CFTC - SEC joint hearings

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September 2 harmonization hearing

Primary issues:

  1. Approval of new products
  2. Portfolio margining
  3. Clearing houses

Panel One — Exchanges, Markets, Clearance and Settlement, and Margin Requirements

  • William Brodsky, Chicago Board Options Exchange
  • Jonathan Short, ICE Futures
  • Craig Donohue, CME Group
  • Anthony Leitner, AJ Leitner & Associates
  • Annette Nazareth, Davis Polk & Wardwell
  • Eric Baggesen, California Public Employees Retirement System (CalPERS)

Brodsky --CBOE

Inconsistencies in principles based approach for CFTC and rules based approach for the SEC. Brodsky recommends the SEC move closer to approach of the CFTC. Actively trade ETF on gold trade put on hold for 3 years. Option on CDS index put on hold for 7 months while Eurex brought out a product in several weeks.

Margin levels should reflect risk profile not regulator. Securities law stronger than futures law on investor protection and futures law should be strengthened.

Short -- ICE

  • SEC/CFTC adopt common core principles
  • Adopt common approach to foreign markets
  • Aviod duplicative regs where possible

Donahue -- CME

Fill gaps from legislative. Hybrid products, trading and clearing of instruments. Do not favor make identical regs from securities and futures/options. Different need for investor protection and ???

Cognizant of foreign standards...

Leitner, AJ Leitner & Associates

Intermediaries play a critical role in fin markets. Portfolio margining... fin intermediary provide customer comprehensive ability to bring assets in one place and leverage done in one place and done appropriately... cross margining is one piece (securities and futures) current portfolio margining regime does not take into account futures (wholesale investors) hedge fund business went to London... when Lehman blew up many investors still haven't got money back... "one pot" guy, clearing houses have agreements among themselves to share information

Annette Nazareth -- Davis Polk & Wardwell

Not first time agencies have been instructrd 2000 CFA to write joint rules. CFTC went to princples and SEC went to rules

  • Investor protection standards
  • Insider trading prohibitions
  • Customer protection and margining
  • Fungible products and common clearing (linked clearing) exchange on which it trades clears though trades... customer cannot DOJ comments to the Treasury in 2008 that commented on these issues

Eric Baggesen -- CalPERS

$180 billion AUM

Excessive leverage, creditworthiness and mismatch of assets/liabilities

Lack of transparency in OTC derivatives makes it almost impossible to know the risks of oru counterparties. Transparency key. Register all market participants. Great affinity for organized markets. Clearinghouse settlement very important. Failure of credit raters.

Effectives -- transparency is first measure... enforcement actions in registration issues?? Futures and securities are the same to us but you approach us as different entities. Know more about us.

Efficiencies... single point of registration would be very helpful.

Chairman Gensler --

Portfolio margining all in favor?? Devils in the details. ICE - rigorous risk management at the clearing houses. Fungibility important for CME? Donahue not for cross margining... investor protection, bankruptcy given the difference between sec/fut... customer segregation rules?? Don... positions in separate accounts not have to deal with diff regimes for customer protection allow 2 pot approach...

Littner --BD in the credit extension business... 2 pot approach ineefficienct ...

Risk based portfolio margining... Congress wrote into law a year ago...

Nazareth... one pot much greater efficiency... two pot inefficient

Commissioner Dunn ---

Donahue -- investors want portability of assets in the market... cross margining is beneficial... last 30 years CCP worked well... it is 2 pot today... cross margining not our issue on a global basis... vast majority of foreign exchanges use portfolio margining???

Baggesen -- look outside the country standard is 1 pot approach... customer son't have to have 1 pot approach can leave it like it is... support creating portfolio margining ... look outside our borders and understand... do we want to encourage our customers to have accounts in London? look at systemic view of having offsetting positions Russell future and Russell option... portfolio margining is customer issue and cross margining is across exchanges

Commissioner Casey -- SEC

Common core set of principles... what are they? Margining, registration, investor protection?

Short - CFA created large transformation in the approach of the CFTC, '75 amendments created the need for the SEC to approve every rule.

ICE-- CFA is good, IOSCO is good core principles, high level of regulatory agreement is good

CME -- shared good... risk based portfolio margining, OTC clearing common principles, SEC move toward a more globally competitive market like the CFTC...

Littner -- Common approach to managing risk at customer level, referee function,

Nazareth -- different market structure, mitigating systemic risk, avoiding reg arbitrage.. SEC embraced portfolio margining,

Calpers -- we know how to manage cash flows as an investor... you need to bring entirely into view

Sommers -- CFTC

Global standards for portfolio margining? How do they approach insolvency regime? Brodsky -- SIPC is a function of the resolution of BDs. If I'm French I can put options, futures, stocks in one account. We have customers who want everything in one account.

Common clearing -- from clearinghousee perspective how do you clear products that you don't trade?

CME-- cash securities have 1 clearer, futures and options have multiplicitiy of clearing houses and we compete on the basis of distinctions of products... systemic risk of interoperatiobility of clearing houses, operational risks of transfer customer accounts, 90% are clearing through vertical structures...

Littner -- fungibility positions in 2 different places... M2M payments going back and forth... systemic risk issue is how do you unwind those 2 positions and net out exposure with least problem? In paper 2 different ways that clearing houses now handle that today. Bring techs and risk managers into discussion first before lawyers in

Walters- SEC

Turf battles?? Brodsy propose a "council" needs to be hardcoded for the agencies to wrok together with Treasury that reconciles differences... ETF recent issue and nothing got resolved for years.

Chilton -- CFTC

We just need adult supervision to resolve these issues. Product approval can take 6-9 months and foreign entities come up quickly.

Manipulation for SEC is just "reckless" and CFTC - must prove "intent" he likes SEC approach better.

Nazareth on insider trading???

Brodsky - comparable products shouldn't have different approaches...

ICE -- ags markets are risk management markets and participants are trading on inside info... comparable products can have insider trading...

CNE -- participants are bringing securities markets info to the futures markets

Aguilar -- SEC

Fundamental differences in markets and can we bridge the differences

CME -- Ownership based investment is very different than option investing. Many differences in these markets. Is gold ETF a security or a future and who regulates that...

ICE -- Washington has a case of "Loopholeitis"... futures markets are speculating what the future will be...

CBOE -- we are where we are because of the history of the markets. It might help to talk to foreign regulators. Insider trading there is a whole world of OTC derivs were there is not regulation or reporting no transparency... much that completely eludes regs... in 2000 Congress excluded these products and what effect on markets cause they lean on our markets to hedge

Paredes -- SEC

ICE - CFA self certification by exchanges is good, healthy competition with other exchanges is good... tension there between exchanges competing... higher level of prudential regulation... regulator sit down with exchanges on real time basis

CME - hybrid products (securities with elements of futurity) CFTC will recognize "functionally comparable" products (FSA) great step would be to think similarly about these products and let the exchanges prick the regime they want to use to bring these products to market. Maybe some different registration regimes. Then you don't need a tiebreaker.

Nazareth -- industry bears the brunt of regulatory differences. If product on futures side would migrate to one exchange.

Shapiro -- SEC

How should different types of investors shape how we see different products and their approval?

Securities have been retail component and futures are mostly institutional? Suitability standard is a level of protection.

CME -- no need for differences for approving products

Panel Two — Exchanges, Markets, Clearance and Settlement, and Margin Requirements

  • Peter Reitz, Eurex
  • Wayne P. Luthringshausen, Option Clearing Corporation
  • Mark Young, Futures Industry Association
  • Lawrence Leibowitz, NYSE Euronext
  • Professor Lawrence Harris, University of Southern California
  • Mark Cooper, Consumer Federation of America

Cooper -- Shouldn't start by asking financial markets participants how they want to be regulated

Harris -- USC

Clearing systems provide a solution to systemic risk problems. 2 aspects of clearing systems how clearing ends up controlling marketplaces... cross margining (1 or 2 pot)

Both agencies have been strident in promoting competition. 1) competition for best price (CFTC has shown more concern) 2) competition among exchanges and providers to provide... clearing systems define how the system is structured

Futures clearing -- single clearer and exchange and clearer are linked together don;t other ATS...

Securities market - NSCC provides level playing field for ATS and exchanges

OCC- clear for 5-6 options exchanges

The result has been a lot of power for markets that control important contrancts and a lot of profit that is extracted hard for startups

Search for best price is complicated by fragmentation

With electronic trading balance of search for best price has been made easier...

Leibowitz -- NYSE Euronext

Regulated by both agencies... exchanges work well in meltdown... support bringing more products onto exchanges

Regs should promote open and fair markets. Current product approval approach can require lengthy approval. Filing process can tip off non regulated entities to new products. "Effective on filing status" Futures and securities in same account. New York Portfolio Clearing formed in June... available initially to house accounts... so it doesn't conflict with SIPC

Reitz -- Eurex

74 members of Eurex are US entities and can address the platform directly under direction of CFTC... trading by US entities is not as transparent to US regulators as it could be... approved by SEC and CFTC for clearing

Young - Kirkland and Ellis (for the Futures Industry Association0

Both agencies overlook the importance of clearing systems.

Luthringshausen -- Option Clearing Corporation

We create the fungibility that exists for 6 options exchanges and had created fierce competition among the markets... cycle... fungibility, greater volumes, lower costs... bringing the model to the futures side... small but optimistic...

Stans -- Monty Carlo system for evaluating margin... had a cross margining with the CBOE??? since after '87??? and it has worked really well

New products -- gold ETF took 3 years to put together... we try and get statutory assurance.. we need clarity with that...

Portfolio margin -- investors put them together and the system should allow that... we need to change SIPC and relieve the segregation requirements

Shapiro -- SEC

Differences in market structure and clearing models -- do we have to chance the market structure in a fundamental way?

Harris - 1) grandfather all existing structures or 2) do it all at once (will take 10-20 years because of money involved)

CFA -- regulated products differently if necessary

Casey -- SEC

Cross margining -- are there benefits of 1 pot vs 2 pot for systemic risk

Smith -- allow portfolio margining at the intermediariy or entity level -- allow dealers to net out positions of customers prior to clearing house settlement and margining

Insider trading... CEA no restriction on insider trading... hedging involves insider trading

Walters -- product approval... be more flexible in allowing changes in market structure and new products... I agree but believe we have a statutory responsiblity to protect investors

Harris -- don't regulate products regulate sales practices, want the CFPA

Cooper -- agree with Professor... consumers need an agency focussed on their needs and that agency will go across products

Sommers -- CFTC

Elaborate on structure in Germany... are there differences in how futures and options are regulated?

Not a separate market where they are traded... traded in the same place across Europe

Exchanges are regulated differently than intermediaries ... exchanges don't have any differences between treatment of different kind of customers

Aguilar -- SEC

Market data regimes under futures and options regimes...

Harris -- -difficult question, 2 different regimes, options side "public data" collected and sold on basis of number of terminals... money flows back to aggressive quoters... futures data??

problems... hard to argue one if retail and one is institutional... it's all about "willingness to trade" its all about market relationships... who has information and access... fees should go back those who create the information... regulating this area is a core issue (12:30)

Chilton -- CFTC

Criminal authority ??? ... 2/3 of cases that are not prosecuted too complicated... we advocated criminal penalties because fines are not sufficient disincentives to behavior.

Harris -- Criminal authorities have been reserved for the executive branch...

Chilton going to DOJ on these issues is not easy... you are right about remaining independent

Parades -- SEC

3rd model of margining???

Harris-- whole margining system is a pyramid where those on higher levels are responsible for those below... on securities 3 days of risk... on futures and opetions the risk exists as long as the contract is alive. Consider intermediary entities where margining can be done. Requires capital at risk...

1 pot treasuries/repos

NYSE -- customer accounts could be a "virtual" one pot because of different insurance regimes between SIPC and ??? (futures)

Gensler --

1. Differences on co-location and flash trading?

2. Funding for SEC and CFTC -- does this make sense

3. For profits and utilities... when we grapple with issues of fungibility it goes to the core of the business model...

Eurex... set standards and let everyone compete...

Panel Three — Intermediaries

  • Edward Rosen, Cleary, Gottlieb, Steen & Hamilton
  • Yvonne Downs, NewEdge
  • Stephen Merkel, BGC Partners, Inc.
  • Brandon Becker, TIAA-CREF
  • Stephen Luparello, FINRA
  • Brian Nigito, GETCO

Rosen -- Cleary

Funds regulated '40 Act and pool operators under the CEA... too many rules aimed at the same policy objectives... don't just aggregate rules sets... margin... dual registrants have conflicting resolution regimes

Downs -- NewEdge

Created in 2008 one of the top derivatives brokers... most important issue is portfolio margining... allows obtaining the benefit of offsets... CFTC and SEC don't recognize each others good customer funds location... NewEdge capital requirements are the same as their customer's requirements... harmonize books and records... client type definations... ECP, QUIBS, credit investors... customer funds protection... should be one way funds are protected...access to foreign markets... suitabilibity... retail should be protectd from unsuitable products

Merkel -- BGC

Uncollateized bilateral transactions...

Existing interdealer brokerrs are ideal places for swaps (alternative swap facilities) CFTC and SEC shouldn;t restrict voice or electronic broking (ASFs) vertically linked derivatives market is uncompetitive... execution platform point...


3.6 million participants

TIAA as an insurance company regulated by th state of NY CREF is an investment advisor

1984 study concluded harmonization was necessary... sustained and consistant attention at the Commission level... concentrate on issues of systemic risk, margin, clearing, bankruptcy

OTC is important... clearing and transparency can be enhanced...

Luparello -- FINRA

230 dually registered firms out of 4,800..

Brian Nigito, GETCO

Dunn -- CFTC

How can CFTC/FINRA/SEC work together more efficiently to prosecute?

Luparello... difficult where it's not clear where the jurisdiction is... more meeting sand cooperation...

Dunn... what has been your experience in working with the Justice department...??

Luparello... episodic coverage from Justice...

Know your customer rule -- specific requirements relative to individuals/risk disclosure

Suitability --

Dunn -- Collocation and flash trading...

Casey -- suitability and fiduciary standard??

Sommers -- CFTC

Portfolio margining operational issues...

NewEdge .. it's important to know customer's overall exposure to us is... systems can accomdate either 1 pot or 2 pot approaches... we gave them a statement that lists everything they are trading with us...

Walters -- coordinating information

Getco -- info in different formats NewEdge -- not inexpensive to get information to the Commissions...

Walters -- is there flash trading in the futures markets?

Getco -- differences.. no ability to internalize ... as the markets go electronic ??

introducing brokers and clearing broking... ???

Cleary -- no reason to treat them differently under two regimes

Chilton --

Flash trading -- Getco says that they are "liquidity" providers and stay in the market a comparable amount of time to other "liquidity" providers...

Aguilar -- audit trail... how it differs in the securities and futures world... how could they be harmonized?

FINRA -- still some inconsistent between markets... NASDAQ has on the run audit trail,.... not NYSE or AMEX... aggregation of audit trials... each market has a wonderful trial but not an aggregated intermarkets... NewEdge... audit trails are different...securities get "blue sheet" request...

Paredes -- SEC

Margining, bankruptcy...

Retail FX policing Non-discrimatory clearing Have to protect against manipulation even for institu

Chairman Gensler's top 12 list

Product approval process

  • Rule approval process
  • Cross and portflio margining
  • Fungibility
  • Segregation and solvency
  • Market structure
  • Manipulation standards
  • Insider trading
  • Suitability vs disclosure regimes
  • Fiduciary duties
  • Mutual recognition
  • Principles versus rules

Cleary -- fungibility and national market structure, cross portfolio margining, resolution NewEdge -- margining, mutual recognition BCG -- Fungibility and market structure TIAA-CREF -- segregation and solvency (systemic risk) cross/portfolio margining, fungibility and market structure FINRA -- market structure, fiduciary standard Getco -- product approval, margining, market structure

September 3 harmonization hearing

View webcast.

Opening Statement: Chairman Gary Gensler

Panel One – Enforcement:

  • Daniel Roth, National Futures Association
  • David Downey, OneChicago
  • Kenneth Raisler, Sullivan & Cromwell
  • William R. McLucas, Wilmer Cutler Pickering Hale and Dorr
  • Damon Silvers, AFL-CIO
  • Richard Owens, Latham & Watkins

Panel Two – Investment Funds:

  • Professor John Coffee, Columbia Law School
  • Richard Baker, Managed Funds Association
  • Sharon Brown-Hruska, NERA Economic Consulting
  • Kathleen Moriarty, Katten Muchin Rosenman
  • Michael Butowsky, Mayer Brown
  • Michael Connolly, Association for Financial Professionals

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