Vol. 79 Friday, No. 21 January 31, 2014

Part III

Commodity Futures Trading Commission

17 CFR Part 75 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds; Final Rule

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COMMODITY FUTURES TRADING be deemed to refer to the final rule of b. Overview COMMISSION the Commission as herein adopted. 1. Proposed Underwriting Exemption 2. Comments on Proposed Underwriting DATES: The final rule is effective April 17 CFR Part 75 Exemption 1, 2014. 3. Final Underwriting Exemption FOR FURTHER INFORMATION CONTACT: Erik c. Detailed Explanation of the RIN 3038–AD05 Remmler, Deputy Director, Division of Underwriting Exemption Swap Dealer and Intermediary 1. Acting as an Underwriter for a Prohibitions and Restrictions on Distribution of Securities Proprietary Trading and Certain Oversight (‘‘DSIO’’), (202) 418–7630, a. Proposed Requirements That the Interests in, and Relationships with, [email protected]; Paul Schlichting, Purchase or Sale Be Effected Solely in Hedge Funds and Private Equity Funds Assistant General Counsel, Office of the Connection With a Distribution of General Counsel (‘‘OGC’’), (202) 418– Securities for Which the Banking Entity AGENCY: Commodity Futures Trading 5884, [email protected]; Mark Acts as an Underwriter and That the Commission. Fajfar, Assistant General Counsel, OGC, Covered Financial Position Be a Security ACTION: Final rule. (202) 418–6636, [email protected]; i. Proposed Definition of ‘‘Distribution’’ Michael Barrett, Attorney-Advisor, ii. Proposed Definition of ‘‘Underwriter’’ SUMMARY: The Commodity Futures iii. Proposed Requirement That the DSIO, (202) 418–5598, mbarrett@ Covered Financial Position Be a Security Trading Commission (‘‘CFTC’’ or cftc.gov; Stephen Kane, Research b. Comments on the Proposed ‘‘Commission’’) is adopting a final rule Economist, Office of the Chief Requirements That the Trade Be Effected to implement Section 619 of the Dodd- Economist (‘‘OCE’’), (202) 418–5911, Solely in Connection With a Distribution Frank Wall Street Reform and Consumer [email protected]; or Stephanie Lau, for Which the Banking Entity is Acting Protection Act (the ‘‘Dodd-Frank Act’’), Research Economist, OCE, (202) 418– as an Underwriter and That the Covered which contains certain prohibitions and 5218, [email protected]; Commodity Financial Position Be a Security i. Definition of ‘‘Distribution’’ restrictions on the ability of a banking Futures Trading Commission, Three entity and nonbank financial company ii. Definition of ‘‘Underwriter’’ Lafayette Centre, 1155 21st Street NW., iii. ‘‘Solely in Connection With’’ Standard supervised by the Board of Governors of Washington, DC 20581. c. Final Requirement That the Banking the Federal Reserve System (the SUPPLEMENTARY INFORMATION: Entity Act as an Underwriter for a ‘‘Board’’) to engage in proprietary Distribution of Securities and the trading and have certain interests in, or Table of Contents Trading Desk’s Underwriting Position Be Related to Such Distribution relationships with, a hedge fund or I. Background i. Definition of ‘‘Underwriting Position’’ private equity fund. Section 619 also II. Notice of Proposed Rulemaking: Summary ii. Definition of ‘‘Trading Desk’’ requires the Board, the Federal Deposit of General Comments iii. Definition of ‘‘Distribution’’ Insurance Corporation, the Office of the III. Scope iv. Definition of ‘‘Underwriter’’ Comptroller of the Currency, and the IV. CFTC-Specific Comments v. Activities Conducted ‘‘In Connection Securities and Exchange Commission to V. Overview of Final Rule With’’ a Distribution also issue regulations implementing A. General Approach and Summary of 2. Near Term Customer Demand section 619 and directs the CFTC and Final Rule Requirement B. Proprietary Trading Restrictions those four agencies to consult and a. Proposed Near Term Customer Demand C. Restrictions on Covered Fund Activities Requirement coordinate with each other, as and Investments appropriate, in developing and issuing b. Comments Regarding the Proposed Near D. Metrics Reporting Requirement Term Customer Demand Requirement the implementing rules, for the E. Compliance Program Requirement c. Final Near Term Customer Demand purposes of assuring, to the extent VI. Final Rule Requirement possible, that such rules are comparable A. Subpart B—Proprietary Trading 3. Compliance Program Requirement and provide for consistent application Restrictions a. Proposed Compliance Program and implementation. To that end, 1. Section 75.3: Prohibition on Proprietary Requirement although the Commission is adopting a Trading and Related Definitions b. Comments on the Proposed Compliance a. Definition of ‘‘Trading Account’’ Program Requirement final rule that is not a joint rule with the b. Rebuttable Presumption for the Short- other agencies, the CFTC and the other c. Final Compliance Program Requirement Term Trading Account 4. Compensation Requirement agencies have worked closely together c. Definition of ‘‘Financial Instrument’’ a. Proposed Compensation Requirement to develop the same rule text and d. Proprietary Trading Exclusions b. Comments on the Proposed supplementary information, except for 1. Repurchase and Reverse Repurchase Compensation Requirement information specific to the CFTC or the Arrangements and Securities Lending c. Final Compensation Requirement other agencies, as applicable. In 2. Liquidity management activities 5. Registration Requirement particular, the CFTC’s final rule is 3. Transactions of Derivatives Clearing a. Proposed Registration Requirement numbered as part 75 of the Organizations and Clearing Agencies b. Comments on Proposed Registration 4. Excluded Clearing-Related Activities of Commission’s regulations, the rule text Requirement Clearinghouse Members c. Final Registration Requirement refers to the ‘‘Commission’’ instead of 5. Satisfying an Existing Delivery 6. Source of Revenue Requirement the ‘‘[Agency]’’ and one section of the Obligation a. Proposed Source of Revenue regulations addresses authority, 6. Satisfying an Obligation in Connection Requirement purpose, scope, and relationship to With a Judicial, Administrative, Self- b. Comments on the Proposed Source of other authorities with respect to the Regulatory Organization, or Arbitration Revenue Requirement Commission. Furthermore, it is noted Proceeding c. Final Rule’s Approach to Assessing that the supplementary information 7. Acting Solely as Agent, Broker, or Source of Revenue generally refers to the ‘‘Agencies’’ Custodian 3. Section 75.4(b): Market-Making 8. Purchases or Sales Through a Deferred collectively when referring to Exemption Compensation or Similar Plan a. Introduction deliberations and considerations in 9. Collecting a Debt Previously Contracted b. Overview developing the final rule by the CFTC 10. Other Requested Exclusions 1. Proposed Market-Making Exemption together with the other four agencies 2. Section 75.4(a): Underwriting Exemption 2. Comments on the Proposed Market- and references to the ‘‘final rule’’ should a. Introduction Making Exemption

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a. Comments on the Overall Scope of the b. Comments Regarding the Proposed b. Permitted Trading Activities of a Foreign Proposed Exemption Compensation Requirement Banking Entity b. Comments Regarding the Potential c. Final Compensation Requirement 9. Section 75.7: Limitations on Permitted Market Impact of the Proposed 6. Registration Requirement Trading Activities Exemption a. Proposed Registration Requirement a. Scope of ‘‘Material Conflict of Interest’’ 3. Final Market-Making Exemption b. Comments on the Proposed Registration 1. Proposed rule c. Detailed Explanation of the Market- Requirement 2. Comments on the Proposed Limitation Making Exemption c. Final Registration Requirement on Material Conflicts of Interest 1. Requirement to Routinely Stand Ready 7. Source of Revenue Analysis a. Disclosure to Purchase and Sell a. Proposed Source of Revenue b. Information Barriers a. Proposed Requirement to Hold Self Out Requirement 3. Final rule b. Comments on the Proposed Requirement b. Comments Regarding the Proposed b. Definition of ‘‘High-Risk Asset’’ and to Hold Self Out Source of Revenue Requirement ‘‘High-Risk Trading Strategy’’ i. The Proposed Indicia i. Potential Restrictions on Inventory, 1. Proposed Rule ii. Treatment of Block Positioning Activity Increased Costs for Customers, and Other 2. Comments on Proposed Limitations on iii. Treatment of Anticipatory Market Changes to Market-Making Services High-Risk Assets and Trading Strategies Making ii. Certain Price Appreciation-Related 3. Final Rule iv. High-Frequency Trading Profits Are an Inevitable or Important c. Limitations on Permitted Activities That c. Final Requirement to Routinely Stand Component of Market Making Pose a Threat to Safety and Soundness Ready to Purchase and Sell iii. Concerns Regarding the Workability of of the Banking Entity or the Financial i. Definition of ‘‘Trading Desk’’ the Proposed Standard in Certain Stability of the United States ii. Definitions of ‘‘Financial Exposure’’ and Markets or asset classes B. Subpart C—Covered Fund Activities and ‘‘Market-Maker Inventory’’ iv. Suggested Modifications to the Investments iii. Routinely Standing Ready to Buy and Proposed Requirement 1. Section 75.10: Prohibition on Sell v. General Support for the Proposed Acquisition or Retention of Ownership 2. Near Term Customer Demand Requirement or for Placing Greater Interests in, and Certain Relationships Requirement Restrictions on a Market Maker’s Sources With, a Covered Fund a. Proposed Near Term Customer Demand of Revenue a. Prohibition Regarding Covered Fund Requirement c. Final Rule’s Approach to Assessing Activities and Investments b. Comments Regarding the Proposed Near Revenues b. ‘‘Covered Fund’’ Definition 1. Foreign Covered Funds Term Customer Demand Requirement 8. Appendix B of the Proposed Rule 2. Commodity Pools i. The Proposed Guidance for Determining a. Proposed Appendix B Requirement 3. Entities Regulated Under the Investment Compliance With the Near Term b. Comments on Proposed Appendix B Company Act Customer Demand Requirement c. Determination to not Adopt Proposed c. Entities Excluded From Definition of ii. Potential Inventory Restrictions and Appendix B Covered Fund Differences Across Asset Classes 9. Use of Quantitative Measurements 1. Foreign Public Funds iii. Predicting Near Term Customer 4. Section 75.5: Permitted Risk-Mitigating 2. Wholly-Owned Subsidiaries Demand Hedging Activities 3. Joint Ventures iv. Potential Definitions of ‘‘Client,’’ a. Summary of Proposal’s Approach to 4. Acquisition Vehicles ‘‘Customer,’’ or ‘‘Counterparty’’ Implementing the Hedging Exemption 5. Foreign Pension or Retirement Funds v. Interdealer Trading and Trading for b. Manner of Evaluating Compliance with 6. Insurance Company Separate Accounts Price Discovery or To Test Market Depth the Hedging Exemption 7. Bank Owned Life Insurance Separate vi. Inventory Management c. Comments on the Proposed Rule and Accounts vii. Acting as an Authorized Participant or Approach to Implementing the Hedging 8. Exclusion for Loan Securitizations and Market Maker in Exchange-Traded Exemption Definition of Loan Funds d. Final Rule a. Definition of Loan viii. Arbitrage or Other Activities That 1. Compliance Program Requirement b. Loan Securitizations Promote Price Transparency and 2. Hedging of Specific Risks and i. Loans Liquidity Demonstrable Reduction of Risk ii. Contractual Rights or Assets ix. Primary Dealer Activities 3. Compensation iii. Derivatives x. New or Bespoke Products or Customized 4. Documentation Requirement iv. SUBIs and Collateral Certificates Hedging Contracts 5. Section 75.6(a)–(b): Permitted Trading in v. Impermissible Assets c. Final Near Term Customer Demand Certain Government and Municipal 9. Asset-Backed Commercial Paper Requirement Obligations Conduits i. Definition of ‘‘Client,’’ ‘‘Customer,’’ and a. Permitted Trading in U.S. Government 10. Covered Bonds ‘‘Counterparty’’ Obligations 11. Certain Permissible Public Welfare and ii. Impact of the Liquidity, Maturity, and b. Permitted Trading in Foreign Similar Funds Depth of the Market on the Analysis Government Obligations 12. Registered Investment Companies and iii. Demonstrable Analysis of Certain c. Permitted Trading in Municipal Excluded Entities Factors Securities 13. Other Excluded Entities iv. Relationship to Required Limits d. Determination to Not Exempt d. Entities Not Specifically Excluded From 3. Compliance Program Requirement Proprietary Trading in Multilateral the Definition of Covered Fund a. Proposed Compliance Program Development Bank Obligations 1. Financial Market Utilities Requirement 6. Section 75.6(c): Permitted Trading on 2. Cash Collateral Pools b. Comments on the Proposed Compliance Behalf of Customers 3. Pass-Through REITS Program Requirement a. Proposed Exemption for Trading on 4. Municipal Securities Tender Option c. Final Compliance Program Requirement Behalf of Customers Bond Transactions 4. Market Making-Related Hedging b. Comments on the Proposed Rule 5. Venture Capital Funds a. Proposed Treatment of Market Making- c. Final Exemption for Trading on Behalf 6. Credit Funds Related Hedging of Customers 7. Employee Securities Companies b. Comments on the Proposed Treatment of 7. Section 75.6(d): Permitted Trading by a e. Definition of ‘‘Ownership Interest’’ Market Making-Related Hedging Regulated Insurance Company f. Definition of ‘‘Resident of the United c. Treatment of Market Making-Related 8. Section 75.6(e): Permitted Trading States’’ Hedging in the Final Rule Activities of a Foreign Banking Entity g. Definition of ‘‘Sponsor’’ 5. Compensation Requirement a. Foreign Banking Entities Eligible for the 1. Definition of Sponsor With Respect to a. Proposed Compensation Requirement Exemption Securitizations

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2. Section 75.11: Activities Permitted in d. Threshold for Application of Enhanced instruments in the near term or Connection With Organizing and Minimum Standards otherwise with the intent to resell in Offering a Covered Fund 2. Appendix B: Enhanced Minimum order to profit from short-term price a. Scope of Exemption Standards for Compliance Programs movements.4 Section 13(d)(1) expressly 1. Fiduciary Services a. Proprietary Trading Activities 2. Compliance With Investment b. Covered Fund Activities or Investments exempts from this prohibition, subject Limitations c. Enterprise-Wide Programs to conditions, certain activities, 3. Compliance With Section 13(f) of the d. Responsibility and Accountability including: BHC Act e. Independent Testing • Trading in U.S. government, agency 4. No Guarantees or Insurance of Fund f. Training and municipal obligations; Performance g. Recordkeeping • Underwriting and market making- 5. Limitation on Name Sharing With a 3. Section 75.20(d) and Appendix A: related activities; Covered Fund Reporting and Recordkeeping • Risk-mitigating hedging activities; 6. Limitation on Ownership by Directors Requirements Applicable to Trading • and Employees Trading on behalf of customers; Activities • 7. Disclosure Requirements a. Approach to Reporting and Trading for the general account of b. Organizing and Offering an Issuing Recordkeeping Requirements Under the insurance companies; and Entity of Asset-Backed Securities Proposal • Foreign trading by non-U.S. c. Underwriting and Market Making for a b. General Comments on the Proposed banking entities.5 Covered Fund Metrics Section 13 of the BHC Act also 3. Section 75.12: Permitted Investment in c. Approach of the Final Rule generally prohibits banking entities a Covered Fund d. Proposed Quantitative Measurements a. Proposed Rule from acquiring or retaining an and Comments on Specific Metrics ownership interest in, or sponsoring, a b. Duration of Seeding Period for New 4. Section 75.21: Termination of Activities Covered Funds or Investments; Authorities for hedge fund or private equity fund. c. Limitations on Investments in a Single Violations Section 13 contains several exemptions Covered Fund (‘‘Per-Fund Limitation’’) VII. Administrative Law Matters that permit banking entities to make d. Limitation on Aggregate Permitted A. Paperwork Reduction Act Analysis limited investments in hedge funds and Investments in all Covered funds B. Regulatory Flexibility Act Analysis private equity funds, subject to a (‘‘Aggregate Funds Limitation’’) number of restrictions designed to e. Capital Treatment of an Investment in a I. Background Covered Fund ensure that banking entities do not f. Attribution of Ownership Interests to a The Dodd-Frank Act was enacted on rescue investors in these funds from loss Banking Entity July 21, 2010.1 Section 619 of the Dodd- and are not themselves exposed to g. Calculation of Tier 1 Capital Frank Act added a new section 13 to the significant losses from investments or h. Extension of Time To Divest Ownership Bank Holding Company Act of 1956 other relationships with these funds. Interest in a Single Fund (‘‘BHC Act’’) (codified at 12 U.S.C. 1851) Section 13 of the BHC Act does not 4. Section 75.13: Other Permitted Covered that generally prohibits any banking prohibit a nonbank financial company Fund Activities entity from engaging in proprietary supervised by the Board from engaging a. Permitted Risk-Mitigating Hedging trading or from acquiring or retaining an Activities in proprietary trading, or from having b. Permitted Covered Fund Activities and ownership interest in, sponsoring, or the types of ownership interests in or Investments Outside of the United States having certain relationships with a relationships with a covered fund that a 1. Foreign Banking Entities Eligible for the hedge fund or private equity fund banking entity is prohibited or restricted Exemption (‘‘covered fund’’), subject to certain from having under section 13 of the 2. Activities or Investments Solely Outside exemptions.2 New section 13 of the BHC BHC Act. However, section 13 of the of the United States Act also provides that a nonbank BHC Act provides that these activities 3. Offered for Sale or Sold to a Resident of financial company designated by the be subject to additional capital charges, the United States Financial Stability Oversight Council 4. Definition of ‘‘Resident of the United quantitative limits, or other States’’ (‘‘FSOC’’) for supervision by the Board restrictions.6 c. Permitted Covered Fund Interests and (while not a banking entity under Activities by a Regulated Insurance section 13 of the BHC Act) would be II. Notice of Proposed Rulemaking: Company subject to additional capital Summary of General Comments 5. Section 75.14: Limitations on requirements, quantitative limits, or Authority for developing and Relationships With a Covered Fund other restrictions if the company adopting regulations to implement the a. Scope of Application engages in certain proprietary trading or prohibitions and restrictions of section b. Transactions That Would Be a ‘‘Covered covered fund activities.3 Transaction’’ 13 of the BHC Act is divided among the c. Certain Transactions and Relationships Section 13 of the BHC Act generally Board, the Federal Deposit Insurance Permitted prohibits banking entities from engaging Corporation (‘‘FDIC’’), the Office of the 1. Permitted Investments and Ownerships as principal in proprietary trading for Comptroller of the Currency (‘‘OCC’’), Interests the purpose of selling financial the Securities and Exchange 2. Prime Brokerage Transactions Commission (‘‘SEC’’), and the d. Restrictions on Transactions With Any 1 Dodd-Frank Wall Street Reform and Consumer Commodity Futures Trading Permitted Covered Fund Protection Act, Public Law 111–203, 124 Stat. 1376 Commission (‘‘CFTC’’).7 As required by 6. Section 75.15: Other Limitations on (2010). Permitted Covered Fund Activities 2 See 12 U.S.C. 1851. 4 C. Subpart D and Appendices A and B— 3 See 12 U.S.C. 1851(a)(2) and (f)(4). The Agencies See 12 U.S.C. 1851(a)(1)(A) and (B). 5 Compliance Program, Reporting, and note that two of the three companies currently See id. at 1851(d)(1). 6 Violations designated by FSOC for supervision by the Board See 12 U.S.C. 1851(a)(2) and (d)(4). 7 1. Section 75.20: Compliance Program are affiliated with insured depository institutions, See 12 U.S.C. 1851(b)(2). Under section and are therefore currently banking entities for 13(b)(2)(B) of the BHC Act, rules implementing Mandate purposes of section 13 of the BHC Act. The section 13’s prohibitions and restrictions must be a. Program Requirement Agencies are continuing to review whether the issued by: (i) The appropriate Federal banking b. Compliance Program Elements remaining company engages in any activity subject agencies (i.e., the Board, the OCC, and the FDIC), c. Simplified Programs for Less Active to section 13 of the BHC Act and what, if any, jointly, with respect to insured depository Banking Entities requirements apply under section 13. institutions; (ii) the Board, with respect to any

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section 13(b)(2) of the BHC Act, the classes, and any other entities study was issued on January 18, 2011. Board, OCC, FDIC, and SEC in October potentially affected by the proposed The FSOC study included a detailed 2011 invited the public to comment on rule, including non-financial small and discussion of key issues related to proposed rules implementing that mid-size businesses. implementation of section 13 and section’s requirements.8 The period for The Agencies received over 18,000 recommended that the Agencies filing public comments on this proposal comments addressing a wide variety of consider taking a number of specified was extended for an additional 30 days, aspects of the proposal, including actions in issuing rules under section 13 until February 13, 2012.9 In January definitions used by the proposal and the of the BHC Act.14 The FSOC study also 2012, the CFTC requested comment on exemptions for market making-related recommended that the Agencies adopt a a proposal for the same common rule to activities, risk-mitigating hedging four-part implementation and implement section 13 with respect to activities, covered fund activities and supervisory framework for identifying those entities for which it is the primary investments, the use of quantitative and preventing prohibited proprietary financial regulatory agency and invited metrics, and the reporting proposals. trading, which included a programmatic public comment on its proposed The vast majority of these comments compliance regime requirement for implementing rule through April 16, were from individuals using a version of banking entities, analysis and reporting 2012.10 The statute requires the a short form letter to express support for of quantitative metrics by banking Agencies, in developing and issuing the proposed rule. More than 600 entities, supervisory review and implementing rules, to consult and comment letters were unique comment oversight by the Agencies, and coordinate with each other, as letters, including from members of enforcement procedures for violations.15 appropriate, for the purposes of Congress, domestic and foreign banking The Agencies carefully considered the assuring, to the extent possible, that entities and other financial services FSOC study and its recommendations. such rules are comparable and provide firms, trade groups representing In formulating this final rule, the for consistent application and banking, insurance, and the broader Agencies carefully reviewed all implementation of the applicable financial services industry, U.S. state comments submitted in connection with provisions of section 13 of the BHC and foreign governments, consumer and the rulemaking and considered the Act.11 public interest groups, and individuals. suggestions and issues they raise in light The proposed rules invited comment To improve understanding of the issues of the statutory restrictions and on a multi-faceted regulatory framework raised by commenters, the Agencies met provisions as well as the FSOC study. to implement section 13 consistent with with a number of these commenters to The Agencies have sought to reasonably the statutory language. In addition, the discuss issues relating to the proposed respond to all of the significant issues Agencies invited comments on the rule, and summaries of these meetings commenters raised. The Agencies potential economic impacts of the are available on each of the Agency’s believe they have succeeded in doing so 12 proposed rule and posed a number of public Web sites. The CFTC staff also notwithstanding the complexities questions seeking information on the hosted a public roundtable on the 13 involved. The Agencies also carefully costs and benefits associated with each proposed rule. Many of the considered different options suggested aspect of the proposal, as well as on any commenters generally expressed by commenters in light of potential significant alternatives that would support for the broader goals of the costs and benefits in order to effectively minimize the burdens or amplify the proposed rule. At the same time, many implement section 13 of the BHC Act. benefits of the proposal in a manner commenters expressed concerns about The Agencies made numerous changes various aspects of the proposed rule. consistent with the statute. The to the final rule in response to the issues Many of these commenters requested Agencies also encouraged commenters and information provided by that one or more aspects of the proposed to provide quantitative information and commenters. These modifications to the rule be modified in some manner in data about the impact of the proposal on rule and explanations that address order to reflect their viewpoints and to entities subject to section 13, as well as comments are described in more detail better accommodate the scope of on their clients, customers, and in the section-by-section description of activities that they argued were counterparties, specific markets or asset the final rule. To enhance uniformity in encompassed within section 13 of the both rules that implement section 13 BHC Act. The comments addressed all company that controls an insured depository and administration of the requirements major sections of the proposed rule. institution, or that is treated as a bank holding of that section, the Agencies have been company for purposes of section 8 of the Section 13 of the BHC Act also International Banking Act, any nonbank financial required the FSOC to conduct a study regularly consulting with each other in company supervised by the Board, and any (‘‘FSOC study’’) and make the development of this final rule. subsidiary of any of the foregoing (other than a Some commenters requested that the subsidiary for which an appropriate Federal recommendations to the Agencies by banking agency, the SEC, or the CFTC is the January 21, 2011 on the implementation Agencies repropose the rule and/or primary financial regulatory agency); (iii) the CFTC of section 13 of the BHC Act. The FSOC delay adoption pending the collection of with respect to any entity for which it is the primary financial regulatory agency, as defined in 12 14 See Financial Stability Oversight Counsel, section 2 of the Dodd-Frank Act; and (iv) the SEC See http://www.regulations.gov/#!docketDetail; D=OCC-2011-0014 (OCC); http://www.federal Study and Recommendations on Prohibitions on with respect to any entity for which it is the reserve.gov/newsevents/reform_systemic.htm Proprietary Trading and Certain Relationships with primary financial regulatory agency, as defined in (Board); http://www.fdic.gov/regulations/laws/ Hedge Funds and Private Equity Funds (Jan. 18, section 2 of the Dodd-Frank Act. See id. federal/2011/11comAD85.html (FDIC); http:// 2011), available at http://www.treasury.gov/ 8 See 76 FR 68846 (Nov. 7, 2011) (‘‘Joint www.sec.gov/comments/s7-41-11/s74111.shtml initiatives/Documents/Volcker%20sec%20619%20 Proposal’’). (SEC); and http://www.cftc.gov/LawRegulation/ study%20final%201%2018%2011%20rg.pdf. 9 See 77 FR 23 (Jan. 23, 2012) (extending the DoddFrankAct/Rulemakings/DF_28_VolckerRule/ (‘‘FSOC study’’). See 12 U.S.C. 1851(b)(1). Prior to comment period to February 13, 2012). index.htm (CFTC). publishing its study, FSOC requested public 10 See 77 FR 8332 (Feb 14, 2012) (‘‘CFTC 13 See Commodity Futures Trading Commission, comment on a number of issues to assist in Proposal’’). CFTC Staff to Host a Public Roundtable to Discuss conducting its study. See 75 FR 61758 (Oct. 6, 11 See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of the Proposed Volcker Rule (May 24, 2012), available 2010). Approximately 8,000 comments were the Treasury, as Chairperson of the FSOC, is at http://www.cftc.gov/PressRoom/PressReleases/ received from the public, including from members responsible for coordinating the Agencies’ pr6263-12; transcript available at http:// of Congress, trade associations, individual banking rulemakings under section 13 of the BHC Act. See www.cftc.gov/ucm/groups/public/@newsroom/ entities, consumer groups, and individuals. id. documents/file/transcript053112.pdf. 15 See FSOC study at 5–6.

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additional information.16 As described To achieve the purpose of the statute, Act became effective on July 21, 2012.19 in part above, the Agencies have without imposing unnecessary costs, the The statute provided banking entities a provided many and various types of final rule builds on the multi-faceted period of two years to conform their opportunities for commenters to provide approach in the proposal, which activities and investments to the input on implementation of section 13 includes development and requirement of the statute, until July 21, of the BHC Act and have collected implementation of a compliance 2014. Section 13 also permits the Board substantial information in the process. program at each banking entity engaged to extend this conformance period, one In addition to the official comment in trading activities or that makes year at a time, for a total of no more than process described above, members of investments subject to section 13 of the three additional years.20 Pursuant to this the public submitted comment letters in BHC Act; the collection and evaluation authority and in connection with this advance of the official comment period of data regarding these activities as an rulemaking, the Board has in a separate for the proposed rules and met with indicator of areas meriting additional action extended the conformance period staff of the Agencies to explain issues of attention by the banking entity and the for an additional year until July 21, concern; the public also provided relevant agency; appropriate limits on 2015.21 The Board will continue to substantial comment in response to a trading, hedging, investment and other monitor developments to determine request for comment from the FSOC activities; and supervision by the whether additional extensions of the regarding its findings and Agencies. To allow banking entities conformance period are in the public recommendations for implementing sufficient time to develop appropriate interest, consistent with the statute. section 13.17 The Agencies provided a systems, the Agencies have provided for Accordingly, the Agencies do not detailed proposal and posed numerous a phased-in schedule for the collection believe that a reproposal or further questions in the preamble to the of data, limited data reporting delay is necessary or appropriate. proposal to solicit and explore requirements only to banking entities Commenters have differing views on alternative approaches in many areas. In that engage in significant trading the overall economic impacts of section addition, the Agencies have continued activity, and agreed to review the merits 13 of the BHC Act. to receive comment letters after the of the data collected and revise the data Some commenters remarked that extended comment period deadline, collection as appropriate over the next proprietary trading restrictions will which the Agencies have considered. 21 months. Importantly, as explained in have detrimental impacts on the Thus, the Agencies believe interested detail below, the Agencies have also economy such as: Reduction in parties have had ample opportunity to reduced the compliance burden for efficiency of markets, economic growth, review the proposed rules, as well as the and in employment due to a loss in banking entities with total assets of less 22 comments made by others, and to than $10 billion. The final rule also liquidity. In particular, a commenter provide views on the proposal, other eliminates compliance burden for firms expressed concern that there may be high transition costs as non-banking comment letters, and data to inform our that do not engage in covered activities entities replace some of the trading consideration of the final rules. or investments beyond investing in U.S. activities currently performed by In addition, the Agencies have been government obligations, agency banking entities.23 Another commenter mindful of the importance of providing guaranteed obligations, or municipal focused on commodity markets certainty to banking entities and obligations. remarked about the potential reduction financial markets and of providing Moreover, the Agencies believe the sufficient time for banking entities to in commercial output and curtailed data that will be collected in connection resource exploration due to a lack of understand the requirements of the final with the final rule, as well as the rule and to design, test, and implement hedging counterparties.24 Several compliance efforts made by banking commenters stated that section 13 of the compliance and reporting systems. The entities and the supervisory experience further substantial delay that would BHC Act will reduce access to debt that will be gained by the Agencies in markets—especially for smaller necessarily be entailed by reproposing reviewing trading and investment the rule would extend the uncertainty companies—raising the costs of capital activity under the final rule, will for firms and lowering the returns on that banking entities would face, which provide valuable insights into the could prove disruptive to banking certain investments.25 Further, some effectiveness of the final rule in commenters mentioned that U.S. banks entities and the financial markets. achieving the purpose of section 13 of The Agencies note, as discussed more may be competitively disadvantaged the BHC Act. The Agencies remain fully below, that the final rule relative to foreign banks due to committed to implementing the final incorporates a number of modifications proprietary trading restrictions and rule, and revisiting and revising the rule 26 designed to address the issues raised by compliance costs. as appropriate, in a manner designed to commenters in a manner consistent ensure that the final rule faithfully 19 with the statute. The preamble below See 12 U.S.C. 1851(c)(1). implements the requirements and 20 also discusses many of the issues raised See 12 U.S.C. 1851(c)(2); see also Conformance purposes of the statute.18 Period for Entities Engaged in Prohibited by commenters and explains the Finally, the Board has determined, in Proprietary Trading or Private Equity Fund or Agencies’ response to those comments. Hedge Fund Activities, 76 FR 8265 (Feb. 14, 2011) accordance with section 13 of the BHC (citing 156 Cong. Rec. S5898 (daily ed. July 15, 2010) (statement of Sen. Merkley)). 16 See, e.g., SIFMA et al. (Prop. Trading) (Feb. Act, to provide banking entities with 21 2012); ABA (Keating); Chamber (Nov. 2011); additional time to conform their See, Board Order Approving Extension of Chamber (Nov. 2013); Members of Congress (Dec. activities and investments to the statute Conformance Period, available at http:// www.federalreserve.gov/newsevents/press/bcreg/ 2011); IIAC; Real Estate Roundtable; Ass’n. of and the final rule. The restrictions and German Banks; Allen & Overy (Clearing); JPMC; bcreg20131210b1.pdf. 22 Goldman (Prop. Trading); BNY Mellon et al.; State prohibitions of section 13 of the BHC See, e.g., Oliver Wyman (Dec. 2011); Chamber Street (Feb. 2012); ICI Global; Chamber (Feb. 2012); (Dec. 2011); Thakor Study; Prof. Duffie; IHS. 23 Socie´te´ Ge´ne´rale; HSBC; Western Asset Mgmt.; 18 If any provision of this rule, or the application See Prof. Duffie. Abbott Labs et al. (Feb. 2012); PUC Texas; Columbia thereof to any person or circumstance, is held to be 24 See IHS. Mgmt.; ICI (Feb. 2012); IIB/EBF; British Bankers’ invalid, such invalidity shall not affect other 25 See, e.g., Chamber (Dec. 2011); Thakor Study; Ass’n.; ISDA (Feb. 2012); Comm. on Capital Markets provisions or application of such provisions to Oliver Wyman (Dec. 2011); IHS. Regulation; Ralph Saul (Apr. 2012); BPC. other persons or circumstances that can be given 26 See, e.g., RBC; Citigroup (Feb. 2012); Goldman 17 See 75 FR 61758 (Oct. 6, 2010). effect without the invalid provision or application. (Covered Funds).

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On the other hand, other commenters legally required.35 However, the undertake some or all of the compliance stated that restricting proprietary Agencies find certain of the information activities under the final rule on an trading activity by banking entities may submitted by commenters concerning affiliated enterprise-wide basis. As of reduce systemic risk emanating from the costs and benefits and economic effects the adoption of the final rule, the CFTC financial system and help to lower the to be relevant to consideration of the estimates that there are approximately probability of the occurrence of another rule, and so have considered this 110 registered swap dealers and futures financial crisis.27 One commenter information as appropriate, and, on the commission merchants that would be contended that large banking entities basis of these and other considerations, banking entities individually and that may have a moral hazard incentive to sought to achieve the balance intended grouping these banking entities together engage in risky activities without by Congress in section 619 of the Dodd- based on legal affiliation would result in allocating sufficient capital to them, Frank Act. The relevant comments are about 45 different business enterprises. 36 especially if market participants believe addressed therein. IV. CFTC-specific comments these institutions will not be allowed to III. Scope In addition to the information sought fail.28 Commenters argued that large Under section 13 of the BHCA, the both by the other Agencies and the banking entities may engage in activities CFTC’s final rule will be applicable to CFTC, the CFTC’s proposal 39 included that increase the upside return at the a banking entity for which the CFTC is 15 additional questions specifically expense of downside loss exposure a ‘‘primary financial regulatory agency’’ regarding the approach the CFTC should which may ultimately be borne by for that banking entity, as the term is take in regards to certain sections of the Federal taxpayers 29 and that subsidies defined by section 2(12) of the Dodd- rule. The relevant sections included associated with bank funding may provisions that were either directly 30 Frank Act. Accordingly, the final rule create distorted economic outcomes. may apply to banking entities 37 that are, related to the CFTC (e.g., definition of Furthermore, some commenters for example, registered swap dealers,38 commodity pool, clearing exemption) remarked that non-banking entities may futures commission merchants, and others that appeared not to be (e.g., fill much of the void in liquidity commodity trading advisors and underwriting, market making of SEC provision left by banking entities if commodity pool operators. The CFTC’s entities, securitization). Many banking entities reduce their current final rule may also apply to other types commenters sent general responses that 31 trading activities. Finally, some of CFTC registrants that are banking touched on issues related to these 15 commenters mentioned that hyper- entities, but it is likely that many such CFTC-specific questions, while other liquidity that arises from, for instance, other registrants will have little or no commenters organized their responses speculative bubbles, may harm the activities that would implicate the by question.40 The CFTC has considered efficiency and price discovery function provisions of the final rule. For these commenters’ views, and has of markets.32 example, registered introducing brokers responded as set forth in the relevant The Agencies have taken these are not likely to undertake proprietary sections below. concerns into account in the final rule. trading or invest in covered funds V. Overview of Final Rule As described below with respect to because their activities are generally particular aspects of the final rule, the limited to brokering. Furthermore, the The Agencies are adopting this final rule to implement section 13 of the BHC Agencies have addressed these issues by CFTC’s final rule will not apply to CFTC Act with a number of changes to the reducing burdens where appropriate, registrants who are not banking entities. proposal, as described further below. while at the same time ensuring that the In addition, it is noted that the CFTC The final rule adopts a risk-based final rule serves its purpose of may have overlapping jurisdiction with approach to implementation that relies promoting healthy economic activity. In other Agencies in exercising authority under each Agency’s respective final on a set of clearly articulated that regard, the Agencies have sought to characteristics of both prohibited and achieve the balance intended by rules. Finally, it is important to note that the jurisdictional scope of the final permitted activities and investments Congress under section 13 of the BHC and is designed to effectively Act. Several comments suggested that a rule does not limit the regulatory authority of the CFTC or the other accomplish the statutory purpose of costs and benefits analysis be performed reducing risks posed to banking entities 33 Agencies under other applicable by the Agencies. On the other hand, by proprietary trading activities and some commenters34 correctly stated that provisions of law. The CFTC believes that many investments in or relationships with a costs and benefits analysis is not affiliated banking entities would covered funds. As explained more fully below in the section-by-section analysis, 27 See, e.g., Profs. Admati & Pfleiderer; AFR (Nov. 35 For example, with respect to the CFTC, Section the final rule has been designed to 2012); Better Markets (Dec. 2011); Better Markets 15(a) of the CEA requires such consideration only (Feb. 2012); Occupy; Johnson & Prof. Stiglitz; Paul ensure that banking entities do not when ‘‘promulgating a regulation under this Volcker. engage in prohibited activities or [Commodity Exchange] Act.’’ This final rule is not 28 See Occupy. promulgated under the CEA, but under the BHC investments and to ensure that banking 29 See Profs. Admati & Pfleiderer; Better Markets Act. CEA section 15(a), therefore, does not apply. entities engage in permitted trading and (Feb. 2012); Occupy; Johnson & Prof. Stiglitz; Paul 36 This CFTC Rule is being promulgated investment activities in a manner Volcker. exclusively under section 13 of the BHC. Therefore, designed to identify, monitor and limit 30 See Profs. Admati & Pfleiderer; Johnson & Prof. the Commission did not conduct a cost benefit the risks posed by these activities and Stiglitz. consideration under Section 15(a) of the 31 See AFR et al. (Feb. 2012); Better Markets (Apr. Commodity Exchange Act. Similarly, Executive investments. For instance, the final rule 16, 2012); David McClean; Public Citizen; Occupy. Orders 12866 and 13563, referenced by some requires that any banking entity that is 32 See Johnson & Prof. Stiglitz (citing Thomas commenters, do not impose obligations on the engaged in activity subject to section 13 Phillipon (2011)); AFR et al. (Feb. 2012); Occupy. CFTC. develop and administer a compliance 33 37 See SIFMA et al. (Covered Funds) (Feb. 2012); See final rule § 75.2(c). program that is appropriate to the size, BoA; ABA (Keating); Chamber (Feb. 2012); Socie´te´ 38 The CFTC notes that provisionally registered Ge´ne´rale; FTN; SVB; ISDA (Feb. 2012); Comm. on swap dealers are registered swap dealers subject to Capital Market Regulation; Real Estate Roundtable. all of the regulatory requirements applicable to 39 See 77 FR 8332 (Feb 14, 2012). 34 See, e.g., Better Markets (Feb. 2012); Randel registered swap dealers except as may otherwise be 40 See, e.g., SIFMA (March Letter); Alfred Brock; Pilo. expressly provided in the CFTC’s regulations. Occupy the SEC.

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scope and risk of its activities and identifying particular activity that purchase or sell specified types of investments. The rule requires the warrants additional scrutiny to financial instruments.41 largest firms engaged in these activities distinguish prohibited proprietary The final rule’s definition of trading to develop and implement enhanced trading from otherwise permissible account also is consistent with the compliance programs and regularly activities. statutory definition.42 In particular, the report data on trading activities to the As a matter of structure, the final rule definition of trading account in the final Agencies. The Agencies believe this will is generally divided into four subparts rule includes three classes of positions. permit banking entities to effectively and contains two appendices, as First, the definition includes the engage in permitted activities, and the follows: purchase or sale of one or more Agencies to enforce compliance with • Subpart A of the final rule describes financial instruments taken principally section 13 of the BHC Act. In addition, the authority, scope, purpose, and for the purpose of short-term resale, the enhanced compliance programs will relationship to other authorities of the benefitting from short-term price help both the banking entities and the rule and defines terms used commonly movements, realizing short-term Agencies identify, monitor, and limit throughout the rule; arbitrage profits, or hedging another risks of activities permitted under • Subpart B of the final rule prohibits trading account position.43 For purposes section 13, particularly involving proprietary trading, defines terms of this part of the definition, the final banking entities posing the greatest risk relevant to covered trading activity, rule also contains a rebuttable to financial stability. establishes exemptions from the presumption that the purchase or sale of prohibition on proprietary trading and a financial instrument by a banking A. General Approach and Summary of limitations on those exemptions, and entity is for the trading account of the Final Rule requires certain banking entities to banking entity if the banking entity The Agencies have designed the final report quantitative measurements with holds the financial instrument for fewer rule to achieve the purposes of section respect to their trading activities; than 60 days or substantially transfers 13 of the BHC Act, which include • Subpart C of the final rule prohibits the risk of the financial instrument prohibiting banking entities from or restricts acquiring or retaining an within 60 days of purchase (or sale).44 engaging in proprietary trading or ownership interest in, and certain Second, with respect to a banking entity acquiring or retaining an ownership relationships with, a covered fund, subject to the Federal banking agencies’ interest in, or having certain defines terms relevant to covered fund Market Risk Capital Rules, the relationships with, a covered fund, activities and investments, as well as definition includes the purchase or sale while permitting banking entities to establishes exemptions from the of one or more financial instruments continue to provide, and to manage and restrictions on covered fund activities subject to the prohibition on proprietary limit the risks associated with and investments and limitations on trading that are treated as ‘‘covered providing, client-oriented financial those exemptions; positions and trading positions’’ (or • services that are critical to capital Subpart D of the final rule generally hedges of other market risk capital rule generation for businesses of all sizes, requires banking entities to establish a covered positions) under those capital households and individuals, and that compliance program regarding rules, other than certain foreign facilitate liquid markets. These client- compliance with section 13 of the BHC exchange and commodities positions.45 oriented financial services, which Act and the final rule, including written Third, the definition includes the include underwriting, market making, policies and procedures, internal purchase or sale of one or more and asset management services, are controls, a management framework, financial instruments by a banking important to the U.S. financial markets independent testing of the compliance entity that is licensed or registered or and the participants in those markets. program, training, and recordkeeping; • required to be licensed or registered to At the same time, providing appropriate Appendix A of the final rule details engage in the business of a dealer, swap latitude to banking entities to provide the quantitative measurements that dealer, or security-based swap dealer to such client-oriented services need not certain banking entities may be required the extent the instrument is purchased and should not conflict with clear, to compute and report with respect to or sold in connection with the activities robust, and effective implementation of certain trading activities; that require the banking entity to be the statute’s prohibitions and • Appendix B of the final rule details licensed or registered as such or is restrictions. the enhanced minimum standards for As noted above, the final rule takes a engaged in those businesses outside of programmatic compliance that certain the United States, to the extent the multi-faceted approach to implementing banking entities must meet with respect section 13 of the BHC Act. In particular, instrument is purchased or sold in to their compliance program, as connection with the activities of such the final rule includes a framework that required under subpart D. 46 clearly describes the key characteristics business. The definition of proprietary trading of both prohibited and permitted B. Proprietary Trading Restrictions also contains clarifying exclusions for activities. The final rule also requires Subpart B of the final rule implements certain purchases and sales of financial banking entities to establish a the statutory prohibition on proprietary instruments that generally do not comprehensive compliance program trading and the various exemptions to involve the requisite short-term trading designed to ensure compliance with the this prohibition included in the statute. intent, such as the purchase and sale of requirements of the statute and rule in Section 75.3 of the final rule contains financial instruments arising under a way that takes into account and the core prohibition on proprietary certain repurchase and reverse reflects the banking entity’s activities, trading and defines a number of related repurchase arrangements or securities size, scope and complexity. With terms, including ‘‘proprietary trading’’ respect to proprietary trading, the final and ‘‘trading account.’’ The final rule’s 41 See final rule § 75.3(a). rule also requires the large firms that are definition of proprietary trading 42 See final rule § 75.3(b). active participants in trading activities generally parallels the statutory 43 See final rule § 75.3(b)(1)(i). to calculate and report meaningful definition and covers engaging as 44 See final rule § 75.3(b)(2). quantitative data that will assist both principal for the trading account of a 45 See final rule § 75.3(b)(1)(ii). banking entities and the Agencies in banking entity in any transaction to 46 See final rule § 75.3(b)(1)(iii).

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lending transactions and securities must be met in order for a banking below, the exemption also provides that acquired or taken for bona fide liquidity entity to rely on the exemption. These the risk as principal, the decision- management purposes.47 requirements are generally designed to making, and the accounting for this In section 75.3, the final rule also ensure that the banking entity’s hedging activity must occur solely outside of the defines a number of other relevant activity is limited to risk-mitigating United States, consistent with the terms, including the term ‘‘financial hedging in purpose and effect.50 Section statute. instrument.’’ This term is used to define 75.5 also requires banking entities to In section 75.7, the final rule prohibits the scope of financial instruments document, at the time the transaction is a banking entity from relying on any subject to the prohibition on proprietary executed, the hedging rationale for exemption to the prohibition on trading. Consistent with the statutory certain transactions that present proprietary trading if the permitted language, such financial instruments heightened compliance risks.51 As with activity would involve or result in a include securities, derivatives, the exemptions for underwriting and material conflict of interest, result in a commodity futures, and options on such market making-related activity, these material exposure to high-risk assets or instruments, but do not include loans, requirements form part of a broader high-risk trading strategies, or pose a spot foreign exchange or spot physical implementation approach that also threat to the safety and soundness of the 48 commodities. includes the compliance program banking entity or to the financial In section 75.4, the final rule requirement and the reporting of stability of the United States.57 This implements the statutory exemptions for quantitative measurements. section also describes the terms material underwriting and market making-related In section 75.6, the final rule conflict of interest, high-risk asset, and activities. For each of these permitted implements statutory exemptions for high-risk trading strategy for these activities, the final rule defines the trading in certain government purposes. exempt activity and provides a number obligations, trading on behalf of of requirements that must be met in customers, trading by a regulated C. Restrictions on Covered Fund order for a banking entity to rely on the insurance company, and trading by Activities and Investments applicable exemption. As more fully certain foreign banking entities outside Subpart C of the final rule implements discussed below, these include of the United States. Section 75.6(a) of the statutory prohibition on, directly or establishment and enforcement of a the final rule describes the government indirectly, acquiring and retaining an compliance program targeted to the obligations in which a banking entity ownership interest in, or having certain activity; limits on positions, inventory may trade, which include U.S. relationships with, a covered fund, as and risk exposure addressing the government and agency obligations, well as the various exemptions to this requirement that activities be designed obligations and other instruments of prohibition included in the statute. not to exceed the reasonably expected specified government sponsored Section 75.10 of the final rule contains near term demands of clients, entities, and State and municipal the core prohibition on covered fund customers, or counterparties; limits on 52 obligations. Section 75.6(b) of the final activities and investments and defines a the duration of holdings and positions; rule permits trading in certain foreign number of related terms, including defined escalation procedures to change government obligations by affiliates of ‘‘covered fund’’ and ‘‘ownership or exceed limits; analysis justifying foreign banking entities in the United interest.’’58 The definition of covered established limits; internal controls and State and foreign affiliates of a U.S. fund contains a number of exclusions independent testing of compliance with 53 banking entity abroad. Section 75.6(c) for entities that may rely on exclusions limits; senior management of the final rule describes permitted from the Investment Company Act of accountability and limits on incentive trading on behalf of customers and 1940 contained in section 3(c)(1) or compensation. In addition, the final rule identifies the types of transactions that 3(c)(7) of that Act but that are not requires firms with significant market- 54 would qualify for the exemption. engaged in investment activities of the making or underwriting activities to Section 75.6(d) of the final rule type contemplated by section 13 of the report data involving several metrics describes permitted trading by a BHC Act. These include, for example, that may be used by the banking entity regulated insurance company or an exclusions for wholly owned and the Agencies to identify trading affiliate thereof for the general account subsidiaries, joint ventures, foreign activity that may warrant more detailed of the insurance company, and also pension or retirement funds, insurance compliance review. permits those entities to trade for a company separate accounts, and public These requirements are generally separate account of the insurance designed to ensure that the banking welfare investment funds. The final rule company.55 Finally, § 75.6(e) of the final also implements the statutory rule of entity’s trading activity is limited to rule describes trading permitted outside underwriting and market making-related construction in section 13(g)(2) and of the United States by a foreign banking provides that a securitization of loans, activities and does not include entity.56 The exemption in the final rule 49 which would include loan prohibited proprietary trading. These clarifies when a foreign banking entity requirements are also intended to work securitization, qualifying asset backed will qualify to engage in such trading commercial paper conduit, and together to ensure that banking entities pursuant to sections 4(c)(9) or 4(c)(13) of identify, monitor and limit the risks qualifying covered bonds, is not covered the BHC Act, as required by the statute, by section 13 or the final rule.59 associated with these activities. including with respect to a foreign In section 75.5, the final rule banking entity not currently subject to 57 implements the statutory exemption for See final rule § 75.7. the BHC Act. As explained in detail 58 See final rule § 75.10(b). risk-mitigating hedging. As with the 59 The Agencies believe that most securitization underwriting and market-making 50 See final rule § 75.5. transactions are currently structured so that the exemptions, § 75.5 of the final rule 51 See final rule § 75.5(c). issuing entity with respect to the securitization is not an affiliate of a banking entity under the BHC contains a number of requirements that 52 See final rule § 75.6(a). Act. However, with respect to any securitization 53 See final rule § 75.6(b). that is an affiliate of a banking entity and that does 47 See final rule § 75.3(d). 54 See final rule § 75.6(c). not meet the requirements of the loan securitization 48 See final rule § 75.3(c). 55 See final rule § 75.6(d). exclusion, the related banking entity will need to 49 See final rule § 75.4(a), (b). 56 See final rule § 75.6(e). Continued

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The definition of ‘‘ownership providing the fund with sufficient the final rule implements the statute’s interest’’ in the final rule provides initial equity for investment to permit requirement that any transaction further guidance regarding the types of the fund to attract unaffiliated investors, permitted under section 13(f) of the interests that would be considered to be or (ii) making a de minimis investment BHC Act (including a prime brokerage an ownership interest in a covered in the covered fund in compliance with transaction) between the banking entity fund.60 As described in this applicable requirements. Section 75.12 and a covered fund is subject to section Supplementary Information, these of the final rule implements this 23B of the Federal Reserve Act,66 which, interests may take various forms. The authority and related limitations, in general, requires that the transaction definition of ownership interest also including limitations regarding the be on market terms or on terms at least explicitly excludes from the definition amount and value of any individual per- as favorable to the banking entity as a ‘‘restricted profit interest’’ that is solely fund investment and the aggregate value comparable transaction by the banking performance compensation for services of all such permitted investments. In entity with an unaffiliated third party. provided to the covered fund by the addition, § 75.12 requires that the In section 75.15, the final rule banking entity (or an employee or aggregate value of all investments in prohibits a banking entity from relying former employee thereof), under certain covered funds, plus any earnings on on any exemption to the prohibition on circumstances.61 Section 75.10 of the these investments, be deducted from the acquiring and retaining an ownership final rule also defines a number of other capital of the banking entity for interest in, acting as sponsor to, or relevant terms, including the terms purposes of the regulatory capital having certain relationships with, a ‘‘prime brokerage transaction,’’ requirements, and explains how that covered fund, if the permitted activity ‘‘sponsor,’’ and ‘‘trustee.’’ deduction must occur. Section 75.12 of or investment would involve or result in In section 75.11, the final rule the final rule also clarifies how a a material conflict of interest, result in implements the exemption for banking entity must calculate its a material exposure to high-risk assets organizing and offering a covered fund compliance with these investment or high-risk trading strategies, or pose a provided for under section 13(d)(1)(G) limitations (including by deducting threat to the safety and soundness of the of the BHC Act. Section 75.11(a) of the such investments from applicable banking entity or to the financial final rule outlines the conditions that capital, as relevant), and sets forth how stability of the United States.67 This must be met in order for a banking a banking entity may request an section also describes material conflict entity to organize and offer a covered extension of the period of time within of interest, high-risk asset, and high-risk fund under this authority. These which it must conform an investment in trading strategy for these purposes. requirements are contained in the a single covered fund. This section also statute and are intended to allow a explains how a banking entity must D. Metrics Reporting Requirement banking entity to engage in certain apply the covered fund investment Under the final rule, a banking entity traditional asset management and limits to a covered fund that is an that meets relevant thresholds specified advisory businesses, subject to certain issuing entity of asset backed securities in the rule must furnish the following limits contained in section 13 of the or a covered fund that is part of a quantitative measurements for each of BHC Act.62 The requirements are master-feeder or fund-of-funds its trading desks engaged in covered discussed in detail in Part VI.B.2. of this structure. trading activity calculated in accordance Supplementary Information. Section In section 75.13, the final rule with Appendix A: 75.11 also explains how these implements the statutory exemptions • Risk and Position Limits and Usage; requirements apply to covered funds described in sections 13(d)(1)(C), (D), • Risk Factor Sensitivities; that are issuing entities of asset-backed (F), and (I) of the BHC Act that permit • Value-at-Risk and Stress VaR; securities, as well as implements the a banking entity: (i) To acquire and • Comprehensive Profit and Loss statutory exemption for underwriting retain an ownership interest in a Attribution; and market-making ownership interests covered fund as a risk-mitigating • Inventory Turnover; of a covered fund, including explaining hedging activity related to employee • Inventory Aging; and the limitations imposed on such compensation; (ii) in the case of a non- • Customer Facing Trade Ratio. activities under the final rule. U.S. banking entity, to acquire and The final rule raises the threshold for In section 75.12, the final rule permits retain an ownership interest in, or act as metrics reporting from the proposal to a banking entity to acquire and retain, sponsor to, a covered fund solely capture only firms that engage in as an investment in a covered fund, an outside the United States; and (iii) to significant trading activity, identified at ownership interest in a covered fund acquire and retain an ownership interest specified aggregate trading asset and that the banking entity organizes and in, or act as sponsor to, a covered fund liability thresholds, and delays the dates offers or holds pursuant to other by an insurance company for its general for reporting metrics through a phased- authority under § 75.11.63 This section or separate accounts.64 in approach based on the size of trading implements section 13(d)(4) of the BHC In section 75.14, the final rule assets and liabilities. Specifically, the Act and related provisions. Section implements section 13(f) of the BHC Act Agencies have delayed the reporting of 13(d)(4)(A) of the BHC Act permits a and generally prohibits a banking entity metrics until June 30, 2014 for the banking entity to make an investment in from entering into certain transactions largest banking entities that, together a covered fund that the banking entity with a covered fund that would be a with their affiliates and subsidiaries, organizes and offers, or for which it acts covered transaction as defined in have trading assets and liabilities the as sponsor, for the purposes of (i) section 23A of the Federal Reserve average gross sum of which equal or establishing the covered fund and Act.65 Section 75.14(a)(2) of the final exceed $50 billion on a worldwide rule describes the transactions between consolidated basis over the previous determine how to bring the securitization into a banking entity and a covered fund that four calendar quarters (excluding compliance with this rule. remain permissible under the statute trading assets and liabilities involving 60 See final rule § 75.10(d)(6). 61 See final rule § 75.10(b)(6)(ii). and the final rule. Section 75.14(b) of obligations of or guaranteed by the 62 See 156 Cong. Rec. S5889 (daily ed. July 15, 2010) (statement of Sen. Hagan). 64 See final rule § 75.13(a)–(c). 66 12 U.S.C. 371c–1. 63 See final rule § 75.12. 65 See 12 U.S.C. 371c; see also final rule § 75.14. 67 See final rule § 75.15.

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United States or any agency of the state and municipal obligations) or VI. Final Rule United States). Banking entities with covered fund activities and investments A. Subpart B—Proprietary Trading $25 billion or more in trading assets and need only establish a compliance Restrictions liabilities and banking entities with $10 program prior to becoming engaged in billion or more in trading assets and such activities or making such 1. Section 75.3: Prohibition on liabilities would also be required to investments.70 In addition, to reduce the Proprietary Trading and Related report these metrics beginning on April burden on smaller banking entities, a Definitions 30, 2016, and December 31, 2016, banking entity with total consolidated Section 13(a)(1)(A) of the BHC Act respectively. assets of $10 billion or less that engages prohibits a banking entity from engaging Under the final rule, a banking entity in covered trading activities and/or in proprietary trading unless otherwise required to report metrics must covered fund activities or investments permitted in section 13.72 Section calculate any applicable quantitative may satisfy the requirements of the final 13(h)(4) of the BHC Act defines measurement for each trading day. Each rule by including in its existing proprietary trading, in relevant part, as banking entity required to report must compliance policies and procedures engaging as principal for the trading report each applicable quantitative appropriate references to the account of the banking entity in any measurement to its primary supervisory requirements of section 13 and the final transaction to purchase or sell, or Agency on the reporting schedule rule and adjustments as appropriate otherwise acquire or dispose of, a established in the final rule unless given the activities, size, scope and security, derivative, contract of sale of a otherwise requested by the primary complexity of the banking entity.71 commodity for future delivery, or other supervisory Agency for the entity. The For banking entities with total assets financial instrument that the Agencies largest banking entities with $50 billion 73 greater than $10 billion and less than include by rule. in consolidated trading assets and Section 75.3(a) of the proposed rule $50 billion, the final rule specifies six liabilities must report the metrics on a implemented section 13(a)(1)(A) of the elements that each compliance program monthly basis. Other banking entities BHC Act by prohibiting a banking entity established under subpart D must, at a required to report metrics must do so on from engaging in proprietary trading minimum, include. These requirements a quarterly basis. All quantitative unless otherwise permitted under measurements for any calendar month focus on written policies and §§ 75.4 through 75.6 of the proposed must be reported no later than 10 days procedures reasonably designed to rule. Section 75.3(b)(1) of the proposed after the end of the calendar month ensure compliance with the final rules, rule defined proprietary trading in required by the final rule unless another including limits on underwriting and accordance with section 13(h)(4) of the time is requested by the primary market-making; a system of internal BHC Act and clarified that proprietary supervisory Agency for the entity except controls; clear accountability for trading does not include acting solely as for a transitional six month period compliance and review of limits, agent, broker, or custodian for an during which reporting will be required hedging, incentive compensation, and unaffiliated third party. The preamble to no later than 30 days after the end of the other matters; independent testing and the proposed rule explained that acting calendar month. Banking entities audits; additional documentation for in these types of capacities does not subject to quarterly reporting will be covered funds; training; and involve trading as principal.74 required to report quantitative recordkeeping requirements. Several commenters expressed measurements within 30 days of the end A banking entity with $50 billion or concern about the breadth of the ban on of the quarter, unless another time is more total consolidated assets (or a proprietary trading.75 Some of these requested by the primary supervisory foreign banking entity that has total U.S. commenters stated that proprietary Agency for the entity in writing.68 assets of $50 billion or more) or that is trading must be carefully and narrowly defined to avoid prohibiting activities E. Compliance Program Requirement required to report metrics under Appendix A is required to adopt an that Congress did not intend to limit Subpart D of the final rule requires a enhanced compliance program with and to preclude significant, unintended banking entity engaged in covered more detailed policies, limits, consequences for capital markets, trading activities or covered fund governance processes, independent capital formation, and the broader activities to develop and implement a testing and reporting. In addition, the economy.76 Some commenters asserted program reasonably designed to ensure Chief Executive Officer of these larger that the proposed definition could result and monitor compliance with the banking entities must attest that the in banking entities being unwilling to prohibitions and restrictions on covered banking entity has in place a program take principal risk to provide liquidity trading activities and covered fund reasonably designed to achieve for institutional investors; could activities and investments set forth in compliance with the requirements of unnecessarily constrain liquidity in section 13 of the BHC Act and the final section 13 of the BHC Act and the final secondary markets, forcing asset 69 rule. To reduce the overall burden of rule. managers to service client needs the rule, the final rule provides that a through alternative non-U.S. markets; The application of detailed minimum banking entity that does not engage in could impose substantial costs for all standards for these types of banking covered trading activities (other than institutions, especially smaller and mid- entities is intended to reflect the trading in U.S. government or agency size institutions; and could drive risk- obligations, obligations of specified heightened compliance risks of large government sponsored entities, and covered trading activities and covered 72 12 U.S.C. 1851(a)(1)(A). fund activities and investments and to 73 12 U.S.C. 1851(h)(4). 68 See final rule § 75.20(d)(3). The final rule provide clear, specific guidance to such 74 See Joint Proposal, 76 FR at 68857. includes a shorter period of time for reporting banking entities regarding the 75 See, e.g., Ass’n. of Institutional Investors (Feb. quantitative measurements than was proposed for compliance measures that would be 2012); Capital Group; Comm. on Capital Markets the largest banking entities. Like the monthly required for purposes of the final rule. Regulation; IAA; SIFMA et al. (Prop. Trading) (Feb. reporting requirement for these firms, this is 2012); SVB; Chamber (Feb. 2012); Wellington. intended to allow for more effective supervision of 76 See Ass’n. of Institutional Investors (Feb. 2012); their large-scale trading operations. 70 See final rule § 75.20(f)(1). GE (Feb. 2012); Invesco; Sen. Corker; Chamber (Feb. 69 See final rule § 75.20. 71 See final rule § 75.20(f)(2). 2012).

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taking to the shadow banking system.77 defining proprietary trading that would considered commenters’ concerns about Others urged the Agencies to determine capture only bright-line, speculative the proposed rule’s potential impact on that trading as agent, broker, or proprietary trading and treat the overall market liquidity and quality. As custodian for an affiliate was not activities covered by the statutory discussed in more detail in Parts VI.A.2. proprietary trading.78 exemptions as completely outside the and VI.A.3., the final rule will permit Commenters also suggested rule.84 However, such an approach banking entities to continue to provide alternative approaches for defining would appear to be inconsistent with beneficial market-making and proprietary trading. In general, these Congressional intent because, for underwriting services to customers, and approaches sought to provide a bright- instance, it would not give effect to the therefore provide liquidity to customers line definition to provide increased limitations on permitted activities in and facilitate capital-raising. However, certainty to banking entities 79 or make section 13(d) of the BHC Act.85 For the statute upon which the final rule is the prohibition easier to apply in similar reasons, the Agencies are not based prohibits proprietary trading practice.80 One commenter stated the adopting a bright-line definition of activity that is not exempted. As such, Agencies should focus on the economics proprietary trading.86 the termination of non-exempt of banking entities’ transactions and ban A number of commenters expressed proprietary trading activities of banking trading if the banking entity is exposed concern that, as a whole, the proposed entities may lead to some general to market risk for a significant period of rule may result in certain negative reductions in liquidity of certain asset time or is profiting from changes in the economic impacts, including: (i) classes. Although the Agencies cannot value of the asset.81 Several Reduced market liquidity; 87 (ii) wider say with any certainty, there is good commenters, including individual spreads or otherwise increased trading reason to believe that to a significant members of the public, urged the costs; 88 (iii) higher borrowing costs for extent the liquidity reductions of this Agencies to prohibit banking entities businesses or increased cost of type may be temporary since the statute from engaging in any kind of proprietary capital; 89 and/or (iv) greater market does not restrict proprietary trading trading and require separation of trading volatility.90 The Agencies have carefully activities of other market participants.91 from traditional banking activities.82 Thus, over time, non-banking entities After carefully considering comments, 84 See, e.g., Ass’n. of Institutional Investors (Feb. may provide much of the liquidity that 2012); GE (Feb. 2012); Invesco; Sen. Corker; is lost by restrictions on banking the Agencies are defining proprietary Chamber (Feb. 2012); JPMC. trading as engaging as principal for the 85 See 156 Cong. Rec. S5895–96 (daily ed. July 15, entities’ trading activities. If so, trading account of the banking entity in 2010) (statement of Sen. Merkley) (stating the eventually, the detrimental effects of any purchase or sale of one or more statute ‘‘permits underwriting and market-making- increased trading costs, higher costs of financial instruments.83 The Agencies related transactions that are technically trading for capital, and greater market volatility the account of the firm but, in fact, facilitate the believe this effectively restates the provision of near-term client-oriented financial should be mitigated. statutory definition. The Agencies are services.’’). To respond to concerns raised by not adopting commenters’ suggested 86 See ABA (Keating); Ass’n. of Institutional commenters while remaining consistent modifications to the proposed definition Investors (Feb. 2012); BOK; George Bollenbacher; with Congressional intent, the final rule Credit Suisse (Seidel); NAIB et al.; SSgA (Feb. of proprietary trading or the general has been modified to provide that 2012); JPMC. certain purchases and sales are not prohibition on proprietary trading 87 See, e.g., AllianceBernstein; Obaid Syed; Rep. because they generally appear to be Bachus et al.; EMTA; NASP; Sen. Hagan; Investure; proprietary trading as described in more 92 inconsistent with Congressional intent. Lord Abbett; Sumitomo Trust; EFAMA; Morgan detail below. Stanley; Barclays; BoA; Citigroup (Feb. 2012); For instance, some commenters STANY; ABA (Keating); ICE; ICSA; SIFMA (Asset a. Definition of ‘‘Trading Account’’ appeared to suggest an approach to Mgmt.) (Feb. 2012); Putnam; ACLI (Feb. 2012); Wells Fargo (Prop. Trading); Capital Group; RBC; As explained above, section 13 defines proprietary trading as engaging 77 See Chamber (Feb. 2012). Columbia Mgmt.; SSgA (Feb. 2012); Fidelity; ICI (Feb. 2012); ISDA (Feb. 2012); Comm. on Capital 78 See Japanese Bankers Ass’n. as principal ‘‘for the trading account of Markets Regulation; Clearing House Ass’n.; Thakor 79 the banking entity’’ in certain types of See, e.g., ABA (Keating); Ass’n. of Institutional Study. See also CalPERS (acknowledging that the Investors (Feb. 2012); BOK; George Bollenbacher; systemic protections afforded by the Volcker Rule transactions. Section 13(h)(6) of the Credit Suisse (Seidel); NAIB et al.; SSgA (Feb. come at a price, including reduced liquidity to all BHC Act defines trading account as any 2012); JPMC. markets). account used for acquiring or taking 80 See Public Citizen. 88 See, e.g., AllianceBernstein; Obaid Syed; 81 positions in financial instruments See Sens. Merkley & Levin (Feb. 2012). NASP; Investure; Lord Abbett; CalPERS; Credit principally for the purpose of selling in 82 See generally Occupy; Public Citizen; AFR et Suisse (Seidel); Citigroup (Feb. 2012); ABA al. (Feb. 2012). The Agencies received over fifteen (Keating); SIFMA (Asset Mgmt.) (Feb. 2012); the near-term (or otherwise with the thousand form letters in support of a rule with few Putnam; Wells Fargo (Prop. Trading); Comm. on intent to resell in order to profit from exemptions, many of which expressed a desire to Capital Markets Regulation. short-term price movements), and any return to the regulatory scheme as governed by the 89 See, e.g., Rep. Bachus et al.; Members of such other accounts as the Agencies Glass-Steagall affiliation provisions of the U.S. Congress (Dec. 2011); Lord Abbett; Morgan Stanley; 93 Banking Act of 1933, as repealed through the Barclays; BoA; Citigroup (Feb. 2012); ABA may, by rule, determine. Graham-Leach-Bliley Act of 1999. See generally (Abernathy); ICSA; SIFMA (Asset Mgmt.) (Feb. The proposed rule defined trading Sarah McGee; Christopher Wilson; Michael Itlis; 2012); Chamber (Feb. 2012); Putnam; ACLI (Feb. account to include three separate Barry Rein; Edward Bright. Congress rejected such 2012); UBS; Wells Fargo (Prop. Trading); Capital accounts. First, the proposed definition an approach, however, opting instead for the more Group; Sen. Carper et al.; Fidelity; Invesco; Clearing narrowly tailored regulatory approach embodied in House Ass’n.; Thakor Study. section 13 of the BHC Act. 90 See, e.g., CalPERS (expressing the belief that a developed)); Morgan Stanley; Capital Group; 83 See final rule § 75.3(a). The final rule also decline in banking entity proprietary trading will Fidelity; British Bankers’ Ass’n.; Invesco. replaces all references to the proposed term increase the volatility of the corporate bond market, 91 See David McClean; Public Citizen; Occupy. In ‘‘covered financial position’’ with the term especially during times of economic weakness or response to commenters who expressed concern ‘‘financial instrument.’’ This change has no periods where risk taking declines, but noting that about risks associated with proprietary trading substantive impact because the definition of portfolio managers have experienced many different activities moving to non-banking entities, the ‘‘financial instrument’’ is substantially identical to periods of market illiquidity and stating that the Agencies note that section 13’s prohibition on the proposed definition of ‘‘covered financial market will adapt post-implementation (e.g., proprietary trading and related exemptions apply position.’’ Consistent with this change, the final portfolio managers will increase their use of CDS only to banking entities. See, e.g., Chamber (Feb. rule replaces the undefined verbs ‘‘acquire’’ or to reduce economic risk to specific bond positions 2012). ‘‘take’’ with the defined terms ‘‘purchase’’ or ‘‘sale’’ as the liquidation process of cash bonds takes more 92 See final rule § 75.3(d). and ‘‘sell.’’ See final rule §§ 75.3(c), 75.2(u), (x). time, alternative market matching networks will be 93 See 12 U.S.C. 1851(h)(6).

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of trading account included, consistent of trading account. The proposed rule commenter recommended that a with the statute, any account that is provided that no account is a trading covered financial position be considered used by a banking entity to acquire or account to the extent that it is used to a trading account position only if it take one or more covered financial acquire or take certain positions under qualifies as a GAAP trading position.107 positions for short-term trading repurchase or reverse repurchase A few commenters requested the purposes (the ‘‘short-term trading arrangements, positions under securities Agencies define the phrase ‘‘short term’’ account’’).94 The proposed rule lending transactions, positions for bona in the rule.108 identified four purposes that would fide liquidity management purposes, or Several commenters argued that the indicate short-term trading intent: (i) positions held by derivatives clearing market risk rule should not be Short-term resale; (ii) benefitting from organizations or clearing agencies.100 Overall, commenters did not raise referenced as part of the definition of actual or expected short-term price 109 movements; (iii) realizing short-term significant concerns with or objections trading account. A few of these arbitrage profits; or (iv) hedging one or to the short-term trading account. commenters argued instead that the more positions described in (i), (ii) or Several commenters argued that the capital treatment of a position be used (iii). The proposed rule presumed that definition of trading account should be only as an indicative factor rather than 110 an account is a trading account if it is limited to only this portion of the a dispositive test. One commenter used to acquire or take a covered proposed definition of trading thought that the market risk rule trading financial position (other than a position account.101 However, a few commenters account was redundant because it in the market risk rule trading account raised concerns regarding the treatment includes only positions that have short- or the dealer trading account) that the of arbitrage trading under the proposed term trading intent.111 Commenters also banking entity holds for 60 days or rule.102 Several commenters asserted contended that it was difficult to less.95 that the proposed definition of trading consider and comment on this aspect of Second, the proposed definition of account was too broad and covered the proposal because the market risk trading account included, for certain trading not intended to be covered by capital rules had not been finalized.112 103 entities, any account that contains the statute. Some of these A number of commenters objected to commenters maintained that the positions that qualify for trading book the dealer trading account prong of the Agencies exceeded their statutory capital treatment under the banking definition.113 Commenters asserted that authority under section 13 of the BHC agencies’ market risk capital rules other this prong was an unnecessary and than positions that are foreign exchange Act in defining trading account to include the market risk rule trading unhelpful addition that went beyond derivatives, commodity derivatives or the requirements of section 13 of the contracts of sale of a commodity for account and dealer trading account, and argued that the definition should be BHC Act, and that it made the trading delivery (the ‘‘market risk rule trading account determination more complex 96 limited to the short-term trading account’’). ‘‘Covered positions’’ under 114 104 and difficult. In particular, the banking agencies’ market-risk account definition. Commenters argued, for example, that an overly commenters argued that the dealer capital rules are positions that are trading account was too broad and generally held with the intent of sale in broad definition of trading account may cause traditional bank activities introduced uncertainty because it the short-term. presumed that dealers always enter into Third, the proposed definition of important to safety and soundness of a positions with short-term intent.115 trading account included any account banking entity to fall within the used by a banking entity that is a prohibition on proprietary trading to the Commenters also expressed concern securities dealer, swap dealer, or detriment of banking organizations, about the difficulty of applying this test 105 security-based swap dealer to acquire or customers, and financial markets. A outside the United States and requested take positions in connection with its number of commenters suggested that, if this account is retained, the final dealing activities (the ‘‘dealer trading modifying and narrowing the trading rule be explicit about how it applies to account’’).97 The proposed rule also account definition to remove the a swap dealer outside the United States included as a trading account any implicit negative presumption that any account used to acquire or take any position creates a trading account, or 107 See ABA (Keating). covered financial position by a banking that all principal trading constitutes 108 See NAIB et al.; Occupy; but see Alfred Brock. prohibited proprietary trading unless it 109 See ABA; BoA; Goldman (Prop. Trading); entity in connection with the activities ISDA (Feb. 2012); JPMC; SIFMA et al. (Prop. of a dealer, swap dealer, or security- qualifies for a narrowly tailored exemption, and to clearly exempt Trading) (Feb. 2012). based swap dealer outside of the United 110 See BoA; SIFMA et al. (Prop. Trading) (Feb. 98 activities important to safety and 2012). States. Covered financial positions 106 held by banking entities that register or soundness. For example, one 111 See ISDA (Feb. 2012). file notice as securities or derivatives 112 See ABA (Keating); BoA; Goldman (Prop. 100 See proposed rule § 75.3(b)(2)(iii). Trading); ISDA (Feb. 2012); JPMC. The banking dealers as part of their dealing activity 101 See ABA (Keating); JPMC. agencies adopted a final rule that amends their were included because such positions 102 See AFR et al. (Feb. 2012); Paul Volcker; respective market risk capital rules on August 30, are generally held for sale to customers Credit Suisse (Seidel); ISDA (Feb. 2012); Japanese 2012. See 77 FR 53060 (Aug. 30, 2012). The upon request or otherwise support the Bankers Ass’n. Agencies continued to receive and consider 103 See ABA (Keating); Allen & Overy (on behalf comments on the proposed rule to implement firm’s trading activities (e.g., by hedging section 13 of the BHC Act after that time. 99 of Large Int’l Banks with U.S. Operations); Am. its dealing positions). Express; BoA; Goldman (Prop. Trading); ISDA (Feb. 113 See ABA (Keating); Allen & Overy (on behalf The proposed rule also set forth four 2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al. of Large Int’l Banks with U.S. Operations); Am. clarifying exclusions from the definition (Prop. Trading) (Feb. 2012); State Street (Feb. 2012). Express; Goldman (Prop. Trading); ISDA (Feb. 104 See ABA (Keating); JPMC; SIFMA et al. (Prop. 2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al. Trading) (Feb. 2012); State Street (Feb. 2012). (Prop. Trading) (Feb. 2012). 94 See proposed rule § 75.3(b)(2)(i)(A). 105 See ABA (Keating); Credit Suisse (Seidel). 114 See ABA (Keating); Allen & Overy (on behalf 95 See proposed rule § 75.3(b)(2)(ii). 106 See ABA (Keating); Ass’n. of Institutional of Large Int’l Banks with U.S. Operations); JPMC; 96 See proposed rule §§ 75.3(b)(2)(i)(B); 75.3(b)(3). Investors (Feb. 2012); BoA; Capital Group; IAA; State Street (Feb. 2012); ISDA (Feb. 2012); SIFMA 97 See proposed rule § 75.3(b)(2)(i)(C). Credit Suisse (Seidel); ICI (Feb. 2012); ISDA (Feb. et al. (Prop. Trading) (Feb. 2012). 98 See proposed rule § 75.3(b)(2)(i)(C)(5). 2012); NAIB et al.; SIFMA et al. (Prop. Trading) 115 See ABA (Keating); Am. Express; Goldman 99 See Joint Proposal, 76 FR 68860. (Feb. 2012); SVB; Wellington. (Prop. Trading); ISDA (Feb. 2012); JPMC.

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and treat U.S. swap dealers investments that do not have price arbitrage profits, and hedging positions consistently.116 changes and that can be sold whenever that result from these activities. In contrast, other commenters the banking entity needs cash should be Specifically, the reference to short-term contended that the proposed rule’s excluded from the trading account resale is taken from the statute’s definition of trading account was too definition.127 definition of trading account. The narrow, particularly in its focus on After carefully reviewing the Agencies continue to believe it is also short-term positions,117 or should be comments, the Agencies have appropriate to include in the short-term simplified.118 One commenter argued determined to retain in the final rule the trading prong an account that is used by that the breadth of the trading account proposed approach for defining trading a banking entity to purchase or sell one definition was critical because positions account that includes the short-term, or more financial instruments excluded from the trading account market risk rule, and dealer trading principally for the purpose of definition would not be subject to the accounts with modifications to address benefitting from actual or expected proposed rule.119 One commenter issues raised by commenters. The short-term price movements, realizing supported the proposed definition of Agencies believe that this multi-prong short-term arbitrage profits, or hedging trading account.120 Other commenters approach is consistent with both the one or more positions captured by the believed that reference to the market- language and intent of section 13 of the short-term trading prong. The risk rule was an important addition to BHC Act, including the express provisions regarding price movements the definition of trading account. Some statutory authority to include ‘‘any such and arbitrage focus on the intent to expressed the view that it should other account’’ as determined by the engage in transactions to benefit from include all market risk capital rule Agencies.128 The final definition short-term price movements (e.g., covered positions and not just those effectuates Congress’s purpose to entering into a subsequent transaction requiring short-term trading intent.121 generally focus on short-term trading in the near term to offset or close out, Certain commenters proposed while addressing commenters’ desire for rather than sell, the risks of a position alternate definitions. Several greater certainty regarding the definition held by the banking entity to benefit 129 commenters argued against using the of the trading account. In addition, from a price movement occurring term ‘‘account’’ and instead advocated the Agencies believe commenters’ between the acquisition of the applying the prohibition on proprietary concerns about the scope of the underlying position and the subsequent trading to trading positions.122 Foreign proposed definition of trading account offsetting transaction) or to benefit from banks recommended applying the are substantially addressed by the differences in multiple market prices, definition of trading account applicable refined exemptions in the final rule for including scenarios where movement in to such banks in their home country, if customer-oriented activities, such as those prices is not necessary to realize the home country provided a clear market making-related activities, and the intended profit.132 These types of definition of this term.123 These the exclusions from proprietary 130 transactions are economically commenters argued that new definitions trading. Moreover, the Agencies equivalent to transactions that are in the proposed rule, like trading believe that it is appropriate to focus on principally for the purpose of selling in account, would require foreign banking the economics of a banking entity’s the near term or with the intent to resell entities to develop new and complex trading activity to help determine to profit from short-term price procedures and expensive systems.124 whether it is engaged in proprietary 131 movements, which are expressly Commenters also argued that various trading, as discussed further below. covered by the statute’s definition of As explained above, the short-term types of trading activities should be trading account. Thus, the Agencies trading prong of the definition largely excluded from the trading account believe it is necessary to include these incorporates the statutory provisions. definition. For example, one commenter provisions in the final rule’s short-term This prong covers trading involving asserted that arbitrage trading should trading prong to provide clarity about short-term resale, price movements, and not be considered trading account the scope of the definition and to activity,125 while other commenters 127 See NAIB et al. See infra Part VI.A.1.d.2. prevent evasion of the statute and final 133 argued that arbitrage positions and (discussing the liquidity management exclusion). rule. In addition, like the proposed strategies are proprietary trading and 128 12 U.S.C. 1851(h)(6). rule, the final rule’s short-term trading should be included in the definition of 129 In response to commenters’ concerns about the prong includes hedging one or more of trading account and prohibited by the meaning of account, the Agencies note the term the positions captured by this prong final rule.126 Another commenter argued ‘‘trading account’’ is a statutory concept and does not necessarily refer to an actual account. Trading because the Agencies assume that a that the trading account should include account is simply nomenclature for the set of banking entity generally intends to hold only positions primarily intended, when transactions that are subject to the final rule’s the hedging position for only so long as the position is entered into, to profit restrictions on proprietary trading. See ABA the underlying position is held. from short-term changes in the value of (Keating); Goldman (Prop. Trading); NAIB et al. The remaining two prongs to the the assets, and that liquidity 130 For example, several commenters’ concerns about the potential impact of the proposed trading account definition apply to definition of trading account were tied to the types of entities that engage actively in 116 See Allen & Overy (on behalf of Large Int’l perceived narrowness of the proposed exemptions. trading activities. Each prong focuses on Banks with U.S. Operations); Am. Express; JPMC. See ABA (Keating); Ass’n. of Institutional Investors analogous or parallel short-term trading 117 See Sens. Merkley & Levin (Feb. 2012); (Feb. 2012); BoA; Capital Group; IAA; Credit Suisse Occupy. (Seidel); ICI (Feb. 2012); ISDA (Feb. 2012); NAIB et activities. A few commenters stated 118 See, e.g., Public Citizen. al.; SIFMA et al. (Prop. Trading) (Feb. 2012); SVB; these prongs were duplicative of the 119 See AFR et al. (Feb. 2012). Wellington. short-term trading prong, and argued the 120 See Alfred Brock. 131 See Sens. Merkley & Levin (Feb. 2012). Agencies should not include these 121 See AFR et al. (Feb. 2012). However, as discussed in this SUPPLEMENTARY prongs in the definition of trading INFORMATION, the Agencies are not prohibiting any 122 See ABA (Keating); Goldman (Prop. Trading); trading that involves profiting from changes in the NAIB et al. value of the asset, as suggested by this commenter, 132 See Joint Proposal, 76 FR at 68857–68858. 123 See Japanese Bankers Ass’n.; Norinchukin. because permitted activities, such as market 133 As a result, the Agencies are not excluding 124 See Japanese Bankers Ass’n. making, can involve price appreciation-related arbitrage trading from the trading account 125 See Alfred Brock. revenues. See infra Part VI.A.3. (discussing the final definition, as suggested by at least one commenter. 126 See AFR et al. (Feb. 2012); Paul Volcker. market-making exemption). See, e.g., Alfred Brock.

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account, or should only consider them term intent.138 Moreover, the final rule recognize that banking entities that are as non-determinative factors.134 To the includes a number of exemptions for the registered dealers may not currently extent that an overlap exists between activities in which securities dealers, engage in such an analysis with respect the prongs of this definition, the swap dealers, and security-based swap to their current trading activities and, Agencies believe they are mutually dealers typically engage, such as market thus, this may represent a new reinforcing, strengthen the rule’s making, hedging, and underwriting. regulatory requirement for these effectiveness, and may help simplify the Thus, the Agencies believe the broad entities. If the regulatory analysis analysis of whether a purchase or sale scope of the dealer trading account is otherwise engaged in by banking is conducted for the trading account.135 balanced by the exemptions that are entities is substantially similar to the The market risk capital prong covers designed to permit dealer entities to dealer prong analysis required under the trading positions that are covered continue to engage in customer-oriented trading account definition, then any positions for purposes of the banking trading activities, consistent with the increased compliance burden could be agency market-risk capital rules, as well statute. This approach is designed to small or insubstantial.143 as hedges of those positions. Trading ensure that registered dealer entities are In response to commenters’ concerns positions under those rules are positions engaged in permitted trading activities, regarding the application of this prong held by the covered entity ‘‘for the rather than prohibited proprietary to banking entities acting as dealers in purpose of short-term resale or with the trading. jurisdictions outside the United intent of benefitting from actual or The final rule adopts the dealer States,144 the Agencies continue to expected short-term price movements, trading account substantially as believe including the activities of a 136 139 or to lock-in arbitrage profits.’’ This proposed, with streamlining that banking entity engaged in the business definition largely parallels the eliminates the specific references to of a dealer, swap dealer, or security- provisions of section 13(h)(4) of the different types of securities and based swap dealer outside of the United BHC Act and mirrors the short-term derivatives dealers. The final rule States, to the extent the instrument is trading account prong of both the adopts the proposed approach to purchased or sold in connection with proposed and final rules. Covered covering trading accounts of banking the activities of such business, is positions are trading positions under the entities that regularly engage in the appropriate. As noted above, dealer rule that subject the covered entity to business of a dealer, swap dealer, or activity generally involves short-term risks and exposures that must be security-based swap dealer outside of trading. Further, the Agencies are actively managed and limited—a the United States. In the case of both concerned that differing requirements requirement consistent with the domestic and foreign entities, this for U.S. and foreign dealers may lead to purposes of the section 13 of the BHC provision applies only to financial regulatory arbitrage. For foreign banking Act. instruments purchased or sold in Incorporating this prong into the entities acting as dealers outside of the connection with the activities that United States that are eligible for the trading account definition reinforces the require the banking entity to be licensed consistency between governance of the exemption for trading conducted by or registered to engage in the business foreign banking entities, the Agencies types of positions that banking entities of dealing, which is not necessarily all identify as ‘‘trading’’ for purposes of the believe the risk-based approach to this of the activities of that banking exemption in the final rule should help market risk capital rules and those that entity.140 Activities of a banking entity are trading for purposes of the final rule address the concerns about the scope of that are not covered by the dealer prong this prong of the definition.145 under section 13 of the BHC Act. may, however, be covered by the short- In response to one commenter’s Moreover, this aspect of the final rule term or market risk rule trading suggestion that the Agencies define the reduces the compliance burden on accounts if the purchase or sale satisfies term trading account to allow a foreign banking entities with substantial trading the requirements of §§ 75.3(b)(1)(i) or banking entity to use of the relevant activities by establishing a clear, bright- (ii).141 foreign regulator’s definition of this line rule for determining that a trade is A few commenters stated that they do 137 term, where available, the Agencies are within the trading account. not currently analyze whether a concerned such an approach could lead After reviewing comments, the particular activity would require dealer to regulatory arbitrage and otherwise Agencies also continue to believe that registration, so the dealer prong of the inconsistent applications of the rule.146 financial instruments purchased or sold trading account definition would by registered dealers in connection with require banking entities to engage in a The Agencies believe this commenter’s general concern about the impact of the their dealing activity are generally held new type of analysis.142 The Agencies with short-term intent and should be statute and rule on foreign banking captured within the trading account. 138 See Joint Proposal, 76 FR at 68860. entities’ activities outside the United The Agencies believe the scope of the 139 See final rule § 75.3(b)(1)(iii). States should be substantially addressed dealer prong is appropriate because, as 140 An insured depository institution may be by the exemption for trading conducted noted in the proposal, positions held by registered as a swap dealer, but only the swap by foreign banking entities under a registered dealer in connection with dealing activities that require it to be so registered § 75.6(e) of the final rule. are covered by the dealer trading account. If an its dealing activity are generally held for insured depository institution purchases or sells a sale to customers upon request or financial instrument in connection with activities of 143 See, e.g., Goldman (Prop. Trading) (‘‘For otherwise support the firm’s trading the insured depository institution that do not trigger instance, a banking entity’s market making-related activities (e.g., by hedging its dealing registration as a swap dealer, such as lending, activities with respect to credit trading may involve positions), which is indicative of short- deposit-taking, the hedging of business risks, or making a market in bonds (traded in a broker- other end-user activity, the financial instrument is dealer), single-name CDSs (in a security-based swap included in the trading account only if the dealer) and CDS indexes (in a swap dealer). For 134 See ISDA (Feb. 2012); JPMC; ABA (Keating); instrument falls within the statutory trading regulatory or other reasons, these transactions could BoA; SIFMA et al. (Prop. Trading) (Feb. 2012). account under § 75.3(b)(1)(i) or the market risk rule take place in different legal entities . . .’’). 135 See Occupy. trading account under § 75.3(b)(1)(ii) of the final 144 See SIFMA et al. (Prop. Trading) (Feb. 2012); 136 12 CFR 225, Appendix E. rule. JPMC; Allen & Overy (on behalf of Large Int’l Banks 137 Accordingly, the Agencies are not using a 141 See final rule §§ 75.3(b)(1)(i) and (ii). with U.S. Operations). position’s capital treatment as merely an indicative 142 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 145 See final rule § 75.6(e). factor, as suggested by a few commenters. 2012); Goldman (Prop. Trading). 146 See Japanese Bankers Ass’n.

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Finally, the Agencies have declined to than the specified period.154 within 60 days due to market adopt one commenter’s Commenters also suggested turning the fluctuations or other changed recommendation that a position in a presumption into a safe harbor 155 or circumstances.167 financial instrument be considered a into guidance.156 After carefully considering the trading account position only if it Other commenters opposed the comments received, the Agencies qualifies as a GAAP trading position.147 inclusion of the rebuttable presumption continue to believe the rebuttable The Agencies continue to believe that for a number of reasons and requested presumption is appropriate to generally formally incorporating accounting that it be removed.157 For example, define the meaning of ‘‘short-term’’ for standards governing trading securities is these commenters argued that the purposes of the short-term trading not appropriate because: (i) The presumption had no statutory basis; 158 account, especially for small and statutory proprietary trading provisions was arbitrary; 159 was not supported by regional banking entities that are not under section 13 of the BHC Act applies data, facts, or analysis; 160 would subject to the market risk capital rules to financial instruments, such as dampen market-making and and are not registered dealers or swap derivatives, to which the trading underwriting activity; 161 or did not take entities. The range of comments the security accounting standards may not into account the nature of trading in Agencies received on what ‘‘short-term’’ apply; (ii) these accounting standards different types of securities.162 Some should mean—from 30 days to one permit companies to classify, at their commenters also questioned whether year—suggests that a clear presumption discretion, assets as trading securities, the Agencies would interpret rebuttals would ensure consistency in even where the assets would not of the presumption consistently,163 and interpretation and create a level playing otherwise meet the definition of trading stressed the difficulty and costliness of field for all banking entities with securities; and (iii) these accounting rebutting the presumption,164 such as covered trading activities subject to the standards could change in the future enhanced documentation or other short-term trading account. Based on without consideration of the potential administrative burdens.165 One foreign their supervisory experience, the impact on section 13 of the BHC Act banking association also argued that Agencies find that 60 days is an and these rules.148 requiring foreign banking entities to appropriate cut off for a regulatory rebut a U.S. regulatory requirement presumption.168 Further, because the b. Rebuttable Presumption for the Short- would be costly and inappropriate given purpose of the rebuttable presumption Term Trading Account that the trading activities of the banking is to simplify the process of evaluating The proposed rule included a entity are already reviewed by home whether individual positions are 166 rebuttable presumption clarifying when country supervisors. This commenter included in the trading account, the a covered financial position, by reason also contended that the presumption Agencies believe that implementing of its holding period, is traded with could be problematic for financial different holding periods based on the short-term intent for purposes of the instruments purchased for long-term type of financial instrument would short-term trading account. The investment purposes that are closed insert unnecessary complexity into the Agencies proposed this presumption presumption.169 The Agencies are not 154 See Occupy. providing a safe harbor or a reverse primarily to provide guidance to 155 See Capital Group. presumption (i.e., a presumption for banking entities that are not subject to 156 See SIFMA et al. (Prop. Trading) (Feb. 2012). the market risk capital rules or are not 157 See ABA (Keating); Am. Express; Business positions that are outside of the trading covered dealers or swap entities and Roundtable; Capital Group; ICI (Feb. 2012); account), as suggested by some accordingly may not have experience Investure; JPMC; Liberty Global; STANY; Chamber commenters, in recognition that some (Feb. 2012). proprietary trading could occur outside evaluating short-term trading intent. In 158 See ABA (Keating); JPMC; Chamber (Feb. 170 particular, § 75.3(b)(2)(ii) of the 2012). of the 60 day period. proposed rule provided that an account 159 See Am. Express; ICI (Feb. 2012). Adopting a presumption allows the would be presumed to be a short-term 160 See ABA (Keating); Chamber (Feb. 2012). Agencies and affected banking entities trading account if it was used to acquire 161 See AllianceBernstein; Business Roundtable; to evaluate all the facts and or take a covered financial position that ICI (Feb. 2012); Investure; Liberty Global; STANY. circumstances surrounding trading Because the rebuttable presumption does not activity in determining whether the the banking entity held for a period of impact the availability of the exemptions for 60 days or less. underwriting, market making, and other permitted activity implicates the purpose of the Several commenters supported the activities, the Agencies do not believe this statute. For example, trading in a provision creates any additional burdens on rebuttable presumption, but suggested financial instrument for long-term permissible activities. investment that is disposed of within 60 either shortening the holding period to 162 See Am. Express (noting that most foreign 30 days or less,149 or extending the exchange forward transactions settle in less than days because of unexpected period to 90 days,150 to several one week and are used as commercial payment developments (e.g., an unexpected instruments, and not speculative trades); Capital months,151 or to one year.152 Some of increase in the financial instrument’s Group. volatility or a need to liquidate the these commenters argued that 163 See ABA (Keating). As discussed below in Part specifying an overly short holding VI.C., the Agencies expect to continue to coordinate instrument to meet unexpected liquidity period would be contrary to the statute, their supervisory efforts related to section 13 of the demands) may not be trading activity invite gamesmanship,153 and miss BHC Act and to share information as appropriate in covered by the statute. To reduce the order to effectively implement the requirements of costs and burdens of rebutting the speculative positions held for longer that section and the final rule. 164 See ABA (Keating); AllianceBernstein; Capital 167 Id. 147 See ABA (Keating). Group; Japanese Bankers Ass’n.; Liberty Global; JPMC. 168 See final rule § 75.3(b)(2). Commenters did not 148 See Joint Proposal, 76 FR at 68859. 165 See NAIB et al.; Capital Group. provide persuasive evidence of the benefits 149 See Japanese Bankers Ass’n. 166 See Japanese Bankers Ass’n. As noted above, associated with a rebuttable presumption for 150 See Capital Group. the Agencies believe concerns about the impacts of positions held for greater or fewer than 60 days. 151 See AFR et al. (Feb. 2012). the definition of trading account on foreign banking 169 See, e.g., Am. Express; Capital Group; Sens. 152 See Sens. Merkley & Levin (Feb. 2012); Public entity trading activity outside of the United States Merkley & Levin (Feb. 2012). Citizen (arguing that one-year demarks tax law are substantially addressed by the final rule’s 170 See Capital Group; AFR et al. (Feb. 2012); covering short term capital gains). exemption for proprietary trading conducted by Sens. Merkley & Levin (Feb. 2012); Public Citizen; 153 See Sens. Merkley & Levin (Feb. 2012). foreign banking entities in final rule § 75.6(e). Occupy.

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presumption, the Agencies will allow a contract.176 To provide additional Act; 182 and (v) any transactions banking entity to rebut the presumption clarity, the proposed rule also provided authorized under section 19 of the for a group of related positions.171 that, consistent with the statute, any Commodity Exchange Act.183 In The final rule provides three position that is itself a loan, a addition, the proposed rule excluded clarifying changes to the proposed commodity, or foreign exchange or from the definition of derivative (i) any rebuttable presumption. First, in currency was not a covered financial consumer, commercial, or other response to comments, the final rule position.177 agreement, contract, or transaction that replaces the reference to an ‘‘account’’ The proposal also defined a number the CFTC and SEC have further defined that is presumed to be a trading account of other terms used in the definition of by joint regulation, interpretation, with the purchase or sale of a ‘‘financial covered financial position, including guidance, or other action as not within instrument.’’ 172 This change clarifies commodity, derivative, loan, and the definition of swap or security-based that the presumption only applies to the security.178 These terms were generally swap, and (ii) any identified banking purchase or sale of a financial defined by reference to the Federal product, as defined in section 402(b) of instrument that is held for fewer than 60 securities laws or the Commodity the Legal Certainty for Bank Products days, and not the entire account that is Exchange Act because these existing Act of 2000 (7 U.S.C. 27(b)), that is used to make the purchase or sale. definitions are generally well- subject to section 403(a) of that Act (7 Second, the final rule clarifies that basis understood by market participants and U.S.C. 27a(a)). have been subject to extensive trades, in which a banking entity buys Commenters expressed a variety of interpretation in the context of one instrument and sells a substantially views regarding the definition of securities, commodities, and derivatives similar instrument (or otherwise covered financial position, as well as trading. transfers the first instrument’s risk), are other defined terms used in that As noted above, the proposed rule subject to the rebuttable definition. For instance, some 173 included derivatives within the presumption. Third, in order to commenters argued that the definition definition of covered financial position. maintain consistency with definitions should be expanded to include Derivative was defined to include any used throughout the final rule, the transactions in spot commodities or swap (as that term is defined in the references to ‘‘acquire’’ or ‘‘take’’ a foreign currency, even though those financial position have been replaced Commodity Exchange Act) and security- based swap (as that term is defined in instruments are not included by the with references to ‘‘purchase’’ or ‘‘sell’’ statute.184 Other commenters strongly a financial instrument.174 the Exchange Act), in each case as further defined by the CFTC and SEC by supported the exclusion of spot c. Definition of ‘‘Financial Instrument’’ joint regulation, interpretation, commodity and foreign currency guidance, or other action, in transactions as consistent with the Section 13 of the BHC Act generally statute, arguing that these instruments prohibits proprietary trading, which is consultation with the Board pursuant to 179 are part of the traditional business of defined in section 13(h)(4) to mean section 712(d) of the Dodd-Frank Act. The proposed rule also included within banking and do not represent the types engaging as principal for the trading of instruments that Congress designed account in any purchase or sale of any the definition of derivative certain other transactions that, although not included section 13 to address. These security, any derivative, any contract of commenters argued that including spot sale of a commodity for future delivery, within the definition of swap or security-based swap, also appear to be, commodities and foreign exchange any option on any such security, within the definition of covered derivative, or contract, or any other or operate in economic substance as, derivatives, and which if not included financial position in the final rule security or financial instruments that would put U.S. banking entities at a 175 could permit banking entities to engage the Agencies may, by rule, determine. competitive disadvantage and prevent The proposed rule defined the term in proprietary trading that is inconsistent with the purpose of section them from conducting routine banking ‘‘covered financial position’’ to operations.185 One commenter argued reference the instruments listed in 13 of the BHC Act. Specifically, the proposed definition also included: (i) that the proposed definition of covered section 13(h)(4), including: (i) A financial position was effective and security, including an option on a Any purchase or sale of a nonfinancial commodity for deferred shipment or recommended that the definition should security; (ii) a derivative, including an not be expanded.186 Another commenter option on a derivative; or (iii) a contract delivery that is intended to be physically settled; (ii) any foreign argued that an instrument be considered of sale of a commodity for future to be a spot foreign exchange delivery, or an option on such a exchange forward or foreign exchange swap (as those terms are defined in the transaction, and thus not a covered Commodity Exchange Act); 180 (iii) any financial position, if it settles within 5 171 The Agencies believe this should help address 187 agreement, contract, or transaction in days of purchase. Another commenters’ concerns about the burdens associated commenter argued that covered with rebutting the presumption. See ABA (Keating); foreign currency described in section AllianceBernstein; Capital Group; Japanese Bankers 2(c)(2)(C)(i) of the Commodity Exchange financial positions used in interaffiliate Ass’n.; Liberty Global; JPMC; NAIB et al.; Capital Act; 181 (iv) any agreement, contract, or transactions should expressly be Group. excluded because they are used for 172 See, e.g., ABA (Keating); Clearing House transactions in a commodity other than Ass’n.; JPMC. foreign currency described in section 182 173 The rebuttable presumption covered these 2(c)(2)(D)(i) of the Commodity Exchange 7 U.S.C. 2(c)(2)(D)(i). trades in the proposal, but the final rule’s use of 183 7 U.S.C. 23. ‘‘financial instrument’’ rather than ‘‘covered 184 See Sens. Merkley & Levin (Feb. 2012); Public 176 financial position’’ necessitated clarifying this point See proposed rule § 75.3(c)(3)(i). Citizen; Occupy. in the rule text. See final rule § 75.3(b)(2). See also 177 See proposed rule § 75.3(c)(3)(ii). 185 See Northern Trust; Morgan Stanley; JPMC; Public Citizen. 178 See proposed rule § 75.2(l), (q), (w); Credit Suisse (Seidel); Am. Express; see also AFR 174 The Agencies do not believe these revisions § 75.3(c)(1) and (2). et al. (Feb. 2012) (arguing that the final rule should have a substantive effect on the operation or scope 179 See 7 U.S.C. 1a(47) (defining ‘‘swap’’); 15 explicitly exclude ‘‘spot’’ commodities and foreign of the final rule in comparison to the statute or U.S.C. 78c(a)(68) (defining ‘‘security-based swap’’). exchange). proposed rule. 180 7 U.S.C. 1a(24), (25). 186 See Alfred Brock. 175 See 12 U.S.C. 1851(h)(4). 181 7 U.S.C. 2(c)(2)(C)(i). 187 See Credit Suisse (Seidel).

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internal risk management purposes and cross-reference the definition of swap while some commenters requested that not for proprietary trading.188 and security-based swap under the certain other instruments, such as Some commenters requested that the Federal commodities and securities foreign exchange swaps and forwards, final rule exclude additional laws.195 be excluded from the definition of instruments from the definition of After carefully considering the financial instrument,203 the Agencies covered financial position. For instance, comments received on the proposal, the believe that these instruments appear to some commenters requested that the final rule continues to apply the be, or operate in economic substance as, Agencies exclude commodity and prohibition on proprietary trading to the derivatives (which are by statute foreign exchange futures, forwards, and same types of instruments as listed in included within the scope of swaps, arguing that these instruments the statute and the proposal, which the instruments subject to the prohibitions typically have a commercial and not final rule defines as ‘‘financial of section 13). If these instruments were financial purpose and that making them instrument.’’ Under the final rule, a not included within the definition of subject to the prohibitions of section 13 financial instrument is defined as: (i) A financial instrument, banking entities would negatively affect the spot market security, including an option on a could use them to engage in proprietary for these instruments.189 A few security; 196 (ii) a derivative, including trading that is inconsistent with the commenters also argued that foreign an option on a derivative; or (iii) a purpose and design of section 13 of the exchange swaps and forwards are used contract of sale of a commodity for BHC Act. in many jurisdictions to provide U.S. future delivery, or option on a contract As under the proposal, loans, dollar-funding for foreign banking of sale of a commodity for future commodities, and foreign exchange or entities and that these instruments delivery.197 The final rule excludes from currency are not included within the should be excluded since they the definition of financial instrument: (i) scope of instruments subject to section contribute to the stability and liquidity A loan; 198 (ii) a commodity that is not 13. The exclusion of these types of of the market for spot foreign an excluded commodity (other than instruments is intended to eliminate exchange.190 Other commenters foreign exchange or currency), a potential confusion by making clear that contended that foreign exchange swaps derivative, a contract of sale of a the purchase and sale of loans, and forwards should be excluded commodity for future delivery, or an commodities, and foreign exchange or because they are an integral part of option on a contract of sale of a currency—none of which are referred to banking entities’ ability to provide trust commodity for future delivery; or (iii) in section 13(h)(4) of the BHC Act—are and custody services to customers and foreign exchange or currency.199 An outside the scope of transactions to are necessary to enable banking entities excluded commodity is defined to have which the proprietary trading to deal in the exchange of currencies for the same meaning as in section 1a(19) restrictions apply. For example, the spot customers.191 of the Commodity Exchange Act. purchase of a commodity would meet One commenter argued that the The Agencies continue to believe that the terms of the exclusion, but the inclusion of certain instruments within these instruments and transactions, acquisition of a futures position in the the definition of derivative, such as which are consistent with those same commodity would not qualify for purchases or sales of nonfinancial referenced in section 13(h)(4) of the the exclusion. commodities for deferred shipment or BHC Act as part of the statutory The final rule also adopts the delivery that are intended to be definition of proprietary trading, definitions of security and derivative as 192 physically settled, was inappropriate. represent the type of financial proposed.204 These definitions, which This commenter alleged that these instruments which the proprietary reference existing definitions under the instruments are not derivatives but trading prohibition of section 13 was Federal securities and commodities should instead be viewed as contracts designed to cover. While some laws, are generally well-understood by for purchase of specific commodities to commenters requested that this market participants and have been be delivered at a future date. This definition be expanded to include spot subject to extensive interpretation in the commenter also argued that the transactions 200 or loans,201 the context of securities and commodities Agencies do not have authority under Agencies do not believe that it is trading activities. While some section 13 to include these instruments appropriate at this time to expand the commenters argued that it would be as ‘‘other securities or financial scope of instruments subject to the ban inappropriate to use the definition of instruments’’ subject to the prohibition on proprietary trading.202 Similarly, swap and security-based swap because on proprietary trading.193 those terms had not yet been finalized Some commenters also argued that, 195 See Alfred Brock. pursuant to public notice and because the CFTC and SEC had not yet 196 The definition of security under the final rule comment,205 the CFTC and SEC have finalized their definitions of swap and is the same as under the proposal. See final rule subsequently finalized those definitions security-based swap, it was § 75.2(y). after receiving extensive public 197 See final rule § 75.3(c)(1). inappropriate to use those definitions as comment on the rulemakings.206 The part of the proposed definition of 198 The definition of loan, as well as comments 194 received regarding that definition, is discussed in derivative. One commenter argued detail below in Part VI.B.1.c.8.a. respect to the exclusion for loans, the Agencies note that the definition of derivative was 199 See final rule § 75.3(c)(2). this is generally consistent with the rule of statutory effective, although this commenter 200 See Sens. Merkley & Levin (Feb. 2012); Public construction regarding the sale and securitization of argued that the final rule should not Citizen; Occupy. loans. See 12 U.S.C. 1851(g)(2). 201 See Occupy. 203 See JPMC; BAC; Citigroup (Feb. 2012); Govt. of Japan/Bank of Japan; Japanese Bankers Ass’n.; 188 202 Several commenters supported the exclusion See GE (Feb. 2012). Northern Trust; see also Norinchukin. 189 See JPMC; BoA; Citigroup (Feb. 2012). of spot commodity and foreign currency transactions as consistent with the statute. See 204 See final rule § 75.2(h), (y). 190 See Govt. of Japan/Bank of Japan; Japanese Northern Trust; Morgan Stanley; State Street (Feb. 205 See SIFMA et al. (Prop. Trading) (Feb. 2012); Bankers Ass’n.; see also Norinchukin. 2012); JPMC; Credit Suisse (Seidel); Am. Express; ISDA (Feb. 2012). 191 See Northern Trust; Citigroup (Feb. 2012). see also AFR et al. (Feb. 2012) (arguing that the 206 See CFTC and SEC, Further Definition of 192 See SIFMA et al. (Prop. Trading) (Feb. 2012). final rule should explicitly exclude ‘‘spot’’ ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security- 193 See id. commodities and foreign exchange). One Based Swap Agreement’’; Mixed swaps; Security 194 See SIFMA et al. (Prop. Trading) (Feb. 2012); commenter stated that the proposed definition Based Swap Agreement Recordkeeping, 78 FR ISDA (Feb. 2012). should not be expanded. See Alfred Brock. With 48208 (Aug. 13, 2012).

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Agencies believe that this notice and solely as broker, agent, or custodian; Several commenters expressed comment process provided adequate through a deferred compensation or support for these exclusions and opportunity for market participants to similar plan; and to satisfy a debt requested that the Agencies expand comment on and understand those previously contracted. After considering them.210 For example, one commenter terms, and as such they are incorporated comments on these issues, which are requested clarification that all types of in the definition of derivative under this discussed in more detail below, the repurchase transactions qualify for the final rule. Agencies believe that providing exclusion.211 Some commenters While some commenters requested clarifying exclusions for these non- requested expanding this exclusion to that foreign exchange swaps and proprietary activities will likely cover all positions financed by, or forwards be excluded from the promote more cost-effective financial transactions related to, repurchase and definition of derivative or financial intermediation and robust capital reverse repurchase agreements.212 Other instrument, the Agencies have not done formation. Overly narrow exclusions for commenters requested that the so for the reasons discussed above. these activities would potentially exclusion apply to all transactions that However, as explained below in Part increase the cost of core banking are analogous to extensions of credit VI.A.1.d., the Agencies note that to the services, while overly broad exclusions and are not based on expected or extent a banking entity purchases or would increase the risk of allowing the anticipated movements in asset prices, sells a foreign exchange forward or types of trades the statute was designed arguing that the exclusion would be too swap, or any other financial instrument, to prohibit. The Agencies considered limited in scope to achieve its objective in a manner that meets an exclusion these issues in determining the if it is based on the legal form of the from proprietary trading, that appropriate scope of these exclusions. underlying contract.213 Additionally, transaction would not be considered to Because the Agencies do not believe some commenters suggested expanding be proprietary trading and thus would these excluded activities involve the exclusion to cover transactions that not be subject to the requirements of proprietary trading, as defined by the are for funding purposes, including section 13 of the BHC Act and the final statute and the final rule, the Agencies prime brokerage transactions, or for the rule. This includes, for instance, the do not believe it is necessary to use our purpose of asset-liability purchase or sale of a financial exemptive authority in section management.214 Commenters also instrument by a banking entity acting 13(d)(1)(J) of the BHC Act to deem these recommended expanding the exclusion solely as agent, broker, or custodian, or activities a form of permitted to include re-hypothecation of customer the purchase or sale of a security as part proprietary trading. securities, which can produce financing of a bona fide liquidity management structures that, like a repurchase plan. 1. Repurchase and Reverse Repurchase Arrangements and Securities Lending agreement, are functionally loans.215 d. Proprietary Trading Exclusions The proposed rule’s definition of In contrast, other commenters argued The proposed rule contained four trading account excluded an account that there was no statutory or policy exclusions from the definition of trading used to acquire or take one or more justification for excluding repurchase account for categories of transactions covered financial positions that arise and reverse repurchase agreements from that do not fall within the scope of under (i) a repurchase or reverse the trading account, and requested that section 13 of the BHC Act because they repurchase agreement pursuant to this exclusion be removed from the final 216 do not involve short-term trading which the banking entity had rule. Some of these commenters activities subject to the statutory simultaneously agreed, in writing at the argued that repurchase agreements prohibition on proprietary trading. start of the transaction, to both purchase could be used for prohibited proprietary 217 These exclusions covered the purchase and sell a stated asset, at stated prices, trading and suggested that, if or sale of a financial instrument under and on stated dates or on demand with repurchase agreements are excluded certain repurchase and reverse the same counterparty,207 or (ii) a from the trading account, repurchase agreements and securities transaction in which the banking entity documentation detailing the use of lending arrangements, for bona fide lends or borrows a security temporarily liquidity derived from repurchase liquidity management purposes, and by to or from another party pursuant to a agreements should be required.218 These a clearing agency or derivatives clearing written securities lending agreement organization in connection with clearing under which the lender retains the 210 See generally ABA (Keating); Alfred Brock; activities. economic interests of an owner of such Citigroup (Feb. 2012); GE (Feb. 2012); Goldman (Prop. Trading); ICBA; Japanese Bankers Ass’n.; As discussed below, the final rule security and has the right to terminate JPMC; Norinchukin; RBC; RMA; SIFMA et al. (Prop. provides exclusions for the purchase or the transaction and to recall the loaned Trading) (Feb. 2012); State Street (Feb. 2012); T. sale of a financial instrument under security on terms agreed to by the Rowe Price; UBS; Wells Fargo (Prop. Trading). See certain repurchase and reverse parties.208 Positions held under these infra Part VI.A.d.10. for the discussion of commenters’ requests for additional exclusions repurchase agreements and securities agreements operate in economic from the trading account. lending agreements; for bona fide substance as a secured loan and are not 211 See SIFMA et al. (Prop. Trading) (Feb. 2012). liquidity management purposes; by based on expected or anticipated 212 See FIA; SIFMA et al. (Prop. Trading) (Feb. certain clearing agencies, derivatives movements in asset prices. Accordingly, 2012). clearing organizations in connection these types of transactions do not 213 See Goldman (Prop. Trading); JPMC; UBS. with clearing activities; by a member of appear to be of the type the statutory 214 See Goldman (Prop. Trading); UBS. For example, one commenter suggested that fully a clearing agency, derivatives clearing definition of trading account was collateralized swap transactions should be organization, or designated financial designed to cover.209 exempted from the definition of trading account market utility engaged in excluded because they serve as funding transactions and are clearing activities; to satisfy existing 207 See proposed rule § 75.3(b)(2)(iii)(A). economically similar to repurchase agreements. See delivery obligations; to satisfy an 208 See proposed rule § 75.3(b)(2)(iii)(B). The SIFMA et al. (Prop. Trading) (Feb. 2012). 215 See Goldman (Prop. Trading). obligation of the banking entity in language that described securities lending transactions in the proposed rule generally mirrored 216 See AFR et al. (Feb. 2012); Occupy; Public connection with a judicial, that contained in Rule 3a5–3 under the Exchange Citizen; Sens. Merkley & Levin (Feb. 2012). administrative, self-regulatory Act. See 17 CFR 240.3a5–3. 217 See AFR et al. (Feb. 2012). organization, or arbitration proceeding; 209 See Joint Proposal, 76 FR at 68862. 218 See Public Citizen.

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commenters suggested that unless the and may involve proprietary trading. trading activity for asset-liability liquidity is used to secure a position for The Agencies further note that if a management (‘‘ALM’’). Commenters a willing customer, repurchase banking entity uses a repurchase or argued that two aspects of the proposed agreements should be regarded as a reverse repurchase agreement to finance rule’s definition of ‘‘trading account’’ strong indicator of proprietary a purchase of a financial instrument, would cause ALM transactions to fall trading.219 As an alternative, other transactions involving that within the prohibition on proprietary commenters suggested that the Agencies financial instrument may not qualify for trading—the 60-day rebuttable instead use their exemptive authority this exclusion.224 Similarly, short presumption and the reference to the pursuant to section 13(d)(1)(J) of the positions resulting from securities market risk rule trading account.229 For BHC Act to permit repurchase and lending agreements cannot rely upon example, commenters expressed reverse repurchase transactions so that this exclusion and may involve concern that hedging transactions such transactions must comply with the proprietary trading. associated with a banking entity’s statutory limits on material conflicts of Additionally, the Agencies have residential mortgage pipeline and interests and high-risks assets and determined not to exclude all mortgage servicing rights, and managing trading strategies, and compliance transactions, in whatever legal form that credit risk, earnings at risk, capital, requirements under the final rule.220 may be construed to be an extension of asset-liability mismatches, and foreign These commenters urged the Agencies credit, as suggested by commenters, exchange risks would be among to specify permissible collateral types, because such a broad exclusion would positions that may be held for 60 days haircuts, and contract terms for be too difficult to assess for compliance or less.230 These commenters contended securities lending agreements and and would provide significant that the exclusion for liquidity require that the investment of proceeds opportunity for evasion of the management and the activity from securities lending transactions be prohibitions in section 13 of the BHC exemptions for risk-mitigating hedging limited to high-quality liquid assets in Act. and trading in U.S. government order to limit potential risks of these 2. Liquidity Management Activities obligations would not be sufficient to activities.221 permit a wide variety of ALM After considering the comments The proposed definition of trading activities.231 These commenters received, the Agencies have determined account excluded an account used to contended that prohibiting trading for to exclude repurchase and reverse acquire or take a position for the ALM purposes would be contrary to the repurchase agreements and securities purpose of bona fide liquidity goals of enhancing sound risk lending agreements from the definition management, subject to certain management, the safety and soundness of proprietary trading under the final requirements.225 The preamble to the of banking entities, and U.S. financial rule. The final rule defines these terms proposed rule explained that bona fide stability,232 and would limit banking subject to the same conditions as were liquidity management seeks to ensure entities’ ability to manage liquidity.233 in the proposal. This determination that the banking entity has sufficient, Some commenters argued that the recognizes that repurchase and reverse readily-marketable assets available to requirements of the exclusion would not repurchase agreements and securities meet its expected near-term liquidity provide a banking entity with sufficient lending agreements excluded from the needs, not to realize short-term profit or flexibility to respond to liquidity needs definition operate in economic benefit from short-term price arising from changing economic substance as secured loans and do not 226 movements. conditions.234 Some commenters argued in normal practice represent proprietary To curb abuse, the proposed rule the requirement that any position taken trading.222 The Agencies will, however, required that a banking entity acquire or for liquidity management purposes be monitor these transactions to ensure this take a position for liquidity management limited to the banking entity’s near-term exclusion is not used to engage in in accordance with a documented funding needs failed to account for prohibited proprietary trading activities. liquidity management plan that meets longer-term liquidity management To avoid evasion of the rule, the 227 five criteria. Moreover, the Agencies requirements.235 These commenters Agencies note that, in contrast to certain stated in the preamble that liquidity 223 further argued that the requirements of commenters’ requests, only the management positions that give rise to transactions pursuant to the repurchase the liquidity management exclusion appreciable profits or losses as a result might not be synchronized with the agreement, reverse repurchase of short-term price movements would be agreement, or securities lending Basel III framework, particularly with subject to significant Agency scrutiny respect to the liquidity coverage ratio if agreement are excluded. For example, and, absent compelling explanatory the collateral or position that is being ‘‘near-term’’ is considered less than 30 facts and circumstances, would be days.236 financed by the repurchase or reverse considered proprietary trading.228 repurchase agreement is not excluded The Agencies received a number of 229 See ABA (Keating); BoA; CH/ABASA; JPMC. comments regarding the exclusion. See supra Part VI.A.1.b. (discussing the rebuttable 219 See Public Citizen. presumption under § 75.3(b)(2) of the final rule); see 220 Many commenters supported the See AFR et al. (Feb. 2012); Occupy. exclusion of liquidity management also supra Part VI.A.1.a. (discussing the market risk 221 See AFR et al. (Feb. 2012); Occupy. rule trading account under § 75.3(b)(1)(ii) of the 222 Congress recognized that repurchase activities from the definition of trading final rule). agreements and securities lending agreements are account as appropriate and necessary. 230 See CH/ABASA; Wells Fargo (Prop. Trading). loans or extensions of credit by including them in At the same time, some commenters 231 See CH/ABASA; JPMC; State Street (Feb. the legal lending limit. See Dodd–Frank Act section expressed the view that the exclusion 2012); Wells Fargo (Prop. Trading). See also BaFin/ 610 (amending 12 U.S.C. 84b). The Agencies believe Deutsche Bundesbank. the conditions of the final rule’s exclusions for was too narrow and should be replaced 232 See BoA; JPMC; RBC. repurchase agreements and securities lending with a broader exclusion permitting 233 agreements identify those activities that do not in See ABA (Keating); Allen & Overy (on behalf of Canadian Banks); JPMC; NAIB et al.; State Street normal practice represent proprietary trading and, 224 thus, the Agencies decline to provide additional See CFTC Proposal, 77 FR at 8348. (Feb. 2012); T. Rowe Price. requirements for these activities, as suggested by 225 See proposed rule § 75.3(b)(2)(iii)(C). 234 See ABA (Keating); CH/ABASA; JPMC. some commenters. See Public Citizen; AFR et al. 226 Id. 235 See ABA (Keating); BoA; CH/ABASA; JPMC. (Feb. 2012); Occupy. 227 See proposed rule § 75.3(b)(2)(iii)(C)(1)–(5). 236 See ABA (Keating); Allen & Overy (on behalf 223 See Goldman (Prop. Trading); JPMC; UBS. 228 See Joint Proposal, 76 FR at 68862. of Canadian Banks); BoA; CH/ABASA.

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Commenters also requested must be limited to securities (in keeping banking entity must incorporate into its clarification on a number of other issues with the liquidity management compliance program internal controls, regarding the exclusion. For example, requirements proposed by the Federal analysis and independent testing one commenter requested clarification banking agencies) and specifically designed to ensure that activities that purchases and sales of U.S. contemplate and authorize the undertaken for liquidity management registered mutual funds sponsored by a particular securities to be used for purposes are conducted in accordance banking entity would be permissible.237 liquidity management purposes; with the requirements of the final rule Another commenter requested describe the amount, types, and risks of and the entity’s liquidity management clarification that the deposits resulting securities that are consistent with the plan. Finally, the plan must be from providing custodial services that entity’s liquidity management; and the consistent with the supervisory are invested largely in high-quality liquidity circumstances in which the requirements, guidance and securities in conformance with the particular securities may or must be expectations regarding liquidity banking entity’s ALM policy would not used.245 Second, any purchase or sale of management of the Agency responsible be presumed to be ‘‘short-term trading’’ securities contemplated and authorized for regulating the banking entity. under the final rule.238 Commenters also by the plan must be principally for the The final rule retains the provision urged that the final rule not prohibit purpose of managing the liquidity of the that the financial instruments purchased interaffiliate transactions essential to the banking entity, and not for the purpose and sold as part of a liquidity ALM function.239 of short-term resale, benefitting from management plan be highly liquid and In contrast, other commenters actual or expected short-term price not reasonably expected to give rise to supported the liquidity management movements, realizing short-term appreciable profits or losses as a result exclusion criteria 240 and suggested arbitrage profits, or hedging a position of short-term price movements. This tightening these requirements. For taken for such short-term purposes. requirement is consistent with the example, one commenter recommended Third, the plan must require that any Agencies’ expectation for liquidity that the rule require that investments securities purchased or sold for management plans in the supervisory made under the liquidity management liquidity management purposes be context. It is not intended to prevent exclusion consist only of high-quality highly liquid and limited to instruments firms from recognizing profits (or losses) liquid assets.241 Other commenters the market, credit and other risks of on instruments purchased and sold for argued that the exclusion for liquidity which the banking entity does not liquidity management purposes. management should be eliminated.242 reasonably expect to give rise to Instead, this requirement is intended to One commenter argued that there was appreciable profits or losses as a result underscore that the purpose of these no need to provide a special exemption of short-term price movements.246 transactions must be liquidity for liquidity management or ALM Fourth, the plan must limit any management. Thus, the timing of activities given the exemptions for securities purchased or sold for purchases and sales, the types and trading in government obligations and liquidity management purposes to an duration of positions taken and the risk-mitigating hedging activities.243 amount that is consistent with the incentives provided to managers of After carefully reviewing the banking entity’s near-term funding these purchases and sales must all comments received, the Agencies have needs, including deviations from indicate that managing liquidity, and adopted the proposed exclusion for normal operations of the banking entity not taking short-term profits (or limiting liquidity management with several or any affiliate thereof, as estimated and short-term losses), is the purpose of important modifications. As limited documented pursuant to methods these activities. below, liquidity management activity specified in the plan.247 Fifth, the The exclusion as adopted does not serves the important prudential apply to activities undertaken with the purpose, recognized in other provisions 245 To ensure sufficient flexibility to respond to stated purpose or effect of hedging of the Dodd-Frank Act and in rules and liquidity needs arising from changing economic aggregate risks incurred by the banking times, a banking entity should envision and address entity or its affiliates related to asset- guidance of the Agencies, of ensuring a range of liquidity circumstances in its liquidity banking entities have sufficient liquidity management plan, and provide a mechanism for liability mismatches or other general to manage their short-term liquidity periodically reviewing and revising the liquidity market risks to which the entity or 244 management plan. affiliates may be exposed. Further, the needs. 246 The requirement to use highly liquid To ensure that this exclusion is not exclusion does not apply to any trading instruments is consistent with the focus of the activities that expose banking entities to misused for the purpose of proprietary clarifying exclusion on a banking entity’s near-term trading, the final rule imposes a number liquidity needs. Thus, the final rules do not include substantial risk from fluctuations in of requirements. First, the liquidity commenters’ suggested revisions to this market values, unrelated to the requirement. See Clearing House Ass’n.; see also management of near-term funding management plan of the banking entity Occupy; Sens. Merkley & Levin (Feb. 2012). The Agencies decline to identify particular types of needs, regardless of the stated purpose 248 237 See T. Rowe Price. securities that will be considered highly liquid for of the activities. 238 See State Street (Feb. 2012). purposes of the exclusion, as requested by some Overall, the Agencies do not believe commenters, in recognition that such a 239 See State Street (Feb. 2012); JPMC. See also that the final rule will stand as an determination will depend on the facts and Part VI.A.1.d.10. (discussing commenter requests to obstacle to or otherwise impair the circumstances. See T. Rowe Price; State Street (Feb. exclude inter-affiliate transactions). 2012). ability of banking entities to manage the 240 See AFR et al. (Feb. 2012); Occupy. 247 The Agencies plan to construe ‘‘near-term 241 See Occupy. funding needs’’ in a manner that is consistent with requirement. See, e.g., ABA (Keating); Allen & 242 See Sens. Merkley & Levin (Feb. 2012). the laws, regulations, and issuances related to Overy (on behalf of Canadian Banks); CH/ABASA; 243 See Sens. Merkley & Levin (Feb. 2012). liquidity risk management. See, e.g., Liquidity BoA; JPMC. 244 See section 165(b)(1)(A)(ii) of the Dodd-Frank Coverage Ratio: Liquidity Risk Measurement, 248 See, e.g., Staff of S. Comm. on Homeland Sec. Act; Enhanced Prudential Standards, 77 FR 644 at Standards, and Monitoring, 78 FR 71818 (Nov. 29, & Governmental Affairs Permanent Subcomm. on 645 (Jan. 5, 2012), available at http://www.gpo.gov/ 2013); Basel Committee on Bank Supervision, Basel Investigations, 113th Cong., Report: JPMorgan fdsys/pkg/FR-2012-01-05/pdf/2011-33364.pdf; see III: The Liquidity Coverage Ratio and Liquidity Risk Chase Whale Trades: A Case History of Derivatives also Enhanced Prudential Standards, 77 FR 76678 Management Tools (January 2013) available at Risks and Abuses (Apr. 11, 2013), available at at 76682 (Dec. 28, 2012), available at http:// http://www.bis.org/publ/bcbs238.htm. The http://www.hsgac.senate.gov/download/report- www.gpo.gov/fdsys/pkg/FR-2012-12-28/pdf/2012- Agencies believe this should help address jpmorgan-chase-whale-trades-a-case-history-of- 30734.pdf. commenters’ concerns about the proposed derivatives-risks-and-abuses-march-15-2013.

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risks of their businesses and operate in to non-U.S. central counterparties 253 In clearing organization or clearing agency, a safe and sound manner. Banking contrast, one commenter argued that the some commenters requested an entities engaging in bona fide liquidity exclusion for derivatives clearing additional exclusion from the definition management activities generally do not organizations and clearing agencies had of ‘‘trading account’’ for clearing-related purchase or sell financial instruments no statutory basis and should instead be activities of members of these for the purpose of short-term resale or a permitted activity under section entities.258 These commenters noted to benefit from actual or expected short- 13(d)(1)(J).254 that the proposed definition of ‘‘trading term price movements. The Agencies After considering the comments account’’ provides an exclusion for have determined, in contrast to certain received, the final rule retains the positions taken by registered derivatives commenters’ requests, not to expand exclusion for purchases and sales of clearing organizations and registered this liquidity management provision to financial instruments by a banking clearing agencie s259 and requested a broadly allow asset-liability entity that is a clearing agency or corresponding exclusion for certain management, earnings management, or derivatives clearing organization in clearing-related activities of banking scenario hedging.249 To the extent these connection with its clearing entities that are members of a clearing activities are for the purpose of profiting activities.255 In response to agency or members of a derivatives from short-term price movements or to comments,256 the Agencies have also clearing organization (collectively, hedge risks not related to short-term incorporated two changes to the rule. ‘‘clearing members’’).260 funding needs, they represent First, the final rule applies the exclusion Several commenters argued that proprietary trading subject to section 13 to the purchase and sale of financial certain aspects of the clearing process of the BHC Act and the final rule; the instruments by a banking entity that is may require a clearing member to activity would then be permissible only a clearing agency or derivatives clearing engage in principal transactions. For if it meets all of the requirements for an organization in connection with clearing example, some commenters argued that exemption, such as the risk-mitigating financial instrument transactions. a clearinghouse’s default management hedging exemption, the exemption for Second, in response to comments,257 the process may require clearing members trading in U.S. government securities, or exclusion in the final rule is not limited to take positions in financial another exemption. to clearing agencies or derivatives instruments upon default of another clearing organizations that are subject to clearing member.261 According to 3. Transactions of Derivatives Clearing commenters, default management Organizations and Clearing Agencies SEC or CFTC registration requirements and, instead, certain foreign clearing processes can involve: (i) Collection of A banking entity that is a central agencies and foreign derivatives clearing initial and variation margin from counterparty for clearing and settlement organizations will be permitted to rely customers under an ‘‘agency model’’ of activities engages in the purchase and on the exclusion if they are banking clearing; (ii) porting, where a defaulting sale of financial instruments as an entities. clearing member’s customer positions integral part of clearing and settling The Agencies believe that clearing and margin are transferred to another those instruments. The proposed and settlement activity is not designed non-defaulting clearing member; 262 (iii) definition of trading account excluded to create short-term trading profits. hedging, where the clearing house looks an account used to acquire or take one Moreover, excluding clearing and to clearing members and third parties to or more covered financial positions by settlement activities prevents the final enter into risk-reducing transactions and a derivatives clearing organization rule from inadvertently hindering the to flatten the market risk associated with registered under the Commodity Dodd–Frank Act’s goal of promoting the defaulting clearing member’s house Exchange Act or a clearing agency central clearing of financial positions and non-ported customer registered under the Securities transactions. The Agencies have positions; (iv) unwinding, where the Exchange Act of 1934 in connection narrowly tailored this exclusion by defaulting member’s open positions may with clearing derivatives or securities be allocated to other clearing members, 250 allowing only central counterparties to transactions. The preamble to the use it and only with respect to their affiliates, or third parties pursuant to a proposed rule noted that the purpose of clearing and settlement activity. mandatory auction process or forced these transactions is to provide a allocation; 263 and (v) imposing certain clearing service to third parties, not to 4. Excluded Clearing-Related Activities obligations on clearing members upon profit from short-term resale or short- of Clearinghouse Members exhaustion of a guaranty fund.264 251 term price movements. In addition to the exclusion for Commenters argued that, absent an Several commenters supported the trading activities of a derivatives exclusion from the definition of proposed exclusion for derivatives ‘‘trading account,’’ some of these clearing organizations and urged the 253 See IIB/EBF. clearing-related activities could be Agencies to expand the exclusion to 254 See Sens. Merkley & Levin (Feb. 2012). considered prohibited proprietary cover a banking entity’s clearing-related 255 ‘‘Clearing agency’’ is defined in the final rule trading under the proposal. Two activities, such as clearing a trade for a with reference to the definition of this term in the commenters specifically contended that customer, trading with a clearinghouse, Exchange Act. See final rule § 75.3(e)(2). ‘‘Derivatives clearing organization’’ is defined in the or accepting positions of a defaulting 258 final rule as (i) a derivatives clearing organization See SIFMA et al. (Prop. Trading) (Feb. 2012); Allen & Overy (Clearing); Goldman (Prop. Trading); member, on grounds that these activities registered under section 5b of the Commodity State Street (Feb. 2012). are not proprietary trades and reduce Exchange Act; (ii) a derivatives clearing 259 systemic risk.252 One commenter organization that, pursuant to CFTC regulation, is See proposed rule § 75.3(b)(2)(iii)(D). 260 See SIFMA et al. (Prop. Trading) (Feb. 2012); recommended expanding the exclusion exempt from the registration requirements under section 5b of the Commodity Exchange Act; or (iii) Allen & Overy (Clearing); Goldman (Prop. Trading); a foreign derivatives clearing organization that, State Street (Feb. 2012). 249 See, e.g., ABA (Keating); BoA; CH/ABASA; pursuant to CFTC regulation, is permitted to clear 261 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC. for a foreign board of trade that is registered with Allen & Overy (Clearing); State Street (Feb. 2012). 250 See proposed rule § 75.3(b)(2)(iii)(D). the CFTC. See also ISDA (Feb. 2012). 251 See Joint Proposal, 76 FR at 68863. 256 See IIB/EBF; BNY Mellon et al.; SIFMA et al. 262 See SIFMA et al. (Prop. Trading) (Feb. 2012); 252 See Allen & Overy (Clearing); Goldman (Prop. (Prop. Trading) (Feb. 2012); Allen & Overy Allen & Overy (Clearing). Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); (Clearing); Goldman (Prop. Trading). 263 See Allen & Overy (Clearing). State Street (Feb. 2012). 257 See IIB/EBF; Allen & Overy (Clearing). 264 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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the dealer prong of the definition of particular, central clearing reduces required by the rules or procedures of a ‘‘trading account’’ may cause certain of counterparty credit risk,271 which can clearing agency, derivatives clearing these activities to be considered lead to a host of other benefits, organization, or designated financial proprietary trading.265 Some including lower hedging costs, market utility that mitigates risk to such commenters suggested alternative increased market participation, greater agency, organization, or utility that avenues for permitting such clearing- liquidity, more efficient risk sharing that would result from the clearing by a related activity under the rules.266 promotes capital formation, and clearing member of security-based Commenters argued that such clearing- reduced operational risk.272 swaps that references the member or an related activities of banking entities Accordingly, in response to affiliate of the member.276 should not be subject to the rule because comments, the final rule provides that The Agencies are identifying specific they are risk-reducing, beneficial for the proprietary trading does not include activities in the rule to limit the financial system, required by law under specified excluded clearing activities by potential for evasion that may arise from certain circumstances (e.g., central a banking entity that is a member of a a more generalized approach. However, clearing requirements for swaps and clearing agency, a member of a the relevant supervisory Agencies will security-based swaps under Title VII of derivatives clearing organization, or a be prepared to provide further guidance the Dodd-Frank Act), and not used by member of a designated financial market or relief, if appropriate, to ensure that banking entities to engage in proprietary utility.273 ‘‘Excluded clearing activities’’ the terms of the exclusion do not limit trading.267 is defined in the rule to identify the ability of clearing agencies, Commenters further argued that particular core clearing-related derivatives clearing organizations, or certain activities undertaken as part of activities, many of which were raised by designated financial market utilities to a clearing house’s daily risk commenters.274 Specifically, the final effectively manage their risks in management process may be impacted rule will exclude the following activities accordance with their rules and by the rule, including unwinding self- by clearing members: (i) Any purchase procedures. In response to commenters referencing transactions through a or sale necessary to correct error trades requesting that the exclusion be mandatory auction (e.g., where a firm made by or on behalf of customers with available when a clearing member is acquired credit default swap (‘‘CDS’’) respect to customer transactions that are required by rules of a clearing agency, protection on itself as a result of a cleared, provided the purchase or sale is derivatives clearing organization, or merger with another firm) 268 and trade conducted in accordance with certain designated financial market utility to crossing, a mechanism employed by regulations, rules, or procedures; (ii) any purchase or sell a financial instrument certain clearing houses to ensure the purchase or sale related to the as part of establishing accurate prices to accuracy of the price discovery process management of a default or threatened be used by the clearing agency, in the course of, among other things, imminent default of a customer, subject derivatives clearing organization, or calculating settlement prices and margin designated financial market utility in its to certain conditions, another clearing 277 requirements.269 member, or the clearing agency, end of day settlement process, the The Agencies do not believe that derivatives clearing organization, or Agencies note that whether this is an certain core clearing-related activities designated financial market utility excluded clearing activity depends on conducted by a clearing member, often itself; 275 and (iii) any purchase or sale the facts and circumstances. Similarly, as required by regulation or the rules the availability of other exemptions to and procedures of a clearing agency, security-based swaps, and requires that banking the rule, such as the market-making derivatives clearing organization, or entities that are swap dealers, security-based swap exemption, depend on the facts and designated financial market utility, dealers, major swap participants or major security- circumstances. This exclusion applies based swap participants collect variation margin only to excluded clearing activities of represent proprietary trading as from many counterparties on a daily basis for their contemplated by the statute. For swap or security-based swap activity. See 7 U.S.C. clearing members. It does not permit a example, the clearing and settlement 2(h); 15 U.S.C. 78c–3; 7 U.S.C. 6s(e); 15 U.S.C. 78o– banking entity to engage in proprietary activities discussed above are not 10(e); Margin Requirements for Uncleared Swaps trading and claim protection for that for Swap Dealers and Major Swap Participants, 76 activity because trades are cleared or conducted for the purpose of profiting FR 23732 (Apr. 28, 2011). Additionally, the SEC’s from short-term price movements. The Rule 17Ad–22(d)(11) requires that each registered settled through a central counterparty. Agencies believe that these clearing- clearing agency establish, implement, maintain and 5. Satisfying an Existing Delivery related activities provide important enforce policies and procedures that set forth the clearing agency’s default management procedures. Obligation benefits to the financial system.270 In See 17 CFR 240.17Ad–22(d)(11). See also Exchange A few commenters requested Act Release No. 68,080 (Oct. 12, 2012), 77 FR 265 See SIFMA et al. (Prop. Trading) (Feb. 2012) 66220, 66,283 (Nov. 2, 2012). additional or expanded exclusions from (arguing that the SEC has suggested that entities 271 Centralized clearing affects counterparty risk the definition of ‘‘trading account’’ for that collect margins from customers for cleared in three basic ways. First, it redistributes covering short sales or failures to swaps may be required to be registered as broker- counterparty risk among members through deliver.278 These commenters alleged dealers); State Street (Feb. 2012). mutualization of losses, reducing the likelihood of that a banking entity engages in this 266 See Goldman (Prop. Trading); SIFMA et al. sequential counterparty failure and contagion. (Prop. Trading) (Feb. 2012); ISDA (Feb. 2012). Second, margin requirements and monitoring activity for purposes other than to 267 See SIFMA et al. (Prop. Trading) (Feb. 2012); reduce moral hazard, reducing counterparty risk. Goldman (Prop. Trading); State Street (Feb. 2012); Finally, clearing may reallocate counterparty risk (Prop. Trading) (Feb. 2012); Allen & Overy Allen & Overy (Clearing). outside of the clearing agency because netting may (Clearing); State Street (Feb. 2012). See also ISDA 268 See Allen & Overy (Clearing). implicitly subordinate outside creditors’ claims (Feb. 2012). 269 See Allen & Overy (Clearing); SIFMA et al. relative to other clearing member claims. 276 See Allen & Overy (Clearing) (discussing rules (Prop. Trading) (Feb. 2012). These commenters 272 See Proposed Rule, Cross-Border Security- that require unwinding self-referencing transactions stated that, in order to ensure that a clearing Based Swap Activities, Exchange Act Release No. through a mandatory auction (e.g., where a firm member is providing accurate end-of-day prices for 69490 (May 1, 2013), 78 FR 30968, 31,162–31,163 acquired CDS protection on itself as a result of a its open positions, a clearing house may require the (May 23, 2013). merger with another firm)). member to provide firm bids for such positions, 273 See final rule § 75.3(d)(5). 277 See Allen & Overy (Clearing); SIFMA et al. which may be tested through a ‘‘forced trade’’ with 274 See final rule § 75.3(e)(7). (Prop. Trading) (Feb. 2012); see also ISDA (Feb. another member. See id.; see also ISDA (Feb. 2012). 275 A number of commenters discussed the 2012). 270 For example, Title VII of the Dodd-Frank Act default management process and requested an 278 See SIFMA et al. (Prop. Trading) (Feb. 2012); mandates the central clearing of swaps and exclusion for such activities. See SIFMA et al. Goldman (Prop. Trading).

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benefit from short term price the broker-dealer’s existing delivery affiliates should be explicitly excluded movements and that it is not proprietary obligations. from the definition of proprietary trading in the same manner as acting as trading as defined in the statute. In 6. Satisfying an Obligation in response to these comments, the final agent, broker, or custodian for Connection With a Judicial, 286 rule provides that a purchase or sale by Administrative, Self-Regulatory unaffiliated third parties. Like the proposal, the final rule a banking entity that satisfies an existing Organization, or Arbitration Proceeding delivery obligation of the banking entity expressly provides that the purchase or or its customers, including to prevent or The Agencies recognize that, under sale of one or more financial close out a failure to deliver, in certain circumstances, a banking entity instruments by a banking entity acting connection with delivery, clearing, or may be required to purchase or sell a solely as agent, broker, or custodian is financial instrument at the direction of settlement activity is not proprietary not proprietary trading because acting in a judicial or regulatory body. For trading. these types of capacities does not example, an administrative agency or involve trading as principal, which is Among other things, this exclusion self-regulatory organization (‘‘SRO’’) one of the requisite aspects of the will allow a banking entity that is an may require a banking entity to statutory definition of proprietary SEC-registered broker-dealer to take purchase or sell a financial instrument trading.287 The final rule has been action to address failures to deliver in the course of disciplinary modified to include acting solely as arising from its own trading activity or proceedings against that banking agent, broker, or custodian on behalf of the trading activity of its customers.279 entity.283 A banking entity may also be an affiliate. However, the affiliate must In certain circumstances, SEC-registered obligated to purchase or sell a financial comply with section 13 of the BHC Act broker-dealers are required to take such instrument in connection with a judicial and the final implementing rule; and action under SEC rules.280 In addition, or arbitration proceeding.284 Such may not itself engage in prohibited buy-in procedures of a clearing agency, transactions do not represent trading for proprietary trading. To the extent a securities exchange, or national short-term profit or gain and do not banking entity acts in both a principal securities association may require a constitute proprietary trading under the and agency capacity for a purchase or banking entity to deliver securities if a statute. sale, it may only use this exclusion for party with a fail to receive position Accordingly, the Agencies have the portion of the purchase or sale for takes certain action.281 When a banking determined to adopt a provision which it is acting as agent. The banking entity purchases securities to meet an clarifying that a purchase or sale of one entity must use a separate exemption or existing delivery obligation, it is or more financial instruments that exclusion, if applicable, to the extent it engaging in activity that facilitates satisfies an obligation of the banking is acting in a principal capacity. timely settlement of securities entity in connection with a judicial, 8. Purchases or Sales Through a transactions and helps provide a administrative, self-regulatory Deferred Compensation or Similar Plan purchaser of the securities with the organization, or arbitration proceeding benefits of ownership (e.g., voting and is not proprietary trading for purposes While the proposed rule provided that lending rights). In addition, a banking of these rules. This clarification will the prohibition on covered fund entity has limited discretion to avoid the potential for conflicting or activities and investments did not apply determine when and how to take action inconsistent legal requirements for to certain instances where the banking to meet an existing delivery banking entities. entity acted through or on behalf of a obligation.282 Providing a limited 7. Acting Solely as Agent, Broker, or pension or similar deferred exclusion for this activity will avoid the Custodian compensation plan, no such similar potential for SEC-registered broker- treatment was given for proprietary The proposal clarified that proprietary dealers being subject to conflicting or trading. One commenter argued that the trading did not include acting solely as inconsistent regulatory requirements proposal restricted a banking entity’s agent, broker, or custodian for an with respect to activity required to meet ability to engage in principal-based unaffiliated third party.285 Commenters trading as an asset manager that serves generally supported this aspect of the the needs of the institutional investors, 279 In order to qualify for this exclusion, a proposal. One commenter suggested that banking entity’s principal trading activity that such as through ERISA pension and results in its own failure to deliver must have been acting as agent, broker, or custodian for 401(k) plans.288 conducted in compliance with these rules. To address these concerns, the final 280 See, e.g., 17 CFR 242.204 (requiring, among 283 For example, an administrative agency or SRO rule provides that proprietary trading other things, that a participant of a registered may require a broker-dealer to offer to buy clearing agency or, upon reasonable allocation, a securities back from customers where the agency or does not include the purchase or sale of broker-dealer for which the participant clears trades SRO finds the broker-dealer fraudulently sold one or more financial instruments or from which the participant receives trades for securities to those customers. See, e.g., In re through a deferred compensation, stock- settlement, take action to close out a fail to deliver Raymond James & Assocs., Exchange Act Release bonus, profit-sharing, or pension plan of position in any equity security by borrowing or No. 64767, 101 S.E.C. Docket 1749 (June 29, 2011); purchasing securities of like kind and quantity); 17 FINRA Dep’t of Enforcement v. Pinnacle Partners the banking entity that is established CFR 240.15c3–3(m) (providing that, if a broker- Fin. Corp., Disciplinary Proceeding No. dealer executes a sell order of a customer and does 2010021324501 (Apr. 25, 2012); FINRA Dep’t of 286 See Japanese Bankers Ass’n. not obtain possession of the securities from the Enforcement v. Fifth Third Sec., Inc., No. 287 See 12 U.S.C. 1851(h)(4). A common or customer within 10 business days after settlement, 2005002244101 (Press Rel. Apr. 14, 2009). collective investment fund that is an investment the broker-dealer must immediately close the 284 For instance, section 29 of the Exchange Act company under section 3(c)(3) or 3(c)(11) will not transaction with the customer by purchasing may require a broker-dealer to rescind a contract be deemed to be acting as principal within the securities of like kind and quantity). with a customer that was made in violation of the meaning of § 75.3(a) because the fund is performing 281 See, e.g., NSCC Rule 11, NASDAQ Rule 11810, Exchange Act. Such rescission relief may involve a traditional trust activity and purchases and sells FINRA Rule 11810. the broker-dealer’s repurchase of a financial financial instruments solely on behalf of customers 282 See, e.g., 17 CFR 242.204 (requiring action to instrument from a customer. See 15 U.S.C. 78cc; as trustee or in a similar fiduciary capacity, as close out a fail to deliver position in an equity Reg’l Props., Inc. v. Fin. & Real Estate Consulting evidenced by its regulation under 12 CFR part 9 security within certain specified timeframes); 17 Co., 678 F.2d 552 (5th Cir. 1982); Freeman v. (Fiduciary Activities of National Banks) or similar CFR 240.15c3–3(m) (requiring a broker-dealer to Marine Midland Bank N.Y., 419 F.Supp. 440 state laws. ‘‘immediately’’ close a transaction under certain (E.D.N.Y. 1976). 288 See Ass’n. of Institutional Investors (Nov. circumstances). 285 See proposed rule § 75.3(b)(1). 2012).

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and administered in accordance with provided that the banking entity divests various modifications to the final rule, the laws of the United States or a foreign the financial instrument as soon as including in particular to the exemption sovereign, if the purchase or sale is practicable within the time period for market-making related activities, made directly or indirectly by the permitted or required by the appropriate address many of commenters’ concerns banking entity as trustee for the benefit financial supervisory agency.290 regarding unintended consequences of of the employees of the banking entity As a result of this exclusion, banking the prohibition on proprietary trading. or members of their immediate family. entities, including SEC-registered 2. Section 75.4(a): Underwriting Banking entities often establish and act broker-dealers, will be able to continue Exemption as trustee to pension or similar deferred providing margin loans to their compensation plans for their employees customers and may take possession of a. Introduction and, as part of managing these plans, margined collateral following a After carefully considering comments may engage in trading activity. The customer’s default or failure to meet a on the proposed underwriting Agencies believe that purchases or sales margin call under applicable regulatory exemption, the Agencies are adopting 291 by a banking entity when acting through requirements. Similarly, a banking the proposed underwriting exemption pension and similar deferred entity that is a CFTC-registered swap substantially as proposed, but with compensation plans generally occur on dealer or SEC-registered security-based certain refinements and clarifications to behalf of beneficiaries of the plan and swap dealer may take, hold, and the proposed approach to better reflect consequently do not constitute the type exchange any margin collateral as the range of securities offerings that an of principal trading that is covered by counterparty to a cleared or uncleared underwriter may help facilitate on the statute. swap or security-based swap behalf of an issuer or selling security The Agencies note that if a banking transaction, in accordance with the 292 holder and the types of activities an entity engages in trading activity for an rules of the Agencies. This exclusion underwriter may undertake in unaffiliated pension or similar deferred will allow banking entities to comply connection with a distribution of compensation plan, the trading activity with existing regulatory requirements securities to facilitate the distribution regarding the divestiture of collateral of the banking entity would not be process and provide important benefits taken in satisfaction of a debt. proprietary trading under the final rule to issuers, selling security holders, or to the extent the banking entity was 10. Other Requested Exclusions purchasers in the distribution. The acting solely as agent, broker, or Agencies are adopting such an approach custodian. Commenters requested a number of additional exclusions from the trading because the statute specifically permits 9. Collecting a Debt Previously account and, in turn, the prohibition on banking entities to continue providing Contracted proprietary trading. In order to avoid these beneficial services to clients, Several commenters argued that the potential evasion of the final rule, the customers, and counterparties. At the final rule should exclude collecting and Agencies decline to adopt any same time, to reduce the potential for disposing of collateral in satisfaction of exclusions from the trading account evasion of the general prohibition on debts previously contracted from the other than the exclusions described proprietary trading, the Agencies are definition of proprietary trading.289 above.293 The Agencies believe that requiring, among other things, that the Commenters argued that acquiring and trading desk make reasonable efforts to disposing of collateral in satisfaction of 290 See final rule § 75.3(d)(9). sell or otherwise reduce its 291 debt previously contracted does not For example, if any margin call is not met in underwriting position (accounting for full within the time required by Regulation T, then the liquidity, maturity, and depth of the involve trading with the intent of Regulation T requires a broker-dealer to liquidate profiting from short-term price securities sufficient to meet the margin call or to market for the relevant type of security) movements and, thus, should not be eliminate any margin deficiency existing on the day and be subject to a robust risk limit such liquidation is required, whichever is less. See proprietary trading for purposes of this structure that is designed to prevent a 12 CFR 220.4(d). trading desk from having an rule. Rather, this activity is a prudent 292 See SEC Proposed Rule, Capital, Margin, and desirable part of lending and debt Segregation, Reporting and Recordkeeping underwriting position that exceeds the collection activities. Requirements for Security-Based Swap Dealers, reasonably expected near term demands Exchange Act Release No. 68071, 77 FR 70214 (Nov. of clients, customers, or counterparties. The Agencies believe that the 23, 2012); CFTC Proposed Rule, Margin purchase and sale of a financial Requirements for Uncleared Swaps for Swap b. Overview instrument in satisfaction of a debt Dealers and Major Swap Participants, 76 FR 23732 previously contracted does not (Apr. 28, 2011); Banking Agencies’ Proposed Rule, 1. Proposed Underwriting Exemption Margin and Capital Requirements for Covered Swap constitute proprietary trading. The Entities, 76 FR 27564 (May 11, 2011). Section 13(d)(1)(B) of the BHC Act Agencies believe an exclusion for 293 See, e.g., SIFMA et al. (Prop. Trading) (Feb. provides an exemption from the purchases and sales in satisfaction of 2012) (transactions that are not based on expected prohibition on proprietary trading for debts previously contracted is necessary or anticipated movements in asset prices, such as the purchase, sale, acquisition, or fully collateralized swap transactions that serve for banking entities to continue to lend funding purposes); Norinchukin and Wells Fargo disposition of securities and certain to customers, because it allows banking (Prop. Trading) (derivatives that qualify for hedge other instruments in connection with entities to continue lending activity accounting); GE (Feb. 2012) (transactions related to underwriting activities, to the extent commercial contracts); Citigroup (Feb. 2012) (FX that such activities are designed not to with the knowledge that they will not be swaps and FX forwards); SIFMA et al. (Prop. penalized for recouping losses should a Trading) (Feb. 2012) (interaffiliate transactions); T. exceed the reasonably expected near customer default. Accordingly, the final Rowe Price (purchase and sale of shares in term demands of clients, customers, or rule provides that proprietary trading sponsored mutual funds); RMA (cash collateral counterparties.294 pools); Alfred Brock (arbitrage trading); ICBA Section 75.4(a) of the proposed rule does not include the purchase or sale of (securities traded pursuant to 12 U.S.C. 1831a(f)). one or more financial instruments in the The Agencies are concerned that these exclusions would have implemented this ordinary course of collecting a debt could be used to conduct impermissible proprietary exemption by requiring that a banking trading, and the Agencies believe some of these entity’s underwriting activities comply previously contracted in good faith, exclusions are more appropriately addressed by other provisions of the rule. For example, with seven requirements. As discussed 289 See LSTA (Feb. 2012); JPMC; Goldman (Prop. derivatives qualifying for hedge accounting may be Trading); SIFMA et al. (Prop. Trading) (Feb. 2012). permitted under the hedging exemption. 294 12 U.S.C. 1851(d)(1)(B).

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in more detail below, the proposed specifically, commenters recommended raising activities facilitated by banking underwriting exemption required that: that the Agencies: (i) Provide a safe entities acting as underwriters on behalf (i) A banking entity establish a harbor for low risk, standard of issuers and selling security holders. compliance program under § 75.20; (ii) underwritings; 300 (ii) better incorporate The final underwriting exemption the covered financial position be a the statutory limitations on high-risk includes the following components: security; (iii) the purchase or sale be activity or conflicts of interest; 301 (iii) • A framework that recognizes the effected solely in connection with a prohibit banking entities from differences in underwriting activities distribution of securities for which the underwriting illiquid securities; 302 (iv) across markets and asset classes by banking entity is acting as underwriter; prohibit banking entities from establishing criteria that will be applied (iv) the banking entity meet certain participating in private placements; 303 flexibly based on the liquidity, maturity, dealer registration requirements, where (v) place greater emphasis on adequate and depth of the market for the applicable; (v) the underwriting internal compliance and risk particular type of security. activities be designed not to exceed the management procedures; 304 or (vi) • A general focus on the reasonably expected near term demands make the exemption as broad as ‘‘underwriting position’’ held by a of clients, customers, or counterparties; possible.305 banking entity or its affiliate, and (vi) the underwriting activities be managed by a particular trading desk, in designed to generate revenues primarily connection with the distribution of from fees, commissions, underwriting 3. Final Underwriting Exemption securities for which such banking entity spreads, or other income not attributable After considering the comments or affiliate is acting as an to appreciation in the value of covered received, the Agencies are adopting the underwriter.306 financial positions or to hedging of underwriting exemption substantially as • A definition of the term ‘‘trading covered financial positions; and (vii) the proposed, but with important desk’’ that focuses on the functionality compensation arrangements of persons modifications to clarify provisions or to of the desk rather than its legal status, performing underwriting activities be address commenters’ concerns. As and requirements that apply at the designed not to reward proprietary risk- discussed above, some commenters trading desk level of organization within taking.295 The proposal explained that were generally supportive of the a banking entity or across two or more these seven criteria were proposed so proposed approach to implementing the affiliates.307 that any banking entity relying on the underwriting exemption, but noted • Five standards for determining underwriting exemption would be certain areas of concern or uncertainty. whether a banking entity is engaged in engaged in bona fide underwriting The underwriting exemption the permitted underwriting activities. Many activities and would conduct those Agencies are adopting addresses these of these criteria have similarities to activities in a way that would not be issues by further clarifying the scope of those included in the proposed rule, but susceptible to abuse through the taking activities that qualify for the exemption. with important modifications in of speculative, proprietary positions as In particular, the Agencies are refining response to comments. These standards part of, or mischaracterized as, the proposed exemption to better require that: 296 underwriting activity. capture the broad range of capital- Æ The banking entity act as an 2. Comments on Proposed Underwriting ‘‘underwriter’’ for a ‘‘distribution’’ of Exemption 300 See Sens. Merkley & Levin (Feb. 2012) securities and the trading desk’s (suggesting a safe harbor for underwriting efforts underwriting position be related to such As a general matter, a few that meet certain low-risk criteria, including that: commenters expressed overall support The underwriting be in plain vanilla stock or bond distribution. The final rule includes for the proposed underwriting offerings, including commercial paper, for refined definitions of ‘‘distribution’’ and established business and governments; and the ‘‘underwriter’’ to better capture the exemption.297 Some commenters distribution be completed within relevant time indicated that the proposed exemption periods, as determined by asset classes, with broad scope of securities offerings used is too narrow and may negatively relevant factors being the size of the issuer and the by issuers and selling security holders market served); Johnson & Prof. Stiglitz (expressing impact capital markets.298 As discussed and the range of roles that a banking support for a narrow safe harbor for underwriting entity may play as intermediary in such in more detail below, many commenters of basic stocks and bonds that raise capital for real 308 expressed views on the effectiveness of economy firms). offerings. 301 Æ specific requirements of the proposed See Sens. Merkley & Levin (Feb. 2012) The amount and types of securities (suggesting that, for example, the exemption plainly exemption. Further, some commenters in the trading desk’s underwriting prevent high-risk, conflict ridden underwritings of position be designed not to exceed the requested clarification or expansion of securitizations and structured products and cross- the proposed exemption for certain reference Section 621 of the Dodd-Frank Act, which reasonably expected near term demands activities that may be conducted in the prohibits certain material conflicts of interest in of clients, customers, or counterparties, connection with asset-backed securities). course of underwriting. and reasonable efforts be made to sell or 302 See AFR et al. (Feb. 2012) (recommending that otherwise reduce the underwriting Several commenters suggested the Agencies prohibit banking entities from acting alternative approaches to implementing as underwriter for assets classified as Level 3 under position within a reasonable period, the statutory exemption for FAS 157, which would prohibit underwriting of taking into account the liquidity, underwriting activities.299 More illiquid and opaque securities without a genuine maturity, and depth of the market for external market, and representing that such a the relevant type of security.309 restriction would be consistent with the statutory 295 See proposed rule § 75.4(a). limitation on exposures to high-risk assets). 296 See Joint Proposal, 76 FR at 68866; CFTC 303 See Occupy. 306 See infra Part VI.A.2.c.1.c. Proposal, 77 FR at 8352. 304 See BoA (recommending that the Agencies 307 See infra Part VI.A.2.c.1.c. The term ‘‘trading 297 See Barclays (stating that the proposed establish a strong presumption that all of a banking desk’’ is defined in final rule § 75.3(e)(13) as ‘‘the exemption generally effectuates the aims of the entity’s activities related to underwriting are smallest discrete unit of organization of a banking statute while largely avoiding undue interference, permitted under the rules as long as the banking entity that purchases or sells financial instruments although the commenter also requested certain entity has adequate compliance and risk for the trading account of the banking entity or an technical changes to the rule text); Alfred Brock. management procedures). affiliate thereof.’’ 298 See, e.g., Lord Abbett; BoA; Fidelity; Chamber 305 See Fidelity (suggested that the rules be 308 See final rule §§ 75.4(a)(2)(i), 75.4(a)(3), (Feb. 2012). revised to ‘‘provide the broadest exemptions 75.4(a)(4); see also infra Part VI.A.2.c.1.c. 299 See Sens. Merkley & Levin (Feb. 2012); BoA; possible under the statute’’ for underwriting and 309 See final rule § 75.4(a)(2)(ii); see also infra Part Fidelity; Occupy; AFR et al. (Feb. 2012). certain other permitted activities). VI.A.2.c.2.c.

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Æ The banking entity establish, The Agencies do not believe that a safe increase the potential for evasion of the implement, maintain, and enforce an harbor is necessary to provide certainty general prohibition on proprietary internal compliance program that is that a banking entity may act as an trading. Similarly, the Agencies are not reasonably designed to ensure the underwriter in these particular types of adopting an exemption that is banking entity’s compliance with the offerings. This is because ‘‘plain unlimited, as requested by one requirements of the underwriting vanilla’’ or ‘‘basic’’ underwriting commenter, because the Agencies exemption, including reasonably activity should be able to meet the believe controls are necessary to prevent designed written policies and requirements of the final rule. For potential evasion of the statute through, procedures, internal controls, analysis, example, the final definition of among other things, retaining an unsold and independent testing identifying and ‘‘distribution’’ includes any offering of allotment when there is sufficient addressing: securities made pursuant to an effective customer interest for the securities and D The products, instruments, or registration statement under the to limit the risks associated with these exposures each trading desk may Securities Act.314 activities.319 purchase, sell, or manage as part of its Further, in response to one Underwriters play an important role underwriting activities; commenter’s request that the final rule in facilitating issuers’ access to funding, D Limits for each trading desk, based prohibit a banking entity from acting as and thus underwriters are important to on the nature and amount of the trading an underwriter in illiquid assets that are the capital formation process and desk’s underwriting activities, including determined to not have observable price economic growth.320 Obtaining new the reasonably expected near term inputs under accounting standards,315 financing can be expensive for an issuer demands of clients, customers, or the Agencies continue to believe that it because of the natural information counterparties, on the amount, types, would be inappropriate to incorporate advantage that less well-known issuers and risk of the trading desk’s accounting standards in the rule have over investors about the quality of underwriting position, level of because accounting standards could their future investment opportunities. exposures to relevant risk factors arising change in the future without An underwriter can help reduce these from the trading desk’s underwriting consideration of the potential impact on costs by mitigating the information position, and period of time a security the final rule.316 Moreover, the Agencies asymmetry between an issuer and its may be held; do not believe it is necessary to potential investors. The underwriter D Internal controls and ongoing differentiate between liquid and less does this based in part on its familiarity monitoring and analysis of each trading liquid securities for purposes of with the issuer and other similar issuers desk’s compliance with its limits; and determining whether a banking entity as well as by collecting information D Authorization procedures, may underwrite a distribution of about the issuer. This allows investors including escalation procedures that securities because, in either case, a to look to the reputation and experience require review and approval of any banking entity must have a reasonable of the underwriter as well as its ability trade that would exceed a trading desk’s expectation of purchaser demand for the to provide information about the issuer limit(s), demonstrable analysis of the securities and must make reasonable and the underwriting. For these and basis for any temporary or permanent efforts to sell or otherwise reduce its other reasons, most U.S. issuers rely on increase to a trading desk’s limit(s), and underwriting position within a the services of an underwriter when independent review of such reasonable period under the final raising funds through public offerings. demonstrable analysis and approval.310 rule.317 As recognized in the statute, the Æ The compensation arrangements of Another commenter suggested that exemption is intended to permit persons performing the banking entity’s the Agencies establish a strong banking entities to continue to perform underwriting activities are designed not presumption that all of a banking the underwriting function, which to reward or incentivize prohibited entity’s activities related to contributes to capital formation and its 311 proprietary trading. underwriting are permitted under the positive economic effects. Æ The banking entity is licensed or rule as long as the banking entity has registered to engage in the activity adequate compliance and risk c. Detailed Explanation of the described in the underwriting management procedures.318 While Underwriting Exemption exemption in accordance with strong compliance and risk management 1. Acting as an Underwriter for a applicable law.312 procedures are important for banking Distribution of Securities After considering commenters’ entities’ permitted activities, the a. Proposed Requirements That the suggested alternative approaches to Agencies believe that an approach implementing the statute’s underwriting Purchase or Sale Be Effected Solely in focused solely on the establishment of a Connection With a Distribution of exemption, the Agencies have compliance program would likely determined to retain the general Securities for Which the Banking Entity Acts as an Underwriter and That the structure of the proposed underwriting interest and high-risk activities in the underwriting exemption. For instance, two exemption by including additional provisions in Covered Financial Position Be a commenters suggested providing a safe the exemption to refer to these limitations. See Security Sens. Merkley & Levin (Feb. 2012). The Agencies harbor for ‘‘plain vanilla’’ or ‘‘basic’’ note that these limitations are adopted in § 75.7 of Section 75.4(a)(2)(iii) of the proposed underwritings of stocks and bonds.313 the final rules, and this provision will apply to rule required that the purchase or sale underwriting activities, as well as all other be effected solely in connection with a 310 exempted activities. See final rule § 75.4(a)(2)(iii); see also infra distribution of securities for which a Part VI.A.2.c.3.c. 314 See final rule § 75.4(a)(3). 311 See final rule § 75.4(a)(2)(iv); see also infra 315 See AFR et al. (Feb. 2012). banking entity is acting as Part VI.A.2.c.4.c. 316 See Joint Proposal, 76 FR at 68859 n.101 312 See final rule § 75.4(a)(2)(v); see also infra Part (explaining why the Agencies declined to 319 See Fidelity. VI.A.2.c.5.c. incorporate certain accounting standards in the 320 See, e.g., BoA (‘‘The underwriting activities of 313 See Sens. Merkley & Levin (Feb. 2012); proposed rule); CFTC Proposal, 77 FR at 8344 U.S. banking entities are essential to capital Johnson & Prof. Stiglitz. One of these commenters n.107. formation and, therefore, economic growth and job also suggested that the Agencies better incorporate 317 See infra Part VI.A.2.c.2.c. creation.’’); Goldman (Prop. Trading); Sens. Merkley the statutory limitations on material conflicts of 318 See BoA. & Levin (Feb. 2012).

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underwriter.321 As discussed below, the a distribution of securities for or on a covered financial position that is a Agencies proposed to define the terms behalf of such issuer or selling security security only in connection with its ‘‘distribution’’ and ‘‘underwriter’’ in the holder; or (c) manage a distribution of underwriting activities.331 The proposal proposed rule. The proposed rule also securities for or on behalf of such issuer stated that this requirement was meant required that the covered financial or selling security holder; and (ii) a to reflect the common usage and position being purchased or sold by the person who has an agreement with understanding of the term banking entity be a security.322 another person described in the ‘‘underwriting.’’ 332 It was noted, i. Proposed Definition of ‘‘Distribution’’ preceding provisions to engage in a however, that a derivative or commodity distribution of such securities for or on future transaction may be otherwise The proposed definition of behalf of the issuer or selling security permitted under another exemption ‘‘distribution’’ mirrored the definition of holder.328 (e.g., the exemptions for market making- this term used in the SEC’s Regulation In connection with this proposed related or risk-mitigating hedging M under the Exchange Act.323 More requirement, the Agencies noted that activities).333 specifically, the proposed rule defined the precise activities performed by an ‘‘distribution’’ as ‘‘an offering of underwriter may vary depending on the b. Comments on the Proposed securities, whether or not subject to liquidity of the securities being Requirements That the Trade Be registration under the Securities Act, underwritten and the type of Effected Solely in Connection With a that is distinguished from ordinary distribution being conducted. To Distribution for Which the Banking trading transactions by the magnitude of determine whether a banking entity is Entity Is Acting as an Underwriter and the offering and the presence of special acting as an underwriter as part of a That the Covered Financial Position Be selling efforts and selling methods.’’ 324 distribution of securities, the Agencies a Security The Agencies did not propose to define proposed to take into consideration the In response to the proposed the terms ‘‘magnitude’’ and ‘‘special extent to which a banking entity is requirement that a purchase or sale be selling efforts and selling methods,’’ but engaged in the following activities: ‘‘effected solely in connection with a stated that the Agencies would expect to • Assisting an issuer in capital- distribution of securities’’ for which the rely on the same factors considered in raising; ‘‘banking entity is acting as Regulation M for assessing these • Performing due diligence; underwriter,’’ commenters generally 325 • elements. The Agencies noted that Advising the issuer on market focused on the proposed definitions of ‘‘magnitude’’ does not imply that a conditions and assisting in the ‘‘distribution’’ and ‘‘underwriter’’ and distribution must be large and, preparation of a registration statement the types of activities that should be therefore, this factor would not preclude or other offering document; • permitted under the ‘‘in connection small offerings or private placements Purchasing securities from an with’’ standard. Commenters did not from qualifying for the proposed issuer, a selling security holder, or an 326 directly address the requirement in underwriting exemption. underwriter for resale to the public; § 75.4(a)(2)(ii) of the proposed rule, • Participating in or organizing a ii. Proposed Definition of ‘‘Underwriter’’ which provided that the covered syndicate of investment banks; financial position purchased or sold Like the proposed definition of • Marketing securities; and ‘‘distribution,’’ the Agencies proposed • Transacting to provide a post- under the exemption must be a security. to define ‘‘underwriter’’ in a manner issuance secondary market and to A number of commenters expressed similar to the definition of this term in facilitate price discovery.329 general concern that the proposed underwriting exemption’s references to the SEC’s Regulation M.327 The The proposal recognized that there may definition of ‘‘underwriter’’ in the a ‘‘purchase or sale of a covered be circumstances in which an financial position’’ could be interpreted proposed rule was: (i) Any person who underwriter would hold securities that has agreed with an issuer or selling to require compliance with the it could not sell in the distribution for proposed rule on a transaction-by- security holder to: (a) Purchase investment purposes. The Agencies securities for distribution; (b) engage in transaction basis. These commenters stated that if the unsold securities were indicated that such an approach would acquired in connection with 334 321 be overly burdensome. See proposed rule § 75.4(a)(2)(iii). underwriting under the proposed 322 See proposed rule § 75.4(a)(2)(ii). exemption, then the underwriter would i. Definition of ‘‘Distribution’’ 323 See Joint Proposal, 76 FR at 68866–68867; CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; be able to dispose of such securities at Several commenters stated that the 330 proposed rule § 75.4(a)(3). a later time. proposed definition of ‘‘distribution’’ is 324 See proposed rule § 75.4(a)(3). too narrow,335 while one commenter 325 See Joint Proposal, 76 FR at 68867 (‘‘For iii. Proposed Requirement That the example, the number of shares to be sold, the Covered Financial Position Be a stated that the proposed definition is too percentage of the outstanding shares, public float, Security broad.336 Commenters who viewed the and trading volume that those shares represent are Pursuant to § 75.4(a)(2)(ii) of the proposed definition as too narrow stated all relevant to an assessment of magnitude. In that it may exclude important capital- addition, delivering a sales document, such as a proposed exemption, a banking entity prospectus, and conducting road shows are would be permitted to purchase or sell raising and financing transactions that generally indicative of special selling efforts and do not appear to involve ‘‘special selling selling methods. Another indicator of special selling efforts and selling methods is compensation 328 See proposed rule § 75.4(a)(4). As noted in the 331 See proposed rule § 75.4(a)(2)(ii). that is greater than that for secondary trades but proposal, the proposed rule’s definition differed 332 consistent with underwriting compensation for an from the definition in Regulation M because the See Joint Proposal, 76 FR at 68866; CFTC offering.’’); CFTC Proposal, 77 FR at 8352; Review proposed rule’s definition would also include a Proposal, 77 FR at 8352. of Antimanipulation Regulation of Securities person who has an agreement with another 333 See Joint Proposal, 76 FR at 68866 n.132; Offering, Exchange Act Release No. 33924 (Apr. 19, underwriter to engage in a distribution of securities CFTC Proposal, 77 FR at 8352 n.138. 1994), 59 FR 21681, 21684–21685 (Apr. 26, 1994). for or on behalf of an issuer or selling security 334 See, e.g., Goldman (Prop. Trading); SIFMA et 326 See Joint Proposal, 76 FR at 68867; CFTC holder. See Joint Proposal, 76 FR at 68867; CFTC al. (Prop. Trading) (Feb. 2012). Proposal, 77 FR at 8352. Proposal, 77 FR at 8352. 335 See SIFMA et al. (Prop. Trading) (Feb. 2012); 327 See Joint Proposal, 76 FR at 68866–68867; 329 See Joint Proposal, 76 FR at 68867; CFTC Goldman (Prop. Trading); Wells Fargo (Prop. CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; Proposal, 77 FR at 8352. Trading); RBC. proposed rule § 75.4(a)(4). 330 See id. 336 See Occupy.

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efforts and selling methods’’ or that the rule explicitly authorize certain Agencies should instead use the ‘‘magnitude.’’337 In particular, these forms of offerings, such as offerings Regulation M definition of ‘‘distribution commenters stated that the proposed under Rule 144A, Regulation S, Rule participant’’ or otherwise revise the definition of ‘‘distribution’’ may 101(b)(10) of Regulation M, or the so- definition of ‘‘underwriter’’ to preclude a banking entity from called ‘‘section 4(11⁄2)’’ of the Securities incorporate the concept of a participating in commercial paper Act, as well as transactions on behalf of ‘‘distribution participant,’’ as defined issuances,338 bridge loans,339 ‘‘at-the- selling security holders.348 Two under Regulation M.354 According to market’’ offerings or ‘‘dribble out’’ commenters proposed approaches that these commenters, using the term programs conducted off issuer shelf would include the resale of notes or ‘‘distribution participant’’ would better registrations,340 offerings in response to other debt securities received by a reflect current market practice and reverse inquiries,341 offerings through banking entity from a borrower to would include dealers that participate 349 an automated execution system,342 replace or refinance a bridge loan. in an offering but that do not deal 343 small private offerings, or selling One of these commenters stated that directly with the issuer or selling security holders’ sales of securities of permitting a banking entity to receive security holder and do not have a issuers with large market capitalizations and resell notes or other debt securities written agreement with the from a borrower to replace or refinance that are executed as underwriting underwriter.355 One commenter further 344 a bridge loan would preserve the ability transactions in the normal course. represented that the proposed provision Several commenters suggested that of a banking entity to extend credit and for selling group members may be less the proposed definition be modified to offer customers a range of financing inclusive than the Agencies intended include some or all of these types of options. This commenter further because individual selling dealers or offerings.345 For example, two represented that such an approach dealer groups may or may not have commenters requested that the would be consistent with the exclusion of loans from the proposed definition of written agreements with an underwriter definition explicitly include all 356 offerings of securities by an issuer.346 ‘‘covered financial position’’ and the in privity of contract with the issuer. One of these commenters further commenter’s recommended exclusion Another commenter requested that, if requested a broader definition that from the definition of ‘‘trading account’’ the ‘‘distribution participant’’ concept is would include any offering by a selling for collecting debts previously not incorporated into the rule, the security holder that is registered under contracted.350 proposed definition of ‘‘underwriter’’ be the Securities Act or that involves an One commenter, however, stated that modified to include a person who has offering document prepared by the the proposed definition of an agreement with an affiliate of an issuer.347 Another commenter suggested ‘‘distribution’’ is too broad. This issuer or selling security holder (e.g., an commenter suggested that the agreement with a parent company to 357 337 See SIFMA et al. (Prop. Trading) (Feb. 2012); underwriting exemption should only be distribute the issuer’s securities). Goldman (Prop. Trading); Wells Fargo (Prop. available for registered offerings, and Other commenters opposed the Trading); RBC. the rule should preclude a banking inclusion of selling group members in 338 See SIFMA et al. (Prop. Trading) (Feb. 2012); entity from participating in a private Goldman (Prop. Trading); Wells Fargo (Prop. the proposed definition of Trading). In addition, one commenter expressed placement. According to the ‘‘underwriter.’’ These commenters general concern that the proposed rule would cause commenter, permitting a banking entity stated that because selling group a reduction in underwriting services with respect to to participate in a private placement members do not provide a price commercial paper, which would reduce liquidity in may facilitate evasion of the prohibition guarantee to an issuer, they do not commercial paper markets and raise the costs of 351 capital in already tight credit markets. See Chamber on proprietary trading. provide services to a customer and their (Feb. 2012). ii. Definition of ‘‘Underwriter’’ activities should not qualify for the 339 See Goldman (Prop. Trading); Wells Fargo underwriting exemption.358 (Prop. Trading); RBC; LSTA (Feb. 2012). Several commenters stated that the 340 See Goldman (Prop. Trading). proposed definition of ‘‘underwriter’’ is A number of commenters stated that 341 See SIFMA et al. (Prop. Trading) (Feb. 2012). too narrow.352 Other commenters, it is unclear whether the proposed 342 See SIFMA et al. (Prop. Trading) (Feb. 2012). however, stated that the proposed underwriting exemption would permit a 343 See SIFMA et al. (Prop. Trading) (Feb. 2012); banking entity to act as an authorized Goldman (Prop. Trading); Wells Fargo (Prop. definition is too broad, particularly due Trading). to the proposed inclusion of selling participant (‘‘AP’’) to an ETF issuer, 344 See RBC. group members.353 particularly with respect to the creation 345 See Goldman (Prop. Trading); SIFMA et al. Commenters requesting a broader and redemption of ETF shares or (Prop. Trading) (Feb. 2012); RBC. definition generally stated that the ‘‘seeding’’ an ETF for a short period of 346 See Goldman (Prop. Trading) (stating that this would capture, among other things, commercial 348 See RBC. 354 paper issuances, issuer ‘‘dribble out’’ programs, and See SIFMA et al. (Prop. Trading) (Feb. 2012); 349 small private offerings, which involve the purchase See Goldman (Prop. Trading); RBC. In Goldman (Prop. Trading); Wells Fargo (Prop. of securities directly from an issuer with a view addition, one commenter requested the Agencies Trading). The term ‘‘distribution participant’’ is toward resale, but may not always be clearly clarify that permitted underwriting activities defined in Rule 100 of Regulation M as ‘‘an distinguished by ‘‘special selling efforts and selling include the acquisition and resale of securities underwriter, prospective underwriter, broker, methods’’ or by ‘‘magnitude’’); SIFMA et al. (Prop. issued in lieu of or to refinance bridge loan dealer, or other person who has agreed to Trading) (Feb. 2012). facilities, irrespective of whether such activities participate or is participating in a distribution.’’ 17 qualify as ‘‘distributions’’ under the proposal. See CFR 242.100. 347 See SIFMA et al. (Prop. Trading) (Feb. 2012). LSTA (Feb. 2012). 355 This commenter indicated that expanding the See SIFMA et al. (Prop. Trading) (Feb. 2012); 350 definition of ‘‘distribution’’ to include both See Goldman (Prop. Trading). Goldman (Prop. Trading); Wells Fargo (Prop. offerings of securities by an issuer and offerings by 351 See Occupy. Trading). a selling security holder that are registered under 352 See SIFMA et al. (Prop. Trading) (Feb. 2012); 356 See Goldman (Prop. Trading). the Securities Act or that involve an offering Goldman (Prop. Trading); Wells Fargo (Prop. 357 See SIFMA et al. (Prop. Trading) (Feb. 2012). document prepared by the issuer would ‘‘include, Trading). This commenter also requested a technical for example, an offering of securities by an issuer 353 See AFR et al. (Feb. 2012); Public Citizen; amendment to proposed rule § 75.4(a)(4)(ii) to or a selling security holder where securities are sold Occupy (suggesting that the Agencies exceeded clarify that the person is ‘‘participating’’ in a through an automated order execution system, their statutory authority by incorporating the distribution, not ‘‘engaging’’ in a distribution. See offerings in response to reverse inquiries and Regulation M definition of ‘‘underwriter,’’ rather id. commercial paper issuances.’’ Id. than the Securities Act definition of ‘‘underwriter’’). 358 See AFR et al. (Feb. 2012); Public Citizen.

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time when it is initially launched.359 represented that such activities are demand for the new issuance;373 (vi) For example, a few commenters noted traditionally undertaken to: Support the purchasing debt securities of that APs typically do not perform some success of a distribution; mitigate risk to comparable issuers as a price discovery or all of the activities that the Agencies issuers, investors, and underwriters; and mechanism in connection with proposed to consider to help determine facilitate an orderly aftermarket.363 A underwriting a new debt security;374 whether a banking entity is acting as an few commenters further stated that (vii) hedging the underwriter’s exposure underwriter in connection with a requiring a trade to be ‘‘solely’’ in to a derivative strategy engaged in with distribution of securities, including due connection with a distribution by an an issuer;375 (viii) organizing and diligence, advising an issuer on market underwriter would be inconsistent with assembling a resecuritized product, conditions and assisting in preparation the statute,364 may reduce future including, for example, sourcing bond of a registration statement or offering innovation in the capital-raising collateral over a period of time in documents, and participating in or process,365 and could create market anticipation of issuing new organizing a syndicate of investment disruptions.366 securities;376 and (ix) selling a security banks.360 A number of commenters stated that to an intermediate entity as part of the However, one commenter appeared to it is unclear whether certain activities creation of certain structured oppose applying the underwriting would qualify for the proposed products.377 exemption to certain AP activities. underwriting exemption and requested According to this commenter, APs are that the Agencies adopt an exemption c. Final Requirement That the Banking generally reluctant to concede that they that is broad enough to permit such Entity Act as an Underwriter for a are statutory underwriters because they activities.367 Commenters stated that Distribution of Securities and the do not perform all the activities there are a number of activities that Trading Desk’s Underwriting Position Be Related to Such Distribution associated with the underwriting of an should be permitted under the operating company’s securities. Further, underwriting exemption, including: (i) The final rule requires that the this commenter expressed concern that, Creating a naked or covered syndicate banking entity act as an underwriter for if an AP had to rely on the proposed short position in connection with an a distribution of securities and the underwriting exemption, the AP could offering;368 (ii) creating a stabilizing trading desk’s underwriting position be be subject to heightened risk of bid;369 (iii) acquiring positions via related to such distribution.378 This incurring underwriting liability on the overallotments370 or trading in the requirement is substantially similar to issuance of ETF shares traded by the market to close out short positions in the proposed rule,379 but with five key AP. As a result of these considerations, connection with an overallotment refinements. First, to address the commenter believed that a banking option or in connection with other commenters’ confusion about whether entity may be less willing to act as an stabilization activities;371 (iv) using call AP for an ETF issuer if it were required spread options in a convertible debt 373 See Wells Fargo (Prop. Trading). The to rely on the underwriting offering to mitigate dilution of existing commenter further stated that the need to purchase 372 the issuer’s other debt securities from investors may exemption.361 shareholders; (v) repurchasing arise if an investor has limited risk tolerance to the existing debt securities of an issuer in issuer’s credit or has portfolio restrictions. iii. ‘‘Solely in Connection With’’ the course of underwriting a new series According to the commenter, the underwriter Standard of debt securities in order to stimulate would typically sell the debt securities it purchased from existing investors to new investors. See id. To qualify for the underwriting 374 See Wells Fargo (Prop. Trading). 363 exemption, the proposed rule required a See Goldman (Prop. Trading). 375 See Goldman (Prop. Trading). 364 purchase or sale of a covered financial See Goldman (Prop. Trading); Wells Fargo 376 See ASF (Feb. 2012) (stating that, for example, position to be effected ‘‘solely in (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. a banking entity may respond to customer or 2012). general market demand for highly-rated mortgage connection with’’ a distribution of 365 See Goldman (Prop. Trading). paper by accumulating residential mortgage-backed securities for which the banking entity 366 See SIFMA et al. (Prop. Trading) (Feb. 2012). securities over time and holding such securities in is acting as underwriter. Several 367 See SIFMA et al. (Prop. Trading) (Feb. 2012); inventory until the transaction can be organized commenters expressed concern that the Goldman (Prop. Trading); Wells Fargo (Prop. and assembled). word ‘‘solely’’ in this provision may Trading); RBC. 377 See ICI (Feb. 2012) (stating that the sale of 368 result in an overly narrow interpretation See SIFMA et al. (Prop. Trading) (Feb. 2012) assets to an intermediate asset-backed commercial (‘‘The reason for creating the short positions paper or tender option bond program should be of permissible activities. In particular, (covered and naked) is to facilitate an orderly permitted under the underwriting exemption if the these commenters indicated that the aftermarket and to reduce price volatility of newly sale is part of the creation of a structured security). ‘‘solely in connection with’’ standard offered securities. This provides significant value to See also AFR et al. (Feb. 2012) (stating that the creates uncertainty about certain issuers and selling security holders, as well as to treatment of a sale to an intermediate entity should investors, by giving the syndicate buying power that depend on whether the banking entity or an activities that are currently conducted helps protect against immediate volatility in the external client is the driver of the demand and, if in the course of an underwriting, such aftermarket.’’); RBC; Goldman (Prop. Trading). the banking entity is the driver of the demand, then as customary underwriting syndicate 369 See SIFMA et al. (Prop. Trading) (Feb. 2012) the near term demand requirement should not be activities.362 One commenter (‘‘Underwriters may also engage in stabilization met). Two commenters stated that the underwriting activities under Regulation M by creating a exemption should not permit a banking entity to stabilizing bid to prevent or slow a decline in the sell a security to an intermediate entity in the 359 See BoA; ICI Global; Vanguard; ICI (Feb. market price of a security. These activities should course of creating a structured product. See 2012); SSgA (Feb. 2012). As one commenter be encouraged rather than restricted by the Volcker Occupy; Alfred Brock. These commenters were explained, an AP may ‘‘seed’’ an ETF for a short Rule because they reduce price volatility and generally responding to a question on this issue in period of time at its inception by entering into facilitate the orderly pricing and aftermarket trading the proposal. See Joint Proposal, 76 FR at 68868– several initial creation transactions with the ETF of underwritten securities, thereby contributing to 68869 (question 78); CFTC Proposal, 77 FR at 8354 issuer and refraining from selling those shares to capital formation.’’). (question 78). investors or redeeming them for a period of time to 370 See RBC. 378 Final rule § 75.4(a)(2)(i). The terms facilitate the ETF achieving its liquidity launch 371 See Goldman (Prop. Trading). ‘‘distribution’’ and ‘‘underwriter’’ are defined in goals. See BoA. 372 See SIFMA et al. (Prop. Trading) (Feb. 2012); final rule § 75.4(a)(3) and § 75.4(a)(4), respectively. 360 See ICI Global; ICI (Feb. 2012); Vanguard. Goldman (Prop. Trading) (stating that the call 379 Proposed rule § 75.4(a)(2)(iii) required that 361 See SSgA (Feb. 2012). spread arrangement ‘‘may make a wider range of ‘‘[t]he purchase or sale is effected solely in 362 See SIFMA et al. (Prop. Trading) (Feb. 2012); financing options feasible for the issuer of the connection with a distribution of securities for Goldman (Prop. Trading); BoA; Wells Fargo (Prop. convertible debt’’ and ‘‘can help it to raise more which the covered banking entity is acting as Trading); Comm. on Capital Markets Regulation. capital at more attractive prices’’). underwriter.’’

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the underwriting exemption applies on may, however, have more than one rule applies the requirements of the a transaction-by-transaction basis, the ‘‘underwriting position’’ at a particular underwriting exemption at the trading phrase ‘‘purchase or sale’’ has been point in time if the banking entity is desk level of organization.381 This modified to instead refer to the trading acting as an underwriter for more than approach will result in the requirements desk’s ‘‘underwriting position.’’ Second, one distribution. As a result, the of the underwriting exemption applying to balance this more aggregated underwriting exemption’s requirements to the aggregate trading activities of a position-based approach, the final rule pertaining to a trading desk’s relatively limited group of employees on specifies that the trading desk is the underwriting position will apply on a a single desk. Applying requirements at organizational level of a banking entity distribution-by-distribution basis. the trading desk level should facilitate (or across one or more affiliated banking A trading desk’s underwriting banking entity and Agency monitoring entities) at which the requirements of position can include positions in and review of compliance with the the underwriting exemption will be securities held at different affiliated exemption by limiting the location assessed. Third, the Agencies have legal entities, provided the banking where underwriting activity may occur made important modifications to the entity is able to provide supervisors or and allowing better identification of the definition of ‘‘distribution’’ to better examiners of any Agency that has aggregate trading volume that must be capture the various types of private and regulatory authority over the banking reviewed to determine whether the registered offerings a banking entity may entity pursuant to section 13(b)(2)(B) of desk’s activities are being conducted in be asked to underwrite by an issuer or the BHC Act with records, promptly a manner that is consistent with the selling security holder. Fourth, the upon request, that identify any related underwriting exemption, while also definition of ‘‘underwriter’’ has been positions held at an affiliated entity that allowing adequate consideration of the refined to clarify that both members of are being included in the trading desk’s particular facts and circumstances of the the underwriting syndicate and selling underwriting position for purposes of desk’s trading activities. group members may qualify as the underwriting exemption. Banking The trading desk should be managed underwriters for purposes of this entities should be prepared to provide and operated as an individual unit and exemption. Finally, the word ‘‘solely’’ all records that identify all of the should reflect the level at which the has been removed to clarify that a positions included in a trading desk’s profit and loss of employees engaged in broader scope of activities conducted in underwriting position and where such underwriting activities is attributed. The connection with underwriting (e.g., positions are held. term ‘‘trading desk’’ in the underwriting stabilization activities) are permitted The Agencies believe that a context is intended to encompass what under this exemption. These issues are distribution-by-distribution approach is is commonly thought of as an discussed in turn below. appropriate due to the relatively distinct underwriting desk. A trading desk nature of underwriting activities for a i. Definition of ‘‘Underwriting Position’’ engaged in underwriting activities single distribution on behalf of an issuer would not necessarily be an active In response to commenters’ concerns or selling security holder. The Agencies market participant that engages in about transaction-by-transaction do not believe that a narrower frequent trading activities. 380 analyses, the Agencies are modifying transaction-by-transaction analysis is A trading desk may manage an the exemption to clarify the level at necessary to determine whether a underwriting position that includes which compliance with certain banking entity is engaged in permitted positions held by different affiliated provisions will be assessed. The underwriting activities. The Agencies legal entities.382 Similarly, a trading proposal was not intended to impose a also decline to take a broader approach, desk may include employees working transaction-by-transaction approach, which would allow a banking entity to on behalf of multiple affiliated legal and the final rule’s requirements aggregate positions from multiple entities or booking trades in multiple generally focus on the long or short distributions for which it is acting as an affiliated entities. The geographic positions in one or more securities held underwriter, because it would be more location of individual traders is not by a banking entity or its affiliate, and difficult for the banking entity’s internal dispositive for purposes of determining managed by a particular trading desk, in compliance personnel and Agency whether the employees are engaged in connection with a particular supervisors and examiners to review the activities for a single trading desk. distribution of securities for which such trading desk’s positions to assess the banking entity or its affiliate is acting as desk’s compliance with the iii. Definition of ‘‘Distribution’’ an underwriter. Like § 75.4(a)(2)(ii) of underwriting exemption. A more The term ‘‘distribution’’ is defined in the proposed rule, the definition of aggregated approach would increase the the final rule as: (i) An offering of ‘‘underwriting position’’ is limited to number of positions in different types of securities, whether or not subject to positions in securities because the securities that could be included in the registration under the Securities Act, common usage and understanding of the underwriting position, which would that is distinguished from ordinary term ‘‘underwriting’’ is limited to make it more difficult to determine that trading transactions by the presence of activities in securities. an individual position is related to a special selling efforts and selling A trading desk’s underwriting particular distribution of securities for methods; or (ii) an offering of securities position constitutes the securities which the banking entity is acting as an made pursuant to an effective positions that are acquired in underwriter and, in turn, increase the registration statement under the connection with a single distribution for potential for evasion of the general Securities Act.383 In response to which the relevant banking entity is prohibition on proprietary trading. comments, the proposed definition has acting as an underwriter. A trading desk ii. Definition of ‘‘Trading Desk’’ been revised to eliminate the need to may not aggregate securities positions consider the ‘‘magnitude’’ of an offering The proposed underwriting acquired in connection with two or and instead supplements the definition more distributions to determine its exemption would have applied certain ‘‘underwriting position.’’ A trading desk requirements across an entire banking 381 See infra Part VI.A.3.c. (discussing the final entity. To promote consistency with the market-making exemption). 380 See, e.g., Goldman (Prop. Trading); SIFMA et market-making exemption and address 382 See supra note 307 and accompanying text. al. (Prop. Trading) (Feb. 2012). potential evasion concerns, the final 383 Final rule § 75.4(a)(3).

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with an alternative prong for registered underwriter receiving special delayed basis),392 bought deals,393 at the offerings under the Securities Act.384 compensation.389 market offerings,394 debt offerings, asset- The proposed definition’s reference to The Agencies are also adopting a backed security offerings, initial public magnitude caused some commenter second prong to this definition, which offerings, and other registered offerings. concern with respect to whether it could will independently capture all offerings An offering can be a distribution for be interpreted to preclude a banking of securities that are made pursuant to purposes of either § 75.4(a)(3)(i) or entity from intermediating a small an effective registration statement under § 75.4(a)(3)(ii) of the final rule regardless private placement. After considering the Securities Act.390 The registration of whether the offering is issuer driven, comments, the Agencies have prong of the definition is intended to selling security holder driven, or arises determined that the requirement to have provide another avenue by which an as a result of a reverse inquiry.395 special selling efforts and selling offering of securities may be conducted Provided the definition of distribution is methods is sufficient to distinguish under the exemption, absent other met, an offering can be a distribution for between permissible securities offerings special selling efforts and selling purposes of this rule regardless of how and prohibited proprietary trading, and methods or a determination of whether it is conducted, whether by direct the additional magnitude factor is not such efforts and methods are being communication, exchange transactions, needed to further this objective.385 As conducted. The Agencies believe this or automated execution system.396 proposed, the Agencies will rely on the prong reduces potential administrative As discussed above, some same factors considered under burdens by providing a bright-line test commenters expressed concern that the Regulation M to analyze the presence of for what constitutes a distribution for proposed definition of ‘‘distribution’’ special selling efforts and selling purposes of the final rule. In addition, would prevent a banking entity from methods.386 Indicators of special selling this prong is consistent with the acquiring and reselling securities issued efforts and selling methods include purpose and goals of the statute because in lieu of or to refinance bridge loan delivering a sales document (e.g., a it reflects a common type of securities facilities in reliance on the underwriting prospectus), conducting road shows, offering and does not raise evasion exemption. Bridge financing concerns as it is unlikely that an entity and receiving compensation that is arrangements can be structured in many would go through the registration greater than that for secondary trades different ways, depending on the process solely to facilitate or engage in but consistent with underwriting context and the specific objectives of the 387 speculative proprietary trading.391 This compensation. For purposes of the parties involved. As a result, the prong would include, among other final rule, each of these factors need not treatment of securities acquired in lieu things, the following types of registered be present under all circumstances. of or to refinance a bridge loan and the securities offerings: Offerings made Offerings that qualify as distributions subsequent sale of such securities under pursuant to a shelf registration under this prong of the definition the final rule depends on the facts and statement (whether on a continuous or include, among others, private circumstances. A banking entity may placements in which resales may be meet the terms of the underwriting 389 made in reliance on the SEC’s Rule This clarification is intended to address exemption for its bridge loan activity, or 144A or other available exemptions 388 commenters’ concern regarding potential limitations on banking entities’ ability to facilitate it may be able to rely on the market- and, to the extent the commercial paper commercial paper offerings under the proposed making exemption. If the banking being offered is a security, commercial underwriting exemption. See supra Part entity’s bridge loan activity does not paper offerings that involve the VI.A.2.c.1.b.i. qualify for an exemption under the rule, 390 See, e.g., Form S–1 (17 CFR 239.11); Form S– 3 (17 CFR 239.13); Form S–8 (17 CFR 239.16b); then it would not be permitted to engage 384 Proposed rule § 75.4(a)(3) defined Form F–1 (17 CFR 239.31); Form F–3 (17 CFR in such activity. ‘‘distribution’’ as ‘‘an offering of securities, whether 239.33). or not subject to registration under the Securities 391 Although the Agencies are providing an Act, that is distinguished from ordinary trading 392 See Securities Offering Reform, Securities Act additional prong to the definition of ‘‘distribution’’ transactions by the magnitude of the offering and Release No. 8591 (July 19, 2005), 70 FR 44722 (Aug. for registered offerings, the final rule does not limit the presence of special selling efforts and selling 3, 2005); 17 CFR 230.405 (defining ‘‘automatic shelf the availability of the underwriting exemption to methods.’’ registration statement’’ as a registration statement registered offerings, as suggested by one 385 filed on Form S–3 (17 CFR 239.13) or Form F–3 (17 The policy goals of this rule differ from those commenter. The statute does not include such an CFR 239.33) by a well-known seasoned issuer of the SEC’s Regulation M, which is an anti- express limitation, and the Agencies decline to pursuant to General Instruction I.D. or I.C. of such manipulation rule. The focus on magnitude is construe the statute to require such an approach. In forms, respectively); 17 CFR 230.415. appropriate for that regulation because it helps response to the commenter stating that permitting 393 identify offerings that can give rise to an incentive a banking entity to participate in a private A bought deal is a distribution technique to condition the market for the offered security. To placement may facilitate evasion of the prohibition whereby an underwriter makes a bid for securities the contrary, this rule is intended to allow banking on proprietary trading, the Agencies believe this without engaging in a preselling effort, such as book entities to continue to provide client-oriented concern is addressed by the provision in the final building or distribution of a preliminary financial services, including underwriting services. rule requiring that a trading desk have a reasonable prospectus. See, e.g., Delayed or Continuous The SEC emphasizes that this rule does not have expectation of demand from other market Offering and Sale of Securities, Securities Act any impact on Regulation M. participants for the amount and type of securities Release No. 6470 (June 9, 1983), n.5. 386 See Joint Proposal, 76 FR at 68867; CFTC to be acquired from an issuer or selling security 394 See, e.g., 17 CFR 230.415(a)(4) (defining ‘‘at Proposal, 77 FR at 8352. holder for distribution and make reasonable efforts the market offering’’ as ‘‘an offering of equity 387 See Joint Proposal, 76 FR at 68867; CFTC to sell its underwriting position within a reasonable securities into an existing trading market for Proposal, 77 FR at 8352; Review of period. As discussed below, the Agencies believe outstanding shares of the same class at other than Antimanipulation Regulation of Securities Offering, this requirement in the final rule appropriately a fixed price’’). At the market offerings may also be Exchange Act Release No. 33924 (Apr. 19, 1994), 59 addresses evasion concerns that a banking entity referred to as ‘‘dribble out’’ programs. FR 21681, 21684–21685 (Apr. 26, 1994). may retain an unsold allotment for purely 395 Under the ‘‘reverse inquiry’’ process, an 388 The final rule does not provide safe harbors speculative purposes. Further, the Agencies believe investor may be allowed to purchase securities from for particular distribution techniques. A safe that preventing a banking entity from facilitating a the issuer through an underwriter that is not harbor-based approach would provide certainty for private offering could unnecessarily hinder capital- designated in the prospectus as the issuer’s agent specific types of offerings, but may not account for raising without providing commensurate benefits by having such underwriter approach the issuer evolving market practices and distribution because issuers use private offerings to raise capital with an interest from the investor. See Joseph techniques that could technically satisfy a safe in a variety of situations and the underwriting McLaughlin and Charles J. Johnson, Jr., ‘‘Corporate harbor but that might implicate the concerns that exemption’s requirements limit the potential for Finance and the Securities Laws’’ (4th ed. 2006, led Congress to enact section 13 of the BHC Act. evasion for both registered and private offerings, as supplemented 2012). See RBC. noted above. 396 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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iv. Definition of ‘‘Underwriter’’ syndicate, have agreed to participate or ‘‘underwriter’’ in the final rule, it may In response to comments, the are participating in a distribution of be able to rely on the market-making Agencies are adopting certain securities for or on behalf of the issuer exemption in the final rule for its modifications to the proposed definition or selling security holder. trading activity. In response to of ‘‘underwriter’’ to better capture The final rule does not adopt a comments noting that APs for ETFs do selling group members and to more narrower definition of ‘‘underwriter,’’ as not engage in certain of these activities 399 closely resemble the definition of suggested by two commenters. and inquiring whether an AP would be ‘‘distribution participant’’ in Regulation Although selling group members do not able to qualify for the underwriting M. In particular, the Agencies are have a direct relationship with the exemption for certain of its activities, defining ‘‘underwriter’’ as: (i) A person issuer or selling security holder, they do the Agencies believe that many AP who has agreed with an issuer or selling help facilitate the successful activities, such as conducting general security holder to: (A) Purchase distribution of securities to a wider creations and redemptions of ETF Securities from the issuer or selling variety of purchasers, such as regional shares, are better suited for analysis security holder for distribution; (B) or retail purchasers that members of the under the market-making exemption engage in a distribution of securities for underwriting syndicate may not be able because they are driven by the demands or on behalf of the issuer or selling to access as easily. Thus, the Agencies of other market participants rather than security holder; or (C) manage a believe it is consistent with the purpose the issuer, the ETF.401 Whether an AP distribution of securities for or on behalf of the statutory underwriting exemption may rely on the underwriting exemption of the issuer or selling security holder; and beneficial to recognize and allow for its activities in an ETF will depend or (ii) a person who has agreed to the current market practice of an on the facts and circumstances, participate or is participating in a underwriting syndicate and selling including, among other things, whether distribution of such securities for or on group members collectively facilitating the AP meets the definition of behalf of the issuer or selling security a distribution of securities. The ‘‘underwriter’’ and the offering of ETF holder.397 Agencies note that because banking shares qualifies as a ‘‘distribution.’’ A number of commenters requested entities that are selling group members To provide further clarity about the that the Agencies broaden the will be underwriters under the final scope of the definition of ‘‘underwriter,’’ underwriting exemption to permit rule, they will be subject to all the the Agencies are defining the terms activities in connection with a requirements of the underwriting ‘‘selling security holder’’ and ‘‘issuer’’ distribution of securities by any exemption. in the final rule. The Agencies are using distribution participant. A few of these As provided in the preamble to the the definition of ‘‘issuer’’ from the commenters interpreted the proposed proposed rule, engaging in the following Securities Act because this definition is definition of ‘‘underwriter’’ as requiring activities may indicate that a banking commonly used in the context of a selling group member to have a entity is acting as an underwriter under securities offerings and is well written agreement with the underwriter § 75.4(a)(4) as part of a distribution of understood by market participants.402 A to participate in the distribution.398 securities: ‘‘selling security holder’’ is defined as These commenters noted that such a • Assisting an issuer in capital- ‘‘any person, other than an issuer, on written agreement may not exist under raising; whose behalf a distribution is made.’’403 all circumstances. The Agencies did not • Performing due diligence; This definition is consistent with the intend to require that members of the • Advising the issuer on market underwriting syndicate or the lead conditions and assisting in the 401 See infra Part VI.A.3. underwriter have a written agreement preparation of a registration statement 402 See final rule § 75.3(e)(9) (defining the term with all selling group members for each or other offering document; ‘‘issuer’’ for purposes of the proprietary trading offering or that they be in privity of • Purchasing securities from an provisions in subpart B of the final rule). Under section 2(a)(4) of the Securities Act, ‘‘issuer’’ is contract with the issuer or selling issuer, a selling security holder, or an defined as ‘‘every person who issues or proposes to security holder. To provide clarity on underwriter for resale to the public; issue any security; except that with respect to this issue, the Agencies have modified • Participating in or organizing a certificates of deposit, voting-trust certificates, or the language of subparagraph (ii) of the syndicate of investment banks; collateral-trust certificates, or with respect to • certificates of interest or shares in an definition to include firms that, while Marketing securities; and unincorporated investment trust not having a board not members of the underwriting • Transacting to provide a post- of directors (or persons performing similar issuance secondary market and to functions) or of the fixed, restricted management, or 397 See final rule § 75.4(a)(4). facilitate price discovery.400 unit type, the term ‘issuer’ means the person or 398 The basic documents in firm commitment persons performing the acts and assuming the The Agencies continue to take the view duties of depositor or manager pursuant to the underwritten securities offerings generally are: (i) that the precise activities performed by The agreement among underwriters, which provisions of the trust or other agreement or establishes the relationship among the managing an underwriter will vary depending on instrument under which such securities are issued; underwriter, any co-managers, and the other the liquidity of the securities being except that in the case of an unincorporated members of the underwriting syndicate; (ii) the underwritten and the type of association which provides by its articles for underwriting (or ‘‘purchase’’) agreement, in which limited liability of any or all of its members, or in the underwriters commit to purchase the securities distribution being conducted. A banking the case of a trust, committee, or other legal entity, from the issuer or selling security holder; and (iii) entity is not required to engage in each the trustees or members thereof shall not be the selected dealers agreement, in which selling of the above-noted activities to be individually liable as issuers of any security issued group members agree to certain provisions relating considered an underwriter for purposes by the association, trust, committee, or other legal to the distribution. See Joseph McLaughlin and entity; except that with respect to equipment-trust Charles J. Johnson, Jr., ‘‘Corporate Finance and the of this rule. In addition, the Agencies certificates or like securities, the term ‘issuer’ Securities Laws’’ (4th ed. 2006, supplemented note that, to the extent a banking entity means the person by whom the equipment or 2012), Ch. 2. The Agencies understand that two does not meet the definition of property is or is to be used; and except that with firms may enter into a master agreement that respect to fractional undivided interests in oil, gas, or other mineral rights, the term ‘issuer’ means the governs all offerings in which both firms participate 399 as members of the underwriting syndicate or as a See AFR et al. (Feb. 2012); Public Citizen. owner of any such right or of any interest in such member of the syndicate and a selling group 400 See Joint Proposal, 76 FR at 68867; CFTC right (whether whole or fractional) who creates member. See, e.g., SIFMA Master Selected Dealers Proposal, 77 FR at 8352. Post-issuance secondary fractional interests therein for the purpose of public Agreement (June 10, 2011), available at market activity is expected to be conducted in offering.’’ 15 U.S.C. 77b(a)(4). www.sifma.org. accordance with the market-making exemption. 403 Final rule § 75.4(a)(5).

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definition of ‘‘selling security holder’’ allotment when market conditions may are not core to the underwriting found in the SEC’s Regulation M.404 make it impracticable to sell the entire function and, thus, are not permitted allotment at a reasonable price at the v. Activities Conducted ‘‘in Connection under the final underwriting exemption. time of the distribution and selling such With’’ a Distribution However, a banking entity may be able position when it is reasonable to do to rely on another exemption for such As discussed above, several so,409 and helping the issuer mitigate its activities (e.g., the market-making or commenters expressed concern that the risk exposure arising from the hedging exemptions), if applicable. For proposed underwriting exemption distribution of its securities (e.g., example, a trading desk would not be would not allow a banking entity to entering into a call-spread option with able to use the underwriting exemption engage in certain auxiliary activities that an issuer as part of a convertible debt to purchase a financial instrument from may be conducted in connection with offering to mitigate dilution to existing a customer to facilitate the customer’s acting as an underwriter for a 410 shareholders). Such activities should ability to buy securities in the distribution of securities in the normal be intended to effectuate the distribution.413 Further, purchasing course. These commenters’ concerns distribution process and provide another financial instrument to help generally arose from the use of the word benefits to issuers, selling security ‘‘solely’’ in § 75.4(a)(2)(iii) of the determine how to price the securities holders, or purchasers in the that are subject to a distribution would proposed rule, which commenters noted distribution. Existing laws, regulations, was not included in the statute’s not be permitted under the underwriting and self-regulatory organization rules 414 405 exemption. These two activities may underwriting exemption. In addition, limit or place certain requirements be permitted under the market-making a number of commenters discussed around many of these activities. For particular activities they believed example, an underwriter’s subsequent exemption, depending on the facts and should be permitted under the sale of an unsold allotment must circumstances. In response to one underwriting exemption and indicated comply with applicable provisions of commenter’s suggestion that hedging the term ‘‘solely’’ created uncertainty the Federal securities laws and the rules the underwriter’s risk exposure be about whether such activities would be thereunder. Moreover, any position permissible under this exemption, the permitted.406 resulting from these activities must be Agencies emphasize that hedging the To reduce uncertainty in response to included in the trading desk’s underwriter’s risk exposure is not comments, the final rule requires a underwriting position, which is subject permitted under the underwriting trading desk’s underwriting position to to a number of restrictions in the final exemption.415 A banking entity must be ‘‘held . . . and managed . . . in rule. Specifically, as discussed in more comply with the hedging exemption for connection with’’ a single distribution detail below, the trading desk must such activity. for which the relevant banking entity is make reasonable efforts to sell or In response to comments about the acting as an underwriter, rather than otherwise reduce its underwriting sale of a security to an intermediate requiring that a purchase or sale be position within a reasonable period,411 entity in connection with a structured ‘‘effected solely in connection with’’ and each trading desk must have robust such a distribution. Importantly, for limits on, among other things, the 413 See Wells Fargo (Prop. Trading). The Agencies purposes of establishing an amount, types, and risks of its do not believe this activity is consistent with underwriting position in reliance on the underwriting position and the period of underwriting activity because it could result in an underwriting exemption, a trading desk time a security may be held.412 Thus, in underwriting desk holding a variety of positions may only engage in activities that are over time that are not directly related to a general, the underwriting exemption distribution of securities the desk is conducting on related to a particular distribution of would not permit a trading desk, for behalf of an issuer or selling security holder. securities for which the banking entity example, to acquire a position as part of Further, the Agencies believe this activity may be is acting as an underwriter. Activities its stabilization activities and hold that more appropriately analyzed under the market- that may be permitted under the position for an extended period. making exemption because market makers generally purchase or sell a financial instrument at the underwriting exemption include This approach does not mean that any request of customers and otherwise routinely stand stabilization activities,407 syndicate activity that is arguably connected to a ready to purchase and sell a variety of related shorting and aftermarket short distribution of securities is permitted financial instruments. covering,408 holding an unsold under the underwriting exemption. 414 See id. The Agencies view this activity as Certain activities noted by commenters inconsistent with underwriting because underwriters typically engage in other activities, 404 See 17 CFR 242.100(b). such as book-building and other marketing efforts, 405 See supra Part VI.A.2.c.1.b.iii. underwriting agreement with the issuer often to determine the appropriate price for a security 406 See supra notes 362, 363, 368–77 and provides for an ‘overallotment option’ whereby the and these activities do not involve taking positions accompanying text. syndicate can purchase additional shares from the that are unrelated to the securities subject to 407 See SIFMA et al. (Prop. Trading) (Feb. 2012). issuer or selling shareholders in order to cover its distribution. See infra VI.A.2.c.2. See Anti-Manipulation Rules Concerning Securities short position. To the extent that the syndicate 415 Although one commenter suggested that an Offerings, Exchange Act Release No. 38067 (Dec. 20, short position is in excess of the overallotment underwriter’s hedging activity be permitted under 1996), 62 FR 520, 535 (Jan. 3, 1997) (‘‘Although option, the syndicate is said to have taken an the underwriting exemption, we do not believe the stabilization is price-influencing activity intended ‘uncovered’ short position. The syndicate short requirements in the proposed hedging exemption to induce others to purchase the offered security, position, up to the amount of the overallotment would be unworkable or overly burdensome in the when appropriately regulated it is an effective option, may be covered by exercising the option or context of an underwriter’s hedging activity. See mechanism for fostering an orderly distribution of by purchasing shares in the market once secondary Goldman (Prop. Trading). As noted above, securities and promotes the interests of trading begins.’’). underwriting activity is of a relatively distinct shareholders, underwriters, and issuers.’’). 409 See SIFMA et al. (Prop. Trading) (Feb. 2012); nature, which is substantially different from 408 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; BoA; BDA (Feb. 2012). market-making activity, which is more dynamic and RBC; Goldman (Prop. Trading). See Proposed 410 See SIFMA et al. (Prop. Trading) (Feb. 2012); involves more frequent trading activity giving rise Amendments to Regulation M: Anti-Manipulation RBC; Goldman (Prop. Trading). to a variety of positions that may naturally hedge Rules Concerning Securities Offerings, Exchange 411 See final rule § 75.4(a)(2)(ii); infra Part the risks of certain other positions. The Agencies Act Release No. 50831 (Dec. 9, 2004), 69 FR 75774, VI.A.2.c.2.c. (discussing the requirement to make believe it is appropriate to require that a trading 75780 (Dec. 17, 2004) (‘‘In the typical offering, the reasonable efforts to sell or otherwise reduce the desk comply with the requirements of the hedging syndicate agreement allows the managing underwriting position). exemption when it is hedging the risks of its underwriter to ‘oversell’ the offering, i.e., establish 412 See final rule § 75.4(a)(2)(iii)(B); infra Part underwriting position, while allowing a trading a short position beyond the number of shares to VI.A.2.c.3.c. (discussing the required limits for desk’s market making-related hedging under the which the underwriting commitment relates. The trading desks engaged in underwriting activity). market-making exemption.

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finance product,416 the Agencies have asset classes and depends on the indicated that if the rule does not not modified the underwriting liquidity of the market.421 Two provide greater clarity and flexibility exemption. Underwriting is distinct commenters expressed views on how with respect to the near term customer from product development. Thus, the near term customer demand demand requirement, a banking entity parties must adjust activities associated requirement should work in the context may be less inclined to participate in a with developing structured finance of a securitization or creating what the distribution where there is the potential products or meet the terms of other commenters characterized as risk of an unsold allotment, may price available exemptions. Similarly, the ‘‘structured products’’ or ‘‘structured such risk into the fees charged to accumulation of securities or other instruments.’’422 underwriting clients, or may be forced assets in anticipation of a securitization Many commenters expressed concern into a ‘‘fire sale’’ of the unsold or resecuritization is not an activity that the proposed requirement, if allotment.429 conducted ‘‘in connection with’’ narrowly interpreted, could prevent an underwriting for purposes of the underwriter from holding a residual Several other commenters provided exemption.417 This activity is typically position for which there is no views on whether a banking entity engaged in by an issuer or sponsor of a immediate demand from clients, should be able to hold a residual securitized product in that capacity, customers, or counterparties.423 position from an offering pursuant to rather than in the capacity of an Commenters noted that there are a the underwriting exemption, although underwriter. The underwriting variety of offerings that present some they did not generally link their exemption only permits a banking risk of an underwriter having to hold a comments to the proposed near term entity’s activities when it is acting as an residual position that cannot be sold in demand requirement.430 Many of these underwriter. the initial distribution, including commenters expressed concern about ‘‘bought deals,’’ 424 rights offerings,425 permitting a banking entity to retain a 2. Near Term Customer Demand and fixed-income offerings.426 A few portion of an underwriting and noted Requirement commenters noted that similar scenarios potential risks that may arise from such a. Proposed Near Term Customer can arise in the case of an AP creating activity.431 For example, some of these Demand Requirement more shares of an ETF than it can sell427 commenters stated that retention or Like the statute, § 75.4(a)(2)(v) of the and bridge loans.428 Two commenters warehousing of underwritten securities proposed rule required that the can be an indication of impermissible underwriting activities of the banking 421 See RBC (stating that the Board has found proprietary trading intent (particularly if acceptable the retention of assets acquired in entity with respect to the covered connection with underwriting activities for a period systematic), or may otherwise result in financial position be designed not to of 90 to 180 days and has further permitted holding high-risk exposures or conflicts of exceed the reasonably expected near periods of up to a year in certain circumstances, interests.432 One of these commenters term demands of clients, customers, or such as for less liquid securities). 422 recommended the Agencies use a metric 418 See AFR et al. (Feb. 2012); Sens. Merkley & counterparties. Levin (Feb. 2012). to monitor the size of residual positions 433 b. Comments Regarding the Proposed 423 See SIFMA et al. (Prop. Trading) (Feb. 2012); retained by an underwriter, while Near Term Customer Demand BoA; BDA (Feb. 2012); RBC. another commenter suggested adding a 424 See SIFMA et al. (Prop. Trading) (Feb. 2012); Requirement requirement to the proposed exemption BoA; RBC. These commenters generally stated that to provide that a ‘‘substantial’’ unsold or Both the statute and the proposed rule an underwriter for a ‘‘bought deal’’ may end up with an unsold allotment because, pursuant to this retained allotment would be an require a banking entity’s underwriting type of offering, an underwriter makes a indication of prohibited proprietary activity to be ‘‘designed not to exceed commitment to purchase securities from an issuer trading.434 Similarly, one commenter the reasonably expected near term or selling security holder, without pre-commitment recommended that the Agencies demands of clients, customers, or marketing to gauge customer interest, in order to provide greater speed and certainty of execution. consider whether there are sufficient counterparties.’’ 419 Several commenters See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. provisions in the proposed rule to requested that this standard be 425 See SIFMA et al. (Prop. Trading) (Feb. 2012) reduce the risks posed by banking interpreted in a flexible manner to allow (representing that because an underwriter generally a banking entity to participate in an backstops a rights offering by committing to entities retaining or warehousing exercise any rights not exercised by shareholders, underwritten instruments, such as offering that may require it to retain an the underwriter may end up holding a residual 420 subprime mortgages, collateralized debt unsold allotment for a period of time. portion of the offering if investors do not exercise In addition, one commenter stated that all of the rights). obligation tranches, and high yield debt the final rule should provide flexibility 426 See BDA (Feb. 2012). This commenter stated of leveraged buyout issuers, which in this standard by recognizing that the that underwriters frequently underwrite bonds in the fixed-income market knowing that they may at the time of the initial extension of the bridge concept of ‘‘near term’’ differs between need to retain unsold allotments in their inventory. commitment. See LSTA (Feb. 2012). The commenter indicated that this scenario arises 429 See SIFMA et al. (Prop. Trading) (Feb. 2012); 416 See ICI (Feb. 2012); AFR et al. (Feb. 2012); because the fixed-income market is not as deep as RBC. Occupy; Alfred Brock. other markets, so underwriters frequently cannot 430 417 A banking entity may accumulate loans in sell bonds when they go to market; instead, the See AFR et al. (Feb. 2012); CalPERS; Occupy; anticipation of securitization because loans are not underwriters will retain the bonds until a sufficient Public Citizen; Goldman (Prop. Trading); Fidelity; financial instruments under the final rule. See amount of liquidity is available in the market. See Japanese Bankers Ass’n.; Sens. Merkley & Levin supra Part VI.A.1.c. id. (Feb. 2012); Alfred Brock. 431 418 See proposed rule § 75.4(a)(2)(v); Joint 427 See SIFMA et al. (Prop. Trading) (Feb. 2012); See AFR et al. (Feb. 2012); CalPERS; Occupy; Proposal, 76 FR at 68867; CFTC Proposal, 77 FR at BoA. Public Citizen; Alfred Brock. 8353. 428 See BoA; RBC; LSTA (Feb. 2012). One of these 432 See AFR et al. (Feb. 2012) (recognizing, 419 See supra Part VI.A.2.c.2.a. commenters stated that, in the case of securities however, that a small portion of an underwriting 420 See SIFMA et al. (Prop. Trading) (Feb. 2012); issued in lieu of or to refinance bridge loan may occasionally be ‘‘hung’’); CalPERS; Occupy BoA; BDA (Feb. 2012); RBC. Another commenter facilities, market conditions or investor demand (stating that a banking entity’s retention of unsold requested that this requirement be eliminated or may change during the period of time between allotments may result in potential conflicts of changed to ‘‘underwriting activities of the banking extension of the bridge commitment and when the interest). entity with respect to the covered financial position bridge loan is required to be funded or such 433 See AFR et al. (Feb. 2012). must be designed to meet the near-term demands securities are required to be issued. As a result, this 434 See Occupy (stating that the meaning of the of clients, customers, or counterparties.’’ See commenter requested that the near term demands term ‘‘substantial’’ would depend on the Japanese Bankers Ass’n. of clients, customers, or counterparties be measured circumstances of the particular offering).

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poses heightened financial risk at the want assistance in marketing their standard originates from section top of economic cycles.435 securities and customers who may wish 13(d)(1)(B) of the BHC Act, and a similar Other commenters indicated that to purchase the securities—with the requirement was included in the undue restrictions on an underwriter’s banking entity serving as an proposed rule.446 The Agencies are ability to retain a portion of an offering intermediary.441 Another commenter making certain modifications to the may result in certain harms to the indicated that an underwriting should proposed approach in response to capital-raising process. These likely be seen as a distribution of all, or comments. commenters represented that unclear or nearly all, of the securities related to a In particular, the Agencies are negative treatment of residual positions securitization (excluding any amount clarifying the operation of this will make banking entities averse to the required for credit risk retention requirement, particularly with respect to risk of an unsold allotment, which may purposes) along a time line designed not unsold allotments.447 Under this result in banking entities underwriting to exceed reasonably expected near term requirement, a trading desk must have smaller offerings, less capital generation demands of clients, customers, or a reasonable expectation of demand for issuers, or higher underwriting counterparties. According to the from other market participants for the discounts, which would increase the commenter, this approach would serve amount and type of securities to be cost of raising capital for businesses.436 to minimize the arbitrage and risk acquired from an issuer or selling One of these commenters suggested that concentration possibilities that can arise security holder for distribution.448 Such a banking entity be permitted to hold a through the securitization and sale of reasonable expectation may be based on residual position under the some tranches and the retention of other factors such as current market underwriting exemption as long as it tranches.442 conditions and prior experience with continues to take reasonable steps to One commenter expressed concern similar offerings of securities. A banking attempt to dispose of the residual that the proposed near term customer entity is not required to engage in book- position in light of existing market demand requirement may impact a building or similar marketing efforts to conditions.437 banking entity’s ability to act as primary determine investor demand for the In addition, in response to a question dealer because some primary dealers are securities pursuant to this requirement, in the proposal, one commenter obligated to bid on each issuance of a although such efforts may form the basis expressed the view that the rule should government’s sovereign debt, without for the trading desk’s reasonable not require documentation with respect regard to expected customer demand.443 expectation of demand. While an issuer to residual positions held by an Two other commenters expressed or selling security holder can be underwriter.438 In the case of general concern that the proposed considered to be a client, customer, or securitizations, one commenter stated underwriting exemption may be too counterparty of a banking entity acting that if the underwriter wishes to retain narrow to permit banking entities that as an underwriter for its distribution of some of the securities or bonds in its act as primary dealers in or for foreign securities, this requirement cannot be longer-term investment book, such jurisdictions to continue to meet the met by accounting solely for the issuer’s decisions should be made by a separate relevant jurisdiction’s primary dealer or selling security holder’s desire to sell officer, subject to different standards requirements.444 the securities.449 However, the and compensation.439 c. Final Near Term Customer Demand 446 The proposed rule required the underwriting Two commenters discussed how the Requirement near term customer demand activities of the banking entity with respect to the The final rule requires that the covered financial position to be designed not to requirement should apply in the context exceed the reasonably expected near term demands of a banking entity acting as an amount and types of the securities in of clients, customers, or counterparties. See underwriter for a securitization or the trading desk’s underwriting position proposed rule § 75.4(a)(2)(v). structured product.440 One of these be designed not to exceed the 447 See supra Part VI.A.2.c.2.b. (discussing reasonably expected near term demands commenters’ concerns that the proposed near term commenters indicated that the near term customer demand requirement may limit a banking demand requirement should be of clients, customers, or counterparties, entity’s ability to retain an unsold allotment). interpreted to require that a distribution and reasonable efforts be made to sell or 448 A banking entity may not structure a complex of securities facilitate pre-existing client otherwise reduce the underwriting instrument on its own initiative using the demand. This commenter stated that a position within a reasonable period, underwriting exemption. It may use the taking into account the liquidity, underwriting exemption only with respect to banking entity should not be considered distributions of securities that comply with the final to meet the terms of the proposed maturity, and depth of the market for rule. The Agencies believe this requirement 445 requirement if, on the firm’s own the relevant type of security. As addresses one commenter’s concern that a banking noted above, the near term demand entity could rely on the underwriting exemption initiative, it designs and structures a without regard to anticipated customer demand. complex, novel instrument and then See AFR et al. (Feb. 2012) In addition, a trading 441 seeks customers for the instrument, See AFR et al. (Feb. 2012). desk hedging the risks of an underwriting position 442 while retaining part of the issuance on See Sens. Merkley & Levin (Feb. 2012). in a complex, novel instrument must comply with 443 See Banco de Me´xico. its own book. The commenter further the hedging exemption in the final rule. 444 See SIFMA et al. (Prop. Trading) (Feb. 2012); 449 An issuer or selling security holder for emphasized that underwriting should IIB/EBF. One of these commenters represented that purposes of this rule may include, among others, involve two-way demand—clients who many banking entities serve as primary dealers in corporate issuers, sovereign issuers for which the jurisdictions in which they operate, and primary banking entity acts as primary dealer (or functional dealers often: (i) Are subject to minimum purchase 435 See CalPERS. equivalent), or any other person that is an issuer, and other obligations in the jurisdiction’s foreign as defined in final rule § 75.3(e)(9), or a selling 436 See Goldman (Prop. Trading); Fidelity sovereign debt; (ii) play important roles in security holder, as defined in final rule § 75.4(a)(5). (expressing concern that this may result in a more underwriting and market making in State, The Agencies believe that the underwriting concentrated supply of securities and, thus, provincial, and municipal debt issuances; and (iii) exemption in the final rule should generally allow decrease the opportunity for diversification in the act as intermediaries through which a government’s a primary dealer (or functional equivalent) to act as portfolios of shareholders’ funds). financial and monetary policies operate. This an underwriter for a sovereign government’s 437 See Goldman (Prop. Trading). commenter stated that, due to these considerations, issuance of its debt because, similar to other 438 See Japanese Bankers Ass’n. restrictions on the ability of banking entities to act underwriting activities, this involves a banking 439 See Sens. Merkley & Levin (Feb. 2012). as primary dealer are likely to harm the entity agreeing to distribute securities for an issuer 440 See AFR et al. (Feb. 2012); Sens. Merkley & governments they serve. See IIB/EBF. (in this case, the foreign sovereign) and engaging in Levin (Feb. 2012). 445 Final rule § 75.4(a)(2)(ii). a distribution of such securities. See SIFMA et al.

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expectation of demand does not require however, subject to the requirement to As a general matter, commenters a belief that the securities will be placed make reasonable efforts to sell or expressed differing views on whether an immediately. The time it takes to carry otherwise reduce the underwriting underwriter should be permitted to hold out a distribution may differ based on position.452 The definition of an unsold allotment for a certain period the liquidity, maturity, and depth of the ‘‘underwriting position’’ includes, of time after the initial distribution. For market for the type of security.450 among other things, any residual example, a few commenters suggested This requirement is not intended to position from the distribution that is that limitations on retaining an unsold prevent a trading desk from distributing managed by the trading desk. The final allotment would increase the cost of an offering over a reasonable time rule includes the requirement to make raising capital 454 or would negatively consistent with market conditions or reasonable efforts to sell or otherwise impact certain types of securities from retaining an unsold allotment of reduce the trading desk’s underwriting offerings (e.g., bought deals, rights the securities acquired from an issuer or position in order to respond to offerings, and fixed-income selling security holder where holding comments on the issue of when a offerings).455 Other commenters, such securities is necessary due to banking entity may retain an unsold however, expressed concern that the circumstances such as less-than- allotment when it is acting as an proposed exemption would allow a expected purchaser demand at a given underwriter, as discussed in more detail banking entity to retain a portion of a price.451 An unsold allotment is, below, and ensure that the exemption is distribution for speculative purposes.456 available only for activities that involve The Agencies believe the requirement (Prop. Trading) (Feb. 2012); IIB/EBF; Banco de underwriting activities, and not to make reasonable efforts to sell or Me´xico. A banking entity acting as primary dealer prohibited proprietary trading.453 otherwise reduce the underwriting (or functional equivalent) may also be able to rely on the market-making exemption or other position appropriately addresses both exemptions for some of its activities. See infra Part result of an outstanding bridge loan, is able to sets of comments. More specifically, this VI.A.3.c.2.c. The final rule defines ‘‘client, qualify for the underwriting exemption, a stringent standard clarifies that an underwriter customer, or counterparty’’ for purposes of the interpretation of the near term demand requirement generally may retain an unsold underwriting exemption as ‘‘market participants could prevent a banking entity from retaining such that may transact with the banking entity in securities if market conditions are suboptimal or allotment that it was unable to sell to connection with a particular distribution for which marketing efforts are not entirely successful. See purchasers as part of the initial the banking entity is acting as underwriter.’’ Final RBC; BoA; LSTA (Feb. 2012). In response to one distribution of securities, provided it rule § 75.4(a)(7). commenter’s request that the Agencies allow a had a reasonable expectation of buying 450 banking entity to assess near term demand at the One commenter stated that, in the case of a interest and engaged in reasonable securitization, an underwriting should be seen as a time of the initial extension of the bridge 457 distribution of all, or nearly all, of the securities commitment, the Agencies believe it could be selling efforts. This should reduce the related to a securitization (excluding the amount appropriate to determine whether the banking potential for the negative impacts of a required for credit risk retention purposes) along a entity has a reasonable expectation of demand from more stringent approach predicted by other market participants for the amount and type time line designed not to exceed the reasonably commenters, such as increased fees for expected near term demands of clients, customers, of securities to be acquired at that time, but note or counterparties. See Sens. Merkley & Levin (Feb. that the trading desk would continue to be subject underwriting, greater costs to businesses 2012). The final rule’s near term customer demand to the requirement to make reasonable efforts to sell for raising capital, and potential fire requirement considers the liquidity, maturity, and the resulting underwriting position at the time of sales of unsold allotments.458 However, the initial distribution and for the remaining time depth of the market for the type of security and to address concerns that a banking recognizes that the amount of time a trading desk the securities are in its inventory. See LSTA (Feb. may need to hold an underwriting position may 2012). entity may retain an unsold allotment vary based on these factors. The final rule does not, 452 The Agencies believe that requiring a trading for purely speculative purposes, the however, adopt a standard that applies differently desk to make reasonable efforts to sell or otherwise Agencies are requiring that reasonable based solely on the particular type of security being reduce its underwriting position addresses efforts be made to sell or otherwise distributed (e.g., an asset-backed security versus an commenters’ concerns about the risks associated equity security) or that precludes certain types of with unsold allotments or the retention of securities from being distributed by a banking entity underwritten instruments because this requirement residual position in light of existing market acting as an underwriter in accordance with the is designed to prevent a trading desk from retaining conditions). In addition, allowing an underwriter to requirements of this exemption because the an unsold allotment for speculative purposes when retain an unsold allotment under certain Agencies believe the statute is best read to permit there is customer buying interest for the relevant circumstances is consistent with the proposal. See a banking entity to engage in underwriting activity security at commercially reasonable prices. Thus, Joint Proposal, 76 FR at 68867 (‘‘There may be to facilitate distributions of securities by issuers and the Agencies believe this obviates the need for circumstances in which an underwriter would hold selling security holders, regardless of type, to certain additional requirements suggested by securities that it could not sell in the distribution provide client-oriented financial services. That commenters. See, e.g., Occupy; AFR et al. (Feb. for investment purposes. If the acquisition of such reading is consistent with the statute’s language and 2012); CalPERS. The final rule strikes an unsold securities were in connection with the finds support in the legislative history. See 156 appropriate balance between the concerns raised by underwriting pursuant to the permitted Cong. Rec. S5895–S5896 (daily ed. July 15, 2010) these commenters and those noted by other underwriting activities exemption, the underwriter (statement of Sen. Merkley) (stating that the commenters regarding the potential market impacts would also be able to dispose of such securities at underwriting exemption permits ‘‘transactions that of strict requirements against holding an unsold a later time.’’); CFTC Proposal, 77 FR at 8352. A are technically trading for the account of the firm allotment, such as higher fees to underwriting number of commenters raised questions about but, in fact, facilitate the provision of near-term clients, fire sales of unsold allotments, or general whether the rule would permit retaining an unsold client-oriented financial services’’). In addition, reluctance to participate in any distribution that allotment. See Goldman (Prop. Trading); Fidelity; with respect to this commenter’s statement presents a risk of an unsold allotment. The SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; RBC; regarding credit risk retention requirements, the requirement to make reasonable efforts to sell or AFR et al. (Feb. 2012); CalPERS; Occupy; Public Agencies note that compliance with the credit risk otherwise reduce the underwriting position should Citizen; Alfred Brock. retention requirements of Section 15G of the not cause the market impacts predicted by these 454 See Goldman (Prop. Trading); Fidelity. Exchange Act would not impact the availability of commenters because it does not prevent an 455 See SIFMA et al. (Prop. Trading) (Feb. 2012); the underwriting exemption in the final rule. underwriter from retaining an unsold allotment for BoA; RBC. 451 This approach should help address a reasonable period or impose strict holding period 456 See AFR et al. (Feb. 2012); CalPERS; Occupy; commenters’ concerns that an inflexible limits on unsold allotments. See SIFMA et al. (Prop. Public Citizen; Alfred Brock. interpretation of the near term demand requirement Trading) (Feb. 2012); RBC; Goldman (Prop. 457 To the extent that an AP for an ETF is able could result in fire sales, higher fees for Trading); Fidelity. to meet the terms of the underwriting exemption for underwriting services, or reluctance to act as an 453 This approach is generally consistent with one its activity, it may be able to retain ETF shares that underwriter for certain types of distributions that commenter’s suggested approach to addressing the it created if it had a reasonable expectation of present a greater risk of unsold allotments. See issue of unsold allotments. See, e.g., Goldman buying interest in the ETF shares and engages in SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. (Prop. Trading) (suggesting that a banking entity be reasonable efforts to sell the ETF shares. See SIFMA Further, the Agencies believe this should reduce permitted to hold a residual position under the et al. (Prop. Trading) (Feb. 2012); BoA. commenters’ concerns that, to the extent a delayed underwriting exemption as long as it continues to 458 See Goldman (Prop. Trading); Fidelity; SIFMA distribution of securities, which are acquired as a take reasonable steps to attempt to dispose of the et al. (Prop. Trading) (Feb. 2012); RBC.

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reduce the underwriting position, which also apply in situations where the banking entity relying on the includes any unsold allotment, within a underwriters sell securities in excess of underwriting exemption would have reasonable period. The Agencies agree the number of securities to which the reasonably designed written policies with these commenters that systematic underwriting commitment relates, and procedures, internal controls, and retention of an underwriting position, resulting in a syndicate short position in independent testing in place to support without engaging in efforts to sell the the same class of securities that were the its compliance with the terms of the position and without regard to whether subject of the distribution.461 This exemption.464 provision of the final exemption would the trading desk is able to sell the b. Comments on the Proposed require reasonable efforts to reduce any securities at a commercially reasonable Compliance Program Requirement price, would be indicative of portion of the syndicate short position impermissible proprietary trading attributable to the banking entity that is Commenters did not directly address intent.459 The Agencies recognize that acting as an underwriter. Such the proposed compliance program the meaning of ‘‘reasonable period’’ may reduction could be accomplished if, for requirement in the underwriting differ based on the liquidity, maturity, example, the managing underwriter exemption. Comments on the proposed and depth of the market for the relevant exercises an overallotment option or compliance program requirement of § 75.20 of the proposed rule are type of securities. For example, an shares are purchased in the secondary discussed in Part VI.C., below. underwriter may be more likely to retain market to cover the short position. an unsold allotment in a bond offering The near term demand requirement, c. Final Compliance Program because liquidity in the fixed-income including the requirement to make Requirement market is generally not as deep as that reasonable efforts to reduce the underwriting position, represents a new The final rule includes a compliance in the equity market. If a trading desk regulatory requirement for banking program requirement that is similar to retains an underwriting position for a entities engaged in underwriting. At the the proposed requirement, but the period of time after the distribution, the margins, this requirement could alter Agencies are making certain trading desk must manage the risk of its the participation decision for some enhancements to emphasize the underwriting position in accordance banking entities with respect to certain importance of a strong internal with its inventory and risk limits and types of distributions, such as compliance program. More specifically, authorization procedures. As discussed distributions that are more likely to the final rule requires that a banking above, hedging transactions undertaken result in the banking entity retaining an entity’s compliance program specifically in connection with such risk underwriting position for a period of include reasonably designed written management activities must be time.462 However, the Agencies policies and procedures, internal conducted in compliance with the recognize that liquidity, maturity, and controls, analysis and independent hedging exemption in § 75.5 of the final depth of the market vary across types of testing 465 identifying and addressing: (i) rule. securities, and the Agencies expect that The products, instruments or exposures The Agencies emphasize that the the express recognition of these each trading desk may purchase, sell, or requirement to make reasonable efforts differences in the rule should help manage as part of its underwriting to sell or otherwise reduce the mitigate any incentive to exit the activities; 466 (ii) limits for each trading underwriting position applies to the underwriting business for certain types desk, based on the nature and amount entirety of the trading desk’s of securities or types of distributions. of the trading desk’s underwriting underwriting position. As a result, this activities, including the reasonably 3. Compliance Program Requirement requirement applies to a number of expected near term demands of clients, different scenarios in which an a. Proposed Compliance Program customers, or counterparties; 467 (iii) underwriter may hold a long or short Requirement internal controls and ongoing position in the securities that are the Section 75.4(a)(2)(i) of the proposed monitoring and analysis of each trading 468 subject of a distribution for a period of exemption required a banking entity to desk’s compliance with its limits; time. For example, if an underwriter is establish an internal compliance and (iv) authorization procedures, facilitating a distribution of securities program, as required by § 75.20 of the including escalation procedures that for which there is sufficient investor proposed rule, that is designed to ensure require review and approval of any demand to purchase the securities at the the banking entity’s compliance with trade that would exceed one or more of offering price, this requirement would the requirements of the underwriting a trading desk’s limits, demonstrable prevent the underwriter from retaining exemption, including reasonably analysis of the basis for any temporary a portion of the allotment for its own designed written policies and or permanent increase to one or more of account instead of selling the securities procedures, internal controls, and a trading desk’s limits, and independent to interested investors. If instead there independent testing.463 This review (i.e., by risk managers and was insufficient investor demand at the requirement was proposed so that any compliance officers at the appropriate time of the initial offering, this level independent of the trading desk) of requirement would recognize that it securities laws and regulations, but is otherwise may be appropriate for the underwriter permitted under the underwriting exemption. 464 See Joint Proposal, 76 FR at 68866; CFTC to hold an unsold allotment for a 461 See supra note 408. Proposal, 77 FR at 8352. 462 465 The independent testing standard is discussed reasonable period of time. Under these For example, some commenters suggested that the proposed underwriting exemption could have a in more detail in Part VI.C., which discusses the circumstances, the underwriter would chilling effect on banking entities’ willingness to compliance program requirement in § 75.20 of the need to make reasonable efforts to sell engage in underwriting activities. See, e.g., Lord final rule. the unsold allotment when there is Abbett; Fidelity. Further, some commenters 466 See final rule § 75.4(a)(2)(iii)(A). sufficient market demand for the expressed concern that the proposed near term 467 See final rule § 75.4(a)(2)(iii)(B). A trading 460 customer demand requirement might negatively desk must have limits on the amount, types, and securities. This requirement would impact certain forms of capital-raising if the risk of the securities in its underwriting position, requirement is interpreted narrowly or inflexibly. level of exposures to relevant risk factors arising 459 See AFR et al. (Feb. 2012); CalPERS; Occupy. See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; from its underwriting position, and period of time 460 The trading desk’s retention and sale of the BDA (Feb. 2012); RBC. a security may be held. See id. unsold allotment must comply with the Federal 463 See proposed rule § 75.4(a)(2)(i). 468 See final rule § 75.4(a)(2)(iii)(C).

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such demonstrable analysis and products, instruments, and exposures analysis that the basis for any temporary approval.469 will help form the basis for the specific or permanent increase to one or more of As noted above, the proposed types of position and risk limits that the a trading desk’s limits is consistent with compliance program requirement did banking entity must establish and is the near term customer demand not include the four specific elements relevant to considerations throughout requirement, and independent review of listed above in the proposed the exemption regarding the liquidity, such demonstrable analysis and underwriting exemption, although each maturity, and depth of the market for approval.474 Thus, to increase a limit of of these provisions was included in the relevant type of security. a trading desk, there must be an analysis some form in the detailed compliance A trading desk must have limits on of why such increase would be program requirement under Appendix C the amount, types, and risk of the appropriate based on the reasonably of the proposed rule.470 The Agencies securities in its underwriting position, expected near term demands of clients, are moving these particular level of exposures to relevant risk customers, or counterparties, which requirements, with certain factors arising from its underwriting must be independently reviewed. A enhancements, into the underwriting position, and period of time a security banking entity also must maintain exemption because the Agencies believe may be held. Limits established under documentation and records with respect these are core elements of a program to this provision, and any modifications to to these elements, consistent with the ensure compliance with the these limits made through the required requirement of § 75.20(b)(6). underwriting exemption. These escalation procedures, must account for As discussed in more detail in Part compliance procedures must be the nature and amount of the trading VI.C., the Agencies recognize that the established, implemented, maintained, desk’s underwriting activities, including compliance program requirements in and enforced for each trading desk the reasonably expected near term the final rule will impose certain costs engaged in underwriting activity under demands of clients, customers, or on banking entities but, on balance, the § 75.4(a) of the final rule. Each of the counterparties. Among other things, Agencies believe such requirements are requirements in paragraphs (a)(2)(iii)(A) these limits should be designed to necessary to facilitate compliance with through (D) must be appropriately prevent a trading desk from the statute and the final rule and to tailored to the individual trading systematically retaining unsold reduce the risk of evasion.475 activities and strategies of each trading allotments even when there is customer desk. demand for the positions that remain in 4. Compensation Requirement The compliance program requirement the trading desk’s inventory. The a. Proposed Compensation Requirement in the underwriting exemption is Agencies recognize that trading desks’ substantially similar to the compliance limits may differ across types of Another provision of the proposed program requirement in the market- securities and acknowledge that trading underwriting exemption required that making exemption, except that the desks engaged in underwriting activities the compensation arrangements of Agencies are requiring more detailed in less liquid securities, such as persons performing underwriting risk management procedures in the corporate bonds, may require different activities at the banking entity must be market-making exemption due to the inventory, risk exposure, and holding designed not to encourage proprietary nature of that activity.471 The Agencies period limits than trading desks engaged risk-taking.476 In connection with this believe including similar compliance in underwriting activities in more liquid requirement, the proposal clarified that program requirements in the securities, such as certain equity although a banking entity relying on the underwriting and market-making securities. A trading desk hedging the underwriting exemption may exemptions may reduce burdens risks of an underwriting position must appropriately take into account associated with building and comply with the hedging exemption, revenues resulting from movements in maintaining compliance programs for which provides for compliance the price of securities that the banking each trading desk. procedures regarding risk entity underwrites to the extent that Identifying in the compliance management.472 such revenues reflect the effectiveness program the relevant products, Furthermore, a banking entity must with which personnel have managed instruments, and exposures in which a establish internal controls and ongoing underwriting risk, the banking entity trading desk is permitted to trade will monitoring and analysis of each trading should provide compensation facilitate monitoring and oversight of desk’s compliance with its limits, incentives that primarily reward client compliance with the underwriting including the frequency, nature, and revenues and effective client service, exemption. For example, this extent of a trading desk exceeding its not proprietary risk-taking.477 473 requirement should prevent an limits. This may include the use of b. Comments on the Proposed individual trader on an underwriting management and exception reports. Compensation Requirement desk from establishing positions in Moreover, the compliance program must instruments that are unrelated to the set forth a process for determining the A few commenters expressed general desk’s underwriting function. Further, circumstances under which a trading support for the proposed requirement, the identification of permissible desk’s limits may be modified on a but suggested certain modifications that temporary or permanent basis (e.g., due they believed would enhance the 469 See final rule § 75.4(a)(2)(iii)(D). to market changes). requirement and make it more 470 See Joint Proposal, 76 FR at 68963–68967 As noted above, a banking entity’s effective.478 Specifically, one (requiring certain banking entities to establish, compliance program for trading desks maintain, and enforce compliance programs with, 474 among other things: (i) Written policies and engaged in underwriting activity must See final rule § 75.4(a)(2)(iii)(D). procedures that describe a trading unit’s authorized also include escalation procedures that 475 See Part VI.C. (discussing the compliance instruments and products; (ii) internal controls for require review and approval of any program requirement in § 75.20 of the final rule). each trading unit, including risk limits for each trade that would exceed one or more of 476 See proposed rule § 75.4(a)(2)(vii); Joint trading unit and surveillance procedures; and (iii) Proposal, 76 FR at 68868; CFTC Proposal, 77 FR at a management framework, including management a trading desk’s limits, demonstrable 8353. procedures for overseeing compliance with the 477 See id. proposed rule). 472 See final rule § 75.5. 478 See Occupy; AFR et al. (Feb. 2012); Better 471 See final rule §§ 75.4(a)(2)(iii), 75.4(b)(2)(iii). 473 See final rule § 75.4(a)(2)(iii)(C). Markets (Feb. 2012).

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commenter suggested tailoring the The Agencies are not adopting an dealer.485 Further, if the banking entity requirement to underwriting activity by, approach that prevents an employee was engaged in the business of a dealer for example, ensuring that personnel from receiving any compensation outside the United States in a manner involved in underwriting are given related to profits arising from an unsold for which no U.S. registration is compensation incentives for the allotment, as suggested by one required, the proposed rule would have successful distribution of securities off commenter, because the Agencies required the banking entity to be subject the firm’s balance sheet and are not believe the final rule already includes to substantive regulation of its dealing rewarded for profits associated with sufficient controls to prevent a trading business in the jurisdiction in which the securities that are not successfully desk from intentionally retaining an business is located. distributed (although losses from such unsold allotment to make a speculative b. Comments on Proposed Registration positions should be taken into profit when such allotment could be Requirement consideration in determining the sold to customers.482 The Agencies also Commenters generally did not address employee’s compensation). This are not requiring compensation to be the proposed dealer requirement in the commenter further recommended that vested for a period of time, as underwriting exemption. However, as bonus compensation for a deal be recommended by one commenter to withheld until all or a high percentage discussed below in Part VI.A.3.c.2.b., a reduce traders’ incentives for undue number of commenters addressed a of the relevant securities are risk-taking. The Agencies believe the distributed.479 Finally, one commenter similar requirement in the proposed final rule includes sufficient controls market-making exemption. suggested that the term ‘‘designed’’ around risk-taking activity without a should be removed from this compensation vesting requirement c. Final Registration Requirement provision.480 because a banking entity must establish The requirement in § 75.4(a)(2)(vi) of c. Final Compensation Requirement limits for a trading desk’s underwriting the underwriting exemption, which position and the trading desk must provides that the banking entity must be Similar to the proposed rule, the make reasonable efforts to sell or licensed or registered to engage in underwriting exemption in the final rule otherwise reduce the underwriting underwriting activity in accordance requires that the compensation position within a reasonable period.483 with applicable law, is substantively arrangements of persons performing the The Agencies continue to believe it is similar to the proposed dealer banking entity’s underwriting activities, registration requirement in as described in the exemption, be appropriate to focus on the design of a § 75.4(a)(2)(iv) of the proposed rule. The designed not to reward or incentivize banking entity’s compensation primary difference between the prohibited proprietary trading.481 The structure, so the Agencies are not proposed requirement and the final Agencies do not intend to preclude an removing the term ‘‘designed’’ from this 484 requirement is that the Agencies have employee of an underwriting desk from provision. This retains an objective simplified the language of the rule. The being compensated for successful focus on actions that the banking entity Agencies have also made conforming underwriting, which involves some risk- can control—the design of its incentive changes to the corresponding taking. compensation program—and avoids a requirement in the market-making Consistent with the proposal, subjective focus on whether an employee feels incentivized by exemption to promote consistency activities for which a banking entity has across the exemptions, where established a compensation incentive compensation, which may be more difficult to assess. In addition, the appropriate.486 structure that rewards speculation in, As was proposed, this provision will and appreciation of, the market value of framework of the final compensation requirement will allow banking entities require a U.S. banking entity to be an securities underwritten by the banking SEC-registered dealer in order to rely on entity are inconsistent with the to better plan and control the design of their compensation arrangements, the underwriting exemption in underwriting exemption. A banking connection with a distribution of entity may, however, take into account which should reduce costs and uncertainty and enhance monitoring, securities—other than exempted revenues resulting from movements in securities, security-based swaps, than an approach focused solely on the price of securities that the banking commercial paper, bankers acceptances individual outcomes. entity underwrites to the extent that or commercial bills—unless the banking such revenues reflect the effectiveness 5. Registration Requirement entity is exempt from registration or with which personnel have managed excluded from regulation as a dealer.487 a. Proposed Registration Requirement underwriting risk. The banking entity To the extent that a banking entity relies should provide compensation on the underwriting exemption in incentives that primarily reward client Section 75.4(a)(2)(iv) of the proposed rule would have required that a banking revenues and effective client services, 485 entity have the appropriate dealer See proposed rule § 75.4(a)(2)(iv); Joint not prohibited proprietary trading. For Proposal, 76 FR at 68867; CFTC Proposal, 77 FR at example, a compensation plan based registration or be exempt from 8353. The proposal clarified that, in the case of a purely on net profit and loss with no registration or excluded from regulation financial institution that is a government securities as a dealer to the extent that, in order dealer, such institution must have filed notice of consideration for inventory control or that status as required by section 15C(a)(1)(B) of the risk undertaken to achieve those profits to underwrite the security at issue, a Exchange Act. See Joint Proposal, 76 FR at 68867; would not be consistent with the person must generally be a registered CFTC Proposal, 77 FR at 8353. underwriting exemption. securities dealer, municipal securities 486 See Part VI.A.3.c.6. (discussing the registration dealer, or government securities requirement in the market-making exemption). 487 For example, if a banking entity is a bank 479 See AFR et al. (Feb. 2012). engaged in underwriting asset-backed securities for 480 See Occupy. 482 See AFR et al. (Feb. 2012); supra Part which it would be required to register as a 481 See final rule § 75.4(a)(2)(iv); proposed rule VI.A.2.c.2.c. (discussing the requirement to make securities dealer but for the exclusion contained in § 75.4(a)(2)(vii). This is consistent with the final reasonable efforts to sell or otherwise reduce the section 3(a)(5)(C)(iii) of the Exchange Act, the final compensation requirements in the market-making underwriting position). rule would not require the banking entity to be a and hedging exemptions. See final rule 483 See AFR et al. (Feb. 2012). registered securities dealer to underwrite the asset- § 75.4(b)(2)(v); final rule § 75.5(b)(3). 484 See Occupy. backed securities. See 15 U.S.C. 78c(a)(5)(C)(iii).

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connection with a distribution of compensate the underwriter for its large and risky positions with municipal securities or government services.490 This requirement provided significant market exposure.495 securities, rather than the exemption in that activities conducted in reliance on To strengthen the proposed § 75.6(a) of the final rule, this provision the underwriting exemption should requirement, one commenter requested may require the banking entity to be demonstrate patterns of revenue that the terms ‘‘designed’’ and registered or licensed as a municipal generation and profitability consistent ‘‘primarily’’ be removed and replaced by securities dealer or government with, and related to, the services an the word ‘‘solely.’’ 496 Two other securities dealer, if required by underwriter provides to its customers in commenters requested that this applicable law. However, this provision bringing securities to market, rather requirement be interpreted to prevent a does not require a banking entity to than changes in the market value of the banking entity from acting as an register in order to qualify for the underwritten securities.491 underwriter for a distribution of underwriting exemption if the banking securities if such securities lack a entity is not otherwise required to b. Comments on the Proposed Source of discernible and sufficiently liquid pre- register by applicable law. Revenue Requirement existing market and a foreseeable market The Agencies have determined that, price.497 for purposes of the underwriting A few commenters requested certain c. Final Rule’s Approach To Assessing exemption, rather than require a modifications to the proposed source of Source of Revenue banking entity engaged in the business revenue requirement. These of a securities dealer outside the United commenters’ suggested revisions were The Agencies believe the final rule States to be subject to substantive generally intended either to refine the includes sufficient controls around an regulation of its dealing business in the standard to better account for certain underwriter’s source of revenue and jurisdiction in which the business is activities or to make it more have determined not to adopt the located, a banking entity’s dealing stringent.492 Three commenters additional requirement included in activity outside the U.S. should only be expressed concern that the proposed proposed rule § 75.4(a)(2)(vi). The subject to licensing or registration source of revenue requirement would Agencies believe that removing this provisions if required under applicable negatively impact a banking entity’s requirement addresses commenters’ foreign law (provided no U.S. ability to act as a primary dealer or in concerns that the proposed requirement registration or licensing requirements a similar capacity.493 did not appropriately reflect certain apply to the banking entity’s activities). With respect to suggested revenue sources from underwriting 498 In response to comments, the final rule modifications, one commenter activity or may impact primary 499 recognizes that certain foreign recommended that ‘‘customer revenue’’ dealer activities. At the same time, jurisdictions may not provide for include revenues attributable to the final rule continues to include substantive regulation of dealing syndicate activities, hedging activities, provisions that focus on whether an 488 businesses. The Agencies do not and profits and losses from sales of underwriter is generating underwriting- believe it is necessary to preclude residual positions, as long as the related revenue and that should limit an banking entities from engaging in underwriter makes a reasonable effort to underwriter’s ability to generate underwriting activities in such foreign dispose of any residual position in light revenues purely from price jurisdictions to achieve the goals of of existing market conditions.494 appreciation. In particular, the section 13 of the BHC Act because these Another commenter indicated that the requirement to make reasonable efforts banking entities would continue to be rule would better address securitization to sell or otherwise reduce the subject to the other requirements of the if it required compensation to be linked underwriting position within a underwriting exemption. in part to risk minimization for the reasonable period, which was not included in the proposed rule, should 6. Source of Revenue Requirement securitizer and in part to serving customers. This commenter suggested limit an underwriter’s ability to gain a. Proposed Source of Revenue that such a framework would be revenues purely from price appreciation Requirement preferable because, in the context of related to its underwriter position. Under § 75.4(a)(2)(vi) of the proposed securitizations, fee-based compensation Similarly, the determination of whether rule, the underwriting activities of a structures did not previously prevent an underwriter receives special banking entity would have been banking entities from accumulating compensation for purposes of the required to be designed to generate definition of ‘‘distribution’’ takes into account whether a banking entity is revenues primarily from fees, 490 See Joint Proposal, 76 FR at 68867–68868 commissions, underwriting spreads, or n.142; CFTC Proposal, 77 FR at 8353 n.148. generating underwriting-related other income not attributable to 491 See Joint Proposal, 76 FR at 68867–68868; revenue. appreciation in the value of covered CFTC Proposal, 77 FR at 8353. The final rule does not adopt a financial positions or hedging of 492 See Goldman (Prop. Trading); Occupy; Sens. requirement that prevents an covered financial positions.489 The Merkley & Levin (Feb. 2012). underwriter from generating any 493 See Banco de Me´xico (stating that primary revenue from price appreciation out of proposal clarified that underwriting dealers need to profit from resulting proprietary spreads would include any ‘‘gross positions in foreign sovereign debt, including by concern that such a requirement could spread’’ (i.e., the difference between the holding significant positions in anticipation of prevent an underwriter from retaining price an underwriter sells securities to future price movements, in order to make the an unsold allotment under any primary dealer business financially attractive); IIB/ the public and the price it purchases EBF (noting that primary dealers may actively seek 495 them from the issuer) designed to to profit from price and interest rate movements of See Sens. Merkley & Levin (Feb. 2012). their holdings, which the relevant sovereign entity 496 See Occupy (requesting that the rule require 488 See infra Part VI.A.3.c.6.c. (discussing supports because such activity provides much- automatic disgorgement of any profits arising from comments on this issue with respect to the needed liquidity for securities that are otherwise appreciation in the value of positions in connection proposed dealer registration requirement in the largely purchased pursuant to buy-and-hold with underwriting activities). market-making exemption). strategies by institutional investors and other 497 See AFR et al. (Feb. 2012); Public Citizen. 489 See proposed rule § 75.4(a)(2)(vi); Joint entities seeking safe returns and liquidity buffers); 498 See Goldman (Prop. Trading). Proposal, 76 FR at 68867–68868; CFTC Proposal, 77 Japanese Bankers Ass’n. 499 See Banco de Me´xico; IIB/EBF; Japanese FR at 8353. 494 See Goldman (Prop. Trading). Bankers Ass’n.

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circumstances, which would be risk controls for their market making- proposed to distinguish between inconsistent with other provisions of the related activities. A flexible approach to permitted market making-related exemption.500 Similarly, the Agencies this exemption is appropriate because activity and prohibited proprietary are not adopting a source of revenue the activities a market maker undertakes trading in proposed Appendix B, and a requirement that would prevent a to provide important intermediation and compliance regime in proposed § 75.20 banking entity from acting as liquidity services will differ based on and, where applicable, Appendix C of underwriter for a distribution of the liquidity, maturity, and depth of the the proposal. This multi-faceted securities if such securities lack a market for a given type of financial approach was intended to address the discernible and sufficiently liquid pre- instrument. The statute specifically complexities of differentiating permitted existing market and a foreseeable market permits banking entities to continue to market making-related activities from price, as suggested by two provide these beneficial services to their prohibited proprietary trading.507 commenters.501 The Agencies believe clients, customers, and these commenters’ concern is mitigated counterparties.505 Thus, the Agencies 2. Comments on the Proposed Market- by the near term demand requirement, are adopting an approach that Making Exemption which requires a trading desk to have a recognizes the full scope of market The Agencies received significant reasonable expectation of demand from making-related activities banking comment regarding the proposed other market participants for the amount entities currently undertake and market-making exemption. In this Part, and type of securities to be acquired requires that these activities be subject the Agencies highlight the main issues, from an issuer or selling security holder to clearly defined, verifiable, and concerns, and suggestions raised by for distribution.502 Further, one monitored risk parameters. commenters with respect to the commenter recommended a revenue b. Overview proposed market-making exemption. As requirement directed at securitization discussed in greater detail below, activities to prevent banking entities 1. Proposed Market-Making Exemption commenters’ views on the effectiveness from accumulating large and risky Section 13(d)(1)(B) of the BHC Act of the proposed exemption varied. positions with significant market provides an exemption from the Commenters discussed a broad range of exposure.503 The Agencies believe the prohibition on proprietary trading for topics related to the proposed market- requirement to make reasonable efforts the purchase, sale, acquisition, or making exemption including, among to sell or otherwise reduce the disposition of securities, derivatives, others: The overall scope of the underwriting position should achieve contracts of sale of a commodity for proposed exemption and potential this stated goal and, thus, the Agencies future delivery, and options on any of restrictions on market making in certain do not believe an additional revenue the foregoing in connection with market markets or asset classes; the potential requirement for securitization activity is making-related activities, to the extent market impact of the proposed market- needed.504 that such activities are designed not to making exemption; the appropriate level exceed the reasonably expected near of analysis for compliance with the term demands of clients, customers, or proposed exemption; the effectiveness 3. Section 75.4(b): Market-Making counterparties.506 of the individual requirements of the Exemption Section 75.4(b) of the proposed rule proposed exemption; and specific a. Introduction would have implemented this statutory activities that should or should not be exemption by requiring that a banking In adopting the final rule, the considered permitted market making- entity’s market making-related activities Agencies are striving to balance two related activity under the rule. comply with seven standards. As goals of section 13 of the BHC Act: To discussed in the proposal, these a. Comments on the Overall Scope of allow market making, which is the Proposed Exemption important to well-functioning markets standards were designed to ensure that as well as to the economy, and any banking entity relying on the With respect to the general scope of simultaneously to prohibit proprietary exemption would be engaged in bona the exemption, a number of commenters trading, unrelated to market making or fide market making-related activities expressed concern that the proposed other permitted activities, that poses and, further, would conduct such approach to implementing the market- significant risks to banking entities and activities in a way that was not making exemption is too narrow or the financial system. In response to susceptible to abuse through the taking restrictive, particularly with respect to comments on the proposed market- of speculative, proprietary positions as less liquid markets. These commenters making exemption, the Agencies are a part of, or mischaracterized as, market expressed concern that the proposed adopting certain modifications to the making-related activities. The Agencies exemption would not be workable in proposed exemption to better account proposed to use additional regulatory many markets and asset classes and for the varying characteristics of market and supervisory tools in conjunction does not take into account how market- making-related activities across markets with the proposed market-making making services are provided in those and asset classes, while requiring that exemption, including quantitative markets and asset classes.508 Some banking entities maintain a robust set of measurements for banking entities engaged in significant covered trading 507 See Joint Proposal, 76 FR at 68869; CFTC Proposal, 77 FR at 8354–8355. 500 See Occupy; supra Part VI.A.2.c.2. (discussing activity in proposed Appendix A, 508 See, e.g., SIFMA et al. (Prop. Trading) (Feb. comments on unsold allotments and the commentary on how the Agencies 2012) (stating that the proposed exemption ‘‘seems requirement in the final rule to make reasonable to view market making based on a liquid, exchange- efforts to sell or otherwise reduce the underwriting 505 As discussed in Part VI.A.3.c.2.c.i., infra, the traded equity model in which market makers are position). terms ‘‘client,’’ ‘‘customer,’’ and ‘‘counterparty’’ are simple intermediaries akin to agents’’ and that 501 See AFR et al. (Feb. 2012); Public Citizen. defined in the same manner in the final rule. Thus, ‘‘[t]his view does not fit market making even in 502 See supra Part VI.A.2.c.2. the Agencies use these terms synonymously equity markets and widely misses the mark for the 503 See Sens. Merkley & Levin (Feb. 2012). throughout this discussion and sometimes use the vast majority of markets and asset classes’’); SIFMA 504 See final rule § 75.4(a)(2)(ii). Further, as noted term ‘‘customer’’ to refer to all entities that meet the (Asset Mgmt.) (Feb. 2012); Credit Suisse (Seidel); above, this exemption does not permit the definition of ‘‘client, customer, and counterparty’’ ICI (Feb. 2012); BoA; Columbia Mgmt.; Comm. on accumulation of assets for securitization. See supra in the final rule’s market-making exemption. Capital Markets Regulation; Invesco; ASF (Feb. Part VI.A.2.c.1.c.v. 506 12 U.S.C. 1851(d)(1)(B). 2012) (‘‘The seven criteria in the proposed rule, and

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commenters expressed particular A number of commenters expressed the Other commenters were of the view concern that the proposed exemption view that the proposed exemption is that it is possible to differentiate may restrict or limit certain activities inconsistent with Congressional intent between prohibited proprietary trading currently conducted by market makers because it would restrict and reduce and permitted market making-related (e.g., holding inventory or interdealer banking entities’ current market making- activity.519 For example, one commenter trading).509 Several commenters stated related activities.513 stated that, while the analysis may that the proposed exemption would Other commenters, however, stated involve subtle distinctions, the create too much uncertainty regarding that the proposed exemption was too fundamental difference between a compliance 510 and, further, may have a broad and recommended that the rule banking entity’s market-making chilling effect on banking entities’ place greater restrictions on market activities and proprietary trading market making-related activities.511 Due making, particularly in illiquid, activities is the emphasis in market to the perceived restrictions and nontransparent markets.514 Many of making on seeking to meet customer burdens of the proposed exemption, these commenters suggested that the needs on a consistent and reliable basis many commenters indicated that the exemption should only be available for throughout a market cycle.520 According rule may change the way in which traditional market-making activity in to another commenter, holding market-making services are provided.512 relatively safe, ‘‘plain vanilla’’ substantial securities in a trading book instruments.515 Two commenters for an extended period of time assumes the related criterion for identifying permitted represented that the proposed the character of a proprietary position hedging, are overly restrictive and will make it exemption would have little to no and, while there may be occasions when impractical for dealers to continue making markets impact on banking entities’ current in most securitized products.’’); Chamber (Feb. a customer-oriented purchase and 516 2012) (expressing particular concern about the market making-related services. subsequent sale extend over days and commercial paper market). Commenters expressed differing cannot be more quickly executed or 509 Several commenters stated that the proposed views regarding the ease or difficulty of hedged, substantial holdings of this rule would limit a market maker’s ability to distinguishing permitted market character should be relatively rare and maintain inventory. See, e.g., NASP; Oliver Wyman 521 (Dec. 2011); Wellington; Prof. Duffie; Standish making-related activity from prohibited limited to less liquid markets. Mellon; MetLife; Lord Abbett; NYSE Euronext; proprietary trading. A number of Several commenters expressed CIEBA; British Columbia; SIFMA et al. (Prop. commenters represented that it is general concern that the proposed Trading) (Feb. 2012); Shadow Fin. Regulatory difficult or impossible to distinguish exemption may be applied on a Comm.; Credit Suisse (Seidel); Morgan Stanley; Goldman (Prop. Trading); BoA; STANY; SIFMA prohibited proprietary trading from transaction-by-transaction basis and (Asset Mgmt.) (Feb. 2012); Chamber (Feb. 2012); permitted market making-related explained the burdens that may result IRSG; Abbott Labs et al. (Feb. 14, 2012); Abbott Labs activity.517 With regard to this issue, from such an approach.522 Commenters et al. (Feb. 21, 2012); Australian Bankers Ass’n. several commenters recommended that appeared to attribute these concerns to (Feb. 2012); FEI; ASF (Feb. 2012); RBC; PUC Texas; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; the Agencies not try to remove all language in the proposed exemption Fidelity; ICI (Feb. 2012); British Bankers’ Ass’n.; aspects of proprietary trading from referring to a ‘‘purchase or sale of a Comm. on Capital Markets Regulation; IHS; Oliver market making-related activity because [financial instrument]’’ 523 or to Wyman (Feb. 2012); Thakor Study (stating that by doing so would likely restrict certain language in Appendix B indicating that artificially constraining the security holdings that a 518 banking entity can have in its inventory for market legitimate market-making activity. the Agencies may assess certain factors making or proprietary trading purposes, section 13 and criteria at different levels, including of the BHC Act will make bank risk management Regulation. Other commenters stated that it is a ‘‘single significant transaction.’’ 524 less efficient and may adversely impact the unlikely that new systems will be developed. See, With respect to the burdens of a diversified financial services business model of e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Oliver banks). However, some commenters stated that Wyman (Feb. 2012). One commenter stated that the transaction-by-transaction analysis, market makers should seek to minimize their proposed rule may cause a banking organization inventory or should not need large inventories. See, that engages in significant market-making activity to expend disproportionate resources trying to reduce e.g., AFR et al. (Feb. 2012); Public Citizen; Johnson give up its banking charter or spin off its market- or eliminate ‘‘the last 10 percent’’ of the risks of a & Prof. Stiglitz. Other commenters expressed making operations to avoid compliance with the certain problem); JPMC; RBC; ICFR; Sen. Hagan. concern that the proposed rule could limit proposed exemption. See Prof. Duffie. One of these commenters indicated that any interdealer trading. See, e.g., Prof. Duffie; Credit 513 See, e.g., NASP; Wellington; JPMC; Morgan concerns that banking entities would engage in Suisse (Seidel); JPMC; Morgan Stanley; Goldman Stanley; Credit Suisse (Seidel); BoA; Goldman speculative trading as a result of an expansive (Prop. Trading); Chamber (Feb. 2012); Oliver (Prop. Trading); Citigroup (Feb. 2012); STANY; market-making exemption would be addressed by Wyman (Dec. 2011). SIFMA (Asset Mgmt.) (Feb. 2012); Chamber (Feb. other reform initiatives (e.g., Basel III 510 See, e.g., BlackRock; Putnam; Fixed Income 2012); Putnam; ICI (Feb. 2012); Wells Fargo (Prop. implementation will provide laddered disincentives Forum/Credit Roundtable; ACLI (Feb. 2012); Trading); NYSE Euronext; Sen. Corker; Invesco. to holding positions as principal as a result of MetLife; IAA; Wells Fargo (Prop. Trading); T. Rowe 514 See, e.g., Better Markets (Feb. 2012); Sens. capital and liquidity requirements). See RBC. Price; Sen. Bennet; Sen. Corker; PUC Texas; Merkley & Levin (Feb. 2012); Occupy; AFR et al. 519 See Wellington; Paul Volcker; Better Markets Fidelity; ICI (Feb. 2012); Invesco. (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz. (Feb. 2012); Occupy. 511 See, e.g., Wellington; Prof. Duffie; Standish 515 See, e.g., Johnson & Prof. Stiglitz; Sens. 520 See Wellington. Mellon; Commissioner Barnier; NYSE Euronext; Merkley & Levin (Feb. 2012); Occupy; AFR et al. 521 See Paul Volcker. BoA; Citigroup (Feb. 2012); STANY; ICE; Chamber (Feb. 2012); Public Citizen. 522 See Wellington; SIFMA et al. (Prop. Trading) (Feb. 2012); BDA (Feb. 2012); Putnam; FTN; Fixed 516 See Occupy (‘‘[I]t is unclear that this rule, as (Feb. 2012); Barclays; Goldman (Prop. Trading); Income Forum/Credit Roundtable; ACLI (Feb. written, will markedly alter the current customer- HSBC; Fixed Income Forum/Credit Roundtable; 2012); IAA; CME Group; Capital Group; PUC Texas; serving business. Indeed, this rule has gone to ACLI (Feb. 2012); PUC Texas; ERCOT; Invesco. See Columbia Mgmt.; SSgA (Feb. 2012); Eaton Vance; excessive lengths to protect the covered banking also IAA (stating that it is unclear whether the ICI (Feb. 2012); Invesco; Comm. on Capital Markets entities’ ability to maintain responsible customer- requirements must be applied on a transaction-by- Regulation; Oliver Wyman (Feb. 2012); SIFMA facing business.’’); Alfred Brock. transaction basis or if compliance with the (Asset Mgmt.) (Feb. 2012); Thakor Study. 517 See, e.g., Rep. Bachus et al.; IIF; Morgan requirements is based on overall activities). This 512 For example, some commenters stated that Stanley (stating that beyond walled-off proprietary issue is addressed in Part VI.A.3.c.1.c., infra. market makers may revert to an agency or ‘‘special trading, the line is hard to draw, particularly 523 See, e.g., Barclays; SIFMA et al. (Prop. order’’ model. See, e.g., Barclays; Goldman (Prop. because both require principal risk-taking and the Trading) (Feb. 2012). As explained above, the term Trading); ACLI (Feb. 2012); Vanguard; RBC. In features of market making vary across markets and ‘‘covered financial position’’ from the proposal has addition, some commenters stated that new systems asset classes and become more pronounced in times been replaced by the term ‘‘financial instrument’’ in will be developed, such as alternative market of market stress); CFA Inst. (representing that the the final rule. Because the types of instruments matching networks, but these commenters distinction is particularly difficult in the fixed- included in both definitions are identical, the term disagreed about whether such changes would income market); ICFR; Prof. Duffie; WR Hambrecht. ‘‘financial instrument’’ is used throughout this Part. happen in the near term. See, e.g., CalPERS; 518 See, e.g., Chamber (Feb. 2012) (citing an article 524 See, e.g., Goldman (Prop. Trading); BlackRock; Stuyvesant; Comm. on Capital Markets by Stephen Breyer stating that society should not Wellington.

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some commenters noted that banking organizational unit’’ of a banking entity. other objective factors; 538 (iii) guidance entities can engage in a large volume of In response to this proposed approach, on permitted market making-related market-making transactions daily, commenters stated that compliance activity, rather than rule which would make it burdensome to should be assessed at each trading desk requirements; 539 (iv) risk management apply the exemption to each trade.525 A or aggregation unit532 or at each trading structures and/or risk limits; 540 (v) few commenters indicated that, even if unit.533 adding a new customer-facing criterion the Agencies did not intend to require Several commenters suggested or focusing on client-related transaction-by-transaction analysis, the alternative or additive means of activities; 541 (vi) capital and liquidity implementing the statutory exemption proposed rule’s language can be read to requirements; 542 (vii) development of imply such a requirement. These for market making-related activity.534 individualized plans for each banking commenters indicated that ambiguity on Commenters’ recommended approaches varied, but a number of commenters entity, in coordination with this issue could have a chilling effect on 543 market making or could allow some requested approaches involving one or regulators; (viii) ring fencing examiners to rigidly apply the more of the following elements: (i) Safe affiliates engaged in market making- 544 requirements of the exemption on a harbors,535 bright lines,536 or related activity; (ix) margin trade-by-trade basis.526 Other presumptions of compliance with the requirements; 545 (x) a compensation- commenters indicated that it would be exemption based on the existence of focused approach; 546 (xi) permitting all difficult to determine whether a certain factors (e.g., compliance swap dealing activity; 547 (xii) additional particular trade was or was not a program, metrics, general customer provisions regarding material conflicts market-making trade without focus or orientation, providing liquidity, of interest and high-risk assets and consideration of the relevant unit’s and/or exchange registration as a market trading strategies; 548 and/or (xiii) overall activities.527 One commenter maker); 537 (ii) a focus on metrics or making the exemption as broad as elaborated on this point by stating that possible under the statute.549 ‘‘an analysis that seeks to characterize 532 See Wellington. This commenter did not provide greater specificity about how it would specific transactions as either market (suggesting that the rule: (i) Provide a general grant define ‘‘trading desk’’ or ‘‘aggregation unit.’’ See id. making . . . or prohibited activity does of authority to engage in any transactions entered 533 See Morgan Stanley (stating that ‘‘trading into as part of a banking entity’s market-making not accord with the way in which unit’’ should be defined as ‘‘each organizational business, where ‘‘market making’’ is defined as ‘‘the modern trading units operate, which unit that is used to structure and control the generally view individual positions as a aggregate risk-taking activities and employees that business of being willing to facilitate customer are engaged in the coordinated implementation of purchases and sales of [financial instruments] as an bundle of characteristics that contribute intermediary over time and in size, including by 528 a customer-facing revenue generation strategy and to their complete portfolio.’’ This that participate in the execution of any covered holding positions in inventory;’’ and (ii) allow commenter noted that a position entered trading activity’’); SIFMA et al. (Prop. Trading) banking entities to monitor compliance with this into as part of market making-related (Feb. 2012). One of these commenters discussed its exemption internally through their compliance and activities may serve multiple functions suggested definition of ‘‘trading unit’’ in the context risk management infrastructure); PNC et al.; Oliver of the proposed requirement to record and report Wyman (Feb. 2012). at one time, such as responding to certain quantitative measurements, but it is unclear 538 See, e.g., Goldman (Prop. Trading); Morgan customer demand, hedging a risk, and that the commenter was also suggesting that this Stanley; Barclays; Wellington; CalPERS; BlackRock; building inventory. The commenter also definition be used for purposes of the market- SSgA (Feb. 2012); Invesco. expressed concern that individual making exemption. For example, this commenter 539 See, e.g., SIFMA et al. (Prop. Trading) (Feb. transactions or positions may not be expressed support for a multi-level approach to 2012) (suggesting that this guidance could be defining ‘‘trading unit,’’ and it is not clear how a incorporated in banking entities’ policies and severable or separately identifiable as definition that captures multiple organizational 529 procedures for purposes of complying with the rule, serving a market-making purpose. levels across a banking organization would work in in addition to the establishment of risk limits, Two commenters suggested that the the context of the market-making exemption. See controls, and metrics); JPMC; BoA; PUC Texas; SIFMA et al. (Prop. Trading) (Feb. 2012) (suggested requirements in the market-making SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop. that ‘‘trading unit’’ be defined ‘‘at a level that Trading). exemption be applied at the portfolio presents its activities in the context of the whole’’ 540 level rather than the trade level.530 and noting that the appropriate level may differ See, e.g., Japanese Bankers Ass’n.; Citigroup Moreover, commenters also set forth depending on the structure of the banking entity). (Feb. 2012). 534 See, e.g., Wellington; Japanese Bankers Ass’n.; 541 See, e.g., Morgan Stanley; Stephen Roach. their views on the organizational level 542 at which the requirements of the Prof. Duffie; IR&M; G2 FinTech; MetLife; NYSE See, e.g., Prof. Duffie; CalPERS; STANY; ICE; Euronext; Anthony Flynn and Koral Fusselman; IIF; Vanguard; Capital Group. proposed market-making exemption CalPERS; SIFMA et al. (Prop. Trading) (Feb. 2012); 543 See MetLife; Fixed Income Forum/Credit should apply.531 The proposed Sens. Merkley & Levin (Feb. 2012); Shadow Fin. Roundtable; ACLI (Feb. 2012). exemption generally applied Regulatory Comm.; John Reed; Prof. Richardson; 544 See, e.g., Prof. Duffie; Shadow Fin. Regulatory requirements to a ‘‘trading desk or other Credit Suisse (Seidel); JPMC; Morgan Stanley; Comm. See also Wedbush. Barclays; Goldman (Prop. Trading); BoA; Citigroup 545 See WR Hambrecht. (Feb. 2012); STANY; ICE; BlackRock; Johnson & 546 525 See G2 FinTech. See, e.g., SIFMA et al. (Prop. Trading) (Feb. Prof. Stiglitz; Fixed Income Forum/Credit 547 2012); Barclays (stating that ‘‘hundreds or Roundtable; ACLI (Feb. 2012); Wells Fargo (Prop. See ISDA (Feb. 2012); ISDA (Apr. 2012). thousands of trades can occur in a single day in a Trading); WR Hambrecht; Vanguard; Capital Group; 548 See Sens. Merkley & Levin (Feb. 2012) (stating single trading unit’’). PUC Texas; SSgA (Feb. 2012); PNC et al.; Fidelity; that the exemption should expressly mention the 526 See, e.g., ICI (Feb. 2012); Barclays; Goldman Occupy; AFR et al. (Feb. 2012); Invesco; ISDA (Feb. conflicts provision and provide examples to warn (Prop. Trading). 2012); Stephen Roach; Oliver Wyman (Feb. 2012). against particular conflicts, such as recommending 527 See, e.g., SIFMA et al. (Prop. Trading) (Feb. The Agencies respond to these comments in Part clients buy poorly performing assets in order to 2012); Goldman (Prop. Trading). VI.A.3.b.3., infra. remove them from the banking entity’s book or 528 SIFMA et al. (Prop. Trading) (Feb. 2012). 535 See, e.g., Sens. Merkley & Levin (Feb. 2012); attempting to move market prices in favor of trading 529 See id. (suggesting that the Agencies ‘‘give full John Reed; Prof. Richardson; Johnson & Prof. positions a banking entity has built up in order to effect to the statutory intent to allow market making Stiglitz; Capital Group; Invesco; BDA (Feb. 2012) make a profit); Stephen Roach (suggesting that the by viewing the permitted activity on a holistic (Oct. 2012) (suggesting a safe harbor for any trading exemption integrate the limitations on permitted basis’’). desk that effects more than 50 percent of its activities). 530 See ACLI (Feb. 2012); Fixed Income Forum/ transactions through sales representatives). 549 See Fidelity (stating that the exemption needs Credit Roundtable. 536 See, e.g., Flynn & Fusselman; Prof. Colesanti to be as broad as possible to account for customer- 531 See Wellington; Morgan Stanley; SIFMA et al. et al. facing principal trades, block trades, and market (Prop. Trading) (Feb. 2012); ACLI (Feb. 2012); Fixed 537 See, e.g., SIFMA et al. (Prop. Trading) (Feb. making in OTC derivatives). See also STANY Income Forum/Credit Roundtable. The Agencies 2012); IIF; NYSE Euronext; Credit Suisse (Seidel); (stating that it is better to make the exemption too address this topic in Part VI.A.3.c.1.c., infra. JPMC; Barclays; BoA; Wells Fargo (Prop. Trading) broad than too narrow).

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b. Comments Regarding the Potential for investors or consumers,555 and or midsized companies.558 A number of Market Impact of the Proposed slower execution times.556 Some commenters discussed the Exemption commenters expressed particular interrelationship between primary and As discussed above, several concern about potential impacts on secondary market activity and indicated commenters stated that the proposed institutional investors (e.g., mutual that restrictions on market making 557 rule would impact a banking entity’s funds and pension funds) or on small would impact the underwriting ability to engage in market making- process.559 to act in [a] market-making capacity [in asset- related activity. Many of these backed securities] would have a dramatic adverse A few commenters expressed the view commenters represented that, as a effect on the ability of securitizers to access the that reduced liquidity would not result, the proposed exemption would asset-backed securities markets and thus to obtain necessarily be a negative result.560 For 550 the debt financing necessary to ensure a vibrant likely result in reduced liquidity, example, two commenters noted that wider bid-ask spreads,551 increased U.S. economy’’); Credit Suisse (Seidel); JPMC; Morgan Stanley; Barclays; Goldman (Prop. Trading); liquidity is vulnerable to liquidity market volatility,552 reduced price BoA; Citigroup (Feb. 2012); STANY; BlackRock; spirals, in which a high level of market discovery or price transparency,553 Chamber (Feb. 2012); IHS; BDA (Feb. 2012); Fixed liquidity during one period feeds a increased costs of raising capital or Income Forum/Credit Roundtable; ACLI (Feb. 2012); Wells Fargo (Prop. Trading); Abbott Labs et sharp decline in liquidity during the higher financing costs,554 greater costs al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, next period by initially driving asset 2012); T. Rowe Price; FEI; AFMA; SSgA (Feb. 2012); 550 See, e.g., AllianceBernstein; Rep. Bachus et al. PNC et al.; ICI (Feb. 2012); British Bankers’ Ass’n.; prices upward and supporting increased (Dec. 2011); EMTA; NASP; Wellington; Japanese Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. leverage. The commenters explained Bankers Ass’n.; Sen. Hagan; Prof. Duffie; Investure; 2012); GE (Feb. 2012); Thakor Study (stating that that liquidity spirals lead to ‘‘fire sales’’ Standish Mellon; IR&M; MetLife; Lord Abbett; when a firm’s cost of capital goes up, it invests by market speculators when events Commissioner Barnier; Quebec; IIF; Sumitomo less—resulting in lower economic growth and lower Trust; Liberty Global; NYSE Euronext; CIEBA; employment—and citing supporting data indicating reveal that assets are overpriced and EFAMA; SIFMA et al. (Prop. Trading) (Feb. 2012); that a 1 percent increase in the cost of capital would speculators must sell their assets to Credit Suisse (Seidel); JPMC; Morgan Stanley; lead to a $55 to $82.5 billion decline in aggregate reduce their leverage.561 According to Barclays; Goldman (Prop. Trading); BoA; Citigroup annual capital spending by U.S. nonfarm firms and (Feb. 2012); STANY; ICE; BlackRock; SIFMA (Asset job losses between 550,000 and 1.1 million per year another commenter, banking entities’ Mgmt.) (Feb. 2012); BDA (Feb. 2012); Putnam; in the nonfarm sector). One commenter further access to the safety net allows them to Fixed Income Forum/Credit Roundtable; Western noted that a higher cost of capital can lead a firm distort market prices and, arguably, Asset Mgmt.; ACLI (Feb. 2012); IAA; CME Group; to make riskier, short-term investments. See Thakor Wells Fargo (Prop. Trading); Abbott Labs et al. (Feb. Study. produce excess liquidity. The 14, 2012); Abbott Labs et al. (Feb. 21, 2012); T. 555 See, e.g., Wellington; Standish Mellon; IR&M; commenter further represented that it Rowe Price; Australian Bankers Ass’n. (Feb. 2012); MetLife; Lord Abbett; NYSE Euronext; CIEBA; would be preferable to allow the FEI; AFMA; Sen. Carper et al.; PUC Texas; ERCOT; Barclays; Goldman (Prop. Trading); BoA; Citigroup discipline of the market to choose the IHS; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; (Feb. 2012); STANY; ICE; BlackRock; Fixed Income Eaton Vance; Fidelity; ICI (Feb. 2012); British Forum/Credit Roundtable; ACLI (Feb. 2012); IAA; pricing of securities and the amount of Bankers’ Ass’n.; Comm. on Capital Markets Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et liquidity.562 Some commenters cited an Regulation; Union Asset; Sen. Casey; Oliver Wyman al. (Feb. 21, 2012); T. Rowe Price; Vanguard; economic study indicating that the U.S. (Dec. 2011); Oliver Wyman (Feb. 2012) (providing Australian Bankers Ass’n. (Feb. 2012); FEI; Sen. estimated impacts on asset valuation, borrowing Carper et al.; Columbia Mgmt.; SSgA (Feb. 2012); financial system has become less costs, and transaction costs in the corporate bond ICI (Feb. 2012); Comm. on Capital Markets efficient in generating economic growth market based on hypothetical liquidity reduction Regulation; TMA Hong Kong; Sen. Casey; IHS; scenarios); Thakor Study. The Agencies respond to Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. those that remain in the fund); Putnam; Fixed comments regarding the potential market impact of 2012); Thakor Study. Income Forum/Credit Roundtable; ACLI; T. Rowe the rule in Part VI.A.3.b.3., infra. 556 See, e.g., Barclays; FTN; Abbott Labs et al. 551 See, e.g., AllianceBernstein; Wellington; Price; Vanguard; IAA; FEI; Sen. Carper et al.; (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012). Columbia Mgmt.; ICI (Feb. 2012); Invesco; Union Investure; Standish Mellon; MetLife; Lord Abbett; 557 See, e.g., AllianceBernstein (stating that, to the Barclays; Goldman (Prop. Trading); Citigroup (Feb. Asset; Standish Mellon; Morgan Stanley; SIFMA extent the rule reduces liquidity provided by (Asset Mgmt.) (Feb. 2012). 2012); BlackRock; Putnam; ACLI (Feb. 2012); market makers, open end mutual funds that are 558 See, e.g., CIEBA (stating that for smaller Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et largely driven by the need to respond to both issuers in particular, market makers need to have al. (Feb. 21, 2012); T. Rowe Price; Sen. Carper et redemptions and subscriptions will be immediately al.; IHS; Columbia Mgmt.; ICI (Feb. 2012) British impacted in terms of higher trading costs); incentives to make markets, and the proposal Bankers’ Ass’n.; Comm. on Capital Markets Wellington (indicating that periods of extreme removes important incentives); ACLI (indicating Regulation; Thakor Study (stating that section 13 of market stress are likely to exacerbate costs and that lower liquidity will most likely result in higher the BHC Act will likely result in higher bid-ask challenges, which could force investors such as costs for issuers of debt and, for lesser known or spreads by causing at least some retrenchment of mutual funds and pension funds to accept lower quality issuers, this cost may be significant banks from market making, resulting in fewer distressed prices to fund redemptions or pay and in some cases prohibitive because the cost will market makers and less competition). current benefits); Lord Abbett (stating that certain vary depending on the credit quality of the issuer, 552 See, e.g., Wellington; Prof. Duffie; Standish factors, such as reduced bank capital to support the amount of debt it has in the market, and the Mellon; Lord Abbett; IIF; SIFMA et al. (Prop. market-making businesses and economic maturity of the security); PNC et al. (expressing Trading) (Feb. 2012); Barclays; Goldman (Prop. uncertainty, have already reduced liquidity and concern that a regional bank’s market-making Trading); BDA (Feb. 2012); IHS; FTN; IAA; Wells caused asset managers to have an increased activity for small and middle market customers is Fargo (Prop. Trading); T. Rowe Price; Columbia preference for highly liquid credits and expressing more likely to be inappropriately characterized as Mgmt.; SSgA (Feb. 2012); Eaton Vance; British concern that, if section 13 of the BHC Act further impermissible proprietary trading due to lower Bankers’ Ass’n.; Comm. on Capital Markets reduces liquidity, then: (i) asset managers’ trading volume involving less liquid securities); Regulation. increased preference for highly liquid credit could Morgan Stanley; Chamber (Feb. 2012); Abbott Labs 553 See, e.g., Prof. Duffie (arguing that, for lead to unhealthy portfolio concentrations, and (ii) et al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, example, ‘‘during the financial crisis of 2007–2009, asset managers will maintain a larger cash cushion 2012); FEI; ICI (Feb. 2012); TMA Hong Kong; Sen. the reduced market making capacity of major dealer in portfolios that may be subject to redemption, Casey. banks caused by their insufficient capital levels which will likely result in investors getting poorer 559 See SIFMA et al. (Prop. Trading) (Feb. 2012); resulted in dramatic downward distortions in returns); EFAMA; BlackRock (stating that JPMC; RBC; NYSE Euronext; Credit Suisse (Seidel). corporate bond prices’’); IIF; Barclays; IAA; investment decisions are heavily dependent on a 560 Vanguard; Wellington; FTN. liquidity factor input, so as liquidity dissipates, See, e.g., Paul Volcker; AFR et al. (Feb. 2012); 554 See, e.g., AllianceBernstein; Chamber (Dec. investment strategies become more limited and Public Citizen; Prof. Richardson; Johnson & Prof. 2011); Members of Congress (Dec. 2011); returns to investors are diminished by wider Stiglitz; Better Markets (Feb. 2012); Prof. Johnson. Wellington; Sen. Hagan; Prof. Duffie; IR&M; spreads and higher transaction costs); CFA Inst. 561 See AFR et al. (Feb. 2012); Public Citizen. See MetLife; Lord Abbett; Liberty Global; NYSE (noting that a mutual fund that tries to liquidate also Paul Volcker (stating that at some point, greater Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); holdings to meet redemptions may have difficulty liquidity, or the perception of greater liquidity, may NCSHA; ASF (Feb. 2012) (stating that ‘‘[f]ailure to selling at acceptable prices, thus impairing the encourage more speculative trading). permit the activities necessary for banking entities fund’s NAV for both redeeming investors and for 562 See Prof. Richardson.

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in recent years, despite increased that non-banking entities will enter the activity; 577 (iv) acting as an authorized trading volumes.563 market or increase their trading participant or market maker in ETFs; 578 Some commenters stated that it is activities, particularly in the short (v) arbitrage or other activities that unlikely the proposed rule would result term.569 For example, one commenter promote price transparency and in the negative market impacts noted the investment that banking liquidity; 579 (vi) primary dealer identified above, such as reduced entities have made in infrastructure for activity; 580 (vii) market making in market liquidity.564 For example, a few trading and compliance would take futures and options; 581 (viii) market commenters stated that other market smaller or new firms years and billions making in new or bespoke products or participants, who are not subject to of dollars to replicate.570 Another customized hedging contracts; 582 and section 13 of the BHC Act, may enter the commenter questioned whether other (ix) inter-affiliate transactions.583 As market or increase their trading market participants, such as hedge discussed in more detail in Part activities to make up for any reduction funds, would be willing to dedicate VI.B.2.c., a number of commenters in banking entities’ market-making capital to fully serving customer needs, requested that the market-making activity or other trading activity.565 For which is required to provide ongoing exemption apply to the restrictions on instance, one of these commenters liquidity.571 One commenter stated that acquiring or retaining an ownership suggested that the revenue and profits even if non-banking entities move in to from market making will be sufficient to replace lost trading activity from 577 See infra Part VI.A.3.c.1.b.ii. (discussing attract capital and competition to that banking entities, the value of the current commenters’ requests for greater clarity regarding activity.566 In addition, one commenter interdealer network among market the permissibility of block positioning activity). 578 See, e.g., SIFMA et al. (Prop. Trading) (Feb. expressed the view that prohibiting makers will be reduced due to the exit 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. proprietary trading may support more of banking entities.572 Several Trading); BoA; ICI (Feb. 2012); ICI Global; liquid markets by ensuring that banking commenters expressed the view that Vanguard; SSgA (Feb. 2012). entities focus on providing liquidity as migration of market making-related 579 See SIFMA et al. (Prop. Trading) (Feb. 2012); market makers, rather than taking Credit Suisse (Seidel); JPMC; Goldman (Prop. activities to firms outside the banking Trading); FTN; RBC; ISDA (Feb. 2012). liquidity from the market in the course system would be inconsistent with 580 See, e.g., SIFMA et al. (Prop. Trading) (Feb. of ‘‘trading to beat’’ institutional buyers Congressional intent and would have 2012); JPMC; Goldman (Prop. Trading); Banco de like pension funds, university potentially adverse consequences for the Me´xico; IIB/EBF. endowments, and mutual funds.567 safety and soundness of the U.S. 581 See CME Group (requesting clarification that the market-making exemption permits a banking Another commenter stated that, while 573 financial system. entity to engage in market making in exchange- section 13 of the BHC Act may Many commenters requested traded futures and options because the dealer temporarily reduce trading volume and additional clarification on how the registration requirement in § 75.4(b)(2)(iv) of the excessive liquidity at the peak of market proposed market-making exemption proposed rule did not refer to such instruments and stating that lack of an explicit exemption would bubbles, it should increase the long-run would apply to certain asset classes and reduce market-making activities in these stability of the financial system and markets or to particular types of market instruments, which would decrease liquidity). But render genuine liquidity and credit making-related activities. In particular, see Johnson & Prof. Stiglitz (stating that the availability more reliable over the long commenters requested greater clarity Agencies should pay special attention to options 568 trading and other derivatives because they are term. regarding the permissibility of: (i) highly volatile assets that are difficult if not Other commenters, however, Interdealer trading,574 including trading impossible to effectively hedge, except through a indicated that it is uncertain or unlikely for price discovery purposes or to test completely matched position, and suggesting that 575 options and similar derivatives may need to be market depth; (ii) inventory required to be sold only as riskless principal under 563 See, e.g., Johnson & Prof. Stiglitz (citing management; 576 (iii) block positioning Thomas Phillippon, ‘‘Has the U.S. Finance Industry § 75.6(b)(1)(ii) of the proposed rule or significantly Become Less Efficient?,’’ NYU Working Paper, Nov. limited through capital charges); Sens. Merkley & 2011); AFR et al. (Feb. 2012); Public Citizen; Better 569 See, e.g., Wellington; Prof. Duffie; Investure; Levin (Feb. 2012) (stating that asset classes that are Markets (Feb. 2012); Prof. Johnson. IIF; Liberty Global; SIFMA et al. (Prop. Trading) particularly hard to hedge, such as options, should 564 See, e.g., Sens. Merkley & Levin (Feb. 2012) (Feb. 2012); Credit Suisse (Seidel); JPMC; Morgan be given special attention under the hedging (stating that there is no convincing, independent Stanley; Barclays; BoA; STANY; SIFMA (Asset exemption). evidence that the rule would increase trading costs Mgmt.) (Feb. 2012); FTN; Western Asset Mgmt.; 582 See, e.g., SIFMA et al. (Prop. Trading) (Feb. or reduce liquidity, and the best evidence available IAA; PUC Texas; ICI (Feb. 2012); IIB/EBF; Invesco. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. suggests that the buy-side firms would greatly In addition, some commenters recognized that other Trading); SIFMA (Asset Mgmt.) (Feb. 2012). Other benefit from the competitive pressures that market participants are likely to fill banking commenters, however, stated that banking entities transparency can bring); Better Markets (Feb. 2012) entities’ roles in the long term, but not in the short should be limited in their ability to rely on the (‘‘Industry’s claim that [section 13 of the BHC Act] term. See, e.g., ICFR; Comm. on Capital Markets market-making exemption to conduct transactions will ‘reduce market liquidity, capital formation, and Regulation; Oliver Wyman (Feb. 2012). in bespoke or customized derivatives. See, e.g., AFR credit availability, and thereby hamper economic 570 See Oliver Wyman (Feb. 2012) (‘‘Major bank- et al. (Feb. 2012); Public Citizen. growth and job creation’ disregard the fact that the affiliated market makers have large capital bases, 583 See, e.g., Japanese Bankers Ass’n. (stating that financial crisis did more damage to those concerns balance sheets, technology platforms, global transactions with affiliates and subsidiaries and than any rule or reform possibly could.’’); Profs. operations, relationships with clients, sales forces, related to hedging activities are a type of market Stout & Hastings; Prof. Johnson; Occupy; Public risk infrastructure, and management processes that making-related activity or risk-mitigating hedging Citizen; Profs. Admati & Pfleiderer; Better Markets would take smaller or new dealers years and activity that should be exempted by the rule); (June 2012); AFR et al. (Feb. 2012). One commenter billions of dollars to replicate.’’). SIFMA et al. (Prop. Trading) (Feb. 2012). According stated that the proposed rule would improve market 571 See SIFMA et al. (Prop. Trading) (Feb. 2012). to one of these commenters, inter-affiliate liquidity, efficiency, and price transparency. See transactions should be viewed as part of a 572 See Thakor Study. Alfred Brock. coordinated activity for purposes of determining 573 565 See, e.g., Sens. Merkley & Levin (Feb. 2012); See, e.g., Prof. Duffie; Oliver Wyman (Feb. whether a banking entity qualifies for an Prof. Richardson; Better Markets (Feb. 2012); Profs. 2012). exemption. This commenter stated that, for Stout & Hastings; Prof. Johnson; Occupy; Public 574 See, e.g., MetLife; SIFMA et al. (Prop. Trading) example, if a market maker shifts positions held in Citizen; Profs. Admati & Pfleiderer; Better Markets (Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; inventory to an affiliate that is better able to manage (June 2012). Similarly, one commenter indicated BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA the risk of such positions, both the market maker that non-banking entity market participants could (Feb. 2012); Goldman (Prop. Trading); Oliver and its affiliate would be engaged in permitted fill the current role of banking entities in the market Wyman (Feb. 2012). market making-related activity. This commenter if implementation of the rule is phased in. See ACLI 575 See SIFMA et al. (Prop. Trading) (Feb. 2012); further represented that fitting the inter-affiliate (Feb. 2012). Chamber (Feb. 2012); Goldman (Prop. Trading). swap into the exemption may be difficult (e.g., one 566 See Better Markets (Feb. 2012). 576 See, e.g., SIFMA et al. (Prop. Trading) (Feb. of the affiliates entering into the swap may not be 567 See Prof. Johnson. 2012); Credit Suisse (Seidel); Goldman (Prop. holding itself out as a willing counterparty). See 568 See AFR et al. (Feb. 2012). Trading); MFA; RBC. SIFMA et al. (Prop. Trading) (Feb. 2012).

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interest in a covered fund.584 Some customers, compensation standards, and • Five requirements for determining commenters stated that no other monitoring and review requirements whether a banking entity is engaged in activities should be considered that are consistent with market-making permitted market making-related permitted market making-related activities.588 These requirements are activities. Many of these criteria have activity under the rule.585 In addition, a designed to distinguish exempt market similarities to the factors included in few commenters requested clarification making-related activities from the proposed rule, but with important that high-frequency trading would not impermissible proprietary trading. In modifications in response to comments. qualify for the market-making addition, these requirements are These standards require that: exemption.586 designed to ensure that a banking entity Æ The trading desk that establishes is aware of, monitors, and limits the and manages a financial exposure 3. Final Market-Making Exemption risks of its exempt activities consistent routinely stands ready to purchase and After carefully considering comment with the prudent conduct of market sell one or more types of financial letters, the Agencies are adopting making-related activities. instruments related to its financial certain refinements to the proposed As described in detail below, the final exposure and is willing and available to market-making exemption. The market-making exemption consists of quote, buy and sell, or otherwise enter Agencies are adopting a market-making the following elements: into long and short positions in those exemption that is consistent with the • A framework that recognizes the types of financial instruments for its statutory exemption for this activity and differences in market making-related own account, in commercially designed to permit banking entities to activities across markets and asset reasonable amounts and throughout continue providing intermediation and classes by establishing criteria that can market cycles, on a basis appropriate for liquidity services. The Agencies note be applied based on the liquidity, the liquidity, maturity, and depth of the that, while all market-making activity maturity, and depth of the market for market for the relevant types of financial should ultimately be related to the the particular type of financial instruments; 591 intermediation of trading, whether instrument. Æ The amount, types, and risks of the directly to individual customers through • A general focus on analyzing the financial instruments in the trading bilateral transactions or more broadly to overall ‘‘financial exposure’’ and desk’s market-maker inventory are a given marketplace, certain ‘‘market-maker inventory’’ held by any designed not to exceed, on an ongoing characteristics of a market-making given trading desk rather than a basis, the reasonably expected near term business may differ among markets and transaction-by-transaction analysis. The demands of clients, customers, or asset classes.587 The final rule is ‘‘financial exposure’’ reflects the counterparties, as required by the intended to account for these aggregate risks of the financial statute and based on certain factors and differences to allow banking entities to instruments, and any associated loans, analysis; 592 continue to engage in market making- commodities, or foreign exchange or Æ The banking entity has established related activities by providing customer currency, held by a banking entity or its and implements, maintains, and intermediation and liquidity services affiliate and managed by a particular enforces an internal compliance across markets and asset classes, if such trading desk as part of its market program that is reasonably designed to activities do not violate the statutory making-related activities. The ‘‘market- ensure its compliance with the market- limitations on permitted activities (e.g., maker inventory’’ means all of the making exemption, including by involving or resulting in a material positions, in the financial instruments reasonably designed written policies conflict of interest with a client, for which the trading desk stands ready and procedures, internal controls, customer, or counterparty) and are to make a market that are managed by analysis, and independent testing conducted in conformance with the the trading desk, including the trading identifying and addressing: exemption. desk’s open positions or exposures D The financial instruments each At the same time, the final rule arising from open transactions.589 trading desk stands ready to purchase requires development and • A definition of the term ‘‘trading and sell in accordance with implementation of trading, risk and desk’’ that focuses on the operational § 75.4(b)(2)(i) of the final rule; inventory limits, risk management functionality of the desk rather than its D The actions the trading desk will strategies, analyses of how the specific legal status, and requirements that apply take to demonstrably reduce or market making-related activities are at the trading desk level of organization otherwise significantly mitigate designed not to exceed the reasonably within a single banking entity or across promptly the risks of its financial expected near term demands of two or more affiliates.590 exposure consistent with its established limits; the products, instruments, and 584 See, e.g., Cleary Gottlieb; JPMC; BoA; Credit 588 Certain of these requirements, like the exposures each trading desk may use for Suisse (Williams). requirements to have risk and inventory limits, risk risk management purposes; the 585 See, e.g., Occupy; Alfred Brock. management strategies, and monitoring and review techniques and strategies each trading 586 See, e.g., Occupy; AFR et al. (Feb. 2012); requirements were included in the enhanced desk may use to manage the risks of its Public Citizen; Johnson & Prof. Stiglitz; Sens. compliance program requirement in proposed Merkley & Levin (Feb. 2012); John Reed. Appendix C, but were not separately included in market making-related activities and 587 Consistent with the FSOC study and the the proposed market-making exemption. Like the inventory; and the process, strategies, proposal, the final rule recognizes that the precise statute, the proposed rule would have required that and personnel responsible for ensuring nature of a market maker’s activities often varies market making-related activities be designed not to that the actions taken by the trading depending on the liquidity, trade size, market exceed the reasonably expected near term demand infrastructure, trading volumes and frequency, and of clients, customers, or counterparties. The geographic location of the market for any particular Agencies are adding an explicit requirement in the financial instruments for the trading account of the type of financial instrument. See Joint Proposal, 76 final rule that a trading desk conduct analyses of banking entity or an affiliate thereof.’’ Final rule FR at 68870; CFTC Proposal, 77 FR at 8356; FSOC customer demand for purposes of complying with § 75.3(e)(13). study (stating that ‘‘characteristics of permitted this statutory requirement. 591 See final rule § 75.4(b)(2)(i); infra Part activities in one market or asset class may not be 589 See infra Part VI.A.3.c.1.c.ii. See also final rule VI.A.3.c.1.c.iii. the same in another market (e.g., permitted §§ 75.4(b)(4), (5). 592 See final rule § 75.4(b)(2)(ii); infra Part activities in a liquid equity securities market may 590 See infra Part VI.A.3.c.1.c.i. The term ‘‘trading VI.A.3.c.2.c. In addition, the Agencies are adopting vary significantly from an illiquid over-the-counter desk’’ is defined as ‘‘the smallest discrete unit of a definition of the terms ‘‘client,’’ ‘‘customer,’’ and derivatives market)’’). organization of a banking entity that buys or sells ‘‘counterparty’’ in § 75.4(b)(3) of the final rule.

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desk to mitigate these risks are and • The use of quantitative market-making exemption.602 Although continue to be effective; 593 measurements to highlight activities a purely guidance-based approach D Limits for each trading desk, based that warrant further review for would provide greater flexibility, it on the nature and amount of the trading compliance with the exemption.598 As would also provide less clarity, which desk’s market making-related activities, discussed further in Part VI.C.3., the could make it difficult for trading including factors used to determine the Agencies have reduced some of the personnel, internal compliance reasonably expected near term demands compliance burdens by adopting a more personnel, and Agency supervisors and of clients, customers, or counterparties, tailored subset of metrics than was examiners to determine whether an on: the amount, types, and risks of its proposed to better focus on those activity complies with the rule and market-maker inventory; the amount, metrics that the Agencies believe are would lead to an increased risk of types, and risks of the products, most germane to the evaluation of the evasion of the statutory requirements.603 instruments, and exposures the trading activities that firms conduct under the Some commenters suggested an desk uses for risk management market-making exemption. approach to implementing the market- purposes; the level of exposures to In refining the proposed approach to making exemption that would focus on relevant risk factors arising from its 604 implementing the statute’s market- metrics or other objective factors. As financial exposure; and the period of discussed below, a number of making exemption, the Agencies closely time a financial instrument may be held; commenters expressed support for using considered the various alternative D Internal controls and ongoing the metrics as a tool to monitor trading approaches suggested by monitoring and analysis of each trading activity and not to determine commenters.599 However, like the desk’s compliance with its limits; and compliance with the rule.605 While the proposed approach, the final market- D Authorization procedures, Agencies agree that quantitative making exemption continues to adhere including escalation procedures that measurements are useful for purposes of to the statutory mandate that provides require review and approval of any monitoring a trading desk’s activities for an exemption to the prohibition on trade that would exceed a trading desk’s and are requiring certain banking proprietary trading for market making- limit(s), demonstrable analysis that the entities to calculate, record, and report related activities. Therefore, the final basis for any temporary or permanent quantitative measurements to the rule focuses on providing a framework increase to a trading desk’s limit(s) is Agencies in the final rule, the Agencies for assessing whether trading activities consistent with the requirements of the do not believe that quantitative are consistent with market making. The market-making exemption, and measurements should be used as a Agencies believe this approach is independent review of such 600 dispositive tool for determining demonstrable analysis and approval; 594 consistent with the statute and strikes an appropriate balance between Æ To the extent that any limit 602 As noted above, a number of commenters identified above is exceeded, the trading commenters’ desire for both clarity and suggested the Agencies adopt a bright-line rule, flexibility. For example, while a bright- provide a safe harbor for certain types of activities, desk takes action to bring the trading or establish a presumption of compliance based on desk into compliance with the limits as line or safe harbor based approach would generally provide a high degree certain factors. See, e.g., Sens. Merkley & Levin promptly as possible after the limit is (Feb. 2012); John Reed; Prof. Richardson; Johnson exceeded; 595 of certainty about whether an activity & Prof. Stiglitz; Capital Group; Invesco; BDA (Oct. Æ qualifies for the market-making 2012); Flynn & Fusselman; Prof. Colesanti et al.; The compensation arrangements of SIFMA et al. (Prop. Trading) (Feb. 2012); IIF; NYSE persons performing market making- exemption, it would also provide less flexibility to recognize the differences in Euronext; Credit Suisse (Seidel); JPMC; Barclays; related activities are designed not to BoA; Wells Fargo (Prop. Trading); PNC et al.; Oliver market-making activities across markets Wyman (Feb. 2012). Many of these commenters reward or incentivize prohibited 601 596 and asset classes. In addition, any expressed general concern that the proposed proprietary trading; and market-making exemption may create uncertainty • The banking entity is licensed or bright-line approach would be more likely to be subject to gaming and for individual traders engaged in market making- registered to engage in market making- related activity and suggested that their proposed related activities in accordance with avoidance as new products and types of approach would alleviate such concern. The applicable law.597 trading activities are developed than Agencies believe that the enhanced focus on risk other approaches to implementing the and inventory limits for each trading desk (which must be tied to the near term customer demand 593 Routine market making-related risk requirement) and the clarification that the final management activity by a trading desk is permitted national securities exchange as a market maker on market-making exemption does not require a trade- under the market-making exemption and, provided that exchange. by-trade analysis should address concerns about the standards of the exemption are met, is not 598 See infra Part VI.C.3. individual traders having to assess whether they are required to separately meet the requirements of the 599 See supra Part VI.A.3.b.2. complying with the market-making exemption on a hedging exemption. The circumstances under 600 Certain approaches suggested by commenters, trade-by-trade basis. which risk management activity relating to the such as relying solely on capital requirements, 603 Several commenters suggested a guidance- trading desk’s financial exposure is permitted under requiring ring fencing, permitting all swap dealing based approach, rather than requirements in the the market-making exemption or must separately activity, or focusing solely on how traders are final rule. See, e.g., SIFMA et al. (Prop. Trading) comply with the hedging exemption are discussed compensated do not appear to be consistent with (Feb. 2012) (suggesting that this guidance could in more detail in Parts VI.A.3.c.1.c.ii. and the statutory language because they do not appear then be incorporated in banking entities’ policies VI.A.3.c.4., infra. to limit market making-related activity to that and procedures for purposes of complying with the 594 See final rule § 75.4(b)(2)(iii); infra Part which is designed not to exceed the reasonably rule, in addition to the establishment of risk limits, VI.A.3.c.3. expected near term demands of clients, customers, controls, and metrics); JPMC; BoA; PUC Texas; 595 See final rule § 75.4(b)(2)(iv). or counterparties, as required by the statute. See SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop. 596 See final rule § 75.4(b)(2)(v); infra Part Prof. Duffie; STANY; ICE; Shadow Fin. Regulatory Trading). VI.A.3.c.5. Comm.; ISDA (Feb. 2012); ISDA (Apr. 2012); G2 604 See, e.g., Goldman (Prop. Trading); Morgan 597 See final rule § 75.4(b)(2)(vi); infra Part FinTech. Stanley; Barclays; Wellington; CalPERS; BlackRock; VI.A.3.c.6. As discussed further below, this 601 While an approach establishing a number of SSgA (Feb. 2012); Invesco. provision pertains to legal registration or licensing safe harbors that are each tailored to a specific asset 605 See infra Part VI.C.3. (discussing the final requirements that may apply to an entity engaged class would address the need to recognize rule’s metrics requirement). See SIFMA et al. (Prop. in market making-related activities, depending on differences across asset classes, such an approach Trading) (Feb. 2012); Wells Fargo (Prop. Trading); the facts and circumstances. This provision would may also increase the complexity of the final rule. RBC; ICI (Feb. 2012); Occupy (stating that there are not require a banking entity to comply with Further, commenters did not provide sufficient serious limits to the capabilities of the metrics and registration requirements that are not required by information to determine the appropriate the potential for abuse and manipulation of the law, such as discretionary registration with a parameters of a safe harbor-based approach. input data is significant); Alfred Brock.

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compliance with the market-making below, the final market-making For instance, absent a market maker exemption.606 exemption includes specific substantive who stands ready to buy and sell, In response to two commenters’ changes in response to a wide variety of investors may have to make large price request that the final rule focus on a commenter concerns. concessions or otherwise expend banking entity’s risk management The Agencies understand that the resources searching for counterparties. structures or risk limits and not on economics of market making—and By stepping in to intermediate trades attempting to define market-making financial intermediation in general— and provide liquidity, market makers activities,607 the Agencies do not believe require a market maker to be active in thus add value to the financial system that management of risk, on its own, is markets. In determining the appropriate by, for example, absorbing supply and sufficient to differentiate permitted scope of the market-making exemption, demand imbalances. This often means market making-related activities from the Agencies have been mindful of taking on financial exposures, in a impermissible proprietary trading. For commenters’ views on market making principal capacity, to satisfy reasonably example, the existence of a risk and liquidity. Several commenters expected near term customer demand, management framework or risk limits, stated that the proposed rule would as well as to manage the risks associated while important, would not ensure that impact a banking entity’s ability to with meeting such demand. a trading desk is acting as a market engage in market making-related The Agencies recognize that, as noted maker by engaging in customer-facing activity, with corresponding reductions by commenters, liquidity can be activity and providing intermediation in market liquidity.611 However, associated with narrower spreads, lower and liquidity services.608 The Agencies commenters disagreed about whether transaction costs, reduced volatility, also decline to take an approach to reduced liquidity would be beneficial or greater price discovery, and lower costs implementing the market-making detrimental to the market, or if any such of capital.613 The Agencies agree with exemption that would require the reductions would even materialize.612 these commenters that liquidity development of individualized plans for Many commenters stated that reduced provides important benefits to the each banking entity in coordination liquidity could lead to other negative financial system, as more liquid markets with the Agencies, as suggested by a few market impacts, such as wider spreads, are characterized by competitive market commenters.609 The Agencies believe it higher transaction costs, greater market makers, narrow bid-ask spreads, and is useful to establish a consistent volatility, diminished price discovery, frequent trading, and that a narrowly framework that will apply to all banking and increased cost of capital. tailored market-making exemption entities to reduce the potential for The Agencies understand that market could negatively impact the market by, unintended competitive impacts that makers play an important role in as described above, forcing investors to could arise if each banking entity is providing and maintaining liquidity make price concessions or unnecessarily subject to an individualized plan that is throughout market cycles and that expend resources searching for tailored to its specific organizational restricting market-making activity may counterparties.614 For example, while structure and trading activities and result in reduced liquidity, with bid-ask spreads compensate market strategies. corresponding negative market impacts. makers for providing liquidity when Although the Agencies are not in the asset values are uncertain, under final rule modifying the basic structure exceed the reasonably expected near term demands competitive forces, dealers compete of the proposed market-making of clients, customers, or counterparties). The Agencies decline to include margin requirements in with respect to spreads, thus lowering exemption, certain general items the final exemption because banking entities are their profit margins on a per trade basis suggested by commenters, such as currently subject to a number of different margin and benefitting investors.615 Volatility is enhanced compliance program elements requirements, including those applicable to, among others: SEC-registered broker-dealers; CFTC- and risk limits, have been incorporated 613 registered swap dealers; SEC-registered security- See supra Part VI.A.3.b.2.b. in the final rule text for the market- based swap dealers: and foreign dealer entities. 614 See supra Part VI.A.3.b.2.b. As discussed making exemption, instead of a separate Further, the Agencies are not providing new above, a few other commenters suggested that to the appendix.610 Moreover, as described requirements regarding material conflicts of interest extent liquidity is vulnerable to destabilizing and high-risk assets and trading strategies in the liquidity spirals, any reduced liquidity stemming market-making exemption because the Agencies from section 13 of the BHC Act and its 606 See infra Part VI.C.3. (discussing the final believe these issues are adequately addressed in implementing rules would not necessarily be a metrics requirement). § 75.7 of the final rule. The limitations in § 75.7 will negative result. See AFR et al. (Feb. 2012); Public 607 See, e.g., Japanese Bankers Ass’n.; Citigroup apply to market making-related activities and all Citizen. See also Paul Volcker. These commenters (Feb. 2012). other exempted activities. also suggested that the Agencies adopt stricter 608 However, as discussed below, the Agencies 611 See supra note 550 and accompanying text. conditions in the market-making exemption, as believe risk limits can be a useful tool when they The Agencies acknowledge that reduced liquidity discussed throughout this Part VI.A.3. However, must account for the nature and amount of a can be costly. One commenter provided estimated liquidity—essentially, the ease with which assets particular trading desk’s market making-related impacts on asset valuation, borrowing costs, and can be converted into cash—is not destabilizing in activities, including the reasonably expected near transaction costs in the corporate bond market and of itself. Rather, liquidity spirals are a function term demands of clients, customers, or based on certain hypothetical scenarios of reduced of how firms are funded. During market downturns, counterparties. market liquidity. This commenter noted that its when margin requirements tend to increase, firms 609 See MetLife; Fixed Income Forum/Credit hypothetical liquidity shifts of 5, 10, and 15 that fund their operations with leverage face higher Roundtable; ACLI (Feb. 2012). percentile points were ‘‘necessarily arbitrary’’ but costs of providing liquidity; firms that run up 610 The Agencies are not, however, adding certain judged ‘‘to be realistic potential outcomes of the against their maximum leverage ratios may be additional requirements suggested by commenters, proposed rule.’’ Oliver Wyman (Feb. 2012). Because forced to retreat from market making, contributing such as a new customer-facing criterion, margin the Agencies have made significant modifications to to the liquidity spiral. Viewed in this light, it is requirements, or additional provisions regarding the proposed rule in response to comments, the institutional features of financial markets—in material conflicts of interest or high-risk assets or Agencies believe this commenter’s concerns about particular, leverage—rather than liquidity itself that trading strategies. See, e.g., Morgan Stanley; the market impacts of the proposed rule have been contributes to liquidity spirals. Stephen Roach; WR Hambrecht; Sens. Merkley & substantially addressed. 615 Wider spreads can be costly for investors. For Levin (Feb. 2012). The Agencies believe that the 612 As noted above, a few commenters stated that example, one commenter estimated that a 10 basis final rule includes sufficient requirements to ensure reduced liquidity may provide certain benefits. See, point increase in spreads in the corporate bond that a trading desk relying on the market-making e.g., Paul Volcker; AFR et al. (Feb. 2012); Public market would cost investors $29 billion per year. exemption is engaged in customer-facing activity Citizen; Prof. Richardson; Johnson & Prof. Stiglitz; See Wellington. Wider spreads can also be (for example, the final rule requires the trading desk Better Markets (Feb. 2012); Prof. Johnson. However, particularly costly for open-end mutual funds, to stand ready to buy and sell a type of financial a number of commenters stated that reduced which must trade in and out of the fund’s portfolio instrument as market maker and that the trading liquidity would have negative market impacts. See holdings on a daily basis in order to satisfy desk’s market-maker inventory is designed not to supra note 550 and accompanying text. Continued

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driven by both uncertainty about run institutional investors.619 The decision-making process in the normal fundamental value and the liquidity statute prohibits proprietary trading course of market making.621 In addition, needs of investors. When markets are activity that is not exempted. As such, in response to a large number of illiquid, participants may have to make the termination of nonexempt comments expressing concern that the large price concessions to find a proprietary trading activities of banking proposed market-making exemption counterparty willing to trade, increasing entities may lead to some general would restrict or prohibit market the importance of the liquidity channel reductions in liquidity of certain asset making-related activities in less liquid for addressing volatility. If liquidity- classes. Although the Agencies cannot markets, the Agencies are clarifying that based volatility is not diversifiable, say with any certainty, there is good the application of certain requirements investors will require a risk premium for reason to believe that to a significant in the final rule, such as the frequency holding liquidity risk, increasing the extent the liquidity reductions of this of required quoting and the near term cost of capital.616 Commenters type may be temporary since the statute demand requirement, will account for additionally suggested that the effects of does not restrict proprietary trading the liquidity, maturity, and depth of the diminished liquidity could be activities of other market participants. market for a given type of financial concentrated in securities markets for Thus, over time, non-banking entities instrument. Thus, banking entities will small or midsize companies or for may provide much of the liquidity that be able to continue to engage in market lesser-known issuers, where trading is is lost by restrictions on banking making-related activities across markets already infrequent.617 Volume in these entities’ trading activities. If so, and asset classes. markets can be low, increasing the eventually, the detrimental effects of At the same time, the Agencies inventory risk of market makers. The increased trading costs, higher costs of recognize that an overly broad market- Agencies recognize that, if the final rule capital, and greater market volatility making exemption may allow banking creates disincentives for banking should be mitigated. entities to mask speculative positions as Based on the many detailed entities to provide liquidity, these low liquidity provision or related hedges. comments provided, the Agencies have volume markets may be impacted first. The Agencies believe the requirements made substantive refinements to the included in the final rule are necessary As discussed above, the Agencies market-making exemption that the to prevent such evasion of the market- received several comments suggesting Agencies believe will reduce the making exemption, ensure compliance that the negative consequences likelihood that the rule, as with the statute, and facilitate internal associated with reduced liquidity would implemented, will negatively impact the banking entity and external Agency be unlikely to materialize under the ability of banking entities to engage in reviews of compliance with the final proposed rule. For example, a few the types of market making-related rule. Nevertheless, the Agencies commenters stated that non-bank activities permitted under the statute acknowledge that these additional costs financial intermediaries, who are not and, therefore, will continue to promote may have an impact on banking entities’ subject to section 13 of the BHC Act, the benefits to investors and other willingness to engage in market making- may increase their market-making market participants described above, related activities. Banking entities will activities in response to any reduction including greater market liquidity, incur certain compliance costs in in market making by banking entities, a narrower bid-ask spreads, reduced price connection with their market making- topic the Agencies discuss in more concessions and price impact, lower 618 related activities under the final rule. detail below. In addition, some volatility, and reduced counterparty For example, banking entities may not commenters suggested that the search costs, thus reducing the cost of currently limit their trading desks’ restrictions on proprietary trading capital. For instance, the final market- market-maker inventory to that which is would support liquid markets by making exemption does not require a designed not to exceed reasonably encouraging banking entities to focus on trade-by-trade analysis, which was a expected near term customer demand, financial intermediation activities that significant source of concern from as required by the statute. supply liquidity, rather than proprietary commenters who represented, among As discussed above, commenters trades that demand liquidity, such as other things, that a trade-by-trade presented diverging views on whether speculative trades or trades that front- analysis could have a chilling effect on non-banking entities are likely to enter individual traders’ willingness to engage 620 the market or increase their market- redemptions and subscriptions. See Wellington; in market-making activities. Rather, making activities if the final rule should AllianceBernstein. the final rule has been crafted around cause banking entities to reduce their 616 A higher cost of capital increases financing the overall market making-related market-making activities.622 The costs and translates into reduced capital activities of individual trading desks, investment. While one commenter estimated that a one percent increase in the cost of capital would with various requirements that these 621 For example, by clarifying that individual lead to a $55 to $82.5 billion decline in capital activities be demonstrably related to trades will not be viewed in isolation and requiring investments by U.S. nonfarm firms, the Agencies satisfying reasonably expected near term strong compliance procedures, this approach will cannot independently verify these potential costs. customer demands and other market- generally allow an individual trader to operate Further, this commenter did not indicate what within the compliance framework established for aspect of the proposed rule could cause a one making activities. The Agencies believe his or her trading desk without having to assess percent increase in the cost of capital. See Thakor that applying certain requirements to whether each individual transaction complies with Study. In any event, the Agencies have made the aggregate risk exposure of a trading all requirements of the market-making exemption. significant changes to the proposed approach to desk, along with the requirement to 622 See supra notes 565 and 569 and implementing the market-making exemption that establish risk and inventory limits to accompanying text (discussing comments on the should help address this commenter’s concern. issue of whether non-banking entities are likely to 617 See, e.g., CIEBA; ACLI; PNC et al.; Morgan routinize a trading desk’s compliance enter the market or increase their trading activities Stanley; Chamber (Feb. 2012); Abbott Labs et al. with the near term customer demand in response to reduced trading activity by banking (Feb. 14, 2012); FEI; ICI (Feb. 2012); TMA Hong requirement, will reduce negative entities). For example, one commenter stated that Kong; Sen. Casey. potential impacts on individual traders’ broker-dealers that are not affiliated with a bank 618 See, e.g., Sens. Merkley & Levin (Feb. 2012); would have reduced access to lender-of-last resort Prof. Richardson; Better Markets (Feb. 2012); Profs. liquidity from the central bank, which could limit Stout & Hastings; Prof. Johnson; Occupy; Public 619 See, e.g., Prof. Johnson. their ability to make markets during times of market Citizen; Profs. Admati & Pfleiderer; Better Markets 620 See supra note 522 (discussing commenters’ stress or when capital buffers are small. See Prof. (June 2012). concerns regarding a trade-by-trade analysis). Duffie. However, another commenter noted that the

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Agencies note that prior to the Gramm- conducts the purchase or sale in indicia of market making-related Leach-Bliley Act of 1999, market- reliance on the market-making activities will vary, but should generally making services were more commonly exemption to hold itself out as being include: (i) Holding oneself out as provided by non-bank-affiliated broker- willing to buy and sell, including willing and available to provide dealers than by banking entities. As through entering into long and short liquidity by providing quotes on a discussed above, by intermediating and positions in, the financial instrument for regular (but not necessarily continuous) facilitating trading, market makers its own account on a regular or basis; 628 (ii) with respect to securities, provide value to the markets and profit continuous basis.624 The proposal stated regularly purchasing securities from, or from providing liquidity. Should that a banking entity could rely on the selling securities to, clients, customers, banking entities retreat from making proposed exemption only for the type of or counterparties in the secondary markets, the profit opportunities financial instrument that the entity market; and (iii) transaction volumes available from providing liquidity will actually made a market in.625 and risk proportionate to historical provide an incentive for non-bank- The proposal recognized that the customer liquidity and investments affiliated broker-dealers to enter the precise nature of a market maker’s needs.629 market and intermediate trades. The activities often varies depending on the In discussing this proposed Agencies are unable to assess the likely liquidity, trade size, market requirement, the Agencies stated that effect with any certainty, but the infrastructure, trading volumes and bona fide market making-related activity Agencies recognize that a market- frequency, and geographic location of may include certain block positioning making operation requires certain the market for any particular financial and anticipatory position-taking. More infrastructure and capital, which will instrument.626 To account for these specifically, the proposal indicated that impact the ability of non-banking variations, the Agencies proposed the bona fide market making-related entities to enter the market-making indicia for assessing compliance with activity described in § 75.4(b)(2)(ii) of business or to increase their presence. this requirement that differed between the proposed rule would include: (i) Therefore, should banking entities relatively liquid markets and less liquid Block positioning if undertaken by a retreat from making markets, there markets. Further, the Agencies trading desk or other organizational unit could be a transition period with recognized that the proposed indicia of a banking entity for the purpose of reduced liquidity as non-banking could not be applied at all times and intermediating customer trading; 630 and entities build up the needed under all circumstances because some (ii) taking positions in securities in infrastructure and obtain capital. may be inapplicable to the specific asset anticipation of customer demand, so However, because the Agencies have class or market in which the market long as any anticipatory buying or substantially modified this exemption making-related activity is conducted. selling activity is reasonable and related in response to comments to ensure that In particular, the proposal stated that to clear, demonstrable trading interest of market making related to near-term a trading desk or other organizational clients, customers, or counterparties.631 customer demand is permitted as unit’s market making-related activities b. Comments on the Proposed contemplated by the statute, the in relatively liquid markets, such as Requirement To Hold Self Out Agencies do not believe the final rule equity securities or other exchange- should significantly impact currently- traded instruments, should generally Commenters raised many issues available market-making services.623 include: (i) Making continuous, two- regarding § 75.4(b)(2)(ii) of the proposed sided quotes and holding oneself out as exemption, which would require a c. Detailed Explanation of the Market- willing to buy and sell on a continuous trading desk or other organizational unit Making Exemption basis; (ii) a pattern of trading that to hold itself out as willing to buy and 1. Requirement to Routinely Stand includes both purchases and sales in sell the financial instrument for its own Ready To Purchase and Sell roughly comparable amounts to provide account on a regular or continuous a. Proposed Requirement To Hold Self liquidity; (iii) making continuous basis. As discussed below, some Out quotations that are at or near the market commenters viewed the proposed on both sides; and (iv) providing widely requirement as too restrictive, while Section 75.4(b)(2)(ii) of the proposed accessible and broadly disseminated other commenters stated that the rule would have required the trading quotes.627 With respect to market requirement was too permissive. Two desk or other organizational unit that making in less liquid markets, the commenters expressed support for the proposal noted that the appropriate proposed requirement.632 A number of presence and evolution of market making after the enactment of the Glass-Steagall Act mutes this 628 particular concern. See Prof. Richardson. 624 See proposed rule § 75.4(b)(2)(ii). The Agencies noted that, with respect to this 625 factor, the frequency of regular quotations will vary, 623 Certain non-banking entities, such as some See Joint Proposal, 76 FR at 68870 (‘‘Notably, as moderately illiquid markets may involve SEC-registered broker-dealers that are not banking this criterion requires that a banking entity relying quotations on a daily or more frequent basis, while entities subject to the final rule, currently engage in on the exemption with respect to a particular highly illiquid markets may trade only by market-making activities and, thus, should have the transaction must actually make a market in the appointment. See Joint Proposal, 76 FR at 68871 needed infrastructure and may attract additional [financial instrument] involved; simply because a n.149; CFTC Proposal, 77 FR at 8356 n.156. capital. If the final rule has a marginal impact on banking entity makes a market in one type of 629 banking entities’ willingness to engage in market [financial instrument] does not permit it to rely on See Joint Proposal, 76 FR at 68871; CFTC making-related activities, these non-banking entities the market-making exemption for another type of Proposal, 77 FR at 8356. should be able to respond by increasing their [financial instrument].’’); CFTC Proposal, 77 FR at 630 In the preamble to the proposed rule, the market making-related activities. The Agencies 8355–8356. Agencies stated that the SEC’s definition of recognize, however, that firms that do not have 626 See Joint Proposal, 76 FR at 68870; CFTC ‘‘qualified block positioner’’ may serve as guidance existing infrastructure or sufficient capital are Proposal, 77 FR at 8356. in determining whether a block positioner engaged unlikely to be able to act as market makers shortly 627 See Joint Proposal, 76 FR at 68870–68871; in block positioning is engaged in bona fide market after the final rule is implemented. Nevertheless, CFTC Proposal, 77 FR at 8356. These proposed making for purposes of § 75.4(b)(2)(ii) of the because some non-bank-affiliated broker-dealers factors are generally consistent with the indicia proposed rule. See Joint Proposal, 76 FR at 68871 currently operate market-making desks, and used by the SEC to assess whether a broker-dealer n.151; CFTC Proposal, 77 FR at 8356 n.157. because it was the dominant model prior to the is engaged in bona fide market making for purposes 631 See Joint Proposal, 76 FR at 68871; CFTC Gramm-Leach-Bliley Act, the Agencies believe that of Regulation SHO under the Exchange Act. See Proposal, 77 FR at 8356–8357. non-bank-affiliated financial intermediaries will be Joint Proposal, 76 FR at 68871 n.148; CFTC 632 See Sens. Merkley & Levin (Feb. 2012); Alfred able to provide market-making services longer term. Proposal, 77 FR at 8356 n.155. Brock.

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commenters provided views on commenters represented that, because commenters requested that the statements in the proposal regarding customer demand may be infrequent in requirement expressly include indicia of bona fide market making in a particular instrument, requiring a transactions in new instruments or more and less liquid markets and the banking entity to provide regular or transactions in instruments that occur permissibility of block positioning and continuous quotes in the instrument infrequently to address situations where anticipatory position-taking. may not provide a benefit to its a banking entity may not have Several commenters represented that customers.638 A few commenters previously had the opportunity to hold the proposed requirement was too requested that the Agencies provide itself out as willing to buy and sell the restrictive.633 For example, a number of further guidance on this issue or modify applicable instrument.641 Other these commenters expressed concern the proposed standard to state that commenters supported alternative that the proposed requirement may limit holding oneself out in a range of similar criteria for assessing whether a banking a banking entity’s ability to act as a instruments will be considered to be entity is acting as a market maker, such market maker under certain within the scope of permitted market as: (i) A willingness to respond to circumstances, including in less liquid making-related activities.639 customer demand by providing prices markets, for instruments lacking a two- To address concerns about the upon request; 642 (ii) being in the sided market, or in customer-driven, restrictiveness of this requirement, business of providing prices upon structured transactions.634 In addition, a commenters suggested certain request for that financial instrument or few commenters expressed specific modifications. For example, some other financial instruments in the same concern about how this requirement commenters suggested adding language or similar asset class or product would impact more limited market- to the requirement to account for market class; 643 or (iii) a historical test of making activity conducted by banks.635 making in markets that do not typically market-making activity, with Many commenters indicated that it involve regular or continuous, or two- compliance judged on the basis of actual was unclear whether this provision sided, quoting.640 In addition, a few trades.644 Finally, two commenters would require a trading desk or other stated that this requirement should be organizational unit to regularly or debt market with heavy trading volume or that are moved to Appendix B of the rule,645 continuously quote every financial in the midst of particular credit developments), but which, according to one of these will trade in other instruments within the group or instrument in which a market is made, sector upon inquiry from customers and other commenters, would provide the but expressed concern that the proposed dealers); Oliver Wyman (Feb. 2012) (discussing data Agencies greater flexibility to consider language could be interpreted in this regarding the number of U.S. corporate bonds and the facts and circumstances of a manner.636 These commenters noted frequency of trading in such bonds in 2009). 646 638 particular activity. that there are thousands of individual See Goldman (Prop. Trading). Other commenters took the view that 639 See, e.g., RBC (recommending that the instruments within a given asset class, Agencies clarify that a trading desk is required to the proposed requirement was too such as corporate bonds, and that it hold itself out as willing to buy and sell a particular permissive.647 For example, one would be burdensome for a market type of ‘‘product’’); SIFMA et al. (Prop. Trading) commenter stated that the proposed maker to provide quotes in such a large (Feb. 2012) (suggesting that the Agencies use the term ‘‘instrument,’’ rather than ‘‘covered financial standard provided too much room for number of instruments on a regular or position,’’ to provide greater clarity); CIEBA interpretation and would be difficult to continuous basis.637 One of these (supporting alternative criteria that would require a measure and monitor. This commenter banking entity to hold itself out generally as a expressed particular concern that a 633 See infra Part VI.A.3.c.1.c.iii. (addressing market maker for the relevant asset class, but not for every instrument it purchases and sells); trading desk or other organizational unit these concerns). could meet this requirement by 634 Goldman (Prop. Trading). One of these commenters See, e.g., SIFMA et al. (Prop. Trading) (Feb. recommended that the Agencies recognize and 2012); Morgan Stanley; Barclays; Goldman (Prop. regularly or continuously making wide, permit the following kinds of activity in related out of context quotes that do not present Trading); ABA; Chamber (Feb. 2012); BDA (Feb. financial instruments: (i) Options market makers 2012); Fixed Income Forum/Credit Roundtable; should be deemed to be engaged in market making any real risk of execution and do not ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC; in all put and call series related to a particular contribute to market liquidity.648 Some MetLife; RBC; IHS; SSgA (Feb. 2012). underlying security and should be permitted to commenters suggested the Agencies 635 See, e.g., PNC (stating that the proposed rule trade the underlying security regardless of whether place greater restrictions on a banking needs to account for market making by regional such trade qualifies for the hedging exemption; (ii) banks on behalf of small and middle-market convertible bond traders should be permitted to entity’s ability to rely on the market- customers whose securities are less liquid); ABA trade in the associated equity security; (iii) a market making exemption in certain illiquid (stating that the rule should continue to permit maker in one issuer’s bonds should be considered banks to provide limited liquidity by buying a market maker in similar bonds of other issuers; 641 securities that they feel are suitable for their retail See Wells Fargo (Prop. Trading); RBC and (iv) a market maker in standardized interest (supporting this approach as an alternative to and institutional customer base by stating that a rate swaps should be considered to be engaged in bank is ‘‘holding itself out’’ when it buys and sells removing the requirement from the rule, but market making-related activity if it engages in a primarily supporting its removal). See also ISDA securities that are suitable for its customers). customized interest rate swap with a customer upon 636 (Feb. 2012) (stating that the analysis of compliance This issue is further discussed in Part request. See RBC. with the proposed requirement must carefully VI.A.3.c.1.c.iii., infra. 640 See, e.g., Morgan Stanley (suggesting that the consider the degree of presence a market maker 637 See, e.g., Goldman (Prop. Trading) (stating that Agencies add the phrase ‘‘or, in markets where wishes to have in a given market, which may it would be burdensome for a U.S. credit market- regular or continuous quotes are not typically include being a leader in certain types of making business to be required to produce and provided, the trading unit stands ready to provide instruments, having a secondary presence in others, disseminate quotes for thousands of individual quotes upon request’’); Barclays (suggesting and potentially leaving or entering other bond CUSIPs that trade infrequently and noting that addition of the phrase ‘‘to the extent that two-sided submarkets). a market maker in credit markets will typically markets are typically made by market makers in a 642 See SIFMA et al. (Prop. Trading) (Feb. 2012). disseminate indicative prices for the most liquid given product,’’ as well as changing the reference This commenter also suggested that such test be instruments but, for the thousands of other to ‘‘purchase or sale’’ to ‘‘market making-related assessed at the ‘‘trading unit’’ level. See id. instruments that trade infrequently, the market activity’’ to avoid any inference of a trade-by-trade 643 See Goldman (Prop. Trading). maker will generally provide a price for a trade analysis). See also Fixed Income Forum/Credit 644 See FTN. upon request from another market participant); Roundtable. To address concerns about the 645 Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. requirement’s application to bespoke products, one See Flynn & Fusselman; JPMorgan. 2012); RBC. See also BDA (Feb. 2012); FTN (stating commenter suggested that the rule clearly state that 646 See JPMC. that in some markets, such as the markets for a banking entity fulfills this requirement if it 647 See, e.g., Occupy; AFR et al. (Feb. 2012); residential mortgage-backed securities and markets structured transactions to its client base Public Citizen; Johnson & Prof. Stiglitz; John Reed. investment grade corporate debt, a market maker and stands ready to enter into such transactions See infra note 751 and accompanying text will hold itself out in a subset of instruments (e.g., with customers, even though transactions may (responding to these comments). particular issues in the investment grade corporate occur on a relatively infrequent basis. See JPMC. 648 See Occupy.

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markets, such as assets that cannot be 157.656 One of these commenters stated that while the proposed factors reliably valued, products that do not explained that Level 3 assets are are reasonably consistent with bona fide have a genuine external market, or generally highly illiquid assets whose market making, the Agencies should instruments for which a banking entity fair value cannot be determined using add two other factors: (i) A willingness does not expect to have customers either market prices or models.657 In to transact in reasonable quantities at wishing to both buy and sell.649 In addition, a few commenters suggested quoted prices, and (ii) inventory support of these requests, commenters that banking entities be subject to turnover.663 stated that trading in illiquid products additional capital charges for market Other commenters, however, stated 658 raises certain concerns under the rule, making in illiquid products. Another that the proposed use of factors from the including: A lack of reliable data for commenter stated that the Agencies SEC’s analysis of bona fide market purposes of using metrics to monitor a should require all market making- making under Regulation SHO was banking entity’s market making-related related activity to be conducted on a inappropriate in this context. In activity (e.g., products whose valuations multilateral organized electronic trading particular, these commenters are determined by an internal model platform or exchange to make it possible represented that bona fide market that can be manipulated, rather than an to monitor and confirm certain trading making for purposes of Regulation SHO 650 659 observable market price); relation to data. Two commenters emphasized is a purposefully narrow concept that 651 the last financial crisis; lack of that their recommended restrictions on permits a subset of market makers to important benefits to the real market making in illiquid markets qualify for an exception from the 652 economy; similarity to prohibited should not prohibit banking entities ‘‘locate’’ requirement in Rule 203 of 653 proprietary trading; and from making markets in corporate Regulation SHO. The commenters 660 inconsistency with the statute’s bonds. further expressed the belief that the requirements that market making- i. The Proposed Indicia policy goals of section 13 of the BHC related activity must be ‘‘designed not to Act do not necessitate a similarly exceed the reasonably expected near As noted above, the proposal set forth narrow interpretation of market term demands of clients, customers, or certain indicia of bona fide market making.664 counterparties’’ and must not result in making-related activity in liquid and a material exposure to high-risk assets less liquid markets that the Agencies A few commenters expressed or high-risk trading strategies.654 proposed to apply when evaluating particular concern about how the factor These commenters also requested that whether a banking entity was eligible regarding patterns of purchases and the proposed requirement be modified for the proposed exemption.661 Several sales in roughly comparable amounts in certain ways. In particular, several commenters provided their views would apply to market making in commenters stated that the proposed regarding the effectiveness of the exchange-traded funds (‘‘ETFs’’). exemption should only permit market proposed indicia. According to these commenters, making in assets that can be reliably With respect to the proposed indicia demonstrating this factor could be valued through external market for liquid markets, a few commenters difficult because ETF market making transactions.655 In order to implement expressed support for the proposed involves a pattern of purchases and such a limitation, three commenters indicia.662 One of these commenters sales of groups of equivalent securities suggested that the Agencies prohibit (i.e., the ETF shares and the basket of banking entities from market making in 656 See AFR et al. (Feb. 2012) (stating that such securities and cash that is exchanged for assets classified as Level 3 under FAS a limitation would be consistent with the proposed them), not a single security. In addition, limitation on ‘‘high-risk assets’’ and the discussion the commenters were unsure whether of this limitation in proposed Appendix C); Public 649 See Occupy; AFR et al. (Feb. 2012); Public Citizen; Prof. Richardson. this factor could be demonstrated in Citizen; Johnson & Prof. Stiglitz; Sens. Merkley & 657 See Prof. Richardson. times of limited trading in ETF 665 Levin (Feb. 2012); John Reed. 658 Two commenters recommended that banking shares. 650 See AFR et al. (Feb. 2012); Occupy. entities be required to treat trading in assets that The preamble to the proposed rule 651 See Occupy. cannot be reliably valued and that trade only by 652 See John Reed. appointment, such as bespoke derivatives and also provided certain proposed indicia 653 See Johnson & Prof. Stiglitz. structured products, as providing an illiquid of bona fide market making-related 666 654 See Sens. Merkley & Levin (Feb. 2012) (stating bespoke loan, which are subject to higher capital activity in less liquid markets. As that a banking entity must have or reasonably charges under the Federal banking agencies’ capital discussed above, commenters had rules. See Johnson & Prof. Stiglitz; John Reed. expect at least two customers—one for each side of differing views about whether the the trade—and must have a reasonable expectation Another commenter suggested that, if not directly of the second customer coming to take the position prohibited, trading in bespoke instruments that exemption for market making-related or risk off its books in the ‘‘near term’’); AFR et al. cannot be reliably valued should be assessed an activity should permit banking entities (Feb. 2012); Public Citizen. appropriate capital charge. See Public Citizen. to engage in market making in some or 659 655 See AFR et al. (Feb. 2012) (stating that the rule See Occupy. This commenter further suggested that the exemption exclude all activities all illiquid markets. Thus, with respect should ban market making in illiquid and opaque to the proposed indicia for market securities with no genuine external market, but that include: (i) Assets whose changes in value permit market making in somewhat illiquid cannot be mitigated by effective hedges; (ii) new making in less liquid markets, securities, such as certain corporate bonds, as long products with rapid growth, including those that do commenters generally stated that the as the securities can be reliably valued with not have a market history; (iii) assets or strategies that include significant imbedded leverage; (iv) indicia should be broader or narrower, reference to other extremely similar securities that depending on the commenter’s overall are regularly traded in liquid markets and the assets or strategies that have demonstrated financial outcome of the transaction is reasonably significant historical volatility; (v) assets or view on the issue of market making in predictable); Johnson & Prof. Stiglitz strategies for which the application of capital and illiquid markets. One commenter stated (recommending that permitted market making be liquidity standards would not adequately account limited to assets that can be reliably valued in, at for the risk; and (vi) assets or strategies that result forth in the FSOC study, which are substantially the a minimum, a moderately liquid market evidenced in large and significant concentrations to sectors, same as the indicia in the proposal); Alfred Brock. by trading within a reasonable period, such as a risk factors, or counterparties. See id. 663 week, through a real transaction and not simply 660 See AFR et al. (Feb. 2012); Johnson & Prof. See AFR et al. (Feb. 2012). with interdealer trades); Public Citizen (stating that Stiglitz. 664 See Goldman (Prop. Trading); SIFMA et al. market making should be limited to assets that can 661 See supra Part VI.A.3.c.1.a. (Prop. Trading) (Feb. 2012). be reliably valued in a market where transactions 662 See Occupy; AFR et al. (Feb. 2012); NYSE 665 See ICI (Feb. 2012); ICI Global. take place on a weekly basis). Euronext (expressing support for the indicia set 666 See supra Part VI.A.3.c.1.a.

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that the proposed indicia are ‘‘market’’ for assets that trade only by A number of commenters supported effective.667 appointment, such as customized, the general language in the proposal The first proposed factor of market structured products and OTC permitting block positioning, but making-related activity in less liquid derivatives.673 expressed concern about the reference markets was holding oneself out as The second proposed criterion for to the definition of ‘‘qualified block willing and available to provide market making-related activity in less positioner’’ in SEC Rule 3b–8(c).681 liquidity by providing quotes on a liquid markets was, with respect to With respect to using Rule 3b–8(c) as regular (but not necessarily continuous) securities, regularly purchasing guidance under the proposed rule, these basis. As noted above, several securities from, or selling securities to, commenters represented that Rule 3b– commenters expressed concern about a clients, customers, or counterparties in 8(c)’s requirement to resell block requirement that market makers provide the secondary market. Two commenters positions ‘‘as rapidly as possible’’ would regular quotations in less liquid expressed concern about this proposed cause negative results (e.g., fire sales) or instruments, including in fixed income factor.674 In particular, one of these create market uncertainty (e.g., when, if markets and bespoke, customized commenters stated that the language is ever, a longer unwind would be derivatives.668 With respect to the fundamentally inconsistent with market permitted).682 According to one of these interaction between the rule language making because it contemplates that commenters, gradually disposing of a requiring ‘‘regular’’ quoting and the only taking one side of the market is large long position purchased from a proposal’s language permitting trading sufficient, rather than both buying and customer may be the best means of by appointment under certain selling an instrument.675 The other reducing near term price volatility circumstances, some of these commenter expressed concern that associated with the supply shock of commenters expressed uncertainty banking entities would be allowed to trying to sell the position at once.683 about how a market maker trading only accumulate a significant amount of Another commenter expressed concern by appointment would be able to satisfy illiquid risk because the indicia for about the second requirement of Rule the proposed rule’s regular quotation market making-related activity in less 3b–8(c), which provides that the dealer 669 requirement. In addition, another liquid markets did not require a market must determine in the exercise of commenter stated that the proposal’s maker to buy and sell in comparable reasonable diligence that the block recognition of trading by appointment amounts (as required by the indicia for cannot be sold to or purchased from does not alleviate concerns about liquid markets).676 others on equivalent or better terms. applying the ‘‘regular’’ quotation Finally, the third proposed factor of This commenter stated that this kind of requirement to market making in less market making in less liquid markets determination would be difficult in less liquid instruments in markets that are would consider transaction volumes liquid markets because those markets do not, as a whole, highly illiquid, such as and risk proportionate to historical not have widely disseminated quotes credit and interest rate markets.670 customer liquidity and investment that dealers can use for purposes of Other commenters expressed concern needs. A few commenters indicated that comparison.684 about only requiring a market maker to provide regular quotations or permitting there may not be sufficient information Beyond the reference to Rule 3b–8(c), available for a banking entity to conduct a few commenters expressed more trading by appointment to qualify for 677 the market-making exemption. With such an analysis. For example, one general concern about the proposed respect to regular quotations, some commenter stated that historical rule’s application to block positioning 685 commenters stated that such a information may not necessarily be activity. One commenter noted that requirement enables evasion of the available for new businesses or the proposal only discussed block prohibition on proprietary trading developing markets in which a market positioning in the context of the because a proprietary trader may post a maker may seek to establish trading proposed requirement to hold oneself 678 quote at a time of little interest in a operations. Another commenter out, which implies that block financial product or may post wide, out expressed concern that this factor would positioning activity also must meet the of context quotes on a regular basis with not help differentiate market making other requirements of the market- no real risk of execution.671 Several from prohibited proprietary trading making exemption. This commenter commenters stated that trading only by because most illiquid markets do not requested an explicit recognition that appointment should not qualify as have a source for such historical risk banking entities meet the requirements 679 market making for purposes of the and volume data. of the market-making exemption when 672 they enter into block trades for proposed rule. Some of these ii. Treatment of Block Positioning customers, including related trades commenters stated that there is no Activity entered to support the block, such as 667 See Alfred Brock. The proposal provided that the 668 See supra note 634 accompanying text. With activity described in § 75.4(b)(2)(ii) of 681 See, e.g., RBC; SIFMA (Asset Mgmt.) (Feb. respect to this factor, one commenter requested that the proposed rule would include block 2012); Goldman (Prop. Trading). See also infra note the Agencies delete the parenthetical of ‘‘but not positioning if undertaken by a trading 740 (responding to these comments). necessarily continuous’’ from the proposed factor as desk or other organizational unit of a 682 See RBC (expressing concern about fire sales); part of a broader effort to recognize the relative SIFMA (Asset Mgmt.) (Feb. 2012) (expressing illiquidity of swap markets. See ISDA (Feb. 2012). banking entity for the purpose of concern about fire sales, particularly in less liquid 669 See SIFMA et al. (Prop. Trading) (Feb. 2012); intermediating customer trading.680 markets where a block position would overwhelm CIEBA. These commenters requested greater clarity the market and undercut the price a market maker or guidance on the meaning of ‘‘regular’’ in the can obtain); Goldman (Prop. Trading) (representing 673 See, e.g., John Reed; Public Citizen. instance of a market maker trading only by that this requirement could create uncertainty about 674 appointment. See id. See AFR et al. (Feb. 2012); Occupy. whether a longer unwind would be permissible 675 670 See Goldman (Prop. Trading). See AFR et al. (Feb. 2012) and, if so, under what circumstances). 676 671 See Public Citizen; Occupy. One of these See Occupy. 683 See Goldman (Prop. Trading). commenters further noted that most markets lack a 677 See SIFMA et al. (Prop. Trading) (Feb. 2012); 684 See RBC. structural framework that would enable monitoring Goldman (Prop. Trading); Occupy. 685 See SIFMA (Asset Mgmt.) (Feb. 2012); Fidelity of compliance with this requirement. See Occupy. 678 See Goldman (Prop. Trading). (requesting that the Agencies explicitly recognize 672 See, e.g., Sens. Merkley & Levin (Feb. 2012); 679 See Occupy. that block trades qualify for the market-making Johnson & Prof. Stiglitz; John Reed; Public Citizen. 680 See Joint Proposal, 76 FR at 68871. exemption); Oliver Wyman (Feb. 2012).

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hedging transactions.686 Finally, one banking entity to engage in sell when they think it is profitable.697 commenter expressed concern that the impermissible front running.690 One of Another commenter suggested the inventory metrics in proposed these commenters indicated that the Agencies impose a resting period on any Appendix A would make dealers Agencies should not restrict order placed by a banking entity in reluctant to execute large, principal anticipatory trading to such a short time reliance on any exemption in the rule transactions because such trades would period.691 To the contrary, the other by, for example, prohibiting a banking have a transparent impact on inventory commenter stated that anticipatory entity from buying and subsequently metrics in the relevant asset class.687 accumulation of inventory should be selling a position within a span of two considered to be prohibited proprietary seconds.698 iii. Treatment of Anticipatory Market trading.692 A few commenters noted that Making c. Final Requirement To Routinely the standard in the proposal explicitly Stand Ready To Purchase and Sell In the proposal, the Agencies refers to securities and requested that proposed that ‘‘bona fide market the reference be changed to encompass Section 75.4(b)(2)(i) of the final rule making-related activity may include the full scope of financial instruments provides that the trading desk that taking positions in securities in covered by the rule to avoid establishes and manages the financial anticipation of customer demand, so ambiguity.693 Several commenters exposure must routinely stand ready to long as any anticipatory buying or recommended that the language be purchase and sell one or more types of selling activity is reasonable and related eliminated 694 or modified 695 to address financial instruments related to its to clear, demonstrable trading interest of the concerns discussed above. financial exposure and be willing and clients, customers, or available to quote, buy and sell, or counterparties.’’ 688 Many commenters iv. High-Frequency Trading otherwise enter into long and short indicated that the language in the positions in those types of financial A few commenters stated that high- proposal is inconsistent with the instruments for its own account, in frequency trading should be considered statute’s language regarding near term commercially reasonable amounts and prohibited proprietary trading under the demands of clients, customers, or throughout market cycles, on a basis rule, not permitted market making- counterparties. According to these appropriate for the liquidity, maturity, related activity.696 For example, one commenters, the statute’s ‘‘designed’’ and depth of the market for the relevant commenter stated that the Agencies and ‘‘reasonably expected’’ language types of financial instruments. As should not confuse high volume trading expressly acknowledges that a market discussed in more detail below, the and market making. This commenter maker may need to accumulate standard of ‘‘routinely’’ standing ready emphasized that algorithmic traders in inventory before customer demand to purchase and sell one or more types general—and high-frequency traders in manifests itself. Commenters further of financial instruments will be particular—do not hold themselves out represented that the proposed standard interpreted to account for differences in the manner required by the proposed may unduly limit a banking entity’s across markets and asset classes. In rule, but instead only offer to buy and ability to accumulate inventory in addition, this requirement provides that anticipation of customer demand.689 a trading desk must be willing and In addition, two commenters 690 See Goldman (Prop. Trading); Occupy. See available to provide quotations and also Public Citizen (expressing general concern that transact in the particular types of expressed concern that the proposal’s accumulating positions in anticipation of demand language would effectively require a opens issues of front running). financial instruments in commercially 691 See Goldman (Prop. Trading). reasonable amounts and throughout 686 See SIFMA (Asset Mgmt.) (Feb. 2012). 692 See Occupy. market cycles. Thus, a trading desk’s 687 See Oliver Wyman (Feb. 2012). This 693 See Goldman (Prop. Trading); ISDA (Feb. activities would not meet the terms of commenter estimated that investors trading out of 2012); SIFMA et al. (Prop. Trading) (Feb. 2012). the market-making exemption if, for large block positions on their own, without a 694 See BoA (stating that a market maker must example, the trading desk only provides market maker directly providing liquidity, would acquire inventory in advance of express customer wide quotations on one or both sides of have to pay incremental transaction costs between demand and customers expect a market maker’s $1.7 and $3.4 billion per year. This commenter inventory to include not only the financial the market relative to prevailing market estimated a block trading size of $850 billion, based instruments in which customers have previously conditions or is only willing to trade on on a haircut of total block trading volume reported traded, but also instruments that the banking entity an irregular, intermittent basis. for NYSE and Nasdaq. The commenter then believes they may want to trade); Occupy. While this provision of the market- estimated, based on market interviews and analysis 695 See Morgan Stanley (suggesting a new of standard market impact models provided by standard providing that a purchase or sale must be making exemption has some similarity dealers, that the market impact of executing large ‘‘reasonably consistent with observable customer to the requirement to hold oneself out block orders without direct market maker liquidity demand patterns and, in the case of new asset in § 75.4(b)(2)(ii) of the proposed rule, provision would be the difference between the classes or markets, with reasonably expected future the Agencies have made a number of market impact costs of executing a block trade over developments on the basis of the trading unit’s a 5-day period versus a 1-day period—which would client relationships’’); Chamber (Feb. 2012) refinements in response to comments. be approximately 20 to 50 basis points, depending (requesting that the final rule permit market makers Specifically, a number of commenters on the size of the trade. See id. to make individualized assessments of anticipated expressed concern that the proposed 688 Joint Proposal, 76 FR at 68871; CFTC Proposal, customer demand based on their expertise and requirement did not sufficiently account 77 FR at 8356–8357. experience in the markets and make trades for differences between markets and 689 See, e.g., SIFMA et al. (Prop. Trading) (Feb. according to those assessments); Goldman (Prop. 2012) (expressing concern that requiring trades to Trading) (recommending that the Agencies instead asset classes and would unduly limit be related to clear demonstrable trading interest focus on how trading activities are ‘‘designed’’ to certain types of market making by could curtail the market-making function by meet the reasonably expected near term demands of requiring ‘‘regular or continuous’’ removing a market maker’s discretion to develop clients over time, rather than whether those quoting in a particular instrument.699 inventory to best serve its customers and adversely demands have actually manifested themselves at a restrict liquidity); Goldman (Prop. Trading); given point in time); ISDA (Feb. 2012) (stating that Chamber (Feb. 2012); Comm. on Capital Markets the Agencies should clarify this language to 697 See Better Markets (Feb. 2012). See also infra Regulation. See also Morgan Stanley (requesting recognize differences between liquid and illiquid note 747 (addressing this issue). certain revisions to more closely track the statute); markets and noting that illiquid and low volume 698 See Occupy. SIFMA (Asset Mgmt.) (Feb. 2012) (expressing markets necessitate that swap dealers take a longer 699 See supra Part VI.A.3.c.1.b. (discussing general concern that the standard creates and broader view than dealers in liquid markets). comments on this issue). The Agencies did not limitations on a market maker’s inventory). These 696 See, e.g., Better Markets (Feb. 2012); Occupy; intend for the reference to ‘‘covered financial comments are addressed in Part VI.A.3.c.2., infra. Public Citizen. Continued

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The explanation of this requirement in based generally on concepts from the commenter suggested that the market- the proposal was intended to address securities laws and is consistent with making exemption apply to each many of these concerns. For example, the CFTC’s and SEC’s description of ‘‘trading unit’’ of a banking entity, the Agencies stated that the proposed market making in swaps,702 the defined as ‘‘each organizational unit ‘‘indicia cannot be applied at all times Agencies note that it is not directly that is used to structure and control the and under all circumstances because based on an existing definition of aggregate risk-taking activities and some may be inapplicable to the specific market making.703 Instead, the approach employees that are engaged in the asset class or market in which the taken in the final rule is intended to coordinated implementation of a market-making activity is take into account and accommodate the customer-facing revenue generation conducted.’’ 700 Nonetheless, the conditions in the relevant market for the strategy and that participate in the Agencies believe that certain financial instrument in which the execution of any covered trading modifications are warranted to clarify banking entity is making a market. activity.’’ 706 This suggested approach is the rule and to prevent a potential substantially similar to the second i. Definition of ‘‘Trading Desk’’ chilling effect on market making-related prong of the Agencies’ proposed activities conducted by banking entities. The Agencies are adopting a market- definition of ‘‘trading unit’’ in Appendix Commenters represented that the making exemption with requirements A of the proposal. The Agencies requirement that a trading desk hold that generally focus on a financial described this prong as generally itself out as being willing to buy and sell exposure managed by a ‘‘trading desk’’ including management or reporting ‘‘on a regular or continuous basis,’’ as of a banking entity and such trading divisions, groups, sub-groups, or other was originally proposed, was impossible desk’s market-maker inventory. The intermediate units of organization used to meet or impractical in the context of market-making exemption as originally by the banking entity to manage one or many markets, especially less liquid proposed would have applied to ‘‘a more discrete trading units (e.g., ‘‘North markets.701 Accordingly, the final rule trading desk or other organizational American Credit Trading,’’ ‘‘Global requires a trading desk that establishes unit’’ of a banking entity. In addition, Credit Trading,’’ etc.).707 The Agencies and manages the financial exposure to for purposes of the proposed are concerned that this commenter’s ‘‘routinely’’ stand ready to trade one or requirement to report and record certain suggested approach, or any other more types of financial instruments quantitative measurements, the proposal approach applying the exemption’s related to its financial exposure. As defined the term ‘‘trading unit’’ as each requirements to a higher level of discussed below, the meaning of of the following units of organization of organization than the trading desk, ‘‘routinely’’ will account for the a banking entity: (i) Each discrete unit would impede monitoring of market liquidity, maturity, and depth of the that is engaged in the coordinated making-related activity and detection of market for a type of financial implementation of a revenue-generation impermissible proprietary trading by instrument, which should address strategy and that participates in the combining a number of different trading commenter concern that the proposed execution of any covered trading strategies and aggregating a larger standard would not work in less liquid activity; (ii) each organizational unit volume of trading activities.708 Further, markets and would have a chilling effect that is used to structure and control the key requirements in the market-making on banking entities’ ability to act as aggregate risk-taking activities and exemption, such as the required limits market makers in less liquid markets. A employees of one or more trading units and risk management procedures, are concept of market making that is described in paragraph (i); and (iii) all generally used by banking entities for applicable across securities, commodity trading operations, collectively.704 risk control and applied at the trading futures, and derivatives markets has not The Agencies received few comments desk level. Thus, applying them at a previously been defined by any of the regarding the organizational level at broader organizational level than the Agencies. Thus, while this standard is which the requirements of the market- trading desk would create a separate making exemption should apply, and system for compliance with this position’’ in the proposed rule to imply a single many of the commenters that addressed exemption designed to permit a banking instrument, although commenters contended that this issue did not describe their entity to aggregate disparate trading the proposal may not have been sufficiently clear suggested approach in detail.705 One on this point. activities and apply limits more 700 Joint Proposal, 76 FR at 68871; CFTC Proposal, generally. Applying the conditions of 77 FR at 8356. 702 See Further Definition of ‘‘Swap Dealer,’’ the exemption at a more aggregated 701 See, e.g., SIFMA et al. (Prop. Trading) (Feb. ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap level would allow banking entities more 2012); Morgan Stanley; Barclays; Goldman (Prop. Participant,’’ ‘‘Major Security-Based Swap Trading); ABA; Chamber (Feb. 2012); BDA (Feb. Participant’’ and ‘‘Eligible Contract Participant,’’ 77 flexibility in trading and could result in 2012); Fixed Income Forum/Credit Roundtable; FR 30596, 30609 (May 23, 2012) (describing market a higher volume of trading that could ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC; making in swaps as ‘‘routinely standing ready to contribute modestly to liquidity.709 MetLife; RBC; SSgA (Feb. 2012). Some commenters enter into swaps at the request or demand of a suggested alternative criteria, such as providing counterparty’’). 703 706 Morgan Stanley. prices upon request, using a historical test of market As a result, activity that is considered market 707 making, or a purely guidance-based approach. See making under this final rule may not necessarily be See Joint Proposal, 76 FR at 68957 n.2. SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman considered market making for purposes of other 708 See, e.g., Occupy (expressing concern that, (Prop. Trading); FTN; Flynn & Fusselman; JPMC. laws or regulations, such as the U.S. securities laws, with respect to the proposed definition of ‘‘trading The Agencies are not adopting a requirement that the rules and regulations thereunder, or self- unit,’’ an ‘‘oversized’’ unit could combine the trading desk only provide prices upon request regulatory organization rules. In addition, the significantly unrelated trading desks, which would because the Agencies believe it would be Agencies note that a banking entity acting as an impede detection of proprietary trading activity). inconsistent with market making in liquid underwriter would continue to be treated as an 709 The Agencies recognize that the proposed exchange-traded instruments where market makers underwriter for purposes of the securities laws and rule’s application to a trading desk ‘‘or other regularly or continuously post quotes on an the regulations thereunder, including any liability organizational unit’’ would have provided banking exchange. With respect to one commenter’s arising under the securities laws as a result of acting entities with this type of flexibility to determine the suggested approach of a historical test of market in such capacity, regardless of whether it is able to level of organization at which the market-making making, this commenter did not provide enough meet the terms of the market-making exemption for exemption should apply based on the entity’s information about how such a test would work for its activities. See Sens. Merkley & Levin (Feb. 2012). particular business structure and trading strategies, the Agencies’ consideration. Finally, the final rule 704 See Joint Proposal, 76 FR at 68957; CFTC which would likely reduce the burdens of this does not adopt a purely guidance-based approach Proposal, 77 FR at 8436. aspect of the final rule. However, for the reasons because, as discussed further above, the Agencies 705 See Wellington; SIFMA et al. (Prop. Trading) noted above regarding application of this exemption believe it could lead to an increased risk of evasion. (Feb. 2012). to a higher organizational level than the trading

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Instead of taking that approach, the The Agencies are not adopting the limits and procedures to the type of Agencies have determined to permit a proposed ‘‘or other organizational unit’’ instruments traded and markets served broader range of market making-related language because the Agencies are by each trading desk. activities that can be effectively concerned that approach would have In response to comments, and as controlled by building on risk controls provided banking entities with too discussed below in the context of the used by trading desks for business much discretion to independently ‘‘financial exposure’’ definition, a purposes. This will allow an individual determine the organizational level at trading desk may manage a financial trader to use instruments or strategies which the requirements should apply, exposure that includes positions in within limits established in the including a more aggregated level of different affiliated legal entities.712 compliance program to confidently organization, which could lead to Similarly, a trading desk may include trade in the type of financial evasion of the general prohibition on employees working on behalf of instruments in which his or her trading proprietary trading and the other multiple affiliated legal entities or desk makes a market. The Agencies concerns noted above. The Agencies booking trades in multiple affiliated believe this addresses concerns that believe that adopting an approach entities. Using the previous example, uncertainty would negatively impact focused on the trading desk level will the U.S. investment grade telecom liquidity. It also addresses concerns that allow banking entities and the Agencies corporate credit trading desk may applying the market-making exemption to better distinguish between permitted include traders working for or booking at a higher level of organization would market making-related activities and into a broker-dealer entity (for corporate reduce the effectiveness of the trading that is prohibited by section 13 bond trades), a security-based swap requirements in the final rule aimed at of the BHC Act and, thus, will prevent dealer entity (for single-name CDS ensuring that the quality and character evasion of the statutory requirements, as trades), and/or a swap dealer entity (for of trading is consistent with market discussed in more detail below. Further, index CDS or interest rate swap hedges). making-related activity and would as discussed below, the Agencies To clarify this issue, the definition of increase the risk of evasion. Moreover, believe that applying requirements at ‘‘trading desk’’ specifically provides that several provisions of the final rule are the trading desk level is balanced by the the desk can buy or sell financial intended to account for the liquidity, financial exposure-based approach, instruments ‘‘for the trading account of maturity, and depth of the market for a which will address commenters’ a banking entity or an affiliate thereof.’’ given type of financial instrument in concerns about the burdens of trade-by- Thus, a trading desk need not be which the trading desk makes a market. trade analyses. constrained to a single legal entity, The final rule takes account of these In the final rule, trading desk is although it is permissible for a trading factors to, among other things, respond defined to mean the smallest discrete desk to only trade for a single legal to commenters’ concerns about the unit of organization of a banking entity entity. A trading desk booking positions proposed rule’s potential impact on that buys or sells financial instruments in different affiliated legal entities must market making in less liquid markets. for the trading account of the banking have records that identify all positions Applying these requirements at an entity or an affiliate thereof. The included in the trading desk’s financial organizational level above the trading exposure and where such positions are Agencies expect that a trading desk 713 desk would be more likely to result in would be managed and operated as an held, as discussed below. The Agencies believe that establishing aggregation of trading in various types individual unit and should reflect the a defined organizational level at which of instruments with differing levels of level at which the profit and loss of many of the market-making exemption’s liquidity, which would make it more market-making traders is attributed.711 difficult for these market factors to be requirements apply will address The geographic location of individual potential evasion concerns. Applying taken into account for purposes of the traders is not dispositive for purposes of exemption (for example, these factors certain requirements of the market- the analysis of whether the traders may making exemption at the trading desk are considered for purposes of tailoring comprise a single trading desk. For the analysis of reasonably expected level will strengthen their effectiveness instance, a trading desk making markets and prevent evasion of the exemption near-term demands of customers and in U.S. investment grade telecom establishing risk, inventory, and by ensuring that the aggregate trading corporate credits may use trading activities of a relatively limited group of duration limits). personnel in both New York (to trade Thus, the Agencies continue to traders on a single desk are conducted U.S. dollar-denominated bonds issued in a manner that is consistent with the believe that certain requirements of the by U.S.-incorporated telecom exemption should apply to a relatively exemption’s standards. In particular, companies) and London (to trade Euro- because many of the requirements in the granular level of organization within a denominated bonds issued by the same banking entity (or across two or more market-making exemption look to the type of companies). This approach specific type(s) of financial instruments affiliated banking entities). These allows more effective management of requirements of the final market-making in which a market is being made, and risks of trading activity by requiring the such requirements are designed to take exemption have been formulated to best establishment of limits, management reflect the nature of activities at the into account differences among markets oversight, and accountability at the level and asset classes, the Agencies believe trading desk level of granularity. where trading activity actually occurs. It As explained below, the Agencies are it is important that these requirements also allows banking entities to tailor the applying certain requirements to a be applied to a discrete and identifiable ‘‘trading desk’’ of a banking entity and unit engaged in, and operated by 711 For example, the Agencies expect a banking personnel whose responsibilities relate adopting a definition of this term in the entity may determine the foreign exchange options final rule.710 The definition of ‘‘trading desk to be a trading desk; however, the Agencies to, making a market in a specific set or desk’’ is similar to the first prong of the do not expect a banking entity to consider an proposed definition of ‘‘trading unit.’’ individual Japanese Yen options trader (i.e., the 712 See infra note 729 and accompanying text. trader in charge of all Yen-based options trades) as Several commenters noted that market-making a trading desk, unless the banking entity manages activities may be conducted across separate desk, the Agencies are not adopting the ‘‘or other its profit and loss, market making, and hedging in affiliated legal entities. See, e.g., SIFMA et al. (Prop. organizational unit’’ language. Japanese Yen options independently of all other Trading) (Feb. 2012); Goldman (Prop. Trading). 710 See final rule § 75.3(e)(13). financial instruments. 713 See infra note 732 and accompanying text.

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type of financial instruments. Further, viewed in a holistic manner and that, receiving approval through its applying requirements at the trading during a single day, a trading desk may escalation procedures.719 desk level should facilitate banking engage in a large number of purchases Under the final rule, the term market- entity monitoring and review of and sales of financial instruments. maker inventory is defined to mean all compliance with the exemption by While all these transactions must be of the positions, in the financial limiting the aggregate trading volume conducted in compliance with the instruments for which the trading desk that must be reviewed, as well as market-making exemption, the Agencies stands ready to make a market in allowing consideration of the particular recognize that they involve financial accordance with paragraph (b)(2)(i) of facts and circumstances of the desk’s instruments for which the trading desk this section, that are managed by the trading activities (e.g., the liquidity, acts as market maker (i.e., by standing trading desk, including the trading maturity, and depth of the market for ready to purchase and sell that type of desk’s open positions or exposures the relevant types of financial financial instrument) and instruments arising from open transactions.720 Those instruments). As discussed above, the that are acquired to manage the risks of financial instruments in which a trading Agencies believe that applying the positions in financial instruments for desk acts as market maker must be requirements of the market-making which the desk acts as market maker, identified in the trading desk’s exemption to a higher level of but in which the desk is not itself a compliance program under organization would reduce the ability to market maker.717 § 75.4(b)(2)(iii)(A) of the final rule. As consider the liquidity, maturity, and The final rule requires that activity by used throughout this SUPPLEMENTARY depth of the market for a type of a trading desk under the market-making INFORMATION, the term ‘‘inventory’’ financial instrument, would impede exemption be evaluated by a banking refers to both the retention of financial effective monitoring and compliance entity through monitoring and setting instruments (e.g., securities) and, in the reviews, and would increase the risk of limits for the trading desk’s market- context of derivatives trading, the risk evasion. maker inventory and financial exposure. exposures arising out of market-making The market-maker inventory of a trading related activities.721 Consistent with the ii. Definitions of ‘‘Financial Exposure’’ desk includes the positions in financial and ‘‘Market-Maker Inventory’’ statute, the final rule requires that the instruments, including derivatives, in market-maker inventory of a trading Certain requirements of the proposed which the trading desk acts as market desk be designed not to exceed, on an market-making exemption referred to a maker. The financial exposure of the ongoing basis, the reasonably expected ‘‘purchase or sale of a [financial trading desk includes the aggregate risks near term demands of clients, instrument].’’ 714 Even though the of financial instruments in the market- customers, or counterparties. Agencies did not intend to require a maker inventory of the trading desk plus The financial exposure concept is trade-by-trade review, a significant the financial instruments, including broader in scope than market-maker number of commenters expressed derivatives, that are acquired to manage inventory and reflects the aggregate concern that this language could be read the risks of the positions in financial risks of the financial instruments (as to require compliance with the instruments for which the trading desk well as any associated loans, spot proposed market-making exemption on acts as a market maker, but in which the commodities, or spot foreign exchange a transaction-by-transaction basis.715 In trading desk does not itself make a or currency) the trading desk manages response to these concerns, the market, as well as any associated loans, as part of its market making-related Agencies are modifying the exemption commodities, and foreign exchange that activities.722 Thus, a trading desk’s to clarify the manner in which are acquired as incident to acting as a financial exposure will take into compliance with certain provisions will market maker. In addition, the trading account a trading desk’s positions in be assessed. In particular, rather than a desk generally must maintain its instruments for which it does not act as transaction-by-transaction focus, the market-maker inventory and financial a market maker, but which are market-making exemption in the final exposure within its market-maker rule focuses on two related aspects of inventory limit and its financial 719 See final rule § 75.4(b)(2)(iii)(E). market-making activity: A trading desk’s exposure limit, respectively and, to the 720 See final rule § 75.4(b)(5). ‘‘market-maker inventory’’ and its extent that any limit of the trading desk 721 As noted in the proposal, certain types of overall ‘‘financial exposure.’’716 is exceeded, the trading desk must take market making-related activities, such as market The Agencies are adopting an action to bring the trading desk into making in derivatives, involves the retention of principal exposures rather than the retention of approach that focuses on both a trading compliance with the limits as promptly actual financial instruments. See Joint Proposal, 76 desk’s financial exposure and market- as possible after the limit is FR at 68869 n.143; CFTC Proposal, 77 FR at 8354 maker inventory in recognition that exceeded.718 Thus, if market movements n.149. This type of activity would be included market making-related activity is best cause a trading desk’s financial under the concept of ‘‘inventory’’ in the final rule. 722 The Agencies recognize that under the statute exposure to exceed one or more of its a banking entity’s positions in loans, spot 714 See proposed rule § 75.4(b). risk limits, the trading desk must commodities, and spot foreign exchange or 715 Some commenters also contended that promptly take action to reduce its currency are not subject to the final rule’s language in proposed Appendix B raised financial exposure or obtain approval restrictions on proprietary trading. Thus, a banking transaction-by-transaction implications. See supra for an increase to its limits through the entity’s trading in these instruments does not need notes 522 to 529 and accompanying text (discussing to comply with the market-making exemption or commenters’ transaction-by-transaction concerns). required escalation procedures, detailed any other exemption to the prohibition on 716 The Agencies are not adopting a transaction- below. A trading desk may not, proprietary trading. A banking entity may, however, by-transaction approach because the Agencies are however, enter into a trade that would include exposures in loans, spot commodities, and concerned that such an approach would be unduly cause it to exceed its limits without first spot foreign exchange or currency that are related burdensome or impractical and inconsistent with to the desk’s market-making activities in the manner in which bona fide market making- determining the trading desk’s financial exposure related activity is conducted. Additionally, the 717 See Joint Proposal, 76 FR at 68870 n.146 (‘‘The and in turn, the desk’ s financial exposure limits Agencies are concerned that the burdens of such an Agencies note that a market maker may often make under the market-making exemption. The Agencies approach would cause banking entities to a market in one type of [financial instrument] and believe this will provide a more accurate picture of significantly reduce or cease market making-related hedge its activities using different [financial the trading desk’s financial exposure. For example, activities, which would cause negative market instruments] in which it does not make a market.’’); a market maker in foreign exchange forwards or impacts harmful to both investors and issuers, as CFTC Proposal, 77 FR at 8356 n.152. swaps may mitigate the risks of its market-maker well as the financial system generally. 718 See final rule § 75.4(b)(2)(iv). inventory with spot foreign exchange.

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established as part of its market making- exposure, will enhance compliance with analyses on the part of both banking related activities, which includes risk the statute’s near-term customer entities and Agency supervisors and mitigation and hedging. For instance, a demand requirement. While the examiners and should be less costly for trading desk that acts as a market maker amount, types, and risks of a trading banking entities to implement than a in Euro-denominated corporate bonds desk’s market-maker inventory are transaction-by-transaction or may, in addition to Euro-denominated constrained by the near-term customer instrument-by-instrument approach. For bonds, enter into credit default swap demand requirement, any other example, the Agencies believe that some transactions on individual European positions in financial instruments banking entities already compute and corporate bond issuers or an index of managed by the trading desk as part of monitor most trading desks’ financial European corporate bond issuers in its market making-related activities (i.e., exposures for risk management or other order to hedge its exposure arising from those reflected in the trading desk’s purposes.724 The Agencies also believe its corporate bond inventory, in financial exposure, but not included in that focusing on the financial exposure accordance with its documented the trading desk’s market-maker and market-maker inventory of a trading hedging policies and procedures. inventory) are also constrained because desk, as opposed to each separate Though only the corporate bonds would they must be consistent with the individual transaction, is consistent be considered as part of the trading market-maker inventory or, if taken for with the statute’s goal of reducing desk’s market-maker inventory, its hedging purposes, designed to reduce proprietary trading risk in the banking overall financial exposure would also the risks of the trading desk’s market- system and its exemption for market include the credit default swaps used maker inventory. making-related activities. The Agencies for hedging purposes. The Agencies note that disaggregating recognize that banking entities may not As noted above, the Agencies believe the trading desk’s market-maker currently disaggregate trading desks’ the extent to which a trading desk is inventory from its other exposures also market-maker inventory from their engaged in permitted market making- allows for better identification of the financial exposures and that, to the related activities is best determined by trading desk’s hedging positions in extent banking entities do not currently evaluating both the financial exposure instruments for which the trading desk separately identify trading desks’ that results from the desk’s trading does not make a market. As a result, a market-maker inventory, requiring such activity and the amount, types, and risks banking entity’s systems should be able disaggregation for purposes of this rule of the financial instruments in the to readily identify and monitor the will impose certain costs. In addition, desk’s market-maker inventory. Both trading desk’s hedging positions that are the Agencies understand that an concepts are independently valuable not in its market-maker inventory. As approach focused solely on the and will contribute to the effectiveness discussed in Part VI.A.3.c.3., a trading aggregate of all the unit’s trading of the market-making exemption. desk must have certain inventory and positions, as suggested by some Specifically, a trading desk’s financial risk limits on its market-maker commenters, would present fewer exposure will highlight the net exposure inventory, the products, instruments, burdens.725 However, for the reasons and risks of its positions and, along with and exposures the trading desk may use discussed above, the Agencies believe an analysis of the actions the trading for risk management purposes, and its such disaggregation is necessary to give desk will take to demonstrably reduce financial exposure that are designed to full effect to the statute’s near term or otherwise significantly mitigate facilitate the trading desk’s compliance customer demand requirement. promptly the risks of that exposure with the exemption and that are based consistent with its limits, the extent to on the nature and amount of the trading The Agencies note that whether a which it is appropriately managing the desk’s market making-related activities, financial instrument or exposure risk of its market-maker inventory including analyses regarding the stemming from a derivative is consistent with applicable limits, all of reasonably expected near term demands considered to be market-maker which are significant to an analysis of of customers.723 inventory is based only on whether the whether a trading desk is engaged in The final rule also requires these desk makes a market in the financial market making-related activities. An policies and procedures to contain instrument, regardless of the type of assessment of the amount, types, and escalation procedures if a trade would counterparty or the purpose of the risks of the financial instruments in a exceed the limits set for the trading transaction. Thus, the Agencies believe trading desk’s market-maker inventory desk. However, the final rule does not that banking entities should be able to will identify the aggregate amount of the permit a trading desk to exceed the develop a standardized methodology for desk’s inventory in financial limits solely based on customer identifying a trading desk’s positions instruments for which it acts as market demand. Rather, before executing a and exposures in the financial maker, the types of these financial trade that would exceed the desk’s instruments for which it acts as a market instruments that the desk holds at a limits or changing the desk’s limits, a maker. As further discussed in this Part, particular time, and the risks arising trading desk must first follow the a trading desk’s financial exposure must from such holdings. Importantly, an relevant escalation procedures, which reflect the aggregate risks managed by analysis of a trading desk’s market- may require additional approval within the trading desk as part of its market maker inventory will inform the extent the banking entity and provide to which this inventory is related to the demonstrable analysis that the basis for 724 See, e.g., SIFMA et al. (Prop. Trading) (Feb. reasonably expected near term demands any temporary or permanent increase in 2012) (stating that modern trading units generally of clients, customers, or counterparties. limits is consistent with the reasonably view individual positions as a bundle of Because the market-maker inventory characteristics that contribute to their complete expected near term demands of portfolio). See also Federal Reserve Board, Trading concept is more directly related to the customers. and Capital-Markets Activities Manual § 2000.1 financial instruments that a trading desk Due to these considerations, the (Feb. 1998) (‘‘The risk-measurement system should buys and sells from customers than the Agencies believe the final rule should also permit disaggregation of risk by type and by financial exposure concept, the customer, instrument, or business unit to effectively result in more efficient compliance support the management and control of risks.’’). Agencies believe that requiring review 725 See ACLI (Feb. 2012); Fixed Income Forum/ and analysis of a trading desk’s market- 723 See infra Part VI.A.3.c.2.c.; final rule Credit Roundtable; SIFMA et al. (Prop. Trading) maker inventory, as well as its financial § 75.4(b)(2)(iii)(C). (Feb. 2012).

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making-related activities,726 and a financial instruments in which the In addition, a trading desk engaged in banking entity should be able to trading desk acts as market maker or market making-related activities in demonstrate that the financial exposure that the desk uses for risk management compliance with the final rule may of a trading desk is related to its market- purposes pursuant to this exemption, direct another organizational unit of the making activities. including the liquidity, maturity, and banking entity or an affiliate to execute The final rule defines ‘‘financial depth of the market for the relevant a risk-mitigating transaction on the exposure’’ to mean the ‘‘aggregate risks types of financial instruments. Thus, trading desk’s behalf.730 The other of one or more financial instruments market factors reflected in a trading organizational unit may rely on the and any associated loans, commodities, desk’s financial exposure should market-making exemption for these or foreign exchange or currency, held by include all significant and relevant purposes only if: (i) The other a banking entity or its affiliate and factors associated with the products and organizational unit acts in accordance managed by a particular trading desk as instruments in which the desk trades as with the trading desk’s risk management part of the trading desk’s market market maker or for risk management policies and procedures established in making-related activities.’’ 727 In this purposes, including basis risk arising accordance with § 75.4(b)(2)(iii) of the context, the term ‘‘aggregate’’ does not from such positions.728 Similarly, an final rule; and (ii) the resulting risk- imply that a long exposure in one assessment of the risks of the trading mitigating position is attributed to the instrument can be combined with a desk’s market-maker inventory must trading desk’s financial exposure (and short exposure in a similar or related reflect consideration of all significant not the other organizational unit’s instrument to yield a total exposure of market factors relevant to the financial financial exposure) and is included in zero. Instead, such a combination may instruments in which the trading desk the trading desk’s daily profit and loss reduce a trading desk’s economic makes a market. Importantly, a trading calculation. If another organizational exposure to certain risk factors that are desk’s financial exposure and the risks unit of the banking entity or an affiliate common to both instruments, but it of its market-maker inventory will establishes a risk-mitigating position for would still retain any basis risk between change based on the desk’s trading the trading desk on its own accord (i.e., those financial instruments or activity (e.g., buying an instrument that not at the direction of the trading desk) potentially generate a new risk exposure it did not previously hold, increasing its or if the risk-mitigating position is in the case of purposeful hedging. position in an instrument, or decreasing included in the other organizational With respect to the frequency with its position in an instrument) as well as unit’s financial exposure or daily profit which a trading desk should determine changing market conditions related to and loss calculation, then the other its financial exposure and the amount, instruments or positions managed by organizational unit must comply with types, and risks of the financial the trading desk. the requirements of the hedging 731 instruments in its market-maker Because the final rule defines ‘‘trading exemption for such activity. It may inventory, a trading desk’s financial desk’’ based on operational not rely on the market-making exposure and market-maker inventory functionality rather than corporate exemption under these circumstances. If should be evaluated and monitored at a formality, a trading desk’s financial a trading desk engages in a risk- frequency that is appropriate for the exposure may include positions that are mitigating transaction with a second trading desk’s trading strategies and the booked in different affiliated legal trading desk of the banking entity or an characteristics of the financial entities.729 The Agencies understand affiliate that is also engaged in instruments the desk trades, including that positions may be booked in permissible market making-related historical intraday volatility. For different legal entities for a variety of activities, then the risk-mitigating example, a trading desk that repeatedly reasons, including regulatory reasons. position would be included in the first acquired and then terminated For example, a trading desk that makes trading desk’s financial exposure and significant financial exposures a market in corporate bonds may book the contra-risk would be included in the throughout the day but that had little or its corporate bond positions in an SEC- second trading desk’s market-maker no financial exposure at the end of the registered broker-dealer and may book inventory and financial exposure. The day should assess its financial exposure index CDS positions acquired for Agencies believe the net effect of the final rule is to allow individual trading based on its intraday activities, not hedging purposes in a CFTC-registered desks to efficiently manage their own simply its end-of-day financial swap dealer. A financial exposure that hedging and risk mitigation activities on exposure. The frequency with which a reflects both the corporate bond position a holistic basis, while only allowing for trading desk’s financial exposure and and the index CDS position better external hedging directed by staff market-maker inventory will be reflects the economic reality of the outside of the trading desk under the monitored and analyzed should be trading desk’s risk exposure (i.e., by additional requirements of the hedging specified in the trading desk’s showing that the risk of the corporate compliance program. exemption. bond position has been reduced by the To include in a trading desk’s A trading desk’s financial exposure index CDS position). reflects its aggregate risk exposures. The financial exposure either positions held at an affiliated legal entity or positions types of ‘‘aggregate risks’’ identified in 728 As discussed in Part VI.A.3.c.3., a banking the trading desk’s financial exposure entity must establish, implement, maintain, and established by another organizational should reflect consideration of all enforce policies and procedures, internal controls, unit on the trading desk’s behalf, a significant market factors relevant to the analysis, and independent testing regarding the banking entity must be able to provide financial instruments each trading desk stands supervisors or examiners of any Agency ready to purchase and sell and the products, 726 See final rule § 75.4(b)(4). instruments, or exposures each trading desk may that has regulatory authority over the 727 Final rule § 75.4(b)(4). For example, in the use for risk management purposes. See final rule banking entity pursuant to section case of derivatives, a trading desk’s financial § 75.4(b)(2)(iii). position will be the residual risks of the trading 729 Other statutory or regulatory requirements, 730 See infra Part VI.A.3.c.4. desk’s open positions. For instance, an options desk including those based on prudential safety and 731 Under these circumstances, the other may have thousands of open trades at any given soundness concerns, may prevent or limit a banking organizational unit would also be required to meet time, including hedges, but the desk will manage, entity from booking hedging positions in a legal the hedging exemption’s documentation among other risk factors, the trading desk’s portfolio entity other than the entity taking the underlying requirement for the risk-mitigating transaction. See delta, gamma, rho, and volatility. position. final rule § 75.5(c).

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13(b)(2)(B) of the BHC Act with records, exposures to U.S. corporate bonds, controls on a trading desk’s financial promptly upon request, that identify corporate bond indexes, and single exposure. These controls include, any related positions held at an name CDS do not exceed the trading among others, a provision requiring that affiliated entity that are being included desk’s limits on the level of exposures a trading desk’s market-maker inventory in the trading desk’s financial exposure to relevant risk factors arising from its be designed not to exceed, on an for purposes of the market-making financial exposure. ongoing basis, the reasonably expected exemption. Similarly, the supervisors Our focus on the financial exposure of near term demands of customers and and examiners of any Agency that has a trading desk, rather than a trade-by- that any other financial instruments supervisory authority over the banking trade requirement, is designed to give managed by the trading desk be entity that holds financial instruments banking entities the flexibility to acquire designed to mitigate the risk of such that are being included in another not only market-maker inventory, but desk’s market-maker inventory. In trading desk’s financial exposure for positions that facilitate market making, addition, the final market-making purposes of the market-making such as positions that hedge market- exemption requires the trading desk’s exemption must have the same level of maker inventory.733 As commenters compliance program to include access to the records of the trading pointed out, a trade-by-trade appropriate risk and inventory limits desk.732 Banking entities should be requirement would view trades in tied to the near term demand prepared to provide all records that isolation and could fail to recognize that requirement, as well as escalation identify all positions included in a certain trades that are not customer- procedures if a trade would exceed such trading desk’s financial exposure and facing are nevertheless integral to limits. The compliance program, which where such positions are held. market making and financial includes internal controls and As an example of how a trading desk’s intermediation.734 The Agencies independent testing, is designed to market-maker inventory and financial understand that the risk-reducing effects prevent instances where transactions exposure will be analyzed under the of combining large diverse portfolios not related to providing financial market-making exemption, assume a could, in certain instances, mask intermediation services are part of a trading desk makes a market in a variety otherwise prohibited proprietary desk’s financial exposure. 735 of U.S. corporate bonds and hedges its trading. However, the Agencies do iii. Routinely Standing Ready To Buy aggregated positions with a combination not believe that taking a transaction-by- and Sell of exposures to corporate bond indexes transaction approach is necessary to and specific name CDS in which the address this concern. Rather, the The requirement to routinely stand desk does not make a market. To qualify Agencies believe that the broader ready to buy and sell a type of financial for the market-making exemption, the definitions of ‘‘financial exposure’’ and instrument in the final rule recognizes trading desk would have to ‘‘market-maker inventory’’ coupled with that market making-related activities demonstrate, among other things, that: the tailored definition of ‘‘trading desk’’ differ based on the liquidity, maturity, (i) The desk routinely stands ready to facilitates the analysis of aggregate risk and depth of the market for the relevant purchase and sell the U.S. corporate exposures and positions in a manner type of financial instrument. For bonds, consistent with the requirement best suited to apply and evaluate the example, a trading desk acting as a of § 75.4(b)(2)(i) of the final rule, and market-making exemption. market maker in highly liquid markets In short, this approach is designed to these instruments (or category of would engage in more regular quoting mitigate the costs of a trade-by-trade instruments) are identified in the activity than a market maker in less analysis identified by commenters. The trading desk’s compliance program; (ii) liquid markets. Moreover, the Agencies Agencies recognize, however, that this the trading desk’s market-maker recognize that the maturity and depth of approach is only effective at achieving inventory in U.S. corporate bonds is the market also play a role in the goals of the section 13 of the BHC designed not to exceed, on an ongoing determining the character of a market Act—promoting financial basis, the reasonably expected near term maker’s activity. intermediation and limiting speculative demands of clients, customers, or As noted above, the standard of risks within banking entities—if there counterparties, consistent with the ‘‘routinely’’ standing ready to buy and are limits on a trading desk’s financial analysis and limits established by the sell will differ across markets and asset exposure. That is, a permissive market- banking entity for the trading desk; (iii) classes based on the liquidity, maturity, making exemption that gives banking the trading desk’s exposures to and depth of the market for the type of entities maximum discretion in corporate bond indexes and single name financial instrument. For instance, a acquiring positions to provide liquidity CDS are designed to mitigate the risk of trading desk that is a market maker in runs the risk of also allowing banking its financial exposure, are consistent liquid equity securities generally should entities to engage in speculative trades. with the products, instruments, or engage in very regular or continuous As discussed more fully in the following exposures and the techniques and quoting and trading activities on both Parts of this SUPPLEMENTARY strategies that the trading desk may use sides of the market. In less liquid INFORMATION, the final market-making to manage its risk effectively (and such markets, a trading desk should engage in exemption provides a number of use continues to be effective), and do regular quoting activity across the relevant type(s) of financial instruments, not exceed the trading desk’s limits on 733 The Agencies believe it is appropriate to apply the amount, types, and risks of the the requirements of the exemption to the financial although such quoting may be less products, instruments, and exposures exposure of a ‘‘trading desk,’’ rather than the frequent than in liquid equity the trading desk uses for risk portfolio of a higher level of organization, for the markets.736 Consistent with the CFTC’s reasons discussed above, including our concern that and SEC’s interpretation of market management purposes; and (iv) the aggregating a large number of disparate positions aggregate risks of the trading desk’s and exposures across a range of trading desks could making in swaps and security-based increase the risk of evasion. See supra Part swaps for purposes of the definitions of 732 A banking entity must be able to provide such VI.A.3.c.1.c.i. (discussing the determination to records when a related position is held at an apply requirements at the trading desk level). 736 Indeed, in the most specialized situations, affiliate, even if the affiliate and the banking entity 734 See, e.g., SIFMA et al. (Prop. Trading) (Feb. such quotations may only be provided upon are not subject to the same Agency’s regulatory 2012). request. See infra note 740 and accompanying text jurisdiction. 735 See, e.g., Occupy. (discussing permissible block positioning).

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‘‘swap dealer’’ and ‘‘security-based Regardless of the liquidity, maturity, occasion creates a customized swap dealer,’’ ‘‘routinely’’ in the swap and depth of the market for a particular instrument or provides a price quote in market context means that the trading type of financial instrument, a trading response to a customer request. Instead, desk should stand ready to enter into desk should have a pattern of providing the trading desk would need to be able swaps or security-based swaps at the price indications on either side of the to demonstrate a pattern of taking these request or demand of a counterparty market and a pattern of trading with actions in response to demand from more frequently than occasionally.737 customers on each side of the market. In multiple customers with respect to both The Agencies note that a trading desk particular, in the case of relatively long and short risk exposures in may routinely stand ready to enter into illiquid derivatives or structured identified types of instruments. derivatives on both sides of the market, instruments, it would not be sufficient This requirement of the final rule or it may routinely stand ready to enter to demonstrate that a trading desk on applies to a trading desk’s activity in into derivatives on either side of the one or more ‘‘types’’ of financial market and then enter into one or more concern that uncertainty could have a chilling effect instruments.741 The Agencies recognize offsetting positions in the derivatives on a banking entity’s willingness to facilitate that, in some markets, such as the customer block trades. See, e.g., RBC; SIFMA (Asset corporate bond market, a market maker market or another market, particularly Mgmt.) (Feb. 2012); Goldman (Prop. Trading). For in the case of relatively less liquid example, a few commenters stated that certain may regularly quote a subset of derivatives. While a trading desk may requirements in Rule 3b–8(c) could cause fire sales instruments (generally the more liquid respond to requests to trade certain or general market uncertainty. See id. After instruments), but may not provide considering comments, the Agencies have decided regular quotes in other related but less products, such as custom swaps, even if that the reference to Rule 3b–8(c) is unnecessary for it does not normally quote in the purposes of the final rule. In particular, the liquid instruments that the market particular product, the trading desk Agencies believe that the requirements in the maker is willing and available to trade. should hedge against the resulting market-making exemption provide sufficient Instead, the market maker would exposure in accordance with its safeguards, and the additional requirements of the provide a price for those instruments ‘‘qualified block positioner’’ definition may present 742 financial exposure and hedging unnecessary burdens or redundancies with the rule, upon request. The trading desk’s limits.738 Further, the Agencies as adopted. For example, the Agencies believe that activity, in the aggregate for a particular continue to recognize that market there is some overlap between § 75.4(b)(2)(ii) of the type of financial instrument, indicates makers in highly illiquid markets may exemption, which provides that the amount, types, whether it is engaged in activity that is and risks of the financial instruments in the trading trade only intermittently or at the desk’s market-maker inventory must be designed consistent with § 75.4(b)(2)(i) of the request of particular customers, which not to exceed the reasonably expected near term final rule. is sometimes referred to as trading by demands of clients, customers, or counterparties, Notably, this requirement provides appointment.739 A trading desk’s block and Rule 3b–8(c)(iii), which requires the sale of the that the types of financial instruments shares comprising the block as rapidly as possible positioning activity would also meet the commensurate with the circumstances. In other for which the trading desk routinely terms of this requirement provided that, words, the market-making exemption would require stands ready to purchase and sell must from time to time, the desk engages in a banking entity to appropriately manage its be related to its authorized market- block trades (i.e., trades of a large inventory when engaged in block positioning maker inventory and it authorized activity, but would not speak directly to the timing quantity or with a high dollar value) element given the diversity of markets to which the financial exposure. Thus, the types of 740 with customers. exemption applies. financial instruments for which the desk As noted above, one commenter analyzed the routinely stands ready to buy and sell 737 The Agencies will consider factors similar to potential market impact of a complete restriction on should compose a significant portion of those identified by the CFTC and SEC in connection a market maker’s ability to provide direct liquidity its overall financial exposure. The only with this standard. See Further Definition of ‘‘Swap to help a customer execute a large block trade. See Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major supra note 687 and accompanying text. Because the other financial instruments contributing Swap Participant,’’ ‘‘Major Security-Based Swap Agencies are not restricting a banking entity’s to the trading desk’s overall financial Participant’’ and ‘‘Eligible Contract Participant’’, 77 ability to engage in block positioning in the manner exposure should be those designed to FR 30596, 30609 (May 23, 2012) suggested by this commenter, the Agencies do not hedge or mitigate the risk of the 738 The Agencies recognize that, as noted by believe that the final rule will cause the cited commenters, preventing a banking entity from market impact of incremental transaction costs financial instruments for which the conducting customized transactions with customers between $1.7 and $3.4 billion per year. The trading desk is making a market. It may impact customers’ risk exposures or Agencies address this commenter’s concern about would not be consistent with the transaction costs. See Goldman (Prop. Trading); the impact of inventory metrics on a banking market-making exemption for a trading SIFMA (Asset Mgmt.) (Feb. 2012). The Agencies are entity’s willingness to engage in block trading in not prohibiting this activity under the final rule, as Part VI.C.3. (discussing the metrics requirement in desk to hold only positions in, or be discussed in this Part. the final rule and noting that metrics will not be exposed to, financial instruments for 739 The Agencies have considered comments on used to determine compliance with the rule but, which the trading desk is not a market the issue of whether trading by appointment should rather, will be monitored for patterns over time to maker.743 be permitted under the final market-making identify activities that may warrant further review). exemption. The Agencies believe it is appropriate One commenter appeared to request that block to permit trading by appointment to the extent that trading activity not be subject to all requirements 741 This approach is generally consistent with there is customer demand for liquidity in the of the market-making exemption. See SIFMA (Asset commenters’ requested clarification that a trading relevant products. Mgmt.) (Feb. 2012). Any activity conducted in desk’s quoting activity will not be assessed on an 740 As noted in the preamble to the proposed rule, reliance on the market-making exemption, instrument-by-instrument basis, but rather across a the size of a block will vary among different asset including block trading activity, must meet the range of similar instruments for which the trading classes. The Agencies also stated in the proposal requirements of the market-making exemption. The desk acts as a market maker. See, e.g., RBC; SIFMA that the SEC’s definition of ‘‘qualified block Agencies believe the requirements in the final rule et al. (Prop. Trading) (Feb. 2012); CIEBA; Goldman positioner’’ in Rule 3b–8(c) under the Exchange Act are workable for block positioning activity and do (Prop. Trading). may serve as guidance for determining whether not believe it would be appropriate to subject block 742 See, e.g., Goldman (Prop. Trading); Morgan block positioning activity qualifies for the market- positioning to lesser requirements than general Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. making exemption. In referencing that rule as market-making activity. For example, trading in 2012). guidance, the Agencies did not intend to imply that large block sizes can expose a trading desk to 743 The Agencies recognize that there could be a banking entity engaged in block positioning greater risk than market making in smaller sizes, limited circumstances under which a trading desk’s activity would be required to meet all terms of the particularly absent risk management requirements. financial exposure does not relate to the types of ‘‘qualified block positioner’’ definition at all times. Thus, the Agencies believe it is important for block financial instruments that it is standing ready to Nonetheless, a number of commenters indicated positioning activity to be subject to the same buy and sell for a short period of time. However, that it was unclear when a banking entity would requirements, including the requirements to the Agencies would expect for such occurrences to need to act as a qualified block positioner in establish risk limits and risk management be minimal. For example, this scenario could occur accordance with Rule 3b–8(c) and expressed procedures, as general market-making activity. if a trading desk unwinds a hedge position after the

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A trading desk’s routine presence in example, a trading desk should be and believe that the likely harms to the market for a particular type of facilitating customer needs in both investors seeking to trade affected financial instrument would not, on its upward and downward moving markets. instruments (e.g., reduced ability to own, be sufficient grounds for relying As discussed further in Part purchase or sell a particular instrument, on the market-making exemption. This VI.A.3.c.3., the financial instruments the potentially higher transaction costs) and is because the frequency at which a trading desk stands ready to buy and market quality (e.g., reduced liquidity) trading desk is active in a particular sell must be identified in the trading that would arise under such an market would not, on its own, desk’s compliance program.748 Certain approach would not be justified,752 distinguish between permitted market requirements in the final exemption particularly in light of the minimal making-related activity and apply to the amount, types, and risks of benefits that might result from impermissible proprietary trading. In these financial instruments that a restricting or eliminating a banking response to comments, the final rule trading desk can hold in its market- entity’s ability to hold less liquid assets provides that a trading desk also must maker inventory, including the near in connection with its market making- be willing and available to quote, buy term customer demand requirement 749 related activities. The Agencies believe and sell, or otherwise enter into long and the need to have certain risk and these commenters’ concerns are and short positions in the relevant inventory limits.750 adequately addressed by the final rule’s type(s) of financial instruments for its In response to the proposed requirements in the market-making own account in commercially requirement that a trading desk or other exemption that are designed to ensure reasonable amounts and throughout organizational unit hold itself out, some that a trading desk cannot hold risk in market cycles.744 Importantly, a trading commenters requested that the Agencies excess of what is appropriate to provide desk would not meet the terms of this limit the availability of the market- intermediation services designed not to requirement if it provides wide making exemption to trading in exceed, on an ongoing basis, the quotations relative to prevailing market particular asset classes or trading on reasonably expected near term demands conditions and is not engaged in other particular venues (e.g., organized of clients, customers, or counterparties. activity that evidences a willingness or trading platforms). The Agencies are not In response to comments on the availability to provide intermediation limiting the availability of the market- proposed interpretation regarding 753 services.745 Under these circumstances, making exemption in the manner anticipatory position-taking, the a trading desk would not be standing requested by these commenters.751 Agencies note that the near term ready to purchase and sell because it is Provided there is customer demand for demand requirement in the final rule not genuinely quoting or trading with liquidity in a type of financial addresses when a trading desk may take customers. instrument, the Agencies do not believe positions in anticipation of reasonably In the context of this requirement, the availability of the market-making expected near term customer ‘‘commercially reasonable amounts’’ exemption should depend on the demand.754 The Agencies believe this means that the desk generally must be liquidity of that type of financial approach is generally consistent with willing to quote and trade in sizes instrument or the ability to trade such the comments the Agencies received on 755 requested by other market instruments on an organized trading this issue. In addition, the Agencies participants.746 For trading desks that platform. The Agencies see no basis in note that modifications to the proposed engage in block trading, this would the statutory text for either approach near term demand requirement in the include block trades requested by final rule also address commenters 756 customers, and this language is not facilitate customers. See, e.g., Better Markets (Feb. concerns on this issue. meant to restrict a trading desk from 2012). The Agencies are not, however, prohibiting all high-frequency trading activities under the final 752 As discussed above, a number of commenters acting as a block positioner. Further, a rule or otherwise limiting high-frequency trading by expressed concern about the potential market trading desk must act as a market maker banking entities by imposing a resting period on impacts of the perceived restrictions on market on an appropriate basis throughout their orders, as requested by certain commenters. making under the proposed rule, particularly with See, e.g., Better Markets (Feb. 2012); Occupy; Public respect to less liquid markets, such as the corporate market cycles and not only when it is Citizen. 747 bond market. See, e.g., Prof. Duffie; Wellington; most favorable for it to do so. For 748 See final rule § 75.4(b)(2)(iii)(A). BlackRock; ICI. 749 See final rule § 75.4(b)(2)(ii). 753 Joint Proposal, 76 FR at 68871 (stating that market-making position has already been unwound 750 See final rule § 75.4(b)(2)(iii)(C). ‘‘bona fide market making-related activity may or if a trading desk acquires an anticipatory hedge 751 For example, a few commenters requested that include taking positions in securities in position prior to acquiring a market-making the rule prohibit banking entities from market anticipation of customer demand, so long as any position. As discussed more thoroughly in Part making in assets classified as Level 3 under FAS anticipatory buying or selling activity is reasonable VI.A.3.c.3., a banking entity must establish written 157. See supra note 656 and accompanying text. and related to clear, demonstrable trading interest policies and procedures, internal controls, analysis, The Agencies continue to believe that it would be of clients, customers, or counterparties’’); CFTC and independent testing that establish appropriate inappropriate to incorporate accounting standards Proposal, 77 FR at 8356–8357; see also Morgan parameters around such activities. in the rule because accounting standards could Stanley (requesting certain revisions to more closely 744 See, e.g., Occupy; Better Markets (Feb. 2012). change in the future without consideration of the track the statute); SIFMA et al. (Prop. Trading) (Feb. 745 One commenter expressed concern that a potential impact on the final rule. See Joint 2012); Goldman (Prop. Trading); Chamber (Feb. banking entity may be able to rely on the market- Proposal, 76 FR at 68859 n.101 (explaining why the 2012); Comm. on Capital Markets Regulation; making exemption when it is providing only wide, Agencies declined to incorporate certain accounting SIFMA (Asset Mgmt.) (Feb. 2012). out of context quotes. See Occupy. standards in the proposed rule); CFTC Proposal, 77 754 See final rule § 75.4(b)(2)(ii); infra Part 746 As discussed below, this may include FR at 8344 n.107. VI.A.3.c.2.c. providing quotes in the interdealer trading market. Further, a few commenters suggested that the 755 See BoA; SIFMA et al. (Prop. Trading) (Feb. 747 Algorithmic trading strategies that only trade exemption should only be available for trading on 2012); Goldman (Prop. Trading); Morgan Stanley; when market factors are favorable to the strategy’s an organized trading facility. This type of limitation Chamber (Feb. 2012); Comm. on Capital Markets objectives or that otherwise frequently exit the would require significant and widespread market Regulation; SIFMA (Asset Mgmt.) (Feb. 2012). market would not be considered to be standing structure changes (with associated systems and 756 For example, some commenters suggested that ready to purchase or sell a type of financial infrastructure costs) in a relatively short period of the final rule allow market makers to make instrument throughout market cycles and, thus, time, as market making in certain assets is primarily individualized assessments of anticipated customer would not qualify for the market-making or wholly conducted in the OTC market, and demand, based on their expertise and experience, exemption. The Agencies believe this addresses organized trading platforms may not currently exist and account for differences between liquid and less commenters’ concerns about high-frequency trading for these assets. The Agencies do not believe that liquid markets. See Chamber (Feb. 2012); ISDA activities that are only active in the market when the costs of such market structure changes would (Feb. 2012). The final rule allows such assessments, it is believed to be profitable, rather than to be warranted for purposes of this rule. Continued

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2. Near Term Customer Demand Under the proposal, activities on an classes, whether it is possible to predict Requirement exchange or other organized trading near term customer demand, and a. Proposed Near Term Customer facility that primarily take liquidity, whether the terms ‘‘client,’’ ‘‘customer,’’ Demand Requirement rather than provide liquidity, would not or ‘‘counterparty’’ should be defined for qualify for the market-making purposes of the exemption. Consistent with the statute, the exemption, even if conducted by a i. The Proposed Guidance for proposed rule required that the trading registered market maker.760 desk or other organizational unit’s Determining Compliance With the Near market making-related activities be, b. Comments Regarding the Proposed Term Customer Demand Requirement with respect to the financial instrument, Near Term Customer Demand As discussed in more detail above, the designed not to exceed the reasonably Requirement proposal set forth proposed guidance on expected near term demands of clients, As noted above, the proposed near how a banking entity may comply with customers, or counterparties.757 This term customer demand requirement the proposed near term customer requirement is intended to prevent a would implement language found in the demand requirement.767 With respect to trading desk from taking a speculative statute’s market-making exemption.761 the language indicating that a banking proprietary position that is unrelated to Some commenters expressed general entity’s determination of near term customer needs as part of the desk’s support for this requirement.762 For customer demand should generally be purported market making-related example, these commenters emphasized based on the unique customer base of a activities.758 that the proposed near term demand specific market-making business line In the proposal, the Agencies stated requirement is an important component (and not merely an expectation of future that a banking entity’s expectations of that restricts disguised position-taking price appreciation), one commenter near term customer demand should or market making in illiquid markets.763 stated that it is unclear how a banking generally be based on the unique Several other commenters expressed entity would be able to make such customer base of the banking entity’s concern that the proposed requirement determinations in markets where trades specific market-making business lines is too restrictive 764 because, for occur infrequently and customer and the near term demand of those example, it may impede a market demand is hard to predict.768 customers based on particular factors, maker’s ability to build or retain Several commenters expressed beyond a general expectation of price inventory 765 or may impact a market concern about the proposal’s statement appreciation. The Agencies further maker’s willingness to engage in block that a trading desk or other stated that they would not expect the trading.766 Comments on particular organizational unit engaged wholly or activities of a trading desk or other aspects of this proposed requirement are principally in trading that is not in organizational unit to qualify for the discussed below, including the response to, or driven by, customer market-making exemption if the trading proposed interpretation of this demands (e.g., arbitrage trading with desk or other organizational unit is requirement in the proposal, the non-customers) would not qualify for engaged wholly or principally in trading requirement’s potential impact on the exemption, regardless of whether that is not in response to, or driven by, market maker inventory, potential the activities promote price customer demands, regardless of differences in this standard across asset transparency or liquidity.769 In whether those activities promote price particular, commenters stated that it transparency or liquidity. The proposal 760 See Joint Proposal, 76 FR at 68871–68872; would be difficult for a market-making stated that, for example, a trading desk CFTC Proposal, 77 FR at 8357. business to try to divide its activities 761 See supra Part VI.A.3.c.2.a. that are in response to customer demand or other organizational unit of a banking 762 See, e.g., Sens. Merkley & Levin (Feb. 2012); entity that is engaged wholly or Flynn & Fusselman; Better Markets (Feb. 2012). (e.g., customer intermediation and principally in arbitrage trading with 763 See Better Markets (Feb. 2012); Sens. Merkley hedging) from activities that promote non-customers would not meet the & Levin (Feb. 2012). price transparency and liquidity (e.g., terms of the proposed rule’s market- 764 See, e.g., SIFMA et al. (Prop. Trading) (Feb. interdealer trading to test market depth 2012); Chamber (Feb. 2012); T. Rowe Price; SIFMA making exemption.759 or arbitrage trading) in order to (Asset Mgmt.) (Feb. 2012); ACLI (Feb. 2012); 770 With respect to market making in a MetLife; Comm. on Capital Markets Regulation; determine their proportionality. security that is executed on an exchange CIEBA; Credit Suisse (Seidel); SSgA (Feb. 2012); Another commenter stated that, as a or other organized trading facility, the IAA (stating that the proposed requirement is too matter of organizational efficiency, firms subjective and would be difficult to administer in will often restrict arbitrage trading proposal provided that a market maker’s a range of scenarios); Barclays; Prof. Duffie. activities are generally consistent with 765 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 767 reasonably expected near term customer 2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); See supra Part VI.A.3.c.2.a. 768 demand when such activities involve Barclays; Wellington; MetLife; Chamber (Feb. 2012); See SIFMA et al. (Prop. Trading) (Feb. 2012). RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset Another commenter suggested that the Agencies passively providing liquidity by Mgmt.) (Feb. 2012). The Agencies respond to these ‘‘establish clear criteria that reflect appropriate submitting resting orders that interact comments in Part VI.A.3.c.2.c., infra. For a revenue from changes in the bid-ask spread,’’ noting with the orders of others in a non- discussion of comments regarding inventory that a legitimate market maker should be both directional or market-neutral trading management activity conducted in connection with selling and buying in a rising market (or, likewise, market making, see Part VI.A.3.c.2.b.vi., infra. in a declining market). Public Citizen. strategy and the market maker is 766 See, e.g., ACLI (Feb. 2012); MetLife; Comm. on 769 See, e.g., SIFMA et al. (Prop. Trading) (Feb. registered, if the exchange or organized Capital Markets Regulation (noting that a market 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. trading facility registers market makers. maker may need to hold significant inventory to Trading); BoA; ICI (Feb. 2012); ICI Global; accommodate potential block trade requests). Two Vanguard; SSgA (Feb. 2012); see also infra Part of these commenters stated that a market maker VI.A.3.c.2.b.viii. (discussing comments on whether based on historical customer demand and other may provide a worse price or may be unwilling to arbitrage trading should be permitted under the relevant factors, and recognizes that near term intermediate a large customer position if the market market-making exemption under certain demand may differ based on the liquidity, maturity, maker has to determine whether holding such circumstances). and depth of the market for a particular type of position will meet the near term demand 770 See Goldman (Prop. Trading); RBC. One of financial instrument. See infra Part VI.A.3.c.2.c.iii. requirement, particularly if the market maker would these commenters agreed, however, that a trading 757 See proposed rule § 75.4(b)(2)(iii). be required to sell the block position over a short desk that is ‘‘wholly’’ engaged in trading that is 758 See Joint Proposal, 76 FR at 68871; CFTC period of time. See ACLI (Feb. 2012); MetLife. unrelated to customer demand should not qualify Proposal, 77 FR at 8357. These comments are addressed in Part for the proposed market-making exemption. See 759 See id. VI.A.3.c.2.c.iii., infra. Goldman (Prop. Trading).

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strategies to certain specific individual with an exchange to qualify for the suggested that the Agencies instead use traders within the market-making proposed market-making exemption. metrics to compare, in the aggregate and organization, who may sometimes be According to these commenters, there over time, the liquidity that a market referred to as a ‘‘desk,’’ and expressed are a large number of exchanges and maker makes rather than takes as part of concern that this would be prohibited organized trading facilities on which a broader consideration of the market- under the rule.771 market makers may need to trade to making character of the relevant trading In response to the proposed maintain liquidity across the markets activity.784 interpretation regarding market making and to provide customers with favorable on an exchange or other organized prices. These commenters indicated that ii. Potential Inventory Restrictions and trading facility (and certain similar any restrictions or burdens on such Differences Across Asset Classes language in proposed Appendix B),772 trading may decrease liquidity or make A number of commenters expressed several commenters indicated that the it harder to provide customers with the concern that the proposed requirement reference to passive submission of best price for their trade.780 One may unduly restrict a market maker’s resting orders may be too restrictive and commenter, however, stated that the ability to manage its inventory.785 provided examples of scenarios where exchange registration requirement is Several of these commenters stated that market makers may need to use market reasonable and further supported limitations on inventory would be or marketable limit orders.773 For adding a requirement that traders especially problematic for market example, many of these commenters demonstrate adherence to the same or making in less liquid markets, like the stated that market makers may need to commensurate standards in markets fixed-income market, where customer enter market or marketable limit orders where registration is not possible.781 demand is more intermittent and to: (i) Build or reduce inventory; 774 (ii) Some commenters recommended positions may need to be held for a address order imbalances on an certain modifications to the proposed longer period of time.786 Some exchange by, for example, using market analysis. For example, a few commenters stated that the Agencies’ orders to lessen volatility and restore commenters requested that the rule proposed interpretation of this pricing equilibrium; (iii) hedge market- presume that a trading unit is engaged requirement would restrict a market making positions; (iv) create markets; 775 in permitted market making-related maker’s inventory in a manner that is (v) test the depth of the markets; (vi) activity if it is registered as a market inconsistent with the statute. These ensure that ETFs, American depositary maker on a particular exchange or commenters indicated that the receipts (‘‘ADRs’’), options, and other organized trading facility.782 In support ‘‘designed’’ and ‘‘reasonably expected’’ instruments remain appropriately of this recommendation, one commenter language of the statute seem to priced; 776 and (vii) respond to represented that it would be warranted recognize that market makers must movements in prices in the markets.777 because registered market makers anticipate customer requests and Two commenters noted that distinctions directly contribute to maintaining liquid accumulate sufficient inventory to meet between limit and market or marketable and orderly markets and are subject to those reasonably expected demands.787 limit orders may not be workable in the extensive regulatory requirements in In addition, one commenter represented 783 international context, where exchanges that capacity. Another commenter that a market maker must have wide may not use the same order types as latitude and incentives for initiating 780 778 See SIFMA et al. (Prop. Trading) (Feb. 2012) trades, rather than merely reacting to U.S. trading facilities. (stating that trading units may currently register as A few commenters also addressed the market makers with particular, primary exchanges customer requests for quotes, to proposed use of a market maker’s on which they trade, but will serve in a market- properly risk manage its positions or to exchange registration status as part of making capacity on other trading venues from time prepare for anticipated customer the analysis.779 Two commenters stated to time); Goldman (Prop. Trading) (noting that there 788 are more than 12 exchanges and 40 alternative demand or supply. Many that the proposed rule should not trading systems currently trading U.S. equities). commenters requested certain require a market maker to be registered 781 See Occupy. In the alternative, this commenter modifications to the proposed would require all market making to be performed requirement to limit its impact on 771 See JPMC. on an exchange or organized trading facility. See id. 772 782 See NYSE Euronext (recognizing that See Joint Proposal, 76 FR at 68871–68,872; ‘‘customers’’), so conferring a positive presumption registration status is not necessarily conclusive of CFTC Proposal, 77 FR at 8357. of compliance on such market makers would ensure engaging in market making-related activities); 773 See, e.g., NYSE Euronext; SIFMA et al. (Prop. that they can continue to contribute to liquidity, SIFMA et al. (Prop. Trading) (Feb. 2012) (stating Trading) (Feb. 2012); Goldman (Prop. Trading); which benefits customers. This commenter noted that to the extent a trading unit is registered on a RBC. Comments on proposed Appendix B are that, for example, NYSE designated market makers particular exchange or organized trading facility for discussed further in Part VI.A.3.c.8.b., infra. This (‘‘DMMs’’) are generally prohibited from dealing any type of financial instrument, all of its activities issue is addressed in note 944 and its with customers and companies must ‘‘wall off’’ any on that exchange or organized trading facility accompanying text, infra. trading units that act as DMMs. See id. (citing NYSE should be presumed to be market making); 774 Some commenters stated that market makers Rule 98). Goldman (Prop. Trading). See also infra note 945 may need to use market or marketable limit orders 784 (responding to these comments). Two commenters See id. (stating that spread-related metrics, to build inventory in anticipation of customer noted that certain exchange rules may require such as Spread Profit and Loss, may be useful for demand or in connection with positioning a block market makers to deal for their own account under this purpose). trade for a customer. See SIFMA et al. (Prop. 785 certain circumstances in order to maintain fair and See, e.g., SIFMA et al. (Prop. Trading) (Feb. Trading) (Feb. 2012); RBC; Goldman (Prop. orderly markets. See NYSE Euronext (discussing 2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); Trading). Two of these commenters noted that these NYSE rules); Goldman (Prop. Trading) (discussing Barclays; Wellington; MetLife; Chamber (Feb. 2012); order types may be needed to dispose of positions NYSE and CBOE rules). For example, according to RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset taken into inventory as part of market making. See these commenters, NYSE Rule 104(f)(ii) requires a Mgmt.) (Feb. 2012). These concerns are addressed RBC; Goldman (Prop. Trading). market maker to maintain fair and orderly markets, in Part VI.A.3.c.2.c., infra. 775 See NYSE Euronext. which may involve dealing for their own account 786 See, e.g., SIFMA (Asset Mgmt.) (Feb. 2012); T. 776 See Goldman (Prop. Trading). when there is a lack of price continuity, lack of Rowe Price; CIEBA; ICI (Feb. 2012); RBC. 777 See SIFMA et al. (Prop. Trading) (Feb. 2012). depth, or if a disparity between supply and demand 787 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 778 See SIFMA et al. (Prop. Trading) (Feb. 2012); exists or is reasonably anticipated. See id. 2012); Chamber (Feb. 2012). Goldman (Prop. Trading). 783 See Goldman (Prop. Trading). This commenter 788 See Prof. Duffie. However, another commenter 779 See NYSE Euronext; SIFMA et al. (Prop. further stated that trading activities of exchange stated that a legitimate market maker should Trading) (Feb. 2012); Goldman (Prop. Trading); market makers may be particularly difficult to respond to customer demand rather than initiate Occupy. See also infra notes 945 to 946 and evaluate with customer-facing metrics (because transactions, which is indicative of prohibited accompanying text (addressing these comments). ‘‘specialist’’ market makers may not have proprietary trading. See Public Citizen.

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market maker inventory.789 two commenters suggested ways in materialize.798 One commenter further Commenters’ views on the importance which a banking entity could predict noted that a banking entity entering a of permitting inventory management near term customer demand.794 One of new market, or gaining or losing activity in connection with market these commenters indicated that customers, may need greater flexibility making are discussed below in Part banking entities should be able to utilize in applying the near term demand VI.A.3.c.2.b.vi. current risk management tools to predict requirement because its anticipated Several commenters requested that near term customer demand, although demand may fluctuate.799 the Agencies recognize that near term these tools may need to be adapted to customer demand may vary across iv. Potential Definitions of ‘‘Client,’’ comply with the rule’s requirements. ‘‘Customer,’’ or ‘‘Counterparty’’ different markets and asset classes and According to this commenter, dealers 790 Appendix B of the proposal discussed implement this requirement flexibly. commonly assess the following factors the proposed meaning of the term In particular, many of these commenters across product lines, which can relate to ‘‘customer’’ in the context of permitted emphasized that the concept of ‘‘near expected customer demand: (i) Recent market making-related activity.800 In term demand’’ should be different for volumes and customer trends; (ii) less liquid markets, where transactions addition, the proposal inquired whether trading patterns of specific customers; the terms ‘‘client,’’ ‘‘customer,’’ or may occur infrequently, and for liquid (iii) analysis of whether the firm has an markets, where transactions occur more ‘‘counterparty’’ should be defined in the ability to win new customer business; often.791 One commenter requested that rule for purposes of the market-making (iv) comparison of the current market the Agencies add the phrase ‘‘based on exemption.801 Commenters expressed conditions to prior similar periods; (v) the characteristics of the relevant market varying views on the proposed liquidity of large investors; and (vi) the and asset class’’ to the end of the interpretations in the proposal and on schedule of maturities in customers’ whether these terms should be defined requirement to explicitly acknowledge 795 these differences.792 existing positions. Another in the final rule.802 commenter stated that the With respect to the proposed iii. Predicting Near Term Customer reasonableness of a market maker’s interpretations of the term ‘‘customer’’ Demand inventory can be measured by looking to in Appendix B, one commenter agreed Commenters provided views on the specifics of the particular market, with the proposed interpretations and whether and, if so how, a banking entity the size of the customer base being expressed the belief that the may be able to predict near term served, and expected customer demand, interpretations will allow interdealer customer demand for purposes of the which banking entities should be market making where brokers or other proposed requirement.793 For example, required to take into account in both dealers act as customers. However, this their inventory practices and policies commenter also requested that the 789 See Credit Suisse (Seidel) (suggesting that the and their actual inventories. This Agencies expressly incorporate rule allow market makers to build inventory in commenter recommended that the rule products where they believe customer demand will permit a banking entity to assume a 798 See ICI (Feb. 2012); CIEBA; RBC; Wellington; exist, regardless of whether the inventory can be position under the market-making Invesco. tied to a particular customer in the near term or to 799 See CIEBA. historical trends in customer demand); Barclays exemption if it can demonstrate a track 800 See Joint Proposal, 76 FR at 68960; CFTC (recommending the rule require that ‘‘the market record or reasonable expectation that it Proposal, 77 FR at 8439. More specifically, making-related activity is conducted by each can dispose of a position in the near Appendix B stated: ‘‘In the context of market trading unit such that its activities (including the term.796 making in a security that is executed on an maintenance of inventory) are designed not to organized trading facility or an exchange, a exceed the reasonably expected near term demands Some commenters, however, ‘customer’ is any person on behalf of whom a buy of clients, customers, or counterparties consistent emphasized that reasonably expected or sell order has been submitted by a broker-dealer with the market and trading patterns of the relevant or any other market participant. In the context of product, and consistent with the reasonable near term customer demand cannot market making in a [financial instrument] in an judgment of the banking entity where such demand always be accurately predicted.797 OTC market, a ‘customer’ generally would be a cannot be determined with reasonable accuracy’’); Several of these commenters requested market participant that makes use of the market CIEBA. In addition, some commenters suggested an the Agencies clarify that banking maker’s intermediation services, either by interpretation that would provide greater discretion requesting such services or entering into a to market makers to enter into trades based on entities will not be subject to regulatory continuing relationship with the market maker with factors such as experience and expertise dealing in sanctions if reasonably anticipated near respect to such services.’’ Id. On this last point, the the market and market exigencies. See SIFMA et al. term customer demand does not proposal elaborated that in certain cases, depending (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012). on the conventions of the relevant market (e.g., the Two commenters suggested that the proposed OTC derivatives market), such a ‘‘customer’’ may requirement should be interpreted to permit 794 See Sens. Merkley & Levin (Feb. 2012); FTN. consider itself or refer to itself more generally as a market-making activity as it currently exists. See 795 See FTN. The commenter further indicated ‘‘counterparty.’’ See Joint Proposal, 76 FR at 68960 MetLife; ACLI (Feb. 2012). One commenter that errors in estimating customer demand are n.2; CFTC Proposal, 77 FR at 8439 n.2. requested that the proposed requirement be moved managed through kick-out rules and oversight by 801 See Joint Proposal, 76 FR at 68874; CFTC to Appendix B of the rule to provide greater risk managers and committees, with latitude in Proposal, 77 FR at 8359. In particular, Question 99 flexibility to consider facts and circumstances of a decisions being closely related to expected or states: ‘‘Should the terms ‘client,’ ‘customer,’ or particular activity. See JPMC. empirical costs of hedging positions until they ‘counterparty’ be defined for purposes of the market 790 See CIEBA; Morgan Stanley; RBC; ICI (Feb. result in trading with counterparties. See id. making exemption? If so, how should these terms 2012); ISDA (Feb. 2012); Comm. on Capital Markets 796 See Sens. Merkley & Levin (Feb. 2012) (stating be defined? For example, would an appropriate Regulation; Alfred Brock. The Agencies respond to that banking entities should be required to collect definition of ‘customer’ be: (i) A continuing these comments in Part VI.A.3.c.2.c.ii., infra. inventory data, evaluate the data, develop policies relationship in which the banking entity provides 791 See ICI (Feb. 2012); CIEBA (stating that, absent on how to handle particular positions, and make one or more financial products or services prior to a different interpretation for illiquid instruments, regular adjustments to ensure a turnover of assets the time of the transaction; (ii) a direct and market makers will err on the side of holding less commensurate with near term demand of substantive relationship between the banking entity inventory to avoid sanctions for violating the rule); customers). This commenter also suggested that the and a prospective customer prior to the transaction; RBC. rule specify the types of inventory metrics that (iii) a relationship initiated by the banking entity to 792 See Morgan Stanley. should be collected and suggested that the rate of a prospective customer to induce transactions; or 793 See Wellington; MetLife; SIFMA et al. (Prop. inventory turnover would be helpful. See id. (iv) a relationship initiated by the prospective Trading) (Feb. 2012); Sens. Merkley & Levin (Feb. 797 See MetLife; Chamber (Feb. 2012); RBC; customer with a view to engaging in transactions?’’ 2012); Chamber (Feb. 2012); FTN; RBC; Alfred CIEBA; Wellington; ICI (Feb. 2012); Alfred Brock. Id. Brock. These comments are addressed in Part This issue is addressed in Part VI.A.3.c.2.c.iii., 802 Comments on this issue are addressed in Part VI.A.3.c.2.c.iii., infra. infra. VI.A.3.c.2.c.i., infra.

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providing liquidity to other brokers and in transactions driven by algorithmic permitted market making-related dealers into the rule text.803 Another trading strategies.811 Three commenters activity 817 and suggested ways in which commenter similarly stated that instead requested more permissive definitions this could be accomplished (e.g., of focusing solely on customer demand, of these terms.812 According to one of through a definition of ‘‘customer’’ or the rule should be clarified to reflect these commenters, because these terms ‘‘counterparty’’).818 that demand can come from other are listed in the disjunctive in the Commenters emphasized that dealers or future customers.804 statute, the broadest term—a interdealer trading provides certain In response to the proposal’s question ‘‘counterparty’’—should prevail.813 market benefits, including increased about whether the terms ‘‘client,’’ market liquidity; 819 more efficient v. Interdealer Trading and Trading for matching of customer order flow; 820 ‘‘customer,’’ and ‘‘counterparty’’ should Price Discovery or To Test Market Depth be further defined, a few commenters greater hedging options to reduce stated that that the terms should not be With respect to interdealer trading, risks; 821 enhanced ability to accumulate defined in the rule.805 Other many commenters expressed concern inventory for current or near term commenters indicated that further that the proposed rule could be customer demand, work down definition of these terms would be interpreted to restrict a market maker’s concentrated positions arising from a appropriate.806 Some of these ability to engage in interdealer customer trade, or otherwise exit a 814 commenters suggested that there should trading. As a general matter, position acquired from a customer; 822 be greater limitations on who can be commenters attributed these concerns to and general price discovery among 815 considered a ‘‘customer’’ under the statements in proposed Appendix B dealers.823 Regarding the impact of rule.807 These commenters generally or to the Customer-Facing Trade Ratio interdealer trading on a market maker’s 816 indicated that a ‘‘customer’’ should be a metric in proposed Appendix A. A ability to intermediate customer needs, person or institution with whom the number of commenters requested that one commenter studied the potential banking entity has a continuing, or a the rule be modified to clearly recognize impact of interdealer trading limits—in direct and substantive, relationship interdealer trading as a component of combination with inventory limits—on prior to the time of the transaction.808 In trading in the U.S. corporate bond the case of a new customer, some of exemption; in addition, compiling inventory of market. According to this commenter, if financial instruments that the bank originated interdealer trading had been prohibited these commenters suggested requiring a should be viewed as proprietary trading). relationship initiated by the prospective 811 See AFR et al. (Feb. 2012). 817 customer with a view to engaging in 812 See Credit Suisse (Seidel) (stating that See MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; transactions.809 A few commenters ‘‘customer’’ should be explicitly defined to include any counterparty to whom a banking entity is BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA indicated that a party should not be providing liquidity); ISDA (Feb. 2012) (Feb. 2012); Goldman (Prop. Trading); Oliver considered a client, customer, or (recommending that, if the Agencies decide to Wyman (Feb. 2012). counterparty if the banking entity: (i) define these terms, a ‘‘counterparty’’ should be 818 See RBC (suggesting that explicitly incorporating liquidity provision to other brokers Originates a financial product and then defined as the entity on the other side of a transaction, and the terms ‘‘client’’ and ‘‘customer’’ and dealers in the market-making exemption would finds a counterparty to take the other should not be interpreted to require a relationship be consistent with the statute’s reference to meeting side of the transaction; 810 or (ii) engages beyond the isolated provision of a transaction); the needs of ‘‘counterparties,’’ in addition to the Japanese Bankers Ass’n. (requesting that it be needs of clients and customers); AFR et al. (Feb. 2012) (recognizing that the ability to manage 803 See SIFMA et al. (Prop. Trading) (Feb. 2012). clearly noted that interbank participants can be customers for interbank market makers). inventory through interdealer transactions should See also Credit Suisse (Seidel); RBC (requesting that be accommodated in the rule, but recommending the Agencies recognize ‘‘wholesale’’ market making 813 See ISDA (Feb. 2012). This commenter’s primary position was that further definitions are not that this activity be conditioned on a market maker as permissible and representing that ‘‘[i]t is having an appropriate level of inventory after an irrelevant to an investor whether market liquidity required and could create additional and unnecessary complexity. See id. interdealer transaction); Goldman (Prop. Trading) is provided by a broker-dealer with whom the (representing that the Agencies could evaluate and 814 See, e.g., JPMC; Morgan Stanley; Goldman investor maintains a customer account, or whether monitor the amount of interdealer trading that is (Prop. Trading); Chamber (Feb. 2012); MetLife; that broker-dealer looks to another dealer for market consistent with a particular trading unit’s market Credit Suisse (Seidel); BoA; ACLI (Feb. 2012); RBC; liquidity’’). making-related or hedging activity through the AFR et al. (Feb. 2012); ISDA (Feb. 2012); Oliver 804 See Comm. on Capital Markets Regulation. customer-facing activity category of metrics); Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 2012). A 805 See FTN; ISDA (Feb. 2012); Alfred Brock. Wyman (Feb. 2012) (recommending removal or few commenters noted that the proposed rule 806 modification of any metrics or principles that See Japanese Bankers Ass’n.; Credit Suisse would permit a certain amount of interdealer would indicate that interdealer trading is not (Seidel); Occupy; AFR et al. (Feb. 2012); Public trading. See, e.g., SIFMA et al. (Prop. Trading) (Feb. permitted). Citizen. 2012) (citing statements in the proposal providing 819 807 See AFR et al. (Feb. 2012); Occupy; Public that a market maker’s ‘‘customers’’ vary depending See Prof. Duffie; MetLife; ACLI (Feb. 2012); Citizen. One of these commenters also requested on the asset class and market in which BDA (Feb. 2012). that the Agencies remove the terms ‘‘client’’ and intermediation services are provided and 820 See Oliver Wyman (Dec. 2011); Oliver Wyman ‘‘counterparty’’ from the proposed near term interpreting such statements as allowing interdealer (Feb. 2012); MetLife; ACLI (Feb. 2012). See also demand requirement. See Occupy. market making where brokers or other dealers act Thakor Study (stating that, when a market maker 808 See AFR et al. (Feb. 2012); Occupy; Public as ‘‘customers’’ within the proposed construct); provides immediacy to a customer, it relies on Citizen. These commenters stated that other Goldman (Prop. Trading) (stating that interdealer being able to unwind its positions at opportune banking entities should never be ‘‘customers’’ under trading related to hedging or exiting a customer times by trading with other market makers, who the rule. See id. In addition, one of these position would be permitted, but expressing may have knowledge about impending orders from commenters would further prevent a banking concern that requiring each banking entity to justify their own customers that may induce them to trade entity’s employees and covered funds from being each of its interdealer trades as being related to one with the market maker). ‘‘customers’’ under the rule. See AFR et al. (Feb. of its own customers would be burdensome and 821 See MetLife; ACLI (Feb. 2012); Goldman 2012). would reduce the effectiveness of the interdealer (Prop. Trading); Morgan Stanley; Oliver Wyman 809 See AFR et al. (Feb. 2012) (providing a similar market). Commenters’ concerns regarding (Dec. 2011); Oliver Wyman (Feb. 2012). definition for the term ‘‘client’’ as well); Public interdealer trading are addressed in Part 822 See Goldman (Prop. Trading); Chamber (Feb. Citizen. VI.A.3.c.2.c.i., infra. 2012). See also Prof. Duffie (stating that a market 810 See AFR et al. (Feb. 2012); Public Citizen. See 815 See infra Part VI.A.3.c.8. maker acquiring a position from a customer may also Sens. Merkley & Levin (Feb. 2012) (stating that 816 See, e.g., JPMC; SIFMA et al. (Prop. Trading) wish to rebalance its inventory relatively quickly a banking entity’s activities that involve attempting (Feb. 2012); Oliver Wyman (Feb. 2012) (recognizing through the interdealer network, which is often to sell clients financial instruments that it that the proposed rule did not include specific more efficient than requesting immediacy from originated, rather than facilitating a secondary limits on interdealer trading, but expressing another customer or waiting for another customer market for client trades in previously existing concern that explicit or implicit limits could be who wants to take the opposite side of the trade). financial products, should be analyzed under the established by supervisors during or after the 823 See Chamber (Feb. 2012); Goldman (Prop. underwriting exemption, not the market-making conformance period). Trading).

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and a market maker’s inventory had under the market-making exemption.832 benefits that are associated with a been limited to the average daily This commenter represented that the market maker’s ability to appropriately volume of the market as a whole, 69 Agencies would be able to evaluate the manage its inventory, including being percent of customer trades would have extent to which trading for price able to meet reasonably anticipated been prevented.824 Some commenters discovery and market depth are future client, customer, or counterparty stated that a banking entity would be consistent with market making-related demand; 837 accommodating customer less able or willing to provide market- activities for a particular market through transactions more quickly and at making services to customers if it could a combination of customer-facing favorable prices; reducing near term not engage in interdealer trading.825 activity metrics, including the Inventory price volatility (in the case of selling a Risk Turnover metric, and knowledge of customer block position); 838 helping As noted above, a few commenters a banking entity’s trading business maintain an orderly market and provide stated that market makers may use developed by regulators as part of the the best price to customers (in the case interdealer trading for price discovery supervisory process.833 of accumulating long or short positions purposes.826 Some commenters vi. Inventory Management in anticipation of a large customer sale separately discussed the importance of or purchase); 839 ensuring that markets this activity and requested that, when Several commenters requested that continue to have sufficient liquidity; 840 conducted in connection with market- the rule provide banking entities with fostering a two-way market; and making activity, trading for price greater discretion to manage their establishing a market-making discovery be considered permitted inventories in connection with market presence.841 Some commenters noted market making-related activity under making-related activity, including that market makers may need to the rule.827 Commenters indicated that acquiring or disposing of positions in accumulate inventory to meet customer 834 price discovery-related trading results in anticipation of customer demand. demand for certain products or under certain market benefits, including Commenters represented that market certain trading scenarios, such as to enhancing the accuracy of prices for makers need to be able to build, manage, create units of structured products (e.g., customers,828 increasing price and maintain inventories to facilitate ETFs and asset-backed securities) 842 efficiency, preventing market customer demand. These commenters and in anticipation of an index instability,829 improving market further stated that the rule needs to rebalance.843 liquidity, and reducing overall costs for provide some degree of flexibility for Commenters also expressed views inventory management activities, as market participants.830 As a converse, with respect to how much discretion a inventory needs may differ based on one of these commenters stated that banking entity should have to manage market conditions or the characteristics restrictions on such activity could result its inventory under the exemption and of a particular instrument.835 A few how to best monitor inventory levels. in market makers setting their prices too commenters cited legislative history in For example, one commenter high, exposing them to significant risk support of allowing banking entities to recommended that the rule allow and causing a reduction of market- hold and manage inventory in market makers to build inventory in making activity or widening of spreads connection with market making-related 831 products where they believe customer to offset the risk. One commenter activities.836 Several commenters noted further requested that trading to test demands of clients, customers, or counterparties. I market depth likewise be permitted 832 See Goldman (Prop. Trading). This commenter want to clarify this language would allow banks to represented that market makers often make trades maintain an appropriate dealer inventory and 824 See Oliver Wyman (Feb. 2012) (basing its with other dealers to test the depth of the markets residual risk positions, which are essential parts of finding on data from 2009). This commenter also at particular price points and to understand where the market-making function. Without that represented that the natural level of interdealer supply and demand exist (although such trading is flexibility, market makers would not be able to volume in the U.S. corporate bond market made up not conducted exclusively with other dealers). This provide liquidity to markets.’’ 156 Cong. Rec. S5906 16 percent of total trading volume in 2010. See id. commenter stated that testing the depth of the (daily ed. July 15, 2010) (statement of Sen. Bayh). 825 market is necessary to provide accurate prices to 837 See Goldman (Prop. Trading); Morgan Stanley. customers, particularly when customers seeks to See, e.g., RBC. 838 See also BDA (Feb. 2012) (stating that if dealers in enter trades in amounts larger than the amounts See Goldman (Prop. Trading). the fixed-income market are not able to trade with offered by dealers who have sent indications to 839 See id. other dealers to ‘‘cooperate with each other to inter-dealer brokers. See id. 840 See MFA. provide adequate liquidity to the market as a 833 See id. 841 See RBC. whole,’’ an essential source of liquidity will be 834 842 eliminated from the market and existing values of See, e.g., SIFMA et al. (Prop. Trading) (Feb. See Goldman (Prop. Trading); BoA. fixed income securities will decline and become 2012); Credit Suisse (Seidel); Goldman (Prop. 843 See Oliver Wyman (Feb. 2012). As this volatile, harming both investors who currently hold Trading); MFA; RBC. Inventory management is commenter explained, some mutual funds and ETFs such positions and issuers, who will experience addressed in Part VI.A.3.c.2.c., infra. track major equity indices and, when the 835 increased interest costs). See, e.g., MFA (stating that it is critical for composition of an index changes (e.g., due to the banking entities to continue to be able to maintain 826 See Chamber (Feb. 2012); Goldman (Prop. addition or removal of a security or to rising or sufficient levels of inventory, which is dynamic in Trading). falling values of listed shares), an announcement is nature and requires some degree of flexibility in made and all funds tracking the index need to 827 See SIFMA et al. (Prop. Trading) (Feb. 2012); application); RBC (requesting that the Agencies rebalance their portfolios. According to the Chamber (Feb. 2012); Goldman (Prop. Trading). One explicitly acknowledge that, depending on market commenter, banking entities may need to step in to commenter provided the following example of such conditions or the characteristics of a particular provide liquidity for rebalances of less liquid activity: if Security A and Security B have some security, it may be appropriate or necessary for a indices because trades executed on the open market price correlation but neither trades regularly, then firm to maintain inventories over extended periods would substantially affect share prices. The a trader may execute a trade in Security A for price of time in the course of market making-related commenter estimated that if market makers are not discovery purposes, using the price of Security A activities). able to provide direct liquidity for rebalance trades, to make an informed bid-ask market to a customer 836 See, e.g., RBC; NYSE Euronext; Fidelity. These investors tracking these indices could potentially in Security B. See SIFMA et al. (Prop. Trading) commenters cited a colloquy in the Congressional pay incremental costs of $600 million to $1.8 (Feb. 2012). Record between Senator Bayh and Senator Dodd, in billion every year. This commenter identified the 828 See Goldman (Prop. Trading); Chamber (Feb. which Senator Bayh stated: ‘‘With respect to proposed inventory metrics in Appendix A as 2012) (stating that this type of trading is necessary [section 13 of the BHC Act], the conference report potentially limiting a banking entity’s willingness in more illiquid markets); SIFMA et al. (Prop. states that banking entities are not prohibited from or ability to facilitate index rebalance trades. See id. Trading) (Feb. 2012). purchasing and disposing of securities and other Two other commenters also discussed the index 829 See Goldman (Prop. Trading). instruments in connection with underwriting or rebalancing scenario. See Prof. Duffie; Thakor 830 See Chamber (Feb. 2012). market-making activities, provided that activity Study. Index rebalancing is addressed in note 931, 831 See id. does not exceed the reasonably expected near-term infra.

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demand will exist, regardless of whether commenters, APs may engage in the A number of commenters stated that the inventory can be tied to a particular following types of activities with respect certain requirements of the proposed customer in the near term or to to ETFs: (i) Trading directly with the exemption may limit a banking entity’s historical trends in customer ETF issuer to create or redeem ETF ability to serve as AP to an ETF, demand.844 A few commenters shares, which involves trading in ETF including the proposed near term suggested that the Agencies provide shares and the underlying customer demand requirement,856 the banking entities with greater discretion components; 848 (ii) trading to maintain proposed source of revenue to accumulate inventory, but discourage price alignment between the ETF shares requirement,857 and language in the market makers from holding inventory and the underlying components; 849 (iii) proposal regarding arbitrage trading.858 for long periods of time by imposing traditional market-making activity; 850 With respect to the proposed near term increasingly higher capital requirements (iv) ‘‘seeding’’ a new ETF by entering customer demand requirement, a few on aged inventory.845 One commenter into several initial creation transactions commenters noted that this requirement represented that a trading unit’s with an ETF issuer and holding the ETF could prevent an AP from building inventory management practices could shares, possibly for an extended period inventory to assemble creation units.859 be monitored with the Inventory Risk of time, until the ETF establishes regular Two other commenters expressed the Turnover metric, in conjunction with trading and liquidity in the secondary view that the ETF issuer would be the other metrics.846 markets; 851 (v) ‘‘create to lend’’ banking entity’s ‘‘counterparty’’ when transactions, where an AP enters a the banking entity trades directly with vii. Acting as an Authorized Participant creation transaction with the ETF issuer the ETF issuer, so this trading and or Market Maker in Exchange-Traded and lends the ETF shares to an inventory accumulation would meet the Funds investor; 852 and (vi) hedging.853 A few terms of the proposed requirement.860 With respect to ETF trading, commenters noted that an AP may not To permit banking entities to act as APs, commenters generally requested engage in traditional market-making two commenters suggested that trading clarification that a banking entity can activity in the relevant ETF and in the capacity of an AP should be serve as an authorized participant expressed concern that the proposed deemed permitted market making- (‘‘AP’’) to an ETF issuer or can engage rule may limit a banking entity’s ability related activity, regardless of whether in ETF market making under the to act in an AP capacity.854 One the AP is acting as a traditional market proposed exemption.847 According to commenter estimated that APs that are maker.861 banking entities make up between 20 844 See Credit Suisse (Seidel). percent to 100 percent of creation and viii. Arbitrage or Other Activities That 845 See CalPERS; Vanguard. These commenters redemption activity for individual ETFs, Promote Price Transparency and represented that placing increasing capital Liquidity requirements on aged inventory would ease the with an average of approximately 35 rule’s impact on investor liquidity, allow banking percent of creation and redemption In response to a question in the entities to internalize the cost of continuing to hold activity across all ETFs attributed to proposal,862 a number of commenters a position at the expense of its ability to take on banking entities. This commenter new positions, and potentially decrease the as of September 2011, ETFs represented assets of possibility of a firm realizing a loss on a position expressed the view that, if the rule approximately $951 billion. See id. by decreasing the time such position is held. See limits banking entities’ ability to serve 856 See BoA; Vanguard (stating that this id. One commenter noted that some banking entities as APs, then individual investors’ already use this approach to manage risk on their determination may be particularly difficult in the market-making desks. See Vanguard. See also investments in ETFs will become more case of a new ETF). Capital Group (suggesting that one way to expensive due to higher premiums and 857 See BoA. This commenter noted that the implement the statutory exemption would be to discounts versus the ETF’s NAV.855 proposed source of revenue requirement could be charge a trader or a trading desk for positions held interpreted to prevent a banking entity acting as AP from entering into creation and redemption on its balance sheet beyond set time periods and to components. See, e.g., JPMC; Goldman (Prop. increase the charge at set intervals). These transactions, ‘‘seeding’’ an ETF, engaging in ‘‘create Trading) (making similar statement with respect to to lend’’ transactions, and performing secondary comments are addressed in note 923, infra. ADRs as well); SSgA (Feb. 2012); SIFMA et al. 846 See Goldman (Prop. Trading) (representing market making in an ETF because all of these (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); activities require an AP to build an inventory— that the Inventory Risk Turnover metric will allow RBC. AP and market maker activity in ETFs are the Agencies to evaluate the length of time that a either in ETF shares or the underlying addressed in Part VI.A.3.c.2.c.i., infra. components—which often result in revenue trading unit tends to hold risk positions in 848 See SIFMA et al. (Prop. Trading) (Feb. 2012); inventory and whether that holding time is attributable to price movements. See id. BoA; ICI (Feb. 2012) ICI Global; Vanguard; SSgA 858 Commenters noted that this language would consistent with market making-related activities in (Feb. 2012). the relevant market). restrict an AP from engaging in price arbitrage to 849 See JPMC; Goldman (Prop. Trading); SIFMA et 847 See, e.g., SIFMA et al. (Prop. Trading) (Feb. maintain efficient markets in ETFs. See Vanguard; al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012); RBC; Goldman (Prop. Trading); JPMC; SIFMA et al. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. ICI (Feb. 2012) ICI Global. Trading); BoA; ICI (stating that an AP may trade (Prop. Trading) (Feb. 2012). See supra Part 850 See ICI Global; ICI (Feb. 2012) SIFMA et al. with the ETF issuer in different capacities—in VI.A.3.c.2.a. (discussing the proposal’s proposed (Prop. Trading) (Feb. 2012); BoA. connection with traditional market-making activity, interpretation regarding arbitrage trading). 851 on behalf of customers, or for the AP’s own See BoA; ICI (Feb. 2012); ICI Global. 859 See BoA; Vanguard (stating that this account); ICI Global (discussing non-U.S. ETFs 852 See BoA (stating that lending the ETF shares determination may be particularly difficult in the specifically); Vanguard; SSgA (Feb. 2012). One to an investor gives the investor a more efficient case of a new ETF). commenter represented that an AP’s transactions in way to hedge its exposure to assets correlated with 860 See ICI Global; ICI (Feb. 2012). ETFs do not create risks associated with proprietary those underlying the ETF). 861 See ICI (Feb. 2012) ICI Global. These trading because, when an AP trades with an ETF 853 See ICI Global; ICI (Feb. 2012). commenters provided suggested rule text on this issuer for its own account, the AP typically enters 854 See, e.g., Vanguard (noting that APs may not issue and suggested that the Agencies could require into an offsetting transaction in the underlying engage in market-making activity in the ETF and a banking entity’s compliance policies and internal portfolio of securities, which cancels out expressing concern that if AP activities are not controls to take a comprehensive approach to the investment risk and limits the AP’s exposure to the separately permitted, banking entities may exit or entirety of an AP’s trading activity, which would difference between the market price for ETF shares not enter the ETF market); SSgA (Feb. 2012) (stating facilitate easy monitoring of the activity to ensure and the ETF’s net asset value (‘‘NAV’’). See that APs are under no obligation to make markets compliance. See id. Vanguard. in ETF shares and requiring such an obligation 862 See Joint Proposal, 76 FR at 68873 (question With respect to market-making activity in an ETF, would discourage banking entities from acting as 91) (inquiring whether the proposed exemption several commenters noted that market makers play APs); ICI (Feb. 2012). should be modified to permit certain arbitrage an important role in maintaining price alignment by 855 See SSgA (Feb. 2012). This commenter further trading activities engaged in by market makers that engaging in arbitrage transactions between the ETF stated that as of 2011, an estimated 3.5 million— promote liquidity or price transparency but do not shares and the shares of the underlying or 3 percent—of U.S. households owned ETFs and, Continued

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stated that certain types of arbitrage Commenters suggested certain to commenters, a banking entity may be activity should be permitted under the methods for permitting and monitoring obligated to perform the following market-making exemption.863 For arbitrage trading under the exemption. activities in its capacity as a primary example, some commenters stated that a For example, one commenter suggested dealer: undertaking to maintain an banking entity’s arbitrage activity a framework for permitting certain orderly market, preventing or correcting should be considered market making to arbitrage within the market-making any price dislocations,878 and bidding the extent the activity is driven by exemption, with requirements such as: on each issuance of the relevant creating markets for customers tied to (i) Common personnel with market- jurisdiction’s sovereign debt.879 the price differential (e.g., ‘‘box’’ making activity; (ii) policies that cover Commenters expressed concern that a strategies, ‘‘calendar spreads,’’ merger the timing and appropriateness of banking entity’s trading activity as arbitrage, ‘‘Cash and Carry,’’ or basis arbitrage positions; (iii) time limits on primary dealer may not comply with the trading) 864 or to the extent that demand arbitrage positions; and (iv) proposed near term customer demand is predicated on specific price compensation that does not reward requirement 880 or the proposed source relationships between instruments (e.g., successful arbitrage, but instead pools of revenue requirement.881 To address ETFs, ADRs) that market makers must any such revenues with market-making the first issue, one commenter stated maintain.865 Similarly, another profits and losses.873 A few commenters that the final rule should clarify that a commenter suggested that arbitrage represented that, if permitted under the banking entity acting as a primary activity that aligns prices should be rule, the Agencies would be able to dealer of foreign sovereign debt is permitted, such as index arbitrage, ETF monitor arbitrage activities for patterns engaged in primary dealer activity in arbitrage, and event arbitrage.866 One of impermissible proprietary trading response to the near term demands of commenter noted that many markets, through the use of metrics, as well as the sovereign, which should be such as futures and options markets, compliance and examination tools.874 considered a client, customer, or rely on arbitrage activities of market Other commenters stated that the counterparty of the banking entity.882 makers for liquidity purposes and to exemption should not permit certain Another commenter suggested that the maintain convergence with underlying types of arbitrage. One commenter Agencies permit primary dealer instruments for cash-settled options, stated that the rule should ensure that activities through commentary stating futures, and index-based products.867 relative value and complex arbitrage that fulfilling primary dealer obligations Commenters stated that arbitrage trading strategies cannot be conducted.875 will not be included in determinations provides certain market benefits, Another commenter expressed the view of whether the market-making including enhanced price that the market-making exemption exemption applies to a trading unit.883 transparency,868 increased market should not permit any type of arbitrage 869 x. New or Bespoke Products or efficiency, greater market transactions. This commenter stated 870 Customized Hedging Contracts liquidity, and general benefits to that, in the event that liquidity or customers.871 A few commenters noted transparency is inhibited by a lack of Several commenters indicated that the that certain types of hedging activity arbitrage trading, a market maker should proposed exemption does not may appear to have characteristics of be able to find a customer who would adequately address market making in 872 arbitrage trading. seek to benefit from it.876 new or bespoke products, including structured, customer-driven service client, customer, or counterparty demand); ix. Primary Dealer Activities transactions, and requested that the rule CFTC Proposal, 77 FR at 8359. 863 A number of commenters requested be modified to clearly permit such See, e.g., SIFMA et al. (Prop. Trading) (Feb. 884 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. that the market-making exemption activity. Many of these commenters Trading); FTN; RBC; ISDA (Feb. 2012). Arbitrage permit banking entities to meet their trading is further discussed in Part VI.A.3.c.2.c.i., primary dealer obligations in foreign necessary or reasonably incidental to its acting as infra. jurisdictions, particularly if trading in a primary dealer in a foreign government’s debt 864 securities); Goldman (Prop. Trading); Banco de See SIFMA et al. (Prop. Trading) (Feb. 2012). foreign sovereign debt is not separately 865 See SIFMA et al. (Prop. Trading) (Feb. 2012); Me´xico; IIB/EBF. See infra notes 905 to 906 and 877 JPMC. exempted in the final rule. According accompanying text (addressing these comments). 866 See Credit Suisse (Seidel). 878 See Goldman (Prop. Trading). 867 See RBC. and ETFs). But see Sens. Merkley & Levin (Feb. 879 See Banco de Me´xico. 868 See SIFMA et al. (Prop. Trading) (Feb. 2012). 2012) (‘‘When banks use complex hedging 880 See JPMC; Banco de Me´xico. These 869 See Credit Suisse (Seidel); RBC. techniques or otherwise engage in trading that is commenters stated that a primary dealer is required suggestive of arbitrage, regulators should require 870 See RBC. to assume positions in foreign sovereign debt even them to provide evidence and analysis 871 See SIFMA et al. (Prop. Trading) (Feb. 2012); when near term customer demand is unpredictable. demonstrating what risk is being reduced.’’). See id. JPMC; FTN; ISDA (Feb. 2012) (stating that arbitrage 873 activities often yield positions that are ultimately See FTN. 881 See Banco de Me´xico (stating that primary put to use in serving customer demand and 874 See SIFMA et al. (Prop. Trading) (Feb. 2012); dealers need to be able to profit from their positions representing that the process of consistently trading RBC; Goldman (Prop. Trading). One of these in sovereign debt, including by holding significant makes a dealer ready and available to serve commenters stated that the customer-facing activity positions in anticipation of future price movements, customers on a competitive basis). category of metrics, as well as other metrics, would so that the primary dealer business is financially 872 See JPMC (stating that firms commonly be available to evaluate whether the trading unit is attractive); IIB/EBF (stating that primary dealers organize their market-making activities so that risks engaged in a directly customer-facing business and may actively seek to profit from price and interest delivered to client-facing desks are aggregated and the extent to which its activities are consistent with rate movements based on their debt holdings, transferred by means of internal transactions to a the market-making exemption. See Goldman (Prop. which governments support as providing much- single utility desk (which hedges all of the risks in Trading). needed liquidity for securities that are otherwise the aggregate), and this may optically bear some 875 See Johnson & Prof. Stiglitz. See also AFR et purchased largely pursuant to buy-and-hold characteristics of arbitrage, although the commenter al. (Feb. 2012) (noting that arbitrage, spread, or strategies of institutional investors and other requested that such activity be recognized as carry trades are a classic type of proprietary trade). entities seeking safe returns and liquidity buffers). permitted market making-related activity under the 876 See Occupy. 882 See Goldman (Prop. Trading). rule); ISDA (Feb. 2012) (stating that in some swaps 877 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 883 See SIFMA et al. (Prop. Trading) (Feb. 2012). markets, dealers hedge through multiple 2012) (stating that permitted activities should 884 See, e.g., SIFMA et al. (Prop. Trading) (Feb. instruments, which can give an impression of include trading necessary to meet the relevant 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. arbitrage in a function that is risk reducing; for jurisdiction’s primary dealer and other Trading); SIFMA (Asset Mgmt.) (Feb. 2012). This example, a dealer in a broad index equity swap may requirements); JPMC (indicating that the exemption issue is addressed in Part VI.A.3.c.1.c.iii., supra, simultaneously hedge in baskets of stocks, futures, should cover all of a firm’s activities that are and Part VI.A.3.c.2.c.iii., infra.

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emphasized the role such transactions positions in financial instruments in risks associated with making a market in play in helping customers hedge the which the trading desk stands ready to that type of financial instrument.893 unique risks they face.885 Commenters purchase and sell consistent with the To clarify the application of this stated that, as a result, limiting a final rule.892 The final rule requires the standard in response to comments,894 banking entity’s ability to conduct such financial instruments to be identified in the final rule provides two factors for transactions would subject customers to the trading desk’s compliance program. assessing whether the amount, types, increased risks and greater transaction Thus, this requirement focuses on a and risks of the financial instruments in costs.886 One commenter suggested that trading desk’s positions in financial the trading desk’s market-maker the Agencies explicitly state that a instruments for which it acts as market inventory are designed not to exceed, on banking entity’s general willingness to maker. These positions of a trading desk an ongoing basis, the reasonably engage in bespoke transactions is are more directly related to the demands expected near term demands of clients, sufficient to make it a market maker in of customers than positions in financial customers, or counterparties. unique products for purposes of the instruments used for risk management Specifically, the following must be 887 considered under the revised standard: rule. purposes, but in which the trading desk (i) The liquidity, maturity, and depth of Other commenters stated that banking does not make a market. As noted the market for the relevant type of entities should be limited in their ability above, a position or exposure that is to rely on the market-making exemption financial instrument(s),895 and (ii) included in a trading desk’s market- demonstrable analysis of historical to conduct transactions in bespoke or maker inventory will remain in its 888 customer demand, current inventory of customized derivatives. For example, market-maker inventory for as long as one commenter suggested that a banking financial instruments, and market and the position or exposure is managed by other factors regarding the amount, entity be required to disaggregate such the trading desk. As a result, the trading derivatives into liquid risk elements and types, and risks of or associated with desk must continue to account for that positions in financial instruments in illiquid risk elements, with liquid risk position or exposure, together with elements qualifying for the market- which the trading desk makes a market, other positions and exposures in its making exemption and illiquid risk including through block trades. Under market-maker inventory, in determining elements having to be conducted on a the final rule, a banking entity must whether the amount, types, and risks of riskless principal basis under account for these considerations when its market-maker inventory are designed § 75.6(b)(1)(ii) of the proposed rule. establishing risk and inventory limits not to exceed, on an ongoing basis, the 896 According to this commenter, such an for each trading desk. approach would not impact the end user reasonably expected near term demands For purposes of this provision, customer.889 Another commenter stated of customers. ‘‘demonstrable analysis’’ means that the analysis for determining the amount, that a banking entity making a market in While the near term customer demand types, and risks of financial instruments bespoke instruments should be required requirement directly applies only to the a trading desk may manage in its both to hold itself out in accordance trading desk’s market-maker inventory, market-maker inventory, in accordance with § 75.4(b)(2)(ii) of the proposed rule this does not mean a trading desk may with the near term demand requirement, and to demonstrate the purchase and establish other positions, outside its must be based on factors that can be the sale of such an instrument.890 market-maker inventory, that exceed demonstrated in a way that makes the what is needed to manage the risks of c. Final Near Term Customer Demand analysis reviewable. This may include, the trading desk’s market making- Requirement among other things, the normal trading related activities and inventory. Instead, records of the trading desk and market Consistent with the statute, a trading desk must have limits on its information that is readily available and § 75.4(b)(2)(ii) of the final rule’s market- market-maker inventory, the products, retrievable. If the analysis cannot be making exemption requires that the instruments, and exposures the trading supported by the banking entity’s books amount, types, and risks of the financial desk may use for risk management and records and available market data, instruments in the trading desk’s purposes, and its aggregate financial on their own, then the other factors market-maker inventory be designed not exposure that are based on the factors to exceed, on an ongoing basis, the utilized must be identified and set forth in the near term customer documented and the analysis of those reasonably expected near term demands demand requirement, as well as other of clients, customers, or counterparties, factors together with the facts gathered relevant considerations regarding the from the trading and market records based on certain market factors and nature and amount of the trading desk’s analysis.891 As discussed above in Part must be identified in a way that makes market making-related activities. A it possible to test the analysis. VI.A.3.c.1.c.ii., the trading desk’s banking entity must establish, market-maker inventory consists of implement, maintain, and enforce a 893 See infra Part VI.A.3.c.3. (discussing the limit structure, as well as other compliance program requirements); final rule 885 See Credit Suisse (Seidel); Goldman (Prop. compliance program elements (e.g., § 75.4(b)(2)(iii). Trading); SIFMA (Asset Mgmt.) (Feb. 2012). 894 See supra Part VI.A.3.c.2.b.i. 886 See Goldman (Prop. Trading); SIFMA (Asset those specifying the instruments a 895 This language has been added to the final rule Mgmt.) (Feb. 2012). trading desk trades as a market maker or to respond to commenters’ concerns that the 887 See SIFMA (Asset Mgmt.) (Feb. 2012). may use for risk management purposes proposed near term demand requirement would be 888 See AFR et al. (Feb. 2012); Public Citizen. and providing for specific risk unworkable in less liquid markets or would 889 See AFR et al. (Feb. 2012). management procedures), for each otherwise restrict a market maker’s ability to hold 890 See Public Citizen. trading desk that are designed to and manage its inventory in less liquid markets. See 891 The final rule includes certain refinements to supra Part VI.A.3.c.2.b.ii. In addition, this provision the proposed standard, which would have required prevent the trading desk from engaging is substantially similar to one commenter’s that the market making-related activities of the in trading activity that is unrelated to suggested approach of adding the phrase ‘‘based on trading desk or other organizational unit that making a market in a particular type of the characteristics of the relevant market and asset conducts the purchase or sale are, with respect to financial instrument or managing the class’’ to the proposed requirement, but the the financial instrument, designed not to exceed the Agencies have added more specificity about the reasonably expected near term demands of clients, relevant characteristics that should be taken into customers, or counterparties. See proposed rule 892 See supra Part VI.A.3.c.1.c.ii.; final rule consideration. See Morgan Stanley. § 75.4(b)(2)(iii). § 75.4(b)(5). 896 See infra Part VI.A.3.c.3.

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Importantly, a determination of its market-maker inventory, irrespective trading desk must continue to whether a trading desk’s market-maker of customer demand, simply because appropriately manage risks of its inventory is appropriate under this the exposure is hedged and the resulting financial exposure over time in requirement will take into account financial exposure is below the desk’s accordance with its financial exposure reasonably expected near term customer financial exposure limit. In addition, the limits. demand, including historical levels of amount, types, and risks of financial As discussed above, several customer demand, expectations based instruments in a trading desk’s market- commenters expressed concern that the on market factors, and current demand. maker inventory would not be near-term customer demand For example, at any particular time, a consistent with permitted market- requirement is too restrictive and that it trading desk may acquire a position in making activities if, for example, the could impede a market maker’s ability a financial instrument in response to a trading desk has a pattern or practice of to build or retain inventory, particularly customer’s request to sell the financial retaining exposures in its market-maker in less liquid markets where demand is instrument or in response to reasonably inventory, while refusing to engage in intermittent.901 Because customer expected customer buying interest for customer transactions when there is demand in illiquid markets can be such instrument in the near term.897 In customer demand for those exposures at difficult to predict with precision, addition, as discussed below, this commercially reasonable prices. market-maker inventory may not closely requirement is not intended to impede The following is an example of the track customer order flow. The Agencies a trading desk’s ability to engage in interplay between a trading desk’s acknowledge that market makers will certain market making-related activities market-maker inventory and financial face costs associated with demonstrating that are consistent with and needed to exposure. An airline company customer that market-maker inventory is designed facilitate permissible trading with its may seek to hedge its long-term not to exceed, on an ongoing basis, the clients, customers, or counterparties, exposure to price fluctuations in jet fuel reasonably expected near term demands such as inventory management and by asking a banking entity to create a of customers, as required by the statute interdealer trading. These activities structured ten-year, $1 billion jet fuel and the final rule because this is an must, however, be consistent with the swap for which there is no liquid analysis that banking entities may not analysis conducted under the final rule market. A trading desk that makes a currently undertake. However, the final and the trading desk’s limits discussed market in energy swaps may service its rule includes certain modifications to below.898 Moreover, as explained below, customer’s needs by executing a custom the proposed rule that are intended to the banking entity must also have in jet fuel swap with the customer and reduce the negative impacts cited by place escalation procedures to address, holding the swap in its market-maker commenters, such as limitations on analyze, and document trades made in inventory, if the resulting transaction inventory management activity and response to customer requests that does not cause the trading desk to potential restrictions on market making would exceed one of a trading desk’s exceed its market-maker inventory limit in less liquid instruments, which the limits. on the applicable class of instrument, or Agencies believe should reduce the The near term demand requirement is the trading desk has received approval perceived burdens of the proposed near an ongoing requirement that applies to to increase the limit in accordance with term demand requirement. For example, the amount, types, and risks of the the authorization and escalation the final rule recognizes that liquidity, financial instruments in the trading procedures under paragraph maturity, and depth of the market vary desk’s market-maker inventory. For (b)(2)(iii)(E). In keeping with the market- across asset classes. The Agencies instance, a trading desk may acquire making exemption as provided in the expect that the express recognition of exposures as a result of entering into final rule, the trading desk would be these differences in the rule should market-making transactions with required to hedge the risk from this avoid unduly impeding a market customers that are within the desk’s swap, either individually or as part of a maker’s ability to build or retain market-marker inventory and financial set of aggregated positions, if the trade inventory. More specifically, the exposure limits. Even if the trading desk would result in a financial exposure that Agencies recognize the relationship is appropriately managing the risks of exceeds the desk’s financial exposure between market-maker inventory and its market-maker inventory, its market- limits. The trading desk may hedge the customer order flow can vary across maker inventory still must be consistent risk of the swap, for example, by asset classes and that an inflexible with the analysis of the reasonably entering into one or more futures or standard for demonstrating that expected near term demands of clients, swap positions that are identified as inventory does not exceed reasonably customers, and counterparties and the permissible hedging products, expected near term demand could liquidity, maturity and depth of the instruments, or exposures in the trading provide an incentive to stop making market for the relevant instruments in desk’s compliance program and that markets in illiquid asset classes. the inventory. Moreover, the trading analysis, including correlation analysis i. Definition of ‘‘client,’’ ‘‘customer,’’ desk must take action to ensure that its as appropriate, indicates would and ‘‘counterparty’’ financial exposure does not exceed its demonstrably reduce or otherwise financial exposure limits.899 A trading significantly mitigate risks associated In response to comments requesting desk may not maintain an exposure in with the financial exposure from its further definition of the terms ‘‘client,’’ market-making activities. Alternatively, ‘‘customer,’’ and ‘‘counterparty’’ for 897 As discussed further below, acquiring a if the trading desk also acts as a market purposes of this standard,902 the position in a financial instrument in response to maker in crude oil futures, then the Agencies have defined these terms in reasonably expected customer demand would not the final rule. In particular, the final include creating a structured product for which desk’s exposures arising from its there is no current customer demand and, instead, market-making activities may naturally soliciting customer demand during or after its hedge the jet fuel swap (i.e., it may trading desk, must be managed within the desk’s creation. See infra note 938 and accompanying text; limits. Sens. Merkley & Levin (Feb. 2012). reduce its financial exposure levels 901 See SIFMA (Asset Mgmt.) (Feb. 2012); T. Rowe 900 898 The formation of structured finance products resulting from such instruments). The Price; CIEBA; ICI (Feb. 2012) RBC. and securitizations is discussed in detail in Part 902 See Japanese Bankers Ass’n.; Credit Suisse VI.B.2.b. of this SUPPLEMENTARY INFORMATION. 900 This natural hedge with futures would (Seidel); Occupy; AFR et al. (Feb. 2012); Public 899 See final rule § 75.4(b)(2)(iii)(B), (C). introduce basis risk which, like other risks of the Citizen.

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rule defines ‘‘client,’’ ‘‘customer,’’ and services, either by requesting such activity and impermissible proprietary ‘‘counterparty’’ as, on a collective or services or entering into a continuing trading. For example, the Agencies are individual basis, ‘‘market participants relationship for such services.906 The concerned that such an approach would that make use of the banking entity’s definition of client, customer, and allow a trading desk to maintain an market making-related services by counterparty in the final rule recognizes outsized inventory and to justify such obtaining such services, responding to that, in the context of market making in inventory levels as being tangentially quotations, or entering into a continuing a financial instrument that is executed related to expected market-wide relationship with respect to such on an exchange or other organized demand. On the other hand, preventing services.’’ 903 However, for purposes of trading facility, a client, customer, or any banking entity from being a client, the analysis supporting the market- counterparty would be any person customer, or counterparty under the maker inventory held to meet the whose buy or sell order executes against final rule would result in an overly reasonably expected near-term demands the banking entity’s quotation posted on narrow definition that would of clients, customer and counterparties, the exchange or other organized trading significantly impact banking entities’ a client, customer, or counterparty of facility.907 Under these circumstances, ability to provide and access market the trading desk does not include a the person would be trading with the making-related services. For example, trading desk or other organizational unit banking entity in response to the most banks look to market makers to of another entity if that entity has $50 banking entity’s quotations and provide liquidity in connection with billion or more in total trading assets obtaining the banking entity’s market their investment portfolios. and liabilities, measured in accordance making-related services. In the context The Agencies further note that, with with § 75.20(d)(1),904 unless the trading of market making in a financial respect to a banking entity that acts as desk documents how and why such instrument in the OTC market, a client, a primary dealer (or functional trading desk or other organizational unit customer, or counterparty generally equivalent) for a sovereign government, should be treated as a customer or the would be a person that makes use of the the sovereign government and its central transactions are conducted banking entity’s intermediation services, bank are each a client, customer, or anonymously on an exchange or similar either by requesting such services counterparty for purposes of the market- trading facility that permits trading on (possibly via a request-for-quote on an making exemption as well as the behalf of a broad range of market established trading facility) or entering underwriting exemption.910 The participants.905 into a continuing relationship with the Agencies believe this interpretation, The Agencies believe this definition is banking entity with respect to such together with the modifications in the generally consistent with the proposed services. For purposes of determining rule that eliminate the requirement to interpretation of ‘‘customer’’ in the the reasonably expected near-term distinguish between revenues from proposal. The proposal generally demands of customers, a client, spreads and price appreciation and the provided that, for purposes of market customer, or counterparty generally recognition that the market-making making on an exchange or other would not include a trading desk or exemption extends to market making- organized trading facility, a customer is other organizational unit of another related activities appropriately captures any person on behalf of whom a buy or entity that has $50 billion or more in the unique relationship between a sell order has been submitted. In the total trading assets except if the trading primary dealer and the sovereign context of the over-the-counter market, desk has a documented reason for government. Thus, generally a banking a customer was generally considered to treating the trading desk or other entity may rely on the market-making be a market participant that makes use organizational unit of such entity as a exemption for its activities as primary of the market maker’s intermediation customer or the trading desk’s dealer (or functional equivalent) to the transactions are executed anonymously extent those activities are outside of the 903 Final rule § 75.4(b)(3). on an exchange or similar trading underwriting exemption.911 904 See final rule § 75.4(b)(3)(i). The Agencies are facility that permits trading on behalf of using a $50 billion threshold for these purposes in recognition that firms engaged in substantial trading a broad range of market participants. 910 A primary dealer is a firm that trades a activity do not typically act as customers to other The Agencies believe that this exclusion sovereign government’s obligations directly with market makers, while smaller regional firms may balances commenters’ suggested the sovereign (in many cases, with the sovereign’s seek liquidity from larger firms as part of their alternatives of either defining as a central bank) as well as with other customers market making-related activities. client, customer, or counterparty anyone through market making. The sovereign government 905 See final rule § 75.4(b)(3)(i)(A), (B). In may impose conditions on a primary dealer or Appendix C of the proposed rule, a trading unit who is on the other side of a market require that it engage in certain trading in the engaged in market making-related activities would maker’s trade 908 or preventing any relevant government obligations (e.g., participate in have been required to describe how it identifies its banking entity from being a client, auctions for the government obligation or maintain customers for purposes of the Customer-Facing customer, or counterparty.909 The a liquid secondary market in the government Trading Ratio, if applicable, including obligations). Further, a sovereign government may documentation explaining when, how, and why a Agencies believe that the first limit the number of primary dealers that are broker-dealer, swap dealer, security-based swap alternative is overly broad and would authorized to trade with the sovereign. A number dealer, or any other entity engaged in market not meaningfully distinguish between of countries use a primary dealer system, including making-related activities, or any affiliate thereof, is permitted market making-related Australia, Brazil, Canada, China-Hong Kong, considered to be a customer of the trading unit. See France, Germany, Greece, India, Indonesia, Ireland, Joint Proposal, 76 FR at 68964. While the proposed Italy, Japan, Mexico, Netherlands, Portugal, South approach would not have necessarily prevented any 906 See Joint Proposal, 76 FR at 68960; CFTC Africa, South Korea, Spain, Turkey, the U.K., and of these entities from being considered a customer Proposal, 77 FR at 8439. the U.S. See, e.g., Oliver Wyman (Feb. 2012). The of the trading desk, it would have required 907 See, e.g., Goldman (Prop. Trading) (explaining Agencies note that this standard would similarly enhanced documentation and justification for generally how exchange-based market makers apply to the relationship between a banking entity treating any of these entities as a customer. The operate). and a sovereign that does not have a formal primary final rule’s exclusion from the definition of client, 908 See ISDA (Feb. 2012). In addition, a number dealer system, provided the sovereign’s process customer, and counterparty is similar to the of commenters suggested that the rule should not functions like a primary dealer framework. proposed approach, but is more narrowly focused limit broker-dealers from being customers of a 911 See Goldman (Prop. Trading). See also supra on firms that have $50 billion or more trading assets market maker. See SIFMA et al. (Prop. Trading) Part VI.A.3.c.2.b.ix. (discussing commenters’ and liabilities because, as noted above, the Agencies (Feb. 2012); Credit Suisse (Seidel); RBC; Comm. on concerns regarding primary dealer activity). Each believe firms engaged in such substantial trading Capital Markets Regulation. suggestion regarding the treatment of primary activity are less likely to act as customers to market 909 See AFR et al. (Feb. 2012); Occupy; Public dealer activity has not been incorporated into the makers than smaller regional firms. Citizen. Continued

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For exchange-traded funds (‘‘ETFs’’) inventory of ETF shares or underlying its underlying instruments in the market (and related structures), Authorized instruments held by the AP can to maintain price continuity between Participants (‘‘APs’’) are generally the therefore be evaluated under the criteria the ETF and its underlying instruments, conduit for market participants seeking of the market-making exemption, such which are exchangeable for one another. to create or redeem shares of the fund as how these holdings relate to Sometimes these firms will register as (or equivalent structure).912 For reasonably expected near term customer market makers on an exchange for a example, an AP may buy ETF shares demand.914 These criteria can be given ETF, but other times they may not from market participants who would similarly applied to other activities of register as market maker. Regardless of like to redeem those shares for cash or the AP, such as building inventory to whether or not the firm is registered as a basket of instruments upon which the ‘‘seed’’ a new ETF or engaging in ETF- a market maker on any given exchange, ETF is based. To provide this service, loan related transactions.915 The this activity not only provides liquidity the AP may in turn redeem these shares Agencies recognize that banking entities for ETFs, but also, and very importantly, from the ETF itself. Similarly, an AP currently conduct a substantial amount helps keep the market price of an ETF may receive cash or financial of AP creation and redemption activity in line with the NAV of the fund. The instruments from a market participant in the ETF market and, thus, if the rule market-making exemption can be used seeking to purchase ETF shares, in were to prevent or restrict a banking to evaluate trading that is intended to which case the AP may use that cash or entity from acting as an AP for an ETF, maintain price continuity between these set of financial instruments to create then the rule would impact the exchangeable instruments by shares from the ETF. In either case, for functioning of the ETF market.916 considering how the firm quotes, the purpose of the market-making Some firms, whether or not an AP in maintains risk and exposure limits, exemption, such market participants as a given ETF, may also actively engage in manages its inventory and risk, and, in well as the ETF itself would be buying and selling shares of an ETF and the case of APs, exercises its ability to considered clients, customers, or create and redeem shares from the fund. counterparties of the AP.913 The proposed source of revenue requirement on AP Because customers take positions in activity should be addressed by the replacement of ETFs with an expectation that the price this proposed requirement with a metric-based rule. Specifically, the exemption for market making relationship will be maintained, such as applied to a primary dealer does not extend focus on when a trading desk generates revenue without limitation to primary dealer activities that from its trading activity. See BoA; infra Part trading can be considered to be market are not conducted under the conditions of one of VI.A.3.c.7.c. (discussing the new approach to making-related activity.917 the exemptions. These interpretations would be assessing a trading desk’s pattern of profit and loss). After considering comments, the 914 inconsistent with Congressional intent for the This does not imply that the AP must perfectly Agencies continue to take the view that statute, to limit permissible market- making activity predict future customer demand, but rather that through the statute’s near term demand requirement there is a demonstrable, statistical, or historical a trading desk would not qualify for the and, thus, does not permit trading without basis for the size of the inventory held, as more market-making exemption if it is wholly limitation. See SIFMA et al. (Prop. Trading) (Feb. fully discussed below. Consider, for example, a or principally engaged in arbitrage 2012) (stating that permitted activities should fixed-income ETF with $500 million in assets. If, on trading or other trading that is not in include trading necessary to meet the relevant a typical day, an AP generates requests for $10 to jurisdiction’s primary dealer and other $20 million of creations or redemptions, then an response to, or driven by, the demands requirements); JPMC (indicating that the exemption inventory of $10 to $20 million in bonds upon of clients, customers, or should cover all of a firm’s activities that are which the ETF is based (or some small multiple counterparties.918 The Agencies believe necessary or reasonably incidental to its acting as thereof) could be construed as consistent with a primary dealer in a foreign government’s debt reasonably expected near term customer demand. this activity, which is not in response to securities); Goldman (Prop. Trading); Banco de On the other hand, if under the same circumstances or driven by customer demand, is Me´xico; IIB/EBF. Rather, recognizing that market an AP holds $1 billion of these bonds solely in its inconsistent with the Congressional making by primary dealers is a key function, the capacity as an AP for this ETF, it would be more intent that market making-related limits and other conditions of the rule are flexible difficult to justify this as needed for reasonably enough to permit necessary market making-related expected near term customer demand and may be activity be designed not to exceed the activities. indicative of an AP engaging in prohibited reasonably expected near term demands 912 ETF sponsors enter into relationships with one proprietary trading. or more financial institutions that become APs for 915 In ETF loan transactions (also referred to as 917 A number of commenters expressed concern the ETF. Only APs are permitted to purchase and ‘‘create-to-lend’’ transactions), an AP borrows the that the proposed rule would limit market making redeem shares directly from the ETF, and they can underlying instruments that form the creation or AP activity in ETFs because market makers and do so only in large aggregations or blocks that are basket of an ETF, submits the borrowed instruments APs engage in trading to maintain a price commonly called ‘‘creation units.’’ In response to a to the ETF agent in exchange for a creation unit of relationship between ETFs and their underlying question in the proposal, a number of commenters ETF shares, and lends the resulting ETF shares to components, which promotes ETF market expressed concern that the proposed market-making a customer that wants to borrow the ETF. At the efficiency. See Vanguard; RBC; Goldman (Prop. exemption may not permit certain AP and market end of the ETF loan, the borrower returns the ETF Trading); JPMC; SIFMA et al. (Prop. Trading) (Feb. maker activities in ETFs and requested clarification shares to the AP, and the AP redeems the ETF 2012); SSgA (Feb. 2012); Credit Suisse (Prop. that these activities would be permitted under the shares with the ETF agent in exchange for the Trading). market-making exemption. See Joint Proposal, 76 underlying instruments that form the creation 918 Some commenters suggested that a range of FR at 68873 (question 91) (‘‘Do particular markets basket. The AP may return the underlying arbitrage trading should be permitted under the or instruments, such as the market for exchange- instruments to the parties from whom it borrowed market-making exemption. See, e.g., Goldman traded funds, raise particular issues that are not them or may use them for another loan, as long as (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) adequately or appropriately addressed in the the AP is not obligated to return them at that time. (Feb. 2012); JPMC. Other commenters, however, proposal? If so, how could the proposal better For the term of the ETF loan transaction, the AP stated that arbitrage trading should be prohibited address those instruments, markets or market hedges against market risk arising from any under the final rule. See AFR et al. (Feb. 2012); features?’’); CFTC Proposal, 77 FR at 8359 (question rebalancing of the ETF, which would change the Volcker; Occupy. In response to commenters 91); supra Part VI.A.3.c.2.b.vii. (discussing amount or type of underlying instruments the AP representing that it would be difficult to comply comments on this issue). would receive in exchange for the ETF compared with this standard because it requires a trading desk 913 This is consistent with two commenters’ to the underlying instruments the AP borrowed and to determine the proportionality of its activities in request that an ETF issuer be considered a submitted to the ETF agent to create the ETF shares. response to customer demand compared to its ‘‘counterparty’’ of the banking entity when it trades See David J. Abner, ‘‘The ETF Handbook,’’ Ch. 12 activities that are not in response to customer directly with the ETF issuer as an AP. See ICI (2010); Jean M. McLoughlin, Davis Polk & Wardwell demand, the Agencies believe that the statute Global; ICI (Feb. 2012). Further, this approach is LLP, to Division of Corporation Finance, U.S. requires a banking entity to distinguish between intended to address commenters’ concerns that the Securities and Exchange Commission, dated Jan. 23, market making-related activities that are designed near term demand requirement may limit a banking 2013, available at http://www.sec.gov/divisions/ not to exceed the reasonably expected near term entity’s ability to act as AP for an ETF. See BoA; corpfin/cf-noaction/2013/davis-polk-wardwell-llp- demands of customers and impermissible Vanguard. The Agencies believe that one 012813-16a.pdf. proprietary trading. See Goldman (Prop. Trading); commenter’s concern about the impact of the 916 See SSgA (Feb. 2012). RBC.

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of clients, customers, or counterparties. However, in determining the reasonably ii. Impact of the Liquidity, Maturity, and For example, a trading desk would not expected near term demands of clients, Depth of the Market on the Analysis be permitted to engage in general customers, or counterparties, a trading Several commenters expressed statistical arbitrage trading between desk generally may not account for the concern about the potential impact of instruments that have some degree of expected trading interests of a trading the proposed near term demand correlation but where neither desk or other organizational unit of an requirement on market making in less instrument has the capability of being entity with aggregate trading assets and liquid markets and requested that the exchanged, converted, or exercised for liabilities of $50 billion or greater Agencies recognize that near term or into the other instrument. A trading (except if the trading desk documents customer demand may vary across desk may, however, act as market maker why and how a particular trading desk different markets and asset classes.925 to a customer engaged in a statistical or other organizational unit at such a The Agencies understand that arbitrage trading strategy. Furthermore reasonably expected near term customer 919 firm should be considered a customer or as suggested by some commenters, demand may vary based on the trading activity used by a market maker the trading desk or conduct market- making activity anonymously on an liquidity, maturity, and depth of the to maintain a price relationship that is market for the relevant type of financial expected and relied upon by clients, exchange or similar trading facility that permits trading on behalf of a broad instrument(s) in which the trading desk customers, and counterparties is acts as market maker.926 As a result, the range of market participants).923 permitted as it is related to the demands final rule recognizes that these factors of clients, customers, or counterparties A trading desk may engage in impact the analysis of reasonably because the relevant instrument has the interdealer trading to: Establish or expected near term demands of clients, capability of being exchanged, acquire a position to meet the customers, or counterparties and the converted, or exercised for or into reasonably expected near term demands amount, types, and risks of market- 920 another instrument. of its clients, customers, or maker inventory needed to meet such The Agencies recognize that a trading counterparties, including current demand.927 In particular, customer desk, in anticipating and responding to demand; unwind or sell positions demand is likely to be more frequent in customer needs, may engage in more liquid markets than in less liquid interdealer trading as part of its acquired from clients, customers, or counterparties; or engage in risk- or illiquid markets. As a result, market inventory management activities and makers in more liquid cash-based that interdealer trading provides certain mitigating or inventory management transactions.924 The Agencies believe markets, such as liquid equity market benefits, such as more efficient securities, should generally have higher matching of customer order flow, greater that allowing a trading desk to continue to engage in customer-related rates of inventory turnover and less aged hedging options to reduce risk, and inventory than market makers in less interdealer trading is appropriate enhanced ability to accumulate or exit liquid or illiquid markets.928 Market 921 because it can help a trading desk customer-related positions. The final makers in less liquid cash-based rule does not prohibit a trading desk appropriately manage its inventory and markets are more likely to hold a from using the market-making risk levels and can effectively allow particular position for a longer period of exemption to engage in interdealer clients, customers, or counterparties to time due to intermittent customer trading that is consistent with and access a larger pool of liquidity. While demand. In the derivatives markets, related to facilitating permissible the Agencies recognize that effective market makers carry open positions and trading with the trading desk’s clients, intermediation of client, customer, or 922 manage various risk factors, such as customers, or counterparties. counterparty trading may require a exposure to different points on a yield trading desk to engage in a certain curve. These exposures are analogous to 919 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC. amount of interdealer trading, this is an inventory in the cash-based markets. 920 See, e.g., SIFMA et al. (Prop. Trading) (Feb. activity that will bear some scrutiny by Further, it may be more difficult to 2012); JPMC; Credit Suisse (Seidel). For example, the Agencies and should be monitored reasonably predict near term customer customers have an expectation of general price by banking entities to ensure it reflects demand in less mature markets due to, alignment under these circumstances, both at the time they decide to invest in the instrument and for market-making activities and not the remaining time they hold the instrument. To the impermissible proprietary trading. 925 See CIEBA (stating that, absent a different contrary, general statistical arbitrage does not interpretation for illiquid instruments, market maintain a price relationship between related makers will err on the side of holding less inventory instruments that is expected and relied upon by of preventing interdealer trading, combined with to avoid sanctions for violating the rule); Morgan customers and, thus, is not permitted under the inventory limits. See Oliver Wyman (Feb. 2012). Stanley; RBC; ICI (Feb. 2012) ISDA (Feb. 2012); market-making exemption. Firms engage in general Because the final rule does not prohibit interdealer Comm. on Capital Markets Regulation; Alfred statistical arbitrage to profit from differences in trading or limit inventory in the manner this Brock. market prices between instruments, assets, or price commenter assumed for purposes of its analysis, the 926 See supra Part VI.A.3.c.2.b.ii. (discussing or risk elements associated with instruments or Agencies do not believe the final rule will have the comments on this issue). assets that are thought to be statistically related, but market impact cited by this commenter. 927 See final rule § 75.4(b)(2)(ii)(A). which do not have a direct relationship of being 923 See AFR et al. (Feb. 2012) (recognizing that 928 The final rule does not impose additional exchangeable, convertible, or exercisable for the the ability to manage inventory through interdealer capital requirements on aged inventory to other. transactions should be accommodated in the rule, discourage a trading desk from retaining positions 921 See MetLife; ACLI (Feb. 2012); Goldman but recommending that this activity be conditioned in inventory, as suggested by some commenters. See (Prop. Trading); Morgan Stanley; Chamber (Feb. on a market maker having an appropriate level of CalPERS; Vanguard. The Agencies believe the final 2012); Prof. Duffie; Oliver Wyman (Dec. 2011); inventory after an interdealer transaction). rule already limit a trading desk’s ability to hold Oliver Wyman (Feb. 2012). inventory over an extended period and do not see 924 Provided it is consistent with the requirements 922 A number of commenters requested that the a need at this time to include additional capital rule be modified to clearly recognize interdealer of the market-making exemption, including the near requirements in the final rule. For example, a trading as a component of permitted market term customer demand requirement, a trading desk trading desk must have written policies and making-related activity. See MetLife; SIFMA et al. may trade for purposes of determining how to price procedures relating to its inventory and must be (Prop. Trading) (Feb. 2012); RBC; Credit Suisse a financial instrument a customer seeks to trade able to demonstrate, as needed, its analysis of why (Seidel); JPMC; BoA; ACLI (Feb. 2012); AFR et al. with the trading desk or to determine the depth of the levels of its market-maker inventory are (Feb. 2012); ISDA (Feb. 2012); Goldman (Prop. the market for a financial instrument a customer necessary to meet, or is a result of meeting, Trading); Oliver Wyman (Feb. 2012). One of these seeks to trade with the trading desk. See Goldman customer demand. See final rule § 75.4(b)(2)(ii), commenters analyzed the potential market impact (Prop. Trading). (iii)(C).

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among other things, a lack of historical infrequently and customer demand is facts and circumstances, it may be experience with client, customer, or hard to predict 933 or when a banking proper for a banking entity to weigh counterparty demands for the relevant entity is entering a new market.934 To these factors differently when product. Under these circumstances, the address these comments, the Agencies conducting an analysis under this Agencies encourage banking entities to are providing additional information provision. For example, historical consider their experience with similar about how a banking entity can comply trends in customer demand may be less products or other relevant factors.929 with the statute’s near term customer relevant when a trading desk is experiencing or expects to experience a iii. Demonstrable Analysis of Certain demand requirement, including a new change in the pattern of customer needs Factors requirement that a banking entity conduct a demonstrable assessment of (e.g., requests for block positioning), In the proposal, the Agencies stated reasonably expected near term customer adjustments to its business model (e.g., that permitted market making includes demand and several examples of factors efforts to expand or contract its market taking positions in securities in that may be relevant for conducting shares), or changes in market anticipation of customer demand, so such an assessment. The Agencies conditions.937 On the other hand, absent long as any anticipatory buying or believe it is important to require such these types of current or anticipated selling activity is reasonable and related demonstrable analysis to allow events, the amount, types, and risks of to clear, demonstrable trading interest of determinations of reasonably expected the financial instruments in the trading 930 clients, customers, or counterparties. near term demand and associated desk’s market-maker inventory should A number of commenters expressed inventory levels to be monitored and be relatively consistent with such concern about this proposed tested to ensure compliance with the trading desk’s historical profile of interpretation’s impact on market statute and the final rule. market-maker inventory.938 makers’ inventory management activity Moreover, the demonstrable analysis The final rule provides that, to help and represented that it was inconsistent required under § 75.4(b)(2)(ii)(B) should determine the appropriate amount, with the statute’s near term demand account for, among other things, how types, and risks of the financial standard, which permits market-making the market factors discussed in instruments in the trading desk’s activity that is ‘‘designed’’ not to exceed § 75.4(b)(2)(ii)(A) impact the amount, market-maker inventory and to ensure the ‘‘reasonably expected’’ near term types, and risks of market-maker that such inventory is designed not to demands of customers.931 In response to inventory the trading desk may need to exceed, on an ongoing basis, the comments, the Agencies are permitting facilitate reasonably expected near term a trading desk to take positions in reasonably expected near term demands demands of clients, customers, or reasonable expectation of customer of client, customers, or counterparties, a counterparties.939 Other potential demand in the near term based on a banking entity must conduct demonstrable analysis of historical demonstrable analysis that the amount, accompanying text (discussing comments on this types, and risks of the financial customer demand, current inventory of issue). financial instruments, and market and Because the final rule does not prevent banking instruments in the trading desk’s entities from providing direct liquidity for market-maker inventory are designed other factors regarding the amount, types, and risks of or associated with rebalance trades, the Agencies do not believe that not to exceed, on an ongoing basis, the the final rule will cause the market impacts that one reasonably expected near term demands financial instruments in which the commenter predicted would occur were such a restriction adopted. See Oliver Wyman (Feb. 2012) of customers. trading desk makes a market, including through block trades. This analysis (estimating that if market makers are not able to The proposal also stated that a provide direct liquidity for rebalance trades, banking entity’s determination of near should not be static or fixed solely on investors tracking these indices could potentially term customer demand should generally current market or other factors. Instead, pay incremental costs of $600 million to $1.8 billion every year). be based on the unique customer base an appropriately conducted analysis under this provision will be both 937 In addition, the Agencies recognize that a new of a specific market-making business entrant to a particular market or asset class may not line (and not merely an expectation of backward- and forward-looking by have knowledge of historical customer demand in future price appreciation). Several taking into account relevant historical that market or asset class at the outset. See supra trends in customer demand 935 and any note 924 and accompanying text (discussing factors commenters stated that it was unclear that may be relevant to new market entrants for how such determinations should be events that are reasonably expected to purposes of determining the reasonably expected made and expressed concern that near occur in the near term that would likely near term demands of clients, customers, or 936 term customer demand cannot always impact demand. Depending on the counterparties). 938 One commenter suggested an approach that be accurately predicted,932 particularly 933 See SIFMA et al. (Prop. Trading) (Feb. 2012). would allow market makers to build inventory in in markets where trades occur products where they believe customer demand will 934 See CIEBA. exist, regardless of whether inventory can be tied 935 To determine an appropriate historical dataset, 929 The Agencies agree, as suggested by one to a particular customer in the near term or to a banking entity should assess the relation between historical trends in customer demand. See Credit commenter, it may be appropriate for a market current or reasonably expected near term conditions Suisse (Seidel). The Agencies believe an approach maker in a new asset class or market to look to and demand and those of prior market cycles. that does not provide for any consideration of reasonably expected future developments on the 936 This analysis may, where appropriate, take historical trends could result in a heightened risk basis of the trading desk’s customer relationships. into account prior and/or anticipated cyclicality to of evasion. At the same time, as discussed above, See Morgan Stanley. As discussed further below, the demands of clients, customers, or the Agencies recognize that historical trends may the Agencies recognize that a trading desk could counterparties, which may cause variations in the not always determine the amount of inventory a encounter similar issues if it is a new entrant in an amounts, types, and risks of financial instruments trading desk may need to meet reasonably expected existing market. needed to provide intermediation services at near term demand and it may under certain 930 See Joint Proposal, 76 FR at 68871; CFTC different points in a cycle. For example, the final circumstances be appropriate to build inventory in Proposal, 77 FR at 8356–8357. rule recognizes that a trading desk may need to anticipation of a reasonably expected near term 931 See, e.g., SIFMA et al. (Prop. Trading) (Feb. accumulate a larger-than-average amount of event that would likely impact customer demand. 2012); Goldman (Prop. Trading); Chamber (Feb. inventory in anticipation of an index rebalance. See While the Agencies are not requiring that market- 2012); Comm. on Capital Markets Regulation. See supra note 843 (discussing a comment on this maker inventory be tied to a particular customer, also Morgan Stanley; SIFMA (Asset Mgmt.) (Feb. issue). The Agencies are aware that a trading desk the Agencies are requiring that a banking entity 2012). engaged in block positioning activity may have a analyze and support its expectations for near term 932 See SIFMA et al. (Prop. Trading) (Feb. 2012); less consistent pattern of inventory because of the customer demand. MetLife; Chamber (Feb. 2012); RBC; CIEBA; need to take on large block positions at the request 939 The Agencies recognize that a trading desk Wellington; ICI (Feb. 2012) Alfred Brock. of customers. See supra note 761 and could acquire either a long or short position in

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factors that could be used to assess are concerned that, absent express requiring a banking entity to be reasonably expected near term customer interest in each significant risk registered as a market maker on an demand and the appropriate amount, associated with the product, a trading exchange or other similar anonymous types, and risks of financial instruments desk could evade the market-making trading facility, if the exchange or other in the trading desk’s market-maker exemption by structuring a deal with similar anonymous trading facility inventory include, among others: (i) certain risk exposures, or amounts of registers market makers, for purposes of Recent trading volumes and customer risk exposures, for which there is no the final rule.945 The Agencies trends; (ii) trading patterns of specific customer demand and that would be recognize, as noted by commenters, that customers or other observable customer retained in the trading desk’s inventory, there are a large number of exchanges demand patterns; (iii) analysis of the potentially for speculative purposes. and organized trading facilities on banking entity’s business plan and Thus, a trading desk would not be which market makers may need to trade ability to win new customer business; engaged in permitted market making- to maintain liquidity across the markets (iv) evaluation of expected demand related activity if, for example, it and to provide customers with favorable under current market conditions structured a product solely to acquire a prices and that requiring registration compared to prior similar periods; (v) desired exposure and not to respond to with each exchange or other trading schedule of maturities in customers’ customer demand.943 When a trading facility may unnecessarily restrict or existing portfolios; and (vi) expected desk acquires risk exposures in these impose burdens on exchange market- market events, such as an index circumstances, the trading desk would making activities.946 rebalancing, and announcements. The be expected to enter into appropriate A banking entity is not required to Agencies believe that some banking hedging transactions or otherwise conduct the demonstrable analysis entities already analyze these and other mitigate the risks of these exposures, under § 75.4(b)(2)(B) of the final rule on relevant factors as part of their overall consistent with its hedging policies and an instrument-by-instrument basis. The risk management processes.940 procedures and risk limits. Agencies recognize that, in certain With respect to the creation and With regard to a trading desk that cases, customer demand may be for a distribution of complex structured conducts its market-making activities on particular type of exposure, and a products, a trading desk may be able to an exchange or other similar anonymous customer may be willing to trade any use the market-making exemption to trading facility, the Agencies continue one of a number of instruments that acquire some or all of the risk exposures to believe that market-making activities would provide the demanded exposure. associated with the product if the are generally consistent with reasonably Thus, an assessment of the amount, trading desk has evidence of customer expected near term customer demand types, and risks of financial instruments demand for each of the significant risks when such activities involve passively that the trading desk may hold in associated with the product.941 To have providing liquidity by submitting market-maker inventory and that would evidence of customer demand under resting orders that interact with the be designed not to exceed, on an these circumstances, there must be prior orders of others in a non-directional or ongoing basis, the reasonably expected express interest from customers in the market-neutral trading strategy or by near term demands of clients, specific risk exposures of the product. regularly responding to requests for customers, or counterparties does not Without such express interest, a trading quotes in markets where resting orders need to be made for each financial desk would not have sufficient are not generally provided. This ensures instrument in which the trading desk information to support the required that the trading desk has a pattern of acts as market maker. Instead, the amount and types of financial demonstrable analysis (e.g., information providing, rather than taking, liquidity. instruments in the trading desk’s about historical customer demand or However, this does not mean that a market-maker inventory should be other relevant factors).942 The Agencies trading desk acting as a market maker on an exchange or other similar 945 See supra notes 774 to 779 and accompanying reasonable anticipation of near term demands of anonymous trading facility is only text (discussing commenters’ response to statements clients, customers, or counterparties. In particular, permitted to use these types of orders in in the proposal requiring exchange registration as if it is expected that customers will want to buy an connection with its market making- a market maker under certain circumstances). instrument in the near term, it may be appropriate related activities. The Agencies Similarly, the final rule does not establish a for the desk to acquire a long position in such presumption of compliance with the market-making instrument. If it is expected that customers will recognize that it may be appropriate for exemption based on registration as a market maker want to sell the instrument, acquiring a short a trading desk to enter market or with an exchange, as requested by a few position may be appropriate under certain marketable limit orders on an exchange commenters. See supra note 777 and accompanying circumstances. or other similar anonymous trading text. As noted above, activity that is considered 940 See supra Part VI.A.3.c.2.b.iii. See FTN; market making for purposes of this rule may not be Morgan Stanley (suggesting a standard that would facility, or to request quotes from other considered market making for purposes of other require a position to be ‘‘reasonably consistent with market participants, in connection with rules, including self-regulatory organization rules, observable customer demand patterns’’). its market making-related activities for a and vice versa. In addition, exchange requirements 941 Complex structured products can contain a variety of purposes including, among for registered market makers are subject to change combination of several different types of risks, without consideration of the impact on this rule. including, among others, market risk, credit risk, others, inventory management, Although a banking entity is not required to be an volatility risk, and prepayment risk. addressing order imbalances on an exchange-registered market maker under the final 942 In contrast, a trading desk may respond to exchange, and hedging.944 In response rule, a banking entity must be licensed or registered requests for customized transactions, such as to comments, the Agencies are not to engage in market making-related activities in custom swaps, provided that the trading desk is a accordance with applicable law. For example, a market maker in the risk exposures underlying the banking entity would be required to be an SEC- swap or can hedge the underlying risk exposures, underlying exposures. See supra Part registered broker-dealer to engage in market consistent with its financial exposure and hedging VI.A.3.c.1.c.iii. making-related activities in securities in the U.S. limits, and otherwise meets the requirements of the 943 See, e.g., Sens. Merkley & Levin (Feb. 2012). unless the banking entity is exempt from market-making exemption. For example, a trading 944 The Agencies are clarifying this point in registration or excluded from regulation as a dealer desk may routinely make markets in underlying response to commenters who expressed concern under the Exchange Act. See infra Part VI.A.3.c.6.; exposures and, thus, would meet the requirements that the proposal would prevent an exchange final rule § 75.4(b)(2)(vi). for engaging in transactions in derivatives that market maker from using market or marketable limit 946 See SIFMA et al. (Prop. Trading) (Feb. 2012); reflect the same exposures. Alternatively, a trading orders under these circumstances. See, e.g., NYSE Goldman (Prop. Trading) (noting that there are more desk might meet the requirements by routinely Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); than 12 exchanges and 40 alternative trading trading in the derivative and hedging in the Goldman (Prop. Trading); RBC. systems currently trading U.S. equities).

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consistent with the types of financial Sensitivities’’ or ‘‘Value-at-Risk and requirements of the market-making instruments in which the desk makes a Stress Value-at-Risk’’ metrics are exemption.951 market and the amount and types of demonstrably ineffective for measuring b. Comments on the Proposed such instruments that the desk’s and monitoring the risks of a trading Compliance Program Requirement customers are reasonably expected to be desk based on the types of positions interested in trading. traded by, and risk exposures of, that A few commenters supported the In response to commenters’ concern desk.948 The Agencies believe that these proposed requirement that a banking that banking entities may be subject to metrics can be useful for measuring and entity establish a compliance program regulatory sanctions if reasonably managing many types of positions and under § 75.20 of the proposed rule as expected customer demand does not trading activities and therefore can be effective.952 For example, one materialize,947 the Agencies recognize useful in establishing a minimum set of commenter stated that the requirement that predicting the reasonably expected metrics for which limits should be ‘‘keeps a strong focus on the bank’s own near term demands of clients, applied.949 workings and allows banks to self- customers, or counterparties is As this requirement applies on an monitor.’’ 953 One commenter indicated inherently subject to changes based on ongoing basis, a trade in excess of one that a comprehensive compliance market and other factors that are or more limits set for a trading desk program is a ‘‘cornerstone of effective difficult to predict with certainty. Thus, should not be permitted simply because corporate governance,’’ but cautioned there may at times be differences it responds to customer demand. Rather, against placing ‘‘undue reliance’’ on between predicted demand and actual a banking entity’s compliance program compliance programs.954 As discussed demand from clients, customers, or must include escalation procedures that further below in Parts VI.C.1. and counterparties. However, assessments of require review and approval of any VI.C.3., many commenters expressed expected near term demand may not be trade that would exceed one or more of concern about the potential burdens of reasonable if, in the aggregate and over a trading desk’s limits, demonstrable the proposed rule’s compliance program longer periods of time, a trading desk analysis that the basis for any temporary requirement, as well as the proposed exhibits a repeated pattern or practice of or permanent increase to one or more of requirement regarding quantitative significant variation in the amount, a trading desk’s limits is consistent with measurements. According to one types, and risks of financial instruments the requirements of this near term commenter, the compliance burdens in its market-maker inventory in excess demand requirement and with the associated with these requirements may of what is needed to facilitate near term prudent management of risk by the dissuade a banking entity from customer demand. banking entity, and independent review attempting to comply with the market- iv. Relationship to Required Limits of such demonstrable analysis and making exemption.955 approval.950 As discussed further below, a banking The Agencies expect that a c. Final Compliance Program entity must establish limits for each trading desk’s escalation procedures Requirement trading desk on the amount, types, and will generally explain the circumstances under which a trading desk’s limits can Similar to the proposed exemption, risks of its market-maker inventory, the market-making exemption adopted level of exposures to relevant risk be increased, either temporarily or permanently, and that such increases in the final rule requires that a banking factors arising from its financial entity establish and implement, exposure, and period of time a financial must be consistent with reasonably expected near term demands of the maintain, and enforce an internal instrument may be held by a trading compliance program required by desk. These limits must be reasonably desk’s clients, customers, or counterparties and the amount and type subpart D that is reasonably designed to designed to ensure compliance with the ensure the banking entity’s compliance market-making exemption, including of risks to which the trading desk is authorized to be exposed. with the requirements of the market- the near term customer demand making exemption, including requirement, and must take into account 3. Compliance Program Requirement reasonably designed written policies the nature and amount of the trading a. Proposed Compliance Program and procedures, internal controls, desk’s market making-related activities. Requirement analysis, and independent testing.956 Thus, the limits should account for and This provision further requires that the To ensure that a banking entity generally be consistent with the compliance program include particular relying on the market-making historical near term demands of the written policies and procedures, exemption had an appropriate desk’s clients, customers, or internal controls, analysis, and framework in place to support its counterparties and the amount, types, independent testing identifying and compliance with the exemption, and risks of financial instruments that addressing: § 75.4(b)(2)(i) of the proposed rule the trading desk has historically held in • The financial instruments each required a banking entity to establish an market-maker inventory to meet such trading desk stands ready to purchase internal compliance program, as demands. In addition to the limits that and sell as a market maker; required by subpart D of the proposal, a trading desk selects in managing its • The actions the trading desk will designed to ensure compliance with the positions to ensure compliance with the take to demonstrably reduce or market-making exemption set out in 948 See Appendix A. § 75.4(b), the Agencies are requiring, for 951 See proposed rule § 75.4(b)(2)(i); Joint 949 The Agencies recognize that for some types of banking entities that must report metrics Proposal, 76 FR at 68870; CFTC Proposal, 77 FR at positions or trading strategies, the use of ‘‘Risk 8355. in Appendix A, such limits include, at Factor Sensitivities’’ and ‘‘Value-at-Risk and Stress 952 a minimum, ‘‘Risk Factor Sensitivities’’ Value-at-Risk’’ metrics may be ineffective and See Flynn & Fusselman; Morgan Stanley. and ‘‘Value-at-Risk and Stress Value-at- accordingly limits do not need to be set for those 953 See Flynn & Fusselman. 954 Risk’’ metrics as limits, except to the metrics if such ineffectiveness is demonstrated by See Occupy. the banking entity. 955 See ICI (Feb. 2012). extent any of the ‘‘Risk Factor 950 See final rule § 75.4(b)(2)(iii); infra Part 956 The independent testing standard is discussed VI.A.3.c.3.c. (discussing the meaning of in more detail in Part VI.C., which discusses the 947 See RBC; CIEBA; Wellington; ICI (Feb. 2012) ‘‘independent’’ review for purposes of this compliance program requirement in § 75.20 of the Invesco. requirement). final rule.

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otherwise significantly mitigate with the exemption.958 Banking entities trader on a market-making desk from promptly the risks of its financial should note that these compliance establishing positions in instruments exposure consistent with the required procedures must be established, that are unrelated to the desk’s market- limits; the products, instruments, and implemented, maintained, and enforced making function. Further, this exposures each trading desk may use for for each trading desk engaged in market identification of instruments helps form risk management purposes; the making-related activities under the final the basis for the specific types of techniques and strategies each trading rule. Each of the requirements in inventory and risk limits that the desk may use to manage the risks of its paragraphs (b)(2)(iii)(A) through (E) banking entity must establish and is market making-related activities and must be appropriately tailored to the relevant to considerations throughout inventory; and the process, strategies, individual trading activities and the exemption regarding the liquidity, and personnel responsible for ensuring strategies of each trading desk on an depth, and maturity of the market for that the actions taken by the trading ongoing basis. the relevant type of financial desk to mitigate these risks are and As a threshold issue, the compliance instrument. The Agencies note that a continue to be effective; program must identify the products, banking entity should be able to • Limits for each trading desk, based instruments, and exposures the trading demonstrate the relationship between on the nature and amount of the trading desk may trade as market maker or for the instruments in which a trading desk desk’s market making-related activities, risk management purposes.959 may act as market maker and the that address the factors prescribed by Identifying the relevant instruments in instruments the desk may use to manage the near term customer demand which a trading desk is permitted to the risk of its market making-related requirement of the final rule, on: trade will facilitate monitoring and activities and inventory and why the Æ The amount, types, and risks of its oversight of compliance with the instruments the desk may use to manage market-maker inventory; exemption by preventing an individual its risk appropriately and effectively Æ The amount, types, and risks of the mitigate the risk of its market making- 958 products, instruments, and exposures The Agencies note that a number of related activities without generating an commenters requested that the Agencies place a entirely new set of risks that outweigh the trading desk uses for risk greater emphasis on inventory limits and risk limits management purposes; in the final exemption. See, e.g., Citigroup the risks that are being hedged. Æ Level of exposures to relevant risk (suggesting that the market-making exemption The final rule provides that a banking factors arising from its financial utilize risk limits that would be set for each trading entity must establish an appropriate risk unit based on expected levels of customer trading— management framework for each of its exposure; and estimated by looking to historical results, target Æ product and customer lists, and target market trading desks that rely on the market- Period of time a financial 960 instrument may be held; share—and an appropriate amount of required making exemption. This includes not inventory to support that level of customer trading); only the techniques and strategies that • Internal controls and ongoing Prof. Colesanti et al. (suggesting that the exemption a trading desk may use to manage its monitoring and analysis of each trading include, among other things, a bright-line threshold risk exposures, but also the actions the desk’s compliance with its required of the amount of risk that can be retained (which trading desk will take to demonstrably limits; and cannot be in excess of the size and type required for market making), positions limits, and limits on reduce or otherwise significantly • Authorization procedures, holding periods); Sens. Merkley & Levin (Feb. 2012) mitigate promptly the risks of its including escalation procedures that (suggesting the use of specific parameters for financial exposures consistent with its require review and approval of any inventory levels, along with a number of other required limits, which are discussed in trade that would exceed a trading desk’s criteria, to establish a safe harbor); SIFMA et al. (Prop. Trading) (Feb. 2012) (recommending the use more detail below. While the Agencies limit(s), demonstrable analysis that the of risk limits in combination with a guidance-based do not expect a trading desk to hedge all basis for any temporary or permanent approach); Japanese Bankers Ass’n. (suggesting that of the risks that arise from its market increase to a trading desk’s limit(s) is the rule set risk allowances for market making- related activities based on required capital for such consistent with the requirements of activities). The Agencies are not establishing 960 This standard addresses issues raised by § 75.4(b)(2)(ii) of the final rule, and specific limits in the final rule, as some commenters commenters concerning: certain language in independent review (i.e., by risk appeared to recommend, in recognition of the fact proposed Appendix B regarding market making- managers and compliance officers at the that appropriate limits will differ based on a related risk management; the market making-related number of factors, including the size of the market- hedging provision in § 75.4(b)(3) of the proposed appropriate level independent of the making operation and the liquidity, depth, and rule; and, to some extent, the proposed source of trading desk) of such demonstrable maturity of the market for the particular type(s) of revenue requirement in § 75.4(b)(2)(v) of the analysis and approval.957 financial instruments in which the trading desk is proposed rule. See Joint Proposal, 76 FR at 68960; The compliance program requirement permitted to trade. See Sens. Merkley & Levin (Feb. CFTC Proposal, 77 FR at 8439–8440; proposed rule 2012); Prof. Colesanti et al. However, banking § 75.4(b)(3); Joint Proposal, 76 FR at 68873; CFTC in the proposed market-making entities relying on the market-making exemption Proposal, 77 FR at 8358; Wellington; Credit Suisse exemption did not include specific must set limits and demonstrate how the specific (Seidel); Morgan Stanley; PUC Texas; CIEBA; SSgA references to all the compliance limits and limit methodologies they have chosen (Feb. 2012); AllianceBernstein; Investure; Invesco; program elements now listed in the final are reasonably designed to limit the amount, types, Japanese Bankers Ass’n.; SIFMA et al. (Prop. and risks of the financial instruments in a trading Trading) (Feb. 2012); FTN; RBC; NYSE Euronext; rule. Instead, these elements were desk’s market-maker inventory consistent with the MFA. As discussed in more detail above, a number generally included in the compliance reasonably expected near term demands of the of commenters emphasized that market making- requirements of Appendix C of the banking entity’s clients, customers, and related activities necessarily involve a certain proposed rule. The Agencies are moving counterparties, subject to the market and conditions amount of risk-taking to provide ‘‘immediacy’’ to discussed above, and to commensurately control customers. See, e.g., Prof. Duffie; Morgan Stanley; certain of these requirements into the the desk’s overall financial exposure. SIFMA et al. (Prop. Trading) (Feb. 2012). market-making exemption to ensure that 959 See final rule § 75.4(b)(2)(iii)(A) (requiring Commenters also represented that the amount of critical components are made part of the written policies and procedures, internal controls, risk a market maker needs to retain may differ compliance program for market making- analysis, and independent testing regarding the across asset classes and markets. See, e.g., Morgan financial instruments each trading desk stands Stanley; Credit Suisse (Seidel). The Agencies related activities. Further, placing these ready to purchase and sell in accordance with believe that the requirement we are adopting better requirements within the market-making § 75.4(b)(2)(i) of the final rule); final rule recognizes that appropriate risk management will exemption emphasizes the important § 75.4(b)(2)(iii)(B) (requiring written policies and tailor acceptable position, risk and inventory limits role they play in overall compliance procedures, internal controls, analysis, and based on the type(s) of financial instruments in independent testing regarding the products, which the trading desk is permitted to trade and the instruments, or exposures each trading desk may liquidity, maturity, and depth of the market for the 957 See final rule § 75.4(b)(2)(iii). use for risk management purposes). relevant type of financial instrument.

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making-related activities, the Agencies inventory by adjusting the amount or making risk management policies and do expect each trading desk to take types of financial instruments in its procedures. appropriate steps consistent with inventory as well as taking steps A banking entity’s written policies market-making activities to contain and otherwise to mitigate the risk associated and procedures, internal controls, limit risk exposures (such as by with its inventory. analysis, and independent testing The Agencies recognize that, to unwinding unneeded positions) and to identifying and addressing the products, follow reasonable procedures to monitor provide effective intermediation instruments, or exposures and the the trading desk’s risk exposures (i.e., its services, a trading desk engaged in techniques and strategies that may be financial exposure) and hedge risks of permitted market making-related used by each trading desk to manage the its financial exposure to remain within activities retains a certain amount of its relevant risk limits.961 risk arising from the positions it holds risks of its market making-related As discussed in Part VI.A.3.c.4.c., in inventory and may hedge certain activities and inventory must cover both managing the risks associated with aspects of that risk. The requirements in how the trading desk may establish maintaining a market-maker inventory the final rule establish controls around hedges and how such hedges are that is appropriate to meet the a trading desk’s risk management removed once the risk they were reasonably expected near-term demands activities, yet still recognize that a mitigating is unwound. With respect to of customers is an important part of trading desk engaged in market making- establishing positions that hedge or market making.962 The Agencies related activities may retain a certain otherwise mitigate the risk(s) of market understand that, in the context of amount of risk in meeting the making-related positions held by the market-making activities, inventory reasonably expected near term demands trading desk, the written policies and management includes adjustment of the of clients, customers, or counterparties. procedures may consider the natural amount and types of market-maker As the Agencies noted in the proposal, hedging and diversification that occurs inventory to meet the reasonably where the purpose of a transaction is to in an aggregation of long and short expected near term demands of hedge a market making-related position, positions in financial instruments for customers.963 Adjustments of the size it would appear to be market making- which the trading desk is a market and types of a financial exposure are related activity of the type described in maker,967 as it documents its specific also made to reduce or mitigate the risks section 13(d)(1)(B) of the BHC Act.965 risk-mitigating strategies that use associated with financial instruments The Agencies emphasize that the only instruments for which the desk is a held as part of a trading desk’s market- risk management activities that qualify market maker or instruments for which maker inventory. A common strategy in for the market-making exemption—and the desk is not a market maker. Further, market making is to establish market- that are not subject to the hedging the written policies and procedures maker inventory in anticipation of exemption—are risk management identifying and addressing permissible reasonably expected customer needs activities conducted or directed by the hedging techniques and strategies must and then to reduce that market-maker trading desk in connection with its address the circumstances under which inventory over time as customer market making-related activities and in the trading desk may be permitted to demand materializes.964 If customer conformance with the trading desk’s engage in anticipatory hedging. Like the demand does not materialize, the risk management policies and proposed rule’s hedging exemption, a market maker addresses the risks procedures.966 A trading desk engaged trading desk may establish an associated with its market-maker in market making-related activities anticipatory hedge position before it would be required to comply with the becomes exposed to a risk that it is 961 It may be more efficient for a banking entity hedging exemption or another available highly likely to become exposed to, to manage some risks at a higher organizational exemption for any risk management or level than the trading desk level. As a result, a provided there is a sound risk banking entity’s written policies and procedures other activity that is not in conformance management rationale for establishing may delegate the responsibility to mitigate specific with the trading desk’s required market- such an anticipatory hedge position.968 risks of the trading desk’s financial exposure to an For example, a trading desk may hedge entity other than the trading desk, including 965 See Joint Proposal, 76 FR at 68873; CFTC against specific positions promised to another organizational unit of the banking entity or Proposal, 77 FR at 8358. of an affiliate, provided that such organizational 966 As discussed above, if a trading desk operating customers, such as volume-weighted unit of the banking entity or of an affiliate is under the market-making exemption directs a average price (‘‘VWAP’’) orders or large identified in the banking entity’s written policies different organizational unit of the banking entity block trades, to facilitate the customer and procedures. Under these circumstances, the or an affiliate to establish a hedge position on the trade.969 The amount of time that an other organizational unit of the banking entity or of desk’s behalf, then the other organizational unit an affiliate must conduct such hedging activity in may rely on the market-making exemption to anticipatory hedge may precede the accordance with the requirements of the hedging establish the hedge position as long as: (i) The other establishment of the position to be exemption in § 75.5 of the final rule, including the organizational unit’s hedging activity is consistent hedged will depend on market factors, documentation requirement in § 75.5(c). As with the trading desk’s risk management policies recognized in Part VI.A.4.d.4., hedging activity and procedures (e.g., the hedge instrument, conducted by a different organizational unit than technique, and strategy are consistent with those 967 For example, this may occur if a U.S. the unit responsible for the positions being hedged identified in the trading desk’s policies and corporate bond trading desk acquires a $100 million presents a greater risk of evasion. Further, the risks procedures); and (ii) the hedge position is attributed long position in the corporate bonds of one issuer being managed by a higher organizational level than to the financial exposure of the trading desk and is from clients, customers, or counterparties and the trading desk may be generated by trading desks included in the trading desk’s daily profit and loss. separately acquires a $50 million short position in engaged in market making-related activity or by If a different organizational unit of the banking another issuer in the same market sector in trading desks engaged in other permitted activities. entity or of an affiliate establishes a hedge for the reasonable expectation of near term demand of Thus, it would be inappropriate for such hedging trading desk’s financial exposure based on its own clients, customers, or counterparties. Although both activity to be conducted in reliance on the market- determination, or if such position was not positions were acquired to facilitate customer making exemption. established in accordance with the trading desk’s demand, the positions may also naturally hedge 962 See supra Part VI.A.3.c.2.c. (discussing the required procedures or was included in that other each other, to some extent. final near term demand requirement). organizational unit’s financial exposure and/or 968 See Joint Proposal, 76 FR at 68875; CFTC 963 See, e.g., SIFMA et al. (Prop. Trading) (Feb. daily profit and loss, then that hedge position must Proposal, 77 FR at 8361. 2012); Credit Suisse (Seidel); Goldman (Prop. be established in compliance with the hedging 969 Two commenters recommended that banking Trading); MFA; RBC. exemption in § 75.5 of the rule, including the entities be permitted to establish hedges prior to 964 See, e.g., BoA; SIFMA et al. (Prop. Trading) documentation requirement in § 75.5(c). See supra acquiring the underlying risk exposure under these (Feb. 2012); Chamber (Feb. 2012). Part VI.A.3.c.1.c.ii. circumstances. See Credit Suisse (Seidel); BoA.

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such as the liquidity of the hedging position can only contain positions, policies and procedures, internal position. risks, and exposures related to the controls, analysis, and independent Written policies and procedures, market-maker inventory that are testing identifying and addressing internal controls, analysis, and designed to meet current or near term specific limits on a trading desk’s independent testing established customer demand and positions, risks market-maker inventory, risk pursuant to the final rule identifying and exposures designed to mitigate the management positions, and financial and addressing permissible hedging risks in accordance with the limits exposure. In particular, the compliance techniques and strategies should be previously established for the trading program must establish limits for each designed to prevent a trading desk from desk. trading desk, based on the nature and over-hedging its market-maker The written policies and procedures amount of its market making-related inventory or financial exposure. Over- identifying and addressing a trading activities (including the factors hedging would occur if, for example, a desk’s hedging techniques and strategies prescribed by the near term customer trading desk established a position in a also must describe how and under what demand requirement), on the amount, financial instrument for the purported timeframe a trading desk must remove types, and risks of its market-maker purpose of reducing a risk associated hedge positions once the underlying inventory, the amount, types, and risks with one or more market-making risk exposure is unwound. Similarly, of the products, instruments, and positions when, in fact, that risk had the compliance program established by exposures the trading desk may use for already been mitigated to the full extent the banking entity to specify and control risk management purposes, the level of possible. Over-hedging results in a new the trading desk’s hedging activities in exposures to relevant risk factors arising risk exposure that is unrelated to accordance with the final rule must be from its financial exposure, and the market-making activities and, thus, is designed to prevent a trading desk from period of time a financial instrument not permitted under the market-making purposefully or inadvertently may be held.971 The limits would be set, exemption. transforming its positions taken to as appropriate, and supported by an A trading desk’s financial exposure manage the risk of its market-maker analysis for specific types of financial generally would not be considered to be inventory under the exemption into instruments, levels of risk, and duration consistent with market making-related what would otherwise be considered of holdings, which would also be activities to the extent the trading desk prohibited proprietary trading. required by the compliance appendix. is engaged in hedging activities that are Moreover, the compliance program This approach will build on existing inconsistent with the management of must provide for the process and risk management infrastructure for identifiable risks in its market-maker personnel responsible for ensuring that market-making activities that subject inventory or maintains significant hedge the actions taken by the trading desk to traders to a variety of internal, positions after the underlying risk(s) of mitigate the risks of its market making- predefined limits.972 Each of these the market-maker inventory have been related activities and inventory— limits is independent of the others, and unwound. A banking entity’s written including the instruments, techniques, a trading desk must maintain its policies and procedures, internal and strategies used for risk management aggregated market-making position controls, analysis, and independent purposes—are and continue to be within each of these limits, including by testing regarding the trading desk’s effective. This includes ensuring that taking action to bring the trading desk permissible hedging techniques and hedges taken in the context of market into compliance with the limits as strategies must be designed to prevent a making-related activities continue to be promptly as possible after the limit is trading desk from engaging in over- effective and that positions taken to exceeded.973 For example, if changing hedging or maintaining hedge positions manage the risks of the trading desk’s market conditions cause an increase in after they are no longer needed.970 market-maker inventory are not one or more risks within the trading Further, the compliance program must purposefully or inadvertently desk’s financial exposure and that provide for the process and personnel transformed into what would otherwise increased risk causes the desk to exceed responsible for ensuring that the actions be considered prohibited proprietary one or more of its limits, the trading taken by the trading desk to mitigate the trading. If a banking entity’s monitoring desk must take prompt action to reduce risks of its market making-related procedures find that a trading desk’s its risk exposure (either by hedging the activities are and continue to be risk management procedures are not risk or unwinding its existing positions) effective, which would include effective, such deficiencies must be or receive approval of a temporary or monitoring for and addressing any promptly escalated and remedied in permanent increase to its limit through scenarios where a trading desk may be accordance with the banking entity’s the required escalation procedures. engaged in over-hedging or maintaining escalation procedures. A banking The Agencies recognize that trading unnecessary hedge positions or new entity’s written policies and procedures desks’ limits will differ across asset significant risks have been introduced must set forth the process for classes and acknowledge that trading by the hedging activity. determining the circumstances under desks engaged in market making-related As a result of these limitations, the which a trading desk’s risk management activities in less liquid asset classes, size and risks of the trading desk’s strategies may be modified. In addition, such as corporate bonds, certain hedging positions are naturally risk management techniques and derivatives, and securitized products, constrained by the size and risks of its strategies developed and used by a may require different inventory, risk market-maker inventory, which must be trading desk must be independently exposure, and holding period limits designed not to exceed the reasonably tested or verified by management than trading desks engaged in market expected near term demands of clients, separate from the trading desk. customers, or counterparties, as well as To control and limit the amount and 971 See final rule § 75.4(b)(2)(iii)(C). by the risk limits and controls types of financial instruments and risks 972 See, e.g., Citigroup (Feb. 2012) (noting that its established under the final rule. This that a trading desk may hold in suggested approach to implementing the market- ultimately constrains a trading desk’s connection with its market making- making exemption, which would focus on risk limits and risk architecture, would build on existing overall financial exposure since such related activities, a banking entity must risk limits and risk management systems already establish, implement, maintain, and present in institutions). 970 See final rule § 75.4(b)(2)(iii)(B). enforce reasonably designed written 973 See final rule § 75.4(b)(2)(iv).

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making-related activities in more liquid the near term demand requirement experiences reduced customer demand financial instruments, such as certain because they must be designed to over a period of time, that trading desk’s listed equity securities. Moreover, the manage the risks of the market-maker limits should be decreased to address types of risk factors for which limits are inventory in accordance with the desk’s the factors prescribed by the near term established should not be limited solely risk management procedures. As a demand requirement. to market risk factors. Instead, such result, the trading desk’s risk A banking entity’s compliance limits should also account for all risk management positions and aggregate program must also include escalation factors that arise from the types of financial exposure are also limited by procedures that require review and financial instruments in which the the current and reasonably expected approval of any trade that would exceed trading desk is permitted to trade. In near term demands of customers. A one or more of a trading desk’s limits, addition, these limits should be trading desk’s market-maker inventory, demonstrable analysis that the basis for sufficiently granular and focused on the risk management positions, or financial any temporary or permanent increase to particular types of financial instruments exposure would not, however, be one or more of a trading desk’s limits is in which the desk may trade. For permissible under the market-making consistent with the near term customer example, a trading desk that makes a exemption merely because the market- demand requirement, and independent market in derivatives would have maker inventory, risk management review of such demonstrable analysis exposures to counterparty risk, among positions, or financial exposure happens and approval of any increase to one or others, and would need to have to be within the desk’s prescribed more of a trading desk’s limits.978 Thus, appropriate limits on such risk. Other limits.975 in order to increase a limit of a trading types of limits that may be relevant for In addition, a banking entity must desk—on either a temporary or a trading desk include, among others, establish internal controls and ongoing permanent basis—there must be an position limits, sector limits, and monitoring and analysis of each trading analysis of why such increase would be geographic limits. desk’s compliance with its limits, appropriate based on the reasonably A banking entity must have a including the frequency, nature, and expected near term demands of clients, reasonable basis for the limits it extent of a trading desk exceeding its customers, or counterparties, including establishes for a trading desk and must limits and patterns regarding the the factors identified in § 75.4(b)(2)(ii) of have a robust procedure for analyzing, portions of the trading desk’s limits that the final rule, which must be establishing, and monitoring limits, as are accounted for by the trading desk’s independently reviewed. A banking well as appropriate escalation activity.976 This may include the use of entity also must maintain procedures.974 Among other things, the management and exception reports. documentation and records with respect banking entity’s compliance program Moreover, the compliance program must to these elements, consistent with the must provide for: (i) Written policies set forth a process for determining the requirement of § 75.20(b)(6). and procedures and internal controls circumstances under which a trading As already discussed, commenters establishing and monitoring specific desk’s limits may be modified on a have represented that the compliance limits for each trading desk; and (ii) temporary or permanent basis (e.g., due costs associated with the proposed rule, analysis regarding how and why these to market changes or modifications to including the compliance program and limits are determined to be appropriate the trading desk’s strategy).977 This metrics requirements, may be significant and consistent with the nature and process must cover potential scenarios and ‘‘may dissuade a banking entity amount of the desk’s market making- when a trading desk’s limits should be from attempting to comply with the related activities, including raised, as well as potential scenarios market making-related activities considerations related to the near term when a trading desk’s limits should be exemption.’’ 979 The Agencies believe customer demand requirement. In lowered. For example, if a trading desk that a robust compliance program is making these determinations, a banking necessary to ensure adherence to the entity should take into account and be 975 For example, if a U.S. corporate bond trading rule and to prevent evasion, although, as consistent with the type(s) of financial desk has a prescribed limit of $200 million net discussed in Part VI.C.3., the Agencies exposure to any single sector of related issuers, the are adopting a more tailored set of instruments the desk is permitted to desk’s limits may permit it to acquire a net trade, the desk’s trading and risk economic exposure of $400 million long to issuer quantitative measurements to better management activities and strategies, ABC and a net economic exposure of $300 million focus on those that are most germane to the history and experience of the desk, short to issuer XYZ, where ABC and XYZ are in the evaluating market making-related same sector. This is because the trading desk’s net activity. The Agencies acknowledge that and the historical profile of the desk’s exposure to the sector would only be $100 million, near term customer demand and market which is within its limits. Even though the net the compliance program requirements and other factors that may impact the exposure to this sector is within the trading desk’s for the market-making exemption, reasonably expected near term demands prescribed limits, the desk would still need to be including reasonably designed written able to demonstrate how its net exposure of $400 of customers. million long to issuer ABC and $300 million short policies and procedures, internal The limits established by a banking to issuer XYZ is related to customer demand. controls, analysis, and independent entity should generally reflect the 976 See final rule § 75.4(b)(2)(iii)(D). testing, represent a new regulatory amount and types of inventory and risk 977 For example, a banking entity may determine requirement for banking entities and the that a trading desk holds to meet the to permit temporary, short-term increases to a Agencies have thus been mindful that it trading desk’s risk limits due to an increase in reasonably expected near term demands short-term credit spreads or in response to volatility may impose significant costs and may of clients, customers, or counterparties. in instruments in which the trading desk makes a cause a banking entity to reconsider As discussed above, while the trading market, provided the increased limit is consistent whether to conduct market making- desk’s market-maker inventory is with the reasonably expected near term demands of related activities. Despite the potential clients, customers, or counterparties. As noted directly limited by the reasonably above, other potential circumstances that could costs of the compliance program, the expected near term demands of warrant changes to a trading desk’s limits include: Agencies believe they are warranted to customers, the positions managed by the A change in the pattern of customer needs, ensure that the goals of the rule and trading desk outside of its market-maker adjustments to the market maker’s business model statute will be met, such as promoting (e.g., new entrants or existing market makers trying inventory are similarly constrained by to expand or contract their market share), or changes in market conditions. See supra note 937 978 See final rule § 75.4(b)(2)(iii)(E). 974 See final rule § 75.4(b)(2)(iii)(C). and accompanying text. 979 See ICI (Feb. 2012).

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the safety and soundness of banking position should be permitted as long as One commenter, however, stated that entities and the financial stability of the it is designed to mitigate the risk the proposed approach is effective.992 United States. associated with positions acquired Another commenter indicated that it is confusing to include hedging within the 4. Market Making-Related Hedging through permitted market making- related activities.984 Other commenters market-making exemption and a. Proposed Treatment of Market emphasized the need for flexibility to suggested that a market maker be Making-Related Hedging permit a market maker to choose the required to rely on the hedging In the proposal, certain hedging most effective hedge.985 In general, exemption under § 75.5 of the proposed 993 transactions related to market making these commenters expressed concern rule for its hedging activity. were considered to be made in that limitations on hedging market As noted above in the discussion of comments on the proposed source of connection with a banking entity’s making-related positions may cause a revenue requirement, a number of market making-related activity for reduction in liquidity, wider spreads, or commenters expressed concern that the purposes of the market-making increased risk and trading costs for exemption. The Agencies explained that 986 proposed rule assumed that there are market makers. For example, one effective, or perfect, hedges for all where the purpose of a transaction is to commenter stated that ‘‘[t]he ability of hedge a market making-related position, market making-related positions.994 market makers to freely offset or hedge Another commenter stated that market it would appear to be market making- positions is what, in most cases, makes related activity of the type described in makers should be required to hedge them willing to buy and sell [financial section 13(d)(1)(B) of the BHC Act.980 whenever an inventory imbalance instruments] to and from customers, To qualify for the market-making arises, and the absence of a hedge in clients or counterparties,’’ so ‘‘[a]ny exemption, a hedging transaction would such circumstances may evidence have been required to meet certain impediment to hedging market making- prohibited proprietary trading.995 requirements under § 75.4(b)(3) of the related positions will decrease the willingness of banking entities to make c. Treatment of Market Making-Related proposed rule. This provision required Hedging in the Final Rule that the purchase or sale of a financial markets and, accordingly, reduce instrument: (i) Be conducted to reduce liquidity in the marketplace.’’ 987 Unlike the proposed rule, the final rule does not require that market the specific risks to the banking entity In addition, some commenters making-related hedging activities in connection with and related to expressed concern that certain individual or aggregated positions, separately comply with the requirements in the proposed hedging requirements found in the risk- contracts, or other holdings acquired exemption may result in a reduction in pursuant to the market-making mitigating hedging exemption if market-making activities under certain conducted or directed by the same exemption; and (ii) meet the criteria circumstances.988 For example, one specified in § 75.5(b) of the proposed trading desk conducting the market- commenter expressed concern that the making activity. Instead, the Agencies hedging exemption and, where proposed hedging exemption would applicable, § 75.5(c) of the proposal.981 are including requirements for market require a banking entity to identify and making-related hedging activities within In the proposal, the Agencies noted that tag hedging transactions when hedges in a market maker may often make a the market-making exemption in a particular asset class take place 996 market in one type of financial response to comments. As discussed alongside a trading desk’s customer flow above, a trading desk’s compliance instrument and hedge its activities using trading and inventory management in different financial instruments in which program must include written policies that same asset class.989 Further, a few and procedures, internal controls, it does not make a market. The Agencies commenters represented that the stated that this type of hedging independent testing and analysis proposed reasonable correlation transaction would meet the terms of the identifying and addressing the products, requirement in the hedging exemption market-making exemption if the hedging instruments, exposures, techniques, and could impact market making by transaction met the requirements of strategies a trading desk may use to discouraging market makers from § 75.4(b)(3) of the proposed rule.982 manage the risks of its market making- entering into customer transactions that related activities, as well as the actions b. Comments on the Proposed do not have a direct hedge 990 or making the trading desk will take to Treatment of Market Making-Related it more difficult for market makers to demonstrably reduce or otherwise Hedging cost-effectively hedge the fixed income significant mitigate the risks of its Several commenters recommended securities they hold in inventory, financial exposure consistent with its that the proposed market-making including hedging such inventory required limits.997 The Agencies believe exemption be modified to establish a positions on a portfolio basis.991 this approach addresses commenters’ more permissive standard for market concerns that limitations on hedging maker hedging.983 A few of these 984 See SIFMA et al. (Prop. Trading) (Feb. 2012); market making-related positions may commenters stated that, rather than RBC. See also FTN (stating that the principal cause a reduction in liquidity, wider applying the standards of the risk- requirement for such hedges should be that they spreads, or increased risk and trading reduce the risk of market making). costs for market makers because it mitigating hedging exemption to market 985 See NYSE Euronext (stating that the best maker hedging, a market maker’s hedge hedge sometimes involves a variety of complex and allows banking entities to determine dynamic transactions over the time in which an 980 See Joint Proposal, 76 FR at 68873; CFTC asset is held, which may fall outside the parameters 992 See Alfred Brock. Proposal, 77 FR at 8358. of the exemption); MFA; JPMC. 993 See Occupy. 986 981 See proposed rule § 75.4(b)(3); Joint Proposal, See SIFMA et al. (Prop. Trading) (Feb. 2012); 994 See infra notes 1073 to 1075 and 76 FR at 68873; CFTC Proposal, 77 FR at 8358. Credit Suisse (Seidel); NYSE Euronext; MFA; accompanying text. Japanese Bankers Ass’n.; RBC. 982 See Joint Proposal, 76 FR at 68870 n.146; 995 See Public Citizen. 987 CFTC Proposal, 77 FR at 8356 n.152. RBC. 996 See, e.g., Japanese Bankers Ass’n.; SIFMA et 988 983 See, e.g., Japanese Bankers Ass’n.; SIFMA et See BoA; SIFMA (Asset Mgmt.) (Feb. 2012). al. (Prop. Trading) (Feb. 2012); Credit Suisse al. (Prop. Trading) (Feb. 2012); Credit Suisse 989 See Goldman (Prop. Trading). (Seidel); FTN; RBC; NYSE Euronext; MFA. (Seidel); FTN; RBC; NYSE Euronext; MFA. These 990 See BoA. 997 See final rule § 75.4(b)(2)(iii)(B); supra Part comments are addressed in Part VI.A.3.c.4.c., infra. 991 See SIFMA (Asset Mgmt.) (Feb. 2012). VI.A.3.c.3.c.

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how best to manage the risks of trading positions being hedged.1002 As removed from the rule.1007 Moreover, in desks’ market making-related activities discussed in Part VI.A.4.d.4., hedging addressing this proposed requirement, through reasonable policies and conducted by a different organizational commenters provided views on: procedures, internal controls, unit than the trading desk that is identifiable characteristics of independent testing, and analysis, responsible for the underlying positions compensation arrangements that rather than requiring compliance with presents an increased risk of evasion, so incentivize prohibited proprietary the specific requirements of the hedging the Agencies believe it is appropriate for trading,1008 methods of monitoring exemption.998 Further, this approach such hedging activity to be required to compliance with this requirement,1009 addresses commenters’ concerns about comply with the hedging exemption, and potential negative incentives or the impact of certain requirements of including the associated documentation outcomes this requirement could the hedging exemption on market requirement. cause.1010 making-related activities.999 With respect to suggested 5. Compensation Requirement The Agencies believe it is consistent modifications to this requirement, a few with the statute’s reference to ‘‘market a. Proposed Compensation Requirement commenters suggested that a market making-related’’ activities to permit Section 75.4(b)(2)(vii) of the proposed maker’s compensation should be subject market making-related hedging to additional limitations.1011 For activities under this exemption. In market-making exemption would have required that the compensation example, two commenters stated that addition, the Agencies believe it is compensation should be restricted to appropriate to require a trading desk to arrangements of persons performing market making-related activities at the particular sources, such as fees, appropriately manage its risks, commissions, and spreads.1012 One consistent with its risk management banking entity be designed not to 1003 commenter suggested that compensation procedures and limits, because reward proprietary risk-taking. In the proposal, the Agencies noted that should not be symmetrical between management of risk is a key factor that gains and losses and, further, that distinguishes permitted market making- activities for which a banking entity has established a compensation incentive trading gains reflecting an unusually related activity from impermissible high variance in position values should proprietary trading. As noted in the structure that rewards speculation in, and appreciation of, the market value of either not be reflected in compensation proposal, while ‘‘a market maker and bonuses or should be less reflected attempts to eliminate some [of the risks a financial instrument position held in 1013 inventory, rather than success in than other gains and losses. Another arising from] its retained principal commenter recommended that the positions and risks by hedging or providing effective and timely intermediation and liquidity services to Agencies remove ‘‘designed’’ from the otherwise managing those risks [ ], a rule text and provide greater clarity proprietary trader seeks to capitalize on customers, would be inconsistent with the proposed market-making exemption. about how a banking entity’s those risks, and generally only hedges or compensation regime must be The Agencies stated that under the manages a portion of those risks when structured.1014 Moreover, a number of proposed rule, a banking entity relying doing so would improve the potential commenters stated that compensation 1000 on the market-making exemption should profitability of the risk it retains.’’ should be vested for a period of time, The Agencies recognize that some provide compensation incentives that such as until the trader’s market making banking entities may manage the risks primarily reward customer revenues positions have been fully unwound and associated with market making at a and effective customer service, not are no longer in the banking entity’s different level than the individual proprietary risk-taking. However, the inventory.1015 As one commenter trading desk.1001 While this risk Agencies noted that a banking entity explained, such a requirement would management activity is not permitted relying on the proposed market-making discourage traders from carrying under the market-making exemption, it exemption would be able to inventory and encourage them to get out may be permitted under the hedging appropriately take into account of positions as soon as possible.1016 exemption, provided the requirements revenues resulting from movements in Some commenters also recommended of that exemption are met. Thus, the the price of principal positions to the that compensation be risk adjusted.1017 Agencies believe banking entities will extent that such revenues reflect the continue to have options available that effectiveness with which personnel 1007 allow them to efficiently hedge the risks See Japanese Bankers Ass’n. have managed principal risk 1008 See Occupy. arising from their market-making 1004 retained. 1009 See Occupy; Goldman (Prop. Trading). operations. Nevertheless, the Agencies b. Comments Regarding the Proposed 1010 See AllianceBernstein; Prof. Duffie; Investure; understand that this rule will result in STANY; Chamber (Dec. 2011). additional documentation or other Compensation Requirement 1011 See Better Markets (Feb. 2012); Public potential burdens for market making- Several commenters recommended Citizen; AFR et al. (Feb. 2012); Occupy; John Reed; related hedging activity that is not AFR et al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof. certain revisions to the proposed Duffie; Sens. Merkley & Levin (Feb. 2012). These conducted by the trading desk compensation requirement.1005 Two comments are addressed in note 1032, infra. responsible for the market-making commenters stated that the proposed 1012 See Better Markets (Feb. 2012); Public requirement is effective,1006 while one Citizen. 998 See SIFMA et al. (Prop. Trading) (Feb. 2012); commenter stated that it should be 1013 See AFR et al. (Feb. 2012) Credit Suisse (Seidel); NYSE Euronext; MFA; 1014 See Occupy. Japanese Bankers Ass’n.; RBC. 1015 See John Reed; AFR et al. (Feb. 2012); 999 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012); 1002 See final rule § 75.5(c). Johnson & Prof. Stiglitz; Prof. Duffie (‘‘A trader’s Goldman (Prop. Trading). 1003 See proposed rule § 75.4(b)(2)(vii). incentives for risk taking can be held in check by 1000 See Joint Proposal, 76 FR at 68961. 1004 See Joint Proposal, 76 FR at 68872; CFTC vesting incentive-based compensation over a 1001 See, e.g., letter from JPMC (stating that, to Proposal, 77 FR at 8358. substantial period of time. Pending compensation minimize risk management costs, firms commonly 1005 See Prof. Duffie; SIFMA et al. (Prop. Trading) can thus be forfeited if a trader’s negligence causes organize their market-making activities so that risks (Feb. 2012); John Reed; Credit Suisse (Seidel); substantial losses or if his or her employer fails.’’); delivered to client-facing desks are aggregated and JPMC; Morgan Stanley; Better Markets (Feb. 2012); Sens. Merkley & Levin (Feb. 2012). passed by means of internal transactions to a single Johnson & Prof. Stiglitz; Occupy; AFR et al. (Feb. 1016 See John Reed. utility desk and suggesting this be recognized as 2012); Public Citizen. 1017 See Johnson & Prof. Stiglitz; John Reed; Sens. permitted market making-related behavior). 1006 See FTN; Alfred Brock. Merkley & Levin (Feb. 2012).

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A few commenters indicated that the their personal compensation depends reward customer revenues and effective proposed approach may be too on these factors.1026 One commenter customer service, not prohibited restrictive.1018 Two of these commenters stated that the proposed requirement proprietary trading.1032 For example, a stated that the compensation could dampen traders’ incentives and compensation plan based purely on net requirement should instead be set forth discretion and may make market makers profit and loss with no consideration for as guidance in Appendix B.1019 In less likely to accept trades involving inventory control or risk undertaken to addition, two commenters requested significant increases in risk or profit.1027 achieve those profits would not be that the Agencies clarify that Another commenter expressed the view consistent with the market-making compensation arrangements must be that profitability-based compensation exemption. designed not to reward prohibited arrangements encourage traders to proprietary risk-taking. These exercise due care because such 6. Registration Requirement commenters were concerned the arrangements create incentives to avoid a. Proposed Registration Requirement 1028 proposed approach may restrict a losses. Finally, one commenter Under § 75.4(b)(2)(iv) of the proposed banking entity’s ability to provide stated that compliance with the rule, a banking entity relying on the compensation for permitted activities, proposed requirement may be difficult market-making exemption with respect which also involve proprietary or impossible if the Agencies do not to trading in securities or certain 1020 trading. take into account the incentive-based derivatives would be required to be 1029 Two commenters discussed compensation rulemaking. appropriately registered as a securities identifiable characteristics of c. Final Compensation Requirement dealer, swap dealer, or security-based compensation arrangements that clearly swap dealer, or exempt from registration incentivize prohibited proprietary Similar to the proposed rule, the or excluded from regulation as such trading.1021 For example, one market-making exemption requires that type of dealer, under applicable commenter stated that rewarding pure the compensation arrangements of securities or commodities laws. Further, profit and loss, without consideration persons performing the banking entity’s if the banking entity was engaged in the for the risk that was assumed to capture market making-related activities, as business of a securities dealer, swap it, is an identifiable characteristic of an described in the exemption, are dealer, or security-based swap dealer arrangement that incentivizes designed not to reward or incentivize outside the United States in a manner proprietary risk-taking.1022 For purposes prohibited proprietary trading.1030 The for which no U.S. registration is of monitoring and ensuring compliance language of the final compensation required, the banking entity would be with this requirement, one commenter requirement has been modified in noted that existing Board regulations for response to comments expressing required to be subject to substantive systemically important banking entities concern about the proposed language regulation of its dealing business in the regarding ‘‘proprietary risk-taking.’’ 1031 jurisdiction in which the business is require comprehensive firm-wide 1033 policies that determine compensation. The Agencies note that the Agencies do located. This commenter stated that those not intend to preclude an employee of b. Comments on the Proposed regulations, along with appropriately a market-making desk from being Registration Requirement compensated for successful market calibrated metrics, should ensure that A few commenters stated that the making, which involves some risk- compensation arrangements are not proposed dealer registration designed to reward prohibited taking. requirement is effective.1034 However, a proprietary risk-taking.1023 For similar The Agencies continue to hold the number of commenters opposed the purposes, another commenter suggested view that activities for which a banking proposed dealer registration that compensation incentives should be entity has established a compensation requirement in whole or in part.1035 based on a metric that meaningfully incentive structure that rewards speculation in, and appreciation of, the accounts for the risk underlying 1032 Because the Agencies are not limiting a 1024 profitability. market value of a position held in market maker’s compensation to specific sources, Certain commenters expressed inventory, rather than use of that such as fees, commissions, and bid-ask spreads, as concern that the proposed inventory to successfully provide recommended by a few commenters, the Agencies compensation requirement could effective and timely intermediation and do not believe the compensation requirement in the liquidity services to customers, are final rule will incentivize market makers to widen incentivize market makers to act in a their quoted spreads or charge higher fees and way that would not be beneficial to inconsistent with permitted market commissions, as suggested by certain other customers or market liquidity.1025 For making-related activities. Although a commenters. See Better Markets (Feb. 2012); Public example, two commenters expressed banking entity relying on the market- Citizen; AllianceBernstein; Investure. In addition, making exemption may appropriately the Agencies note that an approach requiring concern that the requirement could revenue from fees, commissions, and bid-ask cause market makers to widen their take into account revenues resulting spreads to be fully distinguished from revenue from spreads or charge higher fees because from movements in the price of price appreciation can raise certain practical principal positions to the extent that difficulties, as discussed in Part VI.A.3.c.7. The Agencies also are not requiring compensation to be 1018 See SIFMA et al. (Prop. Trading) (Feb. 2012); such revenues reflect the effectiveness vested for a period of time, as recommended by JPMC; Morgan Stanley. with which personnel have managed some commenters to reduce traders’ incentives for 1019 See SIFMA et al. (Prop. Trading) (Feb. 2012); retained principal risk, a banking entity undue risk-taking. The Agencies believe the final JPMC. rule includes sufficient controls around risk-taking 1020 relying on the market-making See Morgan Stanley; SIFMA et al. (Prop. exemption should provide activity without a compensation vesting Trading) (Feb. 2012). The Agencies respond to these requirement. See John Reed; AFR et al. (Feb. 2012); comments in note 1026 and its accompanying text, compensation incentives that primarily Johnson & Prof. Stiglitz; Prof. Duffie; Sens. Merkley infra. & Levin (Feb. 2012). 1021 See Occupy; Alfred Brock. 1026 See AllianceBernstein; Investure. 1033 See proposed rule § 75.4(b)(2)(iv); Joint 1022 See Occupy. The Agencies respond to this 1027 See Prof. Duffie. Proposal, 76 FR at 68872; CFTC Proposal, 77 FR at comment in Part VI.A.3.c.5.c., infra. 1028 See STANY. 8357–8358. 1023 See Goldman (Prop. Trading). 1029 See Chamber (Dec. 2011). 1034 See Occupy; Alfred Brock. 1024 See Occupy. 1030 See final rule § 75.4(b)(2)(v). 1035 See SIFMA et al. (Prop. Trading) (Feb. 2012) 1025 See AllianceBernstein; Investure; Prof. Duffie; 1031 See Morgan Stanley; SIFMA et al. (Prop. (stating that if the requirement is not removed from STANY. This issue is addressed in note 1032, infra. Trading) (Feb. 2012). Continued

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Commenters’ primary concern with the general concern that the proposed in a foreign jurisdiction to the extent requirement appeared to be its requirement may result in the market- required by applicable foreign law. The application to market making-related making exemption being unavailable for Agencies have also simplified the activities outside of the United States market making in exchange-traded language of the proposed requirement, for which no U.S. registration is futures and options because those although the Agencies have not required.1036 For example, several markets do not have a corollary to modified the scope of the requirement commenters stated that many non-U.S. dealer registration requirements in with respect to U.S. dealer registration markets do not provide substantive securities, swaps, and security-based requirements. regulation of dealers for all asset swaps markets.1043 This provision is not intended to classes.1037 In addition, two Some commenters expressed expand the scope of licensing or commenters stated that booking entities particular concern about the provisions registration requirements under relevant may be able to rely on intra-group that would generally require registration U.S. or foreign law that are applicable exemptions under local law rather than as a swap dealer or a security-based to a banking entity engaged in market- carrying dealer registrations, or a swap dealer.1044 For example, one making activities. Instead, this provision banking entity may execute customer commenter expressed concern that these recognizes that compliance with trades through an international dealer provisions may require banking applicable law is an essential indicator but book the position in a non-dealer regulators to redundantly enforce CFTC that a banking entity is engaged in entity for capital adequacy and risk and SEC registration requirements. market-making activities.1050 For management purposes.1038 Several of Moreover, according to this commenter, example, a U.S. banking entity would be these commenters requested, at a the proposed definitions of ‘‘swap expected to be an SEC-registered dealer minimum, that the dealer registration dealer’’ and ‘‘security-based swap to rely on the market-making exemption requirement not apply to dealers in non- dealer’’ do not focus on the market for trading in securities—other than U.S. jurisdictions.1039 making core of the swap dealing exempted securities, security-based In addition, with respect to the business.1045 Another commenter stated swaps, commercial paper, bankers provisions that would generally require that incorporating the proposed acceptances, or commercial bills— a banking entity to be a form of SEC- or definitions of ‘‘swap dealer’’ and unless the banking entity is exempt CFTC-registered dealer for market- ‘‘security-based swap dealer’’ is contrary from registration or excluded from making activities in securities or to the Administrative Procedure Act.1046 regulation as a dealer.1051 Similarly, a derivatives in the United States, a few U.S. banking entity is expected to be a c. Final Registration Requirement commenters stated that these provisions CFTC-registered swap dealer or SEC- should be removed from the rule.1040 The final requirement of the market- registered security-based swap dealer to These commenters represented that making exemption provides that the rely on the market-making exemption removing these provisions would be banking entity must be licensed or for trading in swaps or security-based appropriate for several reasons. For registered to engage in market making- swaps, respectively,1052 unless the example, one commenter stated that related activity in accordance with dealer registration does not help applicable law.1047 The Agencies have 1050 In response to commenters who stated that distinguish between market making and considered comments regarding the the dealer registration requirement should be speculative trading.1041 Another removed from the rule because, among other things, dealer registration requirement in the registration as a dealer does not distinguish 1048 commenter indicated that effective proposed rule. In response to between permitted market making and market making often requires a banking comments, the Agencies have narrowed impermissible proprietary trading, the Agencies entity to trade on several exchange and the scope of the proposed requirement’s recognize that acting as a registered dealer does not platforms in a variety of markets, ensure that a banking entity is engaged in permitted application to banking entities engaged market making-related activity. See SIFMA et al. including through legal entities other in market making-related activity in (Prop. Trading) (Feb. 2012); Goldman (Prop. than SEC- or CFTC-registered dealer foreign jurisdictions.1049 Rather than Trading); Morgan Stanley; ISDA (Feb. 2012). entities.1042 One commenter expressed requiring these banking entities to be However, this requirement recognizes that registration as a dealer is an indicator of market subject to substantive regulation of their making-related activities in the circumstances in the rule, then it should only be an indicative factor dealing business in the relevant foreign which a person is legally obligated to be a registered of market making); Morgan Stanley; Goldman (Prop. dealer to act as a market maker. Trading); ISDA (Feb. 2012). jurisdiction, the final rule only require 1051 A banking entity relying on the market- 1036 See Goldman (Prop. Trading); Morgan a banking entity to be a registered dealer making exemption for transactions in security- Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. based swaps would generally be required to be a 2012); ISDA (Feb. 2012); JPMC. This issue is 1043 See CME Group. registered security-based swap dealer and would addressed in note 1044 and its accompanying text, 1044 See ISDA (Feb. 2012); SIFMA et al. (Prop. not be required to be a registered securities dealer. infra. Trading) (Feb. 2012). However, a banking entity may be required to be 1037 See Goldman (Prop. Trading); RBC; SIFMA et 1045 See ISDA (Feb. 2012). a registered securities dealer if it engages in market- al. (Prop. Trading) (Feb. 2012). 1046 See SIFMA et al. (Prop. Trading) (Feb. 2012). making transactions involving security-based swaps 1038 See JPMC; Goldman (Prop. Trading). 1047 See final rule § 75.4(b)(2)(vi). with persons that are not eligible contract 1039 See Goldman (Prop. Trading); RBC; SIFMA et 1048 See supra Part VI.A.3.c.5.b. One commenter participants. The definition of ‘‘dealer’’ in section al. (Prop. Trading) (Feb. 2012). See also Morgan expressed concern that the instruments listed in 3(a)(5) of the Exchange Act generally includes ‘‘any Stanley (requesting the addition of the phrase ‘‘to § 75.4(b)(2)(iv) of the proposed rule could be person engaged in the business of buying and the extent it is legally required to be subject to such interpreted as limiting the availability of the selling securities (not including security-based regulation’’ to the non-U.S. dealer provisions). market-making exemption to other instruments, swaps, other than security-based swaps with or for 1040 See SIFMA et al. (Prop. Trading) (Feb. 2012); such as exchange-traded futures and options. In persons that are not eligible contract participants), Goldman (Prop. Trading); Morgan Stanley; ISDA response to this comment, the Agencies note that for such person’s own account.’’ 15 U.S.C. 78c(a)(5). (Feb. 2012). Rather than remove the requirement the reference to particular instruments in To the extent, if any, that a banking entity relies entirely, one commenter recommended that the § 75.4(b)(2)(iv) was intended to reflect that trading on the market-making exemption for its trading in Agencies move the dealer registration requirement in certain types of instruments gives rise to dealer municipal securities or government securities, to proposed Appendix B, which would allow the registration requirements. This provision was not rather than the exemption in § 75.6(a) of the final Agencies to take into account the facts and intended to limit the availability of the market- rule, this provision may require the banking entity circumstances of a particular trading activity. See making exemption to certain types of financial to be registered or licensed as a municipal securities JPMC. instruments. See CME Group. dealer or government securities dealer. 1041 See SIFMA et al. (Prop. Trading) (Feb. 2012). 1049 See Goldman (Prop. Trading); RBC; SIFMA et 1052 As noted above, under certain circumstances, 1042 See Goldman (Prop. Trading). al. (Prop. Trading) (Feb. 2012); Morgan Stanley. a banking entity acting as market maker in security-

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banking entity is exempt from of the trading desk or other commenters expressed particular registration or excluded from regulation organizational unit be designed to concern about applying this as a swap dealer or security-based swap generate revenues primarily from fees, requirement to less liquid markets or to dealer.1053 In response to comments on commissions, bid/ask spreads or other facilitating large customer positions, whether this provision should generally income not attributable to appreciation where a market maker is more likely to require registration as a swap dealer or in the value of financial instrument hold inventory for a longer period of security-based swap dealer to make a positions it holds in trading accounts or time and has increased risk of potential market in swaps or security-based the hedging of such positions.1057 This price appreciation (or depreciation).1062 swaps,1054 the Agencies continue to proposed requirement was intended to Further, another commenter questioned believe that this requirement is ensure that activities conducted in how the proposed requirement would appropriate. In general, a person that is reliance on the market-making apply when unforeseen market pressure engaged in making a market in swaps or exemption demonstrate patterns of or disappearance of customer demand revenue generation and profitability security-based swaps or other activity results in a market maker holding a consistent with, and related to, the causing oneself to be commonly known particular position in inventory for intermediation and liquidity services a in the trade as a market maker in swaps longer than expected.1063 In response to or security-based swaps is required to be market maker provides to its customers, this proposed requirement, a few a registered swap dealer or registered rather than changes in the market value commenters stated that it is important security-based swap dealer, unless of the positions or risks held in for market makers to be able to hold a exempt from registration or excluded inventory.1058 certain amount of inventory to: provide from regulation as such.1055 As noted b. Comments Regarding the Proposed liquidity (particularly in the face of above, compliance with applicable law Source of Revenue Requirement is an essential indicator that a banking order imbalances and market 1064 entity is engaged in market-making As discussed in more detail below, volatility), facilitate large trades, and activities. many commenters expressed concern hedge positions acquired in the course 1065 As noted above, the Agencies have about the proposed source of revenue of market making. determined that, rather than require a requirement. These commenters raised a Several commenters expressed banking entity engaged in the business number of concerns including, among concern that the proposed source of of a securities dealer, swap dealer, or others, the proposed requirement’s revenue requirement may incentivize a security-based swap dealer outside the potential impact on a market maker’s market maker to widen its quoted inventory or on costs to customers, the United States to be subject to spreads or otherwise impose higher fees difficulty of differentiating revenues substantive regulation of its dealing to the detriment of its customers.1066 from spreads and revenues from price business in the foreign jurisdiction in For example, some commenters stated which the business is located, a banking appreciation in certain markets, and the need for market makers to be that the proposed requirement could entity’s dealing activity outside the U.S. result in a market maker having to sell should only be subject to licensing or compensated for providing 1059 a position in its inventory within an registration requirements under intermediation services. Several of these commenters requested that the artificially prescribed period of time applicable foreign law (provided no U.S. and, as a result, the market maker would registration or licensing requirements proposed source of revenue requirement be removed from the rule or modified in pay less to initially acquire the position apply to the banking entity’s activities). 1067 certain ways. Some commenters, from a customer. Other commenters As a result, this requirement will not represented that the proposed source of impact a banking entity’s ability to however, expressed support for the proposed requirement or requested that revenue requirement would compel engage in permitted market making- market makers to hedge their exposure related activities in a foreign the Agencies place greater restrictions jurisdiction that does not provide for on a banking entity’s permissible 1062 See, e.g., Morgan Stanley; BoA; BlackRock; T. substantive regulation of dealers.1056 sources of revenue under the market- making exemption.1060 Rowe Price; Goldman (Prop. Trading); NYSE 7. Source of Revenue Analysis Euronext (suggesting that principal trading by i. Potential Restrictions on Inventory, market makers in large sizes is essential in some a. Proposed Source of Revenue securities, such as an AP’s trading in ETFs); Prof. Increased Costs for Customers, and Duffie; SSgA (Feb. 2012); CIEBA; SIFMA et al. Requirement Other Changes to Market-Making (Prop. Trading) (Feb. 2012); MFA. To explain its To qualify for the market-making Services concern, one commenter stated that bid-ask spreads are useful to capture the concept of market-making exemption, the proposed rule required Many commenters stated that the revenues when a market maker is intermediating on that the market making-related activities proposed source of revenue requirement a close to real-time basis between balanced may limit a market maker’s ability to customer buying and selling interest for the same based swaps may be required to be a registered hold sufficient inventory to facilitate instrument, but such close-in-time intermediation does not occur in many large or illiquid assets, securities dealer. See supra note 1051. customer demand.1061 Several of these 1053 For example, a banking entity meeting the where demand gaps may be present for days, weeks, conditions of the de minimis exception in SEC Rule or months. See Morgan Stanley. 3a71–2 under the Exchange Act would not need to 1057 See proposed rule § 75.4(b)(2)(v). 1063 See Capital Group. be a registered security-based swap dealer to act as 1058 See Joint Proposal, 76 FR at 68872; CFTC 1064 See NYSE Euronext; CIEBA (stating that if the a market maker in security-based swaps. See 17 Proposal, 77 FR at 8358. rule discourages market makers from holding CFR 240.3a71–2. 1059 These concerns are addressed in Part inventory, there will be reduced liquidity for 1054 See ISDA (Feb. 2012); SIFMA et al. (Prop. VI.A.3.c.7.c., infra. investors and issuers). Trading) (Feb. 2012). 1060 See infra note 1103 (responding to these 1065 See NYSE Euronext. For a more in-depth 1055 See 7 U.S.C. 1a(49)(A); 15 U.S.C. comments). discussion of comments regarding the benefits of 78c(a)(71)(A). 1061 See, e.g., NYSE Euronext; SIFMA et al. (Prop. permitting market makers to hold and manage 1056 See Goldman (Prop. Trading); RBC; SIFMA et Trading) (Feb. 2012); Morgan Stanley; Goldman inventory, see Part VI.A.3.c.2.b.vi., infra. al. (Prop. Trading) (Feb. 2012); Morgan Stanley. (Prop. Trading); BoA; Citigroup (Feb. 2012); 1066 See, e.g., Wellington; CIEBA; MetLife; ACLI This is consistent with one commenter’s suggestion STANY; BlackRock; SIFMA (Asset Mgmt.) (Feb. (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. that the Agencies add ‘‘to the extent it is legally 2012); ACLI (Feb. 2012); T. Rowe Price; PUC Texas; 2012) BoA. required to be subject to such regulation’’ to the SSgA (Feb. 2012); ICI (Feb. 2012) Invesco; MetLife; 1067 See MetLife; ACLI (Feb. 2012); ICI (Feb. 2012) non-U.S. dealer provisions. See Morgan Stanley. MFA. SSgA (Feb. 2012).

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to price movements, which would likely unavailable in less liquid markets and Many commenters expressed increase the cost of intermediation.1068 hedging can be costly, especially in particular concern about the proposed Some commenters stated that the relation to the relative risk of a trade requirement’s application to specific proposed source of revenue requirement and hedge effectiveness.1075 A few markets, including: The fixed-income may make a banking entity less willing commenters further indicated that markets; 1081 the markets for to make markets in instruments that it making some profit from price commodities, derivatives, securitized may not be able to resell immediately or appreciation is a natural part of market products, and emerging market 1069 in the short term. One commenter making or is necessary to compensate a securities; 1082 equity and physical indicated that this concern may be market maker for its willingness to take commodity derivatives markets; 1083 and heightened in times of market stress.1070 a position, and its associated risk (e.g., customized swaps used by customers of Further, a few commenters expressed the risk of market changes or decreased 1076 banking entities for hedging the view that the proposed requirement value), from a customer. 1084 would cause banking entities to exit the purposes. Another commenter market-making business due to iii. Concerns Regarding the Workability expressed general concern about restrictions on their ability to make a of the Proposed Standard in Certain extremely volatile markets, where profit from market-making activities.1071 Markets or Asset Classes market makers often see large upward or Moreover, in one commenter’s opinion, Some commenters represented that it downward price swings over time.1085 the proposed requirement would would be difficult or burdensome to Two commenters emphasized that the effectively compel market makers to identify revenue attributable to the bid- revenues a market maker generates from trade on an agency basis.1072 ask spread versus revenue arising from hedging the positions it holds in price appreciation, either as a general inventory are equivalent to spreads in ii. Certain Price Appreciation-Related 1077 matter or for specific markets. For many markets. These commenters Profits Are an Inevitable or Important example, one commenter expressed the Component of Market Making explained that, under these opinion that the difference between the circumstances, a market maker A number of commenters indicated bid-ask spread and price appreciation is generates revenue from the difference that market makers will inevitably make ‘‘metaphysical’’ in some sense,1078 between the customer price for the some profit from price appreciation of while another stated that it is almost position and the banking entity’s price certain inventory positions because impossible to objectively identify a bid- changes in market values cannot be ask spread or to capture profit and loss for the hedge. The commenters noted precisely predicted or hedged.1073 In solely from a bid-ask spread in most that proposed Appendix B expressly particular, several commenters markets.1079 Other commenters recognizes this in the case of derivatives emphasized that matched or perfect represented that it is particularly and recommended that Appendix B’s hedges are generally unavailable for difficult to make this distinction when most types of positions.1074 According trades occur infrequently or where spreads because of intra-day price movements.’’); to one commenter, a provision that RBC; Capital Group (arguing that bid-ask spreads in prices are not transparent, such as in the fixed-income markets are not always quantifiable or effectively requires a market-making fixed-income market where no spread is well defined and can fluctuate widely within a business to hedge all of its principal published.1080 trading day because of small or odd lot trades, price positions would discourage essential discovery activity, a lack of availability to cover market-making activity. The commenter 1075 See Wellington. Moreover, one commenter shorts, or external factors not directly related to the explained that effective hedges may be stated that, as a general matter, market makers need security being traded). to be compensated for bearing risk related to 1081 See Capital Group; CIEBA; SIFMA et al. providing immediacy to a customer. This (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012). 1068 See SSgA (Feb. 2012); PUC Texas. commenter stated that ‘‘[t]he greater the inventory These commenters stated that the requirement may 1069 See ICI (Feb. 2012) SSgA (Feb. 2012); SIFMA risk faced by the market maker, the higher the be problematic for the fixed-income markets (Asset Mgmt.) (Feb. 2012); BoA. expected return (compensation) that the market because, for example, market makers must hold 1070 See CIEBA (arguing that banking entities may maker needs,’’ to compensate the market maker for inventory in these markets for a longer period of be reluctant to provide liquidity when markets are bearing the risk and reward its specialization skills time than in more liquid markets. See id. declining and there are more sellers than buyers in that market (e.g., its knowledge about market 1082 See SIFMA et al. (Prop. Trading) (Feb. 2012) because it would be necessary to hold positions in conditions and early indicators that may imply (stating that these markets are characterized by even inventory to avoid losses). future price movements in a particular direction). less liquidity and less frequent trading than the U.S. 1071 See Credit Suisse (Seidel) (arguing that This commenter did not, however, discuss the corporate bond market). This commenter also stated banking entities are likely to cease being market source of revenue requirement in the proposed rule. that in markets where trades are large and less makers if they are: (i) Unable to take into account See Thakor Study. frequent, such as the market for customized the likely direction of a financial instrument, or (ii) 1076 See Capital Group; Prof. Duffie; Investure; securitized products, appreciation in price of one forced to take losses if a financial instrument moves SIFMA et al. (Prop. Trading) (Feb. 2012); STANY; position may be a predominate contributor to the against them, but cannot take gains if the SIFMA (Asset Mgmt.) (Feb. 2012); RBC; PNC. overall profit and loss of the trading unit. See id. instrument’s price moves in their favor); STANY 1077 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 1083 See BoA. According to this commenter, the (contending that banking entities cannot afford to 2012); Goldman (Prop. Trading); BoA; Citigroup distinction between capturing a spread and price maintain unprofitable or marginally profitable (Feb. 2012); Japanese Bankers Ass’n.; Sumitomo appreciation is fundamentally flawed in some operations in highly competitive markets, so this Trust; Morgan Stanley; Barclays; RBC; Capital markets, like equity derivatives, because the market requirement would cause banking entities to Group. does not trade based on movements of a particular eliminate a majority of their market-making 1078 See SIFMA et al. (Prop. Trading) (Feb. 2012). security or underlying instrument. This commenter functions). 1079 See Citigroup (Feb. 2012). See also Barclays indicated that expected returns are instead based on 1072 See IR&M (arguing that domestic corporate (arguing that a bid-ask spread cannot be defined on the bid-ask spread the market maker charges for and securitized credit markets are too large and a consistent basis with respect to many implied volatility as reflected in options premiums heterogeneous to be served appropriately by a instruments). and hedging of the positions. See id. primarily agency-based trading model). 1080 See Goldman (Prop. Trading); BoA; Morgan 1084 See CIEBA (stating that because it would be 1073 See Wellington; Credit Suisse (Seidel); Stanley (‘‘Observable, actionable, bid/ask spreads difficult for a market maker to enter promptly into Morgan Stanley; PUC Texas (contending that it is exist in only a small subset of institutional products an offsetting swap, the market maker would not be impossible to predict the behavior of even the most and markets. Indicative bid/ask spreads may be able to generate income from the spread). highly correlated hedge in comparison to the observable for certain products, but this pricing 1085 See SIFMA et al. (Prop. Trading) (Feb. 2012). underlying position); CIEBA; SSgA (Feb. 2012); would typically be specific to small size standard This commenter questioned whether proposed AllianceBernstein; Investure; Invesco. lot trades and would not represent a spread Appendix B’s reference to ‘‘unexpected market 1074 See Morgan Stanley; Credit Suisse (Seidel); applicable to larger and/or more illiquid trades. disruptions’’ as an explanatory fact and SSgA (Feb. 2012); PUC Texas; Wellington; End-of-day valuations for assets are calculated, but circumstance was intended to permit such market AllianceBernstein; Investure. they are not an effective proxy for real-time bid/ask making. See id.

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guidance on this point apply equally to proposed requirement with One commenter recommended that the certain non-derivative positions.1086 guidance.1093 Some commenters proposed requirement be interpreted to A few commenters questioned how requested that the Agencies modify the limit market making in illiquid this requirement would work in the focus of the requirement so that, for positions because a banking entity context of block trading or otherwise example, dealers’ market-making cannot have the required revenue facilitating large trades, where a market activities in illiquid securities can motivation when it enters into a maker may charge a premium or function as close to normal as position for which there is no readily discount for taking on a large position possible 1094 or market makers can take discernible exit price.1099 to provide ‘‘immediacy’’ to its short-term positions that may ultimately Further, some commenters suggested customer.1087 One commenter further result in a profit or loss.1095 As that the Agencies remove the word explained that explicitly quoted bid-ask discussed below, some commenters ‘‘primarily’’ from the provision to limit spreads are only valid for indicated stated that the Agencies should modify banking entities to specified sources of trade sizes that are modest enough to the proposed requirement to place revenue.1100 In addition, one of these have negligible market impact, and such greater restrictions on market maker commenters requested that the Agencies spreads cannot be used for purposes of revenue. restrict a market maker’s revenue to fees a significantly larger trade.1088 and commissions and remove the v. General Support for the Proposed allowance for revenue from bid-ask iv. Suggested Modifications to the Requirement or for Placing Greater spreads because generating bid-ask Proposed Requirement Restrictions on a Market Maker’s revenues relies exclusively on changes Sources of Revenue To address some or all of the concerns in market values of positions held in discussed above, many commenters Some commenters expressed support inventory.1101 For enforcement recommended that the source of for the proposed source of revenue purposes, a few commenters suggested revenue requirement be modified 1089 or requirement or stated that the that the Agencies require banking removed from the rule entirely.1090 With requirement should be more entities to disgorge any profit obtained 1096 respect to suggested changes, some restrictive. For example, one of these from price appreciation.1102 commenters stated that the Agencies commenters stated that a real market maker’s trading book should be fully c. Final Rule’s Approach To Assessing should modify the rule text,1091 use a Revenues metrics-based approach to focus on hedged, so it should not generate profits customer revenues,1092 or replace the in excess of fees and commissions Unlike the proposed rule, the final except in times of rare and rule does not include a requirement that 1097 1086 See SIFMA et al. (Prop. Trading) (Feb. 2012); extraordinary market conditions. a trading desk’s market making-related Goldman (Prop. Trading). In its discussion of According to another commenter, the activity be designed to generate revenue ‘‘customer revenues,’’ Appendix B states: ‘‘In the final rule should make it clear that primarily from fees, commissions, bid- case of a derivative contract, these revenues reflect banking entities seeking to rely on the ask spreads, or other income not the difference between the cost of entering into the derivative contract and the cost of hedging market-making exemption may not attributable to appreciation in the value 1103 incremental, residual risks arising from the generally seek to profit from price of a financial instrument or hedging. contract.’’ Joint Proposal, 76 FR at 68960; CFTC movements in their inventories, The revenue requirement was one of the Proposal, 77 FR at 8440. See also RBC (requesting although their activities may give rise to most commented upon aspects of the clarification on how the proposed standard would market-making exemption in the apply if a market maker took an offsetting position modest and relatively stable profits 1098 1104 in a different instrument (e.g., a different bond) and arising from their limited inventory. proposal. inquiring whether, if the trader took the offsetting The Agencies believe that an analysis position, its revenue gain is attributable to price this way). This commenter also indicated that the of patterns of revenue generation and appreciation of the two offsetting positions or from ‘‘primarily’’ standard in the proposed rule is profitability can help inform a judgment the bid-ask spread in the respective bonds). problematic and can be read to mean ‘‘more than regarding whether trading activity is 1087 See Prof. Duffie; NYSE Euronext; Capital 50%,’’ which is different from Appendix B’s Group; RBC; Goldman (Prop. Trading). See also acknowledgment that the proportion of customer consistent with the intermediation and Thakor Study (discussing market makers’ role of revenues relative to total revenues will vary by asset liquidity services that a market maker providing ‘‘immediacy’’ in general). class. See id. provides to its customers in the context 1088 See CIEBA. 1093 See BoA (recommending that the guidance of the liquidity, maturity, and depth of 1089 See, e.g., JPMC; Barclays; Goldman (Prop. state that the Agencies would consider the design the relevant market, as opposed to Trading); BoA; CFA Inst.; ICI (Feb. 2012) Flynn & and mix of such revenues as an indicator of Fusselman. potentially prohibited proprietary trading, but only prohibited proprietary trading activities. 1090 See, e.g., CIEBA; SIFMA et al. (Prop. Trading) for those markets for which revenues are To facilitate this type of analysis, the (Feb. 2012); Morgan Stanley; Goldman (Prop. quantifiable based on publicly available data, such Agencies have included a metrics data Trading); Capital Group; RBC. In addition to the as segments of certain highly liquid equity markets). reporting requirement that is refined concerns discussed above, one commenter stated 1094 See CFA Inst. that the proposed requirement may set limits on the 1095 See ICI (Feb. 2012). from the proposed metric regarding values of certain metrics, and it would be 1096 See Sens. Merkley & Levin (Feb. 2012); Better profits and losses. The Comprehensive inappropriate to prejudge the appropriate results of Markets (Feb. 2012); FTN; Public Citizen; Occupy; Profit and Loss Attribution metric such metrics at this time. See SIFMA et al. (Prop. Alfred Brock. collects information regarding the daily Trading) (Feb. 2012). 1097 See Better Markets (Feb. 2012). See also fluctuation in the value of a trading 1091 See, e.g., Barclays. This commenter provided Public Citizen (arguing that the imperfection of a alternative rule text stating that ‘‘market making- hedge should signal potential disqualification of the desk’s positions to various sources, related activity is conducted by each trading unit underlying position from the market-making along with its volatility, including: (i) such that its activities are reasonably designed to exemption). generate revenues primarily from fees, 1098 See Sens. Merkley & Levin (Feb. 2012). This proportion to the risk undertaken with the security. commissions, bid-ask spreads, or other income commenter further suggested that the rule identify See id. attributable to satisfying reasonably expected certain red flags and metrics that could be used to 1099 See AFR et al. (Feb. 2012). customer demand.’’ See id. monitor this requirement, such as: (i) Failure to 1100 See Occupy; Better Markets (Feb. 2012). See 1092 See Goldman (Prop. Trading) (suggesting that obtain relatively low ratios of revenue-to-risk, low supra note 1108 (addressing these comments). the Agencies use a metrics-based approach to focus volatility, and relatively high turnover; (ii) 1101 on customer revenues, as measured by Spread Profit significant revenues from price appreciation See Occupy. and Loss (when it is feasible to calculate) or other relative to the value of securities being traded; (iii) 1102 See Occupy; Public Citizen. metrics, especially because a proprietary trading volatile revenues from price appreciation; or (iv) 1103 See proposed rule § 75.4(b)(2)(v). desk would not be expected to earn any revenues revenue from price appreciation growing out of 1104 See infra Part VI.A.3.c.7.b.

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Profit and loss attributable to current better account for the varying depth and The Agencies recognize that this positions that were also held by the liquidity of markets.1107 In addition, the analysis is only informative over time, banking entity as of the end of the prior Agencies believe these modifications and should not be determinative of an day (‘‘existing positions); (ii) profit and appropriately address commenters’ analysis of whether the amount, types, loss attributable to new positions concerns about the proposed source of and risks of the financial instruments in resulting from the current day’s trading revenue requirement and reduce the the trading desk’s market-maker activity (‘‘new positions’’); and (iii) potential for negative market impacts of inventory are designed not to exceed the residual profit and loss that cannot be the proposed requirement cited by reasonably expected near term demands specifically attributed to existing commenters, such as incentives to of clients, customers, or counterparties. positions or new positions.1105 widen spreads or disincentives to The Agencies believe this quantitative This quantitative measurement has engage in market making in less liquid measurement provides appropriate certain conceptual similarities to the markets.1108 flexibility to obtain information on proposed source of revenue requirement market-maker revenues, which is in § 75.4(b)(2)(v) of the proposed rule 1107 The Agencies understand that some designed to address commenters’ and certain of the proposed quantitative commenters interpreted the proposed requirement concerns about the proposal’s source of measurements.1106 However, in as requiring that both the bid-ask spread for a financial instrument and the revenue a market revenue requirement (e.g., the burdens response to comments on those maker acquired from such bid-ask spread through associated with differentiating spread provisions, the Agencies have a customer trade be identifiable on a close-to-real- revenue from price appreciation determined to modify the focus from time basis and readily distinguishable from any revenue) while also helping assess particular revenue sources (e.g., fees, additional revenue gained from price appreciation (both on the day of the transaction and for the rest patterns of revenue generation that may commissions, bid-ask spreads, and price of the holding period). See, e.g., SIFMA et al. (Prop. be informative over time about whether appreciation) to when the trading desk Trading) (Feb. 2012); Goldman (Prop. Trading); a market maker’s activities are designed generates revenue from its positions. BoA; Citigroup (Feb. 2012); Japanese Bankers to facilitate and provide customer The Agencies recognize that when the Ass’n.; Sumitomo Trust; Morgan Stanley; Barclays; RBC; Capital Group. We recognize that such a intermediation. trading desk is engaged in market requirement would be unduly burdensome. In fact, 8. Appendix B of the Proposed Rule making-related activities, the day one the proposal noted that bid-ask spreads or similar profit and loss component of the spreads may not be widely disseminated on a a. Proposed Appendix B Requirement consistent basis or otherwise reasonably Comprehensive Profit and Loss ascertainable in certain asset classes for purposes of The proposed market-making Attribution metric may reflect customer- the proposed Spread Profit and Loss metric in exemption would have required that the generated revenues, like fees, Appendix A of the proposal. See Joint Proposal, 76 market making-related activities of the commissions, and spreads (including FR at 68958–68959; CFTC Proposal, 77 FR at 8438. Moreover, the burden associated with the proposed trading desk or other organizational unit embedded premiums or discounts), as requirement should be further reduced because we of the banking entity be consistent with well as that day’s changes in market are not adopting a stand-alone requirement the commentary in proposed Appendix value. Thereafter, profit and loss regarding a trading desk’s source of revenue. B.1109 In this proposed Appendix, the associated with the position carried in Instead, when and how a trading desk generates Agencies provided overviews of the trading desk’s book may reflect profit and loss from its trading activities is a factor that must be considered for purposes of the near permitted market making-related changes in market price until the term customer demand requirement. It is not a activity and prohibited proprietary position is sold or unwound. The dispositive factor for determining compliance with trading activity.1110 Agencies also recognize that the metric the exemption. The proposed Appendix also set forth contains a residual component for profit Further, some commenters expressed concern that the proposed requirement suggested market various factors that the Agencies and loss that cannot be specifically makers were not permitted to profit from price proposed to use to help distinguish attributed to existing positions or new appreciation, but rather only from observable prohibited proprietary trading from positions. spreads or explicit fees or commissions. See, e.g., permitted market making-related The Agencies believe that evaluation Wellington, Credit Suisse (Seidel); Morgan Stanley; activity. More specifically, proposed of the Comprehensive Profit and Loss PUC Texas; CIEBA; SSgA (Feb. 2012); AllianceBernstein; Investure; Invesco. The Agencies Appendix B set forth six factors that, Attribution metric could provide confirm that the intent of the market-making absent explanatory facts and valuable information regarding patterns exemption is not to preclude a trading desk from circumstances, would cause particular of revenue generation by market-making generating any revenue from price appreciation. trading activity to be considered trading desks involved in market- Because this approach clarifies that a trading desk’s source of revenue is not limited to its quoted prohibited proprietary trading activity making activities that may warrant spread, the Agencies believe this quantitative and not permitted market making- further review of the desk’s activities, measurement will address commenters concerns related activity. The proposed factors while eliminating the requirement from that the proposed source of revenue requirement focused on: (i) Retaining risk in excess the proposal that the trading desk could create incentives for market makers to widen their spreads, result in higher transaction costs, of the size and type required to provide demonstrate that its primary source of require market makers to hedge any exposure to intermediation services to customers revenue, under all circumstances, is price movements, or discourage a trading desk from (‘‘risk management factor’’); (ii) fees, commissions and bid/ask spreads. making a market in instruments that it may not be primarily generating revenues from able to sell immediately. See Wellington; CIEBA; This modified focus will reduce the price movements of retained principal burden associated with the proposed MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 2012) BoA; SIFMA (Asset Mgmt.) positions and risks, rather than source of revenue requirement and (Feb. 2012). The modifications to this provision are customer revenues (‘‘source of revenues designed to better reflect when, on average and factor’’); (iii) generating only very small 1105 See Appendix A of the final rule (describing across many transactions, profits are gained rather the Comprehensive Profit and Loss Attribution than how they are gained, similar to the way some metric). This approach is generally consistent with firms measure their profit and loss today. See, e.g., Better Markets (Feb. 2012). In response to the one commenter’s suggested metrics-based approach Goldman (Prop. Trading). proposed source of revenue requirement, some to focus on customer-related revenues. See 1108 See, e.g., Wellington; CIEBA; MetLife; ACLI commenters noted that a market maker may charge Goldman (Prop. Trading); see also Sens. Merkley & (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. a premium or discount for taking on a large position Levin (Feb. 2012) (suggesting the use of metrics to 2012) BoA. The Agencies are not adopting an from a customer. See Prof. Duffie; NYSE Euronext; monitor a firm’s source of revenue); proposed approach that limits a market maker to specified Capital Group; RBC; Goldman (Prop. Trading). Appendix A. revenue sources (e.g., fees, commissions, and 1109 See proposed rule § 75.4(b)(2)(vi). 1106 See supra Part VI.A.3.c.7. and infra Part spreads), as suggested by some commenters, due to 1110 See Joint Proposal, 76 FR at 68873, 68960– VI.C.3. the considerations discussed above. See Occupy; 68961; CFTC Proposal, 77 FR at 8358, 8439–8440.

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or very large amounts of revenue per related activity,1116 re-formulating the significant transaction’’ indicated that unit of risk, not demonstrating appendix as nonbinding guidance,1117 the Agencies will review compliance consistent profitability, or or moving certain requirements of the with the proposed market-making demonstrating high earnings volatility proposed exemption to the exemption on a trade-by-trade basis and (‘‘revenues relative to risk factor’’); (iv) appendix.1118 One commenter suggested stated that assessing compliance at the not trading through a trading system the Agencies remove Appendix B from level of individual transactions would that interacts with orders of others or the rule and instead use the be unworkable.1125 One of these primarily with customers of the banking conformance period to analyze and commenters further stated that assessing entity’s market-making desk to provide develop a body of supervisory guidance compliance at this level of granularity liquidity services, or retaining principal that appropriately characterizes the would reduce a market maker’s positions in excess of reasonably nature of market making-related willingness to execute a customer sell expected near term customer demands activity.1119 order as principal due to concern that (‘‘customer-facing activity factor’’); (v) A few commenters expressed concern the market maker may not be able to routinely paying rather than earning about the appendix’s facts-and- immediately resell such position. The fees, commissions, or spreads circumstances-based approach to commenter noted that this chilling (‘‘payment of fees, commissions, and distinguishing between prohibited effect would be heightened in declining 1126 spreads factor’’); and (vi) providing proprietary trading and permitted markets. compensation incentives to employees market making-related activity and A few commenters interpreted certain stated that such an approach will make that primarily reward proprietary risk- statements in proposed Appendix B as it more difficult or burdensome for taking (‘‘compensation incentives limiting interdealer trading and banking entities to comply with the factor’’).1111 expressed concerns regarding potential proposed rule 1120 or will generate limitations on this activity.1127 These b. Comments on Proposed Appendix B regulatory uncertainty.1121 As discussed commenters emphasized that market below, other commenters opposed makers may need to trade with non- Commenters expressed differing proposed Appendix B because of its customers to: (i) Provide liquidity to views about the accuracy of the level of granularity 1122 or due to other dealers and, indirectly, their commentary in proposed Appendix B perceived restrictions on interdealer customers, or to otherwise allow and the appropriateness of including trading or generating revenue from customers to access a larger pool of such commentary in the rule. For retained principal positions or risks in liquidity; 1128 (ii) conduct price example, some commenters stated that the proposed appendix.1123 A number of discovery to inform the prices a market the description of market making- commenters expressed concern about maker can offer to customers; 1129 (iii) related activity in the proposed the complexity or prescriptiveness of unwind or sell positions acquired from appendix is accurate 1112 or the six proposed factors for appropriately accounts for differences distinguishing permitted market 1125 See Wellington; Goldman (Prop. Trading); among asset classes.1113 Other making-related activity from prohibited SIFMA (Asset Mgmt.) (Feb. 2012). In particular, commenters indicated that the appendix proprietary trading.1124 proposed Appendix B provided that ‘‘The particular is too strict or narrow.1114 Some With respect to the level of types of trading activity described in this appendix may involve the aggregate trading activities of a commenters recommended that the granularity of proposed Appendix B, a single trading unit, a significant number or series Agencies revise proposed Appendix B’s number of commenters expressed of transactions occurring at one or more trading approach by, for example, placing concern that the reference to a ‘‘single units, or a single significant transaction, among other potential scenarios.’’ Joint Proposal, 76 FR at greater focus on what market making is 68961; CFTC Proposal, 77 FR at 8441. The Agencies 1116 See Sens. Merkley & Levin (Feb. 2012). This rather than what it is not,1115 providing address commenters’ trade-by-trade concerns in commenter stated that, for example, Appendix B Part VI.A.3.c.1.c.ii., infra. presumptions of activity that will be could deem market making involving widely-traded 1126 treated as permitted market making- stocks and bonds issued by well-established See Goldman (Prop. Trading). corporations, government securities, or highly 1127 See Morgan Stanley; Goldman (Prop. liquid asset-backed securities as the type of plain Trading); Chamber (Feb. 2012). Specifically, 1111 See Joint Proposal, 76 FR at 68873, 68961– vanilla, low risk capital activities that are commenters cited statements in proposed Appendix 68963; CFTC Proposal, 77 FR at 8358, 8440–8442. presumptively permitted, provided the activity is B indicating that market makers ‘‘typically only 1112 See MetLife; ACLI (Feb. 2012). within certain, specified parameters for inventory engage in transactions with non-customers to the 1113 See Alfred Brock. But see, e.g., Occupy levels, revenue-to-risk metrics, volatility, and extent that these transactions directly facilitate or (stating that the proposed commentary only hedging. See id. support customer transactions.’’ On this issue, the accounts for the most liquid and transparent 1117 See Morgan Stanley; Flynn & Fusselman. appendix further stated that ‘‘a market maker markets and fails to accurately describe market generally only transacts with non-customers to the 1118 See JPMC. In support of such an approach, making in most illiquid or OTC markets). extent necessary to hedge or otherwise manage the the commenter argued that sometimes proposed 1114 risks of its market making-related activities, See Morgan Stanley; IIF; Sumitomo Trust; § 75.4(b) and Appendix B addressed the same topic including managing its risk with respect to ISDA (Apr. 2012); BDA (Feb. 2012) (Oct. 2012) and, when this occurs, it is unclear whether movements of the price of retained principal (stating that proposed Appendix B places too great compliance with Appendix B constitutes positions and risks, to acquire positions in amounts of a focus on derivatives trading and does not compliance with § 75.4(b) or if additional consistent with reasonably expected near term reflect how principal trading operations in equity compliance steps are required. See id. and fixed income markets are structured). One of demand of its customers, or to sell positions 1119 See Morgan Stanley. these commenters requested that the appendix be acquired from its customers.’’ The appendix 1120 modified to account for certain activities conducted See NYSE Euronext; Morgan Stanley. recognized, however, that the ‘‘appropriate in connection with market making in swaps. This 1121 See IAA. proportion of a market maker’s transactions that are commenter indicated that a swap dealer may not 1122 See Wellington; Goldman (Prop. Trading); with customers versus non-customers varies regularly enjoy a dominant flow of customer SIFMA (Asset Mgmt.) (Feb. 2012). depending on the type of positions involved and revenues and may consistently need to make 1123 See Morgan Stanley; Chamber (Feb. 2012); the extent to which the positions are typically revenue from its book management. In addition, the Goldman (Prop. Trading). hedged in non-customer transactions.’’ Joint commenter stated that the appendix should 1124 See Japanese Bankers Ass’n.; Credit Suisse Proposal, 76 FR at 68961; CFTC Proposal, 77 FR at recognize that making a two-way market may be a (Seidel); Chamber (Feb. 2012); ICFR; Morgan 8440. Commenters’ concerns regarding interdealer dominant theme, but there are certain to be frequent Stanley; Goldman (Prop. Trading); Occupy; Oliver trading are addressed in Part VI.A.3.c.2.c.i., infra. occasions when, as a matter of market or internal Wyman (Feb. 2012); Oliver Wyman (Dec. 2011); 1128 See Morgan Stanley; Goldman (Prop. circumstances, a market maker is unavailable to Public Citizen; NYSE Euronext. But see Alfred Trading). trade. See ISDA (Apr. 2012). Brock (stating that the proposed factors are 1129 See Morgan Stanley; Goldman (Prop. 1115 See SIFMA et al. (Prop. Trading) (Feb. 2012). effective). Trading); Chamber (Feb. 2012).

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customers; 1130 (iv) establish or acquire respect to the proposed factors, one revenue primarily from certain sources, positions to meet reasonably expected commenter indicated that they are to the actual outcome of activities.1147 near term customer demand; 1131 (v) appropriate,1139 while another With respect to the proposed revenues hedge; 1132 and (vi) sell a financial commenter stated that they are complex relative to risk factor, one commenter instrument when there are more buyers and their effectiveness is uncertain.1140 supported this aspect of the than sellers for the instrument at that Another commenter expressed the view proposal.1148 Some commenters, time.1133 Further, one of these that ‘‘[w]hile each of the selected factors however, expressed concern about using commenters expressed the view that the provides evidence of ‘proprietary these factors to differentiate permitted proposed appendix’s statements are trading,’ warrants regulatory attention, market making-related activity from inconsistent with the statutory market- and justifies a shift in the burden of prohibited proprietary trading.1149 making exemption’s reference to proof, some require subjective These commenters stated that volatile ‘‘counterparties.’’ 1134 judgments, are subject to gaming or data risk-taking and revenue can be a natural In addition, a few commenters manipulation, and invite excessive result of principal market-making expressed concern about statements in reliance on circumstantial evidence and activity.1150 One commenter noted that proposed Appendix B about a market lawyers’ opinions.’’ 1141 customer flows are often ‘‘lumpy’’ due maker’s source of revenue.1135 to, for example, a market maker’s In response to the proposed risk According to one commenter, the facilitation of large trades.1151 management factor,1142 one commenter statement that profit and loss generated A few commenters indicated that the expressed concern that it could prevent by inventory appreciation or analysis in the proposed customer- a market maker from warehousing depreciation must be ‘‘incidental’’ to facing activity factor may not accurately positions in anticipation of predictable customer revenues is inconsistent with reflect how market making occurs in but unrealized customer demands and, market making-related activity in less certain markets and asset classes due to further, could penalize a market maker liquid assets and larger transactions potential limitations on interdealer that misestimated expected demand. because market makers often must trading.1152 According to another This commenter expressed the view that retain principal positions for longer commenter, however, a banking entity’s such an outcome would be contrary to periods of time in such circumstances non-customer facing trades should be the statute and would harm market and are unable to perfectly hedge these required to be matched with existing 1136 liquidity.1143 Another commenter positions. As discussed above with customer counterparties.1153 With requested that this presumption be respect to the source of revenue respect to the near term customer removed because in less liquid markets, requirement in § 75.4(b)(v) of the demand component of this factor, one such as markets for corporate bonds, proposed rule, a few commenters commenter expressed concern that it equity derivatives, securitized products, requested that Appendix B’s discussion goes farther than the statute’s activity- emerging markets, foreign exchange of ‘‘customer revenues’’ be modified to based ‘‘design’’ test by analyzing forwards, and fund-linked products, a state that revenues from hedging will be whether a trading unit’s inventory has market maker needs to act as principal considered to be customer revenues in exceeded reasonably expected near term to facilitate client requests and, as a certain contexts beyond derivatives customer demand at any particular 1137 result, will be exposed to risk.1144 contracts. point in time.1154 A number of commenters discussed Two commenters expressed concern Some commenters expressed concern the six proposed factors in Appendix B about the proposed source of revenue about the payment of fees, commissions, that, absent explanatory facts and factor.1145 One commenter stated that circumstances, would have caused a this factor does not accurately reflect 1147 See Goldman (Prop. Trading). This particular trading activity to be how market making occurs in a majority commenter suggested that the Agencies remove any considered prohibited proprietary of markets and asset classes.1146 The negative presumptions based on revenues and trading activity and not permitted other commenter expressed concern that instead use revenue metrics, such as Spread Profit market making-related activity.1138 With and Loss (when it is feasible to calculate) or other this factor shifted the emphasis of metrics for purposes of monitoring a banking § 75.4(b)(v) of the proposed rule, which entity’s trading activity. See id. 1130 See Morgan Stanley; Chamber (Feb. 2012) required that market making-related 1148 See Occupy (stating that these factors are (stating that market makers in the corporate bond, activities be ‘‘designed’’ to generate important and will provide invaluable information interest rate derivative, and natural gas derivative about the nature of the banking entity’s trading markets frequently trade with other dealers to work activity). down a concentrated position originating with a 1139 See Alfred Brock. 1149 See Morgan Stanley; Credit Suisse (Seidel); customer trade). 1140 See Japanese Bankers Ass’n. Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 1131 See Morgan Stanley; Chamber (Feb. 2012). 1141 Sens. Merkley & Levin (Feb. 2012). 2011). 1132 See Goldman (Prop. Trading). 1142 The proposed appendix stated that the 1150 See Morgan Stanley; Credit Suisse (Seidel); 1133 See Chamber (Feb. 2012). Agencies would use certain quantitative Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 1134 See Goldman (Prop. Trading). measurements required in proposed Appendix A to 2011). For example, one commenter stated that 1135 See Morgan Stanley; SIFMA et al. (Prop. help assess the extent to which a trading unit’s risks because markets and trading volumes are volatile, Trading) (Feb. 2012); Goldman (Prop. Trading). On are potentially being retained in excess amounts, consistent profitability and low earnings volatility this issue, Appendix B stated that certain types of including VaR, Stress VaR, VaR Exceedance, and are outside a market maker’s control. In support of ‘‘customer revenues’’ provide the primary source of Risk Factor Sensitivities. See Joint Proposal, 76 FR this statement, the commenter indicated that: (i) a market maker’s profitability and, while a market at 68961–68962; CFTC Proposal, 77 FR at 8441. One Customer trading activity varies significantly with maker also incurs losses or generates profits as price commenter questioned whether, assuming such market conditions, which results in volatility in a movements occur in its retained principal positions metrics are effective and the activity does not market maker’s earnings and profitability; and (ii) and risks, ‘‘such losses or profits are incidental to exceed the banking entity’s expressed risk appetite, a market maker will experience volatility associated customer revenues and significantly limited by the it is necessary to place greater restrictions on risk- with changes in the value of its inventory positions, banking entity’s hedging activities.’’ Joint Proposal, taking, based on the Agencies’ judgment of the level and principal risk is a necessary feature of market 76 FR at 68960; CFTC Proposal, 77 FR at 8440. The of risk necessary for bona fide market making. See making. See Morgan Stanley. Agencies address commenters’ concerns about ICFR. 1151 See Oliver Wyman (Feb. 2012); Oliver proposed requirements regarding a market maker’s 1143 See Chamber (Feb. 2012). Wyman (Dec. 2011). source of revenue in Part VI.A.3.c.7.c., infra. 1144 See Credit Suisse (Seidel). 1152 See Morgan Stanley; Goldman (Prop. 1136 See Morgan Stanley. 1145 See Goldman (Prop. Trading); Morgan Trading). 1137 See supra note 1086 and accompanying text. Stanley. 1153 See Public Citizen. 1138 See supra note 1111 and accompanying text. 1146 See Morgan Stanley. 1154 See Oliver Wyman (Feb. 2012).

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and spreads factor.1155 One commenter believe that quantitative measurements one or more specific risks, including appeared to support this proposed can be useful to banking entities and the market risk, counterparty or other credit factor.1156 According to one commenter, Agencies to help assess the profile of a risk, currency or foreign exchange risk, this factor fails to recognize that market trading desk’s trading activity and to interest rate risk, basis risk, or similar makers routinely pay a variety of fees in help identify trading activity that may risks, arising in connection with and connection with their market making- warrant a more in-depth review.1161 The related to individual or aggregated related activity, including, for example, Agencies will not use quantitative positions, contracts, or other holdings of fees to access liquidity on another measurements as a dispositive tool for the banking entity. Moreover, market to satisfy customer demand, differentiating between permitted § 75.5(b)(2)(iii) of the proposed rule transaction fees as a matter of course, market making-related activities and required that the transaction be and fees in connection with hedging prohibited proprietary trading. Like the reasonably correlated, based upon the transactions. This commenter also framework the Agencies have developed facts and circumstances of the indicated that, because spreads in for the market-making exemption, the underlying and hedging positions and current, rapidly-moving markets are Agencies recognize that there may be the risks and liquidity of those volatile, short-term measurements of differences in the quantitative positions, to the risk or risks the profit compared to spread revenue is measurements across markets and asset transaction is intended to hedge or problematic, particularly for less liquid classes. otherwise mitigate. Furthermore, 1157 stocks. Another commenter stated 4. Section 75.5: Permitted Risk- § 75.5(b)(2)(iv) of the proposed rule that this factor reflects a bias toward Mitigating Hedging Activities required that the hedging transaction agency trading and principal market not give rise, at the inception of the making in highly liquid, exchange- Section 75.5 of the proposed rule hedge, to significant exposures that are implemented section 13(d)(1)(C) of the traded markets and does not reflect the not themselves hedged in a BHC Act, which provides an exemption nature of principal market making in contemporaneous transaction. Section 1158 from the prohibition on proprietary most markets. One commenter 75.5(b)(2)(v) of the proposed rule trading for certain risk-mitigating recommended that the rule require that required that any hedge position hedging activities.1162 Section a trader who pays a fee be prepared to established in reliance on the hedging 13(d)(1)(C) provides an exemption for document the chain of custody to show exemption be subject to continuing risk-mitigating hedging activities in that the instrument is shortly re-sold to review, monitoring and management. 1159 connection with and related to an interested customer. Finally, § 75.5(b)(2)(vi) of the proposed individual or aggregated positions, Regarding the proposed compensation rule required that the compensation contracts, or other holdings of a banking incentives factor, one commenter arrangements of persons performing the entity that are designed to reduce the requested that the Agencies make clear risk-mitigating hedging activities be that explanatory facts and specific risks to the banking entity in connection with and related to such designed not to reward proprietary risk- circumstances cannot justify a trading taking. Additionally, § 75.5(c) of the unit providing compensation incentives positions, contracts, or other holdings (the ‘‘hedging exemption’’). Section 75.5 proposed rule required the banking that primarily reward proprietary risk- entity to document certain hedging taking to employees engaged in market of the final rule implements the hedging exemption with a number of transactions at the time the hedge is making. In addition, the commenter established. recommended that the Agencies delete modifications from the proposed rule to the word ‘‘primarily’’ from this respond to commenters’ concerns as b. Manner of Evaluating Compliance factor.1160 described more fully below. With the Hedging Exemption c. Determination to Not Adopt Proposed a. Summary of Proposal’s Approach To A number of commenters expressed Implementing the Hedging Exemption Appendix B concern that the final rule required To improve clarity, the final rule The proposed rule would have application of the hedging exemption on establishes particular criteria for the required seven criteria to be met in a trade-by-trade basis.1163 One exemption and does not incorporate the order for a banking entity’s activity to commenter argued that the text of the commentary in proposed Appendix B qualify for the hedging exemption. First, proposed rule seemed to require a trade- regarding the identification of permitted §§ 75.5(b)(1) and 75.5(b)(2)(i) of the by-trade analysis because each market making-related activities. This proposed rule generally required that ‘‘purchase or sale’’ or ‘‘hedge’’ was SUPPLEMENTARY INFORMATION provides the banking entity establish an internal subject to the requirements.1164 The guidance on the standards for compliance program that is designed to final rule modifies the proposal by compliance with the market-making ensure the banking entity’s compliance generally replacing references to a exemption. with the requirements of the hedging ‘‘purchase or sale’’ in the § 75.5(b) limitations, including reasonably requirements with ‘‘risk-mitigating 9. Use of Quantitative Measurements designed written policies and hedging activity.’’ The Agencies believe Consistent with the FSOC study and procedures, internal controls, and this approach is consistent with the the proposal, the Agencies continue to independent testing, and that a statute, which refers to ‘‘risk-mitigating transaction for which the banking entity hedging activity.’’ 1165 1155 See NYSE Euronext; Morgan Stanley. is relying on the hedging exemption be 1156 See Public Citizen. made in accordance with the 1163 See Ass’n. of Institutional Investors (Feb. 1157 See NYSE Euronext. compliance program established under 2012); see also Barclays; ICI (Feb. 2012); Investure; 1158 See Morgan Stanley. § 75.5(b)(1). Next, § 75.5(b)(2)(ii) of the MetLife; RBC; SIFMA et al. (Prop. Trading) (Feb. 1159 See Public Citizen. proposed rule required that the 2012); SIFMA (Asset Mgmt.) (Feb. 2012); Morgan 1160 Stanley; Fixed Income Forum/Credit Roundtable; See Occupy. This commenter also stated that transaction hedge or otherwise mitigate the commentary in Appendix B stating that a Fidelity; FTN. banking entity may give some consideration of 1164 See Barclays. profitable hedging activities in determining 1161 See infra Part VI.C.3.; final rule Appendix A. 1165 See 12 U.S.C. 1851(d)(1)(C) (stating that ‘‘risk- compensation would provide inappropriate 1162 See 12 U.S.C. 1851(d)(1)(C); proposed rule mitigating hedging activities’’ are permitted under incentives. See id. § 75.5. certain circumstances).

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Section 13(d)(1)(C) of the BHC Act c. Comments on the Proposed Rule and anticipatory hedging,1174 or scenario specifically authorizes risk-mitigating Approach To Implementing the Hedging hedging.1175 Some commenters stated hedging activities in connection with Exemption that restrictions on a banking entity’s and related to ‘‘individual or aggregated ability to hedge may have a chilling positions, contracts or other Commenters expressed a variety of effect on its willingness to engage in views on the proposal’s hedging holdings.’’ 1166 Thus, the statute does other permitted activities, such as exemption. A few commenters offered not require that exempt hedging be market making.1176 In addition, many of specific suggestions described more conducted on a trade-by-trade basis, and these commenters stated that, if a fully below regarding how, in their permits hedging of aggregated positions. banking entity is limited in its ability to view, the hedging exemption should be The Agencies recognized this in the hedge its market-making inventory, it strengthened to ensure proper oversight may be less willing or able to assume proposed rule, and the final rule of hedging activities.1168 These continues to permit hedging activities in risk on behalf of customers or provide commenters expressed concern that the financial products to customers that are connection with and related to proposal’s exemption was too broad and individual or aggregated positions. used for hedging purposes. As a result, argued that all proprietary trading could according to these commenters, it will The statute also requires that, to be be designated as a hedge under the be more difficult for customers to hedge exempt under section 13(d)(1)(C), proposal and thereby evade the their risks and customers may be forced 1169 hedging activities be risk-mitigating. prohibition of section 13. to retain risk.1177 The final rule incorporates this statutory By contrast, a number of other Another commenter contended that requirement. As explained in more commenters argued that the proposal detail below, the final rule requires that, the proposal represented an imposed burdensome requirements that inappropriate ‘‘one-size-fits-all’’ in order to qualify for the exemption for were not required by statute, would approach to hedging that did not risk-mitigating hedging activities: The limit the ability of banking entities to properly take into account the way banking entity implement, maintain, hedge in a prudent and cost-effective banking entities and especially market and enforce an internal compliance manner, and would reduce market intermediaries operate, particularly in 1170 program, including policies and liquidity. These commenters argued less-liquid markets.1178 Two procedures that govern and control that implementation of the requirements commenters requested that the Agencies these hedging activities; the hedging of the proposal would decrease safety clarify that a banking entity may use its activity be designed to reduce or and soundness of banking entities and discretion to choose any hedging otherwise significantly mitigate and the financial system by reducing cost- strategy that meets the requirements of demonstrably reduces or otherwise effective risk management options. the proposed exemption and, in significantly mitigates specific, Some commenters emphasized that the particular, that a banking entity is not identifiable risks; the hedging activity ability of banking entities to hedge their obligated to choose the ‘‘best hedge’’ not give rise to significant new risks that positions and manage risks taken in and may use the cheapest instrument connection with their permissible are left unhedged; the hedging activity available.1179 One commenter suggested activities is a critical element of liquid be subject to continuing review, uncertainty about the permissibility of a and efficient markets, and that the monitoring and management to address situation where gains on a hedge cumulative impact of the proposal risk that might develop over time; and position exceed losses on the would inhibit this risk-mitigation by the compensation arrangements for underlying position. The commenter raising transaction costs and persons performing risk-mitigating suggested that uncertainty may lead suppressing essential and beneficial banking entities to not use the most hedging activities be designed not to hedging activities.1171 reward or incentivize prohibited cost-effective hedge, which would make proprietary trading. These requirements A number of commenters expressed hedging less efficient and raise costs for are designed to focus the exemption on concern that the proposal’s hedging banking entities and customers.1180 hedging activities that are designed to exemption did not permit the full However, another commenter expressed reduce risk and that also demonstrably breadth of transactions in which concern about banking entities relying banking entities engage to hedge or reduce risk, in accordance with the on the cheapest satisfactory hedge. The mitigate risks, such as portfolio requirement under section 13(d)(1)(C) commenter explained that such hedges hedging,1172 dynamic hedging,1173 that hedging activities be risk-mitigating lead to more complicated risk profiles to be exempt. Additionally, the final and require banking entities to engage in 1168 See, e.g., AFR et al. (Feb. 2012); AFR (June additional transactions to hedge the rule imposes a documentation 2013); Better Markets (Feb. 2012); Sens. Merkley & requirement on certain types of hedges. Levin (Feb. 2012). 1169 1174 See Barclays; State Street (Feb. 2012); SIFMA Consistent with the other exemptions See, e.g., Occupy. 1170 See, e.g., Australian Bankers’ Ass’n (Feb. et al. (Prop. Trading) (Feb. 2012); Japanese Bankers from the ban on proprietary trading for 2012); BoA; Barclays; Credit Suisse (Seidel); Ass’n.; Credit Suisse (Seidel); BoA; PNC et al.; ISDA market-making and underwriting, the Goldman (Prop. Trading); HSBC; ICI (Feb. 2012); (Feb. 2012). 1175 Agencies intend to evaluate whether an Japanese Bankers Ass’n.; JPMC; Morgan Stanley; See SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012); Wells Fargo (Prop. Trading); JPMC; Goldman (Prop. Trading); BoA; Comm. on activity complies with the hedging Rep. Bachus et al.; RBC; SIFMA et al. (Prop. Capital Markets Regulation. Each of these types of exemption under the final rule based on Trading) (Feb. 2012); see also Stephen Roach. activities is discussed further below. See infra Part the totality of circumstances involving 1171 See Credit Suisse (Seidel); ICI (Feb. 2012); VI.A.4.d.2. 1176 See SIFMA et al. (Prop. Trading) (Feb. 2012); the products, techniques, and strategies Wells Fargo (Prop. Trading); see also Banco de Me´xico; SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Barclays; Goldman (Prop. used by a banking entity as part of its Goldman (Prop. Trading); BoA. Trading); BoA. hedging activity.1167 1172 See MetLife; SIFMA et al. (Prop. Trading) 1177 See SIFMA et al. (Prop. Trading) (Feb. 2012); (Feb. 2012); Morgan Stanley; Barclays; Goldman Goldman (Prop. Trading); Credit Suisse (Seidel). (Prop. Trading); BoA; ABA; HSBC; Fixed Income 1178 See Barclays. Forum/Credit Roundtable; ICI (Feb. 2012); ISDA 1179 See SIFMA et al. (Prop. Trading) (Feb. 2012); 1166 See 12 U.S.C. 1851(d)(1)(C). (Feb. 2012). Credit Suisse (Seidel). 1167 See Part VI.A.4.b., infra. 1173 See Goldman (Prop. Trading); BoA. 1180 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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exposures resulting from the imperfect, hedging exemption has in place follow a principles-based approach cheapest hedge.1181 appropriate internal control processes to requiring a banking entity to document A few commenters suggested the support its compliance with the terms of its hedging strategies for submission to hedging exemption be modified in favor the exemption. While commenters its regulator.1195 The Agencies believe of a simpler requirement that banking proposed a number of alternative that evaluating each banking entity’s entities adopt risk limits and policies frameworks for the hedging exemption, trading activity based on an and procedures commensurate with the Agencies believe the final rule’s individualized set of documented qualitative guidance issued by the multi-faceted approach most effectively hedging strategies could be Agencies.1182 Many of these balances commenter concerns with unnecessarily burdensome and result in commenters also expressed concerns statutory purpose. In response to unintended competitive impacts since that the proposed rule’s hedging commenter requests to reformulate the banking entities would not be subject to exemption would not allow so-called proposed rule as supervisory one uniform rule. The Agencies believe asset-liability management (‘‘ALM’’) guidance,1191 including the suggestion the multi-faceted approach adopted in activities.1183 Some commenters that the Agencies simply require the final rule establishes a consistent proposed that the risk-mitigating banking entities to adopt risk limits and framework applicable to all banking hedging exemption reference a set of policies and procedures commensurate entities that will reduce the potential for relevant descriptive factors rather than with qualitative Agency guidance,1192 such adverse impacts. specific prescriptive requirements.1184 the Agencies believe that such an Further, the Agencies believe the Other alternative frameworks suggested approach would provide less clarity scope of the final hedging exemption is by commenters include: (i) than the adopted approach. Although a appropriate because it permits risk- Reformulating the proposed purely guidance-based approach could mitigating hedging activities, as requirements as supervisory provide greater flexibility, it would also mandated by section 13 of the BHC guidance; 1185 (ii) establishing a safe provide less specificity, which could Act,1196 while requiring a robust harbor,1186 presumption of make it difficult for banking entity compliance program and other internal compliance,1187 or bright line test; 1188 personnel and the Agencies to controls to help ensure that only or (iii) a principles-based approach that determine whether an activity complies genuine risk-mitigating hedges can be would require a banking entity to with the rule and could lead to an used in reliance on the exemption.1197 document its risk-mitigating hedging increased risk of evasion of the statutory In response to concerns that the strategies for submission to its requirements. Further, while a bright- proposed hedging exemption would regulator.1189 line or safe harbor approach to the reduce legitimate hedging activity and d. Final Rule hedging exemption would generally thus impact market liquidity and the provide a high degree of certainty about banking entity’s willingness to engage in The final rule provides a multi- whether an activity qualifies for the permissible customer-related faceted approach to implementing the exemption, it would also provide less activity,1198 the Agencies note that the hedging exemption that seeks to ensure flexibility to recognize the differences in requirements of the final hedging that hedging activity is designed to be hedging activity across markets and exemption are designed to permit risk-reducing in nature and not asset classes.1193 In addition, the use of banking entities to properly mitigate designed to mask prohibited proprietary any bright-line approach would more specific risk exposures, consistent with trading.1190 The final rule includes a likely be subject to gaming and the statute. In addition, hedging related number of modifications in response to avoidance as new products and types of to market-making activity conducted by comments. trading activities are developed than This multi-faceted approach is a market-making desk is subject to the other approaches to implementing the intended to permit hedging activities requirements of the market-making hedging exemption. Similarly, the that are risk-mitigating and to limit exemption, which are designed to Agencies decline to establish a potential abuse of the hedging permit banking entities to continue presumption of compliance because, in exemption while not unduly providing valuable intermediation and light of the constant innovation of constraining the important risk- liquidity services, including related trading activities and the differences in 1199 management function that is served by risk-management activity. Thus, the hedging activity across markets and a banking entity’s hedging activities. final hedging exemption will not asset classes, establishing appropriate This approach is also intended to ensure negatively impact the safety and that any banking entity relying on the parameters for a presumption of soundness of banking entities or the compliance with the hedging exemption 1195 1181 See Occupy. would potentially be less capable of One commenter suggested this principles- 1182 recognizing these legitimate differences based approach. See HSBC. See BoA; Barclays; CH/ABASA; Credit Suisse 1196 (Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); than our current approach.1194 Section 13(d)(1)(C) of the BHC Act permits JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. Moreover, the Agencies decline to ‘‘risk-mitigating hedging activities in connection Trading) (Feb. 2012); see also Stephen Roach. with and related to individual or aggregated positions, contracts, or other holdings of a banking 1183 A detailed discussion of ALM activities is 1191 See SIFMA et al. (Prop. Trading) (Feb. 2012); entity that are designed to reduce the specific risks provided in Part VI.A.1.d.2 of this SUPPLEMENTARY JPMC; PNC et al.; ICI (Feb. 2012); BoA; Morgan to the banking entity in connection with and related INFORMATION relating to the definition of trading Stanley. to such positions, contracts, or other holdings.’’ 12 account. As explained in that part, the final rule 1192 U.S.C. 1851(d)(1)(C). does not allow use of the hedging exemption for See BoA; Barclays; CH/ABASA; Credit Suisse 1197 ALM activities that are outside of the hedging (Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); Some commenters were concerned that the activities specifically permitted by the final rule. JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. proposed hedging exemption was too broad and Trading) (Feb. 2012); see also Stephen Roach. that all proprietary trading could be designated as 1184 See BoA; JPMC; Morgan Stanley. 1193 Some commenters requested that the a hedge. See, e.g., Occupy. 1185 See SIFMA et al. (Prop. Trading) (Feb. 2012); Agencies establish a safe harbor. See Prof. 1198 See, e.g., Australian Bankers Ass’n. (Feb. JPMC; PNC et al.; ICI. Richardson; ABA (Keating). One commenter 2012); BoA; Barclays; Credit Suisse (Seidel); 1186 See Prof. Richardson; ABA (Keating). requested that the Agencies adopt a bright-line test. Goldman (Prop. Trading); HSBC; Japanese Bankers 1187 See Barclays; BoA; ISDA (Feb. 2012). See Johnson & Prof. Stiglitz. Ass’n.; JPMC; Morgan Stanley; Chamber (Feb. 1188 See Johnson & Prof. Stiglitz. 1194 A few commenters requested that the 2012); Wells Fargo (Prop. Trading); Rep. Bachus et 1189 See HSBC. Agencies establish a presumption of compliance. al.; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012). 1190 See final rule § 75.5. See Barclays; BoA; ISDA (Feb. 2012). 1199 See supra Part VI.A.3.c.4.

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financial system or have a chilling effect activity.1202 Some of these commenters banking entity limits its hedging on a banking entity’s willingness to advocated that the final rule presume activities to hedging that is risk- engage in other permitted activities, that a banking entity is in compliance mitigating.1211 The final rule largely such as market making.1200 with the hedging exemption if the retains the proposal’s approach to the These limits and requirements are banking entity’s hedging activity is done compliance program requirement, designed to prevent the type of activity in accordance with the written policies except to the extent that, as requested by conducted by banking entities in the and procedures required under its some commenters,1212 the final rule past that involved taking large positions compliance program.1203 One modifies the proposal to provide using novel strategies to attempt to commenter represented that the additional detail regarding the elements profit from potential effects of general proposed compliance framework was that must be included in a compliance economic or market developments and burdensome and complex.1204 program. Similar to the proposal, the thereby potentially offset the general Other commenters expressed final rule contemplates that the scope effects of those events on the revenues concerns that the hedging exemption and detail of a compliance program will or profits of the banking entity. The would be too limiting and burdensome reflect the size, activities, and documentation requirements in the final for community and regional banks.1205 complexity of banking entities in order rule support these limits by identifying Some commenters argued that foreign to ensure that banking entities engaged activity that occurs in reliance on the banking entities should not be subject to in more active trading have enhanced risk-mitigating hedging exemption at an the requirements of the hedging compliance programs without imposing organizational level or desk that is not exemption for transactions that do not undue burden on smaller organizations responsible for establishing the risk or introduce risk into the U.S. financial and entities that engage in little or no 1206 positions being hedged. system. Other commenters stated trading activity.1213 The final rule also that coordinated hedging through and requires, like the proposal, that the 1. Compliance Program Requirement by affiliates should qualify as permitted banking entity implement, maintain, 1207 The first criterion of the proposed risk-mitigating hedging activity. and enforce the program.1214 hedging exemption required a banking Some commenters urged the Agencies In response to commenter concerns entity to establish an internal to adopt detailed limitations on hedging about ensuring the appropriate level of compliance program designed to ensure activities. For example, one commenter senior management involvement in the banking entity’s compliance with urged that all hedging trades be labeled establishing these policies,1215 the final the requirements of the hedging as such at the inception of the trade and rule requires that the written policies exemption and conduct its hedging detailed information regarding the and procedures be developed and activities in compliance with that trader, manager, and supervisor implemented by a banking entity at the program. While the compliance program authorizing the trade be kept and appropriate level of organization and reviewed.1208 Another commenter under the proposal was expected to be expressly address the banking entity’s suggested that the hedging exemption appropriate for the size, scope, and requirements for escalation procedures, contain a requirement that the banking complexity of each banking entity’s supervision, and governance related to entity employee who approves a hedge activities and structure, the proposal hedging activities.1216 affirmatively certify that the hedge would have required each banking conforms to the requirements of the rule entity with significant trading activities 1211 and has not been put in place for the See final rule § 75.5(b)(1). The final rule to implement robust, detailed hedging retains the proposal’s requirement that the direct or indirect purpose or effect of policies and procedures and related compliance program include, among other things, generating speculative profits.1209 A few written hedging policies. internal controls and independent commenters requested limitations on 1212 See, e.g., BoA; ICI (Feb. 2012); ISDA (Feb. testing designed to prevent prohibited instruments that can be used for 2012); JPMC; Morgan Stanley; PNC; SIFMA et al. proprietary trading in the context of 1210 (Prop. Trading) (Feb. 2012). 1201 hedging purposes. 1213 permitted hedging activity. These The final rule retains the proposal’s See final rule § 75.20(a) (stating that ‘‘[t]he enhanced programs for banking entities terms, scope and detail of [the] compliance program requirement that a banking entity shall be appropriate for the types, size, scope and with large trading activity were establish an internal compliance complexity of activities and business structure of expected to include written hedging program that is designed to ensure the the banking entity’’). The Agencies believe this policies at the trading unit level and helps address some commenters’ concern that the hedging exemption would be too limiting and clearly articulated trader mandates for 1202 See SIFMA et al. (Prop. Trading) (Feb. 2012). burdensome for community and regional banks. See each trader designed to ensure that 1203 See BoA; Barclays; HSBC; JPMC; Morgan ICBA; M&T Bank. hedging strategies mitigated risk and Stanley; see also Goldman (Prop. Trading); RBC; 1214 Many of these policies and procedures were were not for the purpose of engaging in Barclays; ICI (Feb. 2012); ISDA (Apr. 2012); PNC; contained as part of the proposed rule’s compliance prohibited proprietary trading. SIFMA et al. (Prop. Trading) (Feb. 2012). See the program requirements under Appendix C. They discussion of why the Agencies decline to take a have been moved, and in some cases modified, in Commenters, including industry presumption of compliance approach above. order to more clearly demonstrate how they are 1204 groups, generally expressed support for See Barclays. incorporated into the requirements of the hedging requiring policies and procedures to 1205 See ICBA; M&T Bank. exemption. monitor the safety and soundness, as 1206 See, e.g., Bank of Canada; Allen & Overy (on 1215 See Better Markets (Feb. 2012). The final rule well as appropriateness, of hedging behalf of Canadian Banks). Additionally, foreign does not require affirmative certification of each banking entities engaged in hedging activity may be hedge, as suggested by this commenter, because the able to rely on the exemption for trading activity Agencies believe it would unnecessarily slow 1200 Some commenters believed that restrictions conducted by foreign banking entities in lieu of the legitimate transactions. The Agencies believe the on hedging would have a chilling effect on banking hedging exemption, provided they meet the final rule’s required management framework and entities’ willingness to engage in market making, requirements of the exemption for trading by escalation procedures achieve the same objective as and may result in customers experiencing difficulty foreign banking entities under § 75.6(e) of the final the commenter’s suggested approach, while in hedging their risks or force customers to retain rule. See infra Part VI.A.8. imposing fewer burdens on legitimate risk- risk. See SIFMA et al. (Prop. Trading) (Feb. 2012); 1207 See SIFMA et al. (Prop. Trading) (Feb. 2012); mitigating hedging activity. Credit Suisse (Seidel); Barclays; Goldman (Prop. JPMC. 1216 See final rule §§ 75.20(b), 75.5(b). This Trading); BoA; IHS. 1208 See Sens. Merkley & Levin (Feb. 2012). approach builds on the proposal’s requirement that 1201 These aspects of the compliance program 1209 See Better Markets (Feb. 2012). senior management and intermediate managers be requirement are described in further detail in Part 1210 See Sens. Merkley & Levin (Feb. 2012); accountable for the effective implementation of the VI.C. of this SUPPLEMENTARY INFORMATION. Occupy; Andrea Psoras. compliance program.

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Like the proposal, the final rule specific, identifiable risks being underlying positions.1221 This ongoing specifies that a banking entity’s hedged.1220 review should consider market compliance regime must include The final rule also adds that developments, changes in positions or reasonably designed written policies correlation analysis be undertaken as the configuration of aggregated and procedures regarding the positions, part of the analysis of the hedging positions, changes in counterparty risk, techniques and strategies that may be positions, techniques, and strategies that and other facts and circumstances used for hedging, including may be used. This provision effectively related to the risks associated with the documentation indicating what changes the requirement in the underlying and hedging positions, positions, contracts or other holdings a proposed rule that the hedge must contracts, or other holdings. trading desk may use in its risk- maintain correlation into a requirement The Agencies believe that requiring mitigating hedging activities.1217 The that correlation be analyzed as part of banking entities to develop and follow focus on policies and procedures the compliance program before a detailed compliance policies and governing risk identification and hedging activity is undertaken. This procedures related to risk-mitigating mitigation, analysis and testing of provision incorporates the concept in hedging activity will help both banking position limits and hedging strategies, the proposed rule that a hedge should entities and examiners understand the and internal controls and ongoing be correlated (negatively, when sign is risks to which banking entities are monitoring is expected to limit use of considered) to the risk being hedged. exposed and how these risks are managed in a safe and sound manner. the hedging exception to risk-mitigating However, the Agencies recognize that With this increased understanding, hedging. The final rule adds to the some effective hedging activities, such as deep out-of-the-money puts and calls, banking entities and examiners will be proposed compliance program approach better able to evaluate whether banking by requiring that the banking entity’s may not be exhibit a strong linear correlation to the risks being hedged entities are engaged in legitimate, risk- written policies and procedures include and also that correlation over a period reducing hedging activity, rather than position and aging limits with respect to of time between two financial positions impermissible proprietary trading. such positions, contracts, or other While the Agencies recognize there are 1218 does not necessarily mean one position holdings. The final rule, similar to will in fact reduce or mitigate a risk of certain costs associated with this the proposed rule, also requires that the the other. Rather, the Agencies expect compliance program requirement,1222 compliance program contain internal the banking entity to undertake a we believe this provision is necessary to controls and ongoing monitoring, correlation analysis that will, in many ensure compliance with the statute and management, and authorization but not all instances, provide a strong the final rule. As discussed in Part procedures, including relevant indication of whether a potential VI.C.1., the Agencies have modified the escalation procedures.1219 Further, the hedging position, strategy, or technique proposed compliance program structure final rule retains the proposed will or will not demonstrably reduce the to reduce burdens on small banking requirement that the compliance risk it is designed to reduce. It is entities.1223 program provide for the conduct of important to recognize that the rule does The Agencies note that hedging may analysis and independent testing not require the banking entity to prove occur across affiliates under the hedging designed to ensure that the positions, correlation mathematically or by other exemption.1224 To ensure that hedging techniques, and strategies that may be specific methods. Rather, the nature and across trading desks or hedging done at used for hedging may reasonably be extent of the correlation analysis a level of the organization outside of the expected to demonstrably reduce or undertaken would be dependent on the trading desk does not result in otherwise significantly mitigate the facts and circumstances of the hedge prohibited proprietary trading, the final and the underlying risks targeted. If rule imposes enhanced documentation 1217 This approach is generally consistent with correlation cannot be demonstrated, requirements on these activities, which some commenters’ suggested approach of limiting then the Agencies would expect that are discussed more fully below. The the instruments that can be used for hedging such analysis would explain why not Agencies also note that nothing in the purposes; although the final rules provide banking and also how the proposed hedging final rule limits or restricts the ability of entities with discretion to determine the types of positions, contracts, or other holdings that will position, technique, or strategy is the appropriate supervisory agency of a mitigate specific risks of individual or aggregated designed to reduce or significantly banking entity to place limits on holdings and thus may be used for risk-mitigating mitigate risk and how that reduction or interaffiliate hedging in a manner hedging activity. See Sens. Merkley & Levin (Feb. mitigation can be demonstrated without consistent with their safety and 2012); Occupy; Andrea Psoras. In response to one correlation. commenter’s request that the final rule require all soundness authority to the extent the hedges to be labeled at inception and certain Moreover, the final rule requires detailed information be documented for each hedge, hedging activity conducted in reliance 1221 The proposal also contained a continuing the Agencies note that the final rules continue to review, monitoring, and management requirement. require detailed documentation for hedging activity on the hedging exemption be subject to See proposed rule § 75.5(b)(2)(v). The final rule that presents a heightened risk of evasion. See Sens. continuing review, monitoring, and modifies the proposed requirement, however, by Merkley & Levin (Feb. 2012); final rule § 75.5(c); management that is consistent with the removing the ‘‘reasonable correlation’’ requirement infra Part VI.A.4.d.4. The Agencies believe a banking entity’s written hedging and instead requiring that the hedge demonstrably documentation requirement targeted at these reduce or otherwise significantly mitigate specific scenarios balances the need to prevent evasion of policies and procedures and is designed identifiable risks. Correlation analysis is, however, the general prohibition on proprietary trading with to reduce or otherwise significantly a necessary component of the analysis element in the concern that documentation requirements can mitigate, and demonstrably reduces or the compliance program requirement of the hedging slow or impede legitimate risk-mitigating activity in otherwise significantly mitigates, the exemption in the final rule. See final rule § 75.5(b). the normal course. specific, identifiable risks that develop This change is discussed below. 1218 See final rule § 75.5(b)(1)(i). Some 1222 See Barclays. commenters expressed support for the use of risk over time from hedging activity and 1223 See infra Part VI.C.1. Some commenters limits in determining whether trading activity expressed concern that the compliance program qualifies for the hedging exemption. See, e.g., 1220 See final rule § 75.5(b)(1)(iii). The final rule’s requirement would place undue burden on regional Barclays; Credit Suisse (Seidel); ICI (Feb. 2012); requirement to demonstrably reduce or otherwise or community banks. See ICBA; M&T Bank. Morgan Stanley. significantly mitigate is discussed in greater detail 1224 See SIFMA et al. (Prop. Trading) (Feb. 2012); 1219 See final rule § 75.5(b)(1)(ii). below. JPMC.

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agency has such authority.1225 could render a banking entity’s hedges reduce specific risks, the final rule Additionally, nothing in the final rule impermissible if those hedges do not requires that the hedging activity at limits or modifies the applicability of succeed in fully hedging or mitigating inception of the hedging activity, CFTC regulations with respect to the an identified risk as determined by a including, without limitation, any clearing of interaffiliate swaps.1226 post hoc analysis and could prevent adjustments to the hedging activity, be 2. Hedging of Specific Risks and banking entities from entering into designed to reduce or otherwise Demonstrable Reduction of Risk hedging transactions in anticipation of significantly mitigate and demonstrably risks that the banking entity expects will reduces or otherwise significantly Section 75.5(b)(2)(ii) of the proposed arise (or increase).1233 Certain mitigates one or more specific, rule required that a qualifying commenters requested that the hedging identifiable risks, including market risk, transaction hedge or otherwise mitigate exemption provide a safe harbor for counterparty or other credit risk, one or more specific risks, including positions that satisfy FASB ASC Topic currency or foreign exchange risk, market risk, counterparty or other credit 815 (formerly FAS 133) hedging interest rate risk, commodity price risk, risk, currency or foreign exchange risk, accounting standards, which provides basis risk, or similar risks, arising in interest rate risk, basis risk, or similar that an entity recognize derivative connection with and related to risks, arising in connection with and instruments, including certain identified individual or aggregated related to individual or aggregated derivative instruments embedded in positions, contracts, or other holdings of positions, contracts, or other holdings of other contracts, as assets or liabilities in the banking entity, based upon the facts 1227 a banking entity. This criterion the statement of financial position and and circumstances of the individual or implemented the essential element of measure them at fair value.1234 Another aggregated underlying and hedging the hedging exemption that the commenter suggested that scenario positions, contracts, or other holdings of transaction be risk-mitigating. hedges could be identifiable and subject the banking entity and the risks and Some commenters expressed support to review by the Agencies using VaR, liquidity thereof.1238 Hedging activities for this provision, particularly the Stress VaR, and VaR Exceedance, as and limits should be based on analysis requirement that a banking entity be well as revenue metrics.1235 conducted by the banking entity of the able to tie a hedge to a specific risk.1228 The Agencies have considered these appropriateness of hedging instruments, One of these commenters stated that a comments carefully in light of the strategies, techniques, and limits. As demonstrated reduction in risk should statute. Section 13(d)(1)(C) of the BHC discussed above, this analysis must be a key indicator of whether a hedge Act provides an exemption from the include analysis of correlation between is in fact permitted.1229 However, some prohibition on proprietary trading only the hedge and the specific identifiable commenters argued that the list of risks for hedging activity that is ‘‘designed to risk or risks that the hedge is designed eligible to be hedged under the reduce the specific risks to the banking 1239 proposed rule, which included risks to reduce or significantly mitigate. entity in connection with and related arising from aggregated positions, could This language retains the focus of the to’’ individual or aggregated positions, justify transactions that should be statute and the proposed rule on contracts, or other holdings of the viewed as prohibited proprietary reducing or mitigating specific and banking entity.1236 Thus, while the 1240 trading.1230 Another commenter identified risks. As discussed more statute permits hedging of individual or contended that the term ‘‘basis risk’’ fully above, banking entities are aggregated positions (as discussed more was undefined and could heighten the required to describe in their compliance fully below), the statute requires that, to potential that this exemption would be policies and procedures the types of be exempt from the prohibition on used to evade the prohibition on strategies, techniques, and positions that proprietary trading, hedging proprietary trading.1231 may be used for hedging. transactions be designed to reduce The final rule does not prescribe the Other commenters argued that 1237 requiring a banking entity to specify the specific risks. Moreover, it requires hedging strategy that a banking entity particular risk being hedged discourages that these specific risks be in connection must employ. While one commenter effective hedging and increases the risk with or related to the individual or urged that the final rule require each at banking entities. These commenters aggregated positions, contracts, or other banking entity to adopt the ‘‘best hedge’’ 1241 contended that hedging activities must holdings of the banking entity. for every transaction, the Agencies The final rule implements these address constantly changing positions believe that the complexity of positions, requirements. To ensure that exempt and market conditions.1232 Another market conditions at the time of a hedging activities are designed to commenter argued that this requirement transaction, availability of hedging

1233 See Barclays. 1238 See final rule § 75.5(b)(2)(ii). 1225 In addition, section 608 of the Dodd-Frank 1234 See ABA (Keating); Wells Fargo (Prop. 1239 Act added credit exposure arising from securities See final rule § 75.5(b)(1)(iii). Trading). Although certain accounting standards, 1240 borrowing and lending or a derivative transaction Some commenters represented that the such as FASB ASC Topic 815 hedge accounting with an affiliate to the list of covered transactions proposed list of risks eligible to be hedged could standards, address circumstances in which a subject to the restrictions of section 23A of the FR justify transactions that should be considered transaction may be considered a hedge of another Act, in each case to the extent that such transaction proprietary trading. See Public Citizen; Occupy. transaction, the final rule does not refer to or causes a bank to have credit exposure to the One commenter was concerned about the proposed expressly rely on these accounting standards affiliate. See 12 U.S.C. 371c(b)(7) and (8). As a inclusion of ‘‘basis risk’’ in this list. See Occupy. because such standards: (i) are designed for consequence, interaffiliate hedging activity within a As noted in the proposal, the Agencies believe the financial statement purposes, not to identify banking entity may be subject to limitation or inclusion of a list of eligible risks, including basis proprietary trading; and (ii) change often and are restriction under section 23A of the FR Act. risk, helps implement the essential element of the likely to change in the future without consideration 1226 See 17 CFR 50.52. statutory hedging exemption—i.e., that the of the potential impact on section 13 of the BHC transaction is risk-reducing in connection with a 1227 See proposed rule § 75.5(b)(2)(ii); see also Act. specific risk. See Joint Proposal, 76 FR at 68875. See Joint Proposal, 76 FR at 68875. 1235 See JPMC. also 12 U.S.C. 1851(d)(1)(C). Further, the Agencies 1228 See AFR (June 2013); Sens. Merkley & Levin 1236 12 U.S.C. 1851(d)(1)(C). believe the other requirements of the final hedging (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz. 1237 Some commenters expressed support for the exemption, including requirements regarding 1229 See Sens. Merkley & Levin (Feb. 2012). requirement that a banking entity tie a hedge to a internal controls and a compliance program, help 1230 See Public Citizen; see also Occupy. specific risk. See AFR (June 2012); Sens. Merkley to ensure that only legitimate hedging activity 1231 See Occupy. & Levin (Feb. 2012); Public Citizen; Johnson & Prof. qualifies for the exemption. 1232 See, e.g., Japanese Bankers Ass’n. Stiglitz. 1241 See, e.g., Occupy.

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transactions, costs of hedging, and other hedging may result in modification of a chilling effect on risk managers’ circumstances at the time of the hedging exposures across a variety of willingness to engage in otherwise transaction make a requirement that a underlying risks, even as the overall risk permitted hedging activity.1250 banking entity always adopt the ‘‘best profile of a banking entity is reduced, it Other commenters stated that a hedge’’ impractical, unworkable, and would become impossible to position that does not fully offset the subjective. subsequently review, monitor, and risk of an underlying position is not in Nonetheless, the statute requires that, manage individual hedging transactions fact a hedge.1251 These commenters to be exempt under section 13(d)(1)(C), for compliance.1244 The Agencies note believed that the introduction of new hedging activity must be risk-mitigating. that the final rule, like the statute, risks at inception of a transaction To ensure that only risk-mitigating requires that the hedging activity relate indicated that the transaction was hedging is permitted under this to individual or aggregated positions, impermissible proprietary trading and exemption, the final rule requires that in contracts or other holdings being not a hedge.1252 its written policies and procedures the hedged, and accordingly, the review, The Agencies recognize that prudent banking entity identify the instruments monitoring and management risk-reducing hedging activities by and positions that may be used in requirement would not limit the extent banking entities are important to the hedging, the techniques and strategies of permitted hedging provided for in efficiency of the financial system.1253 the banking entity deems appropriate section 13(d)(1)(C) as implied by some The Agencies further recognize that for its hedging activities, as well as commenters. Further, the final rule hedges are generally imperfect; position limits and aging limits on recognizes that the determination of consequently, hedging activities can hedging positions. These written whether hedging activity demonstrably introduce new and sometimes policies and procedures also must reduces or otherwise significantly significant risks, such as credit risk, specify the escalation and approval mitigates risks that may develop over basis risk, or new market risk, especially procedures that apply if a trader seeks time should be ‘‘based upon the facts when hedging illiquid positions.1254 to conduct hedging activities beyond the and circumstances of the underlying However, the Agencies also recognize limits, position types, strategies, or and hedging positions, contracts and that hedging activities present an techniques authorized for the trader’s other holdings of the banking entity and opportunity to engage in impermissible activities.1242 the risks and liquidity thereof.’’ 1245 proprietary trading designed to profit As noted above, commenters were A number of other commenters from exposure to these types of risks. concerned that risks associated with argued that a legitimate risk-reducing To address these competing concerns, permitted activities and holdings hedge may introduce new risks at the final rule substantially retains the change over time, making a inception.1246 A few commenters proposed requirement that, at the determination regarding the contended that a requirement that no inception of the hedging activity, the effectiveness of hedging activities in new risks be associated with a hedge risk-reducing hedging activity does not reducing risk dependent on the time would be inconsistent with prudent risk give rise to significant new or additional when risk is measured. To address this, management and greatly reduce the risk that is not itself contemporaneously the final rule requires that the exempt ability of banking entities to reduce hedged. This approach is designed to hedging activity be designed to reduce overall risk through hedging.1247 A few allow banking entities to continue to or otherwise significantly mitigate, and commenters stated that the proposed engage in prudent risk-mitigating demonstrably reduces or otherwise requirement does not recognize that it is activities while ensuring that the significantly mitigates, risk at the not always possible to hedge a new risk hedging exemption is not used to engage inception of the hedge. As explained exposure arising from a hedge in a cost- in prohibited proprietary trading by more fully below, because risks and the effective manner.1248 With respect to the taking on prohibited short-term effectiveness of a hedging strategy may timing of the initial hedge and any exposures under the guise of change over time, the final rule also additional transactions necessary to hedging.1255 As noted in the proposal, requires the banking entity to reduce significant exposures arising implement a program to review, from it, one of these commenters 1250 See BoA. monitor, and manage its hedging represented that requiring 1251 See Sens. Merkley & Levin (Feb. 2012); Public activity over the period of time the contemporaneous hedges is Citizen; AFR (Nov. 2012). 1252 See Better Markets (Feb. 2012); AFR et al. hedging activity occurs in a manner impracticable, would raise transaction (Feb. 2012). designed to reduce or significantly costs, and would make hedging 1253 See FSOC study (stating that ‘‘[p]rudent risk mitigate and demonstrably reduce or uneconomic.1249 Another commenter management is at the core of both institution- otherwise significantly mitigate new or stated that this requirement could have specific safety and soundness, as well as changing risks that may develop over macroprudential and financial stability’’). 1254 1244 See, e.g., SIFMA et al. (Prop. Trading) (Feb. time from both the banking entity’s See Barclays. 2012). 1245 hedging activities and the underlying Final rule § 75.5(b)(2)(iv)(B). The Agencies 1255 Some commenters stated that it is not always positions. Many commenters expressed believe this provision addresses some commenters’ possible to hedge a new risk exposure arising from concern that the ongoing review, monitoring, and a hedge in a cost-effective manner, and requiring concern that the proposed ongoing management requirement would limit hedging of contemporaneous hedges would raise transaction review, monitoring, and management aggregated positions, and that such ongoing review costs and the potential for hedges to become of individual hedge transactions with a variety of requirement would limit a banking uneconomical. See SIFMA et al. (Prop. Trading) underlying risks would be impossible. See SIFMA entity’s ability to engage in aggregated (Feb. 2012); Barclays. As noted in the proposal, the (Prop. Trading) (Feb. 2012); Barclays; ICI (Feb. 1243 Agencies believe that requiring a contemporaneous position hedging. One commenter 2012); Morgan Stanley. hedge of any significant new risk that arises at the stated that because aggregated position 1246 See ABA (Keating); BoA; Barclays; Credit inception of a hedge is appropriate because a Suisse (Seidel); Goldman (Prop. Trading); SIFMA et transaction that creates significant new risk 1242 A banking entity must satisfy the enhanced al. (Prop. Trading) (Feb. 2012); see also AFR et al. exposure that is not itself hedged at the same time documentation requirements of § 75.5(c) if it (Feb. 2012). would appear to be indicative of prohibited engages in hedging activity utilizing positions, 1247 See Credit Suisse (Seidel); Goldman (Prop. proprietary trading. See Joint Proposal, 76 FR at contracts, or holdings that were not identified in its Trading); SIFMA et al. (Prop. Trading) (Feb. 2012). 68876. Thus, the Agencies believe this requirement written policies and procedures. 1248 See SIFMA et al. (Prop. Trading) (Feb. 2012); is necessary to prevent evasion of the general 1243 See SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays. prohibition on proprietary trading. In response to Barclays; ICI (Feb. 2012); Morgan Stanley. 1249 See SIFMA et al. (Prop. Trading) (Feb. 2012). Continued

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however, the Agencies recognize that The proposed rule explained that, to presence of portfolio hedging should be exposure to new risks may result from be exempt under this provision, hedging viewed as an indicator of imperfections legitimate hedging transactions; 1256 this activities must reduce risk with respect in hedging at the desk level and be a flag provision only prohibits the to ‘‘positions, contracts, or other used by examiners to identify and introduction of additional significant holdings of the banking entity.’’ The review the integrity of specific exposures through the hedging proposal also required that a banking hedges.1269 transaction unless those additional entity relying on the exemption be The final rule, like the proposed rule, exposures are contemporaneously prepared to identify the specific implements the statutory language hedged. position or risks associated with providing for risk-mitigating hedging As noted above, the final rule aggregated positions being hedged and activities related to individual or recognizes that whether hedging activity demonstrate that the hedging aggregated positions. For example, will demonstrably reduce risk must be transaction was risk-reducing in the activity permitted under the hedging based upon the facts and circumstances aggregate, as measured by appropriate exemption would include the hedging of the individual or aggregated risk management tools. of one or more specific risks arising underlying and hedging positions, Some commenters were of the view from identified positions, contracts, or contracts, or other holdings of the that the hedging exemption applied to other holdings, such as the hedging of banking entity and the risks and aggregated positions or portfolio the aggregate risk of identified positions liquidity thereof.1257 The Agencies hedging and was consistent with of one or more trading desks. Further, believe this approach balances prudent risk-management practices. the final rule requires that these hedging commenters’ request that the Agencies These commenters argued that activities be risk-reducing with respect clarify that a banking entity may use its permitting a banking entity to hedge to the identified positions, contracts, or discretion to choose any hedging aggregate positions and risks arising other holdings being hedged and that strategy that meets the requirements of from a portfolio of assets would be more the risk reduction be demonstrable. the proposed exemption 1258 with efficient from both a procedural and Specifically, the final rule requires, 1264 concerns that allowing banking entities business standpoint. among other things: That the banking to rely on the cheapest satisfactory By contrast, other commenters argued entity has a robust compliance program hedge will lead to additional hedging that portfolio-based hedging could be reasonably designed to ensure 1259 used to mask prohibited proprietary compliance with the exemption; that transactions. The Agencies expect 1265 that hedging strategies and techniques, trading. One commenter contended each hedge is subject to continuing as well as assessments of risk, will vary that the statute provides no basis for review, monitoring and management across positions, markets, activities and portfolio hedging, and another designed to demonstrably reduce or banking entities, and that a ‘‘one-size- commenter similarly suggested that otherwise significantly mitigate the portfolio hedging should be specific, identifiable risks that develop fits-all’’ approach would not 1266 accommodate all types of appropriate prohibited. Another commenter over time related to the hedging activity and the underlying positions, contracts, hedging activity.1260 suggested adopting limits that would prevent the use of the hedging or other holdings of the banking entity; By its terms, section 13(d)(1)(C) of the exemption to conduct proprietary and that the banking entity meet a BHC Act permits a banking entity to activity at one desk as a theoretical documentation requirement for hedges engage in risk-mitigating hedging ‘‘hedge for proprietary trading at not established by the trading desk activity ‘‘in connection with and another desk.’’ 1267 responsible for the underlying position related to individual or aggregated Among the limits suggested by these commenters were a or for hedges effected through a positions . . . .’’ 1261 The preamble to requirement that a banking entity have financial instrument, technique or the proposed rule made clear that, a well-defined compliance program, the strategy that is not specifically consistent with the statutory reference formation of central ‘‘risk management’’ identified in the trading desk’s written to mitigating risks of individual or groups to perform and monitor hedges policies and procedures. The Agencies aggregated positions, this criterion of aggregated positions, and a believe this approach addresses permits hedging of risks associated with requirement that the banking entity concerns that a banking entity could use aggregated positions.1262 This approach demonstrate the capacity to measure the hedging exemption to conduct is consistent with prudent risk- aggregate risk across the institution with proprietary activity at one desk as a management and safe and sound precision using proven models.1268 A theoretical hedge for proprietary trading banking practice.1263 few commenters suggested that the at another desk in a manner consistent with the statute.1270 Further, the commenters’ concerns about transaction costs and 1264 See, e.g. ABA (Keating); Ass’n. of Agencies believe the adopted exemption uneconomical hedging, the Agencies note that this Institutional Investors (Sept. 2012); BoA; see also provision only requires additional hedging of allows banking entities to engage in Barclays (expressing concern that the proposed rule 1271 ‘‘significant’’ new or additional risk and does not hedging of aggregated positions could result in regulatory review of individual apply to any risk exposure arising from a hedge. while helping to ensure that such hedging trades for compliance on a post hoc basis); 1256 See Joint Proposal, 76 FR at 68876. HSBC; ISDA (Apr. 2012); ICI (Feb. 2012); PNC; hedging activities are truly risk- 1257 See final rule § 75.5(b)(2)(ii). MetLife; RBC; SIFMA (Prop. Trading) (Feb. 2012). mitigating.1272 1258 See SIFMA (Prop. Trading) (Feb. 2012); 1265 See, e.g., AFR et al. (Feb. 2012); Sens. Credit Suisse (Seidel); Barclays; Goldman (Prop. Merkley & Levin (Feb. 2012); Occupy; Public 1269 See Public Citizen; Occupy; AFR et al. (Feb. Trading); BoA. Citizen; Johnson & Prof. Stiglitz. 2012). 1259 See Occupy. 1266 See Sens. Merkley & Levin (Feb. 2012) 1270 See AFR et al. (Feb. 2012) (citing 156 Cong. 1260 See Barclays. (commenting that the use of the term ‘‘aggregate’’ Rec. S5898 (daily ed. July 15, 2010) (statement of 1261 12 U.S.C. 1851(d)(1)(C). positions was intended to note that firms do not Sen. Merkley)). 1262 See Joint Proposal, 76 FR at 68875. have to hedge on a trade-by-trade basis but could 1271 See MetLife; SIFMA et al. (Prop. Trading) 1263 See, e.g., Australian Bankers’ Ass’n. (Feb. not hedge on a portfolio basis); Johnson & Prof. (Feb. 2012); Morgan Stanley; Barclays; Goldman 2012); BoA; Barclays; Credit Suisse (Seidel); Stiglitz. (Prop. Trading); BoA; ABA (Keating); HSBC; Fixed Goldman (Prop. Trading); HSBC; ICI (Feb. 2012); 1267 See AFR et al. (Feb. 2012) (citing 156 Cong. Income Forum/Credit Roundtable; ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; Morgan Stanley; Rec. S5898 (daily ed. July 15, 2010) (statement of ISDA (Feb. 2012). Wells Fargo (Prop. Trading); Rep. Bachus et al.; Sen. Merkley)). 1272 The Agencies believe certain limits suggested RBC; SIFMA (Prop. Trading) (Feb. 2012). 1268 See, e.g., Occupy; Public Citizen. by commenters, such as the formation of central

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As noted above, several commenters entity is otherwise lawfully permitted to level of correlation,’’ might impede truly questioned whether the hedging have. risk-reducing hedging activity.1279 exemption should apply to ‘‘portfolio’’ When undertaking a hedge to mitigate A number of commenters asserted hedging and whether portfolio hedging the risk of an aggregation of positions, that there could be confusion over the may create the potential for abuse of the the banking entity must be able to meaning of ‘‘reasonable correlation,’’ hedging exemption. The term ‘‘portfolio specifically identify the risk factors which was used in the proposal as part hedging’’ is not used in the statute. The arising from this set of positions. In of explaining what type of activity language of section 13(d)(1)(C) of the identifying the aggregate set of positions would qualify for the hedging BHC Act permits a banking entity to that is being hedged for purposes of exemption. Some commenters urged engage in risk-mitigating hedging § 75.5(b)(2)(ii) and, where applicable, requiring that there be a ‘‘high’’ or activity ‘‘in connection with and § 75.5(c)(2)(i), the banking entity needs ‘‘strong’’ correlation between the hedge related to individual or aggregated to identify the positions being hedged and the risk of the underlying asset.1280 positions . . . .’’ 1273 After consideration with sufficient specificity so that at any of the comments regarding portfolio point in time, the specific financial Other commenters indicated that hedging, and in light of the statutory instrument positions or components of uncertainty about the meaning of language, the Agencies are of the view financial instrument positions held by reasonable correlation could limit valid that the statutory language is clear on its the banking entity that comprise the set risk-mitigating hedging activities face that a banking entity may engage in of positions being hedged can be clearly because the level of correlation between risk-mitigating hedging in connection identified. a hedge and the risk of the position or with aggregated positions of the banking The proposal would have permitted a aggregated positions being hedged entity. The permitted hedging activity, series of hedging transactions designed changes over time as a result of changes when involving more than one position, to rebalance hedging position(s) based in market factors and conditions.1281 contract, or other holding, must be in on changes resulting from permissible Some commenters represented that the connection with or related to aggregated activities or from a change in the price proposed provision would cause certain positions of the banking entity. or other characteristic of the individual administrative burdens 1282 or may Moreover, hedging of aggregated or aggregated positions, contracts, or result in a reduction in market-making positions under this exemption must be other holdings being hedged.1275 The activities in certain asset classes.1283 A related to identifiable risks related to Agencies recognized that, in such few commenters expressed concern that specific positions, contracts, or other dynamic hedging, material changes in the reasonable correlation requirement holdings of the banking entity. Hedging risk may require a corresponding could render a banking entity’s hedges activity must mitigate one or more modification to the banking entity’s impermissible if they do not succeed in specific risks arising from an identified current hedge positions.1276 being reasonably correlated to the position or aggregation of positions. The Some commenters questioned the relevant risk or risks based on an after- risks in this context are not intended to risk-mitigating nature of a hedge if, at the-fact analysis that incorporates be more generalized risks that a trading inception, that hedge contained market developments that could not desk or combination of desks, or the component risks that must be have been foreseen at the time the hedge banking entity as a whole, believe exists dynamically managed throughout the was placed. These commenters tended based on non-position-specific life of the hedge. These commenters to favor a different approach or a type modeling or other considerations. For stated that hedges that do not of safe harbor based on an initial example, the hedging activity cannot be continuously match the risk of determination of correlation.1284 Some designed to: Reduce risks associated underlying positions are not in fact risk- commenters argued the focus of the 1277 with the banking entity’s assets and/or mitigating hedges in the first place. hedging exemption should be on risk liabilities generally, general market On the other hand, other commenters reduction and not on reasonable movements or broad economic argued that banking entities must be conditions; profit in the case of a permitted to engage in dynamic hedging 1279 See, e.g., BoA; Barclays; ISDA (Apr. 2012); general economic downturn; activity, such as in response to market PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. counterbalance revenue declines conditions which are unforeseeable or 2012). generally; or otherwise arbitrage market out of the control of the banking 1280 See, e.g., Occupy; Public Citizen; AFR et. al. imbalances unrelated to the risks entity,1278 and expressed concern that (Feb. 2012); AFR (June 2013); Better Markets (Feb. resulting from the positions lawfully the limitations of the proposed rule, 2012); Sens. Merkley & Levin (Feb. 2012). held by the banking entity.1274 Rather, 1281 See BoA; Barclays; Comm. on Capital Markets especially the requirement that hedging Regulation; Credit Suisse (Seidel); FTN; Goldman the hedging exemption permits the transactions ‘‘maintain a reasonable (Prop. Trading); ICI (Feb. 2012); Japanese Bankers banking entity to engage in trading Ass’n.; JPMC; Morgan Stanley; SIFMA et al. (Prop. activity designed to reduce or otherwise 1275 See proposed rule § 75.5(b)(2)(ii) (requiring Trading) (Feb. 2012); STANY; see also Chamber mitigate specific identifiable risks that the hedging transaction ‘‘hedges or otherwise (Feb. 2012). 1282 related to identified individual or mitigates one or more specific risks . . . arising in See Japanese Bankers Ass’n.; Goldman (Prop. connection with and related to individual or Trading); BoA. aggregated positions that the banking aggregated positions, contracts, or other holdings of 1283 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012). [the] banking entity’’). The proposal noted that this As discussed above, market-maker hedging at the ‘‘risk management’’ groups to monitor hedges of requirement would include, for example, dynamic trading desk level is no longer subject to the aggregated positions, are unnecessary given the hedging. See Joint Proposal, 76 FR at 68875. hedging exemption and is instead subject to the aforementioned limits in the final rule. See Occupy; 1276 The proposal noted that this corresponding requirements of the market-making exemption, Public Citizen. modification to the hedge should also be reasonably which is designed to permit banking entities to 1273 See 12 U.S.C. 1851(d)(1)(C). correlated to the material changes in risk that are continue providing legitimate market-making 1274 The Agencies believe that it would be intended to be hedged or otherwise mitigated, as services, including managing the risk of market- inconsistent with Congressional intent to permit required by § 75.5(b)(2)(iii) of the proposed rule. making activity. See also supra Part VI.A.3.c.4. of some or all of these activities under the hedging 1277 See AFR et al. (Feb. 2012); Public Citizen; see this SUPPLEMENTARY INFORMATION. exemption, regardless of whether certain metrics also Better Markets (Feb. 2012), Sens. Merkley & 1284 See Barclays; Goldman (Prop. Trading); could be useful for monitoring such activity. See Levin (Feb. 2012). Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) JPMC. 1278 See Japanese Bankers Ass’n. (Feb. 2012); see also FTN; BoA.

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correlation.1285 One commenter impede legitimate hedging activity,1290 hedging. Additionally, the final rule suggested that risk management metrics and require an after-the-fact requires the banking entity to engage in such as VaR and risk factor sensitivities analysis.1291 ongoing review, monitoring, and could be the focus for permitted hedging Second, the final rule provides that management of its positions and related instead of requirements like reasonable the determination of whether an activity hedging activity to reduce or otherwise correlation under the proposal.1286 or strategy is risk-reducing or mitigating significantly mitigate the risks that In consideration of commenter must, in the first instance, be made at develop over time. This ongoing concerns about the proposed reasonable the inception of the hedging activity. A hedging activity must be designed to correlation requirement, the final rule trade that is not risk-reducing at its reduce or otherwise significantly modifies the proposal in the following inception is not viewed as a hedge for mitigate, and must demonstrably reduce key respects. First, the final rule purposes of the exemption in § 75.5.1292 or otherwise significantly mitigate, the modifies the requirement of ‘‘reasonable Third, the final rule requires that the material changes in risk that develop correlation’’ by providing that the hedge banking entity conduct analysis and over time from the positions, contracts, demonstrably reduce or otherwise independent testing designed to ensure or other holdings intended to be hedged significantly mitigate specific that the positions, techniques, and or otherwise mitigated in the same way, identifiable risks.1287 This change is strategies used for hedging are as required for the initial hedging designed to reinforce that hedging reasonably designed to reduce or activity. Moreover, the banking entity is activity should be demonstrably risk otherwise mitigate the risk being required under the final rule to support reducing or mitigating rather than hedged. As noted above, such analysis its decisions regarding appropriate simply correlated to risk. This change and testing must include correlation hedging positions, strategies and acknowledges that hedges need not analysis. Evidence of negative techniques for its ongoing hedging simply be correlated to underlying correlation may be a strong indicator activity in the same manner as for its positions, and that hedging activities that a given hedging position or strategy initial hedging activities. In this should be consciously designed to is risk-reducing. Moreover, positive manner, the final rule permits a banking reduce or mitigate identifiable risks, not correlation, in some instances, may be entity to engage in effective simply the result of pairing correlated an indicator that a hedging position or management of its risks throughout positions, as some commenters strategy is not designed to be risk- changing market conditions 1294 while suggested.1288 As discussed above, the mitigating. The type of analysis and also seeking to prohibit the banking Agencies do, however, recognize that factors considered in the analysis entity from taking large proprietary correlation is often a critical element of should take account of the facts and positions through action or inaction demonstrating that a hedging activity circumstances, including type of related to an otherwise permissible 1295 reduces the risks it is designed to position being hedged, market hedge. address. Accordingly, the final rule conditions, depth and liquidity of the As explained above, the final rule requires that banking entities conduct market for the underlying and hedging requires a banking entity relying on the correlation analysis as part of the position, and type of risk being hedged. hedging exemption to be able to required compliance program in order The Agencies recognize that markets demonstrate that the banking entity is to utilize the hedging exemption.1289 and risks are dynamic and that the risks exposed to the specific risks being The Agencies believe this change better from a permissible position or hedged at the inception of the hedge allows consideration of the facts and aggregated positions may change over and any adjustments thereto. However, in the proposal, the Agencies requested circumstances of the particular hedging time, new risks may emerge in the comment on whether the hedging activity as part of the correlation positions underlying the hedge and in exemption should be available in analysis and therefore addresses the hedging position, new risks may certain cases where hedging activity commenters’ concerns that the proposed emerge from the hedging strategy over begins before the banking entity reasonable correlation requirement time, and hedges may become less becomes exposed to the underlying risk. could cause administrative burdens, effective over time in addressing the related risk.1293 The final rule, like the The Agencies proposed that the hedging exemption would be available in certain 1285 See, e.g., FTN; Goldman (Prop. Trading); proposal, continues to allow dynamic ISDA (Apr. 2012); see also Sens. Merkley & Levin cases where the hedge is established (Feb. 2012); Occupy. 1290 Some commenters expressed concern that the ‘‘slightly’’ before the banking entity 1286 See Goldman (Prop. Trading). Consistent proposed ‘‘reasonable correlation’’ requirement becomes exposed to the underlying risk with the FSOC study and the proposal, the might impede truly risk-reducing activity. See, e.g., if such anticipatory hedging activity: (i) Agencies continue to believe that quantitative BoA; Barclays; Comm. on Capital Markets Was consistent with appropriate risk measurements can be useful to banking entities and Regulation; Credit Suisse (Seidel); FTN; Goldman the Agencies to help assess the profile of a trading (Prop. Trading); ICI (Feb. 2012); ISDA (Apr. 2012); management practices; (ii) otherwise desk’s trading activity and to help identify trading Japanese Bankers Ass’n.; JPMC; Morgan Stanley; met the terms of the hedging exemption; activity that may warrant a more in-depth review. PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. and (iii) did not involve the potential for See infra Part VI.C.3.; final rule Appendix A. The 2012); STANY. Some of these commenters stated speculative profit. For example, a Agencies do not intend to use quantitative that the proposed requirement would cause measurements as a dispositive tool for administrative burdens. See Japanese Bankers banking entity that was contractually differentiating between permitted hedging activities Ass’n.; Goldman (Prop. Trading); BoA. obligated or otherwise highly likely to and prohibited proprietary trading. 1291 See Barclays; Goldman (Prop. Trading); 1287 Some commenters stated that the hedging Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) 1294 A few commenters expressed concern that exemption should focus on risk reduction, not (Feb. 2012; see also FTN. the proposed ‘‘reasonable correlation’’ requirement reasonable correlation. See, e.g., FTN; Goldman 1292 By contrast, the proposed requirement did would render hedges impermissible if not (Prop. Trading); ISDA (Apr. 2012); Sens. Merkley & not specify that the hedging activity reduce risk ‘‘at reasonably correlated to the relevant risk(s) based Levin (Feb. 2012); Occupy. One of these the inception of the hedge.’’ See proposed rule on a post hoc analysis. See, e.g., Barclays; Goldman commenters noted that demonstrated risk reduction § 75.5(b)(2)(ii). (Prop. Trading); Chamber (Feb. 2012); SIFMA et al. should be a key requirement. See Sens. Merkley & 1293 Some commenters noted that hedging (Prop. Trading) (Feb. 2012). Levin (Feb. 2012). activities must address constantly changing 1295 Some commenters questioned the risk- 1288 See FTN; Goldman (Prop. Trading); ISDA positions and market conditions and expressed mitigating nature of a hedge if, at inception, it (Apr. 2012); see also Sens. Merkley & Levin (Feb. concern about requiring a banking entity to identify contained risks that must be dynamically managed 2012); Occupy. the particular risk being hedged. See Japanese throughout the life of the hedge. See, e.g., AFR et 1289 See final rule § 75.5(b)(1)(iii). Bankers Ass’n.; Barclays. al. (Feb. 2012); Public Citizen.

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become exposed to a particular risk By contrast, another commenter urged ongoing recalibration of the hedging could engage in hedging that risk in the Agencies to adopt a specific metric activity by the banking entity to ensure advance of actual exposure.1296 to track realized profits on hedging that the hedging activity satisfies the A number of commenters argued that activities as an indicator of prohibited requirements set out in § 75.5(b)(2) and anticipatory hedging is a necessary and arbitrage trading.1304 is not prohibited proprietary trading. If prudent activity and that the final rule Like the proposal, the final rule does an anticipated risk does not materialize should permit anticipatory hedging not prohibit anticipatory hedging. within a limited time period more broadly than did the proposed However, in response to commenter contemplated when the hedge is entered 1297 rule. In particular, commenters were concerns that the proposal would limit into, under these provisions, the concerned that permitting hedging a banking entity’s ability to respond to banking entity would be required to activity only if it occurs ‘‘slightly’’ customer requests and engage in extinguish the anticipatory hedge or before a risk is taken could limit prudent risk management, the final rule otherwise demonstrably reduce the risk hedging activities that are crucial to risk does not retain the proposed associated with that position as soon as management.1298 Commenters requirement discussed above that an reasonably practicable after it is expressed concern that the proposed anticipatory hedge be established determined that the anticipated risk will approach would, among other things, ‘‘slightly’’ before the banking entity not materialize. This requirement make it difficult for banking entities to becomes exposed to the underlying risk accommodate customer requests for and meet certain conditions. To address focuses on the purpose of the hedge as transactions with specific price or size commenter concerns with the statutory a trade designed to reduce anticipated executions 1299 and limit dynamic mandate, several parts of the final rule risk and not for other purposes. The hedging activities that are important to are designed to ensure that all hedging Agencies will (and expect that banking sound risk management.1300 In addition, activities, including anticipatory entities also will) monitor the activities a number of commenters requested that hedging activities, are designed to be of banking entities to identify prohibited the rule permit banking entities to risk reducing and not impermissible trading activity that is disguised as engage in scenario hedging, a form of proprietary trading activities. For anticipatory hedging. anticipatory hedging that addresses example, the final rule retains the As noted above, one commenter potential exposures to ‘‘tail risks.’’ 1301 proposed requirement that a banking suggested the Agencies adopt a metric to Some commenters expressed concern entity have reasonably designed policies monitor the profitability of a banking about the proposed criterion that the and procedures indicating the positions, entity’s hedging activity.1307 We are not hedging activity not involve the techniques and strategies that each adopting such a metric because we do potential for speculative profit.1302 trading desk may use for hedging. These not believe it would be useful to These commenters argued that the policies and procedures should monitor the profit and loss associated proper focus of the hedging exemption specifically address when anticipatory with hedging activity in isolation should be on the purpose of the hedging is appropriate and what without considering the profit and loss transaction, and whether the hedge is policies and procedures apply to associated with the individual or correlated to the underlying risks being anticipatory hedging. aggregated positions being hedged. For hedged (in other words, whether the The final rule also requires that a example, the commenter’s suggested 1303 hedge is effective in mitigating risk). banking entity relying on the hedging metric would not appear to provide exemption be able to demonstrate that information about whether the gains 1296 See Joint Proposal, 76 FR at 68875. the hedging activity is designed to arising from hedging positions offset or 1297 See, e.g., Barclays; SIFMA et al. (Prop. reduce or significantly mitigate, and mitigate losses from individual or Trading); Japanese Bankers Ass’n.; Credit Suisse does demonstrably reduce or otherwise (Seidel); BoA; PNC et al.; ISDA (Feb. 2012). aggregated positions being hedged. 1298 See BoA; Credit Suisse (Seidel); ISDA (Feb. significantly mitigate, specific, 2012); JPMC; Morgan Stanley; PNC et al.; SIFMA et identifiable risks in connection with 3. Compensation al. (Prop. Trading) (Feb. 2012). individual or aggregated positions of the 1299 See Credit Suisse (Seidel); BoA. banking entity.1305 Importantly, to use The proposed rule required that the 1300 See PNC et al. the hedging exemption, the final rule compensation arrangements of persons 1301 See SIFMA et al. (Prop. Trading) (Feb. 2012); performing risk-mitigating hedging JPMC; Goldman (Prop. Trading); BoA; Comm. on requires that the banking entity subject Capital Market Regulation. As discussed above, its hedging activity to continuing activities be designed not to reward hedging activity relying on this exemption cannot review, monitoring, and management proprietary risk-taking.1308 In the be designed to: Reduce risks associated with the that is designed to reduce or proposal, the Agencies stated that banking entity’s assets and/or liabilities generally, general market movements or broad economic significantly mitigate specific, hedging activities for which a banking conditions; profit in the case of a general economic identifiable risks, and that demonstrably entity has established a compensation downturn; counterbalance revenue declines reduces or otherwise significantly incentive structure that rewards generally; or otherwise arbitrage market imbalances mitigates identifiable risks, in speculation in, and appreciation of, the unrelated to the risks resulting from the positions lawfully held by the banking entity. connection with individual or market value of a covered financial 1302 See ABA (Keating); CH/ABASA; see also aggregated positions of the banking position, rather than success in reducing Credit Suisse (Seidel); PNC; PNC et al.; SIFMA et entity.1306 The final rule also requires al. (Prop. Trading) (Feb. 2012). One commenter argued that anticipatory hedging should not be required that the continuing review maintain a permitted because it represents illegal front concept with the requirement that hedging activity reasonable level of correlation between the hedge running. See Occupy. The Agencies note that not ‘‘demonstrably reduce or otherwise significantly transaction and the risk being hedged. See proposed all anticipatory hedging would constitute illegal mitigate’’ specific, identifiable risks. rule § 75.5(b)(2)(v). As discussed above, the front running. Any activity that is illegal under 1304 See AFR et al. (Feb. 2012); see also Part proposed ‘‘reasonable correlation’’ requirement was another provision of law, such as front running VI.C.3.d., infra. removed from that provision and instead a under section 10(b) of the Exchange Act, remains 1305 This requirement modifies proposed rule requirement has been added to the compliance illegal; and section 13 of the BHC Act and any § 75.5(b)(2)(ii) and (iii). As discussed above, the program provision that correlation analysis be implementing rules thereunder do not represent a addition of ‘‘demonstrably reduces or significantly undertaken when analyzing hedging positions, grant of authority to engage in any such activity. mitigates’’ language replaces the proposed techniques, and strategies before they are See 15 U.S.C. 78j. ‘‘reasonable correlation’’ requirement. implemented. 1303 As discussed above, the final hedging 1306 The proposed rule contained a similar 1307 See AFR et al. (Feb. 2012). exemption replaces the ‘‘reasonable correlation’’ provision, except that the proposed provision also 1308 See proposed rule § 75.5(b)(2)(vi).

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risk, are inconsistent with permitted Similarly, a compensation arrangement Some commenters argued that the risk-mitigating hedging activities.1309 that is designed to incentivize an final rule should require comprehensive Commenters generally supported this employee to exceed the potential losses documentation for all activity requirement and indicated that its associated with the risks of the conducted pursuant to the hedging inclusion was very important and underlying position rather than reduce exemption, regardless of where it occurs valuable.1310 Some commenters argued risks of underlying positions would in an organization.1317 One of these that the final rule should limit appear to reward prohibited proprietary commenters stated that such compensation based on profits derived trading rather than risk-mitigating documentation can be easily and from hedging transactions, even if those hedging activities. The banking entity quickly produced by traders and noted hedging transactions were in fact risk- should review its compensation that traders already record execution mitigating hedges, and urged that arrangements in light of the guidance details of every trade.1318 Several employees be compensated instead and rules imposed by the appropriate commenters argued that the rule should based on success in risk mitigation at Federal supervisor for the entity impose a requirement that banks label the end of the life of the hedge.1311 In regarding compensation.1315 all hedges at their inception and provide contrast, other commenters argued that information regarding the specific risk 4. Documentation Requirement the compensation requirement should being offset, the expected duration of restrict only compensation Section 75.5(c) of the proposed rule the hedge, how it will be monitored, arrangements that incentivize would have imposed a documentation how it will be wound down, and the employees to engage in prohibited requirement on certain types of hedging names of the trader, manager, and proprietary risk-taking.1312 transactions. Specifically, for any supervisor approving the hedge.1319 After considering comments received transaction that a banking entity Some commenters requested that the on the compensation requirements of conducts in reliance on the hedging documentation requirement be applied the proposed hedging exemption, the exemption that involved a hedge at a higher level of organization,1320 and final rule substantially retains the established at a level of organization some commenters noted that policies proposed requirement that the different than the level of organization and procedures alone would be compensation arrangements of persons establishing or responsible for the sufficient to address hedging activity, performing risk-mitigating hedging positions, contracts, or other holdings wherever conducted within the activities be designed not to reward the risks of which the hedging organization.1321 Two commenters prohibited proprietary trading. The final transaction is designed to reduce, the indicated that making the rule is also modified to make clear that banking entity was required, at a documentation requirement narrower is rewarding or incentivizing profit minimum, to document: The risk- necessary to avoid impacts or delays in making from prohibited proprietary mitigating purpose of the transaction; daily trading operations that could lead trading is not permitted.1313 the risks of the individual or aggregated to a banking entity being exposed to The Agencies recognize that positions, contracts, or other holdings of greater risks.1322 A number of compensation, especially incentive a banking entity that the transaction is commenters stated that any enhanced compensation, may be both an designed to reduce; and the level of documentation requirement would be important motivator for employees as organization that is establishing the burdensome and costly, and would well as a useful indicator of the type of hedge.1316 Such documentation was impede rapid and effective risk activity that an employee or trading required to be established at the time mitigation, whether done at a trading desk is engaged in. For instance, an the hedging transaction is effected. The desk or elsewhere in the banking incentive compensation plan that Agencies expressed concern in the entity.1323 rewards an employee engaged in proposal that hedging transactions At least one commenter also argued activities under the hedging exemption established at a different level of that a banking entity should be based primarily on whether that organization than the positions being permitted to consolidate some or all of employee’s positions appreciate in hedged may present or reflect its hedging activity into a trading desk value instead of whether such positions heightened potential for prohibited that is not responsible for the reduce or mitigate risk would appear to proprietary trading, either at the trading underlying positions without triggering be designed to reward prohibited desk level or at the level instituting the a requirement that all hedges proprietary trading rather than risk- hedging transaction. In other words, the undertaken by a trading desk be reducing hedging activities.1314 further removed hedging activities are documented solely because the hedges from the specific positions, contracts, or are not undertaken by the trading desk 1309 See Joint Proposal, 76 FR at 68868. other holdings the banking entity that originated the underlying 1310 See, e.g., AFR et al. (Feb. 2012); Sens. 1324 Merkley & Levin (Feb. 2012); Public Citizen. intends to hedge, the greater the danger position. 1311 See AFR et al. (Feb. 2012); AFR (June 2013). that such activity is not limited to The final rule substantially retains the 1312 See Morgan Stanley. hedging specific risks of individual or proposed requirement for enhanced 1313 One commenter stated that the compensation aggregated positions, contracts, or other documentation for hedging activity requirement should restrict only compensation holdings of the banking entity, as arrangements that incentivize employees to engage required by the rule. 1317 See AFR (June 2013); Occupy. in prohibited proprietary risk-taking, rather than 1318 See Occupy. apply to hedging activities. See Morgan Stanley. 1319 See Sens. Merkley & Levin (Feb. 2012); 1314 1315 See 12 U.S.C. 5641. Thus, the Agencies agree with one Occupy; AFR (June 2013). commenter who stated that compensation for 1316 For example, as explained under the 1320 See SIFMA et al. (Prop. Trading) (Feb. 2012); hedging should not be based purely on profits proposal, a hedge would be established at a JPMC; Barclays; see also Japanese Bankers Ass’n. derived from hedging. However, the final rule does different level of organization of the banking entity 1321 not require compensation vesting, as suggested by if multiple market-making desks were exposed to See JPMC; SIFMA et al. (Prop. Trading) (Feb. this commenter, because the Agencies believe the similar risks and, to hedge such risks, a hedge was 2012). final hedging exemption includes sufficient established at the direction of a supervisor or risk 1322 See JPMC; Barclays. requirements to ensure that only risk-mitigating manager responsible for more than one desk rather 1323 See Barclays; JPMC; SIFMA et al. (Prop. hedging is permitted under the exemption without than at each of the market-making desks that Trading) (Feb. 2012); see also Japanese Bankers a compensation vesting provision. See AFR et al. established the initial positions, contracts, or other Ass’n. (Feb. 2012); AFR (June 2013). holdings. See Joint Proposal, 76 FR at 68876 n.161. 1324 See JPMC.

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conducted under the hedging exemption trading desk that conducts hedging ways in response to comments received if the hedging is not conducted by the activities related to the other on the proposal. specific trading desk establishing or permissible trading activities of that a. Permitted Trading in U.S. responsible for the underlying positions, desk so long as the hedging activity is Government Obligations contracts, or other holdings, the risks of conducted in accordance with the which the hedging activity is designed compliance program for that trading Section 13(d)(1)(A) permits trading in to reduce. The final rule clarifies that a desk. various U.S. government, U.S. agency 1329 banking entity must prepare enhanced The Agencies continue to believe that, and municipal securities. Section documentation if a trading desk for the reasons stated in the proposal, it 75.6(a) of the proposed rule, which implemented section 13(d)(1)(A) of the establishes a hedging position and is not is appropriate to retain documentation BHC Act, permitted the purchase or sale the trading desk that established the of hedging transactions conducted by of a financial instrument that is an underlying positions, contracts, or other those other than the traders responsible obligation of the United States or any holdings. The final rule also requires for the underlying position in order to agency thereof or an obligation, enhanced documentation for hedges permit evaluation of the activity. In participation, or other instrument of or established to hedge aggregated order to reduce the burden of the issued by the Government National positions across two or more desks. This documentation requirement while still Mortgage Association, the Federal change in the final rule clarifies that the giving effect to the rule’s purpose, the National Mortgage Association, the level of the organization at which the final rule requires limited trading desk exists is important for Federal Home Loan Mortgage documentation for hedging activity that Corporation, a Federal Home Loan determining whether the trading desk is subject to a documentation established or is responsible for the Bank, the Federal Agricultural Mortgage requirement, consisting of: (1) The Corporation or a Farm Credit System underlying positions, contracts, or other specific, identifiable risk(s) of the holdings. The final rule recognizes that institution chartered under and subject identified positions, contracts, or other to the provisions of the Farm Credit Act a trading desk may be responsible for holdings that the purchase or sale is hedging aggregated positions of that of 1971 (12 U.S.C. 2001 et seq.).1330 The designed to reduce; (2) the specific risk- proposal did not contain an exemption desk and other desks, business units, or mitigating strategy that the purchase or affiliates. In that case, the trading desk for trading in derivatives referencing sale is designed to fulfill; and (3) the putting on the hedge is at least one step exempt U.S. government and agency trading desk or other business unit that removed from some of the positions securities, but requested comment on is establishing and responsible for the being hedged. Accordingly, the final whether the final rule should contain an hedge transaction. As in the proposal, rule provides that the documentation exemption for proprietary trading in this documentation must be established requirements in § 75.5 apply if a trading options or other derivatives referencing contemporaneously with the hedging desk is hedging aggregated positions an exempt government obligation.1331 transaction. Documentation would be that include positions from more than Commenters were generally contemporaneous if it is completed one trading desk. supportive of the manner in which the The final rule adds to the proposal by reasonably promptly after a trade is proposal implemented the exemption requiring enhanced documentation for executed. The banking entity is required for permitted trading in U.S. hedges established by the specific to retain records for no less than 5 years government and U.S. agency trading desk establishing or directly (or such longer period as may be obligations.1332 Many commenters responsible for the underlying positions, required under other law) in a form that argued that the exemption for contracts, or other holdings, the risks of allows the banking entity to promptly permissible proprietary trading in which the purchases or sales are produce such records to the Agency on government obligations should be 1326 designed to reduce, if the hedge is request. While the Agencies expanded, however, to include trading effected through a financial instrument, recognize this documentation in derivatives on government technique, or strategy that is not requirement may result in certain costs, obligations.1333 These commenters specifically identified in the trading the Agencies believe this requirement is asserted that failure to provide an desk’s written policies and procedures necessary to prevent evasion of the exemption would adversely impact as a product, instrument, exposure, statute and final rule. liquidity in the underlying government technique, or strategy that the trading 5. Section 75.6(a)–(b): Permitted Trading obligations themselves and increase desk may use for hedging.1325 The in Certain Government and Municipal 1329 Agencies note that this documentation Obligations 12 U.S.C. 1851(d)(1)(A). requirement does not apply to hedging 1330 The Agencies proposed that United States ‘‘agencies’’ for this purpose would include those activity conducted by a trading desk in Section 75.6 of the proposed rule agencies described in section 201.108(b) of the connection with the market making- permitted a banking entity to engage in Board’s Regulation A. See 12 CFR 201.108(b). The related activities of that desk or by a trading activities that were authorized Agencies also noted that the terms of the exemption by section 13(d)(1) of the BHC Act,1327 would encompass the purchase or sale of enumerated government obligations on a forward 1325 One commenter suggested that the rule including trading in certain government basis (e.g., in a to-be-announced market). In require documentation when a banking entity needs obligations, trading on behalf of addition, this would include pass-through or to engage in new types of hedging transactions that customers, trading by insurance participation certificates that are issued and are not covered by its hedging policies, although guaranteed by a government-sponsored entity (e.g., this commenter’s suggested approach would only companies, and trading outside of the the Federal National Mortgage Association and the apply when a hedge is conducted two levels above United States by certain foreign banking Federal Home Loan Mortgage Corporation) in the level at which the risk arose. See SIFMA et al. 1328 entities. Section 75.6 of the final connection with its securitization activities. (Prop. Trading) (Feb. 2012). The Agencies agree that 1331 documentation is needed when a trading desk is rule generally incorporates these same See Joint Proposal, 76 FR at 68878. acting outside of its hedging policies and statutory exemptions. However, the 1332 See, e.g., SIFMA et al. (Prop. Trading) (Feb. procedures. However, the final rule does not limit final rule has been modified in some 2012); Sens. Merkley & Levin (Feb. 2012). this documentation requirement to circumstances 1333 See BoA; CalPERS; Credit Suisse (Seidel); when the hedge is conducted two organizational CME Group; Fixed Income Forum/Credit levels above the trading desk. Such an approach 1326 See final rule § 75.5(c)(3). Roundtable; FIA; JPMC; Morgan Stanley; PNC; would be less effective than the adopted approach 1327 See proposed rule § 75.6. SIFMA et al. (Prop. Trading) (Feb. 2012); Wells at addressing evasion concerns. 1328 See 12 U.S.C. 1851(d)(1)(A), (C), (F), and (H). Fargo (Prop. Trading).

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borrowing costs to governments.1334 continue by entities other than banking permitted market-making related or risk- Several commenters asserted that U.S. entities. mitigating hedging activities in government and agency obligations and Proprietary trading of derivatives on accordance with the requirements in derivatives on those instruments are U.S. government obligations is not §§ 75.4(b) or 75.(5), the final rule substitutes and pose the same necessary to promote and protect the permits banking entities to acquire a investment risks and opportunities.1335 safety and soundness of a banking entity short or long position in Treasury According to some commenters, the or the financial stability of the United futures through manual trading or significant connections between these States. Commenters offered no automated processes. For example, a markets and the interchangeable nature compelling reasons why derivatives on banking entity would be permitted to of these instruments significantly exempt government obligations pose use Treasury futures to hedge the contribute to price discovery, in little or no risk to the financial system duration risk (i.e., the measure of a particular, in the cash market for U.S. as compared to derivatives on other bond’s price sensitivity to interest rates Treasury obligations.1336 Commenters financial products for which proprietary movements) associated with the banking also argued that trading in Treasury trading is generally prohibited and did entity’s market-making in Treasury futures and options improves liquidity not indicate how proprietary trading in securities or other fixed-income in Treasury securities markets by derivatives of U.S. government and products, provided that the banking providing an outlet to relieve any agency obligations by banking entities entity complies with the market-making supply and demand imbalances in spot would promote the safety and requirements in § 75.4(b). In their obligations. Many commenters argued soundness of those entities or the market making, banking entities also that the authority to engage in trading in financial stability of the United States. frequently trade Treasury futures (and derivatives on U.S. government, agency, For these reasons, the Agencies have not acquire a corresponding long or short and municipal obligations is inherent in determined to provide an exemption for position) in reasonable anticipation of the statutory exceptions granted by proprietary trading in derivatives on the near-term demands of their clients, section 13(d)(1)(A) to trade in the exempt government obligations. customers, and counterparties. For underlying obligation.1337 To the extent The Agencies believe banking entities example, banking entities may acquire a there is any doubt about the scope of will continue to provide significant long or short position in Treasury those exemptions, commenters urged support and liquidity to the U.S. futures to hedge anticipated market risk the Agencies to use the exemptive government and agency security when they reasonably expect clients, authority under section 13(d)(1)(J) if markets through permitted trading in customers, or counterparties will seek to necessary to permit proprietary trading the cash exempt government obligations establish long or short positions in on- in derivatives on government markets, making markets in government or off-the-run Treasury securities. obligation derivatives and through obligations.1338 Two commenters Similarly, banking entities could derivatives trading for hedging opposed providing an exemption for acquire a long or short position in the purposes. The final rule adopts the same proprietary trading in derivatives on ‘‘Treasury basis’’ to hedge the approach as the proposed rule for the exempt government obligations.1339 anticipated basis risk associated with exemption for permitted trading in U.S. making markets for clients, customers, The final rule has not been modified government and U.S. agency or counterparties that are reasonably to permit a banking entity to engage in obligations. In response to commenters, expected to engage in basis trading of proprietary trading of derivatives on the Agencies are clarifying how banking the price spread between Treasury U.S. government and agency entities would be permitted to use futures and Treasury securities. A obligations. Treasury derivatives on Treasury banking entity can also use Treasury The Agencies note that the cash securities when relying on the futures (or other derivatives on exempt market for exempt government exemptions for market-making related government obligations) to hedge other obligations is already one of the most activities and risk-mitigating hedging risks such as the aggregated interest rate liquid markets in the world, and the activities. The Agencies agree with risk for specifically identified loans as final rule will permit banking entities to commenters that some Treasury well as other financial instruments such participate fully in these cash markets. derivatives are close economic as asset-backed securities, corporate In addition, the final rule permits substitutes for Treasury securities and bonds, and interest rate swaps. banking entities to make a market in provide many of the same economic Therefore, depending on the relevant U.S. government securities and in exposures.1340 The Agencies also facts and circumstances, banking derivatives on those securities. understand that the markets for entities would be permitted to acquire a Moreover, the final rule allows banking Treasury securities and Treasury futures very large long or short position in entities to continue to use U.S. are fully integrated, and that trading in Treasury derivatives provided that they government obligations and derivatives these derivative instruments is essential comply with the requirements in on those obligations in risk-mitigating to ensuring the continued smooth §§ 75.4(b) or 75.(5). The Agencies also hedging activities permitted by the rule. functioning of market-making related understand that banking entities that Further, proprietary trading in activities in Treasury securities. have been designated as ‘‘primary derivatives on such obligations will Treasury derivatives are frequently used dealers’’ by the Federal Reserve Bank of by market makers to hedge their market- New York are required to underwrite making related positions across many 1334 See BoA; FIA; HSBC; JPMC; Morgan Stanley; issuances of Treasury securities. This Wells Fargo (Prop. Trading). different types of fixed-income necessitates the banking entities to 1335 See Barclays; Credit Suisse (Seidel); Fixed securities. Under the final rule, market frequently establish very large short Income Forum/Credit Roundtable; FIA. makers will generally be able to positions in Treasury futures to order to 1336 See Barclays; CME Group; Fixed Income continue their practice of using hedge the duration risk associated with Forum/Credit Roundtable; see also UBS. Treasury futures to hedge their activities potentially owning a large volume of 1337 See CME Group; see also Morgan Stanley; PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); as block positioners off exchanges. Treasury securities. As described Wells Fargo (Prop. Trading). Additionally, when engaging in below,1341 the Agencies note that, with 1338 See Barclays; CME Group; JPMC. 1339 See Occupy; Alfred Brock. 1340 See supra note 1335. 1341 See infra Part VI.A.3.c.2.c.i.

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respect to a banking entity that acts as the financial stability of the United their operations.1350 These commenters a primary dealer for Treasury securities, States under section 13(d)(1)(J) of the also contended that an exemption for the U.S. government will be considered BHC Act.1345 proprietary trading in foreign sovereign a client, customer, or counterparty of The treatment of proprietary trading debt would promote and protect the the banking entity for purposes of the in foreign sovereign obligations safety and soundness and the financial market-making exemption.1342 We prompted a significant number of stability of the United States by believe this interpretation appropriately comments. Many commenters, avoiding the possible negative effects of captures the unique relationship including foreign governments, foreign a contraction of government bond between a primary dealer and the and domestic banking entities, and market liquidity.1351 government. Moreover, this various trade groups, argued that the Commenters also contended that in interpretation clarifies that a banking final rule should permit trading in some foreign markets, local regulations entity may rely on the market-making foreign sovereign debt, including or market practice require U.S. banking exemption for its activities as primary obligations issued by political entities operating in those jurisdictions dealer to the extent those activities are subdivisions of foreign governments.1346 to hold, trade or support government outside the scope of the underwriting Representatives from foreign issuance of local sovereign securities. exemption.1343 governments such as Canada, Germany, They also indicated that these The final rule also includes an Luxembourg, Japan, Australia, and instruments are traded in the United exemption for obligations of or Mexico specifically requested an States or on U.S. markets.1352 In guaranteed by the United States or an exemption for trading in obligations of addition, a number of commenters agency of the United States. An their governments and argued that an contended that U.S. and foreign banking obligation guaranteed by the U.S. or an exemption was necessary and entities often perform functions for agency of the U.S. is, in effect, an appropriate to maintain and promote foreign governments similar to those obligation of the U.S. or that agency. financial stability in their markets.1347 provided in the United States by U.S. The final rule also includes an Some commenters also requested an primary dealers and alleged that exemption for an obligation of the FDIC, exemption for trading in obligations of restricting these trading activities would or any entity formed by or on behalf of multinational central banks, such as have a significant negative impact on the FDIC for the purpose of facilitating Eurobonds issued or guaranteed by the the ability of foreign governments to the disposal of assets acquired or held European Central Bank.1348 implement their monetary policy and on by the FDIC in its corporate capacity or Many commenters argued that the liquidity for such securities in many as conservator or receiver under the same rationale for the statutory foreign markets.1353 A few commenters Federal Deposit Insurance Act (‘‘FDI exemption for proprietary trading in further argued that banking entities use Act’’) or Title II of the Dodd-Frank U.S. government obligations supported foreign sovereign debt, particularly debt 1344 Act. These FDIC receivership and exempting proprietary trading in foreign of their home country and of the conservatorship operations are sovereign debt and related country in which they are operating, to authorized under the FDI Act and Title obligations.1349 Commenters contended manage their risk by posting sovereign II of the Dodd-Frank Act and are that lack of an express exemption for securities as collateral in foreign designed to lower the FDIC’s resolution trading in foreign sovereign obligations jurisdictions, to manage international costs. The Agencies believe that an could critically impact the functioning rate and foreign exchange risk exemption for these types of obligations of money market operations of foreign (particularly in local operations), and would promote and protect the safety central banks and limit the ability of for liquidity and asset-liability and soundness of banking entities and foreign sovereign governments to management purposes in different the financial stability of the United conduct monetary policy or finance States because they facilitate the FDIC’s 1350 See Banco de Me´xico; Barclays; BoA; Gov’t of Japan/Bank of Japan; IIAC; OSFI. ability to conduct receivership and 1345 See Joint Proposal, 76 FR at 68878. 1351 See, e.g., Allen & Overy (Gov’t. Obligations); conservatorship operations in an orderly 1346 See, e.g., Allen & Overy (Gov’t Obligations); AFMA; Banco de Me´xico; Ass’n. of German Banks; manner, thereby limiting risks to the Allen & Overy (Canadian Banks); BoA; Australian Barclays; Mexican Banking Comm’n.; EFAMA; EBF; financial system generally that might Bankers Ass’n. (Feb. 2012); AFMA; Banco de French Banking Fed’n.; Goldman (Prop. Trading); otherwise occur if the FDIC was Me´xico; Bank of Canada; Ass’n of German Banks; HSBC; IIB/EBF; HSBC; ICSA; T. Rowe Price; UBS; BAROC; Barclays; BEC (citing the National Institute restricted in its ability to conduct these Union Asset; IRSG; EBF; Mitsubishi (citing Japanese of Banking and Finance); British Bankers’ Ass’n.; Bankers Ass’n. and IIB); Wells Fargo (Prop. operations. BaFin/Deutsche Bundesbank; Chamber (Feb. 2012); Trading); ICI Global. Mexican Banking Comm’n.; French Treasury et al.; b. Permitted Trading in Foreign 1352 See Allen & Overy (Gov’t. Obligations) EFAMA; ECOFIN; EBF; French Banking Fed’n.; (contending that ‘‘even if not primary dealers, Government Obligations FSA (Apr. 2012); FIA; Goldman (Prop. Trading); banking entities or their branches or agencies acting HSBC; Hong Kong Inv. Funds Association; IIB/EBF; The proposed rule did not contain an in certain foreign jurisdictions, such as Singapore ICFR; ICSA; IRSG; Japanese Bankers Ass’n.; Ass’n. and India, are still required to hold or transact in exemption for trading in obligations of of Banks in Malaysia; OSFI; British Columbia; local sovereign debt under local law’’); BoA; foreign sovereign entities. As part of the Que´bec; Sumitomo Trust; TMA Hong Kong; UBS; Barclays; Citigroup; SIFMA et al. (Prop. Trading) proposal, however, the Agencies Union Asset. (Feb. 2012). 1347 specifically requested comment on See, e.g., Allen & Overy (Gov’t Obligations); 1353 See Allen & Overy (Gov’t. Obligations); Bank of Canada; British Columbia; Ontario; IIAC; Australian Bankers Ass’n. (Feb. 2012); BoA; Banco whether proprietary trading in the Quebec; IRSG; IIB/EBF; Mitsubishi; Gov’t of Japan/ de Me´xico; Barclays; Citigroup; Goldman (Prop. obligations of foreign governments Bank of Japan; Australian Bankers Ass’n (Feb. Trading); IIB/EBF; see also JPMC (suggesting that, would promote and protect the safety 2012); AFMA; Banco de Me´xico; Ass’n. of German at a minimum, the Agencies should make clear that and soundness of banking entities and Banks; ALFI; Embassy of Switzerland. all of a firm’s activities that are necessary or 1348 See Ass’n. of German Banks; Goldman (Prop. reasonably incidental to its acting as a primary Trading); IIB/EBF; ICFR; FIA; Mitsubishi; dealer in a foreign government’s debt securities are 1342 See supra note 910 (explaining the functions Sumitomo Trust; Allen & Overy (Gov’t Obligations). protected by the market-making-related permitted of primary dealers). 1349 See Allen & Overy (Gov’t. Obligations); Banco activity); SIFMA et al. (Prop. Trading) (Feb. 2012). 1343 See supra Part VI.A.3.c.2.b.ix. (discussing de Me´xico; Barclays; BaFIN/Deutsche Bundesbank; As discussed in Parts VI.A.2.c.2.c. and commenters’ concerns regarding primary dealer EFAMA; Union Asset; TMA Hong Kong; ICI (Feb. VI.A.2.c.2.b.ix of this SUPPLEMENTARY INFORMATION, activity, as well as one commenter’s request for 2012) (arguing that such an exemption would be the Agencies believe primary dealing activities such an interpretation). consistent with Congressional intent to limit the would generally qualify under the scope of the 1344 See final rule § 75.6(a)(4). extra-territorial application of U.S. law). market-making or underwriting exemption.

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countries.1354 Similarly, commenters to compete with U.S. banking entities in proprietary trading in their obligations expressed concern that the lack of an the U.S.1360 pursuant to such exemption.1367 exemption for trading in foreign Based on these concerns, some The Agencies carefully considered all the comments related to proprietary government obligations could adversely commenters suggested that the Agencies trading in foreign sovereign debt in light interact with other banking regulations, exempt proprietary trading by foreign of the language, purpose and standards such as liquidity requirements under banking entities in obligations of their for exempting activity contained in the Basel III capital rules that encourage home or host country.1361 Other section 13 of the BHC Act. Under financial institutions to hold large commenters suggested allowing trading concentrations of sovereign bonds to section 13(d)(1)(J), the Agencies may in foreign government obligations that grant an exemption from the match foreign currency denominated meet some condition on quality (e.g., obligations.1355 Commenters also prohibitions of the section for any OECD-member country obligations, activity that the Agencies determine expressed particular concern that the government bonds eligible as collateral limitations and obligations of section 13 would promote and protect the safety for Federal Reserve advances, sovereign and soundness of the banking entity and of the BHC Act would likely be bonds issued by G–20 countries, or problematic and unduly burdensome if the financial stability of the United other highly liquid or rated States. banking entities were able to trade in 1362 instruments). One commenter The Agencies note as an initial matter foreign sovereign obligations only under indicated that in their view, provided that section 13 permits banking the market making or other proposed appropriate risk-management entities—both inside the United States exemptions from the proprietary trading procedures are followed, investing in and outside the United States—to make 1356 prohibition. One commenter non-U.S. government securities is as markets in and to underwrite all types expressed the view that lack of an low risk as investing in U.S. government of securities, including all types of exemption for proprietary trading in securities despite current price volatility foreign sovereign debt. The final rule foreign government obligations together in certain types of sovereign debt.1363 implements the statutory market-making with the proposed exemption for trading Some commenters also suggested the and underwriting exemptions, and thus, that occurs solely outside the U.S. may final rule give deference to home the key role of banking entities in cause foreign banks to close their U.S. country regulation and permit foreign facilitating trading and liquidity in branches to avoid being subject to banking entities to engage in proprietary foreign government debt through section 13 of the BHC Act and any final trading in any government obligation to market-making and underwriting is rule thereunder.1357 the extent that such trading is permitted maintained. This includes underwriting According to some commenters, by the entity’s primary regulator.1364 and marketmaking as a primary dealer providing an exemption only for By contrast, other commenters argued in foreign sovereign obligations. proprietary trading in U.S. government that proprietary trading in foreign Banking entities may also hold foreign obligations, without a similar exemption sovereign obligations represents a risky sovereign debt in their long-term for foreign government obligations, activity and that there is no effective investment book. In addition, the final would be discriminatory and way to draw the line between safe and rule does not prevent foreign banking inconsistent with longstanding unsafe foreign debt.1365 Two of these entities from engaging in proprietary principles of national treatment and commenters pointed to several publicly trading outside of the United States in 1368 with U.S. treaty obligations, such as reported instances where proprietary any type of sovereign debt. obligations under the World Trade trading in foreign sovereign obligations Moreover, the Agencies continue to Organization framework or bilateral resulted in significant losses to certain believe that positions, including trade agreements.1358 In addition, firms. These commenters argued that positions in foreign government several commenters argued that not restricting proprietary trading in foreign obligations, acquired or taken for the exempting proprietary trading of foreign sovereign debt would not cause reduced bona fide purpose of liquidity sovereign debt may encourage foreign liquidity in government bond markets management and in accordance with a regulators to enact similar regulations to since banking entities would still be documented liquidity management plan the detriment of U.S. financial permitted to make a market in and that is consistent with the relevant Agency’s supervisory requirements, institutions operating abroad.1359 underwrite foreign government guidance and expectations regarding However, another commenter disagreed obligations.1366 A few commenters liquidity management are not covered that the failure to exempt trading in suggested that, if the final rule by the prohibitions in section 13.1369 foreign government obligations would exempted proprietary trading in foreign The final rule continues to incorporate violate trade agreements or that the sovereign debt, foreign governments this view.1370 should commit to pay for any damage to proposal discriminated in any way The issue raised by commenters, the U.S. financial system related to against foreign banking entities’ ability therefore, is the extent to which proprietary trading in foreign sovereign 1354 See Citigroup; SIFMA et al. (Prop. Trading) 1360 See Sens. Merkley & Levin (Feb. 2012). obligations by U.S. banking entities 1361 (Feb. 2012). See Cadwalader (on behalf of Thai Banks); anywhere in the world and by foreign 1355 See Allen & Overy (Gov’t. Obligations); BoA. IIB/EBF; Ass’n. of Banks in Malaysia; UBS; see also 1356 See Barclays; IIAC; UBS; Ass’n. of Banks in BAROC. banking entities in the United States is Malaysia; IIB/EBF. 1362 See BoA; Cadwalader (on behalf of Singapore consistent with promoting and 1357 See Comm. on Capital Markets Regulation. Banks); IIB/EBF; Norinchukin; OSFI; Cadwalader protecting the safety and soundness of 1358 See Allen & Overy (Gov’t. Obligations); Banco (on behalf of Thai Banks); Ass’n. of Banks in the banking entity and the financial de Me´xico; IIB/EBF; Ass’n. of Banks in Malaysia. Malaysia; UBS; see also BAROC; ICFR; Japanese Bankers Ass’n.; JPMC; Que´bec. stability of the United States. Taking 1359 See Sumitomo Trust; SIFMA et al. (Prop. 1363 Trading) (Feb. 2012); Allen & Overy (Govt. See, e.g., Allen & Overy (Gov’t Obligations). 1367 Obligations); BoA; ICI Global; RBC; ICFR; ICI (Feb. 1364 See Allen & Overy (Gov’t. Obligations); See Better Markets (Feb. 2012); see also Prof. 2012); Bank of Canada; Cadwalader (on behalf of HSBC. Johnson. Singapore Banks); Ass’n. of Banks in Malaysia; 1365 See Better Markets (Feb. 2012); Occupy; Prof. 1368 See final rule § 75.6(e). Cadwalader (on behalf of Thai Banks); Chamber Johnson; Sens. Merkley & Levin (Feb. 2012). 1369 See Joint Proposal, 76 FR at 68862. (Feb. 2012); BAROC. See also IIB/EBF. 1366 See Prof. Johnson; Better Markets (Feb. 2012). 1370 See final rule § 75.3(d)(3).

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into account the information provided government and agency obligations.1373 have determined that this limited by commenters, the Agencies’ At the same time, the risk of these exemption will promote the safety and understanding of market operations, and trading activities is largely determined soundness of banking entities and the the purpose and language of section 13, by the foreign sovereign that charters financial stability of the United States the Agencies have determined to grant the foreign bank. By not permitting by allowing U.S. banking entities to a limited exemption to the prohibition proprietary trading in foreign sovereign continue to be affiliated with and on proprietary trading for trading in debt in insured depository institutions operate foreign banking entities and foreign sovereign obligations under (other than in accordance with the benefit from international certain circumstances. limitations in other exemptions), the diversification and participation in This exemption, which is contained exemption limits the direct risks of global financial markets.1377 However, in § 75.6(b) of the final rule, permits the these activities to insured depository the Agencies intend to monitor activity U.S. operations of foreign banking institutions in keeping with the of banking entities under this exemption entities to engage in proprietary trading statute.1374 Thus, the Agencies have to ensure that U.S. banking entities are in the United States in the foreign determined that this limited exemption not seeking to evade the restrictions of sovereign debt of the foreign sovereign for proprietary trading in foreign section 13 by using an affiliated foreign under whose laws the banking entity— sovereign obligations promotes and bank or broker-dealer to engage in or the banking entity that controls it— protects the safety and soundness of proprietary trading in foreign sovereign is organized (hereinafter, the ‘‘home banking entities and also promotes and debt on behalf of or for the benefit of country’’), and any multinational central protects the financial stability of the other parts of the U.S. banking entity. bank of which the foreign sovereign is United States. Apart from this limited exemption, a member so long as the purchase or The Agencies have also determined to the Agencies have not extended this sale as principal is not made by an permit a foreign bank or foreign broker- exemption to proprietary trading in insured depository institution.1371 dealer regulated as a securities dealer foreign sovereign debt by U.S. banking Similar to the exemption for proprietary and controlled by a U.S. banking entity entities for several reasons. First, section trading in U.S. government obligations, to engage in proprietary trading in the 13 was primarily concerned with the the permitted trading activity in the U.S. obligations of the foreign sovereign risks posed to the U.S. financial system by the eligible U.S. operations of a under whose laws the foreign entity is by proprietary trading activities. This foreign banking entity would extend to organized (hereinafter, the ‘‘home risk is most directly transmitted by U.S. obligations of political subdivisions of country’’), including obligations of an banking entities, and while commenters the foreign banking entity’s home agency or political subdivision of that alleged that prohibiting U.S. banking 1375 country.1372 foreign sovereign. This limited entities from engaging in proprietary Permitting the eligible U.S. operations exemption is necessary to allow U.S. trading in debt of foreign sovereigns of a foreign banking entity to engage in banking organizations to continue to would harm liquidity in those markets, proprietary trading in the United States own and acquire foreign banking the evidence provided by commenters in the foreign sovereign obligations of organizations and broker-dealers did not sufficiently indicate that the foreign entity’s home country allows without requiring those foreign banking permitting U.S. banking entities to these U.S. operations of foreign banking organizations and broker-dealers to engage in proprietary trading (as entities to continue to support the discontinue proprietary trading in the opposed to market-making or smooth functioning of markets in sovereign debt of the foreign banking underwriting) in debt of foreign 1376 sovereigns contributed in any foreign sovereign obligations in the entity’s home country. The Agencies significant degree to the liquidity of same manner as U.S. banking entities 1373 As part of this exemption, for example, the markets in foreign sovereign are permitted to support the smooth U.S. operations of a European bank would be able instruments.1378 Thus, expanding the functioning of markets in U.S. to trade in obligations issued by the European Central Bank. Many commenters represented that exemption to permit U.S. banking entities to engage in proprietary trading 1371 See final rule § 75.6(b). Some commenters the same rationale for exempting trading in U.S. requested an exemption for trading in obligations of government obligations supports exempting trading in debt of foreign sovereigns would multinational central banks. See Ass’n. of German in foreign sovereign debt. See, e.g., Allen & Overy likely increase the risks to these entities Banks; Goldman (Prop. Trading); IIB/EBF; ICFR; (Gov’t. Obligations); Banco de Me´xico; Barclays; and the U.S. financial system without a EFAMA; ICI (Feb. 2012). FIA; Mitsubishi; Sumitomo Trust; Allen & Overy significant concomitant and offsetting (Gov’t. Obligations). In the case of a foreign banking 1374 The Agencies believe this approach entity that is owned or controlled by a second appropriately balances commenter concerns that benefit. As explained above, these U.S. foreign banking entity domiciled in a country other proprietary trading in foreign sovereign obligations than the home country of the first foreign banking represents a risky activity and the interest in & Overy (Gov’t. Obligations); AFMA; Ass’n. of entity, the final rule would permit the eligible U.S. preserving the ability of U.S. operations of foreign German Banks; Barclays; EBF; Goldman (Prop. operations of the first foreign banking entity to banking entities to continue to support the smooth Trading); UBS. engage in proprietary trading only in the sovereign functioning of markets in foreign sovereign 1377 Some commenters represented that the debt of the first foreign banking entity’s home obligations in the same manner as U.S. banking limitations and obligations of section 13 would be country, and would permit the U.S. operations of entities are permitted to support the smooth problematic and unduly burdensome on banking the second foreign banking entity to engage in functioning of markets in U.S. government and entities because they would only be able to trade proprietary trading only in the sovereign debt of the agency obligations. See Better Markets (Feb. 2012); in foreign sovereign obligations under existing home country of the second foreign banking entity. Occupy; Prof. Johnson; Sens. Merkley & Levin (Feb. exemptions, such as the market-making exemption. As noted earlier, other provisions of the final rule 2012). See Barclays; IIAC; UBS; Ass’n. of Banks in make clear that the rule does not restrict the 1375 See final rule § 75.6(c). Many commenters Malaysia; IIB/EBF. proprietary trading outside of the United States of requested an exemption for trading in foreign 1378 See, e.g., BoA; Citigroup; Goldman (Prop. either foreign banking organization in debt of any sovereign debt, and some commenters suggested Trading); IIB/EBF; Allen & Overy (Gov’t. foreign sovereign. exempting proprietary trading by foreign banking Obligations); Australian Bankers Ass’n. (Feb. 2012).; 1372 See Part VI.A.5.c., infra. Many commenters entities in obligations of their home country. See, Banco de Me´xico; Barclays. The Agencies recognize requested an exemption for trading in foreign e.g., Allen & Overy (Gov’t. Obligations); BoA; FSA some commenters’ representation that restricting sovereign debt, including obligations issued by (Apr. 2012); Cadwalader (on behalf of Thai Banks); trading in foreign sovereign debt would not political subdivisions of foreign governments. See, IIB/EBF; Ass’n. of Banks in Malaysia; UBS. necessarily cause reduced liquidity in government e.g., Allen & Overy (Gov’t. Obligations); BoA; 1376 Commenters argued that in some foreign bond markets because banking entities would still Australian Bankers Ass’n. (Feb. 2012); Banco de markets, U.S. banks operating in those jurisdictions be able to make a market in and underwrite foreign Me´xico; Bank of Canada; Ass’n. of German Banks; are required by local regulation or market practice government obligations. See Prof. Johnson; Better BAROC; Barclays. to trade in local sovereign securities. See, e.g., Allen Markets (Feb. 2012).

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entities are permitted by the final rule exemption for proprietary trading in all commenters who recommended to continue to engage fully in market- foreign sovereign debt without the providing an exemption for proprietary making in and underwriting of debt of limitations contained in the trading in foreign government foreign sovereigns anywhere in the underwriting, market making and obligations also requested that the world. The only restriction placed on hedging exemptions could lead to more exemption be extended to derivatives on these entities is on the otherwise complicated risk profiles and significant foreign government obligations.1384 Two impermissible proprietary trading in unhedged risk exposures that section 13 of these commenters urged that trading these instruments for the purpose of of the BHC Act is designed to address. in derivatives on foreign sovereign selling in the near term or otherwise Thus, the Agencies believe use of obligations should be exempt for the with the intent to resell in order to section 13(d)(1)(J) exemptive authority same reason that trading in derivatives profit from short-term price movements. to permit proprietary trading in foreign on U.S. government obligations is The Agencies recognize that, government obligations in certain exempt because such trading supports depending on the extent to which limited circumstances is appropriate. liquidity and price stability in the banking entities subject to the rule have The Agencies decline to follow market for the underlying government contributed to the liquidity of trading commenters’ suggested alternative of obligations.1385 One commenter markets for foreign sovereign debt, the allowing trading in foreign government recommended that the Agencies use the lack of an exemption for proprietary obligations if the obligations meet a authority in section 13(d)(1)(J) to grant trading in foreign sovereign debt could particular condition on quality, such as an exemption for proprietary trading in result in certain negative impacts on the obligations of OECD member derivatives on foreign government markets for such debt. In general, the countries.1381 The Agencies do not obligations.1386 Agencies believe these concerns should believe such an approach responds to The final rule has not been modified be mitigated somewhat by the refined the statutory purpose of limiting risks in § 75.6(b) to permit a banking entity to exemptions for market making, posed to the U.S. financial system by engage in proprietary trading in underwriting and permitted trading proprietary trading activities as directly derivatives on foreign government activity of foreign banking entities; as our current approach, which is obligations. As noted above, the however, those exemptions do not structured to limit the exposure of Agencies have determined not to permit address certain of the collateral, capital, banking entities, including insured proprietary trading in derivatives on and other operational issues identified depository institutions, to the risks of U.S. exempt government obligations by commenters.1379 Foreign sovereign foreign sovereign debt. Additionally, the under section 13(d) and, for the same debt of home and host countries Agencies decline to permit proprietary reasons, have determined not to extend generally serves these purposes. Due to trading in any obligation permitted the permitted activities to include the relationships among global financial under the laws of the foreign banking proprietary trading in derivatives on markets, permitting trading that entity’s home country,1382 because such foreign government obligations. supports these essential functions an approach could result in unintended c. Permitted Trading in Municipal promotes the financial stability and the competitive impacts since banking Securities safety and soundness of banking entities would not be subject to one entities.1380 In contrast, a broad uniform standard inside the United Section 75.6(a) of the proposed rule States. Further, unlike some implemented an exemption to the 1379 Representatives from foreign governments commenters, the Agencies do not prohibition against proprietary trading stated that an exemption allowing trading in under section 13(d)(1)(A) of the BHC believe it is appropriate to require obligations of their governments is necessary to Act, which permits trading in certain maintain financial stability in their markets. See, foreign governments to commit to governmental obligations. This e.g., Allen & Overy (Gov’t. Obligations); Bank of paying for any damage to the U.S. Canada; IRSG; IIB/EBF; Gov’t of Japan/Bank of exemption permits the purchase or sale financial system resulting from the Japan; Australian Bankers Ass’n. (Feb. 2012); Banco of obligations issued by any State or any ´ foreign sovereign debt exemption.1383 de Mexico; Ass’n. of German Banks; ALFI. political subdivision thereof (the Commenters argued that exempting trading in The proposal also did not contain an foreign sovereign debt would avoid the possible exemption for trading in derivatives on ‘‘municipal securities trading negative impacts of a contraction of government foreign government obligations. Many exemption’’). The proposed rule bond market liquidity. See, e.g., BoA; Citigroup; included both general obligation bonds Goldman (Feb. 2012); IIB/EBF. Additionally, and limited obligation bonds, such as commenters suggested that failing to provide an exemption could result in negative consequences— exemption for this activity would impact money such as harming liquidity in foreign sovereign debt revenue bonds, within the scope of this market operations of foreign central banks and limit markets, making it more difficult and more costly municipal securities trading exemption. the ability of foreign sovereign governments to for foreign governments to fund themselves, or The proposed rule, however, did not conduct monetary policy or finance their subjecting banking entities to increased extend to obligations of ‘‘agencies’’ of operations. See, e.g., Barclays; BoA; Gov’t of Japan/ concentration risk—systemic risk could increase or Bank of Japan; OSFI. A number of commenters also there could be spillover effects that would harm States or political subdivisions argued that, since U.S. and foreign banking entities global markets, including U.S. markets. See IIF; thereof.1387 often perform functions for foreign governments EBF; ICI Global; HSBC; Barclays; ICI (Feb. 2012); Many commenters, including industry similar to those provided in the U.S. by U.S. IIB/EBF; Union Asset. Additionally, in participants, trade groups, and Federal primary dealers, the lack of an exemption would consideration of one commenter’s statements, the have a significant, negative impact on the ability of Agencies believe that failing to provide this and state governmental representatives, foreign governments to implement monetary policy exemption may cause foreign banks to close their argued that the municipal securities and on liquidity in many foreign markets. See, e.g., U.S. branches, which could harm U.S. markets. See trading exemption should be interpreted Allen & Overy (Gov’t. Obligations); Australian Comm. on Capital Markets Regulation. Bankers Ass’n. (Feb. 2012); BoA; Banco de Me´xico; to permit banking entities to engage in 1381 Barclays; Citigroup (Feb. 2012); Goldman (Prop. See, e.g., BoA; Cadwalader (on behalf of proprietary trading in a broader range of Trading); IIB/EBF. Some commenters argued that Singapore Banks); IIB/EBF; OSFI; UBS; BAROC; municipal securities, including the banking entities and their customers use foreign Japanese Bankers Ass’n.; JPMC. sovereign debt to manage their risk by posting 1382 Some commenters suggested permitting non- collateral in foreign jurisdictions and to manage U.S. banking entities to trade in any government 1384 See Barclays; Credit Suisse (Seidel); IIB/EBF; international rate and foreign exchange risk. See obligation to the extent that such trading is Japanese Bankers Ass’n.; Norinchukin; RBC; Citigroup (Feb. 2012); SIFMA et al. (Prop. Trading) permitted by the entity’s primary regulator. See Sumitomo Trust; UBS. (Feb. 2012). Allen & Overy (Gov’t. Obligations); HSBC. 1385 See Barclays; FIA. 1380 The Agencies generally concur with 1383 See Better Markets (Feb. 2012); see also Prof. 1386 See Barclays. commenters’ concerns that because the lack of an Johnson. 1387 See Joint Proposal, 76 FR at 68878 n.165.

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following: Obligations issued directly by different States, increase costs, and Commenters suggested that the States and political subdivisions decrease liquidity in the diverse Agencies interpret the term ‘‘political thereof; obligations issued by agencies, municipal securities market.1391 subdivision’’ in section 13 more broadly constituted authorities, and similar Commenters also argued that the market than in the proposal to include a wider governmental entities acting as for securities issued by agencies and range of State and municipal instrumentalities on behalf of States and instrumentalities of States and political governmental obligations issued by political subdivisions thereof; and subdivisions thereof would be agencies and instrumentalities or, obligations issued by such governmental especially disrupted, and would affect alternatively, that the Agencies use the entities that are treated as political about 40 percent of the municipal exemptive authority in section subdivisions under various more securities market.1392 13(d)(1)(J) if necessary to permit expansive definitions of political Commenters recommended that the proprietary trading of a broader array of subdivisions under Federal and state final rule provide a broad exemption to State and municipal obligations.1398 laws.1388 These commenters argued that the prohibition on proprietary trading On the other hand, one commenter States and municipalities often issue for municipal securities, based on the contended that bonds issued by obligations through agencies and definition of ‘‘municipal securities’’ agencies and instrumentalities of States instrumentalities and that these used in section 3(a)(29) of the Exchange or municipalities pose risks to the obligations generally have the same Act,1393 which is understood by market banking system because the commenter level of risk as direct obligations of participants and by Congress, and has a believed the market for these bonds has States and political subdivisions.1389 well-settled meaning and an established not been properly regulated or Commenters asserted that permitting body of law. 1394 Other commenters controlled.1399 A few commenters also trading in a broader group of municipal contended that adopting the same recommended tightening the proposed securities would be consistent with the definition of municipal securities as municipal securities trading exemption terms and purposes of section 13 and used in the Federal securities laws to exclude conduit obligations that would not adversely affect the safety would reduce regulatory burden, benefit private businesses and private and soundness of banking entities remove uncertainty, and lead to organizations.1400 One commenter involved in these transactions or create consistent treatment of these securities suggested that the proposed municipal additional risk to the financial stability under the banking and securities securities trading exemption should not of the United States.1390 laws.1395 According to some apply to tax-exempt municipal bonds Commenters expressed concerns that commenters, the terms ‘‘agency’’ and that benefit private businesses (referred the proposed rule would result in a ‘‘political subdivision’’ are used to as ‘‘private activity bonds’’ in the bifurcation of the municipal securities differently under some State laws, and Internal Revenue Code 1401) and that market that would achieve no some State laws identify certain allow private businesses to finance meaningful benefits to the safety and agencies as political subdivisions or private projects at lower interest rates as soundness of banking entities, create define political subdivision to include administrative burdens for determining agencies.1396 Commenters also noted State or political subdivision of a State . . . .’’). In whether or not a municipal security that a number of Federal statutes and addition, a number of banking regulations also include agencies as examples of political qualifies for the exemption, result in regulations define the term ‘‘political subdivisions or define political subdivision to inconsistent applications across subdivision’’ to include municipal include municipal agencies, authorities, districts, agencies and instrumentalities.1397 municipal corporations and similar entities. See, 1388 See, e.g., ABA (Keating); Ashurst; Ass’n. of e.g., 12 CFR 1.2; 12 CFR 160.30; 12 CFR 161.38; 12 CFR 330.15. Further, for purposes of the tax-exempt Institutional Investors (Feb. 2012); BoA; BDA (Feb. 1391 See, e.g., MSRB; City of New York; Am. Pub. bond provisions in the Internal Revenue Code, 2012); Capital Group; Chamber (Feb. 2012); Power et al.; Wells Fargo; State of New York; Treasury regulations treat obligations issued by or Citigroup (Jan. 2012); CHFA; Eaton Vance; Fidelity; Washington State Treasurer; ABA (Keating); Capital ‘‘on behalf of’’ States or political subdivisions by Fixed Income Forum/Credit Roundtable; HSBC; Group; North Carolina; Eaton Vance; Port ‘‘constituted authorities’’ as obligations of such MEFA; Nuveen Asset Mgmt.; Sens. Merkley & Levin Authority; Connecticut; Citigroup (Jan. 2012); States or political subdivisions, and the Treasury (Feb. 2012); Am. Pub. Power et al.; MSRB; Fidelity; Ashurst; Nuveen Asset Mgmt.; SIFMA (Municipal regulations define the term ‘‘political subdivision’’ State of New York; STANY; SIFMA (Municipal Securities) (Feb. 2012). to mean ‘‘any division of any State or local Securities) (Feb. 2012); State Street (Feb. 2012); 1392 See, e.g., MSRB (stating that, based on data governmental unit which is a municipal North Carolina; T. Rowe Price; Sumitomo Trust; from Thomson Reuters, 41.4 percent of the UBS; Washington State Treasurer; Wells Fargo corporation or which has been delegated the right municipal securities issued in FY 2011 were issued to exercise part of the sovereign power of the (Prop. Trading). by agencies and authorities). 1389 unit. . . .’’ See 26 CFR 1.103–1(b). See, e.g., CHFA; Sens. Merkley & Levin (Feb. 1393 See 15 U.S.C. 78c(a)(29). 2012); Am. Pub. Power et al.; North Carolina; 1398 See ABA (Keating); Ashurst; Ass’n. of 1394 See ABA (Keating); Ashurst; BoA; Capital Washington State Treasurer; see also NABL; Institutional Investors (Feb. 2012); Citigroup (Jan. Group; Chamber (Feb. 2012); Comm. on Capital Ashurst; BDA (Feb. 2012); Chamber (Feb. 2012); 2012); Comm. on Capital Markets Regulation; Sens. Markets Regulation; Citigroup (Jan. 2012); Eaton Eaton Vance; Fidelity; MEFA; MSRB; Am. Pub. Merkley & Levin (Feb. 2012); MSRB; Wells Fargo Power et al.; Nuveen Asset Mgmt.; PNC; SIFMA Vance; Fidelity; MEFA; MTA–NY; MSRB; Am. Pub. (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. (Municipal Securities) (Feb. 2012); UBS. Power et al.; NABL; NCSL; State of New York; 2012). Nuveen Asset Mgmt.; Port Authority; PNC; SIFMA 1399 1390 See Ashurst; Citigroup (Jan. 2012); Eaton See Occupy. (Municipal Securities) (Feb. 2012); North Carolina; Vance; Am. Pub. Power et al.; SIFMA (Municipal 1400 See AFR et al. (Feb. 2012); Occupy. T. Rowe Price; UBS; Washington State Treasurer; Securities) (Feb. 2012); North Carolina; T. Rowe 1401 See 26 U.S.C. 141. In general, the rules Wells Fargo (Prop. Trading). Price; Wells Fargo (Prop. Trading); see also Capital applicable to the issuance of tax-exempt private 1395 Group (arguing that municipal securities are not See Ashurst; Citigroup (Jan. 2012) (noting activity bonds under the Internal Revenue Code of generally used as a profit making strategy and thus, that the National Bank Act explicitly lists State 1986, as amended (the ‘‘Code’’) are more restrictive including all municipal securities in the exemption agencies and authorities as examples of political than those applicable to traditional governmental by itself should not adversely affect the safety and subdivisions); MSRB. bonds issued by States or political subdivisions soundness of banking entities); PNC (arguing that 1396 See, e.g., Citigroup (Jan. 2012). thereof. Section 146 of the Code imposes an annual the safe and sound nature of trading in State and 1397 See, e.g., MSRB; Citigroup (Jan. 2012). In State bond volume cap on most tax-exempt private municipal agency obligations was ‘‘a fact addition to the Federal securities laws, the National activity bonds that is tied to measures of State recognized by Congress in 1999 when it authorized Bank Act explicitly includes agencies and populations. Sections 141–150 of the Code impose well capitalized national banks to underwrite and authorities as examples of political subdivisions. other additional restrictions on tax-exempt private deal in, without limit, general obligation, limited See 12 U.S.C. 24(seventh) (permitting investments activity bonds, including, among others, eligible obligation and revenue bonds issued by or on behalf in securities ‘‘issued by or on behalf of any State project and use restrictions, bond maturity of any State, or any public agency or authority of or political subdivision of a State, including any restrictions, land and existing property financing any State or political subdivision of a State’’); Sens. municipal corporate instrumentality of 1 or more restrictions, an advance refunding prohibition, and Merkley & Levin (Feb. 2012). States, or any public agency or authority of any a public approval requirement.

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a result of the exemption from Federal one or more States or political Agencies recognize that state and income taxation for the interest received subdivisions thereof.’’ political subdivision agency obligations by investors.1402 The final rule modifies the proposal generally present the same level of risk to permit proprietary trading in The final rule includes the statutory as direct obligations of States and obligations issued by agencies and political subdivisions.1410 Moreover, the exemption for proprietary trading of instrumentalities acting on behalf of Agencies recognize that other Federal obligations of any State or political States and municipalities (e.g., port 1403 laws and regulations define the term subdivision thereof. In response to authority bonds and bonds issued by ‘‘political subdivision’’ to include the public comments and for the reasons municipal agencies or corporations).1406 municipal agencies and discussed below, this exemption uses As noted by commenters, many States instrumentalities.1411 The Agencies the definition of the term ‘‘municipal and municipalities rely on securities decline to exclude from this exemption security’’ modeled after the definition of issued by agencies and instrumentalities conduit obligations that benefit private ‘‘municipal securities’’ under section to fund essential activities, including entities, as suggested by some 3(a)(29) of the Exchange Act,1404 but utility systems, infrastructure projects, commenters.1412 with simplifications.1405 The final rule affordable housing, hospitals, The proposal did not exempt defines the term ‘‘municipal security’’ to universities, and other nonprofit proprietary trading of derivatives on mean ‘‘a security which is a direct institutions.1407 Both obligations issued obligations of States and political obligation of or issued by, or an directly by States and political subdivisions. The proposal solicited obligation guaranteed as to principal or subdivisions thereof and obligations comment on whether exempting interest by, a State or any political issued by an agency or instrumentality proprietary trading in options or other subdivision thereof, or any agency or of such a State or local governmental derivatives referencing an obligation of instrumentality of a State or any entity are ultimately obligations of the a State or political subdivision thereof political subdivision thereof, or any State or local governmental entity on was consistent with the terms and whose behalf they act. Moreover, purpose of the statute.1413 The Agencies municipal corporate instrumentality of exempting obligations issued by State did not receive persuasive information and municipal agencies and on this topic and, for the same reasons 1402 See AFR et al. (Feb. 2012). instrumentalities in the same manner as discussed above related to derivatives 1403 See final rule § 75.6(a)(3). the direct obligations of States and on U.S. government securities, the 1404 Many commenters requested that the final rule use the definition of ‘‘municipal securities’’ municipalities lessens potential Agencies have determined not to used in the Federal securities laws because, among inconsistent treatment of government provide an exemption for proprietary other reasons, the industry is familiar with that obligations across States and trading in municipal securities, beyond definition and such an approach would promote municipalities that use different funding the underwriting, market-making, consistent treatment of these securities under 1408 banking and securities laws. See, e.g., ABA methods for government projects. hedging and other exemptions provided (Keating); Ashurst; BoA; Comm. on Capital Markets The Agencies believe that interpreting generally in the rule. The Agencies note Regulation; Citigroup (Jan. 2012); NCSL; Port the language of section 13(d)(1)(A) of that banking entities may trade Authority; SIFMA (Municipal Securities) (Feb. the BHC Act to provide an exemption to derivatives on municipal securities 2012); MSRB. Section 3(a)(29) of the Exchange Act defines the term ‘‘municipal securities’’ to mean the prohibition on proprietary trading under any other available exemption to ‘‘securities which are direct obligations of, or for obligations issued by States and the prohibition on proprietary trading, obligations guaranteed as to principal or interest by, municipal agencies and a State or any political subdivision thereof, or any instrumentalities as described above is 1410 Commenters argued that obligations issued agency or instrumentality of a State or any political consistent with the terms and purposes by agencies and instrumentalities generally have subdivision thereof, or any municipal corporate 1409 the same level of risk as direct obligations of States instrumentality of one or more States, or any of section 13 of the BHC Act. The and political subdivisions. See, e.g., CHFA; Sens. security which is an industrial development bond Merkley & Levin (Feb. 2012); Am. Pub. Power et al.; (as defined in section 103(c)(2) of Title 26) the 1406 Many commenters requested that the North Carolina. In response to one commenter’s interest on which is excludable from gross income municipal securities trading exemption be concern that the markets for bonds issued by under section 103(a)(1) of Title 26 if, by reason of interpreted to include a broader range of State and agencies and instrumentalities are not properly the application of paragraph (4) or (6) of section municipal obligations issued by agencies and regulated, the Agencies note that all types of 103(c) of Title 26 (determined as if paragraphs instrumentalities. See, e.g., ABA (Keating); Ashurst; municipal securities, as defined under the (4)(A), (5), and (7) were not included in such BoA; BDA (Feb. 2012); Fixed Income Forum/Credit securities laws to include, among others, State section 103(c)), paragraph (1) of such section 103(c) Roundtable; Sens. Merkley & Levin (Feb. 2012); direct obligation bonds and agency or does not apply to such security.’’ See 15 U.S.C. SIFMA (Municipal Securities) (Feb. 2012); instrumentality bonds, are generally subject to the 78c(a)(29). Citigroup (Jan. 2012); Comm. on Capital Markets same regulations under the securities laws. Thus, 1405 The definition of municipal securities in Regulation. the Agencies do not believe that obligations of section 3(a)(29) of the Exchange Act has outdated 1407 See, e.g., Citigroup (Jan. 2012); Ashurst; agencies and instrumentalities are subject to less tax references to the prior law under the former SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA effective regulation than obligations of States and Internal Revenue Code of 1954, including (Municipal Securities) (Feb. 2012); Chamber (Dec. political subdivisions. See Occupy. particularly references to certain provisions 2011); BlackRock; Fixed Income Forum/Credit 1411 Commenters noted that a number of Federal involving the concept of ‘‘industrial development Roundtable. statutes and regulations define ‘‘political bonds.’’ The successor current Internal Revenue 1408 Commenters represented that the proposed subdivision’’ to include municipal agencies and Code of 1986, as amended, replaces the prior rule would result in inconsistent applications of the instrumentalities. See, e.g., MSRB; Citigroup (Jan. definition of ‘‘industrial development bonds’’ with exemption across States and political subdivisions. 2012). a revised, more restrictive successor definition of The Agencies also recognize, as noted by 1412 See AFR et al. (Feb. 2012); Occupy. The ‘‘private activity bonds’’ and related definitions of commenters, that the proposed rule would likely Agencies do not believe it is appropriate to exclude ‘‘exempt facility bonds’’ and ‘‘small issue bonds.’’ have resulted in a bifurcation of the municipal conduit obligations, which are tax-exempt In recognition of the numerous tax law changes securities market and associated administrative municipal bonds, from this exemption because such since the last statutory revision of section 3(a)(29) burdens and disruptions. See, e.g., MSRB; Am. Pub. obligations are used to finance important projects of the Exchange Act in 1970 and the potential Power et al.; Port Authority; Citigroup (Jan. 2012); related to, for example, multi-family housing, attendant confusion, the Agencies determined to SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA healthcare (hospitals and nursing homes), colleges use a simpler, streamlined, independent definition (Municipal Securities) (Feb. 2012). and universities, power and energy companies and of municipal securities for purposes of the 1409 Commenters asserted that permitting trading resource recovery facilities. See U.S. Securities & municipal securities trading exception. This revised in a broader group of municipal securities would Exchange Comm’n., Report on the Municipal definition is intended to encompass, among others, be consistent with the terms and purposes of Securities Market 7 (2012), available at http:// any securities that are covered by the definition of section 13. See, e.g., Ashurst; Citigroup (Jan. 2012); www.sec.gov/news/studies/2012/ the term ‘‘municipal securities’’ under section Eaton Vance; Am. Pub. Power et al.; SIFMA munireport073112.pdf. 3(a)(29) of the Exchange Act. (Municipal Securities) (Feb. 2012). 1413 See Joint Proposal, 76 FR at 68878.

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providing the requirements of the advisor, trustee, or in a similar fiduciary b. Comments on the Proposed Rule relevant exemption are met. capacity for the account of that Several commenters contended that customer, and (ii) involved solely d. Determination to Not Exempt the Agencies construed the statutory financial instruments for which the Proprietary Trading in Multilateral exemption too narrowly by limiting banking entity’s customer, and not the Development Bank Obligations permissible proprietary trading on banking entity or any affiliate of the behalf of customers to only three The proposal did not exempt banking entity, was the beneficial 1419 proprietary trading in obligations of categories of transactions. Some of owner. This exemption was intended to these commenters argued the exemption multilateral banks or derivatives on permit trading activity that a banking multilateral development bank in the proposal was not consistent with entity conducts in the context of the statutory language or Congressional obligations but requested comment on providing investment advisory, trust, or 1414 intent to permit all transactions that are this issue. A number of commenters fiduciary services to customers provided 1420 argued that the final rule should include ‘‘on behalf of customers.’’ One of that the banking entity structures the these commenters expressed concern an exemption for obligations of activity so that the customer, and not that the proposed exemption for trading multilateral development banks.1415 the banking entity, benefits from any on behalf of customers may be The Agencies have not included an gains and suffers any losses on the construed to permit only customer- exemption to permit banking entities to traded positions. engage in proprietary trading in Section 75.6(b)(ii) of the proposed driven transactions involving securities obligations of multilateral development rule exempted the purchase or sale of a and not other financial instruments banks at this time. The Agencies do not such as foreign exchange forwards and covered financial position if the banking 1421 believe that providing an exemption for entity was acting as riskless other derivatives. Several commenters urged the trading obligations of multilateral principal.1417 Under the proposed rule, Agencies to expand the exemption for development banks will help enhance a banking entity qualified as a riskless trading on behalf of customers to permit the markets for these obligations and principal if the banking entity, after therefore promote and protect the safety having received an order to purchase or other categories of customer-driven and soundness of banking entities and sell a covered financial position from a transactions in which the banking entity U.S. financial stability. customer, purchased or sold the covered may be acting as principal but that serve financial position for its own account to legitimate customer needs including 6. Section 75.6(c): Permitted Trading on capital formation. For example, one Behalf of Customers offset a contemporaneous sale to or purchase from the customer.1418 commenter urged the Agencies to Section 13(d)(1)(D) of the BHC Act Section 75.6(b)(iii) of the proposed permit customer-driven transactions in provides an exemption from the rule permitted trading by a banking which the banking entity has no ready prohibition on proprietary trading for entity that was an insurance company counterparty but that are undertaken at the purchase, sale, acquisition, or for the separate account of insurance the instruction or request of a customer disposition of financial instruments on policyholders. Under the proposed rule, or client or in anticipation of such an behalf of customers.1416 The statute only a banking entity that is an instruction or request, such as does not define when a transaction or insurance company directly engaged in facilitating customer liquidity needs or activity is conducted ‘‘on behalf of the business of insurance and subject to block positioning transactions.1422 customers.’’ regulation by a State insurance regulator Other commenters urged the Agencies a. Proposed Exemption for Trading on or foreign insurance regulator was to exempt transactions where the Behalf of Customers eligible for this prong of the exemption banking entity acts as principal to for trading on behalf of customers. accommodate a customer and Section 75.6(b) of the proposed rule Additionally, the purchase or sale of the substantially and promptly hedges the implemented the exemption for trading covered financial position was exempt risks of the transaction.1423 Commenters on behalf of customers by exempting only if it was solely for a separate argued that these kinds of transactions three types of trading activity. Section account established by the insurance are similar in purpose and level of risk 75.6(b)(i) of the proposed rule provided company in connection with one or to riskless principal transactions.1424 that a purchase or sale of a financial more insurance policies issued by that Commenters also argued that these instrument occurred on behalf of insurance company under which all transactions could be viewed as market- customers if the transaction (i) was profits and losses arising from the making related activities, but indicated conducted by a banking entity acting as purchase or sale of the financial that the potential uncertainty and costs investment adviser, commodity trading instrument were allocated to the of making that determination would separate account and inured to the discourage banking entities from taking 1414 See id. 1415 benefit or detriment of the owners of the principal risks to accommodate Commenters argued that including 1425 obligations of multilateral developments banks in a insurance policies supported by the customer needs. Commenters also foreign sovereign debt exemption is necessary to separate account, and not the banking requested that the Agencies expressly avoid endangering international cooperation in entity. These types of transactions are financial regulation and potential retaliatory customer-driven and do not expose the 1419 See, e.g., Am. Express; BoA; ISDA (Apr. prohibitions against U.S. government obligations. banking entity to gains or losses on the 2012); RBC; SIMFA et al. (Prop. Trading) (Feb. See Ass’n. of German Banks; Sumitomo; SIFMA et 2012); Wells Fargo (Prop. Trading). al. (Prop. Trading) (Feb. 2012). Additionally, some value of separate account assets even 1420 See, e.g., Am. Express; SIMFA et al. (Prop. commenters represented that an exemption for though the banking entity is treated as Trading) (Feb. 2012). obligations of international and multilateral the owner of those assets for certain 1421 development banks is appropriate for many of the See Am. Express. same reasons provided for exempting U.S. purposes. 1422 See RBC. The Agencies note that acting as a government obligations and foreign sovereign debt block positioner is expressly contemplated and generally. See Ass’n. of German Banks; Barclays; 1417 See Joint Proposal, 76 FR at 68879. included as part of the exemption for market making-related activities under the final rule. Goldman (Prop. Trading); IIB/EBF; ICFR; ICI Global; 1418 This language generally mirrors that used in 1423 FIA; Sumitomo Trust; Allen & Overy (Gov’t. the Board’s Regulation Y, OCC interpretive letters, See BoA; SIMFA et al. (Prop. Trading) (Feb. Obligations); SIFMA et al. (Prop. Trading) (Feb. and the SEC’s Rule 3a5–1 under the Exchange Act. 2012). 2012). See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5–1(b); 1424 See SIMFA et al. (Prop. Trading) (Feb. 2012). 1416 12 U.S.C. 1851(d)(1)(D). OCC Interpretive Letter 626 (July 7, 1993). 1425 See SIMFA et al. (Prop. Trading) (Feb. 2012).

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permit transactions on behalf of proposed rule.1435 One commenter manner consistent with the legislative customers to create structured products, requested that the final rule more intent to allow banking entities to use as well as for client funding needs, clearly articulate who may qualify as a their own funds to purchase or sell customer clearing, and prime brokerage, permissible owner of an insurance financial instruments when acting on if these transactions are included within policy to whom the profits and losses behalf of their customers.1442 At the the trading account.1426 arising from the purchase or sale of a same time, the limited activities In contrast, some commenters financial instrument allocated to the permitted under the final rule limit the supported the proposed approach for separate account may inure.1436 potential for abuse.1443 implementing the exemption for trading Several commenters argued that The final rule slightly modifies the on behalf of customers or urged certain types of separate account proposed rule by providing that a narrowing the exemption.1427 One activities, including the allocation of banking entity is not prohibited from commenter expressed general support seed money by an insurance company to trading on behalf of customers when for the requirement that all profits (or a separate account or the offering of that activity is conducted by the losses) from the transaction flow to the certain non-variable separate account banking entity as trustee or in a similar customer and not the banking entity contracts by the insurance company, fiduciary capacity for a customer and so providing the service for a transaction to would not appear to be permitted under long as the transaction is conducted for 1437 be exempt.1428 One commenter the proposal. Commenters also the account of, or on behalf of the contended that the statute did not expressed concern that these separate customer and the banking entity does permit transactions on behalf of account activities might not satisfy the not have or retain a beneficial customers to be performed by an proposed requirement that all profits ownership of the financial instruments. investment adviser.1429 Another and losses arising from the purchase or The final rule removes the proposal’s commenter argued that the final rule sale of the financial position inure to the express exemption for investment should permit a banking entity to benefit or detriment of the owners of the advisers. After further consideration, the engage in a riskless principal insurance policies supported by the Agencies do not believe an express transaction only where the banking separate account, and not the insurance 1438 reference to investment advisers is entity has already arranged for another company. In addition, commenters necessary because investment advisers customer to be on the other side of the argued that under the proposed rule, generally act in a fiduciary capacity on transaction.1430 Other commenters these activities would appear to fall behalf of clients in a manner that is urged the Agencies to ensure that both outside of the exemption for activities in separately covered by other exclusions the general account of an insurance parties to the transaction agree and exemptions in the final rule. company because the proposed rule beforehand to the time and price of any Additionally, the final rule deletes the defined a general account as excluding relevant trade to ensure that the banking proposal’s express exemption for a separate account.1439 Commenters entity solely stands in the middle of the commodity trading advisors because the urged the Agencies to more closely align transaction and in fact passes on all legal relationship between a commodity the exemptions for trading by an gains (or losses) from the transaction to trading advisor and its client depends insurance company for the general the customers.1431 Commenters also on the facts and circumstances of each account and separate account.1440 urged the Agencies to define other key relationship. Therefore, the Agencies According to these commenters, this terms used in the exemption. For determined that it was appropriate to change would permit insurance instance, some commenters requested limit the discussion to fiduciary that the final rule define which entities companies to continue to engage in the business of insurance by offering the obligations generally and to omit any may qualify as a ‘‘customer’’ for specific discussion of commodity purposes of the exemption.1432 full suite of insurance products to their customers.1441 trading advisors. In order to ensure that Some commenters urged the Agencies a banking entity utilizes this exemption to provide uniform guidance on how the c. Final Exemption for Trading on to engage only in transactions for Agencies will interpret the riskless Behalf of Customers customers and not to conduct its own 1433 principal exemption. One The Agencies have carefully trading activity, the final rule commenter urged the Agencies to clarify considered the comments and are (consistent with the proposed rule) how the riskless principal exemption adopting the exemption for trading on requires that the purchase or sale of would be implemented with respect to behalf of customers with several financial instruments be conducted for transactions in derivatives, including a modifications. The Agencies believe the account of the customer and that it hedged derivative transaction executed that the final rule implements the involve solely financial instruments of 1434 at the request of a customer. exemption in section 13(d)(1)(D) in a which the customer, and not the Several commenters generally banking entity, is beneficial owner.1444 expressed support for the exemption for 1435 See ACLI; Chris Barnard; NAMIC; Fin. The final rule, like the proposed rule, trading for the separate account of Services Roundtable (Feb. 3, 2012). permits transactions in any financial insurance policyholders under the 1436 See Chris Barnard. instrument, including derivatives such 1437 See ACLI; Sutherland (on behalf of Comm. of as foreign exchange forwards, so long as 1426 See SIMFA et al. (Prop. Trading) (Feb. 2012). Annuity Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC. 1427 See, e.g., Alfred Brock; ICBA; Occupy. 1438 See ACLI; Sutherland (on behalf of Comm. of 1442 See 156 Cong. Rec. S5896 (daily ed. July 15, 1428 See ICBA. Annuity Insurers); Fin. Services Roundtable (Feb. 3, 2010) (statement of Sen. Merkley) (arguing that 1429 See Occupy. 2012); NAMIC. ‘‘this permitted activity is intended to allow 1430 See Public Citizen. 1439 See ACLI; Sutherland (on behalf of Comm. of financial firms to use firm funds to purchase assets 1431 See Occupy; Alfred Brock. Annuity Insurers); Fin. Services Roundtable (Feb. 3, on behalf of their clients, rather than on behalf of 1432 See Occupy; Public Citizen. Conversely, other 2012); NAMIC. themselves.’’). commenters supported the approach taken in the 1440 See ACLI; Sutherland (on behalf of Comm. of 1443 Some commenters urged narrowing the proposed rule without requesting such a definition. Annuity Insurers); Fin. Services Roundtable (Feb. 3, exemption. See, e.g., Alfred Brock; ICBA; Occupy. See Alfred Brock. 2012); NAMIC. The Agencies believe the final rule is appropriately 1433 See, e.g., Am. Express; SIMFA et al. (Prop. 1441 See ACLI; Sutherland (on behalf of Comm. of narrow to limit potential abuse. Trading) (Feb. 2012). Annuity Insurers); Fin. Services Roundtable (Feb. 3, 1444 See final rule § 75.6(c)(1)(ii)–(iii). See also 1434 See Am. Express. 2012); NAMIC. proposed rule § 75.6(b)(2)(i)(B)–(C).

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those transactions are on behalf of as riskless principal.1450 The Agencies commenters requested that clearing and customers.1445 note that riskless principal transactions settlement activities and prime While some commenters requested typically are undertaken as an brokerage activities be viewed as that the final rule define ‘‘customer’’ for alternative method of executing orders permitted proprietary trading on behalf purposes of this exemption,1446 the by customers to buy or sell financial of customers,1455 these transactions are Agencies believe the requirements of instruments on an agency basis. Acting not considered proprietary trading as an this exemption address commenters’ as riskless principal does not include initial matter under the final rule.1456 underlying concerns about what acting as underwriter or market maker Finally, the Agencies have decided to constitutes a ‘‘customer.’’ Specifically, in the particular financial instrument move the exemption for trading activity the Agencies believe that requiring a and is generally understood to be conducted by an insurance company for transaction relying on this exemption to equivalent to agency or brokerage a separate account into the provision be conducted in a fiduciary capacity for transactions in which all of the risks exempting trading activity in an a customer, to be conducted for the associated with ownership of financial insurance company’s general account in account of the customer, and to involve instruments are borne by customers. order to better align the two solely financial instruments of which The Agencies have generally equivalent exemptions.1457 As discussed below in the customer is beneficial owner standards for determining when a Part VI.A.7., the final rule provides address the underlying concerns that a banking entity acts as riskless principal exemptions for trading activity transaction could qualify for this and require that the banking entity, after conducted by an insurance company exemption if done on behalf of an receiving an order to buy (or sell) a that is a banking entity either in the indirect customer or on behalf of a financial instrument from a customer, general account or in a separate account customer not served by the banking buys (or sells) the instrument for its own of customers in § 75.6(d). As explained entity. account to offset a contemporaneous below, the statute specifically exempts The final rule also provides that a sale to (or purchase from) the trading activity that is conducted by a banking entity may act as riskless customer.1451 The Agencies intend to regulated insurance company engaged principal in a transaction in which the determine whether a banking entity acts in the business of insurance for the banking entity, after receiving an order as riskless principal in accordance with general account of the company if to purchase (or sell) a financial and subject to the requirements of these conducted in accordance with instrument from a customer, purchases standards. applicable state law and if not (or sells) the financial instrument for its Some commenters requested that the prohibited by the appropriate Federal own account to offset the final rule permit a greater variety of banking agencies.1458 Unlike activity for contemporaneous sale of the financial transactions to be conducted on behalf the general account of an insurance instrument to (purchase from) the of customers. Many of these company, investments made by customer.1447 Any transaction transactions, such as transactions that regulated insurance companies in conducted pursuant to the exemption facilitate customer liquidity needs or separate accounts in accordance with for riskless principal activity must be 1452 block positioning transactions or applicable state law are made on behalf customer-driven and may not expose transactions in which the banking entity of and for the benefit of customers of the the banking entity to gains (or losses) on acts as principal to accommodate a insurance company.1459 Also unlike the value of the traded instruments as customer and substantially and 1448 principal. Importantly, the final rule promptly hedges the risks of the activity qualifies for the market-making exemption 1453 does not permit a banking entity to transaction, may be permissible would discourage banking entities from taking purchase (or sell) a financial instrument under the market-making exemption. To principal risks to accommodate customer needs. without first having a customer order to the extent these transactions are See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012). The Agencies believe that adjustments made to the buy (sell) the instrument. While some conducted by a market maker, the market-making exemption in the final rule help commenters requested that the Agencies Agencies believe that the restrictions address this concern. Specifically, the final market- modify the final rule to permit activity and limits required in connection with making exemption better accounts for the varying without a customer order,1449 the market making-related activities are characteristics of market-making across markets and Agencies are concerned that broadening important for limiting the risks to the assets classes. 1455 See, e.g., SIFMA et al. (Prop. Trading) (Feb. the exemption in this manner would banking entity from these 2012). 1454 enable banking entities to evade the transactions. While some 1456 See final rule § 75.3(d)(4)–(6). See also infra requirements of section 13 and engage Part VI.A.1.d.3–4. in prohibited proprietary trading under 1450 See, e.g., Am. Express; SIFMA et al. (Prop. 1457 Some commenters requested that the the guise of trading on behalf of Trading) (Feb. 2012). Agencies more closely align the exemptions for 1451 See, e.g., 12 CFR 225.28(b)(7)(ii); 17 CFR trading by an insurance company for the general customers. 240.3a5–1(b); OCC Interpretive Letter 626 (July 7, account and separate account. See ACLI; Several commenters requested that 1993). One commenter stated that a banking entity Sutherland (on behalf of Comm. of Annuity the final rule explain how a banking should only be allowed to engage in a riskless Insurers); Fin. Services Roundtable (Feb. 3, 2012); entity may determine when it is acting principal transaction where the banking entity has NAMIC. already arranged for another customer to be on the 1458 See 12 U.S.C. 1851(d)(1)(F). other side of the transaction. See Public Citizen. 1459 One commenter requested clarification on 1445 Some commenters expressed concern that the The Agencies believe that the contemporaneous who may qualify as a permissible owner of an proposed exemption for trading on behalf of requirement in the final rule addresses this insurance policy to whom the profits and losses customers may be construed to not permit comment. arising from the purchase or sale of a financial transactions in foreign exchange forwards and other 1452 One commenter requested an exemption for instrument allocated to the separate account may derivatives. See Am. Express; SIFMA et al. (Prop. transactions at the instruction or request of a inure. See Chris Barnard. The Agencies note that Trading) (Feb. 2012). customer or client or in anticipation of such an the proposed requirement that all profits and losses 1446 See Occupy; Public Citizen. instruction or request, such as facilitating customer arising from the purchase or sale of a financial 1447 See final rule § 75.6(c)(2). liquidity needs or block positioning transactions. instrument inure to the benefit or detriment of the 1448 Some commenters urged the Agencies to See RBC. ‘‘owners of the insurance policies supported by the ensure that the banking entity passes on all gains 1453 Some commenters requested an exemption separate account’’ has been removed. See proposed (or losses) from the transaction to the customers. for these types of transactions. See BoA; SIFMA et rule § 75.6(b)(2)(iii)(C). Instead, the final rule See Occupy; Public Citizen. al. (Prop. Trading) (Feb. 2012). requires that the income, gains, and losses from 1449 See RBC; SIFMA et al. (Prop. Trading) (Feb. 1454 Some commenters stated that the potential assets allocated to a separate account be credited to 2012). uncertainty and costs of determining whether an Continued

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general accounts (which are supported insurance regulator or foreign insurance instrument qualified for the separate by all of the assets of the insurance regulator; account exemption only if: company), a separate account is • The insurance company or its • The banking entity is an insurance supported only by the assets in that affiliate purchase or sell the financial company directly engaged in the account and does not have call on the instrument solely for the general business of insurance and subject to other assets of the company. The account of the insurance company; regulation by a State insurance regulator customer benefits (or loses) based solely • The purchase or sale be conducted or foreign insurance regulator; 1466 on the performance of the assets in the in compliance with, and subject to, the • The banking entity purchases or separate account. These arrangements insurance company investment laws, sells the financial instrument solely for are the equivalent for insurance regulations, and written guidance of the a separate account established by the companies of fiduciary accounts at State or jurisdiction in which such insurance company in connection with banks. For these reasons, the final rule insurance company is domiciled; and • one or more insurance policies issued recognizes that separate accounts at The appropriate Federal banking by that insurance company; regulated insurance companies agencies, after consultation with the • All profits and losses arising from maintained in accordance with Council and the relevant insurance the purchase or sale of the financial applicable state insurance laws are commissioners of the States, must not instrument are allocated to the separate exempt from the prohibitions in section have jointly determined, after notice account and inure to the benefit or 13 as acquisitions on behalf of and comment, that a particular law, detriment of the owners of the insurance customers. regulation, or written guidance policies supported by the separate described above is insufficient to protect account, and not the banking entity; and the safety and soundness of the banking • The purchase or sale is conducted 7. Section 75.6(d): Permitted Trading by entity or of the financial stability of the in compliance with, and subject to, the a Regulated Insurance Company United States. insurance company investment and The proposed rule defined the term other laws, regulations, and written Section 13(d)(1)(F) permits a banking ‘‘general account’’ to include all of the guidance of the State or jurisdiction in entity that is a regulated insurance assets of the insurance company that are which such insurance company is company acting for its general account, not legally segregated and allocated to domiciled. or an affiliate of an insurance company separate accounts under applicable The proposal explained that the acting for the insurance company’s State law.1463 proposed separate account exception general account, to purchase or sell a As noted above in Part VI.A.6.a., represented transactions on behalf of financial instrument subject to certain § 75.6(b)(iii) of the proposed rule customers because the insurance-related conditions (the ‘‘general account provided an exemption for a banking transactions are generally customer- exemption’’).1460 Section 13(d)(1)(D) entity that is an insurance company driven and do not expose the banking permits a banking entity to purchase or when it acted through a separate entity to gains or losses on the value of sell a financial instrument on behalf of account for the benefit of insurance separate account assets, even though the customers.1461 In the proposed rule, the policyholders. The proposed rule banking entity may be treated as the Agencies viewed Section 13(d)(1)(D) as defined a ‘‘separate account’’ as an owner of those assets for certain permitting an insurance company to account established or maintained by a purposes. purchase or sell a financial instrument regulated insurance company subject to for certain separate accounts (the regulation by a State insurance regulator Commenters generally supported the ‘‘separate account exemption’’). The or foreign insurance regulator under general account exemption and the proposal implemented both these which income, gains, and losses, separate account exemption for exemptions with respect to activities of whether or not realized, from assets regulated insurance companies as insurance companies, in each case allocated to such account, are, in consistent with both the statute and subject to the restrictions discussed Congressional intent to accommodate accordance with the applicable contract, 1467 below.1462 credited to or charged against such the business of insurance. For account without regard to other income, instance, commenters argued that the Section 75.6(c) of the proposed rule statute was designed to appropriately implemented the general account gains, or losses of the insurance company.1464 accommodate the business of insurance, exemption by generally restating the subject to regulation in accordance with statutory requirements of the exemption To limit the potential for abuse of the separate account exemption, the relevant insurance company investment that: laws, in recognition that insurance • proposed rule included requirements The insurance company directly company investment activities are engage in the business of insurance and designed to ensure that the separate account trading activity is subject to already subject to comprehensive be subject to regulation by a State 1468 appropriate regulation and supervision regulation and oversight. under insurance laws and not structured A few commenters expressed or charged against the account without regard to concerns about the definition of other income, gains or losses of the insurance so as to allow gains or losses from company. See final rule § 75.2(z) (definition of trading activity to inure to the benefit or ‘‘general account’’ and ‘‘separate ‘‘separate account’’). Thus, the final rule no longer detriment of the banking entity.1465 In references ‘‘owners of the insurance policies particular, the proposed rule provided 1466 The proposed rule provided definitions of the supported by the separate account.’’ The Agencies terms ‘‘State insurance regulator’’ and ‘‘foreign note, however, that the final rule requires exempted that a purchase or sale of a financial insurance regulator.’’ See proposed rule § 75.3(c)(4), separate account transactions to be ‘‘conducted in (13). compliance with, and subject to, the insurance 1463 See proposed rule § 75.3(c)(6). 1467 See, e.g., Alfred Brock; Chris Barnard; Fin. company investment laws, regulations, and written 1464 See proposed rule § 75.2(z). Services Roundtable (Feb. 3, 2012); Sutherland (on guidance of the State or jurisdiction in which such 1465 The Agencies noted in the proposal they behalf of Comm. of Annuity Insurers); TIAA–CREF; insurance company is domiciled.’’ See final rule would not consider profits to inure to the benefit NAMIC. § 75.6(d)(3). of the banking entity if the banking entity were 1468 See, e.g., ACLI (Jan. 2012); Fin. Services 1460 See 12 U.S.C. 1851(d)(1)(F). solely to receive payment, out of separate account Roundtable (Feb. 3, 2012); Country Fin. et al.; 1461 See 12 U.S.C. 1851(d)(1)(D). profits, of fees unrelated to the investment Sutherland (on behalf of Comm. of Annuity 1462 See proposed rule §§ 75.6(b)(2)(iii), 75.6(c). performance of the separate account. Insurers).

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account.’’ 1469 One commenter argued and the final rule using their insurance The final rule also combines the the definition of general account was affiliates.1477 By contrast, other general account exemption and the unclear.1470 A few commenters commenters argued that the reporting separate account exemption into a expressed concern that the proposed and recordkeeping and compliance single section. This makes clear that definition of separate account requirements of the rule should not both exemptions are available only: inappropriately excluded some separate apply to permitted insurance company • If the insurance company or its accounts, such as certain insurance investment activities.1478 These affiliate purchases or sells the financial company investment activities such as commenters argued that insurance instruments solely for the general guaranteed investment contracts, which companies are already subject to account of the insurance company or a would also not fall within the proposed comprehensive regulation of the kinds separate account of the insurance definition of general account.1471 and amounts of investments they can company; Several commenters argued that the make under insurance laws and • The purchases or sales of financial final rule should be modified so that all regulations and that additional instruments are conducted in insurance company investment activity recordkeeping obligations would compliance with, and subject to, the permitted under applicable insurance impose unnecessary compliance insurance company investment laws, laws would qualify for either the general burdens on these entities without regulations, and written guidance of the account exemption or the separate producing significant offsetting benefits. State or jurisdiction in which such account exemption.1472 After considering the comments insurance company is domiciled; and Some commenters argued that the received and the language and purpose • The appropriate Federal banking prohibition in the proposed definition of the statute, the final rule has been agencies, after consultation with the of separate account against any profits modified to better account for the Financial Stability Oversight Council or losses from activity in the account language of the statute and more and the relevant insurance inuring to the benefit (or detriment) of appropriately accommodate the commissioners of the States and the insurance company would exclude business of insurance. relevant foreign jurisdictions, as some activity permitted by insurance As explained in the proposal, section appropriate, have not jointly regulation in separate accounts.1473 For 13(d)(1)(F) of the BHC Act specifically determined, after notice and comment, example, commenters contended that an and broadly exempts the purchase, sale, that a particular law, regulation, or insurer may allocate its own funds to a acquisition, or disposition of securities written guidance regarding insurance is separate account as ‘‘seed money’’ and and other instruments by a regulated insufficient to protect the safety and the profits and losses on those funds insurance company engaged in the soundness of the banking entity, or the inure to the benefit or detriment of the business of insurance for the general 1474 financial stability of the United insurance company. account of the company (and by an 1480 Some commenters expressed specific affiliate solely for the general account of States. concerns about the scope or the regulated insurance company). Like section 13(d)(1)(F) of the BHC requirements of the proposal. For Section 13(d)(1)(D) of the statute also Act, the final rule permits an affiliate of instance, one commenter argued that the specifically exempts the same activity an insurance company to purchase and final rule should provide that a trade is when done on behalf of customers. As sell financial instruments in reliance on exempt if the trade is made by an explained in the proposal, separate the general account exemption, so long affiliate of the insurance company in accounts managed and maintained by as that activity is for the general account accordance with state insurance law.1475 insurance companies as part of the of the insurance company. Similarly, Another commenter urged that the business of insurance are generally the final rule implements section Agencies consult with the foreign customer-driven and do not expose the 13(d)(1)(D) and permits an affiliate of an insurance supervisor of an insurance banking entity to gains or losses on the insurance company to purchase and sell company regulated outside of the value of assets held in the separate financial instruments for a separate United States before finding that an account, even though the banking entity account of the insurance company, so insurance activity conducted by the may be treated as the owner of the assets long as the separate account is foreign insurance company was for certain purposes. Unlike the general inconsistent with the safety and account of the insurance company, account,’’ including that the proposed definition of soundness or financial stability.1476 separate accounts are managed on ‘‘separate account’’ excluded some legitimate separate account activities that do not fall within One commenter suggested that behalf of specific customers, much as a the proposed general account definition. See, e.g., insurance company affiliates of banking bank would manage a trust or fiduciary ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of entities should expressly be made account. Comm. of Annuity Insurers). See also proposed rule subject to data collection and reporting For these reasons, the final rule §§ 75.2(z), 75.3(c)(5). requirements to prevent possible retains both the general account 1480 The Federal banking agencies have not at this time determined, as part of the final rule, that the evasion of the restrictions of section 13 exemption and the separate account insurance company investment laws, regulations, exemption. The final rule removes any and written guidance of any particular State or 1469 See, e.g., Fin. Services Roundtable (Feb. 3, gap between the definition of general jurisdiction are insufficient to protect the safety and 2012); ACLI (Jan. 2012); Sutherland (on behalf of account and the definition of separate soundness of the banking entity, or of the financial stability of the United States. The Federal banking Comm. of Annuity Insurers). account by defining the general account 1470 See Sutherland (on behalf of Comm. of agencies expect to monitor, in conjunction with the Annuity Insurers). to be all of the assets of an insurance FSOC, the insurance company investment laws, 1471 See ACLI (Jan. 2012); NAMIC. company except those allocated to one regulations, and written guidance of States or jurisdictions to which exempt transactions are 1472 See Fin. Services Roundtable (Feb. 3, 2012); or more separate accounts.1479 subject and make such determinations in the future, ACLI (Jan. 2012); NAMIC; see also Nationwide. where appropriate. The Agencies believe the final 1473 See Fin. Services Roundtable (Feb. 3, 2012); 1477 See Sens. Merkley & Levin (Feb. 2012). approach addresses one commenter’s request that ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of 1478 See ACLI (Jan. 2012); Fin. Services the Agencies consult with the foreign insurance Comm. of Annuity Insurers); see also Nationwide. Roundtable (Feb. 3, 2012); Mutual of Omaha; supervisor of an insurance company regulated 1474 See Fin. Services Roundtable (Feb. 3, 2012); NAMIC. outside of the United States before finding that an ACLI (Jan. 2012). 1479 See final rule § 75.2(p), (bb). Some insurance activity conducted by the foreign 1475 See USAA. commenters expressed concerns about the proposed company was inconsistent with the safety and 1476 See HSBC Life. definitions of ‘‘general account’’ and ‘‘separate soundness or financial stability. See HSBC Life.

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established and maintained at the define when a foreign banking entity’s the proposed exemption would cause insurance company. trading occurs solely outside of the foreign banks to exit U.S. markets or Importantly, the final rule applies United States. shrink their U.S.-based operations, only to covered trading activity in a The proposed rule defined both the thereby resulting in less liquidity and general or separate account of a licensed type of foreign banking entity that is greater fragmentation in markets insurance company engaged in the eligible for the exemption and activity without producing any significant business of insurance under the that constitutes trading solely outside of offsetting benefit.1489 Commenters also supervision of a State or foreign the United States. The proposed rule asserted that the proposal would impose insurance regulator. As in the statute, an effectively precluded a foreign banking significant compliance costs on the affiliate of an insurance company may entity from engaging in proprietary foreign operations of foreign banking not rely on this exemption for activity trading through a transaction that had entities and would lead to foreign firms in any account of the affiliate (unless it, any connection with the United States, refusing to trade with U.S. too, meets the definition of an insurance including: Trading with any party counterparties, including the foreign company). An affiliate may rely on the located in the United States; allowing operations of U.S. entities, to avoid exemption to the limited extent that the U.S. personnel of the foreign banking compliance costs associated with affiliate is acting solely for the account entity to be involved in the purchase or relying on another exemption under the of the insurance company.1481 sale; or executing any transaction in the proposed rule.1490 Additionally, As noted above, one commenter United States (on an exchange or commenters argued that the proposal requested that the final rule impose otherwise).1485 represented an improper extraterritorial special data and reporting obligations In general, commenters emphasized application of U.S. law that could be on insurance companies. Other the importance of and supported an found to violate international treaty commenters argued that insurance exemption for foreign trading activities obligations of the United States, such as companies are already subject to of foreign banking entities. However, a those under the North American Free comprehensive regulation under number of commenters expressed Trade Agreement, and might result in insurance laws and regulations and that concerns that the proposed foreign retaliation by foreign countries in their additional recordkeeping obligations trading exemption was too narrow and treatment of U.S. banking entities would impose unnecessary compliance would not be effective in permitting abroad.1491 burdens on these entities without foreign banking entities to engage in producing significant offsetting benefits. foreign trading activities.1486 For a. Foreign Banking Entities Eligible for In accordance with the statute,1482 the instance, many commenters stated that the Exemption Agencies expect insurance companies to the proposal’s prohibition on trading The statutory language of section have appropriate compliance programs activities that have any connection to 13(d)(1)(H) provides that, in order to be in place for any activity subject to the U.S. was not consistent with the eligible for the foreign trading section 13 of the BHC Act. purpose of section 13 of the BHC Act exemption, the banking entity must not The final rule contains a number of where the risk of the trading activity is be directly or indirectly controlled by a other related definitions that are taken or held outside of the United banking entity that is organized under intended to help make clear the States and does not implicate the U.S. the laws of the United States or of one limitations of the insurance company safety net.1487 These commenters argued or more States. The proposed rule exemption, including definitions of that, since one of the principal purposes limited the scope of the exemption to foreign insurance regulator and State of section 13 of the BHC Act is to limit banking entities that are organized insurance regulator. the risk posed by prohibited proprietary under foreign law and, as applicable, 8. Section 75.6(e): Permitted Trading trading to the Federal safety net, the controlled only by entities organized Activities of a Foreign Banking Entity safety and soundness of U.S. banking under foreign law. entities, and the financial stability of the Commenters generally supported this Section 13(d)(1)(H) of the BHC United States, the exemption for foreign aspect of the proposal.1492 However, 1483 Act permits certain foreign banking trading activity should similarly focus some commenters requested that the entities to engage in proprietary trading on whether the trading activity involves final rule be modified to allow U.S. that occurs solely outside of the United principal risk being taken or held by the banking entities’ affiliates or branches States (the ‘‘foreign trading foreign banking entity inside the United that are physically located outside of the 1484 exemption’’). The statute does not States.1488 United States (‘‘foreign operations of Many commenters argued that the U.S. banking entities’’) to engage in 1481 Although one commenter requested that the proposal’s transaction-based approach proprietary trading outside of the final rule exempt a trade as long as the trade is made by an affiliate of the insurance company in to implementing the foreign trading United States pursuant to this accordance with state insurance law, the Agencies exemption would harm U.S. markets believe the final approach properly implements the and U.S. market participants. For 1489 See ICE; ICI Global; BoA; Citigroup (Feb. statute. See USAA. example, some commenters argued that 2012); British Bankers’ Ass’n.; IIB/EBF. 1482 See 12 U.S.C. 1851(e)(1) (requiring that the 1490 See BaFin/Deutsche Bundesbank; Agencies issue regulations regarding ‘‘internal Norinchukin; IIF; Allen & Overy (on behalf of controls and recordkeeping, in order to insure solely for purposes of the rule’s implementation of Canadian Banks); ICFR; BoA; Citigroup (Feb. 2012). compliance with this section’’). section 13(d)(1)(H) of the BHC Act, and does not As discussed below in Part VI.C. of this 1483 Section 13(d)(1)(H) of the BHC Act provides affect a banking entity’s obligation to comply with SUPPLEMENTARY INFORMATION, other parts of the final an exemption to the prohibition on proprietary additional or different requirements under rule address commenters’ concerns regarding the trading for trading conducted by a foreign banking applicable securities, banking, or other laws. compliance burden on foreign banking entities. entity pursuant to paragraph (9) or (13) of section 1485 See proposed rule § 75.6(d). 1491 See Norinchukin; Cadwalader (on behalf of 4(c) of the BHC Act, if the trading occurs solely 1486 See, e.g., IIB/EBF; ICI Global; ICI (Feb. 2012); Thai Banks); Barclays; EBF; Commissioner Barnier; outside of the United States, and the banking entity Wells Fargo (Prop. Trading); BoA. Ass’n. of German Banks; Socie´te´ Ge´ne´rale; Chamber is not directly or indirectly controlled by a banking 1487 See IIB/EBF; Ass’n. of Banks in Malaysia; (Dec. 2012). entity that is organized under the laws of the United EBF; Credit Suisse (Seidel); Cadwalader (on behalf 1492 See Sens. Merkley & Levin (Feb. 2012) States or of one or more States. See 12 U.S.C. of Thai Banks). (arguing that the final rule’s foreign trading 1851(d)(1)(H). 1488 See BaFin/Deutsche Bundesbank; ICSA; IIB/ exemption should not exempt foreign affiliates of 1484 This section’s discussion of the concept EBF; Allen & Overy (on behalf of Canadian Banks); U.S. banking entities when they engage in trading ‘‘solely outside of the United States’’ is provided Credit Suisse (Seidel); George Osbourne. activity abroad); see also Occupy; Alfred Brock.

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exemption.1493 These commenters under the circumstances and subject to Section 13 of the BHC Act also argued that, unless foreign operations of the conditions set forth in the regulation applies to foreign companies that U.S. banking entities are provided or order, the exemption would not be control a U.S. insured depository similar authority to engage in substantially at variance with the institution but that are not currently proprietary trading outside of the purposes of the BHC Act and would be subject to the BHC Act generally or to United States, foreign operations of U.S. in the public interest.1498 The Board has the Board’s Regulation K—for example, banking entities would be at a implemented section 4(c)(9) as part of because the foreign company controls a competitive disadvantage abroad with subpart B of the Board’s Regulation savings association or an FDIC-insured respect to foreign banking entities. One K,1499 which specifies a number of industrial loan company. Accordingly, commenter also asserted that, unless conditions and requirements that a the final rule also provides that a foreign foreign operations of U.S. banking foreign banking organization must meet banking entity that is not a foreign entities were able to effectively access in order to act pursuant to that banking organization would be foreign markets, they could be shut out authority.1500 The qualifying conditions considered to be conducting activities of those markets and would be unable and requirements include, for example, ‘‘pursuant to section 4(c)(9)’’ for to effectively manage their risks in a safe that the foreign banking organization purposes of this exemption 1503 if the and sound manner.1494 demonstrate that more than half of its entity, on a fully-consolidated basis, As noted above, section 13(d)(1)(H) of worldwide business is banking and that meets at least two of three requirements the BHC Act specifically provides that more than half of its banking business that evaluate the extent to which the its exemption is available only to a is outside the United States.1501 Under foreign banking entity’s business is banking entity that is not ‘‘directly or the final rule a banking entity that is a conducted outside the United States, as indirectly’’ controlled by a banking qualifying foreign banking organization measured by assets, revenues, and entity that is organized under the laws for purposes of the Board’s Regulation income.1504 This test largely mirrors the of the United States or of one or more K, other than a foreign bank as defined qualifying foreign banking organization States.1495 Because of this express in section 1(b)(7) of the International test that is made applicable under statutory threshold requirement, a Banking Act of 1978 that is organized section 4(c)(9) of the BHC Act and foreign subsidiary controlled, directly or under the laws of any commonwealth, section 211.23(a), (c), or (e) of the indirectly, by a banking entity organized territory, or possession of the United Board’s Regulation K, except that the under the laws of the United States or States, will qualify for the exemption for test does not require the foreign entity one of its States, and a foreign branch proprietary trading activity of a foreign to demonstrate that more than half of its office of a banking entity organized banking entity.1502 banking business is outside the United under the laws of the United States or States.1505 This difference reflects the one of the States, may not take 1498 See 12 U.S.C. 1843(c)(9). fact that foreign entities subject to advantage of this exemption. 1499 See 12 CFR 211.20 et seq. section 13 of the BHC Act, but not the Like the proposal, the final rule 1500 Commenters noted that the Board’s BHC Act generally, are likely to be, in Regulation K contains a number of limitations that incorporates the statutory requirement may not be appropriate to include as part of the many cases, predominantly commercial that the banking entity conduct its requirements of the foreign trading exemption. See firms. A requirement that such firms trading activities pursuant to sections Allen & Overy (on behalf of Foreign Bank Group); also demonstrate that more than half of 4(c)(9) or 4(c)(13) of the BHC Act.1496 HSBC Life. Accordingly, the final rule does not their banking business is outside the retain the proposal’s requirement that the activity The final rule retains the tests in the be conducted in compliance with subpart B of the United States would likely make the proposed rule for determining when a Board’s Regulation K (12 CFR 211.20 through exemption unavailable to such firms banking entity would meet that 211.30). However, the exemption in section and subject their global activities to the requirement. The final rule provides 13(d)(1)(H) of the BHC Act and the final rule prohibition on proprietary trading. operates as an exemption and is not a separate grant qualifying criteria for both a banking of authority to engage in an otherwise b. Permitted Trading Activities of a entity that is a qualifying foreign impermissible activity. To the extent a banking Foreign Banking Entity banking organization under the Board’s entity is a foreign banking organization, it remains Regulation K and a banking entity that subject to the Board’s Regulation K and must, as a As noted above, the proposed rule separate matter, comply with any and all applicable laid out a transaction-based approach to is not a foreign banking organization for rules and requirements of that regulation. 1497 purposes of Regulation K. 1501 See 12 CFR 211.23(a), (c), and (e). The Section 4(c)(9) of the BHC Act applies proposed rule referenced only the qualifying test Agencies believe that these entities should be to any company organized under the under section 211.23(a) of the Board’s Regulation K; considered to be located within the United States for purposes of section 13. The final rule includes laws of a foreign country the greater part however, because there are two other methods by which a foreign banking organization may meet the within the definition of State a commonwealth, of whose business is conducted outside requirements to be considered a qualified foreign territory or possession of the United States, the the United States, if the Board by banking organization, the final rule incorporates a District of Columbia, the Commonwealth of Puerto regulation or order determines that, reference to those provisions as well. Rico, the Commonwealth of the Northern Mariana 1502 This modification to the definition of foreign Islands, American Samoa, Guam, or the United banking organization is necessary because, under States Virgin Islands. 1493 See Citigroup (Feb. 2012); Sen. Carper; IIF; 1503 the International Banking Act and the Board’s This clarification would be applicable solely ABA (Keating); Wells Fargo (Prop. Trading); Abbot Regulation K, depository institutions that are in the context of section 13(d)(1) of the BHC Act. Labs. et al. (Feb. 14, 2012). located in, or organized under the laws of a The application of section 4(c)(9) to foreign 1494 See Citigroup (Feb. 2012). commonwealth, territory, or possession of the companies in other contexts is likely to involve 1495 See 12 U.S.C. 1851(d)(1)(H). United States, are foreign banking organizations. different legal and policy issues and may therefore 1496 See final rule § 75.6(e)(1)(ii). However, for purposes of the Federal securities merit different approaches. 1497 Section 75.6(e)(2) addresses only when a laws and certain banking statutes, such as section 1504 See final rule § 75.6(e)(2)(ii)(B). For purposes transaction will be considered to have been 2(c)(1) of the BHC Act and section 3 of the FDI Act, of determining whether, on a fully consolidated conducted pursuant to section 4(c)(9) of the BHC these same entities are defined to be and treated as basis, it meets the requirements under Act. Although the statute also references section domestic entities. For instance, these entities act as § 75.6(e)(2)(ii)(B), a foreign banking entity that is 4(c)(13) of the BHC Act, the Board has to date domestic broker-dealers under U.S. securities laws not a foreign banking organization should base its applied the general authority contained in that and their deposits are insured by the FDIC. Because calculation on the consolidated global assets, section solely to the foreign activities of U.S. one of the purposes of section 13 is to protect revenues, and income of the top-tier affiliate within banking organizations which, by the express terms insured depository institutions and the U.S. the foreign banking entity’s structure. of section 13(d)(1)(H) of the BHC Act, are unable financial system from the perceived risks of 1505 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), to rely on the foreign trading exemption. proprietary trading and covered fund activities, the (c), and (e); final rule § 75.6(e)(2)(ii)(B).

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implementing the foreign trading Commenters represented that foreign stated that the proposed requirement exemption and provided that a banking entities currently use U.S. would force issuers to dually list their transaction would be considered to trading platforms to trade in certain securities to permit trading on non-U.S. qualify for the exemption only if (i) the products (such as U.S.-listed securities exchanges and, further, clearing and transaction was conducted by a banking or a variety of derivatives contracts), to settlement systems would have to be set entity not organized under the laws of take advantage of robust U.S. up outside of the United States, which the United States or of one or more infrastructure, and for time zone would create inefficiencies, operational States; (ii) no party to the transaction reasons.1511 Commenters indicated that risks, and potentially systemic risk by was a resident of the United States; (iii) the proposed requirement could harm adding needless complexity to the no personnel of the banking entity that the competitiveness of U.S. trading financial system.1516 was directly involved in the transaction platforms and the liquidity available on Instead of the proposal’s transaction- was physically located in the United such facilities.1512 Some commenters based approach to implementing the States; and (iv) the transaction was stated that this requirement would foreign trading exemption, many executed wholly outside the United effectively result in most foreign commenters suggested the final rule States.1506 banking entities moving their trading adopt a risk-based approach.1517 These Many commenters objected to the operations and personnel outside of the commenters noted that a risk-based proposed exemption, arguing that it was United States and executing approach would prohibit or unworkable and would have transactions on exchanges outside of the significantly limit the amount of unintended consequences. For example, United States.1513 These commenters financial risk from such activities that commenters argued that prohibiting a stated that the relocation of these could be transferred to the United States foreign banking entity from conducting activities would reduce trading activity by the foreign trading activity of foreign a proprietary trade with a resident of the in the United States that supports the banking entities.1518 Commenters also United States, including a subsidiary or financial stability and efficiency of U.S. noted that foreign trading activities of branch of a U.S. banking entity, markets. Moreover, these commenters most foreign banking entities are already wherever located, would likely cause argued that, if foreign banking entities subject to activities limitations, capital foreign banking entities to be unwilling relocate their personnel from the United requirements, and other prudential to enter into permitted trading States to overseas, this would diminish requirements of their home-country transactions with foreign subsidiaries or U.S. jobs with no concomitant benefit. supervisor(s).1519 branches of U.S. firms.1507 In addition, They also contended that the proposal The Agencies have carefully some commenters represented that it was at cross purposes with other parts considered these comments and have would be difficult to determine and of the Dodd-Frank Act and would determined to modify the approach in track whether a party is a resident of the hinder growth of market infrastructure the final rule. The Agencies believe that United States or that this requirement being developed under the requirements the revisions mitigate the potential would require non-U.S. banking entities of Title VII of that Act, including use of adverse impacts of the proposed to inefficiently bifurcate their activities swap execution facilities and security- approach while still remaining faithful into U.S.-facing and non-U.S.-facing based swap execution facilities to to the overall purpose of section trading desks.1508 For example, one enhance transparency in the swaps 13(d)(1)(H). Also, the Agencies believe commenter noted that trading on many markets and use of central that section 13(d)(1)(J) of the BHC Act, exchanges and platforms is anonymous clearinghouses to reduce counterparty which authorizes the Agencies to (i.e., each party to the trade is unaware risk for the parties to a swap provide an exemption from the 1514 prohibition on proprietary trading for of the identity of the other party to the transaction. For example, one any activity the Agencies determine by trade), so a foreign banking entity would commenter represented that the rule ‘‘would promote and protect the likely have to avoid U.S. trading proposed exemption could make it safety and soundness of the banking platforms and exchanges entirely to difficult for non-U.S. swap entities to entity and the financial stability of the avoid transactions with any resident of comply with potential mandatory United States,’’ 1520 supports allowing the United States.1509 Further, execution requirements under Title VII foreign banking entities to use U.S. commenters stated that the proposed of the Dodd-Frank Act and could cause infrastructure and trade with certain rule could deter foreign banking entities market fragmentation across borders U.S. counterparties in certain from conducting business with U.S. through the creation of parallel execution facilities outside of the circumstances, which will promote and parties outside of the United States, protect the safety and soundness of which could also incentivize foreign United States, which would result in less transparency and greater systemic banking entities and U.S. financial market centers to limit participation by 1515 1510 risk. In addition, another commenter stability. U.S. parties on their markets. Overall, the comments illustrated that Commenters also expressed concern 1511 See, e.g., IIF; ICE; Socie´te´ Ge´ne´rale; Mexican both the mechanical steps of the about the requirement that transactions Banking Comm’n.; Australian Bankers Ass’n. (Feb. specified transactions to purchase or be executed wholly outside of the 2012); Banco de Me´xico; OSFI. In addition, a few sell various instruments (e.g., execution, United States in order to qualify for the commenters argued that Canadian and Mexican clearing), and the identity of the entity proposed foreign trading exemption. financial firms frequently use U.S. infrastructure to conduct their trading activities in Canada or for whose trading account the specified Mexico. See, e.g., OSFI; Banco de Me´xico; Mexican trading is conducted are important.1521 1506 See proposed rule § 75.6(d). Banking Comm’n. Consistent with the comments described 1507 See BoA; Citigroup (Feb. 2012); British 1512 See, e.g., ICE; Socie´te´ Ge´ne´rale (arguing that Bankers’ Ass’n.; Credit Suisse (Seidel); George the requirement would impair capital raising efforts above, the Agencies believe that the Osbourne; IIB/EBF. of many U.S. companies); Australian Bankers Ass’n. 1508 See Cadwalader (on behalf of Singapore (Feb. 2012); Canadian Minister of Fin.; Ass’n. of 1516 See IIF. Banks); Ass’n. of Banks in Malaysia; Cadwalader German Banks. 1517 See BaFin/Deutsche Bundesbank; ICSA; IIB/ (on behalf of Thai Banks); IIF; ICE; Banco de 1513 See IIB/EBF. EBF; Allen & Overy (on behalf of Canadian Banks); Me´xico; ICFR; Australian Bankers Ass’n. (Feb. 1514 See Bank of Canada; Banco de Me´xico; Allen Credit Suisse (Seidel); George Osbourne. 2012); BAROC. & Overy (on behalf of Canadian Banks). 1518 See IIB/EBF. 1509 See ICE. 1515 See Allen & Overy (on behalf of Candian 1519 See IIB/EBF. 1510 See, e.g., RBC. Banks). 1520 See 12 U.S.C. 1851(d)(1)(J).

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application of section 13(d)(1)(H) and making-related activities, subject to entity or its affiliate that arrange, their exemptive authority under section certain requirements, and there is no negotiate or execute such purchase or 13(d)(1)(J) should focus on both how the evidence that limiting the range of sale) is not located in the United States transaction occurs and which entity will potential customers for these entities or organized under the laws of the bear the risk of those transactions. would further the purposes of the United States or of any State; 1526 Although the statute does not define statute. In fact, it is possible that • The banking entity (including expressly what it means to act ‘‘as a limiting the customer bases of U.S. relevant personnel) that makes the principal’’ (acting as principal banking entities, as well as other U.S. decision to purchase or sell as principal ordinarily means acting for one’s own firms that are not banking entities, could is not located in the United States or account), the combination of references reduce their ability to effectively organized under the laws of the United to engaging as principal and to a trading manage their inventories and risks and States or of any State; • account focuses on an entity’s incurring could also result in concentration risk. The purchase or sale, including any risks of profit and loss through taking These potential effects of the transaction arising from risk-mitigating ownership of securities and other approach taken in the proposal appear hedging related to the instruments instruments. Thus, the final rule to be inconsistent with the statute’s purchased or sold, is not accounted for provides an exemption for trading goals, including the promotion and as principal directly or on a activities of foreign banking entities that protection of the safety and soundness consolidated basis by any branch or addresses both the location of the of banking entities and U.S. financial affiliate that is located in the United facilities that effect the acquisition, stability. To the contrary, the exemptive States or organized under the laws of holding, and disposition of such approach taken in the final rule appears the United States or of any State; • positions, and the location of the to be more consistent with the goals of No financing for the banking banking entity that incurs such risks the statute and would promote and entity’s purchase or sale is provided, through acquisition, holding, and protect the safety and soundness of directly or indirectly, by any branch or disposition of such positions. banking entities and U.S. financial affiliate that is located in the United The Agencies believe this approach is stability by limiting the risks of foreign States or organized under the laws of consistent with one of the principal banking entities’ proprietary trading the United States or of any State; 1527 • purposes of section 13, which is to limit activities to the U.S. financial system, The purchase or sale is not risks that proprietary trading poses to while also allowing U.S. markets to conducted with or through any U.S. the U.S. financial system.1522 Further, entity,1528 other than: continue to operate efficiently in Æ the purpose of section 13(d)(1)(H) is to conjunction with foreign markets (rather A purchase or sale with the foreign limit the extraterritorial application of than creating incentives to establish operations of a U.S. entity, if no section 13 as it applies to foreign barriers between U.S. and foreign personnel of such U.S. entity that are 1523 banking entities. markets).1524 located in the United States are In addition, prohibiting foreign Thus, in response to commenter involved in the arrangement, banking entities from using U.S. concerns, the final rule has been negotiation or execution of such infrastructure or trading with all U.S. modified to better reflect the text and purchase or sale. counterparties could cause certain achieve the overall purposes of the The Agencies believe it is appropriate trading activities to move offshore, with statute (by ensuring that the principal to exercise their exemptive authority corresponding negative impacts on U.S. risks of proprietary trading by foreign under section 13(d)(1)(J) to also allow, market participants, including U.S. banking entities allowed under the under clause (vi) of the final rule, the banking entities. For example, foreign trading exemption remain solely following types of purchases or sales movement of trading activities offshore, outside of the United States) while conducted with a U.S. entity: Æ A purchase or sale with an particularly in U.S. financial mitigating potentially adverse effects on unaffiliated market intermediary acting instruments, could result in bifurcated competition.1525 In order to ensure these as principal,1529 provided the purchase markets for these instruments that are risks remain largely outside of the less efficient and less liquid and could United States, and to limit potential risk reduce transparency for oversight of 1526 Personnel that arrange, negotiate, or execute that could flow to the U.S. financial a purchase or sale conducted under the exemption trading in these instruments. In system through trades by foreign addition, reducing access to foreign for trading activity of a foreign banking entity must banking entities with or through U.S. be located outside of the United States. Thus, for counterparties for U.S. instruments entities, the final rule includes several example, personnel in the United States cannot could concentrate risks in the United solicit or sell to or arrange for trades conducted conditions on the availability of the States and to its financial system. under this exemption. Personnel in the United exemption. Specifically, in addition to Moreover, the statute provides separate States also cannot serve as decision makers in limiting the exemption to foreign transactions conducted under this exemption. exemptions for U.S. banking entities to banking entities, the final rule provides Personnel that engage in back-office functions, such engage in underwriting and market as clearing and settlement of trades, would not be that the exemption for the proprietary considered to arrange, negotiate, or execute a trading activity of a foreign banking purchase or sale for purposes of this provision. 1522 See, e.g., 12 U.S.C. 1851(b)(1) (directing the 1527 FSOC to study and make recommendations on entity is available only if: This provision is not intended to restrict the implementing section 13 so as to, among other • The banking entity engaging as ability of a U.S. branch or affiliate of a foreign things, protect taxpayers and consumers and principal in the purchase or sale banking entity to provide funds collected in the United States to its foreign parent for general enhance financial stability by minimizing the risk (including any personnel of the banking that insured depository institutions and the purposes. affiliates of insured depository institutions will 1528 ‘‘U.S. entity’’ is defined for purposes of this engage in unsafe and unsound activities). 1524 12 U.S.C. 1851(d)(1)(J). provision as any entity that is, or is controlled by, 1523 See, e.g., 156 Cong. Rec. S5897 (daily ed. July 1525 The proposed rule also contained a definition or is acting on behalf of, or at the direction of, any 15, 2010) (statement of Sen. Merkley) (stating that of ‘‘resident of the United States’’ that was designed other entity that is, located in the United States or the foreign trading exemption ‘‘recognize[s] rules of to capture the scope of U.S. counterparties that, if organized under the laws of the United States or of international comity by permitting foreign banks, involved in the transaction, would preclude that any State. See final rule § 75.6(e)(4). regulated and backed by foreign taxpayers, in the transaction from being considered to have occurred 1529 This provision would generally allow market course of operating outside of the United States to solely outside the United States. The final rule intermediaries to engage in market-making, engage in activities permitted under relevant addresses this point by including a definition, for underwriting or similar market intermediation foreign law.’’). purposes of § 75.6(e) only, of the term ‘‘U.S. entity.’’ functions.

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or sale is promptly cleared and settled However, Congress has determined to requested that the final rule not require through a clearing agency or derivatives generally prohibit U.S. banking entities that any purchase or sale under the clearing organization acting as a central (including foreign branches and exemption be executed wholly outside counterparty; or subsidiaries thereof) from engaging in of the United States. Æ A purchase or sale through an proprietary trading because of the As described above and in response to unaffiliated market intermediary, perceived risks of those activities to commenters’ concerns, the final rule provided the purchase or sale is banking entities and the U.S. provides that a foreign banking entity conducted anonymously (i.e. each party economy.1531 Allowing U.S. banking generally may engage in trading activity to the purchase or sale is unaware of the entities to conduct, through branches or under the exemption with U.S. entities, identity of the other party(ies) to the subsidiaries that are physically located provided the transaction is with the purchase or sale) on an exchange or outside the United States, the same foreign operations of an unaffiliated similar trading facility and promptly proprietary trading activities those U.S. U.S. firm (whether or not the U.S. firm cleared and settled through a clearing firms are expressly prohibited from is a banking entity subject to section 13 agency or derivatives clearing conducting directly through their of the BHC Act) and does not involve organization acting as a central operations located within the United any personnel of the U.S. entity that are counterparty. States would subject U.S. banking in the United States and involved in the The requirements are designed to entities and the U.S. economy to the arrangement, negotiation, or execution ensure that any foreign banking entity very risks section 13 is designed to of the transaction. The Agencies have engaging in trading activity under this avoid. The risks of proprietary trading also exercised their exemptive authority exemption does so in a manner that would continue to be borne by the U.S. under section 13(d)(1)(J) to allow foreign ensures the risk, decision-making, banking entity whether the activity is banking entities to engage in a arrangement, negotiation, execution and conducted by the U.S. banking entity transaction that is either through an financing of the activity resides solely through units physically located inside unaffiliated market intermediary and outside the United States and limits the or outside of the United States. executed anonymously on an exchange risk to the U.S. financial system from Moreover, the robust trading markets or similar trading facility (regardless of trades by foreign banking entities with that exist overseas could allow U.S. whether the ultimate counterparty is a or through U.S. entities. banking entities to shift their prohibited U.S. entity or not) or is executed with The final rule specifically recognizes proprietary trading activities to a U.S. entity that is an unaffiliated that, for purposes of the exemption for branches or subsidiaries that are market intermediary acting as principal, trading activity of a foreign banking physically located outside the United provided in either case that the entity, a U.S. branch, agency, or States under such an exemption, transaction is promptly cleared and settled through a clearing agency or subsidiary of a foreign bank, or any without achieving a meaningful derivatives clearing organization acting subsidiary thereof, is located in the elimination of risk. Accordingly, the Agencies have not exercised their as a central counterparty. United States; however, a foreign bank For purposes of the final rule, market authority under section 13(d)(1)(J) at that operates or controls that branch, intermediary is defined as an this time to allow U.S. banking entities agency, or subsidiary is not considered unaffiliated entity, acting as an to conduct otherwise prohibited to be located in the United States solely intermediary, that is: (i) A broker or proprietary trading activities through by virtue of operation of the U.S. dealer registered with the SEC under 1530 operations located outside the United branch, agency, or subsidiary. This section 15 of the Exchange Act or States. As a consequence, and consistent provision helps give effect to the exempt from registration or excluded with the statutory language and purpose statutory language limiting the foreign from regulation as such; (ii) a swap of section 13(d)(1)(H) of the BHC Act, trading exemption to activities of dealer registered with the CFTC under the final rule provides that the foreign banking entities that occur section 4s of the Commodity Exchange exemption is available only if the solely outside of the United States by Act or exempt from registration or banking entity is not organized under, clarifying that the U.S. operations of excluded from regulation as such; (iii) a or directly or indirectly controlled by a foreign banking entities may not security-based swap dealer registered banking entity that is organized under, conduct proprietary trading based on with the SEC under section 15F of the the laws of the United States or of one this exemption. Exchange Act or exempt from or more States.1532 The Agencies have considered registration or excluded from regulation As discussed above, many whether the concerns raised by as such; or (iv) a futures commission commenters requested that the final rule commenters that the foreign operations merchant registered with the CFTC permit a foreign banking entity to of U.S. banking entities would be under section 4f of the Commodity engage in proprietary trading disadvantaged in competing outside the Exchange Act or exempt from transactions with a greater variety of United States warrant an exemption registration or excluded from regulation counterparties, including counterparties under section 13(d)(1)(J) of the BHC Act as such.1534 that are located in or organized and that extends to foreign operations of These provisions of the final rule, incorporated under the laws of the U.S. banking entities. The viewed as a whole, prevent the competitiveness of U.S. banking entities United States or of one or more 1533 outside the United States often States. These commenters also trading of foreign sovereign debt or similar improves the potential for the obligations of foreign governments. As discussed in operations of U.S. firms outside the 1531 See, e.g., 156 Cong. Rec. S5897 (daily ed. July Part VI.A.5.b. of this SUPPLEMENTARY INFORMATION, 15, 2010) (statement of Sen. Merkley) (‘‘However, the final rule addresses banking entities’ ability to United States to succeed and be these subparagraphs are not intended to permit a engage in transaction in these types of instruments profitable, and thereby, often improves U.S. banking entity to avoid the restrictions on in § 75.6(b). the safety and soundness of the entity proprietary trading simply by setting up an offshore 1534 See final rule § 75.6(e)(5). For example, under and financial stability in the United subsidiary or reincorporating offshore, and this definition, a bank that is exempt from regulators should enforce them accordingly.’’). States. registration as a swap dealer under the de minimis 1532 See final rule § 75.6(e)(1)(i). exception to swap dealer registration requirements 1533 A number of commenters also requested that could be a market intermediary for transactions in 1530 See final rule § 75.6(e)(5). the foreign trading exemption permit proprietary swaps. See 17 CFR 1.3(ggg)(4).

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exemption for trading of foreign banking activities in accordance with section 13 This provision of the final rule entities from weakening U.S. trading and this implementing rule. requires that foreign banking entities markets and U.S. firms that are either The final rule also permits, pursuant trade anonymously and that the trade be not subject to the provisions of section to section 13(d)(1)(J), a foreign banking centrally cleared and settled. The 13 or that conduct activities in entity to trade through an unaffiliated Agencies understand that in these compliance with other parts of section market intermediary if the trade is circumstances, the foreign banking 13. For instance, the final rule permits conducted anonymously on an entity would not have any prior a foreign banking entity to trade under exchange or similar trading facility and information regarding its counterparty the exemption with the foreign is promptly cleared and settled through to the trade. Requiring that the trade be operations of a U.S. firm, so long as the a clearing agency or derivatives clearing executed anonymously preserves the purchase or sale does not involve any organization.1537 Allowing foreign benefits of allowing U.S. entities to personnel of the U.S. firm who are banking entities to generally conduct participate in such trades, while located in the United States and anonymous proprietary trades on U.S. reducing the potential for evasion of involved in arranging, negotiating or exchanges and similar anonymous section 13 that could occur if foreign executing the trade.1535 Transactions trading facilities allows these exchanges banking entities directly arranged that occur outside of the United States and facilities—which are generally not purchases and sales with U.S. between foreign operations of U.S. subject to section 13 and do not take the entities.1540 The final rule specifies that entities and foreign banking entities risks section 13 is designed to address— a trade is anonymous if each party to the improve access to and functioning of to serve the widest possible range of purchase or sale is unaware of the liquid markets without raising the counterparties. This prevents the identity of the other party(ies) to the concerns for increased risk to banking potential adverse impacts from possible purchase or sale. That is, it is lack of entities in the U.S. that motivated reductions in competitiveness of or knowledge of the identity of the enactment of section 13 of the BHC Act. liquidity available on these regulated counterparty(ies) to the trade that is The final rule permits a foreign banking exchanges and facilities, which could relevant. The final rule does not entity to engage in transactions with the also harm other U.S. market participants prohibit foreign banking entities from foreign operations of both U.S. non- who trade on these exchanges and accessing a trading facility through an banking and U.S. banking entities. facilities. In addition, the Agencies unaffiliated U.S. market intermediary Among other things, this approach will recognize that anonymous trading on (which the foreign banking entity would ensure that the foreign operations of exchanges and similar anonymous necessarily know), so long as the foreign U.S. banking entities continue to be able trading facilities promotes transparency banking entity is not aware of the 1536 to access foreign markets. The and that prohibiting foreign banking identity of the counterparty to the language of the exemption expressly entities from trading on U.S. exchanges transaction. requires that trading with the foreign and similar anonymous trading facilities Similarly, also pursuant to section operations of a U.S. entity may not under this exemption would likely 13(d)(1)(J), the final rule allows a foreign involve the use of personnel of the U.S. reduce transparency for trading in U.S. banking entity to trade with an entity who are located in the United financial instruments. All of these unaffiliated market intermediary acting States for purposes of arranging, considerations support the Agencies’ in a principal capacity and effecting a negotiating, or executing transactions. exercise of their exemptive authority market intermediation function, in a Under the final rule, the exemption in under section 13(d)(1)(J) to allow such transaction that is not conducted on an no way exempts the U.S. or foreign trading by foreign banking entities. exchange or similar anonymous trading operations of the U.S. banking entities The final rule requires that foreign facility, as long as the trade is promptly from having to comply with the banking entities trade through an cleared and settled through a clearing restrictions and limitations of section unaffiliated market intermediary to agency or derivatives clearing 13. Thus, the U.S. and foreign access a U.S. exchange or trading organization. This provision recognizes operations of a U.S. banking entity that facility in recognition that existing laws that not all financial instruments are is engaged in permissible market and regulations generally require this traded on an exchange or similar making-related activities or other 1538 structure. For purposes of this anonymous trading facility and, thus, permitted activities may engage in those exemption, an exchange would include, allows foreign banking entities to trade transactions with a foreign banking unless the context otherwise requires, and contribute to market liquidity in all entity that is engaged in proprietary any designated contract market, swap types of U.S. financial instruments trading in accordance with the execution facility, or foreign board of without requiring separate market exemption under § 75.6(e) of the final trade registered with the CFTC, and any infrastructure to be developed outside rule. Importantly, the final rule does not exchange or security-based swap the U.S. for such trading activity, which impose a duty on the foreign banking execution facility, as such terms are could result in inefficiencies and reduce entity or the U.S. banking entity to 1539 defined under the Exchange Act. U.S. market liquidity. Market ensure that its counterparty is intermediaries can serve the same conducting its activity in conformance 1537 Under the final rule, ‘‘anonymous’’ means general purpose as exchanges or similar with section 13 of the BHC Act and the that each party to a purchase or sale is unaware of trading facilities in intermediating final rule. Rather, that burden is at all the identity of the other party(ies) to the purchase between buyers and sellers, particularly times on each party subject to section 13 or sale. See final rule § 75.3(e)(1). 1538 See, e.g., 15 U.S.C. 78f(c)(1) (providing that in asset classes that do not generally to ensure that it is conducting its a national securities exchange shall deny trade on these exchanges or facilities, membership to (A) any person, other than a natural 1535 See final rule § 75.6(e)(3)(v)(A). person, which is not a registered broker or dealer although this intermediation function 1536 The Agencies believe that this provision or (B) any natural person who is not, or is not should address commenters’ concerns that the associated with, a registered broker or dealer). 1540 In addition, allowing a foreign banking entity proposed rule could cause foreign banking entities 1539 See final rule § 75.3(e)(6) (defining the term to trade directly with a U.S. end user customer to avoid conducting business with U.S. firms ‘‘exchange’’). The rule refers to an ‘‘exchange or under the foreign trading exemption could give the outside the United States or could incentivize similar trading facility.’’ A similar trading facility foreign banking entity a competitive advantage over foreign market places to restrict access to U.S. firms. for these purposes may include, for example, an U.S. banking entities with respect to trading in the See, e.g., RBC. alternative trading system. United States.

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may not be as immediate in the case of banking entities’ proprietary trading liquidity of markets, and harm U.S. market intermediaries. activity, particularly counterparty risk, market participants. In either case (i.e., for either an and preclude foreign banking entities 9. Section 75.7: Limitations on anonymous trade or a trade with an from relying on the exemption for Permitted Trading Activities unaffiliated market intermediary), if the trading that creates exposure of U.S. U.S. counterparty to the transaction is a counterparties pursuant to bilateral, Section 75.8 of the proposed rule banking entity subject to section 13 and uncleared transactions, which poses implemented section 13(d)(2) of the these rules, it must comply with an heightened counterparty credit risks.1542 BHC Act,1543 which provides that a exemption to the prohibition on This condition is also consistent with banking entity may not engage in certain proprietary trading, such as the market- the systemic risk benefits of central exempt activities (e.g., permitted market making exemption or the exemption for clearing and may incentivize the use of making-related activities, risk-mitigating riskless principal transactions. Allowing central clearing for trading by foreign hedging, etc.) if the activity would foreign banking entities to trade with banking entities and foreign affiliates of involve or result in a material conflict unaffiliated U.S. market intermediaries, U.S. banking entities. The Agencies of interest between the banking entity including banking entities engaged in believe this approach is consistent with and its clients, customers, or permitted market making-related and reinforces the goals of the central counterparties; result, directly or activities, expands the range of potential clearing framework of Title VIII of the indirectly, in a material exposure by the buyers and sellers for which the U.S. Dodd-Frank Act. banking entity to a high-risk asset or a entities can trade and may result in The final rule does not allow a foreign high-risk trading strategy; or pose a more efficient and timely matching of banking entity to trade with a broader threat to the safety and soundness of the trades, reducing inventory risks to the range of U.S. entities under the banking entity or U.S. financial U.S. market intermediary. At the same exemption because the Agencies are stability.1544 The Agencies sought time, this exemption does not permit a concerned such an approach may result comment on proposed definitions of the U.S. market intermediary that is subject in adverse competitive impacts between terms ‘‘material conflict of interest,’’ to section 13 of the BHC Act to conduct U.S. banking entities and foreign ‘‘high-risk asset,’’ and ‘‘high-risk trading trading activities other than in banking entities with respect to their strategy’’ for these purposes. compliance with the provisions of trading in the United States, which With respect to general comments section 13. Thus, the Agencies believe it could harm the safety and soundness of regarding the proposed rule, is appropriate to allow foreign banking banking entities and U.S. financial commenters generally agreed on the entities to conduct such trading under stability. For example, such an approach need to limit banking entities’ the exemption in section 13(d)(1)(J). could allow foreign banking entities to proprietary trading activities so as to To reduce risks to U.S. entities and act as market makers for U.S. customers avoid material conflicts of interest and the potential for evasion, the provisions under the exemption in § 75.6(e) of the material exposures to high-risk trading allowing trading with U.S. entities final rule so long as the foreign banking strategies and high-risk assets.1545 One include two additional protections. entity held the risk of its market-making commenter expressed support for the First, the final rule does not allow a trades outside the United States. In turn, Agencies’ proposed approach, stating foreign banking entity to trade through this could give foreign banking entities that the proposed rule was clear and an affiliated U.S. entity under the a competitive advantage over U.S. structured in such a manner so that it exemption out of concern that it could banking entities with respect to U.S. should remain effective even as increase the risk of evasion.1541 Second, market-making activities because financial markets evolve and a foreign banking entity’s trades foreign banking entities could trade change.1546 As discussed in greater conducted through an unaffiliated directly with U.S. non-banking entities detail below, most commenters market intermediary on an exchange or without incurring the additional costs, suggested amendments, clarification, or conducted directly with an unaffiliated or being subject to the limitations, alternative approaches. For example, market intermediary must be promptly associated with the market-making or some commenters expressed concern cleared and settled through a clearing other exemptions under the rule. This regarding the application of the agency or derivatives clearing competitive disparity in turn could prudential backstops to the activities of organization acting as central create a significant potential for foreign banking entities.1547 The counterparty. Consistent with the goals regulatory arbitrage. The Agencies do Agencies did not receive any comments of section 13 to reduce risk to banking not believe this result was intended by on the prohibition against transactions entities and the U.S. financial system, the statute. Instead, the final rule seeks or activities that pose a threat to the this requirement is designed to reduce to alleviate the concern that an overly safety or soundness of the banking risk to U.S. entities arising from foreign broad approach to the exemption (e.g., entity or the financial stability of the permitting trading with all U.S. United States. 1541 In addition, allowing a foreign banking entity counterparties) may result in As explained in detail below, the to trade through or with a U.S. affiliate under the competitive impacts and increased risks Agencies have carefully reviewed exemption for trading activity of a foreign banking to the U.S. financial system, while entity could give the foreign banking entity a 1543 Section 75.8 of the proposed rule regarding competitive advantage over U.S. banking entities mitigating the concern that an overly limitations on permitted trading activities is that are subject to limitations on their trading narrow approach to the exemption (e.g., consistent with § 75.17 of the proposed rule activities. Thus, the Agencies are not permitting a prohibiting trading with any U.S. regarding other limitations on permitted covered foreign banking entity to trade through a U.S. counterparty) may cause market funds activities. Accordingly, the discussion affiliate as agent, as requested by some commenters. regarding proposed rule § 75.8 and final rule § 75.7 See, e.g., IIB/EBF. However, the Agencies recognize bifurcations, reduce the efficiency and in this part also pertain to § 75.17 of the proposed that, with respect to trading anonymously, there is rule and § 75.16 of the final rule. See also Part no way to know the identity of the counterparty to 1542 As discussed above, centralized clearing VI.B.6., infra. the trade. Thus, a foreign banking entity would not redistributes counterparty risk among members of a 1544 be in violation of this rule if it traded through an clearing agency or derivatives clearing organization See 12 U.S.C. 1851(d)(2). unaffiliated market intermediary on an exchange, in through mutualization of losses, reducing the 1545 See, e.g., Sens. Merkley & Levin (Feb. 2012); accordance with the exemption for trading activity likelihood of sequential counterparty failure and Public Citizen; Paul Volcker. of a foreign banking entity, and the counterparty to contagion. See supra note 271 and accompanying 1546 See Alfred Brock. its trade happened to be an affiliated entity. text. 1547 See IIB/EBF; Ass’n. of German Banks.

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comments on the proposed rule’s treating one customer involved in a derivatives, and banking laws and implementation of the prudential transaction more favorably than another regulations. backstops under section 13(d)(2) of the customer involved in that transaction. Section 75.8(b)(1) of the proposed rule BHC Act, including commenters’ Concerns regarding conflicts of interest described the two requirements that suggestions for expanding, contracting, are likely to be elevated when a must be met in cases where a banking or revising the proposed rule. After transaction is complex, highly entity addresses and mitigates a material carefully considering these comments, structured or opaque, involves illiquid conflict of interest through timely and the Agencies continue to believe the or hard-to-value instruments or assets, effective disclosure. First, expansive scope of section 13 of the requires the coordination of multiple § 75.8(b)(1)(A)(i) of the proposed rule BHC Act supports a similarly inclusive internal groups (such as multiple required that the banking entity, prior to approach focusing on the facts and trading desks or affiliated entities), or effecting the specific transaction or class circumstances of each potential conflict involves a significant asymmetry of or type of transactions, or engaging in or high-risk activity. Therefore, and in information or transactional data among the specific activity, for which a conflict consideration of all issues discussed participants.1550 In all cases, the may arise, make clear, timely and below, the Agencies are adopting the existence of a material conflict of effective disclosure of the conflict or final rule substantially as proposed.1548 interest depends on the specific facts potential conflict of interest, together The Agencies intend to develop and circumstances.1551 with any other necessary information. additional guidance regarding best To address these types of material This would also require such disclosure to be provided in reasonable detail and practices for addressing potential conflicts of interest, § 75.8(b) of the in a manner sufficient to permit a material conflicts of interest, high-risk proposed rule specified that a material reasonable client, customer, or assets and trading strategies and conflict of interest between a banking counterparty to meaningfully practices that pose significant risks to entity and its clients, customers, or understand the conflict of interest.1554 safety and soundness and to the U.S. counterparties exists if the banking Disclosure that is only general or financial system as the Agencies and entity engages in any transaction, class generic, rather than specific to the banking entities gain experience with of transactions, or activity that would individual, class, or type of transaction implementation of the requirements and involve or result in the banking entity’s or activity, or that omits details or other limitations in section 13 of the BHC Act interests being materially adverse to the information that would be necessary to and this rule, which are all generally interests of its client, customer, or a reasonable client’s, customer’s, or designed to limit risky behavior in counterparty with respect to such trading and investment activities. counterparty’s understanding of the transaction, class of transactions, or conflict of interest, would not meet this a. Scope of ‘‘Material Conflict of activity, unless the banking entity has standard. Second, § 75.8(b)(1)(ii) of the Interest’’ appropriately addressed and mitigated proposed rule required that the 1. Proposed Rule the conflict of interest, and subject to disclosure be made explicitly and specific requirements provided in the effectively, and in a manner that Section 75.8(b) of the proposed rule proposal, through either (i) timely and defined the scope of material conflicts provides the client, customer, or effective disclosure, or (ii) information counterparty the opportunity to negate, of interest which, if arising in barriers.1552 Unless the conflict of connection with a permitted trading or substantially mitigate, any materially interest is addressed and mitigated in adverse effect on the client, customer, or activity, were prohibited under the one of the two ways specified in the proposal.1549 As noted in the proposal, counterparty that was created or would proposal, the related transaction, class be created by the conflict or potential conflicts of interest may arise in a of transactions or activity would be 1555 variety of circumstances related to conflict. prohibited under the proposed rule, The Agencies noted that, in order to permitted trading activities. For notwithstanding the fact that it may be provide the requisite opportunity for the example, a banking entity may acquire otherwise permitted under §§ 75.4 client, customer or counterparty to substantial amounts of nonpublic 1553 through 75.6 of the proposed rule. negate or substantially mitigate the information about the financial However, the Agencies determined disadvantage created by the conflict, the condition of a particular company or that while these conflicts may be disclosure would need to be provided issuer through its lending, underwriting, material for purposes of the proposed sufficiently close in time to the client’s, investment advisory or other activities rule, the mere fact that the buyer and customer’s, or counterparty’s decision to which, if improperly transmitted to and seller are on opposite sides of a engage in the transaction or activity to used in trading operations, would transaction and have differing economic give the client, customer, or permit the banking entity to use such interests would not be deemed a counterparty an opportunity to information to its customers’, clients’ or ‘‘material’’ conflict of interest with meaningfully evaluate and, if necessary, counterparties’ disadvantage. Similarly, respect to transactions related to bona take steps that would negate or a banking entity may conduct a fide underwriting, market making, risk- substantially mitigate the conflict. transaction that places the banking mitigating hedging or other permitted Disclosure provided far in advance of a entity’s own interests ahead of its activities, assuming the activities are particular transaction, such that the obligations to its customers, clients or conducted in a manner that is consistent client, customer, or counterparty is counterparties, or it may seek to gain by with the proposed rule and securities, unlikely to take that disclosure into account when evaluating the 1548 The Agencies note that proposed Appendix C, which required banking entities to describe how 1550 See, e.g., U.S. Senate Permanent transaction, would not suffice. they comply with these provisions, will be adopted Subcommittee on Investigations, Wall Street and Conversely, disclosure provided as Appendix B with similar requirements regarding the Financial Crisis: Anatomy of a Financial without a sufficient period of time for compliance with the limitations on permitted Collapse (Apr. 13, 2011), available at http:// hsgac.senate.gov/public/_files/Financial_Crisis/ the client, customer, or counterparty to activities. evaluate and act on the information it 1549 Section 75.17(b) of the proposed rule defined FinancialCrisisReport.pdf. the scope of material conflicts of interest which, if 1551 See Joint Proposal, 76 FR at 68893. arising in connection with permitted covered fund 1552 See proposed rule § 75.8(b)(1). 1554 See id. activities, are prohibited. 1553 See Joint Proposal, 76 FR at 68893. 1555 See proposed rule § 75.8(b)(1)(B).

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receives, or disclosure provided after separation between various functions of a client, customer, or counterparty, the the fact, would also not suffice under the firm. Information barriers may also banking entity may not rely on those the proposal. The Agencies note that the require that banking entity units or information barriers to address and proposed definition would not prevent affiliates have no common officers or mitigate any conflict of interest. In such or require disclosure with respect to employees. Such information barriers cases, the transaction or activity would transactions or activities that align the have been recognized in Federal be prohibited, unless the banking entity interests of the banking entity with its securities laws and rules as a means to otherwise complied with the clients, customers, or counterparties or address or mitigate potential conflicts of requirements of proposed that otherwise do not involve ‘‘material’’ interest or other inappropriate § 75.8(b)(1).1557 This aspect of the conflicts of interest as discussed above. activities.1556 proposal was intended to make clear The proposed disclosure standard In order to address and mitigate a that, in specific cases in which a reflected the fact that some types of conflict of interest through the use of banking entity has established an conflicts may be appropriately resolved the information barriers pursuant to information barrier but knows or should through the disclosure of clear and § 75.8(b)(2) of the proposed rule, a reasonably know that it has failed or meaningful information to the client, banking entity would be required to will fail to prevent a conflict of interest customer, or counterparty that provides establish, maintain, and enforce arising from a specific transactions or such party with an informed information barriers that are activity that disadvantages a client, opportunity to consider and negate or memorialized in written policies and customer, or counterparty, the substantially mitigate the conflict. procedures, including physical information barrier is insufficient to However, in the case of a conflict in separation of personnel, functions, or address that conflict and the transaction which a client, customer, or limitations on types of activity, that are would be prohibited, unless the banking counterparty does not have sufficient reasonably designed, taking into entity is otherwise able to address and information and opportunity to negate consideration the nature of the banking mitigate the conflict through timely and or mitigate the materially adverse effect entity’s business, to prevent the conflict effective disclosure under the on the client, customer, or counterparty of interest from involving or resulting in proposal.1558 created by the conflict, the existence of a materially adverse effect on a client, The proposed definition of material that conflict of interest would prevent customer, or counterparty. Importantly, conflict of interest did not address the banking entity from availing itself of the proposed rule also provided that, instances in which a banking entity has any exemption (e.g., the underwriting or notwithstanding a banking entity’s made a material misrepresentation to its market-making exemptions) with establishment of such information client, customer, or counterparty in respect to the relevant transaction, class barriers if the banking entity knows or connection with a transaction, class of of transactions, or activity. The should reasonably know that a material transactions, or activity, as such Agencies note that the proposed conflict of interest arising out of a transactions or activity appears to disclosure provisions were provided specific transaction, class or type of involve fraud rather than a conflict of solely for purposes of the proposed transactions, or activity may involve or interest. This is because such rule’s definition of material conflict of result in a materially adverse effect on misrepresentations are generally illegal interest, and did not affect a banking under a variety of Federal and State entity’s obligation to comply with 1556 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)–(IV) regulatory schemes (e.g., the Federal additional or different disclosure or (finding that disclosure and physical separation of securities laws).1559 In addition, the other requirements with respect to a personnel and activities addresses the potential that Agencies noted that any activity conflict under applicable securities, consumers might be misled by the broker-dealer activities of banks). 15 U.S.C. 80b–6(3) (‘‘It shall be involving a material misrepresentation banking, or other laws (e.g., section 27B unlawful for any investment adviser, by use of the to, or other fraudulent conduct with of the Securities Act, which governs mails or any means or instrumentality of interstate respect to, a client, customer, or conflicts of interest relating to certain commerce, directly or indirectly . . . acting as counterparty would not be permitted securitizations; section 206 of the principal for his own account, knowingly to sell any security to or purchase any security from a under the proposed rule in the first Investment Advisers Act of 1940, which client, or acting as broker for a person other than instance. governs conflicts of interest between such client, knowingly to effect any sale or investment advisers and their clients; or purchase of any security for the account of such 2. Comments on the Proposed 12 CFR 9.12, which applies to conflicts client, without disclosing to such client in writing Limitation on Material Conflicts of before the completion of such transaction the Interest of interest in the context of a national capacity in which he is acting and obtaining the bank’s fiduciary activities). consent of the client to such transaction.’’). See also Commenters expressed a variety of Section 75.8(b)(2) of the proposed rule Form ADV, the form used by investment advisers views regarding the treatment of described the requirements that must be to register with the Securities and Exchange material conflicts of interest under the met in cases where a banking entity uses Commission and state securities authorities, and, in particular, Form ADV Part 2: Uniform Requirements proposal, including the manner in information barriers that are reasonably for the Investment Adviser Brochure and Brochure which conflicts may be mitigated or designed to prevent a material conflict Supplements. A registered investment adviser eliminated. One commenter believed of interest from having a materially generally must deliver the Form ADV brochure, that the proposed material conflict of adverse effect on a client, customer or which contains disclosure about conflicts of interest, to its prospective and existing clients. See interest provisions would be counterparty. Information barriers can 17 CFR 275.204–3; Amendments to Form ADV, effective.1560 Another commenter stated be used to restrict the dissemination of Investment Advisers Act Release No. 3060 (July 28, that conflicts of interest were information within a complex 2010) 75 FR 49234 (Aug. 12, 2010) (‘‘We are unavoidable but that the final rule organization and to prevent material adopting a requirement that investment advisers registered with us provide prospective and existing should ensure that institutional conflicts by limiting knowledge and clients with a narrative brochure written in plain investors have confidence that the coordination of specific business English . . . We believe these amendments will banking entities they are dealing with activities among units of the entity. greatly improve the ability of clients and prospective clients to evaluate firms offering Examples of information barriers 1557 advisory services and the firms’ personnel, and to See proposed rule § 75.8(b)(2). include, but are not limited to, understand relevant conflicts of interest that the 1558 See Joint Proposal, 76 FR at 68894. restrictions on information sharing, firms and their personnel face and their potential 1559 See 12 U.S.C. 1851(g)(3). limits on types of trading, and greater effect on the firms’ services.’’). 1560 See Alfred Brock.

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are not operating at a conflict with disclosure to be effective in mitigating a markets.1573 One commenter stated that investors’ goals.1561 conflict of interest.1566 unless the rule requires full disclosure Other commenters expressed differing Some commenters believed that the of a banking entity’s trading strategy and views on whether the proposed rule’s Agencies should consider issuing the rationale behind it, allowing provisions for addressing conflicts of additional guidance regarding the disclosure will permit the banking interest through disclosure or definition of material conflicts of entity to protect itself without information barriers were appropriate. A interest, high-risk assets, and high-risk adequately mitigating the harm of the few commenters stated there is no trading strategies.1567 One commenter conflict. This commenter also noted the statutory basis for allowing conflicts of stated that the final rule should limit the practical difficulties associated with interest in connection with exempted extraterritorial impact of section 13 by disclosing anticipated future conflicts activities even if banking entities only applying the restrictions of section and conflicts in the context of block provide disclosure or establish 13(d)(2) of the BHC Act to the U.S. trading.1574 Another commenter stated information barriers, and the rule operations or activities of foreign market participants understand inherent should prohibit banking entities from banking entities and that the regulation conflicts of interest and believed engaging in permitted activities if of safety and soundness of the foreign disclosure in such situations would be material conflicts of interest exist.1562 operations and activities of foreign burdensome and unnecessary.1575 One One commenter believed the definition banking entities should be left to the commenter stated that the rule should did not appear to address issues of home country regulator or supervisor of require a banking entity to negate, not customer favoritism, in which a bank is a foreign banking entity.1568 just permit the client, customer, or financially incentivized to treat one Some commenters provided general counterparty to substantially mitigate, customer more favorably than another suggestions on enhancing compliance the materially adverse effect of the (typically less sophisticated) with the prohibition on material conflict.1576 customer.1563 Some commenters conflicts of interest. A common A few commenters disagreed with the believed that the proposed definition of suggestion among industry participants disclosure provision, noting that material conflict of interest was too was to implement the prohibition on Congress specifically considered and vague or narrow and suggested it should material conflicts of interest under these rejected disclosure as a mitigation be strengthened by either expanding the rules in a manner consistent with the method for purposes of section 621 of types of transactions that may result in implementation of section 621 of Dodd- the Dodd-Frank Act and that this a material conflict of interest or by Frank.1569 One commenter suggested indicates the Agencies should not imposing additional limitations or that trading in government obligations permit a material conflict of interest to restrictions on transactions.1564 For should not be subject to the material be mitigated through disclosure for instance, one commenter suggested the conflict of interest provision because purposes of section 13 of the BHC final rule consider depositors of a government obligations are broadly Act.1577 banking entity to be ‘‘customers’’ for the traded and do not present the types of Commenters were in disagreement as purpose of this provision, impose a conflicts addressed by the proposed to the extent and timing of disclosure fiduciary duty on any banking entity rule.1570 In contrast, one commenter that should be required under the rule. conducting an exempt activity pursuant stated banking entities should be Some commenters stated the disclosure to section 13(d)(1) of the BHC Act, and required to receive pre-trade clearance provisions would slow trading, and impose size restrictions on any banking from the Federal Reserve for trading in suggested the rule require only one-time entity engaging in proprietary trading certain government obligations like disclosure at the inception of the under an exemption. This commenter municipal bonds and mortgage-backed business relationship 1578 or periodic also stated that a banking entity securities, due to their role in the 2008 disclosures to address ongoing inherently has a material conflict of financial crisis.1571 conflicts.1579 One of these commenters interest with its customer when it takes noted that extensive trade-by-trade a. Disclosure the opposite side of a transaction and, disclosure requirements create the risk therefore, that the final rule should Some commenters expressed concern of unintended breaches of require a banking entity to disgorge all about potential difficulties associated confidentiality.1580 Other commenters principal gains from transactions with the proposed disclosure provision requested the Agencies provide conducted pursuant to any exemption and provided suggestions to address additional guidance, such as when under section 13(d)(1) of the BHC Act, these difficulties. For example, a few transaction-specific disclosure is including market-making, trading in commenters noted the difficulty in necessary,1581 whether disclosure U.S. government obligations, insurance determining what constitutes effective should be written,1582 and what company activities and other exempt disclosure,1572 especially in relation to constitutes ‘‘reasonable detail.’’ 1583 activities.1565 In addition, a few the volume of disclosure or the impact commenters stated that, if disclosure or of information asymmetry in illiquid 1573 See Occupy. information barriers were permitted to 1574 See Public Citizen; see also AFR et al. (Feb. mitigates conflicts under the final rule, 1566 See, e.g., Lynda Aiman-Smith; AFR et al. 2012). clients of the banking entity must be (Feb. 2012); Sens. Merkley & Levin (Feb. 2012). 1575 See SIFMA et al. (Prop. Trading) (Feb. 2012) required to acknowledge in writing that 1567 See Rep. Blumenauer et al.; Sens. Merkley & 1576 See Occupy. 1577 they understand the potential conflicts Levin (Feb. 2012). See, e.g., Occupy. 1568 1578 See ISDA (Apr. 2012); Arnold & Porter. of interest present in order for any See IIB/EBF; EBF. 1569 See ASF (Conflicts) (Feb. 2012); SIFMA et al. 1579 See SIFMA et al. (Prop. Trading) (Feb. 2012); (Prop. Trading) (Feb. 2012); SIFMA (Securitization) ISDA (Apr. 2012). 1561 See Paul Volcker. (Feb. 2012); LSTA (Feb. 2012); Sens. Merkley & 1580 See ISDA (Apr. 2012). 1562 See Public Citizen; Sens. Merkley & Levin; Levin (Feb. 2012). 1581 See SIFMA et al. (Prop. Trading) (Feb. 2012); Occupy; AFR et al. (Feb. 2012). 1570 See BDA (Feb. 2012). 1582 See Sens. Merkley & Levin (Feb. 2012); ICFR 1563 See Public Citizen. 1571 See Occupy. (questioning the effectiveness of enforcement 1564 See, e.g., Occupy; AFR et al. (Feb. 2012); 1572 See Occupy; ISDA (Apr. 2012); Better mechanisms if oral disclosure permitted under the Sens. Merkley & Levin (Feb. 2012). Markets (Feb. 2012); SIFMA et al. (Prop. Trading) rule); Occupy. 1565 See Occupy. (Feb. 2012); ICFR. 1583 See ICFR.

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In addition, some commenters should view information barriers well as being prohibited under section provided suggestions on whether parties favorably. This commenter stated that 13 of the BHC Act. should be required to acknowledge information barriers should be The Agencies believe that certain of receipt of disclosures 1584 or permitted for addressing conflicts of commenters’ suggested modifications to affirmatively consent to the conflict.1585 interest unless the banking entity the proposed rule are outside the scope One commenter proposed allowing a knows, or should reasonably know, that of the Agencies’ statutory authority. For majority of a committee of independent the information barrier would not be example, the Agencies do not believe board members to approve consent to effective in restricting the spread of section 13 of the BHC Act provides waivers of conflicts of interest.1586 One information that could lead to the statutory authority to directly impose 1599 commenter believed disclosure and conflict.1595 To provide greater clarity, limits on the size of banking entities consent by a sophisticated investor another commenter recommended the or to implement specific fiduciary 1600 ought to be sufficient to serve as a Agencies provide guidance on certain standards on banking entities. In waiver to most types of conflict of elements that may be used to determine addition, the Agencies do not believe it 1587 interest. In contrast, another the reasonableness of information is appropriate to expand the definition commenter asserted general disclosure barriers, such as memorialization of of ‘‘customer’’ to include individuals and entities that solely make use of the or waivers of conflicts should never be procedures and documentation of allowed, and the Agencies should not bank’s traditional banking services actions taken pursuant to such provide any additional guidance as to because section 13 is focused on the procedures.1596 the extent, timing, frequency, or scope trading activities and investment in of disclosure appropriate in any given 3. Final Rule which banking entities may be situation.1588 Similarly, one commenter involved.1601 asserted the Agencies should not After considering carefully comments The final rule recognizes that a provide guidance on what issues can be received on the proposal as well as the banking entity may address or addressed by disclosure, as such purpose and language of section 13 of substantially mitigate a potential guidance would be ‘‘dangerously the BHC Act, the Agencies have adopted conflict of interest by making adequate prescriptive and would introduce moral the final rule largely as proposed. Under disclosures or creating and enforcing hazards.’’ 1589 the final rule, a banking entity that informational barriers. Some engages in any transaction, class of commenters argued that the legislative b. Information Barriers transactions, or activity that would history of the Dodd-Frank Act suggests A few commenters addressed the involve or result in the banking entity’s that disclosure or informational barriers information barriers provision of the interests being materially adverse to the are not adequate to address a material proposed rule. One commenter interests of its client, customer, or conflict of interest.1602 However, section expressed support for the proposed counterparty with respect to the 13 of the BHC Act directs the Agencies 1590 approach, while three commenters transaction, class of transactions, or to define ‘‘material conflict of interest’’ 1591 stated this provision was ineffective. activity, must address and mitigate the and gives the Agencies discretion to A few commenters opposed the conflict of interest, where possible, determine how to define this term for information barriers provision because through either timely and effective purposes of the rule. Under the final they believed information barriers disclosure or informational barriers.1597 rule, a material conflict of interest exists would make conflict mitigation more This requirement is in addition to, and when the banking entity engages in difficult 1592 or would effectively does not supplant, any limitations or transactions or activities that cause its mandate that no single officer be aware prohibitions contained in other laws. interests to be materially adverse to the of a banking entity’s collective interests of its client, customer, or 1593 For example, a material operations. counterparty. At the same time, the final A few commenters also requested the misrepresentation by a banking entity to its client, customer, or counterparty in rule provides banking entities the Agencies provide guidance regarding opportunity to take certain actions to the use of information barriers. One connection with market-making activities may involve fraud and is address the conflict, such that the commenter requested the Agencies conflict does not have a materially specify the type and nature of generally illegal under a variety of adverse effect on that client, customer, information barriers and where they are Federal and State regulatory schemes 1598 or counterparty. Under the final rule, a practical to implement.1594 Another (e.g., the Federal securities laws) as banking entity may address a conflict by commenter believed that the Agencies 1595 See SIFMA et al. (Prop. Trading) (Feb. 2012). establishing, maintaining, and enforcing 1596 information barriers reasonably 1584 See, e.g., Arnold & Porter; Sens. Merkley & See ISDA (Apr. 2012) (arguing that its Levin (Feb. 2012); Better Markets (Feb. 2012); suggested guidance was derived from prior SEC and designed to avoid a conflict’s materially Public Citizen; AFR et al. (Feb. 2012); Lynda self-regulatory organization guidance on adverse effect, or by disclosing the Aiman-Smith. information barriers). conflict in a manner that allows the 1597 1585 See Public Citizen; Sens. Merkley & Levin The Agencies note that the definition of client, customer, or counterparty to (Feb. 2012); Better Markets (Feb. 2012). material conflict of interest and the disclosure 1586 See Arnold & Porter. provisions related to that definition apply solely for substantially mitigate or negate any 1587 See Arnold & Porter. purposes of the rule’s definition of material conflict materially adverse effect created by the of interest, and does not affect the scope of that term 1588 See Alfred Brock (stating there is no such conflict of interest. The Agencies in other contexts or a banking entity’s obligation to thing as a ‘‘sophisticated party’’). comply with additional or different requirements believe that, to the extent the materially 1589 See ICFR. with respect to a conflict under applicable adverse effect of a conflict has been 1590 See Alfred Brock. securities, banking, or other laws (e.g., section 27B substantially mitigated, negated, or 1591 See Better Markets (Feb. 2012); Occupy; of the Securities Act, which governs conflicts of avoided, it is appropriate to allow the Public Citizen. interest relating to certain securitizations; section 1592 See Occupy. 206 of the Investment Advisers Act of 1940, which 1599 1593 See Public Citizen (contending that this applies to conflicts of interest between investment See Occupy. would undermine the Dodd-Frank Act’s advisers and their clients; or 12 CFR 9.12, which 1600 See Occupy. requirement to promote sound management, ensure applies to conflicts of interest in the context of a 1601 See Occupy. financial stability, and reduce systemic risk). national bank’s fiduciary activities). 1602 See Public Citizen; Sens. Merkley & Levin 1594 See AFR et al. (Feb. 2012). 1598 See 12 U.S.C. 1851(g)(3). (Feb. 2012); Occupy; AFR et al. (Feb. 2012).

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transaction, class of transaction, or with the opportunity to negate or disclosure is made prior to effecting the activity under the final rule. Continuing substantially mitigate any materially specific transaction or class or type of to view the conflict as a material adverse effect of the conflict on that transactions, or engaging in the specific conflict of interest under these entity or the information barriers are activity, for which a conflict may arise circumstances would not appear to reasonably designed to prevent the and is otherwise timely. As a result, benefit the banking entity’s client, conflict of interest from involving or under § 75.7(b)(2)(i), disclosure must be customer, or counterparty. The resulting in a materially adverse effect provided sufficiently close in time to disclosure standard under the final rule on a client, customer, or counterparty. If the client’s, customer’s, or requires clear and meaningful the banking entity is unable to counterparty’s decision to engage in the information be provided to the client, effectively use disclosure or information transaction or activity to give the client, customer, or counterparty in a manner barriers in a way that meets the rule’s customer, or counterparty an that provides such party the opportunity requirements, then the banking entity is opportunity to meaningfully evaluate to negate or substantially mitigate, any prohibited from engaging in the and take steps that would negate or materially adverse effects on such party conflicted transaction, class of substantially mitigate the conflict. This created by the conflict. transaction, or activity. Additionally, approach is similar to the approach Some commenters suggested that the Agencies note that the material permitted by a variety of consumer obtaining consent to or waiver of conflict of interest provisions in the protection statutes and regulations for disclosed conflicts should be sufficient final rule do not preempt any duties addressing potential conflicts of interest to comply with the rule.1603 The owed to parties outside the transaction, in consumer transactions.1608 Agencies do not believe that consent or including any duty of Some commenters requested that the waivers alone are sufficient to address confidentiality.1605 final rule permit a conflict to be negated material conflicts of interest, and In response to commenters’ or substantially mitigated through continue to believe that any banking statements that the volume of generic or periodic disclosures, such as entity using disclosure to address a information included in a disclosure or at the beginning of a trading conflict of interest should be required to the manner in which the disclosure is relationship or on an annual basis. provide any client, customer, or presented may make it difficult for a Other commenters stated that some counterparty with whom the banking customer to identify and understand the conflicts, such as anticipated future entity has a conflict with the relevant information regarding the conflicts or those that arise in the opportunity to negate or substantially conflict,1606 the Agencies note that the context of block trading, may require the mitigate the materially adverse effect of final rule requires disclosure of the banking entity to provide disclosure in the conflict on the client, customer, or conflict or potential conflict be clear, advance of the actual conflict in order counterparty. The Agencies believe this timely, and effective and that the to allow the client, customer, or approach, which applies equally to all disclosure includes any other necessary counterparty the opportunity to mitigate types of clients, customers, or information. Disclosure is also required the materially adverse effect.1609 The counterparties, will reduce the potential to be provided in reasonable detail and for unintended or differing impacts on in a manner sufficient to permit a 1608 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)—(IV) certain types of clients, customers, or reasonable client, customer, or (finding that disclosure and physical separation of counterparties. In response to one counterparty to meaningfully personnel and activities addresses the potential that commenter’s suggestion that the final understand the conflict of interest.1607 consumers might be misled by the broker-dealer rules require full negation of the activities of banks); 15 U.S.C. 80b–6(3) (‘‘It shall be Thus, disclosure that is only general or unlawful for any investment adviser, by use of the materially adverse effect on the client, generic, that omits details or other mails or any means or instrumentality of interstate customer, or counterparty, the Agencies information that would be necessary to commerce, directly or indirectly . . . acting as continue to believe it is appropriate to principal for his own account, knowingly to sell a reasonable client’s, customer’s, or any security to or purchase any security from a allow a transaction or activity to counterparty’s understanding of the continue if the client, customer, or client, or acting as broker for a person other than conflict of interest, or that is hidden in such client, knowingly to effect any sale or counterparty is provided an opportunity a large volume of needless information purchase of any security for the account of such to substantially mitigate the materially would not meet this standard. The client, without disclosing to such client in writing adverse effect.1604 The Agencies are before the completion of such transaction the Agencies believe these provisions of the concerned that requiring the conflict’s capacity in which he is acting and obtaining the final rule are designed to ensure that consent of the client to such transaction.’’). See also impact to be fully negated under all customers receive sufficient information Form ADV, the form used by investment advisers circumstances could prevent a banking about the conflict of interest so that they to register with the Securities and Exchange entity from providing a service to a Commission and state securities authorities, and, in are well informed and, as required by particular customer despite that particular, Form ADV Part 2: Uniform Requirements the rule, able to negate or substantially for the Investment Adviser Brochure and Brochure customer’s knowledge of the conflict mitigate any materially adverse effect of Supplements. A registered investment adviser and ability to substantially reduce the generally must deliver the Form ADV brochure, the conflict. which contains disclosure about conflicts of effect of the conflict on that customer. In addition to requiring that With regards to commenters’ interest, to its prospective and existing clients. See customers are provided with detailed 17 CFR 275.204–3; Amendments to Form ADV, statements that information barriers and information about the conflict, the final Investment Advisers Act Release No. 3060 (July 28, disclosure will not work to address the rule, like the proposal, requires that 2010) 75 FR 49234 (Aug. 12, 2010) (‘‘We are harm caused by conflicts, the Agencies adopting a requirement that investment advisers emphasize that under the final rule, like registered with us provide prospective and existing 1605 See ISDA (Apr. 2012). clients with a narrative brochure written in plain the proposed rule, a banking entity may 1606 See Better Markets (Feb. 2012) (suggesting English . . . We believe these amendments will use disclosure or information barriers to that a disclosure regime can facilitate abuse by greatly improve the ability of clients and address a conflict only in those enabling market participants to point to obscure prospective clients to evaluate firms offering instances where the disclosure provides and meaningless disclosure as a shield against advisory services and the firms’ personnel, and to liability); Occupy (arguing that a large volume of understand relevant conflicts of interest that the the client, customer, or counterparty disclosed information can be difficult to understand firms and their personnel face and their potential or can serve to hide relevant information). effect on the firms’ services.’’). 1603 See, e.g., Arnold & Porter. 1607 See final rule § 75.7(b)(1)(i) and final rule 1609 See Public Citizen; see also AFR et al. (Feb. 1604 See Occupy. § 75.16(b)(1)(i). 2012).

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Agencies emphasize, however, that The Agencies continue to believe that Importantly, the final rule also provides disclosure provided far in advance of a information barriers can be an effective that, notwithstanding a banking entity’s particular transaction, such that the means of addressing conflicts of interest establishment of such information client, customer, or counterparty is that may arise through, for example, the barriers, if the banking entity knows or unlikely to take that disclosure into spread of information among trading should reasonably know that a material account when evaluating the desks engaged in different trading conflict of interest arising out of a transaction, would not suffice. At the activities that may result in potentially specific transaction, class or type of same time, disclosure provided without inappropriate informational advantage. transactions, or activity may involve or a sufficient period of time for the client, The Agencies are not adopting one result in a materially adverse effect on customer, or counterparty to evaluate commenter’s suggestion that the final a client, customer, or counterparty, the and act on the information it receives, rule specify the particular types of banking entity may not rely on those or disclosure provided after the fact, scenarios where information barriers information barriers to address and would also not be permissible may be effective 1614 because, as mitigate any conflict of interest. In such disclosure under the final rules. The discussed below, the Agencies believe cases, the transaction or activity would Agencies believe that, in considering the banking entities are better positioned to be prohibited, unless the banking entity effectiveness of disclosures, the type, determine when information barriers otherwise complied with the timing and frequency of disclosures may be effective given their trading requirements of § 75.7(b)(2)(i).1618 depends significantly on the customer activities and business structure.1615 In While some commenters requested relationship, the type of transaction, and response to one commenter’s concern that the final rule include additional the matter that creates the potential that information barriers may result in limitations as part of implementing the conflict. Therefore, while written the banking entity’s management not material conflict of interest provisions disclosures may be appropriate in being aware of the firm’s collective in section 13(d)(2), the Agencies do not certain circumstances, the Agencies are operations,1616 the Agencies note that believe additional restrictions are not requiring banking entities to provide information barriers do not require this appropriate at this time. Concerns written disclosure,1610 or obtain result. Rather, information barriers regarding conflicts of interest are likely documentation showing that disclosure would be established between relevant to be elevated when a transaction is was received,1611 because the Agencies personnel or functions while other complex, highly structured or opaque, believe it is more important that personnel, including senior managers, involves illiquid or hard-to-value disclosure is timely than documented. internal auditors, and compliance instruments or assets, requires the For example, if disclosure were required personnel, would have access to each coordination of multiple internal groups to be in writing, this might slow a group separated by the barrier. (such as multiple trading desks or banking entity’s ability to provide the The final rule continues to recognize affiliated entities), or involves a disclosure to the relevant customer, that a banking entity may address or significant asymmetry of information or which could impede the customer’s substantially mitigate a conflict of transactional data among 1619 ability to consider the disclosed interest through use of information participants. In all cases, the information and take steps to negate or barriers. In order to address and mitigate question of whether a material conflict substantially mitigate the conflict’s a conflict of interest through the use of of interest exists will depend on an effect on the customer. The Agencies the information barriers, a banking evaluation of the specific facts and further note that the final rule does not entity is required to establish, maintain, circumstances. For example, certain prevent or require disclosure with and enforce information barriers that are respect to transactions or activities that memorialized in written policies and customers, and counterparties. As part of align the interests of the banking entity maintaining and enforcing information barriers, a procedures, including physical banking entity should have processes to review, with its clients, customers, or separation of personnel, functions, or test, and modify information barriers on a counterparties. limitations on types of activity, that are continuing basis. In addition, banking entities should have ongoing monitoring to maintain and to As noted above, one commenter reasonably designed, taking into expressed concern about the burdens of enforce information barriers, for example by consideration the nature of the banking identifying whether such barriers have not disclosing inherent conflicts and stated entity’s business, to prevent the conflict prevented unauthorized information sharing and such disclosure is unnecessary because addressing instances in which the barriers were not of interest from involving or resulting in effective. This may require both remediating any market participants understand inherent a materially adverse effect on a client, conflicts of interest.1612 As noted in the identified breach as well as updating the customer or counterparty.1617 information barriers to prevent further breaches, as proposal, certain inherent conflicts, necessary. Periodic assessment of the effectiveness of information barriers and periodic review of the such as the mere fact that the buyer and entity is necessarily on the opposite side of a written policies and procedures are also important seller are on opposite sides of a transaction with its client, customer, or to the maintenance and enforcement of effective counterparty. See Occupy. transaction and have differing economic information barriers and reasonably designed 1614 interests, would not be deemed a See SIFMA et al. (Prop. Trading) (Feb. 2012). policies and procedures. Such assessments can be ‘‘material’’ conflict of interest with 1615 The Agencies note examples of information done either (i) internally by a qualified employee respect to permitted activities.1613 barriers that may address or substantially mitigate or (ii) externally by a qualified independent party. a material conflict of interest include restrictions on See Part VI.C.2.e., infra. information sharing, limits on types of trading, 1618 If a conflict occurs to the detriment of a 1610 See Sens. Merkley & Levin (Feb. 2012); ICFR; prohibitions on common officers or employees client, customer, or counterparty despite an Occupy; Alfred Brock. between functions. Such information barriers have information barrier, the Agencies would also expect 1611 See, e.g., Arnold & Porter; Sens. Merkley & been recognized in Federal securities laws as a the banking entity to review the effectiveness of its Levin (Feb. 2012); Better Markets (Feb. 2012); means to address or mitigate potential conflicts of information barrier and make adjustments, as Public Citizen; AFR et al. (Feb. 2012); Lynda interest or other inappropriate activities. See, e.g., necessary, to avoid future occurrences, or review Aiman-Smith. 17 U.S.C. 78o(g). whether such information barrier is appropriate for 1612 See SIFMA et al. (Prop. Trading) (Feb. 2012); 1616 See Public Citizen. that type of conflict. but see Occupy. 1617 The Agencies note that a banking entity 1619 See, e.g., U.S. Senate Permanent 1613 See Joint Proposal, 76 FR at 68893. Thus, the subject to Appendix B of the final rule must Subcommittee on Investigations, Wall Street and Agencies are not adopting one commenter’s implement a compliance program that includes, the Financial Crisis: Anatomy of a Financial suggestion that the final rule consider all among other things, policies and procedures that Collapse (Apr. 13, 2011), available at http:// transactions by a banking entity to involve a explain how the banking entity monitors and hsgac.senate.gov/public/_files/Financial_Crisis/ material conflict of interest because the banking prohibits conflicts of interest with clients, FinancialCrisisReport.pdf.

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simple transactions may implicate Finally, some commenters requested stated the proposed rule was too conflicts of interest that cannot be that the final rule specifically address vague 1625 and implied that banking mitigated by disclosure or restricted by the conflict of interest provisions related entities may be required to exit information barriers. On the other hand, to asset-backed securitizations positions in periods of market stress, certain highly structured and complex contained in section 621 of the Dodd- further reducing liquidity.1626 A few transactions may involve conflicts of Frank Act. As explained below in Part commenters suggested the Agencies interest that can be mitigated by VI.B.1., some securitizations are subject identify and prohibit certain types of disclosure or restricted by information to the final rule, and others such as high-risk assets or high-risk trading barriers. securitizations of loans are not subject strategies under the rule.1627 In contrast, The Agencies believe that conflicts of to section 13 of the BHC Act. For any one commenter asserted the Agencies interest must be determined and securitization that meets the definition should not specify certain classes of addressed in accordance with the of covered fund under the final rule, assets or trading strategies as ‘‘high specific facts and circumstances relationships with and transactions by a risk.’’ 1628 A few commenters requested presented. One commenter suggested banking entity involving those greater clarity on the proposed that the proposed rule be modified so securitizations remain subject to the definitions and suggested the Agencies that a banking entity could conclusively requirements of section 13, including provide additional guidance.1629 One of rely on information barriers unless it the requirements of section 13(d)(2). In these commenters suggested the knows or has reason to know that addition, the banking entity would be Agencies simplify compliance by policies, procedures, and controls subject to the limitations contained in establishing safe harbors, setting pre- establishing barriers would not be section 621 of the Dodd-Frank Act and determined risk limits within risk-based effective in restricting the spread of any rules regarding conflicts of interest approaches, or allowing individual information.1620 By focusing on whether relating to securitizations implemented banking entities to set practical risk- a banking entity knows or has reason to under that section. The final rule in no based standards that the Agencies can know that its policies and procedures way limits the application of section review.1630 would not be effective, rather than on 621 of that Act with respect to an asset- One commenter suggested integrating what the banking entity knows or backed security that is subject to that the ban on high-risk activities should reasonably know about a conflict section. throughout the rule and stated that, of interest that may involve or result in given the evolving nature of financial a material adverse effect on a client, b. Definition of ‘‘High-Risk Asset’’ and markets, regulators should have the customer, or counterparty, the ‘‘High-Risk Trading Strategy’’ flexibility to update criteria for commenter’s suggestion has the 1. Proposed Rule identifying high-risk assets or high-risk potential to allow a banking entity to trading strategies.1631 This commenter engage in transactions that involve a Section 75.8(c) of the proposed rule defined ‘‘high-risk asset’’ and ‘‘high-risk stated the definition of high-risk trading material conflict of interest. Therefore, strategies was appropriately broad and the Agencies have determined not to trading strategy’’ for purposes of the proposed limitations on permitted flexible, but suggested improving the adopt the commenter’s suggested rule by encompassing trading strategies approach. Similarly, the Agencies are trading activities. Proposed § 75.8(c)(1) defined a ‘‘high-risk asset’’ as an asset that are so complex the risk or value rejecting some commenters’ suggestions thereof cannot be reliably and that the final rule prescribe the method, or group of assets that would, if held by 1632 the banking entity, significantly increase objectively determined. The scope, or specific content of commenter also suggested that the 1621 the likelihood that the banking entity disclosures. The Agencies believe quantitative measurements collected that specific guidance on disclosure would incur a substantial financial loss or would fail. Proposed § 75.8(c)(2) under proposed Appendix A could be may provide an incentive for banking utilized to help inform whether a high- entities to consider the form of defined a ‘‘high-risk trading strategy’’ as 1633 a trading strategy that would, if engaged risk asset or trading strategy exists. disclosure provided, rather than One commenter stated that in large in by the banking entity, significantly whether disclosure can address the concentrations, all assets can be high increase the likelihood that the banking substance of the conflict as determined risk. This commenter suggested entity would incur a substantial by the specific facts and circumstances evaluating transactions on a case-by- financial loss or would fail.1623 at hand. Moreover, the Agencies believe case basis and believed all activity banking entities are in the best position 2. Comments on Proposed Limitations exempted under section 13(d)(1) of the to identify and evaluate the conflicts on High-Risk Assets and Trading BHC Act should be viewed as ‘‘high- present in their business as well as the Strategies risk’’ absent prior regulatory approval. most effective method of disclosing With respect to the prohibition on This commenter further suggested that such conflicts. Banking entities must high-risk assets or trading strategies be tailor their compliance programs to transactions or activities that expose defined to include any asset or trading identify, monitor, and evaluate potential banking entities to high-risk assets or strategy that would have forced a conflicts based on their business high-risk trading strategies, one structure and specific activities and commenter stated the provisions were 1625 See AFR et al. (Feb. 2012); Japanese Bankers 1622 effective,1624 while other commenters customer relationships. Ass’n.; Investure; AllianceBernstein; Comm. on Capital Markets Regulation. 1620 See SIFMA et al. (Prop. Trading) (Feb. 2012). 1623 See Joint Proposal, 76 FR at 68894. The 1626 See Obaid Syed. 1621 See Occupy; ISDA (Apr. 2012); Better Agencies noted that a banking entity subject to 1627 See Sens. Merkley & Levin (Feb. 2012); Markets (Feb. 2012); SIFMA et al. (Prop. Trading) proposed Appendix C must implement a Johnson & Prof. Stiglitz; Occupy. compliance program that includes, among other (Feb. 2012); ICFR; Alfred Brock; Public Citizen; 1628 See Alfred Brock. AFR et al. (Feb. 2012); Arnold & Porter; Sens. things, policies and procedures that explain how 1629 See Japanese Bankers Ass’n.; Sens. Merkley & Merkley & Levin (Feb. 2012). the banking entity monitors and prohibits exposure Levin (Feb. 2012); Occupy; Public Citizen. 1622 For a full discussion of the final rule’s to high-risk assets and high-risk trading strategies, 1630 See Japanese Bankers Ass’n. compliance requirements, including a discussion of and identifies a variety of assets and strategies (e.g., 1631 the specific compliance requirements applicable to assets or strategies with significant embedded See Sens. Merkley & Levin (Feb. 2012). different banking entities, see Part VI.C. of this leverage). See Joint Proposal, 76 FR at 68894 n.215. 1632 See Sens. Merkley & Levin (Feb. 2012). SUPPLEMENTARY INFORMATION, infra. 1624 See Alfred Brock. 1633 See Sens. Merkley & Levin (Feb. 2012).

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banking entity to exit the market during asset or trading strategy is high-risk with the financial stability of the United the 2008 financial crisis, and that respect to a banking entity. As stated by States and the proposed approach leverage, rehypothecation, commenters, this framework is effective mirrored the statutory language, the concentration limits, and high and flexible enough to be utilized by the Agencies have determined no changes frequency trading should be viewed as Agencies in a variety of contexts. For to final rule are necessary. indicia of high-risk trading strategies. instance, a trading strategy or asset may B. Subpart C—Covered Fund Activities Finally, this commenter suggested the be high-risk to one banking entity but and Investments Agencies require banking entity CEOs to not another, or may be high-risk to a certify that their institution’s activities banking entity under some market As noted above and except as do not result in a material exposure to conditions but not others. As part of otherwise permitted, section 13(a)(1)(B) high-risk assets or high-risk trading evaluating whether a banking entity is of the BHC Act generally prohibits a strategies.1634 exposed to a high-risk asset or trading banking entity from acquiring or strategy, the Agencies expect that a retaining any ownership in, or acting as variety of factors will be considered, sponsor to, a covered fund.1639 Section 3. Final rule such as the presence of excess leverage, 13(d) of the BHC Act contains certain exemptions to this prohibition. Subpart After considering carefully the rehypothecation or excessively high C of the final rule implements these and comments received, the Agencies have concentration of assets, or unsafe and other provisions of section 13 related to modified the final rule to provide that unsound trading strategies. covered funds. Additionally, subpart C a high-risk asset means an asset or group We believe an approach limiting this contains a discussion of the internal of assets that would, if held by a provision’s applicability to certain controls, reporting and recordkeeping banking entity, significantly increase the permitted activities or creating a safe requirements applicable to covered fund likelihood that the banking entity would harbor for certain assets or trading activities and investments, and incur a substantial financial loss or strategies would be inconsistent with incorporates by reference the minimum would pose a threat to the financial the statutory language, which prohibits compliance standards for banking stability of the United States. Similarly, any permitted activity that involves or entities contained in subpart D of the the final rule defines high-risk trading results in a material exposure to a high- final rule, as well as Appendix B, to the strategy to include any strategy that risk asset or high-risk trading 1635 extent applicable. would, if engaged in by a banking strategy. In addition, the Agencies entity, significantly increase the decline to identify any particular assets 1. Section 75.10: Prohibition on likelihood that the banking entity would or trading strategies as per se high-risk Acquisition or Retention of Ownership incur a substantial financial loss or because a determination of the specific Interests in, and Certain Relationships would pose a threat to the financial risk posed to a banking entity depends 1636 With, a Covered Fund stability of the United States. on the facts and circumstances. Certain facts and circumstances may Section 75.10 of the final rule defines Importantly, under the final rule, the scope of the prohibition on the banking entities that engage in activities include, but are not limited to, the amount of capital at risk in a acquisition and retention of ownership pursuant to an exemption must have a interests in, and certain relationships reasonably designed compliance transaction, whether or not the transaction can be hedged, the amount with, a covered fund. It also defines a program in place to monitor and number of key terms, including the understand whether it is exposed to of leverage present in the transaction, and the general financial condition of definition of covered fund. high-risk assets or trading strategies. For The term ‘‘covered fund’’ specifies the instance, any banking entity engaged in the banking entity engaging in the transaction. In response to one types of entities to which the activity pursuant to the market-making prohibition contained in § 75.10(a) exemption in § 75.4(b) must, as part of commenter’s recommendation that the Agencies adopt a CEO certification applies, unless the activity is its compliance program, have specifically permitted under an reasonably designed written policies requirement specific to the high-risk provisions,1637 the Agencies believe available exemption contained in and procedures, internal controls, 1640 such a requirement is unnecessary in subpart C of the final rule. The final analysis and independent testing rule modifies the proposed definition of regarding the limits for each trading light of the required management framework in the compliance program covered fund in a number of key desk, including limits on the level of aspects. The Agencies have defined the exposures to relevant risk factors that provision of § 75.20 of the final rule, as well as the CEO certification term ‘‘covered fund’’ with reference to the trading desk may incur. These sections 3(c)(1) and 3(c)(7) of the policies and procedure and any activity requirement included in the final rule.1638 Investment Company Act of 1940 conducted pursuant to the final rule (‘‘Investment Company Act’’) with some will be evaluated by the Agencies, as c. Limitations on Permitted Activities additions and subject to a number of appropriate, as part of ensuring the That Pose a Threat to Safety and exclusions, several of which have been safety and soundness of banking entities Soundness of the Banking Entity or the modified from permitted activity and monitoring for exposures to high- Financial Stability of the United States exemptions included in the proposal. risk activities or assets. Finally, as the Agencies did not The Agencies have tailored the final While some commenters stated that receive any comments on the proposed definition to include entities of the type the definition of high risk asset or rule’s limitations on permitted activities that the Agencies believe Congress trading strategy should be more clearly that pose a threat to the safety and intended to capture in its definition of defined, the Agencies believe that it is soundness of the banking entity or to private equity fund and hedge fund in appropriate to include a broad section 13(h)(2) of the BHC Act by definition of these terms that accounts 1635 See BDA (Feb. 2012); Japanese Bankers Ass’n. reference to section 3(c)(1) and 3(c)(7) of for different facts and circumstances 1636 See Occupy. that may impact whether a particular 1637 See Occupy. 1639 See 12 U.S.C. 1851(a)(1)(B). 1638 See § 75.20 and Appendix B of the final rule, 1640 See final rule §§ 75.10(b)–(c). The term 1634 See Occupy. also discussed in Part VI.C., infra. banking entity is defined in final rule § 75.2(c).

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the Investment Company Act. Thus, the investment companies, whose activities by a banking entity only to instances final definition focuses on the types of do not implicate the concerns that where the banking entity acts as entities formed for the purpose of section 13 was designed to address. principal is consistent with the statutory investing in securities or derivatives for Finally, other related terms, including focus on principal activity.1647 The final resale or otherwise trading in securities ‘‘ownership interest,’’ ‘‘resident of the rule takes this approach as discussed or derivatives, and that are offered and United States,’’ ‘‘sponsor,’’ and below. sold in offerings that do not involve a ‘‘trustee,’’ are also defined in § 75.10(d) The proposed rule and preamble 1643 public offering, but typically involve of the final rule. As explained accompanying it described potential offerings to institutional investors and below, these terms are largely defined in exemptions from the definition of high-net worth individuals (rather than the same manner as in the proposal ownership interest for a variety of to retail investors). These types of funds although with certain changes, interests, including interests related to are not subject to all of the securities including changes to help clarify the employee benefit plans, interests held in law protections applicable with respect scope of these definitions as requested the ordinary course of collecting a debt to funds that are registered with the SEC by commenters. Some of these terms previously contracted, positions as as investment companies, and the and related provisions also have been trustee, or interests acquired as agent, Agencies therefore believe that these reorganized to improve clarity. As broker or custodian. Commenters types of entities may be more likely to explained in more detail below, the provided information on each of these engage in risky investment strategies. At Agencies received a number of types of ownership interests, and the same time, the Agencies have comments relating to some of the terms generally supported excluding each of tailored the definition to exclude defined in § 75.10. Some comments these from the section’s prohibition on entities that have more general directly relate to the scope of the acquiring or retaining an ownership corporate purposes and do not present proposed rule and the economic effects interest in a covered fund. associated with the prohibitions on the same risks for banking entities as A significant number of commenters those associated with the funds covered funds activities and investments, some of which focused on employee benefit plans. described above, as well as certain other Commenters generally argued that the entities as further discussed below. commenters argued did not further the purposes of section 13.1644 The prohibition in section 13(a) of the BHC The final rule also contains a revised Act did not encompass interests held on version of the proposal’s treatment of Agencies have carefully considered these and other comments when behalf of employees through an certain foreign funds as covered funds, employee benefit plan. While the which has been modified from the defining the key terms used in the statute and in providing certain proposed rule did not explicitly cover proposal and tailored to include only certain ‘‘qualified plans’’ under the the types of foreign funds that the exclusions to the definition of the term covered fund. The Agencies also have Internal Revenue Code, a number of Agencies believe are intended to be the commenters argued that the prohibition focus of the statute, such as certain sought to provide guidance below, where appropriate, on how these key should not cover activity or investments foreign funds that are established by related to other types of employee U.S. banking entities and not otherwise terms would operate in order to better enable banking entities to understand benefit plans that are not a ‘‘qualified subject to the Investment Company Act. plan’’ under the Internal Revenue The Agencies have not included all their obligations under section 13 and the final rule. Code.1648 A significant number of commodity pools within the definition commenters urged exclusion of interests of covered fund as proposed. Instead, a. Prohibition Regarding Covered Fund in and relationships with foreign and as discussed in more detail below, Activities and Investments employee benefit plans.1649 the Agencies have included only Section 75.10(a) of the final rule Commenters argued that the risks of commodity pools for which the implements section 13(a)(1)(B) of the investments made through employee commodity pool operator has claimed BHC Act and prohibits a banking entity benefit plans are borne by the employee exempt pool status under section 4.7 of from, directly or indirectly, acquiring or beneficiaries of these plans, and any the CFTC’s regulations or that could retaining as principal an equity, decision to cover employee benefit qualify as exempt pools and which have partnership, or other ownership interest plans or investments made by these 1641 not been publicly offered to persons in, or acting as sponsor to, a covered plans under the prohibitions in section who are not qualified eligible persons fund, unless otherwise permitted under 13 of the BHC Act would eliminate or under section 4.7 of the CFTC’s subpart C of the final rule.1645 This severely restrict the availability of 1642 regulations. Qualified eligible provision of the rule reflects the employee programs that are widely persons are typically institutional statutory prohibition. offered, regulated and endorsed under a investors, banking entities and high net The general prohibition in § 75.10(a) system of Federal, state and foreign worth individuals (rather than retail of the proposed rule applied solely to laws.1650 investors). This more tailored approach, the acquisition or retention of an Commenters also supported the together with the various exclusions ownership interest in, or acting as exemption under the proposed rule for from the covered fund definition in the sponsor to, a covered fund, ‘‘as holdings in satisfaction of a debt final rule, is designed to include as 1646 principal.’’ Commenters generally previously contracted in good faith.1651 covered funds those commodity pools supported this approach, arguing that that are similar to funds that rely on applying the prohibition related to 1647 See, e.g., SIFMA et al. (Covered Funds) (Feb. section 3(c)(1) or 3(c)(7) while not also covered fund activities and investments 2012); SIFMA et al. (Mar. 2012). including as covered funds entities, like 1648 See Credit Suisse (Williams); Arnold & commercial end-users or registered 1643 See final rule § 75.10(d)(6), (8), (9), and (10). Porter; UBS; Hong Kong Inv. Funds Ass’n. 1644 See, e.g., SIFMA et al. (Covered Funds) (Feb. 1649 See, e.g., Credit Suisse (Williams); Arnold & 1641 See infra note 1726 and accompanying text 2012); BoA; Goldman (Covered Funds); Rep. Himes; Porter; UBS; NAB; Hong Kong Inv. Funds Ass’n; regarding the meaning of the term ‘‘offer’’ as used SVB; Scale. Australian Bankers Ass’n. (Feb. 2012). in the final rule’s inclusion of certain commodity 1645 See final rule § 75.10(a). 1650 See, e.g., Arnold & Porter. pools as covered funds. 1646 See proposed rule § 75.10(a); see also Joint 1651 See, e.g., SIFMA et al. (Covered Funds) (Feb. 1642 See final rule § 75.10(b)(1)(ii). Proposal, 76 FR at 68896. 2012); LSTA (Feb. 2012).

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This provision of the proposal deferred compensation, stock-bonus, rule on banking entities’ investments in recognized that banking entities may profit-sharing, or pension plan of the and relationships with covered funds. acquire an ownership interest in or banking entity (or an affiliate thereof) b. ‘‘Covered Fund’’ Definition relationship with a covered fund as a that is established and administered in result of a counterparty’s failure to accordance with the law of the United Section 13(h)(2) of the BHC Act repay a bona fide debt and without an States or a foreign sovereign, if the defines hedge fund and private equity intent to engage in those activities as ownership interest is held or controlled fund to mean an issuer that would be an principal.1652 directly or indirectly by a banking entity investment company, but for section Several commenters urged revision to as trustee for the benefit of people who 3(c)(1) or 3(c)(7) of the Investment the proposal to add a specific exclusion are or were employees of the banking Company Act, or ‘‘such similar funds’’ for investments held by a banking entity entity (or an affiliate thereof); 1657 (3) in as the Agencies determine by rule.1659 in the capacity of trustee (including as the ordinary course of collecting a debt Given that the statute defines ‘‘hedge trustee for a charitable trust).1653 These previously contracted in good faith, fund’’ and ‘‘private equity fund’’ commenters argued that failing to provided that the banking entity divests without differentiation, the proposed recognize and exempt these types of the ownership interest as soon as rule and the final rule combine the activities in the final rule would prevent practicable, and in no event may the terms into the definition of a ‘‘covered banking entities that act as trustees from banking entity retain such instrument fund.’’ Sections 3(c)(1) and 3(c)(7) of the effectively meeting their trust and for longer than such period permitted by Investment Company Act are exclusions fiduciary obligations and from the appropriate agency; or (4) on behalf commonly relied on by a wide variety providing these services to customers. of customers as trustee or in a similar of entities that would otherwise be Commenters also argued that the fiduciary capacity for a customer that is covered by the broad definition of exemption for trust activities should not not a covered fund, so long as the ‘‘investment company’’ contained in 1660 be dependent on the duration of the activity is conducted for the account of, that Act. The proposal included as trust because the law governing the or on behalf of, the customer, and the a covered fund any entity that would be duration of trusts is changing and varies banking entity and its affiliates do not an investment company but for the across jurisdictions.1654 have or retain beneficial ownership of exclusion from that definition contained As with the proposed rule, the such ownership interest.1658 in section 3(c)(1) or 3(c)(7) of the prohibition in § 75.10(a) of the final rule Because these activities do not Investment Company Act, any foreign applies only to the acquisition or involve the banking entity engaging in entity that would also be an investment retention of an ownership interest in, or an activity intended or designed to take company but for those same exclusions sponsorship of, a covered fund as ownership interests in a covered fund as were the foreign entity to be organized principal. The Agencies continue to principal, they do not appear to be the or offered in the United States, and a believe section 13 of the BHC Act was types of activities that section 13 of the commodity pool as defined in section BHC Act was designed to address. 1a(10) of the Commodity Exchange designed to address the risks attendant 1661 to principal activity and not those that However, the Agencies note that in Act. The preamble to the proposal are borne by customers of the banking order to prevent a banking entity from recognized that this definition was broad and specifically requested entity or for which the banking entity evading the requirements of section 13 comment on whether and how the lacks design or intent to take a and the final rule, the exclusions for definition of covered fund should be proprietary interest as principal. these activities do not permit a banking modified for purposes of the final rule. In order to address commenter entity to engage in establishing, Commenters contended that the concerns regarding the types of activity organizing and offering, or acting as definition of covered fund should not that are subject to the prohibition, the sponsor to a covered fund in a manner other than as permitted elsewhere in the focus exclusively on whether an entity Agencies have modified and relies on section 3(c)(1) or 3(c)(7) of the reorganized the final rule to make the final rule. The Agencies intend to monitor these activities and investments Investment Company Act. Commenters scope of acting ‘‘as principal’’ clear and argued that sections 3(c)(1) and 3(c)(7) more consistent with the proprietary for efforts to evade the restrictions in section 13 of the BHC Act and the final of the Investment Company Act are trading restrictions under the final exclusions commonly relied on by a rule.1655 The final rule provides that the above. This provision is consistent with the final wide variety of entities that would prohibition does not include acquiring rule’s treatment of banking entities acting on behalf otherwise be covered by the broad or retaining an ownership interest in a of customers as trustee or in a fiduciary capacity. definition of ‘‘investment company’’ 1657 covered fund by a banking entity: (1) The Agencies note that this provision does contained in that Act. Under the Acting solely as agent, broker, or not permit joint investments between the banking entity and its employees. Rather, this provision is Investment Company Act, any entity custodian, so long as the activity is intended to enable banking entities to maintain that holds investment securities (i.e., conducted for the account of, or on deferred compensation and other similar plans

behalf of, a customer, and the banking formed for the benefit of employees. The Agencies 1659 recognize that, since it is possible an employee may See 12 U.S.C. 1851(h)(2). entity and its affiliates do not have or 1660 forfeit its interest in such a plan, the banking entity 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and retain beneficial ownership of the may have a residual or reversionary interest in the 3(c)(7) of the Investment Company Act, in relevant ownership interest; 1656 (2) through a assets referenced under the plan. However, other part, provide two exclusions from the definition of than such residual or reversionary interests, a ‘‘investment company’’ for: (1) Any issuer whose banking entity may not rely on this provision to outstanding securities are beneficially owned by not 1652 See proposed rule § 75.14(b). invest in a covered fund. more than one hundred persons and which is not 1653 See, e.g., ABA (Keating). 1658 See final rule § 75.10(a)(2). For instance, as making and does not presently propose to make a 1654 See, e.g., ABA (Keating); Arnold & Porter; part of engaging in its traditional trust company public offering of its securities (other than short- NAB. functions, a bank or savings association typically term paper); or (2) any issuer, the outstanding 1655 See final rule § 75.3(d)(7)–(9). may act through an entity that is excluded from the securities of which are owned exclusively by 1656 A banking entity acting as agent, broker, or definition of investment company under section persons who, at the time of acquisition of such custodian is not acting ‘‘as principal’’ under the 3(c)(3) or 3(c)(11). This would be included within securities, are qualified purchasers, and which is final rule so long as the activity is conducted for the scope of acting on behalf of customers as trustee not making and does not at that time propose to the account of, or on behalf of, a customer and the or in a similar fiduciary capacity, provided that it make a public offering of such securities. See 15 banking entity does not have or retain beneficial meets the applicable requirements of the exclusion U.S.C. 80a-3(c)(1) and (c)(7). ownership of such ownership interest, as noted under the final rule. 1661 See proposed rule § 75.10(b)(1).

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generally all securities other than U.S. pools; credit funds; real estate securitizations backed by government securities) representing at investment trusts; various securitization derivatives.1673 least 40 percent of the entity’s total vehicles; tender option bond programs; As a potential solution to some of assets would be an investment and venture capital funds.1665 these concerns, a number of company.1662 According to commenters, Commenters requested some of these commenters argued that the Agencies this definition and the accompanying exclusions in order to mitigate the should define covered fund by reference exclusions are part of a securities law impact of the proposal’s inclusion of to characteristics that are designed to and regulatory framework designed for commodity pools as part of the distinguish hedge funds and private purposes different than the prudential definition of covered fund.1666 equity funds from other types of entities purpose that underlies section 13 of the that rely on section 3(c)(1) or 3(c)(7) of BHC Act.1663 Some commenters argued that the the Investment Company Act.1674 A number of comments received on proposal failed to distinguish between Commenters believed this approach the proposal argued that the proposed different types of investment funds.1667 would help exclude some of the definition of covered fund was overly These commenters expressed the view corporate vehicles and funds mentioned broad and would lead to anomalous that the statute provides the Agencies above that they did not believe were results inconsistent with the words, with the discretion to distinguish intended by Congress to be included as structure, and purpose of section 13.1664 between investment funds generally and hedge funds and private equity funds For instance, many commenters asserted a subset of funds—hedge funds and and therefore reduce costs that, in the that the proposed rule’s definition of private equity funds—that may engage commenters’ view, did not further the covered fund would cause a number of in particularly risky trading and purposes of section 13.1675 commonly used corporate entities that investment activities. For example, These commenters proposed a are not traditionally thought of as hedge several commenters argued that the number of different potential types of funds or private equity funds, such as proposed rule’s restrictions on covered characteristics for defining hedge fund wholly-owned subsidiaries, joint fund investments should not cover and private equity fund. Some ventures, and acquisition vehicles, to be venture capital funds that provide commenters focused on certain subject to the covered fund restrictions investment capital to new structural or investment characteristics of section 13. These commenters argued businesses.1668 Others argued an found in traditional private equity funds that this interpretation of section 13 exclusion for securitization vehicles and hedge funds, such as investor redemption rights, performance would cause a disruption to the such as securitizations that are backed, operations of banking entities and their compensation fees, leverage and the use in whole or in part, by assets that are closely related affiliates that does not of short-selling.1676 Another commenter not loans, including corporate debt relate to the intent of section 13 and 1669 1670 argued that the characteristics used to repackagings, CLOs, ABCP define a covered fund should focus on therefore cause an unnecessary burden 1671 on banking entities. Commenters argued conduits, insurance-linked the types of speculative behavior that 1672 that the words, structure and purpose of securities, and synthetic the statute was intended to address, section 13 allow the Agencies to adopt citing characteristics such as volatility a more tailored definition of covered 1665 See ABA (Keating); ABA (Abernathy); SIFMA of asset performance and high et al. (Covered Funds) (Feb. 2012); Allen & Overy 1677 fund that focuses on vehicles used for (on behalf of Foreign Bank Group); Allen & Overy leverage. investment purposes that were the target (on behalf of Canadian Banks); Deutsche Bank In contrast to the majority of the of section 13’s restrictions. (Repackaging Transactions); ICI (Feb. 2012); commenters, one commenter urged that In particular, commenters requested Putnam; JPMC; GE (Feb. 2012); Chamber (Feb. characteristics be used to expand the that the final rule exclude at least the 2012); Rep. Himes; BOK; Ass’n. of Institutional proposed definition to include any Investors (Feb. 2012); Wells Fargo (Covered Funds); following from the definition of covered BoA; NAIB et al.; PNC; SunTrust; Nationwide; fund: U.S. registered investment STANY; BNY Mellon et al.; RMA; Goldman 1673 See AFME et al.; ASF (Feb. 2012); Cleary companies (including mutual funds); (Covered Funds); Japanese Bankers Ass’n; IRSG; Gottlieb; Credit Suisse (Williams); SIFMA the foreign equivalent of U.S. registered ISDA (Feb. 2012); IIB/EBF; Citigroup (Jan. 2012); (Securitization) (Feb. 2012); ABA (Keating). SSgA (Feb. 2012); State Street (Feb. 2012); Eaton 1674 See, e.g., SIFMA et al. (Covered Funds) (Feb. investment companies; business Vance; Fidelity; SBIA; River Cities; Ashurst; Sen. 2012); BlackRock; Credit Suisse (Williams); SSgA development companies; wholly-owned Hagan; Sen. Bennet. (Feb. 2012); State Street (Feb. 2012); Deutsche Bank subsidiaries; joint ventures; acquisition 1666 As discussed below, the Agencies have (Repackaging Transactions); Allen & Overy (on vehicles; financial market utilities; modified the final rule to include only certain behalf of Foreign Bank Group). commodity pools within the definition of covered 1675 See SIFMA et al. (Covered Funds) (Feb. foreign pension or retirement funds; 2012); AFME et al.; Allen & Overy (on behalf of insurance company separate accounts; fund. 1667 See NVCA; see also SIFMA et al. (Covered Foreign Bank Group); ASF (Feb. 2012); Ashurst; loan securitizations, including asset- Funds) (Feb. 2012); ABA (Keating). Barclays; BDA (Feb. 2012); Credit Suisse (Williams); Commercial Real Estate Fin. Council; Fidelity; ICI backed commercial paper conduits; cash 1668 See, e.g., ABA (Keating); ABA (Abernathy); (Feb. 2012); ISDA (Feb. 2012); JPMC; Nuveen Asset Canaan (Young); Canaan (Ahrens); Canaan (Kamra); management vehicles or cash collateral Mgmt.; PNC; RBC; SIFMA et al. (Covered Funds) Growth Managers; River Cities; SVB; EVCA. (Feb. 2012); SIFMA (Municipal Securities) (Feb. 1669 1662 15 U.S.C. 80a-3(a)(1)(A) and (C). The See AFME et al.; Allen & Overy (on behalf of 2012); SSgA (Feb. 2012); State Street (Feb. 2012); definition of securities is very broad under the Foreign Bank Group); ASF (Feb. 2012); Cleary Vanguard; Wells Fargo (Covered Funds). Investment Company Act and has been interpreted Gottlieb; Deutsche Bank (Repackaging 1676 See Ass’n. of Institutional Investors (Feb. to include instruments such as loans, that would Transactions); SIFMA (Securitization) (Feb. 2012). 2012); Barclays; JPMC; SIFMA et al. (Covered not be regarded as securities under the Securities 1670 See SIFMA (Securitization) (Feb. 2012); Allen Funds) (Feb. 2012); see also FSOC study at 62–63 Act of 1933 and the Securities Exchange Act of & Overy (on behalf of Foreign Bank Group); ASF (suggesting a characteristics-based approach 1934. In addition, the determination of what (Feb. 2012); Cleary Gottlieb; Credit Suisse considering compensation structure; trading/ constitutes an ‘‘investment security’’ under the (Williams); JPMC; LSTA (Feb. 2012). investment strategy; use of leverage; investor Investment Company Act requires complex analysis 1671 See Allen & Overy (on behalf of Foreign Bank composition); ABA (Keating); BNY Mellon et al.; and consideration of a broad set of facts and Group); ASF (Feb. 2012); Credit Suisse (Williams); Northern Trust, SSgA (Feb. 2012); State Street (Feb. circumstances. Eaton Vance; Fidelity; GE (Feb. 2012); GE (Aug. 2012); Deutsche Bank (Repackaging Transactions); 1663 See, e.g., NVCA. 2012); ICI (Feb. 2012); IIB/EBF; JPMC; PNC; RBC; T. Rowe Price; RMA (suggesting use of 1664 See, e.g., SIFMA et al. (Covered Funds) (Feb. SIFMA (Securitization) (Feb. 2012); AFME et al. characteristics derived from the SEC’s Form PF for 2012); BlackRock; AHIC; Sen. Carper et al.; Rep. 1672 See AFME et al.; SIFMA (Securitization) registration of investment advisers of private funds). Garrett et al. (Feb. 2012). 1677 See RBC (citing FSOC study).

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issuer that exhibits characteristics of believe is a better reading of the simple concurrent definition with two proprietary trading that the statute statutory provision because it is both self-contained, supplementary parts. prohibits to be done by a banking consistent with the language, purpose Under this approach, all entities entity.1678 According to this commenter, and structure of section 13 and avoids covered by part one of the definition any fund engaging in more than unintended consequences of the less would be included in the definitions of minimal proprietary trading should be a precise definitional approach of the ‘‘hedge fund’’ and ‘‘private equity covered fund and subject to the proposal. fund,’’ and the role of the Agencies requirements of section 13. In the final rule, the Agencies have under the second part was limited to However, not all commenters joined the definitions of ‘‘hedge fund’’ considering whether and how to supported a characteristics-based and ‘‘private equity fund’’ into a single augment the scope of the primary definition. One commenter opposed a definition ‘‘covered fund’’ (as in the statutory definition. characteristics-based definition, statute) and have defined this term as As noted above, commenters argued suggesting that the final rule rely only any issuer that would be an investment that this interpretation led to on the statutory reference to the company as defined in the Investment unintended consequences that were not Investment Company Act, and arguing Company Act but for section 3(c)(1) or consistent with other provisions of that using characteristics to define a 3(c)(7) of that Act with a number of section 13 or the purposes of section 13, covered fund (e.g., leverage) could express exclusions and additions and that other interpretations of the create opportunities for circumvention (explained below) as determined by the definition of covered fund were of the rule.1679 Commenters that Agencies. Thus, for example, an entity consistent with both the words and the generally supported the proposed that invests in securities and relies on purpose of the statute. Also as explained definition argued that its broad scope any exclusion or exemption from the above, commenters offered multiple prevented circumvention.1680 definition of ‘‘investment company’’ alternative interpretations of the One commenter argued in favor of under the Investment Company Act definition of, the scope of the broadening the definition of covered other than the exclusion contained in prohibition on ownership interests in, fund to include entities that rely on an section 3(c)(1) or 3(c)(7) of that Act and relationships with, a covered exclusion from the definition of would not be considered a covered fund fund.1686 investment company other than those so long as it satisfies the conditions of The Agencies believe that the contained in section 3(c)(1) and 3(c)(7), another Investment Company Act language of section 13(h)(2) can best be such as section 3(c)(2) (which provides exclusion or exemption.1683 Such an interpreted to provide two alternative an exclusion for underwriters and entity would not be an investment definitions of the entities to be covered brokers) or 3(c)(6) (which provides an company but for section 3(c)(1) or by the statutory terms ‘‘hedge fund’’ and exclusion for entities engaged in a 3(c)(7), and the Agencies have modified ‘‘private equity fund.’’ Under this business other than investing in the final rule to explicitly exclude such reading, the first part of section 13(h)(2) 1681 1684 securities). By contrast, other an entity. contains a base definition that commenters argued that an entity The Agencies believe this definition is references the noted exclusions under should not be considered a covered consistent with the words, structure, the Investment Company Act (the fund if the entity relies on an exclusion purpose and legislative history of ‘‘default definition’’), while the second or exemption contained in the section 13 of the BHC Act. As noted part grants the Agencies the authority to Investment Company Act other than an above, section 13(h)(2) provides that the adopt an alternate definition that is exclusion contained in section 3(c)(1) or terms ‘‘hedge fund’’ and ‘‘private equity triggered by agency action (the ‘‘tailored 3(c)(7) under that Act, such as the fund’’ mean an issuer that would be an definition’’). Thus, if the Agencies do exclusion contained in section 3(c)(3) investment company as defined in the not act by rule, the definition is set by for bank collective investment Investment Company Act (15 U.S.C. reference to the Investment Company funds.1682 80a–1 et seq.), but for section 3(c)(1) or Act and the relevant exclusions alone; if The Agencies have carefully 3(c)(7) of that Act, or such similar funds the Agencies act by rule, the definitions considered all of the comments related as the Agencies may, by rule, as to the definition of covered fund. While are set by the Agencies under that rule. provided in subsection (b)(2), As noted above, the Agencies have the Agencies believe that the proposal 1685 determine. The statutory provision determined to exercise the authority reflected a reasonable interpretation of contains two parts: A first part that the statutory provision, on further under the second part of the statute to refers to any issuer that is ‘‘an define ‘‘hedge fund’’ and ‘‘private equity review and in light of the comments the investment company, as defined in the Agencies have determined to adopt a fund’’ in the final rule. Investment Company Act, but for Relying on the Agencies’ authority to different approach. The Agencies have section 3(c)(1) and 3(c)(7) of the Act’’; revised the final rule to address many of adopt an alternative, tailored definition and a second part that covers ‘‘such of ‘‘hedge fund’’ and ‘‘private equity the concerns raised by commenters similar funds as the [Agencies] may, by regarding the scope of the original fund,’’ the final rule references funds rule . . . determine.’’ The proposed rule that are similar to the funds in the base proposal in a manner the Agencies offered a reading of this provision as a 1686 In addition to the readings described above, 1678 See Occupy. 1683 For instance, bank common trust and one commenter argued that the section could be 1679 See AFR et al. (Feb. 2012). collective funds that qualify for the exclusion from read to provide that both the reference to issuers 1680 See Sens. Merkley & Levin (Feb. 2012); AFR the definition of investment company pursuant to covered by section 3(c)(1) or 3(c)(7) of the et al. (Feb. 2012); Alfred Brock. section 3(c)(3) or 3(c)(11) of the Investment Investment Company Act in the first part of section 1681 See Occupy (also arguing in favor of Company Act are not covered funds. See 15 U.S.C. 13(h)(2) and the reference to similar funds in the including entities that rely on rule 3a-1 (which 78a-3(c)(3) and (c)(11). These funds are subject to second part of the section should be read as provides an exemption for issuers that hold less supervision and regulation by a Federal banking qualified by the clause ‘‘as the Agencies may by than 45% of their assets in securities excluding agency, thus helping to distinguish them from rule. . . determine.’’ Under this reading, Congress government securities) or 3a-6 (which provides an traditional hedge funds and private equity funds granted the Agencies authority to determine by rule exemption for foreign banks and insurance which are generally not themselves subject to such whether an entity described by the first part would companies) to avoid being regulated as investment supervision or regulation. be covered and whether an issuer would be deemed companies under the Investment Company Act). 1684 See final rule § 75.10(c)(12). to be a similar fund under the second part. See 1682 See, e.g., ABA (Keating). 1685 See 12 U.S.C. 1851(h)(2) (emphasis added). SIFMA et al. (Covered Funds) (Feb. 2012).

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alternative provided in the first contemplated by section 13. Moreover, would be to reference fund alternative definition—that is, an issuer other provisions of the Dodd-Frank Act characteristics. Commenters arguing for that would be an investment company and existing banking laws and a characteristics-based approach stated under the Investment Company Act but regulations would be undermined or that it would more precisely tailor the for section 3(c)(1) or 3(c)(7) of that Act. vitiated by a reading that restricts final rule to the intent of section 13 and The additions and exclusions from that investments in these types of corporate limit the potential for undue burden on definition represent further vehicles and structures.1689 banking entities. A characteristics-based determinations by the Agencies Based on the interpretive and policy definition, however, could be less regarding the scope of that definition considerations raised by commenters, effective than the approach taken in the that were made in the course of a the language of section 13(h)(2), and the final rule as a means to prohibit banking rulemaking conducted in accordance language, structure, and purpose of the entities, either directly or indirectly, with section 13(b)(2) of the BHC Act. Dodd-Frank Act, the Agencies have from engaging in the covered fund The Agencies believe that this reading adopted a tailored definition of covered activities limited or proscribed by of the statutory provision is consistent fund in the final rule that covers issuers section 13. A characteristics-based with the purpose of section 13. That of the type that would be investment approach also could require more purpose appears to be to limit the companies but for section 3(c)(1) or analysis by banking entities to apply involvement of banking entities in high- 3(c)(7) of the Investment Company Act those characteristics to every potential risk proprietary trading, as well as their with exclusions for certain specific covered fund on a case-by-case basis, investment in, sponsorship of, and other types of issuers in order to focus the and create greater opportunity for connections with, entities that engage in covered fund definition on vehicles evasion. As discussed below, the investment activities for the benefit of used for the investment purposes that Agencies have sought to address some banking entities, institutional investors were the target of section 13. The of the concerns raised by commenters and high-net worth individuals.1687 definition of covered fund under the Further, the Agencies believe that the final rule also includes certain funds suggesting a characteristics-based provision permits them to tailor the organized and offered outside of the approach by tailoring the definition of scope of the definition to funds that United States in order to address foreign covered fund to provide exclusions for engage in the investment activities fund structures and certain commodity certain entities that rely on section contemplated by section 13 (as opposed, pools that might otherwise allow 3(c)(1) or 3(c)(7) of the Investment for example, to vehicles that merely circumvention of the restrictions of Company Act and otherwise would be serve to facilitate corporate structures); section 13. The Agencies also expect to treated as covered funds. doing so allows the Agencies to avoid exercise the statutory anti-evasion Some commenters discussed the the unintended results, some of which authority provided in section 13(e) of potential cost to banking entities to commenters identified, that might the BHC Act and other prudential analyze the covered fund status of follow from a definition that is authorities in order to address instances certain entities if the Agencies were to inappropriately imprecise.1688 of evasion.1690 define the term covered fund by The Agencies also note that nothing As discussed above, an alternative reference to sections 3(c)(1) and 3(c)(7), in the structure or history of the Dodd- approach to defining a covered fund arguing that this analysis would be Frank Act suggests that the definition of costly.1691 A characteristics-based hedge fund and private equity fund was 1689 For example, the Dodd-Frank Act requires approach could mitigate the costs intended to necessitate a fundamental banking entities to serve as a source of financial strength to their insured depository institutions and associated with an investment company restructuring of banking entities by requires certain banking entities to form analysis but, depending on the disallowing investments in common intermediate holding companies to separate their characteristics, could result in corporate vehicles such as intermediate financial and non-financial activities. See Sections additional compliance costs in some holding companies, joint operating 167, 616(d) & 626 of the Dodd-Frank Act. These provisions would be severely undermined if the cases to the extent banking entities companies, acquisition vehicles and prohibitions on investments and activities would be required to implement similar entities that do not engage in the contained in section 13 were applied to ownership policies and procedures to prevent types of investment activities of intermediate holding companies. For instance, a bank holding company would not be able to serve potential covered funds from having as a source of strength to an intermediate holding characteristics that would bring them 1687 See 156 Cong. Reg. S.5894–5895 (daily ed. company (or any subsidiary thereof) that is a within the covered fund definition. July 15, 2010) (statement of Sen. Merkley). covered fund due to the transaction restrictions 1688 The Agencies believe that the choice of the contained in section 13(f). See 12 U.S.C. 1851(f). As Furthermore, banking entities may tailored definition is supported by the legislative another example, the Agencies have made certain currently rely on section 3(c)(1) and history that suggests that Congress may have modifications to the final rule to make clear that it 3(c)(7) of the Investment Company Act foreseen that its base definition could lead to will not affect the resolution authority of the unintended results and might be overly broad, too Federal Deposit Insurance Corporation, including to avoid registering various entities narrow, or otherwise off the mark. Part two of the by excluding from the covered fund definition under the Investment Company Act, and statutory definition was not originally included in issuers formed by or on behalf of the Corporation the costs to analyze the status of these the bill reported by the Senate Committee on April for the purpose of facilitating the disposal of assets entities under a statutory-based 30, 2010. While the addition of part two did not acquired in the Corporation’s capacity as receive specific comment, Rep. Frank, a co-sponsor conservator or receiver. See § 75.10(c)(13). definition of covered fund are generally and principal architect of the Dodd-Frank Act, 1690 As discussed in Part VI.C.1 of this already included as part of the fund noted that the default definition ‘‘could technically SUPPLEMENTARY INFORMATION regarding the formation process and the costs of apply to lots of corporate structures, and not just compliance program requirements of the final rule, determining covered fund status may the hedge funds and private equity funds’’ and the Agencies will consider information maintained confirmed that ‘‘[w]e do not want these overdone.’’ and provided by banking entities under the thus be mitigated, especially given the See 156 Cong. Rec. H5226 (daily ed. June 30, 2010) compliance program mandate to help monitor exclusions provided in the final rule. (statement of Reps. Himes and Frank) (noting intent potential evasions of the prohibitions and that subsidiaries or joint ventures not be included restrictions of section 13. Additionally and The entities excluded from the within the definition of covered fund); 156 Cong. consistent with the statute, the final rule permits definition of covered fund are described Rec. S5904–05 (daily ed. July 15, 2010) (statement the Agencies to jointly determine to include within in detail in section (c) below. of Sens. Boxer and Dodd) (noting broad definition the definition of covered fund any fund excluded of hedge fund and private equity fund and from that definition. The Agencies expect that this recommending that the Agencies take steps to authority may be used to help address situations of 1691 See, e.g., SIFMA et al. (Covered Funds) (Feb. ensure definition is reasonably tailored). evasion. 2012).

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1. Foreign Covered Funds commenters argued that a foreign fund After considering the comments in In order to prevent evasion of the organized and offered outside of the light of the statutory provisions and prohibition and purposes of section 13, United States should not be treated as purpose of section 13, the Agencies the proposal included within the a covered fund simply because the have modified the final rule to more definition of covered fund any issuer foreign fund may (or could) rely on the effectively tailor the scope of foreign organized or offered outside of the exclusion under section 3(c)(1) or 3(c)(7) funds that would be covered funds United States (‘‘foreign covered fund’’) of the Investment Company Act were it under the rule and better implement the 1697 that would be a covered fund were it to be offered in the United States. language and purpose of section 13. As organized or offered in the United Some commenters argued that the noted above, section 13 of the BHC Act States.1692 proposal did not clearly identify which applies to the global operations of U.S. Commenters expressed concern that foreign funds would be covered, thereby banking entities, and one of the the proposed treatment of foreign creating uncertainty about the scope of purposes of section 13 is to reduce the covered funds was overly broad, funds to which section 13 would risk to the U.S. financial system of 1698 exceeded the Agencies’ statutory apply. Several commenters argued activities with and investments in authority, was not consistent with that the proposal’s foreign covered fund covered funds. The Agencies proposed principles of national treatment, and definition could be read to include a to include foreign funds within the violated international treaties.1693 foreign fund, even if its securities were definition of covered fund in order to Commenters expressed concern about never offered and sold to U.S. persons, more effectively accomplish the purpose the difficulties of applying Investment because the fund could theoretically be of section 13. In particular, the Agencies Company Act concepts to foreign funds offered in the United States in reliance were concerned that a definition of 1699 that are structured to comply with on section 3(c)(1) or 3(c)(7). covered fund that did not include regulatory schemes under local laws Commenters argued that the definition foreign funds would allow U.S. banking of foreign covered fund should be entities to be exposed to risks and outside the United States. They also 1700 argued that it would be burdensome and tailored. Some commenters argued engage in covered fund activities costly to require foreign banking entities that foreign funds that are not made outside the United States that are to interpret and apply U.S. securities available for sale in the U.S. or actively specifically prohibited in the United laws to foreign structures that are marketed to U.S. investors should be States. This result would undermine designed primarily to be offered and specifically excluded from the section 13 and pose risks to U.S. definition of covered fund.1701 Several sold outside the United States.1694 banking entities and the stability of the Commenters also contended that foreign other commenters supported narrowing U.S. financial system that section 13 mutual fund equivalents, such as retail the definition of foreign covered fund to was designed to prevent. At the same time, section 13 includes Undertakings for Collective Investments those foreign funds with characteristics other provisions that explicitly limit its in Transferable Securities similar to domestic hedge funds or private equity funds.1702 extra-territorial application to the (‘‘UCITS’’),1695 would be treated as activities of foreign banks outside the covered funds under the proposal even ICI (Feb. 2012); SSgA (Feb. 2012); State Street (Feb. United States. As explained below, though they generally are similar to U.S. 2012); JPMC; BoA; Goldman (Covered Funds); Bank section 13 specifically exempts certain registered investment companies, which of Montreal et al. (Jan. 2012); AGC; Cadwalader (on activities in covered funds conducted by are not covered funds, meaning that behalf of Thai Banks); ALFI; BVI; EBF; British foreign banking entities solely outside of under the proposal the scope of foreign Bankers Ass’n.; French ACP; AFME et al.; F&C; IIF; ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA; the United States. funds captured was broader than the Australian Bankers Ass’n. (Feb. 2012); Allen & Based on these considerations and the 1696 scope of domestic funds. These Overy (on behalf of Foreign Bank Group); IFIC; information provided by commenters, Allen & Overy (on behalf of Canadian Banks); RBC; the Agencies have revised the definition 1692 French Treasury et al.; Hong Kong Inv. Funds See proposed rule § 75.10(b)(1)(iii). of covered fund in the final rule to 1693 See SIFMA et al. (Covered Funds) (Feb. Ass’n.; HSBC Life; ICSA Ass’n. of Banks in 2012); BNY Mellon et al.; BlackRock; ABA Malaysia (arguing that foreign banking organization include certain foreign funds under (Keating); AFTI; AFG; ICI Global; Ass’n. of would have to determine how a fund would be certain circumstances. The final rule Institutional Investors (Feb. 2012); ICI (Feb. 2012); regulated under U.S. law before making investments in funds in their home markets). provides that a foreign fund is included SSgA (Feb. 2012); State Street (Feb. 2012); JPMC; within the definition of covered fund BoA; Goldman (Covered Funds); Bank of Montreal 1697 See Allen & Overy (on behalf of Foreign Bank et al. (Jan. 2012); AGC; Cadwalader (on behalf of Group); ABA (Keating); SSgA (Feb. 2012); BoA; only for any banking entity that is, or is Thai Banks); ALFI; BVI; EBF; British Bankers Goldman (Covered Funds). controlled directly or indirectly by a Ass’n.; French ACP; AFME et al.; F&C; IIF; ICSA; 1698 See Australian Bankers Ass’n. (Feb. 2012); banking entity that is, located in or IMA; EFAMA; UKRCBC; AIMA; AFMA; Australian BlackRock. organized or established under the laws Bankers Ass’n. (Feb. 2012); Allen & Overy (on 1699 See BlackRock; SIFMA et al. (Covered Funds) behalf of Foreign Bank Group); IFIC; Allen & Overy (Feb. 2012); JPMC; ABA (Keating); IIB/EBF. These of the United States or of any State. (on behalf of Canadian Banks); RBC; French commenters argued that the proposed definition of Under this definition a foreign fund Treasury et al.; Hong Kong Inv. Funds Ass’n.; TCW; a covered fund could result in virtually every becomes a covered fund only with Govt. of Japan/Bank of Japan. foreign fund being considered a covered fund, respect to the U.S. banking entity (or 1694 See JPMC; see also Cadwalader (on behalf of regardless of whether the fund is similar to a hedge foreign affiliate of a U.S. banking entity) Thai Banks); Cadwalader (on behalf of Singapore fund or private equity fund. Banks); Ass’n. of Banks in Malaysia; Govt. of Japan/ 1700 See, e.g., AGC; Ass’n. of Institutional that acts as a sponsor to the foreign fund Bank of Japan. Investors (Feb. 2012); ABA (Keating); Goldman or has an ownership interest in the 1695 UCITS are public limited companies that, (Covered Funds); BoA; GE (Feb. 2012); Japanese foreign fund. Under the rule, a foreign under a series of directives issued by the EU Bankers Ass’n.; EBF. fund is any entity that: (i) Is organized Commission, coordinate distribution and 1701 See Australian Bankers Ass’n. (Feb. 2012); or established outside the United States management of unit trusts or collective investment AFG; BNY Mellon et al.; BlackRock; Goldman schemes in financial instruments on a cross-border (Covered Funds); IIB/EBF. and the ownership interests of which basis throughout the European Union on the basis 1702 See SIFMA et al. (Covered Funds) (Feb. are offered and sold solely outside the of the authorization of a single member state. 2012); JPMC; Goldman (Covered Funds); Credit United States; (ii) is, or holds itself out 1696 See Allen & Overy (on behalf of Foreign Bank Suisse (Williams); ABA (Keating); IIB/EBF; as being, an entity or arrangement that Group); ABA (Keating); AFG; AFTI; BoA; French Barclays; BoA; GE (Feb. 2012) (discussing the Banking Fed’n.; SIFMA et al. (Covered Funds) (Feb. uncertainty with respect to foreign-based loan and raises money from investors primarily 2012); see also BNY Mellon et al.; BlackRock; ICI securitization programs and whether they would be for the purpose of investing in securities Global; Ass’n. of Institutional Investors (Feb. 2012); deemed covered funds). for resale or other disposition or

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otherwise trading in securities; and (iii) 2. Commodity Pools expanding the definition of covered has as its sponsor the U.S. banking Under the proposal, the Agencies fund to include commodity pools would entity (or an affiliate thereof) or has proposed to use their authority to have the unintended consequence of issued an ownership interest that is expand the definition of covered fund to limiting all covered transactions owned directly or indirectly by the U.S. include a commodity pool as defined in between a banking entity sponsor or banking entity (or an affiliate section 1a(10) of the Commodity investor in a commodity pool and the thereof).1703 A foreign fund therefore Exchange Act.1707 A commodity pool is commodity pool itself.1712 If a may be a covered fund with respect to defined in the Commodity Exchange Act commercial end user is a commodity the U.S. banking entity that sponsors the to mean any investment trust, syndicate, pool for example, this restriction could fund, but not be a covered fund with or similar form of enterprise operated limit access to credit for that entity. respect to a foreign bank that invests in for the purpose of trading in commodity Commenters that opposed the the fund solely outside the United interests.1708 The Agencies proposed to proposal’s inclusion of commodity States. include commodity pools in the pools generally asserted that, if This approach is designed to include definition of covered fund because some commodity pools were nonetheless within the definition of covered fund commodity pools are managed and included as covered funds under the only foreign entities that would pose structured in a manner similar to a final rule, the definition of commodity risks to U.S. banking entities of the type covered fund. pool should be modified so that it section 13 was designed to address. The Some commenters objected to this would include only those pools that Agencies note that any foreign fund, expansion of the definition of covered engage ‘‘primarily’’ or ‘‘principally’’ in including a foreign fund sponsored or fund as beyond the scope of section 13. commodities trading and exhibit owned by a foreign banking entity, that Commenters argued that covering characteristics similar to those of is offered or sold in the United States in commodity pools would extend section conventional hedge funds and private reliance on the exclusions in section 13 of the BHC Act to any entity that equity funds.1713 Other commenters 3(c)(1) or 3(c)(7) of the Investment engages in a single commodity, futures urged the Agencies to incorporate the Company Act would be included in the or swap transaction, including entities exemptions from the commodity pool definition of covered fund under that share few, if any, of the operator registration requirements under § 75.10(b)(1)(i) of the final rule unless it characteristics or risk associated with the Commodity Exchange Act (such as meets the requirements of an exclusion private equity funds or hedge funds.1709 rule 4.13(a)(4)).1714 from that definition as discussed For example, some commenters argued Some commenters supported below.1704 Thus, the rule is designed to that many non-bank businesses that are including commodity pools within the provide parity—and no competitive not investment companies but that definition of covered fund,1715 with advantages or disadvantages—between hedge risks using commodity interests some suggesting that this approach U.S. and non-U.S. funds sold within the would be treated as covered funds if all would be consistent with the goals of United States. commodity pools were covered.1710 In the statute.1716 One commenter asserted addition, registered mutual funds, To further ensure that this approach that including commodity pools would pension funds, and many investment to foreign funds is consistent with the be necessary to prevent banking entities companies that rely on exclusions or scope of coverage applied within the from indirectly engaging in prohibited exceptions other than section 3(c)(1) or United States, the final rule excludes proprietary trading through commodity 3(c)(7) of the Investment Company Act 1717 from the definition of covered fund any pools. Another commenter asserted would be covered as commodity pools. foreign issuer that, were it subject to that the inclusion of commodity pools Commenters argued that the CFTC has U.S. securities laws, would be able to was advisable because the CFTC has in ample authority to regulate the activities rely on an exclusion or exemption from the past viewed many commodity pools of commodity pools and commodity as similar to hedge funds.1718 the definition of investment company pool operators, and nothing in section other than the exclusions contained in After carefully considering these 13 indicates that Congress intended comments, the Agencies have section 3(c)(1) or 3(c)(7) of the section 13 to govern commodity pool Investment Company Act.1705 determined not to include all activities or investments in commodity commodity pools as covered funds as As explained below, the final rule pools.1711 Commenters also argued that proposed. Instead, and taking into also contains an exclusion for foreign 1706 account commenters’ concerns, the public funds. This is designed to 1707 See proposal rule § 75.10(b)(1)(ii). Agencies have taken a more tailored 1708 prevent the extension of the definition Commodity interests include: (i) Commodity approach that is designed to more of covered fund from including foreign for future delivery, security futures product, or swap; (ii) agreement, contract, or transaction accurately identify those commodity funds that are similar to U.S. registered described in section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of pools that are similar to issuers that investment companies, which are by the Commodity Exchange Act; (iii) commodity would be investment companies as statute not covered by section 13. option authorized under section 4c of the Commodity Exchange Act; or (iv) leveraged defined the Investment Company Act of transaction authorized under section 23 of the 1940 but for section 3(c)(1) or 3(c)(7) of 1703 See final rule § 75.10(b)(1)(iii). Commodity Exchange Act. See Joint Proposal, 76 1704 See also Goodwin, Procter & Hoar LLP, SEC FR at 68897 n.224 and accompanying text. 1712 See, e.g., BoA. Staff No-Action Letter (Feb. 28, 1997); Touche 1709 See, e.g., ABA (Keating) (citing see, e.g., 1713 See, e.g., SIFMA et al. (Covered Funds) (Feb. Remnant & Co., SEC Staff No-Action Letter (Aug. CFTC Interpretative Letter No. 86–22, Comm. Fut. 2012); Goldman (Covered Funds); BlackRock; Wells 27, 1984). L. Rep. (CCH) ¶ 23,280 (Sept. 19, 1986)); SIFMA et Fargo (Covered Funds); BNY Mellon, et al.; SSgA 1705 See final rule § 75.10(b)(2). Because any al. (Covered Funds) (Feb. 2012); ICI (Feb. 2012); (Feb. 2012); State Street (Feb. 2012); Credit Suisse issuer that offers its securities under the U.S. BlackRock; Goldman (Covered Funds); Wells Fargo (Williams); ABA (Keating); FIA; IIB/EBF; BoA. securities laws that may rely on an exclusion or (Covered Funds); BoA; EFAMA; TCW; ISDA (Feb. 1714 exemption from the definition of investment 2012); Arnold & Porter; BNY Mellon et al.; SSgA See Credit Suisse (Williams). company other than the exclusions contained in (Feb. 2012); State Street (Feb. 2012); Credit Suisse 1715 See AFR et al. (Feb. 2012); Alfred Brock; section 3(c)(1) or 3(c)(7) of the Investment Company (Williams); RMA; IIB/EBF. Occupy; Sens. Merkley & Levin (Feb. 2012). Act would not be a covered fund, this exclusion is 1710 See Goldman (Covered Funds); TCW; IIB/ 1716 See Sens. Merkley & Levin (Feb. 2012); designed to provide equivalent treatment for foreign EBF. Occupy; AFR et al. (Feb. 2012); Alfred Brock. covered funds. 1711 See, e.g., SIFMA et al. (Covered Funds) (Feb. 1717 See Sens. Merkley & Levin (Feb. 2012). 1706 See § 75.10(c)(1). 2012); ICI (Feb. 2012); BlackRock. 1718 See Occupy.

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that Act, consistent with section therefore have determined that they this element aligns the elements of the 13(h)(2) of the BHC Act. properly are considered ‘‘such similar alternative test with features that define Under the final rule, as a threshold funds’’ as specified in section 13(h)(2) of funds that rely on sections 3(c)(1) and matter, a collective investment vehicle the BHC Act. 3(c)(7) of the Investment Company Act must determine whether it is a Alternatively, a commodity pool for of 1940. ‘‘commodity pool’’ as that term is which exempt pool status under section The assessment as to whether the defined in section 1a(10) of the 4.7 of the CFTC’s regulations has not commodity pool in question satisfies Commodity Exchange Act.1719 The been elected may also be a covered fund this condition must be made at the time Agencies note that collective investment if the pool features certain elements that that the banking entity is required to vehicles need to make this make the pool substantively similar to make the following determinations: determination for purposes of exempt pools under section 4.7. The whether it can obtain new participation complying with the Commodity Agencies are including the alternative units in the commodity pool, whether it Exchange Act regardless of whether definition of commodity pools that are can retain previously purchased commodity pools are covered funds. covered funds because, if the Agencies participation units in the commodity Under section 1a(10), a commodity pool had included only pools for which pool, and whether it can act as the is ‘‘any investment trust, syndicate, or exempt pool status had been elected, commodity pool’s sponsor. The similar form of enterprise operated for covered fund status for pools in which Agencies believe this to be appropriate the purpose of trading commodity banking entities are invested could because it would require the banking interests.’’ 1720 If a collective investment easily be avoided merely by not electing entity to consider current information vehicle meets that definition, the exempt pool status under section 4.7. regarding the commodity pool and its commodity pool would be considered a The following is a description of the participants rather than assess the covered fund provided it meets one of elements of a pool that would cause a composition of the pool’s participants two alternative tests and does not also pool that is not an exempt pool under over time even though its investments qualify for an exclusion from the section 4.7 to be a covered fund. in or relationships with the pool do not covered fund definition (e.g., the The first element is that a commodity change, which could be difficult exclusion for registered investment pool operator for the pool is registered depending upon the length of time that companies). pursuant to the Commodity Exchange the pool has been in operation and the First, a commodity pool will be a Act in connection with the operation of records available at the time of covered fund if it is an ‘‘exempt pool’’ that commodity pool. This element is determination. under section 4.7(a)(1)(iii) of the CFTC’s present for all pools that are exempt Finally, the third element under the regulations,1721 meaning that it is a pools under section 4.7 because exempt alternative definition is that the commodity pool for which a registered pool status can only be elected by commodity pool participation units commodity pool operator has elected to registered commodity pool operators. have not been publicly offered to claim the exemption provided by This element excludes from the persons other than qualified eligible section 4.7 of the CFTC’s regulations. definition of covered fund an entity that persons. Consistent with CFTC The Agencies believe that such is a commodity pool, but for which the regulations addressing the meaning of commodity pools are appropriately pool operator has been either exempted ‘‘offer’’ in the context of the CFTC’s considered covered funds because, like from registration as a commodity pool regulations, the term ‘‘offer’’ as used in funds that rely on section 3(c)(1) or operator or excluded from the definition § 75.10(b)(1)(ii)(B) ‘‘has the same 3(c)(7), these commodity pools sell their of commodity pool operator under the meaning as in contract law, such that, participation units in restricted offerings CFTC’s regulations or pursuant to a no- if accepted the terms of the offer would that are not registered under the action letter issued by CFTC staff.1723 form a binding contract.’’ 1726 This Securities Act of 1933 and are offered The second element under the aspect of the alternative definition is only to investors who meet certain alternative definition is that intended to limit the ability for heightened qualification standards, as substantially all of the commodity commodity pools to avoid classification discussed above.1722 The Agencies pool’s participation units are owned as covered funds through an offer, either only by qualified eligible persons under in the past or currently ongoing, to non- 1719 See 7 U.S.C. 1a(10). section 4.7(a)(2) and (a)(3).1724 This qualified eligible persons ‘‘in name 1720 Id. The CFTC and its divisions have provided element is consistent with the only’’ where there is no actual offer to interpretative guidance with respect to the meaning requirement under section 4.7 that non-qualified eligible persons. of the definition of commodity pool. See, e.g., 46 FR 26004, 26005 (May 8, 1981) (adopting the exempt pool status can only be claimed Accordingly, unless the pool operator CFTC’s regulatory definition of commodity pool in if the participation units in the pool are can show that the pool’s participation 17 CFR 4.10(d), which is substantively identical to only offered or sold to qualified eligible units have been actively and publicly the definition in section 1a(10) of the Commodity persons.1725 Moreover, the inclusion of offered to non-affiliated parties that are Exchange Act); 77 FR 11252, 11258 (Feb. 24, 2012) (explaining the need for swaps to be included in the not qualified eligible persons whereby de minimis exclusion and exemption in 17 CFR 4.5 1723 See, e.g., CFTC regulations 3.10(c) and 4.13 such non-qualified eligible persons and 4.13); CFTC Staff Letter 12–13 (Oct. 11, 2012) and CFTC Staff Letters Nos. 12–37 (Nov. 29, 2012) could in fact purchase a participation (providing interpretative guidance to equity real (relief from registration for operators of certain unit in the commodity pool, a pool that estate investment trusts); and CFTC Staff Letters types of family office pools), 12–40 (Dec. 4, 2012) Nos. 12–14 (Oct. 11, 2012) and 12–45 (Dec. 7, 2012) (relief from registration for operators of business features the other elements listed in the (providing interpretative relief that certain development companies that meet certain securitization vehicles are not commodity pools). conditions) and 12–44 (Dec. 7, 2012) (relief from fund status by distributing a small number of 1721 17 CFR 4.7(a)(1)(iii). registration for operators of mortgage real estate participation units to persons who are not qualified 1722 Although section 3(c)(1) itself does not limit investment trusts that meet certain conditions). See eligible persons. the types of investors who may invest in a fund also supra note 1720. 1726 See 77 FR 9734, 9741 (Feb. 17, 2012) relying on that exclusion, section 3(c)(1) provides 1724 17 CFR 4.7(a)(2) and (a)(3). (describing the meaning of the term ‘‘offer’’ in the that the fund may not conduct a public offering. A 1725 Although section 4.7 requires that all context of the business conduct standards for swap fund relying on section 3(c)(1) therefore must offer participation units be owned by qualified eligible dealers and major swap participants with and sell its interests in offerings that are not persons, this element of the final rule has been counterparties adopted by the CFTC). The term registered under the Securities Act of 1933, which modified to include pools for which ‘‘substantially ‘‘offered’’ as used in this section of the final rule offerings generally are limited to persons who meet all’’ participation units are owned by qualified is not intended to denote an ‘‘offer’’ for purposes certain qualification standards. eligible persons to prevent avoidance of covered of the Securities Act of 1933.

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alternative definition would be a advisors that advise commodity pools, affiliated FCMs may not be able to lend covered fund. Such a showing will not the Agencies believe that it is beneficial money in certain clearing transactions turn solely on whether the commodity to utilize an already established set of to affiliated commodity pools that are pool has filed a registration statement to rules, regulations, and guidance. The covered funds) may result in certain offer its participation units under the Agencies considered alternative changes in the way related entities do Securities Act of 1933 or whether the approaches provided by the business with each other. However, the commodity pool operator has prepared commenters, but have adopted the Agencies believe that because the a disclosure document consistent with approach taken in the final rule for the industry is competitive with a the provisions of section 4.24 of the reasons discussed above and because significant number of alternative non- CFTC’s regulations.1727 Rather, the pool the Agencies believe that the final rule, affiliate competitors, the changes would operator would need to show that a by incorporating concepts with which not result in a less competitive reasonably active effort, based on the commodity pools and their operators are landscape for investors in commodity facts and circumstances, has been familiar, more clearly delineates the pools. undertaken by brokers and other sales commodity pools that are covered 3. Entities Regulated Under the personnel to publicly offer the pool’s funds.1730 Investment Company Act participation units to non-affiliated The Agencies believe that the final parties that are not qualified eligible rule’s tailored approach to commodity The proposed rule did not specifically persons. pools includes in the definition of include registered investment In taking this more tailored approach covered fund commodity pools that are companies (including mutual funds) or to commodity pools that will be covered similar to funds that rely on section business development companies funds, the Agencies are more closely 3(c)(1) and 3(c)(7). The Agencies also within the definition of covered aligning the types of commodity pools note in this regard that a commodity fund.1731 As explained above, the that will be covered funds under the pool that would be a covered fund even statute references funds that rely on final rule with section 13’s definition of under this tailored approach will not be section 3(c)(1) or 3(c)(7) of the a hedge fund and private equity fund by a covered fund if the pool also qualifies Investment Company Act. Registered reference to section 3(c)(1) or section for an exclusion from the covered fund investment companies and business 3(c)(7), and addressing concerns of definition, including the exclusion for development companies do not rely on commenters that the proposal was registered investments companies. either section 3(c)(1) or 3(c)(7) of the overly broad and would lead to Accordingly, this approach excludes Investment Company Act and are outcomes inconsistent with the words, from covered funds entities like instead registered or regulated in structure, and purpose of section 13.1728 commercial end users and registered accordance with the Investment The Agencies believe that the types of investment companies, whose activities Company Act. commodity pools described above do not implicate the concerns section 13 Many commenters argued that generally are similar to funds that rely was designed to address. Rather, the registered investment companies and on section 3(c)(1) and 3(c)(7) in that, final rule limits the commodity pools business development companies would like funds that rely on section 3(c)(1) or that will be included as covered funds be treated as covered funds under the 3(c)(7), these commodity pools may be to those that are similar to other covered proposed definition if commodity pools owned only by investors who meet funds except that they are not generally are treated as covered funds.1732 A few certain heightened qualification subject to the Investment Company Act commenters argued that the final rule standards, as discussed above.1729 of 1940 due to the instruments in which should specifically provide that all SEC- Further, the Agencies believe that the they invest. For all of these reasons, the registered funds are excluded from the final rule’s identification of the Agencies believe that the final rule’s definition of covered fund (and the elements of a commodity pool that is a approach to commodity pools addresses definition of banking entity) to avoid covered fund are clearly established and both the Agencies’ concerns about the any uncertainty about whether section readily ascertainable such that once it is potential for evasion and commenters’ 13 applies to these types of funds.1733 determined whether an entity is a concerns about the breadth of the Commenters also requested that the commodity pool, an assessment that is proposed rule, and provides that the final rule exclude from the definition of already necessary to comply with the commodity pools captured as covered covered fund entities formed to Commodity Exchange Act, then the funds are ‘‘such similar funds,’’ establish registered investment further determination of whether an consistent with section 13(h)(2) of the companies during the seeding period. entity that is a commodity pool is also BHC Act. These commenters contended that, a covered fund can be made based on The Agencies acknowledge that as a during the early stages of forming and readily ascertainable information. result of including certain commodity seeding a registered investment In adopting this approach, the pools in the definition of covered fund, company, an entity relying on section Agencies also are utilizing the current the prohibitions under section 13(f) and 3(c)(1) or (3)(c)(7) may be created to regulatory structure promulgated by the § 75.14 may result in certain structural CFTC under the CEA. As the CFTC changes in the industry. The Agencies 1731 See proposed rule § 75.10(b)(1). regulates commodity pools, commodity 1732 See, e.g., Arnold & Porter; BoA; Goldman note that these changes (e.g., bank- (Covered Funds); ICI (Feb. 2012); Putnam; TCW; pool operators, and commodity trading Vanguard. According to these commenters, a 1730 Operators of commodity pools currently must registered investment company may use security or 1727 17 CFR 4.24 (2013). consider whether they are required to register with commodity futures, swaps, or other commodity 1728 See, e.g., SIFMA et al. (Covered Funds) (Feb. the CFTC as commodity pool operators, and interests in various ways to manage its investment 2012); BlackRock; AHIC; Sen. Carper et al.; Rep. whether the pools have the characteristics that portfolio and be swept into the broad definition of Garrett et al. would make it possible for the operator to claim an ‘‘commodity pool’’ contained in the Commodity 1729 Funds relying on section 3(c)(7) must be exemption under section 4.7. These concepts thus Exchange Act. owned exclusively by qualified purchasers, as should be familiar to commodity pools and their 1733 See Arnold & Porter; Goldman (Covered defined in the Investment Company Act. The operators, and including these concepts in the final Funds); see also SIFMA et al. (Covered Funds) (Feb. Agencies note in this regard that section 4.7 of the rule should allow banking entities more easily to 2012); SIFMA et al. (Mar. 2012); ABA (Keating); CFTC’s regulations use substantially the same determine if a particular commodity pools is a BoA; ICI (Feb. 2012); JPMC; (requesting clarification definition of a qualified purchaser in defining the covered fund than if the Agencies were to develop that registered investment companies are not term qualified eligible person. new concepts solely for purposes of the final rule. banking entities); TCW.

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facilitate the development of a track be a banking entity if it is an affiliate of interlocks, without finding that the bank record for the registered investment an insured depository institution. As holding company controls the fund.1740 company so that it may be marketed to explained in the proposal, a registered The Board has also permitted a bank unaffiliated investors.1734 investment company, such as a mutual holding company to own less than 25 The Agencies did not intend to fund or exchange traded fund, or an percent of the voting shares of a include registered investment entity that has made an effective registered investment company and companies and business development election to be regulated as a business provide similar services without finding companies as covered funds under the development company, would not be an that the bank holding company controls proposal. Section 13’s definition of affiliate of a banking entity for purposes the fund, so long as the fund limits its private equity fund and hedge fund by of section 13 of that Act solely by virtue investments to those permissible for the reference to section 3(c)(1) and 3(c)(7) of of being advised, or organized, holding company to make itself.1741 the Investment Company Act appears to sponsored and managed by a banking reflect Congress’ concerns about entity in accordance with the BHC Act The BHC Act, as amended by the banking entities’ exposure to and (including section 13) and the Board’s Gramm-Leach-Bliley Act, and the relationships with investment funds Regulation Y.1736 Board’s Regulation Y authorize a bank that explicitly are excluded from SEC Under the BHC Act, an entity holding company that qualifies as a regulation as investment companies. (including a registered investment financial holding company to engage in The Agencies do not believe it would be company) would generally be a broader set of activities, and to have appropriate to treat as a covered fund considered an affiliate of a banking a broader range of relationships or registered investment companies and entity, and therefore a banking entity investments with entities, than bank business development companies, itself, if it controls, is controlled by, or holding companies.1742 For instance, a which are regulated by the SEC as is under common control with an financial holding company may engage 1737 investment companies. The Agencies insured depository institution. in, or acquire shares of any company believe that the proposed rule’s Pursuant to the BHC Act, a company engaged in, any activity that is financial inclusion of commodity pools would controls another company if: (i) The in nature or incidental to such financial have resulted in some registered company directly or indirectly or acting investment companies and business through one or more other persons activity, including any activity that a development companies being covered owns, controls, or has power to vote 25 bank holding company is permitted to funds, a result the Agencies did not per cent or more of any class of voting engage in or acquire by regulation or 1743 intend. The Agencies, in addition to securities of the company; (ii) the order. In light of the foregoing, for narrowing the commodity pools that company controls in any manner the purposes of section 13 of the BHC Act will be included as covered funds as election of a majority of the directors of a financial holding company may own discussed above, have also modified the trustees of the other company; or (iii) more than 5 percent (and less than 25 final rule to exclude SEC-registered the Board determines, after notice and percent) of the voting shares of a investment companies and business opportunity for hearing, that the registered investment company for development companies from the company directly or indirectly exercises which the holding company provides definition of covered fund.1735 a controlling influence over the investment advisory, administrative, The Agencies also recognize that an management or policies of the and other services and has a number of entity that becomes a registered company.1738 director and officer interlocks, without investment company or business The Board’s regulations and orders development company might, during its have long recognized that a bank 1740 See, e.g., Societe Generale, 84 Fed. Res. Bull. seeding period, rely on section 3(c)(1) or holding company may organize, 680 (1998) (finding that a bank holding company 3(c)(7). The Agencies have determined sponsor, and manage a mutual fund does not control a mutual fund for which it holds to exclude these seeding vehicles from such as a registered investment up to 5 percent of the voting shares and also provides investment advisory, administrative and the covered fund definition for the same company, including by serving as other services, has directors or employees who reasons the Agencies determined to investment adviser to registered comprise less than 25 percent of the board of exclude entities that are operating as investment company, without directors of the fund (including the chairman of the registered investment companies or controlling the registered investment board), and has three senior officer interlocks and company for purposes of the BHC a number of junior officer interlocks). business development companies as 1741 See letter dated June 24, 1999, to H. Rodgin 1739 discussed in more detail below in Part Act. For example, the Board has Cohen, Esq., Sullivan & Cromwell (First Union VI.B.1.c.12 of this SUPPLEMENTARY permitted a bank holding company to Corp.), from Jennifer J. Johnson, Secretary of the INFORMATION. own up to 5 percent of the voting shares Board of Governors of the Federal Reserve System The Agencies also understand that of a registered investment company for (finding that a bank holding company does not control a mutual fund for which it provides registered investment companies may which the bank holding company investment advisory and other services and that establish and hold subsidiary entities provides investment advisory, complies with the limitations of section 4(c)(7) of that rely on section 3(c)(1) or 3(c)(7) in administrative, and other services, and the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i) order to trade in various financial has a number of director and officer the bank holding company reduces its interest in the fund to less than 25 percent of the fund’s voting instruments for the registered shares after a six-month period, and (ii) a majority investment company parent. If a 1736 See Joint Proposal, 76 FR at 68856. of the fund’s directors are independent of the bank registered investment company were 1737 See final rule § 75.2(a) (defining ‘‘affiliate’’ for holding company and the bank holding company itself a banking entity, section 13 and purposes of the final rule). cannot select a majority of the board) (‘‘First Union 1738 Letter’’); H.R. Rep. No. 106–434 at 153 (1999) (Conf. the final rule would prohibit the See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e). 1739 See, e.g., 12 CFR 211.10(a)(11); Rep.) (noting that the Act permits a financial registered investment company from 225.28(b)(6)(i); 225.86(b)(3); Unicredito, 86 Fed. holding company to sponsor and distribute all types sponsoring or investing in such an Res. Bull. 825 (2000); Societe Generale, 84 Fed. Res. of mutual funds and investment companies); see investment subsidiary. But a registered Bull. 680 (1998); Commerzbank AG, 83 Fed. Res. also 12 U.S.C. 1843(k)(1), (6). 1742 investment company would only itself Bull. 678 (1997); The Governor and Company of the See, e.g., H.R. Rep. No. 106–434 at 153 (1999) Bank of Ireland, 82 Fed. Res. Bull. 1129 (1996); (Conf. Rep.) (noting that the Act permits a financial Mellon Bank Corp., 79 Fed. Res. Bull. 626 (1993); holding company to sponsor and distribute all types 1734 See ICI (Feb. 2012); TCW. Bayerische Vereinsbank AG, 73 Fed. Res. Bull. 155 of mutual funds and investment companies). 1735 See final rule § 75.10(c)(12). (1987). 1743 See 12 U.S.C. 1843(k)(1); 12 CFR 225.86.

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controlling the fund for purposes of the exclusions by permitting banking These commenters contended that non- BHC Act.1744 entities to invest in and have other U.S. public retail funds should be So long as a bank holding company or relationships with entities that do not excluded from the definition of covered financial holding company complies relate to the statutory purpose of section fund because they are regulated in their with these limitations, it would not, 13. These exclusions, described in more home jurisdiction; commenters noted absent other facts and circumstances, detail below, take account of that similar funds registered in the control a registered investment information provided by many United States, such as mutual funds, are company and the registered investment commenters regarding entities that not covered funds.1749 company for purposes of section 13 (and would likely be included within the Some commenters were concerned any subsidiary thereof) would not itself proposed definition of a covered fund, that the proposed definition could be a banking entity subject to the but that are not traditionally thought of inadvertently capture exchange-traded restrictions of section 13 of the BHC Act as hedge funds or private equity funds trading in foreign and any final implementing rules funds.1747 Finally, the Agencies note jurisdictions,1750 separate accounts set (unless the registered investment that providing exclusions from the up to fund foreign pension plans,1751 company itself otherwise controls an covered fund definition, rather than non-U.S. issuers of asset-backed insured depository institution). Also providing permitted activity exemptions securities,1752 and non-U.S. regulated consistent with the Board’s precedent as proposed in some cases, aligns the funds specifically designed for regarding bank holding company final rule with the statute in applying institutional investors.1753 Commenters control of and relationships with funds, the restrictions imposed by section 13(f) also provided several potential effects of a seeding vehicle that will become a on transactions with covered funds only capturing foreign public funds under registered investment company or SEC- to transactions with issuers that are the covered fund definition: U.S. regulated business development defined as covered funds and thus raise banking entities would incur company would not itself be viewed as the concerns section 13 was designed to unnecessary and substantial costs to violating the requirements of section 13 address. rebrand and restructure their non-U.S. during the seeding period so long as the The Agencies recognize, however, regulated funds,1754 banking entities banking entity that establishes the that the final rule’s definition of covered could be eliminated from the potential seeding vehicle operates the vehicle fund does not include certain pooled pool of counterparties, thereby affecting pursuant to a written plan, developed in investment vehicles. For example, the pricing and efficiency,1755 U.S. banking accordance with the banking entity’s definition of covered fund excludes entities may exit the UCITS market and compliance program, that reflects the business development companies, lose competitiveness,1756 the growth of banking entity’s determination that the entities that rely on section 3(c)(5)(C), mutual fund formation in foreign vehicle will become a registered 3(c)(3), or 3(c)(11) of the Investment countries could be limited,1757 and investment company or SEC-regulated Company Act, and certain foreign market liquidity in foreign jurisdictions business development company within public funds that are subject to home- could be impaired.1758 the time period provided by section country regulation. The Agencies expect Some commenters supported 13(d)(4) and § 75.12 for seeding a that the types of pooled investment excluding any foreign public fund that 1745 covered fund. vehicles sponsored by the financial is organized or formed under non-U.S. services industry will continue to c. Entities Excluded From Definition of law, authorized for public sale in the evolve, including in response to the Covered Fund jurisdiction in which it is organized or final rule, and the Agencies will be formed, and regulated as a public As noted above, the final rule monitoring this evolution to determine investment company in that excludes a number of entities from the whether excluding these and other types definition of covered fund.1746 As of entities remains appropriate. The a foreign fund that, were it organized or offered discussed in more detail below, these Agencies will also monitor use of the under the laws of the United States or offered to exclusions more effectively tailor the exclusions for attempts to evade the U.S. residents, would meet the definition of a definition of covered fund to those types requirements of section 13 and intend to domestic covered fund (i.e., would need to rely of entities that section 13 was designed section 3(c)(1) or 3(c)(7) of the Investment Company use their authority where appropriate to Act). Many commenters argued that this definition to focus on. The exclusions thus are prevent evasions of the rule. is too broad and could include as covered funds designed to provide certainty, mitigate various types of foreign funds, like UCITS, that compliance costs and other burdens, 1. Foreign Public Funds commenters argued should not be included. See, and address the potential over-breadth As discussed above, under the e.g., JPMC; BlackRock. of the covered fund definition and proposal a covered fund was defined to 1749 See SIFMA et al. (Covered Funds) (Feb. 2012); Hong Kong Inv. Funds Ass’n.; UBS; ICI related requirements without such include the foreign equivalent of any Global; BlackRock; TCW; State Street (Feb. 2012); covered fund in order to address the SSgA (Feb. 2012); IAA; JPMC; Goldman (Covered 1744 See First Union Letter (June 24, 1999); see potential for circumvention. Many Funds); BoA; Credit Suisse (Williams); BNY also 12 CFR 225.86(b)(3) (authorizing a financial commenters argued that the proposed Mellon, et al.; Union Asset; EFAMA; BVI; IRSG, holding company to organize, sponsor, and manage SEB; IIB/EBF; GE (Feb. 2012) (commenting on the a mutual fund so long as (i) the fund does not definition could capture non-U.S. overbreadth of the definition because of the effect 1748 exercise managerial control over the entities in public retail funds, such as UCITS. on foreign issuers of asset-backed securities); Allen which the fund invests, and (ii) the financial & Overy (on behalf of Foreign Bank Group). holding company reduces its ownership in the 1747 See 156 Cong. Rec. H5226 (daily ed. June 30, 1750 See BlackRock; Vanguard. fund, if any, to less than 25 percent of the equity 2010) (statement of Reps. Himes and Frank) (noting 1751 See BlackRock. of the fund within one year of sponsoring the fund intent that subsidiaries or joint ventures not be 1752 See ASF (Feb. 2012). or such additional period as the Board permits). included within the definition of covered fund); 1753 See Union Asset; EFAMA; BVI. 1745 See final rule §§ 75.10(c)(12) and 75.20(e). 156 Cong. Rec. S5904–05 (daily ed. July 15, 2010) 1754 See Goldman (Covered Funds). Under the final rule, these seeding vehicles also (statement of Sens. Boxer and Dodd) (noting broad 1755 See AFMA. must comply with the limitations on leverage under definition of hedge fund and private equity fund 1756 the Investment Company Act that apply to and recommending that the Agencies take steps to See BoA. registered investment companies and SEC-regulated ensure definition is reasonably tailored); see also 1757 See BVI. business development companies. See final rule FSOC study at 61–63. 1758 See Goldman (Covered Funds). § 75.10(c)(12). 1748 As discussed above, the proposed rule See AFMA. 1746 See final rule § 75.10(c). generally included in the covered fund definition See BoA.

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jurisdiction.1759 In light of the general public who do not possess the A foreign fund that purports to proposal’s broad definition of covered level of sophistication and investment publicly offer its shares but in fact offers fund, some commenters recommended experience typically found among them on a more limited basis, however, explicitly excluding non-U.S. regulated institutional investors, professional may be less likely to resemble a funds based on characteristics to investors or high net worth investors registered investment company in these distinguish the foreign funds that who may be permitted to invest in and other respects. In order to limit the should be treated as covered funds.1760 complex investments or private foreign public fund exclusion to funds Several commenters recommended placements in various jurisdictions. that publicly offer their shares on a excluding non-U.S. funds based upon Retail investors would therefore be sufficiently broad basis, the final rule whether the funds are subject to a expected to be entitled to the full defines the term ‘‘public offering’’ for regulatory framework comparable to protection of securities laws in the purposes of this exclusion to mean a that which is imposed on SEC-registered home jurisdiction of the fund, and the ‘‘distribution’’ (as defined in § 75.4(a)(3) funds; 1761 one commenter specifically Agencies would expect a fund of subpart B) of securities in any identified European UCITS, Canadian authorized to sell ownership interests to jurisdiction outside the United States to mutual funds, Australian unit trusts, such retail investors to be of a type that investors, including retail investors, and Japanese investment trusts as is more similar to a U.S. registered provided that (i) the distribution examples of regulated funds to be investment company rather than to a complies with all applicable excluded.1762 U.S. covered fund. requirements in the jurisdiction in To address these concerns, the final In order to help maintain this which such distribution is being made; rule generally excludes from the distinction and to avoid circumstances (ii) the distribution does not restrict definition of covered fund any issuer that could result in an evasion of section availability to investors having a that is organized or established outside 13 and the final rule, the ownership minimum level of net worth or net of the United States and the ownership interests of the fund must be sold investment assets; and (iii) the issuer interests of which are authorized to be predominantly in one or more public has filed or submitted, with the offered and sold to retail investors in the offerings outside of the United States to appropriate regulatory authority in such issuer’s home jurisdiction and are sold qualify for the exclusion. Given this jurisdiction, offering disclosure predominantly through one or more restriction, a U.S. banking entity documents that are publicly 1765 public offerings outside of the United therefore could not rely on this available. States.1763 Foreign funds that meet these exclusion to set up a foreign public fund Under the final rule, therefore, a foreign fund’s distribution would not be requirements will not be covered funds, for the purpose of selling a significant a public offering for purposes of the except that an additional condition amount of ownership interests in the foreign public fund exclusion if the applies to U.S. banking entities 1764 with fund through one or more offerings distribution imposes investor respect to the foreign public funds they conducted on an unregistered basis restrictions based on a required sponsor. The foreign public fund (whether in a foreign jurisdiction or in minimum level of net worth or net exclusion is only available to a U.S. the United States). The Agencies investment assets. This would not be banking entity with respect to a foreign generally expect that an offering is made affected by any suitability requirements fund sponsored by the U.S. banking predominantly outside of the United that may be imposed under applicable entity if, in addition to the requirements States if 85 percent or more of the fund’s discussed above, the fund’s ownership local law. In addition, the final rule interests are sold to investors that are requires that, in connection with a interests are sold predominantly to not residents of the United States. public offering by a foreign public fund, persons other than the sponsoring The requirements that a foreign public the offering disclosure documents must banking entity, affiliates of the issuer fund both be authorized for sale to retail be ‘‘publicly available.’’ This and the sponsoring banking entity, and investors and sold predominantly in requirement will provide assurance employees and directors of such public offerings outside of the United regarding the transparency for such an entities. States are based in part on the Agencies’ offering and will generally be satisfied For purposes of this exclusion, the view that foreign funds that meet these where the documents are made Agencies note that the reference to retail requirements generally will be accessible to all persons in such investors, while not defined, should be sufficiently similar to U.S. registered jurisdiction. Disclosure documents may construed to refer to members of the investment companies such that it is be made publicly available in a variety appropriate to exclude these foreign of means, such as through a public filing 1759 See ICI Global; ICI (Feb. 2012); SSgA (Feb. funds from the covered fund definition. 2012); BNY Mellon et al. with a regulatory agency or through a 1760 See UBS; ICI Global; ICI (Feb. 2012); Allen & A foreign fund authorized for sale to Web site that provides broad Overy (on behalf of Foreign Bank Group); T. Rowe retail investors that is also publicly accessibility to persons in such Price; HSBC Life; Union Asset; EFAMA; BVI; EBF; offered may, for example, provide jurisdiction. Hong Kong Inv. Funds Ass’n.; IMA; Ass’n. of greater information than funds that are In addition and as discussed above, Institutional Investors (Feb. 2012); Katten (on behalf of Int’l Clients); Credit Suisse (Williams). sold through private offerings like funds the final rule also places an additional 1761 See T. Rowe Price; Credit Suisse (Williams); that rely on section 3(c)(1) or 3(c)(7). condition on a U.S. banking entity’s SSgA (Feb. 2012); BNY Mellon et al. Such foreign funds also may be subject ability to rely on the foreign public fund 1762 See T. Rowe Price. to various restrictions, as deemed exclusion with respect to the foreign 1763 See final rule § 75.10(c)(1). appropriate by foreign regulators in light public funds it sponsors. For a U.S. 1764 Although the discussion of this condition of local conditions and practices, that banking entity to rely on the foreign generally refers to U.S. banking entities for ease of reading, the condition also applies to foreign exceed those applicable to privately public fund exclusion with respect to a affiliates of a U.S. banking entity. See final rule offered funds. Foreign regulators may foreign public fund it sponsors, the § 75.10(c)(1)(ii) (applying this limitation ‘‘[w]ith apply these or other enhanced ownership interests in the fund must be respect to a banking entity that is, or is controlled restrictions or other requirements to sold predominantly to persons other directly or indirectly by a banking entity that is, located in or organized under the laws of the United funds that are offered on a broad basis than the sponsoring U.S. banking entity States or of any State and any issuer for which such to the general public for the protection banking entity acts as sponsor’’). of investors in those jurisdictions. 1765 See final rule § 75.10(c)(1)(iii).

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and certain persons connected to that The Agencies note that the foreign banking entities. The Agencies believe banking entity. Consistent with the public fund exclusion is not intended to that this exclusion represents an Agencies’ view concerning whether a permit a banking entity to sponsor a appropriate balancing of considerations foreign public fund has been sold foreign fund for the purpose of selling that should not significantly increase predominantly outside of the United ownership interests to any banking the risks to the U.S. financial system States, the Agencies generally expect entity (affiliated or unaffiliated) that is, that section 13 was designed to limit. that a foreign public fund will satisfy or is controlled directly or indirectly by this additional condition if 85 percent a banking entity that is, located in or 2. Wholly-Owned Subsidiaries or more of the fund’s interests are sold organized under the laws of the United Under the proposed rule, a banking to persons other than the sponsoring States or of any State (or to a limited entity would have been permitted to U.S. banking entity and certain persons group of such banking entities). The invest in or sponsor a wholly-owned connected to that banking entity. Agencies intend to monitor banking subsidiary that relies on the exclusion This additional condition reflects the entities’ investments in foreign public contained in section 3(c)(1) or 3(c)(7) of Agencies’ view that the foreign public funds to ensure that banking entities do the Investment Company Act to avoid fund exclusion is designed to treat not use the exclusion for foreign public being an investment company under foreign public funds consistently with funds in a manner that functions as an that Act if the subsidiary was carried on similar U.S. funds and to limit the evasion of section 13 in this or any other the balance sheet of its parent and was extraterritorial application of section 13 way. The Agencies expect that one area engaged principally in performing bona of the BHC Act, including by permitting of focus for such monitoring would be fide liquidity management activities.1767 U.S. banking entities and their foreign significant investments in a foreign Commenters argued that, instead of affiliates to carry on traditional asset public fund, including a fund that is providing a permitted activity management businesses outside of the unaffiliated with any banking entity exemption for banking entities to invest United States. The exclusion is not located in or organized under the laws in or sponsor certain wholly-owned intended to permit a U.S. banking entity of the United States or of any State, subsidiaries as proposed, all wholly- to establish a foreign fund for the where such investments represent a owned subsidiaries should be excluded purpose of investing in the fund as a substantial percentage of the ownership from the definition of covered fund means of avoiding the restrictions interests in such fund. under the final rule because wholly- imposed by section 13. Permitting a U.S. In order to conduct this monitoring owned subsidiaries are typically used banking entity to invest in a foreign more effectively, the Agencies also are for organizational convenience and public fund under this exclusion only adopting certain documentation generally do not have the when that fund is sold predominantly to requirements concerning U.S. banking characteristics, risks, or purpose of a persons other than the sponsoring U.S. entities’ investments in foreign public hedge fund or private equity fund, banking entity and certain persons funds, as discussed in more detail below which involves unaffiliated investors connected to that banking entity permits in Part VI.C.1 of this SUPPLEMENTARY owning interests in the structure for the U.S. banking entities to continue their INFORMATION. Under the final rule, a U.S. purpose of sharing in the profits and asset management businesses outside of banking entity with more than $10 losses from investment activities.1768 the United States while also limiting the billion in total consolidated assets will Commenters explained that publicly opportunity for evasion of section 13 as be required to document its investments traded companies often establish discussed below. in foreign public funds, broken out by wholly-owned intermediate companies This additional condition only each foreign public fund and each for the purpose of holding securities of applies to U.S. banking entities with foreign jurisdiction in which any foreign operating entities or other corporate respect to the foreign public funds they public fund is organized, if the U.S. vehicles necessary to the business of the sponsor because the Agencies believe banking entity and its affiliates’ entity. Because these intermediate that a foreign public fund sponsored by ownership interests in foreign public companies invest entirely (or a U.S. banking entity may present funds exceed $50 million at the end of substantially) in the securities of other heightened risks of evasion. Absent the two or more consecutive calendar entities, these intermediate companies additional condition, a U.S. banking quarters. This requirement thus is may be investment companies for entity could establish a foreign public tailored to apply only to U.S. banking purposes of the Investment Company fund for the purpose of itself investing entities above a certain size that also Act but for the exclusion provided by substantially in that fund and, through have substantial investments in foreign section 3(c)(1) or 3(c)(7) of the 1766 the fund, making investments that the public funds. The Agencies believe Investment Company Act.1769 banking entity could not make directly this approach appropriately balances Commenters contended that requiring under section 13. The Agencies believe the Agencies’ evasion concerns and the banking entities to divest their interests it is less likely that a U.S. banking entity burdens that documentation in wholly-owned subsidiaries and cease effectively could evade section 13 by requirements impose. certain intercompany transactions investing in third-party foreign public For all of the reasons discussed above, would have a material adverse effect on funds that the banking entity does not the Agencies believe that the final rule’s the safety, soundness, efficiency and sponsor. In those cases it is less likely approach to foreign public funds is stability of the U.S. and global financial that the U.S. banking entity would be consistent with the final rule’s systems, which could in turn have a able to control the investments of the exclusion of registered or otherwise material adverse effect on the wider fund, and the fund thus likely would be exempt (without reliance on the a less effective means for the banking exemptions in section 3(c)(1) or 3(c)(7)) 1767 See proposed rule § 75.14(a)(2)(iv); Joint entity to engage in proprietary trading funds in the United States. It also limits Proposal, 76 FR at 68913. through the fund. The Agencies the extraterritorial application of section 1768 See, e.g., SIFMA et al. (Covered Funds) (Feb. therefore have declined to apply this 13 of the BHC Act and reduces the 2012), JPMC; Goldman (Covered Funds), NAIB et additional condition with respect to any potential economic and other burdens al.; GE (Feb. 2012); BoA; Chamber (Feb. 2012); Wells Fargo (Covered Funds); ABA (Keating); Ass’n. foreign public fund in which a U.S. commenters argued would result for of Institutional Investors (Feb. 2012); Credit Suisse banking entity invests but does not act (Williams); Rep. Himes; BOK. as sponsor. 1766 See final rule § 75.20(e). 1769 See 15 U.S.C. 80a-3(a)(1)(A) & (C).

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economy in terms of reduced credit, subsidiary, as defined in the final rule, ownership of a vehicle and increased unemployment and reduced is an entity, all of the outstanding accommodating the foreign law output.1770 Commenters also argued that ownership interests of which are owned requirements discussed above is an exclusion for wholly-owned directly or indirectly by the banking consistent with a vehicle’s treatment as subsidiaries is necessary in order to entity (or an affiliate thereof), except a wholly-owned subsidiary. Under the avoid a conflict with other important that (i) up to five percent of the entity’s final rule, the banking entity (or an requirements in the Dodd-Frank Act. ownership interests may be owned by affiliate thereof) will control the vehicle For example, commenters alleged that directors, employees, and certain former because it must, as principal, own at including wholly-owned subsidiaries directors and employees of the banking least 95% of the vehicle.1778 These within the definition of covered fund for entity (or an affiliate thereof); and (ii) conditions are designed to exclude from purposes of section 13 would create a within the five percent ownership the covered fund definition vehicles conflict with the requirement that a interests described in clause (i), up to that are formed for corporate and banking entity that is a bank holding 0.5 percent of the entity’s outstanding organizational convenience, as company serve as a source of strength to ownership interests may be held by a discussed above, and that thus do not its subsidiaries because the prohibition third party if the ownership interest is engage in the investment activities in section 13(f) on transactions between held by the third party for the purpose prohibited by section 13. The exclusion a banking entity and covered funds of establishing corporate separateness or also should reduce the disruption to the owned or sponsored by the banking addressing bankruptcy, insolvency, or operations of banking entities that entity would effectively prohibit the similar concerns.1777 commenters asserted would result from banking entity from providing financial Although the final rule includes the proposed rule.1779 resources to wholly-owned intermediate ownership interests held by certain Importantly, the Agencies note that a holding companies and their former directors and employees for wholly-owned subsidiary of a banking subsidiaries.1771 Other commenters purposes of qualifying for the exclusion, entity—although excluded from the argued that banking entities would bear the exclusion requires that an interest definition of covered fund—still would extensive compliance costs and held by a former (or current) director or itself be a banking entity, and therefore operational burdens and likely would be employee must actually be held by that remain subject to the prohibitions and restricted from structuring themselves person (or by the banking entity) and other provisions of section 13 of the effectively.1772 must have been acquired while BHC Act and the final rule.1780 Commenters proposed several employed by or in the service of the Accordingly, a wholly-owned alternatives to address these concerns. banking entity. For example, if a former subsidiary of a banking entity would For instance, commenters recommended employee subsequently transfers his/her remain subject to the restrictions of that the final rule exclude all wholly- interest to a third party (other than to section 13 and the final rule (including owned subsidiaries from the definition immediate family members of the the ban on proprietary trading) and may of covered fund.1773 Commenters also employee or through intestacy of the not engage in activity in violation of the urged that the final rule include employee), then the ownership interest prohibitions of section 13 and the final ownership interests held by employees would no longer be held by the banking rule. of a banking entity with any ownership entity or persons whose ownership 3. Joint Ventures interests held directly by the banking interests may be aggregated with entity for purposes of qualifying for any interests held by the banking entity for The proposed rule would have exclusion granted by the rule for purposes of the exclusion for wholly- permitted a banking entity to invest in wholly-owned subsidiaries.1774 Another owned subsidiaries under the final rule. or manage a joint venture between the commenter recommended the exclusion The final rule also permits up to 0.5 banking entity and any other person, of subsidiaries, wholly owned or not, percent of the ownership interest of a wholly-owned subsidiary to be held by 1778 Cf. Section 2(a)(43) of the Investment that engage in bona fide liquidity Company Act (defining a ‘‘wholly-owned management.1775 a third party if the interest is held by the subsidiary’’ of a person to mean ‘‘a company 95 per In light of these comments and third party for the purpose of centum or more of the outstanding voting securities consistent with the purposes of section establishing corporate separateness or of which are owned by such person, or by a addressing bankruptcy, insolvency, or company which, within the meaning of this 13 and the terms of the Dodd-Frank Act paragraph, is a wholly-owned subsidiary of such as discussed in more detail above, the similar concerns, and the ownership person’’). Agencies have revised the final rule to interest is included when calculating 1779 The Agencies also note that depositors for exclude wholly-owned subsidiaries the five percent cap on employee and asset-backed securities offerings are important to director ownership. The Agencies the process of securitization. See, e.g., ASF (July from the definition of covered fund, 2012) (noting that a depositor, as used in a including those not engaged in liquidity understand that it is often important, or securitization structure, is an entity that generally management.1776 A wholly-owned in certain circumstances required, under acts only as a conduit to transfer the loans from the the laws of various jurisdictions for a originating bank to the issuing entity for the 1770 See, e.g., SIFMA et al. (Covered Funds) (Feb. parent company to establish corporate purpose of facilitating a securitization transaction 2012). and engages in no discretionary investment or separation of a subsidiary through the securities issuance activities). See also, Rule 191 1771 See SIFMA et al. (Covered Funds) (Feb. issuance of a small amount of under the Securities Act of 1933 (17 CFR 230.191) 2012); BoA; Rep. Himes. (depositor as issuer for registered asset-backed 1772 See, e.g., Goldman (Covered Funds); BoA. ownership interest to a third party. The Agencies believe that permitting securities offerings). Commenters raised a question 1773 See Rep. Himes; Fin. Services Roundtable about the treatment of depositors under the (June 14, 2011); SIFMA et al. (Covered Funds) (Feb. limited employee and director Investment Company Act, and therefore, whether 2012); BOK; Chamber (Feb. 2012); ABA (Keating); they would technically fall within the definition of GE (Feb. 2012); Wells Fargo (Covered Funds); subsidiaries to engage in bona fide liquidity covered fund. See ASF (July 2012); GE (Aug. 2012). Goldman (Covered Funds); Ass’n. of Institutional management. As discussed below, however, a For purposes of the covered fund prohibitions, the Investors (Feb. 2012); BoA; NAIB et al. wholly-owned subsidiary is itself a banking entity, Agencies note that depositors may fall within the 1774 See Wells Fargo (Covered Funds); Credit and thus is subject to all of the requirements that wholly-owned subsidiary exclusion from the Suisse (Williams). apply to banking entities, including the covered fund definition. 1775 See Credit Suisse (Williams). requirements applicable to a banking entity’s 1780 See 12 U.S.C. 1851(h)(1) (defining banking 1776 Although not a condition of the exclusion, liquidity management activities under § 75.3(d)(3). entity to include any affiliate or subsidiary of a banking entities may use wholly-owned 1777 See final rule § 75.10(c)(2). banking entity).

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provided that the joint venture was an a portfolio company investment with from the definition of covered fund with operating company and did not engage third parties.1786 A number of some modifications from the proposal to in any activity or any investment not commenters argued that treating joint more clearly identify entities that are permitted under the proposed rule. As ventures as covered funds would create excluded. Under the final rule, a joint noted in the proposal, many joint the same inconsistencies with other venture is excluded from the definition ventures rely on the exclusion provisions and principles embodied in of covered fund if the joint venture is contained in section 3(c)(1) or 3(c)(7) of the Dodd-Frank Act noted for wholly- between the banking entity or any of its the Investment Company Act.1781 Joint owned subsidiaries, were they to be affiliates and no more than 10 ventures are a common form of treated as covered funds.1787 Several unaffiliated co-venturers, is in the business, especially for firms seeking to commenters argued that the proposed business of engaging in activities that enter new lines of business or new exemption, as drafted, was unworkable are permissible for the banking entity markets, or seeking to share because it did not appear to provide an other than investing in securities for complementary business expertise. exception to the intercompany resale or other disposition, and is not, Commenters supported this aspect of limitations on transactions under and does not hold itself out as being, an the proposal and argued that joint section 13(f), which prohibits entity or arrangement that raises money ventures do not share the same transactions between a banking entity from investors primarily for the purpose characteristics as a hedge fund or and a related covered fund.1788 of investing in securities for resale or private equity fund. However, they Commenters proposed several other disposition or otherwise trading in expressed concern that joint ventures alternatives to address these issues. securities.1794 Banking entities, were defined too narrowly under the Several commenters recommended that therefore, will continue to be able to proposal because the exclusion was the final rule eliminate the operating share the risk and cost of financing their limited to joint ventures that were company condition under the proposed banking activities through these types of operating companies.1782 Some exemption.1789 Other commenters entities which, as noted by commenters commenters criticized the lack of recommended excluding joint ventures as discussed above, may allow banking guidance regarding the meaning of that have an unspecified but limited entities to more efficiently manage the operating company.1783 One commenter number of partners (such as five or risk of their operations. proposed defining operating company fewer joint venture partners).1790 One The Agencies have specified a limit as any company engaged in activities commenter recommended excluding all on the number of joint venture partners that are permissible for a financial ‘‘controlled joint ventures’’ but did not at the request of many commenters that holding company under sections 3 or 4 provide an explanation of how to define suggested such a limit be added (though of the BHC Act, other than a company that term.1791 Another commenter typically without suggesting the specific engaged exclusively in investing in suggested defining a joint venture in one number of partners). The Agencies securities of other companies for resale of the following ways: (1) Any company believe that a limit of 10 partners allows or other disposition.1784 with a limited number of co-venturers flexibility in structuring larger business Another commenter argued that joint that is managed pursuant to a ventures without involving such a large ventures are often used to share risk shareholders’ agreement, as opposed to number of partners as to suggest the from non-performing loans, credit card managed by a general partner; 1792 or (2) venture is in reality a hedge fund or receivables, consumer loans, a joint venture in which: (a) There are private equity fund established for commercial real estate loans or a limited number of unaffiliated investment purposes. The Agencies will 1785 monitor joint ventures—and other automobile loans. According to this partners; (b) the parties operate the excluded entities—to ensure that they commenter, these joint ventures, while venture on a joint basis or in proportion are not used by banking entities to not generally viewed as operating to their relative ownership, including companies, promote safety and evade the provisions of section 13. pursuant to a shareholders’ agreement; The final rule’s requirement that a soundness by allowing a banking entity (c) material decisions are made by one to limit the size of its exposure to joint venture not be an entity or party (for example, a general partner); arrangement that raises money from permissible investments or to more and (d) the joint venture does not efficiently transfer the risk of existing investors primarily for the purpose of engage in any activity or investment not investing in securities for resale or other assets to a small number of partners. permitted under section 13, other than Commenters stated that banking entities disposition or otherwise trading in activities or investments incidental to securities prevents a banking entity often employ similar types of non- its permissible business.1793 operating company joint ventures to from relying on this exclusion to evade In response to commenter concerns, section 13 of the BHC Act by owning or engage in merchant banking activities or the final rule excludes joint ventures other permissible banking activities, and sponsoring what is or will become a covered fund. Consistent with this that the final rule should not prevent a 1786 See ABA (Keating); SIFMA et al. (Covered banking entity from sharing the risk of Funds) (Feb. 2012). restriction and to prevent evasion of 1787 See SIFMA et al. (Covered Funds) (Feb. section 13, a banking entity may not use 1781 See Joint Proposal, 76 FR at 68913. 2012); Goldman (Covered Funds); ABA (Keating); a joint venture to engage in merchant 1782 See,, e.g., ABA (Keating); Chamber (Feb. Chamber (Feb. 2012). banking activities because that involves 2012); SIFMA et al. (Covered Funds) (Feb. 2012); 1788 See, e.g., SIFMA et al. (Covered Funds) (Feb. acquiring or retaining shares, assets, or 2012); Goldman (Covered Funds); ABA (Keating); GE (Aug. 2012); Goldman (Covered Funds); NAIB ownership interests for the purpose of et al.; Rep Himes; Sen. Bennet; see also 156 Cong GE (Feb. 2012); Chamber (Feb. 2012). Rec. H5226 (daily ed. June 30, 2010) (statement of 1789 See SIFMA et al. (Covered Funds) (Feb. ultimate resale or disposition of the Rep. Himes). 2012); ABA (Keating); Credit Suisse (Williams). investment.1795 1783 See, e.g., ABA (Keating); NAIB et al.; GE 1790 See SIFMA et al. (Covered Funds) (Feb. As with wholly-owned subsidiaries, if (Aug. 2012); Chamber (Feb. 2012); SIFMA et al. 2012); Credit Suisse (Williams); GE (Feb. 2012). a banking entity owns 25 percent or (Covered Funds) (Feb. 2012); Wells Fargo (Covered 1791 See Goldman (Covered Funds). more of the voting securities of the joint Funds); Credit Suisse (Williams); Goldman 1792 See ABA (Keating); Credit Suisse (Williams); (Covered Funds). SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA venture or otherwise controls an entity 1784 See SIFMA et al. (Covered Funds) (Feb. et al. (Mar. 2012); see also GE (Feb. 2012); NAIB 2012). et al. 1794 See final rule § 75.10(c)(3). 1785 See Goldman (Covered Funds). 1793 See Goldman (Covered Funds). 1795 See 12 U.S.C. 1843(k)(4)(H).

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that qualifies for the joint venture provisions of section 13 would apply to pension plans as well as plan exclusion, the joint venture would then these vehicles.1799 participants.1802 itself be a banking entity and would In light of the comments, the final Commenters generally argued that remain subject to the restrictions of rule has been modified to exclude foreign pension or retirement funds are section 13 and the final rule (including acquisition vehicles from the definition established by a foreign company or the ban on proprietary trading). of covered fund, rather than provide a foreign sovereign for the purpose of The Agencies note that the statute permitted activity exemption for providing a specific group of foreign banking entities to invest in or sponsor defines banking entity to include not persons with income during retirement the vehicles, so long as the vehicle is only insured depository institutions and or when they reach a certain age or meet formed solely for the purpose of bank holding companies, but also their certain predetermined criteria and are engaging in a bona fide merger or affiliates. In the context of a company typically eligible for preferential tax acquisition transaction and the vehicle that owns an insured depository treatment, and are not formed for the exists only for such period as necessary institution but is not a bank holding same purposes as hedge funds or private to effectuate the transaction.1800 The 1803 company or savings and loan holding equity funds. Commenters argued final rule thus reflects modifications company, the insured depository that the definition of covered fund from the exemption for acquisition institution’s affiliates may engage in should not include certain foreign vehicles in the proposal, which was commercial activities impermissible for pension or retirement funds, including available for acquisition vehicles where managed investment arrangements and banks and bank holding companies. the sole purpose and effect of the entity However, section 13 of the BHC Act and wrap platforms, such as so-called was to effectuate a transaction involving ‘‘superannuation funds,’’ that are the final rule do not authorize a banking the acquisition or merger of one entity entity to engage in otherwise managed by foreign banks as part of with or into the banking entity.1801 The providing retirement or pension impermissible activities. Because of Agencies modified the conditions in the this, the scope of activities in which a schemes to foreign citizens pursuant to final rule, as discussed above, to more foreign law and are generally not joint venture may engage under the final clearly reflect the limited activities in rule will depend on the status and available for sale to U.S. citizens. which an excluded acquisition vehicle Commenters asserted that many foreign identity of its co-venturers. For instance, may engage and to exclude acquisition a joint venture between a bank holding banking entities act as sponsor to and vehicles from the definition of covered organize and offer foreign pension funds company and unaffiliated companies fund, rather than only permit banking may not engage in commercial activities abroad as part of a foreign sovereign entities to invest in or sponsor them program to provide retirement, pension, impermissible for a bank holding pursuant to an exemption. company. or similar benefits to its citizens or The Agencies also note that an workforce.1804 These commenters 4. Acquisition Vehicles acquisition vehicle that survives a contended that a foreign pension plan transaction would likely be excluded might itself rely on the exclusion in Similar to wholly-owned subsidiaries from the definition of covered fund section 3(c)(1) or 3(c)(7) in order to and joint ventures, the proposed rule under the separate exclusion for either avoid being an investment company if it would have permitted a banking entity joint ventures or wholly-owned is offered to citizens of the foreign to invest in or sponsor an acquisition subsidiaries described above. An sovereign present in the United vehicle provided that the sole purpose acquisition vehicle that is controlled by States.1805 and effect of the acquisition vehicle was a banking entity would be a banking Several commenters argued that to effectuate a transaction involving the entity itself and would be subject to the foreign pension and retirement plans acquisition or merger of an entity with restrictions of section 13 and the final should be excluded from the definition or into the banking entity or one of its rule that apply to a banking entity. of covered fund on the same basis as affiliates. As noted in the proposal, 5. Foreign Pension or Retirement Funds U.S. pension and retirement funds that banking entities often form corporate are ERISA-qualified funds that rely on vehicles for the purpose of Under the proposed rule, a foreign pension plan that relied on section the exclusion from the definition of accomplishing a corporate merger or investment company provided under asset acquisition.1796 Because of the way 3(c)(1) or 3(c)(7) of the Investment Company Act to avoid being an section 3(c)(11) of the Investment they are structured, acquisition vehicles 1806 investment company (or that was a Company Act. Commenters alleged may rely on section 3(c)(1) or 3(c)(7) of that without an exclusion for foreign the Investment Company Act.1797 commodity pool), would have been a covered fund. Commenters argued that 1802 Commenters supported the exclusion including pension funds within the As explained above, commenters also argued of acquisition vehicles from the that a foreign pension plan should not be definition of covered fund would considered a banking entity if the plan is sponsored restrictions governing covered funds, produce many unexpected results for by a banking entity or is established for the benefit and argued that acquisition vehicles do of employees of the banking entity. If deemed a not share the same characteristics as a 1799 See, e.g., SIFMA et al. (Covered Funds) (Feb. banking entity, the pension plan could become hedge fund or private equity fund.1798 2012); JPMC; GE (Feb. 2012). subject to the limits on section 13 on investing in covered funds. See Allen & Overy (on behalf of However, similar to concerns articulated 1800 See final rule § 75.10(c)(4). 1801 Canadian Banks); Arnold & Porter; Credit Suisse above with respect to wholly-owned The proposed rule contained an exemption (Williams). The final rule addresses these subsidiaries and joint ventures, for investments in acquisition vehicles, provided comments with the exclusions described above. that the ‘‘the sole purpose and effect of such entity 1803 commenters argued that the proposed is to effectuate a transaction involving the See, e.g., Allen & Overy (on behalf of rule, as drafted, left uncertain how other acquisition or merger of one entity with or into the Canadian Banks). covered banking entity or one of its affiliates.’’ See 1804 See Allen & Overy (on behalf of Canadian proposed rule § 75.14(a)(2)(ii). The final rule Banks); Arnold & Porter; UBS; Hong Kong Inv. 1796 Cf. Joint Proposal, 76 FR at 68897. excludes an acquisition vehicle, which is defined Funds Ass’n. 1797 See Joint Proposal, 76 FR at 68913; SIFMA et as an issuer that is ‘‘[f]ormed solely for the purpose 1805 See Allen & Overy (on behalf of Canadian al. (Covered Funds) (Feb. 2012). of engaging in a bona fide merger or acquisition Banks); Arnold & Porter; UBS; Hong Kong Inv. 1798 See, e.g., JPMC; SIFMA et al. (Covered Funds) transaction’’ and that ‘‘exists only for such period Funds Ass’n.; Credit Suisse (Williams). (Feb. 2012); GE (Feb. 2012); Sen. Bennet; Sen. as necessary to effectuate the transaction.’’ See final 1806 See Arnold & Porter; UBS; Hong Kong Inv. Carper et al. rule § 75.10(c)(4). Funds Ass’n.; Credit Suisse (Williams).

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pension or retirement funds, section 13 securities offering solely to qualified customer-driven insurance or retirement of the BHC Act would have an extra- purchasers or on a limited basis to planning activity and pose a burden on territorial effect on pension or accredited investors. While the insurance companies and holders of retirement benefits abroad that would be proposed rule did not generally exclude insurance policies funded by separate severe and beyond what was insurance company separate accounts accounts, a result commenters alleged contemplated by section 13 of the BHC from the definition of covered fund, the Congress did not intend.1812 Act. proposed rule did provide a limited In response to commenter concerns In light of comments received on the exemption for investing in or acting as and in order to more appropriately proposal, the final rule excludes from sponsor to separate accounts that were accommodate the business of insurance the definition of covered fund a plan, used for the purpose of allowing a in a regulated insurance company, the fund, or program providing pension, banking entity to purchase bank owned final rule excludes an insurance retirement, or similar benefits that is: (i) life insurance (‘‘BOLI’’), subject to company separate account from the Organized and administered outside of certain restrictions.1809 definition of covered fund under certain the United States; (ii) a broad-based Various state or foreign laws allow circumstances. To prevent this plan for employees or citizens that is regulated insurance companies to create exclusion from being used to evade the subject to regulation as a pension, separate accounts that are generally not restrictions on investments and retirement, or similar plan under the separate legal entities but represent a sponsorship of covered funds by a laws of the jurisdiction in which the segregated pool of assets on the balance banking entity, the final rule provides plan, fund, or program is organized and sheet of the insurance company that that no banking entity other than the administered; and (iii) established for support a specific policy claim on the insurance company that establishes the the benefit of citizens or residents of one insurance company. These accounts separate account may participate in the or more foreign sovereign or any have assets and obligations that are account’s profits and losses.1813 In this political subdivision thereof.1807 This is separate from the general account of the manner, the final rule appropriately similar to the treatment provided to U.S. insurance company. Insurance accommodates the business of insurance pension funds by virtue of the exclusion companies often utilize these separate by permitting an insurance company from the definition of investment accounts to allow policyholders of that is a banking entity to continue to company under the Investment variable annuity and variable life provide its customers with a variety of Company Act for certain broad-based insurance to allocate premium amounts insurance products through separate employee benefit plans provided by for the purpose of engaging in various account structures in accordance with section 3(c)(11) of that Act. The investment strategies that are tailored to applicable insurance laws while exclusion from the covered fund the requirements of the individual protecting against the use of separate definition for foreign plans would be policyholder. The policyholder, and not accounts as a means by which banking available for bona fide plans established the insurance company, primarily entities might take a proprietary or for the benefit of employees or citizens benefits from the results of investments beneficial interest in an account that outside the U.S. even if some of the in the separate account. These separate engages in prohibited proprietary beneficiaries of the fund reside in the accounts are generally investment trading and thereby evade the U.S. or subsequently become U.S. companies for purposes of the requirements of section 13 of the BHC residents. Investment Company Act, unless an Act. The exclusion of insurance The Agencies believe this exclusion is exclusion from that definition is company separate accounts from the 1810 appropriate in order to facilitate parallel applicable, and, as noted above, may definition of covered fund therefore is treatment of domestic and foreign rely on the exclusion contained in designed to reduce the potential burden pension and retirement funds to the section 3(c)(1) or 3(c)(7) of the of the final rule on insurance companies extent possible and to assist in ensuring Investment Company Act. and holders of insurance policies While most commenters supported that section 13 of the BHC Act does not funded by separate accounts while also the proposal’s recognition that interests apply to foreign pension, retirement, or continuing to prohibit banking entities 1808 in BOLI separate accounts should be similar benefits programs. from taking ownership interests in, and permitted, commenters generally argued sponsoring or having certain 6. Insurance Company Separate that the final rule should also provide relationships with, entities that engage Accounts a broader exclusion from the definition in investment and trading activities of covered fund for all insurance Under the proposed rule, insurance prohibited by section 13. company separate accounts would have company separate accounts. been covered funds to the extent that Commenters argued that covering 7. Bank Owned Life Insurance Separate the separate accounts relied on section separate accounts could lead to Accounts 3(c)(1) or 3(c)(7). Such reliance would unintended consequences and was As explained above, bank owned life generally occur in circumstances where inconsistent with the statutory insurance (‘‘BOLI’’) is generally offered policies funded by the separate account recognition that the business of through a separate account held by an are distributed in an unregistered insurance should continue to be insurance company. In recognition of 1811 accommodated. These commenters the fact that banking entities have for 1807 See final rule § 75.10(c)(5). argued that covering separate accounts many years invested in life insurance 1808 Additionally and as discussed above, the within the definition of covered fund policies that covered key employees, in prohibitions of section 13 and the final rule do not would disrupt a substantial portion of apply to an ownership interest that is acquired or accordance with supervisory policies retained by a banking entity through a deferred established by the Federal banking compensation, stock-bonus, profit-sharing, or 1809 See proposed rule § 75.14(a)(1). agencies, the proposal contained a 1810 pension plan of the banking entity that is See In re The Prudential Ins. Co. of Am., 41 provision that would permit banking established and administered in accordance with S.E.C. 335, 345 (1963), aff’d, The Prudential Ins. Co. the law of the United States or a foreign sovereign, of Am. v. SEC, 326 F.2d 383 (3d Cir.), cert. denied, if the ownership interest is held or controlled 377 U.S. 953 (1964). 1812 See ACLI (Jan. 2012); Nationwide; Sutherland directly or indirectly by a banking entity as trustee 1811 See ACLI (Jan. 2012); Nationwide; Sutherland (on behalf of Comm. of Annuity Insurers); see also for the benefit of persons who are or were (on behalf of Comm. of Annuity Insurers); see also STANY. employees of the banking entity. STANY. 1813 See final rule § 75.10(c)(6).

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entities to invest in and sponsor BOLI to investments in these accounts would Examples of traditional credit separate accounts.1814 eliminate an investment that helps extensions that commenters requested Many commenters supported the banking entities to efficiently reduce be specifically included within the exemption in the proposal for BOLI their costs of providing employee definition of ‘‘loan’’ included loan separate accounts, arguing that benefits, and therefore potentially participations,1825 variable funding permitting this kind of activity was introduce a burden to banking entities notes or certificates,1826 note purchase appropriate and consistent with safety that would not further the statutory facilities,1827 certain forms of revolving and soundness as well as financial purpose of section 13. The Agencies credit lines,1828 corporate bonds,1829 stability.1815 Conversely, one expect this exclusion to be used by municipal securities,1830 securities commenter objected to the proposed banking entities in a manner consistent lending agreements and reverse rule’s exemption for investments in with safety and soundness. repurchase agreements,1831 auto lease BOLI separate accounts, contending that securitizations,1832 and any other type 8. Exclusion for Loan Securitizations such an exemption did not promote and of credit extension that banking entities and Definition of Loan protect the safety and soundness of traditionally have been permitted to banking entities or the financial stability a. Definition of Loan issue under their lending authority.1833 of the United States.1816 The proposal defined the term ‘‘loan’’ The definition of ‘‘loan’’ in the final After considering comments received for purposes of the restrictions on rule applies both in the context of the on the proposal, the final rule excludes proprietary trading and the covered BOLI separate accounts from the funds provisions and, as discussed in definition of loan. See Alfred Brock. For example, one commenter requested that definition of ‘‘loan’’ definition of covered fund but maintains more detail below, provided an the substance of the conditions from the be revised to include ‘‘(i) any loan, lease (including exemption for loan securitizations in any lease residual), extension [of] credit, or secured proposal designed to ensure that BOLI two separate sections of the proposed or unsecured receivables, (ii) any note, bond or investments are not conducted in a security collateralized and payable from pools of rule. As proposed, loan was defined as loans, leases (including Lease residuals), extensions manner that raises the concerns that ‘‘any loan, lease, extension of credit, or section 13 of the BHC Act was designed of credit or secured or unsecured receivables, and secured or unsecured receivable.’’ 1820 (iii) any contractual rights arising from, or security to address. In particular, in order for a The definition of loan in the proposed interests or liens, assets, property guarantees, separate account to qualify for the BOLI insurance policies, letters of credit, or supporting rule was expansive, and included a exclusion from the definition of covered obligations underlying or relating to any of the broad array of loans and similar credit foregoing.’’ See RBC. Another commenter requested fund, the final rule requires that the transactions, but did not include any that the definition of ‘‘loan’’ be revised to include separate account be used solely for the asset-backed security issued in ‘‘any type of credit extension (including bonds, purpose of allowing one or more other [banking entity-eligible] debt securities, asset- connection with a loan securitization or banking entities (which by definition backed securities [as defined in their letter], otherwise backed by loans. variable funding notes and securities lending includes their affiliates) to purchase a Some commenters requested that the agreements, repurchase agreements, reverse life insurance policy for which such Agencies narrow the proposed repurchase agreements and other similar extensions banking entity(ies) is a beneficiary.1817 of credit) that a banking entity could hold or deal definition of ‘‘loan.’’ 1821 One of these Additionally, if the banking entity is in.’’ See SIFMA (Securitization) (Feb. 2012). commenters was concerned that the 1825 See JPMC. relying on this exclusion, the banking proposed definition could apply to any 1826 See ASF (Feb. 2012); Credit Suisse entity that purchases the insurance banking activity and argued that the (Williams); JPMC (arguing that such notes operate policy (i) must not control the in economic substance as loans); SIFMA definition of loan for purposes of the investment decisions regarding the (Securitization) (Feb. 2012). final rule should not include 1827 underlying assets or holdings of the See ASF (Feb. 2012). This commenter securities.1822 Another commenter, asserted that a note purchase facility is negotiated separate account,1818 and (ii) must citing a statement made by Senator by the asset-backed commercial paper conduit and participate in the profits and losses of allows the asset-backed commercial paper conduit Merkley, asserted that Congress did not the separate account in compliance with to purchase asset-backed securities issued by an intend the rule of construction for the intermediate special purpose vehicle and backed by applicable supervisory guidance loans or asset-backed securities backed by loans. Id. 1819 sale and securitization of loans in regarding BOLI. 1828 section 13(g)(2) to include ‘‘loans that See ASF (Feb. 2012). When made in the normal course, 1829 See Allen & Overy (on behalf of Foreign Bank investments by banking entities in BOLI become financial instruments traded to Group); ASF (Feb. 2012); Credit Suisse (Williams); separate accounts do not involve the capture the change in their market JPMC. 1823 1830 types of speculative risks section 13 of value.’’ See ASF (Feb. 2012). This commenter argued that certain municipal securities may be ABS, the BHC Act was designed to address. Other commenters requested that the Agencies expand the proposed including revenue bonds that involve the issuance Rather, these accounts permit the of senior and subordinate bonds. Id. banking entity to effectively hedge and definition of ‘‘loan’’ to capture many 1831 See Credit Suisse (Williams); SIFMA cover costs of providing benefits to traditional extensions of credit that the (Securitization) (Feb. 2012). 1824 1832 employees through insurance policies proposal would otherwise exclude. See SIFMA (Securitization) (Feb. 2012). This commenter contended that because securitization related to key employees. Moreover, 1820 See proposed rule § 75.2(q). transactions have been viewed by the Agencies and applying the prohibitions of section 13 1821 courts as ‘legally transparent’ (i.e., as simply See AFR et al. (Feb. 2012); Occupy; Public another way for banking entities to buy and sell the Citizen. loans or other assets underlying such securities), 1814 See proposed rule § 75.14(a)(1). 1822 See Public Citizen. This commenter argued 1815 auto lease securitizations supported by a beneficial See ACLI (Jan. 2012); Mass. Mutual; Jones of that the loan definition should be limited to the interest in a titling trust should be treated as Northwestern; AALU; BBVA; BoA; Chris Barnard; plain meaning of the term ‘‘loan’’ and noted that a securitizations of the underlying auto leases and Clark Consulting (Feb. 7, 2012); Clark Consulting loan is not a security. Id. should fall within the loan securitization (Feb. 13, 2012); Gagnon of GW Financial. 1823 See Occupy (citing 156 Cong. Rec. S5895 exemption. This commenter also argued that if the 1816 See Occupy. (daily ed. July 15, 2010)). definition of ‘‘loan’’ is not expanded to include 1817 See final rule § 75.10(c)(7). 1824 See Allen & Overy (on behalf of Foreign Bank securities, then banking entities could not act as 1818 This requirement is not intended to preclude Group); ASF (Feb. 2012); Credit Suisse (Williams); sponsors for auto lease securitizations (including a banking entity from purchasing a life insurance GE (Feb. 2012); Goldman (Covered Funds); ICI (Feb. resecuritizations) supported by a beneficial interest policy from an affiliated insurance company. 2012); Japanese Bankers Ass’n.; JPMC; LSTA (Feb. in a titling trust. 1819 See, e.g., Bank Owned Life Insurance, 2012); RBC; SIFMA et al. (Covered Funds) (Feb. 1833 See Credit Suisse (Williams); Goldman Interagency Statement on the Purchase and Risk 2012); SIFMA (Securitization) (Feb. 2012). One (Covered Funds); SIFMA et al. (Covered Funds) Management of Life Insurance (Dec. 7, 2004). individual commenter supported the proposed (Feb. 2012); SIFMA (Securitization) (Feb. 2012).

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proprietary trading restrictions as well distribution.1837 Regardless of whether a banking entity’s acquisition or retention as in determining the scope of the party characterizes the instrument as a of an ownership interest in such exclusion of loan securitizations and loan, these kinds of instruments, which securitization vehicles that the banking asset-backed commercial paper conduits may be called ‘‘structured loans,’’ must entity did not organize and offer, or for from the definition of covered fund. The be evaluated based on the standards which it did not act as sponsor, final rule modifies the proposed associated with evaluating derivatives provided that the assets or holdings of definition and defines ‘‘loan’’ as ‘‘any and securities in order to prevent such vehicles were solely comprised of loan, lease, extension of credit, or evasion of the restrictions on the instruments or obligations identified secured or unsecured receivable that is proprietary trading and ownership in the proposed exemption. not a security or derivative.’’ 1834 The interests in covered funds. The proposed rules would have definition of loan in the final rule allowed a banking entity to engage in b. Loan Securitizations specifically excludes loans that are the sale and securitization of loans by securities or derivatives because trading An exemption for loan securitizations acquiring and retaining an ownership in these instruments is expressly was contained in two separate sections interest in certain securitization included in the statute’s definition of of the proposed rule. The first, in vehicles (which could be a covered fund proprietary trading.1835 In addition, the section 75.13(a), was proposed as part of for purposes of the proposed rules) that Agencies believe these instruments, if ‘‘other permitted covered fund activities the banking entity organized and not excluded from the definition of and investments.’’ The second, in offered, or acted as sponsor to, without loan, could be used to circumvent the § 75.14(d), was proposed as part of being subject to the ownership and restrictions on proprietary trading. ‘‘covered fund activities determined to sponsor limitations contained in the The definition of loan in the final rule be permissible.’’ These proposed proposed rule.1840 As noted in the excludes loans that are securities or provisions would have acted in concert proposing release, the Agencies derivatives, including securities or to permit a banking entity to acquire recognized that by defining ‘‘covered derivatives of or based on such and retain an ownership interest in, or fund’’ broadly, and, in particular, by instruments. The definition of ‘‘loan’’ act as sponsor to, a loan securitization reference to sections 3(c)(1) and 3(c)(7) does not specify the type, nature or regardless of the relationship that the of the Investment Company Act, structure of loans included within the banking entity had with the securitization vehicles may be affected definition, other than by excluding securitization. The Agencies have by the restrictions and requirements of securities and derivatives. In addition, evaluated all comments received on the proposed rule. The Agencies the definition of loan does not limit the securitizations. These sections of the attempted to mitigate the potential scope of parties that may be lenders or proposed rule were intended to adverse impact on the securitization borrowers for purposes of the definition. implement the rule of construction market by excluding loan securitizations The Agencies note that the parties’ contained in section 13(g)(2) of the BHC from the restrictions on sponsoring or characterization of an instrument as a Act which provides that nothing in acquiring and retaining ownership loan is not dispositive of its treatment section 13 of the BHC Act shall be interests in covered funds, consistent under the Federal securities laws or construed to limit or restrict the ability with the rule of construction contained Federal laws applicable to derivatives. of a banking entity or nonbank financial in section 13(g)(2) of the BHC Act.1841 The determination of whether a loan is company supervised by the Board to sell As a result, under the proposal, loan a security or a derivative for purposes of or securitize loans in a manner that is securitizations would not be limited or the loan definition is based on the otherwise permitted by law.1838 The restricted because banking entities Federal securities laws and the language of the proposed exemption for would be able to find investors or Commodity Exchange Act. Whether a loan securitizations would have buyers for their loans or loan loan is a ‘‘note’’ or ‘‘evidence of permitted a banking entity to acquire securitizations. The proposing release indebtedness’’ and therefore a security and retain an ownership interest in a included several requests for comment under the Federal securities laws will covered fund that is an issuer of asset- on the proposed loan securitization depend on the particular facts and backed securities, the assets or holdings exemption and the application of the circumstances, including the economic of which were solely comprised of: (i) covered fund prohibitions to terms of the loan.1836 For example, Loans (as defined); (ii) rights or assets securitizations. loans that are structured to provide directly arising from those loans Some commenters supported a payments or returns based on, or tied to, supporting the asset-backed securities; narrow exemption for loan the performance of an asset, index or and (iii) interest rate or foreign exchange securitizations and in some cases commodity or provide synthetic derivatives that (A) materially relate to suggested that the proposed exemption exposure to the credit of an underlying the terms of such loans or rights or could be narrowed even further. For borrower or an underlying security or assets and (B) are used for hedging example, one commenter argued that index may be securities or derivatives purposes with respect to the the definition of ‘‘loan’’ for purposes of depending on their terms and the securitization structure.1839 The the exemption could include any circumstances of their creation, use, and proposed rule in § 75.13(d) was further extension of credit and any banking 1842 augmented by the proposed rule in activity. Also, in response to the 1834 See final rule § 75.2(s). § 75.14(a)(2) so that a banking entity 1840 1835 12 U.S.C. 1851(h)(4). would be permitted to purchase loan Id. 1836 See 15 U.S.C. 77b(a)(1) and 15 U.S.C. 1841 See Joint Proposal, 76 FR at 68931. 78c(a)(10); Reves v. Ernst & Young, 494 U.S. 56 securitizations and engage in the sale 1842 See, e.g., Public Citizen. This commenter (1990) ; Trust Company of Louisiana v. N.N.P. Inc., and securitization of loans. This was argued that any exemption should prevent evasion, 104 F.3d 1478 (5th Cir. 1997); Pollack v. Laidlaw accomplished through the authorization should ensure that each exempted securitization Holdings, 27 F.3d 808 (2d Cir. 1994); but see Marine in proposed section 75.14(a)(2) of a reduces risk and should be designed to only serve Bank v. Weaver, 455 U.S. 551 (1982); Banco client needs. A different commenter recommended Espanol de Credito v. Security Pacific National a safe harbor available only to a particular pre- Bank, 973 F.2d 51 (2d Cir. 1992); Bass v. Janney 1837 Id. specified, transparent and standardized Montgomery Scott, Inc., 210 F.3d 577 (6th Cir. 1838 See 12 U.S.C. 1851(g)(2). securitization structure, where Agencies would 2000); Piaubert v. Sefrioui, 2000 WL 194140 (9th 1839 See proposed rule § 75.13(d); Joint Proposal, need to justify why the specified structure protects Cir. 2000). 76 FR at 68912. Continued

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proposing release,1843 some commenters ‘‘any rights or other assets designed to certain rights such as securities.1855 suggested that any exemption for assure the servicing or timely Commenters also had suggestions about securitizations should seek to prevent distribution of proceeds to security the types of derivatives that an evasion of the covered fund prohibitions holders.’’ 1849 Commenters requested exempted securitization vehicle be by issuers with ‘‘hedge-fund or private that various additional rights or assets permitted to hold.1856 For example, one equity fund-like characteristics’’ or be added to the list of permissible assets industry association requested that the issuers with ‘‘hidden proprietary trading held by a loan securitization such as loan securitization exemption include operations.’’ 1844 cash and cash accounts,1850 cash securitizations where up to 10 percent On the other hand, many commenters equivalents,1851 and various other high of the assets are held in the form of believed that the proposed exemption quality short term investments, liquidity synthetic risk exposure that references from the covered fund prohibitions for agreements or credit enhancements, ‘‘loans that could otherwise be held loan securitizations should be expanded certain beneficial interests in titling directly’’ under the proposal in order to to cover securitizations generally and trusts used in lease securitizations or achieve risk diversification.1857 This not just loan securitizations. These lease residuals.1852 One commenter commenter stated its belief that the rule commenters provided various suggested that a loan securitization be of construction requires that synthetic arguments for their request to exempt all permitted to include ‘‘any contractual exposures be permitted because they are securitizations from the covered fund rights arising from or supporting used in certain types of loan prohibitions, including that the obligations underlying or relating to the securitizations. regulation of securitizations was loans.’’ 1853 In addition to requests that specific addressed in other areas of the Dodd- Others requested that loan types of underlying assets be permitted Frank Act,1845 that securitization is securitizations also be permitted to hold under the loan securitization essentially a lending activity,1846 and repurchase agreements or unlimited exemption, the Agencies also received that securitizations have ‘‘long been amounts of various forms of securities, comments about specific types of asset recognized as permissible activities for including municipal securities, asset- classes or structures. Some commenters banking entities.’’ 1847 backed securities, credit-linked notes, suggested certain asset classes or Commenters recommending a broader trust certificates and ‘‘equity like- structures should be an excluded exclusion for securitizations also rights.’’ 1854 Some commenters securitization from the covered fund provided a wide variety of specific requested that loan securitizations be prohibitions including insurance-linked suggestions or concerns. Some permitted to hold a limited amount of securities, collateralized loan commenters suggested that permissible obligations, tender option bonds, asset- assets for a loan securitization include 1849 See GE (Feb. 2012); GE (Aug. 2012); ICI (Feb. backed commercial paper conduits assets other than loans acquired in the 2012). (ABCP conduits), resecuritizations of course of collecting a debt previously 1850 See Allen & Overy (on behalf of Foreign Bank asset-backed securities, and corporate Group); ASF (Feb. 2012); Cleary Gottlieb; Credit debt re-packagings.1858 In some cases, contracted, restructuring a loan, during Suisse (Williams) (including cash that did not arise a loan work out or during the directly from the underlying loans); JPMC; LSTA commenters believed that the Agencies disposition of a loan or other similar (Feb. 2012); LSTA (July 2012); RBC; SIFMA should use their authority under section situation.1848 Commenters noted that, (Securitization) (Feb. 2012). 13(d)(1)(J) of the BHC Act to exempt for example, rules 2a–7 and 3a–7 under 1851 See Cleary Gottlieb; Credit Suisse (Williams). these types of vehicles. Some 1852 the Investment Company Act define See JPMC (requesting high quality, highly commenters identified other vehicles liquid investments, including Treasury securities such as credit funds and issuers of eligible assets for a securitization as not and highly rated commercial paper); LSTA (Feb. only including financial assets but also 2012); LSTA (July 2012) (requesting short-term covered bonds that they believed should highly liquid investments such as obligations be excluded from the covered fund backed by the full faith and credit of the United against the systemic risks associated with States, deposits insured by the Federal Deposit securitization. See AFR (Nov. 2012). 1855 See, e.g., ASF (Feb. 2012); Cleary Gottlieb; Insurance Corporation, various obligations of U.S. 1843 See Request for Comment No. 231 in the LSTA (Feb. 2012). LSTA (Feb. 2012) specifically financial institutions and investments in money requested that entities issuing collateralized loan Proposing Release (noting that many issuers of market funds); ASF (Feb. 2012); Commercial Real asset-backed securities have features and structures obligations that are primarily backed by loans or Estate Fin. Council; RBC (requesting short-term, loan participations also be permitted to hold a that resemble some of the features of hedge funds high quality investments); Allen & Overy (on behalf and private equity funds (e.g., CDOs are managed limited amount of corporate credit obligations. This of Foreign Bank Group) (requesting short-term commenter provided recommendations about such by an investment adviser that has the discretion to eligible investments); Credit Suisse (Williams) limitations—if the amount of such corporate credit choose investments, including investments in (requesting government guaranteed securities, obligations exceeded 10 percent, a CLO would not securities) and requesting comment on how to money market funds and other highly credit-worthy be able to purchase any assets other than senior, prevent hedge funds or private equity funds from and liquid investments); Cleary Gottlieb (requesting secured syndicated loans and temporary structuring around an exemption for asset-backed money-market interests; SIFMA (Securitization) investments (as defined in the letter). If the amount securities from the covered fund prohibitions). (Feb. 2012) (requesting associated investments of such assets exceeded 30 percent, the entity 1844 See, e.g., AFR et al. (Feb. 2012); Occupy; which are customarily employed in securitization should not be able to purchase any assets other than Public Citizen. But see Credit Suisse (Williams) transactions). One commenter further noted that loans. (arguing it would be difficult to use the typical such investments are required by securitization 1856 See AFME et al.; Allen & Overy (on behalf of structure and operation of securitizations to avoid documents. See Commercial Real Estate Fin. Foreign Bank Group); Credit Suisse (Williams); the prohibition on proprietary trading because the Council. Japanese Bankers Ass’n.; LSTA (Feb. 2012); SIFMA structures are not set up to engage in the kind of 1853 RBC. This commenter argued that the loan (Securitization) (Feb. 2012). proprietary trading about which Congress was securitization exemptions as proposed would not 1857 See ASF (Feb. 2012). Permissible synthetic concerned). permit ‘‘traditional securitizations and exposure would include ‘‘credit default swaps, total 1845 See AFME et al.; Ass’n. of German Banks; securitizations with the characteristics of traditional return swaps or other agreements referencing Cleary Glottlieb; Credit Suisse (Williams); GE (Feb. securitizations’’ and ‘‘would effectively eliminate a corporate loans or corporate bonds pursuant to 2012); IIB/EBF; RBC; SIFMA (Securitization) (Feb. substantial portion of the very securitization which the issuer is the seller of credit protection or 2012). activities carried on by banks that the [loan otherwise ‘long’ the credit exposure of the reference 1846 See, e.g., Credit Suisse (Williams). securitization exemptions] are designed to corporate loan or bond, and receives a yield derived 1847 See Credit Suisse (Williams); JPMC. These preserve.’’ from the yield on the reference corporate loan or commenters cited the sponsoring of asset-backed 1854 See Allen & Overy (on behalf of Foreign Bank bond.’’ commercial paper conduits as an example of Group); ASF (Feb. 2012); Credit Suisse (Williams); 1858 See AFME et al.; ASF (July 2012); GE (Aug. permissible bank securitization activity. GE (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered 2012); Capital Group; Goldman (Covered Funds); 1848 See Allen & Overy (on behalf of Foreign Bank Funds) (Feb. 2012); SIFMA (Securitization) (Feb. LSTA (Feb. 2012); SIFMA et al. (Covered Funds) Group); Credit Suisse (Williams); JPMC. 2012). (Feb. 2012).

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prohibitions.1859 On the other hand, the proposal because otherwise a multi-step purchasing or otherwise acquiring, and Agencies also received comment letters securitization could include holding the loans, (C) certain interest that argued that certain securitizations impermissible assets.1863 Some rate or foreign exchange derivatives, and should not be exempted from the commenters also raised question about (D) certain special units of beneficial covered fund prohibitions, including whether depositors would fall within interests and collateral certificates resecuritizations, CDO-squared, and the definition of ‘‘investment company’’ (together, ‘‘loan securitizations’’).1866 In CDO-cubed securitizations because of under the Investment Company Act and, addition, as discussed below, the concern about their complexity and lack therefore, may fall within the proposed Agencies are adopting specific of reliable performance data or ability to definition of covered fund.1864 exclusions for certain vehicles that issue value those securities.1860 After considering carefully the short term asset-backed securities and Because a loan securitization could comments received on sections of the for pools of assets that are part of still be a covered fund, several proposed rule, the Agencies have covered bond transactions which pools commenters expressed concern that the determined to adopt a single section in also meet the conditions delineated proposed loan securitization exemption, the final provision relating to loan above.1867 as drafted, did not exempt loan securitizations that would exclude loan Although commenters argued that securitizations from the prohibitions of securitizations that meet certain criteria various types of assets should be section 13(f) of the BHC Act. As a result, contained in the rule from the definition included within the definition of loan or one commenter noted that the proposed of covered fund. The rule, as adopted, otherwise permitted to be held under loan securitization exemptions would takes into account comments received the loan securitization exclusion, the not have their intended result of on each of the conditions specified in loan securitization exclusion in the final excluding loan securitizations from the the two loan securitization sections of rule has not been expanded to be a BHC Act restrictions applicable to the proposed provisions and has broad exclusion for all securitization covered funds.1861 adopted those conditions with some vehicles. Although one commenter Certain securitization transactions clarifying changes from the proposed suggested that any securitization is may involve the issuance of an language. In addition, in response to essentially a lending activity,1868 the intermediate asset-backed security that comments, as discussed more fully Agencies believe such an expansion of supports the asset-backed securities that below, the Agencies are adopting the exclusion would not be consistent are issued to investors, such as in auto additional exclusions from the with the rule of construction in section lease securitizations and ABCP definition of covered fund for certain 13(g)(2) of the BHC Act, which types of vehicles if they are backed by conduits. Commenters suggested that specifically refers to the ‘‘sale and the same types of assets as the assets the Agencies should look through securitization of loans.’’ The Agencies that are permitted to be held in the loan intermediate securitizations to the assets believe that a broad definition of loan securitization exclusion. These that support the intermediate asset- and therefore a broad exemption for additional exclusions are tailored to backed security to determine if those transactions that are structured as vehicles that are very similar to loan assets would satisfy the definition of securitizations of pooled financial assets securitizations but have particular ‘‘loan’’ for purposes of the loan could undermine the restrictions structural issues, which are described in securitization exemption. If those assets Congress intended to impose on banking more detail below. are loans, these commenters suggested entities’ covered fund activities, which that the entire securitization transaction In light of the comments received on the proposal, the final rule was revised could enable market participants to use should be deemed a loan securitization, securitization structures to engage in even if the assets supporting the asset- to exclude from the definition of covered fund an issuing entity of asset- activities that otherwise are constrained backed securities issued to investors are for covered funds. The Agencies believe not loans.1862 However, some backed securities, as defined in Section 3(a)(79) of the Exchange Act,1865 if the the purpose underlying section 13 is not commenters argued that each step in a to expand the scope of assets in an multi-step securitization should be underlying assets or holdings are comprised solely of: (A) loans, (B) any excluded loan securitization beyond viewed separately to ensure compliance loans as defined in the final rule and the with the specific restrictions in the rights or other assets (i) designed to assure the servicing or timely other assets that the Agencies are specifically permitting in a loan 1859 See Goldman (Covered Funds) (requesting distribution of proceeds to security exclusion for credit funds). AFME et al. (requesting holders or (ii) related or incidental to securitization. exclusion for covered bonds); FSA (Apr. 2012) (requesting exclusion for covered bonds); UKRCBC 1863 See Occupy; Public Citizen. Occupy 1866 See final rule § 75.10(c)(8). Consistent with (requesting exclusion for covered bonds). contended that the structured security issued in a the proposal, certain securitizations, regardless of 1860 See Sens. Merkley & Levin (Feb. 2012). These multi-step securitization can hide underlying risks asset composition, would not be considered commenters argued that there should be increased under layers of structured complexity. See Occupy. covered funds because the securitization issuer is capital charges in line with the complexity of a Public Citizen argued that prohibiting such activity deemed not to be an investment company under securitization and using the ‘‘high risk asset would ensure that securitizations do not become Investment Company Act exclusions other than limitations on permitted activities to bar any proprietary trading vehicles for banking entities that section 3(c)(1) or 3(c)(7) of the Investment Company securitization by a bank from using complex are effectively off-balance sheet. See Public Citizen. Act. For example, this would include issuers that structures, re-securitization techniques, synthetic See infra Part VI.B.1.c.8.b.iv. of this SUPPLEMENTARY meet the requirements of section 3(c)(5) or rule 3a– features, or other elements that may increase risk or INFORMATION. 7 of the Investment Company Act, and the asset- make a risk analysis less reliable.’’ 1864 A depositor, as used in a securitization backed securities of such issuers may be offered in 1861 See AFME et al.; SIFMA (May 2012) (arguing structure, is an entity that generally acts only as a transactions registered under the Securities Act. that because of the narrowness of the proposed conduit to transfer the loans from the originating 1867 As discussed below, the Agencies are exemption and because it would not exempt bank to the issuing entity for the purpose of adopting an exclusion from the definition of securitizations from prohibitions on covered facilitating a securitization transaction and engages covered funds for the pools of assets that are transactions imposed by section 13(f), the rule as in no discretionary investment or securities involved in the covered bond financings. Although proposed ‘‘will effectively prevent banking entities issuance activities. See ASF (July 2012); GE (Aug. the cover pools must satisfy the same criteria as the from sponsoring and owning a large variety of asset- 2012). For purposes of this rule, the Agencies excluded loan securitizations, a separate exclusion backed securities, in contravention of the rule of believe the wholly owned subsidiary exclusion is is needed because the securities involved in the construction.’’) available for depositors. See supra note 1779. covered bond issuance are not asset-backed 1862 See AFME et al.; ASF (Feb. 2012); SIFMA 1865 15 U.S.C. 78c(a)(79). This definition was securities. (Securitization) (Feb. 2012). added by Section 941 of the Dodd-Frank Act. 1868 See, e.g., Credit Suisse (Williams).

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While not expanding the permitted intent expressed in the rule of ‘‘loan’’ was a defined term for purposes assets under the loan securitization construction in section 13(g)(2) of the of the restrictions on proprietary trading exclusion, the Agencies have made BHC Act.1870 The Agencies believe that, and the covered funds provisions. As modifications in response to as reflected in the rule of construction, proposed, a loan was defined as a loan, commenters to ensure that the the continued ability of banking entities lease, extension of credit, or secured or provisions of the final rule to participate in loan securitizations is unsecured receivable.1872 The definition appropriately accommodate the need, in important to enable banks of all sizes to of loan in the proposed rule was administering a loan securitization be able to continue to provide financing expansive, and included a broad array transaction on an ongoing basis, to hold to loan borrowers at competitive prices. of loans and similar credit transactions, various assets other than the loans that Loan securitizations provide an but did not include any asset-backed support the asset-backed securities. important avenue for banking entities to security that is issued in connection Moreover, the Agencies do not believe obtain investor financing for existing with a loan securitization or otherwise that the assets permitted under the loan loans, which allows such banks greater backed by loans. securitization need to be narrowed capacity to continuously provide As discussed above under ‘‘Definition further to prevent evasion and hidden financing and lending to their of Loan,’’ the Agencies received proprietary trading as requested by customers. The Agencies also believe comments regarding the loan definition certain commenters because the that loan securitizations that meet the in the securitization context. In Agencies believe that the potential for conditions of the rule as adopted do not particular, one commenter, citing a evasion has been adequately addressed raise the same types of concerns as other statement made by Senator Merkley, through modifications to the definition types of securitization vehicles that argued that Congress did not intend the of loan and more specific limitations on could be used to circumvent the loan securitization exemption to include the types of securities and derivatives restrictions on proprietary trading and ‘‘loans that become financial permitted in an excluded loan prohibitions in section 13(f) of the BHC instruments traded to capture the securitization. The Agencies have Act. change in their market value.’’ 1873 revised the scope of the loan Under the rule as adopted, loan The Agencies, after considering securitization exclusion to securitizations that meet the conditions carefully the comments received, have accommodate existing market practice of the rule as adopted are excluded from adopted a definition of loan that is for securitizations as discussed by the definition of covered fund and, revised from the proposed definition. commenters while limiting the consequently, banking entities are not The final rule defines ‘‘loan’’ as ‘‘any availability of the exclusion for these restricted as to their ownership of such loan, lease, extension of credit, or particular types of securitization entities or their ongoing relationships secured or unsecured receivable that is transactions to issuers of asset-backed with such entities by the final rule. As not a security or derivative.’’ 1874 The securities supported by loans. the Agencies stated in the proposal, definition of loan in the final rule The Agencies are not adopting permitting banking entities to acquire or specifically excludes loans that are specific exclusions for other retain an ownership interest in these securities or derivatives because trading securitization vehicles identified by loan securitizations will allow for a in these instruments is expressly commenters, including insurance-linked deeper and richer pool of potential included in the statute’s definition of securities, collateralized loan participants and a more liquid market proprietary trading.1875 In addition, the obligations, and corporate debt re- for the sale of such securitizations, Agencies believe these instruments, if packagings.1869 The Agencies believe which in turn should result in the not excluded from the definition of that providing such exclusions would continued availability of funding to loan, could be used to circumvent the not be consistent with the rule of individuals and small businesses, as restrictions on proprietary trading. construction in section 13(g)(2) of the well as provide an efficient allocation of Further, for purposes of the loan BHC Act, which specifically refers to capital and sharing of risk. The securitization exclusion, the loan the ‘‘sale and securitization of loans.’’ Agencies believe that excluding these securitization must own the loan These other types of securitization loan securitizations from the definition directly; a synthetic exposure to a loan, vehicles referenced by commenters are of covered fund is consistent with the such as through holding a derivative, used to securitize exposures to terms and the purpose of section 13 of such as a credit default swap, will not instruments which are not included in the BHC Act, including the rule of satisfy the conditions for the loan the definition of loan as adopted by the construction regarding loan securitization exclusion.1876 As such, a final rule. Moreover, the Agencies note securitizations.1871 securitization that owns a tranche of another loan securitization is not itself in response to commenters that i. Loans resecuritizations of asset-backed a loan securitization, even if the securities and CDO-squared and CDO- The first condition of the loan ownership of such tranche by a banking cubed securitizations could be used as securitization exclusion from the entity would otherwise be permissible a means of evading the prohibition on definition of covered fund is that the under the final rule. the investment in the ownership underlying assets or holdings are As discussed above under ‘‘Definition interests of covered funds. comprised of loans. In the proposal, of Loan,’’ the definition of loan in the As with the proposed rules, the final rule has not been expanded as Agencies are excluding certain loan 1870 As discussed below, the Agencies are requested by some commenters but has excluding those loan securitizations that hold only securitizations from the definition of loans (and certain other assets identified in the final 1872 covered fund and therefore the rule), consistent with the rule of construction in See proposed rule § 75.2(q). prohibitions applicable to banking section 13(g)(2) of the BHC Act. 1873 See Occupy (citing 156 Cong. Rec. S5895 (daily ed. July 15, 2010)). entities’ involvement in covered funds 1871 The Agencies note that the loan securitization and other securitization exclusions apply only to 1874 See § 75.2(r). in order to implement Congressional the definition of covered fund, and therefore the 1875 12 U.S.C. 1851(h)(4). covered fund-related provisions of the rule, and not 1876 Under the final provision, the issuing entity 1869 Commenters’ concerns regarding credit funds to its prohibition on proprietary trading. The for the SUBIs and collateral certificate may rely on are discussed below in Part VI.B.1.d.6. of this Agencies recognize that trading in loans is not the loan securitization exclusion because of the SUPPLEMENTARY INFORMATION. subject to the proprietary trading restrictions. separate provisions allowing such a holding.

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been clarified in some respects in of the additional rights and assets securities; 1884 municipal securities; 1885 response to comments. The final rule requested by commenters include cash repurchase agreements; 1886 credit- explicitly excludes securities or and cash accounts; 1880 cash linked notes; 1887 trust certificates; 1888 derivatives.1877 In addition, the equivalents;1881 liquidity agreements, lease residuals; 1889 debt securities; 1890 definition of loan has not been modified including asset purchase agreements, and derivatives.1891 As an alternative, to include repurchase agreements or program support facilities and support commenters requested that an issuer of reverse repurchase agreements commitments; 1882 credit asset-backed securities be permitted to regardless of the character of the enhancements: 1883 asset-backed hold under the proposed loan underlying asset. The Agencies are securitization exemption certain of such concerned that parties, under the guise additional rights and/or assets up to a of a ‘‘loan’’ might instead create threshold, such as a specified Estate Fin. Council; GE (Feb. 2012); GE (Aug. 2012); instruments that provide the same ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; 1884 See Allen & Overy (on behalf of Foreign Bank exposures to securities and derivatives LSTA (Feb. 2012); LSTA (July 2012); RBC; SIFMA that otherwise are prohibited by section Group); AFME et al.; ASF (Feb. 2012); Credit Suisse et al. (Covered Funds) (Feb. 2012); SIFMA (Williams); GE (Feb. 2012); GE (Aug. 2012); ICI 13 and might attempt to use the loan (Securitization) (Feb. 2012); Vanguard. (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered securitization exclusion to acquire 1880 See Allen & Overy (on behalf of Foreign Bank Funds) (Feb. 2012); SIFMA (Securitization) (Feb. ownership interests in covered funds Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 2012). Commenters requested inclusion of the holding those types of instruments, Suisse (Williams). following examples of asset-backed securities: (i) 1881 See Allen & Overy (on behalf of Foreign Bank SUBI certificates (beneficial interests in titling counter to the terms and the purpose of trusts typically used in lease securitizations) (AFME Group); ASF (Feb. 2012); Cleary Gottlieb; Credit section 13 of the BHC Act. As the et al.; ASF (Feb. 2012); GE (Aug. 2012); SIFMA Suisse (Williams); Commercial Real Estate Fin. Agencies have noted previously, the (Securitization) (Feb. 2012)); (ii) ownership Council; JPMC; LSTA (Feb. 2012); LSTA (July interests and bonds issued by CLOs (JPMC); a broad rules relating to covered funds and to 2012); RBC; SIFMA (Securitization) (Feb. 2012). array of receivables that support asset-backed proprietary trading are not intended to Commenters requested inclusion of the following commercial paper (ICI (Feb. 2012)); certain notes, interfere with traditional lending examples of cash equivalents: government certificates or other instruments backed by loans or practices or with securitizations of loans guaranteed securities, money market funds, and financial assets that are negotiated by the ‘‘other highly credit-worthy and liquid purchasing asset-backed commercial paper conduit generated as a result of such activities. (ASF (Feb. 2012); GE (Feb. 2012)); municipal investments’’ (Credit Suisse (Williams)); and high Although the Agencies have revised the securities that are technically ABS, including quality, highly liquid investments, including revenue bonds that involve the issuance of senior definition of loan in response to Treasury securities and highly rated commercial commenters’ concerns as discussed and subordinate bonds (ASF (Feb. 2012)); paper (JPMC). In addition, LSTA (Feb. 2012) ownership interests in credit funds (as defined in above, the Agencies are not adopting a requested inclusion of the following: (i) short-term their letter) (SIFMA et al. (Covered Funds) (Feb. separate definition of loan for highly liquid investments; (ii) direct obligations of, 2012)); any note, bond or security collateralized and securitization transactions as requested and obligations fully guaranteed as to full and payable from pools of loans, leases (including lease by commenters. The Agencies believe timely payment by, the United States (or by any residuals), extensions of credit or secured or agency thereof to the extent such obligations are unsecured receivables (RBC); asset-backed that the definition of loan adopted in securities issued by intermediate vehicles in a backed by the full faith and credit of the United the final rule appropriately securitization collateralized predominantly by loans States); (iii) demand deposits, time deposits or encompasses the financial instruments and financial assets, and other similar instruments certificates of deposit that are fully insured by the (Credit Suisse (Williams)); and asset-backed that result from lending money to Federal Deposit Insurance Corporation; (iv) securities backed by loans or receivables that are customers. corporate, non-extendable commercial paper; (v) originated by or owned by the sponsor of such notes that are payable on demand or bankers’ securitization or which are issued by an entity that ii. Contractual Rights or Assets acceptances issued by regulated U.S. financial is organized under the direction of the same Under the proposed loan institutions; (vi) investments in money market sponsor as the issuer of the covered fund (ASF (Feb. funds or other regulated investment companies; 2012)). securitization definition, a covered fund 1885 time deposits having maturities of not more than 90 See ICI (Feb. 2012); Vanguard. that is an issuer of asset-backed 1886 days; (vii) repurchase obligations with respect to See Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012). securities would have been permitted to direct obligations and guaranteed obligations of the 1887 See Allen & Overy (on behalf of Foreign Bank hold contractual rights or assets directly U.S. entered into with a regulated U.S. financial Group). arising from those loans supporting the institution; and (viii) other investments with a 1888 See Credit Suisse (Williams). asset-backed securities.1878 The maturity one year or less, with the requirement that 1889 See ASF (Feb. 2012); GE (Feb. 2012); GE each of the investments listed have, at the time of proposal did not identify or describe (Aug. 2012); RBC. the securitization’s investment or contractual such contractual rights or assets. 1890 See GE (Aug. 2012). commitment to invest therein, a rating of the Commenters requested that the 1891 See Allen & Overy (on behalf of Foreign Bank highest required investment category. Agencies expand the list of contractual Group); Credit Suisse (Williams); Japanese Bankers 1882 See Allen & Overy (on behalf of Foreign Bank Ass’n.; LSTA (Feb. 2012); SIFMA (Securitization) rights and assets that an issuer of asset- Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; (Feb. 2012). Commenters requested inclusion of the backed securities would be permitted to RBC; SIFMA (Securitization) (Feb. 2012). following examples of derivatives: (i) credit hold under the proposed loan 1883 See Allen & Overy (on behalf of Foreign Bank derivatives (without explanation) as a means of diversifying the portfolio (Japanese Bankers securitization exemption.1879 Examples Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; Association); (ii) synthetic securities that reference RBC; SIFMA (Securitization) (Feb. 2012). For corporate credits or other debt (Credit Suisse 1877 The determination of whether an instrument example, SIFMA (Securitization) (Feb. 2012) (Covered Fund)); (iii) credit instruments or other falls outside the definition of loan because it is a requested inclusion of third party credit obligations that the banking entity could originate security or a derivative is based on the Federal enhancements such as guarantees and letters of or invest or deal in directly, including tranched or securities laws and the Commodity Exchange Act. credit. Commenters requested inclusion of the untranched credit linked notes exposed to the Whether a loan, lease, extension of credit, or following examples of credit enhancements: (i) credit risk of such reference assets through a credit secured or unsecured receivable is a note or external credit support of borrower obligations default swap or other credit derivative entered into evidence of indebtedness that is defined as a under such loans, including a credit support by the related ABS Issuer (SIFMA (Securitization) security under the Federal securities laws will facilities, third party or parent guarantee, insurance (Feb. 2012)); (iv) any derivatives structured as part depend on the particular facts and circumstances, of the securitization of loans (without explanation) policy, letter of credit or other contractual including the economic terms of the transaction. (Allen & Overy (on behalf of Foreign Bank Group)); See supra note 1836 and accompanying text. commitment to make payments or perform other (v) hedge agreements (Credit Suisse (Williams)); 1878 See proposed rule § 75.13(d). obligations of the borrower under the loans (ASF and (vi) any derivative, including a credit default 1879 See Allen & Overy (on behalf of Foreign Bank (Feb. 2012)); and (ii) property guarantees, insurance swap, as and to the extent a banking entity could Group); AFME et al.; ASF (Feb. 2012); Cleary policies, letters of credit, or supporting obligations use such derivative in managing its own investment Gottlieb; Credit Suisse (Williams); Commercial Real underlying or relating to any of the loans (RBC). portfolio (SIFMA (Securitization) (Feb. 2012)).

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percentage of the assets of such covered Under the final rule, a loan specifically included in the final rule fund.1892 securitization which is eligible for the could be misused in such manner, In response to comments, the final loan securitization exclusion may hold because without limitations on the types rule modifies the loan securitization securities if those securities fall into one of securities in which an excluded loan exclusion from the proposal to identify of three categories.1896 First, such loan securitization may invest, a banking the types of contractual rights or assets securitizations may hold securities that entity could structure an excluded loan directly arising from those loans are cash equivalents. For purposes of securitization with provisions to engage supporting the asset-backed securities the exclusion for loan securitizations, in activities that are outside the scope that a loan securitization relying on the Agencies interpret ‘‘cash of the definition of loan as adopted and such exclusion may hold. Under the equivalents’’ to mean high quality, also to engage in impermissible final rule, a loan securitization which is highly liquid short term investments proprietary trading. Further, the eligible for the loan securitization whose maturity corresponds to the Agencies do not believe that the use of exclusion may hold contractual rights or securitization’s expected or potential thresholds with respect to such other assets (i) designed to assure the need for funds and whose currency types of securities as an alternative is servicing or timely distribution of corresponds to either the underlying appropriate because similarly, such a proceeds to security holders or (ii) loans or the asset-backed securities.1897 securitization would then involve a related or incidental to purchasing or Depending on the specific funding securitization of non-loan assets, otherwise acquiring, and holding the needs of a particular securitization, outside the scope of what the Agencies loans (‘‘servicing assets’’).1893 The ‘‘cash equivalents’’ might include believe the rule of construction was servicing assets are permissible in an deposits insured by the Federal Deposit intended to cover. By placing excluded loan securitization transaction Insurance Corporation, certificates of restrictions on the securities permitted only to the extent that they arise from deposit issued by a regulated U.S. to be held by an excluded loan the structure of the loan securitization financial institution, obligations backed securitization, the potential for evasion or from the loans supporting a loan by the full faith and credit of the United is reduced. Loan securitizations are securitization. If such servicing assets States, investments in registered money intended, as contemplated by the rule of are sold and securitized in a separate market funds, and commercial construction, to permit banks to transaction, they will not qualify as paper.1898 Second, such loan continue to engage in securitizations of permissible holdings for the loan securitizations may hold securities loans. Including all types of securities securitization exclusion.1894 received in lieu of debts previously within the scope of permitted assets in In adopting this approach, the contracted with respect to the loans an excluded loan securitization would Agencies considered commenters’ supporting the asset-backed securities. expand the exclusion beyond the scope concerns and determined to revise the Finally, such loan securitizations may of the definition of loan in the final rule condition to be more consistent with the hold securities that qualify as SUBIs or that is intended to implement the rule definition and treatment of servicing collateral certificates subject to the of construction. assets in other asset-backed provisions set forth in the rule for such securitization regulations, such as the intermediate asset-backed securities. iii. Derivatives exemption from the definition of The Agencies have specifically Under the proposed loan ‘‘investment company’’ under rule 3a–7 limited the types of securities held as securitization definition, an exempted promulgated under the Investment eligible assets in a loan securitization loan securitization would be permitted Company Act.1895 that may be excluded from the to hold interest rate or foreign exchange Although the Agencies have revised definition of covered fund under the derivatives that materially relate to the the proposal in response to commenters’ final rule, even in limited amounts, in terms of any loans supporting the asset- concerns, the final rule does not permit order to assure that the types of backed securities and any contractual a loan securitization to hold as servicing securities are cash equivalents or rights or assets directly arising from assets a number of instruments otherwise related to the loan such loans so long as such derivatives specifically requested by commenters securitization and to prevent the are used for hedging purposes with whether in their entirety or as a possible misuse of the loan respect to the securitization percentage of the pool. Under the final securitization exclusion to circumvent structure.1900 The Agencies indicated in rule, servicing assets do not include the restrictions on proprietary trading, the proposing release that the proposed securities or derivatives other than as investments in covered funds and loan securitization definition would not specified in the rule. prohibitions in section 13(f) of the BHC allow an exempted loan securitization 1899 Act. The Agencies believe that types to use credit default swaps.1901 1892 See ASF (Feb. 2012); Cleary Gottlieb; Credit of securities other than those Suisse (Williams); GE (Feb. 2012); GE (Aug. 2012); Commenters criticized the proposed LSTA (Feb. 2012); LSTA (July 2012). limitations on the use of derivatives 1896 1893 See final rule § 75.10(c)(8)(i)(B). The use of See final rule § 75.10(c)(8)(iii). included in the proposed loan 1897 the term ‘‘servicing assets’’ is not meant to imply If either the loans supporting the loan securitization definition.1902 In that servicing assets are limited to those contractual securitization or the asset-backed securities issued rights or assets related to the servicer and the by the loan securitization are denominated in a particular, one commenter indicated performance of the servicer’s obligations. foreign currency, for purposes of the exclusion a that the use of credit derivatives such as 1894 For example, under the final rule, mortgage loan securitization would be permitted to hold credit default swaps is important in loan insurance policies supporting the mortgages in a foreign currency, cash equivalents denominated in securitizations to provide diversification loan securitization are servicing assets permissible foreign currency and foreign exchange derivatives for purposes of § 75.10(c)(8)(i)(B). However, a that comply with § 75.10(c)(8)(iv). separate securitization of the payments on those 1898 Servicing assets should not introduce 1900 See Joint Proposal, 76 FR at 68912. mortgage insurance policies would not qualify for significant additional risks to the transaction, 1901 Id. the loan securitization exclusion. including foreign currency risk or maturity risk. For 1902 See AFME et al.; Allen & Overy (on behalf of 1895 The Agencies believe that for purposes of the instance, funds on deposit in an account that is Foreign Bank Group); ASF (Feb. 2012) (requesting final rule, in the context of securitization, such swept on a monthly basis should not be invested that an excluded loan securitization be permitted to related or incidental assets in a loan securitization in securities that mature in 90 days. hold up to 10% of its assets in the form of synthetic should support or further, and therefore, be 1899 Commenters expressed concerns about the risk exposure to loans); Credit Suisse (Williams); secondary to the loans held by the securitization use of securitization vehicles for evasion. See, e.g., Japanese Bankers Ass’n.; LSTA (Feb. 2012) (for vehicle. AFR et al. (Feb. 2012); Occupy; Public Citizen. CLOs); SIFMA (Securitization) (Feb. 2012).

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of assets.1903 Another commenter noted to either the loans or the asset-based or other types of derivatives whether or the use of such instruments to manage securities themselves is intended to not they are related either to the risks with respect to corporate loan and quantitatively and qualitatively limit the underlying loans or the asset-backed debt books by accessing capital from a use of derivatives permitted under the securities.1910 Under the final rule, a broad group of capital markets investors loan securitization exclusion.1907 The synthetic securitization in which the and facilitates making markets.1904 In Agencies would expect that neither the asset-backed securities are supported by contrast, two commenters generally total notional amount of directly related cash flow from derivatives, such as supported the limitations on the use of interest rate derivatives nor the total credit default swaps and total return derivatives under the proposed loan notional amount of directly related swaps, would not be permitted to rely securitization definition and indicated foreign exchange derivatives would on the loan securitization exclusion that excluding credit default swaps from exceed the greater of either the because such derivatives are excluded the loan securitization definition was outstanding principal balance of the from the final rule’s definition of loan appropriate.1905 loans supporting the asset-backed specifically, as a derivative. Similarly, a With respect to the use of derivatives, securities or the outstanding principal loan securitization that relies on the the Agencies are adopting the loan balance of the asset-backed loan securitization exclusion would not securitization exclusion substantially as securities.1908 Moreover, under the loan be permitted to hold a credit default proposed with certain modifications to securitization exclusion, the type of swap or total return swap that reflect a restructuring of this provision derivatives must be related to the types references a loan that is held by the loan in order to more closely align the of risks associated with the underlying securitization. Under the final rule as permissible uses of derivatives under assets and may not be derivatives adopted, an excluded loan the loan securitization exclusion with designed to supplement income based securitization would not be able to hold the loans, the asset-backed securities, or on general economic scenarios, income derivatives that would relate to risks to the contractual rights and other assets management or unrelated risks. counterparties or issuers of the that a loan securitization relying on the The second requirement that underlying assets referenced by these loan securitization exclusion may hold. derivatives reduce the interest rate and/ derivatives because the operation of As adopted, for a loan securitization to or foreign exchange risks related to derivatives, such as these, that expand be eligible for the loan securitization either such loans, contractual rights or potential exposures beyond the loans exclusion, the loan securitization may other assets, or such asset-backed and other assets, would not in the hold only interest rate or foreign securities is intended to permit the use Agencies’ view be consistent with the exchange derivatives that meet the of derivatives to hedge interest rate and/ limited exclusion contained in the rule following requirements: (i) the written or foreign exchange risks that result of construction under section 13(g)(2) of terms of the derivatives directly relate to from a mismatch between the loans and the BHC Act, and could be used to 1909 either the loans or the asset-backed the asset-backed securities. circumvent the restrictions on securities that such loan securitization The Agencies believe that the proprietary trading and prohibitions in may hold under the other provisions of statutory rule of construction should be section 13(f) of the BHC Act. The the loan securitization exclusion; and implemented in a manner that does not Agencies believe that the use of (ii) the derivatives reduce interest rate limit or restrict the sale and derivatives by an issuing entity for and/or foreign exchange risk with securitization of loans. The Agencies asset-backed securities that is excluded respect to risks related to either such further believe that the sale and from the definition of covered fund securitization of credit exposures other loans, the asset-backed securities or the under the loan securitization exclusion than ‘‘loans’’ as defined in the rule, such contractual rights or other assets that a should be narrowly tailored to hedging 1906 as through securities or derivatives, loan securitization may hold. activities that reduce the interest rate The first requirement that the written could be abused. The derivatives that and/or foreign exchange risks directly terms of the derivatives ‘‘directly relate’’ may be held in a loan securitization for related to the asset-backed securities or purposes of the exclusion may not be the loans supporting the asset-backed 1903 See Japanese Bankers Ass’n. This commenter used for speculative purposes. securities because the use of derivatives indicated that credit derivatives are important in Consistent with the proposal, the loan securitizations to provide diversification when the for purposes other than reducing securitization exclusion does not permit desired mix of assets cannot be achieved. interest rate risk and foreign exchange 1904 a loan securitization relying on such See ASF (Feb. 2012). This commenter argued risks would introduce credit risk that for some loan securitizations, investors may exclusion to hold credit default swaps seek a broader pool of credit exposures than the without necessarily relating to or bank has available or can obtain to securitize in 1907 involving a reduction of interest rate order to achieve risk diversification. Under the final rule, the Agencies expect that a loan securitization relying on the loan risk or foreign exchange risk. 1905 See AFR et al. (Feb. 2012); Public Citizen. securitization exclusion would not have a On the other hand, while the One of these commenters stated that the credit significant amount of interest rate and foreign default exclusion was appropriate because Agencies are not expanding the types of exchange derivatives with respect to risks arising ‘‘synthetic securitizations and resecuritizations permitted derivatives to be held in a were a key contributor to financial contagion during from contractual rights or other assets. 1908 loan securitization, the Agencies in the the crisis.’’ See AFR et al. (Feb. 2012). Another For example, a $100 million securitization commenter argued that the loan securitization cannot be hedged using an interest rate hedge with final rule are not restricting the use of definition should not permit the use of derivatives. a notional amount of $200 million. all derivatives under the loan See Occupy. This commenter argued that covered 1909 The derivatives permitted in a securitization securitization exclusion as requested by funds should only be permitted to engage in that may rely on the loan securitization exclusion certain commenters. The Agencies hedging activity in accordance with the proposed would permit a securitization to hedge the risk exemption for hedging activity. This commenter resulting from differences between the income believe that a loan securitization that is also argued that the inclusion of derivatives in the received by the issuing entity and the amounts due excluded from the definition of covered loan securitization definition exceeded the under the terms of the asset-backed securities. For fund should be allowed to engage in Agencies’ statutory authority. Id. Two senators example, fixed rate loans could support floating rate indicated that ‘‘complex securitizations’’ including asset-backed securities; loans with an interest rate activities that reduce interest rate and those with ‘‘synthetic features’’ and ‘‘embedded determined by reference to the Prime Rate could derivatives’’ should not be allowed to rely on the support asset-backed securities with an interest rate 1910 Loan securitizations excluded from the exclusion for loan securitizations. See Sens. determined by reference to LIBOR; or Euro- covered fund definition may only hold certain Merkley & Levin (Feb. 2012). denominated loans could support U.S. Dollar- directly related derivatives as specified in 1906 See final rule § 75.10(c)(8)(iv). denominated asset-backed securities. § 75.11(c)(8)(iv) and as discussed in this Part.

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foreign exchange risk because the covered fund prohibitions.1915 For Under the final rule, a loan hedging of such risks is consistent with example, commenters noted that, in a securitization that is excluded from the the prudent risk management of interest securitization of leases with respect to definition of covered fund may include rate and currency risk in a loan portfolio equipment where a titling trust is used SUBIs or collateral certificates, provided while at the same time avoiding the to hold ownership of the equipment, a that four conditions are met.1920 First, potential for additional risk arising from titling trust will typically own the the special purpose vehicle issuing the other types of derivatives.1911 The equipment and the right to payment on SUBI or collateral certificate itself must Agencies do not believe that the the leases, and then will issue a security meet the conditions of the loan exemption for hedging activity or other instrument, often referred to as securitization exclusion, as adopted in applicable to market making and a special unit of beneficial interest the final rule.1921 Under this provision, underwriting under the final rule is the (SUBI), that represents an ownership for example, the special purpose appropriate measure for permitted interest in the titling trust to the vehicle, in addition to the issuing entity, derivatives in a loan securitization that securitization issuer.1916 As another may hold an interest rate or foreign would be excluded from definition of example, certain securitizations exchange derivative or other assets only covered fund 1912 because the hedging frequently use a master trust structure if the derivative or asset is permitted to exemptions for market making and allowing the trust to issue more than be held in accordance with the underwriting are not tailored to the one series of asset-backed security requirements for derivatives in respect hedging requirements of a securitization collectively backed by a common of the loan securitization exclusion. transaction.1913 The Agencies also do revolving pool of assets. In such a Second, the SUBI or collateral certificate must be used for the sole purpose of not believe that they lack the statutory structure, a master trust may hold assets transferring economic risks and benefits authority to permit a loan securitization (such as loans) and issue a collateral of the loans (and other permissible relying on the loan securitization certificate supported by those assets to assets) 1922 to the issuing entity for the exclusion to use derivatives, as an issuing trust that issues asset-backed securitization and may not directly or suggested by one commenter,1914 securities to investors. The assets held by the master trust are typically a pool indirectly transfer any interest in any because the Agencies believe that the other economic or financial exposures. permitted derivatives relate directly to of revolving accounts that may be paid in full each month (e.g., credit card Third, the SUBI or collateral certificate loans that are permitted and have must be created solely to satisfy legal limited the quality and quantity of receivables) or a revolving pool of short- term loans that are replaced with new requirements or otherwise facilitate the derivatives that an excluded loan structuring of the loan securitization. securitization is permitted to hold loans as they mature (e.g., floor plan 1917 Fourth, the special purpose vehicle directly to the reduction of risks that loans). One commenter opposed the inclusion of securitizations backed by issuing the SUBI or collateral certificate result from the loans and the loan and the issuing entity for the excluded securitization. intermediate asset-backed securities, arguing that each step should be viewed loan securitization transaction must be While loan securitizations that separately to ensure compliance to established under the direction of the include non-loan assets are not prevent the inclusion of impermissible same entity that initiated the loan excluded from the definition of covered assets such as prohibited securitization transaction. The Agencies fund, banking entities are not prohibited derivatives.1918 believe that the fourth condition will from owning interests or sponsoring ensure that the resecuritizations of In response to comments, the these covered funds under the final rule. asset-backed securities purchased in the Agencies are modifying the proposal to Under the final rule, these secondary market, which the Agencies provide that a securitization backed by securitizations would be covered funds, do not believe would constitute a loan certain intermediate asset-backed and banking entities engaged with these securitization, will not be able to use securities will qualify for the loan covered funds would be subject to the these special provisions tailored only securitization exclusion. The Agencies limitations on ownership interests and for transactions utilizing SUBIs and recognize that securitization structures relationships with these covered funds collateral certificates in order to fall that use these types of intermediate imposed by section 13 of the BHC Act. within the loan securitization exclusion. asset-backed securities are essentially The Agencies believe that these iv. SUBIs and Collateral Certificates loan securitization transactions, because conditions provide that only the intermediate asset-backed securities securitizations backed by SUBIs and Commenters also argued that, under in the asset pool are created solely for collateral certificates involving loans— the proposed exemption for loan the purpose of facilitating a and not other types of securities or other securitizations, securitizations that are securitization 1919 and once created, are types of assets—will be able to use the backed by certain intermediate asset- issued directly into a securitization loan securitization exclusion. These backed securities would not satisfy the vehicle rather than to any third party conditions are intended to assure that conditions for the exemption and investor. for purposes of the loan securitization therefore would be subject to the exclusion that only SUBI and collateral 1915 See AFME et al.; Allen & Overy (on behalf of certificates that essentially represent the 1911 See AFR et al. (Feb. 2012); Occupy; Public Foreign Bank Group); ASF (Feb. 2012); Credit underlying loans are included Citizen. Suisse (Williams); GE (Aug. 2012); PNC; RBC; consistent with the terms and the 1912 SIFMA (Securitization) (Feb. 2012). See Occupy. This commenter argued that purpose of section 13 of the BHC Act, covered funds should only be permitted to engage 1916 See SIFMA (Securitization) (Feb. 2012). in hedging activity in accordance with the proposed 1917 See, e.g., ASF (Feb. 2012). UK RMBS master while also not adversely affecting exemption for hedging activity. trusts also use a master trust structure. See AFME 1913 For example, a banking entity may hold an et al.; ASF (Feb. 2012); SIFMA (Securitization) (Feb. 1920 See final rule § 75.10(c)(8)(v). ownership interest in a covered fund in order to 2012). 1921 The provision will allow for the existing hedge employee compensation risks. Because 1918 See Occupy. practice of a master trust to hold a collateral securitizations do not have employees, such a 1919 The use of SUBIs, for example, allows the certificate issued by a legacy master trust. hedging exemption would not be applicable to a sponsor to avoid administrative expenses in 1922 This would include a collateral certificate securitization structure. retitling the physical property underlying the issued by a legacy master trust that meets the 1914 See Occupy. leases. requirements of the loan securitization exclusion.

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securitization of ‘‘loans’’ as defined in of assets from being excluded from the proposing release, the Agencies the final rule.1923 The Agencies believe definition of covered fund. requested comment on the proposed that the limitation of the types of asset- Under the final rule, in order to be rule’s definition of ‘‘covered fund’’ with backed securities permitted in an excluded from the definition of covered respect to asset-backed securities and/or excluded loan securitization (only fund, a loan securitization may not hold securitization vehicles 1931 and received SUBIs and collateral certificates) and (i) a security, including an asset-backed numerous comments requesting a the restrictions placed on those SUBIs security, or an interest in an equity or variety of exemptions for ABCP and collateral certificates that are debt security (unless specifically conduits.1932 permitted in an excluded loan permitted, such as with respect to a A number of commenters requested securitization will avoid loan SUBI or collateral certificate as that the final rule exclude ABCP securitizations that contain other types described above), (ii) a derivative other conduits from the definition of covered of assets from being excluded from the than an interest rate or foreign exchange fund 1933 or that the Agencies use their definition of covered fund. derivative that meets the requirements described above,1926 or (iii) a authority under section 13(d)(1)(J) of the 1934 1935 v. Impermissible Assets commodity forward contract.1927 The BHC Act to similar effect. One Agencies have determined that a loan commenter argued that ABCP conduits As discussed above, commenters on do not have the characteristics of a the loan securitization proposals argued securitization relying on the loan securitization exclusion may not private equity fund or hedge fund,1936 that various types of assets should be even though they typically rely on the included within the definition of loan or include a commodity forward contract exemptions set forth in section 3(c)(1) or otherwise permitted to be held by the because a commodity forward contract 1928 3(c)(7) of the Investment Company Act. loan securitization that would be is not a loan. Another commenter argued that the entitled to rely on the proposed 9. Asset-Backed Commercial Paper proposed rule’s definition of covered exemptions. Conduits fund would negatively impact asset- After considering comments, the Under the proposed rule, certain backed securitizations (including ABCP Agencies have determined to retain the securitization vehicles, including ABCP conduits), and suggested that the narrower scope of the permitted assets conduits, would not have been covered Agencies define covered funds, in part, in a loan securitization that is eligible by the loan securitization exclusion and, as those that both (i) rely on section for the loan securitization exclusion. therefore, would have been deemed to 3(c)(1) or 3(c)(7) of the Investment The Agencies have revised the language be a covered fund.1929 ABCP is a type Company Act and (ii) have the regarding loan securitizations from the of liability that is typically issued by a traditional characteristics of private proposal to specify certain types of special purpose vehicle (commonly equity funds or hedge funds.1937 assets or holdings that a loan referred to as a ‘‘conduit’’) sponsored by Another commenter stated that the rule securitization would not be able to hold a financial institution or other entity. of construction set forth in section if it were eligible to rely on the The short term asset-backed securities 13(g)(2) of the BHC Act 1938 is a clear exclusion from the definition of covered issued by the conduit are supported by indication that section 13 of the BHC fund for loan securitizations.1924 The a managed pool of assets, which may Act was not intended to apply to Agencies recognize that securitization change over the life of the entity. securitization vehicles such as ABCP structures vary significantly and, Depending on the type of ABCP conduits.1939 Another commenter stated accordingly, the loan securitization conduit, the securitized assets exclusion as adopted in the final rule that the lending that occurs through ultimately supporting the short term ABCP conduits is the type of activity accommodates a wider range of asset-backed securities may consist of a securitization practices. The Agencies that Congress and the Executive Branch wide range of assets including have urged banks to expand in order to believe that these limitations provide automobile loans, commercial loans, support economic growth and job that only securitizations backed by trade receivables, credit card creation,1940 while another commenter loans—and not securities, derivatives or receivables, student loans, and other stated that ABCP conduits provide low other types of assets—will be able to use loans in addition to asset-backed cost, reliable financing for registered the loan securitization exclusion securities supported by such assets. The investment companies, which poses consistent with the terms and the term of ABCP typically is short, and the purpose of section 13 of the BHC liabilities are ‘‘rolled’’ (i.e., replaced or little risk to the safety and soundness of Act.1925 The Agencies believe that the refinanced) at regular intervals. Thus, banks because Federal law requires limitation of the types of assets ABCP conduits generally fund longer- registered investment companies to permitted in an excluded loan term assets with shorter-term securitization will avoid loan liabilities.1930 In this regard, in the these liabilities issued by the SIV, while securities securitizations that contain other types arbitrage ABCP programs typically have such liquidity coverage, though the terms are more 1926 See final rule § 75.10(c)(8)(iv); see also 7 limited than those of the ABCP conduits eligible for 1923 See, e.g., rule 190 under the Securities Act. U.S.C. 27(a)–(b). the exclusion pursuant to the final rule. See also, e.g., ASF (Feb. 2012) (noting that certain 1927 See the discussion above in Part VI.B.1.c.8 of 1931 See Joint Proposal, 76 FR at 68899. rules under the Securities Act and staff this SUPPLEMENTARY INFORMATION. 1932 See, e.g., ASF (Feb. 2012); BoA; Capital interpretations have carved out SUBIs and collateral 1928 For a discussion of commodity forward Group; Eaton Vance; Fidelity; ICI (Feb. 2012); certificates from certain disclosure and other contracts, see Further Definition of ‘‘Swap,’’ Japanese Bankers Ass’n.; PNC; RBC. requirements). ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap 1933 See, e.g., ICI (Feb. 2012); PNC et al.; SIFMA 1924 See final rule § 75.10(c)(8)(ii). Agreement’’; Mixed Swaps; Security-Based Swap (May 2012). 1925 Agreement Recordkeeping, 77 FR 48208 (Aug. 13, The Agencies discuss earlier in this Part the 1934 See 12 U.S.C. 1851(d)(1)(J). 2012) (Release Nos. 33–9338 and 34–67453, July 18, permissible assets an excluded loan securitization 1935 See ICI (Feb. 2012). may hold and the Agencies’ belief that excluding 2012). 1936 See PNC. loan securitizations as defined in the final rule is 1929 See proposed rule § 75.13(d). 1937 consistent with the terms and the purpose of 1930 Structured investment vehicles (‘‘SIVs’’) and See Barclays. section 13 of the BHC Act, including the rule of securities arbitrage ABCP programs both purchase 1938 See 12 U.S.C. 1851(g)(2). construction in section 13(g)(2). See, e.g., supra securities (rather than receivables and loans). SIVs 1939 See ICI (Feb. 2012). note 1871 and accompanying and following text. typically lack liquidity facilities covering all of 1940 See Credit Suisse (Williams).

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maintain prescribed asset coverage in To this end, commenters proposed that the loan securitization exemption connection with borrowings.1941 several means to exclude ABCP should allow banking entities to Two commenters contended that, conduits from the proposed rule’s sponsor, control, and invest in ABCP while certain issuers of asset-backed restrictions and requirements, including conduits that facilitate the securitization securities may rely on section 3(c)(5) of an expansion of the loan securitization of customer loans and receivables.1952 the Investment Company Act or rule 3a– exemption to treat two-step In contrast, one commenter supported 7 thereunder, and, therefore, not be securitization transactions as a single the restriction of the loan securitization brought under the proposed rule’s loan securitization,1946 a separate exemption to the plain meaning of what definition of covered fund, ABCP exclusion for ABCP conduits,1947 an constitutes a loan and advocated that conduits typically cannot rely on this expansion of the definition of loan,1948 the Agencies not include ABCP section or rule either because to do so or as part of a broad exclusion for all conduits under the exemption.1953 would be too restrictive (in the case of issuers of asset-backed securities.1949 In In addition to the effect the proposed section 3(c)(5)) or because they cannot order to allow ABCP conduits to qualify rule’s definition of covered fund would meet the rule’s requirements.1942 as loan securitizations, commenters have on ABCP conduits, commenters One commenter, employing ABCP suggested that the loan securitization also noted that section 13(f) of the BHC conduits as an example, stated that exclusion should permit a limited Act 1954 would prohibit certain failing to exempt securitization vehicles amount of securities purchased in the transactions between a banking entity from the covered fund prohibitions secondary market.1950 Commenters also sponsor and a covered fund would preclude banking entities from proposed changes to the permissible securitization.1955 Two commenters engaging in activities that have long assets such as allowing a loan requested a specific exemption from been recognized as permissible securitization to hold liquidity and § 75.16 of the proposed rule for ABCP activities for banking entities and that support commitments, asset-backed conduits based on the interpretation are vital to the normal functioning of the securities and certain financial assets in that the proposed rule subjects covered securitization markets, and will have a addition to loans that by their terms funds exempted under the loan significant and negative impact on the convert to cash within a finite period of securitization exemption or other securitization markets and on the ability time.1951 Another commenter argued exemptions to § 75.16.1956 Commenters of banking entities and other companies argued that without liquidity and credit to provide credit to their customers.1943 $49.4 billion of loans to commercial borrowers and support, ABCP conduits are not This commenter further stated that $50.7 billion of trade receivables were financed by 1957 the U.S. ABCP conduit market as of October 31, viable, cannot effectively 1958 1959 ABCP conduits are an efficient and 2011, and that the total outstanding amount of operate, could not function, or attractive way for banking entities to securities sold by ABCP conduits in the U.S. market would not be marketable.1960 One lend their own credit-worthiness to was $344.5 billion as of January 18, 2012. See ASF commenter argued that prohibiting a expand the pool of possible lenders (Feb. 2012). 1946 banking entity from providing liquidity willing to finance key economic activity See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); PNC; SIFMA facilities to ABCP conduits is while maintaining a low cost of funding (Securitization) (Feb. 2012). tantamount to requiring the banking for consumers, and because of the 1947 See ASF (Feb. 2012); Capital Group (alleging entity to wind down the operation of liquidity support provided by the that ABCP does not pose the risks that the rule is such ABCP conduits.1961 sponsoring banking entity, the meant to combat); GE (Feb. 2012). One commenter proposed an exemption for ABCP conduits that In response to the comments received sponsoring banking entity to the ABCP included a requirement of 100% liquidity support and in light of the rule of construction conduit has full exposure to the assets from a regulated, affiliated entity, and such contained in section 13(g)(2) of the BHC acquired by or securing the amounts liquidity support may be conditional or Act, the Agencies have determined in lent by the ABCP conduit and the unconditional. See RBC. the final rule to exclude from the 1948 See Credit Suisse (Williams) (alleging that banking entity subjects those assets and ABCP conduits acquire ownership of loans definition of covered fund an ABCP the obligors to the same analysis as it indirectly through the purchase of variable funding conduit that is a ‘‘qualifying asset- would engage in if the bank were notes, trust certificates, asset-backed securities, backed commercial paper conduit’’ as lending directly against those assets.1944 repurchase agreements and other instruments that defined in the final rule is excluded may be considered securities, all of which 1962 Another commenter stated that the economically are consistent with providing funding from the definition of covered fund. provision of credit to companies to or extensions of credit to customers); ICI (Feb. 2012) finance receivables through ABCP (requesting that the definition of loan include the backed by loans). See Joint Proposal, 76 FR at conduits is an area of traditional broad array of receivables that back ABCP). 68865; GE (Feb. 2012); RBC. banking activity that should be 1949 See AFME et al.; SIFMA (Securitization) 1952 See PNC. (Feb. 2012). 1953 distinguished from the type of high-risk, See Public Citizen. 1950 See ASF (Feb. 2012) (requesting that ABCP 1954 See 12 U.S.C. 1851(f); see also § 75.16 of the conflict-ridden financial activities that conduits be permitted to own asset-backed proposed rule. Congress sought to restrict under section securities purchased on the secondary market only 1955 See, e.g., Allen & Overy (on behalf of Foreign 13 of the BHC Act.1945 if the aggregate principal amount of such securities Bank Group); Credit Suisse (Williams); Fidelity; IIB/ does not exceed 5% of the aggregate principal or EBF; JPMC; PNC; RBC; SIFMA (Securitization) (Feb. face amount of all assets held by the ABCP conduit 1941 See Eaton Vance. 2012). in order to diversify their asset base and avoid the 1956 See ICI (Feb. 2012); Fidelity. 1942 See RBC; ASF (Feb. 2012). negative consequences of divestiture of such assets); 1957 See JPMC. 1943 See Credit Suisse (Williams). RBC (requesting that loan securitizations be 1958 1944 Id. permitted to hold cash equivalents and assets, other See ASF (Mar. 2012). 1959 1945 See ICI (Feb. 2012). This commenter than loans, which, by their terms, convert to cash See Allen & Overy (on behalf of Foreign Bank emphasized the importance of the ABCP conduit within a finite period of time so long as such assets Group). market to money market funds, noting that as of comprise no more than 10% of their total assets 1960 See ASF (Feb. 2012); Fidelity. November 2011, taxable money market funds held based on book value). 1961 See ASF (Mar. 2012). $126 billion of the $348.1 billion of securities 1951 See ASF (Feb. 2012) (arguing that the loans, 1962 See final rule § 75.10(c)(9)(i). The rule of issued by ABCP conduits outstanding, which receivables, leases, or other assets purchased by the construction contained in section 13(g)(2) of the represented approximately 5.4% of taxable money ABCP conduit might have fit the definition of loan BHC Act provides that nothing in section 13 of the market funds’ total assets. Another commenter in the proposed rules but for the proposal’s express BHC Act shall be construed to limit or restrict the noted that approximately $66.7 billion of assertion that the definition of loan does not ability of a banking entity or nonbank financial automobile loans and leases, $52.1 billion of include any asset-backed security that is issued in company supervised by the Board to sell or student loans, $22.3 billion of credit card charges, connection with a loan securitization or otherwise securitize loans in a manner that is otherwise

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Under the final rule, a qualifying sovereign, which would include its under Rule 2a-7 of the Investment asset-backed commercial paper conduit departments and ministries, including Company Act. is an ABCP conduit that holds only (i) the central bank. Second, the asset-backed securities loans or other assets that would be In this regard, under the final rule, the issued by the ABCP conduit must be permissible in a loan securitization 1963 exclusion from the definition of covered supported only by loans and certain and (ii) asset-backed securities that are fund in respect of ABCP conduits is asset-backed securities that meet the supported solely by assets permissible only available to an issuer of short-term requirements of the loan securitization for a loan securitization and are asset-backed securities supported by exclusion. By placing restrictions on the acquired by the conduit as part of an loans and certain asset-backed securities assets permitted to be held by an initial issuance directly from the issuer supported by loans that were issued or excluded loan securitization, the or directly from an underwriter engaged initially sold to the ABCP conduit, and potential for evasion of the covered fund in the distribution of the securities.1964 the short term asset-backed securities prohibitions is reduced. The exclusion In addition, a qualifying asset-backed issued by the ABCP conduit are for qualifying ABCP conduits is commercial paper conduit must issue supported by a liquidity facility that intended, as contemplated by the rule of only asset-backed securities, comprising provides 100 percent liquidity coverage construction in section 13(g)(2) of the of a residual and securities with a term from a regulated liquidity provider. The BHC Act, to permit banks to continue to of 397 days or less and in addition, a exclusion, therefore, is not available to engage in securitizations of loans. ‘‘regulated liquidity provider,’’ as ABCP conduits that lack 100 percent Including all types of securities and defined in the final rule, must provide liquidity coverage. The liquidity other assets within the scope of a legally binding commitment to coverage may be provided in the form permitted assets in a qualifying ABCP provide full and unconditional liquidity of a lending facility, an asset purchase conduit, as with loan securitizations, coverage with respect to all the agreement, a repurchase agreement, or would expand the exclusion beyond the outstanding short term asset-backed similar arrangement and 100 percent scope of the definition of loan in the securities issued by the qualifying asset- liquidity coverage means that, in the final rule that is intended to implement backed commercial paper conduit in the event the qualifying asset-backed the rule of construction. Third, the asset-backed securities event that funds are required to redeem commercial paper conduit is unable for 1965 supporting a qualifying asset-backed the maturing securities. any reason to repay maturing asset- commercial paper conduit must be Under the final rule, a regulated backed securities issued by the issuing purchased as part of the initial issuance liquidity provider is (i) a depository entity, the total amount for which the institution as defined in section 3 of the of such asset-backed securities. Asset- regulated liquidity provider may be Federal Deposit Insurance Act; 1966 (ii) a backed securities purchased by an obligated is equal to 100 percent of the bank holding company or a subsidiary ABCP conduit in the secondary market amount of asset-backed securities thereof; 1967 (iii) a savings and loan will not be permitted because such a outstanding plus accrued and unpaid holding company,1968 provided all or purchase would not be part of an initial interest. In addition, amounts due substantially all of the holding issuance and the banking entity that pursuant to the required liquidity company’s activities are permissible for established and manages the ABCP coverage may not be subject to the credit a financial holding company,1969 or a conduit would not have participated in performance of the asset-backed subsidiary thereof; (iv) a foreign bank the negotiation of the terms of such securities held by the qualifying asset- whose home country supervisor as asset-backed securities. Without a more defined in section 211.21 of the Federal backed commercial paper conduit or direct connection between the banking Reserve Board’s Regulation K 1970 has reduced by the amount of credit support entity and the ABCP conduit, the adopted capital standards consistent provided to the qualifying asset-backed purchase of such asset-backed securities with the Capital Accord of the Basel commercial paper conduit. Under the in the secondary market would resemble Committee on Banking Supervision, as final rule, liquidity coverage that only investments in securities. amended, and that is subject to such funds an amount determined by Fourth, under the final rule, the ABCP standards, or a subsidiary thereof; or (v) reference to the amount of performing conduit exclusion will not be available a sovereign nation.1971 In order for a loans, receivables, or asset-backed to ABCP conduits that lack 100 percent sovereign nation to qualify as a securities will not be permitted to liquidity coverage. The Agencies believe regulated liquidity provider, the satisfy the liquidity requirement for a that the 100 percent liquidity coverage liquidity provided must be qualifying asset-backed commercial requirement distinguishes the conduits unconditionally guaranteed by the paper conduit. eligible for the exemption, which As discussed above, the final rule sometimes hold and securitize a permitted by law. As noted above and explained defines a qualifying asset-backed customer’s loans through an intervening below, a qualifying asset-backed commercial paper commercial paper conduit as having special-purpose vehicle instead of conduit under the final rule is an ABCP conduit certain elements. First, a qualifying holding the loans directly, and are that holds only (i) loans or other assets that would be permissible in a loan securitization and (ii) asset- asset-backed commercial paper conduit supported by a 100 percent liquidity backed securities that are supported solely by assets must issue only a residual interest and guarantee, from other types of conduits permissible for a loan securitization and are short-term asset-backed securities. This with partial liquidity guarantees (such acquired by the conduit as part of an initial requirement distinguishes ABCP issuance directly from the issuer or directly from an as structured investment vehicles) that underwriter engaged in the distribution of the conduits from covered funds that issue have sometimes been operated by securities. partnership interests and mitigates the banking entities for the purpose of 1963 See final rule § 75.10(c)(8). potential that a qualifying ABCP financing portfolios of securities 1964 See final rule § 75.10(c)(9)(i)(B). conduit would be used for evasion of acquired or retained as part of their 1965 See final rule § 75.10(c)(9)(ii) and (iii). the covered fund prohibitions. The 1966 activities in the securities markets. See 12 U.S.C. 1813. Agencies chose a maximum term of 397 The Agencies recognize that ABCP 1967 See 12 U.S.C. 1841. 1968 See 12 U.S.C. 1467a. days for these securities because this conduits that do not satisfy the elements 1969 See 12 U.S.C. 1843(k). time frame corresponds to the maximum of the ABCP conduit exclusion may be 1970 See 12 CFR 211.21. maturity of securities allowed to be covered funds and therefore would be 1971 See final rule § 75.10(c)(9)(iii). purchased by money market funds subject to section 13(f) of the BHC

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Act.1972 As a result of section 13(f) of securitization markets,1974 and to the According to one commenter, the the BHC Act, which prohibits certain creation of new securitization products majority of covered bonds are issued transactions between banking entities to meet investor demands that Congress under specific legislative frameworks and a covered fund securitization that may not have contemplated. 1975 which define permitted characteristics the banking entity sponsors or for which However, financial institutions that are for covered bond issuances, including it provides investment management not banking entities and therefore are the kinds and quality of collateral that services, the banking entity would be not subject to the restrictions on may be included in cover pools, the prohibited from providing liquidity ownership can continue to engage in specific legal framework for issuance of support for the ABCP conduit. activities relating to securitization, covered bonds, and the procedures for Similarly, while some commenters including those securitizations that fall resolution in the event that the issuer requested that the loan securitization under the definition of covered fund. becomes insolvent.1978 Some exclusion permit the holding of a Furthermore, new securitizations may commenters expressed concern about limited amount of securities purchased be structured so as to qualify for the the possibility that certain covered bond in the secondary market, the final rule loan securitization exclusion or other structures could fall within the does not provide for this in the context exclusions under the final rule. For definition of covered fund, as proposed. of ABCP conduits. The Agencies believe these reasons, the impact on In particular, commenters expressed that the limitations on the types of securitizations that are not excluded concern about covered bond structures securities that a qualifying asset-backed under the final rule may be mitigated. in the United Kingdom that also would commercial paper conduit may invest in The Agencies believe that the final be relevant in principle with respect to are needed to avoid the possibility that rule excludes from the definition of covered bond structures used in other a banking entity could use a qualifying covered fund typical structures used in European Union (‘‘EU’’) jurisdictions asset-backed commercial paper conduit the most common loan securitizations (e.g., the Netherlands and Italy) and to securitize non-loan assets or to representing a significant majority of the certain non-EU jurisdictions (e.g., engage in proprietary trading of such current securitization market, such as Canada, Australia, and New securities prohibited under the final 1979 residential mortgages, commercial Zealand). Another commenter rule. Thus this limitation reduces the mortgages, student loans, credit card indicated that covered bonds issued by potential for evasion of the covered fund receivables, auto loans, auto leases and certain French entities that hold a provisions of section 13 of the BHC Act. equipment leases. Additionally, the revolving pool of loans may be impacted In developing the exclusion from the 1980 Agencies believe that esoteric asset by the proposed rule. definition of covered fund for qualifying Certain commenters argued that in classes supported by loans may also be asset-backed commercial paper conduits order to achieve the intended economic able to rely on the loan securitization in the final rule, the Agencies effect of providing recourse to both the exclusion, such as time share loans, considered the factors set forth in bank issuing covered bonds and to the container leases and servicer advances. sections 13(g)(2) and 13(h)(2) of the BHC collateral pool, the issuing bank may Act. The final rule includes conditions 10. Covered Bonds enter into a number of agreements with designed to ensure that an ABCP the SPV that holds the collateral. This conduit established and managed by a Several commenters called for includes transactions where the bank covered bond structures to be excluded takes on credit exposure to the SPV banking entity serves as a means of 1976 facilitating that banking entity’s loan from the definition of covered fund. (e.g., through derivatives and securities securitization activity rather than They indicated that the proposed rule lending, provision of loans, and/or financing that banking entity’s capital may interfere with and restrict non-U.S. investments in securities of the market investments. The final rule banks’ ability to establish or issue SPV).1981 The issuing bank typically distinguishes between qualifying asset- covered bonds. As described by several also provides asset and liability backed commercial paper conduits and commenters, covered bonds are full management services to the SPV and other ABCP conduits in order to adhere recourse debt instruments typically may also repurchase certain assets from to the tenets of section 13 of the BHC issued by a non-U.S. entity that are fully the SPV.1982 Commenters also Act while accommodating the market secured or ‘‘covered’’ by a pool of high- contended that under certain legislative practices discussed by the commenters quality collateral (e.g., residential or frameworks, the SPV issues the covered commercial mortgage loans or public bonds and holds the collateral, and a by facilitating reasonable access to 1977 credit by consumers and businesses sector loans). Certain of these sponsoring bank lends money to the through the issuance of ABCP backed by covered bond structures utilize a special SPV.1983 According to commenters, the consumer and business receivables. As purpose vehicle (‘‘SPV’’) that holds a discussed above, the Agencies collateral pool. As such, under the 1978 See UKRCBC. For example, a commenter understand that some existing ABCP proposed rule, an SPV could be a indicated that in the European Union, Article 52(4) of the EU UCITS Directive sets out the defining conduits may need to be restructured to covered fund that relies on the exclusion in section 3(c)(1) or 3(c)(7) of characteristics of covered bonds, and this directive conform to the requirements of the is implemented by specific legislative frameworks. the Investment Company Act. ABCP conduit exclusion. 1979 See UKRCBC; FSA (Apr. 2012). One To the extent that the definition of commenter argued that there are two main models covered fund, the loan securitization 1974 See Credit Suisse (Williams) (employing used for covered bond structures in Europe—the ABCP conduits as an example); ASF (Feb. 2012) integrated model (where the collateral pool exclusion and the ABCP conduit (describing the constriction of the market for asset- continues to be owned directly by the bank issuer exclusion do not eliminate the backed securities if banking entities are restricted and is segregated by special legislation) and the applicability of the final rule provisions from owning debt classes of new asset backed structured model (where the pool is transferred to to certain covered funds, there may be securities). a special purpose vehicle and is segregated by 1975 operation of legal principles). See UKRCBC. adverse effects on the provision of See RBC; ASF (Feb. 2012). 1976 1980 See Allen & Overy (on behalf of Foreign Bank 1973 See Allen & Overy (on behalf of Foreign Bank capital to customers, to Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. Group). 2012). 1981 See FSA (Apr. 2012). 1972 See 12 U.S.C. 1851(f); see also § 75.16 of the 1977 See AFME et al.; Allen & Overy (on behalf of 1982 See UKRCBC. proposed rule. Foreign Bank Group); ASF (Feb. 2012); FSA (Apr. 1983 See Allen & Overy (on behalf of Foreign Bank 1973 See, e.g., ASF (Feb. 2012). 2012); UKRCBC. Group).

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broad definition of covered fund in the securities prohibited under the final if it meets all of the requirements of that proposed rule could capture an SPV that rule. The Agencies believe this exclusion. holds the collateral, so transactions restriction reduces the potential for The Agencies recognize that many between an SPV and the issuing bank or evasion of the final rule. covered bond programs may involve 1984 sponsor bank may be prohibited. By placing restrictions on the assets foreign covered bond programs (and These commenters argued that permitted to be held by a cover pool, the their related cover pools) that are including covered bond structures in potential for evasion of the covered fund permitted by their respective laws to the definition of covered fund is prohibitions is reduced. The exclusion own residential mortgage-backed inconsistent with the legislative intent for cover pools is intended, as securities and other non-loan assets. As of the rule, would have a negative and contemplated by the rule of a result, the exclusion for covered bonds disproportionate effect on foreign banks, construction in section 13(g)(2) of the in the final rule may not be available to markets and economies and would give BHC Act, to permit banking entities to many of the existing cover pools that rise to potential conflicts with such continue to engage in lending activities support outstanding covered bonds. The 1985 foreign legislative frameworks. and the financing those lending Agencies recognize that this approach According to certain commenters, activities. Including all types of may not exclude all foreign covered SPVs whose sole function is as part of securities and other assets within the bond programs. Although certain an offering of covered bonds should be scope of permitted assets in a cover commenters argued that including excluded from the definition of covered pools would expand the exclusion covered bond structures in the fund in the final rule. These beyond the scope of the definition of definition of covered fund is commenters provided that the proposed loan in the final rule that is intended to inconsistent with the legislative intent rule was not clear on whether these 1992 implement the rule of construction. of the rule, the Agencies believe that SPVs, which effectively function as Additionally, because the exclusion for the exclusion for qualifying covered collateral devices for the covered bond, cover pools is only available to foreign bonds, including the limitations on the would be excluded from the definition banking organizations, allowing such types of securities that a loan of covered fund.1986 One commenter cover pools to hold securities would securitization can hold, is consistent indicated that the key concern was provide unequal treatment of covered with the rule of construction contained primarily due to the wide definition of bonds as compared to a loan in section 13(g)(2) of the BHC Act and covered fund in the proposed rule.1987 securitization sponsored by a U.S. appropriate for the reasons discussed Other commenters indicated that the banking entity. directly above and under ‘‘Definition of final rule should not apply to covered Loan.’’ The Agencies also recognize that Under the definition of covered bond bond transactions because they are not commenters argued that including in the final rule, the debt obligation may traditionally recognized or regulated as covered bonds as covered funds could be issued directly by a foreign banking asset-backed securities transactions, and have a negative and disproportionate organization or by an entity that owns they are not the type of transactions that effect on foreign banks, markets and 1988 a permitted cover pool. In both cases, the rule was intended to address. economies and would give rise to the payment obligations of the debt As a result of comments received on potential conflicts with such foreign obligation must be fully and covered bond vehicles, the final rule legislative frameworks.1993 The unconditionally guaranteed. If the debt specifically excludes from the definition Agencies note that, although they do not obligation is issued by a foreign banking of covered fund certain entities that own know the composition of the cover organization, such debt obligation will or hold a dynamic or fixed pool of assets pools, the Agencies believe that foreign be a ‘‘covered bond’’ under the final rule that covers the payment obligations of banking organizations should be able to if the payment obligations are fully and covered bonds. In order to qualify for look at the composition of their cover unconditionally guaranteed by an entity the exclusion, the assets or holdings in pools to evaluate how to meet the that owns a permitted cover pool.1990 If the cover pool must satisfy the requirements of the exclusion — and the debt obligation is issued by an entity conditions in the loan securitization thus to avoid or mitigate the adverse that owns a permitted cover pool, such exclusion, except for the requirement effects commenters asserted would debt obligation will be a ‘‘covered that the securities they issue are asset- occur—as they determine appropriate. backed securities (the ‘‘permitted cover bond’’ under the final rule if (i) the pool’’).1989 The Agencies believe this payment obligations are fully and 11. Certain Permissible Public Welfare approach is consistent with the rule of unconditionally guaranteed by a foreign and Similar Funds banking organization and (ii) the issuer construction contained in section Section 13(d)(1)(E) of the BHC Act of the debt obligation is a wholly-owned 13(g)(2) of the BHC Act. The rule of permits a banking entity to make and subsidiary (as defined) by such foreign construction in section 13(g)(2) of the retain: (i) Investments in one or more banking organization.1991 Thus, under BHC Act specifically refers to the ‘‘sale small business investment companies the final rule, a covered bond structure and securitization of loans’’ and the (‘‘SBICs’’), as defined in section 103(3) in which an entity holds the cover pool Agencies would not want a banking of the Small Business Investment Act of and issues securities that are fully and entity to use an excluded cover pool to 1958 (SBA) (15 U.S.C. 662) 1994; (ii) engage in proprietary trading of such unconditionally guaranteed by a foreign banking organization may also be able to 1992 See supra note 1985 and accompanying text. 1984 See Allen & Overy (on behalf of Foreign Bank rely on the loan securitization exclusion 1993 Id. Group); UKRCBC; FSA (Apr. 2012). 1994 The Agencies note that section 13(d)(1)(E) of 1985 See Allen & Overy (on behalf of Foreign Bank 1990 See final rule § 75.10(c)(10)(ii)(A). the BHC Act incorrectly provides that the term Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. 1991 See final rule § 75.10(c)(10)(ii)(B). As ‘‘small business investment company’’ is defined in 2012); AFME et al. For a discussion of possible discussed above in the section describing the section 102 of the SBA, while the definition is in economic effects, see FSA (Feb. 2012); UKRCBC; wholly-owned subsidiary exclusion from the fact contained in section 103(3) of the SBA as Allen & Overy (on behalf of Foreign Bank Group). definition of covered fund, the Agencies are codified at 15 U.S.C. 662. The statute includes the 1986 See ASF (Feb. 2012); AFME et al.; UKRCBC. permitting 0.5 of a wholly-owned subsidiary to be correct citation to 15 U.S.C. 662. The Agencies are 1987 See UKRCBC. owned by an unaffiliated party for the purpose of correcting this technical error in the final rule by 1988 See, e.g., AFME et al. establishing corporate separateness or addressing updating the reference to section 102 to section 1989 See final rule § 75.10(c)(10). bankruptcy, insolvency, or similar concerns. 103(3).

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investments that are designed primarily from the application of section 13(f) or, By excluding SBICs and other public to promote the public welfare, of the in the alternative, from the definition of interest funds from the definition of type permitted under paragraph (11) of covered fund.2000 covered fund—rather than provide a section 5136 of the Revised Statutes of In addition, commenters requested permitted activity exemption as the United States (12 U.S.C. 24); and clarification that specific types of public proposed—the Agencies addressed (iii) investments that are qualified welfare, SBIC, and other tax credit commenters’ concerns regarding the rehabilitation expenditures with respect investments would be eligible for the burdens imposed by section 13(f). The to a qualified rehabilitated building or exemption, including Low Income Agencies believe that excluding these certified historic structure, as such Housing Tax Credits, Renewable Energy investments from the definition of terms are defined in section 47 of the Tax Credits, New Markets Tax Credits, covered fund addresses the issues many Internal Revenue Code of 1986 or a and Rural Business Investment commenters raised with respect to the similar State historic tax credit Companies.2001 One commenter application of section 13(f) of the BHC program.1995 The proposed rule requested that applicants for an SBIC Act, and gives effect to the statutory permitted banking entities to invest in license that have received permission exemption of these investments in a and act as sponsor 1996 to these entities, from the Small Business Administration way that appropriately facilitates but did not explicitly exclude them to file a formal SBIC license application national community and economic from the definition of covered fund.1997 be viewed the same as an SBIC.2002 development objectives. The Agencies Commenters generally supported the Other commenters sought coverage of believe that permitting a banking entity proposed exemption for investments in investments in non-SBIC funds that to sponsor and invest in these types of and sponsorship of funds designed to provide capital to small and middle- public interest entities will result in promote the public welfare, SBICs, and market companies,2003 investments in banking entities being able to provide other tax credit funds given the valuable any state administered tax credit valuable expertise and services to these funding and assistance these program,2004 and investments outside entities and to provide funding and investments provide in facilitating the United States that are of the type assistance to small businesses and low- community and economic priorities and permitted under paragraph (11) of and moderate-income communities. The the role these investments play in the section 5136 of the Revised Statutes of Agencies believe that providing the ability of banking entities, especially the United States (12 U.S.C. 24).2005 exclusion will also allow banking community and regional banks, to entities to continue to provide capital to In light of the comments received, the achieve their financial and Community community-improving projects and in final rule excludes from the definition Reinvestment Act (‘‘CRA’’) goals. some instances promote capital of covered fund an issuer that is an SBIC However, commenters raised some formation. (or that has received from the Small issues with respect to the proposed Business Administration notice to 12. Registered Investment Companies exemption and sought clarification on proceed to qualify for a license as an and Excluded Entities its application to specific SBIC, which notice or license has not investments.1998 Of primary concern to The proposed rule did not specifically been revoked) or the business of which include registered investment commenters was the impact of the is to make investments that are: (i) prohibition in section 13(f) of the BHC companies (including mutual funds) or Designed primarily to promote the business development companies Act on the ability of a banking entity public welfare, of the type permitted sponsoring a tax credit fund or its within the definition of covered under paragraph (11) of section 5136 of 2007 affiliate to guarantee certain obligations fund. As explained above, the the Revised Statutes of the United States statute references funds that rely on of the fund in order to provide (12 U.S.C. 24), including the welfare of assurance to investors that the section 3(c)(1) or 3(c)(7) of the low- and moderate-income communities Investment Company Act. Registered investment has been properly structured or families (such as providing housing, to enable the investor to receive the tax investment companies and business services, or jobs); or (ii) qualified development companies do not rely on benefits on which the investment are rehabilitation expenditures with respect either section 3(c)(1) or 3(c)(7) of the sold.1999 Some commenters noted that to a qualified rehabilitated building or Investment Company Act and are failure to address this issue in the final certified historic structure, as such instead registered or regulated in rule would damage a large segment of terms are defined in section 47 of the accordance with the Investment this market and therefore urged the Internal Revenue Code of 1986 or a Company Act. Agencies to exempt these investments similar State historic tax credit Many commenters argued that 2006 registered investment companies and 1995 program. See 12 U.S.C. 1851(d)(1)(E). business development companies would 1996 The proposal implemented a proposed 2000 determination by the Agencies under 13(d)(1)(J) See ABA (Keating); Lone Star; Novogradac be treated as covered funds under the ‘‘that a banking entity may not only invest in such (LIHTC); Novogradac (NMTC); Novogradac (RETC); proposed definition if commodity pools entities as provided under section 13(d)(1)(E) of the SVB; U.S. Bancorp. are treated as covered funds.2008 A few 2001 See NCHSA; SBIA; Novogradac (LIHTC); BHC Act, but also may sponsor an entity described commenters argued that the final rule in that paragraph and that such activity, since it Novogradac (NMTC); Novogradac (RETC). generally would facilitate investment in small 2002 See SBIA; see also SEC Rule 3c-2. should specifically provide that all SEC- businesses and support the public welfare, would 2003 See ABA (Keating); PNC. promote and protect the safety and soundness of 2004 See USAA. qualified rehabilitated building or certified historic banking entities and the financial stability of the 2005 See JPMC; SIFMA et al. (Covered Funds) structure, as provided for under § 75.10(c)(11). United States.’’ Joint Proposal, 76 FR at 68908 (Feb. 2012). 2007 See proposed rule § 75.10(b)(1). n.292. 2006 See final rule § 75.10(c)(11). This provision 2008 See, e.g., Arnold & Porter; BoA; Goldman 1997 See proposed rule § 75.13(a). would cover any issuer that engages in the business (Covered Funds); ICI (Feb. 2012); Putnam; TCW; 1998 See Novogradac (LIHTC); Novogradac of making tax credit investments (e.g., Low Income Vanguard. According to these commenters, a (NMTC); Novogradac (RETC); PNC; Raymond Housing Tax Credit, New Markets Tax Credit, registered investment company may use security or James; SIFMA et al. (Covered Funds) (Feb. 2012); Renewable Energy Tax Credit, Rural Business commodity futures, swaps, or other commodity SBIA. Investment Company) that are either designed to interests in various ways to manage its investment 1999 See AHIC; Novogradac (LIHTC); Novogradac promote the public welfare of the type permitted portfolio and be swept into the broad definition of (NMTC); Novogradac (RETC); SBIA; Union Bank; under 12 U.S.C. 24 (Eleventh) or are qualified ‘‘commodity pool’’ contained in the Commodity U.S. Bancorp. rehabilitation expenditures with respect to a Exchange Act.

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registered funds are excluded from the In order to prevent banking entities inadvertently be included within the definition of covered fund (and the from purporting to use this exclusion for definition of covered fund, a number of definition of banking entity) to avoid vehicles that the banking entity does not commenters urged that the final rule any uncertainty about whether section reasonably expect to become a include a mechanism to exclude other 13 applies to these types of funds.2009 registered investment company or entities from the term ‘‘covered fund’’ Commenters also requested that the business development company, the by rule or order if the Agencies final rule exclude from the definition of exclusion is available only with respect determine such an exclusion is covered fund entities formed to to a vehicle that the banking entity appropriate.2015 establish registered investment operates (i) pursuant to a written plan, As evidenced by the extensive companies during the seeding period. developed in accordance with the comments discussed above identifying These commenters contended that, banking entity’s compliance program, the many types of corporate structures during the early stages of forming and that reflects the banking entity’s and other vehicles (not just investment seeding a registered investment determination that the vehicle will funds) that rely on sections 3(c)(1) and company, an entity relying on section become a registered investment 3(c)(7) but do not engage in investment 3(c)(1) or (3)(c)(7) may be created to company or business development activities of the type contemplated by facilitate the development of a track company within the time period section 13, the scope of an overly broad record for the registered investment provided by the final rule for seeding a definition of covered fund may impose company so that it may be marketed to covered fund; (ii) consistently with the 2010 significant burdens on banking entities unaffiliated investors. leverage requirements under the that are in conflict with the purposes of Section 13’s definition of private Investment Company Act of 1940 that section 13 of the BHC Act. In response equity fund and hedge fund by reference are applicable to registered investment to commenters’ concerns and to address to section 3(c)(1) and 3(c)(7) of the companies and SEC-regulated business the potential that the final rule’s Investment Company Act appears to development companies.2012 A banking reflect Congress’ concerns about definition of covered fund might entity that seeds a covered fund for any encompass entities that do not engage in banking entities’ exposure to and purpose other than to register it as an relationships with investment funds the investment activities contemplated investment company or establish a by section 13, the final rule includes a that explicitly are excluded from SEC business development company must provision that provides that the regulation as investment companies. comply with the requirements of section Agencies may jointly determine to The Agencies do not believe it would be 13(d)(1)(G) of the BHC Act and § 75.11 exclude an issuer from the definition of appropriate to treat as a covered fund of the final rule as described above. The covered fund if the exclusion is registered investment companies and Agencies will monitor this seeding consistent with the purposes of section business development companies, activity for attempts to use this 13 of the BHC Act.2016 which are regulated by the SEC as exclusion to evade the requirements investment companies. The Agencies governing the ownership of and As noted above, the statute permits believe that the proposed rule’s relationships with covered funds under the Agencies to act by rule to modify the inclusion of commodity pools would section 13 of the BHC Act and the final definition of covered fund. After issuing have resulted in some registered rule.2013 the proposed rule and receiving investment companies and business comment on it, the final rule provides development companies being covered that the Agencies may act jointly to funds, a result the Agencies did not 13. Other Excluded Entities provide an exclusion.2017 The Agencies intend. The Agencies, in addition to Section 13(h)(2) permits the Agencies are working to establish a process narrowing the commodity pools that to include similar funds within the within which to evaluate requests for will be included as covered funds as definition of covered fund, but the exclusions and expect to provide discussed above, have also modified the proposal did not contain a process for additional guidance on this matter as final rule to exclude SEC-registered excluding from the definition of covered the Agencies gain experience with the 2018 investment companies and business fund other entities that do not engage in final rule. As a result, the definition development companies from the the investment activities contemplated of covered fund would remain unified definition of covered fund.2011 by section 13. Many commenters argued and consistent. The final rule also The Agencies also recognize that an that the breadth of entities that may be provides that a determination by the entity that becomes a registered required to rely on the exclusions in Agencies to exclude an entity from the investment company or business section 3(c)(1) or 3(c)(7) of the definition of covered fund will be development company might, during its Investment Company Act could result in promptly made public in order to seeding period, rely on section 3(c)(1) or additional unidentified entities ensure that both banking entities and 3(c)(7). The Agencies have determined becoming subject to the definition of the public may understand what entities to exclude these seeding vehicles from covered fund.2014 In order to ensure that are and are not included within the the covered fund definition for the same the final rule effectively addresses the definition of covered fund. reasons the Agencies determined to full scope of entities that may exclude entities that are operating as 2015 See SIFMA et al. (Covered Funds) (Feb. registered investment companies or 2012 See final rule §§ 75.10(c)(12)(i); 10(c)(12)(iii); 2012); Credit Suisse (Williams); GE (Feb. 2012). business development companies as 75.20(e). 2016 See final rule § 75.10(c)(14). discussed above. 2013 The Agencies also note that banking entities 2017 As discussed above, the Agencies also may with more than $10 billion in total consolidated determine jointly that an entity excluded from the assets as reported on December 31 of the previous definition of covered fund under § 75.10(c) is in fact 2009 See Arnold & Porter; Goldman (Covered two calendar years must maintain records that a covered fund, and consequently banking entities’ Funds); see also SIFMA et al. (Covered Funds) (Feb. include, among other things, documentation of the investments in and transactions with such fund 2012); SIFMA et al. (Mar. 2012); ABA (Keating); exclusions or exemptions other than sections 3(c)(1) would be subject to limitations and/or divestiture. BoA; ICI (Feb. 2012); JPMC (requesting clarification and 3(c)(7) of the Investment Company Act of 1940 The Agencies intend to utilize this authority to that registered investment companies are not relied on by each fund sponsored by the banking monitor for and address, as appropriate, instances banking entities); TCW. entity in determining that such fund is not a of evasion. See, e.g., 12 U.S.C. 1851(e)(2). 2010 See ICI (Feb. 2012); TCW. covered fund. See final rule § 75.20(e). 2018 A joint determination specified under 2011 See final rule § 75.10(c)(12). 2014 See also FSOC study. § 75.10(c)(14) may take a variety of forms.

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d. Entities Not Specifically Excluded investments in and relationships with do not appear to need an exclusion. For From the Definition of Covered Fund covered funds and the requirement that example, section 3(b)(1) of the In addition to the entities identified banking entities divest or conform these Investment Company Act excludes from above which are excluded from the investments appear to reflect the the definition of investment company— definition of covered fund under the statutory purpose that banking entities and thus from the definition of a final rule, commenters argued that a be limited in their ability to continue to covered fund—entities primarily number of other entities such as be exposed to these investments outside engaged in a business other than that of 2023 financial market utilities, venture of the statutorily-provided conformance an investment company. If an FMU capital funds, credit funds, cash period. The Agencies believe that is primarily engaged in a business other management vehicles or cash collateral permitting banking entities to hold than those that would make it an pools may also be an investment ownership interests indefinitely beyond investment company, for example, if the company but for the exclusion the conformance period provided by the FMU is primarily engaged in contained in section 3(c)(1) or 3(c)(7) of statute appears inconsistent with this transferring, clearing, or settling the Investment Company Act and purpose. payments, securities, or other financial requested that these entities expressly transactions among or between financial 1. Financial Market Utilities 2024 be excluded from the final rule’s institutions, the FMU could rely on definition of covered fund. The Several commenters contended that the exclusion to the definition of Agencies have considered carefully the financial market utilities (‘‘FMUs’’) investment company provided by comments received on each of these could be covered funds because they section 3(b)(1) and would not need to entities but, for the reasons explained might rely on section 3(c)(1) or 3(c)(7) rely on section 3(c)(1) or 3(c)(7) and, as below, have declined to provide a for an exclusion from the definition of such, would not be a covered fund. investment company under the separate exclusion for them from the 2. Cash Collateral Pools definition of covered fund at this time. Investment Company Act and may not 2020 Some commenters expressed concern As discussed below, some of these qualify for an alternative exemption. that cash collateral pools, which are part entities are not covered funds for These commenters argued that banking of securities lending programs, could be various reasons or may, with relatively entities have long been investors in domestic and foreign FMUs, such as included in the definition of covered little cost, conform to the terms of an 2025 exclusion or exemption from the securities clearing agencies, derivatives fund. According to these definition of covered fund. As noted clearing organizations, securities commenters, banking entities, including above, to the extent that one of these exchanges, derivatives boards of trade bank custodians acting as lending agent entities qualifies for one or more of the and alternative trading systems. These for customer’s securities lending other exclusions from the definition of commenters expressed concern that, activities, typically manage these pools 2026 covered fund, that entity would not be unless FMUs are expressly excluded as fiduciaries for their customers. a covered fund under the final rule. Any from the definition of covered fund, These commenters argued that collateral entity that would be a covered fund banking entities could be prohibited pools are part of a banks’ traditional would still be able to rely on the from entering into any new covered custody and advisory services and have conformance period in order to come transactions with related FMUs and been an integral part of any lending into compliance with the requirements would be required to divest their agent’s role (whether custodial or non- 2027 of section 13 and the final rule. investments in FMUs, thereby custodial) for years. A number of commenters requested disrupting the operations of those FMUs Cash collateral pools are typically that certain existing covered funds be and financial markets generally. formed when, as part of a securities either excluded from the definition of After carefully considering lending program, a customer of a bank covered fund or grandfathered and not commenters’ concerns, the Agencies authorizes the bank to take securities be subject to the limitations of section believe that FMUs are not investment from the customer’s account and lend 13 of the BHC Act.2019 The Agencies vehicles of the type section 13 of the them in the open market. The agent note, however, that section 13 BHC Act was designed to address, but bank then lends those securities and specifically addresses a banking entity’s rather entities that generally engage in receives collateral in return from the preexisting investments in covered other activities, including acting as borrower; a securities lending customer funds by providing a conformance central counterparties that reduce of a bank typically elects to have cash period, which banking entities may use counterparty risk in clearing and collateral provided by a borrower to bring their activities and investments settlement activities. Congress pooled by the agent bank with other into compliance with the requirements recognized, in the Payment, Clearing, cash collateral provided to other of section 13 and the final rule. To the and Settlement Supervision Act of 2010 clients.2028 These investment pools may extent that section 13 could be (title VIII of the Dodd-Frank Act),2021 exist in the form of trusts, partnerships, interpreted to permit the Agencies to that properly designed, operated, and limited liability companies, or separate take a different approach, despite supervised financial market utilities as addressing banking entities’ preexisting defined in that Act mitigate systemic 2023 Section 3(b)(1) of the Investment Company 2022 Act excludes from the definition of investment covered fund investments directly, the risk and promote financial stability. company ‘‘[a]ny issuer primarily engaged, directly Agencies believe it would be However, the Agencies have not or through a wholly-owned subsidiary or inconsistent with the purposes of provided an exclusion from the covered subsidiaries, in a business or businesses other than section 13 to permit banking entities to fund definition for FMUs because these that of investing, reinvesting, owning, holding, or continue to hold ownership interests in kinds of entities do not generally appear trading in securities.’’ 2024 covered funds beyond the conformance to rely on section 3(c)(1) or 3(c)(7) of the See 12 U.S.C. 1562(6); 12 CFR Part 234. 2025 See RMA; State Street (Feb. 2012); see also period provided by the statute. Section Investment Company Act, and therefore BNY Mellon et al. 13’s prohibition on banking entities’ 2026 See RMA; State Street (Feb. 2012). 2020 See SIFMA et al. (Covered Funds) (Feb. 2027 See RMA; BNY Mellon et al. (citing 2019 See, e.g., PNC; SVB; SIFMA (Securitization) 2012); Credit Suisse (Williams). Comptroller’s Handbook: Custody Services (Jan. (Feb. 2012); AFME et al.; BoA. See also, e.g., Credit 2021 12 USC 5461 et seq. 2002)). Suisse (Williams). 2022 See id. 2028 See RMA.

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accounts maintained by more than one After carefully considering comments Company Act.2036 However, in order to party and these structures may rely on received, the final rule does not provide meet the demands of customers and sections 3(c)(1) and 3(c)(7) of the a specific exclusion from the definition avoid undesirable tax consequences, Investment Company Act to avoid being of covered fund for cash collateral some banking entities structure their an investment company.2029 While their pools. The Agencies have determined to REIT offerings by using a passive, pass- ownership interest may be nominal in provide specific exclusions for entities through statutory trust between the amount, the agent banks may hold a that do not function as investment banking entity and the REIT to issue general partnership, limited liability funds, consistent with the intent of REIT preferred securities to the company membership or trustee interest section 13’s restrictions, or in response public.2037 Because the pass-through in the cash collateral pool.2030 As part to other unique considerations (e.g., to trust holds the preferred securities of of these arrangements, custodian banks provide consistent treatment for certain the underlying REIT (which would itself routinely offer borrower default foreign and domestic pension plans). not be a covered fund), as well as indemnifications to the securities lender These considerations do not support a provides administrative and ministerial in a securities lending transactions. separate exclusion for cash collateral functions for the REIT (including Commenters raised concerns that pools. passing through dividends from the these indemnification agreements could The Agencies note, however, that underlying REIT), the pass-through trust be considered a covered transaction some cash collateral pools may not be may not itself rely on the exclusion prohibited by section 13(f) of the BHC covered funds because they rely on an contained in section 3(c)(5) or 3(c)(6) Act.2031 Since some cash collateral exclusion from the definition of and, thus, typically relies on section pools are established outside of the investment company other than those 3(c)(1) or 3(c)(7).2038 United States, commenters requested contained in section 3(c)(1) or 3(c)(7) of Some commenters urged the Agencies that the final rule permit banking the Investment Company Act.2035 to provide an exclusion for pass-through entities to have interests in and Banking entities may determine to REITS from the definition of covered relationships with both U.S. and non- register cash collateral pools with the fund.2039 These commenters argued that U.S. cash collateral pools.2032 These SEC as investment companies or to because the pass-through trust exists as commenters suggested that cash operate them as separate accounts to a corporate convenience as part of collateral pools be excluded from the exclude the pools from the covered fund issuing REIT preferred securities to the definition of covered fund or, in the definition or, if the pools remain banking entity and its customers, it is alternative, that the Agencies make clear covered funds, to organize and offer not the type of entity that the covered that cash collateral pools managed by them in compliance with the fund prohibition in section 13 of the agent banks qualify for the exemption in requirements of § 75.11 of the final rule. BHC Act was intended to address. These § 75.11 of the proposed rule for In response to comments received on commenters also argued that pass- organizing and offering a covered fund the proposal, the Agencies note that the through REITs enable banking entities to and that the prime brokerage exemption provision of a borrower default offer preferable tax treatment to holders from the restrictions of section 13(f) indemnification by a banking entity to of the REIT preferred securities and that would permit the indemnification and a lending client in connection with if pass-through REITs were included as income or settlement services agent securities lending transactions involving covered funds, because of the banks typically provide to the pools.2033 a covered fund is not a covered limitations on covered transactions These commenters also suggested that transaction subject to 13(f) or a contained in section 13(f), the minority the Agencies use their authority under guarantee of the performance or interests in the preferred securities section 13(d)(1)(J) to provide an obligations of a covered fund prohibited issued by the REIT would no longer be exemption for banking entities to under § 75.11 of the final rule. Those able to be included in a banking entity’s continue to have interests in and restrictions apply to transactions with tier 1 capital, thereby negatively provide services to these types of the covered fund or guarantees of the impacting the safety and soundness of pools.2034 covered fund’s performance. Borrower the banking entity.2040 default indemnifications are provided to The Agencies are not providing a 2029 See RMA. the bank’s securities lending customer, specific exclusion from the definition of 2030 See RMA. not to the cash collateral pool. covered fund for pass-through REITs 2031 See State Street; RMA. Commenters also because the Agencies are concerned that argued that as part of offering pooled cash collateral 3. Pass-Through REITS management, agent banks have traditionally such an exclusion could enable banking provided short-term extensions of credit and Some banking entities may issue real entities to structure non-loan contractual income and settlement services to estate investment trust (‘‘REIT’’) securitization transactions using a pass- lending clients and cash collateral pools to facilitate preferred securities to the public trade settlement and related cash collateral through entity in a manner inconsistent investment activities. See RMA. One commenter directly from a subsidiary that qualifies with the final rule’s treatment of similar further argued that if banks are required to for the exclusion in section 3(c)(5) or vehicles that invest in securities. ‘‘outsource’’ cash collateral pools and/or the related section 3(c)(6) of the Investment short-term credit services provided to the pools, 2036 ‘‘participation in securities lending programs would Company Act. These entities would not See PNC. only be cost effective for the largest lending clients’’ be considered a ‘‘covered fund’’ because 2037 See PNC. and, as a result, ‘‘many small and intermediate they may rely on an exclusion from the 2038 See ABA (Keating); PNC. securities lending clients would be denied the definition of an investment company 2039 See ABA (Keating); PNC. incremental revenue securities lending can other than the exclusion in section 2040 See PNC; ABA (Keating). These commenters provide’’; ‘‘securities lending programs could lose argued that most REIT preferred securities contain significant diversification in lending clients, 3(c)(1) or 3(c)(7) of the Investment a conditional exchange provision that allows the lendable assets, borrowers and agent banks’’; and, primary regulator to direct that the preferred as a result of lost revenues, ‘‘the actual costs of [ 2035 For instance, the Agencies understand that a securities be automatically exchanged for preferred ] custodial or other services provided to clients that banking entity may set up a cash collateral pool in shares of the bank or parent BHC upon occurrence no longer participate in lending would increase.’’ reliance on the exclusion contained in section of a conditional exchange event. Because this Id. 3(c)(3) of the Investment Company Act, or may be arrangement involves the purchase of securities 2032 See RMA. able to structure these pools as SEC-registered issued by an affiliate or the purchase of assets, it 2033 See RMA. money market funds operated in accordance with would be prohibited under section 13(f) of the BHC 2034 See RMA. rule 2a–7 under the Investment Company Act. Act if the pass-through REIT were a covered fund.

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Furthermore, banking entities have tender option bonds structure, with the role in the municipal bond markets.2048 alternative manners in which they may investors in floaters taking only limited, Commenters requested that the issue or hold REIT preferred securities, well-defined insolvency and default Agencies use their authority under including through REITs directly, which risks associated with the underlying section 13(d)(1)(J) of the BHC Act to do not raise the same concerns about municipal bonds generally equivalent to exclude tender option bonds because evasion.2041 the risks associated with investing in they argued that tender option bonds promote the safety and soundness of 4. Municipal Securities Tender Option the municipal bonds directly. According banking entities and the financial Bond Transactions to commenters, the structure of tender option bond transactions is governed by stability of the United States by The Agencies received a number of certain provisions of the Internal providing for a deeper, richer pool of comments addressing how the final rule Revenue Code in order to preserve the potential investors, a larger and more should treat municipal securities tender tax-exempt treatment of the underlying liquid market for municipal securities option bond vehicles. A number of municipal securities. that results in lower borrowing costs for commenters argued that issuers of municipalities and other issuers of municipal securities tender option Many commenters requested a municipal securities, and greater bonds would fall under the definition of specific exclusion for municipal tender efficiency and risk diversification.2049 covered fund in the proposed rule option bond vehicles from the definition Commenters also suggested a number of because these issuers typically rely on of a covered fund.2043 These other ways to exclude tender option the exclusion contained in section commenters argued that, without an bonds, including defining ownership 3(c)(1) or 3(c)(7) of the Investment exclusion from the definition of covered interest to exclude any interest in a Company Act.2042 According to fund, banking entities would be tender option bond transaction; 2050 commenters, a typical tender option prohibited from owning or sponsoring defining banking entity to exclude bond transaction consists of the deposit tender option bonds and from providing tender option bond issuers; 2051 of a single issue of highly-rated, long- credit enhancement, liquidity support, expanding the loan securitization term municipal bonds in a trust and the remarketing, and other services required exclusion to include tender option bond issuance by the trust of two classes of in connection with a tender option bond issuers; 2052 and revising the definition securities: a floating rate, puttable program.2044 Commenters argued that of sponsor to exclude sponsors of tender security (the ‘‘floaters’’), and an inverse tender option bond vehicles should be option bond vehicles.2053 One floating rate security (the ‘‘residual’’) excluded because section 13(d)(1)(A) of commenter urged the Commission to with no tranching involved. According the BHC Act already allows banking consider amending the exemption under to commenters, the holders of the entities to own and dispose of rule 3a–7 under the Investment floaters have the right, generally on a municipal securities directly,2045 tender Company Act or providing formal daily or weekly basis, to put the floaters option bonds are economically similar guidance regarding the status of tender for purchase at par. The put right is to repurchase agreements, which are option bond programs.2054 In addition, supported by a liquidity facility expressly excluded from the proprietary some commenters requested an delivered by a highly-rated provider (in trading restrictions of the proposed rule, exclusion for tender option bond many cases, the banking entity and, because they are safe and low risk transactions from the provisions of sponsoring the trust) and allows the are similar to the types of transactions section 13(f) of the BHC Act.2055 floaters to be treated as a short-term that the proposed rule would have After carefully considering the security. The floaters are in large part exempted.2046 Commenters also argued comments received, the final rule does purchased and held by money market that tender option bonds are different not provide a specific exclusion from mutual funds. The residual is held by a from other covered funds that rely on the definition of covered fund or from longer-term investor (in many cases the the exclusion contained in section the prohibitions and requirements of the banking entity sponsoring the trust, or 3(c)(1) or 3(c)(7) of the Investment final rule for tender option bond an insurance company, mutual fund, or 2056 Company Act 2047 and play an important vehicles. The Agencies have hedge fund). According to commenters, determined to provide specific the residual investors take all of the exclusions for entities that they believe market and structural risk related to the 2043 See, e.g., ASF (Feb. 2012); BDA (Feb. 2012); Eaton Vance; Fidelity; ICI (Feb. 2012); RBC; SIFMA fall within the rule of construction (Municipal Securities) (Feb. 2012); SIFMA (May contained in section 13(g)(2) of the BHC 2041 The Agencies recognize that banking entities 2012); State Street (Feb. 2012); Vanguard. Act, which expressly relates to the sale may have relied on pass-through REIT structures to 2044 See Ashurst; ASF (Feb. 2012). and securitization of loans,2057 do not issue preferred securities in the past and 2045 See ASF (Feb. 2012); SIFMA (Municipal prohibiting such transactions may pose Securities) (Feb. 13, 2012); Citigroup (Jan. 2012). inefficiencies. Furthermore, it may not be possible 2048 See Cadwalader (Municipal Securities); ICI See also Cadwalader (Municipal Securities) to unwind or conform past issuances without (Feb. 2012); Ashurst; ASF (Feb. 2012). (alleging that the legislative history of section 13 of significant effort by the banking entity and 2049 See Cadwalader (Municipal Securities). the BHC Act suggests that the exemption relating negotiation with the holders of the preferred 2050 to municipal securities should not be construed to See RBC. securities. As noted above, in these circumstances, 2051 See ICI (Feb. 2012). section 13 provides a conformance period which apply only to the section of the rule pertaining to the proprietary trading prohibitions); BDA (Feb. 2052 See ASF (Feb. 2012). banking entities may take advantage of in order to 2053 bring their activities and investments into 2012) (arguing that any fund or trust the assets of See RBC. compliance with the requirements of section 13 and which are entirely invested in any of the obligations 2054 See Ashurst. the final rule. that are excluded from the proprietary trading 2055 See, e.g., RBC; ASF (Mar. 2012); ASF (Feb. 2042 See, e.g., Ashurst; SIFMA (Municipal prohibitions should also be excluded from the 2012). Securities) (Feb. 2012); Citigroup (Jan. 2012); definition of covered fund). 2056 The Agencies received a variety of requests Cadwalader (Municipal Securities); Vanguard; ICI 2046 See, e.g., Ashurst; Cadwalader (Municipal requesting specific treatment of tender option bond (Feb. 2012); ASF (Feb. 2012); Fidelity; Wells Fargo Securities); Eaton Vance; Nuveen Asset Mgmt.; transactions. See, e.g., supra notes 2050–2055. As (Covered Funds). Commenters also noted that SIFMA (Municipal Securities) (Feb. 13, 2012); State discussed above, the Agencies believe that, in light tender option bond programs as currently Street (Feb. 2012); Vanguard; Wells Fargo (Covered of the comments received, tender option bond structured may not meet the requirements of section Funds); Citigroup (Jan. 2012). vehicles do not fall within the rule of construction 3(a)(5) of the Investment Company Act or rule 3a– 2047 See, e.g., ASF (Feb. 2012); State Street (Feb. contained in section 13(g)(2) of the BHC Act and, 7 thereunder, or any other exclusion or exemption 2012); Citigroup (Jan. 2012); Vanguard; Wells Fargo as a result, the final rule does not provide such under the Investment Company Act. See Ashurst; (Covered Funds); Cadwalader (Municipal treatment. RBC; ASF (Feb. 2012). Securities); Ashurst. 2057 See 12 U.S.C. 1851(g)(2).

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function as investment funds, consistent rule. If a tender option bond vehicle is 5. Venture Capital Funds with the intent of section 13’s a covered fund and an exclusion from Some private equity funds that make restrictions, or in response to other that definition is not available, then investments in early-stage start-up unique considerations. The Agencies do banking entities sponsoring such a companies or other companies with not believe that these considerations vehicle will be subject to the significant growth potential (‘‘venture support a separate exclusion for tender prohibitions in § 75.14 of the final rule capital funds’’) would be investment option bond vehicles, which have and the provisions of section 13(f) of the companies but for the exclusion municipal securities as underlying BHC Act.2060 contained in section 3(c)(1) or 3(c)(7) of assets and not loans. As tender option bond vehicles are the Investment Company Act. Venture The Agencies recognize commenters’ capital funds would therefore qualify as concerns about the treatment of tender considered issuers of asset-backed securities subject to the risk retention a covered fund under the proposal. The option bonds under the final rule, as proposal specifically requested discussed above. However, as there is requirements of section 15G of the Exchange Act, banking entities may look comment on whether venture capital no corresponding rule of construction in funds should be excluded from the section 13 of the BHC Act for financial to the provisions of the final rule governing the limits applicable to definition of ‘‘covered fund.’’ instruments other than loans, the Some commenters argued that venture banking entities’ interests in and Agencies do not believe that the capital funds should be treated relationships with those funds. Under resecuritization of municipal debt differently than other covered funds and instruments should be treated the final rule, as in the statute, a excluded from the definition. These differently than the resecuritization of banking entity that conducts the commenters argued that, unlike 2058 other debt instruments. activities described in section 13(f) of conventional hedge funds and private Notwithstanding the statutory treatment the BHC Act is subject to the restrictions equity funds, venture capital funds do of municipal securities for purposes of on transactions with a tender option not possess high leverage and do not the proprietary trading restrictions, the bond vehicle, including guaranteeing or engage in risky trading activities of the Agencies also do not believe that tender insuring the performance of the tender type section 13 of the BHC Act was option bond vehicles fall within the rule option bond vehicle, contained in designed to address.2065 These of construction contained in section section 13(f) of the BHC Act. As a result, commenters contended that investments 13(g)(2) of the BHC Act, because, in a banking entity is not permitted to and relationships by banking entities in light of commenters’ descriptions of provide credit enhancement, liquidity venture capital funds would be these vehicles, tender option bond support, and other similar services if it consistent with safety and soundness; vehicles are more in the nature of other serves in a capacity covered by section provide important funding and types of bond repackaging 13(f) with the tender option bond expertise and other services to start-up securitizations and other non-excluded program.2061 An unaffiliated third party companies; and provide positive 2059 securitization vehicles. The final may provide such services if it does not benefits to employment, GDP, growth, rule, however, does not prevent a have a relationship with the tender and innovation.2066 These commenters banking entity from owning or option bond vehicle that triggers argued that restricting banking entities’ otherwise participating in a tender application of section 13(f). The extent ability to invest in or sponsor venture option bond vehicle; it requires that to which the final rule causes a capital funds would have a negative these activities be conducted in the disruption to the securitization of, and impact on companies and the U.S. same manner as with other covered market for, municipal tender option economy generally.2067 Some funds. bonds may also affect the economic commenters asserted that bank In this regard, under the final rule, a burden and effects on the municipal investments in venture capital funds are banking entity would need to evaluate bond market and its participants, important to the success of venture whether a tender option bond vehicle is including money market mutual capital,2068 with some citing a a covered fund as defined in the final funds 2062 and issuers of municipal consulting firm’s data indicating that securities. The Agencies recognize that approximately 7 percent of all venture 2058 For these same reasons, and based on the capital is provided by banks.2069 One definitions of sponsor and banking entity in section a potential economic burden may be an 13, the Agencies have not modified those increase in financing costs to commenter argued, therefore, that definitions in the final rule to exclude sponsors of municipalities as a result of a decrease ‘‘preventing banks from investing in tender options bonds and tender bond issuers, in demand for the types of municipal venture thus could depress U.S. GDP by respectively, as some commenters requested. See securities customarily included in roughly 1.5% (or $215 billion annually) supra notes 2051 and 2053 and accompanying text. and eliminate nearly 1% of all U.S. 2059 Commenters also argued that to the extent municipal tender option bond tender option bond programs are not excluded from vehicles 2063 and therefore potential private sector employment over the long the definition of covered fund, the definition of effects on the depth and liquidity of the term,’’ and the funding gap that would ownership interest should exclude any interest in market for certain types of municipal result if banks could not invest in a tender option bond program (see RBC) or that venture capital funds would not be met where a third party owns the residual, the banking securities.2064 entity should not be treated as having an ownership interest, even when it owns a small interest for tax 2065 See SVB; NVCA; Rep. Eshoo; Sen. Boxer; 2060 See 12 U.S.C. 1851(f). purposes or becomes the owner through liquidity or Rep. Goodlatte; Rep. Schweikert; Rep. Speier; Rep. 2061 remarketing agreements (see Cadwalader As discussed above, while commenters Honda; Rep. Lofgren; Rep. Peters et al. (Municipal Securities)). The definition of requested treatment of municipal tender option 2066 See, e.g., NVCA; SVB; Scale. ownership interest in the final rule focuses on the bond vehicles that would cause section 13(f) of the 2067 See, e.g., SVB; Scale; Sen. Boxer; SIFMA et attributes of the interest, as discussed below, and BHC Act not to apply to them, the final rule does al. (Covered Funds) (Feb. 2012) (citing a colloquy not the particular type of covered fund involved. not exclude these vehicles from the definition of between Sen. Dodd and Sen. Boxer supporting an The Agencies are not providing separate definitions covered fund or the prohibitions relating to covered exemption for venture capital funds (156 Cong. Rec. of or exclusions from the ownership interest funds. As a result, section 13(f) of the BHC Act will H5226 (daily ed., June 30, 2010)). definition based on the type of vehicle or financing apply to a banking entity that is sponsoring a tender 2068 See River Cities; Scale. See also Sofinnova; involved. See infra note 2103 and preceding and option bond vehicle. Canaan (Young); Canaan (Ahrens); Canaan (Kamra); following text. Banking entities will need to 2062 See ASF (Feb. 2012); Nuveen Asset Mgmt. Mohr Davidow; ATV; BlueRun; Westly; Charles evaluate whether the interests they may acquire are 2063 See Ashurst. River; Flybridge; SVB. ownership interests as defined under the final rule. 2064 See Eaton Vance. 2069 See, e.g., SVB.

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by other market participants if bank Because Congress chose to distinguish also may provide these companies investments in venture capital were between private equity and venture expertise and other services.2077 Other restricted.2070 Several commenters capital in one part of the Dodd-Frank provisions of the final rule or the statute recommended that venture capital funds Act, but chose not to do so for purposes may facilitate, or at least not impede, be excluded if they: (i) Do not of section 13, the Agencies believe it is other forms of investing that may fundamentally engage in proprietary appropriate to follow this Congressional provide the same or similar benefits. For trading; (ii) do not use leverage to determination. example, in addition to permitting a increase investment returns; and (iii) In addition to the language of the banking entity to organize and offer a typically invest in high-growth start-up statute, it appears to the Agencies that covered fund in section 13(d)(1)(G), companies as compared to more mature the activities and risk profiles for section 13 of the BHC Act does not publicly traded companies.2071 banking entities regarding sponsorship prohibit a banking entity, to the extent Conversely, one commenter alleged of, and investment in, venture capital otherwise permitted under applicable that there was no credible way to funds and private equity funds are not law, from making a venture capital-style exclude venture capital funds without readily distinguishable. Many key investment in a company or business so providing a means to circumvent the structural and operational long as that investment is not through requirements of section 13 and the final characteristics of venture capital funds or in a covered fund, such as through a rule.2072 Another commenter argued are substantially similar to those of direct investment made pursuant to that venture capital funds do in fact hedge funds and private equity funds, merchant banking authority 2078 or engage in risky activities and that, thereby making it difficult to define through business development instead of making investments in venture capital funds in a manner that companies which are not covered funds venture capital funds, banking entities would not provide banking entities with and, like venture capital funds, often may directly extend credit to start-up an opportunity to evade the restrictions invest in small, early-stage companies in a safe and sound of section 13 of the BHC Act. companies.2079 manner.2073 For instance, in addition to relying on Thus, to the extent that banking The final rule does not provide an the same exemptions under the entities are required to reduce their exclusion for venture capital funds. The Securities Act,2076 venture capital investments in venture capital funds, Agencies believe that the statutory funds, private equity funds and hedge certain of these investments may be language of section 13 does not support funds all rely on the exclusion in redirected to the types of entities in providing an exclusion for venture section 3(c)(1) or 3(c)(7) from the which venture capital funds invest capital funds from the definition of definition of investment company under through alternative means. To the extent covered fund. Congress explicitly the Investment Company Act. Moreover, that banking entities may reduce their recognized and treated venture capital like private equity funds, venture investments in venture capital funds funds as a subset of private equity funds capital funds pool funds from multiple that are covered funds, the potential in various parts of the Dodd-Frank Act investors and invest those funds in funding gap for venture capital funds and accorded distinct treatment for interests of portfolio companies for the may also be offset, in whole or in part, venture capital fund advisers by purpose of profiting from the resale of by investments from firms that are not exempting them from registration those interests. Indeed, funds that are banking entities and thus not subject to requirements under the Investment called ‘‘venture capital funds’’ may section 13’s restrictions. Advisers Act.2074 This indicates that invest in the very same entities and to 6. Credit Funds Congress knew how to distinguish the same extent as do funds that call Several commenters requested that venture capital funds from other types themselves private equity funds. the final rule explicitly exclude from the of private equity funds when it desired Venture capital funds, like private to do so.2075 No such distinction definition of covered fund entities that equity funds, also typically charge appears in section 13 of the BHC Act. are generally formed as partnerships incentive compensation to fund with third-party capital and invest in investors based on the price 2070 See SVB. loans or make loans or otherwise extend appreciation achieved on the 2071 See, e.g., SVB (arguing that the definition of the type of credit that banks are ‘‘venture capital fund’’ in section 203(l)–1 of the investments held by the fund and Investment Advisers Act and the SEC’s Form PF provide a return of principal plus gains 2077 As noted above, some commenters quantified reporting requirements for investment advisers to at specific times during the limited life the importance of banking entities to the provision private funds would be instructive for defining an of venture capital by providing information exclusion for venture capital funds for purposes of of the fund. Not including venture indicating that approximately 7 percent of all section 13 of the BHC Act). capital funds in the definition of venture capital is provided by banks. See, e.g., SVB 2072 See Occupy. covered fund, therefore, could allow (citing ‘‘The Venture Capital Industry: A Preqin 2073 See Sens. Merkley & Levin (Feb. 2012). banking entities, either directly or Special Report,’’ published by Preqin, Ltd. (Oct. 2074 See S. Rep. No. 111–176, at 71–3 (2010) (‘‘S. indirectly, to engage in the type of 2010)). The 7% estimate commenters identified Rep. No. 111–176’’); H. Rep. No. 111–517, at 866 activities section 13 was designed to includes information on investors based in North (2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111– America, Europe, and Asia; thus, although 517 contains the conference report accompanying address. potentially indicative of the extent of venture the version of H.R. 4173 that was debated in While the final rule does not provide capital investing by banking entities in venture conference. See S. Rep. No. 111–176, at 74 (‘‘The a separate exclusion for venture capital capital funds, the estimate does not specifically Committee believes that venture capital funds, a funds from the definition of covered address the proportion of investment by banking subset of private investment funds specializing in entities in venture capital funds that are covered long-term equity investment in small or start-up fund, the Agencies recognize that funds, as those terms are defined in the final rule. businesses, do not present the same risks as the certain venture capital investments by 2078 See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 large private funds whose advisers are required to banking entities provide capital and et seq. register with the SEC under this title.’’). Compare funding to nascent or early-stage 2079 See 15 U.S.C. 80a–54. Companies that have Restoring American Financial Stability Act of 2010, elected to be treated as a business development S. 3217, 111th Cong. Sec. 408 (2010) (as passed by companies and small businesses and company are subject to limits under the Investment the Senate) with The Wall Street Reform and Company Act, including: (i) Limits on how much Consumer Protection Act of 2009, H.R. 4173, 111th 2076 These funds all typically offer their shares on debt the business development company may incur; Cong. (2009) (as passed by the House) (‘‘H.R. 4173’’) an unregistered basis in reliance on section 4(a)(2) (ii) prohibitions on certain affiliated transactions; and Dodd-Frank Act (2010). of the Securities Act of 1933 or Regulation D (iii) regulation and examination by the SEC; and (iv) 2075 But see Rep. Honda. thereunder (17 CFR 230.500 through 230.508). registration and filing requirements.

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authorized to undertake on their own 7. Employee Securities Companies plans). These considerations do not 2080 balance sheet (‘‘credit funds’’). Two Several commenters argued that support a separate exclusion for ESCs. commenters contended that the employee securities companies The Agencies also note that non- language of section 13(g)(2) indicates (‘‘ESCs’’) should be explicitly excluded qualified plans are not exempt from the that Congress did not intend section 13 from the definition of covered fund.2085 Investment Company Act under 3(c)(11) of the BHC Act to limit a banking One commenter alleged that, though and thus would be covered funds if they entity’s ability to extend credit.2081 many ESCs could qualify for the are operating in reliance on section They argued that lending is a exemption in section 6(b) of the 3(c)(1) or 3(c)(7) of the Investment fundamental banking activity, whether Investment Company Act, they often opt Company Act. Some of these non- accomplished through direct loans or to rely on section 3(c)(1) or 3(c)(7) qualified plans may be formed as through a fund structure. These instead due to the fact that the section employees’ securities companies, commenters argued that credit funds 6(b) exemption is available only upon however, and could qualify for an functioned like syndicated loans that application to the SEC.2086 According to exemption under section 6(b) of the Investment Company Act for employees’ enable borrowers to secure credit during this commenter, the limitations securities companies as discussed periods of market distress and reduce contained in section 13 on employee above. the concentration of risk for both investments and intercompany individual banking entities and the transactions with covered funds would e. Definition of ‘‘Ownership Interest’’ banking system as a whole. severely limit the ability of a banking The proposed rule defined entity to design competitive employee Commenters suggested different ‘‘ownership interest’’ in a covered fund compensation arrangements.2087 This approaches for excluding credit funds to mean any equity, partnership, or commenter also argued that an from the definition of covered fund. One other similar interest (including, exclusion should be provided for any without limitation, a share, equity commenter recommended excluding an investment vehicle that satisfies the entity that would otherwise be a security, warrant, option, general definition of an ESC under section partnership interest, limited partnership covered fund if more than 50 percent of 2(a)(13) of the Investment Company Act. 2082 interest, membership interest, trust its assets consist of loans. Another After considering carefully the certificate, or other similar instrument) commenter proposed defining a credit comments received on the proposed in a covered fund, whether voting or fund as an entity that met a number of rule, the final rule does not provide a nonvoting, as well as any derivative of criteria designed to ensure the entity specific exclusion for ESCs because the such an interest.2088 This definition only held loans or otherwise engaged in Agencies believe that these vehicles focused on the attributes of the interest prudent lending activity.2083 Another may avoid being a covered fund by and whether it provided a banking commenter requested that the Agencies either complying with the conditions of entity with economic exposure to the use their authority under section another exclusion from the definition of profits and losses of the covered fund, 13(d)(1)(J) to permit a banking entity to covered fund or seeking and receiving rather than its form. The proposal thus sponsor, invest in, or enter into covered an exemption available under section would also have included a debt transactions with related credit funds 6(b) of the Investment Company Act. As security or other interest in a covered that are covered funds.2084 such, the Agencies believe a banking fund as an ownership interest if it entity has a reasonable alternative to The Agencies, however, are unable exhibited substantially the same effectively to distinguish credit funds design competitive employee compensation arrangements. The characteristics as an equity or other from other types of private equity funds Agencies recognize that preparing an ownership interest (e.g., provides the or hedge funds in a manner that would application under section 6(b) of the holder with voting rights, the right or give effect to the language and purpose Investment Company Act or modifying ability to share in the covered fund’s of section 13 and not raise concerns an ESC’s activities to meet the terms of profits or losses, or the ability, directly about banking entities being able to another exclusion from the covered or pursuant to a contract or synthetic evade the requirements of section 13. fund definition is not without costs, but interest, to earn a return based on the Moreover, the Agencies also believe that have determined to provide specific performance of the fund’s underlying 2089 the final rule largely addresses exclusions for entities that do not holdings or investments). As commenters’ concerns in other ways function as investment funds, consistent described further below, the proposed because some credit funds may be able with the purpose of section 13, or in rule excluded carried interest (termed to rely on another exclusion from the response to other unique considerations ‘‘restricted profit interest’’ in the final definition of covered fund in the final (e.g., to provide consistent treatment for rule) from the definition of ownership rule such as the exclusion for joint certain foreign and domestic pension interest. ventures or the exclusion, discussed Many commenters argued that the above, for loan securitizations. To the 2085 See, e.g., ABA (Keating), Credit Suisse proposed definition of ownership extent that a credit fund may rely on (Williams), Arnold & Porter (as it relates to interest was too broad and urged another exclusion from the definition of commodity pools). Section 2(a)(13) of the excluding one or more types of interests Investment Company Act generally defines an ESC from the definition. A number of covered fund, it would not be a covered as ‘‘any investment company or similar issuer all fund under section 13 of the BHC Act. of the outstanding securities of which (other than commenters raised concerns regarding short-term paper) are beneficially owned’’ by the difficulty of applying the ownership employees and certain related persons (e.g., 2080 interest definition to securitization See, e.g., Goldman (Covered Funds); ABA employees’ immediate family members). (Keating); Credit Suisse (Williams); Comm. on structures and questioned whether the 2086 Section 6(b) of the Investment Company Act Capital Markets Regulation; Chamber (Feb. 2012). provides, in part, that ‘‘[u]pon application by any definition of ownership interest might 2081 See ABA (Keating); Goldman (Covered employees’ security company, the Commission apply to a debt security issued by, or a Funds). shall by order exempt such company from the debt interest in, a covered fund that has 2082 See Credit Suisse (Williams). provisions of this title and of the rules and 2083 See Goldman (Covered Funds). regulations hereunder, if and to the extent that such some characteristics similar to an equity 2084 See SIFMA et al. (Covered Funds) (Feb. exemption is consistent with the protection of 2012); see also. ABA (Keating); Chamber (Feb. investors.’’ 2088 See proposed rule § 75.10(b)(3). 2012). 2087 See Credit Suisse (Williams). 2089 See Joint Proposal, 76 FR at 68897.

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or other ownership interest.2090 One Finally, certain commenters argued that, and similar interests, and would not commenter argued that the ownership because the application of the generally cover typical extensions of interest definition should not include ownership interest definition to credit the terms of which provide for debt instruments with equity features securitization structures was payment of stated principal and interest unless the Agencies determine with problematic, alternative regulatory calculated at a fixed rate or at a floating respect to a particular debt instrument, treatment was appropriate.2093 rate based on an index or interbank rate. after appropriate notice and opportunity One commenter expressed concern However, as under the proposal, to the for hearing, that the equity features are over the proposal’s inclusion of extent that a debt security or other so pervasive that the debt instrument is ‘‘derivatives’’ of ownership interests in interest in a covered fund exhibits the functional equivalent of an equity the definition of ownership interest and specified characteristics that are similar interest or partnership interest and was recommended certain derivative to those of equity or other ownership structured to evade the prohibitions and interests of ownership interests in hedge interests (e.g., provides the holder with restrictions in the proposal.2091 Several funds and private equity funds not be the ability to participate in the election commenters argued that the Agencies included within the definition of or removal of a party with investment should explicitly exclude certain debt ownership interest.2094 This commenter discretion, the right or ability to share instruments with equity features from also recommended that the Agencies in the covered fund’s profits or losses, the ownership interest definition.2092 expressly exclude from the definition of or the ability, directly or pursuant to a ownership interest lending contract or synthetic interest, to earn a 2090 See AFME et al.; AFR et al. (Feb. 2012); ASF arrangements with a covered fund that return based on the performance of the (Feb. 2012); BoA; Cadwalader (Municipal contain protective covenants linking the fund’s underlying holdings or Securities); Credit Suisse (Williams); Deutsche Bank interest rate on the loan to the profits of (Repackaging Transactions); Occupy; RBC; SIFMA investments), the instrument would be 2095 et al. (Covered Funds) (Feb. 2012); SIFMA the borrowing fund. an ownership interest under the final (Securitization) (Feb. 2012); TCW. For example, As discussed in detail below, the rule. securitization structures generally provide that Agencies are adopting the definition of In response to commenters and in either the most senior or the most junior tranche ‘‘ownership interest’’ largely as notes have controlling voting rights. One proposed but clarifying the scope of that order to provide clarity about the types commenter argued that under the proposed of interests that would be considered ownership interest definition, a banking entity definition, including with respect to the could be deemed to have an ownership interest in inclusion of interests that are linked to within the scope of ownership interest, an entity it does not own or sponsor simply due to profits and losses of a covered fund and the Agencies have revised the definition its obtaining voting rights. See ASF (Feb. 2012). As the exclusion for a restricted profit of ‘‘ownership interest’’ to define the a further example, one commenter alleged that term more clearly. The Agencies are not securitization structures generally are not viewed as interest in a covered fund.2096 The providing economic exposure to the profits and definition is centered on equity explicitly excluding or including debt losses of the issuer in the same manner as equity interests, partnership interests, securities, instruments or interests with interests in hedge funds and private equity funds. membership interests, trust certificates, equity features as requested by some This commenter argued that the ownership interest commenters, but are instead identifying definition should include only those interests that permit the banking entity to share without limit in be restricted from owning debt classes of new asset- certain specific characteristics that the profits and losses or that earn a return that is backed securities because ‘‘doing so would would cause a particular interest, based on the performance of the underlying assets. substantially constrict the market for asset-backed regardless of the name or legal form of See SIFMA (Securitization) (Feb. 2012). securities.’’ See ASF (Feb. 2012). that interest, to be included within the 2091 See SIFMA et al. (Covered Funds) (Feb. 2093 See AFR et al. (Feb. 2012); Credit Suisse 2012). (Williams); Occupy. One of these commenters definition of ownership interest. The 2092 See AFME et al.; ASF (Feb. 2012); BoA; argued that any general statement about what Agencies believe that this elaboration on Cadwalader (Municipal Securities); RBC; SIFMA instruments would be considered an ‘‘ownership the characteristics of an ownership (Securitization) (Feb. 2012). These commenters interest’’ for purposes of securitization structures interest will enable parties, including argued that the ownership interest definition would be problematic and easy to evade because should not include tender option bond programs transaction documents underlying securitization securitization structures, to more easily and other debt asset-backed securities. Two of these structures are not standardized. This commenter analyze whether their interest is an commenters argued that debt asset-backed suggested as an alternative using a safe harbor for ownership interest, regardless of the securities should not be viewed as ownership standardized, pre-specified securitization type of legal entity or the name of the interests because: (i) they are not typically viewed structures. See AFR et al. (Feb. 2012). Another of as having economic exposure to profits and losses these commenters argued that ‘‘it is difficult to particular interest. of an ABS Issuer; (ii) they have a limited life, characterize holders of ABS securities in most As adopted, the final rule provides periodic fixed or fluctuating cumulative payments, securitization structures as having ‘ownership that an ownership interest would be any and are senior to equity of the issuer should the interests’ in any common understanding of the issuer fail; (iii) they do not have perpetual life with term’’ and the concept of ownership interest is a interest in or security issued by a broad voting rights, appreciation in the market ‘‘poor fit for the securitization market, underscoring covered fund that exhibits any of the value of the issuer and non-cumulative dividends, the benefits of excluding securitization issuers from following features or characteristics on and subordination to the claims of debt holders if the definition of covered fund entirely.’’ See Credit Suisse (Williams). a current, future, or contingent the issuer fails; and (iv) their limited voting rights 2097 (such as the rights to replace a servicer or manager) 2094 See Credit Suisse (Williams). basis: and such rights are protective in nature and similar 2095 See Credit Suisse (Williams) (arguing that • has the right to participate in the to voting rights that accompany securities such arrangements are a fundamental part of a selection or removal of a general traditionally classified by the Agencies as debt bank’s lending activities). partner, managing member, member of securities (including securities formally structured 2096 See final rule § 75.10(d)(6). The concept of a as equity). See AFME et al.; SIFMA (Securitization) restricted profit share was referred to as ‘‘carried the board of directors or trustees, (Feb. 2012). One of these commenters argued that interest’’ in the proposed rule, a term that is often investment manager, investment the ownership interest definition should be limited used as a generic reference to performance-based adviser, or commodity trading advisor to those interests that share in the profits or losses allocations or compensation. The Agencies have of the relevant entity on an unlimited basis or that instead used the term ‘‘restricted profit interest’’ in of the covered fund. For purposes of the otherwise earn a return that is specifically based the final rule to avoid any confusion that could rule, this would not include the rights upon the performance of the underlying assets result from using a term that is also used in other of a creditor to exercise remedies upon because the senior tranche in an asset-based contexts. The final rule focuses only on whether a the occurrence of an event of default or securities transaction often has substantial voting profit interest is excluded from the definition of rights and banking entities should not be penalized ownership interest under section 13, and the final for requiring or otherwise obtaining voting rights rule does not address in any way the treatment of 2097 Each of these factors are designed to clarify that protect their interests. This commenter also such profit interests under other laws, including the interests identified in the proposed definition expressed the view that banking entities should not under Federal income tax law. of ownership interest as noted above.

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similar rights arising due to an index or interbank rate such as LIBOR; definition of ownership interest will acceleration event; or apply regardless of the type of legal • has the right under the terms of the • any synthetic right to have, receive entity or the name or legal form of the interest to receive a share of the income, or be allocated any of the rights above. particular interest. The determination of gains or profits of the covered fund. This provision would not permit whether an interest is an ownership This would apply regardless of whether banking entities to obtain synthetic or interest under the final rule will depend the right is pro rata with other owners derivative exposure to any of the on the features and characteristics of the or holders of interests; 2098 characteristics identified above in order particular interest, including the rights • has the right to receive the to avoid being considered to have an the particular interest provides its underlying assets of the covered fund, ownership interest in the covered fund. holder, including not only voting rights This definition of ‘‘ownership after all other interests have been but also the right to receive a share of interest’’ is intended to address redeemed and/or paid in full the income, gains, or profits of a covered commenters’ concerns regarding the (commonly known as the ‘‘residual’’ in fund, the right to receive a residual, the applicability of the ownership interest securitizations). For purposes of the right to receive excess spread, and any definition to different types of interests. rule, this would not include the rights synthetic or derivative that would The Agencies believe defining of a creditor to exercise remedies upon provide similar rights. While some ‘‘ownership interest’’ in this way will the occurrence of an event of default or commenters argued that securities allow existing as well as potential similar rights arising due to an issued in asset-backed securities holders of interests in covered funds, transactions and by tender option bond acceleration event; including securitizations, to effectively • issuers should not be viewed as has the right to receive all or a determine whether they have an ownership interests due to the nature of portion of excess spread (the positive ownership interest. As an example, this the securities issued or the possible lack difference, if any, between the aggregate definition would include preferred of exposure to profits and losses,2103 the interest payments received from the stock, as well as a lending arrangement Agencies do not believe that the type of underlying assets of the covered fund with a covered fund in which the covered fund involved or the type of and the aggregate interest paid to the interest or other payments are security issued is an appropriate basis holders of other outstanding calculated by reference to the profits of for determining whether there is an 2099 interests); the fund. As a contrasting example, the ownership interest for purposes of the • provides that the amounts payable Agencies believe that a loan that restrictions contained in section by the covered fund with respect to the provides for a step-up in interest rate 13(a)(1)(B) of the BHC Act. The interest could, under the terms of the margin when a covered fund has fallen Agencies believe that making interest, be reduced based on losses below or breached a NAV trigger or distinctions in the definition of arising from the underlying assets of the other negotiated covenant would not ownership interest based on the type of covered fund, such as allocation of generally be an ownership interest. entity or the type of security, in which losses, write-downs or charge-offs of the Banking entities will be expected to many of the same rights exist as for outstanding principal balance, or evaluate the specific terms of their other types of ownership interests, reductions in the amount of interest due interests to determine whether any of would not be consistent with the and payable on the interest; 2100 the specified characteristics exist. In statutory restrictions on ownership. • receives income on a pass-through this manner, the Agencies believe that Similarly, while some commenters basis from the covered fund, or has a the definition of ownership interest in argued that including a safe harbor for rate of return that is determined by the final rule is clearer than under the standardized securitization structures reference to the performance of the proposal and thus should be less would be more effective in identifying underlying assets of the covered burdensome for banking entities in their an ownership interest in securitizations, fund.2101 This provision would not determination of whether certain rights the Agencies believe that the type of include an interest that is entitled to would cause an interest to be an interest and the rights associated with receive dividend amounts calculated at ownership interest for purposes of the interest are more appropriate to a fixed or at a floating rate based on an compliance with the rule. determine whether an interest is an As indicated above, many ownership interest and is necessary to 2098 This characteristic exists for both multi-class commenters on securitizations under avoid potential evasion of the and single-class covered funds. In the context of an the proposed rule made arguments ownership restrictions contained in entity that issues shares, this right could cover, for regarding the difficulty of applying the section 13 of the BHC Act. example, common shares, as well as preferred proposal’s definition of ownership The Agencies understand that the shares the dividend payments of which are interest to securitization structures, determined by reference to the performance of the definition of ownership interest in the covered fund. contending that the definition should final rule may include interests in a 2099 The reference to ‘‘all or a portion of excess not include debt instruments with covered fund that might not be spread’’ is meant to include within the definition equity features, or that the final rule considered an ownership interest or of ownership interest the right to receive any excess should provide a safe harbor under equity interest in other contexts. For spread which remains after the excess spread is used to pay expenses, maintain credit enhancement which the use of a standardized, pre- instance, it may include loans with an such as overcollateralization or is otherwise specified securitization structure would interest rate determined by reference to reduced. not give rise to an ownership the performance of a covered fund or 2100 This characteristic does not refer to any interest.2102 The Agencies are not senior debt interests issued in a reduction in the stated claim to principal or interest adopting a separate definition of of a holder of an interest that occurs either as a securitization. While the definition of result of a bona fide subsequent renegotiation of the ownership interest for securitization ownership interest may affect the ability terms of an interest or as a result of a bankruptcy, transactions, providing for differing of a banking entity to hold such insolvency, or similar proceeding. treatment of financial instruments, or interests, whether existing or in the 2101 This provision is not intended to encompass providing a safe harbor as requested by future, the Agencies believe that the derivative transactions entered into in connection with typical prime brokerage activities of banking some commenters. The revised definition of ownership interest as entities. However, the activities of banking entities are subject to the anti-evasion provisions. 2102 See supra note 2090. 2103 See supra note 2092.

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adopted in the final rule is more the definition of ownership interest, interest have the sole purpose and effect effective in preventing possible evasion arguing that such an exclusion was too of permitting the banking entity or an of section 13 by capturing interests that permissive and inconsistent with the employee thereof to share in the covered may be characterized as debt but confer statute because, for instance, carried fund’s profits as performance benefits of ownership, including voting interest derives its value in part by compensation for services provided to rights and/or the ability to participate in tracking gains on price movements of the fund. While most commenters did profits or losses of the covered fund. investments by the fund.2105 One not object to this criterion, one The definition of ownership interest commenter argued that, despite the fact commenter argued that the wording of in the final rule, like the proposed rule, that carried interest is typically this approach would appear to prohibit includes derivatives of the interests provided as compensation for services an employee of the banking entity from described above. Derivatives of provided to a fund, carried interest is a retaining a carried interest after the ownership interests provide holders form of investment and therefore should employee has changed employment.2113 with economic exposure to the profits be included as an ownership This commenter argued that the and losses of the covered fund or an interest.2106 Another commenter argued determination of the carried interest’s ability to earn a return based on the that permitting banking entities to hold purpose should be made only at the performance of the fund’s underlying an unrestricted amount of carried time the interest is granted, thereby holdings or investments in a manner interest could create an indirect and enabling an employee to retain the substantially similar to an ownership undesirable link between prohibited carried interest if and when the interest. The Agencies believe the final proprietary trading and covered fund employee no longer provides rule’s approach appropriately addresses activities.2107 These commenters also investment management, investment the statutory purpose to limit a banking argued that treating carried interest as advisory, or similar services to the fund entity’s economic exposure to covered compensation for providing services or is no longer employed at the banking funds, irrespective of the legal form, would be inconsistent with the manner entity. name, or issuer of that ownership in which carried interest is treated for Second, the proposal required that interest. tax purposes.2108 carried interest, once allocated, be As noted above, the proposed Other commenters, however, distributed to the banking entity definition of ownership interest did not supported excluding carried interest promptly after it is earned or, if not so include carried interest (termed from the definition of an ownership distributed, not share in the subsequent ‘‘restricted profit interest’’ in the final interest and argued the exclusion was profits and losses of the covered fund. rule). The proposal recognized that consistent with the words and purpose One commenter urged the Agencies to many banking entities that serve as of section 13.2109 One commenter allow the ‘‘reserve’’ portion of carried investment adviser or provide other argued that carried interest is readily interest that for tax purposes is allocated services to a covered fund are routinely distinguished from an investment in a to the investment manager or compensated for services they provide covered fund because carried interest investment adviser, but invested to the fund through receipt of carried normally does not expose a banking alongside the fund and not formally interest. As a result, the proposed rule entity to a covered fund’s losses (other allocated or distributed by the fund, also provided that an ownership interest than in limited instances such as when to qualify for the exclusion as carried with respect to a covered fund did not a ‘‘clawback’’ provision is triggered).2110 interest.2114 This commenter also include an interest held by a banking Another commenter argued that suggested that this criterion should not entity (or an affiliate, subsidiary or permitting a banking entity to receive affect the common European structure employee thereof) in a covered fund for carried interest without being subject to in which allocated carried interest may which the banking entity (or an affiliate, the requirements of section 13 regarding share in the subsequent losses, but not subsidiary or employee thereof) served ownership interests better aligns the the profits, of the fund. as investment manager, investment interest of the investment manager with Third, under the proposal a banking adviser, or commodity trading advisor, that of the fund and its investors.2111 entity (including its affiliates or so long as certain enumerated Another commenter supported employees) was not permitted to conditions were met.2104 expanding the definition of carried provide funds to the covered fund in The enumerated conditions contained interest to include an interest received connection with receiving a carried in the proposal were designed to narrow by a banking entity in return for interest. The proposal specifically the scope of the exclusion of carried qualifying services (e.g., lending, requested comment on whether the interest from the definition of placement, distribution, or equity exemption for carried interest, including ‘‘ownership interest’’ so as to financing) provided to the investment this requirement, was consistent with distinguish between an investor’s manager of the fund, but not directly the current tax treatment and economic risks and a service provider’s provided to the fund itself.2112 requirements of carried interest performance-based compensation. This The proposal established four criteria arrangements.2115 Commenters urged was designed to limit the ability of a that must be met in order for carried the Agencies to relax or amend this banking entity to structure carried interest to be excluded from the criterion so that banking entities, interest in a manner that would evade definition of ownership interest. First, including their affiliates and employees, section 13’s restriction on the amount of the proposal required that carried whether directly or indirectly through a ownership interests a banking entity fund vehicle, would be permitted to may have as an investment in a covered 2105 See, e.g., Occupy; AFR et al. (Feb. 2012). make minimal capital contributions to fund. 2106 See Public Citizens; see also Occupy. the fund (typically less than 1 percent) Commenters disagreed over whether 2107 See AFR et al. (Feb. 2012). in connection with the receipt of carried 2108 the definition of ownership interest See Occupy; Public Citizens; AFR et al. (Feb. interest to the extent that such should exclude carried interest. For 2012). 2109 See, e.g., SIFMA et al. (Covered Funds) (Feb. contributions provide the basis for instance, some commenters did not 2012); TCW; Credit Suisse (Williams); SVB. support excluding carried interest from 2110 See Credit Suisse (Williams). 2113 See TCW. 2111 See TCW. 2114 See Credit Suisse (Williams). 2104 See proposed rule § 75.10(b)(3)(ii). 2112 See Credit Suisse (Williams). 2115 Joint Proposal, 76 FR at 68899.

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treating the interest as carried interest exchange for services provided to a or hold restricted profit interest if the for tax purposes.2116 However, these fund. However, like the proposal, the entity (or the affiliate or employee commenters supported the proposal’s final rule continues to contain a number thereof) serves as investment manager, requirement that any amount of requirements designed to ensure that investment adviser, commodity trading contributed by a banking entity in restricted profit interest functions as advisor, or other service provider to the connection with receiving a carried compensation for providing certain covered fund. For example, an entity interest should be aggregated with the services to a covered fund and does not that provides services to the covered banking entity’s ownership interests for permit a banking entity to evade the fund in a capacity as sub-adviser or purposes of the 3 percent investment investment limitations or other placement agent would be eligible to limits. requirements of section 13. receive or hold restricted profit interest. Under the final rule, restricted profit Fourth, the proposal provided that As requested by commenters, the first carried interest may not be transferable interest is defined to include an interest held by an entity (or employee or former condition in the final rule, in contrast to by the banking entity (or the affiliate, the proposal, permits an employee or subsidiary or employee thereof) except employee thereof) that serves as investment manager, investment former employee to retain a restricted to another affiliate or subsidiary of the profit interest after a change in banking entity. Commenters generally adviser, commodity trading advisor, or employment status so long as the urged removing the proposal’s other service provider so long as: (i) The restricted profit interest was originally limitations on transferability and sole purpose and effect of the interest is received as compensation for qualifying argued, among other things, that this to allow the entity (or an employee or services provided to the covered fund. criterion could prevent a banking entity former employee thereof) to share in the (or its affiliate or employee) from profits of the covered fund as Also in response to issues raised by transferring the carried interest in performance compensation for the commenters, the second condition in connection with selling or otherwise investment management, investment the final rule has been modified to transferring the provision of advisory or advisory, commodity trading advisory, permit so-called ‘‘clawback’’ features other services that gave rise to the or other services provided to the whereby restricted profit interest that carried interest.2117 Similarly, one covered fund by the entity (or employee has been provided to an investment commenter argued that the final rule or former employee thereof), provided manager, investment adviser, should not require carried interest to be that the entity (or employee or former commodity trading advisor, or similar re-characterized as an ownership employee thereof) may be obligated service provider may be taken back if interest if it is transferred among under the terms of such interest to certain subsequent events occur, such as employees, family members of return profits previously received; (ii) if the fund fails to achieve a specified employees or to estate planning vehicles all such profit, once allocated, is preferred rate of return or if liabilities or upon an employee’s death.2118 distributed to the entity (or employee or subsequent losses are incurred by the After considering carefully comments former employee thereof) promptly after fund. Under these circumstances, the received on the proposal, the Agencies being earned or, if not so distributed, is Agencies believe it is appropriate to have determined to retain in the final retained by the covered fund for the sole allow the allocated but undistributed rule the exclusion from the definition of purpose of establishing a reserve profits to be clawed back from the ‘‘ownership interest’’ for a restricted amount to satisfy contractual obligations service provider’s performance with respect to subsequent losses of the profit interest (termed ‘‘carried interest’’ compensation, and the final rule has covered fund and such undistributed in the proposed rule 2119) largely as been amended to allow this practice. profit of the entity (or employee or provided in the proposed rule. The final The final rule makes clear, however, former employee thereof) does not share rule, like the proposal, recognizes that that the undistributed profits may only in subsequent investment gains of the banking entities that serve as investment be held in the fund in connection with covered fund; (iii) any amounts invested adviser or provide other services to a such a clawback arrangement. in the covered fund, including any covered fund are routinely compensated Undistributed profits that remain in the amounts paid by the entity (or employee for such services through receipt of a covered fund after they have been or former employee thereof) in restricted profit interest. The final rule, allocated without connection to such an connection with obtaining the restricted arrangement would be deemed to be an also like the proposal, generally profit interest, are within the investment excludes restricted profit interest from limitations of § 75.12; and (iv) the investment in the fund and would be an the definition of ownership interest interest is not transferable by the entity ownership interest under the final rule. subject to conditions designed to (or employee or former employee Importantly, the final rule also retains distinguish restricted profit interest, thereof) except to an affiliate thereof (or the limitation in the proposal that which serves as a form of compensation, an employee of the banking entity or undistributed profit may not share in from an investment in the fund affiliate), to immediate family members, subsequent investment gains of the prohibited (or limited) by section 13. As or through the intestacy of the employee covered fund. This limitation (together explained in detail below, the definition or former employee, or in connection with the limited circumstances under of restricted profit interest in the final with a sale of the business that gave rise which the undistributed profit may be rule has been modified from the to the restricted profit interest by the retained in the fund) appears necessary proposal in several aspects to respond to entity (or employee or former employee in order to distinguish restricted profit commenters’ concerns and to more thereof) to an unaffiliated party that interest, which functions as effectively capture the types of provides investment management, performance compensation and is not compensation that is often granted in investment advisory, commodity trading intended to be a form of investment, advisory, or other services to the from an ownership interest, which is 2116 See TCW; SIFMA (Covered Funds) (Feb. fund.2120 The final rule, like the designed to be an investment. The 2012); Credit Suisse (Williams). Agencies believe that this approach 2117 See ASF (Feb. 2012); see also Credit Suisse proposal, permits any entity (or the (Williams); SVB. affiliate or employee thereof) to receive achieves an appropriate balance 2118 See TCW. between accommodating receipt of 2119 See supra note 2096 and accompanying text. 2120 See final rule § 75.10(d)(6)(ii). restricted profit interest, including such

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amounts held in ‘‘reserve,’’ 2121 and commodity trading advisory, or other investments in U.S. funds by foreign limiting the ability of a banking entity services to the fund. In response to banking entities.2124 to evade the investment limitations of comments, the final rule also permits Other commenters generally argued section 13. The Agencies expect to the transfer of a restricted profit interest that the final rule should adopt the review restricted profit interests to to immediate family members of the definition of ‘‘U.S. person’’ under the ensure banking entities do not use the banking entity’s employees or former SEC’s Regulation S without the exclusion for restricted profit interest in employees that provide investment modifications in the proposed rule.2125 a manner that functions as an evasion of management, investment advisory, According to many commenters, market section 13. commodity trading advisory, or other participants are familiar with and rely As noted above, the Agencies services to the covered fund, or in upon the body of law interpreting U.S. understand that entities that provide connection with the death of such Person under Regulation S.2126 They investment management, investment employee. Also in response to argued that, to the extent that the advisory, commodity trading advisory comments, the final rule permits the definitions of ‘‘resident of the United or other services to a covered fund may, transfer of a restricted profit interest to States’’ under section 13 and ‘‘U.S. in connection with receiving restricted an affiliate or employee that provides person’’ under Regulation S differ, this profit interest, be required to hold a investment management, investment would create unnecessary uncertainty small amount of ownership interests in advisory, commodity trading advisory, and increase compliance burdens a fund to provide the basis for desired or other services to the covered fund. associated with monitoring multiple tax treatment of restricted profit interest. However, the final rule, like the definitions.2127 Other commenters urged Accordingly, the third condition of the proposed rule, would treat a restricted the Agencies not to depart from the final rule allows an entity that provides profit interest as an ownership interest treatment of international parties and qualifying services to a fund to if the restricted profit interest is organizations (e.g., the International contribute funds to, and have an otherwise transferable. This remaining Monetary Fund and the World Bank) ownership interest in, the fund in restriction recognizes that a freely under the SEC’s Regulation S.2128 connection with receiving restricted transferable restricted profit interest has Many commenters contended that, profit interest. As under the proposal, the same economic benefits as an because the definition of resident of the the amount of the contribution must be ownership interest and is essential to United States in the proposal was counted toward the investment limits differentiating a restricted profit interest generally broader than the definition of under section 13(d)(4) and § 75.12 of the from an ownership interest. U.S. person under Regulation S, many final rule. This would include additional types of persons, entities and attribution to the banking entity of sums f. Definition of ‘‘Resident of the United investors would be deemed residents of invested by employees in connection States’’ the United States for purposes of the with obtaining a restricted profit Section 13(d)(1)(I) of the BHC Act foreign activity exemptions. interest. Thus, the final rule permits a provides that a foreign banking entity Commenters argued that this would banking entity that provides investment may acquire or retain an ownership limit the potential for foreign banking management, investment advisory, or interest in or act as sponsor to a covered entities to effectively use those commodity trading advisory services to fund, but only if that activity is statutorily provided exemptions. A few have both an ownership interest in, and conducted according to the commenters noted that using a receive restricted profit interest from, requirements of the statute, including definition in the foreign fund exemption the covered fund, so long as the that no ownership interest in the that differs from the definition in aggregate of the sums invested in all covered fund is offered for sale or sold Regulation S loses the advantage of ownership interests acquired or retained to a ‘‘resident of the United States.’’ The using a term that is already understood by the banking entity (including a statute does not define this term. by market participants and that avoids general partnership interest), either in Under the proposed rule, the term confusion and limits compliance connection with receiving the restricted ‘‘resident of the United States’’ was used costs.2129 profit interest or as an investment, are in the context of the exemptions for Other commenters suggested that within the investment limitations in covered trading and covered fund defining resident of the United States as section 13(d)(4) and § 75.12 of the final activities. As proposed, the definition of proposed presented problems for rule. The Agencies believe this more resident of the United States was investment funds managed by U.S. appropriately implements the similar, but not identical, to the SEC’s investment advisers, even those without 2130 requirements of section 13 of the BHC definition of U.S. person in Regulation U.S. investors. Some commenters Act by permitting banking entities to S, which governs offerings of securities argued that, under the proposed continue to provide customer-driven outside of the United States.2122 The 2124 investment management services Agencies proposed this approach in See Sens. Merkley & Levin (Feb. 2012) (citing through organizing and offering covered 156 Cong. Rec. S5897 (daily ed. July 15, 2010) order to promote consistency and (statement of Sen. Merkley)). funds, while also abiding by the understanding among market 2125 See, e.g., Union Asset; EFAMA; BVI; AFME investment limitations of section 13. participants that have experience with et al.; IIB/EBF; Credit Suisse (Williams); Hong Kong In response to comments, the fourth the concept from the SEC’s Regulation Inv. Funds Ass’n.; PEGCC; UBS; Allen & Overy (on behalf of Canadian Banks); Allen & Overy (on behalf condition of the final rule permits the S. transfer of a restricted profit interest in of Foreign Bank Group); AFG. Some commenters supported the 2126 See PEGCC; Allen & Overy (on behalf of connection with a sale to an unaffiliated proposed definition of resident of the Canadian Banks); Allen & Overy (on behalf of party that provides investment United States.2123 One commenter Foreign Bank Group); ICI (Feb. 2012); Credit Suisse management, investment advisory, suggested that the proposed rule defined (Williams). 2127 resident of the United States too broadly See IIB/EBF; Credit Suisse (Williams); ICI 2121 The Agencies believe that this addresses a (Feb. 2012); ICI Global; PEGCC. and inappropriately precluded 2128 commenter’s concern regarding the ‘‘reserve’’ See IIB/EBF; ICI Global; Credit Suisse portion of carried interest discussed above; however (Williams). such amounts may not share in subsequent 2122 See proposed rule § 75.2(t); 17 CFR 230.901— 2129 See Allen & Overy (on behalf of Foreign Bank investment gains of the covered fund for the reasons 230.905. Group); IIB/EBF; PEGCC; Union Asset. also discussed above. 2123 See, e.g., Occupy. 2130 See, e.g., MFA; TCW.

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definition, a foreign fund managed by a As noted by commenters and discussed banking entities from providing many U.S. investment adviser or sub-adviser above, market participants are familiar customary services to covered funds.2141 that is not otherwise subject to section with and rely upon the body of law The proposal excluded from the 13 might be deemed a resident of the interpreting U.S. Person under definition of ‘‘trustee’’ as used in the United States, thereby disqualifying the Regulation S, and differing definitions term sponsor a trustee that does not fund from relying on the foreign funds under section 13 and Regulation S could exercise investment discretion with exemption, a result inconsistent with create uncertainty and increase respect to a covered fund, including a the purpose of section 13 and the compliance burdens associated with directed trustee, as that term is used in statutory exemption in section monitoring multiple definitions. The section 403(a)(1) of the Employee’s 13(d)(1)(I).2131 Agencies therefore have defined the Retirement Income Security Act Commenters also argued that the term ‘‘resident of the United States’’ in (‘‘ERISA’’) (29 U.S.C. 1103(a)(1)).2142 On proposed definition raised issues for the final rule to mean a ‘‘U.S. person’’ the other hand, the proposal provided compensation plans of international as defined in Regulation S.2135 that any banking entity that directs a organizations that are subject to section In addition, as explained in detail directed trustee, or that possesses 13 of the BHC Act. Several commenters below in Part VI.B.4.b.3. of this authority and discretion to manage and argued that U.S. employees of a foreign SUPPLEMENTARY INFORMATION, the final control the assets of a covered fund for banking entity should not be considered rule provides that an ownership interest which a directed trustee serves as residents of the United States if they is offered for sale or sold to a resident trustee, would be considered a trustee of invest in a non-U.S. covered fund of the United States if it is sold in an the covered fund. pursuant to a bona fide employee offering that ‘‘targets’’ residents of the Commenters generally supported the investment, retirement or compensation United States.2136 As explained in more exception for directed trustees in the program.2132 The Agencies have detail in that section, this approach is proposed rule but argued that the carefully considered the comments consistent with Regulation S. exception was too narrow because it received on the definition of resident of only referred to directed trustees under the United States, and have determined g. Definition of ‘‘Sponsor’’ section 403(a)(1) of the ERISA and did to modify the final rule as discussed Section 13(h)(5) of the BHC Act not include other similar custodial or below. The term ‘‘resident of the United defines ‘‘sponsor’’ to mean: (i) serving as administrative arrangements that may States’’ is not defined in the statute and a general partner, managing member, or not meet those requirements or be is used by the statute to clarify when trustee of a covered fund; (ii) in any subject to ERISA.2143 These commenters foreign activity or investment of a manner selecting or controlling (or to argued that banking entities that serve foreign banking entity qualifies for the have employees, officers, or directors, or as trustees or custodians of covered foreign funds exemption in section agents who constitute) a majority of the funds may provide a limited range of 13(d)(1)(I). The purpose of this directors, trustees, or management of a ministerial services or exercise limited exemption is to enable foreign banking covered fund; or (iii) sharing with a fiduciary duties that, while not subject entities to continue to engage in foreign covered fund, for corporate, marketing, to ERISA or beyond those permitted for funds activities and investments that do promotional, or other purposes, the a directed trustee under ERISA, not have a sufficient nexus to the United same name or a variation of the same nevertheless do not involve the exercise States so as to present risk to U.S. name.2137 Sponsor is a key definition of investment discretion or control over investors or the U.S. financial because it defines, in part, the scope of the operations of the covered fund in system.2133 The purpose of Regulation S activities to which the prohibition in the same manner as a general partner or is to provide a safe harbor from the section 13(a)(1) applies.2138 managing member. Some of these registration provisions under the Under the proposal, the term sponsor commenters advocated defining Securities Act for offerings that take would have been defined largely as in ‘‘directed trustee’’ more expansively to place outside of the United States.2134 the statute.2139 Nearly all commenters include any situation in which a The Agencies believe that, because who addressed the definition of sponsor banking entity serves solely in a the covered funds provisions of the final argued that the definition was too broad directed, fiduciary, or administrative rule involve sponsoring covered funds and suggested various ways to narrow or role where a third-party and not the and offering and selling securities limit the definition.2140 Commenters banking entity exercises investment issued by funds (as compared to generally expressed concerns that a discretion. counterparty transactional sponsor to a covered fund became In particular, some commenters also relationships), the securities law subject to the restrictions of section argued that a trustee should not be framework reflected in Regulation S 13(f), limiting the relationships of the viewed as having investment discretion, would most effectively achieve the banking entity with the covered fund. and therefore should not be treated as a purpose of the foreign funds exemption. Commenters argued this would prevent sponsor, if it possesses only the authority to terminate an investment 2131 See AFG; BVI. See also MFA; TCW. 2135 See final rule § 75.10(d)(8). adviser to a covered fund and to appoint Similarly, these commenters argued that although 2136 treated as a non-U.S. person under Regulation S, a See infra Part VI.B.4.b.3. another unaffiliated investment adviser non-U.S. fund organized as a trust in accordance 2137 See 12 U.S.C. 1851(h)(5). with local law with a limited number of U.S. 2138 See 12 U.S.C. 1851(a)(1). 2141 See, e.g., ASF (Feb. 2012); BNY Mellon et al.; investors would have been a resident of the United 2139 See proposed rule 75.10(b)(5). Credit Suisse (Williams). States. Under the proposal, this foreign fund could 2140 A number of comments received regarding 2142 See proposed rule § 75.10(b)(6); see also 29 not invest in another foreign covered fund seeking the definition of sponsor relate to securitization U.S.C. 1103(a)(1). to rely on the exemption for covered fund activities structures and are addressed below. There also were 2143 See, e.g., Arnold & Porter; Ass’n. of Global or investments that occur solely outside of the a few comments urging that insurance companies Custodians; BNY Mellon et al.; SIFMA et al. United States. not be considered to sponsor their separate (Covered Funds) (Feb. 2012); State Street (Feb. 2132 See IIB/EBF; Credit Suisse (Williams); UBS; accounts. See Sutherland (on behalf of Comm. of 2012); see also Fin. Services Roundtable (June 14, JPMC. Annuity Insurers); Nationwide. The Agencies 2011) (recommending the definition of directed 2133 See 156 Cong. Reg. S.5894–5895 (daily ed. believe these concerns should be addressed by the trustee under the Board’s Regulation R be used, July 15, 2010) (statement of Sen. Merkley). exclusion of separate accounts from the definition which defines directed trustee to mean ‘‘a trustee 2134 Offers and Sales, Securities Act Release No. of covered fund, as discussed in Part VI.B.1.c.6. of that does not exercise investment discretion with 6863 (Apr. 24, 1990) 55 FR 18306 (May 2, 1990). this SUPPLEMENTARY INFORMATION. respect to the account’’).

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in order to fulfill a demonstrable legal constitute) a majority of the directors, non-banking entities and foreign or contractual obligation of the trustee, trustees or management of a covered banks.2153 These commenters argued or the formal but unexercised power to fund. Some commenters argued that an that the costs of rebranding covered make investment decisions for a covered entity should not be treated as a sponsor funds or an asset manager would far fund in circumstances where one or of a covered fund when it selects a outweigh any potential benefit in terms more unaffiliated investment advisers majority of the initial directors, trustees of reducing the risk that a banking entity have been appointed to manage fund or management of a covered fund that may be pressured to ‘‘bail out’’ a assets. Some commenters argued in are independent of the banking entity, covered fund with a name similar to its favor of excluding trustees serving so long as the banking entity may not investment manager.2154 One under non-U.S. trust arrangements remove or replace the directors, trustees, commenter also requested clarification pursuant to which they may have legal or management and directors are that the name sharing prohibition does or contractual authority to, but in fact subsequently either chosen by others or not apply in the context of offering do not, exercise investment discretion self-perpetuating.2149 One of these documents that carry the names of the (i.e., the entity has the formal authority commenters argued similarly that a manager, sponsor, distributor, as well as to appoint an investment adviser to a banking entity should not be deemed to the name of the fund itself.2155 This trust but does so only in extraordinary sponsor a covered fund if it selects an commenter also advocated that, because circumstances such as appointing a independent general partner, managing of the costs associated with changing a successor investment adviser).2144 member or trustee of a new fund, so fund name, the Agencies give specific A few commenters requested long as the general partner, managing guidance regarding how similar a name confirmation that a banking entity member or trustee may not be may be so as not to be a ‘‘variation of acting as a custodian should not be terminated and replaced by the banking the same name’’ for purposes of the considered a sponsor of a covered entity.2150 Commenters argued that definition of sponsor and the activities fund.2145 One commenter argued that initial selection of these parties was permitted under section 13(d)(1)(G) and traditional client trust accounts for inherently part of, and necessary to § 75.11 of the rule. which a bank serves as discretionary allow, the formation of a covered fund The Agencies have carefully trustee should not, by implication, and would not provide a banking entity considered comments received in light themselves become ‘‘covered funds’’ with ongoing control over the fund to a of the terms of the statute. Section that are ‘‘sponsored’’ by the bank.2146 degree that the banking entity should be 13(h)(5) of the BHC Act specifically One commenter argued that any considered to be a sponsor. defines the term ‘‘sponsor’’ for purposes person performing similar functions to a The statute and proposed rule also of section 13. The Agencies recognize directed trustee (such as a fund defined the term sponsor to include an that the broad definition of sponsor in management company established entity that shares, for corporate, the statute will result in some of the under Irish law), regardless of its formal marketing, promotional, or other effects commenters identified, as title or position, also should be purposes, the same name or a variation discussed above. excluded if the person does not exercise of the same name, with a covered fund. The final rule generally retains the investment discretion.2147 Some One commenter argued in favor of a definition of ‘‘sponsor’’ in the statute commenters argued more generally for narrower interpretation of this statutory and the proposed rule, although with an exclusion from the definition of provision.2151 This commenter argued certain modifications and clarifications trustee (and therefore from the that a covered fund should be permitted to respond to comments received definition of sponsor) for entities that to share the name of the asset manager regarding the exclusion for ‘‘directed act as service providers (such as that advises the fund without the asset trustees.’’ As in the proposed rule, the custodians, trustees, or administrators) manager becoming a sponsor so long as definition of sponsor in the final rule to non-U.S. regulated funds, arguing the asset manager does not share the covers an entity that (i) serves as general that European laws already impose same name as an affiliated insured partner, managing member, or trustee of significant obligations on entities depository institution or the ultimate a covered fund, or that serves as a serving in these roles.2148 parent of an affiliated insured commodity pool operator of a covered Under both section 13 of the BHC Act depository institution.2152 Another fund as defined in § 75.10(b)(1)(ii) of the and the proposal, the definition of commenter argued that the proposal final rule, (ii) in any manner selects or sponsor also included the ability to would put U.S. banking entities at a controls (or has employees, officers, or select or control (or to have employees, competitive disadvantage relative to directors, or agents who constitute) a officers, directors, or agents who majority of the directors, trustees, or 2149 See SIFMA et al. (Covered Funds) (Feb. 2012) management of a covered fund, or (iii) 2144 (recommending the Agencies adopt independence See BNY Mellon et al. (providing proposed guidelines similar to the FDIC’s guidelines for shares with a covered fund, for rule text or suggesting in the alternative determining whether audit committee members of corporate, marketing, promotional, or clarification regarding the phrase ‘‘exercise insured depository institutions are ‘‘independent’’ investment discretion’’ in the final rule preamble); other purposes, the same name or a of management); Credit Suisse (Williams). 2156 Ass’n. of Global Custodians; ICI Global; State Street variation of the same name. 2150 See Credit Suisse (Williams) (arguing that (Feb. 2012). such an approach would be consistent with the 2145 2153 See Ass’n. of Global Custodians; SIFMA et al. existing BHC Act concept of control with respect to See Goldman (Covered Funds). (Covered Funds) (Feb. 2012); ABA (Keating); AFG; funds). 2154 See Credit Suisse (Williams); see also AFTI; BNY Mellon et al.; EFAMA; IMA; State Street 2151 A number of comments were also received Goldman (Covered Funds). (Feb. 2012). regarding the restriction on name sharing that is one 2155 See Credit Suisse (Williams). 2146 See Arnold & Porter. To the extent that a of the requirements of section 13(d)(1)(G) and 2156 See final rule § 75.10(d)(9). Some commenters client trust account would not be an investment § 75.11 of the proposed rule. These comments are asserted that custodians and service providers company but for the exclusion contained in section discussed in Part VI.B.2.a.5. of this SUPPLEMENTARY should not treated as sponsors under the final rule. 3(c)(1) or 3(c)(7) of the Investment Company Act, INFORMATION. The Agencies note, however, that a banking entity such as the exclusion for common trust funds under 2152 See Credit Suisse (Williams); see also ABA is not a sponsor under the final rule unless it serves section 3(c)(3) of that Act, it would not be a covered (Keating); BlackRock; Goldman (Covered Funds); in one or more of the capacities specified in the fund regardless of whether a banking entity acts as SIFMA et al. (Covered Funds) (Feb. 2012); TCW definition; controls or makes up the fund’s board trustee. (proposing similarly to limit the name-sharing of directors or management as described in the final 2147 See BNY Mellon et al. restriction to the insured depository institution in rule; or shares the same name or a variation of the 2148 See EFAMA; F&C; IRSG; Union Asset. context of section 13(d)(1)(G)). same name with the fund as described in the final

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While commenters urged the that are substantially equivalent to those which banking entities may continue to Agencies to provide an exemption from described in paragraph (i).2160 Under benefit from brand equity they have the definition of sponsor for a banking the final rule, a trustee would be developed.2161 The costs a banking entity that selects the initial directors, excluded if the trustee does not have entity would incur to rebrand its trustees, or management of a fund,2157 any investment discretion, but is covered funds would depend on the the final rule has not been modified in required to ensure that the underlying cost to rebrand the banking entity’s this manner because the initial selection assets are appropriately segregated for current funds, as well as the banking of the directors, trustees or management the benefit of the trust. Similarly, a entity’s ability to attract new investor of a fund is an action characteristic of trustee would be excluded if the trustee capital to its current and future covered a sponsor and is essential to the creation has no investment discretion but is funds. The total burden per banking of a covered fund. The Agencies note, authorized to replace an investment entity, therefore, would depend on the however, that the statute and the final adviser with an unaffiliated party when brand equity as well as the number of rule allow banking entities to sponsor the investment adviser resigns. With covered funds that share a similar covered funds, including selecting the respect to an issuing entity of asset- name.2162 One commenter argued that, initial board of directors, trustees and backed securities and as explained as a result, banking entities subject to management, so long as the banking below, a directed trustee excluded from section 13 may be at a competitive entity observes certain requirements and the definition of sponsor would include disadvantage to other firms that are not conforms any initial investment in the a person that conducts their actions subject to these or similar covered fund to the limits in the statute solely in accordance with directions restrictions.2163 The Agencies believe and regulation during the relevant prepared by an unaffiliated party. that the final rule addresses some conformance period as discussed in Part The Agencies believe that this commenters’ concerns to an extent by VI.B.3.b. of this SUPPLEMENTARY exclusion is appropriate because the 2158 adopting a more tailored definition of INFORMATION. Moreover, a banking relevant prong of the definition of covered, including a focused definition entity that does not continue to select or sponsor (i.e., serving as general partner, of foreign funds that will be covered control a majority of the board of managing member, or trustee) specifies funds and an exclusion for foreign directors would not be considered to be entities that have the ongoing ability to public funds.2164 In addition, to the a sponsor under this part of the exercise control over a fund; directed extent that a banking entity would definition once that role or control trustees excluded from definition of otherwise come under pressure for terminates. In the case of a covered fund sponsor in the final rule do not appear reputational reasons to directly or that will have a self-perpetuating board to have this ability and thus do not indirectly assist a covered fund under of directors or a board selected by the appear to be the type of entity that this distress that bears the banking entity’s fund’s shareholders, this would not be prong of the definition of sponsor was name, the name-sharing prohibition considered to have occurred until the intended to capture. If a trustee were could reduce the risk to the banking board has held its first re-selection of itself to assume the role of investment entity this assistance could pose. directors or first shareholder vote on adviser, or have the ability to exercise directors without selection or control by investment discretion with respect to 1. Definition of Sponsor With Respect to the banking entity. the covered fund, the trustee would not Securitizations As explained below, the Agencies qualify for this exclusion. The final rule believe that, in context, the term trustee does not include within the definition Commenters on the definition of in the definition of the term sponsor of sponsor custodians or administrators sponsor in the context of securitization refers to a trustee with investment of covered funds unless they otherwise vehicles generally argued that the discretion. Consistent with this view, meet the definitional qualifications set proposed definition of sponsor was too commenters urged the Agencies to forth in section 13 and the final rule. broad and requested clarification that exclude from the definition of sponsor The definition of sponsor will various roles that banking entities might certain trustees and parties commenters continue to cover entities that share the serve within a securitization structure asserted acted in a similar capacity, as same name or variation of the same would be excluded from the definition discussed above.2159 The final rule name of a covered fund for corporate, of sponsor, including servicers; 2165 therefore has been modified to exclude marketing, promotional, or other backup servicers and master from the definition of trustee: (i) a purposes, consistent with the definition servicers; 2166 collateral agents and trustee that does not exercise of sponsor in section 13(h)(5). The investment discretion with respect to a Agencies recognize that some 2161 See supra notes 2151–2155 and covered fund, including a trustee that is commenters urged the Agencies to accompanying text. subject to the direction of an modify this aspect of the definition of 2162 See infra note 2164. unaffiliated named fiduciary who is not sponsor, and that the name-sharing 2163 See supra note 2153 and accompanying text. a trustee pursuant to section 403(a)(1) of 2164 For example, one commenter argued that it prohibition included in the definition of would need to rebrand approximately 500 the Employee’s Retirement Income sponsor (and in the conditions for the established funds under the rule proposal if the Security Act (29 U.S.C. 1103(a)(1)); or organize and offer exemption) will final rule was not modified to exclude established (ii) a trustee that is subject to fiduciary require some banking entities to rebrand and regulated funds in foreign jurisdictions. See standards imposed under foreign law their covered funds, which may prove Goldman (Covered Funds). 2165 See Allen & Overy (on behalf of Foreign Bank expensive and will limit the extent to Group); ASF (Feb. 2012); Credit Suisse (Williams); rule. See, e.g., supra note 2156 and accompanying SIFMA (Securitization) (Feb. 2012); Wells Fargo text. See also infra note 2160. 2160 See final rule § 75.10(d)(10). With respect to (Covered Funds). One of these commenters argued 2157 See supra note 2149 and accompanying text. the concept of a ‘‘directed trustee’’ under foreign that servicers will not have the right to control the 2158 Similarly, a banking entity may share the law, commenters generally requested changes only decision-making and operational functions of the same name or a variation of the same name with if non-U.S. mutual fund equivalents were not issuer. See SIFMA (Securitization) (Feb. 2012). a covered fund so long as the banking entity does excluded from the definition of covered fund. As Another commenter stated that servicers do not not organize and offer the covered fund in discussed above, the final rule explicitly excludes have the authority to select assets or make accordance with section 13(d)(1)(G) and § 75.11. foreign public funds from the definition of covered investment decisions on behalf of investors. See 2159 See, e.g., supra notes 2143–2144 and fund, which should address these commenters PNC. accompanying text. See also supra note 2156. concerns. See final rule § 75.10(c)(1). 2166 See ASF (Feb. 2012).

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administrators; 2167 custodians; 2168 commenters argued that an entity a covered fund; (ii) have the right to indenture trustees; 2169 underwriters, should not be considered a sponsor select or control a majority of the distributors, placement agents; 2170 even though it has limited investment directors, trustees, or management of a arrangers, structuring agents; 2171 discretion,2182 while others argued that covered fund; or (iii) share with a originators, depositors, securitizers; 2172 investment advisers and parties with covered fund, for corporate, marketing, ‘‘sponsors’’ under the SEC’s Regulation investment discretion should not be promotional, or other purposes, the AB; 2173 administrative agents; 2174 and included in the definition of same name or a variation of the same securities administrators and sponsor.2183 name. If the parties that commenters remarketing agents.2175 Commenters After considering comments received described do not serve in those argued that these parties should not be and the language and purpose of section capacities for a covered fund, do not included in the definition of sponsor 13, the Agencies have determined not to have those rights with respect to a because such parties have clearly adopt a separate definition of sponsor covered fund or do not share a name defined and extremely limited authority for issuers of covered funds that are with a covered fund, such parties would and discretion,2176 do not have the right issuers of an asset-backed security. As not be a sponsor for purposes of the to control the decision-making and described above and consistent with the final rule, and, therefore, they would operational functions of the issuer,2177 statute, the definition of sponsor only not be subject to the restrictions and would not have ‘‘control’’ under includes parties that: (i) Serve as a applicable to the sponsor of a covered BHC Act control precedent.2178 general partner, managing member, or fund, including the restrictions Conversely, one commentator supported trustee (other than a directed trustee) of contained in section 13(f).2184 defining sponsor under the proposed Additionally, the Agencies believe rule to include the Regulation AB collateral administrators, should not be considered that the exclusion of loan securitizations sponsor, the servicer and the investment the sponsor or investment manager of a fund under from the definition of covered fund manager.2179 Commenters also made section 13 of the BHC Act because they have roles that are principally ministerial in nature and do not under the final rule addresses many of arguments regarding the potential generally involve investment discretion or the commenters’ concerns about the detrimental effects to securitization and management and control activities); PNC (arguing sponsor definition because this credit markets if banking entities are that a banking entity should not be deemed a exclusion limits the types of prohibited from acting as sponsors of sponsor simply by serving as underwriter, distributor, placement agent, originator, depositor, securitizations that are covered funds 2180 securitizations. investment adviser, servicer, administrative agent, and subject to the final rule. Similarly, Commenters disagreed as to whether securitizer or similar role because these parties do the exclusion of certain ABCP conduits or not a sponsor under the final rule not have the authority to select assets or make from the definition of covered fund will should include a party with any investment decisions on behalf of investors). mean that the restrictions under section 2182 See Allen & Overy (on behalf of Foreign Bank investment discretion, some investment Group); ASF (Feb. 2012); SIFMA (Securitization) 13(f) will not apply to qualifying asset- discretion or complete investment (Feb. 2012). One commenter argued that the limited backed commercial paper conduits. discretion. Some commenters argued discretion that a servicer, trustee or custodian may As with any other covered fund under that certain parties should not be have to either invest funds within certain the final rule, the term sponsor would parameters, liquidate assets following a default on considered a sponsor because they were the asset or the securitization default, or mitigate include a trustee that has the right to not an investment advisor or did not losses subject to a servicing standard, should not be exercise any investment discretion for have investment discretion.2181 Other considered a sponsor because these entities do not the securitization. For issuers of asset- exercise the level of management and control backed securities, this would generally 2167 Id. exercised by the general partner or managing member of a hedge fund or private equity fund. not include a trustee that executes 2168 See Allen & Overy (on behalf of Foreign Bank Another commenter argued that to the extent that decision-making, including investment Group); ASF (Feb. 2012). any of these parties exercises discretion, such of funds prior to the occurrence of an 2169 Id. discretion (A) involves decisions made after another event of default, solely according to the 2170 See Cleary Gottlieb; Credit Suisse (Williams); party defaults (e.g., post-event of default collateral SIFMA (Securitization) (Feb. 2012); Wells Fargo sale), (B) prescribed by the transaction documents provisions of a written contract or at the (Covered Funds). One of these commentators (e.g., choosing among a limited number of eligible written direction of an unaffiliated argued that placement agents and underwriters will investments) and (C) governed by standards of care party. In addition, under the rule as not have the right to control the decision-making (e.g., the servicing standards). See ASF (Feb. 2012). adopted a trustee with investment and operational functions of the issuer. See SIFMA Another commenter requested clarification that the (Securitization) (Feb. 2012). exclusion of trustees that do not exercise discretion may avoid characterization as 2171 See Cleary Gottlieb (‘‘party that structures the investment discretion would also cover trustees that a sponsor if it irrevocably delegates all asset-backed securities’’); SIFMA (Securitization) (A) direct investment of amounts in accordance of its investment discretion to another (Feb. 2012). with the applicable transaction documents, (B) act unaffiliated party with respect to the 2172 See Credit Suisse (Williams); Wells Fargo as servicer pending the appointment of a successor (Covered Funds). or (C) liquidate collateral. See SIFMA covered fund. The Agencies believe that 2173 See SIFMA (Securitization) (Feb. 2012) (Securitization) (Feb. 2012). One commenter argued these considerations regarding when a (arguing that Regulation AB sponsors will not have that the definition of sponsor should not include an trustee is a sponsor responds to the right to control the decision-making and investment manager unless the investment manager commenters’ concerns regarding the operational functions of the issuer after they deposit (A) serves in one of the capacities designated in the roles of trustees in securitizations.2185 the assets). definition of sponsor and can be replaced at the 2174 See Credit Suisse (Williams). discretion of one or more entities serving in such 2184 2175 See ASF (Feb. 2012); Wells Fargo (Covered capacity or with or without cause by the security As discussed above, commenters argued that Funds). holders or (B) has the ‘‘discretion to acquire or that various roles that banking entities might serve dispose of assets in the securitization for the within a securitization structure should be 2176 See Allen & Overy (on behalf of Foreign Bank primary purpose of recognizing gains or decreasing excluded from the definition of sponsor. See supra Group). losses resulting from market value changes.’’ Id. notes 2165–2175 and accompanying text. 2177 See SIFMA (Securitization) (Feb. 2012). 2183 See Credit Suisse (Williams); SIFMA 2185 The Agencies also note that, while the 2178 See Credit Suisse (Williams). (Securitization) (Feb. 2012); TCW (arguing that the entities commenters identified may not fall into the 2179 See Occupy. investment manager is typically unaffiliated with definition of sponsor, the ability of a banking entity 2180 See ASF (Feb. 2012); Credit Suisse the general partner or equivalent of such fund, does to acquire and retain an interest in a securitization (Williams). not control the board of directors, is not responsible that is a covered fund will depend on whether it 2181 See ASF (Feb. 2012) (arguing that service for the operations or books and records of the fund conducts its activity in a manner permitted under providers, including trustees, custodians, collateral and generally does not perform any other one of the exemptions contained in section 13(d)(1) agents, servicers, master servicers, backup servicers, significant function for the fund, such as acting as of the BHC Act, such as the exemption for securities administrators, remarketing agents and transfer agent). organizing and offering a covered fund.

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2. Section 75.11: Activities Permitted in covered funds under § 75.16 of the provides an exemption from section Connection With Organizing and proposed rule; (v) the banking entity 13(a) of the BHC Act, which prohibits a Offering a Covered Fund may not, directly or indirectly, banking entity from acquiring or Section 13(d)(1)(G) of the BHC Act guarantee, assume, or otherwise insure retaining an equity, partnership or other permits a banking entity to make the obligations or performance of the ownership interest in or sponsoring a investments in and sponsor covered covered fund or of any covered fund in covered fund. To the extent that an funds within certain limits in which such covered fund invests; (vi) activity is not prohibited by section connection with organizing and offering the covered fund, for corporate, 13(a), no exemption to that statutory the covered fund.2186 Section 75.11 of marketing, promotional, or other prohibition is needed to conduct that the final rule implements this statutory purposes, may not share the same name activity. However, it is common for exemption, and includes several or a variation of the same name with the prohibited and non-prohibited activities changes from the proposed rule in banking entity (or an affiliate or to be conducted together in connection response to concerns raised by subsidiary thereof), and may not use the with offering and organizing a covered commenters as described in detail word ‘‘bank’’ in its name; (vii) no fund. For example, an entity that below.2187 director or employee of the banking provides investment advisory services entity may take or retain an ownership to a covered fund (an activity not itself a. Scope of Exemption interest in the covered fund, except for prohibited by section 13(a)(1)(B) of the Section 75.11 of the proposed rule any director or employee of the banking BHC Act) often acquires an ownership described the conditions that must be entity who is directly engaged in interest in a covered fund and/or met in order to qualify for the providing investment advisory or other appoints a majority of management of exemption provided by section services to the covered fund; (viii) the the covered fund (which is included in 13(d)(1)(G) for covered fund activities banking entity must clearly and the definition of sponsor under the conducted in connection with conspicuously disclose, in writing, to statute), both of which are covered by organizing and offering a covered any prospective and actual investor in the statutory prohibition in section fund.2188 These conditions generally the covered fund (such as through 13(a)(1)(B). In that case, the banking mirrored section 13(d)(1)(G) of the disclosure in the covered fund’s offering entity may engage in the prohibited statute, and included: (i) The banking documents) the enumerated disclosures activity as part of organizing and entity must provide bona fide trust, contained in § 75.11(h) of the proposed offering a covered fund only if the fiduciary, investment advisory, or rule; and (ix) the banking entity must prohibited activity is conducted in commodity trading advisory comply with any additional rules of the accordance with the requirements in the services; 2189 (ii) the covered fund must appropriate Agency or Agencies, exemption in section 13(d)(1)(G) or be organized and offered only in designed to ensure that losses in such some other exemption. connection with the provision of bona covered fund are borne solely by The final rule reflects this view in that fide trust, fiduciary, investment investors in the covered fund and not by it permits a banking entity to invest in 2190 advisory, or commodity trading the banking entity. or sponsor a covered fund in connection Commenters raised concern that the advisory services and only to persons with organizing and offering the fund, proposed rule could be read to extend that are customers of such services of which may involve activities that are the prohibition on covered fund the banking entity; (iii) the banking not prohibited by section 13. Under the activities beyond the scope intended by entity may not acquire or retain an final rule, a banking entity that serves as the statute.2191 Because the proposed ownership interest in the covered fund an investment adviser to a covered fund exemption was applicable to banking except in accordance with the (including a sub-adviser), for example, entities engaged in ‘‘organizing and limitations on amounts and value of may permissibly invest in the covered offering’’ a covered fund, commenters those interests as permitted under fund to the extent the banking entity were concerned that the proposed rule subpart C of the proposed rule; (iv) the complies with the requirements of might be interpreted to prohibit a banking entity must comply with the section 13(d)(1)(G) of the Act. An entity banking entity from engaging in restrictions governing relationships with that serves only as investment adviser, activities that are part of organizing and without making any investment or offering a covered fund but that are not 2186 156 Cong. Rec. S5889 (daily ed. July 15, 2010) conducting any activity covered by the prohibited under the covered fund (statement of Sen. Hagan) (arguing that section 13 prohibition in section 13(a), would not permits a banking entity to engage in a certain level prohibition. In this regard, commenters be covered by the prohibition in section of traditional asset management business). contended that the activity of 2187 13(a) and thus would not need to rely See final rule § 75.11; proposed rule § 75.11. ‘‘organizing and offering’’ a covered 2188 See proposed rule §§ 75.11(a)—(h). on section 13(d)(1)(G) and § 75.11 of the fund would include serving as 2189 While section 13(d)(1)(G) of the BHC Act final rule to conduct that investment investment adviser, distributor, broker, does not explicitly mention ‘‘commodity trading advisory activity. advisory services,’’ the Agencies proposed to treat and other activities not prohibited by commodity trading advisory services in the same section 13 of the BHC Act and not As described in more detail below, a way as investment advisory services because the involving the acquisition or retention of number of commenters expressed proposed rule would have included commodity an ownership interest in or sponsorship concern about applying the pools within the definition of ‘‘covered fund.’’ One requirements of section 13(d)(1)(G) and commenter argued that a covered banking entity of a covered fund as those terms are should not be permitted to qualify for the defined in section 13.2192 the final rule outside of the United exemption in section 13(d)(1)(G) based on The Agencies have modified the final States, including with respect to foreign providing commodity trading advisory services. See rule to address this concern, which public funds organized and offered by Occupy. The Agencies believe that commodity foreign banking entities, particularly in trading advisors provide services to commodity reflects a reading of the proposal not pools that are similar to the services an investment intended by the Agencies. Section situations where requirements in foreign adviser provides to a hedge fund or private equity 13(d)(1)(G) of the BHC Act by its terms jurisdictions may conflict with the fund. Because certain commodity pools are requirements of section 13 of the BHC included within the definition of covered fund, 2193 2190 Act and implementing regulations. banking entities may organize and offer these See proposed rule § 75.11(a)–(h). commodity pools as a means of providing these 2191 See, e.g., Arnold & Porter. services to customers. 2192 See Arnold & Porter; F&C. 2193 See, e.g., EFAMA; ICI Global; JPMC.

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The Agencies believe that many of the banking entity of bona fide trust, fund is organized and offered for the concerns raised with respect to applying fiduciary, investment advisory, or purpose of providing bona fide trust, section 13(d)(1)(G) and the proposed commodity trading advisory services to fiduciary, investment advisory, or rule outside the United States have been the customer. This application of the commodity trading advisory services to addressed through the revised definition customer requirement is consistent with customers of the banking entity (or an of covered fund described above and the manner in which these services are affiliate thereof) and not to evade the revisions to the exemption provided for provided by banking entities. The restrictions of section 13 of the BHC activities conducted solely outside the proposed rule also required that a Act. United States. In particular, the revised banking entity relying on the authority The language of the final rule also definition of covered fund makes clear contained in § 75.11 adopt a credible adopts the statutory requirements (and that a foreign fund offered outside the plan or similar documentation outlining modifications related to commodity United States is only a covered fund how the banking entity intended to pools as discussed above) that the under specified circumstances with provide advisory or similar services to banking entity provide bona fide trust, respect to a banking entity that is, or is its customers through organizing and fiduciary, investment advisory, or controlled directly or indirectly by a offering such fund. commodity trading advisory services, banking entity that is, located in or Several commenters indicated and that the covered fund be organized organized or established under the laws support for this customer requirement and offered only in connection with the of the United States or of any State.2194 and, in particular, the Agencies’ view provision of those services. Banking Furthermore, foreign public funds are that the customer relationship need not entities provide a wide range of excluded from the definition of covered be a preexisting one.2198 A few customer-oriented services which may fund in the final rule.2195 Consequently, commenters contended that the statute qualify as bona fide trust, fiduciary, a foreign banking entity may invest in required that a banking entity have a investment advisory, or commodity or organize and offer a variety of funds pre-existing customer relationship, and trading advisory services.2202 outside of the United States without may not solicit investors outside of its Historically, banking entities have used becoming subject to the requirements of existing asset management covered funds as a method of providing section 13(d)(1)(G) and § 75.11 of the customers.2199 One of these commenters these services to customers in a manner final rule, such as the name-sharing argued that this would place banking that is both cost efficient for the restriction or limitations on director and entities at a competitive disadvantage customer and allows customers to employee investments. compared to investment advisers that benefit from access to advice and services that might not otherwise be 1. Fiduciary Services are not banking entities (and thus not subject to the requirements of section 13 available to them. These benefits apply In order to qualify for the exemption and the final rule), but argued that this to long-established customers as well as for activities related to organizing and is a necessary result of section 13.2200 individuals or entities that have no pre- offering a covered fund, section The final rule adopts the language existing relationship with the banking 13(d)(1)(G) generally requires that a largely as proposed, and the Agencies entity but choose to obtain the benefit banking entity provide bona fide trust, continue to believe that the customer of trust, fiduciary, investment advisory, fiduciary, investment advisory, or relationship required under section or commodity trading advisory services commodity trading advisory services, 13(d)(1)(G) and the final rule may be through participation in the covered that the covered fund be organized and established through or in connection fund. Covered funds also allow offered in connection with providing customers to gauge the historical record with the banking entity’s organization these services, and that the banking of the banking entity in providing these and offering of a covered fund, so long entity providing those services offer the services by reviewing the funds’ past as that fund is a manifestation of the covered fund only to persons that are performance. customers of those services of the provision by the banking entity of bona The statute does not require that a banking entity.2196 These requirements fide trust, fiduciary, investment covered fund be offered only to pre- were largely mirrored in the proposed advisory, or commodity trading 2201 existing customers of the banking entity, rule. Requiring a customer relationship advisory services to the customer. and the Agencies believe that imposing in connection with organizing and The final rule requires that a covered such a requirement would not improve offering a covered fund helps to ensure fund be organized and offered pursuant the quality of the trust, fiduciary, that a banking entity is engaging in the to a written plan or similar investment advisory, or commodity covered fund activity for others and not documentation outlining how the trading advisory service, enhance the on the banking entity’s own behalf.2197 banking entity (or an affiliate thereof) safety and soundness of the banking As noted in the proposal, section intends to provide advisory or similar entity, or reduce the risks to the 13(d)(1)(G)(ii) of the BHC Act does not services to its customers through customers or the banking entity. In each explicitly require that the customer organizing and offering the fund. As case, the banking entity provides trust, relationship be pre-existing. part of this requirement, the plan must fiduciary or advisory services to a Accordingly, the Agencies explained in be credible and indicate that the covered fund for the benefit of the the proposal that the customer banking entity has conducted banking entity’s customers, and the relationship may be established through reasonable analysis to show that the statute recognizes that organizing and or in connection with the banking offering a covered fund is a legitimate entity’s organization and offering of a 2198 See Ass’n of Institutional Investors (Feb. method for providing that service. In 2012); SIFMA et al. (Covered Funds) (Feb. 2012); covered fund, so long as that fund is a JPMC. addition, the banking entity must abide manifestation of the provision by the 2199 See Sens. Merkley & Levin (Feb. 2012); AFR by all the statutory and prudential et al. (Feb. 2012); Occupy; Public Citizen. 2194 See final rule § 75.10(b)(1)(iii). 2200 See Sens. Merkley & Levin. 2202 See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (K), 12 2195 See final rule § 75.10(c)(1). 2201 See final rule § 75.11(a)(1)–(2). See Part CFR 225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR 2196 See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule VI.B.2.b. below for a discussion of these 225.125 (with respect to a bank holding company); § 75.11(a). requirements in the context of a banking entity that 12 U.S.C. 24(Seventh), 92a, 12 CFR Part 9 (with 2197 See 156 Cong. Rec. at S5897 (daily ed. July organizes and offers a covered fund that is an respect to a national bank); 12 U.S.C. Part 362 (with 15, 2010) (statement of Sen. Merkley). issuing entity of asset-backed securities. respect to a state non-member bank).

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requirements imposed by section 13 and from, directly or indirectly, underlying obligations of the covered the entity’s supervisors on the provision guaranteeing, assuming or otherwise fund. The requirement of the final rule of those services. The Agencies do not insuring the obligations or performance that a banking entity and its affiliates believe that a pre-existing customer of the covered fund or any covered fund not guarantee the obligations or relationship requirement would be in which such covered fund invests.2207 performance of a covered fund that it meaningful because it could easily be This prong implemented section organizes and offers therefore does not satisfied by a prospective customer 13(d)(1)(G)(iv) of the BHC Act and was prohibit a banking entity from providing seeking to invest in a covered fund by intended to prevent a banking entity borrower default indemnifications to first establishing an account with a from engaging in bailouts of a covered customers. banking entity or purchasing another fund in which the banking entity has an 5. Limitation on Name Sharing With a product (e.g., a brokerage account or 2208 interest. Covered Fund shares of a mutual fund). There were only a few comments received on this aspect of the proposal. Section 75.11(f) of the proposed rule 2. Compliance With Investment prohibited the covered fund from Limitations One commenter supported the restriction on guarantees as effective sharing the same name or a variation of Section 13(d)(1)(G)(iii) of the BHC Act and consistent with the statute.2209 the same name with the banking entity limits the ability of a banking entity that One commenter argued that the final that relies on the exemption in section organizes and offers a covered fund to rule should not prohibit borrower 13(d)(1)(G) of the BHC Act.2211 The acquire or retain an ownership interest default indemnification services (i.e., proposed rule also prohibited the in that covered fund as an the guarantee of collateral sufficiency covered fund from using the word 2203 investment. Both the proposed rule upon a securities borrower’s default) ‘‘bank’’ in its name.2212 and the final rule implement this provided to lending clients by agent The name-sharing restriction was one provision by requiring that a banking banks in connection with securities of the most commented upon aspects of entity limit its investments in a covered lending transactions involving a covered § 75.11. A number of commenters on fund that the banking entity organizes 2210 this section expressed the view that the 2204 fund. This commenter argued that and offers as provided in § 75.12. borrower default indemnification name-sharing restriction in section Comments received on investment services guarantee only the deficit 13(d)(1)(G)(vi) of the BHC Act and the limitations in the proposed rule, and between the mark to market value of proposed rule was too strict. In modifications made to the final rule cash collateral received and the amount particular, a number of commenters implementing these limitations, are of any borrower default, and are argued that the name-sharing restriction described in Part VI.B.3. below. therefore different from and more should allow an asset manager to share 3. Compliance With Section 13(f) of the limited than the type of general its name with a sponsored covered fund BHC Act investment performance or obligation so long as the covered fund does not guarantee that section 13 was designed share the name of the insured Section 75.11(d) of the proposed rule depository institution or its affiliated required that the banking entity comply to prevent. The Agencies believe that the statute holding company or use the word with the limitations on relationships ‘‘bank.’’ 2213 with covered funds imposed by section does not permit either full or partial guarantees of the obligations of a Commenters argued that the name- 13(f) of the BHC Act.2205 The final rule sharing restriction as proposed would adopts this requirement and provides covered fund that the banking entity organizes and offers. Accordingly, the impose significant business and that the banking entity (and its affiliates) branding burdens on the industry must comply with the requirements of final rule, like the proposed rule, continues to mirror the statutory without providing incremental benefit § 75.14. Section 13(f) of the BHC Act 2214 restriction on direct or indirect to the public. These commenters prohibits certain transactions or argued that it would be unduly relationships that would be covered by guarantees of the obligations or performance of a covered fund by a burdensome and costly for funds section 23A of the Federal Reserve Act, currently affiliated with banking entities and provides that any permitted banking entity in connection with reliance on the exemption provided in or managers that are themselves banking transaction is subject to section 23B of entities to change the name of their the Federal Reserve Act, in each section 13(d)(1)(G) of the BHC Act. However, in response to comments affiliated funds and that many of these instance as if such banking entity were funds have developed a reputation in a member bank and such covered fund received on the proposal, the Agencies note that the provision of a borrower the marketplace based on the current were an affiliate thereof.2206 These name of the fund and/or fund manager. limitations apply in several contexts, default indemnification by a banking entity to a lending client in connection and are contained in § 75.14 of the final 2211 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule rule, discussed in detail below in Part with securities lending transactions § 75.11(f). VI.B.5. involving a covered fund is not 2212 Similar restrictions on a fund sharing the prohibited. This type of indemnification same name, or variation of the same name, with an 4. No Guarantees or Insurance of Fund is not a guarantee of the performance or insured depository institution or company that Performance controls an insured depository institution or having obligations of a covered fund because it the word ‘‘bank’’ in its name, have been used Section 75.11(e) of the proposed rule represents a guarantee to the customer previously in order to prevent customer confusion prohibited a banking entity that or borrower of the obligation of the regarding the relationship between such companies organizes and offers a covered fund counterparty to perform and not a and a fund. See, e.g., Bank of Ireland, 82 Fed. Res. guarantee of the performance or Bull. 1129 (1996). 2213 See ABA (Keating); Ass’n of Institutional 2203 See 12 U.S.C. 1851(d)(1)(G)(iii). Investors (Feb. 2012); Blackrock; EFAMA; SIFMA et 2204 See proposed rule and final rule § 75.12. 2207 12 U.S.C. 1851(d)(1)(G)(v); proposed rule al. (Covered Funds) (Feb. 2012); TCW; Katten (on 2205 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule § 75.11(e). behalf of Int’l Clients); Union Asset. § 75.11(d). 2208 See 156 Cong. Rec. S5897 (daily ed. July 15, 2214 See, e.g., ABA (Keating); Ass’n of 2206 See Part VI.B.5. below. The comments 2010) (statement of Sen. Merkley). Institutional Investors (Feb. 2012); Blackrock; see received on section 13(f) and § 75.16 of the 2209 See Occupy. also SVB; Katten (on behalf of Int’l Clients); SIFMA proposed rule are described below. 2210 See RMA. et al. (Covered Funds) (Feb. 2012); UBS.

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Some of these commenters argued that commenter argued that it is common However, the Agencies believe that the name-sharing restriction would practice in Germany to disclose the many of the concerns raised by place asset managers and funds designation of the sponsoring commenters with respect to this affiliated with banking entities at a investment manager in the fund name in provision should be addressed through competitive disadvantage to other asset order to provide transparency to the revised definition of covered fund in managers and funds.2215 investors, while a few commenters the final rule, and modifications to the A few commenters argued that the contended that European jurisdictions, exemption for covered fund activities rationale for the name-sharing including the U.K., require an and investments that occur solely restriction (i.e., to discourage bailing out authorized fund to have a name outside of the United States.2229 For funds) was already addressed under representative of the authorized example, as discussed in greater detail other restrictions of section 13(d)(1)(G) investment manager to avoid misleading above in Part VI.B.1.c.1., foreign public and the proposed rule that prohibit a fund investors.2221 Commenters also funds sold outside the United States are banking entity from, directly or argued that the name-sharing restriction excluded from the definition of covered indirectly, guaranteeing, assuming or was inconsistent with the laws of fund.2230 In addition, pursuant to the otherwise insuring the obligations or Ireland and Hong Kong.2222 Certain definition of covered fund in the final performance of the covered fund or of commenters argued that the impact of rule, a foreign fund only becomes a any covered fund in which such the name-sharing restriction would be covered fund with respect to a U.S. covered fund invested and that require particularly unfair to non-U.S. retail banking entity (including a foreign disclosure that investments in the funds like European UCITS if such affiliate of that U.S. banking entity) that covered fund are not insured by the funds are not allowed to use the name acts as sponsor to, or has an ownership Federal Deposit Insurance of the bank while U.S. mutual funds interest in, the fund. Moreover, Corporation.2216 These commenters would not be subject to the same numerous funds operate successfully questioned the necessity for the name- restriction.2223 with names that differ from the name of sharing restriction when a prohibition By contrast, some commenters the fund sponsor or adviser. on bailing out funds is already in place supported the name-sharing restriction. The Agencies recognize, however, and where there is disclosure that For example, one commenter indicated that the statutory name-sharing investors bear the risk of loss in the that the use of the word ‘‘bank’’ or a restriction may affect some entities that fund. Some of these commenters shared name in the fund’s name was will be covered funds and that cannot contended it was unlikely that investors already strongly discouraged by prior rely on another permitted activity in a covered fund with an SEC- guidance.2224 Another commenter exemption under section 13(d)(1) and registered investment adviser that has a supported the name-sharing restriction the final rule. The name-sharing name unrelated to the name of an but argued it did not go far enough restriction may result in certain costs insured depository institution would be because it did not apply to funds that a and other economic burdens for banking misled to believe that the fund would be banking entity was permissibly allowed entities that advise these funds, as backed in any way by a related insured to sponsor and invest in under other discussed in greater detail in Part depository institution or the Federal provisions of section 13.2225 According VI.B.1.g. above.2231 However, as the Deposit Insurance Corporation.2217 One to this commenter, covered funds Agencies also note above, to the extent of these commenters argued that the permitted under other exemptions that the restriction results in a banking name-sharing restriction should not should not be allowed to share the same entity not otherwise coming under apply to organizations where insured name with the banking entity.2226 pressure for reputational reasons to depository institutions represent a de After carefully considering comments directly or indirectly assist a covered minimis component of the and the express terms of the statute, the fund under distress that shares the organization’s operations.2218 final rule includes the name-sharing banking entity’s name, the name-sharing Other commenters recommended that restriction as proposed.2227 The name- prohibition could reduce the risk to the the name-sharing restriction not be sharing restriction is imposed by the banking entity that this assistance might applied to covered funds that rely on statute and prohibits a banking entity pose. The Agencies also expect that the the exemption for covered fund from sharing the same name or variation conformance period, both for activities and investments that occur of the same name with a covered fund. compliance with section 13 of the BHC solely outside of the United States.2219 The statute also defines the scope of the Act generally and for funds that are A few commenters expressed concern prohibition by defining the term illiquid funds, should be sufficient to that the name-sharing restriction could ‘‘banking entity’’ to generally include allow covered funds to take the steps be incompatible with regulatory any affiliate or subsidiary of an insured necessary to comply with the name- requirements in certain foreign depository institution or any company sharing restriction in the statute and jurisdictions that a covered fund’s name that controls an insured depository final rule. must indicate the fund’s connection institution.2228 with the fund sponsor.2220 One 6. Limitation on Ownership by Directors 2221 See BVI; EFAMA; JPMC; UBS; Union Asset; and Employees 2215 See Ass’n of Institutional Investors (Feb. ICI Global; IAA. Section 75.11(g) of the proposed rule 2222 2012); Katten (on behalf of Int’l Clients); SIFMA et See UBS; Union Asset; ICI Global. implemented section 13(d)(1)(G)(vii) of al. (Covered Funds) (Feb. 2012). 2223 See, e.g., AFG; ICI Global; JPMC. 2216 See Ass’n of Institutional Investors (Feb. 2224 See Arnold & Porter (citing SEC Division of the BHC Act. That statutory provision 2012); SIFMA et al. (Covered Funds) (Feb. 2012); T. Investment Management, Letter to Registrants (May prohibits any director or employee of Rowe Price; TCW. 13, 1993); Memorandum to SEC Chairman Breeden 2217 See TCW; Union Asset. from Division of Investment Management (May 6, 2229 For example, one commenter alleged that it 2218 See T. Rowe Price. 1993); FDIC, Board, OCC, OTS, Interagency would need to rebrand approximately 500 2219 See, e.g., UBS. Statement on Retail Sales of Non-Deposit established funds if the final rule was not modified Investment Products (Feb. 14, 1994)). 2220 See Credit Suisse (Williams); EFAMA; JPMC; to exclude established and regulated funds in 2225 Katten (on behalf of Int’l Clients); Union Asset; IAA; See Occupy the SEC at 165. foreign jurisdictions. See Goldman (Covered ICI Global; UBS; SIFMA et al. (Covered Funds) (Feb. 2226 See id. Funds). 2012) (citing Directive 2004/39/EC of the European 2227 See final rule § 75.11(f). 2230 See final rule § 75.10(b)(1)(ii) and (c)(1). Parliament and Council). 2228 See 12 U.S.C. 1851(d)(1)(G)(vi) and (h)(1). 2231 See Part VI.B.1.g.

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the banking entity from acquiring or entities to offer their U.S. and non-U.S. The final rule retains the requirement retaining an ownership interest in the employees similar choices in retirement limiting the ownership of a covered covered fund, except for any director or plans.2238 fund by directors and employees of a employee of the banking entity who is Two commenters urged that the banking entity (or an affiliate thereof) directly engaged in providing supervisors of a fund’s portfolio relying on the exemption in section investment advisory or other services to managers or investment advisers should 13(d)(1)(G) of the BHC Act.2246 This the covered fund.2232 This allows an be permitted to invest.2239 These limitation is imposed by statute on individual employed by a banking commenters also argued that banking entities that rely on this entity, who also acts as fund manager or individuals who provide support exemption. If a director or employee adviser (for example), to acquire or services to the fund, including does not provide services to the fund, retain an ownership interest in a administrative, oversight and risk they may not invest in that fund. As in covered fund that aligns the manager or management, legal compliance, the statute, the final rule allows adviser’s incentives with those of the regulatory, product structuring, deal employees who provide services to the banking entity’s customers.2233 sourcing and origination, deal fund other than investment advisory One commenter argued that only evaluation and diligence, investor services to invest in the fund. Under the employees or directors who provide relations, sales and marketing, tax, final rule, directors or employees who investment advisory services should be accounting, valuation and other provide investment advice or allowed to make an investment in the operational support services, should be investment management services to the fund and that the rule should not allow permitted to invest in the fund. These fund may invest in that fund. Similarly, employees or directors who provide commenters also requested confirmation directors or employees who provide other, unspecified services to invest in that any director, including an services that enable the provision of a fund.2234 This commenter argued that individual serving on the board or investment advice or investment the proposed rule would allow non- investment committee of a fund or its management, such as oversight and risk adviser banking entity employees who manager, should be permitted to management, deal origination, due have no need to maintain ‘‘skin in the invest.2240 Another commenter argued diligence, administrative or other game’’ to earn profit on the fund’s that employees and directors should be support services, may also invest in the performance. According to another permitted to make their own individual fund. In response to comments, the final commenter, fiduciary clients of banking investment decisions independently rule has been modified to make clear organizations often are less interested in without regard to whether they provide that a former director or employee may whether the fund manager or other services to the covered fund.2241 One retain an interest in a covered fund if service providers have money in the commenter contended that a the director or employee acquired the fund than whether the client’s own grandfathering approach is necessary to interest while serving as a director or account manager, and those individuals address situations where a pre-existing employee of the banking entity and above him/her who are responsible for covered fund already has investments providing investment advisory or other investment decisions, have allocated his from directors and employees who do services to the covered fund. or her own assets in the same way and not directly provide services to the fund The Agencies believe that many of the into the same general asset classes and because the fund may be unable to force concerns raised by commenters funds as the client’s fiduciary account is those individuals out of the fund.2242 regarding the effects of this limitation being allocated.2235 A number of commenters argued that, on foreign funds are addressed through The more prevalent view among if defined too narrowly, this restriction the scope of foreign funds that will be commenters was that the proposed rule may conflict with the laws of other covered funds, and revisions to the should be revised and expanded to jurisdictions that require advisers and/ exemption provided for covered fund permit investments in a sponsored fund or their directors and employees to activities and investments that occur by a broader group of banking entity invest in the funds they manage.2243 For solely outside of the United States. directors, officers, and employees, example, several commenters argued Moreover, the final rule excludes directly or indirectly through employee that this requirement will directly foreign public funds and broad-based benefit programs or trust and fiduciary conflict with the European Alternative foreign pension funds from the accounts, regardless of whether the Investment Fund Managers definition of covered fund and they are individual provides services to the Directive.2244 Two commenters thus not subject to the restrictions of covered fund.2236 Some commenters contended that certain jurisdictions, section 13 or the final rule.2247 argued that narrowly limiting including the Netherlands, require Section 13 clearly contemplates permissible director and employee directors and other personnel of fund investments by certain employees and investments could put asset managers managers to hold fund units or shares of directors of the banking entity.2248 affiliated with an insured depository funds managed by the fund manager as However, the Agencies continue to institution at a competitive part of their pensions.2245 believe that certain director or employee disadvantage relative to managers that investments in a covered fund may are not affiliated with an insured 2238 See T. Rowe Price. provide an opportunity for a banking depository institution,2237 as well as 2239 See Credit Suisse (Williams); Fin. Services entity to evade the limitations regarding Roundtable (Jun. 14, 2011). the amount or value of ownership make it more difficult for banking 2240 See Credit Suisse (Williams); Fin. Services Roundtable (Jun. 14, 2011). interests a banking entity may acquire or 2232 See 12 U.S.C. 1851(d)(1)(G)(vii); proposed 2241 See BOK (citing proposed rule at § 75.17); retain in a covered fund or funds rule § 75.11(g). Arnold & Porter. contained in section 13(d)(4) of the BHC 2233 See 156 Cong. Rec. S5897 (daily ed. July 15, 2242 See SVB. Act and the final rule. In order to 2010) (statement of Sen. Merkley). 2243 See EFAMA; BVI; IAA; ICI Global; JPMC; address this concern, the final rule 2234 See Occupy. Union Asset. attributes an ownership interest in a 2235 See Arnold & Porter. 2244 See Annex II para. 1(m). Directive 2011/61/ 2236 See Arnold & Porter; BOK, Credit Suisse EU of the European Parliament and the Council of (Williams); Fin. Services Roundtable (Jun. 14, 8 June 2011 on Alternative Investment Fund 2246 See final rule § 75.11(g). 2011); PEGCC; T. Rowe Price. Managers. 2247 See final rule §§ 75.10(c)(1) and 75.10(c)(5). 2237 See Credit Suisse (Williams). 2245 See EFAMA; Union Asset. 2248 See 12 U.S.C. 1851(d)(1)(G)(vii).

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covered fund acquired or retained by a the Act and the proposed rule are noted above, this disclosure is already director or employee to a banking entity consistent with disclosures in the commonly provided by banking entities. for purposes of the investment limits in banking agencies’ February 1994 b. Organizing and Offering an Issuing section 13(d)(4) under certain ‘‘Interagency Statement on Retail Sales Entity of Asset-Backed Securities circumstances. This attribution is of Non-deposit Investment Products’’ discussed in detail below in Part and other FINRA and SEC guidance.2252 To the extent that an issuing entity of VI.B.3.f. One commenter suggested that the rule asset-backed securities is a covered fund, the investment limitations 7. Disclosure Requirements include a requirement that the disclosures be issued in plain contained in section 13(d)(4) of the BHC Section 75.11(h) of the proposed rule English.2253 Act also would limit the ability of a required that, in connection with banking entity to acquire or retain an organizing and offering a covered fund, Another commenter argued that the investment in that issuer. Section 941 of the banking entity clearly and Agencies should revise the disclosure the Dodd-Frank Act added a new conspicuously disclose, in writing, to requirements under the proposal so that section 15G of the Exchange Act (15 prospective and actual investors in the offering materials of non-U.S. funds U.S.C. 78o–11) which requires a covered fund that any losses in the provided to non-U.S. investors outside banking entity to retain and maintain a covered fund will be borne solely by the United States need not include the certain minimum interest in certain investors in the covered fund and not by specified disclosures nor refer to the asset-backed securities.2257 In order to the banking entity and its affiliates or FDIC or other specific U.S. agencies.2254 give effect to this separate requirement subsidiaries; and that the banking This commenter argued that a non-U.S. under the Dodd-Frank Act, § 75.14(a)(2) entity’s and its affiliates’ or subsidiaries’ person investing in a non-U.S. fund of the proposed rule permitted a losses in the covered fund will be offered or sponsored by a non-U.S. banking entity that is a ‘‘securitizer’’ or limited to losses attributable to the banking entity has no expectation that ‘‘originator’’ under the provisions of that ownership interests in the covered fund the fund or its interests would be Act to acquire or retain an ownership held by the banking entity and its insured by the FDIC. The Agencies interest in an issuer of asset-backed affiliates or subsidiaries in their believe this concern is addressed securities, in an amount (or value of capacity as investors in the covered through the revised definition of economic interest) required to comply fund. In addition, the proposed rule covered fund, which generally provides with the minimum requirements of required that a banking entity disclose, that a foreign fund offered outside of the section 15G of the Exchange Act and in writing: (i) that each investor should United States will only be a covered any implementing regulations issued 2258 read the fund offering documents before fund with respect to a U.S. banking thereunder. The proposal also investing in the covered fund; (ii) that entity (including a foreign affiliate of the permitted a banking entity to act as the ownership interests in the covered U.S. banking entity) that acts as sponsor sponsor to the securitization. Commenters expressed a variety of fund are not insured by the FDIC, and to, or invests in, the fund.2255 views on the treatment of interests in are not deposits, obligations of, or The final rule adopts the proposed securitizations held under risk retention endorsed or guaranteed in any way, by disclosure requirements substantially as pursuant to the proposed rule. Some any banking entity (unless that happens proposed. As explained above, these commenters argued that the proposal to be the case); and (iii) the role of the disclosures are largely required by the was effective as written and represented banking entity and its affiliates, statute.2256 The proposed requirement a reasonable way to reconcile the two subsidiaries, and employees in to disclose that ownership interests in a sections of the Dodd-Frank Act sponsoring or providing any services to covered fund are not insured by the consistent with the risk-reducing the covered fund. The proposed rule FDIC, and are not deposits, obligations objective of section 13 of the BHC also required banking entities to comply of, or endorsed or guaranteed in any Act.2259 Other commenters also with any additional rules of the way, by any banking entity (unless that supported the proposal’s recognition appropriate Agency designed to ensure happens to be the case) is not expressly that banking entities may be required to that losses in any covered fund are required by the statute. However, hold a certain amount of risk in a borne solely by the investors in the section 13(d)(1)(G)(iii) permits the securitization that would also be a covered fund and not by the banking Agencies to impose additional rules covered fund, but argued that the entity.2249 In proposing the rule, the designed to ensure that losses in a proposed exemption was too Agencies indicated that a banking entity covered fund are borne solely by narrow.2260 may satisfy these disclosure investors in the fund and not by a After carefully considering the requirements by making the required banking entity. The Agencies believe comments received on the proposal, as disclosures in the covered fund’s that requiring a banking entity to make well as the language and purpose of offering documents.2250 this disclosure as part of organizing and section 13 of the BHC Act, the final rule A few commenters supported the offering a covered fund furthers this provides an exemption that permits a disclosure requirement as effective and purpose by removing the potential for banking entity to organize and offer a consistent with the statute.2251 One misperception that a covered fund commenter stated that the disclosures 2257 The relevant agencies issued a proposed rule required in section 13(d)(1)(G)(viii) of sponsored by a banking entity (which by definition must be affiliated with a to implement the requirements of section 15G of the Exchange Act, as required under section 941 of the 2249 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule depository institution insured by the Dodd-Frank Act. See Credit Risk Retention, 76 FR § 75.11(h). FDIC) is guaranteed by that insured 24090 (Apr. 29, 2011). Those agencies recently 2250 To the extent that any additional rules are institution or the FDIC. Moreover, as issued a re-proposal of the risk-retention issued to ensure that losses in a covered fund are requirements. See Credit Risk Retention, 78 FR borne solely by the investors in the covered fund 57928 (Sept. 20, 2013). 2252 and not by the banking entity, a banking entity See Arnold & Porter. 2258 See proposed rule § 75.14(a)(2)(iii). would be required to comply with those as well in 2253 See Occupy. 2259 See Sens. Merkley & Levin (Feb. 2012); Alfred order to satisfy the requirements of section 2254 See Katten (on behalf of Int’l Clients). Brock. 13(d)(1)(G)(viii) of the BHC Act. 2255 See final rule § 75.10(b)(1)(iii). 2260 See, e.g., AFME et al.; SIFMA (Securitization) 2251 See, e.g., Occupy. 2256 See 12 U.S.C. 1851(d)(1)(G)(viii). (Feb. 2012); JPMC; BoA.

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covered fund that is an issuing entity of in section 13(d)(1)(G), provide collateral manager for investment advice asset-backed securities.2261 The limitations on a banking entity’s regarding the assets of the securitization Agencies have determined to provide securitization activities involving vehicle, such a collateral manager this exemption in order to address the covered funds that are consistent with would be required to comply with all of unique circumstances and ownership the limitations imposed with respect to the provisions of § 75.11(a) to acquire structures presented by organizing and offering a covered fund and retain an ownership interest in such securitizations.2262 Under the final rule, that is not an issuing entity of asset- securitization vehicle. a banking entity may permissibly backed securities. For instance, a The final rule therefore both identifies organize and offer a covered fund that banking entity may not share the same certain activities that would be included is an issuing entity of asset-backed name as a covered fund that is an as organizing and offering a securities so long as the banking entity issuing entity of asset-backed securities securitization and modifies the (and its affiliates) comply with all of the and is prohibited from guaranteeing or requirements of § 75.11 to reflect requirements of § 75.11(a)(3) through otherwise ‘‘bailing out’’ a covered fund differences between securitizations and (a)(8).2263 As discussed above, the that is an issuing entity of asset-backed other types of covered funds, as requirements of § 75.11(a)(3) through securities, including being required to discussed above. The Agencies believe, 75.11(a)(8) are that: (i) The banking comply with section 13(f) of the BHC therefore, that the final rule entity and its affiliates do not acquire or Act regarding covered transactions with appropriately addresses the type of retain an ownership interest in the the covered fund. Furthermore, like a activity that is usually associated with covered fund except as permitted under banking entity’s investment in any organizing and offering a securitization § 75.12 of the final rule; 2264 (ii) the covered fund, the final rule limits the and also comports with the manner in banking entity and its affiliates comply ability of a banking entity to invest in which Congress chose to define the type with the requirements of § 75.14 of the a covered fund that is an issuing entity of parties engaged in activities that final rule; (iii) the banking entity and its of asset-backed securities unless it merit special attention related to issuing affiliates do not, directly or indirectly, meets the requirements of § 75.12. entities of asset-backed securities in guarantee, assume, or otherwise insure Unlike many other covered funds, the another part of the Dodd-Frank Act. Agencies understand that banking the obligations or performance of the The Agencies have determined to entities might not act in a fiduciary covered fund or of any covered fund in provide this exemption by using their capacity when they organize and offer a which such covered fund invests; (iv) authority in section 13(d)(1)(J) of the covered fund that is a securitization the covered fund, for corporate, BHC Act and believe that this marketing, promotional, or other vehicle. For instance, as part of organizing and offering a securitization exemption promotes and protects the purposes, does not share the same name safety and soundness of banking entities or variation of the same name with the vehicle, one or more parties may typically organize and initiate the and the financial stability of the United banking entity (or an affiliate thereof) States. Many companies and other and does not use the word ‘‘bank’’ in its securitization by selling or transferring assets, either directly or indirectly, to an entities utilize securitization name; (v) no director or employee of the transactions to efficiently manage, banking entity (or an affiliate thereof) issuing entity of asset-backed securities. An entity that provides these services allocate and distribute risks throughout takes or retains an ownership interest in the markets in a manner consistent with the covered fund except under the typically does so as a service to provide investors and the entity’s customers meeting the demands of their investors. limited circumstances noted in the final with the ability to invest in the assets in Companies also utilize securitizations in rule; and (vi) the banking entity a manner and to a degree that they may order to help provide liquidity to certain complies with the disclosure otherwise be unable to do. In order to asset classes or portions of the market requirements regarding covered funds in identify certain activities that would be that, absent this liquidity, may the final rule. included as organizing and offering a experience decreased liquidity and The Agencies believe that the securitization, the final rule provides increased costs of funding. For instance, requirements of the exemption for that organizing and offering an issuing if banking entities were not permitted to organizing and offering a covered fund entity of asset-backed securities means organize and offer a securitization, the that is an issuing entity of asset-backed acting as the securitizer, as that term is Agencies believe this would result in securities, which are in most aspects used in section 15G(a)(3) of the increased costs of funding or credit for consistent with the exemption for Exchange Act, for the issuer, or many businesses of all sizes that are organizing and offering a covered fund acquiring or retaining an ownership engaged in activities that section 13 of interest in the issuer in compliance with the BHC Act was not designed to 2261 See final rule § 75.11(b). the implementing regulations issued address. Additionally, this exemption 2262 As used in this SUPPLEMENTARY INFORMATION, the term ‘‘securitization’’ means a transaction or under section 15G of that Act. enables banking entities to acquire and series of transactions that result in the issuance of The final rule reflects, as discussed retain ownership interests in a covered asset-backed securities. above, that one or more parties that fund to comply with section 15G of the 2263 See final rule § 75.11(b) (providing the organize and offer an issuing entity of Exchange Act, which requires certain requirements for a banking entity that is organizing asset-backed securities may not provide parties to a securitization transaction to and offering a covered fund that is an issuing entity of asset-backed securities by reference to the any of the services identified in retain a minimum amount of risk in a requirements of § 75.11(a), as discussed above). § 75.11(a)(1). In this case the banking securitization, a requirement not 2264 As explained in detail below in Part VI.B.3. entity is not required to comply with applicable to covered funds that are not addressing the limitations on investments in § 75.11(a)(1) or (a)(2). Section 75.11(b) of securitizations. The Agencies therefore covered funds by a banking entity, the final rule permits a banking entity to acquire and retain the final rule is designed to address have determined that this exemption ownership interests in a covered fund in order to situations where, as discussed above, a will promote and protect the safety and comply with section 15G of the Exchange Act (15 banking entity does not act in a soundness of banking entities and the U.S.C.78o–11) in an amount that does not exceed fiduciary capacity when it organizes and financial stability of the United States the amount required to comply with the banking by facilitating the benefits entity’s chosen method of compliance under section offers a covered fund that is a 15G and the implementing regulations issued securitization vehicle. With respect to securitizations can provide as discussed thereunder. any securitization vehicle that retains a above, and also by enabling banking

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entities to comply with section 15G of Commenters noted that many structured • With respect to any banking entity, the Exchange Act. finance vehicles rely on sections 3(c)(1) the aggregate value of all ownership The Agencies believe it would not be and 3(c)(7) of the Investment Company interests of the banking entity and its consistent with the safety and Act, and argued that, without a market affiliates in all covered funds acquired soundness of banking entities or the making exemption for securities of and retained under § 75.11, including financial stability of the United States to covered funds, banking entities would all covered funds in which the banking prevent banking entities from acquiring be unable to engage in customer-driven entity holds an ownership interest in or retaining ownership interests in underwriting and market making connection with underwriting and securitizations as part of the permitted activity with respect to securities issued market making related activities under activity of organizing and offering by entities such as collateralized loan § 75.11(c), are included in the securitizations or from meeting any obligation issuers and non-U.S. calculation of all ownership interests applicable requirements related to exchange-traded funds.2268 under § 75.12(a)(2)(iii) and securitizations, including those imposed After careful review of the comments § 75.12(d).2269 under section 15G of the Exchange Act. in light of the statutory provisions, the The Agencies believe that providing a The Agencies note that the exemption final rule has been modified to provide separate provision relating to permitted for organizing and offering a a covered fund specific provision for underwriting and market making-related securitization does not relieve banking underwriting and market making-related activities for ownership interests in entities of any requirements that they activities of ownership interests in covered funds is supported by section may be subject to with respect to their covered funds. These underwriting and 13(d)(1)(B) of the BHC Act.2270 The investments in or relationships with a market making activities are within the exemption for underwriting and market securitization, such as any applicable scope of permitted activities under the making-related activities under section requirements regarding conflicts of final rule so long as: 13(d)(1)(B), by its terms, is a statutorily interest relating to certain • The banking entity conducts the permitted activity and exemption from securitizations under section 27B of the activities in accordance with the the prohibitions in section 13(a), Securities Act of 1933. requirements of § 75.4(a) or § 75.4(b), whether on proprietary trading or on respectively; covered fund activities. Applying the c. Underwriting and Market Making for • statutory exemption in this manner a Covered Fund With respect to any banking entity (or an affiliate thereof) that: acts as a accommodates the capital raising Section 13(d)(1)(B) permits a banking sponsor, investment adviser or activities of covered funds and other entity to purchase and sell securities commodity trading advisor to a issuers in accordance with the and other instruments described in particular covered fund or otherwise underwriting and market making 13(h)(4) in connection with certain acquires and retains an ownership provisions under the statute. underwriting or market making-related interest in such covered fund in reliance The final rule provides that a banking activities.2265 The proposal did not on § 75.11(a); acquires and retains an entity must include any ownership discuss how this exemption applied in ownership interest in such covered fund interests that it acquires or retains in the context of underwriting or market and is either a securitizer, as that term connection with underwriting and making of ownership interests in is used in section 15G(a)(3) of the market making-related activities for a covered funds. Exchange Act, or is acquiring and particular covered fund for purposes of Commenters argued that the scope of retaining an ownership interest in such the per-fund limitation under the permitted activities under sections covered fund in compliance with § 75.12(a)(2)(ii) if the banking entity: (i) 13(d)(1)(B), (D) and (F), which section 15G of that Act and the Acts as a sponsor, investment adviser or respectively set out permitted activities implementing regulations issued commodity trading advisor to the of underwriting and market making- thereunder each as permitted by covered fund; (ii) otherwise acquires related activities, activities on behalf of § 75.11(b); or, directly or indirectly, and retains an ownership interest in the customers, and activities by a regulated guarantees, assumes, or otherwise covered fund as permitted under insurance company, apply to all of the insures the obligations or performance § 75.11(a); (iii) acquires and retains an activities prohibited under section 13(a), of the covered fund or of any covered ownership interest in the covered fund whether those activities would involve fund in which such fund invests, then and is either a securitizer, as that term proprietary trading or ownership of or in each such case any ownership is used in section 15G(a)(3) of the 2266 acting as a sponsor to covered funds. interests acquired or retained by the Exchange Act, or is acquiring and Commenters argued that the statutory banking entity and its affiliates in retaining an ownership interest in the exemption for underwriting and market connection with underwriting and covered fund in compliance with making-related activities is applicable to market making related activities for that section 15G of that Act and the both proprietary trading and covered particular covered fund are included in implementing regulations issued fund activities, and recommended that the calculation of ownership interests thereunder each as permitted by the final rule allow banking entities to permitted to be held by the banking § 75.11(b); or (iv) directly or indirectly hold ownership interests and other entity and its affiliates under the guarantees, assumes, or otherwise securities of covered funds for the limitations of § 75.12(a)(2)(ii) and insures the obligations or performance purpose of underwriting and engaging § 75.12(d); and of the covered fund or of any covered in market making-related activities.2267 fund in which such fund invests. This underwriting and market making by a banking is designed to prevent any unintended 2265 See 12 U.S.C. 1851(d)(1)(B). entity of the securities of a covered fund that such 2266 See Cleary Gottlieb et al.; JPMC; Credit Suisse banking entity sponsors, organizes and offers or 2269 See final rule § 75.11(c). (Williams). provides investment management advice or services 2270 A discussion of the implementation of 2267 See BoA; Cleary Gottlieb; Credit Suisse because Section 13(f) of the BHC Act prohibits the section 13(d)(1)(D) and (F) with regard to the final (Williams); SIFMA et al. (Covered Funds) (Feb. purchase of securities by a banking entity from such rule’s limitations on covered fund investments and 2012); see also Deutsche Bank (Fund-Linked a covered fund. See, e.g., ASF (Feb. 2012); Cleary activities is provided in the section that relates to Products); SIFMA (Securitization) (Feb. 2012). Gottlieb; Credit Suisse (Williams); SIFMA permitted covered fund interests and activities by Other commenters argued that application of (Securitization) (Feb. 2012); FSA (Feb. 2012). a regulated insurance company and § 75.13(c) of the Section 13(f) of the BHC Act would prohibit the 2268 See JPMC; Cleary Gottlieb. final rule.

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expansion of ownership of covered under the exemption for underwriting in a covered fund that the banking funds by banking entities that are and market making-related activities in entity organizes and offers for the subject to the per fund limitations under § 75.11(c). In accordance with section purpose of: (i) Establishing the fund and § 75.12. 13(d)(1) of the BHC Act, the Agencies providing the fund with sufficient These banking entities will have a have determined that these restrictions initial equity for investment to permit limited ability to engage in underwriting on reliance on the market-making and the fund to attract unaffiliated investors; or market making-related activities for a underwriting exemption provided by or (ii) making a de minimis investment covered fund for which the banking section 13(d)(1)(B) are appropriate to in the fund, subject to several entity’s investments are subject to the address the purposes of section 13 of the limitations. Section 13(d)(4)(B) of the per-fund limitations in § 75.12 as BHC Act, which is aimed at assuring BHC Act requires that investments by a discussed above. Such a banking entity that banking entities do not bail-out a banking entity in a covered fund must, will have more flexibility to underwrite covered fund and maintain sufficient not later than one year after the date of and make a market in the ownership capital against the risks of ownership of establishment of the fund, be reduced to interests of such a covered fund in covered funds. The Agencies note, an amount that is not more than three connection with organizing and offering however, that the guarantee restriction percent of the total outstanding the covered fund during the fund’s is not intended to prevent a banking ownership interests of the fund. seeding period, since during the seeding entity from entering into arrangements Consistent with the statute, § 75.12 of period a banking entity may own in with a covered fund that are not entered the proposal provided that, after excess of three percent of the covered into for the purpose of guaranteeing the expiration of the seeding period, a fund, subject to the other requirements obligations or performance of the banking entity’s investment in a single in § 75.12. covered fund. For example, this covered fund may not represent more The final rule also provides that all restriction is not intended to prohibit a than three percent of the total banking entities that engage in banking entity from entering into or outstanding ownership interests in the underwriting and market-making related providing liquidity facilities or letters of covered fund (the ‘‘per-fund activities in covered funds are required credit for covered funds; however, it limitation’’).2275 In addition, as to include the aggregate value of all would apply to arrangements such as a provided in the statute, the proposal ownership interests of the banking put of the ownership interest in the provided that the total amount invested entity in all covered funds acquired and covered fund to the banking entity. The by a banking entity in all covered funds retained under § 75.11, including in determination of whether an may not exceed three percent of the tier connection with underwriting and arrangement would fall within this 1 capital of the banking entity (the market making-related activities under guarantee restriction would depend on ‘‘aggregate funds limitation’’).2276 § 75.11(c), in the calculation of the the facts and circumstances. aggregate covered fund ownership b. Duration of Seeding Period for New The Agencies emphasize that any interest limitations under Covered Funds banking entity that engages in § 75.12(a)(2)(iii) (and make the Commenters argued that it is essential underwriting or market making-related associated deduction from tier one to serving their customers efficiently activities in covered funds must comply capital for purposes of calculating that a banking entity be permitted to with all of the conditions applicable to compliance with applicable regulatory acquire and retain an ownership interest such activity as set forth in section capital requirements).2271 in a covered fund that it organizes and §§ 75.4(a) and 75.4(b).2273 Thus, Some commenters asked that the offers as a de minimis investment or for holdings of a single covered fund would Agencies permit banking entities to the purpose of establishing the fund. A be subject to limitations on risk as well engage in market making and number of commenters contended that a as length of holding period, among other underwriting in non-sponsored covered banking entity typically invests a applicable limitations and requirements. fund interests.2272 The final rule permits limited amount of its own capital in a These requirements are designed a banking entity that does not hold an fund (‘‘seed capital’’) as part of specifically to address a banking entity’s ownership interest in the covered fund organizing the fund to produce underwriting and market making-related in reliance on §§ 75.11(a) or 75.11(b) of investment performance as a record of activities and to prohibit holding the final rule, is not a sponsor of the the fund’s investment strategy (‘‘track exposures in excess of reasonably covered fund, is not an investment record’’).2277 Once a track record for the expected near term demand of clients, adviser or commodity trading advisor to fund is established, the banking entity customers and counterparties. the covered fund, and does not, directly markets the fund to unaffiliated or indirectly, guarantee, assume, or 3. Section 75.12: Permitted Investment investors. otherwise insure the obligations or in a Covered Fund Commenters argued that the one-year performance of the covered fund or of seeding period provided in the a. Proposed Rule any covered fund in which such fund proposed rule would be too short to invests to rely on the market-making Section 75.12 of the proposed rule establish a track record for many types and underwriting exemption in implemented section 13(d)(4) of the of covered funds. Commenters argued § 75.11(c) provided that the banking BHC Act and described the limited that the duration of the track record entity meets all of the requirements of circumstances under which a banking investors typically demand before that exemption. These conditions entity may acquire or retain an investing in a new fund depends on a include the aggregate funds limitation ownership interest in a covered fund number of factors (e.g., the type of fund, and the capital deduction contained in that the banking entity (which includes § 75.12 after including all ownership its subsidiaries and affiliates) organizes 2275 See proposed rule §§ 75.12(a)(1)(i); interest held by the banking entity and and offers.2274 Section 13(d)(4)(A) of the 75.12(a)(2)(i)(A) and (B); 75.12(b). its affiliates under § 75.11, including BHC Act permits a banking entity to 2276 See id. at §§ 75.12(a)(1)(ii); 75.12(a)(2)(ii); ownership interests acquired or retained acquire and retain an ownership interest 75.12(c). 2277 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 2012); T. Rowe Price; Credit 2271 See final rule § 75.11(c)(3). 2273 See final rule § 75.11(c)(1). Suisse (Williams); Allen & Overy (on behalf of 2272 See Cleary Gottlieb; Credit Suisse (Williams). 2274 12 U.S.C. 1851(d)(4); proposed rule § 75.12. Canadian Banks);TCW.

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investment strategy, and potential how the limitations apply during the engage in prohibited proprietary investors). According to commenters, an seeding period. The final rule continues trading. inability to demonstrate a track record to provide that a banking entity may As noted above, the proposal did not over multiple years may reduce the invest in a covered fund that it specify ‘‘date of establishment,’’ and allocation of capital by investors who organizes and offers either in commenters suggested a variety of dates are unable to gain an understanding of connection with establishing the fund, that could serve as the date of the investment strategy, risk profile, and or as a de minimis investment.2284 establishment for purposes of potential performance of the fund.2278 Importantly, the statute does not permit determining the duration of the seeding Commenters provided alternative a banking entity to invest in a covered period and the per-fund limitations on suggestions regarding how to define the fund unless the banking entity organizes ownership interests in a covered 2287 start of the seeding period for purposes or offers the covered fund or qualifies fund. After considering comments of applying the statutory exception for for another exemption. As explained received on the proposal, the Agencies investments during the seeding period. more fully in the discussion of § 75.11 have modified the final rule to include For example, two commenters a definition of ‘‘date of establishment’’ above, a wide variety of activities are recommended that the Agencies treat a for a covered fund. In general, the date encompassed in organizing and offering private equity fund as being established of establishment is the date on which an a covered fund. Under the statute, on the date on which the fund begins its investment adviser or similar party asset-acquisition phase and is closed to which generally prohibits investments begins to make investments that execute new investors, and a hedge fund as in covered funds, a banking entity may an investment or trading strategy for the established on the date on which the invest in a covered fund under the covered fund. The Agencies perceive fund has reached its target amount of exemptions provided in section 13(d)(1) the act of making investments to execute funding and begins investing according of the BHC Act, including section an investment or trading strategy as to the fund’s stated investment 13(d)(1)(G) and the provisions of section demonstrating that the fund has begun objectives.2279 Another commenter 13(d)(4), only if the banking entity its existence and is no longer simply a suggested that the permitted seeding engages in one or more of these plan or proposal. In order to account for period begin on the date on which third- permitted activities with regard to that the unique circumstances and manner party investors are first admitted to the covered fund and complies with all in which securitizations are established, fund.2280 applicable limitations under the final for a covered fund that is an issuing Several commenters expressed rule regarding investments in a covered entity of asset-backed securities, the concern that the per-fund limitation fund. date of establishment under the final could be subject to evasion unless the As noted above, the statute allows a rule is the date on which the assets are Agencies require that the seeding period banking entity to acquire and hold all of initially transferred into the issuing begin at the time funds are first invested the ownership interests in a covered entity of the asset-backed securities. 2281 by the banking entity in the fund. fund for the purpose of establishing the This is the date that the entity is formed Some of these commenters suggested fund and providing the fund with and the securities are generally sold the Agencies impose a dollar cap of $10 sufficient initial equity for investment to around this time. The Agencies believe million on the seed capital that a permit the fund to attract unaffiliated this is the appropriate time for the date banking entity may provide to a newly of establishment for securitizations investors.2285 However, the statute also organized covered fund in addition to because this is the date that the imposes a limit on the duration of an the statutory limits based on the amount securitization risks are transferred to the investment made in connection with of the fund’s shares and the amount of owners of the securitization vehicle. seeding a covered fund. At the end of the banking entity’s tier 1 capital.2282 Once the assets have been transferred, These commenters argued that an that period, the investment must the securitization has been established explicit quantitative limit better conform to the limits on de minimis and securities of the issuer may accounted for the size of some banking investments set by the statute. In typically be priced in support of entities, which otherwise made the keeping with the terms of the statute, organizing and offering the issuer. potential amount of capital placed in the final rule, like the proposal, allows Setting a later time, such as when the covered funds quite large.2283 banking entities a seeding period of one- fund becomes fully subscribed or the The Agencies have considered year for all covered funds. The statute assets have been fully assembled, could carefully the comments on the proposal also allows the Board to extend that permit a banking entity to engage in and have made several modifications to period, upon an application by a prohibited proprietary trading under the the final rule to more clearly explain banking entity, for two additional years guise of waiting for investors that may if the Board finds an extension to be never materialize.2288 2278 See et al. (Covered Funds) (Feb. 2012); see consistent with safety and soundness The statute also requires a banking also Ass’n of Institutional Investors (Feb. 2012); and in the public interest.2286 As entity to actively seek unaffiliated Bank of Montreal et al. (Jan. 2012); Allen & Overy explained below, the final rule, like the (on behalf of Canadian Banks); Credit Suisse investors to reduce or dilute the entity’s (Williams); Japanese Bankers Ass’n; SSgA (Feb. proposal, incorporates this process and ownership interest to the amount 2012); T. Rowe Price; Union Asset. One commenter sets forth the factors the Board will permitted under the statute. This argued that this limitation would constrain consider when determining whether to requirement is included in the final portfolio composition of a covered fund due to an allow an extended seeding period. The inability of a fund to raise sufficient capital to make 2287 larger investments. See Credit Suisse (Williams). Board and the Agencies will monitor See SIFMA et al. (Mar. 2012); Credit Suisse (Williams); EFAMA: Hong Kong Inv. Funds Ass’n; 2279 See AFG; Union Asset. these extension requests to ensure that AFG; Union Asset. 2280 See SIFMA (Mar. 2012); see also Credit banking entities do not seek extensions 2288 Importantly, the statute recognizes that a Suisse (Williams). for the purpose of evading the banking entity may need more than the automatic 2281 See AFR et al. (Feb. 2012); Occupy; Public restrictions on covered funds or to one-year seeding period to build a track record and/ Citizen; Sens. Merkley & Levin (Feb. 2012). or market its interests to unaffiliated investors; 2282 See Occupy; Sens. Merkley & Levin (Feb. therefore, a banking entity may apply for an 2012); see also 156 Cong. Rec. S5897 (daily ed. July 2284 See final rule § 75.12(a)(1). extension of the seeding period as provided in 15, 2010) (statement of Sen. Merkley). 2285 12 U.S.C. 1851(d)(4). 75.12(e) of the final rule as discussed below in Part 2283 See, e.g., Public Citizen. 2286 See id. at 1851(d)(4)(C). VI.B.3.h.

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rule, and underscores the nature of in that covered fund.2289 Both requirement under the Dodd-Frank Act, covered fund activities under section calculations were required to be done § 75.14(a)(2) of the proposed rule 13(d)(1)(G) as a method to provide without regard to committed funds not permitted a banking entity that is a investment advisory, trust and fiduciary yet called for investment. The proposed ‘‘securitizer’’ or ‘‘originator’’ under that services to customers rather than allow rule also required the banking entity to provisions of the Act to acquire or retain the banking entity to engage in calculate the value and amount of its an ownership interest in an issuer of prohibited proprietary trading. To ownership interest in each covered fund asset-backed securities, in an amount (or effectuate the requirements of the in the same manner and according to value of economic interest) required to statute, under the final rule, banking the same standards utilized by the comply with the minimum entities that organize and offer a covered covered fund for determining the requirements of section 15G of the fund must develop and document a plan aggregate value of the fund’s assets and Exchange Act and any implementing for offering shares in the covered fund ownership interests.2290 These regulations issued thereunder.2295 The to other investors and conforming the calculations were designed to ensure proposal also permitted a banking entity banking entity’s investments to the de that the banking entity’s investment in to act as sponsor to the securitization. minimis limits to help monitor and a covered fund could not result in more Commenters expressed a variety of ensure compliance with this than three percent of the losses of the views on the treatment of interests in requirement. covered fund being allocated to the securitizations held under risk retention While certain commenters requested banking entity’s investment.2291 pursuant to the proposed rule. Some that the final rule include a quantitative Commenters did not generally object commenters argued that the proposal dollar limit on the amount of funds a to calculating the per-fund limitation was effective as written and represented banking entity may use to organize and based on both number and value of a reasonable way to reconcile the two offer a covered fund, the Agencies have ownership interests. Several sections of the Dodd-Frank Act declined to add this limitation in the commenters urged the Agencies to allow consistent with the risk-reducing final rule. This type of limit is not a banking entity to value its investment objective of section 13 of the BHC required by statute. Moreover, the in a covered fund based on the Act.2296 Other commenters also Agencies believe that imposing a strict acquisition cost of the investment, supported the proposal’s recognition dollar limit may not adequately permit instead of fair market value, that banking entities may be required to banking entities to employ trading or notwithstanding the manner in which hold a certain amount of risk in a investment strategies that will attract the covered fund accounts for or values securitization that would also be a unaffiliated investors, thereby investments for its shareholders covered fund, but argued that the precluding banking entities from generally.2292 One commenter suggested proposed exemption was too meeting the demands of customers that the Agencies allow a banking entity narrow.2297 Some commenters argued contrary to the purpose of section 13. to choose between acquisition cost and that the exemption should be broadened fair value so long as the chosen to permit a banking entity to hold in c. Limitations on Investments in a valuation method is applied excess of the minimum amount required Single Covered Fund (‘‘Per-Fund consistently to both the numerator and under section 15G of the Exchange Act Limitation’’) denominator when calculating the per- instead of allowing only the minimum Section 13(d)(4)(B) imposes limits on fund limitation.2293 amount required by that section.2298 the amount of ownership interest a To the extent that an issuer of an One commenter requested that the final banking entity may have in any single asset-backed security is a covered fund, rule permit a banking entity to hold an covered fund at the end of the one year the investment limitations contained in amount of risk in a securitization that is period (subject to limited extension) section 13(d)(4) of the BHC Act also commensurate with what investors after the date of establishment of the would limit the ability of a banking demand rather than the minimum fund (the ‘‘seeding period’’). In entity to acquire or retain an investment required by section 15G.2299 Some recognition of the fact that a covered in that issuer. Section 941 of the Dodd- commenters argued that banking entities fund may have multiple classes or types Frank Act added a new section 15G of may be subject to similar generally of ownership interests with different the Exchange Act (15 U.S.C. 78o-11) applicable requirements to hold risk in characteristics or values, the proposal which requires certain parties to a securitizations under foreign law, such required that a banking entity apply the securitization transaction, including as Article 122a of the Capital limits to both the total value of and total banking entities, to retain and maintain Requirements Directive issued by the amount of the banking entity’s a certain minimum interest in certain European Union, and that the final rule ownership interest in a covered fund. issuers or asset-backed securities.2294 In should permit banking entities to The proposed rule required a banking order to give effect to this separate comply with these foreign legal entity to calculate the per-fund requirements.2300 limitation using two methods. First, a 2289 See proposed rule § 75.12(b)(2). Conversely, a few commenters banking entity was required to calculate 2290 See proposed rule § 75.12(b)(4). objected to the proposed rule’s the value of its investments and capital 2291 See Joint Proposal, 76 FR at 68904. exemption for risk-retention as unclear 2292 See ABA (Keating); BoA; Arnold & Porter; and argued that if the exemption was contributions made with respect to any BOK; Scale; SVB. ownership interest in a single covered 2293 See ABA (Keating) (alleging that this is 2295 See proposed rule § 75.14(a)(2)(iii). fund as a percentage of the value of all similar to the SEC’s approach to the definition of 2296 investments and capital contributions venture capital fund for the purposes of being See Sens. Merkley & Levin (Feb. 2012); Alfred exempt from investment advisor registration). Brock. made by all persons in that covered 2297 2294 The relevant agencies issued a proposed rule See, e.g., AFME et al.; SIFMA (Securitization) fund. Second, a banking entity was to implement the requirements of section 15G of the (Feb. 2012); JPMC; BoA. required to determine the total number Exchange Act, as required under section 941 of the 2298 See AFME et al.; SIFMA (Securitization) of ownership interests held by the Dodd-Frank Act. See Credit Risk Retention, 76 FR (Feb. 2012); JPMC; BoA. banking entity in a single covered fund 24090 (Apr. 29, 2011). Those agencies recently 2299 See BoA. issued a re-proposal of the risk-retention 2300 See AFME et al.; Allen & Overy (on behalf of as a percentage of the total number of requirements. See Credit Risk Retention, 78 FR Foreign Bank Group); SIFMA (Securitization) (Feb. ownership interests held by all persons 57928 (Sept. 20, 2013). 2012); BoA.

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retained, the Agencies should provide VI.B.1.e. In determining the amount of consistent with its determination of the that any amounts held by a banking ownership interests held by the banking fair market value of its assets for entity in a securitization that exceed the entity and its affiliates, the banking financial statement purposes and that minimum required to satisfy section entity must include an ownership fair market value would be determined 15G of the Exchange Act should count interest permitted under §§ 75.4 and in a manner consistent with the towards the aggregate funds limitation 75.11 of the final rule.2303 Additionally, valuations reported by the relevant of the banking entity.2301 One any banking entity that acts as covered fund unless the banking entity commenter argued that the final rule underwriter or market-maker for determines otherwise for purposes of its should impose higher capital charges for ownership interests of a covered fund financial statements and documents the interests held in these securitizations must do so in compliance with the reason for any disparity. If fair market due to concerns that securitizations limitations of §§ 75.4(a) and 75.4(b) of value cannot be determined, then the involve heightened risks due to the the final rule, including the limits on value shall be the historical cost basis of complexity of their ownership the amount, types, and risk of the all investments and capital structure.2302 underwriting position or market-maker contributions made by the banking The Agencies have carefully inventory as well as in compliance with entity to the covered fund. The final considered the comments received and the per-fund limitation, as applicable, rule also requires that, once a valuation are adopting the calculation and the aggregate funds limitations and method is chosen, the banking entity requirements for the per-fund limitation capital deduction in the final rule. The calculate the value of its investments as proposed with several modifications, Agencies expect to monitor these and the investments of all others in the including modifications designed to activities to ensure that a banking entity covered fund for purposes of the per- address the unique characteristics and does not engage in underwriting or fund limitation in the same manner and ownership structure of securitizations. market making-related activity in a according to the same standards.2305 The final rule, like the proposal, manner that is inconsistent with the This approach is intended to ensure requires that a banking entity calculate limitations of the statute and the final that, for purposes of calculating the per- its per-fund investment limit in covered rule.2304 fund limitation, a banking entity does funds that are not issuing entities of The final rule requires that the value not calculate its investment in a covered asset-backed securities based on both of the ownership interests and fund in a manner more favorable to the the value of its investments and capital contributions made by a banking entity banking entity than the method used by contributions in and to each covered in each covered fund (that is not an the covered fund for valuing the fund and the total number of ownership issuing entity of an asset-backed investments made by others. Under the interests it has in each covered fund. A security) be the fair market value of the final rule and as explained in more banking entity’s investment (including interest or contribution. The Agencies detail below, any ownership interest investments by its affiliates) may not have determined to use fair market acquired or retained by an employee or exceed either three percent of the value value as the measurement of value for director of the banking entity is of the covered fund or three percent of the per-fund value limitation in order to attributed to the banking entity for the number of ownership interests in ensure comparability with the purposes of the per-fund limitation if the covered fund at the end of the investments made in the covered fund the banking entity financed the seeding period. The Agencies continue by others and limit the potential that the purchase of the ownership interest. to believe that requiring the per-fund valuation measure can be manipulated Additionally, any amount contributed limitation to be calculated based on (for example by altering the percentage or paid by a banking entity or its these two measures best effectuates the of gains and losses that are associated employee to obtain an ownership terms and purpose of the per-fund with a particular ownership interest). A interest in connection with obtaining limitation in the statute. Together, these banking entity should determine fair the restricted profit interest must be measures ensure that a banking entity’s market value for purposes of the final included in calculating compliance with exposure to and ownership of each rule, including the calculation of both the per-fund and aggregate funds covered fund is limited. Each measure the per-fund and aggregate funds limitations (See Part VI.B.1.e. alone could provide a distorted view of limitations, in a manner that is above).2306 the banking entity’s ownership interest In determining the per-fund limitation and could be more easily manipulated, 2303 As discussed above in Part VI.B.2.c., the per- for purposes of § 75.12 of the final rule, for example by issuing ownership fund limitation does not apply to ownership the banking entity should use the same interests held by a banking entity that acts as interests with high value or special market maker or underwriter in accordance with methodology for valuing its investments governance provisions. As discussed in § 75.11(c) of the final rule, so long as the banking and capital contributions as the banking more detail below, the final rule entity does not also organize and offer, or act as entity uses to prepare its financial contains a separate method for sponsor, investment adviser or commodity trading statements and regulatory reports.2307 In advisor to, the fund, or, with respect to ownership calculating the value of investments in interests in issuing entities of asset-backed particular, the fair market value of a issuing entities of asset-backed securities, is not a securitizer who continues to own securities due to the fact that these ownership interests or is not an entity that holds 2305 In the context of securitizations, the final rule entities do not have a single class of ownership interests in compliance with Section similarly provides that the valuation methodology 15G of the Exchange Act and the implementing used to calculate the fair market value of the security and thus, the valuation of the regulations adopted thereunder; however, the ownership interests must be the same for both the ownership interests cannot be made on banking entity that is acting as market maker or ownership interests held by a banking entity and a per interest or single class basis. underwriter that is not subject to the per-fund the ownership interests held by all other investors The per-fund limitation on ownership limitation must still comply with the other in the covered fund in the same manner and requirements set forth in §§ 75.4(a) and 75.4(b), according to the same standards. interests must be measured against the respectively, and any other applicable requirements 2306 See Part VI.B.1.e. total ownership interests of the covered set out in § 75.11(c). 2307 For example, a depository institution or bank fund, as defined in § 75.10 of the final 2304 The Agencies note that if a banking entity holding company should use the same methodology rule and as discussed above in Part acts as investment adviser or commodity trading as used in the Report of Condition and Income (Call advisor to a covered fund and shares the same name Report) for depository institutions and the or variation of the same name with the fund, then Consolidated Financial Statements for Holding 2301 See Occupy. that banking entity would be a sponsor and Companies (FR Y–9C) for bank holding companies, 2302 See Sens. Merkley & Levin (Feb. 2012). therefore subject to the limitations of section 13(f). respectively.

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banking entity’s investments and any and the final rule and, accordingly, section regarding risk retention in capital contributions made to a covered would not be permitted to provide securitizations was intended to prevail fund should be the same for purposes of committed funds to a covered fund in a over the more general restriction on § 75.12 of the final rule as reported on manner inconsistent with the ownership of covered funds (which the banking entity’s financial statements limitations in the statute and final rule. applies to a broader range of entities). and regulatory reports. Similarly, if fair After carefully considering the The Agencies believe that the risk market value of all investments in and comments received on the proposal, as limitation goals of section 13 of the BHC capital contributions cannot be well as the language and purpose of Act are met by satisfying the minimum determined for purposes of § 75.12 of section 13 of the BHC Act, the final rule requirement of an applicable option the final rule, then the banking entity provides that, for purposes of applying under section 15G of the Exchange Act should use the same methodology to the per-fund limitation to an investment as the maximum initial investment calculate the historical cost basis of the in a covered fund that is an issuing limit, and applying the other limitations investments and any capital entity of an asset-backed security, the discussed in this section governing contributions as the banking entity uses ownership interest held by the banking aggregate investment in covered funds to prepare its financial statements and entity and its affiliates generally may and capital deductions. regulatory reports. The Agencies will not exceed three percent of the fair As under the proposal, if a banking review carefully the methodology that a market value of the ownership interests entity does not have a minimum risk banking entity uses to calculate the of the fund as measured in accordance retention requirement, that banking value of its investments in and capital with § 75.12(b)(3), unless a greater entity would remain subject to the contributions made to covered funds as percentage is retained by the banking limitations of section 13(d)(4) of the part of the process to monitor entity and its affiliates in compliance BHC Act and § 75.12 on the amount of compliance with the final rule. with the requirements of section 15G of ownership interests it may hold in an The Agencies expect that for the the Exchange Act and the implementing issuing entity of asset-backed securities. majority of covered funds, the party that regulations issued thereunder, in which A banking entity may not combine the organizes and offers the fund or case the investment by the banking amounts under these provisions to otherwise exercises control over the entity and its affiliates in the covered acquire or retain ownership interests in fund will provide a standard fund may not exceed the amount, a securitization that exceed the methodology for valuing interests in the number, or value of ownership interests aggregate permissible amounts. fund. However, the Agencies of the fund required under section 15G Some commenters requested that the understand that for some covered funds, of the Exchange Act and the Agencies coordinate implementation of including issuing entities of asset implementing regulations issued any exemption for risk-retention backed securities, there may be multiple thereunder. A banking entity may rely requirements under section 13 of the parties that organize and offer the fund on any of the options available to it in BHC Act with the issuance of rules that each utilize a different methodology order to meet the requirements of implementing section 15G of the or standard for calculating the value of section 15G, but for purposes of section Exchange Act. The Agencies note that ownership interests of the fund. Going 13 of the BHC Act and this rule, the rules implementing section 15G have forward, the Agencies expect that in amount held by the banking entity may been proposed but not yet finalized, but these circumstances the parties that not exceed the amount required under the Agencies will review the interaction organize and offer the covered fund will the chosen option. Under the final rule, between the rules promulgated under work together or select a responsible if a banking entity’s investment in a section 13 of the BHC Act and section party to determine a single standard by covered fund is held pursuant to the 15G of the Exchange Act once the rules which all ownership interests in the requirements of section 15G of the under section 15G are finalized. covered fund will be valued. Exchange Act, the banking entity must Regardless of any action that may be One commenter suggested the calculate the amount and value of its taken regarding rules implementing Agencies count both invested funds and ownership interest for purposes of the section 15G, the final rule permits committed funds not yet called for per-fund limitation as of the date and banking entities to own ownership investment towards the per-fund according to the same valuation interests in and sponsor covered funds limitation.2308 This commenter argued methodology applicable pursuant to the as discussed above. that a banking entity has already requirements of that section and the Some commenters also requested that contractually allocated committed-yet- implementing regulations issued the final rule provide an exemption to uncalled funds to the covered fund and thereunder. permit banking entities to comply with that depositors face a risk of loss for While the amount retained in any risk retention requirement imposed such funds if the covered fund fails. compliance with section 15G of the under foreign law that is similar to The final rule, like the proposal, does Exchange Act and the implementing section 15G of the Exchange Act. The not count committed-yet-uncalled funds regulations issued thereunder may Agencies are not revising the rule to towards the per-fund limitation; instead, permit a banking entity to own more permit banking entities to own it counts funds once they are invested. than three percent of the ownership ownership interests required to be This approach reflects the fact that these interests in a securitization that is a retained pursuant to risk retention-type funds may never be called while at the covered fund, this approach is requirements under foreign law. The same time ensuring that the banking appropriate to reconcile the competing Agencies are providing the exemption entity must comply with the per-fund policies of section 13 of the BHC Act for the required ownership arising from limitation once the funds are called. The and section 15G of the Exchange Act the risk retention provisions under Agencies note that a banking entity is which requires that a securitizer of section 15G of the Exchange Act in prohibited from guaranteeing or bailing certain securitizations retain a order to reconcile the requirements out a covered fund that the banking minimum of five percent of the risk of under the Dodd-Frank Act applicable to entity or one of its affiliates organizes the securitization. Congress enacted ownership of securitization interests; and offers by the terms of the statute these two apparently conflicting however, the Agencies do not believe at provisions in the same Act, and the this time that such reconciliation is 2308 See Occupy. Agencies believe the more specific appropriate with respect to foreign law

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risk retention-type requirements and costs, while also setting a minimum whether section 15G applies and the those requirements should not prevail recordkeeping standard, the final rule implementing regulations are effective. over the purpose of section 13 of the has been modified to require that a In the case of an ownership interest in BHC Act to reduce banking entities’ banking entity calculate the amount and an issuing entity of an asset-backed exposure to risks from investments in value of its ownership interests in security that is subject to section 15G of covered funds. covered funds other than issuing the Exchange Act and for which The Agencies also note that the entities of asset-backed securities effective implementing regulations have definition of covered fund has been quarterly.2311 The Agencies believe that been issued, the calculation of the per- modified to exclude certain foreign this change will assist in reducing fund limitation shall be made as of the public funds and also any foreign fund unnecessary costs and burdens in date and pursuant to the methodology that is not owned or sponsored by a U.S. connection with calculating the per- applicable pursuant to the requirements banking entity. Moreover, the final rule fund limitation, particularly for smaller of section 15G of the Exchange Act and permits foreign banking entities to banking entities, and will also facilitate the implementing regulations issued. engage in covered fund activities and consistency with the calculation for the For securitizations executed after the investments that occur solely outside of aggregate funds limitation (which is also effective date of the final rule and prior the United States without regard to the determined on a quarterly basis). to the adoption and implementation of investment limitations of section Nevertheless, should a banking entity the rules promulgated under section 13(d)(4) of the BHC Act and § 75.12 of become aware that it has exceeded the 15G of the Exchange Act and for the final rule, which may include per-fund limitation for a given fund at securitizations for which a fair valuation retaining risk in a securitization to the any time, the Agencies expect the calculation is not required by the extent required under foreign law. In banking entity to take steps to ensure implementing rules promulgated under these manners, the final rule permits that the banking entity complies section 15G of the Exchange Act, the per foreign banking entities to comply with promptly with the per-fund fund limitation is calculated as of the requirements under foreign law that limitation.2312 date on which the assets are initially govern their securitization activities or The Agencies have also modified the transferred into the issuing entity of the investments abroad. However, as noted timing and methodology of the per-fund asset-backed securities or such earlier above, section 13 of the BHC Act applies limitation as it applies to securitizations date on which the transferred assets to the global operations of U.S. banking to address the unique circumstances have been valued for purposes of entities and, as such, U.S. banking and ownership structure presented by transfer to the covered fund.2313 This entities’ investments in foreign securitizations, which typically wind calculation for issuers of asset backed securitizations that are covered funds down over time. Unlike many other securities is only required to be would remain subject to the investment covered funds, securitizations do not performed once on the date noted limitations of section 13(d)(4) and generally experience increases in the above, and thereafter only upon the date § 75.12 of the final rule. amount of investors or value of on which the price of additional The proposed rule provided that a ownership interests during the life of securities of the covered fund to be sold banking entity must comply with both the securitization; rather, they generally to third parties is determined. measures of the per-fund limitation at experience only a contraction of the As noted above, the per-fund all times. The preamble to the proposal investor base and reduction in the total limitations for ownership interests in explained that the Agencies expected a outstanding value of ownership issuing entities of asset-backed banking entity to calculate its per-fund interests on an aggregate basis, and may securities are calculated based only on limitation no less frequently than the do so at different rates under the terms the value of the ownership interest in frequency with which the fund performs of the transaction agreements, meaning relation to the value of all ownership such calculation or issues or redeems that the percentage of ownership interests in the issuing entity of the interests, and in no case less frequently represented by a particular ownership asset-backed security and are not than quarterly.2309 interest may increase as the fund calculated on a class by class, or tranche Several commenters requested that amortizes but without the banking by tranche basis. For purposes of the the Agencies modify the frequency of entity adding any funds. The manner in valuation, the aggregate value of all the this calculation and monitoring which securitizations are organized and assets that are transferred to the issuing requirement to a standard quarterly offered, as well as the amortization of entity of the asset-backed securities, and basis.2310 These commenters argued securitizations, differs from many other any assets otherwise held by the issuing that, although some covered funds may covered funds; section 15G of the entity, are determined based on the provide daily liquidation and Exchange Act also requires that certain valuation methodology used for redemption rights to investors, parties to securitization transactions, determining the value of the assets for monitoring the per-fund limitation on a which may include banking entities, financial statement purposes. This continuous basis would be costly and retain a minimum amount of risk in a valuation will be the value of the burdensome and would not provide a securitization, a requirement not ownership interests in the issuing entity significant offsetting benefit. applicable to covered funds that are not for purposes of the calculation. A The Agencies continue to believe that securitizations. Therefore, for purposes banking entity will need to determine for covered funds other than issuing of calculating a banking entity’s per- entities of asset-backed securities the fund limitation with respect to a 2313 In addition, although some commenters requested that banking entities be able to hold more per-fund limitations apply to securitization, the calculation of the per- fund limitation shall be based on than the minimum required by section 15G, the investments in covered funds at all Agencies are not revising the per fund limitation in times following the end of the seeding that manner. One of the purposes of section 13 of 2311 period. However, to relieve burden and See final rule § 75.12(b)(2)(i) and (ii). For the BHC Act is to reduce banking entities’ exposure covered funds that are an issuing entity of asset- to risks from investments in covered funds, and the backed securities, recalculation of the banking Agencies believe at this time that permitting 2309 See proposed rule § 75.12(b); Joint Proposal, entity’s permitted ownership for purposes of the banking entities to retain risk exposure to the 76 FR at 68904. per-fund limitation is not required unless the covered fund in excess of the minimum required to 2310 See, e.g., ABA (Keating); Credit Suisse covered fund sells additional securities. be retained would contradict the purposes of (Williams); JPMC. 2312 See 12 U.S.C. 1851(d)(4)(B)(ii)(I). section 13 of the BHC Act.

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its percentage ownership in the issuing the aggregate, the greater of $1 billion connection with acquiring or retaining entity based on the its contributions to (subject to prudential investment an ownership interest in each covered the entity in relation to the limitations and safety and soundness fund (together with any amounts paid contributions of all parties and after concerns), or three percent of tier 1 by the entity (or employee thereof) in taking into account the value of any capital.2316 connection with obtaining a restricted residual interest in the issuing entity. In In contrast, other commenters urged profit interest under § 75.10(d)(6)(ii)), as addition, for purposes of the final rule, the Agencies to decrease the statutory measured on a historical cost basis. This the asset valuation is as of the date of limit in order to prevent the largest aggregate value is measured against the establishment (the date of the asset banking entities from investing amounts total applicable tier 1 capital for the transfer to the issuing entity of the asset- that, while within the statutory limit, banking entity as explained below. backed securities). could be very large in absolute For purposes of determining the terms.2317 One commenter argued that a aggregate funds limitation, the final rule d. Limitation on Aggregate Permitted loss of three percent of tier 1 capital requires that the value of investments Investments in All Covered funds would be a material loss reflected in a made by a banking entity be calculated (‘‘Aggregate Funds Limitation’’) change in stock price.2318 Another on a historical cost basis. This approach In addition to the per-fund limitation, commenter suggested the Agencies limits the aggregate amount of funds a section 13(d)(4) of the BHC Act provides consider whether the investment banking entity may provide to covered that the aggregate of a banking entity’s supports a large flow of management funds as a percentage of the banking investments in all covered funds may fees linked to market volatility or has entity’s capital as required by statute. At not exceed three percent of the tier 1 significant embedded leverage.2319 the same time, this approach does not capital of the banking entity (referred to Some commenters argued that the permit a banking entity to increase its above as the ‘‘aggregate funds final rule should calculate the value of exposure to covered funds in the event limitation’’).2314 To implement this covered fund investments based on any investment in a particular covered limitation, the proposed rule required a acquisition cost instead of fair market fund declines in value as a result of the banking entity to determine the value.2320 These commenters argued fund’s investment activities. Permitting aggregate value of the banking entity’s that using fair value to calculate the a banking entity to increase its aggregate investments in covered funds by aggregate funds limitation penalizes investments as covered funds lose value calculating the sum of the value of each banking entities for organizing and would permit the banking entity both to investment in a covered fund, as investing in successful funds and, increase its exposure to covered funds at determined in accordance with conversely, would allow banking the same time the covered funds it applicable accounting standards. This entities to increase investments in already owns are losing value and to amount was then measured as a unsuccessful funds (the value of which effectively bail-out investors by percentage of the tier 1 capital of the would decline relative to the capital of providing additional capital to troubled banking entity for purposes of the banking entity). covered funds. Neither of these actions determining compliance with the In contrast, another commenter is consistent with the purposes of aggregate funds limitation. For purposes argued that valuation of a covered fund section 13 of the BHC Act. Moreover of applying the limit, a banking entity investment should include any mark-to- and as explained below, because the that is subject to regulatory capital market increase in a banking entity’s final rule requires that the banking requirements was required under the aggregate investments in order to keep entity deduct from the entity’s capital proposed rule to measure tier 1 capital pace with increases in the capital of the the greater of historical cost (plus in accordance with those regulatory banking entity.2321 earnings) or fair market value of its capital requirements; a banking entity Some commenters discussing the investments in covered funds, the that is not a subsidiary of a reporting frequency of the calculation of the deduction accounts for any profits banking entity and that is not itself aggregate funds limitation supported resulting from investments in covered required to report capital in accordance determining the aggregate funds funds. with the risk-based capital rules of a limitation on the last day of each Historical cost basis means, with Federal banking agency was required by calendar quarter as required in the respect to a banking entity’s ownership the proposed rule to calculate its tier 1 proposal.2322 Other commenters argued interest in a covered fund, the sum of all capital based on the total amount of that the statute requires compliance at amounts paid or contributed by the shareholders’ equity of the top-tier all times rather than periodic banking entity to a covered fund in entity as of the last day of the most calculations of compliance.2323 connection with acquiring or retaining recent calendar quarter, as determined After consideration of the comments an ownership interest (together with any under applicable accounting standards. in light of the statutory provisions, the amounts paid by the entity (or employee Commenters expressed a variety of Agencies have adopted the requirements thereof) in connection with obtaining a views regarding the aggregate funds for calculating the aggregate funds restricted profit interest)), less any limitation. One commenter argued that limitation as proposed with several amounts received as a redemption, sale basing the aggregate funds limitation on modifications as explained below. or distribution of such ownership the size of tier 1 capital of a banking Under the final rule, the aggregate value interest or restricted profit interest. entity provides an advantage to the is the sum of all amounts paid or Under the final rule, any reduction of largest institutions with large absolute contributed by the banking entity in the historical cost would not generally capital bases and disadvantages smaller include gains or losses, fees, income, banks that are well capitalized but have 2316 See, e.g., ABA (Abernathy). expenses or similar items. However, as a smaller absolute capital base.2315 This 2317 See AFR et al. (Feb. 2012); Public Citizen. noted above, the final rule also requires 2318 See Public Citizen. commenter urged the Agencies to 2319 that a banking entity deduct any See AFR et al. (Feb. 2012). earnings from its tier 1 capital even if it permit all banking entities to invest in 2320 See ABA(Keating); BoA; Arnold & Porter; covered funds in an amount that is, in BOK; Scale; SVB. values its ownership interests in a 2321 See Occupy. covered fund pursuant to historical cost. 2314 See 12 U.S.C. 1851(d)(4)(B)(ii)(II). 2322 See ABA (Keating). The concern expressed by 2315 See ABA (Abernathy). 2323 See AFR et al. (Feb. 2012); Occupy. commenters that the aggregate funds

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limitation should account for increases consistent with the language and risk- and soundness of the banking entity.2327 in the fair market value of covered funds limiting purpose of section 13. In contrast, other commenters urged the is addressed in other ways under the e. Capital Treatment of an Investment in Agencies to eliminate the capital final rule. In particular, the final rule a Covered Fund deduction for investments in covered requires that for purposes of calculating funds and questioned the Agencies’ compliance with regulatory capital Section 13(d)(4)(B)(iii) of the BHC Act statutory authority to impose the capital requirements the banking entity deduct provides that, for purposes of deduction.2328 These commenters from the entity’s capital the greater of determining compliance with applicable argued that the statute does not fair market value (or historical cost plus capital standards under section 13(d)(3) authorize or require the Agencies to earnings) of its investment in each of that Act, the aggregate amount of require banking entities to deduct their outstanding investments by a banking covered fund; thus, profits resulting investments in covered funds for entity under section 13(d)(4), including from investments in covered funds will purposes of calculating capital pursuant retained earnings, must be deducted not inflate the capital of the banking to the applicable capital rules. from the assets and tangible equity of entity for regulatory compliance According to these commenters, section purposes. Moreover, as explained above, the banking entity, and the amount of the deduction must increase 13 only requires deductions for the per-fund limitation is generally purposes of determining compliance based on fair market value, which commensurate with the leverage of the with applicable capital standards under maintains the relative level of a banking covered fund.2324 Section 13(d)(3) section 13 and argued the Agencies did entity’s investment in each covered authorizes the Agencies, by rule, to not make the necessary safety and fund. impose additional capital requirements As noted above, the aggregate funds and quantitative limitations, including soundness findings under section limitation applies to all investments by diversification requirements on any of 13(d)(3) to impose additional capital a banking entity in a covered fund that the activities permitted under section 13 requirements on any activities permitted the banking entity or an affiliate thereof of the BHC Act if the Agencies under section 13(d)(1).2329 One holds under §§ 75.4 and 75.11 of the determine that such additional capital commenter urged the Agencies to make final rule. The limitation would also and quantitative limitations are any capital adjustment as part of the apply to investments by a banking entity appropriate to protect the safety and banking agencies’ broader efforts to made or held during the seeding period soundness of banking entities engaged implement the Basel III capital as part of organizing and offering a in such activities.2325 framework.2330 Another commenter covered fund, including ownership The proposed rule implemented the urged the Agencies to apply the capital interests held in order to satisfy the capital deduction provided for under deduction only for purposes of requirements of section 15G of the section 13(d)(4)(B)(iii) of the BHC Act determining a banking entity’s Exchange Act, as well as ownership by requiring a banking entity to deduct compliance with the aggregate funds interests held by a banking entity in the the aggregate fair value of its limitation and not for other regulatory capacity of acting as underwriter or investments in covered funds, including capital purposes.2331 This commenter market-maker. any attributed profits, from tier 1 also argued that a capital deduction is As under the proposal, this capital. As in the statute, the proposed normally not required for assets calculation must be made as of the last rule applied the capital deduction to reflected on a bank’s consolidated day of each calendar quarter, consistent ownership interests in covered funds balance sheet, and that the Agencies with when tier 1 capital is reported by held as an investment by a banking should not require a deduction for a banking entities to the Agencies. entity pursuant to the provisions of covered fund investment that is not Because compliance with the aggregate section 13(d)(4) of the BHC Act, and not consolidated with the banking entity for funds limitations is calculated based on to ownership interests acquired under financial reporting purposes under tier 1 capital, the Agencies believe it is other permitted authorities, such as a GAAP.2332 Some commenters urged the more appropriate to require the risk-mitigating hedge under section 13 Agencies to apply the capital deduction calculation to be performed on the same of the BHC Act. The proposed rule only to a banking entity’s investment in schedule as tier 1 capital is reported. required the deduction to be calculated a covered fund that the banking entity While the aggregate funds limitation consistent with the method for organizes and offers and not to must be calculated on a quarterly basis, calculating other deductions under the ownership interests otherwise permitted the Agencies expect banking entities to applicable risk-based capital rules. The to be held under section 13 of the BHC monitor investments in covered funds proposed rule did not otherwise adopt Act.2333 regularly and remain in compliance additional capital requirements and Several commenters addressed the with the limitations on covered fund quantitative limitations under section manner for valuing an investment investments throughout the quarter. The 13(d)(3) of the BHC Act. Agencies intend, through their Some commenters supported the subject to the deduction. One respective supervisory processes, to proposed dollar-for-dollar deduction commenter urged the Agencies to monitor covered fund investment from tier 1 capital of a banking entity’s permit a banking entity to calculate the activity to ensure that a banking entity aggregate investments in covered funds deduction based on the acquisition cost, is not attempting to evade the and asserted it is consistent with the instead of the fair market value, of the requirements of section 13. statute.2326 One of these commenters banking entity’s ownership interest in The Agencies recognize that banks urged the Agencies to rely on their with large absolute capital bases will be authority under section 13(d)(3) of the 2327 See Occupy. able to place a greater amount of capital BHC Act to apply the capital deduction 2328 See ABA (Keating); BNY Mellon et al.; PNC; in covered funds compared to banks SIFMA et al. (Covered Funds) (Feb. 2012); SVB. to other permitted ownership interests 2329 See, e.g., SIFMA et al. (Covered Funds) (Feb. with small absolute capital bases. in covered funds to protect the safety 2012). However, the amount of risk exposure to 2330 Id. a covered fund, despite their different 2324 See 12 U.S.C. 1851(d)(4)(B)(iii). 2331 See ABA (Keating). investment strategies, will be relatively 2325 Id. at 1851(d)(3). 2332 See ABA (Keating); see also letter from PNC. similar across banking entities, which is 2326 See Occupy. 2333 See Arnold & Porter; SVB.

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the covered fund.2334 This commenter Act. This approach ensures that a more investments in troubled covered emphasized that valuing the investment banking entity can withstand the failure funds. at fair market value would penalize a of a covered fund without causing the The final rule does not require a banking entity if the covered fund banking entity to breach the minimum foreign banking entity that makes a performs well by reducing the amount regulatory capital requirements. covered fund investment in the United of capital available for additional Consistent with the language and States, either directly or through a covered fund investments but reduce purpose of section 13 of the BHC Act, branch or agency, to deduct the the capital charge against troubled this deduction will help provide that a aggregate value of the investment from investments. One commenter argued banking entity has sufficient capital to the foreign bank’s tier 1 capital that the Agencies did not perform an absorb losses that may occur from calculated under applicable home appropriate cost-benefit analysis of the covered fund investments without country standards. However, any U.S. deduction in the proposed rules.2335 endangering the safety and soundness of subsidiary of a foreign banking entity Other commenters sought clarification the banking entity or the financial that is required to calculate tier 1 capital on how the capital deduction would stability of the United States. under U.S. risk based capital regulations apply to a foreign banking organization. must deduct the aggregate value of Several commenters argued that the Accordingly, under the final rule, a investment held through that subsidiary capital deduction should not apply to a banking entity must, for purposes of from its tier 1 capital. foreign banking entity that calculates its determining compliance with applicable While some commenters requested tier 1 capital under the standards of its regulatory capital requirements, deduct that additional capital charges be home country.2336 These commenters the greater of (i) the sum of all amounts imposed on banking entity’s interests in argued that imposing a capital paid or contributed by the banking securitizations, the Agencies have deduction requirement on foreign banks entity in connection with acquiring or declined to do so at this time. Under the would not be consistent with past retaining an ownership interest final rule, the banking entity must practices on the application of U.S. risk- (together with any amounts paid by the deduct the value of its investment in a based capital requirements to foreign entity (or employee thereof) in securitization that is a covered fund banking organizations. connection with obtaining a restricted from its tier 1 capital for purposes of The Agencies have carefully profit interest under § 75.10(b)(6)(ii)), on determining compliance with the considered the comments in light of the a historical cost basis, including applicable regulatory capital statutory provisions requiring a capital earnings or (ii) the fair market value of requirements. This requirement already deduction. The statute requires that the the sum of all amounts paid or requires the banking entity to adjust its aggregate amount of outstanding contributed by the banking entity in capital for the possibility of losses on investments by a banking entity, connection with acquiring or retaining the full amount of its investment. The including retained earnings, be an ownership interest (together with any Agencies do not believe that it is deducted from the assets and tangible amounts paid by the entity (or employee appropriate to impose additional capital equity of the banking entity.2337 This thereof) in connection with obtaining a charges on these securitizations because requirement is independent of the restricted profit interest under it would act as a disincentive to retain minimum regulatory capital § 75.10(b)(6)(ii)), if the banking entity risk in securitizations for which the requirements in the final capital rule accounts for the profits (or losses) of the banking entity acts as issuer or sponsor, published by the Federal Banking fund investment in its financial a result that would contradict the agencies in 2013 (‘‘regulatory capital statements.2339 This deduction must be purpose of section 15G of the Exchange rule’’).2338 made whenever the banking entity Act. Additionally and as noted in the The Federal Banking agencies calculates its tier 1 capital, either proposal, permitting a banking entity to recognize that the regulatory capital rule quarterly or at such other time at which retain the minimum level of economic imposes risk weights and deductions the appropriate Federal banking agency interest and risk in a securitization will that do not correspond to the deduction may request such a calculation. incent banking entities to engage in for covered fund investments imposed Requiring a banking entity to deduct the more careful and prudent underwriting by section 13 of the BHC Act. The greater of historical cost or fair market and evaluation of the risks and Federal Banking agencies intend to value of all covered fund investments obligations that may accompany asset- review the interaction between the made by a banking entity from the backed securitizations, which would requirements of this rule and the entity’s tier 1 capital should result in an promote and protect the safety and requirements of the regulatory capital appropriate deduction that is consistent soundness of banking entities and the financial stability of the United States. rule and expect to propose steps to with the manner in which the banking The Agencies have also declined to reconcile the two rules. entity accounts for its covered fund At the same time, the Agencies impose additional quantitative investments. For instance, if a banking limitations or diversification believe that the dollar-for-dollar entity accounts for its investments in deduction of the fair market value of a requirements on covered fund covered funds using fair market value, investments at this time. The Agencies banking entity’s investment in a covered then any changes in the fair market fund is appropriate to protect the safety believe that the per-fund and aggregate value of the banking entity’s investment funds limitations, as well as the capital and soundness of the banking entity, as in a covered fund should similarly be provided in section 13(d) of the BHC deduction required by the rule, acting reflected in the banking entity’s tier 1 together with the other limitations on capital. Thus, this deduction should not 2334 See SIFMA et al. (Covered Funds) (Feb. covered fund activities, establish an 2012). unduly penalize banking entities for appropriate framework for ensuring that 2335 Id. making successful investments or allow the covered fund investments and 2336 See IIB/EBF. activities of banking entities are 2337 See 12 U.S.C. 1851(d)(4)(B)(iii). 2339 See 12 CFR part 208, subpart D and conducted in a manner that is safe and 2338 See 78 FR 62018, 62072 (Oct. 11, 2013) appendixes A, B, E, and F; 12 CFR part 217 (to be (Board/OCC/FDIC Basel III Final Rule); 78 FR codified), and 12 CFR part 225, appendixes A, D, sound and consistent with financial 55340, 55391 (Sept. 10, 2013) (FDIC Basel III E, and G; see also 12 CFR 240.15c3–1 (net capital stability. The Agencies will continue to interim final rule). requirements for brokers or dealers). monitor these activities and investments

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to determine whether other limitations that the proposed attribution rules could does not control a non-affiliate and are appropriate over time. result in a banking entity calculating the typically has less access to information per-fund limitation in a way that about the holdings of a non-affiliate, this f. Attribution of Ownership Interests to exceeds the banking entity’s actual loss change is unlikely to present a Banking Entity exposure if the attribution rule for opportunity for circumvention of the The proposed rule attributed an controlled investments is interpreted to per-fund and aggregate funds ownership interest to a banking entity require that 100 percent of all limitations. The Agencies will monitor based on whether or not the banking investments made by controlled entities these limitations for practices that entity held the interest through a be attributed to the banking entity.2344 appear to be attempts to circumvent controlled entity. The proposed rule In addition, several commenters them.2347 required that any ownership interest argued that the pro rata attribution of Whether a banking entity controls held by any entity that is controlled, investments held through non- another entity under the BHC Act may directly or indirectly, by a banking controlled structures is not consistent vary depending on the type of entity in entity be included in the amount and with the Board’s rules and practices for question. As noted above in Part value of the banking entity’s permitted purposes of the activity and investment VI.B.1.b.3., the Board’s regulations and investments in a single covered fund. limits in other sections of the BHC Act. orders have long recognized that the The proposed rule required that the pro Commenters also maintained that this concept of control is different for funds rata share of any ownership interest pro rata attribution for non-controlled than for operating companies.2348 In held by any covered fund that is not entities would be impracticable because contrast to the proposal, the final rule controlled by the banking entity, but in a banking entity has only a limited incorporates these different concepts of which the banking entity owns, ability to monitor, direct, or restrain control in part by providing that, for controls, or holds with the power to investments of a covered fund that it purposes of section 13 of the BHC Act vote more than 5 percent of the voting does not control.2345 and the final rule, a registered shares, be included in the amount and Conversely, one commenter investment company, SEC-regulated value of the banking entity’s permitted supported the pro rata attribution business development company, and a investments in a single covered fund. requirement in the proposal. This foreign public fund as described in Many commenters expressed commenter argued that this requirement § 75.10(c)(1) of the final rule will not be concerns regarding the proposed reduced opportunities for evasion considered to be an affiliate of the 2340 attribution requirements. These through subsidiaries, affiliates or related banking entity if the banking entity commenters argued that the proposed entities.2346 owns, controls, or holds with the power pro rata attribution requirements are not The final rule has been modified in to vote less than 25 percent of the voting required or permitted by the statute, light of the comments. Under the final shares of the company or fund, and have unintended and inconsistent rule, a banking entity must account for provides investment advisory, consequences for covered fund an investment in a covered fund for commodity trading advisory, investments, impose heavy compliance purposes of the per-fund and aggregate administrative, and other services to the costs on banking entities, and would funds limitations only if the investment company or fund only in a manner that impede the ability of funds sponsored is made by the banking entity or another complies with other limitations under by banking entities to invest in third- applicable regulation, order, or other entity controlled by the banking entity. 2349 party funds for the benefit of clients. Accordingly, the final rule does not authority. In response to commenter concerns Some commenters argued that the costs generally require that a banking entity regarding the workability of the and complexity of determining whether include the pro rata share of any a banking entity ‘‘controls’’ another proposed rule, the final rule has been ownership interest held by any entity modified to address how ownership banking entity under the BHC Act and that is not controlled by the banking the Board’s precedent are high and interests would be attributed to a entity, and thus reduces the potential banking entity when those interests are urged the Agencies to adopt a simpler compliance costs of the final rule. The 2341 held in a fund-of-funds or multi-tiered test. For example, some commenters Agencies believe that this concept of urged that shares of a company be fund structures. For instance, banking attribution is more consistent with how entities may use a variety of structures attributed to a banking entity only when the Board has historically applied the the banking entity maintains ownership to satisfy operational needs or meet the concept of ‘‘control’’ under the BHC Act investment needs of customers of their of 25 percent or more of voting shares for purposes of determining whether a of the company.2342 trust, fiduciary, investment advisory or company subject to that Act is engaged commodity trading advisory services. Several commenters maintained that in an activity or whether to attribute an applying the attribution requirements to First, except as explained for investment to that company. purposes of calculating a banking fund-of-funds structures and parallel or Furthermore, because a banking entity master-feeder structures would be entity’s permitted investment in multi- unworkable.2343 Commenters contended tier fund structures, the final rule does benefits and allow customers to gain exposure to a not generally attribute to a banking diverse portfolio without having to satisfy the 2340 See ABA (Keating); Arnold & Porter; SIFMA minimum investment requirements of each fund entity ownership interests held by a et al. (Covered Funds) (Feb. 2012); SSgA (Feb. directly. They also argued that parallel and feeder covered fund so long as the banking 2012). entities are established for a variety of client-driven 2341 See SIFMA et al. (Covered Funds) (Feb. reasons, including to accommodate tax needs of 2347 The Agencies note that other provisions of 2012); BlackRock; Arnold & Porter. clients and that these entities should be viewed as the BHC Act and Savings and Loan Holding 2342 See ABA (Keating); Arnold & Porter. a single investment program in which the master Company Act would prohibit a banking entity that 2343 See BoA; SIFMA et al. (Covered Funds) (Feb. fund holds and manages investments in portfolio is a bank holding company or savings and loan 2012); SSgA (Feb. 2012). These commenters argued assets and the feeder fund typically makes no holding company from acquiring 5 percent or more that banking entities traditionally utilize a fund-of- investments other than in the master fund. of a covered fund that is itself a bank holding funds structure to offer customers the opportunity 2344 See SIFMA et al. (Covered Funds) (Feb. company or a savings and loan holding company, to invest indirectly in a portfolio of other funds 2012); BoA; Arnold & Porter; SSgA (Feb. 2012). respectively, without regulatory approval. See 12 (including some funds sponsored and managed by 2345 See SIFMA et al. (Covered Funds) (Feb. U.S.C. 1842(a); 12 U.S.C. 1467a(e). one or more third parties) and that these structures 2012). 2348 See, e.g., First Union Letter. provide customers with certain risk-mitigating 2346 See Occupy. 2349 Id. See final rule § 75.12(b)(1)(ii).

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entity’s investment in the covered fund interest of the other fund that is held employee or director funding for the meets the per-fund limitation in the through the fund of funds. The banking purpose of acquiring the ownership final rule.2350 Absent unusual entity’s investment in the fund of funds interest. Specifically, under the final circumstances or structures, a banking must also meet the investment rule, an investment by a director or entity would not control a covered fund limitations contained in § 75.12. In employee of a banking entity who in which the banking entity has an these manners, the final rule permit a acquires an ownership interest in his or ownership interest that conforms to the banking entity to meet the demands of her personal capacity in a covered fund per-fund and aggregate funds limitations customers of their trust, fiduciary, or sponsored by the banking entity will be contained in the final rule. Thus, the advisory services while also limiting the attributed to the banking entity if the interests held by that covered fund ability of a banking entity to be exposed banking entity, directly or indirectly, would not be attributed to the banking to more than the amount of risk of a extends financing for the purpose of entity for the reasons discussed above. covered fund contemplated by section enabling the director or employee to The final rule also explains how the 13. acquire the ownership interest in the investment limitations apply to As described above in the discussion fund and the financing is used to investments of a banking entity in of organizing and offering a covered acquire such ownership interest in the multi-tier fund structures. The Agencies fund, other provisions of section 13 covered fund.2357 It is also important to believe that master-feeder fund contemplate investments by employees note that the statute prohibits a banking structures typically constitute a single and directors of the banking entity that entity from guaranteeing the obligations investment program in which the master provide qualifying services to a covered or performance of a covered fund in fund holds and manages investments fund.2352 The Agencies recognized in which it acts as investment adviser, and the feeder funds typically make no the proposal that employee and director investment manager or sponsor, or investments other than in the master investments in a covered fund may organizes and offers.2358 fund and exist as a convenience for provide an opportunity for a banking As discussed above in the definition customers of the trust, fiduciary, entity to evade the limitations regarding of ownership interest, the final rule also investment advisory, or commodity the amount or value of ownership attributes to the banking entity any trading advisory services of the banking interests a banking entity may acquire in amounts contributed by an employee or entity. Similarly, trust, fiduciary, or a covered fund.2353 In order to address director when made in order to receive advisory customers of a banking entity this concern, the proposal attributed an a restricted profit interest, whether or may desire to obtain diversified ownership interest in a covered fund not funded or guaranteed by the banking exposure to a variety of funds or acquired or retained by a director or entity. This approach ensures that all investments through investing in a employee to the person’s employing funding provided by the banking fund-of-funds structure that the banking banking entity if the banking entity entity—whether directly or through its entity organizes and offers. either extends credit for the purposes of employees or directors—and all In order to meet the demands of these allowing the director or employee to exposures of the banking entity— customers, the final rule provides that if acquire the ownership interest, whether directly or through a guarantee the principal investment strategy of a guaranteed the director or employee’s provided to or on behalf of an employee covered fund (the ‘‘feeder fund’’) is to purchase, or guarantees the director or or director—is counted against the invest substantially all of its assets in employee against loss on the limits on exposure contained in the another single covered fund (the investment. statute and final rule. At the same time, ‘‘master fund’’), then for purposes of the One commenter supported the way this approach recognizes that employees per-fund limitation the banking entity’s the proposal addressed evasion and directors may use their own permitted investment shall be measured concerns by attributing an ownership resources, not protected by the banking only at the master fund. However, in interest in a covered fund acquired or entity, to invest in a covered fund. order to appropriately capture the retained by a director or employee to a Employees of investment advisers in banking entity’s amount of investment banking entity.2354 A different particular often invest their own in the master fund, a banking entity commenter urged the Agencies to resources in covered funds they advise, must include in this calculation any attribute any employee investments in a both by choice and as a method to align investment held by the banking entity in covered fund to the banking entity itself, their personal financial interests with the master fund, as well as the banking regardless of the source of funds.2355 those of other investors in the covered entity’s pro-rata share of any ownership Another commenter argued that the fund. So long as these investments are interest of the master fund that is held statute prohibits a banking entity from truly with personal resources, and are through the feeder fund.2351 guaranteeing an investment by an not funded by the banking entity, these Similarly, regarding fund-of-funds employee or director.2356 personal investments would not expose structures, the final rule provides that if After considering the comments and the banking entity to loss and would not a banking entity organizes and offers a the language of the statute, the Agencies be attributed by the final rule to the covered fund pursuant to § 75.11 for the have determined to retain the banking entity. This approach is also purpose of investing in other covered requirement that all director or consistent with the terms of the statute, funds (a ‘‘fund of funds’’) and that fund employee investments in a covered fund which expressly contemplates of funds itself invests in another be attributed to the banking entity for investments by directors or employees covered fund that the banking entity purposes of the per-fund limitation and of a banking entity in their individual organizes and offers, then the banking the aggregate funds limitation whenever capacity.2359 entity’s permitted investment in that the banking entity provides the The Agencies intend to monitor other covered fund shall include any investments by directors and employees investment held by the banking entity in 2352 See 12 U.S.C. 1851(d)(1)(G)(vii); final rule of a banking entity to ensure that that other fund, as well as the banking § 75.11(g). 2353 See Joint Proposal, 76 FR at 68902. employee ownership interests are not entity’s pro-rata share of any ownership 2354 See Ass’n. of Institutional Investors (Feb. 2012). 2357 See final rule § 75.12(b)(1)(iv). 2350 See final rule § 75.12(b)(1)(iii). 2355 See Occupy. 2358 See 12 U.S.C. 1851(f)(1). 2351 See final rule § 75.12(b)(34). 2356 See Arnold & Porter. 2359 See 12 U.S.C. 1851(d)(1)(G)(vii).

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used to circumvent the per-fund and safe harbor for situations where a bank covered fund (a ‘‘co-investment fund’’), aggregate funds limitations in section trustee is acting on behalf of the sum of the banking entity’s 13. Among the factors the Agencies will customers.2363 ownership interests in the co- consider, in addition to financing and In contrast, other commenters investment fund and the related covered guarantee arrangements, are whether the contended that the risks of direct fund should not exceed 3% of the sum benefits of the acquisition and retention, investments, such as those made under of the ownership interests held by all such as dividends, inure to the benefit merchant banking authority, are similar investors in the co-investment fund and of the director or employee and not the to those of many investments in covered related covered fund. Finally, the banking entity; the voting or control of funds. These commenters urged the Agencies note that if a banking entity the ownership interests is subject to the Agencies to restrict direct investments makes investments side by side in direction of, or otherwise controlled by, in the underlying holdings or assets of substantially the same positions as the the banking entity; and the employee or a covered fund in the same manner as covered fund, then the value of such 2364 director, rather than the banking entity, direct investments in covered funds. investments shall be included for determines whether the employee or After carefully considering the purposes of determining the value of the director should make the investment. comments and the language of the banking entity’s investment in the The proposed rule contained a statute, the Agencies have determined covered fund. provision intended to curb potential not to adopt the proposed prohibition evasion of the per-fund limitation and on parallel investments in the final rule. g. Calculation of Tier 1 Capital aggregate limitation through parallel As illustrated by commenters, banking investments by banking entities that entities rely on a number of investment The proposal explained that tier 1 were not otherwise subject to section 13 authorities and structures to meet the capital is a banking law concept that, in of the BHC Act. Specifically, the needs of their clients and make the United States, is calculated and proposed rule provided that, to the investments under a variety of reported by certain depository extent that a banking entity is authorities that are not coordinated with institutions and bank holding contractually obligated to invest in, or is investments made by covered funds companies in order to determine their found to be acting in concert through owned or advised by the banking entity. compliance with regulatory capital knowing participation in a joint activity The Agencies believe that many standards. Accordingly, the proposed or parallel action toward a common goal investments made by banking entities rule clarified that for purposes of the of investing in, one or more investments are made for the purpose of serving the aggregate funds limitation in § 75.12, a with a covered fund that is organized legitimate needs of customers and banking entity that is a bank, a bank and offered by the banking entity shareholders, and not for the purpose of holding company, a company that (whether or not pursuant to an express circumventing the per-fund and controls an insured depository agreement), such investment must be aggregate funds limitations in section institution that reports tier 1 capital, or included in the calculation of a banking 13. uninsured trust company that reports entity’s per-fund limitation. Nevertheless, the Agencies continue tier 1 capital (each a ‘‘reporting banking Several commenters objected to this to believe that the potential for evasion entity’’) needed to use the reporting requirement and argued that it was not of these limitations may be present banking entity’s tier 1 capital as of the consistent with the statute. These where a banking entity coordinates its last day of the most recent calendar commenters argued that section 13 of direct investment decisions with the quarter that has ended, as reported to the BHC Act restricts a banking entity’s investments of covered funds that it the relevant Federal banking agency. investments in covered funds, and not owns or sponsors. For instance, the The proposal also recognizes that not direct investments by a banking entity Agencies understand that it is relatively all entities subject to section 13 of the in individual companies under other common for the sponsor of a covered BHC Act calculate and report tier 1 authorities, such as the merchant fund in connection with a privately capital. In order to provide a measure of banking investment authority in section negotiated investment to offer investors 4(k)(4)(H) of the BHC Act.2360 Some equality related to the aggregate funds co-investment opportunities when the limitation contained in section commenters argued that prohibiting or general partner or investment manager limiting direct investments could cause 13(d)(4)(B)(ii)(II) of the BHC Act and for the covered fund determines that the § 75.12(c) of the proposed rule, the a conflict between a banking entity’s covered fund does not have sufficient fiduciary duty to its clients to manage proposed rule clarified how the capital available to make the entire aggregate funds limitation should be their covered fund investments and the investment in the target portfolio banking entity’s duty to its shareholders calculated for entities that are not company or determines that it would required to calculate and report tier 1 to pursue legitimate merchant banking not be suitable for the covered fund to investments.2361 Some commenters capital in order to determine take the entire available investment. In compliance with regulatory capital urged the Agencies not to attribute any such circumstances, a banking entity parallel co-investment alongside a standards. Under the proposed rule, that sponsors the covered fund should with respect to any banking entity that covered fund to a banking entity unless not itself make any additional side by there is a pattern of evasion, and some is not affiliated with a reporting banking side co-investment with the covered entity and not itself required to report requested that there be prior notice and fund in a privately negotiated an opportunity for a hearing to capital in accordance with the risk- investment unless the value of such co- based capital rules of a Federal banking determine whether such a pattern has investment is less than 3% of the value 2362 agency, the banking entity’s tier 1 occurred. Another commenter of the total amount co-invested by other recommended the Agencies provide a capital for purposes of the aggregate investors in such investment. Further, if funds limitation was the total amount of the co-investment is made through a co- 2360 shareholders’ equity of the top-tier See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 investment vehicle that is itself a et seq. See ABA (Keating); BoA; BOK; SIFMA et al. entity within such organization as of the (Covered Funds) (Feb. 2012); SVB. last day of the most recent calendar 2361 2363 See ABA (Keating). See BOK. quarter that has ended, as determined 2362 See BOK; SVB; ABA (Keating); BoA; SIFMA 2364 See Public Citizen; Sens. Merkley & Levin et al. (Covered Funds) (Feb. 2012). (Feb. 2012). under applicable accounting

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standards.2365 For a banking entity that of a national bank) may compute would be consistent with safety and was not itself required to report tier 1 compliance with the aggregate funds soundness and not detrimental to the capital but was a subsidiary of a limitations using the amount of tier 1 public interest. The proposal required a reporting banking entity that is a capital reported by such depository banking entity to submit an application depository institution (e.g., a subsidiary institution. for extension to the Board, and set forth of a national bank), the aggregate funds Several commenters argued that the factors that the Board would limitation was the amount of tier 1 foreign banking organizations should be consider in reviewing an application for capital reported by such depository permitted to use the consolidated tier 1 extension, including a requirement that institution.2366 For a banking entity that capital at the top-tier foreign banking the Board consult with the primary was not itself required to report tier 1 organization level, as calculated under Federal supervisory agency for the capital but was a subsidiary of a applicable home country capital banking entity prior to acting on an reporting banking entity that is not a standards, to calculate compliance with application. depository institution (e.g., a nonbank the aggregate funds limitation.2369 One Some commenters argued that the subsidiary of a bank holding company), commenter noted that the tier 1 capital final rule should be modified to extend the aggregate funds limitation was the of a banking entity may fluctuate based automatically the one-year statutory amount of tier 1 capital reported by the on specific conditions relevant only to period for complying with the per-fund top-tier affiliate of such banking entity the banking entity, and urged the limitation by an additional two years that holds and reports tier 1 capital Agencies to consider an alternative without application or approval on a under the proposal.2367 measure of capital, although this case-by-case basis and to apply the Commenters did not generally object commenter did not suggest any extended conformance period to the to the proposed approach for alternative.2370 aggregate funds limitations.2372 Some of determining the applicable tier 1 capital After considering the comments these commenters suggested that for banking entities. One commenter received and that purpose and language Congress explicitly recognized the need advocated calculating the aggregate of section 13 of the BHC Act, the for a banking entity to have a sufficient funds limitation based on the tier 1 Agencies have determined that for seeding period following establishment capital of the banking entity making the foreign banking organizations, the of a fund, and that funds often require covered fund investment instead of the aggregate funds limitation would be more than one year to attract enough tier 1 capital of the consolidated based on the consolidated tier 1 capital unaffiliated investors to enable the 2368 banking entity. In addition, the of the foreign banking organization, as sponsoring banking entity to reduce its commenter urged the Agencies to calculated under applicable home ownership interests in the fund to the require banking entities to divest any country standards. However, a U.S. level required by section 13(d)(4). portions of the investment that exceeds bank holding company or U.S. savings Other commenters argued that the and loan holding company that is 3 percent of that entity’s tier 1 capital. amount of a banking entity’s own controlled by a foreign banking entity The final rule provides that any capital involved in seeding a fund is must separately meet the per-fund and banking entity that is required to typically ‘‘small’’ and suggested that, in aggregate funds limitations for each and calculate and report tier 1 capital (a order to prevent banking entities from all (respectively) covered fund ‘‘reporting banking entity’’) must engaging in prohibited proprietary investments made by the U.S. holding calculate the aggregate funds limitation trading through a fund, the Board company, based on the tier 1 capital of using the tier 1 capital amount reported should condition the ability of a the U.S. bank holding company or U.S. by the entity as of the last day of the banking entity to qualify for an savings and loan holding company. The most recent calendar quarter as reported extension of the one-year statutory to the relevant Federal banking agency. Federal banking agencies may revisit this approach in light of the manner in period on several requirements, A non-depository institution subsidiary including a requirement that the of a reporting banking entity may rely which the Board implements the enhanced prudential standards and banking entity not have provided more on the consolidated tier 1 capital of the than $10 million in seed capital as part reporting banking entity for purposes of early remediation requirements for of establishing the covered fund.2373 calculating compliance with the foreign banking organizations and The Agencies have carefully aggregate funds limitation. In the case of foreign nonbank financial companies, considered comments received on the a depository institution that is itself a including the proposed U.S. proposal and have determined instead reporting banking entity and that is also intermediate holding company to adopt the process and standards a subsidiary or affiliate of a reporting requirements under that rule.2371 governing requests for extensions of banking entity, the aggregate of all h. Extension of Time To Divest time to divest an ownership interest in investments in covered funds held by Ownership Interest in a Single Fund a single covered fund largely as the depository institution (including the proposed. The Agencies believe that this investments by its subsidiaries) may not The proposed rule provided that the approach is consistent with the process exceed three percent of either the tier 1 Board may, upon application by a and standards set out under the statute. capital of the depository institution or of banking entity, extend the period of As under the proposal, the final rule the top-tier reporting banking entity that time that a banking entity may have to requires any banking entity that seeks controls such depository institution. conform an investment to the 3 percent an extension of the conformance period The final rule also provides that any per-fund limitation. As in the statute, the proposed rule permitted the Board provided for the per-funds limitation to banking entity that is not itself required to grant up to an additional two years submit a written request to the Board. to report tier 1 capital but is a subsidiary if the Board finds that an extension Any such request must be submitted to of a reporting banking entity that is a the Board at least 90 days prior to the depository institution (e.g., a subsidiary 2369 See Credit Suisse (Williams); IIB/EBF. 2370 See Japanese Bankers Ass’n. 2372 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2365 See proposed rule § 75.12(c)(2)(ii)(B)(2). 2371 See Enhanced Prudential Standards and Early 2012); SSgA (Feb. 2012); TCW; Credit Suisse 2366 See proposed rule § 75.12(c)(2)(ii)(A). Remediation Requirements for Foreign Banking (Williams). 2367 See proposed rule § 75.12(c)(1)(B(2)(ii)(B)(1). Organizations and Foreign Nonbank Financial 2373 See, e.g., Occupy; Sens. Merkley & Levin 2368 See Occupy. Companies, 77 FR 76628, 76637 (Dec. 28, 2012). (Feb. 2012).

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expiration of the applicable time period review of the application and, if The Agencies received a range of and provide the reasons why the applicable, prior to imposing conditions comments on the proposed risk- banking entity believes the extension in connection with the approval of any mitigating hedging exemption for should be granted. In addition, the request by the banking entity for an ownership interests in covered funds. request must explain the banking extension of the conformance period. Some commenters objected to the entity’s plan for reducing the permitted While some commenters requested that limited applicability of the statutory investment in a covered fund through the Board modify the final rule to risk-mitigating hedging exemption in redemption, sale, dilution or other permit a banking entity to have covered the covered funds context and urged the methods to the limits imposed by the fund investments in excess of the Agencies to allow ownership interests final rule. To allow the Board to assess aggregate funds limitation,2374 the final in covered funds to be used in any the factors provided in the statute, the rule does not contain such a provision. appropriate risk-mitigating hedging.2379 final rule provides that any extension As noted in the release for the proposed In contrast, other commenters urged the request by a banking entity must rule, the statutory grant of authority to Agencies to delete one or both of the address: (i) Whether the investment provide extensions of time to comply risk-mitigating hedging exemptions as would result, directly or indirectly, in a with the investment limits refers the commenters argued they were material exposure by the banking entity specifically and only to the period for inconsistent with the statute or to high-risk assets or high-risk trading conforming a seeding investment to the otherwise inappropriate.2380 strategies; (ii) the contractual terms per-fund limitation.2375 Commenters also argued that a separate governing the banking entity’s interest As noted in the proposed rule, the risk-mitigating hedging exemption for in the covered fund; (iii) the total Agencies recognize the potential for covered funds is unnecessary because exposure of the covered banking entity evasion of the restrictions contained in the statute provides a single risk- to the investment and the risks that section 13 of the BHC Act through mitigating hedging exemption.2381 disposing of, or maintaining, the misuse of requests for extension of the Some commenters argued that the investment in the covered fund may seeding period for covered funds. proposed rule would impede banking pose to the banking entity and the Therefore, the Board and the Agencies entities from offering covered-fund financial stability of the United States; will monitor requests for extensions of linked products to customers, including (iv) the cost to the banking entity of the seeding period for activity in hedging these products, and would, in divesting or disposing of the investment covered funds that is inconsistent with particular, impair the ability of banking within the applicable period; (v) the requirements of section 13 of the entities to hedge the risks of fund-linked whether the investment or the BHC Act. derivatives with fund-linked swaps or divestiture or conformance of the shares of covered funds referenced in 4. Section 75.13: Other Permitted fund-linked products.2382 These investment would involve or result in a Covered Fund Activities material conflict of interest between the commenters argued this limitation banking entity and unaffiliated parties, a. Permitted Risk-Mitigating Hedging would increase risks at banking entities including clients, customers or Activities and was inconsistent with the purpose of the risk-mitigating hedging counterparties to which it owes a duty; Section 13(d)(1)(C) of the BHC Act exemption. Commenters also proposed (vi) the banking entity’s prior efforts to provides an exemption for certain risk- modifying the proposal to permit risk- reduce through redemption, sale, mitigating hedging activities.2376 In the mitigating hedging activities that dilution, or other methods its ownership context of covered fund activities, the facilitate a customer’s exposure to interests in the covered fund, including proposed rule implemented this profits and/or losses of the covered activities related to the marketing of authority narrowly and permitted a fund, to permit portfolio or dynamic interests in such covered fund; (vii) banking entity to acquire or retain an hedging strategies involving covered market conditions; and (viii) any other ownership interest in a covered fund as fund interests, and to eliminate the factor that the Board believes a risk-mitigating hedge only in two proposed condition that a customer appropriate. In contrast to the proposal, situations: (i) When acting as would not itself be a banking entity.2383 the final rule does not require intermediary on behalf of a customer Some commenters also urged the information on whether the extension that is not itself a banking entity to Agencies to grandfather existing risk- would pose a threat to safety and facilitate exposure by the customer to mitigating hedging activities with soundness of the covered banking entity the profits and losses of the covered respect to any covered-fund linked or to financial stability of the United fund; and (ii) with respect to a products that comply with the hedging States. The categories of information in compensation arrangement with an final rule have been modified in order employee of the banking entity that transaction to accommodate a specific customer to eliminate redundancies. directly provides investment advisory or request or directly connected to the banking entity’s The final rule continues to permit the other services to that fund.2377 The compensation arrangement with an employee; and Board to impose conditions on granting proposed rule imposed specific (ii) the banking entity document, at the time the transaction is executed, the hedging rationale for all any extension granted if the Board requirements on a banking entity hedging transactions involving an ownership 2378 determines conditions are necessary or seeking to rely on this exemption. interest in a covered fund. appropriate to protect the safety and 2379 See BoA; Credit Suisse (Williams); Deutsche soundness of banking entities or the 2374 See ABA (Keating). Bank (Fund-Linked Products); ISDA (Feb. 2012); financial stability of the United States, 2375 See 12 U.S.C. 1851(d)(4)(C). SIFMA et al. (Covered Funds) (Feb. 2012). 2376 2380 See AFR et al. (Feb. 2012); Occupy; Public address material conflicts of interest or See 12 U.S.C. 1851(d)(1)(C). 2377 See proposed rule § 75.13(b)(1)(i)(A) and (B). Citizen; Sens. Merkley & Levin (Feb. 2012). otherwise unsound practices, or to 2378 These requirements were substantially 2381 See BoA. otherwise further the purposes of similar to the requirements for the risk-mitigating 2382 See ISDA (Feb. 2012); BoA; Credit Suisse section 13 of the BHC Act and the final hedging exemption for trading activities contained (Williams); Deutsche Bank (Fund-Linked Products); rule. In cases where the banking entity in proposed § 75.5. In addition, proposed § 75.13(b) ISDA (Feb. 2012); SIFMA et al. (Covered Funds) also required that: (i) The hedge represent a (Feb. 2012). is primarily supervised by another substantially similar offsetting exposure to the same 2383 See, e.g., BoA; SIFMA et al. (Covered Funds) Agency, the Board will consult with covered fund and in the same amount of ownership (Feb. 2012); Deutsche Bank (Fund-Linked such Agency both in connection with its interest in that covered fund arising out of the Products).

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requirements for proprietary trading that the customer will fail to perform, a banking entity may not use as a hedge under § 75.5 of the proposed rule.2384 thereby effectively exposing the banking ownership interests of a covered fund In contrast, other commenters entity to the risks of the covered fund. for which the employee does not objected to the exemption for hedging Furthermore, a customer’s failure to provide services. The requirement covered fund-linked products sold to perform may be concurrent with a under the final rule that the hedging customers. These commenters asserted decline in value of the covered fund, activity be designed to demonstrably that this activity would authorize which could expose the banking entity reduce or otherwise significantly investment in covered funds in a to additional losses. Accordingly, the mitigate the specific, identifiable risks manner that would not be subject to the Agencies believe that these transactions to the banking entity is consistent with three percent per-fund limitation; 2385 or pose a significant potential to expose the requirement in § 75.5 of the final would be inconsistent with the statutory banking entities to the same or similar rule, as discussed above in Part VI.A.4. requirement that a banking entity economic risks that section 13 of the The final rule permits a banking entity actively seek additional investors for a BHC Act sought to eliminate, and have to hedge its exposures to price and other fund.2386 not adopted the proposed exemption for risks based on fund performance that Some commenters urged the Agencies using ownership interests in covered arise from restricted profit interest and to expand the hedging exemption to funds to hedge these types of other performance based compensation allow banking entities to invest in transactions in the final rule. arrangements with its investment covered funds in order to hedge As argued by some commenters, managers. obligations relating to deferred modifying the proposal to eliminate the Section 13(a)(2) of the final rule compensation plans for employees who exemption for permitting banking describes the criteria a banking entity do not directly provide services to the entities to acquire covered fund must meet in order to rely on the risk- covered fund for which the hedge interests in connection with customer mitigating hedging exemption for relates.2387 Another commenter argued facilitation may impact banking entities covered funds. These requirements, that banking entities should be ability to hedge the risks of fund-linked which are based on the requirements for permitted to hedge compensation derivatives through the use of fund- the risk-mitigating hedging exemption investment accounts for executive linked swaps or shares of covered funds for trading activities under § 75.5 of the officers who are not involved in the referenced by fund-linked products.2393 final rule and which are discussed in management of the investment Some commenters on the proposal detail above in Part VI.A.4, have been accounts.2388 In contrast, other argued that innovation of financial modified from the proposal to reflect the commenters objected to the hedging products may potentially be reduced if more limited scope of this section.2395 exemption for compensation the final rule does not permit this type In particular, the final rule permits a arrangements, arguing that it may of activity related to fund-linked increase risk to banking entities,2389 is banking entity to engage in risk- products.2394 The Agencies recognize unnecessary,2390 or may provide mitigating hedging activities involving that U.S. banking entities may no longer banking entities with an opportunity to ownership interests in a covered fund be able to participate in offering certain evade the limitations on the amount of only if the banking entity has customer facilitation products relating ownership interests they may have as an established and implements, maintains to covered funds, but believe it is investment in a covered fund.2391 and enforces an internal compliance After review of the comments, the consistent with the purposes of section program that is reasonably designed to Agencies believe at this time that 13 to restrict these activities. ensure the covered banking entity’s permitting only limited risk-mitigating The final rule maintains the proposed compliance with the requirements of the hedging activities involving ownership exemption for hedging employee hedging exemption, including interests in covered funds is consistent compensation arrangements with reasonably designed written policies with the safe and sound conduct of several changes. To ensure that exempt and procedures and internal controls banking entities, and that increased use hedging activities are designed to and ongoing monitoring and of ownership interests in covered funds reduce one or more specific risks, as authorization procedures, and has could result in exposure to higher required by section 13(d)(1)(C) of the acquired or retained the ownership risks.2392 BHC Act, the proposed rule required interest in accordance with these In particular, the Agencies have that permitted hedging activity be written policies, procedures and determined that transactions by a designed to reduce the specific risks to internal controls. Furthermore, the banking entity to act as principal in the banking entity in connection with acquisition or retention of an ownership providing exposure to the profits and and related to its obligations or interest must demonstrably reduce or losses of a covered fund for a customer, liabilities. The final rule permits a otherwise significantly mitigate, at the even if hedged by the entity with banking entity to acquire or retain an inception of the hedge, one or more ownership interests of the covered fund, ownership interest in a covered fund specific, identifiable risks arising in is a high risk strategy that could provided that the ownership interest is connection with the compensation threaten the safety and soundness of the designed to demonstrably reduce or arrangement with an employee that banking entity. These transactions otherwise significantly mitigate the directly provides investment advisory or expose the banking entity to the risk specific, identifiable risks to the banking other services to the covered fund. The entity in connection with a acquisition or retention also may not, at 2384 See SIFMA et al. (Covered Funds) (Feb. compensation arrangement with an the inception of the hedge, result in any 2012); BoA. employee who directly provides significant new or additional risk that is 2385 See Sens. Merkley & Levin (Feb. 2012). investment advisory or other services to not itself hedged contemporaneously in 2386 See AFR et al. (Feb. 2012). the covered fund. Under the final rule, accordance with the hedging exemption, 2387 See Arnold & Porter. and the hedge must be subject to 2388 See BOK. 2393 See ISDA (Feb. 2012); BoA; Credit Suisse continuing review, monitoring and 2389 See Occupy. (Williams); Deutsche Bank (Fund-Linked Products); 2390 See AFR et al. (Feb. 2012); Public Citizen. SIFMA et al. (Covered Funds) (Feb. 2012). management by the banking entity. 2391 See Occupy. 2394 See SIFMA et al. (Covered Funds) (Feb. 2392 See 12 U.S.C. 1851(d)(2). 2012); Credit Suisse (Williams). 2395 See final rule § 75.13(a)(2).

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The final rule also permits a banking explicitly define what is meant by recognize the regulation and entity to engage in risk-mitigating ‘‘solely outside of the United States.’’ supervision of the home country hedging activities in connection with a The proposed rule allowed foreign supervisor of the foreign banking entity compensation arrangement, subject to banking entities that met certain and of its covered fund activities.2403 the conditions noted above, only if the qualifications to engage in covered fund Some commenters contended that the compensation arrangement relates activities, including owning, organizing proposal represented an improper solely to the covered fund in which the and offering, and sponsoring funds extraterritorial application of U.S. law banking entity or any affiliate thereof outside the United States. The proposed that could be found to violate has acquired an ownership interest and rule defined both the type of foreign international treaty obligations of the the losses on such ownership interest banking entity that is eligible for the United States, such as those under the are offset by corresponding decreases in exemption and when an activity or North American Free Trade Agreement, the amounts payable in connection with investment would occur ‘‘solely outside and might result in retaliation by foreign the related employee compensation of the United States.’’ The proposed rule countries in their treatment of U.S. arrangement.2396 allowed a qualifying foreign banking banking entities abroad.2404 entity to acquire or retain an ownership b. Permitted Covered Fund Activities Commenters also alleged that the interest in, or act as sponsor to, a proposal would impose significant and Investments Outside of the United covered fund under the exemption only States compliance costs on the foreign if no subsidiary, affiliate or employee of operations of foreign banking entities 2397 Section 13(d)(1)(I) of the BHC Act the banking entity that’s incorporated or conducting activity pursuant to this permits foreign banking entities to physically located in the United States exemption.2405 These commenters acquire or retain an ownership interest engaged in offering or selling the argued that foreign banking entities in, or act as sponsor to, covered funds, covered fund. The proposed rule also relying on the foreign fund exemption so long as those activities and implemented the statutory requirement should not be subject to the compliance investments occur solely outside the that prohibited an ownership interest in program requirements contained in United States and certain other the covered fund from being offered for Appendix C with respect to their non- conditions are met (the ‘‘foreign fund sale or sold to a resident of the United 2406 2398 U.S. operations. exemption’’). As described in the States. Several commenters argued that the proposal, the purpose of this statutory Commenters generally expressed restrictions of section 13(f), which limits exemption appears to be to limit the support for an exemption to allow transactions between a banking entity extraterritorial application of the foreign banking entities to conduct and certain covered funds, would not statutory restrictions on covered fund foreign covered fund activities and apply to activities and investments activities and investments, while make investments outside the United made in reliance on the foreign fund States.2400 A number of commenters preserving national treatment and exemption.2407 Some commenters competitive equality among U.S. and also expressed concerns that the argued that the Agencies should foreign banking entities within the proposed foreign fund exemption was 2399 grandfather all existing foreign covered United States. The statute does not too narrow and would not be effective funds and argued that failure to provide in permitting foreign banking entities to relief for existing relationships could 2396 See final rule § 75.13(a)(2)(iii). engage in covered fund activities and 2397 Section 13(d)(1)(I) of the BHC Act permits a cause substantial disruption to foreign investments outside of the United covered funds and significantly harm banking entity to acquire or retain an ownership States. For instance, many commenters interest in, or have certain relationships with, a investors in existing funds without argued that several of the proposal’s covered fund notwithstanding the restrictions on producing a clear offsetting benefit.2408 investments in, and relationships with, a covered restrictions on the exemption were not fund, if: (i) Such activity or investment is required by statute and were 2403 See Credit Suisse (Williams); PEGCC; see also conducted by a banking entity pursuant to inconsistent with congressional intent paragraph (9) or (13) of section 4(c) of the BHC Act; Commissioner Barnier. (ii) the activity occurs solely outside of the United to limit the extraterritorial impact of 2404 See e.g., Norinchukin; Cadwalader (on behalf States; (iii) no ownership interest in such fund is section 13 of the BHC Act.2401 These of Thai Banks); Barclays; EBF; Ass’n. of German offered for sale or sold to a resident of the United commenters argued that the foreign Banks; Socie´te´ Ge´ne´rale; Chamber (Feb. 2012). 2405 States; and (iv) the banking entity is not directly or funds exemption should focus on See BaFin/Deutsche Bundesbank; indirectly controlled by a banking entity that is Norinchukin; IIF; Allen & Overy (on behalf of organized under the laws of the United States or of whether a prohibited activity, such as Canadian Banks); ICFR; BoA. As discussed below one or more States. See 12 U.S.C. 1851(d)(1)(I). sponsoring or investing in a covered in Part VI.C.1, other parts of the final rule address 2398 This section’s discussion of the concept fund, involves principal risk taken or commenters’ concerns regarding the compliance ‘‘solely outside of the United States’’ is provided held by the foreign banking entity that burden on foreign banking entities. solely for purposes of the final rule’s 2406 See AFG; Ass’n. of German Banks; BVI; implementation of section 13(d)(1)(I) of the BHC poses risk to U.S. banking entities or the Comm. on Capital Markets Regulation; IIB/EBF; Act, and does not affect a banking entity’s financial stability of the United Japanese Bankers Ass’n.; Norinchukin; Union Asset. obligation to comply with additional or different States.2402 Commenters also argued that As discussed in greater detail below in Part VI.C.1, requirements under applicable securities, banking, a broader exemption would better activities and investments of a foreign bank that are or other laws. conducted under the foreign funds exemption are 2399 See 156 Cong. Rec. S5897 (daily ed. July 15, generally not subject to the specific requirements of 2010) (statement of Sen. Merkley) (‘‘Subparagraphs fund and private equity fund services to U.S. § 75.20 and Appendices A and B. The U.S. (H) and (I) recognize rules of international persons when such offering could not be made in operations of foreign banking entities are expected regulatory comity by permitting foreign banks, the United States.’’). to have policies and procedures in place to ensure regulated and backed by foreign taxpayers, in the 2400 See, e.g., IIB/EBF; SIFMA et al. (Covered that they conduct activities under this part in full course of operating outside of the United States to Funds) (Feb. 2012); see also Occupy. compliance with this part. engage in activities permitted under relevant 2401 See Ass’n. of German Banks; BVI; Allen & 2407 See Australian Bankers Ass’n.; AFMA; Allen foreign law. However, these subparagraphs are not Overy (on behalf of Canadian Banks); EFAMA; F&C; & Overy (on behalf of Foreign Bank Group); British intended to permit a U.S. banking entity to avoid HSBC; IIB/EBF; ICSA; PEGCC; Socie´te´ Ge´ne´rale; Bankers’ Ass’n.; F&C; French Banking Fed’n.; IIB/ the restrictions on proprietary trading simply by Union Asset; Ass’n. of Banks in Malaysia; EBF; EBF; Japanese Bankers Ass’n; Katten (on behalf of setting up an offshore subsidiary or reincorporating Credit Suisse (Williams); Cadwalader (on behalf of Int’l Clients); Union Asset. See also infra Part offshore, and regulators should enforce them Thai Banks). VI.B.5. accordingly. In addition, the subparagraphs seek to 2402 See IIB/EBF; EBF; Allen & Overy (on behalf 2408 See BVI; Credit Suisse (Williams); EFAMA; maintain a level playing field by prohibiting a of Canadian Banks); Credit Suisse (Williams); IIB/EBF; PEGCC; Union Asset. See supra Part II for foreign bank from improperly offering its hedge Katten (on behalf of Int’l Clients). a discussion regarding the conformance period.

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In response to comments received on controlled by a banking entity that is foreign banking organization must meet the proposal, the final rule contains a organized under the laws of the United in order to act pursuant to that number of modifications to more States or of one or more States. As noted authority.2415 The qualifying conditions effectively implement the foreign fund above, section 13(d)(1)(I) of the BHC Act and requirements include, for example, exemption in light of the language and specifically provides that its exemption that the foreign banking organization purpose of the statute. Importantly, as is available only to a banking entity that demonstrate that more than half of its explained in the section defining is not ‘‘directly or indirectly’’ controlled worldwide business is banking and that covered funds, the Agencies also believe by a banking entity that is organized more than half of its banking business that the more circumscribed definition under the laws of the United States or is outside the United States.2416 Under of covered fund, including the exclusion of one or more States.2411 Because of the final rule a banking entity that is a for foreign public funds, should this express statutory requirement, a qualifying foreign banking organization alleviate many of the concerns raised foreign subsidiary controlled, directly or for purposes of the Board’s Regulation and potential burdens identified by indirectly, by a banking entity organized K, other than a foreign bank as defined commenters with respect to the funds under the laws of the United States or in section 1(b)(7) of the International activities of foreign banking entities.2409 one of its States, and a foreign branch Banking Act of 1978 that is organized office of a banking entity organized under the laws of any commonwealth, 1. Foreign Banking Entities Eligible for under the laws of the United States or territory, or possession of the United the Exemption one of the States, may not take States, will qualify for the foreign fund The statutory language of section advantage of this exemption. exemption.2417 13(d)(1)(I) provides that, in order to be Like the proposal, the final rule Section 13 of the BHC Act also eligible for the foreign funds exemption, incorporates the statutory requirement applies to foreign companies that the banking entity must not be directly that the banking entity conduct its control a U.S. insured depository or indirectly controlled by a banking sponsorship or investment activities institution but that are not subject to the entity that is organized under the laws pursuant to sections 4(c)(9) or 4(c)(13) of of the United States or of one or more the BHC Act. The final rule retains the 2415 Some commenters argued that the Board’s tests in the proposed rule for Regulation K contains a number of limitations that States. Consistent with this statutory may not be appropriate to include as part of the language, the proposed rule limited the determining when a banking entity requirements of the foreign fund exemption. For scope of the exemption to banking would meet that requirement. The final example, subpart B of the Board’s Regulation K entities that are organized under foreign rule also provides qualifying criteria for includes various approval requirements and both a banking entity that is a qualifying interstate office location restrictions. See Allen & law and, as applicable, controlled only Overy (on behalf of Foreign Bank Group); HSBC by entities organized under foreign law. foreign banking organization under the Life. The final rule does not retain the proposal’s The Agencies did not receive Board’s Regulation K and a banking requirement that the activity be conducted in substantive comment on this aspect of entity that is not a foreign banking compliance with all of subpart B of the Board’s organization for purposes of Regulation Regulation K (12 CFR 211.20 through 211.30). the proposal related to the foreign fund However, the foreign fund exemption in section 2412 exemption, though some commenters K. 13(d)(1)(I) of the BHC Act and the final rule offered suggestions to clarify various Section 4(c)(9) of the BHC Act applies operates as an exemption and is not a separate grant parts of the wording of the scope of the to any company organized under the of authority to engage in an otherwise laws of a foreign country the greater part impermissible activity. To the extent a banking definition of banking entities that may entity is a foreign banking organization, it remains qualify for the exemption. The final rule of whose business is conducted outside subject to the Board’s Regulation K and must, as a makes only minor, technical changes to the United States, if the Board by separate matter, comply with any and all applicable more fully carry out the purposes of the regulation or order determines that the rules and requirements of that regulation. exemption would not be substantially at 2416 See 12 CFR 211.23(a), (c), and (e). The statute. proposed rule only referenced the qualifying test Consistent with the statutory language variance with the purposes of the BHC under section 211.23(a) of the Board’s Regulation K; and purpose of section 13(d)(1)(I) of the Act and would be in the public however, because there are two other methods by 2413 BHC Act, the final rule provides that the interest. The Board has which a foreign banking organization may meet the implemented section 4(c)(9) as part of requirements to be considered a qualified foreign exemption is available only if the banking organization, the final rule incorporates a subpart B of the Board’s Regulation reference to those provisions as well. banking entity is not organized 2414 under 2410 or directly or indirectly K, which specifies a number of 2417 This modification to the definition of foreign conditions and requirements that a banking organization from the proposed definition

2409 is necessary because, under the International For instance, many commenters raised Banking Act and the Board’s Regulation K, concerns regarding the treatment of foreign public the BHC Act and § 75.13(c)(1)(i) of the proposal require that a banking entity seeking to rely on the depository institutions that are located in, or funds such as UCITS. As discussed in greater detail organized under the laws of a commonwealth, above in Part VI.B.1, the definition of covered fund foreign fund exemption not be directly or indirectly controlled by a banking entity that is organized territory, or possession of the United States, are under the final rule has been modified from the foreign banking organizations. However, for proposal and tailored to include only the types of under the laws of the United States or of one or more states. For clarification purposes, in addition purposes of the Federal securities laws and certain foreign funds that the Agencies believe are intended banking statutes, such as section 2(c)(1) of the BHC to be the focus of the statute (e.g., certain foreign to the eligibility requirement in Section 13(d)(1)(I) of the BHC Act and the proposal, the final rule also Act and section 3 of the FDI Act, these same entities funds that are established by U.S. banking entities). are defined to be and treated as domestic entities. Foreign public funds are also excluded from the expressly requires that the banking entity not itself be organized under the laws of the United States. For instance, these entities act as domestic broker- definition of covered fund under the final rule. The dealers under U.S. securities laws and their 2411 See 12 U.S.C. 1851(d)(1)(I). modifications in the final rule in part address deposits are insured by the FDIC. Because one of 2412 commenters’ request that foreign funds be Section 75.13(b)(2) only addresses when a the purposes of section 13 is to protect insured grandfathered. To the extent that an entity qualifies transaction will be considered to have been depository institutions and the U.S. financial for one or more of the exclusions from the conducted pursuant to section 4(c)(9) of the BHC system from the perceived risks of proprietary definition of covered fund, that entity would not be Act. Although the statute also references section trading and covered fund activities, the Agencies a covered fund under the final rule. Moreover, any 4(c)(13) of the BHC Act, the Board has to date believe that these entities should be considered to entity that would be a covered fund would still be applied the general authority contained in that be located within the United States for purposes of able to rely on the conformance period in order to section solely to the foreign activities of U.S. section 13. The final rule includes within the come into compliance with the requirements of banking organizations which, by the express terms definition of State any State, the District of section 13 and the final rule. of section 13(d)(1)(I) of the BHC Act, are unable to Columbia, the Commonwealth of Puerto Rico, 2410 The final rule clarifies the eligibility rely on the foreign funds exemption. Guam, American Samoa, the United States Virgin requirements for banking entities seeking to rely on 2413 See 12 U.S.C. 1843(c)(9). Islands, and the Commonwealth of the Northern the foreign fund exemption. Section 13(d)(1)(I) of 2414 See 12 CFR 211.20 et seq. Mariana Islands.

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BHC Act generally or to the Board’s within, the United States. In particular, States.2425 These commenters argued Regulation K—for example, because the § 75.13(c)(3) of the proposed rule that organizing and offering a fund is foreign company controls a savings provided that a transaction or activity be not a prohibited activity so long as it is association or an FDIC-insured considered to have occurred solely not accompanied by ownership or industrial loan company. Accordingly, outside of the United States only if: (i) sponsorship of the covered fund. One the final rule also provides that a foreign The transaction or activity is conducted commenter urged that the final rule banking entity that is not a foreign by a banking entity that is not organized permit U.S. personnel of a foreign banking organization would be under the laws of the United States or banking entity to engage in non-selling considered to be conducting activities of one or more States; (ii) no subsidiary, activities related to a covered fund, ‘‘pursuant to section 4(c)(9)’’ for affiliate, or employee of the banking including acting as investment advisor, purposes of the foreign fund entity that is involved in the offer or establishing fund vehicles, conducting exemption 2418 if the entity, on a fully- sale of an ownership interest in the back-office functions such as day-to-day consolidated basis,2419 meets at least covered fund is incorporated or management and deal sourcing tax two of three requirements that evaluate physically located in the United States; structuring, obtaining licenses, the extent to which the foreign banking and (iii) no ownership interest in such interfacing with regulators, and other entity’s business is conducted outside covered fund is offered for sale or sold related activities that do not involve U.S. sales activity.2426 the United States, as measured by to a resident of the United States. assets, revenues, and income.2420 This Instead of the proposal’s transaction- test largely mirrors the qualifying Commenters suggested that, like the based approach to implementing the foreign banking organization test that is foreign trading exemption, the foreign foreign fund exemption, many made applicable under section 4(c)(9) of fund exemption should focus on the commenters suggested the final rule the BHC Act and § 211.23(a), (c), or (e) location of activities that a banking adopt a risk-based approach.2427 These of the Board’s Regulation K, except that entity engages in as principal.2422 These commenters argued that a risk-based the test does not require the foreign commenters argued that the location of approach would prohibit or entity to demonstrate that more than sales activities of a fund should not significantly limit the amount of half of its banking business is outside determine whether a banking entity has financial risk from such activities that the United States.2421 This difference sponsored or acquired an ownership could be transferred to the United States reflects the fact that foreign entities interest in a covered fund solely outside by the foreign activity of foreign banking subject to section 13 of the BHC Act, but of the United States. Commenters also entities in line with the purpose of the 2428 not the BHC Act generally, are likely to argued that foreign banking entities statue. Commenters also contended be, in many cases, predominantly typically locate marketing and sales that foreign activities of most foreign commercial firms. A requirement that personnel for foreign funds in the banking entities are already subject to such firms also demonstrate that more United States in order to serve activities limitations, capital than half of their banking business is customers, including those that are not requirements, and other prudential outside the United States would likely residents of the United States, and that requirements of their home-country 2429 make the exemption unavailable to such the proposal would needlessly force all supervisor(s). In response to commenters’ concerns firms and subject their global activities covered fund sales activities to shift and in order to more effectively to the restrictions on covered fund outside of the United States. These implement both the statutory activities and investments, a result that commenters alleged that the restrictions prohibition as well as the foreign fund the Agencies do not believe was under the proposal would cause foreign exemption, the final rule has been intended. banking entities to relocate their modified to better reflect the purpose of 2. Activities or Investments Solely personnel from the United States to the statute by ensuring that the Outside of the United States overseas, diminishing U.S. jobs with no principal risks of covered fund concomitant benefit.2423 As noted above, the proposed rule investments and sponsorship by foreign adopted a transaction-based approach to Many commenters requested removal banking entities permitted under the implementing the foreign fund of the proposal’s prohibition on a U.S. foreign funds exemption occur and exemption and focused on the extent to subsidiary, affiliate, or employee of the remain solely outside of the United which the foreign fund transactions foreign banking entity offering or selling States. One of the principal purposes of occur within, or are carried out by fund interests in order to qualify for the section 13 is to limit the risks that 2424 personnel, subsidiaries or affiliates foreign fund exemption. covered fund investments and activities Commenters argued that this limitation pose to the safety and soundness of U.S. 2418 This clarification would be applicable solely was not included in the statute and that banking entities and the U.S. financial in the context of section 13(d)(1) of the BHC Act. the limited involvement of persons The application of section 4(c)(9) to foreign located in the U.S. in the distribution of 2425 See IIB/EBF; Socie´te´ Ge´ne´rale; TCW; Union companies in other contexts is likely to involve ownership interests in a foreign covered Asset; Credit Suisse (Williams); see also Katten (on different legal and policy issues and may therefore behalf of Int’l Clients) (recommending that, similar merit different approaches. fund should not, by itself, disqualify the to the SEC’s Regulation S (17 CFR 230.901 through 2419 For clarification purposes, the final rule has banking entity from relying on the 230.905), the final rule provide that involvement of been modified from the proposal to provide that the foreign fund exemption so long as the persons located in the United States in the requirements for this provision must be met on a fund is offered only outside the United distribution of a non-U.S. covered fund’s securities fully-consolidated basis. to potential purchasers outside of the United States 2420 See final rule § 75.13(b)(2)(ii)(B). For not affect the analysis of whether a non-U.S. purposes of determining whether, on a fully 2422 See Credit Suisse (Williams); IIB/EBF; Katten banking entity’s investment or sponsorship occurs consolidated basis, it meets the requirements under (on behalf of Int’l Clients). outside the United States). § 75.13(b)(2)(ii)(B), a foreign banking entity that is 2423 See Allen & Overy (on behalf of Foreign Bank 2426 See Allen & Overy (on behalf of Foreign Bank not a foreign banking organization should base its Group); Ass’n. of German Banks; Credit Suisse Group). calculation on the consolidated global assets, (Williams); IIB/EBF; Socie´te´ Ge´ne´rale; Union Asset. 2427 See BaFin/Deutsche Bundesbank; ICSA; IIB/ revenues, and income of the top-tier affiliate within 2424 See Allen & Overy (on behalf of Foreign Bank EBF; EBF; Allen & Overy (on behalf of Canadian the foreign banking entity’s structure. Group); Ass’n. of German Banks; Credit Suisse Banks); Credit Suisse (Williams); George Osborne. 2421 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), (Williams); IIB/EBF; Katten (on behalf of Int’l 2428 See IIB/EBF. (c), and (e); final rule § 75.13(b)(2)(ii)(B). Clients); TCW; Union Asset. 2429 See IIB/EBF.

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system. Another purpose of the foreign branch, agency, or subsidiary is not ownership interest.2432 The final rule fund exemption was to limit the considered to be located in the United would thus allow a foreign bank to extraterritorial application of section 13 States solely by virtue of operation of engage in any of these capacities in the as it applies to foreign banking entities the U.S. branch, agency, or U.S. without the need to rely on the subject to section 13. subsidiary.2431 A subsidiary (wherever foreign fund exemption. To accomplish these purposes in light located) of a U.S. branch, agency, or of the structure and purpose of the subsidiary of a foreign bank is also 3. Offered for Sale or Sold to a Resident statute and in response to commenters, considered itself to be located in the of the United States the final rule adopts a risk-based United States. This provision helps give The proposed rule provided that no approach rather than a transaction effect to the statutory language limiting approach to the foreign fund exemption. the foreign fund exemption to activities ownership interest in the covered fund In order to ensure these risks remain of foreign banking entities that occur be offered for sale or sold to a resident solely outside of the United States, the ‘‘solely outside of the United States’’ by of the United States, a requirement of 2433 final rule also includes several clarifying that the U.S. operations of the statute. Numerous commenters conditions on the availability of the foreign banking entities may not focused on the definition of ‘‘resident of foreign fund exemption. Specifically, sponsor or acquire or retain an the United States’’ in the proposed rule the final rule provides that an activity ownership interest in a covered fund as and the manner in which the restriction or investment occurs solely outside the principal based on this exemption. on offers and sales to such persons United States for purposes of the foreign Because so-called ‘‘back office’’ would interrelate with Regulation S fund exemption only if: activities do not involve sponsoring or under the Securities Act of 1933. • The banking entity acting as acquiring or retaining an ownership Commenters asserted that, since market sponsor, or engaging as principal in the interest in a covered fund, the final rule participants have long conducted acquisition or retention of an ownership does not impose restrictions on U.S. offerings of foreign funds in reliance on interest in the covered fund, is not itself, personnel of a foreign banking entity Regulation S 2434 in order to comply and it not controlled directly or engaging in these activities in with U.S. securities law obligations, indirectly by, a banking entity that is connection with one or more covered these same securities law principles located in the United States or funds. This allows providing should be applied to determine whether established under the laws of the United administrative services or similar a person is a resident of the United States or of any State; functions to the covered fund as an • States for purposes of section 13 and the The banking entity (including incident to the activity conducted under final rule to determine whether an offer relevant personnel) that makes the the foreign fund exemption (such as or sale is made to residents of the decision to acquire or retain the clearing and settlement, maintaining United States.2435 ownership interest or act as sponsor to and preserving records of the fund, the covered fund is not located in the furnishing statistical and research data, Certain commenters argued that United States or organized under the or providing clerical support for the because of the way the restriction in the laws of the United States or of any State; fund). statute and proposed rule was written, • The investment or sponsorship, The foreign fund exemption in the it was unclear whether the restriction on including any transaction arising from final rule also permits the U.S. offering for sale to a resident of the risk-mitigating hedging related to an personnel and operations of a foreign United States applied to the foreign ownership interest, is not accounted for banking entity to act as investment banking entity or to any third party that as principal directly or indirectly on a adviser to a covered fund in certain establishes a fund.2436 Commenters consolidated basis by any branch or circumstances. For instance, the U.S. argued the prohibition against offers or affiliate that is located in the United personnel of a foreign banking entity sales of ownership interests to residents States or organized under the laws of may provide investment advice and of the United States should apply only the United States or of any State; and recommend investment selections to the to offers and sales of covered funds • No financing for the banking manager or general partner of a covered organized and offered by the foreign entity’s ownership or sponsorship is fund so long as that investment advisory banking entity but not to covered funds provided, directly or indirectly, by any activity in the United States does not established by unaffiliated third branch or affiliate that is located in the result in the U.S. personnel parties.2437 These commenters reasoned United States or organized under the participating in the control of the that a foreign banking entity should be laws of the United States or of any covered fund or offering or selling an permitted to make a passive investment State.2430 ownership interest to a resident of the in a covered fund sponsored and These requirements are designed to United States. As explained above, the controlled by an unaffiliated third party ensure that any foreign banking entity final rule also explicitly provides that that has U.S. investors as long as the engaging in activity under the foreign acquiring or retaining an ownership foreign banking entity does not itself interest does not include acquiring or fund exemption does so in a manner offer or sell ownership interest in the that ensures the risk and sponsorship of retaining an ownership interest in a covered fund to residents of the United the activity or investment occurs and covered fund by a banking entity acting resides solely outside of the United solely as agent, broker, or custodian, 2432 See final rule § 75.10(a)(2). States. subject to certain conditions, or acting 2433 The final rule has been modified from on behalf of customers as a trustee, or See proposed rule § 75.13(c)(1)(iii). 2434 See 17 CFR 230.901–905. the proposal to specifically recognize in a similar fiduciary capacity for a 2435 See IIB/EBF; EFAMA; ICI Global. that, for purposes of the foreign fund customer that is not a covered fund, so 2436 See Cadwalader (on behalf of Thai Banks); exemption, a U.S. branch, agency, or long as the activity is conducted for the Grosvenor; SIFMA et al. (Covered Funds) (Feb. subsidiary of a foreign bank, is located account of the customer and the banking 2012). in the United States; however, a foreign entity and its affiliates do not have or 2437 See Ass’n. of German Banks; BAROC; Cadwalader (on behalf of Thai Banks); Comm. on bank that operates or controls that retain beneficial ownership of the Capital Markets Regulation; Credit Suisse (Williams); IIB/EBF; Japanese Bankers Ass’n.; 2430 See final rule § 75.13(b)(4). 2431 See final rule § 75.13(b)(5). Katten (on behalf of Int’l Clients); PEGCC.

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States.2438 Commenters contended that banking entity from making an covered fund is not offered or sold to this interpretation would be consistent investment in or sponsoring a foreign residents of the United States in order with section 13’s purpose to prevent fund. However, a foreign banking entity to qualify for the foreign fund foreign banks from using the foreign would not be permitted under the exemption. Commenters argued that fund exemption to market and sell foreign fund exemption to invest in, or only active targeting or marketing covered funds to U.S. investors, while engage in the sponsorship of, a U.S. or towards a resident of the United States simultaneously limiting the foreign covered fund that offers by the foreign banking entity should be extraterritorial impact of section 13.2439 ownership interests to residents in the prohibited by the final rule, and that the Commenters argued that the proposal’s United States unless it does so pursuant incidental presence of a limited number foreign fund exemption would to and subject to the limitations of the of investors that are residents of the negatively impact U.S. asset managers permitted activity exemption for United States in a foreign covered fund unaffiliated with any banking entity organizing and offering a covered fund, offered by a foreign banking entity because they would either be forced to for example, which has the same effect should not prohibit the foreign banking exclude foreign banking entities from for U.S. banking entities. The final rule entity from relying on the foreign fund investing in their funds or would need ensures that the risk of the sponsoring exemption.2449 One commenter argued to ensure that no residents of the United and investing in non-U.S. covered funds that, for certain complex fund structures States hold ownership interests in funds by foreign banking entities remains (e.g., a structure with a master fund and offered to these entities.2440 outside of the United States and that the multiple feeder funds that investors Commenters also contended that foreign foreign fund exemption does not invest in or a parallel fund structure banking entities, including sovereign advantage foreign banking entities both managed by the same fund wealth funds that own or control foreign relative to U.S. banking entities with manager), eligibility for the foreign fund banking organizations, invest tens of respect to providing their covered fund exemption should not be precluded for billions of dollars in U.S. covered funds services in the United States by a fund with no ownership interests and that if these types of investments prohibiting the offer or sale of offered for sale or sold to U.S. residents were not permitted under the foreign ownership interests in related covered even if a related covered fund is offered fund exemption an important source of funds to residents of the United States. to residents of the United States.2450 foreign investment in the U.S. could be Commenters also argued that foreign After considering comments received eliminated.2441 investors in a foreign covered fund on the proposal, the final rule retains Commenters argued that an should not be treated as residents of the the statutory requirement that no investment by a foreign banking entity United States for purposes of the final ownership interest in the covered fund in a third-party unaffiliated fund does rule if, after purchasing their interest in be offered for sale to a resident of the not pose any risk to a U.S. banking the covered fund, they relocate to the United States.2451 The final rule entity or to the U.S. financial system. U.S.,2444 or travel to the U.S. on a provides that an ownership interest in a Moreover, commenters argued that a temporary basis.2445 Commenters also covered fund is offered for sale or sold foreign banking entity that has invested argued that non-U.S. investors in a fund to a resident of the United States for in a fund sponsored and advised by a offered by a foreign banking entity purposes of the foreign fund exemption third party has no control over should not be prohibited from only if it is sold or has been sold whether—and may have no transferring their interests to residents pursuant to an offering that targets knowledge—that the third party has of the United States in the secondary residents of the United States.2452 determined to offer or sell the fund to market.2446 One commenter alleged that, Absent circumstances otherwise U.S. residents.2442 notwithstanding the reasonable efforts indicating a nexus with residents of the As noted above, one of the purposes of foreign banking entities to prevent United States, the sponsor of a foreign of section 13 is to limit the risk to residents of the United States from fund would not be viewed as targeting banking entities and the financial investing in their foreign covered funds, U.S. residents for purposes of the system of the United States. Another investors may find ways to circumvent foreign fund exemption if it conducts an purpose of the statute appears to be to and invest in covered funds without offering directed to residents of one or permit foreign banking entities to knowledge or assistance from the more countries other than the United engage in foreign activities without foreign banking entity.2447 States; includes in the offering materials being subject to the restrictions of Certain commenters argued that there a prominent disclaimer that the section 13 while also ensuring that these was a substantial risk that foreign funds securities are not being offered in the foreign entities do not receive a offered by foreign banking entities United States or to residents of the competitive advantage over U.S. would not be able to rely on the United States; and includes other banking entities with respect to offering exemption due to the presence of a reasonable procedures to restrict access and selling their covered fund services limited number of investors who are to offering and subscription materials to in the United States.2443 As such, the residents of the United States.2448 A few persons that are not residents of the final rule does not prohibit a foreign commenters suggested that the final rule United States.2453 If ownership interests should require that, for both related and 2438 See Grosvenor; IIB/EBF; Japanese Bankers unrelated covered funds, a banking 2449 See AFG; Union Asset; see also BVI; Allen & Ass’n.; Katten (on behalf of Int’l Clients); Sens. entity need only have a reasonable Overy (on behalf of Canadian Banks); Katten (on Merkley & Levin (Feb.2012); Norinchukin; SIFMA belief that an ownership interest in a behalf of Int’l Clients). et al. (Covered Funds) (Feb. 2012). 2450 See Japanese Bankers Ass’n. 2439 See BAROC; Credit Suisse (Williams); 2451 See final rule § 75.13(b)(1)(iii). 2444 Grosvenor; IIB/EBF. See IIB/EBF; Katten (on behalf of Int’l 2452 See final rule § 75.13(b)(3). 2440 Clients); Union Asset. See Comm. on Capital Markets Regulation; 2453 See Statement of the Commission Regarding 2445 Credit Suisse (Williams); PEGCC. See IFIC; see also Allen & Overy (on behalf Use of Internet Web sites to Offer Securities, Solicit 2441 See SIFMA et al. (Covered Funds) (Feb. of Canadian Banks). Securities Transactions or Advertise Investment 2012); see also Grosvenor; PEGCC. 2446 See Ass’n. of German Banks; Credit Suisse Services Offshore, Securities Act Release No. 7516 2442 See AFG; BAROC; Cadwalader (on behalf of (Williams); IIB/EBF; Katten (on behalf of Int’l (Mar. 23, 1998). Reliance on these principles only Thai Banks); Japanese Bankers Ass’n. Clients). applies with respect to whether an ownership 2443 See 156 Cong. Rec. S5897 (daily ed. July 15, 2447 See Credit Suisse (Williams). interest in a covered fund is offered for sale or sold 2010) (statement of Sen. Merkley). 2448 See BVI; EFAMA; Union Asset. to a resident of the United States for purposes of

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that are issued in a foreign offering are that no ownership interest in the exemption for covered fund activities listed on a foreign exchange, secondary covered fund is offered for sale or sold and investments through both the market transactions could be to a ‘‘resident of the United States.’’ As general account and separate accounts undertaken by the banking entity noted above in Part VI.B.1.f describing of an insurance company was integral to outside the United States in accordance the definition of ‘‘resident of the United the business of insurance and that, with Regulation S under the foreign States,’’ the statute does not define this absent an exemption from the covered fund exemption.2454 Foreign banking term. fund provisions, insurance companies entities should use precautions not to After carefully considering comments would lack an effective means to send offering materials into the United received, the Agencies have defined the diversify their holdings and obtain States or conduct discussions with term ‘‘resident of the United States’’ in adequate rates of return in order to persons located in the United States the final rule to mean a ‘‘U.S. person’’ maintain affordable premiums for (other than to or with a person known as defined in the SEC’s Regulation S.2456 customers.2461 to be a dealer or other professional The Agencies note, however, that it Some commenters argued that section fiduciary acting on behalf of a would not be permissible under the 13 of the BHC Act specifically provides discretionary account or similar account foreign fund exemption for a foreign exemptions from both the covered fund for a person who is not a resident of the banking entity to facilitate or participate prohibition of section 13(a)(1), and the United States).2455 In order to comply in the formation of a non-U.S. prohibition on proprietary trading.2462 with the rule as adopted, sponsors of investment vehicle for a person or entity Commenters contended that the covered funds established outside of the that is itself a U.S. person for the exemptions in section 13(d)(1)(F) United States must examine the facts specific purpose of investing in a (referencing activity in general accounts and circumstances of their particular foreign fund. The Agencies believe that of insurance companies) and 13(d)(1)(D) offerings and confirm that the offering this type of activity would constitute an (referencing activities on behalf of does not target residents of the United evasion of the requirements of section customers) cross-reference the States. 13 of the BHC Act. instruments described in section 13(h)(4) and not activity described in With respect to the treatment of multi- c. Permitted Covered Fund Interests and section 13(h)(4). On this basis, tiered fund structures under the foreign Activities by a Regulated Insurance commenters argued the statute exempts fund exemption, the Agencies expect Company that activities related to certain complex both proprietary trading in these As discussed above, section fund structures should be integrated in instruments described in section 13(d)(1)(F) of the BHC Act permits a order to determine whether an 13(h)(4) and investments in those banking entity that is a regulated ownership interest in a covered fund is instruments (including when those insurance company acting for its general offered for sale to a resident of the instruments are ownership interests in account, or an affiliate of an insurance 2463 United States. For example, a banking covered funds). company acting for the insurance Alternatively, commenters argued that entity may not be able to rely on the company’s general account, to purchase the Agencies should use their authority foreign fund exemption to sponsor or or sell a financial instrument subject to in section 13(d)(1)(J) of the BHC Act to invest in an initial covered fund (that is certain conditions.2457 Section provide an exemption for the covered offered for sale only overseas and not to 13(d)(1)(D) of the Act permits a banking fund activities and investments of residents of the United States) that is entity to purchase or sell a financial insurance companies.2464 These itself organized or operated for the instrument on behalf of customers.2458 commenters argued that exempting purpose of investing in another covered The proposal implemented these covered funds activities and fund (that is sold pursuant to an offering exemptions with respect to the investments of insurance companies that targets U.S. residents) and that is proprietary trading activities of would promote and protect the safety either organized and offered or is insurance companies by permitting a and soundness of the banking entity and advised by that banking entity. banking entity that is an insurance financial stability of the United States 4. Definition of ‘‘Resident of the United company to purchase or sell a financial and provide certain benefits to the U.S. States’’ instrument for the general account of financial system by allowing insurance the insurance company or for a separate companies to access important asset As discussed in greater detail above in account, in each case subject to certain classes (for better investment diversity Part VI.B.1, section 13(d)(1)(I) of the restrictions.2459 The proposal did not and returns), provide more diverse BHC Act provides that a foreign banking apply these exemptions to covered fund product offerings to customers, better entity may acquire or retain an activities or investments. manage their investment risks through ownership interest in or act as sponsor A number of commenters argued that diversification and more closely to a covered fund, but only if that section 13 was designed to matching the maturity of their assets activity is conducted according to the accommodate the business of insurance requirements of the statute, including by exempting both the proprietary 2461 See, e.g., Fin. Services Roundtable (Feb. 3, trading and covered fund activities of 2012); TIAA–CREF (Feb. 13, 2012); Sutherland (on section 13 of the BHC Act. In addition, reliance insurance companies.2460 These behalf of Comm. of Annuity Insurers); USAA (citing would not be appropriate if a foreign fund engages FSOC study at 71); HSBC Life; ACLI; NAMIC; in a private placement of ownership interests in the commenters argued that providing an Nationwide. United States in reliance on Section 4(a)(2) of the 2462 See Sutherland (on behalf of Comm. of Securities Act of 1933 or Regulation D (17 CFR 2456 See final rule § 75.10(d)(8). Annuity Insurers); Nationwide; see also Rep. 230.501–230.506). 2457 See 12 U.S.C. 1851(d)(1)(F). McCarthy et al.; Sens. Brown & Harkin. 2454 An offer or sale is made in an ‘‘offshore 2458 See 12 U.S.C. 1851(d)(1)(D). 2463 See, e.g., Fin. Services Roundtable (Feb. 3, transaction’’ under Regulation S if, among other 2459 See proposed rule §§ 75.6(b)(2)(iii); 75.6(c). 2012); USAA; HSBC Life; Country Fin. et al.; conditions, the transaction is executed in, on or 2460 See, e.g., Sutherland (on behalf of Comm. of Sutherland (on behalf of Comm. of Annuity through the facilities of a ‘‘designated offshore Annuity Insurers); ACLI (Jan. 2012); Country Fin. et Insurers); Nationwide (discussing the exemption for securities market’’ as described in Regulation S, al.; Nationwide; NAMIC; Fin. Services Roundtable the general account of an insurance company); which includes a number of foreign stock (Feb. 3, 2012) (citing FSOC study at 71); HSBC Life; ACLI; Nationwide (discussing the exemption for exchanges and markets and any others the SEC Chamber (Feb. 2012); Country Fin. et al.; Mutual of separate accounts). designates. See Securities Act rule 902(h). Omaha; see also Rep. McCarthy et al.; Sen. Nelson; 2464 See, e.g., Sutherland (on behalf of Comm. of 2455 See Securities Act rule 902(k)(2). Sen. Hagan; Sens. Brown & Harkin. Annuity Insurers).

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and liabilities, contribute liquidity to insurance company or its affiliate determine by rule.]’’ This reference capital markets, and support economic acquires and retains the ownership covers an ownership interest in a growth through the provision of capital interest solely for the general account of covered fund. The Agencies believe to entrepreneurs and businesses.2465 the insurance company or for one or these exemptions as modified more Commenters also argued that an more separate accounts established by fully carry out Congressional intent and exemption for insurance companies the insurance company; (2) the the statutory purpose of appropriately from the covered fund prohibitions was acquisition and retention of the accommodating the business of necessary to permit insurance ownership interest is conducted in insurance within an insurance companies that are banking entities to compliance with, and subject to, the company.2473 Insurance companies are effectively compete with insurance insurance company investment laws, already subject to a robust regulatory companies not affiliated with an insured regulations, and written guidance of the regime including limitations on their depository institution.2466 Commenters State or jurisdiction in which the investment activities. alleged that insurance companies are insurance company is domiciled; and 5. Section 75.14: Limitations on already subject to extensive regulation (3) the appropriate Federal banking Relationships With a Covered Fund under state insurance laws that agencies, after consultation with the specifically include provisions designed Financial Stability Oversight Council Section 13(f) of the BHC Act generally to diversify risk among investment and the relevant insurance prohibits a banking entity that, directly categories, limit exposure to particular commissioners of the States and or indirectly, serves as investment types of asset classes including covered relevant foreign jurisdictions, as manager, investment adviser, or sponsor fund investments, and protect the safety appropriate, have not jointly to a covered fund (or that organizes and and soundness of the insurance determined, after notice and comment, offers a covered fund pursuant to company.2467 that a particular law, regulation, or section 13(d)(1)(G) of the BHC Act) from After careful review of the comments written guidance described in entering into a transaction with a in light of the statutory provisions, the § 75.13(c)(2) of the final rule is covered fund that would be a covered final rule has been modified to permit insufficient to protect the safety and transaction as defined in section 23A of an insurance company or its affiliate 2468 soundness of the banking entity, or the the Federal Reserve Act (‘‘FR Act’’).2474 to acquire or retain an ownership financial stability of the United The statute also provides an exemption interest in, or act as sponsor to, a States.2470 for prime brokerage transactions covered fund for either the general The Agencies believe that exempting between a banking entity and a covered account of the insurance company or insurance activities and investments fund in which a covered fund managed, one or more separate accounts from the covered fund restrictions is sponsored, or advised by that banking established by the insurance supported by the language of sections entity has taken an ownership interest. company.2469 13(d)(1)(D) and (F) of the BHC Act,2471 Section 13(f) subjects any transaction These activities are only permitted and more fully carries out Congressional permitted under section 13(f) of the under the final rule so long as: (1) The intent and the statutory purpose of BHC Act (including a permitted prime appropriately accommodating the brokerage transaction) between the 2465 See Fin. Services Roundtable (Feb. 3, 2012); business of insurance within an banking entity and covered fund to TIAA–CREF (Feb. 13, 2012); USAA; HSBC Life; insurance company.2472 Section section 23B of the FR Act.2475 In ACLI (Jan. 2012); NAMIC; Nationwide. general, section 23B of the FR Act 2466 See, e.g., Nationwide. 13(d)(1)(F) of the statute specifically 2467 See, e.g., ACLI (Jan. 2012); Fin. Services exempts general accounts of insurance requires that the transaction be on Roundtable (Feb. 3, 2012); USAA; Chamber (Feb. companies, and, as explained above in market terms or on terms at least as 2012); Country Fin. et al.; Mutual of Omaha; Part VI.A.7, separate accounts are favorable to the banking entity as a NAMIC; Nationwide; Rep. McCarthy et al. See also comparable transaction by the banking 156 Cong. Reg. S. 5896 (daily ed. July 15, 2010) managed and maintained on behalf of (statement of Sen. Merkley) (arguing that activities customers, an activity exempt under entity with an unaffiliated third party. of insurance companies ‘‘are heavily regulated by section 13(d)(1)(D) of the statute. By Section 75.16 of the proposed rule State insurance regulators, and in most cases do not their terms, these are statutory implemented these provisions.2476 pose the same level of risk as other proprietary trading’’). exemptions from the prohibitions in a. Scope of Application 2468 Some commenters urged the Agencies to section 13(a), which includes both the provide that an affiliate or subsidiary of an prohibition on proprietary trading and Section 13(f) of the BHC Act and the insurance company could purchase covered funds the prohibition on covered fund related provisions of the proposal were for the insurance company’s general account or a investments and sponsorship. Moreover, among the most commented upon separate account. See e.g., Fin. Services Roundtable aspects of the covered funds section. (Feb. 3, 2012); TIAA–CREF (Feb. 13, 2012). The the statutory language of sections Agencies note that the final rule provides (as does 13(d)(1)(D) and 13(d)(1)(F), both cross- The majority of commenters argued that the statute) an exemption that permits an insurance reference the instruments described in the broad definition of ‘‘covered fund’’ company or its affiliate to acquire and retain an under the proposal made the proposed ownership interest in a covered fund solely for the section 13(h)(4) and not activity insurance’s company general account (or one or described in section 13(h)(4). These implementation of section 13(f) more of its separate account); such an affiliate or instruments are ‘‘any security, any unworkable and disruptive to existing subsidiary also may be a wholly-owned subsidiary, derivative, any contract of sale of a market practices because it would as defined in the final rule. 2469 The final rule defines the terms ‘‘general commodity for future delivery, any 2473 See 12 U.S.C. 1851(b)(1)(F). See also 156 account’’ and ‘‘separate account’’ largely as option on any such security, derivative Cong. Reg. S. 5896 (daily ed. July 15, 2010) proposed, and includes the new defined term or contract or any other security or (statement of Sen. Merkley) (arguing that ‘‘section ‘‘insurance company,’’ defined as a company that financial instrument that [the Agencies 13 of the BHC Act] was never meant to affect the is organized as an insurance company, primarily ordinary business of insurance’’). and predominantly engaged in writing insurance or 2474 reinsuring risks underwritten by insurance 2470 See final rule § 75.13(c). 12 U.S.C. 371c. The Agencies note that this companies, subject to supervision as such by a state 2471 See 12 U.S.C. 1851(d)(1)(D), (F). does not alter the applicability of section 23A of the insurance regulator or a foreign insurance regulator, 2472 See 12 U.S.C. 1851(b)(1)(F). See also 156 FR Act and the Board’s Regulation W to covered and not operated for the purpose of evading the Cong. Reg. S. 5896 (daily ed. July 15, 2010) transactions between insured depository provisions of section 13 of the BHC Act. Cf. section (statement of Sen. Merkley) (arguing that ‘‘section institutions and their affiliates. 2(a)(17) of the Investment Company Act (defining 13 of the BHC Act] was never meant to affect the 2475 12 U.S.C. 371c–1. the term insurance company). ordinary business of insurance’’). 2476 See proposed rule § 75.16.

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prohibit corporate funding transactions to foreign funds.2483 These changes manager, or investment adviser with ordinary corporate entities that do substantially address the issues raised designee. In addition, the unaffiliated not engage in hedge fund or private by commenters regarding the party designated as sponsor, investment equity activities.2477 Commenters also applicability of section 13(f) of the BHC manager, or investment adviser would argued that activities that the proposal Act to foreign funds. be subject to the restrictions of section appeared to permit as a permitted Commenters also raised a number of 13(f) if the third party is a banking activity exemption (e.g., investments in other issues. For instance, some entity. public welfare funds) would be commenters argued that applying section 13(f) to securitization entities b. Transactions That Would Be a prohibited by the restrictions in ‘‘Covered Transaction’’ 13(f) 2478 and that the Agencies should would in some instances run counter to construe section 13(d)(1)(J) of the BHC the rule of construction contained in Section 13(f) of the BHC Act prohibits Act as allowing them to permit banking section 13(g)(2) regarding the sale and covered transactions as defined in entities to enter into covered securitization of loans.2484 These section 23A of the FR Act between a transactions with a covered fund, if commenters recommended that the final banking entity that serves as investment those activities would promote and rule, at a minimum, grandfather pre- manager, investment advisor or sponsor protect the safety and soundness of existing relationships between banking to a covered fund or that relies on the entities and existing securitization exemption in section 13(d)(1)(G) and a banking entities and the financial 2487 stability of the United States.2479 vehicles to reduce the potential effects covered fund. A number of However, many of the comments of the final rule on agreements and commenters contended that the discussed above and some of the positions entered into before the definition of ‘‘covered transaction’’ in 2485 economic burdens noted by these enactment of the statute. section 13(f) of the BHC Act should incorporate the exemptions available commenters have been addressed by One commenter argued that a banking under section 23A and the Board’s revisions discussed above in Part VI.B.1 entity that delegates its responsibility for acting as sponsor, investment Regulation W.2488 These commenters to the definition of covered fund.2480 A manager, or investment adviser to an alleged that the statute’s general number of these and related comments unaffiliated entity should no longer be reference to section 23A suggests that are also addressed by portions of the subject to the restrictions of section the term ‘‘covered transaction’’ should final rule that provide that the 13(f).2486 By its terms, section 13(f) of be construed in light of section 23A as prohibitions of section 13 do not apply the BHC Act applies to a banking entity a whole, including the exemptions in to interests acquired, for example, as that, directly or indirectly, serves as subsection (d) of that Act and as agent, broker, custodian, in satisfaction investment manager, investment implemented in the Board’s Regulation of a debt previously contracted, through adviser, or sponsor to a covered fund (or W.2489 These commenters also argued a pension fund, or as trustee or fiduciary that relies on section 13(d)(1)(G) of the that the Board’s authority to interpret (all within the limits defined in the final BHC Act in connection with organizing and issue rules pursuant to section 23A rule). and offering a covered fund). The of the FR Act and section 5(b) of the Several commenters argued that Agencies believe that a banking entity BHC Act, the general rule-making applying the restrictions in section 13(f) that delegates its responsibility to act as authority contained in section 13(b) of to foreign activities of foreign banking sponsor, investment manager, or the BHC Act, and the exemptive entities would be inconsistent with the investment adviser to an unaffiliated authority in section 13(d)(1)(J) all presumption against extraterritorial party would still be subject to the application of U.S. law and principles of limitations of section 13(f) if the 2487 The term ‘‘covered transaction’’ is defined in international comity, including banking entity retains the ability to section 23A of the FR Act to mean, with respect to an affiliate of a member bank: (i) A loan or deference to home-country select, remove, direct, or otherwise exert extension of credit to the affiliate, including a regulation.2481 For example, one control over the sponsor, investment purchase of assets subject to an agreement to commenter expressed concern that rules repurchase; (ii) a purchase of or an investment in securities issued by the affiliate; (iii) a purchase of being developed around custody 2483 See final rule § 75.10(b)(1)(ii) and (c)(1). See assets from the affiliate, except such purchase of supra Part VI.B.1. obligations in the European Union may real and personal property as may be specifically 2484 require a prime broker or custodian to Section 75.11(b) of the final rule provides exempted by the Board by order or regulation; (iv) that for purposes of securitizations, organizing and the acceptance of securities or other debt indirectly guarantee assets of a fund, offering includes acting as the securitizer. As which would directly conflict with the obligations issued by the affiliate as collateral discussed in greater detail above in Part VI.B.2.b, security for a loan or extension of credit to any prohibition on guarantees in section a banking entity that continues to hold interests in person or company; (v) the issuance of a guarantee, 13(f) of the BHC Act.2482 As explained a securitization in reliance on this exemption must acceptance, or letter of credit, including an above, the final rule has been modified comply with certain requirements, including the endorsement or standby letter of credit, on behalf requirements of § 75.14. Accordingly, § 75.14 of the of an affiliate; (vi) a transaction with an affiliate that to more narrowly focus the scope of the final rule has also been modified from the proposal involves the borrowing or lending of securities, to definition of covered fund as it applies to prohibit a banking entity that continues to hold the extent that the transaction causes a member an ownership interest in accordance with bank or subsidiary to have credit exposure to the § 75.11(b), and its affiliates, from entering into a 2477 See, e.g., Allen & Overy (on behalf of Foreign affiliate; or (vii) a derivative transaction, as defined covered transaction with a covered fund, subject to in paragraph (3) of section 5200(b) of the Revised Bank Group); BoA; Barclays; Credit Suisse certain exceptions. Statutes of the United States (12 U.S.C. 84(b)), with (Williams); Deutsche Bank (Fund-Linked Products); 2485 See AFME et al.: ASF (Feb. 2012); Ashurst; an affiliate, to the extent that the transaction causes GE (Feb. 2012); Goldman Sachs (Covered Funds); BoA; Barclays; Cadwalader (Municipal Securities); a member bank or a subsidiary to have credit ICI Global; ISDA (Feb. 2012); RMA; SIFMA et al. Credit Suisse (Williams); Commercial Real Estate exposure to the affiliate. See 12 U.S.C. 371c(b)(7), (Covered Funds) (Feb. 2012). Fin. Council; Deutsche Bank (Fund-Linked as amended by section 608 of the Dodd-Frank Act. 2478 See SunTrust; AHIC; SBIA. Products); Fidelity; GE (Feb. 2012); Goldman Sachs 2488 See 12 U.S.C. 371c(d); 12 CFR 223.42; ABA 2479 See SIFMA et al. (Covered Funds) (Feb. (Covered Funds); ICI (Feb. 2012); IIB/EBF; ISDA (Keating); Ass’n. of Institutional Investors (Feb. 2012). (Feb. 2012); JPMC; PNC et al.; PNC; RBC; SIFMA 2012); BoA; BNY Mellon et al.; Credit Suisse 2480 See final rule § 75.10(b). See supra Part et al. (Covered Funds) (Feb. 2012); SIFMA (Williams); SIFMA et al. (Covered Funds) (Feb. VI.B.1. (Securitization) (Feb. 2012); Chamber (Feb. 2012). 2012); see also Allen & Overy (on behalf of Foreign 2481 See IIB/EBF; Katten (on behalf of Int’l These comments are addressed above in Part II Bank Group). Clients); EBF; EFAMA; French Banking Fed’n.; regarding availability of the conformance period 2489 See ABA (Keating); Ass’n. of Institutional Japanese Bankers Ass’n. provisions of section 13 of the BHC Act. Investors (Feb. 2012); BoA; BNY Mellon et al.; 2482 See AIMA. 2486 See Katten (on behalf of Int’l Clients). SIFMA et al. (Covered Funds) (Feb. 2012).

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provide a basis for providing such though these transactions are not within with third parties in an attempt to evade exemptions.2490 the definition of covered transaction for the restrictions on transactions with In particular, commenters argued that purposes of section 23A of the FR covered funds, and the Agencies will intraday extensions of credit; 2491 Act.2499 use their supervisory authority to transactions fully secured by cash or The final rule continues to apply the monitor and restrict transactions that U.S. government securities; 2492 same definition of covered transaction appear to be evasions of section 13(f). purchases of liquid assets and as the proposal. Section 13(f) refers to a c. Certain Transactions and marketable securities from covered covered transaction, as defined in Relationships Permitted funds; 2493 and riskless principal section 23A of the FR Act. Section 13(f) transactions with covered funds all of the BHC Act does not incorporate or While section 13(f)(1) of the BHC Act should be exempt from the restrictions reference the exemptions contained in generally prohibits a banking entity in section 13(f) of the BHC Act.2494 section 23A of the FR Act or the Board’s from entering into a transaction with a These commenters argued that Regulation W. Indeed, the exemptions related covered fund that would be a providing an exemption for intraday for these transactions are not included covered transaction as defined under extensions of credit in particular was in the definition of covered transactions section 23A of the FR Act, other specific necessary to allow a banking entity to in section 23A; the exemptions are portions of the statute permit a banking continue to provide affiliated covered instead in a different subsection of entity to engage in certain transactions funds with standard custody, clearing, section 23A and provide an exemption or relationships with such funds. and settlement services that include from only some (but not all) of the intra-day or overnight overdrafts 1. Permitted Investments and provisions of section 23A governing Ownerships Interests necessary to facilitate securities covered transactions.2500 Therefore, the settlement, contractual settlement, pre- final rule does not incorporate the The proposed rule permitted a determined income, or similar custody- exemptions in section 23A. banking entity to acquire or retain an related transactions. Some commenters Similarly, the final rule incorporates ownership interest in a covered fund in argued that transactions fully secured by the statutory restriction as written, accordance with the requirements of 2501 cash or U.S. government securities do which provides that a banking entity section 13. This was consistent with not expose banking entities to that serves in certain specified roles the text of section 13(f), which by its inappropriate risks, are permitted in may not enter into a transaction with a terms is triggered by the presence of unlimited amounts under section 23A, covered fund that would be a covered certain ownership interests. This view and should not be entirely prohibited transaction as defined in section 23A of also resolved an apparent conflict 2495 under the rule. A few commenters the FR Act as if the banking entity were between the text of section 13(f) and the argued that the proposal would prohibit a member bank and the covered fund reference in section 13(f) prohibiting securities lending transactions and were an affiliate thereof. There are covered transactions under section 23A argued that borrower default certain occasions when the restrictions of the FR Act, which includes acquiring indemnifications by a banking entity in of section 23A apply to transactions that or retaining an interest in securities agency securities lending arrangements involve a third party other than an issued by an affiliate. should not be prohibited under section affiliate of a member bank. For example, Several commenters supported this 2496 2502 13(f). Some commenters argued that section 23A would apply to an aspect of the proposal. There is no a banking entity should be allowed to extension of credit by a member bank to evidence that Congress intended section accept the shares of a sponsored covered a customer where the extension of credit 13(f)(1) of the BHC Act to override the fund as collateral for a loan to any is secured by shares of an affiliate. The other provisions of section 13 with person or entity, in particular where the Agencies believe that these transactions regard to the acquisition or retention of loan is not for the purpose of purchasing between a banking entity and a third ownership interests specifically interests in the covered fund.2497 permitted by the section. Moreover, a One commenter argued that no party that is not a covered fund are not covered by the terms of section 13(f), contrary reading would make these exceptions should be granted to the more specific sections that permit definition of covered transaction, and which (as discussed above) make specific reference to transactions by the covered transactions between a banking financing of covered funds would relate entity and a covered fund mere to greater fund risk.2498 In addition, that banking entity with the covered fund. A contrary reading would prohibit surplusage. Therefore, the final rule commenter contended that the Agencies adopts this provision as proposed.2503 should prohibit a sale of securities by a securities margin lending, which banking entity to a covered fund even Congress has specifically addressed 2. Prime Brokerage Transactions (and permitted) in other statutes. There Section 13(f) provides an exception 2490 is no indication in the legislative history See BNY Mellon et al.; SIFMA et al. (Covered from the prohibition on covered that Congress intended section 13(f) to Funds) (Feb. 2012); see also Credit Suisse transactions with a covered fund for any (Williams). prohibit margin lending that occurs in 2491 prime brokerage transaction with a See ABA (Keating); AFG; Ass’n. of accordance with other specific statutes. covered fund in which a covered fund Institutional Investors (Feb. 2012); BoA; BNY Thus, section 13(f) does not prohibit a Mellon et al.; Credit Suisse (Williams); EFAMA; managed, sponsored, or advised by a banking entity from extending credit to French Treasury et al.; JPMC; IMA; RMA; SIFMA banking entity has taken an ownership et al. (Covered Funds) (Feb. 2012); State Street (Feb. a customer secured by shares of a interest (a ‘‘second-tier fund’’). 2012); SSgA (Feb. 2012); Vanguard. covered fund (as well as, perhaps, other 2492 See BoA; Credit Suisse (Williams); SIFMA et However, the statute does not define al. (Covered Funds) (Feb. 2012). securities) held in a margin account. 2493 See Credit Suisse (Williams). However, the Agencies expect banking 2501 See proposed rule § 75.16(a)(2)(i). 2494 See, e.g., Credit Suisse (Williams). entities not to structure transactions 2502 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2495 See BoA; Credit Suisse (Williams); SIFMA et 2012). al. (Covered Funds) (Feb. 2012). 2499 See 12 U.S.C. 371c(b)(7); see also 12 U.S.C. 2503 The final rule modifies the proposal to clarify 2496 See State Street (Feb. 2012); RMA. 371c–1(a)(2)(B) (including the sale of securities or that a banking entity may acquire and retain an 2497 See BoA; SIFMA et al. (Covered Funds) (Feb. other assets to an affiliate as a transaction subject ownership interest in a covered fund by express 2012); see also Katten (on behalf of Int’l Clients). to section 23B). reference to the permitted activities described in 2498 See Occupy. 2500 See 12 U.S.C. 371c(d). §§ 75.11, 75.12 and 75.13.

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prime brokerage transaction. The recommended that the definition of elsewhere in section 13). Within the proposed rule defined prime brokerage prime brokerage transaction expressly category of transactions prohibited by transaction to include providing one or include transactions in commodities, section 13(f), transactions within the more products or services, such as futures and foreign exchange, as well as definition of prime brokerage custody, clearance, securities borrowing securities, and transactions effected transaction are permitted. or lending services, trade execution, or through OTC derivatives, including, Some commenters argued that the financing, data, operational, and without limitation, contracts for Agencies should provide an exemption portfolio management support.2504 differences, various swaps and security- for prime brokerage transactions with a A few commenters argued that the based swaps, foreign exchange swaps broader array of funds than the proposal proposed definition of prime brokerage and forwards and ‘‘FX prime permitted. For instance, some transaction was overly broad and should brokerage’’.2509 commenters argued that the Agencies not permit securities lending or Based on review of the comments, the should permit a banking entity to enter borrowing services. These commenters definition of prime brokerage into a prime brokerage transaction with argued that securities lending and transaction has been modified in several any covered fund or fund structure that borrowing (and certain other services) ways. For purposes of the final rule, the banking entity organizes and offers could increase leverage by covered prime brokerage transaction is defined or for which it directly serves as funds and the risk that a banking entity to mean any transaction that would be investment manager, investment would bailout these funds.2505 a covered transaction, as defined in adviser, or sponsor, and should not Other commenters argued that the section 23A(b)(7) of the FR Act (12 limit the exception for prime brokerage proposed definition of prime brokerage U.S.C. 371c(b)(7)), that is provided in transactions to only a second-tier transaction was confusing because it connection with custody, clearance and covered fund.2511 Conversely, a few included transactions (such as data or settlement, securities borrowing or commenters argued that the prime portfolio management support) that lending services, trade execution, brokerage exemption should only were not ‘‘covered transactions’’ under financing, or data, operational, and permit a banking entity to provide these section 23A of the FR Act and thus not administrative support. The definition services to a third-party fund in order to prohibited as an initial matter by section of prime brokerage transaction under ensure that the provision of prime 13(f). These commenters argued that the final rule generally recognizes the brokerage services does not give rise to including otherwise permissible same relationships that were considered the same risks that section 13 was transactions within the definition of when defining prime brokerage designed more generally to limit.2512 prime brokerage transaction created transaction under the proposal,2510 The Agencies note that the statute by uncertainty about the permissibility of without certain of the modifications its terms does not restrict prime other transactions or services that are suggested by some commenters that are brokerage transactions generally. As not expressly covered transactions discussed above. The Agencies carefully noted above, section 13(f)(3)(A) of the under section 23A of the FR Act and considered comments received on the BHC Act provides that a banking entity thus not prohibited under section 13(f). definition of prime brokerage may enter into any prime brokerage One commenter proposed defining transaction. As noted above, certain transaction with a second-tier fund. The prime brokerage transaction as any commenters requested that various statute by its terms permits a banking ‘‘covered transaction’’ entered into by a types of transactions be included in or entity with a relationship to a covered banking entity with a covered fund ‘‘for omitted from the definition. The fund described in section 13(f) to engage purposes of custody, clearance, Agencies believe it appropriate to in prime brokerage transactions (that are securities borrowing or lending services, include within the definition of prime covered transactions) only with second- trade execution and settlement, brokerage transaction those transactions tier funds and does not extend to financing and related hedging, that the Agencies believe generally covered funds more generally. Neither intermediation, or a similar constitute the typical type of prime the statute nor the final rule limit purpose.’’ 2506 brokerage transactions provided in the covered transactions between a banking A few commenters supported market. Including this list of entity and a covered fund for which the expanding the definition of prime relationships provides clarity and banking entity does not serve as brokerage transaction to include any certainty for transactions that are investment manager, investment service or transaction ‘‘related to’’ a commonly considered to be prime adviser, or sponsor (as defined in specific list of permissible transactions. brokerage transactions. section 13 of the BHC Act) or have an For instance, one commenter argued The final rule incorporates within the interest in reliance on section that acting as agent in providing definition of prime brokerage 13(d)(1)(G) of the BHC Act. Under the contractual income and settlement transaction a reference to covered statute, the exemption for prime services and intraday and overnight transactions under section 23A(b)(7) of brokerage transactions is available only overdraft protection should expressly be the FR Act. This change aligns the final so long as certain enumerated 2513 included within the definition of prime rules with section 13(f) of the BHC Act conditions are satisfied. The brokerage transaction.2507 This and is designed to eliminate confusion conditions are that (i) the chief commenter also urged that borrower and provide certainty regarding both the executive officer (or equivalent officer) default indemnification should be breath of the prohibition on covered of the banking entity certifies in writing included as a prime brokerage transactions in section 13(f) and the annually that the banking entity does transaction to the extent it would be a scope of the exception for prime not, directly or indirectly, guarantee, covered transaction that is prohibited by brokerage transactions. Thus, a assume, or otherwise insure the section 13(f).2508 Another commenter transaction or relationship that is not a obligations or performance of the covered transaction under section 13(f) 2511 See RMA; Katten (on behalf of Int’l Clients); 2504 of the BHC Act is not prohibited in the See proposed rule § 75.10(b)(4). EFAMA; see also Hong Kong Inv. Funds Ass’n.; 2505 See, e.g., Occupy; Public Citizen. first instance (unless prohibited IMA; Union Asset. 2506 See SIFMA et al. (Mar. 2012). 2512 See Sens. Merkley & Levin (Feb. 2012); 2507 See RMA. 2509 See Katten (on behalf of Int’l Clients). Occupy. 2508 See RMA. 2510 See final rule § 75.10(d)(5). 2513 See 12 U.S.C. 1851(f)(3).

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covered fund or of any covered fund in this condition to a permissible prime definition of a covered fund under which such covered fund invests, and brokerage transaction in which a § 75.10. As noted above, commenters (ii) the Board has not determined that banking entity may engage under the requested that the Agencies clarify that such transaction is inconsistent with the proposal. the limitations in §§ 75.8 or 75.17 of the safe and sound operation and condition Commenters generally did not raise proposed rule apply only to a foreign of the banking entity. The proposed rule any issues regarding the proposal’s banking entity’s U.S. activities and incorporated each of these provisions. implementation of section 13(f)(2) and affiliates.2520 As discussed in greater The final rule provides that this 13(f)(3)(B). The final rule generally detail above in Part VI.B.1, the final rule certification be made to the appropriate implements these requirements in the has been modified to more narrowly Federal supervisor for the banking same manner as the proposal.2519 focus the scope of the definition of entity. covered fund as it applies to foreign 6. Section 75.15: Other Limitations on A few commenters argued that the funds. Pursuant to the definition of a Permitted Covered Fund Activities proposal did not adequately address covered fund in § 75.10(b)(1), a foreign how the CEO attestation requirement in Like § 75.8, § 75.17 of the proposed fund may be a covered fund with section 13(f) would apply to foreign rule implemented section 13(d)(2) of the respect to the U.S. banking entity that banking organizations. They argued that BHC Act, which places certain sponsors the fund, but not be a covered a senior officer with authority for the limitations on the permitted covered fund with respect to a foreign bank that U.S. operations of the foreign bank fund activities and investments in invests in the fund solely outside the should be permitted to make the which a banking entity may engage. United States. Foreign public funds, as required attestation.2514 Consistent with the statute and § 75.8 of defined in § 75.10(c)(1) of the final rule, The statute allows the attestation for the proposed rule, § 75.17 provided that are also excluded from the definition of purposes of the prime brokerage no transaction, class of transactions, or a covered fund. By excluding foreign exception in section 13(f) of the BHC activity was permissible under §§ 75.11 public funds from the definition of Act to be from the chief executive through 75.14 and § 75.16 of the covered fund and by narrowing the officer or ‘‘equivalent officer.’’ 2515 In proposed rule if the transaction, class of scope of the definition of a covered fund the case of the U.S. operations of foreign transactions, or activity would: (i) with respect to foreign funds, the banking entities, the senior officer of the Involve or result in a material conflict Agencies have addressed some foreign banking entity’s U.S. operations of interest between the banking entity commenters’ concerns regarding the or the chief executive officer of the U.S. and its clients, customers, or burdens imposed by proposed rule banking entity may provide the required counterparties; (ii) result, directly or § 75.17. attestation. indirectly, in a material exposure by the banking entity to a high-risk asset or a d. Restrictions on Transactions With high-risk trading strategy; or (iii) pose a C. Subpart D and Appendices A and B— Any Permitted Covered Fund threat to the safety and soundness of the Compliance Program, Reporting, and Sections 13(f)(2) and 13(f)(3)(B) of the banking entity or the financial stability Violations BHC Act apply section 23B of the FR of the United States. Subpart D of the proposed rule Act 2516 to certain transactions and Section 75.17 of the proposed rule implemented section 13(e)(1) of the investments between a banking entity defined ‘‘material conflict of interest,’’ BHC Act and required certain banking and a covered fund as if such banking ‘‘high-risk assets,’’ and ‘‘high-risk entities to develop and provide for the entity were a member bank and such trading strategies’’ for these purposes in continued administration of a program covered fund were an affiliate a fashion identical to the definitions of reasonably designed to ensure and thereof.2517 Section 23B provides that the same terms for purposes of § 75.8 of monitor compliance with the transactions between a member bank the proposed rule related to proprietary prohibitions and restrictions on and an affiliate must be on terms and trading. In the final rule, other than the activities and investments set forth in under circumstances, including credit permitted activities to which §§ 75.7 section 13 and the proposed rule.2521 standards, that are substantially the and 75.15 apply, §§ 75.7 and 75.15 are As explained in detail below, in same or at least as favorable to the also identical. Comments received on response to comments on the banking entity as those prevailing at the the definitions in these sections, as well compliance program requirements and time for comparable transactions with or as the treatment of these concepts under Appendix C (Minimum Standards for involving unaffiliated companies or, in the final rule, are described in detail in Programmatic Compliance) and to the absence of comparable transactions, Part VI.A.9 above. conform to modifications to other on terms and under circumstances, The Agencies also note that some sections of the proposed rule, the including credit standards, that in good concerns identified by commenters Agencies are adopting a variety of faith would be offered to, or would regarding the rule’s extraterritorial modifications to Subpart D of the apply to, non-affiliated companies.2518 application are addressed by proposed rule, which requires certain Mirroring the statute, the proposal modifications in the final rule to the banking entities to develop and provide applied this requirement to transactions for the continued administration of a between a banking entity that serves as 2519 See final rule § 75.14(b). As discussed above, program reasonably designed to ensure investment manager, investment § 75.11(b) of the final rule provides that for and monitor compliance with the purposes of securitizations, organizing and offering adviser, or sponsor to a covered fund prohibitions and restrictions on includes acting as the securitizer. A banking entity proprietary trading activities and and that fund and any other fund that continues to own interests in a securitization controlled by that fund. It also applied in reliance on this exemption must comply, among other things, with the requirements of § 75.14. 2520 See EBF; Ass’n. of German Banks. Accordingly, § 75.14(b) of the final rule has been 2521 For Commission registrants that are swap 2514 See proposed rule § 75.16(a)(2)(ii); IIB/EBF; modified to require that a banking entity that dealers and to which this rule applies, it is noted Credit Suisse (Williams). continues to hold an ownership interest in that the compliance requirements of subpart D are 2515 See 12 U.S.C. 1851(f)(3)(A)(ii). accordance with § 75.11(b) is subject to section 23B included in the Commission’s regulations that are 2516 12 U.S.C. 371c–1. of the Federal Reserve Act, as if such banking entity to be addressed as part of the chief compliance 2517 See proposed rule § 75.16(b). were a member bank and the covered fund were an officer duties and requirements under CFTC 2518 12 U.S.C. 371c–1(a); 12 CFR 223.51. affiliate. regulation 3.3.

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covered fund activities and investments program would be challenging to framework under the Basel accord. This set forth in section 13 of the BHC Act enforce or administer with any commenter argued such a framework and the final rule. As described above, consistency across different banking would increase transparency as well as this compliance program requirement entities and jurisdictions.2524 A few reduce overall complexity and costs of forms a key part of the multi-faceted commenters objected to any attempt to regulation, and that information approach to implementing section 13 of identify every possible instance of relevant to the compliance the BHC Act, and is intended to ensure prohibited proprietary trading in infrastructure, including customer that banking entities establish, maintain otherwise permitted activity.2525 By orientation policies and procedures, and enforce compliance procedures and contrast, some commenters supported target customer and product lists, trade controls to prevent violation or evasion the proposed compliance program as histories, and risk limit calibration of the prohibitions and restrictions on effective and consistent with the statute methodology and analyses, should all be proprietary trading activities and but also suggested a number of ways made available to examiners.2530 covered fund activities and investments. that the proposal’s compliance program Another commenter urged that the The proposal adopted a tiered could be improved.2526 compliance program could be generally approach to implementing the A few commenters argued that the improved by having a greater focus on compliance program mandate, requiring proposed compliance program should the compensation incentives within the a banking entity engaged in proprietary be replaced with a more principles- compliance program of banking trading activities or covered fund based framework that provides banking entities.2531 activities and investments to establish a entities the discretion and flexibility to A number of other commenters compliance program that contained customize compliance programs tailored requested certain types of banking specific elements and, if the banking to the structure and activities of their entities be specifically excluded from entity’s activities were significant, meet organizations.2527 A few commenters having to implement the requirements a number of more detailed minimum argued that building on compliance of the compliance program. For standards. If a banking entity did not regimes that already exist at banking example, some commenters urged that engage in proprietary trading activities entities, including risk limits, risk the details required in proposed and covered fund activities and management systems, board-level Appendix C apply only to those banking investments, it was required to ensure governance protocols, and the level at entities and business lines within a that its existing compliance policies and which compliance is monitored, would banking group that have ‘‘significant’’ procedures included measures that were reduce the costs and complexity of the covered funds or trading activities and designed to prevent the banking entity proposal while also enabling a robust not apply to an affiliate of a banking from becoming engaged in such compliance mechanism for section entity that does not engage in the types activities and making such investments 13.2528 of activities section 13 is designed to and to develop and provide for the Another commenter suggested that address (e.g., an industrial affiliate that required program under § 75.20(a) of the the focus of the compliance program be manufactures machinery).2532 One proposed rule prior to engaging in such on the key goal of reducing risk at commenter argued that the final rule activities or making such investments, banking entities by requiring each should not impose a compliance but was not otherwise required to meet banking entity to establish a risk program requirement on a banking the requirements of subpart D of the architecture that prescribes a customer- entity that owns 50 percent or less of proposed rule. focused business model for market another banking entity in order to making-related activities including a ensure the compliance program did not 1. Section 75.20: Compliance Program comprehensive set of risk limits that discourage joint ventures or other Mandate focuses on servicing customers and arrangements where a banking entity a. Program Requirement ensuring safety and soundness.2529 This does not have actual control over an A number of commenters argued that commenter suggested the proposal’s affiliate.2533 As discussed in Part the compliance program requirements of compliance requirements be replaced by VI.B.4.c. above,2534 other commenters the proposal were overly specific, too a simpler compliance framework that argued that the reporting and prescriptive and complex to be could be harmonized with the broader recordkeeping and compliance workable, and not justified by the costs systemic capital and risk management requirements of the rule should not and benefits of having a compliance apply to permitted insurance company 2524 program.2522 For instance, one See ABA (Abernathy); IIB/EBF; ICFR. While investment activities because insurance the Agencies recognize these issues, the Agencies companies are already subject to commenter expressed concern that the believe the final rule’s modifications to the complexity of the proposed compliance proposal—for example, providing for simplified comprehensive regulation of the kinds regime would undermine compliance programs for smaller, less active banking entities efforts because the requirements were and increasing the asset threshold that triggers 2530 See Citigroup (Feb. 2012). enhanced compliance requirements—helps balance 2531 overlapping, imprecise, and did not See Occupy. enforceability and consistency concerns with 2532 See, e.g., Credit Suisse (Williams); GE (Feb. provide sufficient clarity to traders or implementing a program that helps to ensure 2012); see also NAIB et al.; Chamber (Feb. 2012). compliance consistent with section 13(e)(1) of the banking entities as to what types or 2533 See GE (Feb. 2012). Under the BHC Act, an BHC Act. See 12 U.S.C. 1851(e)(1). levels of activities would be viewed as entity would generally be considered an affiliate of 2525 See, e.g., SIFMA et al. (Prop. Trading) (Feb. permissible trading.2523 Some a banking entity, and therefore a banking entity 2012); RBC; STANY; see also Barclays. itself, if it controls, is controlled by, or is under commenters argued that the compliance 2526 See AFR (Nov. 2012); Occupy; Sens. Merkley common control with an insured depository & Levin (Feb. 2012) institution. Pursuant to the BHC Act, a company 2522 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2527 See SIFMA et al. (Prop. Trading) (Feb. 2012); controls another company if, for instance, the 2012); Citigroup (Feb. 2012); Wells Fargo (Prop. Wells Fargo (Prop. Trading); see also M&T Bank; company directly or indirectly or acting through Trading); see also Barclays; BlackRock; Chamber Credit Suisse (Seidel); State Street (Feb. 2012); see one or more other persons owns, controls, or has (Dec. 2011); Comm. on Capital Markets Regulation; also NYSE Euronext; Stephen Roach. power to vote 25 per cent or more of any class of Credit Suisse (Williams); FIA; Goldman (Covered 2528 See Citigroup (Feb. 2012); SIFMA et al. (Prop. voting securities of the company. See 12 U.S.C. Funds); Investure; NYSE Euronext; RBC; STANY; Trading) (Feb. 2012); see also ABA (Abernathy); 1841(a)(2). The compliance program requirement Wedbush; see also Northern Trust; Chamber (Feb. Paul Volcker. applies to all banking entities in order to ensure 2012). 2529 See Citigroup (Feb. 2012); see also SIFMA et their compliance with the final rule. 2523 See Citigroup (Feb. 2012). al. (Prop. Trading) (Feb. 2012). 2534 See Part VI.B.4.c.

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and amounts of investments they can commenter argued that only U.S. After considering comments on the make under State or foreign insurance affiliates of foreign banking entities proposal, the final rule retains the laws and regulations.2535 However, engaged in proprietary trading and compliance program requirement with a another commenter suggested that covered fund activities as principal in variety of modifications. In particular, insurance company affiliates of banking the United States should be required to the modifications are designed to make entities expressly be made subject to institute the compliance and reporting the compliance program requirements data collection and reporting systems required in the proposal, and clearer and more tailored to the size, requirements to prevent possible that all foreign affiliates only be complexity and type of activity evasion of the restrictions of section 13 required to have policies and conducted by each banking entity.2550 and the final rule using their insurance procedures designed to prevent the The Agencies also believe that the affiliates.2536 banking entity from engaging in relevant revisions build on the limits, procedures A few commenters argued that trading and covered fund activities in and elements of risk management requiring securitization vehicles to the United States.2542 This commenter programs that many banking entities establish even the minimal also expressed concern that the have already developed to monitor and requirements set forth in § 75.20(d) reporting and recordkeeping control the risk of existing trading and would impose unnecessary costs and requirements could be interpreted to investment activities.2551 burdens on these entities.2537 By apply to an entire trading unit, even The final rule builds on the proposed contrast, another commenter argued trading activities with no U.S. nexus, if rule’s tiered approach by adjusting asset that, because of the perceived risks of any portion of a trading unit’s activities, thresholds and by adding a new these entities, securitization vehicles even a single trade, would be required provision allowing a banking entity related to a banking entity should be to rely on the market-making, hedging, with modest covered activities to required to comply fully with the underwriting or U.S. government customize its compliance program. proposed rule regardless of how such security exemptions.2543 Specifically, the final rule allows compliance procedures are funded by Commenters also offered thoughts on banking entities with total assets below 2538 the banking entity. the timeframe within which banking $10 billion to fold compliance measures Several commenters urged that entities must establish a compliance into their existing compliance program foreign activities of foreign banking program. One commenter urged that in a manner that addresses the types entities, which are already subject to reporting begin immediately,2544 while and amounts of activities the entity 2552 their own prudential regulation under another commenter contended that the conducts. The proposal did not applicable home country regulation, be effective date provided banking entities contain such a provision. Similar to the excluded from the compliance program with sufficient time to implement the proposal, the final rule requires that a and argued that to do otherwise would proposal’s compliance program.2545 banking entity that conducts no activity be an extraterritorial expansion of U.S. Other commenters, however, argued subject to section 13 of the BHC Act is law.2539 These commenters contended that banking entities should have not required to develop any compliance that the compliance program additional time to establish compliance program until it begins conducting requirements for foreign banking 2553 programs.2546 Some commenters argued activities subject to section 13. The entities should, in any event, be banking entities should have one-year final rule further modifies the proposal narrowly circumscribed.2540 One from the date of publication of the final by requiring that a banking entity with commenter proposed that the foreign rule to implement their compliance total assets greater than $10 billion but activity of foreign banking entities be less than $50 billion is generally programs,2547 while others urged that excluded from compliance, reporting required to establish a compliance banking entities have a two-year period and other obligations where the risk of program suited to its activities which to build compliance systems.2548 One the activity is outside of the United includes the six elements described in commenter suggested the Board amend States because those risks do not pose the final rule.2554 Additionally, the final a threat to U.S. taxpayers.2541 Another its conformance rule to provide U.S. banking entities with an additional year 2550 The Agencies believe these modifications, 2535 See, e.g., ACLI (Jan. 2012); Country Fin. et al.; for implementing the compliance such as increasing the threshold that triggers NAMIC. requirements with respect to their enhanced compliance standards and allowing 2536 See Sens. Merkley & Levin (Feb. 2012). As foreign operations.2549 smaller banking entities to customize their noted above, the compliance program requirement compliance programs, help address concerns that the proposed requirement was too complex and applies to all banking entities, including insurance 2542 See IIB/EBF. unworkable. See, e.g., SIFMA et al. (Prop. Trading) companies that are considered banking entities, in 2543 order to ensure their compliance with the final rule. See IIB/EBF. (Feb. 2012); Citigroup (Feb. 2012); Wells Fargo 2544 2537 See ASF (Feb. 2012); AFME et al.; SIFMA See Occupy. (Prop. Trading). (Securitization) (Feb. 2012); Commercial Real Estate 2545 See Alfred Brock. 2551 Some commenters argued that the Fin. Council. 2546 See Wells Fargo (Prop. Trading); PNC et al.; requirement should build on banking entities’ 2538 See Occupy. Australian Bankers Ass’n. (Feb. 2012); SIFMA et al. existing compliance regimes. See Citigroup (Feb. 2539 See, e.g., Socie´te´ Ge´ne´rale; IIB/EBF; (Prop. Trading) (Feb. 2012); ABA (Keating); AFME 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); see Australian Bankers Ass’n. (Feb. 2012); Banco de et al.; BoA; Barclays; SIFMA et al. (Covered Funds) also ABA (Abernathy); Paul Volcker. Me´xico; Norinchukin; Cadwalader (on behalf of (Feb. 2012); SIFMA et al. (Mar. 2012); Comm. on 2552 See final rule § 75.20(f)(2). Thai Banks); Cadwalader (on behalf of Singapore Capital Markets Regulation; Credit Suisse 2553 See final rule § 75.20(f)(1). In response to a Banks); Allen & Overy (on behalf of Canadian (Williams); T. Rowe Price; see also Citigroup (Feb. few commenters, the final rule, unlike § 75.20(d) of Banks); BAROC; Comm. on Capital Markets 2012); Socie´te´ Ge´ne´rale; IIB/EBF; Am. Express; the proposed rule, no longer requires a banking Regulation; Credit Suisse (Williams); EFAMA; Hong Arnold & Porter; BDA (Mar. 2012). entity include measures that are designed to Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten 2547 See Wells Fargo (Prop. Trading); PNC et al.; prevent such entity from becoming engaged in (on behalf of Int’l Clients); Ass’n. of Banks in Australian Bankers Ass’n. (Feb. 2012); BoA; covered trading activities or covered fund Malaysia; RBC; Sumitomo Trust; see also AFME et Barclays; SIFMA et al. (Covered Funds) (Feb. 2012); investments and activities. al.; British Bankers’ Ass’n.; EBF; Commissioner SIFMA et al. (Mar. 2012); Credit Suisse (Seidel); see 2554 Under the proposal, each banking entity was Barnier; French Banking Fed’n.; UBS; Union Asset. also BDA (Mar. 2012). required to have a compliance program that 2540 See, e.g., AFME et al.; IIB/EBF; BaFin/ 2548 See SIFMA et al. (Prop. Trading) (Feb. 2012); addressed the elements described in the rule, unless Deutsche Bundesbank; Credit Suisse (Williams); ABA (Keating); AFME et al.; GE; Credit Suisse the banking entity did not engage in prohibited HSBC. (Williams); Goldman (Prop. Trading); Morgan activities or investments, in which case it need only 2541 See Australian Bankers Ass’n. (Feb. 2012); Stanley; RBC; SVB. have existing policies and procedures requiring the see also RBC. 2549 See Morgan Stanley. banking entity to develop a compliance program

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rule requires that the largest and most entity must establish and implement the requirements and limits in the other active banking entities, with total assets compliance program required for that provisions of the rule and, in particular, above $50 billion, or that are subject to entity under § 75.20. Under the final acknowledge the importance of trading the quantitative measurements rule, each banking entity must establish and hedging limits, appropriate setting, requirement due to the size of their the compliance program required for monitoring and management review of trading assets and liabilities, adopt an that entity under § 75.20 as soon as trading and hedging limits, strategies, enhanced compliance program that practicable and in no case later than the and activities and investments, addresses the six elements described in end of the conformance period.2557 The incentive compensation and other the rule plus a number of more detailed Agencies expect that during this period matters. requirements described in Appendix a banking entity will develop and The six elements specified in B.2555 implement the compliance program § 75.20(b) are: In response to commenters’ concerns requirements of the final rule as part of • Written policies and procedures regarding compliance program burdens its good-faith efforts to fully conform its reasonably designed to document, in connection with covered fund activities and investments to the describe, monitor and limit trading activities and investments, the final rule requirements of section 13 and the final activities and covered fund activities is further modified with respect to rule. As explained below in the and investments conducted by the thresholds for covered fund activities discussion of the enhanced minimum banking entity to ensure that all and investments. As noted above, this standards for compliance programs activities and investments that are and the other modifications are under Appendix B, the final rule also subject to section 13 of the BHC Act and designed to make the compliance requires larger and more active banking the rule comply with section 13 of the program requirement clearer and more entities to report certain data regarding BHC Act and the rule; 2559 tailored to the size, complexity and type their trading activities. These • A system of internal controls of activity conducted by each banking requirements have been phased-in to reasonably designed to monitor entity. The final rule, unlike the provide banking entities an opportunity compliance with section 13 of the BHC proposal, does not require a banking to develop the necessary systems to Act and the rule and to prevent the entity to adopt the enhanced capture and report the relevant data.2558 occurrence of activities or investments compliance program if the banking In addition, as explained below, the that are prohibited by section 13 of the entity, together with its affiliates and Agencies will consider, after a period to BHC Act and the rule; 2560 subsidiaries, invests in the aggregate gain experience with the data, revisiting • A management framework that more than $1 billion in covered funds these data collections to determine their clearly delineates responsibility and or if they sponsor or advise covered usefulness in monitoring the risk and accountability for compliance with funds, the average total assets of which types of activities conducted by banking section 13 of the BHC Act and the rule are equal to or greater than $1 billion. entities. and includes appropriate management Banking entities would look to the total b. Compliance Program Elements review of trading limits, strategies, asset thresholds discussed above, hedging activities, investments, instead of the amount of covered fund Section 75.20 of the final rule incentive compensation and other investments and activities, in specifies six elements that each matters identified in the rule or by determining whether they would be compliance program required under that management as requiring attention; 2561 subject to the enhanced compliance section must at a minimum contain. • Independent testing and audit of program requirements. The Agencies With some minor modifications, these the effectiveness of the compliance have also modified the compliance are the same six elements that were program conducted periodically by program reporting obligations of foreign included in the proposed rule. The qualified personnel of the banking banking entities with respect to their changes reflect modifications made in entity or by a qualified outside covered trading and covered fund party; 2562 activities that are conducted pursuant to 2557 As discussed in Part II., the Board is • extending the conformance period by one year. Training for trading personnel and the exemptions contained in §§ 75.6(e) managers, as well as other appropriate 2556 Extension of the conformance period will, among and 75.13(b). other things, provide banking entities with personnel, to effectively implement and The final rule also responds to additional time to establish the required compliance program. The Agencies believe the commenters’ concerns regarding the 2559 This requirement is substantially the same as extension of the conformance period, as well as the timeframe within which a banking the proposed written policies and procedures phased-in approach to implementing the enhanced requirement. See proposed rule § 75.20(b)(1). compliance program in Appendix B, address certain 2560 before engaging in such activities. Further, a commenters’ requests for additional time to This requirement is substantially the same as banking entity that has trading assets and liabilities establish a compliance program. See Wells Fargo the proposed internal controls requirement. See equal to or greater than $1 billion, or equal to 10% (Prop. Trading); PNC et al.; Australian Bankers proposed rule § 75.20(b)(2). or more of total assets, would have been subject to Ass’n. (Feb. 2012); SIFMA et al. (Prop. Trading) 2561 The final rule modifies the proposed additional standards under the proposed rule. See (Feb. 2012); ABA (Keating); AFME et al.; BoA; management framework requirement by adding that proposed rule § 75.20(a), (c), (d). Barclays; SIFMA et al. (Covered Funds) (Feb. 2012); the management framework element must include 2555 Because the Agencies have determined not to SIFMA et al. (Mar. 2012); Comm. on Capital appropriate management review of trading limits, retain proposed Appendix B in the final rule, Markets Regulation; Credit Suisse (Williams); T. strategies, hedging activities, incentive proposed Appendix C is now Appendix B under the Rowe Price; see also Citigroup (Feb. 2012); Socie´te´ compensation, and other matters. See final rule final rule. Ge´ne´rale; IIB/EBF; Am. Express; Arnold & Porter; § 75.20(b)(3). See also proposed rule § 75.20(b)(3). 2556 See, e.g., Socie´te´ Ge´ne´rale; IIB/EBF; BDA (Mar. 2012); Morgan Stanley. One commenter suggested that the compliance Australian Bankers Ass’n. (Feb. 2012); Banco de 2558 Commenters provided a wide range of program requirement have a greater focus on Me´xico; Norinchukin; Cadwalader (on behalf of feedback regarding the timeframe for establishing a compensation incentives. See Citigroup (Feb. 2012). Thai Banks); Cadwalader (on behalf of Singapore compliance program, from requesting that reporting 2562 The final rule modifies the proposed Banks); Allen & Overy (on behalf of Canadian begin immediately to requesting two years from the independent testing requirement by specifying that Banks); BAROC; Comm. on Capital Markets date of publication of the final rule. See, e.g., such testing must be done ‘‘periodically.’’ See final Regulation; Credit Suisse (Williams); EFAMA; Hong Occupy; Alfred Brock; Wells Fargo (Prop. Trading); rule § 75.20(b)(4). See also proposed rule Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 2012). § 75.20(b)(4). The meaning of ‘‘independent testing’’ (on behalf of Int’l Clients); Ass’n. of Banks in The Agencies believe that the final rule’s approach is discussed in more detail below in Part VI.C.2.e. Malaysia; RBC; Sumitomo Trust; see also AFME et appropriately balances the desire for effective The reference to ‘‘audit’’ does not mean that the al.; British Bankers’ Ass’n.; EBF; Commissioner regulation with requests for additional time to independent testing must be performed by a Barnier; French Banking Fed’n.; UBS; Union Asset. establish a compliance program. designated auditor, whether internal or external.

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enforce the compliance program; 2563 the requirements set forth in vehicle to third-party investors and and § 75.20(b).2566 convert it into a registered investment • Making and keeping records For a banking entity with more than company or SEC-regulated business sufficient to demonstrate compliance $10 billion in total consolidated assets, development company within the time with section 13 of the BHC Act and the the compliance program requires period specified in § 75.12(a)(2)(i)(B) of rule, which a banking entity must additional documentation with respect subpart C.2569 Furthermore, for any promptly provide to the relevant to funds. For example, the banking banking entity that is, or is controlled supervisory Agency upon request and entity is required to maintain records directly or indirectly by a banking entity retain for a period of no less than 5 that include documentation of that is, located in or organized under the years. exclusions or exemptions other than laws of the United States or of any State, Under the final rule, these six sections 3(c)(1) and 3(c)(7) of the if the aggregate amount of ownership elements must be part of the compliance Investment Company Act of 1940 relied interest in foreign public funds as program of each banking entity with on by each fund sponsored by the described in § 75.10(c)(1) of subpart C total consolidated assets greater than banking entity (including all owned by such banking entity $10 billion that engages in activities subsidiaries and affiliate) in (including ownership interests owned covered by section 13 of the BHC Act. determining that such fund is not a by any affiliate that is controlled As discussed above, the Agencies covered fund.2567 The banking entity is directly or indirectly by a banking entity have moved particular elements with also required to maintain, with respect that is located in or organized under the respect to the required compliance to each fund sponsored by the banking laws of the United States or of any State) program for the exemptions contained entity (including all subsidiaries and exceeds $50 million at the end of two in § 75.4(a), § 75.4(b), and § 75.5 into the affiliates) for which the banking entity or more consecutive calendar quarters, specific requirements of these relies on one or more of the exclusions beginning with the next succeeding exemptions. The Agencies believe this provided by §§ 75.10(c)(1), 75.10(c)(5), calendar quarter, such banking entity structure more effectively conveys that 75.10(c)(8), 75.10(c)(9), or 75.10(c)(10) must include in its compliance program satisfying the requirements of these of subpart C, documentation supporting documentation the value of the exemptions involves specific the banking entity’s determination that ownership interests owned by the compliance measures or, with respect to the fund is not a covered fund pursuant banking entity (and such affiliates) in underwriting and market making, a to one or more of those exclusions.2568 each foreign public fund and each customer-focused business model, as If the banking entity operates a seeding jurisdiction in which any such foreign requested by some commenters.2564 vehicle described in §§ 75.10(c)(12)(i) or public fund is organized. Such In addition to the generally required 75.10(c)(12)(iii) of subpart C that will calculation must be done at the end of compliance program elements specified become a registered investment each calendar quarter and must in § 75.20(b), a banking entity relying on company or SEC-regulated business continue until the banking entity’s any of these exemptions should employ development company, the compliance aggregate amount of ownership interests the specific compliance tools specified program must also include a written in foreign public funds is below $50 within the relevant section of this rule plan documenting the banking entity’s million for two consecutive calendar to facilitate compliance with the determination that the seeding vehicle quarters.2570 applicable exemption and should will become a registered investment c. Simplified Programs for Less Active appropriately tailor the required company or SEC-regulated business Banking Entities compliance program elements to the development company; the period of individual trading activities and time during which the vehicle will The proposed rule provided that the strategies of each trading desk on an operate as a seeding vehicle; and the six elements of the compliance program ongoing basis. By specifying particular banking entity’s plan to market the required by § 75.20 would apply to all compliance program-related banking entities engaged in covered requirements in the exemptions, the 2566 Some commenters requested a more principles-based framework that allows banking trading activities or covered fund Agencies have sought to provide entities to customize compliance programs to the activities and investments and that the additional guidance and clarity as to structure and activities of their organizations. See minimum detailed standards of how a compliance program should be SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Appendix C would apply to only those structured,2565 while at the same time Fargo (Prop. Trading); see also M&T Bank; Credit Suisse (Seidel); State Street (Feb. 2012); NYSE banking entities above specified providing the banking entity with Euronext; Stephen Roach. thresholds. The application of detailed sufficient discretion to consider the 2567 See final rule § 75.20(e)(1). As discussed minimum standards was intended to type, size, scope and complexity of its under § 75.10 regarding entities excluded from the reflect the heightened compliance risks activities and business structure in definition of covered fund, the Agencies recognize of significant covered trading and designing a compliance program to meet that the final rule’s definition of covered fund does not include certain pooled investment vehicles. The Agencies expect that the types of pooled investment 2569 See final rule § 75.20(e)(3). The rationale for 2563 The final rule retains the proposed training vehicles sponsored by the financial services this additional documentation requirement is requirement. See final rule § 75.20(b)(5). See also industry will continue to evolve, including in provided under the discussion regarding registered proposed rule § 75.20(b)(5). response to the final rule, and the Agencies will be investment companies and business development 2564 One of these commenters suggested the monitoring this evolution to determine whether companies in § 75.10. Agencies adopt a simpler compliance framework excluding these and other types of entities remains 2570 See final rule § 75.20(e)(4). The rationale for that could be harmonized with the Basel accord. appropriate. The Agencies will also monitor use of this additional documentation requirement is See Citigroup (Feb. 2012). The Agencies believe the the exclusions for attempts to evade the provided under the discussion regarding foreign final framework described above helps address requirements of section 13 and intend to use their public funds in § 75.10. For purposes of this concerns about streamlining the compliance authority where appropriate to prevent evasions of requirement, a U.S. branch, agency, or subsidiary of program requirement while meeting the statutory the rule. The Agencies are adopting this additional a foreign banking entity is located in the United requirement to issue regulations ‘‘in order to insure documentation requirement to facilitate such States; however, the foreign bank that operates or compliance’’ with section 13. 12 U.S.C. 1851(e)(1). monitoring activities. controls that branch, agency, or subsidiary is not 2565 One commenter stated that the proposed rule 2568 See final rule § 75.20(e)(2). The Agencies are considered to be located in the United States solely did not provide sufficient clarity as to what types adopting this additional documentation by virtue of operating or controlling the U.S. or levels of activities would be permissible. See requirement for the same reasons discussed above branch, agency, or subsidiary. See final rule Citigroup (Feb. 2012). with respect to § 75.20(e)(1). § 75.20(e)(5).

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significant covered fund activities and order to limit the implementation, required a banking entity to implement investments. operational or other burdens or the enhanced compliance program The proposed rule provided that a expenses associated with the under Appendix C if the banking entity banking entity with no covered compliance requirements for a banking engaged in covered activities and activities or investments could satisfy entity that engages in no covered investments and either: (i) Has, on a the requirements of § 75.20 if its existing activities or investments. The final rule consolidated basis, trading assets and compliance policies and procedures permits banking entities that have no liabilities the average gross sum of were amended to include measures that covered activities or investments (other which (on a worldwide consolidated were designed to prevent the banking than covered transactions in obligations basis), as measured as of the last day of entity from becoming engaged in such of or guaranteed by the United States or each of the four prior calendar quarters, activities or making such investments an agency of the United States and is equal to or greater than $1 billion or and required the banking entity to municipal securities) to satisfy the equals 10 percent or more of its total develop and provide for the required compliance program requirements by assets; or (ii) has, on a consolidated compliance program prior to engaging establishing the required compliance basis, aggregate investments in covered in covered activities or making covered program prior to becoming engaged in funds the average value of which (on a investments. such activities or making such worldwide consolidated basis), as Several commenters expressed investments. This eliminates the burden measured as of the last day of each of concern over the requirement in on banking entities that do not engage the four prior calendar quarters, is equal § 75.20(d) of the proposed rule that a in covered activities or investments. to or greater than $1 billion, or sponsors banking entity that did not engage in Similarly, § 75.20(f)(2) of the final rule and advises one or more covered funds any covered trading activities or covered provides that a banking entity with total the total assets of which are, as fund activities or investments must consolidated assets of $10 billion or less measured as of the last day of each of ensure that its existing compliance as measured on December 31 of the policies and procedures include the four prior calendar quarters, equal to previous two years that does engage in or greater than $1 billion. measures designed to prevent the covered activities and investments may In general, commenters argued that banking entity from becoming engaged satisfy the requirements of § 75.20 by in such activities and making such the activities and investments subject to 2571 including in its existing compliance investments. In particular, some policies and procedures references to section 13 are conducted by only a commenters expressed concern that the the requirements of section 13 and small number of the nation’s largest proposal would have a burdensome subpart D as appropriate given the financial firms and that the compliance impact on community banks and force activities, size, scope and complexity of program requirements should be community banks to hire specialists to 2577 the banking entity.2576 This could tailored to target these firms. Some amend their policies and procedures to include appropriate references to the commenters urged the Agencies to raise ensure compliance with section 13 and limits on trading activities permitted in substantially the proposed $1 billion the final regulations. These commenters reliance upon any of the exemptions threshold for trading assets and argued that a banking entity should not contained in § 75.4(a), § 75.4(b) or liabilities in § 75.20(c)(2) of the proposal be required to amend its compliance § 75.5. to $10 billion or higher due to the high policies and procedures and set up a costs of implementing the enhanced monitoring program if the banking d. Threshold for Application of compliance program. A few commenters entity does not engage in prohibited Enhanced Minimum Standards argued that even if the threshold were 2572 activities. Under the proposed rule, banking raised to $10 billion, an overwhelming A few commenters argued that the entities with significant covered trading percentage of trading assets and Agencies should more carefully activities or covered fund activities and liabilities in the banking industry consider the burden of the compliance investments were required to establish (approximately 98 percent) would still program on smaller institutions that an enhanced compliance program in remain subject to heightened engage in a modest level of permissible compliance requirements included in 2573 accordance with Appendix C, which trading or covered fund activity. Appendix C.2578 Some of these One commenter recommended that contained detailed compliance program requirements. The proposed rule commenters recommended the smaller banks be given the benefit of the threshold for trading assets for doubt regarding compliance.2574 For 2576 Some commenters asked the Agencies to compliance should be increased to no instance, one commenter recommended consider the burden of the compliance program less than $10 billion to mitigate the that banking entities with consolidated requirement on smaller institutions and costs and impact on regional banking recommended that small banks be given the benefit assets of $10 billion or less be permitted organizations that do not engage to engage in a limited amount of interest of the doubt regarding compliance. See Sens. Merkley & Levin (Feb. 2012); Conf. of State Bank proprietary trading subject to the rate swaps and certain other traditional Supervisors; Ryan Kamphuis; SVB. The Agencies prohibition of section 13. These banking activities without being decline to follow the approach suggested by another commenters argued that the compliance commenter to allow banking entities with assets of required to establish a compliance requirements of § 75.20(a)–(b) are 2575 $10 billion or less be permitted to engage in certain program. sufficient to ensure that regional The Agencies have considered limited activities without having to establish a compliance program. See ICBA. The Agencies banking organizations have appropriate carefully the comments received and, as believe that requiring a banking entity engaged in compliance programs.2579 One noted above, have modified the rule in covered trading or covered fund activity to establish a compliance program is a fundamental part of the commenter suggested the threshold for multi-faceted approach to implementing section 13 the enhanced compliance requirement 2571 See, e.g., ICBA; ABA (Keating); Conf. of State of the BHC Act, which requires the Agencies to Bank Supervisors; NAIB; Ryan Kamphuis; be increased to $50 billion in combined implement rules ‘‘to insure compliance with this Wisconsin Bankers Ass’n. section.’’ 12 U.S.C. 1851(e)(1). Further, the Agencies 2572 See, e.g., ICBA; ABA (Keating). believe that the final rule’s modification of the 2577 See, e.g., Sens. Merkley & Levin (Feb. 2012); 2573 See Sens. Merkley & Levin (Feb. 2012); Conf. proposal to allow banking entities with total assets PNC et al. of State Bank Supervisors; Ryan Kamphuis; SVB. under $10 billion to customize their compliance 2578 See ABA (Keating); M&T Bank; PNC et al. 2574 See Sens. Merkley & Levin (Feb. 2012). programs helps ease the burden of this requirement 2579 See PNC et al.; M&T Bank; see also ABA 2575 See ICBA. on smaller institutions. (Abernathy).

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trading assets and liabilities.2580 One that including these investments and Agencies believe that commenters’ commenter also argued that banking funds in the dollar thresholds that concerns about whether certain types of entities required to establish enhanced trigger the programmatic compliance covered fund investments or activities compliance programs should no longer requirements of Appendix C would (e.g., amounts or relationships held be required to do so if they fall below provide a disincentive to banking during the conformance period) are the threshold.2581 entities investing in or sponsoring these included for purposes of calculating the Commenters also offered a number of funds, a result inconsistent with enhanced compliance thresholds are suggestions for modifying the activity permitting these types of investments. addressed because under the final rule, that would be considered in meeting the Similarly, one commenter urged that the enhanced compliance thresholds are thresholds for determining which investments by a banking entity in, and based on total consolidated assets and compliance program requirements apply assets held by, loan securitizations not not the amount of covered fund to a banking entity. Several commenters be included in these thresholds because investments and activities. Similar to argued that certain types of trading these activities and investments are the proposed rule, which provided that assets or fund investments should not expressly excluded from coverage under a banking entity could be subject to the be included for purposes of determining the rule of construction contained in enhanced compliance program if the whether the relevant dollar threshold section 13(g)(2) of the BHC Act Agency deemed it appropriate, the final triggering the enhanced compliance was regarding the securitization of loans.2587 rule’s enhanced compliance program met, particularly those that are not Another commenter urged that this also could apply if the Agency notifies prohibited activities or investments. For threshold not include investments in, or the banking entity in writing that it instance, some commenters urged that assets of, any securitization vehicle that must satisfy the requirements.2590 trading in U.S. government obligations would be considered a covered fund Section 75.20 provides that three should not count toward the calculation because many smaller and regional categories of banking entities will be of whether a banking organization meets banking entities that were not intended subject to the enhanced minimum the trading threshold triggering to be subject to Appendix C likely standards contained in Appendix B. The Appendix C.2582 These commenters also would exceed the $1 billion threshold if first category is any banking entity that argued that other positions or these assets are included.2588 A few engages in proprietary trading and is transactions that do not involve commenters also argued that, during the required to report metrics regarding its financial instruments and that may conformance period, investments in, trading activities to its primary Federal constitute trading assets and liabilities, and relationships with, a covered fund supervisory agency under the final such as loans, should be excluded from that a banking entity is required to rule.2591 This category includes a the thresholds because exempt activities terminate or otherwise divest in order to banking entity that has, together with its should not determine the type of comply with section 13 should not be affiliates and subsidiaries, trading assets compliance program a banking entity included for purposes of calculating the and liabilities that equal or exceed $50 must implement.2583 One commenter compliance thresholds.2589 billion based on the average gross sum urged that foreign exchange swaps and After considering comments received of trading assets and liabilities (on a forwards be excluded from the on the proposal and in order to worldwide consolidated basis and after definition of a ‘‘derivative’’ and not be implement a compliance program excluding trading assets and liabilities subject to compliance requirements as a requirement that is consistent with the involving obligations of or guaranteed result.2584 Conversely, one commenter purpose and language of the statute and by the United States or any agency of urged that all assets and liabilities rule while at the same time the United States) over the previous defined as trading assets for purposes of appropriately calibrating the associated consecutive four quarters, as measured the Market Risk Capital Rule should be resource burden on banking entities, the as of the last day of each of the four included in the $1 billion standard for final rule applies the enhanced prior calendar quarters. A foreign becoming subject to any reporting and minimum standards contained in banking entity with U.S. operations is recordkeeping requirements under the Appendix B to only those banking required to adopt an enhanced final rule.2585 entities with the most significant compliance program if its total trading A few commenters argued that the $1 covered trading activities or those that assets and liabilities across all its U.S. billion threshold for establishing an meet a specified threshold of total operations equal or exceed $50 billion enhanced compliance program should consolidated assets. The final rule, (after excluding trading assets and not include the amount of investments unlike the proposal, does not require a liabilities involving obligations of or in, or assets of, funds that are SBICs or banking entity to adopt the enhanced guaranteed by the U.S. or any agency of similar funds that contain, SBICs or compliance program if the banking the U.S.). While these banking entities other investments specified under entity, together with its affiliates and will be required to begin to report and section 13(d)(1)(E) of the BHC Act, such subsidiaries, invest in the aggregate record quantitative measurements by as investments in and funds that qualify more than $1 billion in covered funds June 30, 2014, they will not be required for low-income housing tax credits, or or if they sponsor or advise covered to implement an enhanced compliance New Markets Tax Credits or that qualify funds, the average total assets of which program by this date. Instead, as for Federal historic tax credits or similar are equal to or greater than $1 billion. discussed above, a banking entity must state programs.2586 These commenters Banking entities would look to the total establish a compliance program as soon argued that each of these types of funds consolidated asset thresholds, instead of as practicable and in no event later than is expressly permitted by the statute and the amount of covered fund investments the end of the conformance period. As and activities, in determining whether explained more fully in Part VI.C.3., this 2580 See State Street (Feb. 2012). they would be subject to the enhanced category expands over time to include 2581 See ABA (Keating). compliance program requirements. The 2582 See PNC et al. 2590 See proposed rule § 75.20(c)(2)(iii); final rule 2583 See PNC et al. 2587 See PNC et al. § 75.20(c)(3). 2584 See Northern Trust. 2588 See ASF (Feb. 2012). 2591 Issues related to the threshold for reporting 2585 See Occupy. 2589 See PNC et al.; SIFMA et al. (Covered Funds) quantitative measurements are discussed in detail 2586 See ABA (Keating); PNC et al. (Feb. 2012). in Part VI.C.3., below.

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any banking entity with trading assets United States. This approach reduces writing that it must satisfy the and liabilities that equal or exceed $10 the burdens associated with the requirements and other standards billion (as measured in the manner enhanced minimum compliance contained in Appendix B. By retaining described above). For banking entities program on banking entities whose the flexibility to impose enhanced below the $50 billion threshold that trading operations consist primarily of compliance requirements on a given become subject to the quantitative trading U.S. government or agency banking entity upon specific notice to measurements requirement through the obligations, which are generally exempt the firm, the Agencies have the ability phased-in approach, they will not from the proprietary trading prohibition to apply additional standards to any become subject to the enhanced under § 75.6(a)(1)(i). While some banking entity with a mix, level, compliance program until the date they commenters argued that additional complexity or risk of activities that, in are required to comply with the assets or liabilities, such as the judgment of the relevant supervisory quantitative measurements requirement. securitizations or investments in SBICs, Agency, indicates that the firm should However, these banking entities will be should be excluded from the appropriately have in place an required to have a compliance program calculation,2595 the Agencies believe enhanced compliance program. that meets the requirements of § 75.20(b) that trading in other assets involves Some commenters argued that the by the end of the conformance period. more complex trading activity and final rule should not require a banking Thus, banking entities with between $25 warrants being included in the entity to establish the type of detailed billion and $50 billion trading assets threshold calculation for applying the compliance regime dictated by and liabilities (as described in enhanced compliance program Appendix C for both trading and § 75.20(d)) will be required to requirement. covered fund activities and investments implement an enhanced compliance To balance the increased trading asset simply because the banking entity program under Appendix B by April 30, and liability threshold with the goal of engages in one but not the other 2016. Similarly, banking entities with requiring appropriate specificity and activity.2597 between $10 billion and $25 billion rigor for large and complex banking To comply with the applicable trading assets and liabilities will be organizations’ compliance programs, the compliance program requirements subject to the requirements of Appendix Agencies have determined to also under § 75.20 and Appendix B of the B by December 31, 2016. require an enhanced compliance final rule, banking entities should After considering comments, the program for any banking entity that has appropriately take into account the type, Agencies have increased the trading reported total consolidated assets, as of size, scope and complexity of their asset and liability thresholds triggering the previous calendar year-end, of $50 activities and business structure in the enhanced compliance program billion or more. Banking entities with determining the terms, scope and detail requirements. The Agencies believe that total assets of $50 billion or more are of the compliance program to be banking entities with a significant among the most complex banking instituted.2598 For example, if all of a amount of trading assets should have entities and have been found by banking entity’s activities subject to the the most detailed programs for ensuring Congress to pose sufficient risk to the rule involve covered fund activities or compliance with the trading and other financial stability of the United States to investments, it would be expected that requirements of section 13 of the BHC warrant being generally subject to the banking entity would have an Act and the final rule. Specifically, enhanced prudential standards under appropriate compliance program consistent with the thresholds for section 165 of the Dodd-Frank Act. With governing those activities (including an reporting and recording quantitative respect to foreign banking entities, this enhanced compliance program if measurements, the threshold will threshold is calculated by reference applicable) and it would not be initially be $50 billion trading assets solely to the aggregate assets of the expected that the banking entity would and liabilities and, over time, will be foreign banking entity’s U.S. operations, construct the same detailed compliance reduced to $10 billion.2592 As noted by including its U.S. branches and program under the proprietary trading commenters, these thresholds will agencies. This approach is consistent provision of the rule. Similarly, if a continue to capture a significant with the statute’s focus on the risks banking entity engages only in activities percentage of the total trading assets and posed by covered trading activities and that are subject to the proprietary liabilities in the banking system, but investments within the United States trading provisions of the rule and does will reduce the burdens to smaller, less and also responds to commenters’ not engage in any covered fund complex banking entities.2593 With concerns regarding the level of burden activities or investments, it would not respect to this first category, the placed on foreign banking entities with be expected that the banking entity Agencies determined, in response to respect to their foreign operations.2596 would implement the same detailed comments,2594 that the threshold for The third category includes any compliance program under the covered proprietary trading should not include banking entity that is notified by its funds section as would be required for trading assets and liabilities involving primary Federal supervisory Agency in its proprietary trading activities. In each obligations of or guaranteed by the of these situations, the banking entity United States or any agency of the 2595 See, e.g., ABA (Keating) (suggesting the would be expected to put in place threshold should not include the amount of investments in or assets of SBICs, or those that sufficient controls to ensure that an 2592 Some commenters requested raising this qualify for low-income housing tax credits (LIHTC) appropriate compliance program is dollar threshold to at least $10 billion. See PNC et New Markets Tax Credits (NMTC), or Federal established before the banking entity al.; PNC; ABA (Keating). One commenter suggested historic tax credits (HTC)); PNC et al. (loans); commences a new covered activity. The the threshold be increased to $50 billion. See State Northern Trust. Street (Feb. 2012). 2596 Several commenters requested that foreign 2593 See PNC et al.; M&T Bank; see also ABA activities of foreign banking entities be excluded 2597 See, e.g., SIFMA et al. (Prop. Trading) (Feb. (Abernathy); ABA (Keating). The Agencies from the compliance program requirement. See, 2012). recognize that, at the $10 billion threshold, a e.g., Socie´te´ Ge´ne´rale; IIB/EBF; Australian Bankers 2598 This is generally consistent with the significant percentage of the trading assets and Ass’n. (Feb. 2012); Banco de Mexico; Norinchukin. proposed rule’s compliance program requirement. liabilities in the banking industry will remain One commenter stated the only U.S. affiliates of See proposed rule § 75.20(a) (requiring that the subject to the enhanced compliance program foreign banking entities should be required to banking entity’s compliance program be appropriate requirement. See PNC. institute the proposed reporting and compliance for the size, scope and complexity of activities and 2594 See PNC et al. requirements. See IIB/EBF. business structure of the banking entity).

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Agencies believe that this treatment is the requirements of section 13 of the enhanced minimum standards consistent with the statutory language BHC Act and the rule; contained in Appendix B to establish, regarding internal controls and • Subject the effectiveness of the maintain and enforce a compliance recordkeeping to ensure compliance compliance program to periodic program that includes written policies with section 13 and also reduces independent review and testing, and and procedures that are appropriate for unnecessary costs and burdens ensure that the entity’s internal audit, the types, size, and complexity of, and associated with requiring banking corporate compliance and internal risks associated with, its permitted entities to implement compliance control functions involved in review trading activities.2599 This portion of requirements that are not appropriate to and testing are effective and Appendix B requires a banking entity to the size, scope and risk of their relevant independent; devote adequate resources and use • activities. Make senior management, and knowledgeable personnel in conducting, others as appropriate, accountable for supervising and managing its covered 2. Appendix B: Enhanced Minimum the effective implementation of the trading activities, and to promote Standards for Compliance Programs compliance program, and ensure that consistency, independence and rigor in The proposed rule contained an the board of directors and CEO (or implementing its risk controls and appendix (Appendix C) which specified equivalent) of the banking entity review compliance efforts. The compliance a variety of minimum standards the effectiveness of the compliance program must be updated with a program; and frequency sufficient to account for applicable to the compliance program of • a banking entity with significant Facilitate supervision and changes in the activities of the banking covered trading activities or covered examination by the Agencies of the entity, results of independent testing of fund activities and investments. The banking entity’s covered trading and the program, identification of Agencies proposed to include these covered fund activities and investments. weaknesses in the program and changes The proposed rule included several minimum standards as part of the in legal, regulatory or other definitions within the appendix. In the regulation itself, rather than as requirements. final rule, all definitions have been accompanying guidance, reflecting the Similar to the proposed rule, section moved to other sections of the rule or compliance program’s importance II.a of Appendix B requires a banking into Appendix A (governing metrics). within the general implementation entity subject to the Appendix to: (i) Any banking entity subject to the framework for the rule. Have written policies and procedures enhanced minimum standards As explained above, the Agencies governing each trading desk that contained in Appendix B may continue to believe that the inclusion of include a description of certain incorporate existing policies, specified minimum standards for the information specific to each trading procedures and internal controls into compliance program within the desk that will delineate its processes, the compliance program required by regulation itself rather than as mission and strategy, risks, limits, types Appendix B to the extent that such accompanying guidance serves to of clients, customers and counterparties existing policies, procedures and reinforce the importance of the and its compensation arrangements; (ii) internal controls assist in satisfying the compliance program in the include a comprehensive description of requirements of Appendix B. implementation framework for section the risk management program for the Section II of Appendix B contains two trading activity of the banking entity, as 13 of the BHC Act. As explained above, parts: One that sets forth the enhanced well as a description of the governance, the Agencies believe that large banking minimum compliance program approval, reporting, escalation, review entities and banking entities engaged in standards applicable to covered trading and other processes that the banking significant trading activities should activities of a banking entity and one entity will use to reasonably ensure that establish, maintain and enforce an that sets forth the corresponding trading activity is conducted in enhanced compliance program. The enhanced minimum compliance compliance with section 13 of the BHC requirements for an enhanced program standards with respect to Act and subpart B; (iii) implement and compliance program have been covered fund activities and investments. enforce limits and internal controls for consolidated in Appendix B of the final As noted above, if all of a banking each trading desk that are reasonably rule. entity’s activities subject to the final designed to ensure that trading activity Similar to the proposed rule, section rule involve only covered trading is conducted in conformance with I of Appendix B provides that the activities (or only covered fund section 13 of the BHC Act and subpart enhanced compliance program must: activities and investments), it would be B and with the banking entity’s policies • Be reasonably designed to identify, expected that the banking entity would and procedures, and establish and document, monitor and report the have an appropriate compliance enforce risk limits appropriate for the covered trading and covered fund program governing those activities activity of each trading desk; and (iv) for activities and investments of the (including an enhanced compliance any hedging activities that are banking entity; identify, monitor and program if applicable) and it would not conducted in reliance on the exemption promptly address the risks of these be expected that the banking entity contained in § 75.5, establish, maintain covered activities and investments and would construct the same detailed and enforce policies and procedures potential areas of noncompliance; and compliance program under the covered regarding the use of risk-mitigating prevent activities or investments funds (or proprietary trading) provisions hedging instruments and strategies that prohibited by, or that do not comply of the rule. As discussed below, the describe the positions, techniques and with, section 13 of the BHC Act and the Agencies have determined not to strategies that each trading desk may rule; include the provisions regarding use, the manner in which the banking • Establish and enforce appropriate enterprise-wide compliance programs. entity will determine that the risks limits on the covered activities and generated by each trading desk have investments of the banking entity, a. Proprietary Trading Activities been properly and effectively hedged, including limits on the size, scope, Like the proposed compliance the level of the organization at which complexity, and risks of the individual appendix, section II.a of Appendix B activities or investments consistent with requires a banking entity subject to the 2599 See Joint Proposal, 76 FR at 68963.

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hedging activity and management will thresholds and trading measures for activity conducted within the United occur, the management in which such each trading desk and heightened States (absent an indication of activity hedging strategies will be monitored review of any trading activity that is conducted or designed to evade the and the personnel responsible for such inconsistent with those thresholds; and requirements of section 13 of the BHC monitoring, the risk management (iv) review, investigation and escalation Act of the final rule).2602 processes used to control unhedged or with respect to matters that suggest a In addition, the compliance program residual risks, and a description of the reasonable likelihood that a trading desk must describe the process for ensuring process for developing, documenting, has violated any part of section 13 of the that liquidity management activities are testing, approving and reviewing all BHC Act or the rule.2601 conducted in conformance with the hedging positions, techniques and Where a banking entity is subject to limits and policies contained in strategies permitted for each trading the reporting requirements of Appendix § 75.3(d)(3). This includes processes for desk and for the banking entity in A, any additional quantitative ensuring that liquidity management reliance on § 75.5. measurements developed and activities are not conducted for the To the extent that any of the standards implemented by the banking entity purpose of prohibited proprietary contained in Appendix B may be under the compliance program trading. appropriately met by policies and requirement are not required to be The banking entity’s compliance procedures, internal controls and other routinely submitted to the relevant program must be reasonably designed requirements that are common to more Agency as provided in Appendix A, but and established to effectively monitor than one trading desk, a banking entity are subject to the recordkeeping and identify for further analysis any may satisfy the requirements for the requirements set forth in subpart D, proprietary trading activity that may enhanced minimum standards of the including the requirement to promptly indicate potential violations of section compliance program by implementing produce such records to the relevant 13 of the BHC Act and subpart B and to such common requirements with Agency upon request. Where a banking prevent violations of section 13 of the respect to any such desks as to which entity is not subject to the requirements BHC Act and subpart B. The standards they are appropriately applicable.2600 of Appendix A, that banking entity set forth in subpart D direct the banking To the extent the required elements of would likewise not be required by this entity to include requirements in its the compliance program apply rule to routinely submit these additional compliance program for documenting differently to different trading desks that quantitative measurements to the remediation efforts, assessing the extent conduct trading in the same financial relevant Agency, but would be subject to which modification of the instruments, a banking entity must to the recordkeeping requirements set compliance program is warranted and document the differences and adopt forth in subpart D, including the providing prompt notification to policies and procedures and implement requirement to promptly produce such appropriate management and the board internal controls specific to each of the records to the relevant Agency upon of directors of material weakness or different trading desks. Overall, the request. significant deficiencies in the policies and procedures should provide In addition to the other requirements implementation of the compliance the Agencies with a clear, that are specific to proprietary trading, program. comprehensive picture of a banking the banking entity’s compliance program must identify the activities of b. Covered Fund Activities or entity’s covered trading activities that Investments can be effectively reviewed. each trading desk that will be conducted Appendix B also requires that the in reliance on the exemptions contained Section II.b of Appendix B requires a banking entity perform robust analysis in §§ 75.4 through 75.6, including an banking entity subject to the enhanced and quantitative measurement of its explanation of (i) how and where in the minimum standards contained in covered trading activities that is organization such activity occurs, and Appendix B to establish, maintain and reasonably designed to ensure that the (ii) which exemption is being relied on enforce a compliance program that trading activity of each trading desk is and how the activity meets the specific includes written policies and consistent with the banking entity’s requirements of such exemption. For procedures that are appropriate for the compliance program; monitor and assist trading activities that rely on an types, size, complexity and risks of the exemption contained in §§ 75.4 through in the identification of potential and covered fund and related activities 75.6, the banking entity’s compliance actual prohibited proprietary trading conducted and investments made, by program should include an explanation activity; and prevent the occurrence of the banking entity. of how, and its policies, procedures and prohibited proprietary trading. In The enhanced compliance program internal controls that demonstrate that, particular, the banking entity must requirements for covered funds and such trading activities satisfy such incorporate into its compliance program investments focus on: (i) Ensuring that exemption and any other requirements any quantitative measure reported by the compliance program provides a of section 13 of the BHC Act and the the banking entity pursuant to process for identifying all covered funds final rule that are applicable to such Appendix A where applicable, and that the banking entity sponsors, activities. A foreign banking entity that organizes or offers, and covered funds in include at a minimum: (i) Internal engages in proprietary trading in controls and written policies and which the banking entity invests; (ii) reliance on the exemption contained in ensuring that the compliance program procedures reasonably designed to § 75.6(e) will be expected to provide ensure the accuracy and integrity of the provides a method for identifying all information regarding the compliance funds and pools that the banking entity quantitative measures employed; (ii) program implemented to ensure ongoing timely monitoring and review sponsors or has an interest in and the compliance with the requirements of type of exemption from the Investment of calculated quantitative that section, including compliance by measurements; (iii) the establishment of Company Act or Commodity Exchange the U.S. operations of the foreign Act (whether or not the fund relies on banking firm, but will only be expected 2600 This is consistent with proposed Appendix C, section 3(c)(1) or 3(c)(7) of the except that the term ‘‘trading unit’’ from the to provide trading information regarding proposal has been replaced with the term ‘‘trading 2602 See AFME et al.; IIB/EBF; BaFin/Deutsche desk.’’ See Joint Proposal, 76 FR at 68965. 2601 See Joint Proposal, 76 FR at 68965. Bundesbank; Credit Suisse (Seidel); HSBC.

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Investment Company Act or section 4.7 regime would be essential to make the enterprise or designated business. If a of the regulations under the Commodity enterprise-wide compliance structures banking entity establishes an enterprise- Exchange Act), and the amount of contemplated in Appendix C effective wide program, like a non-enterprise ownership interest the banking entity because requiring individualized wide program, that program will be has in those funds or pools; (iii) policies and procedures for each subject to supervisory review and identifying, documenting, and mapping business line would diminish the examination by any Agency vested with where any covered fund activities are benefits of enterprise-wide compliance rule writing authority under section 13 permitted to be conducted within the and prevent consistency of these of the BHC Act with respect to the banking entity; and (iv) including an policies and procedures within the compliance program and the activities explanation of compliance; (v) banking entity.2603 One of these or investments of each banking entity describing sponsorship activities related commenters recommended the Agencies for which the Agency has such to covered funds; and (vi) establishing, provide greater options for developing a authority.2608 The banking organization maintaining and enforcing internal compliance program and not limit a would be expected to provide each controls that are reasonably designed to banking entity to a choice between a appropriate Agency with access to all ensure that its covered fund activities or single enterprise-wide program or a records related to the enterprise-wide investments comply with the separate program for each subsidiary compliance program pertaining to any requirements of section 13 of the BHC engaged in activities covered by the banking entity that is supervised by the Act and subpart C, and (vii) monitoring proposed rule.2604 Agency vested with such rule writing of the banking entity’s investments in In contrast, one commenter argued authority. and transactions with any covered that any enterprise-wide compliance For similar reasons, the Agencies have funds. program would only be effective if determined not to adopt some In addition, the banking entity’s combined with additional programs at commenters’ requests that a single compliance program must document the the trading unit or subsidiary level to agency be responsible for determining banking entity’s plan for seeking train all employees at a banking compliance with section 13.2609 At this unaffiliated investors to ensure that any entity.2605 This commenter argued that time the Agencies do not believe such investment by the banking entity in a each trading unit is different and an approach would be consistent with covered fund conforms to the limits suggested that it would be more efficient the statute, which requires each Agency contained in the final rule or that the to mandate enterprise-wide default to adopt a rule for the types of banking covered fund is registered in internal controls, but provide each entities under its jurisdiction,2610 or compliance with the securities laws individual trading unit the flexibility to effective given the different authorities within the conformance period tailor these requirements to its own and expertise of each Agency. The provided in the final rule. Similarly, the specific business.2606 This commenter Agencies expect to continue to compliance program must ensure that also urged that Appendix C’s elements coordinate their supervisory efforts the banking entity complies with any III (internal controls), IV (responsibility related to section 13 of the BHC Act and limits on transactions or relationships and accountability) and VII to share information as appropriate in with the covered fund contained in the (recordkeeping) should not be imposed order to effectively implement the final rule, including in situations in solely at the enterprise-wide level.2607 requirements of that section and the which the banking entity is designated After considering carefully the final rule.2611 as a sponsor, investment manager, comments on the proposal, the Agencies d. Responsibility and Accountability investment adviser or commodity have removed the reference to an trading adviser by another banking enterprise-wide compliance program Section III of Appendix B includes the entity. from the final rule; however, the enhanced minimum standards for The banking entity’s compliance Agencies acknowledge that a banking responsibility and accountability. program must be reasonably designed entity may establish a compliance Section III contains many of the and established to effectively monitor program on an enterprise-wide basis, as provisions contained in the proposed and identify for further analysis any long as the program satisfies the rule relating to responsibility and covered fund activity that may indicate accountability, with certain requirements of § 75.20 and, where 2612 potential violations of section 13 of the applicable, Appendix B. A banking modifications. Section III requires a BHC Act and subpart C. The standards entity may employ common policies banking entity to establish, maintain set forth in subpart D require the and procedures that are established at and enforce both a governance and banking entity to include requirements the enterprise-wide level or at a management framework to manage its in its compliance program for business-unit level to the extent that business and employees with a view to documenting remediation efforts, such policies and procedures are preventing violations of section 13 of assessing the extent to which appropriately applicable to more than the BHC Act and the rule. The standards modification of the compliance program one trading desk or activity, as long as in Section III focus on four key is warranted and providing prompt the required elements of Appendix B constituencies—the board of directors, notification to appropriate management and all of the other applicable 2608 and the board of directors of material compliance-related provisions of the See 12 U.S.C. 1851(b)(2)(B)(i). 2609 See Barclays; Goldman (Prop. Trading); BoA; weakness or significant deficiencies in rule are incorporated in the compliance the design or implementation of the SIFMA Funds et al. (Prop. Trading) (Feb. 2012); program and effectively administered Comm. on Capital Markets Regulation. compliance program. across trading desks and banking 2610 See 12 U.S.C. 1851(b)(2)(B). c. Enterprise-Wide Programs entities within the consolidated 2611 Accordingly, the SEC’s and the CFTC’s final rules, unlike the applicable proposals, do not Appendix C in the proposed rule incorporate by reference the rules and 2603 contained a provision that permitted a See SIFMA et al. (Prop. Trading) (Feb. 2012); interpretations of the Federal banking agencies with Wells Fargo (Prop. Trading). respect to covered fund activities or investments. banking entity to establish a compliance 2604 See Wells Fargo (Prop. Trading). See SEC proposed rule § 255.10(a)(2), Joint program on an enterprise-wide basis. 2605 See Occupy. Proposal, 76 FR at 68942–68943, and CFTC Some commenters argued that a less 2606 See Occupy. Proposal, 77 FR at 8421–8423. specific and more flexible compliance 2607 See Occupy. 2612 See Joint Proposal, 76 FR at 68966.

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the CEO, senior management, and CEO annually attest in writing to the required to meet the independent business line managers. Certain of the appropriate Agency for the banking testing requirement, the Agencies would standards contained in the proposed entity that the banking entity has in expect that, when external auditors are rule relating to business management place processes to establish, maintain, engaged to review compliance by a are separately covered by specific enforce, review, test and modify the banking entity with laws and requirements contained in sections II.a compliance program established regulations, the banking entity would and II.b of Appendix B. Section III pursuant to Appendix B and § 75.20 of give appropriate consideration to the makes it clear that the board of the rule in a manner reasonably need to review the compliance program directors, or similar corporate body, and designed to achieve compliance with required under this rule. the CEO and senior management are section 13 of the BHC Act and this rule. While one commenter suggested the responsible for creating an appropriate Although some commenters stated that final rule prescribe the precise manner ‘‘tone at the top’’ by setting an existing protocols of certain banking in which a banking entity must conduct appropriate culture of compliance and entities would establish appropriate its compliance testing,2619 the Agencies establishing clear policies regarding the oversight of the rule’s compliance believe such a requirement is management of the firm’s trading program,2617 the Agencies believe this unnecessary because the standards in activities and its fund activities and requirement will better help to ensure the final rule will ensure that investments. Senior management must that a strong governance framework is independent testing of the effectiveness be made responsible for communicating implemented with respect to of a banking entity’s compliance and reinforcing the culture of compliance with section 13 of the BHC program is objective and robust. The compliance established by it and the Act, and that it more directly independent testing must examine both board of directors, for the actual underscores the importance of CEO the banking entity’s compliance implementation and enforcement of the engagement in the governance and program and its actual compliance with approved compliance program, and for management framework supporting the rule. This testing must include not taking corrective action where compliance with the rule. In the case of only testing of the overall adequacy and appropriate. the U.S. operations of a foreign banking effectiveness of the compliance program In response to a question in the entity, including a U.S. branch or and compliance efforts, but also the preamble to the proposed rule regarding agency of a foreign banking entity, the effectiveness of each element of the whether the chief executive officer or attestation may be provided for the compliance program and the banking similar officer of a banking entity entire U.S. operations of the foreign entity’s compliance with each provision should be required to provide a banking entity by the senior of the rule. This requirement is intended certification regarding the compliance management officer of the U.S. to ensure that a banking entity program requirements, a few operations of the foreign banking entity continually reviews and assesses, in an commenters urged that the final rule who is located in the United States. objective manner, the strength of its should not require that the board of e. Independent Testing compliance efforts and promptly directors or CEO of a banking entity identifies and remedies any weaknesses review or certify the effectiveness of the Section IV of the Appendix B or matters requiring attention within the compliance program.2613 These includes the enhanced minimum compliance framework. commenters argued that existing standards for independent testing, processes developed by large, complex which are substantially similar to the f. Training banking entities for board of director proposed independent testing Like the proposed compliance reporting and governance processes standards.2618 A banking entity subject appendix, Section V of Appendix B ensure that compliance programs work to Appendix B must ensure that includes the enhanced minimum appropriately, and argued that these independent testing regarding the standards for training.2620 It requires protocols would establish appropriate effectiveness of the banking entity’s that a banking entity provide adequate management and board of directors’ compliance program is conducted by a training to its trading personnel and oversight of the section 13 compliance qualified independent party, such as the managers, as well as other appropriate program.2614 By contrast, several banking entity’s internal audit personnel, in order to effectively commenters advocated requiring CEO department, compliance personnel or implement and enforce the compliance attestation regarding compliance with risk managers independent of the program. In particular, personnel section 13.2615 One commenter trading desk or other organizational unit engaged in covered trading activities suggested that the rule require an being tested, outside auditors, and investments should be educated annual assessment by management of consultants, or other qualified with respect to applicable prohibitions the effectiveness of internal controls and independent parties. If a banking entity and restrictions, exemptions, and policies and require a public accounting uses internal personnel to conduct the compliance program elements to an firm to attest to the accuracy of those independent testing, the Agencies extent sufficient to permit them to make annual assessments.2616 would expect that the banking entity informed, day-to-day decisions that After considering comments received ensure that the personnel responsible on the proposal, the Agencies have for the testing are separate from the unit 2619 One commenter suggested that any determined to include a requirement in and functions being tested (e.g., the compliance testing under the final rule be the final rule that a banking entity’s personnel do not report to a person who monitored by the Agencies and initially tested by internal audit personnel of the banking entity who is directly responsible for the unit or are subject to a specific licensing and registration 2613 See SIFMA et al. (Prop. Trading) (Feb. 2012); involved in the functions being tested) process for section 13 of the BHC Act and Wells Fargo (Prop. Trading). and have knowledge of the requirements supplemented by an annual independent external 2614 See SIFMA et al. (Prop. Trading); see also of section 13 and its implementing review. See Occupy; see also proposed rule Wells Fargo (Prop. Trading). § 75.20(b)(4). The Agencies believe it would be 2615 See Occupy; AFR et al. (Feb. 2012); Sens. rules. Although an external audit is not unnecessarily burdensome to require particular Merkley & Levin (Feb. 2012); Public Citizen; Ralph licensing and registration processes for internal Saul (Oct. 2011); John Reed; see also BEC et al. (Oct. 2617 See SIFMA et al. (Prop. Trading) (Feb. 2012); auditors that are specific to section 13 of the BHC 2011); Matthew Richardson. see also Wells Fargo (Prop. Trading). Act. 2616 See Merkley & Levin (Feb. 2012). 2618 See Joint Proposal, 76 FR at 68967. 2620 See Joint Proposal, 76 FR at 68967.

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support the banking entity’s compliance records for a longer period if entities with smaller amounts of trading with section 13 of the BHC Act and the appropriate. activity, as it appeared that the more rule. In particular, any personnel with limited benefits of applying these 3. Section 75.20(d) and Appendix A: discretionary authority to trade, in any requirements to such banking entities, Reporting and Recordkeeping amount, should be appropriately trained whose trading activities are typically Requirements Applicable to Trading regarding the differentiation of Activities small, less complex, and easier to prohibited proprietary trading and supervise, would not justify the burden permitted trading activities and given Section 75.7 of the proposed rule, associated with complying with the detailed guidance regarding what types which the Agencies proposed to reporting and recordkeeping of trading activities are prohibited. implement in part section 13(e)(1) of the requirements. Similarly, personnel providing BHC Act,2623 required certain banking investment management or advisory entities to comply with the reporting a. Approach to Reporting and services, or acting as general partner, and recordkeeping requirements Recordkeeping Requirements Under the managing member, or trustee of a specified in Appendix A of the Proposal proposed rule. In addition, § 75.7 covered fund, should be appropriately The proposal explained that the required banking entities to comply trained regarding what covered fund reporting and recordkeeping with the recordkeeping requirements in activities and investments are permitted requirements of § 75.7 and Appendix A § 75.20 of the proposed rule, related to and prohibited. of the proposed rule were an important the banking entity’s compliance g. Recordkeeping program,2624 as well as any other part of the proposed rule’s multi-faceted Section VI of Appendix B contains the reporting or recordkeeping requirements approach to implementing the enhanced minimum standards for that the relevant Agency may impose to prohibition on proprietary trading. recordkeeping which are consistent evaluate the banking entity’s These requirements were intended, in with the proposed recordkeeping compliance with the proposed rule.2625 particular, to address some of the standards.2621 Generally, a banking Proposed Appendix A required a difficulties associated with (i) entity must create records sufficient to banking entity with significant trading identifying permitted market making- demonstrate compliance and support activities to furnish periodic reports to related activities and distinguishing the operation and effectiveness of its the relevant Agency regarding various such activities from prohibited compliance program (i.e., records quantitative measurements of its trading proprietary trading, and (ii) identifying demonstrating the banking entity’s activities and create and retain records certain trading activities resulting in compliance with the requirements of documenting the preparation and material exposure to high-risk assets or section 13 of the BHC Act and the rule, content of these reports. The high-risk trading strategies. To do so, any scrutiny or investigation by measurements varied depending on the the proposed rule required certain compliance personnel or risk managers, scope, type, and size of trading banking entities to calculate and report and any remedies taken in the event of activities. In addition, proposed detailed quantitative measurements of a violation or non-compliance), and Appendix B contained a detailed their trading activity, by trading unit. retain these records for no less than five commentary regarding the These measurements were meant to years in a form that allows the banking characteristics of permitted market help banking entities and the Agencies entity to promptly produce these making-related activities and how such in assessing whether such trading records to any relevant Agency upon activities may be distinguished from activity is consistent with permitted request. Records created and retained trading activities that, even if conducted trading activities in scope, type and under the compliance program must in the context of a banking entity’s profile. The quantitative measurements include trading records of the trading market-making operations, would required to be reported under the units, including trades and positions of constitute prohibited proprietary proposed rule were generally designed each such unit. Records created and trading.2626 Under the proposal, a to reflect, and to provide meaningful retained under the enhanced banking entity was required to comply information regarding, certain compliance program must also include with proposed Appendix A’s reporting characteristics of trading activities that documentation of any exemption in the and recordkeeping requirements only if appear to be particularly useful in final rule relied on by the banking entity it had, together with its affiliates and differentiating permitted market to invest in or sponsor a covered fund. subsidiaries, trading assets and making-related activities from While one commenter requested that liabilities the average gross sum of prohibited proprietary trading. For the period for retaining records be which (on a worldwide consolidated example, the proposed quantitative extended from 5 years to 6 years, the basis) was, as measured as of the last measurements measured the size and final rule does not make this change.2622 day of each of the four prior calendar type of revenues generated, and the The Agencies believe that 5 years is an quarters, equal to or greater than $1 types of risks taken, by a trading unit. appropriate minimum period for billion.2627 The Agencies did not Each of these measurements appeared to requiring retention of records to propose to extend the reporting and be useful in assessing whether a trading demonstrate compliance with the final recordkeeping requirements to banking unit was (i) engaged in permitted market rule. The final rule allows the Agencies making-related activity or (ii) materially to require a banking entity to retain 2623 Section 13(e)(1) of the BHC Act requires the exposed to high-risk assets or high-risk Agencies to issue regulations regarding internal trading strategies. Similarly, the controls and recordkeeping to ensure compliance 2621 See Joint Proposal, 76 FR at 68967. with section 13. See 12 U.S.C. 1851(e)(1). Section proposed quantitative measurements 2622 One commenter specifically urged that 75.20 and Appendix C of the proposed rule also also measured how much revenue was records for any type of compliance program be implemented section 13(e)(1) of the BHC Act. required to be kept on all hedges, rather than only generated per such unit of risk, the 2624 SUPPLEMENTARY those placed at a different level or trading unit as See Part III.D. of this volatility of a trading unit’s profitability, under the proposal, and that the retention period INFORMATION. and the extent to which a trading unit 2625 See proposed rule § 75.7. for all compliance records be changed from 5 years trades with customers. Each of those to 6 years in line with the statute of limitations on 2626 See supra Part VI.A.3.c.8 (explaining why civil suits for fraud, contracts and collection of debt Appendix B was removed from the final rule). characteristics appeared to be useful in in accounts in New York State. See Occupy. 2627 See proposed rule § 75.7(a). assessing whether a trading unit is

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engaged in permitted market making- a specific covered trading activity due to possible.2629 This heuristic, gradual related activity. differences between asset classes, approach to implementing reporting However, as noted in the proposal, market structure, or other factors. The requirements for quantitative the Agencies recognize that no single Agencies therefore requested comment measurements was intended to ensure quantitative measurement or on a large number of issues related to that the requirements are formulated in combination of measurements can the relevance, practicability, costs, and a manner that maximizes their utility for accurately identify prohibited benefits of the quantitative identifying trading activity that warrants proprietary trading without further measurements proposed. The Agencies additional scrutiny in assessing analysis of the context, facts, and also sought comment on whether the compliance with the prohibition on circumstances of the trading activity. In quantitative measurements described in proprietary trading, while limiting the addition, certain quantitative the proposal were appropriate to use to risk that the use of quantitative measurements may be useful for help assess compliance with section 13 measurements could inadvertently assessing one type of trading activity, curtail permissible market making- of the BHC Act. but not helpful in assessing another type related activities that provide an of trading activity. As a result, the In addition to the proposed important service to market participants Agencies proposed to use a variety of quantitative measurements, the proposal and the capital markets at large. quantitative measurements to help explained that a banking entity may In addition, the Agencies requested identify transactions or activities that itself develop and implement other comment on the use of numerical warrant more in-depth analysis or quantitative measurements in order to thresholds for certain quantitative review. effectively monitor its covered trading measurements that, if reported by a To be effective, this approach requires activities for compliance with section 13 banking entity, would require the identification of useful quantitative of the BHC Act and the proposed rule banking entity to review its trading measurements as well as judgment and to establish, maintain, and enforce activities for compliance and summarize regarding the type of measurement an effective compliance program, as that review to the relevant Agency. The results that suggest a further review of required by § 75.20 of the proposed rule Agencies did not propose specific the trading unit’s activity is warranted. and Appendix C. The Agencies noted numerical thresholds in the proposal The Agencies proposed to take a that the proposed quantitative because substantial public comment and heuristic approach to implementation in measurements in Appendix A were analysis would be beneficial prior to this area that recognized that intended to assist banking entities and formulating and proposing specific quantitative measurements can only be Agencies in monitoring compliance numerical thresholds. Instead, the usefully identified and employed after a with the proprietary trading restrictions Agencies intended to carefully consider process of substantial public comment, and would not necessarily provide all public comments provided on this issue practical experience, and revision. In the data necessary for the banking entity and to separately determine whether it particular, the Agencies noted that, to establish an effective compliance would be appropriate to propose, although a variety of quantitative program. The Agencies also recognized subsequent to finalizing the current measurements have traditionally been proposal, such numerical thresholds. that appropriate and effective used by market participants and others Part III of proposed Appendix A to manage the risks associated with quantitative measurements may differ defined the scope of the reporting trading activities, these quantitative based on the profile of the banking requirements. The proposed rule tools have not been developed, nor have entity’s businesses in general and, more adopted a tiered approach that required they previously been utilized, for the specifically, of the particular trading banking entities with the most extensive explicit purpose of identifying trading unit, including types of instruments trading activities to report the largest activity that warrants additional traded, trading activities and strategies, number of quantitative measurements, scrutiny in differentiating prohibited and history and experience (e.g., while banking entities with smaller proprietary trading from permitted whether the trading desk is an trading activities had fewer or no market making-related activities.2628 established, successful market maker or reporting requirements. This tiered Consistent with this heuristic a new entrant to a competitive market). approach was intended to reflect the approach, the proposed rule included a In all cases, banking entities needed to heightened compliance risks of banking large number of potential quantitative ensure that they have robust measures entities with extensive trading activities measurements on which public in place to identify and monitor the and limit the regulatory burden imposed comment was sought, many of which risks taken in their trading activities, to on banking entities with relatively small overlap to some degree in terms of their ensure the activities are within risk or no trading activities, which appear to informational value. The proposal tolerances established by the banking pose significantly less compliance risk. explained that not all of these entity, and to monitor for compliance Under the proposal, any banking quantitative measurements may with the proprietary trading restrictions entity that had, together with its ultimately be adopted in the final rule, in the proposed rule. affiliates and subsidiaries, trading assets depending on their relative strengths, To the extent that data regarding and liabilities the average gross sum of weaknesses, costs, and benefits. The measurements, as set forth in the which (on a worldwide consolidated Agencies noted that some of the proposed rule, are collected, the basis), as measured as of the last day of proposed quantitative measurements each of the four prior calendar quarters, may not be relevant to all types of Agencies proposed to utilize the conformance period provided in section equals or exceeds $5 billion would be trading activities or may provide only required the banking entity to furnish limited benefits, relative to cost, when 13 of the BHC Act to carefully review that data, further study the design and quantitative measurements for all applied to certain types of trading trading units of the banking entity utility of these measurements, and if activities. In addition, certain engaged in trading activity subject to necessary, propose changes to the quantitative measurements may be §§ 75.4, 75.5, or 75.6(a) of the proposed difficult or impracticable to calculate for reporting requirements as the Agencies believe are needed to ensure that these 2629 See 12 U.S.C. 1851(c)(2); Joint Proposal, 76 2628 Joint Proposal, 76 FR at 68883. measurements are as effective as FR at 68883.

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rule (i.e., permitted underwriting and with permissible market making-related around metrics.2634 Another commenter market making-related activity, risk- activities.2632 The proposal applied a stated that the identification of metrics mitigated hedging, and trading in smaller number of measurements to a is one of the strengths of the proposed certain government obligations). The smaller universe of trading units for this rule and offered great promise for scope of data to be furnished depended class of banking entities because they successful implementation of the on the activity in which the trading unit are likely to pose lesser compliance risk rule.2635 One commenter expressed was engaged. First, for the trading units and fewer supervisory and examination support for the metrics and argued that of such a banking entity that are challenges. The Agencies noted in the there would be substantial evasion of engaged in market making-related proposal that a less burdensome the rule without reporting of these activity pursuant to § 75.4(b) of the reporting regime, coupled with other measurements.2636 Some commenters proposed rule, proposed Appendix A elements of the proposal (e.g., the proposed a presumption of compliance required that a banking entity furnish compliance program requirement), was so long as trading activity is conducted seventeen quantitative likely to be equally as effective in in a manner consistent with tailored measurements.2630 Second, all trading ensuring compliance with section 13 of quantitative metrics and related specific units of such a banking entity engaged the BHC Act and the proposed rule for in trading activity subject to §§ 75.4(a), thresholds as coordinated and agreed banking entities with smaller trading 2637 75.5, or 75.6(a) of the proposed rule operations. with the relevant Agency. A few of were required to report five quantitative commenters suggested that metrics not Section III.B of proposed Appendix A be used as a bright-line trigger and measurements designed to measure the specified the frequency of required recommended flexibility in the general risk and profitability of the calculation and reporting of quantitative 2631 application of metrics for assessing trading unit. The Agencies expected measurements. Under the proposed that each of these general types of 2638 rule, each required quantitative market-making activities. Two measurements would be useful in measurement needed to be calculated commenters supported metrics as part assessing the extent to which any 2639 for each trading day. Required of a bright lines approach. permitted trading activity involves quantitative measurements were A number of commenters felt that exposure to high-risk assets or high-risk required to be reported to the relevant some metrics might be more relevant trading strategies. These requirements Agency on a monthly basis, within 30 than others, depending upon the would apply to all type of trading units days of the end of the relevant calendar particular asset class, activity, particular engaged in underwriting and market month, or on such other reporting making-related activity, risk-mitigated market, and unique characteristics of schedule as the relevant Agency may 2640 hedging, and trading in certain each banking entity. These government obligations. These require. Section III.C of proposed commenters advocated an approach additional measurements applicable Appendix A required a banking entity to where banking entities and examiners only to trading units engaged in market create and retain records documenting would determine over time the making-related activities were designed the preparation and content of any usefulness and relevance of particular to help evaluate the extent to which the quantitative measurement furnished by metrics.2641 One commenter expressed quantitative profile of a trading unit’s the banking entity, as well as such support for the 5 metrics required for activities is consistent with permissible information as is necessary to permit the trading in U.S. government market making-related activities. relevant Agency to verify the accuracy obligations.2642 A number of Under the proposal, any banking of such measurements, for a period of 5 commenters recommended that metrics entity that had, together with its years. This included records for each be tailored to different asset classes and affiliates and subsidiaries, trading assets trade and position. markets, to avoid the drawbacks of a and liabilities the average gross sum of b. General Comments on the Proposed one-size-fits-all approach.2643 One which (on a worldwide consolidated Metrics commenter argued that application of basis), as measured as of the last day of metrics to market-making activities at each of the four prior calendar quarters, A number of commenters were different firms may produce very equals or exceeds $1 billion but is less supportive of metrics. A few different results, all of which might than $5 billion would be required to commenters argued that the metrics reflect legitimate market-making.2644 could reveal prohibited proprietary provide quantitative measurements to Commenters also indicated that not all be furnished for trading units that trading activity and be an appropriate metrics are meaningful and calculable engaged in market making-related and valuable tool in analyzing activity subject to § 75.4(b) of the positions.2633 One commenter argued 2634 proposed rule. Trading units of such that metrics are the single most valuable See Goldman (Prop. Trading). 2635 See Sens. Merkley & Levin (Feb. 2012). banking entities that engaged in market tool available to the Agencies for 2636 See Occupy. making-related activities needed to distinguishing between prohibited and 2637 See Barclays; see also BoA; Invesco; ISDA report eight quantitative measurements permitted activities and recommended (Feb. 2012); JPMC; Morgan Stanley; SIFMA et al. designed to help evaluate the extent to the compliance program be structured (Prop. Trading) (Feb. 2012). which the quantitative profile of a 2638 See SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Fargo (Prop. Trading); NYSE Euronext; Oliver trading unit’s activities is consistent 2632 See proposed rule Appendix A.III.A. These Wyman (Feb. 2012); UBS; Western Asset Mgmt.; eight quantitative measurements are: (i) Goldman (Prop. Trading); Northern Trust. 2630 Comprehensive Profit and Loss; (ii) Comprehensive See proposed rule Appendix A.III.A. These 2639 See John Reed; Public Citizen. Profit and Loss Attribution; (iii) Portfolio Profit and seventeen quantitative measurements are discussed 2640 Loss; (iv) Fee Income and Expense; (v) Spread Profit See Morgan Stanley; SIFMA et al. (Prop. further below. Trading) (Feb. 2012); Stephen Roach. 2631 See proposed rule Appendix A.III.A. These and Loss; (vi) VaR; (vii) Volatility of Comprehensive 2641 See Wells Fargo (Prop. Trading); Morgan five quantitative measurements are: (i) Profit and Loss and Volatility of Portfolio Profit and Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012); Comprehensive Profit and Loss; (ii) Comprehensive Loss; and (viii) Comprehensive Profit and Loss to Stephen Roach. Profit and Loss Attribution; (iii) VaR and Stress Volatility Ratio and Portfolio Profit and Loss to 2642 VaR; (iv) Risk Factor Sensitivities; and (v) Risk and Volatility Ratio. See UBS. Position Limits. Each of these and other 2633 See, e.g., Paul Volcker; SIFMA et al. (Prop. 2643 See Goldman (Prop. Trading); Northern Trust; quantitative measurements discussed in proposed Trading) (Feb. 2012); Invesco; Comm. on Capital see also UBS. Appendix A are discussed in detail below. Markets Regulation. 2644 See Comm. on Capital Markets Regulation.

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for all trading units and some would be metrics right,2653 while others indicated reporting, but recommended the unnecessarily burdensome.2645 it was unclear how the Agencies could threshold for trading assets and Other commenters did not support the analyze such information to draw useful liabilities be increased from $1 billion to use of metrics. These commenters conclusions.2654 $10 billion to mitigate any cost and argued that metrics reporting was one Some commenters expressed concern burden impact on smaller banking aspect of the complexity of the proposal that metrics were vulnerable to entities.2664 These commenters pointed that increased the cost and difficulty of manipulation and arbitrage.2655 These out that even if the minimum dollar distinguishing market-making from commenters generally felt that the threshold were raised to $10 billion, an prohibited proprietary trading.2646 One quantitative measurements were only overwhelming percentage of trading commenter argued that banking entities appropriate for certain liquid and assets and liabilities in the banking may avoid legitimate market making transparent trading activities but not industry (approximately 98 percent) activities that would produce ‘‘worse’’ meaningful for illiquid markets, would still remain subject to heightened metrics results.2647 including opaque securities and compliance requirements including Several commenters expressed derivatives.2656 These commenters also Appendix A.2665 One commenter concern that the costs exceeded the argued that the vast majority of suggested the threshold be raised to $50 benefits of the required quantitative proprietary trading would not be billion in combined trading assets and metrics in the proposal. In particular, differentiable through analysis of the liabilities.2666 commenters argued that the 17 metrics data.2657 Other commenters expressed Commenters also offered a number of in the proposal calculated at each concern that the use of metrics not suggestions for modifying the activity trading unit was excessive, would replace regulatory review of actual that would be considered in meeting the generate an unmanageable amount of specific trading positions held by thresholds for determining which data, would yield numerous false banking entities.2658 One commenter reporting requirements apply to a positives, and would require the argued that in relying on metrics to be banking entity. Several commenters construction and programming of highly elaborated upon and discussed in the argued that certain types of trading sophisticated systems that are not examination process, the proposed rule assets or fund investments should not currently employed.2648 A few did not meet the fundamental fair notice be included for purposes of determining commenters suggested that a more goal of regulation.2659 whether the relevant dollar threshold limited set of metrics would reduce A few commenters also recommended for compliance was met, particularly compliance complexity.2649 Some creation of a central data repository or those that are not prohibited activities commenters noted that many of these data sharing protocol that would or investments. For instance, some metrics have not been historically promote consistency and accountability commenters urged that trading in U.S. reported by banking entities and some in oversight and regulation and government obligations should not of the metrics would require substantial suggested the Office of Financial count toward the calculation of whether resources and investment infrastructure Research (‘‘OFR’’) be given access to this a banking organization meets the trading to produce some of the metrics without data so that it can provide centralized threshold triggering metrics 2667 a clear functional purpose.2650 analysis and monitoring to identify any reporting. These commenters also According to other commenters, trends that give rise to systemic risk.2660 argued that other positions or however, banking entities currently use These commenters generally supported transactions that do not involve all or nearly all of the proposed compliance benefits that would result financial instruments and that may metrics.2651 One commenter urged that from increased public disclosure of constitute trading assets and liabilities, it would be good to make metrics banking entities’ trading and funds such as loans, should be excluded from consistent with the banking entities’ activities, including all of their trading the thresholds because exempt activities internal reporting and control positions, their valuation models, and should not determine the type of systems.2652 Some commenters argued it 2661 compliance program a banking entity their compliance metrics. 2668 was critical for the Agencies to get the Some commenters expressed support must implement. One commenter for the reporting thresholds contained in urged that foreign exchange swaps and 2645 See Morgan Stanley; see also ISDA (Feb. Appendix A.2662 One commenter forwards be excluded from the 2012). suggested that all banking entities that definition of a ‘‘derivative’’ and not be 2646 See ABA (Keating); Barclays; Citigroup (Feb. subject to compliance requirements as a 2012); ISDA (Feb. 2012); UBS; Oliver Wyman (Feb. engage in any trading (regardless of 2669 threshold) report certain metrics.2663 result. Conversely, one commenter 2012); Prof. Duffie; Wellington. urged that all assets and liabilities 2647 See Oliver Wyman (Feb. 2012). Other commenters supported metrics 2648 See BoA (expressing concern about the need defined as trading assets for purposes of for new systems to distinguish bid-ask spreads from 2653 See, e.g., UBS. the Market Risk Capital Rule should be price appreciation); UBS; Wellington. 2654 See BoA; UBS; Wellington. included in the $1 billion standard for 2649 See BoA; Barclays; Citigroup (Feb. 2012). 2655 See AFR (Nov. 2012); see also Occupy; Public becoming subject to any reporting and 2650 See Credit Suisse (Seidel); Morgan Stanley; Citizen. record-keeping requirements under the ´ ´ ´ ´ UBS; Wells Fargo (Prop. Trading); Societe Generale 2656 See Occupy; AFR (Nov. 2012); Wells Fargo final rule.2670 (arguing that many calculation questions need to be (Prop. Trading). resolved before banking entities can create A number of commenters argued that 2657 See Occupy. necessary systems to measure metrics). monthly reporting was too frequent 2658 See Sens. Merkley & Levin (Feb. 2012). 2651 See Occupy; AFR et al. (Feb. 2012); Western 2659 because of the complexity of the process Asset Mgmt.; Public Citizen. For example, one See ISDA (Feb. 2012) (citing Mason v. Florida that surrounds generation of regulatory commenter cited a study finding that 14 out of 17 Bar, 208 F.3d 952, 958–59 (11th Cir. 2000)). of the proposed metrics are either in wide use today 2660 See Sens. Merkley & Levin (Feb. 2012); see 2664 See PNC et al.; M&T Bank; see also ABA or are possible to implement fairly easily using data also Occupy; Public Citizen. (Abernathy). already collected for internal risk management and 2661 See Sens. Merkley & Levin (Feb. 2012); see 2665 profit and loss purposes. See AFR et al. (Feb. 2012) also Public Citizen; John Reed. See ABA (Keating); M&T Bank; PNC et al. (citing John Lester and Dylan Walsh, ‘‘The Volcker 2662 See ICBA; Occupy. 2666 See State Street (Feb. 2012). 2667 Rule Ban On Prop Trading: A Step Closer to Reality, 2663 See Occupy (suggesting all banking entities See PNC et al. Point of View,’’ Oliver Wyman Company (Oct. that engage in trading be required to provide VaR 2668 See PNC et al. 2011)). Exceedance, Risk Factor Sensitivities and Risk and 2669 See Northern Trust. 2652 See Paul Volcker. Position Limits). 2670 See Occupy at 60.

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reports and suggested that the frequency on resources and comment from the commenters expressed opposition to of reporting should be quarterly.2671 public and the industry in continuing establishing numerical thresholds for One commenter supported the reporting the process of developing and building purposes of the rule,2687 while others frequency as extremely effective and out metrics.2679 stated that thresholds should be said it should not be reduced in any Another commenter requested that established over time.2688 In opposition way.2672 the final rule specify how trading assets of thresholds, one commenter expressed A number of comments were received and liabilities should be reported for concern that numerical thresholds could on the implementation timeframe for savings and loan holding be easily abused and evaded and may metrics reporting. Several commenters companies.2680 This commenter need to be constantly revised and urged allowing banking entities the use requested clarification that positions updated as financial markets evolve.2689 of the full conformance period for held for hedging or liquidity In addition, another commenter stated creating the systems and processes to management purposes should not count that numerical thresholds should not be capture and report the quantitative as trading assets or liabilities for the $5 imposed because metric levels will metrics.2673 Some commenters billion threshold in Appendix A. differ by asset class and type of suggested that metrics should not be Another commenter expressed concern activity.2690 A few commenters required to be reported until one year that derivatives valuation may value suggested that numerical thresholds, after adoption of final regulations.2674 A derivatives substantially lower than based on the specific asset class or different commenter suggested that the their notional exposure and thereby market, would be useful to provide Agencies provide a one-year period make high reporting thresholds not clarity or consistency about the types of during which they determine which meaningful or reflective of inherent activity that are permitted under the metrics will be employed for different risk.2681 rule.2691 Two commenters expressed asset classes and an additional one-year Many commenters expressed concern support for banking entities establishing period during which such metrics could that the smallest trading unit level was numerical thresholds, in consultation be reviewed so metrics would be a too low a level for collecting metrics with the relevant regulator, for different required component of a banking data and suggested the final rule trading units based on differences 2682 entity’s compliance program no sooner provide a higher reporting level. between markets and asset classes.2692 than 2 years after issuance of the final These commenters stated that c. Approach of the Final Rule rule.2675 Another commenter suggested calculating at too low of a level would be more likely to generate false As explained below, the Agencies that banking entities and regulators use 2683 the first year of the conformance period positives and would be burdensome, have reduced the number of metrics that particularly for firms with large trading banking entities must report under to consult with one another and 2684 determine the usefulness and relevance operations. In addition, some Appendix A from the 17 metrics in the commenters indicated that it would be of individual metrics for different proposal to 7 metrics in the final rule. problematic if the definition of ‘‘trading activities, asset classes, and markets and The final rule also increases the level of unit’’ is applied at a legal entity level the second year of the conformance activity that is required to trigger and cannot be applied across multiple period to test the metrics systems to mandatory reporting of metrics data and legal entities within the same affiliate validate the accuracy and relevance of phases in the reporting requirement group.2685 By contrast, two commenters metrics that are agreed upon the first over time. supported the collection of metrics at year.2676 One commenter suggested a Under the final rule, a banking entity the trading desk level and appropriate subset of metrics be rolled out gradually engaged in significant trading activity as levels above the trading desk.2686 One of across trading units before defined by § 75.20 must furnish the these commenters expressed concern following quantitative measurements for implementing the full suite of metrics that the rule allowed for an that are ultimately adopted or metrics each of its trading desks engaged in inappropriately large trading desk unit covered trading activity calculated in could be rolled out one trading unit at that could combine significantly a time.2677 Another commenter said the accordance with Appendix A: unrelated trading desks, which would • Risk and Position Limits and Usage; Agencies should identify key metrics impede detection of proprietary trading • that are clearly workable across all Risk Factor Sensitivities; and supported measurements at • Value-at-Risk and Stress VaR; ranges of trading activity and most multiple levels of organization to • Comprehensive Profit and Loss likely to provide useful data and require combat evasion concerns. Attribution; those metrics be implemented first and In response to questions in the • Inventory Turnover; require other metrics to be phased in proposal about whether the Agencies • Inventory Aging; and over time in consultation with the should establish numerical thresholds • Customer Facing Trade Ratio. banking entity’s primary Federal for some or all of the proposed In response to comments, the final 2678 regulator. One commenter supported quantitative measurements, a number of rule raises the threshold for metrics the heuristic approach of the proposal reporting from the proposal to capture and suggested the Agencies should draw 2679 See AFR et al. (Feb. 2012). only firms that engage in significant 2680 See GE (Feb. 2012). trading activity, identified at specified 2671 See JPMC; see also Stephen Roach. 2681 See Occupy. aggregate trading asset and liability 2672 See Occupy. 2682 See, e.g., BoA; Goldman (Prop. Trading); thresholds, and delays the dates for 2673 See BoA; Barclays; Citigroup (Feb. 2012); JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); reporting metrics through a phased-in Goldman (Prop. Trading); JPMC; Morgan Stanley; Morgan Stanley; RBC. SIFMA et al. (Prop. Trading) (Feb. 2012); UBS; 2683 See JPMC; Goldman (Prop. Trading); SIFMA Stephen Roach. et al. (Prop. Trading) (Feb. 2012); BoA. See also 2687 See SIFMA et al. (Prop. Trading) (Feb. 2012); 2674 See Credit Suisse (Seidel); JPMC; Wells Fargo Sen. Gillibrand. Occupy; Alfred Brock. (Prop. Trading). 2684 See Goldman (Prop. Trading); SIFMA et al. 2688 See Wellington; Barclays; Goldman (Prop. 2675 See BoA. (Prop. Trading) (Feb. 2012); BoA. Trading); CalPERS; John Reed. 2676 See Morgan Stanley; see also SIFMA et al. 2685 See Goldman (Prop. Trading); SIFMA et al. 2689 See Occupy. (Prop. Trading) (Feb. 2012). (Prop. Trading) (Feb. 2012). 2690 See SIFMA et al. (Prop. Trading) (Feb. 2012). 2677 See Goldman (Prop. Trading). 2686 See Sens. Merkley & Levin (Feb. 2012); 2691 See Wellington; CalPERS; John Reed. 2678 See Wells Fargo (Prop. Trading). Occupy. 2692 See Goldman (Prop. Trading); Barclays.

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approach based on the size of trading measurement to its primary supervisory The final rule defines ‘‘trading desk’’ assets and liabilities.2693 Banking Agency on the reporting schedule to replace the concept of ‘‘trading unit’’ entities that meet the relevant established in § 75.20 unless otherwise in the proposal.2696 Under the final rule, thresholds must collect and report requested by the primary supervisory trading desk means the smallest discrete metrics for all trading desks engaged in Agency for the entity. The largest unit of organization of a banking entity covered trading activity beginning on banking entities with $50 billion or that buys or sells financial instruments the dates established in § 75.20 of the greater in trading assets and liabilities for the trading account of the banking final rule. Specifically, the Agencies must report the metrics on a monthly entity or an affiliate thereof. The have delayed the reporting of metrics basis. Other banking entities required to Agencies believe that applying until June 30, 2014 for the largest report metrics must do so on a quarterly quantitative measurements to a level banking entities that, together with their basis.2694 All quantitative measurements that aggregates a variety of distinct affiliates and subsidiaries, have trading for any calendar month must be trading activities may obscure or assets and liabilities the average gross reported no later than 10 days after the ‘‘smooth’’ differences between distinct sum of which equal or exceed $50 end of the calendar month required by lines of business, asset categories and billion on a worldwide consolidated § 75.20, unless another time is requested risk management processes in a way basis over the previous four calendar by the primary supervisory Agency for that renders the measurement relatively quarters (excluding trading assets and the entity except for a preliminary uninformative because it does not liabilities involving obligations of or period when reporting will be required adequately reflect the specific guaranteed by the United States or any no later than 30 days after the end of the characteristics of the trading activities agency of the United States). Banking calendar month. Banking entities being conducted. entities with less than $50 billion and subject to quarterly reporting will be greater than or equal to $25 billion in required to report quantitative While the Agencies recognize that trading assets and liabilities and measurements within 30 days of the end applying quantitative measurements at banking entities with less than $25 of the quarter, unless another time is the trading desk level may result in billion and greater than or equal to $10 requested by the primary supervisory some ‘‘noise’’ in the data and false billion in trading assets and liabilities Agency for the entity in writing.2695 positives, the Agencies believe it is necessary to apply the quantitative would also be required to report these The Agencies believe that together the measurements at the trading desk level metrics beginning on April 30, 2016, reduced number of metrics, the higher to enhance consistency with other and December 31, 2016, respectively. thresholds for reporting metrics, provisions of the final rule. For The Agencies believe that these delayed delayed reporting dates, and modified dates for reporting metrics should allow reporting frequency reduce the costs example, because the requirements of firms adequate time to develop systems and burden from the proposal while the market-making exemption apply at to calculate and report the quantitative allowing collection of data to permit the trading desk level of organization, metrics. The Agencies will review the better monitoring of compliance with the Agencies believe quantitative data collected and revise this collection section 13 of the BHC Act. The Agencies measurements used to monitor a requirement as appropriate based on a also believe that the delayed dates for banking entity’s market making-related review of the data collected prior to reporting quantitative metrics will activities should also calculated, September 30, 2015. provide banking entities with the time reported, and recorded at the trading Under the final rule, a banking entity to develop systems to calculate and desk level. In response to commenters’ required to report metrics must report these metrics. The Agencies are concerns that trading desk level calculate any applicable quantitative not applying these reporting and measurements are more likely to measurement for each trading day. Each recordkeeping requirements to banking generate false positives, the Agencies banking entity required to report must entities with smaller amounts of trading emphasize that quantitative report each applicable quantitative activity, as it appears that the more measurements will not be used as a limited benefits of applying these dispositive tool for determining 2693 As noted above, a number of commenters requirements to banking entities with compliance and, rather, will be used to suggested setting a higher threshold than the monitor patterns and identify activity proposed $1 billion and $5 billion trading asset and lower levels of trading activities, which liability thresholds because even thresholds of $10 represent entities that are typically that may warrant further review. billion to $50 billion would capture a significant small, less complex, and easier to Like the proposal, the final rule does percentage of the total trading assets and liabilities in the banking system. See ABA (Keating); M&T supervise, would not justify the burden not include specific numerical Bank; PNC et al.; State Street (Feb. 2012). The associated with complying with the thresholds. Commenters did not suggest Agencies believe that the phase-in approach to the reporting and recordkeeping specific thresholds for particular metrics metrics requirement established in the final rule requirements of Appendix A. or provide data and analysis that would should generally address commenters’ concerns 2697 about the implementation timeframe by providing support particular thresholds. Given time for analysis, development of systems (if 2694 Consistent with certain commenters’ the range of financial instruments and needed), and implementation of the quantitative requests, the final rule generally requires less trading activity covered by the final measurements requirement. See, e.g., BoA; frequent reporting than was proposed. However, the rule, as well as potential differences Barclays; Citigroup (Feb. 2012); Goldman (Prop. Agencies continue to believe that monthly reporting Trading); JPMC; Morgan Stanley; SIFMA et al. is appropriate for the largest banking entities above among banking entities’ organizational (Prop. Trading) (Feb. 2012); UBS; Stephen Roach; the $50 billion threshold. More frequent reporting structures, trading strategies, and level Credit Suisse (Seidel); Wells Fargo (Prop. Trading). for these firms is appropriate to allow for more of presence in a particular market, the The Agencies are establishing a phase-in approach, effective supervision of their large-scale trading Agencies are concerned that numerical rather than requiring all banking entities above the operations. See JPMC; Stephen Roach. $10 billion threshold to report metrics within the 2695 See final rule § 75.20(d)(3). The final rule thresholds for specific metrics would same timeframe, to strike a balance between the includes a shorter period of time for reporting not account for these differences and benefits of receiving data to help monitor quantitative measurements after the end of the could inappropriately constrain compliance with the rule against the need for time relevant period than was proposed for the largest to assess the effectiveness and usefulness of the banking entities. Like the monthly reporting quantitative measurements in practice and for some requirement for these firms, this is intended to 2696 See final rule § 75.3(e)(13); see also supra firms to develop additional systems for purposes of allow for more effective supervision of their large- Parts VI.A.2.c.1.c.ii. and VI.A.3.c.1.c.i. this requirement. scale trading operations. 2697 See Wellington; CalPERS; John Reed.

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legitimate activity.2698 Further, material exposure to high-risk assets or tend to vary among banking entities.2704 mandated thresholds for the metrics high-risk trading strategies. As This commenter recommended the would not recognize the impact described below, different quantitative development of a standard methodology changing market conditions may have measurements were proposed to by the OFR including a central on a given trading desk’s quantitative identify different aspects and repository for historical calculation data measurements. Consistent with two characteristics of trading activity for the for each asset for the purpose of commenters’ suggested approach, purpose of helping to identify ensuring standard calculation across the banking entities will be required to prohibited proprietary trading, and the industry. This commenter also establish their own numerical Agencies stated in the proposal that expressed concern that VaR calculations thresholds for quantitative they expected that the quantitative are heavily reliant on the quality of measurements under the enhanced measurements would be most useful for input data and stated that many markets compliance program requirement in this purpose when implemented and are unable to provide sufficient Appendix B.2699 reviewed collectively, rather than in information such that VaR calculations isolation. The Agencies stated in the are meaningful, including markets for d. Proposed Quantitative Measurements proposal that they believed that, in the illiquid products for which accurate and Comments on Specific Metrics aggregate, many banking entities already historical price and market information Section IV of proposed Appendix A collect and review many of these is sparse and could severely under described, in detail, the individual measurements as part of their risk represent true potential losses under quantitative measurements that must be management activities, and stated that VaR calculations.2705 furnished. These measurements were they expected that many of the A few commenters expressed concern grouped into the following five broad quantitative measurements proposed about the applicability of VaR when categories, each of which is described in would be readily computed and applied to ALM activities.2706 These more detail below: monitored at the multiple levels of commenters argued that risk • Risk-management measurements— organization included in proposed management metrics such as VaR would VaR, Stress VaR, VaR Exceedance, Risk Appendix A’s definition of ‘‘trading not help to distinguish ALM and valid Factor Sensitivities, and Risk and unit,’’ to which they would apply. risk mitigating hedging activities from Position Limits; Under the proposal, the first set of prohibited proprietary trading. For • Source-of-revenue measurements— quantitative measurements related to instance, one of these commenters Comprehensive Profit and Loss, risk management, and included VaR, stated that the proposed reliance on VaR Portfolio Profit and Loss, Fee Income Stress VaR, VaR Exceedance, Risk and Stress VaR to demonstrate bona fide and Expense, Spread Profit and Loss, Factor Sensitivities, and Risk and hedging is misleading for ALM activities and Comprehensive Profit and Loss Position Limits. Commenters generally due to the typical accounting Attribution; supported the use of risk-management • asymmetry in ALM where, for example, Revenues-relative-to-risk metrics as the most important measure managed liabilities such as deposits are measurements—Volatility of of compliance, indicating that these not marked to market but the Comprehensive Profit and Loss, metrics could potentially provide useful corresponding hedge may be. 2700 Volatility of Portfolio Profit and Loss, supervisory information. One commenter argued that the use of In general, commenters supported the Comprehensive Profit and Loss to stress VaR would be important to guard use of the VaR metric.2701 One of these Volatility Ratio, Portfolio Profit and against excessive risk taking.2707 A few commenters argued that VaR was not Loss to Volatility Ratio, Unprofitable commenters suggested that additional particularly indicative of proprietary Trading Days based on Comprehensive guidance be provided for Stress VaR trading, but could be helpful to reveal Profit and Loss, Unprofitable Trading including linking it to the broader stress a trading unit’s overall size and risk Days based on Portfolio Profit and Loss, testing regime and based on extreme profile.2702 Another commenter Skewness of Portfolio Profit and Loss, conditions that are not based on historic indicated that significant, abrupt or and Kurtosis of Portfolio Profit and precedent.2708 These commenters also inconsistent changes to VaR may need Loss; argued that a one-day holding period • Customer-facing activity to be absorbed by market makers who assumption is inadequate, especially for measurements—Inventory Turnover, absorb large demand and supply shocks less liquid asset classes, and Inventory Aging, and Customer-facing into their inventories.2703 This recommended that stress be measured Trade Ratio; and commenter contended that the six over a longer period. One commenter • Payment of fees, commissions, and largest bank holding companies had argued that Stress VaR should be spreads measurements—Pay-to-Receive proprietary trading losses that removed from the list of required Spread Ratio. frequently exceeded their VaR estimates metrics as it is not in regular use for The Agencies proposed these and the design and supervision of such day-to-day risk management and quantitative measurements because, risk measures should be revisited. provides little relevant information taken together, these measurements One commenter argued that the about the intent or proportionality appeared useful for understanding the definition of VaR was not made clear in context in which trading activities occur the proposal and was missing some and identifying activities that may important information regarding 2704 See Occupy. 2705 warrant additional scrutiny to methodology as VaR methodologies See Occupy. 2706 See JPMC; State Street (Feb. 2012); see also determine whether these activities BoA; CH/ABASA. For instance, one of these involve prohibited proprietary trading 2700 See, e.g., AFR et al. (Feb. 2012); Barclays; commenters stated that the proposed reliance on because the trading activity either is Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. VaR and Stress VaR to demonstrate bona fide inconsistent with permitted market Trading); Invesco; JPMC; Occupy; Public Citizen; hedging is misleading for ALM activities due to the see also BNY Mellon et al. (suggesting the use of typical accounting asymmetry in ALM where, for making-related activities or presents a VaR measures for foreign exchange trading activity). example, managed liabilities such as deposits are 2701 See, e.g., Citigroup (Feb. 2012); Prof. Duffie; not mark-to-market but the corresponding hedge 2698 See SIFMA et al. (Prop. Trading) (Feb. 2012). Goldman (Prop. Trading); Invesco; Public Citizen. may be. See State Street (Feb. 2012). 2699 See Goldman (Prop. Trading); Barclays. See 2702 See Goldman (Prop. Trading). 2707 See Public Citizen. also final rule Appendix B. 2703 See Prof. Duffie. 2708 See AFR et al. (Feb. 2012); Public Citizen.

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between risk assumed and client could be helpful to orient regulators to be flexible enough to be tailored to the demands.2709 a trading unit’s overall size and risk specific trading activities of each trading A number of commenters requested profile.2719 Another commenter desk. Supervisory guidance and that VaR Exceedance be removed from expressed the view risk and position comparisons of these measures across the list of metrics. These commenters limits are the most comprehensive similarly situated trading desks at a argued that the primary function of VaR measures of risk taking and incorporate given entity as well as across entities Exceedance is to analyze the quality of VaR, Stress VaR, and Risk Factor will be used to ensure that the provided a VaR model and that VaR backtesting Sensitivities.2720 A different commenter measurements conform to the is already reported to regulators as part argued it was unclear how position description and calculation guidance of the supervisory process. These limits are in fact a quantitative metric provided in Appendix A. Risk and commenters argued that VaR and not a description of a banking Position Limits and Usage provide an Exceedance does not reveal trading entity’s internal risk policies.2721 explicit assessment of management’s intent or actual risk taken.2710 One After carefully considering the expectation of how much risk is commenter argued that VaR Exceedance comments received, the final rule required to perform permitted market- may be useful to the Agencies as an retains the risk-management metrics making, underwriting and hedging indicator of the quality of the VaR other than VaR Exceedance. The activities. The final rule requires that measure relative to the profit and loss of collection of information regarding Risk the usage of each risk and position limit the trading unit but that a more rigorous and Position Limits, VaR, Stress VaR, be reported so that the risk taking by back-testing process would serve as a and Risk Factor Sensitivities is each trading desk can be monitored and better analytical tool than VaR consistent with the aim of providing a assessed on an ongoing basis.2725 Exceedance to evaluate the quality of means of characterizing the overall risk With the exception of Stress VaR, the VaR model result and should be profile of the trading activities of each each of these measurements are included as an additional metric.2711 trading desk and evaluating the extent routinely used to manage and control One commenter suggested that risk- to which the quantitative profile of a risk taking activities, and are also used based metrics should measure risk as a trading desk’s activities is consistent by some banking entities for purposes of function of capital.2712 Another with permissible activities. Moreover, a calculating regulatory capital and commenter warned that risk metrics number of commenters indicated that allocating capital internally.2726 In the could be significantly higher during the risk management measures would be context of permitted market making- times of market stress and volatility effective at achieving these goals.2722 related activities, these risk management than during normal times.2713 The risk management measure that was measures are useful in assessing A few commenters expressed support not retained in the final rule, VaR whether the actual risk taken is for risk factor sensitivities as useful, Exceedance, was considered, in light of consistent with the level of principal supervisory information.2714 One of the comments, as not offering significant risk that a banking entity must retain in these commenters suggested that risk additional information on the overall order to service the near-term demands factor sensitivities could orient risk profile and activities of the trading of customers. Significant, abrupt or regulators to a trading unit’s overall size desk relative to the burden associated inconsistent changes to key risk and risk profile,2715 while another with computing, auditing and reporting management measures, such as VaR, commenter stated that risk factor it on an ongoing basis.2723 that are inconsistent with prior sensitivities would be the most useful The risk-management measurements experience, the experience of similarly tool for identifying the accumulation of included in the final rule are widely situated trading desks and market risk in different areas of a used by banking entities to measure and management’s stated expectations for banking entity.2716 One commenter manage trading risks and activities.2724 such measures may indicate suggested that several risk factor VaR, Stress VaR, and Risk Factor impermissible proprietary trading, and sensitivity snapshots be taken Sensitivities provide internal, model- may warrant further review. In addition, throughout the day with an average based assessments of overall risk, stated indicators of unanticipated or unusual value reported at the end of day.2717 in terms of large but plausible losses levels of risk taken, such as breaches of This commenter also recommended that that may occur or changes in revenue internal Risk and Position Limits, may trading strategies that rely heavily on that would be expected to result from suggest behavior that is inconsistent models to calculate risk exposures (e.g., movements in underlying risk factors. with appropriate levels of risk and may correlation trading portfolios), should The provided description and warrant further scrutiny. The limits trigger additional disclosures in risk calculation guidance for each of these required under § 75.4(b)(2)(iii) and factor sensitivity reporting.2718 measures is consistent with both current § 75.5(b)(1)(i) must meet the applicable Commenters also supported risk and market practice and regulatory capital requirements under § 75.4(b)(2)(iii) and position limits as providing useful, requirements for banks. The final rule § 75.5(b)(1)(i) and also must include supervisory information. Several does not provide a prescriptive appropriate metrics for the trading desk commenters indicated that these limits definition of each of these limits including, at a minimum, the measurements as these measures must ‘‘Risk Factor Sensitivities’’ and ‘‘Value- 2709 See JPMC. at-Risk and Stress Value-at-Risk’’ 2710 See ABA (Keating); Barclays; Goldman (Prop. 2719 See, e.g., Barclays; Citigroup (Feb. 2012); metrics except to the extent any of the Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); Prof. Duffie; Goldman (Prop. Trading). Wells Fargo (Prop. Trading); UBS. ‘‘Risk Factor Sensitivities’’ or ‘‘Value-at- 2720 See Barclays. 2711 See Occupy. Risk and Stress Value-at-Risk’’ metrics 2721 See Occupy. 2712 See Citigroup (Feb. 2012). 2722 See, e.g., AFR et al. (Feb. 2012); Barclays; are demonstrably ineffective for 2713 See SIFMA et al. (Prop. Trading) (Feb. 2012). Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. measuring and monitoring the risks of a 2714 See Citigroup (Feb. 2012); Prof. Duffie; Trading); Invesco; JPMC; Occupy; Public Citizen; Occupy. see also Northern Trust; State Street (Feb. 2012). 2725 The Agencies believe this clarification 2715 See Goldman (Prop. Trading). 2723 See ABA (Keating); Barclays; Goldman (Prop. responds to one commenter’s question regarding 2716 See Occupy. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); how risk and position limits will be used and 2717 See Occupy. Wells Fargo (Prop. Trading); UBS. assessed for purposes of the rule. See Occupy. 2718 See Occupy. 2724 See Joint Proposal, 76 FR at 68887. 2726 See Joint Proposal, 76 FR at 68887.

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trading desk based on the types of relevant to an overall assessment of calculate Spread P&L and it would be positions traded by, and risk exposures bona fide market making.2734 critical for the Agencies to be flexible of, that desk. A few commenters supported and work with banking entities to Under the proposal, the second set of Portfolio Profit and Loss as a reasonable determine the appropriate proxies for contextual metric to inform whether quantitative measurements related to spreads on an asset-class-by-asset class revenues from market-making the source of revenues, and included and trading desk-by-trading-desk basis. transactions are from customer Comprehensive Profit and Loss, One commenter contended that the transactions.2735 However, one of these Portfolio Profit and Loss, Fee Income, proposed implementation in the commenters argued that this metric proposal was more difficult than Spread Profit and Loss, and would not necessarily be indicative of necessary and suggested End of Day Comprehensive Profit and Loss prohibited proprietary trading and Spread Proxy is sufficient. Another Attribution. A few commenters profits may reflect bona fide market commenter suggested expanding the expressed support for Comprehensive making-related, underwriting, and flexibility offered in choosing a bid-offer Profit and Loss as a reasonable hedging activities.2736 Another source to calculate Spread P&L.2745 contextual metric and contended that commenter argued that this metric However, the majority of commenters the metric could inform the analysis of should serve as a secondary indication recommended removal of Spread P&L as whether market-making revenues are of risk levels and may be subject to a metric.2746 These commenters argued from customer transactions.2727 manipulation.2737 that a meaningful measure for Spread As described above, a number of Some commenters felt that Fee P&L cannot be calculated in the absence commenters expressed concern about a Income and Expense was a useful of a continuous bid-ask spread, making focus on revenues as part of evaluating metric.2738 One of these commenters this metric misleading especially for market-making.2728 For instance, one argued this metric has the potential to illiquid positions and shallow markets. commenter argued that the rule should help distinguish permitted activities A few commenters generally not require, even in guidance, that from prohibited proprietary trading.2739 expressed support for the inclusion of market making-related permitted Another commenter felt this metric Comprehensive Profit and Loss activities be ‘‘designed to generate would be useful in liquid markets that Attribution.2747 One of these revenues from fees, commissions, bid- trade with the convention of fees and commenters stated that this metric was asks spreads or other income,’’ arguing commissions but less useful, but still the most comprehensive metric for that this prejudges appropriate results indicative, in other markets that use measuring sources of revenue and for revenue metrics and implies that a inter-dealer brokers to conduct client- included other metrics as sub-metrics, 2740 bona fide market maker is not permitted related activities. One commenter such as Comprehensive Profit and Loss, to benefit from revenues from market argued that it would be impracticable to Portfolio Profit and Loss, and Fee movements.2729 One commenter produce Fee Income and Expense data Income and Expense. Another expressed concern that the source-of- for foreign exchange trading, which is commenter contended the mention of revenue metrics are subject to predominantly based on bid/offer ‘‘customer spreads’’ and ‘‘bid-ask 2741 manipulation as these metrics depend spread. spreads’’ was unclear and that both of A few commenters thought that these terms should be removed from the on correctly classifying revenue into 2742 market bid-ask spreads as opposed to Spread P&L could be useful. One of calculation guidance. Other commenters these commenters argued that Spread other sources of revenue.2730 One argued that the benefits of this metric do P&L has the potential to help commenter stated that this metric not justify the costs of generating a distinguish permitted activities from should serve as a secondary indication report of Comprehensive P&L prohibited proprietary trading.2743 2748 of risk levels because it could be subject This Attribution on a daily basis. One commenter suggested that the final rule commenter urged the Agencies to to manipulation.2731 Another remove the proposal’s revenue ensure that each institution be commenter recommended use of the requirement as part of market-making permitted to calculate this metric in a sub-metric in Comprehensive P&L and instead rely on revenue metrics way that reflects the institution’s unique Attribution.2732 A different commenter such as Spread P&L.2744 This characteristics.2749 recommended the adoption of clearer After carefully considering the metrics to distinguish customer commenter argued, however, that it will not always be clear how to best comments received, the final rule revenues from revenues from price maintains only a modified version of movements.2733 One commenter 2734 See NYSE Euronext. Comprehensive P&L Attribution metric indicated that after-the-fact application 2735 See Goldman (Prop. Trading); Japanese and does not retain the proposed of quantitative measurements such as Bankers Ass’n; Occupy. Comprehensive Profit and Loss, Comprehensive Profit and Loss may 2736 See Goldman (Prop. Trading). Portfolio Profit and Loss, Fee Income, or cause firms to reconsider their 2737 See Occupy. Spread Profit and Loss metrics. The 2738 commitment to market making and See Goldman (Prop. Trading); Japanese final rule also requires volatility of recommended that, to the extent this Bankers Ass’n; Occupy. 2739 See Goldman (Prop. Trading). This comprehensive profit and loss to be metric is used, it should be applied commenter urged that fee income and expense reported. As pointed out by a number of flexibly in light of market conditions should be considered together with Spread P&L prevailing during the relevant time arguing that these two both measures of customer 2745 See JPMC; UBS; see also SIFMA et al. (Prop. period, and as one of many factors revenues and, in practice, may function as Trading) (Feb. 2012). substitutes for each other. 2746 See ABA et al.; BoA; Barclays; Credit Suisse 2740 See Occupy. (Seidel); Japanese Bankers Ass’n; Northern Trust; 2727 See Goldman (Prop. Trading); Japanese 2741 See Northern Trust. SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Bankers Ass’n; Occupy; see also Barclays. 2742 See, e.g., Goldman (Prop. Trading); JPMC; Fargo (Prop. Trading); see also AFR et al. (Feb. 2728 See supra Part VI.A.3.c.7.b. UBS. 2012); Occupy. 2729 See SIFMA (May 2012). 2743 See Goldman (Prop. Trading). 2747 See Barclays; Occupy. 2730 See AFR (Nov. 2012). 2744 See Goldman (Prop. Trading); see also Paul 2748 See BOK; Goldman (Prop. Trading); SIFMA et 2731 See Occupy. Volcker (supporting a metric considering the extent al. (Prop Trading) (Feb. 2012); Wells Fargo (Prop. 2732 See Barclays. to which earnings are generated by pricing spreads Trading). 2733 See Public Citizen. rather than changes in price). 2749 See SIFMA et al. (Prop Trading) (Feb. 2012).

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commenters, Comprehensive Profit and Under the proposal, the third set of individual trading units through Loss Attribution provides a holistic measurements related to realized risks iterative application of the metrics.2759 attribution of each trading desk’s profit and revenue relative to realized risks, One commenter expressed support for and loss and contains much of the and includes Volatility of Profit and Unprofitable Trading Days based on information content that is provided by Loss, Comprehensive Profit and Loss to Comprehensive Profit and Loss and many of the other metrics, such as Fee Volatility Ratio and Portfolio Profit and Unprofitable Trading Days based on Income and Expense.2750 Accordingly, Loss to Volatility Ratio, Unprofitable Portfolio Profit and Loss indicating that the use of Comprehensive Profit and Trading Days based on Comprehensive these metrics may serve to highlight Loss Attribution in the final rule greatly Profit and Loss and Unprofitable areas requiring further investigation, simplifies the metric reporting Trading Days based on Portfolio Profit since a significant number of requirement and reduces burden while and Loss, and Skewness of Portfolio unprofitable trading days may indicate retaining much of the information and Profit and Loss and Kurtosis of Portfolio a deviation from traditional client- analysis that was provided in the full set Profit and Loss. related activities.2760 Another of five metrics that were contained in A few commenters indicated support commenter suggested that these metrics the proposal. In addition, in response to for these metrics as appropriate, be removed as they would result in commenters’ concerns about the contextual metrics.2754 These market makers being less likely to take burdens of separately identifying commenters indicated that these metrics client-facing positions due to reluctance specific revenue sources (e.g., revenues may serve to highlight areas requiring to incur unprofitable trading days that from bid-ask spreads, revenues from further investigation, since high P&L could indicate the presence of price appreciation), the Agencies have volatility may indicate a deviation from impermissible activity despite the modified the focus of the proposed traditional client related activities and utility of such trades in providing source of revenue metrics to focus on that a well-structured trading operation liquidity to customers.2761 when revenues are generated, rather should be able to obtain relatively high One commenter requested including than the specific sources of revenue.2751 ratios of revenue-to-risk (as measured by Skewness of Portfolio Profit and Loss This approach should also help address various metrics), low volatility, and and Kurtosis of Portfolio Profit and Loss one commenter’s concern about the relatively high turnover.2755 One in the metrics set as the most need for new, sophisticated systems to commenter recommended that New comprehensive metric in the revenue- differentiate bid-ask spreads from price Trades P&L be substituted for Portfolio relative-to-risk category making other 2762 appreciation.2752 The utility of this P&L for purposes of computing metrics unnecessary in this area. modified approach is discussed in more Volatility of P&L because New Trades Another commenter argued that this detail in the discussion of the market- P&L captures customer revenues more metric would produce inconsistent making exemption.2753 Finally, the completely and is therefore more useful results within and across trading units Comprehensive Profit and Loss for distinguishing market making from and would generally not support any Attribution metric will ensure that all proprietary trading.2756 Another meaningful conclusions regarding the components of a trading desk’s profit commenter indicated that Skewness of permissibility or risk of trading 2763 and loss are measured in a consistent Portfolio Profit and Loss and Kurtosis of activities. and comprehensive fashion so that each Portfolio Profit and Loss incorporates After carefully considering the individual component can be reliably (and therefore obviates the need for a comments received, the final rule does compared against other components of a separate calculation of) the metric not include any of the proposed trading desk’s profit and loss without Volatility of Portfolio Profit and revenue-relative-to-risk measurements. being considered in isolation or taken Loss.2757 Each of these measures provides information that may generally be useful out of context. One commenter urged that after-the- for characterizing the overall risk profile This measurement is intended to fact application of Comprehensive Profit of the trading activities of each trading capture the extent, scope, and type of and Loss to Volatility Ratio may cause unit and evaluating the extent to which profits and losses generated by trading firms to reconsider their commitment to the quantitative profile of a trading activities and provide important context market making and argued that this unit’s activities is consistent with for understanding how revenue is metric should be applied flexibly in permissible trading activities. The broad generated by trading activities. Because light of market conditions prevailing information content of these measures, permitted market making-related during the relevant time period and as however, can largely be reproduced activities seek to generate profits by one of many factors relevant to an from transformations of information that providing customers with assessment of overall bona fide market will be provided in the Comprehensive intermediation and related services making.2758 One commenter supported Profit and Loss Attribution and, as while managing, and to the extent monitoring Portfolio Profit and Loss to noted above, volatility of practicable minimizing, the risks Volatility Ratio and argued that the comprehensive profit and loss must be associated with any asset or risk Agencies should establish a clear reported. Analogs to the other metrics inventory required to meet customer pattern of profit and loss results of demands, these revenue measurements such as Skewness of Portfolio Profit and Loss and Kurtosis of Portfolio Profit and would appear to provide helpful 2754 See, e.g., Goldman (Prop. Trading); Volcker; information to banking entities and the John S. Reed; see also AFR et al. (Feb. 2012); Sen. Loss can be computed similarly from Agencies regarding whether actual Merkley; Occupy; Public Citizen. information that will be provided in the revenues are consistent with these 2755 See Occupy; Public Citizen; Sen. Merkley. Comprehensive Profit and Loss 2756 expectations. See Goldman (Prop. Trading) (also suggesting Attribution. Accordingly, the that New Trades P&L be substituted for Portfolio information contained in these metrics P&L in Comprehensive Profit and Loss to Volatility 2750 See Barclays. Ratio and Portfolio Profit and Loss to Volatility 2751 See JPMC; UBS; SIFMA et al. (Prop Trading) Ratio and Unprofitable Trading Days based on 2759 See AFR et al. (Feb. 2012). (Feb. 2012); ABA (Keating); BoA; Barclays; Credit Comprehensive Profit and Loss and Unprofitable 2760 See Occupy. Suisse (Seidel). Trading Days based on Portfolio Profit and Loss). 2761 See Barclays. 2752 See BoA. 2757 See Barclays. 2762 See Barclays. 2753 See supra Part VI.A.3.c.7.c. 2758 See NYSE Euronext. 2763 See Goldman (Prop. Trading).

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is retained in the final rule while the trading desk holds risk and inventory contended that the metric would be burden associated with computing, consistently within the asset class in appropriate as long as banking entities auditing and reporting these additional which such trading desk deals, the type have the flexibility to determine who is metrics on an ongoing basis has been of trading activity in which the trading a customer.2777 One commenter argued eliminated. unit engages, and the scale and scope of that using a definition of ‘‘customer’’ Under the proposal, the fourth set of the client activity that such trading desk that is different between the market quantitative measurements related to serves.2770 This commenter suggested making-related activity and the reported customer-facing activity measurements. tailoring the metric based on the market metric could make legitimate market These metrics include Inventory Risk for a particular asset class and market making-related activity with customers Turnover, Inventory Aging, and conditions because aging levels may be appear to be prohibited proprietary Customer-facing Trade Ratio. higher in less liquid markets. A number trading.2778 This commenter argued that A few commenters supported the of commenters argued that application other dealers and other registered proposal’s Inventory Risk Turnover of the Inventory Aging metric is only market participants should be metric though some of these appropriate for cash products and recognized as customers of the banking commenters suggested modifications to should not be used for trading units entity. A few commenters contended the metric.2764 One commenter argued engaged in transactions in financial that this metric would be burdensome if that this metric could indicate whether instruments such as derivatives.2771 it required a banking entity to tag a given trading unit holds risk and Another commenter argued that the individual trades as customer or non- inventory consistently with the asset Inventory Aging metric is generally not customer.2779 A few commenters argued class in which such trading unit deals, useful for derivatives, and for non- that interdealer trading should be the types of trading activity in which derivatives it provides essentially allowed as part of market making and the trading unit engages, and the scale similar information to Inventory Risk argued this metric would not provide a and scope of the client activity that such Turnover.2772 One commenter requested useful measure of customer-facing trading unit serves.2765 Another additional guidance on how to calculate activity.2780 Some commenters also commenter argued that the final rule this metric.2773 expressed concern about the should explicitly state that a trading A few commenters indicated that the implications of such a metric for unit’s inventory management practices Customer-Facing Trade Ratio could be hedging activity, which may involve will be evaluated using this metric.2766 helpful in distinguishing prohibited relatively less customer-facing Some commenters expressed the view proprietary trading from market making activity.2781 that this metric might be useful in the and would be more effective than the After carefully considering the case of liquid positions but not in the proposal’s negative presumption against comments received, the final rule case of illiquid or difficult-to-hedge interdealer trading to evaluate the retains all three of the customer-facing products, which naturally have lower amount of interdealer trading that is activity measurements from the risk turnover. Others noted support for consistent with market making-related proposal, though each measure has been this metric tailored on an asset-by-asset or hedging activity in a particular modified. A number of commenters basis.2767 business.2774 Some commenters raised issues regarding the complexities A few commenters requested that the suggested that the metric could be associated with computing the final rule clarify that this metric will not improved and argued that the number of Inventory Risk Turnover metric. In be required to be calculated for every transactions executed over a calculation particular, as noted above, some possible Risk Factor Sensitivity period does not provide an adequate commenters argued that computing the measurement for the applicable measure for the level of customer-facing metric for every reported risk factor trading because it does not reflect the sensitivity would be burdensome and portfolio and that a banking entity and 2782 its regulator should determine one or size of transactions or the amount of would not be informative. The two core risk factors per asset classes risk. These commenters suggested inventory metric required in the final with respect to which this metric that replacing the metric with a more risk- rule, Inventory Turnover, is applied at will be calculated to strike a reasonable sensitive metric or defining the ratio so the transaction level and not at the risk balance between costs of calculations that it measures notional principal risk factor sensitivity level. Accordingly, for a given trading desk and calculation and benefits of this metric.2768 Other associated with customer transactions period, e.g., 30 days, there is only one commenters argued the Inventory Risk and is appropriately tailored to the 2775 value of the Inventory Turnover metric Turnover Metric was difficult to relevant asset class or market. rather than one value for each risk factor measure, burdensome, and would create A number of commenters raised sensitivity that is managed and reported uncertainty for derivatives concerns about the definition of by the trading desk. In this sense, the counterparties.2769 customer for purposes of this metric. turnover metric required in the final A few commenters supported the One commenter argued that a failure to rule is similar to more traditional and Inventory Aging metric. One commenter define ‘‘customer’’ to differentiate common measures of inventory argued it should be included in the between customers and non-customers turnover. Moreover, the required metrics set to indicate whether a given would render this metric meaningless.2776 Another commenter turnover metric is simpler and less 2764 See Goldman (Prop. Trading); Barclays; John costly to track and record while still Reed; JPMC; SIFMA et al. (Prop. Trading) (Feb. 2770 See Barclays; see also Invesco. 2012); Wells Fargo (Prop. Trading). 2771 See Barclays; Goldman (Prop. Trading); 2777 See Wells Fargo (Prop. Trading). 2765 See Barclays. Japanese Bankers Ass’n; Morgan Stanley; SIFMA 2778 See SIFMA (Prop. Trading) (Feb. 2012). 2766 See Goldman (Prop. Trading). (Prop. Trading) (Feb. 2012). 2779 See SIFMA (Prop. Trading) (Feb. 2012); see 2767 See, e.g., Barclays; Goldman (Prop. Trading); 2772 See Goldman (Prop. Trading). also Goldman (Prop Trading). JPMC; John Reed. 2773 See Socie´te´ Ge´ne´rale. 2780 See Barclays; Japanese Bankers Ass’n; Oliver 2768 See Goldman (Prop. Trading); JPMC; SIFMA 2774 See Goldman (Prop. Trading); see also Wyman (Dec. 2011); SIFMA (Prop. Trading) (Feb. et al. (Prop. Trading) (Feb. 2012); see also Morgan Invesco. 2012). Stanley. 2775 See Barclays; Goldman (Prop. Trading) ; 2781 See Barclays; Wells Fargo (Prop. Trading). 2769 See Japanese Bankers Ass’n; SIFMA (Asset JPMC; SIFMA (Prop. Trading) (Feb. 2012); UBS. 2782 See Goldman (Prop. Trading); JPMC; SIFMA Mgmt.) (Feb. 2012); Morgan Stanley. 2776 See Occupy. (Prop. Trading) (Feb. 2012).

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providing banking entities and Agencies purposes of the market-making incorporates the Spread P&L metric.2788 with meaningful information regarding exemption. This will ensure that the Some of these commenters argued that the extent to which the size and volume information provided by this metric is the metric requires a trade-by-trade of trading activities are directed at useful for purposes of monitoring analysis which would be expensive to servicing the demands of customers. In compliance with the market-making compute and would not provide any addition, the description of Inventory exemption.2785 additional information that is not Turnover in the final rule provides The fifth set of quantitative available from other metrics. One explicit guidance on how to apply the measurements relates to the payment of commenter alleged that this metric was metric to derivative positions.2783 fees, commissions, and spreads, and not calculable by any methodology.2789 Inventory Aging provides banking includes the Pay-to-Receive Spread The Pay-to-Receive Spread Ratio has entities and Agencies with meaningful Ratio. This measurement was intended not been retained in the final rule. As information regarding the extent to to measure the extent to which trading noted by some commenters, the broad which the size and volume of trading activities generate revenues for information content of this metric will activities are directed at servicing the providing intermediation services, largely be captured in the demands of customers. In the case of rather than generate expenses paid to Comprehensive Profit and Loss Inventory Aging, the proposal required other intermediaries for such services. Attribution measurement. In addition, that the aging schedule be organized Because market making-related the Comprehensive Profit and Loss according to a specific set of age ranges activities ultimately focus on servicing Attribution will place such factors that (i.e., 0–30 days, 30–60 days, 60–90 days, customer demands, they typically are related to the proposed Pay-to- 90–180 days, 180–360 days, and more generate substantially more fees, Receive Spread Ratio in context with than 360 days). This requirement has spreads and other sources of customer other factors that determine total not been adopted in the final rule in revenue than must be paid to other profitability. Accordingly, factors order to provide greater flexibility and intermediaries to support customer relating to the payment of fees, to recognize that specific age ranges that transactions. Proprietary trading commissions and spreads will not be may be relevant for one asset class may considered in isolation but will be activities, however, that generate almost be less relevant for another asset class. viewed in a context that is appropriate no customer facing revenue will Also, to address commenters’ to the entirety of the trading desk’s typically pay a significant amount of uncertainty about how this metric activities. Finally, using the information fees, spreads and commissions in the would apply to derivatives, the final contained in the Comprehensive Profit execution of trading strategies that are rule’s description of the Inventory Aging and Loss Attribution to holistically expected to benefit from short-term metric provides guidance on how to assess the range of factors that price movements. Accordingly, the apply the metric to derivative determine overall profitability, rather Agencies expected that the proposed positions.2784 than requiring a large number of Pay-to-Receive Spread Ratio The Customer Facing Trade Ratio separate and distinct measurements, provides directionally useful measurement would be useful in will reduce the resulting compliance information regarding the extent to assessing whether permitted market burden while ensuring an integrated which trading transactions are making-related activities are primarily and holistic approach to assessing the conducted with customers. In the case generating, rather than paying, fees, activities of each trading desk. of the Customer Facing Trade Ratio, the spreads and other transactional Commenters also suggested a number proposal required that customer trades revenues or expenses. A level of fees, of additional metrics be added to the be measured on a trade count basis. The commissions, and spreads paid that is final rule that were not contained in the final rule requires that the Customer inconsistent with prior experience, the proposal. One commenter, who Facing Trade Ratio be computed in two experience of similarly situated trading advocated for an alternative framework ways. As in the proposal, the metric desks and management’s stated for market making supported by must be computed by measuring trades expectations for such measures could structural and transactional metrics, on a trade count basis. Additionally, as indicate impermissible proprietary suggested that structural metrics could suggested by some commenters, the trading. include the ratio of salespeople to final rule requires that the metric be One commenter expressed concern traders and the level of resources computed by measuring trades on a that after-the-fact application of the Pay- devoted to client research and trading notional value basis. The value based to-Receive Spread Ratio could cause content.2790 Two commenters supported approach is required to reflect the fact firms to reconsider their commitment to the use of a counterparty risk exposure noted by some commenters, that a trade market making. This commenter measure, not only to the risk of count based measure may not accurately suggested that if this measure is used, it counterparty default but also to represent the amount of customer facing be applied flexibly, in light of market potential gains and losses to major activity if customer trade sizes conditions prevailing during the counterparties for each of a list of systematically differ from the sizes of relevant time period, and as one of systemically important scenarios.2791 non-customer trades. In addition, the many factors relevant to an overall One of these commenters suggested that term ‘‘customer’’ for purposes of the assessment of bona fide market entity-wide inflation risk assessments be Customer-Facing Trade Ratio is defined making.2786 Another commenter produced on a daily basis.2792 This in the same manner as the terms client, suggested expanding the flexibility commenter also argued that an customer, and counterparty used for offered in choosing a bid-offer source to important metric that is missing is a the entire process of calculating Pay-to- Liquidity Gap Risk metric that estimates 2787 2783 The Agencies believe that this should address Receive Spread Ratio. A number of commenters’ uncertainty with respect to how the commenters argued for removing this 2788 See CH/ABASA; Goldman (Prop. Trading); Inventory Risk Turnover metric would work for metric because its calculation Japanese Bankers Ass’n; Occupy; SIFMA (Prop. derivatives. See Japanese Bankers Ass’n; SIFMA Trading) (Feb. 2012); Wells Fargo (Prop. Trading). (Asset Mgmt.) (Feb. 2012); Morgan Stanley. 2789 See Morgan Stanley. 2784 See Barclays; Goldman (Prop. Trading); 2785 See SIFMA (Prop. Trading) (Feb. 2012). 2790 See Morgan Stanley. Japanese Bankers Ass’n; Morgan Stanley; SIFMA 2786 See NYSE Euronext. 2791 See Prof. Duffie; Occupy. (Prop. Trading) (Feb. 2012). 2787 See UBS. 2792 See Occupy.

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the price change that occurs following a instrument, may be used by banking all of the quantitative measurements are sudden disruption in liquidity for a entities as they develop their own useful for all asset classes and markets, product, arguing that there needs to be quantitative measurements. as well as for all the trading activities an industry-wide effort to more For each individual quantitative subject to the metrics requirement, or if accurately measure and account for the measurement in the final rule, further tailoring is warranted.2796 The significant effect that liquidity and Appendix A describes the measurement, Agencies propose to revisit the metrics changes in its prevailing level have on provides general guidance regarding and determine, based on a review of the the valuation of each asset. how the measurement should be data collected by September 30, 2015, One commenter argued that the calculated and specifies the period over whether to modify, retain or replace the metrics regime was well-designed for which each calculation should be made. metrics. To allow firms to develop market-making but lacking in other The proposed quantitative systems to calculate and report these areas like hedging. This commenter measurements attempt to incorporate, metrics, the Agencies have delayed all recommended the addition of additional wherever possible, measurements reporting of the metrics until July 2014, metrics more applicable to other non- already used by banking entities to phased in the reporting requirements market making activities like a net profit manage risks associated with their over a multi-year period, and reduced metric for hedging.2793 Two commenters trading activities. Of the measurements the category of banking entities that argued that quantitative measurement proposed, the Agencies expect that a must report the metrics to a smaller for underwriting was not included in large majority of measurements number of firms that engage in the proposal and stated that in a bona proposed are either (i) already routinely significant trading activity. These steps, fide underwriting, unsold balances calculated by banking entities or (ii) combined with the reduction in the should be relatively small so a marker based solely on underlying data that are number of metrics required to be for potential non-bona fide underwriting already routinely calculated by banking reported, are designed to reduce the cost should be recognized if VaR (unhedged entities. However, calculating these and burden associated with compiling and uncovered) of the unsold balance measurements according to the and reporting the metrics while that is allocated to a banking entity is specifications described in Appendix A retaining the usefulness of this data large relative to the expected revenue and at the trading desk level mandated collection in helping to ensure that measured by the pro rata underwriting by the final rule may require banking trading activities are conducted in spread.2794 entities to implement new processes to compliance with section 13 of the BHC After carefully considering the calculate and furnish the required Act and the final rule and in a manner comments received, these and other data.2795 that monitors, assesses and controls the proposed metrics have not been The extent of the burden associated risks associated with these activities. included as part of the final rule. One with calculating and reporting 4. Section 75.21: Termination of major concern raised by a range of quantitative measurements will likely commenters was the degree of Activities or Investments; Authorities vary depending on the particular for Violations complexity and burden that would be measurements and differences in the required by the metrics reporting sophistication of management Section 75.21 implements section regime. In light of these comments, the information systems at different banking 13(e)(2) of the BHC Act, which authorizes an Agency to order a banking final rule includes a number of entities. As noted, the proposal tailored entity subject to its jurisdiction to quantitative measurements that are these data collections to the size and terminate activities or investments that expected to provide a means of type of activity conducted by each violate or function as an evasion of characterizing the overall risk profile of banking entity in an effort to minimize section 13 of the Act.2797 Section the trading activities of each trading the burden in particular on firms that 13(e)(2) further provides that this desk and evaluating the extent to which engage in few or no trading activities paragraph shall not be construed to the quantitative profile of a trading subject to the proposed rule. limit the inherent authority of any desk’s activities is consistent with The Agencies have also attempted to Federal agency or State regulatory permissible trading activities in a cost provide, to the extent possible, a authority to further restrict any effective and efficient manner while standardized description and general investments or activities under being appropriate for a range of different method of calculating each quantitative otherwise applicable provisions of trading activities. Moreover, while many measurement that, while taking into law.2798 commenters suggested a number of account the potential variation among different alternative metrics, many of The proposed rule implemented trading practices and asset classes, section 13(e)(2) in two parts. First, these alternatives are consistent with would facilitate reporting of sufficiently the broad themes, risk management, § 75.21(a) of the proposal required any uniform information across different banking entity that engages in an sources of revenues, customer facing banking entities so as to permit activity, that inform the quantitative activity or makes an investment in horizontal reviews and comparisons of violation of section 13 of the BHC Act measurements that are retained in the the quantitative profile of trading desks final rule. Finally, banking entities will or the proposed rule, or in a manner that across firms. functions as an evasion of the be expected to develop their own The Agencies expect to evaluate the metrics, as appropriate, to further data collected during the compliance inform and improve their own 2796 The Agencies believe this review, along with period both for its usefulness as a the fact that quantitative measurements will not be monitoring and understanding of their barometer of impermissible trading used as a dispositive tool for determining trading activities. Many of the activity and excessive risk-taking and compliance and the removal of many of the alternative metrics that were suggested for its costs. This evaluation will proposed metrics, should help address commenters’ by commenters, especially those that concerns that some of the proposed quantitative consider, among other things, whether measurements will not be as relevant for certain relate to a specific market or type of asset classes, markets, and activities. See Morgan 2795 See Credit Suisse (Seidel); Morgan Stanley; Stanley; SIFMA et al. (Prop. Trading); Stephen 2793 See AFR et al. (Feb. 2012). UBS; Wells Fargo (Prop. Trading); Socie´te´ Ge´ne´rale; Roach. 2794 See AFR et al. (Feb. 2012); see also Public Occupy; Paul Volcker; AFR et al. (Feb. 2012); 2797 See 12 U.S.C. 1851(e)(2). Citizen. Western Asset Mgmt.; Public Citizen. 2798 Id.

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requirements of section 13 of the BHC encouraged the Agencies to rely on their removal actions, and personal cease and Act or the proposed rule, including inherent authority to impose automatic desist orders under section 8 of the through an abuse of any activity or penalties and fines.2805 A few FDIA. Submission of late, false, or investment permitted under subparts B commenters stated that traders, misleading reports, including false or C, or otherwise violates the management, and banking entities statements on compliance with section restrictions and requirements of section should be held responsible for 13 of the BHC Act or the final rule, may 13 of the BHC Act or the proposed rule, violations under certain also result in actions under applicable to terminate the activity and, as circumstances.2806 Finally, another securities, commodities, banking, and relevant, dispose of the investment.2799 commenter recommended that officers criminal laws, including imposition of Second, § 75.21(b) of the proposal and directors of a banking entity be civil money and criminal penalties.2811 provided that if, after due notice and an removed from office, be prohibited from Therefore, the final rule is consistent opportunity for hearing, the respective being affiliated with a banking entity, with the proposal and does not mention Agency finds reasonable cause to and be subject to salary clawbacks for other enforcement actions available to believe that any banking entity has violations of section 13 of the BHC Act address violations of section 13 of the engaged in an activity or made an and the final rule.2807 BHC Act and this final rule. investment described in paragraph (a), The Agencies note that the authorities Section 13 of the BHC Act and the the Agency may, by order, direct the provided for in § 75.21 are not final rule do not limit the reach or entity to restrict, limit, or terminate the exclusive. The Agencies have a number applicability of the antifraud and other activity and, as relevant, dispose of the of enforcement tools at their disposal to provisions of the Federal laws to investment.2800 carry out their obligations to ensure banking entities, including, for example, Several commenters urged the compliance with section 13 of the BHC section 17(a) of the Securities Act of Agencies to strengthen the authorities Act and the final rule, and need not 1933 or section 10(b) and 15(c) of the provided for under § 75.21,2801 with reference them expressly in § 75.21 in Exchange Act and the rules promulgated some commenters expressing concern order to exercise them. Specifically, the thereunder. that the proposed rule does not establish Agencies may rely on their inherent One commenter also suggested that sufficient enforcement mechanisms and authorities under otherwise applicable the Agencies use their authority under penalties for violations of the rule’s provisions of banking, securities, and section 13(d)(3) of the BHC Act to requirements.2802 Some commenters commodities laws to bring enforcement impose additional capital requirements suggested the Agencies add language in actions against banking entities, their and quantitative limitations on banking § 75.21 authorizing the imposition of officers and directors, and other entities for repeat violations of the automatic and significant financial institution-affiliated parties for prohibition on proprietary trading.2812 penalties—as significant as the potential violations of law.2808 For example, a The Agencies believe they can rely on gains from illegal proprietary trading— banking entity that violates section 13 of other inherent enforcement authorities on traders, supervisors, executives, and the BHC Act and the final rule may be to address repeat violations. The firms for violating section 13 of the BHC subject to criminal and civil penalties Agencies note that several other Act and the final rule.2803 These under section 8 of the BHC Act. Banking commenters also requested the Agencies commenters suggested the Agencies entities may also be subject to formal to exercise their authority under section incorporate reference to the Board’s enforcement actions under section 8 of 13(d)(3).2813 The Agencies do not authority under section 8 of the BHC the Federal Deposit Insurance Act believe that it is appropriate to exercise Act into the rule,2804 and others (FDIA), such as cease and desist orders their authority under this section at this or civil money penalty actions,2809 or time, primarily because the capital 2799 See proposed rule § 75.21(a). The proposal safety and soundness orders under treatment of banking entities’ trading noted that the Agencies included § 75.21(a), in section 39 of the FDIA which may be addition to the provisions of § 75.21(b) of the activities is currently being addressed proposed rule, to clarify that the requirement to enforceable through assessment of civil through the Agencies’ risk-based capital terminate an activity or, as relevant, dispose of an money penalties and through the rulemakings.2814 Additionally, the investment would be triggered when a banking Federal court system. In addition, Agencies believe Congress intended entity discovers the violation or evasion, regardless officers, directors, and other institution- section 13(d)(3) to serve the prudential of whether an Agency order has been issued. affiliated parties 2810 may be subject to 2800 See proposed rule § 75.21(b). purposes of bolstering the safety and 2801 See Sen. Merkley; Better Markets (Feb. 2012); civil money penalties, prohibition or soundness of individual banking Occupy; AFR et al. (Feb. 2012); Public Citizen. entities and the wider U.S. financial 2802 See, e.g., BEC et al. (Jan. 2012); John Reed; BHC Act). See also Occupy (requesting the Agencies system. To the extent commenters Better Markets (Feb. 2012); AFR et al. (Feb. 2012); provide penalties that are specific to this rule in Occupy; Sen. Merkley; Public Citizen. addition to the general framework for criminal and 2811 2803 See, e.g., Form Letter Type A; Form Letter civil penalties in section 8 of the BHC Act). See, e.g., 12 U.S.C. 164 (authorizing Type B; Sarah McKee; David R. Wilkes; Ben Leet; 2805 See Better Markets (Feb. 2012); Occupy; AFR imposition of civil money penalties for, among Karen Michaelis; Barry Rein; Allan Richardson; et al. (Feb. 2012). other things, submitting false or misleading reports Ronald Gedrim; Susan Pashkoff; Joan Budd; Frances 2806 See John Reed; Better Markets (Feb. 2012). or information to the OCC); 18 U.S.C. 1005 Vreman; Lisa Kazmier; Michael Wenger; Dyanne See also BEC et al. (Jan. 2012) (arguing that CEOs (authorizing imposition of fines of not more than DiRosario; Alexander Clayton; James Ofsink; and CFOs should be held fully responsible for any $1,000,000 or imprisonment not more than 30 Richard Leining (arguing that violators should face violations of the rule by any employees above the years, or both, for, among other things, making a penalties such as seizure and discharge of the board clerical level); Occupy (recommending that traders false entry in the books, reports or statements of a and executives); Lee Smith; see also Occupy; Public relying on an exemption in the proposed rule be bank with intent to injure, defraud or deceive). Citizen. held personally liable for any losses on trading 2812 See Better Markets (Feb. 2012). 2804 See Better Markets (Feb. 2012) (contending positions). 2813 See Sen. Merkley; Public Citizen; Better that penalties should include specific 2807 See Occupy. Markets (Feb. 2012); Profs. Admati & Pfleiderer. administrative penalties, including monetary 2808 See 12 U.S.C. 1851(g)(3). 2814 See Regulatory Capital Rules: Regulatory penalties, bars, cease and desist orders, 2809 See, e.g., 12 U.S.C. 1818(i) (authorizing Capital, Implementation of Basel III, Capital strengthened penalties for recurring violations, and imposition of civil money penalties up to the Adequacy, Transition Provisions, Prompt Corrective sanctioning of employees involved in the violation maximum daily amount of $1,000,000 for, among Action, Standardized Approach for Risk-weighted and public reporting of such sanctions); AFR et al. other things, knowing violations of law or Assets, Market Discipline and Disclosure (arguing that section 8 of the BHC Act provides civil regulation). Requirements, Advanced Approaches Risk-Based penalties for violations by a company or individual 2810 See 12 U.S.C. 1813(u) (defining ‘‘institution- Capital Rule, and Market Risk Capital Rule; Final and criminal penalties for willful violations of the affiliated party’’). Rule, 78 FR 62017 (Friday, October 11, 2013).

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suggested section 13(d)(3) be employed commenters urged the Agencies to activity or makes an investment in for a punitive purpose, the Agencies do supervise and enforce the rule on a violation of section 13 of the BHC Act not believe the provision was designed coordinated basis so as to minimize or the final rule or acts in a manner that to serve such a purpose nor do the duplicative enforcement efforts, reduce functions as an evasion of the Agencies believe that would be an costs, and promote certainty.2820 requirements of section 13 of the BHC appropriate use of the provision. Thus, Section 13(e)(2) mandates that each Act or the final rule, including through the Agencies believe section 13(d)(3) is Agency enforce compliance of section an abuse of any activity or investment more appropriately employed for the 13 with respect to a banking entity permitted or expressly excluded by the prudential purposes of bolstering the ‘‘under the respective [A]gency’s terms of the final rule, or otherwise safety and soundness of individual jurisdiction.’’ 2821 This section provides violates the restrictions and banking entities and the wider financial the Agencies with the authority to order requirements of section 13 of the BHC stability of the U.S. financial system. a banking entity to terminate activities Act or the final rule, shall, upon Commenters also urged the Agencies or investments that violate or function discovery, promptly terminate the to clearly delineate in the final rule the as an evasion of section 13 of the BHC activity and, as relevant, dispose of the jurisdictional authority of each of the Act.2822 Decisions about whether to investment. This provision allows the Agencies to enforce compliance with issue such orders could be made after Agencies to enforce the rule’s section 13 of the BHC Act and the examinations or otherwise. Nothing in prohibitions against proprietary trading implementing final rule. A number of the final rule limits an Agency’s and sponsoring or owning interests in commenters recommended approaches inherent authority to conduct covered funds regardless of how to coordinating examinations and examinations or otherwise inspect banking entities classify their actions, enforcement among the Agencies, as banking entities to ensure compliance while also providing banking entities well as to providing interpretive with the final rule. Section 75.1 of each the freedom to legitimately engage in guidance.2815 For example, some Agency’s proposed rule described the those banking activities which are commenters observed that more than specific types of banking entities to outside the scope of the statute. one Agency would have jurisdiction which that Agency’s rule applies. The VII. Administrative Law Matters over a given banking entity, and Agencies acknowledge commenters’ recommended that supervision and concerns about overlapping A. Paperwork Reduction Act Analysis enforcement of the final rule for all jurisdictional authority. The Agencies The Paperwork Reduction Act entities within a banking enterprise recognize that, on occasion, a banking 2816 (‘‘PRA’’) provides that a Federal agency remain completely with one Agency. entity may be subject to jurisdiction by may not conduct or sponsor, and a Further, some commenters more than one Agency. As is customary, person is not required to respond to, a recommended that a single Agency be the Agencies plan to coordinate their collection of information unless it appointed to provide interpretations, examination and enforcement displays a currently valid control supervision, and enforcement of section proceedings under section 13, to the number issued by the Office of 13 and the rules thereunder for all extent possible and practicable, so as to 2824 2817 Management and Budget (‘‘OMB’’). banking entities. Similarly, one limit duplicative actions and undue This final rulemaking contains several commenter suggested that the Board be costs and burdens for banking collections of information for which the given initial authority to supervise the entities.2823 three Federal banking agencies—the implementation of the rule because it is The Agencies are adopting § 75.21 Board, the OCC, and FDIC—sought the primary enforcer of the BHC Act and substantially as proposed. Accordingly, control numbers at the time they the single regulator that can currently § 75.21(a) of the final rule provides that proposed the same substantive look across a banking group’s entire any banking entity that engages in an requirements that the Commission later global businesses, regardless of legal proposed.2825 entity. This commenter stated that the jurisdictional authority, such as Super 23A); JPMC To avoid double accounting of Board could then determine whether an (contending that the Agencies should adopt and information collections for which activity should be delegated to one of seek comment on a protocol for supervision and enforcement that will ensure a given banking entity control numbers were sought, the the other Agencies for further Commission did not propose and is not 2818 will face one set of rules and different banking examination or enforcement. In entities will face the same set of rules). The finalizing an information collection addition, with respect to interpretive Agencies decline to adopt the commenter’s request for this rulemaking. Rather, as authority, some commenters indicated suggested approach of deferring to the Board’s sole indicated in its proposed rulemaking, that the Board should be given sole interpretive authority with respect to the provisions of the final rule. The Agencies believe at this time the Board provided that it would submit interpretive authority of the statute and that such an approach would be neither appropriate 2819 its information collection to OMB once the rules thereunder. Other nor effective given the different authorities and its final rule is published, and that the expertise of each Agency. See Part VI.C (discussing submission would include burden for 2815 See SIFMA et al. (Prop. Trading) (Feb. 2012); the Agencies’ decision not to adopt some JPMC; Barclays; Goldman (Prop. Trading); BoA; commenters’ requests that a single agency be Federal Reserve-supervised institutions, ABA (Keating); Comm. on Capital Market responsible for determining compliance with as well as burden for OCC-, FDIC-, Regulation; BEC et al.; ISDA (Apr. 2012). section 13). SEC-, and CFTC-supervised institutions 2816 See Barclays (arguing that ideally the 2820 See SIFMA et al. (Prop. Trading) (Feb. 2012); under a holding company.2826 The umbrella Federal regulator of the enterprise should BoA (stating that the Agencies should issue one set take this role); Goldman (Prop. Trading). of exam findings under these circumstances); ISDA Board, OCC, and FDIC, as well as the 2817 See BoA; BEC et al. (Apr. 2012). SEC, are expected to adopt equivalent 2818 See Comm. on Capital Market Regulation. 2821 See 12 U.S.C. 1851(c)(2). final rulemakings on or about the same 2819 See SIFMA et al. (Prop. Trading) (Feb. 2012); 2822 See 12 U.S.C. 1851(e)(2) (requiring ‘‘due date as the CFTC adopts its final rule. BoA (recommending that the Board be responsible notice and opportunity for hearing’’). The Board, OCC, and FDIC included in for resolving potentially conflicting supervisory 2823 See 12 U.S.C. 1844 (establishing recommendations or matters requiring attention jurisdictional boundaries for regulation of bank 2824 arising from examinations as well); ISDA (Apr. holding companies); see also 12 U.S.C. 1828a 44 U.S.C. 3501 et seq. 2012). See also ABA (Keating) (arguing that the (antievasion statute empowering OCC, FDIC, and 2825 See 76 FR 68846, 68936, Nov. 7, 2011 (joint Agencies should defer to the Board’s sole authority the Board to impose restrictions on relationships or release of the Board, OCC, FDIC, and the SEC), and to interpret provisions of Volcker that intersect with transactions between banks and their subsidiaries 77 FR 8332, 8420, Feb. 14, 2012. other statutory provisions subject to the Board’s and affiliates). 2826 76 FR at 68936.

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the Supplementary Information of their entities’’).2827 Pursuant to section 605(b) compliance program prior to becoming final rulemakings an overview of their of the RFA, a FRFA is not required if an engaged in such activities or making PRA analyses including burden cost agency certifies that the final rule will such investments. In addition, to estimates, with further analyses to be not have a significant economic impact minimize the burden on small banking provided in the supporting statements on a substantial number of small entities, a banking entity with total required to be submitted to OMB entities. The Agencies have considered consolidated assets of $10 billion or less according to their regulations the potential economic impact of the that engages in covered trading implementing the PRA. final rule on small banking entities in activities and/or covered fund activities accordance with the RFA. The Agencies may satisfy the requirements of the final In particular, section 619 of the Dodd- believe that the final rule will not have rule by including in its existing Frank Act provides that the banking a significant economic impact on a compliance policies and procedures agencies, the SEC, and the Commission substantial number of small banking appropriate references to the engage in ‘‘coordinated rulemaking,’’ entities for the reasons described below. requirements of section 13 and the final which includes all entities for which the The Agencies previously considered rule and adjustments as appropriate Commission ‘‘is the primary financial the impact of the proposed rule for given the activities, size, scope and regulatory agency, as defined in section purposes of the RFA and concluded that complexity of the banking entity. Only 2’’ of the Dodd-Frank Act. Section 2 the proposed rule would not appear to those banking entities with total assets defines ‘‘primary financial regulatory have a significant economic impact on of greater than $10 billion will need to agency’’ as a Federal banking agency a substantial number of small banking adopt more detailed or enhanced with respect to certain depository entities. In support of this conclusion, compliance requirements under the institutions except as provided in other the proposed rule, among other things, final rule. (For purposes of the subsections of section 2. In subsection noted that the thresholds for the metrics enhanced compliance program in (12)(C), the Commission is designated as reporting requirements under § 75.7 and Appendix B of the final rule, the the primary financial regulatory agency Appendix A and for the enhanced and threshold for banking entities is total for, among other things, ‘‘any . . . swap core compliance program requirements consolidated assets of $50 billion or dealer . . . registered with the under § 75.20 and Appendix C of the more.) Accordingly, the compliance [Commission] . . ..’’ Section 4s(c)(1) of proposed rule would not capture small requirements under the final rule do not the CEA, as adopted in section 731 of banking entities.2828 have a significant economic impact on the Dodd-Frank Act, provides that ‘‘any The Agencies received several a substantial number of small banking person that is required to be registered comments on the impact of the entities. as a swap dealer shall register with the proposed rule on small entities. Likewise, the final rule raises the Commission regardless of whether the Commenters argued that the Agencies threshold for metrics reporting from the person is also a depository institution.’’ incorrectly concluded that the proposed proposed rule to capture only firms that rule would not have a significant engage in significant trading activities. Accordingly, banking entities, Specifically, the metrics reporting including domestic depository economic impact on a substantial number of small entities.2829 requirements under § 75.20 and institutions and branches and agencies Appendix A of the final rule apply only of foreign banks subject to supervision Commenters asserted that the proposed rule would have a significant economic to banking entities with average trading by OCC or the Board, have registered assets and liabilities on a consolidated, impact on numerous small non-banking with the Commission. It is presently not worldwide basis for the preceding year entities by restricting their access to a known how many additionally may equal to or greater than $10 billion. variety of products and services, register. To ensure that the Commission Accordingly, the metrics reporting including covered fund-linked products has access to fulfill its statutory requirements under the final rule do not for investment and hedging purposes obligations and not unduly burden its impact small banking entities. and underwriting and market-making registrants with duplicative information 2830 Moreover, the Agencies have revised collection requirements, and pursuant related services. the definition of covered fund in the The Agencies have carefully to its proposed rulemaking, the final rule to address many of the considered these comments in Commission will request, pursuant to 44 concerns raised by commenters developing a final rule. To minimize U.S.C. 3509, that the director of the regarding the unintended consequences burden on small banking entities, OMB designate the banking agencies as of the proposed definition.2831 The section 75.20(f)(1) of the final rule the respective collection agencies for definition of covered fund under the provides that a banking entity that does final rule contains a number of PRA purposes for all banking entities for not engage in covered trading activities exclusions for entities that may rely on which the Commission is the primary (other than trading in U.S. government exclusions from the Investment financial regulatory agency with respect or agency obligations, obligations of Company Act of 1940 contained in to this rulemaking. specified government sponsored section 3(c)(1) or 3(c)(7) of that Act but entities, and state and municipal B. Regulatory Flexibility Act Analysis that are not engaged in investment obligations) or covered fund activities activities of the type contemplated by In general, section 4 of the Regulatory and investments need only establish a Flexibility Act (5 U.S.C. 604) (RFA) section 13 of the BHC Act. These include, for example, exclusions for requires an agency to prepare a final 2827 See 13 CFR 121.201; see also 13 CFR wholly owned subsidiaries, joint regulatory flexibility analysis (FRFA) for 121.103(a)(6) (noting factors that the Small Business Administration considers in determining whether ventures, acquisition vehicles, a final rule unless the agency certifies an entity qualifies as a small business, including insurance company separate accounts, that the rule will not, if promulgated, receipts, employees, and other measures of its registered investments companies, and have a significant economic impact on domestic and foreign affiliates). public welfare investment funds. The a substantial number of small entities 2828 See Joint Proposal, 76 FR at 68938–68939. 2829 Agencies believe that these changes will (defined as of July 22, 2013, to include See BoA; SIFMA et al. (Covered Funds) (Feb. banking entities with total assets of $500 2012); Chamber (Feb. 2012); ABA (Keating). 2830 See SIFMA et al. (Covered Funds) (Feb. 2831 See Part VI.B.1. of this SUPPLEMENTARY million or less (‘‘small banking 2012); Chamber (Feb. 2012). INFORMATION.

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further minimize the burden for small PART 75—PROPRIETARY TRADING covered funds, and further explaining banking entities such as those that may AND CERTAIN INTERESTS IN AND the statute’s requirements. use wholly owned subsidiaries for RELATIONSHIPS WITH COVERED (c) Scope. This part implements organizational convenience or make FUNDS section 13 of the Bank Holding public welfare investments to achieve Company Act with respect to banking Subpart A—Authority and Definitions their financial and Community entities for which the CFTC is the Reinvestment Act goals. Sec. primary financial regulatory agency, as 75.1 Authority, purpose, scope, and defined in section 2(12) of the Dodd- Finally, in response to commenters’ relationship to other authorities. Frank Act. assertion that the proposed rule would 75.2 Definitions. (d) Relationship to other authorities. have had a significant economic impact Subpart B—Proprietary Trading Except as otherwise provided under on numerous small non-banking entities 75.3 Prohibition on proprietary trading. section 13 of the BHC Act, and by restricting their access to a variety of 75.4 Permitted underwriting and market notwithstanding any other provision of products and services,2832 the Agencies making-related activities. law, the prohibitions and restrictions note that the RFA does not require the 75.5 Permitted risk-mitigating hedging under section 13 of the BHC Act shall Agencies to consider the impact of the activities. apply to the activities of an applicable final rule, including its indirect 75.6 Other permitted proprietary trading banking entity, even if such activities activities. economic effects, on small entities that are authorized for the applicable 75.7 Limitations on permitted proprietary banking entity under other applicable are not subject to the requirements of trading activities. the final rule.2833 75.8–75.9 [Reserved] provisions of law. For the reasons stated above, the OCC, Subpart C—Covered Fund Activities and § 75.2 Definitions. FDIC, SEC, and CFTC certify, for the Investments Unless otherwise specified, for banking entities subject to each such 75.10 Prohibition on acquiring or retaining purposes of this part: Agency’s jurisdiction, that the final rule an ownership interest in and having (a) Affiliate has the same meaning as will not result in a significant economic certain relationships with a covered in section 2(k) of the Bank Holding impact on a substantial number of small fund. Company Act of 1956 (12 U.S.C. 75.11 Permitted organizing and offering, 1841(k)). entities. In light of the foregoing, the underwriting, and market making with Board does not believe, for the banking (b) Bank holding company has the respect to a covered fund. same meaning as in section 2 of the entities subject to the Board’s 75.12 Permitted investment in a covered Bank Holding Company Act of 1956 (12 jurisdiction, that the final rule would fund. 75.13 Other permitted covered fund U.S.C. 1841). have a significant economic impact on (c) Banking entity. (1) Except as a substantial number of small entities. activities and investments. 75.14 Limitations on relationships with a provided in paragraph (c)(2) of this List of Subjects in 17 CFR Part 75 covered fund. section, banking entity means: 75.15 Other limitations on permitted (i) Any insured depository institution; Banks, Banking, Compensation, covered fund activities. (ii) Any company that controls an Credit, Derivatives, Federal branches 75.16–75.19 [Reserved] insured depository institution; (iii) Any company that is treated as a and agencies, Federal savings Subpart D—Compliance Program associations, Government securities, Requirement; Violations bank holding company for purposes of section 8 of the International Banking Hedge funds, Insurance, Investments, 75.20 Program for compliance; reporting. Act of 1978 (12 U.S.C. 3106); and National banks, Penalties, Proprietary 75.21 Termination of activities or (iv) Any affiliate or subsidiary of any trading, Reporting and recordkeeping investments; penalties for violations. Appendix A to Part 75—Reporting and entity described in paragraphs (c)(1)(i), requirements, Risk, Risk retention, (ii), or (iii) of this section. Securities, Swap dealers, Trusts and Recordkeeping Requirements for Covered Trading Activities (2) Banking entity does not include: trustees, Volcker rule. Appendix B to Part 75—Enhanced Minimum (i) A covered fund that is not itself a For the reasons discussed in the Standards for Compliance Programs banking entity under paragraphs (c)(1)(i), (ii), or (iii) of this section; preamble, the Commodity Futures Authority: 12 U.S.C. 1851. (ii) A portfolio company held under Trading Commission adds part 75 to 17 Subpart A—Authority and Definitions the authority contained in section CFR Chapter I to read as follows: 4(k)(4)(H) or (I) of the BHC Act (12 § 75.1 Authority, purpose, scope, and U.S.C. 1843(k)(4)(H), (I)), or any 2832 See SIFMA et al. (Covered Funds) (Feb. relationship to other authorities. portfolio concern, as defined under 13 2012); Chamber (Feb. 2012). (a) Authority. This part is issued by CFR 107.50, that is controlled by a small 2833 See e.g., In Mid-Tex Electric Cooperative v. FERC, 773 F.2d 327 (D.C. Cir. 1985); United the Commission under section 13 of the business investment company, as Distribution Cos. v. FERC, 88 F.3d 1105, 1170 (D.C. Bank Holding Company Act of 1956, as defined in section 103(3) of the Small Cir. 1996); Cement Kiln Recycling Coalition v. EPA, amended (12 U.S.C. 1851). Business Investment Act of 1958 (15 255 F.3d 855 (D.C. Cir. 2001). Commenters relied (b) Purpose. Section 13 of the Bank U.S.C. 662), so long as the portfolio on Aeronautical Repair Station Association v. Federal Aviation Administration, 494 F.3d 161 (DC Holding Company Act establishes company or portfolio concern is not Cir 2007) to argue that the Agencies must consider prohibitions and restrictions on itself a banking entity under paragraphs the indirect economic effects of the final rule on proprietary trading by, and investments (c)(1)(i), (ii), or (iii) of this section; or small non-banking entities. This case is inapposite, in or relationships with covered funds (iii) The FDIC acting in its corporate however, because there the agency’s own rulemaking release expressly stated that the rule by, certain banking entities. This part capacity or as conservator or receiver imposed responsibilities directly on certain small implements section 13 of the Bank under the Federal Deposit Insurance Act business contractors. The court reaffirmed its prior Holding Company Act by defining terms or Title II of the Dodd-Frank Wall Street holdings that the RFA limits its application to small used in the statute and related terms, Reform and Consumer Protection Act. entities ‘‘which will be subject to the proposed regulation—that is, those small entities to which the establishing prohibitions and (d) Board means the Board of proposed rule will apply.’’ Id. at 176 (emphasis and restrictions on proprietary trading and Governors of the Federal Reserve internal quotations omitted). investments in or relationships with System.

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(e) CFTC or Commission means the Commodity Exchange Act (7 U.S.C. transfer or conveyance of, or Commodity Futures Trading 1a(19)). extinguishing of rights or obligations Commission. (l) FDIC means the Federal Deposit under, a derivative, as the context may (f) Dealer has the same meaning as in Insurance Corporation. require. section 3(a)(5) of the Exchange Act (15 (m) Federal banking agencies means (v) Qualifying foreign banking U.S.C. 78c(a)(5)). the Board, the Office of the Comptroller organization means a foreign banking (g) Depository institution has the same of the Currency, and the FDIC. organization that qualifies as such under meaning as in section 3(c) of the Federal (n) Foreign banking organization has § 211.23(a), (c) or (e) of the Board’s Deposit Insurance Act (12 U.S.C. the same meaning as in section Regulation K (12 CFR 211.23(a), (c), or 1813(c)). 211.21(o) of the Board’s Regulation K (e)). (12 CFR 211.21(o)), but does not include (h) Derivative. (1) Except as provided (w) SEC means the Securities and a foreign bank, as defined in section in paragraph (h)(2) of this section, Exchange Commission. derivative means: 1(b)(7) of the International Banking Act of 1978 (12 U.S.C. 3101(7)), that is (x) Sale and sell each include any (i) Any swap, as that term is defined contract to sell or otherwise dispose of. in section 1a(47) of the Commodity organized under the laws of the Commonwealth of Puerto Rico, Guam, For security futures products, such Exchange Act (7 U.S.C. 1a(47)), or terms include any contract, agreement, security-based swap, as that term is American Samoa, the United States Virgin Islands, or the Commonwealth of or transaction for future delivery. With defined in section 3(a)(68) of the respect to a commodity future, such Exchange Act (15 U.S.C. 78c(a)(68)); the Northern Mariana Islands. (o) Foreign insurance regulator means terms include any contract, agreement, (ii) Any purchase or sale of a or transaction for future delivery. With commodity, that is not an excluded the insurance commissioner, or a similar official or agency, of any country respect to a derivative, such terms commodity, for deferred shipment or include the execution, termination delivery that is intended to be other than the United States that is engaged in the supervision of insurance (prior to its scheduled maturity date), physically settled; assignment, exchange, or similar (iii) Any foreign exchange forward (as companies under foreign insurance law. (p) General account means all of the transfer or conveyance of, or that term is defined in section 1a(24) of assets of an insurance company except extinguishing of rights or obligations the Commodity Exchange Act (7 U.S.C. those allocated to one or more separate under, a derivative, as the context may 1a(24)) or foreign exchange swap (as accounts. require. that term is defined in section 1a(25) of (q) Insurance company means a (y) Security has the meaning specified the Commodity Exchange Act (7 U.S.C. company that is organized as an in section 3(a)(10) of the Exchange Act 1a(25)); insurance company, primarily and (15 U.S.C. 78c(a)(10)). (iv) Any agreement, contract, or predominantly engaged in writing (z) Security-based swap dealer has the transaction in foreign currency insurance or reinsuring risks same meaning as in section 3(a)(71) of described in section 2(c)(2)(C)(i) of the underwritten by insurance companies, the Exchange Act (15 U.S.C. 78c(a)(71)). Commodity Exchange Act (7 U.S.C. subject to supervision as such by a state (aa) Security future has the meaning 2(c)(2)(C)(i)); insurance regulator or a foreign (v) Any agreement, contract, or specified in section 3(a)(55) of the insurance regulator, and not operated Exchange Act (15 U.S.C. 78c(a)(55)). transaction in a commodity other than for the purpose of evading the foreign currency described in section (bb) Separate account means an provisions of section 13 of the BHC Act account established and maintained by 2(c)(2)(D)(i) of the Commodity Exchange (12 U.S.C. 1851). Act (7 U.S.C. 2(c)(2)(D)(i)); and an insurance company in connection (r) Insured depository institution has with one or more insurance contracts to (vi) Any transaction authorized under the same meaning as in section 3(c) of section 19 of the Commodity Exchange hold assets that are legally segregated the Federal Deposit Insurance Act (12 from the insurance company’s other Act (7 U.S.C. 23(a) or (b)); U.S.C. 1813(c)), but does not include an (2) A derivative does not include: assets, under which income, gains, and insured depository institution that is losses, whether or not realized, from (i) Any consumer, commercial, or described in section 2(c)(2)(D) of the other agreement, contract, or transaction assets allocated to such account, are, in BHC Act (12 U.S.C. 1841(c)(2)(D)). accordance with the applicable contract, that the CFTC and SEC have further (s) Loan means any loan, lease, credited to or charged against such defined by joint regulation, extension of credit, or secured or account without regard to other income, interpretation, guidance, or other action unsecured receivable that is not a gains, or losses of the insurance as not within the definition of swap, as security or derivative. that term is defined in section 1a(47) of (t) Primary financial regulatory company. the Commodity Exchange Act (7 U.S.C. agency has the same meaning as in (cc) State means any State, the District 1a(47)), or security-based swap, as that section 2(12) of the Dodd-Frank Wall of Columbia, the Commonwealth of term is defined in section 3(a)(68) of the Street Reform and Consumer Protection Puerto Rico, Guam, American Samoa, Exchange Act (15 U.S.C. 78c(a)(68)); or Act (12 U.S.C. 5301(12)). the United States Virgin Islands, and the (ii) Any identified banking product, as (u) Purchase includes any contract to Commonwealth of the Northern Mariana defined in section 402(b) of the Legal buy, purchase, or otherwise acquire. For Islands. Certainty for Bank Products Act of 2000 security futures products, purchase (dd) Subsidiary has the same meaning (7 U.S.C. 27(b)), that is subject to section includes any contract, agreement, or as in section 2(d) of the Bank Holding 403(a) of that Act (7 U.S.C. 27a(a)). transaction for future delivery. With Company Act of 1956 (12 U.S.C. (i) Employee includes a member of the respect to a commodity future, purchase 1841(d)). immediate family of the employee. includes any contract, agreement, or (ee) State insurance regulator means (j) Exchange Act means the Securities transaction for future delivery. With the insurance commissioner, or a Exchange Act of 1934 (15 U.S.C. 78a et respect to a derivative, purchase similar official or agency, of a State that seq.). includes the execution, termination is engaged in the supervision of (k) Excluded commodity has the same (prior to its scheduled maturity date), insurance companies under State meaning as in section 1a(19) of the assignment, exchange, or similar insurance law.

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(ff) Swap dealer has the same meaning the financial instrument within sixty (ii) Requires that any purchase or sale as in section 1(a)(49) of the Commodity days of the purchase (or sale), unless the of securities contemplated and Exchange Act (7 U.S.C. 1a(49)). banking entity can demonstrate, based authorized by the plan be principally for on all relevant facts and circumstances, the purpose of managing the liquidity of Subpart B—Proprietary Trading that the banking entity did not purchase the banking entity, and not for the § 75.3 Prohibition on proprietary trading. (or sell) the financial instrument purpose of short-term resale, benefitting principally for any of the purposes from actual or expected short-term price (a) Prohibition. Except as otherwise described in paragraph (b)(1)(i) of this movements, realizing short-term provided in this subpart, a banking section. arbitrage profits, or hedging a position entity may not engage in proprietary (c) Financial instrument—(1) taken for such short-term purposes; trading. Proprietary trading means Financial instrument means: (iii) Requires that any securities engaging as principal for the trading (i) A security, including an option on purchased or sold for liquidity account of the banking entity in any a security; management purposes be highly liquid purchase or sale of one or more (ii) A derivative, including an option and limited to securities the market, financial instruments. on a derivative; or credit, and other risks of which the (b) Definition of trading account. (1) (iii) A contract of sale of a commodity banking entity does not reasonably Trading account means any account that for future delivery, or option on a expect to give rise to appreciable profits is used by a banking entity to: contract of sale of a commodity for or losses as a result of short-term price (i) Purchase or sell one or more future delivery. movements; financial instruments principally for the (2) A financial instrument does not (iv) Limits any securities purchased or purpose of: include: sold for liquidity management purposes, (A) Short-term resale; (i) A loan; together with any other instruments (B) Benefitting from actual or (ii) A commodity that is not: purchased or sold for such purposes, to expected short-term price movements; (A) An excluded commodity (other an amount that is consistent with the (C) Realizing short-term arbitrage than foreign exchange or currency); banking entity’s near-term funding profits; or (B) A derivative; needs, including deviations from (D) Hedging one or more positions (C) A contract of sale of a commodity normal operations of the banking entity resulting from the purchases or sales of for future delivery; or or any affiliate thereof, as estimated and financial instruments described in (D) An option on a contract of sale of documented pursuant to methods paragraphs (b)(1)(i)(A), (B), or (C) of this a commodity for future delivery; or specified in the plan; section; (iii) Foreign exchange or currency. (v) Includes written policies and (ii) Purchase or sell one or more (d) Proprietary trading does not procedures, internal controls, analysis, financial instruments that are both include:—(1) Any purchase or sale of and independent testing to ensure that market risk capital rule covered one or more financial instruments by a the purchase and sale of securities that positions and trading positions (or banking entity that arises under a are not permitted under § 75.6(a) or (b) hedges of other market risk capital rule repurchase or reverse repurchase are for the purpose of liquidity covered positions), if the banking entity, agreement pursuant to which the management and in accordance with the or any affiliate of the banking entity, is banking entity has simultaneously liquidity management plan described in an insured depository institution, bank agreed, in writing, to both purchase and paragraph (d)(3) of this section; and holding company, or savings and loan sell a stated asset, at stated prices, and (vi) Is consistent with the holding company, and calculates risk- on stated dates or on demand with the Commission’s supervisory based capital ratios under the market same counterparty; requirements, guidance, and risk capital rule; or (2) Any purchase or sale of one or expectations regarding liquidity (iii) Purchase or sell one or more more financial instruments by a banking management; financial instruments for any purpose, if entity that arises under a transaction in (4) Any purchase or sale of one or the banking entity: which the banking entity lends or more financial instruments by a banking (A) Is licensed or registered, or is borrows a security temporarily to or entity that is a derivatives clearing required to be licensed or registered, to from another party pursuant to a written organization or a clearing agency in engage in the business of a dealer, swap securities lending agreement under connection with clearing financial dealer, or security-based swap dealer, to which the lender retains the economic instruments; the extent the instrument is purchased interests of an owner of such security, (5) Any excluded clearing activities or sold in connection with the activities and has the right to terminate the by a banking entity that is a member of that require the banking entity to be transaction and to recall the loaned a clearing agency, a member of a licensed or registered as such; or security on terms agreed by the parties; derivatives clearing organization, or a (B) Is engaged in the business of a (3) Any purchase or sale of a security member of a designated financial market dealer, swap dealer, or security-based by a banking entity for the purpose of utility; swap dealer outside of the United liquidity management in accordance (6) Any purchase or sale of one or States, to the extent the instrument is with a documented liquidity more financial instruments by a banking purchased or sold in connection with management plan of the banking entity entity, so long as: the activities of such business. that: (i) The purchase (or sale) satisfies an (2) Rebuttable presumption for certain (i) Specifically contemplates and existing delivery obligation of the purchases and sales. The purchase (or authorizes the particular securities to be banking entity or its customers, sale) of a financial instrument by a used for liquidity management including to prevent or close out a banking entity shall be presumed to be purposes, the amount, types, and risks failure to deliver, in connection with for the trading account of the banking of these securities that are consistent delivery, clearing, or settlement activity; entity under paragraph (b)(1)(i) of this with liquidity management, and the or section if the banking entity holds the liquidity circumstances in which the (ii) The purchase (or sale) satisfies an financial instrument for fewer than sixty particular securities may or must be obligation of the banking entity in days or substantially transfers the risk of used; connection with a judicial,

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administrative, self-regulatory (6) Exchange, unless the context (v) Any purchase or sale that is organization, or arbitration proceeding; otherwise requires, means any required by the rules or procedures of a (7) Any purchase or sale of one or designated contract market, swap clearing agency, a derivatives clearing more financial instruments by a banking execution facility, or foreign board of organization, or a designated financial entity that is acting solely as agent, trade registered with the CFTC, or, for market utility to mitigate the risk to the broker, or custodian; purposes of securities or security-based clearing agency, derivatives clearing (8) Any purchase or sale of one or swaps, an exchange, as defined under organization, or designated financial more financial instruments by a banking section 3(a)(1) of the Exchange Act (15 market utility that would result from the entity through a deferred compensation, U.S.C. 78c(a)(1)), or security-based swap clearing by a member of security-based stock-bonus, profit-sharing, or pension execution facility, as defined under swaps that reference the member or an plan of the banking entity that is section 3(a)(77) of the Exchange Act (15 affiliate of the member. established and administered in U.S.C. 78c(a)(77)). (8) Designated financial market utility accordance with the law of the United (7) Excluded clearing activities means: has the same meaning as in section States or a foreign sovereign, if the (i) With respect to customer 803(4) of the Dodd-Frank Act (12 U.S.C. purchase or sale is made directly or transactions cleared on a derivatives 5462(4)). indirectly by the banking entity as clearing organization, a clearing agency, (9) Issuer has the same meaning as in trustee for the benefit of persons who or a designated financial market utility, section 2(a)(4) of the Securities Act of are or were employees of the banking any purchase or sale necessary to 1933 (15 U.S.C. 77b(a)(4)). entity; or correct trading errors made by or on (10) Market risk capital rule covered (9) Any purchase or sale of one or behalf of a customer provided that such position and trading position means a more financial instruments by a banking purchase or sale is conducted in financial instrument that is both a entity in the ordinary course of accordance with, for transactions covered position and a trading position, collecting a debt previously contracted cleared on a derivatives clearing as those terms are respectively defined: in good faith, provided that the banking organization, the Commodity Exchange (i) In the case of a banking entity that entity divests the financial instrument Act, CFTC regulations, and the rules or is a bank holding company, savings and as soon as practicable, and in no event procedures of the derivatives clearing loan holding company, or insured may the banking entity retain such organization, or, for transactions cleared depository institution, under the market instrument for longer than such period on a clearing agency, the rules or risk capital rule that is applicable to the permitted by the Commission. procedures of the clearing agency, or, banking entity; and (e) Definition of other terms related to for transactions cleared on a designated (ii) In the case of a banking entity that proprietary trading. For purposes of this financial market utility that is neither a is affiliated with a bank holding subpart: derivatives clearing organization nor a company or savings and loan holding (1) Anonymous means that each party clearing agency, the rules or procedures company, other than a banking entity to to a purchase or sale is unaware of the of the designated financial market which a market risk capital rule is identity of the other party(ies) to the utility; applicable, under the market risk capital purchase or sale. (ii) Any purchase or sale in rule that is applicable to the affiliated (2) Clearing agency has the same connection with and related to the bank holding company or savings and meaning as in section 3(a)(23) of the management of a default or threatened loan holding company. Exchange Act (15 U.S.C. 78c(a)(23)). (11) Market risk capital rule means imminent default of a customer (3) Commodity has the same meaning the market risk capital rule that is provided that such purchase or sale is as in section 1a(9) of the Commodity contained in subpart F of 12 CFR part conducted in accordance with, for Exchange Act (7 U.S.C. 1a(9)), except 3, 12 CFR parts 208 and 225, or 12 CFR transactions cleared on a derivatives that a commodity does not include any part 324, as applicable. clearing organization, the Commodity security; (12) Municipal security means a Exchange Act, CFTC regulations, and (4) Contract of sale of a commodity security that is a direct obligation of or the rules or procedures of the for future delivery means a contract of issued by, or an obligation guaranteed as derivatives clearing organization, or, for sale (as that term is defined in section to principal or interest by, a State or any transactions cleared on a clearing 1a(13) of the Commodity Exchange Act political subdivision thereof, or any agency, the rules or procedures of the (7 U.S.C. 1a(13)) for future delivery (as agency or instrumentality of a State or clearing agency, or, for transactions that term is defined in section 1a(27) of any political subdivision thereof, or any cleared on a designated financial market the Commodity Exchange Act (7 U.S.C. municipal corporate instrumentality of utility that is neither a derivatives 1a(27))). one or more States or political clearing organization nor a clearing (5) Derivatives clearing organization subdivisions thereof. means: agency, the rules or procedures of the (13) Trading desk means the smallest (i) A derivatives clearing organization designated financial market utility; discrete unit of organization of a registered under section 5b of the (iii) Any purchase or sale in banking entity that purchases or sells Commodity Exchange Act (7 U.S.C. 7a– connection with and related to the financial instruments for the trading 1); management of a default or threatened account of the banking entity or an (ii) A derivatives clearing organization imminent default of a member of a affiliate thereof. that, pursuant to CFTC regulation, is clearing agency, a member of a exempt from the registration derivatives clearing organization, or a § 75.4 Permitted underwriting and market requirements under section 5b of the member of a designated financial market making-related activities. Commodity Exchange Act (7 U.S.C. 7a– utility; (a) Underwriting activities—(1) 1); or (iv) Any purchase or sale in Permitted underwriting activities. The (iii) A foreign derivatives clearing connection with and related to the prohibition contained in § 75.3(a) does organization that, pursuant to CFTC management of the default or threatened not apply to a banking entity’s regulation, is permitted to clear for a default of a clearing agency, a underwriting activities conducted in foreign board of trade that is registered derivatives clearing organization, or a accordance with paragraph (a) of this with the CFTC. designated financial market utility; and section.

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(2) Requirements. The underwriting described in paragraph (a) of this permitted under paragraph (b)(1) of this activities of a banking entity are section in accordance with applicable section only if: permitted under paragraph (a)(1) of this law. (i) The trading desk that establishes section only if: (3) Definition of distribution. For and manages the financial exposure (i) The banking entity is acting as an purposes of paragraph (a) of this section, routinely stands ready to purchase and underwriter for a distribution of a distribution of securities means: sell one or more types of financial securities and the trading desk’s (i) An offering of securities, whether instruments related to its financial underwriting position is related to such or not subject to registration under the exposure and is willing and available to distribution; Securities Act of 1933, that is quote, purchase and sell, or otherwise (ii) The amount and type of the distinguished from ordinary trading enter into long and short positions in securities in the trading desk’s transactions by the presence of special those types of financial instruments for underwriting position are designed not selling efforts and selling methods; or its own account, in commercially to exceed the reasonably expected near (ii) An offering of securities made reasonable amounts and throughout term demands of clients, customers, or pursuant to an effective registration market cycles on a basis appropriate for counterparties, and reasonable efforts statement under the Securities Act of the liquidity, maturity, and depth of the are made to sell or otherwise reduce the 1933. market for the relevant types of financial underwriting position within a (4) Definition of underwriter. For instruments; reasonable period, taking into account purposes of paragraph (a) of this section, (ii) The amount, types, and risks of the liquidity, maturity, and depth of the underwriter means: the financial instruments in the trading market for the relevant type of security; (i) A person who has agreed with an desk’s market-maker inventory are (iii) The banking entity has issuer or selling security holder to: designed not to exceed, on an ongoing established and implements, maintains, (A) Purchase securities from the basis, the reasonably expected near term and enforces an internal compliance issuer or selling security holder for demands of clients, customers, or program required by subpart D of this distribution; counterparties, based on: (B) Engage in a distribution of part that is reasonably designed to (A) The liquidity, maturity, and depth securities for or on behalf of the issuer ensure the banking entity’s compliance of the market for the relevant types of with the requirements of paragraph (a) or selling security holder; or (C) Manage a distribution of securities financial instrument(s); and of this section, including reasonably (B) Demonstrable analysis of designed written policies and for or on behalf of the issuer or selling security holder; or historical customer demand, current procedures, internal controls, analysis inventory of financial instruments, and and independent testing identifying and (ii) A person who has agreed to participate or is participating in a market and other factors regarding the addressing: amount, types, and risks, of or (A) The products, instruments or distribution of such securities for or on behalf of the issuer or selling security associated with financial instruments in exposures each trading desk may which the trading desk makes a market, purchase, sell, or manage as part of its holder. (5) Definition of selling security including through block trades; underwriting activities; (iii) The banking entity has (B) Limits for each trading desk, based holder. For purposes of paragraph (a) of established and implements, maintains, on the nature and amount of the trading this section, selling security holder and enforces an internal compliance desk’s underwriting activities, including means any person, other than an issuer, program required by subpart D of this the reasonably expected near term on whose behalf a distribution is made. part that is reasonably designed to demands of clients, customers, or (6) Definition of underwriting ensure the banking entity’s compliance counterparties, on the: position. For purposes of paragraph (a) (1) Amount, types, and risk of its of this section, underwriting position with the requirements of paragraph (b) underwriting position; means the long or short positions in one of this section, including reasonably (2) Level of exposures to relevant risk or more securities held by a banking designed written policies and factors arising from its underwriting entity or its affiliate, and managed by a procedures, internal controls, analysis position; and particular trading desk, in connection and independent testing identifying and (3) Period of time a security may be with a particular distribution of addressing: held; securities for which such banking entity (A) The financial instruments each (C) Internal controls and ongoing or affiliate is acting as an underwriter. trading desk stands ready to purchase monitoring and analysis of each trading (7) Definition of client, customer, and and sell in accordance with paragraph desk’s compliance with its limits; and counterparty. For purposes of paragraph (b)(2)(i) of this section; (D) Authorization procedures, (a) of this section, the terms client, (B) The actions the trading desk will including escalation procedures that customer, and counterparty, on a take to demonstrably reduce or require review and approval of any collective or individual basis, refer to otherwise significantly mitigate trade that would exceed a trading desk’s market participants that may transact promptly the risks of its financial limit(s), demonstrable analysis of the with the banking entity in connection exposure consistent with the limits basis for any temporary or permanent with a particular distribution for which required under paragraph (b)(2)(iii)(C) of increase to a trading desk’s limit(s), and the banking entity is acting as this section; the products, instruments, independent review of such underwriter. and exposures each trading desk may demonstrable analysis and approval; (b) Market making-related activities— use for risk management purposes; the (iv) The compensation arrangements (1) Permitted market making-related techniques and strategies each trading of persons performing the activities activities. The prohibition contained in desk may use to manage the risks of its described in paragraph (a) of this § 75.3(a) does not apply to a banking market making-related activities and section are designed not to reward or entity’s market making-related activities inventory; and the process, strategies, incentivize prohibited proprietary conducted in accordance with and personnel responsible for ensuring trading; and paragraph (b) of this section. that the actions taken by the trading (v) The banking entity is licensed or (2) Requirements. The market making- desk to mitigate these risks are and registered to engage in the activity related activities of a banking entity are continue to be effective;

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(C) Limits for each trading desk, based other organizational unit of the entity respect to such positions, contracts or on the nature and amount of the trading should be treated as a client, customer, other holdings; desk’s market making-related activities, or counterparty of the trading desk for (ii) Internal controls and ongoing that address the factors prescribed by purposes of paragraph (b)(2) of this monitoring, management, and paragraph (b)(2)(ii) of this section, on: section; or authorization procedures, including (1) The amount, types, and risks of its (B) The purchase or sale by the relevant escalation procedures; and market-maker inventory; trading desk is conducted anonymously (iii) The conduct of analysis, (2) The amount, types, and risks of the on an exchange or similar trading including correlation analysis, and products, instruments, and exposures facility that permits trading on behalf of independent testing designed to ensure the trading desk may use for risk a broad range of market participants. that the positions, techniques and management purposes; (ii) [Reserved] strategies that may be used for hedging (3) The level of exposures to relevant (4) Definition of financial exposure. may reasonably be expected to risk factors arising from its financial For purposes of paragraph (b) of this demonstrably reduce or otherwise exposure; and section, financial exposure means the significantly mitigate the specific, (4) The period of time a financial aggregate risks of one or more financial identifiable risk(s) being hedged, and instrument may be held; instruments and any associated loans, such correlation analysis demonstrates (D) Internal controls and ongoing commodities, or foreign exchange or that the hedging activity demonstrably monitoring and analysis of each trading currency, held by a banking entity or its reduces or otherwise significantly desk’s compliance with its limits; and mitigates the specific, identifiable risk(s) (E) Authorization procedures, affiliate and managed by a particular trading desk as part of the trading desk’s being hedged; including escalation procedures that (2) The risk-mitigating hedging market making-related activities. require review and approval of any activity: trade that would exceed a trading desk’s (5) Definition of market-maker (i) Is conducted in accordance with limit(s), demonstrable analysis that the inventory. For the purposes of paragraph the written policies, procedures, and basis for any temporary or permanent (b) of this section, market-maker internal controls required under this increase to a trading desk’s limit(s) is inventory means all of the positions in section; consistent with the requirements of the financial instruments for which the (ii) At the inception of the hedging paragraph (b) of this section, and trading desk stands ready to make a activity, including, without limitation, independent review of such market in accordance with paragraph any adjustments to the hedging activity, demonstrable analysis and approval; (b)(2)(i) of this section that are managed is designed to reduce or otherwise (iv) To the extent that any limit by the trading desk, including the significantly mitigate and demonstrably identified pursuant to paragraph trading desk’s open positions or reduces or otherwise significantly (b)(2)(iii)(C) of this section is exceeded, exposures arising from open mitigates one or more specific, the trading desk takes action to bring the transactions. identifiable risks, including market risk, trading desk into compliance with the § 75.5 Permitted risk-mitigating hedging counterparty or other credit risk, limits as promptly as possible after the activities. currency or foreign exchange risk, limit is exceeded; interest rate risk, commodity price risk, (a) Permitted risk-mitigating hedging (v) The compensation arrangements of basis risk, or similar risks, arising in activities. The prohibition contained in persons performing the activities connection with and related to § 75.3(a) does not apply to the risk- described in paragraph (b) of this identified positions, contracts, or other mitigating hedging activities of a section are designed not to reward or holdings of the banking entity, based banking entity in connection with and incentivize prohibited proprietary upon the facts and circumstances of the related to individual or aggregated trading; and identified underlying and hedging positions, contracts, or other holdings of (vi) The banking entity is licensed or positions, contracts or other holdings the banking entity and designed to registered to engage in activity and the risks and liquidity thereof; described in paragraph (b) of this reduce the specific risks to the banking (iii) Does not give rise, at the section in accordance with applicable entity in connection with and related to inception of the hedge, to any law. such positions, contracts, or other significant new or additional risk that is (3) Definition of client, customer, and holdings. not itself hedged contemporaneously in counterparty. For purposes of paragraph (b) Requirements. The risk-mitigating accordance with this section; (b) of this section, the terms client, hedging activities of a banking entity are (iv) Is subject to continuing review, customer, and counterparty, on a permitted under paragraph (a) of this monitoring and management by the collective or individual basis refer to section only if: banking entity that: market participants that make use of the (1) The banking entity has established (A) Is consistent with the written banking entity’s market making-related and implements, maintains and enforces hedging policies and procedures services by obtaining such services, an internal compliance program required under paragraph (b)(1) of this responding to quotations, or entering required by subpart D of this part that section; into a continuing relationship with is reasonably designed to ensure the (B) Is designed to reduce or otherwise respect to such services, provided that: banking entity’s compliance with the significantly mitigate and demonstrably (i) A trading desk or other requirements of this section, including: reduces or otherwise significantly organizational unit of another banking (i) Reasonably designed written mitigates the specific, identifiable risks entity is not a client, customer, or policies and procedures regarding the that develop over time from the risk- counterparty of the trading desk if that positions, techniques and strategies that mitigating hedging activities undertaken other entity has trading assets and may be used for hedging, including under this section and the underlying liabilities of $50 billion or more as documentation indicating what positions, contracts, and other holdings measured in accordance with positions, contracts or other holdings a of the banking entity, based upon the § 75.20(d)(1), unless: particular trading desk may use in its facts and circumstances of the (A) The trading desk documents how risk-mitigating hedging activities, as underlying and hedging positions, and why a particular trading desk or well as position and aging limits with contracts and other holdings of the

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banking entity and the risks and period as required under other law or (iii) The purchase or sale as principal liquidity thereof; and this part. is not made by an insured depository (C) Requires ongoing recalibration of institution. the hedging activity by the banking § 75.6 Other permitted proprietary trading (2) Foreign affiliates of a U.S. banking activities. entity to ensure that the hedging activity entity. The prohibition contained in satisfies the requirements set out in (a) Permitted trading in domestic § 75.3(a) does not apply to the purchase paragraph (b)(2) of this section and is government obligations. The prohibition or sale of a financial instrument that is not prohibited proprietary trading; and contained in § 75.3(a) does not apply to an obligation of, or issued or guaranteed (3) The compensation arrangements of the purchase or sale by a banking entity by, a foreign sovereign (including any persons performing risk-mitigating of a financial instrument that is: multinational central bank of which the hedging activities are designed not to (1) An obligation of, or issued or foreign sovereign is a member), or any reward or incentivize prohibited guaranteed by, the United States; agency or political subdivision of that proprietary trading. (2) An obligation, participation, or foreign sovereign, by a foreign entity (c) Documentation requirement. (1) A other instrument of, or issued or that is owned or controlled by a banking banking entity must comply with the guaranteed by, an agency of the United entity organized or established under requirements of paragraphs (c)(2) and States, the Government National the laws of the United States or any (c)(3) of this section with respect to any Mortgage Association, the Federal State, so long as: purchase or sale of financial National Mortgage Association, the (i) The foreign entity is a foreign bank, instruments made in reliance on this Federal Home Loan Mortgage as defined in § 211.2(j) of the Board’s section for risk-mitigating hedging Corporation, a Federal Home Loan Regulation K (12 CFR 211.2(j)), or is purposes that is: Bank, the Federal Agricultural Mortgage regulated by the foreign sovereign as a (i) Not established by the specific Corporation or a Farm Credit System securities dealer; trading desk establishing or responsible institution chartered under and subject (ii) The financial instrument is an for the underlying positions, contracts, to the provisions of the Farm Credit Act obligation of, or issued or guaranteed or other holdings the risks of which the of 1971 (12 U.S.C. 2001 et seq.); by, the foreign sovereign under the laws hedging activity is designed to reduce; (3) An obligation of any State or any of which the foreign entity is organized (ii) Established by the specific trading political subdivision thereof, including (including any multinational central desk establishing or responsible for the any municipal security; or bank of which the foreign sovereign is underlying positions, contracts, or other (4) An obligation of the FDIC, or any a member), or any agency or political holdings the risks of which the entity formed by or on behalf of the subdivision of that foreign sovereign; purchases or sales are designed to FDIC for purpose of facilitating the and reduce, but that is effected through a disposal of assets acquired or held by (iii) The financial instrument is financial instrument, exposure, the FDIC in its corporate capacity or as owned by the foreign entity and is not technique, or strategy that is not conservator or receiver under the financed by an affiliate that is located in specifically identified in the trading Federal Deposit Insurance Act or Title II the United States or organized under the desk’s written policies and procedures of the Dodd-Frank Wall Street Reform laws of the United States or of any State. established under paragraph (b)(1) of and Consumer Protection Act. (c) Permitted trading on behalf of this section or under § 75.4(b)(2)(iii)(B) (b) Permitted trading in foreign customers—(1) Fiduciary transactions. as a product, instrument, exposure, government obligations—(1) Affiliates of The prohibition contained in § 75.3(a) technique, or strategy such trading desk foreign banking entities in the United does not apply to the purchase or sale may use for hedging; or States. The prohibition contained in of financial instruments by a banking (iii) Established to hedge aggregated § 75.3(a) does not apply to the purchase entity acting as trustee or in a similar positions across two or more trading or sale of a financial instrument that is fiduciary capacity, so long as: desks. an obligation of, or issued or guaranteed (i) The transaction is conducted for (2) In connection with any purchase by, a foreign sovereign (including any the account of, or on behalf of, a or sale identified in paragraph (c)(1) of multinational central bank of which the customer; and this section, a banking entity must, at a foreign sovereign is a member), or any (ii) The banking entity does not have minimum, and contemporaneously with agency or political subdivision of such or retain beneficial ownership of the the purchase or sale, document: foreign sovereign, by a banking entity, financial instruments. (i) The specific, identifiable risk(s) of so long as: (2) Riskless principal transactions. the identified positions, contracts, or (i) The banking entity is organized The prohibition contained in § 75.3(a) other holdings of the banking entity that under or is directly or indirectly does not apply to the purchase or sale the purchase or sale is designed to controlled by a banking entity that is of financial instruments by a banking reduce; organized under the laws of a foreign entity acting as riskless principal in a (ii) The specific risk-mitigating sovereign and is not directly or transaction in which the banking entity, strategy that the purchase or sale is indirectly controlled by a top-tier after receiving an order to purchase (or designed to fulfill; and banking entity that is organized under sell) a financial instrument from a (iii) The trading desk or other the laws of the United States; customer, purchases (or sells) the business unit that is establishing and (ii) The financial instrument is an financial instrument for its own account responsible for the hedge. obligation of, or issued or guaranteed to offset a contemporaneous sale to (or (3) A banking entity must create and by, the foreign sovereign under the laws purchase from) the customer. retain records sufficient to demonstrate of which the foreign banking entity (d) Permitted trading by a regulated compliance with the requirements of referred to in paragraph (b)(1)(i) of this insurance company. The prohibition paragraph (c) of this section for a period section is organized (including any contained in § 75.3(a) does not apply to that is no less than five years in a form multinational central bank of which the the purchase or sale of financial that allows the banking entity to foreign sovereign is a member), or any instruments by a banking entity that is promptly produce such records to the agency or political subdivision of that an insurance company or an affiliate of Commission on request, or such longer foreign sovereign; and an insurance company if:

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(1) The insurance company or its meets at least two of the following exchange or similar trading facility and affiliate purchases or sells the financial requirements: is promptly cleared and settled through instruments solely for: (1) Total assets of the banking entity a clearing agency or derivatives clearing (i) The general account of the held outside of the United States exceed organization acting as a central insurance company; or total assets of the banking entity held in counterparty, (ii) A separate account established by the United States; (4) For purposes of paragraph (e) of the insurance company; (2) Total revenues derived from the this section, a U.S. entity is any entity (2) The purchase or sale is conducted business of the banking entity outside of that is, or is controlled by, or is acting in compliance with, and subject to, the the United States exceed total revenues on behalf of, or at the direction of, any insurance company investment laws, derived from the business of the other entity that is, located in the regulations, and written guidance of the banking entity in the United States; or United States or organized under the State or jurisdiction in which such (3) Total net income derived from the laws of the United States or of any State. insurance company is domiciled; and business of the banking entity outside of (5) For purposes of paragraph (e) of (3) The appropriate Federal banking the United States exceeds total net this section, a U.S. branch, agency, or agencies, after consultation with the income derived from the business of the subsidiary of a foreign banking entity is Financial Stability Oversight Council banking entity in the United States. considered to be located in the United and the relevant insurance (3) A purchase or sale by a banking States; however, the foreign bank that commissioners of the States and foreign entity is permitted for purposes of operates or controls that branch, agency, jurisdictions, as appropriate, have not paragraph (e) of this section only if: or subsidiary is not considered to be jointly determined, after notice and (i) The banking entity engaging as located in the United States solely by comment, that a particular law, principal in the purchase or sale virtue of operating or controlling the regulation, or written guidance (including any personnel of the banking U.S. branch, agency, or subsidiary. described in paragraph (d)(2) of this entity or its affiliate that arrange, (6) For purposes of paragraph (e) of section is insufficient to protect the negotiate or execute such purchase or this section, unaffiliated market safety and soundness of the covered sale) is not located in the United States intermediary means an unaffiliated banking entity, or the financial stability or organized under the laws of the entity, acting as an intermediary, that is: of the United States. United States or of any State; (i) A broker or dealer registered with (ii) The banking entity (including (e) Permitted trading activities of the SEC under section 15 of the relevant personnel) that makes the foreign banking entities. (1) The Exchange Act or exempt from decision to purchase or sell as principal prohibition contained in § 75.3(a) does registration or excluded from regulation is not located in the United States or not apply to the purchase or sale of as such; organized under the laws of the United financial instruments by a banking (ii) A swap dealer registered with the States or of any State; entity if: CFTC under section 4s of the (iii) The purchase or sale, including Commodity Exchange Act or exempt (i) The banking entity is not organized any transaction arising from risk- or directly or indirectly controlled by a from registration or excluded from mitigating hedging related to the regulation as such; banking entity that is organized under instruments purchased or sold, is not the laws of the United States or of any (iii) A security-based swap dealer accounted for as principal directly or on registered with the SEC under section State; a consolidated basis by any branch or (ii) The purchase or sale by the 15F of the Exchange Act or exempt from affiliate that is located in the United registration or excluded from regulation banking entity is made pursuant to States or organized under the laws of paragraph (9) or (13) of section 4(c) of as such; or the United States or of any State; (iv) A futures commission merchant the BHC Act; and (iv) No financing for the banking registered with the CFTC under section (iii) The purchase or sale meets the entity’s purchases or sales is provided, 4f of the Commodity Exchange Act or requirements of paragraph (e)(3) of this directly or indirectly, by any branch or exempt from registration or excluded section. affiliate that is located in the United from regulation as such. (2) A purchase or sale of financial States or organized under the laws of instruments by a banking entity is made the United States or of any State; and § 75.7 Limitations on permitted proprietary pursuant to paragraph (9) or (13) of (v) The purchase or sale is not trading activities. section 4(c) of the BHC Act for purposes conducted with or through any U.S. (a) No transaction, class of of paragraph (e)(1)(ii) of this section entity, other than: transactions, or activity may be deemed only if: (A) A purchase or sale with the permissible under §§ 75.4 through 75.6 (i) The purchase or sale is conducted foreign operations of a U.S. entity if no if the transaction, class of transactions, in accordance with the requirements of personnel of such U.S. entity that are or activity would: paragraph (e) of this section; and located in the United States are (1) Involve or result in a material (ii)(A) With respect to a banking involved in the arrangement, conflict of interest between the banking entity that is a foreign banking negotiation, or execution of such entity and its clients, customers, or organization, the banking entity meets purchase or sale; counterparties; the qualifying foreign banking (B) A purchase or sale with an (2) Result, directly or indirectly, in a organization requirements of unaffiliated market intermediary acting material exposure by the banking entity § 211.23(a), (c) or (e) of the Board’s as principal, provided the purchase or to a high-risk asset or a high-risk trading Regulation K (12 CFR 211.23(a), (c) or sale is promptly cleared and settled strategy; or (e)), as applicable; or through a clearing agency or derivatives (3) Pose a threat to the safety and (B) With respect to a banking entity clearing organization acting as a central soundness of the banking entity or to that is not a foreign banking counterparty; or the financial stability of the United organization, the banking entity is not (C) A purchase or sale through an States. organized under the laws of the United unaffiliated market intermediary acting (b) Definition of material conflict of States or of any State and the banking as agent, provided the purchase or sale interest. (1) For purposes of this section, entity, on a fully-consolidated basis, is conducted anonymously on an a material conflict of interest between a

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banking entity and its clients, in by a banking entity, significantly U.S.C. 80a–1 et seq.), but for section customers, or counterparties exists if the increase the likelihood that the banking 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. banking entity engages in any entity would incur a substantial 80a–3(c)(1) or (7)); transaction, class of transactions, or financial loss or would pose a threat to (ii) Any commodity pool under activity that would involve or result in the financial stability of the United section 1a(10) of the Commodity the banking entity’s interests being States. Exchange Act (7 U.S.C. 1a(10)) for materially adverse to the interests of its which: client, customer, or counterparty with §§ 75.8–75.9 [Reserved] (A) The commodity pool operator has claimed an exemption under § 4.7 of respect to such transaction, class of Subpart C—Covered Fund Activities this chapter; or transactions, or activity, and the and Investments banking entity has not taken at least one (B) (1) A commodity pool operator is of the actions in paragraph (b)(2) of this § 75.10 Prohibition on acquiring or registered with the CFTC as a section. retaining an ownership interest in and commodity pool operator in connection (2) Prior to effecting the specific having certain relationships with a covered with the operation of the commodity transaction or class or type of fund. pool; transactions, or engaging in the specific (a) Prohibition. (1) Except as (2) Substantially all participation activity, the banking entity: otherwise provided in this subpart, a units of the commodity pool are owned (i) Timely and effective disclosure. (A) banking entity may not, as principal, by qualified eligible persons under Has made clear, timely, and effective directly or indirectly, acquire or retain § 4.7(a)(2) and (3) of this chapter; and disclosure of the conflict of interest, any ownership interest in or sponsor a (3) Participation units of the together with other necessary covered fund. commodity pool have not been publicly information, in reasonable detail and in (2) Paragraph (a)(1) of this section offered to persons who are not qualified a manner sufficient to permit a does not include acquiring or retaining eligible persons under § 4.7(a)(2) and (3) reasonable client, customer, or an ownership interest in a covered fund of this chapter; or counterparty to meaningfully by a banking entity: (iii) For any banking entity that is, or understand the conflict of interest; and (i) Acting solely as agent, broker, or is controlled directly or indirectly by a (B) Such disclosure is made in a custodian, so long as; banking entity that is, located in or manner that provides the client, (A) The activity is conducted for the organized under the laws of the United customer, or counterparty the account of, or on behalf of, a customer; States or of any State, an entity that: opportunity to negate, or substantially and (A) Is organized or established outside mitigate, any materially adverse effect (B) The banking entity and its the United States and the ownership on the client, customer, or counterparty affiliates do not have or retain beneficial interests of which are offered and sold created by the conflict of interest; or ownership of such ownership interest; solely outside the United States; (ii) Information barriers. Has (ii) Through a deferred compensation, (B) Is, or holds itself out as being, an established, maintained, and enforced stock-bonus, profit-sharing, or pension entity or arrangement that raises money information barriers that are plan of the banking entity (or an affiliate from investors primarily for the purpose memorialized in written policies and thereof) that is established and of investing in securities for resale or procedures, such as physical separation administered in accordance with the other disposition or otherwise trading in of personnel, or functions, or limitations law of the United States or a foreign securities; and on types of activity, that are reasonably sovereign, if the ownership interest is (C) (1) Has as its sponsor that banking designed, taking into consideration the held or controlled directly or indirectly entity (or an affiliate thereof); or nature of the banking entity’s business, by the banking entity as trustee for the (2) Has issued an ownership interest to prevent the conflict of interest from benefit of persons who are or were that is owned directly or indirectly by involving or resulting in a materially employees of the banking entity (or an that banking entity (or an affiliate adverse effect on a client, customer, or affiliate thereof); thereof). counterparty. A banking entity may not (iii) In the ordinary course of (2) An issuer shall not be deemed to rely on such information barriers if, in collecting a debt previously contracted be a covered fund under paragraph the case of any specific transaction, in good faith, provided that the banking (b)(1)(iii) of this section if, were the class or type of transactions or activity, entity divests the ownership interest as issuer subject to U.S. securities laws, the the banking entity knows or should soon as practicable, and in no event may issuer could rely on an exclusion or reasonably know that, notwithstanding the banking entity retain such exemption from the definition of the banking entity’s establishment of ownership interest for longer than such ‘‘investment company’’ under the information barriers, the conflict of period permitted by the Commission; or Investment Company Act of 1940 (15 interest may involve or result in a (iv) On behalf of customers as trustee U.S.C. 80a–1 et seq.) other than the materially adverse effect on a client, or in a similar fiduciary capacity for a exclusions contained in section 3(c)(1) customer, or counterparty. customer that is not a covered fund, so and 3(c)(7) of that Act. (c) Definition of high-risk asset and long as: (3) For purposes of paragraph high-risk trading strategy. For purposes (A) The activity is conducted for the (b)(1)(iii) of this section, a U.S. branch, of this section: account of, or on behalf of, the agency, or subsidiary of a foreign (1) High-risk asset means an asset or customer; and banking entity is located in the United group of related assets that would, if (B) The banking entity and its States; however, the foreign bank that held by a banking entity, significantly affiliates do not have or retain beneficial operates or controls that branch, agency, increase the likelihood that the banking ownership of such ownership interest. or subsidiary is not considered to be entity would incur a substantial (b) Definition of covered fund. (1) located in the United States solely by financial loss or would pose a threat to Except as provided in paragraph (c) of virtue of operating or controlling the the financial stability of the United this section, covered fund means: U.S. branch, agency, or subsidiary. States. (i) An issuer that would be an (c) Notwithstanding paragraph (b) of (2) High-risk trading strategy means a investment company, as defined in the this section, unless the appropriate trading strategy that would, if engaged Investment Company Act of 1940 (15 Federal banking agencies, the SEC, and

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the CFTC jointly determine otherwise, a held by a third party if the ownership conditions of paragraph (c)(8) of this covered fund does not include: interest is acquired or retained by the section and the assets or holdings of (1) Foreign public funds. (i) Subject to third party for the purpose of which are comprised solely of: paragraphs (c)(1)(ii) and (iii) of this establishing corporate separateness or (A) Loans as defined in § 75.2(s); section, an issuer that: addressing bankruptcy, insolvency, or (B) Rights or other assets designed to (A) Is organized or established outside similar concerns. assure the servicing or timely of the United States; (3) Joint ventures. A joint venture distribution of proceeds to holders of (B) Is authorized to offer and sell between a banking entity or any of its such securities and rights or other assets ownership interests to retail investors in affiliates and one or more unaffiliated that are related or incidental to the issuer’s home jurisdiction; and persons, provided that the joint venture: purchasing or otherwise acquiring and (C) Sells ownership interests (i) Is comprised of no more than 10 holding the loans, provided that each predominantly through one or more unaffiliated co-venturers; asset meets the requirements of public offerings outside of the United (ii) Is in the business of engaging in paragraph (c)(8)(iii) of this section; States. activities that are permissible for the (C) Interest rate or foreign exchange (ii) With respect to a banking entity banking entity or affiliate, other than derivatives that meet the requirements that is, or is controlled directly or investing in securities for resale or other of paragraph (c)(8)(iv) of this section; indirectly by a banking entity that is, disposition; and and located in or organized under the laws (iii) Is not, and does not hold itself out (D) Special units of beneficial interest of the United States or of any State and as being, an entity or arrangement that and collateral certificates that meet the any issuer for which such banking raises money from investors primarily requirements of paragraph (c)(8)(v) of entity acts as sponsor, the sponsoring for the purpose of investing in securities this section. banking entity may not rely on the for resale or other disposition or (ii) Impermissible assets. For purposes exemption in paragraph (c)(1)(i) of this otherwise trading in securities. of paragraph (c)(8) of this section, the section for such issuer unless ownership (4) Acquisition vehicles. An issuer: assets or holdings of the issuing entity interests in the issuer are sold (i) Formed solely for the purpose of shall not include any of the following: predominantly to persons other than: engaging in a bona fide merger or (A) A security, including an asset- (A) Such sponsoring banking entity; acquisition transaction; and backed security, or an interest in an (B) Such issuer; (ii) That exists only for such period as equity or debt security other than as (C) Affiliates of such sponsoring necessary to effectuate the transaction. permitted in paragraph (c)(8)(iii) of this banking entity or such issuer; and (5) Foreign pension or retirement section; (D) Directors and employees of such funds. A plan, fund, or program (B) A derivative, other than a entities. providing pension, retirement, or derivative that meets the requirements (iii) For purposes of paragraph similar benefits that is: of paragraph (c)(8)(iv) of this section; or (c)(1)(i)(C) of this section, the term (i) Organized and administered (C) A commodity forward contract. public offering means a distribution (as outside the United States; (iii) Permitted securities. defined in § 75.4(a)(3)) of securities in (ii) A broad-based plan for employees Notwithstanding paragraph (c)(8)(ii)(A) any jurisdiction outside the United or citizens that is subject to regulation of this section, the issuing entity may States to investors, including retail as a pension, retirement, or similar plan hold securities if those securities are: investors, provided that: under the laws of the jurisdiction in (A) Cash equivalents for purposes of (A) The distribution complies with all which the plan, fund, or program is the rights and assets in paragraph applicable requirements in the organized and administered; and (c)(8)(i)(B) of this section; or jurisdiction in which such distribution (iii) Established for the benefit of (B) Securities received in lieu of debts is being made; citizens or residents of one or more previously contracted with respect to (B) The distribution does not restrict foreign sovereigns or any political the loans supporting the asset-backed availability to investors having a subdivision thereof. securities. minimum level of net worth or net (6) Insurance company separate (iv) Derivatives. The holdings of investment assets; and accounts. A separate account, provided derivatives by the issuing entity shall be (C) The issuer has filed or submitted, that no banking entity other than the limited to interest rate or foreign with the appropriate regulatory insurance company participates in the exchange derivatives that satisfy all of authority in such jurisdiction, offering account’s profits and losses. the following conditions: disclosure documents that are publicly (7) Bank owned life insurance. A (A) The written terms of the available. separate account that is used solely for derivative directly relate to the loans, (2) Wholly-owned subsidiaries. An the purpose of allowing one or more the asset-backed securities, or the entity, all of the outstanding ownership banking entities to purchase a life contractual rights of other assets interests of which are owned directly or insurance policy for which the banking described in paragraph (c)(8)(i)(B) of indirectly by the banking entity (or an entity or entities is beneficiary, this section; and affiliate thereof), except that: provided that no banking entity that (B) The derivatives reduce the interest (i) Up to five percent of the entity’s purchases the policy: rate and/or foreign exchange risks outstanding ownership interests, less (i) Controls the investment decisions related to the loans, the asset-backed any amounts outstanding under regarding the underlying assets or securities, or the contractual rights or paragraph (c)(2)(ii) of this section, may holdings of the separate account; or other assets described in paragraph be held by employees or directors of the (ii) Participates in the profits and (c)(8)(i)(B) of this section. banking entity or such affiliate losses of the separate account other than (v) Special units of beneficial interest (including former employees or in compliance with applicable and collateral certificates. The assets or directors if their ownership interest was supervisory guidance regarding bank holdings of the issuing entity may acquired while employed by or in the owned life insurance. include collateral certificates and service of the banking entity); and (8) Loan securitizations—(i) Scope. special units of beneficial interest (ii) Up to 0.5 percent of the entity’s An issuing entity for asset-backed issued by a special purpose vehicle, outstanding ownership interests may be securities that satisfies all the provided that:

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(A) The special purpose vehicle that Deposit Insurance Act (12 U.S.C. (A) Designed primarily to promote the issues the special unit of beneficial 1813(c)); public welfare, of the type permitted interest or collateral certificate meets (B) A bank holding company, as under paragraph (11) of section 5136 of the requirements in paragraph (c)(8) of defined in section 2(a) of the Bank the Revised Statutes of the United States this section; Holding Company Act of 1956 (12 (12 U.S.C. 24), including the welfare of (B) The special unit of beneficial U.S.C. 1841(a)), or a subsidiary thereof; low- and moderate-income communities interest or collateral certificate is used (C) A savings and loan holding or families (such as providing housing, for the sole purpose of transferring to company, as defined in section 10a of services, or jobs); or the issuing entity for the loan the Home Owners’ Loan Act (12 U.S.C. (B) Qualified rehabilitation securitization the economic risks and 1467a), provided all or substantially all expenditures with respect to a qualified benefits of the assets that are of the holding company’s activities are rehabilitated building or certified permissible for loan securitizations permissible for a financial holding historic structure, as such terms are under paragraph (c)(8) of this section company under section 4(k) of the Bank defined in section 47 of the Internal and does not directly or indirectly Holding Company Act of 1956 (12 Revenue Code of 1986 or a similar State transfer any interest in any other U.S.C. 1843(k)), or a subsidiary thereof; historic tax credit program. economic or financial exposure; (D) A foreign bank whose home (12) Registered investment companies (C) The special unit of beneficial country supervisor, as defined in and excluded entities. An issuer: interest or collateral certificate is § 211.21(q) of the Board’s Regulation K (i) That is registered as an investment created solely to satisfy legal (12 CFR 211.21(q)), has adopted capital company under section 8 of the requirements or otherwise facilitate the standards consistent with the Capital Investment Company Act of 1940 (15 structuring of the loan securitization; Accord for the Basel Committee on U.S.C. 80a–8), or that is formed and and Banking Supervision, as amended, and operated pursuant to a written plan to (D) The special purpose vehicle that that is subject to such standards, or a become a registered investment issues the special unit of beneficial subsidiary thereof; or company as described in § 75.20(e)(3) interest or collateral certificate and the (E) The United States or a foreign and that complies with the requirements issuing entity are established under the sovereign. of section 18 of the Investment direction of the same entity that (10) Qualifying covered bonds—(i) Company Act of 1940 (15 U.S.C. 80a– initiated the loan securitization. Scope. An entity owning or holding a 18); dynamic or fixed pool of loans or other (ii) That may rely on an exclusion or (9) Qualifying asset-backed assets as provided in paragraph (c)(8) of exemption from the definition of commercial paper conduits. (i) An this section for the benefit of the holders ‘‘investment company’’ under the issuing entity for asset-backed of covered bonds, provided that the Investment Company Act of 1940 (15 commercial paper that satisfies all of the assets in the pool are comprised solely U.S.C. 80a–1 et seq.) other than the following requirements: of assets that meet the conditions in exclusions contained in section 3(c)(1) (A) The asset-backed commercial paragraph (c)(8)(i) of this section. and 3(c)(7) of that Act; or paper conduit holds only: (ii) Covered bond. For purposes of (iii) That has elected to be regulated (1) Loans and other assets permissible paragraph (c)(10) of this section, a as a business development company for a loan securitization under covered bond means: pursuant to section 54(a) of that Act (15 paragraph (c)(8)(i) of this section; and (A) A debt obligation issued by an U.S.C. 80a–53) and has not withdrawn (2) Asset-backed securities supported entity that meets the definition of its election, or that is formed and solely by assets that are permissible for foreign banking organization, the operated pursuant to a written plan to loan securitizations under paragraph payment obligations of which are fully become a business development (c)(8)(i) of this section and acquired by and unconditionally guaranteed by an company as described in § 75.20(e)(3) the asset-backed commercial paper entity that meets the conditions set forth and that complies with the requirements conduit as part of an initial issuance in paragraph (c)(10)(i) of this section; or of section 61 of the Investment either directly from the issuing entity of (B) A debt obligation of an entity that Company Act of 1940 (15 U.S.C. 80a– the asset-backed securities or directly meets the conditions set forth in 60). from an underwriter in the distribution paragraph (c)(10)(i) of this section, (13) Issuers in conjunction with the of the asset-backed securities; provided that the payment obligations FDIC’s receivership or conservatorship (B) The asset-backed commercial are fully and unconditionally operations. An issuer that is an entity paper conduit issues only asset-backed guaranteed by an entity that meets the formed by or on behalf of the FDIC for securities, comprised of a residual definition of foreign banking the purpose of facilitating the disposal interest and securities with a legal organization and the entity is a wholly- of assets acquired in the FDIC’s capacity maturity of 397 days or less; and owned subsidiary, as defined in as conservator or receiver under the (C) A regulated liquidity provider has paragraph (c)(2) of this section, of such Federal Deposit Insurance Act or Title II entered into a legally binding foreign banking organization. of the Dodd-Frank Wall Street Reform commitment to provide full and (11) SBICs and public welfare and Consumer Protection Act. unconditional liquidity coverage with investment funds. An issuer: (14) Other excluded issuers. (i) Any respect to all of the outstanding asset- (i) That is a small business investment issuer that the appropriate Federal backed securities issued by the asset- company, as defined in section 103(3) of banking agencies, the SEC, and the backed commercial paper conduit (other the Small Business Investment Act of CFTC jointly determine the exclusion of than any residual interest) in the event 1958 (15 U.S.C. 662), or that has which is consistent with the purposes of that funds are required to redeem received from the Small Business section 13 of the BHC Act. maturing asset-backed securities. Administration notice to proceed to (ii) A determination made under (ii) For purposes of this paragraph qualify for a license as a small business paragraph (c)(14)(i) of this section will (c)(9) of this section, a regulated investment company, which notice or be promptly made public. liquidity provider means: license has not been revoked; or (d) Definition of other terms related to (A) A depository institution, as (ii) The business of which is to make covered funds. For purposes of this defined in section 3(c) of the Federal investments that are: subpart:

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(1) Applicable accounting standards (F) Receives income on a pass-through (7) Prime brokerage transaction means means U.S. generally accepted basis from the covered fund, or has a any transaction that would be a covered accounting principles, or such other rate of return that is determined by transaction, as defined in section accounting standards applicable to a reference to the performance of the 23A(b)(7) of the Federal Reserve Act (12 banking entity that the Commission underlying assets of the covered fund; U.S.C. 371c(b)(7)), that is provided in determines are appropriate and that the or connection with custody, clearance and banking entity uses in the ordinary (G) Any synthetic right to have, settlement, securities borrowing or course of its business in preparing its receive, or be allocated any of the rights lending services, trade execution, consolidated financial statements. in paragraphs (d)(6)(i)(A) through financing, or data, operational, and (2) Asset-backed security has the (d)(6)(i)(F) of this section. administrative support. meaning specified in section 3(a)(79) of (ii) Ownership interest does not (8) Resident of the United States the Exchange Act (15 U.S.C. 78c(a)(79)). include restricted profit interest, which means a person that is a ‘‘U.S. person’’ (3) Director has the same meaning as is an interest held by an entity (or an as defined in rule 902(k) of the SEC’s provided in § 215.2(d)(1) of the Board’s employee or former employee thereof) Regulation S (17 CFR 230.902(k)). Regulation O (12 CFR 215.2(d)(1)). in a covered fund for which the entity (9) Sponsor means, with respect to a (4) Issuer has the same meaning as in (or employee thereof) serves as covered fund: section 2(a)(22) of the Investment investment manager, investment (i) To serve as a general partner, Company Act of 1940 (15 U.S.C. 80a– adviser, commodity trading advisor, or managing member, or trustee of a 2(a)(22)). other service provider so long as: covered fund, or to serve as a (5) Issuing entity means with respect (A) The sole purpose and effect of the commodity pool operator with respect to asset-backed securities the special interest is to allow the entity (or to a covered fund as defined in (b)(1)(ii) purpose vehicle that owns or holds the employee or former employee thereof) of this section; pool assets underlying asset-backed to share in the profits of the covered (ii) In any manner to select or to securities and in whose name the asset- fund as performance compensation for control (or to have employees, officers, backed securities supported or serviced the investment management, investment or directors, or agents who constitute) a by the pool assets are issued. advisory, commodity trading advisory, majority of the directors, trustees, or (6) Ownership interest—(i) Ownership or other services provided to the management of a covered fund; or interest means any equity, partnership, covered fund by the entity (or employee (iii) To share with a covered fund, for or other similar interest. An ‘‘other or former employee thereof), provided corporate, marketing, promotional, or similar interest’’ means an interest that: that the entity (or employee or former other purposes, the same name or a (A) Has the right to participate in the variation of the same name. selection or removal of a general employee thereof) may be obligated under the terms of such interest to (10) Trustee. (i) For purposes of partner, managing member, member of paragraph (d)(9) of this section and the board of directors or trustees, return profits previously received; (B) All such profit, once allocated, is § 75.11, a trustee does not include: investment manager, investment (A) A trustee that does not exercise adviser, or commodity trading advisor distributed to the entity (or employee or former employee thereof) promptly after investment discretion with respect to a of the covered fund (excluding the covered fund, including a trustee that is rights of a creditor to exercise remedies being earned or, if not so distributed, is retained by the covered fund for the sole subject to the direction of an upon the occurrence of an event of unaffiliated named fiduciary who is not default or an acceleration event); purpose of establishing a reserve amount to satisfy contractual obligations a trustee pursuant to section 403(a)(1) of (B) Has the right under the terms of the Employee’s Retirement Income the interest to receive a share of the with respect to subsequent losses of the covered fund and such undistributed Security Act (29 U.S.C. 1103(a)(1)); or income, gains or profits of the covered (B) A trustee that is subject to profit of the entity (or employee or fund; fiduciary standards imposed under former employee thereof) does not share (C) Has the right to receive the foreign law that are substantially in the subsequent investment gains of underlying assets of the covered fund equivalent to those described in the covered fund; after all other interests have been paragraph (d)(10)(i)(A) of this section; (C) Any amounts invested in the redeemed and/or paid in full (excluding (ii) Any entity that directs a person covered fund, including any amounts the rights of a creditor to exercise described in paragraph (d)(10)(i) of this paid by the entity (or employee or remedies upon the occurrence of an section, or that possesses authority and former employee thereof) in connection event of default or an acceleration discretion to manage and control the with obtaining the restricted profit event); investment decisions of a covered fund interest, are within the limits of § 75.12; (D) Has the right to receive all or a for which such person serves as trustee, and portion of excess spread (the positive shall be considered to be a trustee of difference, if any, between the aggregate (D) The interest is not transferable by such covered fund. interest payments received from the the entity (or employee or former underlying assets of the covered fund employee thereof) except to an affiliate § 75.11 Permitted organizing and offering, and the aggregate interest paid to the thereof (or an employee of the banking underwriting, and market making with holders of other outstanding interests); entity or affiliate), to immediate family respect to a covered fund. (E) Provides under the terms of the members, or through the intestacy, of (a) Organizing and offering a covered interest that the amounts payable by the the employee or former employee, or in fund in general. Notwithstanding covered fund with respect to the interest connection with a sale of the business § 75.10(a), a banking entity is not could be reduced based on losses arising that gave rise to the restricted profit prohibited from acquiring or retaining from the underlying assets of the interest by the entity (or employee or an ownership interest in, or acting as covered fund, such as allocation of former employee thereof) to an sponsor to, a covered fund in losses, write-downs or charge-offs of the unaffiliated party that provides connection with, directly or indirectly, outstanding principal balance, or investment management, investment organizing and offering a covered fund, reductions in the amount of interest due advisory, commodity trading advisory, including serving as a general partner, and payable on the interest; or other services to the fund. managing member, trustee, or

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commodity pool operator of the covered [such covered fund] will be limited to sponsor, investment adviser or fund and in any manner selecting or losses attributable to the ownership commodity trading advisor to a controlling (or having employees, interests in the covered fund held by particular covered fund or otherwise officers, directors, or agents who [the banking entity] and any affiliate in acquires and retains an ownership constitute) a majority of the directors, its capacity as investor in the [covered interest in such covered fund in reliance trustees, or management of the covered fund] or as beneficiary of a restricted on paragraph (a) of this section; acquires fund, including any necessary expenses profit interest held by [the banking and retains an ownership interest in for the foregoing, only if: entity] or any affiliate’’; such covered fund and is either a (1) The banking entity (or an affiliate (B) That such investor should read the securitizer, as that term is used in thereof) provides bona fide trust, fund offering documents before section 15G(a)(3) of the Exchange Act fiduciary, investment advisory, or investing in the covered fund; (15 U.S.C. 78o–11(a)(3)), or is acquiring commodity trading advisory services; (C) That the ‘‘ownership interests in and retaining an ownership interest in (2) The covered fund is organized and the covered fund are not insured by the such covered fund in compliance with offered only in connection with the FDIC, and are not deposits, obligations section 15G of that Act (15 U.S.C. 78o– provision of bona fide trust, fiduciary, of, or endorsed or guaranteed in any 11) and the implementing regulations investment advisory, or commodity way, by any banking entity’’ (unless that issued thereunder each as permitted by trading advisory services and only to happens to be the case); and paragraph (b) of this section; or, directly persons that are customers of such (D) The role of the banking entity and or indirectly, guarantees, assumes, or services of the banking entity (or an its affiliates and employees in otherwise insures the obligations or affiliate thereof), pursuant to a written sponsoring or providing any services to performance of the covered fund or of plan or similar documentation outlining the covered fund; and any covered fund in which such fund how the banking entity or such affiliate (ii) Complies with any additional invests, then in each such case any intends to provide advisory or similar rules of the appropriate Federal banking ownership interests acquired or retained services to its customers through agencies, the SEC, or the CFTC, as by the banking entity and its affiliates in organizing and offering such fund; provided in section 13(b)(2) of the BHC connection with underwriting and (3) The banking entity and its Act, designed to ensure that losses in market making related activities for that affiliates do not acquire or retain an such covered fund are borne solely by particular covered fund are included in ownership interest in the covered fund investors in the covered fund and not by the calculation of ownership interests except as permitted under § 75.12; the covered banking entity and its permitted to be held by the banking (4) The banking entity and its affiliates. entity and its affiliates under the affiliates comply with the requirements (b) Organizing and offering an issuing limitations of § 75.12(a)(2)(ii) and (d); of § 75.14; entity of asset-backed securities. (1) and (5) The banking entity and its Notwithstanding § 75.10(a), a banking (3) With respect to any banking entity, affiliates do not, directly or indirectly, entity is not prohibited from acquiring the aggregate value of all ownership guarantee, assume, or otherwise insure or retaining an ownership interest in, or interests of the banking entity and its the obligations or performance of the acting as sponsor to, a covered fund that affiliates in all covered funds acquired covered fund or of any covered fund in is an issuing entity of asset-backed and retained under § 75.11, including which such covered fund invests; securities in connection with, directly all covered funds in which the banking (6) The covered fund, for corporate, or indirectly, organizing and offering entity holds an ownership interest in marketing, promotional, or other that issuing entity, so long as the connection with underwriting and purposes: banking entity and its affiliates comply market making related activities (i) Does not share the same name or with all of the requirements of permitted under paragraph (c) of this a variation of the same name with the paragraphs (a)(3) through (a)(8) of this section, are included in the calculation banking entity (or an affiliate thereof); section. of all ownership interests under and (2) For purposes of paragraph (b) of § 75.12(a)(2)(iii) and (d). (ii) Does not use the word ‘‘bank’’ in this section, organizing and offering a its name; covered fund that is an issuing entity of § 75.12 Permitted investment in a covered (7) No director or employee of the asset-backed securities means acting as fund. banking entity (or an affiliate thereof) the securitizer, as that term is used in (a) Authority and limitations on takes or retains an ownership interest in section 15G(a)(3) of the Exchange Act permitted investments in covered funds. the covered fund, except for any (15 U.S.C. 78o–11(a)(3)) of the issuing (1) Notwithstanding the prohibition director or employee of the banking entity, or acquiring or retaining an contained in § 75.10(a), a banking entity entity or such affiliate who is directly ownership interest in the issuing entity may acquire and retain an ownership engaged in providing investment as required by section 15G of that Act interest in a covered fund that the advisory, commodity trading advisory, (15 U.S.C. 78o–11) and the banking entity or an affiliate thereof or other services to the covered fund at implementing regulations issued organizes and offers pursuant to § 75.11, the time the director or employee takes thereunder. for the purposes of: the ownership interest; and (c) Underwriting and market making (i) Establishment. Establishing the (8) The banking entity: in ownership interests of a covered fund and providing the fund with (i) Clearly and conspicuously fund. The prohibition contained in sufficient initial equity for investment to discloses, in writing, to any prospective § 75.10(a) does not apply to a banking permit the fund to attract unaffiliated and actual investor in the covered fund entity’s underwriting activities or investors, subject to the limits contained (such as through disclosure in the market making-related activities in paragraphs (a)(2)(i) and (a)(2)(iii) of covered fund’s offering documents): involving a covered fund so long as: this section; or (A) That ‘‘any losses in [such covered (1) Those activities are conducted in (ii) De minimis investment. Making fund] will be borne solely by investors accordance with the requirements of and retaining an investment in the in [the covered fund] and not by [the § 75.4(a) or (b), respectively; covered fund subject to the limits banking entity] or its affiliates; (2) With respect to any banking entity contained in paragraphs (a)(2)(ii) and therefore, [the banking entity’s] losses in (or any affiliate thereof) that acts as a (a)(2)(iii) of this section.

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(2) Investment limits—(i) Seeding investments pursuant to the written the restrictions on ownership interests period. With respect to an investment in investment strategy for the fund; under paragraphs (a)(2)(i)(B) and (ii)(A) any covered fund made or held (B) Issuing entities of asset-backed of this section: pursuant to paragraph (a)(1)(i) of this securities. In the case of an issuing (i) The aggregate number of the section, the banking entity and its entity of asset-backed securities, the outstanding ownership interests held by affiliates: date on which the assets are initially the banking entity shall be the total (A) Must actively seek unaffiliated transferred into the issuing entity of number of ownership interests held investors to reduce, through asset-backed securities. under this section by the banking entity redemption, sale, dilution, or other (b) Rules of construction—(1) in a covered fund divided by the total methods, the aggregate amount of all Attribution of ownership interests to a number of ownership interests held by ownership interests of the banking covered banking entity. (i) For purposes all entities in that covered fund, as of entity in the covered fund to the amount of paragraph (a)(2) of this section, the the last day of each calendar quarter permitted in paragraph (a)(2)(i)(B) of amount and value of a banking entity’s (both measured without regard to this section; and permitted investment in any single committed funds not yet called for (B) Must, no later than 1 year after the covered fund shall include any investment); date of establishment of the fund (or ownership interest held under § 75.12 (ii) The aggregate value of the such longer period as may be provided directly by the banking entity, including outstanding ownership interests held by by the Board pursuant to paragraph (e) any affiliate of the banking entity. the banking entity shall be the aggregate (ii) Treatment of registered investment of this section), conform its ownership fair market value of all investments in companies, SEC-regulated business interest in the covered fund to the limits and capital contributions made to the development companies and foreign in paragraph (a)(2)(ii) of this section; covered fund by the banking entity, public funds. For purposes of paragraph divided by the value of all investments (ii) Per-fund limits. (A) Except as (b)(1)(i) of this section, a registered in and capital contributions made to provided in paragraph (a)(2)(ii)(B) of investment company, SEC-regulated that covered fund by all entities, as of this section, an investment by a banking business development companies or the last day of each calendar quarter (all entity and its affiliates in any covered foreign public fund as described in measured without regard to committed fund made or held pursuant to § 75.10(c)(1) will not be considered to be funds not yet called for investment). If paragraph (a)(1)(ii) of this section may an affiliate of the banking entity so long fair market value cannot be determined, not exceed 3 percent of the total number as the banking entity: then the value shall be the historical or value of the outstanding ownership (A) Does not own, control, or hold cost basis of all investments in and interests of the fund. with the power to vote 25 percent or contributions made by the banking (B) An investment by a banking entity more of the voting shares of the entity to the covered fund; and its affiliates in a covered fund that company or fund; and (iii) For purposes of the calculation is an issuing entity of asset-backed (B) Provides investment advisory, under paragraph (b)(2)(ii) of this section, securities may not exceed 3 percent of commodity trading advisory, once a valuation methodology is chosen, the total fair market value of the administrative, and other services to the the banking entity must calculate the ownership interests of the fund company or fund in compliance with value of its investment and the measured in accordance with paragraph the limitations under applicable investments of all others in the covered (b)(3) of this section, unless a greater regulation, order, or other authority. fund in the same manner and according percentage is retained by the banking (iii) Covered funds. For purposes of to the same standards. entity and its affiliates in compliance paragraph (b)(1)(i) of this section, a (3) Issuing entities of asset-backed with the requirements of section 15G of covered fund will not be considered to securities. In the case of an ownership the Exchange Act (15 U.S.C. 78o–11) be an affiliate of a banking entity so long interest in an issuing entity of asset- and the implementing regulations as the covered fund is held in backed securities, for purposes of issued thereunder, in which case the compliance with the requirements of determining whether an investment in a investment by the banking entity and its this subpart. single covered fund complies with the affiliates in the covered fund may not (iv) Treatment of employee and restrictions on ownership interests exceed the amount, number, or value of director investments financed by the under paragraphs (a)(2)(i)(B) and ownership interests of the fund required banking entity. For purposes of (a)(2)(ii)(B) of this section: under section 15G of the Exchange Act paragraph (b)(1)(i) of this section, an (i) For securitizations subject to the and the implementing regulations investment by a director or employee of requirements of section 15G of the issued thereunder. a banking entity who acquires an Exchange Act (15 U.S.C. 78o–11), the (iii) Aggregate limit. The aggregate ownership interest in his or her calculations shall be made as of the date value of all ownership interests of the personal capacity in a covered fund and according to the valuation banking entity and its affiliates in all sponsored by the banking entity will be methodology applicable pursuant to the covered funds acquired or retained attributed to the banking entity if the requirements of section 15G of the under this section may not exceed 3 banking entity, directly or indirectly, Exchange Act (15 U.S.C. 78o–11) and percent of the tier 1 capital of the extends financing for the purpose of the implementing regulations issued banking entity, as provided under enabling the director or employee to thereunder; or paragraph (c) of this section, and shall acquire the ownership interest in the (ii) For securitization transactions be calculated as of the last day of each fund and the financing is used to completed prior to the compliance date calendar quarter. acquire such ownership interest in the of such implementing regulations (or as (iv) Date of establishment. For covered fund. to which such implementing regulations purposes of this section, the date of (2) Calculation of permitted do not apply), the calculations shall be establishment of a covered fund shall ownership interests in a single covered made as of the date of establishment as be: fund. Except as provided in paragraphs defined in paragraph (a)(2)(iv)(B) of this (A) In general. The date on which the (b)(3) or (4) of this section, for purposes section or such earlier date on which investment adviser or similar entity to of determining whether an investment the transferred assets have been valued the covered fund begins making in a single covered fund complies with for purposes of transfer to the covered

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fund, and thereafter only upon the date (c) Aggregate permitted investments by, a banking entity that is located or on which additional securities of the in all covered funds. (1) For purposes of organized under the laws of the United issuing entity of asset-backed securities paragraph (a)(2)(iii) of this section, the States or of any State, the tier 1 capital are priced for purposes of the sales of aggregate value of all ownership of the banking entity shall be the ownership interests to unaffiliated interests held by a banking entity shall consolidated tier 1 capital of the entity investors. be the sum of all amounts paid or as calculated under applicable home (iii) For securitization transactions contributed by the banking entity in country standards. completed prior to the compliance date connection with acquiring or retaining (B) U.S. affiliates of foreign banking of such implementing regulations (or as an ownership interest in covered funds entities. With respect to a banking entity to which such implementing regulations (together with any amounts paid by the that is located or organized under the do not apply), the aggregate value of the entity (or employee thereof) in laws of the United States or of any State outstanding ownership interests in the connection with obtaining a restricted and is controlled by a foreign banking covered fund shall be the fair market profit interest under § 75.10(d)(6)(ii)), on entity identified under paragraph value of the assets transferred to the a historical cost basis. (c)(2)(iii)(A) of this section, the banking issuing entity of the securitization and (2) Calculation of tier 1 capital. For entity’s tier 1 capital shall be as any other assets otherwise held by the purposes of paragraph (a)(2)(iii) of this calculated under paragraphs (c)(2)(i) or issuing entity at such time, determined section: (ii) of this section. in a manner that is consistent with its (i) Entities that are required to hold (d) Capital treatment for a permitted determination of the fair market value of and report tier 1 capital. If a banking investment in a covered fund. For those assets for financial statement entity is required to calculate and report purposes of calculating compliance with purposes. tier 1 capital, the banking entity’s tier 1 the applicable regulatory capital (iv) For purposes of the calculation capital shall be equal to the amount of requirements, a banking entity shall under paragraph (b)(3)(iii) of this tier 1 capital of the banking entity as of deduct from the banking entity’s tier 1 section, the valuation methodology used the last day of the most recent calendar capital (as determined under paragraph to calculate the fair market value of the quarter, as reported to its primary (c)(2) of this section) the greater of: ownership interests must be the same financial regulatory agency; and (1) The sum of all amounts paid or for both the ownership interests held by (ii) If a banking entity is not required contributed by the banking entity in a banking entity and the ownership to calculate and report tier 1 capital, the connection with acquiring or retaining interests held by all others in the banking entity’s tier 1 capital shall be an ownership interest (together with any covered fund in the same manner and determined to be equal to: amounts paid by the entity (or employee according to the same standards. (A) In the case of a banking entity that (4) Multi-tier fund investments—(i) is controlled, directly or indirectly, by a thereof) in connection with obtaining a Master-feeder fund investments. If the depository institution that calculates restricted profit interest under principal investment strategy of a and reports tier 1 capital, be equal to the § 75.10(d)(6)(ii)), on a historical cost covered fund (the ‘‘feeder fund’’) is to amount of tier 1 capital reported by basis, plus any earnings received; and invest substantially all of its assets in such controlling depository institution (2) The fair market value of the another single covered fund (the in the manner described in paragraph banking entity’s ownership interests in ‘‘master fund’’), then for purposes of the (c)(2)(i) of this section; the covered fund as determined under investment limitations in paragraphs (B) In the case of a banking entity that paragraph (b)(2)(ii) or (3) of this section (a)(2)(i)(B) and (a)(2)(ii) of this section, is not controlled, directly or indirectly, (together with any amounts paid by the the banking entity’s permitted by a depository institution that entity (or employee thereof) in investment in such funds shall be calculates and reports tier 1 capital: connection with obtaining a restricted measured only by reference to the value (1) Bank holding company profit interest under § 75.10(d)(6)(ii)), if of the master fund. The banking entity’s subsidiaries. If the banking entity is a the banking entity accounts for the permitted investment in the master fund subsidiary of a bank holding company profits (or losses) of the fund investment shall include any investment by the or company that is treated as a bank in its financial statements. banking entity in the master fund, as holding company, be equal to the (e) Extension of time to divest an well as the banking entity’s pro-rata amount of tier 1 capital reported by the ownership interest. (1) Upon application share of any ownership interest of the top-tier affiliate of such covered banking by a banking entity, the Board may master fund that is held through the entity that calculates and reports tier 1 extend the period under paragraph feeder fund; and capital in the manner described in (a)(2)(i) of this section for up to 2 (ii) Fund-of-funds investments. If a paragraph (c)(2)(i) of this section; and additional years if the Board finds that banking entity organizes and offers a (2) Other holding companies and any an extension would be consistent with covered fund pursuant to § 75.11 for the subsidiary or affiliate thereof. If the safety and soundness and not purpose of investing in other covered banking entity is not a subsidiary of a detrimental to the public interest. An funds (a ‘‘fund of funds’’) and that fund bank holding company or a company application for extension must: of funds itself invests in another that is treated as a bank holding (i) Be submitted to the Board at least covered fund that the banking entity is company, be equal to the total amount 90 days prior to the expiration of the permitted to own, then the banking of shareholders’ equity of the top-tier applicable time period; entity’s permitted investment in that affiliate within such organization as of (ii) Provide the reasons for other fund shall include any investment the last day of the most recent calendar application, including information that by the banking entity in that other fund, quarter that has ended, as determined addresses the factors in paragraph (e)(2) as well as the banking entity’s pro-rata under applicable accounting standards. of this section; and share of any ownership interest of the (iii) Treatment of foreign banking (iii) Explain the banking entity’s plan fund that is held through the fund of entities—(A) Foreign banking entities. for reducing the permitted investment funds. The investment of the banking Except as provided in paragraph in a covered fund through redemption, entity may not represent more than 3 (c)(2)(iii)(B) of this section, with respect sale, dilution or other methods as percent of the amount or value of any to a banking entity that is not itself, and required in paragraph (a)(2) of this single covered fund. is not controlled directly or indirectly section.

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(2) Factors governing Board § 75.13 Other permitted covered fund amounts payable under such determinations. In reviewing any activities and investments. compensation arrangement. application under paragraph (e)(1) of (a) Permitted risk-mitigating hedging (b) Certain permitted covered fund this section, the Board may consider all activities. (1) The prohibition contained activities and investments outside of the the facts and circumstances related to in § 75.10(a) does not apply with respect United States. (1) The prohibition the permitted investment in a covered to an ownership interest in a covered contained in § 75.10(a) does not apply to fund, including: fund acquired or retained by a banking the acquisition or retention of any (i) Whether the investment would entity that is designed to demonstrably ownership interest in, or the result, directly or indirectly, in a reduce or otherwise significantly sponsorship of, a covered fund by a material exposure by the banking entity mitigate the specific, identifiable risks banking entity only if: to high-risk assets or high-risk trading to the banking entity in connection with (i) The banking entity is not organized strategies; a compensation arrangement with an or directly or indirectly controlled by a (ii) The contractual terms governing employee of the banking entity or an banking entity that is organized under the banking entity’s interest in the affiliate thereof that directly provides the laws of the United States or of one covered fund; investment advisory, commodity trading or more States; (iii) The date on which the covered advisory or other services to the covered (ii) The activity or investment by the fund is expected to have attracted fund. banking entity is pursuant to paragraph sufficient investments from investors (2) Requirements. The risk-mitigating (9) or (13) of section 4(c) of the BHC Act; unaffiliated with the banking entity to hedging activities of a banking entity are (iii) No ownership interest in the enable the banking entity to comply permitted under paragraph (a) of this covered fund is offered for sale or sold with the limitations in paragraph section only if: to a resident of the United States; and (a)(2)(i) of this section; (i) The banking entity has established (iv) The activity or investment occurs (iv) The total exposure of the covered and implements, maintains and enforces solely outside of the United States. banking entity to the investment and the an internal compliance program (2) An activity or investment by the risks that disposing of, or maintaining, required by subpart D of this part that banking entity is pursuant to paragraph the investment in the covered fund may is reasonably designed to ensure the (9) or (13) of section 4(c) of the BHC Act pose to the banking entity and the banking entity’s compliance with the for purposes of paragraph (b)(1)(ii) of financial stability of the United States; requirements of this section, including: this section only if: (v) The cost to the banking entity of (A) Reasonably designed written (i) The activity or investment is divesting or disposing of the investment policies and procedures; and conducted in accordance with the within the applicable period; (vi) Whether the investment or the (B) Internal controls and ongoing requirements of this section; and divestiture or conformance of the monitoring, management, and (ii)(A) With respect to a banking investment would involve or result in a authorization procedures, including entity that is a foreign banking material conflict of interest between the relevant escalation procedures; and organization, the banking entity meets banking entity and unaffiliated parties, (ii) The acquisition or retention of the the qualifying foreign banking including clients, customers or ownership interest: organization requirements of counterparties to which it owes a duty; (A) Is made in accordance with the § 211.23(a), (c) or (e) of the Board’s (vii) The banking entity’s prior efforts written policies, procedures and Regulation K (12 CFR 211.23(a), (c) or to reduce through redemption, sale, internal controls required under this (e)), as applicable; or dilution, or other methods its ownership section; (B) With respect to a banking entity interests in the covered fund, including (B) At the inception of the hedge, is that is not a foreign banking activities related to the marketing of designed to reduce or otherwise organization, the banking entity is not interests in such covered fund; significantly mitigate and demonstrably organized under the laws of the United (viii) Market conditions; and reduces or otherwise significantly States or of one or more States and the (ix) Any other factor that the Board mitigates one or more specific, banking entity, on a fully-consolidated believes appropriate. identifiable risks arising in connection basis, meets at least two of the following (3) Authority to impose restrictions on with the compensation arrangement requirements: activities or investment during any with the employee that directly (1) Total assets of the banking entity extension period. The Board may provides investment advisory, held outside of the United States exceed impose such conditions on any commodity trading advisory, or other total assets of the banking entity held in extension approved under paragraph services to the covered fund; the United States; (e)(1) of this section as the Board (C) Does not give rise, at the inception (2) Total revenues derived from the determines are necessary or appropriate of the hedge, to any significant new or business of the banking entity outside of to protect the safety and soundness of additional risk that is not itself hedged the United States exceed total revenues the banking entity or the financial contemporaneously in accordance with derived from the business of the stability of the United States, address this section; and banking entity in the United States; or material conflicts of interest or other (D) Is subject to continuing review, (3) Total net income derived from the unsound banking practices, or otherwise monitoring and management by the business of the banking entity outside of further the purposes of section 13 of the banking entity. the United States exceeds total net BHC Act and this part. (iii) The compensation arrangement income derived from the business of the (4) Consultation. In the case of a relates solely to the covered fund in banking entity in the United States. banking entity that is primarily which the banking entity or any affiliate (3) An ownership interest in a covered regulated by another Federal banking has acquired an ownership interest fund is not offered for sale or sold to a agency, the SEC, or the CFTC, the Board pursuant to this paragraph and such resident of the United States for will consult with such agency prior to compensation arrangement provides purposes of paragraph (b)(1)(iii) of this acting on an application by the banking that any losses incurred by the banking section only if it is sold or has been sold entity for an extension under paragraph entity on such ownership interest will pursuant to an offering that does not (e)(1) of this section. be offset by corresponding decreases in target residents of the United States.

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(4) An activity or investment occurs commissioners of the States and foreign (b) Restrictions on transactions with solely outside of the United States for jurisdictions, as appropriate, have not covered funds. A banking entity that purposes of paragraph (b)(1)(iv) of this jointly determined, after notice and serves, directly or indirectly, as the section only if: comment, that a particular law, investment manager, investment (i) The banking entity acting as regulation, or written guidance adviser, commodity trading advisor, or sponsor, or engaging as principal in the described in paragraph (c)(2) of this sponsor to a covered fund, or that acquisition or retention of an ownership section is insufficient to protect the organizes and offers a covered fund interest in the covered fund, is not itself, safety and soundness of the banking pursuant to § 75.11, or that continues to and is not controlled directly or entity, or the financial stability of the hold an ownership interest in indirectly by, a banking entity that is United States. accordance with § 75.11(b), shall be located in the United States or subject to section 23B of the Federal organized under the laws of the United § 75.14 Limitations on relationships with a Reserve Act (12 U.S.C. 371c–1), as if covered fund. States or of any State; such banking entity were a member (ii) The banking entity (including (a) Relationships with a covered fund. bank and such covered fund were an relevant personnel) that makes the (1) Except as provided for in paragraph affiliate thereof. decision to acquire or retain the (a)(2) of this section, no banking entity (c) Restrictions on prime brokerage ownership interest or act as sponsor to that serves, directly or indirectly, as the transactions. A prime brokerage the covered fund is not located in the investment manager, investment transaction permitted under paragraph United States or organized under the adviser, commodity trading advisor, or (a)(2)(ii) of this section shall be subject laws of the United States or of any State; sponsor to a covered fund, that to section 23B of the Federal Reserve (iii) The investment or sponsorship, organizes and offers a covered fund Act (12 U.S.C. 371c–1) as if the including any transaction arising from pursuant to § 75.11, or that continues to counterparty were an affiliate of the risk-mitigating hedging related to an hold an ownership interest in banking entity. ownership interest, is not accounted for accordance with § 75.11(b), and no as principal directly or indirectly on a affiliate of such entity, may enter into a § 75.15 Other limitations on permitted consolidated basis by any branch or transaction with the covered fund, or covered fund activities. affiliate that is located in the United with any other covered fund that is (a) No transaction, class of States or organized under the laws of controlled by such covered fund, that transactions, or activity may be deemed the United States or of any State; and would be a covered transaction as permissible under §§ 75.11 through (iv) No financing for the banking defined in section 23A of the Federal 75.13 if the transaction, class of entity’s ownership or sponsorship is Reserve Act (12 U.S.C. 371c(b)(7)), as if transactions, or activity would: provided, directly or indirectly, by any such banking entity and the affiliate (1) Involve or result in a material branch or affiliate that is located in the thereof were a member bank and the conflict of interest between the banking United States or organized under the covered fund were an affiliate thereof. entity and its clients, customers, or laws of the United States or of any State. (2) Notwithstanding paragraph (a)(1) counterparties; (5) For purposes of this section, a U.S. of this section, a banking entity may: (2) Result, directly or indirectly, in a material exposure by the banking entity branch, agency, or subsidiary of a (i) Acquire and retain any ownership to a high-risk asset or a high-risk trading foreign bank, or any subsidiary thereof, interest in a covered fund in accordance strategy; or is located in the United States; however, with the requirements of §§ 75.11, (3) Pose a threat to the safety and a foreign bank of which that branch, 75.12, or 75.13; and agency, or subsidiary is a part is not soundness of the banking entity or to (ii) Enter into any prime brokerage considered to be located in the United the financial stability of the United transaction with any covered fund in States solely by virtue of operation of States. which a covered fund managed, the U.S. branch, agency, or subsidiary. (b) Definition of material conflict of (c) Permitted covered fund interests sponsored, or advised by such banking interest. (1) For purposes of this section, and activities by a regulated insurance entity (or an affiliate thereof) has taken a material conflict of interest between a company. The prohibition contained in an ownership interest, if: banking entity and its clients, § 75.10(a) does not apply to the (A) The banking entity is in customers, or counterparties exists if the acquisition or retention by an insurance compliance with each of the limitations banking entity engages in any company, or an affiliate thereof, of any set forth in § 75.11 with respect to a transaction, class of transactions, or ownership interest in, or the covered fund organized and offered by activity that would involve or result in sponsorship of, a covered fund only if: such banking entity (or an affiliate the banking entity’s interests being (1) The insurance company or its thereof); materially adverse to the interests of its affiliate acquires and retains the (B) The chief executive officer (or client, customer, or counterparty with ownership interest solely for the general equivalent officer) of the banking entity respect to such transaction, class of account of the insurance company or for certifies in writing annually to the transactions, or activity, and the one or more separate accounts Commission (with a duty to update the banking entity has not taken at least one established by the insurance company; certification if the information in the of the actions in paragraph (b)(2) of this (2) The acquisition and retention of certification materially changes) that the section. the ownership interest is conducted in banking entity does not, directly or (2) Prior to effecting the specific compliance with, and subject to, the indirectly, guarantee, assume, or transaction or class or type of insurance company investment laws, otherwise insure the obligations or transactions, or engaging in the specific regulations, and written guidance of the performance of the covered fund or of activity, the banking entity: State or jurisdiction in which such any covered fund in which such (i) Timely and effective disclosure. (A) insurance company is domiciled; and covered fund invests; and Has made clear, timely, and effective (3) The appropriate Federal banking (C) The Board has not determined that disclosure of the conflict of interest, agencies, after consultation with the such transaction is inconsistent with the together with other necessary Financial Stability Oversight Council safe and sound operation and condition information, in reasonable detail and in and the relevant insurance of the banking entity. a manner sufficient to permit a

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reasonable client, customer, or The terms, scope and detail of the (1) The banking entity engages in counterparty to meaningfully compliance program shall be proprietary trading permitted under understand the conflict of interest; and appropriate for the types, size, scope subpart B of this part and is required to (B) Such disclosure is made in a and complexity of activities and comply with the reporting requirements manner that provides the client, business structure of the banking entity. of paragraph (d) of this section; customer, or counterparty the (b) Contents of compliance program. (2) The banking entity has reported opportunity to negate, or substantially Except as provided in paragraph (f) of total consolidated assets as of the mitigate, any materially adverse effect this section, the compliance program previous calendar year end of $50 on the client, customer, or counterparty required by paragraph (a) of this section, billion or more or, in the case of a created by the conflict of interest; or at a minimum, shall include: foreign banking entity, has total U.S. (ii) Information barriers. Has (1) Written policies and procedures assets as of the previous calendar year established, maintained, and enforced reasonably designed to document, end of $50 billion or more (including all information barriers that are describe, monitor and limit trading subsidiaries, affiliates, branches and memorialized in written policies and activities subject to subpart B of this agencies of the foreign banking entity procedures, such as physical separation part (including those permitted under operating, located or organized in the of personnel, or functions, or limitations §§ 75.3 to 75.6), including setting, United States); or on types of activity, that are reasonably monitoring and managing required (3) The Commission notifies the designed, taking into consideration the limits set out in §§ 75.4 and 75.5, and banking entity in writing that it must nature of the banking entity’s business, activities and investments with respect satisfy the requirements and other to prevent the conflict of interest from to a covered fund subject to subpart C standards contained in Appendix B of involving or resulting in a materially of this part (including those permitted this part. (d) Reporting requirements under adverse effect on a client, customer, or under §§ 75.11 through 75.14) Appendix A of this Part. (1) A banking counterparty. A banking entity may not conducted by the banking entity to entity engaged in proprietary trading rely on such information barriers if, in ensure that all activities and activity permitted under subpart B of the case of any specific transaction, investments conducted by the banking this part shall comply with the reporting class or type of transactions or activity, entity that are subject to section 13 of requirements described in Appendix A the banking entity knows or should the BHC Act and this part comply with of this part, if: reasonably know that, notwithstanding section 13 of the BHC Act and this part; (i) The banking entity (other than a the banking entity’s establishment of (2) A system of internal controls foreign banking entity as provided in information barriers, the conflict of reasonably designed to monitor paragraph (d)(1)(ii) of this section) has, interest may involve or result in a compliance with section 13 of the BHC together with its affiliates and materially adverse effect on a client, Act and this part and to prevent the subsidiaries, trading assets and customer, or counterparty. occurrence of activities or investments liabilities (excluding trading assets and (c) Definition of high-risk asset and that are prohibited by section 13 of the liabilities involving obligations of or high-risk trading strategy. For purposes BHC Act and this part; guaranteed by the United States or any of this section: (3) A management framework that agency of the United States) the average (1) High-risk asset means an asset or clearly delineates responsibility and gross sum of which (on a worldwide group of related assets that would, if accountability for compliance with consolidated basis) over the previous held by a banking entity, significantly section 13 of the BHC Act and this part consecutive four quarters, as measured increase the likelihood that the banking and includes appropriate management as of the last day of each of the four entity would incur a substantial review of trading limits, strategies, prior calendar quarters, equals or financial loss or would pose a threat to hedging activities, investments, exceeds the threshold established in the financial stability of the United incentive compensation and other paragraph (d)(2) of this section; States. matters identified in this part or by (ii) In the case of a foreign banking (2) High-risk trading strategy means a management as requiring attention; entity, the average gross sum of the trading strategy that would, if engaged (4) Independent testing and audit of trading assets and liabilities of the in by a banking entity, significantly the effectiveness of the compliance combined U.S. operations of the foreign increase the likelihood that the banking program conducted periodically by banking entity (including all entity would incur a substantial qualified personnel of the banking subsidiaries, affiliates, branches and financial loss or would pose a threat to entity or by a qualified outside party; agencies of the foreign banking entity the financial stability of the United (5) Training for trading personnel and operating, located or organized in the States. managers, as well as other appropriate United States and excluding trading §§ 75.16–75.19 [Reserved] personnel, to effectively implement and assets and liabilities involving enforce the compliance program; and obligations of or guaranteed by the Subpart D—Compliance Program (6) Records sufficient to demonstrate United States or any agency of the Requirement; Violations compliance with section 13 of the BHC United States) over the previous Act and this part, which a banking consecutive four quarters, as measured § 75.20 Program for compliance; reporting. entity must promptly provide to the as of the last day of each of the four (a) Program requirement. Each Commission upon request and retain for prior calendar quarters, equals or banking entity shall develop and a period of no less than 5 years or such exceeds the threshold established in provide for the continued longer period as required by the paragraph (d)(2) of this section; or administration of a compliance program Commission. (iii) The Commission notifies the reasonably designed to ensure and (c) Additional standards. In addition banking entity in writing that it must monitor compliance with the to the requirements in paragraph (b) of satisfy the reporting requirements prohibitions and restrictions on this section, the compliance program of contained in Appendix A of this part. proprietary trading and covered fund a banking entity must satisfy the (2) The threshold for reporting under activities and investments set forth in requirements and other standards paragraph (d)(1) of this section shall be section 13 of the BHC Act and this part. contained in Appendix B of this part, if: $50 billion beginning on June 30, 2014;

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$25 billion beginning on April 30, 2016; development company within the time adjustments as appropriate given the and $10 billion beginning on December period specified in § 75.12(a)(2)(i)(B); activities, size, scope and complexity of 31, 2016. (4) For any banking entity that is, or the banking entity. (3) Frequency of reporting. Unless the is controlled directly or indirectly by a banking entity that is, located in or § 75.21 Termination of activities or Commission notifies the banking entity investments; penalties for violations. in writing that it must report on a organized under the laws of the United different basis, a banking entity with States or of any State, if the aggregate (a) Any banking entity that engages in $50 billion or more in trading assets and amount of ownership interests in an activity or makes an investment in liabilities (as calculated in accordance foreign public funds that are described violation of section 13 of the BHC Act with paragraph (d)(1) of this section) in § 75.10(c)(1) owned by such banking or this part, or acts in a manner that shall report the information required by entity (including ownership interests functions as an evasion of the Appendix A of this part for each owned by any affiliate that is controlled requirements of section 13 of the BHC calendar month within 30 days of the directly or indirectly by a banking entity Act or this part, including through an end of the relevant calendar month; that is located in or organized under the abuse of any activity or investment beginning with information for the laws of the United States or of any State) permitted under subparts B or C of this month of January 2015, such exceeds $50 million at the end of two part, or otherwise violates the information shall be reported within 10 or more consecutive calendar quarters, restrictions and requirements of section days of the end of each calendar month. beginning with the next succeeding 13 of the BHC Act or this part, shall, Any other banking entity subject to calendar quarter, documentation of the upon discovery, promptly terminate the Appendix A of this part shall report the value of the ownership interests owned activity and, as relevant, dispose of the information required by Appendix A of by the banking entity (and such investment. (b) Whenever the Commission finds this part for each calendar quarter affiliates) in each foreign public fund reasonable cause to believe any banking within 30 days of the end of that and each jurisdiction in which any such entity has engaged in an activity or calendar quarter unless the Commission foreign public fund is organized, made an investment in violation of notifies the banking entity in writing calculated as of the end of each calendar section 13 of the BHC Act or this part, that it must report on a different basis. quarter, which documentation must continue until the banking entity’s or engaged in any activity or made any (e) Additional documentation for investment that functions as an evasion covered funds. Any banking entity that aggregate amount of ownership interests in foreign public funds is below $50 of the requirements of section 13 of the has more than $10 billion in total BHC Act or this part, the Commission consolidated assets as reported on million for two consecutive calendar quarters; and may take any action permitted by law to December 31 of the previous two (5) For purposes of paragraph (e)(4) of enforce compliance with section 13 of calendar years shall maintain records this section, a U.S. branch, agency, or the BHC Act and this part, including that include: subsidiary of a foreign banking entity is directing the banking entity to restrict, (1) Documentation of the exclusions located in the United States; however, limit, or terminate any or all activities or exemptions other than sections the foreign bank that operates or under this part and dispose of any 3(c)(1) and 3(c)(7) of the Investment controls that branch, agency, or investment. Company Act of 1940 relied on by each subsidiary is not considered to be Appendix A to Part 75—Reporting and fund sponsored by the banking entity located in the United States solely by Recordkeeping Requirements for (including all subsidiaries and affiliates) virtue of operating or controlling the Covered Trading Activities in determining that such fund is not a U.S. branch, agency, or subsidiary. covered fund; (f) Simplified programs for less active I. Purpose (2) For each fund sponsored by the banking entities—(1) Banking entities a. This appendix sets forth reporting and banking entity (including all with no covered activities. A banking recordkeeping requirements that certain subsidiaries and affiliates) for which the entity that does not engage in activities banking entities must satisfy in connection banking entity relies on one or more of or investments pursuant to subpart B or with the restrictions on proprietary trading the exclusions from the definition of subpart C of this part (other than trading set forth in subpart B of this part covered fund provided by § 75.10(c)(1), activities permitted pursuant to (‘‘proprietary trading restrictions’’). Pursuant (5), (8), (9), or (10), documentation § 75.6(a)) may satisfy the requirements to § 75.20(d), this appendix generally applies supporting the banking entity’s to a banking entity that, together with its of this section by establishing the affiliates and subsidiaries, has significant determination that the fund is not a required compliance program prior to trading assets and liabilities. These entities covered fund pursuant to one or more becoming engaged in such activities or are required to (i) furnish periodic reports to of those exclusions; making such investments (other than the Commission regarding a variety of (3) For each seeding vehicle described trading activities permitted pursuant to quantitative measurements of their covered in § 75.10(c)(12)(i) or (iii) that will § 75.6(a)). trading activities, which vary depending on become a registered investment (2) Banking entities with modest the scope and size of covered trading company or SEC-regulated business activities. A banking entity with total activities, and (ii) create and maintain records documenting the preparation and development company, a written plan consolidated assets of $10 billion or less content of these reports. The requirements of documenting the banking entity’s as reported on December 31 of the this appendix must be incorporated into the determination that the seeding vehicle previous two calendar years that banking entity’s internal compliance program will become a registered investment engages in activities or investments under § 75.20 and Appendix B of this part. company or SEC-regulated business pursuant to subpart B or subpart C of b. The purpose of this appendix is to assist development company; the period of this part (other than trading activities banking entities and the Commission in: time during which the vehicle will permitted under § 75.6(a)) may satisfy (i) Better understanding and evaluating the operate as a seeding vehicle; and the the requirements of this section by scope, type, and profile of the banking entity’s covered trading activities; banking entity’s plan to market the including in its existing compliance (ii) Monitoring the banking entity’s covered vehicle to third-party investors and policies and procedures appropriate trading activities; convert it into a registered investment references to the requirements of section (iii) Identifying covered trading activities company or SEC-regulated business 13 of the BHC Act and this part and that warrant further review or examination

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by the banking entity to verify compliance measurement results that indicate a c. Recordkeeping with the proprietary trading restrictions; heightened risk of impermissible proprietary A banking entity must, for any quantitative (iv) Evaluating whether the covered trading trading, including with respect to otherwise- measurement furnished to the Commission activities of trading desks engaged in market permitted activities under §§ 75.4 through pursuant to this appendix and § 75.20(d), making-related activities subject to § 75.4(b) 75.6(a) and (b), or that result in a material create and maintain records documenting the are consistent with the requirements exposure to high-risk assets or high-risk preparation and content of these reports, as governing permitted market making-related trading strategies, must be escalated within well as such information as is necessary to activities; the banking entity for review, further permit the Commission to verify the accuracy (v) Evaluating whether the covered trading analysis, explanation to the Commission, and of such reports, for a period of 5 years from activities of trading desks that are engaged in remediation, where appropriate. The the end of the calendar year for which the permitted trading activity subject to § 75.4, quantitative measurements discussed in this measurement was taken. 75.5, or 75.6(a) and (b) (i.e., underwriting and appendix should be helpful to banking market making-related related activity, risk- IV. Quantitative Measurements entities in identifying and managing the risks mitigating hedging, or trading in certain government obligations) are consistent with related to their covered trading activities. a. Risk-Management Measurements the requirement that such activity not result, II. Definitions 1. Risk and Position Limits and Usage directly or indirectly, in a material exposure i. Description: For purposes of this to high-risk assets or high-risk trading The terms used in this appendix have the same meanings as set forth in §§ 75.2 and appendix, Risk and Position Limits are the strategies; constraints that define the amount of risk that (vi) Identifying the profile of particular 75.3. In addition, for purposes of this appendix, the following definitions apply: a trading desk is permitted to take at a point covered trading activities of the banking in time, as defined by the banking entity for entity, and the individual trading desks of Calculation period means the period of time for which a particular quantitative a specific trading desk. Usage represents the the banking entity, to help establish the portion of the trading desk’s limits that are measurement must be calculated. appropriate frequency and scope of accounted for by the current activity of the Comprehensive profit and loss means the examination by the Commission of such desk. Risk and position limits and their usage net profit or loss of a trading desk’s material activities; and are key risk management tools used to (vii) Assessing and addressing the risks sources of trading revenue over a specific control and monitor risk taking and include, associated with the banking entity’s covered period of time, including, for example, any but are not limited, to the limits set out in trading activities. increase or decrease in the market value of §§ 75.4 and 75.5. A number of the metrics c. The quantitative measurements that a trading desk’s holdings, dividend income, that are described below, including ‘‘Risk must be furnished pursuant to this appendix and interest income and expense. Factor Sensitivities’’ and ‘‘Value-at-Risk and are not intended to serve as a dispositive tool Covered trading activity means trading Stress Value-at-Risk,’’ relate to a trading for the identification of permissible or conducted by a trading desk under § 75.4, desk’s risk and position limits and are useful impermissible activities. 75.5, or 75.6(a) or (b). A banking entity may in evaluating and setting these limits in the d. In order to allow banking entities and include trading under § 75.3(d) or 75.6(c), (d) broader context of the trading desk’s overall the Agencies to evaluate the effectiveness of or (e). activities, particularly for the market making these metrics, banking entities must collect Measurement frequency means the activities under § 75.4(b) and hedging activity and report these metrics for all trading desks frequency with which a particular under § 75.5. Accordingly, the limits required beginning on the dates established in § 75.20. quantitative metric must be calculated and under §§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) must The Agencies will review the data collected recorded. meet the applicable requirements under and revise this collection requirement as Trading desk means the smallest discrete §§ 75.4(b)(2)(iii) and 75.5(b)(1)(i) and also appropriate based on a review of the data unit of organization of a banking entity that must include appropriate metrics for the collected prior to September 30, 2015. purchases or sells financial instruments for trading desk limits including, at a minimum, e. In addition to the quantitative the trading account of the banking entity or the ‘‘Risk Factor Sensitivities’’ and ‘‘Value-at- measurements required in this appendix, a an affiliate thereof. Risk and Stress Value-at-Risk’’ metrics except banking entity may need to develop and to the extent any of the ‘‘Risk Factor implement other quantitative measurements III. Reporting and Recordkeeping of Sensitivities’’ or ‘‘Value-at-Risk and Stress in order to effectively monitor its covered Quantitative Measurements Value-at-Risk’’ metrics are demonstrably trading activities for compliance with section a. Scope of Required Reporting ineffective for measuring and monitoring the 13 of the BHC Act and this part and to have risks of a trading desk based on the types of General scope. Each banking entity made an effective compliance program, as required positions traded by, and risk exposures of, subject to this part by § 75.20 must furnish by § 75.20 and Appendix B of this part. The that desk. the following quantitative measurements for effectiveness of particular quantitative ii. General Calculation Guidance: Risk and measurements may differ based on the profile each trading desk of the banking entity, Position Limits must be reported in the of the banking entity’s businesses in general calculated in accordance with this appendix: format used by the banking entity for the and, more specifically, of the particular • Risk and Position Limits and Usage; • purposes of risk management of each trading trading desk, including types of instruments Risk Factor Sensitivities; desk. Risk and Position Limits are often traded, trading activities and strategies, and • Value-at-Risk and Stress VaR; • expressed in terms of risk measures, such as history and experience (e.g., whether the Comprehensive Profit and Loss VaR and Risk Factor Sensitivities, but may trading desk is an established, successful Attribution; also be expressed in terms of other • market maker or a new entrant to a Inventory Turnover; observable criteria, such as net open • competitive market). In all cases, banking Inventory Aging; and positions. When criteria other than VaR or • entities must ensure that they have robust Customer Facing Trade Ratio Risk Factor Sensitivities are used to define measures in place to identify and monitor the b. Frequency of Required Calculation and the Risk and Position Limits, both the value risks taken in their trading activities, to Reporting of the Risk and Position Limits and the value ensure that the activities are within risk of the variables used to assess whether these A banking entity must calculate any tolerances established by the banking entity, limits have been reached must be reported. applicable quantitative measurement for each and to monitor and examine for compliance iii. Calculation Period: One trading day. trading day. A banking entity must report with the proprietary trading restrictions in iv. Measurement Frequency: Daily. this part. each applicable quantitative measurement to f. On an ongoing basis, banking entities the Commission on the reporting schedule 2. Risk Factor Sensitivities must carefully monitor, review, and evaluate established in § 75.20 unless otherwise i. Description: For purposes of this all furnished quantitative measurements, as requested by the Commission. All appendix, Risk Factor Sensitivities are well as any others that they choose to utilize quantitative measurements for any calendar changes in a trading desk’s Comprehensive in order to maintain compliance with section month must be reported within the time Profit and Loss that are expected to occur in 13 of the BHC Act and this part. All period required by § 75.20. the event of a change in one or more

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underlying variables that are significant shared by multiple trading desks, such as an A. The comprehensive profit and loss sources of the trading desk’s profitability and equity price factor, must be applied associated with existing positions must risk. consistently across its trading desks so that reflect changes in the value of these positions ii. General Calculation Guidance: A the sensitivities can be compared from one on the applicable day. The comprehensive banking entity must report the Risk Factor trading desk to another. profit and loss from existing positions must Sensitivities that are monitored and managed iii. Calculation Period: One trading day. be further attributed, as applicable, to as part of the trading desk’s overall risk iv. Measurement Frequency: Daily. changes in (i) the specific Risk Factors and management policy. The underlying data and 3. Value-at-Risk and Stress Value-at-Risk other factors that are monitored and managed methods used to compute a trading desk’s as part of the trading desk’s overall risk Risk Factor Sensitivities will depend on the i. Description: For purposes of this management policies and procedures; and (ii) specific function of the trading desk and the appendix, Value-at-Risk (‘‘VaR’’) is the any other applicable elements, such as cash internal risk management models employed. commonly used percentile measurement of flows, carry, changes in reserves, and the The number and type of Risk Factor the risk of future financial loss in the value correction, cancellation, or exercise of a Sensitivities that are monitored and managed of a given set of aggregated positions over a trade. by a trading desk, and furnished to the specified period of time, based on current B. The comprehensive profit and loss Commission, will depend on the explicit market conditions. For purposes of this attributed to new positions must reflect risks assumed by the trading desk. In general, appendix, Stress Value-at-Risk (‘‘Stress VaR’’) commissions and fee income or expense and however, reported Risk Factor Sensitivities is the percentile measurement of the risk of market gains or losses associated with must be sufficiently granular to account for future financial loss in the value of a given transactions executed on the applicable day. a preponderance of the expected price set of aggregated positions over a specified New positions include purchases and sales of variation in the trading desk’s holdings. period of time, based on market conditions financial instruments and other assets/ A. Trading desks must take into account during a period of significant financial stress. liabilities and negotiated amendments to any relevant factors in calculating Risk Factor ii. General Calculation Guidance: Banking existing positions. The comprehensive profit Sensitivities, including, for example, the entities must compute and report VaR and and loss from new positions may be reported following with respect to particular asset Stress VaR by employing generally accepted in the aggregate and does not need to be classes: standards and methods of calculation. VaR further attributed to specific sources. • Commodity derivative positions: risk should reflect a loss in a trading desk that is C. The portion of comprehensive profit and factors with respect to the related expected to be exceeded less than one loss that cannot be specifically attributed to commodities set out in § 20.2 of this chapter, percent of the time over a one-day period. known sources must be allocated to a the maturity of the positions, volatility and/ For those banking entities that are subject to residual category identified as an or correlation sensitivities (expressed in a regulatory capital requirements imposed by a unexplained portion of the comprehensive manner that demonstrates any significant Federal banking agency, VaR and Stress VaR profit and loss. Significant unexplained non-linearities), and the maturity profile of must be computed and reported in a manner profit and loss must be escalated for further the positions; that is consistent with such regulatory capital investigation and analysis. • Credit positions: risk factors with respect requirements. In cases where a trading desk ii. General Calculation Guidance: The to credit spreads that are sufficiently granular does not have a standalone VaR or Stress VaR specific categories used by a trading desk in to account for specific credit sectors and calculation but is part of a larger aggregation the attribution analysis and amount of detail market segments, the maturity profile of the of positions for which a VaR or Stress VaR for the analysis should be tailored to the type positions, and risk factors with respect to calculation is performed, a VaR or Stress VaR and amount of trading activities undertaken interest rates of all relevant maturities; calculation that includes only the trading by the trading desk. The new position • Credit-related derivative positions: risk desk’s holdings must be performed consistent attribution must be computed by calculating factor sensitivities, for example credit with the VaR or Stress VaR model and the difference between the prices at which spreads, shifts (parallel and non-parallel) in methodology used for the larger aggregation instruments were bought and/or sold and the credit spreads—volatility, and/or correlation of positions. prices at which those instruments are marked sensitivities (expressed in a manner that iii. Calculation Period: One trading day. to market at the close of business on that day demonstrates any significant non-linearities), iv. Measurement Frequency: Daily. multiplied by the notional or principal and the maturity profile of the positions; b. Source-of-Revenue Measurements amount of each purchase or sale. Any fees, • Equity derivative positions: risk factor commissions, or other payments received sensitivities such as equity positions, 1. Comprehensive Profit and Loss Attribution (paid) that are associated with transactions volatility, and/or correlation sensitivities i. Description: For purposes of this executed on that day must be added (expressed in a manner that demonstrates appendix, Comprehensive Profit and Loss (subtracted) from such difference. These any significant non-linearities), and the Attribution is an analysis that attributes the factors must be measured consistently over maturity profile of the positions; daily fluctuation in the value of a trading time to facilitate historical comparisons. • Equity positions: risk factors for equity desk’s positions to various sources. First, the iii. Calculation Period: One trading day. prices and risk factors that differentiate daily profit and loss of the aggregated iv. Measurement Frequency: Daily. between important equity market sectors and positions is divided into three categories: (i) c. Customer-Facing Activity Measurements segments, such as a small capitalization Profit and loss attributable to a trading desk’s equities and international equities; existing positions that were also positions 1. Inventory Turnover • Foreign exchange derivative positions: held by the trading desk as of the end of the i. Description: For purposes of this risk factors with respect to major currency prior day (‘‘existing positions’’); (ii) profit appendix, Inventory Turnover is a ratio that pairs and maturities, exposure to interest and loss attributable to new positions measures the turnover of a trading desk’s rates at relevant maturities, volatility, and/or resulting from the current day’s trading inventory. The numerator of the ratio is the correlation sensitivities (expressed in a activity (‘‘new positions’’); and (iii) residual absolute value of all transactions over the manner that demonstrates any significant profit and loss that cannot be specifically reporting period. The denominator of the non-linearities), as well as the maturity attributed to existing positions or new ratio is the value of the trading desk’s profile of the positions; and positions. The sum of (i), (ii), and (iii) must inventory at the beginning of the reporting • Interest rate positions, including interest equal the trading desk’s comprehensive profit period. rate derivative positions: risk factors with and loss at each point in time. In addition, ii. General Calculation Guidance: For respect to major interest rate categories and profit and loss measurements must calculate purposes of this appendix, for derivatives, maturities and volatility and/or correlation volatility of comprehensive profit and loss other than options and interest rate sensitivities (expressed in a manner that (i.e., the standard deviation of the trading derivatives, value means gross notional demonstrates any significant non-linearities), desk’s one-day profit and loss, in dollar value, for options, value means delta and shifts (parallel and non-parallel) in the terms) for the reporting period for at least a adjusted notional value, and for interest rate interest rate curve, as well as the maturity 30-, 60- and 90-day lag period, from the end derivatives, value means 10-year bond profile of the positions. of the reporting period, and any other period equivalent value. B. The methods used by a banking entity that the banking entity deems necessary to iii. Calculation Period: 30 days, 60 days, to calculate sensitivities to a common factor meet the requirements of the rule. and 90 days.

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iv. Measurement Frequency: Daily. means gross notional value, for options, permitted trading activities. The compliance 2. Inventory Aging value means delta adjusted notional value, program may be tailored to the types of and for interest rate derivatives, value means trading activities conducted by the banking i. Description: For purposes of this 10-year bond equivalent value. entity, and must include a detailed appendix, Inventory Aging generally iii. Calculation Period: 30 days, 60 days, description of controls established by the describes a schedule of the trading desk’s and 90 days. banking entity to reasonably ensure that its aggregate assets and liabilities and the iv. Measurement Frequency: Daily. trading activities are conducted in amount of time that those assets and accordance with the requirements and liabilities have been held. Inventory Aging Appendix B to Part 75—Enhanced limitations applicable to those trading should measure the age profile of the trading Minimum Standards for Compliance activities under section 13 of the BHC Act desk’s assets and liabilities. Programs and this part, and provide for appropriate ii. General Calculation Guidance: In revision of the compliance program before I. Overview general, Inventory Aging must be computed expansion of the trading activities of the using a trading desk’s trading activity data Section 75.20(c) requires certain banking banking entity. A banking entity must devote and must identify the value of a trading entities to establish, maintain, and enforce an adequate resources and use knowledgeable desk’s aggregate assets and liabilities. enhanced compliance program that includes personnel in conducting, supervising and Inventory Aging must include two schedules, the requirements and standards in this managing its trading activities, and promote an asset-aging schedule and a liability-aging Appendix as well as the minimum written consistency, independence and rigor in schedule. Each schedule must record the policies and procedures, internal controls, implementing its risk controls and value of assets or liabilities held over all management framework, independent compliance efforts. The compliance program holding periods. For derivatives, other than testing, training, and recordkeeping must be updated with a frequency sufficient options, and interest rate derivatives, value provisions outlined in § 75.20. This to account for changes in the activities of the means gross notional value, for options, Appendix sets forth additional minimum banking entity, results of independent testing value means delta adjusted notional value standards with respect to the establishment, of the program, identification of weaknesses and, for interest rate derivatives, value means oversight, maintenance, and enforcement by in the program, and changes in legal, 10-year bond equivalent value. these banking entities of an enhanced regulatory or other requirements. iii. Calculation Period: One trading day. internal compliance program for ensuring 1. Trading Desks: The banking entity must iv. Measurement Frequency: Daily. and monitoring compliance with the have written policies and procedures 3. Customer-Facing Trade Ratio—Trade prohibitions and restrictions on proprietary governing each trading desk that include a Count Based and Value Based trading and covered fund activities and description of: investments set forth in section 13 of the i. Description: For purposes of this i. The process for identifying, authorizing BHC Act and this part. appendix, the Customer-Facing Trade Ratio and documenting financial instruments each a. This compliance program must: is a ratio comparing (i) the transactions trading desk may purchase or sell, with 1. Be reasonably designed to identify, involving a counterparty that is a customer separate documentation for market making- document, monitor, and report the permitted of the trading desk to (ii) the transactions related activities conducted in reliance on trading and covered fund activities and involving a counterparty that is not a § 75.4(b) and for hedging activity conducted investments of the banking entity; identify, customer of the trading desk. A trade count in reliance on § 75.5; monitor and promptly address the risks of based ratio must be computed that records ii. A mapping for each trading desk to the these covered activities and investments and the number of transactions involving a division, business line, or other potential areas of noncompliance; and counterparty that is a customer of the trading organizational structure that is responsible prevent activities or investments prohibited desk and the number of transactions for managing and overseeing the trading by, or that do not comply with, section 13 of involving a counterparty that is not a desk’s activities; the BHC Act and this part; customer of the trading desk. A value based iii. The mission (i.e., the type of trading 2. Establish and enforce appropriate limits ratio must be computed that records the activity, such as market-making, trading in on the covered activities and investments of value of transactions involving a sovereign debt, etc.) and strategy (i.e., the banking entity, including limits on the counterparty that is a customer of the trading methods for conducting authorized trading size, scope, complexity, and risks of the desk and the value of transactions involving activities) of each trading desk; individual activities or investments a counterparty that is not a customer of the iv. The activities that the trading desk is consistent with the requirements of section trading desk. authorized to conduct, including (i) 13 of the BHC Act and this part; ii. General Calculation Guidance: For authorized instruments and products, and (ii) 3. Subject the effectiveness of the purposes of calculating the Customer-Facing authorized hedging strategies, techniques and compliance program to periodic independent Trade Ratio, a counterparty is considered to instruments; be a customer of the trading desk if the review and testing, and ensure that the v. The types and amount of risks allocated counterparty is a market participant that entity’s internal audit, corporate compliance by the banking entity to each trading desk to makes use of the banking entity’s market and internal control functions involved in implement the mission and strategy of the making-related services by obtaining such review and testing are effective and trading desk, including an enumeration of services, responding to quotations, or independent; material risks resulting from the activities in entering into a continuing relationship with 4. Make senior management, and others as which the trading desk is authorized to respect to such services. However, a trading appropriate, accountable for the effective engage (including but not limited to price desk or other organizational unit of another implementation of the compliance program, risks, such as basis, volatility and correlation banking entity would not be a client, and ensure that the board of directors and risks, as well as counterparty credit risk). customer, or counterparty of the trading desk chief executive officer (or equivalent) of the Risk assessments must take into account both if the other entity has trading assets and banking entity review the effectiveness of the the risks inherent in the trading activity and liabilities of $50 billion or more as measured compliance program; and the strength and effectiveness of controls in accordance with § 75.20(d)(1) unless the 5. Facilitate supervision and examination designed to mitigate those risks; trading desk documents how and why a by the Agencies of the banking entity’s vi. How the risks allocated to each trading particular trading desk or other permitted trading and covered fund activities desk will be measured; organizational unit of the entity should be and investments. vii. Why the allocated risks levels are treated as a client, customer, or counterparty II. Enhanced Compliance Program appropriate to the activities authorized for of the trading desk. Transactions conducted the trading desk; anonymously on an exchange or similar a. Proprietary Trading Activities viii. The limits on the holding period of, trading facility that permits trading on behalf A banking entity must establish, maintain and the risk associated with, financial of a broad range of market participants would and enforce a compliance program that instruments under the responsibility of the be considered transactions with customers of includes written policies and procedures that trading desk; the trading desk. For derivatives, other than are appropriate for the types, size, and ix. The process for setting new or revised options, and interest rate derivatives, value complexity of, and risks associated with, its limits, as well as escalation procedures for

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granting exceptions to any limits or to any implement and enforce limits and internal contain risk and ensure compliance. In policies or procedures governing the desk, controls for each trading desk that are addition to the quantitative measurements the analysis that will be required to support reasonably designed to ensure that trading reported by any banking entity subject to revising limits or granting exceptions, and activity is conducted in conformance with Appendix A of this part, each banking entity the process for independently reviewing and section 13 of the BHC Act and this part and must develop and implement, to the extent documenting those exceptions and the with the banking entity’s written policies and appropriate to facilitate compliance with this underlying analysis; procedures. The banking entity must part, additional quantitative measurements x. The process for identifying, establish and enforce risk limits appropriate specifically tailored to the particular risks, documenting and approving new products, for the activity of each trading desk. These practices, and strategies of its trading desks. trading strategies, and hedging strategies; limits should be based on probabilistic and The banking entity’s analysis and xi. The types of clients, customers, and non-probabilistic measures of potential loss quantitative measurements must incorporate counterparties with whom the trading desk (e.g., Value-at-Risk and notional exposure, the quantitative measurements reported by may trade; and respectively), and measured under normal the banking entity pursuant to Appendix A xii. The compensation arrangements, and stress market conditions. At a minimum, of this part (if applicable) and include, at a including incentive arrangements, for these internal controls must monitor, minimum, the following: employees associated with the trading desk, establish and enforce limits on: i. Internal controls and written policies and which may not be designed to reward or i. The financial instruments (including, at procedures reasonably designed to ensure the incentivize prohibited proprietary trading or a minimum, by type and exposure) that the accuracy and integrity of quantitative excessive or imprudent risk-taking. trading desk may trade; measurements; 2. Description of risks and risk ii. The types and levels of risks that may ii. Ongoing, timely monitoring and review management processes: The compliance be taken by each trading desk; and of calculated quantitative measurements; program for the banking entity must include iii. The types of hedging instruments used, iii. The establishment of numerical a comprehensive description of the risk hedging strategies employed, and the amount thresholds and appropriate trading measures management program for the trading activity of risk effectively hedged. for each trading desk and heightened review of the banking entity. The compliance 4. Hedging policies and procedures. The of trading activity not consistent with those program must also include a description of banking entity must establish, maintain, and thresholds to ensure compliance with section the governance, approval, reporting, enforce written policies and procedures 13 of the BHC Act and this part, including escalation, review and other processes the regarding the use of risk-mitigating hedging analysis of the measurement results or other banking entity will use to reasonably ensure instruments and strategies that, at a information, appropriate escalation that trading activity is conducted in minimum, describe: procedures, and documentation related to the compliance with section 13 of the BHC Act i. The positions, techniques and strategies review; and iv. Immediate review and compliance and this part. Trading activity in similar that each trading desk may use to hedge the financial instruments should be subject to investigation of the trading desk’s activities, risk of its positions; similar governance, limits, testing, controls, escalation to senior management with ii. The manner in which the banking entity and review, unless the banking entity oversight responsibilities for the applicable will identify the risks arising in connection specifically determines to establish different trading desk, timely notification to the with and related to the individual or limits or processes and documents those Commission, appropriate remedial action aggregated positions, contracts or other differences. Descriptions must include, at a (e.g., divesting of impermissible positions, holdings of the banking entity that are to be minimum, the following elements: cessation of impermissible activity, i. A description of the supervisory and risk hedged and determine that those risks have disciplinary actions), and documentation of management structure governing all trading been properly and effectively hedged; the investigation findings and remedial activity, including a description of processes iii. The level of the organization at which action taken when quantitative for initial and senior-level review of new hedging activity and management will occur; measurements or other information, products and new strategies; iv. The manner in which hedging strategies considered together with the facts and ii. A description of the process for will be monitored and the personnel circumstances, or findings of internal audit, developing, documenting, testing, approving responsible for such monitoring; independent testing or other review suggest and reviewing all models used for valuing, v. The risk management processes used to a reasonable likelihood that the trading desk identifying and monitoring the risks of control unhedged or residual risks; and has violated any part of section 13 of the BHC trading activity and related positions, vi. The process for developing, Act or this part. including the process for periodic documenting, testing, approving and 6. Other Compliance Matters. In addition independent testing of the reliability and reviewing all hedging positions, techniques to the requirements specified above, the accuracy of those models; and strategies permitted for each trading desk banking entity’s compliance program must: iii. A description of the process for and for the banking entity in reliance on i. Identify activities of each trading desk developing, documenting, testing, approving § 75.5. that will be conducted in reliance on and reviewing the limits established for each 5. Analysis and quantitative exemptions contained in §§ 75.4 through trading desk; measurements. The banking entity must 75.6, including an explanation of: iv. A description of the process by which perform robust analysis and quantitative A. How and where in the organization the a security may be purchased or sold pursuant measurement of its trading activities that is activity occurs; and to the liquidity management plan, including reasonably designed to ensure that the B. Which exemption is being relied on and the process for authorizing and monitoring trading activity of each trading desk is how the activity meets the specific such activity to ensure compliance with the consistent with the banking entity’s requirements for reliance on the applicable banking entity’s liquidity management plan compliance program; monitor and assist in exemption; and the restrictions on liquidity management the identification of potential and actual ii. Include an explanation of the process for activities in this part; prohibited proprietary trading activity; and documenting, approving and reviewing v. A description of the management review prevent the occurrence of prohibited actions taken pursuant to the liquidity process, including escalation procedures, for proprietary trading. Analysis and models management plan, where in the organization approving any temporary exceptions or used to determine, measure and limit risk this activity occurs, the securities permissible permanent adjustments to limits on the must be rigorously tested and be reviewed by for liquidity management, the process for activities, positions, strategies, or risks management responsible for trading activity ensuring that liquidity management activities associated with each trading desk; and to ensure that trading activities, limits, are not conducted for the purpose of vi. The role of the audit, compliance, risk strategies, and hedging activities do not prohibited proprietary trading, and the management and other relevant units for understate the risk and exposure to the process for ensuring that securities conducting independent testing of trading banking entity or allow prohibited purchased as part of the liquidity and hedging activities, techniques and proprietary trading. This review should management plan are highly liquid and strategies. include periodic and independent back- conform to the requirements of this part; 3. Authorized risks, instruments, and testing and revision of activities, limits, iii. Describe how the banking entity products. The banking entity must strategies and hedging as appropriate to monitors for and prohibits potential or actual

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material exposure to high-risk assets or high- provide a process, which must include i. The covered fund activities and risk trading strategies presented by each appropriate management review and investments that the unit is authorized to trading desk that relies on the exemptions independent testing, for identifying and conduct; contained in §§ 75.3(d)(3) and 75.4 through documenting covered funds that each unit ii. The banking entity’s plan for actively 75.6, which must take into account potential within the banking entity’s organization seeking unaffiliated investors to ensure that or actual exposure to: sponsors or organizes and offers, and covered any investment by the banking entity A. Assets whose values cannot be funds in which each such unit invests. In conforms to the limits contained in § 75.12 or externally priced or, where valuation is addition to the documentation requirements registered in compliance with the securities reliant on pricing models, whose model for covered funds, as specified under laws and thereby exempt from those limits inputs cannot be externally validated; § 75.20(e), the documentation must include within the time periods allotted in § 75.12; B. Assets whose changes in value cannot information that identifies all pools that the and be adequately mitigated by effective hedging; banking entity sponsors or has an interest in iii. How it complies with the requirements C. New products with rapid growth, and the type of exemption from the of subpart C of this part. including those that do not have a market Commodity Exchange Act (whether or not 5. Internal Controls. A banking entity must history; the pool relies on § 4.7 of the regulations establish, maintain, and enforce internal D. Assets or strategies that include under the Commodity Exchange Act (§ 4.7 of controls that are reasonably designed to significant embedded leverage; this chapter)), and the amount of ownership ensure that its covered fund activities or E. Assets or strategies that have interest the banking entity has in those pools. investments comply with the requirements of demonstrated significant historical volatility; 2. Identification of covered fund activities section 13 of the BHC Act and this part and are appropriate given the limits on risk F. Assets or strategies for which the and investments. The banking entity’s application of capital and liquidity standards established by the banking entity. These compliance program must identify, would not adequately account for the risk; written internal controls must be reasonably document and map each unit within the and designed and established to effectively organization that is permitted to acquire or G. Assets or strategies that result in large monitor and identify for further analysis any hold an interest in any covered fund or and significant concentrations to sectors, risk covered fund activity or investment that may sponsor any covered fund and map each unit factors, or counterparties; indicate potential violations of section 13 of to the division, business line, or other iv. Establish responsibility for compliance the BHC Act or this part. The internal organizational structure that will be with the reporting and recordkeeping controls must, at a minimum require: responsible for managing and overseeing that requirements of subpart B of this part and i. Monitoring and limiting the banking § 75.20; and unit’s activities and investments. entity’s individual and aggregate investments v. Establish policies for monitoring and 3. Explanation of compliance. The banking in covered funds; prohibiting potential or actual material entity’s compliance program must explain ii. Monitoring the amount and timing of conflicts of interest between the banking how: seed capital investments for compliance with entity and its clients, customers, or i. The banking entity monitors for and the limitations under subpart C of this part counterparties. prohibits potential or actual material (including but not limited to the redemption, 7. Remediation of violations. The banking conflicts of interest between the banking sale or disposition requirements of § 75.12), entity’s compliance program must be entity and its clients, customers, or and the effectiveness of efforts to seek reasonably designed and established to counterparties related to its covered fund unaffiliated investors to ensure compliance effectively monitor and identify for further activities and investments; with those limits; analysis any trading activity that may ii. The banking entity monitors for and iii. Calculating the individual and indicate potential violations of section 13 of prohibits potential or actual transactions or aggregate levels of ownership interests in one the BHC Act and this part and to prevent activities that may threaten the safety and or more covered fund required by § 75.12; actual violations of section 13 of the BHC Act soundness of the banking entity related to its iv. Attributing the appropriate instruments and this part. The compliance program must covered fund activities and investments; and to the individual and aggregate ownership describe procedures for identifying and iii. The banking entity monitors for and interest calculations above; remedying violations of section 13 of the prohibits potential or actual material v. Making disclosures to prospective and BHC Act and this part, and must include, at exposure to high-risk assets or high-risk actual investors in any covered fund a minimum, a requirement to promptly trading strategies presented by its covered organized and offered or sponsored by the document, address and remedy any violation fund activities and investments, taking into banking entity, as provided under of section 13 of the BHC Act or this part, and account potential or actual exposure to: § 75.11(a)(8); document all proposed and actual A. Assets whose values cannot be vi. Monitoring for and preventing any remediation efforts. The compliance program externally priced or, where valuation is relationship or transaction between the must include specific written policies and reliant on pricing models, whose model banking entity and a covered fund that is procedures that are reasonably designed to inputs cannot be externally validated; prohibited under § 75.14, including where assess the extent to which any activity B. Assets whose changes in values cannot the banking entity has been designated as the indicates that modification to the banking be adequately mitigated by effective hedging; sponsor, investment manager, investment entity’s compliance program is warranted C. New products with rapid growth, adviser, or commodity trading advisor to a and to ensure that appropriate modifications including those that do not have a market covered fund by another banking entity; and are implemented. The written policies and history; vii. Appropriate management review and procedures must provide for prompt D. Assets or strategies that include supervision across legal entities of the notification to appropriate management, significant embedded leverage; banking entity to ensure that services and including senior management and the board E. Assets or strategies that have products provided by all affiliated entities of directors, of any material weakness or demonstrated significant historical volatility; comply with the limitation on services and significant deficiencies in the design or F. Assets or strategies for which the products contained in § 75.14. implementation of the compliance program application of capital and liquidity standards 6. Remediation of violations. The banking of the banking entity. would not adequately account for the risk; entity’s compliance program must be b. Covered Fund Activities or Investments and reasonably designed and established to A banking entity must establish, maintain G. Assets or strategies that expose the effectively monitor and identify for further and enforce a compliance program that banking entity to large and significant analysis any covered fund activity or includes written policies and procedures that concentrations with respect to sectors, risk investment that may indicate potential are appropriate for the types, size, factors, or counterparties; violations of section 13 of the BHC Act or complexity and risks of the covered fund and 4. Description and documentation of this part and to prevent actual violations of related activities conducted and investments covered fund activities and investments. For section 13 of the BHC Act and this part. The made, by the banking entity. each organizational unit engaged in covered banking entity’s compliance program must 1. Identification of covered funds. The fund activities and investments, the banking describe procedures for identifying and banking entity’s compliance program must entity’s compliance program must document: remedying violations of section 13 of the

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BHC Act and this part, and must include, at engaged in underwriting or market making- provided for the entire U.S. operations of the a minimum, a requirement to promptly related activities under § 75.4 or risk- foreign banking entity by the senior document, address and remedy any violation mitigating hedging activities under § 75.5 so management officer of the United States of section 13 of the BHC Act or this part, that such compensation arrangements are operations of the foreign banking entity who including § 75.21, and document all designed not to reward or incentivize is located in the United States. proposed and actual remediation efforts. The prohibited proprietary trading and compliance program must include specific appropriately balance risk and financial IV. Independent Testing written policies and procedures that are results in a manner that does not encourage a. Independent testing must occur with a reasonably designed to assess the extent to employees to expose the banking entity to frequency appropriate to the size, scope, and which any activity or investment indicates excessive or imprudent risk. risk profile of the banking entity’s trading that modification to the banking entity’s 3. Business line managers. Managers with and covered fund activities or investments, compliance program is warranted and to responsibility for one or more trading desks which shall be at least annually. This ensure that appropriate modifications are of the banking entity are accountable for the independent testing must include an implemented. The written policies and effective implementation and enforcement of evaluation of: procedures must provide for prompt the compliance program with respect to the 1. The overall adequacy and effectiveness notification to appropriate management, applicable trading desk(s). of the banking entity’s compliance program, including senior management and the board 4. Board of directors, or similar corporate including an analysis of the extent to which of directors, of any material weakness or body, and senior management. The board of the program contains all the required significant deficiencies in the design or directors, or similar corporate body, and elements of this appendix; implementation of the compliance program senior management are responsible for 2. The effectiveness of the banking entity’s of the banking entity. setting and communicating an appropriate internal controls, including an analysis and III. Responsibility and Accountability for the culture of compliance with section 13 of the documentation of instances in which such Compliance Program BHC Act and this part and ensuring that internal controls have been breached, and appropriate policies regarding the how such breaches were addressed and a. A banking entity must establish, management of trading activities and covered maintain, and enforce a governance and resolved; and fund activities or investments are adopted to 3. The effectiveness of the banking entity’s management framework to manage its comply with section 13 of the BHC Act and business and employees with a view to management procedures. this part. The board of directors or similar b. A banking entity must ensure that preventing violations of section 13 of the corporate body (such as a designated BHC Act and this part. A banking entity must independent testing regarding the committee of the board or an equivalent have an appropriate management framework effectiveness of the banking entity’s governance body) must ensure that senior reasonably designed to ensure that: compliance program is conducted by a management is fully capable, qualified, and Appropriate personnel are responsible and qualified independent party, such as the properly motivated to manage compliance accountable for the effective implementation banking entity’s internal audit department, with this part in light of the organization’s and enforcement of the compliance program; compliance personnel or risk managers business activities and the expectations of a clear reporting line with a chain of independent of the organizational unit being the board of directors. The board of directors responsibility is delineated; and the tested, outside auditors, consultants, or other or similar corporate body must also ensure compliance program is reviewed periodically qualified independent parties. A banking that senior management has established by senior management. The board of entity must promptly take appropriate action appropriate incentives and adequate directors (or equivalent governance body) to remedy any significant deficiencies or resources to support compliance with this and senior management should have the material weaknesses in its compliance part, including the implementation of a appropriate authority and access to personnel program and to terminate any violations of compliance program meeting the and information within the organizations as section 13 of the BHC Act or this part. well as appropriate resources to conduct requirements of this appendix into their oversight activities effectively. management goals and compensation V. Training structures across the banking entity. 1. Corporate governance. The banking Banking entities must provide adequate 5. Senior management. Senior management entity must adopt a written compliance training to personnel and managers of the is responsible for implementing and program approved by the board of directors, banking entity engaged in activities or enforcing the approved compliance program. an appropriate committee of the board, or investments governed by section 13 of the Senior management must also ensure that equivalent governance body, and senior BHC Act or this part, as well as other effective corrective action is taken when management. appropriate supervisory, risk, independent failures in compliance with section 13 of the 2. Management procedures. The banking testing, and audit personnel, in order to BHC Act and this part are identified. Senior entity must establish, maintain, and enforce effectively implement and enforce the management and control personnel charged a governance framework that is reasonably compliance program. This training should with overseeing compliance with section 13 designed to achieve compliance with section occur with a frequency appropriate to the of the BHC Act and this part should review 13 of the BHC Act and this part, which, at size and the risk profile of the banking the compliance program for the banking a minimum, provides for: entity’s trading activities and covered fund entity periodically and report to the board, or i. The designation of appropriate senior activities or investments. management or committee of senior an appropriate committee thereof, on the management with authority to carry out the effectiveness of the compliance program and VI. Recordkeeping management responsibilities of the banking compliance matters with a frequency Banking entities must create and retain entity for each trading desk and for each appropriate to the size, scope, and risk records sufficient to demonstrate compliance organizational unit engaged in covered fund profile of the banking entity’s trading and support the operations and effectiveness activities; activities and covered fund activities or of the compliance program. A banking entity ii. Written procedures addressing the investments, which shall be at least annually. must retain these records for a period that is management of the activities of the banking 6. CEO attestation. Based on a review by no less than 5 years or such longer period as entity that are reasonably designed to achieve the CEO of the banking entity, the CEO of the required by the Commission in a form that compliance with section 13 of the BHC Act banking entity must, annually, attest in allows it to promptly produce such records and this part, including: writing to the Commission that the banking to the Commission on request. A. A description of the management entity has in place processes to establish, system, including the titles, qualifications, maintain, enforce, review, test and modify Issued in Washington, DC, on December and locations of managers and the specific the compliance program established under 30, 2013, by the Commission. responsibilities of each person with respect this appendix and § 75.20 in a manner Melissa D. Jurgens, to the banking entity’s activities governed by reasonably designed to achieve compliance Secretary of the Commission. section 13 of the BHC Act and this part; and with section 13 of the BHC Act and this part. B. Procedures for determining In the case of a U.S. branch or agency of a Note: The following appendices will not compensation arrangements for traders foreign banking entity, the attestation may be appear in the Code of Federal Regulations.

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Appendices to Prohibitions and CFTC’s ability to oversee swap dealers and A majority of the swaps market is now Restrictions on Proprietary Trading FCMs. being centrally cleared—lowering risk and and Certain Interests in, and Banking entities’ customers and bringing access to anyone wishing to Relationships With, Hedge Funds and counterparties will continue to be provided compete. liquidity through the banking entities’ Ninety-one swap dealers have registered Private Equity Funds—Commission permitted market making. The banking and—for the first time—are being overseen Voting Summary and Statements of entities are permitted to do so as long as each for their swaps activity. Commissioners trading desk’s market-maker inventory is I couldn’t be more proud of this dedicated Appendix 1—Commission Voting designed not to exceed, on an ongoing basis, group of public servants. the reasonably expected near-term demands I am honored to have served along with Summary of clients, customers or counterparties. The them during such a remarkable time in the On this matter, Chairman Gensler and banking entities will be required to maintain history of this agency. an ongoing compliance program and follow Commissioners Chilton and Wetjen voted in Appendix 3—Statement of the affirmative. Commissioner O’Malia voted the rule’s limits on market-maker inventory in the negative. and financial exposure. For instance, banking Commissioner Bart Chilton entities would not be able to stockpile or High Roller’s Room Appendix 2—Statement of Chairman accumulate positions over time that do not Gary Gensler meet expected near-term customer demand. I’m pleased to be voting on a final Volcker The final Volcker Rule also permits Rule. Frankly, two-and-a-half weeks ago, I I support the final ‘‘Volcker Rule’’ before hedging to reduce identified, specific risks had grave doubts about getting this done in the Commission today. It achieves the from the banking entity’s individual or a meaningful fashion. It had become weaker important balance, as directed by Congress, aggregated positions. Permitted hedging than the original proposal. But, thankfully, of prohibiting banking entities from activity will be required to (1) be designed to and I thank the Chairman for his tireless proprietary trading while at the same time and (2) demonstrably reduce or otherwise efforts, we have a rigorous and robust rule allowing banking entities to engage in significantly mitigate one or more specific, before us. permitted activities, including market identifiable risks. The final rule’s preamble If you’ve ever been to a casino, many of making and risk mitigating hedging. further states that this activity is not intended them have a high roller’s room. There’s Further, as directed by the Dodd-Frank to be hedging of generalized risks based on usually a sign about a $1000 minimum bet. Wall Street Reform and Consumer Protection non-position specific modeling or other Many have ornate gaming tables and heavy Act (Dodd-Frank Act), the final rule strikes considerations. Hedging of the general assets draperies. If you walk around, you can catch an appropriate balance regarding banking and liabilities of the banking entity or a guess a glimpse inside. But other than betting a lot entities investment in hedge funds and as to the direction of the economy will no of money, I’m not sure what goes on in there. private equity funds. As Congress directed— longer be permitted. And, that’s fine . . . some high rollers lose other than for de minimis investments— Hedging strategies and positions are and some win. banking entities are prohibited from subject to analysis, including required But, what if what the high rollers did in sponsoring, owning, and having certain correlation analysis, as well as an ongoing that room impacted all of us? What if it relationships with hedge funds or private recalibration requirement to ensure it is not impacted consumers, our economy and our equity funds. The final rule focuses the prohibited proprietary trading. country? What if what the high rollers did in prohibition on entities formed for investing The Commission also has the legal that room cost us $417 billion dollars (in a or trading in securities or derivatives and that authority to enforce the Volcker Rule. If the big bank bailout) because the games they are typically offered to institutional investors Commission believes there is a violation, were playing were tanking the economy? and high-net-worth individuals. The final Dodd-Frank Section 619 and the final rule That’s why we need a strong Volcker Rule. definition was tailored to exclude entities state that it can, after providing an We should never again be put in a that are offered more broadly to retail opportunity to respond, order the registrant circumstance where too big to fail high investors or have a more general corporate to stop that activity. The Commission also rollers play games of chance with our nation. purpose, such as loan securitizations. can use existing authority to discipline This rule takes a heavy velvet rope with brass The Commodity Futures Trading registrants, including FCMs, swap dealers, ends across the doorway and closes the high Commission (CFTC) consulted and and others. The CEA and Commission rules roller’s room. (Maybe they’ll put in more coordinated with the Federal Reserve, the provide that we may restrict, suspend or Blazing 7s or Wheel of Fortunes.) Federal Deposit Insurance Corporation, the revoke a registration for good cause. The dilemma in drafting the final rule has Comptroller of the Currency and the Depending on the facts and circumstances, been that there are certain permitted forms of Securities and Exchange Commission in violation of Dodd-Frank Section 619 may rise trading that have been difficult to define. developing this rule. Based on this to that level. Fortunately, the language has been solidified collaboration, the CFTC’s final rule mirrors The talented CFTC staff working along tightly to avoid loopholes. the language being adopted by the other with my fellow Commissioners—Mike Dunn, First, the key parts of the law, and what I financial regulators. Jill Sommers, Bart Chilton, Scott O’Malia and have focused on for a very long time, are the The CFTC authority to implement the Mark Wetjen—really have delivered for the words surrounding hedging. Proprietary Volcker Rule is for the banking entities for American public. hedging is allowed under the law, but which we are the primary financial With this action, the staff of this small but speculative trading—risky gambles for the regulatory agency. As of today, the CFTC remarkably effective agency will have house—are exactly what Volcker sought to estimates that our authority primarily applies completed 68 rulemakings, orders and end. This rule does that by requiring hedges to approximately 110 registered swap dealers guidances. Though lacking adequate be designed to mitigate and reduce actual and futures commission merchants (FCMs) resources, the CFTC staff has diligently risk, and not just by an accidental or that would each individually be banking sorted through nearly 60,000 public comment collateral effect of the trade. We also have entities under the Volcker Rule. Grouped by letters. They have met with members of the better correlation language in the rule, corporate affiliation these represent about 45 public more than 2,200 times to discuss correlation that shows that the hedging different business enterprises. reform. ‘‘activity demonstrably reduces or otherwise As a foundation, the final Volcker Rule These common-sense reforms have been significantly mitigates the specific, requires banking entities to have a robust truly transformative. identifiable risk(s) being hedged.’’ This is compliance program, including defined Bright lights of transparency now are key—the risk has to be specific and limits on market making, underwriting and shining on the $380 trillion swaps market. identifiable. You can’t just say, ‘‘Ah, oh, that? hedging activities as well as continuous The public can see the price and volume of Hmm, it was a hedge.’’ Nope, we aren’t going monitoring and management of such every transaction, like a modern-day to let ya play that game. The position needs activities. It also requires reporting to tickertape. Transparent, regulated trading to be correlated with the risk. regulators on specific metrics and trading platforms are trading a quarter of a trillion Furthermore, there is now an ongoing details. This transparency will enhance the dollars in swaps each day. requirement to recalibrate the position, the

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hedge, in order to ensure that the position procedures that afford due process to market deliberative body, to engage in reasoned remains a hedge and does not become participants. decision-making. speculative. When people say this version of Former Supreme Court Justice Louis D. Congress established the CFTC as an the Volcker Rule will stop circumstances like Brandeis, who earlier in his career was independent agency led by a Commission— the London Whale, this ongoing recalibration instrumental in establishing the Federal not a director—to act as steward to the provision is exactly what will help avoid Reserve System, stated: ‘‘If we desire respect futures and swaps markets. In doing so, similar debacles. for the law, we must first make the law Congress entrusted each of the Second, the same goes for market making. respectable.’’ But respect—and integrity of Commissioners to independently use his or Yes, market making is allowed, but only for process—is what has been most lacking in her experience and expertise to carefully the benefit of the banks’ customers—for their the Commission’s approach to rulemaking. review and deliberate upon all Commission customers and not solely in order to collect I believe the Commission must get back to action, including rulemaking. Final rules market maker fees provided by the exchange the basics of good government and proper should reflect the input and collective or for any proprietary speculative reason. rulemaking. I cannot vote for a final rule that opinion of the Commission as a whole, but Full stop. is hardly the product of meaningful today’s vote falls far short of that Third, on portfolio hedging: One of the consideration by the full Commission, but fundamental standard. changes that has been made is that we have instead was negotiated exclusively by the It is imperative that the Commission defined what a portfolio is NOT—it can’t be Chairman. In addition, I cannot vote for a respect the letter and spirit of the law and some amorphous set of excuses for doing a final rule where the Commission has not adhere faithfully to APA requirements in our trade. You can’t call deuces and one-eyed devoted enough attention to providing implementation of this new statutory jacks wild after the hand has been dealt. You sufficient clarity and due process in the authority granted by Congress under the BHC can’t do an after-the-fact extract of a set of enforcement of new and untested regulatory Act. Unfortunately, the Commission’s trades as a rationale for a hedge. authority, but still imposes significant rulemaking over the past three years has been Fourth, I’ve spoken many times about obligations upon market participants at an aptly referred to as ‘‘regulation by fiat.’’ 5 We perverse bonus structures that reward the unknown—but surely considerable—cost. cannot continue down this path of reflexive, macho macho men traders. The idea, and it knee-jerk regulation that fails to provide Abuse of Process is contained in actual rule text language, is clarity and certainty to market participants. that big bonuses and rewards in banking Throughout the Commission’s rulemakings The Commission must get back to the basics should not be tied to flyer bets. Our first under the Dodd-Frank Act, I have urged the and return to a thoughtful, measured proposal was fairly poorly drafted on this. It Commission to act faithfully in accordance approach to regulating our markets in an didn’t differentiate between prohibited with the applicable statutory authorities and open and transparent manner. proprietary trading and permitted proprietary the Administrative Procedure Act (‘‘APA’’).3 trading very well. My view of the language However, in the implementation of one of the Jurisdiction and Enforcement Authority that compensation should be ‘‘designed’’ not most important mandates issued by Congress I also believe that the basics of any to reward or incentivize prohibited trading is in response to the financial crisis, the rulemaking are jurisdiction and enforcement. that this is a sufficiently narrow test. One of Commission seems to have forgotten the However, the final rule fails to provide clear the ways we will determine if something is basics of agency rulemaking. I am deeply and consistent procedures for both (1) the designed in this way is how, in fact, traders troubled by the egregious abuse of process in Commission’s new enforcement authority are paid. So we will look after-the-fact at the this rulemaking. Without a doubt, it far under § 13 of the BHC Act and (2) due payouts. surpasses all other previous transgressions to process for market participants. Finally, the Volcker Rule won’t be date. As a threshold matter, the Volcker Rule implemented until July of 2015. That’s ages The first opportunity each Commissioner may give us concurrent, and potentially in these morphing markets where new games had to review a partial draft of the nearly overlapping, jurisdiction as the ‘‘primary seem to be played all the time. I guarantee 1,000-page final rule came only three weeks financial regulatory agency’’ 6 of a there will be efforts to find loopholes, figure prior to today’s vote. Further, because the Commission registrant or registered entity, so out ways around what has been written. Commission was operating in an information long as there is some type of corporate That’s the way of the world. So, my final vacuum, the fact that the Commissioners relationship with a banking entity. It is thought is that this rule must not be static. were not reviewing the working interagency essential that the Commission continue to Regulators need to continue to monitor what draft—but instead had the ‘‘CFTC-preferred’’ work with the other responsible agencies on is taking place. We need our regulatory eyes version of the rule—only came to light a few implementation to further outline the scope in the sky, but also to look around the corner days later.4 The Commission did not receive of each agency’s jurisdiction, maximize for what’s coming next, and be nimble and a near-final draft of the rule (with language regulatory efficiency, and provide quick, to ensure that what we do today holds agreed to by all five agencies) until just six consistency for market participants, with a up and that the high roller’s room isn’t re- days prior to the vote, despite repeated minimum of duplicative and costly opened. requests by Commissioners for a version of requirements and wasted resources.7 The While this may be the end of part of the the draft then in circulation amongst the Commission must also be mindful of foreign rulemaking process, it is, and must be, the responsible agencies. This six-day draft was beginning of a process, that continues. not even accompanied by the courtesy of a 5 See SIFMA, ISDA & IIB v. CFTC, No. 13–CV– Thank you. summary or term sheet in order to aid the 1916 (D.D.C.). Appendix 4—Dissenting Statement of Commission in digesting, at the last minute, 6 Dodd-Frank Act § 2(12). this incredibly complex and dense final rule. 7 Senators Carl Levin and Jeff Merkley, co-authors Commissioner Scott D. O’Malia I am disappointed that today’s vote on the of § 619 of the Dodd-Frank Act, emphasized the I respectfully dissent from today’s final rule is besmirched by the purposeful importance of enforcement to the success of the Commission vote on the final rule circumvention of measured review by each Volcker Rule by urging the five responsible agencies to ‘‘provide coordinated and consistent 1 Commissioner’s office. It is simply not implementing § 619 of the Dodd-Frank Act, enforcement, including data sharing by regulators’’ commonly known as the ‘‘Volcker Rule.’’ I possible to carefully weigh a final rule— in their implementation of a final rule. Letter from cannot support a rulemaking that particularly one with as much detail and Hon. Jeff Merkley, Member, United States Senate, undermines the regulatory process, nor consequence as the Volcker Rule—in the and Hon. Carl Levin, Member, United States Senate, clearly delineates the Commission’s new briefest of timeframes. Accordingly, I am to Hon. Ben Bernanke, Chairman, Board of jurisdiction and enforcement authority under concerned that the lack of meaningful Governors of the Federal Reserve System, Hon. § 13 of the Bank Holding Company Act of participation by the full Commission in the Thomas Curry, Comptroller of the Currency, 1956 (‘‘BHC Act’’) 2 and fails to include rulemaking process has therefore seriously Department of the Treasury, Hon. Gary Gensler, impaired the ability of the Commission, as a Chairman, Commodity Futures Trading Commission, Hon. Martin Gruenberg, Acting 1 Dodd-Frank Wall Street Reform and Consumer Chairman, Federal Deposit Insurance Commission, Protection Act, Public Law 111–203, 124 Stat. 1376 3 5 U.S.C. 500 et seq. and Hon. Mary Shapiro, Chairman, Securities and (2010). 4 Gina Chon, ‘‘CFTC Goes Its Own Way Over Exchange Commission (Apr. 26, 2012) (on file with 2 12 U.S.C. 1851. Volcker Rule,’’ Fin. Times, November 23, 2013. the Commission).

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regulators and seek harmonization in the First, although the statutory text of and major swap participants, but does not extraterritorial application of our § 13(e)(2) suggests that the Commission may, explicitly address revocation of registration. jurisdiction, in accordance with principles of essentially, issue a cease and desist order to Section 8a of the CEA 14 explicitly applies to international comity. a banking entity engaging in violative the registration of an exclusive list of I am concerned that the Commission has activity, the Commission has not Commission registrants (intermediaries), but not devoted enough attention to delineating promulgated any provisions in the final rule does not include swap dealers. Section 8a of our enforcement authority and procedures that would define and delineate such an the CEA authorizes the Commission to under the Volcker Rule, including the order. revoke registration, but only in certain implications of not promulgating the final The issue of enforcement action is not a circumstances as described in, for example, rule under the Commodity Exchange Act problem for the banking agencies, who have (‘‘CEA’’).8 This is important because the final broad supervisory powers over the safety and §§ 8a(2)(A)–(H), 8a(3), and 8a(4). rule is only being promulgated under the soundness of banking entities, and Although some of those provisions may BHC Act. Consequently, the Commission is considerable enforcement powers under § 8 permit the revocation of registration of a limited to only the enforcement measures of the BHC Act, or §§ 8 or 39 of the Federal swap dealer, it is secondary to, for example, provided for by § 13(e)(2) of the BHC Act. By Deposit Insurance Act 11 (as described in the either a finding by a court of law or another not also promulgating the final rule under the preamble to the final rule). Those powers are Federal or State agency that a violation of the CEA, the Commission cannot use its full conferred to the banking agencies as CEA occurred,15 or that the principal of a suite of enforcement tools under the CEA to prudential regulators. The Commission, swap dealer was statutorily disqualified from ensure compliance with the Volcker Rule. however, is not a prudential regulator of its registration,16 or that the swap dealer If the Commission wanted to use its registrants or registered entities and does not willfully aided or abetted in the violation of enforcement powers under the CEA, the final have the same powers as the banking the CEA by another person, or failed to rule must be promulgated under the CEA and agencies. supervise a person that violated the CEA.17 undergo cost-benefit consideration pursuant Second, I have serious concerns that by not Because these powers over registration only to § 15(a) of the CEA.9 But, by choosing to including specific procedures in the final apply where there has been a violation of the forgo any cost-benefit analysis and rule for an enforcement action taken by the CEA, I do not see how they can be applied Commission pursuant to § 13(e)(2), the promulgate the Volcker Rule solely under the to a violation of § 13 of the BHC Act. BHC Act, the Commission has thus limited Commission is not affording due process to 18 any party that might be the subject of a future Commission regulation § 3.60 provides its enforcement powers. procedures for revocation of registration, but To illustrate this point, it is critical to enforcement action. The statutory text in only pursuant to §§ 8a(2), 8a(3), and 8a(4), emphasize that the Commission’s authority § 13(e)(2) explicitly states that ‘‘due notice which do not directly apply to swap dealers under the Volcker Rule is not derived from and opportunity for hearing’’ must be the CEA, which established the CFTC and its provided. But, the final rule does not contain as just discussed. jurisdiction over the futures and swaps any procedures for notice or hearing, and in I am concerned that, because there does market. Section 619 of the Dodd-Frank Act fact does not even mention that statutory not appear to be any Commission regulation amends the BHC Act, which is administered requirement. that permits the revocation of registration for by the Federal Reserve Board. The Volcker Third, I am also concerned that the a swap dealer, and because § 75.21 of the Rule is codified as § 13 of the BHC Act and Commission may nevertheless try to read its final rule does not include any procedures confers limited enforcement authority to the enforcement powers under the CEA into its for an enforcement action taken by the Commission under § 13(e)(2) to order an limited enforcement authority under the BHC Commission pursuant to § 13(e)(2) of the affected party to ‘‘terminate the [violative] Act. The final rule, in new § 75.21(b), states BHC Act, the Commission would not able to activity’’ and ‘‘dispose of the investment.’’ 10 that ‘‘the Commission may take any action effectively enforce the Volcker Rule. Further, permitted by law to enforce compliance with the Commission’s enforcement powers under section 13 of the BHC Act and this part, 8 the CEA are not available to enforce the 7 U.S.C. 1 et seq. including directing the banking entity to 9 Volcker Rule because the final rule was not 7 U.S.C. 19(a). restrict, limit, or terminate any or all 10 promulgated under the CEA. I also reiterate Section 619 of the Dodd-Frank Act, paragraph activities under this part and dispose of any (e)(2), which is entitled Anti-evasion—Termination that I am deeply troubled by the omission of of Activities or Investment, provides that investment.’’ That provision, without being promulgated procedures to afford due process to market ‘‘Notwithstanding any other provision of law, participants. whenever an appropriate Federal banking agency, under the CEA and undergoing cost-benefit the Securities and Exchange Commission, or the consideration, cannot permit the use of Conclusion Commodity Futures Trading Commission, as enforcement powers provided for in the CEA. appropriate, has reasonable cause to believe that a The enforcement powers the Commission has As the Commission moves towards banking entity or nonbank financial company under the CEA explicitly only apply to finalizing the last of the rules mandated by supervised by the Board under the respective violations of ‘‘this Act’’ (the CEA), including the Dodd-Frank Act, I believe it’s about time agency’s jurisdiction has made an investment or ‘‘any rule, regulation, or order of the that it got back to the basics of good engaged in an activity in a manner that functions Commission promulgated in accordance with government and proper rulemaking. The final as an evasion of the requirements of this section 12 (including through an abuse of any permitted . . . this Act’’ (emphasis added). rule does neither because of the abuse of activity) or otherwise violates the restrictions under Although it would be possible for the process in its rulemaking and the lack of due this section, the appropriate Federal banking Commission to exercise its power over process and clarity in its enforcement agency, the Securities and Exchange Commission, registration of a Commission registrant or procedures. Because of these fundamental or the Commodity Futures Trading Commission, as registered entity as a matter of right, it is flaws in the final rule, I cannot support it. appropriate, shall order, after due notice and unclear to me whether the Commission has opportunity for hearing, the banking entity or actually promulgated rules that permit the [FR Doc. 2013–31476 Filed 1–30–14; 8:45 am] nonbank financial company supervised by the revocation of registration for a swap dealer. BILLING CODE 6351–01–P Board to terminate the activity and, as relevant, Section 4s of the CEA 13 governs the dispose of the investment. Nothing in this registration and regulation of swap dealers 14 7 U.S.C. 12a. paragraph shall be construed to limit the inherent authority of any Federal agency or State regulatory 15 7 U.S.C. 8a(2)(E). authority to further restrict any investments or 11 See, e.g., 12 U.S.C. 1818(i). 16 7 U.S.C. 8a(2)(H). activities under otherwise applicable provisions of 12 7 U.S.C. 9(c)(4)(A). 17 7 U.S.C. 8a(3). 13 law.’’ 7 U.S.C. 6s. 18 17 CFR 3.60.

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