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Hearing Of The Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises Of The House Financial Services Committee; Subject: The Effective Regulation Of The Over-The-Counter Derivatives Markets Chaired By Representative Paul E. Kanj

Hearing Of The Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises of the House Financial Services Committee. Subject: The Effective Regulation Of The Over-The-Counter Derivatives Markets. Chaired by: Representative Paul E. Kanjorski. Witness Panel I: Donald Fewer, Chief Executive Officer, Standard Credit Group; Robert Pickel, Chief Executive Officer, International Swaps And Derivatives Association, INC; Timothy J. Murphy, Foreign Currency Risk Manager, 3M; Don Thompson, Managing Director and Associate General Counsel, JPMorgan Chase and Co.; Christopher Ferreri, Managing Director, ICAP; Christian A, Johnson, Professor, U. Of Utah School Of Law; Panel II: Thomas Callahan, Chief Executive Officer, NYSE LIFFE; Terrence A. Duffy, Executive Chairman, CME Group INC; Christopher Edmonds, Chief Executive Officer, International Derivatives Clearing Group, LLC; Jeffery Sprecher, Chief Executive Officer, Intercontinentalexchange INC; Larry E. Thompson, Managing Director And General Counsel, Depository Trust And Clearing Corporation

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REP. KANJORSKI: (Sounds gavel.) This hearing of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises will come to order. Pursuant to committee rules each side will have 15 minutes for opening statements. Without objection, all members' opening statements will be made a part of the record.

I want to recognize and welcome Ms. Waters, a member of the full committee participating in today's subcommittee hearings, and I ask unanimous consent that Mr. McMahon be allowed to participate in today's hearing. Without objection, so ordered.

Today, we meet to consider another area of our capital markets woefully lacking in effective regulatory oversight over-the-counter derivatives. Within less than three decades, over-the-counter derivatives have become a staggering $500 trillion market, in notional value. This market also has the potential to cause considerable harm.

Last year, AIG infamously came crashing down because its lightly regulated financial products unit engaged in credit default swaps in the over-the-counter markets without holding sufficient capital to hedge the risks. Since at least 1994, I have advocated for increased regulation of our derivatives markets.

That year, I helped introduce the Derivatives Safety and Soundness Supervision Act, which sought to enhance the supervision of derivatives activities of financial institutions. In the years since then, I have backed other bills, aimed at improving transparency in and enhancing the oversight of our derivative markets.

While it has taken longer than I would have liked, I am pleased that we are now finally beginning to approach a consensus on these matters. The ongoing financial crisis has made it apparent to nearly everyone that we must move the over-the-counter derivatives market from one that takes place under the table to one that happens out in the open.

In short, the time for common-sense regulation of this vast industry has arrived. In a letter to Congress last month, the Treasury secretary outlined his regulatory proposals for increasing transparency and efficiency in the derivatives markets, reducing risk in the overall financial system, and preventing market manipulation.

I look forward to seeing the administration's legislative language fleshing out its general principles in the very near future. While the Agriculture Committee has shown considerable interest in this field, it is also important that our panel educate itself and act on these matters. The administration's outline recognizes this reality.

Together, I believe that both committees can take action to implement the broad concepts contained in the Treasury secretary's plan. Moreover, we ought to move swiftly, yet deliberately, on these matters in order to improve flagging investor confidence. As we move forward, we should remember that derivatives contracts are highly varied.

Importantly, certain derivatives take the form of customized contracts that non-financial businesses employ to manage risk. By most estimates, more than 90 percent of Fortune 500 companies use over-the-counter derivatives, as do thousands of smaller businesses.

Clearly, some of these customized contracts cannot easily fit within a mandatory clearing or exchange trading regime. We therefore must find a delicate balance. Subjecting all contracts to mandatory exchange trading may cast too wide a net.

Yet, the clearing of most products, not all, through a central clearing entity seems appropriate and should not impose an undue burden on the affected parties. However, carving out too many exceptions -- exemptions as we tackle regulatory reform could create widespread economic harm in the long term.

At the same time, we cannot avoid the realization that products with unique features may require different treatment under whatever regulatory structure becomes adopted. At this point, I believe that the standardization of contracts, where possible, will produce smoother clearing.

And clearing both opens a window through which regulators and market participants can keep a closer eye on the dark corner of the market and reduces the risks posed through the contracts collectively. The debate about the extent to which clearing becomes required is of particular importance today.

Even where clearing of contracts proves unfeasible, transparency can still exist. By mandating the collection of relevant data in a repository, we can help to ensure that regulators maintain access to useful trading information and perhaps detect warning signs of systemically risky transactions.

Electronic trading also increases transparency. Further, electronic execution streamlines trading, minimizes mistakes, and enhances monitoring of the over-the-counter derivatives markets. In sum, we have assembled a number of parties interested in and affected by the actions Congress will take in the months ahead.

As we consider legislation to regulate in this field, their testimony can help guide us toward achieving the appropriate balance as we impose a series -- a sense of order in what until now has truly been the Wild West of the financial services world.

I would like to recognize the ranking member Mr. Garrett for four minutes, for his opening statements.

Mr. Garrett.

REP. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman, and good morning to all the witnesses. Today's hearing is called "The Effective Regulation of the Over-the-Counter Derivatives Markets."

And I think that's important to keep in mind that it is not called the most politically correct sounding regulation of derivatives, nor is it called, let's regulate the heck out of the derivatives market because they've been demonized, and let's ignore all the positive contributions they made to our capital markets under proper management.

Unfortunately, but some of the regulatory proposals that have come forward in this area, you might think that that is the approach that's going to be taken. You know, here's the facts, 95 -- 94 percent of the 500 largest global companies use derivatives to manage risk.

Congress, therefore, needs to tread carefully as it looks at regulatory options for these markets. Overly regulated or improper regulations that might sound good politically could have major unintended negative consequences, not just for our financial markets, but our broader economy as well.

Rather than reducing risk, poor regulatory reform could actually exacerbate it. But before we go any further, it's very important to remember that derivatives did not cause our financial difficulties. In fact, they should be seen more as a symptom of the underlying crisis, rather than a reason for it.

So while our overall financial service regulatory structure can be improved, it's important to preserve and protect the important benefits that they provide. Derivatives products provide firms with the ability to minimize risk, this obviously benefits individual firms, but also benefits the broader market as well.

For example, as members of Congress consider reform proposals, we must not be overwhelmed by the fact that one high profile financial institution, AIG, made a bad investment decision. We must also keep in mind that this occurred while AIG was under the supervision of its regulator, the Office of Thrift Supervision, and was part of broader regulations as well.

So greater expertise then in some cases is clearly required at the functional regulator level for the derivative dealers, but AIG-FP was, as you know, a regulated entity. And the AIG case is a reminder that regulatory failure contributed to our financial crisis as much as anything else did.

Furthermore, the vast majority of exposures in the CDS market, for instance, is contained within the already overly-regulated banking sector. Arguably, everything in place already for regulators to appropriately regulate the bulk of this market and it's dominated by a small number of dealers.

Regulators then already have oversight responsibilities to ensure firms are taking appropriate risks to set proper capital levels. So the power is there; regulators just need to do their jobs. Now, when there has been credit events and there have been a number of them with Lehman failure being the most significant.

In each case, the event has been handled in a very orderly fashion by the existing infrastructure. Now, as I look at some of the particular regulatory ideas that have been put forward, I am persuaded that a central counterparties and clearinghouse hold promise, but I am hesitant to say that as far as they go that they should be mandatory for all standardized products.

You know, the private sector has made significant progress in a relatively short period of time towards providing multiple clearinghouses for various derivative products. And I think we should look at this further. Inappropriate mandating of central clearinghouses will limit that ability to go further and manage risk.

Another area, I'd like to look at is proposal to so-called naked swaps, it's concerning to me. It's important that legislators understand that significant negative consequences will arise if such a proposal was actually enacted.

So the participants and infrastructure providers in the OTC markets have accomplished much in recent years to provide stability from the ISDA master agreement to the recent so-called Big Bang Protocol, to ongoing efforts to provide a more robust infrastructure for these products.

So in conclusion, I look forward to a continued progress being made in regards to greater coordination between the sell-side and the buy-side participants as private sector's efforts progress to increase efficiency and transparency and reduce the risk in the OTC derivative business.

Finally, if Congress pushes forward with further regulation in these markets, we need to guard against unnecessary, overly burdensome regulations that might cause the markets to move, move elsewhere overseas or would hinder or prohibit firms from providing themselves with the superior risk management techniques that are so widely employed today and that could be enhanced by future innovations.

Thank you, Mr. Chairman.

REP. KANJORSKI: Thank you, Ranking Member Garrett.

We now have three minutes for the gentleman from New York, Mr. Ackerman.

REP. GARY L. ACKERMAN (D-NY): Thank you, Mr. Chairman.

Today's hearing is meant to focus on proposals for regulating over-the-counter derivative products such as credit default swap, but in this economy with this market and with our current fractured regulatory regime, we've been naive to consider proposals for regulating and clearing OTC products without also establishing a regulator to protect our markets against systemic risk.

During previous hearings held by both this subcommittee and the full Financial Services Committee, several of our witnesses and a number of our colleagues remarked that systemic risk is a lot like pornography in that while difficult to define, you know it when you see it.

In my view, of the two, systemic risk is actually the more difficult to identify. At least with pornography you have a general idea of what it is you are looking for -- I don't know what that means, somebody wrote that for me.


If we could step into our time-machines and go back in-time before the near collapse of AIG, I have little doubt that would -- we would have near unanimous support for regulating credit default swaps. But of course, we can't go back in time, we can't stop AIG from over- extending itself and the next crisis will not stem from AIG's credit default swap portfolio.

Our financial regulatory structure is like a tattered quilt made up of dozens of patches each representing a state and federal supervisor, agencies, some patches overlapping and we now know some areas completely bare.

Preventing the next crisis will require more than simply sewing yet another patch onto the quilt.

Regardless of how meritorious the proposals to regulate and clear OTC derivatives may be, we need a regulator with the ability to see the complete picture, not just the OTC derivatives market, not just the exchanges, not just the banking system, but all of it.

We need a regulator who has the ability to see trends in the (OCT ?) derivative markets that independently might not be worrisome, but when paired with information pertaining to the reserves of our banks could be cause for concern.

And we need the regulator to have the ability to act appropriately and expeditiously to address systemic risk. So in my view merely granting the FTC or the CFTC the authority to regulate and to clear OTC products is nearsighted and inadequate.

If we are to learn from this financial product -- crisis, any legislation that seeks to regulate OTC products must be paired with a systemic risk regulator.

I thank you and yield back the balance of my time.

REP. KANJORSKI: Thank you very much, Mr. Ackerman.

We'll now hear from the ranking member of the committee, Mr. Spencer Bachus for three minutes.

REP. SPENCER BACHUS (R-AL): Thank you, Mr. Chairman. Mr. Chairman, I'd like to associate myself with the remarks by the subcommittee chair. Derivatives do help companies manage risk and I think they are a very valuable thing. Of course, the derivative market is valued notionally at $684 trillion, which is a tremendous amount.

And the rapid growth of this market coupled with the potential for widespread credit default -- credit defaults and operational problems in the over-the-counter market had led many to conclude that derivatives pose a substantial systemic risk. And that -- therefore, the Treasury released a comprehensive framework for over-the-counter derivatives.

In that they call for financial derivatives as suitable for clearing by a federally regulated central counterparty to be placed on registered exchanges. I personally believe that most derivatives, if they are not too highly customized, should be placed in a clearinghouse situation, and it helps you identify risk and define risk.

And I think from talking to most financial institutions they know what their risk is between two parties, but they sometimes don't know what the party they are dealing with, what their risk with a third party is and I think that's one of the values of a clearinghouse. You not only have to know what your exposure to each other is, but sometimes what the exposure they have to a third party.

The idea, I think that Treasury's proposal -- proposed is really an oversimplification of the use of an exchange and simultaneously may give unsophisticated retail investors a false comfort that their products are now safe for purchase because they've somehow been approved for exchange trading by a government agency.

Furthermore, in testimony before the committee in March, the GAO pointed out that some credit default swaps maybe too complex or they'll be highly tailored and are -- even for a clearing and therefore placing them on an exchange to me will be almost impossible.

And it is in those highly complex derivatives that we're going to have -- particularly have a problem. As we move forward with regulatory reform proposals, we should make every effort to strike the right balance between protecting investors and preserving innovation.

And I think there's where Mr. Garrett and I really agree and that's that there are already private sector initiatives well underway to clear standardized derivative contract. And part of that is a response to what we've seen in the last year or two and some of what we've seen I don't think will take place again because the party is already demanding that.

And I think these are efforts to remind us that market based solutions are capable of generating the information that investors and companies need to make informed decisions. And the last thing Congress should do is prevent new entrants into the derivatives clearing marketplace.

In closing, Mr. Chairman, any ban on over-the-counter derivatives would likely harm responsible and well-managed U.S. corporations that use derivatives to hedge against business risks. Restrictions on credit default swap contracts will also limit the ability of investor to appropriately calculate risk as it has become apparent that CDS spreads have become a more accurate reflection of credit risk than even credit ratings.

And that's one thing that we've learnt in all this is that credit rating agencies were way behind what we were seeing on some of the credit spreads themselves. I appreciate our witnesses testifying and I've read some of your testimony and look forward to, over the next few days, reading the rest of it if I don't hear you.

Thank you.

REP. KANJORSKI: Thank you very much, Mr. Bachus.

And now we'll hear from the gentleman from Georgia, Mr. Scott for three minutes.

REP. DAVID SCOTT (D-GA): Thank you very much, Mr. Chairman. And I want to thank you and Ranking Member Garrett for holding this hearing. As over-the-counter derivatives have been cause for concern with AIG's near collapse caused in large part by its portfolio of credit default swaps.

And the American taxpayer now owns most of this company. As AIG has access now to nearly $200 billion dollars in taxpayer support. And I also understand the frustrations with my constituents as constituents of everyone of us on this committee and in Congress that our constituents are feeling as their money continues to go towards propping up Wall Street firms, all the while, they are simply trying to stay afloat with unemployment numbers rising and people continuing to lose their homes.

However, today, I am interested to hear what the witnesses have to say about the varying regulatory proposals to rein in these financial services products. I'm looking forward to hearing their thoughts on proposals for mandatory clearing of all standardized over- the-counter contracts and reporting of trades from non-standardized contracts to a qualified trade information repository.

Furthermore, as a member of both the Financial Services Committee and the Agriculture Committee, I'm interested to hear the opinions on legislation that would end the exemptions for swaps adopted in the Commodity Futures Modernization Act and a certain new authority over over-the-counter derivatives.

And I would also like to hear their opinions and thoughts on the bill we passed in this committee in February, which would require clearing for all over-the-counter derivatives. Our economy continues to be extremely turbulent as weakening trends envelops us and the experts predict that the downturn might not end any time soon or at least not until the end of next year.

So the bottom line with this hearing is, we must seriously discuss strengthening regulations specifically over these over-the- counter derivatives, but I would put in there strengthening them but with flexibility, so that this system can work with greater transparency and effectiveness.

We must address concerns regarding current regulatory practices and how to further restructure them in a way that will provide for real reform. And Mr. Chairman, while I have this opportunity, I would also like to welcome from Atlanta, Georgia, Mr. Jeffrey Sprecher who's from my area in Atlanta, Georgia as well as Mr. Price's area.

He's the chief executive officer, of IntercontinentalExchange, which we refer to as ICE, from Atlanta, Georgia. Thank you, Mr. Chairman, I look forward to the testimony from our distinguished witnesses.

REP. KANJORSKI: Thank you, Mr. Scott.

Now we'll hear from the second gentleman from Georgia, Mr. Price for one minute.

REP. TOM PRICE (R-GA): Thank you, Mr. Chairman, I appreciate it.

In a free market -- in a free market over-the-counter derivatives provide an essential function by allowing companies to customize the way that they address their risks. Many companies have successfully used OCT products to help their consumers save money and to create jobs including 3M, which is testifying today as an end user of derivatives.

A market-based economy allows institutions to succeed and to fail and they fail for a number of reasons. The business takes on too much risk, maybe under bad management or have an ineffective business model. Despite the fact that credit default swaps have come under fire lately because of AIG's remarkable over-exposure when they are used appropriately they can be a very effective risk management tool.

Thus we need to be extremely cautious and careful as we decide how to appropriately regulate derivatives. In fact, the market has already begun addressing some of the concerns that credit default swaps and OTC derivates pose. So I look forward to hearing from the witnesses about what they are doing to make OTC and CDS trades more transparent.

In the end, however, regulation must not be a one-size-fits-all system. Such a system stifles innovation, raises prices for consumers, punishes entrepreneurs, and destroys jobs. Thank you, Mr. Chairman.

REP. KANJORSKI: Thank you, Mr. Price.

And now the gentleman, Mr. Adler for three minutes.

REP. JOHN ADLER (D-NJ): Thank you, Chairman Kanjorski, I want to commend you and Ranking Member Garrett for holding this hearing today on this important but very, very complicated issue.

Most people can agree including a majority of industry participants that over-the-counter OTC derivatives need to be safer.

However, Congress must be clear that the credit default swaps that damaged AIG's balance sheet made up just a fraction of all OTC derivatives. Thousands of American municipalities, companies, and financial institutions rely on OCT derivatives to manage risk. Interest rate and equity derivatives allow entities to hedge against unexpected losses.

It is my hope that our committee strikes the right balance between creating a safer process of overseeing derivatives while maintaining the flexibility within the marketplace so private and public entities have the ability to manage their interests.

Standardized derivates should be required to go through centralized clearing counterparties, but we should not create a process where all derivates are processed through one CCP because it may actually increase risks by bottlenecking the system.

I hope to hear from our panelists today in how we can best arrive at a definition of derivatives that allows for smarter, more effective regulation while not enforcing a blanket one-size-fits-all set of regulations. Standardization of derivates cannot include all financial contracts because many are individually negotiated and offer parties the opportunity to balance specific risks in a way many other traded products do not.

Clearly, Congress must prevent future activities from endangering our financial system similar to what we witnessed with AIG, Bear Stearns, and Lehman Brothers last year. We have to implement safeguards to bring greater transparency not only to the public, but also for our regulators.

Marketplace participants have already started the process of moving towards greater transparency by creating and utilizing large electronic repositories. Today's hearing will provide my colleagues and me with more information on aggregate data that should be available to the interested parties.

Finally, Mr. Chairman, today our committee should discuss the layered jurisdictional issues preventing the efficient and effective regulation of OTC derivates. Thank you again for the time. I yield back.

REP. KANJORSKI: Thank you, Mr. Adler.

And now we'll hear from gentleman, Mr. Lucas for one minute.

REP. FRANK D. LUCAS (R-OK): Thank you, Mr. Chairman, and ranking member for today -- for holding today's hearing. Serving on this committee, as well as being the current ranking member on the House Agriculture Committee, I have had the opportunity to examine the various issues surrounding the role derivates have played in the current financial crisis and have worked to respond to the need for more effective regulation.

While better transparency and disclosure are needed within the industry, we must make sure that we create responsible legislation that does not impede appropriate innovation and risk management within the marketplace. Additionally, I believe, we must work to ensure that the CFTC plays the leading role in appropriately regulating the derivates and commodities market.

The House Agriculture Committee recently reported a comprehensive bill aimed at addressing these regulatory concerns. I am prepared to use that experience to influence the discussion and the actions of this committee. I look forward to striking the proper balance as we craft the legislation that gives us that regulatory balance we need.

I yield back, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. Lucas.

Now, we'll hear from the gentleman from Massachusetts, Mr. Lynch for one minute.

REP. STEPHEN F. LYNCH (D-MA): Thank you, Mr. Chairman. I thank you for having this hearing and I appreciate the witnesses coming forward. I get the sense I am in the minority just from hearing the testimony on this side of the table.

I do think that derivatives had a lot to do with the impact and the scope of the economic downturn that we're currently experiencing. And while, I think our job should be regulating this industry, I just want to point out that if we're trying to set up a regulatory framework to contain some of the damage that has been caused and nobody has mentioned that in their testimony.

I think, we need to give the tools to our regulator to do just that. And by allowing part or a significant part of the derivatives market to just go off unregulated, we have seen from our experience that that's where the money goes. It goes to the unregulated portions of the market, the opaque areas of the market.

Now, we're setting ourselves up to fail. We're setting ourselves up to fail, we're not going to regulate this, I get the sense of it right now, but we'll be back here someday, it's just -- it's very unfortunate that we are not taking advantage of the -- I think the -- the desire in the financial world to really get at this.

I think, we're making a mistake on part of the taxpayer and investors. I think, we're making a terrible mistake here, Mr. Chairman, in taking a very soft approach here. I get the sense who's winning this fight and, you know, I don't think it's the American taxpayer.

I yield back.

REP. KANJORSKI: Thank you very much, Mr. Lynch.

And now we'll hear from the gentleman from California, Mr. Royce for one minute.

REP. EDWARD R. ROYCE (R-CA): Thank you, Chairman.

Certainly, there appears to be a market consensus forming that highly standardized contracts can and should be sent through a central counterparty.

However, I think, it's worth noting that a portion of the derivatives market is highly customized and tailored to a specific institution covering a specific risk.

Overtime, with calls for greater transparency, market participants will be best equipped to determine which instruments should be cleared and which should be traded on an exchange. If Congress missteps, we run the risk of driving this market overseas and limiting the ability of companies to manage risks associated with their business practices.

In the case of AIG, it appears the failure came from a breakdown in counterparty due diligence not simply the firms usage of derivatives. Market participants, so reliant upon AIG's AAA credit rating failed to see the extent to which AIG was overleveraged in their best exposure to an eroding U.S. housing market.

Deciphering this leverage in an opaque market is key. Information warehousing of the non-cleared customized trades for transparency would logically help in those cases that couldn't be handled by a central clearinghouse.

Thank you again, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. Royce.

Now, we'll hear from the gentleman from California, Mr. Sherman for two minutes.

REP. BRAD SHERMAN (D-CA): Thank you. One of the arguments always made against regulation is, well, let the buyer beware. What the credit agencies were here saying, don't regulate us, just don't rely on our rating. And now we're told well the counterparties should protect themselves.

The fact is, at best these derivatives are insurance; at worst, they are a bet at the casino. Either way, we don't let you sell fire insurance on my house without setting up reserves. And to go to my bank -- and that -- the insurance company is basically -- the insurance policy on my house is basically for the benefit of my bank, you don't want to know how little equity I have in the house.

Yet, you can go to a bank and say we'll protect you not from Brad's house burning down, but from the house declining in value and Sherman defaulting on the loan, and it's not insurance. It's customized. Or you can sell that as a casino bet and bet -- and go to somebody who doesn't hold my mortgage and sell them an insurance policy against me not paying my mortgage.

Either way, there ought to be reserves. Anything else means you can sell an unlimited quantity and ultimately we were told well, this is just a private market decision. Tell that to the taxpayers who have bailed out AIG. And if this business goes overseas there will always be an unregulated casino where you go and you put your money down on number 24 and you win, and the bank doesn't pay you off. Fine, let that casino be offshore.

Let some other government have to bailout the next AIG. Let us not be told that the present system is fine as long as the taxpayers write the check.

I yield back.

REP. KANJORSKI: Thank you very much, Mr. Sherman.

And now, we'll hear from the gentle lady from Illinois, Ms. Biggert for one minute.

REP. JUDY BIGGERT (R-IL): Thank you, Mr. Chairman. To justify a curfew, some parents say to their teenagers, nothing good ever happens after midnight. I would argue that a similar adage holds true when it comes to elements of the derivative market.

This is especially true of those riskier trades of credit default swaps and over-the-counter derivates that were conducted in a kind of darkness, contributed to the collapse of major financial services companies and contributed to our current financial crisis.

I look forward to hear suggestions regarding the increased capital requirements, central clearing, and price discovery as part of the discussions of how to better manage risks within the marketplace. This can only lead to more robust competition, restored investor confidence, and help our markets.

At the same time, I think Congress must aim first to do no harm or legislatively we must be careful not to sacrifice market efficiency and liquidity in the name of more transparent markets or to simply meet a goal of reducing emissions.

Now, the Waxman-Markey bill gives financial regulatory authority to the wrong regulator, over-restricts trading and imposes a new futures transaction tax. A new tax adds to the cost of future transactions which threatens the vitality of U.S. futures markets especially those in Chicago and all who depend on them.

We must strike the right balance. And with that I look forward to hearing from our witnesses, especially my constituent, Mr. Duffy, who is the executive chairman of the CME Group. I yield back.

REP. KANJORSKI: Thank you, Ms. Biggert.

The gentleman from Texas, Mr. Hensarling for one minute.

REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman. And I appreciate the title of the hearing dealing with effective regulation because I think there is a very big difference between effective and ineffective.

Effective regulation helps make markets more competitive and transparent, empowers consumers with effective disclosure to make rational decisions, effectively polices markets for force (ph) and fraud and reduces systemic risk.

Ineffective regulation, though can hamper competition, create moral hazards, stifle innovation, and diminish the role of personal responsibility within our economy. Now with respect to more regulation of the OTC derivates market, I come into this hearing with an open mind, but not an empty mind.

I remember that regulators and legislators don't always get it right. Witness Fannie and Freddie, witness the credit rating agency oligopoly, and let us also remember that the former director of OTS said they have the tools to prevent AIG's position in over-the-counter in the CDS and simply did not exercise it.

Now perhaps, we should look to more enlightened risk assessment for tools to regulators, appropriate capital standards. And with respect to our OTC derivates in current economic turmoil, let's be careful, we do not confuse the cause with the symptoms.

With that Mr. Chairman, I yield back the balance of my time.

REP. KANJORSKI: Thank you very much, Mr. Hensarling.

And now, we'll hear from the gentle lady from Minnesota, Ms. Bachmann, for one minute.

REP. MICHELE BACHMANN (R-MN): Thank you, Mr. Chairman, Mr. Garrett for holding this important meeting today. I am also pleased this committee has invited Mr. Timothy Murphy to speak before us today. He is the foreign currency risk manager for 3M Corporation to testify about 3M's use of these financial products.

Headquartered in St. Paul, Minnesota, it is the hometown company we have been proud of for years. They provide 34,000 people with jobs, more than 60 percent of the manufacturing operations are located here inside the United States. With over 20 years of experience in the over-the-counter derivatives market, Tim presently manages 3M's currency and commodity risk programs as well as its share repurchase program.

He is the person responsible for the management and execution of the company's foreign exchange hedging policy, including identifying the appropriate exposure estimates to be used as the basis for foreign exchange hedging activity and balance sheet hedging.

Prior to joining 3M, he worked at U.S. Bank for more than 10 years managing their foreign currency trading relationships with corporate, mutual fund, and banking clients. As our committee considers the future of over-the-counter derivatives we must remember that many the United States companies responsibly utilize these financial products to manage their risks and limit damage to their balance sheet.

We need to ask the question of those before us today, how will jobs be impacted by the measures that are before us today. These are America's job creators. Congress should be careful not to overreach, and infringe on their ability to hedge risk responsibly. And I look forward to today's important discussion.

I yield back, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Ms. Bachmann. Now, we'll hear from the gentleman from Texas, Mr. Neugebauer. One minute.

REP. RANDY NEUGEBAUER (R-TX): Thank you, Mr. Chairman. You know, one of the things that we've sat here for several months talking about the state of the economy and I think if we went around this room today and asked everybody who -- what they thought caused where we are, we'd get many different answers, which is one of the reasons I am being very concerned about the road that we are going down.

I don't know that we've adequately analyzed where in this system that we had the breakdowns. Instead, I think we have embarked on a road to throw a restrictive regulatory blanket over the entire financial markets.

And what I think we many end up doing is, in many cases some of the people that we are both trying to protect and to help, there might be unintended consequences for this very restrictive regulatory blanket that we are trying to throw over the financial markets.

Derivatives and swaps are important tools not only for discovering risk in many cases, but also for managing risk. We need to make sure that we do not destroy those tools, simply because some don't understand it or some believe that possibly they could have been a cause of the financial breakdown.

We don't know that that is in fact the case. What we do know is many firms were able to -- and manage their way -- risk through this process by having some of these products actually in place.

And so I'll look forward to the testimony that we are going today. But I'll also caution my fellow committee members that let's go down this road with thoughtful debate and discussion and make sure that we get it right because this is a very important issue to our country.

With that I yield back.

REP. KANJORSKI: Thank you, Mr. Neugebauer.

And now, we have one minute for the gentle lady from Kansas, Ms. Jenkins.

REP. LYNN JENKINS (R-KS): Thank you, Mr. Chairman. This committee is being asked to consider massive regulatory reform in the financial markets. I hope that any legislation we consider will strike a balance between protecting the financial system and ensuring open and free markets.

I have concerns with proposals like the one that is the focus of today's hearing. I'm eager to learn more during this hearing about -- at this stage, about all of these issues and I'm concerned about new entry or participation barriers in the over-the-counter markets being discussed such as capital requirements and the effects that they may have on competition.

If this body is to create new regulations in the OTC markets to decrease the possibility of systemic risk and increased transparency, Congress must ensure robust competition and protect the ability of American businesses to use these markets to manage their energy, currency and other risks.

As we take steps to emerge from the current recession and get our economy back on track, I too urge my colleagues to proceed with caution.

I yield back, thank you.

REP. KANJORSKI: Thank you very much, Ms. Jenkins.

Now, we'll have the first panel. I want to thank you for appearing before the subcommittee today. Without objection, your written statements will be made part of the record. You will each be recognized for a five-minute summary of your testimony.

First, we have Mr. Donald Fewer, chief executive officer, Standard Credit Group.

Mr. Fewer.

MR. FEWER: Mr. Chairman Kanjorski, Ranking Member Garrett and members of this subcommittee, my name is Donald Fewer. I'd like to thank the subcommittee for the opportunity to share my views on the regulation of the over-the-counter derivatives market and address the areas of interest outlined by the subcommittee. I have also submitted a larger statement for the record.

Analysis of the credit crisis points to the need for enhanced regulation of the OTC market. Results from such analysis point to multiple, and sometimes conflicting, causes of the crisis, and the role played by the OTC derivatives market.

We suggest creating a cohesive regulatory regime with a systemic risk regulator that has the authority and accountability to regulate financial institutions that are determined to be systemically important.

Regulation need not reshape the market or alter its underlying functionality. The U.S. share of global financial market is rapidly falling. And oversight consolidation should not create a regulatory environment that prohibits capital market formation, increases transaction costs and pushes market innovation and development to foreign markets.

The use of CCPs by all market participants, including end users should be encouraged by providing open and fair access to key infrastructure components including essential clearing facilities, private broker trading venues and derivative contract repositories.

Essential clearing will reduce systemic risk by providing multilateral netting and actively managing daily collateral requirements. Mandated clearing of the most standardized and liquid product segments is congruent with the efficient global trade flow.

Given the size, history and global scope of the OTC derivatives market, migration towards exchange execution has been and will be minimal, apart from mandatory legislative action. OTC derivative markets will use well recognized protocols of size, price, payments, and maturity dates.

Because of these internationally recognized protocols OTC dealers globally are able to efficiently customize and best execute at least cost, trillions of dollars of customer orders within generally acceptable terms to the market. There is a class of OTC product that is extremely conducive to exchange execution and can warrant exchange listing.

The over-the-counter market has a well-established system of price discovery and pre trade market transparency. That includes markets such as U.S. Treasury, U.S. repo, EM sovereign debt. OTC markets have been enhanced by higher utilization of electronic platform execution.

The unique nature of the OTC market's price discovery process is essential to the development of orderly trade flow and liquidity, particularly, in fixed income credit markets. We are in a period of abundance of mis-priced securities, where professional market information and execution is required.

OTC derivatives and underlying cash markets use an exhaustive price discovery service that can only be realized in the OTC market via execution platforms that integrate cash and derivative markets.

Post trade transparency for all OTC derivative transactions can be properly serviced by CCPs and central trade repositories that aggregate trading volumes and positions as well as specific counterparty information.

These institutions can be structured to maintain books and records and provide access to regulatory authorities on trade specific data.

I would not endorse OTC trade reporting to the level that is currently disclosed by TRACE. There is ample evidence in the secondary OTC corporate bond market that the TRACE system has caused dealers to be less inclined to hold inventory and commit capital to support a secondary market.

Successful utilization of electronic trade execution platforms is evident in markets such as U.S. government bonds, U.S. government repo. I would caution against the mandated electronic execution of OTC cash and derivative products by regulatory action.

Effective implementation of such platforms should be the result of a clear demand made by market makers and a willingness by dealers to provide liquidity, electronically.

Our experience in North America is that the dealer community has refrained from electronic execution due to the risks being -- of being held to prices during volatile market conditions. I would strongly endorse the use of hybrid -- the hybrid use of electronic platforms, where market participants utilize the services of voice brokers in conjunction with screen trading technology.

Mr. Chairman, Mr. Ranking Member, members of the subcommittee, I appreciate the opportunity to provide this testimony today. I am pleased to respond to any questions.

REP. KANJORSKI: Thank you very much, Mr. Fewer.

Next, we'll have Mr. Robert Pickel, chief executive officer, International Swaps and Derivatives Association Incorporated.

Mr. Pickel.

MR. PICKEL: Thank you, Mr. Chairman, Ranking Member Garrett, and members of the subcommittee. Thank you very much for inviting ISDA to testify today. We are grateful for the opportunity to discuss public policy issues regarding the privately negotiated, or OTC, derivatives business.

Our business provides essential risk management and risk reduction tools for many users. Additionally, it is an important source of employment, value creation, and innovation for our financial system --- it is one that employs tens of thousands of individuals in the United States and benefits thousands of American companies across a broad range of industries.

In my remarks today, I would briefly like to underscore ISDA's and the industry's strong commitment to identifying and reducing risk in the privately negotiated derivatives business.

We believe that OTC derivatives offer significant value to the customers who use them, to the dealers who provide them, and to the financial system in general, by enabling the transfer of risk between counterparties

OTC derivatives exist to serve the risk management and investment needs of end users. These end users form the backbone of our economy. They include over 90 percent of the Fortune 500 companies, 50 percent of mid-sized companies and thousands of other smaller American companies.

We recognize, however, that the industry today faces significant challenges, and we are urgently moving forward with new solutions. We have delivered and are delivering on a series of reforms in order to promote greater standardization and resilience in the derivatives markets.

These developments have been closely overseen and encouraged by regulators, who recognize that optimal solutions to market issues are effectively achieved through the participation of market participants.

As ISDA and the industry work to reduce risk, we believe it is essential to preserve flexibility to tailor solutions to meet the needs of customers. Efforts to mandate the privately negotiated derivatives business trade only on an exchange would effectively stop any such business from being conducted.

Requiring exchange trading of all derivatives would harm the ability of American companies to manage their individual, unique, financial risks and ultimately, harm the economy.

Mr. Chairman, let me assure you that ISDA and our members clearly understand the need to act quickly and decisively to implement the important measures that I will describe in the next few minutes.

Last month, the Treasury Secretary Geithner announced a compressive regulatory reform proposal for the OTC derivatives market. The proposal is an important step towards much needed reform of financial industry regulation.

ISDA and the industry welcomed, in particular, the recognition of industry measures to safeguard smooth functioning of our markets. And the emphasis on the continuing need for the ability to customize derivatives to the specific needs of users of derivatives.

The Treasury plan proposes to require that all derivatives dealers and other systemically important firms be subject to prudential supervision and regulation. ISDA supports the appropriate regulation of financial and other institutions that have such a large presence in the financial system that their failure could cause systemic concerns.

Most of the other issues raised in the Treasury proposal, and the questions you've ask of the panelists today, were addressed in a letter that ISDA and industry participants delivered to the Federal Reserve Bank of New York earlier this month.

As you may know, a Fed-industry dialog was initiated under Secretary Geithner's stewardship of the New York Fed nearly four years ago. This dialog has led to substantial and on-going improvements in the key areas of the OTC derivatives infrastructure; increased standardization of trading terms improvements in the trade settlement process, greater clarity in the settlement of defaults, significant positive momentum towards a central counterparty clearing, enhanced transparency, and a more open industry governance structure.

In our letter to the New York Fed this month, ISDA and the industry expressed our firm commitment to strengthen the resilience and robustness of the OTC derivatives market.

As we stated, we are determined to implement changes to risk management, processing, and transparency that will significantly transform the risk profile of these important financial markets. We outlined a number of steps toward that end, specifically, in the areas of information transparency and central counterparty clearing.

ISDA and the OTC derivatives industry are committed to engaging with supervisors, globally, to expand upon the substantial improvements that have been made in our business since 2005. We know that further action is required, and we pledge our support in these efforts.

It is our belief that much additional progress can be made within a relatively short period of time. Our clearing and transparency initiatives, for example, are well underway, with specific commitments aired publicly and provided to policymakers.

As we move forward, we believe the effectiveness of future policy efforts will be driven by how well they answer a few fundamental questions. First, do they recognize that OTC derivatives play an important role in the U.S. economy?

Second, do the policy efforts enable firms of all types to improve how they manage risk? Third, are the policy efforts based on a complete understanding of how the OTC derivatives markets function and their true role in the financial crisis? Four, do the policy efforts ensure the availability and affordability of these essential risk management tools.

Mr. Chairman, and committee members, the OTC derivatives industry is an important part of the financial services business in this country and the services we provide help companies of all shapes and sizes. Let me assure you that we in the derivatives industry do recognize the challenges that we face as we seek to enact a comprehensive and prudent system of regulatory reform.

As I have indicated, we are fully committed to working with the legislators of this committee and supervisors to address the key issues ahead.

Thank you for your time and I look forward to your questions.

REP. KANJORSKI: Thank you very much, Mr. Pickel.

Now, we'll hear from Mr. Timothy J. Murphy, foreign currency risk manager, 3M.

Mr. Murphy.

MR. MURPHY: Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee, thank you for inviting 3M to speak today on the importance of the over-the-counter derivatives market. Representative Bachmann, thank you for your kind introduction as well as your kind words about the 3M company.

As you know, my name is Timothy Murphy and I am the Foreign Currency Risk Manager for 3M company. As you now know, 3M is a U.S.- based employer headquartered in Minnesota. We are home to such well- known brands as Scotch, Post-it, Nexcare, Filtrete, Command, and Thinsulate.

3M has over 34,000 employees in the U.S. and operations in 27 states where over 60 percent of 3M's worldwide R&D and over 60 percent of our manufacturing occurs. While our U.S. presence is strong, being able to compete successfully in the global marketplace is critical.

In 2008, 64 percent of our sales over $16 billion were outside the United States and this number is expected to grow to over 70 percent by 2010. It is because of the global success of our brands that we need to manage foreign currency risks via the OTC markets.

Likewise, our desire to efficiently manage our raw material and financing costs gives rise to our use of OTC commodity and interest rate tools. I want to stress that 3M, like the majority of corporate end users, does not speculate with derivatives. All of our hedge transactions are carefully matched with underlying risks from the operation of our businesses.

I'm here today to share 3M's perspective on proposals to establish a regulatory framework for OTC derivatives. While 3M supports the objectives outlined in Treasury Secretary Geithner's recent proposal, as well as many of the ideas put forward by members in the House and Senate, we have strong concerns about the potential impact on OTC derivatives and 3M's ability to continue to use them to protect our operations from the risk of currency, commodity, and interest rate volatility.

3M agrees that the recent economic crisis has exposed some areas in our financial regulatory system that should be addressed. However, not all OTC derivatives have put the financial system at risk and they should not all be treated the same.

The OTC foreign exchange, commodity, and interest rate markets have operated largely uninterrupted throughout the economy's financial difficulties. We urge policy makers to focus on the areas of highest concern.

3M understands and respects the need for reporting and record keeping. Publicly held companies are currently required by the SEC and FASB to make significant disclosures about our use of derivative instruments and hedging activities, including disclosures in our 10Ks and 10Qs.

We would like to work with policy makers on ways to efficiently collect information into a trade repository to further enhance transparency. 3M opposes a mandate to move all derivatives into a clearing or exchange environment. One key characteristic of OTC derivatives for commercial users is the ability to customize the instrument to meet a company's specific risk management needs.

Provisions that would require the clearing of OTC derivatives would lead to standardization, thus impeding a company's ability to comply with hedge accounting requirements for financial reporting, thereby exposing reported corporate financial results to unwarranted volatility, and distracting from our operating results.

While we are mindful of the reduction in credit risk inherent in a clearing or exchange environment, robust, initial and variation margin requirements would create substantial incremental liquidity and administrative burdens for commercial users, resulting in higher financing and operational costs.

Scarce capital currently deployed in growth opportunities would need to be maintained as margins which could result in slower job creation, lower capital expenditures, less R&D and/or higher costs to consumers. The hedging of business risks could well be discouraged.

3M thanks the committee for studying the critical details related to financial system reforms and for considering our perspective in this important debate. Again, 3M respectfully urges the committee to preserve commercial user's ability to continue using OTC derivative products to manage various aspects of corporate risks, while addressing concerns about the stability of the financial system. 3M looks forward to working with the committee as you draft this important legislation.

Thank you.

REP. KANJORSKI: Thank you very much, Mr. Murphy.

Next, we'll hear from Mr. Don Thompson, managing director and associate general counsel, JP Morgan Chase and Company.

Mr. Thompson.

MR. THOMPSON: Mr. Chairman, Ranking Member Garrett, members of the committee, my name is Don Thompson, and I am a managing director and associate general counsel at JP Morgan Chase & Co. Thank you for inviting me to testify at today's hearing.

For the past 30 years, American companies have used OTC derivatives to manage interest rate, currency, and commodity risk. Increasingly, many companies incur risk outside their core operations that, if left unmanaged, would negatively affect their financial performance and possibly even their viability.

In response to marketplace demand, risk management products such as futures contracts and OTC derivatives were developed to enable companies to manage risks. OTC derivatives have become a vital part of our economy. According to the most recent data, over 90 percent of the largest American companies and over 50 percent of mid-sized companies use OTC products to hedge risk.

J.P. Morgan's role in the OTC derivatives market is to act as financial intermediary. In much the same way that financial institutions act as a go-between with investors seeking returns and borrowers seeking capital, we work with companies looking to mange their risk and entities looking to take on those risks.

A number of mainstream America companies have expressed great concern about the unintended consequences of recent policy proposals, particularly, at a time when our economy remains fragile.

In our view, the effect of forcing such companies to face an exchange or a clearinghouse would limit their ability to manage the risks they incur in operating their businesses and have negative financial consequences for them because of increased collateral posting. These unintended consequences have the potential to harm economic recovery.

Let me first touch on some of the benefits of OTC derivatives. Companies today demand customized solutions for risk management, and the OTC market provides them. Keep in mind that customization does not necessarily mean complexity, rather it means the ability to hand tailor every aspect of a risk management product of the company's needs to ensure that the company is able to offset its risks exactly.

For example, a typical OTC derivative transaction might involve a company that is borrowing at a floating interest rate. To protect itself against the risk that interests rate will rise, the company would enter into an interest rate swap.

These transactions generally enable the company to pay an amount tied to a fixed interest rate and the dealer counterparty will pay an amount tied to the floating rate of the loan. This protects the company against rising interest rates and allows them to focus on their core operations.

In addition, the company is often able to qualify for hedge accounting and thus avoids seeing volatility in its financial reporting that would have obscure the true value of its business. OTC derivatives are used in a similar manner by a wide variety of companies seeking to manage volatile commodity prices, foreign exchange rates and other markets exposures.

In addition to customization, the other main benefit of OTC derivate is flexibility with respect to the collateral that supports a derivative transaction. In the interest rate swap example I went through before, the dealer counterparty may ask the company to provide credit support to mitigate the credit risk that it faces in entering into the transaction.

Most often that credit support comes in the same form as the collateral provided for and the extensions of credit by that dealer counterparty to the customer. Thus if the loan agreement is secured by property, equipment or accounts receivables, that same high quality collateral would be used to secure the interest rate swap.

As a result, the company does not have to enter or incur additional costs in obtaining and administering collateral for the interest rate swap. It is important to note that although derivatives currently are offered on U.S. exchanges; few companies use these exchange-traded contracts for two main reasons.

The first, exchange-traded products are, by necessity, highly standardized and not customized. As a result, companies are unable to match the products that are offered on exchanges; to their unique portfolio of risks. Secondly, clearinghouse collateral requirements are by design, onerous and inflexible.

Clearinghouses require their participants to pledge only highly liquid collateral, such as cash or short-term government securities, to support their positions. However, companies need their most liquid assets for their working capital and investment purposes.

Thus, in the example I gave, the company had to execute its hedge on an exchange, it would have had to post cash or readily marketable collateral upfront and twice daily thereafter. By transacting in the OTC market, the company is able to use the same collateral that it has already pledged to secure its loan, with no additional liquidity demands or administrative burdens.

This collateral is high quality be -- given that it's the basis for the extension of credit loan, but posting it does not affect the company's operations or liquidity. The flexibility to use various forms of credit support significantly benefits companies because without it, many companies would choose not to hedge risks because they can't afford to do so.

While we believe that exchanges play a valuable role in risk management, not all companies can or want to trade on exchange. Currently, companies have the choice of entering into hedging transactions on an exchange or in the OTC markets and we believe that companies should be allowed to have that choice to continue to use those competing products.

The discussion of the benefits of OTC derivatives is not to deny that there have been problems with their use, and it is essential that policymakers carefully examine the causes of the financial crisis to ensure that it is not repeated. We have noted recent press reports indicating that banks are engaged in the concerted effort to avoid regulation, this is absolutely not true.

For the past four years, major derivatives dealers, working in conjunction with regulators have been engaged in an extensive effort to improve practices and controls of the OTC derivates market. The letter referred to is just the latest quarterly submission outlining our efforts to enhance market practices and we are committed to reforming the regulatory system and increasing confidence in the markets.

To that end, we propose the following, which is consistent with the administration's position and CFTC Chairman Gensler's recent remarks on the issue. First, financial regulation should be considered on the basis of function, not form.

Secondly, a systemic risk regulator should oversee all systemically significant financial institutions and their activities. Third, standardized OTC derivative transactions between major market participants should be cleared through regulated clearinghouses. And finally, enhanced reporting requirements should apply to all derivatives -- OTC derivatives transactions whether cleared or not.

JP Morgan is committed to working with Congress, regulators and other industry participants to ensure that an appropriate regulatory framework for OTC derivatives is implemented. I appreciate the opportunity to testify and look forward to taking your questions.

REP. KANJORSKI: Thank you very much, Mr. Thompson.

And next, we'll have Mr. Christopher Ferreri, managing director, ICAP.

Mr. Ferreri.

MR. FERRERI: Thank you, Chairman Kanjorski and Ranking Member Garrett, all the members of the subcommittee for allowing me the opportunity to participate in today's hearing.

I'm Chris Ferreri, and I work for a company called ICAP. We are the world's largest interdealer broker employing more than 4,000 personnel worldwide, including New York, New Jersey and the other major financial centers.

Using a combination of voice and electronic services, our function is to match buyers and sellers, specifically, banks and other large financial institutions operating in the wholesale financial markets. On their behalf, we execute thousands of trades daily and a broad array of financial products including U.S. Treasury securities, foreign exchange, commodities, and other financial derivatives.

Products we trade via OTC markets are simply products that do not trade exclusively on registered exchanges. It should be noted that included in these products are U.S. Treasury securities and foreign exchange. By volume of trade, it's world's two largest financial products.

It should also be emphasized, that for the most part, institutional participants in these markets are currently subject to regulation by government authorities, specifically, in the U.S. the Fed, the SEC and FINRA.

During my testimony, I'd like to emphasize the following three points. ICAP supports greater oversight of major participants in OTC markets in particular to ensure the integrity of their capital base. We also support additional transparency through the increased use of electronic trading platforms and post trade reporting facilities, already available through companies like ICAP and others.

Secondly, someone suggested that the solution to greater oversight with regard to over-the-counter market should be to force much of the present activity on to existing exchanges. We don't believe this is necessary or indeed that it would accomplish our intended goal.

Rather, we believe that better use of facilities that already exist such as electronic trading platforms; direct and immediate access to clearinghouses and post trade reporting and processing will lead to greater price transparency, more efficient markets and additionally, facilitate the oversight function of the regulatory authorities.

Thirdly, these products have increased in number and size so dramatically, because virtually every major financial and corporate institution in the world needs and uses them to raise capital, to protect portfolio positions and to mitigate risks. Whatever regulatory decisions are made, we must make every effort that they do not impair access to capital or the ability to hedge risk for private and public institutions alike.

The subcommittee did give us seven points to touch on. I will address as many as I can in the time allotted. Our need on the view for OTC regulation. ICAP favors changes to the regulatory framework supporting fairness and transparency. Interdealer brokers like ICAP are regulated by both the national regulators in each relevant market and by their overall lead regulator.

There are many forms of regulation already in place that apply to the OTC cash and derivatives markets. In cases where the markets themselves may not be regulated the participants can be. How clearing will affect the OTC market. Roughly 60 percent of the OTC markets we operate are cleared. We would expect an increased clearing can lead to increased liquidity in the OTC markets.

The pros and cons of exchange trading; we must first underscore the distinction between exchange trading and clearing. ICAP operates fully electronic marketplaces for many products. And none of them are single silos of exchange trading and clearing, but are traded electronically and cleared centrally.

This one-size-fits-all approach of completely standardized non- fungible contracts means that corporations, mortgage providers, bond issuers and others are unavailable to accurately hedge their risk exposures. It is for this reason that the OTC markets are both larger in scale and broader in scope than the exchange markets.

The potential benefits of electronic trading. Electronic trading can provide more efficient price discovery, simplified trade capture, materially reduce operational risks, improve trading supervision, increase auditability, and create processing capacity in the OTC markets. In addition, multiple trading venues increase competition, keep costs down, and provide security from failure of individual platforms.

Migrating liquidity is difficult; the turnkey development of a completely new market infrastructure is unnecessary and will require significant implementation time and incur a high level of risk. Rather than rushing to develop new infrastructure, better and more extensive use should be made of the tremendous capabilities of the existing OTC market infrastructure.

In summary, it should be clear that the over-the-counter market is not unregulated or even less regulated. Our electronic trading platforms are global, connected to thousands of customers in dozens of countries as well as the world's largest clearance and settlement systems.

ICAP welcomes the coming reform and we feel our goals of promoting competition, electronic trading and clearing helps both our customers and ICAP. The OTC market has already invested significantly in developing its infrastructure for price discovery, trade execution and post trade automated processing which contributes hugely to reducing risks, but it needs to be further developed and better leveraged for the benefit of all.

Once again, I thank the committee for allowing me to speak on this topic, and we look forward to working with the committee on building a bridge to a better marketplace.

Thank you.

REP. KANJORSKI: Thank you very much, Mr. Ferreri.

And finally, we have Mr. Christian A. Johnson, professor, University of Utah School of Law.

Mr. Johnson.

MR. JOHNSON: Thank you, Mr. Chairman and Ranking Member Garrett, and the committee members.

As an academic, I thought I might take a moment and step back and try and provide some historical context as to why the over-the-counter derivative markets look like they do. And the first OTC derivative that was publicly announced, I believe, was a cross currency swap between IBM and Solomon -- I mean IBM and the World Bank back in 1981.

And there was probably activity before that. But at the time there was tremendous legal uncertainty as to whether it was even legal to do over-the-counter derivatives. And the biggest concern, at the time, was whether or not these over-the-counter derivatives were what we call illegal, off-exchange futures transactions and thus subject to CFTC regulation and were -- and could conceivably be held to be void by the courts.

And what began then for a period of about eight years -- seven or eight years -- was a tremendous -- perhaps we'll call it a turf war, going on between the CFTC's thoughts on asserting jurisdictions over this growing market and the large dealers pushing back, oftentimes with the help of regulators, to keep this as an unregulated and customized market.

In 1989, the CFTC officially agreed to not exercise jurisdiction over the over-the-counter derivative market, provided that the transactions were not standardized, and provided that they weren't cleared or didn't enjoy a exchange offset. And so essentially, what happened is, because of this legal uncertainly, the goal of the OTC market was to look as little as possible like, exchange traded derivative transactions.

In 1993, Congress gave the CFTC authority again, to not regulate over-the-counter derivative transactions, provided that the transactions were not standardized. And so in the initial history of the over-the-counter derivative markets, you have tremendous pressure to drive the over-the-counter activity away from what we appear to be trying to do today, to try and get them back to being more standardized and putting -- and put back on to exchanges and traded in a way that might minimize the risks that we've all been talking about.

The problem we have now is we have a global industry that was initially driven by the efforts not to look like standardized transactions that could be cleared and traded over exchanges. So you have a global market that has designed products, created infrastructure, and to do all of the things that we don't want them to do right now.

Now, we're trying to force them back into the model where they are standardized, where they are cleared and enjoy some of those different benefits. The reason I bring this up is, one, again because a lot of this -- the situation we're in was caused because of, I guess, what you'd call regulatory competition over who is going to take control over this particular market.

And the problem we have is we have a very mature and a developed market that doesn't operate in the way that we want it to at this particular moment, and it will probably take time and not just from regulators and from Congress to start doing the kinds of things that we have been talking about today.

When you look at Secretary Geithner's May 13th letter where he talked about what we should be doing to regulate over-the-counter derivatives, his last paragraph is almost a throwaway paragraph and his -- one of his last lines in the letter is, "We would like to promote the implementation of complimentary measures in other jurisdictions."

And essentially, what he is saying is that if we try and regulate here without getting similar regulation in Europe and Asia, that we run the risk that we're going to drive this market offshore. I'm not trying to trivialize this point, but if you look at the OTC markets, it is a bit like a big round children's squishy ball.

And when you grab it and you try and conform it, it pops out in funny directions. And again, I'm not trying to trivialize what we're talking about, but this is a truly global industry that will move quickly and easily from jurisdiction to jurisdiction, wherever it is easiest to trade, and where we have the least regulation.

Concern of course is that we -- that we don't do this and that we're able to preserve the dominance that our institutions have developed and to maintain some control here in the United States. Thank you very much for your time.

REP. KANJORSKI: Thank you very much, Professor. Thank you.

Now, we'll see if we have any questions from our colleagues. And I'll start off. First, let me ask a very obvious question.

Is there anyone of the six of you on the panel that feels there is no corrective action that is necessary taken by the Congress in regards to derivatives?

So I guess, we have uniform agreement that there are at least some or many fixes that should be made in the field of derivates to improve the situation at present, is that correct?

MR. JOHNSON: Yes, Mr. Chairman, I think that's correct. As I mentioned in my testimony, I focus on the efforts that have taken place over the last several years. In very close dialog between regulators and the industry, to identify some of these things -- some of these issues.

There are other parts of the proposal Secretary Geithner particularly on systemic risk and how you address that issue that really cannot be addressed in that private/public dialog. It really needs to be addressed by Congress.

REP. KANJORSKI: One of the issues that the professor brought up in terms of, after the recession is over and after the recovery is had, the next natural pressure will be shopping for forums for the derivative industry and will be -- back in the competition. Is it New York, or is it Chicago, or is it London, or is it Peking going to be the capital, where the industry goes. It perhaps will be a race to the bottom of the least regulated area in the world.

What would you or what could we do to create a position in the American market at least that would deny either getting the contract satisfied by assets held in the United States or some other means so that we wouldn't change the forum of where these actions are taking place.

In other words, can we in America law say any action taken in the derivative market in a foreign country that does not have an equal regulatory regime as the United States will not be actionable in the United States? Would that tend to be detrimental to their being traded abroad or in a different form than they are now?

MR. JOHNSON: Mr. Chairman, I would like to take that question. First of all, I disagree with the premise that derivative's dealers will automatically be looking for jurisdictions to operate in which present the loosest regulation.

It has become abundantly clear to us that even if our own house is in order, if our neighbor's houses are not in order that presents problems to us as an industry. So, I would be careful about accepting the premise of my co-panelists as being fact for all derivatives dealers.

Secondly, I do think one of the key unintended consequences that need to be avoided and you used the word, I believe, actionable, in your question is creation of legal uncertainty about whether contracts are enforceable.

These contracts are market sensitive instruments, which vary in value based upon the underlying market factors on which they are based. And I would urge Congress to avoid any formulation which calls into question the legality of existing contracts based upon any of a number of criteria, which I think has the potential to be significantly destabilizing.

REP. KANJORSKI: So rather than provide for actionableness as the qualifying factor, do you think that by trading or international agreement we could stabilize the world market recognizing standardized conditions?

MR. THOMPSON: I think it would be much more effective and important for American policymakers to make sure that whatever steps we enact here in the United States are broadly consistent with the regulatory regime overseas as well to avoid any regulatory forum shopping of the nature you mentioned before.

REP. KANJORSKI: What portion of nations would have to be participants in that type of standardization of a treaty or otherwise to accomplish the end? Do we have to get 75 or 80 percent of the countries? Not certainly all because we can't -- (inaudible.)

MR. THOMPSON: No, I would imagine it would be you know, Mr. Johnson, is right, this is a global business, but it's a global business which is concentrated in regional hubs New York, Chicago, London, Paris, and a number of Asian jurisdictions -- are the principle ones. I wouldn't limit it to those and I can't give you a precise number.

I think your instinct that you wouldn't have to achieve unanimity in the international community but some, you know, reasonable number of major jurisdictions having the same regulatory framework is probably the right one.

MR. PICKEL: Mr. Chairman, I might also add that there are existing international groups that I'm sure you're well aware of like IOSCO, the securities commissioners; there is the Basel committee which is very important on the bank capital front, and also the newly formed Financial Stability Board, formerly the Financial Stability Forum, which provide frameworks for regulators across the major jurisdictions to coordinate.

And also is actively involved in meeting with regulators around the world getting the word out about, for instance, these commitments made to the New York Fed in the letter last week. I was just on a phone call with the Australian regulators last week.

We had our meeting -- our large annual meeting for members in Beijing in April, and we're addressed by senior regulators from the Chinese community.

REP. KANJORSKI: Thank you very much. I assume my time has expired.

Mr. Garrett, you're recognized for five minutes.

REP. GARRETT: I thank the chairman. I thank the panel.

Mr. Thompson or anyone on the panel, following the chairman's comments, which was certainly going to the direction that if you do certain things in this country we might push the industry off these -- offshore and in your suggestion and others may concur that it may not be an issue of a race to the bottom.

Maybe the flip side of that question is, is there something that we would do -- actually do that would actually attract them back here to this market and say -- and not just by having a proverbial Wild West, as some would say, approach to it.

MR. THOMPSON: Yes, I think that if correctly done, this has the potential to make the United States a pillar of financial responsibility in the sense that regulation intelligently applied will reduce systemic risk, increase transparency and if it is done in an intelligent fashion where it doesn't by virtue of unintended consequences restrict the ability of end-users, mainstream American companies and the like to continue to access custom risk management solutions from the OTC derivates market.

I think it has the potential to make the United States a pillar of responsible financial regulation and perhaps enhance the image of this country internationally.

REP. GARRETT: I would also reference back this whole discussion about legal certainty. The act passed by Congress, the Commodity Futures Modernization Act in 2000 provided that legal certainty and Secretary Geithner's letter makes it very clear and you've heard from the panelists today that we should not tinker with that legal certainty.

In that situation if the wrong decision had been made, the business would have almost by necessity had to move elsewhere. Here, we're talking about aspects of regulation. It may on the margin increase the costs, may in some cases, decrease the costs. That will be a calculation in the decision as to where a transaction might be traded or booked. But we're not talking about undermining the fundamental enforceability.

MR. : And to --

REP. GARRETT: Following along that line along the adding the costs, and maybe Mr. Murphy or others want to chime in on this, a couple of thoughts come to mind.

One is -- one of the proposals that are out there is with regard to clearinghouses, right? And one of the ideas is you have one central clearinghouse and other is multiple clearinghouses.

And one aspect of that is to force on the mandatory use of the clearinghouse.

So could we do more harm than good if we said -- first question would be, is that we have a mandatory use to, basically standardize the marketplace; would that extract or distract?

And along that line we had a gentleman speak to us the other night. And he made this point which I assume very quickly he said that it's counterintuitive. It's almost counterintuitive is that if you allow for the option on the clearinghouses that in fact in order to gain the liquidity that, like Mr. Murphy and other industries would want in the marketplace, do you actually be driven naturally to that clearinghouse because that's where you're going to find the liquidity as opposed to outside of such a clearinghouse mechanism. Is that argument correct, and do you see the -- answer the first question as well.

MR. MURPHY: Well, let me just if I can just back up on this international U.S. issue. From a business perspective my concern is not this, you know, so called race to the bottom. My concern is as a global company 3M has competitors in -- all over the world, Germany, Korea, wherever the case may be.

So it is not a concern about business leaving the U.S., my concern is if I have a competitor in Germany and he can call up his or her banker in Geneva, and deal in the OTC market on a, you know, more or less unfettered basis and we have to deal with a, you know, a different more stringent regime here in the U.S. Now, we're at a competitive disadvantage in terms of our ability to manage risk.

REP. GARRETT: Right. So if you have a mandatory clearinghouse arrangement where you're required to have a cash or collateral backstop to that over here that may create problems actually both over there and over here, do you -- (cross talk.)

MR. MURPHY: Yeah, I mean there is really two issues with the mandatory clearing. Issue one, you may notice this large book that I've brought today with lots of 3M products inside of it.


This is FAS 133, this is Financial Accounting Standards Board's ruling 133, which governs the accounting treatment for derivatives for corporations.

As you might imagine, you know, not a lot of pictures in here, not really -- very light reading, it is a very difficult standard, very stringent, it's getting harder to meet these requirements and not getting easier over time.

The problem with the clearing or exchange environment is that by their nature, products must become more standardized to work in those environments. And when you have a specific business risk, you need to further standard -- hedge it with a specific hedge that matches up very precisely with that risk.

And so if you move to a clearing environment, which is standardized by nature, you end up with a mismatch. You cannot precisely manage the risks, and so what happens is at the corporation you lose hedge accounting treatment which means the mark-to-market on those hedges hits your P&L, your income statement every quarter.

And that is definitely something, as a corporation, you do not want to have happen, and so what that would lead to frankly in my opinion is, you know, companies would probably do less hedging, frankly. So that sort of issue one, is being able to meet this.

The second issue is just the cost issue. We've done some studies, one of my colleagues and I, over the last month say -- over the last three years, what would it cost 3M if we were in a mandatory clearing environment?

And without looking at the administrative burden, without looking at any trading fees, even though all the trading fees are probably not a huge number. The margin required on average for 3M over the last three years would have been $100 million.

At its high point in 2007, it would have been as much as $200 million, so that ($)100 (million) to $200 million of our balance sheet which we would have to move into this clearinghouse account essentially would just sit idle.

Now, 3M is a highly rated corporation --

REP. SHERMAN: Mr. Murphy, the time has expired.

Thank you, Mr. Chairman.

REP. SHERMAN: Now, I'll recognize myself for five minutes. AIG was under the control of ravenous and reckless management, greedy management, not -- yeah, I'm not saying there aren't similar managements in control of other corporations.

But in spite of that management the regulated insurance companies did just fine because the regulation was the counterbalance for the ravenous, reckless, and greedy nature of the management. The unregulated portion failed and no one was hurt much except the taxpayer, the economy.

The officers and directors seem to be doing just fine and more importantly perhaps the counterparties have been insured to the last penny. What concerns me is that everyone in this room is just focused on how is it working for corporate America and not what has happened to the economy, the country, and what risks have been taken by the taxpayer.

Now, is there anyone on this panel that can say that your organization came to Congress a couple of years ago and said, "My God, you've got to stop what's going on in our industry. It threatens the world economy. AIG has gone crazy. Other companies have gone crazy." Is there anyone here that wishes to say that being on the frontline they looked, they saw, and they won?

I see no volunteers. We are told that we could, through legal action make it so that the next AIG was a foreign company. We're told that if you -- that this is really an international business, which begs the question why is it the U.S. had to bail out AIG and the foreign counterparties of AIG? And perhaps if bailing out is one of the responsibilities of the host government, wouldn't we want to drive this industry overseas?

Mr. Pickel, is AIG a member of your organization?

MR. PICKEL: Yes, AIG is a member of our organization.

REP. SHERMAN: When you saw them taking risks that could bring down the economy and forced them to squeeze taxpayers for over $100 billion, did you demand that they take corrective action or kick them out of the organization?

MR. PICKEL: The nature of our organization as the member organization, we don't perform a self-regulatory function, so we don't enforce --

REP. SHERMAN: So if the devil wants to join your organization, the only question is does his dues' check clear?

MR. PICKEL: We have an extensive membership including AIG across the world. Yes, and that's --

REP. SHERMAN: But if the devil wants to join the organization, the question is does the dues' check clear.

MR. PICKEL: We are involved in education, in awareness --

REP. SHERMAN: I'm sure you do wonderful work.

Now, I'm told here we're losing the capacity to get the cheapest insurance most customized. Why can't I buy a customized fire insurance policy for my house from an unregulated Cayman Islands insurance company?

The answer is we've decided that we want secure insurance companies. We don't want to have to be bailing them out and we want the consumer to be paid. Mr. Murphy, I assume that 3M has insurance and fire and casualty and liability insurance.

Do you buy any of that from unregulated companies with no known reserves?

MR. MURPHY: I'll be honest with you. I'm not in the insurance area of 3M. We do purchase insurance for our facilities but I can't really give any more details on that.

REP. SHERMAN: And I've got a number of other questions. I'll ask for the record. I see my time has nearly expired. I now recognize the distinguished ranking member of the full committee, Mr. Bachus.

REP. BACHUS: Thank you, Congressman Sherman. I guess if the devil wanted to run for Congress we couldn't prevent that either, so I'm going to --


REP. SHERMAN: So we would kick him out. Wouldn't we?

REP. BACHUS: I'm not sure we would --


REP. SHERMAN: We'd kick him out of the Democratic caucus. I yield back.

REP. BACHUS: I'm not sure you would.


Let me see, what lessons has the financial services industry learned from the Lehman Brothers bankruptcy and from the near collapse of AIG? Any of you.

MR. FEWER: Let me comment briefly on AIG. They, through their credit default swaps were taking exposure to subprime debt, the collateralized debt obligations, certain tranches of those obligations. So they had an appetite for subprime exposure. In fact, through their regulated insurance companies, as Mr. Polakoff testified in the Senate Banking Committee in March, they were also taking on exposure to subprime past, you know, past the time that the financial products companies stopped taking on exposure well into 2006 and even 2007.

So that was the appetite they had. They also looked at risk in a very narrow way. The head of FP, the financial products division was quoted as saying, he couldn't imagine ever losing a dollar on these trades. And he was looking at that, really only in respect to payouts on the transaction. He wasn't really looking at the mark-to-market exposure which ultimately is what undermined AIG.

They also traded on their AAA. Which other institutions, in fact some of the institutions who have been the source of the greatest problems, Fannie and Freddie, some of the monolines have traded on their AAA resisted the providing of collateral, and even worse, agreed, in certain circumstances, to provide collateral on downgrades.

And frankly, ever since the Group of Thirty report published in 1993, it's been very clear that downgrade provisions where you provide collateral on downgrades are to be dealt with very cautiously because of the liquidity problems they can cause.

In fact, the banking regulators discourage them, they don't prevent them, but they do discourage the use of those types of provisions. So that's -- those are our observations on the AIG situation. And I think it's very important as we look forward in reform.

REP. BACHUS: Okay. Thank you.

MR. THOMPSON: Congressman, I -- you mentioned Lehman Brothers as well, and I think it's important to realize that there were other entities besides AIG who have been part of the financial crisis that we are in, and to recognize that not all of the financial difficulties which have -- we have experienced have been a result of OTC derivatives.

If you look at Lehman Brothers and you look Bear Stearns, for example, you see the classic banking error being made again and again, which hopefully we will learn from, which is buying very long dated assets that are somewhat illiquid, and funding them with overnight money in the wholesale money markets, which can go away at the drop of a hat.

And I think that if you look at exactly what happened to Bear and Lehman that was the paradigm although they were both major OTC derivatives dealers their OTC derivatives operations were mere footnotes in the story of Lehman and Bear. It was really compiling a large volume of 30 year mortgage related assets and funding them overnight in the repo market that did those firms in.

MR. PICKEL: I would like to also just add on Lehman Brothers. It's a very effective example of a clearinghouse existing together with the bilateral. The clearinghouse existed for interest rate swap trades and they settle out their trades very efficiently and parties on the bilateral, it's the master agreement relationship move to terminate and close out on a fairly, you know, reasonable timeframe and crystallize those exposures.

REP. BACHUS: Okay. Thank you. Professor?

MR. JOHNSON: I think one last sentence. That intellectually, we always knew that a big dealer like a Lehman or Bear Stearns could go insolvent. But given the amount of trading that were going on with those institutions I'm not sure that we expected it actually to happen, and that it was sort of one of those 100-year events. And I think the reality has woken up a lot of people that how any counterparty can have these kinds of trouble.

REP. BACHUS: Thank you again. You know, I think that AIG never imagined that these things could go down. I guess a lot of homeowners, a lot of people involved, commercial property and houses sort of assumed the same thing. Obviously, to their detriment but I appreciate those responses and I think they are very entitled.

Dr. Johnson, you mentioned, you know, the turf battle here in Congress sometime between CFTC and SEC. Now, the Commodities Exchange Act actually excludes credit default swaps from a jurisdiction of -- well, they are excluded from the coverage of the Commodities Exchange Act, so the CFTC draws its jurisdiction from that act.

So if we were to give some function as -- on credit default swaps which are really meant to ensure against default by a, you know, publicly traded company, I guess, or a group of publicly traded companies on their -- defaulting on their debt. If we did -- if the CFTC was given that authority would we have to amend the act, or do they have jurisdiction?

MR. JOHNSON: Well, you know, clearly there would have to be -- there is going to have to be a lot of regulatory changes to do what we are trying to do based on the current structure that we have. And that becomes the real question as to who we are going to give this regulatory authority to. And that's been the battle since the early '80s as to who gets to regulate this particular industry.


REP. SHERMAN: The time of the gentleman --

REP. BACHUS: And I'm not advocating regulation.

REP. SHERMAN: I thank the gentleman and recognize the gentleman from Massachusetts.

REP. LYNCH: Thank you, Mr. Chairman. At the outset, I would just like to say if we can't fix this system, given the experience we have had with this, if we can't fix it and allow our investors and institutions to, I think literally rely on a derivatives trading system, it is probably better that it go overseas rather than put the stamp of this country and the full foot -- faith and credit, you know, of this nation behind such a system if we don't think it is really sound.

Now, you know, I've heard that argument before from other firms within the financial services industry that, you know, if we regulate this industry it will go overseas, well, you know there are probably some folks over in London that sort of wish that, you know, that type of dynamic had not been created.

A couple of observations that I want to make, Dimitris Chorafas, he wrote that, "Compared to horse-and-buggy classical bonds and equities, a complex derivatives are supersonic engines." And I just want to bring to mind the power of derivatives. I will readily admit there is some advantage to be had from their use.

But I am very concerned about the idea that there would be customized derivatives outside of a regulatory system. Because I think there is a certain attraction to firms, such as 3M and others, to have a derivative customized to their very specific situation. I understand the attraction of that.

I also understand that where AIG and some others got into some tough situations in terms of the derivatives they were holding is that they weren't fungible, they were so uniquely crafted that no one could determine what the value of those derivatives were and what -- and there was just no buyers in the market so it seized up. So there were advantages but it also created problems.

Well, let me ask you this question. If we allow a customized derivative industry to operate outside of -- just over-the-counter, without anybody knowing the details and the dynamic of those customized derivatives, and frankly, stability has always been gained at some cost to innovation. It is just the way it operates.

But if we're going to allow that to happen, this opaque and complex system, customized derivatives to be traded over-the-counter, how do the regulators protect the American system here, our financial system if we don't know what's going on out there. The only limit is the creativity of some of those folks at -- over at MIT, some of them live in my district.

How do we allow that to operate when, with a lot of the good that your industry might do you also have the ability to destroy the economy and bring the economy down. How do we balance that?

MR. THOMPSON: Well, I would like to address that. I think that the framework that we've been working on with the Fed and the other regulators provides a paradigm here where you have clear transactions between major dealers that are standardized being given up through a clearinghouse.

And then with respect to transactions that are not cleared, you have central trade repositories which contain all of the trade information of those non-cleared transactions, whether they be not clear because of their degree of customization, or because of the counterparties to the transaction which are accessible to regulators in whatever form and as frequently as they want it.

REP. LYNCH: Okay. I understand that part so far. But let's go back to -- my point was, if in these derivatives, you get a substantial number of derivatives that we call it, there-are-too-many- people-on-one-side-of-the-boat phenomenon.

Like we had with AIG and a lot of others, where unbeknownst to us -- (cross talk) -- everybody had loaded up on the same positions, those positions went bad, everybody tried to liquidate at the same time and because we didn't know what the counterparty risk was there we couldn't do anything about it, and so the boat sank. How do we get at that when we have an opaque system of customized derivatives? How do we get at that problem?

MR. THOMPSON: Well, I don't believe you would have an opaque system of customized derivatives because all of the customized derivative trade level information would be in the trade repository and would be available to the systemic regulator on a more or less real time basis.

So to use your analogy, the systemic risk regulator sees who is going over to one side of the boat and is able to take preemptive action before everybody moves over to one side of the boat, or before one major market participant, like an AIG, gets way over to the one side of the boat so --

REP. LYNCH: And I just -- well, I appreciate your attempt there. But having looked at these derivatives and how complex they are, and if they are all carved out individually customized to these firms and their situations, I don't think there is any systemic regulator who is going to be able to make that determination based on the instrument itself. These are very, very complex, mind numbing how complex these things are. And I just don't think that's a realistic expectation.

I think I've exhausted my time, Mr. Chairman.

But I appreciate your attempt to address that. And I appreciate the attendance of all the witnesses. Thank you.

REP. SHERMAN: I will ask you, for the record, to comment on whether instead of just making this available to the regulator every word should be put on the web of everyone of these that are in the depository. But I have no time because I yield to the gentle lady from Illinois.

REP. BIGGERT: Thank you, Mr. Chairman.

This -- my question is directed to all of you or whoever wants to answer. There has been much discussion or warning rather against a one-size-fits-all approach. So my question is, should we have three buckets of OTC products, for example, number one would be standardized OTC products potentially traded on an exchange, or -- and two, OTC products run through a clearinghouse or central counterparty.

And three, customized OTC products that retain -- that remain privately traded, but are reported to a warehouse. So how would these be defined, and how would you define these. And then second, should a trigger mechanism be established so that all OTC products clearly fall into one of these three buckets?

MR. PICKEL: If I could just comment. I think that is a very good division of how this market will evolve and it's already in the process of evolving. You would have the -- an exchange traded or perhaps an electronically traded element, that would allow -- well, the highly standardized trades to be traded that way.

You would have this category of clear trades and then you have the customized trades. I think it's -- you know, with the question of, you know, where a product is in the standardization process is largely a function of how actively traded and how liquid the underlying market is.

Because, keep in mind, a clearinghouse will need to at least daily and sometimes twice daily mark those positions to market and call for a margin. And so it needs to have a liquid market for that product. An exchange needs an even higher degree of liquidity. Market makers who are active in the exchange, ready to do a transaction, you know, at any time during the day, the trading day. So that kind of -- that liquidity, I think, largely drives where the dividing line would be. But that's not an easy determination to make.

REP. BIGGERT: And then what about the customized OTC products that would be privately traded, there would be no control over them, except reported to the warehouse?

MR. PICKEL: Well, there would be -- the reporting to the warehouse, there would be -- most of the dealers who are engaged in these transactions would continue to be regulated primarily by the banking regulators. And then for those entities that would fall into this category of taking on significant exposure to counterparties, the systemically important entities, you would have the systemic risk regulator overseeing their activities.

REP. BIGGERT: Could you suggest a trigger mechanism then that would help to ensure that they fall into one of these buckets?

MR. PICKEL: Well, I think that that is the important issue. And we were actually engaged in conversations with the administration about, you know, how we would go about identifying what is sufficiently standardized to move to a cleared environment and then furthermore to an exchange traded and electronically traded environment. And I think that's something that the administration is wrestling with currently.

REP. BIGGERT: Okay. Anyone else like to --

MR. THOMPSON: Yeah, I would like to add -- (cross talk) -- to the measures that Bob mentioned about the customized bucket of OTC derivatives.

We are broadly supportive of the steps that Chairman Gensler outlined in his recent testimony in terms of codes of business practices, increased capital requirements, strengthened antifraud and market manipulation, and trade reporting.

So I don't think it's fair to say you would be relying entirely on the trade repositories as the only measure. I think there are a host of other measures that Chairman Gensler thoughtfully has outlined then that are broadly consistent with the administration's proposal as well.

REP. BIGGERT: Okay. Thank you. Then another question is can -- would any of you care to describe any issues that you may have with the Waxman-Markey bill and how do you feel about a new transaction fee or a tax? No interest in that?

MR. PICKEL: Well, we've weighed in reports with other organizations that are members to oppose those provisions. And I think that, you know, imposing a tax -- just as this has been debated over the years about imposing a tax on futures trading. I think it harms the efficiencies of these markets.

REP. BIGGERT: Okay, anyone else? Well, then just -- if it's been a concern that some of the OTC derivative products are not safe for retail investors, should we restrict their -- simply restrict participation in these markets. So we heard long ago that there was -- these were not for the people that were in pensions or whatever. But for those who had the ability to take a loss on a large amount of money and somehow it seemed to have slipped from that. Is there any concern that we would go back to that?

MR. THOMPSON: Well, I think it's fair to say the over-the- counter derivative market is already an institutional market. The eligible contract participant requirement in the Commodity Exchange Act restricts it from retail investors. Now, I guess one can quibble about whether that's been set high enough, low enough, or whatever, but it is not and has never been a retail market, unlike the exchange- traded markets.

REP. BIGGERT: Okay. Thank you, I yield back.

REP. KANJORSKI: The gentleman from North Carolina Mr. Miller.

REP. BRAD MILLER (D-NC): Thank you, Mr. Chairman.

You all have spoken of derivatives as being a risk management tool. But it appears that there is a great deal more on derivatives contracts than there is risk to manage. Mr. Kanjorski estimate -- repeated the estimate $500 trillion on outstanding contracts. Mr. Bachus said ($)684, just the number I have heard more often, trillion.

Our GDP is about ($)14 trillion so that's a big number. I know it's not a real number, it's a notional value with both sides of transaction on and on. But it's still a big number. Do you have a sense of how you -- what percentage of the outstanding contracts actually have one of the parties to the contract with, with an interest in the underlying asset, but I was hoping for a short answer not an essay on that.

MR. PICKEL: We don't have a statistic on that specifically. In the credit default swap space there is discussion about whether, you know, 10 or 12 percent or something like that would have that underlying interest. But in --

(Cross talk.)

REP. MILLER: There has been a lot of criticisms of naked derivatives that it creates tremendous uncertainly about what the real economic consequences are for an event, that would appear to be not that consequential. It creates an interconnectedness, that means that a great many institutions are too interconnected to fail.

And some have even said that it means that there are great many economic players who stand to profit from what appears to be an economic loss and have a power to make it happen. There was an article in the Financial Times about six weeks ago about a -- about a bank in Kazakhstan. I'm sure you know about it.

Times have been tough in the -- economically -- in the former Soviet states and the Kazakhstan government took over the bank. Morgan Stanley had debt that they owed -- that bank owed Morgan Stanley debt. Morgan Stanley could call the debt due if there is a change of ownership. Morgan Stanley said, initially, "No, no, go ahead. Just keep making the payments." And then they changed their mind and said, "No, come to think of it, we want you to pay it all." Which they couldn't.

And shortly after that, or about the same time they filed with the International Swaps and Derivatives Association to start formal proceedings to settle credit default swap contracts with that bank and the suggestion -- Financial Times suggestion was that they actually made more money on their credit default swap positions than they would if they got paid by the bank.

Is that concern a valid one? Is that something we should worry about? Will -- Willem Buiter, a prominent economist, despite my difficulty in pronouncing his name, has called for derivatives to become instruments of insurance risk management rather than instruments for placing bets for gambling.

Why -- what is the social value in allowing derivative positions when neither party of the contract has any interest in the underlying contract, give -- I mean, there are obviously a lot of downside to that. What's the advantage?

MR. PICKEL: Well, let me there -- there are a number of things to focus on that. One is this Kazakhstan situation where we, as an organization, and our member firms have been very sensitive to the issue of making sure that there is a Chinese Wall, there is a division between the lending operation of a bank and the trading or CDS trading side of the bank.

We have published a number of guidelines, rules, people follow those very closely. I think Mr. Thompson could elaborate on what is -- how that is addressed at J.P. Morgan, I'm sure. So that is in place. Furthermore, yes, Morgan Stanley did present the question to our determinations committee. It is the -- but that's a committee of 15 firms represented. And they all agreed that what happened there was a credit event, so there was a unanimous support in the market.

REP. MILLER: Why should there but -- but more fundamentally, why should there not be something resembling an insurable interest? Why should 200 people be able to buy life insurance on someone who turns up the victim of foul play? Why should there not -- why should there not be a requirement of an interest in the underlying asset? If there is not, how is it risk management?

MR. PICKEL: Well, primarily, because if you want to be able to have a product there for those that do need to hedge a risk, it's important to have a market there where people are willing to take a view on whether the pricing of that is cheap or expensive, so providing that liquidity.

Furthermore, you've got, you know, you've got the traditional bond or loan holder, but you've got other individuals including the dealers who sell the protection to those people who hold the bonds and loans who will also need to manage that risk. So it's a complicated issue of many different types of risk even though the underlying bond and loan maybe only held by 10 or 15 percent of the users.

REP. MILLER: I have probably not enough time to ask another question. So I yield back.

Well, Mr. Murphy, you mentioned or you held up the FASB rule on how derivatives are treated in accounting. Insurance -- or reinsurance, we don't have much control over reinsurance companies. They are -- it's an international market, much of it is through the markets at Lloyds.

But American insurers only get safety and soundness -- credit from their safety and soundness regulator, state insurance commissioners, if the parties with which they have reinsurance meets certain criteria, why should there not be a similar requirement, or is there a similar requirement for safety and -- how are derivative contracts treated for safety and soundness purposes by financial institutions?

MR. MURPHY: I'm not sure I have an answer for that. I think, maybe Mr. Thompson might be better qualified.

MR. : You used an --

REP. MILLER: Obviously, it is both an asset and a liability, how is treated on the books, how is it treated by safety and soundness regulators?

MR. THOMPSON: So how is -- how are our derivatives activities accounted for?

REP. MILLER: Right -- (cross talk) -- how are they treated for safety and soundness regulation?

MR. THOMPSON: Okay. Well, from an accounting perspective, we operate under a different regime than 3M has opted into with respect to its derivatives hedging activities. We, as a dealer, are subject to mark-to-market accounting with respect to our overall portfolio derivatives transactions.

So everyday, at the end of the day, we tote up all of the gains, tote up all of the losses. And those unrealized gains and losses, as they are called, are listed as assets or liabilities respectively on our balance sheet.

REP. MILLER: And in any of that do you take into account whether the counterparties can actually pay?

MR. THOMPSON: Yes. And in fact under so called fair value accounting there is something applied called a CVA. It's called a credit valuation adjustment, such that, if we, for instance, and 3M being the kind of credit that it is, is a bad example. But I'll use them anyway.

If we have 3M as a counterparty and they owe us, let's say, $100 million across 10 different derivatives contracts. And 3M's credit rating declines, or actually we teed off their credit default swap spreads. If their credit default swap spreads indicate that they are a riskier credit. In effect, we haircut the $100 million that 3M owes us and we will claim it as an asset for, let's say, ($)95 million instead of ($)100 million applying a credit valuation adjustment of $5 million to reflect the riskiness of the asset that we hold on with respect to which 3M is obligated.

REP. MILLER: I really have exceeded my time, Mr. Chairman. Thank you for your indulgence.

REP. KANJORSKI: Thank you very much.

And now, the gentleman from Georgia, Mr. Price, for five minutes. Okay, if you want to subvert the rules on the Republican side -- okay, we'll recognize Mr. Hensarling for five minutes.

REP. HENSARLING: Thank you, Mr. Chairman.

Somehow this may be a little bit of old ground, but I want to put a finer point on it. A Reuters' article came across my desk a couple of weeks ago. And it has this takeaway. I'll quote from it, it's a May 14th article quote, "The Obama administration's plans to move derivatives trading to exchanges could end up hurting companies that use the products, because accounting rules often make customized, off- exchange products a better choice for corporations.

"In the end, the administration will have to limit the scope of the reforms it is looking for, press for new accounting rules for derivatives or risk killing the market for corporate derivatives, experts said," -- whoever those experts may be --I have a panel of experts before me now.

Mr. Murphy, you've commented somewhat on this. Well, could you put up a fine point? Must -- is changing FAS 133, one of the potential answers to this dilemma? And I think you mentioned that already, it is being somewhat moderated, if that's a proper term?

MR. MURPHY: Well, it's definitely not getting easier. I mean, this is a slope that I probably don't want to go down, but I mean, clearly if we move to an exchange or clearing environment, companies would have to reexamine, you know, whether they can continue to hedge under these regulations.

So if you said that they were going to be relaxed somehow, you know, could that possibly, you know, give kind of more running room to continue to hedge risks, I would say, "Yes, that's a possibility," but this is, you know, a big complicated document. And I think changing it would probably not be a slam dunk either, but I mean it's a possibility.

REP. HENSARLING: Anybody else care to -- Mr. Thompson?

MR. THOMPSON: Yeah, I would like to address the question, maybe go through the accounting in a little more detail to make sure everybody understands it. Under the current accounting framework, the general rule for derivates is they need to be mark-to-market. That applies to everybody including 3M.

And the rationale there is clear, their value changes day to day, your financial statement should reflect the value of your assets and liabilities, so to the extent that those assets and liabilities change day to day that should be reflected in your financial statement.

Hedge accounting reflects a very narrow exception to that, and it generally goes like this. When you have a specific liability or a specific risk and you have a derivate so closely associated with that liability, that they are essentially part and parcel of each other and a gain in one will exactly offset a loss in the other, you can ignore both marking the liability and the hedge to market, and ignore fluctuations in the derivative value.

To the extent that you relax FAS 133, and require a looser fit between the hedge and the risk that the hedge is hedging, you then -- you have a problem with respect to fair value accounting generally, because you will allow people to avoid fair value accounting with things that are not a perfect hedge but only an approximate.

REP. HENSARLING: Let's talk about AIG for a moment, since AIG really put credit default swaps on the public's radar screen.

I would think in any prudent system of risk management that pubic policy would want to encourage the proper use of credit default swaps in their risk management. Clearly, in retrospect, AIG took oversized debts that ultimately someone decided -- the taxpayer must be compelled to bailout. I'm sure you know it wasn't me.

But the acting director of OTS under oath in this committee said that his regulatory body had the manpower, had the expertise, had the regulatory authority to curtail AIG's CDS position, they just missed it. They just made a mistake. So I guess my question would be this, if we had this concept of a clearinghouse in place prior to AIG's meltdown, what type of difference might it have made and as we attempt to lessen the risk in the system and clearly the flip side of risk is rate of return, but if all members of the clearinghouse are going to be responsible for risks, does that's not incent some to try to palm the risk off to the larger group and have we not perhaps even created more systemic risks and created the next big bailout with such a clearinghouse?

Anybody who cares to answer? Mr. Pickel seems to be the first to the button.

MR. PICKEL: Right. Now, that is certainly a concern with the clearinghouse and it's been identified by regulators as a significant concern, which is why having the appropriate regulatory oversight, having requirements for capital upfront, margin requirements, a reserve fund, all those things are critical components.

And then the dealers who have been active in putting these together whether it is the existing clearinghouse in the interest rates swaps base or the more recent initiatives in the credit default swaps base have focused on providing just those protections. But it is something that requires regular diligence to oversee and make sure that that clearinghouse does not in fact increase risk.

REP. HENSARLING: Thank you, I see my time has expired.

REP. KANJORSKI: Gentleman from Georgia, Mr. Scott is recognized for five minutes.

REP. SCOTT: Thank you, Mr. Chairman. It seems to me that the issue here is the central clearinghouse, whether or not we should mandate it. And there's been some concerns raised that if we do that, that it would drive business overseas. Then, there is also the issue of illiquid and un-standardized derivatives.

And I would like for you to kind of explain to me how having a clearinghouse as the Secretary of the Treasury Mr. Geithner has proposed, and which seems to be the drift here, would force this business overseas, is that true, first of all, and if so, if you'd explain how that would happen?

And since derivates are based on a value of something else meaning stock and so forth, which I think is liquid. What is an illiquid, an un-standardized, and does that bring a greater risk itself?

MR. FEWER: Congressman, there is a class of -- if talk about credit, there is a class of credit, credit product that is easily conducive to exchange listing. They are a family of, a composite of index products that frankly accounts for a very significant portion of outstanding CDS contracts. And these are very, very standardized products, trade in very large size, high trading frequencies.

There is a class of products, an example would be a bespoke basket of credit default swaps. Dealers have huge portfolios of credit default swaps that they need, they would like to customize and take some very difficult to trade names and put them in a basket and try to have -- try to have the market price what actual protection would be on that bespoke pool.

That would be a very difficult product to force through a potential counterparty clearance. However, it doesn't mean that there couldn't be prudent, from a risk based capital standpoint, and Basel II has done a lot of work along these lines.

But, also, the fact that a central counterparty clear and a trade repository would be able to bring some information regarding that trade, not necessarily give the specific trades that would expose dealers to having their proprietary positions open to the market but being able to give regulators the appropriate information and the ability to assess value of this very, very bespoke types of transactions.

But that would an example of a bespoke transaction as opposed to a index trade, which is a very high, high volume type; a very, very standardized transaction.

MR. PICKEL: I might add on the clearing point and whether that would encourage business to be done overseas. There's an initiative which ICE (ph) is involved in as are our major members with the European Commission to focus on establishing a clearinghouse over in Europe. There could be advantages to having a linkage between a U.S. and a European clearinghouse for the CDS products.

But that's an ongoing discussion so I don't see that -- I don't see clearing as such as a driver for moving certain business over -- at least a market driven reason for moving business here or overseas. It may be a regulatory driven decision, given the stand from the European Commission.

REP. SCOTT: Okay. Yes.

MR. PICKEL: I think that the moving-business-overseas argument is not one I must focus on as the risk that companies such as 3M and other end users of derivatives, if they are forced into a mandatory clearing for everything or exchange trading platform, would simply choose to leave risks un-hedged. And I think that's frankly the greater risk from a public policy perspective in the U.S.

REP. SCOTT: Let me just ask you -- and I got a little bit of more time left. I remember when this whole issue of derivatives came up, a great financial mind that we have all have great respect for, Warren Buffet, referred to them as weapons of mass destruction. Do you all think that Warren Buffet was right?

MR. THOMPSON: I have read that quote as well and after I read that quote I continued to go through Mr. Buffett's piece where he outlined his firms' derivatives portfolio, which as I recall, was a large portfolio of CDS index positions. A recent entrant by his firm in the trading single name credit default swaps, and I believe a large portfolio of puts -- long dated puts on the S&P 500 equity indices.

So, after I read the whole piece, which as is the case with everything with Mr. Buffett, very illuminating, I found it difficult to square the beginning characterization of derivatives with the detailed disclosure of his firm's active participation in a number of OTC derivatives markets.

REP. SCOTT: I see my time has expired. Thank you, Mr. Chairman.

REP. KANJORSKI: Thank you, Mr. Scott. Gentleman from Georgia, Mr. Price for --

REP. PRICE: Thank so much, Mr. Chairman.

REP. KANJORSKI: I am sorry. Okay, very good. Recognize Mr. Price for five minutes.

REP. PRICE: Thank you, Mr. Chairman, I appreciate it. Decisions that we make here are consequential. In fact a decision to do nothing is consequential. But my concern oftentimes here and I know that many of my colleagues share it, whatever we decide we oftentimes don't look at the outcome or the consequences of the decisions we make down the line.

So, Mr. Murphy, if I could ask you a couple of questions, as again the only end user of CDS on the panel of the day, how has 3M utilized CDS to benefit your consumers.

MR. MURPHY: We do not use the CDS products.

REP. PRICE: You don't?


REP. PRICE: And so in the process of this discussion, do you have any thoughts about whether we mandate a clearinghouse in this arena or not?

MR. MURPHY: In the CDS arena?


MR. MURPHY: I really do not have an opinion on that.

REP. PRICE: How about any over-the-counter products?

MR. MURPHY: Yeah, other over-the-counter products, absolutely.

REP. PRICE: And how is the use of over-the-counter products a benefit to your customers?

MR. MURPHY: Well, it benefits our customers because I mean it allows us to go into markets particularly overseas and be confident that we are able to price our products competitively and then manage the risks of, you know, converting those funds back into U.S. dollars.

I mean they are really pretty simple. We sell goods into Thailand and we enter into a very simple derivative that allows us to sell Thai bhat, buy U.S. dollar at a fixed rate, at a date out into the future. So we are able to go into those markets and more or less know what we are going to be getting back, and being able to bring back to our shareholders in the U.S. in the future.

REP. PRICE: Have you, has 3M changed any of the policies that you have regarding OTC products since the financial meltdown last fall?

MR. MURPHY: No, we have not. We just continue to be mindful that we want to spread our business around to various counterparties that we are not doing all of our businesses with one or two banks, we have a half a dozen institutions that we deal with but I would say we have not made any policy changes -- (cross talk.)

REP. PRICE: And the market for those products is same, greater, or less?

MR. MURPHY: It continues, it's really the same. I mean, it's continued to function very well all through last fall.

REP. PRICE: I want to pick up on some of the questions that my colleagues have asked about driving business overseas. Mr. Pickel, if I may, and I apologize for being out earlier but in your testimony you note that mandating that interest rate swaps, credit default swaps be traded on an exchange is likely to result in only higher costs and increased risk to manufacturers, technology firms, retailers, energy producers, utility service companies and others who use OTC derivatives in the normal course of their business. It will put American business at a significant disadvantage to their competitors around the world.

When you say American businesses, you don't mean the clearinghouses, you mean American businesses?

MR. PICKEL: I mean companies like 3M, Cargill, Boeing, others that have exposure either to interest rate fluctuations or currency fluctuations.

REP. PRICE: And in that risk to American businesses, you believe that that would drive businesses overseas?

MR. PICKEL: It's -- and I think Mr. Murphy has highlighted, it will increase their costs and decrease their competitiveness. So what --it would likely result in less business being done out of U.S. companies.

REP. PRICE: You know what other governments are doing to determine their systematic risks in the derivatives market or act upon their systemic risks in derivatives markets?

MR. PICKEL: Well, a lot of discussion is taking place over in the European Commission. It's right now focused primarily on clearing and establishing a clearinghouse for European credit default swap trades. The commission is in the process and we expect to see a report out of them in the next week, to two weeks regarding OTC derivatives, how they might approach some of the issues. We anticipate that it will touch on similar points to Secretary Geithner's letter from a couple of weeks ago.

REP. PRICE: Mr. Thompson, I've got just a few minutes left now. You mentioned that if we mandated a clearing that it would quote, "leave risks -- that -- and companies would leave risks un-hedged." What's the consequence of that?

MR. THOMPSON: The consequence of that is that a company who is an exporter and is exposed to fluctuations in currency risks may incur losses as a consequence of currency exchange rates that it would otherwise might not incur if it were enabled to hedge them in the manner that it wanted to in the OTC market.

REP. PRICE: So a decrease in potential business viability?

MR. THOMPSON: It's generally, being exposed to a risk that's not its core business. 3M is a great example. They make all these little things in the book and they do a great job of really use them. Their specialty is not forecasting interest rates or forecasting the exchange rate of the U.S. dollar versus the Thai baht. They would prefer to hedge those risks away and focus on their core business, which is the attitude of many of our corporate clients.

However, if they have to post liquid securities or cash to a clearinghouse or if they have to suffer income statement volatility because their hedges have to be on an exchange that does not qualify for FAS 133 hedge accounting, they face a difficult choice. Do I pay the increased costs, do I suffer the increased income statement volatility, and go ahead and hedge the risk anyway, or do I not hedge the risk and hope it works out for the best.

I'm sure some companies will pay the increased costs, I am sure companies -- some companies will say no, we will leave the risk open. I think in neither case is that good for America.

REP. PRICE: Thank you Mr. Chairman.

REP. KANJORSKI: Gentleman from Connecticut, Mr. Donnelly from Connecticut.

REP. JOE DONNELLY (D-IN) : No. Indiana.

REP. KANJORSKI: I'm sorry for Indiana. I am always putting you in Connecticut.

REP. DONNELLY: You have me on a vacation, sir -- (laughs.) Thank you, Mr. Chairman.

I guess I just like to ask following on, we heard about the risk to American business. I come from Indiana and I will tell you what the risk to our business has been. It was destruction in the credit markets and we saw business after business fail, because of what happened in the credit market. So when I think about risk to American business, I think about the entrepreneur's in my towns who credit simply dried up on, who were unable to have their function because of what happened, in part, in the derivatives market.

So that risk comes in many different directions. With naked credit default swaps, in reading the testimony we talk about enabling the transfer of risk between counterparties. Now, if we have naked credit default swaps where your -- where Mr. Thompson is betting on Mr. Pickel's package of securities and someone else is insuring it, what risks are your transferring? Isn't that just a straight bet?

I mean, you don't even own anything; you are just betting on somebody else's judgment? Anybody can, oh okay.

MR. THOMPSON: One thing, I think, one needs to keep in mind in the several naked CDS debates is there are a number of different market participants who use the products for very different purpose. There are hedgers, small banks for example, who hedge their loan book with their securities holdings, in a more traditional fashion.

There are also investors hedge funds, asset managers, pension funds and the like who engage in credit derivatives activity as an alternative to other investments either buying bonds or other funded financial assets and they comprise a significant percentage of the over-the-counter CDS market.

REP. DONNELLY: But that's not -- that's speculation that's not a risk transfer. That's a totally different --

MR. THOMPSON: You can assign it whatever term you like. I personally think of it as investing in the hope of getting a return, if that equals speculation, so be it.

REP. DONNELLY: But what risk do you have if you don't own the underlying assets to start with? You are not putting off the risk you have in owning those you are simply speculating on somebody else's judgment that is all you do.

MR. THOMPSON: But that investor is doing, he is deciding to take credit risks in CDS form instead of taking credit risk in more traditional forms such as buying the bonds of a particular issuer or buying loans of a particular issuer. That also happens frequently in the financial markets.

What we have seen with many investors is they prefer to take risk in CDS form because the CDS market provides diversified lower risk forms of credit risks such as the credit default swap indices, which are the most popular products in the over-the-counter CDS.

REP. DONNELLY: But it is not the risk of them having anything underlying that they own -- they are making a bet on someone else's judgment?

MR. THOMPSON: If you think of a typical investor, they are typically long cash, they need to invest that cash in an investment. That investment could be a traditional investment product such as a bond or a loan, or another form of funded financial instrument.

Alternatively, many investors prefer to transact in the derivatives market in a so-called non-funded product, whereby they get compensated for taking credit risks often through a broad based index of companies such as the CDX Index, which is the predominant index which trades in the U.S.

REP. DONNELLY: Why would making those trades more transparent result in less competitive conditions for American companies? Why would transparency harm their -- their ability to manage risks instead of being stuck in a drawer at AIG that everybody in Indiana eventually has to pay for?

MR. THOMPSON: I think that's an excellent question and I think the first one I would make in response to it is we are broadly supportive of increased transparency in the OTC markets generally and particularly in the CDS market. We've been working actively with the Fed and other regulators for the past four years to increase transparency, increase centralized clearing of standardized contracts including many of the index products which I have mentioned to you in my earlier remarks.

It is not at all the case that we are opposed to increased transparency in the OTC market. We do think that one needs to be careful when making decisions about market structure as a public policy maker to consider not just the benefits of transparency, but it does in certain cases have costs as well. And all we ask is that they will be a thoughtful debate about the relative cost -- (cross talk.)

MR. PICKEL: I would also just add that the risk that AIG was taking on through their use of credit default swaps represented a very small portion of the overall CDS business. And what they were doing was taking on exposure again through the underlying subprime risk and to the extent that -- I think that somebody said earlier that the CDS were hard to value. The CDS value is driven by the value of the underlying position of the CDOs that they sold protection on they were -- (cross talk.)

REP. DONNELLY: We say it was a small portion of it, but you know, it's like well that's a small natural gas pipe but it blew up the whole house. We are in a position where we have business after business that folded and encountered extraordinary difficulty because of what happened based on the credit market actions that began in New York, and in another places.

MR. THOMPSON: And no one is advocating another AIG and in fact a key part of many of the proposals, which we as an industry do advocate is the systemic risk regulator, which is professional, well funded, has a holistic view of risk across the entire risk spectrum. And the reason we advocate that is precisely to ensure that another AIG never occurs.

REP. DONNELLY: Thank you very much.

Thank you, Mr. Chairman.

REP. KANJORSKI: Next, the gentleman from Texas, Mr. Neugebauer is recognized for five minutes.

REP. NEUGEBAUER: Thank you, Mr. Chairman.

Mr. Murphy, besides derivatives are there other ways that you could hedge your currency positions in other ways or is that the sole way that's available to you.

MR. MURPHY: There are some operational things you can do. In certain countries, for example, where we don't use derivatives or the derivative markets are not developed, Latin America for example, you can change payment terms with the customers, you can take out, you know, debt in certain currencies and match that against some of your assets in those currencies.

But typically, you know that takes place in those more third world type markets. Where we have -- you know in G20 countries, where we have sophisticated competitors that have access to capital markets, we have got to be, you know, more nimble, more efficient from a pricing standpoint. And so the derivatives are clearly the number one way to go.

REP. NEUGEBAUER: Okay. Mr. Pickel, when you look at the market between what possibly products that could be standardized and then those that are custom, and I think you have done a pretty good job earlier of kind of differentiating what those definitions are. What today, if everything was sorted into two stacks, customized and standard, what would the mix be?

MR. PICKEL: It really varies by products type. In the credit default swaps space especially with some steps taken earlier this year to standardize a couple of other parts of the trading terms, there is a high degree of standardization across index and single name products.

So again, hard to say exactly what that number would be but, you know, people throw out the number of 80 to 90 percent but there is still, you know, a decent portion that would be customized.

In other product areas, for instance, in the interest rates swap world, where there is, there has been an existing clearinghouse in London where, close to the past 10 years, they clear about -- little over 50 percent of interdealer trade. So not the customer trades and not all dealer trades but a significant portion and there's probably more room there in the interest rates swap space to achieve more.

But in -- and also in the energy areas, there is a fair amount of clearing through an ICE facility that is used and also the NYMEX ClearPort facility. Equity derivatives there are some clearing options available. But it is hard to say exactly what that percentage would be.

REP. NEUGEBAUER: And one of the things that's being discussed is whether there should be one clearing or a multiple clearing, just kind of going down the row there, start and can you give me your perspective, one or many?

MR. FEWER: Most likely it would probably make sense that there would be one or two global clearance. The issues in Europe, I think surrounding what constitutes bankruptcy are probably being looked at and properly addressed so that there will be much more cohesion with the U.S. interpretations, so certainly no more than two.


MR. PICKEL: I think inevitably there will be many certainly to begin with but over time the market will determine and I wouldn't be surprised if we moved to two or one.


MR. MURPHY: I would agree with the many answer at least upfront. And I worry about from a bandwidth standpoint, the size of the market that is there a player out there that's really able to take this all on, one big bank.

REP. NEUGEBAUER: Mr. Thompson?

MR. THOMPSON: I would echo Mr. Murphy's comments about the bandwidth restrictions. These are incredibly complicated and difficult things to set up and get up and running. I also think it's worth pointing out that they are, by their nature especially if coupled with some form of mandated clearing requirement, anti- competitive in that, you have no choice. So having some alternative in the sense of one -- more than one is probably a good thing from that perspective.

MR. FEWER: I think it's going to wind up being no more than a handful.

I don't see the benefits to a regulator if it has to look at 30, or 40, or 50 different clearinghouses to start to find out the repositories might be.

Having said that, though I think due to the competitive nature of our business, you have to keep costs down and you have to handle high bandwidth needs of market that will mandate the need for two or three.

MR. JOHNSON: You know there are some academic evidence that suggest the benefits start going down if you have more than one.

REP. NEUGEBAUER: And a follow up question. What benefits start to go down, if you have more than one?

MR. JOHNSON: I think its efficiencies and preparedness I'd be happy to get you a copy of some of the articles on that.

REP. NEUGEBAUER: I would like to see that.

I see that my time is expired. Thank you, Mr. Chairman, and thanks to Congressman Bachus.

REP. KANJORSKI: The gentleman from Illinois, Mr. Foster.

REP. BILL FOSTER (D-IL): Thank you, Mr. Chairman.

When -- Mr. Johnson, on the last page of your written testimony, you have a very interesting pie chart with the different components of the OTC derivatives market. And one thing, the most interesting number to me there is the credit default swaps are 7 percent on which -- interesting considering what the effects that they have had on our economy.

But if you start with the big pieces, interest rate contracts are 71 percent and it seems to me that they represent a rather small systemic risk and are already exchange rated and so. And that really there is not a lot of action, that's necessary from our point of view there. Is that something you would agree with?

MR. JOHNSON: Well, I think the pricing is more stable although we had some wild gyrations that went on after the Lehman failure. I think they are either the more stable and more commoditized and as you --

REP. FOSTER: Are they expectedly all standardized?

MR. JOHNSON: No, they are quite different from each. I think one thing that the market has done though is that -- the pricing of them is very easy to do in terms of everyone is able to price them and come up based on -- (inaudible) -- and come up with that.

REP. FOSTER: And similarly the foreign exchange contracts those -- the transparency of those must be total, essentially?

MR. JOHNSON: Well, it's the most liquid and largest market in the -- the most liquid market is currency and so you do get -- tend to get better pricing although Mr. Murphy probably is quite better --

REP. FOSTER: Yeah, so would you also agree that the systemic risk probably isn't there, if that's what we are worried about?

MR. JOHNSON: Oddly enough, we have had terrible crises involving foreign currency issues back in '98 we had our Indonesian crisis, there where Hong Kong, other places were the problems teed off of foreign currency problems. Mexico, just recently had tremendous problems with their debts made on foreign currencies. It has bankrupted several companies there, tied to the derivative industry, and so it comes and goes, depending on how they are structured.

REP. FOSTER: All right. There's specific motions that we can make that you find attractive to try to stabilize that or prevent that sort of mess in the future?

MR. JOHNSON: Well, I think what is interesting is the good work that is being done in the credit default swap market. The regulators have nudged participants to clean up the area and to -- and to try and reduce systemic risk. Some of the best practices and it is almost become a model for, we could do another area -- just to move forward.

REP. FOSTER: And if I go to the next smaller slice, it's credit default swaps at 7 percent. And let us -- a general question, would have forcing all of the OTC derivatives on to a clearing or an exchange have prevented AIG financial products or at least the part that wasn't related to the mortgage lending or the securities lending business?

MR. JOHNSON: At least -- I think a huge problem with AIG was the -- it was their margin calls they have received since their credit rating slipped, and -- (cross talk.)

REP. FOSTER: Would that have been allowed -- if they had been -- I mean on an exchange, you know at least of the kind I'm familiar with.

MR. JOHNSON: They could have even be margined differently -- (cross talk.)

REP. FOSTER: Right, and so that -- at some points the people who supervised the margins and the capital -- the capital accounts here would have said, okay guys, you know, you are trading on the good name of AIG but we want to see the collateral and that is what would have stopped them? Is that a fair guess as to how the scenario would have played out? Or are there more -- do I not understand the mechanics of how AIG would have been prevented by putting in an exchange?

MR. FEWER: So, Congressman, I think that if -- at the time that what AIG was doing, was selling default swaps on very complex CDOs. If those credit default swaps were then subject to some type of margining certainly earlier on the dealers that were buying those credit default swaps, they hedged their own portfolio, would have looked at it and said, this doesn't make sense.

We wouldn't be able to post the margin that the exchange would require in order for us to do this transaction. So, in margin requirements particularly, in single name default swaps -- this is a complex issue because the default probability that the exchange would have to calculate to get the margin is something that needs work. But --

REP. FOSTER: Okay, so then you think you would say is to actually have margining and capital and collateral posting requirements --

MR. FEWER: Well, that's what it --

REP. FOSTER: To prevent this sort of -- you know that, that is what is actually more important than the transparency from exchanges or all the -- the transparency, I take it, was not an issue with AIG.

MR. FEWER: See the transparency of the over-the-counter market if it's really looked at is generally healthy and the perception that would happen in AIG really reflected the transparency of the global over-the-counter market is in -- there is not a direct relationship there.

Certainly, if there was a central counterparty clearance facility in place when a dealer would have went to try to book a trade to hedge his or the CDO portfolio the amount of margin required certainly would have --

REP. FOSTER: That would have triggered --

(Cross talk.)

And in order to preserve that you need to have that sort of margin requirement for both the customized and the non-customized things if you intend to use margining as the way of preventing future AIGs.

MR. FEWER: Yeah.

REP. FOSTER: Okay, thank you. I yield back.

REP. KANJORSKI: Thank you very much, Mr. Foster. Now, we'll hear from the general lady from Minnesota, Ms. Bachmann .

REP. BACHMANN: Thank you, Mr. Chair.

I had a question for Mr. Murphy, and I understand that earlier that you had mentioned that 3M would see anywhere between 100 to 200 million if that was accurate.

If -- should 3M have to post against their risk management activity?

Is this impact unique to 3M or what are you seeing with other countries across -- other companies across the board?

MR. MURPHY: No, it is -- it would definitely not be unique to 3M. And as we are a large company, you know, those numbers are large, probably relative to other companies, but you know, it could be a smaller company, a mid-sized company, a small company that, you know, ($)50 million in sales and imports, you know, goods from Germany, they could be in the same boat.

And frankly, you know, the smaller company is going to be even worse off because they will have, you know, fewer resources to credit than a 3M would. You know, they may have a single bank and that bank may not, you know, may have tighter covenants on their loan agreements, and so that capital is even, you know, more valuable or more scarce to a smaller entity.

So it would be very, very wide spread. It would not be limited to a large multinational like 3M.

REP. BACHMANN: And what about the issue of transparency. We hear that a lot, and I'm wondering, do you see transparency now being available on over-the-counter of --

MR. MURPHY: Well, I mean, certainly we have very lengthy disclosures that we have to make as a publicly traded company. That's not the same for a privately held firm, obviously. But we, you know, we see in foreign exchange, for example, over 50 percent of the volume in foreign exchange is done on electronic platforms.

And we're definitely in favor of the idea of potentially the trade repository where that information gets delivered on a more real time basis. We'd like to work with the committee on that effort. So we are definitely not opposed to greater transparency.

But I mean, I can tell you the market today is certainly, you know, much more transparent than it was 5 or 10 years ago.

REP. BACHMANN: And what would your suggestions be on the efficiency and transparency? That's where I think the committee wants to go with greater efficiency and transparency. You'd mentioned a little bit of what your concerns were and maybe what your ideas were?

MR. MURPHY: Well, I mean, again I think we certainly would have to work with the dealers. I mean, I think again this trade repository idea is the one that we would be, you know, most in favor of. I mean we believe that the OTC market, as they are structured today, are very efficient for corporations. So I'm not sure, but we certainly do not believe that moving to a mandatory clearing or exchange environment would improve the efficiency of the market in any way.

REP. BACHMANN: Mr. Chair, I don't know if I still have time remaining, but I would open that question out to any one on the panel if you -- your suggestions on improving efficiency and transparency knowing that's where the -- where our body is hoping to go.

MR. FERRARI: If I could add just a comment. Many references have been made to the foreign exchange market that 50 percent of foreign exchange trading in the spot foreign exchange market it happens at ICAP on screens and electronically. The transparency issues are price transparency, which is the over-the-counter and interdealer market, wholesale market, and the trade transparency which falls on to the trade repository.

So it's a two-fold transparency issue. I'd also think it's important -- I haven't had -- heard much about the exchange concept, but delineating between an exchange traded contract and over-the- counter traded contract done on electronic mechanism, all right. We are not defined as electronic exchanges.

But these are fully transparent and in real time. So there are ways to enhance the transparency, they evolve over time. U.S. treasuries, when I started in business a very long time ago, were barely on screen. There were trading over telephone. Today they are fully electronic with real time post-trade processes.

So it's an evolutionary process, mechanisms are in place to advance that, and the ability to advance that frankly, is based on the liquidity as it grows in the United States.

MR. PICKEL: I think to the extent that we can encourage various ways of trading, various ways of managing counterparty credit risks clearing and the -- in a bilateral relationship, all of that generates information for the participants in the market. It generates information for the regulators, and in many cases, it generates information for the public generally.

So, I think to the extent we can encourage clearing, the trade repository, electronic trading. And of course, exchange rating exists in many product areas, not exactly, you know, to mirror the underlying -- or just to mirror the OTC product. But it provides an effective hedge particularly for dealers who are looking to hedge the exposures they take on through their OTC risk. They can lay that off in many ways via the exchange rated products.

So the more variety we can provide here, I think the better transparency overall.

REP. BACHMANN: Good. Well, I yield back, Mr. Chair.

REP. KANJORSKI: Thank you very much, Ms. Bachmann.

Now, we have the gentleman from New York, Mr. McMahon for five minutes.

REP. MIKE MCMAHON (D-NY): Thank you, Mr. Chairman, and thank you for allowing me to participate in this hearing with you today as a guest member. I want to first give a shout out to Mr. Ferreri.

Chris, it's great to see you here and I'm proud to introduce you to my colleagues and to the chairman as a constituent and a proud son from the great borough of Staten Island in New York City.

And as I've said here in my months in Congress, since January; New York City is the financial capital of the world. And when I tell my colleagues that I represent people from the executive level all the way to the back office and the support services, certainly it's great to have you as an example of the people who make this industry run.

I would also -- I know that many of my colleagues feel some anger towards the financial services industry. But I just would like to caution that those who think that it would be okay to let part or all of this industry move to other countries or not be successful, would be a bad thing for our nation. It certainly would be a very bad thing for the people whom I represent. More than 80,000 just in my district alone who directly work in industry and many as well.

And certainly we don't -- we look to, you know, bailout General Motors, but we don't say, let's give away the automobile industry in this country, and I think that that's something that we have to be mindful about.

As you know, Chris, when it comes -- Mr. Ferrari, when it comes to the practice of trading credit default swaps, the House and the Senate have approached this issue in different ways, the House bill, which passed the Ag Committee banned credit default swaps while the Senate bill did not.

If the Senate bill also goes a step further requiring the exchange trading for all over-the-counter derivatives. So there is a blending here. And I even heard in the testimony, it may be a confusion, credit default swaps is that old derivatives.

I know Congressman Foster fleshed this out a little bit, but clearly the credit default swaps led to the downfall of AIG as well as the financial instruments upon which they were based. But if you could just kind of flesh out a little bit more, how much of the overall derivative market is credit default swaps, and what role does it play in the overall industry?

MR. FERRARI: Dr. Johnson put together a very good summary that it is small percentage of the overall derivative market.

Interest rate swap makes up the largest portion of it. Interest rate swaps are on screens, a representation of that market are on screen to hundreds of thousands of people worldwide that participate in the interest rate swap business.

The ability to see a bid and offer, some one willing to take risk take position on a product on a screen or through the interdealer market; thus enhancing information flow, enhancing the knowledge that people have to participate in these markets.

The CDS market for ICAP is very small. For us as a company it is less than 3 or 4 percent of what we do. So it is not -- it is embedded as CDS buyers. I do think frankly that the ability to migrate products as they become illiquid on to screens, on to electronic platforms, is a national progression toward liquidity.

And I think as those markets become more standardized and the ability to clear them and to margin them which isn't talked about very much when we talk about clearing, to effectively margin them, that will make sense.

REP. MCMAHON: But so are credit default swaps the problem and should we all -- that's going on here -- and to focus only on those and leave the rest of the derivative market alone.

And that would allow, certainly Mr. Murphy, 3M, most of their derivative action seem to be with foreign exchange fluctuations and -- did you understand my question?

MR. MURPHY: I think you make --

REP. MCMAHON: Well, we -- might be we are throwing the baby out with the bathwater, can we separate the two here or is it --

MR. MURPHY: It's effective derivative regulation. Right, so this is about the derivatives market in general. CDS, CDOs, as the core of the AIG problems and books are being written about the AIG failure.

But I do think that from a broader perspective the over-the- counter market and derivatives exists because there is a strong need and demand. These aren't products that are built up and no one participates in. These are products that have been developed over time, have been developed to assert a hedge to a specific need, and as a result have become a tradable object.

So I think as those tradable objects become more liquid, we can see that the increased liquidity -- it's an evolutionary process.

REP. MCMAHON: But can we remove anyone? Can we remove the CDSs out of this equation, and leave the derivative markets alone, and just deal with that one issue or you have to deal with it altogether? Fewer?

MR. FEWER: Congressman, I would try to look at the CDS market from a different viewpoint. The CDS market generally is made up of very liquid CDX index product. Most of them are bunch traded and single name products. Those -- that area of the credit linked market can -- is very, very conducive to a central counterparty clearing.

These instruments did not cause the problem of AIG, collateralized debt obligations did. Everyone knows that. It would be a fair comment to say that a proper postmortem of AIG to really understand what the dynamics were between CDS and the actual CDOs.

However, to parcel out CDS from the rest of the derivative world, you know, it's -- we should be able to apply the same rules right across the board. And over a period of time, CDS happens to be in the major headlines but over a period of time, I think that the general public will see that whether it's a credit index, or a equity index, or a interest rate swap, these products can be very well harnessed and managed within the context of proper market protocols.

MR. PICKEL: And I think the critical thing of building on the Geithner proposal is the focus on an entity that builds up significant counterparty exposure. That's the kind of the -- if you will, the AIG clause of the proposal, that's what AIG did. They happened to build that up via selling protection on the super senior tranches of these CDOs, via credit default swaps.

It is conceivable although frankly not that hard to conceive that somebody could build up that position in interest rate swaps, or equity derivatives, or something like that. It is possible.

And therefore I think you have the authority for someone to be able to identify that and step in and regulate that type of build up then, I think, you deal with the AIG issue whether that's the -- whether that next issue is a CDS issue, an interest rate swap issue, or some other derivative type issue.

REP. MCMAHON: But that entity that would identify that. That's the so-called systematic -- systemic risk regulator?

MR. PICKEL: Well, that's who would eventually -- based on the information from these warehouses that would exist for the different product areas. That would be the entity that would step in and oversee that.

I think that would -- the entity would also need to work very closely with the existing regulators, and the banks, and other institutions because the banks see that flow. They see that build up. You know, even in the situation of AIG, the regulators would have been able to see that the banks were taking on exposure to AIG.

REP. MCMAHON: But -- and my time is up and maybe you can end with this, Mr. Thompson. It's, sort of, I call it my Chicken Little question, which is didn't we have those checks and balances in place already?

And weren't there -- there is the Fed and with all these other agencies, why wasn't that done in the past, and why is it that a creation of a so-called systemic risk regulator would inhibit this from happening again when we -- it really should have been inhibited this time around?

MR. THOMPSON: Fair enough. That's an excellent question. And I think when people are talking about the systemic risk regulator the idea isn't just another regulator. It needs to be a regulator who has market savvy across a wide range of financial instruments.

When we think about the problem here, the problem is risk, not the form in which risk is taken. So you know, you can look at AIG and say they piled up all of this risk in CDS form, ban CDS. But then my response, in part, would be, look at Lehman Brothers and Bear Stearns who piled up billions of dollars of risk in the form of mortgage- backed securities, which in and of themselves are fine and unobjectionable and serve a very valid commercial purpose.

But the manner in which they finance them on very thin margins in the repo market meant that they were able to lever up 30 or 40 to 1 with obvious disastrous consequences.

What you need is a systemic risk regulator who can look at the whole risk spectrum, understands all the products, and ensures against a recurrence of overleveraged and excessive risk taking in whatever form.

REP. MCMAHON: Thank you.

Thank you, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. McMahon.

We want to thank the panel for their participation but if I may, before we close down on the first panel, you really heard the questions of the committee members on both sides. We're not looking at just regulating for the sake of regulating.

We're looking at what's the best thing to do under the circumstances. I'm just pointing out my observation on AIG. The reason why it's such a traumatic failure is that it represented a failure of the marketplace.

Every person involved in those transactions with AIG should have been doing due diligence to see whether there were reserves, whether there were margins there, whether their counterparties were responsible to payout.

It shocks me that engaging in $2.7 trillion in the derivative risk by AIG without any of the great companies of the world calling their attention to AIG that they didn't have the support systems or reserves behind the products they were guaranteeing, says to me the market failed.

Now, why it failed? That I don't know. Did the sellers of those risks or the traders of those risks think that they were too large to fail and exactly what would happen as did happen that the government would come in and stand as the supporting party?

And if that's the case then what we see here is a total failure of the marketplace that needs great regulation. I don't happen to agree that we need necessarily great regulation.

But what I capture from the testimony of all six witnesses today is that you obviously have superior knowledge to the members of the committee. I would like you to help us. We have to write some regulations and we've probably identified. We need some requirements for research. We need requirements for transparency.

We need some requirements that when we have a systemic risk evaluator, I won't call them regulator because if we're going to have a systemic risk regulator, that's got to be some super regulator that has authority over every transaction of commerce in the world.

And I don't think America wants that nor can it afford it and we're just putting off till tomorrow another disaster because they won't be testing the great institutions like AIG. They'll be going and looking at the questionable institutions.

So what we really want to get to is an efficient, effective way, call it regulation or call it watching, what you will, but the use of your knowledge, the members of this panel and maybe a few other experts around the country to sit down and argue among yourselves if you will and send us some of your regulations and your suggestions for regulation or oversight, so that we can have that as we deliberate to write the new methodology of doing this.

If you fail to do that I think you can clearly see that there are no derivative experts on the committee of financial services and I have my fellow members here and I think they will agree. So we'll be operating in the blind.

On the other hand if we can get your suggestions and your assistance we probably can make a major attempt here to get this right. That's what, what I would like to see you help us do.

So before I dismiss the panel, is there any reason why any of you wouldn't be willing to serve in advisory roles and perhaps collaborate among yourselves and perhaps over the next several months, because that's all we have until we get to writing the comprehensive regulation that we're going to have covering this field and many others. Particularly, in the derivative field I think it -- as you established to me, it clearly it's a tool of great value.

Listening to 3M's testimony, I can imagine what it would take to do 70 percent of your business worldwide and not have a tool of derivatives to guarantee the cost of your product and the value of the currency you're dealing in the sales contract in the future.

So that being the case, why don't the best minds in the country help out the representatives of people in the country to write the best rules and regulations to allow the markets of the country and the world to properly function? If I could indulge you on that I would appreciate it. Is there anyone that wouldn't be willing to serve?

MR. : I think we would all volunteer for that.

REP. KANJORSKI: Okay. Well, consider yourself --


-- always in the -- the Army to solve the derivative problem, and thank you very much for your appearance and your testimony here today. We certainly do appreciate it.

MR. : Thank you.

MR. : Thank you, Mr. Chairman.


REP. KANJORSKI: Thank you very much. We'll have our second (pile ?) -- panel. First of all, thank you all for appearing before the committee, and without objection, your written statements will be made a part of the record.

You'll each be recognized for a five minute summary of your testimony. First, we have Mr. Thomas Callahan, Chief Executive Officer, NYSE Liffe.

Mr. Callahan.

MR. CALLAHAN: Chairman Kanjorski, and members of the subcommittee, my name is Tom Callahan. I'm the executive vice president and the head of US Futures for NYSE Euronext.

NYSE Euronext operates one of the world's largest and most liquid exchange groups, bringing together seven cash equity exchanges and seven derivatives exchanges in six countries.

In addition, in late May of this year we received approval in principle from the UK's FSA to launch NYSE Liffe Clearing, and we'll shortly begin providing derivative clearing services for our London derivatives market.

We also provide technology to more than a dozen cash and derivatives exchanges throughout the world. NYSE's geographic and product diversity informs our views on the principal issue we are discussing with you here today.

I'm pleased to appear on behalf of NYSE Euronext, and its affiliated exchanges as the subcommittee considers the possible amendments to the various federal laws that affect over-the-counter derivative transactions. NYSE Euronext has always been an advocate for fair, open, and transparent markets.

Accordingly, our global exchange group has a strong interest in the appropriate regulation of OTC derivatives. A large number of over 4,000 listed companies use OTC derivatives as fundamental hedging tools to manage the various risks incurred in the -- in connection with the conduct of their business.

It is essential that these companies have confidence in both the integrity of the transactions they enter into, and in the ability of their counterparties to perform their financial obligations. An appropriate and sensible regulatory regime for OTC derivatives is a necessary element in restoring and retaining this confidence.

While it is essential that OTC derivatives be subject to greater regulatory oversight, it is also important that the regulatory regime not impose unnecessary requirements that greatly diminishes their value, or worse yet drives these vital markets to opaque offshore jurisdictions.

It is for this reason that we strongly support the proposed framework for the regulation of OTC derivatives that Treasury Secretary Geithner set out in his May 13 letter to the congressional leadership, which takes into consideration the differences amongst OTC derivative products and the legitimate needs of market participants that use these products to manage their business risks.

In particular we agree that to the extent OTC derivatives are standardized, they should be traded on a regulated exchange, or a comparably regulated electronic trading system and cleared through a central counterparty.

The clearing of OTC derivatives will reduce systemic and operational risk, increase market transparency, and create market surveillance databases from which regulatory authorities can audit for potentially fraudulent or manipulative activity.

To the extent a limited class of OTC derivatives are sufficiently customized, and therefore cannot be executed through an exchange or electronic trading system, or cleared through a central counterparty, such transaction should be subject to public reporting via a tape mechanism as well as recordkeeping requirements to a regulated trade repository.

Importantly, any trade that falls outside of the regulated exchange and central clearing infrastructure should be subject to robust risk-based capital regimes that appropriately reflect the risk to all counterparties in these transactions.

A number of different bills have been discussed in Congress to address the identified deficiencies of the OTC derivatives market, some of which appear to be designed for certain prescriptive solutions on the market.

Some of these proposals include requiring that all OTC derivatives, standardized, and non-standardized be traded on an exchange in the central limit order book, or requiring that all OTC derivatives be cleared through a CFTC registered clearing organization regardless of the liquidity of the underlying instrument, or prohibiting certain participants from acting in certain markets.

As it undertakes the task of developing a regulatory regime for OTC derivatives, we encourage the subcommittee to strike a balance similar to that suggested in Secretary Geithner's letter.

NYSE Euronext believes it would be unhelpful to impose inflexible solutions that would mandate specific market structures in either execution or clearing.

This could prove disruptive to markets, introduce unacceptable risks into central counterparties, and could have the unintended effect of designated -- designating winners and losers amongst exchanges and clearing organizations and thereby decreasing needed competition.

Consistent with Secretary Geithner's proposed framework, we believe it would be appropriate for Congress to provide this newly regulated market, and the authorities that will oversee it, sufficient flexibility to evolve and adjust over time. We believe that the most efficient way to determine optimum market structure to the wide variety of OTC derivative products is to let market users and regulators decide as market conditions dictate.

On behalf of NYSE Euronext, I want to thank the subcommittee for the opportunity to appear before you today. We look forward to working with you to implement an effective regulatory regime for OTC derivatives. Thank you.

REP. KANJORSKI: Thank you very much, Mr. Callahan. And now we'll hear from Mr. Terrence A. Duffy, executive chairman, CME Group Incorporated.

Mr. Duffy?

MR. DUFFY: Thank you, Chairman Kanjorski, for this opportunity to present our views on effective regulation of the OTC derivatives market.

Treasury Secretary Geithner's May 9, 2009 letter to Senator Harry Reid outlined the administration's plan for regulatory reform of the financial services sector. His plan proposed increased regulation of credit default swaps and other OTC derivatives.

This Committee posed seven questions for our consideration this morning. We agree with many of Secretary Geithner's proposals.

For example, we support position reporting for OTC derivatives and agree that enhanced price transparency across the entire market is essential to quantify and control risk.

We believe, however, that the measures chosen to achieve these ends should be fine-tuned to avoid adverse consequences for U.S. markets. We are concerned that legislation mandating the clearing of all OTC transactions could well induce certain market participants to transfer this business offshore, resulting in significant loss of U.S. futures business.

By reducing liquidity on U.S. exchanges, this would undermine the Congress' attempt to establish greater transparency, price discovery, and risk management of U.S. markets.

We applaud the administration's efforts to enhance transparency, stability, integrity, efficiency, and fairness in all markets. But we believe that with slight modifications to the proposal outlined Secretary Geithner, and the inclusion of a few additional measures would complement the administration's efforts.

We've responded to your specific questions at length in our written testimony. Let me offer a brief summary of our responses.

First, we agree with the informed consensus that the financial crisis was attributable in part to the lack of regulation in the over- the-counter market, which was not subject to appropriate disclosure and risk management techniques.

Two, clearing should be offered to the OTC market in a form that makes a compelling alternative to the current model. Central counterparty clearing offers a well-tested method to monitor and collateralize risk of -- on a current basis, reducing systemic risk, and enhancing fairness for all participants.

We are not in favor of government-mandated clearing, even though we are strong proponents of the benefits of central counterparty clearing. Central counterparty clearing serves as an effective means to collect and provide timely information to regulators.

It also reduces systemic risk imposed on the financial system by unregulated bilateral OTC transactions. Nevertheless, rather than compel clearing of all OTC transactions, we believe appropriate incentives should be put in place.

The incentives could be in the form of reporting and capital charges for uncleared OTC positions, and reduced capital charges for cleared OTC positions. We believe they would contribute both to the transparency and the reduction of systemic risk.

Obviously, we are strong proponents of the benefits of exchange, trading of derivatives, but we are also realists on the issue of whether exchanges can generate sufficient liquidity to make exchange trading efficient and economical for our customers. We are concerned that government-mandated exchange trading will be a massive waste of resources and capital.

Fifth, in our view, electronic trading offers many benefits. It levels the playing field, it enhances price transparency and liquidity, it speeds execution and straight-through processing, and eliminates any classes of errors of unmatched trades.

Overall, it is an enormous benefit to the market and to our customers. Electronic trading, when coupled with our intelligent audit and compliance programs allows us to better monitor our markets for fraud and manipulation.

It also gives us the tools to effectively prosecute anyone foolish enough to engage in misconduct in a forum with a perfect audit trail and a highly skilled enforcement staff.

Six, we believe that there is appropriate balance between price discovery and liquidity that is effectively controlled by the current procedures to police excessive speculation. Regulated futures markets under CFTC have the means and the will to limit speculation that distorts prices, or the movement of commodities in interstate commerce.

Seven; we operate trading systems in a clearing house in which every bid and offer, as well as every completed transaction is instantaneously documented. In addition, those records are preserved for an extended period of time.

We hope that our views on regulating the OTC market will be given significant weight based on our record and experience, and I look forward to answering your questions.

Thank you, sir.

REP. KANJORSKI: Thank you very much, Mr. Duffy. And next we'll have Mr. Christopher Edmonds, chief executive officer, International Derivatives Clearing Group.

Mr. Edmonds?

MR. EDMONDS: Good afternoon, Chairman Kanjorski, members of the subcommittee. I appreciate the opportunity to testify today on behalf of the International Derivatives Clearing Group.

IDCG is an independently managed, majority-owned subsidiary of the NASDAQ OMX Group. IDCG is a CFTC regulated clearinghouse offering interest rate futures contracts which are economically equivalent to the over-the-counter interest rate swap contracts prevalent today.

The effective regulation of the over-the-counter derivatives market is essential to the recovery of our financial markets, and this is a very complicated area that is easy to get lost in. Let me summarize by emphasizing four points that go to the heart of the debate.

First, central clearing dramatically reduces systemic risks. Second, would you not make fundamental changes in the structure these markets, we will not only tragically miss an opportunity that may never come again, but we will also run the risk of repeating the same mistakes.

Half measures will not work. Specifically, access to central clearing should be open, and conflict-free.

Third, the cost of the current system should not be understated. The cost of all counterparties posting accurate risk-based margin pales in comparison to the cost we are incurring today for a flawed system.

Finally, the benefits of central clearing if done correctly, through open access and maximum transparency will benefit all users of these instruments, and allow these financial instruments to play the role they were designed to play, the efficient management of risk, and the facilitation of market liquidity.

With all of the debate around the use of central counterparties, it is important to recognize not all central counterparties are the same. Ultimately, market competition will determine the commercial winners.

But I encourage members of this subcommittee to stay focused on one simple point; all participants must play by exactly the same rules. This in turn increases the number of participants, which reduces systemic risk.

Central clearing gathers strength from greater transparency and more competition. This is in contrast to the current bilateral world where all parties are only as strong as the weakest link in the chain.

There has been much fanfare over the handling of the Lehman default. While it is true some counterparties were part of a system that provided protection, this system was far more of a club than a systemic solution.

The Federal Home Loan Bank system, Jefferson County, Alabama, and the New York Giants Stadium are examples of end-users who suffered losses in the hundreds of millions of dollars.

The current system simply failed the most critical component of user, the end-user. These are real-world examples of why new regulation needs to focus on all eligible market participants.

This is the foundation of the all to all concept. As some have continued to confuse the true cost of clearing services, IDCG began to offer what we call "shadow clearing." This is a way users can quantify the actual cost of moving existing portfolios into our central counterparty environment.

We now have over $250 billion in shadow clearing. Our data has shown significant concentration risk in the interest rate swap world.

In fact, two of the largest four participants were required to raise significant capital as a result of the recently completed stress test. Just last week, before this same subcommittee, Federal Housing Finance Agency Director James Lockhart acknowledged a concentration of counterparties during the past year, along with the deterioration in the quality of some institutions has resulted in Fannie Mae, Freddie Mac, and the Federal Home Loan Banks consolidating their derivatives activities among fewer counterparties.

We must reverse this trend, or we will continue to foster the development of institutions too large to fail. IDCG provides a private industry response to the current financial crisis, and our mission has never been more relevant than in today's difficult economic environment.

Today's financial system is not equal. The rules of engagement are not transparent, and there are significant barriers to innovation.

Unless the work of this committee, Congress, the administration, and all of the participants in the debate yields a system that protects all eligible market participants in a manner consistent with the largest participants, the system will fail again.

Mr. Chairman, thank you for the opportunity to appear as a witness today, and I'm happy to answer any questions.

REP. KANJORSKI: Thank you very much, Mr. Edmonds. And next we have Mr. Jeffrey Sprecher, chief executive officer, IntercontinentalExchange Incorporated.

Mr. Sprecher.

MR. SPRECHER: Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee, I'm Jeff Sprecher, and I'm the chairman and chief executive officer of IntercontinentalExchange, which is also known by our New York Stock Exchange ticker symbol as ICE.

I very much appreciate an opportunity to appear before you today to testify on the over-the-counter derivatives regulation. And Congressman Scott, thank you for your kind introduction earlier today.

In the mid 1990s, I was a power plant developer in California, and I witnessed the state's challenge in launching a market for electricity. Problems arose from a complex market design and partial deregulation.

And I was convinced that there was a more efficient and transparent way to manage risk in the wholesale markets for electric power and natural gas. Therefore, in 1997, I purchased a small energy trading platform that was located in Atlanta, and I formed ICE.

The ICE over-the-counter platform was designed to bridge a void that existed between a bilateral voice-brokered over-the-counter market which were opaque, and open-outcry futures exchanges, which were inaccessible, or they lacked products that were needed to hedge power markets.

ICE has grown substantially over the past decade, and we now own three regulated futures exchanges and five regulated clearinghouses. Yet we still continue to offer over-the-counter processing along with futures markets.

In discussing the need for over-the-counter regulation, it's important to understand the size of the over-the-counter derivatives markets, and their importance to the health of the U.S. economy. In this current credit crisis, derivatives have been commonly described as complex financially engineered products transacted between large banks.

However, in reality an over-the-counter derivative can encompass anything from a promise of delivery in the future between a farmer and his grain elevator, to a uniquely structured instrument like an exotic option, and much of the nation's risk management occurs in between these two extremes.

Derivatives are not confined to large corporations. Small utilities, farmers, manufacturing companies, and municipalities all use derivatives to hedge their risks.

Providing clearing, electronic execution, and trade processing are core to ICE's business model. As such, my company would clearly stand to benefit from legislation that required all derivatives to be traded and cleared on an exchange.

However forcing all OTC derivatives on to an exchange would likely have many negative and unintended consequences for our markets as a whole. In derivative markets, clearing and exchange trading are separate concepts.

At its core, exchange trading is a service that offers order matching to market participants. Listing a contract on an exchange does not necessarily mean it will have better price discovery.

Exchange trading works for highly liquid products, such as the Russell 2000, or standardized commodity contracts that appeal to a whole host of broad set of market participants. However, for many other markets, exchange trading is not the best solution, as the market may be illiquid with very wide bid/offer spreads leading to poor or misleading price signals.

Nonetheless, these illiquid products can still offer a value to hedgers, and thus they have a place in the over-the-counter derivative market. Turning to clearing, this technique greatly reduces counterparty and systemic risk in markets where you have standardized contracts.

However, forcing unstandardized contracts into a clearinghouse could actually increase market risk. Where the market depth is poor, or the cost of contracts are not accurate for price discovery, it's essential that the clearing house be operated so that it can see truly discovered value.

So while ICE certainly supports clearing as much standardized products as is possible, there will always be products which are either non-standard, nor sufficiently liquid for clearing to be practical, economic, or even necessary.

Firms dealing in these derivatives should nonetheless have to report them to regulators, so that regulators have a clear and a total view of the market. ICE has been a proponent of appropriate regulatory oversights of markets, and as an operator of global futures and over-the-counter markets, we know the importance of ensuring the utmost confidence which regulatory oversight contributes to.

To that end, we have continuously worked with regulatory bodies in the U.S. and abroad to ensure that they have access to relevant information that's available from ICE regarding trading activity in our markets.

We've also worked closely with Congress and regulators to address the evolving oversight challenges that are presented by complex derivatives. We continue to work cooperatively to seek solutions that promote the best marketplace possible.

Mr. Chairman, thank you for the opportunity to share our views with you, and I'll be happy to answer any questions that you may have.

REP. KANJORSKI: Thank you, Mr. Sprecher.

We'll now, and lastly hear from Mr. Larry Thompson, managing director and general counsel, Depository Trust and Clearing Corporation.

Mr. Thompson?

MR. THOMPSON: Thank you, Chairman Kanjorski, and members of the subcommittee. I am Larry Thompson, general counsel for the Depository Trust and Clearing Corporation, better known as DTCC.

DTCC brings a unique perspective to your discussion as the primary infrastructure organization serving the U.S. capital markets with a 36-year history of bringing safety, soundness, risk mitigation, and transparency to our financial markets.

Last year, DTCC cleared and settled in U.S. dollars, 1.88 quadrillion in securities transactions across all multiple asset classes. That is the equivalent of turning over the U.S. GDP every three days.

As an example of our safety and soundness following the Lehman bankruptcy last year, DTCC played a significant role in unwinding over $500 billion in open trading positions from trades and equities, muni bonds, mortgage-backed and U.S. government securities without any loss to DTCC, any of its members or to the industry, and obviously to the U.S. taxpayer.

Today, I'd like to share some insights gained from the financial crisis of the past year and to emphasize one fundamental policy point; fragmentation of data in the financial industry can impede the ability of regulators to protect investors, and the integrity of the financial services system as a whole.

These core policy goals are advanced when information on trades are held on a centralized basis. We believe maintaining a single trade repository for OTC derivatives contract is an essential element of the safety and soundness for two primary reasons.

First, it helps assist regulators in assessing systemic risk, thereby protecting consumers and financial markets. Second, as a practical matter, it provides the ability from a central vantage point to identify the obligations of trading parties which can speed the resolution of these positions in the event of a firm failure.

However, there is no absolute assurance a single trade repository for OTC derivatives will be retained unless that public policy objective is expressed in law.

While DTCC supports the role of central counterparties, CCPs, in OTC derivatives trading to support trade guarantees, CCPs do not obviate the need to retain the full details on the underlining trading positions in a central trade repository to support regulatory oversight and transparency in the market.

DTCC's primary mission is to protect and mitigate risk for its members and to safeguard the integrity of the U.S. financial system. We launched the Trade Information Warehouse in November 2006 to provide an automated repository to house all credit default swaps contracts, and during 2007, working with the industry, we updated the warehouse with information on 2.2 million outstanding credit default swaps contracts.

And our Deriv/SERV matching engine is now supplying to the warehouse more than 41,000 trade sites daily. Today, our Trade Information Warehouse is the only comprehensive repository of OTC derivatives activity in the world.

Since last year, DTCC has seamlessly processed or is processing through the warehouse numerous credit events, including Lehman, Washington Mutual, as well as the conservatorships involving Fannie Mae and Freddie Mac. DTCC supports the public policy goals articulated in Secretary Geithner's letter to the House and Senate leadership on the need to promote transparency in the OTC marketplace.

However, we are concerned that regulatory calls to require the use of CCP solutions for standardized derivatives transactions could mislead some to think that that will provide a complete cure for the problem.

Our Trade Information Warehouse connects and services 1,400 market participants, providing a central operation infrastructure covering 95 percent of all current credit derivatives trades.

This trade repository is designed to be, and we recommend that it be mandated, to extend and include other OTC derivative classes. A regulator charged with overseeing the financial market from a systemic risk perspective needs a comprehensive view of where the risks and exposures lay to provide an advance warning to any problems that could jeopardize the stability of the system.

Should there be a firm failure, knowing the underlying position of multiple transactions in a timely manner will be significant in providing transparency to regulators, and in protecting confidence in the market itself.

Therefore, we believe the role of having a central repository should be reinforced as a matter of public policy by Congress. We appreciate your time today, and would be happy to respond to your questions.

REP. KANJORSKI: Well, thank you very much, gentlemen. As you can see this is one of the most exciting issues to come before the Congress and that's why the exceptional turnout. May be that's the reason why we haven't had the legislation move along a lot faster.


REP. KANJORSKI: But I have just a few questions myself before I recognize my ranking member.

Mr. Sprecher, you've talked about the clearing house operation. I was interested, your exchanges, are they for profit owned, or they're not for profit?

MR. SPRECHER: They are for profit, and we're a New York Stock Exchange public company.

REP. KANJORSKI: And who's your regulator, the actual exchanges?

MR. SPRECHER: Well, we have three regulated futures exchanges. So one is regulated here in the United States by the CFTC, one is regulated in Canada by a provincial regulator, and one is regulated in Europe by the London FSA.

We have five regulated clearing houses. Two are regulated in the U.S. by the CFTC. One that's handling credit default swaps is regulated in the U.S. by the New York Fed as a trust bank.

One is regulated by a provincial regulator in Canada, and one is regulated by the Financial Services Authority in the U.K. So that's the world I live in.

REP. KANJORSKI: I myself had some doubts about whether or not we should have had some of the major exchanges change from not-for-profit organizations to for profit. I anticipate there's a great temptation out there to use exchanges for various and sundry purposes that could constitute a scandal.

That hasn't happened yet, but I'm not certain it won't happen sometime in the future. What provisions have you taken to make sure that won't happen on your three exchanges?

MR. SPRECHER: You have an interesting thought about this because one of the things that has happened in the world is we went from mutualized organizations that were memberships to public companies which many of us represent.

And when that happens, you somehow -- you sometimes disconnect from the interests of your members, because they no longer are your bosses. And so all of us that run exchanges have a delicate balance which is trying to be -- act as a neutral counterparty, and meet the needs of our members, but still be beholden to stockholders and regulators.

And so far I think it's worked quite well, and it's created a lot of value within the exchange community. But nonetheless, it's incumbent on managers like myself to continue to poll the market, and make sure we're serving the needs of the ultimate end-user.

REP. KANJORSKI: You said you traded on the New York Stock Exchange. Does that mean that I could buy the controlling interest in any of your exchanges by purchasing stock on the exchange?

MR. SPRECHER: Technically, yes.

REP. KANJORSKI: So that if I wanted to invade the United States, rather than doing it militarily, I could do it economically by taking control of your exchanges and then just closing it?

MR. SPRECHER: You'd have to get through Senator Schumer, but otherwise, yes.


MR. DUFFY: Mr. Chairman?

REP. KANJORSKI: Charlie is a good man. He's not everywhere.

MR. DUFFY: Mr. Chairman?


MR. DUFFY: The CME Group is the largest publicly traded exchange in the world today, and you cannot just come in here and take over a U.S. exchange. We have what's called the "poison pill," so anything over 15 percent ownership you would be technically diluted down in value.

So there's no way you could come in here and just buy a U.S. exchange that's listed. We are also a public company.

REP. KANJORSKI: So you don't think there's any way we could construct hidden trusts or other organizations that if I were representing the oil interests of the world that I could come in and take control of your exchange?

MR. DUFFY: No, I don't.

REP. KANJORSKI: You're a real optimist there. I think that someone could, you know, by convoluted methodologies of using trust et cetera, you could do it successfully and never be detected, unless you were to open up all the trust operations in the country, which obviously we don't do.

I don't -- I'm not sure why we don't do it. May be we need a clearing house for trusts to find out who really owns things, controls -- anyway, that's another issue for another day.

Obviously, do you all agree that there's a role for Congress to play in the derivative market? I'm curious; I asked the question of the prior panel.

Is there any of you that feel absolutely that operations are occurring in such a way in the derivative area that there is no role or need for Congress to take action, or for the government to provide for regulation? Is there anyone that feels we're moving on the course and should stay there as the present law constitutes us to do?

MR. DUFFY: You know, I'll just say that, you know, we've been on the record since the Modernization Act of 2000, that the loophole of 2(h)(3) should be eliminated, that there was going to be a problem with product.

So here we -- you know, in the last panel they asked did anybody foresee this coming, or would they admit it. We are on record as saying we saw this coming and it was going to be a problem with these unregulated markets.

So I think government has a role in these marketplaces. There's a integrity to them, but at the same time we're not talking about huge regulation for the over-the-counter market, we're talking about a few different things.

REP. KANJORSKI: But you definitely see a need for us to act now in some regulatory capacity, is that correct?

MR. DUFFY: I do.

MR. EDMONDS: I would just add to that I don't believe that you can continue the evolution that the market demands at the moment as these instruments continue to be developed and risk-management tools continue to be used over time without an effective involvement from organizations and committees like this one.

I mean, it will not -- it will not reach the point of confidence that market can accept without involvement from the government.

REP. KANJORSKI: What -- why did the market fail -- and this is open to anyone of you who want to take it on -- in terms of AIG for instance?

You know, obviously their counterparty positions were way outside their capacity to perform because they lacked the reserves to do that. Why didn't the parties that were dealing with them see that and have the market itself react, or did they not know what their counterparty positions were and therefore the limitations they had?

Or were they planning on the fact that there would be a too large to fail resolve and that in fact the government was going to stand in their position, so there wasn't any risk in finding out their due diligence -- or pursuing due diligence as to their capacity to perform? Does anybody --

MR. DUFFY: I'll just say that I think that they had a huge bet on the housing market would ever go down. I don't think they ever believed that asset would go down, and they could leverage it as many times over as they want.

And they were undercapitalized to write all these contracts. And that -- when the market turned, you talk about an illiquid market, the housing market might be the most illiquid market in the world. So there's no one to take over the exposures.

REP. KANJORSKI: But you said you saw the risk.

MR. DUFFY: Pardon me?

REP. KANJORSKI: You said you saw the risk.

MR. DUFFY: We talked about the elimination of 2(h)(3) which was including any credit default swaps which was eliminated from the Exchange Act. We said that they should be regulated back in 2000. We said that in 2002 and 2004 and as little as a year ago.


MR. DUFFY: That's what I was referring to.

REP. KANJORSKI: But you didn't see the failure coming?

MR. DUFFY: I don't -- I didn't know what the leveraged balance sheet of AIG was there, no.

REP. KANJORSKI: Well, that would have been interesting, if we'd had a clearing house operation going, what Mr. Thompson is saying, everybody in the world could have examined to see what their exposure was, is that correct?

And that -- would that have afforded the opportunity for the market itself to do the corrective action and not accept them as the counterparty?

MR. EDMONDS: Well, it certainly would have highlighted the issue much earlier. So the default you dealt with or we continued to deal with in the fallout from the AIG default still could -- a fairly -- well, obviously a very significant size.

Well, had you had those mechanisms in place early on, you would have been able to detect that before it spiraled to the level. I'm not going to say there wouldn't have been a default, because there was certainly behavior there that you had to deal with.

But the size of the default may have been mitigated far before it got to a $170 billion of taxpayer money.


MR. THOMPSON: I think, Mr. Chairman, in fairness --


MR. THOMPSON: I don't think anybody has actually done a real study on what the AIG failure has been. It may be a number of reasons.

One, it could be that the counterparties didn't know what their full exposure was, that they were relying totally on the fact that it was a AAA rated company, and therefore did not think that they needed to take the same margin requirements.

Some of them we know did hedge some of their positions though with AIG. We also know now that the particular regulator who did regulate that particular section of AIG perhaps did not go in and do the right kind of examinations.

So I think what you had called for earlier in the first panel, which is really an examination of AIG to see what occurred should occur before we begin to speculate as to what went wrong there.

Obviously, we believe that having all of those contracts in one central location where regulators could have gone in, could have looked at what the positions were, would have been something that would have been very good from the regulatory standpoint. Thank you.

REP. KANJORSKI: I appreciate that, Mr. Thompson, but is it possible that we should recognize that perhaps the capacity of government regulators, because of salary and other limitations in the field are really not adequate to make the type of analysis and regulatory positions that occur in industry because of the lopsided effect of salary, and competency, and size?

MR. THOMPSON: Well, you hit upon a very excellent point, which is that one of the things that we have to do is part of reviewing the whole issue of what regulatory reform means does mean looking at do the regulators have the right skill-sets; do they have the right bandwidth to regulate the industries that they should be looking at.

Is the pay comparable to retain seasoned veterans to look at those particular issues? I think all of those are very good things that should be approached and looked at by this Congress.

REP. KANJORSKI: Well, we are in -- I just want to bring as a matter of fact that point up. In the Federal Home Loan Bank system, Senator Graham has been successful several years ago, before he left the Senate, of restricting the salaries.

And of course, I've been very active with the Federal Home Loan Bank system because it fascinates me in a way of how it's cooperative working with the private sector.

And they came to me and said, well, what we've decided is we'd like to specialize -- that's when we had appointments by the president of members of the boards. And they wanted to make a requirement that each board have at least one specialist in derivatives, because they found it very difficult in dealing with derivatives.

And so the question that was posed in my office, and in a debate at that time was how difficult would it be to find 12 specialists that were willing to work for $19,000 a year, which was the limitation salary on a director to a Federal Home Loan Bank board.

Now, maybe some people who'd be watching this hearing would say why not, but you and I know that specialists in the derivative field generally talk about starting salaries in excess of seven figures going on up. And our problem is that we have no way in government to match that type of a salary.

So how do we go about attracting the type of mathematical talent that's necessary to protect the hedging that occurs in these transactions?

MR. THOMPSON: Well, one way may be to use academia. You know, the one thing that obviously academia would be able to do, professors love to get information and study it to write their papers and to publish things.

So you know, as a resource -- and it's just a suggestion -- there may be a way of getting resources through other neutral sources, even though they may have an interest that -- you know, to publish their information on it as opposed to being a salaried employee. That's just a suggestion.

REP. KANJORSKI: All right.

I've exceeded my time, and I've been lenient with myself, because considering we have such a huge number of members here, I thought may be we could by unanimous consent extend our questions to 10 minutes each. Is there any objection to that?

There being none, let me move and recognize Mr. Garrett for 10 minutes.

REP. GARRETT: Well, I may use just a portion of that.

REP. KANJORSKI: It's okay. And in fact, you can give us a --

REP. GARRETT: I will yield to my comment here.

Thank you gentlemen for your testimony. I'm taking a page or a comment out of the chairman's comments.

I may be pulling out full comments of Mr. Edmonds as well, the idea of trying to find a regulator to be able to do some of these things. Now, just the other day, I had lunch with a gentleman who's a CEO of a smaller international company, international company, but a small one, not one of the big guys.

And when we got -- asked into the aspects of the regulators coming in, he says, do you know how complicated it is within my own business for me to know exactly what's going on in my company, and with my auditing departments, and with my financial units in my company to have a clear picture or a snapshot if you will of at any one point in time how my company is doing, he says, when you talk about the regulator, regardless of how well we pay them, when they come in and just try to take a look at it.

We may be going down the wrong proverbial road if we ever really want to think that we can solve some of these problems by bringing some people in on a short-term basis to examine the books verbally and get a good snapshot of it.

I know the chairman -- I think asked of the panel, asked the question -- I think it was the last panel, did any of you see this all coming, and can you come back and tell us beforehand? And everybody sat mute, although I'm sure some of them probably had some premonitions, but just didn't act on it.

That same question could always be asked by that panel and we have to be careful over asking, if they ever ask us that question, did we ever see any of this coming, and if we did, how come we didn't say anything?

You know, Congress didn't see a lot of it coming. Otherwise the chairman and I would have stopped it --

MR. : Well, I --

REP. GARRETT: I mean, some of you did, some of you did obviously, but we -- yeah, they didn't get there.

But mister -- just here on that last lighter note, I guess, Mr. Edmonds, you were saying with regard to we can't get to where we all need to be, or we would like to be unless Congress steps up and does some of this; you probably have a little more rosy view of the good work that Congress can do in some of these areas in light of our past track record of not providing the appropriate -- that's what you were talking about, not providing the appropriate regulation in the past in some of these areas.

Hopefully, that we will be able to do so in the future; so if you want to comment on that.

MR. EDMONDS: Well, the issue at the end of the day, that what Congress wants, not -- I believe the answer to the question you fundamentally are asking the industry is what is something worth? Whether you are talking about the salary of the regulator is going to be there, but what is the value that you are going to receive for that?

If we look at the question of clearing across all of a number of different products and asset classes at the end of the day, there is some standard or accepted curve of what the value of an instrument is. We come to expect that as just it's going to be there as a constant.

It's only when that's no longer constant that we have a major issue in this predicament. And what we've experienced over the last year is we lost a constant. It was not a defined measure of value that the consensus of the market agreed upon.

We spent a lot of time debating and a lot of time discussing today the processes and how that process of determining what something is valued at impacts the marketplace.

So whether you have the right folks in the right positions at the regulators, paid the right amount and the value is received, or whether or not it's subcommittees like this and others within the government itself producing that function, we all have to agree at some point in time that fair value is worth X.


MR. EDMONDS: And when we lose that, we typically lose our way. And I do believe, and my comment earlier was this is a important time where I believe history says -- (inaudible) -- discipline, we'll step up and intend to correct the show.

And if you look at the energy markets in the earlier part of this decade which is when my career began, you had people take advantage of that in the fall of Enron and in the energy merchant sectors, and there were certain rules put into place that both Mr. Duffy and Mr. Sprecher have great businesses from today.

And this is another point in time where I believe we have to stand up and do that for other asset classes, and I believe those are the questions you are asking the previous panel, and the one that we sit before you today of where does it start and how far can we go without going too far. That's kind of --

REP. GARRETT: Yes. Well, one of the proposals that's out there from CFTC Chairman Gensler was that he said in his proposal we need to protect the public from improper marketing practices. And I guess the one question that follows from that is, is that endemic on the system right now?

We're talking about sophisticated firms that are out there. Is -- improper marketing practices you mentioned in energy, but is that something that we -- is widespread in industry?

And if you put in mandates and what have you -- second part, and anybody can answer this -- if you put in mandates to be on exchanges and clearing house, is the potential -- and may be not, maybe just -- I'm seeing this -- exposing the average investor then to a higher risk at the end of the day? I would --

MR. EDMONDS: Well, I'll start and respond to that. Our solution and others that are represented up here have a certain mechanism that is not going to go down with the retail investor; they are eligible commercial participants.


MR. EDMONDS: But even with that, and that defines some level of sophistication of the use of these instruments, but even with that definition there --


MR. EDMONDS: -- the rules of the game are not the same for all the different participants. And depending upon where you are or how you behave -- in the previous panel Mr. Murphy from 3M spent a long time talking about his business as a corporate, and they have a very defined function in how that works.

But I mean, the world I live in, in interest rate swaps, they -- that type of business only represents sub-10 percent of the marketplace. So the other 90 percent aren't playing by the same rules.

And I believe if we are to get to that point of fair value at some point in time, we're going to have a consensus of what the baseline is.

REP. GARRETT: Thank you.

MR. EDMONDS: Other comments on that, right.

REP. GARRETT: All right.

MR. DUFFY: Well, I know that -- I think Mr. Gensler was referring to was some of the marketing practices that have gone on historically that have targeted some of the uninformed people may be in retirement areas such as California, Florida, and others, trying to target them to solicit and to trade foreign exchange product promising them 60 percent gains in 60 days.

And the problem, what happened with the CFTC most of their budget, I think it was roughly seventy percent was -- the number was going to police off-exchange fraudulent activity. And I think that's what Mr. Gensler was referring to, that that's got to stop.

I mean, they have to either police it or they're not going to police it, but that's a -- big part of their budget was going towards.

REP. GARRETT: And how do you -- I mean, and you stop that just by bringing it all on then?

MR. DUFFY: Well, I mean, I think there's other issues that they have to deal with. A lot of this is going over the web, a lot of this is going over code calls.


MR. DUFFY: How did they get these people? They show up at a bucket shop and the bucket shop's got four kids that never had a job before in their lives, but yet they are the four principals of the firm.

So the real guy that's taking the money has already, you know, to the next city or next village. It's very difficult to police.

REP. GARRETT: Right. And just one little question to Mr. Thompson and if anybody else wants to -- what -- you were speaking when I came in, and I was watching you folks in the back room by the way.

With regard to the repository facilities, how is this all visioned as far as -- I hate this word, but the granular aspect of it, and the aggregation aspect of it?

How much information is actually out there on individual company and trade versus the aggregate aspect of it?

MR. THOMPSON: We publish at the moment once a week 1,000 names information on a aggregate basis in all of the industries. We do that on a public website that everyone has access to.

We obviously give more granular information to regulators. That would include position information by who is doing the trades.

We also put trading information on a aggregate basis on our website, but we do give to regulators including the Fed, the ECB, the FSA, very granular, detailed information as to what the positions are when they're requested.

REP. GARRETT: Okay. All right, appreciate it. Thanks a lot, gentlemen.

REP. KANJORSKI: The chair recognizes Mr. Scott.

REP. SCOTT: Thank you, Mr. Chairman. I might say that this is absolutely stunning in its scope of complexity and challenge.

But as we try to grasp, get our hands around this to try to figure out how we regulate it, I think it would be very helpful, Mr. Sprecher, if you might share with us the description of the day-to-day federal regulation of your clearing house, and whether or not you can come to the conclusion that the federal regulation that you are currently under, and in your opening statement in your response to the chairman you reiterated several layers of federal regulation.

It might be well for you to kind of give us a kind of an overview as to how effective if in your opinion this regulation has been.

MR. SPRECHER: Certainly. Well, we launched a credit default swap clearing house about 90 days ago, and so far have done almost $1 trillion worth of clearing in that market. And that particular clearing house is regulated by the New York Fed.

We -- first of all we had a hard time -- we wanted to be regulated, we had a hard time figuring out who should regulate us. There were some regulatory gaps in credit default swaps that I'm sure many of you are aware of, and it didn't look like it fell under the CFTC, and it didn't look like a security that fell under the SEC.

And ultimately in discussions with the Fed, it seemed appropriate to be under their jurisdiction. So we setup under the Fed. It's our first opportunity of working with the Fed.

I'm frankly very impressed with the quality of people that the Fed has. They are an amazing organization. They have a deep understanding of derivatives, and they are a very hands-on regulator.

In fact, today they are doing I think their second audit of our clearing house, and we are only 90 days old. And I think that audit goes all-week long.

But there are some regulatory voids that I think Secretary Geithner was trying to point out in his letter, things about how the FDIC would get involved in a windup for example of a bank versus a clearing house, whether we would wind up the affairs, or whether the Fed would be involved.

So there are some jurisdictional issues that we're trying to work out between agencies on a collaborative basis. But ultimately, I think Congress may have to step in and help dictate some of these.

REP. SCOTT: If I may proceed just for a moment, if I may. I'm reading your statement, and just to clarify, you state that clearing all over-the-counter derivatives, and the trading of over-the-counter derivatives on a transparent electronic platform, may provide additional risk management and potentially additional price transparency.

However, forcing all over-the-counter derivatives to be cleared and traded on exchange would likely have many unintended consequences. Can you give us a little clarity there?

It seems as if you're saying on the hand that it's good, but on the other hand there's some bad things that will happen.

MR. SPRECHER: Yeah, this is the dilemma that we're all in here, which is we all of us here believe in open, transparent predictable markets, but you all trying to regulate everybody into one of those could have unintended consequences.

One unintended consequence for example may be what a number of us have heard you talk about today, which is the flight of some this business overseas. We have 12 members of our credit default swap clearing house. They are the largest holders of credit default swaps in the world, probably hold at least 80 percent of the open positions in credit default swaps.

Of the 12 members, only four of them are U.S. companies. The other members have come here because they ultimately believe that we need to do clearing. They ultimately believe that it will be better for the marketplace.

So with the case where through some regulatory prodding and cooperation with industry in the aftermath of this terrible credit crisis, there's some voluntary work. But I don't know that we can always depend that foreign companies will cooperate with U.S. regulation.

REP. SCOTT: Mr. Duffy, I think you raised that point, and I asked that question earlier to the other panel, because we really want to be I think very careful and judicious at what we do here.

All this is sort of new territory for us. Can you give us your rationale for your fears? You were pretty strong in your statements that we would lose business overseas.

Would it be on overseas exchanges? Would it be offshore accounts? Can you tell us exactly how we would lose overseas?

MR. DUFFY: Well, I think Mr. Sprecher said it correctly, you've got to look at a lot of these dealers. There's 12 large ones in U.S. of which, you know, they have operations throughout the world, and they can pass their book from one place to another, so the book just travels along through the time zones.

And that's a concern because they can operate outside the United States. Our concern with that aspect is if you take that market off of the U.S. that helps to regulate U.S. futures exchanges because we are really the price discovery mechanism for a lot of the look-alikes that trade over the counters.

So that's the price that they are looking to use for their risk- management needs. So if we have less liquidity in the over-the- counter trading on our exchange, it's going to hurt the whole food- chain. So it is a concern.

So when we look at -- and I'll go back to may be your other question about why we can't take some of these trades in our clearing house. They're so customized in nature where a dealer may be out looking for the other side of a trade for not six milliseconds like we trade at the CME Group, he may be out looking for six hours for the other side of this one particular trade, for this one particular client.

That's why it's very difficult. So we can't bring those into our clearing house, and assume the risks associated with those transactions at CME Group, because we just don't have all the information we have on the standardized futures contract.

But I guess that's a long way of saying is we are concerned about the liquidity which is the direct result that the futures exchanges get from the over-the-counter market. The last panel made a statement, they said that the OTC market is roughly several times larger than the regulated exchange model.

It's five times larger. It's much larger than the regulated exchange model, so they work together. And the pricing comes from the exchange model.

REP. SCOTT: All right. So you say that moving forward we need to separate the requirement if we mandate the clearing house and separate illiquid and unstandardized derivative contracts from non -- from liquid?

MR. DUFFY: Yeah, we don't believe that Congress should mandate it. We think they should use capital incentives for clearing, and that's the way we approach this. We don't think mandating is a good thing to do.

REP. SCOTT: Well, if we did that, would we not be having some sort of loophole that could allow a repeat of what AIG and what Enron -- (cross talk.)

MR. DUFFY: Well, you could have other reporting requirements that are not being put forth today for some of these transactions that will bring greater transparency to the regulator, whether it be the SEC, CFTC, or the systemic risk regulator.

REP. SCOTT: All right.

Thank you, Mr. Chairman.

REP. KANJORSKI: Gentleman from Illinois, Mr. Manzullo.

REP. DONALD A. MANZULLO (R-IL): Thank you, Mr. Chairman.

I -- let me ask a very base question. I believe that we would not be in this crisis that we are today if the subprime market had not gone sour, and thus tainted the basis of the investments which grew -- the investments grow obviously exponentially through derivatives.

Does that statement make sense, or am I missing something out?

MR. SPRECHER: I believe it does. We developed in the world an unbelievable distribution system for syndicating risk with the idea that people holding small amounts of risk widely dispersed is good risk-management, but then we pumped poison through that system and just kept pumping and pumping and pumping --

REP. MANZULLO: Because the underlying investment was --

MR. SPRECHER: Correct --

REP. MANZULLO: -- was destined to go bad. You just can't sell homes to people who can't afford to make the first installment.

In fact the attorney general two years ago in Illinois came out with her report on mortgages and she thought that the reason for the foreclosures were that people were not prepared to pay the increased rate on the -- on the variable-rate mortgages when they began to reset.

And then she shockingly found out that some people couldn't even make the first and second mortgage payments on the original mortgage. And the reason I ask that question is that what you gentlemen do is to provide more liquidity in the market for good loans.

I mean, that's really what you're doing. Would that be correct?

MR. EDMONDS: I think that it may be more accurate to say that what each of us respectively represent are mechanisms that provide better transparency, whether it be through clearing, through execution services.

And that transparency results in an increased confidence. So the increased confidence you have in the next product that is highly correlated back to this standard thing that trades in an exchange, or is cleared in a clearing house is enough for people to take that additional risk. And I think what Mr. Sprecher was --

REP. MANZULLO: Because of confidence?

MR. EDMONDS: Because that increased confidence exists but then what you have to begin to question is the correlation method between what everyone understands and accepts as something of value, and this thing over here that's not something of value that you don't know until it's too late.

REP. MANZULLO: The -- so the emphasis upon more regulation on the derivatives really has its genesis in the fact that the original investments themselves went sour, would that be correct?

MR. THOMPSON: I think that is correct that when you have an underlying instrument such as the subprime that went sour that causes pressure on a loan. The one thing that the U.S. markets have done is pass broad capital here to the U.S. which has made us the broadest capital markets.

And one of the reasons why so many foreign companies want to come here and invest in Mr. Sprecher's company and be involved in it is because the U.S. capital markets have one, been transparent, two, have been very liquid.

And now what the worry is, is that has the regulation stayed in tune with what the instruments are all about, and can they in fact continue to provide the same kind of transparency.

I think they can. I think that the market participants have already started working in that regard. We for instance work very cooperatively with all of the members who are sitting here.

We were instrumental in helping Mr. Sprecher's company set up their CCP, because they pulled the trades on their credit default swaps directly from the Depository Trust and Clearing Corporation.

REP. MANZULLO: The follow-up question would be based upon our discussion. Do you believe that any derivative product that can clear through a clearing house can also trade on an exchange?

MR. THOMPSON: I think there's some confusion between clearing and what exchange-traded means.


MR. THOMPSON: I think what we do at DTCC is clearing. We match, you know, the sides of the trades. We actually net the transactions. We decide through our automated systems what the calculations are.

We actually send those payments to CLS Bank to be set off. That's clearing. Trading is what takes place on an exchange when two sides who want to in fact do a trade decide to put it through.

Clearing is all of the post-trade activity. And making certain --

REP. MANZULLO: Settling of accounts?

MR. THOMPSON: That -- making certain a buyer got what he was supposed to and the seller is getting the funds that he thought he or she should be getting. That is really part of the clearing system.

And I think there has been a little confusion in today's discussion, both in the first panel and to some extent perhaps here, as to what clearance and settlement has meant here in the U.S.

MR. EDMONDS: I would add just a little bit to Mr. Thompson's comments that when we talk about clearing, the next component of the clearing is whether or not you provide credit mitigation.

And Mr. Thompson is incredibly correct in the fact that, you know, there are certain processes that you can use to clear information in some context where you're also removing that credit exposure between the counterparties.

But to your earlier question I think it's incredibly important that until you figure out how to clear it, it is very difficult to move to how can you trade it on an exchange. And there are plenty of asset classes that we haven't yet put into essentially a clearing model.

MR. DUFFY: Congressman, it is important to have liquidity to get price information so you could do risk management in clearing. That normally comes from trading, and then it goes into the clearing house once the price has been established.

And then the risk management process goes on until that position is liquidated. I think that you can do some clearing without trading the product, but you need to have some relevant information from some of the providers that are out there today that are giving you price information as it relates to this.

There are margin requirements. There are twice daily mark-to- market requirements associated with clearing. So there are some things that are not a custom to the OTC world today that will burden additional cost, but will also protect the taxpayer from additional liabilities like they had in the last several months.

REP. MANZULLO: Thank you.

MR. DUFFY: Thank you, sir.

REP. KANJORSKI: Thank you, Mr. Manzullo.

We could go on, but I know that on the Republican side of the aisle they have a commitment for a 3:00 o'clock meeting, is that correct?

REP. : (Off mike.)

REP. KANJORSKI: So rather than holding our members here, we'll wind this up. I just want to thank you first of all for appearing.

Two, I asked a question of the first panel would you all be willing to participate in giving us your best thoughts as to what we can do eventually to do fair and effective regulation without smothering the derivatives industry, but on the other hand, to avoid a reoccurrence of what has happened over the last several years.

Is there anybody here that wouldn't be willing to participate in the future in sort of an advisory role to accomplish that?

MR. DUFFY: I applaud you for doing that, sir. I think it makes a tremendous amount of sense.

REP. KANJORSKI: Well, we appreciate that. You can be of great assistance. And not only that, when mistakes are made in the future as a result of our legislation we can point to the expert advisors -- (laughter) -- and say that you all made the mistake.

No, we'd appreciate it. I certainly invited -- there's nobody on the committee that has the expertise of the panels that we reviewed today. And if we can get your assistance in that, that'll be extremely helpful over these next several months because that's the period in time in which some piece of legislation will occur.

And I may caution you, also take advantage of reviewing the drafts of that legislation as it starts to circulate. Don't hesitate using that thing called a telephone and call any member of the committee or myself and let us know what a dastardly thing we're doing by even considering one part of the piece of legislation.

I'm not guaranteeing that we'll respond positively to your critiques, but we'd like to hear your critiques on all those issues.

REP. MANZULLO: Would the chairman yield for a second?

REP. KANJORSKI: Sure, you're welcome.

REP. MANZULLO: I was just in Switzerland, and met with the folks from FINMA. It took them 10 years, a 10-year study in order to come up with their new regulatory body of all -- of all instruments, of all categories of investments that might in their opinion come up with a systemic risk.

And the first statement that came out of the mouth of the person with whom I spoke, he said, "Congressman," he said, "Whatever system of regulation that you come up with, you must give companies the ability to fail."

He said, if you don't do that, you won't have an investment -- investment system in your country. And I want to commend you for the caution that I know that you are taking, and also Chairman Frank for moving deliberately, but very slowly into an area like this.

REP. KANJORSKI: Well, we thank you. Of course, we're much swifter than --

REP. SCOTT: Mr. Chairman, could you yield for one second please? I'd also like to -- just a word of caution.

I want to certainly make the record reflect that I am very concerned about two major areas as we move forward, as I think we've received some good information from both of these panels that we want to make sure that we get our arms around, and that is the impact this has on farm business going overseas.

I think that is a -- I think you made a good point that we need to be careful as we move forward on that. And the non-standardized derivatives as well, that we might have to do what Mr. Geithner suggested, but to separate that -- those two levels.

REP. KANJORSKI: Appreciate that.

REP. SCOTT: Thank you.

REP. KANJORSKI: You know, may I just add to the record, because Mr. Thompson, you made a statement I wanted to ask you the question; you said 95 percent. Was that in volume or dollar value?

MR. THOMPSON: That's in volume and dollar amount at this point. That's what our belief is.

REP. KANJORSKI: Okay. You mean --

MR. THOMPSON: In CDS, in credit default swaps that we're talking about.

REP. KANJORSKI: Okay, they're equal? One the dollar volume and the --

MR. THOMPSON: It's approximately, but it's based on what the dealers have told us of what they're doing at this point.

REP. KANJORSKI: Okay, very good. Thank you.

MR. DUFFY: Mr. Chairman, if I just may for the record; Mr. Scott, I'm sorry earlier when you asked about the difference between standard and customized products, my comment was that we would not -- we're not supporting mandatory clearing of either one.

I am a supporter of standardized OTC contracts being cleared through a regulated exchange, just sort of clearing that point, sir. I apologize if I was confusing earlier.

REP. KANJORSKI: Well, very good. Again, I want to thank you very much for your testimony, gentlemen, and we will put you on our advisory committee and ask for anything --

MR. DUFFY: Thank you, sir.

REP. KANJORSKI: -- that you can give. Oh, the chair notes that some members may have additional questions for this panel which they may wish to submit in writing.

Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record.

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