[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

OVERSIGHT OF THE SWAPS AND FUTURES MARKETS: RECENT EVENTS AND
IMPENDING REGULATORY REFORMS

=======================================================================

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

SECOND SESSION

__________

JULY 25, 2012

__________

Serial No. 112-34

Printed for the use of the Committee on Agriculture
agriculture.house.gov

U.S. GOVERNMENT PRINTING OFFICE
75-437 WASHINGTON : 2013
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, gpo@custhelp.com.

COMMITTEE ON AGRICULTURE

FRANK D. LUCAS, Oklahoma, Chairman

BOB GOODLATTE, Virginia, COLLIN C. PETERSON, Minnesota,
Vice Chairman Ranking Minority Member
TIMOTHY V. JOHNSON, Illinois TIM HOLDEN, Pennsylvania
STEVE KING, Iowa MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas LEONARD L. BOSWELL, Iowa
K. MICHAEL CONAWAY, Texas JOE BACA, California
JEFF FORTENBERRY, Nebraska DENNIS A. CARDOZA, California
JEAN SCHMIDT, Ohio DAVID SCOTT, Georgia
GLENN THOMPSON, Pennsylvania HENRY CUELLAR, Texas
THOMAS J. ROONEY, Florida JIM COSTA, California
MARLIN A. STUTZMAN, Indiana TIMOTHY J. WALZ, Minnesota
BOB GIBBS, Ohio KURT SCHRADER, Oregon
AUSTIN SCOTT, Georgia LARRY KISSELL, North Carolina
SCOTT R. TIPTON, Colorado WILLIAM L. OWENS, New York
STEVE SOUTHERLAND II, Florida CHELLIE PINGREE, Maine
ERIC A. ``RICK'' CRAWFORD, Arkansas JOE COURTNEY, Connecticut
MARTHA ROBY, Alabama PETER WELCH, Vermont
TIM HUELSKAMP, Kansas MARCIA L. FUDGE, Ohio
SCOTT DesJARLAIS, Tennessee GREGORIO KILILI CAMACHO SABLAN,
RENEE L. ELLMERS, North Carolina Northern Mariana Islands
CHRISTOPHER P. GIBSON, New York TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois JAMES P. McGOVERN, Massachusetts
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin
KRISTI L. NOEM, South Dakota

______

Professional Staff

Nicole Scott, Staff Director

Kevin J. Kramp, Chief Counsel

Tamara Hinton, Communications Director

Robert L. Larew, Minority Staff Director

(ii)

C O N T E N T S

----------
Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, prepared statement...................................... 5
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma,
opening statement.............................................. 1
Prepared statement........................................... 2
Peterson, Hon. Collin C., a Representative in Congress from
Minnesota, opening statement................................... 3
Prepared statement........................................... 4
Southerland II, Hon. Steve, a Representative in Congress from
Florida, submitted material.................................... 114

Witnesses

Gensler, Hon. Gary, Chairman, Commodity Futures Trading
Commission, Washington, D.C.................................... 6
Prepared statement........................................... 8
Supplementary material....................................... 105
Submitted letter and response................................ 108
Submitted questions.......................................... 111
Duffy, Hon. Terrence A., Executive Chairman and President, CME
Group, Inc., Chicago, IL....................................... 50
Prepared statement........................................... 52
Roth, Daniel J., President and Chief Executive Officer, National
Futures Association, Chicago, IL............................... 55
Prepared statement........................................... 57
Lukken, Hon. Walter L., President and Chief Executive Officer,
Futures Industry Association, Washington, D.C.................. 59
Prepared statement........................................... 61
Heck, John M., Senior Vice President, Business Development, The
Scoular Company; Member, Executive Committee and Board of
Directors, National Grain and Feed Association, Omaha, NE...... 67
Prepared statement........................................... 68
Conner, Hon. Charles F., President and Chief Executive Officer,
National Council of Farmer Cooperatives, Washington, D.C....... 74
Prepared statement........................................... 76
McElroy, Paul E., Chief Financial Officer, JEA, Jacksonville, FL;
on behalf of American Public Power Association................. 79
Prepared statement........................................... 81

OVERSIGHT OF THE SWAPS AND FUTURES MARKETS: RECENT EVENTS AND
IMPENDING REGULATORY REFORMS

----------

WEDNESDAY, JULY 25, 2012

House of Representatives,
Committee on Agriculture,
Washington, D.C.
The Committee met, pursuant to call, at 10:05 a.m., in Room
1300 of the Longworth House Office Building, Hon. Frank D.
Lucas [Chairman of the Committee] presiding.
Members present: Representatives Lucas, Goodlatte, King,
Neugebauer, Conaway, Schmidt, Thompson, Stutzman, Tipton,
Southerland, Crawford, Huelskamp, Gibson, Hultgren, Hartzler,
Schilling, Noem, Peterson, Holden, Boswell, Baca, David Scott
of Georgia, Cuellar, Costa, Schrader, Kissell, Owens, Pingree,
Courtney, Welch, Fudge, and McGovern.
Staff present: Jason Goggins, Tamara Hinton, Kevin Kramp,
Josh Mathis, Matt Perin, John Porter, Nicole Scott, Pete
Thomson, Suzanne Watson, Liz Friedlander, C. Clark Ogilvie,
John Konya, Margaret Wetherald, Jamie Mitchell, and Caleb
Crosswhite.

OPENING STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN
CONGRESS FROM OKLAHOMA

The Chairman. This hearing of the Committee on Agriculture
entitled, Oversight of the Swaps and Futures Markets: Recent
Events and Pending Regulatory Reforms, will come to order. I
now recognize myself for an opening statement.
Good morning, and thank you for joining us for this
important hearing. I would like to first thank the Ranking
Member and his staff for their efforts today, and I would also
like to thank our witnesses for their time.
It is beyond unfortunate that for a second time in less
than a year, this Committee is examining the circumstances of a
futures commission merchant bankruptcy where customer funds
were not properly segregated. Once again the very cornerstone
of the futures markets, customer funds' segregation, has been
severely and suddenly called into question.
For decades, futures markets have been a trusted tool for
farmers, ranchers, and businesses seeking to manage risk. The
bedrock of their trust in these markets is based on the
fundamental protections provided by mandatory segregation of
customer funds. Additionally, confidence in the futures and
swaps markets stems from customers knowing that regulators are
doing their job.
As we all know, on July 10, the National Futures
Association halted the operations of PFGBest and the CFTC filed
a Federal suit against the firm and its founder alleging that
the company had committed fraud, violated customer segregation
laws, and falsified financial statements filed with the CFTC.
Later that day, the company filed for bankruptcy. Press reports
indicated that roughly $220 million in segregated client money
is missing.
The clients of firms like PFGBest and MF Global are our
constituents. They are farmers and ranchers who until recently
have never had cause for concern in using the futures markets.
They have never had to worry that the tool for managing risk
would one day turn risky and cast doubt on the integrity of the
futures markets.
In light of the bankruptcy, CFTC has adopted new rules to
strengthen their controls over the treatment and monitoring of
customer funds, and the self-regulating organizations have
proposed several new initiatives that the Committee will
examine today that would ensure another fraud in the futures
markets cannot be carried out for years simply by opening a
P.O. box.
But the question remains: who is minding the store? There
are some in this town who argue that we need more regulations.
But the fact remains that new regulations mean nothing when
regulators are not enforcing the existing rules on the books.
What we need is regulators doing their job.
And it is worth noting that CFTC gave itself high marks for
direct examinations of futures brokers in a 2011 performance
analysis. Yet billions of dollars in customer funds are missing
today as the result of CFTC's failure to perform with MF Global
and now PFGBest.
Today we hope to gain a comprehensive understanding of the
facts surrounding PFGBest's bankruptcy and the failure to miss
such an outright fraud, in addition to an update on MF Global
and recent Dodd-Frank rules that have been finalized by the
CFTC.
I thank everyone in attendance today. I look forward to
hearing from our witnesses.
[The prepared statement of Mr. Lucas follows:]

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress
from Oklahoma

Good morning.
Thank you for joining us for this important hearing. I'd first like
to thank the Ranking Member and his staff for their efforts today. I'd
also like to thank our witnesses for their time.
It is beyond unfortunate that for a second time in less than a
year, this Committee is examining the circumstances of a futures
commission merchant bankruptcy where customer funds were not properly
segregated.
Once again the very cornerstone of the futures markets, customer
funds segregation, has been severely and suddenly called into question.
For decades, futures markets have been a trusted tool for farmers,
ranchers, and businesses seeking to manage risk. The bedrock of their
trust in these markets is based on the fundamental protections provided
by mandatory segregation of customer funds.
Additionally, confidence in the futures and swaps markets stems
from customers knowing that regulators are doing their job.
As we all know, on July 10, the National Futures Association halted
the operations of PFGBest and the CFTC filed a Federal suit against the
firm and its founder, Mr. Russell Wasendorf, Sr., alleging that the
company had committed fraud, violated customer segregation laws, and
falsified financial statements filed with the CFTC. Later that day, the
company filed for bankruptcy. Press reports indicate that roughly $220
million in segregated client money is missing.
The clients of firms like PFGBest and MF Global are our
constituents. They are farmers and ranchers who until recently have
never had cause for concern in using the futures markets. They've never
had to worry that the tool for managing risk would one day turn risky
and cast doubt on the integrity of the futures markets.
In light of the bankruptcy, CFTC has adopted new rules to
strengthen their controls over the treatment and monitoring of customer
funds. And, the self regulatory organizations have proposed several new
initiatives that the Committee will examine today that would ensure
another fraud in the futures markets cannot be carried out for years
simply by opening a P.O. box.
But the question remains: who is minding the store? There are some
in this town who argue that we need more regulations. But the fact
remains that new regulations mean nothing when regulators are not
enforcing the existing rules on the books. What we need is regulators
doing their job.
It is worth noting that CFTC gave itself high marks for direct
examinations of futures brokers in a 2011 performance analysis. Yet,
billions of dollars in customer funds are missing today as the result
of CFTC's failure to perform with MF Global and now PFGBest.
Today, we hope to gain a comprehensive understanding of the facts
surrounding PFGBest's bankruptcy and the failure to miss such an
outright fraud, in addition to an update on MF Global and recent Dodd-
Frank rules that have been finalized by the CFTC.
Thank you. I look forward to hearing from our witnesses today.

The Chairman. I now recognize the Ranking Member for his
opening statement.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE
IN CONGRESS FROM MINNESOTA

Mr. Peterson. Thank you, Mr. Chairman, and thank you for
this hearing.
You know, I had an opportunity yesterday to visit with NFA
trying to get an understanding. I am a CPA, as Mr. Conaway is,
but I am not much of an auditor--I was more of a tax guy--the
auditing I did do, you always sent the confirmation directly to
the bank and the bank sent it directly back to you. I couldn't
understand how you could have a situation where he could
intercept that and forge that. Somehow or another he gave them
a Post Office box that they thought was the bank. I don't know
how that happened or what you can do about it. Now, they are
moving toward e-audit, and that is what smoked this guy out and
apparently precipitated his suicide attempt. They are going to
now implement that and that sounds like that will fix this
problem or largely fix it.
But we are continuing to chase these problems all the time,
and I am not sure that these regulators can ever get ahead of
this. As with farmers, we can pass a farm bill but those guys
are so far ahead of us that they sit on the tractor and they
figure this stuff out before we ever decide how to work things.
I think we have something going on like that in these markets.
You know, these FCMs, as I understand it, no longer make
their money by charging commissions for what they do. The way
they have been making their money is by investing customer
money and using the money they earn on the customer money to
fund their business. Now, this is crazy, and especially in an
interest-rate climate where we have zero percent interest and
the government is going in and continuing zero percent
interest. To some extent we are causing this problem because we
are putting pressure on these guys to make enough money to stay
in business, and then this is what happens.
We have a self-regulatory situation: the CFTC doesn't have
enough people to go out and audit all these folks. We are
trying to cut their budget, not raise it. I think these
hearings are good to look at these things, but we may need to
step back and take a look at how we got into this situation. I
would like to see us go back and look at the CFMA in 2000, and
we never have really examined what we did with that bill when
we deregulated these markets. That is one thing, but the second
thing we did is give legal certainty to these swaps and created
this huge--at the time, I think there was $80 billion in these
derivative markets. It went to $600 trillion in 8 years because
we gave them legal certainty. Well, this is the government,
actually it is a regulation, us interfering in the marketplace
to say that these things are not gambling. If we say it is not
gambling when it actually is gambling, and if we would have
left that alone, I don't think we would be dealing with some of
these things that we are dealing with now.
So, we should go back and look at what we did and get some
people to give us some kind of a sense of what our culpability
in this whole situation is. When we did Dodd-Frank, we would
not bite the bullet and we have these regulators forced to
harmonize regulations when they have completely different
cultures. There are three different regulators involved in the
same situation, and then you wonder why it doesn't work. So I
don't know.
The regulators are doing as best as they can given the
tools that they have. But, these folks that are in these
markets have not learned a damn thing from anything that has
happened so far and there are apparently a bunch of dishonest
people in here and you are not going to catch them all, all the
time. I would like to see us spend some time taking a look at
what we have done as we are looking at all these government
regulations. Let us look, did we--by getting involved in this--
cause problems on the other side of things.
I read the other day where now these securitization people
that were making all this money by securitizing these
mortgages, and that business dropped up because it all blew up.
Now they can't even decide who should run these foreclosed
houses and they are blaming different people and saying well,
we are not in charge and they are in charge. Nobody is in
charge and they are deteriorating, which is the fundamental
problem with that whole deal. But now these guys are going out
and buying these foreclosed properties. They are taking the
rental income from the foreclosed properties and they are
securitizing it so they can raise money to go buy more
foreclosed property. This is another thing that is going to
blow up if this gets to be a big deal. So we need to look at
the bigger picture sometimes and not be chasing these problems
all the time, for whatever it is worth.
I yield back.
[The prepared statement of Mr. Peterson follows:]

Prepared Statement of Hon. Collin C. Peterson, a Representative in
Congress from Minnesota

Good morning. Thank you, Chairman Lucas, for yielding.
I appreciate that we're meeting today to review some important
issues. But frankly I'd rather be on the House floor debating the farm
bill and think a majority of us on the Committee would agree. We still
have a few days before the August recess; I hope everyone keeps the
pressure on Leadership so we can wrap this up before leaving town.
There's really no good excuse not to get this done.
I know some in Leadership question whether there are enough votes
to pass the farm bill. Now, if they want to pass a partisan,
Republican-only bill, which seems to be the case around here, I wish
them luck because they're going to need it. However, if they are
willing to consider a bipartisan farm bill and work in the same
bipartisan fashion as the Agriculture Committee, I stand ready to round
up Democratic votes. When I was Chairman, I got 19 Republicans to join
me when we first passed the farm bill in 2007. I know I can bring more
Democrats than that onboard for the bipartisan bill passed by this
Committee. Right now, I'm just waiting for Leadership to call.
Until then, there is other work to do which is why we're here
today.
CFTC oversight has long been a priority for this Committee. Recent
events including the fraud at Peregrine Financial Group and the LIBOR
manipulation--both of which were occurring during the reign of previous
CFTC Chairmen--on top of the MF Global bankruptcy, have again raised
concerns regarding financial oversight. I hope that both Chairman
Gensler and the witnesses on the second panel will be able to shed some
light on who knew what when, and what steps are being taken to ensure
we don't find ourselves discussing yet another financial scandal in the
coming months.
Of course, the CFTC is still in the process of finalizing many of
the rules that will create a more open and transparent derivatives
market. I've said repeatedly that we need to give them the time to get
the rules right and, by and large, they are getting them right. We also
need to give them the necessary resources to do their work.
So, I look forward to hearing from our witnesses and thank the
chair for holding today' s hearing.

The Chairman. The Ranking Member yields back.
The chair would request that other Members submit their
opening statements for the record so the witnesses may begin
their testimony, and to ensure that there is ample time for
questions.
[The prepared statement of Mr. Conaway follows:]

Prepared Statement of Hon. K. Michael Conaway, a Representative in
Congress from Texas

Mr. Chairman, I want to thank you for convening this hearing today.
Over the past several months, the financial services industry has
continued to garner headlines; unfortunately not often for flattering
reasons. We have seen a large trade go public awry; another Futures
Commission Merchant has failed and lost significant amounts of customer
funds; the first of many banks has faced an enforcement order for
fixing international benchmark financial rates; and a large
international bank has admitted to allowing drug cartels and
international terrorists launder money.
At the same time, the CFTC has continued to work through the
remaining Dodd-Frank rulemakings. Earlier this month, the final product
definition rules were issued, starting a 60 day clock running for swap
dealers to register. Confounding this process, however, is that the
guidance intended to clarify the extraterritorial application of the
CFTC's new regulatory powers has only further confused market
participants and raised the ire of international regulators.
All in all, Mr. Chairman, today is a good day for a hearing to
begin the process of sorting through some of these knotty issues.
Today's hearing is not about assigning blame or finding fault for any
particular event, it is about how to make the system work better for
market participants and most importantly, the end-users who rely on the
financial system to work correctly every single day.
The recent failures and other shortcomings of the industry show
that there is much work to be done. Each crisis we see erodes the
publics' trust in the institutions--both private firms and the
regulators alike--that are essential to our economic growth.
Less visible to the public, but certainly no less important, are
the barrage of rulemakings that the CFTC has been finalizing over the
past year. These rules will be the new regulatory foundation that
Americans believe will prevent another financial meltdown. The size,
scope, and frequency of the failures that will inevitably occur under
this new regime will determine the trust that Americans continue to
place in regulators of high finance.
I continue to worry about the sequencing and timing of the rules,
as well as the refusal of the CFTC to conduct quantitative and
qualitative cost-benefit analysis. In particular, with the
Extraterritoriality guidance that was recently issued. I am troubled
that by choosing to issue guidance instead of proposing a rule, the
Commission has circumvented the need to perform any analysis of the
costs or the benefits of its guidance to market participants or end-
users. The guidance may well have consequences that the Chairman's
staff did not think of which could be detrimental to the ability for
firms to participate in these newly regulated markets.
I would like to close by thanking each of our panel participants
for your participation today and your unfailing willingness to work
with our Committee to improve the regulation and oversight of the
futures and derivatives markets. While we may not always see eye to eye
on every issue, I appreciate the honest and direct discussions that I
have had with many of you about how to improve the financial systems we
all care so deeply about.

The Chairman. I would like to welcome first panel witness
to the table, the Hon. Gary Gensler, Chairman of the U.S.
Commodity Futures Trading Commission, Washington, D.C.
Mr. Chairman, please begin when you are ready.

STATEMENT OF HON. GARY GENSLER, CHAIRMAN,
COMMODITY FUTURES TRADING COMMISSION,
WASHINGTON, D.C.

Mr. Gensler. Good morning, Chairman Lucas, Ranking Member
Peterson, and Members of the Committee.
When we were all kids growing up, we learned in courses
like history, science, and math that we have to rely on hard
facts, figures and research, and the markets rely on hard
facts, figures and research too. So when President Roosevelt
and Congress came together in the 1930s with the great reforms
in that era, I think they really said let us give the public
the hard facts, figures and research on the securities and
futures market. They knew that markets work best when the broad
public has access to the same facts and figures as
sophisticated insiders have. I believe these critical reforms
of the 1930s are at the foundation of our strong capital
markets and many decades of economic growth thereafter.
Swaps subsequently emerged in the 1980s, as we know, to
help companies manage their risk. The financial crisis in
2008--revealed in part to be because the swaps market had not
been regulated led to eight million Americans losing their
jobs. Congress came together in response, similar to in the
1930s, and said the public should have the facts, figures and
research on the swaps marketplace so they can have confidence
in this marketplace as they did in the 1930s reform that
preceded it.
The Commission has made significant progress in these
commonsense reforms with 36 rules completed. We are
increasingly moving from rule writing to implementation of
reform. Light will begin to shine on the swaps market this fall
when swaps price and volume information will be publicly
reported in real time. Regulators will get a fuller picture by
seeing information in data repositories and the dealers in the
marketplace will begin to come under comprehensive regulation
with phasing of those requirements following afterwards. We
have just under 20 further rules to complete, and reform will
also mean once complete that buyers and sellers will meet in a
transparent market and compete with each other, and help end-
users get better prices.
Standardized swaps will be centrally cleared, which will
help lower risk in the marketplace and reform will include
cross-border transactions that affect the U.S. economy. Time
and again we find that crises come back to our shores from the
Cayman Islands or London if it is an affiliate or branch of a
U.S. entity.
Let me now just turn to two recent enforcement matters,
Barclays and Peregrine. Each of these matters reminds me of a
saying that my grandfather, who had immigrated from Russia,
used to say. Simply put, he said ``Figures don't lie but liars
sure can figure.'' I heard this so many times from my mom
growing up. LIBOR and Euribor, which Barclays attempted to
manipulate and falsely reported, are at the center of the
capital markets for both borrowing and derivatives contracts.
One could say it is the mother of all benchmarks. Hundreds of
trillions of dollars of transactions here and abroad are based
on LIBOR. For instance, at the Chicago Mercantile Exchange,
nearly 70 percent of the notional value of their futures
markets--we are not even talking about swaps yet--nearly 70
percent of the notional value of their futures contracts
somehow settled to or priced off of these benchmark rates. If
my grandfather were alive today, he would be shaking his head
but he wouldn't be so surprised. LIBOR has a structural
problem. It is supposedly based on what banks perceive to be
their borrowing rates in the unsecured interbank market but
what if facts, figures and research are limited? What if there
is not such borrowings that exist? They have to put in their
best estimates, I guess, but I believe it is critical for
markets to have an honest transaction-based benchmark, whether
that means changing LIBOR or moving to another rate for the
markets to work off of. I am pretty sure my grandfather would
agree with that.
The recent events at Peregrine would have caught my
grandfather's attention even more so. Simply put, the evidence
points at the owner, Russ Wasendorf, taking customers' funds
right out of the bank and lying about it for years. The
National Futures Association, the self-regulatory organization
responsible for frontline oversight of Peregrine, is required
to conduct periodic audits of Peregrine's customer funds. In
addition, independent certified public accountants audited
Peregrine's annual financial statements. But just like the
local police cannot prevent all bank robberies, market
regulators cannot prevent all financial fraud. Having said
that, the system clearly failed to protect Peregrine's
customers and I believe we all must do better.
The Commission has been actively working to improve
protections of customer funds and we finalized four separate
rules including rules related to investing of customer funds,
which you may have heard was rule 1.25, gross margining that
will go into effect later this year, segregation for swaps and
rules working closely with the CME, FIA, and NFA that the SROs
have various new requirements concerning customer segregated
accounts.
The CFTC is also implementing a significant restructuring
of how we oversee the SROs and intermediaries. We hired new
leadership about 9 months ago but there is much more to do.
Looking forward, I believe it is critical that we further
update our rules giving regulators direct electronic access to
all bank and custodial accounts holding customer funds.
We will conduct a full review of the CFTC's and SRO
examination and audit oversight of futures commission merchants
looking only for improvements including getting advice from the
Public Company Accounting Oversight Board, who has graciously
said that they will give us advice on how they look at the
auditing profession and see how we can learn from the PCAOB and
what they do.
We must do everything within our authorities and resources
to strengthen our oversight programs and protection of customer
funds. We must do it for the public. I also think I want to
keep my grandfather's values and wise admonition in mind about
figures and liars. Thank you.
[The prepared statement of Mr. Gensler follows:]

Prepared Statement of Hon. Gary Gensler, Chairman, Commodity Futures
Trading Commission, Washington, D.C.

Good morning, Chairman Lucas, Ranking Member Peterson, and Members
of the Committee. I thank you for inviting me to today's hearing on
oversight of the swaps and futures markets. I will review the Commodity
Futures Trading Commission's (CFTC) implementation of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), as
well as the recent events related to the London Interbank Offered Rate
(LIBOR) and Peregrine Financial Group.
I also thank my fellow Commissioners and CFTC staff for their hard
work and commitment.
The 2008 crisis--caused in part by swaps--was the worst economic
crisis Americans have experienced since the Great Depression. Eight
million Americans lost their jobs, millions of families lost their
homes and thousands of businesses shuttered.
Following the crisis, the President and the G20 leaders convened in
Pittsburgh in September 2009 and agreed that swaps, which were
basically not regulated in the United States, Asia or Europe, should
now be brought into the light of regulation.
In 2010, Congress and the President came together and passed the
historic Dodd-Frank Act.
The goal of the law's swaps market reforms is to:

Bring public market transparency and the benefits of
competition to the swaps marketplace;

Lower the risk of the interconnected financial system by
bringing standardized swaps into centralized clearing; and

Ensure that swap dealers and major swap participants are
specifically regulated for their swaps activity.

The Commission has made significant progress in implementing
Congress' direction to ensure that common-sense standards are
established for the swaps market.

Turning Point: Implementation of Swaps Market Reforms
Throughout the rule-writing process, we have benefitted from
significant public input. CFTC Commissioners and staff have met nearly
1,800 times with the public, and we have held 18 public roundtables on
important issues related to Dodd-Frank reform. The agency has received
more than 35,000 comment letters related to Dodd-Frank rules.
Last summer, we turned the corner and started finalizing rules. To
date, we've completed 36 rules and now have fewer than 20 to go (see
attachment).
This month, we reached another major turning point in the swaps
market reform process. The CFTC and the Securities and Exchange
Commission (SEC) completed the rule to further define the terms
``swap'' and ``security-based swap.'' These further product definitions
mean many other critical swaps market reforms already completed by the
Commission will come to life. We also finalized this month the rule on
the end-user exception to clearing. With the completion of these
foundational rules, we are increasingly moving from the rule-writing
process to the implementation of reforms that bring transparency to the
swaps marketplace and lower its risks to the public.
Swap dealers, for the first time, will register and begin to come
under comprehensive regulation. This includes implementing already
completed external and internal business conduct standards that will
lower swap dealers' risk to the economy and promote confidence in their
integrity.
Two months after the rule further defining the term ``swap'' is
published in the Federal Register, light will begin to shine on the
swaps market. Initially, likely by October, swaps price and volume
information will be reported in real time to the public for interest
rate and credit default swap (CDS) indices. Three months later, such
real-time reporting will begin for energy and other physical commodity
swaps.
Swap data repositories (SDRs) will receive data on all swaps
transactions, giving regulators their first full window into these
markets. One SDR has already successfully registered with the
Commission, and we have at least four other parties working on their
applications.
The rule further defining ``swap'' is especially meaningful for the
implementation of position limits. For the first time, limits will
apply to the aggregate spot-month positions, including both futures and
swaps. Spot-month limits protect the markets against corners, squeezes
and the burdens that may come from excessive speculation.
I will now go into further detail on the Commission's swaps market
reform efforts.

Transparency
Transparency is critical to both lowering the risk of the financial
system, as well as to reducing costs to end-users. The more transparent
a marketplace is to the public, the more efficient it is, the more
liquid it is, and the more competitive it is.
We have completed the bulk of the Congressionally mandated
transparency reforms for the swaps market. This fall real-time
reporting to the public and to regulators will begin for swaps market
transactions.
Second, detailed and up-to-date reporting by large traders in the
physical commodity swaps markets began last fall. This reporting allows
regulators to better police for fraud, manipulation and other abuses.
Third, the CFTC also plans to begin publishing aggregated swaps
market data. The public has benefited for years from the Commitment of
Traders futures data we publish. Our goal is to provide similar public
transparency for the swaps market.
Fourth, in May we completed rules, guidance and acceptable
practices for designated contract markets (DCMs). DCMs will be able to
list and trade swaps, helping to bring the benefit of pre-trade
transparency to the swaps marketplace.
Looking forward, we have two important transparency rules to
complete related to block sizes and swap execution facilities (SEFs).
These critical Dodd-Frank reforms will bring pre-trade transparency to
the swaps market for the benefit of all the end-users that use swaps.
Central Clearing
For over a century, through good times and bad, central clearing in
the futures market has lowered risk to the broader public. Dodd-Frank
financial reform brings this effective model to the swaps market.
Standard swaps between financial firms will move into central clearing,
which will significantly lower the risks of the highly interconnected
financial system.
The CFTC has made significant progress on central clearing for the
swaps market. We have completed rules establishing new derivatives
clearing organization risk management requirements.
Second, to further facilitate broad market access, we completed
rules on client clearing documentation, risk management, and so-called
``straight-through processing,'' or sending transactions immediately to
the clearinghouse upon execution.
Third, we completed the rule on the end-user exception to clearing.
Consistent with Congressional intent, this rule ensures that end-users
using swaps to hedge or mitigate commercial risk will not be required
to bring swaps into central clearing.
Fourth, the CFTC this month also proposed a rule that would permit
certain cooperatives to choose not to clear member-related swaps.
Cooperatives act on behalf of and are an extension of their members.
Thus, I believe it is appropriate that in certain circumstances, those
cooperatives made up entirely of members that could individually
qualify for the end-user exception should qualify as end-users.
Fifth, yesterday the Commission adopted the final rule for phased
implementation of compliance with the clearing requirement for various
groups of financial entities.
Sixth, the Commission also yesterday approved proposed clearing
requirement determinations based upon clearinghouse submissions on
swaps they already clear. The clearing determinations begin with
standard interest rate swaps in U.S. dollars, Euros, British pounds and
Japanese yen, as well as a number of CDS indices, including North
American and European corporate names.
In addition, the Commission has adopted four important customer
protection enhancements: the amendments to rule 1.25, the gross margin
rule, the LSOC rule for swaps and rules on the minimum requirements for
SROs regarding their financial surveillance of FCMs.
Based upon the Dodd-Frank 90 day clock for making clearing
determinations, the first clearing determinations may be finalized in
October just before the gross margin and LSOC rules go into effect
November 8.
The CFTC also has received substantial public input on the clearing
of swaps among affiliates of the same financial entity. The staff
recommendation, which would exempt certain affiliate swaps from the
clearing requirement, is under review by Commissioners.

Swap Dealers
Regulating banks and other firms that deal in swaps is central to
financial reform. Prior to 2008, it was claimed that swap dealers did
not need to be specifically regulated for their swaps activity, as they
or their affiliates already were generally regulated as banks,
investment banks, or insurance companies. The crisis revealed the
inadequacy of relying on this claim. While banks were regulated for
safety and soundness, including their lending activities, there was no
comprehensive regulation of their swap dealing activity. Similarly,
bank affiliates dealing in swaps, and subsidiaries of insurance and
investment bank holding companies dealing in swaps, were not subject to
specific regulation of their swap dealing activities. AIG, Lehman
Brothers and other failures of 2008 demonstrate what happens with such
limited oversight.
The CFTC is well on the way to implementing reforms Congress
mandated in Dodd-Frank to regulate dealers and help prevent another
AIG. The Commission has finished sales practice rules requiring swap
dealers to interact fairly with customers, provide balanced
communications and disclose conflicts of interest before entering into
a swap. In addition, the Commission has finalized internal business
conduct rules to require swap dealers to establish policies to manage
risk, as well as put in place firewalls between a dealer's trading, and
clearing and research operations. Staff recently provided to
Commissioners recommendations on a final rule on swap relationship
documentation, confirmations and portfolio compression.
We completed in April a joint rule with the SEC further defining
the terms ``swap dealer'' and ``security-based swap dealer.''
Based upon completed registration rules and the recently completed
joint rule further defining the term ``swap,'' we anticipate dealers
will begin registering with the National Futures Association (NFA) in
the early fall.
The CFTC has been working with the Federal Reserve, the other U.S.
banking regulators, the SEC, and international regulators and
policymakers to align margin requirements for uncleared swaps. It is
essential that we align these requirements globally, particularly
between the major market jurisdictions. The international approach to
margin requirements in the consultative paper (sponsored by the Basel
Committee on Banking Supervision and the International Organization of
Securities Commissions) released this month is consistent with the
approach the CFTC laid out in its margin proposal last year. It would
lower the risk of financial entities, promote clearing and help avoid
regulatory arbitrage. Consistent with the CFTC's proposal, it also
excludes non-financial end-users from margin requirements for uncleared
swaps.
The CFTC reopened the comment period on our margin proposal so that
we can hear further from market participants and the public in light of
the work being done to internationally harmonize margin rules. As we
work with international regulators on this coordinated approach, I
would anticipate that the Commission would only take up the final
margin rules toward the end of this year.
Following Congress' mandate, the CFTC also is working with our
fellow financial regulators to finalize the rulemaking to implement the
Volcker Rule. In adopting the Volcker Rule, Congress prohibited banking
entities from engaging in proprietary trading, an activity that may put
taxpayers at risk. At the same time, Congress permitted banking
entities to engage in certain activities, such as market making and
risk mitigating hedging. One of the challenges in finalizing a rule is
achieving these multiple objectives.
Staff also has provided to Commissioners recommendations in two
other areas. The first relates to proposed exemptions for certain
transactions in the electricity markets. In particular, this includes
possible exemptive orders for certain transactions executed on regional
transmission organizations, as well as between and among rural electric
cooperatives and municipal public power providers. Second, now that the
Commission made significant progress on swaps market reforms, we will
consider completing a number of conforming rules.

Market Integrity/Position Limits
Financial reform also means investors, consumers, retirees and
businesses in America will benefit from enhanced market integrity.
Congress provided the Commission with new tools in Dodd-Frank to ensure
the public has confidence in U.S. swaps markets.
Rules the CFTC completed last summer close a significant gap in the
agency's enforcement authorities. The rules implement important Dodd-
Frank provisions extending our enforcement authority to swaps and
prohibiting the reckless use of manipulative or deceptive schemes.
Thus, for example, the CFTC has clear anti-fraud and anti-manipulation
authority regarding the trading of credit default swaps indices.
Also, the CFTC now can reward whistleblowers for their help in
catching market misconduct.
Congress also directed the CFTC to establish aggregate position
limits for both futures and swaps in energy, agricultural and other
physical commodities. In October 2011, the Commission completed final
rules to ensure no single speculator is able to obtain an overly
concentrated aggregate position in the futures and swaps markets. With
the recently completed joint rule further defining ``swap,'' compliance
for all spot-month limits will go into effect in approximately 2
months.
The Commission approved a proposed rule in May that would modify
the CFTC's aggregation provisions for limits on speculative positions.
The proposal would permit any person with a 10 to 50 percent ownership
or equity interest in an entity to disaggregate the owned entity's
positions, provided there are protections and firewalls in place to
ensure trading decisions are made independently of one another.
Two associations representing the financial industry are
challenging the agency's final rule establishing position limits in
court. The Commission is vigorously defending the Congressional mandate
to implement position limits in court.

Cross-Border Application of Dodd-Frank's Swaps Market Reforms
The nature of modern finance is that large financial institutions
set up hundreds, if not thousands, of ``legal entities'' around the
globe. Many of these far-flung legal entities, however, are still
highly connected back to their U.S. affiliates.
The lessons of the 2008 crisis and earlier have demonstrated that
time and again financial transactions executed offshore by U.S.
financial institutions can send risk straight back to our shores. It
was true with the London and Cayman Islands affiliates of AIG, Lehman
Brothers, Citigroup and Bear Stearns. A decade earlier, it was true, as
well, with the collapse of the hedge fund Long-Term Capital Management.
During a default or crisis, the risk that builds up offshore
inevitably comes crashing back onto U.S. shores. The recent events of
JPMorgan Chase, where it executed swaps through its London branch, are
a stark reminder of this reality of modern finance.
Section 722(d) of the Dodd-Frank Act states that swaps reforms
shall not apply to activities outside the United States unless those
activities have ``a direct and significant connection with activities
in, or effect on, commerce of the United States.'' Congress included
this provision for swaps, but included a different provision with
regard to the SEC's oversight of the security-based swaps market.
The Commission, consulting closely with the SEC, the Federal
Reserve and the Treasury Department, recently proposed guidance
interpreting this section of the law. The Commission also proposed in a
separate release phased compliance for foreign swap dealers (including
overseas affiliates of U.S. swap dealers) of certain requirements of
Dodd-Frank swaps market reform. Such phased compliance would enable
market participants to comply with the Dodd-Frank Act in an orderly
fashion and allow time for the CFTC to receive public comment on the
cross-border interpretive guidance.
The proposed guidance interpreting Section 722(d) includes the
following key elements:
First, it provides the guidance that when a foreign entity
transacts in more than a de minimis level of U.S. facing swap dealing
activity, the entity would register under the Dodd-Frank Act swap
dealer registration requirements.
Second, it includes a tiered approach for foreign swap dealer
requirements. Some requirements would be considered entity-level, such
as for capital, chief compliance officer, risk management, swap data
record-keeping, reporting to swap data repositories and large trader
reporting. Some requirements would be considered transaction-level,
such as clearing, margin, real-time public reporting, trade execution,
trading documentation and sales practices.
Third, entity-level requirements would apply to all registered swap
dealers, but in certain circumstances, foreign swap dealers could meet
these requirements by complying with comparable and comprehensive
foreign regulatory requirements, or what we call ``substituted
compliance.''
Fourth, transaction-level requirements would apply to all U.S.
facing transactions. For these requirements, U.S. facing transactions
would include not only transactions with persons or entities operating
or incorporated in the United States, but also transactions with their
overseas branches. Likewise, this would include transactions with
foreign affiliates that are guaranteed by a U.S. entity, as well as the
foreign affiliates operating as conduits for a U.S. entity's swap
activity. Foreign swap dealers, as well as overseas branches of U.S.
swap dealers, in certain circumstances, may rely on substituted
compliance when transacting with foreign affiliates guaranteed by or
operating as conduits of U.S. entities.
Fifth, for certain transactions between a foreign swap dealer
(including an overseas affiliate of a U.S. person) and foreign
counterparties not guaranteed by or operating as conduits for U.S.
entities, Dodd-Frank transaction-level requirements may not apply. For
example, this would be the case for a transaction between a foreign
swap dealer and a foreign insurance company not guaranteed by a U.S.
person.

LIBOR
I'd like now to review the CFTC's recent order against Barclays
concerning the benchmarks LIBOR and Euribor.
People taking out small business loans, credit cards and mortgages,
as well as big companies involved in complex transactions, all depend
upon the honesty of benchmark rates like LIBOR for the cost of their
borrowings. Banks must not attempt to influence LIBOR, Euribor or other
indices based upon concerns about their reputation or the profitability
of their trading positions.
LIBOR and Euribor are indices at the center of the capital markets
for both borrowings and derivatives contracts. LIBOR is the reference
index for the largest open interest of contracts in both the U.S.
futures markets and swaps markets. As of the end of June, the 3 month
Eurodollar futures contracts that settle to U.S. Dollar LIBOR make up
about 70 percent of the notional value of all futures contracts traded
on the CME Group exchanges. U.S. Dollar LIBOR's traded volume in 2011
on the CME was a notional value exceeding $564 trillion. According to
the British Bankers Association, swaps with a total notional value of
approximately $350 trillion and loans amounting to $10 trillion are
indexed to LIBOR.
The CFTC initiated in April of 2008 a review of LIBOR after media
reports raised questions about the integrity of the index. Thereafter,
we began coordinating with the United Kingdom's Financial Services
Authority (FSA), which helped us facilitate information requests. The
FSA and the U.S. Department of Justice subsequently joined the CFTC
with regard to the Barclays matter, and it has been a collaborative
effort throughout.
To conduct such a complicated case, the CFTC enforcement staff had
to sift through a voluminous number of documents and audio recordings
that spanned many years.
The CFTC's Order found that Barclays traders and employees
responsible for determining the bank's LIBOR and Euribor submissions
attempted to manipulate and made false reports concerning both
benchmark interest rates to benefit the bank's derivatives trading
positions. The conduct occurred regularly and was pervasive. Barclays'
traders located at least in New York, London and Tokyo asked Barclays'
submitters to submit particular rates to benefit their derivatives
trading positions. In addition, certain Barclays Euro swap traders
coordinated with and aided and abetted traders at other banks in each
other's attempts to manipulate Euribor.
The Order also found that throughout the financial crisis, as a
result of instructions from Barclays' senior management, the bank
routinely made artificially low LIBOR submissions. Submitters were told
not to submit at levels where Barclays was ``sticking its head above
the parapet.'' The senior management directive was intended to fend off
negative public perception about Barclays' financial condition.
The CFTC's Order required Barclays to pay a $200 million civil
monetary penalty for attempted manipulation of and false reporting
concerning LIBOR and Euribor. In addition, Barclays is required to
implement measures to ensure its future submissions are honest.
Among other things, these requirements included:

Making submissions based on a transaction-focused
methodology;

Implementing firewalls to prevent improper communications,
including between traders and submitters;

Preparing and retaining documents concerning submissions and
certain relevant communications; and

Implementing auditing, monitoring and training measures
concerning submissions and related processes, including making
regular reports to the CFTC.

The CFTC has and will continue vigorously to use our enforcement
and regulatory authorities to protect the public, promote market
integrity, and ensure that these benchmarks and other indices are free
of manipulative conduct and false information. The Commodity Exchange
Act (CEA) is clear in its prohibitions against attempted and actual
manipulation of futures, swaps and commodity prices. Further, the CEA's
Section 9(a)(2) prohibits knowingly making false reports of market
information that affects or tends to affect the price of a commodity.
The FSA is reviewing the LIBOR benchmark, and will be making
suggestions as to how to improve it. Moving forward, the CFTC stands
ready to assist the FSA on its review of LIBOR and how to best assure
that LIBOR, or any alternative benchmark that might emerge, is not
susceptible to attempted manipulation or false reporting. We look
forward to working with regulators and market participants here and
abroad to ensure that benchmarks for interest rates that touch
borrowers and lenders around the globe are reliable and honest.
If these key benchmarks are based on observable transactions,
borrowers, lenders and derivatives users around the globe all benefit.
If these key benchmarks are not based on observable transactions, I
believe their integrity will continue to be subject to question. And if
these key benchmarks are not based on honest submissions, we all lose.

Peregrine Financial Group, Inc.

Background
On July 10, the CFTC filed a complaint in Federal court against
Peregrine and its sole owner, Russell Wasendorf, Sr., alleging that
they misappropriated customer funds from an account held at U.S. Bank.
Criminal authorities arrested Mr. Wasendorf for lying to the CFTC,
and they advised the court that they intended to file more criminal
charges in the future.
The CFTC's complaint, along with the criminal charges, tells a
story of deliberate dishonesty and deception. In a written statement
found when he attempted suicide, as quoted in the criminal charges, Mr.
Wasendorf said he committed fraud, manufactured phony bank documents,
and forged bank signatures. In short, the charges against him are that
he took customers' funds right out of the bank, and lied about it for
years.

The System of FCM Oversight
Peregrine is a CFTC-registered FCM. The NFA, a futures industry
SRO, is responsible for the firm's front-line oversight. The way our
oversight system has been set up for decades, SROs are the primary
regulators of FCMs, introducing brokers, commodity pool operators, and
commodity trading advisors. In 2000, Congress affirmed the Commission's
reliance on self-regulatory organizations by amending Section 3 of the
CEA to state: ``It is the purpose of this Act to serve the public
interests . . . through a system of effective self-regulation of trading
facilities, clearing systems, market participants and market
professionals under the oversight of the Commission.'' Further, based
on this system and the realities of limited CFTC resources, in the wake
of Dodd-Frank, the NFA also will take on additional examination and
registration duties with regard to swap dealers.
As part of its oversight responsibility, the NFA is required to
conduct periodic audits of non-clearing member FCMs' customer funds in
segregated and secured accounts. The CFTC oversees the NFA, examining
them for the performance of their duties. We review the NFA's work
papers only on a limited number of FCMs each year. In addition, the
CFTC also does limited-scope reviews of FCMs in a ``for cause''
situation that are sometimes referred to as ``audits,'' but they are
not full-scale audits as accountants commonly use that term.
Under CFTC rules, FCMs must have their annual financial statements
audited by an independent CPA using Generally Accepted Auditing
Standards. As part of this certified annual report, the independent
accountant also must conduct appropriate reviews and tests to identify
any material inadequacies in systems and controls that could violate
the Commission's segregation or secured amount requirements. Any such
inadequacies are also to be reported to the SRO and the Commission.
The Oversight of Peregrine
The NFA last completed an audit of Peregrine in May 2011, and was
in the process of conducting another periodic audit over the last
several weeks. Peregrine's financials for the year ending December 31,
2011, were reviewed and certified by its independent CPA expressing a
clean opinion on both the financial statements and internal controls
report.
In 2000, the CFTC brought an enforcement action against Peregrine,
finding in an Order that the firm had violated net capital rules. At
the time, Peregrine was much smaller than it was in 2012, with roughly
$800,000 in net capital requirements and $23 million in customer
segregation requirements. The firm was ordered to pay a civil penalty
and to take steps to improve its financial controls, including
retaining a second independent public accounting firm to perform
reviews of certain financial accounts and to report its findings to the
CFTC. The firm retained PricewaterhouseCoopers.
The CFTC's Order in 2000, resolving the enforcement investigation,
was the culmination of a process that began with limited-scope reviews
conducted by the CFTC examinations staff in the 1990s. During these
reviews, the staff noted a number of problems at Peregrine regarding,
among other things, net capital, infusions of capital to avoid net
capital violations, internal financial controls, and records of
segregated and secured customer assets and liabilities. Other issues
related to accounting for receivables and payables; transactions and
agreements with affiliates; differences between journal entries on the
company's books and the statements of one of its banks, Harris Bank;
accuracy of books and records; the abilities of the firm's auditor; and
providing customers with timely trade confirmations and monthly
statements. In addition, CFTC staff questioned whether Peregrine had
tried to mislead them concerning some of these accounting issues. The
staff also noted issues regarding the sufficiency of NFA audits.
Subsequently, in 2007 and 2008, the CFTC examinations staff
reviewed Peregrine's classification and reporting of customer-owned
securities and the investment of customer funds for compliance with
CFTC Regulations. The limited reviews identified improperly titled
segregation bank accounts, which were corrected during the examination.
In addition, the staff in 2010 performed a limited, 2 day review of
Peregrine's anti-money laundering compliance.
Although we do not yet know the full facts of what happened in this
matter, it is clear that the system failed to protect the customers of
Peregrine. The NFA and CFTC staff over the years did not detect Mr.
Wasendorf's alleged stealing of customer funds, which came to light
only a few weeks ago. Though the local police cannot prevent every bank
robbery and market regulators cannot prevent every financial fraud, we
all must do better. We must do everything within our authorities and
resources to strengthen oversight programs and the protection of
customer funds.
Customer Protection

CFTC Customer Protection Reforms To Date
The Commission has been actively working to improve protections for
customer funds. This includes:

The completed amendments to rule 1.25 regarding the
investment of funds bring customers back to protections they
had prior to exemptions the Commission granted between 2000 and
2005. Importantly, this prevents use of customer funds for in-
house lending through repurchase agreements;

Clearinghouses will have to collect margin on a gross basis
and futures commission merchants (FCMs) will no longer be able
to offset one customer's collateral against another and then
send only the net to the clearinghouse;

The so-called ``LSOC rule'' (legal segregation with
operational commingling) for swaps ensures customer money is
protected individually all the way to the clearinghouse; and

The Commission included customer protection enhancements in
the final rule for DCMs. These provisions codify into rules
staff guidance on minimum requirements for self-regulatory
organization (SROs) regarding their financial surveillance of
FCMs.

In addition, this month, we approved an NFA proposal that stemmed
from a coordinated effort by the CFTC, the SROs, and market
participants, including from the CFTC's 2 day roundtable earlier this
year on customer protection.
The three key areas of reform included in the NFA rules are:

First, FCMs must hold sufficient funds in Part 30 secured
accounts (funds held for U.S. foreign futures and options
customers trading on foreign contract markets) to meet their
total obligations to customers trading on foreign markets
computed under the net liquidating equity method. FCMs will no
longer be allowed to use the alternative method, which had
allowed them to hold a lower amount of funds representing the
margin on their foreign futures;

Second, FCMs must maintain written policies and procedures
governing the maintenance of excess funds in customer
segregated and Part 30 secured accounts. Withdrawals of 25
percent or more of excess funds in these accounts (that are not
for the benefit of customers) must be pre-approved in writing
by senior management and reported to the NFA; and

Third, FCMs must make additional reports available to the
NFA, including daily computations of segregated and Part 30
secured amounts, as well as twice monthly detailed information
regarding the cash deposits and investments of customer funds.

CFTC Restructuring and Enforcement
The CFTC also has implemented a significant restructuring, based on
a new strategic plan, regarding our oversight of SROs and
intermediaries.
The CFTC last year established a new division dedicated solely to
the oversight of the SROs and intermediaries. We created a branch
within the division to specifically oversee examinations. We were able
to attract talented individuals from the private sector with many years
of relevant experience to lead this new division and branch. We have
begun the process of strengthening our examination program, including
adding risk and control elements. Separately, we also recently created
a Consumer Outreach Office to help consumers get information about
avoiding fraud.
In addition, the CFTC's enforcement arm aggressively pursues bad
actors in the markets. In the last 2 years, the Division of Enforcement
has been filing cases and opening investigations at the highest rate in
the CFTC's history. Roughly half of the cases involve fraud against
customers.
Since October 2009, the CFTC has brought 22 cases against
registered FCMs, 13 of which involved supervision failures and one of
which involved a failure to maintain customer secured funds properly.
In the same period, the CFTC brought two cases in Federal court against
FCMs, one for violating segregation rules and the other for failing to
be properly capitalized and to maintain books and records.
The Commission in April charged JPMorgan Chase Bank, N.A. for
unlawful handling of Lehman Brothers, Inc.'s customer segregated funds
and imposed a $20 million civil monetary penalty. In another case
against a public accounting firm and a CPA partner of the firm, the
Commission imposed sanctions for failing to conduct proper audits of a
registered FCM. In one of our supervision failure cases, a registered
FCM was sanctioned for failing to follow its own compliance procedures
regarding ``know your customer'' requirements.

Customer Protection Reforms Ahead
While the Commission's enhanced customer protection rules, staff
reorganization and enforcement efforts to date have been significant, I
believe we must do more. I believe we need to further enhance the
agency's rules for customer protection. As outlined below, staff
recommendations, based on substantial Commissioner and market
participant feedback, are now drafted and in front of Commissioners.
First, we must incorporate the NFA rules approved last week into
the Commission's regulations so that the CFTC can directly enforce
these important reforms.
Second, I believe it is critical that we bring the regulators' view
of customer accounts into the 21st century. We must give the SROs and
the CFTC direct electronic access to FCMs' bank and custodial accounts
for customer funds, without asking the FCMs' permission. Further,
acknowledgement letters (letters acknowledging that accounts contain
segregated customer funds) and confirmation letters must come directly
to regulators from banks and custodians.
Third, I believe we need more transparency to customers about their
funds. Futures customers, if they wish, should have access to
information about how their assets are held and with whom, similar to
that which is available to mutual fund and securities customers.
Fourth, I believe we need to consider enhanced controls at FCMs
regarding how customer accounts are handled.
In addition, I believe we need to carefully consider additional
rules laying out the SROs' requirements for conducting examinations and
audits.
Regarding the Commission's oversight of SROs and intermediaries,
though we're making progress through our reorganization and new rules,
the recent events at Peregrine highlight the necessity of looking at
the decades-old system of SROs and the Commission's role in overseeing
SROs.
I have directed the CFTC's staff to do a full review of how the
agency conducts oversight of the SROs, as well as limited scope reviews
of FCMs, to determine what improvements can and should be made. As part
of this review, we have reached out to the Public Company Accounting
Oversight Board (PCAOB), which oversees the audits of public companies.
The Dodd-Frank Act gave the PCAOB oversight authority over the audits
of brokers and dealers who are registered with the SEC. The PCAOB has
agreed to give us the benefit of its insights and expertise.
Building on the customer protection public roundtable earlier this
year, I also have asked CFTC staff to hold another public roundtable
discussion on customer protection issues, including examination
techniques and procedures, which will take place during the 2nd week of
August.

Resources
Confidence in the futures and swaps markets is dependent upon a
well-funded regulator. The CFTC is a good investment of taxpayer
dollars. This hardworking staff of 710 is just ten percent more than
what we had at our peak in the 1990s though the futures market has
grown fivefold. The CFTC also will soon be responsible for the swaps
market--eight times bigger than the futures market.
The Commission's limited resources have historically not allowed
for direct oversight of FCMs. There are 46 staff members, including 35
audit staff, on the CFTC's examinations team who oversee four SROs,
which in turn have responsibilities for more than 4,341 registered
persons. On top of the current lack of staff for examinations, our
responsibilities are expanding to include reviews of many new market
participants. For instance, there are currently 115 FCMs, and staff
estimates a similar number of swap dealers will ultimately register.
More frequent and in-depth risk-based, control-oriented examinations
are necessary to assure the public that firms have adequate capital, as
well as systems and procedures in place to protect customer money.
Greater coverage by regulators--like having more cops on a beat--will
improve the integrity and heighten the deterrent effect of the review
process.
The President's FY 2013 budget, following a similar request in
2012, asked for $308 million, investing in our technology and human
resources, to better protect the public.
Market participants depend on the credibility and transparency of
well-regulated U.S. futures and swaps markets. Without sufficient
funding for the CFTC, the nation cannot be assured that the agency can
adequately oversee these markets.

Conclusion
Nearly 4 years after the financial crisis and 2 years since the
passage of Dodd-Frank, the CFTC has made significant progress in
implementing Congress' common-sense reforms for the swaps market.
With the foundational rules in place, it is critical that we
complete the remaining reforms that will bring transparency and
competition to the swaps market, lower costs for companies and their
customers, and protect the public.
It is also crucial that the CFTC, working with SROs and market
participants, continues its efforts to enhance protections for the
funds of both futures and swaps customers.
Thank you and I look forward to your questions.

Attachment

CFTC Dodd-Frank Update
Final Rules & Guidance
Agricultural Commodity Definition

Agricultural Swaps

Anti-Manipulation

Business Affiliate Marketing and Disposal of Consumer
Information

Client Clearing Documentation, Straight Through Processing,
Clearing Member Risk Management

Commodity Options

Commodity Pool Operators and Commodity Trading Advisors:
Amendments to Compliance Obligations

Derivatives Clearing Organization--General Provisions and
Core Principles

Designated Contract Markets--Core Principles

End-User Exception

External Business Conduct Standards

Foreign Boards of Trade--Registration

Implementation Phasing for Clearing

Internal Business Conduct Standards (Risk Management,
record-keeping, & CCOs)

Investment Advisor Reporting on Form PF (Jt. with SEC)

Investment of Customer Funds (Regulation 1.25)

Large Trader Reporting for Physical Commodity Swaps

Position Limits for Futures and Swaps

Privacy of Consumer Financial Information

Process for Review of Swaps for Mandatory Clearing

Process for Rule Certifications for Registered Entities
(Part 40)

Real-Time Reporting for Swaps

Removal of References to or Reliance on Credit Ratings

Reporting Certain Post-Enactment Swap Transactions (IFR)

Reporting of Historical Swaps

Reporting Pre-Enactment Swap Transactions (IFR)

Retail Commodity Transactions--Interpretive Guidance on
``Actual Delivery''

Retail Foreign Exchange Intermediaries--Regulations &
Registration

Retail Foreign Exchange Transactions--Conforming Amendments

Segregation for Cleared Swaps

Swap, Security-Based Swap, Security-Based Swap Agreement--
Further Definitions (Jt. with SEC)

Swap Data record-keeping and Reporting Requirements

Swap Data Repositories--Core Principles, Duties &
Registration

Swap Dealers and Major Swap Participants--Registration

Swap Dealers, Major Swap Participants, and Eligible Contract
Participants--Further Definitions (Jt. with SEC)

Whistleblowers

Proposed Rules & Guidance
Block Rule

Capital for Swap Dealers & Major Swap Participants

Clearing Exemption for Cooperatives

Clearing Requirement Determinations

Conforming Rules

Cross-Border Application

DCMs--Core Principle 9

Disruptive Trade Practices

Governance and Conflict of Interest (DCM, DCO, & SEF)

Identify Theft (Jt. with SEC)

Internal Business Conduct (Documentation, Confirmation, &
Portfolio Reconciliation)

Margin for Uncleared Swaps

Segregation for Uncleared Swaps

Swap Data Repository Indemnification Interpretation

Swap Execution Facilities--Core Principles, Registration,
and Process for ``Made Available to Trade'' Determinations

Systemically Important Clearing Organizations--Additional
Provisions

Volcker Rule

Yet to be Proposed Rules & Guidance

Inter-Affiliate Clearing for Financial Entities

RTO/ISO Exemptive Relief

201(f) Exemptive Relief

Stress Testing under Section 165

Final Orders
Delegation to National Futures Association (NFA)--Certain
exemptions for Commodity Pool Operators

Delegation to NFA--Foreign Exchange Intermediary
Registration function

Delegation to NFA--Swap Dealer & MSP Registration function

Exemptive orders--Effective Date for Swaps Regulation

Treatment of Grandfather Relief Petitions--Exempt Boards of
Trade & Exempt Commercial Markets

Treatment of Grandfather Relief Petitions--Transactions done
in Reliance on 2(h)

Studies & Reports
Feasibility of Requiring Use of Standardized Algorithmic
Descriptions for Financial Derivatives (Jt. with SEC)

International Swap Regulation (Jt. with SEC)

Risk Management Supervision of Designated Clearing Entities
(Jt. With Board of Governors of the Federal Reserve System and
the SEC)

Study on Oversight of Carbon Markets (Jt. with various other
Agencies)

The Chairman. The chair wishes to thank the Chairman for
those opening comments, and recognizes himself for 5 minutes.
Chairman Gensler, on February 10, 2011, in testimony before
this Committee, you stated that the resource needs of the CFTC:
``Given the resource needs of the CFTC, we are working very
closely with self-regulatory associations like the National
Futures Association to determine the duties and roles that they
can take on in the swap markets. Nevertheless, the CFTC has the
ultimate statutory authority and responsibility for overseeing
these markets,'' your comments from last year. Based on this
statement, is it fair to say that you and your agency take
responsibility for some of what is going on in regards to
customer funds at PFGBest?
Mr. Gensler. Yes, Mr. Chairman, I think that we have to
take a close look at all that the CFTC did overseeing the NFA
but also the FCMs such as Peregrine in this situation.
The Chairman. Because I know your agency has been very busy
on the rulemaking process, and I appreciate that. But even in
the smallest town, the night watchman walks around and shakes
the doorknobs to make sure they are locked, shines the
flashlight through the front door to see that nothing is amiss.
It just seems that perhaps in the aftermath, let us think for a
moment about another one of these problems, MF Global. What
should CFTC have done differently to ensure that customer funds
were properly segregated in that failure?
Mr. Gensler. I think both of these cases we have learned
things. We have worked with the NFA and the Chicago Mercantile
Exchange and the other SROs to put better rules in place. We
were already doing this in terms of closing some of the gaps in
the oversight of investment of customer funds. But we
absolutely need to do more. We are also a very thinly staffed
organization. We do not directly audit the futures commission
merchants, and as I highlighted in that testimony you
highlighted, swap dealers will be brought in as members of the
NFA and directly examined by the NFA, not necessarily by the
CFTC.
The Chairman. Along the topic of MF Global, did CFTC
coordinate with other regulators leading up to the MF Global
bankruptcy? For example, did you consult with the Financial
Industry Regulatory Authority and SEC when they forced MF
Global to change their capital treatment of its foreign
sovereign debt position?
Mr. Gensler. Mr. Chairman, I can speak about what I was
personally involved in, but as I am not involved in the MF
Global matter, but over that weekend as it----
The Chairman. Speak to the point in time up until which you
recused yourself.
Mr. Gensler. That is what I will do. Over that weekend, as
the MF Global events transpired and we at the CFTC were working
to try to move customer funds. We did work with the SEC, with
FINRA and with the international regulators in London, the
Financial Services Authority.
The Chairman. Let us touch on LIBOR for just a moment. I
asked the Federal Reserve Chairman, Ben Bernanke, last week
when the Fed first heard about the possibility of LIBOR
manipulation. He told me in a Financial Services hearing that
he first learned about it in 2008 and that the Federal Reserve
briefed other Federal agencies at that time including CFTC.
Chairman Gensler, why is it that the LIBOR manipulation was
able to continue at Barclays in 2009?
Mr. Gensler. We at the CFTC started and opened an
investigation in April of 2008 based on news reports in The
Wall Street Journal, Financial Times, and elsewhere. That
investigation culminated in what you learned of a few weeks
ago.
The Chairman. But isn't it true that Barclays also self-
reported the derivatives manipulation and it really wasn't the
CFTC that discovered it, it is when they admitted it, and what
does that say about the ability of regulators to discover
wrongdoing? I suppose that is the bottom line, Chairman.
Mr. Gensler. Well, the bottom line is that CFTC worked and
reached out to law enforcement agencies in London, the FSA, and
the Justice Department to develop this case. It is a very
pervasive action that Barclays was involved in involving two
regs, three cities, 4 years of misconduct on the part of
Barclays, and involving senior management. So the CFTC reached
out and developed the evidence also over two continents and
different jurisdictions.
The Chairman. It just seems, Chairman--and my time has
expired--from the country perspective, we spent a lot of time
putting up street signs but we haven't rattled enough doorknobs
lately.
I now recognize the Ranking Member for 5 minutes.
Mr. Peterson. Thank you, Mr. Chairman.
I would like to follow up on this LIBOR situation. So you
were investigating it. Did any of the other regulators contact
you about this or were they working on it, or were you guys
doing this by yourself?
Mr. Gensler. I am aware and we are aware that in June of
2008, and the New York Federal Reserve has put this on their
website, that there was a report to an interagency staff group
about LIBOR--it is called the President's Working Group--that
laid out some of the general concerns that the New York Fed had
in June. But in terms of the law enforcement action, actually
pursuing infractions of the Commodity Exchange Act of false
reporting and attempting to manipulate this rate, that is
something the CFTC did with other law enforcement agencies and
took a long time to develop those facts and get evidence, hard
evidence to take to court or to get Barclays to settle.
Mr. Peterson. So these other folks, they didn't have any
reason or any business to be investigating this, the Fed?
Mr. Gensler. I can only speak to the CFTC, but we reached
out to law enforcement agencies to the SEC and the Justice
Department and the Financial Services Authority, which have law
enforcement and the Financial Services Authority----
Mr. Peterson. So you guys were all working together?
Mr. Gensler. Yes. The Financial Services Authority
initially was facilitating our document requests and
information requests. They subsequently opened a live
investigation, which they publicly said was in 2010.
Mr. Peterson. There were reports in Barron's in July of
2012 that the CME heard complaints from traders about the LIBOR
rate, and I guess they went as far as contacting the British
Bankers Association regarding these complaints. Did the CFTC
ever receive any expression of concern about possible fraud
manipulation or problems about LIBOR from CME?
Mr. Gensler. I am aware that our staff knew that there were
conversations, and it may have even been in the press at the
time between the CME and the British Bankers Association. But
in terms of actually developing a case with hard facts and
evidence of manipulation or false reporting, that was done
directly with law enforcement agencies, shaking the doorknobs,
as the Chairman said.
Mr. Peterson. I understand, but I guess what I am getting
at is that I think you guys did the right thing. You went in,
following the law and developing the case and all that stuff,
but these other folks that are affected by this--and this was
in the press--were they concerned about this? Did they ask
questions? Did they know what you were doing and were they
satisfied with that? Why weren't they concerned for 4 years
that this potentially was a problem? That is what I don't get.
I understand what you are doing, but I mean, the people that
are affected by this, weren't they concerned about this?
Mr. Gensler. Well, those are very important questions. I
can tell you that law enforcement agencies, once we actually
brought something real and actionable with evidence to the
Justice Department, they were terrific, the FSA when they
opened their live investigation, and we were rattling those
doorknobs for quite some time to make sure. This market is so
critical to borrowers and lenders in this country.
Mr. Peterson. That is my point. So why weren't the
borrowers and lenders screaming about this for 4 years, or
didn't they know what was going on, or didn't they care?
Mr. Gensler. There were academic reports, there were news
reports, and I think that as I said earlier, that the market
has become less and less transaction-based and more estimate-
based. This interbank borrowing market had--as Mervin King said
in the fall of 2008, LIBOR is the rate at which banks aren't
lending to each other. Our career staff, well before I got
there, sir, started to focus on this. It takes a long time to
build a case that you can take to court.
Mr. Peterson. I don't understand enough about this to know,
but it just seems to me that if these folks, that if everybody
knew about this and nobody said anything, apparently it must
have been benefiting them so they were just happy to have it
continue. It is another case where these guys, the whole damn
system is set up to benefit Wall Street and nobody else in this
country. I am tired of this. You just wonder where these people
are, and we commend you for what you do and working on this. We
have a system that is so complicated that it takes you 4 years
to nail it down. That tells you something right there.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentleman from Texas, Mr. Neugebauer, for 5
minutes.
Mr. Neugebauer. Thank you, Chairman Gensler, for being here
this morning. Prior to the April 2008 Wall Street Journal
article, your agency didn't have any knowledge that there were
concerns about LIBOR? Is that your testimony?
Mr. Gensler. We opened an investigation in April of 2008.
In talking to some of the career staff, I wasn't there then,
but in talking to them, they were aware of some of the academic
and some of the news stories but it was that Wall Street
Journal piece that they decided to open what is a live
investigation into these matters.
Mr. Neugebauer. So you weren't aware that as early as the
latter part of 2007 that people at the Federal Reserve Bank in
New York were made aware that there could be some problems with
LIBOR? You didn't ever have any notice from the New York Fed of
that?
Mr. Gensler. Congressman, we haven't gone back to do
forensics, but sitting here today, I am not aware that our
staff was made aware of anything except for the news stories
and academic research by April.
Mr. Neugebauer. But it was the Wall Street Journal 2008
article that kind of triggered the opening of a case in your
organization?
Mr. Gensler. That is right, and it was actually reviewed
with Commissioners in late April. We have an every-Friday
surveillance meeting with the surveillance team, and the
enforcement folks talked to Commissioners in April of 2008.
Mr. Neugebauer. Chairman Bernanke was here last week, and
one of the things I asked him is, can one bank--I think there
are 16 U.S. Dollar LIBOR banks that report to make up that
index--could one bank alone influence that rate, and his
response was that no. I think you have in your report or in
your findings alluded that there are other banks involved or
other banks that are under investigation at this time. Is that
in fact, other banks are going under the same investigation
that you did with Barclays?
Mr. Gensler. I am going to try not to compromise an ongoing
enforcement matter, but what we said in the Barclays situation
was that in the case of Euribor, that there were four other
banks that Barclays was aiding and abetting. That means that
Barclays was trying to assist them but they were also asking
these other four banks, which we called bank A, B, C and D, to
assist Barclays in the setting of Euribor for the profits of
their desk. But I might also add that in the Department of
Justice findings and order, Barclays admitted--I can even give
you the paragraph, 30--that in some occasions their
manipulation of their submissions did affect the rate, and that
is in the Barclays order with the Department of Justice.
Mr. Neugebauer. But it would be difficult for one bank to
do that on its own. Would you agree?
Mr. Gensler. Though in the Department of Justice findings
and settlement with Barclays, they did say that on some
occasions it did affect it, because even a basis point
averaged, to walk back for the Committee, 16 banks submit. Four
low ones and four high ones are thrown out. The eight middle
ones are averaged. Even one bank could possibly affect on some
days.
Mr. Neugebauer. So just the bottom line, but there will be
other findings from the CFTC on this issue. Is that your
testimony?
Mr. Gensler. Again, not to compromise any ongoing
enforcement matter, we are going to vigorously pursue
enforcement matters around these benchmark rates. These rates
need to be reliable but it is also the law. The law is, don't
false report, don't attempt to manipulate or manipulate these
rates.
Mr. Neugebauer. I want to go back to Peregrine for just a
minute. I think we are reading that one person was evidently
falsifying a tremendous number of documents, daily reports,
financial statements, bank statements, bank verifications. I
mean, the list goes on and on. And so either we have a very
unsophisticated regulatory structure or this was a very
sophisticated gentleman that could carry off for as long a
period of time as he did this fraud. I would hope, and we are
going to hear today hopefully that we are going to have to jack
our surveillance up, that if one person--and I don't believe
one person could actually have pulled this off--but one person
could defraud a fairly broad number of regulators that are
supposed to be looking after on behalf of the customers of
these institutions. So I am hopeful that we are going to hear
some very positive steps but it doesn't speak well when one
person can pull that off for that period of time.
Mr. Gensler. I share our view that we have to up our
auditing oversight both at the CFTC and the self-regulators,
and I also would say, we don't know all the facts yet. There is
going to be a lot more that we learn about the facts of this
situation.
Mr. Neugebauer. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The chair
recognizes the gentleman from Iowa for 5 minutes, Mr. Boswell.
Mr. Boswell. Thank you, Mr. Chairman.
Thank you, Mr. Chairman Gensler, for being here to talk to
us. Listening to what has been already said, yesterday or
recently we also had some discussions with the NFA personnel
and so on, and understand how they structure their toolbox to
do their work, 2 cents per trade on both the borrower and the
seller and so on. I understand that, and with that, they have
managed to add about 25 percent annually to their toolbox, if
you will. After the collapse of Wall Street, we passed Dodd-
Frank, which I have always felt like would probably need some
tweaking and I have no quarrel with that, but we expanded the
CFTC's responsibilities regarding oversight. Then we discovered
the collapse of MF Global last October, made it apparent that
we must provide our oversight bodies with tools.
So I want to ask you this question. Do you think that the
structure similar to the way we fund the SEC would benefit the
CFTC based on a general growth rate? How do the investments of
technology made by CFTC compare to those made by the SROs?
But before you answer that, I would just say to Mr. Conaway
and Mr. Lucas, I respect you guys very much. There is probably
nobody in the room that has spent more time where you come from
than I have. As a young man, I went to a place west of Odessa
named Monahan. I was out there in an oil field--just a young
farm kid who was willing to do hard work--and they hired me to
substitute so everybody could take vacation on the drilling
rig. I did all the jobs--lee tongs, backups, tower, mud mixer--
I did it all. And then later on I spent time in mineral wells,
Fort Walters, a couple trips, Fort Bliss, Oklahoma, I am
practically an Okie. Fort Sill, I have been there a lot of
times, and so on. I was interested in what happens out there in
agriculture and realized over the years that the technology has
changed so much for farmers because of the intensity of capital
invested. They have to be able to have marketing tools.
And so we went through all this. Thank you, Mr. Peterson,
for what you said about what is going on here and what are we
going to do? I am not sure where--and I say this very
respectfully: maybe we need to talk about this outside the room
but where are you leading us to deal with this? Because I am
ready to follow if I understand it, and I know I sat over there
in the chair when we--after Dodd-Frank I was Chairman and I
have now been Ranking Member with Mike, and I appreciate that.
Maybe you can tell me, where are you trying to take us on this.
I would like to know. Because we have a heavy responsibility. I
want to help. I think we need tools. I guess you have combined
a little wheat and you have certainly pulled a few calves, same
as I, and so on. I could never go to the field even with a
modern combine without a toolbox. I am not too sure that you
have the toolbox. So I hope you can answer that. But I don't
know. I would yield to anybody to help me out. I am kind of
like you, Mr. Peterson. Where are we going and how are we going
to get on top of this? Because if we need to tweak Dodd-Frank,
let us do it, but let us not give them responsibility to do
what we ask them to do and then say whoops, figure out some way
to do it on your own.
I yield.
The Chairman. I thank the gentleman for yielding.
I think we are in the process now of what has been a multi-
year effort. The Chairman regularly alludes to the fact that he
is in the process of fulfilling all of his rulemaking
responsibility under Dodd-Frank, has not completed that yet but
is in the process.
Mr. Boswell. But we still keep trying to take his resources
away by cutting his budget.
The Chairman. I think we have a responsibility on this
Committee--we are not appropriators, we are authorizers--to
provide oversight to make sure that the Chairman and his
Commission are fulfilling the spirit of the law as well as the
letter of law. All of that in addition to their mandated
responsibilities under Dodd-Frank, they are fulfilling all the
other responsibilities that are ongoing with this process. I
used the country phrase about the night watchman shaking the
doorknobs in referencing to that as well as putting up stop
signs or street signs. I understand the Chairman has a
difficult challenge but we also have a responsibility to
provide oversight, to verify that he is following the rules,
that he is doing what he needs to do. If he should deviate from
the intent of the law, our responsibility is to guide him back
to that point and to help move him forward. If there were
indeed flaws in the law or flaws in the rule--I know what would
surprise the Chairman to hear there might be a flaw in the rule
somewhere--if there are flaws, then it is our responsibility to
bring attention to that to help make sure changes can be made.
Right now in the legislative environment we are working in,
it is kind of challenging, as my good friend from Iowa knows,
to get much of anything done. That is just the lay of the land
as we face it. That is why we worked so hard the other night on
a markup on a comprehensive farm bill.
Mr. Boswell. You did a good job.
The Chairman. That is what my main focus is and yours too,
my good friend.
Mr. Boswell. Absolutely.
The Chairman. But we are going to fulfill our
responsibilities. We are going to move this process forward and
our friends are going to work doubly hard, I am sure, to
fulfill their responsibilities.
Mr. Boswell. Thank you very much. I appreciate that, and I
like your analogy of shaking the doorknobs. I think it is kind
of linked up with having the tools in the toolbox. Okay. I went
past my time. I will yield back. You take all the time you
want.
The Chairman. I would say to my good friend, all of our
time has expired, and now I turn to the gentleman from Texas,
Mr. Conaway, for 5 minutes.
Mr. Conaway. Thank you, Mr. Chairman. I appreciate the
comments from Mr. Boswell.
Chairman Gensler, thank you for the call the other day. We
have a target-rich environment this morning for questions on
the array of things that are in front of your Commission, but I
want to talk about the extraterritorial guidance. I appreciate
your call the other day and our conversation about that. I now
know some more about it that I didn't know then, and some
questions have just come up to me, so I am not saving these for
you, I just didn't think about them at that point in time.
This fits in the foundational kind of rules that some would
argue require you to work with the SEC to put this rule or
guidance, whatever we wind up calling it, in place. SEC has
said they don't have the authority to issue guidance the same
way that the CFTC did. Can you walk us through how you came to
conclude this and why this isn't more coordinated with the SEC?
Quickly, because I have a series of questions on this issue.
Mr. Gensler. First, I would say I now have come to use the
word cross border because I can pronounce it, but on the cross-
border issues, we do have a provision in Dodd-Frank that was
not placed in the SEC's side of it. It is section 722(d). What
it says specifically is, we are not to regulate something
unless it has direct and significant effect on the commerce or
activity of the United States. Those words that are in Dodd-
Frank are on our side, not the SEC's. And we received a lot of
questions from many, many market participants: what do those
words mean, can you interpret those words. Congress didn't say
we shall do a rule or anything.
Mr. Conaway. Okay.
Mr. Gensler. So we are trying to interpret those words and
leave some flexibility, frankly, that it is not as rigid.
Mr. Conaway. In that regard then, where does guidance fall
in the pecking order? If I am a cross-border firm and trying to
look at this guidance and it is open for comment for some 45
day period, so the guidance is not even final, I have a 60 day
clock, soon to start running with respect to swap-dealer
registration and I am going to make real-world decisions to
spend money and to reflect that guidance. Are you expecting
folks to comply with this as if it were a rule?
Mr. Gensler. So we have also put out at the same time for
30 day public comment something about phased compliance or an
exemption for 1 year for these foreign-based swap dealers from
many of the rules of Dodd-Frank--the entity-based rules. They
would have to comply with transaction-based rules that are in
effect like real-time reporting if they are doing something
with a company in Texas. So if a bank in France was doing a
trade with somebody in Texas, that would still have to come----
Mr. Conaway. Under the transaction rule but not the entity
itself would----
Mr. Gensler. That is correct.
Mr. Conaway. And do you expect working with your friends at
the SEC that they will come to similar conclusions when they go
through their actual rulemaking process on this?
Mr. Gensler. I think they will be similar but not identical
because again Congress did something different on their side of
the statute than ours so that----
Mr. Conaway. Well, that seems to be the cart driving the
horse. In other words, what we want is regulations that work
for everybody and allows them to comply. I haven't harassed you
too much about the end run on cost-benefit analysis that this
guidance proposal appears to allow you to not do cost-benefit
analysis of what compliance under these guidance rules might
cost and what those benefits are. But the idea is that they
ought to be parallel with the SEC and not rely on a flawed law
that Mr. Boswell said we probably need to fix some of that kind
of stuff, but the idea is, then you would be able to comply
with this and not let the law drive a goofy answer.
Mr. Gensler. The SEC, the Treasury and the Federal Reserve
have all given us advice and counsel for many months on this
document we put out to public comment, and I believe we will be
close whenever the SEC moves forward, but again, because they
have different statutory framework, there will be some
difference.
Mr. Conaway. Let me ask in a similar vein, Barclays, which
you guys did a good job and I was hoping you would brag more on
your team this morning about that because I do think you did a
good job. But the agreement that you made with Barclays Bank
sets in place some things that they will now do with respect to
their operations. Will that now become the industry standard
for everybody else and is this another way to get at a rule
without going through the normal rulemaking processes that we
generally have put in place?
Mr. Gensler. Let me first brag on the team, Vince McGonagle
and Gretchen Lowe, Anne Termine, and David Meister, I mean,
fabulous, tough, tough case, fabulous work they have done.
In terms, yes, we had Barclays commit that as they make
these submissions in the future, they have to be transaction-
based, focused on Barclays transactions, and if there aren't
transactions in this unsecured market, they have to look to
their secured borrowings. They have to have firewalls and----
Mr. Conaway. That is fine, but I really wanted to focus on
the impact this has on the rulemaking process. In other words,
will you use this again in the future with legal operations to
get at a back-door rule for everybody else?
Mr. Gensler. I now understand your question. We were really
focused on Barclays. I mean, Barclays had such pervasive
activity that was not in compliance with the law, so pervasive
we said no, you have to have these undertakings. We have
undertakings in many of our settlements. They just don't get as
much publicity as this here. And I would say that just as in
other cases, people should read those undertakings and
understand them but they are Barclays specific.
Mr. Conaway. You mentioned the PCAOB helping you with
auditing standards. They set the auditing standards for public
companies. I would also refer you to the AICPA, which sets
auditing standards for private companies, and the fellow that I
suspect was auditing Peregrine was likely not registered under
the PCAOB.
Mr. Gensler. I think that is very good advice. I think that
they were registered but it is still very good advice.
Mr. Conaway. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentleman from North Carolina, Mr. Kissell,
for 5 minutes.
Mr. Kissell. Thank you, Mr. Chairman.
Thank you, Chairman Gensler, for being here with us today.
We had a hearing a while back on MF Global; and as Members of
the Committee were questioning board members, Commissioners
from the CFTC about some of the oversight things, it was
pointed out, I believe by the Ranking Member, that MF Global
had really transitioned from a commodities-based firm to a
securities firm and really at that point in time when some of
the bad things happened, it was more of an SEC responsibility
than a CFTC responsibility.
In that regard in that transition, and somewhat in follow-
up to Mr. Conaway's questions, as the CFTC moves forward in its
definitions and its rulemakings, and as the comment time
closes, and looking at the cross-border aspects of some things,
some folks had come to me and talked about, they were concerned
not wanting changes in laws and regulations, just looking for
certainty, and they were concerned if you guys finished your
work too much in advance of the SEC doing the same things.
Looking at MF Global as an example of a company that switched,
in between, are you concerned that if you get too far ahead of
the SEC if there might be the gaps in there that might create
problems in oversight, in the paperwork, in compliance issues
if there is too much of a gap between these things being done?
I just wonder what your thoughts are.
Mr. Gensler. I am mostly concerned that 2 years into this
and 4 years from the crisis we need to get these common-sense
rules of the road and the traffic lights in place. The timing
gap with the SEC, they are overseeing the securities-based
swaps, which is a much smaller part of the market, does raise
some concerns in clearing of credit default swaps, so that is
something we have looked at very closely, especially the
largest clearinghouse, the IntercontinentalExchange. I would
hope that we could get portfolio margining, which is a very
detailed issue, done, because that we need to do with the SEC.
The timing gap that is probably more significant is with
Europe and with the international regulators and this cross-
border issue, and that in part is a significant reason why we
gave this 1 year period to sort through some of these
international issues. We have a proposed exemption for another
year on the international side.
Mr. Kissell. Thank you, Mr. Chairman, once again for being
here and I yield back my time.
The Chairman. The gentleman yields back. The chair now
recognizes the gentleman from Colorado, Mr. Tipton, for 5
minutes.
Mr. Tipton. Thank you, Mr. Chairman. Thank you, Chairman
Gensler, for being here as well.
I think that I would like to follow up a little bit on what
Mr. Conaway and Mr. Kissell have been talking about in regards
to some of the cost-benefit analysis of this. Our counterparts
seem to have pretty much the same conversation, which is
financial certainty in terms of what is being proposed by the
CFTC. You have issued but not published in final form a number
of rules that are going on. When we are talking in country, not
extraterritorial, but in country on the proposed rules, are you
expecting compliance because that seems to still be fluid, and
some of the costs that are going to be associated from these
various groups that they are going to have to try and comply
and then change as that rulemaking process has not been
finalized.
Mr. Gensler. To answer your question, no, and we have been
very clear and issued exemptive language. We are hopeful to get
our proposals finalized by the end of this year. We have
granted relief through the end of the year, and then as we
finalize those we would put in place compliance schedules well
into 2013 for the rules that might be finalized later this
year. But only the final rules that are in place are actionable
and enforceable.
Mr. Tipton. Great. And one thing I would like you to maybe
explain just a little more on, whenever there is a problem, we
all want to make sure that the markets work well, people are
held accountable, the people's resources are sound and we can
count on the information. You had commented that are you doing
some internal examination, that you stated in your testimony
the system failed to protect Peregrine's customers, and that we
need to take a close look at how the CFTC handled its
oversight. Are you identifying, in lieu of new rules, where it
failed internally and how to organizationally make this work
better?
Mr. Gensler. We are doing that. We had already restructured
this group, the examination function and oversight of the self-
regulatory functions and hired a new head of examinations and
also a new head on top of that, but that is not enough. I mean,
they are terrific people but we really do look at this and say
we have to do better. How do we, in essence, audit the
auditors, how do we examine the SROs, because that front line
of defense is embedded in statute? That is what we have had for
decades. Now, how do we enhance that front-line defense and
then the CFTC's responsibilities? As the Chairman says, we
ultimately do have that responsibility and should be held
accountable to make sure we look internally how we can do this
better.
Mr. Tipton. You know, and I think we probably agree, the
majority of the players want to make sure that things are done
properly and abiding by the law that is going on, but when it
got into the extraterritorial rulemaking, the five
Commissioners went ahead and moved through without the
customary input for public comment. Moving on, you have now
opened this up for 45 days. Do you think that is a prudent
thing to do or would it be better maybe to talk to people that
are actually in the business to be able to seek some guidance
in terms of how to make sure that the rulemaking process moves
forward for that interaction with the SEC as well?
Mr. Gensler. Well, Congressman, with all due respect, we
had gotten a lot of input from market participants, and we list
those meetings on our schedule, but I would have no doubt there
were dozens of meetings and dozens of letters from commenters,
if not over 100 letters from commenters, about the cross-border
application, and then we put that in this interpretation and
the relief, the 1 year relief I referred to. We had input from
the SEC before we did that and now we are going to get further
public comment on that because it is critical to get the public
comment.
But I would say that if we followed the industry's approach
completely, they would move the jobs and the markets to London
or the Cayman Islands or somewhere but the risk still comes
crashing back here. AIG Financial Products, that was located in
Mayfair in London. Citicorp's special purpose vehicles, their
off-balance-sheet vehicles, were originated in London and
incorporated in the Caymans. I could go crisis by crisis. The
risks come crashing back to the American public and so we think
that when Congress said to oversee what is direct and
significant that we have to find a way to make sure those
branches and affiliates of U.S. financial parties have in place
some common-sense transparency and risk-reducing rules.
Mr. Tipton. I see my time has expired. Thank you, Mr.
Chairman. I yield back.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentlelady from Maine for 5 minutes, Ms.
Pingree.
Ms. Pingree. Thank you very much, Mr. Chairman, and thank
you for being here with us today.
I am going to ask a slightly different question but it is
on the same perspective of all the work that you are doing.
There was a lot of attention this morning to the fact that
Sandy Weill was, I guess, on CNBC and it has been covered in
The New York Times so obviously the former chair of Citigroup,
and one of his very thoughtful comments was that the big banks
should be broken up into separate commercial banking and
investment entities. So given his perspective, and obviously
this is a clear change of opinion of himself and probably a lot
of other people out there, how does that affect your view of
the current Volcker Rule? Do you think maybe now we should be
thinking about a more robust version as we are going through
this process?
Mr. Gensler. There is a lot in that question.
Ms. Pingree. That is okay. I have 5 minutes.
Mr. Chairman. And you tend to put a lot back in your
answers.
Mr. Gensler. I think we need common-sense rules of the road
so that if a bank fails, there is a freedom to fail, that the
taxpayers are not standing behind banks. I think that has got
to be the heart of what we do in the derivatives regulations
and otherwise in Dodd-Frank. I think in terms of the Volcker
Rule, the approach Congress took is to lower some of the risk
of this proprietary trading but of course at the same time
still permit very important market-making and risk-reducing
hedging. It is probably one of the most challenging rules in
front of regulators, how to prohibit proprietary trading but
permit these important activities, market making and hedging.
Ms. Pingree. I know you are going to give a longer answer
but I am going to just interject for a second because this is
part of my follow-up question. In previous hearings, we have
heard some people question whether you can make the distinction
between a hedge or a proprietary trade, so actually I was going
to ask you a little deeper on that and maybe you could at the
same point comment about how you define it, have we gone far
enough. If certain other bankers are thinking it is still too
confusing, are we going far enough?
Mr. Gensler. I think it is a challenge for regulators. I
think Congress was clear that you can hedge specific risk,
whether it is a specific position or an aggregate position.
Congress decided that. But I don't think that Congress meant by
that that it could just be, well, I am going to say this table
here is a hedge. You see, I am just telling you this is a hedge
and therefore it is hedge. It is hedging something. And it has
to have reasonable relationship to the underlying positions,
and I think that is the challenge. The JPMorgan Chase situation
on credit derivatives and portfolio hedging, we have to learn
from that and think about that. When is portfolio hedging
really related to specific risks and when is it something that
is mutating into just betting on the markets.
Ms. Pingree. So are you imagining that portfolio hedging
will somehow stay in the final rule?
Mr. Gensler. Well, Congress already spoke to that, that it
could be hedging aggregate risk of positions. My own experience
when I was on Wall Street, that when you separate a hedge
further and further from a trading desk and it has a separate
profit-and-loss statement and separate managers, it tends to
mutate into something else, but if it is actually related to
aggregate positions and has a reasonable correlation to that,
for instance, it loses monies when the positions make money and
it makes money when the positions lose money, that probably
tells you it is a real hedge. But otherwise it might be
something else and Congress said let us lower that, let us
prohibit that, in fact.
Ms. Pingree. So I am not an expert in this field, but given
how confusing that is, and if certain bankers are already
saying it is confusing, why doesn't it make us want to go back
and look at the Volcker Rule and say, ``Well, let us just go
back to keeping them completely separate.'' Maybe it is not
going far enough to have a really complex, difficult-to-enforce
and difficult-to-understand rule, why not on the Volcker Rule
do what Sandy Weill said, ``After years of history now looking
back, we ought to just break up the banks?''
Mr. Gensler. I am not familiar exactly with what he said
this morning, but of course, that is part of what Congress
debated and can debate in the future. We would work with you in
any way on that.
The Chairman. If the gentlelady would yield?
Ms. Pingree. Yes.
The Chairman. I think you are referencing that traditional
separation of the two that was put in place in the 1930s under
Glass-Steagall. There is much discussion about that, yes. I
yield back.
Ms. Pingree. And for the record, I am in favor of Glass-
Steagall and going back into that position, and you are right,
I can't paraphrase him or anyone else, but it seems to me given
some of the confusion around the complex way we are trying to
make them separate but not, we should reinstate Glass-Steagall.
Thank you.
Mr. Gensler. I think the critical piece is that if any of
these banks fail we not stand behind them.
The Chairman. The gentlelady's time has expired. The chair
now recognizes the gentleman from Florida, Mr. Southerland, for
5 minutes.
Mr. Southerland. Thank you, Mr. Chairman, and Mr. Gensler,
thank you for appearing before us today.
I have a couple questions. I wanted to read a little bit of
information from--this is PFGBest customer account agreement
that they sent to all of their customers. It says ``If your
securities futures positions are carried in a futures account,
they must be segregated from the brokerage firm's own funds and
cannot be borrowed or otherwise used for the firm's own
purposes. If the funds are deposited with another entity,
(e.g., a bank, a clearing broker or a clearing organization)
that entity must acknowledge that the funds belong to the
customer and cannot be used to satisfy the firm's debt,'' and I
would like, Mr. Chairman, to incorporate PFGBest Customer
Account Agreement into the record.
The Chairman. Seeing no objection, so ordered.
[The information referred to is located on p. 110.]
Mr. Southerland. So my question is, obviously there is
proof that that was violated, I am curious, how do--why didn't
CFTC monitor segregated funds and secured accounts held by
JPMorgan Chase, who obviously knows that rule. There didn't
seem to be a paper trail to prove that those funds were held in
the account as they were supposed to be and that a proper usage
of a withdrawal was proven before they released those funds.
Mr. Gensler. If I understand the question, why wouldn't a
bank have done that? We are going to learn a lot more facts but
there are a number of points of outside auditors, self-
regulatory organizations like the NFA auditing and, yes, even
the CFTC doing some limited-scope reviews. Acknowledgement
letters, you referred to acknowledgement letters, may have been
forged here as well so that it looks like from Russ Wasendorf's
own words and his note found when he attempted to kill himself
was that he was using PowerPoint to forge bank statements as
well as some of these acknowledgement letters and confirmation
letters. All of the points of protection--outside auditors,
NFA, even our limited-scope reviews--did not find this. The
system let down these investors. But I believe acknowledgement
letters, confirmation letters, bank statements and custodial
statements should be directly electronically available to the
regulatory agencies. We are working with the NFA and the CME to
try to get that in place shortly.
Mr. Southerland. But it just seems to me that if JPMorgan
Chase released these funds, they had a burden to confirm--and I
understand what you are saying, that there were forged
documents, but oftentimes many of the American people sometimes
feel that investigators, bureaucrats, and many times regulators
couldn't track an elephant in the snow, and when you look at
this right here, I think that warrants their feelings.
I want to say I know I am running out of time but I want to
ask you this: Unlike stocks, future trades are not covered
under the Securities Investor Protection Corporation, SIPC,
which protects against losses from unauthorized transactions up
to $500,000, or $250,000 limit for cash. Why shouldn't these
futures be covered by SIPC as insurance protection for really
honest investors who in good faith have made those investments?
Mr. Gensler. Well, that is a debate that has come about.
Commissioner Chilton, one of my fellow Commissioners, has
recommended it, and I know that you will be considering that. I
would say there are costs and benefits, and what we need to do
at the CFTC is not frankly wait for that but really put in
place stronger protections around these accounts, even building
on what we have already done because we have done a lot to put
in place further protections as that debate goes on.
Mr. Southerland. Well, and I think that right now we are
doing forensics. It would be nice--you made reference to your
grandfather--my mom raised me on plenty of anecdotes too and
she always said to me, an ounce of prevention is better than a
pound of cure. I would encourage to look at how we can better
protect our investors.
And the last thing I would say, Mama also told me--and by
the way, being a Member of Congress and the older I get, the
more I realize my mom and dad were pretty smart--my mom would
always say, if you wallow with the hogs, you are going to get
dirty, and might I suggest that we monitor the hogs that Mr.
Wasendorf wallowed with? You might find some other dirty hogs.
I yield back.
The Chairman. The gentleman's time has expired on that
thought. The chair now recognizes the gentleman from Vermont
for 5 minutes, Mr. Welch.
Mr. Welch. Thank you very much.
Mr. Gensler, a couple of things. Number one, good job, and
I do hope that we adequately fund you. Much is being expected,
and if you are going to do what is required in order to
maintain the credibility of the futures market--we are going to
have gentlemen and women testifying after you who are using
that market for the purposes for which it is intended--we have
to give you the resources. So I support full funding for your
efforts.
I want to ask you about derivatives and a little bit about
what happened with JPMorgan Chase. One of your predecessors,
James Stone from Massachusetts, wrote an article recently, and
he pointed out that JPMorgan had, as many banks do, a huge
exposure of derivatives notional value contracts. In the case
of JPMorgan, it is about $75 trillion. That is an enormous
outsize risk. And the question that I asked myself and he asked
as well: are there regulations really that we can constantly be
cooking up that somehow keep up with the level of risk and the
level of creativity in the derivatives markets, or is it time
to make some requirement that there be some money on the table
from the big banks when they are putting so much of their
shareholder and depositor money at risk and where obviously it
has implications for the economy?
Just to go through a few of the things that he pointed out,
the risk is disconnected, as you were saying earlier, from the
actual trading desk. I don't think that is true with folks who
are going to be testifying next. There is a direct connection
between what they are doing and how they are trying to offset
that risk, and we support that. But where the three largest
banks have 24,000 percent notional value risk compared to their
assets, any deviation in their risk model where there may be a
black swan, as they call it, where there may be a geopolitical
event, \1/10\ of 1 percent is going to have a big exposure.
Now, rather than doing all these rules and regulations, we
are having fights about it that get reflected in our squeezing
your budget because we can't come to some understanding, one of
the things that Mr. Stone recommended is that those banks or
those derivative players would have to put down \1/10\ of 1
percent to offset that risk, and it means that the taxpayers
may not be exposed. Seventy-five trillion dollars of notional
value would be $75 billion in cash money that would be a factor
that would reduce that counterparty risk, reduce the trading
volumes and bring us back to what had been historically the
purpose of the futures market and hedging, which is to offset.
So rather than all this complicated regulation where I am
starting to get to the view that my colleague here from Maine
had that some of these institutions are too big to fail, they
are too big to regulate as well, what would be your position
about requiring that there be some exposure with a \1/10\ of 1
percent just for discussion purposes on these derivatives
contracts?
Mr. Gensler. I actually think that is what Congress did in
the Dodd-Frank Act by saying that the standard derivatives have
to come into a clearinghouse, so clearinghouses collect margin,
and that the non-standard contracts the banks have to collect
margin, not on the non-financials, the end-users are out of
this, but for the 90+ percent of the market that is insurance
companies and banks and hedge funds, that they have to put up
margin at the clearinghouses, put up margin. If they fail, that
is money in the game, skin in the game that they can unwind
that position and hopefully the taxpayers, the clearinghouse is
not held to account. It is the JPMorgan that would lose in that
circumstance. And so you did that actually. The question is
whether, you might say, is it enough.
Mr. Welch. And in your view, is it?
Mr. Gensler. Well, I think that we put out very strong
rules about the amount of margin that has to be at the
clearinghouses. We haven't finalized the rule on the margin for
the uncleared swaps. We are working internationally. We don't
want to do it ahead of Europe. This is one where we want to
time this with Europe around the end of this year or the first
quarter of 2013. But yes, you should hold us accountable that
there is enough in the uncleared swaps because you wouldn't
want risk to go there inadvertently.
Mr. Welch. Thank you.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentleman from Illinois, Mr. Hultgren, for 5
minutes.
Mr. Hultgren. Thank you, Mr. Chairman.
Thank you, Chairman Gensler, for being with us today. A
couple questions. Yesterday, CFTC published an initial list of
swaps proposed to be subject to the clearing mandate. It
appears that Europe will not be prepared to have any such
clearing mandate in effect until 2013. What is the expected
timing in Asia for an enforceable mandate clearing requirement?
Mr. Gensler. Japan is a little ahead of us actually. They
were targeting November of this year to have their mandate in
place. Hong Kong and Singapore will be later, though, so Japan
is a little ahead of us, Hong Kong and Singapore later.
Mr. Hultgren. What effect do you expect the timing of these
mandates will have since they are not coordinated?
Mr. Gensler. Well, I think that it will lower the risk to
the American public, and that is what we have been chatting
about here, but it would only be a mandate on transactions that
have a direct and significant effect on U.S. commerce or
activity, so it is with U.S. persons. We phased in compliance.
We said for 1 year, for instance, even if you are a large
American bank and you operating out of Frankfurt and you are
operating with some German insurance company, that mandate
doesn't apply there. It is back to U.S. persons and direct and
significant effect back here in the United States.
Mr. Hultgren. Let me ask you briefly just about some of the
cross-border guidance proposal that CFTC put together to inform
market participants and end-users about the extent of overseas
reach of U.S. derivatives regulations. I wondered why the CFTC
chose to address this important issue via guidance rather than
through a formal rulemaking. My concern is, by doing so, you
essentially avoid cost-benefit requirements associated with a
formal rulemaking. Did you take into account the cost of
imposing and enforcing CFTC rules overseas?
Mr. Gensler. To your last point, the cost of not putting
them in place is another crisis. Risk comes back to our shores
and the jobs are overseas. I mean, let me just talk about
American jobs. They will move to London, they will move
elsewhere where somebody thinks the regulation is lighter.
Having worked at a large investment bank with hundreds of legal
entities, you just pop another legal entity somewhere across
the globe but the risk still comes back here in a crisis, so we
did consider that. The reason we did interpretation is because
there are legal words in the statute that a lot of people said
can you interpret them, section 722(d), and so we are trying to
interpret them but maintain some flexibility as well because
each legal entity is going to have different facts and
circumstances.
Mr. Hultgren. Under Dodd-Frank, Congress required CFTC and
SEC to jointly adopt foundational derivative rules such as
those defining swap and swap dealer. Clearly, Congress
expressed its intent that the rules governing the scope of the
entities and products subject to Title VII should be defined by
those two regulators in concert. In my view, the cross-border
guidance is effectively part of that swap and swap dealer
definitional rules. You can't know what a swap or swap dealer
is without clearly understanding how cross-border issues are
impacted, can you?
Mr. Gensler. I think you can, sir, with all respect, and
also as it relates to the SEC, there is no parallel section to
722(d) on the SEC side. There would be no way frankly for us to
do a joint interpretation when they don't have it in their
statute and we do in the Commodities Exchange Act. So I think
that we have coordinated very well with the SEC and gotten
those joint rules behind us. On cross-border application, we
are coordinating but, frankly, there is a different statutory
framework to interpret.
Mr. Hultgren. Well, I disagree. I think there is still
significant amount of misunderstanding over those definitions.
There is clear fear over it. It is paralyzing many entities.
Switching gears a little bit, I come from Illinois. I have
large electric co-ops, also large electric companies there in
Illinois, and there have been some very serious concerns on
those entities of what the impact of the definition of swap
dealer and swaps will be on that. Why did the Commission
appropriately raise the proposed overall de minimis level from
$100 million to $3 billion but didn't raise the level for
special entities such as public power companies and other
utilities?
Mr. Gensler. Because we put it out to public comment. We
received a lot of comments with regard to the overall level. We
didn't get comments--there was one small comment--comments on
special entities. Just to refresh, Dodd-Frank said that if
somebody was dealing with a municipal or a pension fund, they
had to have additional sales practice and treat them as--
Congress called it--special entities. So we had a more narrow
definition there. But we have worked very well with the rural
electric cooperatives and the municipal power companies. They
have a petition in front of us. We have that in front of our
Commissioners to hopefully in the next few weeks or months put
that out to public comment for an exemption for the municipal
power companies dealing with what is called 201(f) rural
electric cooperatives.
Mr. Hultgren. Just a quick follow-up on that. My question
really is, my understanding with Dodd-Frank was recognition of
threats to market really in response to the financial crisis. I
would just ask what role power companies had in creating the
financial crisis.
Mr. Gensler. We are working with the municipal power
companies and the rural electric cooperatives to have an
exemption for them, and we worked through that swap definition
so that many, many electricity contracts that they had concerns
with were addressed. I know the Edison Electric Institute put
out some comments about what we had done. They continue to come
in on very important but narrow issues, and we are going to
continue to work with them on that, but I don't think that the
municipals and the rural electric co-ops and so forth are going
to become swap dealers and so forth.
The Chairman. The gentleman's time has expired.
Mr. Hultgren. Thanks, Mr. Chairman.
The Chairman. The chair now recognizes the gentlelady from
Ohio, Ms. Fudge, for 5 minutes.
Ms. Fudge. Thank you very much, Mr. Chairman, and thank
you, Chairman Gensler, for being here today.
I just really have two questions. The first one is, in your
testimony, you assert the need for increased appropriations for
CFTC in order to allow it to better serve the American people
by providing sufficient oversight. In light of the need for
greater oversight and of course recent events as well, do you
believe that the private regulator NFA is really up to the task
or do you believe that the American people would be better
served by having one centralized Federal regulator?
Mr. Gensler. Well, this is embedded in our oversight for
decades, this system of front-line regulators and then the
Federal regulator overseeing this front-line regulator. So we
are taking a deep dive and looking very closely at how to
enhance this system. Frankly, we don't have the resources. I
mean, this is not just decades old for other reasons but we
don't have those resources.
Ms. Fudge. Right. If you had the resources, my point is,
does it work the way it is? Do you have the confidence in the
private regulator that you should have?
Mr. Gensler. We are doing everything to enhance it. We have
worked closely with the self-regulatory organizations that you
will hear from in the next panel to enhance it. I think in this
circumstances of Peregrine and as evidenced, it did not serve
the benefit of these people. But the reality is, this has been
here for decades. It is enshrined in statute.
Ms. Fudge. That is not my question.
Mr. Gensler. I know. I respect that the challenges of this
self-regulatory organization or Federal regulators is going to
be similar. My answer is, whether it is at a self-regulatory
organization or at the Federal regulator, we need to make sure
that we have windows directly into these accounts, that we have
enough enforcement and a culture of enforcement between them
and ourselves. I think it can work either way, by the way. I
think it is can work either way but this is what has been
enshrined for decades.
Ms. Fudge. Well, since you don't want to give me a direct
answer, we will go to the next question.
And this has been talked about, people have touched on it
today, but I mean, certainly we understand that the public
needs some real protection and some certainty. And people have
asked you about timelines. Could you please discuss the
timelines for completing the rulemaking under Dodd-Frank?
Mr. Gensler. We have been at this about 2 years and we have
just under 20 proposals that are out but haven't been
finalized. I think the bulk of them, not all of them, will be
finalized by December 31st. There are some we have chosen to
wait like the international margining regime to line up with
other regulators. The timeline beyond that is, we will still
continue to phase compliance well into 2013 in terms of
bringing people in because markets need time to adjust and to
lower the burden and let this come into place.
Ms. Fudge. Thank you very much, Mr. Chairman. I yield back.
The Chairman. The gentlelady yields back the balance of her
time. The chair now recognizes the gentleman who represents
most of the great State of Kansas, Mr. Huelskamp, for 5
minutes.
Mr. Huelskamp. Thank you, Mr. Chairman, and Chairman
Gensler, thank you for joining us here today. I would like to
direct some questions to the Peregrine incident. How many years
was wrongdoing occurring there based on information you have?
Mr. Gensler. I am sorry. This is Peregrine?
Mr. Huelskamp. Yes.
Mr. Gensler. We are still trying to develop the facts. His
note that he left when he attempted to take his life said that
it had been for quite some time, maybe up to 20 years, but we
do not have independently verifiable data to say that. In some
cases, banks and others only have records for 7 years. So it
may well be that we won't know the answer to that with
certainty, but his note says maybe up to 20 years.
Mr. Huelskamp. And during those 20 years, how many times
was that company audited or reviewed by your entity?
Mr. Gensler. It would have been audited by outside folks
every year and the NFA every 9 to 15 months. The CFTC, as I
laid out in the written testimony, conducted a number of
limited-scope reviews in the 1990s that led to an enforcement
action in 2000 where Peregrine had to bring others in--
PricewaterhouseCoopers. We also in 2007 and 2008 did some
limited-scope reviews on matters that are outlined and then one
more in 2010 on anti-money laundering. These limited-scope
reviews are not audits in the full sense of the word but we
look at papers and specific issues that have come to our
attention.
Mr. Huelskamp. Did you ever call the bank to verify the
account balances that apparently this CEO was falsifying and
submitting for your reviews?
Mr. Gensler. Though I am not aware of all the details in
all of these reports over the years that CFTC might have done,
the first-line auditors would have been the CPAs and the
National Futures Association, but I am not aware of any calls
to the bank, U.S. Bank or Harris Bank or the other banks, but
it may have occurred.
Mr. Huelskamp. And you mentioned PricewaterhouseCoopers.
Certainly they would have verified the account balances, would
they have not? I mean, you directed them as part of a finding
to find some outside help for this issue.
Mr. Gensler. Under the rules of the CFTC, written
enforceable rules, the yearly CPA has to use Generally Accepted
Auditing Standards, and as I understand it, those auditing
standards do require what you just said about the confirmations
of assets, custodial arrangements in banks.
Mr. Huelskamp. So if it was 20 years, if the suicide note
was apparently the basis for your charges and been occurring
for 20 years, then this outside entity that in 2000 actually
should have looked at those records as well?
Mr. Gensler. Again, there are a lot of facts we are going
to learn but I think that you are correct, sir, that outside
auditors and even in the audit routines of the National Futures
Association is to confirm key balances.
Mr. Huelskamp. On January 25th, Mr. Chairman, you have a
press release still on your website, CFTC Releases Results of
Limited Reviews of Futures Commission Merchants. That review
did include this firm in question?
Mr. Gensler. Yes, it was reviewed by the NFA as part of
that limited-scope review.
Mr. Huelskamp. And what was the role of the Commission in
the review?
Mr. Gensler. We looked at the top, I want to say 10 or 12
largest futures commission merchants and then the Chicago
Mercantile Exchange took the next group and then NFA took their
direct regulated entities.
Mr. Huelskamp. So the CFTC didn't review the entity in
question here, it was NFA?
Mr. Gensler. No. The last time we did a limited-scope
review was on anti-money laundering. It was maybe a year and a
half ago at Peregrine.
Mr. Huelskamp. Obviously, Mr. Chairman, with the $1.6
billion lost through MF Global and the uncertainty out there,
why would you put anything out to the public assuring them
that--and this was assurance to the marketplace and that is how
it was treated--if you hadn't done the work and again we are
relying on outside groups to determine the effectiveness of
your regulatory system?
Mr. Gensler. Sir, I will even go further. This was an
attempt to deceive the regulators and the public for what may
have been many years. The deception would have continued all
the way until July of this year throughout this period of late
last year, and I believe that we need to do more and we need to
do better, but this was an outright fraud, forged bank
statements, forged--so even this would have occurred in
November or December when the NFA took their limited review at
that point.
Mr. Huelskamp. And I appreciate that. Thank you, Mr.
Chairman. I find it troubling that we would put this type of
assurance out, screwed up in MF Global, screwed up on this
entity and then here we are telling the marketplace in January
and then find out later at the various time this assurance was
given that we had these problems still out there. I have
constituents that lost funds in both entities through a massive
failure, and so I appreciate the answers, Mr. Chairman. I look
forward to your further research. I yield back.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentleman from Connecticut, Mr. Courtney,
for 5 minutes.
Mr. Courtney. Thank you, Mr. Chairman, and first of all, I
just want to join my friend, Mr. Conaway, in complimenting the
work that CFTC did in the Barclays case. Again, just for the
record, the U.S. Treasury is collecting $160 million in fines
from Barclays as a result of that enforcement action. Isn't
that the----
Mr. Gensler. It is actually $360 million, because it would
be $200 million in our action and $160 million in the
Department of Justice.
Mr. Courtney. Great. So again, just sort of going back to
your point about resources and CFTC's total budget cost to the
taxpayer, again, the President's submission this year was for a
budget of about $300 million. Is that correct?
Mr. Gensler. That is correct.
Mr. Courtney. Obviously we don't want you to be in the
position of, to use another metaphor today, of a police officer
writing speeding tickets to pay for his budget, but the fact of
the matter is, is that having an adequately financed CFTC will
in fact result in benefit to the taxpayer through enforcement
actions that in some instances collect fines but also hopefully
regulate behavior that is going to be a benefit to consumers
and small businesses.
Mr. Gensler. I think we are a good investment to the
American public because markets will work better, end-users
will get a better deal in these sophisticated markets, and you
are right, occasionally there will be large enforcement fines
but we have to knock on every door that the Chairman said we
have to knock on.
Mr. Courtney. And to follow up on Mr. Huelskamp's
questions, I mean, the fact is, is that the situation at
Peregrine, in my opinion, really demonstrates the weaknesses
that existed pre-Dodd-Frank in terms of your ability to detect
outright cases of fraud and deception. One of the rules that
you have just promulgated, which is in your testimony, is that
you are actually beefing up CFTC's ability to crack down on
actual cases of deception by having whistleblower authority,
which obviously didn't exist years ago when the Peregrine
situation was unfolding. We can never know whether or not that
would have flushed it out, but the fact is, is that when there
are these outright cases of deception, having these more robust
authorities through Dodd-Frank is actually going to help detect
actual cases of fraud and deceit. Isn't that correct?
Mr. Gensler. I think that is correct. You have also
enhanced the anti-manipulation rules. We now have gone to a
recklessness standard from intent-based. It would be easier to
pursue cases around benchmark interest rates like LIBOR, so you
have enhanced a lot.
Mr. Courtney. And again, one of the other metaphors that
you heard from my friend, Mr. Southerland, was that an ounce of
prevention is worth a pound of cure. I mean, in fact, that is
exactly what CFTC is doing by again sort of creating a new
regulatory structure which you described in your opening
comments so that we don't again end up in situations like 2008
or MF Global, etc. I mean, that is exactly what you are trying
to accomplish, isn't it, with the regulations?
Mr. Gensler. That is true, but I would say we are never
going to repeal human nature. We bring about 100 enforcement
cases a year. We have Ponzi cases and we will be having Ponzi
cases for decades to come, unfortunately. This Peregrine
situation while technically not a Ponzi case has all of the
sort of indicia of a similar fraud where somebody has deceived
their customer base and stolen.
Mr. Courtney. Right. And last, in terms of the Dodd-Frank
position limits regulations which I usually ask you about every
time you visit us, again, we are now sort of moving towards
actually a launch date. Isn't that correct, in terms of the
position limit rules going into effect?
Mr. Gensler. That is correct. Two months after this joint
definition of the word swap is in the Federal Register, swap-
month positions limits will be effective for 28 commodities for
swaps and futures, so sometime in October most likely.
Mr. Courtney. Well, I just want to say, Mr. Chairman, for
the record, that there are a lot of small businesses,
particularly people who are end-users in the energy sector,
certainly in my state, who are looking forward to that date
with great anticipation and happiness. Hopefully this measure
which is moving forward in the House this week to freeze all
regulations in its track, a chainsaw throughout the whole
government, won't move forward because even though the stated
purpose of that bill is to protect small businesses, the fact
of the matter is, it is the end-users who rely on the futures
market for energy who would be hurt by freezing that regulation
from going into effect.
And with that, I would yield back, Mr. Chairman.
The Chairman. The gentleman yields back. The chair now
recognizes the gentlelady from Ohio, Mrs. Schmidt, for 5
minutes.
Mrs. Schmidt. Thank you. Thank you very much.
Mr. Chairman, I believe your core mission is oversight and
enforcement and yet since you have been Chairman, two of the
largest failures in future brokers have occurred under your
watch, and listening to your testimony today, I mean, you told
the gentleman from Colorado that you should be held
accountable. That was your words. You told the gentleman from
Florida that now you are going to be looking at electronic
transactions to make sure that what is said to be put in a bank
should be put in a bank. And I am a little confused because it
was under your watch that these systems failed and shouldn't
you have been doing that all along? I believe the buck stops
with you. We can continue to put out more regulations but if
you are not being the watchdog, then the systems are going to
continue to be hurt. So I am just asking you, how did this
occur under your watch?
Mr. Gensler. The CFTC is very vigilant, but as you may be
aware, the front-line regulation, the front-line examination
function of intermediaries in these markets is with the
National Futures Association or the Chicago Mercantile Exchange
or other self-regulatory organizations. That is enshrined in
statute. So we oversee the self-regulatory organizations. We
have done a great deal to enhance the investment of customer
funds and protections around that, sometimes even criticized
that we were doing things that weren't in Dodd-Frank like
saying we can no longer have what was called in-house
repurchase agreements, taking customer money and lending it to
others.
But this situation here shows that we need to change the
rules of how firms are audited and the direct electronic access
to these accounts. This was deception, this was fraud, and that
will occur from time to time, but I am agreeing with you that
we need to do all we can do to protect the customers.
Mrs. Schmidt. But you are relying on outside firms, the
NFA, your last limited-scope review, you used their findings,
and yet you look at certain things in the past that have
occurred that should have put up red flags. If you are the
watchdog, then maybe you should do your own internal
investigation a little more diligently. I am looking at a lot
of people who have lost money and this isn't the first time
that we have had this discussion in this room, and all I hear
is, we need more regulation, more rules, more authority. I am
not seeing you or your organization doing its core mission
right now, which is oversight and enforcement, and I am not
sure any more rules are going to allow you to do the job
better.
So I am asking you, doesn't the buck stop with you and
where is your leadership in this? I mean, are you spending so
much time in rules and regulations that you don't have time to
look at these audits and see if they are true and effective at
what they are stating?
Mr. Gensler. With all respect, we brought more enforcement
actions last year than any time in the history of this agency:
99. We have stepped up our enforcement of segregated accounts
where for 7 years there hadn't been a case and then under the
last 3 years----
Mrs. Schmidt. But you had two of the largest failures in
futures brokers under your watch.
Mr. Gensler. I understand.
Mrs. Schmidt. So regardless of everything else that you
did, the big boys you didn't look at.
Mr. Gensler. And we have restructured and hired new
leadership in our examination and our intermediary oversight
functions but yes, we need to do more. This Peregrine situation
was direct deception. We have done a great deal, but I am
agreeing with you----
Mrs. Schmidt. But you did limited-scope reviews. Shouldn't
you have done a little bit more? I mean, they had a red flag a
few years ago. Shouldn't you have continually watched them to
make sure that they were being good players in this and not
just using a little checkmark and moving on?
Mr. Gensler. With all due respect, with the funding we
have, we are so limited in resources. I have been in front of
this Committee over and over again so I am just going to say,
we relied for decades on self-regulatory organizations as a
front----
Mrs. Schmidt. You relied on somebody else instead of your--
I am sorry. I yield back.
The Chairman. The gentlelady yields back the balance of her
time. The chair now recognizes the gentleman from California,
Mr. Costa, for 5 minutes.
Mr. Costa. Thank you very much, Mr. Chairman.
I think the conversation that we have had here today really
revolves around a transition that is taking place post-Dodd-
Frank. I am one of those that believes that as we are going
through this transition, formulation of the rulemaking, the
timelines that you started to explain in some of the
questioning that progress has been made. You have been asked
the question in a number of different ways. I think you just
stated it in response to the last question. But do you really
believe you have enough resources at this point in time to
perform the role of risk assessment and risk management and
enforcement that is necessary as the Commission?
Mr. Gensler. No, we don't have enough to oversee the
futures market that has grown five-fold since the 1990s and we
are only ten percent larger than 20 years ago, and we don't
have enough to ensure that we can oversee the swaps marketplace
that is eight times larger.
Mr. Costa. What would you anticipate you would need in
terms of resources to address the question that was just asked
by the Congresswoman to provide the level of scrutiny and
enforcement necessary to avoid these kinds of frauds?
Mr. Gensler. With all due respect to the question, though
the President's budget is $308 million, which is about $100
million than we are currently funded at, Congress in statute in
2000 said we were to rely on self-regulatory organizations. If
we were to be the front-line regulator to actually do the
audits, that is not in the President's budget and it is not
what I am recommending here today. I mean, we have a self-
regulatory system. What we need to do is ensure that the CFTC
examines those self-regulatory functions better, that we do
what we do and what Congress has directed us to do better in
examining them and making sure that the system works for the
American public.
Mr. Costa. Do you anticipate being able to coordinate
resources with clearinghouses? You are talking about the
timelines in Japan, the timelines in Hong Kong, and the
timelines for implementation in Europe with those other
clearinghouses to try to provide a worldwide regulatory
framework.
Mr. Gensler. I think we are coordinating well but we have
different politics and different cultures so there will be
different timelines. In some countries, they might be
significantly later than us but I am encouraged by Europe and
Japan and Canada.
Mr. Costa. For your discussion of those timelines, could
you provide the Committee, because you talked about you are
almost at the rulemaking now, what you see the timelines out
for the next 2 years? Would that be possible?
Mr. Gensler. I am sorry. Did you say for the next----
Mr. Costa. Two years.
Mr. Gensler. Two years? I think we can provide something to
you in terms of the rules that are already finalized when there
are compliance dates and then second, when we----
Mr. Costa. Mr. Chairman, I would like that provided to the
Committee so that we can all have a better understanding of
that.
[The information referred to is located on p. 105.]
Mr. Costa. I want to understand the context that you made
this statement. I thought I heard you say earlier in response
to questioning that you would support letting the banks fail. I
suspect we are talking about including those banks that are too
large to fail?
Mr. Gensler. I think a corner grocery store in America can
fail, a farmer can fail. I mean, it is about risk and
innovation.
Mr. Costa. But you don't believe there is such concept of
too large to fail?
Mr. Gensler. I think that we are better if there is a
freedom to fail in our economy, and then----
Mr. Costa. So what is your definition of moral hazard?
Mr. Gensler. If the markets believe that an institution
will be backed by its government and that it is able to borrow
at lower rates, it distorts markets.
Mr. Costa. I have a local question, because my time is
running out here. Do you recall the discussion we had earlier
this year on several investor-owned utilities in California and
California's regulatory environment, concerns that I expressed
and some of my colleagues that the state's energy providers
could inadvertently be swept up in the swap-dealer definition?
We understand that you and the Commissioners have been working
on this, with the stakeholders to provide a clarity needed to
ensure that they and ultimately California ratepayers are not
penalized. Can you give me a quick update on where you are on
that?
Mr. Gensler. I think we did well in the swap and swap-
dealer definition. It may have also been some issues about the
environmental-rights contracts that we specifically addressed
in the swap definition. The last important piece of business is
that we have in front of us a petition from last month from the
municipal electric co-ops and the rural electric co-ops for an
exemption, and that document is in front of Commissioners and I
am hoping that we will put it out for a short comment period in
the next month or so.
Mr. Costa. If I might, Mr. Chairman, my time has run out,
but pertinent to this question, there is a timeline issue, the
next 60 days, I understand, to comply with the documentation on
that. Is there any flexibility in that 60 day timeline period?
Mr. Gensler. I am sorry. For----
Mr. Costa. To comply with information requests from real
swap dealers and major participants while they are trying to
implement their own compliance with the changes that you have
made for these public- and investment-owned utilities.
Mr. Gensler. Maybe we can follow up afterwards because I am
not sure I--the question about the municipal co-op and so
forth, we are going to be putting out hopefully very shortly to
get public comment. They are not swap dealers, from what I
understand, so I don't think they are going to----
Mr. Costa. No. Well, I don't believe they are either, but
as I understand it, in response to the earlier efforts that the
Commission provided to work out this distinction because we
don't believe they are swap dealers. But you have to comply in
the case of California with the state's regulatory regime that
they come in compliance, but they expressed to us that they had
a concern about the timeline that you had provided for them.
Mr. Gensler. I look forward to following up with your
office to better understand that.
Mr. Costa. Okay. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The chair
now turns to the gentleman from Pennsylvania, Mr. Thompson, for
5 minutes.
Mr. Thompson. Thank you, Chairman.
Chairman, thanks for being here and addressing these
important issues. I have just two questions for you, pretty
diverse questions, though, but both relate to the Dodd-Frank
rulemaking but goes from impact on individual farmers and then
also our market's access to other markets.
So let me start with the local one first with farmers. You
know, obviously many in rural America are concerned with the
CFTC's requirement that telephone conversations with farmers
about forward cash contracts need to be recorded and the
records kept for 5 years. It seems like regulatory overkill
really, at its finest. Can you give us any assistance--any
assurance--I am sorry--that this is not the Commission's
intention?
Mr. Gensler. It is not, but this was included in a
conforming rule where members of contract markets needed to
record their conversation, and we have gotten a lot of comments
and we are looking at how to dial that back in any final rule
so that it is really just about that member and what they are
doing directly on the exchange and so forth.
Mr. Thompson. Well, I appreciate you looking at that and I
appreciate your desire to stay with the original intention and
dialing back on that.
And then the opposite end, more about world market access.
Mr. Chairman, you have repeatedly assured the Committee that
CFTC has fully coordinated with international regulators but
then we read letters from foreign regulators threatening to ban
their country's firm from our marketing, and I have a copy of a
letter from a Swiss regulator, the Swiss Financial Market
Supervisor Authority, FINMA, and also in addition an op-ed in
the Financial Times written by your European counterpart that
seems to indicate that anything but coordination is happening.
If the CFTC was really coordinating with international
regulators, one would assume that they would not have to resort
to writing opinion editorials in the newspaper to get your
attention.
Now, because our financial reform was so far ahead of the
rest of the world, how can we at this point, how can you assure
this Committee that the markets of the United States are not
going to suffer due to the lack of international coordination,
especially since it appears most of the rest of the world is
playing catch-up.
Mr. Gensler. They have made very good progress. I had a
very good conversation with the author of the letter from
Switzerland yesterday, and Michel Barnier, who wrote the
opinion piece, and I have had a very good relationship and
continue to even though he expressed his views in an opinion
piece, as you say. What we are trying to ensure on the cross-
border side is that risks booked offshore don't come crashing
back to our taxpayers here. That is really what--and that is
the interpretation of direct and significant.
With regard to the Swiss situation, they have a situation
and France has something similar about secrecy laws. You are
probably familiar with Switzerland and the banking system and
so they have a set of issues as to how their banks can provide
risk transactions to somebody in your home state or in any
state in America and report that information to a data
repository. That is kind of the core issue that he and I were
talking about yesterday about their secrecy laws. It is not an
easy issue but it has to do with a number of countries,
particularly Switzerland and France.
Mr. Thompson. Thank you, Chairman.
Mr. Chairman, I yield back.
The Chairman. The gentleman yields back the balance of his
time. The chair with great enthusiasm now recognizes the
gentleman from Georgia.
Mr. David Scott of Georgia. Thank you, Mr. Chairman.
Mr. Chairman, let me ask you this. I certainly appreciate
your stated desire to increase capital efficiency through
portfolio margining, particularly in the credit default swaps
market, and certainly appreciate your work with Chairman
Schapiro and the SEC on an agreement in this area. It is my
understanding that some progress has been made but there are
some significant issues that remain. I am particularly
concerned that the lack of a regulatory solution will likely
prevent clearing among credit default swap customers and that
would occur if portfolio margining benefits were offered.
Now, your agency and the other agency staff has worked on
this for well over a year now. So Mr. Chairman, enough time
certainly has been spent to understand this issue, and what I
suspect is needed in this case for you and the other
Commissioners including Chairwoman Schapiro of the SEC is to
send a message that this issue needs to be resolved so that
broad-based clearing of credit default swaps will go forward as
Congress intended so that the taxpayers will be protected. Now,
can I get your commitment that you will provide this
leadership, Mr. Chairman?
Mr. Gensler. I support portfolio margining between
securities-based swaps, which are called single-name credit
default swaps, and broad-based credit default swap indices, and
there has been a petition in front of us with regard to that. I
am supportive. It has a challenge at the Securities and
Exchange Commission. It takes two sets of agencies to come
together. We have made great progress on other things, joint
rules, defining swaps and other things. This one, as you have
rightly noted, is not over the line yet but I am supportive of
portfolio margining.
Mr. David Scott of Georgia. So you have been at it for a
year now. I mean, the problem is that patience is wearing thin.
How much longer do we have to wait and why can't we--what is
the problem here? What is the holdup?
Mr. Gensler. The Securities and Exchange Commission
approach to this is different than the petitioner. The
petitioner is IntercontinentalExchange in front of our two
Commissions. They have a different approach to it, so it has to
be worked through between the SEC and the ICE on these matters
to see how to close that gap.
Mr. David Scott of Georgia. Can you give us an estimate of
about how much longer this would take?
Mr. Gensler. I don't know because I am sorry to say that
when it comes to portfolio margining and the markets, the
margining regimes for futures and securities are quite
different, and we could be very supportive at the CFTC but it
needs both agencies.
Mr. David Scott of Georgia. Let me ask you something else.
I am struggling to understand why we continue to support this
SRO model of regulation when we seem to have one large-scale
process failure after another, whether it is Madoff or Stanford
or MF Global or recently PFGBest, but my constituents, I tell
you, back in Georgia are screaming for change. Our farmers are
screaming for change. The people of America are sick and tired
of seeing their livelihoods put at risk by greedy malefactors
who are enabled by a system that seems to be little more than a
good old boy network. We have seen it time and time again. What
on Earth do you all say to them? What do you say to America
when it is situation after situation after situation?
Mr. Gensler. Well, I say the system in 2008 revealed it as
well. The financial system needs common-sense rules of the road
and we need to do more on customer protection. We have done a
lot. We have restructured. We have put in place new rules. We
have brought significantly more enforcement actions but even
this case at Peregrine highlights that we have to take a very
close look at the self-regulatory organizations and the CFTC,
be self-reflective and where we have to change, change
appropriately.
Mr. David Scott of Georgia. Well, is there any value left
in this self-regulatory organization model?
Mr. Gensler. Well, we have had it for decades and it served
the nation in many tough market environments, so what we are
focused on is how to improve it, not to uproot the whole thing
but to change it and enhance it.
Mr. David Scott of Georgia. Thank you, Mr. Chairman. I
yield back.
The Chairman. The gentleman's time has expired.
The chair now recognizes the gentleman from Iowa, Mr. King,
for 5 minutes.
Mr. King. Thank you, Mr. Chairman.
I thank you, Chairman Gensler, for your testimony today. I
spend part of my time over in the Judiciary Committee where we
get some of the Cabinet Members testifying, and they don't come
forward with the intent to try to inform the Committee as
openly as you do. I know we have disagreements but I do believe
your testimony has been directed at informing us with the best
answers you can deliver in a truthful fashion.
So I have a couple of things I would like to ask you to
clarify, and that is, I was only half listening when one of the
other Members of the Committee made a comment, and I just heard
your response that this was an outright fraud, and I wasn't
clear whether that was Peregrine or MF Global or Corzine or
Barclays, whom that might be. Could you clarify that for me,
please?
Mr. Gensler. I thank you for the compliment. I think I was
referencing Peregrine, but I would say on the LIBOR situation
and Barclays, they have settled and that was false reporting
under our Act, which some people would use the broader
circumstance in question. It is not right to lie about such an
important rate.
Mr. King. So I will write false reporting and lying. Is
that not also the definition of fraud?
Mr. Gensler. Because I am not a lawyer, I am just going to
be careful, but what we actually settled on is attempted
manipulation and false reporting, but for your constituents and
for my mom, I think they would see it about the same way as
lying.
Mr. King. I do agree with that, and again, as I listened to
your testimony, when you said we need to change the way these
firms are audited and have direct electronic access to these
accounts, hasn't history pretty much shown us that regulation
once it is established, the people that are intending to
circumvent it, whether it is deception, lying or outright
fraud, have found a way around regulation throughout history?
Mr. Gensler. I think human nature shows that, so we have to
stay abreast of it, and when we enhance this in the next few
months, there might be another fraudster in 2014 or 2017 that
will find another way to test the system.
Mr. King. I would think sometimes about the history of
warfare. When someone invents an offensive weapon, someone else
invents a defensive weapon. The sword and the shield or the
arrow and the shield would be an example, and now we have Star
Wars to defend us from missiles from other continents. So I
think that is an appropriate metaphor for what is going on here
is that we are trying to regulate and build shields against the
people that are engaging in or intending to engage in fraud in
our financial markets, and I would like to say that is what
these regulations are about.
But I would like to turn this a little bit and take this to
an understanding that we haven't been able to write regulations
that are successful, at least always successful, and the
creative people that are out there will find another way around
it. The free markets have done a pretty good job of protecting
the interest if they get a chance to see what those assets
actually are, and so would it be your opinion that the
restraint of markets without the promise of government bailout
is an effective shield?
Mr. Gensler. Well, I absolutely agree with the second part.
There should not be government bailouts. I do think that
common-sense rules of the road to bring transparency to markets
help our economic well-being, and I think that has helped in
the securities and futures markets, and that is what Congress
said to bring to these swaps markets.
Mr. King. Do you, though, get the sense that traders in the
marketplace, especially these traders that happen to be members
of the--I can see five farmers co-ops in my neighborhood that
suffered a loss of $47.5 million altogether to MF Global. They
get a sense that because government is regulating, that they
are protected in their investments. How much of a factor do you
think that is in the confidence in the marketplace that the
government is the regulator and the protector?
Mr. Gensler. Well, I think that farmers need to have
confidence to use these markets so they can lower their risk. I
mean, what is the price of corn going to be at harvest time and
they can use a futures contract to lower that risk, lock in it.
So that type of confidence is a good type of confidence. Is
there is an effective cop on the beat? But I agree with you not
to have the confidence that we are going to bail out banks or
ensure against poor corporate behavior.
Mr. King. So what we are really after here then is balanced
restraint that investors have to control their speculation
judging upon two things, and that is, how solid are the
financials of the entity they are dealing with and how
effective is the financial regulation that comes from the
government. That would be the two pieces of this that would
have to be kind of married together?
Mr. Gensler. Right, so that investors have the facts and
figures to make their investment choices, that they have
markets that function well, that they can hedge these risk in
these derivative contracts, and of course, that we don't stand
behind----
Mr. King. And you would like to have direct electronic
access to the accounts but you wouldn't propose that to the
investors to have that same access?
Mr. Gensler. I actually think investors should know in
these markets where their money is held, so just like they do
in a mutual-fund statement, I actually do think that they
should know where their money is.
Mr. King. Thank you very much, Chairman, I appreciate your
testimony, and I will submit some questions for the record.
The Chairman. The gentleman's time has expired. The chair
now recognizes the gentlelady from South Dakota, Mrs. Noem, for
5 minutes.
Mrs. Noem. Thank you, Mr. Chairman, and I appreciate this
hearing. It is timely given it is the second anniversary of the
Dodd-Frank and we need to look at these reforms and the related
rules and see how they impact people on the ground. For
example, in South Dakota, where I am from, some businesses and
producers who are actively investing in the commodity market
are still dealing with the failure of MF Global, so I just have
a couple questions for you.
Does the CFTC have the power to force a firm into
bankruptcy?
Mr. Gensler. We might need to get back to you, but I am not
aware of that. Even in this Peregrine situation, we went into
court to ask for a receiver to be appointed to freeze the
assets, which we do in Ponzi schemes as well. So I think that
is the route. I believe the answer is no but we seek a court to
appoint a receiver.
Mrs. Noem. Okay. That is the route that is generally
followed? Well, if there is more information on that that you
can give me later, I would appreciate that. That would be
great.
[The information referred to is located on p. 106.]
Mrs. Noem. What role does the CFTC play in initiating the
bankruptcy of such as like MF Global?
Mr. Gensler. A broker dealer--I am not involved in that
specific thing but a broker dealer goes into this proceeding
under the Securities and Investor Protection Act, and that is
under the securities law, so we don't have a direct role. But
then we do have a role in appearing in front of the court and
appearing in front of the trustee to ensure that the
commodities exchange laws are followed, that the segregated
funds are for the customers.
Mrs. Noem. So is that more of an informational-type role
that you fulfill with the courts. Are you summoned in a manner?
Mr. Gensler. Well, it is both an informational role and
also to advocate and file motions on behalf of those segregated
accounts, as I understand it.
Mrs. Noem. Excellent. Thank you. I appreciate that.
With that, Mr. Chairman, I will yield back.
The Chairman. The gentlelady yields back the balance of her
time. The chair now recognizes the gentleman from Indiana, Mr.
Stutzman.
Mr. Stutzman. Thank you, Mr. Chairman.
Thank you, Chairman Gensler, for being here. I would kind
of like to follow up on the gentlelady's questions regarding MF
Global. At what point did you alert your fellow Commissioners
of your recusal from the MF Global investigation?
Mr. Gensler. I informed the General Counsel on a Thursday,
so it may have been that Friday. We have a weekly surveillance
meeting on Friday. That goes back decades. And so the firm went
into bankruptcy on a Monday. The first surveillance meeting was
going to be that Friday, so I did not attend that surveillance
meeting and informed various Commissioners. One, Commissioner
Sommers, was on vacation but the other Commissioners----
Mr. Stutzman. So you did notify them?
Mr. Gensler. I believe it was that Friday.
Mr. Stutzman. How did you notify them? By electronic----
Mr. Gensler. If I remember, I had personal conversations
with three of them and then General Counsel Berkovitz reached
out to Commissioner Sommers, who was in Florida with her
family.
Mr. Stutzman. Okay. So your recusal, is that consistent
with CFTC's process in recusals?
Mr. Gensler. Well, the General Counsel and the ethics
officers actually advised me that I did not under the laws need
to step aside. I thought it was best not to participate. Jon
Corzine, who had been the Chief Executive Officer there, had
been way back when I was at Goldman Sachs a partner of mine and
ultimately my boss at Goldman Sachs. So, I handed this off to
the dedicated enforcement staff and other enforcement officers
and the Commission, and not participate in this matter as it
turns on an enforcement matter that might involve, personally,
Jon Corzine.
Mr. Stutzman. So help me understand, when did you first
hear there was a loss in customer segregated accounts?
Mr. Gensler. About 2:30 a.m. Monday morning.
Mr. Stutzman. And then did you have any conversations with
Mr. Corzine during the final week of October?
Mr. Gensler. No, no personal conversations, no business
conversations. There was a group conference call that Sunday
when the CFTC, the SEC and regulators from London and the New
York Federal Reserve were on a big conference call with the
company and its advisors about moving the customers' funds. At
that point Sunday, it was about moving the customer funds to
some fund called Interactive Brokers, and I believe Mr. Corzine
spoke up in that call that might have had 20 or 40 people on
it.
Mr. Stutzman. That was on Sunday?
Mr. Gensler. Sunday, October 30th.
Mr. Stutzman. And so you were notified at 2:30 a.m. Monday
morning?
Mr. Gensler. Yes, Monday morning. I was woken up.
Mr. Stutzman. So during those conversations, or during that
conversation, was there any discussion of the customer accounts
and segregation of funds brought up?
Mr. Gensler. In the regulators call, what we were focused
on was moving those customer accounts to Interactive Brokers.
We had laid out by that Sunday evening a number of conditions
about that. Interactive Brokers agreed to those conditions and
MF Global as well that they would be fully guaranteed and all
the monies and positions would be moved to Interactive. Of
course, then at 2:30 I was woken up.
Mr. Stutzman. September 1, 2011, MF Global announces in a
public filing that it would comply with FINRA's determination
and increase its capital. Would such a filing trigger any red
flags at CFTC?
Mr. Gensler. As I am not participating, I don't know what
the Commissioners or the agency looked at about that September
1st filing. But just as a general matter, our examination staff
will work with the self-regulatory organizations like FINRA and
Chicago Mercantile Exchange and NFA on any filings about
capital and try to understand what those filings are.
Mr. Stutzman. So did that happen? Did your agency work with
FINRA at all?
Mr. Gensler. Again, I don't know because I haven't gone
back and done the forensics. I haven't been involved since this
whatever, November 2nd or 3rd period of time.
Mr. Stutzman. Is that something you could find out and
notify----
Mr. Gensler. Our General Counsel, Dan Berkovitz, will
follow up with you.
[The information referred to is located on p. 107.]
Mr. Stutzman. Thank you, Mr. Chairman. I will yield back.
The Chairman. The gentleman yields back. The chair
recognizes the gentleman from Iowa for a follow-up question.
Mr. Boswell. Well, thank you. I am the temporary Ranking
Member, I guess.
Mr. Chairman, earlier on in questions, I didn't give you a
chance to answer because I got into a dialogue with Chairman
Lucas, and I agree with his points. At the same time, we have
responsibility that even though we are not appropriators, we
have the tools or the doorknockers or whatever you want to call
it. The idea that I threw out about the funding, would you have
any comment you would want to make about that? I think you told
Mr. Costa earlier that you did not have the resources, and so
just expand on that and then we will be finished.
Mr. Gensler. We don't have enough resources to cover the
futures industry that has grown so significantly from the
1990s, or this new market that I would say is far more complex,
this swaps marketplace that is eight times the size of the
futures marketplace in notional value. It has at least twice as
many actors on that stage.
We would work with Congress in any way Congress would wish
to get funding whether it is direct appropriations, whether it
is also working on fees or transaction fees similar to what
the----
Mr. Boswell. The point of it is that this constant
evaluation of the appropriations or coming from the
Administration or whatever but if you had this fee system, it
would kind of go with the ebb and flow of your need. It seems
to be working for SEC. It seems to be working for NFA. That is
one of the points. I want to know what you think about it.
Mr. Gensler. I think that in the securities field, there
has been a modest transaction fee to cover the cost to the SEC
on an annual basis. I think President Obama has included that
in his budget submissions. I believe previous Presidents,
President Bush also did as well. So we would work with
Congress. If you and the appropriators thought that was
appropriate, we would be right at it with you, but if there are
other ways to get the funding, I am kind of neutral on the way
to do it but I am positive that we need more funding.
Mr. Boswell. But you clearly don't have the resources you
need?
Mr. Gensler. That is correct, sir.
Mr. Boswell. Okay. I yield back. Thank you, Mr. Chairman.
Mr. Conaway [presiding.] I thank the gentleman for
yielding.
Chairman, one real quick follow-up. Section 722(d) is the
section you cite that gives you the authority to do the
guidance on the extraterritorial or cross-border; 722(c), we
think gives the SEC similar authority. What is y'all's
understanding or can you help us understand your interpretation
of those two different sections?
Mr. Gensler. Section 722(c) would be in the swaps section
of the statute. It may well that you want to follow up with----
Mr. Conaway. Okay, if you wouldn't mind getting back with
us on that because----
Mr. Gensler. Because I understood that it is all in the
first part of that Title VII is swaps, which is the CFTC, and
then of course the other section later in the chapter is there
but 722(c), Dan? Maybe we will have to----
Mr. Conaway. All right. We will follow up with you on that
if you wouldn't mind.
[The information referred to is located on p. 108.]
Mr. Gensler. No, I appreciate that, and thank you.
Mr. Conaway. Mr. Chairman, thank you for being here today.
I appreciate your straightforward answers and look forward to
visiting with you again soon.
Mr. Gensler. Thank you very much.
Mr. Conaway. All right. If we can have the other panel step
forward, we will get this one moving.
All right. While everybody is settling in, I will go ahead
and introduce the witnesses. We have with us today Mr. Terry
Duffy, Executive Chairman and President of CME Group, Chicago,
Illinois; Mr. Dan Roth, President and Chief Executive Officer
of the National Futures Association, Chicago; the Hon. Walt
Lukken, President and CEO of Futures Industry Association here
in D.C.; John Heck, Senior VP with The Scoular Company, Omaha,
Nebraska, on behalf of the National Grain and Feed Association;
and the Hon. Chuck Connor, President and Chief Executive
Officer of the National Council of Farmer Cooperatives,
Washington, D.C., and Mr. Paul McElroy, CFO of the JEA,
Jacksonville, Florida, on behalf of the American Public Power
Association.
Mr. Duffy, begin when you are ready, sir.

STATEMENT OF HON. TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN AND
PRESIDENT, CME GROUP, INC., CHICAGO, IL

Mr. Duffy. Thank you, Mr. Chairman and Mr. Boswell.
We at the CME Group are appalled by PFG's theft of customer
segregated funds. This fraud following MF Global has shaken the
very core of our industry. Any breach of trust related to
customer funds is absolutely unacceptable, whether at PFG, MFG
or any other firm.
Since the failure of MF Global, CME Group and others in our
industry have committed to strengthening the protections that
guard customer property. The industry has recently implemented
new regulatory measures, one of which was a new electronic
confirm tool that uncovered Mr. Wasendorf's misreporting,
forgery and theft, but more needs to be done.
CME and the National Futures Association have adopted four
measures to deter, detect and prevent misuse of customer funds.
Three have been implemented. The fourth will be made effective
in coordination with the NFA next month. We have been
conducting surprise reviews of customer segregated accounts
since last December. We have implemented mandatory daily
reporting of segregated statements by all FCMs and now we
require bimonthly reporting to ensure that segregated funds are
properly invested and held at approved depositories. Also in
mid-July, CME began using Confirmation.com, an electronic
method of receiving statements directly from third-party
depositories to verify investment reports. We also began using
Confirmation.com as a tool in our regulatory audits and plan to
require banks to confirm segregated funds using this tool.
In direct response to the MF Global disaster, we will be
implementing the Corzine rule on September 1st. The new rule
requires that FCMs' CEO or CFO sign off on any withdrawals of
customer segregated funds that exceeds 25 percent of excess
segregated funds. Then they must also inform CME at the same
time.
As I have said, more can be done. At the same time, CME
believes that regulators and industry must be careful in
weighing the costs and benefits of all proposals that may
enhance protection for the segregated funds of our clients.
Some have suggested the creation of an industry-funded
insurance program covering fraud and failure losses, possibly
supplemented by privately-arranged insurance. Such a fund would
certainly boost confidence but needs to be balanced against
known negatives. The negatives are the obvious: it being cost-
prohibitive and ineffective due to the amount of funds held in
U.S. segregation. We need to develop procedures and systems
that give regulators direct real-time access to customer
segregated account balances, and we are working with regulators
to do so. And while it may be controversial and perhaps have
disruptive consequences, we should explore whether customer
property not required as collateral at clearinghouses should
nonetheless be held by clearinghouses or other custodians and
whether safeguards should be into place to limit the ability of
FCMs to transfer such property except to authorized recipients.
In addition, CME Group proposes that Congress amend the
Bankruptcy Code to permit clearinghouses that hold sufficient
collateral to support customer positions of a failed clearing
member to transfer those positions of all non-defaulting
customers with the supporting collateral to another stable
clearing member.
While we expect that the misconduct of MF Global and PFG
will renew calls for the elimination of the role of exchanges
and clearinghouses in auditing and enforcement of their
members, we do not believe that a legitimate case can be made
to transfer these responsibilities to a government agency. CME
Group is committed to working with the Congress, CFTC, NFA,
FIA, and the market participants to reevaluate the current
system to find solutions to further protect customer funds at
the FCM level. We are also committed to restoring confidence in
the markets that so many rely on for their risk management
needs.
I thank you for the opportunity to testify before the
Committee and I look forward to answering your questions.
[The prepared statement of Mr. Duffy follows:]

Prepared Statement of Hon. Terrence A. Duffy, Executive Chairman and
President, CME Group, Inc., Chicago, IL

Chairman Lucas, Ranking Member Peterson, Members of the Committee,
thank you for the opportunity to testify regarding the industry's
efforts to deter, detect and prevent the misuse of customer funds. We,
at CME Group, are appalled by the theft by Mr. Wasendorf of Peregrine
Financial Group (``PFG'') of customer segregated funds. This fraud,
following MF Global Inc. (``MFG''), has shaken the very core of our
industry.
Any breach of trust relating to customer funds is absolutely
unacceptable, period--whether at PFG or MFG, or any firm. Since the
failure of MFG, CME Group and others in our industry have been
committed to strengthening the protections that guard customer
property. The industry has recently implemented new regulatory
measures, one of which was the new electronic confirm tool that
uncovered Mr. Wasendorf's misreporting, forgery and theft. But more
needs to be done.
In addition to the pressing issues raised by these recent
deplorable actions, the Committee is examining at this hearing issues
relating to the ongoing regulatory implementation of Dodd-Frank which I
will also address at the end of my written testimony. Our concerns
regarding the implementation of the statute center on ensuring that the
rules do not needlessly hamper the strength, competitiveness and
efficiency of the U.S. derivatives markets.

Industry Proposals to Protect Customers in the wake of MFG's Failure
On March 12th, a special committee composed of representatives from
the futures industry's regulatory organizations, including CME (the
``SRO Committee''), offered four recommendations to strengthen current
safeguards for customer segregated funds held at the firm level. The
first three have been implemented, and the fourth will be made
effective in coordination with the National Futures Association
(``NFA'') in September:

Requiring all Futures Commission Merchants (FCM) to file
daily segregation reports.

Requiring all FCMs to file bi-monthly Segregation Investment
Detail Reports (``SIDR''), reflecting how customer segregated
funds are invested and where those funds are held.\1\
---------------------------------------------------------------------------
\1\ Daily segregation reporting and bimonthly SIDRs were also
recommended by the Futures Industry Association in its proposed initial
recommendations made on February 29th. http://www.futuresindustry.org/
downloads/Initial_Recommendations_for_Customer_
Funds_Protection.pdf.

Performing more frequent periodic spot checks to monitor FCM
---------------------------------------------------------------------------
compliance with segregation requirements since last December.

In direct response to the MFG collapse, the ``Corzine Rule''
will be implemented on September 1st. The ``Corzine Rule''
requires the CEO or CFO of the FCM to pre-approve in writing
any disbursement of customer segregated funds not made for the
benefit of customers and that exceeds 25% of the firm's excess
segregated funds. The CME (or other SROs) must be immediately
notified of the pre-approval.

In addition, to enhance intra-regulator coordination, we have
established routine communications with FINRA for all of our common
firms--the firm coordinators/relationship managers will reach out to
each other to have these communications.
The SRO Committee has also implemented, or is in the process of
implementing, the following initiatives:

Using Confirmation.com--an electronic method of receiving
account statements or balances from a third party bank or
depository to check information provided by FCMs to regulators.
NFA's use of Confirmation.com uncovered the initial statement
and reporting irregularities at PFG.

The SRO Committee plans to use the Confirmation.com tool as
follows:

In regulatory audits now and going forward;

To verify bi-monthly SIDRs (investment reports). CME
started using the tool for this purposed in mid-July; and

To periodically review the accuracy of daily
segregation statements.

Also, the SRO Committee agreed to develop rules to require
all FCMs to provide them with direct online access to their
bank or depository accounts to confirm segregated funds
balances.

The Futures Industry Association's internal controls
recommendations will be presented to the FCM Advisory Committee in
August. These include:

Requiring FCMs to assure the appropriate separation of
duties among individuals working at FCMs who are responsible
for compliance with the rules protecting customer funds;

Requiring FCMs to document their policies and procedures in
several critical areas, including the valuation of securities
held in segregated accounts, the selection of banks, custodians
and other depositories for customer funds, and the maintenance
and withdrawal of ``residual interest,'' which consists of the
excess funds deposited by firms in the customer segregated
accounts.

NFA's Website Access to FCM capital ratios and investment reports
(SIDRs) will be presented to the NFA's Board of Directors in August.

CME Group Initiatives
Notwithstanding the fact that MFG's misconduct was the cause of the
shortfall in customer segregated funds, CME Group's efforts in the wake
of these events speak to the level of our commitment to ensuring our
customers' confidence in our markets:

Guarantee for SIPC Trustee. We made an unprecedented
guarantee of $550 million to the SIPC Trustee in order to
accelerate the distribution of funds to customers.

CME Trust Pledge. CME Trust pledged virtually all of its
capital--$50 million--to cover CME Group customer losses due to
MFG's misuse of customer funds.

CME Group Family Farmer and Rancher Protection Fund. On
April 2, 2012, CME Group launched the CME Group Family Farmer
and Rancher Protection Fund to protect family farmers, family
ranchers and their cooperatives against losses of up to $25,000
per participant in the event of shortfalls in segregated funds.
Farming and ranching cooperatives also will be eligible for up
to $100,000 per cooperative.

The Protection Fund is available to PFG customers that qualify
under Program terms.

Agreement with MFG Trustee. On June 14, 2012, the agreement
between the SIPC Trustee for MFG and CME Group was filed in the
Bankruptcy Court. It provides for the distribution of
approximately $130 million of MFG proprietary assets, on which
CME and its members held perfected security interests, to MFG
customers. The agreement is currently under review by the
Bankruptcy Court.

Bankruptcy Code. The shortfall in customer segregated funds
occurred only in regard to funds under MFG's control. The
customers' funds held in segregation at the clearing level at
CME and other U.S. clearinghouses were intact. However, the
clearinghouses were not able to avoid market disruptions by
immediately transferring those customer positions and any
related collateral because of limitations under the Bankruptcy
Code. We propose that Congress amend the Bankruptcy Code to
permit clearinghouses that hold sufficient collateral to
support customer positions of a failed clearing member promptly
to transfer all customer positions with supporting collateral,
except defaulting customer positions, to another stable
clearing member.

More Can Be Done
However, CME Group believes that more can be done, especially in
light of the recent fraud at PFG and its impact on public confidence.
CME believes that the regulators and industry need to carefully weigh
the costs and benefits of even the most far-reaching proposals that
might enhance protection for the segregated funds of our customers.
Some have suggested creating an industry-funded insurance program
covering fraud and failure losses, possibly supplemented by privately
arranged insurance. Such a program would certainly boost confidence but
needs to be balanced against known negatives. It is likely to be cost
prohibitive and ineffective given the size and scope of the accounts in
our business, and may encourage the ``moral hazard risk'' that comes
into play when customers feel they don't need to worry about their
choice or stability of their FCMs.
We need to develop procedures and systems that give regulators
direct, real time access to customer segregated account balances, and,
as stated above, the SRO Committee is working to do so.
And, while it will be controversial and perhaps have disruptive
consequences, we should explore whether customer property not required
as collateral at clearing houses should, nonetheless be held by
clearing houses or other custodians (while returning interest earned on
that money back to the FCMs) and whether safeguards should be put in
place to limit the ability of FCMs to transfer such property except to
authorized recipients. We believe a look at these proposals in
conjunction with our other efforts is necessary to restore public
confidence in the derivatives markets while preserving the operating
model for the vast majority of firms who respect and comply with the
rules.
Finally, while we expect that the misconduct of MFG and PFG will
renew calls to eliminate the role of exchanges and clearing houses in
auditing and enforcement of their members, we do not believe that a
legitimate case can be made to transfer these responsibilities to a
government agency. Our regulatory systems are resilient, adaptive to
address the challenges and efficient. The next section of my testimony
focuses on why it is more important than ever to not only retain, but
strengthen the self-regulatory structure.

Current Regulatory Structure Should Not Be Abandoned
Some critics suggest that the current regulatory framework is
somehow to blame for MFG's and PFG's misconduct. As further detailed in
the discussion below, ``self-regulation'' in the context of futures
markets regulation is a misnomer, because the regulatory structure of
the modern U.S. futures industry is in fact a comprehensive network of
regulatory organizations that work together to ensure the effective
regulation of all industry participants.
The CEA establishes the Federal statutory framework that regulates
the trading and clearing of futures and futures options in the United
States, and following the recent passage of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, its scope has been expanded to
include the over-the-counter swaps market as well. The CEA is
administered by the CFTC, which establishes regulations governing the
conduct and responsibilities of market participants, exchanges and
clearing houses.
With respect to MF Global, CME was the designated self-regulatory
organization (``DSRO''). As MFG's DSRO, CME was responsible for
conducting periodic audits of MFG's FCM-arm and worked with the other
regulatory bodies of which the firm is a member. Some critics have
suggested that the failure of MFG demonstrates that the current system
of front line auditing and regulation by clearing houses and exchanges
is deficient because of conflicts of interest. However, there is no
conflict of interest between the CME Group's duties as a DRSO and its
duties to its shareholders--both require that it diligently keep its
markets fair and open by vigorously regulating all market participants.
Federal law mandates an organizational structure that eliminates
conflicts of interest. In addition, we have very compelling incentives
to ensure that our regulatory programs operate effectively. We have
established a robust set of safeguards designed to ensure these
functions operate free from conflicts of interest or inappropriate
influence. The CFTC conducts its own surveillance of the markets and
market participants and actively enforces compliance with the CEA and
Commission regulations. In addition to the CFTC's oversight of the
markets, exchanges separately establish and enforce rules governing the
activity of all market participants in their markets. Further, the NFA,
the registered futures association for the industry, establishes rules
and has regulatory authority with respect to every firm and individual
who conducts futures trading business with public customers. The CFTC,
in turn, oversees the effectiveness of the exchanges, clearing houses
and the NFA in fulfilling their respective regulatory responsibilities.
In summary, the futures industry is a very highly-regulated
industry with several layers of oversight. The industry's current
regulatory structure is not that of a single entity governed by its
members regulating its members, but rather a structure in which
exchanges, most of which are public companies, regulate the activity of
all participants in their markets--members as well as non-members--
complemented with further oversight by the NFA and CFTC.
CME Group is committed to working with Congress, CFTC, NFA, FIA and
market participants to re-evaluate the current system to find solutions
to further protect customer funds at the FCM level, and to restoring
confidence in derivatives markets. Finding solutions continues to be or
highest priority. We are prepared to lead.

Dodd-Frank
Turning to Dodd-Frank, as the CFTC and other regulators finalize
the rules implementing the statute, CME Group continues to work with
the CFTC to ensure that these rules promote the fundamental principles
of Dodd-Frank without compromising the growth and strength of the
robust and globally competitive U.S. derivatives markets. For example,
statutory Core Principle 9 was written by Congress to apply flexibly,
allowing all DCMs to develop their means to achieve a ``competitive,
open and efficient market and mechanism'' for trading. The CFTC's
current rule proposal to implement Core Principle 9 would impose a
rigid rule that will require an arbitrary percentage of transactions
(now set at 85%) to take place on the central order book of an exchange
regardless of the underlying products, the market characteristics or
the bona fide needs of customers. At the CFTC's recent roundtable on
this proposal, every market participant opposed the rule as proposed
and expressed strong concerns about the proposal's implications. The
rule would make it impossible for U.S. futures exchanges to develop new
products, force futures exchanges to delist hundreds of successful
products, and force trading into unregulated, less regulated or foreign
markets with less transparency. Moreover, the proposal would
exponentially increase the trading costs, market risk and adverse
regulatory and tax consequences for market users, which costs
ultimately will be reflected in commodity prices. We urge the
Commission to consider this consensus assessment, and avoid adopting
any rule under Core Principle 9 that would have the adverse effects
stated above.
With respect to the reporting of cleared swaps data, the Commission
should allow for implementation of a clearing regime that permits
clearing houses to choose the Swap Data Repository to which it must
report, including their own affiliated SDR. Doing this will make it
possible for SDRs to be up and running for cleared swaps almost
immediately, which would be in the greatest interest of not only the
regulators seeking to implement the statute, but also the marketplace
seeking the most efficient and cost-effective mechanism with which to
comply. The CFTC-adopted regulatory reporting regime does not
appropriately utilize the existing infrastructure available in
derivatives clearing organizations (``DCOs'') as far as cleared trades
are concerned. Any system that requires a DCO that clears a swap trade
to make reports to an external non-DCO data warehouse is inefficient,
costly and unnecessary. A much better approach is to build reporting
requirements that ensure that the DCO that clears a swap trade houses
the complete set of non-public swap information. This is the lowest
cost and least burdensome method for implementing regulatory reporting
requirements and it can be implemented quickly. It is also the best way
to ensure regulators have access to the most accurate swap information
including the ability to view the true positions of market
participants.
Thank you for the opportunity to testify before the Committee today
and for the Committee's continued strong oversight of the
implementation of this seminal statute.

Mr. Conaway. Thank you, Mr. Duffy.
Mr. Roth, 5 minutes.

STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION, CHICAGO, IL

Mr. Roth. Thank you, Congressmen. My name is Dan Roth and I
am the President of National Futures Association. As has been
noted earlier, this is the second time in 9 months that we are
involved with a fraud involving an FCM's misuse of customer
segregated funds.
In the Peregrine case, it has resulted in a shortfall of
customer segregated funds of approximately $200 million. This
fraud was achieved through a sea of forged documents. Peregrine
was required to report daily to NFA on the amount of customer
funds that it was holding and where those funds were being
held. Those reports were false and they were supported by
forged daily bank activity statements, forged monthly
statements, forged acknowledgment letters, forged deposit
slips, forged cashier's checks and forged bank confirmations.
We began our most recent exam of Peregrine in mid-June.
When we began that examination, we informed the firm that we
were switching the way that we had done bank confirmations,
that we were switching to what Terry referred to as the
Confirmation.com. We were switching to a web-based e-
confirmation process. In the past, we had used a traditional
bank confirmation process in which the firm would sign an
authorization to the bank authorizing the bank to release
information to NFA. We would then take that signed document
from the firm and mail it directly to the bank, and the bank
would then mail a response to NFA and then we would compare the
bank's numbers to the numbers that had been provided by the
firm.
As part of the e-confirmation process that we switched to,
we told the firm that they would authorize the firm's
participation in that process. Mr. Wasendorf Sr. executed the
necessary authorization on Sunday, July 8th, and the next day
attempted suicide. We were immediately contacted by the firm,
by Peregrine. They contacted both NFA and the CFTC, and we had
conference calls immediately. As of the previous Friday, the
firm had reported to us that it was holding approximately $380
million in customer segregated funds with a little over \1/2\
of that being held at U.S. Bank, the Cedar Falls branch office
of U.S. Bank.
During the teleconferences on Monday, we had the branch
manager of the bank on the phone, and he told us that the
actual balance in the account as of Friday was approximately $5
million. We also then reviewed with him--we told him that we
had signed bank confirmations from our two previous audits in
front of us and we went over with him the balances for each of
those two dates. We told him the balances that had been
reflected on the dates for which we had written confirmations,
and he confirmed for us that those confirmations were false.
It is clear, after both MF Global and Peregrine, certain
facts are abundantly clear to all of us. Number 1, customers
have to know that their money is safe. Number two, it is up to
the regulators to provide the highest level of assurance that
we can that their money is safe, and that is both government
regulators and self-regulators. Number three, NFA followed
standard audit steps and audit procedures in conducting our
exams of Peregrine, and number four, that doesn't matter. The
fact is, the Generally Accepted Audit Standards, the standard
practices, weren't good enough. They didn't catch this fraud.
We didn't uncover the fraud for longer than we would have
liked. We have to do better.
We began the process of trying to find ways to do better
immediately after MF Global. We formed two committees. We
formed an SRO committee and we formed a special committee of
our public directors, and both of those committees worked on a
package of rules that Mr. Duffy referred to that were presented
to our board of directors in May and that are described in my
written testimony. But we also began working on the second wave
of rules because we recognize that we had to make better use of
technology to monitor our members' compliance with the rules.
So we have a rule that has been in development and that is
going to our August board meeting that will require all FCMs to
provide direct online access, view-only access to their DSRO of
all customer seg bank balances. With that authority, we will be
able to check bank confirms or basically conduct bank confirms,
check those balances on our own without the firm, without the
bank. We can do it for any FCM and for any bank account that we
want to.
But we want to go beyond that. What we are actually going
to try to build is a system which will take the e-confirmation
process that uncovered this fraud and basically make that a
daily event. We intend to build a system in which all seg
depositories will report on a daily basis to NFA on the funds
that they are holding and then on an automated basis will do a
comparison between that and what the firms are reporting to us
and generate alerts for any suspicious discrepancies.
Mr. Chairman, it is another obvious point, I guess, that we
will never be able to completely eliminate fraud but we have to
strive for that. That is what we strive for. That is what we
are working on. That is what we have been working on all along
but with renewed effort after MF Global. We will continue that
process. We look forward to working with the Commission, the
industry, the Congress and hopefully together we can continue
to try to make things harder and harder so that these frauds do
not occur in the future.
Thank you, Mr. Chairman. I would be happy to answer any
questions.
[The prepared statement of Mr. Roth follows:]

Prepared Statement of Daniel J. Roth, President and Chief Executive
Officer, National Futures Association, Chicago, IL

Thank you, Mr. Chairman. My name is Daniel Roth and I am the
President of National Futures Association. For years the futures
industry has built an impeccable reputation for safeguarding customer
funds deposited at FCMs in connection with futures trading. Now, for
the second time in just 9 months, we are dealing with a shortfall in
customer segregated funds at an FCM. Once again, customers have
suffered real harm, the type of harm that all regulators attempt to
prevent.
The full facts are not yet known, but it appears that Peregrine's
customer losses are the result of an elaborate fraud achieved through a
set of forgeries and falsities rooted in both the firm's external and
internal financial records. Forged external records included bank
statements, bank confirmations, print-outs of daily online summary
reports of bank balances, cashier's checks, bank acknowledgement
letters, bank deposit tickets and bank receipts all purportedly from
U.S. Bank. The firm's internal financial records, including daily and
month-end account reconciliations, general ledgers and trial balances
were also false to the extent they were based on forged U.S. Bank
records. Moreover, Peregrine submitted to NFA false daily segregation
reports, monthly financial statements and segregated investment detail
reports, and annual certified financial statements. Even the firm's
customer statements were false to the extent the firm led customers to
believe that sufficient assets were on deposit to cover customers'
liabilities.
I would like to review for this Committee the recent chronology of
events surrounding the Peregrine fraud, the fundamental changes that
need to be made in the way we protect customer funds and monitor firms
for compliance with the rules, how we are going to make those changes
and the steps we have already taken.
NFA began an examination of Peregrine in mid-June. During the
audit, we informed Peregrine staff that NFA was changing its method for
obtaining bank confirmations to a web-based e-confirmation process. We
had completed the necessary data entry for this process by the first
week in July, and told Peregrine staff that the firm must authorize its
participation in the e-confirmation process. On Sunday, July 8, Mr.
Wasendorf, the Chairman of Peregrine, provided the required
authorization that was sent to him a week earlier. The next day he
attempted suicide.
As of the close of business on July 6th, the previous Friday,
Peregrine had reported to us that the firm was holding approximately
$380 million in customer segregated funds, with just over \1/2\ of that
amount on deposit at U.S. Bank. On July 9th, Peregrine notified the
CFTC and NFA of Wasendorf's attempted suicide and we immediately joined
in a teleconference with Peregrine staff. We directed firm personnel to
go to the bank and have the bank manager join the conference call to
confirm the balances as of the previous Friday. The bank manager
informed us that the actual balance in the account was approximately $5
million.
We then asked about the balances on the dates for which NFA had
received written bank confirmations in our two most recent audits--in
2010 and 2011. Those bank confirmation requests had been mailed by NFA
to the P.O. Box on the purported bank acknowledgment letter we had
received for the customer segregated account. (In our experience, it is
not at all uncommon for banks holding customer segregated funds to use
P.O. Boxes to receive confirmation requests since it is a means for
them to control the vast amount of paperwork they receive.) In this
case, the bank manager informed us that the balances reflected on the
two most recent confirmations received by NFA in 2010 and 2011 were
similarly inflated.
NFA immediately issued an emergency Member Responsibility Action,
freezing the firm's accounts and restricting it to trading for
liquidation only. That night the firm's clearing FCM issued margin
calls that were not met and began liquidating open positions. The next
day the CFTC filed its injunctive action and the firm filed its
bankruptcy petition. By then approximately 98% of customer futures
positions had been liquidated.
This is certainly not the first time that NFA has taken emergency
action in a fraud case involving forgery. We issue eight to ten Member
Responsibility Actions per year, most after detecting some form of
fraud, many of them Ponzi schemes. In most cases we uncover the fraud
relatively quickly and close the firm before the losses mount too high.
In a few cases, though, we have uncovered major frauds involving well
over $100 million. Several of our cases, both large and small, have
involved forged bank documents that were identified by our staff. What
sets this case apart is that it involves a registered FCM, an
elaborate, pervasive and convincing level of forgeries, and worst of
all the loss of segregated customer funds.
This most recent case is an extremely painful reminder of the
lessons we learned, and have acted on, after MF Global. The following
points are clear:

For our markets to thrive, customers must know that their
funds are safe.

It is the job of the regulators, both government regulators
and SROs, to provide the public with the highest level of
assurance possible.

NFA followed audit steps developed by the Joint Audit
Committee that were consistent with CFTC Financial and
Segregation Interpretation No. 4-1 in all of our examinations
of Peregrine. But to assure ourselves of that, a committee of
our public directors has directed the commission of an internal
review of our audit practices and procedures, and the execution
of those procedures in the specific instance of Peregrine.

Notwithstanding that, and notwithstanding it was NFA's
actions that uncovered this fraud in our most recent exam, the
simple fact is that Wasendorf's forgeries fooled us, and fooled
us for longer than any of us would like.

Our audit steps alone are not good enough anymore. We are
implementing better ways to monitor members for compliance,
especially with regard to customer segregated funds, and are
looking for even more ways to improve monitoring of firms for
compliance with the rules.

Shortly after the demise of MF Global, we formed an SRO Committee
with the CME and representatives of other exchanges, including ICE, the
Kansas City Board of Trade and the Minneapolis Grain Exchange. As
discussed below, the SRO Committee developed a number of rule proposals
that have already been approved by our Board. Early on in its
deliberations, the committee recognized that we need to make better use
of technology to monitor firms for compliance with segregation
requirements.
The committee has developed a proposed rule that will be presented
at NFA's August Board meeting that would require FCMs to provide
online, view-only access to bank balances for customer segregated and
secured amount accounts to the firm's designated SRO. We understand the
CME will adopt the same rule. Under this rule, SROs will be able to
check any customer segregated bank account balance for any FCM any
time, without asking the firm or the bank, and compare those balances
to the firm's daily segregation report. NFA intends to expand this
approach, once it is implemented, to receive daily reports from all
depositories for customer segregated accounts, including clearing FCMs.
We will develop a program to compare these balances with those reported
by the firms in their daily segregation reports. While there may be
reconciling items due to pending additions and withdrawals, the system
will generate an immediate alert for any material discrepancies.
We have also agreed with the CME to perform an immediate
confirmation of all customer segregated bank accounts for all of our
FCM Members using the e-confirmation process I referred to earlier. The
completion of this work within the next week or so should help ensure
that another Peregrine is not lurking in the industry.
All of this is in addition to the rule changes already approved by
NFA's Board in May and just recently approved by the CFTC. Those
changes include rules requiring that:

All FCMs must report certain information concerning the
FCM's financial condition that will then be made available to
the public on NFA's website. This information includes the
firm's capital requirements; its excess capital; the amount of
customer segregated funds held by the firm; the amount of
excess segregated funds maintained by the firm; whether the
firm engages in proprietary trading, once that term is defined
in the context of the Volcker rule; and whether any custodial
bank holding customer funds is an affiliate of the FCM.

All FCMs must report to NFA detailed information on how
customer segregated funds are invested, and that information
will also be made available to the public through NFA's
website.

If any FCM reduces its level of excess segregated funds by
25% in any one day by making disbursements that are not for the
benefit of customers, a financial principal of the firm must
approve the disbursement, must immediately notify the firm's
DSRO, and must certify that the firm remains in compliance with
all segregation requirements.

All of these rule changes promote greater transparency for both
customers and regulators and should help prevent a recurrence of the
type of problems we saw at MF Global. These rule changes, however, are
only the beginning. The MF Global and Peregrine customer losses are a
painful reminder that we must continuously improve our surveillance,
audit and fraud detection techniques to keep pace with changing
technology and an ever-more-complicated financial marketplace.
Mr. Chairman, for so long as there have been financial markets,
there has been fraudsters who attempt to steal other people's money,
and no regulator can provide assurance that fraud can be completely
eliminated. But this is the second time in 9 months that customers have
suffered losses due to misconduct or fraud on the part of an FCM, and
when customers suffer those devastating losses, it is also devastating
for the industry. We know that we can never completely eliminate fraud,
but we must continue to adopt rules and surveillance techniques to try
to eliminate the possibility that this could happen again. The steps we
took at our May Board meeting and the proposed steps outlined above are
a start in that process. We look forward to working with Congress, the
Commission and the industry to achieve that goal and no ideas should be
off the table in this process.

Mr. Conaway. Thank you, Mr. Roth.
Mr. Lukken for 5 minutes.

STATEMENT OF HON. WALTER L. LUKKEN, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, FUTURES INDUSTRY
ASSOCIATION, WASHINGTON, D.C.

Mr. Lukken. Thank you, Chairman Conaway and Members of the
Committee. I testify today on behalf of the Futures Industry
Association, the leading U.S. trade association for futures,
options and cleared derivatives in the United States.
We now know that over $200 million in customer funds is
missing from Peregrine Financial and that the fraud appears to
date back 20 years. On the heels of the MF Global collapse,
this is appalling and absolutely devastating news in our
industry, and most of all, customers who are the victims of
this egregious fraud.
In the futures industry, we took considerable pride in the
knowledge that the regulated futures markets had come through
the financial crisis of 2008 with relatively few problems.
During those difficult weeks, the futures markets continued to
operate without significant incident to manage the volatile
risks stemming from the financial crisis and to discover
transparent prices when confidence was lost in the over-the-
counter markets.
Today we can no longer say the futures markets came through
these times unblemished. The failures of MF Global and
Peregrine Financial are a stark reminder that diligent efforts
by regulators and the firms themselves are essential to prevent
losses to customers from mismanagement and fraud.
The industry and regulators have already taken a number of
important steps in the wake of the MF Global collapse. In
February, FIA released its initial recommendation for customer
funds protection calling on each FCM to adopt certain
recommended internal control policies and procedures relating
to the protection of customer funds. It is my understanding
that the CFTC and the SROs have adopted or are actively
considering adopting all of these suggestions. FIA has also
taken efforts to educate customers. In February, we issued FAQs
for customer fund protections which is being used by the FCMs
to provide their customers with increased disclosure on how
customer funds are secured.
However, the recent events involving Peregrine make it
evident that more must be done. In this respect, I would like
to discuss the FIA's transparency initiative that I announced
last week. First, FIA strongly supports providing regulators
with the independent ability to electronically review and
confirm customer segregated balances across every FCM at any
time, period.
Second, FIA supports the creation of an automated
confirmation process for segregated funds that will provide
regulators with the timely information that customer funds are
secure. Technology solutions can help prevent this type of
event from occurring again.
Third, FIA supports the creation of an FCM informational
portal that will centrally house firm-specific financial and
related information regarding FCMs so customers can more
readily access material information when evaluating an FCM.
Fourth, FIA recommends that FCMs publicly certify as soon
as practicable that they are in compliance with the initial
recommendations for customer funds protections that FIA issued
in February and that I referred to earlier.
I was encouraged by Chairman Gensler's remarks that the
Commission will be supporting and adopting many of these
sensible industry recommendations. The blocking and tackling of
regulation depends on ensuring that firms have proper internal
risk controls in place and that these are independently
reviewed and verified. Those basics of smart regulation have
not changed over time, and we look forward to working with the
Commission to prioritize initiatives aimed at protecting
customers.
Turning now to Dodd-Frank, FIA has been an active
participant in the rulemaking process undertaken by the
Commission over the last 2 years filing over 50 comment letters
during that time. Having run a derivatives clearinghouse, I
understand the difficulty in complex system builds, and Dodd-
Frank indeed is that. The key to any major project
implementation is prioritization and sequencing. The industry
would greatly benefit from the Commission prioritizing the
critical rules that must be in place and developing a
sequencing of those critical rules to bring certainty of
planning to many of our firms. In fact, the SEC has done just
that with the publishing of its Implementation Policy Statement
aimed at avoiding, ``the disruption and costs that could result
if compliance with all rules where required simultaneously or
haphazardly.''
Unless the Commission acts to establish a well-designed
implementation policy, a significant number of rules will come
into effect in the next few months in a haphazard manner,
imposing a substantial burden on the market participants and
exposing the industry to potential market disruption. These
challenging times have also been compounded by the Commission's
decision to move forward concurrently with significant rule
proposals that are not mandated by Dodd-Frank such as Core
Principal 9 on centralized trading and the redesign of the
ownership and control reports at a cost of $18.8 million per
firm in the industry.
Of the Dodd-Frank rules that are critical, and there are
many, one of the most important is the recent publication of
proposed Commission guidance on the cross-border application of
certain swap provisions. This guidance is not a rule under the
APA and therefore does not require the Commission to conduct a
cost-benefit analysis. It is evident, however, that its cost
may be considerable, given the guidance's broad interpretation
of the definition of U.S. person and, ``activities that would
be deemed to have a direct and significant connection with
commerce in the United States.'' The result would be a complex
and confusing regulatory regime that would expose U.S. FCMs and
swap dealers to consider regulatory risk and would extend the
CFTC's reach to many jurisdictions around the world. On this
theme of prioritization and sequencing, it would be imperative
that the CFTC first clarify this guidance before the swap
regulations and other Dodd-Frank requirements go into effect.
These are challenging times for our industry, not only due
to the regulatory changes described above but also due to the
fundamental shift to the business model. With depressed futures
volumes, historically low interest rates and ultracompetitive
pricing models, FCMs are under tremendous strain financially.
Many are concerned that the business is reaching a point where
it cannot absorb additional costs and a seismic shift in the
model may occur--whether that is a significant consolidation of
FCMs or FCMs leaving the business altogether. This would have
an unfortunate effect of limiting customer choice and reducing
the number of firms that backstop the clearing system, making
it vulnerable to catastrophic losses.
So in conclusion, as we consider these regulatory changes,
it would be wise to carefully weigh the costs of any new
regulatory mandates and concentrate our resources on
implementing only the highest priority reforms ahead of all the
rest.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Lukken follows:]

Prepared Statement of Hon. Walter L. Lukken, President and Chief
Executive Officer, Futures Industry Association, Washington, D.C.

Chairman Lucas, Ranking Member Peterson, and Members of the
Committee, FIA is the leading trade organization for the futures,
options and over-the-counter cleared derivatives markets. Our
membership includes the world's largest derivatives clearing firms as
well as leading derivatives exchanges and clearinghouses from more than
20 countries. Our core constituency consists of futures commission
merchants (FCMs), those regulated businesses that transact and
guarantee the futures trades of customers and end-users. All of our
membership is working overtime to implement the many reforms in the
Dodd-Frank Wall Street Reform and Consumer Protection Act. Significant
progress has been made in finalizing these reforms and I will address
the rulemaking process later in my remarks. First, however, I would
like to focus my remarks on the recent failure of Peregrine Financial
Group (PFG).
We now know that more than $200 million in customer funds is
missing and that the falsification of financial records appears to go
back 20 years. On the heels of the MF Global collapse, this is
appalling and absolutely devastating news for everyone in our industry,
and most of all the customers who are victims of this egregious fraud.
PFG was not a big firm, but its demise resonates throughout the
industry.
In the futures industry, we took considerable pride in the
knowledge that the regulated futures markets had come through the
financial crisis of 2008 with relatively few problems. During those
difficult weeks, the futures markets continued to operate without
significant incident to manage the volatile risk stemming from the
financial crisis and to discover transparent prices when confidence was
lost in the pricing of the over-the-counter markets. The regulated
futures markets, and the regulatory regime that underpins them, became
the foundation of mandated swap clearing of Title VII of the Dodd-Frank
Act.
We can no longer say that the futures markets came through these
times unblemished. The failures of MF Global and Peregrine Financial
Group are a stark and unwelcome reminder that, no matter how well
designed a regulatory structure may be, diligent and sustained efforts
by regulators and the firms they regulate are essential to prevent
losses to customers from mismanagement or fraud.
In addition to the losses suffered by Peregrine's customers, the
most damaging consequence of Peregrine's fraud is the effect on
customer confidence, in particular in the sanctity of customer funds
protections provided under the Commodity Exchange Act (Act) and the
Commission's rules. This confidence was earned over decades by the many
individuals that comprise the regulated futures industry.
Unfortunately, one person's conduct has instantaneously shattered this
trust and now overshadows the hard work and honorable behavior of
everyone else.
At FIA, we understand that it is going to take time to regain
public trust and we are committed to doing whatever it takes to restore
confidence in the safeguards for customer funds. Doing nothing is not
an option.
We also recognize that this is a collective problem, calling for
collective solutions. Firms, exchanges, end-users and regulators must
work together to identify the additional tools that are needed to
protect customer funds and restore confidence and then implement them
promptly and efficiently.

Post-MF Global Reforms
The industry and regulators have already taken a number of
important steps in the wake of the MF Global collapse to strengthen the
customer protection regime in the futures markets. In February, FIA
released its Initial Recommendations for Customer Funds Protection.
These recommendations called on each FCM to adopt and document--to the
extent not already in place--internal control policies and procedures
relating to the protection of customer funds. In particular, FIA
recommended that FCMs maintain appropriate separation of duties among
individuals responsible for compliance with customer funds protections
and develop a training program for chief financial officers and other
relevant employees to help ensure that the individuals responsible for
the protection of customer funds are appropriately qualified.
We also recommended and supported rules adopted by the Chicago
Mercantile Exchange and National Futures Association that subject all
FCMs to enhanced record-keeping and reporting obligations, including:
(i) transmitting daily customer segregation balances to their
respective designated self-regulatory organization (DSRO); and (ii)
requiring the chief financial officer or other appropriate senior
officer to authorize in writing and promptly notify the FCM's DSRO
whenever an FCM seeks to withdraw more than 25 percent of its excess
funds from the customer segregated account in any day. These changes
have now been approved by the Commission.
Another of our recommendations calls on the Commission to require
that each FCM certify annually that there are no material inadequacies
in its internal controls regarding maintenance and calculation of
adjusted net capital and compliance with the rules regarding the
protection of customer funds. FIA encourages the Commission to adopt
this recommendation as part of its package of audit improvements.
Clearly, these recommendations for strengthening internal controls
are relevant to both MF Global and Peregrine Financial. We have
witnessed over the years a number of instances where lax auditing
controls or a lack of separation of duties related to the movement and
protection of customer money have led to wrongful activity and fraud.
The adoption of these basic audit and internal control recommendations
will go a long way to detect and deter inappropriate behavior, going
forward.
FIA also has taken efforts to educate customers on the scope of the
protections for their funds so they can make well-informed decisions
when choosing where to do business. In February, we issued Frequently
Asked Questions on Customer Funds Protections, which is being used by
FCMs to provide their customers with increased disclosure on the scope
of how the laws and regulations protect customers in the futures
markets. This document continues to be updated as we gather comments
from regulators on other areas that should be covered. In addition, we
will be expanding this document to ensure that customers have material
information when evaluating an FCM.

FIA's Transparency Initiative
Even with all that has been done, the recent events involving
Peregrine Financial make it evident that more must be done. In this
respect, I would like to discuss the ``Transparency Initiative'' that I
announced last week.
First, FIA strongly supports providing regulators with the
independent ability to electronically review and confirm customer
segregated balances across every FCM at any time.
Second, FIA supports the creation of an automated confirmation
process for segregated funds that will provide regulators with timely
information that customer funds are secure. Technology solutions can
help prevent this type of event from occurring again.
Third, FIA supports the creation of an ``FCM Information Portal''
that will centrally house firm-specific financial and related
information regarding FCMs so customers can more readily access
material information when evaluating an FCM. FIA's board is actively
considering ways to construct and populate such a system.
Fourth, FIA recommends that FCMs publicly certify as soon as
practicable that they are in compliance with the Initial
Recommendations for Customer Funds Protection that FIA issued in
February, specifically that they have adopted and implemented the
internal control policies and procedures related to the protection of
customer funds. These controls should be subject to independent review
and oversight by the SROs and independent auditors.
I was encouraged by Chairman Gensler's remarks before the Senate
Agriculture Committee last week that the Commission will be supporting
and adopting many of these sensible industry recommendations. The
``blocking and tackling'' fundamentals of regulation depend on ensuring
that firms have proper internal risk controls in place and that these
are independently reviewed and verified. Those basics of smart
regulation have not changed over time, and we look forward to working
with the Commission to prioritize initiatives aimed at protecting
customers.

Dodd-Frank Rulemaking
Turning now to Title VII of the Dodd-Frank Act, FIA broadly
supports the regulatory goals set out therein, which are designed to
implement the G20 commitment that:

All standardised OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate,
and cleared through central counterparties by end 2012 at the
latest. OTC derivative contracts should be reported to trade
repositories.

As with the regulated futures markets, centralized trading and
clearing of swaps will reduce financial and operational risks of all
market participants and bring necessary transparency to this critical
segment of our financial system.
FIA has been an active participant in the rulemaking process
undertaken by the Commission over the past 2 years, filing more than 50
comment letters and taking part in several Commission staff
roundtables. We have also met numerous times with the Commissioners and
Commission staff on various issues, which meetings have been reported
on the Commission's website.
Our comments have generally been supportive of the regulatory
goals, while (i) seeking clarification of the obligations that would be
imposed under certain provisions, (ii) noting the operational burdens
in complying with others, (iii) raising cost-benefit issues where
appropriate, and (iv) recommending alternatives that would achieve the
Commission's regulatory goals more effectively and efficiently. Our aim
is smarter regulation, not necessarily less regulation.
I should emphasize that our concerns are not limited to swap-
related rulemakings. Although the primary focus of Title VII is the
over-the-counter swaps markets, the Commission's rules also require
FCMs to restructure significantly the way in which they have been
conducting their regulated futures businesses for decades and, in the
process, to undertake substantial changes to their record-keeping and
reporting systems. Several such rules, discussed below, have posed a
significant challenge to both FCMs and the Commission.
Large Trader Reports. In July 2011, the Commission published rules
requiring large trader reports for swaps and swaptions on physical
commodities, which became effective on September 20, 2011. The rules
raised a number of questions for which the industry sought guidance
from the Commission staff. However, it was not until December 2011 that
the staff was able to issue a Guidebook that provided additional
guidance and detailed instructions for submitting large swaps trader
reports to the Commission. In May 2012, the staff issued a revised
Guidebook. Because of broad uncertainty surrounding compliance in this
area, the Commission staff has found it necessary to issue temporary
relief from the large trader reporting requirements five times.
Position Limits and the Aggregation of Positions. The Commission's
rules establishing position limits for 28 exempt and physical
commodities generally require that, unless a particular exemption
applies, a person must aggregate all positions for which that person
controls the trading decisions with all the positions for which that
person has a ten percent or greater ownership interest in an account or
position, even if the person does not control trading in the other
accounts. In May, in response to a petition from the Working Group of
Commercial Energy Firms and the Commercial Energy Working Group
(Working Groups), the Commission proposed to amend its policy requiring
the aggregation of positions. As proposed to be amended, the
aggregation policy would permit persons with an ownership that does not
exceed 50 percent to file for disaggregation relief, if they can
demonstrate independence by meeting Commission-established criteria.
In support of their petition, the Working Groups argued, among
other things, that the rules would force information sharing and the
coordination of trading between entities that would be contrary to
existing best practices for antitrust compliance. Moreover, entities
with complex corporate structure arrangements that include established
information barriers to ensure compliance with other regulatory
requirements would face significant costs to monitor positions on an
intra-day basis, notwithstanding the current lack of control over such
trading.
FIA supported the Working Groups' petition and is pleased that the
Commission has proposed to amend its aggregation policy. Nonetheless,
we believe the proposed amendment does not go far enough. The
Commission should permit disaggregation without regard to ownership
interest when entities can demonstrate separate management and control
of trading and positions.
Such a policy is consistent with section 4a of the Act, which calls
for aggregation of positions that are subject, directly or indirectly,
to common control. Section 4a does not require aggregation of positions
arising from common ownership. Such a policy would also recognize
commercial reality in an economy in which companies have passive
ownership interests in scores, if not hundreds, of companies. Without
coordinated trading, there is no increased risk of excessive
speculation or manipulation.
A decision on the proposed amendment to the Commission's
aggregation policy is only one of several issues on which the industry
requires guidance before it can develop the systems necessary to
implement the Commission's position limit rules. Other critical open
issues include: (i) the scope and logistics of grandfathering existing
futures and swaps positions; (ii) the scope of grandfathered risk
management positions; (iii) the scope of bona fide hedging
transactions; and (iv) the unavailability of technology necessary to
monitor for compliance with position limits intra-day. To date,
however, the Commission has not provided a forum for working through
these issues, leaving the industry struggling with how it is to comply
with this rule.
Legally Separate Operationally Commingled (LSOC) Rules. More
recently, the industry has been meeting with representatives of the
several derivatives clearing organizations (DCOs) that clear swaps to
discuss the operational issues that arise in implementing the
Commission's rules for providing protection for cleared swaps customer
collateral.
On their face, these rules, commonly referred to as the LSOC rules,
appear relatively straightforward and FIA has supported the adoption of
this new framework. Each day, clearing member FCMs must provide to the
DCOs at which customer positions are carried information regarding (i)
the identity of the customers whose positions make up the omnibus
account, (ii) the positions carried on behalf of each customer, and
(iii) the value of the margin posted with the DCO that supports each
customer's portfolio of positions. Nonetheless, a number of very
difficult operational questions have arisen that will take time to
resolve. Until they are, there is not enough certainty or consensus on
certain fundamental issues to permit FCMs and DCOs to build the systems
necessary to implement the LSOC rules, which are scheduled to go into
effect in November.
Core Principle 9. Certain pending rules also threaten to have a
significant impact on the conduct of regulated futures activities. One
such rule is the proposed rule implementing Core Principle 9. This
principle requires a designated contract market (DCM) to provide ``a
competitive, open, and efficient market and mechanism for executing
transactions that protects the price discovery process of trading in
the centralized market.'' To implement this principle, the Commission
has proposed to prohibit a DCM from continuing to list a futures
contract unless at least 85 percent of the volume in such contract is
traded through the DCM's centralized order book. If a futures contract
no longer met the 85 percent test, the DCM would be required to de-list
the contract and either liquidate the open positions or transfer the
positions to a swap execution facility.
This simple renaming of the instrument from a future to a swap
would have dramatic effects, including substantially increasing the
amount of initial margin required by the DCO to open the position and
changing the tax treatment of the contract for non-hedge positions.
Consequently, as we noted in our comment letter on the proposed rule,
adoption of the proposed rule would result in significant legal and
regulatory uncertainty and would have the curious effect of placing the
regulated futures markets at a competitive disadvantage to the cleared
swaps markets. In particular, start-up exchanges and new product
offerings would find it difficult to meet this litmus test, thus
lessening competition and innovation in the industry. Again, this
rulemaking was not mandated by Dodd-Frank and its primary aim is the
futures markets, not the swaps market where the financial crisis
largely stemmed.
Cross-Border Guidance. More recently, the Commission has published
for comment what it has termed interpretative guidance on the cross-
border application of certain swaps provisions of the Commodity
Exchange Act. The interpretative guidance is not a ``rule'' under the
Administrative Procedure Act and, therefore, does not require the
Commission to conduct a cost-benefit analysis before adopting it as
final. Although we are still studying its terms, it is evident that the
Commission has proposed to adopt a broad interpretation of the
definition of a ``U.S. person'' and of the activities that would be
deemed to have ``a direct and significant connection with activities
in, or effect on, commerce of the United States.'' The result would be
a complex and confusing regulatory scheme that would expose U.S. FCMs
and swap dealers to considerable regulatory risk and would effectively
extend the CFTC's reach into many jurisdictions around the world. It is
imperative that the CFTC clarify this guidance before the registration
and other Dodd-Frank requirements go into effect so that firms
understand and can plan for the scope of Dodd-Frank's impact on their
global businesses.
Implementation Timetable. In light of this complex and legally
uncertain regulatory environment, we believe it is essential that the
Commission follow the lead of the Securities and Exchange Commission
(SEC), which developed and recently published for comment an
implementation policy statement. As Robert Cook, the Director of the
SEC's Division of Trading and Markets, explained in testimony last
week, the policy statement sets out the order in which the SEC expects
to require compliance by market participants with the final rules to be
adopted under Title VII, with the goal of avoiding ``the disruption and
cost that could result if compliance with all rules were required
simultaneously or haphazardly.''
The implementation policy statement divides the final rules to be
adopted by the SEC into five broad categories and describes the
interconnectedness of the compliance dates of the final rules within
each category, and where applicable, the impact of compliance dates of
final rules within one category upon those of another category. The
statement emphasizes that those subject to the new regulatory
requirements arising from these rules will be given adequate, but not
excessive, time to come into compliance with them.
This is not a new idea. CFTC Commissioners have urged the
Commission to adopt a similar policy statement, as have numerous market
participants and trade associations, including FIA. However, time is
running out. Unless the Commission acts promptly to establish a well-
designed implementation policy, a substantial number of substantive
rules will come into effect in the next few months in a haphazard
manner, imposing a substantial burden on the industry and exposing the
industry to significant risk of enforcement proceedings. In this latter
regard, in order to assure that market participants acting in good
faith to comply with these rules are not unnecessarily exposed to the
threat of enforcement action, it is essential that the Commission
provide all market participants with ``adequate, but not excessive,
time to come into compliance'' with these rules.
I want to point out that the challenges that the industry is facing
in implementing the Dodd-Frank Act have been exacerbated by the
Commission's decision to move forward concurrently with significant
rule proposals that are unrelated to the Dodd-Frank Act. I have already
mentioned the Core Principle 9 rulemaking, which was not a mandated
rule by Dodd-Frank. Another such proposal is the Commission's proposal
to require DCMs and other reporting entities to file ownership and
control reports (OCR) to the Commission on a weekly basis. As
originally proposed, the OCR rules would have required FCMs to collect
and report a substantial amount of information that either is not
collected in the manner the Commission anticipated or is not collected
at all. As a result, the proposed rules would have required a complete
redesign of the procedures, processes and systems pursuant to which
FCMs create and maintain records with respect to their customers and
customer transactions.
To prepare our comment letter on the proposed OCR rules, FIA formed
an OCR Working Group to analyze their potential impact. We found that
the median firm would face total costs of roughly $18.8 million and
ongoing costs of $2.6 million annually. These costs, combined with the
unwarranted structural change in the conduct of business among U.S.
futures markets participants that the proposed rules would require,
could force a number of FCMs to withdraw from the business and raise
the barrier to entry for potential new registrants.
In its comment letter, FIA presented an alternative OCR proposal
that we believe would achieve the essential regulatory purposes of the
Commission's proposed rules. The cost of the alternative OCR was
considerably less than the estimated cost of implementing the OCR
rules, but they are substantial nonetheless. FIA and the DCMs continued
talking with Commission staff following the comment period. The
Commission recently proposed a revised OCR structure that we understand
is closer to the alternative that the industry recommended. We look
forward to analyzing the proposal.
We must emphasize that the FIA alternative was not developed within
the 60 day comment period originally proposed by the Commission. It
took several months of detailed analysis by industry representatives
who otherwise perform critical operational and risk management
responsibilities in their firms. We also want to emphasize that the OCR
rule exemplifies a broader problem; the firms are being overwhelmed
with the volume and complexity of the record-keeping and reporting
programs they are being asked to implement in a very short time frame.
Another rulemaking not directly mandated by Dodd-Frank is the
Commission's recent adoption of rule 1.73 requiring clearing member
FCMs to establish risk-based credit limits for all customers and
implement procedures to screen all orders for compliance with these
limits prior to execution. In particular, an FCM would be required to
screen by automated means all orders received or executed by automated
means. However, no systems currently employed by, or available to,
clearing member FCMs, or the DCMs on which the trade may be executed,
permit a trade to be screened prior to execution for its potential
effect on the customer's existing portfolio of positions. Risk
management systems are designed to monitor a customer's risk on a post-
execution/post-cleared basis. Moreover, the rule appears to require
significant changes in the operational and contractual relationships
among clearing member FCMs, executing brokers and investment managers
as well as substantial systems changes.
FIA is requesting the Commission staff to clarify the intended
scope of the rule, and we are hopeful that the staff will approve an
interpretation of the rule that will be technologically practicable,
while meeting the Commission's regulatory goals.
Conclusion. These are challenging and difficult times for our
industry, not only due to the regulatory changes described above but
also due to fundamental shifts in the business model that underlies the
futures industry. With depressed futures volumes, historically low
interest rates, and an ultra-competitive pricing model, FCMs are under
tremendous strain financially. Many are concerned that the business is
reaching a point where it cannot absorb additional costs without a
seismic shift in the model--whether that is significant consolidation
among FCMs or FCMs leaving the business altogether. This would have the
unfortunate effect of limiting customer choice and reducing the number
of firms that backstop the clearing system, making it more vulnerable
to catastrophic losses. So as we consider regulatory changes, it would
be wise to carefully weigh the costs of any new regulatory mandates and
concentrate our resources on implementing the highest priority reforms
ahead of all the rest.
As discussed above, the industry is working against a short
deadline while faced with considerable uncertainty about how the
Commission plans to implement a wide swathe of its rules and how those
rules will fit in a global regulatory structure. As we move forward, it
is essential that the unintended consequences of any reforms be
eliminated and the many positives that this industry has delivered to
the customers of our markets be preserved.
Thank you and I will be happy to answer any questions.

Mr. Conaway. Mr. Lukken, thank you.
Mr. Heck for 5 minutes.

STATEMENT OF JOHN M. HECK, SENIOR VICE PRESIDENT, BUSINESS
DEVELOPMENT, THE SCOULAR COMPANY;
MEMBER, EXECUTIVE COMMITTEE AND BOARD OF
DIRECTORS, NATIONAL GRAIN AND FEED ASSOCIATION, OMAHA, NE

Mr. Heck. Thank you, Mr. Chairman and Members of the
Committee. I am John Heck, Senior Vice President of the Scoular
Company. I appear today testifying on behalf of the National
Grain and Feed Association. We appreciate the opportunity to
appear before the Committee today.
I serve as Co-Chairman of the NFGA's MF Global Task Force,
which was formed to develop responses and recommendations in
response to the failure of MF Global. Many NGFA member firms
have been deeply affected by the liquidation of MF Global.
Customer accounts were frozen, then transferred to other FCMs
in chaotic fashion and with a dearth of information to
customers so they could possibly manage their financial
exposure. These customer funds were required to be segregated
and held safe by MF Global. We believed for years that
segregated customer funds were completely safe but now we see
that was not the case. The unprecedented loss of customer funds
has led to a loss of confidence in futures markets.
Our task force asked the question: was MF Global a one-time
situation or is the level of customer risk still significant?
Unfortunately, we know today that serious risk still is
present. The apparent long-term fraud and misappropriation of
customer funds at Peregrine Financial Group highlights the need
for more effective regulatory oversight and enhanced safety for
customer funds. The cumulative effect of MF Global and now the
PFG failure, especially at a time when regulators were on
heightened alert, has been a huge loss of confidence in
regulators and in the rules that protect customers. We believe
steps should be taken to help restore confidence and improve
customer protection now.
In early April, the NGFA submitted preliminary
recommendations to the CFTC for enhanced reporting,
transparency and accountability. Those recommendations are
attached to my written testimony in addition to a second set of
recommendations we submitted last month to leadership of the
House and Senate Agriculture Committees. I would like to
highlight several of these today.
The Commodity Exchange Act, CFTC regulations and the
Bankruptcy Code should be harmonized for greater clarity and to
avoid interpretative inconsistencies. Second, strengthen the
CFTC's authority to appoint a trustee who exclusively
represents the interests of commodity customers in a
bankruptcy. Third, the Bankruptcy Code should state clearly
that customers with segregated funds always are first in line
for distribution of funds. Fourth, the Bankruptcy Code should
include authority for commodity customer committees in an FCM
liquidation. And last, safe-harbor provisions of the Bankruptcy
Code should not limit powers of a trustee to recover customer
funds. Reforming the Bankruptcy Code is a major undertaking. We
would welcome working with other organizations that have
similar goals so Congress can act on legislation soon.
The NGFA also recommends establishment of a new type of
voluntary account structure that fully segregates customer
assets. Full segregation will result in additional costs so we
suggest the use of such accounts would be on a voluntary basis
at the agreement of an FCM and its customers. We believe that a
pilot program could be implemented quickly and without
legislation, and we would find a useful way to test the
mechanics of this new account structure and begin to judge its
true costs and benefits.
Because full segregation might not be attractive to all
customers, the NGFA also recommends that insurance coverage be
extended to commodity futures customers in much the same way
that insurance protection now exists for securities customers
under the SIPC.
I would like to close my testimony with some comments about
a proposed rule by the CFTC that has generated serious and
widespread concern among NGFA member firms and agricultural
producers. It has also been mentioned by a Member of the
Committee this morning. It would require that any member of a
designated contract market like the Chicago Board of Trade or
the Kansas City Board of Trade record all oral communications
that could lead to a cash transaction and keep records for CFTC
inspection for 5 years. Many country elevators would be
required to record telephone conversations with farmers about
possibly entering into a forward cash contract to purchase the
farmer's grain, even though forward contracts are specifically
exempted in the Commodity Exchange Act from CFTC's
jurisdiction. This proposal would require substantial new
investment in communications technology for many small
businesses. In addition, it would create a bifurcated cash
marketplace in which some grain purchasers would be required to
record communications and maintain records while others would
not be covered by the rule. We are happy to hear the
Commissioner's comments this morning that he may be able to
dial back on those requirements.
Thank you for the opportunity to share the views of the
National Grain and Feed Association. I would be happy to
respond to any questions.
[The prepared statement of Mr. Heck follows:]

Prepared Statement of John M. Heck, Senior Vice President, Business
Development, The Scoular Company; Member, Executive Committee and Board
of Directors, National Grain and Feed Association, Omaha, NE

Good morning, Chairman Lucas, Ranking Member Peterson, and Members
of the Committee. I am John Heck, Senior Vice President of The Scoular
Company in Omaha, Nebraska. The Scoular Company, founded in 1892,
manages commodity supply-chain risk for customers in food, feed and
renewable fuel markets. From more than 70 locations across North
America, nearly 700 Scoular employees tailor risk-management solutions
for their customers by buying, selling, storing, and transporting grain
and ingredients.
This morning, I am testifying on behalf of the National Grain and
Feed Association (NGFA), the national trade association representing
grain elevators, feed manufacturers, processors and other commercial
businesses that utilize exchange-traded futures contracts to hedge
their risk and to assist producer in their marketing and risk
management strategies. We appreciate the opportunity to testify before
the Committee today.
I serve on the NGFA's Executive Committee and Board of Directors,
and I also serve as Chairman of the Association's Finance and
Administration Committee. More recently, I was asked to co-chair the
NGFA's MF Global Task Force, formed to develop responses and
recommendations to the failure of MF Global. Our priorities are to
advocate regulatory and policy changes that will help ensure that
another similar situation does not recur and to enhance protections for
commodity futures customers.
Many NGFA-member firms have been deeply affected by the MF Global
Holdings bankruptcy and the subsequent liquidation of futures
commission merchant (FCM) MF Global Inc. Following the bankruptcy,
customers' accounts were frozen, then transferred to other FCMs in
chaotic fashion and with a dearth of information to help customers
manage their financial exposure. Today, another distribution of funds
from the MF Global trustee has begun with the goal of bringing all
commodity customer distributions to about 80% of account value, but
many firms still have received only 72% of their funds with no
assurance they ever will be made whole.
It is worth emphasizing again that these customer funds were
required to be segregated and held safe by MF Global. Our industry had
believed for years that segregated customer funds were completely safe,
but we now see that was not the case. The unprecedented loss of
customer funds in the MF Global debacle has led to a loss of confidence
in futures markets and in the ability of the current system to protect
customer funds.
As our Task Force considered regulatory and policy changes in the
aftermath of MF Global, we asked ourselves: ``Was MF Global a one-time
situation, or is the level of customer risk still significant? Did the
MF Global failure and its consequences rise to the level that merited
significant change?''
Unfortunately, we know today that serious risk still is present.
The discovery of apparent long-term fraud and misappropriation of
customer funds at Peregrine Financial Group (PFG) highlights again the
need for more effective regulatory oversight and meaningful change that
will provide additional safety for customer funds both before a failure
occurs and in the event of future FCM liquidations.
We are still awaiting details of the situation surrounding the PFG
situation. On its face, the PFG failure appears to have some key
differences from MF Global--namely, that customer funds were
intentionally misappropriated for a variety of illegitimate purposes
over a very long period of time. However, the cumulative effect of MF
Global and PFG failures within a relatively short time--and especially
the failure of PFG at a time when regulators presumably were on
heightened alert for problems--has been a huge loss of confidence in
regulators and in the adequacy of current rules to protect customer
funds. We look forward to a full explanation by regulators of exactly
what happened at PFG. In the meantime, we believe there are steps that
should be taken to begin restoring confidence and to bolster
protections for segregated customer funds.
In early April, the NGFA submitted to the Commodity Futures Trading
Commission (CFTC) preliminary recommendations for enhanced reporting,
transparency and accountability. Generally, these recommendations were
developed with the intent of assisting customers by providing them with
more information to evaluate FCMs with whom they do business. In
addition, several of our recommendations were aimed at requiring
greater scrutiny by the CFTC and self-regulatory organizations of FCM
practices and financial reporting, and requiring FCMs to develop and
adhere to policies and procedures that rigorously will ensure proper
safeguarding of customer funds. Those recommendations are attached, and
I would be happy to discuss them in greater detail.
Late last month, the NGFA submitted a second set of recommendations
to leadership of both the Senate and House Agriculture Committees.
These recommendations involve significant changes in customer account
structure, reforms to the U.S. Bankruptcy Code to enhance customer
rights and protections, and the potential extension of insurance
coverage to commodity futures customers. The NGFA's letter transmitting
our latest recommendations is attached, and I would like to highlight
several of our recommendations today:

Reforms to the U.S. Bankruptcy Code
The Commodity Exchange Act, CFTC regulations and the
Bankruptcy Code should be harmonized to provide greater clarity
and avoid interpretive inconsistencies in the event of future
FCM liquidations.

The CFTC's authority to appoint a trustee to represent
exclusively the interests of commodity customers should be
strengthened. In a situation like MF Global, where over 95% of
assets and accounts affected were those of commodities
customers, we believe the CFTC should play a larger role and
that a trustee with commodities expertise should be involved.

The Bankruptcy Code should state clearly that customers
always are first in line for distribution of funds, ahead of
creditors, and that all proprietary assets of affiliates should
go to reimburse segregated customer accounts first.

The Bankruptcy Code clearly should state authority for
establishment of commodity customer committees to represent
their interests in an FCM liquidation.

Regardless of the intent behind transfer of customer funds,
``safe harbor'' provisions of the Bankruptcy Code should not
limit powers of a trustee to recover customer funds.

We understand that significant reforms to the U.S. Bankruptcy Code
are a major undertaking. For that reason, the NGFA would welcome
working together with other organizations that have similar goals in
order that legislation can be moved expeditiously by Congress.

Fully Segregated Customer Accounts
Current legal authority provides for pro rata distribution by the
trustee of customer property that was held by a failed FCM. That means
that all customers must share equally in losses in the event of a
shortfall of funds. The NGFA recommends establishment of a new type of
account structure for use by FCM customers on a voluntary basis that
provides for full segregation of customer assets, not commingled with
FCM funds or other customer funds. It will be important in establishing
a new fully-segregated structure that customer funds not fall under the
``customer funds'' definition in the Bankruptcy Code, thereby exposing
them to pro rata distributions and loss-sharing. Creation and
maintenance of fully-segregated accounts necessarily will result in
some additional costs that likely will be borne by customers. For that
reason, we prefer that use of such accounts would be on a voluntary
basis, at the agreement of an FCM and its customers.
We believe that a pilot program would be a useful way to test the
mechanics of this new account structure and to begin to judge its true
costs. The NGFA will look to work with commodity customers, FCMs,
lenders and regulators to identify potential participants. We believe a
pilot program leading to fully-segregated accounts can be implemented
relatively quickly without the need for legislation.

Insurance for Commodity Futures Customer Accounts
Because a fully-segregated account structure may not prove to be a
practical alternative for all customers, the NGFA also has recommended
that insurance coverage be extended to commodity customers, in much the
same way that insurance protection currently exists for securities
customers under the Securities Investor Protection Corporation (SIPC).
Details involving the appropriate level of coverage and funding will
need to be determined, but we believe the added protection for
customers will be perceived as significant and meaningful in today's
environment.

Dodd-Frank Implementation
Finally, I would like to share with the Committee the NGFA's views
on the ongoing implementation by CFTC of the Dodd-Frank law. We
believed from the beginning that agriculture, and the use of
agricultural risk management tools, had nothing to do with the
financial crisis that served as the catalyst for passage of Dodd-Frank.
Responding to the barrage of proposals from the CFTC to implement Dodd-
Frank has required much time and effort by agriculture and agribusiness
firms.
While some uncertainties still exist in how the law will be
implemented by the CFTC, the NGFA generally has appreciated the
Commission's openness and responsiveness to agriculture and
agribusiness concerns. However, I would like to close my testimony with
some comments about one proposal that has generated serious and
widespread concern among NGFA-member firms and the agricultural
producers with whom they work so closely.
Briefly, the proposal would require that any member of a designated
contract market (DCM)--like the Chicago Board of Trade, Kansas City
Board of Trade or Minneapolis Grain Exchange--record all oral
communications that could lead to a cash transaction. In addition,
records would need to be kept for CFTC inspection for up to 5 years,
identifiable by counterparty and transaction. There are several
problems with the proposal as currently written:

The proposal would require, for example, a country elevator
operated by a company that is a member of a commodity futures
exchange to record telephone conversations with farmers about a
forward cash contract--contracts that specifically are exempted
in the Commodity Exchange Act from CFTC's jurisdiction. Taken
even farther, a country elevator manager's conversation behind
the stands at the high school football game on Friday night
with a farmer in the community about buying cash grain the next
day would be required to be recorded. Clearly, this would
constitute a huge expansion of CFTC's authority in the cash
marketplace.

Country elevators are not equipped with the technology to
record conversations and maintain a record of them. The
proposal would require a huge new investment in communications
technology for many small businesses.

The proposal would create a bifurcated cash marketplace in
which some grain purchasers would be required to record
communications and maintain records, while others not operated
by a member of a DCM would not be covered by the rule. Will a
farmer call the elevator where all conversations must be
recorded and records kept for CFTC inspection, or the elevator
down the road where no such requirement exists? Serious
competitive issues are involved.

The NGFA respectfully suggests that the enforcement goals of the
Commission can be effectively accomplished and better served without
this huge new intrusion into the cash grain marketplace.
Thank you for the opportunity to share the views of the National
Grain and Feed Association. I would be happy to respond to any
questions.
Attachment 1
April 2, 2012

Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission,
Washington, D.C.

Dear Chairman Gensler:

The demise of MF Global has shaken the confidence of many futures
market participants with regard to the safety of segregated customer
funds. Many NGFA-member companies continue to struggle to recover their
funds and property.
The NGFA respectfully submits the following preliminary
recommendations as first steps to begin re-establishing confidence
among futures market participants and to help safeguard customer funds.
However, it is extremely important that these types of changes--
designed to enhance reporting, transparency and accountability, with
recommendations we believe should be relatively easily implemented--are
not the end of efforts to ensure that another MF Global-type situation
never recurs.
The NGFA's MF Global Task Force continues its work to examine
various models for segregating and safeguarding customer funds; to
explore the viability and costs of extending insurance coverage to
commodities accounts; and to analyze potential changes to the U.S.
Bankruptcy Code to provide customers with needed protection, especially
to protect customer segregated funds from being swept into liquidation
proceedings and to ensure that ``safe harbor'' rules under the
Bankruptcy Code aren't used to preclude retrieving customer funds. We
expect to issue additional recommendations in these areas soon. In all
these efforts, our bedrock principle will be:
``Customers Come First''
The preliminary recommendations of the NGFA are as follows:

The CFTC should require daily reporting of segregated fund
positions by FCMs to both their Self-Regulatory Organization
(SRO) and to the CFTC.

The CFTC should require daily reporting of segregated fund
investments by FCMs, detailed by maturity and quality, to both
their SRO and to the CFTC.

The CFTC should conduct a formal review of FCM investment
options for customer funds, with a view to whether the
Commission should further limit allowable investments only to
very safe instruments.

The CFTC should require reporting by FCMs to their SRO and
to the CFTC of significant changes in investment policies or
holdings.

FCMs should be required to provide greater transparency to
customers of where customer funds are invested, potentially
achieved through means such as posting on the CFTC website, FCM
websites and/or publication in a customer ``prospectus.''

The CFTC and SROs should enhance monitoring of FCM
reporting. Both regulators should conduct more detailed and
more frequent audits, and unannounced spot checks of FCMs.

To assign accountability and to aid in establishing that
fraudulent activity has occurred in the event customer funds
are misappropriated, CFTC should require the signature of two
authorized principals of an FCM (e.g., CEO, CFO or other senior
officers) to move funds out of segregated customer fund
accounts to non-customer accounts.

FCMs should be required to provide immediate notice to their
SRO and to the CFTC if the firm moves more than some
percentage, to be determined by the CFTC, of excess segregated
funds to non-customer accounts.

FCMs should be required by their SRO to periodically certify
policies and procedures to ensure the safeguarding of customer
segregated accounts and compliance with applicable laws and
regulations regarding such accounts. As part of all
examinations by SROs, principals of FCMs must certify that
policies and procedures are adequate, effective and being
observed by the FCM. At least annually, SROs should be required
by CFTC to review policies and procedures to determine adequacy
and compliance.

A rigorous review by the CFTC of capital requirements for
FCMs and broker-dealers needs to be conducted, with a view to
scrutinizing the current practice of allowing double-counting
of required capital when a firm operates as both an FCM and a
broker-dealer.

We appreciate the opportunity to share these recommendations with
you, and we look forward to working with you to ensure that customer
funds truly are segregated and safe from future misappropriation.
Sincerely,

Matt Bruns, John Heck,
Chair, Chair,
Risk Management Committee; Finance and Administration
Committee.

Attachment 2
June 29, 2012

Hon. Frank D. Lucas, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.

Dear Chairman Lucas and Ranking Member Peterson:

As you are well aware, companies and individuals that were
customers of MF Global Inc.'s futures business continue to deal with
the aftermath of parent company MF Global Holdings' bankruptcy and the
subsequent liquidation of the futures commission merchant (FCM). Most
customers so far have received distributions from the trustee of about
72% of their funds--funds that were supposed to have been segregated
and protected--with no assurance of being made whole.
Shortly following MF Global's demise, the National Grain and Feed
Association (NGFA) established a task force to formulate
recommendations for change to help ensure that another MF Global-type
situation does not occur. On April 2, we submitted to Congress and to
the Commodity Futures Trading Commission (CFTC) a number of preliminary
recommendations for enhanced reporting, transparency and accountability
(attached).* We are pleased that the CFTC and the regulated exchanges
have begun to implement some changes quite similar to the NGFA's
preliminary recommendations.
---------------------------------------------------------------------------
* Editor's note: the document referred to is the preceding attached
letter dated April 2, 2012.
---------------------------------------------------------------------------
This letter transmits a second set of NGFA policy recommendations.
Many of these changes will require action by Congress and/or the CFTC,
and we urge expeditious consideration to protect customers' funds and
to reinforce the principle that ``Customers Come First.''
The NGFA's recommendations are as follows:
Reforms to U.S. Bankruptcy Code--The NGFA believes strongly that
reforms to the U.S. Bankruptcy Code are critically important to
preserving customers' rights and protecting customers' assets in the
event of future FCM insolvencies. To that end, the NGFA recommends the
following statutory changes:

Generally, the Bankruptcy Code provides a limited
description of the liquidation process of a commodity futures
broker. The Commodity Exchange Act and bankruptcy regulations
drafted by the CFTC provide much greater and more detailed
guidance for the liquidation of a commodity broker or FCM. The
NGFA recommends that Part 190 regulations of the CFTC should be
incorporated into Subchapter IV of Chapter 7 of the Bankruptcy
Code to harmonize the statutes and avoid interpretative
inconsistencies.

Under SIPA, the SIPC is authorized to select a trustee and
to oversee the trustee's compensation, while the CFTC has a
limited role. Further, the SIPA trustee is obligated to protect
the interests of both securities and commodities customers. In
order to strengthen commodity customer protection, the NGFA
recommends that CFTC should have a specifically identifiable
role in the liquidation of an FCM. The CFTC should have the
authority to appoint its own trustee to represent exclusively
the interests of commodities customers. (This recommendation is
not intended as a criticism of the SIPA trustee appointed to
oversee liquidation of MF Global Inc. However, in a case where
over 95% of the assets and accounts affected were those of
commodities customers, we believe the CFTC should play a much
larger role.)

Currently, an FCM is required to keep customer funds
segregated from the firm's proprietary funds, but customer
property is commingled. As a result, under the current
statutory scheme, all customers share pro rata in the event of
a shortfall. The NGFA recommends that the Bankruptcy Code
should state clearly that customers always are first in line
for distribution of funds, ahead of creditors, and that all
proprietary assets including those of affiliates must go to
customers first. Knowing that their claims could be
subordinated in the event of a shortfall would provide
incentives to the FCM and any controlling parent firm to ensure
adequate internal controls to prevent segregation violations.
Further, this provision would provide clarity to regulators and
to the courts in terms of prioritization of claims, an area in
which precedent has not been established.

In the MF Global situation, creditor committees were
established under the MF Global Holdings Chapter 7 proceeding,
but there was no statutory provision under the SIPA liquidation
of the MF Global Inc. FCM for establishment of customer
committees. The NGFA recommends that the Bankruptcy Code
expressly should authorize the establishment of customer
committees to represent customer interests.

Under current bankruptcy law, powers of a trustee to recover
customer funds are limited under so-called ``safe harbor''
provisions unless actual intent to defraud customers/creditors
can be shown. The NGFA strongly recommends that any transaction
involving the misappropriation of an FCM's customer property
should not be protected under safe harbor provisions,
regardless of the intent behind a fund transfer.

We are aware that other organizations also are working toward
specific recommendations for changes in the Bankruptcy Code that will
enhance customer protections. The NGFA would welcome the opportunity to
work cooperatively with such groups to develop consensus reforms that
can be moved by Congress expeditiously.
Fully Segregated Customer Accounts--Currently, the Commodity
Exchange Act and U.S. Bankruptcy Code provide for pro rata distribution
of all customer property that was held by a failed futures commission
merchant (FCM). In the case of MF Global, the result has been that
former customers of the firm so far have received only 72% of their
supposedly safe segregated funds back through distributions from the
trustee, with no assurance that they ever will receive all of their
funds. We believe strongly that a new type of account structure needs
to be established for use by FCM customers on a voluntary basis that
will shield customer assets from pooled losses in the event of an FCM
bankruptcy.
It will be of paramount importance in establishing this new
structure that fully-segregated customer funds not fall under the
``customer funds'' definition of the Bankruptcy Code, thereby exposing
them to pro rata distributions (as discussed above in recommendations
for changes in the Bankruptcy Code.)
Creation of a fully-segregated account structure necessarily will
result in some additional costs that likely will be borne by customers
utilizing this voluntary option. If that is the case, it is likely that
some customers will opt for the added protections despite extra costs,
and some customers will be unwilling or unable to bear those extra
costs. For that reason, we propose that the full-segregation option be
utilized on a voluntary basis at the agreement of an FCM and its
individual customers. The NGFA will look to work with like-minded
organizations to design a full-segregation option that responds to
customer needs.
Pilot Program for Full-Segregation Option--We suggest that a pilot
program involving commodity futures customers, FCMs, banks and
regulators could be a useful means of testing the mechanics and
beginning to judge the true costs of a full-segregation structure--and
in the process, moving as quickly as possible toward a more generally
available full-segregation option for customers. The NGFA recommends a
pilot program at the earliest possible date, and commits here to
working with its member firms, the CFTC and other parties to identify
potential participants.
SIPC-Like Insurance for Commodity Futures Customer Accounts--
Because the full-segregation option discussed above may not prove to be
a practical alternative for all market participants, the NGFA
recommends that insurance coverage in the event of an FCM bankruptcy be
extended to commodity futures accounts similar to that currently
provided for securities customers.
Much in the way that the Securities Investor Protection Corporation
(SIPC) has provided insurance protection for securities accounts, the
NGFA recommends creation of a similar structure for commodities. We
believe that a significant fund could be established through very
modest dedicated assessments on commodity futures transactions. Details
concerning the appropriate size of such a fund and the appropriate
level of assessment will need to be determined, but we believe the
customer protections provided will be significant and meaningful to
market participants.
The NGFA does not recommend herein whether housing a commodity
futures insurance fund within the existing structure of the SIPC is the
correct solution, or whether a new and separate entity resembling the
SIPC but dedicated to providing insurance protection for commodity
futures accounts should be established. However, we believe strongly
that insurance protection for commodity futures accounts should be
established, action that likely will require authorizing legislation.
We look forward to working with Congress to achieve that goal.
We look forward to working with Congress, the CFTC and other
stakeholders to achieve the afore-mentioned changes with the goal of
protecting customer funds, both prior to and following a bankruptcy or
an FCM insolvency. Please do not hesitate to contact the NGFA with any
questions.
Sincerely,

Matt Bruns, John Heck,
Chair, Chair,
Risk Management Committee; Finance and Administration
Committee.

The Chairman [presiding.] Thank you, sir.
Mr. Conner, you are recognized for 5 minutes.

STATEMENT OF HON. CHARLES F. CONNER, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL COUNCIL OF
FARMER COOPERATIVES, WASHINGTON, D.C.

Mr. Conner. Chairman Lucas, Congressman Boswell, and
Members of the Committee, on behalf of the nearly 3,000 farmer-
owned cooperatives and their producer-members, thank you for
the opportunity to testify today to discuss implementation of
the Dodd-Frank Act.
The over-the-counter markets have given cooperatives and
their producer members important tools to manage their exposure
and hedge their risk during the volatile commodity markets that
we have seen over the last few years. This Committee's
oversight of CFTC as they have written the rules regulating the
over-the-counter markets has been instrumental in ensuring that
co-ops and farmers continue to have access to those innovative
risk-management tools. I would simply like to personally thank
you for your work and your staff's work in this area.
This continued oversight is important as the process now
turns from one of rulemaking to one of compliance. This shift
is something that NCFC members are now grappling with. They
must clearly understand the provisions of the regulations while
also figuring out how different regulations will fit together
into a coherent regulatory framework. Our members are finding
it very challenging to understand exactly what needs to be done
in order to be in compliance at the end of the day, and of
course, they want to be in compliance.
Part of the concern also lies with CFTC's eventual
enforcement of new regulations. As we have throughout the
process, we do urge the CFTC to continue to work closely with
industry and take a collaborative approach to compliance. We
hope the CFTC will lend a hand and help and educate us, not as
a regulator looking to make an example out of honest mistakes,
misunderstandings and oversights but rather as a partner
determined to see us meet these requirements.
This would be a continuation, Mr. Chairman, of the
willingness that CFTC has shown to listen to our concerns
throughout this rulemaking process. As an example, much of the
regulatory uncertainty for farmer co-ops has recently been
resolved. Most significant is the definition of swap dealer.
The Commission under Chairman Gensler's leadership took the
time to understand farmer co-ops and made a significant
improvement in the final rule. As such, farmer co-ops will not
be regulated as swap dealers.
Other rules that have not yet been finished continue to
cause uncertainty over the new costs that will be imposed on
farmers and their co-ops. Incremental increases in cost,
whether passed on from a swap dealer or imposed directly on the
cooperative, of course will trickle down and impact our
producer-owners. For example, one CFTC proposal imposes
additional record-keeping requirements in the cash commodity
markets has been noted. We appreciate Chairman Gensler's
earlier comments stating that he has no intention of imposing
this new requirement, and we would encourage the Committee to
follow up on this commitment.
Other regulatory burdens could also impact our members'
hedging activities. For instance, swap dealers who co-ops often
use to lay off the risk of offering forward contracts must
comply with capital and margin requirements, which has not yet
been finalized by the agency. How these costs will be passed on
to end-users remains to be seen and again could dramatically
impact the cost-effectiveness of commercial hedging via the
over-the-counter market.
Finally, Mr. Chairman, there is still a question of whether
the so-called Prudential Regulators will require bank swap
dealers to collect margin from end-users. We appreciate very
much this Committee's work on this issue, and of course the
House passage of the Business Risk Mitigation and Price
Stabilization Act by an overwhelming vote. Clearly, mandatory
margin would increase the cost again of hedging operations and
ultimately discourage this very prudent business practice.
Thank you again for the opportunity to testify today, Mr.
Chairman, and I look forward to any questions you may have.
[The prepared statement of Mr. Conner follows:]

Prepared Statement of Hon. Charles F. Conner, President and Chief
Executive Officer, National Council of Farmer Cooperatives, Washington,
D.C.

Chairman Lucas, Ranking Member Peterson, and Members of the
Committee, thank you for the invitation to testify today on the
implementation of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).
I am Chuck Conner, President and Chief Executive Officer of the
National Council of Farmer Cooperatives (NCFC). NCFC represents the
nearly 3,000 farmer-owned cooperatives across the country whose members
include a majority of our nation's more than two million farmers.
Farmer cooperatives--businesses owned, governed and controlled by
farmers and ranchers--are an important part of the success of American
agriculture. They are a proven tool to help individual family farmers
and ranchers through the ups and downs of weather, commodity markets,
and technological change. Through their cooperatives, producers are
able to improve their income from the marketplace, manage risk, and
strengthen their bargaining power, allowing individual producers to
compete globally in a way that would be impossible to replicate as
individual producers.
In particular, by providing price risk management tools to their
farmer-owners, farmer cooperatives help mitigate commercial risk in the
production, processing and selling of a broad range of agricultural and
food products. America's farmers and ranchers must continue to have
access to new and innovative risk management products that enable them
to feed, clothe and provide fuel to consumers here at home and around
the world. The ongoing drought across much of the country, which is
impacting so many producers so severely, once again illustrates the
need for a multilayered risk management strategy in agriculture.
We greatly appreciate the ongoing oversight this Committee has
provided as the Dodd-Frank rules have been written. Your work in
encouraging the Commodity Futures Trading Commission (CFTC) to ensure
that the agriculture industry has affordable access to innovative risk
management tools once the Act is implemented is commendable. With your
continued leadership, agriculture will hopefully avoid being subject to
a one size fits all type of regulation intended for Wall Street.

Cooperatives' Use of the OTC Market
As processors and handlers of commodities and suppliers of farm
inputs, farmer cooperatives are commercial end-users of the futures
exchanges as well as the over-the-counter (OTC) derivatives markets.
Due to market volatility in recent years, cooperatives are increasingly
using OTC products to better manage their exposure by customizing their
hedges. This practice increases the effectiveness of risk mitigation
and reduces costs to the cooperatives and their farmer-owners. Swaps
also play a critical role in the ability of cooperatives to provide
forward contracts, especially in times of volatile markets. Because
commodity swaps are not currently subject to the same margin
requirements as the exchanges, cooperatives can use them to free up
working capital.
OTC derivatives are not just used for risk management at the
cooperative level, however. They also give the cooperative the ability
to provide customized products to farmers and ranchers to help them
better manage their risk and returns. Much like a supply cooperative
leverages the purchasing power of many individual producers, or a
marketing cooperative pools the production volume of hundreds or
thousands of growers, a cooperative can aggregate its owner-members'
small volume hedges or forward contracts. It can then offset that risk
by entering into another customized hedge via the swap markets.

Implementation of the Dodd-Frank Act
NCFC supports elements of the Dodd-Frank Act that bring more
transparency and oversight to the OTC derivatives markets. We also
recognize the complexity in crafting rules for the implementation of
Dodd-Frank that best fit cooperatives and have had a number of
opportunities to express our concerns to the CFTC. With the sheer
volume of rules, the challenges in clearly understanding what is
contained in those regulations, and the complexity of how they will fit
together, NCFC members are now turning their attention to compliance.
Our members are doing their best to put into place policies and
procedures, but they are finding it a challenge to understand what
exactly needs to be done to address the complex regulations.
Our members also have concerns regarding how CFTC will enforce the
regulations. Because the regulations will be very complex, we urge CFTC
to work closely with industry to ensure clear understanding by all
parties.
During the rule writing process, we have worked to ensure that the
implementation of the Dodd-Frank Act preserves risk management tools
for farmers and their cooperatives, and have advocated for the
following:

Treating agricultural cooperatives as end-users because they
aggregate the commercial risk of individual farmer-members and
are currently treated as such by the CFTC;

Excluding agricultural cooperatives from the definition of a
swap dealer;

Exempting agricultural cooperatives from mandatory clearing
or margining but allowing them to perform either at their
discretion; and

Considering aggregate costs associated with the new
regulations and the impact on the agriculture sector.

I am pleased to report that with the recent rulemakings, some of
the uncertainty that created concern for farmer cooperatives over the
past 2 years has been resolved. Most significant is the defining of
``Swap Dealer.'' CFTC provided a definition in the final ``entities''
rule that will allow farmer cooperatives to provide risk management
services to their members and customers without the fear of having to
comply with the additional regulatory requirements intended for
systemically important institutions. We appreciate the work of the
Commission in addressing our concerns, which resulted in significant
improvements in the final rule.
While we now know farmer cooperatives will not be treated as swap
dealers, there are still many unknowns as to how implementation of the
rules will affect cooperatives and their farmer members. Uncertainty
over ultimate costs remains an ongoing a concern. As you know,
agriculture is a high-volume, low-margin industry. Incremental
increases in costs, whether passed on from a swap dealer or imposed
directly on a cooperative, will trickle down and impact producers.
Taken one rule at a time, the costs may not seem unreasonable, but to
those who have to absorb or pass on the collective costs of numerous
regulations, it is clearly evident those costs are significant.
For example, one ``small'' change in the proposed conforming
amendments rule has to do with additional recording requirements. We
are concerned this proposal would not only add swaps to the new record-
keeping requirements, but also extend the new requirements to cash
purchase and forward cash contracts entered into by any member of a
designated contract market. One NCFC member estimates that installation
of record-keeping systems in all of their facilities would cost over $6
million. In fact, the necessary investment to put in place and maintain
such a system would not only greatly add to the cost of doing business,
but would be an extreme compliance burden for the cash grain community
(attached are the comments NCFC submitted to CFTC on this issue). We
are hopeful CFTC will reconsider this requirement as it finalizes the
rule in the coming months.
It is also unclear how other costs will be forced down to end-users
and impact their ability to hedge. For example, recent movements in
grain and oilseed markets have caused a considerable amount of working
capital to be used to cover daily margin calls. The drought affecting
the U.S. has caused corn prices to increase over 50 percent in the last
month. While this creates an opportunity for farmers to price more of
their crop, (if they haven't been impacted by the drought), it also
causes additional margin calls on the production that has been priced.
For farmers to continue to take advantage of selling grain forward
during price rallies, cooperatives have to either increase borrowing or
look for alternative ways to manage such risk, such as the OTC market.
As was the case during the volatile markets in 2008, swaps allow
cooperatives to free up working capital and continue to forward
contract with farmers.
As commercial end-users, cooperatives often use swap dealers in
utilizing the OTC market to lay off the risk of offering those forward
contracts. However, the costs associated with dealers' compliance with
capital, margin and other regulatory requirements are still unclear. We
will have to wait to see how those costs are passed on to end-users and
how cost effective the OTC market remains for hedging activities.
Consistent with Congressional intent, NCFC supports the CFTC's
proposed rules clarifying that it ``would not impose margin
requirements on non-financial entities,'' and that ``parties would be
free to set initial and variation margin requirements in their
discretion and any thresholds agreed upon by the parties would be
permitted.''
However, we are concerned the so-called ``Prudential Regulators''
margin proposal requires bank swap dealers to collect margin from end-
users. As end-users, cooperatives use swaps to hedge interest rates,
foreign exchange, and energy in addition to agricultural commodities.
Often, cooperatives look to their lenders to provide those swaps. Under
the proposed rule requiring end-users to post margin, costs to
businesses will increase as more cash is tied up to maintain those
hedges. The additional capital requirements will be siphoned away from
activities and investment in cooperatives' primary business ventures.
Furthermore, cash for margin is often borrowed from lenders through the
use of credit lines. As a result, we could see a situation where a
commercial end-user would have to borrow cash from its lender, and pay
interest on it, just to give it back to the same lender to hold as
margin. Congressional intent was clear on this point--end-users were
not to be required to post margin. We appreciate the House of
Representatives reaffirming this by passing the Business Risk
Mitigation and Price Stabilization Act back in March.
Thank you again for the opportunity to testify today before the
Committee. We appreciate your role in ensuring that farmer cooperatives
will continue to be able to effectively hedge commercial risk and
support the viability of their members' farms and cooperatively owned
facilities. I look forward to answering any questions you may have.

Attachment
August 8, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

RE: Adaptation of Regulations to Incorporate Swaps; Notice of Proposed
Rulemaking (Federal Register/Vol. 76, No. 109)

Dear Mr. Stawick:

On behalf of the more than two million farmers and ranchers who
belong to farmer cooperatives, the National Council of Farmer
Cooperatives (NCFC) submits the following comments in response to the
Commodity Futures Trading Commission's (the Commission) request for
comments: Adaptation of Regulations to Incorporate Swaps; Notice of
Proposed Rulemaking, to amend the Commodity Exchange Act regulations to
implement regulatory requirements contained in Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act.
Since 1929, NCFC has been the voice of America's farmer
cooperatives. Our members are regional and national farmer
cooperatives, which are in turn composed of over 2,500 local farmer
cooperatives across the country. NCFC members also include 21 state and
regional councils of cooperatives.
America's farmer-owned cooperatives provide a comprehensive array
of services for their members. These diverse organizations handle,
process and market virtually every type of agricultural commodity
produced. They also provide farmers with access to infrastructure
necessary to manufacture, distribute and sell a variety of farm inputs.
For example, a cooperative may consist of a closely coordinated network
to ensure timely and cost-efficient origination, storage,
transportation and marketing of grain and oilseeds.

Proposed Changes to Regulation 1.35
NCFC is concerned with this proposal because it would not only add
swaps to the new record-keeping requirements, but also would extend the
new record-keeping requirements to cash purchase and forward cash
contracts entered into by any member of a designated contract market
(DCM).
This would require all farmer cooperatives that are members of DCMs
(CME, KCBT, MGE, etc.), and by extension every one of their local
facilities, to be bound by this regulation. For example, cooperatives
that are members of DCMs have an integrated network of grain elevators
to originate and store grain purchased from farmers. As such, the
proposed change to 1.35(a) would require those elevators to record,
among other things, all oral communications that lead to execution of
cash transactions with farmers. The proposal includes (proposed
additions in italics):

Included among such records shall be all orders (filled,
unfilled, or canceled), trading cards, signature cards, street
books, journals, ledgers, canceled checks, copies of
confirmations, copies of statements of purchase and sale, and
all other records, which have been prepared in the course of
its business of dealing in commodity interests and cash
commodities, and all oral and written communications provided
or received concerning quotes, solicitations, bids, offers,
instructions, trading, and prices, that lead to the execution
of transactions in a commodity interest or cash commodity,
whether communicated by telephone, voicemail, facsimile,
instant messaging, chat rooms, electronic mail, mobile device
or other digital or electronic media. Each transaction record
shall be maintained as a separate electronic file identifiable
by transaction and counterparty.

Additionally, all such recorded communications would be required to
be maintained for 5 years.
A requirement to record all communication leading to a cash
purchase or cash forward contract would impose huge regulatory burdens
and costs on cooperatives and other businesses and farmers in rural
America. In fact, the necessary investment to put in place and maintain
such a system would not only greatly add to the cost of doing business,
but would be an extreme compliance burden for the cash grain community.
The Commission states these record-keeping requirements would
protect customers from abusive sales practices; protect registrants
from risks associated with transactional disputes; allow registrants to
follow up more effectively on customer complaints; and preserve
evidence that could increase the effectiveness of the Commission's
enforcement actions. We do not believe that requiring this additional
information to be recorded and maintained is necessary to achieve the
stated goals in the cash commodity markets.
Additionally, we do not believe the intent of the Dodd-Frank Act
was to subject cash purchases and forward cash contracts to the
additional new record-keeping requirements proposed under regulation
1.35. In fact, cash and forward contracts have been excluded from the
definition of a swap in the proposed product definitions rule.
Commission Chairman Gary Gensler has highlighted that point on several
occasions while testifying before Congress. We believe this proposed
regulation, as written to apply to the cash market, is in direct
contradiction to that exclusion and to the Congressional intent of the
Dodd-Frank Act.
We would be pleased to discuss with the Commission our concerns
with proposed regulation 1.35. Thank you taking our views into account
as the Commission finalizes rules in the coming months. We appreciate
the opportunity to provide input throughout the process of
implementation of Title VII of the Dodd-Frank Act.
Sincerely,

Charles F. Conner,
President & CEO.

The Chairman. Thank you.
Mr. McElroy, you are recognized for 5 minutes. You may
proceed whenever you are ready.

STATEMENT OF PAUL E. McELROY, CHIEF FINANCIAL OFFICER, JEA,
JACKSONVILLE, FL; ON BEHALF OF AMERICAN PUBLIC POWER
ASSOCIATION

Mr. McElroy. Chairman Lucas, Ranking Member Boswell, and
Committee Members, thank you for the opportunity to testify
this morning. I am Paul McElroy, Chief Financial Officer for
JEA. JEA proudly serves more than 400,000 electric customers in
and around Jacksonville, Florida. Our business is ensuring that
our customers' electric demands are met reliably and
economically today and for generations to come.
I am testifying on behalf of the American Public Power
Association, APPA, the national service organization
representing over 2,000 government-owned electric utilities
providing power to more than 46 million people. Additionally,
my comments are supportive of the positions of the Large Public
Power Council, which represents the 26 largest municipal
entities in the country.
Today I will discuss the swap-dealer rule under the Dodd-
Frank Act. APPA supports Dodd-Frank and continues to work with
the CFTC and others to improve its implementation. Chairman
Gensler mentioned our involvement earlier today. However, we
remain concerned that the CFTC's swap-dealer rule, which took
effect Monday, will hinder our members' ability to hedge
commercial price and operational risks.
We have a long and successful history of hedging commercial
risk for the benefit of our customers, often utilizing swaps of
physical commodities such as natural gas, electric capacity and
energy, and coal, all of which are needed for our commercial
operations. This is not different than swap activity used in
the operations-related hedging activity of any other electric
utility. At issue are the de minimis thresholds set by the CFTC
to determine whether a swap participant is a swap dealer. Under
the rule, a swap participant will be considered a swap dealer
if it engages in more than $3 billion in swap dealing but just
$25 million if dealing with special entities. Special entities
are governmental entities including government-owned utilities
such as APPA's members. The CFTC says it imposed the $25
million threshold in light of the protections that Dodd-Frank
provides for special entities. However, Dodd-Frank never
mentions forcing a non-financial participant into the swap-
dealer regime for entering into swaps with a special entity.
Our concern is that non-financial entities on whom we rely
for hedging such as natural gas producers, independent
generators and investor-owned utility companies will stop
dealing with us to avoid the $25 million threshold because but
for those dealings with us, they would not be pulled into the
Dodd-Frank swap-dealer regime. We are also concerned that large
financial firms, ones which will be considered swap dealers in
any case, will not fill this gap. Electric power is regionally
diverse in both supply and demand. Because of this diversity,
there are often limited counterparties for operations-related
swaps. Large financial institutions may neither have the
ability nor the desire to provide such highly customized,
localized transactions.
The loss of non-financial swap partners will put us at a
disadvantage to other utilities in our ability to effectively
manage power supply costs and operations for our customers.
Each swap counterparty in the market brings important market
liquidity and diversity. If non-financial parties refuse to
enter into swaps with us, price competition will be reduced,
operational risk will increase, and our ratepayers will be
hurt. This will affect all APPA members and so APPA and other
government-owned utility groups have petitioned the CFTC to
amend the swap-dealer rule.
Our proposed amendment would not, and I will repeat, would
not remove the overall swap-dealer threshold nor the sub-
threshold. It simply asks that our operations-related swaps not
count toward the special-entities sub-threshold. Local- and
state-owned utilities have experience and expertise to
understand the operations-related swaps transactions they use
to manage their commercial risk and do not need the special
protections intended by the $25 million sub-threshold. In fact,
and ironically, these protections will likely expose us and our
customers to greater risk.
Thank you for this opportunity again to testify.
[The prepared statement of Mr. McElroy follows:]

Prepared Statement of Paul E. McElroy, Chief Financial Officer, JEA,
Jacksonville, FL; on Behalf of American Public Power Association

Mr. Chairman and Members of the Committee, I am Paul McElroy, Chief
Financial Officer for JEA testifying today on behalf of the American
Public Power Association (APPA). APPA is the national service
organization representing the interests of over 2,000 municipal and
other state- and locally-owned, not-for-profit electric utilities
throughout the United States (all but Hawaii). Collectively, public
power utilities deliver electricity to one of every seven electricity
customers in the United States (approximately 46 million people),
serving some of the nation's largest cities. However, the vast majority
of APPA's members serve communities with populations of 10,000 people
or less.
JEA is a member of APPA. We are located in Jacksonville, Florida,
and proudly serve an estimated 420,000 electric, 305,000 water, and
230,000 sewer customers in Northeast Florida. JEA was created by the
City of Jacksonville to serve those who live there and in the
surrounding communities. The sole purpose of our business is to ensure
that the electric, water and sewer demands of our customers are met,
both today and for generations to come. Our goal is to provide reliable
services at a good value to our customers while ensuring that our
areas' precious natural resources are protected.

Public Power Utilities and Implementation of the Dodd-Frank Act
APPA supports the goals of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act) and has worked closely with
the Commodity Futures Trading Commission (CFTC) and other interested
parties hoping to improve its implementation, particularly related to
regulations affecting ``end-users'' of energy such as JEA and other
APPA members. Even today, now 2 years after enactment, the full effect
of the Dodd-Frank Act on public power utilities is unclear as
regulations implementing the statute continue to be promulgated. We
strongly support the CFTC's efforts to issue these regulations in a
timely fashion while also accommodating a necessary discussion among
stakeholders to fully vet these rules for unintended or adverse
consequences.
One such instance is the final swap-dealer rule,\1\ which took
effect on July 23, 2012. As written, the rule will substantially hinder
public power and public gas utilities' ability to hedge against
operational risks. Just like JEA, these utilities have no shareholders,
so the costs imposed by this regulatory decision will be borne by only
one group: our ratepayers.
---------------------------------------------------------------------------
\1\ CFTC Regulation 1.3(ggg)(4); see 77 Fed. Reg. 30596, at 30744.
---------------------------------------------------------------------------
As you know, the Dodd-Frank Act requires swap dealers and major
swap participants to register with the CFTC and meet capital, margin,
and reporting and record-keeping requirements, as well as to comply
with rigorous business conduct and documentation standards. The Dodd-
Frank Act provides additional standards for swap dealers or major swap
participants advising or entering into swaps with government-owned
utilities and other government entities (referred to under the statute
as ``special entities''). For swap dealers advising or seeking to
advise a special entity, the law states that it is ``unlawful'' to
defraud that special entity.\2\ For swap dealers or major swap
participants entering into swaps with special entities, the law states
that these dealers and swap participants must comply with rules set by
the CFTC requiring special entities to have an independent
representative before trading with a swap dealer or major swap
participant.\3\
---------------------------------------------------------------------------
\2\ 7 USCA 6s(h)(4).
\3\ 7 USCA 6s(h)(5).
---------------------------------------------------------------------------
In December 2010, the CFTC (jointly with the Securities and
Exchange Commission) issued a proposed rule to define the term ``swap
dealer,'' including (as required by the Dodd-Frank Act) \4\ an
exemption from the swap-dealer designation for those entities that
engage in a de minimis quantity of swap dealing.
---------------------------------------------------------------------------
\4\ 7 USCA 1a(49)(D).
---------------------------------------------------------------------------
In the proposed rule, CFTC proposed two separate de minimis
thresholds relating to the dollar quantity of swaps: $100 million
annually for an entity's total swap-dealing activity; and, $25 million
annually for an entity's swap-dealing activity with special entities,
including, as noted above, public power, public gas, and Federal
utilities (government-owned utilities).
In February, 2011, the Not-For-Profit Electric End User Group (NFP
EEU)--which includes APPA-filed comments on the proposed swap dealer
rule. The comments recommended that the CFTC substantially increase the
de minimis thresholds both for total swaps and for swaps with special
entities.
A final rule was approved by the CFTC on April 18, 2012, and was
published in the Federal Register on May 23, 2012. The final rule
greatly increased the overall de minimis threshold from the proposed
rule, raising it from $100 million to $3 billion. During an initial
phase-in period, this threshold will be $8 billion. But, the final rule
did not change the proposed rule's $25 million sub threshold for swap-
dealing activities with special entities. Thus, the disparity between
the two thresholds is now substantially greater. This $25 million sub-
threshold is smaller still when you consider that it is the aggregate
of a swap partner's transactions with all special entities during any
12 month period.\5\
---------------------------------------------------------------------------
\5\ By way of reference a single, 1 year 100 MW swap could have a
roughly $25 million notional value. One-hundred MWs of power is enough
to serve the average demand of approximately 75,000 residential
customers.
---------------------------------------------------------------------------
As a result, non-financial entities (such as natural gas producers,
independent generators, and investor-owned utility companies) that do
not want to be swap dealers will severely limit their swap-dealing
activities with government-owned utilities to avoid exceeding the $25
million threshold.

Why Hedging Is Necessary
Government-owned utilities depend on nonfinancial commodity
transactions, trade options and ``swaps,'' as well as the futures
markets, to hedge commercial risks that arise from their utility
facilities, operations and public service obligations. Together,
nonfinancial commodity markets play a central role in the ability of
government-owned utilities to secure electric energy, fuel for
generation, and natural gas supplies for delivery to consumers at
reasonable and stable prices. Specifically, many government-owned
utilities purchase firm electric energy, fuel and gas supplies in the
physical delivery markets (in the ``cash'' or ``spot'' or ``forward''
markets) at prevailing and fluctuating market prices, and enter into
bilateral, financially-settled nonfinancial commodity swaps with
customized terms to hedge the unique operational risks to which many
government-owned utilities are subject.
In hedging, mitigating or managing the commercial risks of their
utility facilities' operations or public service obligations,
government-owned utilities are engaged in commercial risk management
activities that are no different from the operations-related hedging of
an investor-owned utility or an electric cooperative located in the
same geographic region.

Why Nonfinancial Counterparties Are Necessary
Electric power touches virtually every home and business in the
United States. This near universality gives a false appearance of
homogeneity. It is important to remember that what is being delivered
is a physical commodity, e.g., electricity, coal, or natural gas.
Ownership of a stock can be transferred coast to coast with a click of
a button, but electricity must be delivered to the place it is to be
used.
Each regional geographic market has a somewhat different set of
demands driven by climate, weather, population, and the like. Each
regional geographic market also has a somewhat different group of
financial entity counterparties and nonfinancial entity counterparties
available to meet these demands and thus able to enter into customized
utility operations-related swaps needed for hedging price and supply
risks. For example, a large merchant electric generation station in
western Alabama might be available as a nonfinancial counterparty for a
swap transaction to provide electricity to a specific site in Alabama.
But that same entity would not necessarily be able to offer the
electricity in Oregon, and so would not be able to help an Oregon-based
utility hedge its risks.
Because there are a limited number of counterparties for any
particular operations-related swap sought by a utility, each financial
or nonfinancial swap counterparty brings important market liquidity and
diversity. The greater the number of counterparties, the greater the
price competition. Conversely, reduced price competition necessarily
increases prices.
JEA and the Special Entity Sub Threshold
I would like to illustrate these points with examples from my JEA's
perspective.
As discussed above, the primary mission of JEA's electric system is
to provide reliable and low cost electricity to our customers. I will
say that again. While ensuring sufficient supply to serve our customers
is primary, running a very close second is managing commodity fuel and
purchased power costs. We accomplish this by efficiently and cost-
effectively managing supply and price risks inherent in the procurement
of fuel and power.
Take, for example, a capacity and energy swap between JEA and
another municipal utility. This swap is intended to diversify our
electric generation capability. By way of background, JEA has a large
commitment solid fuel, while our swap partner in this example has a
significant commitment to natural gas. And, history has taught us the
importance of diversification time and time again.
This swap would be governed by Dodd-Frank: it would qualify for the
end-user exception so would not have to be cleared, but one of the
parties would have to report the transaction. However, the notional
amount of the swap would exceed $25 million, and, if it were considered
``dealing'' activity under the rules' facts and circumstances
guidelines, would invoke the sub-threshold provision.
This leaves us with the options of (1) having one party register as
a dealer, (2) placing a registered dealer between the parties, or (3)
affecting a physical exchange instead of a swap.\6\ All of these
solutions add complexity and cost, do nothing to reduce systemic
financial risk, and will cause the transaction to be abandoned. That
said, the same transaction, were it not to involve special entities,
would impose none of the added cost and complexity. This seems neither
appropriate, nor fair.
---------------------------------------------------------------------------
\6\ A physical exchange would be structured as two separate
purchase power agreements, incorporating the costs of transmission and
ancillary services.
---------------------------------------------------------------------------
Likewise, JEA seeks to maximize flexibility regarding terms and
conditions governing supply and price in all long-term fuel and
purchased power contracts. This gives us the flexibility to efficiently
and cost-effectively manage supply and price risks in fuel and power
procurement. However, we have been told by several non-financial energy
suppliers who currently serve as swap partners, none of whom are
currently dealers, that they are looking closely at the ``special
entity sub-threshold'' to determine the terms and conditions they may
be willing to extend to us in the future.
When a major fuel supplier says they are ``reevaluating''
contractual terms and conditions, it almost certainly means that the
level of flexibility we currently enjoy will be curtailed or eliminated
and our costs and risk profile will increase. Again, however, this
supplier can continue to extend to utilities that are not special
entities contracts under the existing terms. And again, this seems
neither appropriate, nor fair.
These are just two examples of how the sub threshold will affect
JEA. As noted above there is a great deal of heterogeneity among APPA
members, including in the use of hedging. Some make substantial use of
hedging: others do not. Likewise, of APPA members who do make use of
hedging, a recent informal survey of members showed great diversity in
terms of the volume of hedging and the extent to which members relied
on non-financial entities.
However, the rules could still affect all of our members. Members
currently hedging will be affected, but so will smaller members who buy
power from larger members who do. For example, while a small municipal
electric distribution utility \7\ in Oklahoma might not hedge its
risks, it may buy its power from a larger public power provider--such
as the Oklahoma Municipal Power Authority--which does. Also, those who
do not currently hedge will be restricted in their ability to do so in
the future.
---------------------------------------------------------------------------
\7\ An electric distribution utility is one which solely
distributes electricity, as distinguished from one which generates and
distributes electricity.
---------------------------------------------------------------------------
The CFTC has said that it retained the $25 million threshold in
light of the special protections that the Dodd-Frank Act affords to
special entities. However, the statute does not require--even mention--
special protections for special entities in regard to the swap dealer
definition. As noted above, the law imposes requirements on swap
dealers and major participants advising or entering into swaps with
special entities. Nowhere does the law mention deeming a participant to
be a swap dealer solely because they happen to be entering into swaps
with a government-owned utility.
APPA thinks the distinction in the law is appropriate. Government-
owned utilities understand the operations-related swap transactions
they use to manage their commercial risks and do not need the special
protections provided by the $25 million sub-threshold. In fact, and
ironically, these ``protections'' are likely to limit the ability of
these utilities to hedge operational and price risks rather than to
protect these utilities and their customers from risk.

Government-Owned Utilities' Petition for Rulemaking
On July 12, 2012, APPA, the Large Public Power Council (LPPC), the
American Public Gas Association (APGA), the Transmission Access Policy
Study Group (TAPS), and the Bonneville Power Administration (BPA),
filed with the CFTC a ``Petition for Rulemaking to Amend CFTC
Regulation 1.3(ggg)(4).'' The petition (see the attachment to this
testimony) requests that the CFTC amend its swap-dealer rule to exclude
utility special entities' operations-related swap transactions from
counting towards the special-entity threshold. This amendment to the
swap-dealer rule would allow producers, utility companies, and other
non-financial entities to enter into energy swaps with government-owned
utilities without danger of being required to register as a ``swap
dealer'' solely because of their dealings with government-owned
utilities.
Specifically, the petition asks for a narrow exclusion:

A government-owned utility's swaps related to utility
operations would not count towards the special entity de
minimis threshold, but would count towards the total de minimis
threshold.

Utility operations-related swaps are those entered into to
hedge commercial risks intrinsically related to the utility's
electric or natural gas facilities or operations or to the
utility's supply of natural gas or electricity to other special
entities. For example, these would include swap transactions
related to the generation, production, purchase or sale, or the
transportation of electric energy or natural gas, or related to
fuel supply of electric generating facilities.

Utility operations-related swaps do not include interest
rate swaps. Those swaps would remain subject to the $25 million
special entity sub-threshold.

We urge Committee Members to support this petition.

Conclusion
In conclusion, the protections the CFTC is trying to afford through
the $25 million special entity sub-threshold were not contemplated by
the Dodd-Frank Act and are not needed for government-owned utility
swaps related to utility operations. Government-owned utilities are
well-versed in the markets in which they are hedging their risks and
rely on these swaps solely to manage price and operational risks. More
importantly, the assumption that financial firms will be able to
replace all the swaps offered currently by our nonfinancial swap
partners reflects a dangerous misunderstanding of how electricity is
delivered and an indifference to the price Wall Street will impose in
the absence of adequate competition and to the risk to supply if that
price cannot be afforded. In sum, a failure to allow the narrow
exclusion sought in our petition will limit our members' ability to
hedge against risks and lead to increased risk and costs to the
millions of ratepayers they serve.
Thank you again for this opportunity to testify, and I would be
more than happy to answer any questions you might have.
Attachment
July 12, 2012

David Stawick,
Office of the Secretariat,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Petition for Rulemaking to Amend CFTC Regulation 1.3(ggg)(4)

Dear Mr. Stawick:

The American Public Power Association (``APPA''), the Large Public
Power Council (``LPPC''), the American Public Gas Association
(``APGA''), the Transmission Access Policy Study Group (``TAPS'') and
the Bonneville Power Administration (``BPA'') (collectively, the
``Petitioners'') respectfully petition the Commodity Futures Trading
Commission (the ``Commission'' or the ``CFTC'') under CFTC Regulation
13.2 to amend CFTC Regulation 1.3(ggg)(4),\8\ which implements the de
minimis exception to the definition of ``swap dealer.'' The Petitioners
specifically request that the rule amendment exclude from the ``special
entity sub-threshold,'' which appears in Regulation 1.3(ggg)(4)(i),
``Utility Operations-Related Swaps'' to which the Petitioners and other
``Utility Special Entities'' are, or may in the future be,
counterparties. The definitions of ``Utility Operations-Related Swap''
and ``Utility Special Entity'' are included directly in the text of the
proposed rule amendment, and narrowly circumscribe the scope of the
proposed rule amendment.
---------------------------------------------------------------------------
\8\ 77 Fed. Reg. 30596, at 30744.
---------------------------------------------------------------------------
Such a rule amendment is permitted by Section 1a(49)(D) of the
Commodity Exchange Act (``CEA'') as amended by the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the ``Dodd-Frank
Act''),\9\ and is specifically contemplated by CFTC Regulation
1.3(ggg)(4)(v).\10\ The rule amendment is necessary in order to
preserve uninterrupted and cost-effective access to the customized,
nonfinancial commodity swaps that Petitioners and other Utility Special
Entities use to hedge or mitigate commercial risks arising from their
utility facilities, operations and public service obligations.
---------------------------------------------------------------------------
\9\ Pub. L. No. 111-203, 124 Stat. 1376 (2010).
\10\ 77 Fed. Reg. 30744-30745.
---------------------------------------------------------------------------
The information required by CFTC Regulation 13.2 follows:

I. The Text Of The Proposed Rule Amendment (Additional language is
underlined and italicized)

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
* * * * * * *
Section 1.3 Definitions.
* * * * * * *
(ggg) Swap Dealer.
* * * * * * *
(4) De minimis exception. (i) Except as provided in
paragraph (ggg)(4)(vi) of this section, a person that
is not currently registered as a swap dealer shall be
deemed not to be a swap dealer as a result of its swap
dealing activity involving counterparties, so long as
the swap positions connected with those dealing
activities into which the person--or any other entity
controlling, controlled by or under common control with
the person--enters over the course of the immediately
preceding 12 months (or following the effective date of
final rules implementing Section 1a(47) of the Act, 7
U.S.C. 1a(47), if that period is less than 12 months)
have an aggregate gross notional amount of no more than
$3 billion, subject to a phase in level of an aggregate
gross notional amount of no more than $8 billion
applied in accordance with paragraph (ggg)(4)(ii) of
this section, and an aggregate gross notional amount of
no more than $25 million (the ``special entity sub-
threshold'' with regard to swaps in which the
counterparty is a ``special entity'' (as that term is
defined in Section 4s(h)(2)(C) of the Act, 7 U.S.C.
6s(h)(2)(C), and 23.401(c) of this chapter); provided
that such $25 million special entity sub-threshold
shall not apply with regard to ``utility operations
related swaps'' to which the counterparty is a
``utility special entity.'' For purposes of this
paragraph, (A) a ``utility special entity'' means a
government ``special entity'' (as described in clause
(i) or (ii) of Section 4s(h)(2)(C) of the Act or in
clause (1) or (2) of 23.401(c) of this chapter) that
owns or operates electric or natural gas facilities or
electric or natural gas operations (or anticipated
facilities or operations), supplies natural gas and/or
electric energy to other utility special entities, has
public service obligations (or anticipated public
service obligations) under Federal, state or local law
or regulation to deliver electric energy and/or natural
gas service to utility customers, or is a Federal power
marketing agency as defined in Section 3 of the Federal
Power Act (16 U.S.C. 796(19)), and (B) a ``utility
operations-related swap'' shall mean any swap that a
utility special entity enters into ``to hedge or
mitigate commercial risks'' (as such phrase is used in
Section 2(h)(7)(A)(ii) of the Act) intrinsically
related to the electric or natural gas facilities that
the utility special entity owns or operates or its
electric or natural gas operations (or anticipated
facilities or operations), or to the utility special
entity's supply of natural gas and/or electric energy
to other utility special entities or to its public
service obligations (or anticipated public service
obligations) to deliver electric energy or natural gas
service to utility customers. For the avoidance of
doubt, ``intrinsically related'' shall include all
transactions related to (i) the generation or
production, purchase or sale, and transmission or
transportation of electric energy or natural gas, or
the supply of natural gas and/or electric energy to
other utility special entities, or delivery of electric
energy or natural gas service to utility customers,
(ii) all fuel supply for the utility special entity's
electric facilities or operations, (iii) compliance
with electric system reliability obligations applicable
to the utility special entity, its electric facilities
or oper-
ations, (iv) compliance with energy, energy efficiency,
conservation or renewable energy or environmental
statutes, regulations or government orders applicable
to the utility special entity, its facilities or
operations, or (v) any other electric or natural gas
utility operations-related swap to which the utility
special entity is a party. Utility operations-related
swaps shall not include a swap based or derived on, or
referencing, commodities in the interest rates, credit,
equity or currency asset classes, or a product type or
category in the ``other commodity'' asset class that is
based or derived on, or referencing, metals, or
agricultural commodities or crude oil or gasoline
commodities of any grade not used as fuel for electric
generation. For purposes of this paragraph, if the
stated notional amount of a swap is leveraged or
enhanced by the structure of the swap, the calculation
shall be based on the effective notional amount of the
swap rather than on the stated notional amount.

II. The Petitioners
APPA is the national association that represents the interests of
approximately 2000 government-owned electric utilities in the United
States. APPA's member utilities are not-for-profit utility systems that
were created by state or local governments to serve the public
interest. Government-owned electric utilities provide over 15% of all
KWh sales to retail electric customers.
LPPC is an organization representing 26 of the largest government-
owned electric utilities in the nation. LPPC members own and operate
over 86,000 megawatts of generation capacity and nearly 35,000 circuit
miles of high voltage transmission lines, representing nearly 90% of
the transmission investment owned by non-Federal Government-owned
electric utilities in the United States.
TAPS is an association of transmission dependent electric utilities
located in more than 30 states. All of TAPS member electric utilities
except one are government-owned electric utilities.
APGA is the national association that represents government-owned
natural gas distribution systems. There are approximately 1,000 public
gas systems in 36 states and over 720 of these systems are APGA
members. Government-owned natural gas distribution systems are not-for-
profit entities owned by, and accountable to, the citizens they serve.
They include municipal gas distribution systems, public utility
districts, county districts, and other government agencies that have
natural gas distribution facilities.
Some government-owned utilities are both electric utilities and
natural gas distribution utilities, and are therefore members of both
APPA and APGA. The purpose of a government-owned electric utility or
natural gas distribution system is to provide reliable, safe and
affordable electric energy and/or natural gas service to the community
it serves.
BPA is a self-financed, nonprofit Federal agency created in 1937 by
Congress that primarily markets electric power from 31 federally owned
and operated projects, and supplies over \1/3\ of the electricity used
in the Pacific Northwest. BPA also owns and operates approximately 75
percent of the high-voltage transmission in the Pacific Northwest.
BPA's primary statutory responsibility is to market its Federal system
power at cost-based rates to its ``preference customers.'' \11\ BPA
also funds one of the largest wildlife protection and restoration
programs in the world.
---------------------------------------------------------------------------
\11\ BPA has 130 preference customers made up of electric utilities
which are not subject to the jurisdiction of the Federal Energy
Regulatory Commission (``FERC''), including Indian tribes, electric
cooperatives, state and municipally chartered electric utilities, and
other Federal agencies located in the Pacific Northwest.
---------------------------------------------------------------------------
III. Nature of the Petitioners' Interest
APPA, LPPC, TAPS and APGA represent thousands of government-owned
electric and natural gas utilities throughout the United States, all of
which are ``special entities'' as that term is defined in Section
4s(h)(2)(C) of the Commodity Exchange Act, as amended by the Dodd-Frank
Act, and 23.401(c) of the Commission's regulations. BPA and the other
Federal power agencies are ``special entities'' as well.\12\ The
Petitioners respectfully seek the rule amendment for the benefit of all
``Utility Special Entities'' that currently, or may in the future,
enter into Utility Operations-Related Swaps with counterparties that
are not registered with the Commission as ``swap dealers.''
---------------------------------------------------------------------------
\12\ According to the Energy Information Administration, there are
nine Federal electric utilities in the United States, which are part of
several agencies of the United States Government (see, http://
www.eia.gov/cneaf/electricity/page/prim2/toc2.html): the Army Corps of
Engineers; the Bureau of Indian Affairs and the Bureau of Reclamation
in the Department of the Interior, the International Boundary and Water
Commission in the Department of State, the Power Marketing
Administrations in the Department of Energy (BPA, Western Area Power
Administration, Southwestern Area Power Administration, and
Southeastern Area Power Administration), and the Tennessee Valley
Authority (TVA).
In addition, three Federal agencies operate electric generating
facilities: TVA, the largest Federal power producer; the U.S. Army
Corps of Engineers; and the U.S. Bureau of Reclamation.
---------------------------------------------------------------------------
``Utility Special Entities,'' as defined in the proposed rule
amendment, are a narrow category of special entities distinguishable by
their electric energy and/or natural gas utility facilities, operations
and public service obligations. None of the Utility Special Entities is
a ``financial entity;'' all are nonfinancial entities and ``commercial
end-users'' as such term is used by Congress and regulatory policy
makers. ``Utility Operations-Related Swaps,'' as defined in the
proposed rule amendment, are a narrow category of ``swaps'' \13\ in the
nonfinancial or ``other commodity'' asset class. Such swaps are, by
definition, of product types intrinsically related to the commercial
risks associated with utility facilities, operations and public service
obligations, and are used to hedge or mitigate such commercial risks.
Such customized nonfinancial commodity swaps are typically not
available on exchanges or electronic trading platforms, due to the
myriad non-numeric operational conditions, requirements and
permutations embedded in such swaps.
---------------------------------------------------------------------------
\13\ This term has not yet been defined by the Commission to the
extent required to provide regulatory clarity to Petitioners and others
in the utility industry. The Petitioners and others in the utility
industry await publication in the Federal Register of rules further
defining ``swap,'' along with the Commission's response to public
comments on any further questions asked by the Commission in the most
recent statutory interpretations relevant to the definition of
``swap,'' the Commission's response to comments solicited on the
nonfinancial commodity ``trade option'' Interim Final Rule, the CFTC/
FERC jurisdictional Memoranda of Understanding called for by Section
720 of the Dodd-Frank Act, the ``tariffed transaction exemption(s)''
and ``between FPA 201(f) transaction exemption'' called for in new CEA
Sections 4(c)(6), and other final rules, interpretations and
exemptions. See the comment letter filed by the Electric Trade
Associations in the ``Product Definitions'' or ``Definition of ``Swap''
docket at: http://comments.cftc.gov/PublicComments/
ViewComment.aspx?id=47934&SearchText=Wasson, and other comment letters,
applications and petitions filed by the Petitioners and others in the
utility industry.
There is no need to wait to consider the proposed rule amendment
for the effective date of the Commission's final rules further defining
the term ``swap.'' The proposed rule amendment, as drafted, will only
be applicable to those utility operations-related transactions which
are ultimately subject to the Commission's jurisdiction as ``swaps,''
and would therefore be considered part of an entity's ``swap dealing
activity,'' and counted against either the general de minimis threshold
or the special entity sub-threshold. In this manner, the proposed rule
amendment is similar to all the Commission's regulations that include
the term ``swap,'' including the Entity Definition rules themselves.
None of these regulations can be fully understood or applied to
Petitioners' and other market participants' businesses until the
Commission's final rules further defining ``swap'' and other
foundational terms that include the term ``swap'' are effective for
relevant asset classes and product types.
---------------------------------------------------------------------------
The Petitioners commented on the Commission's proposed rules
further defining ``swap dealer'' raising concerns that both the general
de minimis threshold and the ``special entity sub-threshold'' needed to
be raised significantly. See comments filed by NFP Electric End User
Coalition, including APPA and LPPC with assistance from TAPS, in the
Commission's ``Entity Definitions'' docket, a link to which appears at:
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=27917&
SearchText=rural at 18-19, supporting the comments filed by the Edison
Electric Institute and the Electric Power Supply Association in the
same docket requesting significantly higher thresholds for both the
general de minimis threshold and the special entity sub-threshold than
were proposed by the Commission, a link to which appears at: http://
comments.cftc.gov/PublicComments/ViewComment.aspx?id=
27918&SearchText=.
The Commission acknowledges the Petitioners' comments in numerous
places in the Adopting Release for the Entity Definitions rules (the
``Adopting Release''). See, for example, 77 Fed. Reg. 30627 and 30707.
In the final rules, however, the Commission raised the general de
minimis threshold by a factor of 80 during the phase in period (and by
a factor of 30 thereafter)--from $100 million to $8 billion during the
phase in period (and $3 billion thereafter). In contrast, the
Commission left the special entity sub-threshold unchanged at $25
million. The Petitioners' concern about the competitive disadvantage
represented by the discrepancy between the two thresholds in the final
rules is the reason for this Petition.

A. Utility Special Entities Require Customized Utility Operations-
Related Swaps.
Utility Special Entities depend on nonfinancial commodity
transactions, trade options and ``swaps,'' as well as the futures
markets, to hedge commercial risks that arise from their utility
facilities, operations and public service obligations. Together, these
nonfinancial commodity markets play a central role in government-owned
utilities securing electric energy, fuel for generation and natural gas
supplies for delivery to consumers at reasonable and stable prices.
Specifically, many government-owned utilities purchase firm electric
energy, fuel and gas supplies in the physical delivery markets (in the
``cash'' or ``spot'' or ``forward'' markets) at prevailing and
fluctuating market prices, and enter into bilateral, financially-
settled nonfinancial commodity swaps with customized terms to hedge the
unique operational risks to which each Utility Special Entity is
subject.
The Utility Special Entities use Utility Operations-Related Swaps
to ensure reliability of utility service and to reduce utility
customers' exposure to future commodity price fluctuations and to
stabilize utility rates. In hedging, mitigating or managing the
commercial risks of its utility facilities operations or public service
obligations, the Utility Special Entity are engaged in commercial risk
management activities that are no different from the operations-related
hedging of an investor-owned utility or an electric cooperative located
in the same geographic region.

B. The ``Market'' for Each Particular Utility Operations-Related Swap
is Illiquid.
Utility Special Entities enter into these bilateral customized
swaps in illiquid regional or local ``markets.'' \14\ Some
counterparties available to transact with Utility Special Entities will
be major financial institutions or other financial entities, such as
hedge funds, that may or may not transact in other swap asset classes
or product types. Other available counterparties will be nonfinancial
counterparties, those which are not ``financial entities'' as such term
is defined in CEA Section 2(h)(7)(C).
---------------------------------------------------------------------------
\14\ The word ``markets'' is used in quotations in this context, as
Utility Operations-Related Swaps do not occur with anywhere near the
frequency or uniformity that financial ``swaps'' occur, or that
agricultural, metals, global oil or other product types of ``swaps'' in
the ``other commodity'' asset class occur. Utility Operations-Related
Swaps are, in some cases, negotiated over a period of days, weeks or
months. Some may be documented based on a master agreement template,
with many pages of specialized operational, credit and other risk
management provisions included by the bilateral counterparties as
schedules. Transacting under standardized master agreement templates
(with bilaterally negotiated schedules and transaction documents)
should not be confused with a conclusion or an assumption that there is
a trading ``market'' for Utility Operations-Related Swaps having,
standardized or ``market'' terms.
---------------------------------------------------------------------------
Each Utility Special Entity actively seeks out available swap
counterparties in order to hedge its unique, ongoing and dynamically-
changing commercial risks.\15\ Commercial risk management policies in
the energy industry typically require diversification of suppliers and
swap counterparties, limited concentration of supplier/vendor/
counterparty credit risk, and other commercial risk management metrics
to prudently manage the commercial risks of bilateral contracting
processes.
---------------------------------------------------------------------------
\15\ Utility Special Entities may also be called upon from time to
time by other utilities located in the same geographic region, by or in
coordination with electric reliability organizations, to act as
counterparties in Utility Operations-Related Swaps for electric system
reliability purposes. Such swaps should not be considered ``swap
dealing activity'' by the utility counterparty or counterparties to
such swaps. Otherwise, the Utility Special Entities may not be able to
participate in such swaps for reliability purposes without causing the
counterparty to exceed the Special Entity Sub-Threshold, which may
compromise the reliability of the interconnected electric system.
---------------------------------------------------------------------------
Each regional geographic market has a somewhat different group of
financial entity and nonfinancial counterparties available to enter
into customized Utility Operations-Related Swaps. An available
counterparty may own or operate commercial businesses related to the
particular nonfinancial commodity that underlies the Utility
Operations-Related Swap. It may be a neighboring utility or electric
cooperative, the owner of a merchant electric generation facility
located in the area, or a natural gas or coal company with production
assets in the region.
For example, a large natural gas utility or the owner of a large
merchant electric generation station in western Alabama might be
available as a nonfinancial counterparty for swaps referencing an
Alabama delivery point. But that same entity would not necessarily
offer the type of customized Utility Operations-Related Swap required
by a Utility Special Entity located in Oregon. Or, a natural gas
producer or coal producer with production assets in Wyoming might offer
Utility Operations-Related Swaps required by a California-based or
Oregon-based Utility Special Entity. But the same counterparty would
not necessarily enter into a similar Utility Operations-Related Swap
referencing a nonfinancial commodity delivered in the Southeast. Nor
would it necessarily offer a Utility Operations-Related Swap
referencing electric energy in any regional market.

C. Utility Special Entities Need All Available Utility Operations-
Related Swap Counterparties.
Due to the limited number of counterparties for any particular
Utility Operations-Related Swap in any particular region, each
available financial or nonfinancial swap counterparty, whether or not a
registered ``swap dealer,'' brings important market liquidity or
supplier/counterparty diversity for a Utility Special Entity. Multiple
available counterparties create price competition for the customized
swaps that a Utility Special Entity requires to cost-effectively hedge
or mitigate unique commercial risks.\16\
---------------------------------------------------------------------------
\16\ In the Adopting Release, the Commission cites comments made by
Petitioners' representatives and other energy industry market
participants at the Commission Roundtable and meetings on these
important points. See 77 Fed. Reg. at 30707-30708. Although a Utility
Special Entity may be able to seek out a CFTC-registered Wall Street
``swap dealer'' or another financial entity, such as a hedge fund, to
provide such a customized Utility Operations-Related Swap, if the
``swap dealer'' does not have assets in the region or is not otherwise
active in the particular regional nonfinancial commodity swap market,
the pricing and customization of the Utility Operations-Related Swap it
offers are unlikely to be competitive.
---------------------------------------------------------------------------
Based on an informal survey of some of the larger Utility Special
Entities, a substantial percentage of the counterparties that are
currently available to enter into Utility Operations-Related Swaps with
such Utility Special Entities are nonfinancial entities engaged in the
electric, natural gas, coal or another aspect of the energy industry in
the same geographic area as the specific Utility Special Entity.
Wall Street financial institutions and other financial entities
tend to offer such swaps only where there is standardization of
transaction terms and liquid trading markets: at trading hubs where the
financial entity's swaps can be promptly and effectively hedged to
maintain a ``balanced book.'' Nonfinancial entities with assets or
operations located in the geographic region may, as a result, face
parallel commercial risks and can use the Utility Operations-Related
Swap to manage some portion or aspect of the commercial risks inherent
in its own physical assets, liabilities and commercial obligations.\17\
---------------------------------------------------------------------------
\17\ The nonfinancial counterparty may itself be entering into a
Utility Operations-Related Swap ``for the purpose of hedging physical
positions,'' as that phrase appears in CFTC Regulation 1.3(ggg)(6)(iii)
and about which the Commission is seeking further comment in the
Adopting Release. That regulation is identified as an ``interim final
rule,'' and therefore presumably is still subject to further Commission
rulemaking before the rules defining ``swap dealer'' are, indeed,
final. See 77 Fed. Reg. 30612. See also footnote 6 with reference to
the Commission's anticipated further rulemakings on the definition of
``swap'' and nonfinancial commodity ``trade options.''
---------------------------------------------------------------------------
Because the Utility Special Entity is hedging a commercial risk,
its focus is to align the Utility Operations-Related Swap as closely as
possible with the underlying and unique commercial risk being hedged,
rather than to settle for a more standardized, shorter-term, and
therefore less ``perfect'' (and consequently less cost-effective) hedge
for such commercial risk.\18\
---------------------------------------------------------------------------
\18\ We have discussed the Special Entity Sub-Threshold issue with
energy trade associations and with large nonfinancial entities that
currently act as regular counterparties to Utility Special Entities in
these types of swaps. A number of these entities have indicated to
Petitioners that they share our concern about the sub-threshold, and
that they are prepared to file comments in support of this Petition.
See footnote 16.
---------------------------------------------------------------------------
D. Utility Operations-Related Swaps Often Have Large Notional Amounts.
Many Utility Operations-Related Swaps have longer terms than may be
typical in other swap asset classes or product types, as a result of
the long-term commercial risks being hedged--risks arising from long-
term utility service obligations, construction projects, generation
outage or availability projections, or long term fuel needs.
Consequently, the notional amount of such swaps can be quite large. In
addition, due to the volatile nature of the market prices of these
nonfinancial commodities, the notional amounts can fluctuate
dramatically over the term of a Utility Operations-Related Swap. The
prices of electric energy, fuel and natural gas are among the most
volatile of traded commodities, especially prices for illiquid delivery
points, subject to regional supply and demand factors such as weather,
and with customized operational conditions and terms.
A single 1 year 100 MW swap or a single 3 year 10,000 mmBtu/day
swap may have a notional value of $25 million.\19\ A nonfinancial
entity would, therefore, be available to enter into only one such swap
with Utility Special Entity counterparties in any rolling twelve-month
period. Otherwise, the nonfinancial entity risks exceeding the special
entity sub-threshold, and would be required to register with the
Commission as a ``swap dealer.''
---------------------------------------------------------------------------
\19\ These examples are based on available quotes for 100 MWs of
7x24 electric energy for calendar year 2013 at Mid-C, PJM West and SP-
15 for ``Firm LD'' power, and on Henry Hub calendar strip prices for
natural gas. Each of these examples is for a relatively liquid delivery
point, and for swaps that are not customized as are many Utility
Operations-Related Swaps. To put these examples (and the $25 million
Sub-Threshold) in context, the Los Angeles Department of Water and
Power owns or operates 6,000 MWs of electric generation, and the New
York Power Authority owns or operates 7,400 MWs of electric generation.
JEA, formerly the Jacksonville Electric Authority, hedges approximately
13.8 million mmBtus of natural gas in an average year as part of its
fuel procurement process for electric operations, based on the past 5
years actual hedging activity. If each of these Utility Special
Entities was limited to one $25 million hedge per year with each non-
``swap dealer'' counterparty, it would dramatically limit the ability
of these Utility Special Entities to hedge or mitigate commercial risks
arising from everyday utility operations.
---------------------------------------------------------------------------
E. Utility Special Entities are At a Competitive Disadvantage to
Similarly-Situated Market Participants due to the Special
Entity Sub-Threshold.
If the Commission denies the proposed rule amendment, Utility
Special Entities could still look to CFTC-registered swap dealers for
these types of swaps, or could use less customized, more expensive
commercial risk management solutions that might be available on an
exchange. Or Utility Special Entities could simply forego using
nonfinancial commodity swaps for commercial risk management purposes
entirely. At the same time, the available counterparties for Utility
Operations-Related Swaps could enter into up to $8 Billion notional in
swaps, or even $8 Billion in Utility Operations-Related Swaps, with
counterparties other than Utility Special Entities, including
neighboring investor-owned utilities and electric cooperatives. As a
direct result of the Special Entity Sub-Threshold, Utility Special
Entities are denied a level playing field in the competition for
available counterparties for these commercial risk hedging swaps.
Utility Special Entities are denied comparable, cost-effective access
to such commercial risk management tools that will instead be offered
to neighboring investor-owned utilities and electric cooperatives by
otherwise available market participants.\20\
---------------------------------------------------------------------------
\20\ An unintended consequence of the $25 million Special Entity
Sub-Threshold applied to Utility Operations-Related Swaps will be to
limit the Utility Special Entities' available counterparties and force
Utility Special Entities to engage in Utility Operations-Related Swaps
with financial institutions and other entities that are registered with
the CFTC. This would concentrate, not disperse, risk to the United
States financial system. For financial institutions, such activity may
or may not be an activity in which such financial institutions or their
``banking entity'' affiliates are permitted to engage once the
regulations implementing the Volcker Rule and other provisions of the
Dodd-Frank Act rulemakings are finalized. Such Utility Operations-
Related Swaps with ``swap dealer'' counterparties may also require the
posting of margin by Utility Special Entities (depending on the
applicable regulators' final rules on capital and margin).
---------------------------------------------------------------------------
In today's regional markets, a Utility Special Entity is equally as
likely as an investor-owned utility in the same region to be an
attractive counterparty for an entity that chooses to ``deal'' in
Utility Operations-Related Swaps, whether the entity is a nonfinancial
company hedging its own commercial risks (or ``hedging a physical
position'' as such phrase is more narrowly defined in the CFTC's
definition of ``swap dealer''), trading for profit (speculating), or
engaging in a regular business of dealing in such swaps. The ``playing
field'' between the Utility Special Entity and the investor-owned
utility, electric cooperative or any other counterparty is currently
``level.''
Moreover, in today's regional markets, if a market participant
(such as the Alabama merchant generator or the Wyoming natural gas or
coal producer referenced above) is considering establishing a new
entrant ``swap dealing'' business in specific regional product types of
Utility Operations-Related Swaps, it will similarly consider the
Utility Special Entity as a potential counterparty with the same
ability to transact as any other potential counterparty. The Utility
Special Entity benefits from any new or additional price competition.
Once the CFTC's Entity Definition rules are effective, as a result
of the significant disparity between the general de minimis threshold
and the special entity sub-threshold, the Alabama-based merchant
generator or the Wyoming-based natural gas or coal producer, or any
other market participant not intending to register as a ``swap
dealer,'' will substantially limit its swap dealing activity in Utility
Operations-Related Swaps with Utility Special Entities. Indeed, in
regions like California and the Southeast United States, where there
are geographic concentrations of Utility Special Entities, a non-``swap
dealer'' counterparty may only be able to execute one such Utility
Operations-Related Swap with one such Utility Special entity in a 12
month period without the risk of exceeding the $25 million sub-
threshold. The entity will set up its swap dealing activity business,
its business processes, its documentation and its compliance programs
to transact with counterparties other than the Utility Special
Entities, including neighboring investor-owned utilities and electric
cooperatives.\21\ The unworkably low, and comparatively
disadvantageous, Special Entity Sub-Threshold threatens the Utility
Special Entities' uninterrupted access to these important and cost-
effective commercial risk management tools.
---------------------------------------------------------------------------
\21\ The Adopting Release notes that the statute's de minimis
exception intended to increase competition within markets for swaps by
encouraging new entrants, thereby decreasing costs for commercial end-
users and decreasing systemic risks by lessening concentration of
dealing activity among a few major financial market participants. See
77 Fed. Reg. 30629. Ironically the special entity sub-threshold acts
directly contrary to this stated statutory and regulatory objective.
For Utility Special Entities hedging commercial risks, the sub-
threshold will serve to discourage new entrants and concentrate the
Utility Special Entity's counterparty credit risk. The proposed rule
amendment would restore this competitive, and less risky, market
structure.
---------------------------------------------------------------------------
IV. Supporting Arguments
For the following reasons, the Commission should approve the
proposed rule amendment as soon as possible:

A. The Commission has the Authority to Approve the Rule Amendment.
Section 1a(49)(D) of the Commodity Exchange Act (``CEA'') as
amended by the Dodd-Frank Act, and new CFTC Regulation 1.3(ggg)(4)(v)
authorize the Commission to change or modify the requirements of the de
minimis exception to the ``swap dealer'' definition by rule or
regulation, without engaging in further joint rulemaking or joint
interpretative guidance with the Securities and Exchange Commission.
The Adopting Release acknowledges this. See footnote 464 at 77 Fed.
Reg. 30634, and related text.
Section 1a(49)(D) provides as follows:

``. . . (D) De minimis exception.--The Commission shall exempt
from designation as a swap dealer an entity that engages in a
de minimis quantity of swap dealing in connection with
transactions with or on behalf of its customers. The Commission
shall promulgate regulations to establish factors with respect
to making of this determination to exempt.''

As the Commission notes on page 30702 of the Adopting Release, ``.
. . CEA Section 1a(49)(D) directs the CFTC to promulgate regulations to
establish factors with respect to the making of the determination to
apply the de minimis exceptions to the definition of the term `swap
dealer.' ''
New CFTC Regulation 1.3(ggg)(4)(v) provides as follows:

``. . . (v) Future adjustments to scope of the de minimum
exception. The Commission may by rule or regulation change the
requirements of the de minimis exception described in
paragraphs (ggg)(4)(i) through (iv) of this section.''

Clearly the Commission has the authority to approve the proposed
rule amendment.

B. The Factors Set Forth the Proposed Rule Amendment are Distinctly and
Uniquely Applicable to Utility Operations-Related Swaps and to
Utility Special Entities.
The proposed rule amendment will have no affect on the de minimis
exception to the ``security-based swap dealer'' definition. Nor will
the proposed rule amendment have any affect on the de minimis exception
to the Commission's ``swap dealer'' definition as it applies in general
to special entities (including Utility Special Entities) engaging in
financial swaps or nonfinancial ``other commodity'' swaps, other than
those product types critical to hedging or mitigating commercial risks
in the utility industry.
The factors set forth in the proposed rule amendment are not
applicable to security-based swap dealers or to their counterparties.
Counterparties to security-based swaps do not need such security-based
swaps to ``hedge or mitigate commercial risks'', as is the case with
commercial end-users' need for nonfinancial commodity swaps to hedge or
mitigate commercial risks. Congress specifically recognized the
importance of protecting ``commercial end-users'' access to
nonfinancial commodity swaps when it emphasized that the Dodd-Frank
Act's focus on financial market stability and price and market
transparency should not be achieved without also preserving commercial
end-users' access to swaps used to hedge or mitigate commercial
risks.\22\
---------------------------------------------------------------------------
\22\ See 156 Cong. Rec. H5238 (the ``Dodd-Lincoln letter'').
---------------------------------------------------------------------------
The factors that argue in favor of the Commission approving the
proposed rule amendment are also inapplicable to entities involved in
agricultural or metal commodities transactions and swaps. Such entities
are simply not subject to public service obligation comparable to those
that apply to utilities that require Utility Operations-Related Swaps
to hedge commercial risks associated with utility facilities,
operations and public service obligations. Utilities (including Utility
Special Entities) have public service obligations under Federal, state
and local laws and regulations, and utility reliability obligations,
that other industries simply do not share. Congress recognized these
important obligations throughout the Dodd-Frank Act as deserving of the
Commission's regulatory deference. See Section 720 of the Dodd-Frank
Act calling for FERC/CFTC Memoranda of Understanding, new CEA Section
2(a)(1)(I) regarding jurisdiction of the various energy regulatory
agencies, and new CEA Section 4(c)(6) directing the Commission to
consider public interest waivers of its jurisdiction.
The Commission clearly has the authority to approve the proposed
rule amendment. The factors that argue in favor of the proposed rule
amendment, and limit its affect, reflect the unique and the different
characteristics of these types of ``swaps'' and these market
participants, and recognize the differing applicable laws and
regulations, and statutory and regulatory policies The Commission
should approve the proposed rule amendment and do so as soon as
possible.

C. Nothing in the Dodd-Frank Act or the CEA Requires the Special Entity
Sub-Threshold.
The proposed rule amendment is narrowly tailored to achieve both
the statutory goals and Congressional intent underlying the Dodd-Frank
Act, and to leave in place the supplemental investor protection
objectives of the Commission in including the Special Entity Sub-
Threshold in the ``swap dealer'' definition.
In the Dodd-Frank Act, Congress imposed on registered ``swap
dealers'' heightened business conduct standards when advising, offering
or entering into swaps with ``special entities.'' Nothing in the Dodd-
Frank Act imposes or requires the Commission to impose business conduct
standards on entities that are not required to register as ``swap
dealers.'' Nothing in the Dodd-Frank Act requires the Commission to
impose an exponentially smaller de minimis sub-threshold for
counterparties that are not registered ``swap dealers'' and that enter
into swaps to which ``special entities'' are counterparties. The
Adopting Release acknowledges as much, characterizing the lower
threshold as ``consistent with the fact that Title VII's requirements
applicable to swap dealers . . . provide heightened protection to these
types of entities.'' 77 Fed. Reg. at 30630 (emphasis added).
The Adopting Release cites the Dodd-Frank Act provisions that
impose on registered swap dealers and major swap participants (those
market professionals whose activities are directly regulated by the
Commission) heightened business conduct standards and documentation
requirements for interacting with ``special entities.'' The Adopting
Release then extrapolates without explanation as to why it is
consistent for the Commission to extend its regulatory reach beyond the
market professionals registered as ``swap dealers,'' whose conduct the
statute intends it to regulate, to impose restrictions on the
activities of entities that are not swap dealers, and whose de minimis
``swap dealing activities'' do not require such registration. The
Special Entity Sub-Threshold is a clear regulatory overreach by the
Commission, and should be modified where such regulatory overreach
negatively affects the ability of yet another group of entities that
are not ``swap dealing''--the ``Utility Special Entities''--to hedge or
mitigate the commercial risks of their nonfinancial, public service
enterprises.
The Adopting Release gives examples of situations where the special
entity ``lacked the requisite sophistication and experience to
independently evaluate the risks of the investment and exposed the
[special entity] to a heightened risk of catastrophic loss ultimately
led to a complete loss of their investments.'' See footnote 425 and
text accompanying at 77 Fed. Reg. 30630 (emphasis added). In the
examples, the special entities were acting outside the scope of their
core operations as investors in financial derivatives, interacting with
financial institution or ``financial entity'' market professionals,
using cash reserves or other cash assets of the special entity to
invest (for profit or loss) in financial derivatives instruments. By
contrast, the Utility Special Entities use Utility Operations-Related
Swaps to hedge the commercial risks of their core utility operations,
not to invest for profit.

D. The Proposed Rule Amendment is Consistent with Both Congressional
Intent of the Dodd-Frank Act and Will have No Affect on the
Commission's Investor Protection Policy Objectives.
The investor protection objectives of the Dodd-Frank Act, and the
Commission's own ``consistent'' and supplemental investor protection
objectives as expressed in the Adopting Release, would not be affected
or compromised by the proposed rule amendment. As is clear from the
proposed definition of ``Utility Operations-Related Swap,'' the Utility
Special Entity enters into such a nonfinancial commodity swap to hedge
commercial risks that arise from its utility facilities, operations and
public service obligations.
The proposed rule amendment is drafted narrowly to respect the
Commission's investor protection policies but to achieve the distinct,
but equally important, Congressional intent of the Dodd-Frank Act: to
preserve cost-effective (and comparative, competitively equal) access
to nonfinancial commodity swaps that Utility Special Entities use ``to
hedge or mitigate commercial risks.''
The proposed rule amendment does not amend either the general de
minimis threshold for swap dealing activity. The general de minimis
threshold would continue to apply to Utility Operations-Related Swaps
to which Utility Special Entities are counterparties. Nor does the
proposed rule amendment change the ``special entity sub-threshold'' for
swaps in asset classes or product types other than Utility Operations-
Related Swaps to which Utility Special Entities are counterparties.
In defining the term ``Special Entity'' in Section 4s(h)(2)(C) of
the Dodd-Frank Act and establishing the heightened business conduct
standards for registered ``swap dealers,'' Congress did not intend for
the Commission expand its regulatory oversight beyond oversight of
regulated ``swap dealers'' to place restrictions on entities that are
not required to register as ``swap dealers.'' In establishing the
Special Entity Sub-Threshold and then not substantially raising it when
it raised the general de minimis threshold, the Commission restricted
Utility Special Entities' competitive abilities, and severely
restricted Utility Special Entities' access to the nonfinancial
commodity swaps needed to cost-effectively hedge or mitigate commercial
risks.

V. Process and Timeline for Petition
The Petitioners respectfully request the Commission to act as soon
as possible on the proposed rule amendment--to remove continuing
regulatory uncertainty for the Utility Special Entities and
counterparties that would, but for the Special Entity Sub-Threshold, be
available to enter into Utility Operations-Related Transactions with
Utility Special Entities. As the Commission's new ``swap'' regulations
are proposed, become final and implementation begins, market
participants are evaluating whether and how to participate in the new
market structure for ``swaps.'' At the same time, Utility Special
Entities have continuing utility public service obligations to provide
affordable, reliable utility service to their customers, and
consequently have both short-term and long-term commercial risks to
hedge.
As the effective dates and compliance dates approach for the new
``swap'' regulatory regime, market participants are beginning to turn
their attention away from current activities in nonfinancial
commodities and commodity swaps in general. The challenges of the new
regulatory requirements applicable to ``swaps,'' including challenges
for systems, staffing, compliance, documentation and reporting are
overwhelming, even for the largest financial institutions and financial
markets professionals, especially given the tight and interrelated
compliance timelines.
The added challenge of determining whether to register as a ``swap
dealer'' for one or more asset classes or product types of ``swaps''
are even more daunting for a nonfinancial entity, whose primary and
ongoing business is not trading or investing or dealing in the
financial markets, but drilling for natural gas, mining coal, or
generating, transmitting and/or delivering electric energy or natural
gas to consumers.\23\
---------------------------------------------------------------------------
\23\ A number of the nonfinancial entities with whom the
Petitioners (or the trade association Petitioners' members) transact in
Utility Operations-Related Swaps have told us that they are currently
evaluating their nonfinancial commodity ``swap'' activities in light of
the final Entity Definitions rules, the Interim Final Rule in Section
1.3(ggg)(6)(iii), and the statutory guidance provided in the Adopting
Release and elsewhere in the CFTC's regulations, interpretations and
precedents. Such nonfinancial entities are also awaiting the CFTC's
final rules defining the term ``swap,'' which is the foundational
rulemaking which will enable the energy industry to understand the
scope of the CFTC's jurisdiction over our industry's transactions. As
of July 10, 2012, for the electric and natural gas utility industry,
the challenges are compounded by the continuing uncertainty as to what
is and isn't a ``swap,'' a ``nonfinancial commodity forward''
transaction, a nonfinancial commodity forward with embedded
optionality, or a ``trade option.'' See footnote 6 above. Once the
rules defining ``swap'' are final with respect to our industry's
transactions, each nonfinancial entity will then (and can only then)
analyze which of its activities will fall within the definition of
``swap,'' and therefore would or could be ``swap dealing,'' which of
its activities will be excluded as ``hedging a physical position''
(depending on the outcome of that final rulemaking), or fit within
other safe harbors under the interpretive guidance provided by the
Commission. Then and only then can the nonfinancial entity decide, as a
business matter, whether to continue all or any of its swap dealing
activities, and whether to register as a ``swap dealer'' or to register
for a limited designation as a ``swap dealer'' for certain asset
classes and product types (that may or may not include particular
Utility Operations-Related Swaps). Alternatively, only then can such a
nonfinancial entity alternatively decide to wind down any swap
activities which the Commission might consider to be ``swap dealing
activities.'' Nothing requires a nonfinancial entity (whose primary
business is not to engage in financial markets transactions like
``swaps'') to continue its past or current business strategies. If a
particular nonfinancial entity decides to continue some level of swap
dealing activity, it may decide not to continue such activity as a
registered ``swap dealer.'' At last decision point, once the new Dodd-
Frank Act rules are effective and as compliance dates approach, these
entities will restrict their swap dealing activity to stay well below
the two very different de minimis exception thresholds in the CFTC's
swap dealer definition.
---------------------------------------------------------------------------
If a market participant decides to continue some amount of ``swap
dealing activity'' in Utility Operations-Related Swaps, it will
carefully evaluate and then establish compliance procedures to monitor
the two de minimis thresholds. In doing so, it will certainly hesitate
or delay incurring the expense of setting up specially calibrated
systems, compliance processes and staff training in order to engage in
one or two such swaps with Utility Special Entities within a 12 month
period. A nonfinancial counterparty that does not choose to register as
a ``swap dealer'' will instead understandably focus on modifying its
business processes and documents to engage in swaps with counterparties
other than Utility Special Entities, under the general de minimis
exception threshold.
We request that the Commission promptly publish the proposed rule
amendment for comment in the Federal Register, without waiting for the
effective date of the Entity Definitions rules. We recommend a public
comment period of no longer than 20 days, and respectfully request
publication of the Commission's final approval or grounds for denying
the rule amendment within 10 days thereafter.\24\ The Petitioners
request that the amended rule be retroactive and prospective for all
Utility Operations-Related Swaps to which a Utility Special Entity is a
counterparty entered into after the effective date of the Entity
Definition rules.
---------------------------------------------------------------------------
\24\ The proposed rule amendment relieves a competitive restriction
on Utility Special Entities, and modifies the special entity sub-
threshold to the de minimis exception to the definition of ``swap
dealer.'' The Commission and interested persons in the electric and
natural gas industry have been on notice of the Utility Special
Entities' concerns since early May 2012. As a result, the proposed rule
amendment is entitled to the earlier effective date permitted by CFTC
Regulation 13.6.
---------------------------------------------------------------------------
VI. Conclusion
The Petitioners respectfully petition the Commission under CFTC
Regulation 13.2 to amend CFTC Regulation 1(ggg)(4), which implements
the de minimis exception to the definition of ``swap dealer,'' as
described above.
Signature Page--Special Entity Sub-Threshold Petition
Please contact any of the individuals below or Patricia
Dondanville, Reed Smith LLP, 10 South Wacker Drive, 40th Floor, Chicago
Illinois 60606, telephone (312) 207-3911, or e-mail
pdondanville@reedsmith.com, if you have questions regarding this
Petition.
Respectfully submitted,

American Public Power Association Large Public Power Council

Susan Kelly Noreen Roche-Carter

Susan Kelly Noreen Roche-Carter
Senior Vice President of Policy Chair, Tax and Finance Task Force
Analysis and General Counsel c/o Sacramento Municipal Utility
District
1875 Connecticut Avenue, N.W. 6201 S Street
Suite 1200 Sacramento, CA 95817-1899
Washington, D.C. 20009-5715
Tel: (202) 467-2933 Tel: (916) 732-6509
E-mail: skelly@publicpower.org E-mail: nrochec@smud.org

Transmission Access Policy Study American Public Gas Association
Group

John Twitty David Schryver

John Twitty David Schryver
Executive Director Executive Vice President
4203 East Woodland Street 201 Massachusetts Avenue, NE
Suite C-4
Springfield, MO 65809 Washington, DC 20002
Tel: (414) 838-8576 Tel: (202) 464-0835
E-mail: 835consulting@gmail.com E-mail: dschryver@apga.org

Bonneville Power Administration

Virginia Schaeffer

Virginia K. Schaeffer
Attorney
Office of the General Counsel--LC-7
P.O. Box 3621
Portland, Oregon 98208-3621
Tel: (503)230-4030
E-mail: vkschaeffer@bpa.gov

CC:

Honorable Gary Gensler, Chairman

Honorable Bart Chilton, Commissioner

Honorable Jill E. Sommers, Commissioner

Honorable Scott O'Malia, Commissioner

Honorable Mark Wetjen, Commissioner

Office of the CFTC General Counsel

The Chairman. Thank you for your testimony, and I would
note to my colleagues on the Committee that at approximately
1:05, maybe 1:15, we will begin a series of votes, so we will
endeavor to conclude all of our business in a timely fashion. I
recognize myself for 5 minutes.
Mr. Duffy, does the CME's recent designation by the FSOC
and the regulatory requirements associated with it put CME in a
better position to hold customer segregated funds instead of a
third-party custodian?
Mr. Duffy. Well, I don't know if the designation has
anything to do with CME or a third party holding the funds. You
know, this is something that we had put out there just to--we
don't have all the details worked out yet. We still believe
that the FCMs are very capable of holding the customer funds,
but at the same time, we know there needs to be confidence in
the marketplace so if in fact the customers felt safer with CME
Group or a third-party depository, we would be prepared to move
forward with that.
The Chairman. Very good point.
Mr. Roth, your testimony states that you began an
examination of PFGBest in mid-June. Was it a scheduled audit or
inspired by some anomaly?
Mr. Roth. The audit that we began in mid-June was part of
our regular cycle of audits for FCMs where we try to see each
FCM each year. I don't want to suggest that that is the only
time we ever examined PFG. We had a number of limited-scope
audits involving sales practice-type issues and their
supervision of IBs but the June audit was part of the regular
cycle.
The Chairman. For the regular audits that you conducted of
PFGBest, was Mr. Wasendorf, Sr. ever personally involved in
those audits?
Mr. Roth. When we would ask questions of staff, I am sure
there were certain questions that we posed to staff that were
answered by Mr. Wasendorf, Sr. I can't say specifically which
questions were directed to him and which were to the chief
compliance officer or the chief financial officer. It would not
surprise me if we had posed certain questions directly to Mr.
Wasendorf.
The Chairman. Based on NFA's internal investigations of
PFGBest, was this a Ponzi scheme in the classic sense?
Mr. Roth. It is a distinction that no one but a regulator
would care about. It is not a Ponzi scheme in the sense that
they were reporting false profits to customers and paying old
customers off with new customer money. It was really just more
of an outright theft of customer funds.
The Chairman. Thinking about the description both in your
written testimony and your oral, do you believe that more than
one person would be required to be involved in such a
defrauding of customers and regulators alike. I mean, getting
both the customers and the regulators is a pretty impressive
accomplishment.
Mr. Roth. You know, obviously there is an ongoing
investigation conducted by the Justice Department. I don't have
any firsthand facts. I can just tell you that the volume, the
sheer volume of forged documents produced on a daily basis was
fairly staggering, and again had to be produced on a daily
basis, and Mr. Wasendorf obviously traveled occasionally and
wasn't in the office, but I really don't have any firsthand
knowledge. I hope that the investigation will ultimately
uncover that.
The Chairman. Thank you.
Mr. Lukken, the CFTC and the SEC have different approaches
to writing and disseminating rules as required by Dodd-Frank.
CFTC has formalized the rules basically one at a time, in some
cases involving an effective date until 60 days after issuing
the final rules on the entity or the product definitions. The
SEC, on the other hand, is holding rules basically until all of
the rules are completed. It will then issue a sequencing
document, as I understand it, and solicit public comment. Which
agency approach is right? You have a little bit of insight
here. And why?
Mr. Lukken. Well, as I mentioned, the Dodd-Frank
implementation, although conceptually most people are in
agreement with what came out of the G20 commitment in
Pittsburgh after the financial crisis, but the implementation
of that has been very tricky and complex within the industry.
As I mentioned in my testimony, the SEC has actually put
forward a good way to try to give certainty to the industry of
how they are going to implement this rather than devote
resources, time and energy potentially wasted if you are either
in and it turns out that you are out and you may devote
resources unnecessarily, or the opposite where you are caught,
where you think you are not in, but you turn out to be in. The
SEC seems to have taken a logical approach, a measured
approach, and I would encourage the CFTC to do the same.
The Chairman. Mr. Heck and Mr. Conner, I believe we all
heard together here today the CFTC Chairman indicate that he
would address the issues pertaining to the recording of
farmers' conversation as it comes to contracts. Do you find
that to be a reassuring public, stressing public, statement by
the Chairman in that regard?
Mr. Conner. Mr. Chairman, I do, and we have worked very
closely with Chairman Gensler throughout the rulemaking process
and he has been good to his word, and he was pretty clear
today. We look forward to seeing the follow-through on that on
what we think is really a pretty absurd concept, when you
really get down to putting it in place out there on the ground.
Mr. Heck. I believe, Mr. Chairman, at the NGFA, we would
agree with Mr. Conner's comments. I think the CFTC is open to
dialogue on this point and we will certainly take advantage of
that.
The Chairman. Mr. McElroy, with my colleagues indulging me
for one last question on the final swap rule, you mentioned the
public power and public gas utilities and the new costs and how
that will be moved on down to the ratepayers, because
ultimately that is who pays the bills in regards to utilities.
One last question, and it is more rhetorical and you can answer
if you care to. What did the customers of public power and gas
companies have to do with the financial crisis to deserve this?
Mr. McElroy. That is a question we have asked over and over
again, and we don't have a good answer for that.
The Chairman. My time has expired. I turn to the fine
gentleman from Iowa for his 5 minutes.
Mr. Boswell. Well, thank you, Mr. Chairman, and I just--
again, our earlier dialogue, you got it right what you were
trying to do as far as the authorization committee but the
appropriations side of it is a concern of mine, and I kind of
want to talk about that just a little bit.
First off, I guess I will go to Mr. Roth. Mr. Wasendorf had
been a member of the NFA advisory committee and the chief
compliance officer of this had been a senior compliance officer
at NFA as well. It indicates to me in looking at the magnitude
of this whole thing, there must be quite a few, or could be
quite a few others implicated. What is your thought about that,
and if you think there could be others, what are we doing to
find out?
Mr. Roth. Well, let me first state with respect to the
chief compliance officer, she had been a former employee of NFA
but she left NFA 15 years ago, so that is a pretty long
departure. I don't think any of the people that were involved
in our audits had overlapped with her at NFA.
Mr. Boswell. So her information having been on the inside
wouldn't necessarily be applicable to how she would try to
defraud us now?
Mr. Roth. Well, obviously, the procedures that we follow
now aren't the procedures that we followed 15 years ago, but I
would also point out, I think there were reports trying to
portray her as having been a high-level executive at NFA, and
she wasn't. She was a member of the compliance department but
she didn't have any sort of senior management position at all.
You mentioned Mr. Wasendorf's position on our FCM advisory
committee. The FCM advisory committee is a committee that does
just that. It has no authority to take any action. It advises
the board on any such rulemaking issues that are coming before
the board. Mr. Wasendorf was one of the nine or ten members on
that committee.
Mr. Boswell. Okay. I am satisfied with that answer.
Again, the magnitude, it seems to me like there has to be a
lot of people involved in this day-to-day operation of the
fraud that took place.
Mr. Roth. Congressman, one point, when we talk about
preventing this type of fraud in the future, and I have tried
to describe the steps we are taking to really make the
surveillance of customer segregated funds as tight as we
possibly can, but let me just mention an obvious point, I
guess. One way to prevent fraud is to deter fraud through
vigorous prosecutions of the laws that are on the books now,
and everybody would agree with that and I would certainly hope
that the ongoing investigation conducted by the Justice
Department will uncover all the evidence and ultimately make
that judgment as to whether other people were involved or not.
Mr. Boswell. Well, I also in our conversation understand
that because of your funding system, you are actually expanding
the size of your operation, personnel, equipment and so on. To
what extent are you expanding and where do you intend to go?
Mr. Roth. I would say that over the last 5 to 6 years, we
have had a 33 percent increase in the size of our compliance
department just because of increased demands. Our budget this
year that was just approved by the board calls for a 27 percent
increase in administrative spending. That is in anticipation of
the increased responsibilities under Dodd-Frank. We frankly
anticipate we will----
Mr. Boswell. Thank you. I understand it well.
And then I guess it picks up, Mr. Chairman, my point is,
how does CFTC do their job, and I continue to be concerned
about that.
Mr. Conner, I haven't seen you for a while. You know my
respect and appreciation for co-ops and farmers and ranchers
and what it means to us, and I would guess that we have a lot
of people out there that were involved in this recent thing
that have really been whacked pretty hard. Would you agree to
that?
Mr. Conner. Well, we certainly know we have members and
farmer-owners, Congressman, who were caught up in the MF Global
circumstance. I think it is a little too early to say in the
other Sioux City circumstance exactly the impact but certainly
you can expect some.
Mr. Boswell. You heard Mr. Roth--thank you, Mr. Roth, for
your straightforwardness about how you intend to expand and how
you are doing it and so on. Are the rest of you, are you doing
the same thing? And also today's electronics, are you actually
looking at what the bank is doing as you look at the reports
you are getting back? Are you doing that now? Maybe you might
comment on that, any and all.
Mr. Duffy. Well, Mr. Boswell, at the CME, we are working in
conjunction with the NFA and the CFTC to have that ability to
go ahead and look straight through into the bank records.
Mr. Boswell. You are looking at it, but are you doing it?
Mr. Duffy. We have the ability today to call the FCM and
say we want to have a look at the bank statement to make sure
the monies are there. Now, it will go on a more real-time basis
but at the moment right now we can today as of recently go
ahead and deploy this technology.
Mr. Boswell. My time is running out, but any of the rest of
you doing it any different than what we just have heard?
Mr. Lukken. I wouldn't say differently but the FCMs, the
problem needs to be solved at all levels, at the Federal
regulatory level, and Chairman Gensler testified this morning
that he is looking at this, at the self-regulatory level, but
the firms themselves who our trade association represent. They
are implementing internal controls, making sure there is
separation of duties between CFOs and compliance people, making
sure that all the controls are in place and disclosures are
happening so that this can be ferreted out earlier so that this
doesn't occur over a 20 year period of time.
Mr. Boswell. Mr. Chairman, my time is up. Could we indulge
the rest of them to see if they want to comment on that
particular question?
The Chairman. The panel is most welcome to address any
thoughts to the Member's question they care to.
It looks like the gentleman's time has expired.
Mr. Boswell. Thank you.
The Chairman. The chair now recognizes the gentleman from
Florida for 5 minutes.
Mr. Southerland. Thank you, Mr. Chairman.
I have to take a deep breath because you guys have some
major problems, and it would be very convenient to blame the
lack of regulation. You know, I have been a state regulator or
appointed to serve as Chairman of regulatory boards. Mr.
Lukken, you mentioned educating customers. Well, that is great.
That is great. You mentioned that with depressed futures
volumes, historically low interest rates and an
ultracompetitive pricing model, FCMs are under tremendous
strain financially. Well, bless your heart. My heart bleeds for
you. I am being a little facetious there because it doesn't. My
heart bleeds for the thousands of hardworking men and women
that have been damaged permanently because of your inaction.
You know, it is not a sin of commission that you are guilty of.
It is a sin of omission.
My family business is in an industry that we helped self-
regulate, and as the Chairman of boards in the State of
Florida, I have handed down death sentences to businesses who
have violated the public trust. Now, your challenges are not
depressed futures volumes. Your challenges are not historically
low interest rates. Your challenges are not ultracompetitive
pricing models or the tremendous strain financially. Gentlemen,
you represent an industry that has an integrity crisis, an
integrity crisis, and you can't build a marriage, a family, a
small business, a state, a country, you can build nothing of
value that can withstand the long haul apart from integrity.
I am led to believe here that for 20 years this company
fooled you. You are the front line. You are it to whom much is
given, much is expected. I have little pity for you. I have
anger for what I have heard here today.
You know, we talk about studying. Well, that is great.
Studying? Do something. We talked about--one of the things that
I hear--we talk about the insurance, the Securities Investor
Protection Corporation, how it needs to be spread to protect
the customers. We have talked about that. Well, by God, do it.
Make it happen. Restore public trust. You have an integrity
problem, and we as Members of Congress, we can't solve your
problems. We can sit here and express anger from those that we
represent that have been harmed by the inaction of this
industry.
I shiver to think what else is out there. It terrifies me.
And Mr. Chairman, I have to tell you, my blood is boiling
because you have not earned the right--you shared here, Mr.
Duffy, you talked about you caution us to move authority to the
government and away from the industry. What have you done to
deserve self-regulation? Your inaction is destroying lives, and
it angers me, and I know that down here on the other end, APPA,
I know that Mr. McElroy, you talk about the great things in
Dodd-Frank. Well, let me tell you some unintended consequences
as a small business owner. I will tell you, Mr. Conner, the
small businesses that you represent, we can't get capital from
our community banks because of Dodd-Frank. There are unintended
consequences of that regulation, and so when you sit here and
you talk about you support it, well, that is wonderful, but to
the small businesses that represent the American economy, Dodd-
Frank is killing our community banks, and you have now created
the legitimacy of regulation, and it will have unintended
consequences on good, hardworking men and women that are doing
everything right, and my family is one of those. I have a
brother that got up this morning at 3:30 to go to the log woods
to haul timber to mills. More regulation? He can't work any
harder. To whom much is given, much is expected. I am terribly
disappointed.
And Mr. Chairman, I know I have gone over my time, but
there are some things that I think need to be said.
The Chairman. The gentleman's time has expired. The chair
now turns to the gentleman from California for 5 minutes, Mr.
Baca.
Mr. Baca. Well, thank you very much, and I want to thank
the witnesses, and I am on the other side and I appreciate the
Dodd-Frank legislation because it is important that we do have
accountability and we have those kind of regulations that are
important for us and that we have the transparency. We also
have the oversight, and if we didn't have this, that is why the
abuse would be there. And so it is very important when we talk
about it, it is easy to talk about not having the regulations.
That is what led us to the problems that we have. We didn't
have a lot of the regulations in the banking industry and Wall
Street, and then we used to have a gentleman that says trust
me, we are making the right kind of decisions. We didn't make
the right kind of decisions. That is why we have come up with
the Dodd-Frank. We have to allow it to grow and develop and
hold those accountabilities to allow community banks and others
to do the right thing for the American people, and unless we do
that and we have those regulations in place, it is not going to
happen. I just wanted to state that because my good friend from
Florida indicated different. I just wanted to make sure that I
presented my side that is a little bit different than him
because he comes from an area that he would like to do whatever
he wants. I don't believe that is the way we should be and we
should have regulations in place. So thank you very much.
With that, I would like to ask a question of Mr. Roth in
terms of how does--in lay terms, how does the e-confirmation
process of customer segregated bank accounts work for the FCM
members? And this is for Mr. Roth.
Mr. Roth. The e-confirmation process that we began using
after the first of the year basically makes the confirmation
process much less paper-intensive, more efficient and really is
no additional cost to the FCM at all. There is a cost that is
paid by NFA to the vendor of this service. But it has really
improved both efficiency and in this particular case helped
uncover a fraud.
Mr. Baca. Thank you, and that is why the regulations are
important and that is the reason the Dodd-Frank is there, and
if we didn't have it, we wouldn't be able to detect that. And
do you think that online confirmation will be an effective
oversight and fraud-prevention tool? Why or why not?
Mr. Roth. I think it is a good step but I don't think it is
enough. That is why we are going to our board and asking for
this direct view-only online access and then moreover building
a system in which we will get daily reports from all
depositories for customer segregated funds. So the e-confirm
process has been a huge help, and it is a step along the way,
but there are certainly bolder steps that we are taking and
starting at our August board meeting and moving on from there
to build the system I described in my testimony.
Mr. Baca. Thank you. Let me ask just a general question
because it is a topic that we were discussing and my good
friend from Florida was saying that we didn't need the
regulations. Do you believe that we should have regulations and
regulations should be in place whether it is the Dodd-Frank
legislation or any others? Do you believe that regulations are
good for us? And I open it to all of you. Or should we just
allow everybody to say trust me, I am going to do the right
thing? And I open it up for all of you?
Mr. Roth. Could I go first?
Mr. Baca. Yes.
Mr. Roth. I have been a regulator for 29 years so I may
bring a little bias to this question, but obviously the whole
point of regulation is based on the recognition that these
markets are vital to our economy. For the markets to thrive,
there has to be public confidence in the integrity of the
markets, and the regulatory process is designed to ensure that
integrity and foster that public confidence--so regulation is
essential. The question is, how to do it right, how to do it
smart and how to do it in a way that the bad guys can't win?
Mr. Baca. That is the only way that we can also restore
that public trust that the gentleman from Florida said that we
needed to do, but thank you.
I will open it up for the rest, any one of you that would
like to address it.
Mr. Lukken. I will quickly address it. I am a former
regulator so I am supportive, as Dan mentioned, smart
regulation, making sure that it makes sense for the
marketplace, that it stops this type of behavior but also
proper enforcement of that regulation. I think that is where we
need to concentrate. There are lots of rules to the road. Let
us make sure that those are being properly enforced, and
certainly some of the things that have been mentioned today,
the e-confirm system, giving access to regulators, those are
all great tools that will allow them to enforce these rules and
make sure this is ferreted out quickly.
Mr. Baca. Thank you.
Anyone else?
Mr. McElroy. I think we are generally supportive but if it
goes so far and we do have unintended consequences, we have to
be careful of that. From our industry standpoint, looking at
some of the regulations that appear to potentially affect,
adversely affect our customers in public power and small
businesses is a little bit of a challenge given the cost-
benefit, and it is an unintended consequence. On a broad scheme
in terms of the regulatory regimes and issues, I couldn't agree
more, couldn't agree more, but when it gets down to such a low
level and unintended consequences, there needs to be a way to
address that and ensure that those small folks, small
businesses on Main Street don't get hurt.
Mr. Baca. Right, and those are areas that we need to work
on and try to define to allow that public trust and allow that
entity to grow, so all of us can agree on that.
Anybody else? If not, I know my time has expired. If not, I
would like to thank the Chairman for allowing me to ask a few
questions. Thank you very much.
The Chairman. The gentleman's time has expired, and the
Chairman will just note that his good friends on the West Coast
and East Coast always have very sincere discussions about
philosophy and policy.
And with that, the gentleman from Illinois is recognized
for the final set of questions for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman, and I do thank you
all for being here. These are tough times. This is difficult.
You know, it is not new that we have corrupt people who break
the law, but we have to do everything we can to go after them
and to be working together to make sure that this doesn't
happen, that we keep the integrity in a system that is so
important to the viability of our nation, of our future.
I want to just follow up on a couple questions I had for
Chairman Gensler just to see if you have any thoughts on this.
I had mentioned about yesterday the CFTC publishing the initial
list of swaps proposed to be subject to the clearing mandate,
talked about that Europe will not be prepared to have any such
clearing mandate in effect until at least 2013. The Chairman
talked a little bit about Asia and where they are coming in,
also a different timing. So it sounds like again there are
going to be different timings that these mandates will come in.
I wanted to ask you what impact you expect the timing of these
mandates to have since they are not coordinated.
Mr. Duffy. I will just quickly answer. I think that any
time you don't have universal coordination on markets that are
global in nature, it could always be an issue. So obviously we
are a bit concerned about the United States always being the
leader in regulation and nobody else following because
sometimes business will go along with it. I know the financial
services industry has not exactly been the shining star in the
room over the last several years, but I assure you, it is one
of the most important things that the United States of America
has going for it is the United States financial system. I would
hate to see us get overregulated to a point or have rules put
upon us that put us in a very--a place that is very anti-
competitive, so that is really my biggest concern, sir.
Mr. Hultgren. I am concerned of that as well. Any other
thoughts that anyone has? Otherwise I have a couple other
questions.
LIBOR has been a big issue obviously through this process,
and given the impact that LIBOR has had on lending for
mortgages and credit cards and now suspicion cast on the
integrity of that rate. I wonder if there are any other
benchmarks that are out there that may be more reliable from
your perspective?
Mr. Duffy. There are several benchmarks out there, sir, but
you have to realize that there is $377 trillion benchmarked to
LIBOR with an additional $10 trillion in loans. This is
probably the largest amount of money benchmarked to any
particular one asset class, and there are other rates such as
Fed funds that could maybe potentially substitute. I think that
many people believe that with the now-discovery of what CFTC
has done with Barclays that the LIBOR process as it goes
forward may become the most reliable index, not the most
vaulted index.
Mr. Hultgren. Let me stick with you, Mr. Duffy, if that is
all right, just a couple more questions. I know that you
testified about hundreds of millions of dollars that the CME
has dedicated to SIPC trustee and you talked about the CME
trust pledge. I wonder if the trustee had taken advantage of
the CME guarantee. Why, if so, or why not?
Mr. Duffy. Congressman, as everybody knows, CME Group
pledged $550 million to the clients of MF Global to the trustee
in order to get money back as quickly as possible. The trustee,
I believe, is up to 82 on the dollar and working its way north
of that. I don't believe the trustee has taken advantage of CME
Group in any which way. I think the trustee has had the ability
to move fast because of what CME did, so I don't believe it was
taken advantage of. I think it was the right thing for us to do
and the right thing for the clients to get.
Mr. Hultgren. Again, Mr. Duffy, Mr. Roth, maybe if you
could comment on this, and this is just a fundamental question
of who has more interest in the integrity of the futures
market? The exchanges or the government? I would like to hear
your point of view of how important integrity is.
Mr. Duffy. I have a real philosophical view on this since I
spent my first 22 years never getting a paycheck in my life and
the only way I made a paycheck is by trading. I believe that
the fundamental core of the futures market is the credibility
of it, and that is where I sit today as Chairman and President
of the company. That is the philosophy, is the credibility,
contrary to what Mr. Southerland said, and the core of this
business, and we will do whatever it takes. So whether we are
now a for-profit public company, if we don't have a credible
business line, we don't have a credible for-profit public
company, and that is the way we put it in order.
Mr. Roth. From my point of view, Congressman, the
suggestion that the fraud at Peregrine would have been
uncovered more quickly if the examiners had been on the
government's payroll instead of our payroll is something that I
just don't think has a rational basis in fact. I think to me,
the key question is less who is doing the looking than it is
how are they doing the looking. That is why we immediately
after MF Global started trying to incorporate as much
technology as we can in this process and why we are taking the
steps that I outlined in my testimony.
Mr. Hultgren. Well, my time has expired. I appreciate again
you being here. These are again very difficult times. All of us
are committed to the integrity of our financial system, so I
ask just to continue to work together. I know you are
passionately committed to that as well as we are to make sure
that that confidence is there but also to make sure that our
constituents aren't hurt, our farmers, ranchers, people who are
engaged in these markets aren't hurt. We want to do that.
So thanks for being here. We are going to need to continue
to work together again to make sure that we solidify that
integrity of the markets and continue to protect our
constituents. With that, I yield back. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. The
gentleman yields back. With that, all time has expired.
I wish to thank our panel as we dismiss them for your
insights and your answers to our questions, and to note before
we adjourn, I invite my acting Ranking Member, any closing
comments, Mr. Acting Ranking Member?
Mr. Boswell. I just appreciate that we have had this today.
Thank you for your work, and I am taking it from here that you
are going to go out there and work harder and increase your
resources to get it done.
Thank you very much, and with that, I yield back.
The Chairman. The gentleman yields back.
Under the rules of the Committee, the record of today's
hearing will remain open for 10 calendar days to receive
additional material and supplemental written responses from the
witnesses to any questions posed by a Member.
This hearing of the Committee on Agriculture is adjourned.
[Whereupon, at 11:18 a.m., the Committee was adjourned.]
[Material submitted for inclusion in the record follows:]

Supplementary Material Submitted by Hon. Gary Gensler, Chairman,
Commodity Futures Trading Commission

During the July 25, 2012 hearing entitled, Oversight of the Swaps
and Futures Markets: Recent Events and Impending Regulatory Reforms,
requests for information were made to Mr. Gensler. The following are
his information submissions for the record.
Insert 1
Mr. Costa. Do you anticipate being able to coordinate
resources with clearinghouses? You are talking about the
timelines in Japan, the timelines in Hong Kong, and the
timelines for implementation in Europe with those other
clearinghouses to try to provide a worldwide regulatory
framework.
Mr. Gensler. I think we are coordinating well but we have
different politics and different cultures so there will be
different timelines. In some countries, they might be
significantly later than us but I am encouraged by Europe and
Japan and Canada.
Mr. Costa. For your discussion of those timelines, could you
provide the Committee, because you talked about you are almost
at the rulemaking now, what you see the timelines out for the
next 2 years? Would that be possible?
Mr. Gensler. I am sorry. Did you say for the next----
Mr. Costa. Two years.
Mr. Gensler. Two years? I think we can provide something to
you in terms of the rules that are already finalized when there
are compliance dates and then second, when we----
Mr. Costa. Mr. Chairman, I would like that provided to the
Committee so that we can all have a better understanding of
that.

A core provision of title VII of the Dodd-Frank Act is the
requirement that standardized swaps be centrally cleared. The Act
includes an exception for non-financial end-users, with the requirement
only applying to a transaction where both counterparties are subject to
it.
For swaps submitted to the Commission for mandatory clearing, the
Commission will review the submission and determine whether the swap,
or group, category, type, or class of swaps described in the submission
is required to be cleared. The Commission, generally, is to make its
determination within 90 days after a complete submission. The
Commission recently finalized a mandatory clearing requirement that
covers specified classes of interest rate and credit default swaps.
Commission rules regarding the clearing requirement include phased
compliance for different categories of market participants.
Transactions involving only swap dealers will be subject to earlier
compliance than those between swap-dealers and non-swap dealers.
Additional time is provided before compliance is required with respect
to a transaction that does not have a swap dealer as a counterparty.
U.S. timing regarding the clearing requirement broadly aligns with
both Japan and Europe.
The legislature in Japan adopted legislation in May 2010 which
mandates clearing of certain swaps. Japanese regulators recently
published the requirement that certain index-based CDS and certain yen-
denominated interest swaps to be subject to mandatory clearing. In
addition, the Japanese Financial Services Agency is considering
expanding its mandatory clearing coverage to include U.S. dollar- and
euro-denominated interest rate swaps, as well as yen-denominated
interest rate swaps referencing TIBOR.
The European Securities and Markets Authority has published its
technical standards for clearing, reporting and certain risk mitigation
rules for adoption by the European Commission.
The Commission continues to consult closely with fellow regulators
in Australia, Hong Kong Singapore, and other jurisdictions.
In June, the Commission--consulting closely with domestic and
foreign regulators--proposed guidance interpreting the cross-border
application of the swaps market reforms of the Dodd-Frank Act. In a
separate release, the Commission proposed phased compliance for foreign
swap dealers (including overseas affiliates of U.S. swap dealers)
regarding certain requirements of Dodd-Frank swaps market reform.
Such phased compliance would enable market participants to comply
with the Dodd-Frank Act in an orderly fashion. It would allow time for
the CFTC, international regulators and market participants to continue
coordinating on regulation of cross-border swaps activity. And it would
allow for appropriate implementation of substituted compliance, or
allowing market participants to comply with Dodd-Frank through
comparable and comprehensive foreign regulatory requirements.
The CFTC has a consistent record of relying on comparable home
country regulation where appropriate. We are very much committed to
recognition regimes for swaps market reforms as well, where there are
comparable and comprehensive requirements.
The CFTC also has had a long history of working with international
regulators to coordinate oversight of cross-border entities. We have
done so with regard to clearinghouses, futures commission merchants and
foreign boards of trade.
Insert 2
Mrs. Noem. Thank you, Mr. Chairman, and I appreciate this
hearing. It is timely given it is the second anniversary of the
Dodd-Frank and we need to look at these reforms and the related
rules and see how they impact people on the ground. For
example, in South Dakota, where I am from, some businesses and
producers who are actively investing in the commodity market
are still dealing with the failure of MF Global, so I just have
a couple questions for you.
Does the CFTC have the power to force a firm into bankruptcy?
Mr. Gensler. We might need to get back to you, but I am not
aware of that. Even in this Peregrine situation, we went into
court to ask for a receiver to be appointed to freeze the
assets, which we do in Ponzi schemes as well. So I think that
is the route. I believe the answer is no but we seek a court to
appoint a receiver.
Mrs. Noem. Okay. That is the route that is generally
followed? Well, if there is more information on that that you
can give me later, I would appreciate that. That would be
great.

The attached CFTC staff memorandum discusses the applicable laws
that affect the insolvency of a futures commission merchant that is
also a broker dealer.

ATTACHMENT

Memorandum
From: Robert B. Wasserman, Chief Counsel, Division of Clearing and
Risk
Re: SIPA Proceedings for insolvent FCMs
Date: April 1, 2012
Introduction
The following is an analysis of the circumstances where the
insolvency of a Futures Commission Merchant that is also a Broker
Dealer would proceed under the Securities Investors Protection Act, 15
U.S.C. 78aaa, et. seq. (SIPA) rather than as a commodity broker
bankruptcy under Subchapter IV of Chapter 7 of the Bankruptcy Code, 11
U.S.C. 761, et. seq. (Subchapter IV).
As discussed further below, jurisdiction under SIPA is based on the
existence of at least one securities customer whose claims may be
satisfied by SIPC, rather than on the predominance of securities
customers versus commodity customers. However, as also discussed
further below, the interests of commodity customers are not ignored
under SIPA.

Discussion
Futures Commission Merchants (``FCMs'') are the financial
intermediaries for futures market transactions.\1\ A bankrupt FCM which
has a ``customer,'' as that term is defined in the Bankruptcy Code, is
known as a ``commodity broker.'' \2\ A commodity broker bankruptcy must
proceed as a liquidation under Chapter 7 of the Bankruptcy Code, rather
than a reorganization under Chapter 11, and the trustee has duties
specified in Subchapter IV of Chapter 7.\3\ Chief among those duties is
the duty to endeavor to transfer the positions of customers of the FCM
to a solvent FCM.\4\ The financial intermediaries for securities are
known as broker dealers (``BDs''), and the insolvency of a BD proceeds
under SIPA. For the reasons that follow, the insolvency of an entity
that is both a commodity broker and a BD (a ``BD/FCM'') will, so long
as there is at least one securities customer, proceed under SIPA.
---------------------------------------------------------------------------
\1\ See generally, Commodity Exchange Act (``CEA'') 1a(28), 4d,
7 U.S.C. 1a(28), 6d.
\2\ See Bankruptcy Code (hereinafter ``Code'') 101(6), 11 U.S.C.
101(6).
\3\ See Code 109(d), 761 et. seq.
\4\ See 17 CFR 190.02(e)(1).
---------------------------------------------------------------------------
Section 5(a)(1) of SIPA \5\ provides that ``[i]f the [SEC] is aware
of facts which lead it to believe that any broker or dealer subject to
its regulation is in or is approaching financial difficulty, it shall
immediately notify SIPC.''
---------------------------------------------------------------------------
\5\ Section 5 of SIPA is codified at 15 U.S.C. 78eee.
---------------------------------------------------------------------------
Section 5(a)(3)(A)(A) provides that SIPC may file an application
for a protective decree with respect to a member with any (securities)
customers if it determines that the member ``has failed or is in danger
of failing to meet its obligations to customers'' and one of the
conditions specified in 5(b)(1) of SIPA exists.\6\ Those latter
conditions include (a) that the debtor is insolvent, or (b) that a
proceeding is pending before any court or agency of the United States
in which a receiver, trustee, or liquidator for such debtor has been
appointed, or (c) that the debtor is not in compliance with the rules
of the SEC or an SRO with respect to financial responsibility or
hypothecation of customer securities, or (d) that the debtor is unable
to make such computations as may be necessary to establish compliance
with such financial responsibility or hypothecation rules.
---------------------------------------------------------------------------
\6\ SIPA 5(a)(3)(A) provides that no application shall be filed
by SIPC with respect to a member, the only customers of which are
persons whose claims could not be satisfied by SIPC advances pursuant
to Section 9 of SIPA. MFG did not fall within this exception.
---------------------------------------------------------------------------
There is no means for the CFTC to effect the placement of a BD/FCM
into a Chapter 7, Subchapter IV proceeding that avoids SIPA. If the BD/
FCM were to file for relief under Chapter 7 of the Bankruptcy Code, the
U.S. Trustee would appoint a trustee from among the panel of persons
established by the U.S. Trustee for that jurisdiction.\7\ If the CFTC
were to take action to appoint a receiver for an FCM with the intention
that the receiver file for bankruptcy, that would, by assumption,
involve the appointment of a receiver. In either case, the condition in
(b) above would be established. Moreover, pursuant to 5(a)(3)(B) of
SIPA, ``[n]o member of SIPC that has a customer may enter into an
insolvency, receivership, or bankruptcy proceeding, under Federal or
State law, without the specific consent of SIPC, except as provided in
title II of the Dodd-Frank Wall Street Reform and Consumer Protection
Act.''
---------------------------------------------------------------------------
\7\ Code 701(a)(1).
---------------------------------------------------------------------------
Accordingly, so long as there is at least one securities customer,
the CFTC has no way to prevent SIPC from initiating a SIPA proceeding,
and SIPA prevents the initiation of a Chapter 7, Subchapter IV
proceeding without SIPC's specific consent.
Additionally, once SIPC initiates a SIPA proceeding, the district
court is, pursuant to Section 5(b)(2)(B)(i) of SIPA, obligated to
``stay any pending bankruptcy, mortgage foreclosure, equity
receivership, or other proceeding to reorganize, conserve, or liquidate
the debtor or its property and any other suit against any receiver,
conservator, or trustee of the debtor or its property, and shall
continue such stay upon appointment of a [SIPC] trustee.'' Thus, any
Subchapter IV proceeding must be stayed by the district court in a SIPA
proceeding.
Thus, the only effect that FCM or CFTC action to cause the
initiation of a Subchapter IV proceeding with respect to a BD/FCM can
have is to confuse and complicate the insolvency of the BD/FCM.
Moreover, the succession of trustees and confusion with respect to
jurisdiction is likely to delay the circumstances in which the
commodity customer positions and any available associated collateral
are transferred from the insolvent FCM to other FCMs.
This does not mean that the interests of commodity customers are
ignored in a SIPA proceeding. Specifically, SIPA 7(b) \8\ provides
that
---------------------------------------------------------------------------
\8\ 15 U.S.C. 78fff-1(b).

``To the extent consistent with the provisions of this chapter
or as otherwise ordered by the court, a trustee shall be
subject to the same duties as a trustee in a case under chapter
7 of Title 11, including, if the debtor is a commodity broker,
as defined under section 101 of such title, the duties
specified in subchapter IV of such chapter 7, except that a
trustee may, but shall have no duty to, reduce to money any
securities constituting customer property or in the general
---------------------------------------------------------------------------
estate of the debtor.''

Thus, commodity customers in a SIPA proceeding do not, pursuant to
SIPA, suffer any disadvantage relative to commodity customers in a
Subchapter IV proceeding.

Insert 3
Mr. Stutzman. September 1, 2011, MF Global announces in a
public filing that it would comply with FINRA's determination
and increase its capital. Would such a filing trigger any red
flags at CFTC?
Mr. Gensler. As I am not participating, I don't know what the
Commissioners or the agency looked at about that September 1st
filing. But just as a general matter, our examination staff
will work with the self-regulatory organizations like FINRA and
Chicago Mercantile Exchange and NFA on any filings about
capital and try to understand what those filings are.
Mr. Stutzman. So did that happen? Did your agency work with
FINRA at all?
Mr. Gensler. Again, I don't know because I haven't gone back
and done the forensics. I haven't been involved since this
whatever, November 2nd or 3rd period of time.
Mr. Stutzman. Is that something you could find out and
notify----
Mr. Gensler. Our General Counsel, Dan Berkovitz, will follow
up with you.

At the end of August 2011, SEC staff contacted CFTC staff regarding
MF Global's repo to maturity transactions.
On September 19, 2011, CFTC staff held a teleconference with FINRA
staff to obtain further information regarding the repo to maturity
transactions.
On October 25, 2011, CFTC staff spoke with FINRA staff regarding MF
Global. During this call, FINRA discussed certain additional steps it
had taken to monitor MF Global.
On October 27, 2011, staff in the CFTC New York Regional office was
contacted by SEC staff. CFTC staff ultimately joined the SEC staff in a
meeting at MF Global that was the initiation of an SEC examination of
the firm.
On October 28, 2011, CFTC staff spoke with FINRA staff regarding
the status of MF Global.
On October 30, 2011, CFTC and SEC staff participated in a
conference call with MF Global regarding MF Global's financial status
and the production of documents related to that status.
Insert 4
Mr. Conaway . . . Chairman, one real quick follow-up. Section
722(d) is the section you cite that gives you the authority to
do the guidance on the extraterritorial or cross-border;
722(c), we think gives the SEC similar authority. What is
y'all's understanding or can you help us understand your
interpretation of those two different sections?
Mr. Gensler. Section 722(c) would be in the swaps section of
the statute. It may well that you want to follow up with----
Mr. Conaway. Okay, if you wouldn't mind getting back with us
on that because----
Mr. Gensler. Because I understood that it is all in the first
part of that Title VII is swaps, which is the CFTC, and then of
course the other section later in the chapter is there but
722(c), Dan? Maybe we will have to----
Mr. Conaway. All right. We will follow up with you on that if
you wouldn't mind.

Section 722(d) of the Dodd-Frank Act relates to the CFTC's
extraterritorial jurisdiction over swaps. Subtitle B of Title VI,
sections 761 through 744, applies to securities-based swaps under the
jurisdiction of the Securities and Exchange Commission.
______

Submitted Letter to Hon. Gary Gensler, Chairman, Commodity Futures
Trading Commission from Hon. K. Michael Conaway, a Representative in
Congress from Texas and Response

August 21, 2012

Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission,
Washington, D.C.

Dear Chairman Gensler:

Thank you for your recent testimony before the House Committee on
Agriculture hearing entitled, Oversight of the Swaps and Futures
Markets: Recent Events and Impending Regulatory Reforms. This letter
serves as a follow-up to my questions inquiring about the coordination
between the Commodity Futures Trading Commission (CFTC) and the
Securities and Exchange Commission (SEC) with respect to the
extraterritorial application of Title VII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (P.L. 111-203). As you will recall,
I asked you during the hearing to clarify why the statutory language
found in Section 722(d) of Title VII of the Dodd-Frank Act serves as
the legal rationale for the CFTC's inability to issue a joint rule with
the SEC on cross-border jurisdiction.
As a follow-up, could you please explain why Section 722(d), which
governs swaps under the CFTC's jurisdiction, and Section 772(c), which
governs security-based swaps under the SEC's jurisdiction, prevents the
two Commissions from coordinating on a single joint rulemaking?
As you know, Section 722(d) of Dodd-Frank provides that Title VII
``shall not apply to activities outside the United States'' unless
those activities ``have a direct and significant connection with
activities in, or effect on, commerce of the United States'' or
``contravene such rules or regulations as the Commission may prescribe
or promulgate as are necessary or appropriate to prevent the evasion of
any provision of this Act that was enacted by [Title VII].'' Similarly,
Section 772(c) of Dodd-Frank provides that ``[n]o provision of [Title
VII] shall apply to any person insofar as such person transacts a
business in security-based swaps without the jurisdiction of the United
States, unless such person transacts such business in contravention of
[SEC rules].''
My plain-language reading of Sections 722(d) and 772(c) appears to
be a limitation on the extraterritorial reach of both agencies, not a
mandate that prohibits the CFTC from engaging with the SEC on a joint
rulemaking. In fact, Sections 712(a)(1) and 712(a)(2) of Dodd-Frank
both require that the CFTC and SEC ``consult and coordinate . . . for
the purposes of assuring regulatory consistency and comparability, to
the extent possible.''
Section 712(a)(7)(A) further reinforces this point by stating that
the CFTC and SEC ``shall treat functionally or economically similar
products or entities . . . in a similar manner.'' As you well
understand, no joint rulemaking between the CFTC and SEC on the
extraterritorial regulation of swaps and security-based swaps would
require that both types of contracts be treated identically by the two
agencies. Rationales to provide different regulatory treatment for very
specific types of contracts would certainly exist within a jointly-
written rule. Indeed, Dodd-Frank Section 712(a)(7)(B) expressly
provides the CFTC and SEC with the flexibility that economically
similar products need not be treated in an identical manner. Read
together, all of the Dodd-Frank sections referenced above seem to
logically point to a thorough joint rulemaking on cross-border
regulation from the CFTC and SEC.
However, I am concerned that the CFTC's proposed cross-border
guidance released on June 29, 2012, is the first action which will
ultimately result in swaps and security-based swaps being governed by
two very different regulatory regimes. From a regulatory compliance
standpoint, the most-restrictive guidance or rulemaking will likely
become the de facto standard for the entire swaps and security-based
swaps marketplace. Nevertheless, we must avoid the illogical creation
of a disparate regulatory environment that would result in the same
market participant being a ``U.S. person'' for trading in swaps while
simultaneously considering them a ``non-U.S. person'' for trading in
security-based swaps.
Finally, Section 752(a) of the Dodd-Frank Act requires the CFTC and
SEC to seek harmonization on an international level by consulting and
coordinating ``with foreign regulatory authorities on the establishment
of consistent international standards'' for swaps regulation. Absent
consistent regulatory standards proposed by our own domestic
regulators, effective coordination between U.S. and foreign regulators
would seem virtually impossible. How does the CFTC plan to coordinate
with international regulators if swaps and security-based swaps are
governed by two different extraterritorial regulatory regimes?
Thank you again for answering the questions above related to the
creation of a consistent regulatory regime for the swaps and security-
based swaps marketplace. I look forward to receiving your written
response by Friday, September 7, 2012, so it can be included in the
official Committee hearing record.
Sincerely,

Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management.

October 10, 2012

Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management,
House Committee on Agriculture,
Washington, D.C.

Dear Chairman Conaway:

Thank you for your letter of August 21, 2012, following up on our
discussion during the Committee on Agriculture's hearing of July 25,
2012.
The Commodity Exchange Act (CEA)--as amended by the Dodd-Frank Wall
Street Reform and Consumer Protection Act--directs the Commodity
Futures Trading Commission (CFTC) to implement swaps market reforms, to
coordinate closely with other domestic regulatory agencies, and to
coordinate as well with regulators in foreign jurisdictions. In
addition, in particular instances, Congress has directed the CFTC to
conduct rulemakings jointly with the Securities and Exchange Commission
(SEC). The two Commissions worked well and closely together to complete
this year final joint rules that further define important terms.
In addition to cooperating on joint rules, the CFTC and the SEC are
coordinating closely in writing other rules to implement the
derivatives provisions of the Dodd-Frank Act. We coordinate and consult
on each rulemaking, including sharing many of our memos, term sheets
and draft work product. This close working relationship has benefited
the rulemaking process, and will continue throughout completion of
rulemaking and implementation. Staffs of the SEC and CFTC have jointly
held a number of roundtable discussions to obtain the public's views.
This process of consultation and coordination has been followed
with regard to considerations of the cross-border application of Dodd-
Frank. On August 1, 2011, staffs of the two Commissions hosted a
roundtable discussion on international issues relating to the
implementation of title VII of the Dodd-Frank Act. This meeting as well
as public comments and other meetings have facilitated the agencies'
understanding of related issues as well as helped us to share a common
understanding with regard to the important matters to be addressed by
both Commissions in our joint and separate rulemakings.
Section 722(d) of the Dodd-Frank Act states that swaps market
reforms under the CEA shall not apply to activities outside the United
States unless those activities have ``a direct and significant
connection with activities in, or effect on, commerce of the United
States.'' The Commission has received requests from market participants
seeking the agency's interpretation of swap market reforms in light of
that provision.
In June, the Commission--consulting closely with domestic and
foreign regulators--proposed guidance interpreting the cross-border
application of the Dodd-Frank Act. In a separate release, the
Commission proposed phased compliance for foreign swap dealers
(including overseas affiliates of U.S. swap dealers) regarding certain
requirements of Dodd-Frank swaps market reform.
Such phased compliance would enable market participants to comply
with the Dodd-Frank Act in an orderly fashion. It would allow time for
the CFTC, international regulators and market participants to continue
coordinating on regulation of cross-border swaps activity. And it would
allow for appropriate implementation of substituted compliance, or
allowing market participants to comply with Dodd-Frank through
comparable and comprehensive foreign regulatory requirements.
The CFTC has a consistent record of relying on comparable home
country regulation where appropriate. We are very much committed to
recognition regimes for swaps market reforms as well, where there are
comparable and comprehensive requirements.
The CFTC also has had a long history of working with international
regulators to coordinate oversight of cross-border entities. We have
done so with regard to clearinghouses, futures commission merchants and
foreign boards of trade. The Commission has sought public comment
regarding these releases and the Commission staff is closely reviewing
that input in preparation for final action.
As the process of swaps market reform implementation proceeds, the
Commission will continue to work closely with the SEC and other
domestic regulators. The Commission is also working closely with
regulators in foreign jurisdictions--often sharing memos, term sheets
and draft work product as we do with other domestic agencies. These
efforts are designed to assure regulatory consistency and comparability
to the extent possible, taking into consideration differences in
markets and in the applicable statutory requirements.
Thank you for your letter and for your support of the work of the
CFTC. If I can be of further assistance, please do not hesitate to let
me know.
Sincerely,

Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission.
______

Submitted Questions
Response from Hon. Gary Gensler, Chairman, Commodity Futures Trading
Commission
Questions Submitted by Hon. Frank D. Lucas, a Representative in
Congress from Oklahoma
Question 1. Chairman Gensler, I received the following questions on
August 2, 2012, in a letter from the following members of the Florida
Congressional delegation: Representatives Stearns, Posey, Mica, Nugent,
Ross, West, Rivera, Buchanan, Ros-Lehtinen, Young, and Miller:
How has the [LIBOR] manipulation affected the housing market in
Florida?

Question 2. With such a large population of older Americans in
Florida, have our constituents' retirement savings been
disproportionately affected compared to the rest of the country?

Question 3. How has the LIBOR manipulation affected private student
loan interest rates, which according to the Consumer Financial
Protection Bureau, has surpassed credit card debt as the biggest source
of unsecured debt for U.S. consumers?
Answer 1-3. The Commission does not have data on the on the Florida
housing market or on private student loans, nor did the Commission's
order find the effect of Barclays actions on LIBOR. The Commission's
order stated that Barclays repeatedly attempted to manipulate and made
false, misleading or knowingly inaccurate submissions concerning LIBOR.

Question 4. What work is the CFTC doing to aid the Department of
Justice in civilly and criminally charging those involved?
Answer. The Commission's Division of Enforcement referred the
Barclays matter to the Department of Justice. That referral culminated
in an agreement with the Fraud Section of the U.S. Justice Department's
Criminal Division, in which Barclays agreed to pay a $160 million
penalty and to continue to cooperate with the Department.

Question 5. How does the CFTC plan to help state governments assess
the impact the LIBOR fraud has had on them as individual states?
Answer. In appropriate circumstances and with appropriate
confidentiality agreements in place, we can and often do share
information with state law enforcement authorities. In fact, the
Commission's Office of Cooperative Enforcement, a unit of the Division
of Enforcement, has the goal of ensuring that enforcement of the
commodity futures laws is addressed through civil, criminal, or
administrative actions by state and Federal agencies or branches of
government whenever possible.

Question Submitted by Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question. Chairman Gensler, do you have any reason to believe the
CFTC would have uncovered this fraud sooner had it been tasked with the
audit of Peregrine instead of the NFA? If the CFTC had the sole
authority to audit market participants, what would you and your staff
have done differently?
Answer. The regulatory system did not adequately protect
Peregrine's customers. More needs to be done to protect customers. The
Commission is proceeding to consider staff recommended proposed rules
that incorporate three key reforms recently adopted by the NFA and
would require:

FCMs to hold sufficient funds in Part 30 secured accounts
(funds held for U.S. foreign futures and options customers
trading on foreign contract markets) to meet their total
obligations to customers trading on foreign markets computed
under the net liquidating equity method. FCMs would no longer
be allowed to use the alternative method, which had allowed
them to hold a lower amount of funds representing the margin on
their foreign futures;

FCMs to maintain written policies and procedures governing
the maintenance of excess funds in customer segregated and Part
30 secured accounts. Withdrawals of 25 percent or more would
necessitate pre-approval in writing by senior management and
must be reported to the designated SRO and the CFTC; and

FCMs to make additional reports available to the SRO and the
CFTC, including daily computations of segregated and Part 30
secured amounts.

Additional reforms in the staff recommendations include requiring
that SROs and the CFTC have direct electronic access to FCMs' bank and
custodial accounts for customer funds, that acknowledgement letters and
confirmation letters come directly to regulators from banks and
custodians, enhanced risk disclosures to customers, setting standards
for the SROs' examinations and the annual certified financial statement
audits, including raising minimum standards for independent public
accountants who audit FCMs and implementing a more effective early
warning system for the Commission and the SROs that alert them to
material events.
If the Commission approves the staff recommendations, further
public comment will be of great value to the agency in devising final
rules that best ensure the protection of customer funds.
Regarding the Commission's oversight of SROs and intermediaries,
though we're making progress through our reorganization at the CFTC and
new rules, the recent events at Peregrine highlight the necessity of
looking at the decades-old system of SROs and the Commission's role in
overseeing SROs.
I have directed the CFTC's staff to do a full review of how the
agency conducts oversight of the SROs, as well as limited scope reviews
of FCMs, to determine what improvements can and should be made. As part
of this review, we have reached out to the Public Company Accounting
Oversight Board (PCAOB), which oversees the audits of public companies.
The Dodd-Frank Act gave the PCAOB oversight authority over the audits
of brokers and dealers who are registered with the Securities Exchange
Commission. The PCAOB has agreed to give us the benefit of its insights
and expertise.

Questions Submitted by Hon. Scott R. Tipton, a Representative in
Congress from Colorado
Question 1. The FCS is a government sponsored enterprise (GSE) that
is made up of 4 Federal Farm Credit Banks and approximately 80 lending
associations. All System entities are jointly and severally liable for
the actions of each other component of the System--in other words, the
actions of one FCS lender ultimately will impact the entire System.
Congress designed it that way. With this system of interlocking
liability in mind, the FCS could be considered a $231 Billion financial
services institution. Did the Chairman consider this fact when he
issued the ``Clearing Exemption for Certain Swaps Entered into by
Cooperatives''?

Question 2. The central idea advanced by the CFTC in the recently
proposed ``Clearing Exemption for Certain Swaps Entered into by
Cooperatives'' is that the FCS banks lend to the FCS associations,
which lend to farmers, and farmers own the FCS associations, which own
the FCS banks--principally that the Farm Credit System is a
cooperative. CFTC then proposes that ``cooperatives meeting certain
conditions are the class of persons that should be exempted from the
clearing requirement for certain types of swaps. cooperatives act on
behalf of their members in certain financial matters. The proposed rule
provides for passing through the end user exemption available to such
cooperative's members.'' I find your logic lacking here. Why does who
owns an entity make any difference in the regulation of the derivatives
market?

Question 3. You observe in the proposed rule: ``cooperatives have a
member ownership structure in which the cooperatives exist to serve
their member owners and not act for their own profit. In a real sense
the cooperative is not separable from its member owners.'' What is
unique about the ownership structure of cooperatives that would prevent
a large financial institution like the Farm Credit System from making
stupid, imprudent, wrong, or costly mistakes? Haven't you have been
charged to regulate the derivatives market to protect the financial
system from stupid, imprudent, wrong and costly mistakes? Doesn't
exempting a financial cooperative with assets of more than $230 billion
from certain derivatives activities expose the entire financial system
to unintelligent, imprudent, wrong or costly mistakes?
Answer 1-3. The comment period for the CFTC's proposed rule on a
``Clearing Exemption for Certain Swaps Entered into by Cooperatives''
ended on August 16, 2012. In response to this proposal, the CFTC
received comment letters from market participants and interested
members of the public. The Commission is reviewing these letters and
evaluating the various issues raised by commenters. The CFTC will
consider the issues surrounding the proposed exemption for certain
cooperative swaps and cooperative structure.

Question Submitted by Hon. Mike McIntyre, a Representative in Congress
from North Carolina
Question. Chairman Gensler, in the proposed rule on Product
Definitions you asked a number of questions of the electric industry,
and I understand that the electric utilities responded and answered the
staff's questions. As you know, the Products Definitions final rule
subjected the capacity and transmission contract language to further
comment. It is my understanding that these transactions--capacity
contracts, transmission contracts and tolling agreements--are forwards
or forwards with embedded options, and not swaps. I believe it was not
the intent of Congress to consider such transactions swaps under the
Dodd-Frank Act. Would you please clarify the CFTC's need for further
comment on capacity and transmission contracts (used to ensure delivery
of electric power to utilities and their consumers) in the Products
Definition final rule?
Answer. Under the Commission's final Product Definition rule,
depending on the relevant facts and circumstances involved, capacity
contracts, transmission contracts, and tolling agreements may qualify
as forwards. The Commission issued interpretive guidance in this regard
for market participants.
The Commission also believed that it would benefit from further
input about that guidance and requested public comment by Oct. 12,
2012. Once this comment period has closed, the Commission will analyze
the issues raised by the commenters.

Submitted Material By Hon. Steve Southerland II, a Representative in
Congress from Florida