House Agriculture Committee Hearing - The Role of Credit Derivatives in the U.S. Economy

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REP. JERRY MORAN (R-KS): Mr. Chairman, thank you very much.

As I understand the testimony, that we have a general belief that these instruments need to be cleared. Is that true? There's no disagreement in regard to that?

MR. RADHAKRISHNAN: Yes, sir. There is no disagreement.

REP. MORAN: And then the question becomes, who's jurisdiction; and whether or not there is a security aspect that the SEC involves themselves once there is clearing in place?

I'd like to hear an explanation for why the SEC believes that these are securities when they behave much more like a commodity?

MR. SIRRI: Happy to answer that.

When these instruments are over-the-counter, they're securities- based swaps. And, under the CFME (sic) -- CFMA, they're explicitly excluded from the definition of security. Our authority only runs to anti-fraud, as we've discussed.

An important part of that determination is that these contracts, their material terms be subject to individual negotiation -- the key phrase is, "subject to individual negotiation." When these instruments come onto a central counterparty, and are novated to that central counterparty -- in other words, I give up this bilateral contract you and I struck; I give it to the central counterparty; and back comes, if you will, a standard, plain vanilla credit default swap. That's the form that that entity produces. That standardized credit default swap is no longer subject to individual negotiation.

More to the point, if, as some of these central counterparty proposals will be -- it will be the case for them, they will have appended onto them exchanges. Those exchanges, by definition, create standardized forms for trade. You don't negotiate the terms of the CDS on an exchange, you buy one or you don't. You're negotiating the -- the question is, the reference entity that you choose, the price and the quantity.

Because of those things, we believe they fall outside the exclusion in the CFMA, and they become securities, and our authority is triggered. But, more importantly than our authority being triggered, we have interests in the issues that are implicated.

REP. MORAN: This may be a -- let me first ask, are there those who disagree with that interpretation? Which I assume is directed at the CFTC.

MR. RADHAKRISHNAN: I will speak for myself, Congressman.

I think the statutory scheme is fairly clear, specifically Section 409 of FDICIA. And I believe what Congress decided in 2000 was that a clearinghouse for OTC derivatives can take various forms, and it is -- and the form that it takes dictates who the regulator is. And I defer to my friend on his interpretation of the securities laws, but I don't see how the very act of clearing changes the nature of the instrument.

In fact, I think it's clear that a lot of these instruments are already standardized to begin with when they trade. So, if something's already standardized, I don't know how clearing makes it even more standardized.

REP. MORAN: I certainly don't claim to be an expert, particularly at the law, in this regard; and would love to be -- have greater level of expertise, but just my common sense tells me that the act of clearing doesn't change the nature of the instrument. And so I'm confused by where the CFTC -- or, where the SEC reaches the conclusion that it reaches.

This may be -- what you just answered may answer my next question, which is, what's the belief by CME and ICE for applying for an exemption from the SEC? Is this the same theory, or they're just overly cautious? Do they believe that they need an exemption from the SEC, or do they just believe they want to avoid any question?

I don't know that you answer what their motivation is, but what's the basis for which the ICE and CME seek an exemption from the SEC?

MR. SIRRI: The exemptions that we're contemplating are four: There's an -- and it depends on the particular entity, but there's an exemption from registration as a clearing agency; there's an exemption from registration being a broker-dealer, if you deal in these instruments, or they -- (inaudible) -- securities; there's an exemption from registration as an exchange, if part of the package of what you're offering is an exchange; and there's a registration from the requirement that these be -- if they're securities, that they're offered as securities. So, there are four places that we believe we have to offer relief.

To the question of why they're coming to us -- which is what you really asked, I think, obviously, we believe that there are authority issues implicated, but more to that, if you were to ask them, I think that others believe that there's -- that it's a serious question, and were they not to come to us, then the status of those instruments would be sufficiently in question, that they wouldn't be successful financial products.

So I think it's important, regardless, I think, of where you come on the technical issue that's being discussed here. I think the provision of exemptions is important for success here.

REP. MORAN: Will this be resolved absent a court determination? And if so, what kind of time frame is the SEC and others on in resolving this legal dispute?

MR. SIRRI: I'm note sure I would characterize it as a dispute. I think we're very much of one mind of what we need to get done here -- I think. I can only speak for my chairman's instructions to me as a staff member, who said, I want you to facilitate this happening.

We decided that process-wise, the way we can get this done most quickly -- rather than registering as a clearing agency, registering as an exchange -- is to exempt them from those requirements, because we can do that quickly.

That's a process that we have in place. And I think all of us are roughly aiming to get this done sometime roughly the middle of December. I think that's what I understand our timeframe to be. I think that comports pretty well with what I understand the timetables of these counterparties to be.

REP. MORAN: I thank you very much.

Thank you, Mr. Chairman, for allowing me to go beyond my time.

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