it's not impossible, and there's just no

 14 visibility to the other customers.

 15 MR. KASWELL: Right, and just as a

 16 footnote to that, I mean, 724 Dodd-Frank says that

 17 you can't use one customer's money for another. I

 18 mean, and I understand there are later exceptions

 19 in the statute, but the basic premise that

 20 Congress is setting out here is that each

 21 individual customer should stand on its own and

 22 that one shouldn't be subsidizing another for,
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 1 again, the very reason that he can't check on my

 2 credit and vice versa. We all look to the FCM to

 3 do that, and that's not a great position for us to

 4 be able to say oh, well, we can look out for

 5 ourselves here. We really can't.

 6 MR. ROSEN: Thank you. First, I want to

 7 want to defend the dignity of this fine

 8 commission. Just to point out that the customer

 9 loses that occurred in Lehman didn't occur on

 10 American soil. The regime that the CFTC

 11 administered worked very well for the protection

 12 of customers. It is impossible not to be

 13 sympathetic to the position of any fiduciary who

 14 wants to minimize the circumstances in which their

 15 beneficiaries might incur losses. It's just

 16 impossible not to be sympathetic to that, but I

 17 think we have all learned from experience you

 18 cannot eliminate risk, you can transfer it, and if

 19 you're transferring it, the question is: To where

 20 is it being transferred, what are the scenarios in

 21 which it will manifest itself, and what are the

 22 ramifications of that? And I think you can't
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 1 ignore that part of the costs, and I think it also

 2 expands the constituencies that we ultimately need

 3 to think about in evaluating the risks and the

 4 benefits and the costs of changing the structure

 5 of this regime, and we can come back to that a

 6 little bit later because this agency is charged

 7 not with protecting us or you or the clearinghouse

 8 or other clearing members, this agency is charged

 9 with protecting the public interest. And, under

 10 certain scenarios, it is the public that I think

 11 could be affected by the judgments that we make

 12 here today.

 13 The one thing I do think, there's both

 14 an analogy to the OCC market that I think should

 15 be drawn, and I think a limitation to the analogy

 16 from the bilateral transacting in swaps to the

 17 clearinghouse, and that is it is true that you

 18 don't have visibility into the other customers of

 19 an FCM, but when you deal bilaterally with a swap

 20 dealer, you accept the credit risk of transacting

 21 with the swap dealer, and the swap dealer's credit

 22 worthiness is a function of other unrelated
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 1 transactions with a panoply of other customers

 2 that can present credit risk for the

 3 clearinghouse. So, I'm not sure there's such a

 4 paradigm shift in the credit risk evaluation that

 5 large, institutional customers are confronted with

 6 in the context of clearing swaps.

 7 I think the other parameter to the

 8 analogy that needs to be drawn on the other hand

 9 is that there's a difference between the risk of

 10 loss that arises in a single bilateral

 11 relationship where you can protect your assets to

 12 a segregation of the independent amount quite

 13 effectively and immunize it, but in the bilateral

 14 context, you don't have the cross pollination of

 15 risk, and what everybody regards as a helpful risk

 16 diversification mechanism in terms of

 17 mutualization of risk and a clearinghouse becomes

 18 a risk concentrating factor in extreme

 19 circumstances, which, as you say, Ritchie, and I

 20 think you're right, those are the scenarios that

 21 we are talking about, and I think when we talk

 22 about costs and constituencies, we have to think
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 1 about the other end of that spectrum because I

 2 think it really is quite consequential at the end

 3 of the day, and I think others can speak to a sort

 4 of quantitative costs and benefits, but what I'm

 5 concerned about is that Congress has just adopted

 6 a statute whose principal purpose is to mitigate

 7 systemic risk, and my fear is that in the worst

 8 scenario, this proposal will have exactly the

 9 opposite effect.

 10 MR. WASSERMAN: Okay, at this point,

 11 let's start talking about models. The issue has

 12 come up. And it seems to me two have already been

 13 mentioned. One, as Rob mentioned, is the current

 14 system that we're operating under, that on the

 15 future side, and one that I think is likely to

 16 continue on the future side, even past any

 17 immediate proposals, and under that system, of

 18 course, there is the collateral is handled in an

 19 omnibus manner, and the risk is managed in an

 20 omnibus manner, and, so, in the event of a default

 21 in a customer account, it has to be the

 22 clearinghouse has every right to look at the
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 1 entire omnibus collateral to protect itself, and,

 2 indeed, that's how it risk manages. Although, to

 3 a certain extent, I think clearinghouses already

 4 do look at the account level. They are in a legal

 5 sense and a formal sense, they only know the

 6 omnibus. And that is the current system.

 7 Another system, as was pointed out by

 8 Stuart and Mark is one could have complete

 9 individual segregation, and that would essentially

 10 go up the line, it would somewhat more

 11 administratively complex, as essentially the

 12 customer would post their collateral at the

 13 broker. That collateral would have to be going to

 14 the clearinghouse in essentially an identified sub

 15 account and keep separately, and, thus, there

 16 would be quite a lot more in the way of

 17 transactions as things move day by day, and, of

 18 course, in the cleared world, everything is done

 19 at least once a day, frequently twice a day, and,

 20 indeed, in extreme circumstances, perhaps, even

 21 more, and one would need to monitor and reconcile

 22 all those transactions.
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 1 I want to mention a third model, and

 2 this is the model that staff here have been

 3 working on, which is an attempt to sort of

 4 navigate between the two. Actually, before I do

 5 that, I do want to talk a little bit about an

 6 understanding of the statute because, as someone

 7 mentioned, the statute does say you cannot use one

 8 customer's collateral to margin guarantee or

 9 secure anyone else's positions. It also says that

 10 you're not supposed to commingle these funds.

 11 There is an exception with respect to commingling,

 12 and it says well, for convenience, the property of

 13 swaps customers collectively, I mean, plural that

 14 is to say, may for convenience be commingled and

 15 deposited in the same account or accounts with a

 16 bank or trust company or with a DCO. There's

 17 nothing in that exception that says and also you

 18 can use one customer's money to margin guarantee

 19 or secure another's positions. And, so, given

 20 this permission for commingling, we're trying to

 21 be, I think, faithful to the statute both in terms

 22 of protecting customers, one from another,
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 1 permitting commingling, and, as was alluded to,

 2 there are some costs, and I'm sure we'll be

 3 getting into discussing that later on.

 4 So, let me tell you about this approach.

 5 The idea would be, first off, one change. Right

 6 now, we have, in some cases, firms, carrying

 7 customers post collateral on a gross basis, in

 8 some cases, it's on a net basis, in some cases,

 9 it's on a somewhat modified gross basis. In order

 10 for this to work, it would have to be gross basis

 11 strictly for all customers and for all

 12 clearinghouses and for all sources. I will note

 13 that some of my colleagues have been looking at

 14 that for reasons separate from customer

 15 protection, and, so, the cost of that may arguably

 16 not be part of the costs of this initiative, but

 17 we'll leave that off to the side.

 18 Right now, clearinghouses, to a certain

 19 extent, know customer exposures through large

 20 trader and have some very excellent systems that

 21 are used to monitor that information. However,

 22 under this approach, every day every clearing
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 1 member would need to send up to the clearinghouse

 2 information on each customer's portfolio positions

 3 or rights and obligations at that clearinghouse.

 4 And, so, if I am an FCM and I have 132 customers,

 5 I would be sending up information on the portfolio

 6 of customer 1 and customer 2 and so on, down to

 7 132. From that information, one can calculate

 8 that that array of positions, what the required

 9 collateral is for that set of positions. And the

 10 amount of customer collateral that I, of ICM,

 11 would have to have on behalf of the customer

 12 account up at the clearinghouse is the sum of

 13 those 132 calculations. The FCM would post that

 14 collateral just as it does today. In other words,

 15 right now, collateral is not identified with very

 16 limited exceptions and not really applicable here.

 17 It's not identified to a particular customer.

 18 Now, the firm might owe the customer back that

 19 collateral when he or she asks for it, but in

 20 terms of where that collateral can be put, I could

 21 have a customer whose positions are all on CME,

 22 but I send their collateral up to LCH. That's
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 1 perfectly fine, and, so, that would not change,

 2 and one would not, therefore, need to keep track

 3 of the collateral on a customer-by-customer basis.

 4 The place where I'm going on that is what the

 5 customer is entitled to in the event of an

 6 insolvency is not the specific collateral; it's

 7 the value, and what we're looking at here is that

 8 the value of the collateral for that set of

 9 positions is what the clearinghouse would be

 10 looking at for each customer. So, all of this

 11 would be going on just as it does today.

 12 Now, in the event of a default by the

 13 FCM and the customer account, the clearinghouse

 14 would then be required to treat each customer

 15 separately. And, so, they would be allocating to

 16 each customer the dollar value of the collateral

 17 that's associated with their position that they've

 18 been informed of. The clearinghouse then would be

 19 able to look at each set of collateral. And, so,

 20 for instance, if I have customers 1 and 2, each of

 21 whom has a collateral of $1 million up, customer

 22 1, his position has lost $50,000. Customer 2, her
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 1 position has lost $3 million. Under the present

 2 system, the clearinghouse would take $2 million

 3 and then $1 million would go down, $1,050,000

 4 would go down the waterfall. Under this proposal,

 5 customer 1 would be entitled to that $950,000

 6 back. Customer 2, of course, has lost all of his,

 7 and he's looking forward to lawsuits. The

 8 clearinghouse then would have the opportunity if

 9 they so chose to transfer each customer's potions

 10 and the associated collateral to a willing

 11 transferee. However, the clearinghouse will have,

 12 must have the unfettered right to liquidate

 13 positions if they believe that is what's in their

 14 best interest. I mean, remember, what we would be

 15 dealing with here is a case where up until then,

 16 each of the customers is backed by the credit of

 17 the clearing member. At this point, by

 18 assumption, the clearing member has defaulted,

 19 and, so, the clearinghouse may be of the opinion

 20 things are simply too risky here, I'm going to

 21 just liquidate base or they may want to work with

 22 things and try and transfer the positions. In the
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 1 event that there were no transfer, the

 2 clearinghouse would then be sending the money back

 3 to the trustee for distribution. So, the customer

 4 then would have their claim against the FCM estate

 5 just like today except in the event there has been

 6 a transfer, it would be adjusted for the fact that

 7 the value that was transferred for the customer.

 8 Now, that's not to say there's no

 9 difference in operations, and I think we'll get

 10 more into this, but I would just simply mention,

 11 right now, clearinghouses already have some vision

 12 into customers, and certainly clearinghouses

 13 monitor their members on an intraday basis. One

 14 might expect that such monitoring would become

 15 somewhat sharper, but that is not something that

 16 we're looking at in these rules, but rather would

 17 be leaving to the discretion of the clearinghouse

 18 as part of their risk management approach.

 19 Throw it open.

 20 MR. PRAGER: I don't know if you named

 21 the third option, but we think of it as maybe

 22 legally segregated and operationally commingled is
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 1 if we understand what you're suggesting. So, I

 2 mean, from our perspective, having thought about

 3 this and discussed it a lot, we're very

 4 sympathetic to the operationally onerous

 5 environment of Frank to maintain both legally

 6 separate and operationally separate. I mean, that

 7 sounds like most people's nightmares. So, we are

 8 sympathetic to that concern coming from the FCMs

 9 and from the clearinghouses. So, we think that it

 10 is potentially an elegant solution to maintain

 11 that legal segregation, while having an

 12 administratively easier life of operationally

 13 keeping things commingled, it obviously sounds

 14 very consistent with the statute, as you

 15 explained, as well. I think it will potentially

 16 have to put an asterisk there in looking at the

 17 value aspect to make sure there might have to be

 18 some ring fencing or rules around the investment

 19 of collateral just to make sure that when it comes

 20 to value, we do the best we can to maintain the

 21 value in case there had to be a liquidation. But

 22 I think that this idea does have merit, and at
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 1 least from our perspective, gives us that legal

 2 certainty of segregation that we would have the

 3 visibility to what is ours, so to speak.

 4 MR. WASSERMAN: Kim?

 5 MS. TAYLOR: Thank you. I wanted to

 6 first just put a little bit more framework around

 7 what we're talking about because I think, although

 8 I agree with Ed, that I'm very sympathetic to the

 9 position that fiduciaries are in in providing what

 10 they would consider to be the optimal protection

 11 for their clients, I do want to encourage us to be

 12 thinking about this problem in the overall context

 13 in which it occurs, and it seems that we're very

 14 focused on one element of the customer protections

 15 that exist in the listed derivatives (inaudible)

 16 now and are presumed to be existing in

 17 over-the-counter cleared derivatives world going

 18 forward, and that is the pooled segregation, but

 19 there are a lot of other elements that are part of

 20 the overall customer protection mechanism that

 21 have collectively contributed to a very good

 22 outcome for customers over a very long period of
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 1 time, and that's the combination of kind of the

 2 membership standards and the ongoing financial

 3 surveillance that clearinghouses perform over

 4 their clearing members. It includes the

 5 surveillance and requirements that the CFTC has

 6 over clearinghouses to ensure that the financial

 7 surveillances is adequate. It includes the

 8 alignment of interests of everyone in the industry

 9 to care about the risk management infrastructure

 10 in the industry, and that is something that I fear

 11 we lose if we make it too easy for a client to

 12 step away from having any risk whatsoever to what

 13 happens at its clearing member. So, that right

 14 now, clients have an interest in making sure that

 15 they choose a financially-sound FCM. FCMs have an

 16 interest in providing financially-sound, good

 17 capital base, good service and good risk

 18 management so that they can attract sophisticated

 19 clients, and the clearinghouses have an alignment

 20 of interest in making sure that the clearing

 21 members are soundly managed.

 22 And then there's also the bankruptcy
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 1 regime here and the way that the regulators

 2 operate within that bankruptcy regime leads to a

 3 situation where, as I've mentioned, Lehman's

 4 parent went bankrupt and no U.S. Customers that

 5 were subject to this customer protection regime

 6 were at any risk.

 7 So, I don't want us to look at just the

 8 one element in isolation, but if we are looking at

 9 the one element, some of the comments that Ritchie

 10 mentioned in his opening statement involved the

 11 fact that, even in the over- the-counter world,

 12 not all of your clients are willing to bear the

 13 costs associated with getting this incremental

 14 protection that some of them find valuable of

 15 having their assets completely segregated from the

 16 risk of any loss, and I'm wondering if there's an

 17 option for us to have another model under

 18 discussion here which would include a regime where

 19 clients could opt to have the extra protection and

 20 bear the extra cost of that in the cleared world

 21 without forcing all clients to bear the collective

 22 costs of having a regime where that had to be
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 1 provided for every account.

 2 MR. WASSERMAN: I mean, clearly, we

 3 should be putting other options on the table as we

 4 have them. We may talk a little bit about those

 5 costs later and how that actually works. I guess

 6 I would ask one thing: As between Richard and

 7 yourself, who's in a better position to look at an

 8 FCM clearing member and determine what the risks

 9 are of that FCM clearing member?

 10 MS. TAYLOR: I think with most of the

 11 clearing members, that this type of customer would

 12 be using, very likely, their public companies, and

 13 there's a lot of publicly-available information.

 14 I think the clearinghouse has an advantage in

 15 being able to see the actual books and records, we

 16 have regulatory authority to observe the control

 17 environment and we can take actions if we find

 18 deficiencies. So, we're in a better position in

 19 that respect, however, any one clearinghouse is

 20 not in kind of an omnificent position about what

 21 the risks are to the clearing member because I see

 22 the customer exposures that faced me and the
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 1 products that I cleared. I don't see the customer

 2 exposures directly in the products that face

 3 Chris. So, the clearinghouses collectively are in

 4 a better position, and any one clearinghouse is in

 5 a better position than any one customer to get

 6 access to certain information. But I wonder if a

 7 way to help alleviate some of the concern might be

 8 to find some type of middle ground where there is

 9 a better disclosure environment, and does that

 10 help alleviate some of the concerns that your

 11 clients have as opposed to moving all the way to

 12 individual, physically-segregated client accounts?

 13 MR. PRAGER: I mean, I just see that as

 14 that regime transferring the burden, the due

 15 diligence burden onto the fiduciary to then

 16 conduct a due diligence of every client you have,

 17 and we'd have the same questions you have of do we

 18 see their overall exposures to the system? So,

 19 and that's not what we do for a living, is to look

 20 at your other clients' market positions and access

 21 suitability and concentration and other things.

 22 So, I think you were right to highlight that you
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 1 have an advantage to see that, where, I don't

 2 know. I'll ask my buy side colleagues if they see

 3 it differently, but I don't think we'd have the

 4 tools to do that diligence.

 5 MR. KASWELL: One of the issues on the

 6 proposal, if there's still on bucket of

 7 collateral, even if it's legally in pieces, that

 8 still creates a problem in the event of

 9 insolvency, and, again, we all understand we're

 10 talking about remote circumstances, but we all

 11 learned in the weekend in September a couple of

 12 years ago that remote circumstances sometimes

 13 happen. And that if the collateral at the central

 14 clearer is still in one bucket, that means that if

 15 customer A wants to pick up and take its marbles

 16 out of that bucket and go someplace else, it may

 17 be very difficult for it to do so. And I think

 18 unless you solve that, and I don't know how to

 19 solve that problem without having separate

 20 buckets.

 21 MR. WASSERMAN: Let me answer that

 22 point. As I see it, there are three major sources
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 1 of loss to an FCM's customer account. One of

 2 those is fraud defalcation operational problems.

 3 I think those are present in any system, and then

 4 you have the choice, as we had in the Lehman case

 5 in the U.K., of saying well, whoever was the

 6 unlucky fellow whose account was insufficient,

 7 that's who loses, or you can socialize that I

 8 guess I'm inclined to the latter, but that,

 9 obviously, folks might differ.

 10 The second source of loss is essentially

 11 loss in value. Now, we have, as you know, under

 12 our Rule 125, restrictions on the investments of

 13 customer funds. I think other colleagues are

 14 working on some changes to that, and I think one

 15 might see changes to a 125 in the near future.

 16 But, again, that is sort of a generic issue.

 17 The third is fellow customer risk, and

 18 what I think we're doing here is addressing that

 19 one, and, so, it seems to me the first two are

 20 more inherently socialized because watch out, if

 21 you don't socialize them, yours might be the

 22 account which the thief took.
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 1 So, I think that's the answer there.

 2 MR. EDMONDS: To Kim's point, it still a

 3 limited view, right? I mean, it's still a limited

 4 view even if that duty of care were to come to the

 5 individual clearinghouses at that point in time.

 6 It might be that you, the regulator, have better

 7 insight on that because of the overarching you

 8 have. I mean, we're not going to share

 9 information necessarily like that and say hey, how

 10 is FCM 123 doing on that point? I mean, it

 11 becomes very problematic, as Kim was pointing out,

 12 because we still have a limited view of how we

 13 could get there.

 14 MR. WASSERMAN: I would note two things.

 15 I mean, first, there is some sharing of

 16 information, for instance, currently with the

 17 Joint Audit Committee. In fact, information about

 18 FCMs is shared between exchanges and

 19 clearinghouses and the like, but, more broadly,

 20 you have a couple of things going on. In addition

 21 to the fact that neither of you has perfect

 22 information, I think it may well be the case that
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 1 the clearinghouses have much better information

 2 that's partly structural in the sense that you

 3 guys can ask about fellow customers and get

 4 information, not only see information, but you can

 5 ask your members, given the supervisory supervised

 6 relationship between you and them.

 7 Two, there's a concentration of

 8 expertise. You folks are their clearinghouse, the

 9 risk management folks are in that business, and,

 10 so, both from an efficiency standpoint, who's

 11 better at this, a dozen clearinghouses or 12,000

 12 customers? It's fewer times being done and a

 13 concentration of expertise.

 14 MS. TAYLOR: I would actually challenge

 15 where the concentration of expertise in this

 16 particular regard lies, I think is actually mostly

 17 with the FCMs themselves or the clearing members

 18 themselves if we're talking about customer due

 19 diligence, because they're the people performing

 20 the detailed customer due diligence, they're the

 21 people performing the detailed customer level of

 22 risk management, and we are making sure that there
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 1 is a certain level of surveillance and a certain

 2 level of adequacy of their controlled

 3 environments, but, actually, the best experts

 4 about the financial adequacy of any one client's

 5 financial position is actually the FCMs more so

 6 than the clearinghouses.

 7 MR. WASSERMAN: I'm sorry if I misspoke,

 8 what I mean is in looking at the FCM, I mean, the

 9 FCM is going to be looking at --

 10 MS. TAYLOR: Right. Okay.

 11 MR. WASSERMAN: And that's true. You

 12 folks supervise them in doing that, but in

 13 determining whether the FCM is likely doing a good

 14 job of that and is likely to survive that between

 15 the customers and yourselves, looking at the FCMs,

 16 I think you all are in the better position.

 17 MS. TAYLOR: I would agree that we're in

 18 a better position than the clients to understand

 19 the picture of how the FCM is doing.

 20 MR. RADHAKRISHNAN: Danny, go ahead.

 21 MR. MAGUIRE: Hi, Danny Maguire,

 22 LCH.Clearnet here.
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 1 I mean, from LCH's position on this,

 2 we're supportive of client choice around this.

 3 Our primary objective here is, regardless of the

 4 different account structures, to ensure that we

 5 always have our risk exposure measured and

 6 covered, and that's really our primary goal here,

 7 and it's head of risk, that's what I think about

 8 every single day. That's regardless of the actual

 9 account structure that we're talking about here.

 10 I expect on either gross omnibus accounts, under a

 11 segregated account, regardless of the different

 12 flavors or structure that we talk about, I need to

 13 be able to see through the FCM and down to the

 14 client to see not the credit risk, which is I

 15 think what we're talking about here, but the

 16 market risk of every single client, because, at

 17 some point, as a CCP, as a head of risk, I will be

 18 potentially in this horrible, double default

 19 scenario, on the hook to actually close out that

 20 position, and this is closing out potentially 10,

 21 20, 30, 40, 50-year risk on OTC derivatives. So,

 22 I think any CCP needs to be able to see the market
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 1 risk at that level, and, likewise, any FCM needs

 2 to be able to see that.

 3 In terms of the responsibility for

 4 credit risk on the client side, that's absolutely

 5 the FCM's responsibility and primary

 6 responsibility because they hold the primary

 7 counterparty exposure and client risk. We only

 8 pick that up if the FCM goes down.

 9 So, I think we need to make a

 10 distinction here between market risk and really

 11 credit risk. Market risk for the clearinghouse,

 12 absolutely, we need to see that all the way

 13 through. Credit risk, I think, primarily, that is

 14 the FCM.

 15 MR. RADHAKRISHNAN: I think it'd be

 16 useful --

 17 MR. SWANN: -- if pay would be involved.

 18 MR. RADHAKRISHNAN: Oh, is that Paul?

 19 SPEAKER: Paul?

 20 MR. RADHAKRISHNAN: Paul, did you want

 21 to say something?

 22 MR. SWANN: Yes, if I could, and my
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 1 apologies. It's always difficult to do these

 2 things when you're joining --

 3 MR. RADHAKRISHNAN: Paul, can you speak

 4 up because we really can't hear you quite well?

 5 MR. SWANN: Can you hear that better?

 6 Can you hear better?

 7 MR. RADHAKRISHNAN: Just somewhat, yes.

 8 MR. SWANN: Thank you. My apologies for

 9 cutting from over the phone. It's always

 10 difficult when you're outside of the room, but I

 11 just wanted to pick up on a point Danny was making

 12 in relation to looking through to the customer

 13 level is the root of individual segregated

 14 accounts was to be promulgated. Actually, the

 15 area that I think we should explore further during

 16 this discussion is what does that do in terms of

 17 the contractual relationships that currently exist

 18 between the central counterparty, the FCM, and the

 19 FCM and the end-users of the products? And, in

 20 particular, in relation to the broader

 21 responsibilities market intermediaries currently

 22 have in relation to other legislation such as
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 1 anti-money-laundering responsibilities or know

 2 your customer responsibilities. At the moment,

 3 the system is designed to ensure that there are a

 4 number of layers in the system that are ensuring

 5 compliance with those legislations. It's not

 6 clear, I think, in an environment where there's a

 7 direct recognition at the central counterparty

 8 level of individual customers as to where that

 9 responsibility lies in the future.

 10 MR. RADHAKRISHNAN: I think that's a

 11 good question, and I think the question that's

 12 being asked is: Are we replacing the legal

 13 relationship that now exists? The future

 14 (inaudible) legal relationship, the privity of

 15 contract is between the customer and the firm on

 16 one hand, and then between the clearing member and

 17 the DCO on the other hand, because I think all

 18 DCOs have rules of disclaim any privity between

 19 themselves and the end customer, if that's fair to

 20 say. So, Paul is that sort of what the crux is of

 21 your question, which is: If we go to this model,

 22 are we somehow displacing that?
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 1 MR. SWANN: Yes, absolutely. I think

 2 the crux really is firstly, are we displacing it?

 3 If so, how are we displacing it? And then as with

 4 the third piece is: What are the fiduciary and

 5 legal responsibilities of the central counterparty

 6 in that new contractual model, assuming the

 7 disclosure at least implies some responsibility.

 8 MS. TAYLOR: I mean, it is very hard to

 9 have a position or a thought around what would be

 10 the outcome of that when we don't know yet what

 11 the target is, what the end result is, but I think

 12 we had been approaching this with the assumption

 13 that this would still be an intermediated

 14 transaction between the clearinghouse and the

 15 clearing member acting as agent for a now more

 16 disclosed principal rather than acting for an

 17 undisclosed principal as it operates now.

 18 MR. RADHAKRISHNAN: Can we get a sense

 19 of cost because there's no free lunch, right? So,

 20 I would like to know from everybody what the costs

 21 are because I think that may then drive us to

 22 which model works because a couple of models have
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 1 been floated. Bob floated some models, Kim

 2 floated a new model, which is choice. So,

 3 perhaps, the firms and the DCOs could tell us --

 4 MR. PRAGER: Maybe one thing, just to

 5 reshape the question slightly, and we have

 6 experience at the table. So, we hear lots of

 7 costs, and, as I said in my opening comments,

 8 we're concerned that they're becoming kitchen sink

 9 costs as the entire retooling of the system is

 10 being put on this particular issue. But when the

 11 dealer community who's been clearing for a decade

 12 chose a model, they actually a segregated account

 13 model, and I presume in their analysis that they

 14 came up with a cost effective way to do that. So,

 15 maybe I don't know if I could put you on the spot,

 16 Dan. Coming from that background, and I

 17 appreciate that's not an FCM model, that's not the

 18 statute as it's written today, but there's

 19 experience there we can learn from. So, I'm just

 20 curious to see. That clearly was a cost effective

 21 model if the dealer community, and you have

 22 several hundred trillion of notional outstanding.
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 1 So, they must have found a cost-effective way to

 2 do that.

 3 MR. MAGUIRE: Yes. So, hi, Dan Maguire

 4 here again form LCH.Clearnet. So, I think there's

 5 two ways of splitting the costs here. The first

 6 one is really the operational and the

 7 infrastructure setup of this. Really, without

 8 trying to cast over that, I think any FCM or

 9 client or any entity that's transacting in these

 10 type of financial instruments needs to have the

 11 relevant knowledge, trading expertise, risk

 12 expertise, technology, operations, et cetera, to

 13 be able to handle these kinds of transactions

 14 because, ultimately on the FCM side, they could

 15 own a client position as a client goes delinquent,

 16 so, they should be able to get out of that

 17 position, and, likewise, the CCP could own that

 18 position from an FCM standpoint.

 19 So, I think some of those costs are

 20 really just the cost of doing business in OTC

 21 derivatives. So, if I just part those for now and

 22 really talk about the real cost that people talk
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 1 about, which is really around default funds,

 2 mutualized costs, and the initial margin cost, I

 3 think that's generally what people refer to as

 4 costs on this.

 5 I see them as to leave us basically.

 6 When I'm quantifying risk, the quantum on a risk

 7 exposure of either a segregated or a omnibus

 8 account or other things on that, as long as we're

 9 talking on a gross basis, which to Bob's point

 10 earlier, I think we're talking in that realm

 11 today. There's different ways you can cut this.

 12 The LCH model that we built over 10 years, which,

 13 to Ritchie's point currently to give some flavor

 14 that's across 14 currencies, is out of 50

 15 immaturity. It's $250 trillion worth of

 16 notionals, so, it's big size, and it worked during

 17 Lehman. The whole underlying premise behind this

 18 is defaulter pays. That's the whole underlying

 19 premise where we started in 1999 through to today.

 20 And how does that work? In the first

 21 instance, it means that the bar is relatively high

 22 in terms of the initial margin costs because we
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 1 see the market risk exposure and the anticipated

 2 amounts of time and risk that we have to close out

 3 during the default event. So, we spend our time

 4 modeling and considering what is the closeout's

 5 time in this, what is the notional (inaudible) in

 6 the market, come and actually get out of these

 7 concentrated risk positions? And, on top of that

 8 initial margin, we may find that there are

 9 positions which are heavily concentrated in a

 10 liquid or less liquid maturity. So, we also have

 11 market risk multipliers on top of that to factor

 12 in this concentration risk. So, the first thing

 13 we always do is look at every single individual

 14 clearing member and we look at the specific risk

 15 and whether we can actually close it out under the

 16 assumptions of our margin model. And I think the

 17 key point on the margin model is we have a worse

 18 case loss. We look at a five-year history, and we

 19 take the worst case loss over a given holding

 20 period.

 21 So, that means in the first instance,

 22 that the bar is relatively high for each
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 1 individual clearing member. It's the same for

 2 each, but it's a high number, so, it means the

 3 likelihood of going through that initial margin

 4 and into the waterfall, be it client funds, member

 5 funds, the whole waterfall and LCH's capital is

 6 reduced.

 7 To give some flavor for that, September

 8 15, 2008, we talked about Lehman quite a bit. We

 9 closed that out. I was there closing that

 10 position out, and that was a $9 trillion position.

 11 It was 5 currencies, and it was 66,000 open

 12 positions and trades that we had. We closed that

 13 position out within the dealer markets.

 14 Obviously, it's very dealer-centric in the first

 15 instance, but we closed that out, and we wrote it

 16 35 to 40 percent of the initial margin held by

 17 Lehman. So, what I meant is that none of the

 18 losses that were incurred were mutualized in any

 19 way or passed on to anybody else within the

 20 clearinghouse. So, I guess proven to work by

 21 having that high confidence interval in that

 22 margin approach is the first thing. And then the
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 1 other lever is the more mutualized part, which is

 2 the default fund. I think there's many ways to

 3 coagulate a default fund, but, really, generally,

 4 it's the stress, losses, the extreme scenarios,

 5 detailed risk that goes over the initial margin,

 6 and that's held. Unlike every DCO, like

 7 ourselves, we're doing that on a daily basis.

 8 We're using historical scenarios and theoretical

 9 scenarios to stress that and look at different

 10 events that could happen. But what we find in our

 11 existing model today is we have a much larger

 12 initial margin pool, albeit to a point, to use a

 13 phrase we're using here today, segregated because

 14 there's no commingling at that initial margin, but

 15 we have a smaller default fund because the

 16 majority of the risks are covered in the margin

 17 rather than mutualized the default fund.

 18 So, that's the model. That's just a

 19 statement of fact. That's the model we arrived on

 20 over the period over the last 10, 11 years for the

 21 OTC derivatives side.

 22 MR. RADHAKRISHNAN: Let's get the FCMs
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 1 to describe for us that, right now, you have a

 2 particular model, which is the omnibus model, and

 3 let's say we were going to move to a model where

 4 there is individual client segregation at the

 5 clearinghouse level. So, I'd like to know what's

 6 involved in that, and what the costs are, what the

 7 complexities are.

 8 MS. BURKE: Sure, this is Maureen Burke

 9 from Bank of America, Merrill Lynch, once again,

 10 representing FIA.

 11 But we did do quite a bit of work as an

 12 industry, and just working with your first

 13 proposal here, Ananda, I'm staying focused on

 14 that. We did look at what it entailed to --

 15 because the industry as a whole is 100 percent

 16 sympathetic to protecting customer funds. That's

 17 paramount. I mean, the whole structure that's set

 18 up is set up to protect customer funds. The

 19 safeguards that are in the system that we have set

 20 out that have worked are there to protect customer

 21 funds, and if we can look to enhance them, we

 22 should do that because understood that you're
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 1 moving into a world where you may not have had to

 2 post any margin.

 3 So, there's going to be a cost, a

 4 posting margin, number one, and if that had been

 5 held in third party, you may have felt more

 6 protected, but the intent in Dodd-Frank was to

 7 reduce systemic risk. So, we did do quite a bit

 8 of work, and I have to tell you there were a lot

 9 of heads that went down and put pen to paper and

 10 did an enormous amount of work when he first came

 11 down and met with Bob here in D.C., to look at

 12 individual seg.

 13 What it does operationally, it

 14 exponentially increases the amount of accounts

 15 that a clearing firm would carry, as you could

 16 guess, because there is multiple accounts that

 17 even in a BlackRock relationship, you'd have to

 18 segregate down to the underlying account owner in

 19 a true individual seg. So, we ran through some

 20 numbers, we looked at the amount of accounts that

 21 would have to be opened up out on the street. You

 22 got to start right from the clearing firm as the
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 1 beginning part because if you're really trying to

 2 protect, you have to start going from the clearing

 3 firm, the funds being directed into the clearing

 4 firm, and then moving along those funds to the

 5 clearinghouse and working with the multiple margin

 6 calls that we work with today.

 7 We would have to increase our staff by a

 8 great level, and that's of course we can do that.

 9 We projected out costs on how much it would cost,

 10 just wire transfer cost, receive and deliver fees,

 11 and in many, many clearing firms, the funds don't

 12 come directly into the same account where you're

 13 going to send them to for the margin requirement.

 14 So, you have the funds coming into a depository

 15 account, moving each cash or securities or

 16 custodial account, and then they need to get wired

 17 out twice a day, today in the futures model, where

 18 we get two margin calls that are sent out to the

 19 clearinghouse, and, in many instances, we may,

 20 where in volatile periods, receive other calls.

 21 So, today, we do that in totality, look at our

 22 total amount of margin obligations of the customer
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 1 in-house and meet those margin calls.

 2 The multiples, we actually have some

 3 numbers here, but it went from, I think, multiples

 4 for 1 account, 1 client trading on 3 different

 5 exchanges where we would have maybe 10 accounts

 6 went to 80 accounts, and you take and you multiply

 7 that out to the number of accounts that you

 8 actually have for all your individual clients. It

 9 makes it operationally burdensome, and concern,

 10 are we creating more prone to error operations,

 11 prone to error? I mean, we would have to trace

 12 back a particular security that is sent from each

 13 client and make sure that we're sending it to the

 14 exchange that they're clearing on, clearinghouse

 15 because the clients come in, they trade on

 16 multiple clearinghouses that come into the

 17 customer seg pool. You need to direct it to the

 18 trade that they're doing on that particular day to

 19 know where the underlying trade resides and where

 20 can we send this security? Today, we look at it

 21 in total because it's a total seg pool.

 22 The estimate that we went through, and
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 1 this isn't a full-blown estimate, for a size of a

 2 firm like Bank of America, Merrill Lynch, it would

 3 be $75 million to $100 million incremental cost on

 4 the yearly basis to open the accounts, receive and

 5 deliver fees, the wired transfer fees. We would

 6 have to perform daily segregation computations

 7 because if you're now going to start with

 8 individual seg, you will have to produce a seg

 9 computation to ensure that what we have in from a

 10 particular client is segregated appropriately.

 11 We'd have the clearinghouse who would extend the

 12 burden out to the clearinghouse. The staff that

 13 they have at the clearinghouse would have to

 14 increase because they're either going to have the

 15 same requirement. It's not just on our books and

 16 records. The clearinghouse is going to have to

 17 have a similar multiple of expansion in their

 18 staff to support this.

 19 We support full customer protection.

 20 The question is: What's the cost and where is

 21 that cost going to be borne? It's going to have

 22 to be borne by the industry as a whole, and we can
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 1 look at there's three different proposals, Ananda

 2 and Bob, that you've put out here is, one, you

 3 have the model we have today. We can talk to

 4 everything that's there; potentially enhance some

 5 of those protections that we have, enhance some of

 6 the safeguards from what we would potentially have

 7 to put in place.

 8 We have the margin grace period today

 9 that if a client's in deficit, $1, if their

 10 account liquidates to a deficit $1 that we haven't

 11 collected, any new trace that they put on that we

 12 haven't collected, it's 100 percent charge against

 13 capital. They have an initial margin. There's a

 14 grace period of four days, and I understand

 15 looking at it going into the OTC space, that's

 16 going to potentially be looked at. Is that an

 17 appropriate grace period for CDS at this stage,

 18 and it'd be down to one for initial end, and the

 19 deficits, if you don't collect it within one day.

 20 But what's paramount is that the initial margins

 21 are set appropriately. That's our first line of

 22 defense in any structure that we set up, even in
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 1 an individual seg, if it's structure, if the

 2 margins aren't set appropriately, that puts risk

 3 into the system, and proper risk management and

 4 monitoring of the margin calls.

 5 MR. RADHAKRISHNAN: So, you raise a good

 6 point because, right now, a clearinghouse issues a

 7 call from IM in the customer origin, you just pay,

 8 right? The firm pays it. You have no choice, you

 9 have to pay it.

 10 MS. BURKE: Correct.

 11 MR. RADHAKRISHNAN: But, in most cases,

 12 it's a pass on, and what it is you get from the

 13 customers, but, in some cases, you fund --

 14 MS. BURKE: It's our own capital.

 15 MR. RADHAKRISHNAN: You fund --

 16 MS. BURKE: But we're meeting that.

 17 MR. RADHAKRISHNAN: You're funding it,

 18 right. Right.

 19 MS. BURKE: We're meeting that margin

 20 call on trade. We're meeting.

 21 MR. RADHAKRISHNAN: Because you may not

 22 have collected it from the client.
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 1 MS. BURKE: Correct.

 2 MR. RADHAKRISHNAN: And the Joint Audit

 3 Committee always gives you four days to collect

 4 it, and otherwise, there's a capital charge. So,

 5 if we go to a world where there is individual

 6 segregation, it could mean one or two things. It

 7 could mean that you have no more grace periods

 8 anymore, right? You collect right away from your

 9 customer and you pass it on, or you're actually

 10 passing on your own money, and it's being called

 11 customer money at the clearinghouse. Is that

 12 possible?

 13 MS. BURKE: That is exactly what is

 14 happening.

 15 MR. RADHAKRISHNAN: That's what happens

 16 now?

 17 MS. BURKE: Yes. I mean, that's exactly

 18 what we have. We went through a whole flow of the

 19 timing and flow of funds. Trade date. There's

 20 direct debit authority against our bank accounts.

 21 The FCMs have their own capital sitting in

 22 segregated bank accounts. There's a prohibition.
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 1 You have a continual requirement to ensure that

 2 you're fully segregated at all times. It's not a

 3 look back, and there is not a cure period for

 4 this. So, we have to ensure at any point in time

 5 when we have a direct debit against our bank

 6 account that we were able to cover that, that

 7 we're not using one customer's funds to meet

 8 another customer's obligations. And all the big

 9 FCMs and even smaller FCMs, in order to ensure

 10 that that is the case, they have to have some of

 11 their firm capital in the segregated bank account,

 12 and the next day, this is for the safeguards that

 13 are in place, a computation has to be prepared by

 14 12:00 p.m. the next day to prove that the amount

 15 of your obligations out to all of your clients

 16 that they were fully segregated, and if there's

 17 any seg deficiencies, a reportable violation that

 18 needs to be reported immediately.

 19 MR. WASSERMAN: Maureen, I just want to

 20 clarify one thing.

 21 MS. BURKE: Yes.

 22 MR. WASSERMAN: And then maybe keep you
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 1 on the spot for a few more minutes. What you've

 2 been talking about for the past couple of minutes

 3 has been the impact of individual segregation.

 4 MS. BURKE: Correct.

 5 MR. WASSERMAN: So, let's look at the

 6 model I was talking about a little bit earlier and

 7 the one we had discussed in our previous meeting.

 8 MS. BURKE: Sure.

 9 MR. WASSERMAN: Clearly, there are some

 10 additional duties that would be involved in terms

 11 of passing information up to the clearinghouse.

 12 MS. BURKE: Yes.

 13 MR. WASSERMAN: That kind of model, what

 14 sort of additional administrative costs, and I

 15 think we're going to be talking after the break

 16 about impacts on guarantee funds and the like.

 17 But just in terms of the types of costs you were

 18 discussing now, the back office costs, if you

 19 will, what sort of impact is that?

 20 MS. BURKE: That's not nearly as

 21 burdensome, as you would know, Bob, and I'm sure

 22 anyone else can figure out. But, so, as you're
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 1 laying out the proposal, it's a reporting of your

 2 underlying clients and their positions, and, from

 3 there, you can compute their initial margin

 4 requirement. So, from the operational burdensome

 5 of multiple, open up massive amount of accounts

 6 and tracing that all the way through, that that

 7 does eliminate that burden. But it still creates

 8 a cost, and this, I guess, will be a part of the

 9 second session. The open question is: What is

 10 that cost, and where would that cost be borne?

 11 MR. PRAGER: Don't you have to calculate

 12 that anyway?

 13 MS. BURKE: Calculate the --

 14 MR. PRAGER: To the endpoint, the

 15 individual customer exposure anyway?

 16 MS. BURKE: We do that. We do that

 17 every day. So, that's why we're saying the

 18 operational burden to send that over to the

 19 clearinghouse gets diminished versus an individual

 20 seg that gets diminished. But we can talk about

 21 the costs now. I don't know if you're putting

 22 that off until the second half, but there will be
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 1 costs to reduce that mutualization, and what is

 2 that cost? That's a critical component that we

 3 need to address. What's the cost, and the cost

 4 would be borne by the industry.

 5 MR. RADHAKRISHNAN: But there's a

 6 difference between the firm telling the

 7 clearinghouse look, I have 10 customers, here's

 8 their individual margin requirement, right?

 9 That's one part of it. But that doesn't mean that

 10 the firm cannot pay the margin that the DCO calls.

 11 MR. PRAGER: Oh, no, no.

 12 MR. RADHAKRISHNAN: The firm's got to

 13 find the margin call. But I'd like to know what

 14 the model is. Is it just a reporting as to what

 15 the requirement is, but not and this is how much

 16 my customer paid me?

 17 MR. WASSERMAN: No.

 18 MR. RADHAKRISHNAN: Right.

 19 MS. BURKE: And, Ananda, that's the

 20 point.

 21 MR. RADHAKRISHNAN: Right.

 22 MS. BURKE: It's assuming the client
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 1 paid, made all those payments, and we go through

 2 the delays. A big chunk of that will be the FCM's

 3 money that's in that number. It's assuming

 4 everything is fully paid for. There's time delays

 5 on the collection of margin. So, it's at what

 6 point in time?

 7 MR. PRAGER: But don't you do that

 8 anyway?

 9 MS. BURKE: We do that anyway, but going

 10 back to the last day, and then what the trustee

 11 has to go after, and whose funds have been sent

 12 off potentially to another clearinghouse or

 13 exchange? Did the customer fully pay for those

 14 positions at that point in time?

 15 MR. RADHAKRISHNAN: Let me make a point.

 16 It would be not a good outcome if, in my view,

 17 there was this reporting, the firm sent the money

 18 up, but it's not your money, it's the firm's

 19 money. Something happens, and you walk away with

 20 the firm's money. That's not a good outcome

 21 because, to me, that's an unjust enrichment on

 22 your part.
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 1 MR. PRAGER: But that can happen today,

 2 can't it?

 3 MR. RADHAKRISHNAN: I don't see how. An

 4 unjust enrichment.

 5 MS. TAYLOR: (Off mike.)

 6 MR. RADHAKRISHNAN: The seg, yes.

 7 MS. TAYLOR: (Off mike.)

 8 MR. RADHAKRISHNAN: Right.

 9 MS. TAYLOR: I think I agree with what

 10 Ritchie's saying. If a firm puts money into seg

 11 now and some customer defaults.

 12 MR. RADHAKRISHNAN: Right. Right.

 13 MS. TAYLOR: That money that the firm

 14 has put into seg is part of what is pro rata or

 15 distributed to all the clients.

 16 MR. RADHAKRISHNAN: To all the clients.

 17 So --

 18 MS. TAYLOR: So, I mean, it's unjust

 19 enrichment of everyone.

 20 MR. RADHAKRISHNAN: Potentially --

 21 MS. TAYLOR: As opposed to unjust

 22 enrichment of --
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 1 MR. RADHAKRISHNAN: I just wanted to

 2 tease that out. (Laughter)

 3 MR. WASSERMAN: Just to be clear, the

 4 firm is essentially making a loan to the client,

 5 and, so, in the insolvency proceeding, either the

 6 customer's claim would be reduced because the

 7 customer might have a claim that is over and above

 8 what was transferred or the customer would

 9 potentially owe the trustee money. But the

 10 customer doesn't get to keep that. That

 11 accounting is ultimately done. Don't count that

 12 money yet. (Laughter)

 13 MS. TAYLOR: Could I ask a question here

 14 because I'm thinking there might be another way to

 15 solve the problem? Is the problem that you

 16 gentlemen are facing that you want to be able to

 17 make sure that you would get your customers' exact

 18 assets back, or you're interested in preserving

 19 value of the assets?

 20 MR. PRAGER: Yes, at least in our case,

 21 we acknowledge in my comments earlier that there's

 22 this value, and there might be slippage. So, I'm
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 1 acknowledging there might be slippage in the value

 2 so it's not trying to make it so onerous that it's

 3 specific. I mean, others might have a different

 4 view, but, I mean, there has to be some

 5 concessions in looking for the balanced solution

 6 here, and we'd run that risk today.

 7 MR. THUM: Yes, it's Bill Thum at

 8 Vanguard. I think the value is the point, and I

 9 think having a more robust way of determining the

 10 value and a more controlled way determining the

 11 value is going to be the important consideration

 12 going forward.

 13 And I think in terms of the costs, while

 14 we can look at the difference between the existing

 15 futures model and this new world that we're

 16 talking about in terms of cleared derivatives, we

 17 could also look at it in terms of the cost the

 18 existing bilateral approach now, where our clients

 19 are not only where you have a strong, highly-rated

 20 or highly-capitalized client trading with a dealer

 21 and getting the benefit in terms of an initial

 22 margin levels, but while, at the same time,
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 1 willing to spend the money in certain

 2 circumstances to set up tri-party custody

 3 accounts, having to do that with every single

 4 dealer on the street with which it trades to

 5 protect its client assets.

 6 So, these are both assessments being

 7 made by dealers at present in terms of what

 8 initial margin levels should apply, and they're

 9 also costs that clients may elect to pay,

 10 sometimes are required to pay in terms of mutual

 11 fund clients to protect client assets. So, those

 12 costs are built into the existing bilateral model.

 13 So, I think when we think about costs, we have to

 14 think are we talking about the difference from the

 15 futures model, are we talking about the difference

 16 from the bilateral derivatives model?

 17 MR. RADHAKRISHNAN: I just want to make

 18 one point, that I don't think the statute said

 19 whatever happens in the bilateral world is going

 20 to happen in the cleared world. I think I want to

 21 make that clear. I don't think that's what the

 22 statute says. I think what the statute says, it
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 1 provides a clearing mandate because I've been

 2 hearing the certain things about well, this is

 3 what happens in the bilateral world, and,

 4 therefore, we must make sure it happens in the

 5 cleared world. I don't think that's the purpose

 6 of the statute.

 7 MR. KASWELL: It's a fair point, but if

 8 I may, I mean, one of the goals, it seems to me,

 9 of Dodd-Frank was to encourage move to a

 10 centrally-cleared environment.

 11 MR. RADHAKRISHNAN: Correct.

 12 MR. KASWELL: And, so, if customers feel

 13 they're getting a poorer deal in the

 14 centrally-cleared environment than they are in the

 15 bilateral, they're not going to want to go there,

 16 and that seems to me defeats one of the key

 17 animating provisions of Dodd-Frank. So, they're

 18 different, I agree, but the goals are --

 19 MR. RADHAKRISHNAN: I agree, but the

 20 question is: What is a good or bad deal? Right,

 21 so, I think that's what we're trying to figure

 22 out.
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 1 MS. TAYLOR: The reason I asked about

 2 the value issue versus the specific collateral is

 3 I wonder if we might be able to solve the customer

 4 protection concern that I'm hearing loud and clear

 5 with an industry-provided insurance vehicle -- I'm

 6 thinking of something that would operate similarly

 7 to how a specific coverage operates in the broker

 8 dealer industry, where the FCMs would be able to

 9 obtain insurance for the return to the clients of

 10 the value in their account, even if there's a

 11 shortfall in the account at the time of an FCM

 12 bankruptcy, and if that type of a vehicle solves

 13 the concern that you have, I wouldn't be surprised

 14 if that would be overall cheaper for the industry

 15 to provide certainly than it would be to provide

 16 the individual segregation, and then it might be

 17 to provide legal but not operational segregation.

 18 MR. EDMONDS: I mean, I think I agree

 19 with that, Kim. I guess the question is: Who's

 20 going to be covered in that? It's been proposed

 21 duty of care for the clearinghouse is just going

 22 to increase potentially.
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 1 Do you disagree with that, Bob? I may

 2 have gotten confused on --

 3 MR. WASSERMAN: No, I guess my only

 4 quibble would be with the term "duty of care."

 5 MR. EDMONDS: Okay. Rather the exposure

 6 would be changed. That would, I assume, then flow

 7 through in terms of how you would approach that

 8 exposure. So, in other words, right now, you can

 9 look at the entire collateral pool of an FCM's

 10 customers and risk manage against that. Now, you

 11 would be looking at customers individually, and I

 12 presume you would risk manage against that, and I

 13 might make assumptions, but those are just

 14 assumptions that I'm making as to how you might

 15 choose to address that different risk environment,

 16 but it's not, in other words, a "duty of care" in

 17 the sense that we're going to be going after you

 18 for failing to do this or that; it's just you're

 19 only going to be able to look at each customer's

 20 positions and then in the event of a default, you

 21 would then essentially not have as much of that

 22 collateral to look at as you do know.
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 1 MR. WASSERMAN: Right, and I think we'll

 2 talk about that in the second session because

 3 that's really the balance between IM and guarantee

 4 funds. So, we'll save that for later. But to

 5 Maureen's point about they send us the report,

 6 right? We have that. We sum up the 132 accounts

 7 that you used in your example. It comes up to be

 8 $100, hypothetically. We know we've collected

 9 $100 in omni account. From a clearinghouse

 10 perspective, is it your interpretation that that's

 11 it, unless there is a default, that we're then

 12 after the default, going back, as we would in a

 13 post-mortem environment anyway in trying to

 14 recreate.

 15 Is that as far as it goes, or is it more

 16 than that?

 17 MR. EDMONDS: Well, it is more than that

 18 in the sense that I would expect that you would

 19 then be looking at that, and I would expect you'd

 20 be risk managing differently. And, so, all those

 21 132 customers, small ones you might well ignore,

 22 saying oh, that guy's not going to cause a
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 1 problem, but just as I think many of you do today,

 2 you look at the larger customers and look at the

 3 exposures at the account level, particularly on

 4 OTC. I think so, for somebody who is rather

 5 relative to the FCM, I'm guessing you would be

 6 looking over their shoulder. But, to be very

 7 clear, it would be over their shoulder, it's their

 8 responsibility, their work, it's just since it's

 9 partially your exposure, I expect you might have

 10 some concern that you would then, using your

 11 judgment, determine okay, what do we need to do

 12 about this, and that would vary by FCM, it would

 13 vary by the size of customer, the size of the

 14 exposure. You would be using your judgment in

 15 supervising the firm's duty. And getting back to

 16 the point we had earlier, who's going to be doing

 17 all of the AML and such? Just like today, it's

 18 the firm. Who's going to be doing the money going

 19 back and forth? Just like today, it's the firm.

 20 It's just like today where if you see one of your

 21 firms doing things that make you wonder, there's a

 22 particular customer, a particular large exposure,
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 1 there's a call made, hey, what's going with

 2 so-and-so? I guess I'm anticipating there might

 3 be a couple more of those calls.

 4 MS. SCHNABEL: Okay, so, just to clarify

 5 what Bob was saying, I think the cost of the more

 6 calls or other action associated with risk

 7 managing on individual customer level may not be

 8 costs that are attributable directly to individual

 9 segregation, and the effect of bankruptcy

 10 protection on the individual customer level. So,

 11 what I'm thinking is the cost of risk managing is

 12 actually going to be under the risk management

 13 core principle cost, whereas, for us, I think we

 14 need to really focus on what the cost is of

 15 individual segregation.

 16 And, to that effect, I have a question

 17 for Maureen, which I was just trying to clarify

 18 the exchange between you and Ritchie because I'm

 19 still a little bit confused as to where the

 20 increase in cost would be with respect to the

 21 individual customer protection model because it

 22 had seemed to me, and maybe I mischaracterized the
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 1 exchange, so, let me know, that whatever you said

 2 you had to do under the individual customer

 3 protection model you already do. So, where is the

 4 increase in cost, I guess?

 5 MS. BURKE: We have to go back. You

 6 spoke about two different models. The first

 7 discussion was full individual seg. Are we

 8 referring to that?

 9 MS. SCHNABEL: We are not. We're

 10 referring to --

 11 MS. BURKE: The positional.

 12 MS. SCHNABEL: We're referring to --

 13 MS. BURKE: The reporting requirement.

 14 MS. SCHNABEL: No, we're referring to

 15 the legally segregated, operationally omnibus.

 16 So, it seems to me from an operational perspective

 17 if it's still omnibus, where is the extra cost?

 18 MS. BURKE: The cost is going to come

 19 from the clearinghouse, and I think we have to

 20 stop here or go right into this now because that's

 21 what we need. We need to know what the cost is

 22 from the clearinghouse because that's the starting
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 1 point. What's the initial margin requirement?

 2 What's the initial margin requirement going to be,

 3 what's the guaranteed fund requirement going to be

 4 if you eliminate that mutualization in the

 5 waterfall?

 6 MR. WASSERMAN: And, so, to be clear,

 7 our entire second part of this is going to be

 8 devoted to just those questions. Any other issues

 9 though on the more operational end or --

 10 MR. PRAGER: Just one comment on the

 11 operational end, and, Maureen, I mean, your

 12 numbers of the escalating accounts, from our

 13 perspective, where we sit, we have to manage all

 14 those accounts anyway. I mean, so, that's, again,

 15 and we did say or at least I said earlier, we're

 16 very sympathetic to any sort of operational burden

 17 of maintaining them, but, to be clear, from our

 18 side, we have to make those money transfers daily.

 19 So, at BlackRock, we have thousands of accounts in

 20 fixed income, nearly 3,000 overall; in north of --

 21 5,000 accounts. We have to maintain those daily.

 22 We make cash payments daily. We reconcile daily.
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 1 So, I mean, we understand that, we get all of

 2 that, and, so, we understand that mushrooms in the

 3 backend, but for an organization like yours, last

 4 time I read the end report, you had some 50

 5 million individual accounts in the retail level.

 6 I mean, there is mechanisms to manage scale out

 7 there. When we manage scale, that's what we do.

 8 The wire transfers and things like that,

 9 I totally appreciate that. We're very sympathetic

 10 to that point of mushrooming in the very

 11 individual, the physically segregated.

 12 MS. BURKE: Well, I mean, we manage all

 13 of the segregation coming into our firm and ensure

 14 that the customers' funds are protected, that

 15 they're segregated. We look at the obligations,

 16 we issue out the margin calls every day, have a

 17 robust system for looking at credit, reviewing the

 18 credit from our clients. It is in the latter part

 19 of that, the wire transfers. That's where the big

 20 chunk of the cost came into play. A very large --

 21 looking at securities that come in from an

 22 individual client, $1 million U.S. Treasury Bill,
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 1 and they have $1 million margin requirement.

 2 Taking that $1 million U.S. Treasury Bill and

 3 having that sent to the Fed wire system. Today

 4 it's in $50 million. So, we send in increments by

 5 CUSIP $50 million increments, and we look at it in

 6 total.

 7 The largest part of the cost is the

 8 second one. We have staff on hand. We reconcile

 9 every account today. That's part of the

 10 responsibility on your seg computation. You can't

 11 just produce a seg, you have to prove that what

 12 you're producing you reconcile to the external

 13 statements. So, it's those multiple of the

 14 accounts and the increase in the reconciliations,

 15 and then the follow-up is an out of balance, and

 16 we're going to have to get massive amount of

 17 information from the clearinghouse. The

 18 clearinghouse is going to duplicate everything we

 19 will have to do, as well, because you want to make

 20 sure it's fully segregated.

 21 MR. PRAGER: That's if it's fully

 22 segregated, not the sort of model --
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 1 MS. BURKE: Correct, on that seg.

 2 MR. PRAGER: The legally segregated

 3 operation --

 4 MS. BURKE: On a legally segregated,

 5 that's a different discussion.

 6 MS. SCHNABEL: Okay, so, just to I guess

 7 sum up, and I know that Bob will have some other

 8 summing up points, on operational costs, it seems

 9 to there's agreement that with respect to the

 10 actual legally separated and operationally

 11 segregated, that there might be an increase in

 12 cost because of various wire transfers and other,

 13 I guess, mechanical issues that would have to be

 14 multiplied across accounts was in the legally

 15 segregated, operationally still omnibus. It seems

 16 as if most of the cost would be in changes in risk

 17 management at the clearinghouse, and, therefore,

 18 there would not be necessarily operational costs,

 19 at least from the FCM level.

 20 MR. ROSEN: Well, I'll say that we can

 21 come back to this at a later time when we get to

 22 them. But I think there are non-account
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 1 operational costs that either of those models

 2 produce that I think we need to discuss at the

 3 appropriate time.

 4 MS. TAYLOR: And, also, depending on how

 5 this is implemented and depending on if it's every

 6 single account, if it's people who can opt out.

 7 Very likely, there would be an increase in the

 8 operational interaction and the cost of that

 9 between the clearing members and the

 10 clearinghouses because, right now, one of the

 11 benefits you get from cleared environments is you

 12 take 1 million payments, and you net them down to

 13 one. And we do that every day. We net down all

 14 the payments that the clearing member owes us

 15 across all their customer to be one net payer

 16 collect, and we do the same thing for their house

 17 account.

 18 So, they pay us twice a day, but they

 19 only pass us two payments or we pay them two

 20 payments. And, depending on how this need for the

 21 legal segregation ends up working, at the very

 22 least, we need to be able to do that at the
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 1 individual segregated account level because if one

 2 of those customers doesn't pay us, if we don't get

 3 paid because of one of those customers, we can't

 4 have netted everything out, and I think there will

 5 be individual payments on a per segregated account

 6 basis that would be likely to occur between the

 7 clearinghouse and the clearing members.

 8 MR. WASSERMAN: Just to be clear, and

 9 then I'm going to break, and then we can come back

 10 to this.

 11 MS. TAYLOR: They may hit the same

 12 account, but they would be different payments.

 13 MR. WASSERMAN: Yes. The intention here

 14 is every day, other than the day of a default,

 15 it's going to be the same net approach as it's

 16 done today, it's just you'll be getting

 17 information that would break that done.

 18 Now, on the day of the default, things

 19 will get very interesting indeed, and very costly

 20 indeed, but that's inherent in a default. But

 21 every other day, the only difference that you're

 22 going to see is you're going to be getting
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 1 additional information. You're going to then want

 2 to use that information, but from a money, asset,

 3 and collateral movement, just the same as it

 4 happens today.

 5 MR. SWANN: Bob, it's Paul Swann again.

 6 If I could just interact and ask a question about

 7 what you've just said. If that's the case,

 8 presuming the day after, insolvency occurs, there

 9 are outstanding payments due from some of the

 10 customers, just in the ordinary reevaluation of

 11 open contracts from customers, and those payments,

 12 therefore, are not going to be satisfied because

 13 they're not going to be met as an omnibus payment

 14 from the now insolvent FCM. What would the

 15 expectation be in relation to the CCP's activities

 16 in relation to those clients which are now

 17 deficient and under-collateralized?

 18 MR. WASSERMAN: Essentially, you have

 19 the collateral that they have posted. At that

 20 point --

 21 MR. SWANN: And the collateral is

 22 deficient. It's now actually --
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 1 MR. WASSERMAN: I'm sorry --

 2 MS. TAYLOR: (Off mike) to market.

 3 MR. WASSERMAN: Right, and that point,

 4 you would have the choice of you could liquidate

 5 and then basically return the collateral, you

 6 could, if you so choose, get the collateral

 7 directly from the customer. If the deficiencies

 8 were sufficiently small, you might be able to

 9 transfer. Ultimately, in other words, you would

 10 not be giving back all of their collateral if

 11 their positions had lost. If they had a variation

 12 pay, you would be deducting that variation pay

 13 from their collateral in determining what each of

 14 those customers is entitled to.

 15 MR. SWANN: The point I'm raising, the

 16 question was really to draw out --

 17 MS. TAYLOR: Then they're under

 18 margined.

 19 MR. SWANN: Hearing the complexity that

 20 particular environment adds to the immediate post

 21 insolvency actions of a central counterparty.

 22 MR. WASSERMAN: And, in fairness, today,
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 1 if you have an FCM who defaults because of a

 2 customer, you're going to have essentially all

 3 that collateral and all those customer positions,

 4 and, again, you're going to have to make the

 5 choice do you want to liquidate it? Do you want

 6 to manage it? What do you want to do? It becomes

 7 more ramified such that you're looking at each

 8 customer individually, and that will, I have to

 9 concede, increase complexity, but, today, if one

 10 of your members defaults their customer account,

 11 one option available to you is to just liquidate

 12 that whole customer account and return what's

 13 left. Ultimately, while there would be more

 14 accounting, that same option would be available to

 15 you under this proposal.

 16 MS. TAYLOR: I don't disagree that

 17 that's an option. I don't disagree that it would

 18 be an option under the new proposal regime. The

 19 problem that I have with not considering the

 20 implications of calculating pay and collect

 21 information and keeping track of on behalf of

 22 which customers we got paid and on behalf of which
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 1 customers we didn't get paid is that I interpret

 2 customer protection to encompass more than just

 3 protecting the collateral assets that we have to

 4 be holding. I interpret customer protection to

 5 include protecting and safeguarding the customer's

 6 positions and their access to the market, and both

 7 of those things will also be threatened in the

 8 case of a clearing member default, and the best

 9 way to be in a position to ensure that the

 10 customers' positions and their access to the

 11 market is preserved is to be aware of which

 12 customers had a problem and which customers didn't

 13 so that the ones who didn't have a problem can

 14 move to their secondary clearing member

 15 immediately. So, if everything has been netted

 16 down and the clearing member failed to the

 17 clearinghouse in one omnibus pay and collect, that

 18 is going to delay the time at which the good

 19 customers can transfer to their second home, and I

 20 think that is a big part of what the customers

 21 want, is better portability in a bankruptcy.

 22 MS. SCHNABEL: Dan? Sorry.
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 1 MR. WASSERMAN: And to be very clear, as

 2 I'm writing the regulation, I think it would be a

 3 requirement for the FCM to make pays on behalf of

 4 those customers other than the defaulting

 5 customer. I must tell you, as I am writing that,

 6 I'm somewhat chuckling to myself because I fear

 7 that this is a regulation -- I hope it would be

 8 followed, but I don't expect it will because I

 9 think the reality is in any kind of a default

 10 situation, the likely outcome is there isn't going

 11 to be any payment. And look what happened, and

 12 people are going to look at what happened to Tex

 13 Griffin and the litigation that's going on even

 14 now and say well, gosh, I'm not going to do

 15 anything, I'm not making any payments. I'll just

 16 let the trustee take care of that. Again, that's

 17 true today, it's true under this regulation. That

 18 is a reality. I mean, we can try, and I will, but

 19 I recognize that it's a try.

 20 MR. ROSEN: But, Bob, you have to go

 21 back to the point that Ananda was making in the

 22 exchange with Maureen earlier, which is that, in
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 1 reality, what happens is that the FCMs put up

 2 their own money, and they have to put up their own

 3 money if they're going to avoid the position being

 4 blown out for being under-margined. If Kim is

 5 going to be able to figure out what accounts are

 6 going to get transferred, and transferees want to

 7 know that they're getting an account that is, in

 8 fact, margined properly and not topped up with

 9 funds that they're entitled to, it's going to

 10 delay that process. And Kim is going to probably

 11 have to get the information from Maureen.

 12 MR. WASSERMAN: 764(b), privileges a

 13 transfer that's approved, what Maureen has done is

 14 loaned Ritchie some money, and that money is what

 15 Kim's holding on to. Kim doesn't know and will

 16 not be, cannot be held responsible for knowing

 17 whether that money was of Ritchie, of his own, or

 18 whether Maureen lent it to them.

 19 MR. ROSEN: Right. Yes, but the person

 20 who cares about it is not Maureen. The person who

 21 cares about it is the person that might be taking

 22 the account.
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 1 MR. WASSERMAN: And under 764(b),

 2 there's no claw back, and, so, what will happen is

 3 assume for the moment that Kim does find a willing

 4 transferee. And let us assume, I mean, for

 5 instance, one possibility is there was no default

 6 at CME, there was a default at ICE, and, so, let's

 7 say, in fact, Kim has all the money. She can

 8 transfer, 764(b) protects the transferee from a

 9 claw back. Now, at that point, Edith, who's

 10 Maureen's trustee, is going to be reducing

 11 Richard's claim, and, indeed, may even going to

 12 Richard and saying excuse me, actually, you owe

 13 me, and please pay it rather quickly. But,

 14 essentially, Kim doesn't know any of this. It

 15 would be operationally very difficult to make her

 16 know any of it, and, therefore, she's looking at

 17 it as I have an account that says Mr. Prager on

 18 it, and it's fully margined, and I don't know

 19 where he got the money, but I don't care.

 20 MS. SCHNABEL: Dan, did you want to say

 21 something?

 22 MS. BURKE: Just one more point on that.
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 1 So, it's a matter of the timing of the margin

 2 calls, and we have that doc, Bob, of issuance of

 3 margin calls, and we see the end of the margin

 4 calls, and it's not just the firm capital, there's

 5 other clients' money that potentially could be

 6 moved out, and then the trustee would have to go

 7 back and claim back those monies. The trustee

 8 would have to claim back the monies. So, we have

 9 a continual seg requirement. You know that, so,

 10 you don't use clients' margins to offset another

 11 client in the debt for the deficits. It's a

 12 continual seg, but it's a matter of the tracing,

 13 and that's what happens in a bankruptcy, the full

 14 tracing.

 15 MR. WASSERMAN: Shall we keep it going

 16 or shall we take a timeout?

 17 MS. SCHNABEL: Can I just say one thing

 18 before we take a timeout, and this will be very

 19 fast. I think that the exchange between Kim and

 20 Bob and Maureen illustrates something. I mean, I

 21 think that if we go with the proposal that Bob had

 22 been thinking about, which was to keep omnibus
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 1 segregation relatively the same operationally, at

 2 least I haven't heard a reason for there to be an

 3 increased cost other than at the clearinghouse.

 4 Now, I think what Kim was saying is

 5 there may be to effect individual customer

 6 protection to the, I guess, best manner, we may

 7 need to change omnibus segregation to all, I

 8 guess, greater granular detail with respect to

 9 pays and collects, and I think that in terms of

 10 that discussion, I think we'd need to acknowledge

 11 that there are benefits because what Kim was

 12 saying was the flip side of the coin is that is

 13 actually going to help protect customers better,

 14 as well as costs, which would be of increased

 15 operational costs.

 16 So, that's it. We're on break.

 17 MR. ROSEN: Just what I was trying to

 18 crystallize was until Maureen explains to Kim who

 19 didn't fund the money, you don't know who's

 20 defaulted. If it is the defaulted account that

 21 goes to a transferee, I'm sorry, but either the

 22 transferee or Maureen has to lose. One or the
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 1 other one. There's no way that everybody is

 2 protected in that scenario. And, so, I'm thinking

 3 that the portability will be affected by the need

 4 to figure out where the default actually occurred,

 5 who didn't fund because, as far as Kim is

 6 concerned, she's got an account that was funded by

 7 the generosity of Maureen.

 8 MR. WASSERMAN: And there is, I think,

 9 two possibilities. I think one possibility is

 10 when Kim looks at her accounts she sees okay, this

 11 one lost $50,000, this one lost this. This one

 12 lost $20 million, and the original margin was $1.

 13 That's probably it. And, in any event, of course,

 14 to that extent, she doesn't need to know who was

 15 the defaulter because all she's transferring is

 16 what that account is entitled to after the

 17 deduction of losses on the positions that she

 18 knows about. Now, it's possible that, in fact,

 19 all of this happened as a result of day trading,

 20 in which event, at that point, Kim is probably not

 21 going to be doing a transfer because she's going

 22 to have to wonder wait, how did all this loss
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 1 happen, and, yet, I haven't seen it in this? I

 2 mean, ultimately, the information is there, and

 3 ultimately, I am giving Kim the choices to act in

 4 a way that will protect the clearinghouse.

 5 Remember, transfer is optional.

 6 MS. TAYLOR: But the transfer is the

 7 whole point.

 8 MR. ROSEN: The only point is that it

 9 does slow down the process of transfer a little

 10 bit. That's all.

 11 MR. WASSERMAN: It is a very important

 12 issue. There are restrooms down the escalators

 13 and to your left. It is 2:46. Could we try and

 14 come back around a couple of minutes of 3:00 so we

 15 can discuss very importantly the next issue?

 16 MR. SWANN: Bob, just for those on the

 17 phone, do we stay on the phone or should we detach

 18 and rejoin?

 19 MR. WASSERMAN: Please do. We'll be

 20 back in about 15 minutes.

 21 (Recess)

 22 MR. WASSERMAN: Ladies and gentlemen,
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 1 could we all take our seats? I know some folks

 2 have planes, so, we really need to get back to

 3 this. I intended to devote the second, now third

 4 of the meeting, to what I've been calling the risk

 5 cost. Before I do, is there any last details that

 6 we need to cover in a minute or two on the other

 7 issues?

 8 Edith? I'm sorry.

 9 MS. O'BRIEN: That's okay. Thank you,

 10 all, for participating today. I think that a

 11 number of individuals from this table don't have

 12 the benefit of the extensive experience of the FCM

 13 structure, and I've heard two hours of dialogue

 14 about seg customer movements between the

 15 clearinghouses and the exchanges, and as the

 16 conversations continued, it appears that this is

 17 extraordinarily myopic view of the current

 18 safeguard structure that operates in America and

 19 has effectively worked to the best of my knowledge

 20 for years. This safeguard structure in this

 21 financial framework is not just about customer seg

 22 money moving from FCMs to exchanges, it is based
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 1 on layers of partners and components across

 2 banking institutions who are approved to be

 3 exchange settlement banks, exchanges approved

 4 participating FCMs. FCMs do credit reviews of

 5 clients. It's layered. Everybody has a role,

 6 some of the roles cross over. There's segregation

 7 rules, there's segregation calculation. There's

 8 now capital rules. There's now capital

 9 calculations. There's rule of 15(c)(3) about what

 10 can be done of the firm while FCMs are holding

 11 them.

 12 So, as we continue the conversation this

 13 afternoon, I want everyone to consider the fact

 14 that there's a greater framework at hand here, one

 15 that has actually worked extremely well.

 16 One of the comments that I've heard over

 17 the last couple of weeks is how do we prevent a

 18 Lehman from happening here? We did. Lehman

 19 happened in the U.K.; it did not happen in

 20 America.

 21 So, I think that Bob does want to

 22 explore the risk components this afternoon, and I
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 1 want everyone to consider what the wider framework

 2 that does effectively work at this time, always

 3 looking at ways to enhance this to protect

 4 customer funds. There's no question about that.

 5 But an enhancement is different than the entire

 6 change to an infrastructure.

 7 MR. WASSERMAN: I would just make one

 8 note in response. Certainly, Lehman was an

 9 example of how well things worked in the future

 10 seg world, and I am very gratified, one might even

 11 say personally gratified at how that happened such

 12 that futures customers, I think, things worked

 13 well with barely a hiccup. But understand that

 14 Lehman was an issue outside of the customer

 15 account. This was not due to a fellow customer,

 16 this was due to a problem essentially on the prop

 17 level and at the parent level. What we're dealing

 18 with here is what happens if there is a problem at

 19 the customer level, and while that has been

 20 happily very rare in the future space, and very

 21 happily so, and that's in large part due to the

 22 excellent work that's done by a lot of people over
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 1 here both at the clearinghouse and at the firms,

 2 we're bringing in a new environment here on the

 3 OTC, where it would be, I feel, a little bit

 4 premature to assume just how well things are going

 5 to work. Obviously, we hope that we are

 6 developing a system where things will work as

 7 well, but there's some different risks that we're

 8 going to be confronting, and, so, there's some

 9 different issues out there.

 10 With that, I think it's important to

 11 talk about what the costs are on the risk level

 12 because this absolutely changes the risk

 13 environment. Today, clearinghouse can look at the

 14 entire omnibus account at an FCM, and that's

 15 essentially in addition to, obviously, the

 16 resources of the FCM, their capital that they are

 17 supposed to use to meet the obligations; their

 18 default fund contribution, their memberships,

 19 their proprietary account, all of that.

 20 Essentially, the next level under the present

 21 system is the collateral of the fellow customers,

 22 and I sort of envision that as somewhat of a
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 1 shield. It is only under the present futures

 2 approach after that shield is consumed that one

 3 then goes to the clearinghouses, capital

 4 contribution, and the rest of the default fund.

 5 Take away that shield, and you're changing the

 6 cost calculations. Clearinghouses, I think, can

 7 address that a number of ways, and one has to

 8 expect that they will address it in some way.

 9 They could increase collateral for everyone. They

 10 could, indeed, to a certain extent, will be

 11 required to because of the financial resources

 12 rules. The default resources are going to have to

 13 be essentially the same in the sense that they

 14 would have to account for that shield, and, so,

 15 I'd like folks to talk a little bit about how

 16 those costs might be calculated, and since mention

 17 has been made of doing this voluntarily, how would

 18 those costs be different under a voluntary system

 19 versus a mandatory system?

 20 MR. PRAGER: Bob, if I could go back to

 21 the conversation before the question I'd asked

 22 Dan. So, in life, you're careful what you wish
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 1 for. So, as we ask for a segregation and we look

 2 at it, we have to consider the added costs, and we

 3 have been looking at that, as well. And then if

 4 you look at the DDD models that are out there,

 5 where, admittedly, they're not FCM models, but to

 6 the OTC models where they have done the

 7 calculation, and I guess with Dan and Chris, you

 8 guys have done it. It's slightly different in

 9 terms of proportion of initial margin versus size

 10 of the fund. You've done the calculation. So, we

 11 know it works, we know that it's a clearing price,

 12 so to speak, from today's functioning market where

 13 most of the volumes rise.

 14 I think the other thing you have to look

 15 at is what other consequences or incentives are

 16 created by, perhaps, this movement of larger

 17 initial margin? I think, Kim, when we got

 18 together before, you were very good about sort of

 19 articulating the good of the system versus the

 20 good of the individual, and we're tilting that

 21 balance and suggesting that. So, how do we

 22 compensate for that? And the logical one is you
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 1 think about how much does your initial margin have

 2 to go up to compensate some of that, as well as

 3 what is the assessment of the backend? But as you

 4 think about if you had a system where, again, we

 5 look to where there is an existing system, that

 6 the market functions well, it's deep in liquid

 7 among the dealers. It also creates an incentive

 8 to keep very tidy books because, as you build

 9 notionals and every time you're paying initial

 10 margin, you now have an incentive to net down and

 11 to build other tools, such as compression tools

 12 and things like that are also good for the system

 13 because you're taking notionals down. So, you

 14 need to think of not just the cost of that per

 15 transaction trade, but what are the other

 16 incentives you're creating to keep a

 17 well-functioning market and keep risks down?

 18 So, I know at least from our perspective

 19 at BlackRock, our swaps desk is incredibly

 20 disciplined about taking notionals down,

 21 constantly netting them down and working with the

 22 dealing partners because of the mitigation and the
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 1 operational risk and the return of initial margin.

 2 So, I think you can't just ask the question in

 3 isolation of what is the cost, but what are the

 4 other benefits actually you're creating by,

 5 perhaps, making some positive incentives in the

 6 system to bring down risk and notionals?

 7 MR. EDMONDS: Maybe I'll take a stab at

 8 least establishing a baseline of numbers we can

 9 talk about, and since you've been asking that for

 10 most of the day, Bob, on that front. And we'll

 11 make a couple of assumptions, and this won't be

 12 asset-specific, it won't be

 13 clearinghouse-specific. These are just general

 14 equations to think about.

 15 Let's just start with the first

 16 assumption, the product or characteristics of the

 17 product has a normal distribution. If it doesn't

 18 have a normal distribution, it likely means it's

 19 going to be a higher price, but let's at least

 20 start with that baseline.

 21 Lots of clearinghouses talk about

 22 confidence intervals, the 99 percent level, and
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 1 this is typically the model used when we think

 2 about the mutualization or the shield that Bob is

 3 making reference to when he walks through his

 4 waterfall. So, at the 99 percent confidence

 5 level, that equates to like 2.33 standard

 6 deviations as a mathematical equation. And let's

 7 assume that we're going to shift the balance to

 8 Ritchie's point about his conversation with Kim

 9 more from this mutualized pool down to more the

 10 initial margin and less in the mutualization pool.

 11 So, let's take it from a 99 percent confidence

 12 level to a 99.99 percent confidence level, again,

 13 assuming a normal distribution of this.

 14 That equates to a 3.8 standard

 15 deviations. So, if we take the difference between

 16 those two, if we divide 3.8 by 2.33, to effect the

 17 cost or at least give us a benchmark of what the

 18 cost might look like in shifting that balance

 19 between the mutualization pool, you end up, again,

 20 simple expression of the normal distribution, of

 21 163 percent increase.

 22 To get you to the same number, Bob, that
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 1 you wanted, you got to have the same number of

 2 funds as a place to start, and then we can start

 3 tearing up are there -- I don't know that this is

 4 the right forum with 43 minutes left in the day or

 5 whatever that you have, but then we can start

 6 talking about the different asset classes and

 7 things of that nature, and how that may be

 8 impacted differently. But if you were to shift,

 9 you still have some tail risk. We still have a

 10 need for guarantee funds. We still have the

 11 guarantee fund contributions. There's going to be

 12 some return on capital from clearing members who

 13 are putting that up, but and maybe that's not the

 14 right balance, but it's at least a place to start.

 15 MR. WASSERMAN: Couple of observations.

 16 First is, assuming this rule were to be passed,

 17 I'm assuming you folks will react to it in the

 18 most cost-effective manner that you guys can think

 19 of. Now --

 20 MS. TAYLOR: That would be in our best

 21 interests.

 22 MR. WASSERMAN: Yes. That may be by
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 1 shifting from one balance of collateral and

 2 guarantee fund to another, which is what you're

 3 mentioning here, and, so, under that approach, you

 4 would be increasing the margin levels by 63

 5 percent, you would presumably be reducing --

 6 MS. TAYLOR: One hundred sixty-three.

 7 SPEAKER: One hundred sixty-three.

 8 MS. TAYLOR: One hundred sixty-three.

 9 SPEAKER: One hundred sixty-three.

 10 SPEAKER: Is that --

 11 MR. WASSERMAN: You said 3.8 sigma

 12 versus 2.3 sigma?

 13 MR. EDMONDS: Yes, divided by.

 14 MR. WASSERMAN: Yes, you'd be

 15 multiplying it by 163, which is an increase of 63.

 16 MR. EDMONDS: Over zero or over --

 17 MR. WASSERMAN: Well, right now, you

 18 charge 2.3.

 19 MR. EDMONDS: Charge one.

 20 MR. WASSERMAN: You'd be going up

 21 another 1.5 to 3.8.

 22 MR. RADHAKRISHNAN: It's not doubling.
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 1 MR. WASSERMAN: Yes, it's not doubling.

 2 MR. EDMONDS: It's not doubling.

 3 MR. WASSERMAN: Okay. You would

 4 presumably then be able to reduce the guarantee

 5 fund because, essentially, there would be that

 6 much less loss, but regardless, that might be the

 7 better way for you to do it. There are other

 8 ways. You might choose to instead increase your

 9 guarantee fund to deal with this potential loss.

 10 And, in other words, rather than increasing it

 11 from 2.3, just simply say when I do my calculation

 12 of my guarantee fund, right now, I can use the

 13 entire customer collateral, now, it would only be

 14 on a customer-by-customer basis.

 15 So, in other words, for each loss, there

 16 would be a customer involved. That customer would

 17 have some collateral both in those positions and

 18 in other positions. You would be doing that in

 19 the guarantee fund for one or two or three

 20 members, however you do your guarantee fund

 21 calculation, assuming you follow our proposal,

 22 let's say the first SIDCOs, it would be, say, the
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 1 top three. So, you would find the top three, but

 2 then socialize that calculation across all of your

 3 clearing members. That might come up with a

 4 different number and it might be a lesser number.

 5 You might do some combination of the two. I guess

 6 what I'm saying is, the difficult thing here, and

 7 I will confess, I'm not sure what the right answer

 8 is, I'm not sure even how to find the right

 9 answer, is I'm assuming that you're going to be

 10 looking at all the possibilities and picking out

 11 the best parts of each and picking out the most

 12 cost effective parts in each, and I'm just not

 13 sure sitting here, and maybe you are, that the

 14 best way to do this is to go the 99.99.

 15 MR. EDMONDS: And we have to start

 16 somewhere. And the conversation we've had today

 17 is where do you start to walk down that exercise

 18 to determine what the menu of opportunities would

 19 be? And at the end of the day, I would ask you

 20 this question: The assumption is we're not going

 21 to have less money as clearinghouses available to

 22 us to cure defaults. That it's got to be at least
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 1 what we have today in some form or fashion in

 2 different buckets, organized in a different

 3 fashion. True?

 4 MR. WASSERMAN: I think mostly yes. I

 5 think the calculation changes. In other words,

 6 the methodology you would use would be similar

 7 today, taking into account the different risk

 8 environment. And, so, part of it depends upon how

 9 much business you're going to do, part of it

 10 depends upon the risk environment based on how

 11 much of the collateral you can use.

 12 MS. BURKE: But, Bob, if you are trying

 13 to reduce systemic risk, which that's the whole

 14 intent here, and, Ritchie, going back to your

 15 point, knowing there's a cost, right? We all know

 16 there's going to be a cost. So, the initial

 17 margin, that's our first line of defense. That's

 18 our first line of defense in the financial

 19 safeguards that are established, and to know that

 20 you're assessing your clients, we don't set the

 21 initial margin. We're -- there's too faulty. The

 22 clearinghouse looks at the risks, looks at the
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 1 positions, looks to the volatility, and makes

 2 decisions on the initial margin. The clearing

 3 firms then step in and say okay, I have my client

 4 base. I now need to go and review my client base

 5 and say do I need to impose more than what the

 6 clearinghouse imposes for initial margin based

 7 upon the risk profile of our clients and after we

 8 go through our credit and risk review. But to say

 9 that it shouldn't go into the initial margin, I'm

 10 not understanding because if a client is bringing

 11 more risk into the system, a particular client is

 12 brining more risk into the system, shouldn't we be

 13 charging them for that risk and making sure they

 14 have the capital and the resources and the

 15 wherewithal to actually meet that margin

 16 obligation?

 17 MR. WASSERMAN: Heavens yes. No,

 18 please, right now, if there's a client, you're

 19 charging 99.99 percent confidence interval for the

 20 collateral, please continue doing that. The

 21 question is what I thought I understood Chris to

 22 be saying is, well, the way we would address this
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 1 or the way we're going to cost this is we're going

 2 to assume we're going to apply to every client

 3 collateral at the 99, that we're going to require

 4 essentially margin at a 99.99 percent. That way,

 5 we'll have much less in the way of risk over and

 6 above client collateral. Is that --

 7 MR. EDMONDS: Well, what I attempted to

 8 articulate, and apologies, Bob, if I

 9 mis-communicated this with you, but I said if we

 10 start with the idea that the 99 percent confidence

 11 interval is typically what's associated with where

 12 the waterfall you went through and accurately

 13 described as this shield of customer funds to

 14 begin with. Your charge to us was what does it

 15 look like if you take that out and begin to shift

 16 the balance other places? In order to shift the

 17 balance to the others, one idea, to walk through

 18 the map that we did, was to go straight to the

 19 99.99, and that's just at the clearinghouse level.

 20 That doesn't bring into the fact what Maureen

 21 said, it is perfectly capable for any of the

 22 clearing members or the clearinghouses or their
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 1 customers to charge more than the clearinghouse

 2 minimums. Don't think that you're going to change

 3 that. I don't think that's on the table in the

 4 conversation. So, it's just about establishing a

 5 baseline in the conversation that if you wanted to

 6 shift that balance, these are the numbers you're

 7 going to end up with.

 8 MS. TAYLOR: And our numbers, magnitude

 9 wise, would be very similar to what Chris is

 10 saying if what the decision was let's make it all

 11 up based on margin. Just I mean --

 12 MR. WASSERMAN: Let me ask one

 13 additional question. One of the other things that

 14 has been on the table occasionally is do this on a

 15 voluntary basis. So, some of these folks have

 16 said you know what, yes, that would be us. We'd

 17 want to do that. What would happen to your

 18 guarantee fund calculation? I'm assuming for the

 19 moment that you're going to permit them to do

 20 that. I think that's at least a possibility.

 21 MR. EDMONDS: We typically don't well

 22 telling customers they can't do something.
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 1 MR. WASSERMAN: Right.

 2 MR. EDMONDS: Long-term basis.

 3 MR. WASSERMAN: So, let's say you do

 4 that. Because here's where I'm coming from on

 5 that score. I know this shield of fellow customer

 6 collateral is important to the guarantee fund

 7 calculation, and I was coming at it actually from

 8 the opposite point. Let's say you don't do it

 9 through increased margin, you do it through

 10 increased guarantee fund. Now, let me tell you

 11 what I was seeing, and I could be entirely wrong.

 12 So, if we let those folks here who would want to

 13 pay for that, they're many of the largest folks,

 14 and, so, if they start walking off, it seems to me

 15 that panels of that shield are walking off with

 16 them. And the amount of that shield, that fellow

 17 customer collateral shield that's available to

 18 reduce what hits the waterfall is walking off with

 19 them. And it seems to me the very folks who are

 20 going to want to walk off, they're folks with very

 21 small accounts that might not be worth it. Folks

 22 with very large accounts, very large exposures,
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 1 big pension funds, they're the ones who are going

 2 to want to do this, and that seems to me to be

 3 taking out a large part of your shield which

 4 means, from where I'm sitting, most of the cost of

 5 the guarantee fund that you'd be incurring if you

 6 took the shield out entirely, you'd still be

 7 incurring if you did it on a voluntary basis.

 8 MS. TAYLOR: That might be true because

 9 the way that I've looked at this situation is that

 10 the customers how are most likely to value this

 11 benefit are going to be customers who are very

 12 large, and potentially, customers who are

 13 primarily fiduciary in their role as opposed to

 14 customers who are risk takers in their role, even

 15 if they might be large. So, depending on the risk

 16 profile, every number that we give you is just a

 17 hypothetical number that we have modeled based on

 18 certain assumptions that we've made that could be

 19 very different in real life because it all depends

 20 on the risk profile of the worst case loss that we

 21 would suffer. So, we have to look at the

 22 potential size and make up and distribution of the
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 1 customer activity and determine whether or not

 2 that drives the worst case loss that the

 3 clearinghouse would face. If it doesn't, then

 4 there wouldn't be a need to change the waterfall

 5 at all, but I think the assumption is that by

 6 nature of splitting out the certain exposures from

 7 a pool, by definition, you're creating increased

 8 risk because you're removing part of the asset.

 9 Right now, if a clearing member owed us

 10 money, we have already netted that we're not going

 11 to pay them any winnings if they have a residual

 12 loss. And, in this model that you're describing,

 13 I think we would be obligated to pay the

 14 individual customers who are making money would

 15 get their payments, and the individual customers

 16 who are not making money, that we potentially

 17 would not be paid for those. So, it's a change in

 18 the pooling nature of the risk profile that the

 19 clearinghouse faces, and, so, every piece of that,

 20 everything you un-pool increases the risk that

 21 you're going to lose your netting benefit.

 22 A clearinghouse is designed to be a bulk
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 1 service, and it is designed to do two things, the

 2 two things Ritchie mentioned and we've talk about

 3 before, customer protection, a very important

 4 part, a very important element of what a

 5 clearinghouse does, but systemic risk protection

 6 is the other very important element of what a

 7 clearinghouse does. And the way that a

 8 clearinghouse does that is, to a large extent,

 9 affected by this ability to pool. So, as we lose

 10 the ability to pool, there will be either a

 11 corresponding increase in the margins that are

 12 paid by the people who are not pooled, or there

 13 will be a corresponding increase in the guarantee

 14 fund contributions that are put in place by the

 15 clearing members who contribute to the guarantee

 16 or there will be some other element, concentration

 17 margin, some other elements will come into play,

 18 but there will be not insignificant increase in

 19 the amount of resources that the clearinghouse

 20 will need.

 21 If you did it completely with margin,

 22 we've estimated numbers that are not dissimilar to
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 1 the numbers that Chris talked about, between 50

 2 and 100 percent, depending on what kind of

 3 assumptions you want to make about the

 4 distribution of what the positions look like. And

 5 if you did it completely with guarantee fund,

 6 under some situations, we thought about how many

 7 customers. It's more likely that any given

 8 customer will default than it is that any given

 9 clearing member will default, and if what we're

 10 assuming is that if a clearing member defaults,

 11 we're at risk of not getting paid from any of the

 12 customers, we'd probably want to cover a larger

 13 number of customer defaults than we would cover

 14 clearing member defaults and setting our

 15 waterfall. And, so, if we looked at covering for

 16 the largest five customer exposures whereas now we

 17 would cover for the largest two clearing member

 18 exposures, that would lead to a guarantee fund

 19 increase that would be quite substantial.

 20 Potentially, your clearing fund requirement could

 21 tend toward meeting to double.

 22 And you mentioned that there definitely
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 1 is a tradeoff, but the tradeoff that I'm the most

 2 concerned about here is if there's a new cost

 3 imposed by the regulatory regime, the market will

 4 either pay it, find a way to pay it, or the market

 5 will dissipate. And if we make the cost of

 6 providing the clearing service too high on the

 7 clearing members, several of the clearing members

 8 have told us that in a regime where the clearing

 9 fund was going to be double the size of what it is

 10 now anticipated to be for the over-the-counter

 11 business, they'd have to think twice about doing

 12 this business, and that increases the

 13 concentration among the remaining players, which

 14 has two effects: It decreases the choices for the

 15 customers to find service providers, it decreases

 16 the customer's ability to diversify their own

 17 exposure across a larger number of clearing

 18 members, and even if everything stayed flat and

 19 nothing changed in the exposure, it increases the

 20 amount by which everyone else has to contribute

 21 because there are fewer people to contribute to

 22 the losses suffered by one defaulter. So, the
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 1 concentration and the further concentration of

 2 providers is something that I take as a very

 3 significant concern.

 4 I also take as a very significant

 5 concern the fact that if the costs are too high

 6 for the clients, the clients will choose not to do

 7 the business in this way, will choose to do a

 8 different type of business, will choose to do

 9 business somewhere else. So, that's why I like

 10 the idea of the choice, the option, better than

 11 enforcing that cost on everyone because then each

 12 client can make an individual business decision on

 13 whether or not the protection that they're gaining

 14 is worth the cost to them and you don't impose

 15 that additional cost then on every client in the

 16 system.

 17 MR. WASSERMAN: But here's my question

 18 on that point: Let's assume Richard and Bill are

 19 customers of your reference member. The top

 20 member who's driving your default fund, who's one

 21 of the two or three who's driving your default

 22 fund calculation, if we give them the option, how
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 1 does that change -- let's assume for the moment we

 2 say fine, this is going to be entirely optional.

 3 My hypothesis, and tell me if you disagree and

 4 please tell me why, is that if these guys are

 5 customers, the reference member, and they are

 6 given the option to walk away, that your costs are

 7 still going to go up significantly, and, indeed,

 8 if they and others like them are a large part of

 9 the customer collateral at that reference member,

 10 then you're going to incur most of the costs,

 11 letting them walk away anyway. And they don't

 12 know, by the way, the reference member doesn't

 13 know hey, I'm the one because if they're at number

 14 four, it doesn't matter.

 15 MS. TAYLOR: If a customer did nothing

 16 but walk away, and by walking away, you mean

 17 choose the optional seg, the individual seg?

 18 MR. WASSERMAN: (Off mike) collateral

 19 (off mike).

 20 MS. TAYLOR: So, if the biggest customer

 21 posing the biggest risk to the clearinghouse in

 22 driving the worst case loss decided to opt for
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 1 individual seg, our risk profile changes by the

 2 same amount that it would if it was required that

 3 he did or that he opted that he did, I agree with

 4 that. But the customer who's going to opt to do

 5 that instead of have it be a mandate would be, I

 6 think, also looking at other ways of managing the

 7 business in addition to just opting into the

 8 individual seg. He can affect his own business by

 9 splitting it up among more clearing members. He

 10 can affect his own business by some of his clients

 11 choose and some of his clients don't choose. Eh

 12 can affect his own business by choosing to opt

 13 into a kind of a mini pool of segregation where he

 14 would put all of his clients for which he's a

 15 fiduciary into their own mini pool instead of

 16 putting them into their own individual pools, and,

 17 therefore, that reduces the increase in the cost,

 18 as well. So, there are actions that the customer

 19 can take. But I think we should provide an

 20 environment where the customer is encouraged to

 21 also take steps that help to get a cost effective

 22 outcome.
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 1 MS. SCHNABEL: Okay, Dan?

 2 MR. MAGUIRE: Okay, so, maybe just to

 3 take a little bit of a step back here. I can get

 4 some real context of this. We have 40, 50 percent

 5 of the global cleared interest rate derivatives

 6 market now. Admittedly, the majority of that is

 7 dealer to dealer, but we're dealing with the same

 8 product here.

 9 I think if I was to characterize what

 10 I'm hearing, there's probably four real questions

 11 here, and we sort of blend between the four. One

 12 is: What is the exposure? And there's different

 13 ways of calculating that, so, how is calculated?

 14 We have a method today for a dealer to dealer, a

 15 community, how would we do it including clients?

 16 You mentioned the top two, top three today on the

 17 clearing member side, but, of course, we need to

 18 consider this double default scenario that we're

 19 talking about. Is it the top 3, 4, 500 customers

 20 within that, whatever that flavor may be.

 21 Then, I think you get into the question

 22 of: Who pays or how you cut it. Those are the
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 1 really two questions. How do you cut that? Is it

 2 all I mean? Is it all default fund? And who's'

 3 going to pay in that?

 4 So, to try to give you some context

 5 today around our existing portfolio, we did some

 6 sample numbers across the 15 largest clearing

 7 members, which constitutes pretty much the

 8 majority of the cleared OTC swap business today,

 9 interest rate swap.

 10 On average, and we are, as we talked

 11 about, very conservative in our margin approach

 12 because our approach is very much defaulter pays

 13 first, which I think every DCO would say the same,

 14 but it's defaulter pays first, so, we have a high

 15 margin charge, which was vindicated through the

 16 2008 experience.

 17 On average, to go from 100 to a 99

 18 confidence interval, and I know statisticians will

 19 argue that may 100 is not really 100, but to go

 20 from 100 to 99 percent, that sees a reduction in

 21 the initial margin on average across those 50

 22 members by 39 percent. In monetary terms, that's
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 1 about $250 million dollars per firm.

 2 The maximum when we did that is a 55

 3 percent reduction, and this is really to Chris'

 4 point, these are not normal in terms of their

 5 distribution. These are non-linear. There is a

 6 high degree of linearity in the swap products, but

 7 these are not normally distributed in terms of

 8 their losses. So, you go a maximum of 55 percent

 9 on 1 particular clearing member, and that was a

 10 $550 million reduction in their margin level. And

 11 then the minimum we saw was 18 percent, and that

 12 was $120 million. So, you need to multiply all

 13 those numbers by 15 to get a sort of size. If we

 14 went from 100 to 99, what would that do, just on

 15 the existing today before we even mention any

 16 scenario involving clients.

 17 Today, in the swap clear service, we

 18 have a grand total of in the region of $15 billion

 19 of initial margin shared across each of those

 20 clearing members, depending on the risk. And it's

 21 very clearly the amount of risk you put in in

 22 terms of your directional diversified position,
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 1 the higher your initial margin is. But to balance

 2 that, we have in the region of $14 billion, $15

 3 billion initial margin, we have $1 billion in

 4 terms of guarantee fund. So, that gives you a

 5 very big flavor of how that is cut today.

 6 If we then move into how you calculate

 7 that exposure, quite simply, my number there is a

 8 14 and 1. My number is 15. That's the way I see

 9 it. I could make that seven and eight or I could

 10 make that nine and six, whichever way you cut

 11 that. But the reality is the first I need to do

 12 is work on my exposures and what the scenarios?

 13 And I think the two keywords in this are prudent

 14 and plausible. Every time we talk about stress

 15 testing an initial margin, we have to have things

 16 that, from an initial margin standpoint, are

 17 plausible in a relevant, economic cycle and a

 18 relevant, historic time period. That's one piece.

 19 On the stress testing, we can create

 20 some crazy, whacky scenarios out there in terms of

 21 market event and extreme moves, but we also have

 22 to think about what is a plausible scenario of the
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 1 client going delinquent as well as the clearing

 2 member at the same time, as well. So, stress

 3 testing plus the initial margins is really what

 4 your risk exposure is.

 5 I don't think there's an answer right

 6 now. We can all speculate, and it's interesting

 7 to hear the DCO's views on this about is about is

 8 it the two plus their top five clients and how you

 9 cut that. I think there needs to be more analysis

 10 done around this. But I think we need to be

 11 careful that we don't polarize this as just an IM

 12 or a stress test debate. The risk exposure is the

 13 same, and that's regardless of a gross omnibus

 14 account, of a gross segregated account with omni

 15 collateral or a gross segregated account with

 16 segregated collateral. The market risk is the

 17 same. It's absolutely the same. It does not

 18 matter which way you cut it.

 19 I might have a different view to Kim and

 20 a different view to Chris of how I calculate my

 21 market risk because it's a subjective science or

 22 art or whatever you want to call it, but it's
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 1 market risk exposure. That's what we're really

 2 talking about here.

 3 So, we don't, as a clearinghouse, have

 4 an answer exactly how we would do this because,

 5 right now, it's quite nebulous. We're talking

 6 about client clearing. But the fact of the matter

 7 is there are no clients really clearing. So, to

 8 speculate on a very few client's clearing OTC

 9 derivatives so I can be specific, it's very hard

 10 for us to say this is the right number and this is

 11 the right configuration. You have to model that.

 12 The extreme scenario I think Kim

 13 referred to is we could just take every single

 14 client within a top two, top three, and that would

 15 be a pretty extreme event and probably be on

 16 plausibility. But that's one way of doing it.

 17 Then you can go the other end of it, but I think

 18 also to your point, Maureen, the first line of

 19 defense is the initial margin. So, back to our

 20 point, the defaulter pays. We put that at the

 21 front of all of it, and we use a pretty high

 22 confidence interval. If you cut it down and down,
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 1 you're just basically going to spread it. For me,

 2 it doesn't matter which way you do it. You're

 3 going to always have to rebalance.

 4 MS. BURKE: And how many days do you

 5 have (off mike)?

 6 MR. MAGUIRE: That's based on a

 7 seven-day holding period over a five-year observed

 8 history.

 9 And maybe just to the final point, which

 10 is touching on some of the introductory remarks

 11 that Ritchie made on this, this is a full

 12 portfolio approach. So, this is a very

 13 diversified methodology. It has 14 currencies.

 14 This goes out to 50 years. These are OTC

 15 derivatives as traded over the last 10, 11 years.

 16 This means that the dealers in this example are

 17 incentivized to do risk impression and trade

 18 compression. So, that means we've

 19 institutionalized tariffs. So, we keep reducing

 20 the notional. You get more and more trades all

 21 the time, but on notional, the point is relatively

 22 constant. It will, over time, one would expect
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 1 start to go down, because the risk that you're

 2 putting in there versus the amount of trades are

 3 two very different things. And risk compression,

 4 as well. So, one is trade and notional

 5 compression, which, personally, I don't see as a

 6 real measure of risk.

 7 The other is the actual risk

 8 compression, as well. That's really a fact of how

 9 you run your buck and what your business is. If

 10 you have a very consolidated risk position, a

 11 30-year dollar swap, if I can't close that in my

 12 assumptions of 7 days or 5 days or 5 years

 13 history, whatever it is, I'm going to apply and

 14 multiply to that, and I can justify that by saying

 15 if I looked at your position today against the

 16 market today and the (inaudible) at the market, I

 17 can't close that side out in 7 days. Therefore, I

 18 have to put a multiplier on that, a concentration

 19 risk or a liquidity risk or whatever you want to

 20 call it. That's what we do actively now at the

 21 dealer level. That's what we also do at a client

 22 level, as well. This has to pass through all the
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 1 way because, going back to my final point, which

 2 was the clearinghouse is looking to credit risk at

 3 a clearing member we're looking at market risk as

 4 a whole throughout the client community. So, I

 5 have to look at the market risk on the clients

 6 regardless of credit. It's absolutely the role of

 7 the FCM to take the credit risk and view the

 8 credit add on, et cetera. I only face that when

 9 the clearing member is gone, but all things being

 10 equal, the clearing member won't go.

 11 MS. BURKE: So, that concentration that

 12 you have drills down to the client and to the

 13 clearing firm or is --

 14 MR. MAGUIRE: Absolutely. In any

 15 account structure we have, it would always go down

 16 to the client account level.

 17 MS. TAYLOR: But let me ask you a

 18 question, Dan, just to make sure I understand.

 19 You talked in terms of going from 100, if that's

 20 your coverage level now, down to 99.

 21 MR. MAGUIRE: Yes.

 22 MS. TAYLOR: And the change being
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 1 between 40 and percent. So, when Chris and I were

 2 talking about the difference being -- going from

 3 99 to basically 100, and our numbers were between

 4 50 and 63 percent --

 5 MR. MAGUIRE: It consists --

 6 MS. TAYLOR: It's the same --

 7 MR. MAGUIRE: It's actually the same --

 8 MS. TAYLOR: Yes, right.

 9 MR. MAGUIRE: Because if went 99 to 100

 10 --

 11 MS. TAYLOR: It's the same.

 12 MR. MAGUIRE: You'd have a lower

 13 numerator, it's the same number, relatively

 14 speaking. Yes, yes. So, I guess the key for us

 15 is under any of these models, the LCH on a swap

 16 cleared, gross omni, gross seg, on collateral

 17 gross seg, seg collateral, the initial margin

 18 number will be the same because the market risk

 19 exposure is the same. It's actually about how you

 20 calculate the stress number, and then it's about

 21 who he's going to pay. If you fund the initial

 22 margin, the default fund de facto will be smaller.
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 1 The guarantee funds, so, it will be smaller.

 2 MR. KASWELL: Thank you. This is very

 3 interesting to listen to because I think this is

 4 the sort of discussion that I think we were

 5 looking forward to where people actually roll up

 6 their sleeves and say what is it actually going to

 7 cost? We're sensitive to cost because,

 8 ultimately, it's customers, and we end up enjoying

 9 a lot of that cost. (Laughter)

 10 But I think in anticipating this kind of

 11 calculation, it's important to say what are the

 12 real costs, and I think what you started to get

 13 into, what is the baseline cost of the system

 14 versus the marginal cost of saying in order for me

 15 to have the individualized seg, what is that

 16 actual difference? Because we all know there's

 17 going to be a cost to building this thing one way

 18 or the other. So, the real question is: How much

 19 more does it cost to have the segregated? I do

 20 fear that your proposed compromise will actually

 21 give us the worst of both, that we'll end up with

 22 some of the additional costs without a lot of the
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 1 legal protections.

 2 But the other thing I think in

 3 considering these costs, it's not just the cost

 4 that the various firms will face, the central

 5 clearing parties will face, but also the external

 6 costs that the users will face, again, because if

 7 we don't think we're getting the kind of

 8 protection that we feel comfortable with, we have

 9 to go out and buy a CDS, and I think it is the

 10 CFTC's responsibility, with all due respect, not

 11 just to look at the individual, but look at the

 12 system-wide cost to make sure that you're not

 13 saying well, it's going to be cheaper here. It's

 14 actually going to be more expensive over there.

 15 And then, finally, the cost at the

 16 individual FCMs, I mean, I understand there is

 17 additional cost involved and there's more

 18 communication between the central clearing party

 19 and the FCM, but, of course, the FCM still has to

 20 keep score about where it is with its own

 21 individual customers and where it's collateral.

 22 That is also a baseline cost that is not going to
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 1 go away.

 2 MR. WASSERMAN: And, in fairness, that

 3 is something that always happens, and that's never

 4 going to change. I think though, again, my big

 5 question is: Okay, if you change from a 99th

 6 percentile to a 99.99, at that point, that might

 7 help you facilitate this. Indeed, it might

 8 address most, if not all of us. It has some other

 9 benefits along with it, among other things, the

 10 default fund would be corresponding, I think,

 11 going down.

 12 MS. TAYLOR: I think the assumption that

 13 was in my numbers was that if the margin went up

 14 by the 50 percent, that mean there was no change

 15 in the default fund, and what would really likely

 16 happen is that it would be a blend, but I was

 17 giving you the number.

 18 MR. WASSERMAN: Yes.

 19 MS. TAYLOR: I don't know what the blend

 20 would be. So, I was giving you the if I did it

 21 all this way, this would be the effect. If I did

 22 it all this way, this would be the effect. Very
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 1 likely, it would be a blend.

 2 MR. KASWELL: Can I just make one more

 3 point? On the choice, I mean, choice always has a

 4 great appeal as an initial matter. You should be

 5 able to opt in or opt out. One, that we think

 6 that there is a risk that the overall cost for

 7 everybody would go up because building choice into

 8 the system means more expense. There's the point

 9 that you were making, Bob, about what happens if

 10 all the big players opt out, and we think there's

 11 also the question of risk to the system if some

 12 people are in and some people are out, where does

 13 that leave you as far as protecting yourself if

 14 one of the big players goes down.

 15 Thank you.

 16 MR. ROSEN: Just a --

 17 MR. SWANN: Bob, can I make one

 18 observation before you move on? There's an

 19 implication in this discussion, the status quo

 20 relation to the mutualized portion of the backing

 21 of a clearinghouse remains stable in circumstances

 22 where the profile at the underlying risk is
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 1 changed, and I think it's for assumption to assume

 2 that in the current environment the direct members

 3 as clearinghouses are willing to socialize the

 4 tail risk beyond what's captured by initial

 5 margining because they know who they're sharing

 6 that risk.

 7 In an environment where they no longer

 8 know who they're sharing that with because they

 9 don't know necessarily who the customers are as

 10 all of the other participants, it's not, I think,

 11 a given assumption that they would equally be

 12 willing to continue to provide the backing that

 13 supports that tail risk. From a systemic point of

 14 view, that's an important point as what's it going

 15 to cost and what's the right distribution?

 16 MS. TAYLOR: That is a very good point,

 17 Bob, because what happens in this kind of a model

 18 is that the tail risk of the -- there's the

 19 clients who made a poor credit decision about

 20 their FCM, and the FCMs who made a poor credit

 21 decision about their clients. You could argue

 22 that either way, and, right now, the pair of those
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 1 two things bears the cost of the problems caused

 2 by those two things much more so than everyone

 3 else who didn't make bad credit decisions bears

 4 those costs. And, so, you shift the mix.

 5 MR. WASSERMAN: I mean, right now, my

 6 understanding is if you get past the shield of the

 7 clients, that's still socialized, and it's

 8 socialized regardless of why it is that happened.

 9 MS. TAYLOR: I don't disagree with that,

 10 but what I'm saying is it's like a first line of

 11 defense is the people who chose the FCM who

 12 couldn't cover the risk of its client business and

 13 the FCM who chose clients who wouldn't pay their

 14 market to market. So, the people who made the

 15 failed credit decision share risk prior to other

 16 parties who were not part of that failed credit

 17 decision.

 18 MR. WASSERMAN: Well, fair enough.

 19 MS. TAYLOR: It's like it's another

 20 example of the defaulter pays model, and we can

 21 switch that model, but we've all been talking

 22 about the costs of it, and Paul pointed that
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 1 there's also kind of a moral hazard cost that none

 2 of us have really talked about, that that's one

 3 way that shows itself.

 4 And I think another way the moral hazard

 5 risk shows itself is that customers now have a

 6 very strong incentive to make a good credit

 7 decision, and if customers are completely isolated

 8 from the credit risk of their FCM, not being able

 9 to make good on its obligations, then they lose a

 10 large amount of the incentive that they have to

 11 make a wise credit decision, and, actually, I

 12 believe that that's one of the elements of the

 13 whole risk management framework in this industry

 14 that has served this industry very well over time.

 15 Everyone had an alignment of interests in making

 16 sure that there was good risk management going on

 17 at every step of the way.

 18 MR. WASSERMAN: Granting that point, if

 19 CME's $100 million comes before the customers,

 20 what does that do to your incentives for risk

 21 management as the clearinghouse, and if the

 22 members of the risk committees default funds come
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 1 before the customers, what does that do to the

 2 risk committees' incentives to look at what you're

 3 doing and ask you to do more of it?

 4 MS. TAYLOR: If people decide that they

 5 want to stay in an environment where that's the

 6 mutualization scheme, there would be an incentive.

 7 There already is a strong incentive for those

 8 elements of risk management to be there. So, I'm

 9 not sure that that incentive could be

 10 strengthened. I mean, there's a very strong

 11 incentive for those protections to be in place.

 12 MS. O'BRIEN: I think what Kim is

 13 referring to is the infrastructure that exists

 14 currently, allows the exchanges, some transparency

 15 to individual composition clearly cohesive

 16 transparency to the omnibus position, the FCM, and

 17 FCMs have an obligation within their capital

 18 structure and their seg structure as they're doing

 19 credit and real-time risk review of clients, that

 20 smaller default component which occur every day,

 21 they occur every day, they stay managed within the

 22 client FCM structure, and they never get to the
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 1 exchange. That's part of the structure as it

 2 exists today, and it's part of the protection to

 3 our client that exists today. Banks are also

 4 involved in this. The first place to get paid

 5 every day is the exchange.

 6 I agree with Kim. I have some level of

 7 concern, as well, that if the exchange is going to

 8 take on a greater role as a result of the

 9 elimination of mutualization, that there could be

 10 a fairly smart client out there that might in a

 11 certain market decide that it would be

 12 advantageous just not to make their position

 13 whole, knowing that the clearing firm or the

 14 exchange would have to segregate that component in

 15 a market. I think, potentially, we could have

 16 some manipulation here. We could walk through --

 17 MR. PRAGER: I think the only thing I'd

 18 add to follow your point, Bob, about would

 19 behaviors change on risk management behaviors, and

 20 I do think we have to look at the totality of the

 21 behaviors that will change in this account class.

 22 So, back to my earlier comments and Dan's
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 1 comments, and when we have looked at across all

 2 our funds, it's not a homogenous group of

 3 investment activity.

 4 We talk about cost. I mean, it may be

 5 the wrong word. From our span, it's what's the

 6 drag on performance to the funds? And that drag

 7 on performance actually would range from none,

 8 based on how we run some of our funds today which

 9 already presume a very high level of initial

 10 margin and presume it's a leveraged account where

 11 it has a lot of turnover to extreme drag on some

 12 of our very long- term liability hedging type

 13 activities where that initial margin is going to

 14 have a material drag. So, you also have to think

 15 of it across all the different types of activities

 16 that we manage as a group of fiduciaries. So,

 17 it's not going to be all the same, that drag, and

 18 I do think that based on how you all come out on

 19 the tilt and whether it's front-loaded or to the

 20 fund, it will very much change the behavior of the

 21 way that money is managed. Not necessarily for

 22 the worst. I think to the extent it's
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 1 front-loaded, you get some of those systemically

 2 beneficial behaviors of tidier books.

 3 And I take your point that it's largely

 4 market risk. Let me tell you, running 5,000

 5 accounts, there's a lot of operational risk that

 6 you take out, as well. So, and that is a real

 7 cost reduction by netting down those notionals.

 8 So, I do encourage everyone to think about not

 9 just we talk about the narrow framework that now

 10 exists. We're talking about the system, and I do

 11 think that from this account class in the cleared

 12 derivatives, you will change the behaviors, as

 13 well. Some of it for the better by the shift in

 14 that balance.

 15 MR. HUSTON: Well, let's be clear on

 16 costs. I mean, ultimately, the cost is going to

 17 filtered down to the end consumer. And what I'm

 18 concerned about when I hear increased costs and

 19 increased initial marginal requirements, to the

 20 extent in the agricultural industry, we're

 21 required to utilize exchange cleared swaps versus

 22 uncleared swaps. Or to a certain degree, exchange
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 1 future or a combination of the two.

 2 Remember back in 2007, 2008, the prices

 3 of corn and wheat got so high that there were

 4 commercial institutions that pulled back out of

 5 the market and would not allow farmers to forward

 6 market and hedge because the volatility was great,

 7 and, thus, the initial margins were so high. And,

 8 so, unlike a drag in performance as it relates to

 9 cost, I mean, here's a situation where bona fide

 10 hedgers don't get the opportunity to hedge

 11 financial risk with their particular operation

 12 because of these increased costs that we're

 13 talking about here today.

 14 MR. ROSEN: And I want to look at this

 15 issue, a pre 20 sigma event and post 20 sigma

 16 event. Pre 20 sigma event, the cost that you're

 17 acknowledging, that, Ritchie, you're willing to

 18 pay as a fiduciary because you see the advantages.

 19 The problem is what you can't avoid is that if you

 20 adopt the voluntary model as you're interpreting

 21 it, which is we will require clearinghouses to

 22 give a choice to customers, you're imposing that
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 1 cost on the people who aren't looking for the

 2 realignment in segregation exposure to the sort of

 3 fellow customer risk. So that someone who's not

 4 looking, but is clearing in the same clearinghouse

 5 is going to end up having to pay for something

 6 that you regard as a benefit, but something that

 7 they don't regard as justified by the benefit.

 8 And there's some other costs here that I

 9 think it's just worth mentioning, and if the

 10 commission is thinking of this as imposing a

 11 requirement that a clearinghouse require cost, I

 12 think there are other considerations and policies

 13 that -- first of all, it's not as clear to me as

 14 it seems to be to some people, that the statute

 15 provides the authority for the commission to do

 16 that. We don't have to go into that, obviously.

 17 We don't have to go into that at this time. I

 18 think that would probably not be productive, but

 19 you might think about accommodating it as a choice

 20 where a clearing organization could decide to

 21 offer this model or not to offer this model and

 22 let people gravitate to clearing organizations
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 1 that have the preferred model and not create this

 2 cross contamination that occurs if you're all half

 3 in or half out.

 4 There are other casualties to this

 5 arrangement though. As I mentioned before,

 6 Dodd-Frank was oriented toward the reduction of

 7 systemic risk. It also preserved the codes policy

 8 of ratable allocation of shortfalls across

 9 customers. That remains in place. It also

 10 clearly had provisions that are designed to

 11 promote portfolio margining, and portfolio

 12 margining may be one of the earliest casualties of

 13 this because you're not going to be able to offer

 14 portfolio margining except in the account that is

 15 either in one camp or another, and if you have

 16 futures that your port into this camp because it's

 17 in the account of a customer that wants this form

 18 of segregation, then you're going to have an

 19 issue, and I think you're going to have an issue

 20 under the code because you may define whatever

 21 account classes you want, but, at the end of the

 22 day, you will have a situation where two futures
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 1 customers, one of whose position is in one of

 2 these accounts and one whose positions are not in

 3 this account, and if there's a loss and the

 4 futures customer whose position is in a combined

 5 account with these protected swaps, the results in

 6 the insolvency will inherently not be ratable

 7 because that party is going to get a much better

 8 rate in the insolvency than the pure futures

 9 customer in the same futures contract and is

 10 carried with the same FCM. I think that's

 11 something that needs to be considered as possible.

 12 One other issue that you'll have to deal

 13 with is that on cross-border business, if these

 14 accounts are disclosed, whether they're legal or

 15 operational, if they've got to be disclosed, then

 16 you have a situation where either you're put in

 17 the position of the U.S. FCM in a position as to

 18 whether or not since they're going to know the

 19 client because they're going to have to disclose

 20 this information, they're going to be subjected to

 21 registration requirements in every jurisdiction

 22 where these clients are sourced, or,
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 1 alternatively, whether foreign brokers who

 2 currently carry their accounts on an omnibus basis

 3 with the U.S. FCM and don't have to register are

 4 going to have to have a direct relationship where

 5 this information is provided to keep it from their

 6 competitors, and then, therefore, require them to

 7 be registered with the FTC as an FCM. So, there

 8 are other collateral consequences post 20 sigma

 9 event. You have to remember that if there such an

 10 event and people are looking where these losses

 11 are falling, we're creating a situation where

 12 those losses, if they get transmitted through the

 13 guarantee structure, and don't forget that there

 14 are multipliers on the guarantee fund that

 15 increase the risk and the accountability for loss

 16 of the clearing members, if that creates a ripple

 17 that runs through, let's face it, the clearing

 18 members of these clearinghouses are the vectors

 19 through which systemic risk is transmitted in a

 20 major financial crisis, and one of the things that

 21 the public will be seeing is that what happened

 22 was a lot of major users of the futures market,
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 1 the clear swap markets who benefited from that

 2 infrastructure were able to walk away with their

 3 marbles, and other people, if clearing members

 4 failed because of the losses that they're going to

 5 have to absorb, people who are utterly unaffected,

 6 didn't benefit, didn't participate in these

 7 markets are potentially going to be at risk, and I

 8 think people will look at the policy judgments

 9 that we're making very differently through that

 10 lens at that time, and I think that's something

 11 that needs to be borne in mind.

 12 MR. WASSERMAN: Just responding to a

 13 couple of those points, we may have differences as

 14 to what we can do in terms of ratability, but

 15 taking as a given the proposal on the table would,

 16 in fact, distribute money ratably, it's just how

 17 much would be coming back from the clearinghouse.

 18 What would be non-ratable is if we endeavored to

 19 do this on a voluntary basis, with some customers

 20 being protected and some customers not.

 21 MR. ROSEN: It's only ratable in the

 22 portfolio margining. If you have a basis for
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 1 concluding the two people that are trading the

 2 same swap positions and the same clearinghouse

 3 through the same clearing member, end up with

 4 different distributions because of which account

 5 structure that you can define those as being sort

 6 of different account classes so I don't have to

 7 treat them ratably with each other, and I think

 8 that's not clear.

 9 MR. WASSERMAN: But what I'm saying is

 10 under the voluntary approach where some customers

 11 may choose this and others not, you are correct.

 12 That's --

 13 MR. ROSEN: Under the mandatory

 14 approach, where all customers are treated the same

 15 way, it would still be ratable. The issue is that

 16 because the clearinghouse would be looking at the

 17 customers individually, you would not have the

 18 fellow customer losses.

 19 MR. WASSERMAN: I think in the portfolio

 20 margining account, even in a mandatory context,

 21 there are issues with ratable distribution, and we

 22 can walk through that at a different --
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 1 MR. ROSEN: Offline, yes.

 2 MR. SZYCHER: I mean, I would take a

 3 slightly different view. And I'm not certainly

 4 not qualified to speak about anything regarding

 5 the code, but I guess I may take a different view

 6 regarding I guess the consequence of certain

 7 clients walking away and sort of who's left in the

 8 pool insofar as to the extent that there's some

 9 perceived detriment to the folks who remain in the

 10 pool, that, to me, is necessarily only the case

 11 if, and in fact only if risk were not priced

 12 correctly to begin with. That is that whoever

 13 left was subsidizing whoever was there to begin

 14 with. And speaking of whoever was going to be

 15 subsidizing, if anyone is going to be subsidizing

 16 anyone else, it's highly probable that, at least

 17 in our minds, a pension fund, probably the lowest

 18 risk of any institutional client, is probably

 19 going to be doing the subsidizing, and, in doing

 20 so, it's not readily apparent that there our

 21 clients are benefiting from the subsidization of

 22 credit risk across other less credit-worthy
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 1 entities.

 2 MR. ROSEN: Great point.

 3 MR. WASSERMAN: I'll let you have the

 4 last word.

 5 MS. TAYLOR: You'll be sorry.

 6 (Laughter) I just wanted to come

 7 back to something that I raised

 8 earlier that I would like us to

 9 think about, given everything that

 10 we've discussed here today. I've

 11 been racking my brain since I've

 12 talked with you first, Ritchie, to

 13 figure out a way where we could

 14 increase the protection that the

 15 customers have without kind of

 16 tipping the balance of the systemic

 17 protection, and the best idea that

 18 I can come up with after talking

 19 internally and talking within the

 20 industry is actually to use some

 21 kind of an insurance vehicle as a

 22 vehicle for protecting the
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 1 customers against the prorated

 2 losses, but not adversely affecting

 3 the way the kind of bulk risk

 4 management, systemic risk

 5 protection mechanisms of a

 6 clearinghouse work. And, so, I

 7 just wanted to throw that back out

 8 on the table.

 9 MR. WASSERMAN: Okay, I'll make myself a

 10 liar. The problem with that is, of course, that's

 11 not there, and we've got rule-makings that we've

 12 got to do now, and, so, it's difficult to base

 13 something on that possibility.

 14 MR. RADHAKRISHNAN: Sorry. You guys may

 15 have discussed this, but it seems to me that if

 16 somebody wants extra protection, they should pay

 17 for it.

 18 SPEAKER: That's the assumption.

 19 MS. TAYLOR: And insurance is an

 20 excellent way of targeting that cost right to the

 21 --

 22 MR. RADHAKRISHNAN: That's right. So,
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 1 the issue is how do you make the people who make

 2 something extra pay for it? Because, right now,

 3 in the futures world, everybody is treated the

 4 same way. What you folks are arguing for, and I'm

 5 not making a judgment on it, is you want something

 6 different from what we have right now because the

 7 cleared swaps, right now, the statute replicates

 8 the futures model. You want something different,

 9 and the question is: Are you willing to pay for

 10 it, right? The way in which you can pay for it

 11 is, and the funds are not going to like this, you

 12 could be a clearing member yourself, right? You

 13 can be a clearing, and then you're not exposed to

 14 other customer -- I know I see unhappy faces.

 15 (Laughter) But you're not exposed,

 16 right? You're not exposed to other

 17 customer risk. Now, of course,

 18 what you then have to do is to

 19 satisfy the clearinghouses that you

 20 can be a clearing member. So,

 21 that's one way of doing it. But

 22 the other way is if you want extra
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 1 protection is to pay for it. Now,

 2 Kim is talking about insurance, and

 3 I'm wondering if there's some other

 4 way because we're talking about the

 5 opt-in approach. Is there some

 6 other way in which people who want

 7 extra protection --

 8 SPEAKER: Their model --

 9 MR. MALOY: Isn't clearing insurance,

 10 you pay a premium, the higher the premium, the

 11 better the protection.

 12 MR. RADHAKRISHNAN: So, you are saying

 13 you pay a higher premium. So, the question is:

 14 What form does it take?

 15 MR. MALOY: Initial margin.

 16 MR. RADHAKRISHNAN: More initial margin.

 17 Okay, so --

 18 MR. MALOY: Or, in our case, the same

 19 initial margin.

 20 MR. RADHAKRISHNAN: I know we're

 21 supposed to end, but is it possible that let's say

 22 you have a firm with 10 accounts. The firm will
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 1 margin each of those accounts, right, and come up

 2 with a number. Let's call that X. Is the margin

 3 requirements that the DCO imposes on the customer

 4 omnibus also X, or could it be something less than

 5 X?

 6 MS. TAYLOR: In our particular case for

 7 the over-the-counter swaps, it would be the sum

 8 total of the requirements across the accounts.

 9 MR. RADHAKRISHNAN: Across, okay.

 10 SPEAKER: Gross.

 11 MR. RADHAKRISHNAN: So, then my idea

 12 doesn't work because I thinking what if you got

 13 more than what you had actually asked for? Is it

 14 over possible that the firm will have more money,

 15 more margin from its customers than you could

 16 offer on the clearing firm?

 17 MR. MALOY: Yes.

 18 SPEAKER: It happens every day.

 19 MR. MALOY: There's a model whereby you

 20 can have -- there's two things here. One is the

 21 amount of margin, and the other is about the

 22 waterfall.
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 1 MR. RADHAKRISHNAN: Right.

 2 MR. MALOY: Talk about the margin. If

 3 you do a -- I'm going to pick on Richard's firm

 4 and say let's say BlackRock have five funds. I

 5 know they've got more than that, but let's say

 6 they have five funds and they said look, we're

 7 happy to commingle all of our five funds together,

 8 and we're happy to say that if the FCM is in

 9 default, we're looking to port, we're going to go

 10 to a backup, a substitute, and those five have to

 11 go together. If they're prepared to do that, then

 12 we can say well, look at that exposure as a net

 13 risk exposure, and, therefore, charge net margin.

 14 That's the clearinghouse would charge that.

 15 The FCM may choose to charge on a gross

 16 basis, and that's where you have a gross margin

 17 and from the clients to the FCM, but from the FCM

 18 to the CCP, that would be a nets margin.

 19 MR. RADHAKRISHNAN: So, think about it,

 20 if a DCO got more money, more than IM, then it

 21 would charge - would that make your life easy?

 22 MS. TAYLOR: I think that's one of the
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 1 things that we figured would be an outcome of

 2 having separate segregation.

 3 MR. RADHAKRISHNAN: Yes. Okay.

 4 MS. TAYLOR: Is that we would have more

 5 --

 6 MR. RADHAKRISHNAN: We would have,

 7 right.

 8 MS. TAYLOR: More money than we

 9 otherwise would have.

 10 MR. WASSERMAN: Though, in fairness --

 11 MS. TAYLOR: More margin than otherwise

 12 would have.

 13 MR. WASSERMAN: Now, in fairness,

 14 customer level margin, Kim, I think you guys

 15 generally charge 130 percent of clearing member

 16 margin or is that --

 17 MS. TAYLOR: That would only be for the

 18 initial initiating trade activity.

 19 MR. WASSERMAN: Right.

 20 MS. TAYLOR: Not on the ongoing basis.

 21 MS. O'BRIEN: But currently today under

 22 the infrastructure, if a clearinghouse makes a
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 1 credit assessment of a client who potentially has

 2 significant intraday volatility and they're not

 3 making intraday call they may do something

 4 effectively super margining. They may charge a

 5 client 140 percent of the actual margin charge by

 6 the exchange.

 7 What occurs with that extra 40 percent,

 8 Bob, you're correct. It does reside within the

 9 FCM, it does reside with the seg pool, which is

 10 one of the infrastructure components today.

 11 Perhaps, there's a dialogue about something called

 12 a buffer. The difference between initial margin

 13 that is required by the exchange. It is not a

 14 funding that would lock up for a quarter like the

 15 guarantee fund does. I will tell you, I have

 16 considerable concerns about putting a significant

 17 rate on FCMs to double the size of a guarantee

 18 fund when you're talking about day-to-day movement

 19 of clients. It's actually not consistent.

 20 SPEAKER: Right.

 21 MR. WASSERMAN: Let me mention two

 22 things. First, from where I'm sitting, there is
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 1 nothing inconsistent with this proposal for a

 2 clearinghouse to say as part of this risk

 3 management or the FCM or either to say you know

 4 what, one of your clients really gets us

 5 concerned, and for that client, because of the

 6 market risk, we want 150 percent of the normal

 7 margin because that client worries. That's one

 8 thing that could be done.

 9 Second, the clearinghouse might say, and

 10 this you won't like as much, you, as the FCM, are

 11 guaranteeing each of your clients. We want you to

 12 post X dollars in collateral to collateralize that

 13 guarantee, and that would run across clients.

 14 That also would be consistent, and then they could

 15 essentially use that. And it's when you said

 16 "buffer" that made me think of that. That could

 17 then be applied to any client, and there'd be

 18 nothing inconsistent with them taking that for any

 19 client because it's not a customer's money, it's

 20 the firm's money.

 21 Again, it seems to me there's really a

 22 wide pallet of ways in which the clearinghouses
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 1 could address this kind of a risk environment, and

 2 it's not (inaudible) to say I'm expecting they

 3 will creatively find the best way to do it.

 4 MS. BURKE: Bob, on the point of the

 5 buffer that you kind alluded to at the end, and

 6 going back to Edith's point that it's not in the

 7 guarantee, I think the firms would have to take a

 8 look at that and evaluate it, and then come back,

 9 but not have it as a guarantee, but have it as

 10 part of your seg buffer that we have today.

 11 MR. WASSERMAN: And, to be clear, to the

 12 extent possible, I want that to be something

 13 that's worked out between the firms and the

 14 clearinghouses rather than by us saying you've got

 15 to do it that way. The regulatory goal is to

 16 protect these guys. The implementation of that

 17 should, from where I'm sitting, as much as

 18 possible, be up to you folks. With that --

 19 MS. SCHNABEL: I think we're done. Our

 20 mailbox is open if anyone wants to submit written

 21 comments.

 22 Okay, thanks.
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 1 MR. RADHAKRISHNAN: Thank you very much.

 2 MR. SWANN: Thank you.

 3 (Whereupon, at 4:13 pm, the

 4 PROCEEDINGS were adjourned.)

 5 * * * * *

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

 4 public in and for the District of Columbia, do

 5 hereby certify that the forgoing PROCEEDING was

 6 duly recorded and thereafter reduced to print under

 7 my direction; that the witnesses were sworn to tell

 8 the truth under penalty of perjury; that said

 9 transcript is a true record of the testimony given

 10 by witnesses; that I am neither counsel for,

 11 related to, nor employed by any of the parties to

 12 the action in which this proceeding was called;

 13 and, furthermore, that I am not a relative or

 14 employee of any attorney or counsel employed by the

 15 parties hereto, nor financially or otherwise

 16 interested in the outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: October 31, 2011

 22