S. HRG. 111–248 OVER-THE-COUNTER DERIVATIVES: MODERNIZING OVERSIGHT TO INCREASE TRANSPARENCY AND REDUCE RISKS HEARING BEFORE THE SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT OF THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION ON MODERNIZING THE REGULATION OF THE OVER-THE-COUNTER DERIVA- TIVES MARKETS AND THE INSTITUTIONS THAT PARTICIPATE IN THESE MARKETS JUNE 22, 2009 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html U.S. GOVERNMENT PRINTING OFFICE 54–589 PDF WASHINGTON : 2010 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS CHRISTOPHER J. DODD, Connecticut, Chairman TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama JACK REED, Rhode Island ROBERT F. BENNETT, Utah CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky EVAN BAYH, Indiana MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee SHERROD BROWN, Ohio JIM DEMINT, South Carolina JON TESTER, Montana DAVID VITTER, Louisiana HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas JEFF MERKLEY, Oregon MICHAEL F. BENNET, Colorado EDWARD SILVERMAN, Staff Director WILLIAM D. DUHNKE, Republican Staff Director DAWN RATLIFF, Chief Clerk DEVIN HARTLEY, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT JACK REED, Rhode Island, Chairman JIM BUNNING, Kentucky, Ranking Republican Member TIM JOHNSON, South Dakota MEL MARTINEZ, Florida CHARLES E. SCHUMER, New York ROBERT F. BENNETT, Utah EVAN BAYH, Indiana MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey DAVID VITTER, Louisiana DANIEL K. AKAKA, Hawaii MIKE JOHANNS, Nebraska SHERROD BROWN, Ohio BOB CORKER, Tennessee MARK R. WARNER, Virginia MICHAEL F. BENNET, Colorado CHRISTOPHER J. DODD, Connecticut KARA M. STEIN, Subcommittee Staff Director WILLIAM H. HENDERSON, Republican Subcommittee Staff Director LAYTH ELHASSANI, Legislative Assistant GREGG RICHARD, Republican Legislative Assistant SARAH NOVASCONE, Republican Legislative Assistant (II) CONTENTS MONDAY, JUNE 22, 2009 Page Opening statement of Chairman Reed ................................................................... 1 Opening statements, comments, or prepared statements of: Senator Bunning ............................................................................................... 2 Senator Crapo ................................................................................................... 3 Prepared statement ................................................................................... 43 WITNESSES Mary L. Schapiro, Chairman, Securities and Exchange Commission ................. 5 Prepared statement .......................................................................................... 44 Responses to written questions of: Chairman Reed .......................................................................................... 88 Senator Schumer ....................................................................................... 93 Senator Bunning ....................................................................................... 96 Gary Gensler, Chairman, Commodity Futures Trading Commission ................. 7 Prepared statement .......................................................................................... 51 Responses to written questions of: Chairman Reed .......................................................................................... 105 Senator Schumer ....................................................................................... 107 Senator Bunning ....................................................................................... 108 Patricia White, Associate Director, Division of Research and Statistics, Board of Governors of the Federal Reserve System ..................................................... 8 Prepared statement .......................................................................................... 56 Responses to written questions of: Chairman Reed .......................................................................................... 110 Senator Schumer ....................................................................................... 114 Senator Bunning ....................................................................................... 115 Henry T. C. Hu, Allan Shivers Chair in the Law of Banking and Finance, University of Texas Law School .......................................................................... 25 Prepared statement .......................................................................................... 58 Responses to written questions of: Chairman Reed .......................................................................................... 117 Senator Bunning ....................................................................................... 119 Kenneth C. Griffin, Founder, President, and Chief Executive Officer, Citadel Investment Group, L.L.C. .................................................................................... 27 Prepared statement .......................................................................................... 64 Responses to written questions of: Chairman Reed .......................................................................................... 121 Senator Bunning ....................................................................................... 127 Robert G. Pickel, Executive Director and Chief Executive Officer, International Swaps and Derivatives Association, Inc. .................................... 29 Prepared statement .......................................................................................... 66 Responses to written questions of: Chairman Reed .......................................................................................... 140 Senator Bunning ....................................................................................... 145 Christopher Whalen, Managing Director, Institutional Risk Analytics .............. 31 Prepared statement .......................................................................................... 69 Responses to written questions of: Chairman Reed .......................................................................................... 161 Senator Bunning ....................................................................................... 163 ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD Letters submitted by Senator Crapo ...................................................................... 172 (III) OVER-THE-COUNTER DERIVATIVES: MODERNIZING OVERSIGHT TO INCREASE TRANSPARENCY AND REDUCE RISKS MONDAY, JUNE 22, 2009 U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Subcommittee met at 3:03 p.m., in room SD–538, Dirksen Senate Office Building, Senator Jack Reed (Chairman of the Sub- committee) presiding. OPENING STATEMENT OF CHAIRMAN JACK REED Chairman REED. Let me call the hearing to order. I want to thank all of our witnesses for joining us this afternoon. I am par- ticularly happy to welcome back Chairman Schapiro. Thank you. And also I want to thank Chairman Gensler for asking to testify before us on the derivatives issue, which gives us a chance to talk directly to you about this issue which transcends several different agencies, and also Pat White from the Federal Reserve. Thank you. I also, obviously, want to recognize Chairman Harkin and his col- leagues on the Agriculture Committee for their longstanding work on derivatives issues, and I look forward to having both Commit- tees coordinate closely as we work to provide transparency and re- duce risk in the financial sector. This week, we find ourselves more focused than ever on the im- portant work of modernizing an outdated financial regulatory sys- tem. I have called this hearing to explore one of the key aspects of such reforms: to modernize the regulation of the over-the-counter derivatives markets and the institutions that participate in these markets. Both exchange-traded and over-the-counter markets have grown extremely rapidly over the past decade. Until the recent downturn of the economic markets, every category of derivatives saw almost a decade of extreme growth, in many cases more than tripling or quadrupling trading volumes. According to data compiled by the Congressional Research Service, between 2000 and 2008, the num- ber of financial futures contracts traded on exchanges rose by 425 percent, and the total notional amount of over-the-counter con- tracts outstanding rose by 522 percent over that period, rep- resenting trillions of dollars of trading. (1) 2 This afternoon’s hearing will focus in particular on over-the- counter derivative markets which today are subject to no direct regulation. One of the key questions we will examine is the extent to which existing and emerging derivatives markets should be sub- ject to regulatory oversight. Until recently, the prevailing presump- tion was that market discipline alone largely protected us from any potential risks we faced from OTC derivatives. But we received a wake-up call, having