UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 OPEN MEETING ON THE NINTH SERIES OF

 PROPOSED RULEMAKINGS UNDER THE DODD-FRANK ACT

 Washington, D.C.

 Thursday, January 13, 2011
 2

 1 PARTICIPANTS:

 2 Commission Members:

 3 GARY GENSLER, Chairman

 4 BART CHILTON, Commissioner

 5 MICHAEL V. DUNN, Commissioner

 6 JILL SOMMERS, Commissioner

 7 SCOTT D. O'MALIA, Commissioner

 8 Presenters:

 STEVE SHERROD

 9 Division of Market Oversight

 10 RICK SHILTS

 Division of Market Oversight

 11

 SARAH JOSEPHSON

 12 Division of Clearing and Intermediary

 Oversight

 13

 ANANDA RADHAKRISHNAN

 14 Division of Clearing and Intermediary

 Oversight

 15

 Also Present:

 16

 DAN BERKOVITZ

 17 General Counsel

 18 DAVID STAWICK

 CFTC

 19

 20

 21 * * * * *

 22
 3

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

 2 (9:38 a.m.)

 3 CHAIRMAN GENSLER: This meeting will

 4 come to order. This is a public meeting of the

 5 Commodity Futures Trading Commission to consider

 6 issuance of proposed rulemakings under Dodd-Frank

 7 Wall Street Reform and Consumer Protection Act.

 8 It will be regarding position limits for physical

 9 commodities which is the pending business before

 10 the Commission and swap trading relationship

 11 documentation requirements for swap dealers and

 12 major swap participants.

 13 Before we hear from staff I'd like to

 14 take this opportunity to congratulate Commissioner

 15 Mike Dunn on his 25 years of service to the

 16 federal government. Mike is a trusted colleague

 17 who works incredibly hard in service to the

 18 American public here at the CFTC, but he also

 19 served at the Farm Credit Administration, the

 20 Department of Agriculture, the Senate Agriculture

 21 Committee under Senator Patrick Leahy's

 22 chairmanship and probably a few other places.
 4

 1 He's been nominated by presidents of both parties

 2 and confirmed by the U.S. Senate I think it's six

 3 times. Having done that myself a few times, six

 4 is something to be honored. I am honored to work

 5 with Mike and call him my friend and colleague. I

 6 want to present him with a plaque if that's all

 7 right. This is his 25 years of service plaque.

 8 COMMISSIONER DUNN: Thank you, Mr.

 9 Chairman.

 10 (Applause)

 11 COMMISSIONER DUNN: Thank you very much,

 12 Mr. Chairman. This is an unexpected pleasure, and

 13 I must say the 25 years of service in the federal

 14 government, and that even goes back to some time

 15 starting with Lyndon Johnson to today, so that

 16 I've earned every gray hair that I have. The most

 17 amazing thing that I have found in my tenure

 18 working with the federal government was the

 19 dedication to the men and women who are known as

 20 the Civil Service Corps. It is too often in the

 21 press today that folks have said the government is

 22 the enemy or is the problem, and then it's shifted
 5

 1 not from the government but for the men and women

 2 who work day to day in government as a problem and

 3 that's just simply not true. I think all of us

 4 and the 25 years that I have in I've never been a

 5 career civil servant. It's always been in an

 6 appointed position and that's pretty amazing.

 7 Some people may say I've managed to fool a lot of

 8 folks, but the reality is that working with career

 9 civil servants has been an honor for me in the 25

 10 years that I have in, the successes I've had are a

 11 result of the great support we've had with those

 12 staffs. Failures, I have to put those on my

 13 shoulders, but thank you all and thank you, Mr.

 14 Chairman, with presenting me with this plaque.

 15 I'm honored.

 16 CHAIRMAN GENSLER: No plaques, but I do

 17 want to thank Commissioner Jill Sommers and

 18 Commissioner Bart Chilton who is joining us by

 19 phone I hope, Bart, you're on, and Commissioner

 20 O'Malia for all their thoughtful work on

 21 implementing Dodd-Frank. I'd also like to make

 22 this as a personal moment to honor somebody's
 6

 1 birthday who have been today and that's my wife.

 2 We lost Francesca about 5 years ago but our three

 3 daughters and I miss her dearly. She was a

 4 beautiful woman and I can't help but thinking

 5 about her today because it was her birthday.

 6 I will return now to the business of

 7 today's meeting, welcoming members of the public,

 8 the market participants, members of the media to

 9 today's meeting as well as those listening by

 10 phone and watching on webcasts. This is our ninth

 11 public meeting to consider rules with regard to

 12 Dodd-Frank rulemaking. Our next meeting will be

 13 January 20. We will also schedule some additional

 14 meetings in February. I think we'll take up the

 15 dates of those meetings at our January 20 meeting.

 16 As we have been doing, we'll announce

 17 the actual rulemakings that we'll consider one

 18 week before the meetings. Staff has worked very

 19 hard on the rulemakings that the Commission is

 20 considering today. They will present their

 21 recommendations. Of course, position limits is

 22 the one that's in front of us so I think we'll be
 7

 1 probably taking some questions for staff on that.

 2 And we of course continue to look forward to

 3 receiving public comments on all the rules that we

 4 put out and there will be questions on answers on

 5 these rules posted on our website. Before I turn

 6 it over, I turn it over to my fellow Commissioners

 7 for their opening statements. Commissioner Dunn?

 8 COMMISSIONER DUNN: Thank you, Mr.

 9 Chairman. Thank you all for joining us today in

 10 this important meeting regarding the

 11 implementation of the Dodd-Frank Act. Today's

 12 meeting will address proposed rules regarding

 13 position limits for physical commodity derivatives

 14 and documentation requirements for swap dealers

 15 and major swap participants. The Commission is

 16 required pursuant to the Dodd-Frank Act to set

 17 position limits as appropriate to diminish,

 18 eliminate and prevent excessive speculation.

 19 There has been the suggestion by some

 20 that once we set position limits on physical

 21 commodity derivatives the price we pay for gas,

 22 bread, milk and other things will inevitably drop,
 8

 1 and that volatility in the commodities markets

 2 will simply cease to exist. I believe this is a

 3 fallacy. Price volatility exists in markets that

 4 have position limits and in markets that do not

 5 have position limits. Price volatility exists in

 6 markets that have substantial participation from

 7 index funds and markets that do not have index

 8 fund participant whatsoever. As Nobel Prize

 9 winning economist Paul Krugman pointed out in a

 10 recent editorial, price volatility exists in a

 11 market because we live in a finite world where

 12 there is not at any given moment in time an

 13 inexhaustible supply of oil, wheat, milk or other

 14 physical commodities to meet the global demand for

 15 such products. Simply put, sometimes prices are

 16 higher because the demand for products around the

 17 globe is greater than the supply. Since these are

 18 global commodities, the demand driving higher

 19 prices might not even be from U.S. consumers but

 20 from a growing middle class in countries with

 21 emerging economies. Mr. Krugman does point out

 22 that this doesn't necessarily mean that
 9

 1 speculation plays no role.

 2 With the passage of the Dodd-Frank Act

 3 now clearly as a mandate to set position limits on

 4 commodity markets and the over-the-counter markets

 5 as appropriate to diminish, eliminate or prevent

 6 excessive speculation, to date CFTC staff has been

 7 unable to find any reliable economic analysis to

 8 support either the contention that excessive

 9 speculation is affecting the market we regulate or

 10 that position limits will prevent excessive

 11 speculation. The task then is for CFTC staff to

 12 determine whether position limits are appropriate.

 13 With such a lack of concrete economic evidence, my

 14 fear is at best position limits are a cure for a

 15 disease that does not exist, or at worst it's a

 16 placebo for one that does.

 17 I am voting for the proposed rules on

 18 position limits in order to gather more

 19 information. If there is more than anecdotal

 20 evidence that there is excessive speculation

 21 distorting prices in our markets, we need to see

 22 it. If there is statistical or economic analysis
 10

 1 that shows that excessive speculation exists and

 2 that position limits will diminish, eliminate or

 3 prevent it we need to see it. If there is

 4 evidence that position limits will lower the price

 5 we pay for gas, milk and steak while

 6 simultaneously ensuring the integrity of our

 7 markets in the price discovery process, we need to

 8 see it. Only after these questions have been

 9 answered will I be able to determine whether or

 10 not position limits are appropriate. If we

 11 determine that position limits are appropriate to

 12 diminish, eliminate and prevent excessive

 13 speculation, I think we must then work with our

 14 sister regulators around the globe to ensure that

 15 limits set here in United States markets are not

 16 simply evaded by trading in other venues around

 17 the world.

 18 Lastly, I would like to speak briefly

 19 about the budget crises facing the CFTC. The CFTC

 20 is currently operating on a continuing resolution

 21 with funds insufficient to implement and enforce

 22 the Dodd-Frank Act. My fear at the beginning of
 11

 1 this process was that due to lack of funds, the

 2 CFTC would be forced to move from a

 3 principle-based regulatory regime to a more

 4 prescriptive regime. Now if our budget woes

 5 continue, my fear is that the CFTC may simply

 6 become a restrictive regulator. In essence, we

 7 will need to say no a lot more. No to new

 8 products. No to new applications. No to anything

 9 that we do not believe in good faith we have the

 10 resources to manage. Such a restrictive regime

 11 may be detrimental to innovation and competition,

 12 but it would allow us to fulfill our duties under

 13 the law with the resources that we have available.

 14 Again I would like to thank staff of the CFTC for

 15 all the hard work in regard to these very

 16 important proposed rules.

 17 CHAIRMAN GENSLER: Thank you,

 18 Commissioner Dunn. Commissioner Sommers?

 19 COMMISSIONER SOMMERS: Thank you, Mr.

 20 Chairman. Good morning. I'd like to start again

 21 today by thanking both of the teams that we have

 22 before us today for all of their hard work on the
 12

 1 proposals we're considering. I know that Sarah

 2 Josephson who is the team lead for Internal

 3 Business Conduct Standards has been before us on a

 4 number of different occasions and this is the last

 5 proposal for her team. I want to thank all of

 6 them for all their hard work on the proposals that

 7 we've already put out and the one today and also

 8 to the Position Limit team who has been before us

 9 on a number of different occasions. I want to

 10 thank all of them for their perseverance on these

 11 very difficult issues surrounding position limits.

 12 I will be supporting the swap trading

 13 relationship documentation proposal today because

 14 I believe this documentation is a critical

 15 component to well- functioning swaps markets. The

 16 documentation increases transparency to the

 17 regulators and increases certainty among

 18 counterparties both of which are vital.

 19 Regarding the position limits proposal,

 20 let me say at the outset that while I opposed the

 21 Commission's 2009 proposal and I oppose this

 22 proposal today, I do not have a per se
 13

 1 philosophical opposition to position limits. I

 2 understand that Congress has directed the

 3 Commission to implement position limits as

 4 appropriate. If we had a reasonable and

 5 enforceable position limit proposal before us

 6 today based on analysis of complete market

 7 information, I would support it. We have not in

 8 the past nor do we now have such a proposal before

 9 us.

 10 I opposed our 2009 position limit

 11 proposal because I thought it was a bad idea to

 12 impose position limits on exchange-traded

 13 contracts when we had no authority to consider

 14 limits on the vastly larger over-the- counter

 15 markets. I believe that had we imposed limits

 16 solely on exchange-traded contracts, we risked

 17 driving market participants out of our regulatory

 18 purview and into the opaque over-the-counter

 19 markets or overseas. This would not have been a

 20 positive regulatory outcome.

 21 I oppose the proposal before us today

 22 because I believe it is flawed in a number of
 14

 1 respects. First, I believe we should conduct a

 2 complete analysis of the swap market data before

 3 we determine the appropriate formula to propose.

 4 We have not done that. Second, without data on

 5 swap market positions, the spot month limits we

 6 are proposing are not enforceable. I think it's a

 7 bad policy to propose regulations that the agency

 8 does not have the capacity to enforce.

 9 Third, in Section (a)(1) Congress

 10 specifically authorized the Commission to consider

 11 different limits on different groups or classes of

 12 traders. This language was added in Section 737

 13 of Dodd-Frank. The proposal before us today does

 14 not analyze or in any way consider whether

 15 different limits are appropriate for different

 16 groups or classes of traders.

 17 Finally, Section 737 of Dodd-Frank

 18 states that the Commission shall strive to ensure

 19 that position limits will not cause price

 20 discovery in the commodity to shift to trading on

 21 foreign boards of trade. This proposal does not

 22 contain any analysis of how the proposal attempts
 15

 1 to accomplish this goal. In fact, the proposal

 2 does not even mention this goal. Driving business

 3 overseas is a longstanding concern of mine and

 4 that concern remains unaddressed. Position limits

 5 has presented and still presents a number of

 6 different challenges for this Commission that I

 7 believe strongly the proposal before us today

 8 still misses the mark. Again, thanks to the two

 9 teams before us today and our enormous efforts in

 10 helping us get these proposals out. Thank you.

 11 CHAIRMAN GENSLER: Thank you,

 12 Commissioner Sommers. Commissioner Chilton I

 13 believe is online.

 14 COMMISSIONER CHILTON: Yes, I'm here,

 15 Mr. Chairman. Thank you and thanks to the staff.

 16 I support both of these rules. I do have a

 17 statement that I'd like to have included in the

 18 record which is short and without objection, Mr.

 19 Chairman.

 20 As regulators, I think we have one key

 21 mission. It is embodied in the Commodity Exchange

 22 Act. We have a singularity of purpose to ensure
 16

 1 efficient and effective markets and to prevent and

 2 deter fraud, abuse and manipulation. Quite

 3 frankly, I think we can do better. We can because

 4 the new Wall Street Reform and Consumer Protection

 5 Act requires that we develop what many of us

 6 consider to be some fairly precious parameters.

 7 Today, I am hopeful we will move forward

 8 to propose a position limits role, a most precious

 9 parameter that we should have proposed much

 10 earlier in a way that would have implemented the

 11 provision as Congress intended. That's not

 12 happening.

 13 Yesterday, eight U.S. senators told us

 14 to move forward on limits. That follows two other

 15 senatorial letters from last month.

 16 This is a commission of five

 17 individuals, a group of people who make these

 18 decisions. That pretty much ensures no individual

 19 will get their way all the time. I'm certainly

 20 not getting my way on position limits, nor are the

 21 senators who wrote to us.

 22 I am thankful that we will have position
 17

 1 points in place as a kind of glide path to

 2 position limits. As I've said repeatedly, points

 3 are not limits. However, they will help us learn

 4 more and do better as we go forward in further

 5 developing important -- and precious --

 6 parameters.

 7 I would also like to congratulate

 8 Commissioner Dunn on his long service. I've had

 9 the pleasure of working with Mike and following

 10 Mike at different places in the Senate and at the

 11 Farm Credit Administration, but also working with

 12 him at USDA and I'm pleased that most of the time

 13 we've been on the same side of issues and that

 14 really makes me comforted and I've known that I'm

 15 doing the right thing a lot of times. We don't

 16 always agree and we both I think are supporting

 17 the position limit rules but for different

 18 reasons.

 19 The only comment I'd make about that is

 20 that the as appropriate language in there I don't

 21 think Congress ever intended that that was to be

 22 interpreted with such elasticity that it meant
 18

 1 that we could say nothing is appropriate. I think

 2 it means we have to do something, it's just

 3 figuring out the right level. Maybe my colleagues

 4 don't disagree with that, but either way we'll see

 5 how things go forward and I support both the rules

 6 and I thank everybody for their work on this and

 7 congratulate Commissioner Dunn.

 8 COMMISSIONER DUNN: I thank Commissioner

 9 Chilton for following behind and cleaning my

 10 messes.

 11 CHAIRMAN GENSLER: Thank you,

 12 Commissioner Chilton. Commissioner O'Malia?

 13 COMMISSIONER O'MALIA: Thank you. I'd

 14 like to also extend my congratulations to

 15 Commissioner Dunn for 25 years of excellent and

 16 outstanding service. He's done a great job and

 17 I've enjoyed working with him in the short time

 18 I've been with him and I enjoy being such close

 19 suite mates upstairs and I can always rely on his

 20 counsel and I appreciate that and his advice is

 21 always well appreciated. Thank you and

 22 congratulations.
 19

 1 I believe that releasing the proposed

 2 rule for position limits for physical commodity

 3 derivatives for comment in its present form while

 4 simultaneously implementing a separate position

 5 points directive is an attempt to set position

 6 limits that is inconsistent with the language and

 7 the purpose of the Dodd-Frank Act. I believe that

 8 the proposed rule and the supplemental directive

 9 will create uncertainty regarding the regulatory

 10 standards for the Commission action and

 11 enforcement in a way that does not comply with the

 12 Administrative Procedures Act.

 13 The uncertainty that will result from

 14 the publication of both the Commission's proposed

 15 rule and a possible attempt to enforce position

 16 points proposal will stymie the ability of market

 17 participants and specifically large commercial

 18 interests to manage their hedging and investment

 19 strategies. Semantics and affirmations of intent

 20 will not lessen the real impact of what

 21 essentially amounts to an attempt to affect legal

 22 rights and obligations. The new position points
 20

 1 proposal operates as a Trojan Horse by attempting

 2 to articulate a requirement of general

 3 applicability without providing the opportunity

 4 for public notice and comment as required under

 5 the Administrative Procedures Act. If setting

 6 federal accountability levels is the preferred

 7 course of action then it should be embodied in the

 8 proposed rule subject to notice and comment under

 9 the APA. That has never been a option put before

 10 me and is not the in the rule today.

 11 With regard to the proposed rule for

 12 position limits, I appreciate the fact that

 13 comprehensive changes to this rule have been made

 14 including two important reforms. The first change

 15 has been the removal of the onerous crowding-out

 16 position and instead looking through the dealer

 17 and applying position limits to the actual

 18 customer. Any customer conducting bona fide

 19 hedging would not be limited by this position

 20 limit proposal. Second, the rule provides that no

 21 position limit will be set until the Commission

 22 has the data to monitor and enforce such limits
 21

 1 and only those can be effectuated through a future

 2 Commission order.

 3 This begs the question how can the

 4 Commission decide to impose position limits on

 5 swaps positions without having the facts or

 6 understanding the impact on the market? Without

 7 the actual data we have no idea as to the impact

 8 on liquidity or excessive speculation as a result

 9 of these limits. I hope that through a public

 10 comment period we will develop a better

 11 understanding of whether or not these proposed

 12 limits are appropriate or if they should be

 13 changed. Further, if the Commission is going to

 14 proceed with implementing limits, I hope that the

 15 supporters of position limits will provide

 16 relevant data and evidence to demonstrate that

 17 position limits will stifle the upward pressure on

 18 prices in the markets as they have stated in their

 19 previous comments. I'd like to thank the staff

 20 for their efforts. They've been through this

 21 wringer a couple of times and they've done a great

 22 job to respond to the Commission's concerns.
 22

 1 Mr. Chairman, you and I have spoken this

 2 morning about position limits. I don't object to

 3 staff collecting data. That's their job. They do

 4 it every day and they do it very well. I do

 5 expect that they will also inform the Commission

 6 as to the applicable hedge limits in their

 7 investigation of the positions at your direction.

 8 I do object to taking any action to enact these

 9 position limits proposals outside the appropriate

 10 rulemaking process however. I will ask a number

 11 of questions to the staff regarding the

 12 implementation of the position points proposal and

 13 will make my decision based on that. Thank you.

 14 CHAIRMAN GENSLER: Thank you so much,

 15 Commissioner O'Malia and all the Commissioners. I

 16 think consistent with our other public meetings,

 17 the staff is here to present proposals and of

 18 course with regard to this group it's the pending

 19 action. I think that taking up where we left off

 20 on December 16 there is currently a motion pending

 21 on the floor to accept the staff recommendations

 22 while the proposal remains the same. Staff has
 23

 1 taken the last month to make some technical

 2 changes to the proposal so that I first ask for

 3 unanimous consent to adopt the substitute proposal

 4 that contains those technical changes. Without

 5 objection so ordered.

 6 In terms of voting on this, I suspect

 7 there are going to be some additional questions so

 8 that I open it up first to Commissioner Dunn if

 9 there are additional questions.

 10 COMMISSIONER DUNN: This is in essence

 11 the same motion we had before us at the last

 12 meeting?

 13 MR. SHERROD: Yes, that's correct.

 14 COMMISSIONER DUNN: Thank you. With

 15 that, Mr. Chairman, I'd like to ask you a few

 16 questions if we could. Mr. Chairman, I'd like to

 17 further understand the direction you gave staff

 18 about surveillance at our last meeting. Is your

 19 direction to staff consistent with what staff

 20 currently does?

 21 CHAIRMAN GENSLER: Yes, it is

 22 consistent. For decades the Commission's
 24

 1 surveillance staff has briefed the Commission

 2 weekly on the positions of traders in futures

 3 markets that are of regulatory interest.

 4 Sometimes this regards large traders, price

 5 volatility, supply-and-demand imbalances, issues

 6 around delivery in the spot month or even around

 7 convergence matters. In that regard, staff

 8 currently monitors large traders in these markets.

 9 Specifically what I've asked staff to report

 10 monthly to the Commission is regarding staff

 11 surveillance activities related to traders with

 12 positions at or above the 10 and 2-1/2 level of

 13 futures open in the market on these 28

 14 agricultural, metal and energy markets for which

 15 we're proposing position limits.

 16 COMMISSIONER DUNN: Mr. Chairman, what

 17 are some of the typical activities that they

 18 engage in and what do they do if they have

 19 concerns?

 20 CHAIRMAN GENSLER: Staff currently

 21 receives information including Forms 40 from large

 22 traders and when traders' positions get large,
 25

 1 staff familiarizes themselves with the business

 2 purposes of the traders' use of derivative in the

 3 markets. This may involve reviewing public data,

 4 confidential market data or contacting traders

 5 directly. When staff has potential concerns, they

 6 may also issue special cause to obtain additional

 7 information about traders' cash and swap activity.

 8 Ultimately, if staff continue to have concerns,

 9 they can recommend appropriate action to the

 10 Commission for its consideration.

 11 COMMISSIONER DUNN: Mr. Chairman, does

 12 this direction given to staff in any implement

 13 position limits for the 28 markets covered by this

 14 proposed rule on position limits?

 15 CHAIRMAN GENSLER: No. Implementation

 16 of these position limits can only be done in a

 17 final rule.

 18 COMMISSIONER DUNN: Thank you, Mr.

 19 Chairman. I'd like to ask General Counsel

 20 Berkovitz a question. Is there anything in what

 21 I've done in directing staff to keep us informed

 22 in this monthly way, this information I've asked
 26

 1 for for all of us that is inconsistent with the

 2 Administrative Procedures Act or any other laws

 3 that you know of for the Commission?

 4 MR. BERKOVITZ: No, Mr. Chairman. As

 5 you have described the surveillance to be

 6 undertaken by staff and as staff as Rick described

 7 the surveillance that will be undertaken, the

 8 surveillance is consistent with current practice

 9 so that this surveillance is fully consistent with

 10 the Commodity Exchange Act and the Administrative

 11 Procedures Act.

 12 CHAIRMAN GENSLER: Thanks. Commissioner

 13 Sommers?

 14 COMMISSIONER SOMMERS: I don't have any

 15 questions with regard to this proposal.

 16 CHAIRMAN GENSLER: Thanks. Commissioner

 17 Chilton?

 18 COMMISSIONER CHILTON: I don't have any

 19 questions. Thank you. I thought the colloquy was

 20 helpful.

 21 CHAIRMAN GENSLER: Commissioner O'Malia?

 22 COMMISSIONER O'MALIA: Thank you. I
 27

 1 have a couple questions for General Counsel

 2 Berkovitz. The colloquy was helpful and did

 3 clarify many concerns I had. Let me ask does the

 4 directive from the Chairman to staff amount to a

 5 Commission policy or guidance and does the staff

 6 directive have any binding legal affect on

 7 registrants or market participants?

 8 MR. BERKOVITZ: Commissioner O'Malia,

 9 the directive is a directive to staff so that this

 10 does not establish Commission policy toward

 11 registrants or the exchanges. This is a manner in

 12 which Commission surveillance will be conducted

 13 internally.

 14 COMMISSIONER O'MALIA: Thank you. When

 15 might the Commission's statutory emergency

 16 authority give it authority to require a trader to

 17 hold or reduce its position below the proposed

 18 position points limit? Will the crossing of a

 19 position point in and of itself amount to an

 20 emergency?

 21 MR. BERKOVITZ: In order to invoke the

 22 emergency authority under Section 8(a)(9) of the
 28

 1 Commodity Exchange Act, the Commission must find

 2 reason to believe that an emergency exists and

 3 that when it finds reason to believe that an

 4 emergency exists the Commission may take such

 5 action as in the Commission's judgment as

 6 necessary to maintain or restore orderly trading

 7 and/or liquidation of a futures contract so that

 8 there are particular statutory criteria that must

 9 be met in order to invoke the emergency authority.

 10 Simply crossing a predetermined threshold or

 11 numerical level in and of itself, there would have

 12 to be additional findings. In and of itself it

 13 wouldn't be sufficient.

 14 COMMISSIONER O'MALIA: Thank you. With

 15 regard to privacy concerns, market surveillance

 16 generally deals with confidential data. With the

 17 position point system the public is put on notice

 18 that at least once a month a list of names and

 19 positions will be presented to the Commission and

 20 Commissioners will likely engage in some

 21 discussion regarding whether or not any action is

 22 necessary. What protections will be in place to
 29

 1 ensure that Section 8 is complied with?

 2 MR. BERKOVITZ: The Commission's normal

 3 practice in its surveillance is obviously fully

 4 consistent with Section 8 and the Commission does

 5 not release any matters that are discussed in the

 6 surveillance meetings. These meets are closed to

 7 the public and the information is protected to

 8 that the protections that have been effective in

 9 our surveillance meetings will be continued to be

 10 applied and the information discussed in those

 11 meetings would be protected from public

 12 disclosure.

 13 COMMISSIONER O'MALIA: Can you remind me

 14 of what the penalties are for violating Section

 15 8(r)?

 16 MR. BERKOVITZ: I would have to look up

 17 exactly the penalties so I can get that to you.

 18 COMMISSIONER O'MALIA: Fair enough.

 19 From a resource standpoint, is the Commission

 20 currently in the position to collect and analyze

 21 the visibility position and related reporting

 22 requirements? Maybe I'll ask that to Rick,
 30

 1 please.

 2 MR. SHILTS: Yes, because as the

 3 Chairman said in the colloquy, we do currently

 4 gather information about reportable traders who

 5 would file a Form 40. We're in regular contact

 6 with them to have a better understanding of their

 7 activity in the markets and as their positions get

 8 large we would have further discussion and

 9 dialogue with them. And our ISS, our surveillance

 10 systems, do get information on traders' reportable

 11 positions so that we do have that information on a

 12 regular basis so it's just a matter of assembling

 13 it in a way that's presentable to the Commission

 14 to provide that information to them about those

 15 traders who have positions above these specific

 16 levels.

 17 COMMISSIONER O'MALIA: When you refer to

 18 ISS technology, you're only referring to the data

 19 on either the futures market data or related SPDC

 20 data?

 21 MR. SHILTS: Yes, futures and options

 22 and then the SPDC and then foreign boards of trade
 31

 1 that have linked contracts.

 2 COMMISSIONER O'MALIA: But by and large

 3 the swap data is not included in that?

 4 MR. SHILTS: It's not included.

 5 COMMISSIONER O'MALIA: And we would only

 6 be working off of the futures- and options-related

 7 data?

 8 MR. SHILTS: That's correct.

 9 COMMISSIONER O'MALIA: In understanding,

 10 would legitimate hedge exemptions apply? Is that

 11 incorporated in the ISS and TSS database? Is that

 12 electronic or is that a manual effort that we're

 13 going to have to bring hedge exemptions and

 14 positions together manually or is that automated?

 15 MR. SHERROD: As you know, there are

 16 only nine commodities subject to federal limits

 17 currently and our process for exemptions involves

 18 three types of activities. One is the filing of a

 19 form, it's the 04 Series form that provides us

 20 with the bona fides of commercial traders. Two

 21 other types of exemptions are granted by

 22 Commission staff. And all of those exemptions and
 32

 1 those two other types are of course for

 2 anticipatory hedges and for the risk- management

 3 exemptions under Regulation 1.47 that are

 4 considered bona fide under the existing

 5 regulations. All of those are automated and

 6 they're in our Integrated Surveillance System, the

 7 ISS system, so as we receive daily reports from

 8 the FCMs on large trader positions, our systems

 9 pick up that data and we can compare it on a

 10 regular basis so that automated system of

 11 exemptions.

 12 COMMISSIONER O'MALIA: Thank you. If we

 13 only have nine contracts with applicable position

 14 limits and therefore hedge exemptions, what

 15 standard for bona fide hedging will we apply to

 16 the other contracts that we'll be looking at in

 17 this new surveillance?

 18 MR. SHERROD: We would continue our

 19 current surveillance practice of monitoring

 20 traders that are very large in the markets and it

 21 wouldn't change our current practice. Because the

 22 traders aren't subject to federal limits and in
 33

 1 many cases there are not applicable exchange

 2 limits, there would be no hedge exemption

 3 provision. They would simply continue to trade as

 4 they currently trade.

 5 COMMISSIONER O'MALIA: How will you

 6 inform the Commission in your monthly surveillance

 7 of the relationship with commercial hedging and

 8 these position points?

 9 MR. SHILTS: As we had said before, we

 10 do gather information from these traders on a

 11 regular basis to have an understanding of the

 12 nature of their positions but we wouldn't

 13 necessarily be conducting an analysis looking

 14 behind each position as to whether it would

 15 qualify as a hedge exemption under the proposed

 16 rules. We would have some idea of the commercial

 17 nature of the position or whether it's

 18 speculative, but not necessarily making a

 19 determination about whether they get a hedge

 20 exemption although having an understanding of the

 21 nature of the trading activity might suggest that

 22 they would qualify for one if limits were in
 34

 1 place.

 2 COMMISSIONER O'MALIA: Thank you. It

 3 does occur to me that obviously if we're going to

 4 be looking at applying a 10/2-1/2 standard in this

 5 proposed rule then we ought to be cognizant of the

 6 relationship to their hedging positions.

 7 CHAIRMAN GENSLER: I would say I think

 8 we're going to benefit over the course of these

 9 months as a rule is outstanding because we'll be

 10 informed and we'll be able to see. Some contracts

 11 as you know have federal limits and some don't,

 12 but for the ones that don't, currently we'll be

 13 better informed as we hopefully address ourselves

 14 to a final rule. Later all five of us will be so

 15 much better informed by this monthly briefing of

 16 the staff.

 17 COMMISSIONER O'MALIA: I hope we are

 18 better informed. I certainly hope the market is

 19 better informed about our intentions and we need

 20 to be honest and clear about how we're going to be

 21 reacting and treating those market participants

 22 going forward and understanding in the interim
 35

 1 period whether we have position limits or not how

 2 this will affect them. I guess I'm satisfied that

 3 based on General Counsel Berkovitz' responses that

 4 the position points proposal is not enforceable

 5 and certainly the colloquy with Commissioner Dunn

 6 is satisfying as well and I appreciate you going

 7 through that.

 8 I'm willing to put out the position

 9 limits proposal for comment as I did in previous

 10 rulemaking meetings but I'm very concerned about

 11 how we treat this going forward and will watch

 12 this very closely. I would like to say that I

 13 have concerns about understanding whether these

 14 are the right limits and how they're going to

 15 affect it because we absolutely do not have the

 16 data on the swaps market and understanding how

 17 that integrates and as we are now picking a limit

 18 and asking the market to comment on it, we don't

 19 have the data to understand how that relates to

 20 excessive speculation or position limits and

 21 liquidity. So I'm willing to put it out to get

 22 the comment but I'm very skeptical of it.
 36

 1 CHAIRMAN GENSLER: I appreciate that,

 2 Commissioner O'Malia and I think that's part of

 3 why like all proposals, it's a proposal with a

 4 60-day public comment period I believe that will

 5 add to the many comments that we had in an earlier

 6 proposal of course, 8,000 I think in that

 7 circumstance. This will take some time to

 8 analyze. In fact, as you noted the proposal

 9 includes that any numbers would only be ultimately

 10 by Commission order based on data. I know that

 11 Commissioner Sommers has some further questions.

 12 COMMISSIONER SOMMERS: I wanted to

 13 clarify something in a question that Commissioner

 14 O'Malia just asked with regard to what we do in

 15 the normal course of business in monitoring

 16 positions. When we're asking for additional

 17 information with regard to a market participant's

 18 position, do we usually ask for their OTC

 19 positions and cash positions?

 20 MR. SHERROD: I don't know that I would

 21 characterize it as usual. Usually is a hard

 22 concept because some of these markets are very
 37

 1 different, ranging from wheat to corn to crude oil

 2 to gold to silver. What we do is try to make

 3 ourselves aware of the full range of their

 4 business activities so that if they are engaged in

 5 a very large position in futures contracts, we

 6 will want to know whether they are active in the

 7 market for the physical commodity, whether that's

 8 on the purchase side or the forward sell side. We

 9 will want to know what their inventories are and

 10 will want to know what their over-the- counter

 11 derivative positions are. Sometimes the

 12 discussions will be qualitative and not

 13 quantitative. If we have heightened concerns we

 14 may ask for quantitative information verbally, and

 15 if we have particularly heightened concerns and

 16 often times that's focused around the delivery

 17 period in the futures contract, we may actually

 18 issue a special call to get a written response to

 19 our concerns and that additional information helps

 20 us formulate an opinion on the trader's activities

 21 and then apprise you as a Commissioner.

 22 COMMISSIONER SOMMERS: Those special
 38

 1 calls for that additional data can be done with

 2 staff authority or that has to be done with

 3 Commission authority?

 4 MR. SHERROD: They can be done either

 5 way. The Commission has the authority and the

 6 Commission has delegated to staff the authority to

 7 issue special calls.

 8 COMMISSIONER SOMMERS: Thank you.

 9 CHAIRMAN GENSLER: Thank you. I will

 10 have a statement for the record but I do support

 11 publishing the proposed rule on position limits.

 12 I'm going to summarize one thought as I think some

 13 other Commissioners said. The Commodity Futures

 14 Trading Commission does not set or regulate

 15 prices. Rather, the Commission is directed to

 16 ensure that commodity markets are fair and orderly

 17 to protect the American public. That's the core

 18 and of course there is much that goes into that

 19 including transparency initiatives and

 20 anti-manipulation and antifraud. But one piece of

 21 it since the 1930s has been this authority to set

 22 position limits and in the past the agency has
 39

 1 sought to ensure this through a concept that there

 2 is a broad group of market participants or a

 3 diversity of views within the market. That's been

 4 at the core of promoting integrity in the

 5 marketplace and it's at the core of why I'm

 6 supporting proposing this. We in fact in the

 7 1980s and 1990s had position limits on many of

 8 these markets. We still have position limits in

 9 the spot market and I believe on most of these 28

 10 markets, there are one or two maybe that we don't.

 11 I'm not entirely sure why. But with regard to the

 12 all months combined, this is a proposal to in

 13 essence reinstate some position limits in the

 14 energy and the metals markets and I'm looking

 15 forward to the public comments on it, but I'll be

 16 supporting the proposal moving forward and am very

 17 interested in public comments. If there are no

 18 further questions, I think Mr. Stawik you get to

 19 do what we almost did on December 16.

 20 MR. STAWIK: Commissioner O'Malia?

 21 COMMISSIONER O'MALIA: Aye.

 22 MR. STAWIK: Commissioner O'Malia, aye.
 40

 1 Commissioner Chilton? Commissioner Chilton?

 2 COMMISSIONER CHILTON: Aye.

 3 MR. STAWIK: Commissioner Chilton, aye.

 4 Commissioner Sommers?

 5 COMMISSIONER SOMMERS: No.

 6 MR. STAWIK: Commissioner Sommers, no.

 7 Commissioner Dunn?

 8 COMMISSIONER DUNN: Aye.

 9 MR. STAWIK: Commissioner Dunn, aye.

 10 Mr. Chairman?

 11 CHAIRMAN GENSLER: Aye.

 12 MR. STAWIK: Mr. Chairman, on this

 13 question the ayes are four, the nays are one.

 14 CHAIRMAN GENSLER: With that I want to

 15 thank the position limit team for their return.

 16 We'll be looking forward to seeing you I know in

 17 the future not only on this rule but also on the

 18 large trader reporting rule that we still have out

 19 for comment and we'll be sending this to the

 20 Federal Register based on that vote.

 21 If Ananda and Sarah and the business

 22 conduct team want to come up, that would be great.
 41

 1 Today's presenters, it feels like, Sarah, you're

 2 back here every so often, but Sarah Josephson and

 3 Ananda Radhakrishnan both from the Division of

 4 Clearing and Intermediary Oversight. They will

 5 present the staff recommendation on proposed rules

 6 related to documentation requirements for swap

 7 dealers and major swap participants. We usually

 8 call you the business conduct standards, but this

 9 one specifically is documentation, so thank you,

 10 Sarah and Ananda, and why don't I turn it over to

 11 you?

 12 MS. JOSEPHSON: Good morning. Today

 13 staff is recommending for the Commission's

 14 consideration a Notice of Proposed Rulemaking with

 15 regard to internal business conduct standards for

 16 swap dealers and major swap participants. The two

 17 proposed rules would be promulgated under new

 18 Section 4(s)(I) of the CEA. This section requires

 19 swap dealers and major swap participants to

 20 conform with standards prescribed by the

 21 Commission that relate to the timely and accurate

 22 confirmation processing, netting, documentation
 42

 1 and valuation of all swaps.

 2 At the last open meeting on December 16,

 3 the Commission considered proposed rules regarding

 4 confirmation, portfolio reconciliation and

 5 portfolio compression under Section 4(s)(I).

 6 Today staff is recommending two rules pertaining

 7 to swap documentation under the same statutory

 8 provision.

 9 Documentation of swaps is a critical

 10 component of the bilaterally traded

 11 over-the-counter derivatives market and has been

 12 the focus of significant domestic and

 13 international attention in recent years. The

 14 proposed regulations would require each swap

 15 dealer and major swap participant to establish

 16 policies and procedures designed to ensure that

 17 prior to or contemporaneously with entering into a

 18 swap, both counterparties agree in writing to all

 19 terms governing their swap trading relationship

 20 including among other things terms addressing

 21 payment obligations, events of default rights and

 22 governing law. The swap trading documentation
 43

 1 would also include credit support arrangements

 2 including initial margin and variation margin

 3 requirements and custodial arrangements. The

 4 specific rules on those provisions have been

 5 considered for custodial arrangements already by

 6 the Commission and for margins in future

 7 rulemaking.

 8 The documentation would also include an

 9 agreement on the methodology by which

 10 counterparties will value each swap in their

 11 portfolio at any time from execution until

 12 termination of the swap. The agreed-upon

 13 methodology would be required to be complete and

 14 independently verifiable and will include

 15 alternative methods for determining the value of

 16 the swap in the event that one or more inputs to

 17 that methodology are unavailable such as times

 18 during times of market stress is illiquidity. The

 19 regulation would also require swap dealers and

 20 major swap participants to notify the Commission

 21 of any valuation disputes that have not been

 22 resolved within set time periods. This provision
 44

 1 corresponds to the portfolio reconciliation rule

 2 that the Commission proposed at its last meeting

 3 and portfolio reconciliation serves to identify

 4 valuation disputes. This would require reporting

 5 to the Commission.

 6 For those swaps that are cleared by a

 7 DCO, a swap dealer or major swap participant would

 8 be required to create a record indicating that in

 9 accordance with the rules of the DCO, the original

 10 swap is extinguished and is replaced by equal and

 11 opposite swaps between the clearing members and

 12 the DCO. The regulations would require that all

 13 terms of the cleared swap conform to templates

 14 established under the DCO's rules. This provision

 15 mirrors a similar provision that the Commission

 16 agreed to in the DCO risk-management rules

 17 considered on December 16. Finally, proposed Rule

 18 23504 would require an annual audit for the swap

 19 trading relationship documentation to ensure

 20 compliance with Commission rules and internal swap

 21 dealer, major swap participant policies and

 22 procedures.
 45

 1 Turning to Proposed Rule 23505, this

 2 provision would require swap dealers and major

 3 swap participants to obtain documentation from any

 4 counterparty seeking to exercise its rights under

 5 the end-user exception from the mandatory clearing

 6 requirement under Section 2(h)(7) of the CEA. For

 7 swaps subject to a mandatory clearing requirement,

 8 the proposed regulation would require that swap

 9 dealers and major swap participants comply with

 10 any mandatory clearing requirement by obtaining

 11 documentation sufficient to provide the dealer or

 12 the major swap participant with a reasonable basis

 13 to believe that its counterparty meets the

 14 statutory conditions required for claiming the

 15 exception to the mandatory clearing requirement.

 16 This provision is important because it will fall

 17 to the swap dealers or the major swap participant

 18 to report the end-user clearing exception claim to

 19 a swap data repository, and absent the end-users

 20 proper invocation of the exception for mandatory

 21 clearing the swap dealer or major swap participant

 22 would be required to otherwise comply with any
 46

 1 clearing mandate that the Commission were to issue

 2 going forward. I'd welcome any questions at this

 3 point on the two proposed rules.

 4 CHAIRMAN GENSLER: Thank you, Sarah.

 5 I'd entertain a motion to accept the staff

 6 recommendation on the documentation rule.

 7 COMMISSIONER DUNN: So moved.

 8 COMMISSIONER SOMMERS: Second.

 9 CHAIRMAN GENSLER: In addition, before

 10 taking questions there is an issue concerning

 11 Title 2 of Dodd- Frank and the Federal Deposit

 12 Insurance Act that the Commission will consider at

 13 a future meeting, and to that end I ask unanimous

 14 consent to revise this proposal consistent with

 15 the Commission's intention to take up these

 16 matters at a separate meeting. Not hearing any

 17 objection, you're advised to make sure it's

 18 consistent with that, Sarah.

 19 I have support for this proposed

 20 rulemaking. I think it establishes very important

 21 swap trading relationship documentation

 22 requirements. For many people or the public who
 47

 1 have read any of the books, there are so many of

 2 them on the 2008 crisis, you may recall that part

 3 of the crisis became so evident in 2007 and 2008

 4 when these derivatives contracts that a large

 5 insurance company, AIG, entered into, there were

 6 valuation disputes. There were great disputes on

 7 what was the value of these contracts in a rapidly

 8 changing market environment. I think the rule

 9 that we propose today subject to public comment

 10 directly addresses some of these issues. It

 11 mandates that parties like AIG in the future,

 12 hopefully there is never an AIG that brings

 13 taxpayers to the heels as that did, but that they

 14 have to have documentation and have to have ways

 15 to value their contracts and where they have

 16 disputes with others they have to be elevated to

 17 senior management and elevated to the regulators,

 18 but I want you to confirm that that's what this

 19 does.

 20 MS. JOSEPHSON: Yes. That is correct.

 21 It requires that the two counterparties agree

 22 ahead of time on, "The methods, procedures, rules
 48

 1 and inputs for valuing the swap," so that they

 2 have to agree ahead of time on the valuation

 3 methodology and if there is a failure of an input

 4 to that methodology they have to agree on

 5 alternatives so that they can value the swap going

 6 forward. And then under rules that were

 7 previously proposed, the duties rules for swap

 8 dealers and major swap participants, they would

 9 have to alert their senior management to valuation

 10 disputes, failures to understand, current exposure

 11 and potential future exposure that are usually

 12 based on disputes regarding valuation. So it

 13 works together with that rule and the portfolio

 14 reconciliation rule which is a process by which

 15 counterparties can identify valuation disputes and

 16 then work to resolve them and the burden is on

 17 those counterparties to identify them, resolve

 18 them and report them to the Commission and the

 19 prudential authorities if those swap dealers and

 20 major swap participants are --

 21 CHAIRMAN GENSLER: So Sarah, this is for

 22 those swaps that may stay bilateral. Correct?
 49

 1 MS. JOSEPHSON: Yes.

 2 CHAIRMAN GENSLER: They don't have the

 3 benefit of central clearing, they're customized

 4 swaps, but if an AIG circumstance happened again,

 5 number one, they have to have an agreement on the

 6 methodology to value the swap. Is that correct?

 7 MS. JOSEPHSON: Yes. That is correct.

 8 CHAIRMAN GENSLER: And two, if they

 9 can't agree during the 10 years that a swap is

 10 outstanding, then they have to highlight it to

 11 senior management under a separate proposal.

 12 Correct?

 13 MS. JOSEPHSON: Correct.

 14 CHAIRMAN GENSLER: And they also have to

 15 share it with the regulator.

 16 MS. JOSEPHSON: Exactly. And I will

 17 just refresh everyone's recollection on the

 18 portfolio reconciliation rule for swap dealer and

 19 major swap participant trades with each other, the

 20 proposal is and we'll get comment back on this is

 21 to resolve that dispute within one business day

 22 and for disputes that arise between swap dealers,
 50

 1 registrants of ours and end users, they're to

 2 resolve those in a timely fashion.

 3 CHAIRMAN GENSLER: Sure, but the swap

 4 dealer to swap dealer disputes were at the heart

 5 of the narrative, that from 2007 and 2008 the big

 6 disputes were between these big swap dealers.

 7 They went unresolved and sometimes unreported to

 8 senior management.

 9 MS. JOSEPHSON: Exactly. And those

 10 losses can be allowed to accumulate and that could

 11 give rise eventually to systemic risk and so the

 12 failure to value that. And your contrast with

 13 clearinghouses is important because with

 14 clearinghouses you arrive at a settlement price

 15 every day, positions are mark to market and they

 16 collateralize the potential future exposure using

 17 initial margin.

 18 CHAIRMAN GENSLER: I thank you. I just

 19 wanted to highlight that to me that's an important

 20 piece and it relates directly to the crisis that

 21 we unfortunately lived through. Commissioner

 22 Dunn?
 51

 1 COMMISSIONER DUNN: Thank you, Mr.

 2 Chairman, and I think you did point out one of the

 3 most salient issues here and I appreciate the hard

 4 work that the staff did with this. This was

 5 difficult because this isn't all within our

 6 bailiwick. It will a great deal of reaching out

 7 to other regulators and other entities. Sarah,

 8 could you describe what you did in that process

 9 and how many people were involved in coming up

 10 with this final proposed rule?

 11 MS. JOSEPHSON: As I've mentioned in

 12 previous presentations to the Commission, we

 13 worked very closely with other U.S. authorities

 14 including the Federal Reserve Bank of New York,

 15 the Board of Governors, the FDIC, the OCC and the

 16 SEC to craft these rules. Indeed, much of the

 17 documentation work and the standardization process

 18 that has been described in the preamble quite

 19 extensively stems from the work that the

 20 supervisors of what's called the Group of Fourteen

 21 Dealers has been working on since 2005 when they

 22 identified the back office concerns including
 52

 1 crucially documentation, and this is in the prior

 2 proposal that the Commission considered on

 3 confirmations, the number one trigger was the

 4 failure to confirm individual swap trades. So

 5 when crises arise with Bear Stearns and with

 6 Lehman, they went in and the back office was

 7 perhaps in some degree of disarray and that led to

 8 problems with the winding down or the transfer of

 9 those positions to solvent or potentially solve to

 10 new parties. So we've been working very closely

 11 with U.S. authorities and with market participants

 12 who have been part of that process to address very

 13 real and recognized concerns in the industry.

 14 COMMISSIONER DUNN: Sarah, I think that

 15 staff also took a great deal of concern to ensure

 16 that there wasn't an excessive burden on this

 17 reporting and I think the industry appreciates

 18 that. I'm worried about the excessive burden then

 19 our staff will have in bringing us all together

 20 and being responsible for having this overall

 21 view. Are we ready, capable and able to do that?

 22 MR. RADHAKRISHNAN: We are ready and we
 53

 1 are capable. I can't answer your last question

 2 because as you pointed out, we've been charged

 3 with executing tremendous responsibilities, the

 4 whole agency, and as a taxpayer I'm sorry to be on

 5 this high horse, but I'm just appalled that our

 6 elected representatives would give us this

 7 responsibility and not give us the money. I don't

 8 know how to explain it. So coming down from my

 9 high horse I'll answer your question. I think

 10 what we will do is we will have a discussion with

 11 the National Futures Association because one of

 12 the proposed rules is for all registrants to

 13 register with the National Futures Association and

 14 then make a determination as to who will have

 15 primary responsibility for examining swap dealers

 16 and MSPs.

 17 I know that the continuing resolution is

 18 supposed to end sometime in March and it remains

 19 to be seen rather we will be funded at 2010 levels

 20 or whether we'll get more money. If we don't get

 21 extra money, and so far I personally have no

 22 reason to believe we are going to get more money,
 54

 1 then I think the National Futures Association will

 2 have to bear the brunt of examination. It's no

 3 secret to them because I've already alerted them

 4 to the possibility. Having said that, it would be

 5 unfortunate if Commission staff did not go along

 6 with them purely to understand the operations of

 7 these new categories of registrants that we have.

 8 The worse situation would be if you have 200 to

 9 300 new registrants and Commission staff has no

 10 view and no understanding of the application or

 11 the execution of Commission regulations. So what

 12 I'm saying is I'm prepared for the worst. The NFA

 13 has the ability to assess fees which we don't and

 14 they are going to ramp up and we'll probably go to

 15 the largest swap dealers first and examine them.

 16 I want to make sure that staff has an

 17 understanding of what it is we do. And at the

 18 same time we will be collaborating, the NFA and

 19 CFTC staff, on designing the examination program

 20 because the examination program of necessity has

 21 to be based on the final regulation that the

 22 Commission promulgates.
 55

 1 COMMISSIONER DUNN: Ananda, thank you

 2 for your unabashed and unvarnished answer.

 3 CHAIRMAN GENSLER: Thank you.

 4 Commissioner Chilton. Commissioner Sommers? I'm

 5 sorry. Commissioner Dunn.

 6 COMMISSIONER SOMMERS: Thank you, Mr.

 7 Chairman. I have a couple of different questions

 8 to clarify from the proposal. There is a piece in

 9 the proposal that talks about swaps that will be

 10 cleared and those contractual agreements having to

 11 be conformed to meet the DCO's rules. I was

 12 wondering if you could talk through an example of

 13 that for us to give us an example of what terms of

 14 a documentation would have to be changed or

 15 conformed to meet a DCO's rules.

 16 MS. JOSEPHSON: Yes. This process

 17 actually happens right now and it just clarifies

 18 that the bilateral swap is extinguished so that

 19 this is for swaps that are not executed on a DCM

 20 or futures contracts executed on a DCM. The

 21 original swap is extinguished between the two

 22 bilateral counterparties and the clearinghouse
 56

 1 novates the contract so that there are two equal

 2 and opposite swaps with the counterparties and

 3 this is the quintessential clearinghouses become

 4 the seller to every buyer and the buyer to every

 5 seller if I got that right. So they're replaced

 6 by equal and opposite swaps and this creates a

 7 level of standardization. The example when they

 8 moved CDS into clearing, one of the prerequisites,

 9 and this discussed in the preamble, is that they

 10 had to standardize the products, this was the big

 11 bang and the small bang that the industry engaged

 12 in, and that facilities fungibility within the

 13 clearinghouse so that these swaps in the event of

 14 a default can be terminated quickly or transferred

 15 to a liquid or solvent FCM or swap dealer

 16 depending on how that default situation would be

 17 handled by the clearinghouse. It makes very clear

 18 that the clearinghouse documentation is what

 19 prevails over the bilaterally negotiated contracts

 20 between the two counterparties.

 21 MR. RADHAKRISHNAN: Also, Commissioner

 22 Sommers, this will ensure that once clearing takes
 57

 1 place that the terms of the contract are the same

 2 throughout the chain meaning that the contract

 3 between the clearing member and the clearinghouse

 4 is exactly the same as the contract between the

 5 client and the clearinghouse. Staff believes that

 6 this is essential to make that client clearing

 7 actually has a chance at success because what

 8 would be unfortunate is if in actuality the terms

 9 of the contract between the client and its

 10 intermediary are different from the terms of the

 11 contract between the intermediary and the

 12 clearinghouse. As you know, that does not happen

 13 in the futures space right now.

 14 COMMISSIONER SOMMERS: Thank you. My

 15 other question is with regard to standardized

 16 documentation that exists today and whether or not

 17 this proposal would impose substantive changes to

 18 that kind of documentation that exists today and

 19 what we do with existing agreements.

 20 MS. JOSEPHSON: We've been very careful

 21 in crafting the proposal and the preamble mentions

 22 all the work that has been done by the industry,
 58

 1 particularly with regard to standardizing the

 2 master agreements and the master confirmation

 3 agreements so that the relationship documentation

 4 between two counterparties that allows them to

 5 execute individual transactions and then the

 6 documentation upon which those transactions are

 7 based, to master confirmation agreements, the

 8 protocols that have been put in place for credit

 9 default swaps, they're working on proposals right

 10 now for equity derivatives to standardize terms.

 11 There is a tremendous amount of work being done

 12 and most of that is being done in conjunction with

 13 as I mentioned the OTC Derivatives Supervisors

 14 Group, a group that has been in place since 2005.

 15 We've tried to be consistent with that to the

 16 extent that that documentation meets the

 17 requirements and again we laid out broad

 18 parameters for what our expectation is for those

 19 documents but we didn't prescribe the actual

 20 documentation so that they continue to use those.

 21 There may need to be additional amendments to

 22 reflect the overall reform and certain provisions
 59

 1 that we view as this is particularly the case with

 2 the collateralization elements that they have

 3 master agreements, credit support arrangements

 4 with ISDA what's called the Credit Support Annex

 5 and those may have to be modified by amendment,

 6 but for the most part we think that the

 7 documentation will work together so that those two

 8 processes are on parallel tracks with the goal

 9 being as consistent as possible and those would be

 10 applicable on a global basis.

 11 COMMISSIONER SOMMERS: To clarify again,

 12 they may need to be modified going forward in the

 13 future or they may need to be modified looking

 14 backwards?

 15 MS. JOSEPHSON: There are two things.

 16 An existing master agreement between two

 17 counterparties is usually in place for a number of

 18 years. You execute one of those and they stay in

 19 place for a number of years. Amendments to those

 20 for swaps executed under it going forward would

 21 have to be done for -- and this is where in the

 22 proposal you'll see we ask a question about
 60

 1 dormant trading relationships so that if you have

 2 documentation in place but you're not executing

 3 swaps under it, you don't have open positions

 4 under it or they're going to expire in a very

 5 short term, then it wouldn't have to apply to

 6 that. But for the transactions that you execute

 7 going forwards, swaps that are subject to CFTC

 8 jurisdiction, then the provisions we anticipate

 9 would apply but that's where we've solicited

 10 comment from the industry and we are very hopeful

 11 that we will get good comments on the application

 12 of these rules to current practices.

 13 COMMISSIONER SOMMERS: Thank you.

 14 CHAIRMAN GENSLER: Thank you,

 15 Commissioner Sommers. Now Commissioner Chilton.

 16 COMMISSIONER CHILTON: I have no

 17 questions. I thank the staff and I support the

 18 rule. They've done good work. Thank you.

 19 CHAIRMAN GENSLER: Thank you,

 20 Commissioner Chilton. Commissioner O'Malia?

 21 COMMISSIONER O'MALIA: Thank you. We

 22 had a proposed rule language before us yesterday
 61

 1 that was provided by the FDIC to the Commission in

 2 the eleventh hour that was an attempt to give two

 3 regulators, the CFTC and the FDIC, the ability to

 4 take control for 24 hours the uncleared swap

 5 positions of all swap dealers and major swap

 6 participants when there was a defaulting

 7 counterparty. Mr. Chairman, I appreciate your

 8 willingness to remove that language from the

 9 proposal so we could vote this morning on our

 10 documentation rule and give us more time to

 11 understand the ramifications of that proposal. I

 12 appreciate that very much so that that is part of

 13 the reason we have changed this proposal.

 14 I have one question. The proposal

 15 discusses providing alternative methods of

 16 valuation. What do you think that might include?

 17 MS. JOSEPHSON: Alternative methods

 18 particularly with regard to inputs, you have to

 19 agree, for instance if there's an illiquidity in a

 20 particular asset class or a reference that you

 21 need to use to value a particular type of swap,

 22 that you would agree ahead of time if we're not
 62

 1 going to rely on for instance an interest rate

 2 curve that's this one, we'll rely on this interest

 3 rate curve instead. It's to address the issue of

 4 parties saying the mortgage- backed securities

 5 market or municipal bond market, there has been

 6 some sort of illiquidity, we no longer have that

 7 data point so we just can't value the swap on our

 8 books. Instead we're asking them ahead to think

 9 through those possible scenarios especially if

 10 you're doing a structure, very unique, customized

 11 product and agree ahead of time between each other

 12 in a private contractual relationship on how you

 13 will substitute a methodology and input a rule to

 14 arrive at a value again with the fundamental point

 15 of in order to understand what your current

 16 exposure is to your counterparty, this is again

 17 bilateral uncleared or the potential -- if you had

 18 to replace that contract if your counterparty were

 19 to default to you, you need to know that risk and

 20 the fundamental building block in understand the

 21 risk is knowing what the value of that contract is

 22 in a current mark to market way.
 63

 1 COMMISSIONER O'MALIA: What is our

 2 responsibility in overseeing these valuations?

 3 MS. JOSEPHSON: In the provision it says

 4 that, "These rules shall be stated with

 5 specificity necessary to allow the counterparties

 6 themselves, the Commission and any applicable

 7 prudential regulator to determine independently in

 8 a substantially comparable manner." How this

 9 would play out I think is if we see through the

 10 reporting of these valuation disputes, and

 11 generally what happens in a valuation dispute

 12 situation is there is uncollateralized exposure.

 13 That means that the parties have not exchanged

 14 collateral based on potential risk so that we

 15 would be notified of that. We could go to the

 16 industry because there would have to be a

 17 significant amount of accumulated risk in the

 18 system and we could say let's look at your

 19 documentation. How can we solve this? What isn't

 20 working in your dispute resolution processes that

 21 is allowing this uncollateralized exposure to

 22 buildup?
 64

 1 COMMISSIONER O'MALIA: Will we use a

 2 different process in terms of a crisis? Looking

 3 at these things on a bright, sunny day and the

 4 markets are functioning very well is a completely

 5 different matter than when we're in a crisis like

 6 we experienced with AIG and Lehman.

 7 MS. JOSEPHSON: The hope is that these

 8 types of provisions in the first instance

 9 facilitate counterparties resolving this between

 10 themselves before it even comes to the attention

 11 of the regulators so that if they resolve the

 12 disputes under the portfolio reconciliation

 13 proposal in a timely fashion then there is no

 14 uncollateralized exposure. It will allow us ahead

 15 of time hopefully identify exposure in the system

 16 and work with the industry to get that sorted out,

 17 and should it be allowed to continue or for there

 18 to be a failure to recognize that in time to stop

 19 it from becoming a true crisis like we saw in

 20 2008, these processes and the documentation that

 21 will be executed between the counterparties will

 22 allow for an orderly wind-down. That's the hope
 65

 1 and that was the provision that you mentioned

 2 under Title 2 in the Federal Deposit Insurance

 3 Act, to allow that sort of concept of an orderly

 4 wind-down transfer of positions to avoid market

 5 disruption so that they work together in that way

 6 hopefully.

 7 COMMISSIONER O'MALIA: Assuming Enron

 8 was a dealer, would we have stepped in with this

 9 new authority and resolved it when it went into

 10 bankruptcy?

 11 MR. RADHAKRISHNAN: Are you saying the

 12 issue of Enron was they did a lot of swaps and

 13 there were improper valuations?

 14 COMMISSIONER O'MALIA: When it failed

 15 there were a number of counterparties that were

 16 impacted by that.

 17 MR. RADHAKRISHNAN: I'm not familiar

 18 with the facts of the case. I thought the Enron

 19 problem was because there was massive fraud

 20 outside of the trading engine.

 21 COMMISSIONER O'MALIA: When they

 22 ultimately failed, under this new authority would
 66

 1 we have stepped in and had the responsibility in

 2 that bilateral space to resolve those

 3 transactions?

 4 MR. RADHAKRISHNAN: I would say yes if

 5 this rule is finalized. I don't see how we cannot

 6 step in because its our registrant.

 7 CHAIRMAN GENSLER: As I understand the

 8 hypothetical, if it's a swap dealer whether it's

 9 Enron or if it's a swap dealer that we regulate,

 10 would we have the authority? I'm changing the

 11 question a little bit. Would we have the

 12 authority to do things? As I understand it, this

 13 rule is a little narrower than that. This rule

 14 just makes sure that if there are these big

 15 valuation disputes, they have to tell us about it,

 16 but this rule specifically doesn't necessarily

 17 give us the stick. There may be other rules that

 18 do, but this rule doesn't.

 19 COMMISSIONER O'MALIA: Going back to

 20 what was originally in this document and what I'm

 21 trying to understand, is that in Title 2?

 22 MS. JOSEPHSON: I can try to clarify
 67

 1 that. The idea behind that provision which will

 2 be considered in potentially a future discussion

 3 is that there would be in the documentation of the

 4 swap dealer and the major swap participant a

 5 one-day delay in their ability to terminate under

 6 that contract to allow if a U.S. authority under

 7 Title 2 or the FDIA had made the affirmation

 8 decision to enter into that scenario to wind down

 9 the entity in an orderly way. So that it is an

 10 affirmative decision by U.S. Financial regulatory

 11 authorities to step into a situation where there

 12 is a crisis that is clearly of a scope that would

 13 be a systemic shock to the overall markets. And

 14 the participation under that process, this is why

 15 we have a little more time to work through the

 16 provisions under Title 2 which is a new section of

 17 Dodd-Frank obviously and then the similar

 18 provisions under the FDIA.

 19 COMMISSIONER O'MALIA: Let me go to one

 20 last question. In resolving some of these

 21 disputes, do we have the authority to make

 22 decisions about the quality of collateral?
 68

 1 MS. JOSEPHSON: Under these rules that's

 2 not something that we are weighing in on. What we

 3 say is the types of assets that may be used as

 4 margin and the asset valuation haircuts so that

 5 the parties have to agree on the types of assets

 6 between each other that can be used to margin the

 7 swaps and then the haircuts imposed which usually

 8 goes to an assessment of the quality of the

 9 collateral but that is in the first instance an

 10 agreement between them on that which will be

 11 guided by rules to be proposed in the future by

 12 this Commission and for those entities that are

 13 banks, by prudential authorities under their

 14 regulations.

 15 COMMISSIONER O'MALIA: How are we going

 16 to inform the market of what we view as quality

 17 collateral versus less-quality collateral just so

 18 they have an understanding of what the rules are

 19 going forward?

 20 MS. JOSEPHSON: I believe that those

 21 proposals will be considered by the Commission in

 22 a future rulemaking or the staff will be proposing
 69

 1 them at a later point.

 2 MR. RADHAKRISHNAN: This will be part of

 3 the capital margin.

 4 CHAIRMAN GENSLER: To clarify because I

 5 think these were very helpful questions, most of

 6 the authorities in fact I think all of the

 7 authorities with regard to bank holding companies

 8 or large financial institutions, if anybody is

 9 going to take a wind-down or anything like that,

 10 that's not this agency. That's the bank

 11 authorities and the FDIC. Your Enron example was

 12 a nonbank.

 13 COMMISSIONER O'MALIA: So they don't get

 14 that protection?

 15 CHAIRMAN GENSLER: What's that?

 16 COMMISSIONER O'MALIA: They don't get

 17 that -- I don't know if it's a benefit or a curse

 18 to have the feds involved at this point because I

 19 don't know that title very well.

 20 CHAIRMAN GENSLER: As I understand it,

 21 and maybe Dan wants to explain or somebody else,

 22 Title 2 really goes to bank holding companies and
 70

 1 systemically important large financial companies

 2 that are identified by the Financial Stability

 3 Oversight Council. Not to suggest that a swap

 4 dealer we regulate would not be large because it's

 5 possible, but if a swap dealer we regulate because

 6 it's not a bank, it's probably not going to be one

 7 of those entities either. Is that as I understand

 8 it?

 9 MS. JOSEPHSON: Yes. I think generally

 10 speaking that is correct and we'll get some more

 11 information to you on this. But for covered

 12 financial companies which is under Title 2, that

 13 regime if a swap dealer that was not a bank, and

 14 again we'll verify all of this, but my

 15 understanding is if they're making 85 percent of

 16 their profit or more from swap trading then they

 17 could be considered a financial company that under

 18 Title 2 could be a part of this orderly wind-down

 19 process that is contemplated. But again we'll

 20 follow-up with additional information for you on

 21 that topic.

 22 CHAIRMAN GENSLER: Thank you. If there
 71

 1 are no further questions, Mr. Stawik?

 2 MR. STAWIK: Commissioner O'Malia?

 3 COMMISSIONER O'MALIA: Aye.

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

 5 Commissioner Chilton?

 6 COMMISSIONER CHILTON: Aye.

 7 MR. STAWIK: Commissioner Chilton, aye.

 8 Commissioner Sommers?

 9 COMMISSIONER SOMMERS: Aye.

 10 MR. STAWIK: Commissioner Sommers, aye.

 11 Commissioner Dunn?

 12 COMMISSIONER DUNN: Aye.

 13 MR. STAWIK: Commissioner Dunn, aye.

 14 Mr. Chairman?

 15 CHAIRMAN GENSLER: Aye.

 16 MR. STAWIK: Mr. Chairman, aye. Mr.

 17 Chairman, on this question the ayes are five, the

 18 nays are zero.

 19 CHAIRMAN GENSLER: Thank you, and we'll

 20 send that to the Federal Register as well. I

 21 think I already asked U.C. on this FDIC thing, but

 22 in case you have other technical provisions at
 72

 1 this point I ask unanimous consent to ask staff to

 2 make technical corrections. And I'm only asking

 3 it for this because the position limit one is

 4 already done. But just a U.C. in case Sarah will

 5 have to make technical corrections. Without

 6 objection and that's so moved.

 7 As you know, we've identified 30-some

 8 topics for our rulemaking. Our next meeting is

 9 going to be on January 20, one week from today,

 10 and the subjects of the rulemaking presented at

 11 that meeting will be published on the Commission's

 12 website I guess today sometime. As I said

 13 earlier, I think that we're going to have a couple

 14 of meetings in February but we'll address the

 15 dates of those meetings next week. On January 20

 16 we'll vote on the dates.

 17 There being no further business, I'd

 18 entertain a motion to adjourn the meeting.

 19 COMMISSIONER DUNN: So moved.

 20 COMMISSIONER SOMMERS: Second.

 21 CHAIRMAN GENSLER: All in favor. Aye?

 22 GROUP: Ayes.
 73

 1 CHAIRMAN GENSLER: The ayes having it,

 2 the meeting is adjourned. Thank you so much.

 3 (Whereupon, at 10:51 a.m., the

 4 PROCEEDINGS were adjourned.)

 5 * * * * *

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 74

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Stephen K. Garland, notary public in

 4 and for the District of Columbia, do hereby certify

 5 that the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

 10 that I am neither counsel for, related to, nor

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 -----------------------------------

 20 Notary Public, in and for the District of Columbia

 21 My Commission Expires: May 31, 2014

 22