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Jan:
Please print the attachments for me. Thanks, Mark ---------------------- Forwarded by Mark - ECT Legal Taylor/HOU/ECT on 12/21/98 09:15 AM --------------------------- Enron Capital & Trade Resources Corp. From: Jeffrey Keeler @ ENRON 12/18/98 10:55 AM To: Mark E Haedicke/HOU/ECT@ECT, Kevin P Hannon/HOU/ECT@ECT, Mark - ECT Legal Taylor/HOU/ECT@ECT, Cynthia Sandherr/Corp/Enron@Enron, Joe Hillings/Corp/Enron@Enron, Steven J Kean/HOU/EES@EES cc: Subject: Sen. Agriculture Hearing on OTC derivatives/CFTC The Senate Agriculture Committee on Wednesday, December 16 held a hearing on OTC Derivatives and the almost-demise of Long Term Capital Management (LTCM) hedge fund. Witnesses included: Panel One: CFTC Commissioners Brooksley Born, Chair John Tull Barbara Holum David Spears James Newsome Panel Two: Presidents Working Group on Financial Markets, Staff Roger Anderson, Treasury Patrick Parkinson, Fed Richard Lindsey, SEC Daniel Waldman, CFTC Panel Three: Former CFTC Chairs Susan Phillips Wendy Gramm William Albrecht Martin Mayer The only members of the Committee present were Chairman Richard Lugar (R-IN) and Ranking Member Tom Harkin (D-IA). Thad Cochran (R-MS) stayed only to make a brief opening statement. In his opening statement, Lugar announced that the Committee would hold hearings and "seminars" in 1999 on OTC Derivatives issues as part of Commodity Exchange Act re-authorization. Lugar also announced that he would be releasing a set of questions for the Committee to consider in advance of next year's hearing. (I will forward the questions as soon as I am able to obtain a copy from the Committee.) CFTC PANEL: 1) Chairperson Born - her testimony was essentially no different than what she's been saying since May when the Concept Release was published. She focused her testimony mostly on the LTCM meltdown and did not really speak to the issue of the appropriateness of derivatives regulation by the CFTC. She only continued to assert that the Concept Release raised necessary questions about the OTC market, and its issuance does not officially mean the CFTC will regulate, but was completely justified and did not cause legal uncertainty or risk in OTC markets. She said that the LTCM situation arose because of the use of derivatives in "highly speculative" activities. LTCM had excessive margin obligations to futures exchanges, derivatives positions of $1.25 trillion (1000 times its capital), and carried excessive debt. Born said that the Concept Release raises questions that go to the heart of the LTCM problem: lack of transparency, excessive leverage, and (most notably) the lack of controls and reporting requirements that allow firms to take positions that jeopardise markets and avoid appropriate regulation. She indicated a hope that the President's Working Group would complete its studies on OTC derivatives and on hedge funds early in 1999, and that the CFTC would work closely with other agencies toward that end. 2) Commissioner Tull - echoed Born's testimony, saying that the LTCM situation raises questions about transparency, leverage, over-lending, disclosure, and systemic risk. He said the Concept Release questions don't mean that regulation is required -- the responses will be important to the CFTC in dealing with situations like LTCM. 3) Commissioner Holum - indicated that the CFTC should definitely not act until the President's Working Group (PWG) completes its studies on derivatives and hedge funds AND until Congress has evaluated the results of those studies and considered the issue fully in CEA re-authorization hearings. She said CEA legislation is the appropriate forum for re-examination of OTC regulation. She added that regulators shouldn't be able to hide behind interpretations of static old regulation, regulations must evolve with the markets. Holum said the LTCM situation occurred due to excessive leverage, arising from a bad investment strategy and over-extension of credit by lenders. The CFTC should not jump to regulation because of one firm's poor management, this could drive business offshore. She also said that regulation of on-exchange markets should be examined along with OTC markets. 4) Commissioner Spears - said that while the Concept Release was purported to be a "fact-finding" exercise, it shouldn't have been done in a "vacuum" without participation from the rest of the PWG agencies. Congress should have a major role in the debate -- as such Spears and Commissioner Newsome have formally indicated that they will not vote for any new regulation until Congress has considered that matter, at least through September 1999. 5) Commissioner Newsome - he echoed Spears' remarks, saying that he wouldn't vote for any new regulation of OTC markets until Congress has fully considered the matter and the PWG has concluded its review and studies. (NOTE: I had a chance to talk to Commissioner Newsome after the hearing, and he indicated that he would like to take Mark Haedicke up on his offer to visit the Enron Trading Floor.) Questions and Answers: -- Lugar indicated that the CFTC had information about LTCM's problems well before the September collapse (this was reported in the Washington Post). He asked why they did not share this information with the PWG agencies or act sooner. Born responded that LTCM (as a Commodity Pooling Organization - CPO) filed audited financial statements and satisfied all reporting requirements in filing the information that the CFTC received before September. She said the commissioners never saw the information -- staff determined LTCM was OK at that point. She also said other agencies had some of the same information at the same time. -- Harkin asked the size of the OTC market -- his point being that it is unknown due to lack of transparency. All commissioners indicated they had no formal answer, but the guess was around $30 trillion. Harkin asked if there was double-counting going on based on the underlying assets on which derivatives are formed. Born responded that there is not even necessarily an underlying asset involved, but yes, there could be multiple-counting. Harkin's comment was that this seemed to him like a "pyramid scheme," and raises serious questions about safety and soundness. Harking then asked Born if imposing reporting requirements were within the CFTC's exemptive authority under the 1993 CEA? Born replied simply, yes. -- Lugar asked what expertise the CFTC has in analyzing the OTC market. Born indicated that CFTC economists and attorneys "try to keep up with" OTC developments, but don't devote a lot of resources in that area because they have made so many exemptions for the OTC market. PWG PANEL: Testimony of all witnesses focused mainly on the relevance of the LTCM collapse in their two studies on derivatives and hedge funds. They all indicated that the PWG was using a consensus process in their review -- no agency's view will be allowed to dominate the studies. They also stressed the importance of looking at OTC markets as international markets, and coordinating with international regulatory bodies. FORMER CFTC CHAIRS PANEL: 1) Susan Phillips - Said that financial derivatives are easier to regulate than commodity derivatives. (Note: She seemed to assume in her testimony that the main participants in OTC markets were banks and financial services firms) She said that the CEA gives the CFTC very broad authority to regulate, and Congress may want to take a fresh look at this. She also said that, in addition to greater market discipline, the best way to deal with "unregulated" participants in OTC markets would be more adequate disclosure requirements. 2) Wendy Gramm - was a superstar witness, advocating no further role for the CFTC or any other agency in OTC market regulation. She said that by the CFTC's merely asking questions in 1987, the commodity swap market moved overseas and did not return until the CFTC issued more friendly policy statement and clarifications. She introduced 2 articles into the record, one that focuses on the CFTC's creating legal uncertainty by asking questions about OTC markets, and another that says that regulators shouldn't use events such as LTCM to advance their own regulatory agenda. She said that any purported regulations need strict review by Congress and cost/benefit analysis. 3) William Albrecht - said there is no role for the CFTC in OTC markets. He said that the CFTC shouldn't use the LTCM situation to stretch its regulatory authority to hedge funds. He reluctantly proposed that the CFTC and SEC be merged, because functional regulation no longer appears to work well due to diversity of participants in the financial markets. 4) Martin Mayer - said the CFTC should re-assert its role in derivatives regulation due to the recent LTCM situation. He believes that any financial instrument that is a "bet" is a derivative - futures included. Questions and Answers: Chairman Lugar asked if OTC market regulation by the CFTC is appropriate. -- Phillips replied No, there may be a need for additional disclosure requirements, and may be an expanded role for the SEC in doing so. -- Gramm replied No, and there is no need for nay expanded regulation -- the authority should not move to another agency, institutional regulation is sufficient. -- Albrecht replied No, it is too complex and difficult to structure functional regulation of derivatives under the CEA. -- Mayer replied Yes. Attached to this document is the testimony of Senator Lugar and each witness, except Commissioner Tull and Daniel Waldman who did not submit testimony. (For Lotus Notes - double click on attachment and choose "Launch"; cc-mail, choose "Launch Attachment" from the attachments menu) If you have trouble opening these files, please let me know and I will have hard-copies sent to you by mail. Any questions, please call me at 202/466-9157. CFTC PANEL PWG PANEL FORMER CFTC CHAIRS PANEL
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