customized, i think that beyond that, which ms. shapiro talked about, i think it will be appropriate to have higher capital, higher margin standards for that dealer. you mentioned a letter earlier from caterpillar. i think they could absolutely customize and make sure that they hedge their risk. but if their risk is a little different not that stashed, it's probably almost the same capital. bit if their risk is really quite different, then it's hard to value that risk, and then the dealer on the other side might have to put up even more capital. but risk, if i might say, is risk, and if it's really highly standardized, we want to make sure the dealers have enough cushion in tough markets. enough cushion and tough markets. >> so are we saying or inability to standardize the risk means the risk is higher?

>> generally in markets it does mean that. that's not always the case but if you can't standardized product but if you see other people trading in that product the risk is been harder to unwind, it's not a technical term but so if the commercial enterprise wants to enter into a transaction it probably means ten or 20 or hundreds of the other parties that want to either speculate on that risk or hedge the risk. the more difficulty is when there is no other party on the other side and frankly that's also the problem in crisis when there's no other party to take the other side. >> knees white? >> the board believes there is value in the stand prez products but it recognizes there are challenges managing the risk associated with the nonstandard list products both from the standpoint of the firms and from the standpoint of the supervisors. clearly improvements need to be

made and the projects are already underway and the supervisory community value waiting for example the appropriateness of the capitol standard associated to make sure dimond standardized products, the capitol charges attached fully reflect the risk of the products. >> thank you. >> thank you. senator johanns? >> chairman gensler, let me follow up on some things that senator crapo was asking and i will be very blunt. your testimony worries me. if i have a very standardized product it's going to go through the system lightning speed, we are going to know exactly what the rules or, but if i have a little bit or maybe even significantly different product it's going to hit a barrier because you're going to have to analyze the risk. some bureaucracy is going to have to shake it and make it and

figure it out and discuss it and then somebody is going to have to say it's now standardized and therefore it has got to be xy and see in terms of the cattle requirement. isn't that what kind of you are getting at? >> senator, i appreciate your concerns. what we are recommending is clear rules of the road would be put out. the regulators best at setting capital which is most likely for the steelers is going to be either back or other provincial in some cases the securities and exchange commission possibly systemic regulator so those capital standards set the role and would be set out for customized standardized products as well. so i wouldn't in addition a trade by trade circumstance or contract by contract. >> but the nature of this system and a reason why you got some legs underneath that is because

it was so adaptable at the end it had its downside and then you add stupidity and greed and they really went south. but as senator draper and shareholders could benefit from this process and it seems to me if you run into anything that isn't standardized you run into the bureaucracy. >> i appreciate your concern and share your concern but i think for a clearer rules of the road the regulators can lay out what capital margin is appropriate for the customized products. on eight do believe we benefit as an economy and society that commercial enterprises can hedge the risks they are faced with and focus on producing a product or a surface for the public and hedge risk. that is with the cftc has been overseeing for decades and agriculture and energy financial

markets. i think we have to promote that but at the same time recognize if it's not standardized it might be appropriate to have a little higher margin and how your capital but said again by public process those rules are set and then you don't have to come in and check each contract. >> okay what if i am a competitor and you've gone through your process however long it takes and have set the capitol requirements and i want to challenge that and appealing because i think the capitol requirements are too low why have the benefit to do that? can i slow the process down even further? >> i think it might not be the cftc but it will be the federal reserve or the sec said in capital in this regime but just as there is capital standards in the full oversight iowa -- i

defer. >> is to analyze the risk of our doing business with each other and to demand collateral against the position we are creating some much of that and now the system would be required here is analysis that i think the dealers are very comfortable doing. the difference would be there would be government oversight but i don't think we will have the capacity to second-guess every transaction whether there is was analyzed appropriately but we would expect the firms to stress test of their models and ensure the risk-management procedures are first class. .. it will help them determine the appropriate level of capital to hold against those positions or potential appropriate level of collateral or margin to see with respect to each transaction. >> i'm running out of time. we never have enough time. it's a complicated area, but

let me ask this question. as a.i.g. was ramping up its exposure in risk, and hindsight is always 20/20, and we can look back and say, boy, that was really dumb, what about your system would have stopped that? would your system have kicked in at some point and you would call the c.e.o. of a.i.g. and say, whoa, you're at $200 billion or whatever, you're done, you're out of the marketplace, you can't do this anymore. would we have stopped a.i.g.? >> senator, it's always part of hindsight, but i think that a number of features here would have slowed down and maybe even stopped. a.i.g. put on an enormous book of business without putting aside capital or margin. and what happened just last fall, when the rating agencies

downgraded a.i.g., all the sudden they had to post significant collateral. i think it was over $30 billion within a day or two. ave had to have done that across the daily basis. it is a harsh discipline, i know, one that i learned when i was in the investment banking business but one i think it an important one, is to value on a daily basis or weekly basis the risks that a firm mass -- has and put aside capital and margin and aig wasn't doing that. >> senator johanns we're doing another round this is a complex topic and we're fortunate to have the chairmen and chairman and miss white from the federal reserve. let me just ask one question. we're engaged in a very

complicated regulatory reform process, which is going to touch many, many different areas. so i would ask you to just tell us, what do you believe the two or three most important legislative changes we have to enact, given the fear that it's going to be so big and so broad that every detail will be considered but we need to know what you think the most importantódáies are in terms of legislative changes, and chairman you seem poised to answer. >> i was poised to let chair shapiro answer first. it's a very appropriate question and it's hard when one's president lays out a bold agenda and i think it's a bold agenda that president obama laid out. i think it's incumbent upon all of us to address this over-the-counter derivatives.

so one of them is absolutely over-the-counter derivatives and i would say protecting consumers. the whole approach to having a strong, vigorous, oversight of the mortgage -- i think the mortgage sales practices in this country failed, failed terribly, all the way through the process of mortgage securitization but i would say the second big one for me -- there's others -- the consumer side. >> i should be more specific. within the context of regulating over-the-counter derivatives or the derivatives market, any specifics? >> it's hard to bring -- break it done. if we're not able to fully regulate the dealers we bill not give the public the comfort they need. if we just did central clearing, which is a very good idea, and

even if we mandate it women by -- we will have not covered the legitimate turn. >> let me turn to chairman shapiro. will there be a definitional debate about who is the cftc dealer and who is an sec deal center because there's agreement that the dealers have to be regulated. >> i would agree with that and actually i could go so far as to say if we don't regular late the dealers we will realize the concern that there's not really any reason to go with standardized -- because with anonymity my continue to engage in otc derivatives through a dealer that we cannot adequately examine and inspect. i think that to the extent there are disagreements between the sec and the -- first of all most dealers were deregulate by the

bank regular laters, frankly, and certainly if the administration is going to create a systemic risk deregulator, that regulator is likely regulate in addition to the regulation. >> my portfolio is much narrower. we really do think it's important to move on these trade information warehouses so we have the data for all the contracts, nonstandardized as well as standardeesed. >> thank you very much. >> for the chairman of the sec, can and should the security and exchange commission require all reporting companies to disclose counterparties and reference entitieses and assets in their

derivative portfolios? >> require public disclosure? if they are -- their relationships are material and they have material contracts with counterparties they should be disclosed at the risk of saying something incorrect here -- in their public filing of their material to the -- >> i'm talking about -- you're talking about someone to regulate these people. i'm talking about -- >> for example, if boeing were to enter into a customized -- >> or even -- yes, customized one. >> if they were regularly engaged in the market they should should be regulated but otherwise our view would be we could get at the information through the dealers' requirement to keep records about counterparties and audit trail

of the transaction, all of the at the terms of rev lens. >> in other words, i've asking about any entities. >> other than just dealers. >> that's correct. >> i believe that we simply could get the information through access to all the dealer information about who they were -- >> are there worries about people slipping through. >> i share that concern with you. to the extent that anyone did not have a dealer at their counterparty so a boeing or another commercial company, and they were engaged in this market with any frequency at all we could get at that directly but we could get the information very clearly through the regulation hoff the dealer and access to the complete books and record of the dealer where they would show they were and, of course, if the information is in a trade, where trade information warehouse or the transaction is done through a central counterparty, we would have access to the information in that method -- in that way as

well. >> here's one for all of you. how do we prevent a clearinghouse or an exchange from being too big to fail? and should they have access to fed borrowing? >> senator, i think that we actually already have a number of clearinghouses that have been very successfully regulated for decades in the securities, options, and futures markets. but if they were to fail -- and they've been successfully regulated -- they're systemically relevant already. we're hoping that we would have large clearinghouses for derivatives, so knowing all would be somewhat systemically relevant, and we, as you say, will need to sort of address this in statute as to that possible --

>> tell me how. >> well, i think that they should be regulated as they have been for decades by the principal -- the clearhouses and exchanges be regulated by the principal market regulators, as each of our agencies have for decades, and the derivative regulation should embody that similarly. they should be regulated for risk management, making sure they have capital and margining and various practices on how they net the contracts and also regulation about their clearing members. but at the same time, recognizing there may be something for the systemic regulators' interest to make sure that if they're going to be called upon in an extreme case to lend money, that they also have some authorities in addition to those of the principal regulators. dn't rule out the federal reserve as being a source they could go to in case of emergency? >> well, i think that it has

never happened -- >> no -- >> but we can't rule it out and it's one of the lessons of this crisis, we have to make sure that our statutes are up to date so that in an extreme -- >> that's what we're trying to go through. >> i'm agreeing with you, senator. >> don't have much to add to that. the securities clearinghouses did work very well in the last year under extraordinary circumstances but the last year taught us that anything can happen that we haven't anticipated historically, real key for clearinghouses will be robust risk management, that they are well capitalized, effective oversight and vigilance from regulatears, whether it's the fed as a backstop regulator or the functional regulators, the sec and the cftc. it will be important for them to have conservative margin requirements and procedures that

are well-understood, transparent for how they resolve the default of a participant in the clearinghouse. >> would you like to comment in any way? >> the board believes that ccps are critical utilities in the financial markets and we think they need to be regulated and have risk management that would ensure that they carry out their functions in a sound manner. they are as you pointed out subject to the possibility of meeting liquidity in extreme situations. the administration has proposed broad 'king the fed's ability to provide liquidity in extreme situations and the board supports that. >> thank you very much. >> senator johanns. >> thank you, mr. chairman. one of the observations at least that i have made as i went back over the last months is it seems to me that big got bigger, they

got more tangled up in some many parts of the economy, very, very bad decisions were made, and you're off to the races, and then the taxpayer was asked -- or told as in general motors' case that, guess what, they bailed them out. if your adding more regulation, capital requirements, transparency, somebody is going to have to comply with that within the dealers' organization. and there's going to be a cost to that. where in your judgment will the cost of that be borne? somebody has to pay for it. if it's the airline industry and they're hedging against the rising cost of fuel for their jets, won't consumers pay for that in higher ticket prices?

>> i will take a stab at that. the cost of regulation clearly will ultimately be borne by consumers and that's just a given historically and going forward. it would be my fervent hope that the cost of regulation going forward would pail in compare son to what we have now but we have to be sensitive though cost of requirements we end up promoting -- >> chairman, i'm not debating that. i think some response to this is absolutely necessary. i'm one of the people screaming about general motors, i thought it was a very bad decision to buy the company. but having said that, we now own it. i would hate to think that we're not doing something here that will protect taxpayers in the future. so, that's not even really a debating point. one of the things i found out as

secretary of agriculture, once you try to do these overarching regulations and press those down upon the agricultural system, the large operators who had access to capital, et cetera, they tended to survive and get bigger because they needed to get big tore pay the cost of the -- bigger to pay the cost of the regulation. the small operators went out of business. they just could not endure what you were asking them to endure. and over time you ended up with exactly what we're trying to deal with here, is the big got bigger. >> right. i completely agree with that. we have to be sensitive to costs going forward. one of the segments of our financial services industry that tellly weathered the past year reasonably well were smaller and medium-sized financial institutions, and so i think it's -- and which shows to me that the diversity of financial institutions in this country is

important to safety and soundness feature in and of itself, and i think it's going to be very important for the regular laters as we create a new regulatory structure of congress to be sensitive to cost particularly those borne by smaller and made yum sized businesses who are very important to access to financial services for americans who will not be going to the largest dealers. >> if i might, senator, i'm actually quite the optimist at this table. i believe for small firms that this will actually lower costs of doing the standard products, and most small firms hedging in interest rate risk or maybe shipping product to europe and want to hedge a currency risk, they don't have transparency right now and even a few basis points which it .01 of 1%, i think lending greater transparency to these markets will benefit the many thousands of small businesses and

municipalities in this country, particularly on the standard product. >> the transparency is not the issue. you can bring up the transparency and i think everybody would love that. the issue is what they have to deal with every day to try to get their transaction done. and i will just tell you, having worked with overarching regulations, i think in the end you hammer the little guy. it just seems to me that the little guy is going look at this and say, i can't make it. i don't have enough where i can pass it on to the consumer, just like the person with 100 cows today is struggling to survive and i just worry that what you're doing here is, if -- unless you do something in that area, you're going to put the little guys out of business. >> i think that you raise a very important point, and as we work together on this regulation and

legislation, i look forward to talking more, but i think they will also greatly benefit by lowering some of the risk and increasing transparency in these markets. >> thank you, mr. chairman. >> thank you very much. thank you for your excellent testimony. there may be additional questions that will be submitted to you for the record and ask you [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2009]

yu, the allen finances chairs at the university of texas school of law. his research centers on corporate governance and financial innovation. his article showed how financial institutions may make big mistakes. his work on the decoupling of debts has attracted a lot of attention including the current issue of the economyis. welcome. our next witness is mr. ken neglect c. griffen. head of citadel.

they operate in major financial centers including london, chicago, hong kong, and san francisco. serves as vice-chairman of the chicago public education fund. our next witness is robert pickle. the executive director and chief executive officer of the international swaps and derivative associations the global trade association for over-the-counter derivatives. previously he was the general counsel of isda since 1997. prior to joining isda he was in the legal department of an international oil and gas company from 1919 to 1997 -- 1991 do 1997. our fourth witness is christopher whalen, but mr. whalen is a proud resident of hudson, new york. they provide consulting services

for audit tore, regular laters and he consults with global companies on a variety of financial and regulatory issues and the regional director of the professional risk managers international association and is a board adviser to a global business security risk in asia. -- huh, hu, would you please begin. >> mr. chairman and distinguished members, thank you for this opportunity. i teach at the university of texas law school and my testimony reflects my view as an academic. i agreed to be working at the securities & exchange commission. i emphasize that i'm currently a full-time academic, have been so for over two decades and after this forthcoming government service will return to my normal academic duties but i will say tied does not reflect the views

of the sec and has not been discussed with or reviewed by the sec. i ask that my written testimony be include in the record. this is a seminal time for the regulation of over-the-counter derivatives. my understanding is that the subcommittee want met to off a broad perspective as to undertaking this staff instead of analyzing specific elements of the president wednesday proposal. almost from the beginning of the otc derivatives market in the late 1970s who you're arching vision have -- one is science run amok in the face of relentless competition, big financial institutions have hired financial scientists to develop now financial bugs, operating in an international whole sale market open to corporate and a paradise hiding

from public view. the scientists relied on computers and models laden with incomprehensive greek letters, but danger lurks. absent these financial created, evolved and mutate exotic risk arise. they have caused havoc in the regional market in economies worldwide. this first vision focuses on the chaos that is presumed to result from the innovational so the chaos could be at the lovely of the entire financial system, so that what motivated, of course, the federal reserve's intervention in 1998 was long-term capital management -- well, perhaps they should have called it something else -- or in terms of the intervention in 2008 as to