[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF THE CFTC: END-USER PERSPECTIVES
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HEARING
BEFORE THE
SUBCOMMITTEE ON
GENERAL FARM COMMODITIES
AND RISK MANAGEMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
JULY 24, 2013
__________
Serial No. 113-7
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
______
Subcommittee on General Farm Commodities and Risk Management
K. MICHAEL CONAWAY, Texas, Chairman
RANDY NEUGEBAUER, Texas DAVID SCOTT, Georgia, Ranking
MIKE ROGERS, Alabama Minority Member
BOB GIBBS, Ohio FILEMON VELA, Texas
AUSTIN SCOTT, Georgia PETE P. GALLEGO, Texas
ERIC A. ``RICK'' CRAWFORD, Arkansas WILLIAM L. ENYART, Illinois
MARTHA ROBY, Alabama JUAN VARGAS, California
CHRISTOPHER P. GIBSON, New York CHERI BUSTOS, Illinois
VICKY HARTZLER, Missouri SEAN PATRICK MALONEY, New York
KRISTI L. NOEM, South Dakota TIMOTHY J. WALZ, Minnesota
DAN BENISHEK, Michigan GLORIA NEGRETE McLEOD, California
DOUG LaMALFA, California JIM COSTA, California
RICHARD HUDSON, North Carolina JOHN GARAMENDI, California
RODNEY DAVIS, Illinois ----
CHRIS COLLINS, New York
(ii)
C O N T E N T S
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Page
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, opening statement....................................... 1
Submitted letters............................................ 87
Scott, Hon. David, a Representative in Congress from Georgia,
opening statement.............................................. 2
Witnesses
Cordes, Scott, President, CHS Hedging, Inc., St. Paul, MN; on
behalf of National Council of Farmer Cooperatives.............. 3
Prepared statement........................................... 5
Submitted questions.......................................... 94
Kotschwar, Lance, Senior Compliance Attorney, Gavilon Group, LLC,
Omaha, NE; on behalf of Commodity Markets Council.............. 9
Prepared statement........................................... 11
Submitted questions.......................................... 95
McMahon, Jr., Richard F., Vice President of Energy Supply and
Finance, Edison Electric Institute, Washington, D.C............ 16
Prepared statement........................................... 17
Submitted questions.......................................... 96
Monroe, Chris, Treasurer, Southwest Airlines Co., Dallas, TX..... 20
Prepared statement........................................... 21
Submitted questions.......................................... 98
Soto, Andrew K., Senior Managing Counsel, Regulatory Affairs,
American Gas Association, Washington, D.C...................... 23
Prepared statement........................................... 25
Submitted questions.......................................... 98
Guilford, Gene A., National & Regional Policy Counsel,
Connecticut Energy Marketers Association, Cromwell, CT; on
behalf of Commodity Markets Oversight Coalition................ 29
Prepared statement........................................... 31
Submitted question........................................... 96
Submitted Material
Auer, Kenneth E., President and CEO, Farm Credit Council,
submitted letter............................................... 92
THE FUTURE OF THE CFTC: END-USER PERSPECTIVES
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WEDNESDAY, JULY 24, 2013
House of Representatives,
Subcommittee on General Farm Commodities and Risk
Management,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:01 a.m., in
Room 1300 of the Longworth House Office Building, Hon. K.
Michael Conaway [Chairman of the Subcommittee] presiding.
Members present: Representatives Conaway, Neugebauer,
Austin Scott of Georgia, Crawford, Gibson, Hartzler, Noem,
Benishek, LaMalfa, Hudson, Davis, Collins, David Scott of
Georgia, Vela, Gallego, Enyart, Vargas, Maloney, Walz, Negrete
McLeod, Costa, Garamendi, Peterson (ex officio), and McIntyre.
Staff present: Caleb Crosswhite, Jason Goggins, Kevin
Kramp, Pete Thomson, Suzanne Watson, Tamara Hinton, John Konya,
C. Clark Ogilvie, Liz Friedlander, and Riley Pagett.
OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE
IN CONGRESS FROM TEXAS
The Chairman. This hearing of the Subcommittee on General
Farm Commodities and Risk Management entitled, The Future of
CFTC: End-User Perspectives, will come to order.
This morning I would like to welcome everyone to the third
in a series of hearings to examine the CFTC's reauthorization
in advance of writing legislation. Yesterday the Committee
heard from CFTC Commissioners Scott O'Malia and Mark Wetjen. It
proved to be a productive and insightful conversation that I
hope will continue today.
Today we are joined by a diverse group of representatives
from across the spectrum of end-users. Today's panelists will
share the perspectives of the farmers, manufacturers,
transportation firms, utility companies and others who produce
the goods and services that every American consumes each day.
Well-functioning markets are essential to help grow the economy
and one needs to look no further than our witnesses here today
to understand how important it is for the CFTC to get its
regulations right.
I thank each of our witnesses for appearing here today to
share your thoughts about how to improve both the operations
and the regulations of the Commodity Futures Trading
Commission. It is important for the Committee to hear your
views, because ultimately, derivatives markets exist to support
end-users, not financial firms. Although derivatives markets
have been broadly mischaracterized as opaque, risky and exotic,
the reality for end-users is far more mundane. Derivatives
contracts are a part of everyday life for thousands of
businesses. They enable risks to be transferred from those who
are willing to pay to avoid it so that manufacturing, energy
production and operations costs can all be predicted to a
reasonable degree of certainty.
As a result, the price of buying a box of cereal, paying
your power or gas bill, or buying an airline ticket home for
Thanksgiving will hopefully remain relatively stable. This
transfer of risk allows businesses to free up productive
capital, to invest in new products, to build new facilities and
to hire new employees. Unfortunately, despite Congress' clear
intent to exempt end-users from the brunt of Dodd-Frank, the
past few years have been a regulatory roller coaster for them.
As I mentioned in yesterday's hearing, I am concerned about
the impact that delays and last-minute no-action letters are
having on how market participants manage their businesses. The
lack of business certainty has no doubt cost many companies
valuable capital and changed their strategic thinking.
Regulations should be created and exist to protect markets, not
to destroy them.
I look forward to hearing the comments of our witnesses on
the rule-making processes and how the CFTC will work to address
the concerns they raise throughout. The perspective of today's
witnesses are essential to crafting a forward-looking
reauthorization bill, and I want to thank them again for taking
the time to visit with us today.
With that, I'd like to turn to my colleague from Georgia,
the Ranking Member, David Scott, for his opening remarks.
David?
OPENING STATEMENT OF HON. DAVID SCOTT, A REPRESENTATIVE IN
CONGRESS FROM GEORGIA
Mr. David Scott of Georgia. Thank you very much, Mr.
Chairman, and I join you in welcoming our distinguished
witnesses. We are certainly looking forward to their important
testimony.
Today's hearing is vitally important as it reminds us of
why the markets regulated by the CFTC exist in the first place
which is to serve companies both large and small, as well as
individuals, small businesses, like farmers and their co-ops in
managing their business risk. It is important to ensure that
our markets function as they are intended and as end-users need
them, too, in order that they can engage in the legitimate
hedging activities necessary for their business operations.
However, I must say that right now, it is perhaps the case
that things are not quite operating as they should. We do have
an issue that is bubbling its head up that we need to watch
very carefully at this point and that is whether banks should
own and control vast storages or warehouses and oil tankers,
pipelines and shipments, distribution of commodities, like
aluminum, like gasoline. Is that fair, with the delays and
timing of getting these commodities like aluminum, gasoline, to
manufacturers and end-users. And the fundamental question is if
these activities could pose another risk or a crisis to our
nation's financial system, so as our Committee is charged with
management, risk and commodities, we have to keep a very
jaundiced eye on this as to whether or not this results in mass
inflated pricing.
And it is very important to note that with this we must
know that banks, holding companies, are allowed certain
commodity activities that are complimentary to financial
activities, and they are permissible for bank-holding
companies. But it is something that is there, and of course
Members of this body as well as my constituents, have concerns
about that and the oil markets as well.
So a careful examination of how commodity markets are
functioning currently with the perspective of those using them
to hedge commodity risk is vitally important as we continue
discussions about the future of the CFTC and the stability and
yes, the even playing field for all of our end-users so that we
protect our banking system, we protect our end-users, we
protect our financial system, and in fact the world economy and
be careful not to ease into another crisis unintentionally.
With that, Mr. Chairman, I yield back.
The Chairman. I thank the gentleman. I would now like to
welcome our panel of witnesses this morning. We have Mr. Scott
Cordes, President, CHS Hedging, Inc., St. Paul, Minnesota, on
behalf of the National Council of Farmer Cooperatives. We have
Mr. Lance Kotschwar. Is that close, Lance?
Mr. Kotschwar. Close.
The Chairman. Okay. Will Lance be okay? Senior Compliance
Attorney, the Gavilon Group, LLC, Omaha, Nebraska, on behalf of
the Commodity Markets Council. We have Mr. Richard F. McMahon,
Vice President, Edison Electric, here in Washington, D.C. We
have Chris Monroe, Treasurer, from Southwest Airlines in
Dallas. We have Andrew Soto, Senior Managing Counsel,
Regulatory Affairs, American Gas Association here in D.C. We
have Mr. Gene Guilford, National & Regional Policy Counsel,
Connecticut Energy Marketers Association, Cromwell,
Connecticut, on behalf of the Commodity Markets Oversight
Coalition.
Mr. Cordes, you are ready to begin, and you have about 5
minutes, if you can hold to the time.
STATEMENT OF SCOTT CORDES, PRESIDENT, CHS HEDGING, INC., ST.
PAUL, MN; ON BEHALF OF NATIONAL COUNCIL OF FARMER COOPERATIVES
Mr. Cordes. Thank you, Chairman. Chairman Conaway, Ranking
Member Scott, and Members of the Committee, thank you for
holding this hearing to review key issues to end-users as you
prepare for CFTC reauthorization. I am Scott Cordes, President
of CHS Hedging, a commodity brokerage subsidiary of CHS Inc.
CHS is a proud member of the National Council of Farmer
Cooperatives, and I appear here today on behalf of NCFC.
Farmer cooperatives are an important part of the success of
American agriculture. In particular, by providing commodity
price risk management tools to their member-owners, farmer
cooperatives help mitigate commercial risk in the production,
processing and selling of a broad range of agricultural, energy
and food products.
As you know, co-ops have long used exchanged-traded futures
and options to hedge the price risk of commodities they
purchase, supply, process or handle for their members. In
recent years, over-the-counter derivatives or swaps have also
become increasingly important to hedge price risk. In fact,
swaps play a critical role in the ability of cooperatives to
provide forward contracts especially in volatile markets.
Therefore, the Committee oversight of CFTC during the Dodd-
Frank rule-making process has been instrumental in ensuring
that co-ops and farmers continue to have access to needed risk
management tools. Continued oversight is important as the
process turns from one of rule-making to one of compliance.
This shift is something that NCFC members are now grappling
with. They must clearly understand the provisions of the
regulations while also figuring out how different regulations
will fit together in a coherent framework. In some instances,
co-ops are finding it challenging to understand how to be
compliant, even as they spend a significant amount of resources
to address the new regulations.
Part of the concern also lies with CFTC's eventual
enforcement of the new regulations. As we have throughout the
process, we urge CFTC to continue to work closely with the
industry and take a collaborative approach to the compliance.
This would be a continuation of the willingness that CFTC has
shown to listen to our concerns during the rule-making process.
Other rules that have not yet been finalized continue to cause
uncertainty over the new costs that will be imposed on the
agriculture industry. For instance, swap dealers, who co-ops
often use to lay off risk, must comply with capital and margin
requirements that are still unknown. What these costs will be
and how they will be processed and passed on to end-users
remains to be seen and could dramatically impact the cost
effectiveness of hedging in the OTC market.
There still is the question of whether the so-called
Prudential Regulators will require bank swap dealers to collect
margin from end-users. We appreciate this Committee's work on
the issue and House passage of the Business Risk Mitigation and
Price Stabilization Act. Clearly, mandatory margin would
increase cost to hedgers, operations and ultimately discourage
prudent hedging practices.
Similarly we are waiting to see what will be contained in
the revised position limits rule. As explained further in my
written statement, two key areas of that rule we ask this
Committee to focus on closely are the definition of bona fide
hedge and the reporting of aggregated positions. The commercial
hedgers could be adversely affected if those issues are not
properly addressed.
In other instances, rules have been finalized and we are
just now finding where it would be difficult or impossible to
comply. In these instances we have to request no-action relief
to the regulation from CFTC. For example, one CFTC regulation
imposes phone recording requirements on some entities, such as
grain elevators, who provide brokerage services so their farmer
customers can hedge on exchanges. Because those elevators are
technically branch offices associated with a futures commission
merchant, they are bound by the same recording requirements as
required as the FCM.
However, given the infrequent and low volume of futures
transaction handled by those branches, complying with the phone
recording requirements under this regulation would not be
economically feasible. The cost to comply with this regulation
would in many cases exceed the total revenues of those FCM
branches. In addition, the recording and indexing of cell phone
conversations pose a huge challenge. If enforced, this
regulation would mean that many local branches would no longer
be able to offer these risk management options. We hope you
will support us in this effort.
Last, I would like to highlight an issue that has generated
a lot of attention with the industry right now, additional
protection for futures customers. NCFC supports much of what
CFTC has proposed in the wake of MF Global and Peregrine's
failures to protect customers. However, we are concerned with
the potential unintended consequences that a one-size-fits-all
regulation may have on hedgers and smaller FCMs. In addition to
increased costs for hedgers, this proposed rule would be more
financially and operationally burdensome to firms like farmer
cooperative owned FCMs which work with hedgers. We are
concerned with several aspects of the proposed regulations
including changes around capital charges, residual interests,
and establishment of risk management systems. Especially
concerning is the requirement that an FCM's residual interest
in customer-segregated account must at all times be sufficient
to exceed the sum of potential margin calls. This is counter to
the historical interpretation and would actually require
customers as farmers to front additional dollars to fund their
hedge accounts while providing little in the way of additional
protection.
While my written testimony delves deeper into those
concerns, I would be pleased to elaborate on the issue or
answer any other questions you may have. Thank you again for
the opportunity to testify today. Thank you, Mr. Chairman.
[The prepared statement of Mr. Cordes follows:]
Prepared Statement of Scott Cordes, President, CHS Hedging, Inc., St.
Paul, MN; on Behalf of National Council of Farmer Cooperatives
Chairman Conaway, Ranking Member Scott, and Members of the
Committee, thank you for the invitation to testify today on
reauthorization of the Commodity Futures Trading Commission (CFTC) and
key issues concerning the agriculture industry's ability to use and
offer risk management tools.
I am Scott Cordes, President of CHS Hedging, a commodity brokerage
subsidiary of CHS Inc. CHS is a farmer-owned cooperative and a grain,
energy and foods company. We are owned by approximately 55,000
individual farmers and ranchers, in addition to about 1,000 local
cooperatives who represent another 350,000 producers. You might also be
interested to know I grew up on a grain and dairy farm in Southeastern
Minnesota that my brother still operates today.
Today, I am testifying on behalf of the National Council of Farmer
Cooperatives (NCFC). NCFC represents the nearly 3,000 farmer-owned
cooperatives across the country whose members include a majority of our
nation's more than two million farmers.
Farmer cooperatives--businesses owned, governed and controlled by
farmers and ranchers--are an important part of the success of American
agriculture. They are a proven tool to help individual family farmers
and ranchers through the ups and downs of weather, commodity markets,
and technological change. Through their cooperatives, producers are
able to improve their income from the marketplace, manage risk, and
strengthen their bargaining power, allowing them to compete globally in
a way that would be impossible to do individually.
In particular, by providing commodity price risk management tools
to their member-owners, farmer cooperatives help mitigate commercial
risk in the production, processing and selling of a broad range of
agricultural, energy and food products. America's farmers and ranchers
must continue to have access to new and relevant risk management
products that enable them to feed, clothe and provide fuel to consumers
here at home and around the world. Last year's drought across much of
the country, which impacted so many producers so severely, once again
illustrates the need for a multilayered risk management strategy in
agriculture.
Cooperatives' Use of Derivative Markets
As processors and handlers of commodities and suppliers of farm
inputs, farmer cooperatives are commercial end-users of the futures
exchanges, as well as the over-the-counter (OTC) derivatives markets.
They use exchange traded futures and options and OTC derivatives to
hedge the price risk of commodities they purchase, supply, process or
handle for their members.
In addition to the exchange-traded contracts, OTC derivatives have
become increasingly important to hedge price risks. Due to market
volatility in recent years, cooperatives are increasingly using these
products to better manage their exposure by customizing their hedges.
This practice increases the effectiveness of risk mitigation and
reduces costs to the cooperatives and their farmer-owners. Swaps also
play a critical role in the ability of cooperatives to provide forward
contracts, especially in times of volatile markets. Because commodity
swaps are not currently subject to the same margin requirements as the
exchanges, cooperatives can use them to free up working capital.
OTC derivatives are not just used for risk management at the
cooperative level, however. They also give the cooperative the ability
to provide customized products to farmers and ranchers to help them
better manage their risk and returns. Much like a supply cooperative
leverages the purchasing power of many individual producers, or a
marketing cooperative pools the production volume of hundreds or
thousands of growers, a cooperative can aggregate its owner-members'
small volume hedges or forward contracts. It can then offset that risk
by entering into another customized hedge via the swap markets.
In addition, there are farmer-owned cooperative futures commission
merchants (FCM), such as CHS Hedging, that provide brokerage services
to farmers, ranchers, and commercial agribusiness. These operations
perform a critical service of providing price risk management to a
customer base comprised largely of physical commodity hedgers.
The Dodd-Frank Act
We greatly appreciate the ongoing oversight the House Agriculture
Committee has provided as the Dodd-Frank rules have been written. Your
work in encouraging the CFTC to ensure that the agriculture industry
has affordable access to innovative risk management tools once the Act
is implemented is commendable. With your continued leadership, we are
hopeful that the agriculture industry will avoid being subject to a
``one-size-fits-all'' type of regulation intended for Wall Street.
As such, we have been working to ensure that the implementation of
the Dodd-Frank Act preserves risk management tools for farmers, their
cooperatives and others involved in the agriculture industry.
During the rulemaking process, NCFC has advocated for the
following:
Treat agricultural cooperatives as end-users because they
aggregate the commercial risk of individual farmer-members and
are currently treated as such by the CFTC;
Exclude agricultural cooperatives from the definition of a
swap dealer;
Acknowledge that forward contracts continue to be excluded
from CFTC swap regulation;
Maintain a bona fide hedge definition that includes common
commercial hedging practices; and
Consider aggregate costs associated with the new regulations
and the impact on the agriculture sector.
We recognize the complexity in crafting rules for the
implementation of Dodd-Frank that best fit cooperatives, and appreciate
the work of the Commission in addressing many of our concerns in the
rule-writing process. While we now know farmer cooperatives will be
treated as end-users and not swap dealers, there are additional
questions and concerns that have arisen since many rules have been
finalized and NCFC members have turned their attention to compliance.
As such, we are doing our best to put into place policies and
procedures, but often find it a challenge to understand what exactly
needs to be done to address the complex regulations. Given this
situation, we also have concerns regarding how CFTC will enforce the
regulations. We urge the Committee to encourage CFTC to work closely
with industry to ensure clear understanding by all parties before
beginning any enforcement actions.
Costs to End-Users
Uncertainty over ultimate costs and market liquidity is an ongoing
concern for farmers and their cooperatives. Agriculture is a high-
volume, low-margin industry, and incremental increases in costs,
whether passed on from a swap dealer or imposed directly on a
cooperative will trickle down and impact farmers. Taken one rule at a
time, the costs may not seem unreasonable, but to those who have to
absorb or pass on the collective costs of numerous regulations it is
evident. Even as end-users, significant resources must be used just to
comply with the additional paperwork requirements. In fact, a number of
NCFC members have had to greatly increase the amounts they have spent
on compliance in the last 2 years on additional staff, outside
assistance, and investments in technology.
It is also unclear how other costs will be forced down to end-users
and impact their ability to hedge. We fear an increased cost structure
due to higher transaction costs (or because certain risk management
tools cease to exist altogether) may discourage prudent hedging
practices. For example, cooperatives often use swap dealers in
utilizing the OTC market to lay off the risk of offering forward
contracts to producers and customers. However, the costs associated
with dealers' compliance with capital, margin and other regulatory
requirements remain unclear.
Additionally, we are concerned with the so-called ``Prudential
Regulators'' margin proposal requiring bank swap dealers to collect
margin from end-users. As end-users, cooperatives use swaps to hedge
interest rates, foreign exchange, and energy in addition to
agricultural commodities. Often, cooperatives look to their lenders to
provide those swaps. Under the proposed rule requiring end-users to
post margin, costs to businesses will increase as more cash is tied up
to maintain those hedges. The additional capital requirements will
siphon away resources from activities and investment in cooperatives'
primary business operations.
Congressional intent was clear on this point--end-users were not to
be required to post margin. We appreciate the House of Representatives
reaffirming this just last month by passing the Business Risk
Mitigation and Price Stabilization Act.
Part 1.35 record-keeping Requirements
As a service to their customers, farmer-owned cooperative FCMs have
a network of branch operations embedded in locations such as grain
elevators, whose primary business is handling the cash grain volume of
their producer customers. As a branch office of a cooperatively-owned
FCM, these commercial grain elevators have chosen to provide brokerage
services as a means of providing access to risk management tools for
their farmer customers who want to hedge their production volume
through futures and/or options.
Given the infrequent and low volume of futures/options transactions
handled by ``branches'' associated with those FCMs, complying with the
oral recording requirements (recording of all phone calls) under this
regulation would not be economically feasible. The necessary investment
to put in place and maintain a system to comply with the regulations
would exceed not only any profits, but in many cases the total revenues
of those FCM branches--to the point that those local branches could no
longer provide brokerage services. The effect would be reduced risk
management options, and their use, by farmers and ranchers.
Moving forward, we intend to ask CFTC for a no-action relief to
this regulation, well before the compliance deadline of December, on
the basis that CFTC recognized the burden that the oral communications
record-keeping requirement would have on other smaller futures brokers.
We hope that you will support our efforts in gaining this relief.
The Position Limits Rule
While the rule imposing position limits for swaps and futures was
vacated by a court decision in September 2012, it is our understanding
that CFTC is redrafting a new proposal. We continue to advocate that
CFTC recognize common commercial hedging practices, such as
anticipatory hedging and cross hedging, as bona fide hedges in that
rule, and look forward to providing input when the proposal is made
available for public comment. We would also encourage this Subcommittee
to keep a close eye on that definition as the rule is rewritten.
Other aspects of this rule have also caused some confusion among
NCFC's members. One example is the section that addresses aggregation
of positions for the purposes of hedge limits for entities in which
ownership of another is ten percent or greater (under the original
rule), or 50 percent under CFTC's earlier re-proposal of the rule.
Given the nature of independent risk management functions of
subsidiaries or joint ventures of some of our cooperatives, it has
caused further confusion over how each partner would communicate and
share that information and/or account for each other's positions on a
day-to-day basis.
The Forward Exclusion
Forward contracting allows farmers, cooperatives, and other
businesses to price their product into the future, take positions to
try to maintain a profit margin, and protect against unknown but
potentially adverse price fluctuations. Therefore, understanding what
constitutes an excluded forward contract is critical in order for
businesses to continue their commercial supply and sales contracts.
We appreciate the guidance set forth regarding the forward
exclusion in the product definitions rule. That guidance provided
certainty about what constitutes an excluded forward contract, as
forward contracts in non-financial commodities that contain embedded
price options would be excluded forward contracts and not considered to
be ``swaps.''
Recently, however, in light of the CFTC's seven-part interpretation
in the rule, some NCFC members have raised concerns over the
appropriate treatment of forward contracts commonly used in physical
supply arrangements that contain volumetric optionality. If the CFTC
were to take a narrow view of the seven-part interpretation, it may
view as options many other routine physical supply contracts in which
the predominant feature is delivery.\1\ Such an interpretation would
require those common commercial forward contracts to come under the
regulations intended for swaps such as reporting and position limits.
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\1\ Many commercial parties, including cooperatives, include some
volumetric flexibility in physical supply agreements for both
commercial and operational reasons. This allows them to address the
uncertainty caused by likely changes in supply and demand fundamentals,
including, for example, changes in suppliers and customers,
transportation/vessel availability and capacity, operation and
maintenance of a facility, and other commercial considerations that
arise in the normal course of managing a physical commodity business.
For example, some dairy cooperatives utilize volumetric flexibility in
the sale of milk, both to minimize marketing costs and to balance
supply and demand. It is not unusual for milk sales contracts to
require a monthly range in deliverable volume. This is done to address
the unknown supply and demand dynamics that will occur between seasons
of the year (more milk is produced in the spring time than in the fall,
while plant-level demand is greater in the fall as product is made for
the holiday season). Additionally, dairy cooperatives that supply
beverage milk plants need to have flexibility to divert deliveries to
beverage plants during high demand parts of the week (beverage bottlers
have their greatest demand on a Thursday to meet supermarket customers'
heaviest grocery shopping period over the weekend).
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The uncertainty of the CFTC interpretation of these types of
contracts, all previously covered under the forward contracting
exclusion, will require NCFC members to expend significant labor and
costs to review hundreds of sales transactions to determine if they
continue to meet the forward contract exclusion. Again, this is an
unnecessary resource and cost burden on end-users that should be
avoided. We hope CFTC will interpret this exclusion consistently with
its historical understanding and prior guidance.
Customer Protection
NCFC supports strengthening protections for futures customers. We
appreciate the House Agriculture Committee's hearings on this issue and
the work CFTC has done in proposing new rules in this area subsequent
to the failure of MF Global and Peregrine Financial Group. However, we
are concerned with the potential unintended consequences that a ``one-
size-fits-all'' regulation may have on hedgers and smaller FCMs. The
proposed rules do not take into account the type of FCM--by size, the
risk profile of their customers, or whether or not the FCM also has
proprietary trading or is a broker-dealer. In addition to increased
costs for hedgers, this proposed rule would be more burdensome to
smaller firms like farmer cooperative-owned FCMs, which largely deal
only with hedgers.
Regulations that would accelerate a further consolidation in the
FCM industry would have the adverse effect of leaving commodity hedgers
with fewer options, while concentrating risk among fewer FCM entities.
While the issues behind the decreasing numbers of FCMs are more complex
than just regulatory burden, we are concerned with several aspects of
the proposed regulations, including changes around capital charges,
residual interest, and establishment of risk management systems under
Rule 1.11, which will be financially and operationally burdensome for
smaller FCMs.
One provision would require an FCM to take a capital charge with
respect to any margin call that is outstanding for more than one
business day, as opposed to the current practice of 3 business days.
This proposed rule would clearly disadvantage smaller FCMs and many
retail customers. Many smaller hedgers do not transfer funds by wire,
but rather write checks. As such, it is common practice for farmer
cooperative-owned FCMs to pay the clearing houses or the clearing FCMs
in advance of receiving customer funds. By adding the additional
capital charge after just one day, FCMs will possibly be forced to
require their customers to wire transfer/ACH funds or maintain
excessive funds in their account. The costs associated with either
option would disproportionately affect smaller hedgers, while adding
little in the way of added customer protection.
Another provision would require that an FCM's residual interest in
the customer-segregated account must at all times be sufficient to
exceed the sum of the margin deficits that the FCM's customers have in
their accounts. This requirement is counter to the historical
interpretation, which requires an FCM to maintain residual interest to
cover customer-segregated accounts with negative net liquidating
balances (debit equity). This gives an FCM time to collect customer
funds prior to the time a payment must be made to the clearing house.
In addition to increased costs for hedgers, this proposed rule
would be more burdensome to firms like farmer cooperative-owned FCMs,
which largely deal only with hedgers. Although the risk profile of the
customer base is very low, customers are predominantly on one side of
the market and therefore more susceptible to big swings in the market.
To require all deficits to be covered immediately would be overly
burdensome on these FCMs given the low-risk profile of their customers
as hedgers. We encourage Members of this Subcommittee to express
concerns over this proposal to CFTC.
Thank you again for the opportunity to testify today before the
Committee on behalf of farmer-owned cooperatives. We appreciate your
role in ensuring that farmer cooperatives will continue to be able to
effectively hedge commercial risk and support the viability of their
members' farms and cooperatively owned facilities. I look forward to
answering any questions you may have.
Thank you.
The Chairman. Thank you. Lance, 5 minutes.
STATEMENT OF LANCE KOTSCHWAR, SENIOR COMPLIANCE ATTORNEY,
GAVILON GROUP, LLC, OMAHA, NE; ON BEHALF OF COMMODITY MARKETS
COUNCIL
Mr. Kotschwar. Thank you, Chairman Conaway, Ranking Member
Scott, and Members of the Subcommittee. Thank you for the
invitation today. My name is Lance Kotschwar. I work for
Gavilon in Omaha, Nebraska, and I am a senior compliance
attorney. I am testifying today on behalf of the Commodity
Markets Council.
CMC is a trade association comprised of exchanges and their
industry counterparts. Our activities include the complete
spectrum of commercial end-users including all the futures
markets and all of energy and agriculture products. We are
well-positioned to provide the consensus views of commercial
end-users of derivatives, and my views today represent the
collective view of the CMC membership.
Our members depend on efficient and competitive functioning
of U.S. futures exchanges, and we support well-regulated
markets as long as the regulations are reasonable. As you seek
to reauthorize to CFTC, we would like to emphasize several
points starting with this. Any time that we change regulations
that affect the hedging mechanism, that is going to introduce
risk into the system that is going to have to be priced, and
that is going to be a negative impact on both producers and
consumers and everything in between. So to help inform you as
you reauthorize, I want to offer a few thoughts and comments
about our end-user concerns. My written statement goes into a
lot of details about protection of customer collateral, but I
want to spend my time focusing on our end-user concerns.
As Mr. Cordes said, we have a lot of concerns about this
Part 1.35 record-keeping requirements. As the CFTC was going
through the rule-making process, CMC was very engaged on it. We
wanted to make sure that this expansion would not require non-
clearing members of a DCM to have to record phone calls related
to physical commodity purchases and sales. Just going to a
straight example, we didn't want grain companies that have
exchange memberships to have to record phone calls to farmers.
Well, we won that battle, but we lost the bigger war
because we weren't paying close attention to the fine print.
The CFTC final rule quietly inserted some additional language
that previously existed only in a guidance document that
significantly expanded the scope of what they consider to be an
electronic document, and they basically expanded to cover
everything except oral conversations. It includes text
messaging, instant messaging, e-mail and any other electronic
communication. The cost of maintaining all this stuff is quite
substantial and particularly you are trying to doing in a
searchable format as the CFTC has requested, to the extent that
is even technically feasible. In our case, we have totally
instructed all of our grain locations they are not to use any
kind of instant messaging at all right now. We have forced them
back to the phones. So that is probably the exact opposite of
what this rule is supposed to do.
Let me just to expand on what Mr. Cordes said. If you have
a grain elevator with 100 locations, on any given day they are
buying and selling grain all over the country. They are not
doing futures for each individual sale. They look at their net
exposure, and then that is what they go to the exchange with.
So under the CFTC's rule, are we going to record all those
phone calls when you have to get a tenuous connection to what
the futures layoff is anyway? It doesn't seem to be a very good
public policy process, especially since they are telling us we
don't have to record phone calls but you have to do everything
else. Let us face it. Text messaging and other kinds of
electronic communications have largely replaced phone calls
today in the 21st century. So if the policy is not to record
phone calls, we need to be a little more logical about it.
Another area that we have some concerns about is bona fide
hedging. Congress provided a definition of bona fide hedging
within Dodd-Frank that the CFTC has unnecessarily narrowed.
They have come up with at least five different definitions in
various rules, and that creates a lot of confusion and could
disrupt legitimate risk mitigation practices. We certainly are
very interested in working with you to try to get this whole
notion of bona fide hedging steered back in the right
direction.
As Mr. Cordes has also said, we also have concerns about
the scope of the swap dealer definition. We believe that the
final rule defining who must register was--the Dodd-Frank Act,
that was largely a category that was designed for large
financial institutions. But we believe the way it has been
implemented, it is altering trading activity between commercial
market participants, and it is pushing more swap activity into
the large dealer banks which is exactly the opposite of what
Dodd-Frank wanted to do. Commercial participants are curtailing
their trading activities for fear of having to get caught up in
that definition of what a swap dealer is because they can't
comply with the requirements.
We have some other concerns, too. I will just briefly
mention them. We have some concerns about historical swap
reporting, the real-time reporting rule as it relates to
especially trading in illiquid months, position limits,
particularly aggregation, and last, residual interest which was
written under the heading of customer protection but as written
will have a costly and negative impact for our members and the
FCMs that we use.
And with that, I yield back the rest of my time.
[The prepared statement of Mr. Kotschwar follows:]
Prepared Statement of Lance Kotschwar, Senior Compliance Attorney,
Gavilon Group, LLC, Omaha, NE; on Behalf of Commodity Markets Council
Chairman Conaway, Ranking Member Scott, and Members of the
Subcommittee: thank you for holding this hearing to review the
reauthorization of the Commodity Futures Trading Commission (``CFTC'').
My name is Lance Kotschwar, Senior Compliance Attorney for Gavilon
Group, LLC. I am testifying today on behalf of the Commodity Markets
Council (``CMC'').
CMC is a trade association that brings together commodity exchanges
and their industry counterparts. The activities of CMC members include
the complete spectrum of commercial end-users of all futures markets
including energy and agriculture. Specifically, our industry member
firms are regular users of the Chicago Board of Trade, Chicago
Mercantile Exchange, ICE Futures U.S., Kansas City Board of Trade,
Minneapolis Grain Exchange and the New York Mercantile Exchange. CMC is
well-positioned to provide the consensus views of commercial end-users
of derivatives. My comments represent the collective view of the CMC
membership.
All CMC member firms depend upon the efficient and competitive
functioning of the risk management products traded on U.S. futures
exchanges. CMC and its members support well-regulated markets, and
while the financial crisis of 2008 had nothing to do with commodity
markets, we recognize the need for the Dodd-Frank Act and support its
goals. In turn, that regulation should be efficient and reasonable
rather than overly prescriptive and complex.
Regulatory initiatives that lack clarity or evolve to be at cross-
purposes with the core principles on which the Commission was founded
are concerning to CMC members. Such regulatory disparities generate
market inefficiencies and costs, which widen price margins between
producers and consumers of energy and agricultural commodities, as well
as those finished food, energy, and consumer products that derive from
the underlying commodities.
Most agricultural commodities are produced seasonally yet consumed
continuously, whereas energy commodities are produced continuously and
consumed seasonally. We manage that flow of physical commodity and
dynamically hedge it, allowing us to offer higher prices to producers
and lower prices to consumers. As Congress seeks to once again
reauthorize the CFTC, we would like to emphasize several points
starting with this: undue regulatory interference with the hedging
mechanism introduces risk that must be priced into the chain,
negatively affecting both ends and everything in between.
At this critical juncture in Dodd-Frank rule writing and
implementation, CMC members are concerned that the CFTC's efforts to
implement new swap regulatory rules has now morphed into a crusade of
rewriting many long-standing futures market regulations that Congress,
via Dodd-Frank, never contemplated. Even more problematic is that this
regulatory barrage is occurring almost entirely without consideration
of real costs on commodity producers or consumers. The additional
regulatory costs that the CFTC is forcing upon end-users and commercial
participants will ultimately be passed on to the consumers of commodity
products and will also reduce market liquidity, further raising the
costs of risk management, and ultimately the cost of finished
agricultural and energy goods.
Issues of Concern
Generally our ideas for legislative changes fall into two main
categories: improvements to the protection of customer collateral in
derivatives markets and concerns related to the implementation of
various provisions of the Dodd-Frank Act with respect to the impacts on
commercial end-users.
Protection of Customer Collateral
Given recent events surrounding the collapse of two Futures
Commission Merchants (``FCMs'') and the mismanagement and disappearance
of customer collateral, we request that the Committee consider the
various market driven proposals to further protect these assets, as
they are vital to our member companies and all other market
participants seeking to manage risk in the derivatives markets. Ideas
of alternative collateral segregation regimes and insurance programs
have been floated, and we encourage both this Committee and other
relevant Congressional committees to fully examine and vet these
proposals to allow for further protection of customer collateral.
CFTC Customer Protection Proposal
CMC commends the efforts of the National Futures Association
(``NFA'') and the CFTC to improve certain aspects of how customer
collateral is treated, although there is one particular issue raised by
the CFTC in a recent proposed rule that has generated serious concern
among our members. Specifically, CMC strongly believes that the
proposed requirement that FCMs maintain a residual amount sufficient to
cover on a constant basis the aggregate of customer margin deficits
could create considerable liquidity issues and increase costs for FCMs,
producers, and end-users. Such a decrease in liquidity could be
substantial and limit the number and type of transactions FCMs clear,
the number of customers they service, and the amount of financing they
provide. The proposal would require FCMs to fund accounts holding their
customers' collateral with proprietary assets in excess of the
aggregated margin deficiencies of all its clients on a continuous
basis. The proposal also appears to require executing FCMs to collect
collateral for give-ups so that customer positions are fully margined
in the event a clearing FCM rejects a trade. If the proposed residual
interest provision were to be finalized, FCMs may be forced to take
steps such as over-margining clients, requiring clients to pre-fund
their margin accounts, imposing punitive interest rate charges on
margin deficit balances, and introducing intra-day margin calls. Such
steps would dramatically increase the cost of using futures markets and
may force many end-users to decrease or discontinue hedging and risk
management practices, which is the reason these markets were created.
Market participants are active in developing methods of early
detection of any improper transfer of customer funds due to errors or
theft. For example the Chicago Mercantile Exchange (``CME'') and the
NFA have implemented various protective measures, including: (1)
requirements regarding an FCM's residual financial interest in customer
accounts, (2) restrictions on an FCM's disbursements from customer
accounts, and (3) procedures that will facilitate monitoring of
customer funds.
In order to detect an improper reporting of asset balances, CME and
NFA have implemented a number of measures, most of which relate to
confirmation of balances and review of bank statements and certain FCM
information. Both designated self-regulatory organizations are using an
aggregator to get bank balances reported to them electronically on a
daily basis.
CME and NFA also perform limited reviews of the customer
investments reported on the Segregated Investment Detail Reports to
ensure compliance with the requirements of CFTC rules. CME performs
detailed audit work on risk-based examinations, including a review of
qualified depositories, third-party statements, reconciliations, mark-
to-market schedules, valuation (readily marketable and highly liquid),
obtaining confirmations, etc. Additionally, in April 2012, CME started
performing limited reviews of customer segregated, secured, and
sequestered statements on a surprise basis outside of the regular risk-
based examination.
End-User Concerns
The CFTC has been working diligently since the passage of Dodd-
Frank in July of 2010 and should be commended for the progress they
have made thus far. CMC recognized and supported the need for reform in
the over-the-counter (OTC) swaps market and believes that Dodd-Frank
provided a foundation for an effective overhaul of this important risk-
management market. However, there are various issues that have arisen
as part of the implementation process which we believe the Committee
should revisit going forward.
Part 1.35 record-keeping Requirements
A significant and concerning expansion of current data requirements
beyond the scope of Dodd-Frank is related to record-keeping
requirements in Part 1 of Commission regulations. In accordance with
Dodd-Frank, the CFTC expanded the futures record-keeping requirements
that existed for certain markets participants to swaps. However, they
also significantly expanded the written requirements, as well as
created a new requirement to record oral conversations.
Compliance costs have already been incredibly substantial now that
compliance with the written requirements is mandatory and will only
increase once compliance with the oral recording requirement comes into
effect later this year. Again, the market is searching for a reason for
and measurable benefit of all of this new information that must be
maintained and archived in a particular way.
In addition, the rule is vague as to which communications must be
retained, so in an abundance of caution, market participants are
effectively saving every e-mail, news article, or any other piece of
information that might ``lead to the execution of a transaction'' and
soon will have to begin recording every phone call that might ``lead to
the execution of a transaction.'' This vague ``lead to . . .'' language
appears nowhere in any prior iteration of Rule 1.35 or in any prior
CFTC Advisory relating to the rule, and operates to expand
substantially the scope and burdens of the rule. Also, the application
of the requirements to members of an exchange seems to have no
regulatory rationale and only serves as a disincentive to be an
exchange member.
Finally, the cost figures contained in the cost-benefit analysis in
the final rule are not justified. Compliance costs are exponentially
higher than they estimate, and in some cases the technology is not even
available to market participants. Requests for clarification have not
yet been answered, and CMC will be submitting a written request soon in
a continued effort to clarify and hopefully narrow the scope of what
must be retained and, therefore, reduce what we view as unnecessary
compliance costs.
Scope of Swap Dealer Definition
The Commission's final rule defining who must register as a swap
dealer, a regulatory category that carries an immense regulatory burden
and was designed for large financial institutions, is altering trading
activity between commercial market participants and pushing more swap
activity into the large dealer banks. This is directly counter to the
goal of Dodd-Frank to increase competition and reduce the concentration
of risk in a few large financial firms. We do not believe that Congress
intended to capture commercial end-users as swap dealers for swap
activity that is ancillary to their physical commodity business, but
that is exactly what the final CFTC rule accomplishes.
Many commercial market participants are curtailing trading
activities with other end-users for fear of being captured by a
complicated, capital-based regulatory regime designed for large
financial institutions with which most end-users are incapable of
complying. We do not believe this was the intent of Congress, and in
fact seems to be the complete opposite outcome by further consolidating
trading activity in a few large financial institutions. We urge the
Committee to revisit this very important issue.
Current regulations have arbitrarily established a de minimis
level, the breach of which requires registration as a swap dealer, at
$8 billion with a drop to $3 billion following an unpredictable CFTC
decision making process. The only certainty in the process is that a
lack of action will result in the de minimis level declining in 5
years. This $3 billion level is also arbitrary and would significantly
affect the number of firms defined and regulated as swap dealers.
Changes should not be made through such a long and ill-defined process,
which includes several unpredictable and difficult to follow steps for
market participants. We need a more predictable process.
Reporting and record-keeping under Part 46
Part 46 of the Commission's regulations requires market
participants to report swap trades entered into from July 21, 2010,
when the Congress passed Dodd-Frank, until April 10, 2013. Included in
the transactions subject to this requirement are energy swaps as well
as cleared Exchange of Futures for Related Positions (``EFRP'') trades,
which were centrally cleared by the CME Group and Intercontinental
Exchange. In these transactions, the original trade only occurs if it
is accepted for clearing, and once it is, the original trade is
terminated and replaced with two new trades with each of the original
executing counterparties facing the clearinghouse. The original trade
creates zero risk, and the reporting of the trade serves no regulatory
purpose that we can discern. The reporting requirement does, however,
create a significant compliance burden on end-users. Given that the
data is available to regulators from the clearinghouses and the
clearinghouses have reported the trades on the market's behalf, the
CFTC should grant the multiple requests from market participants to
waive the historical reporting requirement for end-users.
Real-Time Reporting
Under the real-time reporting rule, end-users have a longer time in
which to report trades with other end-users. However, trades that
involve a swap dealer or major swap participant must be reported in a
much shorter time after execution. Because the rule requires trades
between a non-dealer and a swap dealer be reported within the dealer's
time limit, swap dealers and major swap participants have limited time
to lay off risk before the trade is made public. While the delay may be
sufficient for liquid markets, they are not sufficient for illiquid
markets and time frames. When a dealer has to report such illiquid
trades to the market quickly and the dealer may not be able to lay off
the risk of that trade in the prescribed time, the dealer is taking a
risk and will charge the counterparty (here, the commercial end-user)
for that increased risk if they are willing to execute the trade at
all. This increased cost and possible inability to trade in illiquid
markets will hurt commercial end-users' ability to efficiently hedge.
Inter-Affiliate Transactions
Inter-affiliate trades are subject to record-keeping requirements
under Part 45, requiring that the records of inter-affiliate swaps are
``full, complete, and systematic.'' We view this requirement as
burdensome and providing very little benefit relative to the increased
cost to our members. The information that the Commission is seeking is
available through the visibility of market-facing swaps, as they are
largely identical. Additionally, these inter-affiliate and market-
facing trades are for the purpose of hedging or mitigating commercial
risk and are documented pursuant to inter-affiliate agreements such
that both parties must make payments and deliveries specified, although
the transactions may be settled by an intercompany transfer or
allocation. The internal documentation is done as necessary for
internal purposes, but may not contain all information required or in
the format required under Part 45.
With respect to mandatory clearing and the end-user exception, we
appreciate the Commission's recent relief providing an exemption for
swaps between commonly owned affiliates. The Commission still needs to
clarify that swaps entered into by a centralized hedge function of a
commercial entity are eligible for the end-user clearing exception when
hedging on behalf of the commercial company, whether or not the entity
housing the hedge function for the company is by definition a financial
entity.
Position Limits Aggregation and Reporting of Daily Physical Positions
The CFTC's rule imposing position limits for swaps and futures was
vacated in September 2012 [shortly before compliance became mandatory].
The part of the rule that addressed aggregation of entities for
purposes of position limits was re-proposed but not finalized before
the rule was vacated. That re-proposal required aggregation of entities
in which one has ownership of the other of 50% or greater, and provided
an exception from aggregation at 10% or lower ownership level. Between
10-50%, there is a multi-factor test to determine if aggregation of
required, with a presumption of control.
Although the rule has been vacated, the CFTC has both appealed the
court's ruling and is drafting a new proposal. We urge the CFTC to
adopt a rule that requires aggregation based on control, rather than
percent ownership and not to include any presumption of control.
Aggregation is appropriate only when one entity controls the trading
activity of another entity or has unfettered access to trading
information of such other entity that could be used to facilitate its
own trading. Absent such control and access to information, aggregation
should not be required, regardless of the percent ownership or equity
interest in the owned entity. For example, in the context of a limited
partnership, a limited partner may own a majority of the partnership
and be entitled to the majority of its profits, although day-to-day
control of the partnership actually vests with the general partner.
Further, it is particularly true in connection with joint ventures that
majority ownership does not necessarily equate to the majority owner's
control of the owned entity's trading activity.
The automatic application of the aggregation requirement to persons
holding in excess of 50% ownership or equity interest would force
market participants to share information and coordinate trading, which
is exactly what the CFTC seeks to prevent. Such sharing of information
may also raise antitrust concerns, notwithstanding the Commission's
clarification that an information sharing exemption will be granted
provided such initial sharing of information does not give rise to a
``reasonable risk'' of violating Federal laws. Under the final position
limits rule, affiliated entities will be required to assign position
limits among several accounts that are presently traded independently
of, and in competition with, each other. CMC is concerned that
continuous correspondence and negotiations between affiliated entities
will expose them to charges of collusive and anticompetitive behavior.
Given the nature of trading, it is highly impractical to ask the
opinion of counsel as to whether information sharing at any point
during intra-day trading gives rise to a ``reasonable risk'' of Federal
antitrust laws being violated. As such, in practice, affiliated
entities will be unable to avail themselves of the protection seemingly
afforded by the information sharing exemption currently constructed in
Part 151.7(i).
The vacated position limits rule also required the reporting of
daily physical positions to justify hedge exemptions, which under the
rule were only available to commercial market participants, rather than
the historical requirement of monthly physical position reporting. The
change would be virtually impossible for a global commodities firm to
comply with. The industry viewed the change as unnecessary and overly
burdensome, given that the Commission has always had the ability to ask
for data to justify a hedge exemption. We do not believe it is an
efficient or productive use of resources to devote the time that would
be required to review all of the new data and, if those resources are
not devoted to review all of the data, it is inefficient to constantly
collect given that the CFTC may at any time ask for the data. We
believe the CFTC should retain the historical requirement to report
monthly positions in any new position limits proposal.
Bona Fide Hedging
Congress provided a definition of a bona fide hedge within Dodd-
Frank that the CFTC has unnecessarily narrowed, including related to
anticipatory hedging, and has created at least five different
definitions in various rules of what constitutes a bona fide hedge.
This is nonsensical and creates unnecessary confusion, while disrupting
legitimate risk mitigation practices. We are committed to working with
Congress to set clearer direction on bona fide hedges so that
transactions that limit economic risks are viewed as bona fide hedges
by the CFTC.
Summary
Commodity derivatives markets continue to grow and prosper. They
have become deeper and more liquid, narrowing bid/ask spreads, and
improving hedging effectiveness and price discovery. All of these
developments serve the interests of the trade as well as the public.
The regulation of swaps has also motivated a general industry move
toward the futures market, which has been termed ``futurization.''
While we will continue to transact swaps especially for more tailored
transactions, we support the transition to futures.
The swap reforms in Dodd-Frank were not necessary because of
problems in physical commodity markets. Commercial end-users of
agricultural and energy futures had no role in creating the financial
crisis. In fact, the regulated futures market fared well throughout the
financial crisis and futures markets generally provide greater
regulatory certainty for our members than evolving swaps regulations.
We believe that as Congress considers how the CFTC is to regulate
in the future, it should use the core principles on which the CFTC was
created as its guide. A balance must be maintained between regulatory
zeal and consideration as to how regulatory changes could result in
negative consequences to not just CMC members in the middle of the food
and energy chain, but also to the producers and consumers on each side
of the chain. Given this, we strongly believe that the CFTC's current
trend toward very prescriptive changes to futures market regulation
will hinder rather than improve our economy's ability to manage
commodity market risks.
While the independent regulatory agency that this Committee has
oversight responsibilities over must continue to evolve in order to
adequately regulate increasingly complex derivatives markets, many of
these pending changes also introduce the potential for regulators to
create risk and increase costs by going beyond their purview. Doing so
without consideration of the consequences is dangerous and violates
both the ``do no harm'' principle of being a regulator as well as the
CFTC's core principles regulatory methodology.
At present, this barrage of new CFTC rules is causing compliance
costs to skyrocket. In addition, significant regulatory uncertainty
continues to exist, and despite the approximately 100 various letters
issued by the Commission to clarify rule language or extend compliance
dates, many compliance questions remain.
The objective of the Commodity Exchange Act has never been to
discourage hedging, but rather to create a market and regulatory
environment that maintains market integrity while promoting the
economic benefits of risk management. Purposely adding complexity and
regulatory uncertainty to the marketplace only adds unnecessary costs.
Uncertainty, via additional regulation of the risk management tools
that commodity market participants utilize, actually creates risk where
it didn't previously exist.
Thank you for this opportunity to testify. We look forward to
continuing to work with this Committee to strike the right balance.
I look forward to your questions.
The Chairman. Thank you very much. You get extra-credit for
that later on.
Mr. Kotschwar. Thank you.
The Chairman. Mr. McMahon, 5 minutes.
STATEMENT OF RICHARD F. McMAHON, Jr., VICE PRESIDENT OF ENERGY
SUPPLY AND FINANCE, EDISON ELECTRIC
INSTITUTE, WASHINGTON, D.C.
Mr. McMahon. Good morning. Chairman Conaway, Ranking Member
Scott, and Members of the Subcommittee, thank you for the
opportunity to discuss the perspective of end-users on the
future of the CFTC.
I am Richard McMahon, Vice President of Energy Supply and
Finance for the Edison Electric Institute. EEI is the trade
association of U.S. shareholder-owned electric utilities. My
views are also shared by the Electric Power Supply Association,
which is the national trade association for competitive
wholesale electric suppliers.
The electric power industry is the most capital-intensive
industry in the United States, an $840 billion industry. Our
members are projected to spend approximately $90 billion per
year through 2015 on cleaner generating capacity, environmental
and energy-efficiency upgrades, as well as smart grid and cyber
security improvements.
Our members are non-financial entities that primarily
participate in the physical commodity market and rely on swaps
and futures contracts primarily to hedge and mitigate their
commercial risk. The goal of our member companies is to provide
their customers with reliable electric service at affordable
and stable rates. Since wholesale electricity and natural gas
historically have been two of the most volatile wholesale
commodity groups, our members manage these risks using
derivatives for the benefit of their customers. In essence, our
members are the quintessential commercial end-users of swaps.
Our members support the goals of Dodd-Frank. We believe,
however, that there are areas where Congress should consider
minor adjustments.
A new category of market participants, swap dealers, was
created by Dodd-Frank. These swap dealers must register with
the CFTC and are subject to extensive and burdensome regulatory
requirements. The CFTC was directed to exempt entities that
engage in a de minimis quantity of swap dealing. The CFTC set
this threshold at $8 billion. However, it will be reduced
automatically to $3 billion in 2018 absent CFTC action.
We oppose such a dramatic reduction in the de minimis
threshold without deliberative CFTC action including a formal
rulemaking process that allows stakeholders to provide input on
what the appropriate threshold should be.
As I previously mentioned, the electric power industry is
one of the most capital-intensive industries. Requiring non-
financial end-users to post margin could tie up much-needed
capital that would otherwise be used to invest in local
economies and to create jobs. Congress should clarify that it
did not intend for margin requirements to apply to non-
financial end-users.
Last year, the U.S. District Court vacated final CFTC rules
regarding position limits. These vacated rules defined the term
bona fide hedging in a way that was unnecessarily narrow and
would have discouraged a significant amount of beneficial risk
management activity. This restrictive definition of bona fide
hedging transactions could make hedging more difficult and
costly and inadvertently increase systemic risk by encouraging
end-users to leave large portions of their portfolios unhedged.
Congress should direct CFTC to allow transactions to be
considered bona fide hedging if they meet general requirements,
not limited to this enumerated list.
The Dodd-Frank Act defines the term financial entity as an
entity that is predominantly engaged in activities that are in
the business of banking, or in activities that are financial in
nature. Dodd-Frank allows affiliates or subsidiaries of an end-
user to rely on the end-user exemption when entering into a
swap on behalf of the end-user. However, swaps entered into by
end-user hedging affiliates who fall under the definition of
financial entity cannot take advantage of the end-user
exemption. Congress should amend the definition of financial
entity to ensure that commercial end-users are not
inadvertently regulated as a financial entity.
Currently, the CFTC's rules generally treat affiliate swaps
like any other swap. So companies must, under certain
circumstances, report swaps between majority-owned affiliates
and must submit such swaps to clearing unless the end-user
hedging exception applies or a complex criteria for inter-
affiliate clearing exemptions are met.
The CFTC has provided some relief in the form of no-action
letters. However, these no-action letters are often
insufficient and cause uncertainty among end-users. EEI
supports bipartisan legislation to address the inter-affiliate
transaction issue.
In closing, I would like to thank you and your leadership
and the ongoing interest in the issues surrounding the
implementation of Dodd-Frank and their impact on commercial
end-users.
And again, I appreciate the opportunity to testify and
would be happy to answer any questions.
[The prepared statement of Mr. McMahon follows:]
Prepared Statement of Richard F. McMahon, Jr., Vice President of Energy
Supply and Finance, Edison Electric Institute, Washington, D.C.
Introduction
Chairman Conaway, Ranking Member Scott, and Members of the
Subcommittee, thank you for the opportunity to discuss the perspective
of end-users on the future of the Commodity Futures Trading Commission
(CFTC).
I am Richard McMahon, Vice President of Energy Supply and Finance
for the Edison Electric Institute (EEI). EEI is the trade association
of U.S. shareholder-owned electric utilities, with international
affiliates and industry associates worldwide. EEI's U.S. members serve
virtually all of the ultimate electricity customers in the shareholder-
owned segment of the industry, and represent approximately 70 percent
of the total U.S. electric power industry.
The electric power industry is the most capital-intensive industry
in the United States--an $840 billion industry representing
approximately three percent of real gross domestic product. Our
industry is projected to spend approximately $90 billion a year through
2015 for major transmission, distribution and smart grid upgrades;
cybersecurity measures; new, cleaner generating capacity; and
environmental and energy-efficiency improvements.
My views are shared by the Electric Power Supply Association
(EPSA), which is the national trade association for competitive
wholesale electricity suppliers, including power generators and
marketers. EPSA members include both independent power producers and
the wholesale supply businesses of utility holding companies. EPSA
members supply electricity nationwide with an emphasis on the \2/3\ of
the country located within a regional transmission organization or
independent system operator (so-called ``organized markets''). EPSA
members and other competitive suppliers account for 40 percent of the
installed electric generating capacity in the United States. These
suppliers are the primary sources of electricity for most of Maine to
Virginia, across to Illinois, and in Texas and California.
Our members are non-financial entities that primarily participate
in the physical commodity market and rely on swaps and futures
contracts primarily to hedge and mitigate their commercial risk. The
goal of our member companies is to provide their customers with
reliable electric service at affordable and stable rates, which has a
direct and significant impact on literally every area of the U.S.
economy. Since wholesale electricity and natural gas historically have
been two of the most volatile commodity groups, our member companies
place a strong emphasis on managing the price volatility inherent in
these wholesale commodity markets to the benefit of their customers.
The derivatives market has proven to be an extremely effective tool in
insulating our customers from this risk and price volatility. In sum,
our members are the quintessential commercial end-users of swaps.
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (the ``Dodd-Frank Act'') provides certain
exemptions for non-financial end-users, recognizing that they are not
the entities posing systemic risk to the financial system. Since
passage of the Dodd-Frank Act, we have been actively working with the
Federal agencies, including the CFTC, as they work their way through
the implementation process to ensure that the Congressional intent of
exempting non-financial end-users remains intact. Even though a
majority of the rules have been promulgated by these agencies, concerns
still surround some of the remaining issues important to electric
companies.
Our members support the Dodd-Frank Act's primary goals of
protecting the financial system against systemic risk and increasing
transparency in derivatives markets. We believe, however, that there
are areas where Congress should consider minor adjustments to ensure
the Dodd-Frank Act achieves its purpose while not inadvertently
impeding end-users' ability to hedge. As Congress examines possible
modifications to the Commodity Exchange Act, we ask that you consider
the following issues:
De Minimis Level
A new category of market participants, swap dealers, was created by
the Dodd-Frank Act. These swap dealers must register with the CFTC and
are subject to extensive record-keeping, reporting, business conduct
standards, clearing, and--in the future--regulatory capital and margin
requirements. However, the Act directed the CFTC to exempt from
designation as a swap dealer entities that engage in a de minimis
quantity of swap dealing. The CFTC issued a proposed rule on the de
minimis threshold for comment in early 2011. After review of hundreds
of comments, a series of Congressional hearings and after dozens of
meetings with market participants, the CFTC set this de minimis
threshold at $8 billion. However, it will then be reduced automatically
to $3 billion in 2018 absent CFTC action.
We oppose such a dramatic reduction in the de minimis threshold
without deliberate CFTC action. Inaction is always easier than action,
and inaction should not be the default justification for such a major
regulatory action. In addition, we believe the CFTC should not have the
authority to change the de minimis level without a formal rulemaking
process that allows stakeholders to provide input on what the
appropriate threshold should be.
Absent these procedural changes, we are concerned a deep reduction
in the de minimis level could result in commercial end-users being
misclassified as swap dealers, hindering end-users' ability to hedge
market risk while imposing unnecessary costs that eventually will be
borne by consumers.
Margin Requirements
As I previously mentioned, the electric power industry is one of
the most capital-intensive industries in the United States. With our
industry projected to spend approximately $90 billion a year through
2015 for major upgrades to the electric system, requiring non-financial
end-users to post margin could tie up much-needed capital that
otherwise would be used to invest in local economies. With the lack of
clarity on whether or not Prudential Regulators and possibly the CFTC
plan on requiring non-financial end-users to post margin, Congress
should clarify that it did not intend for margin requirements to apply
to non-financial end-users.
In addition, we ask Congress to clarify that it did not intend for
the CFTC and Prudential Regulators to place limitations on the forms of
collateral swap dealers and major swap participants can accept from
non-financial end-users if they agree to collateralize a swap as a
commercial matter. We support bipartisan legislation that seeks to
further clarify that end-users are exempt from margin requirements.
H.R. 634, sponsored by Rep. Michael Grimm (R-NY), passed the House on
an overwhelmingly bipartisan vote of 411-12. Similar legislation has
also been introduced in the Senate--S. 888, sponsored by Sen. Mike
Johanns (R-NE).
Bona Fide Hedging
On September 28, 2012, the U.S. District Court for the District of
Columbia vacated final CFTC rules regarding position limits. These
vacated rules defined the term bona fide hedging. As written in the
CFTC's rule that was vacated, the definition was unnecessarily narrow
and would have discouraged a significant amount of important and
beneficial risk management activity. Specifically, the rule narrowed
the existing definition considerably by providing that a transaction or
position that would otherwise qualify as a bona fide hedge also must
fall within one of eight categories of enumerated hedging transactions,
a definitional change neither supported in nor required by the Dodd-
Frank Act. This restrictive definition of bona fide hedging
transactions could disrupt the commodity markets, make hedging more
difficult and costly, and may increase systemic risk by encouraging
end-users to leave a relatively large portion of their portfolios un-
hedged.
Financial Entities
The Dodd-Frank Act defines the term ``financial entity'', in part,
as an entity that is ``predominantly engaged in activities that are in
the business of banking, or in activities that are financial in nature,
as defined in section 4(k) of the Bank Holding Company Act of 1956.''
Incorporating banking concepts into a definition that also applies to
commercial commodity market participants has had unintended
consequences.
Unlike our members, banks and bank holding companies generally
cannot take or make delivery of physical commodities. However, banks
and bank holding companies can invest and trade in certain commodity
derivatives. As a result, the definition of ``financial in nature''
includes investing and trading in futures and swaps as well as other
physical transactions that are settled by instantaneous transfer of
title of the physical commodity. An entity that falls under the
definition of a ``financial entity'' is generally not entitled to the
end-user exemption-an exemption that Congress included to benefit
commercial commodity market participants--and can therefore be subject
to many of the requirements placed upon swap dealers and major swap
participants. In addition, the CFTC has used financial entity as a
material term in numerous rules, no-action relief, and guidance,
including, most recently, its cross-border guidance. The Dodd-Frank Act
allows affiliates or subsidiaries of an end-user to rely on the end-
user exception when entering into the swap on behalf of the end-user.
However, swaps entered into by end-user hedging affiliates who fall
under the definition of ``financial entity'' cannot take advantage of
the end-user exemption, despite the fact that the transactions are
entered into on behalf of the end-user.
Many energy companies structure their businesses so that a single
legal entity within the corporate family acts as a central hedging,
trading and marketing entity--allowing companies to centralize
functions such as credit and risk management. However, when the banking
law definitions are applied in this context, these types of central
entities may be viewed as engaging in activity that is ``financial in
nature,'' even with respect to physical transactions. Hence, some
energy companies may be precluded from electing the end-user clearing
exception for swaps used to hedge their commercial risks and be subject
to additional regulations applicable to financial entities.
Importantly, two similar energy companies may be treated differently
if, for example, one entity uses a central affiliate to conduct these
activities and another conducts the same activity in an entity that
also owns physical assets or that has subsidiaries that own physical
assets. Accordingly, Congress should amend the definition of
``financial entity'' to ensure that commercial end-users are not
inadvertently regulated as ``financial entities.''
Inter-Affiliate Transactions
Currently, the CFTC's rules and proposed rules generally treat
inter-affiliate swaps like any other swap. Hence, companies must, under
certain circumstances, report swaps between majority-owned affiliates
and must submit such swaps to central clearing unless the end-user
hedging exception applies or complex criteria for the inter-affiliate
clearing exemption are met. In the absence of a more expansive clearing
exemption for inter-affiliate trades, the costs of clearing likely
would deter most market participants from entering into inter-affiliate
transactions and could create more risk for clearinghouses. For
example, without an exemption, additional affiliates in a corporate
family would need to become clearing members or open accounts with a
Futures Commission Merchant, and all affiliates would need to develop
and implement redundant risk management procedures and trade processing
services, such as e-confirm.
The CFTC has provided some relief in the form of no-action letters.
However, in many circumstances, these no-action letters do not provide
adequate relief and frequently cause more confusion and uncertainty
among end-users. EEI supports bipartisan legislation to clarify the
requirements placed on inter-affiliate transactions. The Inter-
Affiliate Swap Clarification Act (H.R. 677), which seeks to clarify a
number of these requirements, has been introduced by Rep. Steve Stivers
(R-OH) in the House.
Finally, for the reasons enumerated in the testimony of the
American Gas Association, we agree that options and forward contracts
that are intended to be physically settled or contain volumetric
optionality should be excluded from the definition of a swap.
Conclusion
Thank you for your leadership and ongoing interest in the issues
surrounding implementation of the Dodd-Frank Act and their impact on
commercial end-users. We appreciate your role in helping to ensure that
electric utilities and energy suppliers can continue to use over-the-
counter derivatives in a cost-effective manner to help protect our
electricity consumers from volatile wholesale energy commodity prices.
Again, I appreciate the opportunity to testify and would be happy
to answer any questions.
The Chairman. I thank the gentleman. Mr. Monroe for 5
minutes.
STATEMENT OF CHRIS MONROE, TREASURER, SOUTHWEST AIRLINES CO.,
DALLAS, TX
Mr. Monroe. Chairman Conaway, Ranking Member Scott, and
Members of the Subcommittee, thank you for convening this
hearing. My name is Chris Monroe, and I am the corporate
Treasurer of Southwest Airlines. I am pleased to be here today
to explain how the Dodd-Frank Act has caused a major impact to
a commercial end-user like Southwest Airlines.
Mr. Chairman, as a Texan, you know we began operating in
1971 with three planes serving three Texas cities. Back then,
as now, our purpose was to connect people to what is important
to their lives with friendly, reliable and affordable air
transportation. Friendly in this context doesn't just mean
having nice employees. It means allowing customers to change
their flights and check a bag without paying a penalty.
Today, Southwest is the nation's largest domestic airline
in terms of passengers, and we are the only major airline with
a truly national route structure that has not gone through
bankruptcy or imposed mass-employee layoffs or furloughs, or
reduced workers' wages or benefits.
One key to our unparalleled success has been our ability to
hedge fuel through legitimate end-user derivatives purchased in
the futures markets. Hedging at Southwest is enterprise risk
management, essential in our view given our $6 billion annual
fuel bill. To hedge, we commonly enter into transactions many
months or years in advance of needing the physical product.
Trading in these illiquid markets allows us to manage our fuel
costs, which in turn helps us to keep fares low and maintain
large jet flights in the communities we serve.
I am here today to highlight a few issues that have begun
to impact these important markets that companies such as
Southwest rely on to manage risk. One area we are seeing
negative commercial impact is the CFTC's Real-Time Reporting
Rule. That regulation prescribes the maximum time delay before
swap trade data is publicly disseminated. The prescribed time
delays may be sufficient for liquid markets, but the timeframes
are not sufficient for illiquid markets, which, as I said
before, is where Southwest commonly trades. Only a few market
participants trade that far out on the curve, which makes
contracts highly illiquid, even in contracts that may be liquid
in the front months such as crude oil.
Additionally, Southwest has a particularly identifiable
trading strategy, a hedging DNA if you will, which makes us
quite visible in a market with few participants. This is
particularly harmful. It is my understanding that Dodd-Frank
expressly mandated that the identity of legitimate end-users
like Southwest would be kept confidential and for good reasons
as will become clear.
When a dealer has to report illiquid trades to the market
quickly, the dealer is less likely to be able to lay off the
risk of that trade in the prescribed time. If the dealer is
still holding a large amount of risk when the trade is shown to
the public, the dealer can be front-run and, as a result, take
a loss on the trade. That increased risk to the dealer will
either curtail trades or materially increase the costs of the
trade to the end-users. If an end-user like Southwest can no
longer access the markets to hedge fuel, it would be contrary
to the purposes of the legislation and in our view hostile to
Congressional intent.
Since the rule became effective, Southwest is already
seeing changes in market behavior and swap pricing. A recent
trade cost Southwest an additional 35 basis points in spread.
Applying that additional 35 basis points in cost to typical
volumes traded by Southwest in illiquid areas of the crude
curve and in illiquid products such as jet fuel, will add
roughly $60 million in annual costs. Following the rule's
implementation, Southwest heard from dealers who plainly were
aware of our trades that we had entered into that will settle
in 2015 and beyond.
Southwest does not object to real-time reporting of swap
transactions to the CFTC. We support transparency. However,
based on the fact that liquidity diminishes further out in
time, there is a point where the benefits derived from public
reporting do not outweigh the detriment to those who are
trading illiquid contracts as the market participants become
easier to identify, ultimately allowing others to take
advantage of their market position.
In conclusion, it would be fair to say that neither the
drafters of Dodd-Frank nor the CFTC officials intended to
impede Southwest's ability to hedge our high fuel costs as a
legitimate end-user, but unfortunately this has been the result
of the Real-Time Reporting Rule. I look forward to today's
discussion on this issue as well as other issues affecting
commercial end-users. We also encourage the Subcommittee to
consider legislative solutions to address the unintended
consequences of the Real-Time Reporting Rule.
Thank you for this opportunity to testify, and I look
forward to answering your questions.
[The prepared statement of Mr. Monroe follows:]
Prepared Statement of Chris Monroe, Treasurer, Southwest Airlines Co.,
Dallas, TX
Chairman Conaway, Ranking Member Scott, and Members of the
Subcommittee, thank you for convening this hearing. My name is Chris
Monroe and I am the corporate Treasurer of Southwest Airlines. I am
pleased to be here today to explain how the Dodd-Frank Act has caused a
major impact to a commercial end-user like Southwest Airlines.
Mr. Chairman, as a Texan you know we began operating in 1971 with
three planes serving three Texas cities. Back then, as now, our purpose
was to connect people with what's important to their lives with
friendly, reliable, and affordable air transportation. ``Friendly'' in
this context doesn't just mean having nice Employees. It means allowing
Customers to change their flights and check a bag without paying a
penalty.
Today, Southwest is the nation's largest domestic airline in terms
of passengers. We are the ONLY major airline with a truly national
route structure that has not gone through bankruptcy, or imposed mass-
Employee layoffs or furloughs, or reduced workers' wages and benefits.
One key to our unparalleled success has been our ability to hedge fuel
through legitimate end-user derivatives purchased in the futures
markets. Hedging at Southwest is enterprise risk management--essential
in our view given our $6 billion annual fuel bill. To hedge, we
commonly enter into transactions many months or years in advance of
needing the physical product. Trading in these illiquid markets allows
us to manage our fuel costs, which in turn helps us to keep fares low
and maintain large jet (Boeing 737) flights in the communities we
serve.
I am here today to highlight a few issues that have begun to impact
these important markets that companies such as Southwest relay on to
manage risk. One area where we are seeing a negative commercial impact
is the Commodity Futures Trading Commission's (``CFTC's'') Real-Time
Public Reporting of Swap Transaction Data Rule (``Real-Time Reporting
Rule''). That regulation prescribes the maximum time delay before swap
trade data is publicly disseminated. Under this rule, swap dealers and
major swap participants (generally referred to as ``dealers'') have a
much shorter time in which to report trade data after execution than
trades between two commercial end-users. Importantly, trades between a
legitimate commercial end-user and a dealer must be reported within the
dealer's shorter time limit. Given that the vast majority of bilateral
trades entered into by commercial end-users are transacted with a
dealer, this means nearly all commercial end-user trades are reported
on the accelerated time limit.
The dealer time delays may be sufficient for liquid markets, but
the timeframes are not sufficient for illiquid markets, which, as I
said before, is where Southwest commonly trades. Only a few market
participants trade that far out the curve, which makes the contracts
highly illiquid, even in contracts that may be liquid in the front
months such as crude oil. Additionally, Southwest has a particularly
identifiable trading strategy, a hedging ``DNA'' if you will, which
makes us quite visible in a market with few participants. This is
particularly harmful. It is my understanding that Dodd-Frank expressly
mandated that the identity of legitimate end-users like Southwest would
be kept confidential--and for good reasons as will become clear.
When a dealer has to report illiquid trades to the market quickly,
the dealer is less likely to be able to lay off the risk of that trade
in the prescribed time. If the dealer is still holding a large amount
of the risk when the trade is shown to the public, the dealer can be
front-run and, as a result, take a loss on the trade. That increased
risk to the dealer will either curtail trades or materially increase
the costs of the trade to the end-users.) If an end-user like Southwest
can no longer access the markets to hedge fuel it would be contrary to
the purposes of the legislation and in our view hostile to
Congressional intent.
Since the rule became effective, Southwest is already seeing
changes in market behavior and swap pricing. A recent trade cost
Southwest an additional 35 basis points in spread. Applying an
additional 35 basis points in cost to the typical volumes traded by
Southwest--in illiquid areas of the crude curve and in illiquid
products such as jet fuel--will add roughly $60 million in annual
costs. Following the rule's implementation, Southwest heard from
dealers who plainly were aware of trades we had entered into that will
settle in 2015.
Southwest does not object to real-time reporting of swap
transactions to the CFTC. We support transparency. However, based on
the fact that liquidity diminishes further out in time, there is a
point where the benefits derived from public reporting do not outweigh
the detriment to those who are trading illiquid contracts as the market
participants become easier to identify, ultimately allowing others to
take advantage of their market position.
Other issues still open for debate at the regulatory level which
have the potential to completely change how we hedge relate to margin
for uncleared swaps. Congress clearly intended to exempt commercial
end-users from mandatory minimum margin requirements to retain the
flexibility of end-users and their counterparties to avoid
unnecessarily tying up scarce working capital. In that vein, Congress
included specific language in Dodd-Frank \1\ to allow non-cash
collateral to be posted as margin as agreed to by the counterparties.
This is an important practice to Southwest, as we use unencumbered
assets such as aircraft to collateralize our hedge positions. This
allows us to retain cash in the company to invest in our business, grow
our route network, and create new jobs, and keep our fares low for
customers. However the proposed rule related to uncleared margin
requirements from the Prudential Regulators, who regulate nearly all of
our trading counterparties, seems to both require commercial end-users
to post margin and explicitly disallows the use of non-cash collateral
as margin. We believe all involved regulatory bodies should follow the
intent of Congress and retain the flexibility in counterparty trading
relationships with respect to margin for commercial end-users.
---------------------------------------------------------------------------
\1\ Within Section 731 of the Dodd-Frank Act:
``(D) Comparability of capital and margin requirements.--
``(i) In general.--The prudential regulators, the Commission,
and the Securities and Ex-
change Commission shall periodically (but not less frequently than
annually) consult on
minimum capital requirements and minimum initial and variation
margin requirements.
``(ii) Comparability.--The entities described in clause (i)
shall, to the maximum extent
practicable, establish and maintain comparable minimum capital
requirements and min-
imum initial and variation margin requirements, including the use
of non cash collateral,
for--
``(I) swap dealers; and
``(II) major swap participants''
---------------------------------------------------------------------------
In conclusion, it would be fair to say that neither the drafters of
Dodd-Frank nor the CFTC officials intended to impede Southwest's
ability to hedge our high fuel costs as a legitimate end-user, but
unfortunately that has been the result of the Real-Time Reporting Rule.
I look forward to today's discussion on this issue as well as other
issues affecting commercial end-users. We also encourage the
Subcommittee to consider legislative solutions to address the
unintended consequences of the Real-Time Reporting Rule.
Thank you for this opportunity to testify and I look forward to
answering your questions.
The Chairman. Thank you, sir. Mr. Soto for 5 minutes.
STATEMENT OF ANDREW K. SOTO, SENIOR MANAGING
COUNSEL, REGULATORY AFFAIRS, AMERICAN GAS
ASSOCIATION, WASHINGTON, D.C.
Mr. Soto. Chairman Conaway, Ranking Member Scott, Members
of the Subcommittee, thank you for inviting me to appear before
you today. I am here on behalf of the American Gas
Association's more than 200 local energy companies that deliver
clean natural gas throughout the United States. As Raking
Member Scott had indicated earlier at the opening of this
hearing, we believe that gas utilities, large and small, pose
little or no systemic risk to the nation's financial system.
AGA has worked cooperatively with the CFTC and its staff
throughout the rule-making process to implement the Dodd-Frank
Act, and we appreciate the magnitude and difficulty of the
task. However, from a business perspective, regulatory
certainty is essential for planning and compliance. And let me
just take the example of the swap definition as an area of
uncertainty. What is and what isn't a swap is fundamental to
the whole regulatory regime, and yet throughout the process,
there has been an evolution of what transactions fall in and
fall out. There was a three-part test for certain forwards that
were excluded, and then in the interim final rule, the last
discussion on the subject, there was a further seven-part test
and the Commission asked for additional comments. They have not
yet acted on those comments, and as a result, there is
tremendous confusion and disagreement in the energy industry as
to which type of gas supply transactions will be subject to the
CFTC's regulations.
Consequently, some industry counterparties have taken the
view that they will treat all of their energy transactions that
contain any option or choice for one of the parties as a trade
option. Other counterparties are insisting on contract
provisions to be included in their contracts to force agreement
as to how the transactions should be treated. One of my members
has told me that they have entered into routine transactions
with multiple counterparties where the different counterparties
themselves have conflicting interpretations of what are
essentially identical contracts.
Uncertainty is hampering business planning and compliance
and is disrupting contracting practices in the industry, and it
also hampers the CFTC's ability to be an effective market
monitor. Therefore, we believe that the CFTC and the industry
would benefit greatly from additional administrative processes
whereby industry participants could obtain in a timely manner
the kind of regulatory certainty they need for planning and
compliance and challenge agency action if necessary.
In particular, we offer the following three
recommendations. First, AGA recommends that Congress amend the
Commodity Exchange Act to provide clear and defined procedures
for challenging CFTC rules and orders in a United States Court
of Appeals. A broad judicial review provision allowing for the
direct challenge of CFTC rules and orders would both have a
rehabilitative effect on problems with the current process and
a prophylactic effect in strengthening the agency's rule-making
process.
Second and relatedly, AGA recommends that Congress provide
direct judicial review of jurisdictional disputes between the
Commodity Futures Trading Commission and the Federal Energy
Regulatory Commission. For energy end-users such as AGA's
members, the main source of frustration with the CFTC's
implementation of the Dodd-Frank Act has been a lack of
regulatory certainty as to whether physical transactions
traditionally regulated by FERC would now be subject to CFTC
regulation as swaps. Industry participants would greatly
benefit by clearly defined scopes of jurisdiction between the
two agencies.
Third, AGA recommends that Congress require the CFTC to
provide better internal administrative processes for interested
parties to see clarity and guidance on agency issues. Under
current CFTC rules, there are insufficient avenues available
for the public to obtain timely definitive guidance in the form
of a final agency action. As a result, parties have relied on
staff action in the form of no action or exceptive relief,
interpretive guidance and/or interpretations by the General
Counsel to obtain necessary clarification of the agency rules.
And this is the point I believe that Commissioner O'Malia had
made at yesterday's hearing.
AGA believes that the inclusion of administration process
reforms in the CFTC's governing statutes and rules would have a
positive impact on the agency's ability to be a responsive and
effective regulator. And we would be pleased to provide the
Committee with specific recommendations at your request.
I thank you for the consideration of this testimony and
look forward to answering any questions you might have.
[The prepared statement of Mr. Soto follows:]
Prepared Statement of Andrew K. Soto, Senior Managing Counsel,
Regulatory Affairs, American Gas Association, Washington, D.C.
Chairman Conaway, Ranking Member Scott, and Members of the
Committee, I am Andrew K. Soto, Senior Managing Counsel for Regulatory
Affairs at the American Gas Association (AGA). Founded in 1918, AGA
represents more than 200 local energy companies that deliver clean
natural gas throughout the United States. More than 65 million
residential, commercial and industrial natural gas customers, or more
than 175 million Americans, receive their gas from AGA members. In my
role at AGA, I represent the interests of AGA's members before a
variety of Federal agencies, including the Commodity Futures Trading
Commission (CFTC).
Thank you for inviting me to appear before you today on the issue
of the impact of the CFTC's implementation of the Dodd-Frank Wall
Street Reform and Consumer Protection Act on non-financial entities or
end-users. AGA member companies are end-users of futures and swaps in
that they use such financial instruments to hedge and mitigate their
commercial risks, in particular price volatility associated with
procuring natural gas commodity supplies for their customers. AGA
members have an interest in transparent and efficient financial markets
for energy commodities, so that they can engage in risk management
activities at reasonable cost for the benefit of America's natural gas
consumers. We believe Congress intended in the Dodd-Frank Act to
protect end-users' ability to use financial transactions to hedge and
mitigate commercial risk in recognition of the fact that non-financial
end-users did not cause the financial crisis that led to the passage of
the Dodd-Frank Act and pose little or no systemic risk to the financial
system.
My testimony will address three areas. First, I will explain the
importance of transparent and efficient financial markets to gas
utilities that procure and deliver clean, affordable natural gas to
their customers. Second, I will address the impact of the CFTC's
implementation of the Dodd-Frank Act on gas utilities' ability to enter
into financial and physical contracts to manage commercial risks
associated with the business of procuring natural gas. Third, I will
recommend administrative process reforms, which we believe will help
make the CFTC a more responsive regulator and provide additional
avenues to obtain regulatory certainty, which is essential for business
planning and compliance.
Gas Utility Reliance on Financial Markets
AGA member companies provide natural gas service to retail
customers under rates, terms and conditions that are regulated at the
local level by a state commission or other regulatory authority with
jurisdiction. Each year, natural gas utilities develop seasonal plans
to reliably meet the gas supply needs of their retail customers. Gas
utilities build and manage a portfolio of physical gas supplies and
services in order to meet anticipated demand. A portfolio of assets and
contracts may include natural gas supply contracts, pipeline
transportation storage and no-notice services, and on-system assets
such as natural gas storage, liquefied natural gas storage, and propane
air storage. Because a significant portion of customer demand is
weather driven, gas utilities cannot know with certainty when, or even
if, a certain amount of the gas supplies they make plans to have access
to will be needed. Gas utilities, therefore, typically enter into
certain gas supply contracts with flexible delivery terms as part of
their supply portfolios in order to meet demand swings driven by
variable customer loads throughout the season or year. Factors
affecting variable loads include expected and unexpected volatility in
customer demand, weather events, constraints or disruptions to
alternative sources of supply, and heightened seasonal (winter) demand
fluctuations. Flexible delivery terms are an essential element of some
of the gas supply contracts used to meet variable system load
requirements.
Gas utilities have a strong interest in managing their supply
portfolios to ensure that the overall cost for natural gas service
remains stable and at a reasonable cost to their customers. Gas
utilities are commercial entities exposed to commodity risks, most
especially the price of natural gas commodities. In addition to their
physical transaction activities, many gas utilities use a variety of
financial tools such as futures and financial derivatives or ``swaps''
to hedge against volatility in natural gas commodity costs. In general,
gas utilities forecast the anticipated demand on their systems and
assess the underlying physical exposure associated with that demand.
Many gas utilities then determine if financial instruments are
appropriate to mitigate all or a portion of that exposure. Some gas
utilities are required by state regulatory agencies to hedge a portion
of forecasted demand to manage potential price volatility. These
activities are not speculative in nature; rather, gas utilities enter
into financial transactions to hedge or mitigate commercial risk
associated with forecasted demand. As such, the financial transactions
of gas utilities pose little or no systemic risk to the financial
markets.
End-User Issues with CFTC Implementation of the Dodd-Frank Act
As noted above, regulatory certainty is essential for business
planning and compliance. To illustrate the difficulty energy end-users
like gas utilities have encountered in preparing to comply with the
CFTC's regulations implementing the Dodd-Frank Act, let me use the
agency's definition of a ``swap'' as an example. At the outset, it is
important to note that the entire foundation of the CFTC's regulation
of the financial derivatives market rests on what is or is not
considered a ``swap.'' Who is or is not a swap dealer or major swap
participant, what transactions are required to be cleared, what
transactions are required to be reported, what transactions are subject
to position limits, etc., all rest on the definition of a ``swap.''
Many parties, including AGA, initially suggested that the CFTC define
``swap'' at the beginning of its implementation of the Dodd-Frank Act,
so that market participants would have a clear understanding of the
scope of the regulations as the whole regulatory framework was being
developed. Instead, the CFTC did not issue a final rule defining
``swap'' until August 2012, more than 2 years after the Act was passed,
and issued only an ``interim'' final rule at that. Even now, toward the
end of its process, the CFTC has yet to define the parameters of its
``swap'' definition in a manner that can be clearly and consistently
applied within the gas industry.
To give you a better sense of what is at stake, let me walk through
the development of the ``swap'' definition as it relates to natural gas
market participants. In August 2010, the CFTC issued an Advance Notice
of Proposed Rulemaking,\1\ requesting public comment on the key
definitions that would be used to establish the framework for
regulating swaps. The proposal did little more than reference the
statutory definition of ``swap,'' providing no views on what the agency
considered the scope of the definition to be. After a round of public
comment, in May 2011, the CFTC issued a Proposed Rule and Proposed
Interpretations regarding the ``swap'' definition.\2\ There, the CFTC
proposed to exclude forward contracts in non-financial commodities from
the definition of a ``swap'' under the Dodd-Frank Act, consistent with
its historical interpretation of the forward contract exclusion under
the Commodity Exchange Act. The CFTC explained that forward contracts
with respect to non-financial commodities were commercial merchandising
transactions where the primary purpose is to transfer ownership of the
commodity and not to transfer solely the price risk. The CFTC noted
that it had previously established an Energy Exemption for certain
types of transactions that were not considered futures. The CFTC then
proposed an interpretation to withdraw as unnecessary this Energy
Exemption.
---------------------------------------------------------------------------
\1\ Definitions Contained in Title VII of Dodd-Frank Wall Street
Reform and Consumer Protection Act, 75 Fed. Reg. 51429 (Aug. 20, 2010).
\2\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement,''; ``Mixed Swaps; Security-Based Swap
Agreement record-keeping,'' 76 Fed. Reg. 29818 (May 23, 2011).
---------------------------------------------------------------------------
The CFTC believed that the statutory definition of ``swap''
explicitly provided that commodity options are ``swaps.'' Thus, for
non-financial commodity options embedded in forward contracts, the CFTC
established a three-part test. The CFTC explained that a transaction
will be considered an excluded forward contract (and not a swap) where
the non-financial embedded option: (1) may be used to adjust the
forward contract price, but does not undermine the overall nature of
the contract as a forward contract; (2) does not target the delivery
term, so that the predominant feature of the contract is actual
delivery; and (3) cannot be severed and marketed separately from the
overall forward contract in which it is embedded. The CFTC added that
conversely, where the embedded option renders delivery optional, the
predominant feature of the contract cannot be actual delivery, and the
embedded option to not deliver precludes treatment of the contract as a
forward contract. The CFTC then sought public comment on all aspects of
its proposed definitions and interpretations.
The CFTC's proposed rule generated considerable confusion in the
natural gas industry as market participants began to wonder whether
their commercial merchandising transactions, particularly those with
flexible delivery terms, would be considered ``swaps'' under the CFTC's
proposed interpretation. Numerous comments were filed seeking
clarification as to whether particular types of transactions would be
considered ``swaps.'' AGA, for its part, filed comments explaining that
gas utilities enter into physical gas supply transactions with flexible
delivery terms as important elements of their ability to meet their
customers' needs at a reasonable cost. Because gas consumption to
residential and commercial customers is largely weather-driven
(consumption increases as the weather gets colder) and predicting the
weather is not an exact science, gas supply contracts with delivery
flexibility help AGA members make sure gas supplies are, or can be
made, available when the customers actually need the gas without having
to pay excessively higher prices at the actual time of need and/or
other fees associated with pipeline imbalance penalties.
In August 2012, almost 2 years later, the CFTC issued an interim
final rule, further interpretations, and a request for comment on the
interpretations.\3\ The CFTC provided additional guidance on the scope
of its forward contract exclusion. In particular, the CFTC established
a seven-part test that it would apply in determining whether a contract
with flexible delivery terms would be regulated as a ``swap'' or
excluded as a forward contract. The CFTC then provided further
interpretations responding to the requests to clarify whether certain
types of transactions would be considered, and regulated as, ``swaps.''
Notably, the CFTC sought to clarify that certain physical commercial
transactions for natural gas pipeline transportation and storage
service agreements would not be considered options, and thus would not
be regulated as ``swaps,'' if they met a three-part test. However, the
CFTC added that if such transportation and storage agreements employed
a certain two-part rate structure, such agreements would be considered
options subject to swap regulation. The CFTC then believed that these
interpretations would benefit from further public input and requested
additional comments.
---------------------------------------------------------------------------
\3\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and
``Security-Based Swap Agreement''; ``Mixed Swaps''; ``Security-Based
Swap Agreement record-keeping,'' 77 Fed. Reg. 48208 (Aug. 13, 2012).
---------------------------------------------------------------------------
More confusion reigned. Was the rule final or only interim? How
should the seven-part test be applied? What do some of the elements
mean? Did the CFTC really intend to regulate as ``swaps'' all natural
gas pipeline transportation and storage agreements with two-part rates?
Again, numerous comments were filed seeking clarification of the CFTC's
rules and interpretations. Many comments focused on whether pipeline
transportation and storage agreements, long regulated exclusively by
the Federal Energy Regulatory Commission (FERC) under the Natural Gas
Act, would be considered options and subject to the CFTC's swap
regulations. In November 2012, the CFTC's Office of General Counsel
(OGC) issued a Response to Frequently Asked Questions Regarding Certain
Physical Commercial Agreements for the Supply and Consumption of
Energy. In essence, OGC staff stated that if a pipeline transportation
or storage agreement with a two-part rate structure met an additional
five-part test, the transaction would not be considered an option and
thus not subject to regulation as a ``swap.'' Apart from this staff
action aimed solely at clarifying the two-part rate issue for pipeline
transportation and storage contracts, the CFTC has not acted on the
comments it received in response to its request for further public
input on the ``swap'' definition and interpretations.
Relatedly, in April 2012, the CFTC issued an interim final rule
holding that certain commodity options would be considered ``trade
options'' if they met a three-part test. Trade options, while regulated
by the CFTC, would not be subject to the full panoply of regulations
established for ``swaps.'' Notably, trade options would be subject to
significantly less intense reporting requirements for counterparties
that are not already required to report their swaps. Once again,
several comments were filed in response to the interim final rule, yet
the CFTC has not issued any further interpretations or clarifications
regarding trade options, although the CFTC's staff has issued no-action
relief regarding trade option reporting.
In the absence of clear guidance from the CFTC, numerous parties,
including AGA, have filed requests for interpretive guidance and/or no-
action relief from CFTC staff as deadlines for reporting and other
compliance obligations have approached. Many of these requests remain
outstanding and have not been acted upon by the CFTC or its staff.
Where does that leave us? There remain disagreements and confusion
within the natural gas industry as to which types of gas supply
transactions, if any, will be subject to CFTC regulation. These
transactions are normal commercial merchandising transactions that
parties use to buy and sell natural gas for ultimate delivery to end-
use customers. They would not normally be considered speculative,
financial transactions as the parties contemplate physical delivery of
the commodity. Nevertheless, transactions that contain some option or
choice for one or the other counterparty, raise questions for some as
to whether they would be considered commodity options regulated as
swaps, meet a three part test and a seven-part test to be excluded as
options embedded in forward contracts, be viewed as trade options
subject to a lessened reporting burden, or be considered facility use
agreements that meet a three-part test and then a five-part test and
not subject to regulation at all. Some counterparties in the industry
have taken the view that regardless of whether a transaction would
satisfy the seven-part test for options embedded in forward contracts,
they will report all such transactions as trade options out of an
abundance of caution to avoid the risk of a violation of the CFTC's
rules. Other counterparties have insisted upon contract provisions to
force agreement as to the regulatory treatment of the transaction. Some
AGA member companies, in the normal course of business, have entered
into routine transactions with multiple counterparties where the
different counterparties have conflicting regulatory interpretations of
what are essentially identical contracts. Thus, normal contracting
practices in the natural gas industry have been seriously disrupted.
Until the CFTC provides definitive rules clarifying the regulatory
treatment of these transactions, turmoil in the industry will continue.
Moreover, the different interpretations and understandings of the
CFTC's scope of the ``swap'' definition is, and will continue to, lead
to inconsistent reporting of swap transactions to swap data
repositories and to the CFTC.
Administrative Process Reforms
AGA and its members have been frustrated in their efforts to obtain
regulatory certainty from the CFTC in its implementation of the Dodd-
Frank Act. Uncertainty with regard to something so fundamental to
derivatives regulation as what is and what is not a ``swap,'' is
hampering business planning and compliance and disrupting contracting
practices in the industry. It also hampers the CFTC's ability to be an
effective market monitor and regulator. AGA believes that the CFTC and
the industry would benefit greatly from additional administrative
processes whereby industry participants could obtain in a timely manner
the kind of regulatory certainty they need for business planning and
compliance, and could challenge agency action if necessary. In
particular, we offer the following recommendations:
First, AGA recommends that Congress amend the Commodity Exchange
Act (CEA) to provide clear and defined procedures for challenging CFTC
rules and orders in court. Although the CEA currently contains
provisions allowing for judicial review by a U.S. Court of Appeals of
certain agency actions, the provisions are very limited and provide no
defined avenue for challenging CFTC rules and orders generally. A broad
judicial review provision allowing for the direct challenge of CFTC
rules and orders would have both a rehabilitative effect on the current
process and a prophylactic effect on future agency action. Specific
judicial review provisions would allow interested parties to challenge
particular agency actions that are unreasonable and hold the CFTC
accountable for its decisions. In addition, judicial review would have
an important prophylactic effect by requiring the agency to think
through its decisions before they are made to ensure that they are
sustainable in court, thus enabling the agency to be a more
conscientious and prudent regulator. In the absence of specific
judicial review provisions, the general review provisions of the
Administrative Procedure Act (APA) would apply, requiring parties
seeking to challenge CFTC rules to file a claim before a U.S. District
Court, move for summary judgment (as a hearing would likely be
unnecessary), obtain a ruling and then, if necessary, seek further
judicial review before a U.S. Court of Appeals. In the recent
litigation over the CFTC's position limits rule, which followed the
review provisions of the APA, the CFTC's General Counsel acknowledged
the efficiency and desirability of direct review by the U.S. Court of
Appeals of agency rules, and stated that the agency would have no
objection to such direct review assuming Congress were to authorize
it.\4\ Accordingly, provisions allowing for direct review by a U.S.
Court of Appeals of rules and orders of the CFTC would enable both the
industry and the agency to benefit from the administrative economy,
procedural efficiency and certainty of having a dedicated forum in
which agency decisions are reviewed.
---------------------------------------------------------------------------
\4\ See Motion of Respondent to Dismiss for Lack of Subject Matter
Jurisdiction, Doc. #1350987 at pp. 2, 4, International Swaps and
Derivatives Ass'n et al. v. CFTC, No. 11-1469 (D.C. Cir. 2012) (stating
that ``direct review in [the U.S. Court of Appeals] would serve the
interests of judicial economy'' and that ``the Commission recognizes
the benefits of direct appellate review in these circumstances and
would have no objection to such review.''); Reply of Respondent in
Further Support of Motion to Dismiss, Doc. #1353103 at pp. 2 n. 1,
International Swaps and Derivatives Ass'n et al. v. CFTC, No. 11-1469
(D.C. Cir. 2012).
---------------------------------------------------------------------------
Second, and relatedly, AGA recommends that Congress provide direct
judicial review of jurisdictional disputes between the CFTC and the
FERC. In the Dodd-Frank Act, Congress directed the two agencies to
enter into a Memorandum of Understanding within 180 days of enactment
of the legislation, in order to resolve conflicts concerning
overlapping jurisdiction and to avoid, to the extent possible,
conflicting or duplicative regulations.\5\ More than 3 years has
passed, and no such memorandum has been negotiated by the two agencies.
For energy end-users such as AGA's member gas utilities, the main
source of frustration with the CFTC's implementation of the Dodd-Frank
Act has been the lack of regulatory certainty as to whether physical
transactions traditionally regulated by FERC would now be subject to
CFTC regulation as ``swaps.'' Industry participants would benefit
greatly by clearly defined scopes of jurisdiction as between the two
agencies. Congress has already provided mechanisms for the judicial
review of disputes between the CFTC and the SEC regarding swaps and
security-based swaps (Section 712(c)) \6\ and novel derivative products
that may have elements of both securities and futures (Section 718).\7\
We encourage Congress to provide similar mechanisms with regard to
jurisdictional issues as between the CFTC and the FERC.
---------------------------------------------------------------------------
\5\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L.
No. 111-203, 720 (2010).
\6\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L.
No. 111-203, 712 (2010).
\7\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L.
No. 111-203, 718 (2010).
---------------------------------------------------------------------------
Third, AGA recommends that Congress require the CFTC to provide
better administrative processes for interested parties to seek clarity
and guidance on agency issues. Under current CFTC rules, there are
insufficient avenues available for the public to obtain timely,
definitive guidance in the form of final agency action, particularly as
to the impacts of the CFTC's regulations on commercial end-users. As a
result, parties have relied on staff action in the form of no-action or
exemptive relief, interpretive guidance, and/or interpretations by the
General Counsel to obtain necessary clarifications of the agency's
rules. These avenues are less than satisfying in that they reflect only
the views of staff and not those of the Commissioners themselves. The
CFTC should provide commercial market participants with specified
administrative processes in which to obtain definitive guidance from
the agency on a timely basis.
AGA believes that the inclusion of administrative process reforms
in the CFTC's governing statutes and rules would have a positive impact
on the agency's ability to be a responsive and effective regulator. AGA
would be pleased to provide the Committee with supplemental information
on specific mechanisms to achieve these goals.
Thank you for your consideration of these comments.
The Chairman. Thank you, Mr. Soto. Mr. Guilford?
STATEMENT OF GENE A. GUILFORD, NATIONAL & REGIONAL POLICY
COUNSEL, CONNECTICUT ENERGY MARKETERS
ASSOCIATION, CROMWELL, CT; ON BEHALF OF COMMODITY MARKETS
OVERSIGHT COALITION
Mr. Guilford. Honorable Chairman Conaway, Ranking Member
Scott, and distinguished Members of the Subcommittee, on behalf
of the Commodity Market Oversight Coalition, CMOC, we wish to
thank you for the opportunity to appear before you today on the
matter of the Commodity Futures Trading Commission and to
address matters relating to the CFTC's authorities regulating
the activities in the commodity markets and the impact of those
activities on end-users.
The Commodity Market Oversight Coalition, CMOC, is a non-
partisan alliance of organizations that represent commodity-
dependent American industries, businesses, end-users and
consumers. We are the farmers, truckers, heating oil retailers,
Mom and Pop gas station operators, airlines and others who rely
on transparent, functional and stable commodity markets in
which to hedge our operations for the mutual benefits of those
who deliver tangible goods to markets and from which we take
delivery of tangible goods, as well as for the benefit of the
millions of consumers that we serve. Our members rely on
functional transparent and competitive commodity derivatives
markets as a hedging and price discovery tool. As a coalition,
we favor government policies that promote stability and
confidence in the commodity markets, seek to prevent fraud,
manipulation and excessive speculation and preserve the
interests of bona fide hedgers and American consumers. Since
its inception in 2007, our coalition and its member
organizations have delivered testimony and written
Congressional leaders in support of many of the reforms in
Dodd-Frank and in legislation prior to Dodd-Frank's enactment.
And though while Dodd-Frank was indeed historic legislation, it
was not perfect, and Title VII reforms in which we spent the
majority of our time were no exception.
Even with its imperfections, one cannot say that Dodd-Frank
was unnecessary or that that new authorities granted to the
CFTC under the Act were inappropriate. In the mid-1990s, the
over-the-counter derivatives market had a notional value of
between $20 trillion and $25 trillion. Today the derivatives
markets notional value exceeds $600 trillion. But even in the
early 1990s, there had been episodes of fraud, Bankers Trust,
Procter & Gamble, Gibson Greeting Cards. Bankers Trust had
defrauded some of its derivatives customers, and second, there
was evidence of manipulation in the markets. Sumitomo
Corporation had managed to manipulate the world market in
copper in part using the over-the-counter derivatives markets
to disguise its operation and fund them. Later and after the
fact there were other incidents of market manipulation
discovered involving Enron and the electricity markets,
Amaranth and natural gas, BP and propane, and crude oil.
When accepting the John F. Kennedy Profiles of Courage
Award in 2009, former CFTC chair, Brooksley Born, stated,
``Special interest in the financial services industry are
beginning to advocate a return to business as usual and to
argue against the need for any serious reform. We have to
muster the political will to overcome these special interests.
If we fail now to take the remedial steps to close the
regulatory gaps, we will be haunted by our failure for years to
come.''
We, too, express concerns about what Dodd-Frank has done in
our markets and certainly what it has had for impacts on our
companies and our customers. That, however, doesn't mean we
should do nothing, but it does mean that there are things that
we should address. And we look forward to working with the
Committee in the following areas that we would recommend
specific attention be given. Number one is manipulation and
excessive speculation. The Subcommittee should examine the
efficacy of the October 18, 2011, position limits rule. As we
all know, the Federal court remanded that back to the agency
last year because there was a conflict between two different
parts of the statute with regard to whether or not position
limits could be in effect immediately or whether position
limits were subject to an appropriate and necessary clause. The
Federal court remanded it back to the agency in order to go
back and touchstone. We need to clarify that.
Number two, our index funds. The Subcommittee should
inquire within the CFTC of its progress in implementing the
recommendations of the bipartisan PSI staff report in
addressing end-user concerns over index fund speculation.
High-frequency trading. We urge the Committee to
investigate the role of high-frequency trading and other
potentially harmful or disruptive new trends in commodity
markets and determine whether or not additional CFTC authority
is required to deal with the potential impacts of high-
frequency trading.
Penalties. We believe the Subcommittee should consider
extending the statute of limitations for the CFTC from its
present 5 years to a minimum of 10 years for its
investigations.
Bankruptcy protections. In light of MF Global and
Peregrine, we recommend the Committee--we would like to work
with the Committee rather on the extension of the Securities
Investor Protection Act to clients.
The trade option exemption is one that impacts a number of
our members because it has a limitation of a $10 million net
worth requirement with a separate $1 million net worth
requirement for bona fide hedgers, and frequently our companies
are small enough so they fall below that threshold. We would
like to see that changed so that we continue to have access to
engage in trades.
The Energy and Environmental Markets Advisory Committee was
created in 2008, yet it hasn't met since 2009. We think the
CFTC would benefit greatly by the advice of those who were
actually in the industry.
And with that, I would like to thank you for your time and
attention and I would be happy to answer any questions you may
have, Mr. Chairman.
[The prepared statement of Mr. Guilford follows:]
Prepared Statement of Gene A. Guilford, National & Regional Policy
Counsel, Connecticut Energy Marketers Association, Cromwell, CT; on
Behalf of Commodity Markets Oversight Coalition
Honorable Chairman Conaway, Ranking Member Scott, and distinguished
Members of the Committee, on behalf of the Commodity Market Oversight
Coalition [CMOC] we wish to thank you for the opportunity to appear
before you today on the matter of the future of the Commodity Futures
Trading Commission [CFTC] and to address matters relating to the CFTC's
authorities regulating the activities in the commodity markets and the
perspectives of end-users.
About CMOC
The Commodity Markets Oversight Coalition (CMOC) is a non-partisan
alliance of organizations that represent commodity-dependent American
industries, businesses, end-users and consumers. We are the farmers,
truckers, heating oil retailers, mom and pop gasoline station
operators, airlines and others who rely on transparent, functional and
stable commodity markets in which to hedge our operations for the
mutual benefit of those who deliver tangible goods to markets and from
which we take delivery of tangible goods, as well as for the benefit of
the millions of consumers we serve. Our members rely on functional,
transparent and competitive commodity derivatives markets as a hedging
and price discovery tool. As a coalition, we favor government policies
that promote stability and confidence in the commodities markets; seek
to prevent fraud, manipulation and excessive speculation; and preserve
the interests of bona fide hedgers, commodity-dependent industries and
ordinary American consumers. Since its inception in August of 2007, our
coalition and its member organizations have delivered testimony and
written Congressional leaders in support of these reforms. While the
Dodd-Frank Act was indeed historic legislation, it was not perfect
legislation and Title VII reforms are no exception.
We continue to remind the Congress to be mindful of the need for
stable, transparent and accountable futures, options and swaps markets
and the effect on the confidence of consumers, commodity end-users,
bona fide hedgers and other stakeholders.
Why is an active, adequately funded and fully authorized CFTC
necessary?
At the urging of our coalition and in response to dramatic changes
in the marketplace, Congress expanded CFTC authority over the futures,
options and swaps markets during its 2008 reauthorization. This
included language from the bipartisan ``Close the Enron Loophole Act''
expanding oversight to ``price discovery contracts'' on previously
unregulated electronic trading platforms.\1\ The 2008 bill also
strengthened anti-fraud provisions and increased civil monetary
penalties for manipulation and attempted manipulation from $500,000 to
$1 million per violation.
---------------------------------------------------------------------------
\1\ The Close the Enron Loophole Act was introduced in the Senate
(S. 2058) by Sen. Carl Levin (D-MI) on September 17, 2007 and in the
House (H.R. 4066) by Rep. Peter Welch D-VT). The House bill had three
Republican cosponsors, including Reps. Chris Shays of Connecticut, Jeff
Fortenberry of Nebraska and Todd Platts of Pennsylvania.
---------------------------------------------------------------------------
However, much of the deregulation of the derivatives markets under
the Commodity Futures Modernization Act of 2000 (Pub. L. 106-554)
remained unaddressed until the enactment of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010,\2\ simply referred to as
the ``Dodd-Frank Act.'' Building on the reforms included in the 2008
Farm Bill, Congress used the Dodd-Frank Act as a means to further
address the crisis of opacity, instability and diminished confidence in
the derivatives markets and to address factors that lead to the 2007-
2008 bubble in commodity prices.
---------------------------------------------------------------------------
\2\ Pub. L. 111-203.
---------------------------------------------------------------------------
Even with its imperfections, one cannot say that Dodd-Frank was
unnecessary or that the new authorities granted to the CFTC under the
Act were inappropriate.
In the mid-1990s the over-the-counter derivatives market had a
notional value of between $20-$25 trillion. Today the derivatives
market's notional value exceeds $600 trillion. Even then, there had
been episodes of fraud. Bankers Trust was a large over-the-counter
derivatives dealer, and it became clear, through suits brought by some
of its customers--primarily Procter & Gamble and Gibson Greeting
Cards--that Bankers Trust had defrauded some of its derivatives
customers. Second, there was evidence of manipulation in the markets.
Sumitomo Corporation had managed to manipulate the world market in
copper, in part using over-the-counter derivatives to disguise its
operations and fund them. Later, and after the fact, there were other
incidents of market manipulation discovered involving Enron and
electricity markets, Amaranth and natural gas markets,\3\ BP/Propane
and the propane markets,\4\ as well as crude oil.\5\
---------------------------------------------------------------------------
\3\ http://www.hsgac.senate.gov//imo/media/doc/
REPORTExcessiveSpeculationinthe
NaturalGasMarket.pdf
\4\ http://www.cftc.gov/PressRoom/PressReleases/pr5405-07.
\5\ http://www.crai.com/uploadedFiles/Publications/FM-Insights-
Commodity-Price-Manipulation.pdf.
---------------------------------------------------------------------------
Just last week it was reported that the Federal Energy Regulatory
Commission is in discussions with JP Morgan Chase regarding an alleged
manipulation of electricity markets that could cost the bank $500
million.\6\
---------------------------------------------------------------------------
\6\ http://dealbook.nytimes.com/2013/07/17/jpmorgan-in-talks-to-
settle-energy-manipulation-case-for-500-million/.
---------------------------------------------------------------------------
We can never forget that concerns were raised about these
unregulated, rapidly growing markets that were characterized by a lack
of transparency, unlimited leverage, and interconnections between large
institutions through counterparty credit risk. Those features of the
market appeared to create the potential of systemic risk, as was later
confirmed in the financial crisis of 2008.
However, much of the deregulation of the derivatives markets under
the Commodity Futures Modernization Act of 2000 (Pub. L. 106-554)
remained unaddressed until the enactment of the Dodd- Frank Wall Street
Reform and Consumer Protection Act of 2010, simply referred to as the
``Dodd-Frank Act.'' Building on the reforms included in the 2008 Farm
Bill, Congress used the Dodd-Frank Act as a means to further address
the crisis of opacity, instability and diminished confidence in the
derivatives markets and to address factors that led to the 2007-2008
bubble in commodity prices.
The financial crisis that began with the fall of Lehman and a
cascade of other powerful financial institutions, leading ultimately to
the loss of more than $12 trillion of national wealth, the loss of
millions of American jobs, the loss of value of millions of American
homes, 401(k) plans and pensions is why we need the Commodity Futures
Trading Commission. The nation needs commodity markets that are fully
transparent and free of manipulation, excessive speculation and other
disruptive trading activity. We need markets with participants that are
accountable for their actions and properly overseen for the benefit and
protection of consumers and taxpayers. Hopefully, we have not forgotten
what the absence of effective oversight and regulation has wrought upon
the nation as we continue to struggle to recover from the greatest
threat to the nation's economy since the Great Depression.
When accepting the John F. Kennedy Profiles in Courage Award in
2009, former CFTC Chair Brooksley Born stated, ``Special interests in
the financial services industry are beginning to advocate a return to
`business as usual' and to argue against the need for any serious
reform. We have to muster the political will to overcome these special
interests. If we fail now to take the remedial steps to close the
regulatory gap, we will be haunted by our failure for years to come.''
Manipulation and Excessive Speculation
Speculative position limits are important in preserving the
integrity of the commodity markets and the needs of bona fide hedgers.
Such limits serve to prevent market manipulation (such as corners and
squeezes) and unwarranted price swings associated with excessive
speculation. Therefore, our coalition strongly supports the decision of
Congress to mandate speculative position limits under Section 737 of
the Dodd-Frank Act.
Excessive Speculation is defined as that which drives prices higher
in apparent defiance of supply and demand fundamentals. We contend that
recent events point to just such a dislocation in the energy commodity
markets, as follows:
------------------------------------------------------------------------
2007 2012
------------------------------------------------------------------------
Unemployment 4.6% 7.6%
U.S. crude oil consumption 20 mmbls @ day 18.5 mmbls @ day
U.S. domestic crude 5 mmbls @ day 6.5 mmbls @ day
production
U.S. WTI crude oil price $72 @ bbl $94 @ bbl
U.S. gasoline consumption 9.3 mmbls @ day 8.7 mmbls @ day
U.S. gasoline prices [ave] $2.84 @ gal $3.68 @ gal
------------------------------------------------------------------------
In just the last 4 weeks we have seen U.S. WTI prices increase from
$94 @ bbl on the NYMEX [August contract] to over $108 @ bbl--adding $14
@ bbl. At the same time, we have seen U.S. RBOB gasoline on the NYMEX
[August 2013 contract] increase from $2.67 @ gal to $3.13 @ gal, adding
46 @ gallon.
As America consumes 360 million gallons of gasoline a day, NYMEX
driven RBOB contract increases of 46 @ gallon will cost Americans an
additional $165 million per day, $1.1 billion per week, $4.6 billion
per month.
These market activities are occurring while, according to our
Department of Energy's Energy Information Agency, WTI crude stocks at
Cushing, Oklahoma have been at their highest levels ever recorded. In
addition, in 2012 the U.S. saw the largest increase in daily crude oil
production since commercial production began in 1859. Between 2007 and
2012 we saw not only the extraordinary demand destruction of 1.5 mmbls
of daily crude oil demand, but at the same time saw a 1.5 mmbls @ day
of increased domestic crude oil production--a swing of 3 mmbls. Yet,
WTI crude prices increased more than 30%.
Further, in 2011 the U.S. became a net exporter of refined
distillates for the first time since 1948 and in 2012 became a net
exporter of gasoline for the first time since 1960. RBOB gasoline
contract increases of 46 @ gal are with the backdrop of having seen a
domestic demand destruction of 600,000 bbls @ day.
October 2011 Position Limits Rule
The CFTC approved a final rule establishing mandatory position
limits on October 18, 2011. This rule was to go into effect on October
12, 2012. However, the rule was vacated by a District Court Judge on
September 28, 2012 and the decision is currently under appeal. Our
coalition strongly supports the immediate implementation of mandatory
position limits and believes that the intent of the Congress was clear
and unambiguous in this regard. On April 22, 2013, we filed an amicus
curiae brief with the Court of Appeals and we are confident that the
District Court's decision to vacate the position limits rule will be
swiftly reversed.
Still, the Committee should examine the efficacy of the October 18,
2011 position limits rule, as well as the underlying statutory
authorities of the CFTC, in preventing market manipulation and the
harmful effects of excessive speculation.\7\ Specifically, members of
our coalition have expressed concerns to regulators that individual
position limits set forth by the rule are too high, and that the rule
only requires periodic review of established limits (annually for
agricultural contracts and biennially for energy contracts).
---------------------------------------------------------------------------
\7\ 7 U.S.C. Section 6(a)(1).
---------------------------------------------------------------------------
In addition to individual speculative position limits as set forth
by the rule, an effective way to prevent excessive speculation from
distorting commodity prices and to restore the balance between
commercial hedgers and financial investors is to require aggregate
limits on all speculation as a class of trader. In the forthcoming CFTC
Reauthorization Act, the Committee should expand upon the existing
Dodd-Frank Act position limits mandate to require the CFTC to establish
class specific limits on speculation.\8\ We attach as Appendix ``A''
the list of more than 100 independent studies that point to the role
excessive speculation plays in the artificial inflation of commodity
prices that is the focus of the position limits rule.
---------------------------------------------------------------------------
\8\ See comments by Delta Airlines, the Air Transport Association
(now Airlines for America) and the Petroleum Marketers Association of
America and New England Fuel Institute Comment letters on the
``Position Limits for Derivatives,'' 76 FR 4752 (Jan. 26, 2011),
submitted to the CFTC on March 28, 2011.
---------------------------------------------------------------------------
The U.S. Tax Code and Energy Market Speculation
Futures contracts, as prescribed by 26 U.S.C. 1256 of the tax
code, are taxed with a blended rate of long and short-term gains: 60%
long-term capital gains and 40% short-term. Whether one agrees or
disagrees with speculation being a factor in commodity markets, most
should agree that we should examine why this activity is subsidized by
the Tax Code. The Tax Code incentivizes speculation in commodities over
speculation in any other market. Even more, speculation in commodities
is a great way to guarantee a lower tax rate than the general income
tax, when compared to any other profession in America.
In essence, the Tax Code promotes speculation in commodities
markets, and it does so in several ways. People who are speculating in
commodity future markets are inherently short-run, and care far more
about the discount on the short term capital gains tax rate than they
do the increased cost of long-term commodity ownership. Whereas a
short-term equity speculator is taxed at the general income rate, a
commodities/futures speculator is taxed at 23%. The consequences of
this are two-fold: first, there is an economic incentive for
speculators to ply their craft in commodities markets as opposed to
equity markets, and second, speculators desire volatility in the short-
run in order to maximize their capacity to make money, such that there
is a serious misalignment of incentives between speculative market
participants and the purpose of commodity markets. [commercial/bona
fide hedgers versus non-commercial financial speculators]
Meanwhile, short-term transactions that result in realized gains in
commodity markets are not done with the intention ever taking or giving
delivery of the underlying goods themselves. Rather, these transactions
are done for the purpose of realizing a gain off of changes in price.
These transactions require inefficiencies between supplier and buyer
PLUS volatility in order to generate a profit. In seeking volatility,
such transactions promote yet further volatility. Because of this fact,
volatility and market dislocations lead directly to more opportunities
for speculative gains. Pushing such actors into commodity markets
creates a situation where volatility becomes a self-fulfilling prophecy
for the benefit of a significant portion of market participants, but a
detriment to society at large.
In examining the authorities of the CFTC one might examine why one
body of Federal law seems to encourage energy market speculation [the
Tax Code] while another body of Federal law seems to discourage energy
market speculation [Dodd-Frank].
Index Funds
Congress and the CFTC have yet to adequately address the well-
documented harm caused by index fund speculation in the commodity
markets. In June of 2009, the Senate Permanent Subcommittee for
Investigation (PSI) published a bipartisan report by Chairman Carl
Levin of Michigan and ranking Member Tom Coburn of Oklahoma entitled
Excessive Speculation in the Wheat Market.\9\
---------------------------------------------------------------------------
\9\ Link to the Senate PSI Wheat Report: http://bit.ly/WheatRpt
(Accessed May 1, 2013). Editor's note: the referenced link goes through
a third party server, the official Senate link is http://
www.hsgac.senate.gov/imo/media/doc/
REPORTExcessiveSpecullationintheWheat
MarketwoexhibitschartsJune2409.pdf.
---------------------------------------------------------------------------
The report concludes that the ``activities of commodity index
traders, in the aggregate, constituted `excessive speculation,' '' and
that index funds have caused ``unwarranted price changes'' and
constitute an ``unwarranted burden on commerce.'' The PSI report urged
legislative and regulatory measures to limit the impact of index fund
investments in commodities.
These recommendations include the phasing-out of CFTC no-action
letters that essentially classified index funds as bona fide hedgers
and exempted them from speculative position limits. The report also
urges the CFTC to collect more data and evaluate the extent to which
index funds affect prices for non-agricultural commodities including
crude oil. While the CFTC has made considerable effort to improve data
collection, regulators have not yet published any sort of comprehensive
evaluation on the role index funds as recommended by the bipartisan PSI
report. The Committee should inquire with the CFTC on its progress in
implementing the recommendations of the bipartisan PSI staff report and
addressing end-user concerns over index fund speculation.
Of note, our coalition has supported legislation in Congress that
would limit the ability of index funds to speculate in commodities. In
the House of Representatives, then Congressman Ed Markey of
Massachusetts introduced the Halt Index Trading of Energy Commodities
(HITEC) Act (H.R.785) on March 13, 2013. It currently enjoys 21
cosponsors. The bill would prohibit new investments in commodities by
index funds and give existing index funds 2 years to wind down their
positions.
The Congress has to look no further than the way Wall Street
markets participation in index funds for the reason why and how index
funds adversely affect the orderly operation of these markets and
artificially inflate commodity prices, as follows:
``How do I sell something that I don't own, or why would I
buy something I don't need''. The answer is simple. When
trading futures, you never actually buy or sell anything
tangible; you are just contracting to do so at a future date.
You are merely taking a buying or selling position as a
speculator, expecting to profit from rising or falling prices.
You have no intention of making or taking delivery of the
commodity you are trading, your only goal is to buy low and
sell high, or vice-versa. Before the contract expires you will
need to relieve your contractual obligation to take or make
delivery by offsetting (also known as unwind, or liquidate)
your initial position. Therefore, if you originally entered a
short position, to exit you would buy, and if you had
originally entered a long position, to exit you would sell.''
\10\
---------------------------------------------------------------------------
\10\ http://www.altavest.com/education/default.aspx.
Had it not been for the unfortunate 2003 decision of the Federal
Reserve that allowed regulated banks to trade in physical commodity
markets, much of the artificial inflation of commodity prices we have
seen since would not have occurred. Last week the Federal Reserve
announced its intention to ``review'' its 2003 decision \11\ and we
encourage the Congress to make it known to the Fed that reversing that
decision should be a priority at the earliest possible opportunity.
---------------------------------------------------------------------------
\11\ http://www.federalreserve.gov/boarddocs/press/orders/2003/
20031002/attachment.pdf.
---------------------------------------------------------------------------
Figure One graphically illustrates the recent history of the energy
commodity markets, deregulation, Federal Reserve decisions and then the
results for energy prices when the investment banking community began
to play a disproportionate role in those markets.
The Committee should consider proposals to limit the role of index
funds in commodities.
Figure One
Cushing, OK Crude Oil Future Contract 1
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Crude Oil price data from U.S. DOE/EIA.
High Frequency Trading
In order for commodity prices to accurately reflect real-world
supply and demand, futures, options and swaps markets must be driven by
educated traders that are responding objectively to market
fundamentals. Our coalition grows increasingly concerned over the
impact of high-speed automated trading by means of computer
algorithms--also known as algo-trading or High-frequency Trading
(HFT)--on the commodities markets. HFT has already become a dominant
force in the securities markets and many allege it has been responsible
for a series of disruptive market events, including the Flash Crash
that caused the Dow Jones Industrial Average to plunge 1,000 points
(nine percent) on May 6, 2010.
In response to the 2010 ``Flash Crash,'' on November 2, 2011, Sen.
Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) introduced the Wall
Street Trading and Speculators Tax Act, which would impose a .03
percent excise tax on all trades of securities. Sen. Harkin and Rep.
DeFazio said an analysis by the Joint Committee on Taxation estimated
the tax would generate $352 billion in revenue from January 2013
through 2021, if enacted. The tax was designed to disproportionately
affect HFTs, who place thousands of trades in a matter of minutes.
While this effort failed in 2011, on February 28, 2013, Sen. Harkin and
Rep. DeFazio reintroduced a financial transaction tax bill, which was
then referred again to the House Ways and Means and Senate Finance
Committees. CMOC looks forward to working with the Congress as it
considers these important measures.
More recently, some have accused algo-trading as responsible for a
145-point market drop in response to a false tweet about a terrorist
attack on the White House that was posted on a hacked Associated Press
Twitter feed on April 23, 2013.
A May 1, 2013 Wall Street Journal expose further charges that
``High-speed traders are using a hidden facet of the Chicago Mercantile
Exchange's computer system to trade on the direction of the futures
market before other investors get the same information.'' According to
the Journal, such trades are conducted by computers that have an
advantage of just ``one to 10 milliseconds'' and allow the structure of
orders ``so that the confirmations tip which direction prices for crude
oil, corn or other commodities are moving.'' The influence of HFT in
commodities continues to grow. The article cites a Tabb Group estimate
that HFT now comprises ``about 61 percent of all futures market volume,
up from 47 percent in 2008.'' Some market experts told the Journal that
a failure to address this issue could result in market distortions,
increased risks and the loss of liquidity.\12\ Thankfully, the CFTC has
announced that it will investigate the role of High-Frequency trading
in the commodity markets and evaluate the need for new regulations to
protect market participants and preserve market integrity.\13\ They are
not alone. Lawmakers in Europe have become so concerned about this
issue they have even proposed limiting or banning HFT in commodities
markets altogether.\14\
---------------------------------------------------------------------------
\12\ ``High-speed Traders Exploit Loophole,'' The Wall Street
Journal, May 1, 2003. Link:
http://on.wsj.com/15a3uVS (Accessed May 1, 2013)
\13\ ``Statement of Chairman Gary Gensler before the CFTC
Technology Advisory Committee,'' April 30, 2013.
\14\ ``Europe to ban high-frequency trading in commodities,''
BullionStreet (blog), October 29, 2012. Link: http://bit.ly/15a3mG7
(Accessed May 1, 2013)
---------------------------------------------------------------------------
As a corollary to these concerns is the practice of market
information gathering organizations to release data to certain paying
customers minutes prior to the same information being release to the
general public. A June 12, 2013 CNBC report cites that ``contract
signed by Thomson Reuters, the news agency and data provider, and the
University of Michigan, which produces the widely cited economic
statistic, stipulates that the data will be posted on the web for the
general public at 10 a.m. on the days it is released. Five minutes
before that, at 9:55 a.m., the data is distributed on a conference call
for Thomson Reuters' paying clients, who are given certain headline
numbers. But the contract carves out an even more elite group of
clients, who subscribe to the `ultra-low latency distribution
platform,' or high-speed data feed, offered by Thomson Reuters. Those
most elite clients receive the information in a specialized format
tailor-made for computer-driven algorithmic trading at 9:54:58.000,
according to the terms of the contract. On occasion, they could get the
data even earlier-the contract allows for a plus or minus 500
milliseconds margin of error.''
``In the ultra-fast world of high-speed computerized markets, 500
milliseconds is more than enough time to execute trades in stocks and
futures that would be affected by the soon-to-be-public news. Two
seconds, the amount promised to `low latency' customers, is an
eternity.''
``For exclusive access to the data, Thomson Reuters pays the
University of Michigan $1 million per year, according to the contract,
in addition to a `contingent fee' based on the revenue generated by
Thomson Reuters. The contract reviewed by CNBC was signed in September
2009. It expired a year later. Thomson Reuters and the University
Michigan confirmed that the relationship still exists.'' \15\
---------------------------------------------------------------------------
\15\ June 12, 2013 http://www.cnbc.com/id/100809395.
We urge the Committee to investigate the role of HFT and other
potentially harmful or disruptive new trends in the commodity markets
and determine whether or not additional CFTC authority is required to
address these concerns. We attached as Appendix ``B'' the listing of
independent studies showing the harmful effects of high speed trading
on the orderly operation of commodity markets.
Penalties
Current law allows fines of up to $1 million per violation for
manipulation or attempted manipulation and $140,000 for other
violations of the CEA.\16\ In practice, while the amount of these fines
vary, they are often insignificant when compared to the overall profits
of many market participants such as financial institutions and may be
doing little to deter violations of the law. In effect, for many large
firms, these relatively minuscule fines just become part of the cost of
doing business. Given this, the Committee should increase fines and
penalties as appropriate in order to more effectively deter
manipulation and other unlawful behavior.
---------------------------------------------------------------------------
\16\ 7 U.S.C. 13.
---------------------------------------------------------------------------
Additionally, the CFTC is restrained by the blanket 5 year Statute
of Limitations. This restricts the ability of Commissioners to
prosecute violations of the CEA, including cases of fraud and
manipulation. The existing 5 year Statute of Limitations challenges the
CFTC to prosecute cases despite a limited budget and personnel, the
increasing complexity of the markets it regulates and the volume of
data that must be collected and analyzed. Therefore, the Committee
should extend the Statute of Limitations for the CFTC to a minimum of
10 years.
Bankruptcy Protections
Following a series of brokerage-house bankruptcies in the late
1960s, Congress enacted the Securities Investor Protection Act (SIPA)
of 1970 in order to extend FDIC-like protections to brokerage clients
and to restore investor confidence.\17\ The Act established the
Securities Investor Protection Corporation (SIPC) to oversee the
protection of customer funds and investments in the event of a broker-
dealer failure and provide insurance coverage of up to $500,000 for the
value of a customer's net equity, including up to $250,000 for cash
accounts.
---------------------------------------------------------------------------
\17\ Pub. L. 91-598.
---------------------------------------------------------------------------
Unfortunately, Congress failed to extend SIPA protections to
commodity brokerage clients, including commodity hedgers. It is likely
that lawmakers simply did not foresee that commodity hedging would
become such a widespread and vital component of the American economy as
it is today. As a result, when the brokerage firm MF Global filed for
bankruptcy over 18 months ago, its clients lacked adequate Federal
protections for their funds, accounts and positions. They were thrown
into the chaos and uncertainty of recovering their funds, a problem
that could have been alleviated if SIPA-style protections existed for
these customers.
Therefore, we believe the Committee should enhance protections for
commodity brokerage clients, including:
The prioritization of commodity brokerage clients' claims
filed with bankruptcy Trustees;
The creation of a new insurance fund for the protection of
commodity brokerage clients that would provide similar
protections as the SIPA-created securities investor insurance
fund;
The creation of a nonprofit Commodity Futures Protection
Corporation (CFPC) that will be separate from the Securities
Investor Protection Corporation and oversee the remediation of
customer funds in the event of a commodity broker-dealer
failure and to manage the insurance fund associated with the
new law; and
A requirement that in the event of a bankruptcy, the CFPC
work with the CFTC, self regulatory organizations and the
courts in carrying out its mission, especially the restoration
of client funds and the liquidation or transference of
commodity positions.
When combined with enhanced customer protections currently being
considered by the Commodity Futures Trading Commission, self-regulatory
organizations, futures exchanges and brokerage firms, we believe that a
futures insurance program will go a long way to restoring confidence in
these markets. This is especially true for Main Street businesses,
farmers and ranchers, and other industries that utilize futures,
options and swaps to mitigate price risks and to help insulate their
companies and their consumers from volatility and uncertainty.
Trade Options Exemption
The Dodd-Frank Act made it unlawful for anyone that is not an
Eligible Contract Participant (ECP) to enter into an over-the-counter
or off-exchange swap. In order to qualify as an ECP, an entity has to
meet a $10 million net worth requirement, with a separate $1 million
net worth requirement for bona fide hedgers. Although many small
businesses, farmers and other end-users may qualify as an ECP, their
net worth can often fluctuate, causing them to be unsure from time-to-
time whether they satisfy the $1 million net worth requirement for
hedgers. Moreover, an entity's net worth may have an inverse
relationship with its liabilities; that is, as liabilities increase and
the business finds itself with an urgent need to hedge, its net worth
may decrease.
For businesses that do not qualify as ECPs and that hedge commodity
prices through physically settled bilateral options, the CFTC has
proposed a ``trade options exemption'' in order to extend measured
regulatory relief. However, some CMOC members have recommended that the
CFTC extend the trade options exemption to small hedgers that engage in
``financially-settled,'' not just physically-settled, options.
Financially-settled options allow some third-party hedging firms
serving small businesses to aggregate a collection of less-than-
standard contract volumes into a single financially-settled option. The
CFTC has not yet finalized the Trade Options rule. We encourage the
Committee to consult with the CFTC on the status of the trade options
exemption and, if necessary, take action to codify regulatory relief
for small hedgers.
Energy & Environmental Markets Advisory Committee
In response to unprecedented volatility in the energy markets and
at the urging of members of this coalition, the CFTC established the
Energy Markets Advisory Committee in June of 2008. The purpose of this
advisory committee, according to then-Acting CFTC Chairman Walt Lukken,
was to assemble representatives from the energy industry, end-user
groups and other market stakeholders to ``ensur[e] that the Commission
is fully informed of industry developments and innovations so that the
Commission can rapidly respond to changing market conditions and ensure
that these markets are not subject to foul play.'' In 2009 the
committee's charter was revised to include emerging environmental
markets such as carbon trading markets and renamed the ``Energy &
Environmental Markets Advisory Committee'' (EEMAC).
Congress clearly felt the EEMAC was important enough to make it
permanent under Section 751 of the Dodd-Frank Act. Despite this, the
advisory committee has only met three times since it was formed in
2008. Not a single meeting has been held since the EEMAC was made
permanent in 2010. Meanwhile, the CFTC's Agriculture Advisory
Committee, Global Markets Advisory Committee and the Technology
Advisory Committee have met over 20 times. The Committee should require
the CFTC to establish a charter for the EEMAC by a date certain and
require at least annual meetings to receive input from energy market
stakeholders.
CFTC Resources
In retrospect, not to criticize but to make an observation with the
benefit of hindsight, in establishing deadlines for the completion of
regulatory proceedings within 365 days of the enactment of Dodd-Frank
was an error. The hundreds of complex issues that needed to be
addressed, most with the coordination of other agencies, was a recipe
for putting the CFTC severely behind in meeting their statutory
deadlines.
Today CFTC staff is at 689 people, only nine percent bigger than 20
years ago. At minimum CFTC needs 1,015 people in addition to new
technology investments. CFTC collected $2 billion in fines last year
(benefitting the Treasury, not CFTC budget)--that is CFTC
appropriations funding for 22 prior fiscal years. This year the size of
the CFTC actually contracted because of sequestration and cut 20-30
people from the staff. The CFTC hasn't been able to hire experts on
swaps markets, which is needed. The CFTC needs new technology in order
to even try to keep up with the $600 trillion derivatives market and
the private sector technology advancements that the agency is
responsible for overseeing. If flat funding is provided, CFTC would
have to cut another 50 people (about eight or nine percent) despite the
responsibility to cover the swaps market. Therefore, we continue to
urge Congress to fully fund the CFTC at the levels requested by the
Administration.
Conclusion
In this reauthorization effort we need to not only examine the
necessary corrections for the imperfections in Dodd-Frank that we have
cited, but also the magnitude of the new authorities the CFTC was given
to protect the sanctity of the commodity markets and the pocketbooks of
American taxpayers and the diminished resources with which this agency
has had to operate under extraordinarily difficult circumstances.
Thank you for the opportunity to appear with you today and I would
be happy to answer any questions you may have.
Appendix A
Independent Studies on the Negative Effects of Commodity Speculation
Evidence on the Negative Impact of Commodity Speculation by Academics, Analysts and Public Institutions
21 May 2013
Note: This list is constantly being updated and revised. It only collects evidence that supports a critical view of commodity speculation in general or
certain elements of it.
Compiled by Markus Henn, WEED, [Redacted], www.weed-online.org
(A) Academic peer reviewed journal articles
(1) Baffes, John (The World Bank) (2011): The long term implications of the 2007-08 commodity-price boom. Development in Practice, Vol. 21, Issue 4-5,
pages 517-525: ``Demand by emerging economies is unlikely to put additional pressure on the prices of food commodities, although it may create such
pressure indirectly through energy prices. The effect of biofuels on food prices has not been as great as originally thought, but the use of
commodities by investment funds may have been partly responsible for the 2007-08 spike.'' [http://www.tandfonline.com/doi/abs/10.1080/
09614524.2011.562488]
(2) Belke, Ansgar (IZA/University Duisburg-Essen)/Bordon, Ingo G. (University Duisburg-Essen)/Volz, Ulrich (German Development Institute) (2012):
Effects of Global Liquidity on Commodity and Food Prices. World Development, in press: ``Over the period that we observed, 1980-2011, food and
commodity price inflation were apparently driven by monetary expansion in the world's major economies. By examining the pertinence of monetary
liquidity, our results add to the discussion on a financialization of commodities, that stresses the aspect of financial liquidity, where food and
commodity prices are driven to a large extent by flows of portfolio investment seeking return in commodity markets and not merely by demand from the
real economy. Policymakers should care about the negative side-effects of loose monetary policy and consider stricter regulation of food and commodity
markets--such as the imposition of tighter limits on speculative positions in food commodities--to prevent a further flow of liquidity into these
markets.'' [http://www.sciencedirect.com/science/article/pii/S0305750X12003038]
(3) Chevallier, Julien (University of Paris) (2012): Price relationships in crude oil futures: new evidence from CFTC disaggregated data. Environmental
Economics and Policy Studies, August 2012: ``we are able to highlight the influence of the CFTC `Money Managers' net position category (as a proxy of
speculative trading) on the oil price at reasonable statistical confidence levels. (. . .) The policies being considered by the CFTC to put aggregate
position limits on futures contracts and to increase the transparency of futures markets are moves in the right direction.'' [http://
www.springerlink.com/content/41485582m36k3841/?MUD=MP]
(4) Cifarelli, Giulio (University of Florenz)/Paladino, Giovanna (LUISS University/BIS) (2010): Oil price dynamics and speculation: A multivariate
financial approach. Energy Economics, Vol. 32, Issue 2, March 2010, pages 363-372: ``Despite the difficulties, we identify a significant role played by
speculation in the oil market, which is consistent with the observed large daily upward and downward shifts in prices--a clear evidence that it is not
a fundamental-driven market.'' [http://www.sciencedirect.com/science/article/pii/S0301421511000590%20]
(5) Czudaj, Robert/Beckmann, Joscha (Duisburg University) (2012): Spot and futures commodity markets and the unbiasedness hypothesis--evidence from a
novel panel unit root test. Economics Bulletin, 2012, vol. 32, issue 2, pages 1695-1707: ``Our findings show that most spot and futures markets for
commodities were efficient until the turn of the millennium, but appear to be inefficient thereafter owing to an increase in volatility, which might be
attributed to the intense engagement of speculation in commodity markets.'' [http://econpapers.repec.org/article/eblecbull/eb-12-00122.htm]
(6) Du, Xiaodong/Yu, Cindy L./Hayes, Dermott J. (Iowa State University) (2011): Speculation and Volatility Spillover in the Crude Oil and Agricultural
Commodity Markets: A Bayesian Analysis. Energy Economics, Vol. 33, Issue 3, May 2011, pages 497-503: ``Speculation, scalping, and petroleum inventories
are found to be important in explaining oil price variation.'' [http://www.sciencedirect.com/science/article/pii/S014098831100017X%20]
(7) Fan, Ying (Chinese Academy of Sciences)/Xu, Jin-Hua (Hefei University) (2011): What has driven oil prices since 2000? A structural change
perspective: ``Through establishing a comparative model, we quantitatively measure the effects of speculation and episodic events such as wars on oil
price changes. We find that the explanatory power of the models is obviously improved after allowing for the two factors. In particular, during the
`Relatively calm market' period (January, 2000 to March, 2004) and `Bubble accumulation' period (March, 2004, to June, 2008), when the speculation
variables are considered, not only they are significant, but also the explanatory ability greatly rises and various diagnostic tests are improved,
indicating that speculation is a highly influential factor on oil price changes in these periods.'' [http://www.sciencedirect.com/science/article/pii/
S0140988311001228]
(8) Gilbert, Christopher (Trento University) (2010): How to understand high food prices. Journal of Agricultural Economics. Vol. 61, Issue 2, pages 398-
425: ``By investing across the entire range of commodity futures, index-based investors appear to have inflated food commodity prices.'' [http://
onlinelibrary.wiley.com/doi/10.1111/j.1477-9552.2010.00248.x/abstract]
(9) Gutierrez, Luciano (University of Sassari) (2012): Speculative bubbles in agricultural commodity markets. European Review of Agricultural Economics,
2012, pages 1-22: ``We investigate whether commodity prices during the spike of 2007-2008 might have deviated from their intrinsic values based on
market fundamentals. To do this, we use a bootstrap methodology to compute the finite sample distributions of recently proposed tests. Monte-Carlo
simulations show that the bootstrap methodology works well, and allows us to identify explosive processes and collapsing bubbles for wheat, corn and
rough rice. There was less evidence of exuberance in soya bean prices.'' [http://erae.oxfordjournals.org/content/early/2012/06/27/
erae.jbs017.short?rss=1%20]
(10) Hache, Emmanuel/Lantz, Frederic (IFPEnergies Nouvelles, Paris) (2012): Speculative Trading & Oil Price Dynamic: A study of the WTI market, Energy
Economics (Accepted Manuscript, 3 September 2012): ``We conclude that the hypothesis of an influence of noncommercial players on the probability for
being in the crisis state cannot be rejected. In addition, we show that the rise in liquidity of the first financial contracts, as measured by the
volume of open interest, is a key element to understand the dynamics in market prices.'' [http://www.sciencedirect.com/science/article/pii/
S0140988312002162]
(11) Kaufmann, Robert K./Ullman, Ben (Boston University) (2009): Oil prices, speculation, and fundamentals: Interpreting causal relations among spot and
futures prices: ``Together, these results suggest that market fundamentals initiated a long-term increase in oil prices that was exacerbated by
speculators, who recognized an increase in the probability that oil prices would rise over time.'' [http://www.sciencedirect.com/science/article/pii/
S0140988309000243]
(12) Kaufmann, Robert K. (Boston University ) (2011): The role of market fundamentals and speculation in recent price changes for crude oil. Energy
Policy, Volume 39, Issue 1, January 2011, Pages 105-115: ``Although difficult to measure directly, I argue for the role of speculation based on the
following: (1) a significant increase in private U.S. crude oil inventories since 2004; (2) repeated and extended breakdowns (starting in 2004) in the
cointegrating relationship between spot and far month future prices that are inconsistent with the law of one price and arbitrage opportunities; and
(3) statistical and predictive failures by an econometric model of oil prices that is based on market fundamentals. These changes are related to the
behavior and impact of noise traders on asset prices to sketch mechanisms by which speculative expectations can affect crude oil prices.'' [http://
www.sciencedirect.com/science/article/pii/S0301421510007044]
(13) Mayer, Jorg (UNCTAD) (2012): The Growing Financialisation of Commodity Markets: Divergences between Index Investors and Money Managers. Journal of
Development Studies, Vol. 48, Issue 6, pages 751-767: ``During 2006-2009, index trader positions had a price impact for some agricultural commodities,
as well as oil. During 2007-2008, money managers impacted prices for nonagricultural commodities, especially copper and oil.'' [http://
www.tandfonline.com/doi/abs/10.1080/00220388.2011.649261]
(14) Newman, Susan A. (University of the Witwatersand) (2009): Financialization and Changes in the Social Relations along Commodity Chains: The Case of
Coffee. Review of Radical Political Economics. Vol. 41, No. 4, pages 539-559: ``It is argued that increased financial investment on international
commodity exchanges, together with market liberalization, have given rise to opportunities and challenges for actors in the coffee industry. Given the
heterogeneity of market actors, these tend to exacerbate inequalities already present in the structure of production and marketing of coffee.'' [http://
rrp.sagepub.com/content/41/4/539.abstract]
(15) Nissanke, Machiko (University of London) (2012): Commodity Market Linkages in the Global Financial Crisis: Excess Volatility and Development
Impacts. Journal of Development Studies, Vol. 48, Issue 6, pages 732-750: ``This article (. . .) suggests that a significant portion of the closely
synchronised price dynamics in commodity and financial markets is explained by market liquidity cycles in global finance, as financial investors manage
their portfolio at ease through `virtual' stock holdings of commodities in derivatives dealings and markets.'' [http://www.tandfonline.com/doi/abs/
10.1080/00220388.2011.649259]
(16) Morana, Claudio (University of Milano, Bicocca) (2012): Oil price dynamics, macro-finance interactions and the role of financial speculation.
Journal of Banking & Finance, in press: ``While we then find support to the demand side view of real oil price determination, we however also find a
much larger role for financial shocks than previously noted in the literature.'' [http://www.sciencedirect.com/science/article/pii/S037842661200266X]
(17) Sigl-Grub, Christoph/Schiereck, Dirk (Technical University Darmstadt) (2010): Speculation and nonlinear price dynamics in commodity futures
markets. Investment Management and Financial Innovations, Vol. 7, Issue 1, pages 59-73: ``In this article we present theoretical considerations and
empirical evidence that the short-run autoregressive behavior of commodity markets is not only driven by market fundamentals but also by the trading of
speculators.'' [http://businessperspectives.org/journals_free/imfi/2010/imfi_en_2010_01_Sigl.pdf]
(18) Silvennoinen Annastiina (Queensland University)/Thorp, Susan (Sydney University) (2013): Financialization, crisis and commodity correlation
dynamics. Journal of International Financial Markets, Institutions and Money, Vol. 24, April 2013, Pages 42-65: ``Stronger investor interest in
commodities may create closer integration with conventional asset markets. We estimate sudden and gradual changes in correlation between stocks, bonds
and commodity futures returns driven by observable financial variables and time (. . .). Most correlations begin the 1990s near zero but closer
integration emerges around the early 2000s and reaches peaks during the recent crisis. (. . .) Increases in VIX and financial traders' short open
interest raise futures returns volatility for many commodities. Higher VIX also increases commodity returns correlation with equity returns for about
half the pairs, indicating closer integration.'' [http://www.sciencedirect.com/science/article/pii/S1042443112001059]
(19) Tang, Ke (Princeton University)/Xiong, Wei (Renmin University) (2012): Index Investment and the Financialization of Commodities. Financial Analyst
Journal, Vol. 68, Number 6, pages 54-74: ``concurrent with the rapid growth of index investment in commodity markets, prices of non-energy commodities
have become increasingly correlated with oil prices. This trend is significantly more pronounced for commodities in two popular indices: the S&P GSCI
and the DJ-UBSCI. Our findings reflect a fundamental process of financialization among commodity markets, through which commodity prices have become
more correlated with each other. As a result of the financialization process, the price of an individual commodity is no longer determined solely by
its supply and demand. Instead, prices are also determined by the aggregate risk appetite for financial assets and the investment behavior of
diversified commodity index investors.'' [http://www.princeton.edu/ wxiong/papers/commodity.pdf]
(20) Tokis, Damir (ESC Rennes) (2011): Rational destabilizing speculation, positive feedback trading, and the oil bubble of 2008. Energy Economics, Vol.
39, Issue 4, April 2011, pages 2051-2061: ``institutional investors that invest in crude oil to diversify their portfolios and/or hedge inflation can
destabilize the interaction among commercial participants and liquidity-providing speculators.'' [http://www.sciencedirect.com/science/article/pii/
S0301421511000590]
(B) Research papers published by universities and public institutions
(1) Adammer, Philipp/Bohl, Martin T./Stephan, Patrick M. (University of Munster) (2011): Speculative Bubbles in Agricultural Prices: ``The empirical
evidence is favorable for speculative bubbles in the corn and wheat price over the last decade.'' [http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1979521]
(2) Algieri, Bernardina (Bonn University) (2012): Price Volatility, Speculation and Excessive Speculation in Commodity Markets: Sheep or Shepherd
Behaviour?: ``. . . this study shows that excessive speculation drives price volatility, and that often bilateral relationships exist between price
volatility and speculation. (. . .) excessive speculation has driven price volatility for maize, rice, soybeans, and wheat in particular time frames,
but the relationships are not always overlapping for all the considered commodities.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2075579]
(3) Algieri, Bernardina (Bonn University) (2013): A Roller Coaster Ride: an empirical investigation of the main drivers of wheat price: ``The variables
with the largest effects on price movements over the period 1995-2012 are the global demand, speculation, and the real effective exchange rate. This
testifies that the financial 25 and wheat markets have become more and more interwoven, and `speculation' based on investing in futures contracts on
commodity markets, to profit from price fluctuations, is an important determinant of price dynamics.'' [http://www.zef.de/fileadmin/webfiles/downloads/
zef_dp/zef_dp_176.pdf]
(4) Anderson, David et al. (Texas University) (2008): The effects of ethanol on Texas food and feed: ``Speculative fund activities in futures markets
have led to more money in the markets and more volatility. Increased price volatility has encouraged wider trading limits. The end result has been the
loss of the ability to use futures markets for price risk management due to the inability to finance margin requirements.'' [http://www.afpc.tamu.edu/
pubs/2/515/RR-08-01.pdf]
(5) Baffes, John (The World Bank)/Haniotis, Tassos (European Commission) (2010): Placing the 2006/08 Commodities Boom into Perspective. World Bank
Research Working Paper 5371: ``We conjecture that index fund activity (one type of `speculative' activity among the many that the literature refers to)
played a key role during the 2008 price spike. Biofuels played some role too, but much less than initially thought. And we find no evidence that
alleged stronger demand by emerging economies had any effect on world prices.'' [http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/
2010/07/21/000158349_20100721110120/Rendered/PDF/WPS5371.pdf]
(6) Baldi, Lucia/Peri, Massimo, Vandone, Daniela (Universita degli Studi di Milano) (2011): Price discovery in agricultural commodities: the shifting
relationship between spot and futures prices: ``Last but not least, financial speculation, which caused considerable price volatility and prevented the
planning of supply in many countries, contributed to creating a situation of market instability.''
(7) Bass, Hans H. (University of Bremen) (2011): Finanzmarkte als Hungerverursacher? Studie fur Welthungerhilfe e.V.: ``Das Engagement der
Kapitalanleger auf den Getreidemarkten fuhrte nach unseren Berechnungen in den Jahren 2007 bis 2009 im Jahresdurchschnitt zu einem Spielraum fur
Preisniveauerhohungen von bis zu 15 Prozent.'' [http://www.zukunftderernaehrung.org/images/stories/pdf/materialien.texte/
whh_studie_bass_finanzmrkte_hungerverursacher.pdf]
(8) Basak, Suleyman/Pavlova, Anna (London Business School/Centre for Economic Policy Research) (2013): We find that in the presence of institutions the
prices of all commodity futures go up. The price rise is higher for futures belonging to the index than for nonindex ones. If a commodity futures is
included in the index, supply and demand shocks specific to that commodity spill over to all other commodity futures markets. In contrast, supply and
demand shocks to a nonindex commodity affect just that commodity market alone. In the presence of institutions the volatilities of both index and
nonindex futures go up, but those of index futures increase by more. Furthermore, financialization leads to an increase in the correlations amongst
commodity futures as well as in equity-commodity correlations. Increases in the correlations between index commodities exceed those for nonindex ones.
We model explicitly demand shocks which allows us to disentangle the effects of financialization from the effects of rising demand for commodities, and
find that in the presence of demand shocks the impact of institutions on futures prices becomes considerably stronger.'' [http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2201600]
(9) Basu, Parantap/Gavin, William T. (Federal Reserve Bank of St. Louis) (2011): What explains the Growth in Commodity Derivatives?: ``Banks argue that
they need to use commodity derivatives to help customers manage risks. This may be true, but the recent experience in commodity futures did not reduce
risks but exacerbated them just at the wrong time.'' [http://research.stlouisfed.org/publications/review/11/01/37-48Basu.pdf]
(10) Bicchetti, David/Maystre, Nicolas (UNCTAD) (2012): The synchronized and long-lasting structural change on commodity markets: evidence from high
frequency data: ``we document a synchronized structural break, characterized by a departure from zero, which starts in the course of 2008 and continues
thereafter. This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high frequency trading
activities and algorithm strategies have an impact on these correlations.'' [http://mpra.ub.uni-muenchen.de/37486/1/MPRA_paper_37486.pdf]
(11) Boos, Jaap W.B. (Universitat Maastricht, School of Business and Economics)/van der Moolen, Maarten (Rabobank) (2012): A Bitter Brew? Futures
Speculation and Commodity Prices: ``speculation is an important part of the coffee price generation process.'' [http://edocs.ub.unimaas.nl/loader/
file.asp?ID=1709%20]
(12) Borin, Alessandro/Di Nino, Virginia (Bank of Italy) (2012): The role of financial investments in agricultural commodity derivatives markets: ``this
result gives some support to the idea that swap dealers, whose growing weight in the regulated exchanges tends to reflect the large exposures of
`commodity index investors' in the OTC markets, may have a destabilizing impact on futures prices, at least in the short run. On the contrary, the
activity of more traditional speculators seems to favour price stability, probably enhancing market liquidity.'' [http://www.bancaditalia.it/
pubblicazioni/econo/temidi/td12/td849_12/en_td849/en_tema_849.pdf]
(13) Buyuksahin, Bahattin (International Energy Agency)/Robe, Michel A. (American University) (2010): Speculators, Commodities and Cross-Market
Linkages: ``We then show that the correlations between the returns on investable commodity and equity indices increase amid greater participation by
speculators generally and hedge funds especially.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1707103]
(14) Cheng, Ing-Haw (University of Michigan)/Kirilenko, Andrei (CFTC)/ Xiong, Wei (Princeton University) (2012): Convective Risk Flows in Commodity
Futures Markets: ``We find that CITs and hedge fund positions reacted negatively to the VIX during the recent financial crisis . . . Consistent with
theories suggesting this is related to the distress of financial institutions, we find that CITs with high CDS spreads are more sensitive to movements
in the VIX. Contrary to the hedging pressure hypothesis, we do not find that hedgers increased their hedges as the VIX rose. Finally, the findings show
that the reactions of all trader groups were persistent over time. This evidence suggests that during times of distress, there was a flow of risk away
from financial institutions back towards commercial hedgers.'' [http://www.princeton.edu/ wxiong/papers/RiskConvection.pdf]
(15) Coleman, Les/Dark, Jonathan (University of Melbourne) (2012): Economic Significance of Non-Hedger Investment in Commodity Markets: ``We find a
cointegrating relationship in larger markets between scaled open interest and real spot price, where it is usually the price that adjusts to deviations
from long run equilibrium.'' [http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_tID2021919_tcode373191.pdf?abstractid=2021919&mirid=1]
(16) Cooke, Bryce/Robles, Miguel (IFPRI) (2009): Recent Food Prices Movements. A Time Series Analysis: ``Overall, our empirical analysis mainly provides
evidence that financial activity in futures markets and proxies for speculation can help explain the observed change in food prices; any other
explanation is not well supported by our time series analysis.'' [http://www.ifpri.org/sites/default/files/publications/ifpridp00942.pdf]
(17) Creti, Anna/Joets, Marc/Mignon, Valerie (CEPII, Paris) (2012): On the links between stock and commodity markets' volatility: ``Our results show
that correlations between commodity and stock markets are time-varying and highly volatile. The impact of the 2007-2008 financial crisis is noticeable,
emphasizing the links between commodity and stock markets, and highlighting the financialization of commodity markets. We also show that, while sharing
some common features, commodities cannot be considered a homogeneous asset class: a speculation phenomenon is for instance highlighted for oil, coffee
and cocoa, while the safe-haven role of gold is evidenced.''
[http://www.cepii.fr/anglaisgraph/workpap/pdf/2012/wp2012-20.pdf]
(18) Dicembrino, Claudio/Scandizzo, Pasquale L. (University of Rome) (2012): The Fundamental and Speculative Components of the Oil Spot Price: ``Our
results show that speculative components, measured according to mathematical option theory, may be at the origin of significant and sizable effects on
oil prices, specially for what concerns the episodes of extreme variations. The speculation issue, however, suggests that further investigation may be
conducted in order to identify the factors affecting the speculation itself.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2043158]
(19) Dorfman, Jeffrey H./Karali, Berna (University of Georgia) (2012): Have Commodity Index Funds Increased Price linkages between Commodities?: ``In
combination with our results on correlation coefficients and non-stationarity, these empirical results are indicative, but not fully convincing, of the
growth of commodity index funds impacting commodity futures market linkages over the last 8 years.'' [http://www.farmdoc.illinois.edu/nccc134/conf_2012/
pdf/confp01-12.pdf]
(20) Doroudian, Ali/Vercammen, James (University of British Columbia) (2012): First and Second Order Impacts of Speculation and Commodity Price
Volatility: ``Both of these results are consistent with the theoretical arguments that speculation which involves large-scale institutional investment
can have first and second order impacts on commodity price volatility.'' [http://ageconsearch.umn.edu/bitstream/126947/2/
Speculation%20SPAA%20Jan%202012wCover.pdf]
(21) Eckaus, R.S. (MIT) (2008): The Oil Price Really Is A Speculative Bubble: ``Since there is no reason based on current and expected supply and demand
that justifies the current price of oil, what is left? The oil price is a speculative bubble.'' [http://www.cii.org/UserFiles/file/
oil%20prie%20is%20spec%20bubble%20-%20MIT%20study%20-%20June%202008.pdf]
(22) Einloth, James T. (FDIC) (2009): Speculation and Recent Volatility in the Price of Oil: ``The paper finds the evidence inconsistent with
speculation having played a major role in the rise of price to $100 per barrel in March 2008. However, the evidence suggests that speculation did play
a role in its subsequent rise to $140.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1488792]
(23) Frankel, Jeffrey (Harvard Kennedy School)/Rose, Andrew K. (Haas School of Business, UC Berkeley) (2010): Determinants of Agricultural and Mineral
Commodity Prices: ``Our annual empirical results show support for the influence of economic activity, inventories, uncertainty in the spread and recent
spot price changes.'' [http://faculty.haas.berkeley.edu/arose/Commod.pdf]
(24) Gilbert, Christopher (Trento University) (2010): Speculative Influences on Commodity Futures Prices: ``The results . . . indicate that index-based
investment in commodity futures may have been responsible for a significant and bubble-like increase of energy and nonferrous metals prices, although
the estimated impact on agricultural prices is smaller.'' [http://www.unctad.org/en/docs/osgdp20101_en.pdf]
(25) Gilbert, Christopher/Pfuderer, Simone (University of Trento) (2012): Index Funds Do Impact Agricultural Prices: ``We use Granger-causality methods
to re-examine the data analyzed in Sanders and Irwin (2011a). Our analysis supports their conclusion that mo impacts are discernible for the four
grains markets they consider. However, Granger-causality is established in the less liquid soybean oil and livestock markets. We conjecture that index
investment does also have price impact in liquid markets but that market efficiency prevents the detection of this impact using Granger-causality
tests.'' [http://www.york.ac.uk/res/mmf/documents/SI_5.pdf]
(26) Girardi, Daniele (University of Siena) (2011): Do financial investors affect commodity prices? The case of Hard Red Winter Wheat: ``Our empirical
analysis suggests that financial investors played an important role in affecting wheat price fluctuations in recent years. In particular they seem to
have linked wheat price dynamics to U.S. equity market returns and to oil price movements.'' [http://mpra.ub.uni-muenchen.de/35670/1/
MPRA_paper_35670.pdf]
(27) Ghosh, Jayati (Jawaharlal Nehru University) (2010): Commodity speculation and the food crisis: ``Thus international commodity markets increasingly
began to develop many of the features of financial markets, in that they became prone to information asymmetries and associated tendencies to be led by
a small number of large players. Far from being `efficient markets' in the sense hoped for by mainstream theory, they allowed for inherently `wrong'
signalling devices to become very effective in determining and manipulating market behaviour. The result was the excessive price volatility that has
been displayed by important commodities over the recent period--not only the food grains and crops mentioned here, but also minerals and oil.'' [http://
www.wdm.org.uk/sites/default/files/Commodity%20speculation%20and%20food%20crisis.pdf]
(28) Goyal, Ashima/Tripathi, Shruti (Indira Gandhi Institute of Development Research) (2012): Regulations and price discovery: oil spot and futures
markets: ``The results show expectations mediated through financial markets did not lead to persistent deviations from fundamentals. (. . .) But there
is stronger evidence of short-term or collapsing bubbles in mature market futures compared to Indian, although mature markets have a higher share of
hedging. Indian regulations such as position limits may have mitigated short duration bubbles. It follows leverage due to lax regulation may be
responsible for excess volatility.'' [http://www.igidr.ac.in/pdf/publication/WP-2012-016.pdf]
(29) Greenberger, Michael (University of Maryland) (2010): The Relationship of Unregulated Excessive Speculation to Oil Market Price Volatility: ``When
speculators make up too large a share of the futures market, they have the potential to upset the healthy tension between consumers and producers and
resulting adherence of prices to market fundamentals. The resulting volatility makes it more difficult for commercial consumers and producers to
successfully hedge risk, because prices do not reflect market fundamentals, and so they abandon the futures market and risk shifting--thereby further
destabilizing the price discovery influence of these markets.'' [http://www.michaelgreenberger.com/files/IEF-Greenberger-AppendixVII.pdf]
(30) Halova, Marketa W. (Washington State University) (2012): The Intraday Volatility--Volume Relationship in Oil and Gas Futures: ``For the nearby
contract, Granger-causality tests show that past values of volume help explain volatility which agrees with the Sequential Information Arrival
Hypothesis. Past values of volatility have explanatory power for volume only when absolute return is used as the volatility measure; when the
conditional variance from GARCH models is used as the volatility measure, the causality in this direction disappears. These results change when low-
frequency daily data is applied. (. . .) if past volume can be used to forecast volatility, markets are not efficient. Therefore, the lagged volume
having explanatory power for volatility indicates some market inefficiency, at least at the 10-minute interval frequency.'' [http://cahnrs-cms.wsu.edu/
ses/people/marketa_halova/Documents/oilVolumeVolatility_v25_paper.pdf]
(31) Hamilton, James (University of California) (2009): Causes and Consequences of the Oil Shock of 2007-08: ``With hindsight, it is hard to deny that
the price rose too high in July 2008, and that this miscalculation was influenced in part by the flow of investment dollars into commodity futures
contracts.'' [http://www.brookings.edu/ /media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/2009a_bpea_hamilton.pdf]
(32) Hamilton, James D. (University of California)/Wu, Cynthia (University of Chicago) (2011): Risk Premia in Crude Oil Futures Prices: ``We document
significant changes in oil futures risk premia since 2005, with the compensation to the long position smaller on average but more volatile in more
recent data. This observation is consistent with the claim that index-fund investing has become more important relative to commercial hedging in
determining the structure of crude oil futures risk premia over time.'' [http://dss.ucsd.edu/ jhamilto/hw4.pdf]
(33) Henderson, Brian J. (George Washington University)/Pearson, Neil D./Wang, Li (University of Illinois at Urbana-Champaign) (2012): New Evidence on
the Financialization of Commodity Markets: ``Commodity-Linked Notes (CLNs) . . . issuers hedge their liabilities by taking long positions in the
underlying commodity futures on the pricing dates. These hedging trades are plausibly exogenous to the contemporaneous and subsequent price movements,
allowing us to identify the price impact of the hedging trades. We find that these hedging trades cause significant price changes in the underlying
futures markets, and therefore provide direct evidence of the impact of `financial' trades on commodity futures prices.'' [http://www.ccfr.org.cn/
cicf2012/papers/20120525010717.pdf]
(34) Hong, Harrison (Princeton University)/Yogo, Motohiro (University of Pennsylvania) (2009): Digging into Commodities: ``Since 2004 . . . commodity
prices have appreciated considerably, and aggregate basis has fallen (if anything), suggesting that futures prices have responded at least (if not more
than) one-for-one with spot-price shocks. This could reflect the belief among investors that these price shocks are permanent or highly persistent.
This is however unprecedented since even during the energy crisis of the seventies, one did not see such a striking movement in futures prices. This
finding could instead reflect the conventional wisdom that lots of new indexed money flowed into commodity futures (as opposed to the spot market),
chasing returns during this period.'' [http://www.usc.edu/schools/business/FBE/seminars/papers/F_9-25-09_MOTOHIRO.pdf]
(35) Inamura, Yasunari/Kimata, Tomonori/Takeshi, Kimura/Muto, Takashi (Bank of Japan) (2011): Recent Surge in Global Commodity Prices--Impact of
financialization of commodities and globally accommodative monetary conditions: ``While the strong increase in commodity prices has been driven by
global economic growth propelled by emerging economies, speculative investment flows into commodity markets have amplified the intensity of the price
surge. (. . .) global commodity markets have become more sensitive to portfolio rebalancing by financial investors, which has made commodity markets
more correlated with other asset markets, including major equity markets.'' [http://www.boj.or.jp/en/research/wps_rev/rev_2011/rev11e02.htm/]
(36) Jickling, Mark/Austin, Andrew D. (Congressional Research Service) (2011): Hedge Funds Speculation and Oil Prices: ``A statistically significant
correlation is evident between changes in positions held by `money managers' (a category of speculators that includes hedge funds) and the price of
oil. In other words, during weeks when money managers have been net buyers of oil futures and options (or increased the size of their long positions),
the price has tended to rise. Price falls, conversely, have tended to coincide with reductions in money managers' long positions.'' [http://www.fas.org/
sgp/crs/misc/R41902.pdf]
(37) Juvenal, Luciana/Ivan, Petrella (Federal Reserve Bank of St. Louis) (2011): Speculation in the Oil Market: ``We find that the increase in oil
prices in the last decade is mainly due to the strength of global demand, consistent with previous studies. However, financial speculation
significantly contributed to the oil price increase between 2004 and 2008.'' [http://research.stlouisfed.org/wp/2011/2011-027.pdf]
(38) Kawamoto, Takuji/Kimura, Takeshi/Morishita, Kentaro/Higashi, Masato (Bank of Japan) (2011): What has caused the surge in global commodity prices
and strengthened cross-market linkage?: ``Moreover, we find quantitative evidence that an increase in cross-market linkage between commodity and stock
markets was caused by the markets' increased comovements due to large fluctuations in the global economy during the financial crisis as well as by the
`financialization of commodities,' that is, financial investors are increasingly treating commodities as an investment asset class.'' [http://
www.boj.or.jp/en/research/wps_rev/wps_2011/data/wp11e03.pdf]
(39) Khan, Mohsin S. (Petersen Institute) (2009): The 2008 Oil Price `Bubble': ``While market fundamentals obviously played a role in the general run-up
in the oil prices from 2003 on, it is fair to conclude by looking at a variety of indicators that speculation drove an oil price bubble in the first
half of 2008. Absent speculative activities, the oil price would probably have been in the $80 to $90 a barrel range.'' [http://www.piie.com/
publications/pb/pb09-19.pdf]
(40) Lagi, Marco/Bar-Yam, Yavni/Bertrand, Karla Z./Bar-Yam, Yaneer (New England Complex Systems Institute, Cambridge MA) (2011): The Food Crises A
Quantitative Model of Food Prices Including Speculators and Ethanol Conversion: ``The two sharp peaks in 2007/2008 and 2010/2011 are specifically due
to investor speculation, while an underlying upward trend is due to increasing demand from ethanol conversion. The model includes investor trend
following as well as shifting between commodities, equities and bonds to take advantage of increased expected returns. Claims that speculators cannot
influence grain prices are shown to be invalid by direct analysis of price setting practices of granaries.'' Update (2012): ``we extend the food prices
model to January 2012, without modifying the model but simply continuing its dynamics. The agreement is still precise, validating both the descriptive
and predictive abilities of the analysis.'' [http://necsi.edu/research/social/food_prices.pdf] [http://necsi.edu/research/social/foodprices/update/
food_prices_update.pdf]
(41) Lammerding, Marc/Stephan, Patrick/Trede, Mark/Wilfling, Bernd (University of Munster): Speculative bubbles in recent oil price dynamics: Evidence
from a Bayesian Markov-switching state-space approach: ``we find robust evidence for the existence of speculative bubbles in recent oil price
dynamics.'' [http://www1.wiwi.uni-muenster.de/cqe/forschung/publikationen/cqe-working-papers/CQE_WP_23_2012.pdf]
(42) Le Pen, Yannick (Universite Paris-Dauphine)/Sevi, Benoit (Aix-Marseille University) (2012): Futures Trading and the Excess Comovement of Commodity
Prices: ``Our estimates provide evidence of a time-varying excess comovement which is only occasionally significant, even after controlling for
heteroscedasticity. Interestingly, excess comovement is mostly significant in recent years when a large increase in the trading of commodities is
observed. However, we show that this increase in trading activity alone has no explanatory power for the excess comovement. Conversely, measures of
hedging and speculative pressure explain around 60% of the estimated excess comovement thereby showing the strong impact of the financialization on the
price of commodities and the fact that demand and supply variables are not the sole factors in determining equilibrium prices.'' [http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=2191659]
(43) Liu, Peng (Cornell University)/Zhigang, Qui/Tang, Ke (Renmin University of China) (2011) Financial-Demand Based Commodity Pricing: A Theoretical
Model for Financialization of Commodities: ``In this paper, we develop an equilibrium model that shows that financial investment does influence
commodity prices and volatilities. Furthermore, financial investments dilute the relationship between convenience yields (a proxy for the fundamentals)
and commodity prices.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1946197]
(44) Lombardi, Marco J./Van Robays, Ine (European Central Bank) (2011): Do financial investors destablize the oil price?: ``We find that financial
investors in the futures market can destabilize oil spot prices, although only in the short run. Moreover, financial activity appears to have
exacerbated the volatility in the oil market over the past decade, particularly in 2007-2008. However, shocks to oil demand and supply. remain the main
drivers of oil price swings.'' [http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1346.pdf]
(45) Luciani, Giacomo (Gulf Research Center Foundation) (2009): From Price Taker to Price Maker? Saudi Arabia and the World Oil Market: ``The inflow of
liquidity, the increasing role played by the futures market (paper barrels) over the spot (wet barrels), and the proliferation of derivatives which
encourage betting on price changes rather than on the absolute level of prices all contribute to worsen the situation, amplifying price oscillations.''
[http://www.princeton.edu/ gluciani/pdfs/Saudi%20Arabia%20and%20the%20World%20Oil%20Market.pdf]
(46) Mayer, Jorg (UNCTAD) (2009): The Growing Interdependence between Financial and Commodity Markets: ``The increasing importance of financial
investment in commodity trading appears to have caused commodity futures exchanges to function in such a way that prices may deviate, at least in the
short run, quite far from levels that would reliably reflect fundamental supply and demand factors. Financial investment weakens the traditional
mechanisms that would prevent prices from moving away from levels determined by fundamental supply and demand factors--efficient absorption of
information and physical adjustment of markets. This weakening increases the proneness of commodity prices to overshooting and heightens the risk of
speculative bubbles occurring.'' [http://www.unctad.org/en/docs/osgdp20093_en.pdf]
(47) Medlock, Kenneth B./Jaffe, Amy M. (Rice University) (2009): Who is in the Oil Futures Market and How Has It Changed?: ``. . . trading strategies of
some financial players in oil appears to be influencing the correlation between the value of the U.S. dollar and the price of oil. (. . .) We also find
that the correlation between movements in oil prices and the value of the dollar against the trade-weighted index of the currencies of foreign
countries has increased to 0.82 (a significant measure) for the period between 2001 and the present day, compared to a previously insignificant
correlation of only 0.08 between 1986 and 2000.'' [http://www.bakerinstitute.org/publications/EF-pub-MedlockJaffeOilFuturesMarket-082609.pdf]
(48) Mou, Yiqun (Columbia University) (2010): Limits to Arbitrage and Commodity Index Investment: Frontrunning the Goldman Roll: ``This paper focuses on
the unique rolling activity of commodity index investors in the commodity futures markets and shows that the price impact due to this rolling activity
is both statistically and economically significant.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1716841]
(49) Naylor, Rosamund L./Falcon, Walter P. (Stanford University) (2010): Food Security in an Era of Economic Volatility: ``Uncertainty surrounding
exchange rates and macro policies added to price misperceptions, as did flurries of speculative activity in organized futures markets. Events since
2005--including the most recent period of price variability in 2010--underscore the point that uncertainty and expectations can be as important as or
even more important than actual changes in grain demand and supply in driving price variability.'' [http://www.ncbi.nlm.nih.gov/pubmed/21174866]
(50) Nissanke, Machiko (University of London) (2011): Commodity Markets and Excess Volatility. Sources and Strategies to Reduce Adverse Development
Impacts: ``Thus, commodity prices, as prices of any assets traded globally, can be largely influenced by market liquidity cycles in global finance.
From this particular perspective, we can have a plausible narrative of the recent episode of commodity price cycle. (. . .) Clearly, trading activities
in world commodity markets have undergone some fundamental change, as the links between activities in commodity and financial markets has further
intensified.'' [http://common-fund.org/uploads/tx_cfc/CFC_report_Nissanke_Volatility_Development_Impact_2010_02.pdf]
(51) Peri, Massimo/Vandone, Daniela/Baldi, Luca (Universita degli studi di Milano) (2012): Internet, Noise Trading and Commodity Prices: ``Moreover,
results show that variations in information demand have a significant effect on corn futures volatility, and this effect is robust even when
controlling for variations in the supply of information. This result is relevant since it can be interpreted in light of behavioural finance, where
studies consider information demand as an expression of noise trading: the search of information on commodity prices through Internet by noise traders
can amplify volatility especially in case of negative shock, when investment decisions are more easily influenced by panic or irrational behavior.''
[http://www.economia.unimi.it/uploads/wp/DEAS-2012_07wp.pdf]
(52) Phillips, Peter C.B. (Yale University)/Yu, Jun (Singapore University) (2010): Dating the Timeline of Financial Bubbles During the Subprime Crisis:
``a bubble first emerged in the equity market during mid-1995 lasting to the end of 2000, followed by a bubble in the real estate market between
September 2000 and June 2007 and in the mortgage market between August 2005 and July 2007. After the subprime crisis erupted, the phenomenon migrated
selectively into the commodity market and the foreign exchange market, creating bubbles which subsequently burst at the end of 2008, just as the
effects on the real economy and economic growth became manifest.'' [http://cowles.econ.yale.edu/P/cd/d17b/d1770.pdf ]
(53) Pollin, Robert/Heintz, James (University of Massachusetts) (2011): How Wall Street Speculation is Driving Up Gasoline Prices Today: ``A major
additional factor is the rapid growth in large-scale speculative trading around oil prices through the oil commodities futures market. Indeed, we
estimate that, without the influence of large-scale speculative trading on oil in the commodities futures market, the average price of gasoline at the
pump in May would have been $3.13 rather than $3.96.'' [http://www.nefiactioncenter.com/PDF/umass_study.pdf]
(54) Ray, Darryl E./Schaffer, Harwood D. (University of Tennessee) (2010): Index funds and the 2006-2008 run-up in agricultural commodity prices: ``the
fundamentals and/or expectations in the energy and mineral markets rein supreme--grains are along for the ride with little-to-no regard to what is
happening in the grain sector. Worries during the period about the availability of oil drove up the price of crude, which caused index funds to
rebalance their portfolios by making additional purchases of the other commodities to maintain the specified balance. Since the resulting price
increases in agricultural commodities had virtually nothing to do with their market conditions, the record level of activity in the futures market by
index funds would seem to make index funds a logical source of possible price overshooting.'' [http://www.agpolicy.org/weekpdf/545.pdf]
(55) Robles, Miguel/Torero, Maximo/Braun, Joachim von (IFPRI) (2009): When speculation matters: ``Changes in supply and demand fundamentals cannot fully
explain the recent drastic increase in food prices. Rising expectations, speculation, hoarding, and hysteria also played a role in the increasing level
and volatility of food prices.'' [http://www.ifpri.org/sites/default/files/publications/ib57.pdf]
(56) Schulmeister, Stephan (Vienna University) (2009): Trading Practices and Price Dynamics in Commodity Markets: ``Based on the `bullishness' in
commodity derivatives markets, short-term oriented speculators reacted much stronger to news in line with the expectation of rising prices than to news
which contradicted the `market mood'. Hence, they put more money into long positions than into short positions and held long positions longer than
short positions. Due to this trading behavior, upward commodity price runs lasted longer in recent years than downward runs causing prices to rise in a
stepwise process. Commodity price runs were lengthened by the use of trend-following trading systems of technical analysis. These systems try to
exploit price runs by producing buy (sell) signals in the early stage of an upward (downward) run. The aggregate trading signals then feed back upon
commodity prices.'' [http://www.wifo.ac.at/wwa/downloadController/displayDbDoc.htm?item=S_2009_TRANSACTION_TAX_34919$.PDF]
(57) Schulmeister, Stephan (Vienna University) (2012): Technical Trading and Commodity Price Fluctuations: ``If one aggregates over the transactions and
open positions of the 1,092 technical models, it turns out that technical commodity futures trading exerts an excessive demand (supply) pressure on
commodity markets.'' [http://www.wifo.ac.at/wwa/downloadController/displayDbDoc.htm?item=S_2012_COMMODITY_PRICE_FLUCTUATIONS_ 45238$.PDF]
(58) Singleton, Kenneth J. (Stanford University) (2010): The 2008 Boom/Bust in Oil Prices: ``In my view, while spot-market supply and demand pressures
were influential factors in the behavior of oil prices, so were participation in oil futures markets by hedge funds, long-term passive investors, and
other traders in energy derivatives.'' [http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission26_091410-ata.pdf]
(59) Singleton, Kenneth J. (Stanford University) (2011): Investor Flows And The 2008 Boom/Bust in Oil Prices: ``there was an economically and
statistically significant effect of investor flows on futures prices . . . The intermediate-term growth rates of index positions and managed-money
spread positions had the largest impacts on futures prices.'' [http://www.stanford.edu/ kenneths/OilPub.pdf]
(60) Sockin, Michael/Xiong, Wei (Princeton University) (2012): Feedback Effects of Commodity Futures Prices: ``As a result of information frictions and
production complementarity, increases in the futures prices, even if driven by non-fundamental reasons, can lead to increased, rather than decreased,
commodity demand and thus spot prices. This outcome contradicts two widely held arguments that speculators who trade only in futures markets cannot
aect spot prices and that commodity price increases driven by non-fundamental reasons must be accompanied by inventory spikes.'' [http://
www.princeton.edu/ wxiong/papers/feedback.pdf]
(61) Timmer, C. Peter (Center for Global Development, Washington) (2009): Peter Timmer: Peter Timmer: Did Speculation Affect World Rice Prices?:
``Speculative money seems to surge in and out of commodity markets, strongly linking financial variables with commodity prices during some time
periods. But these periods are often short and the relationships disappear entirely for long periods of time.'' [ftp://ftp.fao.org/docrep/fao/011/
ak232e/ak232e00.pdf]
(62) Tse, Yiuman/Williams, Michael (University of Texas at San Antonio) (2011): Does Index Speculation Impact Commodity Prices?: ``We conclude that
speculative pressures exerted by commodity index investors can impact non-index commodities. These results are likely not due to speculative pressure
itself, but rather the subsequent price destabilizing trades of uninformed, positive feedback traders.'' [http://business.utsa.edu/wps/fin/0007FIN-257-
2011.pdf]
(63) Tse, Yiuman (University of Texas at San Antonio) (2012): The Relationship Among Agricultural Futures, ETFs, and the U.S. Stock Market: ``I find
that Granger-causality in returns primarily runs from individual futures to the agriculture ETFs. However, DBA and RJA returns are also significantly
caused by S&P 500 index returns, showing that stock market sentiment influences pricing behavior. The results are also consistent with the impact of
financialization of commodities on agriculture prices.'' [http://business.umsl.edu/seminar_series/Spring2012/DBA20.pdf]
(64) Van der Molen, Maarten (University of Utrecht) (2009): Speculators invading the commodity markets: a case study of coffee: ``The results indicate
that index speculators frustrated the futures market in the period between 2005 and 2008. This conclusion is based on the following indications:
fundamentals have a lower impact on the price, the volume of index speculators has increased and their ability to influence the futures market has
increased.'' [http://library.wur.nl/WebQuery/clc/1934340]
(65) Vansteenkiste, Isabel (European Central Bank) (2011): What is driving oil price futures? Fundamentals versus Speculation: ``We find that for the
earlier part of our sample (up to 2004) that fundamentals have been the key driving force behind oil price movements. Thereafter, trend chasing
patterns appear to be better in capturing the developments in oil futures markets.'' [http://www.ecb.int/pub/pdf/scpwps/ecbwp1371.pdf]
(66) Varadi, Vijay Kumar (ICRIER) (2012): An evidence of speculation in Indian commodity markets: ``results exhibit that speculation has played decisive
role in the commodity price bubble during the global crisis in India.'' [http://mpra.ub.uni-muenchen.de/38337/1/MPRA_paper_38337.pdf]
(67) Von Braun, Joachim (Bonn University), Tadesse, Getaw (IFPRI) (2012): Global Food Price Volatility and Spikes: An Overview of Costs, Causes and
Solutions: ``The general conclusion on price spikes is that they were driven by excessive volumes of futures trading more than by demand side (oil
price) and supply side shocks.'' [http://www.zef.de/fileadmin/webfiles/downloads/zef_dp/zef_dp_161.pdf]
(68) Windawi, A. Jason (Columbia University) (2012): Speculation, Embedding, and Food Prices. A Cointegration Analysis: ``The Wheat Granger test results
show a clustering of speculative financial influences on wheat prices in the period from early 2006 through June of 2010, with a particularly strong
increase in the four subperiods beginning with the first drop in prices. (. . .) Like the wheat tests, the Granger results for Corn . . . were
clustered around the first wave of the food crisis . . .'' [http://academiccommons.columbia.edu/item/ac:146501]
(69) Wray, Randall L. (University of Missouri-Kansas City) (2008): The Commodities Market Bubble--Money Manager Capitalism and the Financialization of
Commodities: ``There is adequate evidence that financialization is a big part of the problem, and there is sufficient cause for policymakers to
intervene with sensible constraints and oversight to reduce the influence of managed money in these markets.'' [http://www.levyinstitute.org/pubs/
ppb_96.pdf]
(C) Research papers and testimonies by analysts and traders
(1) Berg, Ann (former CBoT trader and director, now FAO advisor) (2011): The rise of commodity speculation: from villainous to venerable: ``Structural
changes in global commodity markets have greatly contributed to rising prices and increased price variability. These fundamental trends toward higher
prices have been a key lure for increased speculative activity on the major futures exchanges.'' [http://www.nefiactioncenter.com/PDF/
theriseofcommodityspeculation.pdf]
(2) Bukold, Steffen (2010) (Energycomment): Olpreisspekulation und Benzinpreise in Deutschland: ``Traditionelle Erklarungen, die nur auf den physischen
Olmarkt schauen, sind nicht hilfreich: Ein Uberangebot an Rohol, schwache Nachfrage und uberquellende Lager hatten zu sinkenden, bestenfalls
stagnierenden Roholpreisen fuhren mussen. Die Erklarung liegt im starken Engagement von Finanzinvestoren, die Ol (genauer: Ollieferkontrakte) aus
spekulativen Grunden kaufen, d.h. auf hohere Olpreise wetten. Der Roholmarkt ist dadurch noch starker als bisher zu einem Hybridmarkt geworden, also
einer Mischung aus Rohstoffmarkt und Finanzmarkt.'' [http://www.energiepolitik.de/oelpreisspekulation/]
(3) Cooper, Marc (Consumer Federation of America) (2011): Excessive Speculation and Oil Price Shock Recessions: A Case of Wall Street ``Deja vu all over
again'': ``the paper shows that excessive speculation, not market fundamentals caused the spike in oil prices. The movement of trading and prices in
the 3 years since the speculative bubble in oil burst in 2008 provides even stronger evidence that excessive speculation is a major problem that
afflicts the oil market and the economy.'' [http://www.consumerfed.org/pdfs/SpeculationReportOctober13.pdf]
(4) Deutsche Bank Research (2009): Do speculators drive crude oil prices? Dispersion in beliefs as price determinants: ``The econometric estimates can
reject the null hypotheses that the dispersion in beliefs of speculators has no influence on the crude oil price and its volatility. Both the Granger
causality tests and the distributed lag models, which also include lagged regressors that measure the dispersion in beliefs of speculators, confirm
moreover the role of speculation as a precursor to price movements . . .'' [http://www.dbresearch.com/servlet/reweb2.ReWEB?
ColumnView=0&Function=showPeriOverview(NERESNOT;noTopic;noRegion) &Submit=ShowPdf&rwnode=DBR_INTERNET_EN-PROD$RSNN000000000013
6534&rwobj=ReFIND.ReFindSearch.class&rwsite=DBR_INTERNET_EN-PROD& type=callFunction]
(5) Dicker, Dan (former NYMEX trader) (2011): ``I wrote Oil's Endless Bid to show how the treatment of oil as a stock by investors, far more than any
number of globally significant competing factors, causes the dramatically higher prices that we've seen in recent years. I've witnessed seismic changes
to the oil markets during my many years as a trader, and it's the everyday consumer who shoulders the burden.'' [http://www.marketwire.com/press-
release/oils-endless-bid-taming-unreliable-price-oil-secure-our-economy-dan-dicker-published-1503559.htm]
(6) Goldman Sachs (2011): Global Energy Weekly, March 2011: ``We estimate that each million barrels of net speculative length tends to add 8-10 to the
price of a barrel of oil.'' [http://www.energianews.com/newsletter/files/80e9ebe0ff67bd94432a4031ee17c2b9.pdf]
(7) Evans, Tim (Citigroup energy analyst) (2008): The Official Demise of the Oil Bubble (Wall Street Journal article): ``This is a market that is
basically returning to the price level of a year ago which it arguably should never have left. (. . .) We pumped up a big bubble, expanded it to an
impressive dimension, and now it is popped and we have bubble gum in our hair.'' [http://blogs.wsj.com/marketbeat/2008/10/10/the-official-demise-of-the-
oil-bubble/]
(8) Frenk, David (Better Markets) (2010): Review of Irwin and Sanders 2010 OECD report: ``1) The statistical methods applied are completely
inappropriate for the data used. 2) The study is contradicted by the findings of other studies that apply more appropriate statistical methods to the
same data. 3) The overall analysis is superficial and easily refuted by looking at some basic facts.'' [http://blog.newconstructs.com/wp-content/
uploads/2010/10/FrenkPaperReutingOECDStudy_IrwinAndSanders.pdf]
(9) Frenk, David/Turbeville, Wallace C. (Better Markets) (2011): Commodity Index Traders and the Boom/Bust Cycle in Commodities Prices: ``We find strong
evidence that the CIT Roll Cycle systematically distorts forward commodities futures price curves towards a contango state, which is likely to
contribute to speculative `boom/bust' cycles by changing the incentives of producers and consumers of storable commodities, and also by sending
misleading and non-fundamental, price signals to the market.'' [http://papers.ssrn.com/Sol3/papers.cfm?abstract_id=1945570]
(10) Gheit, Fadel/Katzenberg, Daniel (2008) (Oppenheimer & Co.): Surviving lower oil prices: ``The investment banks that hyped oil prices using voodoo
economics have suddenly reversed their position and now expect much lower oil prices. They helped cause excessive speculation, create the oil bubble,
and contributed to the global financial crisis. They have changed their tune in exchange for a government bailout, not because of changes in market
fundamentals.'' [http://www.nakedcapitalism.com/2008/10/commodities-continue-to-tank.html]
(11) Hunt, Simon (Simon Hunt Strategic Services) (2011): ``Slowly, the truth on whether the global copper market is really tight is coming out. It
illustrates just how large an involvement the financial institutions have become to the copper industry. It shows, too, that by throwing money at a
market, prices can be driven higher. In the process, however, the delicate balance between supply and the industry's requirements for a basic material
used to produce a range of essential products is destroyed. In short, copper is becoming a financial asset in place of its historic role as an
industrial metal.'' [http://traderightuk.wordpress.com/2011/09/07/guest-blog-simon-hunt-on-copper/]
(12) Kemp, John (Reuters) (2008): Crisis remakes the commodity business: ``It does not alter the fact most of the upsurge in futures and options
turnover on commodity exchanges and in OTC markets over the last 5 years has come from investment-related rather than trade-related business.'' [http://
www.reuters.com/article/2008/10/29/column-kemp-idUSLT9693720081029]
(13) Korzenik, Jeffrey (CIO, Caturano Wealth Management) (2009): Fundamental Misconceptions in the Speculation Debate: `` `Overspeculation' or
`excessive speculation' exists when speculators become primary drivers of price. When this happens, commodities are no longer efficiently allocated--if
prices are driven below the point where commercial supply and demand meet, shortages result.'' [http://inefficientfrontiers.wordpress.com/2009/07/29/
fundamental-misconceptions-in-the-speculation-debate/]
(14) Lake Hill Capital Management (2013): Investable indices are distorting commodities and futures: ``. . . it is important to recognize that
institutional and retail indexing demand can create price distortions that cloud the fundamental picture. Increased indexing leads to steeper futures
term structures, and this results in more costly exposure.'' [http://www.hedgefundintelligence.com/Article/3202027/AbsoluteReturn-Opinion/Investable-
indices-are-distorting-commodities-and-futures.html?LS=Twitter]
(15) Lines, Thomas (commodity consultant) (2010): Speculation in food commodity markets: ``These are the main problems that are caused by long-only
index trading: It pushes prices up, irrespective of the market situation. It disrupts the rolling over of futures contracts when the nearest month
expires.'' [http://www.eurodad.org/uploadedFiles/Whats_New/News/Speculation%20in%20Food%20commodity%20markets.pdf]
(16) Masters, Michael W. (Masters Capital)/White, Adam K. (White Knight Research) (2008): The Accidental Hunt Brothers: ``Index Speculators have bought
more commodities futures contracts in the last 5 years than any other group of market participant. They are now the single most dominant force in the
commodities futures markets. And most importantly, their buying and trading has nothing to do with the supply and demand fundamentals of any single
commodity. They pour money into commodities futures to diversify their portfolios, hedge against inflation or bet against the dollar.'' [http://
www.loe.org/images/content/080919/Act1.pdf]
(17) Morse, E. (former Lehman Brothers chief energy economist) (2008): Oil Dotcom, Research Note: ``Fundamental changes cannot explain sudden, severe
price or curve movements. (. . .) Our conclusion from this study is that we are seeing the classic ingredients of an asset bubble.''
(18) Newell, J. (Probability Analytics Research) (2008): Commodity Speculation's ``Smoking Gun'': ``Real market forces in these diverse markets are
largely independent of one another, and therefore price changes should be essentially uncorrelated. This was clearly true historically; from 1984
through 1999 average correlation between all commodities was only 7%. In the last 12 months this average rose to 64%. Correlation with the GSCI was 23%
historically, and rose to 76% in the last year. Index speculation has swamped real market forces.'' [http://accidentalhuntbrothers.com/wp-content/
uploads/2008/11/probalytics-081117.pdf]
(19) Petzel, Todd E. (Offit Capital Advisors) (2009): Testimony before the CFTC: ``I believe these investors in aggregate have had a material impact on
price levels, price spreads and the level of inventories being held.'' [http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/
hearing072809_petzel2.pdf]
(20) Soros, George (2008): Interview with Stern: ``Speculators create the bubble that lies above everything. Their expectations, their gambling on
futures help drive up prices, and their business distorts prices, which is especially true for commodities. It is like hoarding food in the midst of a
famine, only to make profits on rising prices. That should not be possible.'' [http://www.stern.de/wirtschaft/news/maerkte/george-soros-we-are-in-the-
midst-of-the-worst-financial-crisis-in-30-years-625954.html]
(21) Tudor Jones, Paul (Tudor Investment Corporation) (2010): Price Limits: A Return to Patience and Rationality in U.S. Markets. Speech to the CME
Global Financial Leadership: ``Every exchange traded instrument including all securities, futures, options and any other form of derivatives should
have some form of a price limit. And this is all the more urgently needed now that electronic execution dominates trading.'' [http://media.ft.com/cms/
834d6096-de23-11df-9364-00144feabdc0.pdf]
(22) Urbanchuk, John M. (Cardno ENTRIX) (2011): Speculation and the Commodity Markets: ``A careful examination of activity by non-commercial and index
traders (i.e., speculators) in the corn futures market in the context of supply and demand fundamentals strongly suggests that speculation is a major
factor behind the sharp increase in both the level and volatility of corn prices this year.'' [http://ethanolrfa.org/page/-/
ENTRIX%20Speculation%20Paper.pdf?nocdn=1&utm _medium=email&utm_campaign= New+Reports+Fault+Speculation+for+Volatile+Commodity+ Food+Prices&utm_content=
New+Reports+Fault+Speculation+for+Volatile+Commodity+Food+Prices+ CID_284b92e095cb531b6481bde94e6c788a&utm_
source=Email+marketing+software&utm_term=Cardno+Entrix]
(23) Woolley, Paul (former fund manager, York University/London School of Economics) (2010): Why are financial markets so inefficient and exploitative--
and a suggested remedy: ``With the flood of passive and active investment funds going into commodities from 2005 onwards, prices have been increasingly
driven by fund inflows rather than fundamental factors. Prices no longer provide a reliable signal to producers or consumers.'' [http://
harr123et.files.wordpress.com/2010/07/futureoffinance-chapter31.pdf]
(D) Reports by public institutions
(1) Chevalier, Jean-Marie (ed.) (Ministere de l'Economie, de l'Industrie et de l'Emploi) (2010): Rapport du groupe de travail sur la volatilite des prix
du petrole: ``On peut raisonnablement avancer en conclusion que le jeu de certains acteurs financiers a pu amplifier les mouvements a la hausse ou a la
baisse des cours, augmentant la volatilite naturelle des prix du petrole . . .'' [http://www.minefe.gouv.fr/services/rap10/100211rapchevalier.pdf]
(2) House of Commons Select Committee on Science & Technology of the United Kingdom (2011): ``While the debate on the relative importance of the
multiple factors influencing commodities prices is still open, it is clear that price movements across different commodity markets have become more
closely related and that commodities markets have become more closely linked to financial markets.'' [http://www.publications.parliament.uk/pa/cm201012/
cmselect/cmsctech/726/72606.htm]
(3) Jouyet, Jean-Pierre (President de l'Autorite des marches financiers)/de Boissieu, Christian (President du Conseil d'analyse economique)/Guillon,
Serge (Controleur general economique et financier) (2010): Rapport d'etape--Prevenir et gerer l'instabilite des marches agricoles: ``Les marches
agricoles sont confrontes a une mondialisation et a une financiarisation qui influencent leur fonctionnement. La volatilite naturelles des prix qui
caracterise ces marches est amplifiee par de nouveaux facteurs et notamment par une speculation excessive.'' [http://agriculture.gouv.fr/IMG/pdf/
Nouveau_rapport_etape_Jouyet_Boissieu_Guillon.pdf]
(4) Schutter, Olivier de (UN Special Rapporteur on the Right to Food) (2010): Food commodities speculation and food price crises: Regulation to reduce
the risks of financial volatility: ``The global food price crisis that occurred between 2007 and 2008 . . . had a number of causes. The initial causes
related to market fundamentals, including the supply and demand for food commodities, transportation and storage costs, and an increase in the price of
agricultural inputs. However, a significant portion of the increases in price and volatility of essential food commodities can only be explained by the
emergence of a speculative bubble.'' [http://www.theaahm.org/fileadmin/user_upload/aahm/docs/20102309_briefing_note_02_en.pdf]
(5) Tanaka, Nobuo (head International Energy Agency) (2009): IEA says speculation amplifying oil prices moves (Reuters article): ``Our analysis shows
that the fundamentals are deciding the direction of the price while these funds or speculations . . . are amplifying the movement.'' [http://
uk.reuters.com/article/2009/06/30/iea-oil-idUKNWNA801920090630]
(6) United Nations Conference on Trade and Development (UNCTAD) (2009): Trade and Development Report, Chapter II--The Financialization of Commodity
Markets: ``The financialization of commodity futures trading has made commodity markets even more prone to behavioural overshooting. There are an
increasing number of market participants, sometimes with very large positions, that do not trade based on fundamental supply and demand relationships
in commodity markets, but, who nonetheless, influence commodity price developments.'' [http://www.unctad.org/en/docs/tdr2009ch2_en.pdf]
(7) United Nations Conference on Trade and Development (UNCTAD) (2009): The global economic crisis: Systemic failures and multilateral remedies: ``The
evidence to support the view that the recent wide fluctuations of commodity prices have been driven by the financialization of commodity markets far
beyond the equilibrium prices is credible. Various studies find that financial investors have accelerated and amplified price movements at least for
some commodities and some periods of time. (. . .) The strongest evidence is found in the high correlation between commodity prices and the prices on
other markets that are clearly dominated by speculative activity.'' [http://www.unctad.org/en/docs/gds20091_en.pdf]
(8) United Nations Conference on Trade and Development (UNCTAD) (2011): Price Formation in Financialized Commodity Markets: the Role of Information:
``Due to the increased participation of financial players in those markets, the nature of information that drives commodity price formation has
changed. Contrary to the assumptions of the efficient market hypothesis (EMH), the majority of market participants do not base their trading decisions
purely on the fundamentals of supply and demand; they also consider aspects which are related to other markets or to portfolio diversification. This
introduces spurious price signals to the market.'' [http://www.unctad.org/en/docs/gds20111_en.pdf]
(9) United Nations Commission of Experts on Reforms of the International and Monetary System (2009): Report: ``In the period before the outbreak of the
crisis, inflation spread from financial asset prices to petroleum, food, and other commodities, partly as a result of their becoming financial asset
classes subject to financial investment and speculation.'' [http://www.un.org/ga/president/63/interactive/financialcrisis/PreliminaryReport210509.pdf]
(10) United Nations Food and Agricultural Organisation (FAO) (2010): Final report of the committee on commodity problems: Extraordinary joint
intersessional meeting of the intergovernmental group (IGG) on grains and the intergovernmental group on rice: ``Unexpected crop failure in some major
exporting countries followed by national responses and speculative behaviour rather than global market fundamentals, have been amongst the main factors
behind the recent escalation of world prices and the prevailing high price volatility.'' [http://www.fao.org/fileadmin/templates/est/
COMM_MARKETS_MONITORING/Grains/Documents/FINAL_REPORT.pdf]
(11) United Nations Food and Agricultural Organisation (FAO) (2010). Price Volatility in Agricultural Markets. Economic and Social Perspectives Policy
Brief 12: ``Financial firms are progressively investing in commodity derivatives as a portfolio hedge since returns in the commodity sector seem
uncorrelated with returns to other assets. While this `financialisation of commodities' is generally not viewed as the source of price turbulence,
evidence suggests that trading in futures markets may have amplified volatility in the short term.'' [http://www.fao.org/docrep/013/am053e/
am053e00.pdf]
(12) United Nations Food and Agricultural Organisation (FAO), IFAD, IMF, OECD, UNCTAD, WFP, The World Bank, The WTO, IFPRI, UN HLTF (2011): Price
Volatility in Food and Agricultural Markets: Policy Responses: ``While analysts argue about whether financial speculation has been a major factor, most
agree that increased participation by noncommercial actors such as index funds, swap dealers and money managers in financial markets probably acted to
amplify short term price swings and could have contributed to the formation of price bubbles in some situations.'' [http://www.fao.org/fileadmin/
templates/est/Volatility/Interagency_Report_to_the_G20_on_Food_Price_Volatility.pdf]
(13) United States Senate, Permanent Subcommittee on Investigations (2007): Excessive Speculation in the Natural Gas Market: ``Amaranth's 2006 positions
in the natural gas market constituted excessive speculation. (. . .) Purchasers of natural gas during the summer of 2006 for delivery in the following
winter months paid inflated prices due to Amaranth's speculative trading.'' [http://hsgac.senate.gov/public/_files/
REPORTExcessiveSpeculationintheNaturalGasMarket.pdf]
(14) United States Senate, Permanent Subcommittee on Investigations (2009): Excessive Speculation in the Wheat Market: ``This Report concludes there is
significant and persuasive evidence that one of the major reasons for the recent market problems is the unusually high level of speculation in the
Chicago wheat futures market due to purchases of futures contracts by index traders offsetting sales of commodity index instruments.'' [http://
hsgac.senate.gov/public/_files/REPORTExcessiveSpecullationintheWheatMarketwoexhibitschartsJune2409.pdf]
(15) United States Senate, Permanent Subcommittee on Investigations (2006): The Role of Market Speculation in Rising Oil and Gas Prices: ``The large
purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be
delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the
spot market.'' [http//www.hsgac.senate.gov/public/_files/SenatePrint10965MarketSpecReportFINAL.pdf]
Appendix B
38 Independent Studies on the Negative Effects of High Speed Trading on Commodity Markets
--------------------------------------------------------------------------------------------------------------------------------------------------------
Author(s), Title, Year Data Relevant findings
--------------------------------------------------------------------------------------------------------------------------------------------------------
Anand, Tanggaard, Weaver, ``Paying for Swedish equities, 2002-2004 Designated market makers with affirmative obligations improve market
Market Quality'' (2009) quality, increase market valuation.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=7077684&fulltextType=RA&fileId=S0022109009990421]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bank for International Settlements, Foreign exchange, 2010 and 2011 ``HFT has had a marked impact on the functioning of the FX market in
``High frequency trading in the ways that could be seen as beneficial in normal times, but also in
foreign exchange market'' (2011) ways that may be harmful to market functioning, particularly in times
of market stress.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.org/publ/mktc05.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bichetti, Maystre, ``The synchronized U.S. futures and equities, 1997-2011 ``This paper documented striking similarities in the evolution of the
and longlasting structural change on rolling correlations between the returns on several commodity futures
commodity markets: evidence from high and the ones on the U.S. stock market, computed at high frequencies .
frequency data'' (2012) (Added 3/2012) . . we think that HFT strategies, in particular the trend-following
ones, are playing a key role . . . commodity markets are more and more
prone to events in global financial markets and likely to deviate from
their fundamentals.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://mpra.ub.uni-muenchen.de/37486/1/MPRA_paper_37486.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Boehmer, Fong, Wu, ``International Equities in 37 countries (excluding ``Overall, our results show that algorithmic trading often improves
Evidence on Algorithmic Trading'' U.S.), 2001-2009 liquidity, but this effect is smaller when market making is difficult
(2012) (Added 3/2012) and for low-priced or high-volatility stocks. It reverses for small
cap stocks, where AT is associated with a decrease in liquidity. AT
usually improves efficiency. The main costs associated with AT appear
to be elevated levels of volatility. This effect prevails even for
large market cap, high price, or low volatility stocks, but it is more
pronounced in smaller, low price, or high volatility stocks.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2022034]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Chae, Wang, ``Determinants of Trading Taiwanese equities, 1997-2002 Absent mandatory obligations, market maker privileges don't induce
Profits: The Liquidity Provision market makers to provide liquidity; privileged but unconstrained
Decision'' (2009) market makers make profits when demanding liquidity in their own
informed trades; unconstrained market makers are informed traders
rather than liquidity providers in most scenarios.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://mesharpe.metapress.com/link.asp?target=contribution&id=HJV244322G246764]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Easley, Lopez del Prado, O'Hara, ``The U.S. futures, 2010 Unregulated or unconstrained HFT market makers can exacerbate price
Microstructure of the Flash Crash'' volatility when they dump inventory and withdraw, flash crashes will
(2011) recur because of structural issues.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695041]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Egginton, Van Ness, Van Ness, ``Quote U.S. equities, 2010 ``We find that quote stuffing is pervasive with several hundred events
Stuffing'' (2012) (Added 3/2012) occurring each trading day and that quote stuffing impacts over 74% of
U.S. listed equities during our sample period. Our results show that,
in periods of intense quoting activity, stocks experience decreased
liquidity, higher trading costs, and increased short-term volatility.
Our results suggest that the HFT strategy of quote stuffing may
exhibit some features that are criticized in the media.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1958281]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Ferguson, Mann, ``Execution Costs and U.S. futures, 1992 Unregulated or unconstrained market makers in the futures market have
Their Intraday Variation in Futures much more rapid inventory cycles than (regulated) equity market
Markets'' (2001) makers, are active rather than passive traders, and ``actively trade
for their own accounts, profiting from their privileged access . . .''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/10.1086/209666]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Forrest, Duffy, ``Life in the Australian futures, 1997 Unregulated or unconstrained market makers are not passive liquidity
pits: competitive market making and providers, they behave aggressively like informed traders.
inventory control--further Australian
evidence'' (1999)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S1042444X99000134]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Jarnecic, ``An empirical Australian futures, 1997 Unregulated or unconstrained market makers demand liquidity to profit
analysis of the supply of liquidity by from information advantages of privileged access, less likely to
locals in futures markets: Evidence supply liquidity in volatile markets, almost as likely to demand as to
from the Sydney Futures Exchange'' supply liquidity.
(2000)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S0927538X00000238]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Jarnecic, Feletto, ``Local Australian futures, 1997 Unregulated or unconstrained market makers are active and informed
Trader Profitability in Futures traders.
Markets: Liquidity and Position Taking
Profits'' (2009)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://onlinelibrary.wiley.com/doi/10.1002/fut.20393/abstract]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Golub, Keane, ``Mini Flash Crashes'' U.S. equities, 2006-2010 ``As soon as the [HFT] market maker's risk management limits are
(2011) (Added 3/2012) breached . . . the market maker has to stop providing liquidity and
start to aggressively take liquidity, by selling back the shares
bought moments earlier. This way they push the price further down and
thus exaggerate the downward movement.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://fp7.portals.mbs.ac.uk/Portals/59/docs/MC%20deliverables/WP27%20A%20Golub%20paper%202_ReportMiniFlashCrash.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Hautsch, Huang, ``On the Dark Side of U.S. equities, 2010 ``Using data from the NASDAQ TotalView message stream allows us to
the Market: Identifying and Analyzing retrieve information on hidden depth from one of the largest equity
Hidden Order Placements'' (2012) markets in the world.''
(Added 3/2012)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2004231]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Hirschey, ``Do High-Frequency Traders U.S. equities, 2009 ``HFTs' aggressive purchases predict future aggressive buying by non-
Anticipate Buying and Selling HFTs, and their aggressive sales predict future aggressive selling by
Pressure?'' (2011) (Added 3/2012) non-HFTs''; ``These findings suggest HFTs trade on forecasted price
changes caused by buying and selling pressure from traditional asset
managers.''
The author writes that ``On net, it is probable HFTs have a positive
impact on market quality'' because of tighter spreads; investment
managers might disagree.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[https://www2.bc.edu/ taillard/Seminar_spring_2012_files/Hirschey.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Johnson, Zhao, Hunsader, Meng, U.S. equities, 2006-2011 The authors study ``18,520 ultrafast black swan events that we have
Ravindar, Carran, Tivnan, ``Financial uncovered in stock-price movements between 2006 and 2011'' and find
black swans driven by ultrafast ``an abrupt systemwide transition from a mixed human-machine phase to
machine ecology'' (2012) (Added 3/ a new all-machine phase characterized by frequent black swan events
2012) with ultrafast durations.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://arxiv.org/ftp/arxiv/papers/1202/1202.1448.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Joint CFTC-SEC Advisory Committee on U.S. futures and equities, 2010 ``In the present environment, where high frequency and algorithmic
Emerging Regulatory Issues, trading predominate and where exchange competition has essentially
``Recommendations Regarding Regulatory eliminated rule-based market maker obligations, liquidity problems are
Responses to the Market Events of May an inherent difficulty that must be addressed. Indeed, even in the
6, 2010'' (2011) absence of extraordinary market events, limit order books can quickly
empty and prices can crash simply due to the speed and numbers of
orders flowing into the market and due to the ability to instantly
cancel orders.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sec.gov/spotlight/sec-cftcjointcommittee/021811-report.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kim, Murphy, ``The Impact of High- U.S. equities, 1997-2009 Traditional market microstructure models have significantly
Frequency Trading on Stock Market underestimated market spreads in recent years. This is because of how
Liquidity Measures'' (2011) (Added 3/ trade sizes have decreased with the recent dominance of high frequency
2012) trading. When the authors correct for this they find that spreads have
not decreased as much as HFT proponents believe.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.kellogg.northwestern.edu/faculty/murphy_d/murphy_kim_spread.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kirilenko, Samadi, Kyle, Tuzun, ``The U.S. futures, 2010 Unregulated or unconstrained HFT market makers exacerbated price
Flash Crash: The Impact of High volatility in the Flash Crash, hot potato trading, 2 minute market
Frequency Trading on an Electronic maker inventory half-life; ``. . . High Frequency Traders exhibit
Market'' (2010) trading patterns inconsistent with the traditional definition of
market making. Specifically, High Frequency Traders aggressively trade
in the direction of price changes . . . when rebalancing their
positions, High Frequency Traders may compete for liquidity and
amplify price volatility.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686004]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kurov, Lasser, ``Price Dynamics in the U.S. futures, 2001 Unregulated or unconstrained market makers demand liquidity to profit
Regular and E-Mini Futures Markets'' from information advantages of privileged access.
(2004)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/30031860]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Linton, O'Hara, ``The impact of Literature review and survey ``The nature of market making has changed, shifting from designated
computer trading on liquidity, price providers to opportunistic traders. High frequency traders now provide
efficiency/discovery and transaction the bulk of liquidity, but their use of limited capital combined with
costs'' (2011) ultrafast speed creates the potential for periodic illiquidity''; in
``regular market conditions,'' liquidity has improved and transaction
costs are lower.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.gov.uk/assets/bispartners/foresight/docs/computer-trading/11-1276-the-future-of-computer-trading-in-financial-markets.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Locke, Sarajoti, ``Interdealer Trading U.S. futures, 1995 Unregulated or unconstrained market makers demand liquidity to manage
in Futures Markets'' (2004) inventories.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=265932]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Lyons, ``A Simultaneous Trade Model of Model derived from empirical studies Demonstrates hot potato trading among unregulated or unconstrained
the Foreign Exchange Hot Potato'' of 1992 U.S. foreign exchange market. market makers. ``Hot potato trading'' means cascading inventory
(1997) imbalances from market maker to market maker in response to a large
order. Hot potato trading explains most of the volume in foreign
exchange markets. Hot potato trading is not innocuous--it makes prices
less informative.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://linkinghub.elsevier.com/retrieve/pii/S0022199696014717]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Lyons, ``Foreign exchange volume: Sound U.S. foreign exchange, 1992 Unregulated or unconstrained market makers cascade inventory imbalances
and fury signifying nothing?'' (1996) from one to another, as ``. . . trading begets trading. The trading
begotten is relatively uninformative, arising from repeated passage of
inventory imbalances among dealers . . . this could not arise under a
specialist microstructure.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.nber.org/chapters/c11365.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Manaster, Mann, ``Life in the pits: U.S. futures, 1992 Unregulated or unconstrained market makers aggressively manage
competitive market making and inventory, are ``active profit-seeking,'' have much shorter inventory
inventory control'' (1996) cycles than equities market makers.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/2962316]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Manaster, Mann, ``Sources of Market U.S. futures, 1992 Unregulated or unconstrained market makers demand liquidity to profit
Making Profits: Man Does Not Live by from information advantages of privileged access, are ``predominant''
Spread Alone'' (1999) informed traders.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.23.6354&rep=rep1&type=pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
McInish, Upson ``Strategic Liquidity U.S. equities, 2008 ``We model and show empirically that latency differences allow fast
Supply in a Market with Fast and Slow liquidity suppliers to pick off slow liquidity demanders at prices
Traders'' (2012) (Added 3/2012) inferior to the NBBO. This trading strategy is highly profitable for
the fast traders.''; ``[O]ur research focuses on the ability of fast
liquidity suppliers to use their speed advantage to the detriment of
slow liquidity demanders, which we believe unambiguously lowers market
quality. The ability of fast traders to take advantage of slow traders
is exacerbated in the U.S. by the regulatory and market environment
that we describe below.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1924991]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Panayides, ``Affirmative obligations U.S. equities, 1991 and 2001 Mandatory market maker obligations reduce volatility.
and market making with inventory''
(2007)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S0304405X0700133X]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Silber, ``Marketmaker Behavior in an U.S. futures, 1982-1983 Unregulated or unconstrained market makers profit from the information
Auction Market: An Analysis of advantages of privileged access, 2 minute inventory cycles.
Scalpers in Futures Markets'', (1984)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/2327606]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Smidt, ``Trading Floor Practices on Literature review and survey On futures exchanges, inventory imbalances among unregulated or
Futures and Securities Exchanges: unconstrained market makers create ``potentially unstable'' markets
Economics, Regulation, and Policy and price overreactions during ``scalper inventory liquidation.''
Issues'' (1985)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.farmdoc.illinois.edu/irwin/archive/books/Futures-Regulatory/Futures-Regulatory_chapter2.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
United States Commodity Futures Trading U.S. futures and equities, 2010 Unregulated or unconstrained HFT market makers exacerbated price
Commission and Securities and Exchange volatility in the Flash Crash, hot potato trading.
Commission, ``Findings Regarding the
Market Events of May 6, 2010'' (2010)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sec.gov/news/studies/2010/marketevents-report.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
United States Federal Trade Commission, U.S. futures, 1915-1922 Unregulated or unconstrained market makers both cause and exacerbate
``Report of the Federal Trade price volatility; ``The scalpers who operate with reference to
Commission on the Grain Trade,'' fractional changes within the day may have a stabilizing effect on
Volume 7 (1926) prices so far as such changes with the day are concerned, but when the
market turns they run with it, and they may accentuate an upward or
downward movement that is already considerable.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
Van der Wel, Menkveld, Sarkar, ``Are U.S. futures, 1994-1997 Unregulated or unconstrained market makers demand liquidity for a
Market Makers Uninformed and Passive? substantial part of the day and are active and informed speculators.
Signing Trades in the Absence of
Quotes'' (2009)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.newyorkfed.org/research/staff_reports/sr395.html]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Van Kervel, ``Liquidity: What You See U.K. equities, 2009 ``We show that a specific type of highfrequency traders, those who
is What You Get?'' (2012) (Added 3/ operate like modern day market makers, might in fact cause a strong
2012) overestimation of liquidity aggregated across trading venues. The
reason is that these market makers place duplicate limit orders on
several venues, and after execution of one limit order they quickly
cancel their outstanding limit orders on competing venues. As a
result, a single trade on one venue is followed by reductions in
liquidity on all other venues.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2021988]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Venkataraman, Waisburd, ``The Value of French equities, 1995-1998 Designated market makers with affirmative obligations improve market
the Designated Market Maker'' (2006) quality, increase market valuation.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=881585]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Wang, Chae, ``Who Makes Markets? Do Taiwanese equities, 1997-2002 Absent mandatory obligations, market maker privileges don't induce
Dealers Provide or Take Liquidity?'' market makers to provide liquidity; they derive profits from their own
(2003) informed trades; ``While dealers may be meant to perform the socially
beneficial function of liquidity provision, the institutional
advantages granted to them also give the ability to act as super-
efficient proprietary traders if they choose to.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://web.mit.edu/finlunch/Fall03/AlbertWang.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Working, ``Tests of a Theory Concerning U.S. futures, 1952 Unregulated or unconstrained market makers are also trend traders,
Floor Trading on Commodity Exchanges'' profiting from the information advantages of privileged access; they
(1967) can trade aggressively, especially when the market goes against the
firm; inventory cycles of ``minutes''; trend trading accelerates price
changes (but may moderate extremes).
--------------------------------------------------------------------------------------------------------------------------------------------------------
Zhang, ``High-Frequency Trading, Stock U.S. equities, 1985-2009 ``[H]igh-frequency trading may potentially have some harmful effects''
Volatility, and Price Discovery'' because ``highfrequency trading is positively correlated with stock
(2010) (Added 3/2012) price volatility.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Zigrand, Cliff, Hendershott, Literature review and survey Self-reinforcing feedback loops in computerbased trading can lead to
``Financial stability and computer significant instability in financial markets; market participants
based trading'' (2011) become inured to excessive volatility in a cultural ``normalization of
deviance'' until a large-scale failure occurs; research to date has
not shown a persistent increase in market volatility, but HFT research
is nascent.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.gov.uk/assets/bispartners/foresight/docs/computer-trading/11-1276-the-future-of-computer-trading-in-financial-markets.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
The Chairman. All right. Thank you, sir. The chair would
remind Members that they will be recognized for questioning in
order of seniority for Members who were here at the start of
the hearing. After that, Members will be recognized in order of
arrival. I appreciate Members' understanding. We have six panel
members. We will do a second round of questioning if possible,
and I would ask the Members' indulgence that if you ask a
question with precious little time on the clock, you are not
going to get all six members of the panel to answer your
question. So we will probably give you one panel member and
then if that issue is important to you, you will stick around
for a second round and go back to that point in time. So with
that, I will recognize myself for 5 minutes.
Gentlemen, thank you for coming here today and presenting
this to us. As I mentioned to a couple earlier, this is the
detail phase of what we need to be doing. Most of the time
Members of Congress in these hearings stick to the 10,000 foot
level, but we need to get into the weeds with respect to this
reauthorization, and if there are specific details with respect
to the law itself, now is the time to get those in front of us
as a part of that.
Mr. Cordes, regarding the proposed rules on residual
interest and increased margin accounts for FCMs, I know the
CFTC is relooking at that, but it seems to me that the SRO has
done a pretty good job of setting up a daily confirmation
process for cash balances, for segregated accounts. Is there
additional regulation needed or would that be enough in this
regard to protect and avoid forcing your members to put more
money up and more money at risk, quite frankly, in those
segregated accounts, or is the current SRO process adequate to
protect in this regard?
Mr. Cordes. Thank you, Mr. Chairman. The current
legislation that is put in place or I should say the rules that
are there, currently today we have to track and report all of
our segregated funds and report that in. But then it is also--
the SRO has the ability to electronically look at where all
those accounts are. So that is full transparency where that is
today, and that is a big change from where it was probably
about a year ago. They have access to real-time reporting on
knowing what that balance is.
If the change on a residual interest doesn't come to be,
probably what we are going to see is either the FCMs are going
to have to put up additional capital on the balance sheet or
more likely we are going to ask our customers to pre-fund their
margin accounts additionally. It could increase their margin
requirements by almost double if that happens.
The Chairman. I guess the question was, though, is that
enough control already? Let me ask Mr. Monroe. Mr. Monroe,
thank you for quantifying, specifically, an impact. One of the
things that we do on the front end of these regulatory
processes is predict bad things are going to happen, and it is
hard to quantify. Now that we have something in place where you
guys have experienced your costs actually increasing, being
easily identified within the market as to who you were, was
that a one-time occurrence, or you are seeing it regularly now?
Mr. Monroe. No, Mr. Chairman, that actually has continued
to happen and in fact happened again in a trade that we did
last week that was for a contract that would settle in 2014. So
our concern was these low liquidity areas of the market, 2015,
2016 and beyond, and we actually were identified in a 2014
trade.
The Chairman. And the $60 million that you mentioned, was
that an annualized cost or was that on that one trade?
Mr. Monroe. No, that would be an annualized cost looking at
the volume that we typically do in those illiquid areas that
occurred.
The Chairman. All right. Can the regulatory scheme be such
as to bifurcate the real-time reporting to where if you have a
certain number, beyond a certain number of months on the
contract it would fall under one set of rules, while near-term
contracts fall under a different set? Is that too complex to
regulate or what is the solution for your marked out out-month
trades that you are being identified on?
Mr. Monroe. I think there really needs to be a liquidity
test, and we are working with staff at the CFTC. And we have
had numerous meetings with them on this issue, trying to get
some interpretive guidance to come from CFTC on this issue. And
we feel like there is a solution that recognizes that liquidity
narrows as you go out on the curve, and it may be on an early
month in something like jet fuel. And there is some public
benefit or certainly public benefit in the early months where
price discovery is critical. But out in 2017, there is no
public benefit and in fact, we are basically handing inside
information to nefarious folks.
The Chairman. I got you. Mr. Soto, with the time left, you
mentioned judicial review of CFTC. Would you flesh that out a
little bit for us?
Mr. Soto. Currently the Commodity Exchange Act enables
judicial review, direct judicial review, into U.S. Court of
Appeals for very limited provisions, certain transactions and
approvals. What we are seeking is a broad ability to go before
a U.S. Court of Appeals for any rule-making or order issued by
the Commission. At present you have to first go to Federal
District Court, seek a summary judgment, and then appeal that
to the U.S. Court of Appeals to get an answer on the rule-
making, and that is a cumbersome and wasteful process.
The Chairman. All right. Thank you. Mr. Scott for 5
minutes?
Mr. David Scott of Georgia. Thank you, Mr. Chairman. I
would like to ask this question, get a response from each of
you on the panel for this. It has been since 2008 since CFTC
has had reauthorization, budget appropriations. That was before
the financial crisis, that was before the Wall Street meltdown,
before the derivatives regulations, increased responsibilities.
But recently the House Appropriations Committee reported in an
appropriations bill that reduced the funding of the CFTC by
more than $10 million, even though Chairman Gensler warned in
his testimony to the Committee that even at the current
spending levels with sequestration, the Commission would face
furloughs and staff losses.
So I would like to get each of you to respond to three
questions, yes or no basically. Do you believe that the funds
of the CFTC as proposed by the House Appropriations Committee
are at an adequate level? Starting here, basically yes or no.
The Chairman will knock me down if I don't get all these in in
5 minutes.
Mr. Cordes. I would say from our perspective we only see
one piece of what they are doing. I think they could prioritize
what they do. I am not sure if I know that is a yes or a no
without having more details.
Mr. David Scott of Georgia. Mr. Kotschwar?
Mr. Kotschwar. I will give you the same answer as Mr.
Cordes. Without more details, I can't tell you whether that is
going to be enough or not.
Mr. McMahon. I would have to say the same. I really have
not looked at the global issues around budget. So I can't give
you a good answer to that. I apologize.
Mr. David Scott of Georgia. But given the fact that the
CFTC and much of your testimony, you are asking them to do
more. They are faced with a budget crunch. They are losing
staff, furloughs. They have Dodd-Frank Title VII to implement.
You are there. Their workload has been increased by over 400
percent. Is that not enough information for you? Can we go on?
Mr. Monroe, what do you think?
Mr. Monroe. I am not in a position to comment on that,
either.
Mr. David Scott of Georgia. Okay. Mr. Soto?
Mr. Soto. Let me say I don't think the amount is as
important as what the agency does with the funds that they are
given. We hope that they would become a more effective and
responsive regulator with the funds that they have.
Mr. David Scott of Georgia. Mr. Guilford?
Mr. Guilford. Thank you for the question. CFTC staff today
is approximately nine percent larger than it was 20 years ago,
even though the notional value of the derivatives market over
which it has jurisdiction has increased by over 30 times.
Mr. David Scott of Georgia. But could you give me a yes or
no?
Mr. Guilford. And the question was, is the House
Appropriations mark sufficient----
Mr. David Scott of Georgia. Yes.
Mr. Guilford.--in order to fund the agency? The answer is
no.
Mr. David Scott of Georgia. Good. Okay. Now, second, do you
believe that the reduced funding that they have from the
Appropriations Committee hurts the Commission's ability to
listen, to evaluate and to do all the matters, to regulate, to
give guidance on all of the range that they are doing regarding
its rule-making? Yes or no.
Mr. Guilford. And even in some instances not being able to
hire experts in order to carry out its responsibilities.
Mr. David Scott of Georgia. Precisely. Thank you. Yes or
no?
Mr. Soto. Again, it is what they do with the money that
they have, and we hope they become more efficient.
Mr. David Scott of Georgia. All right. Yes?
Mr. Monroe. I would echo Mr. Soto on that.
Mr. David Scott of Georgia. Same thing?
Mr. McMahon. We have always been able to meet with the
staff and Commissioners and had no issue with difficulty there.
Mr. David Scott of Georgia. Yes, sir?
Mr. Kotschwar. I would echo that response. We don't have
any trouble getting audience with the Commission when we need
to, and also point out that----
Mr. David Scott of Georgia. All right.
Mr. Kotschwar.--House Appropriations reported level is one
step in the process. That isn't the amount that is actually
going to be ultimately decided on.
Mr. David Scott of Georgia. Even with an increase in the
workload? Yes, sir, your point, Mr. Cordes, on that question?
Mr. Cordes. I would say from our perspective the part of
the industry we operate in and, I mean, we have had access to
what we need. I would say it is a matter of what you do with
those resources, how you prioritize.
Mr. David Scott of Georgia. All right, finally my final
point on yes or no here is do you believe, given the agency's
responsibilities are growing, that they need resources in an
amount that is greater than the $205 million it received in
2013? In other words, do you think they need more money to cut
the furloughs, to do the staff, to be able to listen, to be
able to do the job that they need to do with the increased
workload that they have in this very complex area?
Mr. Cordes. Once again, I am not an expert in knowing what
that whole budget is. I would just say look at what the
priorities are.
Mr. David Scott of Georgia. All right. Mr.----
Mr. Kotschwar. I would echo that response, but I want to go
just one level deeper. One thing you said earlier is that you
heard a lot of testimony today about us asking them to do more.
I actually--we have a lot of areas where we would like them to
do less. We believe Dodd-Frank was about swaps regulation, and
they are creating a lot of solutions that are in search of
problems in the futures space. We think that they could do some
prioritizing.
Mr. David Scott of Georgia. Go right down very quickly,
please, yes or no.
Mr. McMahon. From the end-user perspective, I think we
would hope for less regulation of the end-user side.
Mr. David Scott of Georgia. Okay.
Mr. Monroe. I think we are fine with----
Mr. David Scott of Georgia. All right. Mr. Guilford? I
mean, Mr. Soto?
Mr. Soto. Commissioner O'Malia yesterday talked about
information resources that he needs. Our point is that the data
that is being developed right now, given the uncertainty in the
market, is inconsistent, it is incomplete. So those technology
resources are not----
Mr. David Scott of Georgia. Thank you.
Mr. Soto.--put to the most effective use, given where the
regulatory regime is right now.
Mr. David Scott of Georgia. I just want to know if you
think they need to get more money to hire the staff that they
need to do the job.
Mr. Soto. If they got more money----
Mr. David Scott of Georgia. That is all.
Mr. Soto.--the data there is incomplete and inconsistent,
and it would be wasteful.
Mr. David Scott of Georgia. Mr. Guilford? Thank you, Mr.
Chairman.
Mr. Guilford. Yes.
Mr. David Scott of Georgia. Thank you so much. I got one
yes.
The Chairman. The gentleman yields back. Mr. Austin Scott.
Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
The Chairman. Five minutes.
Mr. Austin Scott of Georgia. Gentlemen, thank you for being
here today and helping us with this issue. I actually majored
in risk management and have my Series 7, so I feel some of your
pain. And I listened yesterday as the gentleman with the CFTC
talked about their difficulty and even getting to a common
definition with the SEC over the word person. And it seems to
me that when we have two regulatory agencies essentially
regulating the same field, that when they can't agree on what
the definition of the word person is, then we are creating a
situation where you may be in compliance with one regulatory
agency and out of compliance of another, and it simply depends
on which one may be auditing you at the time as to whether or
not you are in compliance or out of compliance.
You talked about pricing. Most of you talked about pricing,
and you talked about compliance and I know, Mr. Monroe, you
talked about the $60 million in additional costs. I assume that
that cost will either be reflected on your bottom line as a
reduction in profits or it will be reflected in the price of a
ticket to travel on Southwest Airlines. And that is one of the
things that I think sometimes gets lost in this debate as we
talk about complex financial issues is that the more we raise
the cost to the end-user, and in my situation, I am talking
about farmers in particular, you increase the cost to the grain
farmer, the price, the cost is born by the person every time
they buy a box of cereal. In the end it goes down to the
consumer that purchases the last product.
So Mr. Cordes, you outlined some of the costs that are
being incurred by end-users in complying with the new Dodd-
Frank Act. Could you be more specific in some of the measures
that the co-ops generally are having to take to address the new
rules?
Mr. Cordes. Yes. Thank you, Congressman. In our particular
situation, I am just talking for our license FCM group, we have
a staff of roughly about 40 individuals. We have had one person
that has been primarily on compliance. We have now ramped that
up where it is taking two body full equivalents to do those
kind of things, so it is those areas. It has increased
compliance around record-keeping, record retention, auditing
amongst our individuals, training, that kind of thing. I would
also say though that under Dodd-Frank now, it has even rolled
out further into the parent company, into the cash and physical
transactions. We are now having to build out a full compliance
group that not only looks at all the other compliance issues
but now things that spill over from Dodd-Frank that start to
affect the end-user that normally they would look at as normal
transactions and commerce around cash and physical transactions
are wondering, does this fit into the scope of new regulation.
Mr. Austin Scott of Georgia. And would you agree that that
increased cost in the end is born by the consumer that
purchases the product?
Mr. Cordes. Yes, ultimately in the end as the market
equalizes itself out, those costs will be passed on at some
point.
Mr. Austin Scott of Georgia. Mr. Soto, you are in the
energy business, is that correct?
Mr. Soto. Yes.
Mr. Austin Scott of Georgia. And the cost of energy is
reflected in everything we purchase in this country. The cost
of manufacturing, energy costs being too high, can send
manufacturing jobs overseas and the cost of transporting a
product. Virtually everything that we purchase at some point or
another gets to the store by a truck. So the cost of that
energy is obviously reflected in the price.
Could you speak to the potential increase in costs to the
energy consumer with the increased rules and regulations based
on the end-users in your industry?
Mr. Soto. Thank you, Congressman. To be honest, many
factors can affect the price of natural gas. Right now natural
gas consumers are enjoying the benefits of tremendously
abundant natural gas resources in this country that is
producing relatively low and stable natural gas prices for
consumers. But having said that, and the concern that I would
raise is that through the increased transaction costs
associated with the hedging programs, the resources that
utilities have to develop to manage these hedging costs, that
all makes it more expensive to manage the price volatility for
consumers, and that gets passed on to consumers. But more
importantly, the wholesale natural gas market in this country
has been tremendously competitive, innovative, creative, all
redounding to the benefit of the customers, prices of the last
decade notwithstanding, it is really a treasure of this nation.
And the problem that I would see is if that market becomes less
efficient, less competitive, because the transacting parties
are concerned that their physical transaction might be
considered a swap, we lose something tremendously.
Mr. Austin Scott of Georgia. Mr. Chairman, I am out of
time, but gentlemen, thank you for your testimony.
The Chairman. The gentleman yields back. Thank you. Mrs.
Negrete McLeod? Mr. Gallego for 5 minutes.
Mr. Gallego. Thank you. With respect to the issue of what
is or is not in a price, is there a way to break that down? I
mean, as you indicated, Mr. Soto, there are a number of factors
that go into any particular price. I am sure that is true in
any industry, whether you are talking about giving somebody a
raise, whether it is a line employee or whether it is an
executive, the market prices for so many things. I mean, all
that impacts--and ultimately the consumer pays for all of that,
is that not accurate?
Mr. Soto. That is correct, and if there are fewer
counterparties willing to trade and if the markets become less
liquid, the product offerings are less innovative, less
creative, then that just costs more to the consumer.
Mr. Gallego. I am curious though as to in terms of--is
there way to allocate costs per factor? I mean, you decided to
give people X rate of return on their investment, so that is
passed on or you decided to, or the price of one thing or
another. I am just talking about the industry. I mean, for the
airlines, it would be the same. I mean every cost--ultimately,
as a businessman, I mean, I was in the restaurant business. My
family was in the restaurant business for a long time, and
ultimately your costs are always passed on. I mean, when the
price of any of the food that you are serving goes up, that
price is ultimately reflected on the prices on your menu.
Mr. Soto. The transaction costs associated with the
uncertainty in the contracting market, that is probably more
easy to quantify and to track. The impacts of illiquidity and
the less innovative product offerings, that is probably much
more difficult to quantify.
Mr. Gallego. So in terms of whether there are more rules
and regulations or those kinds of things, is there a way to
allocate how much that is costing you? Do the industries
specifically break that down by that particular--is there a
code? I mean, in government apparently everybody talks about it
has to be coded right. Is there a code for this, because of
these rules we have to code this differently and so we can
track how much the cost is?
Mr. Soto. We have not made that analysis, no.
Mr. Gallego. Do any of you do that? Can any of you break
that down, any of the industries, break that down and code it
differently so you can tell what is allocated to any change in
the regulations?
Mr. Monroe. I don't know that we necessarily code an
expense in a certain way because of an additional regulation,
but I would say as I spoke to in my testimony that we view it
as enterprise risk management, and if the markets literally are
taken away from us, then there is risk to the enterprise. Not
to overstate that issue, but a fuel price spike has been the
undoing----
Mr. Gallego. Right.
Mr. Monroe.--numerous airlines.
Mr. Gallego. Yes, right. So with respect to the issue of
agencies, one of the interesting things to me is when an agency
in limited--granted, it probably doesn't happen that often, but
when there is a rule that either is repealed or is changed so
that it becomes more efficient. I find it interesting, for
example, that we always talk about how this stuff costs more
and costs more and costs more, and it raises the price, but it
doesn't necessarily ever lower prices. And I mean, I know in
the restaurant business, as an example, that when the price of
a staple went up and your price went up and then when people
got used to paying the higher price and then the price went
back down again, the lower price wasn't always necessarily
reflected in your menu prices. And how do you balance that with
respect to allocating, giving credit where credit is due? Is
there an opportunity to do that, if they make good decisions?
Yes, sir?
Mr. McMahon. Well, the utility industry is a little bit
different than that. It is a cost-of-service industry. It is
regulated at the retail level, and compliance costs are
something that is part of rate. So that is passed through to
customers.
Mr. Gallego. Right.
Mr. McMahon. We have not seen so far any example of the
Dodd-Frank Act as actually----
Mr. Gallego. Lowering, right.
Mr. McMahon.--lower costs or seeing any of the costs
lowered, and our hope going in was that the end-user exemption
was going to be a relatively clean and broad exemption that
would really relieve us from a lot of the regulatory burden,
but that is not the case. And there is a lot of uncertainty
around things such as posting margin, for example. You know,
utilities are very credit-worthy, and therefore, they don't, on
many of their swaps, don't need to post margin. Having to do
that would tie up a lot of capital, and there would be a lot of
costs associated with that.
So that kind of uncertainty hasn't really been fully
quantified yet, but ultimately those costs are born by the rate
payers.
Mr. Gallego. Thank you.
Mr. Monroe. And I would just point out, we are particularly
proud to pass through lower costs to our customers and in
market shares. We are happy to do that.
Mr. Gallego. I fly it regularly, so absolutely.
Mr. Monroe. Thank you.
The Chairman. The gentleman's time has expired. Mr.
Benishek, 5 minutes.
Mr. Benishek. Thank you, Mr. Chairman. Thank you all so
much for coming here this morning. I am a surgeon so I don't
pretend to have a lot of knowledge about the commodities
market, but I am learning fast since I got on this Committee.
But I have a couple of questions on some of the things here.
Mr. Cordes, can you explain to me more about these no-
action letters that the CFTC puts out? And apparently there is
some ambiguity if these letters have any basis in law and it
may create uncertainty. Can you just go through that a little
bit for me, please?
Mr. Cordes. Yes, the simplest way I can explain that for
you, Congressman, is typically there are rules and regulations,
and if you can state your case that it is economically not
feasible or physically impossible to perform under those
things, you can petition the CFTC and say here is the
situation. Can we get some relief? And depending upon the
situation, they might issue a no-action letter or they may not.
If they do issue a no-action letter, then basically it is
giving you relief from having to comply with that particular
regulation in your situation.
Mr. Benishek. Does that ever get overturned then that you
can have like a none other jeopardy once the deadline has been
passed?
Mr. Cordes. I am not aware of that because typically the
CFTC follows through with that, but in my testimony I gave the
example around this phone recording, and there are some issues
there that we will be talking to the Commission about.
Mr. Benishek. Another question I have----
Mr. Guilford. Congressman? May I answer that question?
Mr. Benishek. Sure.
Mr. Guilford. Mr. O'Malia yesterday in his testimony said
that there were just over 100 no-action letters currently
issued by the CFTC in exactly the way the previous speaker just
addressed. However, 24 of those have no expiration date. So our
concern about those would be with regard to the fact that it
isn't only a situation where the agency may not have fully
formulated a policy with an issue, may not have finished a
rule-making may not have extended rule-making far enough or
collected enough public comment. But it is the extent to which
the CFTC relies on no-action letters simply because it hasn't
been able to complete its work.
Mr. Benishek. All right. I have another question about the
record-keeping. I thought it was pretty amazing the way you
described the fact that every message would have to be somehow
documented and searchable and you have relied now on basically
making phone calls to deal with this. Can you recommend some
way for the CFTC to do this in a better way? I mean, obviously
you have some pretty strong feelings about it.
Mr. Kotschwar. Our recommendation would be let us not
extend the notion of what needs to be recorded this far.
Mr. Benishek. What is the object of all that recording?
What is----
Mr. Kotschwar. I don't know what the object of that
recording is. That is our point. We don't see any real good
public policy value of recording.
Mr. Benishek. Is there value in oversight by collecting all
that data? I mean, the way you described it: hundreds of
transactions going on during a day and you have to maybe make a
hedge position on some of your transactions. It seems like it
is----
Mr. Kotschwar. From a commercial perspective, we don't see
any value in it. I mean, when we do a purchase or a sale with
the producer or a customer, we do it with a contract, and we
maintain all the records necessary to memorialize that
transaction. And we don't feel the need to go as far as
recording the phone call where we agreed with the farmer to buy
his grain. That seems a little excessive. You know, we keep the
records necessary for that. So going beyond that seems----
Mr. Benishek. Mr. Guilford, do you have a comment on that
answer? I mean, I am trying to figure out why they have this
requirement. Do you have an answer?
Mr. Guilford. I do, and if I could just follow on the
previous answer I gave you just for a second. Three years ago
we recommended to Congress that----
Mr. Benishek. Well, I would like to stay on the--I have
only got a certain amount of time.
Mr. Guilford. Okay.
Mr. Benishek. So could you answer the question I asked you?
Mr. Guilford. Yes.
Mr. Benishek. What is your opinion?
Mr. Guilford. Of course. We worked a very long time in
Title VII trying to draw distinctions between legitimate
hedgers and non-legitimate hedgers, commercial versus non-
commercial market participants. What we attempted to do in
carrying out that work, Congressman, was to make sure, as much
as we could, and we may not have been perfect in doing it, that
all of the industries and more that are represented on this
panel today----
Mr. Benishek. Well, I am trying to find out the value of
the----
Mr. Guilford. I am getting to that.
Mr. Benishek. Getting. Yes, but I don't have much time.
Mr. Guilford. We had nothing to do with the financial
crisis. So what the agency has done has cast a very wide net
that encompasses everyone, even though we had nothing to do
with the financial crisis, in an attempt to determine the
extent to which there may be systemic risk or other threats
posed to the financial system, none of which arised from the
people you are looking at today.
So in point of fact, a lot of the information may not be
useful.
Mr. Benishek. Unfortunately, you talked for about a minute
but didn't answer the question.
Mr. Neugebauer [presiding.] Gentlemen, we have been joined
by the Ranking Member, Mr. Peterson. Mr. Maloney, you are
recognized for 5 minutes.
Mr. Maloney. Thank you. Thank you all. My question relates
to the CFTC's $8 billion de minimis level. I would like to get
your thoughts on that, to anyone who wants to answer.
Mr. McMahon. Well, when the de minimis level was
established, the CFTC initially set it very low in their
proposed rule. There were hundreds of comments sent into the
CFTC, several oversight hearings and ultimately they settled on
the $8 billion number. We felt that was a good number given the
size of the market, and the fact from the energy perspective,
we enter into oftentimes large volumetric trades. And so to
hedge against some of the risks that we need to hedge on fuel
and also on power supply, that isn't necessarily a very big
number, even though it seems like a large number.
We are concerned that if it falls back to $3 billion
without any kind of process associated with it, that would come
at the wrong time because we are at a trough of the commodities
cycle right now, and as Andrew mentioned, we are benefitting
from low natural gas prices and the $2 to $3 per mmBtu range,
for example. But we have seen in the last 4 or 5 years when it
has been as high as $10 per mmBtu. So having that level set at
an appropriate level high enough will ensure that end-users
aren't pulled in and regulated as large banks as swap dealers.
So that is why it was important.
Mr. Maloney. Yes, thank you. And I am interested in hearing
from the rest of the panel. But is it fair to say, Mr. McMahon,
that you are comfortable then with the $8 billion level on an
ongoing basis?
Mr. McMahon. We feel the $8 billion for now is a good
level, and going forward it should be looked at in terms of
where the overall commodity market is. But that is a good floor
and a good level for where it should be.
Mr. Maloney. Is there someone who disagrees with that?
Would anyone like to comment on the--Mr. Guilford, I will give
you an opportunity to comment on the idea of it dropping to $3
billion.
Mr. Guilford. I agree with the others on the panel who have
said that it is a number that needs to be flexible with where
the energy markets are. So a fixed number in time doesn't allow
that to happen, and it can disadvantage us as competitors.
Mr. Maloney. How would you best accomplish that, sir?
Mr. Guilford. That is a great question. You are going to
have to give us a minute to think.
Mr. Maloney. You and I are going to get along great. You
just keep saying that. We are going to get along great. What
would you prefer as a mechanism there? Would you leave it to--
--
Mr. Guilford. Well, the mechanism, as the previous speaker
indicated, there have been times when energy markets have been
very high with the $8 billion going to go up----
Mr. Maloney. Well, right, it is not the same in all
markets.
Mr. Guilford. Obviously it needs to be able to move with
the markets. If it is a fixed number in time, then it is going
to put us at a disadvantage unnecessarily so.
Mr. Maloney. Correct, simply because the underlying
commodity price.
Mr. Guilford. So we need to fashion a way to be able to
allow that number to move along with energy markets. Now, I am
not smart enough here today, Congressman, in order to give you
an answer to exactly how we may be able to fashion a solution
to that, but I am confident we can find one.
Mr. Maloney. Got it. And in the 2 minutes I have remaining,
I would like to give the panel an opportunity to comment on the
definition of bona fide hedging and where it ended up. You
touched on this, Mr. Guilford, so we can start with you if you
want. Part of the problem here is that people don't understand
that a certain level of speculation does create liquidity in
the markets and is actually a very healthy thing. Obviously it
is a Goldilocks problem, and I am curious whether those on the
panel view excessive speculation currently as being damaging to
the end-users and where you see that balance being struck.
Mr. Guilford. Well, 10 years ago when the markets were
dominated 70 percent by legitimate market participants and 30
percent by speculation, we had far less difficulties than today
where that has been flipped. Now it is about 70 percent
speculation and 30 percent legitimate market participants.
So first, we share a concern with the rest of the panel
with regard to the multiplicity of definitions of bona fide
hedgers. That needs to be clarified, and we need to get all on
the same page. Second, we do believe there is speculation in
some cases and we would argue that those may have been evident
in the past few years, damages our ability to be competitors in
the marketplace and artificially inflates prices to consumers.
Mr. Maloney. Mr. Soto?
Mr. Soto. As the Commissioners mentioned yesterday, there
are several definitions of the bona fide hedge exemption. We
were fine with the definition as it was applied in the end-user
exception. We were fine with it as part of the major swap
participant definition. We have concerns about a much narrower
definition as it applies to the position limits rule, and we
think when the CFTC does come back on the position limits, they
really need to fix that.
Mr. Monroe. I would just say that the markets seem to be
running very efficiently now, and we are generally comfortable
with what you are describing as a Goldilocks scenario. And we
are always concerned about anything that threatens liquidity.
Mr. McMahon. From the utility perspective, again, we have
large and oftentimes customized transactions. So this narrow
enumerated list is very limiting.
Mr. Maloney. Thank you. Thank you, Mr. Chairman.
The Chairman [presiding.] The gentleman yields back. Thank
you. Mr. Collins for 5 minutes.
Mr. Collins. Thank you, Mr. Chairman. I want to thank all
of the participants today, and I am really interested in
following up a little bit on the end-user exception, certainly
to the clearing requirements, and I guess would ask each of
you, is the definition clear enough? You think it would be
black and white if you are an end-user or you are not, are you
finding situations where there is a gray area? How are you
treating that gray area to know whether a particular company
might be considered an end-user for the exceptions or not?
Mr. Cordes. I would say from our perspective, from NCFC is
we are working with the Commission to get better clarity on
that. I think we are getting much better facts on that. There
is still some confusion out in the marketplace on how that
should be treated on different swap dealers that you might work
with to lay off some of that risk as an end-user. It has a ways
to go, but we are getting better.
Mr. Kotschwar. Ditto his answer. That is exactly where we
are.
Mr. McMahon. I think Chairman Gensler described the Title
VII and Dodd-Frank as a mosaic, and indeed it is. There are a
lot of overlapping rules and requirements. It is very, very
intricate, and our concern again on things such as the margin
requirement, I mean one of the advantages of being an end-user
is that you are exempt from margin, or you should be, but there
is a possibility as to the way the rules interact that you
could be subject to margin.
It is those sorts of issues that need to be clarified to
make sure that it is a robust end-user exemption.
Mr. Monroe. Yes, I would echo that concern, and we also
have a concern about being able to post non-cash collateral. We
are unique in the fact that we post aircraft as collateral for
our hedges. And so we want to be able to continue to do that as
well, and that is potentially threatened.
Mr. Soto. Same, from Richard and Mr. Monroe, that non-cash
collateral, margin and capital requirements for uncleared
swaps, that is something that not only the CFTC but the other
Prudential Regulators need to work out.
Mr. Guilford. We currently don't have an issue with the
end-user definition.
Mr. Collins. Thank you. Now, as you have moved forward and
clearly you are looking for clarification from the CFTC, have
any of you experienced the frustration of the no-action letters
and are those shared amongst all of you where at least you are
getting input from each other's questions?
Mr. Cordes. We have not requested one yet specifically for
ourselves going through, so we will learn more of the process
as we go along. I know they are public information after they
are issued. How much collaborative effort going in up front, I
am not aware of.
Mr. Kotschwar. From CMC's perspective, we have asked for
relief in several instances, but no, generally, overall it is
very frustrating. We have a lot of final rules out there and a
no-action letter is really basically an acknowledgment that no
one can comply with the rule, either because of timelines or
because of other substantive issues. So it is very hard to keep
track of. You have the Code of Federal Regulations that says
one thing, and then you have a stack of letters that tell you,
never mind. But very difficult to keep on top of.
Mr. McMahon. I would agree that conflicting and overlapping
issue is very important, and I would also say that in some
cases, for example, under inter-affiliate transactions, there
are no action letters out there but sometimes the guidance is
either insufficient or the facts don't line up exactly with the
particular cases. So it is difficult.
Mr. Monroe. We have not had any experience with a no-action
letter, but we have not found relief from this real-time
reporting rule after several visits and lots of positive
feedback, and yet we still have not seen any interpretive
guidance that would fix that issue.
Mr. Soto. There is a part of the agency's administrative
process that really needs to be strengthened and that is the
finalization of clear, definitive rules that the industry
understands and how to comply with them. And that has to come
at the Commissioner level, but there has to be final agency
actions that everyone understands in the industry what their
compliance obligations are. In the absence of that, we have no
choice but to go to the staff and say don't enforce these rules
that are uncertain in a way that we don't know how to comply
with them. Working with staff has been, I mean, they have been
helpful in trying to understand the industry concerns and
providing the relief that they think is necessary, but it is
indicative of a process where the Commissioners themselves are
not making the decisions they need to make to give the industry
certainty.
Mr. Guilford. We recommended to Congress 3 years ago that
the Congress codify the process of the issuance of no-action
letters. We recommend that to you again in this reauthorization
process. I would be happy to work with you on that.
Mr. Collins. Well, thank you all for your comments. The
time has run out. Mr. Chairman, I yield back.
The Chairman. The gentleman yields back. Mr. Costa for 5
minutes.
Mr. Costa. Thank you very much. Mr. Chairman, I have a
number of questions specifically and generally. Let me begin
quickly. Mr. McMahon and Mr. Kotschwar, in your testimony you
talked about your concerns about the de minimis exemption on
swap dealer registration. Do you envision more companies having
to register under the current $8 billion level? Do you think
that the current de minimis level of $8 billion is appropriate
or do you think that Cargill and BP's dealing activity doesn't
warrant registration or increased oversight?
Mr. McMahon. Well, I think from the utility perspective, as
I said earlier, the $8 billion is appropriate, and that was
recognizing, too, that that number was formulated when we were
in the midst of a trough in the commodity cycle, very low
commodity prices. That number should be a reflection of where
the commodity prices are, where the overall scale and size of
the derivatives and swaps market is, and we think the number is
appropriate. If the number went down, yes, you would see,
unintentionally, end-users who use these products to hedge
commercial risk being pulled in and regulated like banks.
Mr. Costa. And I don't know, Mr. Kotschwar, if you want to
speak. Can you give us a sense how many more non-financial
companies would have to register as swap dealers? As you may
know, I was involved in that effort last year with public
utilities in California that were included under this and I
felt was unfairly impacted. Can you comment?
Mr. Kotschwar. And thank you for your efforts, Congressman.
Yes, I think that we had not done sort of a sensitivity
analysis looking at the different levels and how many companies
would be brought in. But I can tell you that there are lots of
examples where we are using swaps and commodities to hedge
significant volumetric risk. For example, the provider of last
resort obligation that many utilities have in competitive
markets, and they need to hedge that risk in the event that it
needs to be covered. You know, and these are large numbers. I
think that setting it at an appropriate level, $8 billion is
that level.
Mr. Costa. And you also said in your testimony about
amending the definition of financial entity or financial
entities that are not inadvertently regulated. As we know, we
have a number of financial institutions that can and often do
own warehouses and other facilities. They store physical
commodities. How would you talk about changing the definition
in Dodd-Frank under that definitional category?
Mr. McMahon. Well, we want to make sure that commercial
end-users or affiliates of commercial end-users are
specifically excluded from that definition. In many cases
because of codes of conduct and regulatory contracts, again,
our industry is heavily regulated already at the Federal and
state level----
Mr. Costa. How do you do that relief without opening up a
loophole that you can drive a Mack truck through?
Mr. McMahon. I think you just limit the exception to
commercial end-users, those that are using these products to
hedge commercial risk and specifically exclude banks, hedge
funds and everybody of that ilk. So I mean that is what our
argument is because oftentimes we have these subsidiaries set
up within holding companies to do the financial trading for the
rest of the family.
Mr. Costa. Mr. Kotschwar, do you have any different
comments about this quickly? Because I want to move onto
another question.
Mr. Kotschwar. Just to add a little bit to what he said
about owning the stuff. You know, we acknowledge that the issue
is out there, and it is something for the Prudential
Regulators. The Federal Reserve it looking at it closely
whether banks can own this stuff.
Mr. Costa. Right.
Mr. Kotschwar. But you know one of the things the CMC would
observe is that regardless of what the Fed does in terms of
allowing banks in or out of this stuff. If there is a demand
for exposure to commodities, that demand----
Mr. Costa. No, I have no doubt. The creativity of folks out
there is boundless it seems to me----
Mr. Kotschwar. Yes.
Mr. Costa.--which is part of the problem. Mr. Guilford,
your testimony comments about how the Federal Reserve is
reportedly reconsidering its decision to allow banks to play
heavily in the physical commodity markets. I mean,
traditionally, we know what that role has been played. Can you
expand on what role you think the banks may play in these
markets?
Mr. Guilford. I don't think they should be allowed to play
in these markets.
Mr. Costa. At all?
Mr. Guilford. No, I don't.
Mr. Costa. Okay. I am not so sure I don't agree with you.
The whole panel, you may know, that Germany unilaterally
imposed new rules over high-frequency traders including
registration requirements. I hope you are aware of that. We are
working with them on a host of efforts on a new trade deal on
financial regulatory non-tariff area efforts. What are your
thoughts about what the Commission should be doing in this
area? They are looking at greater oversight on these traders.
Should Congress include something about high-frequency traders?
Quickly.
Mr. Kotschwar. From CMC's perspective, I don't know that
Congress needs to do anything about it. It is high-frequency
trading. I think we need to make sure we distinguish between
looking at the technology because technology is a good thing.
It is the trading strategies. I mean, if you are not supposed
to be able to spoof. If you are doing manual trading, you
shouldn't be able to spoof, if you are electronically trading
or high-frequency trading, either.
The Chairman. The gentleman's time has expired. Mr.
Neugebauer for 5 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman. Thank you for
having this important hearing. Mr. Monroe, you mentioned in
your testimony that the specific trades you talked about where
you were in the marketplace and market participants could have
said, ``Oh, Southwest is in the market today.'' Was that a one-
time occurrence or has your DNA been kind of discovered out
there so on a regular basis that people know that is a
Southwest transaction and they are trying to hedge or----
Mr. Monroe. Yes. Well, thank you for that question,
Congressman. Well, it happened the day--we had a trade the day
before the database, the website came up, in a trade the day
after. And the e-mails came and the phone calls came
immediately. And then we were quiet for trading for a while. We
don't trade every day. We are an end-user. We are hedging our
risk. And then when we came back into the market again, we were
discovered again.
So we have a specific footprint that we leave. We trade in
high volume, we trade in certain ways and especially those who
have traded with us before, and if we are not trading with them
on that particular day, they know that that is us.
Mr. Neugebauer. So you think the fact that that is
occurring, is that negatively impacting Southwest Airlines do
you think?
Mr. Monroe. Certainly it is a competitive issue. Typically
we wouldn't have to disclose our hedging positions until the
SEC required it at the end of a quarter, which is fine. But to
have to have that reported the moment that it happens is a
competitive issue, and then there is the concern about the
actual swap price rising or the spread rising on us.
Mr. Neugebauer. So is there anything that could be done to
give you that anonymity that you need? I mean, what would be
the fix for that?
Mr. Monroe. There is a liquidity test that is needed, and
we feel like that liquidity test probably prescribes that the
real-time reporting still continues, needs to be done to the
public in the near close-end months where price discovery is
important. But in these illiquid areas, the delay can be as
much as 30 days. At least that 30 days gives our counterparty
the opportunity to come out of those positions. And we do
believe in real-time reporting to the CFTC. That should happen.
It is just to the public. There is no public benefit to a 2017
crude oil trade being posted within 15 minutes.
Mr. Neugebauer. So you are saying that those far out
contracts really don't affect the near-term cash markets?
Mr. Monroe. Yes, and that is typically, just to your
earlier question, that is typically where we are seen, where we
are recognized as hedging. If I am hedging in the next few
months, they wouldn't see me there. There is too much
liquidity. It is where there is not enough liquidity and there
is clearly a large animal in the room. That is us and they know
it is us.
Mr. Neugebauer. What would the disallowance of non-cash
collateral as margin, how would that impact Southwest Airlines?
Mr. Monroe. Well, that would impact us very negatively.
Again I mentioned earlier, we use aircraft for collateral, and
that helps us to lower our cost of capital rather than to have
to go out and borrow cash to post it as collateral. And we have
billions of dollars' worth of unencumbered aircraft that we are
very proud of, and we use those in these markets.
Mr. Neugebauer. Thank you. I appreciate that. You know, one
of the things I think that we keep hearing, and whether it is
this panel of end-users or when I am in the 19th Congressional
District of Texas, is that people that are using financial
services, whether it is hedging or other financial services,
with Dodd-Frank and CFTC rules and all of these things, is that
it is creating a huge amount of uncertainty, and that
uncertainty is playing out in how companies are conducting
their businesses.
Mr. Cordes, would you say that that is impacting--I think
about grain dealers or grain elevators in Texas. We may make it
difficult where they just quit providing hedging opportunities.
What would that do to the--where would their customers then go
for that service?
Mr. Cordes. Yes, I can provide you a little bit of an
example. If you think back to 2008 when the grain markets were
moving quite a bit higher, we had increased margin requirements
that come into the marketplace, started putting a lot of stress
on the working capital that a lot of these grain dealers had.
Some of them got stretched to the point where they just had to
quit buying grain. They said I cannot physically handle this
anymore. So what happens then is the farmer is faced with where
is an outlet? I like these prices but how can I lock it in?
One, they would have to start financing themselves to do that,
or two, they would just have to wait. And we saw some of them
waited. So there is some opportunity that is missed there.
So that furthers into today's discussion around some of
these potential changes around residual interests. Some of
these things, if we are going to increase the working capital
needs, you are probably going to see some of these firms that
will be stretched to the point where they are saying I can't
continue to buy grain or maybe I need to get out of business
and merge with somebody else. So then it limits the choices
that the farmer ultimately sees.
Mr. Neugebauer. Thank you, sir. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired. Mr. Vargas
for 5 minutes?
Mr. Vargas. Thank you very much, Mr. Chairman. Again, thank
you for the opportunity to ask some questions. I, too, would
like to thank all the witnesses for being here. It sounded like
some of you, that you listened to the testimony yesterday from
the two Commissioners. So a question was asked of them in two
different ways. What is the thing that keeps you up at night or
what is the thing--and you can't say my 3 year old. That has
been used. That was yours, that is true. But what is the thing
that worries you the most? We would all agree with the primary
goals of Dodd-Frank, protecting the financial system against
systemic risk and increasing transparency in the derivatives
market. But what is it that worries you the most? Yes, sir, Mr.
Soto, since my mother's maiden name is Ms. Soto. Why don't we
go to you first, sir?
Mr. Soto. What worries my members is getting that phone
call from CFTC enforcement staff that they have done something
wrong, despite their best efforts in trying to comply with
difficult-to-understand rules, they still, the staff, thinks
that they have done something wrong. And I have seen Federal
agencies, not the CFTC, penalize industry participants millions
of dollars for misclassifying their transactions in a way that
results in a reporting violation.
And so I mean, those concerns are real. So when they come
to their association, their national trade association, and say
what can be done, what keeps me up at night is how do I get a
straight answer from the agency? How do I get a final rule that
is well-defined, clearly sets out what the compliance
obligation is so our members know how to do business planning
and compliance? And that is the source of my frustration. That
is what keeps me up at night.
Mr. Vargas. Well, Mr. Kotschwar, in reviewing your
comments, I think you were saying that it has become--some of
these rules--let me see if I can find exactly. Given that we
strongly believe that the CFTC's current trend toward very
prescriptive changes is a bad thing. So you almost argue the
other way, that there should be some flexibility, that
compliance is very costly. But I mean, I have been trying to
listen to understand because you want some clear rules, but at
the same time, if it is too prescriptive, then the compliance
costs go way up and compliance attorneys like you like that,
but it is not a good thing necessarily for the system.
Mr. Kotschwar. Well, certainty is a good thing, but you
know, over-prescriptiveness is not a good thing, I guess. I
don't know where the fine line is between certainty and being
over-prescriptive. One of the things that CMC members worry
about a lot is where certainty in this area of bona fide
hedging. You have heard the testimony, a lot of different
definitions of it. This is the one where we really see a
situation of this is very ancillary to what Dodd-Frank was
trying to do. You know, we are trying to set up a framework for
swaps. What was going on in the hedging in the grain industry,
in the electricity industry, that requires the regulator to
come in and topple everything we know about bona fide hedging
on its head and start over? This is very destabilizing, and it
worries us.
Mr. Vargas. Anybody else? Mr. McMahon, sir?
Mr. McMahon. Yes, I would just add that I think not falling
over one of the trip wires that would have you miscast as a
swap dealer. I think that there is so much overlapping and
interwovenness between these regulations that there is really a
concern that inadvertently somehow you will hit one of these
trip wires and be miscast as a dealer and regulated to the
extent that banks are and ultimately, in order to avoid that,
anecdotally we are hearing there are fewer counterparties in
the market and companies are going more physical which, in a
lot of cases, is a more costly way to hedge.
Mr. Vargas. Mr. Cordes?
Mr. Cordes. I would say from our perspective what keeps us
up at night is this potential one-size-fits-all. You have
different sized firms. It used to be you had guidance from the
CFTC. Now it is pretty much you must follow this path, this
rule, the prescriptive down. So what gets us worried at night
is, okay, what have we overlooked? What are we missing and what
is it going to cost us to comply with doing all that stuff
which in a lot of times a smaller firm, you have a much better
view. You see a lot of the things. You don't have layers that
things get missed. It is like we can do that guidance, but to
go through all that other stuff just gets to be a lot of
formality that just adds cost.
Mr. Vargas. Thank you. Thank you, Mr. Chairman. I yield
back. Thank you, sir.
The Chairman. The gentleman yields back. Mr. Hudson for 5
minutes.
Mr. Hudson. Thank you, Mr. Chairman. I thank the witnesses
for being here today.
Mr. McMahon, I enjoyed visiting with your folks last week
and appreciate in your testimony where you discuss the
implications of reducing the de minimis threshold with
deliberate CFTC action. I am glad you raised this point because
it is something I am very concerned about, something I am
working with this Committee on.
As I talked to Commissioner O'Malia yesterday, I understand
that the de minimis level is based on a notional value. From
his testimony I gather that works for interest rates lops but
in commodities markets, rising energy prices can push entities
over the threshold by giving them changes in their trading.
This seems like a real problem to me. How would you suggest the
CFTC address this clearing problem?
Mr. McMahon. And thank you for all your support and efforts
on behalf of the industry, Mr. Congressman. At the end of the
day, our hope is that this level, to the extent that they go
for a look-back, that there is a process put in place where all
the stakeholders can come in. I think it should look at the
overall scale and scope of the market but also recognize that
it is a very volatile market, particularly with respect to our
fuels. Historically it has been. Our hope is that it is a
deliberative process. It involves rule-making, that all the
stakeholders have an opportunity to participate and obviously
with the guidance and oversight of the Congressional
committees. I think that is the best way to get a result that
will ultimately preclude commercial end-users, such as the
folks represented on this panel, from being inadvertently being
cast as swap dealers.
Mr. Hudson. Thank you for that. You touched on this a
little bit but has the CFTC's approach to rule-making and the
resulting rules caused any of your members to restructure or
reduce hedging, trade less officially? Could you maybe explain
that in a little more detail?
Mr. McMahon. Thank you. Our industry is heavily regulated
at both the state and Federal level. In some cases there are
overlaps between the regulation. The Dodd-Frank Act did call
for the FERC and the CFTC to put in place an MOU. That
Memorandum of Understanding was really never put in place. I
think that is an issue of some concern for our industry. But in
many cases, one of the things that many of our companies are
set up as holding companies, and in order to be efficient about
how they trade and to separate the regulated businesses from
the non-regulated businesses, they have trading entities within
there and a real concern. We felt that that was an appropriate
way to make sure that the overall entity would be able to
maintain its end-user status since the purpose of that trading
entity was to trade on behalf of the end-user. Because of this
financial entity concern that I put in my statement, that is
something that that end-user status could be lost from that
advantage overall.
So I think that is an example of a real concern with the
way that the rules are coming out, also the interaction between
the other Prudential Regulators and the CFTC, and that is
something that we hope can be resolved.
Mr. Hudson. I appreciate that. Mr. Soto, in your position,
your primary focus as I understand is to inform your members of
the regulations they must adhere to and a system of staying
between the lines, so to speak. Can you explain to the
Committee why regulatory certainty is so critical to what you
do and elaborate some more on specifically what that means for
business planning?
Mr. Soto. Thank you. Our industry, the natural gas
industry, is heavily regulated. There are several Federal and
state agencies that have some oversight over the actions and
activities and operations of the utilities. So our members are
used to compliance, and they build sophisticated programs to
make sure that they understand each of the regulatory
obligations, chart them out, make sure all their transactions
and operations are consistent with those obligations. And the
difficulty comes in if they don't understand what those
obligations are requesting them, whether a particular
transaction would be subject to a specific set of regulations
or overlapping or conflicting regulations with another agency
or whether a particular operation has to be done in a certain
way. IT systems, resources have to be devoted in order to
comply with record-keeping or reporting requirements. Whenever
those regulations are unclear, those operations are disrupted.
And so we are hoping that, again, the theme that I have
been trying to express today is the notion that we need to get
answers from the agency in defining all of their regulatory
obligations, very clearly, very definitively, from the
Commissioners themselves and not necessarily from staff actions
and no-action letters and interpretive guidance. It has to be
the agency through the process. We file comments, answer the
comments. That is what we are really seeking.
Mr. Hudson. Thank you, and Mr. Chairman, I yield back the
seconds I owe you from yesterday.
The Chairman. All right. Let the record reflect that. I
appreciate that. The gentleman yields back. Mr. Scott for a
second round, 5 minutes.
Mr. David Scott of Georgia. Thank you, Mr. Chairman. Mr.
Guilford, let me go back to you. You know, in my opening
statement I remarked about my concern about the banks
purchasing these warehouses and holding onto these tons of
aluminum and other commodities, oil takers, all that. Tell me
why you feel, where is the danger there? What do we have to
look forward to? And can you explain for us why your position
is that this should not be?
Mr. Guilford. It is almost as though the country is being
turned back about 100 years to the turn of the 20th century
when Teddy Roosevelt first broke up the great trusts, and it is
based on the very same reason, the concentration of power in
one place of an entity that controls the physical market to an
extent that it has the ability perhaps to manipulate prices. It
takes vast positions in paper markets, so it is dealing with
both sides of the energy marketplace, and at the very same
time, it is selling us our fuel as a wholesale supplier. It has
another division that is helping us hedge those purchases
because we are literally tens of thousands of businesses whose
responsibility it is to try to provide consistent and stable
prices for consumers. And then on top of that, we can open an
investment account and a 401(k) plan. It seems like it is
becoming just an extraordinary concentration of power in one
place, and we think that there may be great danger in that. And
I think that is where we have to be very cautious. This didn't
start until 2003.
I would only tell you, Mr. Scott, that most of these
contracts went on the markets at the end of the 1970s and the
beginning of the 1980s. We functioned for over 20 years without
the financial services' industry's deep penetration into these
markets. But since that has occurred, our concern has grown
about the nature and extent to which we have distortions in the
markets because of it.
Mr. David Scott of Georgia. Do you see a threat to a
possible crisis in any way, financial instability, inflated
pricing or any of those things? Because it is clear from the
ruling of the Federal Reserve that the banks are operating
basically within the regulations they have, and they have up to
10 years to dispose of these ownerships.
Mr. Guilford. We are grateful for the fact the Federal
Reserve is reviewing that decision with the potential toward it
being overturned in September. And we would encourage the
Congress to communicate with the Federal Reserve, the very
important nature of their doing that and doing it thoroughly.
Mr. David Scott of Georgia. You definitely see a danger
to----
Mr. Guilford. Yes.
Mr. David Scott of Georgia.--financial stability with that?
Mr. Guilford. Yes.
Mr. David Scott of Georgia. All right. Now, back to the
whole panel, I hope I get a better yes or no ratio here. And
this is just the basic yes or no. But some of my Republican
friends--and I do have Republican friends. I work with them
very closely. But they are both in the House and the Senate
supporting legislation that totally would repeal Dodd-Frank.
And with regard to Title VII of which we are all involved in in
the commodities, the derivatives and so forth, do you agree
with my Republican friends that it should be repealed entirely
and that the regulation or lack thereof that existed prior to
the law is the appropriate regulatory regime? Yes or no.
Mr. Cordes. That is a pretty full question. You know,
certainly some of the new things that have come in around
transparency have been helpful. There are some other things
that have been hurtful. I am not sure I can give you a full
answer on a full repeal or not.
Mr. David Scott of Georgia. All right. Good. Yes, sir?
Mr. Kotschwar. I think generally the CMC position on that
would be no because the CMC was supportive of the goals of
Dodd-Frank which was to bring swaps into a regulatory arena
that was somewhat comparable to what existed for futures.
Mr. David Scott of Georgia. So you don't support repeal?
Yes, sir, Mr. McMahon?
Mr. McMahon. As I said in my statement, we support the
goals of Dodd-Frank. We just need to get these issues correct.
Mr. David Scott of Georgia. All right. Mr. Monroe?
Mr. Monroe. We would not.
Mr. David Scott of Georgia. All right. Mr. Soto?
Mr. Soto. I am here on behalf of my members, and my members
have not told me one way or another whether they support repeal
or not. So I can't give you a definitive yes or no answer. I am
here to tell you we want the regulatory regime to be as clearly
defined and understood as possible.
Mr. David Scott of Georgia. All right. And Mr. Guilford?
Mr. Guilford. No, we are not in favor of total repeal.
Mr. David Scott of Georgia. All right. Thank you very much,
Mr. Chairman.
The Chairman. The gentleman yields back. Mr. LaMalfa for 5
minutes?
Mr. LaMalfa. Thank you, Mr. Chairman. Maybe I ought to ask,
would you be in favor of partial repeal which kind of sounds
like that because all or nothing is probably something you
can't say or maybe completely before with a little more clarity
probably being reasonable. So maybe I could just get you all to
nod your heads yes or no. Would you like to see partial repeal?
I am seeing some nods. Okay. All right.
We have some cleaning up to do, a lot of it, and I hear a
lot of complaints in general about the far reach of the law.
When some things went wrong with finance markets recently, some
effort was needed. But as happens around here, we swing the
pendulum not just a little bit, we swing it all the way.
So let me ask Mr. McMahon just a couple, following up on--
you are probably aware of my bill, H.R. 1038. If that was put
into law, having to deal with the threshold for swap dealers
from $25 million to the $8 billion for taxpayer-owned
utilities, if we don't get this, or if CFTC does not act in
this manner as they alluded to at yesterday's hearing, do you
think the effect on rate-payers is going to be detrimental
without this fix?
Mr. McMahon. Ultimately, utilities, our members, can go two
different courses. I think that if the threshold for the de
minimis level went down, you would find people not doing a lot
of the hedging and the activities that would cause them to
cross that threshold. So what that would mean at the end of the
day, again, our goal is to deliver affordable, reliable, stable
rates to our members. So what that would do is basically cause
us to do less hedging which would probably cause more
volatility in rates because of the inherent nature of the fuels
and feed stocks that we use to generate electricity.
You would just see a movement toward more physical sites
with transactions which can be extensive, and you would see a
movement so that you wouldn't become regulated like a bank and
a swap dealer. So we think this is very, very important to get
this right because at the end of the day, there was a
recognition that the activities that the companies and
industries do on this table do not create systemic risk which
was ultimately the objective of Title VII to address systemic
risk and Dodd-Frank. And so we think that getting the level
right is very important.
Mr. LaMalfa. You kind of answered my second follow-up and
that is the whole thrust of our legislation is what did tax-
payer owned utilities have to do with the financial crisis
anyway? You know, so we think it was maybe an oversight or a
little lack of common sense on that.
For Mr. Soto, I am interested in the problems we keep
hearing about the no-action letters. Can you provide an example
of a time that you really had to rely on the relief of a no-
action letter or get regulation clarification from CFTC on
that?
Mr. Soto. As I described earlier today and in my testimony,
there is uncertainty and confusion in the industry as to how
certain gas supply transactions would be treated, whether they
would be treated as exempted or excluded forward contracts, or
whether they should be treated as trade options or whether they
should be treated wholly as swaps. And part of that confusion
was resolved a bit in the CFTC's proposed rule to treat trade
options with a lesser regulatory reporting requirement. But as
that reporting requirement deadline came nearer and nearer and
people were still confused as to what transactions would be--
could we report these as trade options or would they still be
excluded? The CFTC granted no-action relief as to how to report
trade options which gave the industry a little bit of a
breathing room, knowing that in case they had to report these
transactions, at least they could report them under a lower
reporting burden as trade options. And so people breathed
easier a little bit. But the fundamental question of what
transaction is a swap, what transaction is excluded as a
forward, what transaction is a trade option, that is still very
unclear.
Mr. LaMalfa. And the last-minute nature of those
clarifications made it probably even more difficult to----
Mr. Soto. Indeed.
Mr. LaMalfa.--running down two different tracks, et cetera.
Mr. Soto. I think the relief was granted within a week when
the deadline came due.
Mr. LaMalfa. Yes. All right. I yield back, Mr. Chairman.
The Chairman. The gentleman yields back. Mrs. Hartzler for
5 minutes.
Mrs. Hartzler. Thank you, Mr. Chairman. Thank you,
gentlemen, for being here today to let us know how the
implementation of the Dodd-Frank is impacting each of you.
Earlier this year I introduced H.R. 2136, the Small
Business Credit Availability Act, and that would exempt certain
end-users such as farm credit lenders and nonprofit electric
cooperatives from the financial entity definition in Dodd-Frank
if their outward swaps exposure does not exceed $1 billion. And
I have since worked with Representative Michael Grimm from New
York to ensure a comparable exemption was included in his bill,
H.R. 634 which passed overwhelmingly in the House earlier this
summer, and that excludes these end-users from costly capital
and margin requirements.
So I was wondering, Mr. McMahon, can you elaborate on the
effects of including end-users like electric companies and
rural electric cooperatives in the financial entity definition?
Mr. McMahon. Well, again, going back to the question, I
think it would have a very detrimental effect of being
classified as a financial entity because you would lose your
end-user status. Even if one entity within a holding company
was classified that way, they would not be able to trade on
behalf of the regulated entity who is the end-user. So I think
that would be very detrimental.
I think generally we have looked at this issue more broadly
in terms of: if the end-user status was taken away and all of
the swaps and derivatives transactions had to be transacted on
exchange or with margin posted, what the impact would be on our
companies, and we have estimated the impact from a cash flow
standpoint of between $200 and $400 million per year, and that
would have a significant impact because again, we are in the
midst of a major capital expansion, and in some cases, that is
\1/2\ of your capital budget for the year. So it is a
significant number, and again, I think that companies, if they
were subject to those sorts of margin requirements, they would
back off of their hedging, most likely, and to some degree
redirect money toward other things that were in capital spend
programs and so on.
So it would have a negative effect, and that is why it is
so important that our companies are not in any way classified
as financial entities and that the end-user status is robust.
Mrs. Hartzler. Would it have an impact on the rates of your
rate payers if they have $200, $400 million more in capital
needed, I assume you would pass those on?
Mr. McMahon. Yes, absolutely. I mean there is absolutely an
impact because at the end of the day, we are a rate-regulated
industry. We are in the middle of this, in the midst of this on
an industry basis about a $90 billion per year capital spend,
and your average company's capital budget may be in the range
of about $1 billion. So having the ability to manage that price
risk as we do right now where we don't need to post margin,
where we are end-users, it is very cost effective. And our
customers get the advantage of the fact that we are very
creditworthy. So our counterparties don't ask us to post
margin. But as Mr. Monroe said, in some cases, if we do post
margin, we want to do something like use a power plant or use a
physical asset. And having that flexibility is very important.
So these issues all kind of tie together, but at the end of
the day, it is about delivering affordable rates, reliable
rates to our customers.
Mrs. Hartzler. Exactly, and stable, like you mentioned
earlier.
Mr. McMahon. Absolutely.
Mrs. Hartzler. Affordable, reliable and stable. I thought
that was very good. In your opinion, how should the definition
of financial entity be changed to ensure the commercial end-
users are not inadvertently regulated as a financial----
Mr. McMahon. Well, from our perspective, and thank you for
the question, our perspective is commercial end-users should be
explicitly excluded from that definition so that we will not be
sort of brought in through the actions of Prudential Regulators
or the CFTC into that definition. We should be explicitly
excluded.
Mrs. Hartzler. Okay. Well, we are going to keep trying to
work, help that happen.
Mr. McMahon. Thank you so much.
Mrs. Hartzler. You bet. And I wanted to ask Mr. Cordes a
question here because yesterday I asked Commissioner O'Malia
and Wetjen about the damaging proposed rule on residual
interest in same-day margin calls for farmers and ranchers. And
I am cautiously optimistic from their answers. I don't know if
you had an opportunity to hear that but that changes will be
made, and they feel like there is staff drafting such as we
speak. But for the record, can you please elaborate on why the
proposed rule could harm farmers and ranchers?
Mr. McMahon. Yes. I did catch part of that testimony, and
it is good to hear that some things are being redrafted and
looked at. I would say from our perspective, if it is not, here
is what is going to happen. Going forward, you will have to be
ready for that one-day event that might happen once or twice a
year, and for a firm like ours or in our industry where you are
normally hedgers, and if you get a big market move-up, you have
to be prepared to have that money on your balance sheet at that
time, not when the margin call shows up at the end of the day
or later, at that time. There are periods in our system in the
last few years, and some of these days, it might be $100
million a day needs to be--you would have to throw on your
balance sheet just to be ready for that one-day event. Firms
are not going to do that. What you are going to do is you are
going to say, ``Okay, customer, we are going to have you put
some skin on this game, and by that, you are going to have to
increase your margin requirement that is on deposit with us.''
That is going to affect their working capital, and as I think
we have heard on some of the other ones, working capital is
precious, and that costs resources and ultimately hits the
bottom line.
Mrs. Hartzler. Absolutely, as----
The Chairman. The gentlelady----
Mrs. Hartzler.--the farmer who--yes, okay.
The Chairman. The gentlelady's time has expired.
Mrs. Hartzler. Thank you.
The Chairman. Mr. Davis for 5 minutes.
Mr. Davis. Thank you, Chairman Conaway and as it always is
on these Committee hearings, when you are one of the last to
ask questions, I had a lot of great questions to ask you, but
almost all of them have already been asked. Mr. Chairman, am I
the last questioner?
The Chairman. In this round.
Mr. Davis. In this round? Oh, another round. Okay. Well,
then I will keep going. I was going to yield back. I had some
discussion questions, especially from Mr. Cordes and Mr.
Monroe, but again, they have already been asked. What we have
seen here today and what we continue to see is laws like Dodd-
Frank, that have great intentions, have consequences. And from
the testimony that all of you have given us is the consequences
are going to be passed on to the consumers. The flight I take
on Southwest Airlines from Reagan National to St. Louis, to
comply with these rules, the cost that I and so many different
consumers in this country will pay will go up. The cost to
provide electricity will go up. The cost to provide our
agricultural products in central and southwestern Illinois to
our local grain elevators will go up, the law of unintended
consequences when it comes to Dodd-Frank.
And I know there are concerns. We have agreements, and
there are those who disagree with the effectiveness of this
piece of legislation. And with that in mind, you have all been
asked specific questions by different Members of this
Committee. I want to know from each of you, if you decide, is
there any question that we haven't asked you and is there an
issue when it comes to Dodd-Frank that we have not addressed
that you would like to let the Committee know is a concern with
your industry and with your particular business? So with that,
I will start with Mr. Cordes. If you have any issues?
Mr. Cordes. Not specifically an issue, but it gets back to
what we talked about this one-size-fits-all, and your original
comments about--and I hear this a lot from our customers in the
industry saying okay, what did we do? Why are we subject to
this stuff? We were not the cause of all this. We understand
there is Dodd-Frank legislation, but why are we being asked to
do these kind of things and why are my costs going up and what
can we do about it, seems to be kind of the general comments
that I hear back.
Mr. Davis. Thank you. I hear that from many of my farmers.
Mr. Kotschwar. I will get a little more granular with you.
One of the things that hasn't been talked about today but is on
CMC's list of things we are concerned about is it was part of
the position limits rule that got tied up in court. We are
going to be soon, if they resurrect it the way it was in the
proposed rule, we are going to be doing daily reporting of
physical positions. Currently it is agricultural commodities
only, and they are reported to the Commission on a monthly
basis. And we went round and round with the Commission on that
as they were developing this particular part of the rule. We
thought we had won that particular battle, too, and they said,
okay, you are right. We will continue to allow you to do
monthly reports. However, when we looked at the fine print it
is monthly reports of daily positions. If you look at the
history of the CFTC on these physical reports, at one time they
were doing them on a weekly basis, but that was just way too
much information for CFTC. So they pushed it back to a monthly
basis. So that is something else. This is something they were
getting ready to have the industry start doing for from our
perspective very little benefit, and it is still percolating
out there.
Mr. Davis. Okay.
Mr. McMahon. I think from the electric utility perspective,
the one issue that would be very helpful would be to have, that
we haven't discussed already, is to have that Memorandum of
Understanding between FERC and the CFTC that was mandated under
the Dodd-Frank Act, to actually have it hammered out, put in
place, because I think that would help to address some of the
regulatory uncertainty that some of the other panelists have
alluded to with respect to jurisdiction and some of the issues
between the cash market, the futures forwards and derivatives
markets. So I think that would be very helpful.
Mr. Monroe. I would just want to make it crystal clear that
the additional $60 million that we talk about in terms of cost
to Southwest from the real-time reporting rule is not some sort
of $60 million that is going to the government in a new tax or
to some regulative group. This is a group of hedge funds that
have written specific--they have technology that they have
built that has been handed to them by our government to have
free information that they then use to trade against our
counterparties, and it costs us more. And so that is money
going from Southwest to hedge funds, just to be very clear
about that.
Mr. Davis. Thank you.
Mr. Soto. To echo remarks from Mr. McMahon, I have talked a
lot about uncertainty and regulatory uncertainty today, and a
lot of that derives from transactions that have traditionally
been regulated by FERC that are now being regulated by the CFTC
or trying to be regulated or questioned to be regulated by the
CFTC as swaps. What we really would like is for Congress to
sort out and say, look, FERC, you take care of these
transactions and the CFTC, you take care of these transactions.
Right now we have this crazy Venn diagram of overlapping
jurisdictions, and it is causing disruptions in the industry.
The Dodd-Frank Act, Congress has already included provisions to
sort out the jurisdiction between the CFTC and the SEC. Is
there something that can be done between FERC and the CFTC?
Mr. Davis. Mr. Guilford for a couple seconds?
Mr. Guilford. Yes. I would ask who has the big picture? In
Congress for example you have division of responsibilities
between agriculture, financial services and banking. Who has
the big picture between all three? We created a massive piece
of legislation that ostensibly gives responsibilities to four
different agencies, each of which overlap, some of which don't
necessarily overlap but could. Who has the big picture over all
of those things? Because what we did, while it may have been
important in many instances, has created an enormous amount of
not only uncertainty but additional cost and a very time trying
to sort out what to do next.
Mr. Davis. All right. Thank you. If I had time, I would
yield it back, sir.
The Chairman. Well, the record reflects that you are over
about a minute or 2, and we will take that into consideration
at the next hearing.
I recognize myself for 5 minutes, second round. Mr. Soto,
on the delay of the historical reporting requirements back in
April, what impact is that having on your membership in terms
of challenges in reporting and what impact would a second no-
action letter have on your membership?
Mr. Soto. The no-action relief is actually giving the
industry a little bit of a breathing room and understanding
what their compliance obligations are. So in that respect, it
was helpful that the agency provided some relief, but it really
recognizes that the process for defining the regulatory
obligations is not strong enough. So if it comes to the next
deadline, either additional no-action relief is required, but
really what is required is for the agency to issue final rules
that are clear, and it is strengthening that agency rule-making
process that is important.
The Chairman. All right. One of the things we have talked
about is the cost-benefit analysis and how we are going to try
to strengthen those provisions in the bill. Looking back at
Dodd-Frank and the estimates of what the cost and benefits were
going to be to the system, can any of you or would any of you
be willing to quantify the differential if any between what the
Commission said was going to be the costs of compliance with
all of these new regulations in various areas and what your
personal experience or your members' experience has been in
actual costs of compliance and if you have been able to
quantify that for the Committee? Mr. Cordes?
Mr. Cordes. I don't remember exactly what was stated in the
bill, but I would tell you from our perspective, whether it is
ourselves as CHS or other members within NCFC, pretty much
everyone would give you the response that their costs and
compliance are probably double what they were 3, 4 years ago.
The Chairman. Yes, thank you for that. I was trying to get
a differential between what the CFTC said were going to be your
costs and what has been the actual experience. And some of that
may be proprietary that you don't want to fess up to. Does
anyone have a number? Well, if you think of a number or if it
comes to you, we are going to try to defend strengthening the
cost-benefit analysis in the bill, so we will be working
through those provisions.
I want to thank our panel for being here today. I also want
to ask unanimous consent to include in the written record the
comments from the Coalition for Derivatives End-Users and the
comment from ICI and ABA.
[The information referred to is located on p. 87.]
The Chairman. Before we adjourn, I would now like to turn
to the Ranking Member for a closing statement.
Mr. David Scott of Georgia. Well, thank you very much, Mr.
Chairman. Let me just extend my great appreciation to each of
you for coming, taking the time out of your busy schedule to
come. Your viewpoints have been well-appreciated. We have a
number of challenges before us, and we are going to get there
and we are going to avoid another financial crisis for sure. So
thank you very much for coming.
The Chairman. I also want to thank our Members. Clearly the
Dodd-Frank law itself as well as the regulations that have been
put in place to try to implement it and grant guidance to the
system are going to cost the industry and ultimately customers
more money. The offset to that should be that there are
benefits to the markets, that the markets are better protected,
that there is less systemic risk in what is going on. What my
relatively naive view is that we are going to spend an awful
lot of time on risks that can never reach the systemic level
and the costs associated with all of those compliance costs on
risks that really, at the end of the day, don't make a big
deal, and that we have lost sight of the bigger issue.
Dodd-Frank, in my view, was intended to prevent a systemic
meltdown. I am hard pressed to gather up many, or all, of your
users at any one point in time and have them do something
stupid that would systemically put risks to the overall
financial market, and yet, we have burdened them immensely with
additional regulations.
And so one of the things we will try to do with the
reauthorization is not repeal Dodd-Frank, not undo it, but look
at it particularly from a common-sense standpoint and say do we
really need that information every single day in order to
regulate what we need to regulate? There are risks in every
market. There are risks in every transaction that you take.
That is why people make money and lose money. But it is the
systemic protection of the markets and the fairness of those
markets that ought to be the deal. And we see an awful lot of
this regulation that at the end of the day does not protect
from a systemic meltdown; particularly that meltdown that drove
Dodd-Frank.
I thank each one of you for coming here, the preparation
that you did, the money that you spent getting here and all
that team behind you that put together your very informative
written comments. Those will of course go into the record, and
I have an announcement. Under the rules of the Committee, the
record of today's hearing will be held open for 10 calendar
days to receive additional material and supplemental written
responses from the witnesses to any questions posed by a
Member. This hearing of the Subcommittee on General Farm
Commodities and Risk Management is adjourned.
[Whereupon, at 12:04 p.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Letters by Hon. K. Michael Conaway, a Representative in
Congress from Texas
July 23, 2013
Hon. Frank D. Lucas, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Re: End-User Support for Adding H.R. 634 and H.R. 677 to Legislation
Reauthorizing the Commodity Futures Trading Commission
Dear Chairman Lucas and Ranking Member Peterson:
The Coalition for Derivatives End-Users, representing hundreds of
end-user companies that employ derivatives to manage risk, write in
strong support of adding H.R. 634, the Business Risk Mitigation and
Price Stabilization Act of 2013 and H.R. 677, the Inter-Affiliate Swap
Clarification Act, to legislation reauthorizing the Commodity Futures
Trading Commission (the ``CFTC''). These two vital bills would help
prevent unnecessary and harmful regulation of derivatives end-users and
preserve jobs. We have attached our June 11, 2013 letter to the U.S.
House of Representatives in support of the two bills. The letter
provides a sense of the range of end-user companies that stand behind
these important bills.
This Committee, of course, is well aware of these two end-user
bills, and the Coalition commends your efforts in moving the
legislation toward enactment. On March 20, 2013, this Committee ordered
both bills reported by unanimous voice votes. H.R. 634 passed the House
last month by a vote of 411-12 and we are optimistic that passage of
H.R. 677 will soon follow. These are commonsense bills that assist non-
financial end-users in targeted, narrow ways that are consistent with
the intent of Congress in passing the Dodd-Frank Act and that address
problems not solved by regulatory action.
Both bills are urgently needed due to the impending application of
regulatory requirements on end-users. H.R. 634 is needed because
regulations proposed by the Prudential Banking Regulators have
interpreted the Dodd-Frank Act as mandating that margin requirements be
imposed on all swaps, including those entered into by non-financial
end-users. The CFTC's proposed regulations, while preferable to those
proposed by the Prudential Banking Regulators, do not provide end-users
with the predictability and assurance that H.R. 634 provides. As noted
in the attached letter, a 3% initial margin requirement applied to end-
user transactions could cost more than 100,000 jobs.
H.R. 677 is urgently needed as well. Under CFTC rules, clearing
requirements will apply to all swap market participants beginning this
coming September. H.R. 677 would prevent regulators from denying non-
financial companies the use of the end-user clearing exception because
they have chosen to hedge their risk in an efficient, highly-effective
and risk-reducing way--through the use of a centralized treasury unit
(``CTU''). The CTU provision of H.R. 677 is especially important, as it
makes clear that non-financial end-user companies that are using swaps
to hedge or mitigate non-financial risks will not be disparately
treated based on corporate structure and will not be subject to
regulation that disadvantages them for employing what is a best
practice among corporate treasurers.
To ensure timely consideration of these bills and to prevent
unnecessary and harmful regulation of derivatives end-users, we request
that both bills be included in legislation to reauthorize the CFTC if
they have not already been enacted by the time that your Committee
reports out the reauthorization.
Throughout the legislative and regulatory processes surrounding the
Dodd-Frank Act, the Coalition has advocated for strong regulation that
brings transparency to the derivatives market and imposes thoughtful
new regulatory standards that enhance financial stability while
avoiding needless costs. The Coalition appreciates very much your
bipartisan legislative efforts to focus regulation where it is needed
most by removing the burden where it will cause harm and provide no
benefit.
Sincerely,
Coalition for Derivatives End-Users.
attachment
June 11, 2013
U.S. House of Representatives,
Washington, D.C.
Re: End-User Support for H.R. 634 to Protect Derivatives End-Users from
Unnecessary Margin Requirements and for H.R. 677 to
Preserve Central Hedging and Prevent Unnecessary Regulation
of Inter-Affiliate Swaps
Dear Representative:
The undersigned companies and organizations that employ derivatives
to manage risk--write in strong support of H.R. 634, the Business Risk
Mitigation and Price Stabilization Act of 2013, and H.R. 677, the
Inter-Affiliate Swap Clarification Act. These two vital bills would
help prevent unnecessary and harmful regulation of derivatives end-
users and preserve jobs.
H.R. 634 would ensure that regulators would not impose unnecessary
margin requirements on many end-users. 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. While the
regulations proposed by the Commodity Futures Trading Commission (the
``Commission'') are preferable to the regulations proposed by the
Prudential Banking Regulators, the Commission's regulations do not
provide end-users with the predictability and assurance that H.R. 634
provides. According to a Coalition 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 120,000 jobs.
We need Congress to step in and clarify that end-users will continue to
have the ability to manage risk without the threat of having
unnecessary initial and variation margin requirements imposed on them.
In short, we need this bill. In the 112th Congress, an identical bill
(H.R. 2682) received overwhelming bipartisan support when it passed the
House on March 26, 2012. This year's version of the bill was ordered
reported by the House Agriculture Committee by unanimous voice vote and
by the House Committee on Financial Services by a vote of 59-0.
H.R. 677 would prevent certain internal, inter-affiliate trades
from being subject to regulatory burdens that were designed to be
applied only to certain street-facing swaps. It also would prevent
regulators from denying non-financial companies use of the end-user
clearing exception because they have chosen to hedge their risk in an
efficient, highly-effective and risk-reducing way--through the use of
centralized treasury units. Regulators have proposed a clearing
exemption for inter-affiliate trades, but it would impose unreasonable
conditions on financial end-users and would not address the centralized
hedging unit problem. The Coalition believes that regulation of inter-
affiliate trades should square with a simple economic reality: internal
trades do not increase systemic risk. Thus, imposing requirements that
are designed to address systemic risk on inter-affiliate trades would
create costs without a corresponding benefit, placing substantial
burdens on end-users and consumers and increasing costs to the economy.
H.R. 677 also includes language that ensures bank swap dealers and
major swap participants would not be able to take advantage of the
clearing exemption in the bill that is intended for end-users only. The
House Committee on Agriculture ordered the bill reported by unanimous
voice vote and the House Committee on Financial Services approved the
measure by a vote of 50-10. Last year's version of the bill received
overwhelming bipartisan support when it passed the House on March 26,
2012.
Throughout the legislative and regulatory processes surrounding the
Dodd-Frank Act, the Coalition has advocated for strong regulation that
brings transparency to the derivatives market and imposes thoughtful
new regulatory standards that enhance financial stability while
avoiding needless costs. The Coalition encourages you to support these
bipartisan bills when they are voted on in the U.S. House of
Representatives and ensure that new regulations do not impede
innovation, U.S. competitiveness or job growth.
Sincerely,
Air Products & Chemicals, Inc., Allentown, PA
Ameren Corporation, St. Louis, MO
American Honda Finance Corporation, Torrance, CA
Apache Corporation, Houston, TX
Bayer Corporation, Pittsburgh, PA
Blyth, Inc., Greenwich, CT
BP America Inc., Houston, TX
Business Roundtable, Washington, D.C.
Cargill, Minneapolis, MN
Caterpillar, Inc. Peoria, IL
Daimler North America Corporation, Montvale, NJ
Deere & Company, Moline, IL
DuPont Co., Wilmington, DE
DuPont Fabros Technology, Washington, D.C.
Eaton, Cleveland, OH
Edison Electric Institute, Washington, D.C.
Eli Lilly and Company, Indianapolis, IN
EnerVest, Ltd., Houston, TX
EV Energy Partners, Houston, TX
Exelon Corporation, Chicago, IL
Financial Executives International, Morristown, NJ
FMC Corporation, Philadelphia, PA
Ford Motor Company, Dearborn, MI
GE, Fairfield, CT
General Motors Company, Detroit, MI
Hallmark Cards, Inc., Kansas City, MO
Hardinge Inc., Elmira, NY
HCA, Nashville, TN
Health Care REIT, Toledo, OH
Helen of Troy, L.P., El Paso, TX
Hercules Offshore Inc., Houston, TX
Hersha Hospitality Trust, Harrisburg, PA
Honeywell International, Morristown, NJ
IBM Corporation, Armonk, NY
Independent Petroleum Association of America, Washington, D.C.
Johnson Controls, Inc., Milwaukee, WI
Lockheed Martin Corporation, Bethesda, MD
MAHLE Industries, Incorporated, Farmington Hills, MI
Mars, Incorporated, McLean, VA
McDonald's, Oak Brook, IL
Medtronic, Inc., Minneapolis, MN
Merck, Whitehouse Station, NJ
MillerCoors, Chicago, IL
Motor & Equipment Manufacturers Association, Washington, D.C.
National Association of Corporate Treasurers, Reston, VA
National Association of Manufacturers, Washington, D.C.
National Gypsum Company, Charlotte, NC
Nielsen, Wilton, CT
Peabody Energy, St. Louis, MO
Sealed Air Corporation, Elmwood Park, NJ
Siemens Capital Company LLC, Iselin, NJ
Simon Property Group, Indianapolis, IN
The Boeing Company, Chicago, IL
The Coca-Cola Company, Atlanta, GA
The Dow Chemical Company, Midland, MI
The JBG Companies, Chevy Chase, MD
The Procter & Gamble Company, Cincinnati, OH
Time Warner Inc., New York, NY
U.S. Chamber of Commerce, Washington, D.C.
United Launch Alliance, Centennial, CO
United Technologies Corporation, Hartford, CT
Volvo Group North America, Greensboro, NC
Whirlpool Corporation, Benton Harbor, MI
Zimmer, Inc., Warsaw, IN
______
July 24, 2013
Hon. Frank D. Lucas,
Chairman,
House Committee on Agriculture,
Washington, D.C.
Dear Mr. Chairman:
On behalf of the Investment Company Institute, ICI Global, The ABA
Securities Association, and the American Bankers Association, we
respectfully submit the enclosed statement for the record for the July
24, 2013, hearing of the Committee on the reauthorization of the
Commodity Futures Trading Commission. This statement is in regard to
the need to amend the definition of ``foreign exchange forward'' in the
Commodity Exchange Act to include non-deliverable forwards.
If you or your staff have any questions, please call Karrie
McMillan [Redacted] at the ICI, Dan Waters [Redacted] at ICI Global or
Timothy Keehan [Redacted] at the ABA.
Sincerely,
Karrie McMillan, Dan Waters, Cecelia Calaby, Timothy E.
Keehan,
General Counsel, Managing Executive Vice President
Investment Director, Director and and Senior
Company ICI Global; General Counsel,
Institute; Counsel, American Bankers
ABA Securities Association.
Association;
attachment
July 24, 2013
Statement for the Record for the House Agriculture Committee Hearing on
July 10, 2013, on CFTC Reauthorization
The Investment Company Institute (``ICI''),\1\ ICI Global,\2\ the
American Bankers Association (``ABA''),\3\ and the ABA Securities
Association \4\ appreciate this opportunity to submit this statement
for the record for the July 10, 2013, hearing of the House Agriculture
Committee. We wish to bring to your attention an important issue
concerning the fact that one type of foreign exchange forward--non-
deliverable forwards (``NDFs'')--has not been included in the exemption
for foreign exchange forwards granted by the Secretary of the Treasury
under the Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act''). As a result, NDFs are being subject to
unnecessary and costly regulation, creating problems for both the
providers and users of NDFs. These users include U.S. investors and
businesses, such as exporters of agriculture and agriculture-related
products, engaged in international trade.
---------------------------------------------------------------------------
\1\ The Investment Company Institute is the national association of
U.S. investment companies, including mutual funds, closed-end funds,
exchange-traded funds and unit investment trusts. ICI seeks to
encourage adherence to high ethical standards, promote public
understanding and otherwise advance the interest of funds, their
shareholders, directors and advisers. Members of ICI manage total
assets of $15.3 trillion and serve over 90 million shareholders
\2\ ICI Global is the global association of regulated funds
publicly offered to investors in leading jurisdictions worldwide. ICI
Global seeks to advance the common interests and promote public
understanding of global investment funds, their managers, and
investors. Members of ICI Global manage total assets in excess of U.S.
$1 trillion.
\3\ The American Bankers Association represents banks of all sizes
and charters and is the voice for the nation's $14 trillion banking
industry and its two million employees.
\4\ The ABA Securities Association is a separately chartered
affiliate of the ABA, representing those holding company members of ABA
that are actively engaged in capital markets, investment banking, and
broker-dealer activities.
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The problem arises because of the definition of ``foreign exchange
forward'' found in Section 1a(24) of the CEA (7 U.S.C. 1a(24)). That
definition, as amended by the Dodd-Frank Act, has been interpreted as
excluding NDFs. This differential treatment of NDFs, we strongly
believe, was not intended by Congress.
An NDF is a type of foreign exchange forward that is used when it
is impractical or impossible for one of the currencies involved to be
physically delivered outside the home country of that currency due to
local law or other requirements. Because one of the currencies involved
cannot be physically delivered, NDFs are settled in a single currency--
usually U.S. dollars--in an amount that reflects the movement in the
value of the underlying currencies.
The CEA, as amended by the Dodd-Frank Act, defines a foreign
exchange forward as follows:
The term `foreign exchange forward' means a transaction that
solely involves the exchange of two different currencies on a
specific future date at a fixed rate agreed upon on the
inception of the contract covering the exchange.
The differential treatment has resulted from the following language in
this definition: ``that solely involves the exchange of two different
currencies.'' Both the Treasury and the CFTC staffs have interpreted
this language as excluding NDFs from the CEA definition of foreign
exchange forward. Therefore, when the Treasury, using its authority in
the Dodd-Frank Act, exempted foreign exchange swaps and forwards from
the definition of swap, NDFs were not covered by the exemption.\5\
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\5\ See ``Determination of Foreign Exchange Swaps and Foreign
Exchange Forwards'' under the Commodity Exchange Act (Nov. 16, 2012).
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There is every reason to believe that this result was unintended by
Congress when it defined foreign exchange forward. There is nothing in
the legislative history to indicate that Congress intended to
differentiate NDFs or, in fact, was even aware of the existence of
NDFs, which are a very small, though important, part of the foreign
exchange forward market. Conversations we have had with Congressional
staff have reinforced that view.
There is no valid public policy reason for treating NDFs
differently than other foreign exchange forwards.
NDFs and other foreign exchange forwards are treated as
functional equivalents in the marketplace.
Standard foreign exchange market documents treat NDFs as a
subset of the foreign exchange forward.
There is nothing in the record to show that NDFs present any
material regulatory issues or risks different from other
foreign exchange forwards.
NDFs, like other forwards, functioned smoothly before and
during the financial crisis.
NDFs are used by a variety of end-users and are an important tool
to facilitate trade and investment between the U.S. and developing
market countries. For example, asset managers (operating through mutual
fund structures, private funds, or separately managed accounts)
routinely use NDFs to hedge currency risks in investments in these
countries. Likewise, U.S. businesses of all sizes engaged in trade with
important developing economies such as Brazil, Taiwan, South Korea,
India, and Indonesia use NDFs to limit currency risk in their
businesses. These developing economies can be significant markets for
U.S. agricultural products. Producers of such products often will wish
to lock in prices and avoid currency fluctuations. Therefore, such
producers may use NDFs as the only practical way to hedge currency
risks.
The importance of this matter to a variety of businesses is evident
from comment letters submitted to the Treasury and/or the CFTC
requesting that NDFs, like other foreign exchange forwards, be exempted
from the definition of swap. Among those submitting such letters, in
addition to the Investment Company Institute and the ABA Securities
Association, were the Coalition of Derivatives End-Users and the
Committee on Investment of Employee Benefit Assets.
The inability to include NDFs in the Treasury exemption for foreign
exchange forwards causes a number of problems:
Because the electronic nature of this trading means it can
be moved readily, the jobs and capital associated with NDF
trading may easily be relocated to other jurisdictions that
will not bifurcate the regulation of their foreign exchange
markets or impose unnecessary costs on transacting in NDFs.
Treasury already has determined that regulation of foreign
exchange forwards as swaps is unnecessary and, indeed, counter-
productive. These findings also should be applicable to NDFs.
The additional regulatory costs imposed on NDFs, however, will
increase the costs both for U.S. investors and for U.S.
companies trading in developing countries.
U.S. investors and companies seeking to avoid the extra
costs imposed on NDFs will either choose not to hedge, thereby
increasing their own risk as well as the risk to the U.S.
financial system, or they may take the risk of trading NDFs in
foreign jurisdictions that may lack U.S. regulatory and
judicial protections.
The differential regulatory treatment creates confusion
among market participants and creates legal and operational
difficulties for market participants in complying with CFTC
rules.
It should be noted that including NDFs in the Treasury exemption
would not by any means result in their being unregulated. In
particular, NDFs would be subject to the same rules governing foreign
exchange forwards.
Our associations have recently filed a petition for exemptive
relief with the CFTC. Unfortunately, it is far from certain if and when
the CFTC may consider our petition, and the CFTC has no legal
obligation to consider it. Therefore, we recommend that this issue be
addressed through a legislative clarification of the definition of
foreign exchange forward.
Thank you for the opportunity to provide this recommendation for
your consideration.
______
Submitted Letter by Kenneth E. Auer, President and CEO, Farm Credit
Council
July 24, 2013
Hon. Frank D. Lucas, Hon. Collin C. Peterson,
Chairman, Ranking Minority Member,
House Committee on Agriculture, House Committee on Agriculture,
Washington, D.C.; Washington, D.C.
Re: CFTC Reauthorization
Dear Chairman Lucas and Ranking Member Peterson:
On behalf of its members, the Farm Credit Council appreciates the
opportunity to submit this letter concerning the reauthorization of the
Commodity Futures Trading Commission (``CFTC'').
The Farm Credit Council is the national trade association for the
Farm Credit System, a government instrumentality created ``to
accomplish the objective of improving the income and well-being of
American farmers and ranchers by furnishing sound, adequate, and
constructive credit and closely related services to them, their
cooperatives, and to selected farm-related businesses necessary for
efficient farm operations.'' \1\ Today, the Farm Credit System
comprises four banks and 82 associations, which are cooperatively owned
by their member-borrowers.
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\1\ 12 U.S.C. 2001(a).
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This year's reauthorization of the CFTC comes at an important time,
as that agency continues to implement the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank'') and to address rapidly
evolving market conditions. The Farm Credit Council is interested in
these developments because Farm Credit System institutions rely on the
safe use of derivatives to manage interest rate, liquidity, and balance
sheet risk. The safe use of derivatives allows the Farm Credit System
to offer reliable, low-cost, and flexible funding to the farmers,
ranchers, and rural cooperatives that borrow from, and cooperatively
own, Farm Credit System institutions.
CFTC Cooperative Clearing Exemption
The Farm Credit Council commends the CFTC for a number of measures
that the agency has taken to implement Dodd-Frank in a manner that
mitigates systemic risk and increases transparency, without imposing
burdensome new costs on cooperative financial institutions like the
Farm Credit System.
For example, by a unanimous vote of its Commissioners in July 2012,
the CFTC proposed a rule providing that an ``exempt cooperative,'' such
as a Farm Credit System institution, may elect not to clear swaps used
to hedge or mitigate commercial risk related to loans to its
members.\2\ In support of its proposal, the CFTC explained that
cooperatives exist for the benefit of, and cannot be separated from,
their member owners.\3\ The CFTC recognized that member owners of a
financial entity could elect the end-user exception if acting alone,
but could not do so collectively with other member owners at the level
of a cooperative financial entity with total assets exceeding $10
billion.\4\ To address this issue, the CFTC proposed exemptive relief
for cooperative financial institutions, such as a Farm Credit Bank. In
doing so, the CFTC concluded, among other things, that ``[u]sing the
substantial, finance-focused resources of the cooperative to undertake
hedging activities for the numerous members of the cooperative promotes
greater economic efficiency and lower costs for the members,'' and the
proposed cooperative exemption therefore ``would promote responsible
economic and financial innovation and fair competition.'' \5\
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\2\ See Clearing Exemption for Certain Swaps Entered Into by
Cooperatives, 77 Fed. Reg. 41940 (proposed July 17, 2012).
\3\ See id. at 41943 (``Cooperatives have a member ownership
structure in which the cooperatives exist to serve their member owners
and do not act for their own profit. Furthermore, the member owners of
the cooperative collectively have full control and governance of the
cooperative. In a real sense, the cooperative is not separable from its
member owners.'' (footnote omitted)).
\4\ See id. (``[T]he cooperative members would not benefit from the
end-user exception if they use their cooperative as the preferred
vehicle for hedging commercial risks in the greater financial
marketplace. In light of this, the Commission is exercising its
authority under Section 4(c) of the CEA to propose 39.6(f) and
establish the cooperative exemption.'').
\5\ Id. at 41943-44.
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The Farm Credit Council strongly supports the proposed cooperative
exemption, which has not yet been finalized. Pending the issuance of a
final rule implementing the cooperative exemption, the CFTC's Division
of Clearing and Risk has issued several no-action letters stating that
it will not recommend that the CFTC commence an enforcement action for
failure to clear a credit default swap or an interest rate swap,
provided that certain requirements, which are ``essentially the same''
as the requirements of the proposed cooperative exemption, are
satisfied.\6\ The last-issued no-action relief will expire on August
16, 2013.
---------------------------------------------------------------------------
\6\ CFTC Letter No. 12-36, Re: Time-Limited No-Action Relief from
the Clearing Requirement for Swaps Entered Into By Cooperatives (Nov.
28, 2012), available at http://www.cftc.gov/ucm/groups/public/
@lrlettergeneral/documents/letter/12-36.pdf; CFTC Letter No. 13-24, Re:
Time-Limited No-Action Relief from the Clearing Requirement for Swaps
Entered into by Cooperatives (Jun. 7, 2013), available at http://
www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-
24.pdf; CFTC Letter No. 13-30, Re: Extension of Time-Limited No-Action
Relief from the Clearing Requirement for Swaps Entered into by
Cooperatives (Jun. 21, 2013), available at http://www.cftc.gov/ucm/
groups/public/@lrlettergeneral/documents/letter/13-30.pdf.
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It is important for the CFTC to take action to finalize the
proposed cooperative exemption soon because, under the CFTC's phased
implementation schedule for compliance with the clearing requirement,
Farm Credit System institutions will be required to clear interest rate
swaps when the no-action relief discussed above expires.\7\ As the CFTC
recognized in proposing the cooperative exemption, mandatory clearing
will operate to raise the cost of credit for the cooperative members of
the Farm Credit System--America's farmers, ranchers, and farm-related
businesses--without reducing systemic risk.
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\7\ See Clearing Requirement Determination Under Section 2(h) of
the CEA, 77 Fed. Reg. 74284, 74289 n. 52, 74320 (Dec. 13, 2012) (to be
codified at 17 CFR pts. 39 & 50).
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Application of Margin Requirements to Exempt Cooperatives
The Farm Credit Council also wants to commend the Committee for its
continued leadership on the implementation of Dodd-Frank and issues
facing Farm Credit System institutions. For example, the Committee and
the House of Representatives recently passed H.R. 634, the Business
Risk Mitigation and Price Stabilization Act of 2013. H.R. 634 provides,
among other things, that initial and variation margin requirements
``shall not apply to a swap in which a counterparty qualifies for . . .
an exemption issued under section 4(c)(1) from the requirements of
section 2(h)(1)(A) [the `clearing requirement'] for cooperative
entities as defined in such exemption.'' \8\ The intent of this
provision is clear: Margin requirements should not be imposed on Farm
Credit System institutions, or other qualifying cooperative entities,
with respect to their uncleared swaps.
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\8\ H.R. 634, 113th Cong. 2 (passed the House of Representatives
June 12, 2013).
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The Farm Credit Council strongly supports H.R. 634. The CFTC's
proposed cooperative clearing exemption would spare cooperative
entities, like Farm Credit System institutions, the costs of margin
associated with mandatory clearing. H.R. 634 would similarly spare the
same entities the costs of margin associated with uncleared swaps. Both
proposals reflect the sound policy determination that swaps entered
into by cooperative entities, such as Farm Credit System institutions,
serve important purposes for members of cooperatives and the larger
economy, while presenting minimal risk to the U.S. financial system. If
implemented, both proposals should allow Farm Credit System
institutions to manage risk by negotiating responsible collateral
arrangements directly with their swap counterparties.
Achieving this result depends, however, on the CFTC's final
implementation of its proposed clearing exemption for cooperatives and
on the recognition by regulators that Congress intends that margin
requirements will not be imposed on Farm Credit System institutions. If
implemented, the CFTC's proposed cooperative exemption would be ``an
exemption issued under section 4(c)(1) from the requirements of section
2(h)(1)(A) for cooperative entities'' under H.R. 634. Until the CFTC
finalizes the exemption, however, the Farm Credit System will not
secure the relief that H.R. 634 was intended to provide.\9\
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\9\ The Farm Credit Council also supports H.R. 2136, the Small
Business Credit Availability Act, pending before this Committee. By
excluding a Farm Credit System institution whose aggregate
uncollateralized outward exposure plus aggregate potential outward
exposure does not exceed $1 billion from the definition of ``financial
entity'' in Section 2(h)(7)(C)(ii) of the Commodity Exchange Act, H.R.
2136 would effectively allow Farm Credit System institutions to qualify
for the end-user exception to the clearing requirement, under Section
2(h)(7)(A) of the Commodity Exchange Act, subject to the swap exposure
threshold. If the Farm Credit System institution qualified for the end-
user exception, H.R. 634 would then operate to prohibit margin
requirements from being imposed on uncleared swaps entered into by the
same institution. In conjunction with H.R. 634, H.R. 2136 would make
clear that margin requirements (imposed either by clearinghouses or by
regulators on uncleared swaps) should not apply to Farm Credit System
institutions.
---------------------------------------------------------------------------
If the CFTC finalizes its proposed cooperative exemption and H.R.
634 is enacted, H.R. 634 will prohibit the CFTC and the Prudential
Regulators, including the Farm Credit Administration, from imposing
margin requirements on cooperative entities under Section 4s(e) of the
Commodity Exchange Act. This makes sense. Such requirements would
divert capital otherwise used for loans to farmers, ranchers, and farm-
related businesses into margin payments, diminish the Farm Credit
System's members' access to credit, and ultimately adversely affect the
American economy, especially in rural and agricultural communities. The
Farm Credit Council commends this Committee and the entire House for
recognizing and addressing this important issue.
Notwithstanding that the House of Representatives and the CFTC have
expressed their intent that margin requirements (either associated with
clearing or with respect to uncleared swaps) should not apply to Farm
Credit System institutions, the Farm Credit Administration has
suggested that it has authority--separate from the provisions of the
Commodity Exchange Act added by Dodd-Frank--to impose ``special''
margin requirements on swaps to which a Farm Credit System institution
is a counterparty.\10\ Pursuant to this authority, the Farm Credit
Administration has proposed to require Farm Credit System institutions
to collect initial and variation margin from swap dealer or major swap
participant (``swap entity'') counterparties.\11\
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\10\ See Margin and Capital Requirements for Covered Swap Entities,
76 Fed. Reg. 27564, 27583 (proposed May 11, 2011) (to be codified at 12
CFR pt. 624).
\11\ Id. at 27595 (proposed 12 CFR 624.11).
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The Farm Credit Administration's proposal would frustrate the clear
intent of H.R. 634 and the CFTC's proposed cooperative exemption. The
requirement to collect margin from swap entity counterparties will, no
doubt, increase the costs of uncleared swaps. It will likely further
result in swap entities requiring reciprocal margin obligations from
Farm Credit System institutions. This result would undo the very relief
that would be provided by the CFTC's proposed cooperative exemption and
H.R. 634. The Farm Credit Council believes that this would be contrary
to the intent of this legislation and the principal regulator charged
with implementing new derivatives regulation.
* * * * *
The Farm Credit Council appreciates the opportunity to submit this
letter concerning the reauthorization of the CFTC, and thanks the
Committee for its continued leadership on these important matters.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Kenneth E. Auer,
President and CEO,
Farm Credit Council.
______
Submitted Questions
Response from Scott Cordes, President, CHS Hedging, Inc.; on behalf of
National Council of Farmer Cooperatives
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question 1. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Answer. It would have been helpful to have such a timetable, but
more importantly to have a process that sequenced the rules in a
logical fashion. Knowing what rules would apply to our company and
counterparties earlier in the process would have allowed us to focus
more clearly on preparing for implementation. For instance, as rules
were being proposed and finalized that would apply to swap dealers, it
was still unclear as to what transactions, and at what level, would
determine who would be regulated as swap dealers. The uncertainty from
that put business plans on hold and customers held back on their risk
management trading given the uncertainty.
Question 2. Your testimony notes concerns over market liquidity in
the over-the-counter derivatives market for hedgers. To date, have you
seen or experienced any evidence of a lack of liquidity available to
hedge against risks? What is your plan in the future if you find fewer
counterparties to hedge your company's risks?
Answer. Due, in part, to the uncertainly over the regulations,
we've experienced a general decline of trading in swaps over the past
three years. In the future, if swaps are not a viable risk management
option, we would rely on the futures market. However, to the extent the
futures market did not fit a specific hedging need (or a situation as
outlined in the next response exists), we would be forced to increase
our risk exposure, or limit certain business activities.
Question 3. In your testimony, you state that when a farmer goes to
lock in a price for his future production of grain or milk by entering
into a forward contract, someone has to offset that risk in the futures
market, or potentially with a swap. Obviously, no one would be willing
to be exposed without hedging their counterparty risk. Can you describe
what type of financial resources it takes for a local grain elevator to
hedge its future purchase obligations in the futures market, and how
have the use of swaps helped ease the financial burdens of hedging
risks?
Answer. In recent years, a considerable amount of working capital
has been tied up to cover daily margin calls as a result of increased
volatility in grain and oilseed markets. For example, an elevator that
handles five million bushels of corn in a year may enter into 2,000
contracts to hedge those purchases. That elevator may have roughly 200
contracts outstanding at any one time. With initial margin of $2,400
per contract, $480,000 is required up front. Should the market have a
limit up move (40 /bushel) on a given day, an additional $400,000 is
needed to cover that hedge. However, most cooperatives operate a number
of elevators, not just one, so those financial requirements can
increase significantly. And the need for such resources to hedge
purchases, particularly during times of market volatility, can put a
significant strain on working capital.
Thus, for farmers to continue to take advantage of selling grain
forward during price rallies, many cooperatives have to either increase
borrowing or look for alternative ways to manage such risk. Using the
OTC market has become that alternative because commodity swaps are not
currently subject to the same margin requirements as contracts on the
exchanges. For example, in 2008 many grain companies were running out
of working capital due to extreme volatility in grain prices and
stopped forward contracting with farmers. CHS was able to enter into
swaps to free up working capital so that it could continue to contract
and forward price grain with its members. Today, we continue to use
swaps to free up working capital so that we can employ it in other
areas of our business.
Response from Lance Kotschwar, Senior Compliance Attorney, Gavilon
Group, LLC; on behalf of Commodity Markets Council
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question 1. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Answer. Yes, that certainly would have been helpful. The haphazard
finalization of these complex and interconnected rules has created
extensive confusion for companies that are attempting to comply with a
new regulatory regime. Couple the lack of any organized approach with
the flurry of last minute no-action and exemptive relief letters that
are constantly changing compliance dates and it is nearly impossible to
feel comfortable that all regulatory obligations are being met.
Question 2. Do you think the exchanges do a sufficient job of
setting and policing position limits in the energy markets? Are there
potential consequences to shutting investment dollars out of the
derivatives markets?
Answer. Yes, the exchanges have done a great job in not only
setting appropriate limits, but also implementing and policing them in
a sensible way, including how affiliated companies must aggregate
positions for compliance with the limits. As for the appropriateness
and/or effectiveness of position limits themselves and the notion of
placing limits on a class of traders, the government cannot stop
investor demand for physical commodity exposure. If regulators were to
limit, for example, an exchange traded fund backed by crude oil
derivatives in those markets, there is nothing to stop them from
investing in the underlying physical commodity itself, in this case
crude oil. These types of entities not only allow these physical market
investments under their prospectuses, but at times they have shown
interest in leasing or even owning storage capacity. This is one of
many factors that must be considered when arbitrarily limiting trading
activity.
Question 3. If the CFTC significantly narrows the scope of the bona
fide hedging exemption from position limits to allow, for example, only
positions that would be eligible for hedge accounting treatment to
qualify as a bona fide hedges, how would that impact your business?
Answer. It would be detrimental. As a commodity merchant, Gavilon
plays an important role in the physical commodity markets. Most
agricultural commodities are produced seasonally yet consumed
continuously, whereas energy commodities are produced continuously and
consumed seasonally. CMC's members manage that flow of physical
commodity and dynamically hedge it, which allows us to offer higher
prices to producers and lower prices to consumers. We look at our net
exposure to a particular commodity as a combination of physical,
futures, and swap positions, and we hedge based on that net exposure.
No one in our business ties a particular derivatives contract to a
particular bushel of grain or barrel of oil. We are also hedging our
infrastructure. We have empty grain bins that we know we will fill,
empty, and refill again. The same is true for oil storage tanks. We are
constantly looking for a better hedge, a better price, which is why
these markets are as efficient as they are and we are able to offer the
favorable forward contracts to farmers that we do. If this dynamic,
portfolio hedging ability is limited, the result is quite simple: lower
prices for producers and higher prices for consumers.
Question 4. It is my understanding that the CFTC already has access
to your physical positions when you are using a hedge exemption from a
position limit. Why then, did the Commission finalize a rule that would
require you to track those positions on a daily basis rather than the
current monthly requirement?
Answer. The Commission has the authority to ask us for cash market
data any time they want it. For an international commodity merchant
moving grain 24 hours a day, this is an impossible task to achieve on a
daily basis. If the Commission has questions or concerns with a
commercial company's ability to justify a hedge exemption, all they
have to do is ask for more information and they will get it. Daily
physical position reporting would be an enormous waste of resources for
commercial end-users, if compliance is even possible at all. Equally as
important, it is more data than the Commission can process while
providing little regulatory gain, and therefore a waste of resources
for them as well.
Response from Richard F. McMahon, Jr., Vice President of Energy Supply
and Finance, Edison Electric Institute
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question 1. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Answer. Yes--certainty in the process with a realistic timetable
for implementation would have helped EEI members during the rulemaking
and implementation process as EEI members enter into long-term
commodity contracts, and regulatory certainty is needed. The rulemaking
process used by the Commission did not provide certainty as to process
or outcome. For example, key terms, such as the definition of swap,
were not defined until the end of the rulemaking process. Starting with
definitions and then moving on to other issues would have allowed EEI
members to focus on the issues impacting commercial end-users rather
than focusing on all the issues at once.
Additionally, a defined rulemaking and rehearing process would have
promoted certainty in the process. Instead, EEI members were forced to
rely on Interim Rules and last-minute no-action letters, further
increasing uncertainty and costs. Unfortunately, there is still lack of
certainty to the process, and EEI members do not know if or when the
Commission will respond to comments submitted on interim final rules.
For example, EEI members began reporting swap transactions to the
Commission on August 19 but, from July 2010 to the present, have spent
on average over $1 million per company on hardware, software and
consulting costs to implement the Commission's recordkeeping and
reporting rules. Uncertainty still persists as to some of the
requirements, and different swap data repositories require different
information to be provided so it is likely that EEI members will
continue to make system changes going forward, leading to additional
costs.
Question 2. How have your members been impacted by the CFTC
deciding to regulate forward contracts with imbedded ``volumetric
optionality'' as swaps? What are the future consequences of this
regulatory over-reach if the CFTC does not change its regulations?
Answer. Any uncertainty in definitions and implementation increases
transaction costs for members and ultimately for consumers. In response
to the Commission request for comment on the seven-factor test for
imbedded volumetric optionality, EEI and others commented that the test
was unclear and requested changes. Although the Commission stated that
it ``would benefit from public comment about [this] interpretation,''
to date, the CFTC has not responded to our members' comments. The
Commission's interpretation is overly narrow, difficult to understand
and potentially classifies numerous common types of physical forward
transactions as swaps or trade options. The CFTC's interpretation may
result in EEI members modifying the structure of some forward contracts
with volumetric variability or flexibility in ways that are less
efficient, increase transaction costs and/or create additional risk.
In addition, due to the lack of clarity in the application of the
test, there is uncertainty concerning the status of many transactions
with volumetric optionality. It is possible that, under the test,
counterparties to a transaction will view the same transaction
differently, with some viewing it as a forward, some as a trade option
and some as a swap. These differences all affect recordkeeping,
reporting and other requirements. The cleanest solution would be for
the Commission to recognize congressional intent and classify these
transactions as exempt forwards because the transaction involves the
sale of a non-financial commodity for deferred delivery that is
intended to be physically settled. At a minimum, the Commission should
provide clarification as requested in the filed comments as any
uncertainty increases costs and decreases the likelihood of end-users
entering into those transactions.
Question 3. It appears as though the CFTC, because of the way they
defined ``swap'', may actually end up subjecting physical forward
contracts to position limits. What kind of consequences would this have
for your members?
Answer. The Commission's vacated Position Limits rule established
28 referenced contracts--four of which were energy contracts, including
NYMEX Henry Hub contracts--for position limits. The Dodd-Frank Act
requires the CFTC to exempt bona fide hedging transactions and
positions from all position limits. The Commission narrowly defined
bona fide hedging transactions to eight enumerated transactions unless
the CFTC gave specific approval to a particular form of transaction.
The bona fide hedge exemption from position limits is necessary to
allow end-users of physical commodities to properly hedge their
commercial risk. However, we fear that the CFTC's limitation of bona
fide hedges to enumerated transaction types is overly limiting and runs
counter to Congressional intent to exempt the hedging transactions of
commercial end-users. A narrow or formula-based definition of what
constitutes bona fide hedging will place significant limitations on
many end-users' ability to hedge risk properly and efficiently.
Further, the Commission's definition of ``swap'' would subject some
types of physical transactions to position limits, including physical
forward transactions with volumetric optionality and physical commodity
options. Examples that are particularly troubling are power
transactions with volumetric optionality or power transactions
structured ``heat rate call options'' that are priced using a formula
that references NYMEX Henry Hub natural gas prices. These transactions
are for the physical delivery of electricity and the pricing formula
based upon natural gas prices acts as an embedded hedge to help ensure
that electric utilities can meet their variable power needs at
reasonable prices. These transactions are not for the purpose of
speculating on commodity prices and are not even natural gas
transactions; but, since they reference NYMEX Henry Hub natural gas
prices, these physical power transactions would be subject to natural
gas position limits. Physical transactions with embedded volumetric
optionality and physical commodity options should not be subject to
position limits.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress
from California
Question. Some have suggested that the way to ``fix'' the special
entity sub-threshold is for the CFTC to lower the de minimis
registration threshold for the entire energy swaps marketplace to $25
million. What damage would be done to end-users, consumers, and the
marketplace by lowering the registration threshold for all energy swaps
to $25 million?
Answer. The likely end effect of lowering the threshold for all
participants to $25 million would either be that (1) almost all users
of swaps would be classified as swaps dealers, which would subject
commercial end-users in the energy industry to bank-like regulation,
including onerous capital and margin requirements, the inability to use
the end-user clearing exception, and costly and burdensome
recordkeeping and reporting requirements, or (2) entities would be
forced to hedge only with banks or through physical forward
transactions, which will expose hedgers to more risk and higher
transaction costs. The end result of either option will be increased
rates for customers. The Commission's rule states that an entity's swap
dealing activity over the prior 12 months is capped at a gross notional
value of $8 billion. An entity's aggregate effective notional amount of
swap dealing reflects both the gross volume of swap activity that the
entity engages in, and the relative monetary value of that activity,
which reflects the volatile and non-fixed nature of the commodity
price. This is different from the notional amount of a swap referencing
a financial index (e.g., an interest rate swap) which is a set notional
amount irrespective of whether the swap is 1 month or 20 years. Thus, a
single relatively small swap contract could exceed the threshold amount
of $25 million notional value. For example, a single 3 year 50 MW swap
or a single 3 year 10,000 mmBtu/day swap would likely have a gross
notional value well in excess of $25 million, based on projected prices
from the PJM Interconnection, LLC, and Henry Hub. As a result, if the
de minimis level is reduced to $25 million, one transaction could cause
an EEI member to be classified as a swap dealer and subject to
additional registration, capital & margin and reporting requirements.
The volatility of commodity costs and the large amount of the
transactions in the energy markets necessitates a higher de minimis
level to accommodate the volatility in commodity prices and the need to
accommodate customer usage levels. For these reasons, lowering the de
minimis registration threshold for the entire energy swaps marketplace
to $25 million would undermine Congressional intent to exempt
commercial end-users from the burdensome requirements placed on swap
dealers, resulting in higher costs of hedging and increased volatility
for electric utilities and our customers.
Response from Chris Monroe, Treasurer, Southwest Airlines Co.
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question 1. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Answer. Yes. A published implementation timetable that had been
adhered to would have helped our businesses, as well as the Commission,
allocate time and resources by focusing on regulatory matters in order
of their consideration. Additionally we believe that certainty in
timing likely would have reduced market participants' expenses
associated with preparation for compliance.
Question 2. What can Congress do to prevent the prudential banking
regulators from implementing rules to require commercial end-users to
post margin while prohibiting the use of non-cash collateral as margin?
Does H.R. 634 provide the appropriate relief?
Answer. H.R. 634 provides an exemption for end-users from posting
margin on uncleared trades and would satisfy Southwest's need for
relief in terms of margin. It is important to Southwest and other end-
users that any margin that is required to be posted be allowed in the
form of non-cash collateral, which would allow commercial end-users to
post as margin the assets that they most frequently hold. Use of non-
cash assets as collateral allows end-users to have much more dynamic
hedging programs. Southwest takes hedging very seriously not only
because it is the responsible thing to do given the significant use of
fuel in our business, but because it is a direct contributor to lower
costs for our company. Hedging has been a good story for Southwest.
Lower costs paid for a commodity our company must have in order to
operate has generally led to healthier, more predictable business, and
most importantly, lower fares for our customers.
Response from Gene A. Guilford, National & Regional Policy Counsel,
Connecticut Energy Marketers Association; on behalf of
Commodity Markets Oversight Coalition *
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* There was no response from the witness by the time this hearing
went to press.
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Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Response from Andrew K. Soto, Senior Managing Counsel, Regulatory
Affairs, American Gas Association
August 28, 2013
Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management,
Committee on Agriculture,
Washington, D.C.
RE: The Future of the CFTC: End-User Perspectives--Supplemental
Questions for the Record
Dear Chairman Conaway:
On behalf of the American Gas Association (AGA), I am pleased to
submit the following responses to the supplemental questions for the
record regarding my testimony given during the July 24, 2013 public
hearing of the Subcommittee on General Farm Commodities and Risk
Management on The Future of the CFTC: End-User Perspectives.
Questions Submitted By Hon. K. Michael Conaway, a Representative in
Congress from Texas
Question 1. If the CFTC had published a Dodd-Frank implementation
timetable and followed it, would that have helped your businesses to
plan for potential changes in the regulation of the derivatives
markets?
Answer. Yes. As I noted in my testimony, AGA has worked
cooperatively with the Commodity Futures Trading Commission (CFTC) and
its staff throughout the rulemaking process to implement the Dodd-Frank
Wall Street Reform and Consumer Protection Act. We appreciate the
magnitude and difficulty of the task that faced the CFTC following
passage of the Act. Nonetheless, if the CFTC had published an
implementation timetable and followed it, it would have benefitted the
compliance planning efforts of large end-users such as AGA's member gas
distribution utilities. In addition, a better sequencing of the CFTC's
rulemakings would have also been beneficial for compliance planning.
For example, in our June 3, 2011 comment letter to the CFTC, AGA argued
that any sequencing of the final rules must begin with the foundational
definitions of ``swap,'' ``swap dealer,'' and ``major swap
participant.'' AGA noted in that letter that industry participants need
to understand whether and to what extent their activities would be
regulated before they can assess how those activities should be
regulated. AGA also noted that industry participants need to understand
whether their activities would be regulated by the CFTC or the Federal
Energy Regulatory Commission, and urged the CFTC to complete the
negotiation of the Congressionally mandated Memorandum of Understanding
with the FERC defining the respective jurisdictions of both agencies.
As it turned out, the CFTC has only issued an interim final rule
defining ``swap'' near the end of rulemaking process, and comments
regarding the definition remain unanswered. Moreover, the CFTC has yet
to complete negotiations with the FERC regarding jurisdiction.
Apart from an implementation timetable, business planning requires
definitive rules clearly setting out the compliance obligations of
industry participants. AGA believes that the CFTC's rulemaking process
needs to be strengthened to provide better avenues for the public to
obtain timely, definitive guidance from the Commission in the form of
final agency action on the regulatory obligations implementing the
Dodd-Frank Act. In particular, the public should have a meaningful
opportunity to comment on the agency's proposals, and the agency should
consider all relevant comments in fashioning final rules that are well-
reasoned and supported by the record--not interim final rules, and not
promises to consider issues later which have led to indefinite
postponements. We are simply asking the agency to adhere to the
fundamental requirements of the Administrative Procedure Act.
Question 2. Can you explain why large, end-users such as gas
utilities, are having a hard time complying with the CFTC's new rules?
Why is the ``end-user'' exemption from clearing not enough?
Answer. Large end-users such as AGA's member gas utilities are
certainly used to regulation. As public utility companies, many aspects
of their businesses are subject to a variety of regulatory regimes at
both the state and federal level. The rates they charge for service are
regulated at the state level by a public utility commission or other
regulatory body, and their participation in the wholesale natural gas
markets is regulated by the Federal Energy Regulatory Commission. As a
result, gas utilities work hard to develop business operations and
systems to ensure compliance with all applicable Federal, state and
local regulations and take these compliance measures very seriously.
Compliance, however, requires certainty. Companies need clear and
definitive rules in order to understand their compliance obligations
and develop plans to meet those obligations. That certainty has been
lacking with regard to many of the CFTC's regulations implementing the
Dodd-Frank Act.
The area of uncertainty that has had the most material impact on
AGA members relates to the CFTC's rulemaking defining ``swap.'' Gas
utilities are currently entering into what have been traditionally
considered to be normal commercial merchandising transactions to
procure natural gas supplies to meet the peak winter time needs of
their customers. AGA believes that these transactions are excluded from
the CFTC's definition of a ``swap'' and thus not subject to regulation.
As I noted during the hearing, however, there is tremendous
disagreement in the industry as to how these contracts, all of which
are settled by physical delivery of a commodity, should be treated,
which has disrupted normal contracting practices. Instead of providing
clarity for any contract that is intended to settle via physical
delivery, the CFTC's rules require market participants to apply
subjective and difficult to understand multi-part tests to these
transactions to determine whether they fall under the CFTC's definition
of a ``swap.'' Until the CFTC provides definitive rules clarifying the
regulatory treatment of these physical commodity transactions, the
turmoil in the industry will continue. Furthermore, the differing
interpretations and understandings of the CFTC's ``swap'' definition
will continue to lead to inconsistent reporting of swap transactions to
swap data repositories and to the CFTC, thus making the CFTC a less
effective market monitor and regulator.
The end-user exemption does indeed lessen the overall financial
burden, but it does not broadly exempt end-users from the CFTC's
regulation of the swaps markets. It only applies to the requirement to
clear swaps on an exchange or other trading platform. Even as to
uncleared swaps, there are still outstanding rulemakings by the CFTC
and banking regulators as to the requirement to post margin or retain
capital for such transactions. Thus, the end-user exemption is fairly
narrow.
Further, end-users such as gas utilities are subject to the same
recordkeeping and reporting requirements associated with their swap
transactions that are not cleared. End-users are reporting or preparing
to report uncleared commodity swaps and physical commodity transactions
that might be considered ``swaps'' under the CFTC's interim final rule
to swap data repositories. End-users are making significant resource
investments to properly capture and report their swap transaction data,
and paying monthly fees to the swap data repositories to ensure that
their transactions are accurately reported. Even where end-users are
not designated as ``reporting parties'' under the CFTC's rules, they
are required to confirm and verify the uncleared swap transaction data
that is reported on their behalf. Thus, gas utilities must not only
come to an agreement with their counterparties on what is a reportable
transaction, they must also verify and confirm that the swap
transaction data that is reported accurately records the economic terms
of the transactions. It is in this area that gas utilities and their
counterparties are trying to sort out their compliance obligations, and
the area in which current industry confusion and disagreement are
having the greatest impact.
Question 3. What kind of internal processes surrounding
roundtables, ``no action'' letters, and staff guidance would you like
the CFTC to develop to improve their function as a major market
regulator?
Answer. As noted above, AGA believes that the CFTC's rulemaking
process needs to be strengthened to provide better avenues for the
public to obtain timely, definitive guidance from the Commission in the
form of final agency action on the regulatory obligations implementing
the Dodd-Frank Act. While the CFTC's current regulations provide an
opportunity to petition for a rule or modification of a rule (CFTC Rule
13.2), under the regulations there is no obligation on the part of the
agency to act on such a petition, nor to act within a particular period
of time. AGA recommends that the CFTC consider a commitment to act on
petitions for rulemaking or on comments filed in on-going rulemaking
proceedings within a particular period of time. AGA believes that
having a defined, workable process for obtaining agency guidance in the
form of clear, final rules will lessen the need for the industry to
seek exemptive, or ``no-action'' relief from staff in order to obtain
the necessary clarifications of the CFTC's rules.
Further, in April 2013, AGA joined CFTC Commissioner Bart Chilton
in encouraging the CFTC to develop an End-User Bill of Rights, focused
on providing reasonable and timely implementation of the Dodd-Frank Act
as applied to end-users. In particular, Commissioner Chilton called for
the CFTC to create a venue for end-users to air their concerns, to hold
regular meetings with end-users, and perhaps establish an End-User
Advisory Committee. AGA would support all of these proposals. In
particular, AGA would like to see the CFTC host public roundtables
focused on implementation challenges for end-users in the energy
industry, providing sufficient public notice (at least 30 days) in
order to give the public an opportunity to participate. The CFTC could
use its authority in section 751 of the Dodd-Frank Act, to have the
Energy and Environmental Markets Advisory Committee examine end-user
issues. Alternatively, the CFTC could charter a standing committee
under the Federal Advisory Committee Act. In addition, AGA would like
the CFTC to provide public notice on its website or through press
releases, that a specific division of CFTC staff intends to answer, or
not answer, requests for no-action relief, interpretative guidance or
exemptive relief requested by market participants. Currently, market
participants are unable to track what public filings seeking relief
have been received by various divisions within the agency, whether and
when the agency intends to respond to these filings, and which division
plans to respond.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress
from California
Question. Some have suggested that the way to ``fix'' the special
entity sub-threshold is for the CFTC to lower the de minimis
registration threshold for the entire energy swaps marketplace to $25
million. What damage would be done to end-users, consumers, and the
marketplace by lowering the registration threshold for all energy swaps
to $25 million?
Answer. On June 7, 2013, AGA joined several other energy trade
associations in urging CFTC Chairman Gensler not to lower the de
minimis registration threshold for swap dealers. The associations noted
that because swap dealers are subject to costly regulatory
requirements, lowering the de minimis threshold would subject more
market participants to such requirements and thus increase the costs
associated with using swaps to hedge and mitigate commercial risk. For
gas utilities, such cost increases must be borne by the customer, or
the customer is left exposed to greater price volatility if the gas
utility chooses to forego entering into swaps to hedge risk. More
significantly, subjecting additional market participants to the swap
dealer requirements may result in a reduction in the number of market
participants willing to engage in swap dealing activity. Fewer swap
dealers may result in decreased competition, leading to higher costs
and/or less efficient hedging products, and potentially a greater
concentration of swap transactions in systemically risky financial
institutions. Increased transaction costs, decreased competition, and
less liquidity can all result in consumers paying more.
Respectfully submitted,
Andrew K. Soto,
Senior Managing Counsel, Regulatory Affairs,
American Gas Association.