Founded in 1994, EUDA has represented over sixty organizations that use derivatives to manage risk, and has been in the forefront of end-user development in the derivatives market since its inception.

TMA represents about 12,000 treasury professionals who, on behalf of over 5,000 corporations and other organizations, are significant participants in the nation's payment systems and capital markets. Many members are responsible for their organization's derivatives activities with the primary objective of risk management. Organizations represented by members are drawn generally from the Fortune 1000 and the largest of the middle market companies, and they have an active interest and sizable stake in any regulatory and legislative changes affecting usage of derivatives.

Effective June 1st of this year, our organizations have merged to form the End-Users of Derivatives Council of TMA, the pre-eminent professional organization for end-users of derivatives.

Today, I am accompanied by Frank Curran, Vice President for Government Relations and Technical Services for TMA.

Our statement addresses the reauthorization of the Commodity Futures Trading Commission (CFTC) and the ramifications of the CFTC's role in regulating segments of the derivatives market. We also offer our thoughts on the need for changes to the Commodity Exchange Act (CEA) in order to:

• Bring greater certainty to the derivatives market;
   
• Reduce or eliminate obstacles to the development of new products and new ways of accessing these products;
   
• Promote the development of facilities that will enhance liquidity and transparency while reducing counterparty risk exposure.

As background to this critical discussion, we offer the Subcommittee the yet unpublished results of a 1999 survey of derivatives use and risk management practices conducted by TMA. We will summarize the highlighted conclusions of the study, and have attached the complete report to this statement. The survey was conducted for TMA by the National Economic Research Associates (NERA).

TMA has drawn upon its unique membership base -- individuals engaged in the treasury profession at a wide range of organizations such as publicly and privately held corporations, governmental units and other non-profit institutions -- to provide a broad perspective on important and timely issues surrounding the use of derivatives.

Like the original 1995 survey, the current research survey addresses the full spectrum of derivatives, including both OTC and exchange-traded derivative contracts and derivative securities. The current survey places more focus on the use of OTC derivatives in order to address issues involving risk management practices, counterparty relationships, new accounting and disclosure requirements, and proposals for additional regulation.

While the full report contains an extensive analysis of the survey data, the important highlights are summarized below.

Use of Derivatives

• Derivatives are widely used, with 63% of all respondents indicating that they use derivatives for risk management or hedging, in conjunction with obtaining funding, or for investment and trading. For large organizations, 78% used derivatives.
   
• Derivatives are primarily used for risk management or hedging (86% of all users), compared to other uses such as obtaining funding (40%) or investment and trading (19%).
   
• The widespread volatility in financial markets in 1998 did not lead to a reduction in the overall use of derivatives. In fact, roughly 80% of the respondents reported either no change or an increase in derivatives use.

Choice of Derivatives

• For managing foreign exchange exposures, OTC forwards, OTC swaps and OTC options are ranked among the top three instruments in terms of importance by 80%, 35%, and 36% of respondents respectively. Less than 7% of respondents included exchange traded futures and options in the list of the top three instruments.
   
• For managing interest rate exposures, OTC swaps, OTC options, and OTC forwards are ranked among the top three instruments in terms of importance by 69%, 29%, and 27% of respondents respectively. Slightly more than 12% included exchange traded futures in the list of the top three instruments.
   
• For managing commodity price exposures, exchange traded futures were ranked among the top three by 39% with the rest, including exchange traded options, OTC swaps, OTC forwards, and OTC options, being mentioned by 19% to 27% of the respondents.
   
• Of those respondents using OTC derivatives, 63% indicated that the ability to customize transactions to specific needs was one of the most important factors affecting their decision to use OTC derivatives.
   
• Of those respondents using exchange traded derivatives, 83% ranked market liquidity as one of the most important factors in their decision to use exchange traded derivatives.

Risk Management Practices

• Nearly 80% of respondents reported having documented policies and objectives governing the use of derivatives, that clearly define the purposes for which derivative transactions can be undertaken, that are approved by the board of directors, and that are implemented through approved procedures and controls.
   
• Over 95% of the respondents have the means, either internally or through independent third-party sources, to value their existing derivatives exposure. In terms of measuring market and credit risk, over 90% have the means, internally or externally, to measure market risk; 84% have the means to measure current credit exposure; and 79% have the means to measure potential credit exposure.
   
• Over half of the organizations value their derivatives portfolio on a monthly or more frequent basis, 19% on a quarterly basis, and 23% on an as needed basis.

Counterparty Relationships

• Over 95% of the respondents have the means, either internally or through independent third-party sources, to assess the appropriateness of potential derivatives transactions and determine their associated risks.
   
• Commercial banks were a primary source of derivatives transactions for 82% of the derivatives users, followed by investment banks (38%) and exchanges (13%).
   
• Over the last three years, none of the respondents experienced default on a derivatives contract by a counterparty.
   
• On an overall basis, 89% of the respondents were satisfied with the relationship they had with their OTC derivatives dealer. Only 2% reported dissatisfaction, despite 5% reporting having a dispute with their dealer in the last three years. Almost all these disputes were resolved through negotiation.

Accounting and Disclosure

• While 56% of respondents thought FAS133 would have no impact on their organization's hedging activities, the others who responded indicated that it would affect either the extent (19%) or timing (15%) of their hedging transactions or their choice of hedging instruments (19%).
   
• A majority of respondents (60%) thought that the compliance costs of FAS133 would be material or substantial.

Regulation

• Of all respondents using derivatives, 75% do not believe additional federal regulation of the OTC derivatives activities of dealers and end-users is necessary. Only 10% of the respondents believe additional federal anti-fraud enforcement of OTC derivatives activity is necessary.
   
• Privately and publicly held firms were much less likely to believe that additional federal regulation is necessary than were users from the governmental and non-profit category.

*  *  *  *  *

The overall objective of our newly merged organization is to encourage the continued development of an efficient and liquid market for end-users for a variety of exchange-traded and over-the-counter (OTC) derivative products by taking actions to promote:

• Increased understanding of derivatives and their use;
   
• Reduced legal and other risks for end-users of derivative products; and
   
• Development of a legal and regulatory environment which is conducive to the appropriate and prudent use of derivatives.

Our members have long recognized the value and importance of derivatives. In a worldwide economy, where the volatility of interest rates, currency exchange rates, and commodity and equity prices pose significant risks for a wide variety of business entities, derivatives have become essential risk management and investment tools. For many financial institutions and other types of corporations, the prudent use of derivatives offers a cost-effective means to manage those financial risks, which can have a material effect on their balance sheet, income and cash flows. Investment managers properly use derivatives to manage portfolio diversification, duration, liquidity, and cash flows. In the absence of derivatives, these risk management activities would be more costly, and in some instances, would be impossible to undertake.

Our members also recognize that while derivatives are an important tool in the management of financial risks, their use can also pose risks. Accordingly, we have examined a number of situations where the use of derivatives has resulted in unanticipated losses. We have sought to further discussions among end-users on how to curtail or eliminate such mishaps.

There is a need for greater legal certainty concerning the status of OTC derivatives under the CEA.

Much of the legal uncertainty that currently exists in the swap market results from a combination of two factors: 1) attempts to craft exemptions from regulation under the CEA without first determining whether swaps are actually subject to such regulation; and 2) the legal prohibition against off-exchange transactions in futures that are not otherwise exempted. This leaves swaps that fall outside the scope of the exemptions (whether because of the terms of the exemptions themselves, or because of limitations on the CFTC's authority to grant such exemptions) in a state of legal uncertainty. A possible solution to this legal uncertainty would be either: 1) to determine unequivocally that swaps are not covered by the CEA or 2) to provide that the prohibition against off-exchange transactions does not apply to swaps even if they are considered to be futures. Such an approach would eliminate the need for endless tinkering with the terms of the existing exemptions as the market continues to evolve.

There does not appear to be a need for further regulation of OTC derivatives.

Many participants in the swap market are already subject to regulatory oversight involving their derivatives activities. Moreover, based on the survey results we offer with this statement, as well as the results of the General Accounting Office's 1998 study of sales practices for OTC derivatives, it does not appear that the swap market has experienced problems concerning fraud or sales practice abuses to an extent sufficient to warrant regulatory intervention. There may be a need for improvement in dealer/end-user relationships, which have at times been characterized by efforts on the part of the dealer community to define the terms of such relationships unilaterally. For now, however, these issues would seem to be best addressed through ongoing discussions between dealers and end-users.

In general, end-users have become more sophisticated in their risk management skills over the past several years. Part of this elevated focus on risk management is the result of more stringent oversight by bank and other industry regulators. Even for non-regulated end-users however, isolated but high profile cases involving substantial losses have focused greater attention by risk management staff on OTC derivatives activities. As a result, many end-users have enhanced their internal management and control systems.

We recognize that not all end-users possess the same level of sophistication. On the one hand, a growing number of end-users either have internal systems along with highly trained staff allowing them to model OTC derivatives themselves, or have sought independent outside assistance in performing this function. On the other hand, there are still large numbers of end-users that are less sophisticated and that continue to rely on the dealer community for information regarding the fair value of and risks associated with OTC derivatives.

Nevertheless, we do not believe it is in the best interests of end-users to create more stringent rules for the OTC derivatives market to provide additional protection for the less sophisticated end-user. The OTC derivatives market is and should be one in which both dealers and end-users are ready and willing to assume responsibility for their own activities. It does not seem appropriate to introduce regulatory protections as a way of encouraging or facilitating participation in this market by entities that otherwise may not be fully prepared to assume this responsibility.  n addition, to apply more stringent standards of conduct based on the sophistication level of the end-user would be counter-productive to the growth of the derivatives market and would impose a difficult burden on dealers. This burden would inject unnecessary additional costs into each OTC derivatives transaction. It may also reduce the willingness of dealers to create new types of products that are needed by more sophisticated end-users. For these reasons, no new regulation of the OTC market appears to be warranted at this time.

Any regulatory framework for OTC derivatives should promote, rather than discourage, the development of standardized products and increased market transparency.

To address the needs of less sophisticated end-users, any regulatory framework for OTC derivatives should promote, rather than discourage, the development of facilities for the execution of standardized transactions in a manner that enhances market transparency and reduces counterparty risk exposures. This would include taking steps to reduce or eliminate existing regulatory impediments to the development of clearing facilities, multilateral transaction execution facilities or other arrangements that might promote increased liquidity and price transparency in the swap market. Many of the concerns that have been raised about the swap market could be addressed more efficiently by taking such steps than by devoting continued attention to the definition of "eligible participants" or to the regulation of sales practices and related matters.

Summary

As end-users of derivatives, we favor a market environment in which a wide array of products is available to us, and in which we can access these products as efficiently as possible. We believe that Congress now has before it an opportunity to promote the continued growth of such a market by modernizing certain aspects of the Commodity Exchange Act in the course of reauthorizing the Commodity Futures Trading Commission. Specifically, we support changes in the Commodity Exchange Act that would:

• establish legal certainty concerning the status of OTC derivatives;
   
• reduce or eliminate obstacles to the development of new products and new ways of accessing these products; and
   
• promote the development of facilities that will enhance liquidity and transparency while reducing counterparty risk exposures.

We do not believe that any additional regulation of the derivatives market is warranted at this time. We appreciate the opportunity to present our views on these far-reaching and complex issues.