The Story of CFTC Compromise

One by one, Gary Gensler's supporters deserted him. Now thechief U.S. regulator of derivatives was being summoned by TreasurySecretary Jacob J. Lew to explain why he refused to compromise.

Banks and lawmakers, as well as financial regulators from aroundthe world, had besieged Lew with complaints about Gensler'scampaign to impose U.S. rules overseas.

The July 3 meeting in Lew's conference room with a view of theWhite House grew tense, according to three people briefed on it.Gensler argued his plan was vital if the U.S. hoped to seizemeaningful authority over financial instruments that helped pushthe global economy to the brink in 2008, taking down AmericanInternational Group Inc. (AIG) and Lehman Brothers Holdings Inc.and igniting the worst recession since the 1930s.

Lew insisted that Gensler coordinate better with the Securitiesand Exchange Commission (SEC), whose new chairman, Mary Jo White,was also present. Gensler, who was deep into negotiations with hisEuropean counterparts, was surprised by Lew's demand. He'd beenhearing the same request from lobbyists seeking to slow theprocess, and he told the Treasury chief it felt like his adversarybankers were in the room, the people said.

Gensler subsequently apologized to Lew for the outburst. He alsosoftened his demands, cutting a deal with the European Union (EU) aweek later. Gensler, chairman of a historically obscure agencycalled the Commodity Futures Trading Commission (CFTC), had againpushed an idea to the brink until forced to settle.

The fate of one of Gensler's central goals shows why the U.S.attempt to rein in the world's most secretive and profitablefinancial products falls short of the vision he promoted four yearsago. While he won regulators the power to reach deep into a $633trillion market, Wall Street preserved its dominance in derivativestrading with one of the largest sustained lobbying attacks on asingle Washington agency.

In the end, the full force of the rules that the CFTC is writingunder the authority of the 2010 Dodd-Frank financial regulatory lawwill apply to only a small share of the global market—possibly lessthan 20 percent, according to data compiled byBloomberg. PQ1

Whole segments of the business have been carved out of therules. Derivatives based on foreign-exchange rates are largelyexempt. Some firms are modifying their products to escape newoversight. And after Gensler's compromise with Europe, Americanbanks will be able to sell derivatives overseas without direct U.S.scrutiny.

Derivatives were famously labeled “financial weapons of massdestruction” by investor Warren Buffett before they becameaccelerants in the 2008 meltdown and led to the $182 billion U.Sbailout of AIG. The insurer couldn't cover credit-default swaps itsold to banks when the global squeeze began. The derivative rulesnow taking shape are a core element of Dodd-Frank, the government'sbiggest foray into regulating the financial industry since the SECwas created during the Great Depression.

The stakes are high, both for big banks, which have earned morethan $50 billion a year dealing in derivatives, and for the largereconomy. While they are rarely traded by individuals, manybusinesses and institutions use derivatives in investmentstrategies, which affect heating-oil prices, college savings funds,and highway projects. Dairy farmers buy them to protect againstsudden price increases in corn and soybean meal for their cows,helping to keep milk prices stable for consumers.

The CFTC has produced about 60 rules for derivatives. This storyreviews how the banking industry and its allies forced Gensler toretreat on the three most consequential ones for Wall Street. It isbased on agency, court, and congressional records; private notes,e-mails, and documents; and interviews with dozens of executives,lobbyists, and U.S. officials, some of whom spoke on condition ofanonymity to describe private meetings.

Lobbying Blitz

When the standing of finance lobbyists in Washington began torebound along with the economy their industry sent into recession,they sought to influence the language in the CFTC's intricaterulebook. They flooded the agency with visits, unleashed thousandsof comment letters, enlisted sympathetic lawmakers, and stokeddifferences between the CFTC and SEC.

Under the three-year assault, the CFTC created winners andlosers with keystrokes. Changing a single number in one ruleundermined potential competition to banks. Another tweak allowsfirms including Koch Industries Inc. and ConocoPhillips to tradebillions of dollars in swaps and avoid the most stringentrules.

“The banks are going to be fine,” said Sunil Hirani, chiefexecutive officer of trueEX Group LLC, who helped pioneerelectronic trading of derivatives. “They are going to make a ton ofmoney.”

Jill E. Sommers, a Republican CFTC commissioner who stepped downin July, said the outcome leaves the big players in charge.

“Looking back, of course with 20-20 hindsight, I wish we wouldhave done more to encourage competition,” she said. “The onlypeople that can afford to stay in the business are the people whohave already long established their footprint in the market.”

Pride of authorship helps explain why Gensler fought so hard.It's been a closely held secret that he was the invisible handbehind Dodd-Frank's derivatives section. His biggest coup was toslip carefully crafted language into the law that the banks didn'tinitially realize could give the CFTC authority over their foreignbranches.

Gensler turned his agency upside down trying to preserve theintent of his own text. His demanding style got results, while alsodriving aides to a point of exhaustion and sending some running forthe exits. He alienated other commissioners and angered what hecalls the G-16—the 16 big banks that, according to a 2010 CitigroupInc. report cited by Deloitte LLP, earn about $55 billion a yearfrom derivatives.

In the end, Gensler also sacrificed his ambition, creating somany political enemies in Congress and the industry that hischances for a second term as chairman are dim.

“He burned a lot of bridges getting it all done, within thecommission and internationally,” said David Hirschmann, presidentof the Center for Capital Markets Competitiveness at the U.S.Chamber of Commerce.

Gensler, 55, is hustling to finish the rules this year beforehis tenure at the CFTC ends Dec. 31. He says any shortcomings palenext to Dodd-Frank's core accomplishment: Many derivative tradesonce handled privately are being forced into the open. The marketwill be cheaper for buyers and safer for the economy becauseparticipants will report transactions and clear them through athird party, putting up collateral.

Even that success may have unintended consequences. Some financescholars, Wall Street banks, and Gensler himself have warned thatconcentrating trades at a few big clearinghouses that settletrillions of dollars in deals creates a new risk—a potentialtoo-big-to-fail powder keg when the next crisis hits.

Thousand Visits

The lobbying blitz pitted Gensler against banks, including theone where he started his career as a young star—Goldman Sachs GroupInc., which made more than 150 visits and calls to the agency fromApril 2010 through July 2013, an analysis of CFTC recordsshows.

Representatives of Gensler's G-16 opponents together made morethan 1,000 contacts with the agency, the records show. Theyincluded lobbyists, lawyers, and bank presidents. Alone or ingroups, they attended more than a third of the 2,100 sessions thatthe CFTC's staff reported holding with outsiders.

All told, more than 3,500 people joined meetings at the agency'sred-brick headquarters just outside Washington's K Street lobbyingcorridor.

The lineup shows how derivatives have penetrated economic lifebeyond Wall Street. Royal Dutch Shell Plc and Caterpillar Inc. sentemissaries. The American Bankers Association came calling, as didthe American Bakers Association, Chicago Mayor Rahm Emanuel, thehead of Carolina Cotton Growers Cooperative Inc., the director offuel for AirTran Holdings Inc., and the treasurer of Walt DisneyCo. (Among firms lobbying was Bloomberg LP, parent of BloombergNews, which started an electronic derivatives-trading platform thatcompetes with banks. The firm also filed an unsuccessful federallawsuit against the CFTC involving its trading rules.)

The banking industry was the most persistentand well-financed of the visitors. In the first year afterDodd-Frank was enacted, Wall Street's biggest lobbying group—theSecurities Industry and Financial Markets Association, known asSifma—paid more than $3 million to law firms working onregulations, public filings show. Individual banks spent millionsmore.

Sifma President Kenneth Bentsen said the industry's dealingswith Gensler aren't about “a win or lose.” Banks that bear theburden of new rules have a responsibility to make sure lawmakersand regulators understand their perspective, he said.

PQ6 “None of these things are as simple or as crystal clearas they were sold to be,” said Bentsen. “Gary is a very smartindividual. He obviously was in the industry. He has been ingovernment. He is very certain of his view of things and is verydetermined. That's what guides him. But there is more than oneview.”

Seminal Meeting

Gensler's vision took shape on a January day in 2009. He sat ina glass-walled conference room across from two other peoplePresident-elect Barack Obama picked to rebuild the discredited U.S.oversight system for Wall Street: Timothy F. Geithner, who would betaking over the Treasury, and Mary Schapiro, nominated for chairmanof the SEC.

Just as the 2001 terrorist attacks spawned a vast newnational-security complex, the credit crisis was fueling calls fora regulatory wall against future financial disasters. All threeagreed the U.S. had to wrest control from firms including GoldmanSachs, the biggest securities firm that was transformed into abank, and JPMorgan Chase & Co., the biggest U.S. bank byassets, both of which made billions selling derivatives behindclosed doors before taking taxpayer bailouts in 2008.

Gensler wanted trades to be public, buyers forced to postcollateral, and new businesses set up to compete with banks.

“We weren't staffed,” Gensler said, describing the meeting in aninterview. “There were no briefing books.” It was a “vision thatkind of we cobbled together.”

Unlike regulators who have to learn the language of Wall Street,Gensler was a native speaker. With an MBA from the University ofPennsylvania's Wharton School, he became one of the youngestpartners in Goldman Sachs history. He quit at 39, with investmentshe recently reported to be worth more than $15 million, and joinedTreasury in 1997 as an assistant secretary.

Gensler is more self-assured than the typical finance nerd. He'sfond of kicking off his shoes in the office. Unwinding after anindustry conference in Florida last March, he pulled a femaleattendee onto the dance floor and gyrated expertly to pop rocktracks. A video clip went viral among Washington insiders,including surprised CFTC staff members.

Gensler also surprised Wall Street with his two-step onderivatives. At Treasury, he advocated for their deregulation. Hesaid he assumed that since banks were heavily regulated asinstitutions it would be redundant to make rules for each of theiractivities. “That was a bad assumption,” he said.

Derivatives and the debate over their effects on society are atleast as old as capitalism. Some scholars trace them to about 580B.C., noting that Greek philosopher Thales the Milesian was said tohave gotten rich buying rights to purchase olive presses afterdiscerning a big harvest was on the way.

A swap, a common form of derivative, is at its simplest acontract between two parties who agree to exchange money or goodsdepending on what happens to an asset. Swaps are often used tohedge risk. An investor in a company's bonds might buy acredit-default swap, which provides a kind of insurance against thechance the firm can't repay its debt.

AIG Bailout

By the late 1990s, the U.S. swaps market had grown beyond basichedging into a casino of increasingly ingenious and interconnectedproducts.

When Gensler met with Geithner and Schapiro at the Obamatransition offices, set up in a glass-and-concrete office buildingbetween the U.S. Capitol and the White House, the government waswell into the AIG bailout. Gensler wanted the new regulatorymachine to reach beyond the credit-default swaps sold by AIG intoall derivatives that aren't traded on exchanges, the kind known asover-the-counter, or OTC, swaps.

“This would be the entire product suite,” he recalledsaying.

To Geithner, Gensler's views made sense. The Treasury chief hadexamined the derivatives market in 2005 and 2006 while he was headof the Federal Reserve Bank of New York. He saw risk-managementpractices that were stuck in the dark ages—trades confirmed withpaper, pencils, and faxes—and had virtually no oversight, accordingto a person familiar with his thinking.

Within months of the downtown Washington meeting, the Obamaadministration issued a proposal for “comprehensive regulation” ofderivatives. News of that plan roiled the banking industry, whichhad long argued that swaps increase the flow of credit and reducerisk by spreading it around.

With few exceptions, Washington had sided with the banks overthe years. “Regulation that serves no useful purpose hinders theefficiency of markets to enlarge standards of living,” then-FederalReserve Chairman Alan Greenspan told Congress in 1998, explainingwhy swap rules weren't necessary.

When regulation talk resurfaced, banks went looking for helpagain.

There is a “reasonably high risk that the OTC derivatives marketcould be destroyed,” Blythe Masters, then chairman of Sifma, saidat a private April 2, 2009, meeting where Bank of England DeputyGovernor Paul Tucker was also in attendance.

Masters had helped JPMorgan create the credit derivatives marketin the 1990s. She asked Tucker how banks could counter the“increasingly prevailing view within Washington DC and Main Street”that swaps threaten the financial system, according to minutesgiven to Sifma's board members. Tucker suggested the industry“challenge the notion that government knows best and should engagethe academic community,” the minutes show.

Masters now oversees JPMorgan's commodities unit, which agreedto pay $410 million in July to settle claims it manipulatedwholesale electricity markets. She declined through a spokesman tocomment. Tucker didn't respond to requests for comment sent to theBank of England.

Rebuffing Bankers

Bankers who told each other Gensler's resume would make himsympathetic were soon disappointed. It had been more than a decadesince he'd departed Goldman Sachs. He left the Treasury in 2001when Republican George W. Bush became president. In the run-up tothe global financial crisis he was largely focused on being astay-at-home father for his three daughters and a caregiver for hiswife, an artist. She died of cancer in 2006.

In the intervening years, his views had changed. In January2010, Gensler accepted an invitation to lunch at New York's WaldorfAstoria hotel with executives from Goldman Sachs, Credit SuisseGroup AG, Deutsche Bank AG, Bank of New York Mellon Corp., andothers. He rebuffed their concerns, saying his duty now was totaxpayers, according to people who attended. Asked to name the mainobstacle to an improved system, the people said, he gestured at hishosts and replied: “You.”

Congress was already at work on the Obama administration'soversight plan for Wall Street, which reimagined regulation inareas including capital requirements, consumer finance, andmortgages. The derivatives piece landed in the Senate AgricultureCommittee. During drafting sessions, Gensler sometimes sat at thetable reserved for staff, advising its Democratic chairwoman,Blanche Lincoln of Arkansas.

Gensler was reflecting a changed climate in Washington, whereWall Street wasn't welcome on the front lines in Congress asinvestigators probed allegations of wrongdoing during the financialcrisis. The industry that wanted to fight “tooth and nail” againstswap rules turned to others to make its case, said Michael Barr,then an assistant Treasury secretary and an Obama administrationpoint man on Dodd-Frank.

“They brought in CEOs and treasurers of Fortune 500 companies tosay how great it was for America that there was this closed dealermarket,” Barr said.

Industrial firms such as Deere & Co. told lawmakers theirbalance sheets would crater if they had to post collateral ontrades hedging costs of things like fuel. They secured one of thefew exemptions written in the law. Since these so-called end usersusually buy swaps from banks, the carve-out protects one WallStreet profit center.

The core financial industry won little in the drafts ofDodd-Frank, thanks in part to Gensler. As lawmakers debated thebill, he took sections home Friday nights. His aides would wake upon Saturdays to e-mails with suggestions and questions that heoften expected them to deal with before Monday morning, accordingto former and current employees.

Dan Berkovitz, the CFTC general counsel at the time, and JohnRiley, the agency's head of legislative affairs, sent text andsuggestions to Democratic staff members on the House FinancialServices and Agriculture committees that ended up in the billalmost verbatim, e-mails show.

“Here's the cheat sheet,” Riley wrote as he offered advice to aHouse staff member in October 2009. In January 2010, he gave Senateaides Gensler's thinking on trading rules, adding that a “moreformal legislative proposal” would follow. PQ2

Gensler campaigned publicly and behind the scenes. He publisheda Feb. 24, 2010, column in the Financial Times titled “How to stopanother derivatives inferno.” He forwarded the piece to Obama, witha note telling the president that two top priorities—plugging theend-user loophole and making trades more transparent—“are beingweakened as a result of opposition from Wall Street and corporateinterests,” according to a copy of the memo attached to an e-mailto Congress.

In June 2010, as House and Senate lawmakers negotiated the finallanguage in Dodd-Frank, Gensler was seen by reporters paddingaround in his stocking feet for the late-night sessions. Hewhispered in Lincoln's ear to ward off last-minute changes.

Hours after Obama signed Dodd-Frank that July, Gensler invitedCapitol Hill staff members who had worked on the derivativessection to a briefing. The 18 months he had spent pressing his casehad paid off: Most of what he and the administration had wanted,down to exact language in many cases, was now enshrined in law. “Ifelt terrific,” Gensler said.

Annette Nazareth, one of the finance industry's leadingWashington lawyers, heard about Gensler's briefing. The meeting wasto be “followed by a cocktail party as a 'thank you.' Howgracious,” she wrote in mock admiration in an e-mail to a friendwho worked at the SEC on July 22, 2010.

Gensler is “the James Brown of the regulatory agencies,”Nazareth added, comparing him to the legendary hardest-working manin show business.

The celebration was short. Gensler had to defend hiscongressional victories.

An agency that might only write five rules in a year was nowgoing to do 60. He kicked the CFTC staff into high gear,reorganizing them into teams around each rule. He exiled teamleaders who didn't share his mission or perform to his standards,people with knowledge of the process said.

He ran the show more like a Goldman Sachs operator than agovernment bureaucrat. After he pledged to hold a transparent andcooperative process, other commissioners felt cut out of thecommunication loop. They were frustrated and angry when Genslershowed them complex proposals late in the process when he had beendiscussing them for weeks with the staff, according to former andcurrent CFTC employees.

Staff members unaccustomed to working long hours, nights, andweekends would occasionally sleep on the couches on the ninthfloor, where the commissioners had their offices, the people said.With the industry arming for a major pushback, Gensler told them,speed and dedication were essential.

An early battle revolved around a number—one that the CFTCwanted to write into the rules to inject competition into the swapsbusiness.

Slicing Profits

Gensler's idea was to crack open a closed system and create anelectronic market more like futures or stocks. Under existingprocedures, someone wanting to buy a swap was free to contact asingle broker, often a large bank, and make a deal over the phonethat would stay secret.

Big banks and brokers favored the status quo. If forced to showtheir cards to the entire market, others could see their bets andundermine their strategies. Their cut of the deals—andprofits—might also come under scrutiny from customers andregulators. Electronic trading and other rules could slice bankrevenue from OTC swaps by 35 percent, from $33 billion to $21.2billion, the Deloitte study said.

Gensler wanted many of the electronic transactions to take placeon a new kind of platform, competing with banks and with futuresexchanges owned by CME Group Inc. of Chicago and Atlanta-basedIntercontinentalExchange Inc. Publicly visible prices on these SwapExecution Facilities, or Sefs, would shift the advantage “from WallStreet to Main Street,” Gensler said.

How many bids would a swap buyer have to solicit? That was thenumber that set off a two-year fight between Gensler and theindustry.

The topic was discussed more frequently than any other issue onthe CFTC's agenda. It came up during at least 375 meetings withoutsiders, according to data assembled from published CFTCrecords.

One of the lobbyists most often present at those meetings wasMicah Green of Patton Boggs LLP, records show. His firm was hiredby the Wholesale Markets Brokers' Association Americas, a tradegroup that includes swap brokers GFI Group Inc. and ICAP Plc, whichreported spending more than $1 million on legal and advocacy workin the year ending June 2012. Green declined to comment. Along withGreen, ICAP's representatives were the top four visitors on theissue. Their main concern was preserving trading by phone.

Lobbyists also dragged out consideration of the rule byencouraging complaints from Capitol Hill, exploiting differencesamong the CFTC's commissioners, and seeking help at the SEC. Somefirms that mulled opening Sefs drifted away during the delay.

At first, Gensler championed a fully public and electronicsystem, in which traders would only rarely be able to cut deals inprivate on the phone, according to a summary he released in late2010.

Scott O'Malia, a Republican commissioner, sided with industryarguments that Gensler's plan went beyond the CFTC's authorityunder Dodd-Frank and wasn't flexible enough for swaps that don'ttrade as often as futures. The market needs time for “a transitionor an evolution,” he said in an interview.

PQ3-v2 Gensler backtracked. He agreed that not everyone inthe market needed to be asked for a bid. Instead, a swap buyerwould have to request a set number of bids.

Gensler proposed that the number be set at five.

Immediately, banks and big swap buyers such as money managementfirms BlackRock Inc. and Vanguard Group Inc. set out to cut thenumber. One tactic was to encourage a split with the SEC, whichregulates about 5 percent of the swaps market and had to issue itsown Dodd-Frank trading rules.

The SEC was receptive. The agency had “a higher level of comfortthan the CFTC” with letting market participants decide how manybids would be ideal, according to then-SEC chairman Schapiro. Heragency already oversaw off-exchange trading in equity and bondmarkets.

Gensler's number felt arbitrary, Schapiro said in an interview.“How do you pick five?” Schapiro said. “Why not 10? Why not 3?”

The SEC torpedoed the CFTC's idea, proposing that the number bereduced to just one.

Meanwhile, the CFTC stoked interest in the new system. In March2011, it staged an event dubbed Sef-a-Palooza. Representatives fromtwo dozen firms traveled to Washington to show their wares to astanding-room-only crowd. Among them were Tradeweb Markets LLC,MarketAxess Holdings Inc., and GFI Group Inc. (Also presenting wasBloomberg LP, parent of Bloomberg News, which has established aSef.)

The CFTC predicted as many as 40 Sefs would be set up ascompetitors to the banks and exchanges.

Hirani, the derivatives pioneer who had a walk-on role in the2010 film “Wall Street: Money Never Sleeps” and was one of thefirst to trade credit swaps electronically, initially was caught upin the hoopla and planned to start a Sef.

In time, he changed his mind. “I thought it would take too longbased on our judgment of the lobbying that market participantswould unleash,” Hirani said.

His prediction was borne out. Using the SEC's proposal as acudgel, banks including Goldman Sachs, JPMorgan, and Deutsche Bankkept showing up at the CFTC arguing to drop the minimum entirely,records show.

On Capitol Hill, where banks were regaining influence as thecredit crisis waned, the lobby found sympathizers in both parties,including Representative Barney Frank, the Massachusetts Democratwho was one of the bill's namesakes. At a November 2011 hearing, hecalled the CFTC's proposal “more intrusive and more complex thanwas necessary.”

The swing vote on the five-member CFTC was Mark Wetjen, aDemocrat and former policy adviser to Senate Majority Leader HarryReid. Wetjen, who joined the agency in October 2011, had littleexperience with swap rules while working on Capitol Hill. InFebruary 2013, he floated a plan for two bids. “It was the assetmanagers and hedgers who were most convincing, and they wanted itflexible,” he said in an interview.

The debate raged in mid-March when bankers and regulatorsgathered for an annual industry conference in Florida at thepink-stucco Boca Raton Resort and Club—the same meeting whereGensler took his turn on the dance floor.

By the last week of April, Gensler realized the fight was over.He accepted Wetjen's plan for two bids. His only consolation: Thelimit would rise to three bids after a year.

“I would have preferred to keep it closer to the five,” Genslersaid in the interview.

Bart Chilton, a Democratic member of the CFTC, said he votedreluctantly for the compromise. “We certainly did only the bareminimum of what the drafters of Dodd-Frank envisioned,” Chiltonsaid in an interview. “In the end, I think we caved in order tofinalize the rule.”

Avoiding Labels

There was another number regulators had to pick: What amount ofderivatives could a firm sell before it was big enough to beformally designated a swap dealer? That would mean the governmentwould be constantly looking over its shoulder.

The task had its origins in a financial crisis a decade earlier.A small power company born in Nebraska transformed itself into amassive derivatives trading firm that was allowed to operate withalmost no CFTC oversight. It became Enron Corp.

While Enron's 2001 collapse was fueled more by accounting fraudthan derivatives, government officials had been seeking for yearsto ensure that no company could escape regulation by essentiallypretending to be in a less-risky business.

Gensler's initial plan would slap the label “swap dealer” onanyone selling at least $100 million worth a year. That wouldcapture dozens of firms far from Wall Street.

Energy executives who said they expected to escape Dodd-Frank bywinning the end-user exemption from Congress rushed to get the $100million threshold raised. Their yearlong campaign involved newlyformed industry groups that wouldn't disclose members, well-timedcampaign contributions and another back-door assault by theSEC.

To see that the business went far beyond banks, all regulatorshad to do was to scan the roster of the leading trade organizationfor derivatives. Among the biggest members of the InternationalSwaps and Derivatives Association were BP Plc, Shell, and KochIndustries, which use swaps to hedge the price of oil and naturalgas.

Over the past three decades, these energy companies and othersbuilt up side businesses selling derivatives to customers. Koch,for example, has said it was the first dealer of a swap to a majorairline looking to hedge fuel costs.

The energy companies said they weren't banks and shouldn't betreated as if they were. Gensler saw it differently: The more ofthe business that remained outside the stiffest regulations, themore chance of another blow-up. He began calling it the “BPloophole.”

When meeting with lobbyists and industry lawyers, Gensler wasquick to show off his mastery of market details, which left somevisitors with the sense he had already formed his plan and wasn'tinterested in their suggestions, according to multipleparticipants.

Terrence Duffy, executive chairman of CME Group, found Genslerto be different overall than previous CFTC chairmen. “They had amore collegial approach towards making sure the market had anunderstanding of what they were thinking,” he said in aninterview.

Red Font

Early on in the swap-dealer debate, David Perlman of Bracewell& Giuliani LLP in Washington, a former chief counsel ofLehman's commodity business, emerged as a leader of the oppositionto Gensler. His Coalition of Physical Energy Companies includedShell, Apache Corp., and NRG Energy Inc.

Perlman rewrote the text of Gensler's proposal and sent it tothe CFTC in early 2011. His version raised the $100 million bar to$3 billion. He crossed out the agency's number in red font and puthis in blue so no one could miss it, according to a copy laterposted on the agency's website.

The $3 billion threshold could help get many of his clients outfrom under the rules. “The consequence of crossing that line issignificant,” he said in an interview.

Another trade group, the Commodity Markets Council, suggested tothe CFTC that the cutoff be jacked up to $10 billion.

BP, Koch, Shell, Vitol Group, ConocoPhillips, and ConstellationEnergy Group Inc. joined together in yet another association—aworking group of commercial energy firms, according to publicrecords and people with knowledge of the group's members, whichhaven't been publicly disclosed. PQ4

The group hired Sharon Brown-Hruska, a former acting chairman ofthe CFTC now with NERA Economic Consulting. She co-wrote a paperconcluding that the agency's plan to oversee energy firms as swapdealers would be “very harmful” for consumers. Republicans onCapitol Hill e-mailed it to reporters.

Brown-Hruska said in an interview that the study was effectivebecause it “focused on empirical analysis.” The CFTC proposal “justlayered on costs, and it would discourage legitimate and importanthedging activity by those firms,” she said.

Gensler wouldn't budge from his $100 million.

After Republicans became a majority in the House in 2011, theirstaff members met privately with financial lobbyists in the Rayburnoffice building. They strategized on ways to persuade Democraticmembers to sign onto bills aimed at slowing Gensler down, twopeople with knowledge of the sessions said.

In October, Republican legislators wrote a bill that would ordera $3 billion threshold for swap dealers. A few Democrats were onboard, including Dan Boren of Oklahoma and Mike Ross of Arkansas.While never considered by the full House, it gave lawmakers achance to hold a public hearing, during which they slammedGensler's plan.

One company that testified in support of the legislation wasConstellation Energy. The political action committees of theBaltimore utility and the company that was in the process ofacquiring it—Chicago-based Exelon Corp.—together became among thelargest contributors to the 2012 campaign of Representative RandyHultgren, an Illinois Republican who was the bill's sponsor. Theygave a total of $12,500, federal election records show.

Hultgren said in a statement that he backed the bill to protecta “diverse group of Main Street end-users” that he said includedExelon and farmers' cooperatives from “overly broad and burdensomerules that would threaten consumers with higher prices.”

Paul Elsberg, a spokesman for Exelon, said the firm backscandidates “who we believe will support sound energy policies” forIllinois and the nation. “Dodd-Frank should not impose significantcosts or restrictions on the ability of companies like ours tomanage risk and to hedge our physical exposure to physicalcommodity prices,” Elsberg said.

At the SEC, industry arguments found a receptive audience inDaniel Gallagher, the newest commissioner and an avowed free-marketRepublican. SEC staff lawyers already were bucking Gensler,proposing a $1 billion threshold. Gallagher wanted it higher, at$10 billion, to capture only big Wall Street players.

Working with the SEC staff, Gallagher produced an alternativeplan. It eventually called for an $8 billion level and a compromisethat would drop it to $3 billion after a few years.

Gallagher worked quietly to sell the idea to his counterparts atthe CFTC, according to people at both agencies. He invitedRepublican commissioners Sommers and O'Malia to lunch and spokewith Wetjen by phone, the people said.

'Little Caper'

Gensler got wind of Gallagher's campaign and called him in April2012, a week before the agencies were scheduled to vote on therule, said a person with knowledge of the conversation. The two menhad been on friendly terms when both commuted by Amtrak betweenWashington and Baltimore. They hadn't talked or crossed paths inthe five months since Gallagher joined the SEC.

After exchanging some pleasantries, Gensler told Gallagher heknew about “your little caper,” as Gallagher later related toothers at the SEC. Gallagher responded that he was merelyattempting to help put forth responsible regulation.

In the end, Gensler capitulated. He was one of nine officials atboth agencies who voted for the rule. Gensler said he would haveliked a lower bar, but with so many rules to work on it wassignificant that “we got it done.”

The energy lobbyists were ecstatic. The NERA consulting firm,which had been hired by BP, Koch, and the other energy companies,boasted on its website about the CFTC's “significant reversal ofcourse.”

Firms including Exelon, ConocoPhillips, AGL Resources Inc., andMidAmerican Energy Holdings Co., some of which had warned investorsthat their companies might need to register as swap dealers, nowreported they would escape the label.

The company that gave the BP Loophole its name wound upregistering with the CFTC as a swap dealer after all. Scott Dean, aspokesman for BP, declined to comment. So far, Cargill Inc. is theonly other energy or commodity firm to register.

One consequence of the energy firms' win: Banks continue todominate the business. “The large institutions who have always beenmajor players in the swaps business are probably the only ones whocan afford to be dealers because it is costly,” said Sommers, theformer CFTC commissioner.

Some energy companies agreed. “This seems directly counter tothe goal of Dodd-Frank to increase competition and reduce theconcentration in large financial institutions,” said LanceKotschwar, a lawyer for Gavilon Group LLC, who has worked on theissue for the Commodity Markets Council.

Border Security

Gensler still held out against pressure to erode the CFTC'sauthority overseas. Few outside his inner circle realized how muchof a hand he had in Dodd-Frank's language on the matter.

The provision in the law begins by saying that the newderivatives oversight wouldn't apply to trading outside thecountry. Then comes the key wording: “unless those activities havea direct and significant connection with activities in, or effecton, commerce of the United States.”

“I know who here drafted it,” Gensler said with a grin, withoutdisclosing the name. “I know exactly who. And I thank them fromtime to time.”

The banking industry, despite employing hundreds of lobbyistsand lawyers to watch the legislation, didn't grasp its significancefor almost a year. As the CFTC was writing its policy, lobbyistsrushed to delay or kill it, enlisting foreign regulators and U.S.lawmakers in their campaign.

To Gensler and his supporters, there was no sense clamping downon swap trading if the agency couldn't see what U.S. firms didoverseas. Didn't AIG, which sold swaps out of a London subsidiaryand held a French banking license, prove the danger?

“If you develop a set of rules that are designed to prevent thenext AIG and it wouldn't prevent the next AIG, that's a problem,”said Barr, the former Treasury official.

While other countries were developing their own rules, some U.S.officials said they might not be as comprehensive ortransparent.

PQ5 Gensler's education on the issue began much earlierthan AIG. Working for Goldman Sachs in the early 1990s, he helpedoversee the firm's swaps book in Asia, which he said was recordedon one “massive Lotus spreadsheet.”

As a Treasury assistant secretary in 1998, Gensler was sent onan emergency mission to Greenwich, Connecticut, one Sunday to seeif the government could stop the implosion of hedge fund giantLong-Term Capital Management.

After investigating the situation, Gensler rushed back toWashington for the Jewish holiday of Rosh Hashanah, callingTreasury Secretary Robert Rubin from the airport with hisconclusion: Nobody had any idea what would happen to the firm's $1trillion swaps portfolio because it was handled out of a legalentity in the Cayman Islands. Gensler knew well how the industryused such business structures overseas. He had helped set them upat Goldman Sachs.

“I will never forget it,” said Gensler. “This was not a goodphone call to make to the secretary of Treasury.”

So when lawmakers were drafting the derivatives bill in October2009 and considered its overseas reach for five minutes during aseven-hour hearing, Gensler took special notice.

He put his lawyers to work. In late November, the CFTC's Rileysent Agriculture Committee aide Clark Ogilvie and other Housestaffers four paragraphs for an “extraterritoriality provision,”according to an e-mail.

Wake-Up Call

The language in Riley's e-mail was included verbatim in a228-page amendment and approved on the House floor without debate.It never left the bill. In late December, after the House passedthe measure, Riley sent the language to the Senate. Meanwhile, banklawyers, including Nazareth, told clients the provision would limitthe CFTC, not expand it, according to reports issued by herfirm.

“I think that it was fairly common for people at that time to bereading it as a limitation,” Nazareth said in an interview.

Ten months later, Wall Street got its wake-up call. At anOctober 2010 public meeting at the CFTC, Berkovitz, the generalcounsel, announced that the law gave the agency “a wide reach and abroad reach” overseas. That could extend the rules to any branch oraffiliate of a U.S. bank, even if the branch was selling swaps tonon-U.S. customers.

Bankers left the CFTC stunned, according to severalparticipants.

They quickly increased their lobbying. One of their mainadvocates was Edward Rosen, a partner with Cleary Gottlieb Steen& Hamilton LLP, who became the most frequent CFTC visitor onthe issue, records show. Rosen was hired by an informal coalitionof about a dozen large banks including Credit Suisse, CitigroupInc., and Deutsche Bank. Each member kicked in at least $150,000 tostart, according to two participants. Rosen didn't respond torequests for comment.

The banks also enlisted allies in Congress and among overseasregulators. JPMorgan lawyer Don Thompson, testifying before a Housepanel in February 2011 on behalf of Sifma, said some of his firm'soverseas clients were threatening to take their business tonon-U.S. firms like “Barclays or Credit Suisse or a European bank”that wouldn't be subject to Dodd-Frank and could offer theirservices more cheaply.

Three months later, Senator Charles Schumer, a New York Democratwith close ties to Wall Street, led 18 members of his state'scongressional delegation in signing a letter saying Gensler'sproposals could have “significant negative effects on thecompetitiveness of U.S. institutions.”

Foreign Banks

Later in 2011, the law's co-sponsor Frank weighed in, signing aletter to Gensler saying that “Congress generally limited theterritorial scope” of the derivatives law. Frank said he was mainlymotivated by concern about conflicts between CFTC and SECrules.

Foreign banks were focused on the CFTC's reach as well, notwanting certain of their own trades to fall under Dodd-Frank. TheInstitute of International Bankers, a trade group, led an effort tocontact foreign regulators and politicians to put pressure on theirAmerican counterparts, according to people familiar with themeetings. In the end more than a dozen foreign regulatorscomplained to U.S. officials about the CFTC.

As the pressure on Gensler increased, he got cover from theTreasury secretary. Geithner, in a June 2011 speech to bankers inAtlanta, said strong U.S. rules overseas would help avoid “a raceto the bottom around the world.” He singled out the U.K. for itspast “strategy of light-touch regulation to attract business toLondon, away from New York and Frankfurt” noting it “endedtragically.”

Blowback from the speech didn't help Gensler's case. BritishPrime Minister David Cameron went to Obama to complain, accordingto an official briefed on the matter.

In a small victory for the banks in late 2012, Gensler agreed toa six-month delay on determining the rule's reach.

The squeeze on Gensler tightened as the July 12, 2013, deadlineloomed. Banks and foreign regulators pressed for a further delay,and Gensler faced an insurrection at his own agency. “No one hasever accused Gary Gensler of being reasonable,” Sommers said at thetime.

Gensler hadn't even been able to lock in votes from the othertwo Democrats. Wetjen gave a speech in London June 25 in support ofa slowdown. Chilton called for a compromise.

Then Gensler was summoned to Lew's offices at the Treasury.

The July 3 meeting was an echo of the 2009 meeting that launchedhis regulatory crusade. Gensler again found himself in a room withthe heads of the Treasury and SEC. This time it was Lew and Mary JoWhite instead of Geithner and Schapiro.

Lew, who had replaced Geithner in February, wasn't happy to bedrawn into the battle, according to the people briefed on theprivate session, who spoke on condition of anonymity. He said atthe meeting that while he didn't want to undermine Gensler's plan,he wanted the CFTC chief to better share information with hisEuropean counterparts and the SEC.

After the discussion, Gensler called European negotiatorsoffering to give up some of his demands, a person with knowledge ofthe talks said. The deal was struck with Europe 10 days later andthen internally with Wetjen.

Spokesmen for Lew and White declined to comment.

While details are still being worked out, the compromise meanstrades involving overseas parties, even if handled by a U.S.-basedbank, may fall under rules of another country provided those rulesare deemed comparable. The process for making those rulings remainsunder debate.

The international hole that Gensler wanted to plug remains atleast partly open.

The outcome was a relief to banks that had argued Gensler'soriginal vision was too ambitious and would have concentrated toomuch supervision in an agency ill-equipped to manage it.

Gensler's foreign counterparts were especially angered by hisbrinksmanship.

Michel Barnier, the EU commissioner responsible for marketregulation, said it was unfortunate that the agreement had to come“on the eve of the CFTC's last meeting” on the matter.

The process, Barnier said, “isn't necessarilya model.”

As the CFTC retreats on foreign trading and other fronts, themarket that's left for it to oversee is shrinking. Firms aredesigning contracts so that they fall outside the swaps rules.

PQ7 The phenomenon has become known as 'futurization.' Asfar as financial engineering goes, it's simple: Take a swap andcall it a future.

The first part of the business to move in that direction hasbeen energy. Large energy companies with total swap dealing nearthe $8 billion limit were eager for a way to take some of theirtransactions off the count.

One weekend in October 2012, just before the firms had to starttallying trades under the new rules, ICE, the Atlanta-basedexchange, put its futurization plan into effect. On Fridaycontracts were “swaps.” On Monday they were “futures.”

Within weeks, ICE and CME implemented plans to create similarcontracts for the much larger markets in interest-rate and creditswaps.

If enough swaps migrate to futures exchanges, the profitabilityof alternative trading platforms like Sefs may be less robust.(Bloomberg LP, parent of Bloomberg News, asked a federal court toforce the CFTC to act to limit futurization. A judge dismissed thelawsuit, saying that the company had neither the standing nor thefacts to support its case.)

About a dozen Sefs have been established so far. Hirani, thederivatives pioneer, decided in the end to hedge his bets, startinga firm that is both a Sef and a swaps exchange.

CFTC 'Slap'

Advocates of less regulation say futurization shows the folly ofthe government spending several years drawing up complex rules fordynamic markets.

“It is a slap in the CFTC's face,” said Hester Peirce, a seniorresearch fellow at the Mercatus Center at George Mason University,who was on the Republican staff of the Senate Banking Committeewhen Dodd-Frank was drafted. “It's the agency being told this wholescheme it dreamed up is not going to work.”

CME Group and ICE, along with London-based LCH.Clearnet GroupLtd., are also at the center of another vexing question about thenew oversight apparatus. They operate swap clearinghouses. Therules for the first time require them to function as third partiesfor trillions of dollars in trades moving through their platforms,holding collateral from buyers and sellers in case a transactiongoes bad.

The benefit is that clearinghouses will become central hubswhere a bank's exposure to derivatives can be monitored andregulators can get information on the market.

In the aggregate, though, a clearinghouse also winds up holdingall of the risk because it acts as the other side of the trade forboth buyers and sellers.

If a market blows up, the clearinghouse could turn into a sortof supercharged AIG, unable to cover the losses. That could create“potential vectors for the transmission of systemic risk,” theClearing House Association, a trade group representing the largestcommercial banks, said in a December 2012 report. Banks have beenwarning that clearinghouses aren't holding enough capital and areusing less-liquid collateral, such as corporate bonds rather thancash.

Duffy, of CME Group, said the exchange has put protections inplace. “I would have concerns, too, if my trades were in aclearinghouse that I did not know exactly how was beingrisk-managed,” Duffy said. “We are working with the dealers to makesure they're comfortable.”

Gensler, too, has expressed concern about clearinghouses. In May2010 he wrote to Lincoln and Senator Christopher Dodd, aConnecticut Democrat who co-authored the financial regulatory law,in a failed attempt to keep the firms from being put under FederalReserve supervision. Access to the central bank's emergency lendingcould raise “the risk of clearinghouse failure and the possibleneed for a future bailout,” he wrote.

Gensler said that having central clearing is still better thanentrusting the system to individual banks.

Analyzing whether the CFTC's new rules will make the financialsystem safer than it was in 2008 remains an exercise in estimates.Derivative trades are still largely private, and records kept byclearinghouses and other information repositories aren'tstandardized. A review of the best available data from thosesources and government filings shows that CFTC regulations fortrading, clearing, and reporting about transactions may be felt inless than a sixth of the market.

Calculating Market

The total value of OTC derivatives traded worldwide is $633trillion, according to the Basel, Switzerland-based Bank for International Settlements. More thanhalf of that is held outside the U.S., according to governmentrecords, and could be mostly excluded from CFTC oversight.

PQ8 Of the $300 trillion in derivatives held by U.S. banks,only a portion would fall under all the new restrictions, accordingto the review. The biggest banks sometimes trade half their swapswith overseas clients, and under the cross-border policies, thosedeals might be subject to foreign law instead of Dodd-Frank. Aftersubtracting trades that fall under the foreign-exchange andend-user exemptions, as little as $100 trillion of the total $633trillion could feel the full force of Gensler's rules.

Jeffrey Harris, a former CFTC chief economist, said theexemptions mean that “a very small fraction of the total market”will fall under the new requirements.

“It may be as large as $100 trillion, but at the current time itis probably substantially smaller than that,” he said.

Gensler said that such a calculation doesn't fully capture thescope of the CFTC's new authority, which is laid out in 60 newregulations that touch on a broad swath of derivatives held in U.S.banks, a market worth $300 trillion. Swap dealers have alreadyreported trillions of dollars in transactions that wouldn't havebeen public under the old system, he said.

“The market is shifting,” Gensler said. “The public is farbetter off today with the transparency and the reforms we put inplace.”

As the CFTC prepares for operational oversight, it faces morechallenges. No longer a backwater, the agency's resources haven'tcaught up with its new responsibilities. This year it has a $207million budget and 700 employees, making it less than a fifth ofthe size of the SEC.

It is “completely wrong” for Congress to keep the CFTC's fundingso low, said Schapiro, who as SEC chairman had a $1.4 billionbudget at her disposal. If that isn't fixed, she said, “We willhave a false sense of security about what these rules can do forthe stability of the financial system.”

Chairman's Future

For Gensler himself, the future is also undetermined. With histenure required to end by Dec. 31, Obama has given no sign that hewill be reappointed to the commission, according to people briefedon the matter.

Investor advocates see that outcome as a measure of his success.Gensler shows that “you can go through the revolving door and servewith independence and integrity,” said Jeff Connaughton, a formerDemocratic Senate staff member who was involved in the Dodd-Frankdebate and last year wrote a book chronicling the rise of WallStreet's lobbying machine.

Hirschmann, of the Chamber of Commerce, said that while Genslerhas dealt in a straightforward way with his trade group, heoverreached on some proposals. He said it's unclear whether therules will accomplish Gensler's goals.

“My guess is we will find some of it works, some of it didn't,and we will have to come back and fix it,” Hirschmann said.

Gensler said he understood from the beginning that the originalvision wouldn't survive intact.

“Along the way that means there is some moderation and somecompromise,” he said.

He and his inner circle wanted to focus on the most importantmeasures and were able to “maintain the core,” he said. Even withreduced scope, the accomplishment is enormous, he said.

“This is a $300 trillion market coming out of darkness,” Genslersaid.

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