[Senate Hearing 112-313]
[From the U.S. Government Printing Office]


                                                        S. Hrg. 112-313
 
      EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT 

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS


                             FIRST SESSION

                               ----------                              

                            NOVEMBER 3, 2011

                               ----------                              

         Available via the World Wide Web: http://www.fdsys.gov

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs






















      EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT




























                                                        S. Hrg. 112-313

      EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS


                             FIRST SESSION

                               __________

                            NOVEMBER 3, 2011

                               __________

         Available via the World Wide Web: http://www.fdsys.gov

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs

                               ----------
                         U.S. GOVERNMENT PRINTING OFFICE 

72-487 PDF                       WASHINGTON : 2011 

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        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TOM COBURN, Oklahoma
THOMAS R. CARPER, Delaware           SCOTT P. BROWN, Massachusetts
MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri           JOHN ENSIGN, Nevada
JON TESTER, Montana                  ROB PORTMAN, Ohio
MARK BEGICH, Alaska                  RAND PAUL, Kentucky

                  Michael L. Alexander, Staff Director
               Nicholas A. Rossi, Minority Staff Director
                  Trina Driessnack Tyrer, Chief Clerk
                 Patricia R. Hogan, Publications Clerk
                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware           TOM COBURN, Oklahoma
MARY L. LANDRIEU, Louisiana          SUSAN M. COLLINS, Maine
CLAIRE McCASKILL, Missouri           SCOTT P. BROWN, Massachusetts
JON TESTER, Montana                  JOHN McCAIN, Arizona
MARK BEGICH, Alaska                  RAND PAUL, Kentucky
            Elise J. Bean, Staff Director and Chief Counsel
                         David H. Katz, Counsel
          Christopher Barkley, Staff Director to the Minority
               Anthony G. Cotto, Counsel to the Minority
                     Mary D. Robertson, Chief Clerk







































                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Levin................................................     1
    Senator Coburn...............................................     6
Prepared statements:
    Senator Levin................................................    51
    Senator Coburn...............................................    57

                               WITNESSES
                       Thursday, November 3, 2011

Paul N. Cicio, President, Industrial Energy Consumers of America.     8
Tyson T. Slocum, Director, Energy Program, Public Citizen........    10
Wallace C. Turbeville, Derivatives Specialist, Better Markets, 
  Inc............................................................    12
Hon. Gary Gensler, Chairman, Commodity Futures Trading Commission    29

                     Alphabetical List of Witnesses

Cicio, Paul N.:
    Testimony....................................................     8
    Prepared statement...........................................    59
Gensler, Hon. Gary:
    Testimony....................................................    29
    Prepared statement...........................................    98
Slocum, Tyson T.:
    Testimony....................................................    10
    Prepared statement...........................................    68
Turbeville, Wallace C.:
    Testimony....................................................    12
    Prepared statement with attachments..........................    77

                              EXHIBIT LIST

 1. a. GCommodity Index Participation in U.S. Commodity Futures 
  and Swaps, 2007-2011, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   110

    b. GIncrease in Commodity Related Exchange Traded Products, 
  2004-2011, chart prepared by the Permanent Subcommittee on 
  Investigations.................................................   111

    c. GIncrease in Commodity Related Mutual Funds, 2008-2011, 
  chart prepared by the Permanent Subcommittee on Investigations.   112

    d. GWTI Price and World Supply and Consumption, chart 
  prepared by the U. S. Energy Information Administration........   113

 2. a. GCFTC Summary of Final Regulations on Position Limits for 
  Futures and Swaps..............................................   114

    b. GCFTC Q&A--Position Limits for Futures and Swaps..........   116

 3. GPosition Limits and the Hedge Exemption, A Brief Legislative 
  History, testimony of Dan M. Berkovitz, CFTC General Counsel, 
  July 28, 2009..................................................   119

 4. GExecutive Summary and Findings and Recommendations from the 
  June 25, 2007 Staff Report of the Senate Permanent Subcommittee 
  on Investigations entitled, ``Excessive Speculation in the 
  Natural Gas Market.''..........................................   146

 5. GExecutive Summary and Findings & Recommendations from the 
  June 24, 2009 Staff Report of the Senate Permanent Subcommittee 
  on Investigations entitled, ``Excessive Speculation in the 
  Wheat Market.''................................................   156

 6. GCommodity Related Exchange Traded Products:

    a. GList of Selected Commodity Related Exchanged Traded 
  Products.......................................................   176

    b. GInformation related to:
       --ETFS Physical Palladium Shares--PALL....................   179
       --ProShares Ultra DJ-UBS Commodity........................   181
       --United States Oil Fund LP...............................   183

 7. GCommodity Related Mutual Funds:

    a. GList of Selected Commodity Related Mutual Funds..........   185

    b. GInformation related to:
       --Direxion Commodity Trends Strategy Fund.................   186
       --Highbridge Dynamic Commodities Strategy Fund............   190
       --MutualHedge Frontier Legends Fund.......................   192
       --Oppenheimer Commodity Strategy Total Return Fund........   206
       --PIMCO CommodityRealReturn Strategy Fund.................   212
       --PIMCO CommoditiesPLUS Strategy Fund.....................   212
       --Rydex/SGI Long Short Commodities Strategy Fund..........   217
       --Rydex/SGI Managed Futures Strategy Fund.................   219
       --Van Eck CM Commodity Index Fund.........................   221

    c. GNational Futures Association correspondence to CFTC, 
  dated August 18, 2010, to amend CFTC Regulation 4.5 which 
  provides an exclusion from the definition of the term 
  ``commodity pool operator.''...................................   223

    d. G72 IRS Private Letters Authorizing Commodity Investments 
  by Mutual Funds, 2006-2011, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   235

 8. GAnalysis: High-frequency trade fires up commodities, 
  Reuters, June 17, 2011.........................................   241

 9. GLetter from 450 economists to the G20 Finance Ministers 
  regarding impact of speculation on food prices, October 11, 
  2011...........................................................   244

10. GStatement for the Record of Gerry Ramm, Inland Oil Company, 
  Ephrata, Washington, on behalf of the Petroleum Marketers 
  Association of America and the New England Fuel Institute 
  (NEFI).........................................................   266

11. GLetter from the Consumer Federation of America forwarding 
  October 2011 study, Excessive Speculation and Oil Price Shock 
  Recessions, A Case of Wall Street ``Deja Vu All Over Again.''..   273

12. GResponse for the record provided by Gary Gensler, Chairman, 
  Commodity Futures Trading Commission, to question posed at the 
  hearing by Senator Levin regarding mutual fund participation in 
  commodity markets..............................................   308

13. GResponses to supplemental questions for the record submitted 
  by Senator Coburn to Gary Gensler, Chairman, Commodity Futures 
  Trading Commission.............................................   309

14. GResponses to supplemental questions for the record submitted 
  by Senator Tom Coburn to Paul N. Cicio, President, Industrial 
  Energy Consumers of America....................................   313

15. GResponses to supplemental questions for the record submitted 
  by Senator Tom Coburn to Wallace C. Turbeville, Derivatives 
  Specialist, Better Markets, Inc................................   317


      EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

                              ----------                              


                       THURSDAY, NOVEMBER 3, 2011

                                     U.S. Senate,  
              Permanent Subcommittee on Investigations,    
                of the Committee on Homeland Security and  
                                      Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:07 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin and Coburn.
    Staff Present: Elise J. Bean, Staff Director and Chief 
Counsel; Mary D. Robertson, Chief Clerk; David H. Katz, 
Counsel; Michael Wolf, Law Clerk; Lauren Roberts, Law Clerk; 
Christopher Barkley, Staff Director to the Minority; Anthony G. 
Cotto, Counsel to the Minority; William Wright, Kristin 
Boutchyard, Brian Murphy, Steven Hutchinson, and William Wright 
(Senator Brown).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good morning, everybody. Over the past 9 
years, this Subcommittee has held a series of hearings on the 
problem of excessive speculation in the commodity markets. For 
years now, commodity markets have taken the American people on 
an expensive and damaging roller coaster ride with rapidly 
changing prices for crude oil, gasoline, natural gas, heating 
oil, airline fuel, wheat, copper, and many other commodities. 
Commodity prices have whipsawed American families, farms, and 
businesses, run roughshod over supply and demand factors, and 
made our economic recovery that much harder and more chaotic.
    Unstable commodity prices are a key reason why Congress 
enacted, as part of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, new statutory requirements to put a 
lid on excessive speculation and price manipulation. Congress 
enacted the new law not only to protect consumers and 
businesses from unreasonable prices--prices disconnected from 
the usual supply and demand discipline of the marketplace--but 
also to protect the commodity markets themselves from losing 
investor confidence and looking more like a casino or rigged 
game than a marketplace where supply and demand determine 
prices.
    Commodities markets are not stock markets. Stock markets 
are intended to attract investors to provide new capital for 
U.S. businesses to invest and to grow.
    Commodity markets are supposed to serve a different 
function. Their purpose is not to attract investors, but to 
enable producers and users of physical commodities to arrive at 
market-driven prices for those goods and to hedge their price 
risks over time. Prices are intended to reflect supply and 
demand for the actual commodities being traded. Speculators, 
who by definition do not plan to use the commodities that they 
trade but profit from the changing prices, are needed only 
insofar as they supply the liquidity needed for producers and 
users to hedge their risks.
    Another big difference between stock and commodity markets 
involves trading limits. Stock markets do not have them, but 
U.S. commodity markets have been using trading limits to 
varying degrees for over 70 years to combat excessive 
speculation and price manipulation.
    Federal law has long authorized the Commodity Futures 
Trading Commission (CFTC), and U.S. commodity exchanges to 
impose so-called position limits to prevent individual traders 
from holding more than a specified number of futures contracts 
at a specified time, such as during the close of the so-called 
spot month when a futures contract expires, and buyers and 
sellers have to settle up financially or through the physical 
delivery of commodities. Position limits help ensure commodity 
traders cannot exercise undue market power, such as by 
cornering the market.
    The primary problem afflicting U.S. commodity markets today 
is an explosion of speculators who, instead of facilitating, 
have now come to dominate commodity trading, overriding normal 
supply and demand factors, distorting prices, and increasing 
price volatility.
    That explosion began in large part less than 10 years ago, 
with the rise of commodity index funds that enable participants 
to bet on the rise or fall in commodity prices. Commodity index 
funds are operated by swap dealers that enter into swap 
contracts with clients seeking to make speculative bets on 
commodity prices. Those clients typically bet that prices will 
go up and take the long side of the swap. The swap dealers 
usually take the short side of the swap and, to offset the 
financial risk, typically purchase long futures contracts. 
Within a few years, as the funds grew, commodity index swap 
dealers became regular purchasers of massive numbers of futures 
contracts for crude oil, natural gas, wheat, and other 
commodities. According to CFTC data, as shown in this chart 
which we are putting up, Chart 1a in our book,\1\ commodity 
index investors and swap dealers have spent about $300 billion 
in 2011 alone, mostly on long futures and swap contracts.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1a which appears in the Appendix on page 110.
---------------------------------------------------------------------------
    Sometimes referred to as ``massive passives,'' commodity 
index funds have created a massive, ongoing demand for futures 
contracts unconnected to normal supply and demand for the 
underlying commodities. Their steady purchases have created an 
artificial demand for futures contracts. In addition, the more 
index funds and their swap dealers push to buy long future 
contracts and outnumber the speculators seeking to buy shorts, 
the more their buying pressure, by the very nature of supply 
and demand, will drive up the price of the long contracts. The 
resulting higher futures prices then translate all too often 
into higher prices for the underlying commodities, in part 
because so many of commodity contracts for the underlying 
commodities use futures prices as the commodity's selling 
prices. In those cases, higher futures prices translate 
directly into higher costs for consumers of the commodities. 
That is why so many American consumers and businesses continue 
to condemn the speculative money that commodity index funds 
bring to the commodity markets.
    Commodity-related exchange traded products (ETPs), have 
added further fuel to the speculative fire. Exhibit 6 lists 
some of the many ETPs which offer securities that track the 
value of a designated commodity or basket of commodities, but 
trade like stocks on an exchange.\1\ ETPs are marketed to 
investors looking to make money off commodity price changes 
without actually buying any futures. The financial firms 
running the ETPs often support the value of the fund by 
purchasing commodity futures or using futures to offset risks. 
The result, as shown in this chart, which is Exhibit 1b,\2\ is 
that in 2011 alone, these ETPs have poured over $120 billion of 
speculative money into U.S. commodity markets.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 6 which appears in the Appendix on page 176.
    \2\ See Exhibit No. 1b which appears in the Appendix on page 111.
---------------------------------------------------------------------------
    Now, that is not all. A third wave of commodity speculation 
has come from the $11 trillion mutual fund industry which, 
since 2006, has turned its attention to U.S. commodities in a 
big way. Hearing Exhibit 7a \3\ identifies more than 40 
commodity-related mutual funds that, by 2011, as shown in this 
chart, which is Exhibit 1c,\4\ have accumulated assets of over 
$50 billion. That chart shows the growth of the mutual fund 
purchases of these commodity futures. The sales materials from 
some of those mutual funds, which are included in Exhibit 
7b,\5\ show that they are marketing themselves to average 
investors as commodity funds and delving into every kind of 
commodity investment out there, from swaps to futures, putting 
additional speculative pressures on commodity prices.
---------------------------------------------------------------------------
    \3\ See Exhibit No. 7a which appears in the Appendix on page 185.
    \4\ See Exhibit No. 1c which appears in the Appendix on page 112.
    \5\ See Exhibit No. 7b which appears in the Appendix on page 186.
---------------------------------------------------------------------------
    Now, by law, mutual funds are supposed to derive 90 percent 
of their income from investments in securities and not more 
than 10 percent from alternatives like commodities. But the 40 
commodity-related mutual funds that we have identified have 
found ways around that law by, among other steps, setting up 
offshore shell companies that do nothing but trade commodities.
    Those offshore shell companies are typically organized as 
Cayman Island subsidiaries with no offices or employees of 
their own and with their commodity portfolios run from the 
mutual fund's U.S. offices. This blatant end-run around the 90/
10 restriction has nevertheless been blessed by the IRS which 
has issued dozens of private letter rulings, which are listed 
in Exhibit 7d,\6\ which deem the offshore arrangements to be 
investments in securities rather than commodities, since the 
parent mutual funds hold all of the stock in those offshore 
subsidiaries. The IRS has recently put a moratorium on these 
private letter rulings while it studies the issues. In 
addition, the offshore shell corporations are currently exempt 
from CFTC registration requirements, despite operating as 
commodity pools, a situation the CFTC is reviewing as a result 
of a petition filed by the National Futures Association, as 
indicated in Exhibit 7c.\1\
---------------------------------------------------------------------------
    \6\ See Exhibit No. 7d which appears in the Appendix on page 235.
    \1\ See Exhibit No. 7c which appears in the Appendix on page 223.
---------------------------------------------------------------------------
    Now, I am glad the IRS and the CFTC are studying these 
offshore arrangements as well as the broader issue of mutual 
fund investment in commodities. If the mutual fund industry 
were to step up its commodities investments to even just 10 
percent of its overall assets, it would unleash another tidal 
wave of speculative money into the commodities markets.
    There is more. Over the last few years, high-frequency 
traders have also invaded the commodities markets, seeking to 
profit from the increasing price volatility. Those high-
frequency traders have revved up commodity trading with day-
trading strategies that further contribute to constantly 
changing prices.
    Put together the swap dealers, hedge funds, ETPs, mutual 
funds, and high-frequency traders, and the result is a tsunami 
of speculative money pouring into commodity markets at 
unprecedented levels. Today, speculators make up the bulk of 
the outstanding contracts in most commodity markets, providing 
typically more than 70 percent of the market. Producers and 
users of commodities now hold as little as 20 or 30 percent of 
the outstanding contracts in some markets. So it is no surprise 
that commodity prices have become increasingly volatile, with 
exaggerated swings that have little to do with hedging, little 
to do with supply and demand for the underlying commodities, 
and everything to do with folks betting and speculating on 
price changes.
    Take the U.S. crude oil market as an example. In 2007, a 
barrel of crude oil started out the year costing $50, but by 
the end of the year had nearly doubled in price. In 2008, oil 
prices shot up in July to over $145 per barrel and then, by the 
end of the year, crashed to $35 a barrel. In the beginning of 
2011, oil prices took off again, climbing to over $110 per 
barrel in May. Then they fell to a low of $77 per barrel in 
early October, a drop of more than 30 percent in 4 months. 
Three weeks later, they are back up to $92 per barrel, a 15-
percent increase. This price volatility has taken place at the 
same time that world inventories were plentiful and basically 
matched world demand, as shown in this chart prepared for the 
Subcommittee by the Energy Information Agency, which is Exhibit 
1d.\2\ In other words, the price changes in West Texas 
Intermediate, the benchmark crude oil contract for the United 
States, cannot be explained simply as a function of supply and 
demand for oil.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 1d which appears in the Appendix on page 113.
---------------------------------------------------------------------------
    During the same period crude oil prices went haywire, 
speculators have become the dominant players in the crude oil 
market. CFTC data indicates that speculators--traders who do 
not produce oil or use oil in their business--now hold over 80 
percent of the outstanding contracts in the oil futures market. 
While speculation is not necessarily the primary factor setting 
oil prices, the facts indicate that speculation is a major 
contributor.
    It is not just the numbers telling this story. Major 
players in the oil industry also point to the role of 
speculation in crude oil prices. For example, in May 2011, 
ExxonMobil CEO Rex Tillerson agreed that speculation was 
contributing to oil prices, estimating that the price of a 
barrel would be $60 to $70, instead of $110, if governed 
exclusively by supply and demand.
    The same complaint is heard with respect to other 
commodities. Recently, 450 economists from around the world 
stated in a joint letter to the G-20 leaders, which we include 
in the hearing record as Exhibit 9:\2\ ``Excessive financial 
speculation is contributing to increasing volatility and record 
high food prices exacerbating global hunger and poverty.'' And 
the CEO of Starbucks, Howard Schultz, who tracks coffee prices, 
had the following to say:
---------------------------------------------------------------------------
    \1\ See Exhibit No. 9 which appears in the Appendix on page 244.
---------------------------------------------------------------------------
    ``[W]hy are coffee prices going up? [A]nd in addition to 
that, why is every commodity price going up at the same time? I 
think what's going on is financial engineering; that financial 
speculators have come into the commodity markets and drove 
these prices up to historic levels and as a result of that the 
consumer is suffering.''
    Excessive speculation is not new. In fact, much of the law 
related to commodity markets can be understood as an effort to 
prevent excessive speculation and market manipulation from 
distorting prices.
    Over the years, one of the most powerful weapons developed 
to combat the twin threats of excessive speculation and price 
manipulation has been the imposition of position limits on 
traders. But over the years, Federal position limits have lost 
much of their punch due to a growing raft of loopholes, gaps, 
and exemptions. For example, prior to the Dodd-Frank Act, 
position limits didn't apply to some key futures contracts; 
they often applied only in the spot month instead of other 
times; and multiple market participants were given exemptions. 
In addition, until recently, the entire commodity swaps market 
had no position limits at all.
    The combination of increased speculation and weakened 
position limits has clobbered American consumers and businesses 
with unpredictable and inflated commodity prices. That is why, 
when Congress enacted the Dodd-Frank Act last year, Section 737 
directed the CFTC to establish position limits on all types of 
commodity-related instruments, including futures, options, and 
swaps. The Dodd-Frank Act also directed the CFTC to issue a 
rule establishing the new position limits by January 2011, one 
of the earliest implementation dates in the entire law.
    The CFTC missed that deadline but 2 weeks ago, after 
reviewing over 15,000 public comments, at long last issued a 
final rule. The good news is that the agency complied with the 
law's requirements to establish position limits to ``diminish, 
eliminate, or prevent'' excessive speculation, and rejected 
unfounded claims that excessive speculation had to be proven 
for each commodity before a limit could be established to 
prevent damage to consumers and the economy. That has never 
been the law, and it has no basis in the Dodd-Frank Act which 
is aimed at preventing problems, not waiting for them to occur 
and cleaning up afterwards.
    Also good news is that the CFTC rule applies position 
limits to 28 key agricultural, metal, and energy commodities; 
applies those limits to futures, options, and swaps; and covers 
all types of speculators.
    The bad news, from my perspective, is that while the limits 
appear designed to prevent any one trader from amassing a huge 
position that could lead to price manipulation in a particular 
month, the limits do not appear to be designed to combat the 
type of excessive speculation caused by large numbers of 
speculative investment funds. In addition, exempting multi-
commodity index swaps from any position limits, failing to 
apply effective position limits to commodity index swap 
dealers, and delaying implementation of the swap position 
limits for another year are troubling.
    Roller coaster commodity prices and the growing flood of 
speculative dollars continue, while it will be another year 
before the full range of position limits in the new CFTC rule 
take effect. In the meantime, we are talking about ongoing 
gyrations in gasoline prices, heating and electricity costs, 
and food prices that affect every American family. We are 
talking about unstable prices for copper, aluminum, and other 
materials essential to industry. At stake are energy, metal, 
and food costs key to inflation, business costs, and family 
budgets nationwide.
    Until effective position limits are actually in place, the 
American economy will remain vulnerable to chaotic price swings 
that benefit speculators at the expense of American consumers 
and businesses.
    Today's hearing is intended to shine a spotlight on the 
ongoing role of speculation in U.S. commodity markets and how 
the new position limits can combat excessive speculation. We 
will hear today from a panel of experts representing business, 
consumers, and academia, as well as from CFTC Chairman Gary 
Gensler.
    Now let me invite our Ranking Member, Dr. Coburn, to share 
his views with us.

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. Thank you, Mr. Chairman.
    I want to thank Senator Levin for holding this hearing 
today. He has been a leader for years in Congress on efforts to 
better understand and monitor commodity markets, which should 
make us more capable of holding market regulators accountable 
in their efforts to ensure American exchanges remain the most 
dynamic, transparent, and desirable places to do business.
    Commodity markets and pricing have profound effects on the 
people in my home State of Oklahoma, who are invested in 
virtually all of the commodities covered by the rules we will 
discuss today. Whether it is oil, natural gas, wheat, or any of 
the other 28 commodities, market participants all the way from 
the producer to the end user will be affected by recent and 
upcoming regulatory changes.
    It is our obligation in Congress to make sure regulators 
act in the public interest, based on facts and data, rather 
than reflexively placing restrictions on unpopular market 
participants. While today's hearing will focus on the concept 
of ``excessive'' speculation, it is imperative that we remember 
one fundamental truth: That futures markets cannot function 
without speculators who make markets, provide liquidity for 
hedgers, aid in price discovery, and take risks.
    Two weeks ago, the CFTC issued its long-awaited position 
limits, imposing limits on the number of futures contracts 
individuals or institutions can hold. The most recent version 
of the rule was rushed through the Commission and applied 
across the board to 28 separate commodities. Much of this seems 
to have been done in response to intense pressure, and the 
unfortunate result is likely to be challenged in court.
    In addressing commodities, the Dodd-Frank Act said the CFTC 
``shall by rule, regulation, or order establish limits on the 
amount of positions, as appropriate.'' In at least two 
Commissioners' views, those tests have not been met. Yet now 
every participant in the commodities market must comply with a 
final rule that is over 300 pages long.
    Commissioner Scott O'Malia indicated in his dissenting 
opinion that the Commission voted ``without the benefit of 
performing an objective factual analysis based on the necessary 
data to determine whether these particular limits and limit 
formulas will effectively prevent or deter excessive 
speculation.'' There is no question we want to limit excessive 
speculation, but it needs to be based on data and facts, not 
feelings.
    Commissioner Jill Sommers also worried that the CFTC ``is 
setting itself up for an enormous failure'' by issuing a 
position limits rule that ``ironically, can result in increased 
costs to consumers.''
    Position limits can be a very effective regulatory tool, 
but must be used in the right way. For example, we have limits 
on cotton--they are in place--yet the cotton No. 2 futures 
contract has hit 16 record-setting prices since December 1, 
2010. Why is that? Because of crop failures around the rest of 
the world, and because of a drought in the United States.
    Position limits must be set at the proper level for each 
individual commodity. Unfortunately, the CFTC chose to use the 
blunt weapon of across-the-board limits for nearly every 
commodity.
    While today's hearing will be a good opportunity to discuss 
the effects of that excessive speculation--and in that I agree 
with my Chairman--we need to be careful not to accuse investors 
of wrongdoing where none has occurred. Commodity index funds, 
exchange traded funds, and mutual funds are not diabolical 
schemes. They are simply financial instruments that some 
investors use as tools to hedge or gain exposure to commodity 
markets, thus protecting against inflation and other risks in 
their portfolios.
    Last, I would like to address my strong concerns with the 
Dodd-Frank Act in general, which itself was rushed through 
Congress last year. The law that was supposed to help fix our 
financial system has instead wreaked regulatory havoc, 
increasing uncertainty and compliance costs, doing nothing to 
address unemployment, and it did nothing to effect the 
initiation of the problems that we are presently faced with, 
basically Fannie Mae and Freddie Mac. The act required over 300 
new regulations and studies and has overwhelmed our regulatory 
agencies while causing widespread confusion in the marketplace.
    As we move forward, we in Congress must improve our 
understanding of the markets being regulated, as well as the 
internal and external challenges facing our regulators. 
Continuous oversight and transparency through hearings like 
this are essential to ensure our regulators do not overreach 
their mandates and that U.S. markets remain the envy of the 
world.
    One of my greatest concerns is every trader in the world is 
one click away from trading somewhere else, and there are 
tremendous markets in this country that are going to be put at 
risk through this new rule.
    The last thing we want to do is suffocate those markets and 
chase interested participants to other exchanges and trading 
venues abroad, many of whom would like nothing more than to 
take away America's business.
    Despite my concerns about the Dodd-Frank Act, it must be 
implemented in a thoughtful, responsible manner by our 
regulators. I look forward to a healthy discussion during this 
hearing, Mr. Chairman. I thank our witnesses for attending, and 
I look forward to hearing your views and recommendations today. 
Thank you.
    Senator Levin. Thank you very much, Dr. Coburn.
    We are now going to call our first panel of witnesses for 
this morning's hearing: Paul Cicio is President of the 
Industrial Energy Consumers of America. Tyson Slocum is Public 
Citizen's Emergency Program Director. Wallace Turbeville is a 
Derivatives Specialist with the nonprofit Better Markets, 
Incorporated.
    Now, the Subcommittee invited and we had hoped to have with 
us Dr. Craig Pirrong, who is professor of finance at the Bauer 
College of Business at the University of Houston. He was able 
to make our originally scheduled hearing, but was unable to 
make this hearing, which we regret that he could not be with us 
today to give us his views. But what we will do is invite him 
to provide his views in a written statement.
    We do appreciate each of the witnesses who were able to 
join us this morning. We look forward to your testimony. 
Pursuant to Rule VI, all witnesses who testify before the 
Subcommittee are required to be sworn. At this time I would ask 
our first panel to please stand and raise your right hand. Do 
you swear that the testimony you will give before this 
Subcommittee is the truth, the whole truth, and nothing but the 
truth, so help you, God?
    Mr. Cicio. I do.
    Mr. Slocum. I do.
    Mr. Turbeville. I do.
    Senator Levin. Now, we are going to use the timing system 
today. About 1 minute before the red light comes on, you will 
see the lights change from green to yellow, which will give you 
an opportunity to conclude your remarks. Your written testimony 
will be printed in the record in its entirety. We would ask 
that you limit your oral testimony to no more than 7 minutes.
    Mr. Cicio, we are going to have you go first, followed by 
Mr. Slocum, followed by Mr. Turbeville. After we have heard all 
the testimony, we will then turn to questions.
    So, Mr. Cicio, please proceed.

  TESTIMONY OF PAUL N. CICIO,\1\ PRESIDENT, INDUSTRIAL ENERGY 
                      CONSUMERS OF AMERICA

    Mr. Cicio. Chairman Levin, Ranking Member Coburn, and 
Subcommittee Members, thank you for the opportunity to testify 
before you today. My name is Paul Cicio, and I am the President 
of the Industrial Energy Consumers of America (IECA).
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Cicio appears in the Appendix on 
page 59.
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    IECA has been a long-time supporter of setting responsible 
speculative position limits. Since all of our companies use 
substantial quantities of natural gas, we will use natural gas 
illustrations to address the Subcommittee questions.
    Speculative trading volumes have been explosive in growth, 
even though natural gas consumption in the country has only 
increased moderately. For example, natural gas open interest 
increased by 590 percent since 1995, even though U.S. 
consumption has increased only 6.5 percent. Almost all of the 
open interest is from noncommercial trades.
    Large speculative volumes can be a problem because they can 
move market price and they do increase volatility. Charts 1 and 
2 of our written testimony uses CFTC data to show that, in late 
2008, four trades controlled about 50 percent of the open 
interest in natural gas. Eight traders controlled 60 percent of 
the open interest. That means that only a handful of trading 
companies can have an incredibly important impact on the price 
of natural gas.
    High volatility will increase the cost of hedging to 
manufacturers because there is a direct relationship between 
volatility and, for example, the option price premium. Higher 
volatility also increases the bid-ask spread in the forward 
market.
    To illustrate the point, using the closing Henry Hub Index 
price of natural gas, just last Friday, at $4.04 per million 
Btu, a call option for 100,000 MM Btus with a 6-month 
expiration at the money would cost a manufacturer approximately 
$36,500. If we increased the implied volatility of only 5 
percent, the premium cost goes up 15 percent. If we increased 
the implied volatility 10 percent, the premium cost rises 31 
percent. And if we increase the implied volatility 20 percent, 
it increases the option premium a whopping 61 percent.
    IECA supports the imposition of speculative position 
limits, but setting the limit at 25 percent of the estimates 
deliverable supply is too large and will do little to reduce 
excessive speculation.
    Let us put in perspective what setting speculative position 
limits at 25 percent means by looking again at natural gas. If 
only 100 traders trade at the spec limit, they would control 25 
times the U.S. monthly demand. There are approximately 250 to 
350 traders that report to the large trader report at the CFTC 
from time to time. If only 100 trade, they would control 25 
times the entire consumption.
    Regarding commodity index funds and ETFs, we believe that 
passive speculators should be banned from the futures market. 
At minimum, they should be subjected to individual speculative 
position limits.
    The next best alternative is to set spec position limits on 
all commodity-related ETFs and index funds. Swap dealers and 
ETF managers should be subject to speculative position limits 
except for hedges associated with transactions with producers 
and consumers of the underlying commodity.
    There are several reasons that passive index funds should 
be banned. First, passive index funds put upward pressure on 
price. CFTC index investment data for natural gas between 
December 2007 and September 2011 show that index funds held a 
long position 86.2 percent of the time and only held short 
positions 17.4 percent of the time. And index funds continue 
explosive growth. CFTC data indicates that index open interest 
contracts increased by 294 percent just since December 2007.
    Second, passive index speculators also reduce liquidity by 
buying and then holding larger and larger quantities of futures 
contracts. This is inconsistent with the functioning of the 
futures market that serves consumable commodities that have a 
prompt month that expires.
    And last, they also buy without regard to price, supply, or 
demand, which, of course, impacts price discovery. Thank you.
    Senator Levin. Thank you, Mr. Cicio. Mr. Slocum.

  TESTIMONY OF TYSON T. SLOCUM,\1\ DIRECTOR, ENERGY PROGRAM, 
                         PUBLIC CITIZEN

    Mr. Slocum. Chairman Levin and Ranking Member Coburn, thank 
you very much for the opportunity to allow me to testify today. 
I am Tyson Slocum, and I direct Public Citizen's Energy 
Program. We are one of America's largest consumer advocacy 
groups, and we are proud to be celebrating our 40th anniversary 
this year. We work on a range of issues, and I head up our 
energy work.
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    \1\ The prepared statement of Mr. Slocum appears in the Appendix on 
page 68.
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    I am tasked at Public Citizen with promoting those policies 
that are going to produce affordable, reliable, and clean 
energy, and it is clear from my personal work on this issue 
over a decade that current energy markets are driven not by the 
supply-demand fundamentals but by speculation.
    There has been a lot of great work, Mr. Chairman, by this 
Committee over the years, as you mentioned in your opening 
statement, that has helped make that case. But it is not just 
this Committee, it is not just industrial consumers, and it is 
not just household consumers, but members of industry as well. 
You mentioned in your opening statement that the chairman and 
CEO of ExxonMobil noted the role that speculation plays in the 
current price of a barrel of oil, and even the investment bank 
Goldman Sachs earlier this year revealed that they believe the 
speculation price is around $27 a barrel for 2011. And Dr. Mark 
Cooper, a colleague at the Consumer Federation of America, 
estimated that around $30-a-barrel-oil of a speculation tax 
equates to about $600 in increased gasoline costs for the 
average family and about $200 billion across the economy.
    So when I am taking a look at these markets, it is clear 
that around a $30 speculation tax, which translates to about 
$600 costs to the average family over the course of a year is 
indeed excessive levels of speculation, and it is the duty of 
Congress and regulators to help protect household consumers and 
businesses from these excessive costs.
    Does the Dodd-Frank Act and the way that it has been 
implemented by the CFTC effectively address that? And Public 
Citizen's analysis is that the proposed position limit 
rulemaking does not go far enough. As my colleague, Mr. Cicio, 
pointed out, the speculation limit of 25 percent and then 10 
percent and then 2.5 percent, depending on the contracts, 
allows for too great of holdings. There was some recently 
leaked data by a U.S. Senator to the media that detailed the 
positions of individual traders, and this clearly showed that 
the largest five operators in the WTI market--Goldman Sachs, 
Vital, Morgan Stanley, Deutsche Bank, and Barclays--had 
positions that were between 5.3 and 8.7 percent. And that is 
why Public Citizen believes that speculation limit needs to be 
more in line with proposed legislation that has sponsorship in 
both the Senate and the House, S. 1598 and H.R. 3006, that 
would establish a statutory position limit of 5 percent that 
would get at the concentrations that the leaked data clearly 
shows.
    It is not just banks that are involved in these markets and 
making profits. Again, a leaked document that Chevron 
inadvertently leaked to the public this summer showed that the 
company earned $360 million over the first 6 months of this 
year not from doing what it is supposed to do, which is 
providing the American public with oil that it works hard and 
spends a lot of money to get out of the ground in the United 
States and elsewhere and refine into useful products, but in 
speculating, that Chevron was speculating far and above their 
hedging needs and using the commodity markets to make money the 
same way that investment banks do. And when the Wall Street 
Journal reported this, they noted that Chevron, like other 
major proprietary traders that also feature control or 
ownership over energy infrastructure assets, utilized those 
energy infrastructure assets to have a sneak peek at the market 
and give them a massive competitive advantage.
    Mr. Chairman, like you said, they do not like to gamble. 
They want to have more certainty, and having a large control 
over the market in terms of their positions and having access 
to energy infrastructure assets provides them that advantage. 
We have seen Goldman Sachs through its control over Kinder 
Morgan now is going to have control over about 67,000 miles of 
petroleum product and natural gas pipelines throughout the 
United States. They have ownership interests now in two 
refineries in the United States. Morgan Stanley spends hundreds 
of millions of dollars a year on acquiring control over storage 
capacity. None of this is adequately regulated, and another 
issue that Public Citizen promotes is having firm rules 
limiting the communications between energy infrastructure 
affiliates and trading affiliates.
    In addition, Public Citizen shares the concerns of this 
Subcommittee and the research that was presented to us in your 
opening statement that the rise of index funds is highly 
disruptive, and like my colleague, Mr. Cicio, I believe that 
index funds do not have a legitimate role in these markets. And 
I applaud the efforts of the Subcommittee to examine problems 
of mutual funds getting involved in these markets as well.
    Thank you very much for your time, and I look forward to 
your questions.
    Senator Levin. Thank you, Mr. Slocum. Mr. Turbeville.

TESTIMONY OF WALLACE C. TURBEVILLE,\1\ DERIVATIVES SPECIALIST, 
                      BETTER MARKETS, INC.

    Mr. Turbeville. Good morning, Chairman Levin and Ranking 
Member Coburn. Thank you for the opportunity to speak today. My 
name is Wallace Turbeville, and I am a derivatives specialist 
at Better Markets, Inc. Better Markets is a nonprofit, 
nonpartisan organization whose mission is to promote the public 
interest in the domestic and global capital and commodity 
markets.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Turbeville with attachments 
appears in the Appendix on page 77.
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    Personally, I have worked in the securities industry for 31 
years as a practicing attorney first, as an investment banker 
at a Wall Street firm, and managing companies as a principal.
    In the 10 years since deregulation, commodities markets 
have changed dramatically, and the public has been plagued by 
boom-and-bust price cycles. Prior to that time, physical 
hedgers consistently represented about 70 percent of the 
futures markets. Now the ratio of participants has reversed. 
Speculators now account for about 70 percent or more of the 
open interest in many markets, while physical hedgers have 
fallen to only about 30 percent. This increased speculation is 
in large part driven by commodity index funds, which are 
predominantly sponsored by large dealer banks. These are 
vehicles reminiscent of residential mortgage structures 
designed to synthetically convert barrels of oil and bushels of 
corn into investment asset classes. These changes have 
profoundly affected prices and price discovery.
    Now, the CFTC adopted position limits in response to the 
congressional mandate to address the issues in energy, 
agriculture, and metals just recently. This rule establishes 
some very important principles, but much remains to be done to 
improve limits on speculators, in particular commodity index 
traders.
    Since 2004, highly structured commodity index investment 
vehicles have become dominant forces in the futures markets 
with dramatic impacts in the physical markets as well. Not 
surprisingly, we are now in a period of boom-and-bust commodity 
prices as a result. These investments have been marketed to 
large institutional investors as a new asset class for 
diversifying investment portfolios, and they have responded 
quite well for the marketers.
    Index investors have injected amounts which have been 
estimated to be between $200 and $300 billion into the market, 
fundamentally changing the way the futures markets work.
    Analysis of commodity speculation is now in the hands of 
academics, self-interested market participants, and the CFTC. 
Each seeks the answer to a single question: Are the boom-bust 
price cycles in basic commodities related to the explosion of 
speculative and highly structured trading activities? Or is it 
just merely a coincidence that these happened at the same time?
    Now, commodity index investments were created to 
synthetically mimic ownership of market baskets of physical 
commodities and are valued using indices. It is kind of an 
interesting thing. I am not aware that anybody considered the 
possibility that if you synthetically created a huge ownership 
interest in barrels of oil and bushels of wheat and corn, 
whether that synthetic ownership interest in large size would 
actually affect the market because the market would interpret 
that as hoarding activity when these vehicles were first 
created. But the consequences, as it has turned out, are very 
serious.
    Unlike a business with shares that trade, the value of a 
barrel of oil or bushel of corn derives from its consumption, 
at which point that value ends. If it can never be consumed, it 
has no value. However, commodity index funds are, in theory, 
perpetual. It is a synthetic ownership interest that goes on 
forever.
    To synthesize perpetual ownership and make it look more 
like a share of stock, the commodity index fund bank sponsors 
take large futures and physical commodity positions and roll 
them over continuously in massive amounts at specified times. 
So everyone in the whole market knows that at specified times 
during each month this large rollover of futures contracts 
occurs.
    Like the Phoenix, the index hedges, all of them, and 
repeatedly, are destroyed and re-created with longer maturities 
at each roll in order to create synthetic perpetual ownership. 
These repeated events are so important to the market that many 
trades focus a bulk of their activities on the commodity index 
rolls.
    The concern is that the rolls affect the price curves. 
Price curves are very important. The price curve is how the 
market tells the world what prices are likely to be this month 
and in the month to come. When it slopes upward--that is to 
say, November prices are higher than October--the futures 
market is telling producers and consumers that prices are 
likely to rise. When it is flat or downward sloping, the 
message is that the prices will be stable or fall. This is 
tremendously important because businesses organize themselves 
along these lines.
    The shape of the price curve has changed. Historically, it 
was flat to downward sloping most of the time. Since 2004, it 
has been upward sloping almost all of the time. The message is 
that prices are rising, and it is a constant message that is 
repeated over and over.
    Better Markets recently released a study of price curve 
dynamics in the roll. We isolated the predominant roll periods 
for each trading month over the last 27 years and compared them 
to determine whether there was a tendency for prices to rise--
sorry, for the price curve to rise at the time of the roll. We 
found that starting in 2004, when index trading expanded, the 
correlation between the roll period and its bias was 
pronounced. In fact, the price bias in the crude oil futures 
markets was correlated at 99 percent level with the roll. For 
every other 5-day period in every other month over that 27 
years, there was no correlation between upward or downward 
prices for these periods. So we concluded that the forces which 
were signaling increased prices were specific to the roll 
period and were caused by commodity index roll trading.
    The market as a whole reacted to the signal, and a price 
bubble emerged. Eventually, supply-and-demand forces must 
overcome the trading-driven sentiment, and the bubble bursts.
    Thank you for the opportunity to discuss these crucial 
questions. I am pleased to answer any questions you may have 
now or in the future.
    Senator Levin. Thank you very much, Mr. Turbeville, and 
each one of you. We will try an 8-minute first round. I expect 
we will have a number of rounds for each panel.
    Mr. Cicio, first, tell us again very directly how 
businesses are harmed when oil futures prices are subject to 
roller coaster prices like the ones that are pushed up to 
artificial levels and then plummet down and then climb back up.
    Mr. Cicio. The example that we have provided in our 
testimony is very clear. When there is increased volatility, it 
increases the cost of hedging. Manufacturers are consumers. 
They are only going to hedge as much as they are going to 
consume, or they may hedge less than they will consume. The 
example that we have provided is an option on natural gas and 
it illustrates that increased implied volatility has a 
substantial cost increase on the premium of that option. The 5-
percent increase in implied volatility increases the premium 
cost of that option 15 percent. Fifteen percent all by itself 
is a large amount for a company to lay out. Anything they lay 
out above that existing on-the-money option is cash that they 
have to put up. That is working capital that could be used for 
other things.
    Senator Levin. Is that usually passed down to consumers?
    Mr. Cicio. Manufacturers compete in a very globally 
competitive environment. If it is possible for us to pass that 
through to our customers, we would. But in most cases, costs of 
this nature cannot be passed through because of global 
competition.
    Senator Levin. And the hedging that they want to do is to 
provide themselves with a stable economic environment so that 
they can know what the costs of oil or any other commodity is. 
Is that correct?
    Mr. Cicio. Yes, that is correct. Think of it this way: One 
of the first things we do is buy basic raw materials like 
natural gas or crude oil that is used to produce our products. 
The time frame from producing the product to making a widget, a 
manufactured product, and then getting it out to the customer, 
is a long time. We price our product out a long time. If we 
price the product out and in the interim the price of the raw 
materials continues to escalate, then we have a price with 
rising costs that reduce our margins.
    Senator Levin. Now, according to the Consumer Federation of 
America--and this I will address to you, Mr. Slocum--excessive 
speculation has added about $30 per barrel to the cost of crude 
oil in 2011, and as you pointed out, that added $600 to the 
average household expenditure for gasoline in 2011. The total 
drain on the economy in 2011 from speculation-driven excessive 
cost is more than $200 billion, and the report concludes, 
``Transferring that much purchasing power from consumers on 
Main Street to speculators on Wall Street puts a severe drag on 
the economy'' and has ``already dampened economic growth.''
    What do you think of those findings?
    Mr. Slocum. I agree with it. And like I said, it is also in 
line with what Goldman Sachs itself said in a research note to 
its investors. So the estimate provided by Dr. Mark Cooper that 
you just cited is absolutely in line with what one of the 
largest speculators in the country, Goldman Sachs, also 
estimated. And just like Mr. Cicio's members are hit hard by 
these increasing prices and the volatility, so are working 
families across the country. And people are beginning to 
understand the role that Wall Street plays in this. We see 
citizens of all walks of life participating in activities 
around the country directed at frustrations with Wall Street 
profits while families are really struggling to make ends meet.
    Senator Levin. Mr. Turbeville, speculators, according to 
your testimony, are now overwhelming the commodity markets and 
dwarfing the participation by commercial hedgers. They now 
account, I believe your testimony was, for 70 percent or more 
of the outstanding contracts in many commodity markets while 
actual hedgers have fallen to only 20 or 30 percent 
participation, and even lower in some markets.
    You have, I think, indicated that this is a historically 
new shift. Is that correct?
    Mr. Turbeville. That is correct.
    Senator Levin. In other words, a few years ago it was very 
different, perhaps the opposite, but at least very different 
from what it is now. Are there any barriers to speculators 
making up 90 percent of the commodity market, or even 99 
percent?
    Mr. Turbeville. No. In fact, the new position limit rules 
go to the percentage of open interest that an individual 
speculator might have, so that the aggregate amount of 
speculation in a market, in fact, is not limited. And that is a 
real concern. It is not just the size of speculation. It is 
also the structure of speculation and how speculation has 
created this--has been created in sort of an ecosystem around 
the big bank traders that are trading these roll period 
contracts that I described.
    So it is both the size, absolute size, and the actual 
structure of the speculation that is very much a concern.
    Senator Levin. The most important question is the 
relationship between the amount of speculation in commodities 
and the prices of those commodities. We had a chart we put up 
there which shows that most of the speculative interest is on 
the long side, but there is obviously a short for every 
long.\1\ But, nonetheless, when the speculative interest is on 
the long side and is pushing prices upward, sooner or later 
there may be a short side to make to be on the other side of 
the deal, but that has an upward price pressure on futures 
contracts. Like any market, if there is a greater demand for 
the paper, it is going to push the price of the paper up, if 
there is a great demand for the long side of that paper.
---------------------------------------------------------------------------
    \1\ See Exhibit 1a which appears in the Appendix on page 110.
---------------------------------------------------------------------------
    Now, how does that get translated into the price of the 
commodity? I think that is what we really need to drive home, 
that these futures contracts and the demand for futures 
contracts and the demand for the long side on futures 
contracts, which will be met by somebody willing to go short, 
but, nonetheless, as the demand goes up for that long side--or 
the bet that the price is going to go up--will not just affect 
the price of the futures contract but that huge demand will be 
translated somehow into a demand for the underlying commodity.
    In my opening statement, I tried to describe how that is 
done in a very simple way, but could each of you now take a try 
at that issue. Let us start with you, Mr. Cicio.
    Mr. Cicio. One just needs to look at the index fund data 
that we cited earlier that shows that 86-plus percent of all of 
the positions are long.
    Senator Levin. This is for the index fund people.
    Mr. Cicio. For the index funds, that is correct.
    Senator Levin. OK.
    Mr. Cicio. And when that happens, there is mounting 
pressure month after month because they roll their volumes 
forward. When it comes to speculation and what impact it has on 
price really depends upon the specific commodity. Like in the 
case of natural gas today, you saw the numbers. We have a lot 
more speculators open interest than hedgers and producers. 
Because there is a lot more of physical natural gas--there is 
more supply today than there is demand for natural gas--the 
speculators are having a very difficult time creating that 
speculation because the physical product is so overwhelming 
that it is keeping the trading within a narrow range. So in 
that situation, having tight speculative position limits is not 
all that important. The reverse is what we are really worried 
about. If you have a market, a physical market that is 
basically in supply and demand, or there is more demand than 
there is supply, is when you need spec limits. That is when it 
is crucial that those be in place because speculators have a 
herding effect. They make money on the changes in price. They 
love speculation. They thrive on it. That is when their 
profitability increases. And they go to specific commodities 
when they sense that supply and demand of the physical 
commodity is in their favor to create speculation. So these 
things all tie together to impact the price, but it is on a 
commodity basis.
    Senator Levin. It depends on the supply-and-demand 
situation for the underlying physical commodity in your 
judgment.
    Mr. Cicio. Yes, sir.
    Senator Levin. Mr. Slocum, do you want to try to address my 
question? How does the speculation get translated into impact 
on price?
    Mr. Slocum. I would be happy to. I think what you see--and 
you kind of alluded to this--is this manufactured demand of 
these entities buying and selling these contracts and 
controlling such a big chunk of it, and particularly the 
disruptive influence that the index funds play, particularly as 
the contract month comes to expiration, where it is crowding 
out the folks that are looking to legitimately hedge. And so it 
is increasing prices for the market as a whole, and a lot of 
this has to do with the fact that we do not have adequate 
limits on the size of the positions that the banks can take.
    You also see a lot of other effects go on. Markets are 
based on fundamentals. They are based on opportunities. They 
are also psychological. Everyone knows that a Goldman Sachs is 
a major presence and player in the market, so when their 
analysts produce a report that say oil is going to hit $90 a 
barrel or go up to $100, it has a phenomenon of saying, well, 
that is where Goldman is headed and that is where we need to 
head because they are driving the market. And so I think that 
is an issue that also needs be examined.
    Senator Levin. OK. Mr. Turbeville.
    Mr. Turbeville. When the rollover occurs, you see firms 
like Goldman Sachs and JPMorgan and all the very sophisticated 
firms selling the November contract and then buying the 
December contract at a higher price because they are 
insensitive to the actual prices they get on the contracts, 
that all gets passed through to the investors. So they are 
really doing this rollover on behalf of the investors and 
passing the prices through.
    So what happens is that the message goes through to the 
market that sophisticated folks believe that prices are on the 
rise, prices will rise, and it really changes the information 
that the market has about supply and demand. The assumption is 
that those sophisticated folks must have some really good 
supply-and-demand information. That message is very important, 
and it passes through to prices.
    Mechanically, buying the December contract means that for 
many of the markets the physical delivery of product is indexed 
usually to the next maturing contract. So if the price curve is 
sloping upward, upward, upward, and pushed up, up, up, then 
what gets translated through is next month's future contract is 
higher; therefore, that gets indexed to the actual delivery 
contracts for physicals so----
    Senator Levin. I want to end my questions, but I want you 
to just drive that point home.
    Mr. Turbeville. Yes.
    Senator Levin. Because this to me is where there is a link, 
a direct link----
    Mr. Turbeville. Absolutely.
    Senator Levin. A direct link between a futures contract 
going up in price because of that last month, and that is used 
by the people who are actually buying and selling the 
commodity.
    Mr. Turbeville. That is right.
    Senator Levin. So that there is a direct link between the 
futures contract price going up and the commodity price going 
up because people buying and selling the actual commodity use 
that next month's futures price as the basis for their price in 
the actual commodity purchase and sale. Is that correct?
    Mr. Turbeville. That is absolutely the truth. The first 
thing you would look to, not only is it in the contracts, not 
only is it in the procedures for Platts and others that create 
indices like in the oil markets, it actually makes common 
sense. The first price that you would look to is the price that 
occurs--that is indicated for the next month. That will tell 
you whether you should hold onto your commodity or sell it now, 
which means that the next price is absolutely feeding into by 
contract, by indices, and by common sense the price for 
delivery of product in the current month.
    Senator Levin. Real product.
    Mr. Turbeville. Real product.
    Senator Levin. In the real current time.
    Mr. Turbeville. That is right.
    Senator Levin. Thank you. Dr. Coburn.
    Senator Coburn. Let me just follow up on that for a minute. 
What you are saying is this is divorced from supply and demand, 
real supply and real demand.
    Mr. Turbeville. Actually, what I am saying is that real 
supply and real demand, there is not a chart that producers and 
consumers go look up supply and demand, here is the price.
    Senator Coburn. No, but take the example--that is not 
happening on natural gas contracts right now.
    Mr. Turbeville. That is correct.
    Senator Coburn. And the reason is because there is an 
absolute excess supply of domestic natural gas in this country. 
Correct?
    Mr. Turbeville. I think there are two reasons. One is that 
prices are low because of excess supply. The other reason is 
that natural gas is structure--we have looked at this actually 
in our research, that natural gas is structurally different 
from products like oil and wheat. Natural gas comes through 
pipelines and is largely unstorable, so that the best predictor 
of price during a delivery month is actually the price in the 
nearest maturing futures contract, not the next one. And that 
is how people actually contract for natural gas.
    Senator Coburn. Except it is storable because I can show 
you all the wellheads that are turned off in Oklahoma because 
there is so much gas and there is no place to put it, so they 
are leaving it in the ground.
    Mr. Turbeville. You are absolutely right. It is relatively 
less storable----
    Senator Coburn. Let me go to each of you. One of our 
problems is volatility, which the Chairman has talked about, 
which we are seeing, and the connection of volatility to excess 
speculation. So would each of you give me what your definition 
of ``excessive speculation'' is?
    Mr. Cicio. Let me give you a reference point. Prior to 
2000, prior to deregulation of this market, producers and 
consumers of natural gas were about 70 percent of the market, 
and speculators were 30 percent. And I will tell you, from the 
energy managers that are a part of our organization, the market 
worked very well. The prices that we hedged reflected the 
underlying supply and demand of the market all the time. Now, 
these same people would say that the underlying price of the 
commodity does not always do that, and it is because of the 
influx of a lot of speculators who want to do a deal--but 
because the producer and the consumer have already taken care 
of their hedging, speculators will speculate with speculators. 
They are looking for deals to turn, and, again, the only way 
the speculators can turn a profit thru relative volatility.
    And so when you have large traders like the kind I talked 
about earlier, five traders or eight traders controlling 60 
percent of the natural gas market in 2008, these are companies 
with large amounts of cash, and they can move markets.
    Senator Coburn. All right. But let me go back to my 
question. What is ``excessive speculation''? Because that is 
our whole problem. And as you answer this, think about this one 
thing. Can we change the rules here, in our country can we 
change the rules on our exchanges and solve this problem? 
Because unless they are doing it in London, unless they are 
doing it in the rest of the trading centers around the world, 
my fear is, no matter what we do or how we do it and whether we 
are right or we are wrong, what we are going to do is the same 
behavior is going to take place unless all the exchanges 
throughout the world--because we will just trade somewhere 
different. We are just one click away.
    So you agree we have to have some speculators in the market 
to make a market.
    Mr. Cicio. Yes, sir, absolutely.
    Senator Coburn. So what is your definition of 
``excessive''?
    Mr. Cicio. The only reference point--and this is not a good 
one. But the only reference point would be the one I mentioned 
earlier. Prior to deregulation, with 30 percent speculators----
    Senator Coburn. So compared to what it was then.
    Mr. Cicio. We had deals getting done, producers, consumers, 
and speculators, and so I would say--this is not an 
organization statement, but anything more than 30 percent.
    Senator Coburn. All right. And I would just say that 
discounts the change from 2000 to 2011 in terms of the 
globalization of all this trading, right? I mean, we have a lot 
of participants in our market that are not Americans.
    Mr. Cicio. But, Senator, this market is all about a 
commodity, a physical commodity, and the players, the number of 
players and the physical product in this case, natural gas, has 
hardly changed at all. It has only increased 6.5 percent since 
1995, but the volume of trades has increased 600 percent.
    Senator Coburn. So it has not had any effect on price.
    Mr. Cicio. Today, that is correct because of the 
oversupply. But just go back a few years ago, and, yes, sir, we 
did have high volatility and erratic pricing and prices higher 
than what we should have had.
    Senator Coburn. Yes, OK. Mr. Slocum, thank you.
    Mr. Slocum. Yes, I would like to just build on Mr. Cicio's 
comment, but it is clear that the data indicate a rise in the 
level of speculators, and to specifically answer your question, 
I think it is when those that do not have physical delivery or 
production contacts to the underlying commodity have a 
dominating presence in the market. Those that have delivery 
commitments or want to hedge--or if they are suppliers and want 
to hedge their exposure, when they are vastly outnumbered, and 
particularly with the rise of the index funds, where there is 
no interest in the physical delivery or supply of the 
underlying commodity, I think that the markets have become 
skewed. And transparency and disclosure I think is essential 
because the more transparent the marketplace is, the better 
functioning it is going to be for all participants, and we 
still do not see enough transparency. And I really think we 
need to see trader- specific-level data, not instantaneous 
because that would violate some proprietary issues, but for too 
long the banks have enjoyed their relative obscurity in not 
being publicly identified.
    I remember I was at a hearing at the CFTC, and I was making 
comments critical of some of the large investment banks for 
their speculative activities. And there was a gentleman from a 
hedge fund who sounded a lot like me, and I had to talk to this 
guy and figure out why a hedge fund guy was sounding a lot like 
the Energy Program director at Public Citizen. And it was 
because he was complaining that the banks control the market, 
that it is too secret. This is a large hedge fund, one of the 
largest in the country, and he felt that he was at a massive 
disadvantage to Goldman Sachs. So imagine if you are one of 
those smaller independent gas producers in Oklahoma or a 
manufacturer trying to compete in a global economy. The deck is 
stacked against them as long as the banks are able to operate 
in secret and do not have adequate controls over the size of 
their positions.
    Senator Coburn. So it is your assumption that it is all the 
banks that are creating the excessive speculation?
    Mr. Slocum. I think the data indicates, and especially the 
leaked data that finally named some individual names, that the 
banks clearly are at the top of the list in terms of their 
positions. But it is also clear that there are major, 
especially vertically integrated players in the petroleum 
sector that are also big. Chevron inadvertently disclosed that 
it----
    Senator Coburn. Yes, that is a repeat. Mr. Turbeville.
    Mr. Turbeville. I think you start with what excessive 
speculation is. There is actually some fairly good knowledge on 
what the required amount of speculation is, and that tends to 
be somewhere about a third of the whole market. Two-thirds 
hedging/one-third speculation makes the market work.
    Speculation in excess of that really ties into the very 
purpose of the market, which, interestingly, sort of reflects 
the language of the Commodities Exchange Act. When they 
originally talked about back in the old days excessive 
speculation, they described it as ``unwarranted and 
inappropriate higher prices in volatility.'' I think that ties 
into the purpose of the market. To the extent that speculation 
is not required but is in excess of what is required, it is 
excessive, meaning it is bad, if it damages the price discovery 
function so that suppliers and consumers can know what the 
forward price is--in other words, it damages the forward price 
curve that I was talking about before--or it inhibits in anyway 
hedgers actually hedging their positions in the market--the two 
real functions of the market, hedging and price discovery, 
which are related.
    So if volatility causes it to be very expensive to hedge, 
that is a bad thing, and if excessive speculation causes that, 
it should be ended. If the price discovery function is damaged, 
meaning I do not know where prices are going because of things 
that are being done in the speculative market, that is a bad 
thing.
    So speculation is excessive if it damages price discovery 
or the ability to hedge well.
    Senator Coburn. Excessive speculation leads to markedly 
increased volatility, what you should expect some market force 
on real supply and demand to have some influence on.
    Mr. Turbeville. You would.
    Senator Coburn. In up movements you should see exaggerated 
up movements. In down movements you should see exaggerated down 
movements. And from the testimony I hear, I am not hearing that 
there is an excessive down movement. Explain that to me on 
speculation, when there is a marked excess supply, why we do 
not see an excessive down movement.
    Mr. Turbeville. That is really an interesting point, and it 
goes to the issue--you would expect to see it. We have all 
grown up in the Chicago School of Economics that markets work 
perfectly and are very efficient, which I think sometimes makes 
it hard for some of the academics to understand what is going 
on in the commodities markets right now. I am not an academic, 
so maybe that is easier for me somehow.
    Senator Coburn. So maybe you can understand it.
    Mr. Turbeville. Exactly. [Laughter.]
    I think the reason is the market is actually imperfect. If 
you have a huge sector of the market that is long only and is 
insensitive to price and trades on specific days that everybody 
knows about, what you have is this force, this bias, if you 
will, towards upward prices. So I think what you see in sort of 
the boom-bust cycle, what is suggestive, as our research 
suggested, is that, in fact, what is happening, this constant 
trading without regard to what the price is, I do not care what 
price----
    Senator Coburn. I know if that is the case, that means the 
investors in those instruments are price insensitive as well.
    Mr. Turbeville. That is correct.
    Senator Coburn. And why are they?
    Mr. Turbeville. Because they actually are investing to 
create a portfolio effect in a larger----
    Senator Coburn. Then why is not everybody doing that? Why 
isn't all the money moved there? If it is a sure deal, if it is 
a sure bet and that price is on the come and it is going to 
rise, why isn't everybody doing it? You cannot have it both 
ways.
    Mr. Turbeville. Right.
    Senator Coburn. If they are price insensitive, if they do 
not care what the price is because they are sure they are going 
to make money on the next month as they roll it over, why isn't 
everybody doing that?
    Mr. Turbeville. Well, OK. There are two questions. If you 
would, indulge me here. The investors are not in it to make 
money like you would make money on a stock. They are in it 
because they want to have part of their portfolio that moves 
just like commodities move.
    The other side of the coin, which is a really interesting 
one, which is our premise is that because of the trading 
activity, the curve moves up, right? Why don't the arbitragers 
squeeze that out instantaneously? That is a really good 
question, and efficient markets theorists would say that would 
happen. Our data suggests that it actually does not happen, so 
you sort of ask yourself the question why.
    I personally believe that the reason why is that the market 
as a whole--remember, the trading is done by Goldman Sachs and 
JPMorgan, those folks. As they see those traders pricing those 
contracts, their interpretation is, well, they must know 
something that we do not. And it is not random trading 
activity. But it is not trading activity based on the rationale 
of profit and loss.
    Senator Coburn. Of a transparent market.
    Mr. Turbeville. Right. So it confuses the world about what 
the supply and demand is. I actually think that is what is 
going on, is that the prices are distorted. So going back to 
excessive speculation, if the price discovery function is being 
injured, that is a problem, and I would consider that excessive 
speculation and speculation that should be corrected.
    Senator Coburn. Thank you very much.
    Mr. Slocum. Dr. Coburn, may I quickly add something?
    Senator Coburn. Sure.
    Mr. Slocum. As part of my written testimony, I took a look 
at the Goldman Sachs Commodity Index (GSCI), and so your 
question is, if these index funds are such a good deal, why 
isn't everyone moving into them? According to SEC filings by 
GSCI, in January 2009 there were 135 shareholders or entities 
that were investors in GSCI. Two years later, in January 2011, 
there were 49,120. Now, they do not provide any explanation of 
whether or not there was some sort of plausible explanation of 
this or whether or not Goldman's sales reps are doing a heck of 
a job selling to institutional investors and high-net-worth 
individuals. But those numbers are staggering, and it is clear 
that Goldman is promoting this as an investment vehicle for 
certain key audiences.
    Senator Levin. All right. Let us try another round. I want 
to move to high-frequency trading. Are you aware, each of you, 
of an increased presence of high-frequency traders in the 
commodity markets? And if so, are those high-frequency traders 
exacerbating volatility and price distortion? Let us start with 
you, Mr. Cicio.
    Mr. Cicio. Well, yes, high-frequency trading is putting a 
lot of pressure on volatility. As stated earlier, traders make 
their profits on price movements. It does not matter whether it 
is up or down. And so the high-frequency trades is having a 
direct impact on moving the market, and that is not good for 
price discovery when we are looking at a consumer for a price 
that reflects the supply and demand rather than reflecting 
high-frequency, computer-driven, technical trading, speculator-
driven type of decisionmaking.
    Senator Levin. Mr. Slocum, do you agree with that?
    Mr. Slocum. Absolutely. Mr. Chairman, I testified before a 
panel that the CFTC put together a year or so ago, and after 
our research at Public Citizen, we deemed that high-frequency 
traders do not serve a legitimate function in these markets.
    With all due respect to the hard-working career staff at 
the CFTC, which are doing a heck of a lot with relatively 
little resources----
    Senator Levin. And they are looking right at you as you 
testify.
    Mr. Slocum. Right. They cannot compete with the types of 
strategies, computers, and resources. It is overwhelming for 
enforcement staff to keep up with the activities and the volume 
and the constantly evolving strategies of these high-frequency 
traders. And as long as our hard-working regulators are unable 
to get a handle on how these high-frequency traders are 
operating, it is clear that they are not serving a legitimate 
market function. It is clearly disadvantaging those that are 
seeking to enter the market for legitimate hedging purposes.
    Senator Levin. OK. Mr. Turbeville.
    Mr. Turbeville. I agree with the other panelists in what 
they have said. The high-frequency trading is to gain advantage 
based on a different level of knowledge that others in the 
market have. That is the whole point of it. And in the 
commodities markets, that is a very dangerous thing. It is 
different from the stock markets and bond markets which are 
really--there is no such thing, for instance, as excessive 
speculation in the stock market. So that kind of activity in 
the commodities market can be more damaging to the market 
itself because of the functions that we described, hedging and 
price discovery being the main ones.
    I am also concerned about this: I am concerned that as the 
markets evolve into markets with swap execution facilities so 
that everything is electronic but that there are multiple 
venues in which transactions can be matched, that the ability 
of high-frequency trading to actually move around from venue to 
venue to venue to take advantage of things like payment for 
volume--in other words, a swap execution facility could well 
pay for volume because they get value from the other side of 
the trade--that you might see the kind of activity from high-
frequency traders that is actually gaming the system that is 
actually created to maximize full disclosure of what is going 
on. So the full disclosure is really good, but without some 
kind of a control to make sure that HFT types do not move 
transactions around, that could actually allow those folks to 
game the system to the detriment of others and make it an 
unfair system.
    Senator Levin. Let me ask you about Exhibit 1b,\1\ which is 
a chart which shows total assets invested in commodity-related 
exchange traded products. These totaled over $100 billion last 
year, these commodity-related ETPs, as they are called. And we 
have listed a lot of those in Exhibit 6 \2\ in our book. ETPs 
offer securities now that track the value of a commodity--or a 
basket of commodities, but they trade like stocks on an 
exchange.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1b which appears in the Appendix on page 111.
    \2\ See Exhibit No. 6 which appears in the Appendix on page 176.
---------------------------------------------------------------------------
    Are ETPs adding to speculative pressures on the commodity 
markets? Let us start with you, Mr. Turbeville.
    Mr. Turbeville. There is no question. If you look at it 
from a more cosmic level, the 30,000-foot level, one of the 
things happening is you are creating a huge amount of synthetic 
ownership of commodities as if they were hoarded, and the 
market is actually interpreting that at some level the 
commodities are being hoarded, therefore, the prices move up 
until something happens and the bubble bursts and everybody 
say, oh, yes, I remember now, those were just synthetically 
hoarded. So it is absolutely a similar kind of thing.
    To be honest with you, there is one question that the world 
should ask itself. This desire to own commodities, if you own a 
basket of commodities for 125 years, should we all live that 
long? You will have made something like the inflation rate on 
that market basket. That is all.
    The world should ask itself: Why is this such a popular 
thing to do? Is it because it is a good thing to sell by the 
sales folks? Or are people actually making sensible investment 
decisions by actually putting their money into commodities if, 
in fact, what I said is true, is after 100 years you have just 
got inflation after all?
    Senator Levin. Just very quickly, because I have some other 
questions, Mr. Slocum, would you agree with that, that ETPs are 
adding to speculative pressures on the commodity market?
    Mr. Slocum. I would, absolutely, and I really applaud the 
efforts of this Subcommittee to address some of the issues of 
this, particularly what you outlined in your opening statement 
about mutual funds using their investments in this to kind of 
get around some existing regulations. That is clearly 
problematic.
    Senator Levin. OK. Mr. Cicio.
    Mr. Cicio. Most certainly.
    Senator Levin. And now let us go to the mutual funds 
question. As I mentioned, we have an exhibit, Exhibit 7a,\1\ 
that identifies 40 mutual funds that primarily trade in 
commodities. The commodity-related mutual funds over the last 
several years have gotten into the game big time. We have come 
across one mutual fund that has over $25 billion in assets with 
one of its primary purposes to trade in commodities.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7a which appears in the Appendix on page 185.
---------------------------------------------------------------------------
    Are mutual funds that trade in commodities also 
contributing to commodity price speculation? And do you believe 
that we ought to keep the 90-percent rule that investment 
revenues accrued by mutual funds must be realized from 
investments in securities and no more than 10 percent should be 
realizable from alternative investments, including commodities? 
Can you give me a yes, no, or maybe? Mr. Cicio.
    Mr. Cicio. We think that mutual funds should not be 
participating in commodities period because, again, it has 
nothing to do with supply and demand and price discovery.
    Senator Levin. We currently have a 10-percent rule, so you 
at least would want us to hold to that.
    Mr. Cicio. Yes, sir.
    Senator Levin. Mr. Slocum.
    Mr. Slocum. I agree, absolutely, yes.
    Senator Levin. OK. Mr. Turbeville.
    Mr. Turbeville. The numbers are just staggering. Any 
percentage of mutual funds added compared to an open interest 
in commodities, in physical commodities of around $900 billion 
would just swamp it, yes.
    Senator Levin. And there is no stopping it now if they are 
allowed to continue to have these offshore deals that they 
wholly own and if they are allowed to in other ways circumvent 
the 10-percent rule?
    Mr. Turbeville. There is no stopping it, and the sales 
forces must be very effective, as I pointed out before.
    Senator Levin. By the way, we did actually stop it in the 
Senate. We had a House bill which would have eliminated that 
limit of 90 percent and said you can have as many speculative 
investments as you want in commodities. It came over from the 
House with the abolition of the 10 percent. We were able to 
strike it here. And the Senate sent it back to the House 
without that. There were some other things, mutual funds 
requested, but it did not get that one. And I think there has 
been very little attention paid to this issue, and I would hope 
that one of the things this hearing will do is to focus on this 
question really for the first time as to whether we ought to 
have this circumvention, through the offshore--these 
corporations which are shell corporations, and who is going to 
regulate them, and that is a big issue which we will also get 
into with Mr. Gensler.
    I think I am over my time on the second round. Dr. Coburn.
    Senator Coburn. Thank you. Let us go back to what we have 
kind of created. It is very interesting. I am trying to get a 
balance on where this bubble, if we do not do something about 
what is going on, is going to end, because it is not going to 
go up forever. In other words, there is going to be a point in 
time where somebody says, well, these guys are trading this 
next month. They are saying, ``How do I make money off that?'' 
And then there is going to be the opposite of that.
    So, we are always going to have to have speculators to make 
a market. We really cannot make a market without some 
speculation in it. If we could, we would not be where we are 
today. If we go too far or if we do not go far enough, we are 
going to have price exaggerations, either below or above, and I 
think everybody would agree with that. And we are always going 
to have some price exaggeration based on world events, whether 
it be Libya causing oil to cost $15 to $17--maybe that was 
exaggerated based on what we are seeing today, but the fact is 
there was a world event that put world oil supplies at risk and 
that should have some effect on commodity prices. The same 
thing on cotton, as I mentioned before. You had crop failures. 
You had $4 cotton in this country, which nobody had ever seen.
    Was that an exaggeration because of this? Was it made 
worse? So I would like your comment on how you tie in true 
supply-demand effects and what we are seeing. How are those 
true supply-demand effects that enter the market, that are 
fundamental differences in available supply or excess supply or 
marked increase in demand for some reason or another, how do 
those interact with what we are seeing going on in the market?
    Mr. Slocum. I think that there is no question that the 
supply-demand fundamentals play a role in these markets. It is 
why you have seen this big disconnect with natural gas and 
crude oil. It is because natural gas is not globally priced, 
and we do have enormous supply. That will definitely change if 
we start switching more and more of our coal plants to gas or 
if T. Boone gets his way and we have got more trucks on the 
road using natural gas. And as Mr. Cicio noted, it was in the 
very recent past that we saw significant price increases and 
volatility. Natural gas has a long history of that kind of 
volatility.
    But it shows that with massive amounts of supply-demand 
evidence that is dominating the market, supply-demand can play 
a role, but in a globally priced commodity like crude oil, 
where you have speculators playing a significant role, I think 
that what we see is the volume being driven by these 
speculators and by the index.
    Senator Coburn. With the marked excess in supply of natural 
gas, why isn't it significantly lower than it is today if these 
guys are playing? Why isn't it $2 instead of $3.60 or $3.90?
    Mr. Slocum. Right.
    Senator Coburn. Why isn't it $2?
    Mr. Cicio. That is what manufacturers are asking.
    Senator Coburn. But I am asking it on the basis if we have 
excess speculation based on market forces or intended market 
forces, why aren't we seeing an exaggeration on decreased 
price? That is my whole problem with what we are being 
presented with here today. Everything seems to be rigged for an 
upward bias, but when there is fundamental market indices that 
say there is absolute two to three times as much natural gas as 
this country can consume available right now, why aren't you 
seeing the other side of this? Where is the market failure in 
that?
    Mr. Cicio. Well, actually, Senator, as consumers, given the 
increased supply of physical natural gas, we think that prices 
probably should be lower than they are. But because of the ETFs 
and the ongoing long positions that I talked about, remember, 
86 percent of all of the index positions historically have been 
long. There is this growing amount in volume of long positions 
that keeps encouraging the upward pricing pressures versus a 
reflection of the oversupply of the marketplace.
    But interesting about natural gas is that if you look at 
the Chicago Mercantile Exchange, which I did last week, and 
look out 5 years to see what the price of natural gas is, given 
our vast supply of natural gas, one would think that there 
would be a downward price curve, much like what was talked 
about earlier, which is historically what commodities had. They 
had a downward pricing curve. Natural gas prices 5 years out 
show a 52-percent increase.
    Senator Coburn. Yes, but that is readily explainable. We 
are building LNG terminals. We are going to ship it to the 
Chinese and Europe. The other factor is we are going to see 
massive inflation in this country in 2 or 3 years, and people 
are anticipating that. So maybe that is the reason that there 
is not the downward side to it. But I still have problems. Mr. 
Turbeville.
    Mr. Turbeville. One of the things that occurs to me about 
natural gas is something you mentioned, which is that natural 
gas gets stored in the ground as opposed to next to its use. So 
there is a limit on how low natural gas can go because no 
matter how much the supply is, the constraint is actually the 
transmission associated with it. But the fact is that one way 
to approach all of this is to try to decide how much--or what 
really is the effect of trading as opposed to supply and 
demand, is to look at elements that are unrelated to supply and 
demand--I am sort of promoting what we did, but that is 
specifically why we did it.
    We looked at the 5-day roll periods--over 27 years, which 
has nothing to do with supply and demand, and looked at the 
bias associated with that. The law of supply and demand has not 
been repealed. Nobody should think that is true. However, it is 
fairly certain that this inefficiency does occur on the margin, 
and how much is it? It is hard to say. The St. Louis Fed has 
said it is something like 17 percent of the price. It probably 
changes over time. But it also is biased towards upward levels, 
and it is because of this huge price-insensitive long that is 
in the market. I believe that is true, too.
    Senator Coburn. All right. Thank you.
    Senator Levin. The rule that came from the CFTC makes a 
distinction between commodity swaps that reference a single 
commodity, like oil, and those that reference a basket of 
different kinds of commodities, like oil, gold, and wheat. The 
rule applies position limits to single commodity swaps but no 
limits at all to multiple commodity swaps.
    Can you give us your opinion as to the basis for that 
distinction? And how does it affect the effort to combat 
excessive speculation? Let us start with you, Mr. Slocum.
    Mr. Slocum. Well, in terms of why the CFTC has taken this 
approach, I think Mr. Gensler is following us, and I think he 
is a lot more qualified to----
    Senator Levin. We will ask him, too, but do you----
    Mr. Slocum. Yes, I do not know why they have done that. I 
am concerned that differing treatment is problematic and will 
encourage levels of speculation because of that loophole that 
are going to be problematic for consumers.
    Senator Levin. OK. Mr. Turbeville.
    Mr. Turbeville. I guess we are mostly interested in the 
result, right? Do commodity index funds get effectively 
regulated and limited? They have taken this approach of saying 
a multiple index swap is not disaggregated into its component 
parts. It is just a swap that exists out there and is not 
subject to----
    Senator Levin. Does that trouble you? Are you OK with it?
    Mr. Turbeville. I am OK with it as long as the actual 
limits themselves--because what happens is, of course, the 
bankers then have to go do swaps and futures on the other side 
of that. If those swaps and futures really got effectively 
regulated, it would not be a problem. My concern is that there 
are too many ways to use the single entity limits in such a way 
and to manipulate them so that the bankers never will get 
regulated. So the better result would have been to say a 
multiple swap is regulated and limited.
    Senator Levin. What happens if a basket is 99 percent oil 
and 1 percent something else? Doesn't that kind of make the 
position limits ineffective?
    Mr. Turbeville. Yes.
    Senator Levin. I know you are worried about that. We are 
just warming up for Mr. Gensler. [Laughter.]
    Mr. Turbeville. I understand. Yes, I would have been 
personally, and as an organization, more comfortable to go 
ahead and address the issue straight on and say let us talk 
about the swaps themselves rather than indirectly trying to 
get--you are right. What happens is it becomes a metaphysical 
concept.
    There is by analogy in other rules, agricultural rules, 
that more than 50 percent will constitute that swap, an oil 
swap, but it does not actually apply to oil.
    Senator Levin. OK. Mr. Cicio, do you have a thought on 
that?
    Mr. Cicio. Well, just briefly. We were troubled by the 
differing treatment as well, and we would rather have the spec 
position limits apply to all, so undifferentiated.
    Senator Levin. OK. Just one last question about a netting 
rule in the final rule of the CFTC which allows a swap dealer 
who sponsors a single commodity index fund to net any short 
position created by the sale of a commodity swap to a client 
with a long future involving the same type of commodity. So the 
netting rule means that to the extent the swap dealer is 
hedging its financial risk by buying long futures to offset its 
client's speculative bet, the swap dealer can claim his 
position is flat and not subject to any position limits.
    So the swap dealer then could sell $1 billion in swaps to a 
lot of clients and then offset that risk by buying $1 billion 
in futures, affect the price of those futures it is buying, but 
still not be subject to any position limit. Does that netting 
rule open up a loophole for swap dealers who will be able to 
sell and offset as many single commodity swaps as they want 
even if that activity floods the commodity markets with 
speculative money? Is there a loophole created by that rule, 
Mr. Turbeville?
    Mr. Turbeville. That was a change to the proposed rule that 
was in the final rule. The concern there is that what the rule 
suggests is that the swaps market and the futures markets are 
all one market and should be viewed as such. We think that is 
not appropriate. We think that the futures market is a very 
specific market that creates a very important--it has a very 
important role in price formation and price discovery. And so 
the netting across those two clearly should not be allowed, 
although it is.
    Senator Levin. OK. Mr. Slocum, do you want to comment on 
that?
    Mr. Slocum. I definitely share your concern. I think you 
articulated a potential abuse, and I think it underlies the 
fallacy of creating this potential for loopholes.
    Senator Levin. OK. Mr. Cicio.
    Mr. Cicio. And we agree with you, sir.
    Senator Levin. I said that was my last question, but I do 
have one other comment I want to make, and that has to do with 
a comment of the CEO of the Intercontinental Exchange (ICE). It 
is headquartered in Atlanta, and Jeffrey Sprecher was quoted in 
a September investment bank research report as saying that the 
energy markets may work better with position limits in place. 
It is a very important comment because it is coming from the 
CEO of ICE, but it has not been, I think, widely quoted yet, 
and I hope this may help a little bit if I quote it:
    ``It is not necessarily a bad thing for exchanges to 
prevent one large player from having concentration. ICE imposed 
its own version of position limits in its markets. The volume 
had actually increased. There was a healthier market with more 
and smaller players as a result.''
    And here is what he then said: ``A lot of people do not 
like the thought of being limited in any way, but the reality 
is, and the evidence so far at ICE is, that we have grown very 
well during a position limit regime.''
    I am just wondering whether each of you would welcome that 
kind of a comment from a person in that position. Mr. Cicio.
    Mr. Cicio. Clearly, yes, sir.
    Senator Levin. OK. Mr. Slocum.
    Mr. Slocum. Yes, I think it underlies how much of the 
debate on this issue, and sometimes others, where you have some 
powerful interests where their status quo is threatened and 
they will claim that the sky is falling is very basic 
regulatory oversight is applied to their sprawling complex 
operations. And every once in a while you get a moment of truth 
in that, like apparently the CEO of ICE. So I am glad that you 
are quoting him on that.
    Senator Levin. Mr. Turbeville.
    Mr. Turbeville. I not only welcome it, I agree with 
everything he said.
    Senator Levin. Thank you all. We are going to make all the 
statements part of the record, and there is an additional 
request for a statement to be made part of the record by the 
Petroleum Marketers Association of America and the New England 
Fuel Institute, and we will make that testimony part of the 
record. We will leave the record open for other organizations 
that might wish to file statements.\1\
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Ramm, Petroleum Marketers 
Association of America and the New England Fuel Institute which appears 
in the Appendix as Exhibit No. 10 on page 266.
---------------------------------------------------------------------------
    We will thank this panel. It has been very useful and 
helpful testimony. Thank you all.
    [Pause.]
    Mr. Gensler, we welcome you. We appreciate your not just 
coming here to testify but taking some extra time to listen to 
our other witnesses. We very much appreciate that. We look 
forward to your testimony.
    I think as you know, all the witnesses who testify before 
our Subcommittee are required by our rules to be sworn, so I 
would ask you to please stand and raise your right hand. Do you 
swear that the testimony you are about to give will be the 
truth, the whole truth, and nothing but the truth, so help you, 
God?
    Mr. Gensler. I do.
    Senator Levin. The light will go on from green to yellow 
about a minute before the 10-minute period is up, so we would 
ask you to try to limit your oral testimony to no more than 10 
minutes. There will be whatever time we need, obviously, to get 
your entire testimony in one way or another. So we again thank 
you for being here and please proceed.

  TESTIMONY OF THE HON. GARY GENSLER,\2\ CHAIRMAN, COMMODITY 
                   FUTURES TRADING COMMISSION

    Mr. Gensler. Good morning, Chairman Levin and Ranking 
Member Coburn.
---------------------------------------------------------------------------
    \2\ The prepared statement of Mr. Gensler appears in the Appendix 
on page 98.
---------------------------------------------------------------------------
    Senator Levin. We expect he will be able to return. He had 
another important mission here this morning.
    Mr. Gensler. Well, if Ranking Member Coburn is listening 
somewhere, I thank him as well.
    I thank you for inviting me here today to talk about the 
changing nature of the derivatives markets and on position 
limit rules.
    The derivatives markets have changed significantly since 
the CFTC opened its doors back in 1975, and you have noted in 
some of your excellent charts these changes. But, first, there 
is the swaps market as well. This emerged in the 1980s, and it 
is now seven times the size of the futures market.
    Second, instead of being traded just in the trading pits in 
Chicago and New York and elsewhere around the globe, much of 
the market, over 80 percent, is traded electronically, a click 
of a button.
    Third, while the futures market has always been where 
hedgers and speculators meet in a marketplace, a significant 
majority of the market is made up of now swap dealers, hedge 
funds, and other financial traders.
    Fourth, the vast majority of trading is now day trading or 
trading in what is called calendar spreads, between 1 month and 
a later month, but not necessarily to go outright long or 
outright short. And I would add, as your charts suggest also, a 
fifth point is that a significant portion of the market is now 
in these index investments, more on the long side than on the 
short side.
    Now, the CFTC is focused on ensuring our regulations are 
responsive to today's markets. We are an agency that is not set 
up to be a price-setting agency, but it is an agency to promote 
transparency in markets, to police against fraud, manipulation, 
and other abuses, and to ensure that there is integrity in 
markets and the price discovery in the market has integrity for 
all the hedgers in this market.
    This summer, of course, with the Dodd-Frank Act's passage, 
we turned a corner and began finalizing many rules with regard 
to the swaps market but also updating some of the market rules 
on the futures market, and to date, we have completed 18 final 
rules and have a busy schedule throughout the rest of the year 
and into next year.
    We have completed rules giving the CFTC enhanced anti-
manipulation and anti-fraud authority, and it extended the 
Commission's reach to include reckless use of fraud-based 
manipulative schemes. And I know we have chatted about this in 
the past as a very important extension of our authority to fill 
a gap in our enforcement tools.
    The CFTC also approved a final rule on large trader 
reporting for physical commodity swaps. For the first time, the 
clearinghouses and the dealers, the swap dealers themselves, 
must report to the Commission information about swaps activity 
on the large trades, and that rule actually went effective last 
month--well, now 2 months ago, September.
    The CFTC also completed the rules that are the center of 
this hearing, the aggregate position limits rules for physical 
commodities. A position limit regime is a critical component of 
comprehensive regulatory reform of the derivatives markets. 
Position limits have served since the Commodities Exchange Act 
passed in 1936 as a tool to curb or prevent excessive 
speculation that may burden interstate commerce, and the 
emphasis might be on prevent, as the Chairman mentioned 
earlier, and it has been used since, I think, we first put in 
place our predecessor's position limits in 1938 using that 
initial authority. I think it was then in bushels. It might 
have been 2 million bushels of a certain grain.
    And though, as I mentioned, the CFTC is not a price-setting 
agency, at the core of our obligations is to promote market 
integrity, which the agency has historically interpreted to 
include ensuring markets do not become too concentrated. You 
mentioned that quote of an exchange leader--but I think that 
was really at the core of what Mr. Sprecher's quote was--about 
concentration of markets and making sure that there is no one 
who has an outsize position.
    In the Dodd-Frank Act, Congress mandated the CFTC to set 
aggregate positions for physical commodity derivatives, and 
this would include for the first time and historically position 
limits on swaps as well as futures, which I mentioned are seven 
times the size of the market, and even certain linked contracts 
on foreign boards of trade that might be trading overseas but 
linked to these contracts. And the final rule achieved that.
    The Dodd-Frank Act also tightened the definition of bona 
fide hedging. Since the 1930s, the concept was this was a limit 
on speculators not hedgers, but over time there had been some 
creeping and widening of that by the CFTC, various rules and 
interpretations and sometimes no-action letters. Congress 
addressed that and said it should be narrowed such that the 
exemption only be for transactions and positions that served to 
mitigate risk in the cash market for a physical commodity, and 
I believe the final rule achieved that as well.
    The Dodd-Frank Act also mandated that we set position 
limits for energy, metals, and agriculture for the spot month 
and something called individual month and all months combined, 
and I believe the final rule achieved this on the 28 physical 
commodities. I would mention that the rule re-establishes 
position limits for all months combined and individual months 
for energy and metals, which had existed actually, but had been 
taken off in 2001 in energy and in the late 1990s in the metals 
markets.
    Before I close, I would like to briefly mention the events 
this week of MF Global, if I might. Earlier this week the CFTC 
and SEC determined that the Securities Investor Protection 
Corporation-led bankruptcy proceeding would be the safest and 
most prudent course of action to protect customers of this 
failing financial institution. The most troubling aspect about 
MF Global's situation is the shortfall of customer money in the 
firm. Segregation of customer funds is at the core, and it is 
really a foundation of customer protection in the commodity 
futures and swaps markets. Segregation must be maintained at 
all times. Simply put, that is at every moment of every day 
down to the nanosecond.
    The Commission intends to take all appropriate action 
within the purview of the Commodities Exchange Act and the 
Bankruptcy Code to ensure that customers maximize the recovery 
of funds and, I say, to discover the reason for the shortfall 
in the segregated customer money. The CFTC and SEC and other 
regulators will continue to closely coordination actions, and I 
thank you. I would be happy to take any questions.
    Senator Levin. Well, thank you very much, Mr. Gensler. 
Since you made reference to the MF Global, let me just start 
with that. Is there any risk of a taxpayer bailout in this 
case?
    Mr. Gensler. No, I think this was an example, actually, of 
a financial institution having the freedom to fail.
    Senator Levin. So there is no risk of a taxpayer bailout.
    Mr. Gensler. I think that is right. I think when the 
Chairman of the SEC and I were on these middle-of-the-night 
conference calls from 2:30 a.m. to about 7 a.m. on Monday and 
we not only informed that there was not somebody to take the 
customer positions over but that there was the shortfall in the 
customer accounts, we really saw no alternative but to protect 
the customers, put it into bankruptcy, and it is in 
liquidation. But, Chairman, I do not think that there is any 
taxpayer money behind this.
    Senator Levin. Or at risk.
    Mr. Gensler. Or at risk.
    Senator Levin. Now, you made reference to what the CFTC is 
going to do or continue to do, I think was your word. Can you 
tell us just briefly what you have done and what actions you 
can take or will take to protect their clients?
    Mr. Gensler. Well, throughout this week we have worked very 
closely with the court-appointed trustee who is now in place 
over this company, and we have worked very closely with the 
various clearing organizations and other clearing firms to try 
to move the positions. We were successful yesterday that the 
bankruptcy court did an order to allow customer positions to 
move. But the monies themselves may have to wait a bit because 
the trustee and the bankruptcy court have to really do a full 
accounting. We are in there as well. We have had people at MF 
Global since last Thursday really trying to assess this, but, 
of course, events changed dramatically on Monday with the 
shortfall.
    Senator Levin. OK. Now, getting back to the subject of the 
hearing today, let me start by asking you about the Dodd-Frank 
Act requirement that you have attempted to implement in your 
rule and trying to curb excessive speculation and manipulation 
in the commodity markets by imposing position limits on 
commodity traders. I am just wondering whether you feel, as the 
Dodd-Frank Act believes and reflects, that it is critical to 
put this rule in place for jobs, for economic recovery, to help 
ensure that prices for vital commodities like crude oil will 
reflect supply and demand rather than speculative pressures.
    Mr. Gensler. I do think it was critical to put this in 
place and to fully implement it. I think it is critical that 
these markets have only--that they not have outsize 
concentration by one party or another, and particularly as 
Congress intended for us to do to place these limits on 
speculators. I think that markets work best when they have a 
diversity of points of view and a diversity of speculative 
interest. They are really primarily, as I think you and others 
have said, for hedgers to hedge. It was originally somebody 
growing corn or wheat to lock in the price at harvest time, and 
then, yes, there was a speculator on the other side who locked 
in that price and in a sense was taking a bet on where corn or 
wheat would trade.
    Senator Levin. But the speculation has now gone way beyond 
providing the needed liquidity for that kind of hedging, so now 
speculation is a greater part of the market than the actual 
trading that is needed if you are going to hedge. Would you 
agree with that?
    Mr. Gensler. Yes. I remember discussing this with you about 
3 years ago when we were in your office, when I was just a 
nominee for this job. But I think I share that view.
    Senator Levin. And do you believe that the price swings in 
oil futures in 2008 and 2001 were caused in part by speculation 
and that became disconnected to the fundamentals of supply and 
demand, that these broad price swings in oil obviously have an 
actual market connection to the real fundamentals of supply and 
demand, but that there is a significant part of these price 
swings in oil futures that are the result of speculation.
    Mr. Gensler. We are not a price-setting agency, but when 
the markets are made up of--I will use oil--approximately 12 or 
13 percent of the long positions of producers and merchants, 
and if I recall, maybe 18 percent of the shorts. And we publish 
these figures every Friday. They are public. So that means 80 
to 87 percent of the market are financial participants, swap 
dealers, hedge funds, and other financials.
    Senator Levin. Those are the speculators we are talking 
about.
    Mr. Gensler. People generally use that word.
    Senator Levin. Right.
    Mr. Gensler. But I think it is both hedgers and 
speculators, and financials have an influence on price, so on 
any given day it is hard to determine whether it is up or down, 
but I think it is uncontroversial that speculators, when they 
are 80-plus percent of the oil market, and some of the 
agricultural markets at 60 percent, have a role to play, as has 
been known since the 1930s, and then we police for fraud and 
manipulation. We promote transparency, and then we use position 
limit regimes to ensure against any concentrated position and 
also to police against manipulation.
    Senator Levin. So there is a legitimate role that is played 
by people who obviously have to fund people who want to hedge. 
That is a legitimate role.
    Mr. Gensler. That is correct.
    Senator Levin. In terms of the excessive amount of 
speculation, you do not consider that to be legitimate? If it 
is excessive, it is not legitimate.
    Do you agree that excessive speculation, however it is 
defined, is not legitimate? By definition do you agree?
    Mr. Gensler. Well, I think Congress made a finding, and 
what we were asked to do is then to set position limits, which 
we have done not only just 2 weeks ago but since the 1930s, to 
ensure against the burdens that may come. The burdens can be 
just that a large position wants to sell at an inappropriate 
time for everybody else. It is their right to sell, but it 
could distort prices in the midst of a crisis or even in clear 
times. Or the burden could come from either direction because 
it is an outsize position that pushes the price down or up. So 
we have used it to sort of ensure against the concentration of 
positions in the marketplace.
    Senator Levin. And are price distortions and large price 
swings a problem?
    Mr. Gensler. Well, these markets--and again, we are not a 
pricing agency--will have volatility, just like securities 
markets will have volatility. But what producers and merchants 
want to do is lock in a price so that they can do what they are 
really good at. What they are really good at is either tilling 
the field or merchandising product to consumers. And so it is 
important that they have confidence in the markets and can 
ensure that the markets have supply and demand at their core of 
the price discovery.
    Senator Levin. And is it important that supply and demand 
be at the core of price discovery?
    Mr. Gensler. Yes.
    Senator Levin. And is that frustrated when there is a large 
amount of speculators, as we have defined it here, in the 
market where that dominates?
    Mr. Gensler. It is an excellent question, is there, in 
essence, a percent, as was asked earlier.
    Senator Levin. I am not asking you what the percent is. Is 
that legitimate function for hedging frustrated when there are 
large amounts of speculation as we have defined it?
    Mr. Gensler. I think at our core is to ensure that the 
markets are free of manipulation and fraud--I am thankful that 
you and others helped us get better manipulation authority--and 
then to use these position limits to ensure that no one is 
greater than a certain percent. For instance, at the core of 
our rule is that no one is greater than approximately 2.5 
percent of these markets for the all-months combined. I mean, 
if they are a smaller market, there is another percent. And so 
that means there in essence would have to be a diverse number 
of speculators, not one that necessarily has an outsize 
position.
    Senator Levin. Do you believe that the purpose of our 
congressional enactment is to prevent excessive speculation? 
The word ``prevent,'' which is in the law, do you believe that 
is the congressional intent?
    Mr. Gensler. I am well advised by counsel that once worked 
with you who tells me it is to prevent the burdens that may 
come from excessive speculation. So it is preventative and 
forward-looking, and that is how we have used it in the past, 
and I think Congress understood that, and it is the clear 
intent of the statute, Dodd-Frank Act, that we set these 
aggregate positions.
    Senator Levin. Let me read Section 737 of the Dodd-Frank 
Act to you: The CFTC ``shall set limits . . . to the maximum 
extent practicable . . . to diminish, eliminate, or prevent 
excessive speculation . . . '' So is that one of the purposes 
of the Dodd-Frank Act, to prevent excessive speculation?
    Mr. Gensler. I do not have the actual words. I always 
thought it was ``the burdens that come from,'' but I trust----
    Senator Levin. Is the word ``burdens'' in there?
    Mr. Gensler. I thought, but if not--but I trust whatever 
the Chairman's reading.
    Oh, I see. I am thinking of 4(a)(1), and there is----
    Senator Levin. I am reading Section 737. In that section, 
would you agree I read it correctly?
    Mr. Gensler. Yes.
    Senator Levin. That is good. Did you hear me when I quoted 
the head of ICE, Mr. Sprecher?
    Mr. Gensler. Yes.
    Senator Levin. Were you familiar with that comment before 
that?
    Mr. Gensler. I was familiar with his thinking, though maybe 
not the exact quote, but he had shared that thinking with us, 
yes.
    Senator Levin. And do you agree with him about the 
potential benefits of position limits creating healthier 
commodity markets?
    Mr. Gensler. I do. I voted for the rule. I did because I 
think Congress mandated that we do it, but I also believe that 
it helps promote the integrity of markets.
    Senator Levin. Much of the new speculation comes from the 
commodity index fund investors and swap dealers who sponsor 
those funds, hedge their risk on their client's speculative 
bets by purchasing long futures contracts. Do you know 
approximately what percentage of the demand for long futures 
contracts across the futures markets is attributable to 
commodity index funds, approximately?
    Mr. Gensler. The figures that we put out monthly show--and 
I think they were summarized in the charts--approximately this 
$250 or $260 billion equivalent in futures because some of that 
is swaps investment. The marketplace in the commodities, the 
most recent figures, is about $1 trillion in notional amount of 
futures. So it is a little bit of apples-to-oranges, but you 
can think of it roughly as about 25 percent of the longs and, 
because the shorts are about $70 billion, about 7 or 8 percent 
of the shorts, though I would note there is a little apples and 
oranges there.
    Senator Levin. OK. When you testified before the 
Subcommittee before regarding excessive speculation in the 
wheat market in 2009, I asked if the CFTC as part of its work 
would look at the question of whether or not commodity index 
trading constitutes excessive speculation in the wheat market, 
and you told us that the CFTC would be looking at it not only 
for index investors but also for the broader class of 
speculators in financial markets. I am wondering if you have 
conducted that review.
    Mr. Gensler. Well, I think since then--and I apologize, I 
do not remember the exact date of that hearing--we had three 
public hearings in the oil markets and one in the metals 
markets, and then we have had two public meetings on this rule 
itself and conducted a great deal of inquiry, including 8,000 
comments on the initial rule and 15,000 on the latter and 
hundreds of meetings. So collectively, yes, we have also looked 
at over 50 studies that were referenced in the comment file on 
position limits and reviews those and had our Office of the 
Chief Economist review those studies.
    Senator Levin. We have talked this morning about the 
commodity-related exchange rate traded products (ETPs), which 
are set up as securities but are designed to enable speculators 
to bet on changes in commodity prices without buying the 
underlying commodities. These are hybrids that combined 
securities and commodities. They can directly affect 
commodities futures prices. They are currently responsible for 
about $120 billion in commodity investments. Do you believe 
that exchange traded products that offer investors the chance 
to invest in baskets of commodities have added to the 
speculative money in the commodity markets and that they have 
contributed to speculative pressures on commodity prices?
    Mr. Gensler. Well, they are a group of financial investors 
that are speculating. Again, as hedgers and speculators meet in 
markets, this is a new vehicle for the retail public for the 
person to invest rather than maybe buying a bar of gold or--
when I was growing up, my dad used to have a couple of gold 
coins, I remember he would show them to me every once in a 
while. He thought it was good always to have a little gold. 
This is a new vehicle to have that.
    Senator Levin. My dentist, by the way, is telling me the 
same thing. It is good to have a little gold.
    Mr. Gensler. I see.
    Senator Levin. Anyway, I interrupted you.
    Mr. Gensler. No.
    Senator Levin. The Dodd-Frank Act acknowledged the 
existence of these mixed swaps as hybrid instruments that 
warrant oversight from the SEC and the CFTC, and I am wondering 
if ETPs are not the same, essentially, set up as securities but 
intended to function as commodity investments. Would you agree?
    Mr. Gensler. Yes. One of our staff calls it a ``securitized 
warehouse receipt.'' In a warehouse somewhere there is gold or 
silver, but it is traded in the securities market. Not all of 
these are that, but the majority of them are.
    Senator Levin. And, therefore, does it require oversight 
from either or both the SEC and the CFTC?
    Mr. Gensler. Well, the SEC does have oversight. We have 
coordinated with them for the last 6 or 7 years when this 
market started on that. But most directly it is the SEC's 
oversight, though they have done it in a cooperative way with 
us.
    Senator Levin. Are the commodity-related issues looked at 
by the SEC? Their function is not to look at the issues 
involved in commodities trades, so I want to know who is 
looking at the commodity-related issues in these instruments.
    Mr. Gensler. On these instruments, if they were used with 
regard to a manipulative scheme in the commodity futures 
markets or shortly in the commodity swaps markets, we would. 
But if it were just the trading of these and they did not come 
into a manipulative scheme, then it would be separate. But it 
would also, if I might say, be somewhat like if somebody was 
just trading gold but it was not part of a manipulative scheme, 
we would not necessarily be looking at that either.
    Senator Levin. And are you taking steps to prevent them 
from being used as manipulative schemes, or are you waiting for 
something to happen? In other words, are you doing the 
oversight of these securities and the way they are used as 
commodity trades? Is that something you are trying to prevent 
manipulative schemes from being used, or you are just saying, 
well, the SEC is looking at the trades and we are going to wait 
until there is some evidence that accumulates somewhere?
    Mr. Gensler. I think, frankly, this would have to be a 
little bit more evidence-based, if we saw something in our 
futures markets we oversee or a whistleblower or somebody comes 
to us. Frankly, with the 700 people that we have, the resources 
are not such--nor do we necessarily just go to see if somebody 
is doing something with gold. But if it comes into our markets, 
comes into the futures markets that we oversee or shortly the 
swaps market and becomes part of a manipulative scheme or 
device, we have in the past and will in the future do so.
    Senator Levin. So the oversight of these particular types 
of products is different from the futures.
    Mr. Gensler. That is correct, sir.
    Senator Levin. And isn't that a problem?
    Mr. Gensler. It may be. I do believe that if it came to our 
attention it was being used as part of a manipulative scheme, 
we would certainly use everything that we have in our 
resources, but I think you have the accurate picture.
    Senator Levin. Thank you. Senator Coburn.
    Senator Coburn. Welcome. Sorry I was not here to hear your 
oral testimony.
    How does the CFTC define ``excessive speculation''?
    Mr. Gensler. Congress actually had a finding in the 1930s, 
and we first put position limits in in 1938 based on that 
finding. And though some of the language has changed over the 
years, it is really that we were to use position limits to help 
curb or prevent some of the burdens that may come from 
excessive speculation. And so what we did then and have over 
the decades is really looked to ensure two things: In the spot 
month, when somebody is actually delivering the natural gas 
down in a certain spot in Louisiana or delivering the oil in 
Cushing, Michigan, which you know well, that there is not a 
corner or a squeeze or a manipulation in that delivery period; 
and then, second, that over all of the contracts, which we call 
all-months combined, that there is not a concentration or an 
outsize position. It used to be labeled in numbers of bushels 
of grain, the first position limits were that way, and then 
subsequently, by the 1970s and 1980s, we turned to a percentage 
of the market. This most recent rule really used a formula that 
we put in place through notice and public hearings in the late 
1980s and early 1990s, so it is about 20 years ago, and it is 
roughly 2.5 percent of the speculators. The speculators could 
not each have more than 2.5 percent.
    Senator Coburn. So is excessive speculation happening now? 
We did not really get to a definition. So whatever it is, is it 
happening now?
    Mr. Gensler. The markets are made up of hedgers and 
speculators coming together, and one of the increasing features 
of the market is more and more financial parties. In the oil or 
natural gas markets, about 13 to 18 percent of the market are 
producers and merchants, and the other 80-plus percent are 
hedge funds and swap dealers and other financial actors. What 
we do is we use our authorities to police against fraud and 
manipulation and ensure transparency, that people see that 
price function, and then also to have positions to help prevent 
against manipulation, corners and squeezes, as I mentioned, 
help ensure the integrity of the market with regard to the all-
months combined, that no one speculator has an outsize 
position.
    Senator Coburn. So I will go back to my question. Is 
excessive speculation happening now?
    Mr. Gensler. Well, we know that the speculative group in 
the market can be anywhere from 50 or 60 percent in the grain 
markets to 80 to 88 percent or so in the energy market. 
Congress made the finding not only in the 1930s but also in the 
Dodd-Frank Act, once again came back to it, added more words 
that the Chairman and I just were--he was good enough to remind 
me of the additional words--and asked us, really mandated for 
us to put in place these regimes to help as a preventative 
matter moving forward.
    Senator Coburn. So you do not know whether excessive 
speculation is happening now? Or you do know and do not want to 
define it? Or you are just responding to Congress and the 
assumption that there is?
    Mr. Gensler. Well, I think that we have been responding to 
Congress for 70-plus years on this, and it has been reaffirmed 
by Congress just last year that to ensure for the integrity of 
markets that we have a per se limit, that it is a specific 
limit that we set in place. So we use these well-worn formulas 
that have worked. We had limits in the energy and metals 
markets before.
    Senator Coburn. I am not debating that. Is the assumption 
by the CFTC there is excess speculation now so, therefore, you 
wrote new position limits?
    Mr. Gensler. No, I think that what we took was Congress' 
clear mandate to do this, and with the regime that we have used 
in the past----
    Senator Coburn. The language says ``as necessary,'' so how 
do you decide whether it is necessary unless you assume there 
is excess speculation?
    Mr. Gensler. Well, we took this up and had many comments, 
some on both sides of this very issue that you just raised, 
Senator. It is the Commission's belief in finalizing this rule 
that Congress mandated that we move forward and that it is not 
necessary to find that there had been a burden, that these are 
also preventative, these are forward-looking, so ensure that 
there is not manipulative schemes, corners, and squeezes.
    Senator Coburn. So the new regulation is not based on the 
fact that there is an assumption that there was excessive 
speculation. It is to prevent any future excessive speculation. 
Is that what you are telling me?
    Mr. Gensler. That is what the statute actually says, and 
the Commission's finding on this is that. But in addition, we 
had over 50 studies referenced in the file, and about half of 
them are on one side and about half of them are on the other. I 
do not want to say a percentage, but they are mixed, the 
economic studies.
    Senator Coburn. So for clarity for the American people, 
either there is or there is not excessive speculation, and we 
have put forward regulations to prevent the potential for that 
in the future.
    Mr. Gensler. To prevent the burdens that may come from 
excessive speculation.
    Senator Coburn. Well, position limits are designed to stop 
excessive speculation, correct?
    Mr. Gensler. I believe that the statute has in 4(a)(1) the 
words to curb or prevent the burdens that may come to 
interstate commerce from excessive speculation, and then in 
4(a)(2), as the Chairman pointed out, there were added four 
factors, and so it was also about manipulation, it was about 
promoting liquidity in the markets, and promoting the price 
discovery----
    Senator Coburn. So you could have written a rule that would 
have allowed for excessive speculation but would not have had a 
burden.
    Mr. Gensler. I am not sure I am following that.
    Senator Coburn. Well, you just said the statute is to 
prevent the burden in terms of the price to the markets and to 
the country. So you could have had a rule that allowed for 
excessive speculation as long as the excessive speculation did 
not affect the price.
    I will not go any further on it. The point is the factual 
basis of determining excessive speculation needs to be based on 
something that is concrete, not an aftereffect but something 
that is concrete. And my worry is you are going to get tied up 
in a lawsuit that is going to--the well-intentioned thought of 
eliminating excessive speculation and decreasing volatility so 
that people are not paying too high of a price for something 
that the market truly is not saying--that speculation caused it 
to be higher, more speculation than necessary to then create 
the market. What my worry is is two things: One is that you are 
going to get tied up and spend a lot of your budget defending 
it; and two is what we have written here is a click away from 
not having any effect at all because they are going to go to 
some other market.
    What do you think will happen in the rest of the commodity 
exchanges around the world on the basis of the new rule that 
you all have put out?
    Mr. Gensler. I think we have made very good progress. In 
September, working along with international regulators in 
something called--I do not know that you are familiar with it, 
but it is the International Organization of Securities (IOSCO) 
regulators--put forward a joint report, and then that was moved 
up actually to the G-20, the 20 countries that form the 
Financial Stability Board, to put in place regimes that have 
anti-manipulation rules similar to what we have that could go 
after attempted manipulation, have more transparency. We 
actually have some of the best transparency here. And, also, it 
included--they called it ``position management regimes,'' a 
little bit different word. We would be glad to brief your staff 
on that.
    So I think we have made good progress, but you are 
absolutely right, capital and risk knows no geographic 
boundary. So Congress also included that if there was a foreign 
exchange that linked their contract to contracts here, for 
instance, if somebody in London linked the contract to 
something in your State, Oklahoma--it is called West Texas, the 
WTI contract. If it were linked, that has to come under the 
position limits, and we finalized a rule that said if anywhere 
around the globe a foreign board of trade links it to one of 
the contracts here, then it has to be in that same regime.
    Senator Coburn. Yes, but none of that is implemented 
anywhere yet, correct? Those are proposals to be implemented.
    Mr. Gensler. That is right.
    Senator Coburn. We have a rule that is going to be in 
effect, questions about it, lots of learning curve on it. What 
is going to happen in the meantime? Let me just assume for a 
minute, since Europe is functioning so well--they are 
functioning just about as poorly as we are as a legislative 
body. What happens if those do not get put in effect given ours 
goes into effect? What do you foresee--what is the downside for 
American jobs, American price discovery, American valuation for 
products and commodities that are made here, what is the 
downside for our country if that does not happen in the rest of 
the trading centers around the world? What is the downside?
    Mr. Gensler. I think we saw some of the downside of weak 
regulation in 2008. I think our financial system failed in part 
because our regulatory system failed in 2008, and 8 million 
Americans are out of work today because of that, not because of 
position limits but because of our weak regulatory system.
    Senator Coburn. Well, let us talk about what I asked you. 
What is the downside if they do not do it and we have?
    Mr. Gensler. But I think that Congress mandated us to do 
this and a lot of other pieces of----
    Senator Coburn. I understand. What is the downside?
    Mr. Gensler. I think the downside is if we do not protect 
our markets, the price discovery and the integrity of these 
markets are weakened. So I think what Congress recognized and 
what the Commission recognized is that we have to promote the 
integrity of the markets and the price discovery function here. 
Congress also did ask--and we will do this--1 year after these 
rules go into effect, we have to report back to Congress, and 
one of the specific things Congress asked us to report on is 
exactly that which you raise, about the overseas effect, where 
are we at that point in time and report back, whether it is--I 
do not remember the exact words, but any effects of where we 
are overseas versus here. And I think that was very 
appropriate.
    Senator Coburn. So I take it from your answer you are not 
extremely concerned that disconnecting from WTI, disconnecting 
from the Chicago Board, disconnecting from all these others, 
that people decide that they will speculate somewhere else, and 
given that we are in a global economy, we cannot regulate the 
global economy by only regulating us, and the very things that 
we are trying to limit, excessive speculation, whatever that 
is--since nobody will define that for me except Mr. 
Turbeville--excessive speculation is going to occur somewhere 
else outside, and we are still going to have the same price 
swings in our market. Is that not the downside?
    Mr. Gensler. I think that we are working very closely with 
international regulators, and I share your view that we should 
harmonize as much as we can. But we do have, as you mentioned, 
different political systems, different cultures, and it is 
possible, it is even likely that we will end up with some 
differences in not only position limits but anti-manipulation, 
the oversight of swap dealers, and the like.
    Senator Coburn. How many people are employed in commodity 
trading in this country?
    Mr. Gensler. I know the figures for the whole financial 
industry is into the hundreds of thousands. I do not know the 
specific number to your question, but we could try to get back 
to you on that.
    Senator Coburn. Well, we have got it. The point I am saying 
is we have a problem, the Chairman has identified a problem. We 
know we want real price discovery. We know we want real 
transparency in our markets. We know we have to have 
speculators to create a market. We know we do not want 
excessive speculation. We know we want the CFTC when they are 
cornering markets or abnormal. Is the regulatory framework that 
you put up, without that being put up around the rest of the 
world, going to be effective in accomplishing what--even if 
Congress told you to do it or whether it was apparent as 
necessary you should do it, is it going to accomplish its goal?
    Mr. Gensler. I think that it is important that we promote 
the price discovery and the integrity of the markets that we 
can oversee here. You are absolutely right. We do not oversee 
all the markets around the globe. If it is linked back to these 
markets, we do. We have that hook. But you are right----
    Senator Coburn. Yes, but all they will do is delink it. I 
mean, think oil. Where is the vast majority of the oil 
produced? Not here. So if, in fact, we have trading limits here 
and the rest of the world does not put them in, the oil is not 
going to be traded here. It is going to be traded in London, or 
it is going to be traded in Singapore. It is going to be traded 
somewhere else besides here, and we will not have accomplished 
the purpose. And what needs to happen is the effective 
implementation of transparency and price stability in all the 
markets, not here. Because what my worry is is we are one click 
away--my computer, one additional click, I can go to London and 
trade.
    Mr. Gensler. No, that is my worry about the European crisis 
right now. We are one click away the other direction. So we are 
working pretty hard to finish our rules to make sure our 
financial institutions are less at risk, less interconnected 
through the swaps market, and that the more transparency in the 
markets that we can oversee actually have greater transparency 
and greater integrity.
    Senator Coburn. Let me go to one other area if I might for 
a moment.
    Senator Levin. Sure.
    Senator Coburn. Have you all created a true definition of 
what a swap is?
    Mr. Gensler. I think that Congress had a very good 
definition. We were asked by Congress to further define the 
word ``swap,'' working along with the Securities and Exchange 
Commission. We had a lot of public input through what is called 
an Advanced Notice of Proposal, and we are working to finalize 
that in the next several months.
    Senator Coburn. So you cannot regulate it until we define 
it, correct? You are going to have trouble applying a position 
limit on a swap until you have a definition of what a swap is.
    Mr. Gensler. We have actually envisioned exactly that these 
rules go into effect for certain futures products in the spot 
month, but to the extent that they relate to swaps, because 
Congress asked us to ``further define'' it with the SEC, we 
need to finalize that role. As I say, we are envisioning----
    Senator Coburn. When does that have to be done by?
    Mr. Gensler. Well, Congress asked us to finish it by this 
past July, but we are not working against a clock. We are 
working to get this in a balanced way.
    Senator Coburn. And when do the regulations on swap 
position limits take effect?
    Mr. Gensler. The spot month limits that are on certain 
futures will take effect, but the ones that relate to swaps we 
need to finalize that further definition, as the Senator says, 
and that is probably several months away.
    Senator Coburn. Yes, it is not going to take effect--there 
are no limits on a swap until you have defined a ``swap.'' Is 
that what you are telling me?
    Mr. Gensler. That is generally correct. There are some 
exceptions because in a law passed in 2008 around significant 
price discovery contracts, there are some in natural gas, but--
we do have some.
    Senator Coburn. So there is not going to be any position 
limits enforced by the CFTC until the definition of what a swap 
is is out, with the exception of what you described in----
    Mr. Gensler. That is generally correct.
    Senator Coburn. All right. You already have position limits 
for legacy contracts, correct?
    Mr. Gensler. That is correct.
    Senator Coburn. And is cotton No. 2 one of those?
    Mr. Gensler. Yes, sir.
    Senator Coburn. And yet cotton hit 16 record-setting prices 
in the last 12 months, did it not?
    Mr. Gensler. If that is the number you have, sir, I trust 
the number.
    Senator Coburn. Did the position limits in place prevent 
wheat, corn, and soybean volatility in 2007 and 2008?
    Mr. Gensler. We are not a price-setting agency. I think 
that position limits are to help ensure the integrity of 
markets, that no one party has an outsized or concentrated 
position in the markets.
    Senator Coburn. I know, but the reason I ask the question 
is the panel before you, based on these new methods of trading, 
outside of true commodity users and people who are hedging, the 
implication was that the price is on the way up regardless of 
supply-demand, essentially, unless extreme supply-demand 
differences. And yet in wheat, corn, and soybeans, from 2007 to 
2008, we saw tremendous price increases, yet we had position 
limits on them. We saw a tremendous increase in volatility. And 
I agree with you, you are not in the position to control price. 
You are in the position to create transparent and stable 
markets.
    Mr. Gensler. We agree on that.
    Senator Coburn. So the point I am making is we had position 
limits on those commodities, yet we saw tremendous swings, 
tremendous increased speculation, and tremendous increased 
volatility. So my point is we are not necessarily going to 
change pricing, which was our testimony of the first panel, 
that the bias is for an increased price, that there are no real 
market forces in the long term to drive price the other way on 
the other side of the trading with position limits. The whole 
goal for position limits is to make sure not anybody is 
manipulating the market, correct?
    Mr. Gensler. I think that it is--in my own words, we are 
not a price-setting agency. It is to ensure that the price 
discovery function has integrity, and that is integrity against 
manipulation, but also, as the agency has for decades, that 
there is not concentrated parties that can distort on the way 
down or distort on the way up, just that there is a diversity 
of actors. There are more actors on a stage, there is more 
competition in the market, less likely that one party distorts 
the market.
    Senator Coburn. But you would agree that the prices on 
corn, soybeans, and wheat had good price integrity during this 
period of increased volatility, increased speculation? I mean, 
corn is still at $6.40 a bushel. Three years ago it was at $3. 
There is nothing wrong with that pricing mechanism, is there? 
It worked.
    Mr. Gensler. Well, in some of these there are issues about 
the pricing mechanism with regard to convergence, which was an 
earlier hearing, in the wheat markets.
    Senator Coburn. Right.
    Mr. Gensler. And there is still very much focus----
    Senator Coburn. You mean in terms of the close-out month.
    Mr. Gensler. The close-out month, and there are very 
serious issues still in a couple of contracts that we watch on 
a very regular basis. We also look in closed-door sessions at 
surveillance and look at issues of enforcement matters. I do 
not want to ever say that there are not things that we look at 
on a very regular, intensive way.
    Senator Coburn. I appreciate that.
    Mr. Gensler. But I think I share your view that position 
limits are about--I believe our whole regime, position limits, 
anti-manipulation, transparency, and the other rules we have, 
is to ensure for the integrity of markets and the price 
discovery. It is not about whether prices should be higher or 
lower.
    Senator Coburn. Right.
    Mr. Gensler. It is to allow the markets to come together 
and these hedgers and speculators to meet in this market.
    Senator Coburn. Yes. I want to thank you for your 
testimony, also for your service. I will have some additional 
questions for the record, if you would not mind responding to 
those.
    Mr. Gensler. I would look forward to it and meeting with 
you at any time.
    Senator Coburn. And I would just re-emphasize my worry, Mr. 
Chairman. If this is not a global regulatory scheme on 
commodity pricing, what you have done will have no significant 
effect. This is a global market. We live in a global world in 
terms of commerce, and what we will do in our attempt to do 
something good, we will actually hurt our country, hurt a lot 
of jobs that are employed in the commodities exchanges and 
trading in this country, and what we are going to do is shift 
it, like we have the medical device industry, to Europe or to 
Singapore.
    Senator Levin. Would you agree, Mr. Gensler, that the goal 
of making our markets more transparent and greater integrity is 
an attraction to investors?
    Mr. Gensler. I do.
    Senator Levin. And so even if other markets do not have 
integrity that we do, do not have transparency that we do, do 
not follow rules that help a market have integrity, that those 
markets are not necessarily going to be attracting investors; 
they may be, as a matter of fact, putting investors off that 
want markets that have integrity. Would you agree with that?
    Mr. Gensler. I do. Market participants want to come to deep 
pools of liquidity where a lot of other actors are, where no 
one party can control the market--and in that regard I think 
position limits help--and where there is market integrity and 
when there is a cop on the beat.
    Senator Levin. And removing a cop on the beat is what we 
tried before, and we saw the result of it with the 2008 problem 
that we had. Would you agree with that?
    Mr. Gensler. I think that was certainly part of it. There 
are a lot of other reasons as well, of course.
    Senator Levin. There are good reasons to have a global 
regime. I happen to agree with that. But we want to have 
markets that have integrity, investor confidence, even if 
markets in other places do not, and rather than money flowing 
out, we are going to have money flowing into a market that has 
integrity if it is competing with markets that do not have 
integrity, do not have the kind of transparency, do not have 
the kind of anti-manipulation regulators in place.
    Mr. Gensler. I agree with that, but if I might add, I also 
think that market integrity helps protect the taxpayers against 
some of the bailouts that so unfortunately our public had to 
face in 2008 and unfortunately then Europe is struggling with 
now.
    Senator Levin. I think we all would agree with that. There 
are a lot of reasons for assuring market integrity.
    Would you agree with me, without having to go back and read 
the Dodd-Frank Act, that the CFTC is allowed to prohibit 
foreign countries from installing trading terminals here in the 
United States unless they have similar position limits?
    Mr. Gensler. Yes.
    Senator Levin. So you can use that authority to level the 
playing field. Is that correct?
    Mr. Gensler. Yes.
    Senator Levin. On the question of mutual funds, we have an 
existing law which says that for certain tax benefits, mutual 
funds can invest no more than 10 percent in alternative 
investments, including in commodities. Alternative investments 
meaning alternatives to investments in securities. Mutual funds 
are getting around this 10-percent limit in one of two ways, 
both of which have been so far approved by the IRS but which 
the IRS is now reviewing. One, they are investing in commodity-
related ETPs which qualify as securities; and, two, some mutual 
funds have established offshore entities that they use to 
invest in commodities, doing indirectly what they cannot do 
directly by creating shell corporations offshore which they 
control.
    Now, we have identified in Exhibit 7,\1\ 40 mutual funds 
whose primary focus is to invest in commodities, adding tens of 
billions of dollars of additional speculative pressures on 
commodity prices. What is your understanding of the extent to 
which mutual funds are active in commodity markets now, either 
directly through ETPs or indirectly through offshore shell 
entities?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7 which appears in the Appendix on page 185.
---------------------------------------------------------------------------
    Mr. Gensler. Well, I think this is an excellent exhibit for 
the public and for us as well. But this is part of that other 
number, the $250 billion or so that is in our monthly reports 
on commodity index investment. So this is a piece of that 
larger pie.
    Senator Levin. My staff is saying that they are not a 
subset; they are an overlap here.
    Mr. Gensler. It is not a perfect subset; that is correct. 
There is some overlap because the way that we collect that data 
is not this entire universe. We collect that data through swap 
dealers and some large index investors. So there is an overlap, 
which I think it would take a bit of research to see what the 
extent of the overlap is. When I meant ``part of this,'' it 
might make it 280 or 290, but it is part of the same overall 
investment piece.
    We did propose something earlier this year--it could have 
been late in December of last year--which we have yet to 
finalize, which is with regard to certain exemptions that were 
granted, I think in 2003, for commodity pool operators and 
whether they file with us as a commodity pool operator that 
also relates to some of these exemptions that you are referring 
to in the mutual fund area. And we actually proposed revising 
and in some cases repealing them--this is Section 4.5--that 
would, if we were to finalize it, I think give us greater 
transparency as an agency. It just means they are filing their 
financials. But it still is a helpful piece to have them file 
as a commodity pool operator, some that had been getting 
exemptions for their offshore pieces.
    Senator Levin. All right. So you are looking at eliminating 
that exemption.
    Mr. Gensler. We have actually proposed that exemption from 
2003 with regard to certain Section 4.5, so to speak, entities.
    Senator Levin. All right. So as I understand it, these 
offshore affiliates of mutual funds that do not now have to 
register as commodity pool operators with you, even if they 
market themselves to investors as commodity funds and actually 
operate a commodity pool. This is allowed because of Rule 4.5, 
which is a regulation exempting them from the registration 
requirement on the ground that they are subsidiaries of mutual 
funds which are regulated by the SEC. And so the question that 
you are addressing, as I understand your testimony, is given 
their exclusive or primary activity in the commodity markets, 
they are going to have to register? Is that correct?
    Mr. Gensler. Well, we have not yet finalized the rule, and 
we have a lot of comments. We have had mutual funds come in and 
remind us, ``Well, we do not have to file right now.'' I would 
say they did not remind me. I did not quite know that we had 
somehow missed this in 2003. But they were exempted in 2003. We 
proposed revising and repealing in certain parts that, and we 
are looking at how to finalize it. The mutual fund companies 
have a point of view, and they have expressed it in their 
comment letters.
    Senator Levin. Is there a proposed rule change then that 
you have published?
    Mr. Gensler. Yes. I am sorry, in the Federal Register, I 
think, last December or January.
    Senator Levin. So when is that due to be finalized?
    Mr. Gensler. I would think in the first quarter.
    Senator Levin. All right. Getting back to Dr. Coburn's 
important question about a definition of ``swap,'' his point is 
you are going to have to define ``swap'' before the new rule 
affecting swaps comes into place. And I could not agree with 
him more.
    My understanding is that your definition is due to be 
published fairly soon. Is that not true?
    Mr. Gensler. That is true. It is a joint rule with the SEC, 
and we are sorting through a lot of things. We also had the 
events of MF Global this week, as the news reports, that we 
were doing some other things, Chairman Mary Schapiro and I.
    Senator Levin. But is it fair to say that we could expect 
that definition this month or no later than the end of this 
year? Is that fair?
    Mr. Gensler. It would be every bit my hope, but I would say 
this to be transparent: The next joint role with the SEC that 
is in our docket is the joint swap dealer definition, and these 
are the two definitional things. So we are looking at trying to 
finalize the ``swap dealer'' definition first, and we are very 
close on that, and then the ``swap'' and ``security-based 
swap'' thereafter. So I would say in the next several months, 
but I would not say in the next month.
    Senator Levin. But it is clear that it has to be defined 
before the rule takes effect using the word which needs to be 
defined.
    Mr. Gensler. Yes, though it was----
    Senator Levin. I think that is what Dr. Coburn----
    Mr. Gensler. No, I am agreeing with both of you.
    Senator Levin. I think that is what his point was. It is 
obvious, isn't it?
    Mr. Gensler. It is interesting. Congress actually defined 
the word ``swap'' and then said we were supposed to ``further 
define'' it. So it is all in this, what does it mean, ``further 
define.''
    Senator Levin. Well, that is what regulators do. We adopt 
laws and you guys implement it, and in your discretion you 
further define things. Isn't that your function to do that? We 
have a law, in the Dodd-Frank Act, which says you are supposed 
to ``set limits to the maximum extent practicable'' in your 
discretion--the limits would be in your discretion--to 
``prevent excessive speculation.'' That is what we say, 
``prevent excessive speculation.'' But what is the maximum 
extent practicable? You have got discretion to determine that; 
isn't that just your ordinary function?
    Mr. Gensler. Right. So we will finalize--one of the reasons 
I say that, I think most people know what 2-year interest rate 
swap is.
    Senator Levin. All right. My time is up. Dr. Coburn.
    Senator Coburn. I am going to send you some questions on MF 
Global just simply because here we now have a regulatory 
scheme. If, in fact, it is true investor money was used 
inappropriately, that is a regulatory concern for me. I am very 
interested in how in the world did that get past you all, how 
it got past the SEC. Here we now have a new regulatory scheme. 
We have done a lot of changing since what happened in 2007 and 
2008, and it is concerning that we have another company that 
has just potentially blatantly violated the rules. So I will 
send you some letters on that.\1\
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    \1\ See Exhibit No. 13 which appears in the Appendix on page 309.
---------------------------------------------------------------------------
    Again, I thank you for your service. You do not have an 
easy job. You have a tough budget. I understand that. It is not 
going to get any better, the budget. The job is probably not 
going to get any better either, but I appreciate the work of 
you and your staff, and I am concerned about the challenge to 
this rule. I hope you do not end up spending a lot of time in 
court defending it because of some of the lack of definition.
    Mr. Gensler. I appreciate your advice, your questions, and 
it is an honor to be in this job. It truly is. And I think it 
is about protecting the taxpayers and promoting these markets, 
and as relates to MF Global, and all companies, protecting 
customers. I said--and I will repeat it because you were not in 
the room at the time--that I think at the core of our regime is 
customer money, the sanctity of it. It is supposed to be 
segregated. It is sort of like you do not put your hand in the 
cash register. You just do not. It is the customer's money, and 
it is supposed to be there every nanosecond of the day, 
segregated.
    Senator Coburn. Thank you. Thank you, Mr. Chairman.
    Senator Levin. I think we all agree on that, by the way. 
Thank you, Dr. Coburn. There may be some disagreements on some 
subjects, but when it comes to protecting the taxpayer, we are 
going to take steps to do that, and that is going to require 
regulators being put back on the beat. We are going to protect 
the taxpayers from companies that are too big to fail. We are 
going to try to make sure we take steps that we do not see the 
taxpayers bailing out companies again. The issue, as I 
understand it, with the fund that went bankrupt is that the 
customers may have gotten injured by improper activity, or they 
may have gotten injured by taking risks. But to me, it is your 
function to help protect customers of that hedge fund, but it 
is doubly important that we understand that there is no 
taxpayer liability here that you know of.
    Mr. Gensler. This is an example of freedom to fail, and I 
was part of that decision set of putting it into bankruptcy, 
and no taxpayer money is behind this at all.
    Senator Levin. If there was improper activity here that 
impacted their customers and their clients, that needs to be 
taken up as well.
    Mr. Gensler. We are going to fully pursue this.
    Senator Levin. We are, but it is a very different issue 
from the battles which we have been waging here to try to 
protect taxpayers and the Treasury from companies that are too 
big to fail, either getting bailed out or going under and there 
being some kind of a governmental obligation. That is not the 
case here, thank God, but what may be the case here is 
something which should not be allowed to happen either because 
we do not want customers to be either defrauded or to be 
improperly dealt with. We do not know that is the case here, 
but we have cops on the beat to help prevent that as well, and 
you folks are into it.
    On the high-frequency trader, we have CFTC data showing 
that up to 80 percent of trading in key futures markets is day 
trades or trading around the expiration of contracts. The day 
trading is conducted in part by high-frequency traders that use 
computers to engage in rapid-fire trades, usually profiting 
from slight price increases over a brief period of time. Do you 
believe that this day-trading activity is adding to the 
volatility in the commodity markets?
    Mr. Gensler. I think that there are a number of things that 
have changed in our marketplace, and you have addressed one 
important one. What was once day trading in a sense on the 
floor of the futures market or even the floor of the securities 
markets is now in a computer group, and it is called high-
frequency trading. I think that while in calm markets they 
can--and there are studies that have shown they can--even 
narrow the difference between the bids and the offers and, so 
to speak--narrow the big-offer spread, that in times that are 
not so calm, like a year and a half ago on May 6, 2010, they 
can sometimes step away from a marketplace, and the liquidity--
sometimes people confuse volume in a market for liquidity. And 
they have added greatly to the volume in the market. It is not 
clear that at all times they are adding to liquidity in the 
market.
    So we have come forward with proposals. These are not final 
rules, but we have proposed that exchanges and clearinghouses 
have to have new pre-trade risk filters and pre-trade risk 
controls with regard to protecting the markets and the 
integrity of the markets better in these circumstances.
    Senator Levin. There has been some discussion here this 
morning about position limits not applying to the 
multicommodity swaps. You have made that distinction. These are 
extremely common in the commodities markets. Some of our 
earlier witnesses did not know why you made that distinction. 
Why did you?
    Mr. Gensler. I would say a number of reasons. One, if I 
might say because you mentioned it, the Goldman Sachs Commodity 
Index, there is actually a futures commodity, that index, on 
CME, and they do have a position limit, a hard 10,000-contract 
limit. So we addressed ourselves to that is not the only 
reason, but that is one reason. But what we addressed ourselves 
to is these 28 individual commodities and trying to reimpose or 
bring back in the energy and metals markets where there had not 
been for all months combined, and trying to sort through a 
really significant docket with regard to what Congress mandated 
to do.
    The commodity index is not really about the corner and 
squeeze issue in the same way because it is an index across 
many products and you cannot deliver oil or wheat or corn into 
the commodity index. It is an index. It is not--has the same 
delivery function. So I think given the full docket of trying 
to take on the 28, given that the exchange actually right now 
does have this limit on this one contract, and that it is less 
about the spot month and the delivery period, these are some of 
the factors that influenced us. It is also something we can 
still take up. I mean, it is not that we cannot take it up.
    Senator Levin. Do you expect you will take that up?
    Mr. Gensler. I do not know, sir, just given the full docket 
of what we are doing, and also we are supposed to report back 
to Congress in a year as to how the current regime is working.
    Senator Levin. Would it be useful for you to take that up?
    Mr. Gensler. Well, I think there are a number of questions, 
that plus there are these questions that were raised on the 
earlier panel and that you have raised about limits across a 
certain sector and so forth that I think are additional issues 
that--whether it be in the study that we report back to 
Congress or otherwise, are things that many people will 
continue to review.
    Senator Levin. You made reference to the mutual fund 
industry's effort to eliminate the 10-percent restriction on 
alternative investments, in particular because they want to 
increase the percentage of their portfolio investments in 
commodities. They did not succeed in that bill. I am glad for 
that and had something to do with that, but in any event, they 
are trying to apparently continue their efforts to remove that 
restriction.
    What would be the impact in your estimation as to the 
amount of speculation in commodity markets if that 10-percent 
restriction on mutual funds' alternative investments was 
removed?
    Mr. Gensler. I do not have a developed view.
    Senator Levin. Do you have a hunch as to whether it would 
increase speculation?
    Mr. Gensler. I frankly----
    Senator Levin. That is why they want to get it removed, so 
would you think that if that is their motive in getting it 
removed that it would have the effect they seek, which is that 
they would be able to speculate more than 10 percent of their 
funds in the commodities markets?
    Mr. Gensler. Well, it would open up a broader class of 
investors in the marketplace or broader class of speculators, 
but I just will pause there and say I am just not familiar 
enough with the provision that they were seeking to pull----
    Senator Levin. Are you familiar with the 10-percent limit 
on alternative investments that mutual funds have?
    Mr. Gensler. I mean, just generally, but I am not familiar 
with what they are trying to change.
    Senator Levin. They are trying to get rid of it.
    Mr. Gensler. They are trying to get rid of it, so it would 
broaden the class of potential speculators.
    Senator Levin. A hundred percent of $11 trillion could go 
into speculation in commodities if they so chose.
    Mr. Gensler. So some of these ratios that we had earlier 
could go up. There would be more financial actors.
    Senator Levin. Do you have an opinion as to whether or not 
if they got rid of that limit and there is now a possibility of 
$11 trillion getting into speculation in commodities, whether 
or not, in fact, there would be a significant increase in 
mutual funds' purchase of those investments or betting on 
commodities? Do you think there would be an increase? You do 
not have an opinion on it?
    Mr. Gensler. I just have not developed a view. I mean, this 
is the first discussion I have had on it. I am glad to look at 
it and come back and meet with you or at the least----
    Senator Levin. No, you do not have to do that. I would just 
ask you that question for the record so you can discuss that 
with your staff as to whether the elimination of that 10-
percent limit on mutual fund purchases and investments so that 
they could invest more than 10 percent of their funds in 
commodity speculation, whether or not that would have an 
increase--whether there would be an increase in speculation in 
commodities. That is my question. You can take that for the 
record.\1\
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    \1\ See Exhibit No. 12 which appears in the Appendix on page 308.
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    Mr. Gensler. It certainly would expand the pool of parties 
that could invest.
    Senator Levin. How about the amount of money that would be 
or could be invested?
    Mr. Gensler. It would expand the pool of money.
    Senator Levin. But you do not have an opinion as to whether 
it would lead to that?
    Mr. Gensler. I have not talked to any mutual funds. I am 
not familiar with the----
    Senator Levin. Could you get yourself familiar with us and 
let us know?
    Mr. Gensler. Sure. I will try my best.
    Senator Levin. For the record--I assume if you try your 
best that we can count on you to give us an answer for the 
record to that question.\1\
    Mr. Gensler. Yes, of course.
    Senator Levin. Well, we thank you. It has been a long 
morning. You have a huge amount on your plate, and you are 
doing the very best that you can to follow the congressional 
wishes and intent, which are the wishes of our people, to get a 
cop back on the beat, and Wall Street needs it big time. And 
you are one of the folks that can bring it back. We hope you do 
it with gusto, and we will stand adjourned.
    Mr. Gensler. Thank you.
    [Whereupon, at 12:08 p.m., the Subcommittee was adjourned.]

































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