UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 OPEN MEETING ON THREE FINAL RULE PROPOSALS,

 ONE PROPOSED RULE AND A DELEGATION OF AUTHORITY

 ORDER

 Washington, D.C.

 Wednesday, January 11, 2012
 2

 1 PARTICIPANTS:

 2 Commission Members:

 3 GARY GENSLER, Chairman

 4 BART CHILTON, Commissioner

 5 MARK WETJEN, Commissioner

 6 JILL E. SOMMERS, Commissioner

 7 SCOTT D. O'MALIA, Commissioner

 8 Staff:

 9 DAVID STAWICK, Office of the Secretariat

 10 DAN BERKOVITZ, Office of General Counsel

 11 Presentation No. 1: Final Rule on Protection of

 Cleared Swaps Customer Contracts and Collateral:

 12 Conforming Amendments to the Commodity Broker

 Bankruptcy Provisions

 13

 14 BOB WASSERMAN, Division of Clearing and Risk

 15 LAURA ASTRADA, Division of Clearing and Risk

 16 MARTIN WHITE, Office of General Counsel

 17 Presentation No. 2: Final Rule on Business

 Conduct Standards for Swap Dealers and Major Swap

 18 Participants with Counterparties

 19 PHYLLIS CELA, Enforcement Division

 20 TED KNELLER, Enforcement Division

 21 CHARLES MCCARTY, Enforcement Division

 22
 3

 1 PARTICIPANTS (CONT'D):

 2 Presentation No. 3a: Final Rule on Registration

 of Swap Dealers and Major Swap Participants:

 3

 BARBARA GOLD, Division of Swap Dealer and

 4 Intermediary Oversight

 5 CHRIS CUMMINGS, Division of Swap Dealer and

 Intermediary Oversight

 6

 ELIZABETH MILLER, Division of Swap Dealer and

 7 Intermediary Oversight

 8 GARY BARNETT, Division of Swap Dealer and

 Intermediary Oversight

 9

 Presentation No. 3b: Delegation of Authority

 10 Order on Performance of Registration Functions by

 National Futures Association with Respect to Swap

 11 Dealers and Major Swap

 12 BARBARA GOLD, Division of Swap Dealer and

 Intermediary Oversight

 13

 CHRIS CUMMINGS, Division of Swap Dealer and

 14 Intermediary Oversight

 15 ELIZABETH MILLER, Division of Swap Dealer and

 Intermediary Oversight

 16

 GARY BARNETT, Division of Swap Dealer and

 17 Intermediary Oversight

 18 Presentation No. 4: Proposed Rule on Prohibitions

 and Restrictions on Proprietary Trading and

 19 Certain Interests in, And Relationships with,

 Hedge Funds and Private Equity Funds:

 20

 STEVEN SEITZ, Office of General Counsel

 21

 GARY BARNETT, Division of Swap Dealer and

 22 Intermediary Oversight
 4

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

 2 (9:33 a.m.)

 3 CHAIRMAN GENSLER: Good morning. This

 4 meeting will come to order. This is a public

 5 meeting of the Commodity Futures Trading

 6 Commission to consider final and proposed rules

 7 under the Dodd-Frank Act.

 8 I'd like to welcome members of the

 9 public, market participants, members of the media,

 10 as well as those listening to this meeting on the

 11 phone and watching this webcast, the first of our

 12 meetings in 2012.

 13 I'd first like to wish everybody a happy

 14 New Year, and like to thank Commissioner Sommers,

 15 Chilton -- is Bart on the phone?

 16 COMMISSIONER CHILTON: I'm here, Mr.

 17 Chairman.

 18 CHAIRMAN GENSLER: Great. Commissioner

 19 O'Malia, Commissioner Wetjen for their significant

 20 contributions to this entire process as we move

 21 along, and I thank all of the members of the

 22 hardworking CFTC staff that are so dedicated to
 5

 1 this mission.

 2 This is our 23rd open meeting of the

 3 commission to consider Dodd-Frank rule-making, and

 4 today we'll consider staff recommendations on

 5 segregation of customer funds for cleared swaps, a

 6 business conduct standards rule, which helps on

 7 sales practices -- what we call external business

 8 conduct rules. Thirdly, registration of swap

 9 dealers and major swap participants.

 10 And in addition, we will be voting on a

 11 delegation order to a registration authority to

 12 the National Futures Association. Those would be

 13 finals that we would look at.

 14 Lastly, we'll vote on a proposed rule on

 15 proprietary trading provisions, which is best

 16 known as the Volcker Rule.

 17 Today's segregation rule is an important

 18 step that staff is about to describe in protecting

 19 customers and reducing risk of the swaps market --

 20 segregation of customer funds at the core

 21 foundation of customer protection in the futures

 22 and swaps marketplace.
 6

 1 The rule further protects customers by

 2 ensuring that futures commission merchants and

 3 clearing organizations segregate customer

 4 collateral supporting cleared swaps. It prohibits

 5 clearing organizations from using the collateral

 6 of non-defaulting, innocent customers to protect

 7 themselves and their clearing members.

 8 So in essence, this rule builds upon

 9 what we have in the futures world by saying that a

 10 clearing organization cannot use non-defaulting

 11 customers' money to fill the hole of a defaulting

 12 customer's money. But I know that Bob and Laura

 13 and Martin will give us a better explanation.

 14 For the first time, customer money must

 15 be protected all the way down to the clearinghouse

 16 on an individual basis. We've received tremendous

 17 amount of input on this rule, starting really

 18 shortly after the President signed the Dodd- Frank

 19 Act, but it's included two staff roundtables, as

 20 well as through comments on not only the proposal

 21 but something earlier called an "Advance Notice to

 22 Proposed Rule Making."
 7

 1 This rule builds on the customer

 2 protections included in the clearinghouse rules

 3 that we voted out in October. Most importantly,

 4 what we finalized in October included a provision

 5 that said that clearinghouses had to take customer

 6 money and keep it on a gross basis, not net one

 7 customer against another -- or more precisely, not

 8 let the futures commission merchants net that

 9 money against each other.

 10 What we are continuing to gather

 11 thoughtful input on how we might build upon

 12 today's proposed final rule. And I've asked staff

 13 to carefully analyze proposals from market

 14 participants, and to make further recommendations

 15 on further safeguarding client collateral on an

 16 individual basis. And there have been numerous

 17 letters even in the last week, in the last month

 18 about some thoughts, and I've asked staff to

 19 consider those and give the best thoughts to those

 20 and bring back recommendations to this commission.

 21 I've also requested staff to report to

 22 the commission on whether it would be appropriate
 8

 1 to eventually consider segregation protections for

 2 futures that are similar to those that we hope to

 3 adopt today for swaps. And I've asked the staff

 4 to put together public roundtables, maybe more

 5 than one -- thank you, Bob and Laura, in advance

 6 -- on these potential customer protection

 7 initiatives.

 8 The commission has made significant

 9 progress on three critical aspects of reform:

 10 Transparency in the marketplace, lowering risk to

 11 the public and enhancing market integrity.

 12 Today, we turn to a new topic, which is

 13 the swap dealers themselves, and we'll consider

 14 registration of those swap dealers and external

 15 business conduct standards as well. This is just

 16 the first step. There will probably be, if I

 17 count right, five or six other rules that we'll

 18 consider throughout the rest of this year. But it

 19 starts us on a fourth and critical area of reform.

 20 The external business conduct rule will

 21 establish and enforce robust sales practices in

 22 the swaps market. The registration rule will
 9

 1 allow the commission to monitor the swap dealers

 2 and major swap participants for compliance, but it

 3 will be in partnership with the NFA, because I

 4 hope that we would also vote out a delegation

 5 order to them as well.

 6 We'll also talk a bit today about the

 7 Volcker Rule. And if I'll just close on this

 8 hopefully, but putting out to comment the Volcker

 9 Rule proposal, it will be consistent with what the

 10 bank regulators and the SEC did in -- I think it

 11 was October. This joint rule proposal that they

 12 put out actually is under the Bank Holding Act,

 13 and what we will vote on today will be our part of

 14 this. I know the proposal will get a lot of

 15 comments, and I very much look forward to the

 16 public comments on this important rule.

 17 I'd like to take a moment, though, also

 18 to discuss a possible schedule for considering

 19 final Dodd-Frank rules. I stress this is just a

 20 possible schedule because we're human. We're five

 21 Commissioners, and we're all going to have a lot

 22 of input, but just as I did in September, I put
 10

 1 something out there so the public could at least

 2 know something about our internal deliberations.

 3 So a more complete, tentative list will

 4 be up on our website today, but in addition to the

 5 three rules that we're consider today to finalize

 6 in the first quarter of 2012, I'm hopeful we can

 7 finalize both of the joint rules with the SEC on

 8 definitions. That's the entity and product

 9 definitions.

 10 Other potential final rules for

 11 consideration relate around the end user exception

 12 and certain internal business conduct rules, and

 13 possibly core principles on designated contract

 14 markets.

 15 In addition, I would be hopeful that we

 16 can put out some new proposals. One area that

 17 we've talked about in December collectively that

 18 is repropose a block rule, and also that we would

 19 explicitly seek public comment on some of the

 20 international aspects, or what's called the

 21 extraterritoriality applications of Dodd-Frank's

 22 Title VII.
 11

 1 One area that's also come up, and I know

 2 the press has written a little bit about it, is

 3 I'm hopeful that working with regional

 4 transmission organizations and rural electric

 5 cooperatives and municipal power authorities; that

 6 they will actually file petitions with us for

 7 what's called 4C exemptions. This is highly

 8 dependent upon when they come to us, but the best

 9 news right now is that the regional transmission

 10 organizations are close to filing something that

 11 we would put out to public comment and get the

 12 public's input on these possible exemptions.

 13 As with the first 22 final rules, the

 14 CFTC's working to complete these remaining rules

 15 thoughtfully, not against a clock. It's based on

 16 thousands of public comments, more roundtables to

 17 come and lots of meetings.

 18 But in brief, I wanted to thank

 19 everybody from this commission and the staff for

 20 what we've accomplished. It's really remarkable.

 21 To promote transparency, we've completed rules on

 22 large trader reporting, on the swap data
 12

 1 repositories and then just in the end of December,

 2 on the actual data that goes to these data

 3 repositories, as well as realtime reporting to the

 4 public.

 5 To lower risk to the public, we've been

 6 successful in completing rules on risk management

 7 of clearinghouses and enhanced customer protection

 8 on the investment of customer funds. And to

 9 enhance market integrity, we've finished rules

 10 giving the commission authority to prosecute

 11 wrongdoers against recklessly manipulating the

 12 markets. Whistleblower office -- not only did we

 13 finish the rules, but the office is now

 14 operationally up, and I want to welcome Vincente

 15 Martinez to the CFTC, who's running that office,

 16 and we finalized position limit rules on aggregate

 17 speculative positions.

 18 These final rules represent a

 19 substantial down payment on making the marketplace

 20 safer and more transparent.

 21 And with that, I think I'm going to turn

 22 it to Commissioner Sommers.
 13

 1 COMMISSIONER SOMMERS: Thank you, Mr.

 2 Chairman, and as always, thank you to the four

 3 teams that have worked so diligently to get the

 4 rules that we are considering today before us.

 5 They're enormous, complex rules, and we much

 6 appreciate all the hard work and dedication that

 7 you put into getting these rules to a place that

 8 is reasonable. So thank you all very much.

 9 Today, we are considering a Volcker Rule

 10 proposal and final rules relating to the

 11 registration of swap dealers and major swap

 12 participants, external business conduct standards

 13 and segregation of collateral for cleared swaps.

 14 The Volcker proposal and the external

 15 business conduct rules are lengthy and extremely

 16 complex, and I do not think we've taken sufficient

 17 time to fully consider all of their implications.

 18 This is due in part to the fact that much of our

 19 time over the past few weeks has been taken up

 20 with considering a host of policy issues regarding

 21 how to best address segregation and bankruptcy

 22 issues for both futures and swaps, and whether we
 14

 1 should forge ahead with final rules that fail to

 2 include futures.

 3 I am troubled that this is the path the

 4 commission has chosen. I'm also very concerned

 5 that in just two weeks, we will again be voting on

 6 rules that are both massive in length and

 7 extremely complicated without taking sufficient

 8 time to consider all of their implications.

 9 I have been advised that on January 25,

 10 the commission and the SEC will vote to finalize

 11 joint rules defining the terms swap dealer and

 12 major swap participant, and that the CFTC will

 13 also vote on internal business conduct standards

 14 and final rules for CPOs and CTAs. I don't

 15 believe this schedule is workable.

 16 As we vote on the Volcker Rule proposal

 17 today, I can't help but question the timing of

 18 this vote and why the commission did not join the

 19 other agencies in their proposal back in October.

 20 It certainly should not have come as a surprise to

 21 us last summer and early fall that the other

 22 agencies were getting close to being ready to
 15

 1 issue their proposal.

 2 Moreover, we had a CFTC team dedicated

 3 to the Volcker Rule -- a team that was

 4 coordinating with those other agencies. Had we

 5 planned better, we could've joined the October

 6 proposal.

 7 Unfortunately, we are proposing rules

 8 that are virtually identical to the other

 9 agencies' proposed rules well after they have been

 10 widely criticized, and after many have called for

 11 those agencies to start over -- including Paul

 12 Volcker.

 13 What will we do if they repropose their

 14 rules? Will we be prepared to withdraw our

 15 proposal and join a reproposed Volcker Rule with

 16 the other agencies? It seems as if we have put

 17 ourselves on a separate track, which I fear will

 18 needlessly complicate an already convoluted and

 19 likely unworkable set of rules.

 20 Today, we're also voting on registration

 21 rules for swap dealers and major swap

 22 participants. I would've preferred to vote on
 16

 1 these registration rules, along with the entity

 2 definitions and had hoped that the comprehensive

 3 rules relating to the extraterritorial application

 4 of Dodd-Frank would have been considered ahead of

 5 both of those.

 6 Instead, we are continuing with the

 7 piecemeal approach. And while I and many market

 8 participants have been eager to take up the issue

 9 of extraterritoriality, the critical issue remains

 10 unaddressed.

 11 As I have said many times over the last

 12 year, a logical plan for sequencing and

 13 implementing rules is critical if we expect the

 14 transition to this new regulatory regime to be

 15 smooth. We must consider comprehensively what

 16 sort of implementation and compliance schedule is

 17 truly realistic, given the realities of the

 18 markets we regulate.

 19 We have already learned that the final

 20 rules we adopted for large trader reporting of

 21 swaps are unworkable, which required staff to

 22 issue broad, market-wide no action relief. Market
 17

 1 participants were telling us all along that our

 2 requirements and deadlines were not workable, but

 3 we went ahead nonetheless.

 4 I suggest we learn from that experience,

 5 and pay closer attention to what market

 6 participants tell us about legitimate compliance

 7 challenges and obstacles.

 8 I also have serious concerns regarding

 9 the business conduct rules we are finalizing

 10 today. It is clear that Congress intended for us

 11 to implement increased protections for special

 12 entities. However, shortly after our proposed

 13 rules were published, special entities began to

 14 tell us that the protections we proposed were not

 15 protections at all. We heard over and over again

 16 from special entities, right up until last week,

 17 that our rules would not provide additional

 18 protections, but would actually harm them by

 19 making it more difficult for them to enter into

 20 arm's length transactions with swap dealers.

 21 As I listened to these special entities

 22 tell me how our so-called protections would
 18

 1 actually harm them, I could not help but think of

 2 President Reagan and his statement that the nine

 3 most terrifying words in the English language are,

 4 "I'm from the government, and I'm here to help."

 5 I will be voting against the business

 6 conduct rules. Finally, I'm very concerned about

 7 voting today on the segregation rules. The final

 8 rules provide swap customers with protections from

 9 fellow customer risk -- protections that do not

 10 apply to futures customers.

 11 During the discussions over this issue

 12 over the last year, we focused almost exclusively

 13 on the need to alleviate the risks that swap

 14 customers posed to their fellow swap customers

 15 with accounts at the same FCM. We did not focus

 16 on the risk customers face due to the actions of

 17 the FCM.

 18 Given recent events, we need to rethink

 19 this approach so we can provide adequate

 20 protections in a comprehensive and coherent way,

 21 to swaps customers and futures customers.

 22 I do not accept this piecemeal approach
 19

 1 to customer protection as a step in the right

 2 direction.

 3 Thank you, Mr. Chairman, and thank you

 4 again to all the teams today.

 5 CHAIRMAN GENSLER: Thank you,

 6 Commissioner Sommers. Commissioner Chilton?

 7 COMMISSIONER CHILTON: Thanks, Mr.

 8 Chairman. I'm going to commend you for what

 9 you've done. I understand that Commissioner

 10 Sommers has some concerns. I think a lot of them

 11 have some merit, but we shouldn't let the perfect

 12 be the enemy of the good, and as you've discussed,

 13 we've got a panoply of accomplishments so far on

 14 this legislation with all the rules.

 15 We're seven months behind the schedule

 16 that Congress gave us, and I appreciate the

 17 forthrightness that you've undertaken to get us

 18 going down the road. We're late on a lot of

 19 things, but that doesn't mean that we haven't made

 20 important progress, and I thank you for your

 21 leadership and all the help of the staff.

 22 Sometimes you need to see what things
 20

 1 look like when they go really wrong, in order to

 2 appreciate how good you have it when things are

 3 going right. And we've seen a few things that

 4 have gone really wrong in the past couple of

 5 months, and it's made us think about how good we

 6 actually had it.

 7 And I'm talking about something

 8 Commissioner Sommers referred to, and that's about

 9 MF Global, and how for so many years, we had the

 10 confidence that customer funds were very well

 11 protected by the Federal Commodities Segregated

 12 Account Statutes and Regulations. But MF Global

 13 was really sort of a slap in the face, wakeup call

 14 for us all, and it hit the very heart of who we

 15 are as regulators and who we are as an industry --

 16 and most important, it's now a constant sort of

 17 clanging bell for me that we have to see what we

 18 need to do in order to ensure that customer funds

 19 -- taxpayers' money, that is -- are taken care of,

 20 first and foremost, before anything else.

 21 We're in the middle of this path.

 22 Everybody knows that. We're in the process. Our
 21

 1 investigators are trying to track down the money,

 2 and we're pursuing it, along with other civil and

 3 criminal authorities, all the available

 4 enforcement avenues.

 5 At the same time, I think we need to

 6 look at what we can do to change our oversight

 7 system. Commissioner Sommers mentioned one thing

 8 there, but treating customers' monies the same in

 9 the swaps and the futures world. But we need to

 10 make sure that this doesn't happen again -- or at

 11 the very least, make sure that we're not making it

 12 easier for our customers to get ripped off.

 13 I've spoken about a couple of things I

 14 think we need to do, and I appreciate, Mr.

 15 Chairman, that you have asked for suggestions,

 16 that we're holding roundtables. But I think the

 17 clock is ticking, and we're moving as forthrightly

 18 as we can.

 19 But a couple of things I've talked about

 20 that I think we should do, and that I hope people

 21 will consider. One is an insurance fund in the

 22 derivatives space. And that would be similar to
 22

 1 SIPC in the securities area and similar to the

 2 FDIC and the banking industry.

 3 The second thing is we scaled back our

 4 1.25 Reg in early December, but I actually think

 5 we might need to go further than that. I do think

 6 we need to go further than that, and pull back on

 7 the type of investments that brokers can use to

 8 invest customer money. Since 1968, the commission

 9 has sort of gone down a slippery slope and allowed

 10 more and more things to be used, and I think we

 11 should, out of an abundance of caution, pull that

 12 back.

 13 And then another thing is -- and I think

 14 most of my colleagues met with some of the folks

 15 that were in a couple of weeks ago. Some of them

 16 had some European counterparts, and they've got

 17 customer choice there. And customers can choose

 18 whether or not they want to opt out of any

 19 investment whatsoever using segregated funds. And

 20 I think that deserves our consideration.

 21 And separately, but it's similar,

 22 there's also this idea of a guaranteed customer
 23

 1 account. So you could still opt out, but there

 2 would also be a guaranteed customer account, which

 3 would in essence provide another alternative,

 4 perhaps even a third party to the FCM, to keep the

 5 funds segregated and safe.

 6 And finally, as Commissioner Sommers

 7 said, I think it makes sense for us to consider

 8 this concept of regularizing the treatment of

 9 futures and swaps segregated funds so that we

 10 could more fully protect customers.

 11 So anyway, I don't think we have a whole

 12 lot of time to waste. I do appreciate the fact

 13 that everybody's working hard. There's not much

 14 more you can get out of people than we're getting,

 15 Mr. Chairman.

 16 But we're doing the LSOC Rule today, and

 17 I fully support that. But I think the lessons

 18 that we've learned so far from MF Global teaches

 19 that we don't have the luxury of time in making

 20 additional progress to protect customers. We need

 21 to do more, and we need to do it now, and I know

 22 that you feel that way too, Mr. Chairman, and I
 24

 1 look forward to working with you and all my

 2 colleagues.

 3 Thank you very much.

 4 CHAIRMAN GENSLER: Thank you,

 5 Commissioner Chilton. Commissioner O'Malia?

 6 COMMISSIONER O'MALIA: Thank you, Mr.

 7 Chairman. That it was all very complicated --

 8 Michael Lewis wrote this in his 2010 book, "The

 9 Big Short: Inside the Doomsday Machine." He was

 10 writing about how customers were sold publicly

 11 traded credit default swaps by Wall Street firms

 12 that were kept in the dark about the nature and

 13 the value of these investments.

 14 It was complicated because no one would

 15 want to believe that the customers were being

 16 duped into paying to essentially take out the

 17 garbage of the housing bubble.

 18 Fortunately, today's rule makings seek

 19 to require dealers to be more accountable to their

 20 customers and offer improved protections of

 21 segregated funds by FCMs.

 22 I'd like to thank the four teams
 25

 1 responsible for today's three final and one

 2 proposed rule. Combined, these documents total

 3 over 1,000 pages -- a massive amount of work for

 4 the commission to review and to provide comment,

 5 and I commend the staff for their patience and

 6 willingness to work with the commission on very

 7 short time tables.

 8 As is made clear in the book "The Big

 9 Short," many customers were not provided a full

 10 picture of the risks and various products,

 11 including specifically mortgage-backed securities,

 12 let alone the inherent conflicts of interest when

 13 dealers took positions opposite their customers.

 14 Today, final rules relating to external

 15 business conduct standards present an informed

 16 integration of the statutory language,

 17 Congressional intent, existing statutory and

 18 regulatory and self-regulatory requirements for

 19 market professionals, securities law and industry

 20 best practices.

 21 The final rules do not preserve many of

 22 the unworkable proposals, such as the best
 26

 1 execution and the prohibition against trading and

 2 front-running, which were not at all supported in

 3 the comments.

 4 As well, there are multiple

 5 modifications to the proposed rule, to, where

 6 possible and appropriate, avoid creating trading

 7 delays or barriers between swap dealers and major

 8 swap participants and their counterparts. One

 9 significant manner in which this is all

 10 accomplished is by allowing in many instances the

 11 demonstration of and compliance with the rules on

 12 a relationship basis through disclosures and

 13 counterparty representations through

 14 documentation. To the extent that they can

 15 standardize it, good luck, but that is provided in

 16 the rule.

 17 Rules also provide safe harbors for swap

 18 dealers, from acting as an advisor to a special

 19 entity, and for dealers and MSPs to meet the

 20 requirement. They have a reasonable basis to

 21 believe that the special entities' representations

 22 meet the statutory specified qualifications to be
 27

 1 a counterpart.

 2 The final rule also confirms through a

 3 statement through the Department of Labor, the

 4 commission's external business conduct rules will

 5 not cause a swap dealer or MSP to become an ERISA

 6 fiduciary under existing law or in subsequent

 7 regulations, which I strongly support.

 8 I believe, with the modification, the

 9 commission has endeavored to be responsible

 10 through the provision of guidance in appendix A to

 11 the subpart, and staff has assured me that the

 12 market participants may seek additional guidance

 13 from the commission staff if the rules are unclear

 14 or onerous. And I'm reminded of part 20, large

 15 trader reporting, when we thought we had it right

 16 and it was still confusing. So I'm pleased that

 17 we will offer some flexibility to help people

 18 develop the appropriate standards.

 19 I also support the final rule making on

 20 the protection of cleared swaps, customer

 21 contracts and collateral, because I believe it's

 22 the most effective way to achieve customer
 28

 1 portability.

 2 However, as Commissioner Sommers noted,

 3 this rule making does not address, much less

 4 solve, MF Global. The rule making, properly

 5 understood, is simply a first step in the

 6 commission's reconsideration of the customer

 7 segregation regime for both futures, who bore the

 8 brunt of the MF Global failure, and cleared swaps

 9 customers.

 10 I've drafted a separate statement on

 11 this final rule making and its significant

 12 limitations in an effort to inform the public and

 13 to prevent inaccurate perceptions of the proposal

 14 we have offered today.

 15 In addition, I do not support the

 16 commission's version of the Volcker Rule. It is

 17 an unworkable solution that is entirely too

 18 complex and provides the commission with little to

 19 no means to enforce or to deter violations of this

 20 rule. Volcker Rule sets in motion what Sheila

 21 Bair, the former Chairman of the FDIC, aptly

 22 described as a 300 page Rube Goldberg contraption
 29

 1 of regulation proposed by federal agencies.

 2 As many commenters, including foreign

 3 banks and end users, allege, the rule may have

 4 unpredictable consequences for swaps liquidity.

 5 I've drafted a separate statement on this as well,

 6 that all you can find on my website, on the

 7 commission's webpage.

 8 With regard to registration swap dealers

 9 and MSP, the commission is finalizing a final rule

 10 that requires SDs and MSPs to become and remain

 11 members of a registered futures association. To

 12 implement this regulation regime, the commission

 13 has delegated to the NFA the authority to perform

 14 the full range of registration functions and

 15 requires the NFA to monitor compliance of

 16 applicants and persons registered as SDs or MSPs.

 17 This is consistent with the current regulatory

 18 practice for futures, and wisely builds on the

 19 existing registration experience of the NFA.

 20 The delegation will avoid the costly

 21 investment of taxpayer dollars to recreate NFA's

 22 registration system at the commission, and will
 30

 1 allow the resources to be better employed at the

 2 commission's other -- towards the commission's

 3 other oversight responsibilities.

 4 The following rule is an improvement

 5 over the proposal, and revised in two significant

 6 ways to address the concerns of commenters.

 7 First, the following rule has been

 8 revised to make clear that the provisional

 9 registration will be granted upon filing of one's

 10 application and not upon NFA's review and approval

 11 of the application document. This will allow

 12 market participants to continue to conduct

 13 business while the NFA reviews their applications

 14 and is not burdened by arbitrary timelines.

 15 The firms won't be forced to expend

 16 considerable amount of resources complying with

 17 the regulations, and must be given adequate time

 18 to do so.

 19 Second, the rule allows for phased

 20 implementation of the business conduct rules, and

 21 I ultimately hope for all commodity exchange 4(s)

 22 rules to have the same flexibility.
 31

 1 Specifically, dealers will have 180 days

 2 after the effective date of that regulation or the

 3 date on which SDs or MSPs are required to apply

 4 for registration pursuant to regulation 310, the

 5 mandatory compliance reporting date --

 6 registration date, actually.

 7 Although this solution allows market

 8 participants more time to demonstrate compliance,

 9 it will still require market participants to track

 10 multiple rules to determine which 4(s)

 11 requirements they do or do not need to demonstrate

 12 compliance in order to comply with the NFA

 13 registration. Only the government could think it

 14 wise to pass over a simple, clear-cut bright line

 15 rule and instead adopt a cumbersome, complex set

 16 of timing rules on various separate rules.

 17 The piecemeal approach makes it even

 18 more important that the commission issue a

 19 schedule outlining the order of rules to be

 20 considered and an implementation timeline for all

 21 of the rules. More transparency into scheduling

 22 and implementation will accelerate compliance and
 32

 1 ensure those who have to register can do so in

 2 full knowledge of when the deadlines will occur.

 3 Let me close again by thanking the staff

 4 who have worked very hard to prepare and negotiate

 5 over 1,000 pages of rule makings before the

 6 commission today. I think in terms of pages, this

 7 might be our biggest day, which is not our

 8 proudest moment. It's ridiculous to do 1,000

 9 pages in one day. It's just not possible to get

 10 it right, and we should take a more measured

 11 approach on considering the number of rules we

 12 consider in any one meeting.

 13 I do appreciate you circulating that

 14 timeline. It's something I've asked for, and it's

 15 essential, and I greatly appreciate that. Don't

 16 misread my frustration with the volume that we've

 17 had to achieve today, and I'd like to see that we

 18 make sure that we do a regular number of rule

 19 makings so we can get it right.

 20 CHAIRMAN GENSLER: Just to address it --

 21 I think -- and I'm -- so much depends on people

 22 not at this dais. I mean, their staffs, the SEC,
 33

 1 other regulators and so forth. But that schedule,

 2 if we were to finalize these three finals today,

 3 list 11 things for the first quarter. So that

 4 would be eight other final Title VIIs. Now I am

 5 hopeful that we do these two proposals, the block

 6 rule and the extraterritoriality, and there's one

 7 non-Title VII, that CPO document that we've all

 8 had for about a month and a half.

 9 And depending upon people's reactions --

 10 so that might be two a meeting or something.

 11 There might be one meeting that will have to be

 12 three a meeting, but I think that would get us

 13 through the quarter.

 14 But of course, we never know because

 15 maybe we're not able to get something from a staff

 16 recommendation up to the commission itself.

 17 COMMISSIONER O'MALIA: We can do this

 18 now or do it later, but if you want to talk about

 19 your schedule and I'll comment on this. But there

 20 are a number of things that are not on this list

 21 that we know are pending -- OCR, colocation,

 22 things like -- I'd like to see. Commissioner
 34

 1 Chilton lists several things he wants -- no-year

 2 FCM, 30.7 seg requirements, how that money's held.

 3 We've talked about that. Are we going to consider

 4 that as part of a customer protection post-MF

 5 Global? Joint several liability for APs, which we

 6 discussed here, that was not able to get into this

 7 rule that you said we're going to immediately

 8 proceed to.

 9 What are we going to do about the

 10 Volcker Rule? And this is coming back. This rule

 11 is so bad, it really merits re-proposal. So

 12 that's got to fit into all of this, and that does

 13 have a hard July 12 deadline, I understand.

 14 So we've got some roundtables we've got

 15 to do, and these are just the things that, as I

 16 was scanning the rules, what's -- these are

 17 Dodd-Frank rules.

 18 There are other rules that we need to do

 19 as well, and MF Global is going to force us to

 20 consider other rules as well.

 21 So let's put this out, but let's put the

 22 full picture out, and then let's look at how many
 35

 1 rules we are going to be doing in a day and see

 2 what we can get done.

 3 CHAIRMAN GENSLER: I'm going to hand off

 4 to Commissioner Wetjen, but I totally agree. This

 5 is a critical time for this agency. We have so

 6 much that the people really want us to do -- to

 7 complete Dodd-Frank in a thoughtful, balanced way

 8 so that there's less risk and more transparency in

 9 the markets, while at the same time, there's

 10 significant non-Dodd-Frank matters to enhance

 11 customer protectors -- whether through rule

 12 making, roundtables or even some of the issues

 13 that Commissioner Chilton raised would probably

 14 take the work of Congress, as well as some of the

 15 key rules that you mentioned around ownership and

 16 control and colocation and so forth.

 17 Commissioner Wetjen?

 18 COMMISSIONER WETJEN: Thank you,

 19 Chairman Gensler. Thank you also to the

 20 professional staff for your hard work on the

 21 recommendations for us today. I appreciate all of

 22 your hard work on these rules. I also appreciate
 36

 1 your dedication to getting these regulations

 2 right, and that you have remained open to public

 3 input and feedback from my office and others.

 4 Clearly, there's a critical component --

 5 the Dodd- Frank Act's regulatory regime for swaps

 6 and one of its primary means of reducing systemic

 7 risk in the financial markets.

 8 Today, we are considering final

 9 regulations that will take important first steps

 10 to ensure that customer collateral is

 11 appropriately protected throughout the swaps

 12 clearing process.

 13 The commission previously requested

 14 comment on a number of clearing models, each with

 15 certain customer protections and operational

 16 costs. After considering these models and

 17 engaging in detailed discussions with the public,

 18 I am confident that, at present, the legal

 19 segregation with operational comingling model sets

 20 forth the most cost- effective framework to

 21 protect customer collateral for swap transactions.

 22 The LSOC model substantially reduces
 37

 1 fellow customer risk. Derivatives clearing

 2 organizations will be prohibited from accessing

 3 non-defaulting customer collateral in the event of

 4 a double default of a customer and its FCM

 5 clearing member.

 6 In the event of such a default,

 7 moreover, LSOC facilitates the movement of

 8 positions and related collateral. Each DCO will

 9 have customer information on a customer by

 10 customer basis, and thus will be less reliant upon

 11 the defaulting FCM for that information.

 12 To be clear, certain risks remain under

 13 the LSOC model. First, although fellow customer

 14 risk is significantly reduced, it is not

 15 completely eliminated. In the event of a double

 16 default, customers continue to face the risk that

 17 substantial variation margin will not be credited

 18 and imported immediately with non-defaulting

 19 customer collateral due to payment-netting

 20 practices.

 21 Second, excess collateral in the FCM's

 22 customer account is always exposed to operational
 38

 1 risks, including risks of fraud or

 2 misappropriation.

 3 But no regulation -- indeed, no

 4 segregation model in itself -- will, in every

 5 case, prevent the willful misappropriation of

 6 customer funds. That is why I've asked the staff

 7 to consider whether additional or other collateral

 8 protections could further reduce risks to customer

 9 collateral.

 10 For instance, I am eager to further

 11 discuss the merits of a guaranteed clearing

 12 participant relationship that would permit a

 13 customer to hold its collateral in a third party

 14 custodial account with a guarantee from its FCM

 15 clearing member. Commissioner Chilton mentioned

 16 this in his statement.

 17 In the meantime, today's final

 18 regulations take the initial step of clarifying

 19 that customer collateral may be deposited at the

 20 election of the FCM and its customers and a third

 21 party safekeeping account. As indicated, the

 22 staff is planning two roundtables to seek public
 39

 1 input concerning other potential measures to

 2 provide further protections for customer

 3 collateral.

 4 I look forward to working with the staff

 5 on these important ongoing initiatives.

 6 One of the issues we need to explore is

 7 whether similar protections for customer

 8 collateral in the futures markets would be

 9 appropriate. That's clearly a concern shared by

 10 my fellow Commissioners.

 11 This should not, however, prevent us

 12 from taking important first steps to protect swaps

 13 customer collateral now. I therefore will be

 14 supporting the staff's recommendations.

 15 We are also considering final

 16 regulations to establish external business conduct

 17 standards, which require a very delicate balance.

 18 If our rules prove unworkable or raise

 19 unacceptable legal risks, then swap dealers and

 20 major swap participants may choose not to do

 21 business with some counterparties, especially

 22 special entities as defined by Dodd-Frank. This
 40

 1 could deprive swap market participants of the

 2 liquidity they need to manage the risks.

 3 I commend the staff for their diligent

 4 efforts and thoughtful consideration of the strong

 5 views expressed by those on all sides of this

 6 debate. The staff has fairly considered

 7 conflicting viewpoints in crafting a rule that, in

 8 their professional judgment, protect

 9 counterparties from abusive practices.

 10 I support the staff's recommendations

 11 because, in my judgment as well, they take a

 12 reasoned approach consistent with the statute.

 13 On the one hand, the rules implement a

 14 robust, investor protection regime as directed by

 15 Congress, especially with respect to special

 16 entities that the public depends on for

 17 stewardship of retirement benefits, public funds

 18 and endowments.

 19 On the other hand, the rules set

 20 standards that are reasonably tailored to the

 21 manner in which the swap markets operate, and

 22 thus, market participants should be able to comply
 41

 1 without undue regulatory risks and costs.

 2 I appreciate the willingness of the

 3 staff to accommodate changes throughout the rule

 4 making process. These changes have improved the

 5 final regulations.

 6 For example, the revisions made to

 7 develop safe harbors with respect to ERISA plans

 8 supported by my office and others reflect sound

 9 public policy in light of the established

 10 regulatory structure under ERISA and the high

 11 fiduciary standards already imposed.

 12 I also support the shift in the final

 13 rules from proposed requirement -- that swap

 14 dealers provide a scenario analysis for high-risk,

 15 complex swaps. Rather than leaving difficult

 16 determinations as to what constitutes high-risk or

 17 complex to the dealer, the final rules permit a

 18 counterparty to opt in by requesting a scenario

 19 analysis for any swap together with disclosure,

 20 the material assumptions and limitations of the

 21 analysis.

 22 Where, however, a counterparty performs
 42

 1 its own analysis and does not elect to obtain one

 2 from the dealer, we will not prescriptively

 3 mandate that one be provided anyway.

 4 The final rule will build strong, new

 5 investor protections into the swap marketplace.

 6 It includes robust disclosure requirements that

 7 ensure counterparties require information

 8 sufficient to assess the nature and the extent of

 9 the material risks of a swap.

 10 And the final rules contain a strong

 11 independence test to ensure that where a special

 12 entity has a qualified independent representative

 13 to act in its best interests, that representative

 14 is truly independent of the swap dealer or major

 15 swap participant on the other side of the

 16 transaction.

 17 Finally, while I support this rule, our

 18 work in this area will not end here. The staff

 19 continues to work with the SEC, the Department of

 20 Labor, the National Futures Association and the

 21 Municipal Securities Rule Making Board to

 22 harmonize, where appropriate, our respective
 43

 1 rules.

 2 Equally important, some commenters have

 3 suggested that a registration and testing regime

 4 for independent representatives be created. The

 5 staff is exploring whether such a regime is

 6 feasible.

 7 Today's registration process rules

 8 leverage the commission's existing framework by

 9 delegating to the National Futures Association

 10 full registration authority. The NFA will be

 11 responsible for reviewing applications and

 12 confirming initial compliance with commission

 13 rules.

 14 Importantly, the commission will

 15 maintain the authority to review the NFA's

 16 performance and conduct onsite examinations of

 17 swap dealers and major swap participants.

 18 I will be supporting these rules because

 19 they establish an appropriate process for

 20 provisional registration while the new regulatory

 21 framework comes into effect.

 22 Finally, we are also considering a
 44

 1 proposal to implement what is commonly known as

 2 the Volcker Rule. Among other things, the Volcker

 3 Rule generally prohibits banking entities from

 4 engaging in short-term proprietary trading for

 5 their own accounts, and from owning or sponsoring

 6 hedge funds or private equity funds.

 7 The commission's proposal includes

 8 questions concerning the applicability of certain

 9 provisions to CFTC- regulated entities, including

 10 FCMs, DCOs, swap dealers and major swap

 11 participants.

 12 This proposal is an important step

 13 towards finalizing the Volcker Rule and providing

 14 much-needed regulatory certainty to the public and

 15 the banking community.

 16 The commission's issuance of this

 17 proposal, together with the recent extension of

 18 the comment period by the other financial

 19 regulatory agencies, will afford the public an

 20 appropriate opportunity to review and comment on

 21 each agency's Volcker Rule.

 22 I would like to thank the staff for
 45

 1 their hard work and coordination with other

 2 financial regulators. I will be supporting this

 3 proposal, and I look forward to the comments.

 4 Again, I want to thank the staff for its

 5 hard work, and I appreciate having all the

 6 briefings and discussions we've had over the last

 7 couple of weeks.

 8 Thank you.

 9 CHAIRMAN GENSLER: Thank you,

 10 Commissioner Wetjen. And I think with that, the

 11 staff will make presentations concerning their

 12 recommendations on final rules for Dodd- Frank.

 13 And following each of the discussions, the

 14 commission may take a vote on the recommendations

 15 as presented.

 16 To that end, I ask unanimous consent

 17 that all final votes conducted in this public

 18 meeting should be recorded votes, and the results

 19 of these votes be included in their relevant

 20 Federal Register releases.

 21 Not hearing any objection, thus so

 22 ordered. Mr. Stawick, do you mind telling me why
 46

 1 I couldn't just do that for all Dodd-Frank, and I

 2 wouldn't have to do it each meeting?

 3 MR. STAWICK: I cannot tell you why you

 4 can't do that for all other meetings.

 5 CHAIRMAN GENSLER: All right.

 6 MR. STAWICK: I think you can --

 7 CHAIRMAN GENSLER: So maybe if I could

 8 just ask unanimous consent, then, for the

 9 remainder of our meetings, we'll always do

 10 recorded votes, and then I won't have to ask that

 11 each time.

 12 So without objection -- okay. That's

 13 out of the script now.

 14 At this time, I'd like to welcome Bob

 15 Wasserman and Laura Astrada from the Division of

 16 Clearing and Risk, Martin White from the Office of

 17 General Counsel to present the staff's

 18 recommendation concerning the final rule. Though

 19 there are only three people at the table, that did

 20 not really go to the extent of all the people from

 21 the Office of the Chief Economist, from the Office

 22 of General Counsel's Office, Division of Clearing,
 47

 1 to the Division of Swaps and Intermediary

 2 Oversight, all the Commissioners' offices, even

 3 the Division of Market Oversight, if I can recall

 4 some meetings.

 5 So I thank everybody. But Bob and Laura

 6 and Martin --

 7 MR. WASSERMAN: Thank you, Mr. Chairman.

 8 I'm Robert Wasserman, of the Division of Clearing

 9 and Risk, and I am lead for the segregation

 10 bankruptcy team. I'd like to express my deep

 11 appreciation to my deputy, Laura Astrada, sitting

 12 to my right, and Martin White, of OGC, sitting to

 13 my left, as well as other members of my team -- my

 14 DCR colleague Alicia Lewis, Jennifer Bauer of Swap

 15 Dealer and Intermediary Oversight, and David

 16 Reiffen and Todd Prono, of the Office of the Chief

 17 Economist. This work could not have happened

 18 without their assistance.

 19 This final rule represents a culmination

 20 of a year and a half of extensive public

 21 consultation, including dozens of meetings with

 22 representatives of DCOs, FCMs on the buy side, an
 48

 1 advance notice of proposed rule making, a notice

 2 of proposed rule making and two public

 3 roundtables.

 4 Section 724 of Dodd-Frank requires FCMs

 5 and DCOs to segregate the cleared swaps collateral

 6 of swaps customers. The final rule before you for

 7 consideration implements this provision. The rule

 8 also implements certain technical amendments

 9 concerning time periods and bankruptcy from some

 10 earlier legislation.

 11 Segregation rules are designed to

 12 navigate through three concerns. First,

 13 customers, many of whom insist upon individual

 14 collateral protection with respect to their

 15 uncleared swaps, are concerned about fellow

 16 customer risk, the risk that a DCO would need to

 17 access the collateral of non- defaulting cleared

 18 swaps customers to cure an FCM default.

 19 Moreover, some firms have expressed

 20 concern about the impact of such a loss of

 21 collateral on portability -- that is, the ability

 22 to transfer customer positions from a failing firm
 49

 1 to a stable one, and the importance of avoiding

 2 disruptions that might be caused by a forced

 3 liquidation of customer positions.

 4 Second, some firms and clearinghouses

 5 expressed concern about the costs of changing from

 6 a model where customers are protected on an

 7 anonymous basis -- that is, as a group -- to a

 8 model where customers are protected individually.

 9 Third, we must operate within the limits

 10 of the bankruptcy code -- in particular, section

 11 766(h) of the bankruptcy code requires pro rata

 12 distribution of customer property.

 13 And the model that staff is recommending

 14 has been referred to as complete legal segregation

 15 or legally segregated but operationally comingled

 16 or LSOC.

 17 These rules permit operational

 18 comingling, allowing FCMs and DCOs to keep the

 19 cleared swaps collateral of a firm, swaps

 20 customers together, just as is done today under

 21 the futures model. This avoids the administrative

 22 costs of managing, accounting for and reconciling
 50

 1 collateral transfers between FCMs and DCOs for

 2 what may be thousands of customers on an

 3 individual basis.

 4 The rules require legal segregation.

 5 They oblige firms to transmit information defining

 6 the cleared swaps portfolios of their customers up

 7 to the DCO at least once a day. The DCO will use

 8 this information to calculate the collateral

 9 associated with each customer's portfolio of

 10 cleared swaps.

 11 The rules also allow DCOs to permit or

 12 to require excess or additional collateral for

 13 individual customers' portfolios, while tracking

 14 that collateral as attributable to the individual

 15 customer.

 16 In the event the FCM clearing member

 17 defaults to the DCO, the rules require the DCO to

 18 treat these portfolios individually, using only

 19 the collateral attributable to a customer whose

 20 portfolio reflects losses to meet those losses.

 21 The remaining collateral will be

 22 available to support a DCO's transfer of customer
 51

 1 portfolios to one or more transfer FCMs, will be

 2 returned to the bankruptcy trustee for

 3 distribution to customers.

 4 This model does not achieve perfect

 5 protection of customer collateral. Risks remain

 6 -- in particular, operational risk and investment

 7 risk. However, staff believes that this rule

 8 making strikes the best balance between achieving

 9 the goals of swaps customer collateral protection

 10 and fostering portability at a reasonable cost,

 11 all within the bounds of the bankruptcy code.

 12 We realized that there are some market

 13 participants -- they've been referred to, of

 14 course, this morning -- who seek perfect

 15 protection of collateral, even at significant

 16 added cost. You have set us the challenge of

 17 working with these market participants and FCMs

 18 and DCOs to devise additional measures to achieve

 19 such protection consistent with the goal of risk

 20 management and the constraints of the bankruptcy

 21 code. You have also charged us to examine

 22 additional protections for futures customer
 52

 1 collateral.

 2 We intended to meet these challenges

 3 with dispatch, and to properly provide you with

 4 proposals.

 5 Thank you.

 6 CHAIRMAN GENSLER: Thank you, Bob. With

 7 that, I will entertain a motion to consider the

 8 staff recommendation on segregation of cleared

 9 swaps.

 10 COMMISSIONER SOMMERS: So moved.

 11 COMMISSIONER O'MALIA: Second.

 12 CHAIRMAN GENSLER: With that, I intend

 13 to support this, I think, very critical rule --

 14 this Congress-mandated. Customers dealing in

 15 swaps should get the full benefit of segregation,

 16 and we had to do a rule. And I think this is an

 17 important step forward in protecting customers and

 18 reducing risk in the swaps trading.

 19 I think at the core, what it does is it

 20 ensures that at the clearinghouse, if one customer

 21 default brings down a futures commission merchant,

 22 a clearinghouse can't tap into another customer's
 53

 1 funds to cover that. Is that right, Bob and

 2 Laura?

 3 MR. WASSERMAN: Yes.

 4 CHAIRMAN GENSLER: So it increases the

 5 protection under our rules and under the

 6 bankruptcy code. Is that right?

 7 MR. WASSERMAN: Yes.

 8 CHAIRMAN GENSLER: Yeah. And so I

 9 support it. I know that there are some -- some of

 10 the letters that we've received recently that have

 11 asked us, can we do something with regard to third

 12 party custodial accounts, individual segregated

 13 accounts, guaranteed accounts? They seem to have

 14 different names by different models.

 15 But I do have a question about an

 16 interpretation that the CFTC put out in 2005

 17 called Interpretation 10-1. And two questions.

 18 Why have commenters raised this with us, in simple

 19 plain English? And does it apply to swaps?

 20 MR. WASSERMAN: So back in 1984, we had

 21 permitted certain third party custodial accounts

 22 to be used for futures. Of course, this was
 54

 1 before swaps were subject to our jurisdiction. In

 2 the early 2000s, some problems were seen with

 3 this.

 4 As a result, in 2005, essentially we

 5 pulled back from that 1984 interpretation. What

 6 the commission is doing in the preamble to this

 7 rule is making clear that that 2005 action does

 8 not apply to swaps, and so swaps customers would

 9 be able to use third party custodial accounts

 10 under the same conditions, under the same

 11 limitations as are set forth in the 1984 original

 12 Interpretation 10.

 13 CHAIRMAN GENSLER: So as I take it that

 14 third party custodial accounts as they existed

 15 from 1984 to 2005 were no longer allowed for

 16 futures, and the commenters asked, but did that

 17 speak to swaps? And we're saying in the preamble,

 18 no, it doesn't prohibit it in swaps -- at least,

 19 along the conditions that were set back in that 20

 20 year period.

 21 MR. WASSERMAN: Yes.

 22 CHAIRMAN GENSLER: But some commenters
 55

 1 have asked us to go a bit further -- that even if

 2 they, on a optional basis, wanted to go directly

 3 and set up -- there's so many titles of these

 4 things -- but individually segregated accounts or

 5 quit individual clearing accounts or guaranteed

 6 accounts, I think they're sometimes called --

 7 you'll conduct a roundtable and do your best to

 8 come back with recommendations to the commission

 9 as to what is achievable, that best protects

 10 customers and is within our laws.

 11 MR. WASSERMAN: Exactly.

 12 CHAIRMAN GENSLER: Great. So once

 13 again, I support this rule. I think it's a very

 14 critical rule. It is only to swaps. It is not

 15 yet to futures, and it shouldn't be confused that

 16 way, but I've asked staff to consider what would

 17 be appropriate -- what timing and to do a

 18 roundtable, and it might be subject to as much

 19 public comment as this was because this had

 20 enormous input from the public.

 21 But I think this is an important step

 22 forward, where swaps customers in essence will get
 56

 1 greater protection than if we had just gone with

 2 what's called the futures model. So I thank you.

 3 COMMISSIONER O'MALIA: Mr. Chairman, can

 4 I -- on that question you asked regarding the 2005

 5 ruling, can I ask a follow-on?

 6 CHAIRMAN GENSLER: Absolutely, as long

 7 as Commissioners don't mind the out of order.

 8 Sure, yeah.

 9 COMMISSIONER O'MALIA: Bob, can you tell

 10 us what the bankruptcy treatment will be if we get

 11 rid of the 2005 for swaps? What does the 1984

 12 bankruptcy treatment provide in pro rata

 13 distribution?

 14 MR. WASSERMAN: And as noted in the 1984

 15 interpretation, we basically said that we were

 16 concerned that persons making use of such accounts

 17 would mistakenly expect special treatment in the

 18 event of a bankruptcy. And so indeed, the pro

 19 rata distribution would continue to apply,

 20 regardless of the use of a third party account.

 21 CHAIRMAN GENSLER: I take it,

 22 Commissioner O'Malia, what some people have raised
 57

 1 and what hopefully staff can work on is, is there

 2 a way to both comply with Dodd-Frank section 4(d)

 3 -- is it F -- 4(df) and the bankruptcy code, but

 4 get the protections they would like through these

 5 individual accounts?

 6 COMMISSIONER O'MALIA: Won't that

 7 require an act of Congress?

 8 CHAIRMAN GENSLER: I don't know.

 9 MR. WASSERMAN: And I think that we can

 10 work with folks, and I think through some

 11 combination of this, make it so that they are not

 12 acting through FCMs but rather are guaranteed by

 13 FCMs in what would be a direct relationship with a

 14 clearinghouse, at which point then they would fall

 15 outside the definition of customer property, and

 16 that's how one works around 766(h).

 17 CHAIRMAN GENSLER: All I'm asking is

 18 that you get a lot of public input. And of

 19 course, anything -- even if we were to consider

 20 something, it would come back to this commission.

 21 It would be subject to notice and comment, and if

 22 it needs an act of Congress, then obviously we
 58

 1 probably should figure that out with the public

 2 input that we get.

 3 COMMISSIONER O'MALIA: Right. Well, we

 4 are running out of time. I mean, if customer

 5 protection actually hinges on bankruptcy reform,

 6 then Congress needs to get on with it.

 7 CHAIRMAN GENSLER: Which means, I guess

 8 -- is another spur to figure this out soon.

 9 MR. WASSERMAN: Yes, as I said, with

 10 dispatch.

 11 CHAIRMAN GENSLER: Thank you,

 12 Commissioner O'Malia. Commissioner Sommers?

 13 COMMISSIONER SOMMERS: Thank you, Mr.

 14 Chairman, and thank you again to this team for all

 15 your hard work.

 16 I have a couple of different questions

 17 that hinge a lot on how protections could extend

 18 to futures, and while I understand you are working

 19 on solutions that may extend to futures, can we

 20 expect that what may extend to those customers is

 21 the same solution that we're voting on today --

 22 that we would just simply extend this LSOC model
 59

 1 to futures?

 2 MR. WASSERMAN: I think in light of

 3 recent events, we're going to be considering a

 4 number of things. I think that I would certainly

 5 not say that the consideration would be limited to

 6 extending LSOC to futures.

 7 COMMISSIONER SOMMERS: Okay. So in

 8 light of potentially going further or doing

 9 something different, is it prudent to require DCOs

 10 to set up operationally the systems to allow them

 11 to implement LSOC by November 8 of this year if

 12 that is not what is going to be the eventual

 13 solution?

 14 So I guess what I'm saying is, if we go

 15 further and allow either optionality or some sort

 16 of completely segregated -- legally segregated --

 17 account, should we be, at this point, finalizing a

 18 rule that sets up a different system and asking

 19 people to go to the expense of setting that up

 20 when we may not use that?

 21 MR. WASSERMAN: I think it's at the last

 22 point where there may be a bit of distinction
 60

 1 because I think what we're dealing with here is

 2 LSOC is essentially the baseline that would be

 3 available for swaps customers. To the extent

 4 we're looking at additional matters for certain

 5 swaps customers, those would be over and above

 6 LSOC, which is that baseline, and those would be

 7 specific to those individual customers.

 8 I think there will be a lot of swaps

 9 participants who might not participate as much,

 10 who might not have as extensive accounts, for whom

 11 LSOC is where it stops because to do an individual

 12 relationship would be simply not cost beneficial

 13 given the nature of their relationship. And I

 14 think that might well be by number a very large

 15 number of the swaps participants.

 16 So what we're talking about in terms of

 17 individual customer protection, I think, or

 18 individual client protection or however it gets

 19 structured and denominated, is something that

 20 would be for a relatively small but very important

 21 sliver. That doesn't mean that LSOC is going to

 22 be thrown away -- rather, that's what's going to
 61

 1 be there as the baseline for, I think, by number,

 2 the majority of swaps customers.

 3 COMMISSIONER SOMMERS: Which sort of

 4 leads me back to my first question about futures.

 5 Will that end up being --

 6 MR. WASSERMAN: Well, my second point is

 7 --

 8 COMMISSIONER SOMMERS: Okay.

 9 MR. WASSERMAN: Right now, we have the

 10 futures model, and that plumbing, if you will, is

 11 there for futures customers. What will be

 12 happening between now and November 8 is the

 13 building and the testing and the implementation of

 14 LSOC for swaps customers. By implementing that

 15 for swaps customers, you're basically setting up

 16 the framework that would then, assuming the

 17 commission were to adopt LSOC for futures

 18 customers, could then be extended to the futures

 19 customers.

 20 So we have an existing futures model.

 21 We will have an LSOC model, and then essentially

 22 you'd be building off of that. And so it's not
 62

 1 that any of this is going to be just simply thrown

 2 away, but rather what you have is a building up.

 3 COMMISSIONER SOMMERS: Okay. So my next

 4 question relates to in the interim, those people

 5 who have swaps accounts and can take advantage of

 6 LSOC -- if they would like to take advantage of

 7 the type of netting efficiencies you would receive

 8 of having your futures and your swaps in the same

 9 account, will they be able to put their futures in

 10 their swaps account?

 11 MR. WASSERMAN: We have a process for

 12 putting futures in a swaps account, basically

 13 under section 4(d), and essentially those have

 14 been referred to as 4(d) orders. And

 15 historically, in a number of cases, have granted

 16 such orders.

 17 Moreover, as part of the DCO rules that

 18 were enacted back in November, we have a provision

 19 -- I believe it's 39.15 -- under which the DCO can

 20 request and by rule and providing certain

 21 information approval for comingling between

 22 futures and swaps. This would be generally done
 63

 1 based on particular contracts, at the request of

 2 the DCO, as opposed to an individual customer's

 3 account by account.

 4 COMMISSIONER SOMMERS: So this would

 5 have to be something that the DCO would initiate

 6 with us, not necessarily something a FCM or

 7 customer would initiate with the DCO.

 8 MR. WASSERMAN: Historically, that's the

 9 way it's proceeded.

 10 COMMISSIONER SOMMERS: Okay, okay. So

 11 again, I think just to point out -- and for the

 12 sake of beating this too much, this will be my

 13 last question with regard to futures.

 14 MR. WASSERMAN: Please.

 15 COMMISSIONER SOMMERS: If somebody who

 16 has a swaps account is able to put their futures

 17 in their swaps account and take advantage of

 18 greater customer collateral protection, I fear

 19 that the only people that are left out are those

 20 who do not have swaps accounts.

 21 MR. WASSERMAN: Again, I think this is

 22 done more on a product by product basis, and
 64

 1 generally, these rules -- putting futures in the

 2 swaps account generally has happened -- well, it

 3 hasn't happened yet, of course, but comingling,

 4 rather, in the same account has happened with

 5 products that are risk-related.

 6 COMMISSIONER SOMMERS: Right.

 7 MR. WASSERMAN: And so for instance,

 8 when you have a futures product --

 9 COMMISSIONER SOMMERS: Right.

 10 MR. WASSERMAN: -- and a swaps product

 11 that are -- and so I'm not sure that what you're

 12 suggesting --

 13 COMMISSIONER SOMMERS: Right.

 14 MR. WASSERMAN: -- would be as likely to

 15 happen --

 16 COMMISSIONER SOMMERS: Well --

 17 MR. WASSERMAN: -- but obviously --

 18 COMMISSIONER SOMMERS: So I guess what

 19 you could assume is that for products like

 20 commodities, there may not be the offsetting swaps

 21 position in commodities yet or -- right?

 22 MR. WASSERMAN: Yeah.
 65

 1 COMMISSIONER SOMMERS: More likely not

 2 for those accounts, instead of for financial

 3 futures, interest rates --

 4 MR. WASSERMAN: Yeah.

 5 COMMISSIONER SOMMERS: Thank you so

 6 much.

 7 CHAIRMAN GENSLER: Thank you,

 8 Commissioner Sommers. Commissioner Chilton?

 9 COMMISSIONER CHILTON: I don't have a

 10 question. I just wanted to make a quick

 11 statement, and then thank this team.

 12 But we continue to see a lot of the same

 13 people at the table here, who are really the stars

 14 of the agency. Bob Wasserman in particular has

 15 been a real star. He's worked extra hard on the

 16 MF Global circumstance, leaving his family during

 17 the holidays and being up in New York, and we

 18 thank you, Bob, and appreciate all the work that's

 19 going on -- not just the people at the table, but

 20 the people behind them -- but particular Bob.

 21 You've done a great job on this one, on the other

 22 things you've worked on.
 66

 1 Again, I don't have any questions.

 2 Thank you, Mr. Chairman.

 3 MR. WASSERMAN: Thank you.

 4 CHAIRMAN GENSLER: Thank you,

 5 Commissioner Chilton. That is true. Bob and

 6 Laura and Martin -- I mean, everything that you're

 7 doing is very significant for the public.

 8 Commissioner O'Malia?

 9 COMMISSIONER O'MALIA: This was kind of

 10 a tough rule for me. And Bob, we've gone round

 11 and round on this one, but I do appreciate the

 12 time you've spent. And Laura and Martin, all the

 13 work you've done on this rule.

 14 And Commissioner Sommers points out a

 15 significant flaw in this -- that it is one piece

 16 to a real customer protection regime. And it's

 17 not only segregation. There are many other kind

 18 of reforms that we really have to consider, and

 19 have to do so in a timely fashion, to really

 20 implement true customer protection, not just in

 21 segregation.

 22 This is, when you look at MF Global,
 67

 1 really a small part because what we're doing today

 2 doesn't even affect what happened at MF Global.

 3 So I was weighing the process issue

 4 versus the rule issue. And I decided I'd vote yes

 5 on this only because of the rule and only because

 6 it offers better customer portability and a

 7 customer to customer relationship. The

 8 operational risks exist. The bankruptcy

 9 challenges exist. We've got two trustees. We've

 10 got a trustee not in the FCM model, but we're

 11 balancing that against -- and in any trustee

 12 situation, we're always going to find a pro rata

 13 situation that's going to limit our ability,

 14 despite what our part 190 rules say about moving

 15 and porting positions. You get into that trustee

 16 business, everything stops.

 17 And I know they're trying to be careful,

 18 and I know they're trying to look out for

 19 customers, but we can't promise more than we can

 20 deliver on these things, and we should be very

 21 clear about what this rule delivers.

 22 I have a bunch of questions along these
 68

 1 lines, and so just be patient with me, and the

 2 shorter the answers, the quicker it'll go.

 3 And we're applying just this LSOC model

 4 -- and I believe it's a complete misnomer to call

 5 it complete legal segregation. I think we

 6 continue to confuse the issue, but let's just

 7 stick with LSOC.

 8 First of all, it does not apply to

 9 futures customers at all, correct?

 10 MR. WASSERMAN: Correct.

 11 COMMISSIONER O'MALIA: In many ways, the

 12 operational structures that this final rule making

 13 creates is modeled on the future segregation

 14 structure, correct?

 15 MR. WASSERMAN: Correct.

 16 COMMISSIONER O'MALIA: So would it be

 17 fair to say to the extent that future segregation

 18 structures may have vulnerabilities, this rule

 19 making may share in such vulnerabilities?

 20 MR. WASSERMAN: Correct.

 21 COMMISSIONER O'MALIA: If the commission

 22 were to reconsider such aspects of the future
 69

 1 segregation structure, would the commission need

 2 to make similar changes in this final rule making

 3 -- if we were going to fix more broadly the

 4 operational risks?

 5 MR. WASSERMAN: This is when I'll have

 6 to do more than one word. I would say that I

 7 think if we consider doing added things in

 8 futures, I would expect we would continue doing

 9 those same added things in swaps. My point being

 10 that we would be building on the structure rather

 11 than ripping the structure out.

 12 COMMISSIONER O'MALIA: So an

 13 intermediary may be making technological

 14 investments is directed in this final rule making

 15 only to be potentially redirected -- and

 16 potentially even this year.

 17 MR. WASSERMAN: That's where I'm

 18 pointing out that I think these would be -- they

 19 might well be making additional investments. I

 20 don't believe that they would be essentially

 21 building something up only to rip it out and put

 22 something different in its place. I would see
 70

 1 this as something additional.

 2 COMMISSIONER O'MALIA: Okay, thank you.

 3 To highlight some of the operational limitations

 4 --

 5 What is operational risk and what is

 6 investment risk?

 7 MR. WASSERMAN: Operational risk in this

 8 context essentially comes from the operations of

 9 the entity, and one thing that is included in this

 10 context is from people misusing funds -- whether

 11 intentionally or accidentally.

 12 And investment risk -- as you know, we

 13 have our Rule 125 and this parallels 125. And

 14 while Rule 125 -- the commission has since --

 15 recently, of course, tightened up to reduce the

 16 investment risk, investment risk remains in

 17 anything really other than cash.

 18 COMMISSIONER O'MALIA: So is it fair to

 19 say that even for cleared swaps customers, this

 20 rule making does not mitigate operational risk,

 21 nor does it mitigate investment risk?

 22 MR. WASSERMAN: I think that would
 71

 1 probably be a bit too far. It does mitigate it to

 2 the same extent that these rules that we have --

 3 which, in fairness, while there have been

 4 failures, they do tend to work mostly and most of

 5 the time.

 6 And so to the extent we have segregation

 7 rules in the futures models, we are having much

 8 the same in this model. To the extent we have

 9 limitations on investments of customer funds, in

 10 the futures model, there will be exactly the same

 11 in this model. And so it is mitigated but not

 12 perfectly so.

 13 COMMISSIONER O'MALIA: Do you want to

 14 elaborate on the customer to customer

 15 relationship, in terms of what that protects -- in

 16 terms of portability?

 17 MR. WASSERMAN: I'm not sure I

 18 understand the question. Sorry.

 19 COMMISSIONER O'MALIA: What does this

 20 operationally provide for -- protections -- you

 21 want to elaborate on the -- you indicated that

 22 there are operational protections this does
 72

 1 provide for. What are they?

 2 MR. WASSERMAN: Essentially, this

 3 requires FCMs to treat customer funds as belonging

 4 to the customers. And so for instance, it is an

 5 FCM's responsibility -- and of course, we have

 6 capital requirements and supervision requirements

 7 over FCMs to make sure that they are fulfilling

 8 their responsibilities, and that they have the

 9 wherewithal to do so.

 10 And so if one customer loses money, it

 11 is the FCM's responsibility to have that money in

 12 segregation in advance so that at each point, the

 13 FCM has enough money to meet its obligations to

 14 all those customers with positive balances, and

 15 that they're not using one customer's money to

 16 margin guarantee or secure, as the statute has it,

 17 another customer's positions.

 18 And so it is the FCM's responsibility to

 19 use their own capital to do this, and we have

 20 capital rules to make sure they have the

 21 wherewithal to do that.

 22 COMMISSIONER O'MALIA: As I understand
 73

 1 it, fellow customer risk, as defined in this rule

 2 making, does not extend to any collateral that an

 3 intermediary holds outside of the DCO. So any

 4 excess collateral that a cleared swaps customer

 5 may provide to its intermediary is not protected.

 6 Is that correct?

 7 MR. WASSERMAN: One of the changes we

 8 made as a result of a comment is that excess

 9 collateral can be sent to the DCO, but to the

 10 extent you're asking if there's collateral that is

 11 held at the FCM, is that subject to operational

 12 risk? And the answer is, of course, yes.

 13 COMMISSIONER O'MALIA: Okay. In the DCO

 14 core principles rule making, we state that a DCO

 15 must require its clearing members to collect

 16 excess collateral. Do we have a conflict here? I

 17 mean, we obviously have operational risk. In

 18 another rule making, we put a premium on excess

 19 collateral.

 20 So how do we solve this? I think that

 21 to some of Commissioner Sommers's concerns, that's

 22 another step that we have to think about. But
 74

 1 we've identified a weakness, obviously.

 2 MR. WASSERMAN: I'm not sure I would

 3 agree, and here's why. First off, as I mentioned,

 4 excess -- the requirement under the DCO rule

 5 making is that they must collect collateral in an

 6 amount greater than that which would be required

 7 from the FCM acting, in other words, as a direct

 8 clearing member.

 9 It is possible that this excess

 10 collateral would be staying at the FCM. It is

 11 also possible that the FCM, under this rule, would

 12 be sending that higher level of collateral, that

 13 excess collateral, to the DCM.

 14 And so no, there's not an inherent

 15 conflict. Moreover, again, I think in light of

 16 recent events, we're going to be looking at how

 17 the seg system works and whether there are

 18 additional things that should be put on top of the

 19 rules we currently have.

 20 And so I think that part of that process

 21 would be addressing this, but also, as I say, that

 22 excess collateral could be sent to, could be
 75

 1 required by, the DCO.

 2 COMMISSIONER O'MALIA: Yeah. I get the

 3 importance of having excess and protection. That

 4 mitigates risk. That's a cushion. Everybody

 5 understands that. But we also have to be honest.

 6 We have to put in place the proper protections to

 7 ensure that's taken care of.

 8 Obviously people have, including myself,

 9 have agreed that the rule making needs to be

 10 adopted now because swaps are being cleared now.

 11 The company collateral is therefore vulnerable to

 12 fellow customer risk.

 13 I'm trying to understand, in some

 14 respects, the timing of this. The Chairman and I

 15 have talked about at this dais when the clearing

 16 mandate begins. And how does this work with a seg

 17 rule that it becomes operational in November, and

 18 we potentially could have a mandatory clearing

 19 requirement in third quarter, end of second

 20 quarter?

 21 How do we rationalize and bring this

 22 together? Will we have protections in place? Are
 76

 1 we going to force them to go to a -- whatever's

 2 existing in a DCO today and then change again in

 3 November?

 4 MR. WASSERMAN: And so we already do

 5 have some protections for cleared swaps now, as

 6 you quite rightly said. I am focused on these

 7 requirements, and we're implementing this at the

 8 implementation date of November 8 -- is the same

 9 time at which the gross margining requirement

 10 under the DCO rule becomes effective, and thus

 11 because this rule requires gross margining to

 12 work, that's when this becomes effective.

 13 My familiarity with all the

 14 implementation issues is a little bit thin, and so

 15 I'm not sure I'm the best guy to answer those

 16 questions.

 17 COMMISSIONER O'MALIA: Well, I agree.

 18 CHAIRMAN GENSLER: May I --

 19 COMMISSIONER O'MALIA: Please.

 20 CHAIRMAN GENSLER: Sure. I think you

 21 raise a very good point. I see Sarah Josephson

 22 here, who's been sort of --
 77

 1 COMMISSIONER O'MALIA: So this is

 2 Sarah's fault?

 3 CHAIRMAN GENSLER: No, no.

 4 COMMISSIONER O'MALIA: Okay.

 5 CHAIRMAN GENSLER: Actually, I think it

 6 works. I think it works because we haven't yet

 7 gotten a comment summary up to Commissioners on

 8 the comments from the implementation phasing, but

 9 as you recall, the clearinghouses start the

 10 process. They haven't kicked it off yet, so I

 11 don't know when that 90 day process will start.

 12 So part of it is when does that start.

 13 The first bucket or the first group was

 14 dealer to dealer, and I guess the high activity

 15 hedge funds. So we would have to think through --

 16 and I don't know what the commenters have said

 17 there to here. So I think your question is a very

 18 good question that needs to be joined when we

 19 start to look at those comments. If that first

 20 bucket -- in essence, if that first bucket is

 21 before November 8, then it is -- but most of that

 22 bucket is dealer to dealer, which wouldn't be in
 78

 1 -- because this is customer money.

 2 MR. WASSERMAN: Yeah, this would not

 3 affect dealer to dealer.

 4 COMMISSIONER O'MALIA: Well, obviously

 5 if we're going to explain where we are going with

 6 cleared customer money, then that's going to

 7 dictate obviously a big change in the industry.

 8 They're going to have to adopt this. They're not

 9 going to want to adopt multiple proposals -- I

 10 mean, to Commissioner Sommers's point -- so we

 11 just have to be clear and get the phasing right so

 12 everybody understands.

 13 We did say, I believe, in that rule

 14 making that people who want to clear earlier can

 15 do so if they want, and that may include

 16 customers.

 17 CHAIRMAN GENSLER: That's right.

 18 COMMISSIONER O'MALIA: What does their

 19 universe look like?

 20 CHAIRMAN GENSLER: Right. But that was

 21 voluntary, rather than mandatory.

 22 COMMISSIONER O'MALIA: But --
 79

 1 MR. WASSERMAN: And there is, under our

 2 2010 cleared OTC rule, there is protection for

 3 that collateral if the DCO rules require

 4 segregation. And so in this case, if customers

 5 voluntarily choose to clear -- and of course, by

 6 doing so, mitigating counterparty risk -- their

 7 customer collateral would be protected, assuming

 8 the DCO -- I know for instance CME has implemented

 9 just such a rule, and so collateral for cleared

 10 swaps at, say, the CME or anyone else, any other

 11 DCO which adopts a requirement for segregation --

 12 and that's what would be in effect prior to

 13 November 8. That collateral would be protected as

 14 part of the cleared OTC account class.

 15 COMMISSIONER O'MALIA: So what is the

 16 process for -- if they clear under that rule and

 17 then have to come in compliance with an LSOC rule,

 18 what is the process for -- what do they have to do

 19 to switch segregation regimes?

 20 MR. WASSERMAN: There's not a whole --

 21 COMMISSIONER O'MALIA: And if you get

 22 out of the position?
 80

 1 MR. WASSERMAN: I don't -- no, forgive

 2 me. This is -- these rules apply to the FCM, and

 3 this tells the FCM and DCO, this is what you must

 4 do with customer collateral. And so a customer

 5 who has cleared swaps, say, on November 7 and

 6 through November 9, there is nothing they will

 7 need to do.

 8 What the FCM will need to do is on

 9 November 7, prior to November 8, they would be

 10 subject to the DCO rule. The DCO rule -- my

 11 understanding of the CME rule, having worked with

 12 them a bit on it, is it is very analogous to what

 13 we have under the futures model and, as we

 14 discussed earlier, the cleared swaps rule, in

 15 terms of the basic requirements, is also

 16 analogous.

 17 In short, they would need to do certain

 18 additional things in terms of providing

 19 information about portfolios of positions to the

 20 DCO, and the DCO would be receiving that, and

 21 tracking it and making calculations on November 8

 22 that they wouldn't be making or wouldn't be
 81

 1 required to make on November 7.

 2 But essentially, what you're talking

 3 about is a model that, in terms of its

 4 implementation, I think would be very similar from

 5 the seventh to the eighth. There would just be

 6 some additional things in terms of information

 7 flow that would be going up.

 8 And then what could be done with that

 9 information in the event of a default? That's

 10 what would change November 8 versus November 7.

 11 COMMISSIONER O'MALIA: Just one final

 12 comment. To the extent that we're going to

 13 continue to make changes to this -- let's not do

 14 it in a piecemeal approach. Let's try to get our

 15 ducks in a row on customer protections across

 16 FCMs, DCOs, et cetera, to understand what the full

 17 universe looks good, as opposed to rushing ahead

 18 and providing third party while we leave futures

 19 customers in third place, which is kind of where

 20 Bob pointed out.

 21 We've talked about providing complete

 22 legal segregation or third party segregation.
 82

 1 Well, that's all well and good to direct the

 2 staff, but what about the futures customers?

 3 And to further -- let's talk to the Hill

 4 about it because I remember when this first came

 5 up. It was because we were doing it because of

 6 the magic letter S -- whether it was customer or

 7 customers. Obviously there was a strong -- I

 8 think we put out a memorandum justifying why we

 9 had no other choice but to do it because of the

 10 magic S or the lack thereof. Let's make sure that

 11 the Hill is -- that this time, we're clear about

 12 what the Hill expects for this, and we engage with

 13 them as we look for -- because these are --

 14 CHAIRMAN GENSLER: Gary Barnett, don't

 15 leave.

 16 COMMISSIONER O'MALIA: So --

 17 CHAIRMAN GENSLER: I was just going to

 18 say -- no, Gary -- so just -- Gary Barnett is part

 19 of this too. You should be -- you can leave in 30

 20 seconds, but your staff at the Division of Swap

 21 and Intermediary Oversight also should be involved

 22 and engaged in these roundtables and so forth
 83

 1 because I agree with, I think, what Commissioner

 2 O'Malia is saying -- is that we want to look at

 3 this customer protection thing thoughtfully, hear

 4 from the public, hear from the Hill in a

 5 thoughtful way, across these divisions and these

 6 topics.

 7 The only thing is, it may well be that

 8 something becomes ripe and all five of us say,

 9 well, no, this is something that we can do, and

 10 there might be other things that need statutory

 11 changes that would take longer.

 12 COMMISSIONER O'MALIA: And that's why we

 13 have to engage the Hill -- because we could come

 14 up to significant bankruptcy rule changes. On pro

 15 rata distribution, pointing out the 1985 and 2005

 16 guidance -- that we may not be able to give them

 17 the protection they think they want in bankruptcy.

 18 And obviously the MF Global trustee issue is

 19 pointing out where we're stuck with bankruptcy.

 20 CHAIRMAN GENSLER: Mr. Barnett, you can

 21 leave now. Thanks. Thank you.

 22 Commissioner Wetjen?
 84

 1 COMMISSIONER WETJEN: I'd just like to

 2 point out, it's a number of tough acts to follow

 3 -- some very good questions.

 4 COMMISSIONER O'MALIA: I've been there.

 5 COMMISSIONER WETJEN: Does that mean you

 6 have sympathy or that you don't have sympathy?

 7 COMMISSIONER O'MALIA: Not anymore.

 8 CHAIRMAN GENSLER: He might have advice,

 9 though. You always want to have a good line about

 10 Macy.

 11 COMMISSIONER WETJEN: Thanks again to

 12 the team for your work on this rule.

 13 One thing I still have on Commissioner

 14 O'Malia is that I'm younger than he is. But my

 15 shorter time on this Earth, I've already

 16 discovered that life is a series of tradeoffs a

 17 lot of times, and in each of these rules, I think

 18 we've had to make some.

 19 And one of them is with respect to FCMs

 20 and the risk management processes. And one of the

 21 things that has come up in my discussions is that

 22 when there is exposure to fellow customer risk, it
 85

 1 actually has a good effect on FCMs because it

 2 forces them to be more careful and to develop

 3 better risk management processes, knowing that

 4 they might not attract customers without those

 5 processes in place.

 6 So we're trying to do away with a lot of

 7 the fellow customer risk here with LSOC, but what

 8 kind of an effect is that going to have on the

 9 FCMs' risk management processes? And clearly the

 10 rule has made a judgment about that, and has

 11 decided to go the direction of the LSOC anyway,

 12 but I wondered if you'd just provide some comments

 13 about why we've gone in the direction we've gone

 14 in. Why do those --

 15 MR. WASSERMAN: And I guess I would

 16 answer that -- as some of the customers have

 17 pointed out, what this will do is enhance the

 18 incentive of the DCO, who is now closer to the

 19 risk to risk manage their FCM members. Now of

 20 course, DCOs are already responsible for risk

 21 managing their members. They already have

 22 programs in place. They are, in fact -- first
 86

 1 off, because they're more concentrated, this is

 2 essentially their main job. They have departments

 3 devoted to this in a better position.

 4 And most importantly, this information

 5 about fellow customers -- that if I go to an FCM

 6 and I ask about my fellow customers, there's a

 7 limit to how much information they can give me

 8 because of issues with confidentiality. The DCO,

 9 on the other hand, is a market neutral, and a

 10 self-regulatory organization. So they can go to

 11 the FCM and ask very specific questions about

 12 specific fellow customers about whom the DCO is

 13 already getting information on.

 14 And so the DCO, I think, is

 15 well-positioned to make sure that its member FCMs

 16 have excellent risk management.

 17 COMMISSIONER WETJEN: Thanks for the

 18 explanation. Commissioner O'Malia had talked

 19 about a number of different risks that remain,

 20 even with LSOC. And one of them that caught my

 21 attention relates to the payment processes that

 22 clearing organizations use.
 87

 1 And so in the event of a double default

 2 of an FCM and a customer, you could still have a

 3 situation where a DCO is going to have to net

 4 payments to defaulting customers with payments --

 5 I should say payments from defaulting customers

 6 with payments owed to non-defaulting customers.

 7 Could there have been a way for the rule

 8 to address that? And if so, why haven't we done

 9 that here? As I understand, it could very well be

 10 a situation that it's not really resolvable. But

 11 I wondered if the staff had considered this

 12 particular risk.

 13 MR. WASSERMAN: There are some

 14 additional things that DCOs will be able to do.

 15 Right now, the rule requires, based on our

 16 assessment of where the state of the art was at

 17 the time we were looking at this and is now,

 18 requires information to essentially go up once a

 19 day -- no less frequently than once a day.

 20 But that's no less frequently. And so

 21 it is currently open to DCOs to require that their

 22 members provide that information more frequently
 88

 1 -- or indeed, as I understand, some DCOs may be

 2 looking at requiring that each transaction be

 3 associated with a particular customer so that the

 4 DCO could essentially do this on a quasi-realtime

 5 basis.

 6 And so even within the rule as it's

 7 structured, DCOs could, by requiring that

 8 information, more frequently lessen the risk that

 9 you're referring to. And it may be the case that

 10 as the state of the art develops, we realize that

 11 in fact this is really the practice that folks are

 12 doing -- in which event we might then change the

 13 rule to require that.

 14 But at the present time, looking at

 15 where we are, we didn't yet require it, and so

 16 that, to a certain extent, limits the protection.

 17 But it limits the required protection. Again, a

 18 DCO is perfectly free, even today, to start

 19 requiring that their members provide that

 20 information on a realtime basis. And so that

 21 would then reduce that risk.

 22 COMMISSIONER WETJEN: Thanks, Bob. I
 89

 1 had a question about third party safety accounts,

 2 but the Chairman had already covered that, and

 3 also one about the interplay with the bankruptcy

 4 code and our rules, which Commissioner O'Malia had

 5 touched on, but the one other thing I wanted to

 6 mention or ask about -- and it relates to one of

 7 Commissioner Sommers's questions.

 8 We had heard from some commenters as

 9 recently as yesterday about the kinds of effects

 10 LSOC would have on the futures space. And I'm

 11 wondering if the staff had considered that, and

 12 what sort of discussions you might have had.

 13 For example, I think -- as I understood

 14 one of these comments, with the perceived greater

 15 protections of LSOC and swaps, you might actually

 16 drive a lot of trading volume to swaps and away

 17 from futures, and that could have a number of

 18 different pricing consequences for the futures

 19 markets, for participants who are more comfortable

 20 using futures, have been using them for a long

 21 time and otherwise would plan to continue to do

 22 so.
 90

 1 So I'm wondering what kinds of

 2 discussions the staff had about this particular

 3 problem -- if that's something that's come up

 4 before.

 5 MR. WASSERMAN: I think the answer is

 6 that -- of course, with the swaps and the futures

 7 markets sort of moving closer together, to the

 8 extent that you have liquidity going to the swaps

 9 markets, you might well have customers following

 10 that liquidity.

 11 And so to the extent you have particular

 12 contracts in the futures markets that lose

 13 liquidity because of a corresponding contract in

 14 the swap market, then you might find customers

 15 following that liquidity to the swap market.

 16 To the extent you have the same

 17 contracts or similar contracts, then you might

 18 well have DCOs essentially putting in rules under

 19 that 39.15 that I mentioned, whereby essentially

 20 there would be moving the futures collateral into

 21 the swaps account, and the approach we take in the

 22 rule is that if you have futures in the swaps
 91

 1 account, then the customers would -- and the

 2 collateral would -- enjoy the protections of the

 3 swaps account.

 4 It also works the other way around, and

 5 so if you put swaps in the futures account, then

 6 you would have those protections.

 7 And so I guess there's a number of ways

 8 of looking at it. And finally, as I pointed out,

 9 we are going to be looking with great dispatch at

 10 what else we can do for the futures customers and

 11 the futures accounts.

 12 COMMISSIONER WETJEN: When I read these

 13 comments -- I mean, I think felt some of the same

 14 things, had some of the reactions I'm hearing that

 15 Commissioner Sommers had, which is you have -- I

 16 don't want to use this in a pejorative sense, but

 17 perhaps less sophisticated market participants who

 18 could be left disadvantaged somehow by this

 19 process.

 20 I don't think, based on your answer and

 21 some of the other discussions we've had, I don't

 22 think it's a reason for us to not move forward
 92

 1 with LSOC today, especially given the fact we

 2 already have swaps being cleared. But I do think

 3 it's a legitimate issue, and something that we

 4 should all be mindful of.

 5 MR. WASSERMAN: Clearly, and we are

 6 limited today because under the Administrative

 7 Procedure Act, the commission can only adopt --

 8 COMMISSIONER WETJEN: Right.

 9 MR. WASSERMAN: -- what was proposed or

 10 a logical outgrowth. But certainly we're going to

 11 be looking at a lot of these things very quickly,

 12 to see basically what more we can do.

 13 COMMISSIONER WETJEN: Thank you.

 14 Thanks, Bob.

 15 CHAIRMAN GENSLER: Thank you,

 16 Commissioner Wetjen. If there are not further

 17 questions, then Mr. Stawick.

 18 MR. STAWICK: Commissioner Wetjen?

 19 COMMISSIONER WETJEN: Aye.

 20 MR. STAWICK: Commissioner Wetjen, aye.

 21 Commissioner O'Malia?

 22 COMMISSIONER O'MALIA: Aye.
 93

 1 MR. STAWICK: Commissioner O'Malia, aye.

 2 Commissioner Chilton?

 3 CHAIRMAN GENSLER: So now we know what

 4 those two beeps were on the phone. I thought it

 5 was Commissioner O'Malia's sort of thing to keep

 6 your answers short, but it apparently cut

 7 Commissioner Chilton off.

 8 MR. STAWICK: Commissioner Sommers?

 9 COMMISSIONER SOMMERS: No.

 10 MR. STAWICK: Commissioner Sommers, no.

 11 Mr. Chairman?

 12 CHAIRMAN GENSLER: I'm going to do two

 13 things for you, Mr. Stawick. I'm reading a

 14 proxy -- this is to certify that the undersigned,

 15 Mark Chilton, he's left a proxy in support of the

 16 final rule on protection of cleared swaps

 17 customers, contracts and collateral on conforming

 18 amendments, commodity broker, bankruptcy

 19 provision.

 20 This is so the public knows. This was

 21 left in case there was some problem with the

 22 telephones.
 94

 1 MR. STAWICK: Commissioner Chilton is

 2 noted as voting aye. Mr. Chairman?

 3 CHAIRMAN GENSLER: Aye.

 4 MR. STAWICK: Mr. Chairman, aye. Mr.

 5 Chairman, on this question, the yays are four, the

 6 nays are one.

 7 CHAIRMAN GENSLER: I thank you, Mr.

 8 Stawick. The ayes have it. The staff

 9 recommendation is accepted, given that the

 10 majority has passed it.

 11 So I thank you, Mr. Wasserman, Ms.

 12 Astrada, Mr. White. You have a lot of work still

 13 do to, obviously to get this in the Federal

 14 Register, but also on the roundtables, and to give

 15 thoughtful consideration to all that the five

 16 Commissioners have asked you to give thoughtful

 17 consideration to -- because we all asked you a

 18 lot. But thank you.

 19 The second group that's going to come up

 20 to the table, I think, is a group to discuss rules

 21 on external business conduct -- Phyllis Cela, Ted

 22 Kneller, Charles McCarty, all from the Division of
 95

 1 Enforcement, to present the staff's recommendation

 2 concerning a final row of business conduct

 3 standards.

 4 Charles, you and I both, think, twinged

 5 and I couldn't help it. No, it's not Pat McCarty

 6 here today. Pat's back there, is he? Where is

 7 Pat? There you are, man. My twin doesn't do that

 8 to me. God help us when he does.

 9 All right. It's over to you.

 10 MS. CELA: Okay. Thank you, Mr.

 11 Chairman. I'm joined today by Ted Kneller and

 12 Barry McCarty.

 13 Ted is our specialist in special entity

 14 issues, and Barry has been working hard and

 15 specializing in the disclosure issues.

 16 Good morning, and before presenting an

 17 overview of the final rules, I'd like to

 18 acknowledge the rest of the team as well -- Katie

 19 Driscoll, Michael Solinski, Todd Prono, Peter

 20 Sanchez, and colleagues in OGC, Mark Higgins and

 21 Rob Schwartz.

 22 We have worked closely with our
 96

 1 counterparts at the SEC, and I would like to

 2 acknowledge Lourdes Gonzalez, the team leader

 3 there.

 4 In the course of preparing the final

 5 rules, we received very helpful comments from

 6 numerous stakeholders through letters and

 7 consultations, and also from staff at fellow

 8 regulators, in particular the Department of Labor.

 9 Section 731 of the Dodd-Frank Act adds

 10 section 4(sh) to the Commodity Exchange Act, and

 11 requires the commission to promulgate rules to

 12 establish business conduct standards for swap

 13 dealers and major swap participants dealing with

 14 counterparties generally.

 15 In addition, Dodd-Frank requires the

 16 commission to promulgate rules to implement

 17 special protections for special entities,

 18 including governmental entities, public and

 19 private pension plans, and endowments.

 20 The final rules are informed by

 21 statutory language in section 4(sh), Congressional

 22 intent, existing requirements for market
 97

 1 professional under the CEA and commission

 2 regulations, securities law, SRO requirements,

 3 industry best practices, comment letters and

 4 consultations with stakeholders and regulators.

 5 Generally, the rules require swap

 6 dealers and major swap participants to engage in

 7 fair dealing, make disclosures of material

 8 information and undertake due diligence concerning

 9 their counterparties.

 10 Major swap participants are excluded

 11 from some of the due diligence requirements based

 12 on the nature of their swaps business.

 13 The rules were designed where possible

 14 to avoid creating trading delays, imposing market

 15 entry barriers for counterparties and chilling

 16 communications between swap dealers or major swap

 17 participants and their counterparties.

 18 For example, where appropriate, the

 19 final rules allow compliance on a relationship

 20 basis by including the prior disclosures and

 21 counterparty representations in master agreements.

 22 Also, certain rules provide safe harbors
 98

 1 that mitigate compliance risk. The release states

 2 that in exercising its prosecutorial discretion

 3 for violation of these rules, the commission will

 4 consider whether the swap dealer or major swap

 5 participant complied in good faith with its

 6 policies and procedures.

 7 There are two broad categories of rules.

 8 First, rules that apply to deals with virtually

 9 all counterparties. And two, rules that apply to

 10 dealings with special entities.

 11 In response to commenters' concerns, the

 12 release confirms that the external business

 13 conduct standards rules do not cause swap dealers

 14 or major swap participants to be advisers or

 15 otherwise owe fiduciary duties to counterparties

 16 solely by virtue of compliance with the rules.

 17 In addition, the rule provides an

 18 exclusion from the commodity trading adviser

 19 definition for swap dealers whose advice is solely

 20 incidental to their business as a swap dealer.

 21 We also understand from the Department

 22 of Labor that compliance with the final business
 99

 1 conduct standards rules alone will not cause a

 2 swap dealer or major swap participant to become an

 3 ERISA fiduciary under existing ERISA law.

 4 We are continuing to discuss with SEC

 5 staff the treatment of swap dealers and major swap

 6 participants under the municipal adviser

 7 definition as the SEC continues to consider final

 8 registration rules for municipal advisers.

 9 The rules will apply to swap dealers and

 10 major swap participants when they know their

 11 counterparties prior to entering into a swap.

 12 Often these will be uncleared bilateral swaps.

 13 The disclosure and due diligence

 14 requirements will not apply to swaps initiated on

 15 a designated contract market or a swap execution

 16 facility where the swap dealer or major swap

 17 participant does not know the identity of the

 18 counterparty prior to execution.

 19 The general provisions contain

 20 prohibitions against fraud, manipulation and

 21 abusive practices, incorporating the statutory

 22 text from new section 4(sh)4.
 100

 1 The final rule adds an affirmative

 2 defense to fraud violations that are based on the

 3 business conduct standards rules.

 4 The final rules also protect

 5 confidential counterparty information, but do not

 6 adopt the proposed freestanding trading ahead or

 7 front running rule.

 8 The rules require disclosure of material

 9 risks and characteristics of the swap, and the

 10 material incentives and conflicts of interest of

 11 the swap dealer or major swap participant in

 12 connection with the swap.

 13 Unlike the proposed rule, only swap

 14 dealers will be required to provide a scenario

 15 analysis, and only upon request for swaps that are

 16 not made available for trading on a SEF or a DCM.

 17 The final verification of eligibility

 18 rule includes a safe harbor to facilitate

 19 compliance. For uncleared swaps, swap dealers and

 20 major swap participants must provide a daily mark,

 21 which is defined as the mid-market mark of the

 22 swap.
 101

 1 Swap dealers and major swap participants

 2 will be required to communicate to counterparties

 3 in a fair and balanced manner, based on principles

 4 of fair dealing and good faith. The final rules

 5 also include an institutional suitability rule

 6 that applies when swap dealers make

 7 recommendations to counterparties.

 8 The final suitability rule is harmonized

 9 with the SEC and FINRA requirements, and includes

 10 safe harbors that rely on the exchange of

 11 particular representations by the parties.

 12 The adopting release also includes an

 13 appendix to the rules providing guidance to swap

 14 dealers that make recommendations under the

 15 suitability rule and the special entity adviser

 16 rule.

 17 The final rules referring the definition

 18 of special entity for certain municipal special

 19 entities and employee benefit plans -- a swap

 20 dealer will act as an adviser to a special entity

 21 when it recommends a swap or trading strategy

 22 involving a swap that is tailored to the
 102

 1 particular needs or characteristics of the special

 2 entity. The adopting release confirms that the

 3 best interest duty is not a fiduciary duty under

 4 this rule.

 5 The final rule includes two safe harbors

 6 -- one for ERISA plans and the other for all

 7 special entities. For ERISA plans, a swap dealer

 8 will not be acting as an adviser to a special

 9 entity if the plan represents that it has an ERISA

 10 fiduciary coupled with several other

 11 representations.

 12 Under the second safe harbor, the swap

 13 dealer will not be subject to a best interest duty

 14 if it does not express an opinion as to whether

 15 the special entity should enter into a recommended

 16 swap, and then the special entity represents that

 17 it will not rely on the swap dealer, will rely on

 18 advice if it's an independent representative and

 19 the swap dealer discloses that it is not acting in

 20 the special entity's best interests.

 21 Swap dealers and major swap participants

 22 that offer to or enter into a swap with a special
 103

 1 entity other than an ERISA plan must have a

 2 reasonable basis to believe -- excuse me -- that

 3 the special entity has a representative that meets

 4 certain criteria, including independence from the

 5 swap dealer or major swap participant.

 6 The rule includes a safe harbor for the

 7 swap dealer or major swap participant where the

 8 special entity and representative represent that

 9 they have complied in good faith with policies and

 10 procedures reasonably designed to ensure that the

 11 representative satisfies the applicable criteria.

 12 For ERISA plans, a swap dealer or major

 13 swap participant will have a reasonable basis to

 14 believe that the plan has an independent

 15 representative if that representative is an ERISA

 16 fiduciary.

 17 The final special entity rules also

 18 adopt pay to play restrictions for swap dealers

 19 when dealing with governmental special entities.

 20 This rule is harmonized with existing

 21 security-side rules for investment advisers and

 22 municipal securities dealers.
 104

 1 The final rules do not include the

 2 proposed swap execution standards rule, and should

 3 the commission determine to consider such a rule

 4 in the future, it will repropose the rule.

 5 Thank you, and I am happy to try to

 6 answer any questions. Sorry for the length.

 7 CHAIRMAN GENSLER: Thank you, Phyllis,

 8 Ted and Barry. I don't know why I say Charles.

 9 Is that --

 10 MR. MCCARTY: It's my first name.

 11 CHAIRMAN GENSLER: Your first name.

 12 COMMISSIONER WETJEN: It always throws

 13 me off, Mr. Chairman.

 14 CHAIRMAN GENSLER: What's that?

 15 COMMISSIONER WETJEN: When everyone

 16 calls him Barry, and then you see Charles.

 17 CHAIRMAN GENSLER: Yeah, I know -- and

 18 then I started to think it's triplets.

 19 All right. With that, I'll entertain a

 20 motion to accept the staff recommendation on

 21 external business conduct.

 22 COMMISSIONER SOMMERS: So moved.
 105

 1 COMMISSIONER O'MALIA: Second.

 2 COMMISSIONER WETJEN: It's exacerbated

 3 by the fact he looks so much like his twin.

 4 CHAIRMAN GENSLER: Yeah.

 5 MS. CELA: Maybe we should bring him to

 6 the table.

 7 CHAIRMAN GENSLER: I don't know. No, I

 8 don't think -- I'd probably break all sorts of

 9 federal laws, and it would set a precedent with my

 10 twin that just --

 11 I support the final rules to establish

 12 business conduct, and I have a longer statement

 13 for the record, but this final rule implements

 14 important features that Congress was addressing.

 15 I think Commissioner O'Malia captured colorfully

 16 in terms of referring to various popular books

 17 about Wall Street, that Congress really wanted to

 18 address protections for counterparties, and in

 19 particular, special entities -- municipal

 20 governments, pension funds that are entrusted with

 21 trillions of dollars of assets on behalf of

 22 people's retirements, and I think this rule takes
 106

 1 a balanced approach to it.

 2 I'm just going to mention three things.

 3 One is I think it's very important. It was a

 4 Congressional mandate, but I think we've got it

 5 right in the rule. The counterparties will get a

 6 daily what's the value of this outstanding swap,

 7 and I think that's particularly important for a

 8 lot of municipals and pension funds, but also

 9 small banks, small end users, midmarket companies

 10 that would not necessarily know what's the value

 11 of that -- or at least what does their dealer

 12 think the value is on those bilateral swaps. And

 13 they'll get it midmarket before the profits or the

 14 charges that would be there. I think it's very

 15 critical.

 16 Two, I think it does help protect

 17 against fraud and other abuses in the market, but

 18 it has a balanced approach with three or four or

 19 five places probably in the rule where there's

 20 safe harbors, where there's affirmative defenses

 21 -- I mean, that we really worked with the pension

 22 fund community, the ERISA plans particularly,
 107

 1 where ERISA has a fiduciary's -- and there's a

 2 whole Congressional mandated process that I think

 3 this finds the balance.

 4 Maybe it is just one question that will

 5 come out of it, but I take that it that ERISA

 6 plans will be able to access this market as they

 7 have in the past, though with additional

 8 protections. Is that correct, Phyllis?

 9 MS. CELA: Yes, yes.

 10 CHAIRMAN GENSLER: It's a big yes. All

 11 right, good. And thirdly, I think -- though it

 12 doesn't usually get a lot of notice in this, I

 13 think it's really important that we, like the

 14 Securities and Exchange Commission and the

 15 Municipal Securities Board, have brought pay to

 16 play prohibitions as well -- that a dealer in

 17 dealing with a municipal or state government

 18 that's entering into swaps, that we have similar

 19 rules. I think it's not the heart of this rule,

 20 but I think it's a really critical piece for the

 21 integrity of these markets, and to protect the

 22 taxpayers of those various municipal and state
 108

 1 folks that enter into swaps.

 2 So I support the rule. With that, I'm

 3 going to turn to Commissioner Sommers.

 4 COMMISSIONER SOMMERS: Thank you and,

 5 again, thank you to this team for all of your hard

 6 work. These are very challenging issues, and I

 7 think we all understand how complicated it's been

 8 to get to the right place on these, but I have a

 9 number of different questions that highlight some

 10 of my concerns.

 11 The first question may just be a

 12 clarification. It was with regard to a change

 13 that was made last night to the safe harbor and to

 14 the first part of the safe harbor for ERISA plans.

 15 And we added in the language that I think brings

 16 consistency to where this same language was used

 17 in other places in the rule -- the language that

 18 was added was complied in good faith.

 19 And that same language is used in a

 20 number of different places, but it brought to

 21 light a question with regard to the way it's

 22 worded, saying that the ERISA plan represents in
 109

 1 writing that it has complied in good faith with

 2 written policies and procedures reasonably

 3 designed to ensure that any recommendations the

 4 special entity receives from the swap dealer

 5 materially affecting the swap transaction is

 6 evaluated by a fiduciary before the transaction

 7 occurs.

 8 So does that -- the way the words are on

 9 the page make this backward-looking to where it

 10 would have to be on a transaction by transaction

 11 basis?

 12 MS. CELA: So I take the tense issue. I

 13 think that's a good catch, and I actually think

 14 that it would be -- if it's going to be in

 15 counterparty relationship documentation, it

 16 probably should be forward-looking so it should

 17 say that it will comply.

 18 COMMISSIONER SOMMERS: Bart, is that

 19 you?

 20 MS. CELA: Commissioner Sommers, I think

 21 it should be forward-looking.

 22 COMMISSIONER SOMMERS: So I think it's
 110

 1 used --

 2 MS. CELA: That it will comply in good

 3 faith.

 4 COMMISSIONER SOMMERS: It's used in

 5 other places so it may be language that needs to

 6 be changed in other places as well, as long as in

 7 all the other places, you don't intend for it to

 8 be on a transaction by transaction basis. I don't

 9 know what the intent is.

 10 MS. CELA: We will go through and make

 11 sure in each place whether they are saying

 12 something about something they've already done,

 13 and the way the reliance on representations works

 14 is that you can make a representation today, and

 15 you can have it renewed with each swap, assuming

 16 that there are no changes in the circumstances of

 17 the parties.

 18 So the fact that it would say something

 19 in the past tense -- is renewed, as if it were new

 20 again, with respect to a subsequent swap so it may

 21 be okay, but we will flyspec.

 22 COMMISSIONER SOMMERS: Okay.
 111

 1 MS. CELA: This one, I think, feels to

 2 me like it should be forward-looking.

 3 COMMISSIONER SOMMERS: Okay, thank you.

 4 The next part that I had a question about was the

 5 addition -- this is on page 187 -- the addition

 6 that we made to the preamble with regard to the

 7 non-ERISA plans, and saying that they can have

 8 representations included in their relationship

 9 documentation that says that swap dealers will

 10 represent that they will not express an opinion,

 11 and that they are allowed to do that if they want

 12 to in their relationship documentation, but that

 13 does not avail them of some sort of safe harbor to

 14 get them out of the other requirements.

 15 MS. CELA: The way it works is, if what

 16 the swap dealer -- I could imagine this situation.

 17 Swap dealer makes a determination that it doesn't

 18 want to be acting in the best interests. It

 19 doesn't want to be held to that standard so it

 20 wants to train around a standard that would cause

 21 sales staff not to use certain opinions,

 22 subjective opinion language.
 112

 1 So in shaping the relationship between

 2 the parties -- and the relationship documentation

 3 is the place where parties do that -- it would

 4 certainly be a fair thing. It's not mandated in

 5 the rule, but we wanted to clarify that it

 6 certainly would be permitted in the rule for them

 7 to say, our communications to you are not going to

 8 express an opinion about whether you should enter

 9 into any particular swap.

 10 Now at the end of the day, if they have

 11 a rogue salesperson, somebody who acts outside of

 12 that training, it will not protect completely the

 13 dealer from responsibility for having that best

 14 interest standard applied to whatever opinion was

 15 expressed by the person who's working for or on

 16 behalf of the dealer.

 17 But we thought that it would be helpful

 18 to the parties to say, when you're listening to

 19 what we are saying, we are not going to the place

 20 where we're making a subjective recommendation to

 21 you to do a certain thing that you should do this.

 22 In that place, you should consult your independent
 113

 1 representative, who you must have under paragraph

 2 five --

 3 COMMISSIONER SOMMERS: Right. So under

 4 that example, if you assume that it is represented

 5 in their relationship documentation that the swap

 6 dealer will not express an opinion and a swap

 7 dealer does express an opinion, then does the

 8 relationship documentation that says it will not

 9 -- it's voided and all the best interest duties

 10 kick in.

 11 MS. CELA: I think it's really a facts

 12 and circumstances case, frankly. When you get

 13 into litigation -- I don't know whether we're

 14 talking here about private litigation or we're

 15 talking about enforcement action -- the place

 16 where I'm comfortable because can't really affect

 17 private litigation.

 18 But in the enforcement context, we have

 19 said, throughout this document, on your behalf --

 20 hopefully you'll accept it -- that when the

 21 enforcement division evaluates a non-scientor of

 22 these rules to make a judgment -- whether it's
 114

 1 appropriate in any particular case -- to bring an

 2 action for a strict liability provision, it will

 3 consider whether or not the swap dealer has acted

 4 in good faith, in compliance with reasonably

 5 designed policies and procedures.

 6 From our perspective, it does two

 7 things. It's not a "gotcha" enforcement regime,

 8 and yet it is a force for good in a way. It

 9 incentivizes the swap dealer to have robust

 10 policies and procedures, and to engage in a

 11 compliance regime with respect to those, so that

 12 when the time comes and if it comes, they have a

 13 basis to say, you should look at us in that light,

 14 as opposed to a person who has acted intentionally

 15 or without policies and procedures.

 16 COMMISSIONER SOMMERS: Okay. Well, I do

 17 continue to think that this opinion versus

 18 recommendation place for non- ERISA plans is an

 19 issue, and I wonder why non-ERISA plans are not

 20 able to rely on the same sort of safe harbor that

 21 ERISA plans can rely on. If they are representing

 22 that they have a qualified, independent
 115

 1 representative and they don't, then that would be

 2 a problem. But many of these plans do, and do not

 3 rely on opinions from swap dealers.

 4 So I'm not sure why we would not let

 5 them rely on that safe harbor, but if you can

 6 explain that --

 7 MS. CELA: This is a place where we were

 8 -- our approach to this was that where the statute

 9 spoke specifically about a particular issue, we

 10 felt more constrained in our discretion, and this

 11 is one of those places.

 12 In fact, you could take the view that

 13 rule making wasn't required here. You didn't even

 14 need to say that there are rules about what it

 15 means to act as an adviser and a swap dealer would

 16 be essentially left without any guidance about

 17 what would cause them to have to act in the best

 18 interest, including what the best interest duty

 19 is.

 20 So we thought there was a significant

 21 amount of compliance risk in that place, and that

 22 we looked for ways to cabin the risk without
 116

 1 gutting the effect of the provision.

 2 The provision says that there will be a

 3 time when a swap dealer will act as an adviser.

 4 It seemed to us, based on what we had heard from

 5 commenters -- and I fortunately or unfortunately

 6 actually had worked on the Bankers Trust case in

 7 the middle '90s and Gibson Greetings and Procter &

 8 Gamble, and the issues there were all about at

 9 what point did the swap dealer assume advisory

 10 duties with respect to the counterparty.

 11 And even though there was nothing in

 12 writing that said that somebody was acting as an

 13 adviser, there were claims. The commission made a

 14 claim that Bankers Trust was acting as an adviser

 15 subject in that case to 4O, which is our fiduciary

 16 essentially -- fiduciary duty obligation with

 17 respect to fraud for pool operators and trading

 18 advisers.

 19 So we were told that there is a place

 20 where people are trained to not venture into that

 21 space unless it's understood and there is a real

 22 understanding between the parties about the nature
 117

 1 of the relationship, and the dealer is prepared to

 2 take on those additional duties. That was the

 3 baseline.

 4 So for us, it seemed to be, based on

 5 what we were told in our consultations, that the

 6 line they train around are these subjective

 7 opinions -- that you could make all kinds of

 8 recommendations more objectively stated. It could

 9 be based or tailored to the needs of a particular

 10 counterparty, but what the swap dealer would say

 11 in that case would be more along the lines, I

 12 understand your risk to be this. This is a swap

 13 that would accomplish that risk reduction.

 14 Whether or not you should enter into this, based

 15 on your circumstances, you should consult your

 16 adviser who you are paying to do that kind of

 17 work. I'm not acting in your best interest.

 18 So we think it allows for the making of

 19 the recommendations. Now this is such a long

 20 answer, but in the last places where we

 21 distinguish between the ERISA plans -- in the case

 22 of ERISA, there is a full-blown federal regulatory
 118

 1 scheme. DOL is the principal regulator. Under

 2 ERISA, they have rules specific to ERISA

 3 fiduciaries, what the requirements of ERISA

 4 fiduciaries are.

 5 We had heard a lot, as you did too,

 6 about the risks of not simply relying on the ERISA

 7 law, with the potential that we would create

 8 potentially inconsistencies, unintended

 9 consequences. So in that one narrow space where

 10 we had another federal regulatory scheme that we

 11 could rely on comfortably -- and in consultation

 12 with the Department of Labor, we said, okay, here

 13 and in the paragraph five provision, if there is

 14 an ERISA fiduciary on the scene, then that will be

 15 the safe harbor for ERISA plans.

 16 For all others, which frankly are

 17 governed by very many approaches to fiduciary

 18 status -- common law, state law, local law --

 19 there isn't a coherent, single scheme to which we

 20 could have deferred.

 21 And so in that way, we felt like this

 22 was an appropriate line, giving meaning to the
 119

 1 statute, without unduly creating an impossible

 2 situation for the counterparties who want to

 3 transact.

 4 Sorry for the long answer.

 5 COMMISSIONER SOMMERS: That's okay.

 6 Thank you. I appreciate that, and I think that

 7 many people who are listening probably appreciate

 8 that comprehensive answer. So thank you for that.

 9 The other couple of questions I have are

 10 with regard to how this will actually work, and

 11 why the rules apply when these transactions are on

 12 trading facilities and cleared. So these

 13 disclosure requirements -- and I think in a number

 14 of different places, it talks about the section

 15 not applying with respect to transactions that are

 16 initiated on a designated contract market or

 17 initiated on a SEF if the swap dealer or major

 18 swap participant do not know the identity of the

 19 counterparty to the transaction prior to

 20 execution.

 21 So if they do know the identity of their

 22 counterparty prior to execution in a RFQ-type
 120

 1 model, how will this type of disclosure regime

 2 work?

 3 MS. CELA: Right. How it will work --

 4 ultimately, in practice, I think it will depend

 5 upon the evolution of communications systems and

 6 the technology on the platforms, and their

 7 functionality, et cetera.

 8 But our choice for drawing the line

 9 there again was another place where we felt there

 10 was very limited discretion for the commission

 11 given the way the disclosure provision is written

 12 in the statute. It talks about disclosure of

 13 material risks. There is no out. There is no

 14 limitation on when that happens.

 15 There is another provision that

 16 discusses special entity provisions and references

 17 transactions on the SEF or DCM where the swap

 18 dealer doesn't know the identity of its

 19 counterparty.

 20 But for example, the SEC interpreted

 21 that language to apply only to the acts as an

 22 adviser and independent rep provisions, and not to
 121

 1 apply to disclosures. So if I'm correct, I think

 2 the SEC's view is that disclosures are made

 3 whether you know your counterparty or not.

 4 And so we thought that we could use the

 5 language in the statute to allow for easier and

 6 more effective and less compliance risk, and what

 7 we imagined -- again, looking at the SEC's release

 8 and talking to others who are familiar with how

 9 these things can work, the SEF environment will be

 10 an electronic environment for the most part. They

 11 could develop functionality to put out disclosures

 12 for transactions that are permitted to trade on

 13 that SEF. They could be given to the SEF by the

 14 swap dealer so that the swap dealer can use a sort

 15 of substituted compliance to make it happen that

 16 way, or the swap dealer could put all the

 17 disclosure information that it thinks is relevant

 18 to the types of swaps that it enters into, whether

 19 in the SEF environment or in the bilateral

 20 environment, and put them in a place -- and as

 21 long as either they're directed by the SEF or

 22 through the response to the RFQ, the counterparty
 122

 1 will know where to look. We are not anticipating

 2 this be a stop the music kind of disclosure.

 3 The other thing is that it is our

 4 understanding that for transactions on SEF, it's

 5 likely too that the participants on those

 6 platforms will have counterparty relationship

 7 documentation with other participants in that

 8 marketplace. They may not know who they're

 9 transacting with at any particular moment, or they

 10 may only know about it just before execution.

 11 But they would be able, in that

 12 counterparty relationship documentation, to

 13 include the kinds of disclosures that you're

 14 talking about.

 15 So we think that where there's a

 16 business opportunity and a way to do this, it may

 17 very well be in the interests of both the SAF --

 18 for the sake of drawing liquidity into the

 19 marketplace, and to have the dealer have a

 20 facilitating way to comply. So we're expecting

 21 those functionalities to develop.

 22 COMMISSIONER SOMMERS: I guess my
 123

 1 concern is that it doesn't limit participation on

 2 the SEFs to only people that the swap dealer has

 3 this type of documentation with --

 4 MS. CELA: Right.

 5 COMMISSIONER SOMMERS: -- and so the

 6 swap dealer feels safe in saying, I know that

 7 anybody I may execute a transaction with on this

 8 SEF, I'm already papered with so I'm not running

 9 the risk of having to --

 10 MS. CELA: Right, right.

 11 COMMISSIONER SOMMERS: -- one second

 12 before execution --

 13 MS. CELA: Right.

 14 COMMISSIONER SOMMERS: -- find out that

 15 this is somebody I don't have disclosure

 16 documentation with, and now we have to --

 17 MS. CELA: Right. So the guidance in

 18 the release is explicit on this point -- that the

 19 swap dealer would be able to work with --

 20 COMMISSIONER SOMMERS: Right.

 21 MS. CELA: -- the SEF or --

 22 COMMISSIONER SOMMERS: Right.
 124

 1 MS. CELA: -- the DCM to develop this

 2 functionality.

 3 COMMISSIONER SOMMERS: Right.

 4 MS. CELA: We would consider that

 5 substitutive compliance and not an invasion, and

 6 so we actually think it would be an interesting

 7 business model, to see how that might look.

 8 COMMISSIONER SOMMERS: The next question

 9 I have is with regard to the scenario analysis.

 10 MS. CELA: Yes.

 11 COMMISSIONER SOMMERS: And it talks

 12 about how the swap dealer or major swap

 13 participant, prior to entering into a swap with a

 14 counterparty -- I'm sorry. I should read this

 15 verbatim or else I'm going to mess it up.

 16 Prior to entering into a swap with a

 17 counterparty other than swap dealer or major swap

 18 participant -- security- based swap dealer or a

 19 major security-based swap participant, that is not

 20 made available for trading.

 21 So if we finalize a rule like we have

 22 proposed, that the SEF can make the determination
 125

 1 that everything they list is made available for

 2 trading, do we really want to hinge the scenario

 3 analysis on that fact -- that everything that's

 4 listed on a SEF is considered made available for

 5 trading and the scenario analysis then is not

 6 required?

 7 MS. CELA: The proposed rule had a more

 8 prescriptive approach to this, and was

 9 definitionally challenging. People were concerned

 10 about that, and we agreed, and made it more of an

 11 optional rule.

 12 COMMISSIONER SOMMERS: But the

 13 optionality only kicks in on the made available

 14 for trading.

 15 MS. CELA: If it's not made available --

 16 COMMISSIONER SOMMERS: Right.

 17 MS. CELA: -- for trading. Right. So

 18 the idea is -- in the bespoke area, for example --

 19 in the area where it's likely to be bilateral,

 20 subject to extensive negotiation, that's when --

 21 COMMISSIONER SOMMERS: I guess my point

 22 here is a SEF -- if our proposal is finalized as
 126

 1 proposed, there could be a number of very illiquid

 2 bespoke swaps that are listed on a SEF, and

 3 because the SEF believes it's in their best

 4 interest to deem them made available for trading,

 5 it seems to be an odd quality to tag this with.

 6 MS. CELA: So for us, it was really a

 7 balancing of burdens. This is a discretionary

 8 rule, in the sense that Congress didn't direct us

 9 to provide for scenario analysis as scenario

 10 analysis.

 11 So in justifying the discretionary rule,

 12 we tried to figure out where a line might be where

 13 we were very comfortable imposing this burden,

 14 this cost on dealers, to have to respond to such a

 15 request.

 16 Nothing in the rule, as we say in the

 17 adopting release -- nothing in the rule would

 18 preclude parties from negotiating the receipt of

 19 such scenario analysis separate from Judy under

 20 (inaudible) rule.

 21 And in fact, what we were told during

 22 our consultations -- which is why we thought this
 127

 1 was an appropriate rule at all -- was that it is

 2 routine business practice when a counterparty asks

 3 for scenario analysis, that it is provided, and

 4 it's often provided without any cost to the

 5 counterparty -- at least, any separate payment.

 6 So I think what we were feeling

 7 comfortable with was that in the places where it

 8 was likely to be the most helpful, it would be

 9 required at the option of the counterparty. In

 10 other places, it would be the subject of

 11 negotiation.

 12 This was one of those where we were

 13 hearing concerns about cost and burden. We

 14 thought it was a valuable rule, and came to this

 15 ground, this line for us.

 16 COMMISSIONER SOMMERS: Thank you.

 17 CHAIRMAN GENSLER: Thank you,

 18 Commissioner Sommers. I think Commissioner

 19 Chilton is back on.

 20 COMMISSIONER CHILTON: Yeah, I'm here,

 21 Mr. Chairman.

 22 CHAIRMAN GENSLER: Good.
 128

 1 COMMISSIONER CHILTON: Sorry about the

 2 technical issues, and I'm glad you had my proxy.

 3 I do support all the rules.

 4 I don't have any questions on this one.

 5 Thank you.

 6 CHAIRMAN GENSLER: Thank you,

 7 Commissioner Chilton. Commissioner O'Malia?

 8 COMMISSIONER O'MALIA: Thank you, Mr.

 9 Chairman. Thank you to the team.

 10 Can you tell me -- given that swap

 11 dealers and MSPs will be commission registrants,

 12 who will be responsible for direct oversight of

 13 compliance with the rules today -- NFA or the

 14 CFTC? And how will compliance with these rules be

 15 monitored?

 16 MS. CELA: I think we should probably

 17 have Mr. Barnett at the table, as we had Ananda

 18 the last time.

 19 CHAIRMAN GENSLER: Is Gary Barnett in

 20 the room? Gary, you've been invited to the table

 21 by Phyllis, to talk about these sort of

 22 collaboration -- assuming that later today we
 129

 1 might actually delegate to the NFA, what we might

 2 delegate to the NFA.

 3 Red button.

 4 MR. BARNETT: Okay. In response to the

 5 question, the part that gets delegated is just

 6 registration and determining that there's

 7 compliance at a time of registration.

 8 In terms of overall oversight, what

 9 typically happens is that the NFA would adopt

 10 rules that are as tight as or tighter than our

 11 rules, and then they would require their members

 12 to comply with those rules.

 13 And then we would oversight the NFA's

 14 oversight of its members, and in doing so,

 15 occasionally we would go in and do direct review

 16 of the compliance of its members.

 17 But that's the basic methodology, and it

 18 does allow us to leverage the reach of the NFA.

 19 COMMISSIONER O'MALIA: Thank you.

 20 Followup on Commissioner Sommers's questioning

 21 regarding a SEF -- I support the rule, but with

 22 all good rules, they can go too far, and some of
 130

 1 my concerns, which I think have been addressed

 2 here, are what will happen on anonymous

 3 transactions, and creating some burden that can't

 4 be fulfilled in a non-exchange kind of

 5 environment.

 6 This rule, I think, appropriately

 7 understands that this is still a principal to

 8 principal market, while the Volcker Rule totally

 9 misses that slight nuance, but nonetheless, I

 10 think you guys have probably done it better than

 11 -- certainly better than that rule.

 12 But I do have some concerns about this,

 13 to make sure that we don't create an expectation

 14 and a burden that just can't be fulfilled, due to

 15 the on-screen nature of these things.

 16 And one of the concerns is the voice

 17 broker relationship. And we have no idea whether

 18 that's going to be allowed or not in the SEF

 19 proposal, and trying to draft rules.

 20 Do you have any sense of what kind of

 21 relationship -- it's kind of a middle ground.

 22 You're kind of negotiating trades but it's going
 131

 1 to be on-screen. How do we -- what is the burden

 2 in your rule for that kind of relationship, if

 3 it's allowed?

 4 MS. CELA: These rules apply to swap

 5 dealers and major swap participants when they know

 6 their counterparties. So I'm not sure that I

 7 could answer your question because I'm not sure of

 8 what interface would occur through the voice

 9 broker.

 10 If through the voice broker, the swap

 11 dealer or major swap participant comes to

 12 understand and know who that counterparty is going

 13 to be, in the same way that we talked about in the

 14 SEF environment, it would seem to me that that

 15 voice broker could play a role in helping the swap

 16 dealer to comply, either upfront or on a

 17 transaction basis.

 18 But really, I'm a little uncomfortable

 19 here because I'm not sure that I -- I know that I

 20 don't know the environment well enough to give you

 21 an answer you could rely on.

 22 COMMISSIONER O'MALIA: Great, thank you.
 132

 1 Can you explain why the best execution standard

 2 was dropped from this rule?

 3 MS. CELA: There were a lot of comments,

 4 as you would imagine, on the best execution rule.

 5 That rule depended upon more of an understanding

 6 of the kinds of things that you just asked me

 7 about, that remain -- in my mind anyway -- still

 8 fuzzy and unclear, and haven't fully been

 9 developed.

 10 So as I recommended that we defer

 11 consideration of this, for me, it was that I

 12 didn't feel like I understood well enough what the

 13 communication schemes were that would cause a

 14 dealer to be able to get the necessary information

 15 or how transactions would occur.

 16 But that will be happening. We will get

 17 clarity around that, and if and when the time

 18 comes that we know what that looks like, then it

 19 would be perfectly appropriate for the commission

 20 to repropose the rule in light of those

 21 requirements, and then get fresh comment on it.

 22 COMMISSIONER O'MALIA: While I do
 133

 1 appreciate the fact that we didn't overreach on

 2 something we had no understanding of how the

 3 market will transact -- so I definitely support

 4 that.

 5 MS. CELA: Well, at least as with

 6 respect to me. I'm sure there are others who

 7 probably know better, but I didn't.

 8 COMMISSIONER O'MALIA: Today's rules

 9 defer all discussion on the international reach of

 10 the rules until the commission addresses

 11 extraterritoriality issues in a separate release.

 12 What does the 4(sh) of the act say with

 13 regard to extraterritorial reach of the external

 14 business conduct rules?

 15 MS. CELA: The business conduct standard

 16 rules apply to swap dealers and major swap

 17 participants, with respect to counterparties.

 18 The definition of counterparty is not

 19 limited by geography, and neither is the

 20 definition of swap dealer defined in terms of

 21 territory.

 22 So read as it is, if you have a swap
 134

 1 between a swap dealer -- somebody who would be

 2 within the meaning of a swap dealer and somebody

 3 who would be within the meaning of a counterparty,

 4 on its face the rules would apply.

 5 But there is the extraterritoriality

 6 provision in Dodd-Frank. I couldn't recite it to

 7 you at the moment, but there is a test in there

 8 with respect to which kinds of activities or

 9 conduct would cause the commission to have an

 10 interest, something that would affect the commerce

 11 of the United States or something along those

 12 lines.

 13 And so while the statute in this place

 14 doesn't speak to territoriality, if you couple

 15 that with the extraterritorial provision, it would

 16 be understood that you'd have to make the case for

 17 transactions that have foreign components to have

 18 to understand what the reach of these rules will

 19 be in any particular circumstance.

 20 COMMISSIONER O'MALIA: Do you have any

 21 sense of any other international jurisdictions

 22 that are proposing such a rule or have rules in
 135

 1 place similar to this?

 2 MS. CELA: What we do know is that in

 3 the EU, for example -- we know that in the EU,

 4 there are comparable or there are business conduct

 5 standards rules that address many of the issues

 6 that we have here. What their extraterritorial

 7 effect is, that I couldn't respond to.

 8 Substantively, they accomplish several

 9 of the things that we are doing.

 10 COMMISSIONER O'MALIA: Cost benefit

 11 analysis -- the commission has certified the rule

 12 as a major rule under the Congressional Review

 13 Act, and OMB has concurred. But we never received

 14 any data from anybody so I'm not exactly sure how

 15 we arrived at an over $100 million economic

 16 impact. How did we arrive at it? This is a

 17 little thin on the numbers.

 18 MS. CELA: I think this may be one where

 19 we may want to ask OGC to join, but what we did

 20 appreciate was that because we didn't have the

 21 data -- the data were not easily susceptible to

 22 gathering and hadn't been offered to us -- that we
 136

 1 couldn't rule out the fact that it could have, and

 2 rather than undersell the rule, we thought it was

 3 better to declare it and then have it considered

 4 that way so that we weren't undercounting. It was

 5 important not to undercount or mislead.

 6 COMMISSIONER O'MALIA: The large trader

 7 reporting rules -- we thought we had it figured

 8 out. Put it out, people had number questions. I

 9 think we put out a 150-page count -- 150 plus page

 10 guidance to help clarify that. Your rule is

 11 infinitely more complex than that reporting

 12 requirement. It is what it is.

 13 Will we provide additional guidance or

 14 clarification or flexibility for firms that are

 15 confused, unclear, have questions? How will we

 16 deal with this when they come pounding on our

 17 door?

 18 MS. CELA: So the issues around -- which

 19 we felt that there was the most concern was in

 20 this recommendations area, and the safe harbors

 21 that would apply in the suitability space and in

 22 the acts as an adviser to special entities place.
 137

 1 We did prepare a separate appendix that

 2 will be included in the part 23 rules so that

 3 anybody that's going to the rulebook will also

 4 have a few pages of explanation.

 5 There is a routine process at the

 6 commission for relief. So if it turns out that

 7 there is a particularly aggrieved party as a

 8 result of these rules, whether it's on a

 9 implementation basis or it's a unique business

 10 practice that they would like to get some comfort

 11 on, I am certain that process could be used to

 12 provide additional guidance.

 13 And I would assume that if the staff is

 14 permitted and encouraged by the commission, we

 15 would be very happy to take people through these

 16 rules and forms that are comfortable, to try to

 17 give some texture to the words.

 18 CHAIRMAN GENSLER: Let me just jump in

 19 and clarify. You are absolutely permitted -- the

 20 staff on every rule team as we finalize these

 21 things is encouraged to help market participants,

 22 subject to staff resources. We are an agency that
 138

 1 is limited in resources, but to help market

 2 participants understand that which these rules

 3 mean.

 4 COMMISSIONER O'MALIA: That's all I

 5 have. Thank you. Thank you to the rule team.

 6 CHAIRMAN GENSLER: Thank you,

 7 Commissioner O'Malia. Commissioner Wetjen?

 8 COMMISSIONER WETJEN: I think my fellow

 9 Commissioners and I -- I think all of us have had

 10 tours of duty in the public sector, in the private

 11 sector and we've all interacted with a number of

 12 different people -- a lot of very talented people,

 13 impressive people.

 14 But I just wanted to start by saying

 15 that I've found that Phyllis and her team have

 16 been very, very professional and impressive, and

 17 in all these different areas where I've worked in

 18 my short career, I've not seen it surpassed by

 19 what I've seen with this team.

 20 So I just want to make sure I publicly

 21 acknowledged how impressed I've been with this

 22 team and appreciate all the hard work on this.
 139

 1 MS. CELA: That feels like a star. Bob

 2 Wasserman was a star so --

 3 COMMISSIONER WETJEN: We talk about

 4 starting a rookie of the year award or something.

 5 Maybe we should have a veteran of the year award

 6 too, possibly.

 7 But Phyllis, you and team and I, we had

 8 some good discussions about this rule, and I think

 9 you could sense that when I first came to our

 10 discussions, I had some pretty serious concerns

 11 about it, but I was very reassured after we

 12 talked, and we talked about the know your customer

 13 requirement, we talked about the scenario analysis

 14 requirement. It was also talked on here by

 15 Commissioner Sommers. The best execution

 16 requirement, which was dropped. Commissioner

 17 O'Malia just mentioned that. Suitability,

 18 counterparty eligibility, and of course, the safe

 19 harbors for the special entities.

 20 So all of these were very significant

 21 issues, and I was, again, very, very relieved once

 22 we had a visit and I got to understand better how
 140

 1 those issues were treated in the final rule --

 2 that this would be a very workable set of

 3 standards for the dealer community.

 4 While I'm thinking of it, Commissioner

 5 Sommers mentioned this issue about opinions, and

 6 specifically mentioned some of the preamble

 7 language and how the dealers could, in fact,

 8 include some language in their representations,

 9 that they would not be rendering opinions.

 10 And you and I had a very good discussion

 11 about this, and if you'll permit me to elaborate a

 12 little bit -- what I took from our discussion is

 13 that this language, while not exonerating for a

 14 swap dealer, could be very, very useful in a

 15 number of different respects, and at a minimum, if

 16 there were some sort of litigation where a judge

 17 was having to determine whether the standard was

 18 met or not, certainly this would be a mitigating

 19 circumstance if they had a document that included

 20 a written representation that they were not

 21 rendering opinions.

 22 You had mentioned earlier in your
 141

 1 discussion about that doesn't take away from the

 2 fact you could have other facts that could, in

 3 fact, show an opinion was given. But certainly,

 4 that would be a mitigating factor, to have that

 5 language in a master agreement.

 6 And it also would have the very desired

 7 effect, I think, of helping the dealer community

 8 train their staff. I think you touched on that as

 9 well a little bit earlier.

 10 So while not exonerating, I agreed with

 11 you in our discussion that it would be probably a

 12 useful guiding principle included in the preamble.

 13 So I was supportive of that language.

 14 In a cost benefit discussion of the

 15 rule, there's a discussion about the rule would

 16 allow dealers to comply with their disclosure

 17 requirements by partnering with some of these

 18 trading execution platforms. I wonder if you

 19 could just discuss for a moment how you would

 20 envision that taking place.

 21 MS. CELA: I think we talked a few

 22 moments ago about what we would envision to be
 142

 1 compliant disclosure in, let's say, a SEF

 2 environment, and it seemed to us that there could

 3 be a variety of ways. And by this list, nobody

 4 should take that it is limiting. It is only some

 5 ideas based on technology that you see today when

 6 you want to buy an airline ticket and click

 7 through terms and conditions and things.

 8 We understand that there is popup

 9 capability. We understand that a SEF may have an

 10 interest in putting on its own website the

 11 documentation or the disclosures that would apply

 12 to swaps that are permitted to be traded on that

 13 SEF.

 14 The swap dealer might go out by itself

 15 and put on its own website disclosures about the

 16 transactions that it would do in that environment.

 17 I think you could just imagine a number

 18 of ways. Today, for example, if you want to trade

 19 a futures contract, the description of the

 20 contract that you're trading doesn't come from

 21 your FCM. It is posted on the website of the

 22 designated contract market.
 143

 1 So there is sort of a business practice

 2 that could be elaborated on, that might accomplish

 3 the kinds of purposes we're talking about.

 4 And as I say, to the extent that there's

 5 any question about whether it would work, I would

 6 expect people to come in the way that they do

 7 today to get some comfort in the areas that

 8 they're unsure of.

 9 COMMISSIONER O'MALIA: Phyllis, can I

 10 make a comment?

 11 If we have modeled these rules to be

 12 comparable to what airlines disclose, we've

 13 completely screwed it up.

 14 MS. CELA: You know what? I'm with it.

 15 So let me take that back.

 16 COMMISSIONER O'MALIA: All right.

 17 You're going to get a different analogy, right?

 18 MS. CELA: Yeah. So a different

 19 analogy, absolutely. I think the better way -- I

 20 guess the issue is that the disclosure is

 21 particular to the kind of transaction that's being

 22 disclosed.
 144

 1 If you're doing what has been described

 2 to us as the flow business -- the plain vanilla,

 3 this is the business that's going through -- the

 4 disclosures, it seems to me, can be in a very

 5 standard format, and can be really anywhere where

 6 the counterparty will have access and know to go.

 7 The more complex the transaction is, the

 8 less available the information is to the

 9 counterparty, the more process needs to be put on

 10 top of the disclosure process. So you would

 11 expect more particularized disclosures, enough

 12 time with respect to those, more complex swaps to

 13 be able to appreciate the information, the risk

 14 and take account of it.

 15 So the problem with this rule is, it's

 16 both the good and the bad. It's a

 17 principles-based rule that is supposed to take

 18 account of the most standardized transactions and

 19 the most complex. So depending upon the

 20 environment and depending upon the nature of the

 21 swap, these kinds of pre-done website references

 22 may very well work just fine, particularly if it's
 145

 1 the kind of transaction that a particular

 2 counterparty is doing day in and day out.

 3 That was all I meant to suggest.

 4 COMMISSIONER WETJEN: No apologies

 5 needed. Regulatory harmonization has been an

 6 important part of the discussions about Dodd-Frank

 7 implementation. It's something that I heard a lot

 8 about while I was still working on Capitol Hill,

 9 and I've heard about it some more here at the

 10 commission.

 11 But I was hoping you could walk me and

 12 the rest of the group here through some of the

 13 ways that this rule comes into closer harmony with

 14 the SEC's proposal.

 15 MS. CELA: Just by way of background,

 16 our proposed rules came out last December, about

 17 six months ahead of the SEC's proposed rules.

 18 So when we proposed our rules, there was

 19 a comment period that followed, and for better or

 20 for worse, the SEC had the benefit of the comments

 21 that were made to our rules. And so their

 22 proposals were different in some respects from
 146

 1 ours, in part as a result of the comments that we

 2 had received.

 3 So the places where we thought we should

 4 move toward the SEC -- because there was really no

 5 good government reason to have a different

 6 approach -- for example, would be, know your

 7 counterparty. We had adopted know your

 8 counterparty more from the broker model that

 9 existed under the NFA rules, and there were some

 10 provisions in the know your counterparty that

 11 counterparties were concerned was going to cause

 12 them to have to give confidential information to

 13 their brokers. The SEC had stripped the rule of

 14 those. We went more toward the SEC model.

 15 Another one is suitability. They got at

 16 the same thing, but the language wasn't quite the

 17 same. We thought it was worth -- since this is an

 18 area where they truly are the experts. They have

 19 been living under the suitability rule for years.

 20 They developed it. It's something understood and

 21 observed in the securities markets. And so we

 22 moved our suitability rule closer, much closer to
 147

 1 have the same kind of outcome there that we had.

 2 The other thing that they had done was

 3 when they proposed, not all of the "discretionary

 4 rules" applied to MSPs. In the final rules here,

 5 we took a closer look at the type of business that

 6 we anticipated an MSP to be doing by definition,

 7 and we decided that certain of the rules, like

 8 scenario analysis, know your counterparty, pay to

 9 play would not apply to MSPs because they would

 10 not be -- if they were doing the kind of business

 11 that those rules presupposed, they would probably

 12 be swap dealers.

 13 So those are the kinds of adjustments

 14 that we made to our rules that we're really

 15 inspired by, with a view toward trying to come

 16 together with them.

 17 COMMISSIONER WETJEN: It's more of an

 18 observation than a question, but, I think,

 19 Phyllis, you touched on it too in some of your

 20 earlier remarks, but this part of the statute --

 21 most of it, if not all of it, is self-affecting, I

 22 believe.
 148

 1 MS. CELA: Only one provision is, and

 2 Terry and I can have a legal debate about whether

 3 paragraph four stands on its own, or because

 4 there's mandatory rule making -- otherwise in

 5 4(sh), we had to write rules. We wound up writing

 6 the rules, but no. It's mandatory rule making.

 7 So there's a standard set by Congress, directing

 8 the commission to write the rule.

 9 COMMISSIONER WETJEN: Well, not

 10 withstanding that point of clarification, I think

 11 the other thing I took away from our discussions

 12 and my review of the rule is that while there were

 13 different pieces of it that were discretionary in

 14 nature, I think the sum total effect of the rule

 15 is actually one where there's some very, very

 16 valuable clarification brought to the statute,

 17 rather than unnecessary new, additional burdens.

 18 I mean, that was an important takeaway that I had,

 19 again, after reviewing the rule and after having

 20 our briefing session earlier in the week.

 21 So that's all I had for comments and

 22 questions.
 149

 1 CHAIRMAN GENSLER: Thank you,

 2 Commissioner Wetjen. Mr. Stawick?

 3 MR. STAWICK: Commissioner Wetjen?

 4 COMMISSIONER WETJEN: Aye.

 5 MR. STAWICK: Commissioner Wetjen, aye.

 6 Commissioner O'Malia?

 7 COMMISSIONER O'MALIA: Aye.

 8 MR. STAWICK: Commissioner O'Malia, aye.

 9 Commissioner Chilton?

 10 COMMISSIONER CHILTON: Aye.

 11 MR. STAWICK: Commissioner Chilton, aye.

 12 Commissioner Sommers?

 13 COMMISSIONER SOMMERS: No.

 14 MR. STAWICK: Commissioner Sommers, no.

 15 Mr. Chairman?

 16 CHAIRMAN GENSLER: Aye.

 17 MR. STAWICK: Mr. Chairman, aye. Mr.

 18 Chairman, on this question, the yays are four, the

 19 nays are one.

 20 CHAIRMAN GENSLER: The ayes have it, and

 21 the staff recommendation is accepted. Before you

 22 leave the table, if I -- did you have something,
 150

 1 Phyllis?

 2 MS. CELA: I just wanted to say that we

 3 are going to make an adjustment to one bit of

 4 language here that we're going to check

 5 throughout, and so I think you do something where

 6 you allow --

 7 CHAIRMAN GENSLER: I'm all right. I'm

 8 all right.

 9 MS. CELA: I'm sorry.

 10 CHAIRMAN GENSLER: I'm all right. But

 11 thank you for that bit of advice.

 12 I just want to compliment the teams for

 13 all that you've done here. Not picking anything,

 14 but I think that when Mr. Obie suggested when you

 15 didn't know it that you'd be the team lead for

 16 this, it was an excellent recommendation.

 17 So a shout-out for Phyllis, for Steve

 18 Obie, for David Meister for letting the

 19 enforcement division so well contribute to this

 20 rule making.

 21 So thanks. And with that, I think now

 22 we have the team that will be coming up with
 151

 1 regard to registration rules. And so I think Gary

 2 Barnett's just going to stay at the table, but

 3 Barbara Gold and Chris Cummings, Elizabeth Miller,

 4 all from the Division of Swap Dealer and

 5 Intermediary Oversight present the staff

 6 recommendations on the registration of swap

 7 dealers and major swap participants.

 8 The team will also present a separate

 9 order delegating the performance of registration

 10 functions by the National Futures Association,

 11 with respect to swap participant.

 12 So we'll get the presentation on both,

 13 and then we'll take the votes in term.

 14 CHAIRMAN GENSLER: Phyllis, is that your

 15 son who -- another twin and flowers.

 16 Congratulations.

 17 From the SEC? It might be. Thank you,

 18 for the Securities and Exchange Commission. Thank

 19 you very much, fellows.

 20 MS. GOLD: Okay.

 21 CHAIRMAN GENSLER: Handing it over to

 22 Barbara Gold, who's been the team lead on this,
 152

 1 and Elizabeth, Chris and Gary.

 2 MS. GOLD: Thank you. Preliminary, I'd

 3 like to thank the members of my team -- Richard

 4 Wagner, Warren Gorlick, Steve Kane, Lee Ann Duffy,

 5 Gloria Clement and, specifically from DSIO, my

 6 staff, Chris Cummings and Elizabeth Miller.

 7 Chris first developed the concepts of

 8 provisional registration and phased

 9 implementation, which is a concept we know now

 10 that other teams are employing.

 11 As far as Elizabeth, Elizabeth has been

 12 involved in every single of this process, and at

 13 every single step, her performance has been

 14 exemplary. So I'm sure all of us on the team

 15 would say that for us, Elizabeth has been the star

 16 of this team.

 17 I'd also like to thank Mike Crowley,

 18 Associate General Counsel at NFA, for his

 19 continuing availability on technical assistance

 20 throughout the rule making process.

 21 At the outset, I'd like to clarify that

 22 these regulations go solely to the registration
 153

 1 process. They don't go to the swap dealer and

 2 major swap participant definitions. They don't go

 3 to any exceptions from registration because the

 4 act prohibits exceptions from registration.

 5 As we've already heard, they don't go to

 6 extraterritorial matters because

 7 extraterritoriality is going to be considered at a

 8 subsequent date, and these regulations don't go to

 9 the substance of any of these section 4(s)

 10 implementing regulations because those regulations

 11 are being separately considered. We just heard

 12 one of them -- external business conduct. So

 13 again, these registration regulations just go to

 14 the process of regulation itself.

 15 The commission proposes registration

 16 process in November 2010, and what the commission

 17 did at that point in time and what we're

 18 recommending it adopt today is amendments to the

 19 existing registration scheme for all other

 20 registrants. This is identical to what the

 21 commission did for retail foreign exchange

 22 dealers, or RFEDS, in October 2010.
 154

 1 So what these regulations would do would

 2 incorporate swap dealers and major swap

 3 participants into part three, which is the

 4 commission's registration regulations.

 5 Unlike other registration issues or

 6 situations, however, the commission didn't also

 7 propose to require the registration of salespeople

 8 or associated persons of swap dealers and major

 9 swap participants because Dodd-Frank did not give

 10 us that authority -- that is, the registration

 11 authority over APs of SDs and MSPs.

 12 And as has also been mentioned today,

 13 that consistent with prior options the commission

 14 proposed to delegate to the National Futures

 15 Association, NFA, the authority to register swap

 16 dealers and major swap participants.

 17 Based on the comments the commission

 18 received, we're recommending that the commission

 19 adopt the registration process regulations,

 20 essentially in the form as proposed.

 21 So registration of swap dealers and

 22 major swap participants would commence with the
 155

 1 filing of the requisite forms with NFA that say 7R

 2 for the firm and 8R for each principal, and

 3 additionally, a fingerprint card for each

 4 principal.

 5 Persons must apply on the latest

 6 effective date applicable to the SD, MSP or swap

 7 product definition. However, they would be able

 8 to apply to start the registration process at any

 9 time prior to that mandatory date.

 10 When a person applies, they must also

 11 submit such documentation as may be required to

 12 demonstrate compliance with whatever section 4(s)

 13 implementing regulation is applicable to them at

 14 that time.

 15 This is this whole concept of

 16 provisional registration. So when someone applies

 17 -- and until the entire section 4(s) implementing

 18 regulation scheme is in place -- an applicant for

 19 SD or MSP registration would be issued a

 20 provisional registration by NFA. The applicant

 21 would be under a continuing obligation to update

 22 in its documentation and whatever else would be
 156

 1 required as this section 4(s) implementing

 2 regulations become applicable to it.

 3 Once all of the section 4(s)

 4 implementing regulations are in place and

 5 compliance with them has been confirmed by NFA,

 6 the SD or MSP applicant would become fully

 7 registered, such that at some point in the future,

 8 when all of the 4(s) regulations are effective,

 9 compliance states have been reached, so on and so

 10 forth, and everyone who today is a swap dealer or

 11 a major swap participant has been registered,

 12 there will be no more provisional registration.

 13 This is truly a temporary stopgap measure,

 14 intended to permit, intended to not disrupt

 15 ongoing business operations. So NFA would confirm

 16 initial compliance with section 4(s) implementing

 17 regulations.

 18 The proposal would have had a 30-day

 19 cure period in the event that NFA advised an

 20 applicant that its materials, what it had

 21 presented was deficient. However, we're

 22 recommending that the commission adopt a 90-day
 157

 1 cure period with the provision for an extension in

 2 the event an applicant did not -- its compliance

 3 with a 4(s) requirement was not confirmed.

 4 As far as associated persons, Dodd-Frank

 5 did not make clear whether an associated person of

 6 an SD or an MSP had to be a natural person. The

 7 Commodity Exchange Act provides that APs of all

 8 other registrants are natural persons. We asked

 9 for comments. The comments were uniformly in

 10 support of the commission having a regulation that

 11 clarified that APs of SDs and MSPs were natural

 12 persons, and that would appear in the final

 13 regulations.

 14 As far as statutorily disqualified

 15 associated persons, Dodd-Frank provides that,

 16 except as otherwise provided by rule, regulation

 17 or order by the commission, no SD or MSP can

 18 permit that person to affect swaps if the person

 19 is subject to a statutory disqualification and if

 20 the swap dealer or major swap participant knows or

 21 should know of the statutory disqualification.

 22 The proposal did not have any exception.
 158

 1 The proposal just would have had an outright ban

 2 on the association. NFA in its comment letter

 3 pointed out that without an exception, this would

 4 result in an anomalous situation.

 5 Over the years, the commission has

 6 delegated to NFA the authority to register

 7 persons, including APs. And in connection with

 8 this delegated authority, from time to time, NFA

 9 has given a pass to an applicant as an AP or as a

 10 principal who has, for example, a statutory

 11 disqualification, but it might be any fine for

 12 marijuana possession, two ounces, 25 years old.

 13 So what NFA said was that if this person had

 14 gotten into the system as an AP on the retail

 15 side, it would be anomalous not to let it into the

 16 system as an AP on the institutional swap side.

 17 So in the regulations you have before

 18 you today, we're recommending that the commission

 19 does adopt, pursuant to statutory authority, an

 20 exception for APs and principals in this

 21 situation.

 22 As to the vetting of APs of SDs and
 159

 1 MSPs, we're not recommending that NFA be required

 2 to be the third party service provider, but rather

 3 that a swap dealer or major swap participant

 4 should be allowed to use whatever third party

 5 service provider it would like in this regard.

 6 For example, Krull is someone who readily comes to

 7 mind. Let's see -- consistent -- and this has

 8 also been brought up -- consistent with the

 9 current registration scheme. And as proposed,

 10 we're recommending that the commission would

 11 delegate its registration responsibilities under

 12 the act to NFA. This would be in the notice in

 13 order that you have before you today.

 14 So NFA would process applications for

 15 registration as an SD or MSP, and then if they

 16 would confirm initial compliance with the section

 17 4(s) implementing regulations. However -- and I

 18 believe this also previously had been mentioned,

 19 but I believe it bears repeating -- the notice in

 20 order specifically states that the commission

 21 would retain all authority over SDs and MSPs as

 22 its registrants, including the authority to
 160

 1 develop regulations for them and to conduct

 2 inspections of them. And this is consistent with

 3 our current operations, with respect to all other

 4 registrants.

 5 Further, with respect to NFA, we're

 6 recommending adoption of the proposed requirement

 7 that SDs and MSPs become a member of a registered

 8 futures association. Currently, NFA is the sole

 9 registered futures association, and we are aware

 10 that NFA has been taking steps to amend its

 11 organizational documents and its rules to include

 12 SDs and MSPs within them.

 13 Thank you.

 14 CHAIRMAN GENSLER: Thank you. The chair

 15 will entertain a motion to accept the staff

 16 recommendation on registration.

 17 COMMISSIONER SOMMERS: So moved.

 18 COMMISSIONER O'MALIA: Second.

 19 CHAIRMAN GENSLER: I might have to ask

 20 Dan a question. Can I ask questions about the

 21 delegation as well, even though there's not a

 22 stint -- I mean -- or do I -- all right. I can
 161

 1 ask questions about that. Great. Thanks, Dan.

 2 I think I support both of these -- the

 3 rule and the order. But I just have a question on

 4 the delegation. We're delegating to NFA the

 5 registration function.

 6 MS. GOLD: Yes.

 7 CHAIRMAN GENSLER: And that's a process.

 8 MS. GOLD: Yes.

 9 CHAIRMAN GENSLER: But it ties to the

 10 question that Commissioner O'Malia had, I think,

 11 earlier with Gary Barnett. Are we formally

 12 delegating examination as well, or is it just as a

 13 practical effect of this delegation they have the

 14 examination? I'm just trying to --

 15 MS. GOLD: We are delegating the

 16 authority to confirm initial compliance with the

 17 section 4(s) implementing regulations, business

 18 conduct, internal, external, designation of chief

 19 compliance officer and so on.

 20 We're also requiring that swap dealers

 21 and major swap participants become members of NFA.

 22 NFA is amending its documents, amending its rules
 162

 1 and adopting new rules to provide for the

 2 regulation, the oversight of SD and MSPs as their

 3 members. These rules are going to be equivalent

 4 to or stricter than the rules that we have for SDs

 5 and MSPs. This is exactly what goes on today, for

 6 example, with FCMs.

 7 NFA conducts oversight activities, has

 8 rules for FCMs as its members. We additionally

 9 have rules for FCMs. NFA's rules are based off of

 10 ours, and we additionally engage in oversight

 11 activities. Basically this is a good way, also as

 12 I believe mentioned, to leverage off of NFA's

 13 existing resources.

 14 CHAIRMAN GENSLER: I think I understood

 15 that. I guess -- so we're going to go through.

 16 Today, we finalized one of the business conduct

 17 rules called the 4(s) rules, and today is a

 18 significant day because we're starting this new,

 19 critical package of final rules of business

 20 conduct.

 21 But I think there's five or six more.

 22 There's internal business conduct. There's
 163

 1 documentation, segregation for uncleared swaps and

 2 so forth -- capital, margin. And so it relates to

 3 Commissioner O'Malia's question. I just want to

 4 make sure the delegation's all that we need.

 5 The NFA would be conducting ongoing

 6 compliance, not just registration compliance but

 7 some ongoing examination, ongoing compliance, as I

 8 understand our dialogue with the NFA.

 9 MS. GOLD: Yes, with respect to SDs and

 10 MSPs as their members.

 11 CHAIRMAN GENSLER: I see. So because

 12 it's as a member, we don't have to say anything

 13 explicitly in this delegation.

 14 MS. GOLD: That's correct.

 15 CHAIRMAN GENSLER: Okay.

 16 MS. GOLD: Part of NFA or part of the

 17 obligations of a registered futures association,

 18 to get registered and to stay registered, is to

 19 have a regulatory scheme that is comparable, if

 20 not more so, than the commission's existing

 21 scheme. It's an oversight function.

 22 CHAIRMAN GENSLER: Well, I support this
 164

 1 final rule, as I will also support the delegation.

 2 I think that it is just one of the important

 3 steps. Critical to this is getting the entity

 4 definition rule finalized with the SEC, moving

 5 forward, of course, on the product definition rule

 6 as well, because there's no registration that is

 7 required until both of those occur, and then as we

 8 thoughtfully go through this next quarter, next

 9 two quarters, maybe three quarters -- but to go

 10 through these 4(s) requirements. I think this is

 11 an important first step, and I'm glad to see that

 12 we're able to take it at this time.

 13 I think critically, as we leverage off

 14 of NFA, it's important that we and the public

 15 understand that we still have critical

 16 responsibilities to oversee this market, and so we

 17 may be leveraging off of them, but we also retain

 18 oversight of NFA and, ultimately, oversight of the

 19 dealers. Is that correct?

 20 MS. GOLD: Yes, and in fact, the very

 21 last paragraph of the order says, "Nothing in this

 22 order affects the commission's authority to, among
 165

 1 other things, adopt and enforce regulations

 2 applicable to SDs and MSPs as commission

 3 registrants, and to conduct onsite examinations of

 4 the operations and activities of SDs and MSPs as

 5 commission registrants.

 6 CHAIRMAN GENSLER: Okay. Thank you.

 7 Commissioner Sommers?

 8 COMMISSIONER SOMMERS: Thank you, and

 9 thank you also to this team for all of your hard

 10 work. I just have a couple of questions with

 11 regard to compliance.

 12 And so if I understand it correctly,

 13 compliance would kick in -- your 7R or 8R would

 14 have to be filed 60 days after the effective date

 15 of either the latter of entity or product

 16 definitions.

 17 So if there are people who are unclear

 18 of whether or not either what they trade is a swap

 19 or how they're treated as a dealer, they better

 20 figure it out in 60 days, right -- or just file an

 21 application to be safe. But is that --

 22 MS. GOLD: Correct.
 166

 1 COMMISSIONER SOMMERS: Okay. And then,

 2 with regard to demonstrating compliance with the

 3 4(s) requirements and this whole idea of

 4 provisional registration, I have a number of

 5 different questions, and I'm not sure if you can

 6 answer them, or if perhaps Gary can answer them,

 7 with regard to what 4(s) requirements we've chosen

 8 to pull out and make applicable to our

 9 implementation plan, and other 4(s) requirements

 10 that have a number of other types of compliance

 11 deadlines -- it becomes this very confusing matrix

 12 of when you have to be in compliance with what

 13 4(s) requirements, and how it is actually going to

 14 work in practice to demonstrate compliance with

 15 all of these things separately, and whether or not

 16 that's going to be a nightmare.

 17 I mean, you may have a compliance date

 18 for some 4(s) requirement kicking in every two

 19 weeks for six months, and these people are filing

 20 and filing and filing with the NFA, and the NFA's

 21 going to have to be continually trying to update

 22 and monitor whether or not this actually works.
 167

 1 I'm not exactly sure I get why it's

 2 effective or efficient to have provisional

 3 registration when there's no way they'll be able

 4 to demonstrate compliance with 4(s) requirements

 5 that may not have even been finalized.

 6 MS. GOLD: Provisional registration --

 7 and I may ask Chris to jump in and help me because

 8 he's the author of the concept -- but provisional

 9 registration is intended to bridge the gap, so to

 10 speak, between the fact that Dodd-Frank says on a

 11 date which we've passed -- but on a date, everyone

 12 who comes within the definition must be

 13 registered, and the fact that the section 4(s)

 14 implementing regulations will not have been issued

 15 and their compliance date will not be known by

 16 that time.

 17 So provisional registration essentially

 18 is a temporary status, intended to permit people

 19 to continue in business. There is no requirement,

 20 and the regulations do not contemplate, that one

 21 must be in compliance, that NFA must have made a

 22 finding that an applicant is in compliance on the
 168

 1 date that they file. The regulations clarify that

 2 subsequent to the filing of the application, the

 3 form 7R, 8R prints -- whatever else is necessary

 4 at that time -- subsequent to taking that initial

 5 action, then NFA will confirm initial compliance

 6 with whatever is out there at that time.

 7 COMMISSIONER SOMMERS: I understand all

 8 that.

 9 MS. GOLD: Okay.

 10 COMMISSIONER SOMMERS: My actual

 11 concerns are with regard to the whole host of

 12 different compliance dates. Some things are

 13 subject to the implementation plan, which may or

 14 may not be finalized. Some things are not.

 15 They're all 4(s) requirements.

 16 How is somebody supposed to know -- and

 17 I actually think it's an enormous burden for NFA.

 18 GARY BARNETT: They're only supposed to

 19 be in compliance with these rules as they become

 20 effective. I mean, we're not talking about trying

 21 to -- so I'm missing the question, but as they

 22 provisionally register, if some rules are not yet
 169

 1 effective, they don't have any obligation to be in

 2 compliance.

 3 And then as those become effective, they

 4 have to show compliance.

 5 COMMISSIONER SOMMERS: Right. My

 6 concern is that there is potentially dozens of

 7 different dates for compliance. So I guess what I

 8 would wonder, if it would be a more efficient way

 9 to look at this is to just have one date that all

 10 4(s) requirements become -- the compliance of

 11 those requirements become effective on one date.

 12 A dealer that's provisionally registered

 13 with the NFA could demonstrate compliance with

 14 those 4(s) requirements all at one time.

 15 MR. BARNETT: So you'd have some people

 16 in the market who are complying and others are not

 17 complying --

 18 COMMISSIONER SOMMERS: That's not what

 19 I'm suggesting.

 20 MR. BARNETT: You would just have

 21 everything wait until one date.

 22 COMMISSIONER SOMMERS: Exactly.
 170

 1 MR. CUMMINGS: The downside of that is

 2 that everything hits NFA all at once.

 3 COMMISSIONER SOMMERS: I understand

 4 that. I just --

 5 CHAIRMAN GENSLER: Thank you,

 6 Commissioner Sommers. Commissioner Chilton?

 7 COMMISSIONER CHILTON: I don't have any

 8 questions. I think you reached a good middle

 9 ground on this, and these are complicated rules

 10 because they're complicated markets, and then

 11 myriad types of entities. I think you've done a

 12 good job of threading the needle.

 13 Thank you.

 14 CHAIRMAN GENSLER: Thank you,

 15 Commissioner Chilton. Before Commissioner O'Malia

 16 goes, I just wanted to mention something

 17 Commissioner O'Malia and I have both worked with

 18 staff on in the General Counsel's office is

 19 there's one issue that NFA has raised, which I've

 20 asked staff to come back with as soon as

 21 thoughtfully and practically, as to a proposal

 22 that we could consider to go out to notice and
 171

 1 comment on -- if somebody is an associated person

 2 of more than one swap dealer -- and I just wanted

 3 to, for the record, say that I hope that can

 4 occur.

 5 MS. GOLD: It will. Thank you.

 6 CHAIRMAN GENSLER: Thank you.

 7 Commissioner O'Malia?

 8 COMMISSIONER O'MALIA: Thank you, Mr.

 9 Chairman, for that. That is a -- it's a customer

 10 protection issue, and the sooner we can get it

 11 done, the better. And I understand we missed it

 12 the first time, and due to the rules, we have no

 13 choice but to repropose.

 14 I understand Commissioner Sommers's

 15 frustration on this thing, because I too have

 16 wanted to make sure that we get this right. And

 17 we have an early throughput issue, right? We're

 18 going to have all these people trying to figure

 19 out if they are a dealer.

 20 My concern isn't so much whether

 21 Goldman-Sachs or any of the big guys are. It's

 22 the little guys that, if we get the dealer rule
 172

 1 wrong, whether they are or they aren't, they're

 2 going to be hanging on the very last rule. Then

 3 they have to develop a compliance regime. These

 4 are not big, sophisticated Wall Street firms, more

 5 than likely. They're small guys.

 6 And frankly, I suspect, based on what

 7 I've seen of the entity definition, I think many

 8 of them shouldn't be dealers. But we'll have to

 9 kind of work that through.

 10 I just want to make sure that NFA is not

 11 under any artificial timeline to make these

 12 proposals, and therefore not do an adequate job to

 13 make sure that they're in full compliance, and

 14 firms have adequate timeframe.

 15 I'm not asking a question, so just

 16 relax. We did have -- I did propose an amendment

 17 to this proposal that would have put all of the

 18 timetable fixes in this so you could see it in

 19 this proposal. I understand that is not the will

 20 of the commission. They preferred a more

 21 piecemeal approach, on a rule by rule basis. I

 22 don't like that idea, but I am satisfied that we
 173

 1 did have other fixes on the provisional

 2 registration that will not force NFA into making

 3 bad decisions or untimely decisions so I'm okay

 4 with that. Not real satisfied with the piecemeal,

 5 but we'll go from there.

 6 So I appreciate --

 7 CHAIRMAN GENSLER: Can I just add

 8 something? I think in -- I'll take a rule that I

 9 think we won't get to until sometime this spring,

 10 and even maybe into the summer -- is a 4(s)

 11 requirement on margin.

 12 We're working -- I don't know where

 13 Jackie Mesa is, but we're working internationally

 14 to try to have a coordinated effort. A lot of

 15 people -- Congress would like us to be coordinated

 16 internationally, dealers would like us to be,

 17 customers would. So that's a 4(s) requirement

 18 that, by its nature, could come later, and we

 19 might even put a long implementation. I don't

 20 know -- whatever the will of this commission and

 21 the SEC and other are, whereas others, like

 22 external business conduct might -- once people
 174

 1 know they're a dealer, might actually go

 2 effective, I guess, in the fall of this year.

 3 I think we laid out something which was

 4 six months plus two months. I think it was an

 5 eight month implementation. So that would

 6 probably be going effective -- if we finalize all

 7 the other rules in the fall, whereas margin might

 8 be later.

 9 So I think that's why I'm more inclined

 10 towards this, as you call it, rule by rule --

 11 because I wouldn't want to force a decision on

 12 margin earlier because I'm not sure where we'll

 13 end up on margin, for instance.

 14 That's why we might have a difference

 15 here. Thank you. Commissioner Wetjen?

 16 COMMISSIONER WETJEN: Thanks, Mr.

 17 Chairman. Thank you to the team for your work on

 18 this rule. Appreciate all your efforts.

 19 I guess, piggybacking on the back and

 20 forth to my left here -- I guess what I was

 21 wondering is I think I've been hearing different

 22 messages from folks. In fact, this comment or
 175

 1 question could relate more to Commissioner

 2 Sommers's remarks, but it's not clear to me that

 3 every market participant wants one single date of

 4 compliance just because of the burdens that would

 5 pose on their folks internally.

 6 And so I guess the question to the group

 7 here, with respect to this rule, is what sorts of

 8 things have you folks been hearing along those

 9 lines, and why did you settle on the requirement

 10 that you did?

 11 MR. BARNETT: I mean, just asking --

 12 market participants have teams in place, allocated

 13 and divided responsibilities to put Dodd-Frank

 14 into place, and I think they want clarity and they

 15 want to know what's required of them as soon as

 16 possible.

 17 So I think for them to want to wait for

 18 some later date and then be told at once, and then

 19 have to make everything move at once -- I don't

 20 think that's -- at least that's not what I've

 21 heard from people. That's not the message that's

 22 been communicated to me, anyway.
 176

 1 MS. GOLD: I can't -- oh, I'm sorry. I

 2 can't recall in the comments that anyone

 3 specifically said they wanted all of the rules

 4 issued at one time, the section 4(s) rules. I

 5 think what the comments went more to -- just

 6 having adequate notice and adequate time.

 7 COMMISSIONER WETJEN: That's all I got.

 8 COMMISSIONER SOMMERS: Can I clarify

 9 something?

 10 CHAIRMAN GENSLER: Sure, Commissioner

 11 Sommers.

 12 COMMISSIONER SOMMERS: I wasn't

 13 suggesting that we issue all the rules at the same

 14 time. There's no doubt, I think, in the schedule

 15 that we've talked about putting on the website

 16 from today that we're going to be doing these 4(s)

 17 rules for the next six months. We've already done

 18 some of them.

 19 So there's going to be, I think, a

 20 staggered time for us voting on those rules. But

 21 if you look far enough ahead in the future to say

 22 that there would be one date for compliance, it
 177

 1 just seems to make sense to me.

 2 COMMISSIONER WETJEN: Yeah. My question

 3 was about compliance, not when the rules were

 4 issued, but --

 5 CHAIRMAN GENSLER: I'm just going to

 6 add, as I said to Commissioner O'Malia -- and I

 7 know that you were out of the room for a second --

 8 I think that it helps lower the cost and lower the

 9 burden on the dealer and ultimately the cost of

 10 this change that some of these are staggered and

 11 phased -- phased implementation.

 12 And I used as an example margin, which,

 13 for a lot of reasons, we want to get international

 14 input, SEC input, bank -- there's a lot of

 15 discussion about what the bank regulators are

 16 going to do on margin because we only have the

 17 margin on the non-bank dealers.

 18 So that coordination will take awhile to

 19 finalize, but also we might decide at that point

 20 to give a longer implementation phase because if

 21 we finalize it this summer, than, for instance,

 22 what we did earlier today on external business
 178

 1 conduct.

 2 So I think it helps -- and we might have

 3 a difference here, but I think it helps lower some

 4 of the uncertainty and cost to allow the dealers

 5 to stagger some of these things, and we might

 6 legitimately decide margin, for instance, needs a

 7 lot more time -- not only because we finalized the

 8 rule this summer, but maybe even just to -- if

 9 they have to collect margin from people that it

 10 takes -- we give them more time.

 11 If there are no more questions on the

 12 registration rule, Mr. Stawick.

 13 MR. STAWICK: Commissioner Wetjen?

 14 COMMISSIONER WETJEN: Aye.

 15 MR. STAWICK: Commissioner Wetjen, aye.

 16 Commissioner O'Malia?

 17 COMMISSIONER O'MALIA: Aye.

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

 19 Commissioner Chilton?

 20 COMMISSIONER CHILTON: Aye.

 21 MR. STAWICK: Commissioner Chilton, aye.

 22 Commissioner Sommers?
 179

 1 COMMISSIONER SOMMERS: Aye.

 2 MR. STAWICK: Commissioner Sommers, aye.

 3 Mr. Chairman?

 4 CHAIRMAN GENSLER: Aye.

 5 MR. STAWICK: Mr. Chairman, aye. Mr.

 6 Chairman, on this question, the yays are five, the

 7 nays are zero.

 8 CHAIRMAN GENSLER: The vote being

 9 unanimous, we will send it to the Federal

 10 Register, and I thank the team.

 11 But we have to consider a motion on the

 12 delegation order.

 13 I'll make a motion because we have to do

 14 the delegation as well. That's a separate vote,

 15 right?

 16 MR. STAWICK: That's a separate

 17 question, correct. So it would be in order at

 18 this point to entertain a motion --

 19 CHAIRMAN GENSLER: Yes. So I'm

 20 entertaining a motion to accept the staff

 21 recommendation to delegate to the NFA this

 22 registration function.
 180

 1 COMMISSIONER SOMMERS: So moved.

 2 COMMISSIONER O'MALIA: Second.

 3 CHAIRMAN GENSLER: And are there are any

 4 further questions on the delegation? I just want

 5 to make sure people had those questions now.

 6 If no further questions, then Mr.

 7 Stawick.

 8 MR. STAWICK: Commissioner Wetjen?

 9 COMMISSIONER WETJEN: Aye.

 10 MR. STAWICK: Commissioner Wetjen, aye.

 11 Commissioner O'Malia?

 12 COMMISSIONER O'MALIA: Aye.

 13 MR. STAWICK: Commissioner O'Malia, aye.

 14 Commissioner Chilton?

 15 COMMISSIONER CHILTON: Aye.

 16 MR. STAWICK: Commissioner Chilton, aye.

 17 Commissioner Sommers?

 18 COMMISSIONER SOMMERS: Aye.

 19 MR. STAWICK: Commissioner Sommers, aye.

 20 Mr. Chairman?

 21 CHAIRMAN GENSLER: Aye.

 22 MR. STAWICK: Mr. Chairman, aye. Mr.
 181

 1 Chairman, on this question, the yays are five, the

 2 nays are zero.

 3

 4 CHAIRMAN GENSLER: The vote being

 5 unanimous, not only will we send it to the Federal

 6 Register, but we will ask the NFA and Mr. Dan Roth

 7 to get ready -- as I know they already have been,

 8 and I really thank them for all their

 9 collaboration. I thank this team, and I look

 10 forward to your recommendations on this associated

 11 person matter as soon as you think is thoughtful

 12 to bring it to our attention.

 13 Thank you. I think with that, unless --

 14 I'm going to ask my fellow Commissioners. Do you

 15 want to just keep going, or do you want a break?

 16 All right. So we're going to keep going, and then

 17 Dan Berkovitz and Steve Seitz and whomever else --

 18 hey, Paul.

 19 Gary Barnett, you're going to stay with

 20 this one? Great.

 21 So we will hear from the staff about

 22 proposing under Dodd-Frank section 619 of the
 182

 1 Volcker Rule. And I thank Steve and Gary Barnett

 2 and Dan Berkovitz and Paul Schlicting, who is

 3 sitting in the audience. I do want to do a little

 4 shout-out. Paul is the team lead, and is now over

 5 at the Securities and Exchange Commissions because

 6 we work so well amongst these two agencies.

 7 Sometimes people do move from one to the other,

 8 but he can't sit at the table for some reason

 9 under the SEC's rules. But we see you here and

 10 feel your presence, Paul, and thank you for all

 11 you've done.

 12 Is this Steve or Dan? Who's taking the

 13 lead here? Steve.

 14 MR. SEITZ: Good afternoon, Mr. Chairman

 15 and Commissioners.

 16 Today, staff are recommending that the

 17 commission propose rules implementing section 619

 18 of the Dodd-Frank Act, commonly known as the

 19 Volcker Rule. Section 619 amends the Bank Holding

 20 Act and generally prohibits any banking entities

 21 from either engaging in proprietary trading or

 22 sponsoring or acquiring an ownership interest in
 183

 1 certain covered funds.

 2 Section 619 also contains several

 3 exemptions to these general prohibitions,

 4 including permitting certain activities, such as

 5 underwriting, market-making related activities and

 6 risk-mitigating hedging.

 7 Section 619 also provides exemptions for

 8 organizing and operating a covered fund, and for

 9 making a de minimis investment in these funds.

 10 This proposed rule today would only

 11 apply to banking entities, including affiliates

 12 and subsidiaries for which the CFTC is the primary

 13 financial regulatory agency, as set forth in

 14 section two of the Dodd-Frank Act. Most notably,

 15 this would include CFTC-registered swap dealers,

 16 commodity pool operators and commodity trading

 17 advisors.

 18 Before summarizing the proposed rule,

 19 I'd like to thank the staff and various divisions

 20 here at the commission who have helped draft the

 21 proposed rule. And additionally, we'd also like

 22 to thank our colleagues at the Board of Governors
 184

 1 of the Federal Reserve System, the Office of the

 2 Comptroller of the Currency, the Federal Deposit

 3 Insurance Corporation, the Securities and Exchange

 4 Commission, as well as the Treasury Department for

 5 all of their help in formulating this proposal.

 6 Section 619 requires the various

 7 financial regulators to consult and coordinate

 8 with each other to ensure that the Volcker

 9 regulations are comparable and consistently

 10 applied to the affected banking entities.

 11 This proposed rule is the result of an

 12 extensive and coordinated rulemaking process among

 13 the various financial regulators.

 14 Accordingly, the CFTC's proposed rule is

 15 substantively similar to the joint rule that was

 16 previously proposed by the banking regulators and

 17 the SEC in October.

 18 Staff is recommending, similar to these

 19 other agencies, that the commission propose the

 20 entire text of the proposed common rules section

 21 from the joint rule. And similar to these other

 22 agencies, the CFTC is proposing to modify this
 185

 1 commonly shared joint rule with CFTC-specific rule

 2 text.

 3 Our proposal also contains several

 4 additional questions asking whether certain

 5 provisions of the joint rule are applicable and

 6 should be applicable to CFTC-regulated banking

 7 entities.

 8 As required under section 619 of the

 9 Dodd-Frank Act, the proposed rule prohibits

 10 banking entities such as registered swap dealers,

 11 commodity pool operators and commodity trading

 12 advisors from engaging in proprietary trading and

 13 having certain interest in, and relationships

 14 with, covered funds.

 15 The proposed definition of proprietary

 16 trading generally mirrors the statutory

 17 definition. And this means engaging as a principal

 18 for the trading account of a covered banking

 19 entity in any purchase or sale of certain

 20 financial instruments. It does not include acting

 21 as a custodian, agent or broker for an

 22 unaffiliated third party.
 186

 1 The proposed definition of proprietary

 2 trading contains two critical terms. The first is

 3 trading account, and the second is covered

 4 financial position. If a banking entity enters

 5 into a transaction or trading strategy that falls

 6 outside of these two definitions, then such

 7 transaction or trading strategy is not covered by

 8 the Volcker Rule prohibitions.

 9 The proposed definition of trading

 10 account includes accounts used to acquire

 11 financial positions principally for the purpose of

 12 short-term gain. Second, positions that are

 13 market risk capital rule cover positions. And

 14 third, positions held by a swap dealer registered

 15 with the commission.

 16 The proposed definition of trading

 17 account also includes all positions held by a

 18 registered swap dealer. This ensures that the

 19 definition of trading account includes all of the

 20 dealing book of any banking entity swap dealers,

 21 including long data derivatives that are held to

 22 term or expiration.
 187

 1 The proposed definition of covered

 2 financial position includes positions in

 3 securities, derivatives, commodity futures and

 4 options on these instruments, but does not include

 5 positions in loans, spot foreign exchange or spot

 6 commodities.

 7 Although the definition of trading

 8 accounts for registered swap dealers is broad, the

 9 proposal, like the statute, specifically permits

 10 certain activities. The statutory exemptions

 11 include underwriting, market making- related

 12 activities, risk mitigating hedging, trading in

 13 certain government obligations, trading on behalf

 14 of customers, trading by insurance company for

 15 general accounts and trading solely outside the

 16 United States.

 17 This proposal also provides detailed

 18 guidance on what banking entities must do to

 19 qualify for each of these exemptions, including

 20 proposing detailed, quantitative measurements that

 21 are indicative of market making-related

 22 activities. The quantitative measurements are
 188

 1 designed to help differentiate between prohibited

 2 proprietary trading and market making-related

 3 activities.

 4 In addition, pursuant to the statute,

 5 there are limitations on these permitted

 6 activities. Banking entities may not use these

 7 exemptions if their trading activities would

 8 result in a material conflict of interest between

 9 the banking entity and its client, customer or

 10 counterparty. Second, if it would result in a

 11 material exposure to either high-risk trading

 12 strategies or high-risk assets, or third, if it

 13 would pose a threat to either the safety and

 14 soundness of the bank entity or to the financial

 15 stability of the United States.

 16 The proposal also requires large banking

 17 entities to comply with recordkeeping and

 18 recording requirements; specifically, covered

 19 banking entities that have, together with their

 20 affiliates and subsidiaries, trading assets and

 21 trading liabilities equal to or greater than $1

 22 billion will be required to calculate and report
 189

 1 these quantitative measurements for their trading

 2 units that are engaged in market making-related

 3 activities.

 4 Additionally, covered banking entities

 5 with more than $5 million in trading assets or

 6 liabilities will be required to calculate and

 7 report additional quantitative measurements.

 8 These proposed quantitative measurements

 9 would cover five categories: Risk management,

 10 source of revenue, revenues relative to risk,

 11 customer-facing activity and pay-to-receive spread

 12 ratio.

 13 The proposal sets forth both a general

 14 description and calculation guidance for each of

 15 these metrics. The proposed rule also includes

 16 questions regarding the applicability of each

 17 metric to CFTC-regulated markets and products.

 18 Furthermore, under the proposal, all

 19 covered banking entities that engaged in either

 20 covered trading activities or covered fund

 21 activities under the proposal will be required to

 22 develop and administer a program that is
 190

 1 reasonably designed to ensure and monitor

 2 compliance with the statute and the proposed rule.

 3 This compliance program would include

 4 six elements: Written policies and procedures,

 5 internal controls, independent testing of the

 6 effectiveness of the compliance program, a

 7 management framework that delineates

 8 responsibility and accountability for compliance,

 9 trading for personnel to both implement and

 10 enforce the compliance program, and creating and

 11 keeping records sufficient to demonstrate

 12 compliance with the statute and the proposed rule.

 13 Under the proposal, covered banking

 14 entities meeting certain size thresholds for

 15 trading would need to establish an enhanced

 16 compliance program. The enhanced compliance

 17 program would need to meet certain standards

 18 outlined in the proposed rule.

 19 The second part of the proposed rule

 20 prohibits banking entities from investing in, or

 21 engaging in, certain relationships with private

 22 equity funds, hedge funds, commodity pools and
 191

 1 certain foreign funds. These are referred to in

 2 the proposal as covered funds.

 3 In this part of the rule, the proposal

 4 defines banking entity broadly to include any

 5 affiliate of a bank, such as an affiliate that is

 6 a registered commodity pool operator or a

 7 commodity trading advisor.

 8 The purpose of the prohibition on

 9 investments and covered funds is to prevent a bank

 10 from indirectly engaging in proprietary trading

 11 through direct investments and covered funds, and

 12 also to prevent a bank from possibly bailing out

 13 such funds.

 14 The statute contains three provisions

 15 governing investments and private funds sponsored

 16 by banks. First, the bank and its affiliate

 17 advisor can invest no more than three percent of

 18 its tier one capital in a private fund and

 19 sponsors, which is the aggregate limitation.

 20 Second, the bank and its affiliate advisor can own

 21 no more than three percent of the private fund.

 22 This is the per fund limitation. And third, the
 192

 1 bank and its affiliate advisor cannot bail out any

 2 fund that it sponsors.

 3 As stated earlier, the proposed rule

 4 clarifies the statutory provisional investments

 5 and covered funds, and defines terms in a manner

 6 that is consistent with the provisions proposed by

 7 the federal banking regulators and the SEC in

 8 October.

 9 The proposal attempts to not impose

 10 unnecessary restrictions on the ability of

 11 commodity pool operators and commodity trading

 12 advisors to provide advisory services.

 13 CPOs and CTAs can continue to sponsor,

 14 advise and invest in commodity pools, provided

 15 that they comply with certain requirements, such

 16 as setting up a compliance program that

 17 independently meets certain conditions.

 18 The proposal also asks questions on how

 19 advisors, such as CPOs and CTAs, would be affected

 20 by the proposed regulation.

 21 In conclusion, we look forward to

 22 receiving comment from market participants and the
 193

 1 public on the proposal, and we are happy to answer

 2 any questions that you may have.

 3 CHAIRMAN GENSLER: Thank you, Steve. I

 4 will now entertain a motion to accept the staff

 5 recommendation on this proposal.

 6 COMMISSIONER SOMMERS: So moved.

 7 COMMISSIONER O'MALIA: Second.

 8 CHAIRMAN GENSLER: Now it's time for

 9 questions. I'm going to support this proposal,

 10 and I'll chat a little bit about why in a minute,

 11 but I do have a couple of questions.

 12 Can you just walk through, Steve or Dan,

 13 walk through the CFTC's role and how that relates

 14 to other -- the bank regulators and the SEC? And

 15 the reason -- I mean, we've discussed this in my

 16 office a bunch, but I think it's helpful for the

 17 public to understand where it fits in. If a

 18 banking entity -- these rules only apply to

 19 banking.

 20 First question -- this only applies to

 21 banking entities, correct?

 22 MR. SEITZ: That's correct. The rule
 194

 1 applies only to certain banking entities, and then

 2 within those banking entities, it's the entities

 3 that we are the primary financial regulator for,

 4 such as swap dealers that are associated or

 5 affiliated with those banking entities.

 6 CHAIRMAN GENSLER: So you've answered

 7 part of my question. So it only relates to where

 8 a primary financial regulator, such as a swap

 9 dealer -- or is it also a futures commission

 10 merchant that's part of a larger banking entity?

 11 MR. SEITZ: That's correct. There's a

 12 series of entities for which we're the primary

 13 regulator under section two. It includes swap

 14 dealers, futures commission merchants, CPOs, CTAs.

 15 CHAIRMAN GENSLER: So if you can answer

 16 a question I asked yesterday -- but if there's a

 17 swap dealer that's part of a bank, does any rule

 18 that we finalize eventually one day finalize apply

 19 to the rest of the bank, or what portion of the

 20 bank does it apply to -- our rule versus the

 21 Federal Reserve's rules and everybody else's

 22 rules?
 195

 1 MR. BERKOVITZ: Our rule would apply to

 2 those activities with respect to which we are the

 3 primary regulator.

 4 CHAIRMAN GENSLER: So in essence, it's

 5 the swap dealer activities.

 6 MR. BERKOVITZ: Correct. The activities

 7 that make somebody a swap dealer, that's who it

 8 would apply to.

 9 CHAIRMAN GENSLER: And another example,

 10 just for the public -- if it was a joint futures

 11 commission merchant/broker-dealer, would it apply

 12 to the broker-dealer activities of the joint FCM

 13 broker-dealer or would the SEC's rules?

 14 MR. BERKOVITZ: The CFTC's rules would

 15 apply to the FCM activities and the SEC's rules

 16 would apply to the broker- dealer activities.

 17 CHAIRMAN GENSLER: So it's just

 18 targeted, in essence, to those -- because

 19 Commissioner O'Malia and I have had a lot of

 20 discussions about this and with you, Dan -- can

 21 you walk us through? We have rule writing

 22 authority. What is our examination or enforcement
 196

 1 authorities with regard to this rule, or is it the

 2 banking regulators that have some of that?

 3 MR. BERKOVITZ: Section 619, which

 4 amended the Bank Holding Company Act and gives the

 5 CFTC several authorities with respect to the

 6 Volcker Rule. One is rule writing authority, rule

 7 making authority -- and that is the authority

 8 we're using to promulgate this rule.

 9 As part of that rule, we are given

 10 authority to require records be kept and

 11 information to be reported, and along with that

 12 authority, that recordkeeping and reporting, is

 13 authority for us to look at those records and

 14 require periodic reporting to us as we determine

 15 appropriate -- or allow us to examine the books

 16 and records that they have and we require them to

 17 keep.

 18 So that is the basic -- we, I think,

 19 could refer to it as examination authority, to

 20 look over those books and records.

 21 The statute also provides authority when

 22 there is a violation of the prohibitions on
 197

 1 proprietary trading. After notice and opportunity

 2 for the potential violator to be heard, we can

 3 order that the offending activity be terminated or

 4 undone. So we do have that very specific

 5 enforcement authority -- when there's been a

 6 violation, to terminate the activity in order that

 7 the investment be divested, basically.

 8 CHAIRMAN GENSLER: But in fact -- am I

 9 correct that under the Bank Holding Company Act,

 10 it's the banking regulators that have the broader

 11 enforcement authority for any violations of rules

 12 promulgated onto the Bank Holding Company Act?

 13 MR. BERKOVITZ: That's correct. The

 14 banking regulators have broad authority under the

 15 Bank Holding Company Act to take enforcement

 16 action for any violation of that act, and that

 17 would include our rules that we have promulgated

 18 pursuant to that act.

 19 CHAIRMAN GENSLER: Right. So they would

 20 have that enforcement authority.

 21 MR. BERKOVITZ: Correct.

 22 CHAIRMAN GENSLER: The reason I ask it
 198

 1 is -- I do support the proposed implementing rule.

 2 I think it's important to put it out to public

 3 comment. The banking regulators and the SEC put

 4 out to public comment in September -- no, I guess

 5 it was October. In October, this is virtually --

 6 I mean, it's a mirror of that. I mean, we changed

 7 all references to the SEC to references to us and

 8 things like that, but this is basically a mirror.

 9 I'm glad we added a handful of

 10 additional questions, and the spirit of those

 11 questions were, do we really need this in our

 12 rule? Is this necessary for swap dealers and

 13 futures commission merchants? But it's a mirror

 14 of what they have done.

 15 To answer a question that's come up from

 16 Congress and the press and sometimes from fellow

 17 Commissioners -- why didn't we do it in October?

 18 From my perspective as Chairman, it was pure

 19 capacity, pure just what we had on our agendas in

 20 October. The document came to us that last week

 21 of September. First week of October, we

 22 distributed it to Commissioners' offices, and I as
 199

 1 Chair decided not to press forward, partly because

 2 Commissioner Dunn was also about at the end of his

 3 long, distinguished term here, and Commissioner

 4 Wetjen was coming on board.

 5 So that's a large part of why I -- but I

 6 also didn't hear back from Commissioners that they

 7 wanted changes in the documents, and so that's the

 8 document we're doing right now. And Commissioner

 9 Sommers is right. Now the public is able to weigh

 10 in on ours and the banking rules together. As I

 11 understand it, they've extended their timeline.

 12 So I think that they and we will hear -- we're

 13 going to put this out for 60 days. So our comment

 14 period might go a little longer than theirs, but I

 15 would envision if we adopt the proposal today,

 16 that we'll be considering comments that will be

 17 consistent with the comments they're getting.

 18 From my perspective, what's most

 19 important to hear from the public is how to get

 20 this -- if there's ways to make it less of a

 21 compliance burden, to make it less of a compliance

 22 burden. I think it's a very challenging thing
 200

 1 that Congress has given the regulators to do here,

 2 and ultimately the dealers and the banks to do, is

 3 how to legitimately make markets, how to

 4 underwrite securities, how to keep liquid markets

 5 going but at the same time not proprietary trade.

 6 I mean, that's what we'll be sorting through in

 7 these comments.

 8 Truly, I look forward to the comments

 9 and to your question. I mean, if for some reason

 10 the other regulators decide that something's not a

 11 logical outgrowth and has to be reproposed, I

 12 would assume that we'd be right in there with them

 13 doing similar things, to your question,

 14 Commissioner Sommers -- because I think our role

 15 here is -- it's important, it's significant, but

 16 it's actually just a supporting member, where the

 17 bank regulators have the lead role. I don't know

 18 if, Dan or Gary, you agree with that, but I think

 19 they have the lead role, from what I understand,

 20 in this. Is that right?

 21 MR. BARNETT: Yes.

 22 CHAIRMAN GENSLER: So I'm going to --
 201

 1 Commissioner Sommers.

 2 COMMISSIONER SOMMERS: I just have a

 3 couple of questions, and one of them is a followup

 4 to, Dan, your answer that you just gave about what

 5 our enforcement authority is. So if there is a

 6 violation of a prohibited trade, we can ask them

 7 to get out of that trade.

 8 What if they refuse? Do we have the

 9 ability to then rip their registration, to do

 10 other -- what's the hammer to tell them, you need

 11 to get out of this trade -- but if we can't do

 12 anything about it if they don't --

 13 MR. BERKOVITZ: Well, I think that we --

 14 along with the statutory provision, we have the

 15 authority to require the divestment, which would

 16 be judicially enforceable, that -- an order issued

 17 under that authority of the Bank Holding Company

 18 Act that we would have would be something that's

 19 judicially enforceable in and of itself.

 20 COMMISSIONER SOMMERS: So we could take

 21 them to court to say get out of the trade, but we

 22 couldn't fine them or --
 202

 1 MR. BERKOVITZ: The enforcement

 2 authority for that type of civil penalty

 3 authority, the statute, section 13, the Bank

 4 Holding Company Act, does not give us that

 5 authority.

 6 COMMISSIONER SOMMERS: Okay. My other

 7 question is with regard to a change that was made

 8 this morning, and I'm just trying to make sure

 9 that I understand this additional text on page 57,

 10 which has to do with the interplay between market

 11 making in the Volcker Rule and what we end up

 12 doing in the entity definition rule making.

 13 So if we define market making in the

 14 entity definition rule, whether or not it's

 15 considered -- in a way, to determine whether or

 16 not it's considered bona fide market making -- and

 17 that is in conflict with what's in the Volcker

 18 Rule, what happens then?

 19 MR. BERKOVITZ: The purpose of the

 20 additional language that was circulated was that

 21 when this was proposed, when this language was

 22 proposed last -- it was basically proposed last
 203

 1 October, and it was proposed at that time by the

 2 four financial regulatory agencies.

 3 And now we're in -- as Steve has

 4 explained -- in this proposal here, we're

 5 basically just taking what the proposal was in

 6 order to be consistent and take the consistent

 7 approach, recognizing at the same time in our

 8 entities definitions rule making, we're addressing

 9 the issue of what is market making -- because that

 10 is one of the components of this swap dealer

 11 definition. We have to determine what is --

 12 actually referencing a couple of the components of

 13 the definition -- somebody's who making a market,

 14 somebody who's known as a market maker.

 15 So the question arises, should we have

 16 the same considerations for market making in both

 17 rules, or are there considerations that would lend

 18 that there be one different than the other, or

 19 should it be the same?

 20 So the purpose of the additional

 21 language was basically to put the public on notice

 22 that we're coming out with this entities
 204

 1 definition rule making. We've gotten a lot of

 2 comments on what market making is in the context

 3 of that rule making, and therefore is it

 4 appropriate in this rule making to be consistent

 5 with what we come out with market making and the

 6 entities definitions rule making, rather than just

 7 go with what was proposed.

 8 MR. SEITZ: They don't need to be the

 9 same, and one shouldn't drive the meaning of the

 10 other. So you could look at too much market

 11 making as a definition cuts into Volcker, but too

 12 much prop trading can cut into swap dealing for

 13 purposes of our swap dealer definition.

 14 You look at definitions in the context

 15 in which they're adopted. By analogy, you could

 16 look at U.S. person -- definition of U.S. person

 17 -- and used in one context, you might exclude

 18 foreign vehicles that are invested in by U.S.

 19 People. In another context, you might define it

 20 in a different way, where you want to look through

 21 to U.S. people. So there's no need to look at it

 22 that way, but we will be considering it.
 205

 1 COMMISSIONER SOMMERS: Okay.

 2 CHAIRMAN GENSLER: Thank you,

 3 Commissioner Sommers. Commissioner Chilton?

 4 COMMISSIONER CHILTON: Thanks, Mr.

 5 Chairman. Like I said, I support the proposals.

 6 I did want to clarify something -- because for the

 7 longest time, I just assumed that we didn't even

 8 need to do a proposal on this, that this was

 9 pretty much in the banking world and that what

 10 they did sort of superseded what we did.

 11 So in following on the Chairman's

 12 questions about what this proposal would do and

 13 who it would impact, and essentially just our

 14 registrants -- Mr. Berkovitz, if the banking

 15 regulators obligated the rule as proposed, would

 16 we even need to follow all the rules?

 17 I mean, doesn't their ability with

 18 regard to overseeing and enforcing this sort of

 19 supersede anything we would do? Not anything, but

 20 couldn't it be done without us, I guess is my

 21 question.

 22 MR. BERKOVITZ: They would have the
 206

 1 ability to finalize their rule with respect to the

 2 entities for which they are the primary financial

 3 regulator, but with respect to the entities for

 4 which we are the primary financial regulator, we

 5 would have to finalize a rule to make it effective

 6 for those activities for which we are the primary

 7 financial regulator.

 8 COMMISSIONER CHILTON: So if they use

 9 some language, Dan, that said something like any

 10 bank or entity thereof may not be involved in

 11 proprietary trading, that wouldn't take care of an

 12 FCM? Any bank or entity thereof -- that wouldn't

 13 just automatically say that the FCM can't be

 14 involved in prop trading?

 15 MR. BERKOVITZ: Yeah, we would have to

 16 issue the rule with respect to the FCMs for which

 17 we are the primary financial regulator. It

 18 specifically gives us the authority in those

 19 areas. So that's why the rule is joint between

 20 all the various agencies -- because each agency

 21 has to do it within the scope of its own

 22 authority.
 207

 1 COMMISSIONER CHILTON: So the reach does

 2 not include FCMs from the banking regulators. If

 3 they say bank or entity thereof -- or whatever the

 4 appropriate word -- there's no way that they would

 5 be able to cover what's going on in our space?

 6 MR. BERKOVITZ: That's correct. And I

 7 just want to be clear -- in our space. As the

 8 Chairman's question initially indicated, an FCM

 9 may be an FCM broker-dealer so they may have

 10 several -- an entity may have several different

 11 spaces, and the rule could be effective for things

 12 that are not in our space, but things that are

 13 specifically in our space such as the FCM

 14 registered activities -- futures commission

 15 merchants basically activities for their

 16 customers, swap dealers for their swap dealing

 17 activities. We have to issue the rule to have the

 18 proprietary trading prohibitions and fund

 19 investment prohibitions going --

 20 COMMISSIONER CHILTON: Okay. Just one

 21 more -- keep it out, just one more little bit

 22 here.
 208

 1 So you said earlier in answer to a

 2 question, Dan -- you said that the banking

 3 regulators would have enforcement authority, if

 4 they saw that the banks were involved in

 5 proprietary trading even in our space. So they'd

 6 have some enforcement authority, but not

 7 overseeing authority in our area?

 8 MR. BERKOVITZ: They would have

 9 enforcement authority because this would be a rule

 10 promulgated under the -- it will have been a rule

 11 that will have been promulgated under the Banking

 12 Holding Company Act. So once it's promulgated and

 13 the entity is within their jurisdiction and the

 14 entity is subject to the Bank Holding Company Act

 15 and the requirements thereunder, which would

 16 include our regulations at that time -- then there

 17 would be that type of enforcement authority that

 18 they would have.

 19 And it's my understanding that in the

 20 near future, the agencies, the various regulatory

 21 agencies who are involved in this will be getting

 22 together and working together, and starting to
 209

 1 figure out how to allocate these enforcement

 2 authorities and how to work cooperatively together

 3 so they'll be done in a coordinated way.

 4 But essentially, the answer is yes, that

 5 once we promulgate our rules, we will have certain

 6 authorities that we can do -- inspection

 7 authorities -- examination authorities, I should

 8 say. We will have the authority to terminate the

 9 investments, and then they will have certain

 10 authorities too over the books and records because

 11 ultimately these are banking entities that they

 12 have a broader jurisdiction over under the Bank

 13 Holding Company Act.

 14 COMMISSIONER CHILTON: Okay, thank you.

 15 I have nothing further. Thank you.

 16 CHAIRMEN GENSLER: Thank you,

 17 Commissioner Chilton. I'm going to turn to

 18 Commissioner O'Malia, unless you thought you had

 19 anything you had to add. No? Okay, Commissioner

 20 O'Malia.

 21 COMMISSIONER O'MALIA: Thank you, Mr.

 22 Chairman. This is a difficult situation.
 210

 1 Obviously we have to comply with the statute, and

 2 do so in a responsible way. And my questions and

 3 concerns with this fatally flawed rule do not

 4 imply that I don't agree that we don't have a job

 5 to execute the statute, but this rule is not it.

 6 The rule suffers from massive conflicts,

 7 and the regulatory sphere has been highlighted and

 8 certainly confirmed by Mr. Barnett's statement

 9 about swap dealer definitions. The statute

 10 dictates a trade by trade oversight, yet the rule

 11 attempts to develop a broader entity compliance

 12 approach, which frankly is the only way they can

 13 be accomplished.

 14 But it's unclear how any sort of

 15 regulatory consistency across entities, assets and

 16 markets -- this can be achieved.

 17 The commission is voting on a document

 18 that's nearly 300 pages in length, establishing

 19 CFTC rules and regulation under the Volcker Rule.

 20 However, the rule fails to provide the CFTC with

 21 any specific enforcement authority as highlighted

 22 by Commissioner Sommers's questions, and leaves us
 211

 1 with an ineffective capacity to simply audit firms

 2 with the strongest possible remedy of liquidating

 3 the position.

 4 Do you believe that's a very effective

 5 deterrent?

 6 MR. BARNETT: No. I actually wasn't

 7 tracking your whole question to the end.

 8 COMMISSIONER O'MALIA: Do you believe

 9 liquidation is a fair, effective deterrent for a

 10 violation?

 11 MR. BARNETT: No.

 12 COMMISSIONER O'MALIA: The rule imposes

 13 a massive oversight responsibility to verify the

 14 complex metrics required by this rule. And it's a

 15 tiered regulatory approach. I think maybe that's

 16 a good idea. I don't know if -- $1 billion or $5

 17 billion -- I don't know where they got those

 18 numbers. Do you have any sense?

 19 MR. BARNETT: No, but I think what they

 20 -- I mean, to the extent you're asking me, I think

 21 they were trying to excise prop trading as

 22 concisely as they can. I mean, it's a colloquial
 212

 1 term. To define it colloquially would have left

 2 permitted activities at risk.

 3 So you see a lot of stuff going on where

 4 they're trying very hard to define prop trading,

 5 and at the same time, they're building in all

 6 kinds of safeguards against permitted activities,

 7 and by the time you're done, you've got this very,

 8 very large rule that everybody said go back and

 9 think about it again.

 10 COMMISSIONER O'MALIA: All right. Do

 11 you have any sense of how many entities this

 12 commission will be regulating under this rule?

 13 MR. BARNETT: I do not at this point. I

 14 could run it down for you, but I haven't it.

 15 COMMISSIONER O'MALIA: Okay. And I'm

 16 curious as to how we're going to perform this

 17 oversight rule. Clearly, we require firms to set

 18 up a compliance program. We have either 17 or

 19 seven metrics, depending on how big you are in

 20 your tiered approach. That reporting has to come

 21 in on roughly a monthly basis on very subjective

 22 things.
 213

 1 How are we going to surveil that? It

 2 seems difficult to me. I don't think this is a

 3 technology solution.

 4 MR. BARNETT: I agree with you. I mean,

 5 I think we're looking at this as dealing with 619.

 6 That requires comparable and consistently applied

 7 statutes, and we know that we want to get on the

 8 same page with our coregulators and go back

 9 through these questions. So I don't know that

 10 we're looking at how to comply with what is here,

 11 but we need to get into the discussion here, and

 12 then --

 13 CHAIRMEN GENSLER: If I could try just

 14 -- I think that -- though I have not yet taken any

 15 part of this, I know from the staff that the

 16 banking regulators are looking to work with the

 17 SEC, and also on some understands, whether those

 18 are documented in literally a written document or

 19 whatever, to answer some of your very question --

 20 that if a banking entity is under the Federal

 21 Reserve and they have supervisors usually there

 22 anyway -- I mean, they have more staff than us --
 214

 1 that we might actually -- in this arrangements

 2 with the banking regulators -- answer your

 3 questions, but I think it's still to be worked

 4 out, rather than us having to go in there.

 5 COMMISSIONER O'MALIA: That still

 6 doesn't solve the conflict here. Realize we've

 7 got 300 pages of regulation that are specific to

 8 this body, and we have kind of an obligation now.

 9 We've created this obligation that we have some

 10 oversight and responsibility, yet no way to

 11 enforce it, no way to make it happen. Frankly, no

 12 way to understand how the metrics are being used.

 13 I mean, MF Global highlighted the fact

 14 that on 30 days after -- we have the seg reporting

 15 requirement. 30 days after, they have to report

 16 how their seg funds are doing. In a matter of

 17 days, that all changed, and now we've got brand

 18 new metrics that are, frankly, wide, vast, and

 19 vague, and require us to pinpoint at an exact time

 20 whether these firms are in compliance or not --

 21 after the fact, on an ad hoc basis.

 22 It's an impossible job for us to do, and
 215

 1 yet, even if we did do it, utilizing the resources

 2 we don't have, we have no authority to enforce it.

 3 I'm going to keep going. On page 67,

 4 68, the document discusses seven criteria a bank

 5 must rely on for a hedging exemption. In the

 6 third criteria, there's a discussion about

 7 "dynamic hedging." At the top of page 68, it

 8 says:

 9 The CFTC recognizes such dynamic

 10 hedging, material changes and risk may require a

 11 corresponding modification to the banking

 12 entities' current hedge position. That makes

 13 complete sense to me. I get it. Especially in a

 14 principal to principal OTC market, things are

 15 changing, markets change. There's credit risk, et

 16 cetera.

 17 We go on to the next criteria, the

 18 fourth criteria. The proposal lays out several

 19 factors that would impact the "reasonableness of

 20 correlation, depending on the facts and

 21 circumstances."

 22 And these are the factors: Initial
 216

 1 position, risk created, liquidity of the

 2 instrument and legitimacy of the hedge. Again,

 3 all of those make sense to me, but it doesn't make

 4 our job very easy, of course, because these are

 5 somewhat subjective, based on kind of a point in

 6 time.

 7 But then the fourth paragraph closes

 8 with this last sentence: Regardless of the

 9 precise degree of correlation, if the predicted

 10 performance of a hedge position, during the period

 11 that the hedge position and the related position

 12 are held, would result in a banking entity earning

 13 appreciable more profit on the hedge than it stood

 14 to lose, the hedge position would appear likely to

 15 be prop trading designed to result from profit

 16 rather than the exempt hedge position.

 17 So we've gone through all these

 18 criteria, saying it's very subjective, facts and

 19 circumstances, blah, blah, blah. And then we go

 20 at the end of the day and say, oh by the way, you

 21 made too much money. It's kind of an ad hoc

 22 ex-post determination.
 217

 1 How is anybody supposed to have any

 2 confidence that they can put on a position and

 3 have this type of standard being the controlling

 4 regulation? What do people do with that?

 5 It's more rhetorical.

 6 MR. BARNETT: I understand.

 7 COMMISSIONER O'MALIA: Well, maybe -- I

 8 mean, we did go through a number of these

 9 questions about these criteria, and I am really

 10 struck by how many questions we asked, whether

 11 this is even the right criteria for something that

 12 we seem -- we're prepared to vote on today and

 13 approve. We asked so many questions about is this

 14 the right criteria.

 15 Let me ask you one question. This is

 16 not going to be rhetorical. I actually want the

 17 answer on this one. Hedging a customer trade --

 18 this is something we dealt with in position limits

 19 -- trying to figure out if a dealer is supporting

 20 a customer that's a legitimate hedging entity,

 21 they're entitled to go lay off that hedge, but

 22 they can only do it once.
 218

 1 So what happens when they lay that off

 2 in the market? The dealer takes that legitimate

 3 hedging trade and goes to meet somebody else in

 4 the market. How do they find liquidity if every

 5 other dealer is banned from that proprietary --

 6 from meeting them in that proprietary trade,

 7 unless they have some serendipitous position at

 8 the exact same time that they're looking --

 9 they're too qualified looking to hedge. How does

 10 this happen? In what world does this happen?

 11 Let me ask -- I was actually going to

 12 ask, looking for an answer. Anyone want to take

 13 that? I mean --

 14 MR. BERKOVITZ: Can I -- let me just

 15 make a couple points, and maybe this is not

 16 directly responding, but the philosophy under this

 17 is it's basically a facts and circumstances test

 18 for whether this is proprietary trading or bona

 19 fide hedging or market making or whatever.

 20 There's a number of factors and metrics that are

 21 going to be looked at.

 22 The firms are supposed to have
 219

 1 compliance programs. They look at the metrics.

 2 They're going to see whether their hedges are

 3 correlated or not correlated with the positions

 4 they took, and if you have consistently

 5 uncorrelated positions, well, maybe that's an

 6 indication that your trader is not really hedging,

 7 that they are taking proprietary positions. And

 8 your compliance program is designed to detect

 9 that, and then the regulatory agencies are going

 10 to oversee the compliance program and how it's

 11 working. It's going to be on some audited basis,

 12 I presume.

 13 So each element in this is really going

 14 to go to that and not if you have one trade that

 15 doesn't correlate, that means that your entire

 16 hedging program is out. It's going to go into

 17 these facts and circumstances tests, and so you

 18 have to look at the big picture.

 19 So I think you need to look at more than

 20 --

 21 COMMISSIONER O'MALIA: But --

 22 MR. BERKOVITZ: -- one element to
 220

 1 determine what the effectiveness will be.

 2 COMMISSIONER O'MALIA: And I'm -- well,

 3 this unfortunately does look at it from a trade by

 4 trade standpoint, but the compliance has to be

 5 kind of portfolios larger -- I get that, but

 6 that's why I read what's on page 67 and 68. It

 7 certainly goes back and says, well, on that per

 8 trade basis, that's not a legitimate hedge.

 9 That's an individual trade. That is not the book

 10 kind of approach that I was hoping that we might

 11 try to enforce.

 12 I get how difficult this is, and I

 13 understand the conflicting objectives of market

 14 making and then banning prop trading, and that's

 15 not a bright line. I do understand that, but this

 16 rule doesn't get that.

 17 Corporate debt issuance -- I understand

 18 dealers will help underwrite corporate debt

 19 issuances and say, listen, we'll make you a firm

 20 commitment. We'll take the rest of it -- anything

 21 you don't sell. Is that prop trading, taking the

 22 remainder?
 221

 1 Paul, you want smoke signals from the

 2 back?

 3 MR. BARNETT: It's a colloquial term. I

 4 mean, prop trading -- I don't know how you want to

 5 define it for purpose of the statute. I think --

 6 I don't know if you're -- the way I'm looking at

 7 this is we have to adopt rules, and do we want to

 8 start off on our own, or do we want to get back --

 9 do we want to be in the game with the group that's

 10 going to reexamine this rule and how do we do

 11 that?

 12 But I understand the criticisms that

 13 have been made of the rule that was proposed by

 14 the other regulators, and we can restate those

 15 criticisms of this one, but then what is it that

 16 we want to do?

 17 COMMISSIONER O'MALIA: We received --

 18 Volcker Rule provides for an exemption from prop

 19 trading ban for U.S. Treasuries or U.S.

 20 obligations, but does not provide a similar

 21 exemption for Canadian or Mexican debt, and

 22 whether or not this -- I'm interested to know
 222

 1 whether this -- A, we know it ticks them off, but

 2 whether this violates any NAFTA agreement. And

 3 did FSOC consider any ramifications of this policy

 4 decision by declaring all foreign debt obligations

 5 to be prop trading?

 6 MR. BARNETT: I don't know.

 7 MR. BERKOVITZ: The list of specific

 8 government obligations that are not considered

 9 prop trading, specifically statutory -- in the

 10 statutes so the proposed rule just follows the

 11 statute in that respect.

 12 COMMISSIONER O'MALIA: Yep, I did notice

 13 Canadian debt on there. And obviously we -- the

 14 point being, we have a letter from the Canadians

 15 and others saying, this is problematic if you ban

 16 investment in our -- anyway -- Dan, we were

 17 working on some language.

 18 This is to Commissioner Sommers's point

 19 about trying to figure out the definition --

 20 reconcile our definition and the Volcker

 21 definition with regard to swap dealer, and we were

 22 -- it appeared as though the document, the Volker
 223

 1 document, contains the SEC version of dealer

 2 definition -- dealer/trader distinction. And we

 3 don't do that in our entity definition.

 4 And then two minutes, three minutes

 5 before this markup began, we received an email

 6 from you saying that we're changing that. And we

 7 ask a question -- which wasn't the way I would've

 8 drafted it certainly, although I think we were

 9 asking for a question on this. And it says -- the

 10 question is, to what extent should the CFTC

 11 incorporate concepts regarding market making from

 12 the entities definition for the proposed section

 13 13 of the Bank Holding Company Act? Couldn't we

 14 fuzz that up to say either the CFTC definition or

 15 any other entity?

 16 Maybe we can get comment on the full

 17 panoply of different definitions out here, since

 18 we're asking questions. I mean, we've asked

 19 thousands of -- over a thousand questions. Why do

 20 we have to draft this so narrowly?

 21 MR. BERKOVITZ: This question was

 22 specifically -- I was mentioning in response to
 224

 1 the question from Commissioner Sommers that the

 2 proposal had a very specific definition of

 3 specific treatment of market making, and we wanted

 4 to indicate that we're going to be addressing

 5 market making in the context of the entities

 6 definition.

 7 So as we address it in that context is

 8 how we're addressing it in entities definition.

 9 We wanted people to comment on whether that would

 10 be an alternative way, whether or not it's

 11 appropriate, as Gary was mentioning, to address it

 12 in the Volcker Rule, and get comments on that.

 13 And I believe the comments that are

 14 already in the document -- the questions in the

 15 document seeking comments, asking whether the

 16 treatment of market making -- and I don't have

 17 question 88 right in front of me, but I believe

 18 that should enable folks to comment on this

 19 incorporation, even without question 88.1, which

 20 was the one I was just referring to -- was the

 21 concept of market making that is in this document

 22 useful?
 225

 1 Generally, these questions say, what

 2 other concept would be useful? I think there's

 3 already implicit in here an invitation to suggest

 4 other market making concepts. If people don't

 5 believe that either of these is right, they're

 6 free to suggest. Certainly don't see any problem

 7 with proposing other concepts in here.

 8 COMMISSIONER O'MALIA: All right.

 9 Definition of high-risk asset and high-risk

 10 trading strategy -- this is a beauty. It says --

 11 basically defines high-risk asset as an asset or

 12 group of assets that would, if held by a banking

 13 entity, significantly increase the likelihood that

 14 a banking entity would incur substantial loss or

 15 would fail.

 16 Is this under the 30 day reporting

 17 requirement? And how do we -- it's a pretty broad

 18 definition, I think. What would we do if we found

 19 somebody with -- just liquidate the position?

 20 MR. BERKOVITZ: If the permitted

 21 activity exceeds that level, then they would have

 22 to bring it down.
 226

 1 COMMISSIONER O'MALIA: So we would leave

 2 it up to the entity to define what high-risk asset

 3 and high-risk trading strategy is, and if they

 4 went over that -- if they crossed their own line,

 5 then we would have to go get them.

 6 MR. BERKOVITZ: That's right.

 7 COMMISSIONER O'MALIA: So it's like

 8 trusting MF Global to say what the seg rules are.

 9 MR. BERKOVITZ: Well, they have a

 10 compliance program. They have metrics. They have

 11 a compliance program. They have considerable

 12 discretion the way this is to determine how it's

 13 employed, and we will have the oversight program,

 14 and this is what we will be working with the

 15 fellow regulators to ensure that indeed their

 16 compliance program, that their use of their

 17 metrics are appropriate.

 18 But in the first instance, it is going

 19 to be their compliance program, and we will be

 20 responsible for ensuring that it's appropriate.

 21 COMMISSIONER O'MALIA: I've got plenty

 22 more questions, but I don't want to take it out on
 227

 1 you guys. I'm done.

 2 CHAIRMAN GENSLER: Commissioner O'Malia,

 3 I want to thank you. It's a good primer for me

 4 for next week's Congressional hearing.

 5 Commissioner Wetjen.

 6 COMMISSIONER WETJEN: I did have a

 7 question related to the applicability of these

 8 quantitative measurements to CFTC regulated

 9 entities, but Commissioner O'Malia touched on that

 10 a little bit in his questions.

 11 So I guess my only remaining question

 12 would be, would you be disappointed if I had no

 13 others?

 14 MR. BARNETT: Absolutely not.

 15 COMMISSIONER WETJEN: I didn't think so.

 16 Okay, fair enough. That's all I have.

 17 CHAIRMAN GENSLER: Fair enough.

 18 Commissioner Sommers?

 19 COMMISSIONER SOMMERS: I have one other

 20 question on the effective date of this rule. And

 21 so if, hypothetically, the other agencies decided

 22 they were going to repropose and we join in that
 228

 1 reproposal and it's not finalized by July, does

 2 the statutory language go into effect no matter

 3 what?

 4 MR. BERKOVITZ: The statutory effective

 5 date, I believe, it's a hardwired effective date,

 6 which would be two years after enactment. There

 7 is authority in there to extend the compliance

 8 period. So the compliance period could be

 9 extended.

 10 COMMISSIONER O'MALIA: Since -- who gets

 11 to extend the compliance period? Could we do that

 12 unilaterally, since we're going to define dealers

 13 unilaterally?

 14 CHAIRMAN GENSLER: I think it's the

 15 Federal Reserve, Commissioner O'Malia.

 16 MR. BERKOVITZ: That's the Board. It's

 17 the Federal Reserve -- has the authority under the

 18 statute.

 19 CHAIRMAN GENSLER: I'm going to call a

 20 vote in a second, but at the core -- I mean, it's

 21 lots of pages and lots of questions, and we're

 22 going to -- this is just a proposal, and we're
 229

 1 trying to, as, I think, Gary Barnett said so well,

 2 get into the slipstream. I mean, in October,

 3 everybody was saying why isn't the CFTC doing

 4 this? And it was capacity, and now we're doing

 5 it, and we have letters from the Canadians and

 6 others.

 7 But at the core, as I understand this --

 8 and maybe this is a question, but that this rule

 9 making requires that the banking entity have any

 10 of their trading -- and it's got to be over these

 11 $5 billion and $1 billion numbers, but any of

 12 their trading must be in compliance with rule 619.

 13 But it's a policies and procedures

 14 approach, is it not? Isn't it that they have to

 15 have policies and procedures and compliance

 16 programs to ensure that they're in compliance with

 17 619? Is that right?

 18 MR. BERKOVITZ: That's basically correct

 19 -- that the activities are prohibited, and they're

 20 only permitted unless they are conducted pursuant

 21 to the compliance program and policies and

 22 procedures.
 230

 1 CHAIRMAN GENSLER: Again, I'm going to

 2 say -- I mean, I support getting this proposal out

 3 there, being consistent with the other regulators,

 4 letting the public have the opportunity to comment

 5 with us for 60 days, and I know the bank

 6 regulators have extended their comment period.

 7 And then seeing what the public says, to get this

 8 right and balanced and so forth, and I appreciate

 9 because you're helping me for next week.

 10 Anytime, Mr. Stawick.

 11 MR. STAWICK: Commissioner Wetjen?

 12 COMMISSIONER WETJEN: Aye.

 13 MR. STAWICK: Commissioner Wetjen, aye.

 14 Commissioner O'Malia?

 15 COMMISSIONER O'MALIA: No.

 16 MR. STAWICK: Commissioner O'Malia, no.

 17 Commissioner Chilton?

 18 COMMISSIONER CHILTON: Aye.

 19 MR. STAWICK: Commissioner Chilton, aye.

 20 Commissioner Sommers?

 21 COMMISSIONER SOMMERS: No.

 22 MR. STAWICK: Commissioner Sommers, no.
 231

 1 Mr. Chairman?

 2 CHAIRMAN GENSLER: Aye.

 3 MR. STAWICK: Mr. Chairman, aye. Mr.

 4 Chairman, on this question, the yays are three,

 5 the nays are two.

 6 CHAIRMAN GENSLER: The ayes have it.

 7 The staff recommendation is accepted.

 8 I also at this point ask unanimous

 9 consent to allow the staff to make technical

 10 corrections to the documents voted on prior to

 11 sending them to the Federal Register.

 12 Without objection, so ordered. Our next

 13 scheduled public meeting is Wednesday, January 25.

 14 Subjects of the rule making will be published a

 15 week in advance, seven days in advance.

 16 As many people have heard, one of the

 17 things in our docket -- and very critically -- is

 18 this entity definition rule, but there's some

 19 others in the dockets, and we'll just see how

 20 Commissioners feedback. And I appreciate all that

 21 we've done here as well.

 22 But I think with that, if there's no
 232

 1 more, then I'll entertain a motion to adjourn the

 2 meeting.

 3 COMMISSIONER SOMMERS: So moved.

 4 COMMISSIONER O'MALIA: Second.

 5 CHAIRMAN GENSLER: All in favor, aye.

 6 Thank you. Thank you. Thank you. Paul, good to

 7 see you again and good luck at the SEC.

 8 (Whereupon, at 1:36 p.m., the

 9 PROCEEDINGS were adjourned.)

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Irene Gray, notary public in and for

 4 the District of Columbia, do hereby certify that

 5 the forgoing PROCEEDING was duly recorded and

 6 thereafter reduced to print under my direction;

 7 that the witnesses were sworn to tell the truth

 8 under penalty of perjury; that said transcript is a

 9 true record of the testimony given by witnesses;

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

 11 employed by any of the parties to the action in

 12 which this proceeding was called; and, furthermore,

 13 that I am not a relative or employee of any

 14 attorney or counsel employed by the parties hereto,

 15 nor financially or otherwise interested in the

 16 outcome of this action.

 17

 18

 19 (Signature and Seal on File)

 20 -----------------------------------

 21 Notary Public in and for the District of Columbia

 22 My Commission Expires: April 30, 2016