[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
EXAMINING LEGISLATIVE IMPROVEMENTS TO TITLE VII OF THE DODD-FRANK ACT
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HEARING
BEFORE THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
MARCH 14, 2013
__________
Serial No. 113-3
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Printed for the use of the Committee on Agriculture
agriculture.house.gov
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COMMITTEE ON AGRICULTURE
FRANK D. LUCAS, Oklahoma, Chairman
BOB GOODLATTE, Virginia, COLLIN C. PETERSON, Minnesota,
Vice Chairman Ranking Minority Member
STEVE KING, Iowa MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas DAVID SCOTT, Georgia
MIKE ROGERS, Alabama JIM COSTA, California
K. MICHAEL CONAWAY, Texas TIMOTHY J. WALZ, Minnesota
GLENN THOMPSON, Pennsylvania KURT SCHRADER, Oregon
BOB GIBBS, Ohio MARCIA L. FUDGE, Ohio
AUSTIN SCOTT, Georgia JAMES P. McGOVERN, Massachusetts
SCOTT R. TIPTON, Colorado SUZAN K. DelBENE, Washington
ERIC A. ``RICK'' CRAWFORD, Arkansas GLORIA NEGRETE McLEOD, California
MARTHA ROBY, Alabama FILEMON VELA, Texas
SCOTT DesJARLAIS, Tennessee MICHELLE LUJAN GRISHAM, New Mexico
CHRISTOPHER P. GIBSON, New York ANN M. KUSTER, New Hampshire
VICKY HARTZLER, Missouri RICHARD M. NOLAN, Minnesota
REID J. RIBBLE, Wisconsin PETE P. GALLEGO, Texas
KRISTI L. NOEM, South Dakota WILLIAM L. ENYART, Illinois
DAN BENISHEK, Michigan JUAN VARGAS, California
JEFF DENHAM, California CHERI BUSTOS, Illinois
STEPHEN LEE FINCHER, Tennessee SEAN PATRICK MALONEY, New York
DOUG LaMALFA, California JOE COURTNEY, Connecticut
RICHARD HUDSON, North Carolina JOHN GARAMENDI, California
RODNEY DAVIS, Illinois
CHRIS COLLINS, New York
TED S. YOHO, Florida
______
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
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Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, prepared statement...................................... 40
Fudge, Hon. Marcia L., a Representative in Congress from Ohio,
prepared statement............................................. 41
Hudson, Hon. Richard, a Representative in Congress from North
Carolina, submitted letters.................................... 117
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma,
opening statement.............................................. 1
Prepared statement........................................... 2
Submitted legislation........................................ 4
Submitted letters............................................ 115
Peterson, Hon. Collin C., a Representative in Congress from
Minnesota, opening statement................................... 39
Prepared statement........................................... 40
Witnesses
Gensler, Hon. Gary, Chairman, U.S. Commodity Futures Trading
Commission, Washington, D.C.................................... 42
Prepared statement........................................... 43
Submitted questions.......................................... 122
Bentsen, Jr., Hon. Kenneth E., Acting President and Chief
Executive Officer, Securities Industry and Financial Markets
Association, Washington, D.C................................... 72
Prepared statement........................................... 74
Submitted question........................................... 124
Colby, James E., Assistant Treasurer, Honeywell International
Inc., Morristown, NJ........................................... 78
Prepared statement........................................... 80
Submitted questions.......................................... 125
Naulty, Terrance P., General Manager and Chief Executive Officer,
Owensboro Municipal Utilities; Member, American Public Power
Association, Owensboro, KY..................................... 82
Prepared statement........................................... 83
Submitted questions.......................................... 125
Thompson, Larry E., Managing Director and General Counsel, The
Depository Trust and Clearing Corporation, New York, NY........ 88
Prepared statement........................................... 90
Hollein, C.T.P., Marie N., President and Chief Executive Officer,
Financial Executives International and Financial Executives
Research Foundation, Washington, D.C.; on behalf of Coalition
for Derivatives End-Users...................................... 94
Prepared statement........................................... 95
Submitted questions.......................................... 126
Turbeville, Wallace C., Senior Fellow, Demos, New York, NY; on
behalf of Americans for Financial Reform....................... 97
Prepared statement........................................... 98
EXAMINING LEGISLATIVE IMPROVEMENTS TO TITLE VII OF THE DODD-FRANK
ACT
THURSDAY, MARCH 14, 2013
House of Representatives,
Committee on Agriculture,
Washington, D.C.
The Committee met, pursuant to call, at 10:00 a.m., in Room 1300
of the Longworth House Office Building, Hon. Frank D. Lucas
[Chairman of the Committee] presiding..........................
Members present: Representatives Lucas, Neugebauer, Conaway,
Thompson, Austin Scott of Georgia, Tipton, Crawford,
DesJarlais, Gibson, Hartzler, Noem, Benishek, Denham, Fincher,
LaMalfa, Hudson, Davis, Collins, Yoho, Peterson, David Scott of
Georgia, Walz, Schrader, McGovern, DelBene, Negrete McLeod,
Vela, Nolan, Gallego, Enyart, Vargas, Bustos, Maloney, and
Courtney.......................................................
Staff present: Debbie Smith, Jason Goggins, John Porter, Josh
Mathis, Kevin Kramp, Lauren Sturgeon, Matt Schertz, Nicole
Scott, Suzanne Watson, Tamara Hinton, Anne Simmons, C. Clark
Ogilvie, Liz Friedlander, John Konya, 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 to
examine legislative improvements to Title VII of the Dodd-Frank
Act will come to order. Thank you for being here today.........
In a way we have already had this hearing during the last
Congress. In fact, we held more than a dozen hearings on Dodd-
Frank Act during the last Congress with dozens of witnesses,
and we have discussed all of the bills or topics that are on
the agenda today during those past hearings....................
Unfortunately, the reason we are still talking about the very
same issues is because the same concerns still exist with parts
of Dodd-Frank. We stand to harm significant portions of our
economy if these issues are not addressed in legislative fixes.
Since the start of 2011, the feedback we have heard all across
the country has been fairly consistent; farmers, ranchers,
financial firms, main street businesses are worried about some
of the unintended consequences of Dodd-Frank rules. We have
heard from public power companies that might not be able to
hedge against volatile energy prices because their
counterparties are walking away. As a result, energy prices
could rise for millions of Americans, an unacceptable result of
what was certainly never contemplated when Dodd-Frank was
written to reform our financial system.........................
And we have heard from manufacturers who employ hundreds of
thousands of Americans that they will have to alter their
business models because they may be required to post margin on
important risk management trades or on their very own internal
transactions. It boils down to this. Some of these regulations
could make using derivatives so expensive that businesses will
be forced to stop using them to hedge against risk. That
increases costs for consumers and reduces stability in the
marketplace. This is completely contrary to the intent of the
original Dodd-Frank legislation................................
Today we will review legislation that is balanced, that our
balanced proposals that ensure that legislation is implemented
in the manner that Congress intended or provides a technical
fix to ensure that Dodd-Frank does not interrupt the markets or
harm the economy. It is good to note that this Committee heard
from top regulators from Japan and the European Union just last
December, who warned that without better coordination between
the CFTC and international regulators there will be global
fragmentation of the derivatives markets. That cannot be
allowed to happen..............................................
One of today's bills, a discussion draft, will directly address
that issue in a commonsense manner that Dodd-Frank should have
already included. It is very important to note that every
single bill we will discuss here today is bipartisan with
Republicans and Democrats both on the Agriculture Committee and
the Financial Services Committee supporting them. They are
bipartisan because they contain commonsense tweaks to ensure
that Dodd-Frank does not unnecessarily burden our agricultural
producers, job creators, local utilities, financial
institutions, and small businesses.............................
Again, all of these bills are intended to restore the balance
that I believe can exist between sound regulation and a healthy
economy. I look forward to advancing all of them in a
bipartisan fashion.............................................
[The prepared statement of Mr. Lucas follows:]...................
Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress
from Oklahoma
Thank you all for being here today.
In a way, we have already had this hearing during the last
Congress. In fact, we held more than a dozen hearings on the Dodd-Frank
Act during the last Congress with dozens of witnesses. And, we have
discussed all of the bills or topics that are on our agenda today
during past hearings.
Unfortunately, the reason we are still talking about the very same
issues is because the same concerns still exist with parts of Dodd-
Frank. We stand to harm significant portions of our economy if these
issues are not addressed with legislative fixes.
Since the start of 2011, the feedback we have heard all across the
country has been fairly consistent. Farmers, ranchers, financial firms,
and Main Street businesses are worried about the unintended
consequences of Dodd-Frank rules.
We've heard from public power companies that might not be able to
hedge against volatile energy prices because their counterparties are
walking away. As a result, energy prices could rise for millions of
Americans--an unacceptable result that was certainly never contemplated
when Dodd-Frank was written to reform our financial system.
And we've heard from manufacturers--who employ hundreds of
thousands of Americans--that that they will have to alter their
business models because they may be required to post margin on
important risk management trades or on their very own internal
transactions.
It boils down to this: some of these regulations could make using
derivatives so expensive that businesses will be forced to stop using
them to hedge against risk.
That increases costs for consumers and reduces stability in the
marketplace. That is completely contrary to the intent of the original
Dodd-Frank legislation.
Today, we will review legislation that are balanced proposals that
ensure the legislation is implemented in the manner Congress intended
or provides a technical fix to ensure Dodd-Frank does not disrupt
markets or harm the economy.
It is good to note that this Committee heard from top regulators
from Japan and the European Union just last December who warned that
without better coordination between the CFTC and international
regulators, there will be global fragmentation of the derivatives
markets. That cannot be allowed to happen. One of today's bills--a
discussion draft--will directly address that issue in a common-sense
manner that Dodd-Frank should have already included.
It is very important to note that every single bill we will discuss
today is bipartisan with Republicans and Democrats both on the
Agriculture Committee and the Financial Services Committee supporting
them. They are bipartisan because they contain common-sense tweaks to
ensure that Dodd-Frank does not unnecessarily burden our agricultural
producers, job-creators, local utilities, financial institutions, and
small businesses.
Again, all of these bills are intended to restore the balance that
I believe can exist between sound regulation and a healthy economy.
I look forward to advancing all of them in a bipartisan fashion.
I now will turn to the Ranking Member to make his opening
statement.
Legislation
H.R. 634, Business Risk Mitigation and Price Stabilization Act of 2013
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H.R. 677, Inter-Affiliate Swap Clarification Act
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H.R. 742, Swap Data Repository and Clearinghouse Indemnification
Correction Act of 2013
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H.R. 992, Swaps Regulatory Improvement Act
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H.R. 1003, To improve consideration by the Commodity Futures Trading
Commission of the costs and benefits of its regulations and
orders.
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H.R. 1038, Public Power Risk Management Act of 2013
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[Discussion Draft] H.R. __, Swap Jurisdiction Certainty Act *
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* Editor's note: The bill was introduced as H.R. 1256 on March 19,
2013.
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The Chairman. I now turn to the Ranking Member to make his
opening statement.
OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE
IN CONGRESS FROM MINNESOTA
Mr. Peterson. Thank you, Mr. Chairman, and I want to
welcome CFTC Chairman Gensler back to the Committee for what I
have been told is his 50th appearance before Congressional
committees going all the way back to his confirmation hearing,
so I think that must be some kind of a record. So we appreciate
your endurance.
For his first 2 years in office Chairman Gensler was
helping us fix the financial mess left over from years of
deregulation and lax oversight, and during the past 2 years he
has been called to account for the Commission's implementation
of Dodd-Frank reforms enacted in 2010.
Last Congress this Committee held several hearings as the
Chairman has indicated where we listened to a host of
stakeholders express concerns about Dodd-Frank's
implementation. At each of these hearings I repeatedly
recommended patience and caution for those seeking to change
the law, and I think that patience generally has been rewarded
with the Commission producing thoughtful final rules that
respond to the concerns that were being raised.
Today's hearing is to examine legislative proposals seeking
to address many of those same concerns, and I, again, recommend
patience. Despite the bipartisan support that some of these
bills may have, I just don't see how any of these have any
chance of passing the Senate.
Additionally, given the CFTC's performance, I still believe
that much of the legislation we are discussing today will not
be needed in the end. The CFTC is most likely going to get this
right, and today many of the final rules coming out of the
Commission have broad bipartisan support and are addressing the
concerns that stakeholders have expressed to both us and to the
Commission.
Ironically, the issue that may truly need to be addressed,
margin requirements on end-users, is a problem not being caused
by the CFTC but by the proposed rule of the Prudential
Regulators. In my opinion we should be bringing the Prudential
Regulators in to answer questions about their proposed rule,
because we aren't holding them accountable for their actions. I
raised this same issue in the previous Congress when we held a
hearing on the predecessor, H.R. 634, and we still haven't
heard from them.
Sometime this summer the CFTC will complete the vast
majority of its rulemaking. To me that is the best time to see
what has been done, see the whole picture, and at that point
fix what needs to be fixed, and hopefully by that time we will
have completed our work in the House on the farm bill, and then
we can turn our attention to the CFTC reauthorization, which I
believe is the best chance for enacting any improvements to
Dodd-Frank, if necessary.
So with that, Mr. Chairman, I appreciate the time and yield
back.
[The prepared statement of Mr. Peterson follows:]
Prepared Statement of Hon. Collin C. Peterson, a Representative in
Congress from Minnesota
Thank you, Mr. Chairman. I want to welcome CFTC Chairman Gensler
for what I have been told is his 50th appearance before a Congressional
Committee, going all the way back to his confirmation hearing. That has
to be some kind of record.
For his first 2 years in office, Chairman Gensler was helping us
fix the financial mess left over from years of deregulation and lax
oversight. During the past 2 years, he has been called to account for
the Commission's implementation of the Dodd-Frank reforms Congress
enacted in 2010.
Last Congress, this Committee held several hearings where we
listened to a host of stakeholders express concerns about Dodd-Frank's
implementation. At each of these hearings, I repeatedly recommended
patience and caution for those seeking to change the law. I believe
that patience has generally been rewarded, with the Commission
producing thoughtful, final rules that respond to the concerns being
raised.
Today's hearing is to examine legislative proposals seeking to
address many of those same concerns and I, again, recommend patience.
Despite the bipartisan support that some of these bills may have, I
just don't see how they have any chance passing the Senate.
Additionally, given the CFTC's performance, I still believe that
much of the legislation we're discussing today will not be needed. The
CFTC is going to get this right. To date, many of the final rules
coming out of the Commission have broad bipartisan support and are
addressing the concerns that stakeholders have expressed to both us and
the Commission.
Ironically, the issue that may truly need to be addressed--margin
requirements on end-users--is a problem not being caused by the CFTC,
but by the proposed rule of the Prudential Regulators.
We really should be bringing the Prudential Regulators in to answer
questions about their proposed rule because we aren't holding them
accountable for their actions. I raised this same issue in previous
Congress when we held a hearing on the predecessor to H.R. 634.
Sometime this summer, the CFTC will complete the vast majority of
its rulemaking. To me, that is the best time to see what has been done
and fix what needs to be fixed. Hopefully, we will have completed our
work in the House on the farm bill and can turn our attention to CFTC
reauthorization, which I believe is the best chance for enacting any
improvements to Dodd-Frank, if necessary.
With that Mr. Chairman, I appreciate the time and I yield back.
The Chairman. I thank the gentleman for his comments.
The chair requests that other Members submit their opening
statements for the record so that the witnesses may begin their
testimony and to ensure there is ample time for questions.
[The prepared statement of Mr. Conaway and Ms. Fudge
follow:]
Prepared Statement of Hon. K. Michael Conaway, a Representative in
Congress from Texas
Mr. Chairman, thank you for convening this hearing and offering our
Committee another opportunity to examine the Dodd-Frank Act, its
implementation, and potential fixes to some of the legislative
oversights in the bill.
I don't think anyone in this room would say that we got Dodd-Frank
exactly right, so it is important that we take time at hearings like
this to see what sections need to be corrected, what exemptions need to
be broadened, and what instructions to the Commission need to be made
more clear. Six of the bills we will examine today make exactly these
type of narrow, focused changes to the law. In fact, because our
Committee is focused on narrow fixes to the law, and not wholesale
repeal, all of the bills we are examining today have bipartisan
support. I am grateful to my Democratic colleagues for working with us
on these issues.
One issue that has been particularly unclear over the past several
years has been the extra-territorial application of the Dodd-Frank Act.
How laws flow across jurisdictional boundaries has a profound impact on
how businesses operate. Last December, Members of this Committee heard
testimony from several foreign regulators who expressed grave concerns
about the CFTC's approach to these cross-border issues. I am worried
that if the CFTC continues to go its own way, financial firms will exit
American markets, reducing liquidity and increasing costs for end-users
and other market participants.
I am pleased that our Committee will consider the Swap Jurisdiction
Certainty Act which would require the CFTC to cooperate with the SEC on
promulgating a rule on the cross-border application of the Dodd-Frank
rules, as well as to recognize the competence of foreign regulators. I
am deeply concerned that the current course the CFTC is pursuing will
have substantial economic burdens for little regulatory benefits.
This is not the first rulemaking that I have had concerns about the
appropriate accounting of the costs and benefits. Throughout the entire
process of implementing Dodd-Frank, I have asked Chairman Gensler
repeatedly to step up the standards of economic analysis for the rules
the CFTC is proposing.
In his defense, Chairman Gensler has said that the Commission is
complying with the law, which only requires that the CFTC ``consider''
the costs and benefits of a particular rulemaking. The Inspector
General of the CFTC has said this has lead to a ``check-the-box''
approach to cost-benefit analysis, where the actual analysis is often
performed by the lawyers instead of economists.
That is why I am again offering a bill, along with the support of
Ranking Member Scott, Congressman Vargas, and others, that would set
new standards for the economic analysis that the CFTC must perform on
each new rulemaking. I believe that the Executive Order laid out by
President Obama on cost-benefit analysis should represent the standard
to which agencies are held, and the bill we are discussing today would
do just that.
One final issue that I am concerned about is the breaches of data
confidentiality that have been seen in the Commission in recent months.
The CFTC is privy to a wealth of proprietary information regarding the
trades, positions, and strategies of every market participant. It
relies on this data to be an effective regulator, but the recent
reports that proprietary data has been made public calls into question
the strength of the Commission's internal controls on the data it
collects.
As a recent Washington Post Op-Ed co-written by former CFTC
Chairman James Newsome and former Commissioner Fred Hatfield states
clearly, ``If [market] participants believe others have a likelihood of
re-creating trading strategies or identifying their derivatives
positions from leaked data, they will work to avoid sharing data with
regulators. Doing so would be a tremendous blow to regulators and a
critical setback for industry participants who want to operate in
markets free from fraud, manipulation and other abuses.''
It is imperative for the Commission to instill trust and confidence
in market participants. The CFTC cannot do so if the confidential data
market participants provide the Commission makes its way into the
public eye.
I look forward to the opportunity to discuss our proposed
legislation with Chairman Gensler and the rest of our witnesses. As I
have said many times, it is more important that we get Dodd-Frank
reform right than that we get it done quickly. Today's bills will help
ensure that we get Dodd-Frank right.
______
Prepared Statement of Hon. Marcia L. Fudge, a Representative in
Congress from Ohio
Thank you for convening this hearing. Recently, I and
Representatives Stivers, Moore, and Gibson introduced H.R. 677, the
Inter-Affiliate Swap Clarification Act. H.R. 677 makes plain that
inter-affiliate transactions, when the parties to the transaction are
under common control or use centralized hedging units to manage risk
efficiently, should not be regulated as swaps. Last Congress, my
colleagues and I introduced similar legislation that eventually passed
the House by a vote of 357-36. Given the broad consensus and bipartisan
support this issue received last year, I'm hopeful that H.R. 677 will
be widely supported as well.
I appreciate having the opportunity to hear from experts in the
field on why clarification on the regulations for inter-affiliate swaps
is needed.
The Chairman. I would like to welcome our first panel
witness today, the Hon. Gary Gensler, Chairman of the U.S.
Commodity Futures Trading Commission, Washington, D.C. Chairman
Gensler, please begin when you are ready.
STATEMENT OF HON. GARY GENSLER, CHAIRMAN, U.S.
COMMODITY FUTURES TRADING COMMISSION,
WASHINGTON, D.C.
Mr. Gensler. Chairman Lucas, Ranking Member Peterson,
Members of this Committee, it is always good to be with you. I
appreciate that note about 50 hearings in this job, but I think
I have also been told it is my 10th before you, and I always
enjoy being here and the advice and counsel that you give us,
whether it is in the rule writing or everyday business of the
Commission.
Five years ago tomorrow Bear Stearns failed. You might
remember this was a large financial institution in New York.
The Federal Reserve and others arranged its quick sale to
JPMorgan, but that was really the beginning of what we now call
the 2008 Financial Crisis. Those next 6 months, or next year,
put so many people at risk in the American economy and eight
million people lost their jobs.
In response, this Committee was the first to address
derivatives reform early in 2009, when you passed a bill and
then working later with the House Financial Services passed
what was the core of what became Title VII, and most of that is
now in place.
So what does this mean? For the first time the public is
actually benefitting from seeing the price and volume of each
swap transaction. It is available free of charge on a website.
I see the members from DTCC are here. They can tell you about
the website. It is free of charge like a modern-day tickertape
where people can see the price and volume of swaps
transactions.
For the first time the public also benefits from greater
access to the markets with the risk reduction of central
clearing. This week on Monday mandatory clearing for these big
dealers took hold. That means that there is lower risk, and the
system is a little less interconnected.
And for the first time the public is benefiting from the
oversight of the dealers themselves. We now have 73 that are
registered. It was at the center of your hearing that you had
with the international regulators in December. We did move
forward, exempting many of the things that they need to do
until this coming July to try to get it right and focus on
something called substituted compliance.
This reform was not about preventing firms from failing,
though. Just as Bear Stearns failed 5 years ago, certainly some
firms will fail in the future. I think that this part of the
bill is about making the system safer because it is less
interconnected, that it is less likely that taxpayers will have
to come in and help out or bail out a firm as we all did in
AIG, but I think it is also so that the end-users get a more
transparent market and more access to the market.
It is about those firms that employ 94 percent of private-
sector jobs. That is what end-users are: the non-financial
firms that employ 94 percent of jobs in this economy, and the
reforms were about giving end-users a choice. They don't have
to come into clearing and by the CFTC rules, as the Ranking
Member mentioned, they would not be caught up in margining for
the non-cleared swaps.
Now, we do have key things in front of us. In 2013, we
still need to finish up some pieces of this business. We are
still promoting further transparency before the transaction. It
is called pre-trade transparency. Due to that we have in front
of us finishing rules on what is called swap execution
facilities.
Second, a big part of it is the cross-border application as
the Chairman mentioned of the swaps market reform. Congress
recognized in enacting reform is that in modern finance many of
these institutions span the globe, and risk knows no boundary.
If a run starts in one part of a financial institution, it runs
right back here. That is what happened at Bear Stearns, of
course, but also it was true of AIG, which ran most of its
swaps business out of London. It was true of Lehman Brothers,
it was true a decade earlier in something called Long-Term
Capital Management. The company, LTCM, was run in Connecticut
but booked their $1.2 trillion of derivatives in the Cayman
Islands.
Failing to incorporate the basic lesson of modern finance
would leave the American public at risk. It would move maybe
the jobs to the Cayman Islands or the P.O. Boxes on the Cayman
Islands or the jobs somewhere else, but the risk would spill
right back here if it is a U.S. financial institution. So, I
think we have to address that, and we are trying to do that by
July of this year.
We also have in front of us an important and tough agenda
around the London Interbank Offered Rate. It is not the center
of this hearing, but I am glad to take any questions on that. I
think long term, though, we are going to find that that rate--
that has been so pervasively and readily rigged--is not
sustainable in our financial markets.
I would like to just close by mentioning the need for
resources. The CFTC today is a little smaller than we were 1
year ago, and yet now the swaps reform is upon us. I think that
we are not right sized for the critical missions that you have
given us. The Congress has given us responsibility for the
futures markets as well as the swaps market so that the end-
users of this country can have confidence that these markets
are well-overseen and don't present risk to them.
So I thank you, and I look forward to questions.
[The prepared statement of Mr. Gensler follows:]
Prepared Statement of Hon. Gary Gensler, Chairman, U.S. 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 testify on the status
of Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) Title VII implementation. I also want to thank the Commodity
Futures Trading Commission's (CFTC) Commissioners and staff for their
hard work and dedication.
Introduction
I am pleased to have the opportunity to discuss with you the CFTC's
efforts on behalf of the public. The agency has been directed by
Congress to oversee and police the nation's derivatives markets, both
in the futures and swaps markets. It strives to promote transparency,
fairness and integrity in these markets. The CFTC continues to carry
out its historical mission regarding the rapidly changing futures
market, while developing and integrating comprehensive standards for
the swaps market. The Commission has reorganized its divisions to best
ensure ongoing oversight of the futures market, as well as the swaps
markets. We also have implemented improvements in protections for
customer funds and are developing others. We continue to engage in
targeted enforcement efforts in the public interest. These include the
historic actions regarding benchmark rates, such as the London
Interbank Offered Rate (LIBOR), a reference rate for much of the U.S.
futures and swaps markets.
The New Era of Swaps Market Reform
Congress made history with the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act), and the CFTC now oversees the
entire derivatives marketplace--across both futures and swaps. The
common-sense rules of the road for the swaps market that Congress
included in the law have taken shape and market participants are
adapting to them.
For the first time, the public is benefiting from seeing the price
and volume of each swap transaction. This post-trade transparency
builds upon what has worked for decades in the futures and securities
markets. The new swaps market information is available free of charge
on a website, like a modern-day ticker tape.
For the first time, the public will benefit from the greater access
to the markets and the risk reduction that comes with central clearing.
Required clearing of interest rate and credit index swaps between
financial entities began this week.
For the first time, the public is benefitting from specific
oversight of swap dealers. More than 70 swap dealers have provisionally
registered. They are subject to standards for sales practices, record-
keeping and business conduct to help lower risk to the economy and
protect the public from fraud and manipulation.
An earlier economic crisis led President Roosevelt and Congress to
enact similar common-sense rules of the road for the futures and
securities markets. I believe these critical reforms of the 1930s have
been at the foundation of our strong capital markets and many decades
of economic growth.
In the 1980s, the swaps market emerged. Until now, though, it has
lacked the benefit of rules to promote transparency, lower risk and
protect the public, rules that we have come to depend upon in the
futures and securities markets. What followed was the 2008 Financial
Crisis--a crisis that was due in part to the swaps market. Eight
million American jobs were lost. In contrast, the futures market,
supported by earlier reforms, weathered the financial crisis.
Congress and the President responded to the worst economic crisis
since the Great Depression and carefully crafted the Dodd-Frank swaps
provisions. They borrowed from what has worked best in the futures
market for decades: transparency, clearing and oversight of
intermediaries.
The CFTC has largely completed swaps market rule-writing, with 80
percent behind us. On October 12, the CFTC and Securities and Exchange
Commission's (SEC) foundational definition rules went into effect. This
marked the new era of swaps market reform.
The CFTC is seeking to consider and finalize the remaining Dodd-
Frank Act swaps reforms this year. In addition, as Congress directed
the CFTC to do, I believe it is critical that we continue our efforts
to put in place aggregate speculative position limits across futures
and swaps on physical commodities.
The agency has completed each of these Congressionally-directed
reforms with an eye toward ensuring that the swaps market works for
end-users, America's primary job providers. It's the end-users in the
non-financial side of our economy that provide 94 percent of private
sector jobs.
Dodd-Frank Act swaps market reforms benefit end-users by lowering
costs and increasing access to the markets. They benefit end-users
through greater transparency--shifting information from Wall Street to
Main Street. Following Congress' direction, end-users are not required
to bring swaps into central clearing. Further, the Commission's
proposed rule on margin provides that end-users will not have to post
margin for uncleared swaps. Also, non-financial companies, other than
those genuinely making markets in swaps, will not be required to
register as swap dealers. Lastly, when end-users are required to report
their transactions, they are given more time to do so than other market
participants.
Congress also authorized the CFTC to provide relief from the Dodd-
Frank Act's swaps reforms for certain electricity and electricity-
related energy transactions between rural electric cooperatives and
Federal, state, municipal and tribal power authorities. Similarly,
Congress authorized the CFTC to provide relief for certain transactions
on markets administered by regional transmission organizations and
independent system operators. The CFTC is looking to soon finalize
exemptive orders related to these transactions, as Congress authorized.
The CFTC has worked to complete the Dodd-Frank reforms in a
deliberative way--not against a clock. We have been careful to consider
public input, as well as the costs and benefits of each rule. CFTC
Commissioners and staff have met more than 2,000 times with members of
the public, and we have held 23 public roundtables. The agency has
received more than 39,000 comment letters on matters related to reform.
The rules also have benefited from close consultation with domestic and
international regulators and policymakers.
Throughout this process, the Commission has sought input from
market participants on appropriate schedules to phase in compliance
with swaps reforms. Now, over 2\1/2\ years since the Dodd-Frank Act
passed and with 80 percent of our rules finalized, the market is moving
to implementation. Thus, it's the natural order of things that market
participants have questions and have come to us for further guidance.
The CFTC welcomes inquiries from market participants, as some fine-
tuning is expected. As it is sometimes the case with human nature, the
agency receives many inquiries as compliance deadlines approach.
My fellow Commissioners and I, along with CFTC staff, have listened
to market participants and thoughtfully sorted through issues as they
were brought to our attention, and we will continue to do so.
I now will go into further detail on the Commission's efforts to
implement the Dodd-Frank Act's swaps market reform, our efforts to
enhance protections for futures and swaps customers, and the CFTC's
work with international regulators regarding benchmarks.
Transparency--Lowering Cost and Increasing Liquidity, Efficiency,
Competition
Transparency--a longstanding hallmark of the futures market, both
pre- and post-trade--lowers costs for investors, consumers and
businesses. It increases liquidity, efficiency and competition. A key
benefit of swaps reform is providing this critical pricing information
to businesses and other end-users across this land that use the swaps
market to lock in a price or hedge a risk.
As of December 31, 2012, provisionally registered swap dealers are
reporting in real time their interest rate and credit index swap
transactions to the public and to regulators through swap data
repositories. These are some of the same products that were at the
center of the financial crisis. Building on this, swap dealers began
reporting swap transactions in equity, foreign exchange and other
commodity asset classes on February 28. Other market participants will
begin reporting April 10.
With these transparency reforms, the public and regulators now have
their first full window into the swaps marketplace.
To further enhance liquidity and price competition, the CFTC is
working to finish the pre-trade transparency rules for swap execution
facilities (SEFs), as well as the block rule for swaps. SEFs would
allow market participants to view the prices of available bids and
offers prior to making their decision on a transaction. These rules
will build on the democratization of the swaps market that comes with
the clearing of standardized swaps.
Clearing--Lowering Risk and Democratizing the Market
Since the late 19th century, clearinghouses have lowered risk for
the public and fostered competition in the futures market. Clearing
also has democratized the market by fostering access for farmers,
ranchers, merchants and other participants.
The Commission approved the first clearing requirement last
November, following through on the U.S. commitment at the 2009 G20
meeting that standardized swaps be cleared by the end of 2012. A key
milestone was reached this week with the requirement that swap dealers
and the largest hedge funds clear as of March 11. The vast majority of
interest rate and credit default index swaps are being brought into
central clearing. Compliance will continue to be phased in throughout
this year. Other financial entities begin clearing June 10. Accounts
managed by third party investment managers and ERISA pension plans have
until September 9.
Consistent with the direction of Dodd-Frank, the Commission in the
fall of 2011 adopted a comprehensive set of rules for the risk
management of clearinghouses. These final rules were consistent with
international standards, as evidenced by the Principles for Financial
Market Infrastructures (PFMIs) consultative document that had been
published by the Committee on Payment and Settlement Systems and the
International Organization of Securities Commissions (CPSS-IOSCO).
In April of 2012, CPSS-IOSCO issued the final Principles. The
Commission's clearinghouse risk management rules cover the vast
majority of those standards. Commission staff are working expeditiously
to recommend the necessary steps so that the Commission may implement
any remaining items from the PFMIs not yet incorporated in our
clearinghouse rules. I look forward to the Commission considering
action on this in 2013.
I expect that soon we will complete a rule to exempt swaps between
certain affiliated entities within a corporate group from the clearing
requirement. This year, the CFTC also will be considering possible
clearing determinations for other commodity swaps, including energy
swaps.
Swap Dealer Oversight--Promoting Market Integrity and Lowering Risk
Comprehensive oversight of swap dealers, a foundational piece of
the Dodd-Frank Act, will promote market integrity and lower risk to
taxpayers and the rest of the economy. Congress directed that end-users
be able to continue benefitting from customized swaps (those not
brought into central clearing) while being protected through the
express oversight of swap dealers. In addition, Dodd-Frank extended the
CFTC's existing oversight of previously regulated intermediaries to
include their swaps activity.
As the result of CFTC rules completed in the first half of last
year, 73 swap dealers are now provisionally registered. This initial
group of dealers includes the largest domestic and international
financial institutions dealing in swaps with U.S. persons. It includes
the 16 institutions commonly referred to as the G16 dealers. Two major
swap participants also are registered. Other entities will register
once they reach the de minimis threshold for swap activity.
In addition to reporting trades to both regulators and the public,
swap dealers will implement crucial back office standards that lower
risk and increase market integrity. These include promoting the timely
confirmation of trades and documentation of the trading relationship.
Swap dealers also will be required to implement sales practice
standards that prohibit fraud, require fair treatment of customers and
improve transparency.
The CFTC is collaborating closely domestically and internationally
on a global approach to margin requirements for uncleared swaps. We are
working along with the Federal Reserve, the other U.S. banking
regulators, the SEC and our international counterparts on a final set
of standards to be published by the Basel Committee on Banking
Supervision and the International Organization of Securities
Commissions (IOSCO). The CFTC's proposed margin rules excluded non-
financial end-users from margin requirements for uncleared swaps. We
have been advocating with global regulators for an approach consistent
with that of the CFTC. I would anticipate that the CFTC, in
consultation with European regulators, would take up final margin
rules, as well as related rules on capital, in the second half of this
year.
Following Congress' mandate, the CFTC also is working with our
fellow domestic financial regulators to complete the Volcker Rule. In
adopting the Volcker Rule, Congress prohibited banking entities from
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.
International Coordination on Swaps Market Reform
In enacting financial reform, Congress recognized a basic lesson of
modern finance and the 2008 crisis: during a default, risk knows no
geographic border.
Risk from our housing and financial crisis contributed to economic
downturns around the globe. If a run starts in one part of a modern
financial institution, whether it's here or offshore, the risk comes
back to our shores. It was true with AIG, Lehman Brothers, Citigroup,
Bear Stearns and Long-Term Capital Management.
AIG Financial Products, for instance, was a Connecticut subsidiary
of the New York insurance giant that used a French bank license to run
its swaps operations out of a Mayfair branch in London. Its near-
collapse ultimately required a government bailout of more than $180
billion and nearly brought down the U.S. economy.
Last year's events of JPMorgan Chase, where it executed swaps
through its London branch, were a stark reminder of how when risk is
booked offshore, any losses are absorbed back here at home.
Congress addressed this reality of modern finance in Section 722(d)
of the Dodd-Frank Act, which 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.''
To give financial institutions and market participants guidance on
this provision, the CFTC last June sought public consultation on its
interpretation of this provision. The proposed guidance is a balanced,
measured approach, consistent with the cross-border provisions in the
Dodd-Frank Act and the recognition that risk easily crosses borders.
As the CFTC completes the cross-border guidance, I believe it's
critical that Dodd-Frank swaps reform applies to transactions entered
into by branches of U.S. institutions offshore, between guaranteed
affiliates offshore, and for hedge funds that are incorporated offshore
but operate in the U.S. Otherwise, American jobs and markets may move
offshore, but, particularly in times of crisis, risk would come
crashing back to our economy.
The proposed guidance includes a commitment to permitting foreign
firms and, in certain circumstances, overseas branches and guaranteed
affiliates of U.S. swap dealers, to meet Dodd-Frank requirements
through compliance with comparable and comprehensive foreign rules. We
call this ``substituted compliance.''
The Commission also proposed granting time-limited relief until
this July for non-U.S. swap dealers (and foreign branches of U.S. swap
dealers) from certain Dodd-Frank swap requirements. In December, the
Commission finalized this relief.
Under this time-limited relief, foreign swap dealers may phase in
compliance with certain entity-level requirements. In addition, it
provides relief for foreign dealers from specified transaction-level
requirements when they transact with overseas affiliates guaranteed by
U.S. entities, as well as with foreign branches of U.S. swap dealers.
In July, when the relief expires, various Dodd-Frank Act
requirements will apply to non-U.S. swap dealers. Overseas financial
institutions who wish to look to substituted compliance to fulfill
Dodd-Frank requirements are encouraged to engage now with the CFTC, as
well as their home country regulators.
We are hearing that some swap dealers may be promoting to hedge
funds an idea to avoid required clearing, at least during an interim
period from March until July. I would be concerned if, in an effort to
avoid clearing, swap dealers route to their foreign affiliates trades
with hedge funds organized offshore, even though such hedge funds are
managed (or otherwise have their principal place of business) in the
United States or they are majority owned by U.S. persons. Such an
effort is not consistent with the spirit of the Dodd-Frank Act or the
international consensus to clear all standardized swaps. The CFTC is
working to ensure that this idea does not prevail and develop into a
practice that leaves the American public at risk.
If we don't address this, the P.O. boxes may be offshore, but the
risk will flow back here.
Customer Protection
The Dodd-Frank Act included provisions directing the CFTC to
enhance the protection of swaps customer funds. While it was not a
requirement of the Dodd-Frank Act, in 2009 the CFTC also reviewed and
updated customer protection rules for futures market customers. As a
result, a number of the enhancements affect both futures and swaps
market customers. I would like to review these enhancements, as well as
an important customer protection proposal.
The CFTC's completed amendments to rule 1.25 regarding the
investment of customer funds benefit both futures and swaps customers.
The amendments include preventing in-house lending of customer money
through repurchase agreements. The CFTC's gross margining rules for
futures and swaps customers require clearinghouses to collect margin on
a gross basis. FCMs are no longer able to offset one customer's
collateral against another or to send only the net to the
clearinghouse.
Swaps customers further benefit from the new so-called ``LSOC''
(legal segregation with operational comingling) rules, which ensure
funds are protected individually all the way to the clearinghouse.
The Commission also worked closely with market participants on new
customer protection rules adopted by the self-regulatory organization
(SRO), the National Futures Association (NFA). These include requiring
FCMs to hold sufficient funds for U.S. foreign futures and options
customers trading on foreign contract markets (in Part 30 secured
accounts). Starting last year, they must meet their total obligations
to customers trading on foreign markets under the net liquidating
equity method. In addition, withdrawals of 25 percent or more of excess
segregated funds would necessitate pre-approval in writing by senior
management and must be reported to the designated SRO and the CFTC.
These steps were significant, but market events have further
highlighted that the Commission must do everything within our
authorities and resources to strengthen oversight programs and the
protection of customers and their funds.
In the fall of 2012, the Commission sought public comment on a
proposal that would strengthen the controls around customer funds at
FCMs. It would set new regulatory accounting requirements and would
raise minimum standards for independent public accountants who audit
FCMs. And it would provide regulators with daily direct electronic
access to the FCMs' bank and custodial accounts for customer funds.
The proposal includes a provision on residual interest to ensure
that the assets of one customer are not used to cover the positions of
another customer. We are considering the many comments we have received
on this and plan to finalize the proposal consistent with the specific
provisions of the Commodity Exchange Act and the overall goal of
protecting customers.
Further, the CFTC intends to finalize a rule this year on
segregation for uncleared swaps.
Benchmark Interest Rates
This hearing comes at a critical juncture.
It comes as there has been a lot of media attention surrounding the
three enforcement cases against Barclays, UBS and RBS for manipulative
conduct with respect to the London Interbank Offered Rate (LIBOR) and
other benchmark interest rate submissions.
More importantly, it comes as market participants and regulators
around the globe have turned to consider the critical issue of how we
reform and revise a system that has become so reliant on LIBOR, Euribor
and similar rates.
I believe that continuing to reference such rates diminishes market
integrity and is unsustainable in the long run.
Let's look at what we've learned to date.
Foremost, the Interbank, unsecured market to which LIBOR, Euribor
and other such rates reference has changed dramatically. Some say that
it is has become essentially nonexistent. In 2008, Mervyn King, the
governor of the Bank of England, said of LIBOR: ``It is, in many ways,
the rate at which banks do not lend to each other.'' He went on further
to say: ``[I]t is not a rate at which anyone is actually borrowing.''
There has been a significant structural shift in how financial
market participants finance their balance sheets and trading positions.
There is an increasing shift from borrowing unsecured (without posting
collateral) toward borrowings that are secured by posting collateral.
In particular, this shift has occurred within the funding markets
between banks.
The Interbank, unsecured market used to be where banks funded
themselves at a wholesale rate. The 2008 Financial Crisis and
subsequent events, however, have shattered this model. The European
debt crisis that began in 2010 and the downgrading of large banks'
credit ratings have exacerbated the hesitancy of banks to lend
unsecured to one another.
Other factors have played a role in this structural shift. Central
banks are providing significant funding directly to banks. Banks are
more closely managing demands on their balance sheets.
Looking forward, recent changes to Basel capital rules will take
root and will move banks even further from interbank lending. The Basel
III capital rules now include an asset correlation factor, which
requires additional capital when a bank is exposed to another bank.
This was included to reduce financial system interconnectedness.
Furthermore, the rules introduce a liquidity coverage ratio (LCR). For
the first time, banks will have to hold a sufficient amount of high
quality liquid assets to cover their projected net outflows over 30
days.
At an IOSCO roundtable on financial market benchmarks held in
London last month, one major bank indicated that the LCR rule alone
would make it prohibitively expensive for banks to lend to each other
in the interbank market for tenors greater than 30 days. Thus, this
banker posited that it is unlikely that banks will return to the days
when they would lend to each other for 3 months, 6 months or a year.
The public also has learned that LIBOR and Euribor--central to
borrowing, lending and hedging in our economies--has been readily and
pervasively rigged.
Barclays, UBS and RBS were fined approximately $2.5 billion for
manipulative conduct by the CFTC, the UK Financial Services Authority
(FSA) and the U.S. Justice Department. At each bank, the misconduct
spanned many years; took place in offices in several cities around the
globe; included numerous people--sometimes dozens, and even senior
management; and involved multiple benchmark rates and currencies. In
each case, there was evidence of collusion.
In the UBS and RBS cases, one or more inter-dealer brokers painted
false pictures to influence submissions of other banks, i.e., to spread
the falsehoods more widely. Barclays and UBS also were reporting
falsely low borrowing rates in an effort to protect their reputation.
These findings are shocking, though the lack of an interbank market
made the system more vulnerable to such misconduct.
In addition, a significant amount of publicly available market data
raises questions about the integrity of LIBOR and similar rates today.
A comparison of LIBOR submissions to the volatilities of other
short-term rates reflects that LIBOR is remarkably more stable than any
comparable rate. For instance, in 2012--looking at the 252 submission
days for 3 month U.S. dollar LIBOR--the banks did not change their rate
85 percent of the time. Some banks did not change their submissions for
3 month U.S. Dollar LIBOR for upwards of 115 straight trading days.
This means, in effect, that one bank represented that the market for
its funding was completely stable for 115 straight trading days or more
than 5 months.
Further, when comparing LIBOR submissions to the same banks' credit
default swaps spreads or to the broader markets' currency forward
rates, there is a continuing disconnect between LIBOR and what those
other market rates tell us.
Nassim Nicholas Taleb, the best selling author of The Black Swan,
has written a recent book called Antifragile: Things that Gain from
Disorder. He notes that systems that are not readily able to evolve and
adapt are fragile. Such systems succumb to stress, tension and change.
One of his key points is that propping up a fragile system in the
interest of maintaining a sense of stability only creates more
instability in the end. One can buy an artificial sense of calm for a
while, but when that calm cracks, the resulting turmoil is invariably
greater.
I think that the financial system's reliance on interest rate
benchmarks, such as LIBOR and Euribor, is particularly fragile. These
benchmarks basically have not adapted to the significant changes in the
market. Thus, the challenge we face is how the financial system adapts
to this significant shift.
International regulators and market participants have begun to
discuss transition. The CFTC and the FSA are co-chairing the IOSCO Task
Force on Financial Market Benchmarks.
One of the key questions in the consultation with the public is:
how do we address transition when a benchmark is no longer tied to
sufficient transactions and may have become unreliable or obsolete?
Without transactions, the situation is similar to trying to buy a
house, when the realtor cannot provide comparable transaction prices in
the neighborhood--because no houses were sold in the neighborhood in
years.
Given what the public has learned, it is critical to move to a more
robust framework for financial benchmarks, particularly those for
short-term, variable interest rates. A reference rate has to be based
on facts, not fiction.
I recognize that moving on from LIBOR and Euribor may be
challenging. Today, LIBOR is the reference rate for 70 percent of the
U.S. futures market, most of the swaps market and nearly half of U.S.
adjustable rate mortgages.
Yet, as the author Nassim Taleb might suggest, it would be best not
to fall prey to accepting that LIBOR or any benchmark is ``too big to
replace.''
Resources
The CFTC's hardworking team of 684 is just seven percent more in
numbers than at our peak in the 1990s. Yet since that time, the futures
market has grown five-fold, and the swaps market is eight times larger
than the futures market.
Investments in both technology and people are needed for effective
oversight of these markets by regulators.
Though data has started to be reported to the public and to
regulators, we need the staff and technology to access, review and
analyze the data. Though 75 entities have registered as new swap
dealers and major swap participants, we need people to answer their
questions and work with the NFA on the necessary oversight to ensure
market integrity. Furthermore, as market participants expand their
technological sophistication, CFTC technology upgrades are critical for
market surveillance and to enhance customer fund protection programs.
Without sufficient funding for the CFTC, the nation cannot be
assured this agency can closely monitor for the protection of customer
funds and utilize our enforcement arm to its fullest potential to go
after bad actors in the futures and swaps markets. Without sufficient
funding for the CFTC, the nation cannot be assured that this agency can
effectively enforce essential rules that promote transparency and lower
risk to the economy.
The CFTC is currently funded at $207 million. To fulfill our
mission for the benefit of the public, the President requested $308
million for Fiscal Year 2013 and 1,015 full-time employees.
Thank you again for inviting me today, and I look forward to your
questions.
The Chairman. Thank you, Chairman Gensler.
The chair would like to remind Members they will be
recognized for questioning in the order of seniority for
Members who were here at the start of the hearing, and after
that Members will be recognized in order of arrival. As always,
I appreciate the Members' understanding.
And I recognize myself for 5 minutes now.
Chairman, top regulators from European Union and Japan
testified before the Committee in December and detailed serious
concerns about CFTC's cross-border guidance, stating that if
cross-border rules weren't harmonized, trades will not be able
to clear, if they can't be cleared, they won't take place,
firms and users will not hedge the risk or firms will hedge the
risk, but they will only take place within one jurisdiction.
The consequences of that is obviously a fragmented market,
significant concentration of financial risk in the U.S. system,
and is exactly what we have tried to prevent with our global
regulatory reforms.
Now, given multiple failed attempts to coordinate between
the United States and international regulators, the most
recently-failed negotiations occurring in February, and we are
moving quickly towards that scenario described to us in
December. Chairman, with all due respect, why don't you believe
that long established markets will have sufficient regulatory
regimes or overseas swap transactions within their own borders?
Expand on that if you would.
Mr. Gensler. We have made tremendous progress here in this
country with the financial reform that this Committee helped
put in place in Dodd-Frank, and there has been great progress
in Europe, Canada, and Japan in terms of the central clearing,
data reporting and some other means.
We have embraced and said that where there is comparable
and comprehensive regimes in other countries, we would look to
something we call substituted compliance. We could look to that
home country's rules, but if a U.S. firm is guaranteeing
activities of a London affiliate or a Cayman Islands affiliate
or somewhere else, if they are guaranteeing that, that risk can
still come back here to the U.S. So we said there has to at
least be comparable and comprehensive oversight. Not every
jurisdiction would have that. Many will. Many will.
The Chairman. Moving to another important subject, I have
heard concerns from farmers, ranchers, the small to medium-
sized futures commission merchants opposing CFTC's proposed
rule to improve customer protections. Many of those folks say
the new proposals would profoundly increase their costs,
potentially threaten their existence, and this is very
disturbing to me because many of these smaller FCMs are the
ones who actually serve risk management needs of my farmers and
ranchers, the two groups that are of the utmost importance to
this Committee.
Putting aside your statutory requirements and given the
importance of this subject, was there an extensive cost-benefit
analysis performed by the Office of Chief Economist before
those rules were proposed, Chairman?
Mr. Gensler. Yes. We take seriously the cost-benefit
provisions that were put in the statute over a dozen years ago,
and the Chief Economist's Office participates and signs off on
each of those before they come to the Commissioners. Rules are
also put out for public comment. In this case we put out a set
of proposals on customer protection to the public. Many of
those proposals have gotten strong support. We received about
125 comment letters, but you are absolutely right, Mr.
Chairman. There is one issue in there--people have been using
the term residual interest--that has been raised where we are
going to take a very thoughtful look at the comments that have
come in because people have raised not only cost issues, but
just some practicality issues with regard to it.
The Chairman. So along that line, given the outcry, does
the Commission plan to re-propose the rule or make extensive
changes to the rule?
Mr. Gensler. I don't know yet, and I would like to keep
this Committee and you apprised. The comment period only closed
about 2 weeks ago. We extended it an extra month at the request
of many market participants. At its core what we did was we
repeated what is in the law. The law says that no futures
commission merchant should take one customer's money and use it
to benefit or secure, guarantee another customer's position,
their deficit or their position.
And that is, in fact, what we said, but what we found is
commenters have said that intraday, during the day they
actually do sometimes have one customer's surplus guaranteeing
other customer's deficits, and so we have to sort through that
practical circumstance.
The Chairman. Just bear in mind, Commissioner, that the
Committee won't ignore the pleas from the smaller ag players in
the market, and I am hopeful the Commission won't either.
Returning to the cross-border issue, I understand the
European officials could stretch the implementation timeline
out into next year for their own derivatives rules, and earlier
this week one of your Commissioners even stated or one of the
Commissioners even stated it would not be unlikely for the CFTC
to grant another extension to implement the cross-border
guidance.
So I guess my question is if the European regulators extend
their own rulemaking process into next year, and we made no
progress on substituted compliance by July 2013, global markets
would be in danger of, I think the appropriate phrase is
fragmentation and pooling risks. How do you plan to avoid that
outcome, Chairman?
Mr. Gensler. We have been committed this whole time to
phased implementation. You actually only gave us 1 year to get
everything in place, and here we are nearly 3 years since Dodd-
Frank passed. There were even bills considered at some point to
ask us to take more time. We have not felt we are doing this
against the clock. We want to get it balanced and appropriately
in place, but I also think we keep in mind that 5 years ago
Bear Stearns failed, and eight million people lost their jobs.
So I would envision as we get closer to July we will have
checked off more things with the Europeans and Canadians and
others, like Japan. We now have 30 international dealers
regulated and registered, which is a big positive. We have the
public seeing their transactions for the first time, which is a
big positive, and we will see where we are as we approach July
as to whether there is some appropriate additional phased
compliance.
The Chairman. Thank you, Mr. Chairman. My time has expired.
I now recognize the gentleman from Minnesota for 5 minutes.
Mr. Peterson. Thank you, Mr. Chairman.
Following up on that a little bit, one of my reservations
as you know about moving forward on these bills is that we
don't have the whole picture of all the rules, and we don't
have all the rules in place and in effect, and we don't have a
full picture of what this swap market is yet.
In your testimony you say you are 80 percent of the way
completed with these rules, and by August, how much of the
remaining 20 percent do you hope to have finalized, and are
there any potential issue, outliers that may take longer to
resolve, and if so, what are they?
Mr. Gensler. We now have with the Commission full final set
of rules on pre-trade transparency provision, the swap
execution facility, and we are working through it in a very
constructive way amongst the five of us to reach a consensus
and move something out. The cross-border issues we look to
finish up many of the big pieces, the guidance, by July, but
there is certainly going to be more work internationally that
will just continue on a day-to-day basis. We will address more
issues about rural electric cooperatives and various
electricity companies where we are planning certain exemptions.
So I think the bulk of what we need to do will be done by
August, but one area I just want to mention that will still be
outstanding is we purposely slowed down on finalizing margin
for uncleared swaps--the issue that is so interesting to end-
users. The Federal Reserve slowed down as well because we
wanted an international agreement, and we have been working on
that. We put something out in consultation last summer. We put
a new document out I think it was in February, and that should
point us to probably finalizing the margin rules closer to the
4th quarter of this year because we didn't want to move forward
if there wasn't, as the Chairman said, harmonization on this
key issue.
We have been advocating with the Federal Reserve and with
the international regulators that there is not a requirement
for the banks to charge a margin on this uncleared swaps for
the non-financial end-users, but that is one piece that we are
purposely waiting on until the fourth quarter.
Mr. Peterson. I mean, you get unfairly blamed for this
margin requirement. What is the discussion with you and these
Prudential Regulators? They are the ones that are causing this
problem, right?
Mr. Gensler. Well, we have jurisdiction. You gave us
jurisdiction if it is a non-bank, and of the 70 or so swap
dealers we now have statistics. The majority of them are
actually non-banks. They are often the affiliate of a bank. You
know, they are the sister of a bank, but you have given us that
jurisdiction.
I think we are pretty comfortable with what we proposed.
Mr. Peterson. But the problem is that the ones that are
banks that are regulated, they are telling their customers they
are going to have to put margins on because the Prudential
Regulator is going to require them to have margins. Is that
what is going on?
Mr. Gensler. Well, the proposal from the Prudential
Regulators, the Federal Reserve and others, was that there was
no specific requirement, but then they did include in the
preamble several sentences that said, but, of course, if you
are extending credit, you should do that consistent with your
overall credit policies of the bank, and those key sentences in
the preamble is what has been debated, and I don't know where
the Federal Reserve will end up. I know what we have been
advocating is to be consistent with where we are.
Mr. Peterson. Now, you have been advocating that these end-
user, non-bank end-users shouldn't be required on this margin
requirement.
Mr. Gensler. Right. That it be just a matter of commercial,
private negotiation.
Mr. Peterson. Yes, but you think that the Prudential
Regulators may come to the right conclusion at the end of the
day?
Mr. Gensler. I think so, because in February we put out a
new consultation internationally, not just here domestically
but internationally, that included that the end-users would not
be caught up in this. So that is what is this last
international document that was put out and should be finalized
by the summer.
Mr. Peterson. Right. So, I mean, this has been a big issue
that has been going on for 2, 3 years. We have bills introduced
and all this stuff, am I right that it is premature to be
passing bills before we know what the final outcome of this is
going to be?
Mr. Gensler. I think that you gave us clear direction on
this and clear authority. We have the authority to finalize it
the way you wish. The CFTC is doing that. The international
consensus is aligned with what your Committee's views are or at
least your views were.
Mr. Peterson. Thank you. Thank you, Chairman.
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, Mr. Chairman. Chairman Gensler,
it is good to have you.
I was particularly interested in your testimony about some
of the things that you are doing on LIBOR. As you know in
another committee assignment I had we had some discussions
about LIBOR, and can you kind of give me a blueprint of kind of
where we are headed with that, and what kind of timeline, and
who are the market participants that are working on this issue?
Mr. Gensler. I thank you, and I thank you for your
leadership on these issues because I know you have been looking
at in the Committee. Where we are is there is a market called
Interbank Lending, bank-to-bank lending without posting
collateral. It is called the unsecured market or it was. What
we know is it is essentially non-existent now due to a lot of
changes, structural changes in the banking market and also new
rule changes in the Basel Committee's capital rules.
So since 2008, we have had LIBOR referencing something that
essentially is non-existent, and we have had these three large
cases that have led to $2.5 billion in fines at Barclay's RBS
and UBS, but I don't think that is the central part of the
story. The central part of the story is what do we do when a
market is referencing something that is not actually trading,
and if it were just not trading for 3 days or even a week or 2,
that would be one thing, but this is long term.
So the international regulators, both bank regulators and
market regulators, have been pursuing dialogues and
discussions, security regulators have a consultation out on
best practices and also looking at if we were to transition how
to smooth that transition. This would not be easy to transition
from U.S. Dollar LIBOR to something else. It would be very
challenging, should take a long time, it should be smooth,
because it is so embedded in the financial system. There have
been a lot of market participants involved either by written
consultation or brought into round table discussions. But this
goes well beyond the U.S., well beyond the CFTC because the
system uses this rate in so many ways even though the rate, I
think, long term is not sustainable.
Mr. Neugebauer. So is the direction it is moving is that
currently there are different currency LIBORs, Euro LIBOR, U.S.
LIBOR? Are you moving to continue to have a rate in each
currency, or are you looking for a larger, a universal number
that everybody is working off?
Mr. Gensler. So what the international securities
regulators came around to in this public consult is that any
benchmark to be viable and reliable should be anchored in real
transactions. It is sort of like if you were to buy a home, and
you asked your realtor what are the comparable prices in the
neighborhood, you would like to know what the comparable price
is. Now, if there is no transactions for the last 4 years, that
leaves you guessing what to pay for that house.
So to anchor in real transactions, Martin Wheatley, who
runs the Financial Services Authority in London--has already
recommended last summer--he recommended that there shouldn't be
Canadian Dollar LIBOR, Australian Dollar LIBOR, and six other
currencies. He said there just isn't enough there, but then
that brings us back to the question about U.S. Dollar LIBOR,
Euro LIBOR, and like you said, those are more challenging
because they are so part of the financial system. We have this
fragility of relying on something that may not be referencing a
true market.
Mr. Neugebauer. Are any of the Fed's benchmarks being
considered? And the only reason I ask you that is because the
Fed has the ability, obviously, to manipulate that but in many
cases that does trigger other transactions, in other words, the
discount rate or Fed funds rate, those kinds of things that
would reflect what banks could either borrow from the Fed or
could borrow from each other.
Mr. Gensler. There are three or four different alternatives
that market participants have been chatting about. One of them
is something called overnight index swap rate that does
ultimately refer to in an indirect way to overnight funding
rates for the banks, but it is based on real transactions.
Other things people are looking at are there rates based on how
people do collateralized lending, general collateral or
repurchase agreements? There is even looking at the treasury
yield curve and so forth.
Mr. Neugebauer. Thank you. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired.
The chair now recognizes the gentleman from Georgia, Mr.
Scott, for 5 minutes.
Mr. David Scott of Georgia. Thank you very much, Mr.
Chairman, but I must say at the outset that it is somewhat
unfortunate that we are trying to pack so much into one
relatively brief hearing. Each of these bills we are examining
today deal with very complex issues that entire armies of
lawyers are paid to try to understand, and while the idea's
embodied in these bills are not new, a great many of the
Members of this Committee are, so in my humble opinion it would
be preferable to break some of these bills into just a few
hearings so as not to force our Members who are new to Congress
and new to this Committee to sort of drink from a fire hose.
So I am hoping, Mr. Chairman, that at least we will get one
more bite of the apple before we pass this, but nonetheless,
this is the hand that we dealt, so here we are.
I do want to say at the outset, however, that I am
supportive of these bills that we are discussing today, because
I think it is very important for us to emphasize that none of
these bills, neither in spirit nor in letter, seek to undermine
the regulatory regime prescribed by Title VII of Dodd-Frank.
Rather, they all seek to address areas of either statute or
rulemaking that require clarification and adjustment, and that
is why all of them have historically had strong bipartisan
support both in this Committee and the other Committee I serve
on, Financial Services.
It is in my opinion that these bills will not lead to new
loopholes, these bills will not lead to lax regulation, and
they will not lead to another Wall Street meltdown. These bills
are not about protecting the bottom line of big banks or
helping the exchanges skirt regulation. The legislation before
us today is about keeping the cost of doing business down for
end-users of derivatives, whether they are big companies like
Delta Airlines or Home Depot or small and large farms and
ranches in our districts and allowing them to continue to hedge
price risk.
This, in turn, helps keep costs down for consumers, and the
ideas contained in these bills are not incompatible with the
stated goals of Dodd-Frank on transparency or customer
protection. We must not be afraid to make changes to Dodd-Frank
where they are warranted, particularly to portions that may not
work as we intended them to do or may have unintended negative
consequences.
So with that said, let me turn to you, Chairman Gensler,
and ask you about an issue that I have raised with you many
times, and that is the extraterritorial application of Dodd-
Frank rules. It would seem that with the application of
clearing and margin requirements as well as swap dealer and
major swap participant registration and reporting requirements
would prevent any risk of another AIG-like market failure, and
yet the cost of such extraterritorial application would be
quite substantial, not to mention the risk to U.S.
competitiveness in this space.
Given developments late last year unnecessary disruptions
around the October 12, deadlines, last-minute, no-action
letters reports that foreign banks wouldn't do business with
U.S. firms and interim final rules.
Let me ask you why should Congress have any level of
confidence that you are moving in the right direction and that
markets won't be negatively impacted by the actions of the CFTC
with respect to extraterritoriality, and also how do you intend
on getting the rest of the world to follow the United States
when the SEC and the CFTC rules currently don't align on
timing, process, or content in many areas?
Mr. Gensler. I would hope that you would have confidence in
any agency that was handed an enormous task and has largely
completed it, that we have had 40,000 public comment letters
and 2,000 meetings, and we have actually addressed where we
need to move in moderation or even re-proposed rules in a
number of circumstances.
I think also on the cross-border side I just raised, that
even the bills before you could blow a hole in the bottom of
Title VII with all respect because whether it is through
booking something in an affiliate or booking it offshore, that
risk will and does come back here. That is exactly what
happened in AIG.
Mr. David Scott of Georgia. Let me ask you, what would
happen later this year if there still is not an international
harmonization or even domestic harmonization?
Mr. Gensler. We will continue to work, I think, very
closely with the international community. We will not be
exactly the same, but where there are conflicts, we are taking
a very pragmatic approach. We have worked through a number of
them with Japan with Mr. Masamichi who testified here in
December. They have a clearing requirement, we have a clearing
requirement. They were actually tightly aligned, but there was
a conflict, and we did one of those no-action letters so that
U.S. firms can clear in a Japanese clearing house, for
instance.
So where there are conflicts, we have been pragmatists, and
that is what has led to a lot of these no-action letters is
trying to adjust and moderate.
Mr. David Scott of Georgia. Thank you, Mr. Chairman.
Mr. Conaway [presiding.] The gentleman's time has expired.
Thank you, Mr. Scott.
I now recognize myself for 5 minutes.
Chairman, thank you for being here. Welcome.
Following up on the cross-border jurisdiction issues, are
there countries now that you trust their regulatory scheme to
be good enough that you could go ahead and grant them the
substituted compliance designation like Japan or EU or Canada
where at least with respect to those jurisdictions you could
put these kinds of questions aside without a lot of hassle?
Mr. Gensler. I think it is an excellent question. There are
six jurisdictions overseas; just six that have registered swap
dealers with us; Europe, Switzerland, Canada, Japan, Australia,
and Hong Kong. We have reached out to all six and said, let's
get going because we could probably identify maybe not all the
rules but a substantial number of them where we can look to
that home country's substituted compliance, and we made some
good progress with Canada and Europe in some of those
discussions.
Mr. Conaway. Are there any of the six that you don't out of
hand trust?
Mr. Gensler. I trust all of my fellow regulators, but their
laws and rules are sometimes a little different than ours. So
it is a question of whether, technically whether they are
comparable and comprehensive. Let's say they have a clearing
requirement that it is comparable enough. It doesn't have to be
identical.
Mr. Conaway. All right. So perfection is the enemy of the
good here, is it?
Mr. Gensler. No, no, no. It has to be comparable and cover
the sort of waterfront but not identical.
Mr. Conaway. One of these comes up from time to time that
we generally vehemently oppose is some idea of combining the
SEC and the CFTC, and one of the fodder for that idea is that
you can't do joint rules. You have a U.S. person rule that for
the SEC's one kind of a U.S. person, and you have a different
one. Why can't you guys get together so we can put some of
these kind of arguments aside, because quite frankly, I think
that would be in the worst interest of the overall scheme to
try to combine you, but those kinds of apparent lack of
cooperation, for lack of a better phrase, give people fodder
for that idea.
Mr. Gensler. Yes. I want to say that I do share your view
about it I don't think it would benefit the American public
to----
Mr. Conaway. I don't either.
Mr. Gensler. All right. We are together on that.
Mr. Conaway. Absolutely.
Mr. Gensler. But in terms of coordination, we are
coordinating with the SEC. You granted this agency oversight of
about 95 percent of the swaps market, and SEC has about five
percent. On U.S. person, more specifically, we put out a
proposal on guidance last July. We have actually narrowed it to
a more territorial approach, and I think we put that out in
December. We had one set of questions left about offshore
commodity pools that are still for the benefit of U.S. persons
managed here in the U.S. But that narrower territorial approach
actually, I think, has been working reasonably well.
That means if you do a trade offshore even with a
guaranteed affiliate, it doesn't get counted like it does to
this more territorial U.S. person approach.
Mr. Conaway. Well, let the record reflect I vehemently
oppose that idea because I do think the public would be harmed
by it, but the closer you can work together on joint rules like
that, obviously the better.
We have the cost-benefit legislation that my colleagues and
I have proposed last year, passed the House with overwhelming
bipartisan support, would require the CFTC to come in line with
the President's Executive Order of cost-benefit analysis.
Do you oppose that idea? Is that not in the best interest
of the regulated?
Mr. Gensler. I think that considering costs and benefits
have benefited our rulemaking. I think we have done it better
because we have focused on those costs and benefits. There are
many choices, though, that Congress makes--we are delegated
authority--but you make the key choice, whether there is
clearing, whether there is public transparency and so forth,
and so I think just to raise the concern that you wouldn't want
us to have to reconsider the things that you have already
decided in the eyes of some cost-benefit.
Mr. Conaway. Chairman, you are wonderful at answering, but
the question was do you oppose the legislation?
Mr. Gensler. Oh, the legislation? I think the legislation
would make our jobs quite a bit harder. In the future, whether
there are tweaks to any cost-benefit in the Commodity Exchange
Act, we will live with it, but it may well be hard to get any
rule out of the building.
Mr. Conaway. Okay. Speaking of the building, there is a
report out that there is a data access issue with respect to
the Office of Chief Economist. Can you talk to use about when
you knew about it, did you approve the program in its
inception, or just kind of quick snapshot of what is going on
there.
Mr. Gensler. So our Chief Economist Office for years, maybe
decades, has done research on data that comes into the building
and sometimes publishes some results and puts that out to
benefit the public and benefit the markets. They also have, and
this is for many years, used some outside consultants and
academics who are credentialed and signed in. There was a
question that came to our attention in December about at least
one research report written by an outside academic as to
whether they had the right to use the data and so forth. It
came to my attention then. We immediately started to look at
our credentialing, how are they documented, what sort of
documents they signed, and so forth. And what we did at that
point in time is we said let's for the moment just shut down
the use of any outside academics, consultants as we found some
that our documentation and internal controls weren't fully up
to snuff. We shut it down promptly, and we referred it to our
Inspector General.
Mr. Conaway. Okay. Well, if you decide to do something
again in that arena, we would appreciate being briefed on the
internal controls and the other things that you are going to
put in place.
Mr. Gensler. I think that is a good idea that we would do
that.
Mr. Conaway. All right. My time has expired.
Mr. Enyart, Illinois, 5 minutes. Bill. All right. No
questions.
Mr. Vargas.
Mr. Vargas. Thank you very much, Mr. Chairman. I appreciate
the opportunity.
You did comment when you first got here that you were quite
restrained, that we had given you an enormous task, and you
were quite restrained because of resources. Could you comment a
little further on that?
Mr. Gensler. Well, we have 684 people. That is about 50
more people than we had 20 years ago or seven percent more than
we had 20 years ago and a little smaller than a year ago. In
that time Congress gave us the job to oversee the swaps market
that is eight times larger in risk than the futures market that
we had overseen.
So we think that we need about 1,000 people, and we also
need significantly to grow the technology, and I know this is
hard because Congress is grappling with big issues about the
Federal budget, and an extra $100 million for this small agency
is hard to find, but I think it is a good investment for the
American public, and simply put we are not right-sized for the
mission that we have right now. We just simply don't have the
staff to do the examinations, we don't have the staff to do the
enforcement. Our enforcement staff is smaller than it was, I
think, 2 years ago or about the same size, and though it is not
a way to measure it, these LIBOR cases brought in $2 billion to
the U.S. Treasury, and the last 12 months we are funded at
about $200 million.
Mr. Vargas. And a follow-up question with respect then to
sequester. Is the sequester in any way causing havoc in your
agency or not really, or how it is affecting you?
Mr. Gensler. It pinches us. It definitely pinches us. As I
said, we are a little smaller than we were a year ago. We were
cautious this year because frankly I thought it was a
reasonable possibility that we would end up with a sequester,
and maybe I am a man that came from markets and playing the
odds or something, but so we have been cautious, and so we are
able to make it through the next 6 months we think without
furloughs, but we are just not in the right place. We shrank a
little bit over this last year to prepare for sequestration. We
are not spending enough on technology either.
Mr. Vargas. You mentioned that there are six international
regulators, and where do you find the convergence or divergence
with them on the issues that we have been discussing so far?
Mr. Gensler. Geographically we are best with Europe and
Japan because they are further along. They have passed their
legislation, and they have put in place most of their rules.
Canada almost as far, Australia and Hong Kong have more work to
do legislatively.
In terms of substance, in terms of policy where we are
closest is central clearing seems to be a good, solid, strong,
international consensus, data reporting to the regulators,
strong international consensus, and some of these margin
issues, actually a growing consensus. Where we are less close
is whether the public gets the benefit, the end-users get the
benefit from seeing the price in volume and transparency. In
our country we have benefited since the 1930s in the securities
markets, the futures markets, and I think we come together
actually across the philosophies that transparency is a good
thing, but it does tip things away from Wall Street, and so it
shifts some information to the public, to the end-users, and
that consensus isn't as well formed in some of the other
jurisdictions around the globe.
Mr. Vargas. Like which ones?
Mr. Gensler. In Europe they are still putting that in front
of their European Parliament, and they look to try to finalize
that this summer, so I think they are going to get there. It
feels very good that they will get there. Japan has it but more
narrowly than ours, and then other jurisdictions do not have
the public transparency components like Hong Kong or Singapore
for instance.
Mr. Vargas. Thank you very much. Thank you very much, Mr.
Chairman.
Mr. Conaway. The gentleman yields back.
Mr. Austin Scott for 5 minutes.
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman, and
many of the questions that I had have been asked, but I do want
to commend you, Chairman, for the statement that you made that
you actually prepared for the sequester. That is not something
that we have heard from many of the people that were in charge
of their agencies.
Mr. Gensler. I thank you. I just was reading the
newspapers.
Mr. Austin Scott of Georgia. Yes. I majored in risk
management, so I think that it was just prudent to prepare for
it once it became the law of the land, so thank you for running
your agency like that.
I think the other thing I would just reiterate that has
been talked about a good bit here is that making sure that we
are able to maintain the difference in the end-users who don't
pose a systemic risk to the markets and the others who do pose
a risk, and with that said, H.R. 634 is before us. We passed
this bill last year, 370 to 24. It is the legislation that
simply, essentially says that if you are an end-user and you
qualify for the clearing exemption, you would also qualify for
the margin exemption.
Again, it passed 370 to 24 last year in the House. We are
going to be dealing with it again this year, broad bipartisan
support. It was not taken up in the Senate.
Do you have any thoughts on that that you would care to
share with the Committee?
Mr. Gensler. The non-financial part of our economy employs
94 percent of private-sector jobs, and Congress came to a
judgment that those parties who only, if I can use another
statistic, only make up about nine percent of this swaps
market. So 94 percent of jobs, if I can say it that way but
nine percent of the swaps market. Congress came to the judgment
that the Administration supported that they didn't have to come
into central clearing. Consistent with that we have proposed
that they are not caught up in margin.
Mr. Austin Scott of Georgia. The margin.
Mr. Gensler. The margin and I think that is where we will
end up as a final rule later this year as well, and that is
what we have been advocating with the international community.
We have also looked at whether end-users should have more
time to report their data to the data repositories. In every
spot we reach out to many of these end-user communities, and
you will hear from some of them later today.
Mr. Austin Scott of Georgia. Yes.
Mr. Gensler. As to how we can accommodate to make sure that
this might touch them but touch them lightly.
Mr. Austin Scott of Georgia. Okay. One last question if I
might. I have been through 50 Committee hearings. So is the
President going to sentence you to another 50 hearings or----
Mr. Gensler. I guess you maybe have read some news reports.
There are ongoing discussions about that. It is a terrific
honor to serve, privilege, and I hope that a significant part
of my remaining professional life is in public service. So I
think this job is terrific, and appearing before this Committee
is terrific.
Mr. Austin Scott of Georgia. Up until that I think your
testimony was very honest.
Thank you, Mr. Chairman. Thank you, Mr. Gensler. I yield
the remainder of my time.
Mr. Conaway. The gentleman yields back.
Mr. Gallego from Texas, 5 minutes. No? All right.
Mrs. McLeod for 5 minutes. No?
Anybody else? Mr. Nolan, 5 minutes? All right.
Mr. Crawford.
Mr. Crawford. Thank you, Mr. Chairman, and before I begin
with questions, I would like to thank both panels for being
here to testify today about the current state of Dodd-Frank
implementation, particularly thank you to Mr. Larry Thompson,
General Counsel, for the Depository Trust and Clearing
Corporation, who has come before the Committee before to
testify particularly on the merits of legislation H.R. 742, the
Swap Data Repository and Clearinghouse Indemnification
Correction Act of 2013. I certainly appreciate my colleague,
Congressman Sean Patrick Maloney for joining me as a cosponsor
of this bill, and finally, Chairman Gensler, I would like to
thank you as you are charged with the difficult task of
improving market transparency and systemic risk mitigation and
global derivatives market. I am hopeful the CFTC will achieve
these goals, and I introduced H.R. 742 to fix the Dodd-Frank
provision which threatens to undermine the bipartisan goal of
enhancing transparency and mitigating systemic risk.
Currently Dodd-Frank law includes a provision requiring a
foreign regulator to indemnify a U.S.-based SDR for any
expenses arising from litigation relating to a request for
market data. Unlike most of the world, the concept of
indemnification is only established within U.S. tort law. As a
result, foreign regulators have been reluctant to comply with
the provision, and international regulatory coordination is
being thwarted.
While the idea of the provision was to protect market
confidentiality, in practice it threatens to fragment global
data on swap markets. Foreign regulators would be forced to
create their own SDRs, resulting in fragmented global data
framework where regulators can't possibly see a complete
picture of the marketplace. Without effective coordination
between international regulators and SDRs monitoring and
mitigating global systemic risk is severely limited. H.R. 742
fixes this problem, and while the CFTC seeks to clarify this
provision through interpretive guidance, all indications are
that there is no viable solution without adopting my
legislation as we will hear from Mr. Thompson later in the day.
So with that I have the following question for you,
Chairman Gensler. Recently your colleagues, Commissioners
Sommers and Chilton both testified before this Committee and
agreed that H.R. 742 is a necessary fix to the indemnification
provision of Dodd-Frank. The SEC testified to that same effect
before the Financial Services Committee last year.
Do you agree or disagree with your colleagues?
Mr. Gensler. I think that you have provided us in title VII
a great deal of flexibility, and we have used that flexibility
in the interpretation we have done. The bill as I understand it
is consistent with that, and certainly international regulators
would like that extra step. I mean, what we did in the
interpretation that we put out--that you referenced--is that
international regulators, if in their statute, anywhere in that
statute they have authority to get that information, then the
indemnification doesn't apply.
So we interpreted it, I think, just about as broadly, but
your bill certainly just goes further by just removing the
indemnification altogether.
Mr. Crawford. You have indicated that interpretive guidance
would be enough to address the indemnification problem, so I
think as you indicated global regulators disagree and have
expressed that they actually support the legislative approach.
I am just wondering why there was a difference of opinion
there.
Mr. Gensler. Well, we have addressed it. I think that in
some circumstances global regulators would like to see
information that they don't necessarily have authority to see,
that their local laws or legislation haven't given them the
authority to see, and so I think as they have expressed to us,
for instance, they might want to see in these data repositories
information about U.S. traders who might do a transaction
referencing one of their government rates or something. So they
wanted to go a little further in what they could see.
Mr. Crawford. Okay. Why are reforms like cross-border
guidance at CFTC being made through interpretive guidance and
staff no-action letters versus a formal rulemaking process?
Shouldn't the CFTC follow the Administrative Procedures Act
requirements?
Mr. Gensler. With regard to guidance we do follow the
Administration Procedures Act quite closely. There have been
four or five places where we were not asked to do rules, but
somebody has come in and said can you interpret some words in a
statute, and this cross-border provision is something that
Congress put in--it is actually technically called Section
722(d)--that did not have required rulemaking. Furthermore, is
not in the provisions for the Securities and Exchange
Commission. This was one place that it was not the same.
And so we had a lot of people come in. We debated whether
we just left it to facts and circumstances, issue no
interpretation, or put out an interpretation, or third, put out
an interpretation subject to public comment. We chose the third
to get the public input, and yes, we have gotten a lot of
public input. I would include this hearing in that public
input. So it has been very helpful to interpret these words,
and I think give guidance.
Mr. Crawford. I appreciate that. You anticipated my next
question so I don't have to ask it. I am out of time. I
appreciate your being here, Chairman Gensler.
I yield back.
Mr. Conaway. The gentleman yields back.
With apologies to Mr. Maloney from New York for skipping a
while ago. Sean, you are recognized for 5 minutes. Sorry about
that.
Mr. Maloney. That is quite all right, Mr. Chairman. I am
the youngest of six kids. I am quite used to it. My mother says
I was lucky to get a name, Mr. Gensler, at the end of five
brothers.
Listen, I want to reiterate the comments of my colleagues
and commend you on what I think is really extraordinary public
service. I was with a very significant player in a marketplace
that you oversee just on Sunday night, and he said to me there
are a dozen or so guys in Chairman Gensler's position all over
the globe, and he is the only one getting anything done, and
regardless of the minor differences, a lot of the people you
oversee have with each of the decisions you have made, there is
from my perspective a real growing consensus that you have been
extremely effective given the extraordinary responsibilities
that Congress has placed on you recently. And so thank you,
first of all, for the work you have done. I think it is
extraordinary and critical to the functioning of these markets.
When I was last in Washington, I was working in the White House
for President Clinton, but when I left, I ran a commodity
derivatives risk management company, and we made software to
try to get at some of the very issues for the commodity
derivatives market that we are still wrestling with in the
larger derivatives markets.
So I have been an observer of this space for a decade,
although I am a little rusty having worked in other areas
since. But I am particularly concerned about your comments
about the resources that you have been provided, and I want to
give you a chance to elaborate on that because I really would
like you to be able to inform the Committee what the world is
going to look like if we don't right size your agency given the
extraordinary increasing responsibilities that we have bestowed
on you.
Mr. Gensler. I thank you. I am one of five children, and I
am at the bottom end, too, so I know that which you speak of.
I think it is also about risk assessment. I think that a
wrong-sized agency can survive for a while and then at some
point something kind of pops up. We don't have the staff right
now. We don't go into the big clearinghouses annually as
Congress directed us to do for the systemically important ones;
Chicago Mercantile Exchange, ICE, and LCH. We don't really have
the staff to do examinations of the future commission merchants
and now the swap dealers.
Now, we first rely on the National Futures Association, but
we feel some obligation to have back up and to have spot checks
and to move in from time to time. We don't really have the
staff to answer all the hundreds of questions that are coming
in. The futures industry comes in with questions, the swaps
industry, and we do our best, but it would be better to have
more people, and in the enforcement side we don't have enough
people on the enforcement side.
I liken it sometimes to if the National Football League
took on eight times the number of games--because we have eight
times the number of risks that we are overseeing--and kept the
same number of referees, and so you would have one ref per
seven games, and then one game wouldn't even be reffed.
And I think what we know would happen in football is it
would be a rougher, tougher game out there probably, but the
fans over time would lose confidence, and I think the analogy
is the investors at some point would lose confidence because
there would be some major hiccup, everybody would haul us up
here, I would be up here for my 76th hearing, and it would be,
well, why, Mr. Gensler, did you let this happen, and nobody
would want to hear because we didn't have resources. I mean,
the American public needs some protection and oversight, and so
I think that is where we are.
Mr. Maloney. Well, thank you for that, and in the time I
have remaining let me just cut the other way a little bit. I
mean, do you feel that you also have a role in reducing the
regulatory burden of some of the firms you oversee, and where
do you think, if there are areas where Dodd-Frank went too far
or where we could reduce both their burden and yours, what
would you like to see us do?
Mr. Gensler. Well, I think title VII coupled with a
provision that was passed 20 years ago which gave the
Commission exemptive authority, where we can exempt some
provisions if it is in the public interest, has worked very
well. We have taken to heart end-users, non-financial companies
that are 94 percent of jobs but only nine percent of the market
and tried to give them more time. There were issues that were
focused on in the inter-affiliate area. I know there are bills
here that I might have concerns about because I think you could
really undercut this. We are going to address the inter-
affiliate issues, and we have something in front of
Commissioners to finalize it.
We have end-users coming in about something called the
treasury function. If they set up a treasury function, how to
address that, but, again, I think our exemptive authority gives
us pretty good ways to craft things. Where we can't we would
come to you, but I think we have some pretty good authorities,
and we look to your advice and guidance on these things as
well.
Mr. Maloney. Thank you, Mr. Chairman.
Mr. Conaway. The gentleman yields back.
Mr. Denham from California, 5 minutes.
Mr. Denham. Thank you, Mr. Chairman.
Mr. Chairman, I wanted to follow up on that same line of
questioning on the regulatory level. First of all, my belief
obviously with Dodd-Frank was it was designed for the big
banks, yet in my community we are dealing with a lot of
challenges on a day-to-day level with some of my smaller
irrigation districts.
Do you think that it is appropriate that that long reach
goes all the way down to the irrigation districts and some of
their day-to-day activities?
Mr. Gensler. I would like to follow up with you and
understand what they have raised, because if I think of an
irrigation district, they would be an end-user. They wouldn't
have to use this clearing and margining. I would like to find
out and if there is some practical issues there that we could
explore together.
Mr. Denham. Thank you. I will send you some of those
details right after this hearing and certainly would love to
follow up with you on a meeting.
Mr. Gensler. You know, it would be very helpful if we got
such details, and we can then follow up a week or 2 later and
then sit down and see what the issues are.
Mr. Denham. Thank you. Just one other question. Do you
believe that the swap execution facilities should have five
RFQs?
Mr. Gensler. Congress incorporated in the bill a provision
to promote transparency that buyers and sellers meet in the
marketplace and compete in the marketplace, and it actually
used words that it would be multiple parties having the ability
to transact with multiple parties. Roughly. I don't have the
words.
We proposed that there are a number of ways to do that. The
traditional way which is called an order book where everybody
sees the bids and offers and the whole market sees it, but as
an alternative also because this is a little bit different
market, a more narrow focus called a request for quote that you
could go out to a smaller number. We proposed five. I think
that that is an appropriate level.
I would note there are 73 registered swap dealers. It is
not a small community, and even though some of those are
multiple in a company, there are at least 35 or 40 separate
families or big companies making markets.
I would also note this requirement would only be in the big
interest rate markets, the big four currency markets that we
have a clearing mandate and for the big credit default swap
entities that were at the heart of this marketplace. So it is
narrow that way as well.
And last, I would note you gave us authority to exempt from
this any large notional size transactions or what people
usually call block trades. So it is only those markets that are
liquid enough to be cleared. There are 73 registered swap
dealers, so it is not like there is only a handful of them. It
is not about energy or agriculture or metal products because we
don't have a clearing mandate on those at this time.
Mr. Denham. The SEC has an alternative proposal on what the
mandatory requirement is. Why the difference between the two
Commissions?
Mr. Gensler. They had also included something which I know
it is in the weeds, but it is called order integration. They
said if there is an order book, you must go to that, and that
gets what is called time and price priority. We did not do
that. That is more central to their marketplace than the
futures marketplace and what we proposed. We didn't do this for
the swaps marketplace.
There are also many, many things that are identical in
their swap execution facility rules, proposals, but those tend
to get less focus, of course. This issue is one, but, again, we
are working through this, the five Commissioners. We have done
most of what we have done unanimous. Many other things
bipartisan. We seek consensus at the Commission. We are not
there yet on this one.
Mr. Denham. Thank you. I would like to follow up with you
on that one as well. And just to clarify, I understand that I
call things somewhat differently than you do. Our irrigation
districts are your special entities. That is the challenge in
the regulation on irrigation districts, but I will follow up
with you on that as well.
Mr. Gensler. Okay. I look forward to that.
Mr. Denham. Thank you.
The Chairman [presiding.] The gentleman yields back.
The chair now recognizes the gentleman from Florida, Mr.
Yoho, for 5 minutes.
Mr. Yoho. Thank you, Mr. Chairman.
Mr. Gensler, I appreciate you being here, and it is an
honor to be here, and I heard you say that, too, and I also
want to reiterate what Austin Scott said that you prepared for
sequestration, and I commend you for that.
You know, the Dodd-Frank financial reform bill, it came
out, it was such a massive change to the economy. It was
something we needed some oversight and some of those things
granted, but it also created so much confusion in the
marketplace, and what we need now is jobs, and what we have to
do right now is create that certainty. And I look through this,
and I look forward to these bringing that certainty to parts of
the market.
But one of the things here it says, excuse me, it says,
``Congress never intended for the end-user to be subject to
expensive margin requirements which would require companies to
take capital away from their businesses and hinder their
ability to make job creation investment.''
We see that in the community banks in our area in north
central Florida. We have a lot of the community banks that the
farmers go to, and it is impeding them in doing business, and
the more clarity that we can bring to that would be great, and
I look forward to working through those proposals for you.
And one question I do have for you is it is my
understanding that there are five different definitions of
hedging, including separate definitions within the same rule.
Do you think this provides clarity for the regulated community?
Mr. Gensler. You know, it is an interesting challenge being
at a regulatory agency and sometimes a hedging exemption
Congress would want it to be wide and sometimes they would want
it to be narrow, depending upon the circumstance, whether it is
related to position limits or this clearing exception and so
forth.
We made it very wide with regard to the clearing exception,
and I should mention we also used our exemptive authority to
exempt community banks, those smaller than $10 billion,
thousands of banks in this land, from the clearing exception.
So the vast majority of banks are treated like non-financial
end-users as well.
But sometimes the words in the statute and sometimes even
the intent of Congress is to be wide or narrow, and in the
clearing requirement it was pretty clear you wanted us to be
pretty wide to give these end-users an out from clearing if
they were hedging.
Mr. Yoho. Okay. Following up with that, is there any harm
in using just one common definition? Why or why not, and if you
could discuss that a little bit.
Mr. Gensler. There could be. I think if we were to use the
same definition and position limits and people debate whether
they are for or against position limits, but I think it is
pretty clear Congress in Dodd-Frank and for decades earlier
wanted us to have them, you probably exempt almost everybody
from position limits even the speculators. I mean, the way that
we sort of wrote the hedgers out of clearing was very wide and
was not the same words. They are not the same Congressional
words because in the position limit area it talks about bona
fide hedging in a different way, but I think it would not be
appropriate to use the same definition and position limits
because we would have to then be too narrow in the clearing
exception.
Or you might say, well, that would be good because you
would just basically gut position limits, one way or the other.
Mr. Yoho. All right. Thank you.
Mr. Chairman, I yield back the remainder of my time.
The Chairman. The gentleman yields back the balance of his
time.
The chair now recognizes the gentleman from California for
5 minutes.
Mr. LaMalfa. Thank you, Mr. Chairman, and for having this
hearing.
As we know, regulations hopefully well intended, can have
sometimes an adverse impact on people's lives and sometimes it
is unclear what the benefits may be from some of those regs.
For example, public utilities like I have in my district
and probably common to many areas of the country, are seeing
their access to energy supplies cut off by arbitrary
regulations.
So without a correction I think one of the byproducts of
this portion of Dodd-Frank may be increased cost for
electricity and gas bills for regular rate payers all around
the country, which to me, especially at this time is
unacceptable or not when it is hard to see what the benefit
really is. So myself and my colleagues, Mr. Vargas and Mr.
Denham and a few others have joined in on a bill, H.R. 1038,
which would allow government-owned utilities to continue
managing their risks, with many of their former counterparties
who have continued to walk away from even in like the ability
to enter into these agreements because of the CFTC's non-
binding no-action letter.
So I wonder would you support what we are trying to do in a
very narrow scope of H.R. 1038?
Mr. Gensler. If I could just mention a little background
that emanated in Dodd-Frank from the Senate side but just a
little background, there was a provision in the final bill that
there had to be enhanced sales practices and enhanced
protections for transacting these swap transactions with what
was defined as special entities, which included municipals and
pension funds or certain pension funds.
We sorted through a second provision, where Congress gave
us authority to further define a swap dealer and a de minimis,
if you were less than a certain level, you didn't have to
register as a swap dealer. The special entity provisions were
to provide greater protections of whether it was for a
municipal electric co-op or just a municipal government or as I
said, pension fund.
Mr. LaMalfa. Certainly, and I know my time is limited, I am
sorry, so I guess what we are finding in practice, though, is
that people are pulling back from entering into these
agreements, and so my bottom line is H.R. 1038, do you feel in
its narrow scope a supportable measure?
Mr. Gensler. Well, I haven't read it in detail so I----
Mr. LaMalfa. Okay.
Mr. Gensler.--want to stay away from that but let me just--
--
Mr. LaMalfa. Let's move from there then.
Mr. Gensler.--I think the policy issue that we will be
addressing is the protection of those entities, those
protections, those sales practice protections, those that you
want to be at that level. We did use that to make it easier.
Mr. LaMalfa. I am sorry. Let me ask on that. Has there been
a problem in the past? What role did public power companies
play in the crisis we have seen before then?
Mr. Gensler. They didn't play a role or any material role
except for they were the losers in a sense by a crisis. Their
jobs and their markets were hurt. I think that what we did was
we recognized this, we gave exemptive authority, we raised the
de minimis, meaning you don't have to register as a swap dealer
unless you do more than $800 million of transactions with
special entities, and we did that because the one comment
letter we got on this gave us a ratio to make it \1/10\ of the
overall de minimis. So we were reacting to comment letters as
well. At the time the comment letter came in they suggested
$300 million. We went to $800 million, but again, I respect
that some of these rural electric cooperatives think it should
be higher.
Mr. LaMalfa. Yes. We are looking to level the playing field
with the independent utilities as well, which has $8 billion.
What they are running into is that they don't believe that what
is called the no-action letter gives them enough certainty to
be able to operate. This would be like driving through a town
where the speed limit says 25 miles an hour but everybody says
you can go 50. Well, you don't know if they are going to
enforce that or not. So the no-action letter that says that
they can go up to the $800 million, do you believe that really
provides them with the certainty they need?
Mr. Gensler. The history of our regulatory system, these
no-action letters, have given people a lot of confidence. I
understand the metaphor, but I think it is more than that. The
staff recommends not to bring an enforcement action. The
Commission doesn't then sort of impose and without a lot of
public notice, and I think we have maybe withdrawn two or three
no-action letters in the last 20 or 30 years, but then we do
it, and people know it, and it is public and----
Mr. LaMalfa. The input we are getting is that people are
pulling back and drawing out of it, so I am out of time. Thank
you.
Mr. Conaway [presiding.] I thank the gentleman. Mrs.
Hartzler for 5 minutes.
Mrs. Hartzler. Thank you, Mr. Chairman. Thank you, Chairman
Gensler, for being here with us and for working and listening
to people as you have implemented these rules, and I have heard
of some positive outcomes, and people are feeling like that you
are being responsive. And so I don't know if we are completely
there, all the concerns are aligned, but I know you are trying,
so thank you for that.
I wanted to ask a little bit about MF Global, kind of
switch topics just a little bit because I have a lot of
constituents in my district that were impacted by that. I know
we are kind of winding up that situation there, but I wondered
first of all if you could kind of give your perspective on how
that happened and kind of summarize the recent findings and
suggestions for changes to see that that doesn't happen again.
Mr. Gensler. One, I want to thank you. There is always more
work to be done, so if there are issues, we want to address
them.
On MF Global, and I don't know if you are aware, within
days after the collapse of MF Global and as it turned to a
possible enforcement action involving senior executives of MF
Global including Jon Corzine, who I once had worked with now 15
years ago at Goldman Sachs, I stepped aside, I am not
participating and have not participated in these last 18 months
or so since that occurred, but certainly we could take that
question back. John Riley is here and could get it back.
Commissioner Sommers heads up from the Commission to get you--
--
Mrs. Hartzler. Yes.
Mr. Gensler.--details that you just asked about.
Mrs. Hartzler. Okay. Well, the Committee here has been
aware of a recent internal report conducted by the CFTC lawyers
on whether you were required to withdraw from matters involving
MF Global, and the Committee has seen recent press which
essentially said you were not required to withdraw and from a
legal and ethical perspective your participation in Commission
matters involving MF Global were not improper.
As part of the oversight mandate of this Committee, we have
an obligation to understand fully this, including the contents
of the December 13, 2012, memo.
So I wondered if you could please provide a copy of the
memo by the end of this week?
Mr. Gensler. Sure. I think it is actually on our website,
but we will certainly get it to you directly.
Mrs. Hartzler. Great, and has this internal report altered
your daily activities into the investigation and your
subsequent rule proposals for customer protection?
Mr. Gensler. It has certainly changed my involvement. I am
not in any way participating in that investigation.
With regard to rulemaking, rulemakings of general
applicability, I have been involved with that, voted on the
proposals as staff recommended, those proposals last October,
which have brought applicability to the marketplaces.
Mrs. Hartzler. Okay. Great. There has been another recent
press report about a possible serious data breach at the
Commission surrounding the OCE Net Program run by the former
chief economist, who is now a professor at MIT.
So how familiar were you with how this program operated
during its existence, and what are you doing to investigate
what happened?
Mr. Gensler. We have had for many years, well before I was
at the Commission, a Chief Economist Office that works and does
research on data but also uses from time to time outside
consultants, academics that are then credentialed in to
maintain that confidential information. In December it came to
our attention. Somebody contacted us and said they saw a
research report by one academic, and though that research
report didn't name any specific data by any one market
participant, they wanted to know how does that work.
And we started looking at it immediately, and I promptly
directed that we should suspend any of the outside consultants.
So what we found that there were some concerns about internal
controls, about whether they were fully documented as signed,
their non-disclosure agreements and things like that.
We also promptly referred it to our Inspector General. We
have been conducting a management review, but we also see the
benefit of having an independent IG look at it as well.
Mrs. Hartzler. Very good. Did you know how OCE Net
operated?
Mr. Gensler. I have learned a lot about it since December.
Mrs. Hartzler. Okay. All right. Well, thank you very much,
Mr. Chairman. I appreciate it.
Mr. Conaway. The gentlelady yields back. Mr. Hudson for 5
minutes.
Mr. Hudson. Thank you, Mr. Chairman. As a cosponsor along
with my friend from New York, Mr. Maloney, of one of the bills
being considered before the House Agriculture Committee, I
appreciate the opportunity to hear the testimony of Chairman
Gensler and look forward to the testimony of our future panel.
The Swaps Regulatory Improvement Act, H.R. 992, which we
introduced on Wednesday last week, along with two bipartisan
colleagues in the House Financial Services Committee, amends
the provision of the Dodd-Frank Act which sought to prevent
risky swaps activities of banks from being eligible for a
Federal bailout, FDIC insurance, or capital infusions from the
Federal Reserve. While we believe this provision was proposed
in good faith, it simply does not prevent the risk that the
author has intended.
Moreover, this provision of the bill will cause many
American financial institutions to operate at a significant
disadvantage to our foreign competitors. Federal Reserve
Chairman Ben Bernanke, former Federal Reserve Chairman, Paul
Volcker, who was also Chairman of the President's Economic
Recovery Advisory Board, and former FDIC Chairman Sheila Bair,
have all raised concerns about Section 716. I have with me
today letters from the above-mentioned financial and economic
leaders which illustrate the views on this particular section.
Without objection, Mr. Chairman, I would like to submit
them into the record.
Mr. Conaway. Without objection they will be submitted.
[The documents referred to are located on p. 117]
Mr. Hudson. Thank you. I should also point out that 18
Democrats, colleagues from the House Financial Services
Committee, including the Ranking Member, Maxine Waters, and
former Chairman Barney Frank wrote that they supported the bill
that addressed the issues with Section 716 in the last
Congress, which is identical to H.R. 992 in this Congress.
I would also like to add that letter for the record, Mr.
Chairman.
Mr. Conaway. No objection.
[The document referred to is located on p. 121.]
Mr. Hudson. Just last month on February 26, 2013, Chairman
Bernanke testified before the Senate Banking Committee that,
``Dodd-Frank is a very big, complicated piece of legislation in
an area proving difficult is the push-out provision for
derivatives.'' The next day, February 27, when testifying
before the House Financial Service Committee, Chairman Bernanke
elaborated on the need for Section 716 reform and stated, ``It
was not evident that Section 716 makes the company as a whole
safer, and what we do see is that it will likely increase costs
to people who use the derivatives and make it more difficult
for the bank to compete with foreign competitors who can
provide a more complete set of services.''
Now, Mr. Chairman, I would like to use the balance of my
time to ask Chairman Gensler about his concerns with Section
716. Chairman Gensler, I appreciate the opportunity to speak
with you today and thank you for your time.
Given the statements from Fed Chairman Bernanke and former
Fed Chairman which I provided today, do you agree that Section
716 needs to be reformed?
Mr. Gensler. I don't have a particular developed view on
section 716 partly because it is under the Federal Reserve
side, and we have so much we are focused on, and what has
happened and what we know. Facts on the ground, 73 registered
swap dealers. The vast majority of them are not insured
depository institutions. The vast majority are actually
affiliates already, which is what they would be if section 716
pushes things out. I would make an observation the vast
majority of the swap dealers registered with us in the last 2
months actually are not the banks themselves. Thirty of them
are foreign but even amongst the other 45 the majority of those
are the affiliates that are ready, and I think section 716
doesn't go into effect for another year or 2, but, again, I am
not as close to it.
Mr. Hudson. Would you consider it an overreach in the
authority, or would you categorize it that way? Do you think--
--
Mr. Gensler. You mean the original statute? I am sorry.
Mr. Hudson. Yes, section 716.
Mr. Gensler. No. I think as I remember it it was a judgment
of those who worked on it at the time that certain
transactions, energy, and non-interest rate derivatives, as
well as certain credit default swaps would be put in the
affiliates. The actual facts on the ground are many of these
are in affiliates. I think the largest dealers right now, the
Goldman Sachs and the Deutsche Banks and so forth do have
energy affiliates because that is how they chose to organize
themselves, and I could get back to you to look at our list to
see how they are organized.
Mr. Hudson. I appreciate that. You mentioned the
international folks. To your knowledge are any international
jurisdictions proposed or implemented in any type of swaps,
seek push-out provisions similar to this?
Mr. Gensler. I am not aware of any, sir.
Mr. Hudson. Okay. As I see my time is dwindling, Mr.
Chairman, I will just yield back the balance of my time. Thank
you.
Mr. Conaway. The gentleman yields back the balance of his
time.
We do have a second panel, and I had not intended to a
second round of questioning, but with unanimous consent, Mr.
Maloney from New York wants one other question, so the
gentleman is recognized for 2 minutes.
Mr. Maloney. Thank you, Mr. Chairman. I will be brief.
Chairman Gensler, I just wanted to ask you, I know you
spoke a little bit about the cross-border harmonization efforts
that you are engaged in, and I am curious on your view on the
status of that. I know you mentioned it before, but I think I
may have missed some of what you said, but in particular I am
curious about are there areas of dis-harmonization that would
create regulatory arbitrage opportunities that worry you?
Mr. Gensler. There are. We have made tremendous progress
with the European Union, Canada, and Japan, and we have other
jurisdictions like Australia and Hong Kong, Singapore are
always in our--when we meet, when we do these things. Frankly
we are further along with Europe particularly.
Where I would raise the greatest policy difference that we
just haven't locked in yet is after the transaction and before
the transaction in the U.S. the public gets the benefit of some
transparency. Europe has that in front of their Parliament
right now. I think they are going to do it. It seems to be the
consensus to do it, but they are not there yet, and then this
other thing is is there are many jurisdictions, whether it is
the Cayman Islands or others, that are probably not going to do
things. And so that is where, if a U.S. financial institution
is guaranteeing their affiliate let's say in the Cayman Islands
or something, that risk is going to come right back here. It is
going to be unfortunately in our markets, our taxpayers that
aren't supposed to stand behind it, but have that risk, and we
think that we need to at least say that if it is guaranteed
affiliate, we will look to substituted compliance, we will look
to home country rules if they are comparable, but if they are
not comparable, then it has got to be--we have to look to Dodd-
Frank.
Mr. Maloney. I will yield back, Mr. Chairman.
Mr. Conaway. All right. Thank you, Mr. Maloney.
Chairman Gensler, thank you very much. Excellent testimony
again. We appreciate it, and thank you and your team for coming
to visit with us. We have lots of things to talk about as we
move forward and----
Mr. Gensler. It is truly always an honor to be here, and
Member Scott didn't think so, I really do enjoy coming here.
Mr. Conaway. Well, thank you. You may need to run for an
elected office at some point in time with those skills.
Mr. Gensler. No, no, no. I won't do that. No. That is for
you all.
Mr. Conaway. All right. I would now like to introduce our
second panel. Thank you, Mr. Gensler.
While they are making their way forward, I will do the
introductions. First off we will have Hon. Kenneth E. Bentsen,
Acting President and CEO of Securities Industry and Financial
Markets Association here in D.C. We have Mr. Jim Colby,
Assistant Treasurer, Honeywell International Inc., Morristown,
New Jersey. We have Mr. Terrance Naulty, General Manager and
CEO of Owensboro Municipal Utilities, Owensboro, Kentucky, on
behalf of the American Public Power Association. We have Mr.
Larry Thompson, General Counsel, The Depository Trust and
Clearing Corporation, New York, New York. We have Ms. Marie
Hollein, President and CEO, Financial Executives International
and Financial Executives Research Foundation here in Washington
on behalf of the Coalition for Derivatives End-Users, and
finally, we have Mr. Wallace Turbeville, Senior Fellow, Demos,
New York, New York, on behalf of the Americans for Financial
Reform.
We got everybody seated, the right name tags up. All right.
So, Mr. Bentsen, you are now recognized for 5 minutes at your
leisure. Thank you.
STATEMENT OF HON. KENNETH E. BENTSEN, Jr., ACTING PRESIDENT AND
CHIEF EXECUTIVE OFFICER, SECURITIES INDUSTRY AND FINANCIAL
MARKETS ASSOCIATION,
WASHINGTON, D.C.
Mr. Bentsen. Thank you, Mr. Chairman and Members of the
Committee. I appreciate the opportunity to testify on several
important legislative improvements to Title VII of the Dodd-
Frank Act that this Committee is considering.
As you know, the Dodd-Frank Act created a broad new
regulatory regime for derivative products commonly referred to
as swaps. However, if Title VII is implemented incorrectly, it
may cause more harm than good. We believe that appropriate
sequencing in Title VII rules and coordination is critical to
the successful implementation of the Act. In addition, we
encourage the regulators to harmonize their rules so that
similar products will be subject to similar rules.
I would like to focus my testimony on five specific pieces
of legislation that we understand the Committee may take up in
the near future.
First, the Swap Push-Out Rule was added to the Dodd-Frank
Act at a late stage in the Senate, not debated in the House at
all. It would force banks to push out certain swap activities
into separately-capitalized affiliates and subsidiaries. As has
been mentioned already at this hearing, this provision was
opposed at the time and continues to be opposed by then, by
Chairman Bernanke of the Federal Reserve, as well as former
Chairman of the FDIC Sheila Bair. We believe it would create
increased systemic risks and significantly increase costs to
banks providing customers with swap products at the expense of
those customers.
Last week Congressmen Hultgren and Himes among others
introduced bipartisan legislation to modify this provision
which we strongly support.
Second, with respect to cross-border, the CFTC and the SEC
have not yet finalized rules clarifying their interpretation of
which swap activities will be subject to U.S. regulation and
which will be subject to foreign regulations. The result has
been a significant uncertainty in the international marketplace
and due to the CFTC's proposed guidance, a reluctance of
foreign market participants to trade with U.S.-registered swap
dealers until that uncertainty is resolved.
Last Congress Congressmen Himes and Garrett introduced
bipartisan legislation that would provide clarity on this
issue, and we understand that the Committee is considering
legislation and based upon drafts that we have been informed
of, we believe appropriately mandates joint rulemaking as well
as providing for coordination on a cross-border basis with our
G20 partners.
I would like to mention in addition to that risk of
fragmentation that this Committee should be aware of, and that
is with respect to the European Union and its recent proposal
for what is known as CRD-4, which is the European Union's
implementation of Basel III. As proposed by the European Union,
this provision would create an exemption under certain Basel
III capital calculations for swaps between EU supervised banks
and EU non-financial end-users, which would create even further
fragmentation on top of that which we see coming out of the
CFTC's cross-border guidance, and again, undermine the
principles of the G20 of trying to have uniform standards and
rules across all jurisdictions.
Third, the Dodd-Frank Act requires a subset of the most
standardized swaps to be traded on an exchange or new platform
know as swap execution facility. This is something where the
CFTC has come out with a proposed rule, yet the SEC has not put
out as the SEC, but they are very different in their approach,
and in particular, our concern is with the CFTC's proposal to
have a minimum mandatory request for quotes that we believe
actually undermines the intent of this provision to the
detriment of the customers. And in our case, our asset
management group and so these are the people that the provision
would seek to help, believe that this actually would impede
best execution for the benefit of their customers, which
include everyday investors, and we think it is appropriate that
the Congress take up legislation similar to that which was
passed last year by the House Financial Services Committee.
With respect to inter-affiliate swaps, again, this is
something where the Act was not clear on. Congressman Stivers
has introduced legislation that would clarify inter-affiliate
swaps which are a critical part of risk management functions of
institutions, and we think the Committee should take that up.
Last, it is critical that regulators carefully balance the
benefits of swap-related regulation and the potential decrease
in liquidity and increased costs to customers using hedging
activities. We think it is appropriate for cost-benefit
analysis. In fact, this is consistent with the Obama
Administration's Executive Order 13563, which asks agencies to
follow similar cost-benefit analysis that Executive Branch
agencies and departments already follow under statute. The SEC,
I might add, has already weighed into this. We think it is
appropriate for the CFTC as well, and we appreciate Congressman
Conaway's bill that would bring this into implementation.
With that, Mr. Chairman, I appreciate the opportunity to
testify on behalf of our members at SIFMA, and I am happy to
answer your questions at the appropriate time.
[The prepared statement of Mr. Bentsen follows:]
Prepared Statement of Hon. Kenneth E. Bentsen, Jr., Acting President
and Chief Executive Officer, Securities Industry and Financial Markets
Association, Washington, D.C.
Chairman Lucas and Ranking Member Peterson. My name is Ken Bentsen
and I am Acting President and CEO of the Securities Industry and
Financial Markets Association (SIFMA).\1\ SIFMA appreciates the
opportunity to testify on several important legislative improvements to
Title VII of the Dodd-Frank Act relating to derivatives being
considered by the House of Representatives.
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\1\ The Securities Industry and Financial Markets Association
(SIFMA) brings together the shared interests of hundreds of securities
firms, banks and asset managers. SIFMA's mission is to support a strong
financial industry, investor opportunity, capital formation, job
creation and economic growth, while building trust and confidence in
the financial markets. SIFMA, with offices in New York and Washington,
D.C., is the U.S. regional member of the Global Financial Markets
Association (GFMA). For more information, visit http://www.sifma.org.
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As you know, the Dodd-Frank Act created a new regulatory regime for
derivative products commonly referred to as swaps. Dodd-Frank seeks to
reduce systemic risk by mandating central clearing for standardized
swaps through clearinghouses. capital requirements and collection of
margin for uncleared swaps; to protect customers through business
conduct requirements; and to promote transparency through reporting
requirements and required trading of swaps on exchanges or swap
execution facilities. SIFMA supports these goals. There have been
significant and constructive reforms put in place that market
participants have implemented. Late last year, firms engaged in
significant swap dealing activities were required to register with the
CFTC as swap dealers and became subject to reporting, record-keeping
and other requirements, many more of which will be phased in over time.
This week, the first swap transactions were required to be cleared at
central clearinghouses to decrease systemic risk in the swap markets.
These accomplishments will make our system safer, and it is important
that market participants realize that these changes represent real
progress.
However, as with all regulation, if Title VII is implemented
incorrectly it may cause more harm than good. Specifically, incorrect
implementation of Title VII has the potential to detrimentally limit
the availability and increase the cost of derivatives, which are a
valuable risk management tool for American businesses, including
manufacturers and the agricultural industry.
We recognize the tremendous undertaking required by regulators in
their efforts to implement derivatives reform. Throughout this process,
SIFMA has sought to constructively engage with regulators through the
comment process.
As an overarching matter, I want to emphasize our belief that
appropriate sequencing of Title VII rules and coordination between the
various regulators responsible for them is critical to successful
implementation of the Dodd-Frank Act. In order to adapt to the new swap
regulatory regime, our member firms are making dramatic changes to
their business, operational, legal and compliance systems. We continue
to work closely with the relevant regulators on developing an
appropriate implementation timeline to avoid a rushed process that
would raise unnecessary complications and risk. In addition, we
encourage the regulators to harmonize their rules so that similar
products will be subject to similar rules.\2\
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\2\ SIFMA/ISDA Comments to CFTC on Proposed Schedule for Title VII
Rulemaking (June 29, 2012), http://www.sifma.org/issues/
item.aspx?id=8589939400; SIFMA Comments to SEC on the Sequencing of
Compliance Dates for Security-Based Swap Final Rules (Aug. 13, 2012),
http://www.sifma.org/issues/item.aspx?id=8589939893.
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In the remainder of my testimony, I would like to focus on a few
specific issues that are the topic of legislation currently pending
before this Committee, which could have a profound impact on the
success of Title VII and its impact on the marketplace.
The Swap Push-Out Rule
The first important initiative I would like to highlight is
legislation to amend Section 716 of the Dodd-Frank Act, often referred
to as the ``Swap Push-Out Rule.'' The Swap Push-Out Rule was added to
the Dodd-Frank Act at a late stage in the Senate and was not debated or
considered in the House of Representatives. It would force banks to
``push out'' certain swap activities into separately capitalized
affiliates or subsidiaries by providing that a bank that engages in
such swap activity would forfeit its right the Federal Reserve discount
window or FDIC insurance.
The Swap Push-Out Rule has been opposed by senior Prudential
Regulators from the time it was first considered. Ben Bernanke,
Chairman of the Federal Reserve, stated in a letter to Congress that
``forcing these activities out of insured depository institutions would
weaken both financial stability and strong prudential regulation of
derivative activities.'' \3\ Sheila Bair, former FDIC Chairwoman, said
that ``by concentrating the activity in an affiliate of the insured
bank, we could end up with less and lower quality capital, less
information and oversight for the FDIC, and potentially less support
for the insured bank in a time of crisis'' and added that ``one
unintended outcome of this provision would be weakened, not
strengthened, protection of the insured bank and the Deposit Insurance
Fund.'' \4\
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\3\ Letter from Ben Bernanke, Federal Reserve Chairman, to Senator
Christopher Dodd (May 13, 2010), available at http://blogs.wsj.com/
economics/2010/05/13/bernanke-letter-to-lawmakers-on-swaps-spin-off/.
\4\ Letter from Sheila Bair, FDIC Chairman, to Senators Christopher
Dodd and Blanche Lincoln (Apr. 30, 2010), available at http://
www.gpo.gov/fdsys/pkg/CREC-2010-05-04/pdf/CREC-2010-05-04-pt1-PgS3065-
2.pdf#page=5.
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In addition to the increase in risk that would be caused by the
Swaps Push-Out Rule, the limitations will significantly increase the
cost to banks of providing customers with swap products as a result of
the need to fragment related activities across different legal
entities. As a result, U.S. corporate end-users and farmers will face
higher prices for the instruments they need to hedge the risks of the
items they produce.\5\ Mark Zandi, Chief Economist at Moody's
Analytics, stated in a letter to Congressman Garrett that ``Section 716
would create significant complications and counter the efforts to
resolve [large financial] firms in an orderly manner.'' \6\
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\5\ An example of negative impacts of the ``Swap Push-Out Rule''
can be seen when a mid-size agriculture producer (``Ag Producer'')
receives a revolver loan with a floating rate of interest from a bank.
In order to hedge the interest rate exposure, the Ag Producer executes
a master swap agreement with the Bank and executes a fixed-for-floating
interest rate swap as a hedge (``Interest Rate Hedge''). The Ag
Producer's risk management guidelines require it to hedge the price
exposure related to its production of wheat by executing a wheat swap
(``Wheat Hedge''). Under the Push-Out Rule, the bank would not be able
to execute the wheat swap with the Ag Producer. With this restriction,
the Ag Producer would be required to negotiate another master swap
agreement with an affiliate of the bank or a third party and then
execute the wheat swap with such entity. With separate entities as
hedging counterparties, there is no netting of the Wheat Hedge and the
Interest Rate Hedge. Without the efficiency of netting, the Ag
Producer's gross exposure to both entities would be used to calculate
its exposure and margin requirements.
\6\ Letter from Mark Zandi, Chief Economist, Moody's Corporation,
to Congressman Scott Garrett (Nov. 14, 2011).
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Last Congress, Congresswoman Nan Hayworth introduced H.R. 1838,
(http://www.gpo.gov/fdsys/pkg/BILLS-112hr1838ih/pdf/BILLS-
112hr1838ih.pdf) legislation that would strike Section 716 from the
Dodd Frank Act. The House Financial Services Committee considered and
made significant changes to this bill. The first change was to modify
this bill so that additional types of products could remain within the
bank. This bill also included an important provision for foreign
institutions. SIFMA supported both of these changes and submitted a
letter of support for this bill.\7\
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\7\ http://www.sifma.org/workarea/downloadasset.aspx?id=8589937400.
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Last week, Congressman Hultgren introduced bipartisan legislation
(H.R. 992) (http://www.gpo.gov/fdsys/pkg/BILLS-113hr992ih/pdf/BILLS-
113hr992ih.pdf) that would, in his words, ``modify the `push-out'
provision in the Dodd-Frank Act to ensure that federally insured
financial institutions can continue to conduct risk-mitigation efforts
for clients like farmers and manufacturers that use swaps to insure
against price fluctuations.'' \8\ SIFMA applauds Congressman Hultgren
for this critical legislation and urges the House Committee on
Agriculture to favorably report this bill.
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\8\ In addition, the bill would fix a drafting error acknowledged
by the Swap Push-Out Rule's authors, under which the limited exceptions
to the rule that apply to insured depositing institutions appear not to
include U.S. uninsured branches or agencies of foreign banks.
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Cross-Border Impact of Dodd-Frank
Though Title VII was signed into law 2\1/2\ years ago, we still do
not know which swaps activities will be subject to U.S. regulation and
which will be subject to foreign regulation. Section 722 of the Dodd-
Frank Act limits the CFTC's jurisdiction over swap transactions outside
of the United States to those that ``have a direct and significant
connection with activities in, or effect on, commerce of the U.S.'' or
are meant to evade Dodd-Frank. Section 772 limits the SEC's
jurisdiction over security-based swap transactions outside of the
United States to those meant to evade Dodd-Frank. However, the CFTC and
SEC have not yet finalized (or, in the SEC's case, proposed) rules
clarifying their interpretation of these statutory provisions. The
result has been significant uncertainty in the international
marketplace and, due to the aggressive position being taken by the CFTC
as described below, a reluctance of foreign market participants to
trade with U.S. financial institutions until that uncertainty is
resolved.
While the CFTC has proposed guidance on the cross-border impact of
their swaps rules, that guidance inappropriately recasts the
restriction that Congress placed on CFTC jurisdiction over swap
transactions outside the United States into a grant of authority to
regulate cross-border trades. The CFTC primarily does so with a very
broad definition of ``U.S. Person,'' which it applies to persons with
even a minimal jurisdictional nexus to the United States. In addition,
the CFTC has released several differing interim and proposed
definitions of ``U.S. Person'' for varying purposes, resulting in a
great deal of ambiguity and confusion for market participants. SIFMA
supports a final definition of U.S. Person that focuses on real, rather
than nominal, connections to the United States and that is simple,
objective and determinable so a person can determine its status and the
status of its counterparties.\9\ Equally significant, the CFTC has
issued its proposed cross-border release as ``guidance'' rather than as
formal rulemaking process subject to the Administrative Procedure Act.
By doing so, the CFTC avoids the need to conduct a cost-benefit
analysis, which is critical for ensuring that the CFTC appropriately
weighs any costs imposed on market participants as a result of
implementing an overly broad and complex U.S. person definition against
perceived benefits.
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\9\ SIFMA Comments to CFTC Proposed Interpretive Guidance (August
27, 2013), available at http://www.sifma.org/issues/
item.aspx?id=8589940053; SIFMA/TCH/FSR Comments to CFTC on Further
Proposed Guidance (Feb. 6. 2013), available at http://www.sifma.org/
issues/item.aspx?id=8589941955.
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The SEC has not yet proposed cross-border rules. The Commission and
its staff have publicly suggested, however, that they will consider a
holistic cross-border rule proposal later this year. It is rumored that
this document will be nearly 1,000 pages long and will include many
questions for public comment.
Last Congress, Congressmen Himes and Garrett introduced bipartisan
legislation (H.R. 3283) (http://www.gpo.gov/fdsys/pkg/BILLS-
112hr3283ih/pdf/BILLS-112hr3283ih.pdf) that would provide clarity on
this issue. The Himes-Garrett bill would permit non-U.S. swap dealers
to comply with capital rules in their home jurisdiction that are
comparable to U.S. capital rules and adhere to Basel standards. The
legislation also prevents the requirement that registered swap dealers
post separate margins for each jurisdiction under which they are
regulated. During the 112th Congress, the House Financial Services
Committee acted to support this legislation by a vote of 41 to 18.
SIFMA strongly supports this effort to clarify the jurisdiction of U.S.
regulators and urges the House Agriculture Committee to vote for this
critical legislation.
Swap Execution Facilities
As I noted above, the Dodd-Frank Act requires a subset of the most
standardized swaps to be traded on an exchange or a new platform known
as a ``swap execution facility,'' commonly called a ``SEF.'' Congress
generally defined what constitutes a SEF but left further definition to
the CFTC and SEC. To date, both the CFTC and SEC have proposed SEF
definitions for the products under their respective jurisdiction, but
neither Commission has adopted a final definition.
An appropriately flexible definition of ``SEF'' is critical for
ensuring that SEF trading requirement does not negatively impact
liquidity in the swap markets. In truth, it remains unclear what will
happen to liquidity of instruments that have been traditionally
transacted bilaterally when they are subjected to a SEF environment.
Understanding this reality, the SEC has proposed a rule that would
permit SEFs to naturally evolve their execution mechanisms for those
swaps that are widely traded. These SEFs could be structured in many
different ways, similar to how electronic trading platforms have
evolved in the securities markets.
The CFTC has proposed a different rule that would require customers
to either trade swaps on SEFs as if they were traded on exchanges or to
solicit prices by issuing requests for quotes, generally known as
``RFQs,'' from a minimum of five market participants for each swap
subject to the SEF trading requirement. This differs from current
market practice and could have significant impact on the liquidity in
the swap market. By signaling to the market the desire to purchase a
swap, customers may be telegraphing important information that may
impede best execution of their orders. While we appreciate the CFTC's
goals of encouraging competition among dealers to decrease the price of
swaps, the reality is that this practice will do just the opposite and
drive up the cost of transactions, ultimately harming the corporations
and other swaps users this rule aims to protect.
Last Congress, the House Financial Services Committee supported, by
voice vote, legislation that would require CFTC and the SEC to adopt
SEF rules that allow the swaps markets to naturally evolve to the best
form of execution (H.R. 2586)
(http://www.gpo.gov/fdsys/pkg/BILLS-112hr2586rh/pdf/BILLS-
112hr2586rh.pdf). H.R. 2586 would explicitly not require a minimum
number of participants to receive or respond to quote requests and
would prevent regulators from requiring SEFs to display quotes for any
period of time. Finally, this bill would prevent regulators from
limiting the means by which these contracts should be executed and
ensuring that the final regulation does not require trading systems to
interact with each other. SIFMA urges Congress to support similar
legislation in this Congress.
Inter-Affiliate Swaps
The Dodd-Frank Act is effectively silent on the application of swap
rules to swaps entered into between affiliates. Such inter-affiliate
swaps provide important benefits to corporate groups by enabling
centralized management of market, liquidity, capital and other risks
inherent in their businesses and allowing these groups to realize
hedging efficiencies. Since the swaps are between affiliates, rather
than with external counterparties, they pose no systemic risk and
therefore there are no significant gains to be achieved by requiring
them to be cleared or subjecting them to margin posting requirements.
In addition, these swaps are not market transactions and, as a result,
requiring market participants to report them or trade them on an
exchange or swap execution facility provides no transparency benefits
to the market--if anything, it would introduce useless noise that would
make Dodd-Frank's transparency rules less helpful.
During the 112th Congress, the House of Representatives voted 357
to 36 in support of legislation (H.R. 2779) (http://www.gpo.gov/fdsys/
pkg/BILLS-112hr2779pcs/pdf/BILLS-112hr2779pcs.pdf) that would exempt
inter-affiliate trades from certain Title VII requirements due to the
important role the transactions play in firms' risk management
procedures and the negative impact the full scope of Title VII
regulation would have if applied to them. In this Congress, Congressman
Stivers has introduced H.R. 677 (http://www.gpo.gov/fdsys/pkg/BILLS-
113hr677ih/pdf/BILLS-113hr677ih.pdf), the Inter-Affiliate Swap
Clarification Act, which would exempt certain inter-affiliate
transactions from the margin, clearing, and reporting requirements
under Title VII. SIFMA supports this initiative and urges the House
Committee on Agriculture to vote in support of this important bill.
Cost-Benefit Analysis
As noted above, it is critical that regulators carefully balance
the benefits of swap-related regulation with the potential decreases in
liquidity and increased costs to customers wishing to hedge their
activities. As a result, throughout the Title VII rulemaking process,
SIFMA has encouraged regulators to conduct comprehensive cost-benefit
analysis for all Dodd-Frank rules.
This is consistent with the Obama Administration's efforts to
promote better cost-benefit analysis for Federal agencies through
Executive Order 13563,\10\ which requires all agencies proposing or
adopting regulations to include cost-benefit analyses in an attempt to
minimize burdens, maximize net benefits and specify performance
objectives. The President also stated that regulations should be
subject to meaningful public comment, be harmonized across agencies,
ensure objectivity and be subject to periodic review. In 2012, in
testimony before the House Committee on Government Reform, SEC Chairman
Schapiro stated ``I continue to be committed to ensuring that the
Commission engages in sound, robust economic analysis in its
rulemaking, in furtherance of the Commission's statutory mission, and
will continue to work to enhance both the process and substance of that
analysis.'' \11\
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\10\ http://www.whitehouse.gov/the-press-office/2011/01/18/
improving-regulation-and-regulatory-review-executive-order.
\11\ http://www.sec.gov/news/testimony/2012/ts041712mls.htm.
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Congressman Conaway has introduced legislation (H.R. 1003) that
would require the CFTC's cost-benefit analysis to be both quantitative
and qualitative and specifies in greater detail the costs and benefits
that the CFTC must take into account as part of their cost-benefit
analyses. The bill also requires that a regulation adopted by the CFTC
must ``measure, and seek to improve, the actual results of regulatory
requirements.'' SIFMA strongly supports H.R. 1003 and urges the House
Committee on Agriculture to support this vital initiative that would
enhance cost-benefit analysis done by the CFTC.
Thank you for giving me this opportunity to explain our views
related to several important measures to be considered by the House
Committee on Agriculture.
The Chairman. Thank you, Mr. Bentsen.
You may proceed when you are ready, Mr. Colby.
STATEMENT OF JAMES E. COLBY, ASSISTANT TREASURER, HONEYWELL
INTERNATIONAL INC., MORRISTOWN, NJ
Mr. Colby. Mr. Chairman, Ranking Member Peterson, and other
Members of the Committee, thank you for inviting me to testify
at this important hearing. I am an Assistant Treasurer at
Honeywell International, and today I speak on behalf of
Honeywell and other commercial end-users, including members of
the Coalition for Derivatives End-Users.
Honeywell is a diversified technology and manufacturing
leader serving customers worldwide with aerospace products and
services, control technologies for buildings, homes, and
industry, turbochargers, and performance materials. Honeywell's
growth is driven by technologies that address some of the
world's toughest challenges such as energy efficiency, clean
energy generation, safety and security, globalization, and
customer productivity.
Honeywell is truly a global company with more than 50
percent of our sales outside of the United States, and we are,
therefore, exposed to market risks from changes in interest
rates, foreign exchange rates, and commodity prices. When
appropriate, we hedge exposures through the use of derivative
contracts. The purpose of our hedging activities is to
eliminate risks that we cannot control, allowing us to focus on
our core strengths, namely delivering high-quality products to
our customers. We do not use derivatives for speculative
purposes.
I will provide some examples to demonstrate how we use
derivatives. We sell satellite and launch vehicle inertial
measurement units manufactured in Florida to customers in
Germany. Europe is a key growth market for commercial space
products, and in order to qualify for consideration on certain
opportunities, we may be required to enter into contracts
denominated in Euros, even though all costs of production are
incurred in U.S. dollars. The period for this type of contract
can span multiple years during which changes in the value of
the Euro versus the U.S. dollar can significantly impact its
economic viability. To mitigate this risk we may enter into a
forward contract to sell an amount of Euros equal to our net
exposure to lock in the market rate.
Honeywell sells catalysts and adsorbents manufactured in
multiple U.S. manufacturing plants to customers in the refining
industry. As the refinery starts up, a supply of catalysts is
required to operate it, and Honeywell could arrange a catalyst
supply agreement with the customer as part of the overall
package. During contract negotiations, some European customers
will require sales contracts to be denominated in Euros whereas
all costs of production are incurred in U.S. dollars. To
mitigate this risk, Honeywell may enter into a forward contract
to sell an amount of Euros equal to our net exposure to lock in
the market rate.
Honeywell carefully manages its ratio of fixed to floating-
rate debt in order to lower its overall cost of debt while
providing sufficient interest rate certainty to accurately
forecast and manage interest expense. Floating-rate debt has
historically been cheaper than fixed-rate debt but cannot be
easily issued in longer maturities, thereby exposing Honeywell
to refinancing risks. Honeywell uses interest rate derivatives
to convert a portion of its fixed-rate debt to floating,
thereby creating a synthetic floating-rate note with a longer
term maturity that can be issued directly in the capital
markets.
With compliance deadlines looming, Honeywell is concerned
with the direction in which certain rules appear to be heading.
We strongly support two bills referred to your Committee. H.R.
634 would exempt transactions in which a non-financial end-user
is a party from margin requirements, whereas H.R. 677 would
exempt inter-affiliate transactions of end-users from clearing
requirements.
The margin bill is of particular interest to Honeywell. In
the Dodd-Frank Act Congress made clear that end-users were not
to be subject to margin requirements. Nonetheless, regulations
proposed by the Prudential Banking Regulators could require
end-users to post margin. This stems directly from what they
view to be a legal obligation under Title VII. While the
regulations proposed by the CFTC are preferable, they do not
provide end-users with the certainty that legislation offers.
According to a Coalition for Derivatives End-Users' survey, a
three percent initial margin requirement could reduce capital
spending by as much as $5.1 to $6.7 billion among S&P 500
companies alone and cost 100,000 to 130,000 jobs.
What does this mean for Honeywell? We had approximately $2
billion of hedging contracts outstanding at year end that would
be defined as a swap under Dodd-Frank. Applying the three
percent initial margin and ten percent variation margin implies
a potential margin requirement of $260 million. Cash deposited
in a margin account cannot be productively deployed in our
business, and therefore, detracts from Honeywell's financial
performance and the ability to promote economic growth and
protect American jobs.
The margin bill does not undermine Dodd-Frank. It helps
ensure that the final Act and rules function as intended and
that commercial end-users do not face the same regulatory
burden as those who speculate and create systemic risk. Not
only did commercial end-users not contribute to the financial
crisis, but they were a safe haven during the financial
turmoil. Investors who were afraid to invest in the debt of
financial institutions purchased the debt of companies like
Honeywell, companies that prudently use derivatives to manage
and reduce risk and to manage the financial crisis without need
for government assistance.
In conclusion, we need Congress to enact legislation so
that end-users like Honeywell will continue to have the ability
to manage risks without having margin requirements imposed on
us.
Thank you for inviting me to testify today. We greatly
appreciate the support that the Committee has provided, and I
look forward to answering any questions that you may have.
[The prepared statement of Mr. Colby follows:]
Prepared Statement of James E. Colby, Assistant Treasurer, Honeywell
International Inc., Morristown, NJ
Mr. Chairman, Ranking Member Peterson, and other Members of the
Committee, thank you for inviting me to testify at this important
hearing. I am an Assistant Treasurer at Honeywell International and
today I speak on behalf of both Honeywell and commercial end-users.
Honeywell is a diversified technology and manufacturing leader,
serving customers worldwide with aerospace products and services;
control technologies for buildings, homes and industry; turbochargers;
and performance materials. Honeywell's growth is driven by technologies
that address some of the world's toughest challenges such as energy
efficiency, clean energy generation, safety & security, globalization
and customer productivity. The company's more than 132,000 employees
include 20,000 scientists and engineers who are focused on developing
innovative products and solutions that help Honeywell's customers--and
their customers--improve performance and productivity.
Honeywell is truly a global company, with more than 50 percent of
our sales outside of the United States and we are therefore exposed to
market risks from changes in interest rates, foreign exchange rates and
commodity prices. When appropriate, we hedge exposures through the use
of derivative contracts. The purpose of our hedging activities is to
eliminate risks that we cannot control, allowing us to focus on our
core strengths, namely delivering high-quality products, on time, to
our customers in a manner that not only meets, but exceeds
expectations. We do not use derivatives for speculative purposes.
I'll provide some examples to demonstrate how we use derivatives.
We sell satellite and launch vehicle inertial measurement units
manufactured in Florida to customers in Germany. Europe is a key growth
market for commercial space products and, in order to qualify for
consideration on certain opportunities, we may be required to enter
into contracts denominated in Euros even though all costs of production
are incurred in U.S. Dollars. The period for this type of contract can
span multiple years, during which changes in the value of the Euro
versus the U.S. dollar can significantly impact its economic viability.
To mitigate this risk, we may enter into a forward contract to sell an
amount of Euros equal to our net exposure to lock in the market rate.
Honeywell sells catalysts and adsorbents manufactured in multiple
U.S. manufacturing plants to customers in the refining industry. As a
refinery starts-up, a supply of catalysts is required to operate it and
Honeywell will attempt to arrange a Catalyst Supply Agreement with the
customer as part of the overall package. During contract negotiations,
some European customers will require sales contracts to be denominated
in Euros, whereas all costs of production are incurred in U.S. Dollars.
To mitigate this risk, Honeywell may enter into a forward contract to
sell an amount of Euros equal to our net exposure to lock in the market
rate.
Honeywell carefully manages its ratio of fixed-to floating rate
debt in order to lower its overall cost of debt, while providing
sufficient interest rate certainty to accurately forecast and manage
interest expense. Floating rate debt has historically been cheaper than
fixed-rate debt, but cannot be easily issued in longer maturities,
thereby exposing Honeywell to refinancing risk. Honeywell uses interest
rate derivatives to convert a portion of its fixed-rate debt to
floating, thereby creating a synthetic floating rate note with a
longer-term maturity than can be issued directly in the capital
markets.
With compliance deadlines for end-users looming, Honeywell is
concerned with the direction in which certain rules appear to be
heading. We strongly support two pieces of legislation that have been
referred to your Committee. H.R. 634 would exempt transactions in which
a non-financial end-user is a party from margin requirements, whereas
H.R. 677 would exempt inter-affiliate transactions of end-users from
clearing requirements.
Today I will focus on the margin bill, as it is of particular
interest to Honeywell. In approving the Dodd-Frank Act, Congress made
clear that end-users were not to be subject to margin requirements.
Nonetheless, regulations proposed by the Prudential Banking Regulators
could require end-users to post margin. This stems directly from what
they view to be a legal obligation under Title VII. While the
regulations proposed by the CFTC are preferable, they do not provide
end-users with the certainty that legislation offers. According to a
Coalition for Derivatives End-Users survey, a 3% initial margin
requirement could reduce capital spending by as much as $5.1 to $6.7
billion among S&P 500 companies alone and cost 100,000 to 130,000 jobs.
To shed some light on Honeywell's potential exposure to margin
requirements, we had approximately $2 billion of hedging contracts
outstanding at year-end that would be defined as a swap under Dodd-
Frank. Applying 3% initial margin and 10% variation margin implies a
potential margin requirement of $260 million. Cash deposited in a
margin account cannot be productively deployed in our businesses and
therefore detracts from Honeywell's financial performance and ability
to promote economic growth and protect American jobs.
The following is an excerpt of a question and answer session on
July 17, 2012 between Senator Mike Crapo and Federal Reserve Board
Chairman Ben Bernanke at the Hearing of the Senate Banking, Housing and
Urban Affairs: ``The Semiannual Federal Reserve Monetary Policy Report
to the Congress.'' This dialogue underscores why a Margin bill is
necessary.
Senator Crapo: ``According to the proposed rule, the proposal
to require margins stems directly from what they view to be a
legal obligation under Title VII. Recently I offered an
amendment with Senator Johanns to fulfill Congressional intent
by providing an explicit exemption for margin requirements for
non-financial end-users that qualify for the clearing
exemption. The amendment is identical to the House bill which
passed the House by a vote of 370 to 24.''
``Is it accurate in your opinion, that regardless of
Congressional intent, the banking regulators view the plain
language of the statute as requiring them to impose some kind
of margin requirement on non-financial end-users unless
Congress changes the statute?''
Chairman Bernanke: ``We believe that the statute does require
us to impose some type of margin requirement. We tried to
mitigate the effect as much as possible by allowing for
exemptions when the credit risk associated with the margin was
viewed as being sufficiently small. So many small end-users
would be exempt in practice.''
Senator Crapo: ``Do you agree that the non-financial end-
users hedging does not contribute to systemic risk, that the
economy, the economic benefits from their risk management
activity--excuse me--that the economy benefits from their
hedging activity and that it's appropriate for Congress to
provide an explicit exemption for margin requirements for non-
financial end-users that qualify for the clearing exemption?''
Chairman Bernanke: ``I certainly agree that non-financial
end-users benefit and that the economy benefits from the use
of--of derivatives. It seems to be the sense of a large portion
of the Congress that that exemption should be made explicit.
And speaking for the Federal Reserve, we're very comfortable
with that proposal.''
We are not interested in dismantling Dodd-Frank. We are simply
trying to ensure that the final Act and rules function as intended and
that commercial end-users do not face the same regulatory burden as
those who speculate and create systemic risk. Not only did commercial
end-users not contribute to the financial crisis, but they were a safe-
haven during the financial turmoil. Investors who were afraid to invest
in the debt of financial institutions were actively purchasing the debt
of companies like Honeywell, companies that prudently use derivatives
to manage and reduce risk and who continued to be profitable throughout
the financial crisis, with no need for government assistance.
In conclusion, we need Congress to enact legislation so that end-
users like Honeywell will continue to have the ability to manage risk
without having margin requirements imposed on us.
Thank you for inviting me to testify today. We greatly appreciate
the support that the Committee has provided and I look forward to
answering any questions that you may have.
The Chairman. Thank you, Mr. Colby.
Mr. Naulty, you may begin when you are ready.
STATEMENT OF TERRANCE P. NAULTY, GENERAL MANAGER AND CHIEF
EXECUTIVE OFFICER, OWENSBORO MUNICIPAL UTILITIES; MEMBER,
AMERICAN PUBLIC POWER
ASSOCIATION, OWENSBORO, KY
Mr. Naulty. Good morning, Mr. Chairman, Members of the
Committee. My name is Terrance Naulty. I am the General Manager
and CEO of Owensboro Municipal Utilities. Prior to this
position I spent 15 years in senior management at utility-
affiliated trading companies and at a financial entity.
I thank you for the opportunity to testify today on behalf
of the American Public Power Association of which we are a
member. OMU provides water and telecommunications and electric
services to over 26,000 customers in Owensboro, the third
largest city in Kentucky. We operate a 540 megawatt coal-fired
power plant that produces some of the lowest cost power in the
Midwest and Southeast. Approximately 63 percent of our electric
revenues are derived from the wholesale market.
Traditionally we have hedged future wholesale electric
revenues with bilateral fixed-for-floating swaps at liquid
trading points that are in close proximity to the point of
physical delivery. These swaps hedge future wholesale revenue
and consequently protect our customer owners from the wholesale
price fluctuations associated with both long-term and short-
term market movements. By hedging this future revenue stream we
can ensure stable and low electric rates.
To limit our credit risks and reduce costs we would enter
into financial swap transactions with the most active and
credit-worthy counterparties in the physical markets we sell
into. Most of these counterparties are affiliates of investor-
owned utilities. We also have limited enabling agreements with
financial entities. With these financial entities and more
importantly the utility-affiliated trading counterparties, OMU
is able to hedge its position with virtually no cash reserve
requirements due to the strength of our balance sheet.
However, CFTC regulations implementing the Dodd-Frank Act
have made this pragmatic and conservative hedging strategy very
difficult. Under the regulations our non-swap dealer
counterparties can engage in just $25 million per year in swap
dealing activities with government-owned utilities and other
special entities before being classified as a swap dealer.
Even OMU's relatively small hedge position has an notional
value in excess of $200 million. Also, the comparable limit for
swap-dealing activities with other non-governmental entities is
$8 billion. As a result, two of our three largest trading
counterparties informed us that they would no longer transact
financial swaps with us for fear of becoming a swap dealer
under the Act. This decision has forced us to change our risk
management strategy in two ways.
First, we can now only use financial entities willing to
register as a swap dealer. Our hedging transactions have
migrated from utility-affiliated companies to these financial
entities, and we have seen the bid-ask spreads widen.
Second, to avoid these wider spreads and define liquidity
where we hedge, we have been forced to the ICE and IMEX trade
platforms to manage our position. Both these futures platforms
require cash reserves to meet initial and maintenance margin.
This means OMU can no longer take advantage of its negotiated
collateral arrangements. As a result, our Board of Directors
has required us to establish incremental reserves of $10
million to ensure that the utility can meet margin calls
associated with its hedge position. If this $10 million in
incremental cash reserves were funded from our customers, the
result would be approximately ten percent rate increase.
The CFTC in October provided a no-action letter which we
heard about this morning that moved the threshold from $25
million to $800 million. However, the letter has imposed a
number of new and additional requirements, and as a result, the
position of our lost trading counterparties has not changed.
In response just this Monday H.R. 1038, the Public Power
Risk Management Act of 2013, was introduced. The legislation
provides narrow targeted relief for utility operations related
to swaps for government-owned entities. The legislation
carefully defines which entity would qualify as a utility
special entity and the types of swaps that could and could not
be considered a utility operations-related swap.
In conclusion, the protection that CFTC is trying to afford
through the $25 million special entity sub-threshold are not
needed for government-owned utilities. We are well versed in
the markets and rely on these swaps solely to manage the price
and operational risks. A failure to allow the narrow exclusion
provided under this Public Power Risk Management Act will limit
our members' ability to hedge against risks and lead to higher
costs for the customers they serve.
Thank you again for the opportunity to testify.
[The prepared statement of Mr. Naulty follows:]
Prepared Statement of Terrance P. Naulty, General Manager and Chief
Executive Officer, Owensboro Municipal Utilities; Member, American
Public Power Association, Owensboro, KY
Mr. Chairman and Members of the Committee, I am Terry Naulty,
General Manager and CEO of Owensboro Municipal Utilities (OMU)
testifying today on behalf of my utility and the American Public Power
Association (APPA).\1\
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\1\ ``Public Power'' is not defined in the law, but generally
refers to government-owned utilities. This is distinguished from a
``public utility'' which generally refers to an investor-owned utility,
as under the Public Utility Holding Company Act of 1935 and the Federal
Power Act.
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OMU is located in Owensboro, Kentucky, proudly serving an estimated
26,100 electric customers and 24,739 water users, including both
residential and commercial accounts. The sole purpose of our business
is to ensure that the electric and water and sewer demands of our
customers are met, both today and for generations to come.
OMU is a member of APPA, 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, these government-owned utilities
deliver electricity to one of every seven electricity customers in the
United States (approximately 47 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.
I appear today to speak in favor of H.R. 1038, the Public Power
Risk Management Act of 2013, legislation that will allow my utility,
and other government-owned power and natural gas utilities, to hedge
against price risks on a level playing field with all other utilities.
This legislation will protect our customers from unnecessary price
increases.
Public Power Utilities and the Dodd-Frank Act
In the wake of the 2007 and 2008 Financial Crisis, the Dodd-Frank
Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)
required the Commodity Futures Trading Commission (CFTC) to provide
comprehensive regulations for the swaps marketplace. Specifically, 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 a swap dealer acting as
an advisor to a special entity, the law states that the swap dealer
shall have a duty to act in the best interests of the 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 a qualified independent representative before trading
with a swap dealer or major swap participant.\3\
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\2\ 7 U.S.C. 6s(h)(4).
\3\ 7 U.S.C. 6s(h)(5).
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Also, in part to address concerns that the legislation would force
too many entities into this more stringent regime, the Dodd-Frank Act
included a ``de minimis exception'' to the definition of a swap
dealer.\4\
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\4\ 7 U.S.C. 1a(49)(D).
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APPA supports the goals of the Dodd-Frank Act and has worked
closely with the CFTC and other interested parties to improve its
implementation, particularly related to regulations affecting ``end-
users''--that is, non-financial parties that enter into swaps to hedge
or mitigate their commercial risks. OMU and other APPA members are
``end-users.'' Dozens of new regulations affect our members'
businesses, and APPA and a coalition of not-for-profit electric
utilities have submitted formal comments on 17 specific regulations
from the CFTC and Securities and Exchange Commission (SEC) related to
implementation of the Dodd-Frank Act.
One such instance is the rule defining swap-dealer,\5\ which became
final on July 23, 2012. Swap dealer registration regulations went into
effect on October 12, 2012, at which time entities were required to
begin counting their ``swap dealing'' activities. Those with dealing
activity in excess of the de minimis thresholds had to register as swap
dealers by December 31, 2012. However, the CFTC issued several no-
action letters that allow swap dealers to delay their compliance with
most of the business conduct and documentation standards until July
2013.
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\5\ CFTC Regulation 1.3(ggg)(4); see 77 Fed. Reg. 30596, at 30744.
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As written, the swap-dealer definition will substantially hinder
government-owned utilities' ability to hedge against operational risks.
Just like OMU, these utilities have no shareholders, so the costs
imposed by this regulatory decision will be borne by only one group:
our residential and business customers.
In December 2010, the CFTC jointly with the SEC issued a proposed
rule to define the term ``swap dealer,'' including (as required by the
statute) an exception from the swap-dealer designation for those
entities that engage in a de minimis quantity of swap dealing.
In the proposed rule, the 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 threshold both for total swaps and for swaps with special
entities.
A final swap dealer 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.\6\
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\6\ 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.
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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 non-financial 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, non-
financial 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 natural 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 non-financial commodity swaps with customized terms
to hedge the unique operational risks to which many government-owned
utilities are subject. Additionally, many government-owned utilities
have traditionally used the swaps and futures products to hedge their
excess electrical generation capacity, thus providing revenue and rate
certainty to their customer/owners. 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 Non-Financial 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,
either power or fuel to provide power, is a physical commodity, e.g.,
electricity, coal, natural gas, and the like. 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. Further, storage of
electricity for future use, unlike other commodities such as gasoline,
grain, coffee, etc. is not currently viable and thus electricity must
be produced at the time it is used.
Each regional geographic market has a somewhat different set of
demands driven by climate, weather, population, and industrial
activity, among other factors. Each regional geographic market also has
a somewhat different group of financial entity counterparties and non-
financial entity counterparties available to meet these demands and
thus able to enter into 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 non-
financial 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. Further, owners of
electrical generation facilities and distribution utilities, whether
investor-owned utilities, cooperative utilities, merchant generation
companies, or government-owned utilities, operate in their geographical
proximity and as they balance their generation to meet changing demands
on an hour-to-hour basis are the most likely trading counterparties in
their regions. These regional market participants, unlike financial
entities, have a vested interest in maintaining the reliability of the
grid and ensuring that sufficient liquidity exists to manage their
operations.
In Regional Transmission Organization (RTO) markets such as PJM and
MISO, the market design is such that using financial swaps and futures
contracts to manage risk is now the standard. This is because the RTO
markets provide unlimited physical liquidity in the day-ahead and real-
time markets to ensure reliability of service, and thus converting a
financial price hedge to a physically delivered product in real-time
is, by design, the way these RTO markets function.
Because there are a limited number of counterparties for any
particular operations-related swap sought by a utility, each financial
or non-financial 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.
OMU and the Special Entity Sub-Threshold
I would like to illustrate these points with examples from my
utility's perspective.
OMU has been providing electric service to its community since
1900. OMU owns a coal-fired power plant and has surplus power that it
sells into the wholesale market in order to offset transferring the
fixed costs associated with such surplus capacity to its retail
customers. OMU uses financial transactions in the forward market to
lock in the best price for these sales, to reduce its market risk, to
stabilize revenue, and, most importantly, to provide rate certainty to
its customers/owners.
OMU's approach has been to enter into enabling agreements with the
most active physical and financial traders with solid credit ratings in
our region. Prior to the establishment of the special entity rule de
minimis threshold, this short list of counterparties allowed OMU to
accomplish the hedging necessary while spreading the credit risk among
counterparties. Because OMU has been pragmatic in choosing its trading
counterparties, limiting the population to those entities with superior
credit ratings, the negotiated collateral agreements do not require OMU
to post collateral unless it exceeds a specified credit limit.
However, since the CFTC's implementation of the special entity de
minimis threshold, two of OMU's three largest counterparties, which are
both utility-affiliated trading companies and not ``swap dealers,'' are
no longer willing to do business with OMU. They cite the compliance
risk and lack of internal systems to keep track of special entity
transactions and ensure that they do not exceed the threshold. This
compliance risk is not due solely to their business with OMU, but also
because they do business with multiple ``special entities'' across the
country and in our region.
This means that swap dealers are the only entities willing to enter
into swap transactions with OMU. Since OMU's ability to hedge via swaps
bilaterally with physical generation owners in our region has been
greatly diminished, OMU has seen the bid-ask spread from swap dealer
counterparties widen.
Consequently, OMU has been forced to move most of its hedging
transactions to the ICE trading platform, which offer futures
contracts. This means that OMU can no longer take advantage of its
negotiated collateral agreements, and instead must comply with initial
and maintenance margin requirements to support its hedging activities.
As a result, OMU's board of directors required OMU to establish
reserves of $10 million to ensure that the utility can meet margin
calls associated with its hedged positions. If this $10 million in
incremental cash reserves were funded from our customers/owners, the
result would be an approximate ten percent rate increase.
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, and 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. Also, smaller members who are
unlikely to hedge may still be affected, if they buy power from larger
members who do.
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 swap participants advising or entering into swaps
with special entities. Nowhere does the law mention deeming a
participant to be a swap dealer solely based on its volume of swaps
with government-owned entities.
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 requests that the CFTC amend its
swap-dealer rule to exclude utility special entities' utility
operations-related swap transactions from counting towards the special-
entity threshold. This amendment to the swap-dealer rule would allow a
producer, utility company, or other non-financial entity to enter into
energy swaps with government-owned utilities without danger of being
required to register as a ``swap dealer'' solely because of its
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 utility
special entities, or to its public service obligations to
deliver electric energy or natural gas service to utility
customers. For example, these would include swap transactions
related to the generation, production, purchase, sale, or
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.
CFTC ``No Action'' Letter
CFTC released on October 12, 2012 a no-action letter relating to
the $25 million special entity sub-threshold. The letter allows a
counterparty to deal in up to $800 million in swaps with government-
owned utilities without being required to register as a swap dealer. As
the CFTC explained in that letter, the $800 million is derived from a
comment letter endorsed by the NFP EEU group suggesting that the
special entity sub-threshold be set at \1/10\ that of the overall swap
dealer threshold.
The no-action letter, however, also included a number of additional
limitations on a counterparty wishing to take advantage of the relief
provided by the letter. Specifically, under the terms of the CFTC's no-
action letter, the $800 million threshold applies only:
If the special entity that is a party to the swap is using
the swap to hedge a ``physical position;''
If the counterparty is not a ``financial entity'' as defined
in the Commodity Exchange Act;
If the swap is related to an exempt commodity in which both
parties transact as part of the ``normal course of their
physical energy businesses;'' and
If a counterparty wanting to take advantage of the relief
provided by the no-action letter files with the CFTC a notice
that it is making use of the relief and provides, by December
31 (and quarterly thereafter), a list of each utility special
entity with which it has entered into swaps and the total gross
notional value of those swaps.
Certain counterparties have expressed concerns over one or more of
the conditions imposed in the no-action letter, but it could also be
that counterparties, in general, are not willing to spend the time and
money to create a separate compliance process and adjust their policies
and procedures in order to facilitate transactions with the small
segment of any particular regional market that utility special entities
represent. This is especially likely now as counterparties are focused
on implementing compliance programs dealing with the whole range of
Dodd-Frank requirements. Finally, there is the overarching issue that
the no-action letter, by definition, is temporary and can be revised or
revoked without any of the steps of a formal rulemaking process.
Whatever the reason, the no-action letter has failed to provide
non-financial counterparties with the assurances they need to enter
into swap transactions with our members.
A November 19, 2012, letter to the CFTC explaining this outcome has
failed to produce any further action from the CFTC, and some
Commissioners have indicated that we should turn to Congress to achieve
the remedy we are seeking.
The Public Power Risk Management Act
On March 11, 2013, the Public Power Risk Manage Act of 2013 (H.R.
1038) was introduced by Congressman Doug LaMalfa (R-CA), a Member of
this Committee, with fellow Committee Members Jim Costa (D-CA), Jeff
Denham (R-CA), and John Garamendi (D-CA), along with House Financial
Services Committee Member Blaine Luetkemeyer (R-MO)
The legislation largely mirrors the intent and effect of the NFP
EEU petition to the CFTC, providing narrowly targeted relief for
operations-related swaps for government-owned utilities.
Specifically, the legislation would provide that the CFTC, in
making a determination to exempt a swap dealer under the de minimis
exception, shall treat a utility operations-related swap with a utility
special entity the same as a utility operations-related swaps with any
entity that is not a special entity.
Under the current threshold/sub-threshold regulatory regime adopted
by the CFTC, this would mean that utility operations-related swaps with
a government-owned power or natural gas utility would not be counted in
calculating whether swap dealing activity exceeded the $25 million
special entity de minimis threshold, but would be counted in
calculating whether swap dealing activity exceeded the $8 billion de
minimis threshold.
The legislation carefully defines which entities would qualify as a
``utility special entity.'' It also specifically defines the types of
swaps that could and could not be considered a ``utility operations-
related swap.'' For example, the legislation specifically prohibits
interest, credit, equity, and currency swaps from being considered as a
utility operations-related swap. Likewise, except in relation to their
use as a fuel, commodity swaps in metal, agricultural, crude oil, or
gasoline would not qualify either.
Finally, the legislation also confirms that utility operations-
related swaps are fully subject to swap reporting requirements.
When implemented, this legislation should provide the certainty to
non-financial entities that they can enter into swap transactions with
government-owned utilities without fear of being deemed a swap dealer.
It truly levels the playing field. And, it does nothing to otherwise
alter the CFTC's implementation of the Dodd-Frank Act.
We wish the legislation were not necessary, but given the realities
we face and the ongoing damage being done under the current rules, we
urgently request the Members of this Committee to support this narrow
legislative fix.
Finally, because of our experience with the $25 million sub-
threshold, we are intrigued by another bipartisan bill recently
introduced in the House. The legislation, H.R. 1003, would require the
CFTC to quantify the costs and benefits of future regulations and
orders. Sadly, the legislation is prospective, but we believe that had
such an analysis been made, it could have prevented the turmoil
currently being caused by the $25 million special entity sub-threshold.
Conclusion
In conclusion, the protections the CFTC is trying to afford through
the $25 million special entity sub-threshold are not needed for utility
operations-related swaps entered into by government-owned utilities.
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 non-financial 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.
In sum, a failure to allow the narrow relief provided under the
Public Power Risk Management Act will limit our members' ability to
hedge against risks and lead to increased risk and costs to the
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.
The Chairman. Thank you, Mr. Naulty.
You may proceed when you are ready, Mr. Thompson.
STATEMENT OF LARRY E. THOMPSON, MANAGING DIRECTOR AND GENERAL
COUNSEL, THE DEPOSITORY TRUST AND CLEARING CORPORATION, NEW
YORK, NY
Mr. Thompson. Thank you, Mr. Chairman. I am Larry Thompson,
General Counsel of The Depository Trust and Clearing
Corporation, DTCC, a participant-owned and governed cooperative
that serves as a critical financial market utility for the U.S.
and global financial markets. DTCC strongly supports H.R. 742,
the Swap Data Repository Clearinghouse Indemnification
Correction Act of 2013. I want to thank Congressman Crawford
and Maloney for their leadership on this issue.
I would like to focus on three points today. First, I will
briefly review DTCC's role in the swaps market, second, I will
explain the indemnification provision in Dodd-Frank and the
problems it poses for swap data sharing and systemic risk
oversight, and third, I will discuss a legislative remedy to
resolve this matter.
DTCC has a long history serving the over-the-counter swaps
market and going back to 2005, we are the only party that has
run a swap data repository. More recently we began operating a
U.S. swap data repository called DDR, which is a swap data
repository registered with the CFTC under Dodd-Frank. The DDR
began accepting trade data from clients the first day that
financial institutions began trade reporting under Dodd-Frank.
On December 31 we were the first and only registered swap data
repository to publish real-time price information. DDR is also
the only registered swap data repository to offer repository
and public reporting across all five asset classes.
Earlier this week, we also announced that DTCC's
registration application to establish a Japanese OTC
derivatives trade repository was approved. DDRJ is the first
trade repository to be approved and established for the
Japanese market. We also have a trade repository registered
with the FSA in the UK called DDRL.
Turning to my second point today, the indemnification
provision in Dodd-Frank requires a registered swap data
repository as a condition of sharing information with a foreign
regulator to first receive a written statement and agreement
with that regulator will abide by certain confidentiality
requirements and indemnify both the SDR and the regulator for
any expenses arising from the litigation relating to the
information provided. We believe those provisions are
complicated and unworkable.
First, many foreign countries and their legal systems do
not recognize the concept of indemnification. Even where they
do, many foreign governments cannot or will not agree to
indemnify foreign private third parties such as U.S.-registered
SDR or a foreign government. In order to access the necessary
information without indemnification each jurisdiction may have
to establish a local trade repository. A proliferation of local
trade repositories would undermine the ability of regulators to
obtain timely, consolidated, and accurate view of the global
marketplace. The implementation of this provision will also
undo the existing data sharing system that was developed
through the OTC Derivatives Regulators Forum or ODRF and a
Committee on Payment and Settlement Systems of the
International Organization of Securities Commissions known as
CPSS IOSCO.
For nearly 3 years regulators globally have followed the
ODRF guidelines to access the information they need for
systemic risk oversight. It is the standard that DTCC uses to
provide regulators around the world with access to global
credit, default swap, and interest rate data stored in its
voluntary trade repositories, and it has worked well to date.
Turning my third and final point, during the 112th Congress
the SEC testified in support of a legislative solution and
three of the five CFTC Commissioners publicly endorsed the need
for legislation to clarify this provision of Dodd-Frank.
Furthermore, a bipartisan coalition of more than 40 lawmakers
in the House signed on as cosponsors of legislation similar to
H.R. 742. The Dodd-Frank Indemnification Requirement has not
been copied by regulators overseas. In fact, the European
Market Infrastructure Regulation known as EMIR, considered and
rejected the indemnification requirement. Congress should enact
H.R. 742 to quickly issue a regulatory comity with
international counterparts. By passing this legislation to
ensure that technical corrections to indemnification are
addressed, Congress will help create the proper environment for
the development of a global trade repository system to support
systemic risk management and oversight.
Thank you, and I await your questions.
[The prepared statement of Mr. Thompson follows:]
Prepared Statement of Larry E. Thompson, Managing Director and General
Counsel, The Depository Trust and Clearing Corporation, New York, NY
Thank you for holding today's hearing to examine legislative
improvements to Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank). The Depository Trust & Clearing
Corporation (DTCC) supports efforts to improve the effectiveness of
this landmark legislation, particularly in areas related to regulators'
ability to access and utilize a global data set for systemic risk
oversight and mitigation purposes.
DTCC strongly supports the Swap Data Repository and Clearinghouse
Indemnification Correction Act of 2013 (H.R. 742), a bipartisan
proposal cosponsored by Congressman Bill Huizenga (R-MI), Congressman
Rick Crawford (R-AR), Congressman Sean Patrick Maloney (D-NY), and
Congresswoman Gwen Moore (D-WI). H.R. 742 will resolve issues
surrounding Dodd-Frank's indemnification provisions and confidentiality
requirements.
My testimony today explains the Dodd-Frank indemnification
provision, how it will fragment swap data, and how fragmentation will
hinder regulators' efforts to oversee a global market. I also provide
information on how indemnification risks negating the existing global
data sharing framework. Finally, I will address the Commodity Futures
Trading Commission's (CFTC) interpretive guidance, what it may mean for
U.S. regulators, and explain why legislation is needed in this
instance.
I appreciate the opportunity to bring greater attention to the
unintended consequences of these provisions and the need for a
legislative solution. These concerns have been echoed by regulatory
officials and policymakers globally, including by representatives of
the European Parliament, European Commission and Council, by Asian
governments and by both Republican and Democratic Members of the U.S.
Congress.
The Dodd-Frank Confidentiality and Indemnification Provisions
Sections 728 and 763 of Dodd-Frank apply to swap data repositories
(SDRs) registered with the CFTC and the Securities and Exchange
Commission (SEC), respectively. Prior to sharing information with U.S.
Prudential Regulators, the Financial Stability Oversight Council, the
Department of Justice, foreign financial supervisors (including foreign
futures authorities), foreign central banks, or foreign ministries,
Dodd-Frank requires (i) registered SDRs to receive a written agreement
from each entity stating that the entity shall abide by certain
confidentiality requirements relating to the information on swap
transactions that is provided and (ii) each entity must agree to
indemnify the SDR and the CFTC or the SEC (as applicable) for any
expenses arising from litigation relating to the information provided.
In practice, these provisions have proven to be unworkable.
As an initial matter, indemnification is a common law concept with
its origin in tort law. Many countries and their legal systems do not
recognize indemnification, and further, many foreign governments cannot
or will not agree to indemnify foreign, private third parties (U.S.
registered SDRs). Further, regulators have noted that they are already
following policies and procedures to safeguard and share data based on
both the OTC Derivatives Regulators' Forum (ODRF) and the International
Organization of Securities Commissions' (IOSCO) Multi-Lateral
Memorandum of Understanding.
Indemnification Requirement Will Fragment the Global Data Set and
Impede Regulatory Oversight
The continued presence of the indemnification requirement is a
significant barrier to the ability of regulators globally to
effectively utilize the transparency offered by a trade repository
registered in the U.S. Without a Dodd-Frank compliant indemnity
agreement, U.S.-registered SDRs may be legally precluded from providing
regulators market data on transactions that are subject to their
jurisdiction. In order to access the swap transaction information
necessary to regulate market participants in their jurisdiction, global
supervisors will be forced to establish local repositories to avoid
indemnification.
Foreign regulators have noted concerns with a scenario in which a
foreign regulator has an interest in certain data in a U.S. SDR
resulting from a jurisdictional nexus with respect to the currency or
underlying reference entity, where neither party to the transaction
falls under the foreign regulator's oversight authority. For example, a
U.S. and a London-based bank may trade on an equity swap involving a
Japanese underlying entity, and the trade is reported to a U.S. SDR. If
the Japan Financial Services Agency has an interest in accessing such
data, it does not appear to be able to do so absent a confidentiality
and indemnity agreement.
The creation of multiple SDRs will, by definition, fragment the
current consolidated information by geographic boundaries. While each
jurisdiction would have an SDR for its local information, it would be
far less efficient, more expensive, and prone to error when compared
with the current global information sharing arrangement in place today.
Further, a proliferation of local trade repositories would
undermine the ability of regulators to obtain a timely, consolidated,
and accurate view of the global marketplace. If a regulator can only
``see'' data from the SDR in its jurisdiction, then that regulator
cannot get a fully aggregated and netted position of the entire market
as a whole. And if a regulator cannot see the whole market, then the
regulator cannot see risk building up in the system or provide adequate
market surveillance and oversight. In short, regulators will be blind
to market conditions as a direct result of the indemnification
provision. In the name of transparency, this provision creates opacity.
This could have a profound impact for U.S. regulators if other
jurisdictions adopt a provision like Dodd-Frank's confidentiality and
indemnification requirement. The imposition of the indemnification
requirement on foreign governments increases the potential that foreign
regimes will adopt reciprocal provisions. The CFTC, SEC, and others may
find themselves precluded from accessing non-U.S. SDR data unless they
agree to indemnify the non-U.S. private third party trade repository.
The SEC noted in testimony before the House Financial Services
Committee last year that the agency ``would be legally unable to meet
any such indemnification requirement and has argued vigorously against
similar requirements in other contexts.'' \1\ The CFTC would likely
face a similar challenge.
---------------------------------------------------------------------------
\1\ H.R. __, the Swap Data Repository and Clearinghouse
Indemnification Correction Act of 2012: Hearing Before the H. Comm. on
Fin. Servs., 112th Cong. (2012) (statement by Ethiopis Tafara,
Director, Office of International Affairs, SEC), available at http://
financialservices.house.gov/uploadedfiles/hhrg-112-ba-wstate-etafara-
20120321.pdf.
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Indemnification Requirement Threatens Existing Global Data Sharing
Framework
The indemnification provision threatens to undo the existing data
sharing system that was developed through the cooperative efforts of
more than 50 regulators worldwide under the auspices of the ODRF and
the Committee on Payment and Settlement Systems and the International
Organization of Securities Commissions (CPSS-IOSCO).
For nearly 3 years, regulators globally have followed the ODRF
guidelines to access the information they need for systemic risk
oversight. It is the standard that DTCC uses to provide regulators
around the world with access to global credit default swap (CDS) and
interest rates data stored in its trade repositories. For example,
under ODRF guidelines, regulators must maintain the confidentiality of
information they obtain from DTCC's trade repositories and must affirm
that information obtained is of material interest to their oversight.
The Dodd-Frank indemnification requirement has not been copied by
Asian and European regulators. In fact, the European Market
Infrastructure Regulation (EMIR) considered and rejected an
indemnification requirement. Congress should enact H.R. 742 quickly to
bring American law in line with the rest of the world.
Limitations of the Commodity Futures Trading Commission Interpretive
Statement
In May 2012, the CFTC issued an Interpretative Statement Regarding
the Confidentiality and Indemnification Provisions of the Commodity
Exchange Act (Interpretive Statement). DTCC appreciates the
Commission's serious effort to address these problems in the context of
its rulemaking authority. However, due to the limitations inherent in a
regulatory modification to a statutory problem, and in light of
discussions with regulators globally, the language of the statute
ultimately requires a ``legislative fix'' to clarify the scope and
applicability of Dodd-Frank's confidentiality and indemnification
provisions. Many regulators globally have expressed to DTCC the belief
that a legislative resolution is needed to address the issues presented
by this provision. Congress should act to bring certainty and clarity
to global swaps markets.
While the Interpretative Statement provides clarification with
respect to how the Commission proposes to construe the application of
Dodd-Frank, it does not provide complete resolution to the concerns
expressed by foreign regulatory authorities relating to regulator
access. Even with adoption of the Interpretative Statement, which DTCC
supports as a necessary first step, the indemnification provisions may
still cause limited data sharing across jurisdictions.
The Swap Data Repository and Clearinghouse Indemnification Correction
Act of 2013
The Swap Data Repository and Clearinghouse Indemnification
Correction Act of 2013 would make U.S. law consistent with existing
international standards by removing the indemnification provisions from
sections 728 and 763 of Dodd-Frank. DTCC strongly supports this
legislation, which we believe represents the only viable solution to
the unintended consequences of indemnification.
H.R. 742 is necessary because the statutory language in Dodd-Frank
leaves little room for regulators to act without U.S. Congressional
intervention. This point was reinforced in the CFTC/SEC January 2012
Joint Report on International Swap Regulation, which noted that the
Commissions ``are working to develop solutions that provide access to
foreign regulators in a manner consistent with the DFA and to ensure
access to foreign-based information.'' \2\ It indicates legislation is
needed, saying that ``Congress may determine that a legislative
amendment to the indemnification provision is appropriate.'' \3\
---------------------------------------------------------------------------
\2\ CFTC and SEC, Joint Report on International Swap Regulation
(Jan. 31, 2012), at 103, available at http://www.cftc.gov/ucm/groups/
public/@swaps/documents/file/dfstudy_isr_013112.pdf.
\3\ Id.
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H.R. 742 would send a clear message to the international community
that the United States is strongly committed to global data sharing and
determined to avoid fragmenting the current global data set for over-
the-counter (OTC) derivatives. By amending and passing this legislation
to ensure that technical corrections to indemnification are addressed,
Congress will help create the proper environment for the development of
a global trade repository system to support systemic risk management
and oversight.
Bipartisan and Regulatory Support for the Swap Data Repository and
Clearinghouse Indemnification Correction Act of 2013
The SEC supports removing the indemnification provision from the
DFA. During a hearing of the House Financial Services Capital Markets
Subcommittee last year, the Commission testified that the
``indemnification requirement interferes with access to essential
information, including information about the cross-border OTC
derivatives markets. In removing the indemnification requirement,
Congress would assist the SEC, as well as other U.S. regulators, in
securing the access it needs to data held in global trade repositories.
Removing the indemnification requirement would address a significant
issue of contention with our foreign counterparts, while leaving intact
confidentiality protections for the information provided.'' \4\
---------------------------------------------------------------------------
\4\ H.R. __, the Swap Data Repository and Clearinghouse
Indemnification Correction Act of 2012: Hearing Before the H. Comm. on
Fin. Servs., 112th Cong. (2012), supra note 1.
---------------------------------------------------------------------------
CFTC Commissioners Scott O'Malia, Bart Chilton, and Jill Sommers
have publicly stated their support for a legislative solution to
address the unintended consequences of the provision.\5\ Recently,
during a Senate Committee on Agriculture, Nutrition, and Forestry
hearing, CFTC Chairman Gary Gensler identified the indemnification
issue as one that Congress may address.\6\
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\5\ See Commissioner Jill Sommers and Commissioner Scott O'Malia,
Dissenting Statement, Interpretative Statement Regarding the
Confidentiality and Indemnification Provisions of Section 21(d) of the
Commodity Exchange Act, available at http://www.cftc.gov/PressRoom/
SpeechesTestimony/sommers_omailadissentstatement; see also Dodd-Frank
Derivatives Reform: Challenges Facing U.S. and International Markets:
Hearing Before the H. Comm. on Agric., 112th Cong. (2012) (Commissioner
Bart Chilton expressing support for a legislative solution), transcript
available at http://agriculture.house.gov/sites/
republicans.agriculture.house.gov/files/transcripts/112/112-35New.pdf.
\6\ See Oversight of the Commodity Futures Trading Commission:
Hearing Before the S. Comm. on Agric., Nutrition, and Forestry, 113th
Cong. (2011) (colloquy between Chairman Gensler and Senator Saxby
Chambliss).
---------------------------------------------------------------------------
There is bicameral, bipartisan support to resolve the consequences
of indemnification. In the last Congress, H.R. 4235 secured 41
cosponsors and was the only DFA corrections bill to garner bipartisan,
bicameral support. While the legislation passed the House Financial
Services Committee, it was ultimately taken off the House Agriculture
Committee hearing calendar.
In addition, several other Members of Congress have publicly
declared their support for a technical correction to the provision.
Senator Agriculture Committee Chairwoman Debbie Stabenow (D-MI) and
former Ranking Member Pat Roberts (R-KS), and former House
Appropriations Agriculture Subcommittee Congressman Jack Kingston (R-
GA) and Ranking Member Sam Farr (D-CA), authored separate letters to
their counterparts in the European Parliament expressing interest in
working together on a solution to this issue.\7\
---------------------------------------------------------------------------
\7\ See Letter from Representative Jack Kingston and Representative
Sam Farr to Mr. Sharon Bowles, Mr. Jean-Paul Gauzes, Dr. Werner Langen,
and Mr. Gabor Butor (May 18, 2011); see also Letter from Senator Debbie
Stabenow and Senator Pat Roberts to Ms. Sharon Bowles and Dr. Werner
Langen (June 2, 2011).
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DTCC Has Experience Operating Global Trade Repositories
DTCC provides critical infrastructure to serve all participants in
the financial industry, including investors, commercial end-users,
broker-dealers, banks, insurance carriers, and mutual funds. We operate
as a cooperative that is owned collectively by its users and governed
by a diverse Board of Directors.
DTCC has extensive experience operating as a trade repository and
meeting transparency needs.
We provide trade repository services in the U.S., the UK, Japan,
Singapore and The Netherlands and have established a global trio of
fully replicated GTR data centers. To support Dodd-Frank requirements,
the DTCC Data Repository (DDR) applied for and received provisional
registration from the CFTC to operate a multi-asset-class SDR for OTC
credit, equity, interest rate, foreign exchange (FX) and commodity
derivatives in the U.S. DDR began accepting trade data from its clients
on October 12, 2012--the first day that financial institutions began
trade reporting under the DFA. Furthermore, on December 31, DDR was the
first and only registered SDR to publish real-time price information.
DTCC has been providing public aggregate information for the CDS market
on a weekly basis, including both open positions and turnover data,
since January 2009. This information is available, free of charge, on
www.dtcc.com.
Last week, DTCC announced that registered swaps dealers are now
submitting OTC derivatives trade information for all five major asset
classes into the DDR. The DDR is the only repository to offer reporting
across all asset classes, a major milestone in meeting regulatory calls
for robust trade reporting and risk mitigation in the global OTC
derivatives market. Currently, there are approximately three million
new positions across asset classes for a total of nearly seven million
positions registered in the DDR.
I am pleased to report that DTCC's application for registration to
establish a Japanese OTC derivatives trade repository was recently
approved by the Financial Services Agency of Japan (J-FSA). DTCC will
begin operating this service ahead of the J-FSA's mandated April 1
deadline for market participants in Japan to begin reporting their OTC
derivatives transactions. DTCC Data Repository (Japan) KK (DDRJ) is the
first trade repository to be approved and established for the Japanese
market. DDRJ will support trade reporting across four major OTC
derivatives asset classes including credit, equities, interest rates,
and FX.
In 2012, DTCC expanded the Global Trade Repository (GTR) in order
to support mandatory regulatory reporting requirements for over-the-
counter (OTC) derivatives. The GTR, which holds detailed data on OTC
derivatives transactions globally, gives market participants and
regulators an unprecedented degree of transparency into this $650
trillion market--an essential tool for managing systemic risk.
The GTR is now established as the industry's preferred provider for
global OTC derivatives reporting. It holds data on more than 98% of
credit default swaps, 70% of interest rate derivatives and 60% of
equities derivatives traded globally--and it is expanding to include
foreign exchange and commodities derivatives.
Thanks in large part to the financial industry's voluntary effort
to report data to the GTR, the CDS market is the most transparent in
the world as far as regulatory understanding of counterparty exposures.
In fact, we believe the CDS market is even more transparent than the
equity and bond markets.
The GTR's Regulators Portal, which provides detailed information on
counterparty positions as well as notional and transaction-level data,
is leveraged on a regular basis by more than 40 supervisors globally to
help manage sovereign debt crises, corporate failures, credit
downgrades and significant losses by financial institutions. The portal
is the first global service of its kind in the financial marketplace to
provide regulators with granular data on transactions that occur within
their jurisdictions.
Although DTCC and the industry continue to work closely to meet
regulatory reporting requirements, the obstacles presented by the DFA
indemnification provisions and confidentiality requirements aren't
going away. Ultimately, Congress must act to avoid further unintended
consequences and to ensure market transparency and risk mitigation of
global financial markets.
Thank you for your time and attention this morning. I am happy to
answer any questions that you may have.
The Chairman. Thank you, Mr. Thompson.
Ms. Hollein, you may begin when you are ready.
STATEMENT OF MARIE N. HOLLEIN, C.T.P., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, FINANCIAL EXECUTIVES INTERNATIONAL AND
FINANCIAL EXECUTIVES RESEARCH FOUNDATION, WASHINGTON, D.C.; ON
BEHALF OF
COALITION FOR DERIVATIVES END-USERS
Mr. Hollein. Thank you. Chairman Lucas, Ranking Member
Peterson, and Members of the Committee, I want to thank you for
inviting me to testify today. I am the President and CEO of
Financial Executives International, the professional
association of 15,000 senior-level financial executives from
over 8,000 companies across all industries.
For more than 30 years I worked in the treasury function of
several major corporations, including Westinghouse, Citicorp,
ABN AMRO, and led CPMG's treasury practice for non-financial
institutions. Today I speak on behalf of FEI and the Coalition
for Derivatives End-Users. The coalition includes more than 300
companies and trade associations representing thousands of end-
users united in one respect. They use derivatives to manage
risk, not create it.
Corporate treasurers utilize over-the-counter derivatives
to hedge and mitigate business risks, not for speculative
purposes, which is why these end-users should not be regulated
in a way that imposes unnecessary costs or restrictions.
Congress heard our concerns in several respects and provided
for key exemptions in Dodd-Frank for end-users.
Unfortunately, over the 2\1/2\ years since Dodd-Frank was
enacted, it appears that these end-user exceptions are not
being upheld in the rulemaking process. This is especially
evident in the proposed margin rule and in the lack of clarity
around inter-affiliate swaps and the use of treasury hedging
centers.
Despite these issues the compliance clock keeps ticking
toward imminent deadlines. The coalition strongly supports two
pieces of legislation that have been referred to your
Committee; H.R. 634 and H.R. 677. We would like to thank the
Committee and the full House for supporting similar bills last
Congress.
Today I will focus my comments on the Inter-Affiliate Swap
Clarification Act, H.R. 677, introduced by Congressmen Stivers,
Fudge, Gibson, and Moore. This legislation would ensure that
inter-affiliate derivative trades do not face the same
demanding regulatory requirements as market-facing swaps. This
bill also ensures that end-users are not penalized for using
treasury hedging centers to manage their commercial risks.
There are two serious problems facing end-users that needs
to be addressed. First, under CFTC's proposed rule financial
end-users would have to clear internal trades between
affiliates unless they post variation margin or met specific
requirements for an exception. Financial end-users such as
pension plans, captive finance affiliates, and mutual life
insurance companies use derivatives exactly the same way that
non-financial end-users do.
If these end-users have to post variation margin, there is
little point to exempt international-affiliate trades from
clearing requirements as the cost could be similar. And let's
not forget the larger point. Internal end-user trades do not
create systemic risk and hence, should not be regulated the
same as those trades that do.
Second, roughly \1/4\ of end-users we surveyed execute
swaps through an affiliate. Many companies find it more
efficient to manage their risks centrally instead of having
hundreds of affiliates making trades in an uncoordinated
fashion. Using this type of hedging unit centralizes expertise,
strengthens financial controls, increases transparency, and
improves price. These advantages led me to centralize the
treasury function at Westinghouse while I was there.
However, the Regulators' interpretation of the Dodd-Frank
Act confronts non-financial end-users with a choice, either
clear all of their trades or dismantle their treasury hedging
centers and find a new way to manage risk. Stated differently,
this problem threatens to deny the end-user clearing exception
to those who have chosen to hedge their risk in an efficient,
highly-effective, and risk-reducing way. It is difficult to
believe that this is the result Congress hoped to achieve.
For these reasons we hope Congress will pass H.R. 677.
Thank you, Mr. Chairman, and I look forward to the
questions.
[The prepared statement of Ms. Hollein follows:]
Prepared Statement of Marie N. Hollein, C.T.P., President and Chief
Executive Officer, Financial Executives International and Financial
Executives Research Foundation, Washington, D.C.; on Behalf of
Coalition for Derivatives End-Users
Chairman Lucas, Ranking Member Peterson, and Members of the
Committee, I want to thank you for inviting me to testify today on the
topic of legislative improvements to Title VII of the Dodd-Frank Act.
I am the President and Chief Executive Officer of Financial
Executives International, the professional association of choice for
15,000 senior-level financial executives, from over 8,000 public and
privately-held companies, across all industries. For 30 years before
coming to FEI, I worked in the treasury functions of several major
corporations, including Westinghouse, Citicorp, ABN AMRO, and Ruesch
International and worked in the Financial Risk Management Practice
leading treasury for non-financial institutions for KPMG.
Today I speak both on behalf of FEI and as a representative of the
Coalition for Derivatives End-Users. The Coalition includes more than
300 end-user companies and trade associations and, collectively, we
represent thousands of end-users from across the economy. Our members
are united in one respect; they use derivatives to manage risk, not
create it.
FEI as an organization is dedicated to advancing ethical and
responsible financial management. As such, a number of FEI members,
namely corporate treasurers, utilize over-the-counter derivatives to
hedge and mitigate business risk. During the debate leading up to the
Dodd-Frank Act, FEI worked alongside the Coalition to educate lawmakers
on how derivatives are an effective tool used by non-financial
companies for risk-management purposes and not for speculation, which
is why end-users should not be regulated in a way that imposes unwieldy
costs or unnecessary burdens. Congress heard our concerns in several
respects and provided for key exceptions for end-users from some of the
most burdensome derivatives requirements, such as central clearing
requirements.
Unfortunately, over 2\1/2\ years since the enactment of the Dodd-
Frank Act, it appears that the intent of these end-user exceptions is
not being upheld in the rulemaking process, as evidenced by the
proposed margin rule and in the lack of clarity regarding companies
that employ inter-affiliate swaps or use a centralized treasury hedging
center. Despite these outstanding issues, the compliance clock keeps
ticking away and companies must be ready to meet key deadlines.
For these reasons, the Coalition strongly supports two pieces of
legislation that have been referred to your Committee, H.R. 634 and
H.R. 677. We would like to thank the Committee for reporting similar
bills by voice vote last Congress. Both bills subsequently passed the
House by significant bipartisan majorities.
Today, I will focus my comments on the Inter-Affiliate Swap
Clarification Act, H.R. 677, introduced by Congressmen Stivers, Fudge,
Gibson and Moore. This legislation would ensure that inter-affiliate
derivatives trades, which take place between affiliated entities within
a corporate group, do not face the same demanding regulatory
requirements as market-facing swaps. The legislation would also ensure
that end-users are not penalized for using central hedging centers to
manage their commercial risk.
There are two serious problems facing end-users that need
addressing. First, under the CFTC's proposed inter-affiliate swap rule,
financial end-users would have to clear purely internal trades between
affiliates unless they posted variation margin between the affiliates
or met specific requirements for an exception. The Coalition is
comprised of both financial and non-financial end-user members, and
financial end-users, such as pension plans, captive finance affiliates,
mutual life insurance companies, and commercial companies with non-
captive finance arms, use derivatives the same way non-financial end-
users do. If these end-users have to post variation margin, there is
little point to exempting inter-affiliate trades from clearing
requirements, as the costs could be similar. And let's not forget the
larger point--internal end-user trades do not create systemic risk and,
hence, should not be regulated the same as those trades that do.
Second, many end-users--approximately \1/4\ of those we surveyed--
execute swaps through an affiliate. This of course makes sense, as many
companies find it more efficient to manage their risk centrally, to
have one affiliate trading in the open market, instead of dozens or
hundreds of affiliates making trades in an uncoordinated fashion. Using
this type of hedging unit centralizes expertise, allows companies to
reduce the number of trades with the street and improves pricing. These
advantages led me to centralize the treasury function at Westinghouse
while I was there. However, the regulators' interpretation of the Dodd-
Frank Act confronts non-financial end-users with a choice: either
dismantle their central hedging centers and find a new way to manage
risk, or clear all of their trades. Stated another way, this problem
threatens to deny the end-user clearing exception to those end-users
who have chosen to hedge their risk in an efficient, highly-effective
and risk-reducing way. It is difficult to believe that this is the
result Congress hoped to achieve.
The Coalition believes that regulation of inter-affiliate swaps
should square with the economic reality that inter-affiliate swaps do
not pose systemic risk. H.R. 677 would make sure that end-users will
not be forced to clear swaps simply because they use inter-affiliate
trades or a centralized hedging structure. Thank you Chairman Lucas, I
will be happy to answer any questions Members of the Committee might
have.
The Chairman. Thank you, and the chair now recognizes Mr.
Turbeville whenever you are ready, sir.
STATEMENT OF WALLACE C. TURBEVILLE, SENIOR FELLOW, DEMOS, NEW
YORK, NY; ON BEHALF OF AMERICANS FOR
FINANCIAL REFORM
Mr. Turbeville. Thank you, Chairman Lucas and Members of
the Committee. Thanks for having me here.
My name is Wallace Turbeville. I am a Senior Fellow at
Demos, which is a national public policy organization working
to reduce political and economic inequality, advancing a vision
of a country where we all have an equal say in our democracy,
and have an equal chance in our economy. I am talking today on
behalf of Americans for Financial Reform, which is a coalition
of more than 250 organizations which have come together to
advocate for the reform of the financial sector. I would like
to thank Marcus Stanley, AFR's Policy Director, for assisting
with the preparation of my testimony.
I come to this testimony with a strangely appropriate set
of experiences. First of all, I was born near Owensboro,
Kentucky, which is not exactly qualification, but I did
practice law in municipal bonds and worked with many municipal
utilities for many years and then went onto Goldman Sachs to
work in its municipal bond department for many years. After
being at Goldman Sachs in Europe and elsewhere, I moved onto an
international infrastructure finance and ran a derivatives risk
service company for 7 years as CEO. Then 2\1/2\ years ago I
decided to devote myself 100 percent of my time to thinking and
writing about the reform of the financial markets.
Today the Committee is considering seven pieces of
legislation. Six of these would amend Title VII, and the cost-
benefit analysis would amend another part of the Act. The
Americans for Financial Reform oppose six of these legislative
proposals. We do not oppose the matter that was discussed by
the gentleman from DTCC.
In truth there is no urgency for technical amendments to
Title VII at this time. This may seem surprising given the
length of the scope of the legislation, but, in fact, what is
happening is in large measure as Chairman Gensler pointed out,
many of these issues are being dealt with on an ongoing basis.
Given the complexity of the swaps space and the approach of
Dodd-Frank Act in relying on regulatory expertise to craft
rules, Congress should think about whether it is premature to
do some of these things. Specifically, there are several issues
at play here. One is the business risk management section, H.R.
634. Now, the bill as has been talked about several times
today, the whole issue of end-user margin is that the CFTC has
not required end-users to post margin, but the risks that are
associated with swaps that are margined are dead. Pure and
simple. They are credit extensions. So the fact of the matter
is that the Prudential Regulators have said it would be prudent
for a bank who is doing a swap to set a threshold or a limit on
how much debt they extend. To do otherwise would be to suggest
that it would be prudent for banks to extend unlimited credit,
which I think is hard to address.
There are a couple of other points I would like to make
quickly before we just move on. One is associated with the
whole notion of the push-out provision. As best I can tell the
biggest concern about the push-out provision is that it might
be more expensive to work through an affiliate by some of the
banks.
As Chairman Gensler pointed out, many of the banks are
working through affiliates in this area. I want to point out
that the Federal Reserve tells us that JPMorgan has 3,391
affiliates in its organization, B of A, 2,091, Goldman Sachs,
3,115, Morgan Stanley, 2,884, and Lehman before it died had
2,800. So the banks can manage to work through affiliates. The
primary cost associated with the push-out is a cost of capital.
If you have to capitalize an affiliate as opposed to relying on
the capital of an insured bank, the cost of capital may be
higher.
But here is the point. That cost of capital may be higher.
That might even cause some costs to be passed along to
counterparties, but the alternative is to have the people of
the United States grant a subsidy through their guarantees of
these banks, and that is an inappropriate way to do things.
I am perfectly happy to talk about any and all of these
other provisions, and I look forward to your questions. Thank
you.
[The prepared statement of Mr. Turbeville follows:]
Prepared Statement of Wallace C. Turbeville, Senior Fellow, Demos, New
York, NY; on Behalf of Americans for Financial Reform
Chairman Lucas, Ranking Member Peterson and Members of the
Committee, good morning and thank you for the opportunity to testify
before the Committee today.
My name is Wallace Turbeville. I am a Senior Fellow at Demos, a
national public policy organization working to reduce political and
economic inequality, advancing a vision of a country where we all have
an equal say in our democracy and an equal chance in our economy. I am
testifying today on behalf of Americans for Financial Reform, a
coalition of more than 250 organizations who have come together to
advocate for the reform of the financial sector. I would also like to
thank Marcus Stanley, AFR's Policy Director, for assistance in
preparing this testimony.
I come to this testimony with extensive professional experience in
both the derivatives markets and the commodity markets. For 7 years, I
practiced law specializing in public and private securities offerings,
primarily municipal bond offerings for states, local governments and
governmental utilities. I was then an investment banker at Goldman
Sachs in its Municipal Bond Department for more than twelve years,
specializing in governmental utilities in the United States and in
Europe. After leaving Goldman, I managed a small advisory firm
specializing in infrastructure finance around the world. I also served
as CEO of a firm providing counterparty credit management services in
the derivatives markets. For the last 2 years, I have focused my
efforts on financial system reforms, participating in dozens of formal
comments and various roundtable discussions at the request of
regulatory agencies, the vast majority of them related to Title VII of
the Dodd-Frank Act. This experience has prepared me well to discuss the
amendments of Title VII of the Dodd-Frank Act that are the subject of
this hearing.
Today the Committee is considering seven pieces of legislation. Six
of these would amend Title VII of the Dodd-Frank Act, and one would
impose new requirements for cost-benefit analysis on the Commodity
Futures Trading Commission (the ``CFTC''). Americans for Financial
Reform oppose six of these legislative proposals. The specific reasons
for our opposition to each bill are outlined in detail in my written
testimony and will also be outlined in opposition letters that we are
submitting today or will be submitting in the future. A guiding
principle for AFR is that the trillions of dollars in economic costs
created by the 2008 financial crisis, as well as the numerous related
problems revealed in Wall Street scandals, mean that we need increased
oversight of our financial system and full implementation of the Dodd-
Frank Act. This should not be a controversial position. Over 70 percent
of the public supports tougher rules and enforcement for Wall Street,
and similar proportions support the Dodd-Frank Act.\1\ But the
legislation offered here moves in the wrong direction. Bills such as
H.R. 992 would enable additional bailouts of Wall Street banks.
Legislation such as H.R. 677 on inter-affiliate swaps or the discussion
draft on extraterritorial derivatives regulation would effectively
limit the ability of regulators to provide proper oversight of complex
derivatives markets.
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\1\ Lake Research Partners, ``Polling Memo: Two Year Anniversary Of
The Wall Street Reform Law'', July 18, 2012, available at http://
ourfinancialsecurity.org/blogs/wp-content/ourfinancialsecurity.org/
uploads/2012/07/AFR-AARP-CRL-NCLR-Lake-Research-Dodd-Frank-Anniversary-
Poll-MEMO-7-18-121.pdf.
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The title of this hearing suggests that the Committee is
considering ``improvements'' of the derivatives provisions of the Dodd-
Frank Act. Despite the fact that the great majority of the Dodd-Frank
Act has not yet been implemented or tested in the market, it has been
suggested that there is a need for ``clarifications'' and ``technical
amendments.''
This has caused me to think carefully about the concepts of
improvements, clarifications and technical amendments. Derivatives
bristle with devilishly complex risks and valuation issues. Even a
sophisticated bank might value the same derivative differently in
separate organizational units of the bank.\2\ It has been reported that
the infamous ``London Whale'' episode involved the obscuring of massive
risk positions at JP Morgan Chase, a firm that claims industry
leadership in risk management, by alteration to the quantitative
formulas measuring risk.\3\ In this technical area, these concepts are
likely to be viewed differently by those who evaluate the regulation of
the derivatives markets differently.
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\2\ Arora, S., Barak, B., Brunnermeier, M., Ge, R., ``Computational
Complexity and Information Asymmetry in Financial Products,'' October
19, 2009, available at http://scholar.princeton.edu/markus/
publications/term/39.
\3\ Brinded, L., ``JP Morgan's $2 Billion `London Whale' Loss
Challenges Industry's Risk Measures,'' International Business Times,
June 13, 2012, available at http://www.ibtimes.co.uk/articles/351700/
20120613/jp-morgan-cio-bruno-iksil-london-whale.htm.
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In truth, there is no urgency for ``technical amendments'' to Title
VII at this time. This may seem surprising given the length and scope
of the legislation, but there are two good reasons that it is true.
First, in almost every area Title VII grants regulators extensive
discretion to tailor and fine tune the broad directives in the Dodd
Frank Act, and to introduce exemptions if need be. Indeed, regulators
have been generous in doing just that, perhaps to a fault. Second,
almost none of the significant elements of Title VII have yet been
fully implemented. Without implementation, claims about their supposed
harms are unfounded--especially since the key elements of Title VII,
such as clearing, exchange trading, and improved risk management, are
hardly radical. They are based on tried and true solutions with which
we have long experience in real markets.
Given the complexity of the swaps space, and the approach of the
Dodd-Frank Act in relying on regulatory expertise to craft specific
rules, Congress should not be advancing broad and sweeping statutory
exemptions that overturn the judgment of expert regulators and
effectively deregulate portions of the swaps market only a few years
after the decision to regulate them for the first time. Given the
delays in implementation of the Title VII provisions and the importance
of gaining experience with how these provisions work once they are
actually implemented, Congress should not be acting to delay their
implementation even further. Yet several of the bills before you today
do exactly that. For example, H.R. 677, the ``Inter-affiliate Swap
Clarification Act'', would create an overbroad and sweeping exemption
for all inter-affiliate swaps that completely ignores the nuanced and
thoughtful work done by the CFTC in crafting its own rule proposal for
inter-affiliate swaps. And H.R. 1003 would add burdensome additional
cost-benefit analysis requirements to the Commodity Exchange Act, the
effect of which would not be to improve the quality of rulemaking but
instead to create indefinite additional delays in the implementation of
financial reforms.
Instead, the Congressional emphasis now should be on supporting the
drastically under-funded CFTC with adequate resources to complete Dodd-
Frank rulemaking and to actually implement those rules through
enforcement and market monitoring. Only then will Congress have the
necessary information to examine how well these rules are actually
working based on real data rather than the usual industry calls for
deregulation and exemptions.
The proposed bill on extraterritorial jurisdiction creates a
different kind of impediment for the CFTC. The derivatives markets are
truly international with trading taking place in cyberspace. Events in
other jurisdictions can easily spread to the U.S. through intricate
interrelationships across markets. The nature of the regulations in
other jurisdictions, as well as their timing and even existence,
remains an unknown. The ideal approach to jurisdiction in these
circumstances is for the law to provide broad jurisdiction to the CFTC
and to enhance the prospect that the rules in other jurisdictions will
be comparable to the U.S. approach. Broad jurisdiction means that there
will be no gaps in terms of scope and timing. The exercise of
jurisdiction can be managed through substituted compliance, if
justified. Broad jurisdiction together with point-by-point examination
of the rules of other jurisdictions will allow the CFTC to work with
agencies of other jurisdictions to achieve regulatory harmony which
reflects the U.S. approach to rules, an approach that will most
certainly be the most prudent and efficient. Yet as I outline further
in my testimony, the proposed bill on extraterritorial jurisdiction
would interfere with this process and undermine the CFTC's ability to
regulate swaps that directly affect the U.S. economy.
Americans for Financial Reform does not object to actual technical
amendments, by which I mean amendments that make non-substantive and
necessary changes to facilitate the achievement of the goals of the
original statute. One of the bills before the Committee today, H.R.
742, the ``Swap Data Repository and Clearinghouse Indemnification
Correction Act of 2013,'' fits this description well. AFR does not
oppose it.
However, the other bills here are far from being ``clarifications
or technical amendments'' and AFR does not see them as improvements.
Instead, they significantly alter the Dodd-Frank Act in ways that
effectively deregulate the financial sector and work against the goals
of improving the safety, stability, fairness, and efficiency of our
financial system.
I use the term ``financial system'' intentionally. Far too often,
discourse on financial reform conflates the profitability of individual
financial institutions with a safe, sound and efficient financial
system. Financial institutions seek short term profits and massive
earnings from derivatives, and all too often they are able to sustain
the long term risks involved in this pursuit due to the public safety
net that supports too-big-to-fail banks. Combined with the fact that
executive pay is frequently determined by short-term profits, this
means that short-term incentives dominate their behaviors, often at the
expense of the public at large and the safety of the broader financial
system. The Dodd-Frank Act puts sensible risk limits on activities in
the derivatives markets. This is good for the financial system, even if
it reduces the profitability potential of some financial institutions.
In thinking about the benefits of sensible limitations on
derivatives activities, I would also like to add a personal note on one
of the bills under consideration. H.R. 1038 purports to benefit public
utilities by exempting them from some of the protections in Title VII
of the Dodd Frank Act. This is a subject near and dear to my heart
since I devoted most of my professional career to assistance of
governmental enterprises in their capital-raising activities. In those
years, I had the uncomfortable opportunity to witness sales calls by
derivatives specialists on governmental utilities. I have seen the
technique of fostering a sense of trust, encouraging an advisory
relationship that can be exploited to sell an immensely profitable
derivative when other alternatives could be better. As pointed out
earlier, even the most sophisticated financial institutions struggle
with evaluating the risks associated with derivatives. It is completely
unreasonable to expect that governmental utilities will have the
ability to measure the risks of derivative transactions. This is
especially so given the massive incentives of swap dealers to
ingratiate themselves as functional advisors and obfuscate their costs
and risks. This means that swap dealers must be constrained in their
dealings with governmental utilities. Their business conduct standards
should be enhanced, not undercut. Public entities are at a major
disadvantage in negotiating with swap dealers and the public's interest
is in rectifying this imbalance, not facilitating it.
Below, I discuss the bills before you today in more detail. I would
also refer you to the opposition letters that Americans for Financial
Reform is submitting on most of these pieces of legislation.
Extraterritoriality
CFTC Chairman Gensler has correctly observed that a faulty
extraterritoriality rule could blow a hole in the bottom of the ship of
derivatives regulation. Modern markets are interrelated and trading
occurs in cyberspace. The very concept of national jurisdictions is
challenged by the modern financial system, especially in the area of
derivatives.
American financial institutions operate derivatives businesses in
many nations through branches and guaranteed affiliates. Moreover,
foreign banks similarly maintain large derivatives businesses in the
U.S. There is no assurance that financial regulations in those
countries will regulate their activities using comparable standards,
either in the form of written rules or in their application. Indeed, in
some jurisdictions, there is no assurance when or even if rules will be
finalized.
The discussion draft on extraterritoriality before the Committee
today would greatly hamper the ability of the CFTC to effectively
address the complex problem of extraterritoriality. It does this by
undermining the jurisdiction granted to the agency in Section 722(d) of
the Dodd-Frank Act and limiting the ability of the agency to work with
foreign regulators to ensure the full comparability of U.S. and foreign
derivatives rules. Given the centrality of proper cross-border
regulation to effective oversight of the derivatives markets, as well
as the potential exposure of the U.S. taxpayer and the U.S. financial
system to failures in regulation abroad, it is of central importance to
support the CFTC in implementing strong cross-border rules. Instead,
this legislation would weaken it.
There is no doubt that the viability of the U.S. financial system
is tied inextricably to international markets. In 2008, foreign banks
needed access to U.S. dollars to avoid default on ongoing dollar
denominated liabilities. They could not rely on borrowing dollars in
the crippled U.S. commercial paper market. The only remaining source
was the foreign exchange market in which dollars are swapped between
U.S. and foreign banks as of a future date in exchange for other
currencies, a $4 trillion per day market.\4\ Banks in other countries
came to doubt the reliability of U.S. banks--no one knew whether U.S.
banks were solvent because they held huge quantities of toxic mortgage
assets that could no longer be valued accurately. The market began to
evaporate, as foreign banks feared that U.S. banks would not deliver
the required currency on the appointed date. A worldwide collapse might
ensue if the foreign banks defaulted for want of dollars. The Fed
offered unlimited access to foreign central banks to swap dollars for
foreign currency so that the central banks could in turn loan dollars
to local banks, avoiding their default. Most accurately measured, the
daily peak of Fed swaps exceeded $850 billion.
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\4\ Bank for International Settlements, ``Triennial Central Bank
Survey, Report on Global Foreign Exchange Market Activity in 2010,''
December 2010, available at http://www.bis.org/publ/rpfxf10t.pdf.
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Under these circumstances, a prudent approach to
extraterritoriality is essential. Jurisdiction and the exercise of
jurisdiction are two different things. The best result is if the U.S.
sets the standard for meaningful and prudent regulation and the foreign
jurisdictions meet that standard. The best way to achieve that goal is
to strive for broad jurisdiction for the CFTC. This likely means that
jurisdictions will overlap. But that has several benefits. First, it
will mean that there are no jurisdictional gaps that can be exploited.
Second, it will mean that U.S. regulators will be in the best position
to harmonize jurisdictional overlap under conditions in which the
foreign rules are substantially comparable with U.S. rules. And for the
period in which foreign rules are not in place, U.S. regulators can
protect American taxpayers rather than allowing foreign activities to
put the U.S. financial system at risk.
The language of Section 722(d) of the Dodd-Frank Act strikes this
balance wisely. It gives the CFTC jurisdiction over any activities that
``have a direct and significant connection with activities in, or
effect on, commerce of the United States.'' As stated above, the CFTC
is not required to exercise this jurisdiction. It retains the option to
tailor regulations to specific activities abroad. It is difficult to
imagine any reason why the American public would not want to give our
regulatory agencies jurisdiction over derivatives activities that have
a ``direct and significant connection'' with the U.S. economy. If
substituted compliance is appropriate, the CFTC can negotiate that out
from a position of strength.
It is unwise to subject these kind of jurisdictional matters to the
Administrative Procedures Act. The APA may be appropriate for the
design of specific derivatives rules, but should not limit the proper
application of these rules to all areas directly affecting the U.S.
economy.
Further, the legislation would direct and limit the standard for
comparability in a way that undercuts the discretion of the CFTC to
work with foreign jurisdictions to achieve the standards that will
protect the American public. The bill requires that, for G20 member
nations, the agencies make overall comparability determinations based
on the ``broad comparability'' of the entire regime in another country
to the entire derivatives regime in this country. This eliminates the
CFTC's ability to determine the comparability of other national regimes
in specific areas and to permit substituted comparability for some
requirements and not others. Given the scope of derivatives
requirements this regulatory flexibility is valuable. Indeed, it is
possible that the ability to approve on a point-by-point basis will
allow regulatory agencies to be more permissive in some cases (by
permitting substituted requirements for a few requirements when the
overall regime is not comparable). If substituted compliance is
implemented, the CFTC should be empowered and encouraged to vigorously
work through the elements of regulatory regimes on an ongoing basis to
make certain that the high standards required by Congress and the
American people are upheld in every jurisdiction that could be the
source of grave harm to the American economy.
Finally, SEC extraterritoriality jurisdiction has its origin in a
regulatory mandate that is very different from the CFTC. The nature of
the derivatives markets regulated by the CFTC demands the standards set
forth in Section 722(d). If the two standards were to be reconciled, it
only makes sense that the language of Section 722(d) would prevail. In
a world in which a financial meltdown can easily and quickly be
transmitted throughout the international system, it makes no sense to
make fine distinctions about jurisdictions of organization or physical
locations of offices when it comes to the derivatives markets.
Bank Derivatives Subsidiaries
Perhaps the most dramatic example before you today of legislation
that undermines the goals of the Dodd-Frank Act is H.R. 992, the
``Swaps Regulatory Improvement Act''. This would amend Section 716 of
the Dodd-Frank Act, a provision that bans public bailouts of a broad
range of derivatives dealing activities. This ban would require
Federally supported banks to transact their derivatives dealing
business in separate corporations, not guaranteed by the banks. H.R.
992 weakens this section enormously by greatly increasing the types of
swaps dealing activities that are exempted from the Section 716 ban on
public bailouts of derivatives dealing. It would significantly expand
the range of derivatives dealing that insured depository institutions,
the banks most susceptible to public bailout, would be permitted to
engage in and to fund. It is truly remarkable that only a few years
after the bailout of AIG and the public support provided to derivatives
dealing at numerous Wall Street banks, that we would see a proposal
that allows additional public bailouts of Wall Street derivatives
activities. Yet this is exactly what H.R. 992 would do.
Opposition to Section 716 is really an issue of cost. The Section
716 ban on public support would effectively require the affected
institutions to separately capitalize subsidiaries to engage in
derivatives dealing. We do not dispute that it would be cheaper for the
banks to support this business using the cheap funding available
through insured deposits. But that is because the public is forced to
subsidize the cost of their capital because the failure of the banks
would be potentially damaging to the public at large. The real question
here is whether the public should subsidize these derivatives
businesses. AFR and many others believe that the public should not. If
these businesses cannot be done profitably without taxpayer subsidy,
they should not be done.
It may be argued that the increased cost of capital will adversely
affect pricing for derivatives market participants. This argument is
superficial, especially in its implication that costs will increase on
a dollar-for-dollar basis. However, to the extent the elimination of
the subsidy increases cost, taxpayers generally will be benefited from
the reduction of the subsidy. The Federal Government can always affect
prices by granting taxpayer subsidies to any business. The use of
subsidies in this area is a particularly dubious policy.
Any other result distorts the markets and constitutes a drag on the
economy. The subsidized derivatives business has been immensely
profitable for the banks. It has been estimated that devoting capital
to support derivatives has been ten times more profitable than the use
of that capital to support lending to American businesses and
governments.\5\ That figure is completely consistent with statements
made to me by derivatives professionals. This is completely
inconsistent with an efficient and transparent marketplace.
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\5\ Corporation for Public Broadcasting, Frontline, ``Money, Power
and Wall Street,'' Episode 1, Remarks of Christopher Whalen, available
at http://video.pbs.org/video/2226666502.
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Margin Requirements
The stated purpose of H.R. 634, entitled the ``Business Risk
Mitigation and Price Stabilization Act,'' is ``To provide end-user
exemptions'' from certain provisions of the Dodd-Frank Act. Those
provisions deal with margining of swaps that are exempted from the
clearing requirement. The collateralization of uncleared swaps is a
vital area for the safety and soundness of both non-bank derivatives
entities and for banks with extensive derivatives activities.
It is vital to understand that margin is collateral for real, not
``technical'' or imagined, extension of credit. If a swap moves out-of-
the-money for a counterparty, the opposite counterparty is just as
exposed to the credit of the out-of-the-money counterparty as if money
had been loaned.\6\ Variation margin collateralizes this credit
exposure. But that is insufficient. The credit exposure is uncapped, so
it can grow between the time variation margin was last posted and the
time that a counterparty can react to the default of its opposite
counterparty. Initial margin collateralizes that additional credit
risk.
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\6\ Mello, A, and Parsons, J., ``The Collateral Boogeyman--
Packaging Credit Implicitly and Explicitly,'' October 2010, available
at http://bettingthebusiness.com/2010/10/.
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The bill would eliminate the authority of the CFTC and the SEC to
require swap dealers and major swap participants who are not banks to
include margining requirements for swaps affecting commercial end-
users. This is unnecessary. The agencies have already elected not to
require margin for uncleared swaps that originate from a non-financial
end-user.\7\ Not only is it unnecessary, it is potentially dangerous.
Should the agencies discover in the future that unmargined swaps from
commercial end-users create a risk to the safety and soundness of non-
bank swap dealers, they may wish to reassess elements of their current
rules. This statutory change prevents them from doing so.
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\7\ CFTC Proposed Rule, Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 76 FR 23732, available at
http://cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_5_CapMargin/
index.htm; SEC Proposed Rule, Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-Based
Swap Participants and Capital Requirements for Broker-Dealers, 78 FR
4365 available at
http://www.sec.gov/rules/proposed.shtml.
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But the bill goes further. It may affect the ability of Prudential
Regulators from requiring that banks set a limit on the amount of
credit extended to commercial end-user customers under derivatives
before margin collateral is required. The Prudential Regulators have
likewise not required margin of commercial end-users in most
circumstances, but they have required a bank-set credit limit to the
extent of unmargined derivatives.\8\ While technically, there is no
limit to the credit loss if prices run away from the bank before the
derivative position can be covered, this would at least limit the
likely amount of credit exposure. The Prudential Regulators do not
impose a credit limit; they simply require the bank to set one as an
exercise of basic prudence.
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\8\ 76 FR 2764, Proposed Rule, Margin and Capital Requirements for
Covered Swap Entities.
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I would note that this bill does appear to be drafted fairly
narrowly, striking only at Dodd-Frank authorities for margin
requirements for non-financial end-users, and apparently not affecting
authorities to require capital under Dodd-Frank or prudential
authorities outside of Dodd-Frank. While we still believe the bill is
at best unnecessary and at worst harmful, the narrow crafting of the
bill is positive and must be preserved if this legislation is to move
forward. It is critical that the exemption proposed in this bill does
not affect the authority of Prudential Regulators to set reasonable
credit limits in all cases, including the derivatives markets, and also
that it does not affect the ability to require appropriate capital.
That authority is critical to bank regulation. It also benefits end-
user customers, who for their own safety should not incur excessive
levels of concealed debt through derivatives exposures.
Cost-Benefit Analysis
The stated purpose of H.R. 1003 is ``To improve consideration by
the Commodity Futures Trading Commission of the costs and benefits of
its regulations and orders.'' This proposed legislation would
unnecessarily add numerous additional requirements to the already
existing statutory cost-benefit requirements for the CFTC. These
requirements could effectively paralyze the CFTC's ability to implement
laws passed by Congress to safeguard our financial system. The rules
affected would range from those designed to prevent excessive
speculation that drives up prices for gas and other commodities to
derivatives oversight necessary to prevent the repeat of a crisis like
that of 2008.
The requirement for consideration of costs and benefits should not
create an opportunity to reconsider the decisions made by Congress.
Congress enacted a comprehensive regulatory regime that is intended to
serve the interests of the public by making the derivatives markets
more transparent, fairer and safer. The CFTC has finalized 40 rules
implementing Dodd-Frank and 20 more remain to be finalized. Each has
its own benefits and each is beneficial as part of a mosaic of
financial reform. The steps that are required in the bill for each
element of each rule envision a reconsideration of those decisions,
first by the agency an then by the Courts on review. This is an
inappropriate balancing of the branches of government and does not
serve the public's interests.
Existing law (Section 15(a) of the Commodity Exchange Act) already
requires the CFTC to consider the costs and benefits of regulatory
action before issuing a new regulation. Existing law also requires the
agency to consider the effects of any new regulation on the efficiency
and competitiveness of the markets it supervises. In addition to such
consideration, prior to any rulemaking the CFTC must consult
extensively with industry and other interested parties who submit
comments to the agency. Over the last 2 years the CFTC has collected
and reviewed thousands of public comments and held numerous public
round tables on Dodd-Frank rules.
H.R. 1003 would add numerous additional requirements to these
already extensive procedures. It would also force the agency to measure
costs and benefits of a new rule before that rule was even implemented
or market data resulting from the rule was available. The new
requirements imposed by this bill also include enormously broad and
vague mandates such as determining whether a regulation imposes the
`least burden possible' among all possible regulatory options. A court
could overturn the CFTC's decision in any case where it found any one
of the numerous analyses required here to be inadequate. The vagueness
of mandates like the `least burden possible' means that court
challenges or court decisions could rest on claims that are essentially
speculative and theoretical. These new mandates would not increase the
quality of the regulatory process, they would stop it in its tracks,
These extensive new procedural requirements are being proposed even
as the CFTC is being starved of the resources it needs to do its job.
The massive new requirements added by H.R. 1840 would make the problem
much worse. Any attempt to improve the analytic capacities of the CFTC
and its capacities to assess the effectiveness of its rules must start
with additional funding, not with piling on unnecessary additional
mandates and requirements that will trigger additional litigation.
Swap Dealer Business Conduct Standards and Dealer Registration Rules
Applicable to Governmental Entities
The stated purpose of H.R. 1038 is ``To provide equal treatment for
utility special entities using utility operations-related swaps, and
for other purposes.'' This is a subject near and dear to my heart since
I devoted most of my professional career to assistance of governmental
enterprises in their capital-raising activities. Section 731 of the
Dodd-Frank Act imposes enhanced business conduct standards on swap
dealers transacting with ``special entities,'' a term that includes
state and local government agencies and Federal agencies. H.R. 1038
would carve out governmental electricity and gas utilities and Federal
power marketing agencies. I suppose the ``equal treatment'' that is
called for by the bill means equal treatment with far more
sophisticated corporations rather than equal treatment with other
governments and their agencies and instrumentalities.
In my career, I have had the uncomfortable opportunity to witness
sales calls by derivatives specialists on governmental utilities. I
have seen the technique of fostering a sense of trust, encouraging an
advisory relationship that can be exploited to sell an immensely
profitable derivative when other alternatives could be better. I have
also seen the influence that can be brought to bear through politicians
who have appointment power with regard to these utilities. Too often,
derivatives can be structured to disguise debt from the public, a
tempting alternative for officials who are concerned with public
opinion.
As pointed out earlier, even the most sophisticated financial
institutions struggle with evaluating the risks associated with
derivatives. It is completely unreasonable to expect that governmental
utilities will have the ability to measure the risks of derivative
transactions. This is especially so given the massive incentives of
swap dealers to ingratiate themselves as functional advisors and
obfuscate the costs and risks and the complex influences on public
servants. This means that registered swap dealers must be constrained
in their dealings with governmental utilities. Their business conduct
standards should be enhanced, not undercut. They are at a major
disadvantage in negotiating with swap dealers and the public's interest
is in rectifying this imbalance, not facilitating it.
It also means that firms that specialize in work with special
entities, including governmental utilities, should register as swap
dealers even though their business volumes are lower than the general
registration thresholds. Special entities need the protection of swap
dealer registration more than the typical market participants.
Interaffiliate Rules
H.R. 677, ``The Inter-affiliate Swaps Clarification Act'' would
create a broad and sweeping exemption to Title VII margin, capital,
clearing, and execution requirements between affiliated entities, so
long as neither entity is an insured depository bank. ``Affiliated'' is
defined broadly, as any two entities that do financial reporting on a
consolidated basis.
This bill is ignores the careful work performed by regulators in
making expert judgments concerning the implementation Act. The
supporting materials for this bill claim that inter-affiliate swaps do
not create systemic risk, and also that the Dodd-Frank Act should
exempt them but does not. Yet the CFTC, in a lengthy and carefully
reasoned proposal on the regulation of inter-affiliate swaps, outlined
numerous ways in which inter-affiliate swaps can in fact create
systemic risk. In addition, the CFTC proposal creates a balanced
approach which partially exempts inter-affiliate swaps from some Title
VII requirements while still retaining basic requirements for risk
management, a limited use of margin to back swaps trades, and clearing
in appropriate cases. Indeed, Americans for Financial Reform criticized
the CFTC proposal for relaxing Title VII requirements excessively.
H.R. 667 would replace this framework with a sweeping and
excessively broad exemption that would effectively leave inter-
affiliate swaps completely unregulated under Title VII, with the
exception of some reporting requirements.
The bill includes a number of limiting clauses restricting the
effect of these exemptions on prudential regulation and insurance
regulation. Last year Prudential Regulators insisted that these clauses
be added to the prior version. This is because the control and
regulation of inter-affiliate transfers of risk has been at the center
of both banking and insurance regulation for over 50 years, since the
passage of New Deal financial regulations and the passage of the Bank
Holding Company Act. Of course, swaps are one of the most direct and
effective ways to transfer risk. The centrality of the regulation of
inter-affiliate risk transfers to oversight of large financial
institutions should tell us that it is deeply misguided to completely
exempt inter-affiliate transfers from the Title VII framework.
Maintaining some of the basic requirements of Title VII for inter-
affiliate swaps while granting exemptions only in the areas where it is
appropriate, as the CFTC has recommended, is the correct approach.
* * * * *
Thank you for the opportunity to provide the foregoing testimony. I
hope that it is useful for your deliberations.
The Chairman. Thank you, sir.
I now recognize myself for 5 minutes, and I direct my first
question I guess to Mr. Bentsen and Mr. Naulty. The derivative
markets touch virtually every aspect of the economy, the food
we eat, the price at the pump, our mortgages, credit cards, our
retirement savings. With this in mind, do you think the CFTC
rulemaking marathon since Dodd-Frank became law, are inherently
flawed due to the lack of sufficient cost-benefit analysis?
Mr. Bentsen. Thank you, Mr. Chairman, for the question. I
don't know that I would go as far as to say they are all
inherently flawed, but I think they are missing a key component
in how you craft the rule as other departments and agencies
either under statute or in adherence to the President's
Executive Order look at how that rule is going to be crafted,
what the cost, what the benefits are. And our view is that we
don't really have an understanding as to what that is with
respect to the CFTC rule proposals.
And so the whole idea behind cost-benefit analysis is to
really help guide the agency in that rulemaking and to come out
with what works best in trying to achieve that balance. So that
has not been the case with the CFTC.
The Chairman. Mr. Naulty, would you like to add anything to
that?
Mr. Naulty. I share my colleague's concerns as it relates
to the public power entities. The benefits are dubious, if any,
for the treatment that we are receiving to classify us as a
special entity solely because of the fact that we are a public
entity doesn't recognize the fact that we manage the same risks
in the same markets as our colleagues in the investor-owned
utility space. We are very capable of managing and understand
those risks, and although we have worked with the CFTC to make
them aware of these concerns, we have not seen, and they have
taken some action, we have not seen the end benefit that we
need, which is this exemption that we are asking for.
The Chairman. Speaking of that, Mr. Naulty, in your
testimony you stated CFTC's no-action letter in response to
your industry's petition to eliminate the special entities
threshold has not given your would-be counterparties enough
confidence to resume doing business with public power
utilities.
Do you think our bureaucrats having essentially eliminated
an avenue for which you have to manage your risks, do you think
your regulators up here really know how better to run your
business in Owensboro than you do?
Mr. Naulty. Well, I think that is a risk, Congressman,
Chairman, that you get when you use a broader brush to paint
over an issue like this, and we certainly understand how to run
our business. You know, we are watching out for our ratepayers
and to take away this avenue that we have used traditionally,
and by the way, the way the market is designed, it was designed
to allow and promoted the use of swaps in order to provide
price certainty both for buyers and sellers in these RTO
markets.
I think we do understand our business, and we can manage
our own risks on an even playing field with investor-owned
utilities.
The Chairman. Mr. Bentsen, one last question. I understand
there is what might be described as a brewing disconnect
between the U.S. and the EU on the Basel III derivatives rules.
Could you expand on this developing issue and the potential
impact on U.S. financial institutions?
Mr. Bentsen. Yes.
The Chairman. And users for that matter.
Mr. Bentsen. Yes, Mr. Chairman. This is--and I mentioned in
my oral testimony, the European Union is in the process of
finalizing the adoption of their implementation of Basel III,
which is the international capital accords that the U.S., all
of the G20 countries have agreed to implement. The U.S. is
going through its own rulemaking, principally through the
Federal Reserve to implement Basel III capital standards.
The European Union's proposal, which is called CRD-4,
Capital Regulation Directive 4, would exempt swaps between EU-
supervised banks or dealers who are otherwise subject to the
Basel III requirements under the EU supervision, with swaps
that they engage in with EU non-financial end-users as it
relates to something called the credit evaluation adjustment.
So it is an advanced methodology for establishing a capital
requirement against that swap.
What that means is that for swaps, if this goes to
fruition, which it appears that it will, what that means is
that the capital charge that EU-supervised banks would have to
take to engage in a swap with an EU non-financial end-user
would be different and less than a non-EU bank, that could be a
U.S. bank, an Asian bank, a Canadian bank, and engaging with
those EU end-users, and frankly would be a disadvantage
presumably to non-EU end-users as well in terms of a
competitive disadvantage.
I think the other, and let me say, there is a problem with
the CVA calculation, the calibration. No question about that,
and I think that is why this happened, but importantly this
results in a further fragmentation of trying to have a uniform
standard set across the G20 countries, and in this case in the
Basel Rule. So this is a real problem that we believe U.S.
regulators and global regulators to the Basel Committee at the
National Stability Board and others need to engage on.
The Chairman. Thank you. My times has expired.
The chair now recognizes the gentleman from Georgia for 5
minutes. Mr. Scott.
Mr. David Scott of Georgia. Thank you, Mr. Chairman.
Mr. Bentsen, let me start with you. Concerning extra-
territorial application of the Dodd-Frank rules, I gathered in
your testimony that you have concerns with that, and I would
like for you to tell us the most negative consequences that you
see for the marketplace if Congress doesn't address this.
Mr. Bentsen. Well, I think there are multiple negative
consequences, Mr. Scott. Number one is you have in this interim
period where the CFTC came out with its guidance and really in
our views go ahead of the curve not waiting to do this with the
SEC, which is still in a rulemaking process. Remember, this is
something where this pivots off of the definition of what is a
swap, what is a swap dealer, which was a joint rulemaking as
prescribed by Congress under the Act and yet the CFTC went on
its own to do this without doing it in a joint rulemaking with
the SEC.
But also it got out in front and we believe in lack of
coordination with our other regulators around the globe as was
talked about with Chairman Gensler earlier today, and that has
created conflict not just with those regulators, but it has
created conflict in the marketplace, and I think you referenced
this in your comments, Mr. Scott. I was actually in Tokyo on
October 12 when the first instance of swap requirements were
going to take effect at the World Bank and IMF meetings with a
program with the Japanese Security Dealers Association. And at
that time I was hearing from both U.S. and non-U.S. firms that
they were getting pushback from non-U.S. swap dealer
counterparties who hadn't, that they weren't clear whether they
would deal with someone who is registered as a swap dealer.
So it created a market fluctuation that didn't need to
exist, and that continues to happen.
The second thing I would say is you have a potential for
redundancy and conflict between U.S. and non-U.S. rules where
it is not clear who will be required, who will be subject to
those rules and whether or not some dealers will be subject to
duplicative or redundant rules which has no question will have
a price in competitive impact.
So I think there are a number of things that come out of
it. One is market fluctuation. The other is complexity and
redundancy and conflict.
Mr. David Scott of Georgia. All right. Thank you very much.
Mr. Thompson, let me ask you, you talked about the
indemnification not being a legal concept as respected by
foreign jurisdictions, and could you share with us why in H.R.
742 we need to make this change, and if we don't, what those
consequences would be? How does that indemnification not being
accepted by foreign jurisdictions have a negative impact?
Mr. Thompson. Thank you, Congressman Scott. First,
indemnification basically comes out of U.S. common law tort
law, and a lot of foreign jurisdictions follow civil law,
especially in Europe so that is a concept that they simply
don't have. But just here in the U.S. a lot of foreign
governments just like we do not allow our governmental
authorities to actually indemnify each other. The SEC, when
they testified on this issue, actually said that if they had to
indemnify a foreign regulator, they couldn't because U.S. law
would not allow them to do it. So if they had to indemnify the
CFTC in order to get information, they couldn't do it, which is
one of the reasons that they came out in favor of a legislative
solution here.
We think, as I have said and testified before, that the
best way to assure that these global markets continue to stay
global and you don't have local solutions to deal with this
issue, is to do away with any impediments or fragmentation, and
we see indemnification as an impediment to the globalization of
the market.
Mr. David Scott of Georgia. I just have to get one more
little question in. There have been scores of economists that
argue that excessive speculation in commodities derivatives has
been a driving factor in recent radical price swings and market
uncertainty, and I am hearing a lot of this from our main
street businesses.
Do you all believe that excessive speculation is a factor
behind the kinds of price swings that we have seen over the
last 5 years?
Start with you, Mr. Bentsen. Do you believe that?
Mr. Bentsen. Yes. There has been a lot of academic research
in this area, Congressman, over whether or not, to what effect
does market speculation impact price, and this goes to the
whole question of position limits, and Chairman Gensler talked
about that before.
And we can talk about the rule itself and why we had
problems with it, and that gets really more to cost-benefit,
but I think what is important is the academic research is quite
frankly inconclusive as to the material impact of speculation
on actual price. I think that is something that regulators, not
just in the U.S. but globally, because the other thing we have
to remember is commodity markets you all know better than we,
commodity markets are global markets, and they are impacted by
various global factors, and that is another thing that has to
be taken into consideration.
Mr. David Scott of Georgia. Thank you very much, Mr.
Chairman.
The Chairman. The gentleman's time has expired.
The chair recognizes himself for a motion.
Without objection I would like to submit the following
letters for the record, the first from the U.S. Chamber of
Commerce supporting H.R. 992, a second from the Illinois
Chamber of Commerce supporting H.R. 992, third, a February,
2013, letter from the Japanese Financial Services Agency to the
CFTC expressing their concerns about cross-border rules.
Seeing no objection, so ordered.
[The information referred to is located on p. 115.]
The Chairman. With that I now recognize the gentleman from
California, Mr. LaMalfa, for 5 minutes.
Mr. LaMalfa. Thanks, Mr. Chairman.
One question for Mr. Naulty there. First, Owensboro, isn't
that the home of the Waltrip family there?
There is a second question but----
Mr. Naulty. Congressman, I am not a NASCAR fan, so I don't
know the answer to that question unfortunately.
Mr. LaMalfa. Well, okay.
Mr. Naulty. But I do thank you for your leadership and your
sponsorship of our legislation.
Mr. LaMalfa. The Waltrips would probably like me to sponsor
them somehow, but, anyway, I just wanted to drill down a little
more on that no-action letter that you mentioned in your
comments there, which as you mentioned added additional
requirements. Does that letter really inspire the confidence
that you need to go forward or that your counterparties would
as well, which we are gathering it doesn't.
Mr. Naulty. Well, I think the answer to your question,
Congressman, is that the proof is in the pudding, and while the
no-action letter has been in place for quite some time, we have
not seen any counterparties come back, and part of the reason
is because of the uncertainty around some of the additional
requirements and what the CFTC decided, tried to clarify in
that letter but mostly because of the compliance risk that
those counterparties perceive they would be burdened with. The
compliance risk is that if they continue to do business with
special entities and somehow trip over the threshold level,
they would be pulled in as a swap dealer, and rather than
putting in the systems and risk controls within their
organizations, many of which are not large swap dealers, we are
talking utility-affiliated trading companies, that cost-benefit
just doesn't work for them. And so the easiest thing for them
to do is to just not trade with special entities.
Mr. LaMalfa. Limiting options. Yes. Maybe we could follow
up later and talk about some of those specifics, those
requirements, but additionally, I would like to find out the
largest municipal utility in my district has a little under
45,000 customers, and we have been talking, and they are
expecting that the reporting requirements under Dodd-Frank are
going to require additional staff and costs that, again, a
fairly small utility like the one where I am from can't really
bear.
I wondered what you might be able to share with us on the
effects with Owensboro there.
Mr. Naulty. Well, the reporting requirements are actually
the requirements that would be imposed on the swap dealer, and
while there are additional reporting requirements for us as
municipal utilities, due to the fact that we do transactions
that involve swaps, they are not nearly as onerous as those
that would be imposed on entities that are trying to avoid
being swap dealers.
There is a compliance burden. Make no doubt about it for us
and for all APPA members that use these derivative markets. We
have not quantified exactly how many headcount we are going to
have to add, but clearly there is an additional compliance
burden for us.
Mr. LaMalfa. But an even bigger deterrent for your
counterparties there that in a spectrum of things that are
going to drive their costs and probably not----
Mr. Naulty. Yes.
Mr. LaMalfa.--as likely to do business with you then.
Mr. Naulty. Correct, and as it drives their costs, then
they become less competitive as a supplier or a buyer of our
products. You know, the real issue for us is that these are
costs that are being imposed on our business. The inability to
access the markets in an equal way as our investor-owned
utility counterparties and those costs, we have no other choice
but to pass those through to ratepayers, and there is really no
systemic risk and no benefit to the ratepayer for this penalty.
Mr. LaMalfa. Now, we haven't seen where the risk has been a
problem for utilities in this process here, so, well, maybe
just make it up in volume.
Thank you. I yield back my time.
The Chairman. The gentleman yields back.
The chair now recognizes the gentleman from Georgia, Mr.
Scott, for 5 minutes.
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
Ma'am, Gentlemen, thank you for being here today, and Mr. Colby
and Ms. Hollein, I, along with many of my colleagues, both
Democrats and Republicans, have cosponsored H.R. 634, very
similar to the bill that passed the House of Representatives
last year, 370 to 24, that allowed end-users who qualified for
the clearing exemption to also qualify for the margin
exemption, basically making sure that the cost of the margin
exemption is only used where a systemic risk to the financial
markets is.
Secretary Gensler gave an indication earlier today that he
was supportive of that and that he thought that a rule would be
coming forward that would be very similar to that.
My question for you is have you heard any timeline on that
particular rule, and could you just explain briefly why it is
so important to allow end-users to be exempt from the cost of
the margin requirements?
Mr. Colby. Do you want me to start?
Mr. Austin Scott of Georgia. Yes, sir. That is fine.
Mr. Colby. Sorry. We haven't heard of a very specific
timeline being provided. Although the CFTC has indicated in
their preliminary ruling that they are supportive of commercial
end-users not being required to post margin, the proposed rules
by the Prudential Regulators is very troublesome, and even if
the final rules don't require end-users to post initial margin
and if they are high thresholds for variation margins, there
are not assurances that in the future those rules might not
change and be imposed upon us.
The bill does provide such certainty, and it should be
noted that Chairman Bernanke has on the record in front of the
Senate Banking Committee indicated that he would be supportive
of such an explicit exemption for end-users.
Ms. Hollein. Congressman, I agree with Mr. Colby as far as
the margin requirements. The issue is most non-end-users really
hedge for the sake of mitigating their risk, especially on the
inter-affiliate agreements. It is just centralizing and more
treasuries have moved towards the centralization process. It is
the best practice to just be more efficient. It does not cause
systemic risk or counterparty risk. If you think about it, the
end-users only make up as Chairman Gensler mentioned, nine to
ten percent of the swap market.
The objective of corporates are really just to mitigate
their risk and try to efficiently manage that risk and look at
the portfolio. My fear is if there is this margin requirement
that it will cause companies to move away from it and not
manage their risks, thereby increasing their risk in the
marketplace.
Mr. Colby. In terms of the cost side of that question,
diverting cash flow from a company's business operations where
we can create jobs and protect jobs and generate a good return
for shareholders is very costly. There is a high-opportunity
cost that in our opinion outweighs the small credit mitigation
benefits of posting margin.
As Chairman Gensler indicated, commercial end-users
represent nine percent of the OTC market, but we create 94
percent of the jobs. So the margin bill is going to very
slightly impact the 90 percent but potentially significantly
impact the 94 percent, which is the one that I think that we
care about.
Mr. Austin Scott of Georgia. Yes, sir, and Mr. Colby, you
bring up an important point there, and 27 months ago I was in
the private sector, and you used two words up here that we
don't hear much from regulators, and that is cash flow, and
certainly in the private sector we can't use the same dollar
twice at the same time, can we? And that it----
Mr. Colby. No, we can't.
Mr. Austin Scott of Georgia. And I think that is where the
real issue comes in and where we can help America's economy by
making sure that the end-user is not subject to that extra cost
because every dollar that is locked up is a dollar that can't
be used to expand your business and put Americans back to work,
and our goal is to help you get Americans back to work.
So thank you so much, and Mr. Chairman, I yield the
remainder of my time.
The Chairman. The gentleman's time has expired.
Mr. David Scott of Georgia. Mr. Chairman.
The Chairman. Does the gentleman have a request?
Mr. David Scott of Georgia. Yes. I would like to ask for 1
minute if I could. I wanted to get Mr. Turbeville's response to
my question on speculation.
The Chairman. Seeing no objection, the chair yields the
gentleman 1 minute that he therefore yields to the witness.
Mr. David Scott of Georgia. Thank you very much, sir.
Mr. Turbeville. Thank you. The question really is about
speculative activity in the futures and swaps markets as it
relates to prices on delivery swap prices, and the connection
between the two has to do with the fact that in the futures
market or in the swaps market you are creating a forward curve
which is the expectation that prices are going to rise, fall,
or stay the same.
There is no question that if speculative activity changes
the forward curve for prices it will change spot prices. For
instance, if it appears that the prices are going to rise over
time, then spot prices will go up as well as people withhold
from the market waiting for the prices to rise later. If prices
are going to fall, people will put more supply into the market.
So there is no question about that.
My colleague here, Mr. Bentsen, said there were many
studies that didn't find any connection, and that is like
saying that there are many studies that didn't find Pluto until
they found Pluto. Once you find Pluto, you got Pluto, the
planet, not the dog.
So there have been studies that have found connections. I
participated in one that found a connection, and my particular
study that I looked at asked the following questions. Commodity
index funds, if you are familiar with those, which there is
these huge commodity index funds that sort of die and recreate
themselves every month in effect. So all of their futures get
sold off, then they buy longer-dated futures, and what we took
a look at is whether there was a connection between that period
where they do that lengthening of their positions and they put
pressure on the out-years, does that actually cause the forward
curve to go up, or does it have an influence on the forward
curve going up? And we found that for several commodities, oil,
some of the grains there was a correlation of 99.9 percent of
that rollover period with upward movement pressures on the
forward curve. Upper movement pressures on the forward curves
means the spot prices are likely to go up.
So the answer is there has been some good work done on it.
It is hard to measure, but there has been a measurement of it,
and I think that the real conclusion should be perhaps it is
how much speculation but the easier thing to find the
connection with this is what kind of speculation. If you do
something every month that pushes, puts pressure out on the
forward curve causing it to go up, then you are going to affect
spot prices.
Mr. David Scott of Georgia. Thank you.
The Chairman. The gentleman's minute has expired.
The chair now recognizes the gentleman from Tennessee, Mr.
Fincher, for 5 minutes.
Mr. Fincher. Thank you, Mr. Chairman. Following up with
that, when you said the rollover, are you talking about getting
out of the positions and getting longer positions in the
market?
Mr. Turbeville. That is correct. What happens is a bank
like Goldman Sachs, which is one of the major players, has done
a swap with somebody like a pension fund or a university fund,
and the swap is all about the price of futures.
Mr. Fincher. Right.
Mr. Turbeville. And what they are doing is they are
financializing. They are creating a synthetic ownership of oil,
corn, wheat, soybeans, everything else. Synthetic ownership on
the part of these funds. But to create the synthetic ownership
the bank then has to go out into the market and----
Mr. Fincher. Right.
Mr. Turbeville.--replicate that and roll it over every
month.
Mr. Fincher. To stay in the market. To stay----
Mr. Turbeville. That is right. So futures expire. This is
like ownership which is permanent. So what happens is that the
rollover puts pressure on the out-years of the market, which
causes, the technical term is causes the forward curve to go
more into contango, being more forced up, and that has an
effect on prices because people price over next month's forward
price, and they have index contracts, Platts, who has oil price
index, references that contract, and just commonsense tells you
that you are going to look out there. And I am actually from
Tennessee.
Mr. Fincher. All right. Well, the issue I have, and I have
a couple of questions for Mr. Bentsen and Ms. Hollein also, but
the two words and being from the private sector and a large
family farm background and have done a lot of marketing and
used derivatives often, is are the unintended consequences that
go with more government and more regulation, and the things
that it will do to the market as we are starting to learn as we
get into Title VII even more.
If you, in my opinion, again, knowing the details of a lot
of this, if you try to take all of the risks out of the market,
then you have no market. You will destroy the market
completely, and there is a certain amount of risk that you are
going to have. We have to take positions on everything now to
make sure we are hedged in order to stay in business.
But to Mr. Bentsen, section 716 would negatively affect
uninsured depository institutions such as many foreign banks
that operate branches in the United States.
Would the credit availability from these institutions be
impacted if section 716 is fully implemented, and why or why
not?
Mr. Bentsen. Mr. Fincher, I think that the biggest problem
with section 716, I will come back to your point, in our view
and I think this is where Chairman Bernanke is coming from and
I think this is where then Chairwoman Bair was coming from is
that you are taking capital out of the bank, and you are
putting it into an affiliate and shifting part of the activity
which otherwise has been under their jurisdiction and
prudential jurisdiction and supervision. And so you are
depleting, one, you are depleting capital from the entity that
you are regulating, and then you are creating a separate
affiliate that you may not have primary supervision over.
And so I think that is where their primary concern is. So
that is why on the whole our view is that section 716 and their
view is that section 716 doesn't work and doesn't make sense,
and I might just add, one thing that Chairman Gensler said that
he thinks it is probably going to come into effect in a year or
in 2 years. It actually is supposed to come into effect on July
21 of this year, but there has been no proposed rulemaking, and
in fact, the OCC just recently put out a request, sort of
guidance with the request for firms who would be subject to it
to ask for an extension. They do have a conformance or an
extension period.
To your point with respect to the foreign banks, the
foreign branch operations, the way the law was crafted is that
it applies to insured depository institutions. So if you are a
foreign bank branch or agency that is not operating an insured
bank in this country, then it is not at all clear how you are
affected by this rule or not if you read literally off the
statute. The Federal Reserve has some flexibility under some
existing statutes, but it is not clear that they can make an
adjustment.
But I think the main point is that this is something that
causes depletion and shift of capital and really moves things
out of more primary jurisdiction. Congress at the end kind of
split the thing in half with some swaps in, some swaps out, and
it really doesn't make any sense. And so that is why I think
you are seeing the principle regulator saying this ought to be
fixed.
Mr. Fincher. Will H.R. 992 provide the fix?
Mr. Bentsen. Yes. I think so.
Mr. Fincher. Okay, and one more follow-up question to Ms.
Hollein. Do you think end-users pose a systemic risk?
Ms. Hollein. Do I think they cause systemic risk?
Mr. Fincher. Do they pose a systemic risk to U.S. financial
institute?
Ms. Hollein. No. I do not believe they do at all. In fact,
they are just mitigating their risk. They don't cause any
systemic risk at all.
Mr. Fincher. Okay. I yield back, Mr. Chairman. Thank you
very much.
The Chairman. The gentleman yields back the balance of his
time. That concludes our questions.
I would like to note for my colleagues that this has been a
very worthwhile hearing. These are very important subject
matters, and I would expect some time in the very near future
we will move towards a legislative markup.
With that 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 question posed by a Member.
This hearing of the House Agriculture Committee is
adjourned.
[Whereupon, at 12:30 p.m., the Committee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Letters by Hon. Frank D. Lucas, a Representative in Congress
from Oklahoma
March 13, 2013
Hon. Randy Hultgren, Hon. James Himes,
U.S. House of Representatives, U.S. House of Representatives,
Washington, D.C.; Washington, D.C.;
Hon. Richard Hudson, Hon. Sean Patrick Maloney,
U.S. House of Representatives, U.S. House of Representatives,
Washington, D.C.; Washington, D.C.
Dear Reps. Hultgren, Himes, Hudson, and Maloney:
The U.S. Chamber of Commerce, the world's largest business
federation representing the interests of more than three million
businesses and organizations of every size, sector, and region,
supports H.R. 992 and S. 474, the Swaps Regulatory Improvement Act.
This bipartisan, bicameral legislation would serve to promote vibrant
and efficient capital markets by modifying section 716 of the Dodd-
Frank Act, a provision that undermines the Act's central policy
objective of mitigating systemic risk.
When section 716--often referred to as the swaps push-out
provision--was enacted, its proponents described it as ``quarantining
highly risky swaps activity.'' The provision attempts to accomplish
this objective by requiring that insured depository institutions spin-
off certain derivatives activities (e.g., commodity derivatives that
agricultural market participants use to reduce risk) into separately
capitalized affiliates of an insured depository institution.
However, contrary to its objectives, section 716 would increase
risk for derivatives market participants, while at the same time
driving up costs. It would do so by requiring market participants to
transact with multiple entities within the same banking organization,
which would create new risks for market participants because it would
eliminate their ability to net multiple contracts into a single
obligation. Additionally, it would add cost and complexity by requiring
market participants to put in place multiple agreements and make
multiple settlements on their derivatives transactions.
Such outcomes would disrupt aspects of the derivatives market that
work well and that played no role in the financial crisis. Indeed,
market participants have implemented these practices to reduce risk.
Additionally, section 716 would weaken prudential regulation by
shifting activities to entities that are not prudentially regulated.
These are among the reasons international regulators have refrained
from introducing or implementing similar provisions in their own
regulatory regimes. Now more than 2\1/2\ years since Dodd-Frank was
enacted, no government has followed America's lead in implementing a
provision like section 716. Consequently, while serving no useful
function, the provision threatens to undermine the competitiveness of
U.S. capital markets.
The Chamber supports the Swaps Regulatory Improvement Act and looks
forward to working with the Congress to ensure the U.S. maintains its
position as the world leader in fair, efficient, and innovative capital
markets.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
R. Bruce Josten.
Executive Vice President, Government Affairs,
U.S. Chamber of Commerce
______
March 7, 2013
Hon. Randy Hultgren,
U.S. House of Representatives,
Washington, D.C.
Dear Congressman Hultgren:
The Illinois Chamber of Commerce is writing in support of H.R. 992,
a bipartisan bill that will help promote bank safety and soundness,
limit the risks and costs associated with bank failure, and reduce
Illinois businesses and agriculture producers cost of managing risk. We
thank you for taking the lead on this important issue.
The Dodd-Frank ``push-out'' provision (Section 716), would prohibit
bank entities from engaging in certain derivatives activities within
the bank. By forcing these activities out of the bank, it complicates
bank risk management activities and increases the cost of a potential
bank resolution.
For these reasons, several current and former bank regulators,
including Federal Reserve Chair Ben Bernanke, former FDIC-Chair Sheila
Bair, and former Federal Reserve Chairman Paul Volcker, expressed
concerns with this provision of Dodd-Frank.
Your bill will reduce these risks, while at the same time, ensuring
that banking activities cannot engage in the riskiest types of
derivatives activities. By doing so, it achieves a common sense balance
of allowing banks to service their customers' needs, while protecting
bank safety and soundness. For this reason, we commend you on this
bipartisan legislation.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Todd Maisch,
Executive Vice President,
Illinois Chamber of Commerce.
______
February 6, 2013
Hon. Gary Gensler,
Chairman,
U.S. Commodity Futures Trading Commission,
Washington, D.C.
Re: Further Proposed Guidance Regarding Compliance With Certain Swap
Regulations
Dear Gary,
We appreciate the opportunity to comment on the further proposed
guidance regarding compliance with certain swap regulations. We are
writing to ask the Commission's consideration of our general and three
specific comments with respect to (i) exclusion from aggregation of
U.S. and non-U.S. affiliates' transactions with U.S. persons for the
purposes of the de minimis test for a non-U.S. person, (ii)
clarification of the scope and definition of U.S. person, and (iii)
flexibility in the expiration of the final exemptive order.
I. General Comment
We appreciate the Commission's effort to provide market
participants with as much clarity as possible on (i) the aggregation
rule for de minimis threshold for a non-U.S. person and (ii) the scope
and definition of U.S. person in the final exemptive order published on
December 21, 2012. However, we are concerned that the alternative
interpretation on the aggregation rule and the scope and definition of
U.S. person in the further proposed guidance would make the scope of
application of the Commission's regulations broader for non-U.S.
persons. Since we believe that the scope of application on those two
matters in the final exemptive order is acceptable, we would like to
request the Commission to adopt this exemptive order as the permanent
one, after the order expires in July 2013.
II. Specific Comments
In addition to this general comment, we have three specific
comments on the further proposed guidance as follows.
1. Exclusion From Aggregation of U.S. and Non-U.S. Affiliates'
Transactions With U.S. Persons for the De Minimis Test for a
Non-U.S. Person
Under the further proposed guidance, a non-U.S. person would be
required, in determining whether its swap dealing transactions exceed
the de minimis threshold, to include the aggregate notional value of
swap dealing transactions entered into by all its affiliates under
common control (i.e., both non-U.S. affiliates and U.S. affiliates),
but would not be required to include in such determination the
aggregate notional value of swap dealing transactions of any non-U.S.
affiliate under common control that is registered as a swap dealer.
As far as the Japanese financial institutions are concerned, we
believe that they should not be required to include the aggregate
notional value of swap dealing transactions entered into by all their
U.S. affiliates, and non-U.S. affiliates under common control that are
not registered as swap dealers, in addition to any non-U.S. affiliate
that is registered as a swap dealer, since those affiliates are
supervised by FSA Japan on a consolidated basis.
In particular, since both U.S. and non-U.S. affiliates registered
as swap dealers would be subject to the Commission's regulations and
supervision, their transactions with U.S. persons should be excluded
for de minimis test for the non-U.S. person.
2. Clarification of the Scope and Definition of U.S. Person
We appreciate the Commission's effort to narrow the scope and
definition of U.S. person in the final exemptive order, compared with
that of the proposed interpretive guidance of July 2012.
Furthermore, the proposed interpretive guidance correctly states
that a foreign affiliate or subsidiary of a U.S. person would be
considered a non-U.S. person, even where such an affiliate or
subsidiary has certain or all of its swap-related obligations
guaranteed by the U.S. person. However, it is not clear to us in this
regard whether the further proposed guidance maintains this
interpretation. We think the interpretation adopted in the proposed
interpretive guidance is adequate, because non-U.S. affiliates of the
U.S. person established under the law of foreign countries are under
regulation and supervision by foreign regulators. We would like to
confirm that this interpretation holds valid under the further proposed
guidance.
3. Flexibility in the Expiration of the Final Exemptive Order
We understand that the Commission intends to conduct assessment for
substituted compliance with foreign regulatory requirements before the
expiration date (July 12, 2013) of the final exemptive order. If, at
the expiration date, substituted compliance with the Japanese
regulatory requirements is not available for Japanese financial
institutions which registered as swap dealers, they would be subject to
the Commission's regulations after the expiration date. This is not
acceptable to us. Therefore, we would like to urge the Commission to
consider extending the effectiveness of the final exemptive rule,
depending on whether and when such substituted compliance would be
available.
We would like to kindly request that the Commission take into
account the above and amend the further proposed guidance in accordance
with our requests. Should you have any questions concerning the above,
please do not hesitate to contact us.
Sincerely yours,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Masamichi Kono,
Vice Commissioner for International Affairs,
Financial Services Agency,
Government of Japan.
CC:
Commissioner Ms. Jill E. Sommers, CFTC;
Commissioner Mr. Bart Chilton, CFTC;
Commissioner Mr. Scott D. O'Malia, CFTC;
Commissioner Mr. Mark P. Wetjen, CFTC;
Chairman Elisse B. Walter, SEC;
Under Secretary for International Affairs Lael Brainard, U.S.
Department of the Treasury.
______
Submitted Letters by Hon. Richard Hudson, a Representative in Congress
from North Carolina
May 12, 2010
Hon. Christopher J. Dodd,
Chairman,
Senate Committee on Banking, Housing, and Urban Affairs,
Washington, D.C.
Dear Mr. Chairman:
You have asked for my views on section 716 of S. 3217. This section
would prevent many insured depository institutions from engaging in
swaps-related activities to hedge their own financial risks or to meet
the hedging needs of their customers, and would prohibit non-bank swaps
entities, including swap dealers, clearing agencies and derivative
clearing organizations, from receiving any type of Federal assistance.
The Federal Reserve has been a strong proponent of changes to
strengthen the regulatory framework and infrastructure for over-the-
counter (OTC) derivative markets to reduce systemic risks, promote
transparency, and enhance the safety and soundness of banking
organizations and other financial institutions. Title VII and Title
VIII of S. 3217 include important provisions designed to achieve these
goals. For example, Title VII would require most derivative contracts
to be cleared through central clearinghouses and traded on exchanges or
open trading facilities, require information concerning all other
derivatives contracts to be reported to trade repositories or
regulators, and provide the regulatory agencies significant new
authorities to ensure that all swaps dealers and major swap
participants are subject to strong capital, margin, and collateral
requirements with respect to their swap activities. Title VIII also
includes provisions designed to help ensure that centralized market
utilities for clearing and settling payments, securities, and
derivatives transactions (financial market utilities), which are
critical choke points in the financial system, are subject to robust
and consistent risk management standards--including collateral, margin,
and robust private-sector liquidity arrangements--and do not pose a
systemic risk to the financial system.
I have also frequently made clear that we must end the notion that
some firms are ``too-big-to-fail.'' For that reason, the Federal
Reserve has advocated the development of enhanced and rigorous
prudential standards for all large, interconnected financial firms, and
the enactment of a new resolution regime that would allow systemically
important financial firms to be resolved in an orderly manner, with
losses imposed on the Federal Reserve to provide emergency, secured
credit to nondepository institutions only through broad-based liquidity
facilities designed to address serious strains in the financial
markets, and not to bail out any specific firm.
S. 3217 makes important contributions to the goals of reducing
systemic risk, eliminating the too-big-to-fail problem, and
strengthening prudential supervision. I am concerned, however, that
section 716 is counter-productive to achieving these goals.
In particular, section 716 would essentially prohibit all insured
depository institutions from acting as a swap dealer or a major swap
participant--even when the institution acts in these capacities to
serve the commercial and hedging needs of its customers or to hedge the
institution's own financial risks. Forcing these activities out of
insured depository institutions would weaken both financial stability
and strong prudential regulation of derivative activities.
Prohibiting depository institutions from engaging in significant
swaps activities will weaken the risk mitigation efforts of banks and
their customers. Depository institutions use derivatives to help
mitigate the risks of their normal banking activities. For example,
depository institutions use derivatives to hedge the interest rate,
currency, and credit risks that arise from their loan, securities, and
deposit portfolios. Use of derivatives by depository institutions to
mitigate risks in the banking business also provides important
protection to the deposit insurance fund and taxpayers as well as to
the financial system more broadly. In addition, banks acquire
substantial expertise in assessing and managing interest rate,
currency, and credit risk in their ordinary commercial banking
business. Thus, banks are well situated to be efficient and prudent
providers of these risk management tools to customers.
Importantly, banks conduct their derivatives activities in an
environment that is subject to strong prudential Federal supervision
and regulation, including capital regulations that specifically take
account of a bank's exposures to derivative transactions. The Basel
Committee on Banking Supervision has recently proposed tough new
capital and liquidity requirements for derivatives that will further
strengthen the prudential standards that apply to bank derivative
activities. Titles I, III, VI, VII and VIII of S. 3217 all add
provisions further strengthening the authority of the Federal banking
agencies and other supervisory agencies to address the risks of
derivatives. Section 716 would force derivatives activities out of
banks and potentially into less regulated entities or into foreign
firms that operate outside the boundaries of our Federal regulatory
system. The movement of derivatives to entities outside the reach of
the Federal supervisory agencies would increase, rather than reduce the
risk to the financial system. In addition, foreign jurisdictions are
highly unlikely to push derivatives business out of their banks.
Accordingly, foreign banks will have a competitive advantage over U.S.
banking firms in the global derivatives marketplace, and derivatives
transactions could migrate outside the United States.
More broadly, section 716 would prohibit the Federal Reserve from
lending to any swaps dealer or major swap participant--regardless of
whether it is affiliated with a bank--even under a broad-based 13(3)
liquidity facility in a financial crisis. Experience over the past 2
years demonstrates that such broad-based facilities can play a critical
role in stemming financial panics and addressing severe strains in the
financial markets that threaten financial stability, the flow of credit
to households and businesses, and economic growth. These facilities
will be less effective if participants must choose between continuing
(or unwinding) derivatives positions and participating in the market-
liquefying facility.
I am concerned that section 716 in its present form would make the
U.S. financial system less resilient and more susceptible to systemic
risk and, thus, is inconsistent with the important goals of financial
reform legislation. We look forward to continuing to work with the
Congress as you work to enact strong regulatory reform legislation that
both addresses the weaknesses in the financial regulatory system that
became painfully evident during the crisis, and positions the
regulatory system to meet the inevitable challenges that lie ahead in
the 21st century.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Ben S. Bernanke,
Chairman,
Board of Governors of the Federal Reserve System.
______
May 6, 2010
Dear Mr. Chairman:
A number of people, including some Members of your Committee, have
asked me about the proposed restrictions on bank trading in derivatives
set out in Senator Lincoln's proposed amendment to Section 716 of S.
3217. I thought it best to write you directly about my reaction.
I well understand the concerns that have motivated Senator Lincoln
in terms of the risks and potential conflicts posed by proprietary
trading in derivatives concentrated in a limited number of commercial
banking organizations. As you know, the proposed restrictions appear to
go well beyond the proscriptions on proprietary trading by banks that
are incorporated in Section 619 of the reform legislation that you have
proposed. My understanding is that the prohibition already provided for
in Section 619, specifically including the Merkley-Levin amended
language clarifying the extent of the prohibition on proprietary
trading by commercial banks, satisfy my concerns and those of many
others with respect to bank trading in derivatives.
In that connection, I am also aware of, and share, the concerns
about the extensive reach of Senator Lincoln's proposed amendment. The
provision of derivatives by commercial banks to their customers in the
usual course of a banking relationship should not be prohibited.
In sum, my sense is that the understandable concerns about
commercial bank trading in derivatives are reasonably dealt with in
Section 619 of your reform bill as presently drafted. Both your Bill
and the Lincoln amendment reflect the important concern that, to the
extent feasible, derivative transactions be centrally cleared or traded
on a regulated exchange. These are needed elements of reform.
I am sending copies of this letter to Secretary Geithner and to
Senators, Shelby, Merkley, Levin and Lincoln.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Paul A. Volcker.
______
April 30, 2010
Hon. Christopher J. Dodd,
Chairman,
Senate Committee on Banking, Housing, and Urban Affairs,
Washington, D.C.;
Hon. Blanche L. Lincoln,
Chairman,
Senate Committee on Agriculture, Nutrition, and Forestry,
Washington, D.C.
Dear Chairman Dodd and Chairman Lincoln:
Thank you for reaching out to the Federal Deposit Insurance
Corporation for our views on Title VII of the ``Wall Street
Transparency and Accountability Act'' contained in S. 3217, the
``Restoring American Financial Stability Act of 2010.'' At the outset,
I would like to express my strong support for enhanced regulation of
``over-the-counter'' (OTC) derivatives and the provisions of the bill
which would require centralized clearing and exchange trading of
standardized products. If this requirement is applied rigorously it
will mean that most OTC contracts will be centrally cleared, a
desirable improvement from the bilateral clearing processes used now. I
would also like to express my wholehearted endorsement of the ultimate
intent of the bill, to protect the deposit insurance fund from high
risk behavior.
I would like to share some concerns with respect to section 716 of
S. 3217, which would require most derivatives activities to be
conducted outside of banks and bank holding companies. If enacted, this
provision would require that some $294 trillion in notional amount of
derivatives be moved outside of banks or from bank holding companies
that own insured depository institutions, presumably to non-bank
financial firms such as hedge funds and futures commission merchants,
or to foreign banking organizations beyond the reach of Federal
regulation. I would note that credit derivatives--the riskiest--held by
banks and bank holding companies (when measured by notional amount)
total $25.5 trillion, or slightly less than nine percent of the total
derivatives held by these entities.
At the same time, it needs to be pointed out that the vast majority
of banks that use OTC derivatives confine their activity to hedging
interest rate risk with straightforward interest rate derivatives.
Given the continuing uncertainty surrounding future movements in
interest rates and the detrimental effects that these could have on
unhedged banks, I encourage you to adopt an approach that would allow
banks to easily hedge with OTC derivatives. Moreover, I believe that
directing standardized OTC products toward exchanges or other central
clearing facilities would accomplish the stabilization of the OTC
market that we seek to enhance, and would still allow banks to continue
the important market-making functions that they currently perform.
In addition, I urge you to carefully consider the underlying
premise of this provision--that the best way to protect the deposit
insurance fund is to push higher risk activities into the so-called
shadow sector. To be sure, there are certain activities, such as
speculative derivatives trading, that should have no place in banks or
bank holding companies. We believe the Volcker rule addresses that
issue and indeed would be happy to work with you on a total ban on
speculative trading, at least in the CDS market. At the same time,
other types of derivatives such as customized interest rate swaps and
even some CDS do have legitimate and important functions as risk
management tools, and insured banks play an essential role in providing
market-making functions for these products.
Banks are not perfect, but we do believe that insured banks as a
whole performed better during this crisis because they are subject to
higher capital requirements in both the amount and quality of capital.
Insured banks also are subject to ongoing prudential supervision by
their primary banking regulators, as well as a second pair of eyes
through the FDIC's back up supervisory role, which we are strengthening
as a lesson of the crisis. If all derivatives market-making activities
were moved outside of bank holding companies, most of the activity
would no doubt continue, but in less regulated and more highly
leveraged venues. Even pushing the activity into a bank holding company
affiliate would reduce the amount and quality of capital required to be
held against this activity. It would also be beyond the scrutiny of the
FDIC because we do not have the same comprehensive backup authority
over the affiliates of banks as we do with the banks themselves. Such
affiliates would have to rely on less stable sources of liquidity,
which--as we saw during the past crisis--would be destabilizing to the
banking organization in times of financial distress, which in turn
would put additional pressure on the insured bank to provide stability.
By concentrating the activity in an affiliate of the insured bank, we
could end up with less and lower quality capital, less information and
oversight for the FDIC, and potentially less support for the insured
bank in a time of crisis. Thus, one unintended outcome of this
provision would be weakened, not strengthened, protection of the
insured bank and the Deposit Insurance Fund, which I know is not the
result any of us want.
A central lesson of this crisis is that it is difficult to insulate
insured banks from risk taking conducted by their non-banking
affiliated entities. When the crisis hit, the shadow sector collapsed,
leaving insured banks as the only source of stability. Far from serving
as a source of strength, bank holding companies and their affiliates
had to draw stability from their insured deposit franchises. We must be
careful not to reduce even further the availability of support to
insured banks from their holding companies. As a result, we believe
policies going forward should recognize the damage regulatory arbitrage
caused our economy and craft policies that focus on the quality and
strength of regulation as opposed to the business model used to support
it.
The FDIC is pleased to continue working with you on this important
issue to assure that the final outcome serves all of our goals for a
safer and more stable financial sector. We hope that a compromise can
be achieved by perhaps moving some derivatives activity into
affiliates, so long as capital standards remain as strict as they are
for insured depositories and banks continue to be able to fully utilize
derivatives for appropriate hedging activities.
Please do not hesitate to contact me at [Redacted] or have your
staff contact Paul Nash, Deputy Director for External Affairs, at
[Redacted].
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Sheila C. Bair,
Chairman,
Federal Deposit Insurance Corporation.
______
excert from h. rept 112-476
minority views
The Wall Street Reform and Consumer Protection Act requires, for
the first time, the regulation of over-the-counter derivatives,
previously opaque transactions that helped bring our financial system
to the brink of disaster. The vast majority of derivatives must now be
centrally cleared and publicly reported, and be backed by margin and
capital to ensure that swap dealers and major swap users can honor
their commitments. In addition, the reform law also prohibits banks
from placing bets with federally insured deposits through the ``Volcker
Rule''. Both measures serve as important safeguards as we rebuild trust
in our financial system.
As amended, H.R. 1838 would repeal portions of Section 716 of the
financial reform law, also known as the ``push-out provision.'' Section
716 prohibits banks from engaging in several types of derivatives.
Questions have been raised about this provision by economists and
regulators including FDIC's Sheila Bair, who are concerned that it
might interfere with a bank's ability to use derivatives to diminish
risk. Section 716 was not part of the original House-passed version of
the financial reform law.
During the Full Committee markup, Democrats worked with the
Majority to amend H.R. 1838 to continue the prohibition of complex
swaps employed by AIG with devastating effect. H.R. 1838, as amended,
addresses the valid criticisms of Section 716 without weakening the
financial reform law's important derivative safeguards or prohibitions
on bank proprietary trading.
Barney Frank.
Wm. Lacy Clay.
Gwen Moore.
James A. Himes.
Ruben Hinojosa.
Andre Carson.
Gary L. Ackerman.
Al Green.
Stephen F. Lynch.
David Scott.
Maxine Waters.
Carolyn B. Maloney.
Melvin L. Watt.
Luis V. Gutierrez.
Gary C. Peters.
Ed Perlmutter.
Michael E. Capuano.
Gregory W. Meeks.
______
Response from Hon. Gary Gensler, Chairman, U.S. Commodity Futures
Trading Commission
Questions Submitted By Hon. Frank D. Lucas, a Representative in
Congress from Oklahoma
Question 1. Chairman Gensler, in June of 2011, CFTC proposed a rule
that would have required companies that have a futures exchange
membership to record all oral and written communication regarding
futures and related cash commodity trades and retain those
communications for 5 years. In your final rule, the CFTC excluded
members of a DCM--that are not otherwise registered with either the
CFTC or NFA--from the oral recording requirements. If the appropriate
policy regarding members of a DCM--that are not otherwise required to
be registered with the CFTC--is to not require recording of oral
communications related to cash commodity sales, are they required to
retain the 21st century analogs for oral conversation, such as text
messages and instant messages?
Answer. In 2009, the Commission's Division of Market Oversight
(DMO) issued an Advisory to clarify certain Commission record-keeping
requirements pertaining to futures commission merchants (FCMs),
introducing brokers (IBs), and members of a designated contract market.
The Advisory was to clarify that the individuals and entities subject
to the Commission's record-keeping requirements should maintain all
electronic forms of communications, including email, instant messages,
and any other form of communication created or transmitted
electronically for all trading. Also noted in the Advisory is that
record-keeping regulations do not distinguish between methods used to
record the information covered by the regulations, including e-mails,
instant messages, and any other form of communication created or
transmitted electronically. The Commission adopted the proposed
amendment to regulation 1.35(a) to clarify that the existing
requirement to keep written records applies to electronic written
communications, such as emails and instant messages.
The amended regulation provides that among the records required to
be kept are all oral and written communications provided or received
concerning quotes, solicitations, bids, offers, instructions, trading,
and prices that lead to the execution of a transaction in a commodity
interest and related cash or forward transactions, whether communicated
by telephone, voicemail, facsimile, instant messaging, chat rooms,
electronic mail, mobile device, or other digital or electronic media.
The final rule does not specifically include ``voicemail'' in the
category of written communication but provides a list of included modes
of communication in the requirement that ``all oral and written
communications'' be kept.
Question 2. It is my understanding that text messaging and instant
messaging are difficult, if not impossible, for a company to capture
and retain, especially with respect to mobile devices, which have
proprietary software and operate on proprietary networks. If they are
required to keep text messages and other non-verbal communications in
order to comply with the final rule as written, employees of companies
will have no choice but to avoid text and instant messaging, and simply
go back to using the phone, which they do not have to record. Is this
the policy outcome that you envisioned under the final rule?
Answer. Commission staff are aware that there are companies that
have been offering technological solutions for entities to capture and
retain IMs and text messages.
The overarching purpose of the Commission's final rule is to
promote market integrity and protect customers. Requiring the recording
and retention of oral communications will serve as a disincentive for
covered entities to make fraudulent or misleading communications. The
Commission received comments regarding the cost of implementing and
maintaining an oral communication recording system for small entities
and the commercial end-user, non-intermediary members of a DCM or SEF.
In response the Commission determined to exclude from the new oral
communications requirement members that are not registered or required
to be registered with the Commission in any capacity.
Questions Submitted By Hon. Jeff Denham, a Representative in Congress
from California
Question 1. Congress enacted Dodd-Frank to reform oversight of big
financial firms. Do you think it is appropriate for the CFTC's
regulatory reach to extend into the day-to-day operational transactions
of electric utilities?
Question 2. Municipal utilities have laid out a compelling case
that the entity definitions rule is flawed and creates unintended
consequences for the electric sector. Why can't you fix this at the
regulatory level?
Answer 1-2. The final rule adopted jointly by the CFTC and the SEC
to further define the term ``swap dealer'' provides that a person shall
not be deemed a swap dealer if swap dealing activity for the preceding
12 months results in swap positions with an aggregate gross notional
amount of no more than $3 billion, and an aggregate gross notional
amount of no more than $25 million with regard to swaps with a
``special entity'' (which includes municipalities, other political
subdivisions and employee benefit plans). The rule also provides for a
phase-in of the de minimis threshold to facilitate orderly
implementation of swap dealer requirements. During the phase-in period,
the de minimis threshold would effectively be $8 billion (while the $25
million threshold for swaps with special entities would apply).
In developing the rule further defining the term ``swap dealer''
and other rules under the Dodd-Frank Act that may affect municipal
utilities, CFTC Commissioners and staff met with municipal utility
representatives and their advisors and counterparties regarding their
concerns. The final joint rule contains a provision that excludes from
the calculation certain swaps entered into for the purpose of hedging
physical positions. In addition, on October 12, 2012, Commission staff
issued no-action relief, which states that staff will not recommend
enforcement action if non-financial entities enter into swaps as part
of a swap dealing business with utility special entities (such as
municipal utilities) with a notional value of up to $800 million
annually without registering as a swap dealer. By its terms, the no-
action relief will remain in effect until Commission action is
completed on a petition submitted by public utilities requesting an
amendment to the rule to exclude from the special entity de minimis
threshold relevant swap contracts relating to utility operations.
Congress also authorized the CFTC to provide relief from the Dodd-
Frank Act's swaps reforms for certain electricity and electricity-
related energy transactions between rural electric cooperatives and
federal, state, municipal and tribal power authorities. Similarly,
Congress authorized the CFTC to provide relief for certain transactions
on markets administered by regional transmission organizations and
independent system operators. The Commission recently finalized
exemptive orders related to these transactions, as Congress authorized.
Question 3. Chairman why do you believe Swap Execution Facilities
(SEFs) should require five (5) Requests for Quotes (RFQs) when the SEC
has an alternate proposal that does not include this mandatory
requirement?
Answer. On May 16, 2013, the Commission approved the final
rulemaking on swap execution facilities (SEFs). This rule is key to
fulfilling transparency reforms that Congress mandated in the Dodd-
Frank Act.
The Dodd-Frank Act included a trade execution requirement for
swaps. Swaps subject to mandatory clearing and made available to trade
were to move to transparent trading platforms. Market participants will
benefit from the price competition that comes from trading platforms
where multiple participants have the ability to trade swaps by
accepting bids and offers made by multiple participants. Congress also
said that the market participants must have impartial access to these
platforms.
Farmers, ranchers, producers and commercial companies that want to
hedge a risk by locking in a future price or rate will get the benefit
of the competition and transparency that trading platforms, both SEFs
and designated contract markets (DCMs), will provide.
These transparent platforms will give everyone looking to compete
in the marketplace the ability to see the prices of available bids and
offers prior to making a decision on a transaction. By the end of this
year, a significant portion of interest rate and credit derivative
index swaps will be in full view to the marketplace before transactions
occur. This is a significant shift toward market transparency from the
status quo.
Such common-sense transparency has existed in the securities and
futures markets since the historic reforms of the 1930s. Transparency
lowers costs for investors, businesses and consumers, as it shifts
information from dealers to the broader public. It promotes competition
and increases liquidity.
As Congress made clear in the law, trading on SEFs and DCMs would
be required only when financial institutions transact with financial
institutions. End-users would benefit from access to the information on
these platforms, but would not be required to use them.
Further, companies would be able to continue relying on customized
transactions--those not required to be cleared--to meet their
particular needs, as well as to enter into large block trades.
Consistent with Congress' directive that multiple parties have the
ability to trade with multiple parties on these transparent platforms,
these reforms require that market participants trade through an order
book, and provide the flexibility as well to seek requests for quotes.
To be a registered SEF, the trading platform will be required to
provide an order book to all its market participants. This is
significant, as for the first time, the broad public will be able to
gain access and compete in this market with the assurance that their
bids or offers will be communicated to the rest of the market. This
provision alone will significantly enhance transparency and competition
in the market.
SEFs also will have the flexibility to offer trading through
requests for quotes. The rule provides that such requests will have to
go out to a minimum of three unaffiliated market participants before a
swap that is cleared, made available to trade and less than a block
could be executed. There will be an initial phase-in period with a
minimum of two participants to smooth the transition.
As long as the minimum functionality is met, as detailed in the
rule, and the SEF complies with these rules and the core principles,
the SEF can conduct business through any means of interstate commerce,
such as the Internet, telephone or even the mail. In this way, the rule
is technology neutral.
Under these transparency reforms coupled with the Commission's rule
on making swaps available for trading, the trade execution requirement
will be phased in for market participants, giving them time to comply.
These reforms benefited from extensive public comments. Moving
forward, the CFTC will work with SEF applicants on implementation.
Response from Hon. Kenneth E. Bentsen, Jr., Acting President and Chief
Executive Officer, Securities Industry and Financial Markets
Association
Question Submitted By Hon. Jeff Denham, a Representative in Congress
from California
Question. Mr. Bentsen what are your concerns regarding the CFTC's
cross-border guidance? Will it negatively affect the marketplace?
Answer. Following the March 14, 2013 House Committee on Agriculture
hearing, you inquired what SIFMA's concerns were regarding the CFTC's
cross-border guidance, and whether the guidance would negatively affect
the marketplace.
While SIFMA supports many of the stated goals of Title VII of the
Dodd Frank Act, we have serious concerns regarding the approach the
CFTC has taken with regard to the cross-border application of the
derivatives regulatory regime. I appreciate this opportunity to
elaborate on the position of SIFMA and its member firms.
Though Title VII was signed into law 2\1/2\ years ago, we still do
not know which swaps activities will be subject to U.S. regulation and
which will be subject to foreign regulation. Of specific concern is the
CFTC's release of multiple proposed definitions of ``U.S. Person.''
These ``U.S. Person'' definitions are very broad and give rise to
concerns that CFTC regulation may be applied to persons with minimal
jurisdictional nexus to the United States. This has consequently
created a great deal of ambiguity and confusion for market participants
as they try to determine their ``U.S. Person'' status and that of their
counterparties, along with any accompanying regulatory obligations.
SIFMA has advocated for a final definition of ``U.S. Person'' that
focuses on significant, rather than nominal, connections to the United
States and is simple, objective and transparent enough for a person to
determine its status and the status of its counterparties on an ongoing
basis.
The CFTC has not adequately coordinated with other domestic and
international regulators regarding the definition of ``U.S. Person''
and the scope of its extraterritorial jurisdiction. We are also
concerned with the CFTC's proposed approach to comparing foreign-
country regulation with U.S. regulation. This proposed approach
involves a determination by the Commission of the comparability and
comprehensiveness of the rules relating to swaps activity on a rule-by-
rule basis. SIFMA believes this goes far beyond any established regime
and does not comport with established norms or comity.
Additionally, we have expressed concerns regarding the fact that
the CFTC has issued its proposed cross-border releases as ``guidance,''
rather than through a formal rulemaking process subject to the
Administrative Procedure Act. By proposing guidance as opposed to a
formal rule, the CFTC has avoided requirements to conduct the rigorous
cost-benefit analysis critical to ensuring that the Commission
appropriately weighs any costs imposed on market participants that may
result from implementing an overly broad and complex cross-border
regulatory regime.
With regard to the impact of the CFTC's cross-border guidance on
the marketplace, SIFMA member firms have indeed witnessed instances of
disruption. On October 12, 2012 (the date on which market participants
began counting their swap dealing transactions to determine if they
would be required to register with the CFTC), some counterparties
outside of the U.S. refrained from entering into swap transactions with
U.S. entities due to uncertainty in determining which transactions
might subject the firm to CFTC registration. In light of this
disruption, the CFTC issued numerous temporary no-action relief letters
and other documents in an effort to assuage market concerns but this
process was completed in a haphazard and last-minute manner.
Notwithstanding the relief that has been issued to date by the CFTC,
there remains significant uncertainty in the international marketplace
due to the confusing and short-term nature of the CFTC's actions and
public statements by CFTC officials.
Due to these conditions, concern over the cross-border reach of the
CFTC has generated the great risk of driving the swaps market and
related business out of the U.S. Such a migration could result in a
decrease in the availability of hedging instruments and an increase in
transaction costs for corporations and other Main Street end-users
seeking to manage risk.
Response from James E. Colby, Assistant Treasurer, Honeywell
International Inc.
Question Submitted By Hon. Marcia L. Fudge, a Representative in
Congress from Ohio
Question. Dodd-Frank has been largely silent on the regulatory
treatment of inter-affiliate swaps. As a result, some are concerned
that the Commodity Futures Trading Commission may treat inter-affiliate
transactions as it treats other swaps by subjecting them to clearing,
execution and margin requirements. Why is it important to clarify that
inter-affiliate swaps be treated differently than market-facing swaps?
What negative impacts will be seen by end-users if no clarification is
given?
Answer. Commercial end-users frequently utilize a hedging model
incorporating centralized treasury units. Under this model, a company's
affiliates will hedge their exposures with the centralized treasury
unit, which will net these exposures (because many affiliates'
exposures will offset one another) and hedge the company's net exposure
by executing market-facing swaps with banks. The centralized treasury
unit model significantly lowers both the number and notional value of a
company's externally-facing derivatives transactions and materially
reduces a company's hedging costs and bank credit line requirements.
Consolidating all market-facing transactions within one entity makes it
much easier to ensure that market-facing transactions are executed by
experienced staff and greatly improves controls around derivatives
transactions.
Centralized treasury units that are organized as a separate legal
entity within the structure of a non-financial end-user might be
considered persons engaged in activities that are financial in nature
as defined in section 4(k) of the Bank Holding Company Act of 1956.
These centralized treasury units could be considered Financial Entities
under Dodd-Frank and, without the clarification provided under H.R.
677, could be denied the clearing exception simply because they employ
an efficient centralized treasury unit approach that reduces costs and
mitigates systemic risk.
Response from Terrance P. Naulty, General Manager and Chief Executive
Officer, Owensboro Municipal Utilities; Member, American Public
Power Association
Questions Submitted By Hon. Jeff Denham, a Representative in Congress
from California
Question 1. How familiar is your utility with transactions that
hedge the operational risk of fuel costs , which affect the entire
business model of municipal utilities in my Congressional district,
such as Modesto Irrigation District and Turlock Irrigation District?
Answer. I am very familiar with these types of fuel hedging
transactions. They are critical to managing fuel price risk and,
ultimately, to maintaining stability of electric rates to consumers.
Specifically, for public power utilities that use natural gas as a fuel
for generation of electric energy, the ability to ``lock in'' the price
of fuel is absolutely essential. As your question notes, Modesto
Irrigation District and Turlock Irrigation District both rely on
natural gas a fuel for electric generation.
By way of background, a public power utility will generally
establish a fixed electric rate for consumers. As a result, the utility
is contractually obligated to sell electricity at this fixed price for
some period of time in the future. Without the ability to hedge (or
purchase) the associated natural gas quantity for the corresponding
period of time, the price risk imposed on the public power utility is
not prudent. Thus, most utilities use financial instruments to fix the
price of natural gas for such future deliveries. Doing so gives the
utility certainty on what it will cost to produce the power and thus
insure sufficient revenues to meet their expenses.
For utilities that burn coal or use uranium for electric
generation, generally the use of financial instruments to fix the
future price is not as important today because these fuels do not have
the same level of price volatility as natural gas. In part because of
this price stability, coal and uranium purchases are normally done
through long-term physical contracts. However, as is the case with
Owensboro Municipal Utilities, obtaining price certainty--through
financial hedging--for surplus electrical generation from whatever fuel
source is critical to maintaining stable and low electric rates to our
customers.
As I pointed out in my testimony to the Committee, reducing a
public power utility's access to the market place through the $25
million special entity sub-threshold limit imposed by the CFTC un-
levels the playing field of the market. This is true whether the public
power utility is hedging fuel price risk or power price risk. Again,
suppliers that choose not to enter fuel price swap transactions with a
public power utility to avoid being designated as a ``swap dealer''
represent a reduction in market liquidity to the public power utility.
The public power utility must then turn to the smaller pool of
financial entities for its fuel hedging business. These financial
entities, with full understanding of these impacts, will have the
ability to increase the bid/ask spread on these hedging instruments.
Thus, the affected public power utility rate payers ultimately will
pay higher rates than they need to. To the extent that the public power
utility has negotiated collateral limits with non-financial hedge
counterparties that are now not willing to transact with them, there is
a real potential that the public power utility will incur higher credit
costs than needed. Again, these costs will be passed on to rate payers.
Entering into financial swap transactions with non-financial
traders (many of whom are physical natural gas suppliers in the market)
creates no incremental risk to the public power utility. The
protections that the CFTC is trying to provide to these entities
through the special entity sub-threshold are not needed and create real
potential for higher electric rates with no reduction in risk.
Question 2. Does your utility engage in other types of financial
transactions, such as speculation in the financial markets, that could
increase your utility's risk of bankruptcy?
Answer. No. Owensboro Municipal Utilities uses financial swaps
solely to hedge price risk and manage cash flow. Under current CFTC
regulations, limiting trading counterparties as a direct result of the
sub-threshold imposed upon special entities actually increases our
bankruptcy risk. This is because we can no longer rely upon the
collateral arrangements that we painstakingly negotiated with our non-
financial trading counterparties that do not want to be swap dealers.
Currently we must provide cash margin as opposed to relying upon the
strength of our balance sheet to meet our collateral obligations for
hedge transactions. Large price movements in natural gas or electric
futures that normally could be accommodated within the collateral
limits we had negotiated may force liquidation of trades in order to
avoid the immediate cash margining impacts to OMU. These forced
liquidations would result in realized losses that otherwise could have
been weathered under the terms of bilateral agreement with non-
financial counterparties.
Response from Marie N. Hollein, C.T.P., President and Chief Executive
Officer, Financial Executives International and Financial
Executives Research Foundation; on behalf of Coalition for
Derivatives End-Users
Questions Submitted By Hon. Marcia L. Fudge, a Representative in
Congress from Ohio
Question 1. Dodd-Frank has been largely silent on the regulatory
treatment of inter-affiliate swaps. As a result, some are concerned
that the Commodity Futures Trading Commission may treat inter-affiliate
transactions as it treats other swaps by subjecting them to clearing,
execution and margin requirements. Why is it important to clarify that
inter-affiliate swaps be treated differently than market-facing swaps?
What negative impacts will be seen by end-users if no clarification is
given?
Answer. The Coalition for Derivatives End-Users believes that
regulation of inter-affiliate swaps should square with the economic
reality that inter-affiliate swaps do not pose systemic risk and
therefore should not be regulated the same as trades that do. Without
clarification, certain end-users could be faced with clearing their
internal, inter-affiliate swaps, despite the end-user exception from
clearing granted under Dodd-Frank. Without the clarification provided
under H.R. 677, end-users that structure using an efficient centralized
treasury hedging unit could be forced to dismantle this central unit
because it could be considered a ``financial entity.'' These companies
would be forced to abandon their business model of only having one
street-facing entity handling swap transactions, which has become a
best practice, leaving a system where their hundreds of affiliates
would be trading directly with bank counterparties. The result would be
a system that is more costly, less efficient, eliminating the benefits
of centralizing expertise in the company. H.R. 677 is necessary as the
CFTC final rule exempting inter-affiliate swaps from clearing does not
fix the centralized treasury unit issue that the legislation seeks to
address. If left un-addressed, some companies could be facing a
disadvantage against their competitors who do not structure in the same
way and do not have to clear their swaps transactions.
Question 2. Inter-affiliate swaps are a common accounting practice
used by several American corporations in multiple sectors of our
economy. These companies have decided that managing risk in this
fashion is more efficient and cost-effective. In your testimony, you
stated that approximately \1/4\ of the end-users your company surveyed
executed swaps through an affiliate. What are the benefits to managing
risk through inter-affiliate swaps?
Answer. Many companies find it more efficient to manage their risk
centrally, to have one affiliate trading in the open market, instead of
dozens or hundreds of affiliates making trades in an uncoordinated
fashion. Using this type of hedging unit centralizes expertise, allows
companies to reduce the number of trades with the street and improves
pricing. These advantages led me to centralize the treasury function at
Westinghouse while I was there.
Question 3. If the Inter-Affiliate Swaps Clarification Act was to
be made law, what's the likelihood that more companies would look to
manage risk through inter-affiliate swaps? Do you think there would be
a significant increase in these kinds of transactions?
Answer. I believe that the trend is moving toward centralization
because it is a best practice. Companies that may not use this model
now, may want to do so in the future. Yet, if Title VII of the Dodd-
Frank Act makes it more costly to operate in a centralized manner,
companies may abandon their plans to move toward the type of
centralized treasury unit that would not qualify for the end-user
exception from clearing.
Question 4. Our bill last year was reported out of both this
Committee and the House Financial Services Committee unanimously. That
said, perhaps the only criticism we heard about the bill is that it
applied to inter-affiliate trades made by bank swap dealers and major
swap participants, and not just end-users. So we have amended our bill
to make it clear that is does not apply to Wall Street Banks and major
swap participants. Do you think that this year's version of our bill is
sufficiently tailored to address the problems faced by end-users
without creating a loophole that could be exploited by other market
participants?
Answer. The Coalition for Derivatives End-Users fully supports H.R.
677, which would ensure that end-users can continue to use the end-user
exception from clearing granted under Dodd-Frank regardless of their
utilization of inter-affiliate swaps or a centralized treasury unit
business model. In terms of preventing exploitation of the exemption
provided under this legislation, both versions--last Congress and this
Congress--included a specific grant of anti-evasion authority to
regulators to prevent abuse. This year's version of the legislation
also prevents a `swap dealer' or a `major swap participant' that is an
insured depository institution from using the inter-affiliate exemption
provided under this legislation to address concerns raised last year.
Question 5. The Coalition for Derivatives End-Users has been on
record for supporting strong regulations that ``bring transparency to
the derivatives market.'' How does the Inter-Affiliate Swap
Clarification support that goal?
Answer. The Coalition for Derivatives End-Users seeks to ensure
that financial regulatory reform measures promote economic stability
and transparency without imposing undue burdens on derivatives end-
users. Under the Inter-Affiliate Swap Clarification Act, certain trades
would still be reported to regulators to meet the goal of transparency
in the financial markets, but end-users would not be overly burdened in
terms of clearing each internal transaction, which could be extremely
costly.