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H.R. 4062 — THE FINANCIAL DERIVATIVES SUPERVISORY IMPROVEMENT ACT OF 1998 AND H.R. 4239 — THE FINANCIAL CONTRACT NETTING IMPROVEMENT ACT
FRIDAY, JULY 24, 1998
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
The committee met, pursuant to call, at 10:15 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach; Representatives Roukema, Bereuter, Baker, Lazio, Bachus, Castle, Campbell, Lucas, Kelly, Snowbarger, Fossella, LaFalce, Vento, Roybal-Allard, Watt of North Carolina, Hinchey, Bentsen, Kilpatrick, J. Maloney of Connecticut, Sherman and Lee.
Chairman LEACH. The hearing will come to order, and I apologize for starting a few minutes late. There have been some new developments on this issue; and, second, I think everyone should be aware that in five to ten minutes there will be a fairly important vote on the House floor on a rule on the health care bill that Congress is considering today, so there will be some interruptions.
The Chair would like unanimous consent that a fairly lengthy statement he has prepared be placed in the record.
I would just like to say just by opening that this is one of the most unusual circumstances I have ever confronted as a Member of Congress. What we have is a disorderly institutional situation coupled with the potential of market disorder in one of the most extraordinary areas of commerce the world has ever known.
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In terms of institutional disorder, we have three significant institutions of regulation, the United States Department of the Treasury, the Federal Reserve Board and the Securities and Exchange Commission, which are in disagreement with a fourth regulator, the Commodity Futures Trading Commission.
It is important for Congress to recognize and honor institutional independence. It is also important in areas where there is overlapping jurisdiction to expect harmony of regulation and jurisdiction. It is particularly the case in this circumstance where we are talking about a multi-trillion-dollar market of instruments of enormous sophistication and the implications of actions of one regulator who may be in disagreement with other regulators and clearly in disagreement with past commissions is a very significant situation.
The Chair has attempted to do everything possible to come up with a nonlegislative remedy, and we have placed on the table a series of draft agreements. Three of the four regulators have concurred with the final one. The fourth regulator has suggested that she can only concur in the draft agreement that her institution has written, one which the other regulators consider to be unresolving of the issues.
There is on the table today a letter that amounts to what might be considered acceptence of a partial unilateral standstill by the CFTC, but one which does not resolve the philosophical issues, nor in many ways goes as far as the draft agreement that the other regulators have rejected. And so the question remains for Congress whether to insist on a more comprehensive nonlegislative approach or to move toward legislation. These are issues which I think the committee will take under consideration in the wake of today's hearings and in the wake of market reactions.
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I would conclude by saying that at issue is a market that is primarily an American market now, but that could in very short order be moved overseas. If it is, not only will this be to the disadvantage of the United States market participants, that is institutions that serve as intermediaries, but to American consumers who will not have the certitude benefit of United States supervision.
And so in this situation we are dealing with a very, very uncertain set of circumstances. This is an area in which Congress is not thoroughly expert, and so we rely on the judgment particularly of those in the Administration whose expertise of this nature is evident.
In addition, we are asked today to comment on certain bankruptcy change provisions based upon a Presidential working group recommendation which echoes recommendations contained in a 1993 report from the Minority in this committee seeking more certitude in the banking area.
[The prepared statement of Hon. James A. Leach can be found on page 284 in the appendix.]
Chairman LEACH. But at this point let me turn to Mr. LaFalce.
Mr. LAFALCE. Let me thank you for your understanding in this area. They have been excellent.
Second, I ask unanimous consent to have my testimony and opening statement presented in the record in full.
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Third, let me make some brief observations.
This is an extremely complicated and difficult issue, and every regulator is approaching it in good faith, and every regulator is approaching it from the perspective of advancing the best public policy interests. I understand that. I do not place blame on CFTC, SEC, Fed, Treasury. People have honest differences of opinion both to interpretations of existing law and as to what future public policy should be.
It is my hope that this legislation would be unnecessary, that the regulators could resolve this issue amongst themselves. That may be a very naive thought. It may be like asking the Banking Committee and the Commerce Committee to resolve their differences over financial services jurisdiction, so we may have to act. And if we do have to act, it is not so much what the law is, it is what the law ought to be. What is the best supervisory climate.
As the whole question of operating subsidiaries as opposed to affiliates, reasonable people could disagree. Sometimes they can disagree reasonably, and sometimes they can disagree unreasonably, but they are always well-intentioned. The world is very fragile right now, and the issue of derivatives is an explosive one, given the fragility of the global marketplace and the uncertainties and complexities of derivatives. We must get on with it and act in a preventive manner and preemptive manner. We can't come in after the problem has arisen.
I really look forward to your testimony to help give this committee guidance because I fear that we are going to have to come up with a legislative solution, as much as I hope that the regulators could do it themselves. Thank you.
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[The prepared statement of Hon. John J. LaFalce can be found on page 289 in the appendix.]
Chairman LEACH. Does anyone else wish to make an opening statement?
Mr. Bachus.
Mr. BACHUS. Mr. Chairman, I read Chairman Greenspan's testimony, and one thing that sort of stands out to me is where he said, ''I have no doubt derivative losses will mushroom at the next significant downturn, as will losses on holdings of other risk assets both on and off the exchange.''
I think that is significant. I am not surprised that you make that statement, but I think it is quite significant.
Chairman LEACH. Mr. Vento.
Mr. VENTO. Just briefly, I appreciate your comments and oversight in this issue and further legislation on the matter.
We are sort of torn here in terms of—it is a sort of a classic question when a regulator shapes the market and who that regulator ought to be. These legislative proposals, I am certain that those which do not now have the authority, such as the Commodity Futures Trading Commissioner, are happy to assume some of that authority. Most regulators don't complain about being given more power and authority.
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I am looking for what the role of the regulator should be in terms of shaping the market and whether we have the right balance. And the fact that those questions are being asked by the Commodity Futures Trading Commission, I think, to my point of view, is what we need more of in terms of regulators.
So in looking, obviously, if you want to assume some of this role and responsibility how you would shape the market rather than simply taking the position of something ought to be unfettered, and if you don't do it our way, we are going to go overseas, I think we have more of a role. I don't think that is viable in terms of the role we play in a global economy. I think we have more of a role in setting the epitome of what is going to be the type of standard. We see a lot going into swaps and derivatives and a lot going into commodity futures types of arrangements, and I am glad someone said, stop the music, and we are going to talk about this, otherwise you could be dealing with a House of cards in terms of the financial underpinnings of the global economy. They are important questions.
I don't want to say that the Commodity Futures Trading Commission is right and everybody else is wrong, but I am pleased that the questions are, frankly, being asked, and I think they ought to be asked by all of the regulators and not just this regulator. That is not coming through to me, so I am looking forward to some of the answers to that and to continue this process, Mr. Chairman. Thank you.
Chairman LEACH. Does anyone else wish to make an opening statement? If not, the Chair would like to ask unanimous consent that the opening statements of all other Members be placed in the record.
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The Chair would also like unanimous consent to place in the record the letter dated today from Chairman Born to Congressman Robert Smith on this subject, what might be described as suggesting a partial unilateral stand still. Without objection that letter will be placed in the record, and I am having staff photocopy it for Members' attention.
[The information can be found on page 427 in the appendix.]
Chairman LEACH. We will begin with Secretary Hawke.
STATEMENT OF HON. JOHN D. HAWKE JR., UNDER SECRETARY FOR DOMESTIC FINANCE, U.S. DEPARTMENT OF THE TREASURY
Mr. HAWKE. Thank you, Mr. Chairman. I appreciate the opportunity to present the views of the Treasury Department on the CFTC Concept Release and on the legislative proposal made jointly by the Secretary of the Treasury and the Chairmen of the Federal Reserve Board and the Securities and Exchange Commission. We greatly appreciate the efforts of Chairman Leach to bring about an agreement among the interested parties on this matter. The markets would be well served by such an agreement, but if no agreement is reached, we believe legislation is essential to cure the uncertainty that has been engendered in this area.
The issuance of the CFTC's Concept Release is a serious development for the OTC derivatives market. While the market appears to have been somewhat reassured by the prompt expression of grave concern by Secretary Rubin, Chairman Greenspan, and Chairman Levitt immediately following the issuance of the release, market participants remain worried about what the Concept Release may portend.
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The Concept Release suggests that the CFTC is at least considering imposing significant new regulatory requirements on the OTC derivatives market. Specifically, questions raised in the Concept Release suggest that the CFTC may be considering overseeing OTC derivatives clearinghouses, regulating multilateral transaction execution facilities for OTC derivatives, requiring registration by OTC derivatives dealers and perhaps other market participants, imposing capital requirements for OTC derivatives dealers, prescribing internal control requirements for OTC derivatives market participants, establishing extensive sales practice rules and disclosure requirements for OTC derivatives dealers, adopting recordkeeping and reporting requirements for OTC derivatives dealers and requiring mandatory membership in a self-regulatory organization for OTC derivatives dealers.
The problem is that any attempt to use the CEA in its current form to accomplish such a far-reaching regulatory regime increases legal uncertainty about certain types of existing contracts and raises anew difficult jurisdictional questions. Currently there is no clear consensus in the Government or in the private sector concerning any possible additional regulation for this market, nor is there any consensus that the CFTC currently has the legal authority to regulate this market. We submit that the issue of major changes in the regulatory regime for OTC derivatives is for Congress to decide.
The law in this area is not clear. For the past ten years, there has been an implicit consensus that the OTC derivatives market should be allowed to grow and evolve without deciding the difficult jurisdictional questions concerning the potential applicability of the CEA to any of these transactions. At the heart of this consensus has been a recognition that swap transactions should not be regulated as contracts subject to the CEA, whether or not a plausible legal argument could be made that any of these transactions are covered by the CEA.
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The CFTC release, even though it purports to do no more than pose questions, upsets that consensus because the inescapable inference is that the CFTC has concluded that many swaps are subject to their jurisdiction as futures contracts and can be appropriately regulated as such. We do not concur with that conclusion. It is our view that swaps are not futures under the CEA, and that the Congress did not intend that swaps, or those who arrange swap transactions, should be subject to futures regulation.
It is our judgment, and the judgment of the Federal Reserve and the SEC, that, in the absence of an agreement such as the one Chairman Leach has been working for, temporary legislation should be enacted as soon as possible to alleviate the current legal uncertainty created by the CFTC action while more permanent solutions are considered.
Because of the serious implications of the CFTC Concept release, we and other members of the President's Working Group on Financial Markets concluded that a prompt response to the CFTC Concept Release was necessary. On May 7, the day the Concept Release was made public, the Secretary of the Treasury and the Chairmen of the Federal Reserve Board and the SEC expressed in a joint statement their grave concern about the CFTC's action, a concern stemming in part from reports about the possibility of increased legal uncertainty for certain types of OTC derivatives. The joint statement also indicated a willingness to pursue, if appropriate, legislation providing greater certainty concerning the legal status of OTC derivatives. To this end Secretary Rubin and Chairmen Greenspan and Levitt transmitted a legislative proposal to Congress on June 5. H.R. 4062, introduced by Chairman Leach, is based on our proposal.
Our legislative proposal would do three things. First, it would require the President's Working Group to conduct a study of OTC derivatives and hybrid instruments and to report to Congress the results of this study within one year. Second, it would prohibit the CFTC from restricting or regulating any swap or hybrid instrument eligible for exemption under current CFTC rules until the enactment of reauthorization legislation.
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Third, it would make clear that OTC derivative instruments based on nonexempt securities that meet the conditions of the existing CFTC exemptive rule and that are entered into prior to the enactment of reauthorization legislation will not be deemed to be illegal under the CEA.
Chairperson Born has made the criticism that our legislative proposal could impede the Commission's enforcement efforts. That was certainly not our intention, and we have urged the CFTC to provide drafting suggestions to ameliorate their concern in this regard. We feel confident that, working with the Congress and the CFTC, we can devise language that achieves the objective of bringing certainty to the market without having an overbroad and unintended effect.
Without doubt, the CFTC release has raised legitimate questions that merit study, discussion and debate. However, by raising these questions in the manner it has, two major problems have been caused.
First, the Concept Release appears implicitly to assume the CFTC has broad jurisdiction over the OTC derivatives market. This is far from clear and is subject to dispute. The Concept Release has thus increased concern about the legal status of OTC derivatives, particularly those based on so-called nonexempt securities; that is, those securities that, subject to the jurisdiction of the SEC, are not exempt from the registration provisions of the securities laws.
These derivatives potentially include some equity derivatives, emerging market security derivatives, and credit derivatives, among others. This concern is created because of limitations on the CFTC's authority to exempt futures contracts based on nonexempt securities from the CEA.
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The problem arises because the unavoidable implication of the release is that the CFTC has decided it has jurisdiction to regulate the OTC derivatives market. If such jurisdiction exists, it must be based on the conclusion that many swaps are the principal type of contract covered by the CEA; that is, futures contracts. If this conclusion is correct—and we believe it is not—it would call into question the legality of swaps involving nonexempt securities.
Second, the Concept Release causes uncertainty for other types of OTC derivatives, even those that would clearly be covered by the CFTC's exemptive authority if they were deemed to be futures contracts, since it raises the possibility of increased regulation over this market or new, restrictive interpretations of existing exemptions.
As a result, in the absence of any reassurance to market participants, some business may not be undertaken in this market and other business may be shifted abroad. The United States could lose its leadership role in the OTC derivatives business as such business is moved to foreign financial centers perceived as providing more hospitable legal and regulatory climates for these transactions.
I need to emphasize, Mr. Chairman, that the concerns that I have described are not hypothetical or academic. From our discussions with market participants, we understand that some derivatives business is already beginning to be shifted abroad because of the legal uncertainty in the U.S. We also understand from market participants that, if it becomes obvious that the Congress is unwilling to address this issue, the move to curtail U.S. derivatives business and to shift much of this business abroad will accelerate.
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This committee heard from some of the witnesses at last week's hearing that, in light of the threat implicit in the Concept Release, they are considering curtailing or suspending their derivatives business in this country, and have actually begun to relocate some of their activities. Because of this and the very real danger posed to the market for nonexempt security derivatives, we believe that legislation is necessary to provide legal certainty to market participants until more permanent decisions can be made about the OTC derivatives market.
Our legislation does not try to resolve any of these issues permanently. That is why all of its provisions have time limits. It would simply give Congress and the working group agencies time to study the issues and to prevent harm to the markets while the issues are being studied.
Any changes in the regulatory structure for derivatives should be carefully studied by the financial regulatory community and by Congress, with input from market participants and other interested parties, and we look forward to participating in this exercise.
In considering whether additional regulation is necessary, we would caution that this is a global financial market. It is, therefore, relatively easy for participants to shift a considerable amount of business to other jurisdictions if they believe regulatory requirements in a particular country have become too onerous.
Mr. Chairman, that concludes my prepared statement. I would be happy to respond to any questions that you or other Members of the committee may have.
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[The prepared statement of Hon. John D. Hawke Jr. can be found on page 294 in the appendix.]
Chairman LEACH. I appreciate that, Mr. Secretary.
It is my understanding Chairman Greenspan has a substantial statement. Based on that, rather than getting into it and coming back, I think we ought to recess at this time so it can be presented without interruptions. So the committee is in recess subject to the vote.
[Recess.]
Chairman LEACH. Before turning to Chairman Greenspan, let me just say what a delight it has been to work with Secretary Hawke as Under Secretary, and we wish you well in your new position, and we are confident that you will be one of the strongest comptrollers in the history of the comptrollership.
Mr. HAWKE. Thank you very much, Mr. Chairman.
Chairman LEACH. Chairman Greenspan.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. GREENSPAN. Thank you, Mr. Chairman, and I must say that I wish the Under Secretary well myself. We will now have to readjust our sights to deal with, I suspect, a slightly different view than the previous comptroller, but we will manage.
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In any event, Mr. Chairman, Members of the committee, I am most pleased to be here today. In fact, I feel that this is my home away from home, this particular place.
Today we are here to present the Federal Reserve Board's views on the regulation of over-the-counter derivatives. Under Secretary Hawke has already addressed the specific questions raised in your letter and invitation. The Federal Reserve Board generally agrees with the Treasury Department's views on these issues. In my testimony this morning I would like to step back from these issues of immediate concern and address the fundamental underlying issue, and that is whether it is appropriate to apply the Commodity Exchange Act to over-the-counter derivatives and, indeed, to financial derivatives generally, in order to achieve the CEA's objectives; that is, deterring market manipulation and protecting investors.
The Commodity Exchange Act of 1936 and its predecessor, the Grain Futures Act of 1922, were a response to the perceived problems of manipulation of grain markets that were particularly evident in the latter part of the nineteenth and early part of the twentieth centuries. Endeavors to corner markets in wheat, while rarely successful, often led to temporary but sharp increases of prices that engendered very large losses to those short sellers of futures contracts who had no alternative but to buy and deliver grain under their contractual obligations. Because quantities of grain following the harvest are generally known and limited, it is possible, at least in principle, to corner a market.
It is not possible to corner a market for financial futures where the underlying asset or its equivalent is in essentially unlimited supply. Financial derivative contracts are fundamentally different from agricultural futures owing to the nature of the underlying asset from which the derivative contract is derived. Supplies of foreign exchange, Government securities, and certain other financial instruments are being continuously replenished, and large inventories held throughout the world are immediately available to be offered in markets if traders endeavor to create an artificial shortage. Thus, unlike commodities whose supply is limited to a particular growing season and finite carryover, the markets for financial instruments and their derivatives are deep and, as a consequence, are extremely difficult to manipulate. The type of regulation that is applied to crop futures appears wholly out of place and inappropriate for financial futures, whether traded or on organized exchanges or over the counter, and accordingly, the Federal Reserve Board sees no need for it.
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The early legislation on the trading of commodity futures was primarily designed to discourage forms of speculation that were seen as exacerbating price volatility and hurting farmers. In addition, it included provisions designed primarily to protect small investors in commodity futures, whose participation had been increasing and was viewed as beneficial.
The Commodity Futures Trading Commission Act of 1974 did not make any fundamental changes in the objectives of derivatives regulation. However, it expanded the scope of the CEA quite significantly. In addition to creating the CFTC as an independent agency and giving the CFTC exclusive jurisdiction over commodity futures and options, the 1974 Act expanded the CEA's definition of a so-called commodity beyond a specific list of agricultural commodities to include, and I quote the language of the Act, ''. . . all other goods and articles, except onions, and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.''
Given this broadened definition of a commodity and an equally broad interpretation of what constitutes a futures contract, a wide range of off-exchange transactions would have been brought potentially within the scope of the CEA. The Treasury Department was particularly concerned about the prospect that foreign exchange markets might be found to fall within the Act's scope. Aside from the difficulty of manipulating these markets, Treasury argued that participants in over-the-counter markets, primarily banks and other financial institutions, and large corporations, did not need the consumer protections of the Commodity Exchange Act.
Consequently, Treasury proposed and Congress included a provision in the 1974 Act, the so-called ''Treasury Amendment,'' which excluded off-exchange derivative transactions in foreign currency, as well as Government securities and certain other financial instruments, from the newly expanded CEA. What the Treasury did not envision, and the Treasury Amendment did not protect, was the subsequent development and spectacular growth of a much wider range of over-the-counter derivative contracts—swaps on interest rates, exchange rates and prices of commodities and securities.
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The vast majority of privately negotiated over-the-counter contracts are settled in cash rather than through delivery. Cash settlement typically is based on a rate or price in a highly liquid market with a very large or virtually unlimited deliverable supply, for example, LIBOR or the spot dollar-yen exchange rate. To be sure, there are a limited number of over-the-counter derivative contracts that apply to nonfinancial underlying assets. There is a significant business in oil-based derivatives, for example. But unlike farm crops, especially near the end of a crop season, private counterparties in oil contracts have virtually no ability to restrict the worldwide supply of this commodity. Even OPEC has been less than successful over the years. Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.
To be sure, professional counterparties to privately negotiated contracts also have demonstrated their ability to protect themselves from losses, from fraud, and counterparty insolvencies. They have managed credit risks quite effectively through careful evaluation of counterparties, the setting of internal credit limits, and judicious use of netting and collateral agreements. In particular, they have insisted that dealers have financial strength sufficient to warrant a credit rating of A or higher. This, in turn, provides substantial protection against losses from fraud. Dealers are established institutions with substantial assets and significant investments in their reputations. When they have been seen to engage in deceptive practices, the professional counterparties that have been victimized have been able to obtain redress under laws applicable to contracts generally. Moreover, the threat of legal damage awards provides dealers with strong incentives to avoid misconduct.
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A far more powerful incentive, however, is the fear of loss of the dealer's good reputation, without which it cannot compete effectively, regardless of its financial strength or financial engineering capabilities. In these respects, derivative dealers bear no resemblance to the so-called ''bucket shops'' whose activities apparently motivate the exchange trading requirement.
Mr. Chairman, I do not mean to suggest that counterparties will not in the future suffer significant losses on their over-the-counter derivatives transactions. Since 1994, the effectiveness of their risk management skills has not been tested by widespread major declines in underlying asset prices. I have no doubt derivatives losses will mushroom at the next significant downturn as will losses on holdings of other risk assets, both on and off exchanges. Nonetheless, I see no reason to question the underlying stability of the over-the-counter markets or the overall effectiveness of private market discipline, or the prudential supervision of the derivatives activities of banks and other regulated participants. The huge increase in the volume of over-the-counter transactions reflects the judgments of counterparties that these instruments provide extensive protection against undue asset concentration risk. They are clearly perceived to add significant value to our financial structure, both here in the United States and internationally.
Accordingly, the Federal Reserve Board sees no reason why these markets should be encumbered with a regulatory structure devised for a wholly different type of market process where supplies of underlying assets are driven by the vagaries of weather and seasons. Inappropriate regulation distorts the efficiency of our market system and, as a consequence, impedes growth and improvement in standards of living.
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Recently, some participants in the over-the-counter markets have shown interest in utilizing centralized mechanisms for clearing or executing over-the-counter derivative transactions.
Beyond question, a centralized execution and clearing of what to date have been privately negotiated and bilaterally cleared transactions would narrow the existing differences between exchange-traded and over-the-counter derivatives transactions. However, that is not a reason to extend the CEA to cover over-the-counter transactions. As we have argued, doing so is unnecessary to achieve the public policy objectives of the Commodity Exchange Act. Moreover, as the economic differences between over-the-counter and exchange-traded contracts are narrowing, it is becoming more apparent that OTC market participants share this conclusion; their decision to trade outside the regulated environment implies they do not see the benefits of the CEA as outweighing its costs.
Instead the Federal Reserve believes that the fact that over-the-counter markets function so effectively without the benefits of the CEA provides a strong argument for development of a less burdensome regulatory regime for financial derivatives traded on futures exchanges. Indeed Congress has rejected the notion of a ''one-size-fits-all'' approach to regulation of exchange trading. The exemptive authority that the Congress gave CFTC in 1992 permitted it to create a less restrictive regulatory regime for professional trading of financial futures. However, the pilot program proposed by the CFTC evidently has not met the competitive and business requirements of the futures exchanges. No contracts are currently traded under the program. If progress toward a more appropriate regime is not forthcoming soon, Congress should seriously consider passage of legislation that would mandate progress.
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In conclusion, the Board continues to believe that aside from safety and soundness regulation of derivative dealers under the banking or securities laws, regulation of derivatives transactions that are privately negotiated by professionals is unnecessary. Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living.
In choosing a particular regulatory regime, it is important to remember that no system will fully eliminate inappropriate or illegal activities. Banking examiners, for example, find it difficult to unearth fraud and embezzlement in their early stages. Securities regulators have difficulty ferreting out malfeasance. Even trading on exchanges does not in itself eliminate all endeavors at manipulation, as the Hunt brothers' 1979–1980 fiasco in silver demonstrated. The primary source of regulatory effectiveness has always been private traders being knowledgeable of their counterparties. Government regulation can only act as a backup. It should be careful to create net benefits to markets.
Mr. Chairman, I have more extended remarks and request that they be included in the record.
[The prepared statement of Hon. Alan Greenspan can be found on page 303 in the appendix.]
Chairman LEACH. Without objection the full statements of all of the witnesses will be included in the record.
Chairwoman Born.
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STATEMENT OF BROOKSLEY BORN, CHAIRPERSON, COMMODITY FUTURES TRADING COMMISSION
Ms. BORN. Mr. Chairman and Members of the Committee, I am very pleased today to represent the Commodity Futures Trading Commission—CFTC—to testify concerning the over-the-counter—OTC—derivatives market. The Commodity Exchange Act vests the CFTC with exclusive jurisdiction over futures and commodity option transactions. The reach of the Act extends to both exchange-traded futures and those that are sold over-the-counter, as well as options both on and off exchange.
The Act generally contemplates that futures and commodity options are to be sold through Commission-regulated exchanges. Transactions in OTC futures and options, in contrast, generally have been prohibited unless explicitly exempted from the exchange trading requirement of the CEA.
The CEA itself specifically exempts certain types of OTC derivatives from the requirements of the Act. It also authorizes the Commission to grant additional exemptions subject to such terms and conditions as are appropriate in the public interest. Pursuant to this statutory authority, the Commission adopted regulations in 1993 exempting certain swap agreements and hybrid instruments from some, but not all, provisions of the Act subject to specified terms and conditions.
The Commission's regulations exempt certain swaps from provisions of the Act other than the antifraud provisions, the antimanipulation provisions, and Section 2(a)(1)(B). To be eligible for exemptive treatment, a swap must be a customized bilateral agreement between financially sophisticated persons or institutions. Exempt swaps may not, under the regulations, be traded on an exchange or be cleared through a clearinghouse.
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The CFTC has been engaged for the past 18 months in a comprehensive regulatory reform effort designed to update and streamline its regulations and to eliminate undue regulatory burdens. The Commission's review of its regulatory system would be incomplete in an important respect if it did not address the Commission's rules regarding OTC derivatives. The five years since those rules were adopted by the Commission have been characterized by dramatic growth in the volume and value of OTC derivative transactions. Furthermore, the structure of the OTC derivatives market has changed significantly, creating a potential divergence between the Commission's regulations and the realities of the marketplace.
As an example, there is an increasing demand for swaps clearing, which is currently prohibited under the regulations, and the Commission is currently considering a petition to amend its rules to permit a swaps clearing operation for the first time.
In addition, allegations of serious sales practice abuses by OTC derivatives dealers have been made in recent years in cases involving major losses by derivatives end-users, including Proctor and Gamble, Gibson Greeting Cards, Orange County, California, and the State of Wisconsin Investment Board. Such losses affect many Americans who have interests in the mutual funds, pension funds, municipalities and corporations trading in these instruments.
In order to examine whether its regulatory framework relating to OTC derivatives remains appropriate in light of these recent market developments, the Commission issued a Concept Release on OTC derivatives on May 7, 1998. The Concept Release seeks public comment on whether the Commission's current exemptions for swaps and hybrid instruments remain appropriate as to the definitions of eligible transactions and eligible participants and the prohibitions against swaps clearing and exchange trading. It asked whether the current prohibitions on fraud and manipulation in swaps transactions are adequate to protect the public interest, or whether the Commission should consider additional terms and conditions such as registration, sales practice provisions, recordkeeping or reporting.
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The Concept Release does not propose any modification in the Commission's regulations, nor does it presuppose that any modification is needed. It merely poses questions for public comment by OTC derivatives dealers, end-users, futures and option exchanges, other Federal regulatory agencies and other interested persons. The Commission states in its Concept Release that it is open to evidence in support of broadening its exemptions, evidence indicating a need for additional safeguards and evidence for maintaining the status quo.
In the event the Commission were eventually to determine that regulatory changes were needed, proposed changes would first be published for public comment before any final rules would be considered for adoption. Moreover, as the Concept Release states, any changes which impose new regulatory obligations or restrictions would be applied prospectively only.
The Concept Release explicitly states that it does not in any way alter the current status of any transaction under the CEA or the Commission's regulations. All currently applicable exemptions, interpretations and policy statements issued by the Commission regarding OTC derivatives remain in effect and may be relied upon by market participants.
H.R. 4062 was introduced in response to the Commission's Concept Release. The Commission has significant concerns about H.R. 4062 and urges this committee to consider it very carefully.
The Commission received a modified version of the bill yesterday from Chairman Leach, and I will try to address my comments to the modified bill, although the Commission as a whole and its staff have not had an opportunity to review that bill, and there is no formal Commission position on the modified language.
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H.R. 4062, as modified, would create significant regulatory gaps by forbidding the Commission to enforce its existing laws and regulations relating to certain transactions in the OTC derivatives market, by barring the Commission from addressing new developments in that market, and by preventing the Commission from modernizing and streamlining its regulations governing that market.
H.R. 4062 would for the first time restrict the independence of the Commission as a Federal regulatory agency by subjecting certain of its actions relating to the OTC derivatives market to prior approval by the Secretary of the Treasury.
It would also retroactively legalize OCT futures contracts on nonexempt securities and narrowly based securities indexes, which have been forbidden by law since 1982.
H.R. 4062 would create a new statutory authority dominated by Federal banking regulators and would authorize the new agency to evaluate the Federal law governing derivatives markets and derivatives exchanges currently under the jurisdiction of the CFTC and the SEC. These profound changes in the law, having significant impact on long-standing regulation of the OTC derivatives market, should be carefully examined. Important public interests would be harmed by their adoption.
Proponents of H.R. 4062 have argued that emergency legislation is needed to maintain the status quo in regulating the OTC derivatives market and to resolve legal uncertainty. It is clear that the proposed legislation would profoundly alter the regulator status quo, not maintain it. Moreover, while the CFTC's hands would be tied, other regulators would be free to adopt new regulations governing the OTC derivatives market. Furthermore, the ambiguities in H.R. 4062 created concerning the powers of the Commission would create legal uncertainty, not reduce it.
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Finally, there is no emergency. The Commission's Concept Release did not alter the legal status of any OTC derivative instruments. It has not proposed any action whatsoever, and it has not caused market disruption.
Mr. Chairman, thank you very much for this opportunity to present the views of the Commission. I might just add that we, along with other members of the President's Working Group, unanimously support the insolvency legislation.
[The prepared statement of Brooksley Born can be found on page 313 in the appendix.]
Chairman LEACH. Thank you, Chairwoman Born.
Mr. Lindsey.
STATEMENT OF RICHARD R. LINDSEY, DIRECTOR, DIVISION OF MARKET REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. LINDSEY. Chairman Leach and Members of the committee, I appreciate the opportunity to testify on behalf of the SEC to discuss the regulation of transactions involving over-the-counter derivatives. These issues involve significant questions of public policy that require the close attention of Congress, the financial regulator community, and the industry.
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The Commission has prepared a written statement, and asks that it be included in the record of the hearings.
Chairman LEACH. Without objection, that has been agreed to.
Mr. LINDSEY. OCT derivative instruments are important financial management tools. They reflect the unique strength and innovation of American capital markets, and the securities firms and banks that participate in those markets.
The growth of the OTC derivatives market has come in part as a result of the careful approach taken by Congress and U.S. financial regulators. That approach has focused on promoting legal certainty for OCT derivatives transactions and building consensus among regulators through the President's Working Group on Financial Markets.
Unfortunately, the CFTC's recent Concept Release on OCT derivative instruments represents a significant departure from this approach. In it, the CFTC contemplates a new, comprehensive regulatory scheme for transactions involving swaps and hybrid instruments. Ironically, for swaps and hybrids to be exempted from the CEA, the CFTC would require compliance with an extensive set of new regulations.
In May, Chairman Levitt, Secretary Rubin, and Chairman Greenspan objected to the issuance of the CFTC's Concept Release. In a joint statement, they expressed their concern that the CFTC action might create legal uncertainty for swaps, destabilizing a significant global financial market. Regulators and market participants alike are asking why the CFTC would suggest a radically new approach to the treatment of OCT derivatives and hybrids. We have seen no evidence of developments in this market to suggest that such an action is warranted.
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The CFTC's Concept Release is particularly troubling because it sets out a broad regulator agenda under the guise of exercising exemptive authority. We strongly disagree with this approach.
First, it appears to be based on the CFTC's erroneous conclusion that swaps are futures. If this were so, then the enforceability of trillions of dollars of OCT swaps currently in place would, overnight, be thrown into question. The short-term consequences would prove catastrophic for the industry, and in the long term, these swaps would simply be traded offshore, placing the United States at a severe competitive disadvantage. Traditional swaps that are not traded through a multilateral transaction execution facility are not futures and are not subject to regulation under the CEA.
Second, we have serious doubts about the CFTC's authority to regulate OCT markets. The CEA only provides for the regulation of exchange-traded futures, making off-exchange futures transactions illegal. Nowhere in the CEA has Congress articulated an intent that the CFTC regulate off-exchange markets.
Third, we disagree with the CFTC's plan to use exemptive authority as a means to regulate areas that are not expressly within its authority. In enacting the Futures Trading Practices Act of 1992, Congress gave the CFTC broad exemptive, not regulatory, authority concerning swaps transactions. The conference report for the CEA verifies that the purpose for giving the CFTC those exemptive powers was to provide certainty and stability to existing and emerging markets, thereby fostering financial innovation and market development. The objective was legal certainty for swaps, not expansive regulation of an evolving market.
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The CFTC's Concept Release also raises significant concerns regarding its current hybrid exemption. All hybrids that satisfy the current exemption are already regulated as banking or securities products. There is no need to add another layer of regulation under the CEA.
Last month Chairman Levitt joined Secretary Rubin and Chairman Greenspan in requesting legislation that would give Congress and financial regulators adequate time to consider the important public policy issues we are discussing here today. It also calls for a study of these issues by the President's Working Group. The Commission recognizes that this request is unprecedented, but we feel that it should be viewed as an indication of our grave concern with the CFTC's action.
In the weeks since the legislative request, there have been a number of proposals and attempts to remedy the current predicament. Unfortunately, a pending SEC proposal, commonly known as Broker-Dealer Lite, has gotten caught in the fray. There is a lot of misinformation being dispensed. Let me be clear. Broker-Dealer Lite is deregulatory. It deals with capital and margin requirements.
Since the creation of the agency in 1934, the SEC has been a prudential regulator of the firms that it oversees, protecting investors and the financial soundness of broker-dealers by setting capital requirements. Those capital requirements have always allowed OCT derivative transactions to be conducted in a broker-dealer. However the capital reserve treatment is so harsh that much of this business has been driven into less regulated entities. After a long, hard look and several years of consultation with the industry, the SEC has proposed applying to certain securities firms capital and margin rules modeled after those required for banks. The B-D Lite proposal would not expand or shrink any agency's jurisdiction. Furthermore, it would be entirely voluntary. For these reasons, it is not only supported, but encouraged by the industry.
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We welcome any questions that you may have on these issues, and we look forward to continued discussions with the Congress, the President's Working Group, and the industry on these important issues. Thank you.
[The prepared statement of Richard R. Lindsey can be found on page 356 in the appendix.]
Chairman LEACH. Thank you very much.
Let me briefly respond to Chairman Born by saying that it is true that new legislative approaches do involve some change in responsibility, but that is in reaction to what appears to be the unanimous perspective of the other regulators in the industry that the CFTC today is taking a position out of step with where it has been in the past.
For example, not only are you in a position counter to the other three regulators, but no previous CFTC head, from Chairwoman Wendy Gramm to Mary Shapiro and Susan Phillips to Acting Chairman Sheila Baird and Barbara Holum, has ever asserted that swaps are futures, or at least maintained the position that swaps are futures. And so an implication that this Commission may be moving in that direction is what has caused the rupture. Without that implication, there would be no controversy today.
So, I think it should be understood that legislation has been the result of an act, not a precipitator of an act. I have said from the very beginning that I prefer a nonlegislative result. We have attempted a series of approaches.
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You have laid on the table, today, frankly, one that may be 50 percent in the right direction, so it is a positive step. It is welcomed. Whether it is a sufficient step or whether it resolves the issues is a very different matter.
At this point I would like to ask the other panelists how they perceive the letter that you have laid on the table today. Maybe I should begin with Mr. Hawke.
Mr. HAWKE. Mr. Chairman, let me start by saying that I think that the fact that this proposed agreement, which is really a unilateral proposal, is put on the table is a tribute to the efforts that you have put forward in trying to get agreements among the parties here.
We just received the final version of this this morning. We have not had a chance to discuss it extensively, but we think it falls short in one major respect, and that is that it does not provide the legal certainty to that portion of the market that deals in swaps based on nonexempt securities that the legislation would bring. That is a material difference between this proposal and the legislation.
Chairman LEACH. Chairman Greenspan.
Mr. GREENSPAN. I, too, have not had a chance to discuss the substance of the letter among my colleagues, for whom I am speaking today. I would agree, basically, with what Under Secretary Hawke has said. The issue of whether or not the potential uncertainty which is being engendered by the concept letter is resolved is not an issue that we, ourselves, can judge. It is up to the market to make that judgment.
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As the Under Secretary indicated in his prepared remarks, we are already beginning to see evidences of various different types of dealers moving their contractual relationships abroad, out from under the regulation and supervision of the United States, which would be most unfortunate, because if the basic purpose is to have a sensible regulator structure between counterparties, we do have one here.
I am not certain the extent to which that is replicated in various other jurisdictions. So a crucial issue here is something which we can't really make a judgment on, because we don't know how the markets will behave or how dealers will behave with this type of agreement.
More fundamentally, I think it clearly doesn't address the deep-seated issue which we are all concerned with and have discussed at great length, and that is the underlying structure of how these particular markets should be regulated.
Chairman LEACH. Chairman Born, do you agree with the letter you have written?
Ms. BORN. That is the position of the Commission. It voted unanimously this morning to take that position. Maybe it would be useful to just state that essentially what the Commission has decided is that it will not propose or issue new regulations to regulate swaps and hybrid instruments prior to Congress' reconvening in 1999, except as necessary in an emergency.
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However, it will respond to petitions for exemptive relief, including the imposition of terms and conditions with respect to such exemptive relief.
Mr. LINDSEY. Echoing the comments of Under Secretary Hawke and Chairman Greenspan, we also have not had enough time to analyze this particular letter.
I agree with Chairman Greenspan that it is going to be very difficult, in the sense of this, for the regulators to step back and say whether or not this letter provides enough legal certainty for the markets to continue to execute these contracts. That is something that the market participants for themselves are going to have to decide.
Chairman LEACH. Thank you. I have one brief question for Secretary Hawke that I want to get for the record. In her written statement, Chairperson Born stated, ''The Treasury Department has taken the legally erroneous position that the Commission has no statutory jurisdiction over swaps,'' and the CFTC Chairman cites your recent testimony as evidence of this, and says that it is in conflict with statements made by Secretary Bentsen in 1994.
Would you comment on this, Mr. Hawke?
Mr. HAWKE. Mr. Chairman, I am afraid that my former partner and dear friend and colleague Chairperson Born has misunderstood what we have said. It is our position that swaps are not and should not be treated as futures.
If we are correct in this, and I think there is a substantial body of opinion that agrees with us, it seems to me that it is indisputable that the CFTC has no jurisdiction, to the extent that they want to regulate swaps as futures, other than swaps that are based on commodity options.
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In Secretary Bentsen's 1994 statement, he was simply recognizing that the Commission could change the contours of the safe harbor that Congress authorized the CFTC to adopt, but without deciding the fundamental question of whether transactions that take advantage of that safe harbor are, as a matter of law, covered by the Commodities Exchange Act.
The problem here is if it is the Commission's position that they can use their exemptive authority as a foundation for constructing a broad regulatory regime over all over-the-counter derivatives, we profoundly disagree with that. We think the clear intent of Congress in granting that authority was to bring certainty to the markets, and not to empower the CFTC to assert an entirely new regulatory authority.
Chairman LEACH. Thank you.
Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
Ms. Born and gentlemen, the Chairman said, with reference to the CFTC's letter of this morning, that it was 50 percent right and 50 percent wrong. I am not sure about right and wrong, and I am not sure about the 50 percent either, but I would say that I interpreted it as 50 percent conciliatory and 50 percent a hardening of position; conciliatory at least to the extent of no action until the reconvening of Congress in 1999, and hardening in the sense that it seemed to me a reaffirmation of your right to act whenever you deemed it appropriate.
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Does anybody want to quarrel with that characterization?
Ms. BORN. We certainly did not consider it a hardening of the position that the Commission has held. The Commission does believe that it has jurisdiction over futures and commodity options that are traded over the counter. It is willing to forego adopting any new regulations or proposing any new regulations with respect to those instruments between now and the time Congress reconvenes so that Congress can be fully apprised of any proposals that eventually may come out of this process.
Mr. LAFALCE. Ms. Born, I appreciate that. One of the difficulties is how is this going to be interpreted? Is this going to be interpreted as conciliatory, or is this going to be interpreted as, all right, Congress, we will give you between now and sometime in January of 1999, and in January of 1999 we are going to act? Or is that reconvening in 1999 just to say, look, we will put it off, and we may put it off again for six months or six years, and so forth?
I don't know that I want to push you too hard on this, because I don't know that I want to harden your position. I think the ambiguity might well be better than pressing you into a corner on it, but that is my concern.
Ms. BORN. Let me just say that the Commission has no idea whether there will be any proposed regulations. Our Concept Release——
Mr. LAFALCE. There is no present intent whatsoever?
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Ms. BORN. Absolutely not.
Mr. LAFALCE. It is just simply a reservation of a legal nexus?
Ms. BORN. That is correct. Right now our Concept Release is out for public comment. It asks a number of questions, and we will be getting those responses probably sometime in September.
Mr. LAFALCE. All right. Fine.
Ms. BORN. We will be analyzing them. That is all that is intended at this time.
Mr. LAFALCE. Fine. I would ask the other three panelists to embellish a bit, and maybe that is a bad word, flesh out a bit the facts as you see them of markets moving overseas because of the creation of uncertainty in your mind because of the issuance of the Concept Release?
Mr. Hawke, Mr. Greenspan, Mr. Lindsey, if you wish, and then, of course, Ms. Born, I would appreciate your comments on that, also.
Mr. HAWKE. Mr. LaFalce, there is, I think, a kind of an illusory element to this commitment in the first paragraph of the letter that you are focusing on. There are 5 months left between now and the beginning of 1999, and I think it would be impossible to adopt a new rule in that time, and extremely difficult even to formulate and draft one. So the commitment not to do anything until Congress reconvenes in many senses is illusory.
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The negative implications of it are, as I think you were pointing out, that after that date the markets may be in jeopardy of having regulations adopted. I think that could contribute to increasing the anxieties that would lead to overseas movement.
If this commitment were extended to include the duration of the next Congress, which would make some sense because it would give the Congress an opportunity to deal with these issues over the course of a full Congress, rather than presenting——
Mr. LAFALCE. Are you suggesting that the Committee on Banking and Financial Services, the Agriculture Committee, other committees, are not known for their ability to act immediately on controversial financial services legislation?
Mr. HAWKE. I wouldn't suggest that at all. There is so much else on their plate that there are competing demands for their time.
Mr. LAFALCE. Dr. Greenspan and others.
Mr. GREENSPAN. I might add that I happen to agree with the Under Secretary, but we ought to make certain that Brooksley Born gets three times the time that any of the three of us get, because this is scarcely an even balance, if I may point out.
I am concerned that we are dealing with a situation which reminds me of the emergence of the Eurodollar market many, many decades ago, which essentially occurred as a result of a regulatory action on the part of the United States, and set up the beginnings of a market abroad which, once it got started, it didn't turn around.
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So what my concern would be is that if we essentially create an exodus of derivative activities from the United States, I think it will be exceptionally difficult to get them back, no matter what we do. And it may well be that this concept letter is merely raising hypothetical issues, but if somebody says to me, I'm contemplating punching you in the nose, I don't presume that that is a wholly neutral statement. My inclination is to pack up and move to another neighborhood.
Ms. BORN. If I my just add, I think what we are saying is, in——
Mr. LAFALCE. You don't intend to punch Dr. Greenspan in the nose, do you, Ms. Born?
Ms. BORN. It is more correctly stated, do you think you need a punch in the nose? That is the question that is being asked.
Mr. GREENSPAN. I will yield to your interpretation.
Mr. HAWKE. I would say that the implication is that if the answer to that question is yes, then the Commission has said it has the full authority to administer that punch.
Ms. BORN. Let me just add that our economists who follow the OTC derivatives markets have been looking for any empirical evidence of disruption in the markets or flow of transactions offshore and have not seen any ascertainable evidence of that to date. They have been watching this since the beginning of the year.
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Mr. LINDSEY. I, for one, take little comfort in the fact that there hasn't been a mass exodus outside the U.S. to a foreign market as evidence that there has not been a disruption in the market.
Indeed, if you recall, the day that the Concept Release was issued, the SEC joined with the Treasury and the Federal Reserve to issue comments about that particular Concept Release and raise questions as to whether or not there was jurisdiction or authority.
Indeed, in the intervening time period, this has been hotly debated with a number of hearings and a number of discussions and a number of proposals. So if you are faced with the decision to relocate a department that may consist of a significant number of people and a significant amount of technology, I think that as you are standing there waiting to see if this is going to sort out one way or another, you might not be moving all of your business abroad overnight on the issuance of the Concept Release, hoping that indeed it is resolved in your favor, rather than against you.
So I wouldn't personally base a lot of hope in that moving forward with this wouldn't disrupt the markets.
Mr. LAFALCE. I have so many more questions, but I also have time constraints. Let me just try to express to the panelists some of my concerns, and have you respond to the ones you think you most want to respond to. Others will have their opportunity to ask questions.
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I am concerned, Mr. Hawke, about the effectiveness of the working group. I am concerned that we are debating primarily the question of regulatory jurisdiction as opposed to what appropriate regulation ought to exist for this burgeoning market, which I think is an even more an important question.
I am also concerned, too, about activities going overseas, but not simply because it might mean a loss of jobs within the United States, but because our response might be to engage in competitive laxity, and regulatory laxity, for competitive reasons. I don't know that that is the case, but I am wondering if it is the case. If it is the case, I am wondering whether or not our legislative concerns should be addressed to that in some way.
These are just some of my concerns. Anybody who wants to address them is more than welcome.
Mr. HAWKE. Well, Mr. LaFalce, I think it certainly would have been better if the working group could have resolved this difference of views without the need to bring it before of the Congress. I think a discussion of some of the fundamental principles would have been very desirable. I think Chairman Greenspan's tremendously compelling analysis would have been the kind of basis for that kind of discussion within the working group.
But it has to be remembered that the working group is not a decisional body. It doesn't have the power to bind its members by majority vote. The issue of the Concept Release was discussed at a working group meeting, and among staff of the various agencies. Chairman Greenspan and Secretary Rubin, both of whom have very significant responsibilities with respect to markets, expressed strong reservations about the proposed CFTC action at the working group meeting and urged that it not be taken. They made clear at that time that they felt that legislation might be needed to deal with the market disruption that could be caused if the CFTC decided to go ahead with the issuance of the release.
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The Commission, for reasons that it believed were sufficient, decided to go ahead. I don't think that reflects a failure in the working group. It is sort of inherent in the nature of the entity.
Chairman LEACH. Chairman Greenspan, you can respond, if you would like.
Mr. GREENSPAN. I was at the birth of the CFTC. I was Chairman of the Council of Economic Advisors at that time, the other CEA, which the CFTC Act amended the CEA.
My recollection of the period, and this is late 1974, was that in constructing the Act at that point, the projections or suppositions as to what might eventually evolve in the markets in the years ahead were wholly lacking in that we didn't have a clue as to what was about to emerge.
Much of that Act, I think, was debated within the Congress, and indeed, within the Administration at that time, without any real awareness of what was to come in this extraordinarily burgeoning derivatives market which has so markedly altered the structure of not only our domestic financial system, but the international financial system, as well.
So a lot of the language that is in the bill, and one of the reasons why there is such a degree of confusion at this particular stage, is that the regulatory structure basically coming out of the Commodity Exchange Act was really addressed to a much different view as to the way the financial system was going to evolve, and we are struggling with that ambiguity ever since. One of the reasons——
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Mr. LAFALCE. Dr. Greenspan, isn't that true of all the financial services legislation?
Mr. GREENSPAN. Pretty much, yes.
Mr. LAFALCE. They were passed in a distant era? They could not contemplate the present marketplace, so you must interpret the law that was passed at that time within the present context?
Mr. GREENSPAN. That is certainly the case, but in this particular instance, the order of magnitude is what is different. In other words, we were dealing, as you know, with financial services regulation, which is clearly the big issue. Obviously, Glass-Steagall is a major anachronism in that regard. But this is different, not in quality, but in quantity. The surge of these markets, the remarkable remaking of the risk dispersion aspects of our financial institutions since the Act was passed, was nowhere contemplated in the discussions that preceded the enactment of that law.
As you may sense, we very much would like to have this all reviewed, because there is a new world out there.
Ms. BORN. If I could just respond to Mr. LaFalce's questions——
Chairman LEACH. Chairman Born, I think Chairman Greenspan made a valid point, that you deserve a little time.
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Ms. BORN. Thank you very much.
Addressing your last issue first, Mr. LaFalce, competitive regulatory laxity as a problem, let me just say that shortly after we issued our Concept Release in May, I was contacted by a number of foreign regulators of derivatives. You know, all of us are members of IOSCO, the International Organization of Securities Commissions, to say how much they welcomed our raising these questions about these markets.
They said they, too, felt that it was very important to study these markets carefully and to think about the appropriate regulatory regime. A number of them suggested to me that this was a particularly appropriate thing for international regulators to raise because they stated that whenever they had raised issues in their own country, participants in the market in that country said they would move overseas if those questions were raised.
With respect to the effectiveness of the working group, I, too, was at the meeting of the working group where Secretary Rubin and Chairman Greenspan stated opposition to our issuance of the Concept Release. Secretary Rubin stated we should not issue it because we had no statutory authority relating to any off-exchange transactions.
I asked for the legal analysis that was the basis of that opinion. The Treasury Department said they would provide that to us. We waited for about three weeks, and never yet received any legal analysis, including legal analysis that could form the basis for the statement that the Commission has no off-exchange authority. Indeed, we have been bringing enforcement actions against illegal off-exchange transactions for decades.
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Let me just add one thing about the appropriate regulatory regime, here. Clearly, the Commission decided in 1993 that as to bilateral, customized transactions transacted over-the-counter by sophisticated institutions, there was very little need for regulation. The fraud and manipulation prohibitions were sufficient, and therefore, we used the flexibility that Congress had given us in our exemptive authority to fashion a very, very light-handed regulatory regime for over-the-counter futures and options that met our swaps definition and that met our hybrid instruments definition.
Let me also add that while manipulation is one of the prohibitions in the CEA, it is only a very small part. Indeed, we have found the CEA tremendously adaptable to our markets. Our exchange-traded markets now are about 75 percent financial futures and options.
The statute deals with the financial integrity of exchanges and clearinghouses, fair access to markets, full dissemination of price information, protection of market participants from fraud and trading abuses, assurance of the financial stability of the 64,000 commodity professionals who are registered with us. We spend a great deal of time on these and other issues, as well as manipulation.
Let me just add that one of our most recent manipulation cases involved 10-year U.S. Treasury notes that were traded on the CBOT. We entered an order prohibiting that manipulation and fining the manipulator, based on a settlement. Thank you.
Chairman LEACH. Let me apologize to the committee. I would like to ask that the lights be put on. Maybe they are not working this morning. I have allowed too much time, and I would like to suggest that we will try to keep to five-minute segments, and then we may go a second round of questions if we can.
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Mrs. Roukema.
Mrs. ROUKEMA. Thank you, Mr. Chairman. I have just arrived, so I am going to catch up, although I am applying what I have heard, or what I heard last week in our hearing, to what I am hearing today. I was hopeful that we were a little more consistent or a little more in sync, let us put it that way. I will defer any questions I have until later. Thank you.
Chairman LEACH. Mr. Baker.
Mr. BAKER. Thank you, Mr. Chairman.
Mr. Lindsey, I would just make a comment for later response, either by yourself, if appropriate, or Chairman Levitt. You may recall that some months ago I expressed grave concerns about the market implications of proposed rules of the Financial Accounting Standards Board, an independent agency of the SEC, and the potential consequences of moving forward with regulations which, in my limited understanding of the matter, may, in fact, cloud transparency disclosure as opposed to enhancing it.
I find it rather unique that given the position of the SEC today, that with the actions of another independent agency not proposing a rule for promulgation but merely asking the questions about market performance, that the 24-hour response by the SEC to that proposal would be to come to Congress and ask for legislative interference. If Mr. Levitt would choose to discuss this with me, I would be very pleased to hear his response.
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Mr. Greenspan, I don't want to discuss in great detail with you, because I have read your statement and find it to be very persuasive. I would simply request that if it is available, any empirical data that might be made available to the committee, not just through the current moment, but as to some reports, so we can continue to look at this matter over time, and at the very earliest outset, that if we see offshore activity increasing or a deterioration of the market condition, I think it would be most helpful for us to see that.
Mr. GREENSPAN. May I say that once we have the data, it is too late. The real problem occurs when you get executive committees of institutions discussing where they will position various different aspects of their business, because there is a considerable lead time before they implement that. Once they implement it, and we know about it, then it is too late.
Mr. BAKER. I agree with you, and you make a very interesting point. When the question was that of a derivatives explosion and the failure of Orange County, we did not have sufficient data in our hands to respond after receiving the data, it was then too late for regulators to act. I agree with your point. I just take it from a slightly different perspective. Thank you, though.
Mr. Hawke, I wish to speak to the question of the current authority of the CFTC to act. I am using Mr. Greenspan's testimony, because he raises the issue very clearly. The 1974 Act expanded the CEA's definition of a commodity beyond a specific list of agricultural commodities, and it goes on, ''. . . except onions . . . and all services, rights, and so forth.'' And so it would appear that a swap dependent on future delivery of some agricultural commodity, save onions, would be within the scope of the regulatory authority of the CFTC.
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If we forget the word ''future'' for the moment and simply stick to the word ''swap,'' and a swap that would provide for future delivery of some deliverable product as defined under CEA, wouldn't that be something that would fall under the purview of the CFTC, since they are specifically authorized to regulate contracts for sale of future delivery?
Mr. HAWKE. I think that is precisely the issue as to which there is enormous disagreement, Mr. Baker. The question is whether a swap is a futures contract within the regulatory jurisdiction of the CFTC, or is a forward contract, or something else that is not subject to their jurisdiction. There are significant analytical distinctions between many types of swap transactions and classic commodity futures transactions.
Mr. BAKER. As to the point of whether it is customized, dealing with sophisticated investors of limited number, as opposed to a standardized contract which deals with larger numbers of perhaps less sophisticated investors, is another determinant.
My point in raising these issues is simply, ought we not ask the questions? And can we not bear the heat of looking, as regulators, in the policy world? Even the least estimate of notional value is in excess of $30 trillion. Can we at this point say that we are not concerned about the unbelievable expansion of this market in this decade, looking at the potential interrelationships between trading partners, and we are only to rely on the professionalism of the counterparties and their fear of embarrassment in the market as being sufficient regulatory oversight?
I don't want to leave the impression that I am opposed to your positions, but I am very concerned that we ought to at least ask the questions. As a South Louisiana S&L survivor, I have learned one thing: Trust, but verify. What we are hearing from the regulators is, we need to trust the markets to do this properly, and I think that is a high degree of risk that we should not assume.
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Mr. HAWKE. Mr. Chairman, I think there should be no disagreement with your fundamental points that these are questions that need to be asked, and we very much support the asking of these questions and the analysis that would go with it. The problem is that when the CFTC poses a series of questions that ask what the opinion is of the public on whether they should regulate this market in 10 or 20 different ways, that implies a conclusion on their part that they have the legal authority to do it. And if they do have the legal authority to do it, it must be based on their conclusion that swaps are futures. If somebody else asks that question, it would carry different implications with it.
The disruption that has been caused here has been caused by the fact that the person—to use Chairman Greenspan's analogy—the person who is asking whether we should give you a punch in the nose is the agency that would deliver the punch.
Mr. BAKER. I have no complaint that the manner in which the message was delivered may have been, from a market perspective, inappropriate. I am simply saying that the message should be delivered, and I don't care who does it. But to stand by and say this level of development of such economic consequence should not at least be worth a question, not a promulgated rule, I find to be unusual. Thank you.
Chairman LEACH. Mr. Watt.
Mr. WATT. Thank you, Mr. Chairman.
I want to pick up, actually, about where Secretary Hawke left off, and direct Chairman Greenspan's attention to the one sentence of his statement at the bottom of page 7, where you say, ''The Federal Reserve believes that the fact that OTC markets function so effectively without the benefits of the CEA provides a strong argument for development of a less burdensome regulatory regime for financial derivatives traded on future exchanges.''
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I take it from the bulk of what you said and the rest of your statement that a less burdensome regulator regime would be almost nonexistent, but I will leave that question aside.
The question that I do think cries out for comment from all of the participants on this panel is, regardless of what the regulatory regime is, who should be doing it? Apparently you believe that the CFTC should not be doing it, but I haven't heard anybody say who they believe should be doing it. I would like to at least have some general contours of what your perception is that that regulatory regime should be.
I would like all four parties to comment on that one question.
Mr. GREENSPAN. That is a very good question, Congressman. I don't think the issue is who does the regulation, but what is the regulation. The issue——
Mr. WATT. But the issue right now apparently as between you all is that there is disagreement about who ought to do it, and if we can't get beyond that hurdle——
Mr. GREENSPAN. No, I don't think so. The disagreement is really the question as to whether, in fact, extensive increased regulation of over-the-counter derivatives is an appropriate vehicle to enhance the functioning of that market, which has been so productive and effective to the development of our financial system.
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The issue is not who happens to be doing that, it is the nature of the regulation that I think is really at root on this whole question. What we are arguing is the regulation now exists. For example, the substantial proportion of derivative dealers are banking organizations who are supervised and regulated by the Federal Reserve and the Comptroller of the Currency.
As best I can judge, we do a reasonably good job in that type of supervision and regulation. The market is functioning. It is doing well. It is creating value added to our society and our economy. The question of a significant disruption by altering the mechanisms which are employed to supervise and regulate that particular market strikes me as problematic.
Mr. WATT. So you are saying the regulatory regime is already in place and is being done by the regulatory agencies that are already doing it.
Mr. GREENSPAN. I would say the Comptroller and ourselves for the banks and the SEC for other organizations create a degree of supervision and regulation which, in my judgment, is properly balanced and appropriate.
Chairman LEACH. Will the gentleman yield on this, Mr. Watt?
Mr. WATT. Yes.
Chairman LEACH. One of the surprising aspects of Chairman Born's testimony is, and I would like to quote this, she said that ''the proposed legislation would delegate review of Federal law governing derivatives markets from the jurisdiction of the CFTC and SEC to a body dominated by banking regulators with no expertise in derivatives and market regulation.''
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I would like to ask Mr. Hawke, the name of the Secretary of the Treasury of the United States at this time is Robert Rubin. Does he have a background in financial supervision and financial market participation?
Mr. HAWKE. If he were here, he would say that he spent 27 years in that.
Chairman LEACH. I would continue to ask Mr. Hawke, the name of the Chairman of the Federal Reserve Board of the United States is Alan Greenspan. Does he have a background in financial market participation?
Mr. HAWKE. I believe he does.
Chairman LEACH. Ms. Born, on the entirety of the CFTC board, is there a single member with a background in financial market supervision or participation?
Ms. BORN. Certainly we are the regulator which has been given the authority to oversee the major derivatives markets in the United States. Historically, we and the SEC are the market regulators. The SEC regulates certain derivatives markets, options on securities and securities indexes. We have exclusive jurisdiction over all other options and future transactions.
Chairman LEACH. I appreciate that. You testified to this committee that the Chairman of the Federal Reserve Board of the United States and the Secretary of the Treasury have no financial market expertise, as I read this testimony.
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Ms. BORN. No. I said that banking regulators have not historically played any role in derivatives market regulation. They do, and they are involved with their regulated persons. They oversee banking institutions, and the SEC oversees broker-dealers. We oversee our 64,000 commodity professionals, and we all do prudential regulation of those people, looking at whether or not their net capital and other activities are financially stable and sound. That is highly different from the kind of market regulation that we and the SEC perform.
Chairman LEACH. I apologize to interrupt you, Mr. Watt.
Mr. WATT. Thank you, Mr. Chairman. I didn't want to reclaim my time because it was an interesting question, but I still would like, if you don't mind, again, a response to the other interesting question that we put out there, which is, I seem to be hearing that the CFTC shouldn't be asking these questions that were asked.
The question I guess I am asking is should anybody be asking these questions that were asked, and who should be asking them, and are they being asked?
Mr. GREENSPAN. Congressman Watt.
Mr. WATT. Congressman Watt should be asking them?
Mr. GREENSPAN. Yes. The Congress should be asking these questions, because it is the process by which the enactment of laws occurs in this country. As the Under Secretary said——
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Mr. WATT. Wait a minute, now. I hear you say that, and I am honored that you would think that Congress would do that, but these regulatory bodies have been stepping into voids that the Congress has not acted on in ad infinitum. We have got a whole body of regulation. That is what H.R. 10 is all about.
So, yes, we should be doing it, but in the absence of our doing it, somebody has to step into the void. It sounds like the CFTC stepped in there and aggressively did this, and all I am trying to find out is if they were wrong in doing it, who should have been doing it, and is it being done. That is the only question I have asked. I cannot seem to get an answer here.
Ms. BORN. Last year the General Accounting Office did a study of the OTC derivatives markets and came out with a report recommending that the President's Working Group on Financial Markets needed to study the sales practices of OTC derivatives dealers and the counterparty relationships in OTC derivatives transactions.
In March of this year, the Secretary of the Treasury, on behalf of all four members of the President's Working Group on Financial Markets, wrote to Congress and said that the President's Working Group would not study these markets, that it was the role and responsibility of each of the members, and you have the organizations here who are the four members, to decide within its own statutory authority whether and to what extent a study should be done. We then moved forward to do a study.
We believe our study is clearly within our statutory authority. It is essentially examining our own regulations, and it is the responsible thing to do. I would welcome the other Federal financial regulators to comment also as to this matter, and I would also welcome their views on each and every one of the questions we posed.
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Mr. HAWKE. If I might just take one minute, Mr. Chairman, to respond to Mr. Watt's question.
The question of who should regulate, if regulation is determined to be appropriate, is not our concern at all. The concern that we had about the CFTC asking these questions is that their release, in which they asked 75, 100 questions about whether they should regulate this market, implied a conclusion on their part that they thought that they had jurisdiction to do this. If they did, it is derived from the conclusion that swaps are futures. If swaps are futures, then that casts a significant cloud of potential illegality over a portion of the swaps market that they don't have authority to exempt from the exchange trading requirement. That is our concern about them asking the question. It was the implication——
Mr. WATT. I know what your concern is. I want to know who ought to be doing this.
Mr. HAWKE. It would have been much healthier for the markets if Congress had asked these questions.
Mr. WATT. Somebody has got to do it, right?
Chairman LEACH. The gentleman's time has expired. Let me assert that the draft agreement as well as the draft legislation allows the study to go forward, because I didn't want to place this committee in the position of being anti-intellectual. Having said that, this committee has made a lot of efforts to deal with the derivatives issue. We have had draft legislation and reports, and I would say in this regard I am extremely pleased at the manner in which the SEC has moved forward, and the Fed and the Treasury, to adopt many of the recommendations that have emanated from this committee, but I do believe that there is always——
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Mr. WATT. Maybe I should ask the Chairman who he thinks these questions ought to be asked by.
Chairman LEACH. I think care has to be taken not to imply powers that may not reside.
Mr. BACHUS. Point of order.
Chairman LEACH. The gentleman has a point of order.
Mr. BACHUS. I think we are in the questioning process.
Chairman LEACH. That is true. If the gentleman will restrain for a second, do you mind if the Chairman of the Fed makes an observation?
Mr. GREENSPAN. I will withhold.
I am sorry, let me make one observation. I was trying to restrain myself, but I failed.
Let's not assume that any question that can be asked is neutral. It is not. We don't ask in this country shall we review the freedom of the press. Do we decide that certain criminalities may be acquiesced in? There are certain things we take as a given. There are a lot of questions which can be asked in this area which imply very significant increases in the degree of regulation in the system. If the markets perceive that those are all real questions, even if only a few of them get implemented, the implication of that is that there is a fundamental change in the philosophy of supervision and regulation in this country which can have very profound implications as to how people behave.
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I don't want to let the presumption go that any such questions are potentially on the table. They really are not, and I think that it is very easy to create an aura of very substantial alteration in our regulatory structure by just neutrally, in quotes, putting questions on the table which have very profound implications on how they are answered.
Chairman LEACH. Mr. Lazio.
Mr. LAZIO. Thank you for providing a venue for this discussion and for letting us focus on the legislation, and let me congratulate Secretary Hawke for his nomination. We look forward to his continued service.
Let me address this to the panel. Both the Chairman's mark and the position papers by the Fed and by the Treasury and SEC all contain not just moratorium language but also a modification on Shad-Johnson accords, and we had some testimony last week from witnesses who spoke to the issue of whether we could impose a moratorium but that changes in Shad-Johnson might be either unnecessary or undesirable at this time.
My question is could you support a bill that just dealt with the issue of moratorium without taking up the tangential issues of Shad-Johnson accords?
Mr. HAWKE. Mr. Lazio, the reason for the inclusion of that provision was to try to bring some legal protection to that segment of the market which is not eligible for the CFTC's exemptions. The reason that it was felt necessary was because the implication that was in the release that the Commission had determined that swaps are futures could potentially give rise to private actions in which counterparties might repudiate their positions under swap agreements on the grounds that they were illegal futures and not subject to the exemption. We felt that the uncertainty that had been caused by the release warranted bringing some legal certainty to those existing contracts during the period that this issue was being revisited by the Congress.
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Mr. LAZIO. Would you characterize that as speculative at this point or is there some concrete non-theoretical basis upon which to make that presumption?
Mr. HAWKE. I don't have personal knowledge of situations in which parties to swap agreements have repudiated the agreements based on this uncertainty, but it was the fear that this could happen which motivated that particular provision.
Mr. LAZIO. Does anybody else want to comment on that?
If not, let me make a follow-up point, if I can. It seems to me that virtually all trading of equity products and equity derivative products such as stock index funds and option funds are substantially regulated, and it seems like virtually all equity products except for equity swaps fall under the scope of pretty significant regulation. And I am wondering, there has been a lot of discussion about level playing field between futures and swaps, and I want to know if there is also a need for level playing field between equities and equity swaps and equity options and equity swaps, and let me address this to Ms. Born, if I could, and ask the Chairwoman if so why; and if not, why not?
Ms. BORN. Of course equity swaps are customized bilateral transactions off exchange between sophisticated consumers. Presumably, under the current status of the law, although we don't have any power to exempt futures on securities from our Act, we have adopted a swaps policy statement in 1989 that provides a safe harbor for equity swaps right now, and they are certainly protected from any regulatory or enforcement action by us because of that.
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Last year this issue was raised before Congress of whether there should be some specific addressing of the prohibition in our statute for our creating a regulatory regime or exempting equity swaps, and certainly at that point I personally favored legislation that would permit the CFTC and the SEC to work together to arrive at an appropriate regulatory regime for those instruments, including giving us the power to exempt them from our statute.
Mr. LAZIO. I yield back to the Chairman.
Chairman LEACH. Mr. Hinchey.
Mr. HINCHEY. Thank you very much, Mr. Chairman. I think this has been a fascinating discussion. I would like to observe that when the present Secretary of the Treasury leaves, someone is going to replace him. When the head of the OCC leaves, someone is going to replace that person as well. You might get an academic in one position, you might get a banking lawyer in the other position. So it is not always guaranteed that you have the same level of market experience going into those positions with the people who may currently be holding them up. This is just sort of a gratuitous observation, but nevertheless I thought I would make it.
Ms. Born, I think you have done us all a great service by the publication of this Concept Release because it has stimulated a great deal of concern on the part of some of your colleagues, as well as some of the Members of Congress. This is a subject that I think really needs some attention, and if nothing else you have given it that.
My understanding, and correct me if I am wrong, that the Concept Release that you issued back in May results from a moratorium that was established on the regulation of derivatives sometime back in 1993, which itself flowed from a congressional action in 1992, which suggested that derivatives should be specifically exempted from commodities and future trading regulations. It would seem to me that when the Congress did that, the presumption was that the agency had the authority to issue those regulations and therefore recognizing that that authority existed, simply said, please don't do that right now. Let's give this new market an opportunity to develop, absent regulation, and let's see where it goes.
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Ms. BORN. What Congress did in 1992 was to give the Commission for the first time the ability to exempt futures from the exchange trading requirement of the Act. And in that statute, Congress explicitly said that we could under that power exempt swaps and hybrid instruments from such provisions of the statute as we thought appropriate in the public interest and that we could also apply such terms and conditions to that exemption as we deemed were consistent with the public interest.
So in response to that, the Commission did exempt certain types of swaps and hybrid instruments from some but not all provisions of the Act. We retained fraud and manipulation prohibitions for swaps, for example, and we put terms and conditions on the kinds of instruments that would be exempted. For example, it is forbidden under the exemption for there to be exchange trading in the instruments. It is forbidden for them to be cleared through a clearinghouse. They have to be entered into by big financial institutions, not sold to the retail public.
Mr. HINCHEY. That is a very——
Mr. HAWKE. Mr. Hinchey, I would take exception to one characterization.
Mr. HINCHEY. Was it the banking lawyer or the academic?
Mr. HAWKE. I am concerned about the academic, but I think the legislative history of the 1992 legislation would demonstrate that Congress had no presumption about whether the CFTC had jurisdiction, that that was an issue by common consensus was agreed not to be decided at that point and the exemptive authority was like the old joke about chicken soup, it couldn't hurt. The Commission was given the authority to exempt transactions whether or not they had the jurisdiction to regulate them. And there was——
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Mr. HINCHEY. They didn't give that same attention to the Federal Reserve or to the Treasury Department. They directed it specifically at this particular agency.
Mr. HAWKE. I was handed an excerpt from the legislative history. It says, ''In granting the Commission such exemptive authority, the conferees makes no decision concerning whether swaps and hybrids are futures subject to regulation under the Act.''
Mr. HINCHEY. That is a very prudent paragraph to put in, but the fact of the matter is that they directed their attention in a specific direction, and by so doing they indicated certain things to us, and I think we would be foolish to overlook them.
Mr. HAWKE. But because they were giving the Commission authority to exempt——
Mr. HINCHEY. I understand that. With regard to the way that this market is regulated, let me say and perhaps you might want to respond, it is one thing to regulate from the point of view of the institutions, for example. We have bank regulations. The purpose of the banking regulation is to ensure safety and soundness within the institution. That is the purpose of that regulation. It is not the purpose of that regulation or the purpose of that agency to make sure that the consumer isn't being fleeced, say for example. We have another agency that does that.
So in this particular case I think that the CFTC is raising some questions in the construct of this now $30 trillion industry not in a way that is designed to ensure the safety and soundness of the institutions that are issuing these instruments, but to pay some attention to the security of the people who may be purchasing them and who may not be so sophisticated as the dealers might be. They may be buying something that they don't fully understand. I know that this kind of thing has happened in the past. Mr. Greenspan mentioned 1974, which was a very important year in my life, and 1975, an important year in the life of New York City.
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I remember as a new member of the State Legislative Banking Committee in Albany seeing how some very large banks took the opportunity during the New York City financial crisis, when the city was about to go into bankruptcy, to sell city instruments to unsuspecting customers, and I think that is at the heart of questions that are being raised here with regard to these instruments. Is it possible that somebody could be hurt.
Now, Ms. Born raised the issue of Orange County and Procter & Gamble, and if the Chairman would allow me another few seconds, I would ask you, Ms. Born, who was hurt by the Procter & Gamble situation? Who lost money? A lot of money changed hands in that situation.
Ms. BORN. It was the shareholders, and with respect to Orange County, it was the taxpayers of Orange County whose money was lost. These are pension funds that are being invested in these markets. These are insurance funds that are being invested in these markets. These are mutual funds that at this point most of us have some interest in.
Mr. HINCHEY. In other words, in many cases the life savings of ordinary people?
Ms. BORN. Exactly.
Mr. HINCHEY. Which are increasingly being placed in jeopardy, and they have nothing to say about the manner in which that is being done and they have no one to turn to to represent their interests in these particular transactions; is that an accurate statement?
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Ms. BORN. Yes.
Chairman LEACH. The time of the gentleman has expired.
Mr. GREENSPAN. There is a factual question here that both the Comptroller and ourselves have very significant elements of supervision and regulation which look at sales practices of these particular derivative dealers and make judgments as to whether in fact, beyond the issue of fraud, the counterparties are perceived to have the capability of implementing the contracts which they are engaged in in an effective manner. So in that regard, the supervision and regulatory structure is there.
Mr. HINCHEY. What happened in the case of Procter & Gamble?
Mr. GREENSPAN. All I can tell you is that you are going to run into examples of people doing things which are alien to or directly contradict particular supervisory and regulatory processes all the time. I mean, what happened there——
Mr. HINCHEY. Don't we have a responsibility to minimize that?
Mr. GREENSPAN. After the fact we all moved in.
Mr. HINCHEY. Let us do it before the fact.
Mr. GREENSPAN. The trouble is that you do as best as you can, and periodically you get embezzlements which——
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Mr. HINCHEY. Mr. Chairman, the question raised now is are we doing the best that we can? Are we ensuring that we are protecting innocent people to the maximum amount possible?
Mr. GREENSPAN. I have been observing this phenomenon for a number of years. I think when you are dealing with a market this huge, the fact that we can elicit so few examples of problems is itself a tribute to how well this market is functioning.
Mr. HINCHEY. You say that the losses are going to mushroom the next time we have a financial downturn?
Mr. GREENSPAN. Absolutely. All markets will respond. It has nothing to do with derivatives markets. I am talking about the underlying markets.
Mr. HINCHEY. But people who enter into those transactions in a very sophisticated way who understand the risk, that is one thing. But people whose money is put into those transactions in a way that they have no control over and who don't understand the risk and are totally unsophisticated and are placing everything that they have in the world in jeopardy, that is a different story, and there ought to be some mechanism that at least lets those people know what their money is being used for and what kind of risk they are sustaining.
Mr. GREENSPAN. Congressman, let's remember who is where in this particular issue. When you are dealing with Procter & Gamble, you are talking about a chief financial officer of a major corporation. Now he and others I presume got into contracts which they probably should not have gotten involved in and the shareholders of Procter & Gamble suffered.
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Now, is a chief financial officer of a major corporation considered to be somebody who is uninformed?
We have dealings where you have major financial executives in charge of all sorts of funds in one form or another. Are some of them inept? They certainly are.
Do they as a consequence undercut the individuals for whom they have a fiduciary obligation? The answer is yes.
We have this going on all the time and it invariably occurs in areas where you have people who should be far more technically proficient turn out not to be. Somebody appointed them. I mean, the mayor, for example, of certain cities will appoint somebody in charge of their pension fund. It may turn out he is inadequate and he will be effectively misled inadvertently or otherwise by somebody in a derivatives deal. We tried to avoid that by insisting on derivative dealers who basically come under our supervisory control, to at least look beyond the issue of just fraud and whether in fact the contracts that are being let can effectively by everyone's knowledge be—can they be resolved in an effective manner. So we are trying to do that. Do we fail on occasion? We do. Is there a way to avoid that? I know of no way to avoid that. We do the best we can, and I think frankly we do pretty well.
Mr. HINCHEY. I know that you do.
Chairman LEACH. I am sorry, the gentleman has had quite a lengthy examination.
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Mr. HINCHEY. Just a brief response.
Chairman LEACH. Very brief.
Mr. HINCHEY. I know that you do the best you can. No one would ever question that, especially in your case. They may question your point of view or philosophy perhaps. But you are looking at in this case the agency. You are looking at the bank. You are not looking enough at the people who are buying these things and who may not know what they are buying, and I think that this is something that we ought to take a look at more closely and carefully; and, therefore, I think what has been done by Ms. Born is a good contribution to all of our efforts to try to minimize risk, particularly for those people who can't afford it.
Chairman LEACH. The Chair would recognize Mr. Bachus.
Mr. BACHUS. Thank you.
Chairman LEACH. Would you be willing to yield to the Chair for 15 seconds?
Mr. BACHUS. Yes, sir.
Chairman LEACH. I just think that it is very important to add to this perspective that it was the Federal Reserve Board in this case, the case of the Fed of New York, that moved very strongly against the bank that was involved in Procter & Gamble. It is the SEC who led the charge in Orange County. And so these institutions when there is wrongdoing do act, and they acted fairly strongly, particularly in the case of Procter & Gamble. So I don't want any presumption that there was not a very strong counteraction that occurred.
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Mr. Bachus.
Mr. BACHUS. Thank you. First of all, we have talked about Orange County as an example here, but it wasn't a swap gone bad, was it?
Mr. LINDSEY. No, it was not.
Mr. BACHUS. That is not what we are talking about here today?
Ms. BORN. It was an over-the-counter derivative. They were involved in over-the-counter derivatives transactions, as well as other kinds of transactions.
Mr. BACHUS. But what we are talking about here is swaps?
Ms. BORN. I think over-the-counter derivatives in general is one of the topics here, and certainly Bankers Trust did involve swaps, and the CFTC brought an enforcement action against it for fraud in the sale of those swaps to Gibson Greeting Cards and entered an order ordering it to cease and desist and requiring it to pay a fine of $10 million.
Mr. BACHUS. I thought the hearing was whether or not you had jurisdiction over off-exchange swaps?
Mr. LINDSEY. Nobody is arguing that just because the label ''swap'' is written at the top of the paper that it makes it a swap.
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So in the case of Bankers Trust and Procter & Gamble, the instruments that caused problems, while they may have somebody write ''swap'' at the top of the page, the enforcement actions were not brought against swaps, they were brought against other instruments.
Mr. BACHUS. Chairperson Born, what desirable policy objective is achieved by the trading commission exercising jurisdiction over swaps?
Ms. BORN. Well, as I said, we do have jurisdiction over futures and commodity options off-exchange, and there is no question that some transactions over-the-counter are in fact——
Mr. BACHUS. You started questioning that maybe you ought to exercise jurisdiction over——
Ms. BORN. We have existing regulations that govern swaps and hybrid instruments to the extent that they are futures and commodity options—or commodity options. We have had those on the books for more than five years. We have been enforcing and implementing those regulations for the last 5 1/2 years.
There have been such enormous changes in this marketplace that the Commission feels that it is required to look at whether those regulations remain valid or whether they need to be changed. For example, swaps clearinghouses are forbidden under our exemption. That is one of the conditions, that the swap may not be cleared. We now have a number of institutions which are very interested in creating swaps clearinghouses, and indeed we have put out for public comment a petition to change our regulations in order to permit swaps clearing.
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Mr. BACHUS. I guess my question is the swaps that you are talking about that you may want to step up regulation on, what is the public benefit to you doing that?
Ms. BORN. We have not said whether with respect to truly bilateral customized exchange transactions between financially sophisticated entities, we need anything more than—we are just asking questions.
Mr. BACHUS. But if you ask the question, isn't there a reason? There has to be a public policy objective to motivate you to ask the question. What is your concern?
Ms. BORN. We have seen an enormous growth and change in the market. We are told that there are many additional participants in this market who are significantly less sophisticated than were the participants five years ago. We have been—and we did not even keep—although we have the fraud authority, we did not require that participants do risk disclosure. We did not require record keeping. We are asking the participants in this market do they need risk disclosure.
Mr. BACHUS. I guess my question again is what are you trying to protect?
Ms. BORN. We are trying to protect the money of the American public which is at risk in these markets.
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Mr. BACHUS. Are you talking about against fraud, price manipulation?
Ms. BORN. And the issue is in my mind whether we are adequately protecting it now, which we may well be, or whether anything additional is needed. It is also an issue of whether we need to broaden the exemptions to allow more activity in the market or whether our current exemptions are standing in the way of beneficial innovations in this market, like swaps clearing. I tend to think that they may be, and I think we ought to examine that.
Mr. BACHUS. What is the danger? You are saying in an all-encompassing way you want to protect the American people's money. What is it about these swaps between two highly sophisticated corporations off an exchange that you feel like regulation—what are you trying to achieve?
Ms. BORN. You understand that the only regulation we have in place right now is fraud and manipulation prohibitions in our statute.
Mr. BACHUS. Is there something else that you wanted to extend that to?
Ms. BORN. We don't want to do anything. We want to ask questions from the over-the-counter derivatives dealers and from the end users of these whether we got it right 5 1/2 years ago.
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Mr. BACHUS. Maybe now you have said that fraud and price manipulation are your concerns?
Ms. BORN. Those are the two powers.
Mr. BACHUS. So you would have to want to prevent fraud.
Ms. BORN. And we have brought a number of actions from an enforcement point of view that have penalized people for fraud or manipulation in the over-the-counter market.
Mr. BACHUS. If they are on an exchange, there are already CFTC style protections for the parties, right? They already have the protection of the CEA?
Ms. BORN. They currently are subject to the full panoply of the CEA, although one of the questions in the Concept Release is whether there should be permitted an effective lower level of regulation for professional markets; that is, markets with so-called ''sophisticated'' participants, whether they be called swaps markets, futures markets, or options markets.
Mr. BACHUS. May I ask one more question of now-Comptroller Hawke?
Chairman LEACH. Yes.
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Mr. BACHUS. I am not sure that you have jurisdiction over where this is coming from.
In 1971, futures exchanges began to trade financial futures for the first time. Those contracts were not regulated by Ms. Born's commission at that time because that commission didn't even come into existence until 1974, and the contracts weren't regulated by the Department of Agriculture, which has authority to regulate only enumerated agricultural commodity contracts.
Even when Congress in the Commodity Exchange Act created the Commission of which she is now chairperson, they specifically stated that the Commission had no authority over off-exchange trading in foreign currency or Government securities, which at that time were the only financial products traded on futures exchanges. And they specifically said you have got no authority over those.
My question is when has Congress ever specifically asked the Trading Commission to regulate off-exchange trading in financial derivatives, and I will ask that of Secretary Hawke and then of the other panelists.
Mr. HAWKE. I think one has to look to the 1992 legislation that authorized the Commission to grant exemptions for swaps.
The concern that the Congress had at that time was that swaps might be caught up under futures regulation, and that would inhibit a market that was just in its infancy at that point. As I think it is clear from the legislative history that I read in response to Mr. Hinchey's question, that the Congress explicitly avoided in deciding the ultimate jurisdictional issue whether swaps are futures. It said that whether swaps are futures or not subject to the CEA, we will give the Commission the authority to fashion exemptions so that will bring some certainty to this market.
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I want to make clear that what this hearing really is about is one or two steps removed from the question of how the over-the-counter derivatives market should be regulated. I think Mr. Hinchey certainly raises a lot of important questions about the public interest in the regulations of the over-the-counter derivatives market.
What we are concerned about here is the market uncertainty that has been caused by this Commission asking a series of questions that imply that it believes it has jurisdiction to regulate this industry on the only ground that is available and that is that swaps are futures.
That we believe has caused uncertainty and dislocation in the marketplace, and that was the genesis of the legislative proposal. That legislative proposal did not prejudge any of the questions about what regulation there should be and who should regulate it. We think that those questions ought to be asked by a body that doesn't carry with it the implication that the ultimate jurisdictional question has been decided because if that question has been decided, it puts a substantial portion of this industry into a position of potential illegality.
Mr. BACHUS. Mr. Greenspan.
Mr. GREENSPAN. I agree with the Secretary.
Mr. BACHUS. Ms. Born.
Ms. BORN. Let me just say, Congressman, that in 1974 Congress gave the Commission jurisdiction over futures on all commodities, which included intangible interests, including financial instruments, except onions, which were explicitly exempted from the Act.
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We also were given jurisdiction over all commodity options. Since that day, we actively have enforced the law with respect to all over-the-counter futures and options, whether they were financial instruments or instruments on physical commodities. And Congress has overseen us very carefully. We have been up for reauthorization four or five times since that time. The only alteration in our jurisdiction since 1974 with respect to financial derivatives was in 1982 when Congress explicitly amended our Act to give options on securities and securities indexes to the SEC's jurisdiction. So we have jurisdiction over futures and options on financial instruments.
Mr. BACHUS. Mr. Lindsey.
Mr. LINDSEY. I agree with Under Secretary Hawke.
Chairman LEACH. Let me explain briefly, the Chairman of the Federal Reserve and the Secretary of the Treasury have to leave at 1:30, so I want to try to get everybody in. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman. I am sorry that I have been in and out, but I have been trying to pay attention.
I am always happy to see a regulator take some action in terms of the concept at least of over-the-counter derivatives. I think almost any one of you at the table from the standpoint of regulating banks or the underlying instruments registered as securities could make the claim in terms of jurisdiction, so we have a case here, and I don't think it is a question, obviously by saying you could exempt something, that to me means that you have some inherent power to possibly regulate it. If you were not giving it up, it may not be as clear that you can exempt, you can certainly exclude doing it, but it also implies that you could. So there is still a debate over that. I will leave that to my legal counsel here.
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As an aside, congratulations, Mr. Hawke, on your nomination to the OCC, and we look forward to you achieving that responsibility. You will be a great addition in that role.
My concern is that almost anyone can begin putting out rules and regulations. The question is do we have as regulators a responsibility to try to define or discipline this particular market in these instruments, these instruments that are coming out. Is there anyone at the table that would disagree that there is a regulator role in terms of trying to discipline or address this particular market?
I mean, we need to play a role here. When I was listening to the questions about fraud, I thought those are sort of self-evident. No one is in favor of fraud. The point is if we convict people on the basis of bad business decisions, our prisons would be overflowing.
In terms of the free market or free enterprise system, we need to have that dynamic take place. But our concern gets to whether or not the house of cards that is being built with swaps is one that will perform? Can it execute?
Can the representations and warrants and other activities that are going on in this particular endeavor perform? The type of risk that we understand is inherent here, and I am concerned because if banks are loaning money and are involved, we are concerned in terms of those institutions not coming back or being able to perform. Or if others are buying these, will they actually perform. We know that there is a lot of risk inherent in this, and that really is the question.
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Now, I understand that—just as a way of statement there has been this letter put out, and obviously there is an open Presidential group that has been working on this, a working group on financial markets. There has to be some cooperation because everyone can come out with different regulations and there could be a detrimental effect in terms of what happens with swaps and derivatives and the other instruments that are being discussed.
But I understand that Secretary Hawke has indicated that this is only a concept of a release, but it has a profound effect, as you are suggesting, in terms of what is happening with the markets. Threats to leave this country to go to other nations where they would not be affected is one I find of concern for a variety of reasons, but there has been the letter put out to suggest that the only actions to be taken are emergency actions. It doesn't suggest—it says no rules or regulations are being adopted right now. How long is that going to last? Congress is going to be in session for the next two or three months, and will regulations be put forth before Congress reconvenes in the next session, Ms. Born?
Ms. BORN. No. The Commission has voted unanimously that we will not even propose new regulations until Congress reconvenes next year. We are in the midst of a very careful, deliberative study. There is no proposal that we have in mind. We have asked questions of the industry.
Mr. VENTO. I think the thing that is of concern to me and as I suggested, I think you should have the option to do this and take action where you see that it is necessary, but how is that cognizant of the other regulatory responsibilities of your partners? This has not been done in a coordinated manner, and I don't think you ought to be co-opted.
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Ms. BORN. We hope that they will all comment and provide us with their views on these questions, and we are happy to coordinate and cooperate with them in any way.
A number of them also have not concept releases, but proposed rules that have been put out for public comment and that are awaiting adoption on matters within their purview in the OTC derivatives market. We have commented on some of those rules and had staff discussions.
Mr. VENTO. So the point is that there will be no action until Congress reconvenes, so there is no need for us——
Ms. BORN. There will not even be proposed action.
Mr. VENTO. So not acting this year would not preclude action in the future by Congress?
Ms. BORN. That is correct.
Mr. VENTO. Mr. Hawke, did you have any comment?
Mr. HAWKE. As I said earlier, Mr. Vento, I think there is a kind of illusory quality to this commitment because it would be difficult to draft regulations between now and the time the new Congress convenes. We would feel much more comfortable, if they were going to make a commitment of this sort, that the commitment extend through the next Congress so that the implication is not left on the table that as soon as Congress reconvenes, they may be confronted with a CFTC rulemaking.
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Mr. VENTO. I appreciate that, and I will let you all get together and work out that and hopefully the answer will not come back that we will not be pushed into some action at a late date.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Mr. Campbell.
Mr. CAMPBELL. Thank you very much, Mr. Chairman.
I would like to try out a possible compromise with Ms. Born and get comments from the other panelists.
I understand where your analysis has led you, and the problem is that it has led you to say that swaps are futures, and if that is right, then all existing swaps that were not transacted on the exchange are subject to private party invalidation.
If I am right that that is where you are going, I just draw your attention to the fact that other regulatory agencies have in their careers expanded and contracted their jurisdiction by rulemaking. The NLRB does it as to what is an employee. Some boards have said some employees are private contractors, and another board comes and reverses it.
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The Federal Trade Commission, under the Federal Trade Commission Act Section 5—which I used to administer when that was my job—would expand and contract definitions of what unfair and deceptive acts and practices were.
So my suggestion is because you have this very serious risk of invalidating existing swaps, the CFTC ought to promulgate a rule that says, ''Under the authority given to us by Congress, we exempt all swaps from the reach of our jurisdiction until such time as by subsequent regulation we specifically include them.'' You then dissipate all uncertainty in the market as to existing swaps. You don't concede the point on your jurisdiction. At any time you wish, you may begin a notice of proposed rule making and you may take testimony. And if at that moment you put the hammer down, swaps from that point forward are subject to your jurisdiction. Everyone has fair notice, and no swap that is in existence now is vulnerable.
Now I would be very happy to hear your comment and the others on that suggestion.
Ms. BORN. Let me say first that swaps are a very broad and diverse group of transactions, some of which under our definition of swaps are options which we have jurisdiction over. Some of them may be futures. Some of them are probably other kinds of instruments over which we have no jurisdiction.
We did do exactly what you are suggesting in 1993 by adopting exemptions for swaps from our statute. We have the power given to us by Congress in 1992 to exempt instruments from the exchange trading requirement. We have done so. There is no question that instruments which are complying with our exemptive provisions are legal and valid even though they are traded over-the-counter and not on a futures exchange.
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Mr. CAMPBELL. There is a gray area or we would not be here today.
Ms. BORN. The sole gray area is the result of a congressional provision in 1992 that we could not exempt any instrument that was contrary to a prohibition in the Act that was part of the Shad-Johnson Accord on futures, on non-exempt securities or narrowly based securities indexes. For those instruments if they are out there, what we have done and we have said this is still in effect, even though we don't have the exemptive power, we adopted a policy statement saying as a matter of policy we were creating a safe harbor for all of those instruments. They will not be subject to regulatory or enforcement action by us, and we have urged Congress to reconsider their refusal to give us exemptive power as to those instruments.
Mr. CAMPBELL. The remaining element, though, is private party action, and so that is the point I was suggesting, to which you have not yet responded. The uncertainty of private party action comes over the potential definition of the word ''futures,'' and what I am telling you is that you do not lose anything by promulgating a regulation saying that futures does not include swaps. And you can be much more refined than simply the one word. You can address the problem that Secretary Hawke and Chairman Greenspan in particular referred to of these existing contracts whose legitimacy is in doubt.
You have only told me how you have proposed to exempt some swaps from your enforcement action. What I am suggesting is that you promulgate a regulation which exempts the word ''swaps.'' That will take care of all third party actions. Why can't you do that?
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Ms. BORN. We could certainly consider that. However, in framing the definitions, we need to be very careful that we do not totally eviscerate the current scope of our regulations or the definition of futures that has been built up by not only the Commission but the U.S. Courts of Appeals around the country over the last 2–1/2 decades.
Mr. CAMPBELL. Thank you and it is a sincere suggestion. It seems to me that you don't eviscerate your authority, because just like in the NLRB and the FTC example, you can always come back and reestablish your jurisdiction by rulemaking. But this approach has the great virtue of giving clear notice and not catching folks unaware.
I wonder if Mr. Hawke can respond?
Mr. HAWKE. I think that is an enormously interesting idea, Mr. Campbell. In effect you are saying that by granting even a temporary exemption from the definition of futures for equity-based swaps, the Commission has within its power to bring the certainty to that portion of the market that they don't have the power to exempt under the exemptive power. I think that is something that is really worth looking at.
Mr. CAMPBELL. Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Campbell.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman. Panelist Born, you are doing a very good job. Usually it is Mr. Hawke who is having to defend himself on the panel, and I am tempted to raise the issue how we would regulate swaps transactions through operating subsidiaries and national banks, but I am not going to do that today.
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I actually think my colleagues have raised a lot of interesting questions. I think one thing that is important, and Mr. Campbell and I have had some discussions about this because I think he has thought about the issue of derivatives and he is one of few knowledgeable members on this whole issue, but I think Mr. Greenspan is right because it is Congress that ought to be asking these questions because it seems to me what we have here, we are getting deeply into the semantical definition of what is a swap, what is a future. And the Concept Release either directly or indirectly raises jurisdictional questions and raises legal questions as to the credibility of existing contracts, your statements notwithstanding, but it also does raise some interesting questions. I am just not sure that the CFTC is the appropriate party to ask those questions, and I don't know who is necessarily, but I know that you have asked in the capital standards section and in the sales practices section, which I think are very important questions to ask and we have talked about them on this committee, but I am not sure that the CFTC, for instance in section 48 or question 48, asking the question on whether or not capital standards are adequate for OTC derivative sales, I am not sure that you have jurisdiction to say whether or not Bankers Trust has adequate capital. I think that might be the purview of the Fed or it might be the purview of the SEC if it is being done through a broker-dealer operation. And so that is part of the problem here.
I am curious why you didn't, and maybe you didn't think that this would cause the firestorm that it did, but I am curious why you didn't maybe do this in conjunction with your fellow regulators, much like they have done with respect to CRA or TELA or RESPA or any of the other financial acronyms that we have so that there would be some broad ownership and we wouldn't get into this jurisdictional question.
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Ms. BORN. Let me respond by first reminding you that in March the other regulators through the President's Working Group said they did not want to do a study as a group of these issues.
Second, in our Concept Release we have made it very clear that in areas where other regulators are operating and operating well, such as prudential oversight of some of the institutions that are in these markets by the banking regulators and the SEC, we proposed that we should defer to them and ask for comment on that as well, and that certainly would be my personal predisposition.
The problem is that there are many, many, many other participants in these markets who are not commercial banks, who are not broker-dealers, who are not subject to the oversight of any of the financial regulators.
Mr. BENTSEN. That very well could be true, and I don't know that it is CFTC's jurisdiction. We have no one here from the state regulators, and we raise questions where is the MSRB because you have in the municipal market, you have forward delivery type bonds. When I was in that business we were doing forwards that we thought were swaps. We certainly did not think that they were futures, and our counsel certainly never told us that they were.
In your letter to Chairman Smith dated—I don't know what day today is——
Ms. BORN. Today.
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Mr. BENTSEN. And when we finished earlier this morning, I wasn't sure what day it was, but you state, ''It continues to be the Commission's view, as the Commission stated in its the policy statement concerning swap transactions, that certain swaps are not appropriately regulated as futures contracts under the CEA.'' Is that stated in your Concept Release?
Ms. BORN. Yes. It is in the Concept Release. My recollection is that it is, but I may be wrong. We have certainly said that.
Mr. BENTSEN. I read it this morning, but I may have missed it.
Ms. BORN. We explicitly say that all market participants can continue to rely on the policy statement.
Mr. BENTSEN. My concern is this. I don't disagree, like Mr. Baker said, about asking the questions. I think Congress ought to be asking them or you ought to be doing them jointly but your letter today, this sentence is not as innocently asking in a survey form of whether there is a regulatory gap and how that regulatory gap might be filled. This letter makes a statement in effect to me that you believe that there is a regulatory gap under the CFTC's jurisdiction with respect to futures. And that raises——
Ms. BORN. What the policy statement provided, as most participants in the market are aware, was a safe harbor. This was something that the Commission granted before Congress gave us any power to exempt swaps or hybrid instruments from the Act. And so in 1989 in order to allow the swaps markets to develop and thrive, we took a regulatory position somewhat similar to what Congressman Campbell is suggesting, saying we do not think under the current structure of the Act, which requires all futures to be traded on exchange, that this is appropriately regulated as a future; and, therefore, we will give OTC swaps meeting certain terms and conditions a safe harbor, and that is what we were referring to conceptually.
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Mr. BENTSEN. One more question, with the Chairman's indulgence. I have 20 more, but this one is: Do you have any empirical evidence that, A, the growth in the OTC derivatives market is directly related to the inadequate amount of regulatory oversight; and, B, do you have any empirical evidence, which I don't think that you state in your Concept Release, that the marketplace has changed significantly in terms of the end user to either a small institution or a retail market to the point that there is a regulatory gap in consumer risk?
Or is this based upon assumptions that that may be the case?
Ms. BORN. We are asking that as one question. We have heard anecdotally that there is much broader participation in this market than existed in 1993, when we framed our definition of who is an eligible participant under our exemption.
So we are asking the industry whether there has been a significant broadening, and if so, do we need to broaden our definition of ''eligible participant?''
Chairman LEACH. I apologize. We have agreed that the witnesses leave at 1:30. We have two additional speakers.
Mr. Lucas.
Mr. LUCAS. Thank you, Mr. Chairman.
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Chairman Born, if we could for just a moment, I suppose, in regard to the comments of several of my colleagues, if we could step back for a moment from what the Commission that you are Chairman of has done and not done, what you have exempted or not, whatever letters you have or have not written, could we step back just for a moment, and I would ask you to expand and fill in some of the knowledge base.
From your perspective, what are some of the characteristics of swaps that may or may not make them similar to futures?
Ms. BORN. Our statute gives us authority over two kinds of instruments. One is options, and some swaps, under our definition of swaps and our swap exemption, are clearly over-the-counter options. Indeed, there are categories of swaps called ''swaptions.''
The other is contracts for future delivery of a commodity, broadly defined to include any interest at this point. Backed out from that definition are forward contracts, which we do not have jurisdiction over, which may not have been clear here.
Our Act says, in effect, that contracts used for merchandising purposes that contemplate, in effect, actual delivery of the underlying commodity, are not within our jurisdiction. So a great many forward contracts in both financial markets and agricultural and other markets are completely out of this.
We have, in various enforcement actions, found that some instruments—and they have to be looked at particularly and analyzed under the two definitions, one of commodity options and the other of contracts for future delivery of a commodity—we have found a number of off-exchange instruments to be either futures or options. Our swaps exemption is meaningful only to the extent that there are futures or options subject to our jurisdiction out there being traded, and it is only as to them that the terms and conditions of our exemption are applicable.
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Obviously, if there is a security or something else out there, the terms and conditions of our exemption are meaningless. Also, only as to those instruments within our statutory authority do we have the retained fraud and manipulation authority.
Now, just in the last couple of months we brought an action against Sumitomo Corporation for manipulating the U.S. market in copper. It effectuated that manipulation in two ways. One was through transactions on the London Metal Exchange in futures contracts, and the other was through OTC derivative contracts. We fined them $150 million in civil penalties and restitution to U.S. interests that lost money. The fine was not merely for their exchange trading, but also for their OTC derivatives trading, too.
Mr. LUCAS. Mr. Chairman, out of respect for the panel and my colleague, Mr. Fossella, I would like to yield back my time.
Chairman LEACH. Mr. Fossella.
Mr. FOSSELLA. Thank you, Mr. Chairman.
I am going to look at this from I guess a global and sort of a parochial concern; global, in that I have been listening to the debate, and I appreciate all of your patience. The notion that this derivative market, according to some, is in a way too successful—as I look at it, one of the greatest things that has happened in the last 20 years or so is that we have been able to increase wealth across the board. Just look at 401(k)s or participation in IRAs, and the so-called millionaire next door, which I think is a wonderful thing.
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From a parochial point of view, I happen to represent Staten Island and Brooklyn, where many of those people work, in downtown Manhattan. What concerns me is the concern raised by some in this room, and indeed some on the panel, that someone with some of this business could, with a flick of the switch or a computer, could go overseas, which means loss of jobs, which means my constituents would be affected.
I grant that there are different types of risks. There is tangible risk. I look at it from the point of view if I have a house and you are my neighbor, the status quo remains, nothing changes. One day you come with a bulldozer and knock my house down. That is a tangible risk that is affecting me, as opposed to sort of an intangible risk, where you come in front of my house one day with an architect, and you start looking at my house with plans. I say, what are you doing? And you say, oh, nothing. But the architect starts playing with adding or taking away a room or adding a patio, whatever.
It sounds to me that the CFTC wants to come into somebody else's yard here, and thereby are creating this legal uncertainty. I have stayed around this long because I have not been satisfied with the degree in which the CFTC has been willing to move toward eliminating that legal uncertainty and thereby diminishing the risk in the market.
Again, underscoring my view and that shared by others, do you believe that CFTC is creating any uncertainty in the market by just raising these questions and attempting to begin or at least appear to begin to regulate swaps, which up until now it has not regulated?
Ms. BORN. Let me first say that I, too, think this is a wonderful, thriving, dynamic, robust market. As an American citizen, I am very proud that it has developed in the last decade.
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I also think that it is sufficiently robust and resilient so that asking questions about whether our regulations still conform to the needs of the markets, or whether they need to be altered to conform to the markets, will not harm the markets. I think, indeed, it should in the long run lead to much greater legal certainty.
If the participants in the market feel, for example, that there are needs for additional exemptions, that is what we are asking about. If they feel that there are needs for other kinds of action, that is what we are asking about. If they feel that we have our regulations and exemptive provisions just right, I think we will all be pleased.
But this is merely a reaching out to the very people you are talking about to ask them, do we have this right or not?
Mr. FOSSELLA. Two things. I am not doubting your belief that the growth and prosperity has been a good thing, but there are those, we heard it here today, along the path of prosperity who point to one bump and say, ''Aha, our system needs more regulation and a bigger hand,'' as opposed to a more invisible one.
I speak to that, which has been raised today.
Ms. BORN. The commission, over the last 18 months I have been in office, a little less than two years, has been systematically trying to reduce regulatory burdens. We have been reaching out to other elements of the industry, including the exchanges and the registered commodity professionals, and asking them for their wish lists of how we could reduce unnecessary regulatory burden, and we have taken a great many actions in that direction.
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Mr. FOSSELLA. That is appreciated. I will close now, Mr. Chairman. Something Chairman Greenspan alluded to, essentially that the market moves faster than Congress.
My concern is not this debate, where in just the last few hours billions of dollars have crossed the wires, but it is that there is somebody sitting back in New York or Chicago or L.A., wherever, and watching this, and saying, ''You know what, there is too much uncertainty here. I'm not waiting for Congress to make a decision affecting the future of our markets and our industry. Let's move our business overseas, whether it is London or anywhere else.'' That will have a direct impact, not only on the people I represent, but New York City's economy and New York State's economy, maybe not as great as some people would think, but I think it will.
With that, I really appreciate your time and listening. Thank you. Thank you, Mr. Chairman.
Chairman LEACH. Thank you. I thank all my colleagues.
Let me say in conclusion, Chairman Greenspan noted that Congress is a good place to ask questions. I think he is right. Five years ago the then minority asked a yearlong set of questions of the industry, and we produced a 900-page report with 30 recommendations which have largely been implemented.
Second, I might add the CFTC did a report that was concluded in 1993, touching on some of the issues. Four or five years can produce quantum changes, so I think it is not unrealistic for Government at any point to ask questions.
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The implications on how those questions are asked have to be carefully measured, however. Chairman Born was correct in saying what is at issue is protecting the money of the American people. Having said that, there is some presumption that I think we should be cautious about that any single agency has that mission over others.
We have at the table the Federal Reserve Board of the United States. One might suggest that is preeminently their issue, and arguably also that of the Department of the Treasury, the SEC, and the CFTC. But we also have a circumstance where three of the four are at odds, and we have disharmony in the regulatory community, which in itself is awkward. I think we do have a question of where responsibility for regulation to protect the American people's money resides.
The second question is the role of law enforcement regulation, and whether it can become counterproductivite as we have found often in public life. That is, is a too-heavy hand of regulation likely not to protect the money of the people of the United States, because it may prompt markets to go overseas, where there is less protection for the people of the United States? These are very reasonable questions that all of us have to bear in mind.
In any regard, we have gone through quite an exercise and dialogue that has involved informal meetings with all of you. We have also had several formal hearings, and we will have a group to testify after you. We have made some progress today.
The letter of Ms. Born is a half-step in the direction of the other three regulators, and I think this is an issue that will be further considered as this Congress comes to a close, as well as in the next Congress. These are very important and weighty matters, and we hope to work collectively with you all.
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Thank you all, and I am sorry we have gone a little bit longer than we might have expected. Thank you very much.
Ms. BORN. Thank you, Mr. Chairman.
Mr. GREENSPAN. Thank you.
Chairman LEACH. We have two further panels and legislative action on the floor. Because of the circumstance and the timing, I would like to combine the two panels into one.
I would ask Mr. Michael Brosnan, who is Deputy Comptroller for Risk Evaluation of the OCC; Mr. Kenneth Ryder, Executive Director, Office of Research and Analysis, the Office of Thrift Supervision; Mr. Douglas Jones, who is Senior Deputy General Counsel of the FDIC; Mr. Douglas Harris, who is a partner at Arthur Andersen; and Mr. Richard Miller, who is a partner at White & Case, to come to the table.
What I would like to do is to begin, and hear from one witness and perhaps two before taking a break.
By unanimous consent, the full statements of the witnesses will be placed in the record.
Mr. Brosnan, why don't you begin.
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STATEMENT OF MICHAEL L. BROSNAN, DEPUTY COMPTROLLER FOR RISK EVALUATION, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. BROSNAN. Mr. Chairman, Members of the committee, I appreciate the opportunity to testify on issues relating to over-the-counter derivatives.
Recent years have seen important changes in the financial marketplace. Stimulated by competition and innovation, banks today are increasingly well-positioned to serve their customers' needs for quality financial products. We, as the financial supervisor, have worked to create a consistent, predictable, and responsive environment in which banks can operate without excessive regulatory burden, and which is conducive to the safety and soundness of the banking system.
Among the most important of these recent product innovations are over-the-counter derivatives. The first quarter of 1998 was the 9th consecutive quarter of growth in the notional derivatives at U.S. commercial banks. As of March 31 of this year, this figure stood at $26 trillion, compared to just over $20 trillion at the beginning of 1997. Such growth cannot be ignored, and the committee is to be commended for its continuing efforts to monitor the derivatives market and its system-wide implications.
The committee has recognized that, properly used, derivatives can be an effective and flexible risk management tool. You and others have noted that derivatives can contribute to the viability of banks by allowing them to diversify their revenue sources and thus improve their ability to withstand downturns in the business cycle.
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Using derivatives, banks can also perform an important service to business customers who are searching for ways to better manage their own exposure. That is a win-win for banks and their clients. But you have quite properly asked questions about the supervision of these powerful instruments. My written statement provides a detailed summary of the supervisory measures implemented by the OCC over the past several years to ensure the number of national banks that currently participate in derivatives activity do so in a safe and sound manner.
Our examination findings suggest that the participating banks are doing just that, and we are committed to ensuring that our basic supervisory system provides effective and appropriate safeguards against the risks associated with derivative activities going forward. As I said at the outset, a regulatory regime must be predictable and consistent to be effective. That is why we have misgivings about proposals to alter the regulatory structure regarding derivatives activities.
The possibility raised by the recent CFTC Concept Release that certain types of derivatives, namely swaps and hybrids, might henceforth be considered as futures contracts and regulated as such, has already raised unsettling questions about the legality of existing transactions. Such concerns may discourage some banks from using derivatives to manage risk. That would undermine safety and soundness.
If such a change in the regulatory regime were to take place, it might well have the effect of driving derivatives transactions outside the United States and diminishing the competitiveness of U.S. banks, while lessening the effectiveness of U.S. financial supervision—clearly undesirable outcomes.
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Such potentially far-reaching regulatory changes should not be undertaken lightly. The OCC believes that the President's Working Group on Financial Markets is the appropriate forum for the discussion of this issue, which cuts across markets and regulatory jurisdictions. It is also appropriate that this multi-agency body be comprised of principals from the key regulatory agencies that supervise the major firms engaged in derivatives activities.
Mr. Chairman, we at the OCC are committed not only to working with our colleagues at the other Federal regulatory agencies, but also with you and other Members of Congress to ensure that the dynamic over-the-counter market for derivatives continues to enhance the safety and soundness and the competitiveness of our banking system.
As one further example of the way the consultative and cooperative process can and should work, let me say just a few words about H.R. 4239, the Financial Contract Netting Improvement Act of 1998.
Chairman LEACH. If I could interrupt you for just a second, I think maybe we will recess pending the vote, and then come back to you, Mr. Brosnan, if we can.
The hearing is in recess.
[Recess.]
Chairman LEACH. The hearing will reconvene. Let me apologize. We have had a long series of votes. It was unfortunate for those who are interested in the hearing. We were toward the end of Mr. Brosnan's statement, but he has more to go, so why don't I recognize you again, Mr. Brosnan.
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Mr. BROSNAN. Thank you, Mr. Chairman. I will just start where I left off.
This bill, which you and other Members of the committee introduced last week, was drafted with the assistance of staff members of the agencies represented on the President's working group, including the OCC. This bill would provide significant benefits to the financial markets by reducing systemic risk and providing greater legal certainty to commercial banks and their customers.
The OCC fully supports H.R. 4239, and we commend you, Mr. Chairman, and the committee for your prompt and statesmanlike action to see that this important bill becomes the law of the land.
Mr. Chairman, that concludes my statement.
[The prepared statement of Michael L. Brosnan can be found on page 371 in the appendix.]
Chairman LEACH. Thank you, sir.
Mr. Ryder.
STATEMENT OF KENNETH F. RYDER, EXECUTIVE DIRECTOR, OFFICE OF RESEARCH AND ANALYSIS, OFFICE OF THRIFT SUPERVISION
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Mr. RYDER. Thank you, Chairman Leach, for inviting me to discuss the Office of Thrift Supervision's views on H.R. 4062, the Financial Derivatives Supervisory Improvement Act of 1998. I understand that the written statement that we submitted will be inserted into the record, so I will try and limit my remarks to a brief overview of what was in there.
The OTS's regulatory interest in derivatives is fairly straightforward. Some of the thrifts that we supervise, including many of our largest institutions, use derivatives, primarily over-the-counter interest rate swaps and interest rate options, to help manage their exposure and sensitivity to interest rate risk. None of the OTS-supervised thrifts acts as dealers. Instead, they are simply end users of derivative products.
Mr. Chairman, as you know, thrifts are in the business of making residential mortgages and financing them with retail deposits. Thrifts offer consumers a wide variety of mortgage products, 30-year and 15-year fixed level term mortgages, as well as a range of adjustable rate mortgages.
The availability of this broad array of mortgage products has helped support the continued growth of home ownership in this country. Equally as important, these tailored mortgage products can expand home ownership opportunities for those American families with unique or special financing needs that are not well met by standard mortgages configured for the secondary market.
Unfortunately, one consequence of meeting these housing financing needs is that thrifts must also manage the interest rate risk generated by these activities. Derivatives provide one of the many tools available for thrifts to manage those risks.
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Other ways that thrifts manage their interest rate risks include holding more capital, securitizing and selling part of a long-term fixed-rate mortgage portfolio, substituting longer-term advances and other debt for shorter-term deposits, limiting their concentration in longer-term loans, and diversifying into other consumer-oriented lines of business that involve shorter-term lending.
As of March, 1998, the latest data that we have available, there were 95 thrifts that used financial derivatives. Of those, 79 reported positions in options, such as interest rate caps or floors and collars, 44 held swaps, and 10 held futures. As might be expected, the use of derivatives is concentrated among our larger institutions. Of the 95, 44 had assets in excess of $1 billion. That represented about 43 percent of the larger institutions that OTS regulates. The 95 users together account for over 55 percent of the total assets of OTS-regulated institutions.
But to give you a little more perspective, the total notional value of derivatives held by thrifts was only about $60 billion. Remember, what we heard earlier was that this was a total market that is somewhere on the order of $28 to $30 trillion, so OTS-regulated thrifts are a small player, but for those thrifts these are significant products.
From OTS's perspective, derivatives can be effective risk management tools when used in a safe and sound manner. The principal purpose of OTS's interest rate risk management program, initiated in 1989 with the issuance of Thrift Bulletin 13, is to help thrifts understand these interest rate risks and to develop sound strategies for managing them.
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Over the past nine years, OTS oversight of thrifts' management of interest rate risk has consisted primarily of three elements: First, issuance of policy guidance on the management of interest rate risk; second, off-site monitoring and surveillance by OTS; and third and most important, on-site exams to see how well the institutions are performing.
The OTS policy guidance on the management of interest rate risk has consistently emphasized a total portfolio approach. While thrift management must understand the risks associated with particular investments, including derivatives, it is particularly important that they understand how those investments will affect their total portfolio and the exposure of that portfolio to interest rate changes.
OTS's initial policy guidance on this interest rate risk was contained in Thrift Bulletin 13, and was recently updated and expanded in April of this year. The proposed policy guidance provided in Thrift Bulletin 13A that we issued in April addresses three major risk management areas: interest rate risk, investment securities, and financial derivatives.
At the same time, in April OTS also proposed to streamline its existing regulatory approach by implementing a single regulation applicable to all derivative instruments. The proposed rule merges three existing rules dealing with specific types of derivatives that had existed, and emphasizes that reducing risk exposure, particularly interest rate risk exposure, should be the principal reason for thrifts to use derivatives.
In addition to requiring thrifts to establish prudent interest rate risk limits and monitor their own adherence to those limits, the OTS independently monitors thrift interest rate risk, using a supervisory model initially developed in 1991. The OTS net portfolio value model that we use employs scenario analysis, or stress testing, to estimate how changes in interest rates affect the financial condition of individual thrifts, including the effects of derivatives on those total portfolios of the individual thrifts.
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The information produced by the model is used by OTS supervisory and examination personnel during the exam process to assess the manner in which the thrift institution is using derivative contracts and the impact of the derivatives on the thrift institution's interest rate risk exposure. The information is also shared with the individual institutions in the form of exposure reports to help them evaluate their interest rate risk exposure, as well.
While we believe that the current OTS interest rate risk management program effectively addresses the issues raised by the thrift industry's current use of derivatives, we recognize that the CFTC's Concept Release issued in May of this year raises a number of broader questions and issues relating to the regulation of derivative markets. We fully support the committee's view that such broad issues must be reviewed jointly by all the affected financial regulatory agencies.
Before I conclude, I would like to emphasize the importance of exercising caution and restraint in any call for additional Government regulations in the over-the-counter derivatives market. OTS would be concerned if the cost of OTC derivative transactions were to increase significantly as a result of additional regulation. It would be unfortunate, indeed, if the cost of engaging in derivative transactions to hedge or manage interest rate risk were to escalate to a point where it became prohibitive for our regulated institutions to use them for that purpose.
In sum, OTS-regulated thrifts, particularly the larger thrifts, have been prudently using derivatives to help manage their interest rate risk. Reducing their exposure to interest rate risk also reduces risks to the Federal Deposit Insurance funds. For this reason, we must be careful to avoid creating a regulatory environment that discourages insured institutions from prudently using these instruments.
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Thank you, Mr. Chairman. That concludes my remarks.
[The prepared statement of Kenneth F. Ryder can be found on page 382 in the appendix.]
Chairman LEACH. Thank you, Mr. Ryder.
Mr. Jones.
STATEMENT OF DOUGLAS H. JONES, SENIOR DEPUTY GENERAL COUNSEL, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. JONES. Thank you, Mr. Chairman. The Federal Deposit Insurance Corporation appreciates the opportunity to present its views on the regulation of financial derivatives and the financial derivative market and on legislation to revise insolvency laws relating to financial derivatives.
We particularly would like to thank you, Mr. Chairman, for introducing H.R. 4239, the Financial Contract Netting Improvement Act of 1998, and for holding the hearing today to consider this important legislation. We would also like to thank Ranking Member LaFalce, Vice Chairman McCollum, and Financial Institutions Subcommittee Chairwoman Roukema for cosponsoring H.R. 4239.
Banks and corporations use over-the-counter derivative contracts to shape earnings, market liquidity, and credit risk profiles. The FDIC insures banks and thrifts that are both dealers and end users of OTC contracts. However, the banks that we supervise are primarily end users of these contracts.
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The benefits of OTC contracts include less concentrated risk to end-user banks. By entering into these contracts, the end user is afforded the opportunity to secure more stable earnings, for example, when interest rates change dramatically. Many end users would be less successful in managing their exchange rate and interest rate volatility exposures if the OTC market was unavailable.
The market for OTC contracts has grown and evolved significantly over the last few years. Mr. Chairman, your legislation works toward the important goal of preserving the health and continued evolution of this important financial marketplace.
The Commodity Futures Trading Commission in its Concept Release has raised a number of important issues about this market which has led to concerns by some market participants and regulatory authorities about international competitiveness and legal uncertainties. Given the importance of OTC contracts for risk management and the large size of the market, examination and careful study of the issues surrounding the functioning of the OTC market and its regulation is advisable.
This effort should include the expertise of several different sectors, including the CFTC, the SEC, the banking and regulatory agencies and others. The existing Working Group on Financial Markets could serve as an appropriate vehicle for the conduct of this study. Whatever the vehicle, however, we support the prompt commencement of a multiparty study.
I will turn now to H.R. 4239, which adopts the proposals of the President's Working Group on Financial Markets. The FDIC participated on the working group and assisted in drafting the group's proposals. We strongly support H.R. 4239.
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Depository institutions can manage their interest rate and other risks through swaps and other types of derivative contracts. These advantages do not come without risks. One of the primary risks is the potential market disruption and contractual uncertainty created by the insolvency of one of the parties to a derivative or other financial contract.
H.R. 4239 will result in more consistent and predictable treatment of derivatives by clarifying the rights of the parties to a derivative contract and the treatment of those contracts if a party becomes insolvent. The legislation will also clarify the FDIC's right, as the receiver for failed banks and thrifts, to transfer qualified financial contracts, or QFCs, and expand the number of potential transferees.
The Federal Deposit Insurance Act defines QFCs as consisting primarily of financial derivatives and similar instruments. The FDI Act and the Bankruptcy Code grant special treatment to QFCs in insolvency proceedings, and grant those who have entered into financial derivative contracts with parties who have subsequently become insolvent greater rights than to those who enter into most contracts.
In the case of a derivative contract, a market participant has greater rights to terminate the contract and to net, dollar for dollar, its obligations to the insolvent against the insolvent's debts to the counterparty. Without modification, current statutes governing netting will not adequately address market innovations.
Consistency, predictability, and enhanced protection in the case of insolvency are extremely important in the derivatives market. Absent these conditions, market participants will be more likely to take precipitous action to protect their interests if a counterparty exhibits financial weakness, potentially impairing the efficient functioning of the capital markets.
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More important, consistency, predictability, and enhanced protection can reduce the systemic risk to the financial systems that an insolvency can pose, given the enormous volume of derivative contracts and the interdependence of participants.
The ability to terminate or transfer QFCs is extremely important to the receiver of an insolvent bank or thrift. QFCs can be valuable assets and significant liabilities. Parties to QFCs receive, and should receive, additional protection under insolvency laws. A bank receiver must have a clear right to terminate or transfer QFCs. This allows the receiver to determine the most appropriate resolution for a failed institution and to maximize the recovery for depositors, the Deposit Insurance Fund, and other creditors. Granting these rights also reduces the systemic risk by permitting transfer rather than forcing termination of QFCs.
In closing, let me reiterate the FDIC's strong support for H.R. 4239. Passage of the bill would benefit the market, market participants, and the creditors of failed banks and thrifts. It will fix a problem before it arises.
Thank you, Mr. Chairman.
[The prepared statement of Douglas H. Jones can be found on page 402 in the appendix.]
Chairman LEACH. Thank you, Mr. Jones.
Mr. Harris.
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STATEMENT OF DOUGLAS E. HARRIS ESQ., PARTNER, ARTHUR ANDERSEN LLP
Mr. HARRIS. Chairman Leach, I greatly appreciate this opportunity to come before you and share with you my views on some of the important issues associated with over-the-counter financial derivatives. I have a long and varied involvement with the derivatives industry, which, I believe, gives me a unique perspective on these issues.
I am a lawyer by training, and I started my career in 1975 with a firm that at the time represented the Commodity Exchange. In 1979 I joined the legal department of JPMorgan. In 1981 I co-drafted an application to the Federal Reserve Board to establish JPMorgan Futures as the first bank-affiliated futures commission merchant in this country. As the general counsel of JPMorgan futures, and as the person responsible for drafting portions of JPMorgan's first OTC derivatives documentation, I became involved in almost every legal and regulatory issue associated with the involvement of commercial banks in both the exchange-traded and OTC derivatives market.
In 1993 I joined Gene Ludwig at the OCC and became the Senior Deputy Comptroller for Capital Markets. There, I was responsible for all capital markets activities, and specifically the derivatives and emerging market activities. of this country's national banks.
In October 1993, shortly before this committee held its first hearings on derivatives, we published Banking Circular 277, Risk Management of Financial Derivatives. BC–277 was the first attempt by a regulator in this country to provide comprehensive guidance to banks as to how they should deal with what we at the OCC always considered to be the most important issue with respect to bank use of derivatives—the management of risk.
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In fact, I would note that throughout my tenure at the OCC, whenever the Comptroller was called to testify on issues related to derivative products, our message was consistent:
Financial derivatives in and of themselves are not a problem. Managing the risks associated with derivatives has often been problematic for both banks and their clients. Not only do we, the bank regulators, have the necessary tools to appropriately supervise banks' derivatives activities, we are using them. We have enhanced disclosure and reporting requirements. We have issued guidelines on risk management and, in the case of the particularly risky structured notes issued by Government-sponsored enterprises, we adopted sales practice rules under the amendments to the Government Securities Act. In addition, the banks are doing their part to maintain the integrity of the market.
I left the OCC in 1996, having provided additional guidance to banks on investing in structured notes, and acting as a futures commission merchant on this country's organized derivative exchanges.
Last year I joined Arthur Andersen as a partner in the Derivatives and Treasury Risk Management Group. I now have the opportunity to counsel clients on some of the guidance that the regulators have put in place. I try to help those clients make sense of what they see as a nasty jurisdictional fight among the Federal regulators. I explain to our clients that turf is a very small part of what this controversy is all about and that, in fact, there is much more at stake than which Federal agency establishes the rules of the derivatives game.
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The issues we face today in the derivatives markets in the U.S. are much bigger than one might think from the controversy over the SEC's issuance of the Broker-Dealer Lite proposal or the CFTC's OTC Derivatives Concept Release. The fact that we often look at these issues in a vacuum, or we isolate them from other events and changes taking place in the financial world, hinders our ability to structure the appropriate regulatory scheme for derivatives.
These issues are not exclusive or particular to the OTC markets or the U.S. markets or the exchange-traded markets. This conflict is not a jurisdictional fight between the CFTC and the SEC, or the CFTC and the bank regulators, or the banks and the exchanges. The fight is for the continued health, viability, and competitiveness of U.S. markets and U.S. market participants.
The issue of the appropriate degree and level of regulation of the derivatives industry, both OTC and exchange-traded, must be considered in the context of, first, the rapid development of new and complex financial transactions; second, the structural changes taking place in the global financial services industry, and in particular the mergers and acquisitions of financial service providers across financial service industry lines; and, finally, the almost complete globalization and internationalization of the capital markets.
With all due respect, the important issue is not whether the CFTC ought to use a single definition of ''sophisticated investor'' whenever the concept arises under the Commission's regulations. The issue is, first of all, whether we will create a legal and regulatory environment in this country that encourages rather than constrains the continued development of innovative financial products; whether we properly structure the wholesale markets such that the cost of regulation is not a significant factor in the decision to trade or not to trade on a particular market; and whether U.S. market participants, traders, hedgers, dealers, brokers, and exchanges are properly positioned to compete in the global marketplace.
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Any regulatory scheme we put in place for OTC derivatives certainly ought to assist us in meeting these three goals. Does H.R. 4062 help to meet these goals? Unfortunately, yes. ''Unfortunately,'' because the existing President's Working Group on Financial Markets should have, and was intended to, serve just this purpose; that is, as a forum in which the major governmental decisionmakers and policymakers could candidly discuss significant financial markets issues so as to achieve a coordinated and consistent approach to the regulation and supervision of financial markets, financial products, and financial market participants.
The fact that the CFTC issued the Concept Release without the support of its sister agencies signals a serious problem in the regulatory community and the unfortunate breakdown of the accepted political process. In fact, to believe that any one U.S. agency, acting alone and in conflict with its sister agencies, can accomplish the goals that I outlined above does not recognize the realities, political and financial, of 1998 and the many ways in which the financial services industry has changed since the CFTC was created in 1975.
It is absolutely necessary that the U.S. determination of the proper regulatory framework for OTC derivatives represent a well-thought-out, coordinated and consistent approach agreed upon by all the Federal financial regulatory agencies.
The argument has been made that the Concept Release creates legal uncertainty and will, therefore, chill the development of new, complex financial transactions and drive existing derivatives business offshore. A strong case was made at the hearings last Friday before this same committee that that is already beginning to happen.
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However, it is an inescapable fact that legal uncertainty exists today, and that legal uncertainty is placing U.S. interests at a competitive disadvantage right now. The uncertainty I refer to is with respect to equity derivatives and Section 2(a)(1)(B) of the Commodity Exchange Act. This committee could provide no greater benefit to the OTC derivatives industry and the clients they serve at this time than to fix the equity derivatives problem. I suggest that this committee strongly consider the language addressing this issue contained in the draft legislation sent by Treasury Secretary Rubin, SEC Chairman Arthur Levitt, and Federal Reserve Board Chairman Alan Greenspan to Speaker Newt Gingrich on June 5, 1998.
But there is a more fundamental legal issue that must finally be resolved, i.e., the definition of a futures contract. At this point it is necessary, for the long-term viability of U.S. financial market participants, that it be stated clearly that swaps are not futures.
This could be done on the legal and technical basis that, notwithstanding their similarities, swaps are fundamentally different from futures contracts in a number of ways which have already been detailed to this committee. It could also be done on a more practical and pragmatic basis, that the over-the-counter derivatives market, largely comprised of large, sophisticated institutional participants, does not require or lend itself to the type of regulatory scheme imposed upon the exchange-traded market, where the integrity of the market, the preservation of the price discovery function, the prohibition of market manipulation, and customer protection are the primary supervisory concerns.
At the same time, we also need to consider the regulatory issues being raised by the exchange-traded futures markets as well. In many cases these markets are quite different than they used to be. In addition, the exchanges are developing innovative structures and proposals, many of which are languishing before the CFTC, that would allow them to compete more effectively with their foreign competitors.
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For example, if we allow equity derivative swaps in the OTC market, why shouldn't we also allow equity futures contracts on the exchange-traded markets? The exchange traders have legal, legitimate competitive issues that need to be addressed.
Thank you for this opportunity to express my views. I will be happy to answer any questions you have.
[The prepared statement of Douglas E. Harris can be found on page 414 in the appendix.]
Chairman LEACH. Thank you very much, Mr. Harris.
Mr. Miller.
STATEMENT OF RICHARD A. MILLER ESQ., PARTNER, WHITE & CASE LLP
Mr. MILLER. Thank you, Mr. Chairman. Good afternoon. My name is Richard Miller, from the law firm of White & Case. In addition, I am the editor-in-chief of the Futures and Derivatives Law Report since its inception in 1981. Thus, for the better part of 20 years I have practiced law extensively in the ever-changing area of futures and derivatives law and regulation, and I observed closely its dramatic evolution in my capacity as an editor of a journal devoted to this subject.
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Also, in 1987 I was privileged to serve on the staff of the Presidential Task Force on Market Mechanisms, better known as the Brady Commission, which was tasked with the responsibility of studying and recommending remedies for the breakdown of market systems that occurred during and contributed to the 1987 stock market crash.
I would note in passing that the views expressed here today are my own, and not necessarily those of my firm.
The CFTC's recent Concept Release on Over-the-Counter Derivative Instruments has prompted a cascade of criticism both from the derivatives industry and other governmental regulators. Wall Street dealers have proclaimed loudly and frequently that the Commission's initiative will enlarge the legal risks attendant to OTC transactions in general and equity swaps in particular.
They fear that these transactions could be invalidated merely in light of the CFTC's Concept Release, and they foresee a parade of horrors if the Commission persists in reviewing its policies for OTC products, including the eventual loss of this huge and profitable line of business to London and other non-U.S. market centers. Finally, they see the Concept Release as something of a Trojan horse, a thinly disguised incursion into regulatory turf that properly lies beyond the Commission's domain.
These concerns, as eloquently propounded to you at last Friday's and this morning's hearings, are sincere in heart and firmly held. However, for the moment at least, I believe that the Concept Release is something more like a trial balloon than an invading army. I strongly doubt that this Commission is intent upon burdening the OTC markets with restrictive revisions to Parts 34 and 35 of its rules.
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There is no factual or experiential foundation for supporting a retreat from the exemptive relief, and the criteria for qualifying for that relief, which is already in place and widely relied upon. Instead, I prefer to see the CFTC's recent initiative as a precursor to a more, not necessarily less, permissive stance toward the OTC markets, perhaps foreshadowing rules that will, for example, allow multilateral swaps execution and settlement facilities, and exchange trading of swap-like instruments, including the equity swaps that Mr. Harris just referred to. If allowed, such new products and mechanisms would strengthen, not weaken, these markets. They would be welcomed adaptations to current market practices.
As for the suggestion that the Concept Release immediately imperils existing transactions by creating greater uncertainty over what is a futures contract, as a close observer of legal precedents and as a practicing advocate, I strongly doubt that as a legal matter any transaction has been any more endangered by the CFTC's Concept Release, even when it is coupled with Chairwoman Brooksley Born's ambiguous remarks about certain unspecified OTC transactions being futures.
In my experience, no right-thinking court should ever rely on such generalized regulatory observations as evidence that a specific transaction, hauled before the bar of justice, is an illegal futures contract and not a lawful OTC swap or option. Convincing authoritative legal analysis will always hinge on far finer points than the inconclusive Concept Release and Ms. Born's perhaps deliberately broad, Delphic expressions. Moreover, the CFTC's pronouncements have been offset by uniform dissents by Treasury and the Federal Reserve Board. So, for the moment, I don't think that the Concept Release as such has imperiled the markets.
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However, the fact that the CFTC's Concept Release created such a furious alarm and we are sitting here today discussing these important issues is symptomatic of the truly troublesome problem we really do face. Our regulatory system for financial instruments makes no sense.
We have constructed a crazy quilt of sometimes overlapping and sometimes disparate, but always conflicting regulatory schemes, each with an independent agency charged with its enforcement in the public interest.
Is it any wonder then that the CFTC, with a relatively new chair and senior staff and with the public's interests presumably in mind, should take an opportunity to essentially think about fine-tuning its rules for a rapidly growing centrally important market. Was it not this Congress that first ordered it to consider these OTC transactions for exemptive relief from its substance of rules? The surprisingly critical flaw revealed by the Concept Release is not that the CFTC has the Chutzpah to open a dialogue on a sensitive subject; rather it is the fear on the part of the OTC market that its products hang by the slenderest of threads.
And this is not an irrational anxiety. Our inherently flawed and tottering regulatory structure is laced with nonsensical distinctions and ambiguities. Futures are allocated to one side and equities to another and OTC swaps, who knows where. We leap into crisis footing at the least provocation precisely because the lines of distinction are so fine and arbitrary that the least change will resonant far beyond its immediate source.
The statutory and regulatory scheme for OTC and exchange-traded financial instruments was built on expedient and necessary compromises that on the whole made sense at the time. But times change. I am sure you have heard it a thousand times before, technology is changing everything. The explosive growth of the OTC markets must be seen as 21st century technology's triumphant outgrowth of 20th century regulatory schemes.
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As Chairman Greenspan referred to it this morning, the origin of the Commodity Exchange Act came out of agricultural protoplasm, not that which we have today in the financial markets. Given the speed of change today, it should come as no surprise that our system of regulating OTC and exchange-traded markets has become woefully outmoded in just 25 years. It is high time to reshape the regulatory system to accommodate the market's advancements, to lift the cloud of ambiguity and to provide unassailable safe harbors for innovative financial products.
While I do not necessarily endorse all of its features, H.R.4062's establishment of a working group on financial derivatives would mandate a process of regulatory coordination that is overdue. Hopefully, concrete legislative remedies that have a broad consensus will emerge from that process and be enacted into law. If the CFTC's Concept Release ultimately precipitates such an initiative, I believe it will have served its ultimate purpose, a central regulatory process will have been brought up to date with market practices.
In conclusion, I would note that ten years ago, following the 1987 market crash, the Brady Commission comprised of a handful of market-savvy traders, academics and lawyers promulgated its far-reaching and in many ways prescient report in 64 days. It was the original inspiration for such present market fixtures as speedier trade settlements, more unified trade clearing, cross-market circuit breakers and improved cross-market surveillance.
But the overall conclusion of that report was that the convergence of the stock, OTC and futures markets mandated a fundamental reassessment of how these markets are to be regulated and by whom. That process is not yet complete, but the need is no less apparent today than it was then.
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Thank you, Mr. Chairman.
[The prepared statement of Richard A. Miller can be found on page 422 in the appendix.]
Chairman LEACH. Thank you, Mr. Miller. And I appreciate all of your excellent testimony.
Let me just lead with a query of how you perceive the Born letter today. I want to ask you, Mr. Brosnan, is this a significant new way of repeating an old position? How would you characterize it?
Mr. BROSNAN. Like everyone else, I just received it this morning. It very much looks like an old position. My initial reaction to reading the letter is that there is no change to the legal uncertainty issues. Under Secretary Hawke spoke earlier about the illusory nature of the timeframe that is mentioned here. And in the very last paragraph, the letter again revisits the issue of the jurisdiction of off-exchange futures without providing any guidance or clarity as to what might be captured in there.
I believe that we continue to be at risk from business being lost at the margin because of this legal uncertainty. I think some of the discussion that took place this morning was, you know, where is the gap in pricing, things like that.
I think what is really happening out in the marketplace, as I discuss things with bankers, is that business at the margin just isn't being done or new things that are being contemplated to be offered to the United States are in fact going to be offered in London, which is a major financial center, if not outright the largest in the world. And that is where this trend will continue to go until there is greater certainty.
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So I look at business over the medium and longer term to shift out, but you probably won't see a major gap in the short run from this.
Chairman LEACH. Thank you.
Mr. Ryder.
Mr. RYDER. Mr. Chairman, I agree with Mr. Brosnan, it is hard to see how this letter removes the cloud of uncertainty that has been raised by the CFTC's issuance of the Concept Release paper on the question of the over-the-counter derivatives market.
Chairman LEACH. Mr. Jones.
Mr. JONES. I agree generally with the same. To the extent there is uncertainty in the market at this stage, I don't see how this eliminates the uncertainty.
Chairman LEACH. Mr. Harris.
Mr. HARRIS. Far from removing the uncertainty, this continues the existing uncertainty. And I don't see how this helps at all. I think any organization that is moving transactions offshore or is slowing down the number of new transactions will continue to do so as a result of this letter. This won't give them any comfort whatsoever.
Chairman LEACH. Mr. Miller.
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Mr. MILLER. I will make it unanimous. I don't think it has changed the situation at all. In fact, I think it is a politically adroit move on the Chairman's part or the commission's part. So I think it gets points for that, but as a practical matter, agreeing to stand still until January is about the same thing as my agreeing not to run a 4-minute mile. They couldn't enact anything between now and then anyway, so they have kind of agreed to just maintain the status quo and in the same timetable.
Chairman LEACH. Let me raise the subject of fraud for a second. There is some presumption that only the CFTC has a fraud mandate. Isn't it true that each of the regulatory bodies looks at this sort of thing, and isn't it also true that from the banking industry's perspective you have a tougher standard; that is, that you can stop a practice not only if it may be against a regulation or a law, but if it, for example, undercuts the reputation of the bank?
Is that not valid, Mr. Brosnan?
Mr. BROSNAN. Chairman Leach, that is very valid. Fraud or intentional misrepresentation to clients is not a way to maintain yourself as a banker or a bank with a solid reputation over a long period of time. That is just a bare minimum thing that you just can't do to be in business, particularly the derivatives business.
The standards that we have applied on banks represent a significant hurdle. There is a high bar there for all the right reasons though.
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We expect banks to know how a transaction fits in with its client and the financial consequences of that for all transactions, not just transactions that are recommended to the client as would be under the suitability rule. We do that because we believe it is important that the bank get paid back on monies that might be owed to it, and the bank might also get paid back in other transactions that they have with that same client.
Going down that same path, a bank that does its business well and serves its customer well and knows its client and provides successful risk management solutions most likely has a good reputation with that client, has a long-term relationship and a viable revenue stream. Banks that don't do that or participants in the market that don't do that are likely to develop a poor reputation and be forced out of the business rather quickly.
In order to comply with the standards that we have set out in Banking Circular 277 and that we have implemented with some vigor over the past five years, banks have to jump through several hurdles to get there. There is not an easy checklist that they can follow or a simple disclosure that they can hand out.
In practice, the major dealer banks have had to set up extensive internal control mechanisms that range from a series of progressive approvals as a contract gets to be more complex, as well as a series of reviewing approvals as a client becomes progressively less sophisticated; so the more complex the contract or the less sophisticated the client, the more review and approval is required, and so those matrixes are quite extensive.
I don't know of other entities outside of the commercial banks in the United States who have to go through this type of thing, but we require it because of the importance of banks to the country, to the payment systems, to the FDIC insurance fund. This is an increasingly important business for them, so if they are going to stay in it, they need to do it well.
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And we are not tolerant of noncompliance there. So fraud is, at a bare minimum, not tolerated. We are expecting a lot more.
Chairman LEACH. Thank you.
Mr. Ryder.
Mr. RYDER. Well, Mr. Chairman, as I indicated, our thrifts are simply end-users. They are not dealers. What we do require of our thrifts is, if they choose to use derivatives to hedge their interest rate risk, that they understand the risks that they are undertaking, and as I indicated, that they are able to evaluate those risks relative to their entire portfolio.
This means that the institutions have to have some kind of internal modeling capability, and they have to have staff who are familiar with using those models to evaluate that kind of an effort.
Chairman LEACH. Thank you.
Mr. Jones.
Mr. JONES. Mr. Chairman, similar to Mr. Ryder, the banks that we supervise are end-users as opposed to dealers. But we have guidance, very similar to what Mr. Ryder mentioned, that the board and senior management of the banks are responsible for managing the risk irrespective of the dealers' responsibility and the focus is on one of the end-users' side as opposed to the dealer side.
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Chairman LEACH. Thank you.
Mr. Harris.
Mr. HARRIS. I will answer the question maybe a little differently, since I am no longer a regulator. It seems to me that fraud and manipulation have not been a significant part of the OTC derivatives market. When we think of the fraud that has taken place, we can all come up with one name, but we are hard-pressed to think of another.
In fact, these are very sophisticated wholesale markets, and the markets themselves are very unforgiving; and possibly the market and the market participants are less forgiving than even regulators are.
And so fraud has not had much of a place in this market. It has not occurred generally. It has occurred primarily with respect to one institution and that one institution's clients.
And manipulation has hardly occurred at all. In fact, one has to wonder—this, I think, is one of the reasons that people have questioned the release of the Concept Release—exactly what problems in the market caused the CFTC to decide that this release needed to be issued, certainly not ongoing fraud, certainly not ongoing manipulation in this market.
Chairman LEACH. Thank you.
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Mr. Miller.
Mr. MILLER. I would take a slightly different approach from my colleagues up here.
If I take your question to mean, how does the fraud powers, the CFTC play into H.R. 4062, I would echo Chairman Born's observations this morning, that I don't think anything should be done to tie the hands of the commission with respect to its enforcement powers and its powers to bring antifraud actions in the marketplace. Even with respect——
Chairman LEACH. If I can interrupt you there, I mean, we have taken a lot of this into consideration; we have a revised document that makes that very clear, that we don't. And so I don't think that is a problem.
Mr. MILLER. Candidly, I have not had a chance to review the revised H.R. 4062. But I am grateful that is not the case then. That is all I can say on it.
Chairman LEACH. Do all of you agree with the possibility that if a sledgehammer drops, the derivatives business moves overseas, or is that something that wouldn't occur; that is, if you have regulation that is substantially more constrained than in other markets, that the business would simply shift?
Mr. HARRIS. I think that absolutely will be the case. We have seen it before. Several years back when the CFTC issued an advance notice of proposed rulemaking the business did go offshore. I was at JPMorgan at the time, and we saw our business move offshore.
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We saw more complicated, innovative transactions being done out of the London office rather than the New York office. I think it certainly will be the case. And I think this is part of a bigger point I was trying to make earlier, that this market that we keep talking about, the derivatives markets it is not a U.S. market, it is an international and global market; the business can be done anywhere. The business can be done anywhere by U.S. companies, JPMorgan or Citibank can do the deal in Tokyo if they want to, or New York or Frankfurt.
So if we create an environment here that is hostile to the development of new products, the business will go offshore. Some of it still may be done by U.S. market participants, but it won't be done here.
Mr. MILLER. Mr. Chairman, if I may, and this goes back to something I said in my prepared remarks. I think to some extent we are whistling by the graveyard on this issue of the ambiguity that drives the business offshore. It doesn't begin or end with the CFTC; the problems are more fundamental than that.
The problem is, what is a futures contract? What is a board of trade? The fundamental ambiguities that exist. You could pass H.R. 4062, but a court tomorrow in some case that may be filed today could rule that these instruments are unlawful, off-exchange futures contracts, and it's the same problem; because the way the statute is constructed, using statutory interpretation, and the same problem that we are discussing here today will arise again, and the business may flee overseas.
The cure is not simply H.R. 4062 and freezing the CFTC; it is addressing the fundamental flaws in the statutory scheme and how we define these instruments.
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Chairman LEACH. You have got two issues here; one is how you define instruments, second is how you define regulation. Do you think the regulatory framework is appropriate today or there ought to be adjustments in it?
Mr. MILLER. I think this regulatory division between the CFTC and the SEC and the banking community, I am not sure how to solve it, but I know it is not working and you know it is not working. We all know it is not working. We have spent days, years. We have killed trees with the amount of paper that we have spent on this.
And it is not efficient. I mean, I think everyone would have to concede there are better things to do than to spend so much energy and time arguing over these very narrow distinctions when there is certainly more important business before this committee.
Chairman LEACH. Well, it has always struck me that the far bigger issue is the definition of a product, and the lesser issue is who regulates. But by the same token, who regulates can affect the other; you can have an interplay and maybe, as time goes on, Congress ought to think that through.
Do you think that regulators ought to be consolidated in any way or do you think that there is a case for groups of regulators? Is there a role for something like a working group and then keeping the same framework, or do you think there is an argument for consolidating the framework itself?
Mr. MILLER. I have thought about this, and I don't have an answer for you, Mr. Chairman. I wish I did. The flip side of regulatory arbitrage is regulatory competitiveness. Had it been left up to the SEC, many products that were successful, wonderful financial innovations would not have occurred. And I don't know how you remedy that; it may take some thinking that can be done, you know, in the confines of a working group or in a more expansive way.
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We are at the end of a millennium and a century, maybe we have to come up with something different that we haven't even thought about today on how we approach regulation of a market. I know one thing, I know that this market is very divided. There is a retail side of things, and there is an interbank, sophisticated side of things. And if there is a problem here, it is that the CFTC is grappling with all the time. It is how you divide those between the two, and maybe that is the line we have got to follow and come up with a new way of regulating between retail on the one hand and nonretail institution on the other and, you know, if we follow that line.
But how you divide that up, whether it means a merger of agencies or maybe a new agency or a different working group, I am not sure. But somebody has got to start doing this or we are just going to be back here again in another 6, 10 months arguing over the same thing again.
Chairman LEACH. Does the British model of a single regulator have any appeal to anyone, moving toward a single regulator?
Mr. MILLER. There they have one regulator, but under that roof are many different pockets of regulation, and I am not sure how they resolve all of their differences.
To some extent, we have that here, too, and it is that intramural fighting that constantly occurs that brings us back.
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Chairman LEACH. Mr. Harris, would you like to comment on any of these questions?
Mr. HARRIS. I think Richard has made a great point here that the real distinction in the market these days is between the retail sector and the wholesale sector, but that is not how we are divided up on a regulatory basis. We are divided according to regulation of product, the regulation of entity. And the distinctions that we have between the regulatory agencies—between the bank regulation, the OCC and the Fed on one hand, and the SEC on the other, and the CFTC on the other, have nothing at all to do with the way we really look at the market and the way the markets divide themselves. And that is part of the problem.
If we were trying to develop a regulatory scheme from scratch right now, no one in this room would ever imagine that we would have come up with those four different regulatory agencies. But the fact is that the political reality is, we have them, and that is not going to change. So the best we can do is an organization like the President's Working Group on Financial Markets that does attempt to achieve a certain amount of coordination in the way we regulate, and maybe more importantly, how we supervise markets. Possibly the big mistake we are making with respect to the OTC derivatives markets is in thinking that it needs to be regulated, maybe what it needs is supervision.
Chairman LEACH. In conclusion, let me just give any of you three the chance to comment on these questions.
Mr. Ryder, do you think it ought to be concentrated in the OTC; is that the answer? I meant that facetiously.
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Mr. RYDER. No, no. Obviously, the issue of regulatory consolidation has been debated for quite some time. I would think the more important issue is the one Chairman Greenspan raised earlier this morning, which is, it really doesn't matter who regulates; the real question is, what is it you want to regulate and why do you want it regulated.
The efficiency of the regulatory apparatus, I think is clearly a secondary issue to the question of what kind of regulation.
Chairman LEACH. Who makes that decision?
Mr. RYDER. Mr. Chairman, I think, as Chairman Greenspan said, that is a decision that the Congress is charged with making.
Chairman LEACH. Mr. Brosnan, do you want to comment?
Mr. BROSNAN. Mr. Chairman, I don't know if I am missing something, but I will—my belief is that the regulatory scheme that we have now is not broken.
I don't think that the issue is that things are uncovered; I think the issue is, is there going to be duplicative or triple coverage in various things? I see the issue as being uncertainty.
To the extent that there is uncertainty, then dealers will move offshore; and not only will they move offshore, they will then, by definition, be restricted from doing business with entities in the United States. So that is one option.
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The other option is, if you do impose certainty and however that turns out, if it is good, bad or in the middle, it will impose a defined cost on entities here in the United States. If those costs are not competitive, as Mr. Harris said, the customers will seek products from entities in Canada or Mexico, Europe, or wherever it is they provide the most efficient, flexible product.
So I don't think that things are uncovered out there. I don't know where the gaps are where entities are out there conducting transactions that don't have appropriate supervision or if customers are harmed where they don't have remedies for redress against someone who does a fraudulent transaction or something that is improper.
Chairman LEACH. Thank you.
Mr. Jones.
Mr. JONES. Mr. Chairman, we agree more along the lines contained in H.R. 4062, that the area needs careful study. But I am afraid at this time I have no recommendations or solutions for you.
Chairman LEACH. Good.
Let me thank you all of you for your thoughtful testimony. We appreciate your help.
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The hearing is adjourned.
[Whereupon, at 3:58 p.m., the hearing was adjourned.]
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